Tyler Technologies, Inc.

Hello and welcome to today's Tyler Technologies third quarter 2022 conference call. Your host for today's call is Lynn Moore, President and CEO of Tyler Technologies. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session and instructions will follow at that time. As a reminder, this conference is being recorded today, October 27, 2022. I would like to turn the call over to Mr. Moore. Please go ahead.

Thank you, Cheryl, and welcome to our call. With me today is Brian Miller, our Chief Financial Officer. First, I'd like for Brian to give the safe harbor statement. Next, I'll have some comments on our quarter, and then Brian will review the details of our results. I'll then end with some additional comments, and then we'll take questions.

Brian? Thanks, Lynn. During the course of this conference call, management may make statements that provide information other than historical information and may include projections concerning the company's future prospects, revenues, expenses, and profits. Such statements are considered forward-looking statements under the safe harbor provision of the Private Securities Litigation Reform Act of 1995 and are subject to certain risks and uncertainties which could cause actual results to differ materially from these projections. We would refer you to our Form 10-K and other SEC filings for more information on those risks. Please note that all growth comparisons we make on the call today will relate to the corresponding period of last year, unless we specify otherwise. Lynn?

Thanks, Brian. Our third quarter results were highlighted by strong execution that drove solid organic revenue growth and higher earnings, while also advancing our cloud-first strategy. Total revenues grew approximately 3%, with organic growth excluding COVID-related revenues of approximately 9%. Recurring revenues comprised 78.5% of our quarterly revenues. On an organic basis, excluding COVID-related revenues, subscription revenue grew 14.5%, reflecting both our accelerating shift to the cloud and growth in transaction-based revenues. We achieved solid revenue growth even as the shift in new software contracts mix continued to accelerate to SAS from licenses. In Q3, 91% of our new software contract value was SAS, compared to 74% in Q3 last year. Our largest new software contract for the quarter was with the US Department of State for our case management development platform, formerly known as IntelliTRAC. This five-year SAS arrangement is valued at over $54 million and includes over $5 million of ARR in the first year, ramping to over $8.5 million of ARR in the fifth year. However, due to certain contract terms, only approximately $8 million of the value of this contract is included in backlog and bookings for the third quarter. The second largest deal of the quarter was a five-year SAS deal for our enterprise supervision solution with the Arizona Office of the Courts, valued at over $15 million. This arrangement includes two five-year optional renewals and, with add-on components, has the potential to grow to more than $82 million over 15 years. We also signed a notable statewide SAS deal for our enterprise supervision solution with the State of Oregon Judicial Department, valued at approximately $3.5 million. These contracts are great examples of our ability to make a strategic tuck-in acquisition and grow the acquired product by leveraging our client base and sales channel. When we acquired Caseload Pro, which is now our enterprise supervision product, four years ago, its annual revenues were approximately $2.7 million. This quarter alone, our new sales of enterprise supervision added almost $4 million of ARR. In other title divisions, we signed five additional significant SAS deals, each for different product suites, and each with a total contract value greater than $2 million. Those include Pierce County, Washington for our enterprise assessment and tax solution, the city of Abilene, Texas, the Racine Unified School District in Wisconsin, and Alachua County, Florida for our enterprise ERP solution, the Toronto Region Conservation Authority in Ontario, for our enterprise permitting and licensing solution. In addition, we signed 12 SAS deals in the quarter with contract values between $1 and $2 million each. We also signed three notable license deals in the quarter for our enterprise public safety, enforcement mobile, and data and insight solutions with Hidalgo County, Texas, which was funded by ARPA, the Combined Regional Communications Authority in Colorado, and the City of Melbourne, Florida. Also during the third quarter, we successfully renewed our NIC enterprise contract in Alabama and won a competitive rebid for our enterprise contract in Maine. Subsequent to the end of the quarter, in October, we renewed our NIC enterprise contract in Oklahoma, and our contract in Pennsylvania is expected to expire in the fourth quarter. We also converted our state of Iowa data and insights agreement from a third-party reseller to the NIC master contract. In addition, NIC signed a new four-year SAS agreement for our medical cannabis regulation solution with the Arkansas Department of Health Medical Cannabis Licensing with ARR of approximately $450,000. Before I turn the call over to Brian, I'd like to comment on the Rapid Financial Solutions acquisition we announced this morning. We're extremely excited to partner with the innovative team at Rapid who will join our payments group Rapid is a leader in the payment solutions market with 20 years experience and expands our capabilities with best-in-class digital disbursements. We will now be able to offer our public sector clients a reliable, scalable, and secure platform for disbursing payments. Rapid has more than 1,500 customers concentrated in courts and correction facilities, which includes managing disbursements for VendEngine, which we acquired in September of last year. Combined with our approximately 7,200 clients in the payment space, we believe this is a significant opportunity to leverage the full suite of market-leading payment solutions to make customer interaction stronger and more secure. Now I'd like for Brian to provide more detail on the results of the quarter and our annual guidance for 2022.

