Tyler Technologies, Inc. (TYL) Earnings Call Transcript & Summary

Hello, everyone, and thank you for joining us for our Growth Stock Conference and today's presentation from Tyler Technologies. My name is Jonathan Ho, and I'm the cybersecurity analyst for William Blair and Company. Our speaker today is Brian Miller, who is the CFO of Tyler. Before we begin, I'm required to inform you that a complete list of research disclosures or conflicts of interest is available at our website at www.williamblair.com. With that, I'll hand it over to Brian to give us an overview of Tyler followed by a brief fireside chat. Thank you.

Good morning, everyone. As Jonathan said, I'm going to give just a little bit of setup for an overview of Tyler for those of you that might not be as familiar with us, and then we'll have a Q&A and talk a little bit more about some of the current events. So Tyler is an enterprise software company focused really exclusively on the public sector vertical market. We're very broad in terms of the breadth of products that we have. We have the broadest set of solutions for the public sector compared to any of our competitors, and we have the largest customer base than anyone serving the public sector, and we work at all levels of the public sector, local, state and federal. We're at -- a very long-term growth story. We've had an acceleration of our shift to the cloud in recent years. So our recurring revenues have grown more rapidly growing north of 20% over the last 5 years. Our SaaS revenue growing close to 30% over the last 5 years and still operating in a very, very fragmented market, so still a sub-10% market share with a really, really long runway ahead of us. As I mentioned we have a wide range of products. This kind of outlines those areas of government that we serve, public admin, ERP is our biggest sector, but we have a large presence, really the leading provider of Courts & Justice Solutions, Public Safety platform technologies includes our transaction-based businesses. So we have a growing business around processing transactions and payments for governments on top of our software platforms, Appraisal & Tax, property taxes, Civic Services, licensing, permitting, things like that. As I said, we're the leading provider of public sector software solutions in the country, we have now close to 85% recurring revenues and consistently generate strong free cash flow. Our clients are very, very sticky. We have about 98% to 99% gross client retention significantly higher than that on a net basis. We really kind of look at our history of Tyler in 3 segments, and I joined the company in 1997. So I've been here through the entire journey as a software company. In the first 20 or so years, we really built the position that we have, both through organic growth and acquisitions, put together the product portfolio we have and assembled a very large and valuable customer base. We expanded that vision in the last 5 years with our move to the cloud and really a big focus on shifting from an on-premise model to a cloud-based model and also really doing a lot of work around further integrating our products and furthering the vision that we have for what we call Connected Communities and enabling jurisdictions to be able to share data, work effectively and sort of break down the silos that exist within the jurisdiction and across jurisdictions, in a region or a state or even across the country. And really, '23 was sort of a [ year of ] inflection for us around our cloud transition, and it marked the trough in terms of margin compression around the cloud transition. It was the point at which our revenues sort of hit that inflection point where our cloud revenues now are greater than our on-premises revenues. And we're really entering a period of what we believe will be accelerated revenue growth and consistent margin improvement going forward. We had an Investor Day last June and set out some both midterm and long-term targets in 2025 and 2030. And those really focus on growing recurring revenues and expanding margins and cash flow. And there's 4 basic pillars to that growth. One is leveraging our installed base. As I said, we have a very large and valuable customer base that has taken decades to acquire. And so that provides us with a huge opportunity for up-selling and cross-selling additional products into that base. And we continue to expand that portfolio of products through both M&A and R&D. Expanding our TAM for many years, we were primarily focused on the local government sector, but in recent years, we've expanded more into the state government, primarily through the acquisition of NIC in 2021 and have sort of dipped into the federal market, and we expect that we'll continue to expand in both of those markets. The cloud transition has a lot of different drivers around it, but that is -- that will continue to be a major both margin driver and revenue accelerator. And then growing our transactions business. We really got into the payment space in a big way through the NIC acquisition. And now there's a big focus on continuing to expand that, driving payments into our software customer base and adding that layer on to complement our software business. The targets we set out by 2030, right now, this year, our revenues will be just a little bit north of $2 billion. Our target is to grow our recurring revenues to north of $2 billion and total revenues to closer to $4 billion by 2030. And you can see our maintenance will continue to run off as our on-premise customers migrate to the cloud. And revenues from the SaaS business will continue to grow at a CAGR in the low double digit -- or the high double digit -- high teens, sorry. Collectively, we expect to drive margins from -- our operating margin was 23% in 2023. We expect that to be north of 30% by 2030, with most of that coming from the gross margin line and quite a bit of that coming from the cloud transition. So some of the big drivers there are exiting our proprietary data centers as we move to AWS. We have what we call bubble costs around the operating our own data centers while we're moving customers into AWS and that be completed over the next couple of years. Optimizing our software solutions for the cloud. Many of our software products were originally developed to be deployed on-premises. And so initially weren't optimized or really efficient in the cloud, and we've gone through development exercises to optimize those products, and that's having a growing impact on our margins. And then consolidating versions. We have a lot of products, but we also have a lot of versions of a lot of products. And so as we move to the cloud, we moved to 1 version of the product for all customers, and that's having an effect on lowering our support costs and lowering our R&D costs, and that process will continue over the next several years as well. So our model is really based on this algorithm, driving strong organic revenue growth and driving margin expansion around that and generates very strong free cash flow. We believe, we've been wise allocators of that capital and have created significant value for the shareholders through that model. A little snapshot of those near and midterm goals. As I said, revenue is growing to $2.3 billion to $2.4 billion with kind of high 80s recurring revenue mix by 2025 and approaching $4 billion by 2030 with more than 90% recurring. And these are all organic targets, so they exclude the impact of potential M&A. And you can see the margin going from 23% in 2023 to around 25% next year and north of 30% the following year. Also our free cash flow margins, we expect to continue to expand right now. There's sort of a short-term impact from the Section 174 tax changes that's impacting our cash taxes that will moderate. And as our margins expand and we expect our cash flow -- our free cash flow margins to go from the high teens to the high 20s. Those goals are aligned with our executive compensation. So based on those same targets drive our long-term compensation. Again, recurring revenue is kind of 10% to 12% CAGR on an organic basis over the next 7 years with recurring revenue growing to north of 90% of that margin expansion to north of 30% and free cash flow growing to the high teens, and we expect to be generating north of $1 billion in free cash flow by 2030. So with that, we can move on to the fireside chat.

