(CA Technologies, Inc., Islandia, NY, www.ca.com) The world's largest diversified software vendor offering more than 500 applications from micro to mainframe. Founded as Computer Associates in 1976 by Charles Wang and three associates, its first product was CA-SORT, a very successful IBM mainframe utility. Its first personal computer software was SuperCalc, one of the earliest spreadsheets. CA Technologies grew via numerous acquisitions over the years, and in 1989, was the first independent software company to reach $1 billion in sales. In 2018, CA was acquired by Broadcom and operates as a Broadcom subsidiary.

There is good news and bad news in American foreign policy . The bad news first: The country’s defense industrial base is hollowed out, leaving the United States without the weapons that it would need in future conflicts and barely able to maintain a precarious peace in the near term.

The good news: The problem is fixable, and doing so would not only strengthen America’s defenses but boost the economy by creating durable jobs.

On all fronts, in other words, America would stop writing checks it can’t cash.

THE SPY BALLOON THAT CHANGED THE US CONVERSATION ABOUT CHINA

We simply don’t have the industrial capacity to maintain our current policy menu indefinitely, which includes aiding Ukraine in its war against Russian aggression and boosting Taiwan to forestall an invasion from China.

Indeed, a new report by the Center for Strategic and International Studies, a think tank in Washington, D.C., detailed the challenges facing the defense industrial base. That study , titled "Empty Bins in a Wartime Environment," concluded that “in the event of a major regional conflict — such as war with China in the Taiwan Strait — the U.S. use of munitions would likely exceed the current stockpiles of the U.S. Department of Defense.”

Some of the report’s findings are bleak.

Seth Jones, the senior vice president of CSIS and the author of the report, said the U.S. would likely run through its stockpile of long-range anti-ship missiles, or LRASMs, a weapon that would likely be used in any showdown with China, in less than a week. CSIS ran war games that showed the U.S. would deplete many key precision-guided munitions in a very short time frame. This occurred, Jones noted , in “virtually every” iteration of the war games.

This is disturbing. As the historian Cathal J. Nolan convincingly argued in his 2017 book, The Allure of Battle, most modern wars are wars of attrition. A protracted conflict would likely take America to its breaking point, possibly leaving it without the means to fight and supply its forces. Such occurrences are not unheard-of. And they are not without severe political ramifications.

In World War I, for example, this happened to Russia and Great Britain. The czar’s inability to field arms properly contributed to the public’s loss of faith in his rule. And the so-called Shell Crisis of 1915, in which British forces had to contend with a shortage of artillery shells, became a scandal that weakened Prime Minister Henry Asquith and led to the rise of his successor, the former Minister of Munitions David Lloyd George.

It’s not just about offense. This problem erodes a country’s ability to prevent war. As Jones noted: “How do you effectively deter if you don’t have sufficient stockpiles of the kind of munitions you’re going to need in a China-Taiwan Strait kind of scenario?”

“The defense industrial base,” Jones has said, “is not prepared for the security environment that now exists.” At present, he warned , the U.S. defense industrial base is operating on a “peacetime footing” that is hardly adequate for the challenges of today, much less those on the horizon. Indeed, those threats are of a different caliber and magnitude than what the U.S. has encountered in latest years.

For the past quarter of a century, the U.S. has been mired in asymmetrical conflicts, primarily with nonstate actors such as al Qaeda and the Islamic State or with third-rate armies such as Iraq's. These are hardly enemies that compare to the military and economic power of the Chinese Communist Party of today.

Indeed, the U.S. military hasn’t fought a war with industrialized nation-state competitors since World War II. Yet both the Biden and Trump administrations have correctly recognized that the world has reentered an era of great power conflict, with America and Europe facing threats from Russia and China. But our defense industrial base has yet to adjust.

As the New York Times reported on Jan. 18, in latest months the U.S. has begun to transfer weapons from stockpiles in Israel to Ukraine. The weapons are stored as part of an agreement in which Israel can request access to the weapons, should it run low — which happened during wars in 2006 and 2014. But otherwise, the stockpiles are only accessible to U.S. military personnel. The U.S. has also requested that the Jewish state transfer its Hawk missiles, which are in storage in the event that they need to be refurbished and used, to Ukraine. The U.S. is also dipping into stockpiles in South Korea to help arm Ukraine.

“Stockpiles in the United States,” the report said, “have become strained and American arms makers have not been able to keep up with the pace of Ukraine’s battlefield operations.” The CSIS study noted that it might take as long as three to seven years to replenish certain munitions that are now being used in Ukraine. With some top U.S. military officials predicting a Chinese invasion of Taiwan by 2025, the U.S. might not have that long. Indeed, there is now a nearly $19 billion backlog in U.S. arms sales to Taiwan.

On Jan. 11, Secretary of the Navy Carlos Del Toro warned that if the defense industry didn’t boost production, arming both the U.S. and Ukraine would soon become “challenging.” Del Toro was responding to comments made by Adm. Daryl Caudle, the head of U.S. Fleet Forces Command, at a Surface Navy Association conference. Caudle openly panic that “the Navy might get to the point where it has to make the decision whether it needs to arm itself or arm Ukraine.” That these officials felt compelled to voice their concerns publicly speaks volumes about how perilous the situation has become.

Nor are they alone.

In April 2022, Deputy Defense Secretary Kathleen Hicks warned of a “substantial decline” in competition in the defense industrial base. Hicks lamented that the U.S. is reliant on a mere “five prime contractors” and called for greater “competition.” Indeed, a February 2022 Pentagon report singled out the 1990s as a time in which “the defense sector consolidated substantially, transitioning from 51 to 5 aerospace and defense” contractors. Now, for example, 90% of missiles come from a mere three sources. The number of suppliers in major weapons systems categories has “declined substantially,” the Pentagon study noted .

Ironically, the U.S. is now suffering from the aftereffects of the “unipolar moment” of the 1990s when America was the sole, uncontested world power after the Soviet Union’s collapse. Those heady days are now gone, as even top administration officials have conceded.

During the 2022 rollout of the administration’s national security strategy, Biden national security adviser Jake Sullivan echoed Hicks’s concerns. Sullivan noted the importance of making “far-reaching investments” in the nation’s “industrial and innovation base.”

