Tyler Technologies, Inc.

conference call. Your host for today's call is Lynne 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 question to one and one follow-up question per person. And as a reminder, this conference is being recorded today, February 15, 2024. I would like to turn the call over to Hala El-Sabini, Tyler's Senior Director of Investor Relations. Please go ahead.

Thank you, Babesh. And welcome to our call. With me today is Lynne Moore, our President and Chief Executive Officer, and Brian Miller, our Chief Financial Officer. After I give the Safe Harbor Statement, Lynne 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. Lynne will end with some additional comments, and then we'll take your 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. Every conciliation of GAAP to non-GAAP measures is provided in our earnings release. We have also posted on the Investor Relations section of our website under the Financials tab schedules with supplemental information, including information about quarterly bookings, backlog, and recurring revenues. On the Events and Presentations tab, we posted an Earning 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.

Fourth quarter results reflected a strong finish to a pivotal year in our cloud transition and return to -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 .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 and 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 a 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 continue 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 -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've seen a significant increase in SaaS adoption with new clients as well as signing our first flips. We also signed an expanded multi-year 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 system more 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 payments 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 USC Direct, with enhanced functionality to add Tyler's -to-end payment solution, enabling everything from reservations booking to payment processing. We're 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 multi-year transaction-based contract with the Wyoming state parks and a SAS 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 website and MyCivic platform to bridge access to public and 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 continued to build momentum in the public safety market with strong fourth quarter contract activity. Significant contracts included several competitive wins against 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 SAS adoption of our public safety solutions, with SAS 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 Clamath Falls, Oregon embraced a cloud-first strategy, signing a contract for a SAS deployment for our 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 SAS 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 SAS 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 SAS offering. Our largest new SAS deal of the quarter was with the state of North Carolina, where we extended the term of our existing court SAS agreement for five years and expanded the agreement to add our solution for appellate courts. We also achieved key operational milestones in 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 SAS 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 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 AR Inspect and Resource X in October for a combined purchase price of approximately $37 million in cash and stock. We're pleased to see multiple early wins for our application platform, leveraging field operations and inspection capabilities that came to us through AR Inspect. Now I'd like Brian to

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 .4% and organically rose 10.8%. Within subscriptions, our SaaS revenues grew .7% to $141 million and grew organically 21.2%, which is consistent with our near-term growth expectations of a 20% CAGR and SaaS revenues through 2025. Keep in mind that there's often a lag from the signing of a new 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 .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 a 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. SAS deals comprised approximately 89% of our Q4 new software contract value compared to 86% last year. Professional services revenue declined .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 SAS arrangements and converted 92 existing on-premises clients to SAS with a total contract value of approximately $137 million, an increase of 39% over last year. In Q4 of last year, we added 140 new SAS arrangements and had 82 on-premises conversions with a total contract value of approximately $99 million. Also, note while the contract with the California State Parks includes our SAS solution for outdoor recreation, it is not included in the new SAS contract value because it is funded completely from transaction fees. Overall, our pace of on-premises conversions to SAS continues 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 .2% on an organic basis. Our total annualized recurring revenue was approximately $1.61 billion, up .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 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 a fourth quarter at $147.4 million and $134.4 million respectively. Cash flow in the quarter was approximately $15 million of incremental cash taxes due to section 174. 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. 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 website. Now I'd like to turn the call back over to Len.

Thanks, Brian. We enter 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 GovTech100 company for 2024. This marks our eighth 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.

Thank you. We will now begin the question and answer session. To enter a question into the question queue, please press star 1 on your touchstone phone. If you are using a speakerphone, please pick up your handset and then press the star key and the number 1. To withdraw your question, please press the star key and the number 1 again. As a reminder, please limit your question to one and one follow-up question so we may stay within the allotted time. We'll pause for a moment. We'll pause momentarily to assemble our roster. Our first question comes from the line of Ken Wong of Oppenheimer & Co. Please go ahead.

Fantastic. Thanks for taking my question. I wanted to maybe just touch on the accelerating pace of flips going into 2024. On one hand, 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'm modeling maybe mid single digits. 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?

Well, really a lot of the movement in flips 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. It doesn't require a great deal of increase in sales and marketing expenses. Generally, we feel like that single digit growth in sales and marketing, like a lot of efficiencies to do more cross-selling, create more energies across our sales organization, put more products in the same sales reps 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 that we expect to see over the next several years.

