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

Tyler Technologies with us. Brian, thanks for making it in time.

Sure.

I'm sure you're always busy, especially heading into the holidays this time of the year. I don't want to be labor with the entire history of Tyler, which is long standing at this point in time. But maybe if you could start off with just an overview of the past couple of years for Tyler. I know cloud has been top of mind. We'll get into some of the 2030 targets, but just engaging progress and maybe where you expected Tyler to be in 2025, a few years ago?

Yes, sure. It's probably a good time frame because we had a big Investor Day in 2023 and post the acquisition of NIC, us getting into the state business, payments business, we were sort of an inflection point in our cloud transition. So we thought it was a good time to sort of reframe everything and make sure everyone was aligned with how -- where we saw the company going over the next few years. And so we set some targets for 2025 and then for 2030, which was certainly much further out than we typically talked about long-term targets. But -- so now here we are closing to the end of '25 and happy to say that we're really on track or ahead of plan to achieve all of those 2030 targets. For 2025, we've really achieved higher growth around our transaction business than the targets we originally set out. So that is going well. We've also achieved significantly higher cash flow margins than we planned. So those are the 2 areas where we've really sort of are really ahead of track. We're right on track for the flips of our on-prem customers to the cloud. That's not a linear process, but we're -- we've said we're comfortable with the targets that we set for 2030 and the progress we've made towards those. Made a lot of progress towards margin and that's on track as well. So really -- feel really good about where we are 2 years in. We plan to have another Investor Day next -- midyear next year and I expect we'll be updating, providing those [indiscernible]. One of the interesting things was in 2023, AI was not really in our vocabulary [indiscernible] so amazingly. So there really wasn't any, either from a revenue perspective or from a cost efficiency perspective, that wasn't a part of those targets. So we'll be probably looking to frame those a little bit more as we have a number of activities, both on the internal use side and in our products going on around AI. So yes, we talked about long-term margin expansion of going from a 23% operating margin in 2030 -- 2023 to a 30%-plus margin in 2030 and achieving a target of $1 billion in free cash flow by that point.

You just speak a little bit to the visibility you have as CFO into kind of framing those targets. I know Tyler has a broad customer base, but there's been a predictability to the business. And so maybe you can just provide a little bit of what you see from the CFO perspective there?

Yes. It's a good place to be. We operate in a market that's not the most exciting market in the world, not -- there's never explosive growth. It's not a super high growth market, but it's also one that provides really steady reliable kinds of growth serving -- we serve exclusively in the public sector, but we're very broad in terms of the size of governments we serve, the breadth of governments we serve and the levels of government from state and local or local to state to a very small presence in the federal government. The government market is slow moving, long sales cycle. So typically, we have -- although the timing you're never sure of, but we have pretty good long-term visibility. A lot of our sales are ultimate driver of governments acquiring software is that their old system is at end of life, and they've used it as long as they possibly can. It's about to die and they have to replace it. And that may mean they bought that 20 or 30 or sometimes 40 years ago, a lot of homegrown systems that are no longer supportable. And these things all automate, mission-critical functions of government, public safety, 911, courts, property taxes, licensing and permitting, utility bills. So these are all very sort of essential functions of government. So that sort of is the broad backdrop for our business, it gives us a good long-term predictability. We have -- we're more than 85% recurring revenues today, either from SaaS, maintenance from on-prem customers or transactions. So a big recurring revenue base in a lot of growth opportunities within that base and with new logos as well.

Yes. So this year -- and maybe it's less of a conversation point directly for Tyler, but overall, it was a bit of a different year in terms of public sector because of DOGE and some of the federal impacts. And I know you've been clear on some of the more recent earnings calls and the difference between what state and local fees and what federal government fees. But was there any difference at all in the metrics that you track this year? Was there any hesitation just in terms of uncertainty that rippled into some of your customers at all? Or how would you characterize this year relative to prior?

