Operator:

Hello, and welcome to today's Tyler Technologies Second Quarter 2024 Conference Call. Your host for today's call is Lynn Moore, President and CEO of Tyler Technologies. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded today, July 25, 2024. I would like to turn the call over to Hala Elsherbini, Tyler's Senior Director, Investor Relations. Please go ahead.

Lynn Moore:

Thanks, Hala. We built on the momentum from our strong first quarter performance to, again, deliver exceptional second quarter results marked by consistently high execution and a continuation of solid operating and financial performance. Each of our key metrics across revenues, earnings, operating margin and cash flow exceeded our expectations. These results are especially meaningful given the significant shift towards SaaS in our new software contract mix, which pressured revenues and margins. Recurring revenues grew 8.4% and comprised 83% of our total revenues. SaaS revenues grew 23.2%, our 14th consecutive quarter of SaaS revenue growth of 20% or more above our target of a 20% CAGR in SaaS revenues through 2025. In addition, transaction revenues were ahead of plan driven by higher transaction volumes, including an increase in e-filing volumes and expanded payment services. Since committing to our cloud-first strategy in 2019, we've been intently focused on supporting our public sector's clients' digital transformation and guiding their migration to Tyler's next-generation cloud applications. Last year, we reached an inflection point where valuable, long-term recurring SaaS revenues surpassed on-premises' license and maintenance revenues. We're pleased to reach another milestone as we have now essentially completed the exit of our Dallas data center. This move is a significant achievement in our cloud migration road map as we continue to scale our deployments at AWS and drive more durable growth and margin benefits from our SaaS-based operating model. The public sector market remains healthy, characterized by high levels of RFP and sales demo activity. Our new business pipeline remains at elevated levels, reflecting the robust market environment, growing cross-sell opportunities and continued strong execution by our sales organization. Our leading market position and competitive strengths, including our deep domain expertise continue to differentiate us in the marketplace. These strengths underpin our long-term strategic focus on four key growth drivers, leveraging our unmatched installed base, expanding into new markets, completing our cloud transition and growing our payments business. Our large client base represents one of our most significant assets, and we're pleased to see strong go-to-market execution with significant cross-sell and upsell wins during the quarter, which included a joint effort with our Justice Group, leveraging our Digital Solution division's strong relationships in Florida, for an agreement with the Florida Department of Corrections to manage all aspects of money transfer services for correctional facilities across the state. The contract brings together disbursement solutions from our Rapid Financial Solutions acquisition, inmate trust and accounting and e-communications from the VendEngine acquisitions and payments through our Digital Solutions division. A single sourced enterprise supervision and enterprise public safety contract with Cherokee Nation, Oklahoma, adding to its existing enterprise ERP solutions. The SaaS agreement was a joint collaborative sales effort resulting in a total Tyler client win. Additionally, we continue to innovate and elevate our clients' resident engagement experience by empowering citizens with direct connections to government through Tyler's MyCivic platform. In Mississippi, we expanded citizen access to mental health resources with the Mississippi State Department of Health, leveraging our state enterprise agreement. We continue to advance our cloud transition and make substantial progress with our product version consolidation efforts, which will accelerate our continued migration of on-premises clients to the cloud. We're also pleased with the numerous second quarter SaaS contract wins, which underscore the public sector market's recognition of cloud benefits, including enhanced security. One of the key themes that emerged during client interactions at our recent Connect 2024 user conference was a notable shift in client openness to embrace cloud technology and a growing expectation among on-premises clients that they will migrate to the cloud. This shift is especially apparent in the state and federal market with our application platform and in the public safety market, where 90% of second quarter public safety contract value was SaaS compared to 13% a year ago. Primarily as a result of this accelerated shift in public safety cloud adoption, SaaS arrangements comprised 97% of our new software contract value in the second quarter. Additionally, we signed 111 flips of on-premises clients, including a number of larger clients, with the average ARR flips growing 21.8%. We also had a very successful go-live in May with the SaaS migration of the Idaho State Court system. This is our first flip to the cloud of a statewide court system, and Idaho went live just four months after the project kicked off. This high-profile migration has been watched closely by other statewide and large county courts and its successful execution is certainly a positive reference point as we engage with other large core clients about moving to the cloud. Key second quarter new SaaS deals and flips included a competitive win with the City of Topeka, Kansas for multiple integrated solutions, including enterprise ERP, enterprise permitting & licensing, enterprise asset management for nearly $700,000 in ARR. And ERP Pro and Payments contract with Richland County, Wisconsin, funded via ARPA funds. That was executed on an accelerated 90-day sales cycle, leveraging our enhanced sales enablement and competitive intel teams. The Idaho State Police signed a SaaS contract for our integrated enterprise public safety suite including CAD, records management and e-citations. This Tier 1 competitive win demonstrates our growing momentum with state public safety agencies and represents the sixth state police agency to adopt our enterprise public safety solutions. The United County, New York Department of Emergency Services also chose our integrated Public Safety Suite for 64 agency client-driven, SaaS deployment. Hunt County, Texas, upgraded to Enterprise Public Safety from our Public Safety Pro solution and Spotsylvania County, Virginia, signed a contract for our enforcement Mobile Solutions, joining eight of the 14 largest Virginia agencies using Tyler Public Safety applications. We signed an enterprise justice SaaS flip with Fulton County, Georgia, which includes Atlanta. The contract with ARR of $1.9 million follows Fulton County's Enterprise appraisal and tax SaaS flip signed in the first quarter, and includes integrated justice solutions such as prosecutor and jail as well as additional client management services under our unified One Tyler approach. We also signed an enterprise supervision expansion with the Arizona Supreme Court that builds on the success of adult probation to add juvenile probation for all 15 counties across the state. We leveraged the state relationship, which led to a five-year enterprise justice agreement with the Phoenix Municipal Court, representing in excess of $2.25 million in ARR. This strategic and highly competitive win includes five one-year extension options and paves the way for expansion and new court software opportunities in a large population state. Another theme coming out of Connect '24 was pronounced interest in AI and our expanded AI capabilities that were added through our 2023 acquisitions. High interest is turning into multiple new deals and cross-sell wins for our application platform, leveraging our augmented field operation solutions, formerly ARInspect with four inspection SaaS arrangements in the quarter across state, environmental, health and regulatory agencies. These included the California State Board of Pharmacy to configure and automate five regulatory inspection types, the Kentucky Department Environmental Protection, the New York Department of Health and the Arkansas Department of Labor and Licensing, which was a cross-sell win leveraging our Digital Solutions division state enterprise relationship. Another key to our growth strategy is expanding our differentiated payments business. And similar to our first quarter results, higher transaction volumes contributed to better-than-expected transaction revenues. In the second quarter, we signed 195 new payments deals across Tyler Software clients, representing approximately $8 million in projected ARR. In our state enterprise portal business, we secured extensions for our digital government and payment processing services under four state enterprise contracts, including Hawaii, New Jersey, Kansas and Kentucky and also won a sole source award with the state of Rhode Island as no extensions remained under the previous contract. We also signed a two-year renewal with the state of Illinois for our Outdoor and Enterprise Licensing Solutions. Now I'd like Brian to provide more detail on the results for the quarter and our updated annual guidance for 2024.

Lynn Moore:

Thanks, Brian. Our exceptional performance in the first half of 2024 positions us well for a strong second half. We're pleased with our progress across all fronts as we remain on track with key initiatives around our four-pronged growth strategy while demonstrating our competitive strength and model durability. Our cloud transition is beginning to generate the expected benefits of margin improvement and enhanced client experience. As you know, in 2019, we launched a multiyear cloud strategy to shift our solutions and operations to a cloud-first business model, leading our clients to a future in the cloud. As we enter the next phase of our cloud journey, and as more new and existing clients embrace our cloud strategy, we see increasing opportunities to prove areas critical to our clients that ultimately affect client satisfaction, including product release cycles, product consistency, performance reliability and cost effectiveness. To effectively address these areas and lead this change, I'm pleased to share that Russell Gainford has been promoted to Chief Cloud Officer, effective immediately. Over the past three years, Russell has proven his ability to own the overall vision for Tyler's cloud-first strategy. And in his new capacity, he will continue to drive our cloud initiatives across our organization, including developing our cloud technology and operation standards, controls and business processes, overseeing our strategic business partner and vendor relationships as well as architecting the organizational design and staffing plans in collaboration with operational leaders. Shifting to capital allocation. Our disciplined approach bolsters our strong balance sheet as we've repaid our term debt during this period of higher interest rates. This coupled with our ability to consistently generate strong free cash flow provides tremendous flexibility to take advantage of opportunities to make investments that drive shareholder value, including product development, M&A and potentially stock buybacks. And while the bar is currently high for acquisitions, we continue to evaluate strategic tuck-in acquisitions, while building liquidity to be in a position to address our convertible debt maturity in March of '26. I'm also pleased to highlight that Tyler recently was recognized by two leading publications as we were included on Times list of America's best midsized companies and Forbes' Best Employers for Women's list. Before I close, I'd like to welcome our two new board members, Margot Carter and Andy Teed, who were elected at our May 9th Annual Meeting. Margot brings a wealth of experience in cloud software and SaaS transformations, AI and payments. She currently serves as President of Living Mountain Capital, where she invests in and advises companies and private equity firms on digital transformation and innovative strategies. She has an extensive background in finance M&A and corporate governance and has served on several public company boards. Andy is a seasoned technology executive with significant public sector experience. He currently serves as the CEO of Eco Parking Technologies, an integrated lighting and parking guidance company. Prior to that, Andy spent nearly 20 years at Tyler in various senior leadership roles. His extensive public sector experience and familiarity with our products and clients along with his knowledge of cloud technologies, make Andy a valuable addition to our Board. I also want to thank our two outgoing Board Directors, Dusty Womble and [Mary Landro] for their years of service and contributions to Tyler's success. Finally, I'd like to express my appreciation to our entire Tyler team for their hard work and continued commitment to driving growth while leading our clients on their digital modernization journeys. Our leadership is aligned with a unified focus on cloud living, and I've never been more confident in our prospects and Tyler's future. Now, we'd like to open the line for Q&A.

Alexei Gogolev:

Thank you, Brian. Congratulations with great results. Brian, I was wondering the components of higher CapEx, what were they? If you could elaborate on that? And why are we seeing some decline in R&D? And does this have anything to do with your plans to reallocate certain R&D components? Remember, you were saying you were planning to do that for COGS going into OpEx?

Alexei Gogolev:

Understood. And then the second one about your AWS contract renewal. Could you elaborate on the potential benefits to gross margin and whether you think there will be a one-off benefit or you expect to unlock more discounts as you progress through the contract?

Operator:

Next question is from the line of Matt VanVliet with BTIG. Your line is now open.

Lynn Moore:

Yes, Matt, it's a good point. We are seeing more momentum, certainly more cross-sell momentum in that state space. I think it's a testament to our DSD division's long-standing relationships and really our enhanced focus on leveraging those these last couple of years. There's things that we've done. We've talked about in the last couple of earnings calls around compensation and sales commissions and also executive leadership compensation that sort of try to break down some of those barriers and enhance those cross-sell opportunities. We are seeing more and more multiproduct deals. I think I referenced a few in my notes earlier. And that again, that's just -- it's a testament to what we've been -- what I've been sort of calling for the last couple of years, this vision of one Tyler operating more as a singular unified company, breaking down any sort of internal barriers that might have been just a slight hindrance in the past around cross sells and upsells. And I think we're starting to see that pay off as relationships are continuing to forge and as they start to become more and more productive.

Rob Oliver:

Great. Lynn, my question is for you. Just a pretty rapid and somewhat stunning, I guess, I would say, having followed you guys a long time increase in public safety's willingness -- public safety’s customers willingness to adopt the cloud. And you guys clearly are right there to address that opportunity. I was just wondering this is one of the areas within core Tyler that has been historically the most competitive. And I think somewhat of a modest concern for investors. I was hoping you could address the extent to which this cloud move is really underscoring competitive advantages for you guys, perhaps the relationship with AWS as you take a sector of your market that historically was somewhat more reticent to move to the cloud, how that is helping you? And then as you look at that public safety pipeline where you see sort of current Tyler customers and where that cross-sell advantage might be?

Operator:

Next question is from the line of Michael Turrin with Wells Fargo. Your line is now open.

Brian Miller:

Yes. I don't think there's anything particularly seasonal around the pace of those, both the timing of new deals and especially the timing of flips can be a little bit lumpy. So, we certainly expect the trend to continue to be over the mid- and long term for the number of flips and the size of flips to continue to increase. That was one of the big factors this quarter was that the average ARR from flips this quarter was up almost 20%, and we highlighted some of those larger flips that are taking place. But I think in general, obviously, we're at a very high percentage of SaaS at 97% of the new business. I think public safety still will have some license deals in the second half of the year. And so that may even fall back a little bit. But the trend that Lynn just described is certainly continuing of greater acceptance of SaaS and public safety. So, I think you'll continue to see the flips trend upward, although they may bounce around a little bit from quarter to quarter and that the continuing -- the vast majority of our new deals coming in and SaaS will also continue.

Operator:

Next question is from the line of Charles Strauzer with CJS Securities. Your line is now open.

Brian Miller:

I don't think there's a whole lot at a very high level, I think you'll continue to see revenue step up a bit from where they were in the second quarter, particularly around professional services, we'll continue to see grow a bit. SaaS will continue to see growth sequentially. I think the biggest growth in the second half will be, as you'd expect, SaaS revenues continue to step up quarter-to-quarter as more new customers come online and as we execute more flips and we get the impact of those revenues. The other revenue lines, I think generally, you'll see be fairly consistent with where they were in the second quarter across the third and fourth quarters. And dropping down to the bottom line, I think you'll see earnings generally in the same range that we see in the second quarter in the third and fourth quarters. And cash flow, certainly, the third quarter historically is by far our strongest cash flow quarter because of timing of maintenance collections and that will be the case as well.

Alex Zukin:

I'm going to try to link a few threads and just throw something out there, which is it seems like your -- the flips are happening faster, they're larger. You're promoting somebody to run cloud full-time immediately. And so, I guess my question is, does it feel as though the value of that maintenance portfolio, the value of these flips given even the attach rate and the expanded portfolio of other services that you're cross-selling and the transactional revenues, is it just growing -- like if you look at the value of that pipeline, is it a lot larger than maybe what you were previously anticipating? And kind of how do you see that -- how should we think about that playing out in the P&L over the course of the next year or two?

Operator:

Next question is from the line of Saket Kalia with Barclays. Your line is now open.

Brian Miller:

Yes. I think, and obviously, the change from the sort of low single-digit growth in the first half to the mid- to high teens in the second half, mostly revolves around that, the impact of us lapping the gross to net change from one of our state contracts midyear last year. But if you break down that kind of high teens growth, I think, generally, sort of the -- and it's a high level, but the sort of the same same-store growth or the same customer growth is typically kind of high-single digits, maybe approaching 10%, but kind of in that range is how we think about it. Some of that around our Digital Solutions division state contracts where they either have higher transaction volumes or we add additional services in a state that drive more revenues with that same customer. And then the difference going up into the mid- to high teens is sort of our new customer growth, and that's really reflecting the impact of driving the payments platform into our local government customer base and attaching it to both new and existing software customers. And we've talked about those being higher margin, higher premium pricing kinds of engagements. And those are the ones we're talking about. For example, this quarter that added $8 million of new ARR from new payment customers in our -- associated with our software customers. So, that's kind of generally how we think about that split.

Operator:

Next question is from the line of Terrell Tillman with Truist. Your line is now open.

Lynn Moore:

Yes. Good question, Terry. On the Idaho SaaS flip, our courts -- there's only so many state court implementations out there. And so, getting the first one out there on time, live and referenceable was a pretty impressive feat by our people. And I'm going to make a little sidebar comment because we've talked about it before over the years. But I think one of the things that's really impressive about our teams is all the work that we do behind the scenes. We talk a lot about the numbers, but there's a lot of work that goes into getting these clients up and actionable, whether it's a SaaS flip or even just a new implementation, and our teams just did an incredible job. And as you know, this entire business is a reference business. And there were a lot of state courts who had inquired, have been asking about the SaaS flip, but they all were sort of keeping an eye on Idaho. So do I expect that to translate into other large, statewide SaaS flips or just other large court SaaS flips, I do. I'm not going to say that they're going to start happening in the month of September. But I think as you look out over the coming quarters, you'll start to see that momentum grow and build in that market?

Lynn Moore:

Yes, there's a lot of buzz for these out in the marketplace, Terry. And as Brian said, it's kind of twofold. On the one hand, it's a great playbook that we've run for many years, a tuck-in acquisition that we can get in the hands of our sales teams and get out to our installed base but also in areas like ResourceX, for example, I mean, it's a differentiator for us in our new enterprise ERP sales. So, it's both a competitive advantage in new sales but also a huge opportunity to deploy through our installed base.

Josh Reilly:

Just on the Dallas data center closure, can you just remind us in the income statement where the expenses for that data center lie? And what's the implication for our second half modeling with that shutting down? And then just secondarily, along the margin front, can you just give us some color on what drove the margin improvement in services?

Lynn Moore:

Yes, I'd say -- I'd add to that, Josh. One of the things that's gratifying to me is we outlined this vision of closing the data centers a couple of years ago, and we're basically hit it on track. And that takes a lot of work by a lot of people. And again, it continues to validate some of the things that we've outlined a couple of years ago as we started our cloud transformation. So that's gratifying to see. The other obvious upside of getting out of the Dallas data center and eventually out of the [indiscernible] data center is all the future CapEx savings. We would spend a lot of money over the next five, seven years, adding to those capabilities had we not done that. Your question on pro services gross margins, it's a couple of things. I would say, one, it's been an enhanced focus, sort of a top-down focus from the management team over the last year plus. It's something that we're dissecting and continue to dissect and look at things around really focusing on those gross margins, utilization, things like that. The other thing that's been driving it is we're starting to see a little more stability in our workforce, and we've been seeing that for several quarters. So turnover is a lot lower. And in the Pro Services area, when you experience elevated turnover, which we did coming out of COVID, we did during sort of that period post COVID when people were transferring out and going through -- the grass is always greener. It's tough because it takes a long time to get people trained, up to speed and get to a point where they can be out in the field and be billable. And so, I think it's part of what we're seeing overall in the labor market. But having that return of more stability and more consistent, historical Tyler turnover levels is certainly helping. But it's also been an enhanced focus from the management team.

