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

Good morning, and thank you for joining us at the 2021 Needham Growth Conference. My name is Scott Berg. I lead our enterprise software and SaaS research efforts here at Needham. Today, with us, we have Tyler Technologies and the company's long time CFO, Brian Miller. Brian, good morning.

Good morning.

Thanks for joining us, of course.

You bet.

I guess, as a -- the first question I always like to start off with is, why don't you give an overview of Tyler for maybe that one person in the audience that's not familiar with the company.

Sure, happy to. Yes, Tyler is an enterprise software company focused on the public sector vertical market. We have a very broad presence of applications that run essential back-office functions of government, primarily focused on local governments. So cities, counties, school districts make up 80% to 85% of our business, a smaller presence in state governments and about 5% of our business is with federal government. We have what we believe is the broadest line of products that serve the public sector market as well as the biggest customer base in the public sector market. We have about 26,000 installations of our products across roughly 11,000 different local jurisdictions. Revenues last year crossed the $1 billion or 2019 did, 2018, will be up a little bit from that. Market cap somewhere around $18 billion, joined the S&P 500 last year as well. So there's a real high-level overview. We can get into more details.

Certainly. And then right on cue, I literally just got an e-mail that came in that said Missouri's second largest counties likes Tyler Technologies' appraisal software and services. I guess what timing since we're talking right now.

Our communications group is good.

Apparently. I guess, one of the first things I'm covering is -- with most of my companies this week is trying to take a look back at the pandemic and how it's impacted your business over the last 10 months or so. Initially, businesses stopped in late March and early April. I assume your business did, at least like most of the companies I cover. But can you talk about how overall sales cycles have responded once work days began to normalize, maybe in late April, for a lot of your customers?

Yes. Like most companies, we adapted to working from home as well as our customers. We're doing the same thing. I'd say, generally, the public sector probably struggled maybe a little bit more than a lot of private sector enterprises with figuring that out. So we certainly did see some pauses in projects. At any given time, we may have hundreds of implementations going on at the same time, mostly with a number of Tyler people on-site, at the client sites, sales efforts that are ongoing, live demos on-site, customers or prospects visiting other sites. So all of that stuff obviously stopped. I think we did a pretty good job of shifting to work from home. And around 30% of our staff worked from home pre-COVID. So we had some experience there. So yes, there were some initial pauses in -- both in professional service engagements as well as in sales processes as we and our customers figured out how to adapt to the new working environment. Generally, those things have all pretty quickly got back on track, probably a little bit slower for sales versus implementation engagements. We shifted to doing all of our implementations remote, remotely delivering professional services that would normally be on-site. Actually, in the long term, we think that's a net positive. We have a lot of inefficient time from hundreds of people getting on airplanes every Monday morning and every Friday afternoon. And so now with those teams working remotely, we have more hours that we can deliver and bill. And I think that's -- a portion of that will remain a permanent change. From sales, A, you really kind of step back and look at kind of why customers usually are buying a system from us. And usually it's because they have an aging system that has reached end-of-life. And that generally means it's 20, 25 years old, not a few years old. Governments are different than the private sector. They don't have competition effectively. They don't deal with each other. So they'll tend to use these systems even though they manage their important systems. They manage essential functions like property taxes, courts, jails, 911, payroll, but they'll use them really until they get to end-of-life. And what causes them to determine that it's end-of-life may be a variety of things. It could be an old hardware platform that's at end-of-life. It could be a COBOL system from the '70s that is not -- there aren't resources around to maintain it any longer. But when it gets to that point, it's a fairly nondiscretionary decision to replace that system. So they may be able to delay it a bit. But generally, there -- when it gets to that time that they've made that decision to replace it, it's pretty important. So generally, processes that were underway pre-COVID, after those initial delays, started up again. So we maybe lost a quarter or 2 in terms of lengthening the pipeline, but we really don't think there's any fundamental change in demand. In fact, we believe that some of the demand is likely accelerated because old systems that have proven not to work effectively in a remote environment. So generally, sales processes are resumed and kind of back on track. We had a really good third quarter for bookings. Fourth quarter is typically pretty strong for us as well. So everybody has figured it out one way or another and operating pretty much in the new normal well.

