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

Welcome, everyone. Thanks for joining us today. My name is Scott Berg. I lead the enterprise software and SaaS research efforts here at Needham. With us today, we have Tyler Technologies and the company's CFO, Brian Miller. Hey, Brian, thanks for joining.

Scott, thanks for having me.

Brian is going to run through a quick overview of the company. There's a couple of slides here. And then we'll get to our fireside questions. From a housekeeping perspective, though, I will be taking questions from the audience when we're done here. In your presentation window, there's a field for you to submit questions if you want. They'll pop up on my screen, and I'll facilitate those questions per your wish. And with that, Brian, it's all yours.

Okay. Thanks, Scott. I'll just run through just a few slides here to give those of you who may not be as familiar with Tyler a brief overview of what we do. We are an enterprise software company providing essential back-office solutions to the public sector, primarily local governments. We're the largest provider of software focused solely on the public sector. Consistent grower over the last 18 years. We've averaged 20% EPS growth, 13% revenue growth. So market that provides this very consistent, stable market, never really an explosive market, but certainly has given us the opportunity to be a very consistent grower in markets. Gartner says about a 7% to 8% growth market. Expect that, that will not be the case over the near term, but we do expect to continue to grow through this year. Broadly, our product suites, we serve, as I said, essential functions of government. ERP and financial systems is our biggest sector, 44% of our revenues, accounting, human resources, payroll. Courts & Justice, we provide the systems that manage court cases, jails, juries, probation. public safety could be the police, fire and ambulance systems, 911 systems. In tax and appraisal, we manage property taxes, which are generally the largest revenue stream for most local governments, so an essential function there. And then things like licensing, permitting, community development, K-12 schools, grades and attendance, scheduling, bus transportation and things like that. Last year, we crossed $1 billion in revenues for the first time, where about 70% recurring revenues is either maintenance or from on-premise customers or subscriptions from our host of cloud customers. We have a long-term margin expansion opportunity that we expect to continue to take advantage of and generate significant cash flow, averaging about 1.2x our non-GAAP income. This illustrates what our revenues have done over the last couple of decades, 13% CAGR, most of that organic, about 11%, and about 2% from acquisitions. And we really said, you should think of us as kind of an 8% to 10% organic grower off of the current base and expect to regularly supplement that with acquisitions. So as you see, our free cash flow has expanded over the years in the last decade, certainly faster than our revenue growth. And our recurring revenues have grown faster than our total revenues. So we've continued to really build that subscription base. Just a snapshot over the last decade, 16% CAGR in revenues, a little higher than that on the recurring revenue side and well above 20% on EPS and free cash flow. And lastly, just a little bit about the background of why companies -- why customers are buying these systems from us. Generally, we're replacing a system that's at end of life. A system, it could be a decades-old mainframe system, COBOL systems, green-screen systems that have been in use for long periods of time that have now become unreliable, no longer supported, sometimes run on hardware that has to be replaced. We think that 2/3 of the systems that all local governments use today would fall in that category of being -- not necessarily have to be replaced today, but it came from a vendor that's no longer competitive, that some of it doesn't have a current offering in the space or systems that are homegrown systems that were custom built. And again, some of those are 3 or 4 decades old. Recent articles highlighting the age of some government systems. And certainly, we've seen more of those more recently as more cracks in these systems have emerged as they've tried to adapt to remote operations to working from home. I think a lot of people saw recently where the Governor of New Jersey came out and had a plea for COBOL programmers to volunteer to help them keep their unemployment system running. And that's not uncommon in terms of the vintage of the systems that are currently in use across local governments. Our recurring revenues, as we continued to move more towards a SaaS model, has continued to expand faster than our overall revenues. Now 70% of our revenues, those grew 21% year-over-year last year and the fourth quarter annualized and the SaaS revenues, in particular, growing close to 40%. And with that, we can move on into the Q&A. Back to you, our chat.

Great. I guess you might need a few more colors on your color wheel and products here, given your acquisition track in the last 4 or 5 years, right?

