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

All right. Good morning. Thank you so much for joining us. Delighted to be on stage with Jeff Puckett, COO of Tyler Technologies. My colleague, Maura Hager to my right. Thank you for joining us.

Thanks for having me.

So Jeff, one of the things that I really appreciate about Tyler. The company has been around since the 1960. And you've been with Tyler Technologies since 1991.

And it's only been a software company since the late 1990's. But yes, I've been there 30-something years.

So I feel like you have a unique perspective here on how a company prove durable across multiple decades, multiple generations. What would you describe as Tyler's core competencies? And how do you now translate that to an AI first of all?

That's a great question. And I think there are some things about, Tyler, that are somewhat unique and especially when people from Silicon Valley or other parts of the industry come to work at Tyler and they say, "Hey, this is different." And the primary difference is the market that we serve, which is primarily state and local government, about 5% federal government, but mostly state and local. It's a slow-moving market. It's very conservative, very risk averse. And it requires us to have built a company that takes a very, very long view of the market. So we don't make decisions around quarterly impacts and in some cases, not even around annual impacts. We try to look out where do we want this 30-year customer relationship to go? And that manifests itself in a lot of ways. We do an implementation project and the customer wants things or there's problems that require us to even lose money on the initial implementation we're willing to do that because of the customer value that we're going to be able to play for over a much longer period of time. That's what I think -- that's what Tyler's secret sauce has always been is that long view.

Well, so it leads really nicely to a question, what do you think the next 30 years and 30 years is a long time. So maybe we say the next 3 to 5 years, we all experienced some of the government organizations that you work with from a consumer-facing or a user-facing standpoint and the technology really quite painful. So give us a little bit of a sense, what are you most excited about if you were to take ERP, for example, in terms of being able to move that technology stack forward, are there 1 or 2 product cycles that you would put in front of us as watch the space?

So I think -- so broadly, across local government specifically, there's kind of a graying effect of the workforce in state and local government. And what's happening behind the scenes is that local government is finding it increasingly difficult to fill open positions and to retain employees, that's putting a really significant impact on their workforce and on their service delivery. So what we're seeing is a much higher demand for technology to compensate for what they previously solved through labor. And I think that opens all kinds of opportunities up for future use of AI in state and local government. And in looking to basically rethink processes that are anchored in not just decades, but in some cases, hundreds of years of behavior and statute that govern the way that the government works. So I think if you look forward into the next 30 years, their labor circumstances are going to force behavioral changes in government that have been elusive in the past.

Yes. And that leads nicely into a question on some of the near-term priorities as well because this year, there has certainly been an elevated volume of conversation on modernizing government infrastructure, primarily in the federal level, but certainly, there is an impact on state and local as well. The same forcing function could be had for state and local. So talk to us a little bit about, are you seeing more catalysts for change. And on the flip side, has there been any incremental disruption into your typical sales processes in your conversation?

So early in the year, if anyone was paying attention to the newspapers at the beginning of the year, there was a lot of generalized anxiety in our marketplace around the world. Okay, what's happening at the federal government level and how is it going to impact us? And that did cause some delays and pauses and elongation of procurement processes. But I think we've washed through all of that at this point in time. And I think in the local government space specifically, that's been heavily discounted. It's not going to have a long-term impact. What happened at the federal government level, less so at the state level. There is -- there are elements where state funding is derived through federal funding sources and less about the DOGE initiative and so forth, but just the disruption in the flow of funds, it also creates some noise. I don't think it's a structural. It's -- I think it's a kind of a temporary effect on how fast procurements occur.

Yes. Well, maybe the other way to ask this question. So you're talking about the growing effect and the pressure on labor. What do you think needs to happen to accelerate change or to take the technology budget? However you want to benchmark them at your customers, one could argue that the technology budgets should be meaningfully higher on how state and local government thinks about technology adoption. So curious your thoughts on that. What do you think has to happen to level off modernize.

