Tyler Technologies Inc Q1 FY2022 Earnings Call

Hello, and good morning, everyone, and welcome to today's Tyler Technologies First Quarter 2022 Conference Call. Your host for today's call is Lynn Moore, President and CEO of Tyler Technologies. As a reminder, today's conference is being recorded today, April 28, 2022. And I'd like to turn the conference call over to Mr. Moore. Sir, please go ahead.

Thank you, Jamie, and welcome to our call. With me today is Brian Miller, our Chief Financial Officer. First, I'd like Brian to give the safe harbor statement. Next, I'll have some comments on our quarter, and then Brian will review the details of our results. I'll end with some additional comments, and then we'll take questions. Brian?

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

Thanks, Brian. Our first quarter results surpassed our expectations and provided a very strong start to 2022. Total revenues grew approximately 55%, with robust organic growth of 12.8%, the highest in 20 quarters. NIC continued to perform well in the first quarter, with core revenue growth of 13%, excluding COVID-related revenues. NIC's growth was boosted by revenues under the new statewide payments contract in Florida and in particular, by revenues associated with corporate filings with the Department of State that are concentrated in the first quarter. NIC's COVID-related revenues were in line with our expectations at $20.6 million. Recurring revenues comprised 79.5% of our quarterly revenues and were led by 140% growth in subscription revenues. On an organic basis, subscription revenues grew a robust 33.8%, reflecting both our accelerating shift to the cloud and growth in transaction-based revenues. We have now achieved greater than 20% subscription revenue growth in 57 of the last 65 quarters. We're particularly pleased with our strong revenue growth, even as we saw an acceleration of the shift in our new software contract mix from licenses to SaaS. In Q1, 80% of our new software contract value was SaaS compared to 66% in Q1 last year. As we outlined on our last earnings call, while our move to the cloud builds long-term value, margins compressed in Q1, reflecting the new business mix shift, the inclusion of NIC and in particular, their COVID-related revenues, as well as expenses related to the cloud transition. As a result, our non-GAAP operating margin declined 250 basis points year-over-year to 24.3% but increased 70 basis points sequentially from Q4 of 2021. We continue to be very pleased with NIC's performance and with the growing pipeline of joint opportunities for Tyler and NIC. During the first quarter, NIC successfully extended our enterprise contract in Alabama. And in April, we extended our enterprise agreement with New Jersey. NIC also signed a new 5-year SaaS deal with the State of Mississippi to provide our NIC cannabis licensing platform valued at approximately $4.3 million. We continue to experience success with sell-through deals of Tyler products through NIC's state relationships. In Q1, those deals included sales of our data and insights platform to the state of Vermont and our entellitrak platform for Veterans Affairs in Alabama. We also signed agreements for NIC's payments platform with existing Tyler clients in Hillsboro County, Florida; Montgomery County, Maryland; and Glendale, California. Our largest new deal in the quarter was a SaaS arrangement with the San Diego Association of Governments for Enterprise ERP powered by our Munis solution, along with our data and insight solution, valued at approximately $4.9 million. We won five notable SaaS deals, each with a total contract value greater than $2 million with Glen County, Georgia for our enterprise assessment and tax powered by IAS World Solution; the cities of Rialto, California and Alamagordo, New Mexico for our enterprise ERP powered by Munis; and enterprise permitting and licensing powered by EnerGov; and the cities of Mansfield and Burson in Texas for our enterprise ERP powered by Munis solution. Our largest license deal in Q1 was a $2.7 million agreement with the Utah Department of Public Safety, our first public safety deployment in the state of Utah. The deal includes enterprise law enforcement records, mobile, field mobile, enforcement mobile and public safety analytics. We also signed four other notable license arrangements in the quarter, each with a total contract value of over $1 million with the St. Johns County property appraiser in Florida for our enterprise assessment and tax powered by IAS World; the city of Elmhurst, Illinois for our enterprise ERP powered by Munis solution; St. Mary's County government in Maryland for our enterprise public safety, powered by New World and Data and insight solutions; and the city of Virginia Beach, Virginia for our enforcement mobile powered by Brazeau solution. Now I'd like for Brian to provide more detail on the results for the quarter and our updated guidance for 2022.

