Tyler Technologies Inc

NYSE:TYL

Earnings Call Transcript 2022-Q2

[Operator]

Hello, and welcome to today's Tyler Technologies Second Quarter 2022 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. And as a reminder, this conference is being recorded today, July 28, 2022.

I'd now like to turn the call over to Mr. Moore. Sir, please go ahead.

[Lynn Moore, President, CEO]

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

Brian?

[Brian Miller, CFO]

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

Lynn?

[Lynn Moore, President, CEO]

Thanks, Brian. We're pleased with our second quarter results as the public sector market environment remains strong and RFP and demo activities continue to trend positively. We leveraged successful multi-suite wins and cross-selling efforts to deliver a solid quarter, and our strong competitive position, coupled with an active public sector market, drove a 21% increase in bookings.

Overall, we see the challenging broader macro environment as an opportunity to support our clients by replacing aging mission-critical systems and adding advanced digital services to serve the public more efficiently. Total revenues grew approximately 16% with organic growth of 6.2%.

Services revenues were flat on an organic basis, exhibiting some softness due to labor market challenges affecting our hiring of implementation resources. Recurring revenues comprised 79.5% of our quarterly revenues and were led by 28% growth in subscription revenues.

On an organic basis, excluding COVID-related revenues, subscription revenues grew 14%, reflecting both our accelerating shift to the cloud and growth in transaction-based revenues. We have now achieved greater than 20% subscription revenue growth in 58 of the last 66 quarters. We achieved solid revenue growth even as the shift in new software contract mix accelerates to SaaS from licenses.

In Q2, 74% of our new software contract value was SaaS compared to 65% in Q2 last year. As expected, margins compressed, reflecting the increase in our SaaS new business mix and the associated decline in license revenues as well as costs related to the cloud transition. Along with bookings performance, cash flow was a high point of the quarter as both cash flows from operations and free cash flow achieved new highs for a second quarter. April 21 marked the first anniversary of our NIC acquisition, and we continue to be excited about their performance and the growing pipeline of joint opportunities for both Tyler and NIC. NIC's core organic revenue growth was 8%.

During the second quarter, we successfully extended our enterprise contracts in West Virginia, Vermont, Kansas and Kentucky. NIC also signed our largest ARR contract for the quarter, a new four-year arrangement with the state of New Jersey for digital motor vehicle titling solution, which we estimate will generate transaction-based revenues of approximately $5 million per year.

In addition, NIC signed a new SaaS agreement for our cannabis solution with the states of Alabama and Illinois, which are both state enterprise clients. We continue to build momentum with our joint and cross-sell opportunities with NIC. Our active cross-sell pipeline doubled in value from Q1, and we closed three new deals with NIC clients, including the state of Utah for our Entellitrak Veterans Benefit System and the state of Kentucky for our VendEngine Resident Resources Solution.

In other Tyler divisions, we signed four additional notable SaaS deals, each for different product suites and each with a total contract value greater than $3.8 million. Those include Maricopa County, Arizona, for our enterprise permitting and licensing solution; Lancaster, California for our enterprise ERP solution; Lima, Ohio for our enterprise justice and supervision solutions as well as our full suite of public safety applications; and Orange County, Florida for our enterprise assessment and tax solution.

In addition, we signed six SaaS deals in the quarter with contract values between $2 million and $3 million each and 14 SaaS deals with contract values between $1 million and $2 million each. During the second quarter, we also amended our e-filing agreement with the state of Washington from a transaction-based volume arrangement to a fixed fee contract. The deal spans nine years for approximately $27 million.

However, due to certain contract terms, the majority of this contract was not included in backlog or bookings this quarter. The deal adds approximately $2.8 million in ARR, expanding to over $3 million in ARR in the latter half of the agreement. Our largest new software contract in the quarter was a license deal with Montreal, Quebec for our enterprise assessment and tax solution valued at approximately $13 million. We also signed a second deal in Canada for the same solution with the Yukon territory worth approximately $2 million. In addition, we signed a significant license deal with Dallas County, Texas for our enterprise correction solution valued at approximately $4.5 million.

Dallas County, which currently uses our enterprise case management solution, has the ninth largest jail system in the U.S., making it our largest jail client. Other significant license arrangements signed in the quarter, each with a total contract value of greater than $1 million include Charlotte County, Florida and Huntington Park, California for enterprise ERP solution; Fort Worth, Texas for our enforcement mobile solution; and Owasso, Oklahoma for our enterprise public safety, enforcement mobile and data and insight solutions. Now I'd like for Brian to provide more detail on the results for the quarter and our annual guidance for 2022.

[Brian Miller, CFO]

Thanks, Lynn. Yesterday, Tyler Technologies reported its results for the second quarter ended June 30, 2022. 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 Financial Reports tab, schedules with supplemental information provided on this call, including information about quarterly bookings, backlog and recurring revenues.

Both GAAP and non-GAAP revenues for the quarter were $468.7 million, up 16%, including NIC and our other acquisitions from the last 12 months. Organic revenue growth, excluding COVID-related revenues was 6.2% on a GAAP basis and 5.8% on a non-GAAP basis. NIC's COVID-related revenues for the quarter exceeded our expectations at $15.2 million. Revenues from the TourHealth initiatives concluded in the second quarter and the Virginia rent relief program is expected to be completed in the third quarter with about $8 million of revenues anticipated in the quarter. As expected, license revenues declined 14.7% as our new software contract mix continued to shift to SaaS.

Software revenues rose 18.3% -- service revenues rose 18.3% but on an organic basis were essentially flat with last year. Services revenues were impacted by delays in hiring new professional services staff in the current labor market. While we hired a large class of implementers during the quarter, there is an onboarding period of several months before they will be fully billable. We intend to continue to grow our implementation team during the second half of the year to support delivery of our growing backlog and pipeline, but we'll likely continue to see some pressure on services revenues in the short term as those teams ramp up. Subscription revenues rose 28.2% with strong organic growth of 14.1%.

