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

Thank you, Colby, 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 additional comments on our quarter and then Brian will review the details of our results and provide an update to our annual guidance. Lynn will end with some additional comments, and then we'll take your questions. During this conference call, management may make statements that provide information other than historical information and may include projections concerning the company's future results, 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've also posted on the Investor Relations section of our website under the Financials tab schedules with supplemental information, including information about our quarterly bookings, backlog, and recurring revenues. On the Events and Presentations tab, we posted an earnings summary slide deck to supplement our prepared remarks. Please note that all growth comparisons we make on the call today will relate to the corresponding period of last year unless we specify otherwise. Lynn?

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

Thanks, Lynn. Total revenues for the quarter were $504.3 million, up 7.6%. Organic revenue growth, which also excludes COVID-related revenues in 2022, was 10.4%. Last year's second quarter included $15.2 million of revenues from COVID-related initiatives at our Digital Solutions division, formerly NIC, all of which ended in 2022. Subscription revenues increased 16.4% and organically rose 16%. Within subscriptions, our SaaS revenues grew 20% to $131.5 million and transaction revenues grew 13.7% to $166.3 million. On an organic basis, transaction revenues grew 12.8%. License revenue declined 34.8% as our new software contract mix continued to shift to SaaS at an accelerated pace, with SaaS deals comprising 82% of our Q2 new software contract value compared to 74% last year. Professional services revenue declined 7.7% due to the absence of COVID-related revenues but rose 12.9% organically. We added 170 new SaaS arrangements and converted 94 existing on-premises clients to SaaS, with a total contract value of approximately $93 million. In Q2 of last year, we added 167 new SaaS arrangements and had 96 on-premises conversions, with a total contract value of approximately $115 million. As a reminder, in last year's second quarter, we signed a $20 million SaaS contract for a digital motor vehicle titling solution in New Jersey. Our total annualized recurring revenue was approximately $1.66 billion, up 11.2% and organically grew 11.6%. Operating margins in the quarter were once again pressured by the acceleration of the shift to the cloud in new business and the related decline in license revenues. We've also seen expenses associated with employee health benefits grow well above planned levels during the first half of the year, and we remain cautious about future increases for the balance of the year and next year. As we previously stated, we expect operating margins to trough in 2023 and the return to a trajectory of margin expansion in 2024. As we also discussed in prior quarters, merchant and interchange fees from our payments business under the gross revenue model have a meaningful impact on our overall margins. In Q2, we paid merchant fees of approximately $44 million. If those fees were netted out of both revenues and costs of revenues, our consolidated non-GAAP operating margin for the quarter would have been approximately 220 basis points higher. Both cash flows from operations and free cash flow were negative this quarter at $19.2 million negative and $33.2 million, respectively, mainly due to incremental cash tax payments of approximately $90 million related to the current status of IRC Section 174 capitalization rules. On a pro forma basis, excluding the Section 174 cash taxes, our year-to-date free cash flow would be approximately $120 million, up 19% over last year. We did not pay down term debt in Q2 due to the elevated cash tax payments, but we expect to continue to prioritize debt payments as our cash flow accelerates in the second half of the year. We ended Q2 with total outstanding debt of $875 million and cash and investments of approximately $148 million, and net leverage at quarter end of approximately 1.55x trailing 12-month pro forma EBITDA. Our updated 2023 guidance is as follows: We expect total revenues will be between $1.94 billion and $1.965 billion. The midpoint of our guidance implies organic growth of approximately 8%. We expect GAAP diluted EPS will be between $3.87 and $4.02 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 $7.60 and $7.75. Interest expense is expected to be approximately $25 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 and in the Q2 earnings deck posted on our website. In conjunction with our guidance for the full year, I'd like to remind you of the seasonality around our transaction revenues. While transaction revenues will grow year-over-year, we expect they will decline sequentially in Q3 and again in Q4. Historically, transaction revenues are driven by 2 primary factors: They determine deadlines like corporate filings and hunting seasons and the number of business days. Transaction revenues typically are at their highest in Q2 coinciding with peak outdoor seasons and tax deadlines. In addition, starting in Q3, we'll see the revenue impact of contractual changes in one of our state enterprise agreements that includes a move from a gross to net model for payments. Now I'd like to turn the call back over to Lynn.

Thanks, Brian. We finished a strong quarter and first half performance excelled across our business. The quarter was highlighted by 2 highly successful events: Connect 2023, which was our most attended user conference to date with nearly 6,000 attendees and our first stand-alone investor event in 4 years, where we unveiled our Tyler 2030 vision and key growth pillars driving our strategic direction toward organic recurring revenue long-term CAGR of 10% to 12%, sustainable margin expansion with non-GAAP operating margins of 30% or greater, and expanded free cash flow of $1 billion and free cash flow margins in the high 20s. If you didn't attend our Investor Day in person or virtually, we invite you to watch the replay or access the presentations on our website. It's an exciting time in Tyler's next era of growth, and we see a clear pathway to achieve our mid- and long-term goals, guided by a well-defined growth strategy and powerful financial algorithm to deliver sustained value creation and support our public sector clients' digitally empowered future. Now we'd like to open the line for Q&A.