Thanks, Lynn. Yesterday, Tyler Technologies reported its results for the first quarter ended March 31, 2022. In our earnings release, we've included non-GAAP measures that we believe facilitate understanding of our results and comparisons with peers in the software industry. A reconciliation of GAAP to non-GAAP measures is provided in our earnings release. We've also posted on the Investor Relations section of our website under the Financial Reports tab schedules with supplemental information provided on this call, including information about quarterly bookings, backlog and recurring revenues. Both GAAP and non-GAAP revenues for the quarter were $456.1 million, up 54.7% with the inclusion of NIC and our other acquisitions from the last 12 months. Organic revenue growth was the highest since Q4 of 2016 at 12.8%. Software licenses and services grew 24.7%, or 3.7%, excluding NIC. Subscription revenues rose 139.5% with very strong organic growth of 33.8%. We added 149 new subscription-based arrangements and converted a new high of 88 existing on-premises clients, representing approximately $76 million in total contract value. In Q1 of last year, we added 84 new subscription-based arrangements and had 39 on-premises conversions, representing approximately $52 million in total contract value. Our software subscription bookings in the first quarter added $16.2 million in new ARR. Subscription contract value comprised approximately 80% of the total new software contract value signed this quarter compared to 66% in Q1 of last year, reflecting our ongoing shift to a cloud-first approach to sales and increasing client preferences for cloud-based solutions. The value weighted average term of new SaaS contracts this quarter was 3.4 years compared to 4.0 years last year. Transaction-based revenues, which include NIC portal, payment processing and e-filing revenues and are included in subscriptions, were $150.9 million, up 461%. Excluding NIC, Tyler's transaction-based revenues grew 9.8%. E-filing revenues reached a new high of $18.2 million, up 16.9%. For the first quarter, our non-GAAP ARR was approximately $1.45 billion, up 63.6%. Non-GAAP ARR for SaaS software arrangements was approximately $378.1 million, up 25.1%. Transaction-based ARR was approximately $603.7 million, up 461%. And non-GAAP maintenance ARR was down slightly at approximately $468.1 million due to the continued migration of on-premises clients to the cloud. Our backlog at the end of the quarter was $1.76 billion, up 13.8%. Because the vast majority of NIC's revenues are transaction-based, their backlog at quarter end was only $26.3 million. Excluding the addition of NIC, Tyler's backlog grew 12.1%. Bookings in the quarter were strong at approximately $419 million, up 70.1%, including the transaction-based revenues at NIC. On an organic basis, bookings were also quite robust at approximately $283 million, up 14.7%. For the trailing 12 months, bookings were approximately $1.9 billion, up 65% and on an organic basis, were approximately $1.4 billion, up 21.7%. If our weighted average contract term for new SaaS contracts had been the same as last year, organic bookings growth would have been 17.1%. Cash from operations declined this quarter by 25.3% to $53.5 million, mainly due to changes in working capital related to higher payments of accrued incentive compensation and cash tax payments related to stock-based compensation. Free cash flow declined by 33.5% to $41 million due to the decrease in cash from operations and somewhat higher capital spending this quarter. Our balance sheet remains very strong. During the quarter, we repaid $20 million of our term debt. And since completing the NIC acquisition, we have paid down $415 million of term debt. We ended the quarter with total outstanding debt of $1.32 billion and cash and investments of $322.6 million and net leverage of approximately 2.1x trailing 12-month pro forma EBITDA. As Lynn mentioned earlier, we're off to a great start in 2022, resulting in an improvement in our outlook for the full year. As a result, we have raised our 2022 annual revenue and earnings guidance as follows. We expect both GAAP and non-GAAP total revenues will be between $1.835 billion and $1.87 billion. The midpoint of our guidance implies organic revenue growth of approximately 9.5%. We expect total revenues will include approximately $40 million of COVID-related revenues from NIC's TourHealth and pandemic rent relief services. The TourHealth revenues are currently expected to continue through the second quarter of 2022, while revenues from the rent relief program are expected to continue through the third quarter. We expect GAAP diluted EPS will be between $3.92 and $4.08 and may vary significantly due to the impact of stock incentive awards on the GAAP effective tax rate. We expect non-GAAP diluted EPS will be between $7.48 and $7.64. Based on updated assumptions regarding additional interest rate hikes this year, we have increased our estimated expense for the year by $3.4 million to $23 million, with an impact on non-GAAP diluted EPS of approximately $0.06 a share. Other details of our guidance are included in our earnings release. Finally, before I turn the call back to Lynn, I'd like to announce that Hala Elsherbini will be joining Tyler as Senior Director of Investor Relations, effective May 9. Many of you have worked with Hala in the past, and we're very excited to have an IR professional with Hala's experience and knowledge of Tyler join our team.

