Ladies and gentlemen, thank you for standing by. Hello, and welcome to today's Tyler Technologies Fourth Quarter 2023 Conference Call. Your host for today's call is Lynn Moore, President and CEO of Tyler Technologies. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, also, this conference is being recorded today, February 15, 2024. I would like to turn the call over to Hala Elsherbini, Tyler's Senior Director of Investor Relations. Please go ahead.

Thank you, Bhavesh, and welcome to our call. With me today is Lynn Moore, our President and Chief Executive Officer; and Brian Miller, our Chief Financial Officer. After I give the safe harbor statement, Lynn will have some initial comments on our quarter and then Brian will review the details of our results and provide our annual guidance for 2024. Lynn will end with some additional comments and then we'll take questions. During this call, management may make statements that provide information other than historical information, and may include projections concerning the company's future prospects, revenues, expenses and profits. Such statements are considered forward-looking statements under the safe harbor provision of the Private Securities Litigation Reform Act of 1995 and are subject to certain risks and uncertainties, which could cause actual results to differ materially from those projections. We would refer you to our Form 10-K and other SEC filings for more information on those risks. Also in our earnings release, we have included non-GAAP measures that we believe facilitate understanding of our results and comparisons with peers in the software industry. A reconciliation of GAAP to non-GAAP measures is provided in our earnings release. We've also posted on the Investor Relations section of our website under the Financials tab schedules with supplemental information, including information about quarterly bookings, backlog and recurring revenues. On the Events and Presentations tab, we posted an 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. Fourth quarter results reflected a strong finish to a pivotal year in our cloud transition and return to year-over-year operating margin expansion. We achieved our key objectives for the year, and earnings and cash flow surpassed our expectations with free cash flow representing a new high for a fourth quarter. Recurring revenues grew 8% and comprised 84% of our total revenues. Our SaaS mix continued to accelerate and comprised 89% of Q4 new software contract value. The quarter was also highlighted by SaaS revenue growth of 21.7% and represented our 12th consecutive quarter of SaaS revenue growth of 20% or more, exceeding our near-term growth expectations of a 20% CAGR in SaaS revenues through 2025. Transaction-based revenues were impacted by seasonal trends and contractual changes in one of our state enterprise agreements that included a change from a gross to a net revenue model for payments. I want to remind you of the significance of pass-through merchant fees in our payments business and how they impact both revenue growth and margins. The majority of our payment processing arrangements are accounted for under a gross model where we charge a fixed percentage of the transaction and are responsible for the merchant and interchange fees. Under this model, merchant fees are reflected in both revenues and expenses with the resulting drag on margins. In a smaller number of arrangements, the client is responsible for paying merchant fees directly and we record revenues on a net basis. We do not control which model the client chooses, although we expect that the majority of payment processing contracts will continue to be under the gross model. Throughout the year and during the fourth quarter, we continued to make solid progress with key initiatives around our cloud transition. We started to realize the benefits of our cloud optimization efforts as we released cloud-efficient versions of many of our products and began to experience hosting cost improvements as we scaled our deployments at AWS. These efficiencies related to our cloud operations contributed significantly to our year-over-year operating margin expansion in the fourth quarter. Cloud adoption with both new and existing on-premises clients continued at an accelerated pace across our product portfolio. In the fourth quarter, the number of on-premises migrations or flips signed was a new fourth-quarter high at 92. The increased SaaS adoption in 2023 was particularly notable in the public safety market where we have seen a significant increase in SaaS adoption with new clients as well as signing our first flips. We also signed an expanded multiyear strategic collaboration agreement with Amazon Web Services to further enable the growing demand for our clients and public sector agencies to move to the cloud. Under the expanded agreement, we will jointly expand our framework and share programs to streamline migrations from on-premises solutions to our next-generation cloud applications. This is another major step forward in making the cloud accessible for our clients, further improving business continuity, continuous delivery and enhanced security. It also supports our Tyler 2030 vision to complete our transition to the cloud. The public sector market remains very healthy as evidenced by our elevated levels of RFPs and sales demo activity. Our pipeline reflects the benefits of