Definitely was some noise, especially in the beginning of the year that led to some uncertainty in our customers, but ultimately not really an impact on our customer. So there really wasn't any fundamental change in demand either short term or long term. But all the noise in -- especially at the beginning of the year, DOGE and everything that went with that, tariffs, just new administration, all of that created a lot of noise. Now our business, as I said, is mostly local, 70% to 75% of local government, cities, county, school districts. Roughly 20% to 25% state, but our state business is almost all under a self-funded model, it's a transaction-based model. So it's all -- almost all funded by convenience fees and user fees that citizens or businesses pay to interact with government. So it's not appropriated fund, so it's not driven by budgets. So that model is fairly insulated. And then only about 4% with the federal government. So it was really more of a -- in terms of sales processes that a lot of local governments at all levels sort of took a pause and said, I need to figure out if all this stuff really impact me or if something is going to change. Ultimately, pretty much came to the conclusion that no, this doesn't really affect us. But there was a little bit of a slowdown in bookings in the first quarter that, that I think we've largely sort of proven up that, that was a very short-term phenomenon and that it's really hasn't been any fundamental change. In the longer term, we really look at not necessarily the DOGEs itself, but the whole increased focus on government efficiency as definitely a tailwind because the way government get more efficient is through the use of technology, often that -- they are inefficient in part because their processes are inefficient because they are governed by old technology, so they can't do things online or they can't provide citizen self-service or they don't have AI capabilities. So they really -- increasingly governments are starting to kind of change from that idea that I'm just going to use it until it dies and then I'll replace it. So yes, there is an ROI. And if I replace this, I can get these efficiencies. Big issue with staffing shortages. Governments typically don't have enough people to do the essential things they need to do, and they have a shrinking workforce, whether it's from retirement or just people shifting into the private sector. So that's a big challenge for them. And all those things are -- technology is the solution to it.

Yes. This is what I was going to follow up on, and you kind of beat me to the punch a little bit. But just -- have you found a way to kind of shift your go-to-market message or sales strategy to now respond to some of the questions that are out there around efficiencies or reasons to use technology. And if we look at some of the major subsegments that you serve, are there specific subverticals, ERP or some other area where you think those are maybe more direct potential, just soft tailwinds for your business?

Yes. I don't know that any of the verticals or subverticals are particularly different. There's opportunities across really all of them. Yes, we -- it's always been a little bit of a point of frustration for us that it's hard to accelerate demand. So even though there is this good ROI story, and there always was, it's not just new, that you replace a paper-based system with a totally digital system, and there's cost savings there that have a very fast return. One of our Courts customers, a top 5 county in the country, had a staff of 10 people whose only job was to push shopping carts of court files to the court rooms every day, stack them on the judge's benches and take them back at the end of the day. Our system is entirely digital when they replaced it. They have those people, I don't know what those people do now, but they don't do what they did. They -- there are no paper documents in the courts anymore. The judge has an electronic bench. They massive amounts of storage space that they used to keep all this paper in has gone and there's an environmental impact as well. But there's a really clear ROI, but they still didn't do it because of that. They did it because the old system was 40 years old and they're running more [ court ball ] programmers. So it's always been a little frustrating. So now that there's maybe a little bit more change, a little bit more openness, a different way of looking at things, that excites us that there's an opportunity too because that story resonates with customers a little bit more now because they're hearing about it and they're feeling the pressure. And it does away with a little bit of an inertia. It's not like a total shift. We haven't seen thousands of RFPs come flooding in to replace old systems, but it's sort of gradual and it feels different.

Yes. That's why I said, modest tailwind. No, that's very helpful. You reported 3Q results recently and it seemed to be a bit of a stabilizing for us given you mentioned some of the questions around first quarter and bookings. And I think the commentary was fairly consistent in terms of RFP volume and deal activity in some of the indicators that you look at. But maybe just frame for those who weren't necessarily fully paying attention to 3Q, what the highlights, key takeaways of your perspective, should have been for Tyler?

