泰勒科技 (TYL) 2019 Q3 法說會逐字稿

Hello, and welcome to today's Tyler Technologies Third Quarter 2019 Conference Call.

Your host for today's call is John Marr, Chairman of Tyler Technologies.

(Operator Instructions) As a reminder, this conference is being recorded today, October 31, 2019.

I'd like to turn the call over to Mr. Marr.

Please go ahead.

Thank you, Nick, and welcome to our third quarter 2019 earnings call.

With me on the call today are Lynn Moore, our President and Chief Executive Officer; and Brian Miller, our Chief Financial Officer.

First, I'd like for Brian to give the safe harbor statement.

Next, Lynn will have some preliminary comments, then Brian will review the details of our third quarter results and update our 2019 guidance.

Then I'll have some final comments and we'll take your questions.

Brian?

Thanks, John.

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.

Before we get into the third quarter results, I'd like to highlight 2 announcements we made this week.

First, on Tuesday, we announced that we have entered into a strategic collaboration agreement with Amazon Web Services.

As public sector clients continue to increasingly trend toward the cloud, we continue to evolve our applications in response to their needs.

This agreement allows us to leverage the AWS Cloud to lay the groundwork for the future of cloud services for the public sector.

It provides this framework for development, training and collaboration in order to support next-generation applications that have the scalability, resiliency and security that AWS offers, and we look forward to working closely together to bring the most advanced cloud native services to Tyler clients.

We also announced yesterday that we have acquired Courthouse Technologies, a leading provider of jury management systems based in Vancouver, British Columbia.

CHT's SaaS solution serves courts of all states across the United States and Canada, including 5 state-wide agreements, and their addition will complement and elevate our existing suite of court solutions.

Now turning back to Q3 results.

Our execution in the third quarter was solid as we continue to build upon a strong first half of the year.

Cash provided by operations and free cash flow both reached new quarterly highs in the third quarter as did non-GAAP EPS.

This is our 32nd consecutive quarter of double-digit revenue growth as both GAAP and non-GAAP revenues grew 16.7%.

All of our software-related revenue lines grew by double digits, and organic revenue growth accelerated from the second quarter.

Our core software revenues from licenses and subscriptions grew 26% on a non-GAAP basis with 20% organic growth.

Software license and royalty revenues in the third quarter were the second highest in our history, increasing 13.1%.

As expected, the new contracts mix shifted somewhat compared to the second quarter as on-premises license deals made up approximately 48% of the number and 49% of the third quarter total new contract value.

We signed 288 new software contracts in the quarter, a new quarterly high.

And through the first 9 months of 2019, we have already surpassed the total number of new deals signed in the full year of 2018.

Our new software subscription deals added $10.6 million of new annual recurring revenue, up 59%.

GAAP subscription revenues grew 28.2% and non-GAAP subscription revenues grew 26.1%.

Total recurring revenues from maintenance and subscriptions grew 19.5% and comprised 67% of total revenue.

While revenue and bookings in the third quarter were good, they were also affected by delays in the timing of several federal contracts at MicroPact as an increasing amount of MicroPact sales are coming through its partner channel.

Several significant deals were signed by partners at the end of the quarter, but the related contracts with MicroPact will not execute until October and will be recognized in the fourth quarter.

These include the largest deal, a contract for the Veterans Administration Vocational Rehabilitation and Education for a $3.2 million license fee.

As a result, MicroPact achieved its largest-ever license sales month in October.

Our strong sales for our Odyssey Court case management solution continued this quarter as well.

Our largest deal in the quarter was a SaaS arrangement with the District of Columbia Superior Court for Odyssey Case Management as well as e-filing with a total value of approximately $7.7 million.

We also added 2 new Odyssey clients in California, a license arrangement with Shasta County and a SaaS agreement with the Mendocino Superior Court along with a new fixed fee e-filing contract with Snohomish County, Washington.

New sales for our ERP solutions continue to be robust and for our Munis solution, the number of new deals in the quarter was an all-time high.

Significant contracts included multi-suite deals that include some of our more recently acquired solutions.

Among those were contracts with North Richland Hills, Texas for a number of products, including Munis, EnerGov, Socrata Data & Insights and MobileEyes; and a contract with Longview, Texas for our Munis and Socrata Data & Insights solutions.

We also signed a SaaS agreement for our Munis ERP solution valued at $4.3 million with the Union County Public Schools in North Carolina.