Thanks, Lynn. Yesterday, Tyler Technologies reported its results for the third quarter ended September 30th, 2022. In our earnings release, we have included non-GAAP measures that we believe facilitate understanding of our results and comparisons with peers in the software industry. A reconciliation of GAAP to non-GAAP measures is provided in our earnings release. We have also posted on the investor relations section of our website under the financials tab schedules with supplemental information provided on this call, including information about quarterly bookings, backlog, and recurring revenues. Both gap and non-gap revenues for the quarter were $473.2 million, up 2.9% and 2.7%, respectively. Organic revenue growth, excluding COVID-related revenues, was strong at 9% on a gap basis and 8.8% on a non-gap basis. NIC's COVID-related revenues for the quarter were $11.7 million, compared to $43.3 million in last year's third quarter. Revenue from the Tour Health Initiative ended in the second quarter, and the Virginia Rent Relief Program has now officially ended, with less than $2 million of remaining revenues anticipated in the fourth quarter. License revenue declined 10.6% as our new software contract mix has shifted to SAS even more rapidly than planned at the beginning of the year. Professional services revenues rose 15.7% and 6.3% organically. We intend to continue to grow our implementation team during the fourth quarter to support delivery of our growing backlog and pipeline, but we'll likely continue to see some pressure on professional services revenue in the near term as those teams ramp up to become fully billable. Subscriptions revenue was just slightly above Q3 of last year due to the expected $37 million decline in COVID-related subscription revenue, but organically rose 14.5%. We added 153 new subscription-based arrangements and converted 70 existing on-premises clients, representing a total of approximately $149 million in contract value. In Q3 of last year, we added 144 new subscription-based arrangements and had 67 on-premises conversions, representing a total of approximately $84 million in contract value. Our software subscription bookings in the third quarter added $28.1 million in new ARR. Subscription contract value comprised a new high of approximately 91% of total new software contract value signed this quarter compared to 74% in Q3 of last year. The value-weighted average term of new SAS contracts this quarter was 3.8 years compared to 3.4 years last year. Transaction-based revenues, which include NIC portal, payment processing, and e-filing revenues, and are included in subscriptions, were $148.9 million, down 13%, but excluding COVID-related revenue grew 11.1%. E-filing revenue reached a new high of $19.7 million, up 13.3%. Our non-GAAP ARR was approximately $1.49 billion, which was flat with last year, but up 11.2%, excluding COVID-related revenues. Non-GAAP ARR for SAS software arrangements was $421.7 million, up 27.7%. Transaction-based ARR was $595.6 million, down 13%, but up 11.1%, excluding COVID-related revenues. Non-gap maintenance ARR was flat with Q3 last year at $469.4 million due to the continued migration of on-premises clients to the cloud. Our backlog at the end of the quarter was a new high of $1.88 billion, up 6.3%. Bookings in the quarter were approximately $499 million, down 17% on a difficult comparison to Q3 of last year for three main reasons. First, Q3 of last year included the state of Illinois fixed fee e-filing renewal of approximately $63 million. Second, COVID-related revenues and bookings were approximately $43 million in Q3 last year versus $11 million in the current quarter. And finally, most of the federal Department of State deal signed this quarter was not included in backlog or bookings. Normalizing for these items, bookings grew 7.7%. On an organic basis, bookings were approximately $364 million, down 17.9%, but grew 7.7% on a normalized basis. For the trailing 12 months, bookings were approximately $1.9 billion, up 18.1%, and on an organic basis were approximately $1.4 billion, up 2.1%. As a result of an increase in our estimated research tax credit, our annual GAAP and non-GAAP effective tax rates were positively affected. Our non-GAAP annual effective tax rate is now 22.5%, down from the 24% previously used, and the non-GAAP effective tax rate for the third quarter was 19.6% to adjust the year-to-date tax rate. This resulted in an 11-cent uplift to our third quarter non-GAAP EPS. For the full year, we expect this tax rate change to impact non-GAAP EPS by approximately 14 cents. Cash flows from operations were 129.4 million, down 37%, and free cash flow was 115.6 million, down 40%, mainly due to the timing of working capital items such as payroll accruals, remittance of portal fees, and taxes. And we expect to see positive impacts of these timing items in the fourth quarter. We continue to strengthen our already solid balance sheet. During the quarter, we repaid $190 million of our term debt, and since completing the NIC acquisition, we have paid down $665 million of term debt. We ended the quarter with total outstanding debt of $1.085 billion and cash and investments of $247.9 million. As a reminder, $600 million of our debt is in the form of convertible debt with a fixed interest rate of a quarter of a percent. The remaining $485 million is in prepayable term debt due in 2024 and 2026 with interest at floating rates based on LIBOR plus a margin of 125 or 150 basis points. So our exposure to floating rates is limited. We also have an undrawn $500 million revolver. Our net leverage at quarter end was approximately 1.79 times trailing 12-month pro forma EBITDA. Looking forward, we've adjusted the upper end of our full-year revenue guidance to reflect lower license revenue as a result of a higher SAS mix, as well as the timing of new license contracts in our public safety and federal divisions, along with ongoing pressures on professional services revenue. Adjusted for the change in our effective tax rate, the midpoint of our non-EPS guidance is unchanged. Our updated 2022 guidance is as follows. We expect both GAAP and non-GAAP total revenues will be between $1.837 billion and $1.857 billion. The midpoint of our guidance implies organic growth of approximately 8%. We expect total revenues will include approximately $49 billion of COVID-related revenues from NIC's tour health and pandemic rent relief services. Revenue from tour health ended in the second quarter, while revenue from the rent relief program is expected to end in the fourth quarter. We expect GAAP EPS will be between $3.89 and $4.05 and may vary significantly due to the impact of stock option activity on the GAAP effective tax rate. We expect non-GAAP diluted EPS will be between $7.51 and $7.65. Interest expense is expected to be approximately $28 million, including approximately $7 million of non-cash amortization of debt discounts and issuance costs. For the full year, the net impact of the change in our tax rate, offset by increases in estimated interest expense, resulted in a two-cent net reduction in non-GAAP EPS compared to our initial guidance. Other details of our guidance are included in our earnings release. Now I'd like to turn the call back over to Lynn for his comments.