Got it. I guess if you look back at your sales pipelines from a year ago going into calendar '20 versus deals that were actually signed, obviously, COVID linked in sales cycles, as you mentioned. But was there any nuances around maybe some priorities that shifted for your customers, given the pandemic? My guess is no because, like you said, most of these systems kind of hit that age where they have to replace them anyways. But I didn't know if you saw anything kind of on a minutia level that would be interesting to call out on if any of those might have shifted a little.

Yes. Not a whole, I mean, these core systems still are the priorities and make up most of our business. But there are -- certainly around the edges, there's certainly things that became new priorities around COVID, obviously, solutions that help people work remotely. Sub courts is a good example. We're a major -- certainly the leading player, if not a dominant player, in providing court case management systems that the courts use to run their operations. And when courts shut down because of the pandemic, physical access to courthouses wasn't available. And many courts remain kind of closed, except for the bare essentials. So they weren't -- a lot of courts, most courts weren't able to do routine things like conduct hearings or have normal trials. So we actually had a product that was close to being ready to release that we -- our timing was fortunate. Then we were able to push that out rapidly, a virtual court's product that enables customers who have a municipal court system to conduct hearings and operate normally in a remote environment through sort of an integrated video platform as part of their court case management system. So we offered that on a free trial basis for 90 days, had somewhere -- the last time I saw it was 70 or so courts were using it. Most of those, if not close to all of those, have converted to paying customers after the initial term. So that's an example of a solution that we saw, certainly, an increased level of demand for. I'd say the other thing is around data. We did a significant acquisition a couple of years ago, Socrata, a company that provides a data and analytics platform for the public sector. And we've seen a lot of new uses around that, using data to make better decisions is sort of at the core of that solution. And we've seen a number of applications to provide the public with better access to data around COVID and to help our customers manage their operations more efficiently through the use of the data platform.

Got it. I guess one of the learnings that I had studying this public sector space from back in the Great Recession -- I think I've covered Tyler for about 8 years now, so I spent a bunch of time then just because I'm trying to track what demand trends were like coming out of the Great Recession. But I think one of the interesting learnings there was the -- any change in demand to your business was really a late cycle. Those customers had budget dollars to spend. Like you said, those systems were kind of at an age where they had to do it. So like in 2008, maybe the first quarter of 2009, your bookings returned pretty healthily -- in a healthy nature because those delayed bookings just ended up getting done relatively quickly. But any customers that were to change spending priorities were really kind of later in 2009 or early into 2010 because it always occurred at their next budget cycle. Do you think we have the chance to see kind of the same phenomenon this time? Or what you're seeing today maybe wouldn't suggest that?

