Tyler Technologies, Inc. ($TYL)

Great. Hello, everyone, and welcome to JPMorgan Boston CMC Conference. My name is Alexei Gogolev, Head of Vertical SaaS research team. And today, I'm delighted to be hosting Tyler, CFO, Brian Miller. Brian, welcome.

Thank you. .

If I may begin our conversation with your SaaS growth durability, you've explained the 2026 SaaS growth bridge so prior bookings and new bookings and flips. But what are the biggest execution risks that could shift timing or maybe what are the most upside levers that you see for those numbers, perhaps it's things like go-live, cadence or some renewal and pricing timing?

Yes. It's mostly around timing. So the biggest driver of our SaaS growth this year is prior year bookings. So things that we signed last year that there's a lag from the time we sign a contract to when the revenues start or -- and some of those are even things that we signed in which was a really, really strong bookings year for us. And so we had a partial year of revenues last year and the full year of revenues this year. So more than half of the growth comes from prior year bookings. Pricing is -- there's not a lot of variability around that. And then the new bookings have less of an impact on the current year, again, because of that lag. And then there's our flips of our on-prem customers moving to the cloud. So most of the -- either the risk or the opportunity is around timing. So whether someone signs to flip from on-prem to the cloud and we get that revenue uplift, in Q2 or in Q3 or whether it takes 1 quarter or 2 quarters before they're ready for us to execute that migration or the timing of bookings. Generally, especially as we get into the second half of the year, actual bookings for this year won't have much impact on this year's revenues. So more around the -- just the all those variables around timing that caused things to either happen a little bit sooner or a little bit slower.

Brian, taking that into account, so given the contract duration can swing and the fact that transaction funded software doesn't really show up in cleaning your bookings. What metrics would you suggest that people should focus more on? Do you think things like ACV from new and flips and then renewal prices, maybe some RFP to demo, to award stage like are those better reflections of your problems?

I think so. I think really, when you just look at high-level bookings, it's a pretty good -- we give total SaaS bookings, it does include -- it's a TCV number, but the duration tends to be pretty stable these days. So that number, the ACV of new SaaS plus flips, but is another metric, but that doesn't capture all of our SaaS. So really kind of our total SaaS bookings is probably the best leading indicator, which encompasses flips, renewals because actually the majority of our new SaaS bookings are from add-on sales to existing customers.

Perfect. You've had a pretty strong quarter, and you've raised your guidance. And maybe can you explain the SaaS revenue guide, which rose by about 1% or about $8 million at the midpoint. How much of that is coming from FTR your recent acquisition. And on the surface, it did seem like outlook was a bit more conservative. Maybe you can set the record straight around your confidence about the year. And what sort of assumptions are you making around this acquisition that you made, FTR?

Sure. Yes, at a high level, our adjustments to guidance after the first quarter were -- at least in terms of total revenue, it was pretty much entirely the acquisition of FTR, which we closed in April, but prior to report in Q1. So we had the forecast for that to include. Typically, we don't revise guidance after the first quarter unless there's something unusual. It's not very long from the time we report year-end and the end of February to when we're reporting Q1. So usually, there's not a guidance revision there. So it's not unusual that really kind of the only change we made was around FTR. FTR is going through a cloud transition of their own. So we have an estimate of what their total revenues will be and what their SaaS revenues will be. But there's going to be some variability around it, because we're not sure exactly how their revenues for the remainder of the year will play out between cloud and on-prem. So we cushioned it a little bit. But I think at the high-level answer is there's really no change in our outlook for the full year around SaaS. Anything -- there's some minor tweaking around timing of flips as well, but nothing that was meaningful at all in terms of a change in our outlook for the full year of SaaS.

Okay. That's great to hear. In terms of cloud flips, so you've hit record levels. What has fundamentally improved in Tyler's ability to execute those flips and what still limits how fast the flywheel can turn.