I think we'll find some.

All right. Fair enough. We'll start with what I'm calling the C topic, COVID, just because I know it's top of mind and still continue to get a lot of questions on it. But if you look at your product portfolio, which segments -- which Tyler segments are most impacted in the short term due to COVID? And are there any that would actually benefit from the current environment?

Yes. I think in terms of our major products, I don't think there's a lot that are either affected in the short term or have major benefits. It's really more around what I described earlier, the aging systems that are in place today that don't work in this current environment. And I think we've continued to see our SaaS offerings, the demand increase for those as people find that a better solution over on-premises systems, more flexibility, more remote capabilities, and to some extent, less concerns around security. I think public safety remains something that's a very high priority, and we've increased our competitive position there in recent years, had a big investment in our public safety offering. We are addressing a much bigger market there than we previously did. And I think that continues to be a very high priority among -- in terms of local government spending and as well as funding. So I think that offering will continue to enjoy success. We have seen, on the margins, some of the -- some solutions that we've offered in some cases with our Virtual Courts offering. The timing was good for us. We already had a product close to release and moved that out faster in response to COVID, so a solution called Virtual Court that allows our municipal courts to manage hearings. These would be mostly traffic or low complexity hearings without lots of parties, but enable to -- them to manage those remotely through an online offering. We started offering that towards the end of the quarter on a free trial basis for 90 days to clients. We've had, I think, at this point now about 90 clients take us up on that. A large portion of those are live now. We would expect that the majority of them would continue that as paying customers once the free trial period is over. But that's an example of a new product that really has accelerated because of the current environment.

As you look at the current, we'll call it a recessionary environment, because it will be at least for the short term. Don't know about the duration. But how does today differ from 2008 and 2009 based on maybe demand trends, what you're hearing from customers, budgets, et cetera?

Yes. I mean it's a little early. One of the reasons why we suspended guidance after the first quarter, it's a little early to tell them, because this happened pretty rapidly around the virus as opposed to sort of a slower decline. But we do think there are a lot of parallels with what we experienced in 2008, '09, '10. One thing that's clear in our space is that there's a lag in how the public sector reacts to the broader economic conditions. They tend to continue with things that are budgeted and funded already. Those tend not to really be adjusted. And so in the short term, you don't see a lot of impact. Mostly we've just seen delays around complications of the logistics around people not being in the office, city council meetings not taking place. And that's certainly different than the recession, sort of an added layer of complication. But a lot of those things now we've adapted to and are back on track. I think the biggest difference for Tyler is certainly not around the essential nature of our products. That was the case then and this is the case now, that generally, someone is buying a new system from us because their own system is dying, end of life. And it tends to be a very high priority replacement for them. These are mission-critical things. As the property tax system is close to not functioning, they need to replace it. And so it's going to be a high priority. I think the big difference for us today is that in 2008-2009, we were less than 50% recurring revenues. And so we were more dependent on new business and particularly new licenses. Today, we're 70% recurring revenues, and those recurring revenues are really very solid, extremely high retention rates, very low attrition and typically get consistent annual increases in our pricing, and that continues to be the case. But now with 70% recurring revenues, a lot more predictability around our revenue base. And more of our new business is coming to us through subscriptions, were under 10% of our revenues or licenses today. So not as big of an impact from those potential delays as someone might need to buy a new system, but I'm going to have to wait 1 year and put it into next year's budget. We did see some of that in the recession. We saw it over a number of quarters. The worst year we had was 2010, and our new business was off, licenses were off 17%, but our total revenues were flat in that year, followed by a 7% growth year and a 17% growth year. We wouldn't expect to see as big of an impact, given the nature of our recurring revenues today.

Helpful. And then one question I've received a lot over the last 2-plus months is trying to understand where the funding or revenue sources for your customers on the local and county level come from. Can you break down, kind of from a percentage perspective, how you feel those revenues come in?