Lynn Moore:

And to that point, Brian, I guess, remote delivery of services, it's something we really started around COVID and clients continue to have more and more acceptance of that delivery model.

Peter Heckmann:

Most of my questions have been answered. I just wanted to follow up on the NIC transaction and just see if you're seeing any changes in terms of those self-funded, state-level IT portal deals. If the states are looking for something different, something more and then just curious about the -- it looks like you had good renewal activity here in the first half. But do you -- I guess, what's your perception of other states migrating to that self-funded portal model in the future? Or do you think it's more likely that you do something more on an agency-by-agency basis at the state level?

Operator:

Next question is from the line of Jonathan Ho with William Blair. Your line is now open.

Lynn Moore:

Yes, Jonathan. I mean, as we know, it's a reality. We always say it's even -- it's not a matter of if, it's when. And cybersecurity event has certainly impacted both our clients and other public sector agencies that aren't our clients. It is a natural opportunity to accelerate discussions around moving to the cloud and flipping to the cloud. We've had a number of those. We don't necessarily -- I talked about a couple of public safety that happened last quarter. I don't really like to highlight them too much. but that's -- it's a reality that's going on in the market. And one of the things that I think we're getting better at is as we're flipping clients to the cloud for whatever reason but certainly in the cyber -- as a result, cybersecurity is, it is an opportunity to get them more modern and add some more products in the mix. So again, it's out there. we're all dealing with it. And our goal really is to be as responsive to our clients as possible, and we've gotten better. I've mentioned at public safety -- we've also gotten better about being able to stand up clients really quickly, maybe not with the full functionality that they might have had in an on-premise system out of the box but enough to get them going, which also gives us an opportunity to sort of reevaluate all of their requirements and potentially upsell other items. And so yes, it's just out there.

Kirk Materne:

Yes. Congrats on the quarter. Lynn, I was wondering, on the public safety side, when customers are now flipping in a bigger way towards cloud, how does that change the competitive environment for you? Meaning, I'd imagine there are a lot of smaller competitors that don't necessarily either have the scale on the cloud side or potentially or as advanced as you all, is that leading to better, I guess, win rates in that particular segment of your business as well?

Operator:

Next question is from the line of Gabriela Borges with Goldman Sachs. Your line is now open.

Lynn Moore:

Yes. I don't know that -- yes, we -- for a lot of our clients are on June 30 fiscal year. But I don't know that we necessarily have significant insight in those budgets. They're pretty steady. They're pretty healthy. Most of our sales procurement cycles are multiple years long or certainly long, not all multiple years but they tend to be lengthy. I think -- I'm sorry, I lost my more train of thought there. So yes, I think the budgets are healthy right now. And I think our win rates are good. One of the things that I've -- we have noticed this year is, I think, probably a leading indicator is when you look across our product lines, all of the indicators are still strong. And really, most of our divisions, almost all of our products are either at or above sort of what their sales projection was for the year in terms of being midyear. So that's a good tailwind as we look out over the next several quarters. And right now, we're not seeing any -- certainly no negative changes in the public sector budgets.

Operator:

Next question is from the line of Mark Schappel with Loop Capital Markets. Your line is now open.

John Marr:

Yes, sure, Mark, obviously, version consolidation has been a big part of what I've been calling sort of Phase 1 of our cloud transformation. Phase 1 is selecting AWS. It's a product optimization, it's version consolidation. It's the flips, it's exiting the data centers. Version consolidation is critical for a lot of reasons. One is we need to get down to a single product. We need to get down to a cloud release. We need to get our clients up-to-date on the modern versions. Otherwise, they're not really going to be flipping the cloud. That's part of the foundation for that. We don't really go I don't know that you see necessarily quarter-by-quarter progress, but you see goals that are being hit and attained. Anecdotally, for example, in our enterprise ERP division, which is formerly our munis product we now have about 95% of our clients down on a single version, whereas a couple of years ago, there were several versions with maybe hundreds of clients on different types of versions. So that's significant progress that's been made, and it's a focus across all of our divisions and all of our operating units, and they're making similar progress.

Lynn Moore:

Thanks, Matt. And thanks, everybody, for joining us today. If you have any further questions, please feel free to contact Brian Miller or myself. Thanks, everybody. Have a great day.

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. [Operator Instructions] And as a reminder, this conference is being recorded today, April 25, 2024.

Hala Elsherbini:

Thank you, Christa, 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.

Brian Miller:

Lynn, total revenues for the quarter were $512.4 million, up 8.6% and organically grew to 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.

Operator:

[Operator Instructions] And your first question comes from Rob Oliver from Baird.

H. 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.

Operator:

Your next question comes from the line of Saket Kalia from Barclays.

H. 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, may be 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.

Matthew VanVliet:

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 flips side [indiscernible] Public Safety or maybe holding you back [indiscernible] the case for or, 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?

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.

Operator:

Your next question comes from the line of Ken Wong from Oppenheimer.

H. 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 -- 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 ProServe 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.

Alexei Gogolev:

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?

Operator:

Your next question comes from the line of Joshua Reilly from Needham & Company.

H. Moore:

Yes, Joshua, 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.

Operator:

Your next question comes from Clarke Jeffries from Piper Sandler.

Brian Miller:

Yes. It's not so much of the capacity. 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.

H. Moore:

Yes. Clarke, 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.

Michael Turrin:

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.

Jonathan Ho:

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?

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 traffic 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.

Operator:

Your next question comes from the line of Keith Housum from Northcoast Research.

H. 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.

S. Kirk Materne:

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.

Operator:

Your next question comes from the line of Gabriela Borges from Goldman Sachs.

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 sort of 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 payments-only type contracts.

Operator:

Your next question comes from the line of Mark Schappel from Loop Capital Markets.

John Marr:

Yes. The ARPU 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 sort of 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.

Operator:

Your next question comes from the line of Terry Tillman from Truist Securities.

H. 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 3 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 3 of these clearly ticked that box. I think the acquisition of CSI probably has a little bit bigger near-term market opportunity. The RexourceX 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.

Brian Miller:

And collectively, those 3 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.

Aleksandr Zukin:

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?

Aleksandr Zukin:

And I usually never asked 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?

Operator:

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

Operator:

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

Operator:

Ladies and gentlemen, thank you for standing by. Hello, and welcome to today's Tyler Technologies Fourth Quarter 2023 Conference Call. Your host for today's call is Lynn Moore, President and CEO of Tyler Technologies. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time [Operator Instructions]. As a reminder, also, this conference is being recorded today, February 15, 2024. I would like to turn the call over to Hala Elsherbini, Tyler's Senior Director of Investor Relations. Please go ahead.

Lynn Moore:

Thanks, Hala. Fourth quarter results reflected a strong finish to a pivotal year in our cloud transition and return to year-over-year operating margin expansion. We achieved our key objectives for the year, and earnings and cash flow surpassed our expectations with free cash flow representing a new high for a fourth quarter. Recurring revenues grew 8% and comprised 84% of our total revenues. Our SaaS mix continued to accelerate and comprised 89% of Q4 new software contract value. The quarter was also highlighted by SaaS revenue growth of 21.7% and represented our 12th consecutive quarter of SaaS revenue growth of 20% or more, exceeding our near term growth expectations of a 20% CAGR in SaaS revenues through 2025. Transaction based revenues were impacted by seasonal trends and contractual changes in one of our state enterprise agreements that included a change from a gross to a net revenue model for payments. I want to remind you of the significance of pass through merchant fees in our payments business and how they impact both revenue growth and margins. The majority of our payment processing arrangements are accounted for under a gross model where we charge a fixed percentage of the transaction and are responsible for the merchant and interchange fees. Under this model, merchant fees are reflected in both revenues and expenses with the resulting drag on margins. In a smaller number of arrangements, the client is responsible for paying merchant fees directly and we record revenues on a net basis. We do not control which model the client chooses, although, we expect that the majority of payment processing contracts will continue to be under the gross model. Throughout the year and during the fourth quarter, we continued to make solid progress with key initiatives around our cloud transition. We started to realize the benefits of our cloud optimization efforts as we released cloud efficient versions of many of our products and began to experience hosting cost improvements as we scaled our deployments at AWS. These efficiencies related to our cloud operations contributed significantly to our year-over-year operating margin expansion in the fourth quarter. Cloud adoption with both new and existing on premises clients continued at an accelerated pace across our product portfolio. In the fourth quarter, the number of on premises migrations or flips signed was a new fourth quarter high at 92. The increased SaaS adoption in 2023 was particularly notable in the public safety market where we have seen a significant increase in SaaS adoption with new clients as well as signing our first flips. We also signed an expanded multiyear strategic collaboration agreement with Amazon Web Services to further enable the growing demand for our clients and public sector agencies to move to the cloud. Under the expanded agreement, we will jointly expand our framework and share programs to streamline migrations from on premises solutions to our next generation cloud applications. This is another major step forward in making the cloud accessible for our clients, further improving business continuity, continuous delivery and enhanced security. It also supports our Tyler 2030 vision to complete our transition to the cloud. The public sector market remains very healthy as evidenced by our elevated levels of RFPs and sales demo activity. Our pipeline reflects the benefits of a heightened level of sales collaboration across our division, driving strong upsell, cross sell and multi-suite deal momentum. Additionally, we continue to build sales synergies across Tyler with our integrated payments team as we execute our unified payment strategy. I'd like to highlight some of our significant fourth quarter wins. Our new transaction based contracts included a landmark win with the California Department of Parks and Recreation for our integrated outdoor recreation platform. This transaction based eight year contract is the largest transaction based arrangement in Tyler's history. This self funded contract, which is provided at no cost to California taxpayers, is valued at an estimated $175 million and includes two one year renewal options. It extends our existing relationship under our 2016 agreement, formerly as US eDirect, with enhanced functionality to add Tyler's end to end payment solution, enabling everything from reservations booking to payment processing. We are honored to be chosen to have such a key role in managing the nation's largest state park system. We also added to our growing footprint in outdoor recreation with a multiyear transaction based contract with the Wyoming State Parks and a SaaS arrangement with the City of Miami, Florida. We continue to execute on cross sell opportunities through our digital solutions, formerly NIC, state enterprise agreements that enable enhanced resident engagement across multiple public sector services. We signed two contracts under our state enterprise agreement in Mississippi as part of our newly launched resident engagement platform using Tyler's MyCivic platform. Working with the Mississippi Attorney General, we launched the Mississippi Access to Maternal Assistance mobile app, which includes the program's Web site and MyCivic platform to bridge access to public and private services across the state. We also signed an agreement with the Mississippi Department of Mental Health to develop a mobile application on our MyCivic platform that will allow the agency to provide useful mental health information to Mississippians affected by mental illness. We continue to build momentum in the public safety market with strong fourth quarter contract activity. Significant contracts included several competitive wins against a key competitors, making 2023 our most successful new business year in public safety since we acquired New World Systems in 2015. We also experienced a significant increase in SaaS adoption of our public safety solutions with SaaS comprising 46% of our fourth quarter public safety deals. Existing on premises public safety clients are also showing heightened interest in moving to the cloud, and three public safety clients signed contracts in the fourth quarter to flip to the cloud. The City of Klamath Falls, Oregon embraced the cloud first strategy signing a contract for a SaaS deployment for integrated enterprise public safety suite, which includes the full suite of our public safety solutions, including Enterprise Records Management, Jail Manager, Fire, electronic patient care reporting, civil process, e-citations and analytics. Our recent contract signed in Q2 with the Oregon State Patrol serve as a strong reference for this competitive win. Other notable public safety deals included a SaaS contract with Santa Rosa County, Florida and on-premises contracts with Rensselaer County and Wayne County both in New York. We also had a significant cross sell win under our state enterprise agreement in Arkansas for a public safety solution for Pulaski County, Arkansas. In the court space, we signed our first SaaS flip of a statewide court system with the Idaho Supreme Court. This five year agreement includes migrating the court's 44 counties and 200 courtrooms from on premises deployments to our SaaS offering. Our largest new SaaS deal in the quarter was with the state of North Carolina where we extended the term of our existing court SaaS agreement for five years and expanded the agreement to add our solution for appellate courts. We also achieved key operational milestones in Courts & Justice during the quarter, including the successful go live of our Enterprise Justice solution with the LA County Criminal Courts. This completed the countywide rollout across 35 court locations in the nation's largest court. With our application platform, we secured a key SaaS win with the Virginia Department of Education to upgrade its enterprise state regulatory system and modernize its citizen portal. The system will support the management of Virginia's child daycare programs, which are transitioning from the Department of Social Services to the DOE. During the fourth quarter, we also signed 172 new payments deals, bringing the total to 600 for the year. We also signed a new state enterprise contract in Maryland following a competitive rebid of our expiring contract as well as an extension of our Oklahoma enterprise agreement. Finally, as noted on our last call, we completed the acquisitions of ARInspect and ResourceX in October for a combined purchase price of approximately $37 million in cash and stock. We're pleased to see multiple early wins for application platform leveraging field operations and inspection capabilities that came to us through ARInspect. Now, I'd like Brian to provide more detail on the results for the quarter and our annual guidance for 2024.

Lynn Moore:

Thanks, Brian. We entered 2024 with tremendous optimism and confidence in the year ahead and beyond as we execute our mid to long term strategy supporting our Tyler 2030 vision. We expect to return to a trajectory of consistent operating margin expansion in 2024 as we increasingly realize the benefits of our cloud optimization initiatives and execute our planned exits from our two proprietary data centers in 2024 and 2025. We continue to leverage our competitive strengths and demonstrate the value of our deep domain expertise across the broadest, most integrated offerings that are uniquely focused on the public sector, while empowering our clients who serve the public through Tyler's next generation cloud applications. Finally, we are proud to be recognized by Government Technology Magazine as a GovTech 100 company for 2024. This marks our 8th consecutive year being recognized for our work in making a difference for government through technology. Now, we'd like to open the line for Q&A.

Ken Wong:

I wanted to maybe just touch on the accelerating pace of flips going into '24. On one hand, like I think that's a fantastic initiative. You guys are also dialing back or at least decelerating the pace of sales and marketing growth or SG&A, I guess, I'm modeling maybe mid single digits. I guess, what's the confidence in being able to accelerate that pace while also maybe not leaning in as aggressively on the sales and marketing side?

Lynn Moore:

Just a follow-up on that. I mean when we outlined our Tyler 2030 vision, we obviously -- we've got some goals around flips over the next six, seven years. And we also have goals on on some of our G&A initiatives. So I think those are both tracking right now in line and with our expectations going forward.

Lynn Moore:

I think there's still room to go and there's a lot that goes into that. We're continuing to optimize our products and find ways for them to run more efficiently. On the other side of it, we're also seeing -- continuing to make strides in our version consolidation, particularly with our major product lines. We've seen, over the last 12 months, significant version consolidation in two of our larger flagship products, and that will continue to contribute efficiencies as we go forward, as well as with some of our other products that are out there.

Saket Kalia:

Lynn, maybe for you, just along those lines. I was wondering if you could just go one level deeper into the latest agreement with AWS. And maybe the question is, how does the new agreement maybe change what you had previously and how can that sort of continue to support the profitability growth that we're clearly seeing?

Saket Kalia:

That sounds like a win-win for everybody. I'll stick to the one follow-up and Brian, maybe it's for you. Great to see Tyler reach the 17% to 19% free cash flow target. I think one year ahead of schedule, and you correct me there if I'm wrong. I know we're not speaking to 2025 necessarily on this call, but maybe conceptually, how do you sort of think about free cash flow margin expansion versus EBIT margin expansion? Should those two things move largely in the same range or is there any reason to think that one should expand faster than the other? Does that make sense?

Operator:

Our next question comes from the line of Joshua Reilly from Needham.

Lynn Moore:

Josh, right now, I would say I'm confident in both our 2025 and our 2030 projections just from overall what I'm seeing in the business. As Brian remarked or pointed out in the opening remarks, a couple of things impact revenue growth this year, and one really is the flat to slightly declining merchant fee growth. So when you pull out merchant fees, our growth is really more in the closer to mid-9s, probably 93%, 94%, it's about 90 basis points and those tend to fluctuate. And part of that is, as Brian mentioned, due to one of our large state enterprise contracts flipping from the gross to net model. Overall, as you pointed out, I mean, what we're seeing in the markets right now, the demand, the number of new business deals we're signing, our competitive position, wins against really some key large Tier 1 competitors are the things that really give me a lot of confidence. We recently had our national sales meeting really dive deep into sales forecast, not only for the next 12, 24 months, but even beyond. And right now, things look pretty good.

Lynn Moore:

Yes, I think it's hard to say, Joshua. All of our global submarket’s a little bit different and the courts market, for sure, it's an area where people may be a little reluctant to go first. So getting Idaho there and going, eyes are going to be on it. And I think as we successfully pull off that deal, I do think it will trigger more throughout the courts community. As you know, everything we do is reference business. But particularly in these larger state wide deals our state corp business, I think all the other states are watching Idaho. So we need to do what we do best, which is go and execute on the business and go make it a great experience. And I do think that will be a domino that will ripple throughout the client base.

Connor Passarella:

This is Connor Passarella on for Terry. I also just wanted to ask one on the Idaho state court deal. First, could you maybe just break down how we should think about this deal playing out in the model, and maybe what the time line looks like for getting a large court system like this live in terms of the courtrooms and the counties and kind of how it all works with getting to cloud?

Lynn Moore:

I think about midyear is -- because that midyear is when we expect to start to bring them up into AWS. And that uplift is included in our guidance for the year, but it's a couple of million dollar uplift from what they were paying in maintenance.

Brian Miller:

As we've talked about, one of our state contracts actually midyear changed from gross to net. So we had that impact in the second half of this year and it also impacts us in the first half of next year. I think the overall impact for the second half of the year was in the $9 million to $10 million range. The first half of next year, because is, I believe, somewhere in a similar range. And that was probably split between Q3 and Q4 but probably a little bit more of that impact was in Q3, but there was a several million dollar impact on the quarter.