Yes. And if you step back and look at our total customer base today by revenue, so if you take our cloud revenues today, our SaaS revenues, and our current maintenance from on-prem customers if you translate or convert our on-prem maintenance to SaaS that it's roughly a 1.7, 1.8x uplift that we typically get, where about 55% of our revenue -- equivalent revenue is in SaaS today and about 45% is on-prem. There are a lot of variables that go into how fast those customers or what pace or what the timing is of those on-prem customers moving to the cloud. We've said that we expect that by 2030, at least at our last Investor Day, we said we expected that 2030. They roughly 80% of those customers that were on-prem in 2023 would have moved to the cloud. And we said we're on track to achieve that. In some cases, what governs when they move is around their own infrastructure concerns. I guess for starters, there's -- the public sector moves kind of slowly at all technology changes. A lot of it is around their own infrastructure challenges. So there are challenges in hiring technical people, systems, administrators, applications administrators, their concerns and that's a big issue for governments, especially local governments. They have a lot of retirements coming and really struggle with replacing those people with competing with the private sector, with paying private sector salaries, being an attractive place to go to work for those people. So they're challenged with hiring people. Some of it is around their own data centers and when their equipment is going to need to be renewed. So if they're -- they've got a lot of hardware that's going to be depreciated in 2028. That may be when they're looking at moving to the cloud after they fully depreciate the equipment before they have to buy new hardware. Cybersecurity is a growing issue. Certainly, a lot of government, their own networks and infrastructure are -- they have concerns around their security. There's a lot of vulnerabilities around those. In a lot of cases, they're targets for the bad actors. And so that either when they actually have a cybersecurity event or when they become more concerned about one, maybe see peers or neighbors suffer in an attack, then that becomes a motivating factor. So a lot of these factors drive when they move. A lot of it's just their overall IT road map. So for example, Los Angeles County is one of our largest clients, both in the court space and in the licensing and permitting space. They signed last year, I think, Q3 to flip their licensing and permitting system to the cloud, but their court system is going to be further down the road. And I would say that our on-prem customer base is still a little bit more heavily weighted towards large customers as well. so they can be kind of lumpy in terms of how that drives it. But we do expect the peak of conversions still to be 2 or 3 years out, kind of the '27, '28, '29 time frame is where we see the peak, both in terms of the average size and the number of clients flipping, and then we'll be more on the downhill side beyond that. As we look at what we can do to accelerate that because it's not only a better client experience, it's better for us for those customers to be in the cloud, but it's also a better client experience. So A lot of it is around educating customers on the benefits they get from moving to the cloud and why they should do that. I think at this point, you'd find very few customers that would say they have no plans at all to ever move to the cloud. It's more about when and how and all the planning and how that fits into their overall IT road map. But we currently, I think, are more in the carrot world. We've increasingly told customers that new features and functionality will only be available in the cloud, while we will continue to support their on-prem system that they won't get new features and functionality that we believe they'll want, including in some cases, AI functionality. And then adjusting maintenance pricing, so bigger increases in maintenance prices to provide more of a financial motivation to move to the cloud would be on the horizon as well.

Okay. So when customers do flip, what is the most repeatable attach motion you're seeing? And how are you helping this flips to consistently come with that incremental ACV beyond what you just mentioned, the 1.7, 1.8?

Yes. So the 1.7 to 1.8x uplift is kind of like-for-like, so it's moving the same product, taking their maintenance and moving it to SaaS, which incorporates the hosting costs as well. But we are seeing opportunities to up-sell or cross-sell other products when they move to the cloud. So for example, someone might be moving their court case management system with Tyler to the cloud but they have a jail system from another vendor and that's on-prem and maybe that vendor doesn't have a cloud offering or it's not a -- it's a legacy system that just isn't current technology. So that creates an opportunity for us to have a conversation with them and present them with a proposal to move that system to a system that's already integrated. It's already the same -- uses the same data part of a complete integrated suite of solutions. So we could be -- their jail system, their prosecutor system, their probation system, jury system. So there are multiple opportunities to kind of accelerate the replacement of other systems around the cloud. I think today, compared to, say, 2 or 3 years ago, we're much more intentional around kind of pursuing those opportunities. We look for those and bring in appropriate sales resources. And so we would expect that we'll continue to see higher attachment rates and better uplift around those as we continue to refine that go-to-market process.

And so payments is one of those attached products. How do you think about penetration of embedded payments across the installed base by some major workflows? And where is the clearest path to materially higher attach for payments?