Yes. Thank you, Brian, for that overview. So let me just start it off here. Brian, we've known each other for a long time. And in many ways, when I first took a look at the Tyler story back in 2010 until now, there's been many consistent themes and elements in the business. As you look back at your time with Tyler, can you maybe help us think about what are some of the things that stand out that are unique about Tyler and that you think have maybe allowed the company to succeed over the years?

Yes. We have known each other for a long time, we were trying to figure out how many Blair conferences I've been to. I think 15 or so. Yes, I think really, a lot of the success around Tyler is our focus. When I started, we had the same strategy that we have today. It was to create something that didn't exist at the time, a national company with a broad set of products serving, at the time, the local government market, but more broadly, the public sector market. And we set out to put that together, the market was historically served by a lot of fragmented kind of niche companies and still really aside from Tyler, it still is. And so we set out to put that together and we've really kind of stuck to that plan for more than 25 years. So we haven't wavered from our strategy, proved to be a good strategy. And so it's really that laser focus on public sector. That's all we do. I mean we were a vertical software company in 1998, but that wasn't a term then. We were just public sector software company. Now there's a name for it. So I think it's really that laser focus. I think it's the focus on customer service and references and reputation are probably the biggest drivers of buying decisions in our space. Our customers are risk averse. They talk to each other. They don't compete with each other. So having success really kind of builds on itself. And we've executed at a high level over those years with a really strong focus on customer service and taking care of our customers and investing in our products and kind of balancing the 3 constituents, the shareholders, the employees and the customers. And I think we've also been a good allocator of capital. I think we've made -- we've done a lot of acquisitions, roughly 60 acquisitions. But I think we've been very disciplined about valuations, about strategic, about cultural fit. And the way we've used capital has proven to create value.

Excellent. Excellent. One thing that we're often asked by investors is why Tyler has high moats and durability to its business. Can you help us understand sort of the challenges and complexity of building these systems? And why it serves as potentially a higher competitive moat relative to other industries?