We will now begin the question-and-answer session. Your first question comes from the line of Pete Heckmann from D.A. Davidson.

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

Yes, Pete. To start, the ERP market is really strong right now. Market activity is good, with an increase in RFPs and demos. We mentioned this at the end of the first quarter earnings call. It is a very competitive market, and we observe that Workday is more active at the higher end, particularly in larger deals. They tend to compete well in scenarios where clients are more focused on HR-specific solutions rather than comprehensive suites. However, we believe that having a fully integrated suite of products is the best long-term strategy, and we are performing effectively when we focus on that aspect.

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

Yes, that's correct. We discussed this briefly at the investor conference. One challenge in transitioning customers to the cloud and upgrading them is that some are still using older versions, and we are actively addressing this across all our product lines in an effort to achieve version unification. Some divisions are further along than others. This emphasizes my previous point that Tyler is undergoing multiple cloud transitions rather than just one, as we have various core applications in different phases with differing versions, technologies, starting points, and endpoints. It involves numerous moving parts. Nonetheless, this is a critical factor affecting all of them, and different products are currently in varying stages.

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

Okay. That’s good to hear. I appreciate it. I’ll get back in the queue.

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

I guess as we look at the strength of the SaaS business, especially on the SaaS bookings, I wonder if you could help us think through maybe the cadence of the bookings throughout the quarter? Were they a little bit more back-end weighted? or anything from sort of a timing perspective? And then a second part there is we seem to have seen some of the best organic growth in a number of quarters here. So business is performing well. But maybe think about why you didn't raise the midpoint of the revenue guidance for the year, just sort of what went into the process of essentially maintaining the midpoint on the guidance there.

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

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

Lynn, my first question for you is regarding unified payments, where you mentioned 132 payment deals. I'm interested in the revenue synergy aspect, especially considering new use cases related to disbursements. How does the second half look in terms of building confidence in these revenue synergies? Can we continue to expand on the 132 payment deals as we enter Q3 and beyond? Could we see further positive developments similar to what we've experienced so far?

Yes. Terry, that's a good question. I think payments is an area where it continues to even outbeat our internal plan. And so my expectation is that's going to continue. It's something that we push with every deal. It's the more that we get involved, it's also involved in a lot of our inside sales, which also continues to outpace quarter after quarter. As it relates to Rapid, we're still pretty early. We're about 9 months into the Rapid acquisition. We've got a lot of good traction. We've got a lot of deals that are in the works that are really pretty exciting deals that we wouldn't have without Rapid and that are going to add really some extra revenues down the road. So where we are with payments right now is I'm excited about where we are. I'm really excited about the Rapid deal. It's something that's being pushed throughout our entire sales channel, and I would expect that to continue to grow.

There is usually a delay from the moment we finalize a new payments agreement to when those revenues begin to appear on the income statement. This delay could be one or two quarters, or it may take longer. Often, we are replacing an existing payments provider, which can require some time for that transition. Additionally, payments may be linked to the deployment of a new solution, such as the utility billing system, and will start once that new system is operational. Therefore, while we are pleased to see a growing number of new deals signed, indicating positive future revenue growth in that sector, it is important to note that this will not happen immediately.

Got it. I have a follow-up question, and then I'll get back in the queue. It was good to mention the variability in your exposure to large deals. So if we exclude the $20 million deal, the software contract value was slightly down year-over-year. It seems like there's been strong demand activity year-to-date. However, I'm curious if there were fewer smaller large deals in this quarter compared to last year's second quarter. Also, is there anything we should highlight for Q3 that would coincide with a significant deal from last year in the second quarter?

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

Yes. I think what's interesting is that while there were no significant mega deals this quarter, all of our divisions are exceeding their targets in terms of sales, pipeline, and overall activity. Typically, there are fluctuations, but this quarter has been strong across the board, both in revenue and execution.

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

Understood. Good look into Q3. Thanks.

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

I wanted to follow up on the comment on RFPs and demos now being at or above pre-COVID highs. Would love to get a little bit of color on how much of that is activity changing at the customer versus maybe Tyler-specific initiatives? And is there any reason to think that the quality of these RFPs and demos could be better or worse? In other words, how do you think about conversion rates for some of this great top-of-funnel pipeline activity relative to the history?

Yes, Gabriela. The increase in RFPs and demos is primarily driven by market conditions. There may still be some lingering effects from COVID, but we're observing this trend across all our business units. In terms of RFP quality, some units are becoming more selective, which is likely to improve our win rates, as we're seeing in public safety. Overall, the market is quite healthy right now.