Thanks, Brian. We're encouraged by continued strength in the public sector markets as reflected in stable or increasing RFP and demo activity across our business units and a strong competitive position that continues to drive high win rates. A key characteristic of the public sector market is its relative stability across economic cycles. given the ongoing need to upgrade and replace aging mission-critical systems with next-generation applications. Our deep domain expertise, combined with the breadth of our product offerings, underscores our unique ability to deliver scalable and innovative digital solutions to meet these mission-critical needs. Our industry-leading competitive position remains high, in part due to our integrated solutions and our ability to expand existing client relationships as we leverage our installed base the largest in the public sector market. Our cross-sell pipeline continues to grow, particularly as we begin to gain momentum with our NIC go-to-market strategy and leverage our strong sales organization and client relationships. Our pipeline of sell-through opportunities with NIC state enterprise relationships expanded approximately 16% in the third quarter, with emerging opportunities across multiple solutions, with many influenced by our enterprise data and insights offering. Additionally, we are seeing larger deal opportunities in the pipeline that require longer procurement cycles. Our cloud-first strategy is also tracking well as we continue to invest in optimizing products for more efficient cloud deployment and as higher cloud adoption is reflected in the mix of our new business pipeline. Our expectations of the SaaS mix for new business for this year and 2023 have increased since the beginning of the year. We've talked about the impact of our accelerated move to the cloud on our margins in 2022 and the expectation that we will see further margin contraction in 2023 before rebounding in 2024. In addition to impacting margins, the accelerated pace and the shift in new business mix towards SAS puts pressure on revenue growth as we now expect 2022 license revenue to decline more than previously expected. We expect that trend to continue into 2023 and we are pleased that our early planning for next year indicates that SAS adoption should increase even faster than previously expected, even in our public safety and federal divisions. As a result, we expect to see license revenue decline even more previously than anticipated, with the license decline in the 40% range. Also, a reminder that with NIC's COVID-related initiatives now finished, $49 million of 2022 revenues, of which 11 million were in subscriptions, and 38 million were in professional services will not be present in 2023. Despite current macroeconomic uncertainty, we continue to execute against our long-term growth strategy, capitalizing on the durability of our recurring revenue model and solid financial position. We have a proven and successful track record of strategic and opportunistic acquisitions that support our growth priorities, expand our product portfolio, and extend our TAM. As we have commented in the past, we have the benefit of reliable cash flow, enabling us to aggressively manage our debt profile and impact from rising interest rates. We expect to continue to de-lever and use excess cash to reduce debt, while still taking advantage of strategic acquisitions at reasonable valuations, such as RAPID, which further enhances our ability to address the significant public sector payments TAM. Our business is resilient. And while we are not immune to the effects of inflation, the long-term capital investment decisions we've made in strengthening our products and shifting to a cloud-first approach are foundational to driving sustainable growth and delivering stakeholder value. With that, we'd like to open the line for Q&A.

We will now begin the question and answer session. To enter a question into the question queue, please press star 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset, then press the star key and the number one. To withdraw your request, again, press the star key, then the number one. Please limit yourself to one question and one follow-up, and then place yourself back into the queue for additional questions. We will pause momentarily to assemble our roster. Your first question is from Sami Badri of Credit Suisse. Please go ahead. Your line is open.

Hi, thank you. I have a couple of questions. First one is there was a mention of the ARPA project that was funded using federal funds. Could you kind of give us a characterization of what you guys see as the pipeline of potential projects and opportunities that are coming directly from federal funds? And on the second question, my next question would be on the comment regarding longer procurement cycles. And I think What's a little bit intriguing about you guys making this comment is that it seems to be that there is a significant amount of federal funds being allocated to local governments, federal government, and several other branches. And you'd think that with those funds being allocated and the speed of those allocations that are now starting to accelerate, you'd think that lead times and procurement cycles would actually start to either stay the same or compress. So I was hoping you could just kind of explain to us what's going on regarding longer procurement cycles.

Yeah, sure, Sammy. Let me start and Brian jump in. First on the ARPA deal, that was a really nice deal for a lot of reasons. I mentioned in my comments that was Hidalgo County, Texas. It was a full enterprise public safety suite deal, enforcement mobile civil process. ARPA funds were certainly a factor in getting that deal signed and funded. It's about a million and quarter license deal and about a $450,000 ARR deal. I think also what's interesting about that is that's a deal that also where our Tyler Alliance story really helped close the deal. So some of the strategic things that we've been talking about, again, are continuing to resonate with our clients. It's also interesting because it's an AWS GovCloud deployment. which is continuing, I think, our comments around what we're starting to see is more and more receptiveness in public safety to potentially move into the SAS world. But yes, it was funded by ARPA. We track ARPA funds. Sometimes it's not easy to always identify specific deals tied to ARPA funds because a lot of times these funds may be used for other things which then free up funds for deals that we're pursuing. We see ARPA funds more often in areas where they're more like singular purchases. We expect to see some, for example, in a school bus transportation deal where they're purchasing a large amount of hardware or something like that. The comment on longer procurement cycles, I don't want that to be taken out of context really. I think our cycles generally are on track with where they've been. I think the comment was really meant to say as we're looking at more and more cross-sell opportunities through NIC and as those deals are getting larger, some of those larger deals are taking a little bit longer. But I wouldn't characterize procurement cycles across the Tyler portfolio products as actually getting longer. So if we misspoke there, I want to make that clarification.