Thanks, Brian. I'm very pleased with our first quarter performance and our outlook for the year. Activity in our public sector market continues to trend positively, and we are well positioned to take advantage of the continued strength in our market. We remain on track with our strategic initiatives, including our development projects to optimize our products for more efficient deployment in the cloud and our cloud-first approach to sales, which we believe will create significant long-term value for clients and shareholders alike. Our balance sheet and cash flow remained very strong, and we continue to be opportunistic with regard to capital allocation. We're excited about the acquisition of US eDirect in February, which significantly expands our outdoor recreation portfolio, allowing us to offer an extensive all-in-one outdoor recreation solution that will seamlessly integrate with our NIC payments platform. While we continue to evaluate strategic acquisition opportunities, we are heavily focused on the integration and execution around the acquisitions we've completed over the last two years, making the bar for new acquisitions at this time relatively high. Last Thursday marked the one-year anniversary of our landmark acquisition of NIC. As I reflect on the acquisition and all that we have accomplished as a combined entity over the last 12 months, I can truly say that it has exceeded our expectations, which were already high. Our teams have come together as one unified organization, and our collective excitement about the opportunities that the combination unlocks has continued to grow. We've integrated our payments teams and have refined our strategy to pursue what we believe is a huge Total Addressable Market in government payments. As we've discussed, we're winning new business with sell-throughs into our respective client bases. In this quarter, we doubled the number of sell-through opportunities in our pipeline. We look forward to continuing to report on our progress in the second year of our combination. The challenges of today's labor market continue to be an area of significant focus for us. While we added 195 new team members in the first quarter, we currently have a higher-than-normal number of open positions. Although our open positions have a short-term positive impact on margins, we have aggressive hiring plans for the balance of the year to support our growth. Finally, we're extremely excited to host clients live and in person at Connect, our annual user conference, which will take place in Indianapolis from May 15 through May 18. With that, we'd like to open up the line for Q&A.

Ladies and gentlemen, at this time, we will begin the question-and-answer session. Our first question from Jonathan Ho from William Blair.

Congratulations on the strong quarter. I just wanted to maybe start out with your thoughts around just the win rates that you're seeing and potentially whether the investments that you've made over the past few years are now starting to have an impact as you start to look at the state of competition?

Yes, sure, Jonathan. And I think that's right. The markets right now are really strong. I'd say they're probably about as strong as I can remember. And our competitive position is really high, really across the board. You're right; we went through a significant period of elevated investments pre-COVID, and I think that's really paying off right now across all of our lines of business. Our win rates are strong. Our final rates are strong. It's really setting us up well for the next few years. And so I appreciate that comment.

Got it. Got it. And then just as a follow-up, how should we think about the pace of integration that we're seeing with AWS? And maybe what customers, when you've had some discussions with them, what's that reception been like in terms of potentially shifting from Tyler hosted to AWS?

Yes, I think that's going real well, Jonathan. AWS is going to be a great long-term partner for us. We're already starting to move customers into the AWS cloud. We're working on plans right now to exit the Tyler data centers over the next couple of years and move them into AWS. They're a great partner. Where we're going with our cloud initiative lines up well, our cultures line up well. And our clients see that. Our clients see the benefits. They see the future roadmap that we've laid out, and our clients are excited about it.

And our next question comes from Pete Heckmann from D.A. Davidson.

Just two questions on the annual guidance. Your very strong organic subscription growth of the first quarter seems to argue that, at least the way I look at my model, I have something more in the mid- to high-teens embedded for organic growth for subscription revenue for the rest of the year, and I'm getting into the top end of your revenue guidance. Are there some other considerations we should think about why subscription revenue growth wouldn't continue to run at this elevated rate for the rest of the year?

Well, Pete, I think the biggest factor there, and we mentioned it in the remarks, is there is some seasonality around some of the transaction-based revenues around payments. There are two things around that. One, as we pointed out, the Florida contract for statewide payments with NIC, which is a new contract, is ramping up, but there were some revenues in Q1 that are specific to Q1 around filings — revenues associated with corporate filings with the Department of State in Florida. And that added, I think, roughly close to $6.5 million of revenue in subscriptions in Q1. And so this accounted for a couple hundred basis points of overall growth in the quarter that really aren't expected to be there throughout the year. And then seasonally, in Q4, some of the transaction-based revenues around the portals tend to be a little lighter as well. So I think those are the biggest factors. But certainly, we have an opportunity to continue to broaden our subscription revenues as we move through the year. But I keep those seasonality factors in mind.

Yes. I think, Pete, I'd just add that the thing about the Secretary of State filings in Florida is it was a little unexpected as we entered the year. And I think it shows the potential of not just the Florida payment contracts, but really the things that we can do across the country. And so while there's some seasonality to that, to me, it's an exciting indicator of the things that we can achieve down the road.

Great. Great. And that helps. I missed the significance of that. And then just in terms of the expense ramp we talked about last quarter that's embedded in your annual guidance, you talked about maybe hiring running behind schedule. But generally, would you say that the expense levels in the first quarter were at your expectations? A little bit below? I'm just trying to figure out if that contributed to the upside, at least from our forecast to the earnings number in the quarter.

Yes. I'd say as it relates to headcount, Pete, is probably a little bit below, and that's been really the case for probably at least a year or so. And my sense is that's the case generally across all industries right now. There's certainly a lot of labor market challenges. It certainly helps with margins in the short term. We want to be a little more aggressive, and we are aggressive. Our HR department is working hard so that we can deliver on a lot of the sales, the good sales activity that we've had over the long run, and being able to get these installations deployed, continuing to keep our customers happy is going to require getting some of those heads in.

And our next question comes from Josh Reilly from Needham.

