Tyler Technologies Inc

NYSE:TYL

Earnings Call Transcript 2017-Q4

[Operator]

Hello everyone. And welcome to today's Tyler Technologies’ Fourth Quarter and Year-End 2017 Conference Call. Your host for today's call is John Marr, Chairman 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, today's conference call is being recorded today, February 22, 2018.

At this time, I would like to turn the conference call over to Mr. Marr. Sir, please go ahead.

[John Marr, Chairman and Chief Executive Officer]

Thank you, Jaime. And welcome to our fourth quarter 2017 earnings call. With me on the call today, are Lynn Moore, our President; and Brian Miller, our Chief Financial Officer.

First, I'd like to Brian to give the Safe Harbor statement. Next, Lynn will have some preliminary comments. Then Brian will review the details of our fourth quarter results and 2018 guidance. Then I'll have some final comments, and we'll take your questions.

[Brian Miller, Chief Financial Officer]

Thanks, John. 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]

Thanks, Brian. We are pleased with our results for the quarter, which provided the strong finish to 2017. We returned to double-digit revenue growth for the quarter with total GAAP revenue growth of 13% and non-GAAP revenue growth of 12%. We also achieved solid margin improvement as our non-GAAP operating margin rose 120 basis points to a new high. License and royalties revenues also reached to new high and exceeded $20 million for the first time ever. Subscription revenue was once again strong growing 26%.

Total recurring revenues from maintenance and subscriptions grew 14% and comprised 64% of total revenue. Bookings for the quarter were very strong up 37%. For the year, bookings grew 15% compared to 2016 and our quarter end backlog grew 18% to just over $1.1 billion. Bookings were robust under both our license and subscription models, but then as expected, our new business mix in the fourth quarter shifted back toward a higher proportion of license deals than in the second and third quarters.

Subscriptions represented about a third of the total new software contract value in the fourth quarter. The mix was impacted somewhat by a large state wide Odyssey contracts, as well as seasonally strong bookings for our public and safety solutions, which are typically on-premises license deals. Our largest new license deal in the quarter was the state wide Odyssey Courts & Justice's software contract with the state of Kansas Judicial Branch, valued at approximately $21 million, including a multiyear maintenance agreement. This represents our 14th state Odyssey arrangement.

Other significant on-premises license deals signed during the quarter, each with a total contract value of $1 million or more included multiproduct arrangements with Marion County, Florida for our Munis, EnerGov and ExecuTime solutions, Norman, Oklahoma, for our Munis and EnerGov solutions, Fredericksburg, Virginia for our Munis iasWorld, EnerGov and ExecuTime solutions and Henry County, Georgia, in the Atlanta Metropolitan area, which signed contracts valued at $3.6 million for our New World Public Safety, Brazos and SoftCode solutions, as well as our Munis and EnerGov solutions.

We had a very active quarter in the public safety market with the highest quarterly total contract signing since we acquired New World in 2015. Significant New World public safety license deals included the Cities of Orlando and Tallahassee, Florida, Elk County, Pennsylvania and Clayton County, Georgia, located in the Atlanta area. Clayton County also signed a significant license contract for our EnerGov solution and the Visalia Unified School District in California signed a major new contract for our Munis ERP solution.

Significant new SaaS contracts in the quarter included multi-product deals for our Munis and EnerGov solutions with the cities of Wilmington, North Carolina and Wellington and Riviera Beach in Florida. We also signed notable SaaS arrangements with Fontana, California, and Muscogee Creek Nation in Oklahoma for our Munis ERP solution and with Edison, Illinois for our new world ERP solution. Finally, we signed a five-year $13 million extension of our state-wide e-filing contract with the State of Oregon, which is converting to a fixed fee arrangement.

Now, I'd like to Brian to provide more detail on the results for the quarter and provide our annual guidance for 2018.

[Brian Miller, Chief Financial Officer]

Thanks, Lynn. Yesterday, Tyler Technologies reported its results for the fourth quarter ended December 31, 2017. I'm going to provide some additional data on the quarter's performance and provide our annual guidance for 2018. Then John will have some additional comments.

In our earnings release, we’ve included non-GAAP measures that we believe facilitate understanding of our results and comparisons with peers in the software industry. These measures exclude write-downs of acquisition-related deferred revenue and acquired leases, share-based compensation expense, employer portion of payroll taxes on employee-stock transactions and amortization of acquired intangibles. 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 Web site under the financials and annual report tab, schedules with supplemental information provided on this call, including information about quarterly bookings, backlog and recurring revenues.

GAAP revenues for the fourth quarter were $217.9 million, up 12.7%. On a non-GAAP basis, revenues were $218.1 million, up 11.8%. Subscription revenues for the quarter increased 26.1%. We added 83 new subscription-based arrangements and converted 19 existing on-premises clients, representing approximately $44.4 million in total contract value. In Q4 of last year, we added 61 new subscription-based arrangements and had six on-premises conversions, representing approximately $18.4 million in total contract value.

Subscription clients represented approximately 42% of the number of new software contracts in the quarter compared to 30% in the prior year quarter, while subscription contract value comprised 33% of the total new software contract value signed this quarter compared to 19% in Q4 last year. The value-weighted average-term of new SaaS contracts this quarter was 5.8 years compared to 5.6 years in last year's fourth quarter.