a heightened level of sales collaboration across our division, driving strong upsell, cross-sell, and multi-suite deal momentum. Additionally, we continue to build sales synergies across Tyler with our integrated payments team as we execute our unified payment strategy. I'd like to highlight some of our significant fourth-quarter wins. Our new transaction-based contracts included a landmark win with the California Department of Parks and Recreation for our integrated outdoor recreation platform. This transaction-based eight-year contract is the largest transaction-based arrangement in Tyler's history. This self-funded contract, which is provided at no cost to California taxpayers, is valued at an estimated $175 million and includes two one-year renewal options. It extends our existing relationship under our 2016 agreement, formerly as US eDirect, with enhanced functionality to add Tyler's end-to-end payment solution, enabling everything from reservations booking to payment processing. We are honored to be chosen to have such a key role in managing the nation's largest state park system. We also added to our growing footprint in outdoor recreation with a multiyear transaction-based contract with the Wyoming State Parks and a SaaS arrangement with the City of Miami, Florida. We continue to execute on cross-sell opportunities through our digital solutions, formerly NIC, state enterprise agreements that enable enhanced resident engagement across multiple public sector services. We signed two contracts under our state enterprise agreement in Mississippi as part of our newly launched resident engagement platform using Tyler's MyCivic platform. Working with the Mississippi Attorney General, we launched the Mississippi Access to Maternal Assistance mobile app, which includes the program's website and MyCivic platform to bridge access to public and private services across the state. We also signed an agreement with the Mississippi Department of Mental Health to develop a mobile application on our MyCivic platform that will allow the agency to provide useful mental health information to Mississippians affected by mental illness. We continue to build momentum in the public safety market with strong fourth-quarter contract activity. Significant contracts included several competitive wins against key competitors, making 2023 our most successful new business year in public safety since we acquired New World Systems in 2015. We also experienced a significant increase in SaaS adoption of our public safety solutions with SaaS comprising 46% of our fourth-quarter public safety deals. Existing on-premises public safety clients are also showing heightened interest in moving to the cloud, and three public safety clients signed contracts in the fourth quarter to flip to the cloud. The City of Klamath Falls, Oregon embraced the cloud-first strategy by signing a contract for a SaaS deployment for integrated enterprise public safety suite, which includes the full suite of our public safety solutions, including Enterprise Records Management, Jail Manager, Fire, electronic patient care reporting, civil process, e-citations, and analytics. Our recent contract signed in Q2 with the Oregon State Patrol serves as a strong reference for this competitive win. Other notable public safety deals included a SaaS contract with Santa Rosa County, Florida and on-premises contracts with Rensselaer County and Wayne County both in New York. We also had a significant cross-sell win under our state enterprise agreement in Arkansas for a public safety solution for Pulaski County, Arkansas. In the court space, we signed our first SaaS flip of a statewide court system with the Idaho Supreme Court. This five-year agreement includes migrating the court's 44 counties and 200 courtrooms from on-premises deployments to our SaaS offering. Our largest new SaaS deal in the quarter was with the state of North Carolina where we extended the term of our existing court SaaS agreement for five years and expanded the agreement to add our solution for appellate courts. We also achieved key operational milestones in Courts & Justice during the quarter, including the successful go-live of our Enterprise Justice solution with the LA County Criminal Courts. This completed the countywide rollout across 35 court locations in the nation's largest court. With our application platform, we secured a key SaaS win with the Virginia Department of Education to upgrade its enterprise state regulatory system and modernize its citizen portal. The system will support the management of Virginia's child daycare programs, which are transitioning from the Department of Social Services to the DOE. During the fourth quarter, we also signed 172 new payments deals, bringing the total to 600 for the year. We also signed a new state enterprise contract in Maryland following a competitive rebid of our expiring contract as well as an extension of our Oklahoma enterprise agreement. Finally, as noted on our last call, we completed the acquisitions of ARInspect and ResourceX in October for a combined purchase price of approximately $37 million in cash and stock. We're pleased to see multiple early wins for the application platform leveraging field operations and inspection capabilities that came to us through ARInspect. Now, I'd like Brian to provide more detail on the results for the quarter and our annual guidance for 2024.

