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

Good morning, everyone. Thank you for joining us at Needham's annual -- excuse me, Annual Tech & Media Conference. Today, with us, we have Tyler Technologies and the company's CFO. Welcome, Brian. Thanks for joining.

Good morning, Scott.

I guess, for a start, why don't you give a brief overview of Tyler for the maybe one or 2 people here that are unfamiliar with the company.

Sure, happy to. Tyler is a vertical software company focused on the public sector exclusively. We have a very wide range of applications that power essential functions of government, primarily, at least, historically focused on local governments, cities, counties and school districts, but in recent years, have started to increase our presence at the state and federal levels as well. So if you think about things like public safety systems, 911 systems, courts, jails, financial systems, property tech systems, utility billings, school bus transportation, those are the kinds of things that we provide software for. We're on track to be a little north of, I think, $1.2 billion this year prior to a large acquisition that we did, that I'm sure we'll talk about a little bit more, a couple of weeks ago. So we're north of the $1.6 billion revenue run rate now.

All right. Great start. I guess, from a bit of housekeeping, 2 items for everyone. First, I will be taking audience Q&A, if there's any questions. There should be a Q&A box in your presentation window, feel free to put them in, and I will obviously take them towards the end. Secondly, I took a drink of water. It went down the wrong way right before this. So if I get choked up, it's purely because I'm dying over here. But besides that, we should be just fine. I guess, let's start with current business trends, Brian. In the first quarter, your bookings declined 12% year-over-year, excluding the large North Carolina Courts & Justice comparison. The single quarter has never really meant much about your business trends. I mean in my 9 years covering it, I've seen some bookings that have ebbed and flow, and had nothing necessarily to do with current demand. But how much of the bookings weakness was driven by maybe the pandemic or bubble from the pandemic? And how do sales pipelines look today versus maybe 18 months ago pre-pandemic?

Yes, I'd agree with you. It's hard to put too much importance on one quarter's bookings. So our bookings can be very lumpy, even though our business tends to be very consistent, where we're now, prior to the NIC acquisition, 75% recurring revenues. And NIC significantly increases that recurring percentage. But the bookings can be lumpy, particularly with respect to large contracts. Certainly, we saw that in Q1. Last year's Q1 was a very tough comp because it had a number of large contracts, but particularly 2 very large 10-year SaaS deals with the state of North Carolina that totaled about $38 million in bookings. The bookings really reflect kind of what was -- given our sales cycles tend to be kind of long, 9 to 12 months would be normal and, in some cases, they can be longer than that. So bookings really reflect sort of what was going on in the market 9 to 12 months ago. And certainly, there was an effect on the pandemic -- from the pandemic, not really on demand. To a large part, demand in our space is driven by aging systems in the public sector. And because governments are not -- they don't have competition, they're not ROI-driven, not profit-motivated, they tend to use software for a very long time, really, until it's almost ready to die and then they look at replacing it. So demand tends to be somewhat nondiscretionary in these decisions. But we certainly saw it in the -- from about this time last year, certainly through the third quarter, a slowdown in activity as governments shifted to working remotely, just like we did. Sales processes were disrupted. We didn't do live or on-site demos and had to shift to doing those remote. And governments had concerns about budgets. There was uncertainty around what the impact of the pandemic could be, both on the revenues, which turned out not to be as bad as they might have feared, but certainly some extraordinary expenses incurred. And so their -- all of those things combined to slow down activity. We saw fewer RFPs, sales processes encountered delays. And as we got towards the end of the year, we started to see those things pick back up, starting in the fourth quarter. And certainly, in the first quarter, we've seen RFP activity, not all the way back to pre-pandemic levels, but certainly improving above what we saw in Q2 and Q3. We've seen RFPs that we would have expected to come out last year starting to come out again and delayed processes moving forward. And certainly, the stimulus is helping that as well. So the bookings this quarter really reflected those delays and slowdowns that happened early last year as the effects of the pandemic became apparent.

I guess, as you look back over the last 9 months or maybe what you're hearing from customers today, will the pandemic change anything? And what or how your customers maybe buy from you going forward?

