Tyler Technologies, Inc. (NYSE:TYL) Q1 2024 Earnings Call Transcript

Tyler Technologies, Inc. (NYSE:TYL) Q1 2024 Earnings Call Transcript April 25, 2024

Tyler Technologies, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Hello, and welcome to today’s Tyler Technologies First Quarter 2024 Conference Call. Your host for today’s call is Lynn Moore, President and Chief Executive Officer 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. [Operator Instructions] And as a reminder, this conference is being recorded today, April 25, 2024. I would like to turn the call over to Hala Elsherbini, Tyler’s Senior Director of Investor Relations. Please go ahead.

Hala Elsherbini: Thank you, Krista, and welcome to our call. With me today is Lynn Moore, our President and Chief Executive Officer; and Brian Miller, our Chief Financial Officer. After I give the safe harbor statement, Lynn will have some initial comments on our quarter and then Brian will review the details of our results and update our annual guidance for 2024. Lynn will end with some additional comments, and then we’ll take your questions. During 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 those projections.

We would refer you to our Form 10-K and other SEC filings for more information on those risks. Also, 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, including information about our quarterly recurring revenues and bookings. On the Events and Presentations tab, we posted an earnings summary slide deck to supplement our prepared remarks. 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?

Lynn Moore: Thanks, Hala. Our first quarter results provided an exceptional start to the year, exceeding our expectations across key metrics, including revenues, earnings, operating margin and cash flow. Recurring revenues grew almost 9% and comprised 84% of our total revenues. SaaS revenues grew 22%, our 13th consecutive quarter of SaaS revenue growth of 20% or more, exceeding expectations of a 20% CAGR in SaaS revenues through 2025. In addition, transaction revenue surpassed our plan with higher volumes and positive pricing trends. Our performance demonstrates the power of our business model against the backdrop of robust public sector demand, supported by generally healthy budgets. Our leading sales activity indicators remain elevated, and our pipeline reflects growing sales synergies as we execute our integrated go-to-market strategy.

During our Investor Day last year, we announced our Tyler 2030 Vision, which aligns our strategic focus on four key growth drivers: leveraging our installed base, expanding into new markets, completing our cloud transition and growing our payments business. Leveraging our unmatched installed base has been a cornerstone of our growth strategy, and we’re pleased with the outstanding execution by our sales organization, driving impactful cross-sell and upsell activity that further deepens existing client relationships and expands our market reach with new client engagements. Notable cross-sell and upsell wins during the quarter included a records management and ERP pro contract, including payments with Ada County, Idaho, leveraging our state enterprise relationship.

And on premises contract for our full enterprise public safety suite with the City of Columbus, Georgia, adding to its existing Tyler courts, corrections, ERP, tax and permitting solutions. An enterprise ERP win with the Texas Legislative Council facilitated by our existing digital solutions division relationship in Texas, which avoided an RFP process to secure a new enterprise ERP client in a nontraditional market. A combined SaaS contract with the City of Juneau, Alaska, for enterprise assessment and tax and enterprise permitting and licensing solutions. By prioritizing the cloud as one of our key growth drivers, we are unlocking new levels of innovation and responsiveness in making the cloud accessible for our clients, while providing enhanced security.

Our new software SaaS mix continue to expand and comprised 93% of Q1 new software contract value. We’re particularly encouraged to see a growing preference for cloud technology in the state and federal market with our application platform and an accelerated shift in public safety cloud demand with multiple client-driven SaaS selections. In fact, 75% of our first quarter enterprise public safety deals were SaaS. Because the pace of the shift to SaaS in these markets this year is faster than we previously anticipated, we have lowered our expectations for license revenues for the year. And across Tyler, the volume of flip signed in the first quarter was in line with our expectations, with a 21.5% increase in average ARR. Key first quarter new SaaS deals and flips included multiyear SaaS arrangements with the Hawaii Department of Natural Resources and land between the Lakes National Recreation area that build on our momentum in the outdoor recreation space.

Competitive SaaS wins for public safety included a full enterprise public safety suite contract with Palm Beach, Florida, which was focused on a cloud-only strategy. We also won a sole-source enterprise public safety contract with the city of Evanston, Illinois, which expands our growing footprint in the Chicagoland area. An enterprise appraisal in tax for Fulton County, Georgia, which includes Atlanta. The contracts with ARR of more than $1 million was executed on accelerated timeline with a go-live completed within one month. Two public safety SaaS flips with Birmingham, Alabama and Germantown, Tennessee, both of which were client-driven SaaS selections and accelerated go-lives. The Kansas Judicial Branch signed an enterprise justice appellate court SaaS flip as we continue to see a growing interest in moving to the cloud from our on-premises courts clients.