Thanks, Lynn. Total revenues for the quarter were $480.9 million, up 6.3%. Organic revenue growth, which also excludes COVID related revenues in 2022, was 6.1%. The fourth quarter of 2022 included $3.5 million of revenues from COVID-related initiatives at our Digital Solutions division, all of which ended in 2022. Subscription revenues increased 11.4% and organically rose 10.8%. Within subscriptions, our SaaS revenues grew 21.7% to $141 million and grew organically 21.2%, which is consistent with our near-term growth expectations of 20% CAGR in SaaS revenues through 2025. Keep in mind that there is often a lag from the signing of a new SaaS deal or a flip to the start of revenue recognition that can vary from one to several quarters. Because of this as well as the timing of SaaS renewals and related price increases, SaaS revenue growth, both year-over-year and sequentially, may fluctuate from quarter to quarter. Transaction revenues grew 3% to $145.1 million and were up 2.1% on an organic basis. The lower growth rate in transaction revenues reflects in part the change from gross to net revenue recognition for payments under one of our state enterprise agreements. Just a reminder here about the seasonality of our transaction revenues. Our seasonality is really driven by two primary factors; state determined deadlines, such as corporate filing deadlines or hunting seasons; and the number of business days. Even with online transactions, we see a decline in volumes over the holidays. Q2 is typically our highest volume quarter with peak outdoor seasons along with tax season deadlines followed by Q1 due to the high volume of corporate filing services with Q1 deadlines. Q4 will always lag with the holiday seasons, which lead to fewer business days. While the smaller impact revenues from driver history records are also stronger in the first half of the year. The sequential decline in transaction revenues this quarter reflects that typical seasonality. SaaS deals comprised approximately 89% of our Q4 new software contract value compared to 86% last year. Professional services revenue declined 3.7% due to the absence of COVID-related revenues and was flat organically. As Lynn noted earlier, public sector demand remains healthy and we're pleased with the strength of our new contract signings in Q4. During the quarter, we added 156 new SaaS arrangements and converted 92 existing on-premises clients to SaaS with the total contract value of approximately $137 million, an increase of 39% over last year. In Q4 of last year, we added 140 new SaaS arrangements and hit 82 on-premises conversions with a total contract value of approximately $99 million. Also note that while the contract with the California State Parks includes our SaaS solution for outdoor recreation, it is not included in the new SaaS contract value, because it is funded completely from transaction fees. Overall, our pace of on-premises conversions to SaaS continued at a steady pace with 338 flips in 2023. More importantly, the total contract value associated with flips increased to $92 million compared to $76 million last year. As we've discussed, conversions are a significant growth driver over the next several years as we accelerate the pace of flips. Including transaction revenues, expansions with existing clients and professional services, total bookings increased 21.2% on an organic basis. Our total annualized recurring revenue was approximately $1.61 billion, up 7.9% and organically grew 7.1%. Operating margins were better than expected despite pressure from our ongoing cloud transition. Our non-GAAP operating margin was 22.3%, up 70 basis points from Q4 last year. As Lynn discussed earlier, merchant and interchange fees from our payments business under the gross revenue model have a meaningful impact on our overall margins as they are passed through to clients and are included in both revenues and cost of revenues. We paid merchant fees of approximately $35 million in Q4 and approximately $157 million for the full year of 2023. Both cash flows from operations and free cash flow reached new highs for our fourth quarter at $147.4 million and $134.4 million respectively. Cash flow in the quarter was impacted by approximately $15 million of incremental cash taxes due to Section 174. And for the full year, those incremental cash taxes were approximately $127 million. We continue to prioritize repayment of term debt as a use of our cash flow. And in Q4, we reduced our term debt by $90 million, bringing our total repayments for the year to $345 million. We ended Q4 with total outstanding debt of $650 million and cash and investments of approximately $183 million. Our net leverage at quarter end was approximately 0.97 times trailing 12-month pro forma EBITDA. Our 2024 guidance is as follows. We expect total revenues will be between $2.095 billion and $2.135 billion. The midpoint of our guidance implies organic growth of approximately 8%. We also expect that merchant fees will be down slightly and that implied growth, excluding merchant fees, would be approximately 90 basis points higher. We expect GAAP diluted EPS will be between $5.17 and $5.37 and may vary significantly due to the impact of discrete tax items on the GAAP effective tax rate. We expect non-GAAP diluted EPS will be between $8.90 and $9.10. We expect our free cash flow margin will be between 17% and 19%, including the impact of incremental cash taxes related to Section 174 of approximately $50 million. Other details of our guidance are included in our earnings release and in the Q4 earnings deck posted on our website. Now, I'd like to turn the call back over to Lynn.

