Tyler Technologies, Inc. ($TYL)

Thank you for joining us today. My name is Pete Heckmann. I'm the fintech analyst at D.A. Davidson, and hope you're having a good day here at our Technology and Consumer Conference. Joined today by long-time CFO, Brian Miller, of Tyler Technologies. Brian, thanks for participating with us today.

Yes, absolutely. Good to be here.

Definitely. And so Brian just came off a big event just yesterday, Investor Day.

Tuesday.

Tuesday, that's right. And Tyler did a fairly bold thing back in 2023 at their Investor Day. They provided guidance out to 2030. And I think that's the first time I've seen one of my companies or a company within my sector provide essentially a framework for thinking about growth in margins over 7 years. And A big part of that was the multiyear transition from on-premise software to the public cloud, and you've made significant progress on that. But can you talk just a little bit about it and some of the big milestones you're trying to hit like closing the data center, talk about that and talk about some of the milestones that you expect to see? And then you talk a little bit about where do you think you'll be by 2030?

Yes. I'll talk about the cloud specifically and then how that plays into our overall projections. Yes, in 2023, we laid out a vision for 2030, especially around the key objectives around recurring revenue growth and the cloud is a big part of that as well as our transactions business and around free cash flow targets. And we also set out interim targets for 2025, and so having 2025 in the books now, it was a good time to have the next Investor Day and update those longer-term targets. Really pleased that for every one of our 2025 targets we met or, in almost all cases, exceeded those. So the progress we've made to date gave us a lot more confidence in updating and effectively raising the 2030 targets as well. Around the cloud transition specifically, we've kind of talked about it in a couple of phases. We've gone from originally being, for many years, strictly an on-premises business. So we have a huge base of customers, most of whom were on-premises and paying us maintenance, very, very sticky customers, as you can imagine, the public sector. All of our customers are public sector. And then we had a hybrid model for several years where we offered our products either in the cloud, which was a private cloud hosted in a Tyler data center, or on-prem, and we were kind of neutral or agnostic around that. And then in 2019, we had a shift really to cloud first. And we said, really, we're only going to try to sell software in the cloud going forward, and we're going to have a more aggressive plan to move our on-prem customers to the cloud. And at the same time said we don't really want to be in the data center business long term. We can't scale that and we don't have an advantage over AWS or Microsoft, so partnered with AWS to be our primary public cloud provider. So we had some targets through '25, a big one of getting out of our data centers. So we had 5,000 clients to migrate out of our data centers into AWS, and we laid out a timetable for that. And we completed that on time, so at the end of '25, we exited our last data center. So now all of our cloud customers are in AWS and all of our new customers go into AWS. We -- part of -- a big part of that, especially as it relates to margins has been around version consolidation. So Tyler has a lot of products that we serve really all of the essential back-office functions of government, things like tax systems, court systems, public safety systems, 911, licensing and permitting, land records, school bus transportation, so a wide range of products, dozens of kind of major products and then within that hundreds of SKUs of modules within this. So we've had a lot of products. We've got -- we've also historically supported multiple versions of a lot of products. So we didn't force customers to upgrade to the newest version. And so over time, that became very expensive that we're supporting, we're devoting development efforts and costs into products that aren't the current version of our software. So we've had a fairly aggressive program of consolidating, sunsetting older versions, moving clients to the current versions of the product, which then puts them in a better position if they're on-prem to move to the cloud. So the second phase is really what we call cloud living, and it's really truly operating, not just hosting in the cloud, but operating as a true cloud company. Everyone will be on one version of the software and they will all stay on that version. They'll all upgrade at the same time. It will be seamless sort of bite-sized upgrades on regular schedules rather than like a big annual release, much better client experience, but also better for us to have everyone -- and much more efficient on the same product. We've also done a lot of work around cloud optimization, so optimizing the architecture of our products to run more efficiently and take advantage of the cloud features. So we've made a lot of progress with that. There still is work to be done over the next few years. So that's part of our ongoing margin expansion. So we've really set out a new target of expecting around the 20% CAGR in SaaS revenues over the next 5 years. That's up from a previous target of the high teens. We also raised our margin expectations from -- on an overall basis. Previously, it targeted a 30% operating margin by 2030. Now we've raised that to the mid-30s. And that's roughly 1,000 basis points of margin expansion from where we are today, I'd say, 300 to 400 points of that is coming from the cloud opportunity. We also raised our free cash flow target from high 20s to the low 30s free cash flow margin, and our cash flow target from $1 billion to now $1.1 billion to $1.2 billion in free cash flow by 2030.