Yes. I think there are a lot of similarities. And you're right, there's certainly a lag, both on the downside and the upside in how public sector reacts. Typically, they have -- as you said, they've got a budget cycle or a budget in place. They tend to operate into that budget even if conditions are changing around them and then deal with it on the next budget cycle. And those budget cycles vary, some are June, some are September, some are December. So we had some clients that put new budgets into place July 1, but certainly in a period where there was a lot of uncertainty. Others are -- just put budgets into place January 1. So it's kind of spread out. But yes, they -- you tend to see the impact of broader economic changes and changes to their budgets kind of in the next cycle and sometimes even longer. Now as I described, sort of the underlying demand isn't driven by budgets or the broader economic conditions. The demand is driven by an old system aging to the point where it's not viable anymore. But they do have the ability within that sometimes to say, "Well, I really need that new system, or I was going to buy it this year, but I'm going to -- I can push it out for one more budget year. And so that's what we saw during the recession. The pipelines actually got bigger. So deals were slowed, but they still stayed in the pipeline. And I think that's effectively what we're seeing now. It's a little different in this situation because it was a more gradual decline in kind of 2009 time frame, our worst year, where we were at sort of the bottom. We were mostly a license business then. Today, most of our new business is subscription. But -- so licenses, which sort of represented new business. At the bottom, we're off, I think, about 17% year-over-year, and that was in 2010. Our overall revenues for that year, again, the worst year, were flat. And that really represent this -- the stability of the recurring revenue base, which, at that time, we were less than 50% recurring revenues. Today, we're north of 70% recurring revenues. So we had a flat year. That was followed by sort of a recovery year that was, I think, a 7% growth year. But that was followed by a 17% growth year. And so there really is sort of a catch-up where that pent-up demand comes through. I think the difference here is that, obviously, with the pandemic, things slowed down, or it was much more rapid slowdown or event that caused the budget pressures that were likely to -- that we're starting to see now. And so we also would expect that, as there's recovery, as the vaccine is more widely available, as people get back to normal, that, that recovery is a bit faster and that there's a sort of a pent-up demand that works its way through the system. Again, not quite as dramatic because we're more of a recurring revenue model now. And there's certainly not anything to change to attrition as a result of that. And these systems are all crucial systems that they use to manage essential functions. So we're still -- we still have growth in 2020, certainly a lot well below where we expected to be coming into the year, but we're still growing through it and do think that there'll be a catch-up and that recovery is probably a bit faster than we saw in the recession.

Sure. In 2019, the company started pushing a cloud-first theme versus your prior kind of platform-neutral stance. Do you think COVID has accelerated the interest or demand in your subscription delivery model? And I asked the question relative to some of your customers might not have systems that are ready to be replaced, maybe they're at years 10, 11 or 12 versus 15 to 20, but the version that they implemented might not work as well in that environment. My guess is as we're working from home, that subscription-based ability to use it in the cloud might seem a little bit more appealing.

Yes, absolutely. I think -- as I sort of mentioned earlier, I do think that this whole shift to remote work has exposed flaws and cracks in systems that they knew were old, but they might have thought had many years of service left in them. But they're finding that they flat out don't work or don't work efficiently in the remote environment. So you've got a court system that's a mainframe COBOL-based systems in the '70s that really only works if the user is at a terminal at their desk that's hardwired to a mainframe. So they don't have remote access. They might not have the ability to do electronic filing of documents for lawyers to file documents electronically into the system. So they're paper-based. They're relying on couriers bringing paper to the courthouse, which is now closed, and they don't want that physical interaction. They, like I said, don't have the ability to conduct video trials. So those systems really aren't working effectively. And so I think you'll see some of those -- they're coming to those conclusions. Now there still is a process to go through to replace those systems. It doesn't happen overnight. They're -- they have to budget them. They have to go through a procurement process. But we do believe that, as we come out of this, that there will be some systems that are replaced sooner than they would have otherwise. And then, again, there are some ancillary products and offerings like electronic filing like online dispute resolution, a solution that we offer to allow parties to resolve the dispute through an online process rather than in a physical courtroom, like the video -- or virtual courts offering that we'll see kind of happen sooner than they would have otherwise. So we -- and that might be -- when you actually start to see that sales activity might be well into next -- well, well into 2021 or even in 2022, but we do think there'll be some acceleration that takes place because of this new environment. And then the other thing is around cybersecurity. It certainly is a concern. You read a lot of cybersecurity incidents around the public sector as well as the private sector. And I think that's helping increase the push towards more cloud-based systems and certainly increasing the interest we're seeing from customers. As you said, we've -- historically, we're kind of cloud neutral. We offered all of our products, either in a traditional on-premise deployment or in the cloud, which, for us, is primarily a private cloud, historically hosted at a Tyler data center. We entered into a major partnership with AWS a little over a year ago and are -- kind of have projects on underway to start to enable us to shift new customers and, ultimately, our existing customers out of Tyler data centers into AWS as well as working to optimize our products to be more efficiently deployed in the public cloud. So all those things kind of come together, along with the underlying shift in the desire of our customers and our prospects to have more systems in the cloud to really, as you said, create a cloud-first approach for Tyler as opposed to our previous approach.

