Tyler Technologies, Inc. (NYSE:TYL) Q4 2023 Earnings Call Transcript

Tyler Technologies, Inc. (NYSE:TYL) Q4 2023 Earnings Call Transcript February 15, 2024

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

Operator: 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.

Hala Elsherbini: Thank you, Bhavesh, 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 provide our annual guidance for 2024. Lynn will end with some additional comments and then we’ll take questions. During this call, management may make statements that provide information other than historical information, and may include projections concerning the company’s future prospects, revenues, expenses and profits. Such statements are considered forward-looking statements under the safe harbor provision of the Private Securities Litigation Reform Act of 1995 and are subject to certain risks and uncertainties, which could cause actual results to differ materially from those projections.

We would refer you to our Form 10-K and other SEC filings for more information on those risks. Also in our earnings release, we have included non-GAAP measures that we believe facilitate understanding of our results and comparisons with peers in the software industry. A reconciliation of GAAP to non-GAAP measures is provided in our earnings release. We’ve also posted on the Investor Relations section of our Web site under the Financials tab schedules with supplemental information, including information about quarterly bookings, backlog and recurring revenues. On the Events and Presentations tab, we posted an earnings summary slide deck to supplement our prepared remarks. Please note that all growth comparisons we make on the call today will relate to the corresponding period of last year unless we specify otherwise.

Lynn?

Lynn Moore: Thanks, Hala. 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.

Brian Miller: Thanks Lynn. Total revenues for the quarter were $480.9 million, up 6.3%. Organic revenue growth, which also excludes COVID related revenues in 2022, was 6.1%. The fourth quarter of 2022 included $3.5 million of revenues from COVID related initiatives at our Digital Solutions division, all of which ended in 2022. Subscription revenues increased 11.4% and organically rose 10.8%. Within subscriptions, our SaaS revenues grew 21.7% to $141 million and grew organically 21.2%, which is consistent with our near term growth expectations of 20% CAGR and SaaS revenues through 2025. Keep in mind that there is often a lag from the signing of a new SaaS deal or a flip to the start of revenue recognition that can vary from one to several quarters.

Because of this as well as the timing of SaaS renewals and related price increases, SaaS revenue growth, both year-over-year and sequentially, may fluctuate from quarter-to-quarter. Transaction revenues grew 3% to $145.1 million and were up 2.1% on an organic basis. The lower growth rate in transaction revenues reflects in part the change from gross to net revenue recognition for payments under one of our state enterprise agreements. Just a reminder here about the seasonality of our transaction revenues. Our seasonality is really driven by two primary factors; State determined deadlines, such as corporate filing deadlines or hunting seasons; and the number of business days. Even with online transactions, we see a decline in volumes over the holidays.

Q2 is typically our highest volume quarter with peak outdoor seasons along with tax season deadlines followed by Q1 due to the high volume of corporate filing services with Q1 deadlines. Q4 will always lag with the holiday seasons, which lead to fewer business days. While the smaller impact revenues from driver history records are also stronger in the first half of the year. The sequential decline in transaction revenues this quarter reflects that typical seasonality. SaaS deals comprised approximately 89% of our Q4 new software contract value compared to 86% last year. Professional services revenue declined 3.7% due to the absence of COVID related revenues and was flat organically. As Lynn noted earlier, public sector demand remains healthy and we’re pleased with the strength of our new contract signings in Q4.

During the quarter, we added 156 new SaaS arrangements and converted 92 existing on premises clients to SaaS with the total contract value of approximately $137 million, an increase of 39% over last year. In Q4 of last year, we added 140 new SaaS arrangements and hit 82 on premises conversions with a total contract value of approximately $99 million. Also note that while the contract with the California State Parks includes our SaaS solution for outdoor recreation, it is not included in the new SaaS contract value, because it is funded completely from transaction fees. Overall, our pace of on premises conversions to SaaS continued at a steady pace with 338 flips in 2023. More importantly, the total contract value associated with flips increased to $92 million compared to $76 million last year.