We think so, maybe on a couple of fronts. On one hand, what I just described, historically, customers have waited until a system is almost ready to die to replace it. And certainly, they'll use systems much longer than the private sector typically will, I'd say. Maybe the average system we replace is north of 20 years old. It's not uncommon for us to replace systems that are 40 years or more old, particularly in very large governments that have -- still using mainframe systems written in COBOL in the 70s to manage essential functions like property taxes reports. And they wait until their -- really, their systems are unreliable, difficult to maintain, no more COBOL programmers around, those kinds of things. And so that's typically what's driven demand. But as we've certainly seen the need to shift to remote work to be able to have remote access, a lot of these systems don't accommodate that. We've seen a lot of examples of courts that, because the court house was physically closed and people weren't coming in, that they weren't able to conduct trials or conduct normal business. Some of juries do all those things because they did not have the ability to access those systems remotely. And we provide some products. We provide some products that enable virtual trials, for example, that sort of bridge that gap. But we do believe that this change in the way people have had to work has certainly exposed flaws or weaknesses in some existing systems that governments might have otherwise thought. They recognized they were old, they weren't state-of-the-art, but they might have thought they had years of life left in them, and now that's proving not to be the case. So we do believe that there will be systems replaced sooner than they would have otherwise been. They'll still need to go through buying processes. They're still going to budget it. So it's not like an immediate spike in demand, but we do believe there'll be some acceleration. We also believe there are a number of opportunities for incremental products like our virtual ports offering, which is offered on a subscription basis. And the data and analytics become increasingly important, and that's another area where governments have often lagged behind in terms of having business intelligence, analytics capabilities, around these systems that are very often siloed. And so with our Socrata Data and Analytics platform that we acquired a couple of years ago, we are seeing a number of new applications for that and increased expectation -- or increased interest in that. And I'd say, thirdly, with NIC, with our recent acquisition. NIC's business is really about providing digital access to government through -- mostly at the state level, but through portals and providing payment services online. And we've certainly seen an increase in the desire of citizens and businesses to interact digitally with government rather than in-person. And we think the pandemic certainly has increased that. So we do believe that there are a number of changes that come. And lastly, I'd say, as you know, we've had an ongoing transition of our business model from mostly on-premises to mostly SaaS. We have been accelerating that ourselves. But certainly, the desire of governments to migrate more systems to a SaaS model has been accelerated by the pandemic, and that certainly fits in really well with what we're doing with our product suites.

Yes. I've always thought you guys had the best strategy of the public sector vendors on the SaaS subscription side, so I can imagine how that's going to be a benefit to you going forward. I guess, one of the things I was interested to learning about more is on your perspective of how the pandemic can create a more competitive advantage for Tyler even going forward. So if we look back at the business in 2012, when I first started covering the company, the one item that really stood out was how you all continue to press on the R&D accelerator during the financial crisis. And that really changed your competitive positioning in the public sector market. Your win rates went from, my guess, was maybe 20% to 25%, especially in your ERP Munis product, up to oftentimes 65% or 70%. But I guess as we look 3 or 5 years down the pipeline, can the recent events over the last year maybe drive some sort of other differentiation based on what you're doing today?

Yes. I think there are some parallels there. We talked about it kind of early on in the recession -- or in the pandemic, but parallels to the financial crisis and the recession over a decade ago. We're certainly a much stronger company today than we were then. But even then, we were kind of the leader in the space. In many of the product areas, we didn't have as strong a leadership position as we do today, but we did have a strong financial position. We had the ability to continue to invest and maybe the foresight to continue to invest in R&D initiatives. We accelerated our R&D spend. We didn't cut back on sales efforts. We absorbed some excess costs and took a bit of an earnings hit during that period, but we thought it was important to continue to invest at a high level. And we had competitors that couldn't or didn't do the same thing, that they cut back on discretionary R&D spending, cut back on sales efforts. And just like now, the demand didn't go away, it was just delayed. People said, "I need to buy a new system, but I'm going to put it off for a year. Now it's not a good time." So we continue to invest at a high level, and we're really well positioned. We have moved forward competitively, whereas competitors had stood still or, in some cases, gone backwards. And so as things return to normal, we did see really strong gains and win rates and how our products fared competitively against key competitors. And a lot of this never -- most of those never -- we didn't go back, we didn't give that up. Those were sort of permanent changes, and some parallels today, I think, this seems to be likely to be a little bit faster recovery. But we have, as you know, really elevated our R&D spend for the last several years, and that was also the case going into last year. We had expectations for low double-digit organic growth last year, that didn't turn out to be the case. We had low single-digit growth. But we continued all of our strategic initiatives, all of our investing. We've actually accelerated our investment around the move to the cloud and devoted more resources to that. So we think we've continued to move forward, and we have competitors who, indications are, haven't been able to do the same thing. We've got some private equity-owned competitors that are highly leveraged that were -- appears to be more affected by the slowdown, and that likely affects their ability to make those kinds of incremental investments. So we feel really good about the way our positions continue to move forward. We've done 1 large and a few small acquisitions during this time frame, and we still have a very, very strong balance sheet with a relatively modest amount of leverage and great cash flow. Last year was a record cash flow year for us. We continued that in Q1, with record Q1 cash flow. So we've got a really, really solid foundation to continue to move forward, and that seems to be the case through this last year.

