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

All right. Good afternoon, everyone. I'm David Chen with Morgan Stanley, and I'm very pleased to have Brian Miller here, Chief Financial Officer of Tyler Technologies. Brian, welcome.

Thanks. Great to be here.

All right. So why don't we just kind of get started with, for those of you that are possibly maybe new to the Tyler story. Provide -- just kind of give us the quick sense of the company and the products.

Sure. vertical software company focused exclusively on the public sector market. So we provide a wide range of software applications that manage essential mission-critical functions of government. More of -- most of our focus is the local government level. So cities, counties, school districts, local agencies make up about 70% to 75% of our business. Another 20% to 25% is at the state level and less than 5% federal. So not much exposure there. We have, by far, the largest, broadest product portfolio in the industry, which is a very fragmented space historically as well as the largest customer base. So we've got about 45,000 systems installed across about 15,000 different jurisdictions. Revenues will be about $2.5 billion this year. Market cap is around 15%. And we also have a growing transactions business as well. So we do a lot of things about processing and transaction-based services, especially for state governments, but we're driving that down into our local government base through integration with our software products. So we have a really -- the transactions are about 1/3 of our business today.

I thought maybe just bring it to something that everyone can relate to. Just maybe pick one of your flagship customers that are using a wide variety of your products across public admin, public safety, and just bring to light what that customer is actually using Tyler for across kind of the core software categories?

Yes, sure. We have some customers we call total Tyler customers that have jumped on the bandwagon fully. And one of our big growth drivers over time is our ability to cross-sell and upsell. So the average customer at Tyler has 2 or 3 products. And when I say products, I mean like a suite of products or products in a suite or an office like public safety or courts or property tax or public admin, ERP. So the average customer has 2 or 3 of those products, could have 8 to 10 with most customers. And then even within a suite of products, we have opportunity to -- they don't necessarily have everything. We have -- some of them have our court case management system, but not our jail system or our jury system or our probation system. So there are a lot of different cross-sell opportunities. But a customer like Mobile, Alabama is a really good midsized kind of right down the middle, total Tyler customer. They have our ERP system, utility billings, public safety, municipal courts, licensing and permitting. So really almost all of their core functions are run on Tyler. They were also one of the early clients to move to the cloud. So they were one of the first clients to have all of those products in the cloud. So they've been kind of a flagship customer. Another bigger customer where we're located in Plano, Texas, Collin County, just outside Dallas, started with our ERP system years ago, added our Courts & Justice system, our jail system, and has continued to expand their relationship with us. So still a really big cross-sell opportunity in front of us and now we're laying payments on top of those software products.

Yes. So bring to life, it might not be just intuitive if you're a typical software investor that looks at more horizontal categories, Salesforce, CRM, sales and marketing service, that's very intuitive. Like in your space, I guess my favorite example is like if I get arrested by a cop, he or she can then book me into the court room faster. Give me a sense for some of the natural linkages between your...

There's a lot of value created by having more and more Tyler products. They all get sold based on stand-alone features, functionality, references and reputation. Our presence in the market is a big thing. Governments are risk averse. They don't like change. Take a lot of comfort in buying something that works really well in peers and also problems also are really well known because they don't compete with each other. They talk to each other a lot. But if you think one of the great examples is the integration of public safety and courts. So those are bought by different decision-makers. Public safety system would generally be, say, the police chief and the court would be a courts administrator. And they're obviously adjacent markets. We're the only company that has products in both of those suites. So we compete with all a bunch of companies in public safety, like Motorola, CentralSquare. In courts, we have a different set of competitors, but those products are tightly integrated. But if you think about that whole, an incident or a process from start to finish, so there's a 911 call that's dispatched through a computer-aided dispatch system. The police officer responds, he arrests somebody. There's a record management system where all that data is captured and reports are created. He takes the guy to jail. The jail may not be in the city, it may be in the county. So you may be now crossing a jurisdiction, but they're booked into a jail through a jail system. The prosecutor files charges through a prosecutor system. There's a trial. So there's a court case management system. There's a jury system that manages the jury and then say the person is put on probation so there's a system for probation. Along the way, there's an electronic warrant system as well, and there's other things. Maybe you think about that, I don't know what that was like maybe 8 different...