Matt VanVliet:

I guess on the deal with the California Parks division there, you talked about it being exclusively funded through transaction revenue. Maybe just help us think about kind of I guess, not only maybe what the contractual minimums might be there, what's sort of embedded in guidance? How much potential upside is there to what's embedded in guidance? And then maybe more importantly down the road, do you envision other states trying to take on approach more like this, where there's less contracted SaaS revenue and more funded through the program itself?

Brian Miller:

Just to say, your point is good, because it isn't a fixed SaaS fee that the transaction revenues are currently an estimate. And we think we have a pretty good idea of what volumes will be, but they may vary from that. And it will -- currently in the plan for this year, we expect a few million dollars of revenues and then it ramps up to that north of $20 million starting and it will be approaching, we think, $20 million next year and then be north of $20 million beyond that as volumes increase and it becomes fully ramped. But yes, it is subject to variances and subject to seasonality as well unlike a regular SaaS contract that is a pro rata revenue recognition every quarter. This will also have seasonality and it's around those as we do in many of our outdoor transaction revenues.

Lynn Moore:

No, I think there's still more leverage. And I think generally going forward, we make certain commitments to AWS, and we're making those commitments based on projections. But we're continuing, as I mentioned earlier, to further optimize our products, further reduce our versions. I think the leverage in our cloud operations still has quite a bit of room to go.

Operator:

Our next question comes from the line of Gabriela Borges of Goldman Sachs.

Lynn Moore:

You're right. Kelly, our flips in Q4 were actually up about 12% over Q4 last year. We're not putting out guidance as far as I know, Brian, on specific foot deal count. There's a lot of things that go into that. And as you look out to 2030, the goals we outlined, clearly, we will be ramping up as over time. There's things that go into the flips and a lot of it is, we have to get our customers on more modern versions. And when I talk about our version collapse efforts that have been going on for several years but some of the strides that we've been making, as we continue to make strides on that, it will make -- it will help accelerate the pace of flips going forward.

Unidentified Analyst:

A quick follow-up. On that version control point, you mentioned last quarter, you had the goal kind of by the end of 2022 or early 2024 of only supporting two of the most recent versions of each product. Where are you at in kind of achieving that goal?

Operator:

Our next question comes from the line of Rob Oliver from Baird.

Lynn Moore:

Rob, it's actually -- it's very interesting and to your point, gratifying to see this shift. And we've been anticipating it, but we just didn't know when it was going to happen. I think we mentioned in the opening remarks, about 46% of our Q4 deals were cloud deals in public safety, that's up from 16% in Q2. And as we look out next year, we think it's going to cross 50% and we're sort of planning on a little north of 50%. We're taking an approach that now with public safety as we see the market receptiveness start to be, it's an approach that we took generally with Tyler going back four, five years, which is, going forward, we really want to be leading to the cloud. We think the market is ready. As it relates to competitors, I'm not going to list all the different competitors in public safety. Obviously, we've had a few pop up in the last couple of years that were more cloud native already. Those have been a little bit smaller competitors and they have had their own set of issues to deal with. I think that we are well positioned with our cloud strategy in public safety to take advantage of this market shift. We have new leadership at public safety. If you've been on our Web site, you might have seen a new division president that came on last year, came from outside of Tyler. He's actually has led -- been a part of leading companies through the cloud transition. So it's exciting to have him there, have him up in Troy with the people and really sort of helping lead those efforts. So I like where we are, like where we sit. And to reiterate your words, it's gratifying to see these early results. But a lot of things I'm going to caution is a lot of things to go execute on in the future, but it is good to see this shift starting to happen in public safety.

Brian Miller:

I mean, I think it continues to be a lot of development around the cloud and our optimization and efficiency efforts around optimizing our products for the cloud. There is a shift from some R&D that was previously being capitalized, especially around some of the cloud projects that will now be expensed. So a lot of it is the same people but now running through expense as opposed to being capitalized. And that's -- obviously, it doesn't change our cash flow but it changes where it turns up on the income statement. So I think it's important to note that we are expecting to drive margin expansion even as we have a movement away from capitalized software development and to more R&D expense.

Charles Strauzer:

Looking at the guidance, especially as it pertains to the quarters. Are there any abnormalities that we should take into account as we build our models out?

Charles Strauzer:

And then just more of a macro question for you, given the impact in Congress related to the spending bill. Are you seeing any changes to the sales cycle, especially in your federal business?

Operator:

Our next question comes from the line of Jonathan Ho of William Blair.

Brian Miller:

I'd say most of the leverage that we're seeing in the model is coming from cloud operations and the things we've talked about, the impact of our -- moving customers out of our data centers and into ABS and our plan to have that first data center close midyear, the benefits we're getting from both scale and improved costs at AWS as we put our new customers there and move existing hosted customers into AWS. So those unit costs become lower. And I think the new agreement with AWS further helps that pricing and leverage that we get as we scale that business. The version consolidation expenses or benefits that Lynn mentioned as we eliminate multiple versions of software and create efficiencies around both support and development. So those cloud operations are really the biggest things driving our margin leverage and those are the things we pointed to at Investor Day that will continue to drive that margin expansion that we expect to see over the next several years as we [Technical Difficulty] 2030 targets.

Jonathan Ho:

Just with regards to use of capital, now that your debt payments have put sort of the interest payments under 1 times EBITDA, how should we think about your plans for capital deployment going forward?

Operator:

Our next question comes from the line of Kirk Materne of Evercore ISI.

Lynn Moore:

Well, it certainly is another conversation point with the client. So anytime you use a conversation point, there's opportunities for cross sell, upsell. But we've got installed sales teams across all of our organizations and they're reaching out to clients whether they're halfway through their SaaS contract or at the beginning of the SaaS contract or towards the end of it. So I don't know that that's a specific trigger for signify material uplift, but it's another data point that's a contact point with our clients.

Kirk Materne:

And then I guess, Brian, speaking of flips, obviously, you're guiding maintenance revenue to come down a little bit, which makes tons of sense as you flip people from on-prem to cloud. Can you just remind us the benefits of the uplift of that change? That plays out over a couple of years, meaning you just used the Idaho example. The reason you're not seeing sort of the SaaS revenue get all the benefit of that flip is you're just not going to see it on the income statement until '25. So is that the way we should think about sort of that 1.7% uplift that plays out over 24 months?

Operator:

Our next question comes from the line of Alex Zukin of Wolfe Research.

Brian Miller:

Well, I'd just say when we talk about the number of flips, it's just not that precise. I mean the timing, for example, the Idaho -- signing the Idaho agreement, I think, it was almost three years in the making that we had discussions with them and planning. As Lynn was talking about, it's very complex to move a statewide court system, a lot of planning on their part, a lot of planning on our part and how that all goes and getting comfortable with that, so what quarter that actually gets signed in. Now not all of them are that complex but there's not that much precision around directionally whether it's 92 or 100 or 103. So I'd say that the number was generally in line and the pace at which they're moving is in line with our expectations. The dollar value probably was a bit ahead of, but we expected. So there was a little bit more larger ones in there and the uplifts were a little better than we expected. But it's really hard to be very precise from quarter-to-quarter about what we expect. But we are saying that we are on track with our long term expectation that the number of clients and the dollar volume that will migrate over the next several years as we drive towards that 75% to 85% of our customer base migrated to the cloud by 2030. But just like with new business signings, the exact quarter it falls in is a bit hard to predict, but we're at least in line with our expectations around flips.

Brian Miller:

Yes, it's a little hard to tell exactly. I think the bill that's out there now that I believe is passed the house would actually not resend it, it would delay it until 2026. So the incremental taxes that we would -- if that became effective, we would not have to pay in the incremental taxes, the $50 million that we've talked about for this year and lesser numbers going forward. It's a little unclear exactly how and when we would sort of get back the taxes we paid in and incremental taxes we paid in, in 2023, which were $127 million, presumably, those would either offset our normal tax payments to reduce those tax payments over the next year or two or we would file for a refund, which also takes some time. So it's hard to exactly quantify how that would be. But clearly, we wouldn't have those incremental payments going forward. And in some manner, we would look to recover the incremental taxes we paid in either through refunds or lower estimated payments going forward.

Keith Housum:

In terms of the backlog, you obviously had a nice jump this quarter year-over-year. How are we thinking about the duration of that backlog? Is it holding relatively stable or is that getting longer?

Keith Housum:

Just as a follow-up. There's obviously been a lot of high-profile cybersecurity issues over the past year with public agencies. Have those issues been with agencies that have been primarily on-prem versus the cloud? And if it's been on-prem, are you seeing that as perhaps 1 of the impetuses for the acceleration of the flips?

Operator:

[Operator Instructions] Our next question comes from the line of Alexei Gogolev of JP Morgan.

Lynn Moore:

Yes, I think at Investor Day, we said we were somewhere around 15%. And so obviously, we've made progress since then. I'd say we're probably more around the 20% number now in terms of the -- that we've moved. But as I said earlier, we are -- each of our products has a time line and a road map for how they get to that point that converges on our entire customer base being 75% to 85% of the existing on-prem customers converted by 2030. So each product is starting from a different place with their customer base. We've talked about public safety just getting its first flips this past year. Other products are much further along. So everybody has their own road map that converge on that overall number by 2030. And none of those will happen exactly as planned but we have said that we are collectively on track to achieve those targets by 2030.

Clarke Jeffries:

Lynn, I wanted to go back to something you said about the California contract and the fact that there will be a drag on margins but margin expansion over multiple years. Wondering if you could help explain that. Does that mean that there will be partial volume that moves to you and then full volume over time? Is that just reflective of services implementation costs in the first year that go away and [Multiple Speakers].

Operator:

Our final question comes from the line of David Unger of Wells Fargo.

Brian Miller:

We would expect license revenues to -- well, license revenues, which are mostly recognized upfront. So we actually expect low single digit growth this year. But in terms of the mix for them to continue to decline as part of our overall mix, I don't have that sort of broken out year-by-year or quarter-by-quarter. But we would expect that, that percentage of new business that's now in the high 80s to continue to expand incrementally year-by-year until there's very little license revenue left. We do have some third party licenses. We have some license sales back into existing on-prem customers. But really selling very little, only a couple of products where we really sell any licenses at all in the new business market.

Operator:

We appear to be no further questions at this time. Mr. Lynn Moore, President and CEO of Tyler Technologies. I'll turn the call back over to you.

Operator:

Thank you. This does conclude today's conference call. We thank you for participating. You may now disconnect.

Operator:

Hello, and welcome to today's Tyler Technologies Third Quarter 2023 Conference Call. Your host for today's call is Lynn Moore, President and CEO of Tyler Technologies. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. In order to address your questions and stay within the allotted time, please limit your questions to one question per person. [Operator Instructions] As a reminder, also, this conference is being recorded today, November 2, 2023. I would like to turn the call over to Hala Elsherbini, Tyler's Senior Director of Investor Relations. Please go ahead.

Lynn Moore:

Thanks, Hala. Our third quarter earnings and cash flow surpassed expectations and reflect a continuation of execution at a high level on key operational initiatives. We achieved strong performance across several of our key metrics with double-digit recurring growth and free cash flow growth of more than 40%. Our recurring revenue mix rose to 83.4% of our total revenues with SaaS revenues up 26% organically. This was our 11th consecutive quarter of SaaS revenue growth of 20% or more and exceeded our near-term growth expectations of a 20% CAGR in SaaS revenues through 2025, as outlined during our June Investor Day. We also achieved solid growth in our transaction-based revenues, which were up 8.5%. While operating margins this quarter declined slightly from last year as expected due to our cloud transition, margins were ahead of plan as a result of our operating efficiencies and expense management, especially around cloud operations. It is encouraging to see margins hold essentially flat with last year even as we made considerable progress in our cloud optimization and cloud transition efforts, establishing a clear road map for operating margin improvement in 2024. The third quarter presented a very difficult comparison for our new software contract value and mix as last year's third quarter included two very large SaaS contracts that totaled $70 million in contract value. As we discuss regularly, the timing of large deals such as the two signed in last year's third quarter can cause significant lumpiness in our new software bookings. We're continuing to see a healthy public sector market environment and our new business pipeline is active. Leading indicators RFPs and sales demos remain strong with deals generally moving through the pipeline at a normal pace, which is often a 12- to 18-month procurement process. Overall, our competitive position and win rates are strong with growing momentum in cross-selling activities, a key value creation lever. Additionally, our transaction business continues to capture higher volumes as we gain traction with our unified payments solution. I'd like to highlight some of our significant third quarter wins, which included a number of cross-sell opportunities. We continue to build momentum with our public safety solutions. Key third quarter wins include the Naperville, Illinois Police Department for integrated public safety suite including CAD, records management and e-citations. Naperville is the fourth largest city in Illinois, a state where we also have a strong presence with our Enterprise Justice solution. We're also pleased to see SaaS adoption growing and acceptance in the market with several cloud contracts signed during the quarter. We continue to gain traction with cross-sell wins under our digital solutions division, formerly NIC, and our state enterprise agreements. Under our state enterprise agreement in Utah, we won a cross-sell opportunity with the Utah Department of Corrections for our enterprise corrections electronic messaging solution. We also added deals for our application platform formerly entellitrak, under our state enterprise agreements in Louisiana and Indiana. In the federal market, we secured a significant license win with the US National Guard Bureau for our turnkey suite of workforce case management applications. This is our largest workforce case management application within the Department of Defense and is another marquee win that spans 54 US states, territories in the District of Columbia that will be hosted in our FedRAMP-certified private cloud. We signed a five-year multi-suite SaaS contract with Port Angeles, Washington, which includes our enterprise ERP, enterprise permitting licensing and cybersecurity solutions as well as payments. In the outdoor accretion space we won a competitive deal for accretion dynamic solutions with the Minnesota State Parks. In our Payments business, we signed a one-year extension for enterprise payment processing under our state enterprise agreement in New Jersey. In Harris County, Texas, the third largest county in the nation, added our digital jury solution, leveraging the disbursements capabilities that came to us through the Rapid Financial acquisition last year. Before I turn the call over to Brian, I want to highlight our recent acquisition activity. As I said at our Investor Day, M&A is part of our DNA. And during the third quarter, we completed the acquisition of Computer Systems Innovations for approximately $36 million in cash. CSI brings AI-driven automation and enhanced document processing technology that can be leveraged across many of Tyler's vertical applications. It has primarily served the court technology space for many years, and we're excited about the opportunity to combine expansive footprint with CSI's expertise in AI and machine learning applications to elevate several of our other solutions. Earlier this week, we completed two other tuck-in acquisitions. ARInspect is a leading provider of AI-powered machine learning and data-driven solutions for public sector field operations. ARInspect's advanced AI solution and expertise extends our applications platform with intelligent edge technology that can be leveraged across our state and federal verticals. ResourceX adds priority-based budgeting solutions to our entire ERP portfolio to address key challenges our clients face in their traditional budgeting process. The total purchase price for these two acquisitions was approximately $38 million in cash and stock. We're thrilled to welcome each of these companies and their team members to Tyler. Now I'd like Brian to provide more detail on the results for the quarter and our annual guidance for 2023.

Lynn Moore:

Thanks, Brian. We're making solid progress every quarter to deliver our near and long-term objectives that we discussed in detail at our Investor Day earlier this year. Consistent with our track record, we continue to scale our enterprise while capturing more efficiencies as we transform into a largely pure cloud business, supported by a unified One Tyler strategy. Our strong year-to-date performance, underpinned by our powerful financial algorithm, strong balance sheet and our unique ability to deliver mission-critical software solutions, enabling the public sector's ongoing digital transformation. We're also proud that 11 of our state partners won E-Republic Government Experience Awards. Our clients in Utah, Mississippi, Indiana, Arkansas and Virginia swept the top 5 spots in the GovEx awards. Our momentum continues to build as we complete this pivotal year in our cloud transition. Our team is excited about the tremendous opportunity ahead of us, and we look forward to sharing our continued progress as we finish out 2023. Now we'd like to open the line for Q&A

Matthew VanVliet:

Yeah, good morning. Thanks for taking the question. I guess, when you look at the ongoing portfolio of company -- or of customers that are looking to make cloud migrations and the overall flips there and then some of the net new business, I know you've highlighted public safety in the past as probably being a laggard longer term. But it seems like momentum of cloud deals there is starting to pick up. Do you anticipate that encouraging more of your existing customers to make those flips? How are those conversations going? And ultimately, how much upside do you feel like there's still left on the public safety side as you get more momentum in the cloud there?

Matthew VanVliet:

Great. Thank you.

Kirk Materne:

Yeah. Thanks very much. Congrats on the quarter, guys. Lynn, can you just give a little bit more color on what you're seeing sort of across some of the product categories in terms of SaaS bookings, meaning activity levels maybe on ERP versus Courts & Justice versus public safety? Just kind of a little bit more color on that might be helpful. Just trying to get a sense of where you're seeing momentum. And any color, I guess, on public safety into the fourth quarter too would also be helpful. Thanks.

Kirk Materne:

Thanks. I’ll hop back in the queue.

Joshua Reilly:

Yes. Thanks for taking my question. Nice job on the quarter here. Our checks indicated that the MicroPact business had a pretty strong pipeline coming into Q3 here, which makes sense with the fiscal year-end for the federal government. Can you just give some more color on how these deals closed and how -- anything to note on the cross-sell into the NIC state contracts that might be adjacent with the MicroPact business? And is there any more of these deals that potentially fell into the fourth quarter? Thank you.

Brian Miller:

Yes. And on the cross-sell, the opportunities with our application platform, the formerly called MicroPact entellitrak product, remains one of the strongest opportunities and one of the areas where we're seeing the most activity in terms of leveraging the digital solutions state contracts to sell that into those states. And we had a couple of deals this quarter that we mentioned in the prepared remarks in different applications. I think in Louisiana and Indiana, where we've seen progress. And we've seen a number of those deals since the acquisition of NIC and that continues to be an opportunity that we're pursuing actively.

Joshua Reilly:

Thanks guys. Nice job on the quarter.