Yes. And it's certainly different at the local level than it is at the state level, for most local governments. And we're about, I'd say, close to 80% of our business is with local governments, cities, counties, school districts, local agencies; probably around 15% from states; and about 5% from federal. So local governments, generally, the biggest revenue stream would be property taxes. And in most cities or counties, that could approach half of their revenues. Property taxes tend to be pretty stable. They -- even if your property value goes down, your tax doesn't go down immediately and it may not go down for a very long time. It may not go down at all, because they may raise the rates to offset the decline in value. So that -- there tends not to be a lot of short-term pressure from property taxes. And secondly would be -- at the city level would be things like utilities; water; sewer; trash; court fines, fees and costs; traffic tickets; court costs and fines. Those certainly, we're seeing pressure to right now. Some of our jurisdictions are telling us that traffic citations are down 90%. People aren't driving. And I think these officers are reluctant to get in front of people if they don't have to. So there's just not a lot of volume there. That will certainly come back but -- utilities, local fees and then things like licensing and permitting. Business licenses, building permits, animal licenses, alarm permits, all those sorts of things in a typical city might make up 10% of the revenues, sometimes -- generally in that range. And at the county level, slowdown -- funds flowing down from the state level could be as much as 1/4 of their budget. At the local level, that would be a smaller piece in a city or a town that might be more in the 10% to 15% of their revenues. So a wide range of revenue streams -- income tax and sales tax would typically be a lot smaller piece, typically sort of single digits, maybe mid-single digits in terms of a percentage of their budget from sales tax and income tax, would be a small percentage, in some places like Texas, none.

Sure. Yes, that's the one thing I think that will be different is in '07, '08, '09, property taxes were coming down with the housing bubble. The revenues from them were certainly coming in for a couple of years, and right before, they obviously sucked that pull back up, if you want to call it that. And this year, it's all around, I call it, usage fees. Yes, the usage fees were pretty stable back then, but they're more variable. So how does that kind of change your opinion in the short term?

The other wildcard here is the Federal stimulus money. That wasn't a part of the recession. But here, the CARES Act had a significant funding for state and local governments, I think, a little short of $500 billion. This next round proposal has significantly more than that, some estimates up to sort of close to $1 trillion that would go to state and local governments. And I think there's not a lot of clarity around that right now as our customers put together their upcoming budgets, but it's clear that there is a significant amount of money coming from Federal stimulus to local governments.

Sure. So moving off COVID a little bit. Last fall, you announced a strategy to focus on kind of pivoting towards a -- from a cloud-neutral strategy to one that's really more cloud-first and trying to push that delivery model a little bit more. I guess how is this theme progressing? And are you hearing a lot of pushback from customers that may not have wanted cloud-based solution before?

Yes. It is -- we're well underway with that transition. And you're right, we signaled really a change from being cloud-agnostic or cloud-neutral. We offer all of our major products historically in either an on-premise license model or a hosted cloud-based model paid for with the subscription. For us, most of our products -- our core products weren't architected originally to be deployed in the cloud. So our cloud deployments or hosted model was not as efficient as it could be. And we've historically let the market decide. We haven't really tried to push customers one way or another. And the market has, over the recent years, increasingly -- without us pushing it, we've seen more appetite for the cloud, more willingness to move systems from on-premises to the cloud. We have maintained our own data centers. So it's really a private cloud hosted in our data centers. As I said, our -- we don't really get all of the efficiencies of a true cloud deployment with our single-tenant model with the footprint of our products. So the AWS relationship and partnership is really one key element in us accelerating that move to the cloud and going to cloud first. So we -- AWS will be our primary hosting partner. So we'll be increasingly deploying new clients at AWS, and over time, lifting clients out of our data centers into the AWS cloud. That certainly frees up capacity for us, enables us to accelerate the move both of new customers and existing customers off of on-premises installations. Also working with a lot of internal resources as well as resources from AWS to optimize our products to be deployed more efficiently in the cloud. In some cases, that may mean rewriting applications in a cloud-native or multi-tenant environment. In other cases, it's modifying the current applications that would -- might be single-tenant architecture, but optimized to be deployed more efficiently in the cloud, which will in turn lower our hosting costs, improve our margins and enable us to continue to accelerate moving customers there, likely being much more active in trying to actively move customers to the cloud, whether it's through changing our commission structures, changing pricing, changing features, but being much more proactive about moving customers to the cloud. And we expect that -- last year was the first year that more than 50% of our new business came to us through the cloud. In Q1, it was 73% of our new contract value. So it certainly consistent with what the market wants. And I think we -- in the public sector space, we have a leadership position there in terms of being positioned to take our customers to the cloud.