Different things, yes...

A lot of places that would be 8 different systems from 8 different vendors, maybe 2 of them are homegrown. Some of them are integrated, some of them aren't. So a lot of those points along the way, they start all over with data entry. The biggest example is when that police officer, he's arrested somebody, captures a lot of information. Who's the guy, what did he do? And that goes into an arrest report on the terminal in his car. But he takes the guy to jail and they start all over, who's the guy, what did he do? And it might take 45 minutes to book someone into jail. If those are both systems from Tyler, even though one may be in the city and one is in the county, they're integrated out of the box. So all of that data kind of pre-populates or prebooks the guy. So it takes 15 minutes instead of 45 minutes. And so you get 30 minutes more. The police officer is back on the street 30 minutes faster. And so those are the kinds of advantages that you get from being able to buy more and more products from Tyler. And we are, by far, the largest provider of court systems. About 55% of the country uses our court case management system. So as those jurisdictions need a public safety system, we should have a very strong advantage in being the vendor selected there.

Yes. That naturally -- like question on just like go to market. Just how do you take -- a typical enterprise software company has a field sales person and then product leads in different functions that -- and that's just a coordinated -- this is one person who sells to the entire organization. Like how does that work?

That's a little different. Within each of these functions, they're typically a different decision-maker. It's typically not a top-down decision. They may have IT sort of some standards or -- but generally, it's not like a CIO making the decision, and it's not like a city manager making the decision across all this stuff. It's the functional leaders, some of whom may be elected, some may be not. But -- so they each buy based on features and functionality and reputation. But they understand the advantage, and we show them the advantage. So we have a different sales organization for each product. But they work in a coordinated manner. And one of the things we've done more recently to help us drive more cross-sell and create a more unified customer experience because it becomes also they get more and more products from Tyler. It has become more complicated for them because we have different support organizations, different professional services team. And so we have a new client -- Chief Client Officer, who's really driving a lot of standardization to create a unified client experience with the ultimate goal of being able to have much happier customers that want to buy a lot more stuff from us.

Yes, to make sure the left hand is talking to the right hand.

Exactly, one door to Tyler, those sorts of things. But we also have kind of account executives now, starting with the biggest clients, but where there's just one overall account executive who's responsible for helping them develop their long-term road maps across multiple products, but also just being their single point of contact and then they bring in their appropriate resources.

So you are...

We actually are rolling out more of the...

Software model.

Yes.

How big of a customer would that be to get an account executive?

Yes, to have a dedicated one or to have one who has a handful, probably the top 25%, 30% of our customer base, and we have a lot of really small clients. And the other thing we've done, last year, we created a dedicated state sales organization. State is a newer market for us. We established a big presence in the state -- government space through the acquisition of NIC about 5 years ago. And one of the strategies around that was that these relationships we had with NIC on the transaction side, would give us a leg up and sell software to state governments where we didn't have relationships, didn't have sales organization. So we've more recently created a dedicated state organization that is sort of a bridge between those relationships we have and all the Tyler products that we could sell in there. So there's like one primary account rep, and then they bring in the product specialists when they need to.

I'd say. So within any given state, you could have account execs for different jurisdictions. And then you have a state -- and overall representative. Yes, I see. That's interesting. And all of that is relatively new for Tyler.

Yes, a lot of it's evolving.

A couple of years...

Tyler is grown as we've done acquisitions and broadened our product portfolio and had more of those opportunities. The business model needs to evolve to make sure we're taking advantage of all those opportunities and the structure needs to continue to evolve as well as some of the back-end stuff.

Yes. Big question would just be just in terms of just the overall demand drivers. Just help us make sense of just, you've got expectations of citizens. You've got ARPA, which was a big driver, but then it's obviously come down, just like workforce pressure, just -- heads and tails, just like...

The basic demand driver. At the core for most of the demand is just, they've got an old system that's reached end of life. And it's sort of...

Half paper and pencil or just...