Congrats on the strong quarter here. How would you characterize the impact of the stimulus funds benefiting the 13% organic growth rate in the quarter? And how much of a tailwind can this be over the next couple of years? Is it closer to a 1- to 2-point benefit? Or could it be up to a 5-point benefit to sales?

Yes, Josh, it's a good question. At times, it's hard to isolate. I think what I would say — I'd go back to my comment to Jonathan's question about the budgets overall. From what I'm seeing right now, our clients' budgets are as healthy as they've ever been. Leading up to 2018, 2019, the economy was really good. The budgets were really strong. There was an anticipation of negative COVID impact that prediction really didn't come through. And since then, as you mentioned, we've lumped on a lot of stimulus money. In addition to that, and I think I mentioned on the last call, perhaps we all see what's going on in the real estate market and the boom that's going on there, which is driving appraisals and valuations up, which further drives up assessments and property taxes, which is a big funder of a lot of our work, particularly with our local government clients. We're seeing the impact. It's sometimes hard to track individual deals. But we're certainly seeing the impact and the fact that I think it's a very robust market right now.

Yes. All I would add is that the stimulus money is available through the end of 2024 for them to make commitments around spending that. So I'd say we're still — we believe a lot of governments haven't — certainly haven't fully spent their funds or are still in the process of determining where those will be spent. So we believe it's a potential tailwind over the next two or three years. But I'd say right now, if there's an impact there, it's probably fairly modest. It's not a 5-point growth, but it's certainly part of that very active market we're seeing.

Got it. That's helpful. And then just curious on the US eDirect acquisition, is there anything specific in terms of the functionality that you acquired there that's different than what you had internally for parks and recreation?

Yes, sure. And I'd say the answer to that is yes; they're really a good complement. The outdoor market is something that we believe is a good growth opportunity. We believe the Total Addressable Market is there. There is demand for this sort of all-in-one solution. And really what NIC brought was really a first-in-class solution around hunting and fishing licenses, and US eDirect really was a leading outdoor reservation platform. So it sort of combines that into creating, as we said, sort of an all-in-one opportunity. We've seen the pipeline already just this year grow significantly in that space. And I think one of the things that we're excited about is not just combining the NIC technology with US eDirect, which is also, by the way, deployed in AWS, but our ability to go out and sell it. So it's a solution — when you talk about outdoor reservations and things, it's not just going in the states, which will be through NIC's sales channels, but we also have the ability to go sell it more locally through some of Tyler's sales channels.

And our next question comes from Terry Tillman from Truist Securities.

And the congrats on the first quarter results. Maybe a couple of questions for me. And one is a follow-up to a prior question on the stimulus dollars. What about on the enterprise ERP business side? So those are longer sales cycle type deals, big transformation projects. I think maybe you mentioned San Diego. But how is that sales pipeline playing out? And do you see like a quarter where if the pipeline is building, where you see a lot of conversions? Or do you think that's going to be more smooth over the next couple of years — 2 or 3 years on the enterprise ERP side?

Yes. I think, generally speaking, what we're seeing on enterprise ERP is that the market and the deals that we're signing each quarter really reflects those pre-COVID levels, so that's very encouraging. We have identified a handful of deals that can be tied specifically to the ARPA funding and things like that. But again, it's hard to know specifically where a jurisdiction allocates those funds. Our growth — our deal volume in enterprise ERP is good. We're really focusing on expanding payments through that customer base. As you mentioned, we're focusing on expanding our flips, which are continuing to increase at a faster rate quarter-by-quarter. Our installed client sales continue to be really strong there. So it's a very healthy business that's continuing to grow, and we're pretty pleased with the outlook.

Got it. And on the state of Utah, that was great to see that statewide public safety deal. Maybe, and maybe easier said than done, but it seems like a great rinse and repeat opportunity across the broader NIC customer base with all these public safety solutions you have. Not trying to put you on the spot, but could we see more, and more quickly, with a repeat of what we saw with State Utah on the public safety side?

Well, I guess I'd step back and just say, yes, we're excited about all of our cross-sell opportunities through the NIC base. The Utah deal was a great win for our public safety team. It was a very large contract. I think it's early to say that — I mean, obviously, part of our sales plan is to repeat these types of wins; that's part of our playbook. It may be — to say that those can happen relatively quickly. Sales cycles still sort of take a life of their own, but we're excited about the way our teams are working together across all of our products and the potential with NIC.

Our next question comes from Matt VanVliet from BTIG.

Nice job on the quarter. Lynn, I wanted to follow up on something you mentioned at the end of your prepared remarks, and maybe it's a bit of a follow-up to Terry's last question there. But you mentioned that the pipeline for sell-through opportunities has doubled. Curious if you look at the assessment of kind of all of the NIC customer portfolio, how far along are you in terms of kind of following up with those potential sell-through opportunities? Have you doubled that? Have you sort of gotten to all of those customers? Or is there still more that could be added to the pipeline in the near term?

