Tyler Technologies Inc Q1 FY2023 Earnings Call

Hello, and welcome to today’s Tyler Technologies First Quarter 2023 Conference Call. Your host for today’s call is Lynn Moore, President and CEO of Tyler Technologies. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. Your conference is being recorded today, April 27, 2023. I would like to turn the call over to Hala Elsherbini, Tyler Senior Director of Investor Relations. Please go ahead.

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

Thanks, Lynn. Yesterday, Tyler Technologies reported its results for the first quarter ended March 31, 2023. Total revenues for the quarter were $471.9 million, up 3.5%. Organic revenue growth, which also excludes COVID-related revenues, was 7.2%. Last year's first quarter included $20.6 million of revenues from COVID-related initiatives at our Digital Solutions division, formerly NIC, all of which ended in 2022. License revenue declined 39% as our new software contract mix continued to shift to SaaS at an accelerated pace. Professional services revenue declined 13% due to the completion of COVID initiatives but rose 4.7% organically. Subscriptions revenue increased 14.3% and organically rose 16.4%. Within subscriptions, our SaaS revenues grew 24.4% to $126.6 million and transaction revenues grew 7.1% to $153.9 million. On an organic basis, which also excludes COVID-related revenues, transaction revenues grew 13.1%. We added 145 new SaaS arrangements and converted 73 existing on-premises clients to SaaS with a total new software contract value of approximately $86 million. In Q1 of last year, we added 149 new SaaS arrangements and had 88 on-premises conversions, with the total new software contract value of approximately $76 million. Our new SaaS bookings in the first quarter added $17.1 million in new ARR. Our total ARR was approximately $1.58 billion, up 9.1% and organically grew 11.5%. Since Q4 of last year, SaaS revenues now exceed our maintenance revenues. Operating margins in the quarter were once again pressured by the acceleration of the shift to the cloud in the new business and the related decline in license revenues. As we've previously stated, we expect operating margin to trough in 2023 and to return to a trajectory of margin expansion in 2024. As we also discussed last quarter, merchant and interchange fees from our payments business under the gross revenue model have a meaningful impact on our overall margins. In Q1, we paid merchant fees of approximately $42 million. If those fees were netted out of both revenues and cost of revenues, our consolidated non-GAAP operating margin for the quarter would have been approximately 200 basis points higher. Cash flow was robust this quarter with cash flow from operations of $74.7 million, up 39.5%, and free cash flow of $63.6 million, up 55.1%. As a reminder, cash flow for the balance of the year will be impacted by an estimated $131 million of cash tax payments resulting from the Section 174 tax changes, of which $73 million is related to 2022 taxes and $58 million is related to 2023 estimated taxes. We continue to strengthen our balance sheet as we repaid $120 million of floating rate term debt during the first quarter. We ended Q1 with total outstanding debt of $875 million and cash and investments of approximately $174.2 million. Our net leverage at quarter end was approximately 1.52 times trailing 12-month pro forma EBITDA. Our revenue and non-GAAP earnings guidance for the year are unchanged. Our 2023 guidance is as follows: we expect total revenues will be between $1.935 billion and $1.970 billion. The midpoint of our guidance implies organic growth of approximately 8%. We expect GAAP diluted EPS will be between $3.65 and $3.80 and may vary significantly due to the impact of stock option activity on the GAAP effective tax rate. We expect non-GAAP diluted EPS will be between $7.50 and $7.65. Interest expense is expected to be approximately $26 million, including approximately $5 million of noncash amortization of debt discounts and issuance costs. Other details of our guidance are included in our earnings release. I'd like to turn the call back over to Lynn.

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

And your first question comes from the line of Ryan from Credit Suisse Securities USA. Your line is open.

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

Sure. Regarding the second part of your question, I don't believe we've reached the lowest point for the full year yet. We anticipate that our consolidated margin for the year will be lower compared to last year, and our guidance reflects that. I also believe that the second quarter won't be the time when we see year-over-year margin improvement. However, we expect to see year-over-year margin improvement by the fourth quarter. As for our overall margin, we do not provide quarterly guidance, so we don't have a specific quarterly margin target. Our earnings and revenue guidance remains largely unchanged from the beginning of the year, so our expectations are generally consistent. In the first quarter, we experienced good performance and growth in subscription revenues as some of those revenues have started to come in from deals signed in previous quarters, which can impact the timing somewhat. I think our subscription revenues were likely slightly above market expectations. Nevertheless, our expectations for full-year margins have not shifted.

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

Next question comes from the line of Kirk Materne from Evercore ISI. Your line is open.