Yes, or just an old system. So governments, again, because they don't have competition, because they're not profit motivated, have historically, they don't like change. So they've historically used software until it's like on its deathbed, right. About -- it may be from a vendor who's no longer supporting it, it maybe runs on old hardware. We're replacing systems that were purchased in 1999 because of Y2K. It could be an in-house system written in COBOL in the '70s. So for whatever reason, they've decided that now I really have to replace it. And that sort of creates this very stable consistent demand, it's never explosive, but it also never goes away. And we still think that well over half of the systems that governments use fall in that category. So that -- it's a little bit hard to accelerate that demand or to create demand, but it's always there. The more -- the things that kind of on top of that are some of the things you mentioned. Workforce is a big problem. Governments, especially local governments have aging workforce, people retiring, big percentage of their workforce retiring in the next few years. Struggling to hire people, to attract them to work for public -- in the public sector. To pay market rates especially on the IT side. That's one of the big drivers of our customers moving from on-prem to the cloud because they just struggle with running their systems in-house, even if they want to. There is a -- I think what we're seeing more recently, though, and it's -- I mean, you could sort of associate it with DOGE, but there was really a lot of focus, an increasing focus on government efficiency even before there was a DOGE. Governments constantly have to do more with less. It's a common theme. It's nothing new. They never have enough resources to do everything they want to, but they've normally been insulated because they don't have competition. You don't really have a choice. Where -- it may be cumbersome to go down to the DMV and you don't like it, but you don't -- there's nowhere else to go get your license plates. So they have typically not used technology to move forward. But now with this growing focus on efficiency as well as pressures from the public, I mean, the public does want better service and says, "Why can't I get the same experience I get as a consumer with the government." But there is a growing awareness and focus on efficiency. And ultimately, the way they get more efficient is using technology. It's -- a lot of times, their processes are inefficient because they're really driven by the technology limitation. So they have an old system that doesn't provide for online access. So there's no ability to provide citizen self-service. They may be very paper-based. So we replaced a lot of court systems that were entirely paper-based with -- Cook County, Illinois, had 10 people whose only job was to push shopping carts of case files to the courtroom every day and stack Manila folders on the judge's benches. That system now is entirely digital. There is no paper in the courts. Documents are filed electronically. The judge has an electronic bench. And there's massive amounts of storage. It's kind of a green story because all that paper isn't used anymore. But those are examples. And so I think what we're starting to see is -- and there's sort of some incremental demand or some pull forward of demand. It's not a flood of anything today, but there is some incremental demand around people saying, yes, if I make the effort now, spend the money now, I actually do get a return that is valuable to me.

Yes. Makes sense. All right. Got to hit the big topic. So I mean kind of related to what you just said, we have Sam Altman tomorrow, we had Anthropic yesterday. What's it like at a local police department or local city office, where they're seeing this AI craziness. Are they saying "Hey, I'm going to go try to Vibe code my own technology." Or are they saying, "I don't get into that?" Or are they saying, "Hey, maybe I need to get some of the benefit from that through some of the vendors outside."