Policymakers are right to be worried.

“History has proved that nations once great that neglected their national defense are dust and ashes,” Gen. Douglas MacArthur warned in 1935. MacArthur was then serving as the Army’s chief of staff, battling with Congress over defense budget cuts amid the Great Depression.

As Adolf Hitler’s Germany and Imperial Japan increased their defense spending, the Western democracies of France, Germany, and the U.S. cut theirs.

Yet the Depression alone wasn’t responsible for the sorry state of military readiness on the eve of World War II. The U.S. has often rapidly drawn down its forces after conflict, including after World War I and, in later years, after both World War II and Operation Desert Storm. At the end of World War I in 1918, the U.S. had the fourth-largest army in the world. By the late 1930s, it was 18th — just ahead of the Netherlands.

When then-Brig. Gen. George Patton took over the Army’s 2nd Armored Brigade in the months before Hitler invaded Poland, it had a mere 325 tanks, compared to Nazi Germany’s 2,000. Patton even had to use a Sears and Roebuck catalog to order nuts and bolts for the tanks as the Army’s quartermaster was unable to supply them. As historian Arthur Herman detailed in his book Freedom’s Forge: How American Business Produced Victory in World War II, at the time, the Army had just six working arsenals to manufacture weapons. Eighty-five percent of the machines in those arsenals were over 10 years old, with some stretching back to the 1860s and the Civil War.

As Herman chronicled, it took American ingenuity and government-backed incentives to unleash the country’s industrial might, providing the U.S. and its allies with the “arsenal of democracy” that proved key to victory. But history offers another warning, as well.

The U.S. didn’t start to arm seriously until 1938 — three years before Pearl Harbor. And it was still woefully unprepared and underarmed in the beginning stages of that conflict. Indeed, it didn’t have the means to launch a full-scale invasion of Hitler’s Fortress Europe until the summer of 1944. Absent the use of nuclear weapons, many military planners didn’t think an invasion of mainland Japan would be possible until 1946 at the earliest.

Importantly, the U.S. also had key allies in World War II, such as the Soviet Union and the British Empire, which could tie down their opponents. And even at the war’s opening stages, the U.S. dwarfed Japan as an industrial power. Also: Many of the key American defense industrial planners in World War II had learned from the bitter experiences of World War I, when the U.S. was similarly late to mobilize — and when many arms and material didn’t reach Europe until after the fighting was over.

The U.S. was late to enter both world wars, giving its industrial powers time to gear up and prepare. And it was not initially the primary combatant. Suffice it to say: These are not advantages that the U.S. currently possesses.

In the event of a Sino-American conflict over Taiwan, time is a luxury that the U.S. might not have. As one secretary of defense famously said : “You go to war with the Army that you have, not the Army that you might want or wish to have at a later time.” This is particularly true when it comes to the defense industrial base, which can’t be built overnight.

Encouragingly, there is growing awareness of the deterioration of the defense industrial base. And concern is bipartisan. Lawmakers as ideologically diverse as Rep. Ro Khanna (D-CA) and Sen. Josh Hawley (R-MO), among others, have called to revitalize our nation’s industrial base to better safeguard U.S. interests.

Multiyear contracting for munitions would alleviate some of the fears of companies, allowing them to produce needed arms without incurring undue risks. Indeed, such a strategy was critical to harnessing its industrial strength on the eve of World War II. The U.S. must incentivize industry, cut red tape, and promote innovation.

“Spending more money,” defense strategist Elbridge Colby said , “isn’t necessarily the answer.” Competition is. And that is something that America has historically excelled at. As British Foreign Secretary Edward Grey observed during World War I: “America is like a giant boiler” — once the fire is lit, “there is no limit to the power that it can generate.” That fire needs to be lit — and fast.

As Jacob Helberg, the newly appointed commissioner of the U.S.-China Economic and Security Review Commission, observed, “The decline of American manufacturing jobs and the rise of China as a manufacturing powerhouse” has had “profound consequences for U.S. national security.” It is, he lamented in 2021, “shocking how reliant the U.S. military is on Chinese production.” The U.S. must reduce its dependency on the manufacturing capabilities of hostile nations. This is common sense that needs to be more common.

The past few years have shown the importance of supply chains and the need to reshore critical materials. This will mean more investment upfront. But it will also mean more jobs for the U.S. and key allies.

FOR MORE FROM THE WASHINGTON EXAMINER MAGAZINE

Finally, the very definition of the defense industrial base needs to be expanded to include areas beyond armaments. The growing importance of rare earth metals, which are key to defense technologies, has been belatedly recognized. But China’s chokehold on the production of basic drugs, including penicillin and blood pressure medication, gives Beijing leverage that could allow it to shut down U.S. hospitals — or hamper the fighting ability of American fleets and fighting men and women.

It is incumbent upon both U.S. officials and businesses to do what’s necessary to avert a looming disaster. As MacArthur told journalist Theodore White in 1940: “The history of failure in war can be summed up in two words: Too late.”

Sean Durns is a foreign affairs analyst based in Washington, D.C. His views are his own.

The school year was starting in 10 days, and Donald Keegan was a busy man. An associate superintendent of the North Syracuse Central School District, Keegan had to make sure the bus drivers were trained and the cafeterias fully staffed. He had a tour to lead that afternoon and a school board meeting in the evening.

But that late August morning, Keegan took time to attend a demonstration inside a local factory, where he observed a series of windows being obliterated by an AR-15-style rifle.

Keegan was joined by other school officials from central New York, a school custodian and a pair of school architects. They stood with their arms crossed as Tom Czyz, the founder of Armoured One, a company that sells protective glass and film, fired more than 30 rounds at a window at close range. The room shook with skull-rattling force. By the end of the presentation, Czyz’s arms were speckled with shards of glass and dripping with blood.

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“It’s sad, really,” Keegan said later in an interview. “But it’s part of our job to make sure kids don’t get shot. That is part of the current reality.”

Of all the troubling aspects of gun violence, among the most dispiriting may be scenes like the one in the Syracuse, New York, glass factory: Preparing school administrators for a mass shooting is becoming routine.