Do you have a sense on timing or maybe how long it would take to make this evolution to optimize your solutions for this cloud-first environment?

Yes. I think we've broadly talked about it as sort of a 3- to 5-year effort. It's certainly not a year, and it's not a decade. But I'd put it in terms of kind of 3 to 5 years. It's different for different products. Some products are much closer to ready. We certainly have some products, particularly those things that we've acquired or that we've built in the last 2 or 3 years that are multi-tenant, like our Socrata data and analytics platform, like the jury solution we recently acquired. Our student transportation system, Traversa, is a cloud-only product. So we have some products that are already there. We've got others that are closer to it. The -- our public safety Records Management System is -- there was recently a big investment and is optimized for the cloud. Other products, there's going to be more effort. And there are different priorities for different products. Some product sets, their customer bases are more -- have a greater appetite for the cloud than others. So that timetable seems to be about right for us.

Along the lines of product investments, we'll start talking a little bit about the product. You acquired New World Systems in 2015. That brought you a much greater presence in the public safety environment. And the one thing that I thought was interesting about that solution is when we went to the IACP conference this last fall in October, we had a chance to speak with the product manager of that product. You guys were just kind of releasing what the final version of all the investments were. It was a 4-year plan, big undertaking. But I think if you look at your win rates the last couple, 3 years, the efforts have been well worth it, because the product has certainly seen benefits there. But can you discuss the investments in the solution and why sales have trended so positively? Is there something you're able to correlate between maybe pieces of functionality that you built into it relative to what the market has been seeking?

Yes. The public safety space, as you said, we acquired New World, it was the largest acquisition in our company's history, about a $700 million purchase. Most of their business was in the public safety space. They had a really nice competitive product mostly focused on the mid-market and with sights at the lower mid-market and had 2 or 3 competitors that were very similarly situated. So we had, typically, win rates in the 25%, 30% range and as did our competitors. So nobody really was too differentiated, different geographic strengths sometimes, but a competitive market. And we were a good competitor with a solid product and really a very deep domain expertise having been in the public safety space for, I guess, 30 years. So certainly well-thought out product, but one that we saw an opportunity to make a significant investment in and to sort of expand both the TAM by broadening the market where they're competitive and particularly integrate it with our Courts & Justice solutions. So in the space, we are unique in that we're the only company that has a public safety solution as well as a Courts & Justice solution. So even though they're certainly adjacent markets and those products are very integrated or the processes are integrated, we're the only company that has really a solution for both parts of public safety, the computer dispatch 911 as well as the records management. It has deep mobile capabilities as well as the courts offering, so case management, jails, jury, prosecutor, probation. So in a lot of jurisdictions today, that would literally be 6 or 7 different systems from different vendors. So we're unique in terms of having the ability to offer all of those. And we've made significant investments in integrating those solutions over the 4 years that we've owned the public safety business. The other investments we made really were about adding features and functionality in both the records management and the Computer Aided Dispatch, adding cloud capabilities and then adding significant mobile capabilities. So we really believe that we're the leader in that space now in terms of mobile capabilities. And we added features and functionalities that we needed to be able to compete at the upper end of the market. So now we believe that we can be and are competitive in Tier 1 opportunities. And last year, we went live with our first dispatch system in a Tier 1 jurisdiction, Orlando, Florida, replacing a competitor with our 911 system, and we expect to be able to build on that and compete more and more through a much broader market. But those investments, the integration with Tyler have had a significant impact on our win rates in public safety. And we've gone from that 25%, 30% win rate to really consistently winning in the 50s. So winning more than half of the business we compete for in a broader market. We're just on the front end of being -- of seeing larger opportunities. So those are typically long sales cycles, so we expect to build on our success in Orlando and continue to see more success at the upper end of the market, while continuing to expand our win rates in the mid-market.

