Tyler Technologies - Q2 2023

Transcript

Operator (participant)

Hello, and welcome to today's Tyler Technologies Second Quarter 2023 conference call. Your host for today's call is Lynn Moore, President and CEO of Tyler Technologies. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will follow at that time. In order to address your questions and stay within the allotted time, please limit your question to one question per person. As a reminder, this conference is being recorded today, July 27th, 2023. I would like to turn the call over to Hala Elsherbini, Tyler's Senior Director of Investor Relations. Please go ahead.

Hala Elsherbini (Senior Director of Investor Relations)

Thank you, Colby, and welcome to our call. With me today is Lynn Moore, our President and Chief Executive Officer, and Brian Miller, our Chief Financial Officer. After I give the Safe Harbor statement, Lynn will have some additional comments on our quarter, and then Brian will review the details of our results and provide an update to our annual guidance. Lynn will end with some additional comments, and then we'll take your questions. During this conference call, management may make statements that provide information other than historical information and may include projections concerning the company's future results, future prospects, revenues, expenses, and profits. Such statements are considered forward-looking statements under the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995 and are subject to certain risks and uncertainties, which could cause actual results to differ materially from these projections.

We would refer you to our Form 10-K and other SEC filings for more information on those risks. 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 tab, schedules with supplemental information, including information about our quarterly bookings, backlog, and recurring revenues. On the Events and Presentations tab, we posted an earnings summary slide deck to supplement our prepared remarks. Please note that all growth comparisons we make on the call today will relate to the corresponding period of last year, unless we specify otherwise. Lynn?

Lynn Moore (President and CEO)

Thanks, Hala. Tyler delivered exceptionally strong Q2 results that exceeded expectations across our key performance measures. We also reached a new milestone for total quarterly revenues, surpassing the $500 million mark for the first time. Our results reflect a high level of execution and collaborative One Tyler approach across our organization that is the foundation of our long-term growth strategy. Total revenue growth was 7.6%, with 10.4% organic growth. Recurring revenue comprised 82% of our quarterly revenues and grew organically almost 11%. It's gratifying to achieve double-digit revenue growth, even as the shift to SaaS and our new software contract mix continue to accelerate, with SaaS deals comprising 82% of our Q2 new software contract value.

Most importantly, SaaS revenues grew organically 20%, our 10th consecutive quarter of SaaS revenue growth of 20% or more. At the start of the year, we characterized 2023 as a pivotal year in our cloud transition, where the significant decline in license revenue is replaced by valuable, long-term, recurring SaaS revenue. Halfway through the year, the accelerated pace of cloud adoption, coupled with our heightened focus on our cloud optimization and migration efforts, position us well to drive sustained long-term growth and operating margin improvement. Operating margins this quarter declined from last year as expected due to our cloud transitions, margins were better than planned because of operating efficiencies. We continue to deliver results that reflect our competitive strength and market-leading position in the public sector.

Key to our performance is our hyper-focus on leveraging our largest asset, our unmatched installed client base, to drive an increasing number of cross-sell and upsell wins, prioritize migration of on-premises clients to the cloud, and capture higher transaction volumes through our unified payment solution. Overall, sales activity is high in what we see as a robust demand environment, with leading indicators such as RFPs and demos generally at or above pre-COVID highs. In addition to software solutions, our unified payment strategy and our Digital Solutions Division continue to prove their tremendous value to our growth algorithm. During the Q2, we signed 132 new payment deals, including a contract with Cook County, Illinois, for traffic court payments. We also signed renewals of our state enterprise contracts in Wisconsin and Connecticut, and extensions of our state enterprise agreements in West Virginia, Illinois, Idaho, New Jersey, and Kentucky.

Additionally, synergies from our disbursements business through our acquisition of Rapid Financial Servicess and deals influenced by Data and Insights continue to materialize and provide compelling offerings in the state and federal markets. I'd like to highlight a few strategic Q2 deals that illustrate these successes. We've seen growing momentum in the public safety market, with our best H1 sales performance since we acquired New World in 2015. During the Q2, we signed contracts with two state police organizations for enterprise CAD and mobility solutions. These marquee license agreements include a cloud deployment for the Oregon State Police and an on-premises deployment for the Missouri State Highway Patrol. Additionally, Harris County, Texas, the third-largest county in the United States, selected Tyler's Enforcement Mobile Solution for eCitations and eCrash applications.