Yes. As we talked about at Q2, the -- largely the uncertainties around the first quarter were behind us. We said in Q2, we saw bookings grow sequentially from Q1, and we should expect that in Q3 again, and that happened. In addition to -- there's a couple of things that kind of around bookings noise in general that we have -- what I just talked about in terms of some of the slowdowns, the very short-term slowdown from DOGE noise. We also had some bookings that were pulled into last year from -- that would have naturally occurred this year because of the deadline for ARPA for the stimulus funds at the end of last year. And then we had a really extraordinarily strong second half of last year with new logo sales, especially around large deals, and that's really just reflective of inherent lumpiness in the business, and there were just a number of large deals that happen to close in the second half of last year. So that's created a tough comp for this year. So against that backdrop, we've really achieved what we expected. And we said that as we look at completing the year, our sales for the year pretty much right where we thought they would be at the beginning of the year. So yes, hopefully, we've put a lot of that noise to bed. We've also talked about at least a preliminary look at next year's SaaS revenue growth because we heard concerns that bookings in -- especially in the first part of this year, what impact that would have on next year's growth. And we talked about an expectation that they'll still have around 20% SaaS growth next year and to try to get a better view.

Yes, that makes sense. I was going to ask why. And so just the visibility that you have into next year at this point for 20%, your confidence level in putting that baseline out initially. And then if bookings are lumpy, which I think we can appreciate they would be in your business. Is it better to look at trailing-12, 24 months? What would you encourage investors to spend time focusing on?

Yes. I mean, you really have to do it. I mean, if we think of the last 2 years taken as a whole, pretty good combined. The -- so yes, a trailing-12 or 24 months really does create this kind of wipe out some of that lumpiness and give probably a more accurate picture. There's also a lag from the time bookings are signed, a deal is signed, whether it's a new SaaS deal or a flip of an on-prem customer to when those revenues actually hit. It could be a quarter or couple of quarter. So when we kind of deconstructed that 20% growth for next year, about -- we get about 12% growth from things that are already -- bookings that have happened going -- already have happened going into '26. And those could be even deals we signed in '24 that we only had a partial year of revenues this year. Next year, we'll have a full year. All the deals we signed in '25, certainly, we have a partial year of revenue and we'll have a full year. If they're signed in the fourth quarter, we may have no revenue this year from those. And then pricing increases across our customer base, which typically kind of in the 4% to 5% range. So that accounts for 12% growth. About 3% was from flips. So the on-prem customers moving to the cloud. We typically get a 1.7x uplift on -- from maintenance revenue to SaaS. We've said that we've got sort of this bell-shaped curve over the next few years as we move towards getting, say, 85% of our customers migrated to the cloud by 2030. The peak is still a couple of years out, but -- so we have decent visibility over that, the timing always can be kind of a little bit uncertain, but we feel pretty good about the number of that percentage. And then about 5% of next year's SaaS growth will come from bookings next year. New logo sales, add-on sales to existing customers, which really are the majority of those bookings. And that the last 5%. So pretty good visibility over all of them. There's always timing around all of those things that can vary a little bit, but we wanted to kind of give that expectation that we're still in that ballpark.

Where would you say, Tyler is -- and I appreciate you you're kind of built towards this with some of the commentary around the cadence of when -- flips. And we've seen, you give more metrics than most companies around some of the moving factors in the model. If I ask you sort of to set the stage of what inning Tyler is in its cloud migration journey or where you're at from a repeatability standpoint, meaning now you have confidence, you've seen it enough time so you can go faster. Where would you say you are in terms of the Cloud journey today? And what are you embedding towards those 2030 targets alongside that?