Another key driver of our long-term growth is our transactions and payments business. As I mentioned earlier, better-than-expected transaction volumes contributed to first quarter revenues that exceeded our expectations. In the first quarter, we signed 288 new payments deals across Tyler, representing approximately $9 million in projected ARR. In our state enterprise portal business, we signed a new 3-year enterprise contract with the State of Mississippi, extending our existing 14-year relationship. Our enterprise agreement with the state of Idaho was also renewed for two years in a rebid through the NASPO Citizen Engagement Agreement. We’re also very pleased to see early traction and growing demand for the solutions we added to our portfolio through our 2023 acquisitions of CSI, AR Inspect and Resource X, each of which brought us expanded AI capabilities.

With CSI, we signed a contract with our existing course client in Dallas County, Texas, adding approximately $900,000 of ARR. We’ve seen demo activity double over pre-acquisition levels for our augmented field operation solution, formerly AR Inspect, with first quarter wins that included the city of Newark manhole inspections and an expansion contract with the New Jersey Department of Environmental Protection. For our priority-based budgeting solution powered by Resource X, we signed contracts with Collier County, Florida and Fort Worth, Texas that added almost $600,000 of ARR. Now I’d like Brian to provide more detail on the results for the quarter and our updated annual guidance for 2024.

Brian Miller: Lynn, total revenues for the quarter were $512.4 million, up 8.6% and organically grew 7.8%. Subscriptions revenue increased 11.7% and organically rose 11.4%. Within subscriptions, our SaaS revenues grew 22% to $148.8 million and grew organically 21.3%. Keep in mind that there’s often a lag from the signing of a new SaaS deal or a flip to the start of revenue recognition that can vary from one to several quarters. Because of this, as well as the timing of SaaS renewals and related price increases, SaaS revenue growth both year-over-year and sequentially may fluctuate from quarter-to-quarter. Transaction revenues grew 3.7% to $164.5 million. While transaction revenues exceeded our plan, primarily due to higher transaction volumes from new and existing clients, including driver history records, the year-over-year comparison continues to be impacted by the change last year from the gross model to the net model for payments under one of our state enterprise agreement.

SaaS deals comprised approximately 93% of our Q1 new software contract value compared to 87% last year. During the quarter, we added 200 new SaaS arrangements and converted 90 existing on-premises clients to SaaS with a total contract value of approximately $86 million. In Q1 of last year, we added 145 new SaaS arrangements and had 73 on-premises conversions with a total contract value of approximately $86 million. More importantly, the average ARR associated with our Q1 flips increased 21.5% over last year, including transaction revenues, expansions with existing clients and professional services, total bookings increased 15.7% on an organic basis. Our total annualized recurring revenue was approximately $1.72 billion, up 8.8% and organically grew 8.2%.

In previous quarters, we discussed our expectation that 2023 would be the operating margin trough from our cloud transition and that 2024 would mark a return to operating margin expansion. Our non-GAAP operating margin in the first quarter was 23.8%, up 210 basis points from last year. The margin expansion reflects improved margins for our cloud operations along with effective operating expense management. As we discussed on previous calls, merchant and interchange fees from our payments business under the gross revenue model, have a meaningful impact on our overall margins as they are passed through to clients and are included in both revenues and cost of revenues. We paid merchant fees of approximately $42 million in Q1. Both cash flows from operations and free cash flow were above expectations for the quarter at $71.8 million and $57.2 million, respectively, which allowed us to repay the remaining $50 million of term debt outstanding from the NIC acquisition earlier in the year than planned.

We ended the quarter with $600 million of convertible debt outstanding and cash and investments of approximately $202 million. Our net leverage at quarter end was approximately 0.79 times trailing 12-month pro forma EBITDA with our only remaining debt of $600 million convertible due in 2026. Our updated 2024 annual guidance is as follows. We expect total revenues will be between $2.110 billion and $2.140 billion. The midpoint of our guidance implies organic growth of approximately 8.5%. We now expect that merchant fees will be up slightly over last year and that implied organic growth, excluding merchant fees, would be approximately 50 basis points higher. We expect GAAP diluted EPS will be between $5.27 and $5.47 and may vary significantly due to the impact of discrete tax items on the GAAP effective tax rate.

We expect non-GAAP diluted EPS will be between $9.10 and $9.30. We expect to see sequential growth in earnings throughout the year with both revenues and EPS slightly weighted towards the second half. We expect our free cash flow margin will be between 17% and 19%, including the estimated impact of approximately $58 million of incremental cash taxes related to Section 174. Other details of our guidance are included in our earnings release and in the Q1 earnings deck posted on our website. Now, I’d like to turn the call back over to Lynn.

Lynn Moore: Thanks Brian. Our performance in the quarter demonstrates strong execution by team members across Tyler in key strategic areas, anchored to our Tyler 2030 Vision. We are starting to see the expected benefits of our cloud transition through progress with version consolidation, cloud optimization of products, cost efficiencies and improved agility as we empower our clients who serve the public through Tyler’s next-generation cloud applications. Our strong first quarter results and positive outlook for the remainder of the year are reflected in our revised annual guidance. Even with lower expectations for license revenues because of the accelerated shift to SaaS with our public safety and application platform solutions, we’ve raised our revenue guidance while also increasing our earnings outlook.