We added 167 new subscription-based arrangements and converted a new high of 96 existing on-premises clients, representing approximately $115 million in total contract value. In Q2 of last year, we added 170 new subscription-based arrangements and had 62 on-premises conversions, representing approximately $73 million in total contract value. Our software subscription bookings in the second quarter added $27.6 million in new ARR. Subscription contract value comprised approximately 74% of the total new software contract value signed this quarter compared to 65% in Q2 of last year. The value weighted average term of new SaaS contracts this quarter was 3.7 years compared to 4.1 years last year.

Transaction-based revenues, which include NIC portal, payment processing and e-filing revenues and are included in subscriptions, were $154.4 million, up 29.1%. Excluding NIC, Tyler's transaction-based revenues grew 17.5%. E-filing revenues reached a new high of $18.5 million, up 14%. For the second quarter, our non-GAAP ARR was approximately $1.49 billion, up 16.3%. Non-GAAP ARR for SaaS software arrangements was approximately $405.6 million, up 24.9%.

Transaction-based ARR was approximately $617.7 million, up 29.1% and non-GAAP maintenance ARR was down 2.3% at approximately $467.3 million due to the continued migration of on-premises clients to the cloud. Our backlog at the end of the quarter was a new high of $1.85 billion, up 13.9%. Bookings in the quarter were very strong at approximately $562 million, up 21%, including transaction-based revenues. On an organic basis, bookings were also quite robust at approximately $423 million, up 16.3%. For the trailing 12 months, bookings were approximately $2 billion, up 53.2% on an organic basis were approximately $1.5 billion up 21.1%.

If our weighted average contract terms for new SaaS contracts had been the same as last year, organic bookings growth would have been 18.3%. As Lynn mentioned earlier, both cash flows from operations and free cash flow reached new highs for a second quarter. Cash flows from operations were $76.7 million and free cash flow rose to $60 million from negative $33.5 million last year. We continue to strengthen our already solid balance sheet. During the quarter, we repaid $60 million of our term debt.

And since completing the NIC acquisition, we have paid down $475 million of term debt. We will also pay down an additional $100 million in term debt at the end of this month. We ended the quarter with total outstanding debt of $1.275 billion and cash and investments of $314 million. As a reminder, $600 million of our debt is in the form of convertible debt with an interest rate of 0.25% and the remainder is in prepayable term debt due in 2024 and 2026. We also have an undrawn $500 million revolver.

Our net leverage at June 30 was approximately 2.07x trailing 12 months pro forma EBITDA and our leverage should be under 2x at the end of July. Interest rate hikes thus far this year and projected for the remainder of the year have resulted in significantly higher projected interest expense for the year than we anticipated at the beginning of the year. In addition, we have debt discounts and issuance costs related to our term debt that are being amortized as noncash interest expense. And as we prepay term debt, we are required to accelerate the amortization of those costs. Accordingly, we have adjusted our earnings guidance for the full year to reflect those changes in assumptions around interest.

Our current guidance for the full year interest expense of $30 million represents an increase of about $7 million or approximately $0.12 per share for both GAAP and non-GAAP EPS compared to our previous guidance. The $7 million increase includes about $4 million of cash interest on term debt and $3 million of additional noncash amortization of debt discounts and issuance costs. It's important to note that our revenue guidance has not changed, and our expectations for operating margins are generally consistent with our previous outlook. Our updated 2022 guidance is as follows. We expect both GAAP and non-GAAP total revenues will be between $1.835 billion and $1.870 billion.

The midpoint of our guidance implies organic growth of approximately 9%. We expect total revenues will include approximately $44 million of COVID-related revenues from NIC's TourHealth and pandemic rent relief services. Revenues from TourHealth concluded in the second quarter, while revenues from the rent relief program are expected to wind down in the third quarter. We expect GAAP diluted EPS will be between $3.60 and $3.76 and may vary significantly due to the impact of stock incentive awards on the GAAP effective tax rate. We expect non-GAAP diluted EPS will be between $7.36 and $7.52.

Interest expense is expected to be approximately $30 million, including approximately $7.5 million of noncash amortization of debt discounts and issuance costs. Other details of our guidance are included in our earnings release. Now I'd like to turn the call back over to Lynn.

[Lynn Moore, President, CEO]

Thanks, Brian. Against the backdrop of generally strong public sector budgets supplemented by federal stimulus funds, we're experiencing a very active market. With our leading competitive position and ongoing investments in strategic initiatives, we are well positioned to take advantage of the continued strength in our market.

The acquisitions we've made over the last 18 months, including NIC, VendEngine and US eDirect, are performing well and contributing to our strong competitive position, helping us create more cross-sell and upsell opportunities with both new and existing clients. In particular, our enthusiasm around the cross-sell opportunities through NIC continues to grow, with recent wins across multiple Tyler products and a rapidly growing pipeline of opportunities.

We're also pleased with our progress around our combined payments business. as we begin to execute our go-to-market strategy to pursue a tremendous public sector payments TAM. We believe Tyler is uniquely qualified to deliver government-focused payment solutions, leveraging the strength of NIC's payment platform, analytics and reporting and deep domain expertise together with Tyler's broad software portfolio and extensive client base, and we look forward to reporting our progress in the coming quarters.

Even as we face an uncertain economic macro environment with rising inflation and interest rates, we have a great deal of confidence in our ability to continue to generate solid financial results and to grow cash flow. There are a number of factors that make Tyler's business resilient and relatively defensive compared to many software peers.

The public sector market is more stable than many segments of the private sector. We provide solutions that power essential government services often replacing mission-critical systems that are end of life, and our clients don't go out of business or get acquired. Recurring revenues comprised approximately 80% and growing of our total revenues, generating highly reliable cash flow. In addition, the public sector is increasingly focused on moving into the cloud, which we support with our cloud-first model. Our experience during the recession more than a decade ago supports our confidence and Tyler is clearly in a much stronger position today to succeed during an economic downturn.

We also have the advantage of a very strong balance sheet and reliable cash flow, which enables us to continue to invest strategically in growth even if some competitors may be constrained. While we have term and convertible debt associated with the NIC acquisition and have been impacted by rising interest rates, we are modestly leveraged at approximately 2x adjusted EBITDA, and we expect to continue to delever.