Rising gun violence, punctuated by massacres such as the attack at the elementary school in Uvalde, Texas, last year and the shooting on Michigan State University’s campus this week, is fueling not only the debate over gun control but also a more than $3 billion industry of companies working to protect children or employees against mass murder.

The offerings are numerous: automatically locking doors, bullet-resistant tables, Kevlar backpacks, artificial intelligence that detects guns and countless types of training exercises, like breathing techniques to avoid panic during an attack or strategies for how to use a pencil to pierce a shooter’s eyes.

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But even as Congress increases funding for school security measures — including $300 million to help schools “prevent and respond to violence” as part of a bipartisan gun control compromise — the effectiveness of the school security industry’s products and services remains largely unproven.

“This is an entire industry that capitalizes on school shootings; however, these companies have very little evidence that what they are selling works,” said Odis Johnson, the executive director of the Johns Hopkins Center for Safe and Healthy Schools and a Bloomberg distinguished professor at the university. (Billionaire Michael Bloomberg, an alumnus, has been a major supporter of gun control efforts.)

Schools and apartments have to be built to withstand fires and earthquakes, and the Occupational Safety and Health Administration issues fines for hazardous working conditions. But there is no equivalent of rigorous and standard monitoring of whether an employer is reasonably prepared for an active shooter.

This regulatory netherworld, industry executives say, is partly the result of the nation’s political paralysis over guns. Many say protective windows and backpacks would not be necessary if guns, particularly military-style rifles, faced more restrictions. Creating standards for school security against guns, some believe, would be seen as giving in to the notion that mass shootings are a part of American life, that they can be defended against but not eliminated.

Czyz said political leaders who did not support stepping up security measures at schools — or “hardening” them — were naive. “If you aren’t for hardening the schools, then unlock your front door, unlock your windows and let whoever in,” he said. It typically costs about $350 to install an Armoured One protective window in a classroom door, which Czyz said could slow down someone trying to shoot his way into a locked room.

With each new mass shooting, more schools and businesses, even in parts of the country that support stricter gun control, are taking steps to bolster the security of their buildings and train their staff. In a survey of more than 1,000 public schools last year by the National Center for Education Statistics, a research arm of the Education Department, the majority said they were taking some measures, such as putting locks on doors, to defend against shooters. As the threat of violence grows, so is the industry that is offering ways to stop it.

An industry gathers to show off its products.

In one measure of how school shootings have become normalized, the industry holds an annual conference — meeting last summer in Orlando, Florida, just like dairy farmers, golf course managers and tax lawyers did over the past year.

At the Omni Orlando Resort, the National School Safety Conference attracted dozens of businesses selling a wide range of products, from locking devices for classroom doors to a series of “ballistic” tables meant to be used as shields. The participants included law enforcement agents and educators.

Most of the vendors were small operators, but there were a few larger companies like Navigate360 and Raptor Technologies, whose security app was used by the Uvalde School District to alert employees that an active shooter was in the elementary school. But even after a Uvalde school employee used the app, the gunman was able to enter classrooms and carry out the shooting while police officers waited to confront him, which led to more deaths.

The failure of the law enforcement response in Uvalde hung heavily over the conference because many of the technologies and products on display were designed to buy time before the police can arrive. If the police fail to take further action, many of the products cannot ultimately help.

During the day, conference participants attended presentations and walked through a hall of displays. At night, there were entertainment and networking events that are typical of conferences.

A casino night was hosted by ZeroEyes, which sells a software platform that monitors existing security cameras and uses artificial intelligence to detect and warn about people carrying guns into buildings. According to the company, if the AI system picks up what appears to be a gun, it sends an alert to a ZeroEyes employee, who determines whether the threat is real and law enforcement should be dispatched.

Since the company was founded in 2018, ZeroEyes technology has detected “hundreds of guns,” one of the founders, Sam Alaimo, said in an interview. Many detections involve students taking unloaded guns or fake guns to school as pranks.

The company sponsored a social event at the conference to provide attendees a break from the “emotionally exhausting” course of school shootings, Alaimo said.

“Like many others whose business is tied to life and death, such as military personnel, heart and brain surgeons and oncologists, school administrators cannot always remain steeped in the gravity of their severe subject matter,” he said in an email. “A sponsored event at the end of the show is a way to commiserate, decompress and prepare for another day of tackling a major issue.”

‘Trying to change the way people live.’

Some business owners in the active-shooter-defense industry say they are not just selling products but preparing people to defend themselves.

One of them is Ken Alexandrow, a former police officer in Tennessee who runs Agape Tactical, a company that has taught nurses, teachers and church staff techniques for defending against a shooter. His basic sessions cost $1,000.

“We are trying to change the way people live in society,” Alexandrow said over breakfast while visiting New York to discuss his classes with a company that provides unarmed security guards for businesses. “We want to make people responsible for themselves and stop acquiescing security to someone else.”

He said that many training companies focused on teaching people how to run or hide from a shooter, but that meeting violence with violence was also effective. “Fighting works,” he said.

Alexandrow started by training employees and volunteer security guards at churches around the South. These students tended to be older men who were familiar with firearms.

More recently, Alexandrow has branched out into health care and day care.

On his laptop, he played a video of day care workers pouncing on and punching him as he walked through a building in a red padded suit, carrying a fake rifle.

Alexandrow has also trained people how to “drive” a pen, a pencil or a set of keys into a shooter’s eyes and into the brain.

“If they are squeamish, we tell them, ‘Think about what the shooter has in store for you,’” he said.

Joe LeMaster attended a training that Alexandrow held in North Carolina at the Outpatient Surgery Center of Asheville in July. LeMaster, who oversees the surgery center’s nursing staff, said the employees had learned how to rush a shooter, grab a firearm by the barrel and push it toward the ceiling, among other protective strategies.

“It was empowering for them to know there is more options than being a victim and waiting for something to happen,” he said.