This agreement is 1 of 8 new SaaS contracts this quarter with North Carolina school districts under the master service agreement we signed with the state Department of Public Construction earlier this year.

For our public safety solutions, we signed significant contracts with Nassau County, New York; the Metropolitan Computer Aided Dispatch in Champaign County, Illinois; Fulton County, New York and Grove City, Ohio.

For our Appraisal & Tax solutions, we signed a significant SaaS agreement with the city of Minneapolis, Minnesota and license deals with Santa Clara County, California and Macomb County, Michigan.

For our Socrata Data & Insights solution, we had a key win for the Socrata-connected government cloud with the New Mexico Administrative Office of the Courts, a long time Odyssey client.

Other significant new signings include the Virginia Department of Rail and Public Transportation and the U.S. Department of Veterans Affairs.

For our recently acquired MicroPact solution, we signed notable arrangements for entellitrak with the Utah Department of Health, the Office of Personnel Management with the Inspector General's Office and the Illinois Department of Agriculture.

Now I'd like for Brian to provide more detail on the results for the quarter and update our annual guidance for 2019.

Thanks, Lynn.

Yesterday, Tyler Technologies reported its results for the third quarter ended September 30, 2019.

I'm going to provide some additional data on the quarter's performance and update our annual guidance for 2019, and then John will have some additional comments.

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've also posted on the Investor Relations section of our website, under the Financial Reports tab, schedules with supplemental information provided on this call, including information about quarterly bookings, backlog and recurring revenues.

GAAP revenues for the quarter were $275.4 million, up 16.7%.

On a non-GAAP basis, revenues were $277.2 million, up 16.7%.

Organic revenue growth rose from the second quarter of 2019 to 8.9% on a GAAP basis and 8.3% on a non-GAAP basis.

Our core software license and subscription revenues combined grew organically approximately 20%.

Subscription revenues for the quarter increased 28.2%.

We added 150 new subscription-based arrangements and converted 20 existing on-premises clients, representing approximately $47 million in total contract value.

In Q3 of last year, we added 81 new subscription-based arrangements and had 31 on-premises conversions, representing approximately $29 million in total contract value.

Subscription contract value comprised 51% of the total new software contract value signed this quarter compared to 37% in Q3 of last year.

The value weighted average term of new SaaS contracts this quarter was 2.7 years compared to 3.6 years in Q3 of last year.

Revenues from e-filing and online payments, which are included in subscriptions, increased 19% to $21.3 million from $17.9 million.

That amount includes e-filing revenue of $14.7 million, up 10.5% over last year.

Annualized GAAP recurring revenues for Q3 were approximately $740 million, up 19.5%, and on a non-GAAP basis were approximately $747 million, also up 19.5%.

Our non-GAAP operating margin increased sequentially 100 basis points from 24.6% in the second quarter to 25.6% in the third quarter but declined 150 basis points from last year's third quarter.

The year-over-year decline reflects 2 major factors: our increased investment in R&D and the lower operating margins from acquisitions completed in the last 2 years, which also are receiving significant investments that affect their near-term profitability as they are integrated into Tyler.

Our R&D expense in the third quarter increased almost 24% from last year.

If our R&D expense were flat with last year and the results of our 2018 and 2019 acquisitions were excluded, our Q3 non-GAAP operating margin would have been 28%, up 90 basis points, and on a year-to-date basis, 27.9%, up 130 basis points.

Our backlog at the end of the quarter was $1.41 billion, up 13.9%.

Backlog included $393 million of maintenance compared to $355 million a year ago.

Subscription backlog was $592 million compared to $488 million last year and includes approximately $129 million related to fixed fee e-filing contracts.

Our bookings for the quarter were approximately $259 million, an increase of 1.6% from Q3 of last year.

For the trailing 12 months, bookings were approximately $1.2 billion, up 18.9%.

The intentional reduction in the term of new subscription contracts also impacted bookings growth.

Had the average term of subscription bookings in the quarter been the same as last year, bookings growth would have been approximately 4.3%.

Our software subscription bookings in the quarter added $10.6 million in new annual recurring revenue, up 58.9% over last year's $6.7 million.

For comparison, if all of our new subscription contracts had been under license arrangements, we estimate that they would have represented additional license revenue of approximately $14 million.

We signed 49 new on-premises contracts in the quarter that included software licenses greater than $100,000, and those contracts had an average license of $293,000 compared to 29 new contracts with an average license value of $465,000 in the third quarter of 2018.

