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

Extremely happy to have with us at our 10:45 session, Tyler Technologies. With Tyler, we have Brian Miller, EVP, CFO of the company. Brian, thanks for joining us.

You bet. Good to be here.

So just for everyone, we'll go through a fireside chat format. I'll try to run through questions for the first, kind of, let's say, 20, 30 minutes. And then we'll open it up for the audience to ask questions, fire something through on the webcasting portal. If you can't sort that out, feel free to shoot me an e-mail at [email protected]. But the quickest and most efficient will be going directly through that portal. So all right, with that out of the way, Brian, look, I think everyone generally knows what Tyler does but you guys do serve a fairly unique niche. So perhaps just give us a kind of a quick overview of Tyler Technologies, so that everyone is on the same page.

Sure. Vertical software company focused exclusively on the public sector vertical. So everything we do is for the public sector. But within the public sector, we're very broad in terms of the levels of government we serve. So we serve federal, state and local governments, historically, mostly local. So even today, we're probably, 70% or more of our business is with the local governments, cities, county school districts, about, I'd say, 20% to 25% with state governments, most of that through the acquisition of NIC that we did about 3 years ago and then 5% or so federal government. We're also very broad in terms of the breadth of products that we offer governments. So we offer a wide range of sort of mission-critical functions that are applications that automate essential functions of government. So everything from financial systems to court systems, public safety, 911 systems, property taxes, licensing and permitting, really anything that governments do on the back end to operate their business as we provide the software to manage this. And then we, through the NIC acquisition, we have a really big transaction-based business that supplements or complements our government software business and providing payment processing for governments as well as providing access through portals at the state level to conduct transactions with governments generally where we get paid through convenience fees or transaction fees. So -- and that's a business that we expect to continue to grow at or above Tyler's core growth rate over the next several years.

Okay. Perfect. Really appreciate that quick overview there. Look, I feel like we can't get through any of these sessions today without at least initially touching on macro, top of mind for everyone. So maybe what is Tyler seeing from a macro perspective? Historically, how should we think about like what that impact could look like on financials?

Yes. We've talked about really for, I guess, the last year or so, at least our market activity being very strong, certainly back to pre-COVID levels, in most cases beyond pre-COVID levels. So when we think about kind of buying activity, the number of RFPs, we're seeing the number of sales demos we're doing each quarter. Those things are very strong. And we -- our commentary for the last few quarters, including the last one, is that they're at these elevated levels and they're at least stable at elevated levels and in some cases, continuing to grow but a really robust end market and we've not seen signs of that slowing down. Generally, the budget backdrops for governments, again, lots of governments at lots of different levels. But generally, they're in pretty good shape. At the local level, property taxes often are their biggest single revenue stream. And there's not a lot of pressure on property taxes right now. Generally, values are relatively high and -- so those are pretty solid stream. But things like sales taxes, licensing and permitting, just the combination of relatively strong employment and inflation actually helps sales taxes and there's a pretty strong backdrop and it's been supplemented by the federal stimulus, the ARPA funds that are -- they really have until the end of 2026 to spend. So although a lot of those have been committed at this point, they'll -- we'll see them flowing through the -- through their expenditures for the next couple of years. So strong backdrop, we're 98% domestic. So we're not really affected by geopolitical factors. We are -- there's an underlying demand that's just driven by aging systems needing to be replaced. But there are some other things right now that are contributing to that drive and the move to the cloud is certainly one of those.

Okay. Perfect. And so you touched on a few things there that I think would make sense to dive into. So one, the demand has, potentially in certain pockets, gotten back to pre-COVID or above pre-COVID levels. I think that's probably just one of the more surprising comments considering the current climate we're in. Any clear pockets of products or specific verticals within government that you're seeing where there's outsized demand, outsized buying activity right now?