It is not clear how many people have stopped a shooter after taking a class, but in some cases, fighting a shooter can reduce injuries and deaths. Two men were credited with halting the gunman at Club Q in Colorado Springs, Colorado, in November by disarming and kicking him in the face. Five people were killed and 18 wounded, and police said the death toll could have been higher if not for the actions of the two men, one an Army veteran and the other a Navy petty officer. In January, a man in Alhambra, California, disarmed a gunman who had killed 10 at a nearby ballroom and prevented him from entering another dance hall, where he appeared ready to shoot more people.

But Johnson, the Johns Hopkins professor, said that while teaching self-defense skills was important, the focus should be on preventing guns from falling into the wrong hands.

“The idea that a teacher escalating the situation by confronting the shooter is not going to have unintended consequences is naive,” he said. “That is why we need comprehensive gun reform to prevent guns from getting into the building.”

Massad Ayoob, who runs “armed citizen” classes around the country, said medical professionals were the most common students in his classes, which include instruction on how to draw a gun and “fast, accurate shot placement.”

“They treat the survivors of violence,” he said. “They see physically the tragedy of these things.”

Ayoob, who is the president of the Second Amendment Foundation, which advocates gun rights, also teaches students how to deal with the psychological and legal fallout after they kill someone.

In Utah, where teachers can obtain permits to carry concealed weapons in schools, the Utah County Sheriff’s Office trains school personnel how to safely handle firearms, techniques to deescalate a conflict and how to shoot at an attacker rampaging through a school. Sgt. Spencer Cannon, a spokesperson for the sheriff’s office, said he was surprised at how many of the attendees — a mix of teachers, speech pathologists and janitors — did not own a gun.

“We expected to have a lot of people who are all about guns,” Cannon said. “But we have people who have never touched a firearm.”

As part of the course, the teachers and other school personnel are taken to a shooting range, where “they get a feel for what they are like,” he said.

A common customer: Educators.

Many of the executives in the active-shooter-defense industry who were interviewed for this article said they did not support more gun restrictions.

Czyz, the owner of the protective glass company in Syracuse, said the gun debate “has blinded” many schools and businesses into overlooking practical steps they could take, while the broader issues remained mired in politics.

“Should we start addressing gun laws and mental health? Yup,” said Czyz, a former homicide detective. “But we have been having the same stupid argument since Columbine in 1999.”

Czyz added that he did not support a ban on military-style rifles because he “does not trust the government” to carry that out effectively.

Maria Cloonan, an administrative assistant at a school in western Massachusetts, said some staff members were panic about the psychological impact that active-shooter training could have on students and faculty.

“Some folks think the training is too strenuous on kids and staff,” said Cloonan, who serves on her school’s “safety team.”

But she said she believed that such training was helpful. Two years ago, when she was director of a nursery school in a church in Springfield, Massachusetts, Cloonan hired a firm run by two former local law enforcement officers to train her teachers how to deal with a shooter. She had grown nervous because of increased crime in the city.

“We hope and pray this doesn’t happen to us,” she said. “But we also hope a child never has to use an EpiPen, but if they do the training kicks in.”

Keegan, the associate superintendent in North Syracuse, said that he thought there should be tighter gun restrictions but that the issue felt distant from his daily reality.

“We certainly hope for greater levels of gun control, but that is not something that we are going to hang our hat on,” he said.

Still, each year, his schools are adding more intense security measures. This fall, for example, North Syracuse has started posting armed officers at its elementary schools, in addition to the middle and high schools.

The school district recently approved about $30 million for safety and security enhancements to its buildings. Keegan is considering buying more of Czyz’s glass. He’s constantly being pitched on new products.

“We are getting hit with people trying to sell us,” he said. “My email is blowing up every day with that stuff.”

© 2023 The New York Times Company

Participants

Brian K. Miller; Executive VP, CFO & Treasurer; Tyler Technologies, Inc.

H. Lynn Moore; CEO, President & Director; Tyler Technologies, Inc.

Hala Elsherbini; Senior Director of IR; Tyler Technologies, Inc.

Ahmed Sami Badri; Senior Analyst; Crédit Suisse AG, Research Division

Aleksandr J. Zukin; MD & Head of the Software Group; Wolfe Research, LLC

David B. Unger; Associate Equity Analyst; Wells Fargo Securities, LLC, Research Division

Gabriela Borges; Analyst; Goldman Sachs Group, Inc., Research Division

Jonathan Frank Ho; Technology Analyst & Partner; William Blair & Company L.L.C., Research Division

Joshua Christopher Reilly; Senior Analyst; Needham & Company, LLC, Research Division

Keith Michael Housum; MD & Equity Research Analyst; Northcoast Research Partners, LLC

Matthew David VanVliet; VP & Application Software Analyst; BTIG, LLC, Research Division

Peter James Heckmann; MD & Senior Research Analyst; D.A. Davidson & Co., Research Division

Robert Cooney Oliver; Senior Research Analyst; Robert W. Baird & Co. Incorporated, Research Division

Saket Kalia; Senior Analyst; Barclays Bank PLC, Research Division

Terrell Frederick Tillman; Research Analyst; Truist Securities, Inc., Research Division

Unidentified Analyst

Presentation

Operator

Hello, and welcome to today's Tyler Technologies Fourth Quarter 2022 Conference Call. Your host for today's call is Lynn Moore, President and CEO of Tyler Technologies. (Operator Instructions) As a reminder, this conference is being recorded today, February 16, 2023. I would like to turn the call over to Hala Elsherbini, Tyler's Senior Director of Investor Relations. Please go ahead.

Hala Elsherbini

Thank you, Emma, 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 provide the safe harbor statement, Lynn will have some initial comments on our quarter, and then Brian will review the details of our results and provide our annual guidance. Lynn will end with some additional comments, and then we'll take your questions.

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H. Lynn Moore

Thanks, Hala. Our fourth quarter results marked a solid finish to an eventful year as public sector demand remains strong and SaaS adoption continues at an accelerated pace. Total revenues grew 4.3%, with organic growth, excluding COVID-related revenues, of approximately 6%, inorganic revenue growth for the full year was solid at approximately 8.2%.

Brian K. Miller

Thank you, Lynn. Yesterday, Tyler Technologies reported its results for the fourth quarter ended December 31, 2022. Both GAAP and non-GAAP revenues for the quarter were $452.2 million, up 4.3% and 4.2%, respectively. Organic revenue growth, excluding COVID-related revenues, were 6% on a GAAP basis and 5.8% on a non-GAAP basis.