Rob Oliver:

Great. Hi, thanks. Good morning. In the prepared remarks, you called out the Naperville, Illinois win in public safety. And it sounds like that was a cross-sell on Courts & Justice. So just curious if that's a path you guys are -- you called out because you're seeing success there. Obviously, the Tyler One vision, those being tied together would make a lot of sense. But is that a go-to-market play that you see driving increased wins for public safety in the future here? Thank you.

Rob Oliver:

Great. Thanks for the color. Appreciate it.

Connor Passarella:

Great. Good morning. This is Connor Passarella on for Terry. Appreciate you taking the question. Just curious on the payments business and how we should be thinking about organic growth going forward in that segment. And then also just on the payment disbursement use cases that have progressed since the acquisition of Rapid Financial last year. Thank you.

A –Brian Miller :

Yes. And on the expectations for growth rates around payments, at Investor Day, we broadly talked about an expectation of transaction revenues growing in the 10% to 13% range and expanding margins there over the next several years. As we've said, we're in the very early innings of executing on the cross-sell opportunity of driving payments more deeply into our local government customer base. And so we're still ramping that up, seeing good success in expanding those numbers of new deals each quarter. But generally, that 10% to 13% CAGR for transaction revenues is our expectation over the next few years.

Operator:

Thank you for your question. Our next question is from the line of Alex Zukin with Wolfe Research. Your line is live.

A –Brian Miller :

Yes. So a couple of things there. Cash flow, most of the outperformance was -- you see it in the working capital side and just really strong collections around our revenues driving good performance around our receivables. I think we're continuing to see the impact of more and more recurring revenues and the positive cash flow characteristics around that. Not really any onetime things there. But I think that our expectation for the year has ratcheted up a little bit. I think right now, even after the impact of the Section 174 cash taxes, which the biggest impact was in the first half of the year, I think we said there's a $22 million impact on cash taxes this quarter, back around the $15 million incremental taxes in Q4. But I think our expectation for the full year now is more in the $220 million to $240 million range for free cash flow, which is up from where we thought last quarter. We did make some minor reclasses in the historical data, the split between -- in subscription, so all in the subscription category on the face of our income statement. But in the breakout of those, between transaction revenues and SaaS revenues. As we transition to a new financial system this quarter, we had better clarity on some of the mapping of the revenues, primarily from acquisitions since NIC and reclassified those somewhat between transactions and SaaS. So we've just sort of cleaned up some of those historical numbers. Don't expect any more changes going forward.

A –Brian Miller :

Yes, the booking side, we talked about this, it can be kind of lumpy. But generally, the -- really a reflection of kind of the combination of all the new SaaS business, the new increases in the transaction business, which kind of run through bookings at the same time as they run through revenues. And just the combination of all that led to a stronger quarter this quarter. We didn't have any of the mega deals, but we did have a really solid flow of new SaaS deals, some -- a couple of not super large but meaningful license deals this quarter and then pretty good activity around the expansions with existing customers as well. So it's pretty broad-based, but again not driven by super large contracts, but nice growth across all of our revenue streams.

Operator:

Thank you for your question. Our next question comes from the line of Saket Kalia with Barclays. Your line is live.

Brian Miller:

Yes. I don't have that number in front of me. They're not restatements. In the financial statements, they were always all in subscription revenues. It's in the...

Brian Miller:

Some of those were -- when we originally acquired NIC and before we basically had almost all their revenues classified in our transaction category. And some of the revenues from a contract can have sort of a blend of some SaaS revenues and transaction revenues around those. So they're providing some software services but getting paid with transaction fees. And so sometimes there's some boring between that. Also, when we acquired the VendEngine acquisition, we initially made an additional judgment from their financials of how those revenues should be spread. And with a deeper understanding of those, we start to map those to our new financial system. We just found that some of those were more appropriately classified a different way. So those are all relatively minor reclassifications as well. So I don't think there's a big change in the trend, but...

Brian Miller:

No, no. There's not a significant change from that. That's not really accelerating it. The 26% growth is actually an acceleration this quarter. But again, we said that will maybe move around from quarter-to-quarter. But generally, we expect this around the 20% CAGR over the next couple of years in SaaS revenue. Some quarters, it may be higher. And as we talked about, some of that variability from quarter-to-quarter has to do with the lag from when we sign a new SaaS deal to when those revenues hit, which can be a quarter or two occasionally longer.

Operator:

Thank you for your question. Our next question is from the line of Jonathan Ho with William Blair. Your line is live.

Lynn Moore:

Yes, sure, Jonathan. Obviously, it's a pretty rapidly evolving landscape. There's a lot that's in the news, some of it may be a little more hype. But it's real. And we see AI benefits within Tyler, we're kind of looking at it in two different ways. We're looking at it sort of pointing it internally, things that we're doing, how can we make ourselves more efficient by using AI. Because I think one of the biggest benefits around AI really is when you're talking about sort of high-volume repetitive tasks, which there are pieces of our business that do that, whether it's some software coding, it may be some things around some support, things like that. The other side of it is how do we make our products more competitive and differentiate them more? What we've done internally is we've organized a working group that's been in place for several quarters, looking at all the various opportunities. There's pockets of AI going on all around Tyler right now. We want to take -- not surprisingly, what we always do at Tyler is sort of a deliberate targeted approach. Sort of we're in the process of identifying what are the couple of key areas that we want to focus on in both of those scenarios, whether we're pointing it internally around creating more efficiencies or adding more competitiveness to our products. The CSI acquisition is a great example of that. They really started off as a sort of a document redaction sort of extraction leader. Recently, they've added some machine learning and robotic process automation. This is something that all of our core clients need and some of our core clients were already using. Tarrant County, which is here out in Fort Worth, they've utilized the CSI acquisition and what it saved in their personnel costs, this is their numbers not mine. they're saying they've cut their labor costs by 50% by sort of automating some of these more repetitive things around documents which, of course, there's a lot there. So even the CSI acquisition, we were just talking earlier the Rapid acquisition. Initially, it's in the court space, that's where we're pointing it. But we also see a lot of places and leverage it across other platforms in Tyler, whether it's things in our ERP space like invoice processing and things like that. So a lot of applicability. You're right, states and clients are -- they're taking different approaches, and we're going to take that deliberate approach with our clients.

Clarke Jeffries:

Good morning Thank you for taking the question. I apologize, I'm maybe going to beat a dead horse and ask a little bit more questions about the reclass. But specifically, looking at SaaS ARR either pre-reclass or post reclass, been in this mid-single-digit sequential growth paradigm. And what stood out was an acceleration of maybe a high single-digit sequential growth in ARR. And so, Brian, I wanted to ask, is this a reflection of maybe the good bookings you had last year and some of those deals finally reaching the timing where they would be going live in revenue terms? Or was there a change being made in the business, either on a capacity level or a new bookings level that we may not appreciate that contributed to an acceleration in ARR growth? Thank you.

Clarke Jeffries:

Thank you very much.

Kelly Valenti:

Hi. This is Kelly Valenti on for Gabriela. One for Mobi [ph]. Last quarter, you made very specific comments on RFP and demo activity at or above pre-COVID highs, while it sounds like top of funnel remains strong. What are you seeing in the back half of this year compared to that dynamic that you were seeing in the first half? And then are there any idiosyncracies of the government end market making you more or less bullish on RFP and demo activity next year?

Operator:

Thank you for your question. [Operator Instructions] Our next question is from the line of David Unger with Wells Fargo. Your line is live.

Lynn Moore:

Yeah. Thanks, David. Sure. As you know, we've been prioritizing debt paydown a lot at the same time while we're still looking at other deals. I'm excited to -- once we dropped under 1.5 net leverage, our rate in our bank changed, and we were able to achieve that at the end of Q3. So that's encouraging. We've paid over about $1 billion of debt down. Brian talked earlier about the impact of Section 174 taxes and the pro forma free cash flow. We'd actually be out of term debt or pretty close to out of term debt right now, absent that, which is encouraging. As it relates to private market valuations there, I would say there's -- we're starting to see in the market and the deals and the things that we're hearing that expectations are finally starting to change. It's always been a little bit amazing to me that when you see things going on in the public markets and yet the private sector deals or people still think that the market should be where it was a couple of years ago. We're still pretty disciplined in how we look at acquisitions. So in areas when private expectations still are too high, we'll simply pass on the deal. We're pretty excited to get these 3 deals done, 1 in Q3 and the ones that we announced earlier this week. These are good deals. These are good business deals, things that are going to help drive our growth, things that will leverage the growth drivers that we outlined in Tyler 2030. And they're going to be accretive to revenues and margins over in pretty short order. So it's interesting, too. There's a lot of companies went private equity in the last few years. And I think we're going to start seeing a time when we're going to start spinning back out. And historically, I think they paid pretty high premiums. It's going to be interesting to see what happens in the markets, but our disciplined approach to how we do things isn't going to change.

David Unger:

Appreciate that. Thank you gentlemen.

Pete Heckmann:

Thank you. Good morning. Just wanted to see if you had any preliminary thoughts on the potential for the Federal Reserve to cut debit interchange and whether based on the convenience fee model that NIC had, whether a lower interchange might be a benefit to margins?

Pete Heckmann:

Okay. And then just a housekeeping item, Brian. Were there any single deals above, let's say, $10 million in TCV in the quarter?

Pete Heckmann:

Yeah, yeah. Just a lot of singles and doubles okay, I appreciate it. Thank you.

Helen Smith:

This is Helen Smith on for Alexei Gogolev from JPMorgan. Thank you for taking my question. So my first question revolves around your private data centers. At your Investor Day, you talked at length that one data center will be closed in 2024 and the other in 2025. Do you have any updates on that front?

Helen Smith:

Great. Thank you so much. And my second question revolves around security. There have been some pretty high-level security breaches recently out like Clorox and GM, Caesars. I was wondering if this has changed the way that you're working with your customers or if your customers have brought forward any sort of concerns.

Helen Smith:

Great. Thank you so much.

Saket Kalia:

Okay. Great. Hey, guys. Thanks for taking the follow-up question here. Brian, one follow-up question for you, if I may. Can we just talk a little bit about the blended duration on SaaS bookings this quarter a little bit, putting aside the re-class. I think if we look at SaaS bookings ARR, that expectedly faced the tough comp that we were talking about earlier. So that was down year-over-year pretty decently. But SaaS TCV was actually pretty decent in terms of total bookings. I just wondered if duration was anything to consider there and how you thought about that?

Saket Kalia:

Got it. Very helpful. Thanks.

Lynn Moore:

Thanks, Aaron, and thanks, everybody, for joining us today. If you have any further questions, please feel free to reach out to Brian Miller or myself. Have a great day.

Operator:

Hello, and welcome to today's Tyler Technologies Second Quarter 2023 Conference Call. Your host for today's call is Lynn Moore, President and CEO of Tyler Technologies. [Operator Instructions] As a reminder, this conference is being recorded today, July 27, 2023. I would like to turn the call over to Hala Elsherbini, Tyler's Senior Director of Investor Relations. Please go ahead.

Lynn Moore :

Thanks, Hala. Tyler delivered exceptionally strong second quarter results that exceeded expectations across our key performance measures. We also reached a new milestone for total quarterly revenues surpassing the $500 million mark for the first time. Our results reflect a high level of execution and collaborative one Tyler approach across our organization that is the foundation of our long-term growth strategy. Total revenue growth was 7.6% with 10.4% organic growth. Recurring revenue comprised 82% of our quarterly revenues and grew organically almost 11%. It's gratifying to achieve double-digit revenue growth even as the shift to SaaS in our new software contract mix continue to accelerate, with SaaS deals comprising 82% of our Q2 new software contract value. Most importantly, SaaS revenues grew organically 20%, our tenth consecutive quarter of SaaS revenue growth of 20% or more. At the start of the year, we characterized 2023 as a pivotal year in our cloud transition where the significant decline in license revenue is replaced by valuable long-term recurring SaaS revenue. Now halfway through the year, the accelerated pace of cloud adoption coupled with our heightened focus on our cloud optimization and migration efforts position us well to drive sustained long-term growth and operating margin improvement. While operating margins this quarter declined from last year as expected due to our cloud transitions, margins were better than planned because of operating efficiencies. We continue to deliver results that reflect our competitive strengths and market-leading position in the public sector. Key to our performance is our hyper focus on leveraging our largest asset, our unmatched installed client base to drive an increasing number of cross-sell and upsell wins, prioritize migration of on-premises clients to the cloud and capture higher transaction volumes through our unified payment solution. Overall, sales activity is high in what we see as a robust demand environment, with leading indicators such as RFPs and demos generally at or above pre-COVID highs. In addition to software solutions, our unified payment strategy in our Digital Solutions division continued to prove their tremendous value to our growth algorithm. During the second quarter, we signed 132 new payment deals, including a contract with Cook County, Illinois for traffic court payments. We also signed renewals of our state enterprise contracts in Wisconsin and Connecticut, and extensions of our state enterprise agreements in West Virginia, Illinois, Idaho, New Jersey and Kentucky. Additionally, synergies from our disbursements business through our acquisition of Rapid Financial Solutions, and deals influenced by data and insights continue to materialize and provide compelling offerings in the state and federal markets. I'd like to highlight a few strategic second quarter deals that illustrate these successes. We've seen growing momentum in the public safety market with our best first half sales performance since we acquired New World in 2015. During the second quarter, we signed contracts with 2 state police organizations for enterprise CAD and mobility solutions. These marquee license agreements include a cloud deployment for the Oregon State Police and an on-premises deployment for the Missouri State Highway Patrol. Additionally, Harris County, Texas, the third largest county in the United States, selected Tyler's enforcement mobile solution for eCitations and eCrash applications. We want a cross-sell opportunity with Michigan Bureau of Elections, a Digital Solutions division client to replace an existing custom solution with Tyler's application platform, formerly entellitrak with $1.7 million of ARR. We also added our enterprise licensing platform and 1 outdoor solution under our state enterprise agreement in Illinois with $5.2 million of ARR. 94 clients signed contracts to migrate on-premises Tyler solutions to the cloud, including the Cab County, Georgia, for their enterprise justice solution; Charleston, West Virginia for their enterprise ERP solution and the Wyoming State control for their public safety solution. Now I'd like for Brian to provide more detail on the results for the quarter and our annual guidance for 2023.

Lynn Moore :

Thanks, Brian. We finished a strong quarter and first half performance excelled across our business. The quarter was highlighted by 2 highly successful events

Pete Heckmann:

Can you talk a little bit about the ERP business and whether you've seen any changing dynamics there competitively. I always thought it was interesting that some of the big horizontal ERP companies really just focused on the top tier. But are you seeing any instances of some players, maybe like Workday coming down into the mid-tier where Tyler has historically been very strong?

Pete Heckmann:

Okay. And then in terms of like some of the dynamics around in-to-out migrations, it seems like that's continuing a pace. I guess are there any pockets of either certain software products that will need to be upgraded before they can be moved into the cloud or just certain areas where the customer base has maybe been more reluctant where you think they could be hold out in terms of eventually moving to the cloud?

Brian Miller:

And I'll just add to that, that public safety is probably the area that lags both in terms of adoption of new customers of the cloud and migration of existing customers. But that is changing. We're seeing a continuous move towards a higher percentage of the new public safety deals coming to us in the cloud. And this year, we've had our first 2 flips of on-prem public safety clients to the cloud 1 in Q1 and then the Wyoming State Patrol this quarter.

Operator:

Your next question comes from the line of Matthew VanVliet from BTIG.

Brian Miller:

Yes. I’d say the cadence of bookings has been pretty normal. Our bookings typically are not terribly back-end loaded. They tend to be – within a quarter, they tend to be generally spread throughout the quarter. We obviously have some push to get things in at the end of the quarter, but probably different than some of the businesses, software businesses that are focused on the private sector. So I don’t think there’s anything unusual this quarter. As we said, it continues to be a pretty robust market with a lot of activity. In terms of the revenue guidance, typically, we’re not making big changes in that through the early part of the year. We did narrow the range. So more confident around where the bottom end and the top end are, but our expectations really haven’t changed. It’s more around the timing. This quarter, there were a few deals that happened maybe a little earlier than we planned in the year, but our outlook for the full year really hasn’t changed much of then to narrow.

Terry Tillman:

And maybe, Lynn, first question for you is in terms of unified payments and you called out 132 payment deals. I'm just curious on that kind of revenue synergy side and now taking into account new use cases around disbursements. How does the back half look in terms of kind of building confidence in these revenue synergies? And can you keep building on top of like 132 payment deals as we move into 3Q and beyond just a little bit more around -- could we see more goodness where you've seen so far?

Brian Miller:

And I would point out that there is a lag typically from the time we sign a new payments deal to the time those revenues start hitting the income statement. It might be a quarter or 2, it might be longer. They often -- we're replacing an incumbent payments provider and so there may be some time period for that change to take place? Or the payments are associated with the implementation of a new solution like the utility billing solution. And so those payments start when that new system is implemented. So the fact that we're continuing to see a growing number of new deals signed, bodes well for future revenue growth in that area, but it is an instant.

Brian Miller:

Yes, it was a tough comp from a bookings perspective. This year, our biggest deal was an $8.8 million total contract value in the Michigan Bureau of elections. And we -- on the SaaS side and then we had I guess, 5 other deals that were worth more than $2 million and one large license deal, the Missouri Highway Control deal. Last year, we had the New Jersey deal, which was a $20 million deal. So we don't have anything that approached that size deal this year. And we also had a $13 million license deal with the tax system in Montreal. So there were just a number of large deals last year. This year was much more, I'd say, kind of normal. In Q3, I don't believe we have a meaningful sort of comp issue. I think our biggest license deal was a $2.5 million deal. And we did have -- on the SaaS side, we did have a very large deal with the State Department last year in Q3, which was a total contract value of north of $50 million. And we had a statewide supervision deal, that was a $15 million SaaS deal. So those will make for a difficult comp on the SaaS side next quarter.

Brian Miller:

We've talked for a long time about the lumpiness of those mega deals. They come along from time to time. We -- in some of these product areas where like Courts & Justice and tax, we're very well positioned to win those, but they're not here every quarter. So they do create some lumpiness, whether it's SaaS or license bookings.

Operator:

Your next question comes from the line of Gabriela Borges from Goldman Sachs.