Yes, it's really fairly consistent across the products. There's not really big outliers either on the upside or the downside. It's pretty consistent. One market where we are seeing a lot of success and actually an acceleration of the move to the cloud is the public safety market. So there, we provide certain wide range of systems but the core applications are computer aided dispatch, which is the 911 system and police, fire and ambulance record systems. And then we have a whole lot of ancillary products around that like electronic citations and field reporting. And that's generally a pretty strong market just because it's well funded. It's obviously something that's a high priority in government and there's probably a greater impact from technology changes as -- more so than in some of the other areas of government as more recently, things around more mobile capabilities that have driven some demand there. So it's also a market where there's lot of competition and there are some good competitors there. But we've seen win rates expand. We've seen more success at the upper ends of the market, where we've won some nice Tier 1 deals, like last quarter, the Idaho State Police selected us as their public safety vendor. We've also seen an acceleration in the move to the cloud, which is driving activity there as well. So that's one where we're having a lot of success. But generally, the demand is pretty strong across all of our areas. So there's sort of the underlying demand that's created by sort of the normal factors in government that they tend to use systems for a long time, I mean, multiple decades often until they really get to end of life, until they're dying and then because they don't have competition or they're not profit driven, they tend to be much more tolerant of old systems. So there's this steady replacement cycle that as they get to end of life and then they have to be replaced and it's kind of a nondiscretionary decision. But today, I think we're seeing more activity around systems that aren't necessarily at their end of life but don't support functionality that would be considered more essential today, whether it's providing online access so citizens can conduct transactions online rather than going down to the DMV office, for example or provide the ability for governments to have workers that are remote or hybrid. And often, their systems don't have those capabilities today, a need for greater data analytics. So a desire to have better business intelligence or access to information to make better decisions. And so those are things, I think, that are driving some incremental demand. So this sort of push for digital modernization has become a little bit more urgent and sort of supplements the sort of standard replace the [indiscernible] system, that, sort of that consistent demand that's there.

Got you. Got you. And one of the other things you touched on was the cloud transition. It's something that's been talked about for kind of multiple years now. Can you just update us on where we are from a customer buy-in perspective, a product rollout and then monetization. I'm sure we're at different parts of the different innings across each of those particular areas.

Yes, yes, for sure. And that's really a key to a lot of things around Tyler, right -- our growth opportunities, our margin expansion. A lot of those things are tied to our cloud transition. And last year was really kind of a pivotal year where we've been in a sort of a long-term cloud transition for a number of years but it was sort of an inflection point where we crossed over the point where now our cloud revenues are greater than our on-prem revenues. And we've sort of changed from it being a margin headwind to being a margin tailwind now. So for a long time, for decades actually, Tyler sold primarily on-prem systems and has a huge customer base of customers that are on-prem, requires maintenance. Probably almost 20 years ago, we started offering products in a private cloud or a hosted model and we were neutral for a number of years around how clients chose to deploy their software. So we sold systems either way. And then really going back to 2019 was when we said we're cloud first. We want our customers to be in the cloud, we want to lead our customers to the cloud. And we did a number of things to start to facilitate that shift, to accelerate it. Government is rarely on the leading edge of adopting new technologies or doing new things and that was certainly the case with the cloud. So we saw very relatively slow acceptance of the cloud and a move there. But that's really accelerated since 2019, partially because the market has become more open to it and partially because we've been pushing it and leading our customers that way. So today, in terms of the new business, almost all of our new business is coming to us in the cloud, we really only have a couple of products that we still sell license or on-prem to new customers and public safety is one of those. But even in the last year, that has shifted pretty dramatically towards that market, embracing the cloud. We -- so I think last quarter, it was 97% of our new contract value was in the cloud. I think that it's a 90-ish percent, is kind of where we're -- it varies from quarter-to-quarter but we're around that and moving pretty quickly towards 100% of our new customers coming to the cloud. We still have this big base of on-prem customers that we're migrating. We're, I guess, we talked about it at Investor Day last year. At that point, about 15% of our on-prem customers have migrated to the cloud. We're starting to see that rate of customers flipping to the cloud accelerate. Although we've said really 2025 and beyond is when we expect to see a more rapid acceleration of those flips as we have done some of the groundwork around upgrading customers to the current cloud version of the software and releasing our cloud optimized products that sort of put us in a position to more rapidly flip customers to the cloud. If you look at our overall customer base, at least in a sort of a dollar perspective, today, about 40% of our customers are in the cloud from a revenue perspective and about 60% are still on-prem. We get a really nice uplift, typically, kind of 1.7x to 2x uplift as customers move to the cloud. So there's a big revenue growth opportunity over these next several years as we flip that, that remaining base of customers to the cloud. But there really has been a noticeable shift in the last year around not just customers kind of accepting that they're going to go to the cloud but kind of embracing it. And so that's something where we've got the products. We've got the experience there. We've got a close relationship with AWS, where we host our cloud customers. And that's -- was just renewed earlier this year. And so we're seeing better costs as we see the benefits of more scale there in the new agreement with AWS.