Accordingly, in the near term, we are prioritizing using our cash flow to reduce debt while retaining the flexibility to pursue strategic acquisitions and investments that provide long-term value. Finally, I'm happy to report that we remain on track with our major strategic initiatives, including projects related to optimizing our products for efficient deployment of the cloud, moving from our proprietary data centers to AWS, and ultimately accelerating the migration of our on-premise clients to the cloud and driving long-term margin expansion.

With that, we'd like to open the line for Q&A.

[Operator]

[Operator Instructions] Our first question is from Sami Badri with Credit Suisse. Your line is open.

[Sami Badri, Credit Suisse]

First, I just wanted to ask about the sales cycle that you guys -- sorry, going back, looking at the larger deals that you guys announced, there were several this quarter. What was the sales cycle for these? Are sales cycles tightening, elongating? Are they in line with prior length? Any color on that?

And then the second kind of question tied to that is we are seeing a strengthening state and local budget spend environment. And I think one question we do get from a lot of investors is how do you connect those revisions in those state and local budgets? And how do those end up making their way into companies, right, like yourselves? Could you kind of give us an idea from what you guys see in the field from the date budgets are announced to the date that they're actually translated into actual bookings or revenues on your side?

[Lynn Moore, President, CEO]

Yes, sure, Sami, it's Lynn. I'll start and I'll let Brian jump in. I think right now, our sales cycles are pretty normal. I think we've experienced times if you go back to the recession in '08, '09, that's where you started seeing things push out and get delayed. We saw a little bit of that during COVID.

But I think the key is we continually talk about the fact that what we provide is essential functionality and the software that we do provide are things that are needed and they're often replacing out of date or systems. And so right now, the market looks good. The sales cycles are pretty typical for a normal healthy time, even with respect to those large deals. Sales cycles will vary a little bit across our different divisions. Some have longer than others.

And sometimes the larger deals do take a little bit longer. But I think across the board, across our different product suites, I'd say sales cycles are pretty much on track. When you talk about state and local government spending environment, what we're seeing right now really is it's pretty healthy. I agree their budgets are in good shape. I've made comments before that I think coming out of COVID, they were not hit nearly as hard as a lot of people anticipated some of the journal reports and other things that we've read.

Also with the infusion of some stimulus. And I know Brian's got some numbers and thoughts around ARPA. But I think right now, what we're seeing in our pipeline, all our leading indicators around RFPs and demos, things like that, you're seeing it a little bit in some of our bookings this quarter is that things are well right now in the state and local government.

[Brian Miller, CFO]

And I'd just add a couple of things. Clearly, on the larger contracts, typically do have a longer sales cycle and some of these very large ones, sales cycles can be sometimes measured in years from the time we start talking to someone about a solution and the timing of when those actually show up in a signed contract can be somewhat unpredictable.

And I'd say that's the case with a couple of these larger deals, the Montreal deal and the Dallas deal that we talked about, both had pretty long cycles, but we're pretty persistent. In terms of the timing of how something makes it into the bookings, that can also vary quite a bit. Some jurisdictions will start the process of acquiring a solution before they have it budgeted, knowing that it's a mission-critical solution and replacing it is somewhat nondiscretionary.

So they may start the sales process or the buying process well in advance of that actually showing up in a budget and be prepared then when it's funded to sign a contract and move forward pretty quickly. Others may get it in a budget and then start a process or really accelerate a process. So it can take place in a variety of ways, but -- so the fact that new budgets are rising doesn't immediately result in sort of a flood of new pipeline activity that don't always perfectly match up.

[Operator]

Next question is from Matthew VanVliet with BTIG. Your line is open.

[Matthew VanVliet, BTIG]

You mentioned on the professional services side and overall implementation. You were a little bit limited both from a headcount perspective and the ability to hire new headcount to add to that. Just curious in terms of how that's progressing, both through July and what expectations, how those have changed through the end of the year? And then secondarily, has this increased your appetite to look to external partners to help with some of at least the more straightforward implementations or some of the more blocking tackling components of the deployments?

[Lynn Moore, President, CEO]

Sure. Thanks, Matthew. And I guess I would just say that the labor market challenges that are out there, we talk about a lot of things in our business where we may be a little bit immune to some of the external macro factors. But the challenges in the labor market, we're not unique there. And so we've been experiencing this for some time.

It has been a challenge, both in terms of hiring and recruiting, and we're also seeing it with a little bit higher early retirements and things like that. The impact is -- we're seeing it right now, and we've got a lot of business we want to execute on and deliver on, but our services revenues are off a little bit. And I'd probably expect some of that to carry through throughout the year. We do generally make sort of large hiring classes. You take, for example, our enterprise ERP group.

They hired a very large class back in February. I think we're looking at hiring another very large class in the next few weeks. But even when you hire those large classes, it takes time for them to get up to speed and get to a point where they can go out and become fully billable on client implementation. So it can take four, five, six months. So there's a little bit of delay there.

So there's a little bit of impact that will happen even as our margins as we bring these people on, but it takes a little time for them to start becoming billable. As it relates to external partners, I think historically, we've always wanted to keep our services in-house. It's certainly not a big margin advantage to have them in-house, but we think from a professional and competitive and client ownership advantage, it really has been -- has played out and been a lot of value to us really for the last 25 years.

The thought of always having the touch point from initially from our sales, handing it off to our implementation team, handing it off to our support team, I think that client relationship and client experience is part of what drives our success in the market. And so as of right now, we're not really looking to do that. It's such a unique business that I think we just want to keep these things in-house, at least for the time being.

[Matthew VanVliet, BTIG]

Very, very helpful. And then as you look at the state hunting license agreements that NIC has in place, how do you feel you're progressing in terms of getting through any demand associated with those customers, making your way into, I guess, sort of the local level that roll up through those statewide purchasing agreements. You've captured a lot of the sort of low-hanging fruit that NIC just didn't have the product to sell through. Or are we still very early stages of the overall opportunity that those present for you?

[Lynn Moore, President, CEO]

Yes, Matthew. I think I made the comment on the last call that we're probably in the first inning of our -- what we can do with NIC and maybe even just the top of the first inning. I wouldn't say that -- they did -- the reality is they didn't really have some of the local relationships. We're still learning about each other. The fact that this soon, we've already done the number of deals that we've done, I think we've closed 15 deals already.