Yes. It's -- each of these areas are -- each of the products we have, the functions that we serve in government are all mission-critical functions for government. They're all essential applications, running property taxes, which is generally there, their major source of revenue, 911 systems, managing the courts, licensing and permitting, financials. All those things are essential and each of them have a very specific complex areas. So running public safety or how 911 works or how courts work are complex and very specific. And so we've built up this tremendous domain expertise over decades. Some of the companies that are part of Tyler were around for 20 years before Tyler acquired them. So we have the deep domain expertise that's reflected both in our products, but also in our people, the people that develop the software, the people that implement the software and the people that support the software. So -- and that takes a long time to acquire. So someone could build a system in the cloud and can put something together pretty rapidly and put together a PowerPoint sales demo deck and sell things, but really implementing it, supporting it, building those references and building the trust of your clients takes a long time. And so we've seen competitors kind of come into the space but not really succeed when it comes time to add executing, and we've done that at a high level. We talk about the domain expertise. I think about north of 40% of our employees have worked in the public sector in the past. And so they speak the same language, our customers are confident that we're going to be around for a long time. We're going to continue to invest in our products and bring them the technology and the things they need to continue to succeed.

We've heard from many start-up company that they have underestimated when they entered this space that complexity and the challenges of really implementing these systems. And there are a lot of challenges around implementation, not just from the technology side, but also from the customers being ready to do that as well.

Yes, customers, they often require a lot of assistance around this stuff. They typically -- because our customers are not ROI-driven, they don't have competition. They tend to use software as long as they possibly can. They're not replacing software on a 7-year cycle. They keep the software until it kind of dies if it's from someone other than Tyler. And so that either a homegrown system that they can no longer manage a system from a vendor who hasn't invested in the next generation of technology. I mean, we're replacing systems that were bought in 1999 because of Y2K. A few years ago, we replaced here in Chicago and Cook County replaced the court system, which was a 43-year-old mainframe system that was built in the 70s and they used it as long as they could and they would still use it if they were any COBOL programmers still around to keep it running. So they -- and then when they go through that process, they really -- we have to help them understand how to transform their business processes, how to change, how they do things to use the capabilities of modern software. And so they really look to us to help them make those transformations.

Got it. Got it. Maybe switching gears a little bit to the acquisitions that you've been making as a company I think like -- at least over time, there always seems to be a few blockbuster acquisitions that investors seem to appreciate, but not really understand sort of the time frame in which you expect to see relative revenue synergies and what I'm referencing is that mostly we follow enterprise-type software companies that are relatively short-cycle sales. Synergies are recognized within the first 12 to 24 months. Can you talk a little bit about how that process unfolds for Tyler in terms of recognizing the synergies and some of the key differences that exist...

Sure. When we make acquisitions -- well, almost everything in our space moves more slowly than it does in the private sector. I mean, our sales cycles tend to be long. Obviously, the replacement cycles are very long. And I'd like to say we've got a lot of sort of institutional patients, and you really have to when you're in this space. And sometimes, when we compete with horizontal competitors, which is not very frequently, usually most of our competitors are also focused on the public sector, but just in 1 product area of the public sector. But when we compete with a horizontal ERP company, for example, a Workday or Infor, someone like that, they often don't have that same patients for the public sector. They'd rather be focused on a market where they can make sales in 3 or 4 months as opposed to 18 months from the start to finish. And so their interest seems to kind of ebb and flow in terms of their focus on the public sector. But when we make acquisitions, generally, where -- most of our acquisitions are tuck-ins. So they're adding filling in a gap, sometimes around an existing portfolio of products like in our court space where we're the leading provider of court systems, we've added through acquisitions, a probation system and a jury system. So small niche companies that were focused on a narrow sort of adjacent space. And sometimes, we're adding a bigger sort of new sub-vertical markets. So public safety was an area that we got into through the acquisition of New World in 2015. And then, of course, the NIC acquisition, which was north of $2 billion in 2021 that got us into the state space and into the payments area. So usually when we're buying something, it's because we think it can grow much faster under Tyler and grow faster than our core growth rate. It's something that we can leverage our sales organization that we can leverage our customer base and sell it into that base and drive that growth faster. But often, there's some work that has to be done first. We have to integrate the product with other Tyler products, we have to develop sort of the sales strategy. Sometimes we have to make investments in their product. But generally, in recent years, we're sort of buying things that are ready. But there's a little bit of time around that. It's not the kind of acquisition where we expect to like cut a lot of costs, get rid of a lot of people. It's really more around the integration. Then we have longer sales cycles. So it may be, we start selling it to our customers, but it takes quarters or a couple of years before we're actually seeing that kind of growth. But in the long run, our acquisitions have been a significant contributor. I would say that the acquisitions we've done more recently, and particularly the 3 we did last year, all of which sort of had AI components to them, have been contributing a bit faster. In fact, last quarter, our biggest software deal of the quarter came from an acquisition that we did last August, CSI, which is in the sort of document management and space focus on court. We sold that to Dallas County, which is an existing courts customer and added almost $1 million of ARR from that deal. So I think we're seeing some of these hit a little bit faster, but still our acquisition strategy is a long-term strategy.