Lynn Moore:

Yes, Gabriela. I think it's just -- the RFPs and demos up is just a function of the market. And I think there's probably still been a little bit of hangover from COVID, but we're seeing it really across the board, across all of our business units. As it relates to the quality of RFPs, I think there are certain business units where we're actually probably being even a little bit more selective, which I think is going to increase our win rates. I know we're doing that, for example, at public safety. But generally speaking, it's just a healthy market right now.

Operator:

Your next question comes from the line of Josh Reilly from Needham.

Brian Miller:

Well, I think we continue to see operating efficiencies around a number of aspects of our business, but they’re certainly impacting our recurring revenues and our SaaS business. We’re continuing to be very efficient around managing our staffing levels. We’re seeing some of the efficiency gains, for example, around the Digital Solutions reformer NIC business that from changes that have been made there to operate more efficiently. So as we expect that as the SaaS revenues grow, margins should continue to expand. I think we’re also seeing improved efficiencies around our public cloud, AWS operations and better per unit costs as we add more customers there. So even though we are seeing certainly pressure on margins because of the cloud transition, the things we’ve talked about, the bubble costs around – until we exit our proprietary data centers, we are seeing efficiency gains around those operations as we continue to scale those.

Saket Kalia:

Okay. Great. Brian, maybe just for you. Great to see the SaaS revenue here, I think, continue to grow 20% plus in the quarter. I know that's the CAGR that we talked about at Analyst Day recently, I think, out to '25. So maybe the question is, should we sort of think about this continuing pretty steady in this range in the medium term? Or should we think about just maybe a little bit of a different shape around SaaS revenue over the next couple of years? Just curious how you think about kind of this quarter's growth in the context of that long-term target.

Saket Kalia:

Got it. And then if I could fit in a housekeeping question. Really interesting point you made in your prepared remarks, Brian, just on having one customer switch from gross to net in the payments business here in Q3. Could you just maybe dig into how much of a revenue impact that is in Q3 that we should think about? And is this going to be more of a trend? Or do you think this is a little bit of a one-off?

Operator:

Your next question comes from the line of Alek Zukin from Wolfe Research.

Brian Miller:

Yes, the demand environment, as we said in the prepared remarks, is stable or growing generally at or above kind of our pre-COVID highs. So a very robust demand environment coming out of Investor Day and really very similar to what we’ve seen throughout this year and don’t see signs of that changing right now. So stable at a high level. With respect to flips, I’d say generally, we’re performing a long plan – the number of flips is very similar to last year, but the dollar value is higher. So we are seeing bigger customers flip. And I think that will continue to be the case, especially in the early days, flips most of the customers doing that. We’re on the small end today. We’re seeing more of the larger customers. We talked about a couple this quarter that were on the larger side, a large county in Georgia with a court system. As I said, we’ve seen our first couple of public safety customers flip. So I’d say, generally, those migrations are in line with our expectations for the year.

Michael Turrin:

I wanted to go back to something that was asked earlier, but with a slightly different tilt. If we look at the subscription mix as a percent of total contracts, it's very consistent with what we've seen recently. If we look at the TCV and the term metrics, they're down a bit. And this is plus a year-on-year comparison question and more. Just wondering if there's anything to call out in terms of customer behavior, whether it's rising rates or something that might be driving a slightly smaller initial deal size? And then just thinking through if there are impacts that flow into the backlog or bookings numbers that we're looking at. Just wanting to reconcile if there's anything to call out there and just try to kind of calibrate maybe what to expect on those metrics rest of the year?

Lynn Moore:

Yes. I think I would add there that generally, there’s a couple of areas in our business that sign larger deals. Appraisal and tax often has some very large deal, multiyear deals. Our Courts & Justice, Enterprise Justice has some very large deals. And the appraisal tax stuff can be a little cyclical. The large deals are – they come and they go. We’ve talked about it for years. That’s what makes – that’s the 1 reason why we stopped talking about bookings numbers and started focusing on different metrics. I’d go back to my comment earlier today that really performance across the board has been really solid and actually above plan in Q2, which is pretty exciting to see given as well as our competitive position and sort of the demand nature that’s out there right now.

Kirk Materne:

Question on sort of flips. I was wondering, Lynn, if you could talk a little bit about when customers are considering moving from on-prem to cloud, is that a cross-sell opportunity as well for you all, meaning when they're having that discussion, has that given you all an opportunity to go in and talk about the sort of other products that might hang off the product they're moving to the cloud. I was just wondering if you have any thought process or if there's anything you could share in terms of what percentage of flips come along with incremental revenue associated with it?

Kirk Materne:

And can you talk about just in terms of moving to the cloud, obviously, as people start talking more about generative AI and AI in general, to take advantage of you sort of need to be in the cloud. Has that started to percolate at all as a topic of discussion for customers to move over to the cloud? Or is it still just super early days in the public sector?

Operator:

Your next question comes from the line of Charles Strauzer from CJS Securities, Inc.

Lynn Moore:

Yes. I mean it’s an unfortunate reality of doing business is the world of cybersecurity and breaches. And our clients are not immune to it. I think there’s been a fair number of those over the last couple of years. My guess is for the ones that are publicized, there’s probably even more that are not. It does create opportunities for us. I think it creates opportunities to flip people into the cloud. It’s creating opportunities around, for example, our cybersecurity offering. We didn’t talk a lot about it last year. We had a client last year in Arizona that we had been trying to flip to the cloud for really for some time, and they had a security breach and that was the decision point for them to pull the trigger and flip to the cloud. So again, it’s an unfortunate part of doing business. But I think that also creates opportunities for our clients to move into more secure environments.

Jonathan Ho:

Just wanted to maybe understand some of sort of your comments around seeing some additional out margin pressure around employee increases. Is this a change relative to your prior expectations? And can you maybe walk through some of the dynamics or the details around that?

Brian Miller:

Yes. There continues to be higher inflation, I think on the health care side, even than in the environment in general, utilization is up, more high claims experience. So – we continue to monitor it. We believe we have adjusted our expectations for the balance of the year in our guidance. But it is – I would point out that it’s several million dollars of expense in the first half of the year above what our expectations were. And so I think that makes our – the performance we’ve turned in for the first half of the year, even more positive. But – and you see that throughout our margins, but also especially in the SG&A side.

Keith Housum:

Brian, a question for you on your commentary regarding the Public Safety segment having the first -- the best first half of the year. Is there something in the market that's helping to contribute to that? Or is this a market share gain, but how do you guys explain, I guess, your success you're having there?

Brian Miller:

Yes, the competitive position is -- continues to improve. We've made investments in that product over the last several years. And I think the integration with some of the other acquisitions we've made, like our enforcement mobile product, our data and analytics capabilities are very, very strong. And so all of those things that create a very strong integrated public safety platform along with the integration to our Courts & Justice platform, continue to improve our market position.

Operator:

We have no further questions at this time. I will now turn the call back over to Lynn Moore for any further remarks.

Operator:

This concludes today's conference call. You may now disconnect.

Operator:

Hello, and welcome to today’s Tyler Technologies First Quarter 2023 Conference Call. Your host for today’s call is Lynn Moore, President and CEO of Tyler Technologies. At this time, all participants are in 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 27, 2023. I would like to turn the call over to Hala Elsherbini, Tyler Senior Director of Investor Relations. Please go ahead.

Lynn Moore:

Thanks, Hala. We began 2023 by delivering strong first quarter results that met or exceeded our expectations for most key metrics. We continue to see broad-based demand across our product solutions, reflecting strength in the public sector market and our unique ability to support our public sector client’s digital modernization needs. We're seeing a high level of request for proposal and demo activity across our software business with particularly strong activity in the ERP space. Our mix of new software business also demonstrates how our market continues to embrace the move to the cloud. Total revenue growth was 3.5% with 7.2% organic growth, which also excludes COVID-related revenues and recurring revenues comprised nearly 84% of our quarterly revenues. We're pleased with our solid revenue growth even as the shift to SaaS and our new software mix continued to accelerate, with SaaS deals comprising 87% of our Q1 new software contract value compared to 80% last year. Most importantly, SaaS revenues grew organically at 24.4%. Our sales activity this quarter reflected strong cross-selling success including opportunities driven by leveraging state relationships at our Digital Solutions division, formerly NIC, and upsells with our data and insight solutions. In addition to our current quarter wins, our pipeline of cross-sell opportunities continues to grow. We also continue to execute our growth strategy around our payments business. During the first quarter, we signed more than 120 new payment deals, and we are especially pleased with the early traction that we are gaining with our acquisition of Rapid Financial Solutions and their robust payment issuing capabilities. I'd like to highlight a couple of first quarter deals that illustrate these successes. In Indiana, we expanded the relationship between Indiana's family and social services administration and our Digital Solutions division with a contract for Tyler's Disbursement as a Service platform to improve the payment disbursement process for sending its existing child care and development fund payments to providers. The purpose of the CCDS federal program is to increase the availability, affordability and quality of childcare. Leveraging the capabilities from the Rapid acquisition, in combination with our existing state enterprise contract, we will streamline the entire disbursement process from portal setup, including registering users and collecting banking information from providers to virtual account payments across all payment types and channels. Through Rapid's robust platform, the solution will also provide reporting and reconciliation features to support complete oversight of the payment program. In addition, we signed two payments contracts to provide rapid disbursement solution for court funds, including Fort Bend County, Texas, a current user of Tyler's jury management solution and Shelby County, Tennessee, a current Tyler Enterprise courts client. The quarter's largest SaaS deal valued at approximately $18.5 million was with the province of New Brunswick in Canada for our enterprise assessment solution. New Brunswick becomes the fourth Canadian province to implement our flagship property tax solution. Now I'd like for Brian to provide more detail on the results for the quarter and our annual guidance for 2023.

Lynn Moore :

Thanks, Brian. Our first quarter results demonstrate the strong momentum we are building across our business. Our cloud transition initiatives are on track in this pivotal year as we make progress with our move from Tyler's data centers to AWS and managed through expected margin headwinds resulting from the accelerated pace of cloud adoption as well as cloud bubble costs. Our successes in the marketplace reflect our unparalleled competitive strength, synergistic cross-sell and upsell momentum and highly desirable cloud solutions and position us well to execute on our long-term strategic growth road map. In the next few days, we'll release our fourth annual corporate responsibility report. We hope you'll take some time to review it and learn more about the progress we've made with our ESG efforts. To close, we're extremely excited to host clients in person at Connect, our annual user conference, which will take place in San Antonio from May 7 through May 10. Registrations are an all-time high, and this will be our largest connect ever, with some 6,000 public sector clients attending. We also look forward to our upcoming Investor Day that will be held in person on June 15 in Frisco, Texas, along with a live webcast. We look forward to highlighting our differentiated value proposition in our mid- to long-term strategic plan, growth drivers and financial targets supporting our Tyler 2030 vision. More details will be communicated soon, and we hope you'll be able to join us in person or online. With that, we'd like to open the line for Q&A.

Sami Badri:

This is Sami Badri on Ryan's line. The first question I wanted to kick off with was just about operating margins. It looks like you guys did better than what Street and our models were forecasting. And I kind of just want to understand if the mechanism kind of going into the model or into the business, it's allowing you guys to execute a little bit better. Are you seeing better pricing, better cost control? Any other kind of details around the margin beat? And then the other question is, I know that you guys have been messaging about operating margins troughing in 2022 before they expand in 2024. But is it possible that we have already seen your operating margins trough and those are very well understood and you're going to be building and expanding from this point forward maybe from a 2Q base? Can you just give us color on margins, please?

Lynn Moore:

Yes, Sami, I'd add this, too. We've talked a lot over the last couple of years about the cloud transition and the impact on both revenue headwinds and margins, but there's a lot more going on within Tyler. And I'd say right now, there's a lot of intentionality going on at Tyler. It's a little bit more than just sort of sitting back and letting the cloud transition run through the financial analysis. We have a lot of internal analysis, we have a lot of initiatives going on beyond just the cloud transition, taking a look -- deep look at different parts of our business, different things that we should be doing and can be doing. And I really commend our executive team and really our entire staff for the work that's going on right now. There's a lot of work going on at Tyler for sure. But I could say that everybody is sort of aligned generally with what our long-term goals and our long-term vision is and part of that is around margin expansion. So there's just a lot of things going on, a lot of intentionality. There are some bigger pieces. There's smaller things that we're doing. But I think there's just a lot of intentionality going on.

Kirk Materne:

Thanks very much. Lynn, given that you're going to connect next week or next week or in the next couple of weeks, can you just talk about what you're hoping clients take away from that? And I was just kind of curious if you've seen more folks from, say, state governments signing up to participate at the conference?

Operator:

Your next question comes from the line of Matthew VanVliet from BTIG. Your line is open.

Lynn Moore:

Yes, sure, Matthew. I think we're -- part of your question, I think we're still in the early innings. I'd say we're still in the early innings with everything we're doing with NIC. Probably talked a year ago about being in the first inning. We might be in the top of the second. The cross-sell opportunities continue to grow. We take a very deliberate approach around that. We've been instituted this year. We've been doing the strategic account management meetings where we're getting the Tyler salespeople together with state GMs and really sort of doing what we call sort of a state of the state baseline where we're sort of taking a deep dive and look into what are the objectives in that particular state, what are the relationships NIC, our Digital Solutions division brings, where what's the Tyler product footprint, what's the terms of the contract vehicle, how can we easily get products into those clients' hands. When we talk about what those near-term opportunities are, we do qualify them. I mean we have a number of opportunities that we think are more longer term, but what we call more qualified leads. We're up around sort of in the 175, 180 range right now. All different types of plays that we're looking at there, probably somewhere around $50 million ARR is what we've considered a more qualified pipe. Qualified pipe to me is not something that's going to close in the next month or 2, but it's something that I think has got a pretty viable horizon on it.

Joshua Reilly:

Yes, thanks for taking my question. You mentioned the strong ERP results in the quarter and the pipeline for the rest of the year. Can you just speak to what's driving that pipeline and the visibility that you have in ERP deals for the rest of 2023? Thank you.

Operator:

Next question comes from the line of Terry Tillman of Truist Securities. Your line is open.

Lynn Moore:

Sure. I think we certainly use the flips and conversions as an opportunity to upsell. That is part of our strategic direction. We're still going at a pretty healthy pace. I think when we get to Investor Day in June, probably give us -- we'll probably hear a little more guidance on the pace of our conversions and where we think we'll be over the next 4, 5, 6, all the way up to Tyler 2030. But yes, you're exactly right. It's an opportunity for us to once again reach out and upsell other products around and then help incentivize flip to. As it relates to Rapid, this is a transaction that we're pretty excited about. It's a capability that we didn't have in-house. It's not a capability that I didn't have in house, the whole bringing in the whole issuing side of disbursements and the fact that we closed that deal at the end of November. And so we've owned this company for just a little over about 5 months now, not quite 5 months and already the synergies in working with the digital services team, formally NIC, these deals that we've already got signed, I think this early is something a little unusual for us with acquisitions. It normally takes a little bit of time. There's a lot of road map looking out on the disbursement side payments. As you know, they're primarily focused right now sort of in the justice space, but there's applicability across all of our product lines. That again is going to take years to develop, but it's pretty exciting, the early momentum we've seen.

Operator:

Your next question comes from the line of [indiscernible] from Wolfe Research. Your line is open

Lynn Moore:

Yes. I think when we talk about what we're seeing in the market, it's a couple of things, probably. I mean we're -- it certainly reinforces the principle that the things that we're providing are essential functionality. I think it reinforces the principle that we went through some periods of time where there might have been a little pent up demand coming out of COVID and also the continued shift towards modernization and digitization of local government. We also see where we talk about the labor markets, for example, and how the labor markets are affecting different companies, but they're also affecting our clients. And as there's labor shortages and turnovers with our clients, it's also creating challenges for our clients, which is having them really point to and use technology to help bridge that gap. So there's just a lot of things going on right now. It's a good market right now. And it's -- I don't know how I'd characterize this to my expectation, but I'm pretty happy with where the market is right now.

Operator:

Your next question comes from the line of Saket Kalia from Barclays. Your line is open.

Brian Miller:

Yes. Appraisal is certainly a much smaller piece of our business. Appraisal Services, it's an important service that we provide often to customers that we also have sold or will sell a property tax system to. But it's now well under 2% of our revenues. And so we've consolidated that line into the professional services line. And again, the focus, as you've seen from some of the things we've talked about really is around subscriptions revenue growth, the recurring revenues. And we've given some detail breaking that out between the SaaS revenues and the transaction-based revenues, which would be things like payments, our digital solutions portal, e-filing those sorts of things. In the SaaS bookings detail, you're correct, it grew sort of mid-single digits. But the -- that's really just referring to basically new logo SaaS deals. So there's additional SaaS bookings in the upsells, pricing increases, inside sales of additional products to existing customers. So the metric we really think is important is the bookings growth number for subscriptions overall, which are the transactions and SaaS revenues, and that was 23.6% this quarter.

Peter Heckmann:

Thank you. Good morning. Just a couple of quick questions. You've done a fabulous job of reducing net leverage post the acquisition of NIC. How are you thinking about the potential for M&A? How does that landscape look as well as valuations? And then really have focused mainly on deleveraging and not so much on the share repurchase plan. I mean what are your thoughts there in terms of resuming share repurchase at some level of net leverage?

Operator:

Question comes from the line of Charles Strauzer of CJS Securities, Inc. Your line is open.

Brian Miller:

Well, I think we'd still be in the same range for the full year. I'd say we're increasingly confident of that range, and we may be trending a little bit more to the upper end of the range at this point, although it's still early in the year. But I think that yes, maybe the ramp is -- I mean I think we were still in the ballpark. We did $1.66. Last year, we did $1.76 in the first quarter, but I think that jump up into Q2 and Q3 and Q4 would be maybe a little less pronounced, but again, we're in the -- pretty much in the same range.

Michael Turrin:

Thanks, good morning. Appreciate you taking the question. The commentary around the demand environment, RFP volume has remained consistently upbeat. I realize there are some moving pieces, but the organic growth number 7% towards the lower end of the target range. So can you just help us square those things? What is the organic growth number not entirely reflecting relative to the demand backdrop, whether it's pipeline bookings or just general mix and transition impacts? Any context you can provide just around your view on that number is helpful.