Our active pipeline is around 100 deals, north of $30 million. That's pretty exciting in such a short period of time while we're still doing just our normal integrations with NIC. We've won some pretty significant contracts. I think, last quarter, we talked about VendEngine won a contract with the Arkansas Department of Corrections, mentioned in my comments earlier, another VendEngine contract with Kentucky, our Entellitrak Veterans Benefits contract with Utah.

That's pretty exciting stuff, particularly with -- when I mentioned a deal between NIC and VendEngine and something I've said internally is these are both acquisitions that we've brought on in the last year and in different parts of the business and to see that coordination already and to be able to leverage the relationships that NIC has got those deep state relationships as well as those enterprise contracts, it's pretty exciting stuff.

[Brian Miller, CFO]

And I'd just add that specifically on hunting and fishing, we're still integrating US eDirect with the NIC outdoor recreation platform, but really a significant increase in our capabilities there. But I'd say we're in the very early stages of being able to drive that down more broadly, both within local government and at the state and federal levels. But that is one of the product areas that on a combined basis, we've got a lot of strength in and that we're looking for big things out of...

[Lynn Moore, President, CEO]

I apologize, Matthew, if you're asking about hunting, I heard state, we call those understanding.

[Matthew VanVliet, BTIG]

No, I was talking about the NIC deals, those agreements. But thanks for the extra color, Brian. Appreciated guys.

[Operator]

The next question is from Saket Kalia with Barclays. Your line is open.

[Saket Kalia, Barclays]

Okay. Great. Lynn, maybe just for you. Can you just talk a little bit about what product areas are having the most success in converting maintenance customers to SaaS? I know there were a lot more -- there was a lot more in TCV converted this year than -- or this quarter versus last -- Q2 of last year.

Where do you feel like you're having that success? And then related to that, how do you think about that base moving over to SaaS in the coming years?

[Lynn Moore, President, CEO]

Yes, sure, Saket. Thanks for the question. It's a good question. I think right now, probably the primary areas where we're seeing the most flips is in our ERP side of the -- suite of the business. So both our enterprise ERP and our ERP Pro solutions.

We had -- and coincidentally, those are the areas where we actually have the most customers. That's our largest customer base. I think at our top end, our enterprise ERP, we're already well ahead of our plan for the year in flips. We're about 35% ahead through the first half. The lower end in our ERP Pro solution, which is our formerly our Incode solution, we plan to do about 180 a year down in that product suite.

We're obviously seeing it in other businesses, but that's probably our highest volume. And as we continue to move forward, you're going to see that increase not only there, but across all of our product suites. As we model out and look forward, we're starting to do some internal modeling around what we call Tyler 2030. And a big part of our growth strategy is converting that very high customer base from on-prem over into the SaaS world. I'm not prepared today to sort of give you a projection of how many per year and how much that's going to grow.

But I would expect over the next five to seven years, you're going to continue to see momentum and increased movement in that area.

[Saket Kalia, Barclays]

Got it. That makes sense. Brian, maybe for you as a follow-up. And maybe this is related to some of the hiring commentary that you folks had mentioned on services. But can you just talk a little bit about software and services bookings?

It's been a couple of strong quarters of bookings, strong on bookings than done on revenue, frankly. So can you just talk about what's driving that strength? And just maybe anything different this year about the conversion to revenue here versus prior years?

[Brian Miller, CFO]

Well, I think on the second part of the question, the conversion to revenue is just that more of it is SaaS or -- and so you don't necessarily get a revenue hit. In fact, you typically don't get a revenue hit immediately. Often, it's a quarter or two after the signing before their environment stood up and we start to recognize revenues. So even with the SaaS customer, there's a lag. And then, of course, you've got a recurring revenue stream that you're starting to grow.

So it may start in the third month of the quarter and so you get a month's worth of revenues, and the next quarter you get a quarter's worth and so forth. And so that ongoing change in the mix has been a part of that with less licenses, which are typically recognized mostly upfront. We talked about a little bit of the service pressure as well. So that also is with our -- a little bit below plan headcount there, we're, I think, not ramping up those new signings as quickly as we might once we're sort of fully staffed with our billable implementation teams. So I think that's the biggest thing.

I think in terms of just driving higher bookings, we've always said bookings can be somewhat lumpy from quarter-to-quarter, especially around those big deals. In this quarter, a couple of those big deals that did have long sales cycles got to contract. But generally, I'd say it's sort of a combination of those factors we pointed out, pretty strong economic backdrop in budget situation around governments. It's certainly aided by the ARPA funds, the federal stimulus that's available to them. As we've talked about on prior calls, sometimes it's not clearly identifiable that a deal was funded with ARPA funds.

Sometimes it is, and there are some of those in this quarter. Other times ARPA funds are used for something else, but it frees up money that helps perhaps make an incremental purchase or an add-on sales. We're seeing real strength in our inside sales selling additional products to existing customers, and we believe some of that is driven by the federal stimulus. But as we've said in the past, that's sort of a long-term tailwind they've got until the end of 2024 really to commit those funds and through 2026 to spend those. And we saw a study by Brookings that indicated that at least as of the end of 2021, only about 40% of the stimulus funds had been committed yet by cities and counties.

So we think there's sort of an ongoing tailwind there. So strength in the market and then our competitive position is really strong. I mean, we continue to invest at a high level. We've got multiple products that we've added through acquisitions and internal builds. So our average sales are often bigger than they would have been in the past because we've got more products that are bundled together, things like our data and insight solution that's often bundled in a new sale, a number of our public safety products that now are often in a new sale that make that bigger.

So there are a number of factors contributing to that. But yes, there is typically a lag from bookings growth to revenue growth.

[Operator]

The next question is from Michael Turrin with Wells Fargo Securities. Your line is open.

[Michael Turrin, Wells Fargo Securities]

There were several comments throughout the prepared remarks around the strength and resilience of the demand environment. Just wondering if there's any more color you can add around what you're seeing from public sector customers currently and how the RFP volumes you're referencing compare to what you're used to generally seeing this time of the year?

