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

Good afternoon, everyone. Welcome to the 29th Annual Oppenheimer Technology Conference. Super happy to have with us Tyler Technologies. Representing Tyler will be EVP, CFO, Brian Miller. Brian, welcome.

Thanks. Good to be here.

And for everyone in the audience, this is a fireside format. I'll run through a series of questions with Brian, but we also have the option for some audience participation. Please feel free to dump some questions that you might have into the conference portal, and I will get to those kind of on the back half of this presentation. So with that, Brian, look, I think everyone generally knows Tyler in this room, but perhaps just a quick background on Tyler and the product capabilities that you guys offer to customers?

Yes, you bet. For starters, we serve exclusively the public sector. So focused on governments, primarily domestic governments. We're about 98% domestic in the U.S., most of the 2% is Canada. We provide a very broad range of software applications that really power the mission-critical functions of government. We're about 75-ish percent local governments, so cities, counties, school districts, local agencies, roughly 20% -- a little over 20% state government and most of that is through a transaction funded model, providing access to back-end systems through portals and building those interfaces to enable citizens to conduct business with state governments. We also have state government software applications as well. And then less than 5% with the federal government. But we have, by far, the broadest set of solutions for the public sector and the biggest customer base. So we have about, I think, close to 16,000 distinct government entities that are our customers and roughly 50,000 systems installed across those customers. We also have a transaction business with embedded payments and software, including software provided under a transaction-funded model that complements the core software business as well.

Fantastic. Really appreciate that backdrop. Maybe taking a wider lens to the Tyler business first, you guys just had your Investor Day a couple of months back. You laid out some new financial targets, specifically bumping up your recurring revenue ranges, also a 15% increase to your free cash flow targets. I would love to just kind of get your view on what was the primary driver for that increased confidence? Like what are some of the factors that are underpinning that growth rate, those margins?

Yes, sure. At our previous Investor Day in 2023, we had laid out targets for 2030, which was certainly something new for us to go out 7 years with targets. But there was a lot going on in the company around that time. We had done the acquisition of NIC, our largest acquisition ever. So we had this new transactions business. . We were sort of at the inflection point in our cloud transition at that point, both around revenues and margins. So we have a lot of things going on there. And so we had laid out these 2030 targets as well as some interim targets for 2025. So at our Investor Day in June, we certainly outlined how we had done versus those 2025 targets and pretty much well, in every case, we had either met or exceeded the 2025 targets, and then we recalibrated the 2030 targets. And again, in every case, either they were unchanged, but in almost all cases, they were raised. So part of the revisions and the increases to our 2030 targets was based on our sort of outperformance through 2025. So the fact that we were ahead of track in terms of our -- certainly our margin expansion. We were ahead of track by a wide range on our cash flow target there. We were making the kind of progress we expected around flips of our on-prem customers to the cloud. So a lot of that the higher assumptions are based on what we've already accomplished through 2025 as well as some new opportunities. So we -- our transaction-based business is more mature now. And we have had success in our go-to-market with embedding payments with our software solutions. So we had more visibility around that. We've made significant progress on our cloud transition around things like version consolidation, eliminating multiple versions of products, exiting our data -- our proprietary data centers and moving exclusively into the AWS world. So those things all kind of colored how we look at the next 5 years going forward. We -- so the targets for SaaS revenue growth that we previously targeted high-teens CAGR through 2030 now for the last 5 years, we're targeting around a 20% CAGR, 10% growth in transactions. And we framed all of this as exclusive of M&A and incremental AI contribution. So laid out a lot of reasons why we think AI wasn't part of the conversation in 2023. It certainly is now. We laid out in great detail the reasons why we think Tyler is a winner in AI in our space. But at this point, being too early to really put dollars on how much incremental revenues over the next 5 years. But that should be incremental, and we also have historically been consistently active with acquisitions. But any further contribution from future acquisitions is also not included in those growth targets.

Understood. And maybe diving into one of the areas that you guys are progressing on. It's been out there for a while. You guys are kind of at the turning point for the cloud migration. Would just kind of love an update on kind of how you're thinking about the path to the peaks, how does that underpin your confidence in that 20% plus SaaS revenue growth. I know there's a lot of back and forth on SaaS bookings and whatnot, but I feel like at the end of the day, as you guys progress through that cloud migration, that's probably the most important piece to getting to some of those targets.