H. Lynn Moore

Thanks, Brian. During 2022, we achieved notable milestones towards several key strategic initiatives. We've made meaningful progress on our cloud journey through continued investment in cloud optimization and moving to cloud-only deployment for many of our core solutions. Our intentional innovation is based on knowing our clients and anticipating their future needs.

Question and Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Sami Badri with Credit Suisse.

Ahmed Sami Badri

I had a question about the margin troughing in '23. And maybe you could just provide us color on the ramp on -- from the bottom of '23, what should we be thinking about where margins could go in '24? And I think the big thing here is maybe you could provide us color on like, what are some reasons why the bounce off the trough could be faster versus slower? What are some things that could influence the speed of the margin movements?

Brian K. Miller

Yes, I think it's still a little early for us to provide much color around sort of how we see that trajectory playing out in 2024 and over the midterm, say, over the next 5 to 7 years. As we mentioned in the prepared remarks, we expect to have an Investor Day around midyear and provide more detail on that. But we're still refining those models. So not really able to provide a lot of color on that as we've talked about some of the factors that provide us confidence that we do return to margin expansion in 2024, particularly around the wind down of some of the bubble costs as we exit our first data center. We think that this year actually, we sort of reached that inflection point where the impact of declines in licenses are offset by the current stream of recurring revenues from subscriptions.

H. Lynn Moore

Yes. I think just to amplify on that, we've talked over the last couple of years, we're about 4 years or so into this cloud transition. And we've talked about sort of the two pieces of it, the getting to the other side on the revenue side, and then sort of getting the other side on the cost and expense side. And as Brian mentioned, on the revenue side, we're seeing that sort of inflection point that's going to take place probably later this year. And in the last couple of years, the lost licenses has been a significant impact.

Ahmed Sami Badri

Got it. I want to shift gears a little bit and just talk about your end market, your customers, the funding flywheel. We've clearly started to see some companies that are indexed to federal, state and municipal budgets start to see the benefit of funds flowing in. They could be coming in from ARPA. Some of them are still coming in from the CARES Act. And just in general, state and local budgets are up or up a lot, I guess, in 2022 -- fiscal 2022. And looks like they're going to be up low single digits in fiscal year '23, which means like the base level of staying local budgets are just much higher than what we've really seen before. Have you been able to identify some of those incremental lifts in those budget allocations or federal funds start to come into the business in the form of contracted revenue or bookings?

H. Lynn Moore

I think the answer is probably similar to what we've said in the past. I would say, as I look at our clients' budgets, they're generally very healthy. As I've mentioned before, they were not as impacted by COVID as people thought. They are having access to federal funds. Some of it, Brian -- the timetables of one of that, they still have a couple of years (inaudible). So we're just generally seeing healthy budgets, healthy buying seasons, sort of just a really good, robust market. In terms of identifying specific deals, there are occasions for that. But I think really what it does is it's more about just overall confidence in our clients being willing to spend money.

Operator

Your next question comes from the line of Rob Oliver with Baird.

Robert Cooney Oliver

Great. Lynn, one for you. You mentioned the milestones on the cloud side since 2019 when you pivoted to the cloud-first approach. And certainly, it seems like those are paying off, particularly with new business around subscription, definitely felt that among your customers in Indianapolis last year talking to them about the readiness for cloud. But I wanted to ask a little bit about -- you talked about new flips. How should we think about the pace of conversions. This is clearly going to be an important driver here, they're up modestly from last year, nothing to really write home about. So can you just help us understand how you're thinking about maybe success relative to conversions and migrations of existing customers this year? And then I have a quick follow-up for Brian.

H. Lynn Moore

Yes. Sure, Rob. I think you're right. Our flips actually -- I think they're up quite a bit year-over-year. I think this year, we did about 336 flips. Last year, we did about 239 flips, provide or take. So up roughly 40%. I see flips being a significant driver of revenue growth over the next 5 to 7 years. I see them continuing to grow at a healthy pace. And I don't really -- I'm not in a position to tell you that we're going to grow another 15%, 20% each year, but we have a wide and deep customer base that has become a priority, and we're prioritizing our flips internally.

Robert Cooney Oliver

Great. Okay. Excellent. And then, Brian, just one on the Q4 operating margin was a bit below our expectations. And that could be driven indeed by those flips or by NIC, but just wanted to get a little bit more color on that.

Brian K. Miller

Yes, I'd say probably the two biggest factors there were one that licenses declined pretty significantly, and we've talked about that expectation kind of going into 2023. But Q4 had a bit of a deeper decline from the mix of new business. So licenses were a relatively low number. And again, most of that is a shift in the mix as opposed to less new business. We did -- as we typically have with our more license-heavy products and public safety and platform technologies, some slippage out of the quarter in terms of timing, but that's pretty typical. So I'd say the lower licenses were a big factor. And then -- probably the other factor is the higher R&D expense that we mentioned where some expenses that we had expected to be capitalized were actually expense because of the nature of the development efforts. And so that impacted our margins as well.

Operator

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

Matthew David VanVliet

I guess looking at the margin guide for '23, Brian, and just trying to reconcile kind of where we were previously to maybe some of the moving parts. I know you just mentioned the R&D coming in higher on the expense level than capitalized. I wonder if you could sort of quantify how much of that sort of changed versus what you were previously expecting? It looked like around maybe $6 million flip from capitalized to expense in the fourth quarter. Curious if you have a general sense of what that level will be in '23? And then secondarily, just how much of the compression on the EBIT -- on the operating margin side is from the declining license mix versus the bubble costs versus those R&D expenses? .

Brian K. Miller

Yes. So yes, for the full year, the difference in the capitalized versus expensed R&D versus our expectation was close to $9 million. We gave guidance for R&D for next year in the range of $108 million to $110 million that's expensed and our capitalized R&D in 2023 is expected to be in the high 30s, say, around $37 million. So capitalization is a little bit higher, but R&D expense is higher in 2023. If you look at the sort of the midpoint of our guidance, it implies, I'd say somewhere between 60 and 100 basis points of operating margin compression in total. And we mentioned that the bubble costs are estimated to be about 130 basis points of impact on the 2023 margins.