[Lynn Moore, President, CEO]

Yes, sure, Michael. I mean it's -- the last few years have been a little bit rocky with COVID and everything else. What we're seeing right now is really a return to pre-COVID levels generally across the board. Our RFPs are up, our demos are up and I'd say the market looks pretty strong. In some parts of our business, the pipeline is growing even beyond those levels.

In some parts, it's sort of returned back to sort of pre-COVID levels. So right now, what we're seeing out there in the market, all the leading indicators is budgets are strong and healthy and the demand is there.

[Michael Turrin, Wells Fargo Securities]

That's helpful. Brian, you provided us with a lot of useful detail around segmentation and various splits of the business. In terms of where your focus lies, can you help level set what you view as the True North metric for top line or a couple of metrics as you're working through the transition? Is it backlog, the SaaS ARR metric or something else, I think it would be useful to hear you talk through just given the moving pieces of the model and the macro we're all working through here?

[Brian Miller, CFO]

Yes. We recognize that our business is maybe a little bit more complicated given the transition from license to the cloud and the addition of NIC and their transaction-based revenue streams and our plans to grow what already is a pretty sizable payments business through NIC to grow that significantly. So we give a lot of metrics and we recognize you probably give too many metrics.

But I'd say, if you're looking for kind of the North Star and what's really important is our model evolves, it would be those metrics around ARR and particularly, we do get the breakdown of those different components of ARR, but particularly software subscription ARR and transaction ARR. And we expect that maintenance will kind of flat right now, will start to decline as more of those customers flip to the cloud.

So really, the things that probably the most important metric would be around those recurring ARs from subscriptions and transactions.

[Operator]

The next question is from Joshua Reilly with Needham. Your line is open.

[Joshua Reilly, Needham]

How should we think about the seasonality, if any, around the payments business now, including NIC, both from the portal revenues from core Tyler and NIC?

[Brian Miller, CFO]

Yes. Typically, the fourth quarter is lighter there, less activity through the portals, less maybe slightly less in terms of payment volumes that are often associated with those portal transactions. So around the holidays and as people get to the end of the year, there's just a little bit lower activity there.

The other thing that we talked about last quarter which is sort of new to us is in the Florida contract with the revenues around the payments for the Department of State and their corporate licensing activity, which is almost all in the first quarter, a little bit of it lags into the second quarter. And I think they were around $6 million of revenues associated with that that's seasonally towards the beginning of the year.

But other than that, it's primarily a fourth quarter slowdown around the payments.

[Joshua Reilly, Needham]

That's helpful.

[Lynn Moore, President, CEO]

I think too, Josh, was as we continue to grow that payments business and we were -- as you know, we're already growing it within Tyler and as you extend it beyond just some of the NIC things around outdoor activities and stuff. As we look out several years, I think you'll see that as the volume gets bigger and it's across a larger base and it's across using more products and more constituents, you'll see that, I think, over time, flatten out, but that will take some time.

[Joshua Reilly, Needham]

Got it. And then just one other follow-up on the NIC business. What are you seeing in terms of the driver history record hold revenue that was from that segment? Is that recovering as you would have expected? And how much could that potentially positively impact revenue throughout the rest of the year?

[Lynn Moore, President, CEO]

Yes, I'd say the DHR right now, it's kind of on our internal plan for the year, which is really essentially sort of flat with very little growth. And I think that's one of the areas in our business when we talk about being recession resistant. It's an area where I think we're seeing a little bit of impact in the DHR business. At the same time, DHR used to be -- if you go back several years, it was a very big substantial piece of the NIC businesses as we're starting to grow these other streams. I'm expecting the impact of DHR and the percentage of that business to somewhat decrease within that business unit.

I think right now, it's about 17% of their total revenues, maybe 19% outside of COVID, and I think that's trending towards maybe down in the 15% range as we're starting to grow some of these other state interactive government services revenues, payments revenues and some more products going through their systems.

[Brian Miller, CFO]

Yes. So typically, this quarter, they were down about 2%. So they're recovering a bit, but still softness there. And that's one also that we believe is affected indirectly by supply chain and some of that's tied to new vehicle sales. And those are a broader economy.

There's no cars out there.

[Operator]

The next question is from Kirk Materne with Evercore ISI. Your line is open.

[Kirk Materne, Evercore ISI]

Congrats on a really nice bookings quarter. Lynn, I was wondering could you just talk a little bit about what's your discussions like with customers today in terms of consolidating the number of vendors they're working with. I was just kind of curious you all obviously have a much more expansive product portfolio than you did 10 years ago. How much is the ability to sort of take wallet share a bigger part of the story today than it was say, 5, 10 years ago? And is that accelerating?

Is that conversation accelerating? I'm just sort of wondering about thinking about you all more in sort of a net revenue retention basis, meaning the ability to expand sort of cross and upsell versus just be as reliant as you were on sort of net new, say, again, 5, 10 years ago?

[Lynn Moore, President, CEO]

Yes, sure, Kirk. Good question. I think part of our strategy has always been to have a comprehensive suite and compete that way and sell our products as a suite as opposed to single point solutions. I still think that's a significant competitive advantage. There are some consultants and things out there that are sometimes suggesting to go the other way.

I'm not really quite sure why because having to do a bunch of extra integrations, trying to get multiple vendors, just seems to me to be more of a headache rather than going to a single vendor. And you're right. I think one of our help it takes decades to develop. And so when you look at cross-selling and upselling back into that base, that's also a big strategic driver for us going forward. Every quarter, the reports I'm seeing were -- our inside sales channels are continuing to outdo themselves each and every quarter.

And as we continue to do tuck-in acquisitions and broaden our portfolio, I think you're going to continue to see that. And I do think it's one of our competitive advantages in the market.

[Kirk Materne, Evercore ISI]

And Brian, just on the ramp in sort of your services business and bring out more billable or more headcount on that side. How should we think about that sort of impacting margins as we think a little bit ahead to 23%. I realize you guys are expecting margins maybe start picking up again in '24, not next year. But is there anything we should be aware of, meaning maybe a little bit heavier weight on the first half of the year next year as people get ramped up versus the back half? Any just color on that would be helpful.