Closer to the latter. Governments are never -- rarely, I'd say, want to be the first with anything. There are a few governments that are more progressive than others. But generally, government is not the first to adopt any new technology, and that's certainly been evidenced by the very slow pace at which they've moved to the cloud. They -- and AI is, I think, right now, the same. They're very curious about it. They obviously hear a lot about AI, just like all of us do. But they don't want to be the first. They're certainly not going to do it themselves, Vibe coding or something. They really are interested in how AI can solve real-world, real practical problems that cause them tax and toil all day long. So they're kind of pretty simple sorts of things that are the kinds of use cases they're interested in. And that's where we're focusing or prioritizing our investments. We have some products already that some of them have been acquired that are discrete products that have AI at their core. So we have a product called priority-based budgeting which uses AI to help a government align their budget with their priorities, and they basically find places where they can reallocate funds to a higher priority topics. We have a product called document automation that came from an acquisition of a partner of ours in the court space that automates data entry in the court system. And so instead of a clerk having to look at a lawsuit that came in and create a case in the system and extract data. That can be done with AI to identify all those data elements, pre-populate -- populate the case file, so they need fewer clerks. We sold that to a large county in Florida. It was paying us about $750,000 a year in maintenance for the court system. They're paying us $950,000 a year for the document automation piece, but they saved more than $2 million a year in labor costs. So clear value, something they're willing to pay for and that they can solve the problem that they have. They don't have enough clerks. One of the things you talked -- you mentioned the report writing. So police officers spend a lot of their day writing reports 2 or 3 hours a day on average. So integrating AI capabilities to help them assist with that. I think what governments are looking for and what Tyler can provide is that it's not part of current buying processes. We're not seeing it in RFPs or current requirements. Say, but what we're bringing to them are things that solve those kind of real problems. The things that give us an advantage there and why they -- we believe they'll continue to want to buy those from us is the domain expertise. So each of these things like report writing in the public safety system, they could use ChatGPT. I guess, the police officer to write a report, but this has to be right. It has to be integrated with the whole law enforcement process. It has to be ready to go into a criminal case or whatever. So there's a whole layer of domain expertise around how that's embedded in the product. We have another product, one of our early development efforts is around application reviews. So another kind of simple subject, but we're a big provider of licensing and permitting systems, like building permits. A lot of places, there's a really big backlog to get a building permit. It might take 6 months because there's just not enough clerks to review those applications. So AI can review that application in minutes and replace the work that a lot of clerks do. But it needs to be -- we've got the domain expertise because we built the underlying system of record, which is a really pretty complex workflow around licensing and permitting. So customers trust us to have the domain expertise and to integrate it with those products. We have the relationships. So we've got decades-long relationships with a lot of these customers. So they have that trust factor that they don't have with a start-up or a company that doesn't have a lot of experience in the public sector. And the third thing is really around data. So we have not just the data from that customer system and their transactions, but we've got the data from hundreds of licensing and permitting customers and thousands or millions of building permit applications over time that can help train those models and make them more effective. So that combination is something that others can't match, and it's what governments are looking for.

So in many cases, you're actually the system of record?

Yes, yes. So we've provided that under -- that court system or we provided -- so just like someone else could write an application, could use AI to do data entry. But we fully understand how that court process works and what court documents look like and they get it from us. It's not -- they don't have to have another vendor. And as requirements change or processes change, it will stay up-to-date.

And the last piece would just be the idea of a -- not a nationwide network effect, but there are some really interesting localized network effects with...

Yes. Around data, there is some -- that's another one of the advances you can get from working with Tyler. So not necessarily completely AI driven, but we have the ability to create networks or regional networks or in some cases, particularly national networks using data in Tyler systems. So one good example is -- and we talked about kind of a concept of connected communities. So things that don't necessarily stop at a city limit or a border. So in the court space, again, there are outstanding warrants for people that are wanted for something. Those are typically -- although TV might have you believe that there's a big nationwide database of all of these kinds of things. There's really not. And so those warrants are typically at a county level and are contained in the county court system. So in North Texas, where we're located, there are probably 10 or 12 counties in a region. So a police officer could have one -- someone stopped in Collin County. Literally across the street is Dallas County and they could be wanted for something there and have a warrant out for them, but that officer wouldn't see that.

Wouldn't see it, yes.

So where those counties are all Tyler customers, they're all on their own system, in their own instance of the software. But we have the ability to publish different data elements that are important to a private cloud and have that shared amongst them. So they all have access to outstanding warrants for anyone in that group of counties. So we're able to provide that access to that data through our presence there without someone trying to build individual interfaces across these lines.

Right. Excellent. One of the key strategic focus areas for the company over last several years has been the SaaS migration. So just give us a sense for where you are in that journey and how is it going?

Yes, it's been a long process. Again, very representative of government. So originally long ago, we were completely an on-prem license model. Then for a long time, we had a hybrid model. So we offered a cloud, actually a private cloud or a hosted model in Tyler data centers, paid for us a subscription, but really the same software just hosted a Tyler data center. And we were cloud neutral or cloud agnostic. We didn't care how people bought it. And then really going back, I guess, 2019 was kind of the tipping point we said we were cloud first. We're going to stop selling on-prem licenses for most products. We're going to do what we need to do to encourage customers to -- on-prem customers to move to the cloud more rapidly.