Thanks, Brian. We entered 2024 with tremendous optimism and confidence in the year ahead and beyond as we execute our mid to long-term strategy supporting our Tyler 2030 vision. We expect to return to a trajectory of consistent operating margin expansion in 2024 as we increasingly realize the benefits of our cloud optimization initiatives and execute our planned exits from our two proprietary data centers in 2024 and 2025. We continue to leverage our competitive strengths and demonstrate the value of our deep domain expertise across the broadest, most integrated offerings that are uniquely focused on the public sector, while empowering our clients who serve the public through Tyler's next-generation cloud applications. Finally, we are proud to be recognized by Government Technology Magazine as a GovTech 100 company for 2024. This marks our 8th consecutive year being recognized for our work in making a difference for government through technology. Now, we'd like to open the line for Q&A.

Our first question comes from Ken Wong of Oppenheimer and Co.

I wanted to maybe just touch on the accelerating pace of flips going into '24. On one hand, I think that's a fantastic initiative. You guys are also dialing back or at least decelerating the pace of sales and marketing growth or SG&A, I guess, I'm modeling maybe mid-single digits. I guess, what's the confidence in being able to accelerate that pace while also maybe not leaning in as aggressively on the sales and marketing side?

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

Just a follow-up on that. I mean when we outlined our Tyler 2030 vision, we've got some goals around flips over the next six, seven years. And we also have goals on some of our G&A initiatives. So I think those are both tracking right now in line with our expectations going forward.

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

I think there's still room to go and there's a lot that goes into that. We're continuing to optimize our products and find ways for them to run more efficiently. On the other side of it, we're also seeing continuing to make strides in our version consolidation, particularly with our major product lines. We've seen, over the last 12 months, significant version consolidation in two of our larger flagship products, and that will continue to contribute efficiencies as we go forward, as well as with some of our other products that are out there.

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

Lynn, maybe for you, just along those lines. I was wondering if you could just go one level deeper into the latest agreement with AWS. And maybe the question is, how does the new agreement change what you had previously and how can that sort of continue to support the profitability growth that we're clearly seeing?