Got it. Thank you. Maybe just maybe double-clicking on the procurement cycles excluding NIC and big deals. Are you starting to see an acceleration of deals getting signed as a function of federal funds, or has that not translated or is not Is that not really kind of going through the way maybe some people thought it would go through in 2022?

Yeah, I don't think right now it's necessarily accelerating deals. You know, we've talked before about our public sector clients. Their budgets are already healthy. The ARPA funds are there. And as you know, some of them have limits on when those funds need to be spent. I don't think we're seeing that right now as a sort of a sense of urgency or emergency that they've got to flush all that through and then right now. Now, will that change over the next 12 months?

It might, but we're not seeing that right now. Got it. Thank you.

Your next question is from Pete Heckman of DA Davidson. Please go ahead. Your line is open.

Good morning. Thanks for taking the question. Could you just revisit that piece you mentioned there towards the end of your prepared comments? regarding the continued shift to software and potentially an acceleration of a decline in software license fees. Could you repeat that comment, and then just specifically, kind of what time period are you looking at? Is it just reflecting next year, or I guess, is that a one-time event, or would you expect really the software, the remaining software revenue to decline faster than you'd originally expected?

Yeah, thanks, Pete. So I think what we're seeing is different divisions, different product suites have been moving at different paces to the cloud. Some of them we've talked before, like this year our enterprise ERP solution is almost exclusively this year, and we budgeted this year to move to the cloud. Our lower end, formerly our LGD, but our ERP Pro solution has continued to go at accelerated rates. What we're seeing is in areas, for example, like our enterprise permitting and licensing solution, You know, we budgeted this year that all new deals there would be 75% SAS. And what we're seeing is they're a hundred percent SAS. Uh, we're starting to see it in our property and recording solutions, particularly our recording solution that we budgeted this year at 60% SAS it's 85% SAS. Um, what we're starting to see now also in the market. And as we look into next year is our two divisions, which have had really more dependency on licenses, particularly in the last couple of years has obviously been public safety and Tyler federal. Tyler Federal has been moving, I think, a little bit faster to SAS, and we've talked before in the past about public safety's lag. But public safety, what we're seeing now, and as we're looking into next year, we're looking at a lot higher subscription-based arrangements, probably more so than we anticipated earlier in the year. And so as we look into 2023, we're seeing the effects now, but as we preliminarily model, and again, this is not a 2023 call, but as we preliminary look out to 2023, we see the license is declining at a faster rate than we anticipated, and it's just a little bit shorter timeframe.

Okay. But as an offset, perhaps, because you're not seeing necessarily a slowdown in contracting activity, your subscription backlog should grow and potentially bode for subscription revenue growth on an organic basis, several quarters out, continue to be in the mid to high teens. Does that seem accurate?

Yeah, I think so. I mean, our market activity, I'll dovetail there. The market activity is strong right now. We're not seeing any impact of economic factors that may be affecting other industries. All our leading indicators, RFPs, demos, they've already been elevated. They're either continuing to increase or those elevated levels are stable right now. So, you know, we signed in Q3, we actually signed a record number of deals with our enterprise ERP and enterprise permitting licensing solution. So the activity's there, the market's there, our clients' budgets are healthy, and so I think your comments are spot on.

Okay, I appreciate it. I'll get back to you.

Your next question is from Kirk Matter of Evercore ISI. Please go ahead. Your line is open.

Yeah, thanks very much. Lynn, in the cross-sell pipeline, when you think about the deals with NIC that are starting to come about, Are there any specific Tyler products that are sort of merging together with NIC better than others? Meaning, excuse me, it makes sense to see the ERP. ERP might not make a ton of sense in statewide deals, but I assume maybe courts and justice. Can you just give a little bit more detail about what product categories are maybe attaching with NIC really well in some of the state deals?

Yeah, sure, Kirk. It's a good question. I think, you know, out of the gate our data and insights, our analytics product has been something that has been extremely well received and that's still got a lot of the opportunities. We are seeing a lot of areas in courts and justice just, you know, cross-selling our payment solutions. Tyler Federal as well, you know, and I think you'll see as time goes on probably areas like our permitting and licensing products. The top three or four right now are really our analytics, courts and justice, federal, and payments.

Okay, that's helpful. And Brian, as we start, I know, preliminarily looking forward to 23, can you just remind us of some of the puts and takes from a margin perspective for you guys next year? I know there's a lot going on with the transition to AWS, but some of the COVID-related revenues going away, which I assume is pretty high margin for you all. Can you just give us some puts and takes, maybe where you're going to have some pressure on margin, but maybe some offsets to that?