We recently published our 2023 corporate responsibility report, our fifth annual sustainability disclosure covering our environmental, social and governance activities. Our sustainability initiatives in 2023 included investments in data management, validation and processes to drive reporting efficiencies. We also undertook a double materiality assessment to understand key insights for multiple constituents on both financial materiality and impact materiality. We hope you take the time to review our report, which is available on our website. Finally, we’re excited about Tyler Connect 2024, which will take place May 19 to 22 in Indianapolis. Nearly 5,000 Tyler clients and 900 Tyler team members will come together for training, collaboration and networking, and we’re looking forward to inspiring our clients with the latest innovations from Tyler.

Now we’d like to open the line for Q&A.

See also 10 Stocks American Politicians are Buying in 2024 and 10 Best Soaps and Cleaning Materials Stocks to Buy.

Q&A Session

Operator: Thank you. We will now begin the question-and-answer session. [Operator Instructions] And your first question comes from Rob Oliver from Baird. Please go ahead.

Rob Oliver: Great. Thanks very much for taking my question. Good morning. Lynn, mine is for you. You mentioned in the outset of your prepared remarks, kind of your growth focus areas, but you talked about the kind of growing sales synergies and the integrated go-to-market strategy that you guys laid out in more detail last year. And I know this has been a big push of your since you assumed the CEO role. Could you give us a little bit of color on kind of what if some of those growing sales synergies are? Where you’re excited about the progress you’ve had so far? What some of the levers you’re pulling are? And what are some areas you still need to improve on? I appreciate it.

Lynn Moore: Yes. Sure, Rob. It’s a good question. Last year, we elevated a couple of people to oversee all of our public admin sales, all of our justice sales. They’re working more closely together than ever before. We’ve done things around aligning some incentive comp plans and changing the way people are comped to make sure that, for example, it’s – in the old days, it’s well – whose P&L is this recognized by. And we wanted to break down some of those barriers so that really, when – it’s all about Tyler, when Tyler wins, everybody wins. And so we’ve been doing things like that. We’ve done some things, and we’re still in the process of – and some of that’s still work in progress. I mean when I say that we started these initiatives, they’re not by any means finished, but these are things that are work in progress.

We’re doing things around our PSD and DSD divisions, our application platform and formerly NIC, we see a lot of synergies there. So, we’re doing things right now to start to bring some of those divisions closer together so that they can work more closely with sales and operating efficiencies. We believe the application platform is tailor-made for state government. And so just a number of initiatives like that. It’s – there’s a lot going on. And I think we’re going to continue to see improvement as we look out forward.

Rob Oliver: Great. Okay. Thanks for that. I’ll hop back in the queue and stick to one. Appreciate it.

Operator: Your next question comes from the line of Saket Kalia from Barclays. Please go ahead.

Saket Kalia: Okay. Great. Hi Lynn, hi Brian, thanks for taking my question here. Lynn, the numbers are pretty straightforward. So maybe I’ll ask just a little bit of a higher level question. It sounds like just the spending backdrop in state and local governments continues to sound healthy. But just to make sure the question is asked, can you talk about, Lynn, what you’ve seen historically from those customers in presidential election years? I mean I imagine that those two things aren’t terribly related. But again, I just want to ask – I want to make sure that question is asked as we kind of get deeper into election season.

Lynn Moore: Yes, I don’t know that historically, there’s been much of a correlation between our sales and the presidential election year more so than what may be going on in the broader macroeconomic environment. As you note, the budgets for our clients are healthy and strong. Our sales outlook for the year, and we have some pretty aggressive sales plans, but our sales outlook for the year are looking on plan and significant parts of our business actually maybe ahead of plan. Maybe a little bit in the Federal space. I don’t know that I’ve got enough experience yet with our federal space as to what impact that may have. But it’s normally more so around what’s going on with the federal funding and budgets. But I think generally, in our – if you look at our traditional local and state space, I haven’t seen a lot of change in my 25 years plus.

Saket Kalia: Very helpful. Thanks.

Operator: Your next question comes from the line of Matt VanVliet from BTIG. Please go ahead.

Matt VanVliet: Yes, good morning. Thanks for taking my question. I said you continue to see a higher and higher mix of business going to set contracts and I believe even see an acceleration to a certain extent on the flip side. It seems like areas like public safety are maybe holding you back more, but that doesn’t seem to be the case. Is there any, I guess impetus to try to push forward on more flips, maybe encouraged customers at a little bit more of an accelerated pace to move over and just try to get this done with sort of as quickly as possible? Or any changing in your thinking there of the motivation of customers?