Cash flow from operations rose 16% to $130.1 million and free cash flow rose almost 21% to $125.3 million, both new quarterly highs.

We ended the quarter with $230 million in cash and investments and no outstanding debt.

During the quarter, we also entered into a new 5-year $400 million unsecured revolving credit facility.

The new credit facility replaces our previous $300 million secured credit facility, which was scheduled to mature in November of next year.

The new credit facility also provides a minimum of $250 million additional uncommitted funding through an accordion feature.

In addition to expanding the size and moving to unsecured, the credit facility also contains improved pricing compared to our previous facility.

Days sales outstanding and accounts receivable was 114 days at September 30, 2019, compared to 107 days at September 30, 2018.

The increase in DSOs is primarily related to the timing of milestone billings under several large percentage of completion contracts, resulting in a $32 million year-over-year increase in unbilled receivables.

Excluding current unbilled receivables, DSOs were unchanged from last September at 79 days.

Our guidance for the full year of 2019 is as follows: We expect 2019 GAAP revenues will be between $1.082 billion and $1.095 billion and non-GAAP revenues will be between $1.090 billion and $1.103 billion.

We expect 2019 GAAP diluted EPS will be between $3.50 and $3.63 and may vary significantly due to the impact of stock incentive awards on the GAAP effective tax rate as well as the final valuation of acquired intangibles.

We expect 2019 non-GAAP diluted EPS will be between $5.22 and $5.35.

For the year, estimated pretax noncash share-based compensation expense is expected to be approximately $62 million.

We expect R&D expense for the year will be between $81 million and $83 million.

Fully diluted shares for the year are expected to be between 40 million and 40.5 million shares.

GAAP earnings per share assumes an estimated annual effective tax rate of 10% after discrete tax items, includes approximately $27 million of estimated discrete tax benefits related to share-based compensation, which may vary significantly based on the timing and volume of stock option exercises.

Our estimated non-GAAP annual effective tax rate for 2019 is 24%.

We expect our total capital expenditures will be between $45 million and $47 million for the year, including approximately $20 million related to real estate and approximately $6 million of capitalized software development costs related to MicroPact.

Total depreciation and amortization is expected to be approximately $76 million, including approximately $52 million of amortization of acquired intangibles.

Now I'd like to turn the call back over to John for his comments.

Thanks, Brian.

We're pleased to continue to build on the strong first half of the year with a very solid third quarter.

We again achieved double-digit revenue growth as well as achieving the highest quarterly non-GAAP EPS and free cash flow in our history.

Our competitive position remains high, in part reflecting our increased investment in R&D over the last 2 years, and we signed a record number of new deals in the quarter.

We continue to be active in the integration of our 2018 and 2019 acquisitions into Tyler and we are encouraged by the progress.

We're starting to see benefits from the investments we've made in acquired products, including integration to Tyler's core products.

For example, 22 new ERP and public safety deals this quarter included Socrata's Data-as-a-Service platform and we had 7 wins with CaseloadPRO, now branded Tyler Supervision.

As Lynn noted, we're also very excited about our new strategic collaboration agreement with Amazon Web Services.

This multifaceted agreement brings together Tyler, the nation's largest software company focused exclusively on the public sector, and AWS, the broadest and deepest cloud platform.

We look forward to working together to accelerate innovation in the development of these strategic initiatives.

As we continue to evolve our applications in response to the public sector needs, this collaboration will enable Tyler's clients to deliver better experiences for citizens and further enable governments to use data as a strategic asset in the design, management and delivery of their programs.

Now Nick will take your questions.

(Operator Instructions)

First question comes from Kirk Materne, Evercore ISI.

I guess, maybe just to start, I guess, Lynn or John, can you just talk a little bit more about the AWS deal just in terms of what maybe you're hoping to accomplish with that in the immediate sort of near term?

Are clients asking about AWS and having the flexibility of moving over -- move over to it?

How do you think about that as a development platform for your own applications?

Maybe just a little bit more color on that kind of what some of the near term goals are and then maybe longer-term goals?

Yes, sure, Kirk.

I think it's -- this is kind of something I've been talking about for the last several quarters.

I've been talking about an initiative within Tyler, really a long-term strategic initiative about really coming up with a comprehensive company-wide cloud strategy.

We've talked about -- it involves a lot of different things.