As we’ve discussed, conversions are a significant growth driver over the next several years as we accelerate the pace of flips. Including transaction revenues, expansions with existing clients and professional services, total bookings increased 21.2% on an organic basis. Our total annualized recurring revenue was approximately $1.61 billion, up 7.9% and organically grew 7.1%. Operating margins were better than expected despite pressure from our ongoing cloud transition. Our non-GAAP operating margin was 22.3%, up 70 basis points from Q4 last year. As Lynn discussed earlier, merchant and interchange fees from our payments business under the gross revenue model have a meaningful impact on our overall margins as they are passed through to clients and are included in both revenues and cost of revenues.

We paid merchant fees of approximately $35 million in Q4 and approximately $157 million for the full year of 2023. Both cash flows from operations and free cash flow reached new highs for our fourth quarter at $147.4 million and $134.4 million respectively. Cash flow in the quarter was impacted by approximately $15 million of incremental cash taxes due to Section 174. And for the full year, those incremental cash taxes were approximately $127 million. We continue to prioritize repayment of term debt as a use of our cash flow. And in Q4, we reduced our term debt by $90 million, bringing our total repayments for the year to $345 million. We ended Q4 with total outstanding debt of $650 million and cash and investments of approximately $183 million.

Our net leverage at quarter end was approximately 0.97 times trailing 12 month pro forma EBITDA. Our 2024 guidance is as follows. We expect total revenues will be between $2.095 billion and $2.135 billion. The midpoint of our guidance implies organic growth of approximately 8%. We also expect that merchant fees will be down slightly and that implied growth, excluding merchant fees, would be approximately 90 basis points higher. We expect GAAP diluted EPS will be between $5.17 and $5.37 and may vary significantly due to the impact of discrete tax items on the GAAP effective tax rate. We expect non-GAAP diluted EPS will be between $8.90 and $9.10. We expect our free cash flow margin will be between 17% and 19%, including the impact of incremental cash taxes related to Section 174 of approximately $50 million.

Other details of our guidance are included in our earnings release and in the Q4 earnings deck posted on our Web site. Now, I’d like to turn the call back over to Lynn.

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.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from the line of Ken Wong of Oppenheimer and Co.

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?

Brian Miller: Well, really, a lot of the movement in flip is — doesn’t require a lot of sales and marketing efforts. A lot of that is done through our inside sales organization through our existing client relationship managers, and it doesn’t require a great deal of increase in sales and marketing expenses. And generally, we feel like that sort of mid single digit growth in sales and marketing like a lot of [Technical Difficulty] more cross selling [Technical Difficulty] more synergies across our sales organization, put more products in the same sales rep bags. So those two factors don’t really conflict with each other. But we believe the resources we have in place really are sufficient to drive the pace of flips we expect to see over the next several years.

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.

Ken Wong : And then just a quick follow-up in terms of the hosting efficiencies. I guess would you say we’ve peaked in terms of kind of extracting the efficiencies there or is there still a little room to go?

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.

Operator: Our next question comes from the line of Saket Kalia of Barclays.

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?

Lynn Moore: As you know, we signed an extension that now runs through the end of 31, which runs through our Tyler 2030 initiative, which is great. It obviously just further deepen those relationships. We’ve made certain commitments to AWS around migrating our existing Tyler clients, our net new clients into AWS. AWS has also made commitments back to us around certain pricing commitments, innovation, marketing, things like that. I’m not really at liberty to go into the specifics of what those details and those commitments and pricing concessions are. But what I can say is that AWS has been a great partner for us. I couldn’t be more happy with the relationship that we started in the fall of 2019. And this extension, I think, further embraces that.

They’re very collaborative with us and are eager to work with us to help us find ways to lower our costs. So they are a true partner. Similarly, we view our clients in the public sector as partners, that’s why they view us. And I think part of the difference also in our relationship now is it’s more mature. And we’re a lot farther along in our cloud journey than we were when we first signed it. If you remember when we first signed the agreement, we were still trying to figure out how our products would really operate in AWS, and we spent a long time trying to just figure out the cost of just moving simply lift and shift. And now we’ve transformed and we’ve done all that and it’s how can we make them run even more efficiently in the public cloud.

So great partner, excited that they’re on this journey with us for the next at least eight years.

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?