I think, first, I think everybody has to have realistic expectations about what local government, state government can do and how fast they can move. All the incentives are against them to make dramatic changes. So the effect is going to be incremental improvement. And success breeds success, breeds success. So if you can show a customer that, hey, you're doing this manually with 50 people, we can replace this at a higher level of accuracy, a higher level of service for 20% of the cost using AI, they'll do that every day of the week. I think they're going to be less prone to making speculative bets on technology or AI than what we'll see in the private sector, just out of their nature. Again, all the incentives are lined up against them, taking those kinds of risks. And so they're going to look for the private sector to lead the way in innovation and then they're going to copy and steal from that.

Yes. Well, actually, it's a great opportunity to talk a little bit about AI. And more specifically, how do you get your customers comfortable at this early stage with some of the more leading-edge technology products that you have? Or is the answer you've just got to wait and see how this next phase of private adoption points out?

Part of it is waiting is being a little bit patient. We've seen a lot of companies in both the private and the public sector, rush features and capabilities to market that have a more elusive return on investment proposition and we've resisted that, right? So we want to be able to go to our customers with a very clear ROI that says this is how this feature is going to pay for itself and we can demonstrate that to you. And an example would be we're using AI, for example, to read unstructured court document filings and to extract and do data entry off of -- and that's a very easy conversation to have with the customer. You've got 35 or 40 people that do this all day long. It's a low-value, high-volume, low-complexity activity. It's perfect for AI. And the way that they look at it is they're not going to lay those people off. They've got vacancies all over the place they can't fill so they're going to repurpose those people to higher-value activities and use AI to take care of the dredge work.

Yes. Fantastic. I'll ask one more here and turn it over to Maura. Priorities as a COO, I know you're entering -- I'm guessing you're entering annual planning in the next several weeks. What are you most focused on? What are you most excited to work on?

So the things that I spend my time on are -- and I've joked with people that Tyler is the largest software company that nobody has ever heard of. And if you dig below the covers of Tyler, it's really a portfolio of businesses serving different parts of the local and state government space. And so a lot of what I spend my time on are unifying the experience of the customer through all of those different businesses. So whether that's our cloud transition and making sure that customers have a consistent, high-quality experience in the cloud, or it's the overall customer experience so that the way that we do implementations, the way that we deliver support is consistent. One of the things that we're trying to do because our installed base has gotten so big over the years is when we look at our future sales prospects, most of our future sales are going to come from customers who already own another piece of software from Tyler. And so that referenceability of that customer is really important as an impact on those future sales. So they want to have a good experience, they want to have a consistent experience. And that means I've got a unified parts of our organization that have typically been successful by operating in a focus silo. So cloud, customer experience, AI, those are all of the things where it's important and what I'm spending a good portion of my time on and probably the fourth one to round it out is our payments operation, which is also something we are unifying across our entire business.

Yes. On the cloud transition, Tyler has made great progress to date. There's still a lot of work to do. Can you just level set us on the work that you've done, what you've learned from the conversions to date and how that's informing the next cohorts that are approaching?

So if you look at our installed base, our installed base is not homogenous, right? There's different verticals, whether it's ERP or courts and justice or public safety. Each of those have a different set of dynamics and their willingness to make the transition into a cloud environment. For example, public safety, 2 years ago, we had 0 sales in public safety SaaS arrangements. And today, it's 2 years later, it's 100%. There's also a big difference between a large customer, where the complexity of the shift is high, but the sophistication of the customer is high as well. Compare that to a small customer, which we have a lot where it's actually a fairly simple technical task to migrate them into a cloud environment, but the customer sophistication is more limited so they need more help. So we have to balance all of those in the way that we go to market with this cloud transition and the way that we try to act as a partner with the customer. And for some customers, the journey is going to be 18 months. For other customers, it's going to be 5 years, and we have to hold their hand along the way to make sure that we don't attrit a significant portion of that customer base we've thought so hard to build because we were sloppy in the way that we were going about making -- transitioning into a new state.

And on those larger customers, the on-prem base currently is more heavily tilted to those larger customers, just given the complexity. As you approach the flips that are expected to peak in '27 and 2028, how are you thinking about the kind of carrots versus sticks of getting those customers over?