Lynn Moore: And you kind of cut it out, I think I got most of your question, Matt, I’ll start. Brian, you can certainly jump in. At Public Safety, I think it’s a couple of things. I think actually, as you step back and you go back to 2019, when we sort of announced that we were going to go cloud first from cloud agnostic, some of the message was we were going – at least internally was, we were going to take our leadership position and start leading the market to where we thought it was going to go and needed to go. And Public Safety, as you know, historically, it’s been a little bit slower. We’ve spent a couple of years. We’ve got some new leadership Public Safety. Our position in public safety is we’re very competitive. It’s a competitive space, but we’re in a very competitive space and a place, excuse me.

And really starting this year and started more so third quarter, fourth quarter last year, we’ve taken the approach that we are going to start leading with SaaS with Public Safety. And so that’s resonating. We talked about the Palm Beach, Florida contract. That was a deal where they were only looking for a SaaS arrangement. As we look out this year, we’re going to continue to do things to push things quicker to SaaS. At the end of the day, it’s still the customer’s choice. There’s a lot of selling things around that. You look at our Public Safety, I think – our plan for the year was to do about 50% on-prem licenses, give or take, which was up significantly from last year. And what we’re seeing right now, I think we reported 75% in Q1. As it relates to flips, there’s a lot of selling messages generally around flips and where all our sales folks are armed with those.

I think one thing that you’re also starting to see, and we’ve talked about it before on earnings calls is the continued rise of cybersecurity and ransomware attacks are also sort of triggering clients to want to push to SaaS faster. And the more that they see that out in their community, which aren’t always publicized, I think that’s also sort of starting to grease the wheels a little bit to make that decision to move to SaaS.

Brian Miller: I guess the only thing I’d add to that is in terms of our ability to significantly increase the pace of flips beyond the sales efforts that Lynn talked about. We have talked about in the past the need for clients who aren’t on the current version of our products generally to upgrade to that version either before or when they look to the cloud as we drive towards having one version of each product in the cloud. And we’ve made a lot of progress with version consolidation and sunsetting old versions and moving clients along, but that continues to be a gating factor in the pace of flips. And so as we continue to make progress with that, it opens up more opportunities from clients being in a position to flip. But as we’ve talked about, especially as we move into the larger flips, they’re complicated processes from a planning perspective.

And so the timing leading up to the flip from the time we start engaging with clients, sometimes can be kind of lengthy. So we’re certainly pushing it as fast as possible. We’ve talked about a roadmap that varies by product, but across all of our products, converges on us being at 80%, 85% of our on-prem customer base having moved to the cloud by 2030, and all of our business units have roadmaps that are aligned with that goal.

Matt VanVliet: Great. Thank you.

Operator: Your next question comes from the line of Ken Wong from Oppenheimer. Please go ahead.

Ken Wong: Great. Thank you for taking my question. This one for you, Lynn. When we look at the number of subscription contracts, it looks like it took a really big step up this quarter. I think you touched on some of the highlights. Just wondering if that’s more of a kind of a lumpy volatile seasonality type of a situation we’re seeing there from the jump up to 200? Or do you think that, that is perhaps a closer reflection of the run rate we can expect going forward?

Lynn Moore: It’s probably a little bit of both. I think one – obviously, with 200 new deals are going to vary in size and scope. But if you step back generally, when I think about 200 new contracts a year or a quarter, that plays out to over 800 a year. That’s a lot of business we’re doing, and that’s a lot of business we’re executing on. It’s great work by our sales teams. It’s great work by our pro-serve teams to then turn that into revenue. But I think it’s – I don’t know that that’s the new – it’s certainly higher than it was coming out of Q4 last year and most of last year. I think last year, we did about 750 new deals, give or take for the year. So we’re on pace a little better. But as I said, right now, markets are healthy, budgets are strong. Our sales outlook, all indicators are positive and our sales outlook looks good for the year.

Ken Wong: Got it. Fantastic. Thank you.

Operator: Your next question comes from the line of Alexei Gogolev of JPMorgan. Please go ahead.

Alexei Gogolev: Hello, everyone. Considering the elevated level of demand that Lynn, you just referred to, has your win rate remained relatively consistent at around 50%? And if it has, it feels like you should be taking more market share. Do you feel that you could show acceleration of organic revenue growth in the near term?

Lynn Moore: Yes. Thanks, Alex. I’d say, generally, our win rates across the board are consistent. And when you say 50%, that’s – you got to look by each sort of major products. So there’s certainly some areas where our win rates are 80%, 85%, some that are more competitive spaces. We talk about public safety, we talk about sort of the mid- to higher ERP space where there’s – it’s a lot more competitive market, and they may sort of be around there. So those really haven’t changed. There’s still – we still have some of the same lag factors that we talked about before between time of getting a deal to contract to getting them up and running. But yes, I mean, we – as we look out, we’ve – our overall revenue growth sort of slowed over the last two years, and I think we’ve said we expect that to pick back up, and we’re starting to see some of that.