Yes. So since we acquired NIC in 2021 and acquired a really robust payment platform, we've kind of shifted our strategic approach to payments in transactions broadly across Tyler from kind of reselling third-party payment solutions to our own embedded platform and having that platform tightly integrated with the systems of record that produce the bills and process the account for the payments. So things like a utility billing system, a licensing and permitting system, parks and recreation, property taxes, utility billings. All of those are big applications for us where we have thousands of customers using those systems and most of them are not using Tyler for payment processing around those. So we have done the technology integrations where those systems are fully integrated. And so it creates more value for the customer because it automates reconciliations, provides better reporting, better security, so it's a better solution for the customer. They only have to deal with one provider for both the payments and the core software. And so what we're doing now is bundling that with new software sales. So any time we have a proposal or a sales opportunity for any of those systems that have payments with them that they're getting a payments proposal from us, and then we're going back across our installed base of thousands of customers using those various products and either trying to replace their existing payments provider, sometimes that has to happen when their current arrangement ends or, in many cases, initiating online payments for the first time ever. And so I think we're still pretty early in that. I think we've gotten a lot of the low-hanging fruit in the first couple of years. Now we have a much more kind of refined go-to-market and how we approach those sales with the combination of a payment specialist and the application specialists and have a pretty compelling value proposition and are having a lot of success with that. But still the penetration the opportunity, even just in our installed base is really significant. We're still in the very early days of that.

And so with that in mind, Brian, with the Texas contract rolling off, what does the kind of steady state transaction growth look like? And what sort of indicators would you highlight that we validate that, maybe some client mix or unit economics of gross versus net mix?

Yes. We have talked about a sort of low double-digit growth rate, I think 11% to 13% is what we talked about at our last Investor Day for our transaction revenue business. And really our transactions revenues kind of go beyond just payments. Sometimes the terms are used interchangeably. But it's really a lot more than payments. In some cases, the former NIC business, we have these broad state relationships where we provide a wide range of services, including software often, but it's funded by payments or user fees, convenience fees, and we process the payments around those as well. But it goes well beyond just pure commodity payment processing. Increasingly, we're selling software under these transaction-funded revenues. Our biggest software deal last quarter was one of those, it was a digital motor vehicle titling system for a state government that we have an existing relationship with. It's not a -- we're providing software, but it's not -- it won't show up in SaaS revenues. It didn't show up in SaaS bookings. It's paid for through transaction fees. So when you renew your -- or you buy a car, you pay that titling fee that goes to the state and then there's a transaction fee that's added to that, that goes to Tyler that pays for that system. This contract that we signed this quarter will generate more than $20 million a year in ARR. So it will be a very significant revenue stream. But again, it will show up in transaction revenues, not SaaS revenues. So broadly that kind of low double-digit expectation, I think, is still our baseline. We have a number of opportunities both around selling software into that transaction model, disbursements is an area of kind of the other side of most of our payments revenues today are around inbound payments. So we have offerings around disbursements, AP automation, jury payments, child care payments that we have tremendous opportunities within our customer base that we're also in the very early days of pursuing those. So we think there are a lot of vectors that get us to being very comfortable with that low double-digit growth rate and opportunities that it could potentially be higher. We've been a bit higher than that the last couple of years, some of that around, as I said, some of the early penetration into our customer base and as well as some third-party payments that -- third-party revenues that had some pricing that boosted our revenue growth, but really wasn't sustainable long-term revenue growth. So this year, our transaction revenues are a bit below that level because of the impact of the Texas payments contract rolling off at the end of last year. The Texas payments contract was a kind of a non-core piece of payments business that was strictly payments. It was very commoditized, very low margin, less than 10% margin, and didn't really have those other connections that the rest of our payments businesses have. And so that's providing a headwind for this year's revenue growth, a tailwind for margins. And so as we work through that this year, I think our normalized payments growth would have been something like 13% last quarter, excluding the impact of Texas.

Okay. That makes sense. So you talked a lot about the states impact from NIC, but generally, your exposure to the state contracts. Can you elaborate a bit more about your state specialized sales team? It sounds like it's opening a lot of doors already. Where do you see the biggest upside? Do you think there could be some opportunity with some coverage model or maybe some coordination with product teams, target workflows, like how do you see that state sales team evolving?