Yes. Yes, very impressive. And so when we think about versus 2023, we are -- to 2030, we're moving towards a more recurring revenue model. Can you talk about like SaaS subscription as a percentage of revenue back in '23 and where you think it will be in 2030?

Yes. Yes. SaaS right now is a -- subscription is around 1/3 of our business and maintenance from on-prem is around 20% and then transactions is about another 1/3 and then nonrecurring revenue sources make up that other balance, which are really professional services and hardware. Those nonrecurring streams are growing at a much lower rate like mid-single digits by design. And we don't want to do more of those. They're not highly profitable. So yes, SaaS will be well north of 90% recurring revenues. And by 2030, that will be, say, about 1/3 of our revenues -- we expect still roughly 1/3 from transactions, but the SaaS will be another 55% or something, so move from 35% to 55%.

Yes. Yes. A real transition and some heavy lifting. I remember when we met [ 25 ] 6 years ago, Tyler was a much smaller company, but now really has become the category leader within the public sector. And can you categorize -- I mean, we just -- on the municipal market first, we can talk about state and local in a little bit, but just on the municipal market first, kind of how you characterize that market in the terms of like how many -- I think generally, you said like 55,000 municipal entities that each require about 6 systems. Can you talk about how your evolution has gone in terms of serving those needs, and kind of how you characterize your share today?

Yes. Yes. We have, by far, the broadest set of solutions for the public sector. No one else is close to us in terms of having that breadth of product offerings. We've also got the biggest customer base, although it's a really fragmented market. So we're still not highly penetrated in terms of a market -- well, highly penetrated, but not anywhere near saturation in terms of market share. So our revenues, at a high level, were roughly 70% to 75% local governments, so cities, counties, school districts, local agencies, authorities, that sort of stuff. We're about 20% to 25% state with most of the state business being transaction funded. And then we are less than 5% federal. So that's a relatively small exposure. Yes, so if you add up all the cities, there's like 37,000 cities and towns, 3,200 counties, 15,000 to 17,000 school districts, a lot of special agencies. So there's, yes, probably somewhere around 75,000 entities. And we have a presence in about 16,000, so -- that have at least one system from Tyler. We've got about 50,000 systems installed. So that math says the average customer has about 3 products from us. And we believe the average customer could have 8 to 10 products from us. Now what a city would have versus what a county versus the school district, they might be different products, but there's that kind of an opportunity. So there's a huge upsell opportunity or a huge TAM just in our existing customer base, those places we already have a product, and then there's a lot of green space for expansion in places that we don't have systems today. So if you take that, we say there's like roughly 500,000 systems across the local government space, and we've got 50,000, so it's a 10%, 11% market share kind of at the high level of looking at it. It varies by product, and every system is not the same size or the same dollar value, but there is that kind of an opportunity to expand just within our customer base. And then I'd say one of the things that's important about kind of how governments, especially local governments, buy software is very different than the private sector. There's a lot of things that are really different. But sales cycles are really long. They're typically replacing a system that's at end of life. So governments have not historically been ROI driven, although they are starting to look at things a little differently in today's environment. They don't have competition. They don't like change. So they tend to use systems much longer than you would typically see a system used in the private sector. We -- probably the average we replace is like a 20-year old system. So they use systems until they die. They buy a system and they use it until they absolutely is not supported anymore. It runs on old hardware, so they have to replace it. The mainframe systems, a lot of homegrown systems, some are 30 or 40 years old that are still being used, and there's no more programmers around that can keep it going. So that's created this very steady, but never explosive growth, just a very steady growth. And there's this constant replacement. It's a nondiscretionary decision. But now we're seeing more of a focus on efficiency and the way governments get more efficient is through the use of technology, so put in a new system. Even though old systems, maybe they can get another 5 or 10 years out of it, but it doesn't have online access, so there's no citizen self-service. There's no -- it's a paper-based system. So they're massive amounts of paper being dealt with, all kinds of reasons that there is -- that I think we're starting to see a trend -- trend may not be the right word, but starting to see more cases where governments are saying, well, there really is an ROI. There's a compelling reason from an efficiency standpoint for me to replace the system even though we don't have to. So we think that could potentially create some acceleration of demand, again, not explosive, but I think that we're starting to see some signs that kind of changes in the market a bit.