Alexei Gogolev: Thank you, Lynn.

Operator: Your next question comes from the line of Joshua Reilly from Needham & Company. Please go ahead.

Joshua Reilly: Yes. Thanks for taking my question. So we’re hearing some of your venture-backed start-up competitors in public safety, specifically records management are having challenges getting customers live. Are you using this as an opportunity to go back to these customers and highlight the Tyler value proposition? And then just more broadly, how often have you seen this across other product lines where some of the venture-backed start-ups are making promises about getting customers live on timelines that they are unable to execute on?

Lynn Moore: Yes, Josh, that’s a good question. And it’s something we’ve seen, I’d say, really, over the 25-plus years I’ve been at Tyler. There’s always seems to be little periods where someone comes up, makes little splash, they have a little spotlight on them. They certainly have a demo that looks good. They wouldn’t have the depth of functionality and products that we’ve had because they haven’t been in the space for as long as we have but they win some business, but that’s only part of the battle. We’ve always said part of Tyler secrets sauce is not just winning the business, but executing on the business. And it’s hard stuff. Take, for example, our municipal and schools division, which really sells more on the low end of ERP and has some courts and things like that.

They did, I think, last year – I mean last quarter, they did 207 go-lives in one quarter. Now obviously, those are small deals, but that’s a lot of business. And that’s the hard part. And people, I think, from the outside, generally sort of look at Tyler’s results and say, boy, this is an easy business. This business is something we ought to invest in and get into. And what we found, not just with venture backed but some PE money that’s come in, is they didn’t really understand the market, and it’s a lot more difficult than it may look at times from the outside. And it’s a testament to all our hard-working people at Tyler, it’s testament to our culture, it’s a testament how we view our relationships with our clients. So no, it’s – I appreciate you bringing that up because it’s not something we spend a lot of time talking about.

But it’s – you’re only successful as your last implementation in this business and all our clients talk. So when you fail, everybody knows.

Operator: Your next question comes from Clarke Jeffries from Piper Sandler. Please go ahead.

Clarke Jeffries: Thank you for taking the question. Brian, very encouraging to see operating margins up substantially, operating income dollars up 19% year-over-year. You talked about improved cloud operations as a driver of that. does that mean that some of the capacity in the private cloud is already being reduced? And you’re taking up EPS today, but could you talk a little bit about the expectations for full year, how operating margins pan out for the rest of the year?

Brian Miller: Yes. It’s not so much of the capacity – capacity debt or we do continue to move clients to AWS, and we are on track with our plans to evacuate our first data center midyear of this year. But really, that – a lot of those costs don’t go out until after that data center is closed. So that’s not really the biggest factor. Some of the things driving those improved cloud efficiencies are the releases we’ve had over recent quarters of the cloud optimized versions of our product, which improves the efficiencies and lowers our hosting costs at AWS. The progress we’ve made with version consolidation, and we made significant progress last year and continue to have aggressive plans this year about sunsetting older versions of products and getting the benefits from both support costs and development costs around the expenses associated with supporting multiple versions of multiple products.

And the new AWS agreement that we talked about last quarter has provided us with increased efficiencies or increased cost efficiencies around our hosting costs. So – all of those are continuing to play out. And then on the revenue side, the outperformance in terms of revenues, especially on the payment side, where we were able to cover fixed costs in a better way with incremental revenues from things like driver history records above our plan that contributed there. And then lastly, we mentioned briefly, but continue to have effective expense management of OpEx. So both sales and marketing and G&A costs are growing at a slower rate than our than our overall revenues. So we’re getting efficiencies there and those factor into the rest of the year as well.

Lynn Moore: Yes. Clark, I’d add we are seeing efficiencies through the cloud, but there’s still a runway to go in the efficiencies that we’re going to achieve. And there’s some other internal initiatives we don’t talk a lot about, things like improving our gross margins on pro services. We’ve seen – we saw an uptick of that in Q1. That’s really a function of a few different things. It’s more of – it’s a strategic focus that we started working on last year. But it’s also a function of that we’ve had a more stable labor market. Our turnover has been much lower and sort of returned back to pre-COVID levels. And that really helps. It helps drive billable utilization. Other internal initiatives around things like rationalization of some internal IT costs and real estate costs.

Things that we’ve been working on behind the scenes are all starting to show some results in addition to the cloud. But I want to emphasize that the efficiencies that we’re going to see from further version consolidation and optimization and all the things that we’re going to do in the cloud are still out there for us to go capture.

Operator: Your next question comes from the line of Michael Turrin from Wells Fargo Securities. Please go ahead.