Yeah, just to follow up on that, when we outlined our Tyler 2030 vision, we obviously got some goals around flips over the next six, seven years, and we also have goals on some of our GNA initiatives. So I think those are both tracking right now in line and with our expectations going forward.

Okay, perfect. 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?

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.

Perfect. Thanks a lot,

guys. Thank you. Our next question comes on line in a second. Kalia of Barclays, please go ahead.

Okay, great. Hey, guys. Thanks for taking my questions here. 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. Maybe the question is, how does the new agreement maybe change what you had previously, and how can it continue to support the profitability growth that we're clearly seeing?

Yeah, those are good questions. As you know, we signed an extension that now runs through the end of 31, which runs through our 2030 initiative, which is great. It obviously just further deepens 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. They are a true partner, similar to the way we view our clients in the public sector as partners. That's the way they view us. I think part of the difference also in our relationship now is it's more mature. 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. We spent a long time trying to figure out the costs of just simply lift and shift. Now we've transformed and we've done all that. It's how can we make them run even more efficiently in the private clouds, I mean in the public cloud. Great partner, excited that they're on this journey with us for the next at least eight years.

That's great. 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 percent free cash flow target. I think one year ahead of schedule, and you correct me there from 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?

Yeah, 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 a $127 million impact on our free cash flow in 2023. It's about a $50 million impact in 2024 and it'll 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 things. We continue 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 a 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, you know, paid in advance and create deferred revenue. The transaction revenues 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 a greater impact on the impact of causing our cash flow to grow faster than the EBIT.

Very helpful. Thanks guys.

Thank you. Our next question comes from Joshua Riley from Needham. Please go ahead.

All right. Thanks for taking my questions and nice job on the quarter here. 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?

Yeah, Josh, that's right now I'm, you know, I would say I'm confident in our, in our both our 2025 and our 2030 projections just from overall what I'm seeing in the business. As Brian remarked or pointed out in opening remarks, you know, a couple 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, you know, our growth is really in the closer to mid-nines, probably 93, 94. It's about 90 basis points and those tend to fluctuate and part of that is, as Brian mentioned, due to the to one of our large state enterprise contracts flipping from the gross to net model. That overall, that's

super helpful. Yeah, I just

say 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 one competitors is, are the things that really give me a lot of confidence. We recently had our national sales meeting really dive deep into, into sales forecast, not only for the next 12, 24 months, but even beyond. And, you know, right now things, things look pretty good. Got

it. 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 other 16 or 17 states are still a couple years away from migrating? Thanks.

Yeah, I think it's hard to say, Joshua, they, you know, every, all of our little sub markets are a little bit different. In 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. You know, as you know, everything we do is reference business, but particularly these larger, you know, statewide deals, our state, our state court 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 that will be a domino that will ripple throughout the client base.

Got it. Thanks guys. Nice job.

Thank you. Our next question comes from the line of Terry Tillman of Truist Securities. Please go ahead.

Great. Good morning, Tim. This is Connor Bacerella on for Terry. Appreciate you taking the question. I also just wanted to ask one on the Idaho State Cooperative Deal first. Could you maybe just break down how we should think about this deal playing out in the model and maybe what the timeline looks like for getting a large court system like this live in terms of, you know, the courtrooms and the counties and kind of how it all works with getting to cloud?

Yeah, it's going to take some time for the full impact of this deal. 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. You know, all of our projects, we talked about the LA Criminal Courts go live. Probably one of the most successful go lives we've had in Tyler's history. This will this will mirror that and it will be our first statewide flip. But from a timing perspective, revenues uplift all that we'll get we'll get about 50% of it in in 2024 and 2025. We'll have the full run rate.

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

Got it. Yeah, that makes sense. And then just on a follow up, I just want to ask one around transaction revenues. Could you maybe just talk a little more about the impact of payments from customers slipping gross to net in the quarter? I think you mentioned the slip in front of the state enterprise agreements. I'm just curious on how that impacted overall revenue in that segment.

Yeah, as we've talked about one of our state contracts, actually mid year change from growth to net. So we had that impact in the second half of the 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 nine to $10 million range. The first half of next year, because is, I believe somewhere in a similar range. And that was probably, um, yeah, split between Q3 and Q4, but probably a little bit more of that impact was in Q3. But it was a several million dollar impact on the quarter.

Great. Thank you.

Thank you. Our next question comes to the line of Matt Van Vliet of BTIG. Please go ahead.