Transaction-based revenues from e-filing and online payments, which are included in subscriptions, increased 28.2% to $16.3 million from $12.7 million last year. That amount includes e-filing revenue of $12.5 million, up 29.8% over the last year. The growth in e-filing revenues was primarily driven by the ramp-up of e-fling and research solutions in Illinois.

Annualized total non-GAAP recurring revenues for the fourth quarter were $563 million, up 14.2% from last year. Our GAAP effective tax rate was significantly impacted by the enactment of the Tax Cuts and Jobs Act bind in the December, mainly due to the re-measurement of our deferred tax assets and liabilities at the new corporate tax rate, which reduce our tax provision for the year and the quarter by approximately $21.6 million and reduced our full year tax rate by 13.4%.

In addition, our GAAP tax rate includes significant excess tax benefit from stock option exercises, which reduced our tax provision for the year by approximately $40.6 million and reduced our full year tax rate by 25.1%. As a very profitable company with nearly all of our operations in the U.S., we expect that our effective rate going forward will reflect a significant reduction as a result of the new lower federal tax rates.

Cash flow from operations was $53.4 million compared to $51.8 million last year, up 3%. Free cash flow, which is calculated as cash from operations less CapEx, was $48.1 million up 10.2%. Our CapEx for the quarter was $5.3 million, including $4.9 million related to real estate compared to total CapEx of $8.2 million in Q4 of last year. Cash flow for the quarter was negatively impacted by the timing of milestone billings associated with certain large contracts, which resulted in a higher than normal level of unbilled receivables, as well as by higher federal tax payments that resulted in a higher prepaid tax position at year-end.

We ended the quarter with $249.7 million in cash and investments and no outstanding debt. Day sales outstanding and accounts receivable was 94 days at December 31, 2017 compared to 93 days at December 31, 2016. In Q4, we repurchased 2,600 shares of our common stock at an average of the $169.93 per share. For the full year of 2017, we repurchased 44,496 share of our common stock at an average of $148.62 per share.

Our backlog at the end of the quarter was a record $1.1 billion, up 17.6%. Software-related backlog, which excludes backlog from appraisal services contracts, was $1.1 billion and 18.4% increase. Backlog included $279.9 million of maintenance compared to $242.7 million a year ago. Subscription backlog was $459.2 million compared to $364.1 million last year and includes approximately $148 million related to 60 e-filing contracts.

Our bookings for the quarter, which are calculated from the change in backlog plus non-GAAP revenues, were approximately $290 million, an increase of 36.8%. For the trailing 12 months, bookings were approximately $1 billion, a 14.8% increase which is a new annual high.

A new metric that we are now providing is the annual recurring revenues of new software subscriptions. Our software subscription bookings in the fourth quarter added a total of $7.1 million in new annual recurring revenue, up 155.5% from $2.8 million last year. For the full year, we added $24.9 million as the annual recurring revenue from software subscriptions, up 61.1%. For comparison, if all of our new subscription contracts had been under license arrangements, we estimate that they would have represented additional license bookings of approximately $7.8 million for the fourth quarter and $33 million for the full year.

We signed 48 new contracts in the fourth quarter that included software licenses greater than $100,000, and those contracts had an average license of $468,000 compared to 57 new contracts with an average license value of $406,000 in the fourth quarter of 2016.

Our guidance for the full year of 2018, which reflects the preliminary estimated impact of the adoption of ASC 606 effective January 01, 2018 is as follows. We expect 2018 GAAP revenues will be between $912 million and $928 million and non-GAAP revenues will be between $913 million and $929 million. We expect 2018 GAAP diluted EPS will be approximately between $3.65 and $3.75, and may vary significantly due to the impact of stock option exercises on the GAAP effective tax rate.

We expect 2018 non-GAAP diluted EPS will be approximately $4.73 to $4.83. For the year, estimated pretax non-cash share-based compensation expense is expected to be approximately $49 million. We expect R&D expense for the year will be approximately $58 million to $60 million. Fully diluted shares for the year are expected to be between 40 million and 40.5 million shares.

GAAP earnings per share assumes an estimated annual effective tax rate of 11% after discrete tax items, and includes approximately $26 million of discrete tax benefits related to share-based compensation, which may vary significantly based on the timing and volume of stock option exercises. We estimate the non-GAAP effective tax rate for 2018 will be approximately 24%. This rate was reduced from 35% for 2017 to reflect the enactment of the Tax Cuts and Jobs Act. This rate is based on Tyler's estimated annual GAAP income tax forecast adjusted to account for items excluded from GAAP income in calculating Tyler's non-GAAP income, as well as significant non-recurring tax adjustments.

The non-GAAP tax rate used in future periods will be reviewed periodically to determine whether it remains appropriate in consideration of factors, including Tyler's periodic effective tax rate calculated in accordance with GAAP, changes resulting from tax legislation, changes in the geographic mix of revenues and expenses, and other factors deemed significant.

We expect our total capital expenditures will be approximately $22 million to $25 million. Total depreciation and amortization is expected to be approximately $59 million, including approximately $35 million of amortization of acquisition intangibles.