Yes, that's -- broadly, the cloud transition is the biggest margin contributor and we've talked about adding almost 1,000 basis points of margin -- operating margin between now, we were at 26% last year to target in the mid-30s by 2030. And the cloud operations, cloud transition is probably the biggest contributor to that. So there are a number of different vectors around that. One of those is version consolidation. So where with many of our products, especially in the on-prem world, we have historically supported multiple versions of those products, which has become very expensive from a support and development standpoint. So we've made a lot of progress in consolidation and [ sunsetting ] older versions, getting customers, more and more customers on the current version, which in turn puts them in a position to move to the cloud. We still have some work to do around that, but we've seen some margin improvements from that, and there's more to come. We now are at mid- to high 90s in terms of the percentage of our new business that's cloud. We only in a couple of products, sell a very limited number of new licenses. Public safety is one where we still some licenses, but that even has moved pretty rapidly towards embracing the cloud. So in the new business market, we're pretty much there in terms of almost being all cloud. The biggest thing is the progress we've made and what's left to come around flipping or migrating our on-prem customers to the cloud. So today, we still have a big base, more than $400 million of annual maintenance revenues from on-prem customers. We had previously set a target of 75% to 85% -- 75% to 80% of those on-prem clients in '23 moving to the cloud by 2030. We have upped that now to a target of about 85% flipping by 2030. We have various incentives and disincentives or carats and sticks, if you will, that support our effort to move those customers. As you get further down the curve, you get into where there are more customers who just are subject to inertia, which is fairly common in government. They need a little bit of a push. They're not resisting moving to the cloud. They understand the benefits of being in the cloud, easier to stay on current versions of the software, a better client experience from easier upgrades and new releases. Don't have to worry about all the headaches that they face with internal systems, whether it's staffing, technical roles, buying hardware, managing cybersecurity. So they understand all of that, but there's still a lot of places that just go, well, I'm going to move at some point, but I don't have a firm deadline. So we have increasingly told customers that new features and functionality will only be available to customers in the cloud. So they'll still be supported on-prem, but there'll be new features and functionality, including a lot of things involving AI that they will want, but only be available in the cloud. We've also told customers just this past quarter, our CEO sent a letter to every on-prem customer, telling them that over the coming months, we'll be sitting down with them and mapping out a strategy, a pathway to the cloud, that it's not an open-ended forever on-prem opportunity and that we'll be working out those pathways. We'll understand what their concerns are, what their needs are, if they need help. We're hearing from a lot of customers that they want to move, but they need help kind of selling it internally whether it's a CFO trying to work with the CIO to get that move prioritize, whether they need to get more budget and understand the savings -- internal savings that will be -- that will offset the cost of moving to the cloud, so working with customers on that. But also those conversations involve what are the disincentives and those are mainly that, at some point, if they remain on-premise, their maintenance will increase significantly, which reflects our higher cost of supporting a smaller and smaller number of on-prem customers. And then ultimately, there'll be a point at which there will be end of life for support for on-prem products. So all that's kind of supporting this 85% moving by 2030 and there's a lot of activity going on around that in a more proactive role as we continue to evolve into this next phase of our cloud transition.

Understood. So that does seem to set at least a relatively high floor in terms of that SaaS revenue growth. The other piece of the equation is the new SaaS bookings, and you did see a rebound in the first half of the year compared to last year. How should we think about that pipeline? And what kind of visibility do you have in terms of being able to execute and close on some of those transactions to keep that 20% SaaS number? Or I guess to the extent that it doesn't impact that 20% number that much, I mean it would be great to get a sense [indiscernible]

Certainly part of it. Part of the SaaS growth, I mean it comes kind of from 3 places. It's new clients, and that can be both in our SaaS bookings. It's both brand-new logos, and its significant amount of add-on sales to existing customers. So we have a big, big customer base. Our average customer has 2 to 3 products from Tyler and they could, in most cases, they have 8 to 10 products from Tyler. So it's -- there's -- and there's cross-sell opportunities within a suite of products. So a customer that has our port system, adding a probation system, and then there's a cross new suites. So some of [indiscernible] core existing system selling them an ERP system. There are a lot of cross-sell and upsell opportunities. We've done a lot of things internally with our sales staff around sales compensation and commissions around how we manage quotas to incentivize more cross-sells, how we're adding sales reps that are focused on that. So there's new sales, there's upsales to existing customers. There's certainly pricing on renewals. And then there's the incremental revenue from flips. And typically, we're seeing about a 1.7x uplift from maintenance to SaaS as we move those customers. All that adds up to that 20% CAGR target. In terms of the new sales, what we said over the last several quarters, I think our commentary has been really pretty consistent that it's an active market -- budget, and there's certainly a lot of differences across whether you're talking about the state of California or whether you're talking about city in Texas, different budget situations. But generally, budgets are reasonably stable, underpinned by really solid property tax revenues, which form a big part of the base. So we've said in terms of market activity leading indicators like RFPs, sales demos, we're seeing a lot of stability there at fairly active levels. So I feel good about the pipeline, the activity in the market. What we have seen over -- if you look back really like 1.5 years, some volatility in the sales cycles, the second half of '24 was extraordinarily strong, and we saw really outsized bookings growth. That was driven by some large deals, which can be lumpy and they're just sort of -- we're at a number of those in the second half of '24 and also by there was a pull forward of bookings from early '25 because there was a deadline for the ARPA stimulus funds. So that in turn had a negative impact in the first part of '25 because some of that business had been pulled forward. And then there was noise around the new administration around [indiscernible] and tariffs and all the noise that came with the new administration that caused a lot of sales cycles to slow as governments trying to figure out what kind of impact all of that might have on them. Ultimately, I figured out that it didn't have a big impact on it and that things sort of normalize as we got into the second half of last year. So we're seeing the benefit of a more, I guess, normalized market, more consistent market right now, consistent sales cycles. So bookings growth was really good in the first 2 quarters of this year. The comps get a little bit harder in the second half of the year, but they're kind of more normal. From a long-term perspective, if we're going to grow SaaS revenues at around 20%, our SaaS bookings need to grow around 20%. They were a little north of that in Q2. But I would expect over the next few quarters, we'd kind of -- absent any new external factors that we'd probably kind of settle in more around that 20% bookings growth that would be more in line with our long-term revenue growth expectations.