Is it carrot, stick?

Today, it's more carrots. So -- and that process of customers moving has been slow, but has accelerated in recent years. But still, if you look from a revenue perspective, if you put all of our revenue -- our maintenance revenue on that cloud equivalent. I think we're 47% on-prem and 53% cloud. So we still have a ways to go. We expect that -- we've said...

Just roughly 53 -- just give us a sense of where just maybe a few years ago, where was that...

When we -- in I guess 2019, we made the shift. It was probably 25% of cloud, maybe even less, maybe 20%. We've said that by 2030, we had an Investor Day a couple of years ago, set a certain number of targets for 2030, some interim targets for 2025. But we said, by 2030, we expected that of that base that was on-prem at that time that 80% to 85% of that would convert by 2030, and we're well on track for that.

Still on track...

The peak is really going to be, if you think about a bell curve, kind of the top of the curve is going to be in that '27, '28, '29 time frame, somewhere in there. The on-prem base is still more heavily weighted towards large customers, not surprisingly, it takes them longer. They've got more things to manage. So we still have the impact of a lot of large customers to go. But carrots and sticks, today, I think the biggest carrot we're using, obviously, they know that we don't sell on-prem anymore. I think with virtually every customer, it's not a matter of why they should move to the cloud or are they going to move? And I think we'd have almost no customers that say, I have no plans to ever move. And that was different, like 3 years ago, convincing them why, but it's more about when, how, what the process is and how it fits into their priorities. We have increasingly told customers that new features will only be available in the cloud for our court system, for example, last year, at the beginning of '25, we told customers that the '25 release was the last one for on-prem customers that wouldn't have any new features. Further down the road, maintenance pricing can be used to create more of an economic incentive, and we haven't really done that at this point. There are some other gating items like version consolidation. We have a lot of -- we have historically had a lot of clients that weren't on the current version of the software. We supported multiple versions. So we've been putting a lot of effort into sunsetting older versions and getting customers current. So that they're in a position to move to the one cloud version. So there's a number of things. We couldn't move everybody next quarter if they wanted to, but the trajectory has been strong. The fourth quarter was both in terms of the number of flips of on-prem customers and the dollar value was by far the biggest quarter we've ever had, and we're still a ways away from the peak. Typically getting a 1.7 to 1.8x uplift on a like-for-like basis as customers move from maintenance to SaaS. And then starting to see more examples of upsells and add-on sales expansion as they move to the cloud. So they might move a Tyler court system to the cloud, but have other products that from another vendor like jails maybe that doesn't have a cloud option. And so that gives us an opportunity to bring those to the cloud through Tyler.

Great. So if anyone in the audience has any questions, let me know. So you -- on the back end side, I see you made a big switch from your own data centers to AWS. Just give us a sense of where you are on that evolution?

We're done with it. So that was a multiyear process. We had 2 major data centers and a few satellite ones, but 2 main ones where our clients were hosted. And back in '23, we said that by the end of '25, we would be out of those data centers. So big effort. We have a really strong partnership with AWS that we renewed about a year ago. Really, really good relationship with them.

And on a gross margin basis, I know initially, it was a slight hit just because you have to actually maintain both systems. Are you through that?

Yes. So we've had a bubble cost or duplicate costs because there are a lot of fixed costs around running the data center, and they don't go away until you actually get out of it, and you're also spending money with AWS. We're through a lot of that. There are some of those really that run through the end of this year. We had some tooling and some other -- some VMware costs that continue through this year that kind of help facilitate that move, but all of the customers are now out of our data centers. And I think we'll see a little bit more margin uplift next year as we get the last of those bubble costs drop off.

Right. Any questions from Brian? There's one.

So you're 100% U.S., right? So any ambitions to [indiscernible]?