Yes. And Tyler has such a great brand and these municipal CIOs and CTOs and sheriffs, they go to a lot of events and conferences and they talk to their peers. And so referenceability is a big thing, but I think that's really contributed to your win rates. I guess, how do you -- and thinking about like the relative -- in terms of your growth algorithm, the relative ease of adding a new logo in terms of a new municipality versus sometimes the challenge of cross-selling just because sometimes the person making the purchasing decision can be the person who could be very siloed within municipalities.

Yes. Governments are very siloed. And -- so yes, but it's always better to have -- you are right, references, reputation, trust are a big thing in the public sector. And again, because they don't compete with each other, they talk to each other a lot and they share successes and failures. So the fact that Tyler does have a very strong record over decades of execution, and so they're wary of new entrants. It takes a long time. You don't see a lot of new entrants in our space that are super successful. So it's always better to have a reference down the hall -- at City Hall than a reference across the country. So -- and we have a lot of reasons besides just a good reputation that our products work well together. We've got a lot of foundational elements, the same technology across things like payment platforms or workflow engines or security and sign on that say, okay, if you buy that next product from Tyler, it makes it easier. We -- and in some, they're very tightly integrated, like courts and public safety are adjacent markets. So there's a lot of really compelling integrations there from having those from the same vendor. But -- and I think that trust is one of the things that -- we'll probably get into AI a little bit, but as our customers think about and are just starting to think about AI, they're also very cautious about that, but they're telling us that they want it from someone they trust. They don't trust a startup to come bolt some AI on top of a Tyler product, but they want it integrated with their product and they want it from us. And that trust is a huge thing. They want to trust how their data is going to be used and where their data is going to go because they're very cautious about that in governments. In our systems, there's a lot of very sensitive data around that governments have, if you think about a court system or a public safety system or a payroll system. So that trust and reputation is a big thing. And so we think we should have almost an unfair advantage to sell more products to our existing customers, but also to continue to have very high win rates in new logos.

Right. And one of the amazing things and what makes it kind of easy to track, Tyler, but relative to your underlying 50,000 of 500,000 potential installations, your win rates are much higher than your current share. So can you talk about some of the win rates across...

Yes. I mean our win rates, they vary by product, but typically, we're winning. Often in our flagship products, our win rates are more than 50% or around 50%. So we're winning kind of more than our share compared to the number of competitors. Some areas like courts, where we're really the clear leader in that space, we have win rates of 75%, 80%. Other areas that have more broad competition like public safety, where there's a number of good competitors, we still have strong win rates. There might be 4 or 5 competitors, and we're winning 1/3 of the business, something like that. So yes. So we do continue to gain -- even though these systems turn over kind of slowly, we win a strong percentage of the new ones. And so we're gaining market share every time those turnover.

Yes. And retention rates just by the nature of who you serve are higher because there's no M&A...

They don't go out of business. They don't get acquired.

Yes. So your typical client lifetime relationship is going to be...