Yeah, good morning. Thanks for taking the question. I guess on the deal with the California Parks Division there 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 what 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 SAS revenue and more funded through the program itself?

Yeah, Matt, I'll start. Brian, you may jump in. There's a couple of things that are real exciting about that California State Parks deal. One obviously is it's the largest transaction deal in Tyler's history. The second thing is, is it, as you point out, it validates this sort of self-funding model. It's not a surprise, anybody who reads the journal, that California has significant deficits, 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 2025 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...

Yeah, I just would say your point is good, that because it isn't a fixed SAS fee, that the transaction revenues are currently in estimate, and we think we have a pretty good idea of what volumes will be, but they may vary from that. And it'll, 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 dollars, starting in, it'll be approaching, we think, 20 million dollars next year, and then be north of 20 million dollars beyond that as volumes increase, and it becomes fully ramped. But yeah, it is subject to variances and subject to seasonality as well. Unlike a regular SAS contract that is a pro-rata revenue recognition every quarter, this will also have seasonality in and around those, as we do in many of our outdoor transaction revenues.

Okay, very helpful. 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 years through that contract, or are we at a level now where it's kind of a -you-go as you get more scale?

No, I think there's still more leverage, and I think generally going forward, you know, 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.

Great, thank you very helpful.

And I'll 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 existing agreement we have with California under – with USD Direct, 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.

Okay, thank you.

Thank you. Our next question comes from the line of Gabriella Borges of CommonSax. Please go ahead.

Hi, this is Callie Valencian for Gabriella. Another question on the number of conversions. Convergence has 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?

So I'll start. You're right, Callie. Our flips in Q4 were actually up about 12 percent over Q4 last year. We're not putting out guidance as far as I know, Brian, on specific flip 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 help accelerate the pace of flips going forward.

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 our prepared remarks, we talked about 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 these 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 and the dollar size. 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.

Yeah, thank you. That's helpful. Quick follow up. On that version control point, you mentioned last quarter, you had the goal kind of by the end of 2023 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?

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 2023, 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. Thank

you. Thank you. Our next question comes from Rob Oliver from Baird. Please go ahead.

Great. Thanks, guys. 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 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 and public safety as these deals shift more to cloud first? And then I had a quick follow up for Brian.

Yeah, Rob, 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. As we look out next year, we think it's going to be across 50%. And when 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 the approach that we took generally with Tyler going back four or five years, which is going forward, we really want to be leading to the cloud. We think the market's 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 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 website, you might have seen a new division president that came on last year, came from outside of Tyler. He actually has led been a part of leading companies through a cloud transition. It's exciting to have him there, have him up in Troy with the people and really sort of helping to lead those efforts. I like where we are, I like where we sit. To reiterate your words, it's gratifying to see these early results. But a lot of things I'm going to caution, 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.

I appreciate that. Thank you. Brian, just a question around the R&D expense guide for the year, implying 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?

Thanks. Yeah, I think it continues to be a lot of development around the cloud and new 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 a lot of it is the same people, but now running through expense as opposed to being capitalized. Obviously, it doesn't change our cash flow, but it changes where it turns up on the income statement. 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.

Thank you.

Thank you. Our next question comes to the line of Charles Chauza of CJS Securities Inc. Please go ahead. Hi, good morning.

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?

I don't think there's anything unusual. What we did point out, I think we in the street are still getting used to the seasonality of the transaction business. I see when they were a separate public company, certainly we're well versed in that and people who followed them more. 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.

Great. Then just more of a macro question for you. Given the impacts in Congress related to the spending bill, are you seeing any changes to the sales cycle, especially in your federal business?

Charles, yeah, not really. Not right now. Q1 is probably, we talk about seasonality, Q1 is probably a little bit slower time in that business as well. Right now, there's no real change in

our time. Thank you. Our next question comes from Jonathan or William Blair. Please go ahead.

Good morning. 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?

I'd say most of the leverage that we're seeing in the model is coming from cloud operations. It's the things we've talked about, the impact of moving customers out of our data centers and into AWS and our plan to have that first data center closed mid-year, 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. 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. 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 target those 2030 targets.

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 that really sounds weird. We're progressing on.

Makes sense. That makes sense. Just with regards to use of capital, now that your debt payments have put the interest payments under one time's leave, how should we think about your plans for capital deployment going forward? Thank you.