[Brian Miller, CFO]

Yes. I think the margin impact is more of what we're seeing this year because you bring those people on, obviously, you're paying them there in your expenses, but it's maybe kind of a six months ramp-up to become fully billable. So initially, you get a margin hit from having the cost without the revenues associated with it. And then so from a negative impact, you will see that more this year. And then as they become billable and they're starting to generate revenues, and help us deliver that backlog, then you see a positive impact.

Services aren't a high-margin business for us as it is. But -- so I would expect that as you get into the early part of next year through the middle of next year, you'll start to see a positive impact from those employees being productive. And we hired, as Linda, a pretty big class or classes cumulatively pretty large across Q2 and have pretty strong hiring plans in the second half of the year. So assuming we can execute on those and turnover seems to be settling down a bit. Then we'll have those resources billable in the first part of next year.

[Operator]

The next question is from Charles Strauzer with CJS Securities. Your line is open.

[Charles Strauzer, CJS Securities]

Just picking up on that last question about the labor hiring looking at the gross margin on a percentage basis in Q2, it was down pretty significantly year-over-year and down a touch sequentially while SG&A was lower. Was that kind of the main driver behind that?

[Lynn Moore, President, CEO]

Yes. I think the margin, there's a combination of professional services is part of that, as I just described. We're certainly seeing as we talked about as we headed into the year with our guidance, a return of some of the, I'd say, COVID cost savings. Some of those are in the SG&A lines. Some of those are in cost of sales, particularly billable travel.

So while we still currently and expect in the future to deliver a significant amount of services remotely as we did during COVID, there is billable travel returning across some segments of our business. And so that's having an impact from margins, which we expected. And then we've talked about some of the transaction cost, the bubble costs associated with our cloud transition and specifically with the move from our proprietary data centers to AWS. And so those things are generally in line with what we expected. We did have also a bit higher revenue stream from the COVID-related revenues at NIC.

Those have typically a bit lower margin than Tyler's overall margin. So the sort of over-performance in those revenues had a negative margin impact. And as we've said, we expect those to -- the last of those to go away at the end in the third quarter. So that will be a positive from a margin perspective.

[Charles Strauzer, CJS Securities]

That's helpful. And just staying on the AWS transition there, where do you think you are in terms of the -- your expectations for that transition? And are you tracking ahead behind on schedule, that kind of thing.

[Lynn Moore, President, CEO]

Yes. I think, Charlie, we're on track with our internal plans, both in terms of where we are with our product investments, what we've outlined for plans to exit our data centers. And when we talk about sort of getting the other side of the bubble costs. So right now, internally, I'm pleased with where we're sitting.

[Operator]

Next question is from Rob Oliver with Baird. Your line is open.

[Rob Oliver, Baird]

There hasn't been a lot of commentary on public safety on the call. So then I thought I'd ask about that. It was a bit of a focus in Indianapolis. And over the last couple of years, you guys certainly have begun to see some nice success in cross-sell of public safety into your core. So just curious to know how you characterize that market right now?

And when you look at the components of that RFP activity and pipeline, how does public safety fare in their win rates and then how it sets up for that sort of all-important back half for the year in Q4?

[Lynn Moore, President, CEO]

Yes, sure, Rob. I appreciate that comment. I'd say public safety right now, the market has moved back to sort of pretty much back to normal. Our competitive landscape. I like our position.

There's a couple of strong competitors. We've talked about them before. We've also know that there's some competitors out there that are in that space that are carrying a lot of debt, which I think are probably with the change in rates might be impacting their ability to execute. We've seen some reports on some smaller competitors who may be going through a little bit more difficult time and seen some layoffs and things like that. But right now, we're pretty pleased with where we sit.

We made a big investment years ago into things like mobility. And that continues to be a significant competitive edge for us, along with, as you mentioned, leveraging a lot of these other acquisitions we've done in our Tyler Alliance story. I mentioned in my opening comments, the contract with Lima County, Ohio, which was principally -- we sold our Enterprise Courts & Justice product and some things on the C&J side, but also the public safety side and that Alliance story really resonated with the client. So we're starting to see good things there. The market is still, I think, somewhat resistant to the cloud, but we're starting to get some SaaS deals done.

We're looking at potentially getting our first beta client in the AWS Cloud, maybe later this year or early next year. So there's some exciting things going on in that market.

[Rob Oliver, Baird]

Great. Okay. That's really good color. And then, Brian, just a quick one for you, just on the CapEx reduction, and I apologize if I missed it. If you could just talk a little bit about what the components were of that.

[Brian Miller, CFO]

On the CapEx? Nothing really significant. It's just some tweaking of the timing of some of the things, particularly around our -- some of our facilities and NIC, for example, is moving into a new facility in the Kansas City area and the timing of some of those things has just shifted around a bit.

So I don't think there's anything early notable in our CapEx right now relative to what we thought at the beginning of the year. A little bit minor changes too in our capitalization around some of our internal software development efforts, most of that being associated with the cloud optimization of some of our products.

So sometimes there's a little bit of a difference of how we originally estimated it will fall in how the accounting rules ultimately end up with what we capitalize and what runs through expense.

[Operator]

The next question is from Alex Zukin with Wolfe Research. Your line is open.

[Alex Zukin, Wolfe Research]

Just maybe a few for me. It sounds -- a lot of this has been asked, but it sounds like the bookings were really strong this quarter. And particularly, if you adjust for the duration of the contracts, it's even better. What -- if you think about the headwind to SaaS revenues, particularly that you're seeing from that services hiring challenge that you talked about what would it be -- what would -- is it possible to know like where SaaS revenues would be if you didn't have that challenge? And then I've got a few more.

[Brian Miller, CFO]

Yes, I'm not exactly sure how we would translate that. I think the lag in the start is pretty modest, but I think we would be seeing a little bit higher level, but I don't know that it's sort of a double-digit effect. I think it's pretty modest now. And like I said, we have pretty aggressive hiring plans for the rest of the year to get our teams up to full strength. And so I think it's a relatively short-term impact.

We'll see how it plays out through the balance of the year. It could create some softness on that services side. But I think at this point, it's not a big impediment to growth in the subscription revenues, but certainly is some sort of a factor there.