Yes. Our gross retention over, same thing, decades is like 98% in terms of revenue, 98% names, 99% dollars, and then net retention with upsells and pricing is significantly better than that, kind of north of 110%.

Yes, yes. And so up until 2019, 2018, maybe like fair to say municipal was closer to 90% of revenues?

Yes. We were almost all local before that. A little bit state -- mostly systems that were used at the local level, but bought at this state level, like a state-wide court system. The courts are run at the county level, but the state bought the system. And then the NIC acquisition in 2021 really got us into the state space as well as the transactions or payments space.

And that's been fascinating. When I covered NIC since 2005 and until the buyout -- I think it was 2008, but in any case until the buyout, and it is a company that...

They got very few analysts to cover...

Right. Right. I thought I had a really unique mousetrap, and I thought, well, I wonder how that's going to translate to Tyler, but it's been fabulous. And so can you talk a little bit about how kind of the hunting licenses that NIC had with 28, 29, 30 states have allowed you then to sell more into the state? And then what capabilities really did NIC have primarily from their self-funded model that you've gotten and deployed?

Yes. So while we were almost all at the local level, they were almost all at the state level. We were almost all the back-end software. They were more the front end door to government and providing interfaces to what were often big mainframe legacy systems for citizens or business to interact with them and that was all through a self-funded model or transaction-funded model. So you think about -- and they had the state enterprise or have. We have the state enterprise arrangements with, I think it's 28 states that are very broad arrangements, provide a wide range of services, but things like motor vehicle registrations. So you want to renew your car license online, there's a big mainframe DMV system somewhere in the back of the state that was not built to have online access. So we built a portal. We built the interface to that so you can renew your license plates online. Maybe the state charges you $70, there's a $7 convenience fee that goes to Tyler that funds that. So the state doesn't have to budget any money to pay Tyler. They don't have to budget for SaaS fees or other costs out of their budget. It's tacked on. So same thing, you get a fishing license or campground reservation or business license or professional license, all of those things are kind of funded through that. Now there are some things that we provide services that don't have those revenues, but the whole model works by funding from the services that do have revenues attached to. So it's a really attractive model to the states. It's very sticky. We become very, very embedded with the state. We're -- we have close relationships so we know what initiatives they have coming that they're going to need something. So the premise behind acquiring NIC was that where Tyler didn't have these relationships or didn't have a sales force, but we have products that we could sell to states, but we just really didn't have access to that market and would take a while to build it up. So the idea was that now through these relationships, we can sell more Tyler products. So for example, Tyler has a very robust set of regulatory products for licensing and permitting, including a cannabis licensing product. So as more states have legalized cannabis, they need a system to manage all that. And there's all kinds of aspects of that, the retail and the taxes and the medical marijuana, and all those things have to be regulated. So we're already there. And so we say, "Hey, we've got a system." We know well ahead of time that it's coming. We've got a system for it. There's no RFP. There is no competitive process. There's no lengthy contract negotiation because it's treated as a new statement of work under our existing contract. And so we've been able to sell software into those states. And we're still in the fairly early stages. Even 3 or 4 years into it we said, we really kind of need more of a bridge here between all these products and the relationships. So last year, we built out a new state -- kind of senior state sales force that's kind of creating that bridge. So that was kind of the big opportunity, which is -- it plays out over time, but it's definitely meeting our expectations. The second opportunity was to take their payment engine and to be able to integrate that with Tyler products that have payments around them. So Tyler has a lot of products at the local level that facilitate payments, present bills, things like utility billing systems, licensing and permitting systems, property taxes, traffic court, tickets, fines and fees. But we didn't have a payment engine. So we kind of had third parties that we resold payment services, but that really wasn't part of our model. So now we came with these huge payment capabilities, a very robust platform that NIC had built out to service their customers. And so now we're integrating that with all of our products. So that going back and adding those payment capabilities to our software products, both to existing customers and then with new software sales, adding a new layer of revenues from transactions on top of that. It's better than a commoditized payment system. We talk a lot about how it's more than just payments because it's embedded in the software. So it's one solution for the customer, provides a lot of advantages like automating reconciliations. And there's some real reasons why it's better for the customers and can have premium pricing. So we're moving away from kind of commoditized payments and more towards this kind of value add or selling software that's funded through transactions.