Brian Miller: Yes. I think in the near term, they likely expand in the same range. And particularly, I think you see that in 2024, most likely, especially because we still, although, it’s lessening and lessens over the next several years, there still is an impact of the Section 174 change. It was $127 million impact on our free cash flow in 2023. It’s about a $50 million impact in 2024 and it will decline again over the next four years after that until it sort of reaches equilibrium. But I think in the longer term, we would expect that free cash flow growth would be higher, especially if you take out that Section 174 impact, because of a couple of things. We’ve continued to get leverage out of CapEx and especially as we exit our data centers where a significant amount of our CapEx has been focused in recent years as we continue to become more efficient around how we manage office facilities and our other CapEx associated with our business.

And actually, you’ll see we have lower expectation for CapEx around software development going forward as well. But most importantly, the cash flow characteristics of the recurring revenues, the SaaS revenues paid in advance and create deferred revenue, the transaction revenue is generally getting paid at the time of the transaction. So there aren’t big receivables associated with those. So as those businesses grow, those revenue streams grow, they should have the impact of causing our cash flow to grow faster than the EBIT.

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

Joshua Reilly: Overall, the demand environment seems very strong, but the initial revenue guidance for 2024 was a bit below the Street at the midpoint, and implies a little greater acceleration in 2025 to hit the midterm target for revenue of $2.35 billion. How are you thinking about the progression to hit this 2025 target now, given the initial revenue guidance for the year?

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.

Joshua Reilly: And then just a quick follow-up. The Idaho Courts deal, that seems like an important deal in terms of being the first. I believe it’s the first state to migrate out of the 16 or 17 that you have on-premise case management installations. Do you think this is a tipping point or do you think that the others 16 or 17 states are still a couple of years away from migrating?

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.

Operator: Our next question comes from the line of Terrell Tillman of Truist Securities.

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?

Brian Miller: Yes, it’s going to take some time for the full impact of this deal. And I think we’re going to recognize probably about 50% of the uplift revenue in 2024 and we’ll really see the full impact in 2025. All of our courts’ businesses are large projects. We talked about the L.A. criminal courts go live, probably one of the most successful go-lives we’ve had in Tyler’s history. This will mirror that as it will be our first statewide flip. But from a timing perspective, revenues, uplift, all that, we’ll get about 50% of it in 2024, and in 2025, we’ll have the full run rate.

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.

Connor Passarella: And then just on a follow-up. I just wanted to ask one around transaction revenues. Could you maybe just talk a little more about the impact of payments from customers flipping gross to net in the quarter? I think you mentioned the flip in one of the state enterprise agreements. I was just curious on how that impacted overall revenue in that segment?

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.

Operator: Our next question comes from the line of Matt VanVliet of BTIG.

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?

Lynn Moore: Matt, I’ll start and Brian, you may jump in. There are a couple of things that are really exciting about that California State Parks deal. One obviously is it’s the largest transaction deal in Tyler’s history. The second thing is, as you pointed out, it validates this sort of self funding model. It’s not a surprise. Anybody who reads the journal that California has significant deficits and significant budgetary issues right now. And so going to them with a self funded model on this type of contract is really about the only way they can do it. And so again, it validates that model, that part of our business. Because it’s self funded, the impact going forward we will be recognizing a lot more expense in 2024. It’s actually a little bit of a drag on margins in 2024.

But ramps up significantly in ’25 and continues that ramp up with margin expansion all the way through the end of the contract in 2031, assuming we don’t get the two one year extensions, which if we execute, we think we would get. Brian, do you have anything more to add?

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.

Matt VanVliet: And then maybe just one clarification around the AWS extension. As you continue to scale that business, are we still at maybe a subscale type of cost relative to the revenue running through that system? Meaning is there still more leverage that can be achieved over the next couple of years through that contract or are we at a level now where it’s kind of a pay as you go as you get more scale?

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.

Brian Miller: And I’d point out one other thing about the California contract. As we mentioned on the call, this is a significant expansion of what is already in an existing agreement we have with California under with US eDirect, which we acquired after we acquired NIC. So there are currently annual revenues under that agreement of a little less than $3 million a year. So it’s not all incremental revenues but it’s a significant increase in the revenues as that has expanded and especially because it now includes payment processing.

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

Unidentified Analyst: This is Kelly [indiscernible] on for Gabriela. Another question on the number of conversions. Conversions have been in kind of the 70 to 100 range per quarter for the past two years. How should we think about the ramp to converting maybe hundreds of customers a quarter, and are you sharing any expectations for a number of flips in 2024?