And on this path to 2025 and beyond, as far as flipping customers to the cloud, I get that you guys have definitely -- message intends to accelerate that. We've seen it in the last quarter -- actually, last few quarters. Any other actions from a carrot or stick perspective to kind of move that process along?

Yes, there's a couple of gating items that we've been working on and made a lot of progress in the last couple of years. One I mentioned is, is releasing cloud optimized versions of our products. So a lot of our products were -- and so these are internal items for Tyler. A lot of our products were initially, originally built and architected to be deployed on-prem. So when they're hosted in the cloud, they haven't been terribly efficient. And so over the course of the last 2 or 3 years, we've been developing and releasing cloud optimized or cloud efficient versions of the software, which are cheaper to host and more efficient. Made a lot of progress on that last year. And I'd say this year, we expect to release most of the rest of those products. So that provides us with more efficient products that enables us to accelerate. We don't want to move a lot of customers to the less efficient version. So we wanted to get those out there. Version consolidation is also a big gating item. We not only have a lot of products but in many cases, we have multiple versions of our products that we currently support. That's really expensive from a support standpoint and from a development standpoint. A lot of resources going into those multiple versions in the cloud. Our objective is to have 1 version that all the customers are on, everyone upgrades at the same time. It's a better customer experience but also much more efficient for us. And so in order to get to that point when customers move to the cloud, they either, either before or when they move to the cloud, we want them to upgrade to the current version of the software. And so we've been laying the groundwork for that by sunsetting the older versions of products and eliminating those, moving those customers to current versions, so they're in a position to flip to the cloud, made a lot of progress with that in the last year. And it's a multiyear process that, made a lot of progress with that in the last year, especially around our Enterprise ERP product, our Enterprise Justice product. So those are things that are putting us in a position that as we move forward kind of in the next, say, 3 or 4 years, we can be at kind of on the upper end of the top side of a bell curve around these flips. In terms of the market and customer acceptance or customer desire to move, I think there's a couple of factors there. Today, I think it's more of a carrot approach. Our customers clearly understand that we're only selling new software in the cloud, that, that's our direction. They understand the reasons why that's not just better for us but better for them. We have told clients around most of our products that new features will increasingly only be available in the cloud. So we may support your on-prem product for an extended period of time but there'll be new features and functionality that you want that only will be available in the cloud. Longer term, I think there is certainly stakes available to us, anywhere from increasing maintenance prices to make it more economically attractive to move to the cloud, to just eliminating support of on-prem products that, as we said, this is sort of a process. It's different for each product but that runs out through 2030 and beyond. So it's a multiyear process to move these thousands of customers. And we've got a lot of different work streams around that. But we're definitely seeing a higher interest in moving to the cloud. And one of the factors that's contributing to that is clearly cybersecurity and ransomware attacks. So we're seeing just like in the private sector but the public sector certainly sees its share of, or more than its share of maybe of ransomware attacks generally through phishing or somehow exploiting vulnerabilities and getting into a client's internal network and locking up systems. So to the extent that they either suffer a ransomware attack or peers or neighbors do so, there's a heightened interest in moving to the cloud because of the additional security available or the additional security provided by having those solutions hosted in AWS. So that clearly is a factor in a lot of the flips we see today. And I think it all may continue to be a bigger factor in why customers have a heightened interest in moving to the cloud.

And I guess on that cybersecurity front, I realize it's fairly recent and maybe it hasn't set in but any uplift in conversations with customers after the CrowdStrike, Microsoft, debacle from a few weeks back.