It will certainly be interesting to see because, like I said earlier, it -- the financial crisis was a great kind of catalyst for the business based on your decisions and certainly expect something similar here going forward. Let's move to the acquisition. You've alluded to it a couple of times. You acquired NIC, ticker EGOV, for those that aren't familiar with it. Not a small acquisition, certainly your largest ever, mainly, I guess, constructed with debt, which is not surprising because you've certainly done that before, especially with New World Systems. But you've -- you being Tyler have historically sold most of your software to local governments, cities and counties, some of the Courts & Justice certainly was at the state level at times. But that kind of revenue mix or sales mix really started to shift a couple of years ago when you acquired Socrata and MicroPact that had more of a presence, especially on the state levels. Besides giving you more access at that state-level government, what did NIC bring you strategically?

Yes. NIC, as you said, is the largest acquisition we've done in our history, a $2.3 billion purchase price, and I see was north of $400 million a year in revenues. It's the first time we've acquired a public company, so it's a little bit different process for us. They're actually, in terms of their relative size to Tyler, it's pretty similar to the size New World was when we acquired it 5 years ago, around 20-ish percent of our business, maybe a little bit bigger for NIC, but on a relative basis, similar. NIC is almost totally complementary to us. We don't really overlap much at all either in our products and offerings or in, as you said, the levels of government that we serve. Tyler's revenues, for example, we're about 84% local government, cities, counties, school districts, local agencies; about 12% state governments; and about 4% federal. And most of that federal and a good portion of the state came within the last 3 years through those 2 acquisitions that you mentioned. NIC is about 95% state government and about 5% federal and almost no local presence. So there's a big difference in terms of our focus on levels of government. And whereas Tyler is really focused on the back-end software, the application software that runs these essential functions, NIC is really more on the front end. They provide the digital access to government, so they -- generally through these state-wide enterprise contracts. So they have relationship with around 30 states, where they provide the full range of digital access to these back-end systems at the states, whether it's a driver's license system or motor vehicle registration or licensing system or outdoor recreation, having the fishing licenses, literally hundreds of different back-end applications. And often, those are running at the state level on these kinds of mainframe systems or all kinds of different back-end applications. But NIC provides the digital portal, the state website that allows -- and they build these interfaces to these back-end systems so that people, businesses or citizens can transact business with government. Some of it is citizen-facing, some of it is business-facing, about 25% of their business is for -- is from providing access to driver records for insurance companies to set insurance premiums. So they facilitate that with a number of states and collect revenues from the insurance companies for that. And they have a big payments business. So they generally are processing the payments that are associated with all these transactions at the state level. Their model is really recurring revenue model. It's -- although it's not selling software, it is really a transaction-based model. So in a lot of -- or in a number of ways, it's very similar to our e-filing model. So they don't typically get a check or get paid by the government, they get paid by fees related to the transactions, $2 to renew a license or something. And they get payment or fees associated with the payment processing as well. So they're about 95% recurring revenues. It's not contractually recurring like a SaaS software contract, but it's very highly predictable. The volumes are -- tend to be very stable. They tend to grow kind of high single digits around same-state contracts. And so it's a really complementary revenue model to us. From a strategic perspective, so what we -- what it brings us, really, a couple of primary things. One, as you said, a lot more exposure to the state governments, where -- and federal, where we look to grow our business. So what we believe is that we have a significant opportunity to leverage these very deep, often decades-long relationships we have -- that they have with state governments to be able to sell Tyler software into those opportunities as these back-end systems age, as they need to be replaced at the state level. Through the relationships that NIC already has with the CIOs and all of these agencies, we believe we have products, such as our MicroPact low-code development platform, that serves a wide range of state applications. Obviously, we have business in the courts and in the property taxes at the state level, licensing and permitting. And so we look to leverage those NIC relationships to extend our software business further in the states. The second big opportunity for us is in payments. NIC is much, much bigger and more mature than us in the payments business. And we've talked about over the last year or so the importance of what we believe is a significant opportunity in payments at the local level, so being able to provide more payment services, participate in more of the payment streams to our local government customers that use our software. And for us, that's been a fast-growing business, but still pretty small. We processed about $3 billion of payments for our customers last year, mostly utility bills and traffic tickets, and had about $30 million of revenues associated with that. NIC processed about $24 billion of payments last year for their state customers. And they, actually, second half of last year, signed a contract with the State of Florida, under which they'll be providing all of the payment processing for the State of Florida, which will come online late this year. But ultimately, Florida has north of $50 billion a year of payments that are running through there. So they have a much more mature and robust platform, a lot of capabilities that we would have looked to build -- to be building out in the future that come through that. They've a lot more experience there. And so we look to use their platform and their capabilities to expand into our local government market and to be able to accelerate the growth of our payments business.