We won a cross-sell opportunity with the Michigan Bureau of Elections, a Digital Solutions Division client, to replace an existing custom solution with Tyler's Application Platform, formerly Entellitrak, with $1.7 million of ARR. We also added our Enterprise Permitting & Licensing platform and One Outdoor solution under our state enterprise agreement in Illinois, with $5.2 million of ARR. 94 clients signed contracts to migrate on-premises Tyler solutions to the cloud, including DeKalb County, Georgia, for their enterprise justice solution, Charleston, West Virginia, for their enterprise ERP solution, and the Wyoming Highway Patrol for their public safety solution. I'd like for Brian to provide more detail on the results for the quarter and our annual guidance for 2023.

Brian Miller (EVP and CFO)

Thanks, Lynn. Total revenues for the quarter were $504.3 million, up 7.6%. Organic revenue growth, which also excludes COVID-related revenues in 2022, was 10.4%. Last year's Q2 included $15.2 million of revenues from COVID-related initiatives at our Digital Solutions Division, formerly NIC, all of which ended in 2022. Subscriptions revenues increased 16.4% and organically rose 16%. Within subscriptions, our SaaS revenues grew 20% to $131.5 million, and transaction revenues grew 13.7% to $166.3 million. On an organic basis, transaction revenues grew 12.8%.

License revenue declined 34.8% as our new software contract mix continued to shift to SaaS at an accelerated pace, with SaaS deals comprising 82% of our Q2 new software contract value, compared to 74% last year. Professional services revenue declined 7.7% due to the absence of COVID-related revenues, but rose 12.9% organically. We added 170 new SaaS arrangements and converted 94 existing on-premises clients to SaaS, with a total contract value of approximately $93 million. In Q2 of last year, we added 167 new SaaS arrangements and had 96 on-premises conversions, with a total contract value of approximately $115 million. As a reminder, in last year's Q2, we signed a $20 million SaaS contract for a digital motor vehicle titling solution in New Jersey.

Our total annualized recurring revenue was approximately $1.66 billion, up 11.2%, and organically grew 11.6%. Operating margins in the quarter were once again pressured by the acceleration of the shift to the cloud in new business and the related decline in license revenues. We've also seen expenses associated with employee health benefits grow well above planned levels during the H1 of the year, and we remain cautious about future increases for the balance of the year and next year. As we've previously stated, we expect operating margins to trough in 2023 and to return to a trajectory of margin expansion in 2024. As we also discussed in prior quarters, merchant and interchange fees from our payments business under the gross revenue model have a meaningful impact on our overall margins.

In Q2, we paid merchant fees of approximately $44 million. If those fees were netted out of both revenues and cost of revenues, our consolidated non-GAAP operating margin for the quarter would have been approximately 220 basis points higher. Both cash flows from operations and free cash flow were negative this quarter at $19.2 million negative and $33.2 million, respectively, mainly due to incremental cash tax payments of approximately $90 million related to the current status of IRC Section 174 capitalization rules. On a pro forma basis, excluding the Section 174 cash taxes, our year-to-date free cash flow would be approximately $120 million, up 19% over last year.

We did not pay down term debt in Q2 due to the elevated cash tax payments, we expect to continue to prioritize debt payments as our cash flow accelerates in the H2 of the year. We ended Q2 with total outstanding debt of $875 million and cash and investments of approximately $148 million, and net leverage at quarter end of approximately 1.55 times trailing 12-month pro forma EBITDA. Our updated 2023 guidance is as follows: We expect total revenues will be between $1.94 billion and $1.965 billion. The midpoint of our guidance implies organic growth of approximately 8%.

We expect GAAP diluted EPS will be between $3.87 and $4.02, and may vary significantly due to the impact of stock option activity on the GAAP effective tax rate. We expect non-GAAP diluted EPS will be between $7.60 and $7.75. Interest expense is expected to be approximately $25 million, including approximately $5 million of non-cash amortization of debt discounts and issuance costs. Other details of our guidance are included in our earnings release and in the Q2 earnings deck posted on our website. In conjunction with our guidance for the full year, I'd like to remind you of the seasonality around our transaction revenues. Transaction revenues will grow year-over-year, we expect they will decline sequentially in Q3 and again in Q4.