Operator:

Your next question comes from line of Jonathan Ho from William Blair & Company. Your line is open.

Lynn Moore:

Yes, Jonathan. I think I mean data insights is something that -- when I look out in the future of public sector, that's to me is an offering that I can see every single public sector agency needing. It's a very unique offering. We're in a unique position given our big -- our large footprint and our ability to surface data across so many different solutions, not only our own but even non-Tyler solutions. I think it's something that -- look, we made that investment now 5, 6 years ago. And I think we're starting to see more and more demand for it. What we've also seen is internally, we've actually sort of deconstructed the D&I former division within Tyler, and we now sort of have it integrated with each of our divisions so that we're aligning more product with the individual demand, so it's something that I think is a differentiator for us. I think it's always been a differentiator for us. We've seen it even in the last year or so, it's been a differentiator for NIC. When we talk about a year ago, we were talking about the South Carolina rebid or the early renewal of the Texas payments contract. Those were done in part or primarily or a major factor was our data insights. So it's something that we're going to continue to leverage. I think we're in a unique position with it, and it's something that the public sector really needs.

Rob Oliver:

Great. Brian, one for you. I know last quarter, it seemed like a couple of big deals that slipped out of the quarter and the deal sizing, I think, a bit more moderate. And just curious if you saw some of those deals closed this quarter and what you're seeing in terms of deal sizing. And then just a quick follow-up. So just on the free cash flow, just to understand that better. Is that is the impact there all of the catch-up from '22? Or is there anything else on the tax side that's impacting free cash flow? I apologize laryngitis here.

Operator:

Your next question comes from the line of Gabriela Borges from Goldman Sachs. Your line is open.

Lynn Moore:

Yes, Gabriela, I don't expect it will be linear. And certainly, margins and our targets and broadly how we view the trajectory of 1 of the topics we'll be looking to address at the Investor Day, that things are rarely linear. I do think around the timing of flips over the next few years as we accelerate the move of our clients from on-prem to the cloud, the timing of -- if that's a J-curve or an S curve or how that works will be a factor in that margin trajectory. I think that we're more certain around the timing of the closing of our data centers and we've talked about that in 2024 and towards the end of 2025, closing those 2 data centers and being able to reduce those bubble costs and so those will have more of an impact in those years. So I don't expect it to be linear. I really can't give much color beyond that right now, but it is something we'll continue to refine our outlook for and we'll be talking about margins will certainly be a significant topic at Investor Day.

Operator:

Your next question comes from the line of Keith Housum of Northcoast Research. Your line is open.

Brian Miller:

Yes. I think we've continued to hire new staff as well as are seeing attrition flow, which is not surprising, given some of the shifts in the broader employment markets. So as we've talked about over the last few quarters, we've added new people, new classes on the pro services side and those people are becoming billable. I think you'll see in Q2 and beyond, you'll see more of the impact of that, so we will likely see nice growth in services revenue, which will also help lead most importantly, bringing subscription revenues or SaaS revenues online at a faster pace. So I think you'll start to see that really the impact of those people becoming fully billable in Q2. And I think we're pretty well on plan with our efforts to step up to the capacity we want to have.

Operator:

Your next question comes from the line of Clarke Jeffries of Piper Sandler. Your line is open.

Brian Miller:

There's not a -- there was a very small reclass, I think, of some revenues from transaction revenues to SaaS revenues. So getting those kind of in line with our current reporting, but not a significant one, but -- and that's reflected in the supplemental data.

Joe Goodwin:

I guess, Lynn and Brian, how different at the product or technology level would you say the current payment portfolio is so NIC, Rapid, everything you have there now that is built for governments versus other players in the space? And would you say you differentiate beyond your existing relationships and market presence? Or is there some differentiation on the technology level as well?

Lynn Moore:

Yes. And Joe, I think you can expect at the Investor Day in June, for us to provide a little more color, maybe in a little more detail around some of these topics, specifically the topic around differentiation in the market and what we -- why we're different and the opportunities that we have in front of us.

Kirk Materne:

Just a follow-up, Lynn, your comment on sort of payments and maybe, I guess, I'll drag Brian into this as well. Just on the gross revenue recognition, A, I assume you all have no real ability to pick which 1 you want to go with, meaning I assume that would be easier, but I assume grosses are required by accounting rules. And is there a certain scale that payments gets to that were the drag from a mix shift perspective becomes less, meaning probably I appreciate you calling out the 100 bps this quarter. Should we expect that to get incrementally better as it just grows in scale? So I was just kind of curious about if there's any flexibility to maybe get to that and then sort of how we should think about sort of the drag as that part of the business gets bigger? Thanks.

Lynn Moore:

Yes. And just to be clear, Kirk, the -- it is customer driven, as Brian said, in the gross model, while lower margin actually produces higher free cash flow. So it's a benefit to our free cash flow.

Lynn Moore:

Thanks Kevin, and thanks everybody for joining us today. If you have any further questions please feel free contract Brian Miller, or myself. Have a great day.

Operator:

Hello, and welcome to today’s Tyler Technologies Fourth Quarter 2022 Conference Call. Your host for today’s call is Lynn Moore, President and CEO of Tyler Technologies. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. As a reminder, this conference is being recorded today, February 16, 2023. I would like to turn the call over to Hala Elsherbini, Tyler Senior Director of Investor Relations. Please go ahead.

Lynn Moore:

Thanks,s Hala. Our fourth quarter results marked a solid finish to an eventful year as public sector demand remained strong and SaaS adaption continues at an accelerated pace. Total revenues grew 4.3%, with organic growth excluding COVID related revenues of approximately 6% and organic revenue growth for full year was solid at approximately 8.2%. Recurring revenues comprised nearly 83% of our quarterly revenues. On an organic basis, subscription revenue grew 14.3%, reflecting both our accelerating shift to the cloud and growth and transaction-based revenues. Most importantly, SaaS revenues included in subscriptions grew 19.3%. We achieved solid revenue growth even as the shift in new software contract mix continue to accelerate to SaaS from licenses. In Q4, 86%, of our new software contract value was SaaS compared to 77% in Q4 last year. In our digital solutions division, which is formerly known as NIC, we continue to execute on cross-selling opportunities. And in Q4, we signed a significant new contract with the Kansas Department of Revenue to provide our Data and Insights Assessment Connect Solution, which will work with our Enterprise Assessment solution used statewide in Kansas. We also signed sell-through deals for our recreation dynamic solution with Utah division of outdoor recreation and the Mississippi Department of Wildlife, Fisheries and parks. Our Digital Solutions division also signed notable SaaS software agreements with the state of Nevada and the Alabama Alcohol Beverage Control Board. We also signed a payments processing contract with the Wisconsin Department of Motor Vehicles, which is our first payments opportunity in Wisconsin. Finally, our Digital Solutions division won a competitive rebid for our master enterprise contract with the state of Colorado’s Statewide Internet Portal Authority Board, as well as an extension of our master enterprise contract with the state of Oklahoma. In other Tyler divisions, we signed seven additional significant SaaS deals, each for different product suites and each with a total contract value greater than $2 million. Those include contracts with the Cypress Fairbanks Independent School District in Texas for our student transportation solution; the cities of Prosper Texas and Glendora, California for our enterprise ERP and enterprise permitting and licensing solutions; the Placer County Water Agency in California, and the City of Helena, Montana for our enterprise ERP solution; the City of Albuquerque, New Mexico for enterprise permitting licensing solution; and Lucas County, Ohio for our enterprise justice solution. In addition to those deals, we signed 12 SaaS deals in the quarter, with contract values between $1 million and $2 million each. In the fourth quarter, we signed 153 new payments deals worth more than $4.7 million in estimated annual recurring revenue across Tyler divisions, other than digital solutions. The largest of those was an agreement to provide payment processing for the City of Milwaukee, Wisconsin, was estimated annual revenues of more than $1.2 million. For the full year 2022, we signed 571 new payments deals, with more than $13 million in annual recurring revenue, many of which we were able to pursue because of the new capabilities that came to us with NIC. More than 80% of those were sold to existing Tyler software clients. New payments only agreements typically have a lag of three to six months between signing and revenue generation. While payments agreements that are embedded in a broader solution, such as new ERP sale, may have a period of 6 to 18 months from signing to revenue generation. In our justice group, we signed two notable multi suite license deals in the quarter for enterprise public safety, enforcement mobile and data insight solutions with Stearns County, Minnesota and Richland County, Ohio. We also signed two significant license contracts for our Enterprise Justice Solution with Midland County, Texas and Kankakee County, Illinois, which also include our Enterprise Solution - Supervision solution. Now, I’d like for Brian to provide more detail on the results for the quarter and our annual guidance for ‘23.

Lynn Moore:

Thanks, Brian. During 2022, we achieved notable milestones towards several key strategic initiatives. We made meaningful progress on our cloud journey through continued investment in cloud optimization, and moving to cloud only deployment for many of our core solutions. Our intentional innovation is based on knowing our clients and anticipating their future knees. As you recall, in 2019, we launched a strategic shift from a cloud agnostic model to a cloud first model to deliver secure, scalable, dependable and compliant digital infrastructure. We’re pleased to see the accelerated pace of cloud adoption amongst our new clients, as well as the steady increasing pace of cloud migrations of on-premises clients. Additionally, we integrated our Tyler and NIC payments teams and launched a significant go to market strategy for payments with a growing and active pipeline. During the year, we added 571 new payments clients with the vast majority at the local level. We leveraged our strong relationships across state and local agencies, including the NIC state enterprise contracts, to expand our cross sell opportunities with significant multi solution deals that demonstrate the power of our One Tyler approach. We’re still in the early stages of cross sell, and it’s exciting to see tremendous momentum and collaboration taking place. Since completing the acquisition of NIC synergies between NIC and Tyler have delivered 19 cross sell transactions worth $9.5 million in total contract value. Overall, the year was highlighted by significant wins highly successful upsell efforts and state renewals and expansions. Throughout the year, we also demonstrate a balanced yet opportunistic approach across our business and with respect to capital allocation. We maintain a strategic lens toward acquisitions and close three transactions that bring innovative and robust offerings to elevate our digital solutions payments business, broaden our integrated solutions, and add new technology. All three acquisitions Quadrate, USC Direct and Rapid Financial Solutions support a unified client experience and further our connected communities vision to support thriving communities through a common digital foundation for better data access, engagement, and transparency. As we move into 2023, I’ve never been more confident about Tyler’s long term prospects. This is an important year in our cloud transition. And we are tracking well with our cloud optimization product development efforts and the plan to exit from our proprietary data centers in 2024 and 2025. We expect to reach an inflection point in our cloud transition in 2023 with a significant decline in licensed revenues that are being replaced by valuable long term recurring SaaS revenue. As a result of the short term revenue headwinds from this mix shift, together with bubble costs related to SaaS transition, including duplicate costs of operating our proprietary data centers, while moving our hosting to AWS operating margins are expected to trough this year. The estimated impact of bubble costs on our 2023 non-GAAP operating margin is approximately 130 basis points. We are committed to returning to a trajectory of consistent operating margin expansion beginning in 2024. In fact, you’ll see in our upcoming proxy statement that we have added operating margin expansion as a second metric for our long term incentive plans for our senior leadership. Our move to cloud first builds long term value and supports multiple long term growth drivers. In the midterm over the next five to seven years, we’ve talked about annual organic revenue growth in the 8% to 10% range, with consistent long term margin expansion of at least 50 to 100 basis points a year beginning in 2024 excluding the impact of merchant PCs from payments expansion. We continue to refine our Tyler 2030 plan and look forward to sharing our longer term vision and clearly defined targets for revenue, margin and payments growth during an investor day planned for mid year. Look for more details on that soon. When we look at our operating margins, it’s also important to consider the impact that growth in our payments business has on margins. We recognize revenues for payment processing under multiple revenue models. A gross model for agreements, where we are responsible for merchant fees on the transactions, a net model where a client assumes direct responsibility for merchant fees, and a revenue sharing model similar to the net model where we are effectively reselling a third party processor services. The majority of NIC’s payment processing is under the gross model. And in 2022, we paid a total merchant fees of approximately $145 million with a small margin earned on those fees. If those same contracts were on a net basis, our consolidated non-GAAP operating margin would have been approximately 200 basis points higher. Our operational and financial discipline coupled with a strong balance sheet and ample liquidity allow us to aggressively manage our debt profile and moderate the impact of rising interest rates. And delevering continues to be a priority for capital allocation. While the bar is high for acquisitions, we continue to have the flexibility to evaluate M&A prospects that present compelling strategic growth opportunities. To close I’m proud of our team Tyler team and what we continue to accomplish every day even amid macro economic uncertainty. As you’ve seen in our press releases, we received many industry and regional accolades, which is a testament to our work ethic, our culture, and our tireless efforts to support our clients’ needs. We also receive gratifying recognition for our environmental, social and governance practices, being named to the Dow Jones Sustainability Index North America for the second consecutive year. The DJSI cited are notable gains in IT security, risk analysis, privacy protection, and human capital development. In addition, we were recently named to Newsweek’s list of America’s greatest workplaces for diversity. We’re proud of these recognitions, and remain committed to sustainable business practices. With that, we’d like to open up the line for Q&A.

Sami Badri:

Hi, thank you very much. And I had a question about the margin troughing in ‘23 and maybe you could just give us color on the ramp on from the bottom of ‘23 what should we be thinking about where margins could go in ‘24? And I think the big thing here is maybe you could give us color on like, what are some reasons why the bounce off the trough could be faster versus slower? And what are some things that could influence the speed of the margin movements?

Lynn Moore:

Yes, I think just to amplify on that we’ve talked over the last couple of years we’re about three or four years or so into this cloud transition. And we’ve talked about sort of the two pieces of it, the getting dealer side on the revenue side, and then sort of getting the other side on the cost and expense side. And as Brian mentioned, on the revenue side, we’re seeing that sort of inflection point it’s going to take place, probably later this year. And last couple of years, the last licenses has been a significant impact. And our internal models are now showing that really the new flips, the gains from flip as well as the SaaS business over the last couple of years, is going to later this year, sort of past that point of where we lost licenses. Remember, back in 2019, we did just over $100 million in licenses. So it’s a significant change that we’ve been running through the financials. And then when you look on the cost side each years go by, as these, as time goes by, we’re getting better and better visibility where we are making progress on optimizing our products. We’re making more progress on our plans to exit our proprietary data centers. We’re getting better data on how our products are actually operating within the public cloud. And so a lot of that stuff gives us that confidence that 2023 is that margin trough. As we look out farther there’s other things that we’re doing as well. We have a lot of internal initiatives around efficiencies, things like consolidating just some of our internal IT. We have other sort of satellite data centers that we’re looking to collapse, as well as things like looking at real estate and stuff like that. So there’s a lot of initiatives around that, which I think give us that confidence when we talk about ‘23 being sort of the margin trough.

Lynn Moore:

I think the answer is probably similar to what we’ve said in the past. I would say, as I look at our clients budgets, they’re generally very healthy. As I’ve mentioned, before, they were not as impacted by COVID, as people thought. They are having access to federal funds. Some of it, Brian, the timetables of one that they still have a couple of years, I think it’s been there. So we’re just generally seeing healthy budgets, healthy buying seasons, sort of just a really good, robust market. In terms of identifying specific deals there are occasions for that. But I think really, what it does is it’s more about just overall confidence in our clients being willing to spend money.

Rob Oliver:

Great. Thanks, guys. Good morning, Lynn, one for you. You mentioned the milestones on the cloud side since 2019 when you pivoted to the cloud-first approach and certainly, seems like those are paying off, particularly with new business around subscription definitely felt that among your customers in Indianapolis last year talking to them about their readiness for cloud. But I wanted to ask a little bit about you talked about new flips. How should we think about the pace of conversions? This is clearly going to be an important driver here. They are up modestly from last year, nothing to really write home about. So can you just help us understand how you’re thinking about maybe success relative to conversions and migrations of existing customers this year and then I had a quick follow up for Brian. Thanks.

Rob Oliver:

And then Brian, just one on the Q4 operating margin was a bit below our expectations. And that could be driven indeed, by those flips, or by NIC but just wanted to get a little bit more color on that. Thanks.

Operator:

Your next question comes from the line of Matt VanVliet with BTIG. Your line is now open.

Brian Miller:

Yes. So yes, for the full year, the difference in the capitalize versus expensed R&D versus our expectation was close to $9 million. We gave guidance for R&D for next year, in the range of $108 million to $110 million that’s expensed and our capitalized R&D in 2023 is expected to be in the high 30s, say around $37 million. So capitalization is a little bit higher, but R&D expense is higher in 2023. If you look at the sort of the midpoint of our guidance, it implies I’d say somewhere between 60 and 100 basis points of operating margin compression in total and we mentioned that the bubble costs are estimated to be about 130 basis points of impact on 2023 margins.

Brian Miller:

New bubble costs. So and that’s higher than the impact was in 2022. We talked about those as being a little less than 100 basis points of impact and that’s to be expected, because we continue to move more customers into the public cloud and while we still operating our two data centers and so the duplicate costs expand this year, and we’ve talked about an expectation in the first half of 2024 that will be out of the first data centers and that’ll start to mitigate.

Brian Miller:

Yes, I think one of the bigger factors around backlog I think backlog is probably becomes maybe a little less meaningful or less of a full picture when you look at it is really around how the accounting drives what goes into backlog and what doesn’t. So transaction revenues don’t sit in the backlog. So as we add new payments or new portal revenues, those typically are under fixed arrangements so even though they may be highly predictable and recurring. So there typically wouldn’t be an addition to backlog for those. And then we’ve talked in the past as well about sometimes the terms of a contract agreement dictate how much goes into backlog. So for example, a termination for convenience provision can significantly limit that we saw that with a really large contract last quarter. That was a 50 plus million dollar contract that only $8 million went into backlog because that’s a termination for convenience provision. So I think there’s a lot of factors that start to make the backlog number maybe less of an important metric to look at how we expect to perform going forward.