So far, we've been really heavy on the carrots, right? [indiscernible] exclusively. We haven't really pulled any sticks out at all. The carrots are all around putting features into the application that they can only access if they're a cloud customer, pricing incentives to help them manage the transition from a maintenance arrangement to a SaaS arrangement, additional services and so forth. I think what my experience has been in these types of transitions is that it is a bell curve. You have early adopters on one side of the bell curve and you have resistant objectors on the other side. And -- but as time goes by, that pool of resistant objectors is going to shrink. They're going to look around at their peers, and they're going to say, okay, this is actually working for everyone. I'm going to make the transition. Where we can help them is as that pool of customer starts to shrink that are still on on-prem maintenance arrangements is that their maintenance rates will start to go up as disincentive to remain in that state. We may start to telegraph end of life or end of support or reduced support types of arrangements over time. We haven't gotten to that point but sometime between probably 2027 and 2030, we will. We'll start to introduce those disincentives to remain on-prem.

That make sense. And version consolidation has been another key goal of transitioning these clients over. Could you give us an update on the time frame where you are with sunsetting some older versions?

Sure. So across all of our major verticals, we've reduced the version footprint to 2 to 3 versions per product that are in the field. But the challenge is, and this is also a part of the cloud transition story. The challenge is that's a moment in time snapshot because as long as the customer remains in control of when they take updates, the possibility for them to proliferate out to have multiple versions is still there. So in order -- as a prerequisite to flipping customers to the cloud, we have shrunk that footprint. The next term for us is in the -- those customers that are in the cloud in the '27 to '28 time frame there's going to be a shift where the control of reversion update shifts from the customer to us. Once we have control of those version updates that's going to allow us to really harmonize the number of the environments that are out there so that our installed base is consistent and on consistent versions of software. It's also going to allow us to deliver value to them faster because we don't have to go through a dozen different versions of software that are in the field. That's been -- so we're really happy with where we're at. But again, it's just a moment in time the real change and the thing that we've telegraphed is going to also produce impact on our gross margins going forward is shifting that update control from the customers back to us.

That makes sense. And your partnership with AWS is crucial for the scalability. How are you thinking about that partnership evolving as more of the large and complex customers do begin to migrate over to the cloud?

So I've worked with all of the big hyperscalers, all the big software companies. I'm going to be a little commercial for AWS. In my 30-plus years, they probably are, without question the best partner we have ever worked with. Their MO has consistently been how can we help, what can we do? Whether that's designing very creative business arrangements or its technical assistance or in some cases, they've even funded things for customers or for our R&D teams in order to shift this workload into their environment. It's been a really successful collaboration, and I expect that to continue. There has not been a scenario where we have asked AWS to help us with something where they have not produced a valuable solution. And that has not been my experience, by the way, with the rest of the marketplace.

And we talked about how the public sector can be a bit slower moving to adopt these new technologies. But have you seen a shift in motivation to move over to the cloud, just given these AI-driven solutions and...

So actually, I'd say that there's one single driver that's providing more of an incentive for customers to migrate into the cloud than anything else. And that is their security exposure. For every headline that you read about some local government or school district or state agency being the subject of cybercrime, there's 25 more that never make the papers. And in some cases, it's not an attack on them, it's an attack on a neighboring jurisdiction and they see how debilitating it is. And we've been very responsive to customers that have been in that scenario to either they've been the subject of an attack or they're concerned about one to escalate their transition into a cloud environment. So that's -- I'd say that's probably the biggest single driver.

Let's talk about payments.

Okay.

So you've got a group of investors here, and we have our external data points. You have all of the incredible customer conversations that you're having and you're in a ton of road map. How would you advise us to model payment? Meaning, how do you think about the structure of adoption? How do you think about being above your long-term target today, 14% to [indiscernible], maybe 10% to 13%. Give us a little bit of a flavor for how you internally think about payments?