Makes a ton of sense. Why is the payments area so attractive to Tyler? I think there's a perception in the market that Tyler is just sort of handling the transaction or payment gateway piece of these deals as the primary value add. Can you help us understand what the main components are to these types of deals? And why you've found this to be an active area.

Yes. And we're not the only software company that has thought that payments on top of their software can make sense. But for us, I think it's really -- it's a very complementary revenue stream. We have a lot of software products that facilitate payments that have payments or revenue coming into the governments of utility billing systems, a big part of what we do, municipal court systems, traffic tickets and fines and fees, licensing and permitting systems, all the things that you pay the government for licenses, property tax, parks and recreation. So lots and lots of revenue coming into the state or into the government through our systems. And then the flip side that is a little bit newer is the disbursement side. So all that money turning around and going back out. And a lot of that is going through a Tyler ERP system. So we have a lot of software that already has payments running through it and so we believe that we can provide really a differentiated offering from a horizontal or a generic payments company because -- primarily because we can integrate that -- the payments into our software and have sort of a seamless -- the system of record, the system that's doing the bill presentment that's accounting for the revenue is integrated with that payment. So the biggest advantage there is that it automates the reconciliation process. So rather than getting a statement from a payment processor and having to manage that reconciliation, it can be automated, which is significant for the government, also able to provide better data, better specific reporting, better insights around their payments. So we believe we have a differentiated offering that can -- and also it gives them kind of one throat to choke. So they're just dealing with 1 vendor. And so we believe that, that enables us to also get premium pricing. Now margins are lower around payments than they are in our software business, but it still provides really strong additional cash flow and in our goals for 2030. We expect that -- we said that we'll be generating north of $400 million of free cash flow from payments, which is more than our cash flow today as for the whole company. So we started out, Tyler prior to NIC. Our payment strategy was really more around, we were sort of a reseller of third-party payments. So we would bring a third-party processor and had really kind of a really light integration. So we really didn't provide all of those benefits and we get revenue share from those third-party vendors. But with the capabilities we got from the NIC acquisition, which a big part of their business was processing payments and facilitating access to state-level systems, and they process north of $50 billion of payments for governments last year. So that -- those capabilities came to us, and now we are the payment processor, and we have that platform that we can now leverage into our local customer base rather than being a reseller and generate more revenue and actually keep more of that revenue than we do through the third parties. We're still in the pretty early days but driving that. We spent the last couple of years combining our payments organization with NICs, integrating the products, developing our go-to-market strategy, figuring out what sales reps sell it payments when we sell it into a software customer, how do they all get paid. And so those things are pretty much in place and we're starting to see some nice growth there. I think last quarter, we had north of 280 new payments deals with our software customers that add roughly $9 million a year in ARR that was up from the fourth quarter, where it was like $170 million and $6 million of ARR. So we're starting to see the sales successes around that, but we're in the -- just the very beginning of it.

Can you walk us through maybe the process for some of these customers to add payments to an existing Tyler solution? Like how easy is it for them to maybe change out an existing gateway existing provider for Tyler?