As you know, we signed an extension that now runs through the end of 2031, which runs through our Tyler 2030 initiative, which is great. It obviously just further deepens those relationships. We've made certain commitments to AWS around migrating our existing Tyler clients, and our net new clients into AWS. AWS has also made commitments back to us around certain pricing commitments, innovation, marketing, and things like that. I'm not really at liberty to go into the specifics of what those details and those commitments and pricing concessions are. But what I can say is that AWS has been a great partner for us. I couldn't be more happy with the relationship that we started in the fall of 2019. And this extension, I think, further embraces that. They're very collaborative with us and are eager to work with us to help us find ways to lower our costs. So they are a true partner. Similarly, we view our clients in the public sector as partners; that's why they view us. And I think part of the difference also in our relationship now is it's more mature. And we're a lot farther along in our cloud journey than we were when we first signed it. If you remember when we first signed the agreement, we were still trying to figure out how our products would really operate in AWS, and we spent a long time trying to just figure out the cost of just moving simply lift and shift. And now we've transformed and we've done all that and it's how can we make them run even more efficiently in the public cloud. So great partner, excited that they're on this journey with us for the next at least eight years.

That sounds like a win-win for everybody. I'll stick to the one follow-up and Brian, maybe it's for you. Great to see Tyler reach the 17% to 19% free cash flow target. I think one year ahead of schedule, and you correct me there if I'm wrong. I know we're not speaking to 2025 necessarily on this call, but maybe conceptually, how do you sort of think about free cash flow margin expansion versus EBIT margin expansion? Should those two things move largely in the same range or is there any reason to think that one should expand faster than the other? Does that make sense?

Yes, I think in the near term, they likely expand in the same range. And particularly, I think you see that in 2024, most likely, especially because we still, although it's lessening over the next several years, there still is an impact of the Section 174 change. It was a $127 million impact on our free cash flow in 2023. It's about a $50 million impact in 2024 and it will decline again over the next four years after that until it sort of reaches equilibrium. But I think in the longer term, we would expect that free cash flow growth would be higher, especially if you take out that Section 174 impact. We've continued to get leverage out of CapEx, especially as we exit our data centers where a significant amount of our CapEx has been focused in recent years as we continue to become more efficient around how we manage office facilities and our other CapEx associated with our business. And actually, you'll see we have a lower expectation for CapEx around software development going forward as well. But most importantly, the cash flow characteristics of the recurring revenues, the SaaS revenues paid in advance, create deferred revenue; the transaction revenue is generally getting paid at the time of the transaction. So there aren't big receivables associated with those. So as those businesses grow, those revenue streams grow, they should have the impact of causing our cash flow to grow faster than the EBIT.

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

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

Josh, right now, I would say I'm confident in both our 2025 and our 2030 projections just from overall what I'm seeing in the business. As Brian remarked or pointed out in the opening remarks, a couple of things impact revenue growth this year, and one really is the flat to slightly declining merchant fee growth. So when you pull out merchant fees, our growth is really more in the closer to mid-9s, probably 93%, 94%; it's about 90 basis points and those tend to fluctuate. And part of that is, as Brian mentioned, due to one of our large state enterprise contracts flipping from the gross to net model. Overall, as you pointed out, I mean, what we're seeing in the markets right now, the demand, the number of new business deals we're signing, our competitive position, wins against really some key large Tier 1 competitors are the things that really give me a lot of confidence. We recently had our national sales meeting really dive deep into sales forecast, not only for the next 12, 24 months, but even beyond. And right now, things look pretty good.

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

Yes, I think it's hard to say, Joshua. All of our global submarkets are a little bit different and the courts market, for sure, is an area where people may be a little reluctant to go first. So getting Idaho there and going, eyes are going to be on it. And I think as we successfully pull off that deal, I do think it will trigger more throughout the courts community. As you know, everything we do is reference business. But particularly in these larger statewide deals, our state corp business, I think all the other states are watching Idaho. So we need to do what we do best, which is go and execute on the business and go make it a great experience. And I do think that will be a domino that will ripple throughout the client base.

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

This is Connor Passarella on for Terry. I also just wanted to ask one on the Idaho state court deal. First, could you maybe just break down how we should think about this deal playing out in the model, and maybe what the timeline looks like for getting a large court system like this live in terms of the courtrooms and the counties and kind of how it all works with getting to cloud?