Yes, there's kind of 2 parts to that. So there's the new business, and that really is almost entirely in the cloud now. Go back to 2019, we were about half and half, half of our new sales were on-prem, half were cloud. We were cloud agnostic. We didn't really try to push people one way or another. We let the market decide. And in 2019, we kind of changed that and said we're cloud first. We're really only want to sell software in the cloud. So today, high 90% of our new sales are cloud. We saw a little bit of licenses back to current on-prem customers and a little bit in public safety, but almost all there in terms of new business. We have decades of on-prem customers that -- and many of them are still on-prem. We've been migrating customers for a long time already. But again, accelerated that in 2019 when we partnered with AWS and made the decision to exit proprietary data centers and put customers in AWS. And that created an opportunity or the ability for us to accelerate that rather than us trying to scale data centers, which didn't make sense. So we -- as we talked about in '23, if you look at the customer base that was still on-prem at that point, we said, we expected 80% or more of that customer base to move to the cloud by 2030 that it would continue to kind of accelerate over the next several years and with a peak in the probably '27, '28, maybe '28-'29 time frame, somewhere in there. We had a number of gating items around that. One is that we supported -- have historically supported a lot of versions of a lot of software products, which is expensive. A lot of development resources, a lot of support resources spent on that. Obviously, the goal in the cloud is 1 version of every product that everyone is on, that everyone upgrades at the same time in a little bite-sized bits. So a better client experience, but much better for us. So we've been sunsetting older versions of products, consolidating versions. So reducing that version sprawl and getting down to now where most of the major products were down to a couple of versions. So we're not quite all the way there, but we've made a lot of progress, which then puts more customers in a position to move to the cloud. We've also -- we've talked a lot about carrots and sticks. And increasingly, we have -- I was told that our Accounting department was going to dress as carrots and sticks for Halloween, I'm not sure, I was out of town that day. But we have talked about initially, we're increasingly telling customers that while we'll support on-prem product for a fairly extended period of time, new features will only be available in the cloud. So you get bug fixes and legislative changes, but new features you only get if you move to the cloud. And then longer term, we have the ability to look at higher maintenance increases to help drive people. And then ultimately, we have the ability to discontinue support for on-prem products, but I think that's probably still a ways off. So if you look at our whole customer base today and if you take all the on-prem maintenance customers and convert that to SaaS equivalent revenues, we're kind of about half and half. So about half of our customer base in terms of revenue left to move. We saw about $450 million of maintenance that will turn into 1.7x that in SaaS. And so that will create a fairly steady incremental revenue growth over these next several years, and then it will peak and then it will start to tail off as we get on the downhill side. So it's kind of a good balance. Again, we're doing the things we need to do to get people in line, but excited about getting everyone to the cloud. I think the key thing really is over the last couple of years, our customers, it's changed from kind of convincing them why they should be in the cloud and why it's good for them, why it's a better experience to really, I think pretty much everybody knows they're going to be in the cloud, and they know why, and they agree with that. It's just a matter of when and what's their process to get there. But our on-prem base still is more heavily weighted towards large customers. So there's more -- there can be some lumpiness around those flips as we go forward, but there's still a lot of impact left from bigger customers moving.

Can you touch on -- I mean there were several things in that response that seem like they would be margin enhancing over time. You mentioned kind of moving away from some of the data center footprint that you're managing, the single versions of cloud, just all of the consolidation that goes into that. So just what that gives you from a predictability margin standpoint and maybe embed that with the 2030 targets?

Yes, in terms of the margin expansion we expect to get through 2030 and beyond. It doesn't end in 2030, but we talked about the interim targets. Those weren't [ ceilings ], but interim targets. A lot of that comes from the cloud transition and the things we just talked about. The version of consolidation is a really big part of it in terms of the impact on both dev costs and support costs. The scale we get as we continue to scale in AWS and the lower unit costs we get from buying more and more capacity from them. The release of cloud optimized versions of our products that are more efficient to run in the cloud, those are all things that we're well down the path with. And then just the ability to deploy software more easily, to cross-sell more easily when the customer is already in the cloud to layer on things like AI capabilities. But -- so a lot of our margin expansion from '23 to today has come at the OpEx line or lines and more of what -- some has come from the gross margin line, more of what's left to come is coming from -- will from the gross margin line. There's some at data centers as well. So eliminating those costs and especially we've had duplicate costs because we've been putting customers into AWS, but still a lot of fixed costs around our data centers. So as we exit that last data center this year, over the next year or so, those costs will bleed off and we'll see some enhancement there. So a bunch of factors there that all kind of play together. But we see really good path towards margins that start to look a lot more like a more mature SaaS company would be expected to look like.

You have a big payments business layered in our...