Got it. And from a housekeeping point of view, we will be taking the questions from the audience in about 10 minutes. If you have a question you'd like to pose to Brian, there's a Q&A tab in the upper right-hand corner of the presentation window. Feel free to put them in, and we'll certainly run through those, time allowing. Yes, I guess I just got 2 more on the COVID thing just because there's lots of questions, obviously, there. But one of the areas that we've been excited about over the last 2 years is your new payments business. Obviously, payments stopped overnight when -- in March and early April. But could COVID actually be an accelerator to that area? And then I asked because, obviously, there's not a lot of people going in and making some of these payments at. MyDMV still requires us to pay by cash or check. My teenage daughter went in to renew our license, which is kind of weird to say renew her license -- it's old, I guess -- yesterday, and they wouldn't take credit cards. So -- but I assume that the pandemic has a chance to accelerate the business, but just didn't know if you're seeing anything specifically in payments.

Yes. We believe so. And payments is an area that I'd say is a high level of focus for us today. That's not too unusual among software companies looking to participate in payment streams. As I mentioned, we have a very large customer base today across a wide range of local, state and some federal government entities. And our back-office systems facilitate a lot of payments or process the underlying transactions. So if you think about courts, traffic tickets, utilities, we have utility billing systems, licensing and permitting systems, parks and recreation. So there are a number of back-office systems that Tyler has that have payment components to them. Historically, we didn't really focus on being a part of those payment streams. We just had the software that managed that transaction. Over time, we have, in different segments of our business, started to participate in facilitating those payments, I'd say, not really in a cohesive way. It sort of grew up with different strategies in different parts of our business. Today, we have approaching $30 million in revenues from payments where we manage the portal, provide the processing relationship and get a cut of the credit card fees or convenience fee, $2 per traffic ticket that -- for tickets that are paid online. There still is -- our penetration is -- our customer base is still relatively low. And they're still, as you noted, are a lot of government entities that currently might not take credit card payments, don't take online payments. You have to mail in a check where you have to, in some cases, show up to pay your traffic -- either mail it in or show up to pay your traffic ticket in person of the courthouse. That's not the kind of experience that people are certainly used to in the private sector. And so there's increasing demand even pre-COVID for -- to have a more normal consumer life experience with government. But COVID certainly, I think, has accelerated that. So where they don't have people there to open the mail and process payments, where people don't want to come down and do something in person, so we're seeing increased interest in that. Certainly, in the short term, there has been some decline. So there's a lot lower volume of traffic tickets today because people haven't been driving as much. So we've seen those volumes fall. With courts being closed, we've seen a decline in electronic filings, which often have payments that accompany those for filing fees or court costs. So we've seen some softness in that in the short term. We expect that there'll be a catch-up. But in the long term, there's certainly an increased interest in government entities offering online payments and credit card payments. So our strategy there really is we've built an enterprise payments portal. We have done a lot of work in the payments portals in our individual systems like a court system or a utility billing system. And we also have an enterprise portal that, really, the government can use to manage all of their payments, whether the back-office system is a Tyler payment system or a system from another vendor or a homegrown system. And so our strategy really is around increasing our penetration into our customers, longer-term offering payments to people who aren't our customers and then offering those payments more broadly across their back-office systems. So a town might have one payment processor for the utility that they selected. They may be using a different processor for the courts. They might not be accepting payment -- online payments at all, or credit cards for the parks and recreation departments already is -- to kind of bring this together, give them a better deal from participating in the volume that we're able to bring from all of our Tyler customers and provide them with sort of a unified payment experience. And so we're sort of -- we've done a lot of the back-office work or back-end work on the systems. We're consolidating our payments relationship with one primary processor, and we have -- refining our go-to-market strategy to drive this more deeply into our customers. And so I think you'll hear a lot more about that from us over the coming year.