I think it is a combination of both, the strength of the market, I think the stimulus is a factor there, but not the major factor, but also the strength of Tyler's broader presence, the ability for us to leverage our customer relationships and see more opportunities and see some of those opportunities sooner through the NIC state contracts and our ability. We talk about RFPs and demos but a growing number of our deals take place without RFPs. So in sole source or deals that bypass that formal RFP process. So that's a positive for us as well.

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

Nice job on the quarter here. Subscription and maintenance gross margin was higher in the quarter. Maybe you can give us some color on what drove that increase quarter-over-quarter? And how is the cloud migration impacting gross margin near term here versus some of the operating expense line items?

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

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

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

Yes. I think, at the Investor Day, we actually talked about kind of high-teens CAGR over that period collectively from now through 2030. So right now and for the next few years, we'll continue to see a bump to the growth from the flips from our on-prem customers. Over time, that certainly will accelerate over the next few years and then we'll wind down as we talked about the cadence we expect to convert those customers over. So we are getting higher benefit from those flips, and we'll continue to see that. But I think ultimately, it moves more into the teens. But I'd expect to see this growth in this range for the near future.

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

Yes. I think we actually talked about that when we gave guidance for the full year. There is 1 state that’s about a $10.5 million that’s changing midyear, so that impact will start to hit this year, and we estimated that at around $10.5 million in the second half of the year, probably a little more of that impact in Q3. It happens really on a state or a customer by customer basis. The vast majority of our business is on the gross model, and we expect that to continue to be the case. Customers generally prefer the certainty and the predictability around having us assume the responsibility for the merchant and interchange fees and have a set percentage that they’re going to pay for their payments processing. There are some customers that are willing to accept that risk around those merchant interchange fees and prefer the net model, and sometimes there are changes there as we’ve seen this year. We really – I think we had 2 states that’s been the case with this year. But again, generally, we would expect that the vast majority of our payments business would continue to be on the gross model.

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

This is Ethan Park on Alek Zukin. I have 2 parts here. Just first, can you talk a little bit about the shape of the quarter, just comment a bit about kind of the environment coming in and out of the Analyst Day? And then just a question on the SaaS works. How did it perform just relative to your internal expectations as we look at about a year versus a year ago and just how to think about that trending through the rest of this year and into 2024.

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

Your next question comes from the line of Michael Turrin from Wells Fargo Securities.

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

Yes. I don’t think there’s anything of note around that. The mix of what deals signed in any given quarter can just vary a lot depending on the timing of when those things happen and what happens to be in the pipeline. So I don’t think there’s a trend to call out or anything, any macro condition that’s affecting. We continue to – if we look at comparison to last year, I think some of those metrics are skewed a bit by those very large deals. But I don’t think there’s anything really notable to call out there, and I’d expect that – generally, we expect to continue to see deal sizes grow over time, but it’s hard to predict exactly what will happen in Q3 or Q4. But I don’t think there’s anything fundamentally changing in the market around that.

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

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

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

Yes, that's a good point, and you're right. That's a significant aspect of our sales strategy. I would characterize this more as an upsell opportunity. We discuss both cross-sells and upsells, which allows us to introduce our data and insight solutions, our payment solutions, and other offerings. As we mentioned earlier, much of this requires customers to upgrade to a newer version of the software, which also facilitates access to other modules and compatible features. In terms of moving to the cloud, obviously, as people start talking more about generative AI and AI in general, to take advantage of, you sort of need to be in the cloud. Has that started to percolate at all as a topic of discussion for customers to move over to the cloud? Or is it still just super early days in the public sector? I think from a customer standpoint, the concept of AI is very early days. As you know, our customer base is generally pretty conservative and risk-averse. And I think they probably are more on a wait-and-see approach. Now we at Tyler are not just sitting around taking a wait-and-see approach. We are actively looking at AI. We formed our own AI task committee. We’re actively already using a little bit of AI. We’re looking at how it can improve some of our internal efficiencies. We're looking at how it can improve our competitiveness as well as how it can improve our clients’ efficiency. So we’re looking at that right now. But I would say, from a Tyler perspective, we’re pretty early on. And from a client’s perspective, they’re even earlier on.

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

Just a quick question. Just it seems like every month or so, there's the high-profile data breach, the latest one being the MOVEit data breach, that has been in the news impacting government clients and private businesses. Have you seen any impact on your business from that? And more importantly, are you seeing opportunities from that as well?

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

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

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

Yes. It's not primarily about our labor costs or headcount; it's more focused on healthcare. We set a budget for healthcare each year and use the best data from the previous year to guide us. This year, however, we've been seeing a higher rate of employee claims compared to our budget. Last year, our claims were slightly below budget, but this year they are on the rise. We're trying to manage this situation as we move forward and anticipate that this trend may continue throughout the year, even though there are fluctuations related to healthcare.

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

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

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

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