Yeah, I think the biggest factor in terms of pressure on margins downward would be around the decline in licenses. So as we talked about in an earlier question and during the prepared remarks, a very early look at next year's revenue plans would have licenses declining perhaps around 40%. And as you know, licenses are very, very high margins. And the time it takes to the offsetting subscription revenues for those same deals in a subscription form to ramp up, there's a lag there. So that would be the biggest downside pressure. The COVID revenue is going away. Generally, the COVID revenues, at least early on, the tour health revenues were at lower than our average margins. The Virginia Rent and Leave Program margins were more in line with our overall margins. less of an uplift from those going away, but maybe overall a slight positive impact. And then subscriptions revenue, I mean services revenues, we've talked about being under some pressure, mostly from us still ramping up staffing. The services revenues typically are low to no margin revenues, and so The absence of those in the short term has a positive impact. But again, we expect to ultimately build those back up. So probably not as much of an overall impact from those, but potentially a slight positive impact from those being a little lighter. But certainly the license decline around that shift is going to be the biggest factor by us taking a big step forward with that next year.

I'd also add, Kirk, we talked about it a lot back in February at call, I think, just sort of the ongoing bubble cross as we make this transition, as we're running dual data centers and also moving into AWS. So that puts some pressure. But I would say as you step back and you look at sort of how we've been modeling out the next few years, which we've been doing for some time, You know, this is all expected. This is what, you know, we expected 2023 to sort of be the highest, the year with the most margin pressure. I think the impact on revenue growth is a little bit more than we expected in the beginning of the year, and I think it's a function of what we were talking about earlier, some of these other divisions probably moving quicker to subscriptions that Brian just referenced.

Got it.

Thanks, guys. Congrats on the quarter.

Your next question is from Michael Turin of Wells Fargo Securities. Please go ahead. Your line is open.

Hey, great. Thanks. Good morning. I appreciate you taking the questions. It's pretty clear just in the commentary, the move to subscription and SaaS is happening a bit quicker than expected. The subscription TCV metric looks great. I appreciate just the categories you've mentioned, but If you had to characterize why this is happening now, is there anything else you'd add just around how much has been fine-tuning the product set in your own go-to-market versus just customer interests and comfort levels with the cloud picking up and making those conversations a bit more palatable?

Yeah, I think it's all of the above, Michael. And we talked about what we saw as the changing landscape coming out of COVID. Fortunately, we had internally made this decision before COVID A lot of it is around sales, how we're incentivizing sales. Some of it, you know, some announcements we've made around products, how, you know, we have various product lines that are over time, that started this year, that are going to be basically selling a cloud-only version. And so, you know, it's market receptiveness. It's improvements in our product and our, you know, what we've been doing. And it's what we're doing internally to drive that subscription growth.

That's helpful. Brian, just one on the financials, if I may. The transaction-based revenue ticked down a bit sequentially. Can you remind us just how much of that is tied to NIC seasonality or just volatility versus some of the one-time impacts there and maybe how we should think about just the seasonal profile of that line on a go-forward basis?

Yeah, that line does tick down more so in the fourth quarter around seasonality of NIC transaction-based revenue. There's typically around the holidays as you move to the end of the year, there's just fewer transactions going through there. There also was year over year a $37 million reduction in the COVID revenues that are included in those transaction-based revenues. And those also ticked down from Q2. So there's an impact there. And of course, those are going away permanently. But, yeah, seasonality a little bit in Q3, more so in Q4.

Yeah, I think for NIC, they're state enterprise transactions, which is a growing revenue line, and it's something that we're looking to grow. You know, while it was up in Q3 year over year, it was down a little bit from Q2. So as Brian mentioned, Q2 is really the strongest for them seasonally, and it goes down a little bit in Q3, and it's expected to taper in Q4. But that's to be expected.

That's helpful. Thank you.

Your next question is from William McNamara of BTIG. Please go ahead. Your line is open.

Yeah, thanks. This is Matt VanVleet. I guess first on the services capacity that you're seeing, you know, talking about trying to catch up on hiring and having a little bit of, I guess, a backlog of services to be deployed. So I guess two-part question. When do you expect to feel like you're sort of caught up there from both ramping the ones you've hired now and continuing to hire? And then second part, how much of that is limiting the subscription deployments and with that the revenue recognition that might have missed or caused a little bit of a shortfall in the subscription growth versus what most of us were modeling?

Yeah, there definitely is a little bit of that there.

As you noted, it's not a lack of the services revenues coming in or the contracts being signed and then getting to the related initiation of the subscription revenues, but there have been delays around that. And we added... A significant class or classes in late Q2 and have continued to hire in Q3 and Q4. It does seem that turnover, which has been at an elevated level with us, as with many companies, does seem to be moderating somewhat. So that's a positive. But we think it's still, you know, it will take, there's roughly, you know, call it a six-month lag time from the time we hire someone to the time they're really fully trained and billable. So this is a multiple quarter sort of exercise to catch back up. And it probably, in some of the subscription deals, is causing us to be maybe like a quarter or so behind when we might otherwise have started recognizing those revenues. I guess to an offsetting factor, to some extent, Our clients have often had elevated turnover as well, and so some of it is around client readiness to begin a project. And so some of these projects are delayed slightly because clients need to staff up before they're ready to launch into an implementation. So we've seen effects from both sides, but there is some lag. in the startup of subscription deals that are in backlog.

Okay, helpful. And then looking at the State Department deal that you announced, can you maybe just walk through some of the mechanics of why only a portion of that can be recognized in bookings and backlog? Is it something you have to sort of earn your way into those other years on the contract? Or how should we think about that going from 8 million to the 50 plus million that's in the headline number?