It involves evaluating our current products, our potential road maps, trying to figure out how to get them on the right path to become more cloud efficient and hopefully, cloud optimized, looking at our historic approach of cloud agnostic, looking at the long-term strategy of the Tyler cloud, evaluating opportunities with public cloud providers and on and on.

And so this really is an extension of that.

It's a piece of that overall puzzle that we've been working on for the past year.

As we continue to focus more on delivering more of our solutions in the cloud and building next-gen applications, partnering with AWS helps with that.

It helps modernizing our portfolio short term.

It also helps with some training for our staff to help them get the skills necessary to build some of these next-gen apps.

It helps with our long-term strategy, eventually moving away from the Tyler cloud.

So it's really just a continuation of stuff that we've been talking about.

I don't know that we're in a position still to sort of outline you can expect this in this quarter and that in that quarter.

But it's a part of an overall movement that we've been working on for the past year.

I want to be careful on a couple of things.

I want to make sure that it's clear about what it's not.

We're not -- it's not an immediate radical shift in our business model, away from on-premise.

We certainly recognize the increasing market shift in the public sector.

We believe that's going to continue in the future.

We've talked about where rates were 5 years ago versus today and where we think they'll be in the future.

But we're going to continue to be responsive.

There's still significant demand in the market for on-premise, and we're going to be responsive to that demand, even as we are evolving and moving the strategy more to the cloud.

It's also not an immediate move away from our existing Tyler cloud.

We've got existing customer commitments.

We've got financial commitments.

And again, as I mentioned, some of our products will -- can today move more easily into a public cloud, into a more cost-efficient manner, and some needed some work to become a little more cloud efficient and hopefully, over time, cloud optimized.

So at a high level, that's where it is.

In the near term, it's -- we're going to continue to solidify our relationship.

It's an overarching framework for us to work on various initiatives but we're really focusing on future development, on training, on collaboration, migrating customers where it makes sense but really recognizing the market and where it's going, and again, an extension of the work we've been doing inside of Tyler for the past year.

Super.

That's helpful.

And maybe just one follow-up for Brian.

Brian, I apologize if I missed this, but any impact from Courthouse on the fourth quarter guidance?

Or maybe how to think about it for fiscal '20?

No, it's a relatively small deal, less than $5 million in annual revenues so the impact won't be material in Q4.

Our next question comes from Scott Berg, Needham & Company.

I guess let's start with when -- we were at the IACP event here earlier this week and had some great discussions on the public safety side of your business and how that business is positioning better upmarket.

Could you maybe talk about the company's overall efforts to move more into those Tier 1 type customers?

Historically, it hasn't been a big focus.

I know you're doing more there more recently, but maybe an update on some successes and opportunities there would be great.

Yes, sure, absolutely.

So we've talked about it a little bit, Scott, over the last -- really last couple of years, we've made a lot of investments.

Part of the purpose of those investments was, one, to get the product more competitive but also position it to move upscale, upmarket.

Those investments have been paying off in our core market in terms of number of RFPs we're responding to, short-listing.

But I think you've also seen this year, the number of new names we're getting is up significantly year-over-year.

And an example to your direct question is, the larger deals are starting to be on our horizon.

We expect to close, by the end of the year, approximately twice as many deals that were in the $1 million-plus range as last year.

So a good example of those investments.

I think stepping back, when you look at the quarter, for public safety, there were really 2 big operational milestones, which are really key to fueling that growth upmarket.

I mean, we've done the work on the product.

And we don't talk a lot about it but we had 2 really big go-lives this quarter, Scott.

One was in Orlando, Florida, and that was really our first Tier 1 CAD go live.

And by that I mean, it's a jurisdiction that has over 1 million-plus calls a year.

So it's the first time we've been able to do that.

Burlington County, New Jersey, another successful go-live.

They were a Tier 1 client for both CAD and records.

We talk about this stuff occasionally.

But again, this is kind of the secret sauce of Tyler; this is the hard stuff, getting clients up and running on time, on budget.

As you know, it's a reference business.

Getting them happy is going to help play as we continue to move upmarket and get more and more opportunities, having these Tier 1 sites up and running and referenceable.

In Orlando's case, for example, our team got multiple personal handwritten notes from the clients just all about the success of the implementation.

So that's really good stuff.

We don't put out press releases about it.

But to your point about moving upstream, you got to get those references in place, and it was a really good quarter for public safety to do that.