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

I think about midyear is when we expect to start bringing them into AWS. That increase is included in our guidance for the year, but it's a couple of million dollar increase from what they were paying in maintenance.

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

As we've talked about, one of our state contracts actually midyear changed from gross to net. So we had that impact in the second half of this year and it also impacts us in the first half of next year. I think the overall impact for the second half of the year was in the $9 million to $10 million range. The first half of next year, because is, I believe, somewhere in a similar range. And that was probably split between Q3 and Q4 but probably a little bit more of that impact was in Q3, but there was a several million dollar impact on the quarter.

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

I guess on the deal with the California Parks division there, you talked about it being exclusively funded through transaction revenue. Maybe just help us think about kind of I guess, not only maybe what the contractual minimums might be there, what's sort of embedded in guidance? How much potential upside is there to what's embedded in guidance? And then maybe more importantly down the road, do you envision other states trying to take an approach more like this, where there's less contracted SaaS revenue and more funded through the program itself?

Matt, I'll start and Brian, you may jump in. There are a couple of things that are really exciting about that California State Parks deal. One obviously is it's the largest transaction deal in Tyler's history. The second thing is, as you pointed out, it validates this sort of self-funding model. It's not a surprise. Anybody who reads the journal that California has significant deficits and significant budgetary issues right now. And so going to them with a self-funded model on this type of contract is really about the only way they can do it. And again, it validates that model, that part of our business. Because it's self-funded, the impact going forward we will be recognizing a lot more expense in 2024. It's actually a little bit of a drag on margins in 2024. But ramps up significantly in '25 and continues that ramp up with margin expansion all the way through the end of the contract in 2031, assuming we don't get the two one-year extensions, which if we execute, we think we would get. Brian, do you have anything more to add?

Your point is valid, as the transaction revenues are currently an estimate rather than a fixed SaaS fee. We have a good idea of what the volumes will be, but they may fluctuate. This year, our plan anticipates a few million dollars in revenues, which is expected to increase to over $20 million, starting to approach that figure next year, and continuing beyond that as volumes grow and it becomes fully ramped. However, these figures are subject to variances and seasonality, unlike a typical SaaS contract that recognizes revenue on a pro-rata basis each quarter. Our transaction revenues will similarly be affected by seasonality.

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

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

You're right. Kelly, our flips in Q4 were actually up about 12% over Q4 last year. We're not putting out guidance as far as I know, Brian, on specific flip deal count. There's a lot of things that go into that. And as you look out to 2030, the goals we outlined, clearly, we will be ramping up as we go over time. There's things that go into the flips and a lot of it is, we have to get our customers on more modern versions. And when I talk about our version collapse efforts that have been going on for several years but some of the strides that we've been making, as we continue to make strides on that, it will help accelerate the pace of flips going forward.

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

A quick follow-up. On that version control point, you mentioned last quarter, you had the goal kind of by the end of 2022 or early 2024 of only supporting two of the most recent versions of each product. Where are you at in achieving that goal?

We've made a lot of progress, in particular, if you look at our enterprise ERP product, for example, I think at the end of last year, we only had about 23% of that client base on the more modern version; at the end of this year, that was up to 86%. We've made similar strides with our Enterprise Justice solution. So just generally, across the board, we're tracking on that. I'm not sure if I remember saying at the end of 2025; I think it was more by 2026. But I think we're actually ahead of the pace that I was thinking about and discussing maybe 18 months, 24 months ago.