Yes. We make it pretty easy. I mean typically, governments are not particularly religious around who their payment processor is. Again, we think we have a great story around the added benefits they get. So there's kind of 2 ways. One is with new customers. So if a government is looking for any utility billing system or a municipal court system, and we're responding to an RFP or in a sales process, whether they ask for or not, they're going to get a proposal for payments along with that software solution, and we're going to explain those benefits to them and try to sell that to them. And then we're also going back to our installed base and looking to either replace their existing payment processor, again, by providing those additional benefits or in some cases, they're not doing online payments or not -- they still take checks. So being able to put that together for them. So the actual process of replacing the payment processor from a technical standpoint, is not very hard. But again, we're in the kind of early days of this cross-sell strategy. We're having a lot of success with new customers when we sell a new software system, and we're starting to see some of those processes where we're replacing other payment providers. We also have -- and the payments don't have to be limited to a Tyler back-end system. So we have, for example, payments gateway solution, bill presentment solutions, a cash hearing solution that many of our customers already use that integrate with other third-party payment providers. So we can do enterprise-wide payments. And that's sort of the next step beyond just selling payments associated with the Tyler software solution is to do all of the city's payments because a lot of places right now would have multiple payment providers. They might have Chase for the courts because Tyler brought Chase to them. They're using Paymentus for utility billing and U.S. Bank for the parks and recreation because each of these departments went out and got somebody on their own and so in longer term we have an opportunity to consolidate that just like we do at the state level, where we do all of the payment processing for the state of Florida. So we have the ability to -- certainly, the capabilities to do that. That's a little bit heavier lift in terms of the sales effort, but that's on our road map as well.

Great. Great. Tyler historically has hosted its own SaaS solutions and is now moving to AWS. What inning are we in terms of that move? And can you maybe help us understand the cost synergies that are still left there to recognize?

Yes. Yes, historically, we had 2 proprietary data centers where we hosted our cloud customers in a private cloud. Starting in 2019, we entered into a partnership with AWS to be our primary public cloud provider and decided as we scale and move to really a 100% SaaS business that we don't want to be in the data center business and don't want to continue to scale there. So we started that transition back in 2019 and at the beginning of this year, we signed a new agreement with AWS that further improves our costs and take -- really takes into account the scale that we're working with them at now. All of our new customers are going into -- directly into AWS. And we've had a process underway to move our existing customers that are in our data centers out of those data centers into AWS. And we're about 70% complete with that. Our first -- first of our 2 proprietary data centers will close around midyear this year, so really within the next month or so. And the second one around the end of 2025. In terms of the costs associated with that, we have what we call bubble costs. So a lot of the costs around running our data centers sort of fixed costs. And so as we move our customers out of our data center in AWS, we start paying AWS, but we still have a lot of costs around our own data center until we actually close it. So we're probably [ fourth ] inning in terms of reducing those bubble costs. And so that's part of that margin expansion that we talk about over the next few years as we're able to kind of get those out of the picture. But we're making really good progress and on track with those timetables that we set out a couple of years ago.

Just 1 last one. Can we spend a little bit of time also talking about the spending environment? It seems like this is a very strong spending period with both local government budgets and stimulus still there, at least through 2026. Do you think this is sort of a new normal in terms of spending levels? Or is there some potential that we're pulling forward some demand from future periods?

Yes. I think in recent days, as recent weeks as some of the enterprise software companies have talked about weakening demand and seats. I say that we don't have any seat-based pricing, all of ours are [ tiered ] based on kind of size of government, we don't do seat-base pricing. So I've gotten that question a lot lately. Our environment has been strong. I mean we've said for the last year or so pretty consistently, but it's a very, very active market that -- but certainly back to pre-COVID levels and generally beyond that, the number of RFPs we're responding to, the number of sales demos we're doing, all those things are at very elevated levels, pretty much all-time highs. And right now, that continues. They're not -- they're kind of stable at those elevated levels, but we're not really seeing any signs of those slowing down. The economic backdrop for most of our customers is pretty good. Property values are relatively high. There's not a lot of pressure on property taxes. Most of their revenue sources are pretty strong. And there's the federal stimulus the ARPA plan that's still is providing funds that they've got until the end of 2026 to spend. A lot of those have been allocated but not yet spent. So that kind of provides them with some additional confidence around their budgets. But -- and I think what we're seeing is an increased drive towards digital modernization. So the traditional driver of sales of old system Is dying and needing to be replaced, that is very stable and kind of nondiscretionary. But I think we are seeing some things sort of pulled forward because remote work, hybrid work, where systems -- old systems don't accommodate that. Really a much heightened focus on data. And that data, business intelligence, being able to drive better decisions using data is something that governments haven't done a lot of, and now we're seeing the value of and they need different solutions to help that work. So -- so the budgets -- a lot of governments have June year end. So new budgets are going into place pretty soon. And generally, the indications we have for those are very consistent with last year, broadly across the country. So we really don't see any signs of a slowdown in our space right now.

Excellent. We'll continue the discussion in the [ Richardson breakout ], and thank you, Brian.

Great. Thanks.