Gosh, I don't know the numbers specifically but, yes, it was a little bit different kind of a situation but it wasn't a really ransom or a cybersecurity. And I don't know that how much difference it would make if they were in the cloud or on-prem with those. But there's certainly a heightened awareness. And I think the key is, a lot of governments, whether it's cybersecurity or other sort of infrastructure management issues, really struggle with running their IT infrastructure. Staffing is a big issue, broadly across governments. They've not rebuilt their workforces from people they lost during COVID. And on the technical side, where they've seen people leave to go to private sector, facing a lot of competition there, a lot of difficulty hiring, paying market rates, replacing aging workforces that retire. So they struggle with managing their IT infrastructure and cybersecurity is just one of the aspects of that. And so moving to the cloud and sort of taking that out of their internal environments provides them with some relief there. And that's something that doesn't appear to be changing.

That totally makes sense. And maybe touching on kind of the longer-term dynamic, you put out 2030 targets, double-digit revenue growth is the general expectation. I think within that, the bridge is, you've got flips, you've got the kind of net expansion ex flips, you've got like all the transactional stuff. Where would you say you're -- we're maybe seeing some outperformance today? Like, as we think about that 2030 estimate, like which of those particular levers arguably has the most, I guess, ceiling, if you would.

Yes. As you said, there's a bunch of sort of underlying drivers to that. There's sort of the core growth rate, which for Tyler has historically been kind of high single digits. There's transactions which we expect to grow a bit above Tyler's overall growth rate. There's the cross-sell and upsell. So leveraging what is the largest customer base in the government software space. But most of our customer -- our average customer has 2 or 3 products from Tyler and could have 8 or 10 products from Tyler. So huge opportunity there. And then the kind of low double-digit growth rates expected through 2030 are organic. So certainly, M&A is part of our history and will be going forward. And generally, we look to acquire people who -- they can grow faster than Tyler Forge growth rate. So all of those are important cross-sell and upsell, certainly one of the bigger drivers given the huge opportunity and we're doing a lot of things around taking advantage of that and accelerating that. But I'd say, of all of those, the one that probably has the most upside opportunity is probably around the transaction revenues. So we're in the very early stages. We acquired a really robust transaction business and a really strong payments platform with the NIC acquisition 3 years ago. Their business is focused on state governments primarily. So we're taking that platform and leveraging our local government customer base by integrating that transaction or the payments platform with our software products like utility billings or traffic court or property taxes so that we have an integrated payment solution with the system of record that produces the bill. And so we're kind of in early stages of selling that to new customers bundled with a new software product or going back to our installed base and selling payments to them around their existing systems and ultimately looking for enterprise-wide payments at cities and counties. So early successes there but a really big TAM just in our existing customer base in terms of the volumes that run through there. Another part of payments that we've only scratched the surface of, is the disbursement side. So we do a lot with inbound payments or acquiring payments. But every dollar the governments take in that goes out, out of the other side. So we've got newer opportunities around facilitating their outbound payments and are really just in the very early days of that. So we've set -- sort of embedded in our -- that long-term targets of low double-digit growth, 9% to 12% overall growth is an assumption around 10% to 13% transaction revenue growth over the next 7 years. But that -- of all the areas that seem to have the most opportunity to outperform, I'd say that's probably the most likely. For example, our -- we've pointed to in the first half of this year, transaction growth, particularly transaction volumes being higher than planned, has really been the biggest contributor to our revenue outperformance this year and raising our guidance in both of the first 2 quarters. And our expectation for growth around transactions in the second half of this year is mid- to high teens growth. Now, as we said, it won't necessarily be linear. And that's not necessarily the rate that we'll see over the next several years but we're actually running ahead of that targeted growth rate right now.

Got it. And touching on the transaction is a fantastic segue into kind of my next question, which is -- from the outside looking in, I think a lot of times, we think of payments as just a commodity and why would -- what's the value prop to switch into some other vendor, if not price? You guys have touched on maybe being able to get premium pricing. So what is the value add? What is the key kind of selling proposition for Tyler when you're going in on a payments transaction?