The actual impact of ASC 606 is obviously subject to a number of variables and uncertainties, including the mix and timing of new contracts and specific terms contained in individual contracts. For comparison purposes, under the prior ASC 605 basis, our guidance for 2018 would be as follows: GAAP total revenues would be expected to be in the range of $918 million to $934 million; non-GAAP total revenues would be expected to be in the range of $919 million to $935 million; GAAP diluted earnings per share would be expected to be between $3.75 and $3.85; and Non-GAAP diluted earnings per share would be expected to be between $4.81 and $4.91.

Now I'd like to turn the call back over to John for historical further comments

[John Marr, Chairman and Chief Executive Officer]

Thank you, Brian. This was another very strong quarter for Tyler, and we're pleased that we reached the high end of our earnings guidance with our highest quarterly non-GAAP operating margin ever. But the year we exceeded the upper end of our initial earnings guidance even as we faced a significant revenue headwind with higher than expected level of subscription in our new contract mix.

Looking back to 2017, we’re particularly pleased with the progress we made in the public safety area. We significantly expanded our presence in the market with the New World acquisition in late 2015. In 2016, we laid the ground work for that business, investing in the client support organization, developing a strong roadmap for Tyler Reliance and our Integrated Public Safety and Courts and Justice Solution and strengthening our sales organization and process. Those efforts showed tangible results in the market in 2017. We are progressing very well with major development projects that are adding features and functionality to strengthen our competitive position and enable us to compete effectively at the upper end of the public safety market.

The market is viewing our strategy positively. Although, growth in our public safety division was well below our blended company rates in 2017, our public safety win rates and the number of new clients added during the year more than doubled. We also have had success in selling additional Tyler solutions, such as our Brazos e-citation solution into the New World client base. The public safety space has a number of good competitors, but we have a focused long-term strategy and we believe Tyler has unique advantages that will enable us to continue to build momentum and accelerate growth in the coming years.

Public safety is certainly not the only area for our business where we’re investing at high level and product development initiatives. As we outlined at the beginning of last year, we ramped up our R&D spend on a number of project companywide in 2017. And R&D expense increased approximately 10% to $47.3 million in 2017. As we previously discussed, we have an ongoing white space analysis through which we identify gaps in our product suits and prioritize opportunities to improve the competitiveness of our products, broaden our offerings and expand our addressable market.

In many of these cases, we consider bill versus by scenarios. While we continue to pursue strategic acquisitions in many M&A process, especially those that are banker led, we’ve seen transactions take place at valuations that are often well and excess of the level we consider reasonable. We always expect to pay fair prices for our acquisitions. But over the years, we believe we've excised discipline and patients when it comes to making the right decisions on acquisitions.

Our cash flow is robust and growing, and will be enhanced by the reduction of our tax rate starting this year. In addition, with the completion of the expansion of our Yarmouth office, our 2018 capital expenditures will be approximately half of the 2017 level. Our balance sheet is extremely strong with $249.7 million in cash and investments, and no debt at year end. Against that backdrop, we have identified a number of internal development projects that we believe offer high potential to help drive growth and achieve our product objectives, and we’ve made the decision to incrementally increase our discretionary investments in internal product development. As Brian noted in our guidance, we plan to increase our R&D expense by 23% to 27% in 2018 to a total of between $58 million and $60 million.

While the incremental expense is small relative to our cash flow, all of our software development is expensed. So the short-term earnings effect is more meaningful. These new discretionary investments stand our products suites including ERP, planning, regulatory maintenance, courts and public safety. Some of these projects will add features, functionality and technology to enhance our current products and improve our competitive position. Other projects will broaden our offering with new products that will drive new revenue streams. In addition, we are adding resources to our enterprise development group, which focuses on Tyler wide development initiatives that further our connected communities’ vision.

Our singular focus on the public sector help having a deep understanding of our market, anticipating client needs and innovating through long-term vision, such as connected communities have been Tyler’s strength for many years. And we're confident in our ability to continue to make both organic and external investments that will further our strategy and drive long-term success.

We have a solid plan for 2018. There is some noise around the numbers with accounting changes from ASC 606. Looking at our 2018 guidance under ASC 605 accounting comparable to 2017, our non-GAAP revenue growth is just over 10% at the midpoint of our range and our GAAP EPS growth at the midpoint under 605 is 24%. We look forward to building on our fourth quarter with an acceleration of revenues and earnings growth while ramping our R&D investments to drive future growth.

Now, Jaime we will take questions.

[Operator]

Ladies and gentlemen, at this time we’ll begin the question-and-answer session [Operator Instructions]. And our first question today comes from Kirk from Evercore ISI. Please go ahead with your question.

[Kirk Materne, Evercore ISI]

John, I guess the first question I had is for you just on the R&D increase. It seems like it's somewhat opportunistic for you guys to try and take advantage of your position in the market, and the fact things are going well. But I'm just curious. Is this the new norm, this level of spend on an absolute dollar basis? And should -- after we up level this year, should that -- should the incremental growth on R&D normalize back to be in line with revenue or potentially slower than revenue growth as we think about 2019?