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

Yes, Kirk, that's a great question. We are organizing special events for our state government clients, and many key stakeholders will be attending. They will meet many members of our executive team, and there will be a dedicated side session for them, as well as participation in the larger forum. Connect is a unique opportunity for us. We have numerous clients, and it's a chance to engage with them, share our vision, and listen to their needs and aspirations. It's also a great opportunity for us to provide more training, share information, and discuss our new offerings that can enhance their efficiency. This event is significant and requires considerable effort. Our marketing and events teams do an incredible job. I highly recommend it to anyone who hasn’t attended; it’s organized exceptionally well. A lot of work goes into it, and although it’s not cheap, it is definitely worthwhile. I believe both Tyler and the executive team gain valuable insights from it, as do our clients.

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

Good morning. Thanks for taking the question. I guess, Lynn, on the back of the last question there, you referenced a number of potential pipeline opportunities around some of the state-level contracts. Curious if you could give us some sense of the magnitude of how much you feel like is in the near-term pipeline, where you're actually discussing specific deal terms and things of that nature? And maybe just compare to sort of how much upsell cross-sell has come through those contracts since the acquisition closed and I guess maybe it boils down to sort of what inning or what percentage of those potential opportunities do you think you've realized so far? What's on sort of the near term and then what's maybe more long term in terms of mix? Thanks.

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

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

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

Yes. I think what I would say there, Josh, is that what we're seeing in terms of the sales indicators, the RFP volume, and the number of demos that we're doing is really at almost all-time highs. Now that's not going to turn into business for several quarters, but it's very encouraging to see. I can't really put my finger on what's driving that right now other than the fact that demand remains high and our clients' budgets remain solid.

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

Good morning, Lynn and Brian. Hala, thank you for taking my question. I have a follow-up regarding the conversions. Lynn, I'm interested to know if there have been any developments in terms of your strategy for multi-suite conversions and how you’re thinking more broadly about your product offerings. Additionally, I'd like to know more about Rapid Financial Solutions. It seems promising, and I'm curious if there's any information on the size of that business now.

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

And we don't disclose the revenues for Rapid separately, but when we acquired them, they were in the kind of $14 million, $15 million annual revenue range.

Your next question comes from the line of an analyst from Wolfe Research. Your line is open.

Hey, this is Alex. I have a quick question about the demand environment. It seems, Lynn, that every company has been discussing the strength of state and local sectors. While budgets have generally been better relative to other areas, is there anything unique happening? Additionally, regarding your own rate of new SaaS bookings, has there been any change? Is the environment performing better than you had anticipated, or is it meeting your expectations? I would appreciate any insight on this. Also, Brian, thank you for the information on operating margin trends throughout the year. Can you provide some clarification on free cash flow, particularly the $130 million and how that impacts cash tax payments over the year? As you consider cash conversion on an annual basis, how does that play out?

Yes, when we discuss what we're observing in the market, there are a few key points. It clearly highlights that the services we offer are essential. It also suggests that we've experienced some pent-up demand following COVID, along with the ongoing transition towards modernization and digitization of local government. Additionally, we are noticing the impact of labor markets on various companies and our clients. With labor shortages and turnover affecting our clients, they're increasingly relying on technology to address these challenges. There are many factors at play currently, and the market is performing well. While I can't definitively categorize my expectations, I'm quite pleased with the current state of the market.

Regarding free cash flow and the bookings growth that Lynn mentioned, our total bookings growth was around 7% on an organic basis. However, our subscription bookings grew nearly 24% on the same basis, closely aligning with our revenue growth. The strength lies in both SaaS and transaction bookings. Concerning free cash flow, the estimated incremental cash taxes this year tied to Section 174 is around $130 million to $131 million, which is higher than what we discussed in the fourth-quarter call due to updated calculations. This includes $73 million from last year's tax deposit and about $58 million for this year. While this impact is set to decrease each year, we are navigating a two-year catch-up period this year, which should taper off annually until it stabilizes after five years. The largest portion of this impact was in mid-April, approximately $85 million, followed by around $15 million in each of the last three quarters. Overall, our free cash flow margin, excluding the Section 174 impact, is in the 18% to 20% range. When including this impact, the margin falls into the high single-digit to low double-digit range, making it significant this year.

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

Good morning, Lynn and Brian, thank you for taking my question. Brian, I appreciate the additional information on SaaS bookings ARR. I believe it showed mid-single digit growth this quarter, which is impressive given the challenging comparison. Could you discuss the trend and how you expect it to progress through the year? Additionally, could you provide some insights on the changes in disclosure? For instance, I noticed that the appraisal metric we previously received has been consolidated elsewhere. Please clarify some of the disclosure changes and highlight what we should focus on moving forward.