Understood. And that's super helpful in terms of how you laid that out. Maybe shifting gears to sort of the topic Dejar for the last couple of years. the AI side of the equation. I realize Tyler is not embedding any uplift, which makes a lot of sense given a lot of new products, waiting for adoption. But you mentioned earlier, you feel Tyler has the right to win, at least in the government space. Could you maybe lay out some of the rationale there? And what are some of the data points you're seeing from customers that might support you're thinking that Tyler is going to be their vendor of choice when they do make those final decisions?

Yes. So like with a lot of things in the public sector, to start with government is a much slower adoption curve than you're going to see in the private sector. We saw that with SaaS. We've seen it with other technology evolutions. That might not mean it's a decade, but public sector is going to be much more cautious about embracing AI, about how they use it and who they get it from than you'll see in the private sector. What we hear from our clients is, certainly, they hear a lot about AI. They're very curious about it. They're interested in how it can help them solve real problems, a lot of their real problems stem from staffing shortages. Governments are always having to do more with fewer resources, and particularly fewer people. Governments already are very often short staffed, sometimes because of budget issues, but often just because they have a hard time attracting and retaining staff, they're facing a big wave of retirements, and it's really hard to attract a lot of different roles, but especially technical roles, it's hard to pay market salaries. And so staffing shortages are a big problem with government, which leads to things like long delays in getting a building permit application approved or backlogs in the courts or not enough police officers, all those sorts of things. So they're interested in how AI can help solve those problems, and that's what we're focusing our investments and we're showing them those road maps of where Tyler is bringing AI to them around their core systems of record, around the public safety system they have from Tyler, around the licensing and permitting system they already have from Tyler. So what we're hearing from our customers is trust is a big factor. So they're typically distrustful of start-ups and new entrants. They want to see references. They want to know it works somewhere else like them. They are very concerned about their data. Public data can be -- or public sector data can be very sensitive if you think about courts data, public safety data. It's a highly regulated environment. So they're really concerned about how their data might be used, who might get -- who might use it, where it might go. They're obviously very concerned about accuracy that these things need to be right. So we believe we have the trust of the clients. We have often decades-long relationships with them. We have a huge amount of domain expertise. So we built a system of record, which manages very complex workflows. So we understand how these things should work for government. We're not burning on their time. And we have a well-developed sales channel already along with these relationships. So all of those things, we think, give us advantages in bringing clients AI. So we're hearing from clients. They don't want AI that someone bolts on to their system of record. They want AI that's embedded with it, and that's where our investments are going. So we have some products that are fully AI-enabled that are like stand-alone products that use AI at the core. And some of those we've had for 2 or 3, 4 years, things like AI to assist with the budget development, which is probably the most important thing the government does every year from an administrative standpoint. So allocating budget to figuring out how to best allocate budget to higher priority initiatives. So in areas where we've seen -- we've proven we've got large number of users already where we've proven the ROI and the kinds of savings they can get, we're seeing really meaningful uplifts in our revenue as the customers add that. Couple of examples we talked about at our Investor Day, Tarrant County, Fort Worth, Texas, when they added document automation to automate data entry. It was a 43% uplift from -- they were paying us $900,000 a year for the core court management system, added 43% to that annual fee to add document automation, but they're saving a couple of million dollars a year in labor costs. Placer County, California added our supervision assistant to their probation system, 177% uplift from our SaaS fee. So we're seeing good uptake from this. But again, we're in the very early days. We're starting to roll out agents -- release agents to the market around each of our core products by the end of the year of this year. All of our flagship products will have agentic AI capabilities that are in what we call a private preview stage. So it's where it's basically with a handful of pilot customers that are testing it, giving us feedback, collecting references and use cases. And then we move on into the next stage of public preview. So that's where we get a broader range of customers. And these really form that whole cohort of referenceable customers that new sales prospects can talk to and see, yes, it's doing what it says. It's -- we said it would do. It's providing the ROI we expected. The price is justified and the economics work for us and then it moves into kind of general release. So we said that by the time we get through all that process, given the pace at which governments move, we're probably looking at the second half of next year before we see more meaningful contribution from this incremental AI opportunities. And as we talked about at Investor Day, all of that is incremental to these targets that we've already set for 2030.

Understood. Super helpful. You touched on a point where you're addressing some labor issues, Tarrant County saving millions on some of the labor costs. I mean when you think about Tyler, historically, I mean we look at it as you're kind of fighting for IT budget. Are your customers now maybe shifting labor dollars or like what they would have spent for employees over to, I guess, the tech budget, if you will. What are you seeing there?