Sure. And it can be a commodity and that's not the kind of business we're looking to go after. And in fact, some of the historical business that NIC had was more of the commodity type payments. So where there really wasn't a value add, they're competing with or they were competing in some cases with horizontal [Technical Difficulty] payment processors at -- and competing on the basis of price. And that's not what we're -- how we're trying to grow our payments business. So as I mentioned, we've integrated the payments platforms, are integrating it with our software products to create that additional value. So the system of record, say utility billing system that produces a bill, manages that payment once it comes in from Tyler, is integrated with our payments platform so that the transactions match up and it automates reconciliations. So it's different than just getting a statement from a horizontal processor. And now you have to manage, actually manually reconcile it. Where were the chargebacks? Did we get paid for each of the transactions? And so it automates a process that can be a pretty significant headache for governments. Also, we can provide better sort of tailored reporting security features that are tailored to those specific systems and the government. So it really does provide them with tangible benefits that make it a more efficient system. It also just gives them 1 vendor to deal with, so and 1 implementation. So the customers we're seeing are willing to pay a premium price for that. And part of the benefit is that they can often pass part of that on to the payer. So when you pay your utility bill online, you may pay $1 convenience that would go to Tyler. So we not -- we might get 2% plus $1, rather than just getting 2% in a sort of highly competitive payment processing only transaction. And so -- so we're seeing governments that are -- that recognize the benefit of that. And we can do -- we can provide those advantages with that integrated solution. And so we're now bundling it with new software sales. So selling in the utility system or a court system, we'll give the customer, whether they ask for or not, we'll give them a proposal for payments. And then we're going back to our thousands of customers that are using those systems today and looking to either provide online payments for the first time or replace an existing vendor. And sometimes they have contracts that are in place that -- so that may not be something we can do immediately but that might may be 1 quarter or 2 or 3 down the road. And then beyond that, we would like to do enterprise payments. So we don't have to just do payments that have Tyler systems behind them. So in a lot of cases, governments don't have really a payment strategy. So the utility may use 1 payment provider, the Parks & Recreation department uses another, the courts use [indiscernible] mail and a check. So we have the opportunity, kind of a longer-term opportunity in some cases because you're managing multiple agencies but to go in and bring all those together under a Tyler payment system. So there's a couple of different stages to that growth. And then on the disbursement side, the same thing, where we can provide advantages around integration with back-end Tyler systems. So for example, on the court side. We're the largest provider of court systems by far in the country. We have about -- I don't know, 55% or so of the courts in the U.S. that use our case management system to manage courts. We have a jury management application. So a lot of courts -- most courts. I think today, when you serve jury duty you get paid some small amount. I think in Dallas, it's $20 a day for serving on the jury and they actually cut you a check for -- if you serve 1 day, I don't know, 3 or 4 weeks later, you're going to get a check in the mail for $20 and it's really expensive to issue checks, manage checks. There's a lot of fraud around them. So we have a solution that's integrated with our system using the disbursements capability that came to us through the Rapid Financial acquisition a couple of years ago. So when you -- citizens serve jury duty, they get a debit card when they leave at the end of the day and it's cheaper for the courts. We get paid to issue that card and we get a fee when the card is used. So the court gets the savings of not having to manage all those disbursements and it's a better solution, a better experience for the citizen. So we're leveraging our existing court space to now go and sell that system or that payment platform to those jury systems. So there's a lot of different aspects to it but the key is that we can provide value and we have an existing relationship that we can leverage to provide a better solution for the customer.

Got it. Again, I'll pause for a second, see if there's questions from the audience, please submit it into the portal or you can send it to me at [email protected]. I do have 2 questions in the queue right now. The first, are you completely agnostic to which cloud providers use by customers? Or do you direct that decision?

In most cases, we direct that decision or lead the customer there. We have a primary relationship with AWS. We -- our products are agnostic in that they can be hosted in other cloud providers. And we have some customers who might have an Azure relationship already and prefer to go there. And so we can -- our products can be hosted in any -- they're not exclusive to AWS, they're optimized for AWS and that's our primary relationship and the vast majority of our customers, whether they're new customers or flipping customers, move into AWS. We just renewed our -- we just came up on our 5-year anniversary of our relationship with AWS and just renewed it. So we have what we believe are really attractive terms around the hosting costs and especially as we scaled up our volume with AWS, those are pretty much, the more you buy, the more capacity you buy, the lower the unit costs are. And so as we scale there, those costs have come down. AWS provides a lot of support for us and our customers. And so the vast majority of our customers go into AWS.