Sure. Brian, I think we should back up and be honest about one thing is, you're the only vendor that has product in both public safety and courts, because you've kind of won most of the courts environments and all the other vendors have kind of shuttered their doors, shall we say. You've done such a good job there.

Well courts, we're very, very strong in. We do have good competitors, and we compete for every deal, and we don't take them lightly. But we've had a lot of success. We've executed at a really high level in courts. It is our strongest, I guess. From a competitive standpoint, we have roughly 50% of the case management market by population in the country. I think we've got 16 or 17 statewide court systems. We have 8 of the 10 largest counties in the country and have a win rate that's well in the 80%. So -- but it's really a matter of us continuing intend to execute at a high level and do a good job on implementing those systems, supporting those systems and continuing to implement and invest in those systems.

Fair enough. Last question from me, and then I'll open it to some of the questions I've seen pop up on my screen here, is on the payment side. Payments is a bit of a new theme for Tyler. I assume payments to local governments have obviously sold the last couple of months. And I was surprised here, like you said, traffic tickets are certainly down as people aren't driving. But what does this opportunity look like over the next several years to maybe a decade? And then can you help us understand the revenue model? This is all in the context that payments is a hot space for a lot of investors right now. So it's a key question that we've been receiving lately.

Yes, payments is a hot space, and it's certainly not something in the software space is unique to us in terms of looking to expand our software presence through leveraging that into our customers' payments. And we've had various payment revenue streams within Tyler for some time, but I wouldn't say we've had a really cohesive strategy or really company-wide strategy. They've sort of been built in a fragmented way within our product groups. Today what we do, we generate about $7 million a quarter based on last quarter's run rate of revenues for Tyler from online payment processing. It's mostly today in 2 areas, traffic tickets and utility bills. So customers that have those back-end systems from Tyler, which have portals, we have payment engines built in. Some customers manage those themselves. Some customers and a relatively small percentage of our existing customers have Tyler manage that portal, manage the payment stream. And we collect a convenience fee, $2 traffic ticket and/or a share of the credit card fees, depending on where we sit in that payment stream. As I said, it's about $7 million a year today across our product groups. We have multiple payment processor relationships. So we haven't consolidated that to take advantage of scale, and that's what we're in the process of doing. On one hand, consolidating our volume and our future volume into one processor, becoming a merchant services provider so that we are getting a payment or a share of all of the payments coming in and then going to our customer base more broadly to offer those services, and in some cases, even beyond just the systems that Tyler has, where they have other payment streams, and being able to offer a financial advantage to them from being aggregated with the volume from all of our customers and being able to provide an attractive customer group to our payment processing partner. So we believe there are a number of other revenue streams, things like licensing and permitting. We do a little bit of property taxes. Not a lot of people pay their property taxes online today, but more property tax payments and certainly broadening our presence with courts and utilities on the payment stream. So I'd say we haven't really sized the volume that is potentially available to us. I think over the course of the next few quarters, you'll hear us talk a lot more about it, give more indications of what we think the market size could be and how much of it we could capture, talk about partnerships there. But I think the key is that we've just barely scratched the surface of what is potentially available to us through the massive amounts of payments that flow in through our customers.

Sure. We all certainly pay a lot to our own local governments one way or the other, no doubt. All right. A couple of questions from the audience. We'll start with M&A strategy. Well what does your M&A strategy looks like maybe over the next 12 to 24 months? Do you go back to making some bigger deals, but a fewer number or something on the smaller side with more frequence? And then are there any segments or areas that you'd specifically target?