Yes. Appraisal is a smaller part of our business. Appraisal Services is an essential service we provide to customers who either have purchased or will purchase a property tax system from us. However, it now accounts for less than 2% of our revenues. As a result, we have integrated that line into the professional services category. Our main focus, as we've discussed, is on subscription revenue growth and recurring revenues. We've provided details distinguishing between SaaS revenues and transaction-based revenues, which include payments, our digital solutions portal, and e-filing. The growth in SaaS bookings was mid-single digits, but this mainly pertains to new logo SaaS deals. There are additional bookings from upsells, price increases, and cross-selling to existing customers. The key metric we emphasize is the overall growth in subscription bookings, which includes both transactions and SaaS revenues, and that saw an increase of 23.6% this quarter.

Your next question comes from the line of Pete Heckmann of D.A. Davidson. Your line is open.

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

Yes, Pete, I agree. Our primary focus remains on reducing debt and using our capital for that purpose. It's notable that our term debt has decreased to nearly 30% of our total debt, down from about 65%. We've made significant progress in that area. We are still considering mergers and acquisitions and regularly assess various opportunities. For instance, we completed the Rapid Solutions acquisition last fall. If a situation arises that offers substantial long-term strategic value, we will pursue it. This approach has been consistent even during periods of higher net leverage. That said, we have numerous initiatives underway at Tyler that keep us quite busy. While I can envision us continuing with acquisitions similar to Rapid, a larger transformative deal or entering an entirely new market is unlikely in the near future.

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

Hi, good morning. Brian, on the last call, you talked about Q1 being similar to Q4 in terms of the EPS, a big ramp in Q2 with the full-year guidance essentially unchanged. Should we assume that the ramp in Q2 will be less given that Q1 results were better than expected?

I believe we will remain within the same range for the entire year. I'm increasingly confident in that range and it seems we might be leaning towards the upper end at this point, though it's still early in the year. I think we're still in the ballpark. Last year, we reported $1.76 in the first quarter, and this year we achieved $1.66. However, the increase into Q2, Q3, and Q4 may be less significant, but overall, we're still aligned with the same range.

Michael Turrin from Wells Fargo Securities. Your line is open.

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

I'll try to address that. The main issue is the delay between signing a new deal and when revenues begin to appear in our income statement. We've reported strong SaaS bookings recently, particularly this quarter, but there is usually a delay. For new software deals, it can take a quarter or two, or sometimes even longer, from when we sign the contract to when we can start recognizing revenue once the client’s environment is set up. This also applies to our transaction-based revenue contracts. For example, if we secure a new payment deal, there might be about a quarter delay before we start seeing those revenues. Conversely, we notice the immediate impact of lower licenses, because if those were license deals, we would have recognized most of that revenue right after signing the contract. Additionally, transitions from on-premises to the cloud also involve a period where we won't see an immediate uplift in revenue, even if we sign the contract now.

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

Hi, good morning. Can you talk a little bit about the data insights opportunity that you referenced in the script? And perhaps what kind of upsell opportunities you're seeing in and around that product grouping? Thank you.

Yes, Jonathan. I believe that data insights is an offering that every public sector agency will need in the future. It's a unique offering, and we are positioned well due to our extensive reach and our capacity to provide data across various solutions, including those not developed by Tyler. We made this investment about five or six years ago, and we are now witnessing increasing demand for it. Internally, we have restructured our former data and insights division and integrated it into each of our divisions to better align our products with specific demands. I see this as a key differentiator for us, and it has always been. Over the past year, this has also been a differentiator for NIC. For instance, when we discussed the South Carolina rebid or the early renewal of the Texas payments contract, a significant factor in those decisions was our data insights. We plan to continue leveraging this advantage, as it is something the public sector truly requires.

Your next question comes from the line of Rob Oliver of Baird. Your line is open.

Great. Brian, I have a question for you. Last quarter, it seemed a few significant deals were postponed and the deal sizes appeared to be somewhat modest. I'm curious if any of those deals were finalized this quarter and what you're noticing regarding deal sizes. Also, I have a quick follow-up about free cash flow. Can you clarify if the impact is solely due to catching up from 2022 or if there are other tax-related factors affecting free cash flow? I apologize for my laryngitis.