Got it, helpful.

And then from a follow-up perspective, you had a couple of MicroPact deals that kind of moved out of Q3 into Q4 and I certainly understand the rationale there.

But as you moved into new segments -- federal is obviously new with MicroPact; Socrata has brought some state opportunities and international maybe that you didn't have before.

How do you view the predictability of the business today around deal flow?

I know the business has always had some quarters where deals will get awarded but maybe not get invoiced, and there'll be some movement there.

But it seems like the last couple of quarters, there's been some more movements there.

Is this kind of a short-term trend as you have these assets kind of for the first time in your purview?

Or maybe is predictability a little bit less certain versus what's been historically very easy to guide to with the small local customers?

Yes, Scott, I think it's a couple of things.

I think you're right.

We're still learning a little bit about these markets.

And then as it relates to MicroPact, we're still learning and they're still learning really about this -- the partner channels, and they have spent some time and made some investments over the last couple of years, but this is really the year that it's really starting to see fruition.

And I think that was just sort of a little bit of an internal miss that, as you know, some of the federal deals, which is a significant part of their business -- certainly not all their business -- has a lot of business that comes in at September 30.

Well, the partners were getting that business but didn't turn around.

And sometimes that business comes in, literally, at the stroke of midnight on September 30.

Well, there's no time for us to get that contract.

I think part of it, too, is -- and you see this in a couple of our lines is when you don't have the -- as the business is growing and you don't have the deal flow and you have some -- a little bit more larger deals, you tend to have some deals that will slip that may impact performance a little bit more as opposed to say, our ERP side of the business, where there's a more continuous and constant deal flow.

So deals slip in, deals slip out.

It's kind of -- that's just the nature of the business, and we don't normally talk about it.

But some of these lines, where there's a little bit larger deals, we see this with Odyssey, sometimes even in our core business, the predictability gets a little bit off internally.

But for the year, and generally, like I told the guys at MicroPact, the good news is you've won the business.

We'll take the business when we get it.

As you know, we don't put out quarterly guidance.

Perhaps this is part of the reason.

But the good news is that all the business trends are there but you're right, we're still learning a little bit of the space.

Our next question comes from Keith Housum, Northcoast Research.

In terms of the Courthouse acquisition, I'm just trying to understand, is this typical of your, I guess your common pattern of making acquisitions?

Do you foresee a need to spend some significant amount of R&D in terms of updating their portfolio or integrating with yours?

Yes, Keith, I'd say it's in line with a lot of our recent acquisitions, which are -- have been more strategic and primarily product acquisitions.

We've talked in the past about our white space initiative and looking for things that are either voids or deficiencies in our current offerings.

And I think that's -- Courthouse Technology sort of fits that bill.

I'd say it's very similar rationale and thought process as our CaseloadPRO, which is now Tyler Supervision, acquisition last year.

Courthouse Technologies is a company that had a -- really a leading jury management solution.

We had our own existing jury management solution.

It was probably not an A. It was certainly not a strength of ours.

It's something that we see in a lot of deals -- I think about half of our Odyssey deals requesting jury as well as other products.

We had some outstanding customer requirements.

So it's been on our list, our R&D list to put in some more investment, and yet we were able to find a company with a solid product to bring in.

To your question about R&D, like almost every investment we do, we don't just put them in and let them run.

We make some investments, we make some integrations.

We usually end up spending a year or 2 sort of getting them Tylerized, getting them on track, and our history has generally been, as you look out a couple of years and you really see that growth start to take off.

So I do expect some investment there.

But the product's in pretty good shape and a lot of that will be integration-related.

Great.

I appreciate it.

And then just, Brian, perhaps a little bit about drilling down deeper into the e-filing business.

I know you're up about 10% year-over-year.

But at some point over the next year or 2, should we expect even acceleration of that growth as you sign -- you guys sign up more customers?

Or is this a pretty good cadence to think about that growth quarter-over-quarter and year-over-year?

I think, generally, kind of mid-teens is probably the right way to think about it.

We have some sort of backlog of e-filing in that we've got commitments from some clients that are in the process of implementing case management solutions that will go live on e-filing once that system's in place.

We have others that are still not fully mandatory.

So there's additional volumes to come.

And then we expect to continue to win new business as we did this quarter.

I think Snohomish County, Washington was a new e-filing customer.

So I think generally, it can be a bit lumpy, too, especially if larger solutions or larger systems come online or jurisdictions.