[John Marr, Chairman and Chief Executive Officer]

It's a great question, Kirk and it's hard to answer just because we don’t want to handcuff ourselves going forward. I appreciate that now for a couple of years, we've talked about incremental R&D spend that’s discretionary and widens the moat in terms of our leadership position, and at the same time, indentify some new opportunities and broadens our addressable market. That happened last year and we’re reinforcing and maybe even raising the bar a little bit this year.

I generally believe what we’re doing is moving investments that could happen over a longer period of time forward, and adding heads. We certainly add it a lot of heads last year of public safety that could have been done over a longer period of time, but we felt we’re on a position to make those investments and we felt they were important to do. And this year, we’ve identified similar opportunities across the suite of applications that we think are very good investments for us to make.

You combine that with looking at the market today, and as you said being opportunistic. And we're not buying a lot of our stock back, we're not doing a lot of M&A,that certainly could change at any time. But we're in a very strong position to make these investments, and we think it's the right thing to do. It'd be my expectation that again these are moving headcount and investments forward; and will create some lumpiness in the R&D spend; and that we'll grow into it; and we'll achieve the same margins that we've always expected to. But I'd be cautious, because if we see great opportunities in the future that we believe deserve funding, then we'll fund.

So again, a very good question and we'll certainly be as transparent as we can be going forward. We certainly see higher margins and we believe they're completely available to us today. But we think these are the right investment levels for Tyler to have at this point in time.

[Kirk Materne, Evercore ISI]

And then for Brian, just how should we think about the tax -- lower tax rates, again your cash flow. Meaning are there any -- obviously EPS is going up, it's on a lower non-GAAP tax rate. Does that flow directly through to the cash flow number? I guess, I am just trying to get a sense on how should we think about operating cash flow growth, next year?

[Brian Miller, Chief Financial Officer]

Yes, the reduction in the tax rate generally does flow through to cash taxes. So that starting point of going down from roughly 35% to 24%, before the discreet items from stock option exercises, which is a less predictable number but also a cash number, should flow right down to our cash tax provision as well.

[Kirk Materne, Evercore ISI]

So should I think about operating cash flow growing roughly in the same range as EPS next year, is that a fair way or a decent starting point?

[Brian Miller, Chief Financial Officer]

Yes, I'd say that's a pretty decent starting point.

[Operator]

Our next question comes from Brian Kinstlinger from Maxim Group. Please go ahead with your question.

[Brian Kinstlinger, Maxim Group]

Can you talk about your top two or three priorities in terms of product set that you plan to employ the increased R&D budget?

[John Marr, Chairman and Chief Executive Officer]

Well, this year, Brian, different than last year I would have answered public safety, obviously, that we elevated that specifically and the elevation there was disproportionate to other areas. Although, there were again number of discretionary heads added across the other areas as well. This year it's broader, so I can't give you two or three that stand out, it's definitely spread out across significant -- most of our primary applications. There's a fair amount happening at Munis and those are across the board, these functions, technology and innovation really all across the board. So there aren’t one or two lead projects, it's really a distribution ahead across the different applications that we think all make sense.

[Brian Kinstlinger, Maxim Group]

And then my second question is, you mentioned bookings for public safety were the strongest since acquiring New World, and I think you doubled the number of client wins and your win rate. So how far along are you in a process of improving the competitive positioning, being able to bid on larger contracts, and having a more consistent win rate as opposed to maybe this is one quarter maybe two quarters of solid wins?

[John Marr, Chairman and Chief Executive Officer]

The first result is improved win rates in that traditional market, and we've already seen that that actually are pretty consistent with win rates. There’s really been about three quarters now that we’re seeing something in 50% to 100% improvement in there win rates. So that’s we’re cautious to believe whether or not that sustainable. But certainly, those results are very encouraging. The second phase of that is to broaden the addressable market space, namely moving up in the larger jurisdictions and that’s a process. We don’t all of a sudden set the bar at jurisdictions that are several times the size with traditionally been competitive, we’ll gradually grow into that space, and that’s happening.

I think we will see -- you will never know for certain, which deals you would have or not would have won historically. But I think we’ll see deals in the first half of this year that will reflect a more competitive position in the larger jurisdictions.

[Operator]

Our next question comes from Alex Zukin from Piper Jaffray. Please go ahead with your question.

[Alex Zukin, Piper Jaffray]

First, couple of questions just on the guidance, on the same track of as the previous question for public safety. Can you talk about what your guidance for 2018 implies for growth in that business versus the corporate average and compare that to 2017 as well.

[John Marr, Chairman and Chief Executive Officer]

It will again be modestly below the blended Tyler rate. So the win rates experienced in the marketplace are still somewhat leading indicators, but those manifesting themselves in the P&L the back it up are still a little ways out. So we anticipate that public safety to actual recognize revenue this year, will again be modestly below the overall Tyler blended rate.

[Lynn Moore, President]

This is Lynn, just to supplement that. I think there were still some headwinds coming out of the acquisition that are being overcome or that have been overcome by our public safety division. And I think that you see that has an impact as well on the slightly below Tyler rate. But we expect that in the future to catch up and accelerate, and be in line or actually help drive the growth rate going forward.