So let me first just by starting out -- in our -- in the 2030 plan that we published in '23, we showed a growth trajectory around our transactional revenue. And sometimes people conflate transactional revenue with payments. Payments is a component of that, but a significant portion of that transactional revenue stream is actually software that we are monetizing through transactions. In other words, we're providing an entire application suite for a customer, right? They don't pay us anything for it upfront. We're monetizing it through transactional revenue. And in addition to that, there is a payments component to that. So I think, first of all, when you model it, you've got to understand that there are different moving parts here. The second thing -- the second reason it's important to understand that is that we don't really have any interest in being in a commoditized payments provider, right? The race to the bottom with low margins. It's not sticky, it's too easy to replace. So what we do is we look for opportunities to create arrangements where we are monetizing transactions with the public or vendors with government or we can provide some significant value add that is worth the customer paying a premium price to us. Now that may be tight integration with the back-end system. It may be helping them reconcile with their bank. There's a number of different ways that we can go about doing that. But one of the characteristics of this payment strategy is we want it to be as sticky as our software business is, right? We don't want to create a big segment of our business that has a high churn rate. So that means the strategy has to also have these hooks that keep customers embedded.

So it's interesting that if you look at your payments revenue today, I know part of it is inherited. But how do you think about the percentage which is differentiated as you target versus the part that is commodity?

So the vast majority of it actually is differentiated. So there was a when we acquired NIC, there was a relatively small percentage of their total business that was pure commoditized payments. And most of that has churned off or is churning off. And it's low margin, 10% or less margin on it. So it's not attractive business for us, and it will be -- we think it will be out of our portfolio in the next year or so.

Well, the flip side of that though is you have a number of customers that don't currently engage with you on payments.

That's right.

So how do you think about that next tranche of customers for payment adoption? How do you target and then encourage those customers to adopt?

So a couple of different thoughts about that. One is, if you look at -- if you were to deconstruct all of our add-on sales that we're going to existing customers and upselling them on new capabilities, a significant -- I don't have the percentage in front of me, but a significant percentage of that business is actually payment sales to new customers. And that there's, in some cases, a fairly considerable lag between the time we contract for that versus the time the revenue start to show up. But I would say payments is probably the most highly demanded add-on feature inside our portfolio without a close competitor. It also has applicability across a broad array of our portfolio. So whether it's permitting or it's ERP or its courts and justice, there is a payments component to what government does.

Yes. Yes. Fantastic. Well, it leads nicely -- the add-on discussion leads nicely to a discussion on cross-sell.

Sure.

Yes. So currently, your customers on average have 2 to 3 products in Tyler's portfolio, but there's a broad depth of products available, and you've talked about driving that closer to 8 to 10. To start it off, like what do you see as the most -- not easy, but a cross-sell that makes the most sense where products are most complementary to each other, where have you had the most success?

So what a lot of folks don't understand about the way the government works, because, in some cases, it was intentionally designed to not work very well. Is that many of the things that we do with government are very long-lived, multiyear processes that affect multiple government offices. So I'll give you 2 examples. Simple example that everybody always understands is the justice system. You get arrested by a police agency, you go to a county jail, the prosecutor decides to file a case, it goes to court, you end up in probation. Those are 5 different government offices, and that process that I just described can take a year or 2 years or 3 years to complete. And so the adjacency, if we have one customer that's in that long-lived process, a court, then we should be able to have a competitive advantage to unify the rest -- the other pieces of those processes across those other agencies. Another example would be a property. So you build a house, you have to get a permit, there's a deed that's recorded. There's construction and inspections that occur. There's taxes and assessments or appraisal that occurs. And then eventually, you go back and you add a swimming pool and it gets -- so again, multiple government offices in multiple jurisdictions, you can have cities, counties, state agencies in that whole mix. And so our ability to go in and say, "Look, you've already got this piece and this piece. But look at all the work you're doing to compensate for the fact that these other steps are in different -- or using different solutions, let's unify it into one comprehensive process." It's a very compelling value proposition to customers.

And how are you going to market? What's the sales motion look like for making sure that these local governments know that they have all these solutions available through Tyler?