Yes, the impact on free cash flow is primarily due to the catch-up related to Section 174, and this calculation is complicated and still being refined as it involves additional overhead. The impact turned out to be greater than our initial expectations, especially concerning the amount for 2022. The average deal size in this quarter was slightly larger than in the first quarter of last year. We typically have deals that shift from one quarter to another, and in our subscription model, this has less impact. However, we did finalize a couple of license deals we mentioned in Q4 that were not named, which closed this quarter. We secured two significant license agreements for our property recording product with large counties in North Carolina—Wake County, which includes Raleigh, and Mecklenburg County, home to Charlotte. Additionally, we completed a noteworthy public safety deal with the Virginia State Police this quarter. Overall, while some deal timing was adjusted, we have successfully closed those deals.

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

Good morning. Thank you. I wanted to follow up on some of the commentary on margin expansion. So Lynn and Brian, as you think about the longer-term trajectory for margins, I know you've given us some qualitative color and a little bit of quantitative color as well. Is your expectation that margin progression after this year is likely to be linear? Or do you see a period of time when maybe there's an accelerated structure for margins?

Yes, Gabriela, I don't expect the progression to be linear. Margins and our targets will be one of the topics we address at the Investor Day since things are rarely linear. I believe the timing of the transitions over the next few years, as we accelerate our clients' movement from on-prem to the cloud, will impact the margin trajectory. We're more confident about the timeline for closing our data centers, which we expect to happen in 2024 and towards the end of 2025, allowing us to reduce associated costs more significantly during those years. Therefore, I don't anticipate a linear progression. I can't provide much more detail at this moment, but we will keep refining our outlook, and margins will be a key topic at the Investor Day.

Yes. And of course, as we grow out through Tyler 2030 and we talk about our growth in our SaaS and our flips, but at the same time, we're actively growing our transaction business and our payments business, which will have somewhat of a negative effect. So depending on the growth rates between those two businesses will have some impact on overall margins.

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

Good morning, guys. Brian, I know quarters past, you talked about the servicing revenue and the staffing up with that unit. Can you perhaps talk about the staffing really you're currently at, you’re? And if you have those people now, they're actually able to contribute to the bottom line?

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

Yes. And I think to be clear, we've talked historically over the years about services and our margins on services. And services historically is not accretive to margins. We've talked in the past about it maybe in breakeven or really more of a loss leader. That's likely not to change going forward. I think when I talked earlier about intentionality around other things that we're doing within the business, part of that is things around what we can do to minimize the negative impact of services on overall margins.

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

Brian, I just wanted to ask, was there a restatement of SaaS revenue in 2022? As I look to Q4 as an example, it seems like we were talking about $110 million last quarter, and now it's $120 million in the supplementals. Was there any change here?

There was a very small reclassification of some revenues from transaction revenues to SaaS revenues to align them with our current reporting. This change is not significant and is reflected in the supplemental data.

Your next question comes from the line of Joe Goodwin of JMP. Your line is open.

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

Yes, we believe our technology stands out significantly from the more general payment providers. The various payment channels we offer, along with our strong disbursement capabilities, enhance both the payment acquisition aspect and the reporting process. Our integration with Tyler's back-end systems simplifies reconciliations and makes life easier for our clients, which is a key differentiator for us. This advantage often allows us to command solid pricing and, in some cases, premium rates because we deliver extra value. Rapid has added to these capabilities, but NIC already possessed strong functionalities and continues to invest in and improve its payments platform. Currently, we are working on integrating this payment platform more closely with Tyler's back-end systems to further strengthen our competitive advantage through this integration.

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

Your next question comes from the line of Kirk Materne of Evercore ISI. Your line is open.

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

There's limited flexibility in how these fees are accounted for. The key issue is whether we take on the responsibility and risk of paying merchant and interchange fees, which can differ based on the type of credit card used, such as Amex or Visa, and whether it's for business or personal use. Typically, our clients prefer that we manage these fees so they can have clarity on their costs. We charge a percentage of the transaction, around 2%, while the merchant and interchange fees might be approximately 1.75%, though they can fluctuate. We also receive a per-transaction fee and thus earn a small margin on the merchant fees. In a different model, the customer would directly pay those fees, and we would only receive a per-transaction charge for our services. Generally, clients prefer us to absorb this risk, which necessitates gross accounting. It’s important to illustrate the impact of these fees on a net basis, and when removed from both revenues and expenses, it shows a 200 basis point effect on our overall operating margin. This influence can change depending on the growth rate of these fees compared to the rest of the business. We plan to continue sharing these numbers to help you understand their impact and trends over time.

Yes. To clarify, it is customer driven, and while the lower margin actually leads to higher free cash flow, this ultimately benefits our free cash flow.

And that was the last we have for today. So I’d like to hand back to Lynn Moore for closing comments.

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

That does conclude our conference today. Thank you for participating. You may now disconnect.