[Alex Zukin, Piper Jaffray]

And I guess what types of indicators are you guys looking for? Because you’re talking about, over the next couple of years, for this rate to be well ahead potentially the corporate average. So what do you need to see, or has anything changed over the last three or six months to influence that opinion?

[John Marr, Chairman and Chief Executive Officer]

Well, it takes so while. It’s taking probably three years by the time we're done from the beginning through this year for things to settle out. So when we get the company, churn rates were higher and they don’t stop overnight, they are coming down. Tyler generally experiences almost zero, very, very low churn, so that’s an initiatives that has to settle out and is improved on. Wining this business and improving backlog to work from is happening. Again, that leading indicator is reinforced by their experience in the marketplace. And the last thing to happen is that actually shows up in the financial results.

And I think we're looking at later this year and early next year, we’ll start to see their overall top line growth rate accelerate to and then beyond Tyler’s overall rate. And I think that will driver higher margins. The margins are lower now than when we acquired them based on these discretionary investments that we’re making. And we think they will go back to where they were over the next 12 to 18 months certainty.

[Alex Zukin, Piper Jaffray]

And then the other item around guidance. Could you give us a sense for, given the mix shift to subscription in 2017 was a bit ahead of your expectations. Can you talk about how you’re handicapping that for 2018? Do you feel like you need to take a more conservative approach to this given just the dynamics in the industry of your drive to cloud? And help us get a sense for how you’re thinking about that?

[John Marr, Chairman and Chief Executive Officer]

Yes, I think we’ve definitely take into account in our planning process. The mix doesn’t impact each of our business lines equally. We had warrants and businesses that are on POC, so it doesn’t impact it. But in our larger areas in Munis, we certainly budgeted in a higher than traditional adoption rate, I wouldn’t say it's meaningfully higher, but it's certainly higher. And that's two add a little more conservative into our plan.

[Brian Miller, Chief Financial Officer]

Clearly, as we've talked about a number of times, the mix is lumpy and it varies quite a bit from quarter-to-quarter and year-to-year. It's also interesting to note that for 2017, the mix between licenses and subscription and new deals based on dollar volume 63% license, 37% subscription, was exactly the same as it was in 2015. So over that three year period, it's shaking out to be the same. And we do expect that over the long-term there’ll be more of a shift, but our -- the midpoint of our guidance assumes a fairly similar mix to what we saw in 2017. And as you've seen we've widened the range a bit on our guidance, which also gives us a little more room to accommodate to various outcomes that we could do.

[Alex Zukin, Piper Jaffray]

And then just the last one from me and this is a bigger picture questions. But John, given the breadth of the portfolio increasing, given the incremental investments you’re making in R&D. Could you -- I mean we're not now looking for a long-term guide here. But just give me your comfort level for a time horizon that you anticipate being able to maintain double-digit revenue growth. Is this something you think you can do over the next five to 10 years? Is this something that could start to dip a little bit over the next couple of years? Just trying to get a sense of that long-term durability?

[John Marr, Chairman and Chief Executive Officer]

Well, certainly all those things could happen. We dipped down here this past year just below the double-digit level for the year. We're pleased in the fourth quarter we comfortably get back in the double-digits. As we said in the call, the midpoint of our guidance for this year is a little bit above 10%. We believe that the investments we’re making and the things we're doing are helping to curve that backup. And everything we're doing, these investments we’re making and everything we do in the marketplace is to bend that curve backup and get it comfortably above 10% again.

And all indications to us are that that's very reasonable. I don’t know for certain where the growth rate will be three years from now. But we think we have this core growth rate as to weigh the company work. If you take nearly zero attrition; and you take price increases; and you take tail of the on-premise sales we sell and the contribution to recurring revenues there; if you take the deals we know about on the e-file horizon, there are already customers; you look at the SaaS business and those run rates; that puts out about an 8% or 9% growth rate for the overall company here.

And so I think that’s absent any major change in the industry or our position in the industry is our core growth rate is the way we look at it. And so these incremental investments and these things we’re doing, which are a big focus ours and where we’re spending a lot of a discretionary money we’re spending are all about adding that other 2%, 3%, 4%, to get you to the traditional growth levels where we know our model works very, very well. We believe that we’re doing those things that will make that happen. And so we think, I don't know about 10 years, but I think as you look over the next five years that we have a reasonable likelihood to perform in that area.

[Operator]

Our next question comes from Jonathan Ho from William Blair and Company. Please go ahead with your question.

[Jonathan Ho, William Blair and Company]

Just wanted to start out with maybe some thoughts around what you're seeing in the pipeline of opportunity for 2018 and just your general feel for the environment. And whether that is maybe having an impact in terms of your desire to make those additional investments?

[Brian Miller, Chief Financial Officer]

The pipeline and the markets behave very well. The deals are robust. And yes, we certainly believe that making these investments will be received well by a good marketplace that has the capacity to reward us for that. Having said that, we’ve invested through challenging times before. I mean some of the best investments we’ve made historically were during the 2009, 2010 weakness in the markets, because a lot of our competitors didn't and they looked it at the other way and said this is a soft market, why would we want to be investing at this level. And when we came out of that time, we experienced couple of very high double-digit growth years, catching up on the business that had been deferred. So I do think the market is strong right now and I do think we won't have to be patient to get a return on these investments. But really Tyler historically has invested in these products throughout up and down markets and I think that's worked well for us.