Peter Heckmann:

Good morning. Thanks for taking the question. I have a few just clarifications there. And I may have missed some detail. So forgive me if I’m repeating myself. But when we look at bookings we typically see this quarter as a big public safety bookings quarter. Can you talk about how they are receiving the idea of converting to subscription? And then just clarifying, were there any deals with containers in bookings in the quarter that were greater than 5 million of TCB?

Brian Miller:

Yes, and this quarter, we did not have any individual contracts that were more than $5 million in total contract values. We had a couple in the $4 million range on the software side. We did have a competitive rebid when, with our state enterprise agreement in Colorado, which is one of our bigger states. And certainly the total value of that contract over the five year term is well above $5 million. But on the software side, no individual deals more than 5 million. So it was more of a high volume sort of more mid range deals this quarter.

Brian Miller:

Yes, and actually on the payment deal, that there really wouldn’t be anything that in the bookings number, only the actual revenues as they come through in a given quarter basically run through bookings and revenue at the same time. So for payments, we don’t include it again, because they’re not a fixed amount. We don’t include those in bookings or in backlog. But those payments deals for the full year we estimate that they’ll add more than $13 million in annual recurring revenues. And there’s a mixture of contracts there that are either gross or net processing through our platform and still some deals that are through our reseller arrangements where we have a revenue sharing arrangement. So the revenues are lower but the margins are higher on those.

Alex Zukin:

Yes, hey, guys. So maybe just two for me. I guess the first one just similar to one of the questions, I think that’s been asked, but maybe on a slightly different metrics. Again, the subscription ARR added in the quarter this quarter seemed to be lower sequentially than the last two. So just maybe clarifying what drove that from a bookings perspective? And then more broadly, as we are much more geared towards subscription and SaaS, how should we think about at least how were you guys thinking about kind of net new SaaS ARR, net new kind of subscription bookings growth for ‘23? And then I have got a quick follow up on cash flow.

Alex Zukin:

And then I guess, Brian, from a free cash flow perspective, when you think about the lag or the delta between operating margins and free cash flow for this year, it’s obviously a little bit higher than in previous years, given some of the items you mentioned around tax and expense or capitalization versus some R&D expenses. As we think about it for ‘23 and even more so for ‘24. What’s the right expectation for free cash flow margins versus operating margins? And that delta specifically in these two years as we kind of trough margins and transition to SaaS?

Alex Zukin:

Understood, so, I guess, is it fair once we get through ‘23 and CapEx starts to trend down would you expect it to kind of go back to that historical still 200 to 300 point delta between margins and free cash flow margins? operating margin?

Operator:

Your next question comes from the line of Gabriella Borges with Goldman Sachs. Your line is now open.

Brian Miller:

Gabri, I don’t. Right now, procurement cycles are pretty normal. They’re going in line with our clients budgets are healthy. And we’re not really seeing delayed procurement cycles right now. Again, from our perspective, the market is relatively healthy, their budgets are healthy, and our competitive position remains strong. So we’re seeing a pretty normal, really above normal market.

Brian Miller:

I’ll take, I’ll start on that and Lynn can add to that. We do think that in our space, that the shift to the cloud and our cloud strategy gives us a competitive advantage. As you know, we compete across products with different competitors, and generally in each of our products suite. And those range from some very large companies to a lot of smaller, more niche e-companies. And we think that where we are in the cloud transition, is well in advance of where a lot of our competitors are. And as that desire, on our client base to move to the cloud accelerates that gives us an advantage and an ability to increase our share because of where we are in our cloud transition. And then, as we’ve talked about in the past, our connected communities vision, and the fact that we have this broad suite of products that work increasingly well together, continues to provide us with a competitive advantage there in clients that are looking for a sweet solution. And we think that this could be one of our strengths.

Saket Kalias:

Okay, great. Hey, good morning, guys. Thanks for taking my questions here. Lynn maybe start with you. That was helpful detail in your prepared remarks just on the composition of NIC or digital payments. When it comes to gross versus net? Maybe the question is, Could you put a finer point, just on how much of that digital payments business or the transaction revenue one is gross versus net and then relatedly, how you maybe think about that mix going forward?

Brian Miller:

I don’t know that. I have a lot to add to that. It clearly is the vast majority. We did mention that a couple of our date enterprise agreements that digital solutions are shifting in 2023 to net from gross and that’s got about a $2.5 million impact. But as Lynn said, we don’t really fully control that. And so I would expect that still going forward, the majority of the business comes to us through the gross model where we’re paying the merchant fees which is why we wanted to sort of give you the apples to apples comparison of the margin impact of a couple of 100 basis points, if all of those net ones were on the gross model, and you took the merchant fees out of the revenue side. So I would say that as more Tyler customers that have traditionally been on a sort of a reseller with third party payment processors, where we get a revenue share, which is a net accounting, as more of those overtime migrate to our proprietary platform, we could have a shift with from those customers that are currently on a net basis moving to a gross basis with Tyler. The net result is we keep more of the transaction. So we make more money. We’d have higher revenues, but it would have a negative impact on margins. And we’ll attempt at our investor day to provide more color on how those work and how we see that playing out. Because clearly significant growth in the payments business is an objective of ours and something that we’re having a lot of success with and expect to continue to.

Brian Miller:

Yes, I think it was generally in line with our expectation. I don’t know that it was significantly varied from plan. I guess one other factor that plays into that is the lag between when we sign a SaaS deal and when we start to recognize revenues. And that can vary, but it can be typically the implementations are quicker or the time from signing to starting to recognize revenues is quicker on a SaaS deal than on an on-prem deal. But that can vary and that can typically be, say six months that can be longer. And so I think when I talk about timing, it’s more around the difference between when we signed something and when we’re starting to recognize revenues.

Operator:

Your next question comes from the line of Jonathan Ho with William Blair. Your line is now open.

Brian Miller:

Yes, Jonathan, I mean, cross selling is one of our major mid to long term growth drivers. It’s something we’re talking about internally, as you look out over the next seven, eight years to about Tyler 2030. And things that can, quote, really move the needle. It’s these things like flips, its payments, it’s cross selling, it’s also a lot of other things that we do really well. And we’ve talked about areas of our business like supervision, where the where the market is good, where the TAM is good, and where we’re making really big gains there. But cross selling is something that we’re prioritizing across all of Tyler, where we’ve actually started some new sort of strategic account management approach within NIC and bringing other resources, getting even further exposure to our sales channels, our sales leads. There are things that we will be working on in terms of internally around how we recognize revenue from cross sells, and how we incentivize things and structurally internally, things that we need to sort of clear out some of those barriers to sort of unleash that power even more. We’re pretty excited about it. I mean we had probably this past quarter, probably one of the best stories we’ve had in a long time in terms of both cross selling and sort of connected communities which was the Kansas Department of Revenue story that I mentioned in my opening remarks. This was a deal where this deal took place because of our DNI solution around assessments, and the fact that we had such a broad footprint and presence within the state of Kansas from our enterprise assessment. But it also didn’t happen without NIC and their contacts at the state and utilizing that state master contract. So that was three different pieces of our organization coming together to create a really great result and something that I think we can replicate across other states that deals a $600,000, AAR deal, really an ideal, but really took the efforts of multiple divisions to do that. And I think that’s sort of an example of what we’re looking to do in the future.

Unidentified Analyst:

Yes, guys, it’s actually Peter on for Kirk. Appreciate taking the questions. So maybe, Brian, just one for you. Curious are we at the point where there should sort of be more stability in terms of the impact of this subscription transition on revenue versus your guidance? I mean, I think we all get the moving target, but just curious if the level of dispersion is likely to go down from here on that, in that sense?

Operator:

Your next question comes from the line of Terry Tillman with Truist Securities. Your line is now open.

Lynn Moore:

Yes, my expectation is that at least one of those larger deals is on track to close in Q1. As it relates to Tyler federal. I think you’re right. I mean, things that I’m seeing that’s coming out of that that division, in terms of sales indicators, the pipeline, the volume of deals is up significantly since year-over-year. We’re also seeing interesting going up more and more movement in the federal side to SaaS, which is good to see. It’s something that we put an internal focus on in the last two years. And we’re starting to see more of that receptiveness there. So I think there’s positive things coming out of the federal space. And I like our position there right now.

Brian Miller:

Yes, I think the growth rate on payments is going to be above Tyler’s overall growth rate is going to be a positive contributor. And I expect that, in general, that will be accelerating from 2022 both from adding new customers through the cross sell motion, which we talked about, we’ve integrated our payments teams. We’ve really got the go to market strategy down and now we’re starting to execute on it. Whether it’s using the expanded capabilities around that NICs platform brought us to drive that business down into the local level, continuing to have a focus on penetrating more of our customer base with payments, either with our product form or partner platforms, driving more adoption into the customer base. And then the addition of rapid so giving us capabilities on the disbursement side. And we’ve got some really interesting opportunities around that and think that’s going to be a nice growth driver. So I’d say we generally expect the payments business to grow faster than sort of Tyler’s top line revenues at least in 2023.

Operator:

Your next question comes from the line of Joshua Reilly with Needham, Your line is now open.

Brian Miller:

Yes, the guidance for 2023 of $37 million in capitalized software development encompasses how we expect those projects to be accounted for. So that’s reflect, the impact of that change is reflected there as well as other capitalized development projects that are either starting or ramping up during the year. So that’s fully encompassed there. But the change in expensing versus capitalizing for the full year of 2022 had about a $9 million impact versus what our initial guidance for capitalized software and R&D was.

Brian Miller:

Well, it impacted the full year, but most of that impact was seen in the Q4 results. So that resulted in a much lower number in Q4 versus the rest of the year.

Unidentified Analyst:

Thanks very much for squeezing me and I appreciate it. Just one for me. Brian, I heard your comments in the prepared remarks. You’re touching on growing implementations team or 2023 to meet backlog. Can you just talk about the labor market trends you’re seeing and where you stand currently in terms of hires? What we’re seeing in terms of wage inflation, etc? Thank you.

Lynn Moore:

Yes, I’d say, David if you go back 12 months ago, we were still experiencing really pretty high elevated turnover, still lower than industry, but higher than our norms, which, as you know, was all companies we’re dealing with. As we progress throughout the year, things started, I think there’s I talk a lot about the pendulum and the labor market pendulum is another one that I talked about. And it’s definitely started to swing back as we fell back into sort of November, December, I would say our turnover has actually come back down to sort of pre-COVID levels. Still early to see if that’s where it stays. But I like words, it’s I like that trend. As it relates to things like that Brian mentioned our services and implementation. That was an area that was hit particularly hard over the last couple years, and we’ve won a lot of business. We do have to do some hiring to ramp up to deliver on that business. And we’re doing that. It’s also creates a little bit of margin pressure in the near term. Because when we hire large classes of implementers, it normally takes four or five, six months before we get them out billable on the road.

Operator:

Your last question comes from the line of Keith Housum with Northcoast Research. Your line is now open.

Brian Miller:

I’d say the majority of that number, although not the majority of the dollars, but the majority of the number would be certainly new payments for most of this customer. So a lot of those are existing Tyler customers where we’re adding payments to a utility billing system or a licensing and permitting system. So we may be adding capabilities. they may have only taken checks before and now we’re providing online payment capabilities or credit card payments. And a number of those are still under rev share agreements. So the revenue generated is on an individual payment opportunity may be relatively small, but at good margins. But some of the more significant wins are competitive wins, like we mentioned the City of Milwaukee. That’s a full enterprise payment processing contract. And we’re replacing another vendor there. So I’d say the larger wins tend to be competitive ones, the smaller ones tend to be more first time payments.

Lynn Moore :

Great. Thanks, everybody for joining us today. If you have any further questions, please feel free to contact Brian Miller or myself. Have a great day everybody.

Operator:

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

Brian Miller:

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

Brian Miller:

Thanks Lynn. Yesterday, Tyler Technologies reported its results for the third quarter ended September 30th, 2022. In our earnings release, we have included non-GAAP measures that we believe facilitate understanding of our results and comparisons with peers in the software industry. A reconciliation of GAAP to non-GAAP measures is provided in our earnings release. We have also posted on the Investor Relations section of our website under the Financials tab, schedules with supplemental information provided on this call, including information about quarterly bookings, backlog and recurring revenues. Both GAAP and non-GAAP revenues for the quarter were $473.2 million, up 2.9% and 2.7%, respectively. Organic revenue growth, excluding COVID-related revenues was strong at 9% on a GAAP basis and 8.8% on a non-GAAP basis. NIC's COVID-related revenues for the quarter were $11.7 million compared to $43.3 million in last year's third quarter. Revenue from the TourHealth initiative ended in the second quarter and the Virginia Rent Relief program has now officially ended with less than $2 million of remaining revenues anticipated in the fourth quarter. License revenue declined 10.6% as our new software contract mix has shifted to SaaS even more rapidly than planned at the beginning of the year. Professional services revenues rose 15.7% and 6.3% organically. We intend to continue to grow our implementation team during the fourth quarter to support delivery of our growing backlog and pipeline, but we'll likely continue to see some pressure on professional services revenue in the near term as those teams ramp up to become fully billable. Subscriptions revenue was just slightly above Q3 of last year due to the expected $37 million decline in COVID-related subscription revenue, but organically rose 14.5%. We added 153 new subscription-based arrangements and converted 70 existing on-premises clients, representing a total of approximately $149 million in contract value. In Q3 of last year, we added 144 new subscription-based arrangements and had 67 on-premises conversions, representing a total of approximately $84 million in contract value. Our software subscription bookings in the third quarter added $28.1 million in new ARR. Subscription contract value comprised a new high of approximately 91% of total new software contract value signed this quarter compared to 74% in Q3 of last year. The value weighted average term of new SaaS contracts this quarter was 3.8 years compared to 3.4 years last year. Transaction-based revenues, which include NIC portal, payment processing and e-filing revenues and are included in subscriptions, were $148.9 million, down 13% but excluding COVID-related revenue, grew 11.1%. E-filing revenue reached a new high of $19.7 million, up 13.3%. Our non-GAAP ARR was approximately $1.49 billion, which was flat with last year, but up 11.2%, excluding COVID-related revenues. Non-GAAP ARR for SaaS software arrangements was $421.7 million, up 27.7%. Transaction-based ARR was $595.6 million, down 13%, but up 11.1%, excluding COVID-related revenues. Non-GAAP maintenance ARR was flat with Q3 last year at $469.4 million due to the continued migration of on-premises clients to the cloud. Our backlog at the end of the quarter was a new high of $1.88 billion, up 6.3%. Bookings in the quarter were approximately $499 million, down 17% on a difficult comparison to Q3 of last year for three main reasons. First, Q3 of last year included the State of Illinois fixed fee e-filing renewal of approximately $63 million. Second, COVID-related revenues and bookings were approximately $43 million in Q3 last year, versus $11 million in the current quarter. And finally, most of the Federal Department of State deals signed this quarter was not included in backlog or bookings. Normalizing for these items, bookings grew 7.7%. On an organic basis, bookings were approximately $364 million, down 17.9%, but grew 7.7% on a normalized basis. For the trailing 12 months, bookings were approximately $1.9 billion, up 18.1% and on an organic basis, were approximately $1.4 billion, up 2.1%. As a result of an increase in our estimated research tax credit, our annual GAAP and non-GAAP effective tax rates were positively affected. Our non-GAAP annual effective tax rate is now 22.5%, down from the 24% previously used and the non-GAAP effective tax rate for the third quarter was 19.6% to adjust the year-to-date tax rate. This resulted in an $0.11 uplift to our third quarter non-GAAP EPS. For the full year, we expect this tax rate change to impact non-GAAP EPS by approximately $0.14. Cash flows from operations were $129.4 million, down 37% and free cash flow was $115.6 million, down 40%, mainly due to the timing of working capital items such as payroll accruals, remittance of portal fees, and taxes and we expect to see positive impacts of these timing items in the fourth quarter. We continue to strengthen our already solid balance sheet. During the quarter, we repaid $190 million of our term debt and since completing the NIC acquisition, we have paid down $665 million of term debt. We ended the quarter with total outstanding debt of $1.085 billion and cash and investments of $247.9 million. As a reminder, $600 million of our debt is in the form of convertible debt with a fixed interest rate of 0.25%. The remaining $485 million is in pre-payable term debt due in 2024 and 2026, with interest at floating rates based on LIBOR plus a margin of 125 or 150 basis points. So, our exposure to floating rates is limited. We also have an undrawn $500 million revolver. Our net leverage at quarter end was approximately 1.79 times trailing 12-month pro forma EBITDA. Looking forward, we have adjusted the upper end of our full year revenue guidance to reflect lower license revenue as a result of a higher SaaS mix as well as the timing of new license contracts in our Public Safety and Federal divisions along with ongoing pressures on professional services revenue. Adjusted for the change in our effective tax rate, the midpoint of our non-EPS guidance is unchanged. Our updated 2022 guidance is as follows; we expect both GAAP and non-GAAP total revenues will be between $1.837 billion and $1.857 billion. The midpoint of our guidance implies organic growth of approximately 8%. We expect total revenues will include approximately $49 million of COVID-related revenues from NIC's TourHealth and Pandemic Rent Relief services. Revenue from TourHealth ended in the second quarter, while revenue from the Rent Relief program is expected to end in the fourth quarter. We expect GAAP EPS will be between $3.89 and $4.05 and may vary significantly due to the impact of stock option activity on the GAAP effective tax rate. We expect non-GAAP diluted EPS will be between $7.51 and $7.65. Interest expense is expected to be approximately $28 million, including approximately $7 million of non-cash amortization of debt discounts and issuance costs. For the full year, the net impact of the change in our tax rate, offset by increases in estimated interest expense, resulted in a $0.02 net reduction in non-GAAP EPS compared to our initial guidance. Other details of our guidance are included in our earnings release. Now, I'd like to turn the call back over to Lynn for his comments.

Operator:

We will now begin the question-and-answer session. [Operator Instructions] Your first question is from Sami Badri of Credit Suisse. Please go ahead, your line is open.