H. Lynn Moore

So new bubble costs.

Brian K. Miller

So new bubble costs. And that's higher than the impact was in 2022. We talked about those as being a little less than 100 basis points of impact. And that's to be expected because we continue to move more customers into the public cloud and while we're still operating our two data centers. And so the duplicate costs expand this year, and we've talked about an expectation in, I guess, the first half of 2024 that will be out of the first data centers, and that will start to mitigate.

Matthew David VanVliet

Okay. Very helpful. And then looking at -- just trying to square together some of the numbers with the commentary, it sounds like the subscription side and certainly SaaS embedded within that continues to perform quite well. And you're seeing not only new customers, but the flips sort of at elevated rates.

Brian K. Miller

Yes. I think one of the bigger factors around backlog, I think backlog is probably -- becomes maybe a little less meaningful or a little less of a full picture when you look at it is really around how the accounting drives what goes into backlog and what doesn't. So transaction revenues don't sit in backlog. So as we add new payments or new portal revenues typically are under a fixed arrangement. So even though they may be highly predictable and recurring. So there typically wouldn't be an addition to backlog for those. And then we've talked in the past as well about sometimes the terms of a contract agreement dictates how much goes into backlog. So for example, a termination for convenience provision, can significantly limit that, and we saw that with a really large contract last quarter. That was a $50-plus million contract, but only $8 million went into backlog because the termination for convenience provision. So I think there are a lot of factors that start to make the backlog number maybe less of an important metric to look at how we expect to perform going forward.

Operator

Your next question comes from the line of Pete Heckmann with D.A. Davidson.

Peter James Heckmann

A few just clarifications there, and I may have missed some details. So forgive me if I'm repeating myself, but the -- when we look at bookings, we typically see this quarter as a big public safety bookings quarter. Can you talk about how they are receiving the idea of converting to subscription? And then just clarifying, were there any deals, any -- was it contained within bookings in the quarter that were greater than $5 million of TCV?

H. Lynn Moore

Yes. Sure, Pete. On the public safety side, it is typically a little bit larger quarter. We don't typically talk about deals that we've awarded but not signed. I will say that we had a couple of deals that were of significance that pushed for the quarter. We are continuing to see more and more acceptance on the public safety side to the SaaS model and to subscriptions. And I think we're going to continue to see that going forward.

Brian K. Miller

Yes. In this quarter, we did not have any individual contracts that were more than $5 million in total contract base. We had a couple in the $4 million range on the software side. We did have a competitive rebid win with our state enterprise agreement in Colorado, which is one of our bigger states. And certainly, the total value of that contract over the 5-year term is well above $5 million. But on the software side, no individual deals more than $5 million. So it was more of a high volume sort of more mid-range deals this quarter.

Peter James Heckmann

Got it. And so to your point, that bookings might become a slightly less useful metric given how you gross up the TCV related to variable revenue streams and contracts. I missed what you said when you -- on the 500 and some payments deals, what was the TCV related to that? And then can you kind of provide an approximation of how much of that was included in full year bookings? Would it have just been your estimate in the first year?

Brian K. Miller

Yes. And actually, on the payment deals that there really wouldn't be anything that's in the bookings number, only the genuine revenues as they come through in a given quarter, basically run through bookings and revenue at the same time. So for payments, we don't include -- again, because they're not a fixed amount, we don't include those in bookings or in backlog. But those payments deals for the full year, we estimate that they'll add more than $13 million in annual recurring revenues. And there's a mixture of contracts there that are either gross or net processing through our platform and still some deals that are through our reseller arrangements where we have a revenue-sharing arrangement. So the revenues are lower, but the margins are higher on those.

Operator

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

Aleksandr J. Zukin

So maybe just two for me. I guess the first one kind of similar to one of the questions I think that's been asked but maybe on a slightly different metric. Again, the subscription ARR added in the quarter. This quarter seemed to be lower sequentially than the last two. So just maybe clarifying what drove that from a bookings perspective. And then more broadly, as we are much more geared towards subscription and SaaS, how should we think about -- at least how are you guys thinking about kind of net new SaaS ARR, net new kind of subscription bookings growth for '23? And then I've got a quick follow-up on cash flow.

Brian K. Miller

Well, we expect -- clearly, we expect that subscription booking and subscription ARR will accelerate from 2022 and 2023, both on the transaction side and the SaaS software side. Part of that, again, the change in the mix accelerating and a more significant decline in licenses this year with that being replaced by new subscription arrangements. I think the question about just the new subscription ARR. Again, that number really just relates to new software deals. And as we said, there weren't any mega deals in this quarter, but a good volume of sort of midsized deals. I think more of that's just around the timing. We've said that the pipeline continues to be very strong. The RFP activity remains generally stable at pretty elevated levels. So the market activity supports that expectation that we'll continue to see an accelerating rate of new software ARR.

Aleksandr J. Zukin

Okay. Perfect. And then I guess, Brian, from a free cash flow perspective, when you think about the lag or the delta between operating margins and free cash flow for this year, it's obviously a little bit higher than in previous years given some of the items you mentioned around tax and expense or capitalization versus some R&D expenses. As we think about it for '23 and more -- and even more so for '24, what's the right expectation for free cash flow margins versus operating margins as that delta specifically in these 2 years as we kind of trough margins and transition to SaaS?

Brian K. Miller

Yes. I think generally, we would expect that -- and we talked about what our capitalization, our CapEx, both software and non-software CapEx is for 2023. That's a bit higher and some of that's related to software CapEx and some of that's related to facilities investments that we're making in a couple of particular locations. I'd expect that in '24 that, that CapEx would decline. In general, I think our cash flow margin would grow in line with or faster than our operating margin once that CapEx starts to normalize. The impact of the Section 174, which is still a bit unclear, will be significant on cash flow in 2023. Because if it stands, if it's not repealed or -- and we're not the first company or the first software company to talk about this, you're starting to see more of it. I know Microsoft talked about more than $1 billion impact on their taxes.