Sure. The question is about international expansion. And do we have plans there. Yes, we're about 98% domestic and the 2% is mostly Canada. We have a few court system in Australia and a few cats and dogs, but mostly domestic. And I think that's where the focus will primarily stay for the foreseeable future. There's still an awful lot of runway in the U.S. And -- so the international business has been sort of targeted. Opportunities that are really good fits, mostly former British Commonwealth countries that have a similar justice system or in the case of Canada, we have a number of property tax systems in several provinces there. So their property taxation process is very similar to ours. Australia has a very similar justice system. So we have a court system there. But really, our focus in the foreseeable future is pretty much domestic. Having said that, we have an acquisition that we announced about a month or so ago that is currently pending HSR approval of a company that has -- works in the courtroom, around court reporting and digital court transcription, and they're an Australian company. And we -- so they have some international operations in a very narrow niche, but probably not something that we're really looking to expand a lot in the near term. We just have a lot of runway left in the U.S.

Thanks -- are there any overlaps with Axon's cloud offering [indiscernible] or you have spoken to [indiscernible] a lot of overlap?

Yes. The question is about overlap with Axon. Yes, we do compete in the public sector space, so every public safety space. So in public safety, there's kind of 2 major areas. The computer-aided dispatch, which is the 911 system and records management, which is kind of everything else. And then there's some ancillary areas there. We have the full suite of public safety applications. We're probably one of 2 or 3 leaders in that space. We compete a lot with Motorola. So there's a lot of opportunities where Tyler and Motorola would be the 2 finalists, it's probably the most common thing you see. CentralSquare has a presence in the space, Intergraph. Axon has been sort of moving into the software side to, I guess, leverage their body cam and Taser business, the relationships they already have. They are in the records management side, not in the computer-aided dispatch side. So they are -- just I'd say that compared to our offering, it's, I'd say, not as deep in terms of functionality and not as broad in terms of what they offer. Motorola leverages their hardware presence with software. We leverage our presence in courts and other areas of public sector to drive public safety business. We have -- public safety has been an area that has really been growing nicely for us. We've been, I think, at the forefront of leading that space to the cloud. And we've also seen a lot of success in terms of moving up into larger opportunities. We've got, I think, 5 or 6 state police agencies, all of which we've signed in the last couple of years. And so we've seen -- that's a really nice growth area for us, although it's a very competitive market.

Importance of the payments business [indiscernible].

Yes, around the payments business and transactions. So yes, payments is almost 1/3 of our business today or transactions. We have a lot of different flavors of that. But one of the big things we're doing, we have a lot of software systems that have payments embedded in them, utility billing, licensing and permitting, property taxes, courts, traffic tickets. So now we have, through the NIC acquisition, a very robust payment platform that we've integrated to our software products to kind of create an end-to-end payments integrated with the system of record that produce the bill. So that is a more valuable system to the customer because it automates reconciliations, provides better analytics, better reporting and they're willing to pay more for that than a commoditized payment. And so we're seeing a lot of growth around that, improving our payments margins as a result of that. And it just gives us a nice -- another layer of recurring revenues on top of the core software revenues. We are seeing some instances where we're selling software under a transaction model. So providing, say, an outdoor recreation system like we did for the California State Parks, but rather than charging a SaaS fee, we're getting paid by convenience fees that are levied on campground reservation or a kayak rental. So it's self-funded. The state doesn't have to budget SaaS fees. It's paid by user fees. And we're in a position that we're able to do that.

That was one of your big deals last year, right?

That's actually the biggest software deal Tyler has ever done, even though it is not -- in software, California. California State Park is about a $200 million deal over 8 years. But it didn't show up in SaaS bookings or SaaS revenues, it's showing up in transactions.

Yes. Great. One quick one.

Just a segue [indiscernible].

We'll see. Obviously, multiples have changed. Ours has changed quite a bit. Most of the companies we look at acquiring are private companies, a lot of them are small and valuation is always a big factor. And it's been somewhat frustrating to us over the last few years that especially PE firms have been paying multiples that often we thought were not reasonable. We'll see how this all resets. I think it's a little bit early, especially around some of the PE owned assets, the bigger things. But we do think it will be an opportunity to acquire some things at more reasonable valuations.

All right. Brian, thank you very much.

Thank you.