Michael Turrin: Hi, thanks very much. Appreciate you taking the question. Maybe on transaction revenue, the prepared materials mentioned a customer change from gross to net. Would be curious on the rationale there, whether that’s something we could see other customers elect for? And Brian, maybe you can just walk through both the margin impacts for us to consider there as well as the increased growth guide. Fast start came up a couple of times on the call, but if there’s any supporting commentary on what’s driving that, also helpful.

Brian Miller: Sure. Yes, last year, and we talked about this some last year, we actually had two clients last year, state enterprise clients that had changes from the gross to the net model. And still, the vast majority of our payments business is on the gross model, and we expect that to continue to be the case. So we really don’t see sort of large-scale changes like that ahead. It is a client decision. Most of our clients prefer the certainty and predictability they get from having a growth arrangement with us, where we’re responsible for the merchant fees and interchange fees and bear the risk of the fluctuation of those. And – so most of our clients prefer that. These two clients, one changed towards the beginning of the year.

The one that’s still impacting our comparisons changed midyear last year, and they had roughly between $4 million and $5 million, a quarter of merchant fees associated with that account. So it will impact us in terms of our comparison for the first half of this year, and then it will lap itself and it won’t be a factor. So as a result, our growth in transaction revenues because of that impact, and again, an impact on revenues, it actually improves margins by going to the gross model and the merchant fees for the first half of the year will just be up – or transaction fees for the first half of the year, grow in the low single digits. But the second half of the year, we expect low to mid-teens when that impact has lapped. But again, I don’t see that as a real trend going forward, but it is a client decision on an individual basis and different clients have different approaches to the risk they’re willing to take and whether they’re willing to manage those and pay those merchant interchange fees directly themselves.

Michael Turrin: Details helpful. Thanks Brian.

Operator: Your next question comes from the line of Jonathan Ho from William Blair. Please go ahead.

Jonathan Ho: Hi. Just wanted to maybe understand a little bit better the progress that you’re seeing, I guess, adding more transaction-based systems to your existing customers. Can you give us a sense of how penetrated you are in terms of those transaction systems? And whether you’re sort of on plan or on track in terms of adding more content to these existing contracts? Thank you.

Lynn Moore: Yes, that’s a good question, Jonathan. I don’t have those numbers just off here off the top of my hand, we certainly can get back to you with those. I would say that generally speaking, we got a long runway left. We’re still pretty early in our transactions business. You can point to our presentation at Tyler 2030 for how we saw transactions revenue to grow and the cash flow from that over the next five to six years.

Brian Miller: Yes. We’re still in the very early stages, very early innings of driving that cross-sell. We’ve done a lot of work with integrating the payments platform into our software products that have significant payments capabilities, things like utility billing and court and licensing and permitting. And then as Lynn talked about earlier, the initiatives we’ve had to – that in place more effective cross-selling sales motions. And we’re starting to see the impact of that with I think we see 288 new payments deals across Tyler’s customer base, but it’s a very small fraction that we’ve penetrated so far of our software customer base with our payments platform, and that continues to build momentum, and we’re really pleased with – I’d say we’re at least on track with our plans for this year. But again, in the very early innings of that.

Lynn Moore: Yes. And I’d add to that, Jonathan. I mean, last – I guess, now two years ago, we acquired Rapid Financial, which is the disbursements world. We are – we barely scratched the surface with that. So still a lot to do on both sides. I would say if you look – again, point you to our 2030 presentation, I’d say we’re on track right now for that.

Jonathan Ho: Right. Thank you.

Operator: Your next question comes from the line of Keith Housum from Northcoast Research. Please go ahead.

Keith Housum: Good morning. I want to unpack a comment you made earlier in terms of cybersecurity as a driver of public agencies moving to the cloud. Are we seeing like the concerns about ransomware and cybersecurity is perhaps a tailwind that you guys are dealing now with just for public safety, but across the board. And are you seeing the life cycle of the systems that you’re replacing, is that shrinking? So are we seeing an acceleration in the refresh cycle, albeit it might be small, but are we seeing some level of that, you think?

Lynn Moore: I don’t know about that. I guess I would just say that – so my comment before on cybersecurity is look, we all know what’s out there. It’s a big event when it happens to a client. Generally, they – as I said, they view us and we view them as their trusted partner, and we’re usually there to help them. And one of the things that they realize quickly is getting them into the cloud will make them much more secure. It’s – to say that there’s driving flips, it is. It’s not a huge tailwind, but it’s out there. And it’s not necessarily something that we’re hoping for. But it’s just a fact of life. It’s a fact of doing business in today’s world.

Keith Housum: Great. Thank you.

Operator: Your next question comes from the line of Kirk Materne from Evercore ISI. Please go ahead.

Kirk Materne: Yes. Thanks very much for taking the question. Brian, on the 21% growth in ARR and the flip, is that just largely pricing? Does that include cross-sell, upsell? I guess what does that entail? Is that – I’m just trying to get a sense of it, that’s sort of apples-to-apples or if you’re seeing some of the sales synergies Lynn discussed earlier, factoring into that growth as well? Thanks.