[Jonathan Ho, William Blair and Company]

And then just as a follow-up. Can you talk a little bit about the competitive landscape? And are you seeing any shifts there, particularly around the public safety markets?

[Brian Miller, Chief Financial Officer]

There aren't any significant shifts. We said in the prepared remarks, that's a good marketplace, there're strong competitors there. No markets are easy and I think sometimes when we achieve high market share, people think it might be a little less challenging than it is. There're certainly good competitors across the board in those marketplace. And while we get good results, we fight pretty hard to get them and nothing is to be taken for granted. Public safety though, I would say, what happened in tax, what happened in courts where we really became a dominant leader in a pretty short period of time, it's less likely to happen there in that shorter period of time.

As we said, we believe Tyler has some unique advantages and we know we'll invest and execute over the long term. And ultimately, we'll be rewarded with a strong leadership position. But there's strong players in that place, and they're not just going to turn away. So I think this will be a long process to continue to improve our position in that marketplace.

[Operator]

Our next question comes from Scott Berg from Needham and Company. Please go ahead with your question.

[Scott Berg, Needham and Company]

My question Brian is for you around cash flows. If you look at your operating cash flow margins, you're actually down a little bit year-over-year versus '16, and I think it's all working capital related. But does some of that kind of unwind here in '18, or will these be maybe slightly compressed from what we've historically seen?

[Brian Miller, Chief Financial Officer]

I think the factors that we pointed to earlier, the increase in the receivables much of that un-billed related to billings, milestone based billings on some large some large projects we have going on and the timing of those and the prepayment in taxes before we really knew what the level of option benefit we would get in Q4 was, both of those really turn around in 2018. And as we’ve also stated very much lower CapEx in 2018, roughly half the level they were this year. So I think the cash flow margins do improve in 2018.

[Scott Berg, Needham and Company]

Then my follow up for you there, John or Lynn is, you guys can talk all year about the success you’ve had in public safety area, and plenty of questions asked about it today. But you guys enrolled a new theme run connected communities at our conference last year. And I’ve been enamored with it because I get the long term vision of how the products come together, I get the R&D investments and how that will drive that. But are customers understanding what that vision looks like, is that actually impacting a better win rates across your products last year.

[John Marr, Chairman and Chief Executive Officer]

I think customers definitely do see the value in that. We certainly rolled that out at our user conferences. There is a lot of excitement around it. As we said before, it’s a long term process. I don’t know if that specifically isn’t impacted win rates to date. I do expect that it’s going to impact win rates going forward. Whether or not one jurisdiction and its neighboring jurisdiction and their options are between Tyler and other product, and we’re the next jurisdiction and the benefits of those two will bring, if they go with Tyler and they can be connected, both in public safety and then from their court system, that’s the value that we can bring that nobody else can.

We're actively working on that. We talk about it. I don’t know that we’ve specifically seen that as driver in the win rates. I think the driver in our win rates really has been the focus we've done so far as we talked about in prepared comments of shoring up the customer references, doing things on the customer side, as John mentioned, to eliminate some of the churn, all the product investment, the new features and functionality. I think that coupled with the strength of Tyler behind it, the vision of Tyler alliance is, its creating excitement around public safety. And I do think that over the next few years, that’s going to help be the deciding factor in a number of deals that this Tyler alliance vision that you're also excited about.

[Brian Miller, Chief Financial Officer]

It’s also a always a number of things that affects a decision. So it will always be hard to isolate the primary reasons. So we certainly think that contributes to our position in the marketplace. But I would say tangibly what we’re seeing are a lot of multi Tyler suite applications, and a lot of the names that Lynn referred to in the remarks were multi suite applications, Munis and EnerGov, Munis and Muni-Court and then starting to see public safety and Odyssey deals. And no question, people see the incremental value to one Tyler application to another based on our more comprehensive vision.

[Operator]

Our next question comes from Brent Bracelin from KeyBanc Capital Markets. Please go ahead with your question.

[Brent Bracelin, KeyBanc Capital Markets]

Question I had was wanted to circle back to the subscription business. If I just look at revenue mix, its biggest one year increase in revenue mix from 19% to 20% of the mix now since 2014. I think it’s down 42% of software backlog. So as you think about that mix shift this year, is there a preference within local government where you’re starting to see this shift slowly increase more or is there a dynamic here where you’re including e-filing revenue in that subscription mix that just e-filing growth is the bigger factor driving a mix shift on that subscription side? And then I have one follow-up.

[John Marr, Chairman and Chief Executive Officer]

It's definitely broader than e-filing. Munis this past year had a much higher mix, not only higher mix in names the average value of SaaS deals was up significantly. Though, it's pretty broad and it's crapped up into the higher size deals, that maybe the biggest change from previous years as the average deal size was significantly higher. So I think it's fair to say that it's not surprising, government is a little later to adopt this type of delivery than other industries. And I think it's moved for real. And in the stay, I'm not sure that it can get a little ahead of itself in the middle of this past year and maybe it’ll settle down a little bit before it accelerates again. But I think what we’ve expected a long-term gradual shift is exactly what we're experiencing.