Well, it doesn't have the same margin, but it generates a lot of cash. So...

Yes. You're right on script. [indiscernible] you can read my not my eligible handwriting in some way, shape or form because I want to touch on NIC and the payments opportunity. Now you and I spent a lot of time talking about this after last earnings [ print ]. Transaction revenue has been a source of strength. You're marching well in stride with the target levels. I think we've been kind of watching, engaging progress in NIC to understand the cross-sell opportunity. And so I'm wondering, from your perspective, what's driving the sort of the durable transaction revenue growth and how you would characterize your progress with cross-sell between NIC and the core Tyler offerings?

Yes. So when we acquired NIC in 2021, kind of 2 big cross-sell opportunities. They brought us a big presence in the state government market with these very deep enterprise relationships that we thought we could sell Tyler software products into in state governments. It wasn't historically a significant market for us. But also taking the NIC Payments engine that is processing tens of billions of dollars of payments for state governments primarily and leveraging that into our customer base to integrate it tightly with Tyler software products and create an integrated payment solution with the system of record. So we have a lot of products that, that produce bills, have payments that are associated with them, utility billing, municipal courts, traffic tickets and fines, licensing and permitting, property taxes, parks and recreation and all kinds of systems that have payments flying around them. But we didn't typically process those payments. We had some third-party relationships where we basically are a reseller and we get a revenue share. And we still have some of those in place, although we don't sell new ones. But we have -- since we -- since the acquisition, we have done those integrations that we now have a sort of a -- it goes beyond the commoditized payment system but because of the integration with the system of record, it provides efficiencies around automating reconciliations, providing better reporting. It's a better solution for the client. They're willing to pay more for that. So it has higher margins than a commoditized payment system. So we have had success -- early success in selling that into our existing software customers. Still have a lot of room to go there. We're still in the fairly early days of that. In bundling it with new software sales so we sell a new utility billing system, we give them a payment proposal as well and having success with that. And over time, replacing other payment providers with those customers. Disbursements, so the outbound side of payments is also an area we're focusing on because we have a big presence with ERP systems, payables and we have court systems that facilitate jury duty payments. We have correction systems that manage funds for inmates that have payments associated with that. So a lot of opportunities there that we are in the very, very early stages of. So as we've talked about this sort of CAGR of 10% to 13% for our transaction revenues through 2030. We're running ahead of that. Some of that is some of the kind of early low-hanging fruits, but we do believe there's a long runway of durable growth there. We've seen some outsized growth from some of our third-party payment partners running rate changes through that's provided higher revenues to us. I think that's largely run its course. But we've also seen a lot of volume, higher-than-expected volumes. So we work with our customers, our customers try to drive more transactions online and they're having success with that. So I guess the last thing around transaction growth has been sort of a hybrid model where we have in a number of instances, sold software to a customer, but it's being paid for through transaction fees. So here in California, actually, the largest contract Tyler has ever signed in its history, estimated total value of about $200 million over 8 years. We provide our outdoor recreation in terms of the California State Parks, so managing all the aspects of running the State Parks. We -- but rather than the state have to appropriate budget and find money to pay a SaaS fee, they're paying for that through adding convenience fees to charges that they charge users. So you reserve a campground, you pay $15, it might be a $3 charge to Tyler. Towards the Hearts Castle, pay a $20 ticket, $3 charge to Tyler. Running a kayak, all that kind of stuff. So the state doesn't have to budget money. We get paid through transaction fees that are fairly predictable book of transactions. It's not straight line, so it can be seasonal. But it's a little bit not as visible because it shows up in transaction revenue, not software revenue. So our SaaS growth actually would be better, and our SaaS bookings would be better if those were pure SaaS. And we also process all those transactions as well. So we're the payment processor. So it's got a little bit of a hybrid model in there that we're sort of in a unique position to be able to offer that because of our payment capabilities and our software solutions. So we've seen that in some outdoor recreation and some motor vehicle registration systems as well. So it kind of shows the flexibility that we have, but has also driven a little bit higher than planned transaction growth.