Lynn Moore: Yes. I think the biggest factor is larger average deal size. So we’re seeing at least in the mix this quarter, and it won’t necessarily be consistent every quarter because that can be kind of lumpy what that mix is. But we saw more bigger customers move we highlighted one of them, Fulton County, Georgia, with their tax solution. I think $1.3 million in ARR from that one. So seeing generally more larger customers in the mix. Last quarter, we had our first court flip. This quarter, we had the pellet court in Kansas flipping. So it’s more around the average size of the clients. But there also is upsell in those as well. So I think the average we’ve talked about still tends to be about a 1.7, 1.8 times uplift relative to the maintenance, but in some of these – especially some of the larger ones, we’ve seen a bigger uplift where we’ve added new services or additional products when they flip, so a combination of both of those things.

Lynn Moore: Yes. And Kirk, I think there’s also been a few occasions where we may have won business a while ago. And to get that business, we had some contract concessions, maybe had some fixed pricing for a period of time. And the SaaS flip is an opportunity to sort of revisit that.

Operator: Your next question comes from the line of Gabriela Borges from Goldman Sachs. Please go ahead.

Gabriela Borges: Hi, good morning. Thank you. Lynn and Brian, I want to reconcile some of the commentary you’re making on transaction on the transaction business. You commented specifically around higher transaction volumes and better pricing. So maybe just help us understand, is the volume is a function of the traction you’re making in cross-sell and the run rate that you talked about earlier? Or is there an underlying dynamic going on as well? And then if you could touch on the pricing as well. Is there an additional dynamic around pricing independent of some of the specific contracts you talked about changing from gross to net and vice versa? Thanks.

Brian Miller: Yes. On the pricing side, specifically, we’ve talked about that as we continue to drive more business into the Tyler software customer base, we’re able to generally achieve premium pricing or better pricing than a commodities type payment arrangement where we provide additional value from things like automated reconciliations. So having the software or the payments platform embedded with the software creates additional value for the customer and lets us get better pricing than some of the just payment-only type contracts. So as we continue to add those, we’re seeing improvements there. We’ve seen as well some price increases in some of our revenue-sharing arrangements with third-party payment processors that have also benefited us.

And then we also saw, even though they’re down year-over-year, we saw better-than-expected revenues from some of the other transaction volumes like driver history records, which tend to be a higher margin business as well. So a combination of things driving that pricing.

Gabriela Borges: Thank you for the details.

Operator: Your next question comes from the line of Mark Schappel from Loop Capital Markets. Please go ahead.

Mark Schappel: Hi. Thank you for taking my question. John, I believe the remaining ARPA funds must be allocated by year-end. I was wondering if you could just comment on the impact ARPA funds are having on your business today? And whether you anticipate any demand falling off next year as these funds come to an end?

Brian Miller: Yes. The ARPA funds generally have to be committed by the end of 2024 and spent by the end of 2026. And so the commitments – I mean, largely, I think, at this point across the universe of our customers and prospects, I think the majority of those have been committed probably a strong majority, I think, 80%, 85%, maybe more than that. But committed and an internal commitment and doesn’t necessarily mean that they’ve even started a buying process. So they may have committed funds for a new ERP system, but they haven’t even issued the RFP yet. We’ve said that we believe it is a factor in the strong market conditions we’ve talked about, but not the biggest factor. And so we expect it to continue to be a tailwind of some sort, really through 2026 as those commitments turn into to purchases and then turn into deliveries and revenue recognition for us.

But we don’t expect a big drop-off after that. Most – we think some of the funds used for things like hardware purchases around our school transportation solution that are sort of onetime purchases. But generally, when they’re buying something from us, it creates a recurring revenue stream that they may fund the first two or three years out of ARPA funds, and then they have an ongoing expense with us for a subscription. So, I think it’s a tailwind, not the biggest factor in the market, we’re seeing the one that will continue for a while.

Mark Schappel: Thank you.

Operator: Your next question comes from the line of Terry Tillman from Truist Securities. Please go ahead.

Terry Tillman: Good morning Lynn, Brian, and Hala. Most of my questions have been answered. But one question I still had was, maybe we could talk about traction with AI-powered acquisitions. I think it was called out and it’s on your slide deck. Just kind of curious, I know these were probably small acquisitions, but I’m curious about the revenue size of these products? And maybe kind of stack rank in terms of – in your possession and with your size and scale and go-to-market, how would these opportunities stack up versus maybe what you did in the parks and recreation area or the vend engine and stuff in jails in the recent past? Just trying to better understand how meaningful these could be? Thank you.

