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

Thanks, everybody, for being here today. Apologies, might be 30 seconds late. We got lost running up and down the stairwell, but I'm sure we can all relate. My name is Steven Anderson, Managing Director on Citi's Software Investment Banking team. Pleased to be here today with Brian Miller, CFO of Tyler Technologies. We're going to have a couple of questions here, fireside chat. If there is time at the end, happy to open up to Q&A from the audience as well. Brian, as we think about Tyler Technologies, we know you as a major player in the GovTech ecosystem. You've been a leader for decades in the space, and you've been helping governments modernize their business through technology. For folks who are not as familiar with Tyler Technologies, can you just maybe spend a quick intro on who you are, what you do and the business strengths?

Yes. So as you said, we're the leading provider of software solutions, mission-critical software solutions for the public sector, primarily focused historically on the local government markets, so cities, counties, school districts, they make up 70% to 75% of our business, have gotten a bigger position with state governments, mostly through the acquisition of NIC 5 years ago, and that makes up about 20% to 25% of our business, pretty limited exposure to the federal government, less than 5%. So we have the broadest product portfolio of anyone serving public sector software. And we have by far the largest customer base of anyone serving the market. Having said that, it's still a very, very fragmented market, and we still have an awful lot of runway domestically as well as internationally. And we -- in addition to the software solutions we provide, we have a pretty significant transactions business, makes up about 1/3 of our revenues, so providing payment processing as well as software that's provided under transaction-funded arrangements.

Very good. And one thing I'd love to drill into a lot of the companies who are here at this conference today serve into the enterprise horizontal markets. Those can be very, very different than focusing explicitly on government customers. What is unique about your end market? What is differentiated about serving your customers?

Yes. The public sector, there's a lot of things that are very different about it than the private sector. At the core, one of the big things is our customers don't compete with each other. They talk to each other a lot. So they take a lot of comfort in solutions that work at other places like them. So references and reputation are a really big thing, and that's something that Tyler has an incredible amount of strength at. Not surprisingly, governments move slowly. So we have long sales cycles, long replacement cycles. Very often, they keep systems until they die. So they don't think about -- historically, they don't -- it's changing a little bit, but historically, they don't really think about software from an ROI perspective. Again, they don't compete with each other. They're not profit motivated. So they don't like change. So they tend to use systems as long as they can. So historically, it's been hard to kind of create demand. But that replacement creates a very steady sort of nondiscretionary demand because when one of these systems does get to end of life, they're all mission-critical applications, public safety, courts, property taxes, utility bills, those kinds of things. So replacing it is -- not replacing it is not an option. So it creates an opportunity for very steady compounding growth as Tyler has demonstrated over a very long time. And I think it becomes if you're not in this market, there are a lot of those characteristics you might view as negative. If you're in the market, there's a lot of those things that are really positive. So -- but at the end, Tyler's strength is really our deep domain expertise, the breadth of our products and our very long history of focusing just on government.

I want to drill in just a little bit on one of the comments you made about they have to -- they might use assets until end of life. They might sweat them all the way through. Maybe correctly or incorrectly, probably a lot of people have a view the public sector may not necessarily always be at the forefront of technology innovation. But what have you seen? Obviously, the cloud transition is something we'll talk about a little bit more now with AI. Are governments becoming more front-footed? Are they becoming more technology oriented? How have these cycles evolved as you've seen them play?

Yes, they really are. And I think some of it is really related to an increased focus on government efficiency. DOGE was obviously a big topic 1.5 years ago in the news every day. But even before DOGE, there was starting to be more of a focus on government efficiency. A lot of state governments, even local governments had efficiency initiatives. And governments always have -- they never have enough resources, enough budget. They always have budget pressures. They always are trying to do more with less. But really, the way governments get more efficient is a more effective use of technology, not only with an old mainframe-based system, is it just old technology that's hard to run, but it doesn't have citizen self-service or online access. It's not a good platform to build AI on top of paper-based in a lot of cases and not digital. So replacing those systems does have a really strong ROI. And governments are -- I think as they look at how they become more efficient, at least at the state and local level, it's not that they can fire thousands of people, but they don't have enough people to get the basic work done to start with. So technology is the way they're going to address that. And so we're starting to see more customers looking at ROI cases, seeing that around AI applications and talk about replacing systems that aren't necessarily at end of life that they could get another 5 or 10 years out of, but that they're starting to understand that there are real benefits from making that effort and investment.