Yeah, sure, Donathan. I think right now we're still in the same place we've been for the last couple years. Even though we will likely pay off the term debt sometime early this spring, sometime this spring, we still have that $600 million convert that's due in a little more than two years. 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. At the same time, just like we've done over the last couple years, we will continue to do M&A particularly where it makes sense strategically and where it's a creative to Tyler. Last year we did four deals. I think we spent about -$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 pay down. 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.

Thank you.

Thank you. Our next question comes from Lennon Kirk-Matern of Evercore SI. Please go ahead.

Yes, thanks very much. 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, op-sell for you, meaning as your immunists 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 years. Just wondering how that works in terms of the uplift either on a cross or op-sell basis.

Well, it certainly is another conversation point with the client. So anytime there's a conversation point, there's opportunities for cross-sell, op-sell. But we've got install 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 is just another data point that's a contact point with our clients.

And that's all. 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 they will continue to look for those opportunities for greater up-sells and cross-sells.

Okay. And I guess, thank you for that. 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 on that change? That plays out over a couple of years, meaning just use the Idaho example. The reason you're not seeing the SAS 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 that 1.7 uplift that plays out over 24 months?

Yeah, 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 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 cause a delay. Or there are a variety of reasons why there can be a lag 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 the uplift starts at different times. So I think generally it's not 24 months, but that it could be from one to a few quarters before we see that full impact of those from the time we sign it to when we see the impact on the uplift.

Super helpful. Thank you all.

Thank you. Our next question comes on the line of Alex Zirkin of Wolf Research. Please go ahead.

Hey guys, thanks for taking the question. 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's the opportunity for a higher dollar value in 24. Just help us understand a little bit about that dynamic.

Yeah, well I just say when we talk about the number of flips, it's just not that precise. I mean the timing, for example, by Idaho, you know, signing the Idaho agreement, I think was almost three years in the making that we had discussions with them and planning. As Linda 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 what we expected, so there was a little bit more of 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 percent 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.

Got it. Helpful. 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 have to make. What would be the impact of that? If that act passed on you guys, how much and when would you see those dollars returned?

Yeah, it's a little hard to tell exactly. I think that the bill that's out there now that I believe has passed the House would actually not rescind it, but 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 get back the incremental taxes we paid in 2023, which were $127 million. Presumably those would either offset our normal tax payments, so 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. In some manner, we would look to recover the incremental taxes we paid in either through refunds or lower estimated payments going forward.

Got it. Thank you guys. Thank you. The next question comes from the line

of Keith Husserl of North Coast Research.

Please go ahead. Good morning guys. 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 it getting longer?

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 SAF 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 affect that number. But on the software side, I'd say there aren't any meaningful changes in that duration of backlog.

That's helpful. 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 one of the impetuses for the acceleration of the flips?

Yeah, 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 may have been resistant to the cloud have flipped because of some sort of recent ransomware or

other issue. Great, thank you.

Thank you. As we are now past our scheduled start time, please limit your questions to one per person. Our next question comes from the line of Alexei Gogolov of JPMorgan. Please go ahead.

Good morning, 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?

Yeah, I think at Investor Day we said we were somewhere around 15%. And so we've obviously 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, each of our products has a timeline and a roadmap 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 roadmap 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.

Thank you.

Thank you. Our next question comes in line up with Clark Jeffries of Piper Standlock. Please go ahead.

Hello. Thank you for taking the question. Lynne, I wanted to go back to something you said about the California contract and that the fact that it will be a drag on margins, but margin expansion over multiple years. I'm 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 you go ahead.

Yeah, 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 2025. 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 were expecting it to just slightly more than double that. But you look out in 2025, it goes to 20 million. 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.

Thank you. Thank you. Our final question comes from

David Unger of Wells Fargo. Please go ahead.

Thanks very much, guys. So back to the flips again. And the topic is you're of the call. Different 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? Thank you.

So, yeah, we would expect license

revenues to or license, well, license revenues, which are mostly recognized upfront. So to, 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 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 really selling very little, only a couple of products where we really sell any licenses at all in the new business market.

Part of your question was around total contract value, TCV. Yeah, so that'll that'll obviously vary a little bit depending on the SAS term that we sign. You know, if you could use a rule of thumb of what a license deal and a one year maintenance might drag on that versus sort of what we would project as a normal SAS deal. So, you know, if the SAS 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 a probably initial higher TCV.

Thanks for the detail,

gentlemen. Thank you. 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.

Thanks, Vivesh. 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.

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