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

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

It's quite interesting, and gratifying to witness this shift. We've anticipated it, although we weren't certain when it would occur. As mentioned in the opening remarks, approximately 46% of our Q4 deals were cloud deals in public safety, which is an increase from 16% in Q2. Looking ahead to next year, we expect this figure to exceed 50%, and we are planning for slightly above that. Our approach in public safety is similar to what we adopted with Tyler about four or five years ago; we aim to lead with cloud solutions as the market begins to embrace this transition. Regarding competitors, I won't name all the various players in public safety, but we've seen a few new cloud-native companies emerge in recent years. While these competitors are smaller, they have faced their own challenges. We believe our cloud strategy in public safety positions us well to capitalize on this market change. We have new leadership in public safety, including a new division president who joined last year from outside of Tyler. He has experience leading companies through cloud transitions, which is exciting as he works with our team in Troy to steer these efforts. Overall, I am pleased with our current position and, as you mentioned, it is gratifying to see these early results. However, I want to emphasize that there is still much to accomplish in the future, but it's encouraging to see this shift beginning in public safety.

And then Rob, just a question around the R&D expense guide for the year, implying kind of mid-teens year-over-year growth. Can you just talk about what some of the biggest drivers of that are within that R&D line? I think there is ongoing development in the cloud and our efforts to optimize and enhance our products for it. We are experiencing a transition where some of our previously capitalized R&D, particularly related to cloud projects, will now be categorized as expenses. Essentially, the same team is involved, but now their work will be reflected as an expense instead of being capitalized. This change does not affect our cash flow; however, it does alter where this appears on our income statement. It is important to highlight that we anticipate achieving margin expansion despite this shift from capitalized software development to increased R&D expenses.

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

Looking at the guidance, especially as it pertains to the quarters. Are there any abnormalities that we should take into account as we build our models out?

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

And then just more of a macro question for you, given the impact in Congress related to the spending bill. Are you seeing any changes to the sales cycle, especially in your federal business?

Charles, not really, not right now. Q1 is probably a little slower for that business as well. And right now, there is no significant change in our outlook.

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

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

Most of the leverage we're observing in our model is originating from cloud operations and the factors we've discussed, particularly the transition of customers from our data centers to AWS. Our goal is to have the first data center closed by midyear, and we are reaping benefits from both scale and reduced costs at AWS as we onboard new customers and migrate existing hosted customers. This transition results in lower unit costs. Additionally, our new agreement with AWS enhances the pricing and leverage we gain as we expand that business. The consolidation expenses or benefits mentioned by Lynn, as we streamline multiple versions of software to improve efficiency in support and development, are also key. Therefore, cloud operations are the primary drivers of our margin leverage, which we pointed out during Investor Day as factors that will contribute to our anticipated margin expansion over the upcoming years.

And Jon, I would just add that we're always looking for ways to improve our efficiency. There are several internal initiatives underway where we're identifying opportunities to operate more effectively. We are actively working on a number of these initiatives, and we are making progress.

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

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

Well, it certainly is another conversation point with the client. So anytime you use a conversation point, there's opportunities for cross-sell, upsell. But we've got installed sales teams across all of our organizations and they're reaching out to clients whether they're halfway through their SaaS contract or at the beginning of the SaaS contract or towards the end of it. So I don't know that that's a specific trigger for significant material uplift, but it's another data point that's a contact point with our clients.

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

And then I guess, Brian, speaking of flips, obviously, you're guiding maintenance revenue to come down a little bit, which makes tons of sense as you flip people from on-prem to cloud. Can you just remind us the benefits of the uplift of that change? That plays out over a couple of years, meaning you just used the Idaho example. The reason you're not seeing sort of the SaaS revenue get all the benefit of that flip is you're just not going to see it on the income statement until '25. So is that the way we should think about sort of that uplift that plays out over 24 months?

Yes, there is always a delay. Sometimes we may sign a deal and it begins next quarter, at which point we might notice an increase. Other times, the delay could be due to client needs, such as upgrading to the latest software version or addressing their own internal priorities and resource allocation. There are various factors that can lead to a lag, which could last from one quarter to several. Additionally, the changes may not all take effect simultaneously, as clients may be transitioning multiple applications with us, resulting in different starting points for the benefits. Generally speaking, it’s not usually 24 months, but it can take from one to a few quarters before we fully realize the impact from the time we sign the agreement to when we observe the benefits on the uplift.

