Welcome. My name is Clarke Jeffries. I'm on the software research team here at Piper Sandler. Pleased to be joined by Brian Miller, CFO of Tyler Technologies. Thank you for joining us again in Nashville.
Thank you. Great to be here.
Yeah. All right, perfect. Well, we can kick it off with a little bit of just an intro on Tyler, you know, for those who may be less familiar. You know, at a high level, what is Tyler Technologies all about, and what's the mission of the company?
Yeah, we're a vertical software company focused exclusively on the public sector. So, everything we do is for the public sector, but we take a very broad view of the public sector. We serve governments at all levels from local city, county school districts, which is probably close to 70% of our business. State government, roughly 20%, and then 20-25%. And then federal government, much smaller position there, but around 5% of our business. We're really broad in terms of the breadth of products we offer governments. So we have mission-critical software applications that power essential services of government. Things like property taxes, public safety, 911 , courts, licensing and permitting, ERP, school bus transportation.
So all these essential functions of government, we provide the software that runs those. We're by far the biggest provider in terms of the breadth of products and the number of customers of any software company exclusively serving the government space. It's a really, really fragmented market, so historically served by a lot of sort of niche players. And so we generally compete with different competitors across all of our product areas and believe we have a pretty significant competitive advantage due to the breadth of products we have and the depth of relationships that we have.
Yeah, absolutely, and so it's, it's a very unique market. I mean, the governments don't go out of business.
Yeah.
There's not new ones being created each day, hopefully. And so, you know, at a high level, what drives growth in that market? You know, how do you have a mechanism to grow, you know, well above GDP? You know, what is, to start off, what is the market growth rate for government software, and then what's the strategy kind of going on that?
Yeah. The growth rate, you know, it's a very. As you can imagine, it's never an explosive market. It's a very stable, steady market. As you said, our customers don't get acquired. They don't go out of business. They're very sticky. They don't like change. So, they on one hand, it's a very, very stable business. Pretty consistent growth in kind of the mid-single digit range, you know, 5%-7%. It's, there's sort of this core growth or core demand that's driven really by replacement of aging systems. Because our customers don't have competition, they're not ROI-driven or profit-driven, that's not their motivation to buy new software. So they tend to use systems much longer than you see in the private sector, often for decades.
I mean, the average system we replace is probably 20 years old, sometimes 30 or 40 years old. So they tend to use these systems often, really until they're at end of life, really end of life. And then replacing them becomes a fairly non-discretionary decision. So that's kind of there's this core growth that's, or this core demand that's just driven by replacement of aging systems. And then today, I think increasingly, you see a little bit of shift around that, where there's more of a drive towards digital modernization of government.
And anybody that interacts with their local government or their state government probably understands that governments often are a bit behind or a lot behind in terms of their IT infrastructure and the applications and the consumer experience with government. So there is increasingly a demand sort of an acceleration of demand or pull forward as governments look to replace systems that aren't necessarily at end of life but that don't provide features or functionality or options that used to be maybe more optional but today are maybe more required. So providing the ability for people to work from home. Governments weren't very good at adopting remote work or hybrid work.
They're used to government workers need to be at a desk in city hall or at the courthouse, and so as they try to adapt to the reality of different kinds of work, that's driving some accelerated replacement of systems. Being able to provide better citizen self-service, so people want to do more things online rather than go down to the DMV, for example. So there's a push for that, and as well as a desire to have better data and analytics. So sort of the concept of BI, or business intelligence, has been not something that's been at the forefront of governments, but increasingly they recognize the need to have better data. A lot of this data sits in siloed systems.
We, for example, provide a really robust data and analytics platform that sits on top of our systems and other systems that allows the users to access information, use it to make better decisions.
Yeah.
There are some trends that are changing a bit, but there's this very steady kind of demand-
Replacement, and then on the, you know, margins, some transformative initiatives either, you know, to the citizen level or administratively trying to, you know, operate a better municipality.
Right.
Well, then, let's, you know, shift gears into what I think, you know, has been the most interesting dynamic of the business, maybe for the last twelve months, maybe more than the last twelve months, with the SaaS transition. You know, could you recap where the company stands today in terms of progress with the SaaS transition? It's been an interesting year in terms of some of the metrics that you put out.