But I think kind of mid-teens is the right way to think about that, on average, as growth.

Our next question comes from Rob Oliver from Baird.

First question is for Lynn.

Lynn, I just wanted to ask -- it sounds like you guys got some nice traction with New World and some wins on the public safety side this quarter.

And just wanted to get a sense for you, both near term, tactically, how -- obviously, it's more of a Q4 back-end loaded type of land.

So how you feel kind of headed into Q4?

And then the nature of some of those wins?

And if you're starting to see that kind of federation effect from your Tyler installed base starting to cross-pollinate in terms of wins on the public safety side.

Yes, I think going back to my comments before, I'm pleased with where public safety sits today.

Like a lot of our -- we just talked on the question before about acquisitions and investments.

And we've invested a lot over the years, and sometimes it takes a little bit -- even longer than we think to sort of get that momentum going but the momentum is there.

I mentioned some of the metrics -- we're shortlisted now and more than 90% of our RFPs are new names -- through 3 quarters are up 75% from last year; the size of deals is going up.

Q4 is setting up for a big quarter.

It still tends to be a little bit seasonal that way.

And they have a lot of big deals in the pipeline.

It's a lot of operational execution to try to get all those closed and it's a difficult thing to do.

But sort of stepping back at the 20,000-foot level, all the metrics are trending in the right direction.

The competitiveness is trending in the right direction.

Our products are there.

We're getting the references.

I mentioned from Orlando and Burlington, which are key for -- to move upmarket.

And overall customer sat is in such a different place than it was a couple of years ago.

And you just can't overlook that, making sure that our clients are happy and feel like they're getting value.

As we've talked before, as you guys know, everything we do is out in the public.

Our customers are not competitors, they share everything.

So being successful with your existing base is such a big part of getting the new business and they're just doing a great job.

And I just would add 1 thing on your question about cross-pollination and how public safety is working with other Tyler products.

We're certainly seeing that.

Our public safety solution had not had much success in Texas historically, and in the last year or so, they've had a number of deals in Texas.

I think all of those within jurisdictions that use our Odyssey case management solution on the court side.

Many of our public safety deals include Brazos, our eCitation product.

Mentioned earlier in the remarks that Socrata Data & Insights is being included in a lot of public safety deals, and we expect to go back to our public safety base and add Socrata to a lot of those clients.

So clearly, we're seeing the impact of Tyler on the public safety business.

That's great.

And then just a quick follow-up, Brian, while I've got you.

So the 51% mix on subscriptions this quarter, you've got MicroPact deals that are going to hit this quarter, assuming some of them are going to be perpetual license since it tends to be more perpetual.

And then you've got kind of public safety, year-end kind of skewing perpetual.

How should we think about that mix into Q4?

Well, there's still uncertainty, there's still a lot of deals that are in the pipeline, particularly on the ERP side, where we have -- we're either a finalist or, in some cases, have been awarded but the client is still deciding whether they're going to go to the cloud or be on-premises.

But generally, I think there's 2 factors: MicroPact has a number of license deals that will be in Q4.

Public safety tends to be much more heavily weighted towards license deals today.

And so their seasonality in Q4, both of those tend to trend to Q4 more heavily towards licenses than the cloud.

But having said that, in Q3, and we did see a bigger mix in ERP in the cloud.

So I don't think it's going to be heavily cloud like Q2 was but we still have a fairly wide range on the revenue side.

And the biggest factor there is how some of those deals that are uncertain today fall out.

Our next question comes from Pat Walravens, JMP Securities.

So looking out sort of -- it's a long time, but sort of 5 years to 7 years, right, let's assume we're going to be a lot more in the cloud, and SAP's got S/4HANA and they're doing a public cloud version and Oracle's got Fusion but they bought NetSuite.

For your core ERP, what's the plan?

I mean, are you going to rewrite it so that we have sort of a multi-tenant, true SaaS solution?

Well, Pat, we're -- like I said earlier, we are currently in the process of evaluating all of our core products and trying to get them on the right road map to be able to be more responsive in the cloud and be more first, cloud efficient and then cloud optimized.

Our near term, you look out over the next couple of years, I think we're looking to evolve away from our approach of -- historical approach of being cloud-agnostic as a business model, to perhaps cloud-first as a business model.

But again, recognizing that there's still going to be significant demand for on-premises.

It's a technical, strategic question and I'm not sure I'm ready to give you that product road map right now, but it's something that we're working on intently.