Yeah, it's really pretty simple. I mean, there are effectively termination for convenience provisions in there that we certainly don't expect to be, to come into play. But when contracts have those terms under the accounting rules, we can only recognize in backlog and bookings. Therefore, the sort of the first-year revenues. You know, we certainly expect that the full five years of the contract and potential extensions beyond that would be realized and that we'll get that full contract value, but those contract provisions limit us to what we can put into backlog.

All right, great. Thank you.

Your next question is from Joshua Riley of Needham. Please go ahead.

Your line is open.

Yeah, thanks for taking my question. How much of the decline at the high end of the guidance for the year in revenue is due to customers and public safety increasingly choosing subscription versus license here in the short term? Because we know that Q4 is typically a seasonally strong quarter for public safety. And then how should we think about the implied impact to license versus services revenue here in Q4?

Hey, Joshua, let me start and then Brian will jump in. What we're seeing is, like I said, we're seeing more interest in moving to subscription-based models at Public Safety. A lot of the deals that we still have identified in Q4 are license deals. We have a lot of deals, you're right, typically Q4 is a strong quarter. We've got a lot of deals identified, and we don't talk a lot about the selections, but a lot of selections. What we're seeing and what we're sort of forecasting is that some of those deals will actually slip into next year. So I think that's the majority of that there.

Yeah, it's more around the timing of deals getting done and whether that falls in Q4 or Q1 versus the mix right now. As we look forward into next year, as Lynn commented earlier, we do believe that a higher percentage of the public safety deals will be subscription deals. But I don't think that's really the case as much in Q4 as it is looking into next year.

Got it. That's super helpful. And then just to follow up, our work in the space, I think others have been doing as well, indicates that the competitive landscape in public safety, for RMS and CAD is becoming more favorable for you guys. Can you speak to the opportunity there, uh, given your redesigned user interface and now cloud ready offering, um, for the opportunity to gain further market share there over the next few years? Thanks guys.

Yeah. Yeah, Joshua. Thanks. We, uh, we like where we sit competitively as you, as you know, you follow us in, I think, you know, follow some other players in this space. We've made a lot of investments there. Um, we're winning deals against, uh, You know, probably our top competitor there. You know, we just came out of the IACP conference, which was here in Dallas a couple of weeks ago. You know, there were some interesting things that we saw or didn't see there. Some of those smaller competitors that sort of grabbed some attention a couple of years ago, you know, there was one that actually didn't even have a presence at all. Another competitor had a significantly reduced presence. um we've got another one who's carrying significant debt debt load and and we don't believe they're investing at the at the rates that they they may would like to or certainly not the rates that we've been investing so um you know we like where we sit um the investments we we've made are paying off you know we're still in the process of implementing a lot of deals and and you know these things take time when you go through this but uh we're getting through that cycle and getting those verifications and getting those you know our references get stronger and stronger and And I like where we sit with public safety going forward from a competitive standpoint.

Your next question is from Alex Zukin of Wolf Research.

Please go ahead. Your line is open.

Hey, guys. Thanks for taking the question. So I guess just a few modeling ones and then a high-level one. Brian, given the variability in kind of some of the line items on the cash flow statement on a quarterly basis, it would be helpful just to better understand kind of where you guys are thinking of landing for free cash flow for the fourth quarter. And then also understanding a little bit more about the impact to maintenance revenue for next year and consequently kind of how you're thinking about a next year from a cash flow growth standpoint, assuming, of course, that kind of the margin step down is about 100 to 150 basis points from where we would end this year.

Yeah. And again, we're not giving 2023 guidance yet. We've had more work around the revenue side than on the other side. So we're not really in a position to talk about other than that we do expect further compression about the extent of that next year on the margin perspective. I'd say next year on maintenance, we'd expect that to be down, you know, probably low single digits based on the normal increases, the shift in new business more towards the cloud, and then the lower level of new licenses both this year and next year, but I think it's still probably a low single-digit decline. The cash flow, yeah, I'd say probably our expectations for this year have ticked down a bit around that timing. We do believe that a lot of these sort of timing changes that impacted this quarter versus the same quarter last year turn around in the fourth quarter. For example, accrued payroll, we had an extra payroll. that ran through cash this quarter compared to last year. I think that turns around in Q4, but payroll for us today is close to $30 million. So that's a shift from what we see in Q3 to what we see in Q4. Last year, some of the timing of NIC revenues, the flow of cash around their portals, caused a bigger sort of a shift from Q2 last year to Q3 of last year. So it skews the comparison for this year a bit. And so I think probably our expectation has come down a bit, but that a lot of this lightness in Q3 moves the other way into Q4. And as we said on the tax side, And with the change in our tax rate, that's not just a book tax rate. Those are also cash taxes. And so we expect to have lower cash tax payments, actually no federal tax payment in Q4, and much lighter tax payments next year as well. And I'd say that the overall mix on... revenues and margins for next year probably net net we probably come out pretty similar to this year's cash flow with you know maybe maybe our increase is a bit less than we previously expected but we still expect cash flow to grow and and part of that also of course interest will be significantly lower next year as a result of the

um the the debt payments we've we've made this year understood um and then maybe just and sorry are you saying the cash flow margin for next year is going to be similar to this year or the cash flow growth or the dollar cash flow for next year cash flow margin would be um similar got it okay And then I guess when you're looking at the acquisition you guys made, can you maybe just talk on what were the incremental functionality or features that you guys saw an opportunity to add and double down on here that you didn't have or NIC didn't have? And if you think about the general M&A landscape, should we expect more in payments? Should we expect less in payments going forward? Do you have what you need here now?