Yes. It's sort of all those things. So our business broadly today is around 75% -- 70%, 75% local governments, 20% to 25% state and less than 5% federal. Most of that state business came from the NIC acquisition. Most of that is transaction driven. So it's not funded by appropriated funds or by budgeted funds, but it's primarily paid for by user fees, convenience fees, transaction fees. So it's somewhat insulated from the budget cycle. Part of the -- one of the premises of the NIC acquisition was the idea that we could expand our presence at the state level where Tyler didn't have -- we were almost 100% local prior to the NIC acquisition. So most of our software products are installed at local governments. We have some state contracts for things like court systems, but they're used at the local level. So we didn't have really a state sales organization, state relationships, even though we had a lot of products that we could sell to state governments. And I see, had these, I think, it's 28 state enterprise contracts where we're deeply embedded with the state governments, with the CIOs, with the administrations supporting their initiatives, and providing the interfaces for citizens to interact with these state governments. So the idea is that we can leverage those relationships and sell more software from Tyler products at the state level. But what we learned as we went along the way was we kind of were missing a bridge in the middle. So we've got these strong state relationships on the former NIC side. We've got dozens of Tyler products with sales organizations selling those. But how we sort of matched up those state opportunities with the products was a little more complex. So we created a, kind of, starting at the beginning of last year, a new dedicated state sales force that provides that bridge. So it's kind of high-level sales executives that are really the single sales point of contact for a state government that can bring to bear all the Tyler products. So as we become aware of opportunities, which we often do early on because of our state relationships. We can say, "Hey, Tyler has a product for that, let us bring the right team in." So we're a lot more efficient about matching those up. So we're seeing some good successes things like this motor vehicle titling deal I just talked about. In a number of states, we've sold our licensing system for cannabis regulation as states legalized marijuana, that creates a need for a whole new set of software solutions to manage that, and we have a platform for that. So we've been able to bring that to, I think, 6 states without RFPs, without lengthy sales processes, without contract negotiations, without new contracting because we treated as a new statement of work under the existing arrangement. So again, that sales force has just really been built out in the last year. Some of these are long processes, but we're starting to see early success, and we expect that that's really the catalyst we need to kind of fully realize that opportunity.

Brian, can we talk about your AI strategy. You've emphasized discipline over hype. So what ROI thresholds do you require for customer-facing AI features to be productized and scaled?

It's amazing. We went 25 minutes without uttering AI. Yes. So in the public sector, as with almost every technology change, they're amongst the last adopters. The adoption curve is much, much lower in the public sector. They don't want to be the first at anything, and that seems to be the case here. We had our user conference about a month ago with close to 6,000 customers. AI was certainly a big topic conversation, Tyler talking about our vision of AI in the public sector, the road map around our products, the things we have today, the things that are coming. And a lot of client questions and curiosity. So I think we characterized it as kind of cautiously curious about AI, not in a lot of cases, not ready to embrace it, but curious about it, but with a lot of concerns, especially around data, around how it impacts their workforces, how it impacts their communities. So a lot of concerns and questions but also a lot of interest in how AI can help solve real day-to-day problems, a lot of which stem from staffing shortages. So governments face a lot of upcoming retirements. A lot of workforce challenges already lost a lot of workforce during COVID that haven't been rebuilt. So generally, most of your -- especially your local governments just don't have enough people to do the work they need to do. So as a result, there are things like a 6-month wait to get a building permit application approved, or backlog of court cases that haven't been entered into the system, so trials are delayed. So those are the kind of real problems they're dealing with, and that's where we're focusing a lot of our AI development efforts in solutions that use AI to help solve those problems. And that can provide a real measurable clearly understandable ROI, which is not the way governments have usually looked at software through an ROI lens but that they can really see the benefit. And so we have a handful of products already, some of which came from applications that are kind of stand-alone ROI or AI-driven products. One of the best examples is a product called Document Automation. It interfaces with our court system to automate data entry in the court system. So rather than a clerk having to look at a filing, a lawsuit, a court document and enter it into the system to create a case file or to add data to a case file. It uses AI trained on millions of court documents that have gone through our systems to automate that data entry process. We have had success, for example, last quarter, we signed contracts with 2 top 10 counties in the country. Harris County, which is Houston and Miami-Dade County, which use our court system to add that on. In both cases, the incremental ARR from the application is significantly more than they're paying already for the core court system. But the savings in terms of labor are 2 to 3x what they're paying us in ARR for the AI application. We are also investing in development around not necessarily stand-alone products, but AI add-ons, there would be SaaS uplifts to existing products. So for example, in the licensing and permitting space, where we have a very big presence. We have a application review AI assistant that uses AI to review, for example, building permit application and say, yes, that meets code or no, it doesn't, approves it right now. a lot of places, there's a really long delay for those because there's not enough clerks to review that. And it slows down community development, it slows down property tax revenues. There's a lot of implications around not being able to get building permits approved. So it provides a real value to the customer, provides a revenue uplift for us. And we believe they want to get that from Tyler because Tyler understands that licensing permitting process, the complex workflows extremely well because we provide the leading system in that space. We have the clients' trust because we have long relationships with these customers. They trust what we're going to do with their data, how we're going to use their data, how we use other clients' data. And we have the sales channel, and we have the relationships. And we think all of those combined really provide that moat that will say, our clients are going to want to get that application from Tyler rather than a third-party plug-in or a startup coming into build an application on top of a Tyler solution. And they're certainly not doing it themselves. So that's the feedback we're getting from customers and the things that we're building around our products are aligned with where they see value and where they see need and that they're looking to Tyler to get those things.