[Alex Zukin, Wolfe Research]

Got it. And then the other question is, I mean, with all the headlines around inflation and software companies raising price, can you remind us what are kind of the inflation adjustments or pricing vectors that you have in your model with customers. And particularly, I know that annual maintenance upticks are part of that. So as you see more customers converting to SaaS, how do you make sure that you continue to capture those unit economics on the subscription contracts -- on the SaaS contracts.

[Lynn Moore, President, CEO]

Yes, sure, Alex. So -- and you're right, most of our maintenance contracts are annual agreements. We do have a few multiyear ones. A small percentage of those have built-in escalators, but generally, most of them have the ability to adjust pricing on an annual basis. Some of those are tied to CPI, but I think that's probably not the majority.

But there is some flexibility there. And we took a look at that this spring. Still a majority of our maintenance contracts are on the sort of the June 30, July 1 cycle, and it's something that we talked about internally back in March and April before we went out. As it relates to SaaS contracts, similar things. I mean we -- these are -- after you get through the initial engagement, you do have the ability to start putting in price increases.

A lot of our initial SaaS deals are multiyear terms. Some of them are they may be built-in escalators, but the way the revenue recognition has worked historically is that we actually have been recognizing them on more of a flat rate. So there can be a little bit of a declining margin. It's one of the reasons why we've tried really hard to shorten the length of those initial contracts, but we're also looking at doing some things with contract terms so that we will be able to get those built-in escalators. We do price them in.

So we're getting the cash in those agreements. And then as they roll off and we move into their annual renewals, we'll have the ability to change that pricing even more. But there are obviously some existing agreements that are out there that had pricing that was built in a year or two ago that we're -- we can't adjust at this point.

[Brian Miller, CFO]

And in some of our products, we did implement sort of our above-normal maintenance increases this year. And we've also taken a look at our professional services billing rates and in some cases, adjustments there to account for inflation.

[Alex Zukin, Wolfe Research]

Perfect. And then I guess on the topic of cash in the door, if you actually look at your guys' model, every two years, your free cash flow seasonality in the first half jumps around. It goes from like 23% to 24% of the total year to 10% to 12% of the total year. So first of all, just help us understand the -- it looks like we're in one of those years where it could be more like the 20-plus percent year, but I just want to understand the seasonality from a free cash flow perspective as we look at the second half, specifically and the full year? And then just tie that in with capital allocation.

You talked about wanting to pay down the debt, which makes perfect sense given the raising interest rate expenses and environment. But also maybe comment given where the stock is, given where the fundamentals are around your -- the possibility of an increased buyback.

[Brian Miller, CFO]

I'll take the first part of that. Yes, the cash flow does -- typically the third quarter, and I think that's every year is the strongest quarter, primarily because of those maintenance billings. We have close to $470 million a year in maintenance. Not all of it, but the biggest chunk of that is renewed as of July 1. They typically build late in the second quarter and collected in the third quarter.

Those they are typically don't age. So those are paid relatively promptly. So that drives that third quarter cash flow growth. I think some of -- there was a little bit of an anomaly last year in the second quarter around NIC shortly with -- because they were only in for part of the quarter. And there was some sort of unusual dynamics around the timing just when we acquired them, they happen to have a fair amount of, I guess, what I'd describe as customer cash that's sort of passing through that from their transaction-based revenue streams that was on their balance sheet that then was paid out, remitted on to the customers after acquisition.

So it created sort of an anomaly there. This year, it's sort of the normal full quarter and NIC's cash flow is more consistent across the year given the transaction-based nature of most of their revenues. So I think you'll see that start to even out a little bit more. But I still think, yes, you probably see certainly more than half and more in the kind of 2/3 of our cash flow for the year in the second half of the year. But I think there was that sort of unusual situation last year.

[Lynn Moore, President, CEO]

Yes. And on the second question around use of cash, you're right. Our priority still is debt pay downs. But we're still actively looking at acquisitions. We're not -- it's not like we've closed the door.

We're not answering calls. We've been actively looking. We've participated in a couple of processes this year. Obviously, we purchased USD Direct early in the year. But we need something compelling and something that's really at a reasonable valuation.

What we've seen in the acquisition front, at least even recently, even as the broader markets have gone through a little bit of turbulence in the last few months. The expectations for some of these private companies has not changed. And in fact, in some cases, has almost exceeded.

I mean if people pitch deals where they tell me that I need to be paying higher valuations than Tyler. And that's a little bit hard for me to understand. It's a bit of a head scratcher. Our debt right now is our blended rate is about -- after we make this payment this month. It will be about 2%.

But that's really a function of the fact that we've paid so much debt down. when we first took out our debt, I think our convertible was about 34% of our total debt. After this payment this month. It will be more just over 50%. So as we continue to pay our term down, we won't be as impacted by interest rates as we look out over the next year, which is nice.

As it relates to share repurchases, I think right now, I agree with you as I look out five years, seven years from now, the stock could look pretty attractive. But I think unless we're really wanting to do a significant move, I'd rather just pay down the debt in the near term.

[Operator]

The next question is from Terry Tillman with Truist Securities. Your line is open.

[Terry Tillman, Truist Securities]

In Brian, I feel like I should follow the 10 because we're going past an hour, but I can't help myself since I have you, I'm going to ask a couple of questions. First, I do want to use some fringe because of the Montreal deal for Bongor I guess the first question just relates to -- we talked to one court system. They had a 25-year plus old case management system. I know you've talked about your high-end ERP business, your ERP Pro business and then somebody asked about -- Matt asked about public safety. How is case management opportunities right now in terms of how would that stack rank versus some of these other kind of cloud replacement opportunities?

And then a quick.

[Brian Miller, CFO]

Case management. Yes. Case Management is one of our most I'd say probably our most dominant products in the marketplace, probably one of our biggest market shares. So our enterprise case management formerly Odyssey is I think north of 55% of the courts in the U.S. use that solution.

I think it's 8 of the 10 largest counties in the country something like 17 state-wide implementation. So it's a very strong product for us. But it also can be somewhat of a lumpy business, particularly with respect to those really big contracts because it is not unusual for us to see 20, think we've replaced a couple of 40-plus year old case management systems that were custom written in the 70s in some of these large counties. And so there's sort of some long-term activity in the backdrop. We see more of the kind of mid-range deals that are more currently active in the pipeline, but I don't think there are any big statewide deals that are sort of currently actively in the market.