Yes, I would say we're a year now into the NIC acquisition. Standing here a year later, I'm more than pleasantly surprised at how the teams are working and the number of opportunities that have already surfaced. Stepping back, looking at maybe a 20,000-foot level, we may still be in the first inning of this deal. We've got a long way to go. We're still learning about each other. We spent a lot of time last year educating both teams on products and sales channels and the ways to go about addressing the market. I think we're just barely scratching the surface of what we can achieve together.

All right. Very helpful. And then I guess maybe thinking about the stimulus and the ARPA funds from a little different angle. Have you seen sales cycles shorten at all? Or do you feel like some deals have gotten pushed through maybe a little more quickly because there's more budget dollars available? And would you allocate some of that rationale to having more of the stimulus funds out there? Or has there not been any kind of consistency across the time to contract?

Yes. I would say that on one level, I've talked about the robust market. I think my comment there would be that some of it is still just the release of pent-up demand during COVID. I do think we're seeing a little bit, maybe quicker sales cycles in some of our inside sales and that may be a little more directly tied to some ARPA funding. We're also — one thing I didn't mention earlier is we're being pretty proactive about marketing the availability of the ARPA funds and how our clients can use them. We've done several webinars, podcasts, blogs, and emails to sort of help stimulate that use and hopefully direct some of it to Tyler.

Our next question comes from Saket Kalia from Barclays.

Okay. Great. Appreciate you having me on the call. Maybe first for you, Brian, actually, just to maybe mix it up. It felt like software and services bookings were maybe stronger than what we've seen historically, and SaaS was maybe a little bit more in line. And again, that's on a bookings perspective. Part of that, I think, you called out is rightfully duration. But curious if you saw anything in mix or preference for on-prem versus SaaS? And how are you sort of thinking about that for the rest of the year?

Yes. I think it was an interesting quarter from a new business perspective because even though SaaS, as a percentage of the new deal volume increased pretty significantly over last year from 66% to 80%. And we also saw growth in license revenues and had several pretty decent-sized, not super large, but several decent-sized license deals, including the Utah Public Safety deal and some ERP deals. So we saw a little bit of both. On a broad basis, our expectation for the year is around 80% to the low 80s percentage of our new contract volume coming in SaaS. So we're generally on line with that. However, we would expect that we continue to see an ongoing shift towards that preference for new customers to come through the cloud. As we talked about at year-end, part of that reflects the change in our approach to sales, including a number of significant products that are now only available through the cloud that are no longer being offered in a license model in new proposals. So yes, we'd expect that trend to continue through the year.

Got it. Got it. Lynn, maybe that's a good segue for a question I have for you. We've talked about some tools that were offered both on-prem and SaaS but might phase out on-prem this year. I think we've talked about maybe one or two of the ERP products as an example. Can you just recap that for us? And then without preannouncing anything, of course, are there other products where that might make sense to do as well in terms of leading with SaaS and maybe not even offering on-prem anymore? Does that make sense?

Yes. No, I understand your question, and you're right. So coming into this year, and we announced perhaps in Q3 of last year, certainly on the Q4 call, our enterprise ERP powered by Munis solutions are now really just being offered in a SaaS model. I've made the comment that you should expect to see more of our core flagship products move in that direction, including probably one later this year and moving into next year. I'm a little hesitant to outline some of that right now because we haven't even notified all of our customers yet of our future strategy. Our clients generally know that we are going cloud first. That's not a surprise to anyone. But in terms of specific timelines, I'd rather sort of keep that messaging within us right now until we're ready to do that. But that's our strategic direction. It's not a surprise to anyone. We're making progress on our cloud initiatives, and we will reach the point generally across our portfolio with perhaps the exception of parts of public safety, which will be a little bit market-driven. And then we talked before, they've been a little bit slower to move to the cloud.

Our next question comes from Michael Turrin from Wells Fargo.

This is David filling in for Michael Turrin. I just wanted to focus on free cash flow margin. Brian, I know you mentioned there were some things that happened this quarter. You mentioned cash taxes and working capital. But I just wanted to get a sense for — I mean, historically, you do like 22% free cash flow margin over the past 5 years. So I just wanted to get an understanding of the seasonality of that and how that will work itself out over the course of the year?

Yes. I generally expect that our free cash flow margins, there are a lot of puts and takes there. But generally, as we move through this year, probably in line with that historical number. Very seasonal in terms of being weighted towards the third quarter. A lot of that has to do with the vast majority of our maintenance renewals, which are around $470 million a year of maintenance revenues. The vast majority of those renew as of July 1. And so we typically bill those in Q2 and collect them in Q3. So that drives really strong growth in our cash flow in our cash flow in Q3. Other than that, transaction revenues, we've talked about some seasonality around those being a little lighter in Q4. But as we continue to expand the subscription business, that tends to smooth out the cash flow. So Q1 is typically the lightest. Q3 is very much the strongest, but I think the margins, you can expect to be fairly consistent.