And you mentioned DOGE, lots of headline around DOGE, certainly more at the federal level. I know you're more state and local, but can you talk about any spillover impact? Did you notice it more than headline? Or was it a real thing in your customer base?

Well, it didn't really have much of an impact, but there was an impact on sales cycles in the first part of '25 because there was a lot of conversation, a lot of noise. And again, we don't have much federal exposure. But at the local level, whether it was those, tariffs, just a lot of noise around the new administration, it was enough that local governments and state governments had to sort of step back and say, "Hey, is this going to affect me? Am I going to lose revenues? Am I going to have a bunch of work that I didn't used to do that I'm going to have to do?" And so there was a slowdown in sales cycles in the first part of last year that impacted our bookings. It ultimately didn't impact demand. I mean, ultimately, state and local government said, no, this doesn't really change anything. So there was a bit of a pause or a slowdown. And by the end of the year, it was pretty much back to normal. We've talked about in recent quarters, a very active market, really strong RFP activity, sales demo activity. So really no ultimate impact other than what I talked about earlier in terms of a positive focus on efficiency that is -- that will drive more technology purchase.

Perfect. And then you talked a little bit about your market continuing to be despite your leadership position being very fragmented. So maybe can we just spend a minute on really just how has the competitive landscape evolved? Who do you sort of see an RFP? Is there a new wave of more, call it, AI native folks showing up on your radar as well? What does that look like?

Yes. There haven't really been a lot of fundamental changes around the competitive landscape. The market historically was served by a lot of niche players, point solutions, often companies that were focused on one product area and often even narrowly geographically focused. So a company that did court systems in California or property tax systems in New York and New Jersey. And those really were kind of the providers that served the market for a long time and still have a big market share. A lot of those companies have become sort of legacy companies, so they haven't kept up with new technology or invested, but they're still collecting maintenance or from large installed bases that over time will migrate off. We have different competition in each of our sub-verticals or our functional areas. So the companies we compete with in the court software space are completely different than the companies we compete with for property tax software, and those are different than the ERP competitors. And those are different than the public safety competitors. So there may be a few companies that have a couple of products, but no one has the breadth. And that provides us with a big advantage because in some cases, like public safety and courts, they're very tightly integrated because they're adjacent markets. But in other cases, where we have foundational elements that are common across all of our products like common security and ID or payment platforms or workflow engines that, that creates more efficiencies around having more and more products from Tyler. In terms of new entrants, I mean, as cloud software became a thing, there were some cloud-native new entrants. Some of those became good acquisition for targets. The difference really is those fundamental things that make it hard for new entrants. They don't have references. They don't have deep domain expertise. The products are typically lighter in terms of functionality. And it takes a really long time to build up all of that. And so not everybody kind of makes it all the way in. We've seen some good -- like we've acquired a number of good cloud-native point solutions that have filled in gaps in our portfolio. But we haven't really seen big significant competition. And kind of the same thing around AI. We know that lots of AI native companies are talking to public sector customers, but they're not really quite ready for anything. And so our customers are really looking for Tyler to bring them AI that's integrated with their products rather than bolted on by someone they don't really trust.

Very good. And let's maybe pivot a little bit more just to the ongoing strategy and financial pivot. But one of the most common things we hear about every quarter is the cloud transition. It's been going on very steadily and we will continue to on go the concept of customer flips moving them from an on-prem to the cloud. Just give us a little color on how is that transition moving for you from your perspective? You've given some targets for your 2030 model, what the business looks like. How do you feel you're on track to that as well?

Yes. We are on track to achieve our targets. And actually, we raised our target. So we had an Investor Day in 2023. And at that point, we said kind of with the starting point we were at then that we expected that of our on-prem base at that time that 75% to 80% would migrate to the cloud by 2030. At our latest Investor Day this past June, we've changed that target to 85% partially because of the progress we've made to date and also the way we see it playing out over the next few years. If you look at our entire customer base today on a kind of a revenue equivalent basis, if you converted all of our maintenance from on-prem customers to SaaS revenues, we're about 55% of our customer base is in the cloud today and about 45% is on-prem. Almost 100% of our new sales are in the cloud and have been for some time, but we still have this base of on-prem customers that are migrating. So we're well on track to hit that 85%. We've talked about disincentives, carrots and sticks and working with all those things.

Very good. And then maybe a little bit on the carrots and sticks. But as you think about folks who are still yet to make the jump, what is it that -- is there something that prevents them? Is there something that they have to get comfortable with? What is it that stands in the way of getting to 85% and beyond?