Right, right. And so I think maybe 3 or 4 years after you did the NIC deal, I think you had crossed over 1,000 new payments contracts to your existing contracts, but they're not all small deals. Talk a little bit about the contract you signed in the state of California.

Yes. In fact, that was the biggest contract in Tyler's history, and it's interesting because it was a software deal, but it's not showing up in our software revenues. So the state of California -- we have a very robust suite of outdoor recreation products to manage of all the aspects of parks from campground reservations to retail to anything they need to run this park. So California needed an antiquated systems. California State Parks is the biggest park system in the country, or state park system. We had all the software capabilities, but all the payments capabilities. So we were able to provide them with this complete suite of software as well as payment processing, but we can do it under a transaction-funded arrangement. So California has budget issues. And so rather than them paying us a $20 million a year SaaS fee for the product, they pay us through -- we get paid through transactions. So if you reserve a camp ground and maybe the state charges you $15, there's a $3 charge to Tyler. Tour the Hearst Castle, there's a $20 ticket, maybe there's a $4 fee of Tyler. Rent a kayak, there's a [ fee to ] park. So -- and we do all the payment processing around that. So the state doesn't have to appropriate any funds, find any money in their budget. We have a pretty good confidence around the number of transactions, but there's upside as volumes go up. And it's north of a $20 million, $200 million total contract value. But because of the model, it's not showing up in our SaaS revenues. So there's kind of this...

Nor did it show up in bookings.

[indiscernible] up in our SaaS bookings, even though it's our biggest deal ever. So -- because the transaction funded deals still have to have a transaction occur. So there's really kind of this -- in the middle, there's a bit of a blurring of software and transactions, and that's why we say transactions is a lot more than -- it's not just payment processing, it's wrapped around software at the core and sometimes it's delivering software through a transaction. That doesn't apply to every kind of payment or every kind of software opportunity, but outdoor recreation, we've done several -- our biggest deal last quarter was a DMV deal in a large state in the South for new digital motor vehicle titling, so car titles won't be paper anymore, they're all digital. And it's the same thing. We get paid through a fee that's tacked on to your registration when you buy a new car or sell a car. And so it creates a really nice revenue stream, but again, it didn't show in our bookings, didn't show up in -- it won't show up for a year until the system is live.

Yes. Yes. Well, you can't talk to a software company without talking about AI a little bit. And I really appreciate it, at your Investor Day, the time that you spent on it. Talk about how Tyler is developing AI-enabled systems, provisioning AI? And it's the first time I've seen a company doing a really nice job of saying like, "Hey, here's how we monetize it and here's why we feel we have a right to win." Can you talk a little bit about that because I think it's pretty interesting.