Sounds like a win-win and I assure you, California residents aren't [ balking ] at the biggest fee relative to [indiscernible] exactly. I want to just try to touch on a couple more with the time left. M&A has always been a part of the capital allocation strategy. I think NIC, it's a bit bigger than typical, but what do you see in the private market currently from a deal perspective? How would you assess the landscape? And are there certain areas, whether it's AI or something else where your maybe have a bit more interest or intent?

Yes. We talked on our third quarter call some about maybe a little more proactive and intentional approach to M&A going forward. After the NIC acquisition, which was a $2.3 billion acquisition that included a debt component. We had debt. And typically, we haven't had debt or much debt. It still wasn't a lot of debt. We were leveraged at the peak, a little over 3x, but paid that down very rapidly, deleveraged and paid off the last of the term debt well ahead of schedule. So with that behind us, we have a convert, that's $600 million that matures next spring, and we have well over $1 billion in cash on the balance sheet today. So we will be debt-free fairly soon. So we've got plenty of capital capacity. We've also been, I guess, a little bit more constrained or we said the bar has been high on acquisitions because of management bandwidth, because of all the things I talked about around the SaaS transition and the payment [indiscernible]. And a lot of big initiatives that have consumed a lot of management time, and we said, let's not throw a bunch more acquisitions on top of the people that are running these businesses, ensuring all that. A lot of that is behind us now. And so we've said that M&A is -- we're a little bit more open today, not changing our criteria around a strong strategic fit, a good cultural fit and a reasonable valuation. So generally looking for acquisitions that could be small tuck-ins or even bigger adjacencies that fill in gaps in our portfolio, that fill in an adjacent market. The things that we can leverage our sales force, put products in the same sales reps bag that we can sell to our existing customer base to drive more cross-sell. Ideally, we -- if there's a payments opportunity on top of it, that's good. There's an AI opportunity on top of that, that's good. But I think from when we talk about a more intentional approach, it's really not just looking at things that are for sale because we do get shown about anything in the GovTech space. But also identifying and prioritizing those needs and then going out and going after going -- approaching companies that fit those needs and seeing if we can make deals. So we think there's a big, big universe of those kinds of companies, and we're prioritizing that. But I'd expect us to be more active over the next couple of years. Also, it could talking about whether we'd rather do a handful of midsized acquisitions or 1 or 2 big acquisitions and the pluses and minuses of each of those in the private market, there are a lot of PE owned GovTech business now, some of which have pretty good scale, none close to Tyler size but decent-sized businesses. And based on where they are in the PE life cycle, they'll will likely be in the market over the next couple of years. Valuations, it's still kind of little early to see. Obviously, public markets have reset a lot of software companies valuations. And it's still maybe a little too early to see if private sellers have adjusted their expectations or if they're still kind of I think -- have something in mind that's more like looking backwards a little bit in terms of valuation. So -- but we feel good about our ability. We've done a -- I've been at the company for 28 years, and we've done more than 60 acquisitions during that time frame. And we feel like that's a core competency of the company that we're good at. And that will continue to be a part of our growth going forward.

Last 1 for you, Brian, and then you're off the stage. Just things that are top of mind for you and planning for next year. And then if we're here in 3 years, what do you think will be talking about with Tyler?

Yes. I think right now, we gave some indication, some of our revenue, not all of our revenue guidance, but some of it. We have -- but really what's to think of right now is figuring out exactly what our investments will be. We've got some elevated investments in the second half of the year that will carry into next year around some AI projects. Some product competitiveness initiatives to kind of stay ahead and still determining exactly what that level of investment will be at least in the next year or so. All of that in the -- still in the framework of those long-term margin objectives. But that's kind of top of mind right now, how -- what we do with that on the investment side. But I think 3 years from now, I think we're well along on the cloud transition. AI, I think we'll have a lot more clarity about how that's driving revenues and giving us cost benefits. And I think we'll be well on track to be kind of approaching that $4 billion company with $1 billion of free cash flow.

That's great. Thanks very much, Brian. I appreciate you joining.

Yes. [ You bet ] [indiscernible]. Thanks.