Okay. And I know there are several questions asked about the fiscal stimulus, and this is — sorry to beat the dead horse on this, but I think it's maybe a couple of quarters ago you mentioned the couple dozen or so deals that are in the pipeline that are sourced from fiscal stimulus. Is that still roughly a similar type number? Just trying to get a sense of that.

Yes, it's probably similar. But as Lynn said, it becomes harder and harder to identify deals that are specifically funded by stimulus. In a lot of cases, the stimulus may be used for something else but frees up funds that are then used to move forward with something they're purchasing from us. So it's not exactly a science trying to pin down that number. But I'd say it's probably a fairly consistent number of deals that we're seeing, which is consistent with what we're saying that we expect this not to be a big flood of new business at one time, but to be somewhat of a tailwind over the next, call it, 3 years.

And our next question comes from Charles Strauzer from CJS Securities.

Brian, maybe you can help me with this on. Looking at Q2, other than the continuation of the COVID revenue, what other factors should we think about when we build out our model for Q2?

This — I don't think there's anything particularly unusual to think about in Q2. We would expect, I think, licenses to likely be at a fairly similar level to what we saw in Q1. Subscriptions should continue to grow. I think maintenance, as we've said in the past, for the year is likely to be flat to down low single digits, and I think we'll continue to see that trend as we have more and more on-prem clients move to subscription. But I think those broad ranges of growth that we talked about on the year-end call are still generally true. When we talk about — we don't give quarterly guidance, but when we talk about the full year, I think licenses will likely see a mid-single-digit decline. Services are likely to be around the mid-teens kind of growth. Subscriptions, expect to remain really solid growth in the 25% to 30% range for the year. Maintenance, as I said, flat to down low single digits. Appraisal is seeing a nice resurgence in activity after some slowdowns during COVID and expect to see high teens growth there. Hardware is a much smaller piece of our business. But with Connect coming back in person this year, those revenues fall there. So we expect to see kind of mid-30% growth on a relatively small base of revenues in hardware and other.

Yes. And then I'd probably add to that, Charlie, I think we mentioned earlier, the COVID — the TourHealth revenues out of NIC should — our expectation is those will pretty much wind down in Q2.

Great. That's very helpful. And then just lastly for me on the cash flow side, is debt pay down still kind of your top priority for use of cash?

I'm sorry — yes. So yes, Charlie, I think right now, our priority is to pay down the debt, particularly as interest rates have continued to increase. We already talked about readjusting our plan for the higher rates, and it costs us an extra $0.06. So that's our priority. We're continuing to do everything else we've always done, which is be opportunistic, look at our internal R&D. We continue to look at acquisitions. With the softness in the market, we'll continue to evaluate repurchase opportunities versus paying down the debt. But I'd say right now, that's our priority. Just as a reminder, as Brian mentioned, we paid down $415 million of the debt. And of our outstanding debt, about $600 million is sitting in a convertible, which right now is about 45%, and that's at a fixed rate of 25 basis points, that's not maturing until '26. I'd like to see us get some of that bank debt paid down. But again, if opportunities present themselves, we'll probably move on those as well.

Our next question comes from Kirk Materne from Evercore ISI.

Lynn, when you look at the sort of organic Tyler business and you think across ERP and Munis, Courts & Justice, Public Safety, my sense listening to you is that the pipeline is pretty balanced, and you're seeing a nice rebound or growth in all of those areas. Are there any sort of points of strength versus maybe not as strong yet? I was just kind of curious how we should think about that if there's any one product that kind of leads you out of a downturn or if they're all pretty balanced right now?

I'd say generally, they're pretty balanced. Like I mentioned earlier, our reprise ERP, powered by Munis solution, that market is — we're seeing the deal volume that's similar to pre-COVID. Really, at the lower end, we continue to see deal volume and growth higher than pre-COVID, which is great. And that's our ERP Pro, our old Incode solution. If you look at our appraisal and tax solutions, we started to see some increasing sales momentum late last year, and we're seeing that start to continue. You look at Courts & Justice, we've made a number of acquisitions in the last couple of years, and we're pretty bullish on expanding those markets, whether it's our vend engine or our corrections. There's a lot of opportunity there. We're seeing that. We're also — I think we sort of referenced it, our e-filing is back to prepandemic levels, which is good to see. And public safety continues to do the things that we expected to do with our investments. They signed another large deal. Their competitive position is strong. They've done a good job with their clients on some of these new products, getting them live, getting them settled, getting referenceable. So across the board, it's pretty good.

That's helpful. And Brian, with 80% of the sort of booked software in the quarter being more subscription-based, if it continues at this rate, does the overhang on margins in terms of the conversion essentially start to drop off a little bit? I'm just trying to get a sense of how much of the overhang on margins that we're looking ahead is just on the business model conversion versus more discrete items?