Historically, transaction revenues are driven by two primary factors: state-determined deadlines, like corporate filings and hunting seasons, and the number of business days. Transaction revenues typically are at the highest in Q2, coinciding with peak outdoor seasons and tax deadlines. Transactions are at a seasonal low in the Q4, with fewer business days and less activity around the holidays. In addition, starting in Q3, we'll see the revenue impact of contractual changes in one of our state enterprise agreements that includes a move from a gross to net model for payments. I'd like to turn the call back over to Lynn.

Lynn Moore (President and CEO)

Thanks, Brian. We finished a strong quarter, and H1 performance excelled across our business. The quarter was highlighted by two highly successful events: Connect 2023, which was our most attended user conference to date with nearly 6,000 attendees, and our first standalone investor event in 4 years, where we unveiled our Tyler 2030 vision and key growth pillars driving our strategic direction toward organic recurring revenue, long-term CAGR of 10%-12%, sustainable margin expansion with non-GAAP operating margins of 30% or greater, and expanded free cash flow of $1 billion and free cash flow margins in the high 20s. If you didn't attend our Investor Day in person or virtually, we invite you to watch the replay or access the presentations on our website.

It's an exciting time in Tyler's next era of growth, and we see a clear pathway to achieve our mid and long-term goals, guided by a well-defined growth strategy and powerful financial algorithm to deliver sustained value creation and support our public sector clients' digitally empowered future. Now, we'd like to open the line for Q&A.

Operator (participant)

We will now begin the question and answer session. To enter a question into the question queue, please press star one on your touch tone phone. If you are using a speakerphone, please pick up your handset and then press the star key and the number one. To withdraw your request, press the star key, then the number one. As a reminder, please limit your question to one question so we may stay within the allotted time. We will pause momentarily to assemble our roster. Your first question comes from the line of Pete Heckmann from D.A. Davidson. Your line is open.

Pete Heckmann (Managing Director and Senior Research Analyst)

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

Lynn Moore (President and CEO)

Yeah, sure, Pete. I think to start the background, the ERP market is really strong right now. Market activity is good. It's RFPs are up, demos are up. I think we comment on that at the end of the Q1 earnings call. You know, it is a very competitive market. We do see Workday more so at the top end, as you mentioned, more so in larger deals. Really, it's. We see them more in deals where clients may be driven more from a HR point solution rather than a suite solution, and they compete very well there.

You know, we think over the long term that having a suite of products that's fully integrated, is the best bet, and we're competing well when we compete on that front.

Pete Heckmann (Managing Director and Senior Research Analyst)

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

Lynn Moore (President and CEO)

Yeah. No, that's right. That's one of the I think we talked a little bit about that at the investor conference. You know, one of the, I guess, hurdles to getting people into the cloud and getting them upgraded and migrated is some of them are on older versions, and that's something that we're consciously attacking across all our product lines, trying to get to version collapse. Some divisions are a little ahead, more ahead than others.

I think it also sort of highlights what I've said a lot of times is, you know, Tyler's not really going through a single cloud transition, it's going through multiple cloud transitions because we have multiple core applications who are in different stages with different versions out there, different technology, different beginning points, different end points. It's kind of. It's a lot of moving parts. Yeah, that's certainly a key factor that plays across all of them, and different products are in different points right now.

Brian Miller (EVP and CFO)

I'd just add to that.

Lynn Moore (President and CEO)

Okay

Brian Miller (EVP and CFO)

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

Pete Heckmann (Managing Director and Senior Research Analyst)

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

Operator (participant)

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

Matthew VanVliet (VP, Equity Research)

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

Brian Miller (EVP and CFO)

Yeah, I'd say the cadence of bookings has been pretty normal. Our bookings typically are not terribly back-end loaded. Within a quarter, they tend to be, you know, generally spread throughout the quarter. We always have some push to get things in at the end of the quarter, but they're probably different than some of the businesses, software businesses that are focused on the private sector. I don't think there's anything unusual this quarter. As we said, it continues to be a pretty robust market with a lot of activity. In terms of the revenue guidance, typically, we're not making big changes in that.