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.

Brian Miller: I just would add that it’s also important, I think, to look at the size of the flips and the dollar value. So for example, this quarter with the signing the Idaho State Port deal significantly bigger than most of our typical flips. So even though that only counts as one of the 92, the dollars were pretty meaningfully different. And I think in our prepared remarks, we talked about the the size of the increase in the dollar value of the flip contracts. And so in general, I’d expect that as we go forward over the next few years that we’ll see more of our larger clients start to move, and so it has a bigger impact on that uplift on the dollar side. So obviously, each flip is not created equal and in general, we’ve got more of our large clients that are still to be migrated.

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?

Lynn Moore: We’ve made a lot of progress, in particular, if you look at our enterprise ERP product, for example, I think at the end of last year, we only had about 23% of that client base on the more modern version at the end of this year, end of 202,3 that was up to 86%. We’ve made similar strides with our Enterprise Justice solution. So just generally, across the board, we’re tracking on that. I’m not sure if I remember saying at the end of 2025, I think it was more 26%. But I think we’re actually ahead of the pace that I was thinking about and discussing maybe 18 months, 24 months ago.

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

Rob Oliver: Lynn, first question is for you. Just around public safety, it must be gratifying just to see the way the business is working after many years through the New World acquisition and now moving to cloud faster than expected. So my question is, it seems like that would be good for Tyler. I just would be curious to hear your view on any potential shift in the competitive landscape that, that might cause, meaning some of your legacy typical competitors that we know in this space, are they properly cloud enabled and conversely, are you seeing new competitors in the market in public safety as these deals shift more to cloud first? And then I had a quick follow-up for Brian.

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.

Rob Oliver: And then Brian, just a question around the R&D expense guide for the year, implying kind of mid-teens year-over-year growth. Can you just talk about what some of the biggest drivers of that are within that R&D line?

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.

Operator: Our next question comes from the line of Charles Strauzer of CJS Securities, Inc.

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?

Brian Miller: I don’t think there’s anything unusual. What we did point out, I think we and the Street are still getting used to the seasonality of the transaction business. And I see when they were a separate public company, certainly we’re well versed in that and people who followed them more. But as that impacts Tyler and as we saw this quarter that seasonality around the transactions is pretty significant. I don’t expect that to be meaningfully different in 2024, but I think that’s the biggest thing to look out for when you look at the quarters.

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?

Lynn Moore: Charles, not really, not right now. Q1 is probably — we talked about the situation — was talking about seasonality. Q1 is probably a little bit slower time in that business as well. And right now, there’s no real change in our outlook.

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

Jonathan Ho: Just one question to start out with in terms of operating leverage. Can you maybe walk through for us some of the levers that you have to pull down on for additional operating leverage and some of the moving parts there as we think about your guidance for 2024.

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.

Lynn Moore: And Jon, I would just add to — I mean, we’re always looking at levers to help make us more efficient. There’s a number of internal initiatives going on where we look around and look up and see opportunities for where we can operate internally more efficiently. And there’s a number of those things that we’re actively acting on, which is, that really sounds weird, we’re progressing on.

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?

Lynn Moore: I think right now, we’re still sort of in the same place we’ve been for the last couple of years. We’re even though we will likely pay off the term debt sometime this spring, we still have that $600 million convert that’s due in a little more than two years. So my anticipation would be we will be building some cash reserves to be in a position to pay that off rather than renegotiate that at a high bank rate. But at the same time, just like we’ve done over the last couple of years, we were going to continue to do M&A, particularly where it makes sense strategically and where it’s accretive to Tyler. Last year, we did four deals. I think we spent about $75 million, $76 million in cash and stock. Over the last few years, we’ve spent several hundred million dollars of deals even as we were prioritizing debt paydown.

So we still want to prioritize being in a good position when the convertible is due, but at the same time, we’ll make smart acquisitions along the way.

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

Kirk Materne: Lynn, can you remind us just when, say, contracts that you signed on a SaaS basis, four or five years ago start to come up for renewal. How much of that is the renewal function, an opportunity for cross-sell, upsell for you? Meaning as Munis or ERP deals or SaaS deals come up, is that an opportunity for the salespeople to start talking about additional products or solutions? Meaning we should start to get into a little bit of a renewal cycle over the next couple of years. Just wondering how that works in terms of the uplift, either on a cross or upsell basis?