And in terms of pricing, I think you said that you do not plan seat-based AI pricing. So how are customers reacting to some more of a SaaS or value-based AI packaging?

Yes. In general, for Tyler's software solutions, we don't do seat-based licensing. So to the extent that, that has been a concern around some software models, in terms of lower headcounts or lower number of seats, that's not applicable to Tyler. Most of our products are priced based on some measure of the size of government. So a property tax system would be based on the number of parcels of property County Hays, has a public safety system would be based on the number of 911 calls they answer. So this is some measure of the size of government. Our AI applications as well in government, they don't like consumption-based pricing. It doesn't really work well for them because everything in the government is based on the budget, and they set the budget at the beginning of the fiscal year. They know what they think their revenues are going to be. They allocate all their costs. And when there's no more budget, there's no more money. So they really have to have predictable cost and so they want a fixed price model. And so our pricing -- so we have kind of -- we sort of see 3 different pricing structures around AI. One are the kind of stand-alone products that I talked about that would have a fixed SaaS fee with caps. So there's caps on usage, so that we're not exposed on costs, but that is reflective of the value of the application, which is generally reflective of the labor savings. So like in Tampa, they're paying us $950,000 a year for the Document Automation application, but they've identified that they'll save more than $2 million a year in labor costs. Things that are SaaS uplift would also be sort of value-based but again, a fixed SaaS fee with caps on it. And then I think ultimately, there'll be some features that will be embedded in products that will separately be priced. They'll just be part of the standard product and provide additional value to the customer and a competitive advantage for us. But we generally don't see -- all those things are more value-based and more size-based than seat-based.

So with the Investor Day coming up, the first one you've had recently was in 2023 and prior targets did not include any AI potential upside. What are the most important scoreboard metrics investors should focus on to evaluate some progress that you are obviously making in AI and cloud and transactions.

Yes. It is funny that just 3 years ago, AI was barely in our vocabulary. And it wasn't part of the discussion at our last Investor Day or part of the models that we put out there. So we had set forth at our '23 Investor Day, what we referred to as our 2030 Vision. So we set out targets pretty far ahead of time for different revenue streams, our growth rates, free cash flow growth, margin expansion between 2023 and 2030, and we had set some interim targets for 2025. So for 2025, we clearly either met or exceeded all of those interim targets and said we were on track to meet or exceed the 2030 targets. So we'll be updating those at our upcoming Investor Day. As you said, AI wasn't part of those at that point. So to the extent that we have identified cost efficiencies internally around using AI and development in professional services, implementations and customer support. We will factor those into our updated targets and the kind of margin improvement we expect to see. I would say we're still pretty early, so we don't have perfect vision. So we'll probably be probably more on the conservative side. But at least to the extent we have visibility around that. On the revenue side, I think certainly, there are some revenue streams from some of those products that we currently have ongoing revenues from. But I think in terms of trying to incredibly predict what our 2030 AI revenues will be is not something we can do at this point, but we'll talk a lot about kind of where we see those revenue streams coming from. In the case for why this will come from Tyler and while they'll be incrementally positive to us, we won't be quantifying those at this point, but we'll be kind of laying out the road map and how we expect those to be accretive.

Great. Brian, thank you very much for being with us today.

Thank you.