Yes. Obviously, it's a big topic of conversation and certainly something that we think has affected our valuation. But at a real high level, we think it makes Tyler more valuable. We see it as a tailwind, as an opportunity, not a threat. We think our customers -- and we hear from our customers that they want AI that is integrated into their core systems of record that manage these essential functions. They want it from someone they trust, and they want their data protected and they want to comfortable with that. There -- I guess, at this point, governments are mostly kind of cautiously curious about AI. There -- the adoption curve like with everything else is going to be much slower in the public sector. But we are -- we see it as an opportunity, not besides internally using AI, but from a product perspective, an opportunity to add new AI applications around our existing products. In some cases, we've made a couple of acquisitions that are products that are AI-driven. But things like -- and things that we can monetize and things that solve real practical problems that customers have, which mostly stem from a lack of staffing. Governments are not typically overstaffed, they're way understaffed, and they're facing another big wave of retirements, and they struggle to replace people to compete with the private sector. So that's a big challenge for them. So example would be an application review assistant for our licensing and permitting system to use AI to review a building permit application. Because there's not enough clerks to review them, so it might take 6 months to get a building permit application approved. AI can do it in minutes, and customers are willing to pay for that because it's create -- solves the problem they have, and it creates more development and more tax revenues, so it's a good thing. And in many cases, they're seeing it as something that should come out of the labor budget and not out of a software budget. So we're seeing uplifts and we treat that as an uplift to their SaaS revenue. And we're seeing -- we gave some examples where we've seen, in some instances, 20% or 30% uplift. In the case of one state client, we talked about a 170% uplift from, I think, it was document automation because they can see that they're going to save $2 million a year of labor from clerks not having to do this, and they're willing to pay $700,000 a year for that. So high level, we see it as an opportunity. We did not build incremental AI. Today, our revenues are probably $20 million, $25 million around AI, specific AI products. But we did not include in our 2030 targets. We said AI will be on top of that because we just don't think we can -- it's too much that's unknown right now about how fast the adoption curve will be, how all the pricing will ultimately work out. So we're confident that it's incremental and it's a tailwind, but it's too early to give a credible number for 2030. But we think we've got a wide moat, and that really revolves around the domain expertise we have, that we understand these complex workflows and the system of record is more than just processing transactions. The relationships and sales channel that we have as a trusted partner and the data that we have both access to, to build better models, but also their concerns about data leaving their system, and therefore, wanting to get that from Tyler.

Yes. Yes. I think we're almost out of time, but I did want to just comment like Tyler has made a number of -- like 68 relatively smaller acquisitions over the last 25 years, and that's been additive to the overall growth. And when you've talked about your 2030 revenue growth goals, not only does it not include AI, it also does not include future M&A. But you have a great balance sheet, you have a great track record and a process of finding acquisitions. Given the recent conversion, should we expect anything different from...

Not really different. I mean I think we still look for opportunities to fill in spaces or adjacencies around existing products, often things that we can leverage our sales force and leverage our customer base to grow faster. We gave an example of the 7 acquisitions we did from '23 through '25. Those -- the CAGR for those businesses through 2030 is about 24.5%. So they're growing at twice the growth rate of Tyler because they're being sold through our sales channel and being sold into our customer base. So that's still the thing. I think we'll still see tuck-ins. I think there'll be bigger opportunities right now. It seems like sellers are still kind of coming to grips with a different valuation framework. Public companies, obviously, like Tyler are coming to grips with it too, but we don't have a choice right now. We have also -- so we've got -- I think the key is we've got a lot of firepower. We've got $1 billion in cash on our balance sheet. Over the next 5 years, we'll generate north of $4 billion of free cash flow. We got $1 billion revolver. So we've got $6 billion of firepower to use for acquisitions, and we've got a really good track record of doing this well, and stock buybacks. We've been opportunistic about buybacks, being more aggressive when there are more compelling opportunities. We certainly view this and us trading at a multiple that's at least a 15-year low, even though the company is many, many times stronger and the high visibility into future cash flows. So we put in place a $1 billion buyback authorization earlier this year. We've already bought back $670 million of stock, about 5% of our stock, since February. And we've got a lot of firepower left to do that as well. So I think we can do both acquisitions and M&A and drive a lot of shareholder value through both of those.

I know there's a huge vote of confidence at the time where you've clearly passed the tipping point of your move to the public cloud. So you've done a lot of heavy lifting there. You're executing the biggest acquisition in your history, you've executed on very, very well. You've given guidance out to 2030, but because of this unique market environment, stocks trading at 20 year -- multiple lows. And so it was great to see a step up and be aggressive on the buyback. So that I think there's a lot of reasons to feel confident in the outlook at Tyler. And so I really appreciate you participating with us today, and we're out of time, but thank you for coming, and we look forward to the next update.

I appreciate the opportunity to tell the story.

Thank you.