Yeah, thanks, Alex. I'm glad you asked that question because we're pretty excited about this acquisition. As you know, we view payments as really a significant long-term growth driver. And just a little history, you remember, we were already in payments. We made the NIC acquisition because they were the leader in public sector payments. But really, our expertise was on the acquiring side of payments. We had on our roadmap to get more involved on really the issuing side, generating the payouts. And we actually believe the issuing side of payments is about the, the TAM is about the same size as the acquiring side. Um, you know, when you talk about issuing side of payments, you know, you monetize it by things like transaction load fees, there's interchange revenue, there's account fees, and, you know, rapid was already currently in courts and corrections, uh, on the issuing side. That's an, again, that's an area we did not have expertise in. Um, but something that we would have tried to build out sometime over time. Um, but our focus still was on the acquiring side. Um, we think in the near term we can, we've already proven it because they were partner of end engine that we can in the near term, you know, expand that presence in courts and corrections given our footprint. But then as we look across our Tyler's Tyler portfolio and market presence, you know, we see a lot of opportunities, other, other opportunities in the justice space, you know, where it's juror payments or in make work release or things like that, you know, on the state side. you know, unemployment, unclaimed property, tax refunds, parks and outdoor, enterprise, federal, social services. There's all kinds of avenues that I think we can build this out across our portfolio of existing products. Caution is always, you know, as we do acquisitions, they take time. But bringing in that expertise is something that gives us the full end-to-end cycle with respect to payments that we didn't have before. And so we're pretty excited about this opportunity. Obviously, we've got to We've got a lot of work ahead of us, a lot to go execute on, but it really rounds us out in the complete cycle where I don't think anybody else has the ability to play in that cycle.

And the only thing I'd add there is on the issuing side versus the acquiring side or the processing side, the margins are better.

So that's also a positive. Perfect. Thank you, guys. Congrats on a great quarter.

Your next question is from Charles Strouser of CJS Securities. Please go ahead. Your line is open.

Hi. Good morning. Just a quick circle back on the staffing topic. When you look at the – I know, Brian, you talked about turnover moderating and you're finding it a little bit easier to find headcount. Are you seeing any moderation, too, on the wage inflation?

Yeah, Charlie, it's a – look, We say we have a little moderation. There is a little moderation, but the labor challenges out there are real and they're present, and it's not just us. Now, historically, our turnover rates have been lower than others in the tech industry, and we track that. We look at turnover, and we're down probably from Q1. Our turnover is down about 10% from where it was in Q1, but it's still quite elevated from our historic levels. There are continuous pressures on wages. We're trying to address that where we can, but the labor market's tough right now, and we're trying to keep our people. We've got really good benefits. We've got a really good culture. People love to come to work here. Generally, we have pretty high engagement. We do internal surveys around that, but it's just a difficult market right now, and we're trying to address it the best we can.

Great. Thank you, Glenn. And also just a quick question, you know, kind of picking up back on the pipeline. I know that, you know, it's very robust right now and you're seeing excellent activity, but are you hearing any trepidation from your clients at all about, you know, with all the recession talk?

You know, we haven't seen it. And, you know, we just came out of our quarterly management meetings last week. And, you know, obviously that was a question I asked each of our managers. And right now we're just not seeing it. And we have to remember that even though we've got what I call choppy waters out there in the economic world, our clients' budgets are still real healthy, and they've been healthy for some time, and that's excluding any ARPA funding or things like that. So right now we're not seeing it. It's something we continue to ask and probe into, but we're not seeing it right now.

Great. Thank you very much.

question is from Saket Kalia of Barclays.

Please go ahead. Your line is open.

Okay, great. Hey, guys, thanks for taking my questions here. Brian, maybe I'll start with you. I was curious if you could talk a little bit about how bookings did versus your expectations. Great to see the SAS mix go over 90%. Maybe a little curious how the denominator in that equation did and whether we stay at that 90% mix in future quarters.

I don't think we stay at the 90% mix, at least near term in future quarters. That was skewed by the Department of State contract we talked about. 90% value. 90% value. And that's 90% of the value. In terms of the number of deals, it was 74% subscription and 26% on-prem, which is, I'm sorry. Yeah, 78%. I don't think we stay at 90% of the value because it was a bit skewed by that $54 million deal with the Department of State. The total value, though, really grew nicely. It grew sequentially from last quarter, $126 million to $145 million. It's double what the first quarter was. total contract value was. So net-net, we feel really good about it. The comparison to last and we feel good about the continued trend towards more cloud in the new bookings. The comparison, as we said, was very difficult because we had a big, well, in overall bookings last year, it wasn't a software booking, but the e-filing in Illinois was a $63 million value. And then, of course, the COVID revenues flow through bookings and the reduction there affected it as well. But that was certainly expected. So I'd say in an overall sense, probably the number of contracts and the value of those contracts was a bit higher than we expected coming into the quarter and skewed a bit by that Department of State deal.

Got it. Got it. That makes a lot of sense. Lynn, maybe just a higher level question on this topic. In your prepared remarks, clearly this year, you and the team have made changes to encourage SaaS adoption, whether it was sales incentives or end of life and some perpetual SKUs, to the extent that you can. Are there any levers that you can talk about that the team can maybe pull or sort of tweak next year to continue that momentum?