[Brent Bracelin, KeyBanc Capital Markets]

So there is still some volatility around the mix trends, but net-net it does sound like that large deal shift. It seems to be the biggest cut change you’re seeing now versus maybe a couple of years ago you weren’t seeing that. As a follow-up to that on the maintenance side, Brian, we saw maintenance growth slowed to 9% year-over-year. I think that's the lowest growth rate in maintenance since we've seen, and at the end of '13 early '14. What are the drivers there to reaccelerate maintenance? Are there some price increases you can flow through? Obviously, as you see the mix shift to subscription, you no longer get the incremental benefit of maintenance. So just trying to think about how we should level set the maintenance growth profile over the next couple of years in an environment where you are seeing a mix shift to cloud?

[Brian Miller, Chief Financial Officer]

Well, clearly that mix shift does affect the maintenance line. It's certainly more than offset on the subscription line, but it’s a combination of more of a new business coming in the cloud. And so again, more than on the subscription line and less new maintenance, as well as the flip to the conversions that we have, and those continue at a steady but pretty pace of the number of customers each quarter that are currently on-premises paying maintenance that move to our subscription model and move to the subscription line, typically at 2x what they were paying in maintenance. But it does have a negative effect on the maintenance line. So those two things together really what have slowed the maintenance growth.

And I think again based on the current mix that 7.5% to 8% growth in maintenance is what you should expect. We do get annual maintenance increases so we work very hard to be very consistent with those and to provide significant value associated with those annual maintenance increases through our evergreen model. And that hasn’t really changed. So we're not seeing really a difference in the way where pricing maintenance increases and our attrition remains very, very low on the maintenance side. So no real changes there, it's really more just a mix of new businesses driving a lower maintenance growth.

[Brent Bracelin, KeyBanc Capital Markets]

So as we think about maybe some downward pressure on the maintenance growth profile over the next few years maybe, the metric when you would look at and is maintenance plus subscription growth rate. I think you referenced that as what growing 14%. So it’s probably the better proxy to look at on a blended basis going forward.

[Brian Miller, Chief Financial Officer]

Yes I would say so. And we are -- I'd say, we’ve always able to add the numbers up. So we're pointing towards that metric and getting the annualized, referring to the annualized recurring revenues of those two combined is something you have to look at.

[Operator]

Our next question comes from Mark Schappel from Benchmark. Please go ahead with your question.

[Mark Schappel, Benchmark Capital]

Brian, first question for you, I have another question on the product mix, in Q4. Was the shift to subscriptions, was this driven by just market preferences in your view, or were there some internal policy or sales incentives that were being offered?

[Brian Miller, Chief Financial Officer]

It's really market driven. Generally, sales reps are compensated very similarly for the same deal, whether it's a subscription or a license deal and our pricing structure has not changed, so we haven't really changed the pricing to try to drive new customers to one model or the other. I'd say that to the extent we are able to do that, we would have a preference towards the subscription model, but we do believe that in most cases, we have a fairly limited ability to push that new customer one way or other. So it's really primarily market driven.

[Mark Schappel, Benchmark Capital]

And then John as a follow-up. Any update on the success you're having with respect to the relatively new online dispute resolution solution?

[John Marr, Chairman and Chief Executive Officer]

Lynn is close that, I'll let him take that.

[Lynn Moore, President]

Mark, it's pretty small acquisition but it's an acquisition that we think has a lot of interest around the country. And we've already had significant interest in our client base. We’ve had a number of jurisdictions who have agreed to sign up for some pilot court systems. We've agreed to some pricing on that. I do think it's something that it does have excitement, like a lot of things that we do, it's going to take some time. It's going to take some time for those revenues to build and grow. But we're looking at something that could, as part of transforming the way justice is done, certainly at certain levels of justice.

I think it's a new efficient way. And I think particularly some of our larger more progressive clients are ready to embrace this and roll it out. So it's going well, but like everything else, it's slow. I don't expect significant or meaningful revenues in the near term. But over the long term, like a lot of our growth initiatives, we expect that it's going to add significant revenues at a little higher rate and add incremental growth to Tyler.

[Operator]

Our next question comes from Peter Heckmann from D.A. Davidson. Please go ahead with your question.

[Peter Heckmann, D.A. Davidson]

Brian, could you just give us a quick update, I know it's a small number. But Microsoft royalties recognized in revenue this year, and then any anticipation of a material change in that relationship in 2018?

[Brian Miller, Chief Financial Officer]

Revenues were relatively flat this year. And as we've seen, it's not really material number, but our total royalties for the year, not including our direct channel, were $3.7 million, last year they were $3.4 million, so not a big movement there. I think I'd like Lynn speak to the relationship and any changes there. Although, there haven't really been any significant lately.

[Lynn Moore, President]

No real significant change. Royalties, I think they’ve increased in the fourth quarter. Our relationship with Microsoft is still good. And I would say, there is no material change at this point.