We see where the market's going.

We know the efficiencies of the cloud, not just from a revenue standpoint, but what it can mean for the customer in continuous delivery, continuous improvement, which is (inaudible) part with your multi-tenancy and what it can do operationally as we reduce versions out in the field and stuff like that.

So we're in the middle of all that.

I think you'll continue to hear us each quarter be a little more specific or give a little more info as this strategy unfolds.

But we're going to take our disciplined approach and the way we've done -- tackled the rest of our business.

And I think the direct answer to your question though is no.

We won't be rewriting any of the major apps.

They're all architected in ways that they can continue to evolve to be native cloud, certainly multi-tenant or whatever the specific objective is.

So it's really a matter of priorities that we have functional priorities, quality priorities, user experience priorities and then the technical priorities of evolving toward a more cloud native solution.

And we look at the marketplace.

We work with our sales and marketing people, and we balance those things and make those decisions.

So I think as Lynn's been saying, over the last year or 2, there has been a little more focus, and the pendulum has swung towards attributing more attention and more resources toward cloud native solutions.

So we'll do that.

But all of our major applications can evolve to be entirely cloud-native without a rewrite.

Rewrites are generally not part of the Tyler strategy.

They're not just disruptive to our business, they're very disruptive to the customer.

And so we generally take an approach where we continue to evolve the products without blowing our customers out of the water and delivering this in a nondisruptive way to both our clients as well as our business strategies.

Our next question comes from Mark Schappel from Benchmark.

I've got a question for you on the competitive front.

You have a relatively new private equity-backed competitor that's out there, that's basically been stitched together during the past year or so.

I was wondering if -- given their larger size, if they're starting -- if you're seeing them in more RFPs, if you're seeing any major impact competitively out there?

Mark, so I'm assuming you're -- I think I know who you're talking about.

Two PE firms got together and have acquired a number of assets of significant size.

We're pretty familiar with all those assets.

We've competed with them in the markets for years.

I think if you follow them closely, you probably also know they've got a significant amount of debt.

I think their debt's recently been downgraded.

We see them in the market.

I don't know, generally -- the PE playbook is -- they look a little more at the near term.

We know that what they've been doing is -- has been a little bit disruptive in the market in terms of trying to consolidate product lines, consolidate business BizOps.

So it's been a little bit disruptive in the customer and their employee base.

I heard that a little bit anecdotally.

But our competitive position with them has remained strong as it does with, I guess, all our other competitors.

Our win rates are good across the board.

Great.

And then Brian, a question for you.

This has been an investment year from an R&D standpoint, which has impacted your operating margins.

I was wondering if you could just address in kind of broad brush strokes, the company's longer-term view on the margin front over the next couple of years.

Yes, I'd say, broadly, we expect to be sort of growing into this new level of R&D.

We certainly have had elevated investments -- over the last couple of years, I think R&D has been up more than 30% in each of the last 2 years.

That is starting to level out a bit.

I think our total R&D expense, excluding acquired companies, was pretty flat with last year's Q3.

So I expect that all else being equal in terms of not having other large compelling opportunities to invest internally, that we'll see R&D headcount start to level out and that we won't see that growth of R&D expense that's way above our revenue growth.

And that if you look out over the next few years, we'll see leverage again on that line.

And along with that, that we'll be sort of back on a trajectory of long-term operating margin improvement that's more consistent with what we've seen in -- over a longer period of Tyler's history.

So we do believe there's significant operating margin opportunity ahead of us.

I'd say the other factor that we pointed out on the call as well is in -- generally around the acquired businesses, which really are the biggest reason for the falloff in margin improvement in the last year.

As Lynn talked about, generally we're making investments in the short term after we acquire someone.

Some of that's in R&D and some of that's in operating expense, but those investments are sometimes around the product, sometimes around the integration with other Tyler products, sometimes beefing up their organization to take advantage of the opportunities that they have ahead of them.

And so with the 7 acquisitions we've done in the last 2 years, collectively, those businesses are just about breakeven right now.

So that's a bit of a drag on our margin improvement.

But again, as we get through those initial investments, we expect to see profitability and contribution to margin, where today, they're not.

So yes, if we look out over the next couple of years, margin improvement is still a big part of our story and something that we do have a focus and discipline on and we'd expect to be getting back to that.

Our next question comes from Tyler Wood from Northland.