There's a lot of internal education of our own sales teams because our sales teams, again, have operated historically in silos, serving a particular sub-verticals. So part of it is going to a piece of market where we have a position of strength. We have a very large installed base in a particular area and identifying what are those areas of adjacency. What what kinds of programs can be put into place that can create awareness. It's a lot of restructuring inside Tyler to make that a more effective movement.

That make sense. And so Tyler has had an M&A story for a while. How do you ensure that all of these products come together cohesively, it feels like one product? I know you hired Andrew Kahl like the first Chief Client Officer. How does that fit into the whole portfolio?

So great question. When -- so when we acquire a new company, there are a number of different dimensions that we evaluate on making it look like -- first of all, it has to look like a Tyler product. So there is a whole cosmetic refresh that typically occurs to meet with a standard so that this is like I bought software from the same company. There's an integration of consistency, the APIs and so forth that we -- so there's a couple of years' worth of technical alignment that's an element that our CTO manages. Andrew Kahl, who's our new Chief Client Officer, his focus is on making sure that the client has the same implementation experience, the same support experience, even that we're using the same nouns and verbs when we're talking to the customer about their environments. And then the last piece is an enhanced customer success capability, where we're going into customers that have been implemented and making sure that they are getting all of the value out of the solution that they paid for, which often then turns into upsell opportunities for us because we can see something that's adjacent to their current footprint.

And given the breadth of the portfolio and the installed base, obviously, cross-sell is such a big part of the story. But are you thinking about the white space and both state and local government is still -- there's a lot of room to run. How do you think about that versus cross-sell and prioritization?

Well, part of it is a mental shift. And like I said, the way that we're looking at it right now is, if I go back in time 15 years ago, when we sold a piece of software to a city or to a county or to a state, it was likely the first piece of software they had ever purchased from Tyler. Today, that's not true. They already know who we are, and so the referenceability of that customer, that implementation that I already have has a direct bearing on my ability to sell them payments, to put them into the cloud, to sell them new pieces of software. And so that's why you guys have heard our CEO get up and talk so much about recommitting to that consistent, high-quality customer experience across our whole portfolio. And that's what Andrew wakes up every day trying to improve.

And are there any like specific initiatives since I know it's fairly new to the role that you've seen customers speak to or that have been driving more customers?

Yes. So we're just now starting to introduce the work product from Andrew's team into that environment. But I'll give you an example of one that our whole organization has started to embrace and that is essentially a no wrong door philosophy. What that means is it doesn't matter which service organization, a customer starts with. What we don't want to do is have them go there and say, "Well, that's not us, you need to call those people over there, right?" So regardless of which door the customer goes through, it's the right door, and we are going to get them to the right people who can solve their problem without a lot of finger pointing. And you see good -- you see really good customer response from that. I mean it's a lot more effort, and it requires a lot more technical infrastructure for us to be able to even be able to hand customers off from one office in one city to another office in another city in a seamless way. But but the impact on the customer experience is significantly.

It actually reminds me a lot. We had a similar issue a few ago with Goldman Sachs and all of the different pieces of Goldman Sachs, and we came up with the One GS initiative. But I guess my question for you is, you mentioned the technical infrastructure. Maybe give us a couple of examples of that. And that's not easy, what you're describing to get all of these pieces of Tyler, which has been around since the '60s in various shapes or forms to communicate. So how are you doing that internally? Maybe give us a little more depth there.

A lot of it is through -- I mean, I think you see this in any company as that matures. There's a tension in any company between people who are closest to the field having autonomy to basically do what they need to do to be successful and centralization and consistency and efficiency. And what's happened over time with Tyler is that needle has really shifted closer to the -- no, this needs to be a Tyler solution, not a public safety solution, right? And that's changed the decision-making. It's changed the way that we -- and a good example of that, again, is all of the telecommunications technology that's in place for us to interact with customers. If you go back 5 years ago, there were probably 8 different solutions. And so -- and it wasn't a problem for most customers who only had an arrangement with that one division. But this cross-selling now that they have relationships with multiple divisions, multiple product lines, they don't only to have 9 different numbers to call and have 9 different experiences and 9 different types of services arrangements. So harmonizing that and making it consistent, and that's not about just the lowest common denominator. It's about defining where is the standard. This is what we want our customers to experience and lifting everybody up to that level.