But we do have a very high success rate as those come along. And then as we've been able to build on that really very strong position we have in the case management space, where most of our growth in courts is coming from now is from those products that we have in that suite around it. So we mentioned on the call today, one of our bigger deals, Dallas County. Dallas County has been a long time. It's a top 10 county been a longtime case management customer -- but now we were able to add our jail solution to the products that they use.

So building on that relationship, and we've done a number of acquisitions in that space, probation, jury, prosecutor, process service solutions that broaden our offerings there and enable us to grow there. But I'd say it's certainly a solid business, and we still have a very strong competitive position. But right now, not as much new activity. But as it comes along, we're well positioned.

[Lynn Moore, President, CEO]

Yes. And just to add to that, Jonathan, that last point that Brian said, I think is worth emphasizing. Using -- leveraging our strong position in -- it's still an anchor. It's still the gateway and the ability to take some of these other investments we've done, whether it's around corrections like the Dallas County Jail deal, but even supervision, if you remember a few years ago, I think it was about four years ago, we did an acquisition of a company called CaseloadPRO. And we won this -- we signed this in Q2, L.A.

County, for enterprise supervision, supervision. That's pre trial. We talked about the different areas and even in supervision, whether it's juvenile adult and things like that. And we think we're going to be adding those additional solutions to L.A.

County, which is the largest coronal justice departments and counties in the United States. So.

[Terry Tillman, Truist Securities]

That's great. Congrats on the quarter.

[Operator]

The next question is from Jonathan Ho with William Blair. Your line is open.

[Jonathan Ho, William Blair]

I'll keep it to one question. With the upcoming quarter, can you remind us of whether there are any large deals in terms of maybe some tougher bookings comparisons? SP1.

[Brian Miller, CFO]

A second. Yes. Last year, in Q3, we didn't really have any mega deals. Our biggest SaaS deal was about a $5 million contract value with Lawrence, Kansas, and we had a handful of license deals, the biggest of which was less than $3 million. So I think it's a pretty normal comp coming up.

[Operator]

The next question is from Keith Housum with Northcoast Research. Your line is open.

[Keith Housum, Northcoast Research]

I'll keep mine to one question while I know we're running late here. Brian, maybe you just touch on the NIC acquisition, your ability to retain employees over the past year and how that affects the business going forward.

[Brian Miller, CFO]

Yes, it's been really solid, both at the senior management level and the staff level I think we've had very solid retention, I think, for all the reasons that the acquisition made a ton of sense created great opportunities for growth at NIC as well as Tyler. And I think their teams have recognized that.

I think it's been -- as we look back over the last year, a smooth integration for a deal of that size, particularly one that was completed while we were still almost all remote during COVID. We've got some new, not new to NIC, but people in new senior leadership roles there, particularly Lizabeth the President and Thomas, the COO and they've done a great job of managing that team and working with the integration. So I think we're very happy with the retention and the opportunities that it's created across NIC and Tyler.

Their payments team, for example, our Tyler Payments team has joined with the NIC Payments team, and they've taken the leadership there. So yes, we're really pleased with the retention there.

[Lynn Moore, President, CEO]

Yes. I think the excitement that we see in the cross opportunities and the things that we can do together, that just naturally flows up and down the organization, and I think that helps with retention.

[Operator]

Our final question is from Clarke Jeffries with Piper Sandler. Your line is open.

[Clarke Jeffries, Piper Sandler]

I'll keep it brief. I just wanted to get a sense of what your rough range of organic or core growth expectations are for NIC, the considerations in terms of how the revenues are being driven today and sort of how the macro is impacting that. So from the 8% today, what's the general range you expect going forward?

[Brian Miller, CFO]

Yes. I mean historically, NIC was about an 8% grower on average, looking back over several years, sort of pre-covid around the, what they call, state growth. So sort of a proxy for organic growth. And so that, I think, is sort of our baseline. We've seen pretty strong growth over the last couple of years with all the shift towards citizens and businesses doing more business with government digitally and so higher transaction volumes.

So they're really growing off of this 8% growth, we think, is really pretty impressive this quarter, given that it's off of a very strong base that was established over the last couple of years. But I'd say that's kind of the baseline and that as we continue to drive more cross-selling and so more opportunities particularly in the payment space. And through things like the USC Direct acquisition, which is now a part of NIC, that there's certainly an opportunity to move up into the even into the low double-digit range. But for right now, I think this 8% is kind of a good baseline and all of our initiatives around the combination with Tyler should ultimately drive that higher?

[Lynn Moore, President, CEO]

Yes. I think, Clarke, obviously, taking out the near-term growth headwind of COVID, which I assume that, that was part of your -- you've taken that out. But as we go forward, it's like a lot of acquisitions. I mean they're a big stand-alone division within Tyler. But to Brian's point, a lot of the cross-sell opportunities whether or not internally, we recognize those on a different division P&L versus NIC's P&L.

I think as you go over time, we don't really report on specific organic growth within our business units. And you'll see some of that just the opportunities are there. And as payments grows, some of that payments business may go to our ERP because it's going to their client base, but I see played a significant hand just like the vend engine deal in Arkansas, Kentucky, that revenue really doesn't happen without NIC yet it's sitting on the books over in our Courts & Justice division.

So I think as we go forward, you'll probably see us less comment on their specific revenues and growth as they just become more integrated with NIC. We've kind of thought it was appropriate, really for the first year or so, but it will be like the rest of our other divisions because there's so much as we talked about, a lot of our opportunities are through cross-sells and how we leverage each other.

And so to us, at one point, it just becomes all Tyler.

[Operator]

At this time, there proves to be no more questions. Mr. Moore, I'll turn the call back over to you for closing remarks.

[Lynn Moore, President, CEO]

Okay. Great. Thanks, Chris, and thanks, everybody, for joining us today. If you have any more questions, please feel free to contact Brian Miller or myself. Thanks, everybody.

Have a great day.

[Operator]

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.