Got it. I was going to skip this question, but I've had a lot from the audience already on it. So it's topical. So where I saw a lot of ticket here is on the COVID theme. The one question I probably received the most from investors is trying to understand the sources of revenue that your customers -- where that revenue comes from for your customers? You mentioned the city and county governments still comprise roughly 85% of your business, a little less is -- a lot less is state, obviously, and I believe federal is a little bit more than your state presence out there. But when you look at this predominant layer, predominantly local government base, if you broke it up on a 100% scale, where do you think most of them get their funding sources today?

Yes. So that's a good point because it's something that most people don't have a real clear understanding of. So for most local governments, property taxes are, by far, their biggest revenue stream. And I'd say, probably, in most cases, it's more than 50% of their budget. If you look at a city, a county, school district, local agency, property taxes are really a pretty stable revenue base. So as you know, even through the pandemic, real estate values have generally held up pretty well. It's also a pretty -- it's not -- the property taxes don't change very rapidly. So the fact even if your house is worth more, less or more today than it was 3 months ago or 6 months ago, your property tax bill probably doesn't change. And that process of revaluing properties, which is something our software, and we have services to assist our customers with, is kind of a slow process and not the most efficient in the world. So those property taxes tend to be a really stable revenue base, and they also generally have the ability, if the values fall, to raise the rates. So they tend to be pretty stable and then they certainly are today. Sales taxes vary quite a bit. Typically, they would be a single-digit component in terms of a percentage of revenues. Certainly different in a place like New York City or Dallas as opposed to a small suburban bedroom community. But property -- sales taxes would be a smaller piece. Income taxes, some places like Texas, 0, other places like New York City would -- there would also be a component there. But generally, that would also be a single-digit percentage. You've got things that are -- I guess you'd say fees -- and so things like court fees, courts are generally fairly self-sufficient in terms of fines, fees, seizure, property seizures, those sorts of things. You've got licensing and permitting so building permits, business licenses, those sorts of things, they would typically sort of be in the -- maybe the 15% to 20% of the local government budget. And then you may have pushdowns of aid from state government, so where they distribute revenues down to the local level. So to the extent there's pressure at the state level, that sometimes puts pressure on local governments because there are revenue sharing that comes from the state may be pulled back. And then you've got various grants. So particularly public safety is an area that is -- we're seeing a lot of growth in our public safety business. And there's a fair amount of federal grants that come in there. As well as in public safety, there's a charge on every phone bill and every cell phone bill that helps fund 911 systems and 911 operations. So that's a major source of revenues that fund those specific systems.

Given the -- this is part of the follow-up question, at least, kind of moving into those was there's been some documented budget difficulties within kind of the state government angle, probably a little less so than the local government angle. Is that a real headwind for the business? Or is that more of a kind of a perceived headwind? And then the follow-up question to that is, does a Biden relief package for the states that didn't get done in the prior pandemic relief bill, if that skeleton moves into maybe a new relief bill here, does that ultimately turn into a headwind -- or excuse me, a tailwind for the business?