Yeah. So historically, you know, Tyler was a traditional licensed and a maintenance model. Most of our systems were sold on-prem, and that's kind of the way we operated for a long time. And then really going back twenty years ago, we started the transition, I guess. We started offering some of our systems in a hosted model, paid for with a subscription to sort of a private cloud model. And we were, for years, sort of a hybrid or a cloud neutral. So we let customers decide if they wanted to acquire systems and deploy them on-prem or in our data centers. And we didn't really try to push customers one way or another in the market.
Like a lot of things in public sector, moved very, very slowly towards the cloud. And then in 2019, there was a pretty significant change in our approach. We said we're really cloud first now. We need to lead our customers to the cloud, even though governments were moving very slowly. We said we don't want to be in the data center business anymore either. We can't really scale that to for the long term. So we entered into our first relationship with AWS as our primary cloud provider, launched a long-term project to migrate our customers out of our data centers into AWS. Started putting our new customers there, and really shifted towards really pushing SaaS sales over on-prem sales.
From twenty nineteen—and twenty nineteen was the first year, actually, that more than half of our new business chose the cloud. So from twenty nineteen till now, all of that has accelerated, and we've really only a handful of products do we even offer licenses anymore. So a high percentage of our new business, around 90% of our new business, is now coming to us in the cloud. And, those customers are going directly into AWS. We've made really good progress in exiting our data centers. And then we've also made significant progress, but still have a long way to go in terms of migrating our existing on-prem customer base to the cloud.
Today, if you look at our whole base of customers, sort of on a revenue basis or a SaaS equivalent basis, about 40% of our customers or our revenue is in the cloud, and about 60% is still on-prem, but in terms of new customers, 90% of them are coming to us in the cloud, and so we said that we expect by 2030 to have migrated, you know, close to 85% of our on-prem customer base to the cloud, and that'll be accelerating, and so last year really was sort of a pivotal year in that cloud transition. It was the year in which our SaaS revenues crossed over and surpassed our license and maintenance revenues. It was also the trough in terms of the margin impact.
As we've transitioned from on-prem to the cloud, giving up those big upfront license revenues that are real high margin and replacing them with a bigger recurring revenue stream. Last year was really that transition year, and we said that 2023 was the trough in margins, and we're back on a path of margin expansion. We're starting to see accelerating revenue growth as well, now that, again, we're through the impact of that transition, kind of changing from a headwind to a tailwind.
Yeah. And maybe we could talk about, you know, hitting that 90% level for new business. You know, as you mentioned, 2019 was the first majority year, but it's been a, you know, a pretty steady ramp, and I don't think... I certainly wasn't expecting it to go above this 90% level in this year. It... you know, what, what do you think about the big drivers that improved it to that 90% level versus the 70 and 80? I know that had been historically some holdout categories, but, you know, what changed with those holdout categories that we really got to this level?
Yeah, I think it's been a combination of us pushing and clients being in the public sector space, being much more receptive and not just sort of accepting of the cloud, but really understanding the benefits-
Embracing it.
- and embracing the cloud.
Yeah.
There's a few reasons behind that. As far as us pushing it, it's been pretty clear. There were a couple of, like you said, holdout areas, public safety being the biggest one. Public safety is around 10% of our revenues, but agencies in that space were much more reluctant to put 911 systems and police and fire and ambulance systems in the cloud, concerns around broadband or reliability.
Yeah.
Those, as we've had, they increasingly have good experiences there and have reference points, those concerns are largely going away. So in public safety, we actually saw 90% of our new business last quarter in the cloud, compared to 13% a year ago. So really fast shift there. Now, in Q3 and Q4, it's probably not gonna be 90%. There's still some licensed business rolling through.
Public safety, heavy in Q3.
Yeah, they're, they're heavier in the second half, but, but a very significant change. We had our first flip of an on-prem customer in public safety just last year. And now we're seeing growing numbers and some bigger customers flipping. And then our, our low-code application platform in the federal and state space, we still have a pretty significant, especially federal agencies, still buying licenses, but that's shifting fairly rapidly now, too. So I think part of it, in public safety specifically, part of it is pushing it, part of it is good experiences and the market accepting it. And then broadly, across the landscape, cybersecurity and ransomware events have been a big driver of both new customers increasingly choosing the cloud and on-prem customers flipping.
Just like in the private sector, there's a lot of ransomware and cybersecurity attacks. Generally, those are a bad actor getting into the client's internal network, usually through phishing or some other hacking into their network, you know, locking it up, and the on-prem systems are the ones that are affected, so when those systems are in the cloud, and particularly at AWS, they're just safer. It's harder to get into that network-
Yeah.