[Peter Heckmann, D.A. Davidson]

And then if we could maybe shift gears to the state wide deal for e-fillings. Congratulations on Kansas, looks like there is some others in the queue. Can you talk about how many dates have now made an award for an e-filling project, how many those has Tyler won, and the few cases where you’ve lost, whether there maybe some particular issue around technology or anything else that may have pushed decision away from Tyler.

[John Marr, Chairman and Chief Executive Officer]

There is a lot of different categories there, so there’s not a short answer. There are mandatory state wide deals, those are obviously the ones that are fully up the scale and we can see there’s good visibility on the number, where they are click based or fixed contract based on click. And then there is others that is part of the contracts, but they’re not fully on line yet. But generally, our expectation is that all of our existing significant clients will have e-file and some of them will come up with mandatory and we’ll see the spike right off of that, and we like those obviously and some will take time as we have to drive adoption rates over that long term.

I think we’ve really only lost one significant deal at that level, say in the last five years. So our position is very strong and you're going to occasionally lose a deal based on relationship or pricing, or things that we can’t change our model to, to embrace without jeopardizing our overall strategies. So very few losses and again only comes to mind that would have been significant.

[Lynn Moore, President]

And we ever a presence in e-filing in 16 states and I believe all but four of those are state wide, so some California, Georgia, Ohio, we do not have state wide, it’s a county-by-county presence we have there.

[Peter Heckmann, D.A. Davidson]

And then just last follow up on e-filing. Do you see any increase in tendency or preference on the part of states or counties to move towards fixed fee rather than a transaction fees for e-filing?

[John Marr, Chairman and Chief Executive Officer]

I guess so. We've seen a few of them, we've done it. So people know it’s an option. I would stress that you don’t want to over-emphasize the difference, because they’re just looking for better visibility and something we know the government have to budget and that’s what they looking for. So it really tough is just doing the math and putting the number to it that is within the mid range of what would occur. So we're a subscription based and pretty much a quick base organization on that and that’s our model. But if somebody says, hey look, we’ve got a lot of history here, we can see, we know the range, as this, lets negotiate something that’s fair to both sides, obviously, will be a good partner and do that. But we’ve seen more people take us up on that and it gives better visibility to client in the west.

[Operator]

Our next question comes from Kevin Liu from B. Riley FBR. Please go ahead with your question.

[Kevin Liu, B. Riley FBR]

Just a quick follow up to that last question. So for the deals that on e-file that you have seen move to more to fixed fee. Has that generally been with your annual terms fairly flattish relative to what you were doing on a quick basis or do you see any increase or decrease in that rate?

[Brian Miller, Chief Financial Officer]

Generally, very-very close unless their experience changes dramatically, it’s relatively flat. Now renewals are good for us, because we have a lot of cost brining up the initial engagements and while that's been recovered, so flat renewals are not necessarily a bad thing for us.

[Kevin Liu, B. Riley FBR]

And then just one other question you talked about the research product you introduced last quarter. Any sense for how traction for that is building within the marketplace and what's been your experience in terms of how much of an uplift you think you can get from an e-file customer if they adopt that?

[John Marr, Chairman and Chief Executive Officer]

I don’t think we have enough data points yet to point to where that uplift is going to go. We're still at the stage where we’re rolling this out and there is excitement in terms of, for example, Illinois, where we announced it in terms of being fully turned on and fully utilized. We haven't hit that yet. So that's something that we're going to watch overtime. And there is some interest and we've talked before about other states we’re interested in this product, and we think that it's a good driver. But we don’t have enough data points yet to give you more guidance on that.

[Operator]

[Operator Instructions] Our next question comes from Tim Klasell from Northland Securities. Please go ahead with your question.

[Tyler Wood, Northland Securities]

How does the backlog duration look? And then going into 2018, will this be converting into revenue at a different rate than what we've seen previously? Thanks.

[Brian Miller, Chief Financial Officer]

As we've pointed out over the years, the percentage of our backlog -- although, our backlog continues to grow significantly. There is more and more long-term backlog in that number with more subscription arrangements, which are typically I think we said 5.8 years in duration and the new bookings this year, and the multiyear e-filing arrangements, all of those things and as well, some of the large software deals that are multiyear implementations. So that percentage of backlog to be delivered even if the dollars to be delivered in the next year coming out of backlog or larger the percentage is smaller.

So at year-end, it's right at 52% of our backlog of that $1.1 billion is expected to be delivered in the next 12 months, and the balance to be delivered over as long as the next seven years in some cases. And that's come down over the last few years. So last year going into 2017, it was 61% of our backlog, log was expected to be delivered in the next 12 months. And so there is much more long-term visibility in the existing backlog.

[Operator]

Ladies and gentlemen, at this time, there appear to be no further questions. Mr. Marr, I'll turn the call back over to you for closing remarks.

[John Marr, Chairman and Chief Executive Officer]

Well, thank you, Jaime. And thank you all for joining us on the call today. If you do have any additional questions, feel free to reach-out to Brian, Lynn or myself. Have a great day.

[Operator]

And ladies and gentlemen, with that we’ll conclude today's conference call. We do thank you for attending. You may now disconnect your lines.