Yes. I mean generally, we've been active with M&A and somewhat opportunistic over the years. We were very active in 2018 and 2019. We did 8 acquisitions over that time frame. 2 of those, Socrata at about $150 million purchase price and MicroPact at just over $200 million are larger deals for us. We did 6 much smaller deals that they reached a few million dollars. I think generally, our appetite would be to do deals that have more on the larger size and scale. But we certainly are interested in some smaller opportunities where there are businesses that can enhance our competitive offerings can leverage our sales organization, leverage our customer base and grow much faster within Tyler. So even though they're a small company outside of the Tyler, they're an offering that could grow much bigger within Tyler. We've sort of taken a bit of a pause since the fourth quarter of last year. As we said, we really wanted to focus on integrating the 8 companies we had bought in the last 2 years, both from a product and an organizational perspective. We're pretty well along with that. I'd say we're pretty open for M&A activity now. We have a great balance sheet. We have no debt. We've got about $400 million in cash and a pretty sizable credit facility available to us. So we've seen certainly over the last couple of years -- most of the acquisitions we do are not consolidations of not buying a competitor, but really buying something that broadens our product offering, it expands our TAM, fills in a gap, or in some cases, supplements a solution that we have today that's not a leader. Or in some cases, like the public safety adds a whole new subvertical market for us. And I think that's still where our focus is. I would -- we've seen certainly elevated valuations and elevated valuation expectations from sellers over the last couple of years. And it will be interesting to see if those change and how valuations might be adjusted or -- and how maybe potentially sellers are more hesitant about making significant investments in their businesses in a more uncertain environment. And Tyler has the ability to do that. So I think as we move into the second half of the year, we'll see how the market starts to shake out. But we're certainly open to M&A activity now.

Yes. You're certainly not shy about doing either smaller or large and even employing or deploying some debt and a little leverage in certain scenarios if needed. So next question is on the federal market opportunity. Have you built out a separate sales force as you've taken some of your products, whether it's MicroPact or maybe Socrata, to target those customers?

Yes. And most of our federal business, it's about 5% of our total revenues today are from the federal government. Most of those are through MicroPact, the acquisition we did just a little over a year ago, and to a lesser extent, through Socrata, the data and analytics platform we acquired 2 years ago. MicroPact, in particular, has a sales organization that is focused on the federal market. It is a different procurement process. It's a different way of doing business in -- from a lot of aspects. But they have been in that space for quite a while. They know it well. They function very effectively there. I think they have installations in 90% of federal agencies across the whole spectrum of federal government. They also have a very well-developed partner network, which is not something that we've typically used in most of our traditional businesses. But there, they've got a lot of relationships with systems integrators and partners who do significant business in the federal space, but don't have a product. And increasingly, more of their sales as well as professional services are coming through a partner network. So that is a dedicated organization. And they do a really good job there. And we're interested to continue to build on our experience with MicroPact and see how that can apply to some other Tyler solutions that might have federal opportunities as well.

Great. Well we have about 30 seconds, time for one more question. It's on Socrata. Where is Socrata in its growth track? What do you -- maybe what inning is it in?

Well I'd say they're still pretty early. We've owned it for 2 years. There's -- I wouldn't say it's been a pivot, but we've certainly had an expanded focus within Tyler on creating Socrata data and analytics platforms on top of key Tyler products like our finance product. Socrata for Finance, so for transparency and analytics capabilities on top of our ERP, crime mapping and crime analytics on top of our public safety system. We've had a lot of investment there over the last year, 18 months and seeing really good traction through those product groups, while they're continuing within Socrata to build out their business with the Socrata Connected Government Cloud, more of the enterprise application for analytics for governments of all sizes. So I'd say we're probably in the second or third inning of growth there. But we've made significant investments, and we're excited about the opportunities they have as part of Tyler.

Wonderful. That's all we have time for today. I'd like to thank everyone for joining us. And Brian, thank you so much. Hope all is well down there in Dallas, and I'm sure we'll talk soon.

Thank you. Good to see you.

Thank you. Farewell. Bye-bye.