- and they just typically don't have those same incidents, and it's easier to recover. So, often customers, either that actually experience a ransomware attack or that one of their neighbors or peers do, often those are customers that are moving to the cloud. And as that becomes clearer to people, that's certainly one of the drivers. I think the other driver is the ongoing struggles that governments have, with maintaining their IT infrastructure, and particularly around people. So, governments, especially with really skilled IT positions, like applications administrators, and database administrators, and security people, they have a lot of aging workforces, and as they retire, they really struggle with replacing those people, with finding people and attracting them to work in government, versus the private sector, and paying them what the market demands.
So, they had a lot of migration out during COVID, and they really haven't rebuilt those workforces, so they struggle with that infrastructure. So again, moving it into the cloud takes away a lot of those pressures, and that doesn't seem to be changing. So, that historically was a big driver and continues to be.
Yeah. Well, then let's go, you know, maybe a level deeper and talk about the maintenance revenue today. You know, $450-odd million of maintenance revenue. And, you know, one of the big initiatives had been the versioning. You know, moving a lot of on-premise customers to a most recent version and helps prepping them to do a SaaS migration. You know, where do you sit today in terms of that versioning journey, and how close are you to bringing that maintenance base to the close-current version?
Yeah, version consolidation is both a challenge and a big opportunity for us. So, as we have, as I said, a really big portfolio of products. We have a lot of products, but we also, in many cases, have historically supported multiple versions of many of those products. In some cases, as many as eight or nine or 10 versions at any given time. So clients were allowed to stay on older versions and not always move to the current version. That's really expensive in terms of both support costs to the level of resources we have supporting those different versions and the nuances around them, as well as development costs.
So as we push new features or changes back into multiple versions, as we push security patches or you know, legislative changes, it's just a lot more expensive on a development side. So in the cloud, we want one version of every product. Everybody stays on the same version, everybody upgrades at the same time. It's not only better for us and better for our margins, but it's better for the customers. They stay on the current version, they have a better software experience. The upgrades are almost constant and really almost invisible, so it's a much less painful upgrade process as they move to different versions. So it's really important for us to get to that one version.
But as we migrate our on-prem customers to the cloud, either before they migrate or when they migrate, if they're not on the current version, they need to move to that version. So that's been a gating item around those customers moving. And typically, when our customers move from on-prem to the cloud, we're seeing a you know, 1.7 to 2X uplift in revenues. So, you know, that $450 million of maintenance revenue we have today will turn into, you know, something closer to $800 million
of SaaS revenue, and so that's one of the reasons why our SaaS growth has been north of 20% for an extended period of time. I think it's 14 straight quarters. So we've made a lot of progress there. Each product has a roadmap, and it's starting in a little bit different place, but we have a roadmap for getting those products all consolidated down to one cloud version. Last year, we made a lot of progress with a couple of big products. Our Enterprise ERP product, which has our biggest single customer base, our Enterprise Courts and Justice, which has a lot of our really big customers.
So with both of those products, by the end of this year, I think 95% of the customer base will be on either the current version or one version back. So, and so we've made a lot of progress there. It's still, you know, another, you know, three or four years before we're down on every product. But, but making a lot of progress, and we're actually seeing some of that benefit show up now in our margins.
Yeah, absolutely. And so then maybe we can talk about this, you know, that you laid the groundwork to start really moving more aggressively towards the migration journey. You know, maybe can we talk about, you know, in this post-versioning framework, you know, what are the ways you'll incentivize the flips?
Yeah.
What are the dynamics in how often a customer may decide, you know, their contract term? How often are they saying, "No, I don't want to move," or "Yes, I want to move?
Yeah. Yeah, the version consolidation has been one of the factors. The second one really was around releasing cloud-optimized versions of our products. A lot of our major products were originally architected and built to be deployed on-prem, so when you host them in the cloud, they haven't been super efficient, and they've been expensive, more expensive to host. And so also starting in 2019, we started a series of development projects to optimize all of our products for the cloud. And those, again, by the end of this year, will be largely complete. So as we've been releasing those cloud-optimized versions, lowering our hosting costs, we're also able to start to accelerate the pace of those conversions.
customers, almost all of our maintenance agreements are annual agreements, so customers really can choose to flip at any time. There's not really sort of an end of contract or a decision point. To date, most of it has been more carrots than sticks, so most of our, so we haven't really been ready to start moving.