Aleksandr J. Zukin

Understood. So I guess, is it fair -- once we get through '23 and CapEx starts to trend down, would you expect it to kind of go back to that historical 200 to 300-point delta between margins and free cash flow margins -- operating margins?

Brian K. Miller

I think that's fair.

Operator

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

Gabriela Borges

Lynn, I want to follow up on some of your comments on the demand environment. I think last quarter, you talked about procurement cycle stretching out a little bit. Maybe just provide us an update there? And are you seeing any issue, positive or negative with (inaudible) negative being bottlenecking on procurement and positive being, hey, we don't have (inaudible) we need to accelerate our adoption of technology (inaudible)?

H. Lynn Moore

I don't -- right now, procurement cycles are pretty normal. They're going in line with our clients, budgets are healthy and we're not really seeing delayed procurement cycles right now. Again, from our perspective, the market is relatively healthy. Their budgets are healthy and our competitive position remains strong. So we're seeing a pretty normal -- really above normal market.

Unidentified Analyst

Okay. And my follow-up is on competitive position. So as you think about the progress you've made with your cloud transition and really leaning into that, is there a scenario where you see a pace of share gain or you have pace of displacement (inaudible) potentially already seeing? Is that something that could be on the come a little bit on how it advantages you competitively?

Brian K. Miller

I'll take -- I'll start on that and Lynn can add to that. We do think that in our space that the shift to the cloud and our cloud strategy gives us a competitive advantage. As you know, we compete across products with different competitors and generally in each of our product suites and those range from some very large companies to a lot of smaller, more niche companies. And we think that where we are in the cloud transition is well in advance of where a lot of our competitors are and that desire on our client base to move to the cloud accelerates, that gives us an advantage and an ability to increase our share because of where we are in our cloud transition.

Operator

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

Saket Kalia

Lynn, maybe to start with you. That was helpful detail in your prepared remarks just on the composition of NIC or digital payments when it comes to gross versus net. Maybe the question is, could you put a finer point just on how much of that digital payments business or the transaction revenue one is gross versus net? And then relatedly, how you maybe think about that mix going forward?

H. Lynn Moore

Yes, I'll start, and Brian has probably got better numbers. NIC, which in our Digital Solutions division, I would say the overwhelming majority of their payments business was on a gross basis. I would say, on the Tyler side beforehand, more of it has been on the net basis. It's actually not a lever that we fully control. It's generally controlled by the customer and whether or not the customer wants to take the risk and on the interchange fees or if not, there's a number of factors that go into there. But as of right now, a substantial part of Tyler's overall business is on the gross model because of NIC and where NIC was and how mature and vast that business was. We've got the number for merchant fees that we pass through last year was about -- I think on the NIC side, it was about $142 million and maybe just a handful of $3 million, $4 million, $5 million on the Tyler side. And looking into next year, I think NIC side is probably more around $145-ish million, again, with the same few million more on top from Tyler.

Brian K. Miller

Yes. I don't know that I have a lot to add to that. It clearly is the vast majority. We did mention that a couple of our state enterprise agreements that digital solutions are shifting in 2023 to net from gross and that's got about a $10.5 million impact. But as Lynn said, we don't really fully control that. So I would expect that still going forward, that the majority of the business comes to us through the gross model where we're paying the merchant fees, which is why we want to sort of provide you the apples-to-apples comparison of the margin impact of a couple of hundred basis points, if all of those net ones were on the gross model and you took the merchant fees out of the revenue side.

Saket Kalia

Got it. That's very helpful. Brian, maybe for my follow-up. And apologies, I think this question has been asked a couple of different ways. I just -- I want to try one other way. The question is, maybe how SaaS ARR did versus your own expectations this quarter? I think you said that maybe it was timing. We expect SaaS ARR to accelerate next year. I think it grew about 19% this quarter. I know last quarter had some big deal activity that maybe makes it a tough sequential compare, but I'm just kind of curious how you think about sort of that SaaS ARR growth trajectory this year? And if there's anything that we should keep in mind for how that -- for how that performed this quarter versus your expectations?

Brian K. Miller

Yes, I think it was generally in line with our expectation. I don't know that it was significantly varied from plan. I guess one other factor that plays into that is the lag between when we sign a SaaS deal and when we start to recognize revenues and that can vary, but it can be -- typically, the implementations are quicker or the time from signing to starting to recognize revenues is quicker on a SaaS deal than on an on-prem deal. But that can vary and that can typically be, say, 6 months but can be longer. And -- so I think when I talk about timing, it's more around the difference between when we sign something and when we're starting to recognize revenues.

H. Lynn Moore

I'd say there's two things around timing. One is, just as Brian mentioned, Yes, in the old days, when you sign an on-prem license, you recognize the entire license upfront. On a SaaS deal, particularly when we're doing multi-suite, multi-module deals, they're generally going to start paying those when those particular modules or pieces go live. So you've got a delay from the time you sign to where you get first parts of the customer up live, but as you continue that implementation and other pieces go live, then you'll get that build up. I'd say the other side is when you look at flips, there's things around flips that while long-term, obviously, provide really great long-term value.

Operator

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

Jonathan Frank Ho

Just wanted to, I guess, touch a little bit about cross-sell activity, which you spoke about quite a bit. Is there anything that we could expect to see either inflect or grow even more for 2023 as the NIC relationship has had a little bit more time to mature and with some of the new acquisitions?

H. Lynn Moore

Yes, Jonathan, I mean, cross-selling is one of our major mid- to long-term growth drivers. It's something we're talking about internally as you look out over the next 7, 8 years, talk about Tyler 2030 and things that can really move the needle. It's these things like flips, it's payments, it's cross-selling. It's also a lot of other things that we do really well, and we've talked about areas of our business like supervision, where the market is good or the TAM is good and where we're making really big gains there. But cross-selling is something that we're prioritizing across all of Tyler, where we've actually started some new sort of strategic account management approach within NIC and bringing other resources getting even further exposure to our sales channels, our sales leads. There's things that we will be working on in terms of internally around how we recognize revenues from cross-sells and how we incentivize things. And structurally internally, things that we need to sort of clear out some of those barriers to sort of unleash that power even more. We're pretty excited about it.