Yes, it certainly would help. Yes. And again, state governments are roughly, I'd say, somewhere around 10% of our total revenues. So -- and I think states probably are under a little bit more pressure than the typical local government, but certainly seeing pressures all across the board on those revenue streams, really, other than property taxes. So there is some impact and some headwind there. Yes, the first round of stimulus of the CARES Act included a pretty significant amount, mostly for state governments and large local governments, large cities and counties. Some of that was, again, pushed down. So a county like Dallas County, where we're located, parceled out the money they got to a number of the smaller cities and towns of the county. But it was -- it wasn't as widely distributed. And it was, I think, earmarked for COVID-related expenses or to offset losses of revenue around COVID. So there were certain requirements. It was originally had to be spent by the end of the year, I think the sort of the latter stimulus -- the late-year stimulus changed that and allowed them to a longer period of time to spend it. And we've seen some customers using CARES Act funding to acquire new systems, I guess, on the premise that COVID has rendered their old systems ineffective. But certainly, a larger, more broadly distributed stimulus for state and local governments would help relieve those pressures and maybe enable those processes that have sort of been put on hold because of broader budget concerns to move forward more rapidly. The whole subject of more stimulus for state and local government was kind of shelved at the end of the year and taken out of some of the proposed packages. I think there's a pretty strong sense that the Biden administration as well as the democratically controlled Congress would likely have significant more aid to state and local governments in future stimulus. So I think it's more, again, around kind of getting the timing moving more quickly. There's also a bill that was initiated back in August, I think, the state and local government IT Modernization Act, which would provide, I think, $28 billion over 5 years, specifically to state and local governments to upgrade aging IT systems. So that certainly would be a benefit as well. That had pretty strong bipartisan support. It's currently in committee, and I don't think we have any update on when we actually expect that, that might move forward. But I think that very specific kind of aid for replacing systems, which, there's a pretty broad recognition that there have been some pretty pressing needs around some of these systems that have not worked effectively in the COVID environment. So we're also hopeful that, that will move forward in the new administration and provide more relief to our customers.

We have time for maybe 1 or 2 more questions. We had a question come in about your SaaS offerings. Are they off the in-house center or the AWS? You kind of touched that on a little bit that you're kind of in the process of moving all of those to AWS over a multiyear time frame. But the second part of the question, I think, as kind of interesting is kind of as you move to AWS eventually with all of those, are there any significant savings -- cost savings that you'd gain from it or maybe some greater flexibility around the technology infrastructure?

Yes. Certainly, flexibility. I think, initially, our general sense is that we would expect that we can deploy an existing product for roughly the same cost that we're operating those in-house in a Tyler data center in AWS. Most of our core products weren't originally built to be deployed in the cloud. So they were built to be deployed on-premises. So they're not optimized. They're not really efficiently deployed in the cloud. They have big footprints. They use more data center capacity. And so they're more expensive to deploy in the cloud than they would be if they were architected differently. So we think it's kind of cost-neutral, in a general sense, deploying that same customer in AWS but -- as the products are architected today. As I mentioned, we have a -- projects underway to, in some cases, really re-architect products to be more efficiently deployed in the cloud and really take advantage of the public cloud. AWS is providing us with some resources there and, certainly, technical assistance and training as we sort of work through products. We have a lot of products as well. So that process is a multiyear process. We've finished -- talked about a 3 to 5-year sort of window for that, that's underway. I think in the short term, there's probably some duplicate costs in that we still have our 2 Tyler data centers that we maintain, and we hope to get down to one first and then get out of the data center business. But we won't be able to eliminate all those costs until we're kind of fully shifted over to AWS. And we're starting to put new customers this year into AWS, and then we'll have a longer-term process to lift and shift existing customers out of the Tyler data center. So long-term, there's a cost advantage to us, both from optimizing our products for the cloud and getting out of the data center business. But again, that will be realized over a few year period. The -- certainly, the upside for us is effectively unlimited capacity at AWS as opposed to our 2 data centers, which were approaching capacity. And we were going to have to make additional capital investments there and continue to build out that infrastructure in an area that we really don't want to be in long term. So we've got, roughly, I guess, approaching 4,000 cloud customers, where we've got 22,000 on-premise installations. And so over a long period of time, to be able to shift those customers to the cloud through the AWS platform rather than trying to build out a Tyler or capacity to do that, that's really where the big advantage for us is in the long term, to be able to effectively double our revenues from those current on-prem customers as they shift to the cloud, and AWS provides us with the capacity to do that.

Got it. Well, we are up against the clock and out of time. I wanted to thank everyone for joining us. Thank you, Brian, again. We've been doing this for a while now. I appreciate the time. And I didn't get to half the questions. There's so much going on in the company, which is great.

Thanks for the opportunity. Thank you.

Thanks, everyone. Bye-bye.