Lynn Moore: Yes. Thanks Terry. So, I guess, first of all, like I said, we’re early with these acquisitions. These acquisitions really fit the mold of acquisitions that we’ve done that have been very successful, which is a product differentiator that we can take into our installed base where we’ve got a really commanding position to leverage. I think each one of these three are – have different growth trajectories, which is another one of our criteria is can this grow at a rate faster than Tyler’s overall rate. And I think all three of these clearly ticked that box. I think the acquisition of CSI probably has a little bit bigger near-term market opportunity. The Resource X will drive sufficient – a lot of revenue in its own right, but it’s also going to drive higher win rates for our ERP solutions, which is not necessarily as measurable.

AR Inspect our field operations, new product. Again, we talked about there’s a lot of interest there, a lot of excitement. And I’d expect that to really sort of all of them to outperform our expectations coming in. But based on those the criteria that I sort of originally outlined. So, we’re excited about all three of these. We’re generally excited about every acquisition we do. But we – these are off and running and off to a good start, and we’re already seeing movements in the market based on these three acquisitions, and that’s what’s really appealing to me.

Brian Miller: And collectively, those three are around $4 million of revenues for the quarter. So yes, small compared to Tyler’s total. But interestingly, a couple of those deals we called out were significantly sized deals with large customers. So, the Dallas County CSI, almost $1 million of ARR from the CSI product. So, you see how that – relative to a business group that are collectively doing around $4 million a quarter in revenues, adding single contracts that add $1 million of ARR is off to a nice start.

Terry Tillman: Definitely. Thank you.

Operator: Your next question comes from the line of Alex Zukin from Wolfe Research. Please go ahead.

Alex Zukin: Yes, hi guys. Thanks for taking the question. So, correct me if I’m wrong, but this is, I think, the first time since almost like 2014 that you’ve actually raised the top line guide for the full year after Q1. So, maybe Lynn, just talk about and walk through what’s giving you that confidence to do that? You guys don’t usually do that. Is it improving demand from new arrangements as it flips? Is it transaction revenue expectations? It might be all of the above. It might be the M&A. But like what is driving that incremental confidence and conviction to kind of do something you don’t usually do?

Lynn Moore: Yes, it’s a good point, Alex. And I was actually thinking to myself, when was the last time we’d ever done it, because I couldn’t recall and you did my homework and told me it was 10 years ago. We just come off our management quarterly meetings. We’ve got really good visibility on what we see out there. And I would say it’s improved. I talked earlier about not just the demand in the market, but what we’re seeing for our sales outlook. We’re just seeing a lot of things lining up in a way that gives us that confidence to do it, as you point out, I mean, it’s not something we typically do. We were – I wouldn’t say we were conservative, but we like to not get ahead of our skis. And we’d like to tell you what we’re going to do then we’re going to go do it.

And it’s just – it’s a combination of a lot of factors. I can tell you that for the last couple of years, one of the mantras I’ve been saying within Tyler to not just the management team, but to all the employees, whether it’s in a town hall or what is, I would say, the last couple of years, I have never been more excited about Tyler’s future then I am today. And coming into this year and really the last couple of months, I’ve switched that a little bit. So, I’ve never been more confident in Tyler’s future then I am today. And again, it’s just a lot of things going right. We’re clicking on all cylinders right now, and we’ve got an aligned management team with a singular vision, singular focus. There’s a lot of initiatives going on at Tyler.

I mean we’re not just sitting back. There’s a lot of things going on, but I just like where we sit right now.

Brian Miller: And just generally, the revenue outperformance in Q1, obviously, it was not sort of pull forward or timing of things that we might have seen in the later quarter especially around the transaction-based revenue, truly was additive to what we expected for the rest of the year. And so that drove us raising the outlook for the full year.

Alex Zukin: And I usually never ask this follow-up question, particularly because we love margins, and we love efficiency. But I guess, given this, call it, once in a decade incrementally higher level of confidence and conviction this early in a year. Is there a world where you do maybe push the throttle a little bit more on investments, both organic and/or inorganic as it does seem like the market seems to be coming to you at a faster pace?

Lynn Moore: It’s a good question, Alex. I think we – I mean I don’t know that we’ll deviate from our historical practice of just taking a disciplined approach. We’ve got plans in place as it relates to margin and investment I like our balance right now, I like our capital allocation where we sit right now. So, I don’t think you’re going to hear us say this isn’t 2017, 2018, where we’re going to say, hi, this is now the time for elevated investment. We’ve got plenty of investments going on. And like I said, a lot of initiatives and both around revenue growth and margin expansion. So I don’t think you’ll hear that out of us over the next several quarters.

Alex Zukin: Excellent. Thank you guys. Great quarter.

Lynn Moore: Thanks Alex.

Operator: This does conclude our question-and-answer session. I will now turn the call back over to Lynn Moore for closing remarks.

Lynn Moore: Thanks Krista and thanks everybody for joining us today. If you have any further questions, please feel free to contact Brian Miller or myself. Thanks again, and have a great day.

Operator: This concludes today’s conference call. Thank you for your participation and you may now disconnect.