Through the early part of the year, we did narrow the range, so more confident around where the bottom end and the top end are. Our expectations really haven't changed. It's more around the timing. This quarter, there were a few deals that happened, maybe a little earlier than we planned in the year, our outlook for the full year really hasn't changed much other than to narrow.

Matthew VanVliet (VP, Equity Research)

Okay, great. Thank you.

Operator (participant)

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

Terry Tillman (Equity Research Analyst)

Hi, good morning, Lynn, Brian, and Hala. Thanks for taking my question and follow-up. Maybe, Lynn, first question for you is in terms of unified payments, you know, you called out 132 payment deals. I'm just curious on that kind of revenue synergy side, and now taking into account new use cases around disbursements, how does the back half look in terms of kind of building, you know, confidence in these revenue synergies? Can you keep building on top of, like, 132 payment deals as we move into Q3 and beyond? Just a little bit more around could we see more goodness where you've seen so far?

Lynn Moore (President and CEO)

Yeah, Terry, that's a good question. I think payments is an area where it continues to even outbeat our internal plan, my expectation is that's going to continue. It's something that we push with every deal. It's the more that we get involved, it's also involved in a lot of our inside sales, which also continues to outpace, you know, quarter after quarter. As it relates to Rapid, you know, we're still pretty early. We're what? Nine months, eight months into the Rapid acquisition. We've got a lot of good traction. We've got a lot of deals that are in the works, that are really pretty exciting deals, that we wouldn't have without Rapid, that are gonna add really some extra, you know, extra revenues down the road.

You know, where we are with payments right now is, I'm excited about where we are. I'm really excited about the Rapid deal. It's something that's being pushed throughout our entire sales channel, and I would expect that to continue to grow.

Brian Miller (EVP and CFO)

I would point out that there is a lag typically from the time we sign a new payments deal to the time those revenues start hitting the income statement. It might be a quarter or 2, it might be longer. Often we're replacing an incumbent payments provider, there may be some time period for that change to take place, or the payments are associated with the implementation of a new solution, like the utility billing solution, those payments start when that new system is implemented. The fact that we're continuing to see a growing number of new deals signed bodes well for future revenue growth in that area, but it isn't instant.

Terry Tillman (Equity Research Analyst)

Got it. Thanks for that as well, Brian. I guess maybe, Brian, just a follow-up question, then I'll get back in the queue. It was good to call out that, you know, the lumpiness and large deal kind of exposure that you all have. So the $20 million deal, if you back it out, I mean, the software contract value was down a little bit year-over-year. You know, it sounds like year to date, there's been robust demand activity, but I'm just kind of curious, you know, was there smaller, large deals in the quarter and, you know, compared to maybe last year's 2Q? You know, is there anything we should call out into Q3 that you anniversary like a big deal like last year in 2Q? Thank you.

Brian Miller (EVP and CFO)

Yeah. It was a tough comp from a bookings perspective. This year, our biggest deal was an $8.8 million total contract value, the Michigan Bureau of Elections, and on the SaaS side. Then we had, I guess, 5 other deals that were worth more than $2 million, and one large license deal, the Missouri Highway Patrol deal. Last year, we had the New Jersey deal, which was a $20 million deal, so we don't have anything that approached that size deal this year. We also had a $13 million license deal with the tax system in Montreal. There were just a number of large deals last year. This year was much more, I'd say, kind of normal.

Terry Tillman (Equity Research Analyst)

That's helpful.

Brian Miller (EVP and CFO)

In Q3, I don't believe we have as a meaningful sort of comp issue. I think our biggest license deal was a two and a half million dollar deal. We did have, on the SaaS side, we did have a very large deal with the State Department last year in Q3, which was a total contract value of north of $50 million. We had a statewide supervision deal that was a $15 million SaaS deal. Those will make for a difficult comp on the SaaS side next quarter.

Lynn Moore (President and CEO)

Yeah, I think what's interesting there, Terry, is while there were no huge mega deals this quarter, really across the board, all of our divisions are outperforming plan, and what they're seeing in their sales, and in their pipeline, and in their activity. You know, typically, there's always puts and takes, but really this is really just a strong quarter across the board, both from a revenue standpoint and an execution standpoint.