Yeah.
customers, you know, sort of opening the spigot on moving customers because of the version consolidation and the cloud optimization. So we've sort of been laying the groundwork for all that and getting in a position to start to accelerate the pace. But we are continually seeing both the number of flips and the size, the average size of flips, the more bigger customers flipping. So to date, it's mostly been carrots. So, the biggest one being, clearly, our customers understand that we really don't sell on-premise software anymore, and that's where the direction of the company is, and educating them on why that's good for, not just for Tyler, but for them.
A lot of that's been done in recent years, and you know, for example, this year at our user conference, there was a pretty noticeable change in kind of the conversations, and it wasn't so much convincing customers or explaining to them why they should be in the cloud, but more around they understand it, and it's more about when and how they move to the cloud, so they also understand that with most of our products, although we'll support on-prem versions for an extended period of time, new features and functionality will increasingly only be available in the cloud, so if they want the new features and things, they're gonna want those, they'll need to move to the cloud to get.
As we move forward, you know, further down the road, when we're probably on the other side of sort of this bell curve of flips, and we've got sort of the slower resisters, then it's more likely to be more economic incentives
like raising maintenance at significantly higher rates than currently we typically have about a 5% annual increase in maintenance. So through pricing to drive them to the cloud, and ultimately, we have the ability with products to say, "This product is no longer supported on-prem, and you either need to move to the cloud or you'll have an unsupported product," which is not typically something governments want, so.
Yeah. And then, I guess the last question on the mechanics of this, you know, what's the expectation for when we really see that maintenance revenue start to decline? Because I think what's interesting to me is, you know, the bookings and the backlog in maintenance are actually up. You know, even though you do have conversions and migrations-
Yeah.
there is a baseline of a tailwind from pricing, and so it-
Yeah, maintenance has been really surprisingly consistent. You know, we, on one hand, we have almost no attrition, so you know, our attrition on a gross basis is, you know, 1% or 2%. We get that kind of 5% annual increase, and we're still selling, you know, a little bit of licenses, you know, again, for a couple of products and then for some add-ons to existing customers that are on-prem, might be adding other applications. But yeah, that's - we're really kind of on the verge of that starting to decline more. It was kind of flattish in the first half of the year.
I think the second half of the year will be down 2-3%, and then as the flips increase, so we take away $1 of maintenance, but we add $1.70-$2 of SaaS fee. But as those flips start to increase, and we really think 2025 is the year where that pace will start to increase, and we'll probably have a few years where we're kind of on top of the curve, you'll start to see maintenance decline more significantly. So I think next year. Well, while this year, it's down low single digits, next year, I think you'll, you know... I don't know. We haven't given guidance yet, but you'll probably see something around mid-single digits.
Yeah.
Then start to see that pace accelerate, decline, but also you'll see the-
Yes
The pace of SaaS grow faster.
So, maybe you can sort of, you know, talk about margins, because I think overlapping with all of this, you know, migration on the SaaS side is a margin benefit or a margin change.
Mm-hmm.
You know, you've touched on versioning and cloud efficiency in some of these cloud built versions. But, you know, maybe we could talk about the efficiency benefit from cloud operator pricing versus the software-driven gains. You know, how do we think about some of these things being linear with the revenue and some of these being lumpy and-
Yeah, a lot of them aren't linear. So broadly, we talked about at our Investor Day last year, we talked about going from a 23% operating margin to 30% plus by 2030. So it's an average of about 100 basis points a year, but definitely not linear. I'd say where we sit a year into that is we're a little bit ahead of pace. So most of that overall margin expansion comes from cloud, cloud operations in general. It's a combination of the version consolidation, the optimized products. Just as we scale in AWS, our unit costs go down, the more capacity we buy, and we entered into a new agreement with them at the beginning of this year that have better pricing and that continues to get better as we scale.
Largely around those things are the biggest drivers. In the near term, we also have what we call bubble costs or duplicate data center costs. So we had a lot of fixed costs around our proprietary data centers. As we move those customers to AWS, we start paying AWS, but we don't shed a lot of the fixed costs until we actually close the data center. We closed the first data center on schedule at the end of the second quarter, and the second data center, there's just two. The second one closes at the end of 2025, so we'll see more of an impact in 2026 as we get that data center closed.
Smaller impacts around the improvements to margins in the long term, around improvements to our payments business margins, a little bit of leverage around operating expenses as well as G&A and marketing as we continue to scale as well.
All right. Well, I think that's all we have time for. But, Brian, I really appreciate you making it to Nashville.
You bet. Thank you.
All right, thanks.