Yes. I think that kind of fits in with what we talked about at year-end as kind of what we expect to see with margins over the next couple of years. We talked about the pressure on margins from not just the bubble costs associated with the cloud transition and moving from Tyler data centers to AWS. But the impact on margins and revenue from the runoff of licenses and as that business continues to shift towards a higher percentage coming in the SaaS. We said really by the end of both of those have impacts over the next couple of years. But we think that sort of that inflection point where licenses or the runoff of the remaining licenses or shift of those into a SaaS model no longer has a negative impact on margins, because we have built up that run rate of subscription revenues, and we really believe that 2023 is sort of the trough on margins. After that, along with that is the lessening of the impact of the mix shift. So what we're seeing this year is pretty much in line with how we looked at the estimated mix going in. But we do expect that percentage at 80% to continue to grow.

Our next question comes from Alex Zukin from Wolfe Research.

So I guess I want to drill into a figure that you're giving us in the supplemental disclosures, and that's calculated SaaS net new ARR. I'm trying to square the commentary around the strength of the subscription business as a percentage — or of SaaS contracts as a percentage of the total going up year-over-year. But then when I look at net new ARR of $6 million, it's down pretty substantially year-over-year and sequentially. And I know that's a very volatile seasonal metric. But just help us understand why that is? Also, if you think about the year in terms of the mix between new core Tyler business license versus SaaS, how are we thinking about that? Meaning — what type of net new ARR growth should we kind of think about this year versus the kind of license decline? Or is license going to be flat? I think that would be a good thing to just explore.

Yes. There is some lumpiness in the growth in ARR around — as there is with our license and our bookings. We do expect for the full year licenses to decline and to be down likely sort of in the mid-single digits. We expect subscription revenues to grow in the 25% to 30% range. And we would expect that new ARR would also grow in that 25% to 30% range.

Got it. Okay. And so I guess, from a — is there anything that was just different seasonally from a deal construction standpoint this quarter versus maybe previous last year's Q1 or anything to read into?

Not that I'm aware of. I think it's just a little bit of the lumpiness of the structure of the contracts, but not aware of anything that's particularly notable in terms of a difference from the prior year.

Got it. And then I guess, are the — do you feel like — it sounds like you were a little surprised at the strength of the license business in Q1. Is there — do you feel like those changes — it's going to be the changes in the incentive structures or in the product that's going to drive that change in mix in the second half? Or I guess, what — where could you be wrong with respect to that?

I'd say there that for the year, I think our licenses are sort of on track with our plan. They were a little higher in Q1 than our expectations. Some of that comes through our robust inside sales. Some of those tend to have trended to be more licenses than we expected. Our new business generally is in line with our expectations. I think our licenses outlook for the year is in line, but it was higher in Q1, which obviously helped with our organic growth number.

Perfect. And then just the last one on cash flow. I guess, Brian, if you think about it as we progress through the year given those — given some of those mix shift dynamics, what's the right way to think about the free cash flow progression through the year?

Yes, I still think that, again, we still have a big base of maintenance, that a lot of that cash flow comes in Q3. So still expect that the progression will probably be similar to what we saw last year that Q3 would be, by far, the peak of cash flow, but Q4 should be relatively strong as well. But I think we still sort of follow the historical seasonality of cash flow. Our CapEx should be fairly consistent across the year. And the — obviously, the recurring revenues with a much bigger base of transaction-based revenues help smooth out the seasonality around that piece of our revenues.

Our next question comes from Keith Housum from Northcoast Research.

Just following up on the last question actually. I was going to ask the same thing but more from a booking standpoint. Bookings in the quarter of $419 million were the lowest of the past four quarters. Is it just a matter of more timing in terms of either the pipeline is healthy, but the deals haven't closed just given some of the optimism we're hearing here? Or is duration playing a part of it where that duration is attributing to, I guess, lower bookings amount this quarter than what we see in the past three?

Yes. Duration is certainly a part of it. This quarter with the 3.4 years duration of our new subscription deals is much closer to what we're trying to drive to with sort of a standard of 3 years on most of our new subscription deals. So that certainly played a part in it. It's down from 4 years last year. And I think that also would be the lowest average duration we've seen over, call it, the last year or so. So I think that's playing a part in it. Bookings growth on an organic basis was still pretty solid at north of — I think, the number was 14%. So duration certainly would be one of the factors there. But we feel pretty good about bookings growth actually being on an organic basis being ahead of where revenue growth currently is. Again on maintenance because those bookings come in when those renewals happen in Q2. Q2 typically is a stronger seasonal bookings quarter just because of where the maintenance falls, and Q1 is pretty light there. The subscription bookings were certainly the strongest point of the bookings growth this quarter, which is what we like to see.