Lynn Moore:

Yes, sure, Sami. Let me start, and Brian jump in. First, on the ARPA deal, that was a really nice deal for a lot of reasons. As I mentioned in my comments, that was Hidalgo County, Texas. It was a full enterprise public safety suite deal, enforcement mobile civil process. ARPA funds were certainly a factor in getting that deal signed and funded. It's about $1.25 million license deal and about a $450,000 ARR deal. I think also what's interesting about that is that's a deal that also where our Tyler Alliance story really helped close the deal. So, some of the strategic things that we've been talking about are -- again, are continuing to resonate with our clients. It's also interesting because it's an AWS Gov cloud deployment, which is continuing. I think our comments around the -- what we're starting to see is more and more receptiveness in public safety to potentially move into the SaaS world. But yes, it was funded by ARPA. We track ARPA Funds. It's sometimes it's not easy to always identify specific deals tied to ARPA Funds because a lot of times these funds may be used for other things, which then free up funds for deals that we're pursuing. We see ARPA funds more often in areas where they are more like singular purchases. We expect to see some, for example, in school bus transportation deal where they're purchasing a large amount of hardware or something like that. The comment on longer procurement cycles, I don't want that to be taken out of context really. I think our cycles generally are on track with where they've been. I think the comment was really meant to say, as we're looking at more and more cross-sell opportunities through NIC and as those deals are getting larger, some of those larger deals are taking a little bit longer, but I wouldn't characterize procurement cycles across the Tyler portfolio of products is actually getting longer. So, if we misspoke there, I want to make that clarification.

Lynn Moore:

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

Operator:

Your next question is from Pete Heckmann of D.A. Davidson. Please go ahead. Your line is open.

Lynn Moore:

Yeah. Thanks, Pete. So I think what we're seeing is different divisions, different product suites have been moving at different paces to the cloud. Some of them we've talked before, like this year, our enterprise ERP solution is almost exclusively this year, and we budgeted this year to move to the cloud. Our lower end, or formerly our LGD, but our ERP Pro solution has continued to go at accelerated rates. What we're seeing is in areas, for example, like our enterprise, permitting and licensing solution, we budgeted this year that all new deals there would be 75% SaaS. And what we're seeing is they're 100% SaaS. We're starting to see it in our property and recording solutions, particularly our recording solution. We budgeted this year at 60% SaaS, it's 85% SaaS. What we're starting to see now also in the market and as we look into next year, is our two divisions, which have had really more dependency on licenses, particularly in the last couple of years has obviously been public safety and Tyler Federal, Tyler Federal has been moving, I think, a little bit faster to SaaS. And we've talked before in the past about public safety's lag. But public safety, what we're seeing now and as we're looking into next year, we're looking at a lot higher subscription based arrangements probably more so than we anticipated earlier in the year. And so as we look into 2023, we're seeing the effects now, but as we preliminary model, and again, this is not a 2023 call, but as we preliminarily look out to 2023, we see the licenses declining at a faster rate than we anticipated. And it's just a little bit shorter timeframe.

Lynn Moore:

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

Operator:

Your next question is from Kirk Materne of Evercore ISI. Please go ahead, your line is open.

Lynn Moore:

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

Brian Miller:

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

Kirk Materne:

Got it. Thanks guys. Congrats on the quarter. Operator

Lynn Moore:

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

Brian Miller:

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

Michael Turrin:

That’s helpful. Thank you.

Matt VanVliet:

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

Matt VanVliet:

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

Matt VanVliet:

All right. Great. Thank you.

Joshua Reilly:

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

Brian Miller:

Yes, for around the timing of deals...

Brian Miller:

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

Lynn Moore:

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

Alex Zukin:

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

Alex Zukin:

Understood. And then maybe just -- and sorry, are you saying the cash flow margin for next year is going to be similar to this year, or the cash flow growth, or the dollar cash flow for next year?

Alex Zukin:

Got it. Okay. And then, I guess, when you're looking at the acquisition you guys made, can you maybe just talk on where -- what were the incremental functionality or features that you guys saw an opportunity to add and double down on here that you didn't have or NIC didn't have. And if you think about the general M&A landscape, should we expect more in payments? Should we expect less in payments going forward? Do you have what you need here now?

Brian Miller:

And the only thing I'd add there is on the issuing side versus the acquiring side of the processing side, the margins are better. So that's also a positive.

Operator:

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

Brian Miller:

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

Lynn Moore:

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

Operator:

Your next question is from Saket Kalia of Barclays. Please go ahead. Your line is open.

Brian Miller:

I don't think we stay at the 90% mix, at least near-term in future quarters that was skewed by the Department of State contract, we talked about...

Brian Miller:

90% of the value. In terms of the number of deals, it was 74% subscription and 26% on-prem, which is -- I'm sorry…

Brian Miller:

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

Lynn Moore:

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

Operator:

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

Lynn Moore:

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

Brian Miller:

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

Terry Tillman:

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

Keith Housum:

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

Keith Housum:

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

Keith Housum:

Great. Thanks. Appreciate it.

Joe Goodwin:

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

Brian Miller:

No. The expected notification in the fourth quarter, but..

Brian Miller:

And that, that would be for a start in -- at the beginning of 2024. So that would be a full year ramp up and set up from the time the award takes place until the revenues would actually start.

Operator:

There are no further questions at this time. I will now turn the call over to Lynn Moore for closing remarks.

Operator:

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

Operator:

Hello, and welcome to today's Tyler Technologies Second Quarter 2022 Conference Call. Your host for today's call is Lynn Moore, President and CEO of Tyler Technologies. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. And as a reminder, this conference is being recorded today, July 28, 2022. I'd now like to turn the call over to Mr. Moore. Sir, please go ahead.

Brian Miller:

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

Brian Miller:

Thanks, Lynn. Yesterday, Tyler Technologies reported its results for the second quarter ended June 30, 2022. In our earnings release, we have included non-GAAP measures that we believe facilitate understanding of our results and comparisons with peers in the software industry. A reconciliation of GAAP to non-GAAP measures is provided in our earnings release. We'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. Both GAAP and non-GAAP revenues for the quarter were $468.7 million, up 16%, including NIC and our other acquisitions from the last 12 months. Organic revenue growth, excluding COVID-related revenues was 6.2% on a GAAP basis and 5.8% on a non-GAAP basis. NIC's COVID-related revenues for the quarter exceeded our expectations at $15.2 million. Revenues from the TourHealth initiatives concluded in the second quarter and the Virginia rent relief program is expected to be completed in the third quarter with about $8 million of revenues anticipated in the quarter. As expected, license revenues declined 14.7% as our new software contract mix continued to shift to SaaS. Software revenues rose 18.3% -- service revenues rose 18.3% but on an organic basis were essentially flat with last year. Services revenues were impacted by delays in hiring new professional services staff in the current labor market. While we hired a large class of implementers during the quarter, there is an onboarding period of several months before they will be fully billable. We intend to continue to grow our implementation team during the second half of the year to support delivery of our growing backlog and pipeline, but we'll likely continue to see some pressure on services revenues in the short term as those teams ramp up. Subscription revenues rose 28.2% with strong organic growth of 14.1%. We added 167 new subscription-based arrangements and converted a new high of 96 existing on-premises clients, representing approximately $115 million in total contract value. In Q2 of last year, we added 170 new subscription-based arrangements and had 62 on-premises conversions, representing approximately $73 million in total contract value. Our software subscription bookings in the second quarter added $27.6 million in new ARR. Subscription contract value comprised approximately 74% of the total new software contract value signed this quarter compared to 65% in Q2 of last year. The value weighted average term of new SaaS contracts this quarter was 3.7 years compared to 4.1 years last year. Transaction-based revenues, which include NIC portal, payment processing and e-filing revenues and are included in subscriptions, were $154.4 million, up 29.1%. Excluding NIC, Tyler's transaction-based revenues grew 17.5%. E-filing revenues reached a new high of $18.5 million, up 14%. For the second quarter, our non-GAAP ARR was approximately $1.49 billion, up 16.3%. Non-GAAP ARR for SaaS software arrangements was approximately $405.6 million, up 24.9%. Transaction-based ARR was approximately $617.7 million, up 29.1% and non-GAAP maintenance ARR was down 2.3% at approximately $467.3 million due to the continued migration of on-premises clients to the cloud. Our backlog at the end of the quarter was a new high of $1.85 billion, up 13.9%. Bookings in the quarter were very strong at approximately $562 million, up 21%, including transaction-based revenues. On an organic basis, bookings were also quite robust at approximately $423 million, up 16.3%. For the trailing 12 months, bookings were approximately $2 billion, up 53.2% on an organic basis were approximately $1.5 billion up 21.1%. If our weighted average contract terms for new SaaS contracts had been the same as last year, organic bookings growth would have been 18.3%. As Lynn mentioned earlier, both cash flows from operations and free cash flow reached new highs for a second quarter. Cash flows from operations were $76.7 million and free cash flow rose to $60 million from negative $33.5 million last year. We continue to strengthen our already solid balance sheet. During the quarter, we repaid $60 million of our term debt. And since completing the NIC acquisition, we have paid down $475 million of term debt. We will also pay down an additional $100 million in term debt at the end of this month. We ended the quarter with total outstanding debt of $1.275 billion and cash and investments of $314 million. As a reminder, $600 million of our debt is in the form of convertible debt with an interest rate of 0.25% and the remainder is in prepayable term debt due in 2024 and 2026. We also have an undrawn $500 million revolver. Our net leverage at June 30 was approximately 2.07x trailing 12 months pro forma EBITDA and our leverage should be under 2x at the end of July. Interest rate hikes thus far this year and projected for the remainder of the year have resulted in significantly higher projected interest expense for the year than we anticipated at the beginning of the year. In addition, we have debt discounts and issuance costs related to our term debt that are being amortized as noncash interest expense. And as we prepay term debt, we are required to accelerate the amortization of those costs. Accordingly, we have adjusted our earnings guidance for the full year to reflect those changes in assumptions around interest. Our current guidance for the full year interest expense of $30 million represents an increase of about $7 million or approximately $0.12 per share for both GAAP and non-GAAP EPS compared to our previous guidance. The $7 million increase includes about $4 million of cash interest on term debt and $3 million of additional noncash amortization of debt discounts and issuance costs. It's important to note that our revenue guidance has not changed, and our expectations for operating margins are generally consistent with our previous outlook. Our updated 2022 guidance is as follows. We expect both GAAP and non-GAAP total revenues will be between $1.835 billion and $1.870 billion. The midpoint of our guidance implies organic growth of approximately 9%. We expect total revenues will include approximately $44 million of COVID-related revenues from NIC's TourHealth and pandemic rent relief services. Revenues from TourHealth concluded in the second quarter, while revenues from the rent relief program are expected to wind down in the third quarter. We expect GAAP diluted EPS will be between $3.60 and $3.76 and may vary significantly due to the impact of stock incentive awards on the GAAP effective tax rate. We expect non-GAAP diluted EPS will be between $7.36 and $7.52. Interest expense is expected to be approximately $30 million, including approximately $7.5 million of noncash amortization of debt discounts and issuance costs. Other details of our guidance are included in our earnings release. Now I'd like to turn the call back over to Lynn.

Operator:

[Operator Instructions] Our first question is from Sami Badri with Credit Suisse. Your line is open.

Lynn Moore:

Yes, sure, Sami, it's Lynn. I'll start and I'll let Brian jump in. I think right now, our sales cycles are pretty normal. I think we've experienced times if you go back to the recession in '08, '09, that's where you started seeing things push out and get delayed. We saw a little bit of that during COVID. But I think the key is we continually talk about the fact that what we provide is essential functionality and the software that we do provide are things that are needed and they're often replacing out of date or systems. And so right now, the market looks good. The sales cycles are pretty typical for a normal healthy time, even with respect to those large deals. Sales cycles will vary a little bit across our different divisions. Some have longer than others. And sometimes the larger deals do take a little bit longer. But I think across the board, across our different product suites, I'd say sales cycles are pretty much on track. When you talk about state and local government spending environment, what we're seeing right now really is it's pretty healthy. I agree their budgets are in good shape. I've made comments before that I think coming out of COVID, they were not hit nearly as hard as a lot of people anticipated some of the journal reports and other things that we've read. Also with the infusion of some stimulus. And I know Brian's got some numbers and thoughts around ARPA. But I think right now, what we're seeing in our pipeline, all our leading indicators around RFPs and demos, things like that, you're seeing it a little bit in some of our bookings this quarter is that things are well right now in the state and local government.

Operator:

Next question is from Matthew VanVliet with BTIG. Your line is open.

Lynn Moore:

Sure. Thanks, Matthew. And I guess I would just say that the labor market challenges that are out there, we talk about a lot of things in our business where we may be a little bit immune to some of the external macro factors. But the challenges in the labor market, we're not unique there. And so we've been experiencing this for some time. It has been a challenge, both in terms of hiring and recruiting, and we're also seeing it with a little bit higher early retirements and things like that. The impact is -- we're seeing it right now, and we've got a lot of business we want to execute on and deliver on, but our services revenues are off a little bit. And I'd probably expect some of that to carry through throughout the year. We do generally make sort of large hiring classes. You take, for example, our enterprise ERP group. They hired a very large class back in February. I think we're looking at hiring another very large class in the next few weeks. But even when you hire those large classes, it takes time for them to get up to speed and get to a point where they can go out and become fully billable on client implementation. So it can take four, five, six months. So there's a little bit of delay there. So there's a little bit of impact that will happen even as our margins as we bring these people on, but it takes a little time for them to start becoming billable. As it relates to external partners, I think historically, we've always wanted to keep our services in-house. It's certainly not a big margin advantage to have them in-house, but we think from a professional and competitive and client ownership advantage, it really has been -- has played out and been a lot of value to us really for the last 25 years. The thought of always having the touch point from initially from our sales, handing it off to our implementation team, handing it off to our support team, I think that client relationship and client experience is part of what drives our success in the market. And so as of right now, we're not really looking to do that. It's such a unique business that I think we just want to keep these things in-house, at least for the time being.

Lynn Moore:

Yes, Matthew. I think I made the comment on the last call that we're probably in the first inning of our -- what we can do with NIC and maybe even just the top of the first inning. I wouldn't say that -- they did -- the reality is they didn't really have some of the local relationships. We're still learning about each other. The fact that this soon, we've already done the number of deals that we've done, I think we've closed 15 deals already. Our active pipeline is around 100 deals, north of $30 million. That's pretty exciting in such a short period of time while we're still doing just our normal integrations with NIC. We've won some pretty significant contracts. I think, last quarter, we talked about VendEngine won a contract with the Arkansas Department of Corrections, mentioned in my comments earlier, another VendEngine contract with Kentucky, our Entellitrak Veterans Benefits contract with Utah. That's pretty exciting stuff, particularly with -- when I mentioned a deal between NIC and VendEngine and something I've said internally is these are both acquisitions that we've brought on in the last year and in different parts of the business and to see that coordination already and to be able to leverage the relationships that NIC has got those deep state relationships as well as those enterprise contracts, it's pretty exciting stuff.

Lynn Moore:

I apologize, Matthew, if you're asking about hunting, I heard state, we call those understanding.

Operator:

The next question is from Saket Kalia with Barclays. Your line is open.

Lynn Moore:

Yes, sure, Saket. Thanks for the question. It's a good question. I think right now, probably the primary areas where we're seeing the most flips is in our ERP side of the -- suite of the business. So both our enterprise ERP and our ERP Pro solutions. We had -- and coincidentally, those are the areas where we actually have the most customers. That's our largest customer base. I think at our top end, our enterprise ERP, we're already well ahead of our plan for the year in flips. We're about 35% ahead through the first half. The lower end in our ERP Pro solution, which is our formerly our Incode solution, we plan to do about 180 a year down in that product suite. We're obviously seeing it in other businesses, but that's probably our highest volume. And as we continue to move forward, you're going to see that increase not only there, but across all of our product suites. As we model out and look forward, we're starting to do some internal modeling around what we call Tyler 2030. And a big part of our growth strategy is converting that very high customer base from on-prem over into the SaaS world. I'm not prepared today to sort of give you a projection of how many per year and how much that's going to grow. But I would expect over the next five to seven years, you're going to continue to see momentum and increased movement in that area.

Brian Miller:

Well, I think on the second part of the question, the conversion to revenue is just that more of it is SaaS or -- and so you don't necessarily get a revenue hit. In fact, you typically don't get a revenue hit immediately. Often, it's a quarter or two after the signing before their environment stood up and we start to recognize revenues. So even with the SaaS customer, there's a lag. And then, of course, you've got a recurring revenue stream that you're starting to grow. So it may start in the third month of the quarter and so you get a month's worth of revenues, and the next quarter you get a quarter's worth and so forth. And so that ongoing change in the mix has been a part of that with less licenses, which are typically recognized mostly upfront. We talked about a little bit of the service pressure as well. So that also is with our -- a little bit below plan headcount there, we're, I think, not ramping up those new signings as quickly as we might once we're sort of fully staffed with our billable implementation teams. So I think that's the biggest thing. I think in terms of just driving higher bookings, we've always said bookings can be somewhat lumpy from quarter-to-quarter, especially around those big deals. In this quarter, a couple of those big deals that did have long sales cycles got to contract. But generally, I'd say it's sort of a combination of those factors we pointed out, pretty strong economic backdrop in budget situation around governments. It's certainly aided by the ARPA funds, the federal stimulus that's available to them. As we've talked about on prior calls, sometimes it's not clearly identifiable that a deal was funded with ARPA funds. Sometimes it is, and there are some of those in this quarter. Other times ARPA funds are used for something else, but it frees up money that helps perhaps make an incremental purchase or an add-on sales. We're seeing real strength in our inside sales selling additional products to existing customers, and we believe some of that is driven by the federal stimulus. But as we've said in the past, that's sort of a long-term tailwind they've got until the end of 2024 really to commit those funds and through 2026 to spend those. And we saw a study by Brookings that indicated that at least as of the end of 2021, only about 40% of the stimulus funds had been committed yet by cities and counties. So we think there's sort of an ongoing tailwind there. So strength in the market and then our competitive position is really strong. I mean, we continue to invest at a high level. We've got multiple products that we've added through acquisitions and internal builds. So our average sales are often bigger than they would have been in the past because we've got more products that are bundled together, things like our data and insight solution that's often bundled in a new sale, a number of our public safety products that now are often in a new sale that make that bigger. So there are a number of factors contributing to that. But yes, there is typically a lag from bookings growth to revenue growth.