Yes. Part of it is just inertia governments move slowly and there are always some early adopters. There's others that move along the way, and then there's some that just need to push or some sort of catalyst to get them to move. I'd say at this point, there's virtually none of our customers that are just saying, I never want to move to the cloud. I don't see any reason why I should be in the cloud, don't understand it. I think they all understand that at some point, they'll be in the cloud, but there are different factors about when that happens. In some cases, it might be hardware. I mean they might know that in 2028, they're going to have to replace a lot of the servers in the data center. And so that's when they're planning to move. They don't want to replace it, but they also want to run them off until they get to that point. Sometimes it's people driven as they -- especially in technical roles, governments really are struggling with competing with the private sector for filling those systems administrators and database administrators and cybersecurity people. And they're facing a big wave of retirements over the next few years that's going to make those problems a lot worse. And so moving to the cloud helps with that. Cybersecurity as well. Ransomware attacks are a big factor. In terms of other factors, as we move to -- we not only have a lot of products, we have historically supported multiple versions of a lot of our products. And so that's been really expensive from a development standpoint and a support standpoint for Tyler. A lot of reasons why we've allowed that to happen. But our goal, obviously, is to have one cloud version, cloud-optimized version of each product and to get all the customers on that as they move to the cloud. But if a customer is not on the current version of the software, they need to upgrade to that version before or when they migrate to the cloud. And so we've been making a lot of progress with that in terms of sunsetting older versions, getting more and more of our client base on the current version, so they're in a position to move to the cloud. And we still have some work to do around that, which will also show up in margin expansion. But that's been probably the biggest gating item on our side, and we continue to make progress around that. I think the biggest development, I guess, if you will, is in this last quarter, a letter went out from our CEO that all of our on-prem customers kind of letting them know that over the next few months that we'll be sitting down with every customer and starting the plan to map out a more formal plan for their migration to the cloud, the timeline, kind of understanding what are the factors on their side that govern that decision, what -- some of the incentives and disincentives on the Tyler side, we've talked about to clients about the new features, including a lot of AI features will only be available to cloud customers. We also expect that along this journey that there'll be more significant maintenance price increases for customers that are still on-prem. And ultimately, there'll be an end of life for on-prem products. And so those will be part of those conversations. And so it's a little bit not quite so open-ended and indefinite, but there will be -- there needs to be a plan around moving to the cloud.

And then one of the things you mentioned just on the revenue front, moving from a maintenance contract to SaaS, there's an uplift. I think you disclosed 1.7 type multiplier. And so especially as we think about getting towards the end of a transition, that creates a great growth tailwind in the middle of it. What does the -- what happens after the fact? What does the cross-sell, upsell opportunity to drive?

Yes. So yes, part of our -- and we've had above 20% SaaS growth for -- I think last quarter it was 23% straight quarters. Part of that is our core growth and part of it is this additional uplift that's coming from the flips of moving from maintenance to SaaS. And we said we expect -- it won't be perfectly linear, especially because it can be lumpy with respect to large customers. A lot of our on-prem base still is made up of really large customers. And so as they move, it has -- can make it a little lumpier. But we expect that the volume -- the dollar value of flips will continue to increase over the next 3 or 4 years and will peak somewhere out there as we get towards that 85% move and then it will start to tail off. So we would expect that incremental revenue growth from flips to be a little bit higher each year for the next 2 or 3 years. And then over time, it will revert back to whatever our kind of core growth rate is if it's low teens, something like that. But we are seeing -- when we talk about this 1.7 uplift, that's really on a like-for-like basis. So we are seeing increased opportunities to upsell more things when a client moves to the cloud. So they may be moving their court system with Tyler to the cloud, but they have a probation system that's an in-house system or a system that's from a vendor who doesn't have a cloud offering. So rather than leaving those things behind, it creates an opportunity to bring more of those together in an integrated solution from Tyler. And we're having those conversations. I think we're a little more intentional about that around how we approach those opportunities. And so we are seeing. In some cases, uplifts that are 3 or 4x the existing maintenance revenues from additional products and services.

I did not expect to hear that the 3 and 4x...

I wouldn't say that's the average.

But there's opportunity, which is great that those are out there as well. And then one other big product that's become a notable part of your revenue mix. A couple of years ago, you bought a company called NIC to bring payments online. What is the sort of remaining -- what is the remaining opportunity for payment as you think about your customer base? Are there more areas of payments to capture? Is it just more customers? What does that look like?