Brian Miller (EVP and CFO)

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

Terry Tillman (Equity Research Analyst)

Understood. Good luck in the Q3. Thanks.

Operator (participant)

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

Gabriela Borges (Equity Research Analyst)

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

Lynn Moore (President and CEO)

Gabriela, I think the, you know, it's just the RFPs and demos up, is just a function of the market, and I think there's probably still been a little bit of hangover from COVID. We're seeing it really across the board, across all of our business units. As it relates to the quality of RFPs, I think there are certain business units where we're actually probably being even a little bit more selective, which I think is going to increase our win rates. I know we're doing that, for example, at Public Safety. Generally speaking, it's just a healthy market right now.

Brian Miller (EVP and CFO)

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

Gabriela Borges (Equity Research Analyst)

Good stuff. Thank you.

Operator (participant)

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

Josh Reilly (Senior Research Analyst)

All right, thanks for taking my question, and nice job on the quarter here. Subscription and maintenance gross margin was higher in the quarter. Maybe you can give us some color on what drove that increase quarter over quarter, and how is the cloud migration impacting gross margin near term here versus some of the operating expense line items? Thank you.

Brian Miller (EVP and CFO)

Well, I think, we continue to see operating efficiencies, around, you know, a number of aspects of our business, but they're certainly impacting, our recurring revenues and our SaaS business. We're continuing to be very efficient around managing our staffing levels. We're seeing some of the efficiency gains, for example, around the Digital Solutions or former NIC business, that from changes that have been made there, to operate more efficiently. As we expect that as the SaaS revenues grow, margins should continue to expand. I think we're also seeing improved efficiencies around our public cloud, the AWS operations, and better per unit costs as we add more customers there.

Even though we are seeing certainly pressure on margins because of the cloud transition, the things we've talked about, the bubble costs around until we exit our proprietary data centers, we are seeing efficiency gains around those operations as we continue to scale those.

Operator (participant)

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

Saket Kalia (Managing Director and Equity Research Analyst)

Okay, great. Hey, good morning, Lynn, good morning, Brian. Thanks for taking my questions here. Brian, maybe just for you, great to see the SaaS revenue here, I think, continue to grow 20% plus in the quarter. I know that that's the CAGR that we talked about at Analyst Day recently, I think out to 2025. Maybe the question is, should we sort of think about this continuing pretty steady in this range in the medium term? Or should we think about just maybe a little bit of a different shape around SaaS revenue over the next couple of years? Just curious how you think about, you know, kind of this quarter's growth in the context of that long-term target.

Brian Miller (EVP and CFO)

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

I'd expect to see this, you know, growth in this range for the near future.

Saket Kalia (Managing Director and Equity Research Analyst)

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

Brian Miller (EVP and CFO)

Yeah, I think we actually talked about that at our when we gave guidance for the full year. There is one state that's about a 10 and a half that's changing mid-year, so that impact will start to hit this year, and we estimated that at around ten and a half million dollars in the H2 of the year. Probably a little more of that impact is in Q3. It happens really on a state or customer by customer basis. The vast majority of our business is on the gross model, and we expect that to continue to be the case.

Customers generally prefer the certainty and the predictability around having us assume the responsibility for the merchant and interchange fees and have a set percentage that they're going to pay for their payments processing. There are some customers that are willing to accept that risk around those merchant interchange fees and prefer the net model, and sometimes there are changes there, as we've seen this year, really. I think we had 2 states that that's been the case with this year. Again, generally, we would expect that the vast majority of our payments business would continue to be on the gross model.

Saket Kalia (Managing Director and Equity Research Analyst)

Got it. Thanks, guys. Appreciate the time.

Operator (participant)

Your next question comes from the line of Alex Zukin from Wolfe Research. Your line is open.

Ethan Barkon (Research Associate)

Hey, this is Ethan Barkon for Alex Zukin. Thank you for taking the question. I have two parts here. Just first, can you talk a little bit about the shape of the quarter? Just comment a bit about kind of the, the environment coming in and out of the Analyst Day. Then just a question on the SaaS flips, and how did it perform just relative to your internal expectations as we look at about a year, kind of versus the flips versus a year ago, and just how to think about that trending through the rest of this year and into 2024?