Got it. And then the second question and this is definitely a new one for me, that is, usually focused on all the U.S. stuff. But can you tell us which part of the government you work for in the U.K.?

I believe what we do in the U.K. is around our data and analytics platform. So we did an acquisition of a company called Socrata several years ago that was a sort of data transparency and a data and analytics platform. So taking data out of these sort of siloed government systems and making it accessible and actionable and interpretable and then as well as often making that data or information transparent to the public. And I believe our clients in the U.K. are primarily on that data and analytics platform. We're today, we're about 98% domestic, most of the 2% that's international is in Canada. But we have some systems, for example, we have a court system in Australia. We have some other -- a few other international systems but the vast majority is domestic. But Socrata had a base of customers internationally, with that product as well.

Got it. And then, so a lot of top line focus. So maybe shifting gears because there is another also equally compelling half of the Tyler story, which is driving leverage, getting operating margins of 500 basis points plus. Maybe just quickly kind of touch us on where should we expect to see that leverage on this path to 2030?

Yes. We've talked about, in 2023, our operating margin was 23% on a non-GAAP basis. We talked about 30% plus is our target by 2030. And so that, that kind of roughly 100 basis points a year, although it won't necessarily be on a straight line, it won't be linear. But there are a number of different factors. Broadly, cloud operations are the biggest driver of that, probably 500 basis points or so of that coming from the cloud. There's a couple of underlying things there, one, I mentioned the release of cloud optimized products. So becoming more efficient in the cloud, improving our unit hosting costs as we continue to scale. The version consolidation is a big part of that. And we've seen some of that starting to impact us now but that's a multiyear process. And so we'll continue to see benefits from version consolidation and then data centers. We've talked about today. We have 2 Tyler data centers or had 2 Tyler data centers where our customers were historically hosted on. We moved those customers to AWS and we're able to eliminate this fixed costs around running those data centers. In the meantime, we have duplicate costs because we have fixed costs around our data centers, while we're starting to pay AWS as we migrate customers out. We closed the first of our data centers on schedule at the end of the second quarter. And we'll start to see some of the benefits of that in the second half of this year. At the same time, we're continuing to move customers out of the second data center and so we see those duplicate costs continue to grow until we close that data center at the end of 2025 and then we'll see additional benefit from that. So most of that benefit coming from cloud operations, there's some benefit that comes from SG&A and marketing costs. There's some leverage there as we continue to scale. And we do expect that our payments margins will continue, even though they're below software margins that they'll continue to improve as we continue to grow more of that payments business through those higher margin and premium pricing payments arrangements, I talked about earlier.

Got it. And then one more from the audience. We've got -- can you give us an overview on the federal strategy? How focused on that area, are you? How big can it be?

Yes, most of our business in the federal -- Tyler at the core is an off-the-shelf software company. We sell -- we don't build one-off systems, we -- and a lot of stuff at the federal level has historically been sort of custom development with systems integrators building big one-off projects. Our business in the federal is primarily through what became our Tyler application platform, which is a low-code development platform for kind of case management or business process management that came through the acquisition of MicroPact several years ago. So we have a low-code platform similar to something like the Pegasystems might have or ServiceNow that is designed specifically for government. It's used mostly at the federal and state level, where we have prebuilt accelerators or prebuilt platforms that can then be customized for different functions. So we do a lot of things like EEOC, claim processing or claims management or case management or security checks and background, or security finances and background checks that we do for a lot of the federal agencies. So we have a big network of systems integrators and partners that we work with there that actually deploy a lot of the software and that has -- have federal relationships. And that's where most of our growth in the federal market is coming from. So we're able to approach that market with an effectively off-the-shelf or a platform type of product but be able to leverage similar kinds of case management opportunities across a lot of state and federal agencies.

Okay. Fantastic. I think with that, we are right up on time. Brian, thank you for participating at the OpCo Tech Conference and to the audience, thank you guys all for tuning in. Have a great day.

Thanks. Appreciate it.