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

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

When discussing the number of flips, it’s not very precise. For instance, the Idaho agreement took almost three years of discussions and planning. As Lynn mentioned, moving a statewide court system is complex and requires significant planning from both parties. Therefore, it’s challenging to determine precisely which quarter the agreement is signed in. Not all cases are as complicated, but there isn’t much precision in estimating whether it will be 92, 100, or 103. Overall, I would say the number aligns generally with our expectations, and the pace of progress meets what we anticipated. The dollar value was likely higher than we expected, as there were some larger transactions, and the uplifts exceeded our projections. However, it’s difficult to provide a precise expectation from quarter to quarter. We do believe we are on track with our long-term goal of migrating 75% to 85% of our customer base to the cloud by 2030. While we can’t pinpoint the exact quarter for this progression, we are at least aligned with our expectations regarding flips.

As a follow-up, there is legislation that could reverse some of the R&D tax payments you have made. What would be the impact if that act passed? How much and when would you see those dollars return?

It's a bit difficult to determine the specifics. The bill currently moving through Congress, which I believe has been approved by the House, would not rescind but rather delay the implementation until 2026. If that happens, we would not need to pay the additional $50 million in taxes we mentioned for this year, and the amounts would be lower moving forward. The timeline and method for recovering the taxes we paid in 2023, which totaled $127 million, is unclear. These payments could either reduce our normal tax obligations over the next couple of years or we might file for a refund, which also takes time. Therefore, it's challenging to quantify the effect accurately. However, it's evident that we would avoid those extra payments in the future, and we would seek to recover the additional taxes we paid, either through refunds or reduced future tax payments.

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

In terms of the backlog, you obviously had a nice jump this quarter year-over-year. How are we thinking about the duration of that backlog? Is it holding relatively stable or is that getting longer?

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

Just as a follow-up. There's obviously been a lot of high-profile cybersecurity issues over the past year with public agencies. Have those issues been with agencies that have been primarily on-prem vs. the cloud? And if it's been on-prem, are you seeing that as perhaps one of the impetuses for the acceleration of the flips?

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

Our next question comes from Alexei Gogolev of JP Morgan.

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

Yes, I think at Investor Day, we said we were somewhere around 15%. And so obviously, we've made progress since then. I'd say we're probably more around the 20% number now in terms of the customers that we've moved. But as I said earlier, each of our products has a timeline and a roadmap for how they get to that point that converges on our entire customer base being 75% to 85% of the existing on-prem customers converted by 2030. So each product is starting from a different place with their customer base. We've talked about public safety just getting its first flips this past year. Other products are much further along. So everybody has their own roadmap that converges on that overall number by 2030. And none of those will happen exactly as planned, but we have said that we are collectively on track to achieve those targets by 2030.

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

Lynn, I wanted to go back to something you said about the California contract and the fact that there will be a drag on margins but margin expansion over multiple years. Wondering if you could help explain that. Does that mean that there will be partial volume that moves to you and then full volume over time? Is that just reflective of services implementation costs in the first year that go away?

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

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

So back to the flips again, and the topic that you mentioned earlier in the call, if I would ask is, how should we think about license TCV as a percentage of total TCV on a normalized quarterly run rate path to both the midterm and long-term target?

We anticipate that license revenues, which are primarily recognized upfront, will experience low single-digit growth this year. However, we expect that their proportion will continue to decline within our overall mix. I don't have specific figures broken down by year or quarter, but we believe the percentage of new business, currently in the high 80s, will gradually increase each year until there is very little license revenue remaining. We do have some third-party licenses and a few sales back to existing on-prem customers, but overall, we are selling very few licenses in the new business market.

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

We appear to be no further questions at this time. Mr. Lynn Moore, President and CEO of Tyler Technologies. I'll turn the call back over to you.

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

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