Well, I think we've already got those levers in place as it relates to the new business market. There's other levers around flips. Those obviously come with added expense. We're still, again, early in our planning for 2023 and what we're going to target for flips. But I would say that's probably an additional lever. But on the new business market, the things that we've done with product, as you said, the announcements we've made to clients, the things we're doing around sales, they're all working in that direction. And And part of it, too, is going back is we're taking a very solid but traditional Tyler deliberative approach to this, and some of this has been around timing of when some of the products have been more cloud-efficient, ready to be pulling those levers.

Very helpful. Thanks, guys.

Your next question is from Terry Tillman of Truist Securities. Please go ahead. Your line is open.

Yeah, thanks for fitting me in as well and taking my questions. I guess the first question is, you know, we've got some research that we've been gathering in terms of the federal business and some really interesting incremental opportunities for you all going forward. It was good to see this deal, this large deal in the quarter. What can you say about what's going on on the federal side, whether it's case management within Teletrack or other areas? Do you feel like there's an inflection point and potentially a step up in federal business and then add a follow-up?

Yeah, that's a great question, Kerry. I'm actually very encouraged with what I'm seeing in our federal business. The number of deals that we were chasing this year over last year, the size of the deals that we were chasing this year over last year, and I'm highlighting mostly Q3, although things spill over into Q4. The opportunities have grown. The deal size has grown. We've got an excellent sales staff that does just a fabulous job out there. And I'm bullish on where they're going in the future.

That's great. And maybe just to follow up for you or Brian, as we think into 23 and really over a multi-year period, how do we think about the mix of SaaS and transaction revenue and that subscription line item? I know there's some noise still that we have to grapple with COVID-related maybe transactional revenue, but just in 23 and beyond, Do you see a market shift between those two line items and what would be the gross margin implications, if any? Thank you.

Well, at a really high level, taking out the short-term impact of next year there being none of the COVID-related revenues in there and this year there being a significant amount, generally we would expect to see really good growth there, mostly around the payment side. We believe that over time, The portal revenues will continue to trend upward as more and more citizens look to do more things digitally with government that they used to do through another channel in person or through the mail, and that governments look to be able to provide more of those services digitally to citizens. But I think the big growth there we've talked about, we expect... to continue to see our payments business grow meaningfully through things like with the rapid acquisition getting more into the dispersing side and driving the NIC payments platform that's currently primarily at the state level down into our local government customers. And we expect to start to see fruits of that next year. In general, the margins on payments are a bit lower, particularly where we have gross contracts. There's a mix of gross and net, but generally the margins are a bit lower there. But as far as incremental growth opportunities, we do expect to see, if you're looking out, say, over the next five to seven years, significant growth around the payment side.

Yeah, I think it's a little early to sort of forecast margins on the transaction side because of what Brian just said on the payments and the arrangements and how these things go. For example, as we announced last quarter, we won the competitive rebid for South Carolina. In the past, that was a gross revenue payment contract. That's actually shifting to a net revenue, so that will have actually a revenue headwind next year. but it will be a more positive margin headwind. So as we sort of map out our payments future and figure out exactly where we think we're going to be growing growth side, where we're going to be growing net side, we'll probably be able to get a little better color there.

That's great. Good luck in 4Q. Thank you.

Your next question is from Keith Husam of North Coast Research. Please go ahead. Your line is open.

Thanks. Appreciate it. Good morning, guys. Just to follow up on the rapid financial acquisition, Brian, I think you mentioned the margin profile was better. Can you elaborate? Was that better than the acquiring side or better than Tyler's general operating margins?

It's better than the acquiring side. I was just talking about on a relative basis. The dispersing side or the issuing side has better overall margins than acquiring.

Gotcha, gotcha. And then following up on the Department of State contract, you mentioned you guys recognized $8 million out of that $54 million in backlog. I think over time we've heard that same comment about other contracts. As you look at similar contracts like that, I mean, one, is that true? Then two, how is that growing over time in terms of the contracts are assigned that you just can't recognize all that in the backlog?

It's pretty rare. It's not in a lot of contracts. We've seen it in, I think we've had a similar thing with e-filing contracts. If they weren't, we would have a multi-year contract, but if they weren't a fixed fee, there were times when we couldn't put the whole contract in value, and there are occasionally, but I'd say it's a handful of times within a year, and generally not on contracts of this size. But we fully expect that The Department of State will fully utilize this contract. They're already an existing client, so this represents a big expansion from what we've already done for them. We have a multi-year relationship with them already, so we certainly don't expect that the termination for convenience provisions would come into play, but from an accounting perspective, they do govern how we can recognize in backlog.

Great. Thanks. Appreciate it.

Your last question is from Joe Goodwin of JMP Securities. Please go ahead. Your line is open.

Great. Thank you for taking my question. Is there any update on the NIC contract with the IRS that was put on pause about a year ago?

Yeah, we did the – well, there's no meaningful update. We submitted our rebid. We're expecting the IRS to award I think sometime in the next month or so we're fully expecting to get that award, but there's no material update that I'm aware of, Brian.

No. They expected a notification in the fourth quarter that... Unfortunately, it hasn't happened yet. And that that would be for a start at the beginning of 2024. So there'd be a full year of...

ramp up and set up from the time the award takes place until the revenues would actually start understood thank you there are no further questions at this time i will now turn the call over to lynn moore for closing remarks great thanks carol and thanks everybody for joining us today if you have any further questions please feel free to reach out to myself or brian miller thanks everybody have a good day

This concludes today's conference call. Thank you for your participation. You may now disconnect.