Okay. I appreciate that. And in terms of the employees, and I appreciate the commentary that there's some more hiring that needs to be done. But can you speak a little bit about, I guess, turnover and inflationary cost pressures? Obviously, it's been a very dynamic quarter in terms of inflationary pressures. But as the year is developing, is it worse than you expected in terms of what you guys are pulling up for new employees? Or just any commentary on that matter?

Yes. So there's a lot there, Keith, to talk about. We mentioned, I think, in our last earnings call that part of our OP pressure this year was the fact that we were generally increasing our budget for employee compensation a little higher than we had traditionally. The labor market challenges are out there. Our turnover is higher than historic. But from what we see and the studies that we look at, we still believe it's lower than most in the tech industry. The competition is tough out there right now. I sometimes look at it, however, in terms of — when I think about external factors, be it inflation or recession concerns or the labor market, is what do we do within Tyler? How does it impact us versus our competitors? And people like to come to work here. We've got a good culture. I like to think that some of these things may disproportionately affect some of our smaller competitors as it relates to inflation and pricing. As you know, most of our agreements are annual agreements or multi-year agreements with some ability to adjust pricing. We have the ability to adjust those — adjust pricing on our services that we send out there. So I think we're in a position where we can attack inflationary pressures. Our people are working hard to staff and hire. We've done a lot of business in the last year, and we need to go execute on some of it. And that's part of it: we need to get some people in here to go execute on some of these deals we've sold.

Our next question comes from Brent Bracelin from Piper Sandler.

Lynn, I wanted to double-click into the payment business, in particular, just revisiting the upside in the quarter from the Florida statewide contract. Pretty meaningful contribution, that begs the question, how many other states are you active in discussions with replicating what you did in Florida today? And then could you maybe talk about the 5-year opportunity? Do you think this is an opportunity where you could get a dozen states that potentially could look more like that Florida contract? Or is it a bigger opportunity than that?

Yes. So with the Florida upside in the first quarter around the Secretary of State filings, we anticipated to have the Secretary of State filings; the manner in which the revenue model turned out to be a little bit different than we had anticipated, and we were able to go with the convenience fee as opposed to a per click per payment percentage, and that drove significantly higher dollars to us. My comments are really about the fact that the extension of what we can do with Tyler. We've talked about being able to be in the local markets in Florida. Our ability because of our robust payment engine to do things that certain other payment providers can't do that are in our focus on the government space drives that as you look out towards other states and other localities. But payments is one of our big future growth drivers. It's something that all of our divisions are focusing on. And I think it's something that you're going to see drive growth over time. It's going to — like a lot of our long-term growth drivers, it will ramp up over time. If you say, where are we out 5 years from now, we think the market's pretty big. The Total Addressable Market for payments is, I think, well north of $500 million, and we're positioned and targeted to go get a vast majority of that.

Helpful of color. And then, Brian, just as a follow-up on the maintenance side of the business. Certainly encouraged to see the SaaS mix increasing. Sounding like 80% of new contract volumes are going to be SaaS related. The flip side of that is maintenance. Maintenance, I would expect, at some point, would decline at a steeper pace with that mix shift, but it hasn't yet. I mean — a slow decline. What's the offset there? What is — are there annual price escalators that are helping insulate maintenance? And again, I understand it's a slow decline here, but what's the offset that maybe we might see a steeper decline or not preventing a steeper decline in maintenance?

The offset really is the annual increases. I mean most of our maintenance agreements, the vast majority of them are annual agreements, so renewable annually with pricing adjustments annually. And historically, I'd say, across most of our customers, we're typically in the 4% to 5% annual increase on a pretty consistent basis over a number of years, and that hasn't changed. So yes, on the base, we typically get that low single-digit annual increase. We, as you know, have very, very low attrition in terms of customers leaving us. In terms of dollars, probably around 1%. And then certainly, as fewer new customers come to us in a license model with maintenance, there's a smaller and smaller number of new adds, but we have that 20% of our new business that is coming in license that does generate new maintenance. The bigger impact that is likely to accelerate over the coming years is the flips or the migrations of those on-premise customers that are currently paying us maintenance, moving into the cloud and shifting to subscription. So it's a change in what revenue line they come on, but typically doubles what they're paying us over maintenance. So while we lose maintenance revenues, we gain close to 2x that on the subscription line.

And I'd add there, Brent, that while we talk about our flips and our flips continue to increase quarter by quarter, I think our flips are year-over-year; they’re up maybe about 125%. Much like my comment on NIC, we're still in the very early innings on flips. That's a long roadmap and a long tailwind. And as our products continue to get more cloud efficient and more cloud optimized, as we develop more systems to make that a little more of an efficient process, that's something that will be a tailwind for the next several years.

And ladies and gentlemen, with that, we'll be ending today's question-and-answer session. Mr. Moore, I'll turn the call back over to you for closing remarks.

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

Ladies and gentlemen, with that, we'll be concluding today's conference call. We do thank you for attending today's presentation. You may now disconnect your lines.