Yes. And I know your pretty early days. Is this a multiyear initiative? How soon do you think before you're at the holy grail the company working seamlessly on projects like this?

I don't know that there ever is a finished one right? But we have set internal goals for us to be able to get up in front of our customers, every one of our connect conferences every year for the next 2 or 3 years and show significant improvements in the way that they experience us. And kind of the mantra is we don't want the experience to be worse, the more products you have, we want the experience to be better, the more products you have. So everything is geared around that value proposition. There's a lot of commoditization in any kind of business. And often, what makes the difference is the relationship and the service experience, right? You guys experienced that in your own organization, right? So that's got to be something front of mind for us as well.

So there's an obvious way to measure success, which is number of products per customer. I'm curious what are the metrics you're tracking internally because customer experience, there are all kinds of ways you can measure that.

Products per customer, ARR per customer, we talk about payments, for example. And one of the reasons we're excited about payments is you can take a customer that's paying you x in SaaS fees. And by overlaying payments on top of that, you can move it to 2x in annual recurring revenue, right? And really at no cost in many cases, to the actual jurisdiction itself because they're monetizing this through user fees. So that's another big metric. I'd say a couple those are the 2 things that we look at the most is what is the average ARR that we're driving from a customer and how much have we increased that ARR over time, and how many products do they have?

Yes. Last one from us. So Maura already touched on some of the M&A success that you've had. As COO, what is the #1 learning that you've taken away from all of the numerous M&A deals that you've done that's now forming your M&A strategy?

When I talk to my CEO about this, there are a couple of different things that he often says that always -- that have sunk in. One is that some of the worst decisions he's ever made is when he had too much money right? And so being disciplined around not just chasing that bow on the windshield that looks like a shiny toy, but really making sure that there is a strategy behind why. What problems are we trying to solve? What kinds of companies we're looking to fill them? The second piece is that in addition to all the financial characteristics that everybody looks at when they go to do an acquisition and how it impacts our trading multiples and all that kind of stuff. There is a cultural match that is just as important, if not more important, than the financial synergy. Are these people that are going to fit within Tyler's culture and adopt Tyler's values and interact with their customers in the same way. That has had more to do with our success in successfully integrating companies probably than anything else over time is being that selective about not wanting to just go hire -- go buy a company where the principles and key employees are all immediately going to depart for the next paycheck. These are -- we want people who are invested, who care about their customers and who want to see it grow. And we reward them for doing that.

Very well said. Jeff, thank you so much for your time. Please join me in thanking Tyler. [indiscernible] question on the back.

Thank you for your presentation [indiscernible] to the company, they were really nice. Could you help me understand what the -- there are like [indiscernible] structural protections that the company has that stops new entrants. Perhaps talk about if there is a minimum R&D expenditure that you need to do to remain competitive. I mean, what keeps some of the other folks [indiscernible] probably from attacking you?

There's 2 or 3 things. So the first one is this marketplace is a very slow-moving marketplace. It takes a long -- I've worked with customers. We're getting a contract signed is a year or 2 years or 3 years. A lot of new businesses can't survive that kind of tempo. They need the wins, they need the revenues. The second one is it's not enough to just have a product. You have to be able to successfully implement it and successfully service it. And what we see as a lot of companies can't make that transition. They can bring a product to market, but 2 years later, they're out of business because they basically had to make a bunch of promises that they couldn't deliver during the services piece. And then the third piece, I would say, is it took us 30 years to build the installed base that we have today. Our attrition, our churn rate is in low single digits, 1.5%, 2%. Everything that we do at Tyler is built around accommodating the pace of the marketplace and on making sure that, that churn rate is as close to 0 as we can make it. And that takes a lot of oxygen out of the space for other companies to thrive into.

Yes. Very good. Thank you for the question. Thank you, Jeff.

Thank you.

Appreciate your time.