Brian Miller (EVP and CFO)

Yeah. The first is around the demand environment. Yeah, the demand environment, as we said in the prepared remarks, is stable or growing generally at or above kind of our pre-COVID highs. Very robust demand environment coming out of Investor Day and really very similar to what we've seen throughout this year and don't see signs of that changing right now. Stable at a high level. With respect to flips, I'd say generally we're performing along plan. The number of flips is very similar to last year, but the dollar value is higher, so we are seeing bigger customers flip. I think that'll continue to be the case, especially in the early days of flips. Most of the customers doing that were on the small end.

Today, we're seeing more of the larger customers. We talked about a couple this quarter that were on the larger side. You know, a large county in Georgia with a court system. As I said, we've seen our first couple of public safety customers flip. I'd say generally, those migrations are in line with our expectations for the year.

Operator (participant)

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

Michael Turrin (Managing Director and Senior Software Equity Research Analyst)

Hey, great, good morning. Thanks for taking the question. I wanted to go back to something that was asked earlier, but with a slightly different tilt. If we look at the subscription mix as a % of total contracts, it's very consistent with what we've seen recently. If we look at the TCV and the term metrics, they're down a bit, and this is less a year-over-year comparison question, and more just wondering if there's anything to call out in terms of customer behavior, whether it's rising rates or something that might be driving a slightly smaller initial deal size. Then just thinking through if there are impacts that flow into the backlog or bookings numbers that we're looking at.

Just wanting to reconcile if there's anything to call out there, and just try to kind of calibrate on maybe what to expect on those metrics for the rest of the year. Thanks.

Brian Miller (EVP and CFO)

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

Don't think there's anything fundamentally changing in the market around that.

Lynn Moore (President and CEO)

Yeah, I think I, I would add there that, you know, generally, there's a couple areas in our business that sign larger deals. Appraisal and tax often has some very large deal, multi-year deals. Our, our courts and justice, enterprise, justice, has some very large deals. You know, the appraisal and tax stuff can be a little cyclical. The large deals, you know, they come, and they go. We've talked about it for years, that's one reason why we stopped talking about bookings numbers and started focusing on different metrics.

I'd go back to my comment earlier today that really, performance across the board has been really solid and actually above plan in Q2, which is pretty exciting to see, given as well as the, our competitive position and sort of the demand nature that's out there right now.

Michael Turrin (Managing Director and Senior Software Equity Research Analyst)

Appreciate the thoughts. Thank you.

Operator (participant)

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

Kirk Materne (Senior Analyst)

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

Lynn Moore (President and CEO)

Yeah. No, that's a, that's a good point. You're right. That's a, that's a big part of our sales strategy. I'd say we actually probably call that more of an upsell opportunity. We talk about cross-sells and upsells. You know, it's a, it's an opportunity to add things like our Data and Insights solutions, our payment solutions, as well as just other, other things. We talked earlier about how, you know, a lot of this requires the customers to upgrade to a, a newer version of the software, which also opens up doors for, for other modules and things that, that are more compatible.

Kirk Materne (Senior Analyst)

Can you talk about just, you know, in terms of moving to the cloud? Obviously, as people start talking more about generative AI and AI in general, you know, take advantage of that. You know, you sort of need to be in the cloud. Has that started to percolate at all as a topic of discussion for customers to move on, over to the cloud, or is it still just super early days in the public sector?

Lynn Moore (President and CEO)

I think from a customer standpoint, the concept of AI is very early days. As you know, our customer base is generally pretty conservative, pretty risk-averse. I think they probably are more on a wait-and-see approach. Now, we at Tyler are not just sitting around taking a wait-and-see approach. We are actively looking at AI. We formed our own AI task committee. We're actively already using a little bit of AI. We're looking at things about how it can improve some of our internal efficiencies. We're looking at things at how it can improve our competitiveness, as well as how it can improve our clients' efficiency. We're looking at that right now, but I would say from a Tyler perspective, we're pretty early on, and from a client's perspective, they're even earlier on.

Kirk Materne (Senior Analyst)

Great. Thank you.