Operator

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

Unidentified Analyst

This is actually (inaudible) on for Kirk. So maybe, Brian, just one for you. Curious, are we at the point where there should sort of be more stability in terms of the impact of the subscription transition on revenue versus your guidance? I mean I think we all get at the moving target, but just curious if the level of dispersion is likely to go down from here on that -- in that sense?

Brian K. Miller

Yes, I think so. There's -- we certainly expect a bigger decline in license revenues this year. Licenses are always the most -- or the least predictable of our revenue streams at least in the short term. And so now with well into the 80s as a percentage of our revenues that are recurring, there's much less -- a much higher level of predictability. So I think we're definitely kind of around that corner and that there should be an increasingly higher level of confidence around our outlook versus what we actually -- where results come in.

Operator

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

Terrell Frederick Tillman

Unfortunately for you, I still have some of my questions, even though a bunch have been answered. Maybe, Lynn, the first question for you. It's kind of a twofold first question. And then Brian, I'm going to ask you about payment. Lynn, in terms of those couple of larger public safety deals that slid into the first half, do you expect those to close in the first quarter? And then the second part of the first question for you is, you had a great deal last quarter with the Department of State. And I know it's still small in terms of the federal sector for you all, but just anything you can share about optimism and more we could hear this year on that side? And then I wanted to ask you about payments, Brian.

H. Lynn Moore

Yes. My expectation is that at least one of those larger deals is on track to close in Q1. As it relates to Tyler Federal, I think you're right. I mean things that I'm seeing that's coming out of that division in terms of sales indicators, the pipeline, the volume of deals is up significantly since year-over-year. We're also seeing interestingly enough more and more movement in the federal side to SaaS, which is good to see. It's something that we put an internal focus on in the last 2 years, and we're starting to see more of that receptiveness there. So I think there's positive things coming out of the federal space, and I like our position there right now.

Terrell Frederick Tillman

That's great to hear. And then, Brian, we've gotten a lot of data points on payments, and there's lots of puts and takes, though, particularly the gross to net or when there's a rev share. But could you just like really try to help boil it down in terms of '23, the payments revenue business, I mean, would that grow at about a similar rate in '22? Or just anything you can share about the growth rate on the recognized revenue for payments?

Brian K. Miller

Yes. I think the growth rate on payments is going to be above Tyler's overall growth rate and it's going to be a positive contributor. And I expect that, in general, that will be accelerating from 2022, both from adding new customers through the cross-sell motion, which we talked about. We've integrated our payments teams.

H. Lynn Moore

Yes. As we have our inside sales focusing on that existing customer base, when you look at areas like our enterprise side, whether it's enterprise ERP. We're including payments in all new response -- all new deal responses. That doesn't mean they're getting in every new deal, but we are pushing payments in all of our new deals.

Operator

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

Joshua Christopher Reilly

I'll just ask one question here since we're running over time. The software development costs were only $2 million in the quarter, which is, obviously, below what we were expecting. Can you just discuss the impact of the accounting changes to this figure? And how guidance of $37 million for 2023 is the proper amount implying an increase given the accounting changes that we have here?

Brian K. Miller

Yes. The guidance for 2023 of $37 million in capitalized software development encompasses how we expect those projects to be accounted for. So that's reflected -- that -- the impact of that change is reflected there as well as other capitalized development projects that are either starting or ramping up during the year. So that's fully encompassed there, but the change in expensing versus capitalizing for the full year of 2022 had about a $9 million impact versus what our initial guidance for capitalized software and R&D was.

Joshua Christopher Reilly

And was that just reflected in that Q4 number (inaudible) the full $9 million impact? Or how -- why was that only $2 million, I guess, in the quarter?

Brian K. Miller

Well, it impacted the full year, but most of that impact was seen in the Q4 results. So that resulted in a much lower number in Q4 versus the rest of the year.

Operator

Your next question comes from the line of David Unger with Wells Fargo.

David B. Unger

Just one for me, Brian. I heard your comments in your prepared remarks, you're touching on growing the implementation team in 2023 to meet backlog. Can you just talk about the labor market trends you're seeing and where you stand currently in terms of hires, what we're seeing in terms of wage inflation, et cetera?

Brian K. Miller

Yes, there continues to be challenges in the labor market, but it's definitely mitigating from what we saw last year. Obviously, it's been very common across multiple industries, but certainly in technology where you're seeing layoffs, hiring freezes and -- so there's less pressure, I think, on us in terms of turnover, which is moderating and there's less pressure than we saw last year on wage increases. So each of those are working in a positive manner for us.

H. Lynn Moore

Yes, I'd say, David, if you go back 12 months ago, we were still experiencing really pretty high elevated turnover, still lower than industry, but higher than our norms, which, as you know, as all companies were dealing with it. As we progress throughout the year, things started -- I think I talked a lot about the pendulum and the labor market pendulum is another one that I talk about, and it's definitely started to swing back as we fell back into sort of November, December, I would say our turnover has actually come back down to sort of pre-COVID levels.

Brian K. Miller

Most of the growth in our headcount this year will be in revenue-generating positions.

Operator

Your last question comes from the line of Keith Housum with Northcoast Research.

Keith Michael Housum

Just unpacking the payments just a little bit further, the 571 wins is, obviously, a phenomenal number for the year. Are these mostly agencies that are going to be taking on payments for the first time? Are these actually competitive wins? And what do you see the trajectory, I guess, in 2023 for that same question?

Brian K. Miller

I'd say the majority of that number, although not the majority of the dollars, but the majority of the number would be certainly new payments for most of those customers. So a lot of those are existing Tyler customers where we're adding payments to a utility billing system or a licensing and permitting system. So we may be adding capabilities. They may have only taken checks before and now we're providing online payment capabilities or credit card payments. And a number of those are still under rev share agreements. So the revenue generated is on an individual payment opportunity, maybe relatively small, but at good margins.

Operator

This concludes our question-and-answer session for today. I turn the call back over to you, Lynn Moore.

H. Lynn Moore

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

Operator

This concludes today's conference. Thank you for attending. You may now disconnect.