Right, going back to the AWS partnership and the cloud-native stuff, when you look across your different business lines, the ERP and the public safety, the courts, which do you see as the best fit for cloud delivery and you think will be quickest to migrate?

And then what do you expect to be more gradual and stay on-prem for a longer time?

Well, I think that question has 2 parts.

One is, what's the state of our current products to run more efficiently in a public cloud?

As you know, all the products run in the Tyler cloud today.

The second thing is what is the market calling for and where is the demand?

It's interesting, the shift and move to the cloud, the SaaS, even Tyler Cloud or whatever, it has been increasing.

We've seen a lot on the ERP side.

But we're also seeing it in the other lines.

We're seeing it kind of really across the board.

If you look at large -- recently large court deals, the North Carolina deal we announced last -- we talked about last earnings call, the DC courts deal, Bexar County, all the larger deals are starting to trend that way.

We talked a little bit about, on the ERP side, this North Carolina state-wide schools contract.

All those implementations will be SaaS in the cloud.

In the public safety side, you're seeing more and more receptiveness from the public safety buyer and the public safety user to having their information up in the cloud, whereas I say, 4 years, 5 years ago, that was probably an area that was more reluctant.

So I don't know that there's a specific area where the trend is hotter than the other.

It's just the overall market trend that's moving that way.

(Operator Instructions) The next question comes from Jonathan Ho, William Baird & Company (sic) [William Blair & Company].

I just wanted to maybe touch on the ARR metric and just, I guess, better understand what your broader expectations for maybe what ARR should be growing.

And just given the duration shift in bookings, is this sort of a more relevant metric when we think about sort of the forward-looking performance of the company?

Yes, Jonathan, I'd say, certainly, as we become more and more of our new business coming through the cloud, that the ARR metric becomes more important.

There are a lot of nuances to it around Tyler.

The $10.6 million of new ARR that we talked about this quarter was up 59% over the new ARR last year's third quarter.

That is really around new software bookings.

We certainly have -- we're now 2/3 of recurring revenue.

A big chunk of that is maintenance.

That's not included in that ARR.

It also doesn't include things like e-filing, which are also recurring revenue streams.

So it's really just new software deals from the cloud so it's a piece of it.

And it's hard to predict that growth.

But certainly, our cloud business, our subscription business has been growing in the 20% to 30% range for -- very, very consistently over the last several years and we expect that to continue.

So I think we'll continue to refine that metric and put more emphasis on it but definitely a high-growth piece of our business.

Got it.

And then can you talk a little bit about the reaction from clients and the sales force now that you're a few quarters into this initiative to pursue, I guess, shorter-duration contracts?

Has there been much pushback or have you had to, I guess, change incentives in order to get this through?

I don't believe there's been pushback.

I think it's more in line with most software companies.

We -- in the early days of our cloud business, we were, I think, less -- we -- and this is going back 15 years ago, we and our clients, were newer to it.

We felt like we needed to sign customers up to very long-term agreements.

There's certainly no more attrition in our cloud business than there is in our on-prem.

I guess there's actually somewhat less, although it's on a bigger sample, and we have pretty negligible attrition in general.

So I think it's those kinds of -- the 3-year term that we generally lead with is, I think, pretty consistent with what other vendors provide.

And our customers are comfortable with that.

And so there haven't been really any changes in the sales process.

It's just an evolution to -- these are our standard terms now.

Look, our early cloud strategy -- our early cloud strategy often bundled the deployment services into the annual fee.

So by doing that, we went for extended terms in order to keep the annual costs reasonable.

Over time, as the market matured, and generally, the de facto relationship had services paid for on the side and the annual fee typically was a subscription fee and the hosting fee, it became less necessary for us to require our clients to sign these longer-term agreements.

So that was really an evolution in the relationship we had.

And as professional services became a line item that they paid for on the side, it wasn't necessary so we felt there was no reason to have that hurdle out there in the new business market.

So it's been well received by clients.

Obviously, it gives us some flexibility if the market changes or our cost changes to have some price flexibility down the road.

But the reality is that those increases are very reasonable and have never been anything significant enough to hurt the client.

At this time, there appear to be no more questions.

Mr. Marr, I'll turn the call back over to you for closing remarks.

Okay.

Well, thank you, Nick, and thank you all for joining us on our call today.

If there are any further questions, feel free to reach out to myself, Brian or Lynn.

Thanks again.

Have a great day.