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.

Brian Miller: Flips provide that same opportunity. So we’re having conversations with clients about moving a product to the cloud, it gives us an opportunity to have that conversation around other products, maybe in that same suite that they might have on premises from another provider that aren’t Tyler products, and the opportunity to bring together an integrated set of solutions while they’re moving to the cloud. And I think that as we continue to accelerate the pace of those that we’ll continue to look for those opportunities for greater upsells and cross sells.

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?

Brian Miller: Yes, there’s always a lag. And sometimes we might sign a flip and it starts next quarter and then we see that uplift then. Other times, whether it’s because of things that the client needs to do to get internally to get ready to move, whether it’s that they need to upgrade to a current version of the software or they need to do things, they’ve got other internal priorities around their own resources that caused a delay or — there are a variety of reasons why there can be a lag of from one to multiple quarters. And sometimes it doesn’t all happen at once. So they may be flipping multiple applications with us so that they start — the uplift starts at different times. So I’d say generally, it’s not 24 months, but it could be from one to a few quarters before we see the full impact of those from the time we sign it to when we see the impact on the uplift.

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

Alex Zukin: Maybe just the first one. I think last quarter, you talked about wanting to do about 100-plus flips in Q4. Is the right way to think about it that the dollar value of the flips was in line with your expectations, but maybe not the actual number? And then to the point earlier, did some of those get pushed into ’24 and now there is the opportunity for a higher dollar value in ’24? Just help us understand a little bit about that dynamic.

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.

Alex Zukin: And then maybe just as a follow-up. There’s currently legislation out there that could reverse some of the R&D tax payments that you had to make. What would be the impact of — if that act passed on you guys, like how much and when would you see those dollars return?

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.

Operator: Our next question comes from the line of Keith Housum of Northcoast Research.

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?

Brian Miller: It’s generally stable. The part that’s expected to be recognized in the next 12 months, I think, is reasonably stable with where it’s been. The term of new SaaS deals, for example, this quarter, I think, was very similar. It was a little under four years average term. So it’s fairly consistent with what we’ve seen in recent quarters. And then, of course, the transaction contracts don’t really go into backlog. So they don’t really affect that number. But on the software side, I’d say it’s — there aren’t any meaningful changes in that duration of backlog.

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?

Lynn Moore: Yes, absolutely. You’re spot on on both. And some of these issues have come with obviously some existing clients of ours and it is an opportunity. The cloud is more stable, more secure. We actually have done some deals where clients who might have been resistant to the cloud have flipped, because of some sort of recent ransomware or other issue.

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

Alexei Gogolev: Lynn, I recall comments from last year that roughly 20% of your customers have migrated to the cloud. Can you provide an update of that mix as you move towards that target of 75% by 2030?

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.

Operator: Our next question comes from the line of Clarke Jeffries of Piper Sandler.

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].

Lynn Moore: Yes, let me clarify that. It’s a drag on margin in 2024. It will probably equate roughly to maybe a little bit of margin drag in ’25, but it’s just the ramp-up of revenues versus expenses. So the expenses are more front loaded to get them up and running. As Brian mentioned, we’re going from a contract that was a little under $3 million a year in revenues. I think first year, we’re expecting it to just slightly more than double that. But you look out in 2025, it goes to $20 million and we expect it to grow all the way up to close to $30 million by the end of the contract. We do expect positive OP starting next year and ramping up significantly each year over time.

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

David Unger: So back to the flips again, and the topic [Indiscernible] the call, if I would ask is, how should we think about license TCV as a percentage of total TCV on a normalized quarterly run rate path to both the midterm and long term target?

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.

Lynn Moore: And I think part of your question was around total contract value, TCV. So that will obviously vary a little bit depending on the SaaS term that we sign. You could use a rule of thumb of what a license deal and a one year maintenance that might drag on that versus sort of what we would project as a normal SaaS deal. So if the SaaS contract was probably only one or two years, it’s probably going to have a lower TCV. If it’s north of three years, we get to four years, five years, we’d have probably initial higher TCV.

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.

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

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