Operator (participant)

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

Charles Strauzer (Senior Managing Director and Research Analyst)

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

Lynn Moore (President and CEO)

Yeah, I mean, it's an unfortunate reality of doing business, is the world of cybersecurity and breaches, and, you know, our clients are not immune to it. I think there's been a fair number of those over the last couple of years. My guess is for the ones that are publicized, there's probably even more that are not. It does create opportunities for us. I think it creates opportunities to flip people into the cloud. It's creating opportunities around, for example, our cybersecurity offering. We didn't talk a lot about it last year.

We had a client last year, in Arizona, that we had been trying to flip to the cloud, for really for some time, and, and they had a, a security breach, and that was the decision point for them to, to pull the trigger and, and flip to the cloud. Again, it's an unfortunate part of, of doing business, but I think that also creates opportunities for our clients to, to move into more secure environments.

Charles Strauzer (Senior Managing Director and Research Analyst)

Great. Thank you.

Operator (participant)

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

Jonathan Ho (Partner and Senior Equity Analyst)

Hi, good morning. Just wanted to maybe understand some of, you know, sort of your comments around, you know, seeing some additional, margin pressure around employee increases. Is this a change relative to your prior expectations? Can you maybe, you know, walk through some of the dynamics or the details around that? Thank you.

Lynn Moore (President and CEO)

Yeah, it's really, it's not around our labor costs generally or our headcount. It was really more around healthcare. You know, we budget healthcare every year. We do the best we can. We model it based on last year's practices, and we've just been experiencing a higher level of employee claims this year than the budget. Last year, I think our employee claims were a little bit below budget. This year, they're trending higher. You know, we're just trying to grapple with that as we go forward. It's something that we're probably modeling to continue throughout the rest of the year. There's ebbs and flows as it relates to healthcare.

Brian Miller (EVP and CFO)

Yeah, clearly, there continues to be higher inflation, I think, on the healthcare side even than in the environment in general. Utilization is up, more high claims experience, so, you know, we continue to monitor it. We believe we have adjusted our expectations for the balance of the year in our guidance. Would point out that it's several million dollars of expense in the H1 of the year above what our expectations were. I think that makes our the performance we've turned in for the H1 of the year even more positive. You see that, you know, throughout our margins, but also especially in the SG&A side.

Operator (participant)

As a reminder, if you would like to ask a question, please press star 1 on your telephone keypad. Your next question comes from the line of Keith Housum from Northcoast Research. Your line is open.

Keith Housum (Managing Director and Equity Research Analyst)

Great, guys. Good morning. Hey, Brian, question for you on your commentary regarding the public safety segment, having the best H1 of the year. Is there something going on in the market that's helping to contribute to that, or is this a market share gain? How do you guys explain, I guess, your success you're having there?

Lynn Moore (President and CEO)

I'd say it's a couple things, Keith. Market activity is really strong in public safety. We're seeing demos right now are on pace for their highest level in a year that we've seen in a long time. Proposals are up. Our competitive position is good. We've done some internal resets at public safety, and really kind of excited about where we are. I mean, we landed three really large deals this quarter, sort of in the range of $1.8 million-$2 million range, which we haven't done in a while. We're excited about what's going on at public safety. We're excited about where the market is and some of the things we've done internally to capture that market.

Brian Miller (EVP and CFO)

The competitive position is continues to improve. We've made investments in that product over the last several years. I think the integration with some of the other acquisitions we've made, like our Enforcement Mobile product, our data and analytics capabilities are very, very strong. All of those things that create a very strong integrated public safety platform, along with the integration to our Courts and Justice platform, continue to improve our market position.

Lynn Moore (President and CEO)

Yeah, our mobility platform, big differentiator. I think what's also encouraging is that we talked about it, I think Brian mentioned in his remarks earlier, is the fact that the public safety market is really starting to slowly, I'll say slowly, but embrace movement to the cloud. It's been sort of moving at a snail's pace. I'm not suggesting it's going crazy, but we are seeing a lot more receptiveness, which was highlighted by some of the deals we talked about earlier.

Keith Housum (Managing Director and Equity Research Analyst)

Great. Thank you.

Operator (participant)

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

Lynn Moore (President and CEO)

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

Operator (participant)

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