Got it. One thing on the NIC acquisition that I thought interested me is how their software is developed and deployed. And you and I have obviously discussed this a couple of times. But Tyler, historically, has always, for those that are less familiar, not wanted to get involved with any sort of custom software, wanted to be something more off-the-shelf, readily deployable. Obviously, there's some customizations in your perpetual product at times to some of your larger customers, but not, yes, a fully custom solution. And if you look at NIC, historically, a lot of their software, even though their revenues might be recurring, the implementation and the development of that has a much heavier custom component of it. How do you maybe productize that or streamline that going forward to reduce some of those costs and some of those implementation kind of hurdles that get in the way at times?

Yes, each of their states is somewhat different. And I'd say they're not really building a lot of custom software. But they're building custom interfaces and, in some cases, building software around a solution for a state. They have sort of a consistent framework, but there are differences from state to state. And they have upfront costs as they go into a state or as they expand with more and more applications or services within a state. They have, certainly, over the years, had a focus on trying to standardize that more. We believe there are some opportunities to use some Tyler software products, including our MicroPact entellitrak platform, to help facilitate that standardization that will certainly be a focus of ours. But yes, there's -- those differences from state to state have, I think, limited a little bit their ability to really sort of be the same or have a consistent -- or leverage some of those development efforts. And that's not -- that's an area that we're looking at pretty closely. It's still pretty early, we just bought them a couple of weeks ago. But that was already a focus of theirs. That's certainly a focus of ours. And as we move down in more opportunities in the local market with payments, that's also something we'll be looking at. In addition to their -- these sort of transaction-based services and payment services they provide, they have, over the last few years, started to build some vertical software products that would be more like Tyler. They really have 4 areas that they've -- have products that they've either built or acquired. They have a pretty strong position in the outdoor recreation, so hunting and fishing licenses, parks and campground reservations, those sorts of things. They have a cannabis licensing business that came through an acquisition. They have a prescription drug monitoring software solution that's used in several states. And they have 1 other, but just kind of 4 major software products that are still a small piece of their business, but that are expected to grow. And we believe we can leverage our sales organization to help that happen.

I can't believe you don't have all the answers yet, even though you only had the asset for 3 weeks since.

More work to do.

Yes, maybe just a little. But kind of along those lines is, I know you haven't given any guidance yet on NIC's impact to your '21 business model. But if I look back at the New World acquisition, the company increased its R&D expenses roughly 2 points of revenue annually for integration work and the start of your broader Connected Communities strategy. You talked about MicroPact and a couple of other platforms that should be able to integrate well and maybe take over some of this functionality. But should we expect a similar type of spend step-up on the R&D side, do you think, with NIC? Or are those increases maybe a little bit more modest than 2 points?

Yes. I don't think you should expect to see a significant step-up in our R&D specifically around NIC. NIC already has their R&D built into their model. There's not really a lot of integration. With New World, for example, we had to build integrations between their public safety system and our Courts & Justice system. So there was much more of a product integration aspect to that acquisition. In the case of NIC, there's not really that. Over time, there will be -- they already integrate to some Tyler back-end products. They're integrated with Socrata, for example, in a number of states where we have common customers. But there's not a big software integration between Tyler products and NIC's front-end. So I really wouldn't expect to see that at the level that we saw, for example, with New World, where there was -- and then with New World, for example, we were also migrating that, upgrading the product. We had significant investments to expand the functionality of that product to serve larger governments and larger agencies. And so we don't really have that with NIC. So a little bit different approach here.

Got it. One more for me, and then, as I mentioned, happy to take any questions from the audience. Just put those questions in the Q&A box in your presentation window, and we're happy to take that. I think last -- in the pandemic as your, I'll call it, new Public Safety platform that the company released in the fall of 2019. I know that you all were pretty excited about from the years of that R&D spend, I mentioned, on New World Systems, to kind of roll this out to the market. I thought it should have been well positioned to take advantage of some strong seasonal public safety spend in the second half of '20 as we got into those sales cycles, but obviously, the pandemic slowed that a bit. But what should we expect to see from this product set area over the next couple of years with the New World platform?

Yes, their -- it did push out our sort of our momentum a little bit, but we've made significant investments in the Public Safety product. That was really part of the strategy we talked about when we made that acquisition. And over a 3- or 4-year period, we've made a lot of investment aimed at both increasing the functionality and the features around sort of the core business where New World was typically focused on sort of the mid-market, and adding the features and functionality that we needed to compete effectively at the highest tiers in the public safety market and to compete for bigger clients. Also have investments going on there around SaaS capabilities, even though the public sector -- safety market has been slower than the other markets to move to a SaaS model. We still believe that, that will be the future of the product, and so we're getting out ahead of that. We also did a number of small acquisitions in the public safety space and have added complementary products like SceneDoc, which is a field incident reporting sort of mobile capabilities around that. So we've done several small acquisitions that have further strengthened our overall product suite. And so yes, really, as we kind of came out of 2019 into 2020, we were starting to see some of the positive impact of that. We were starting to win some bigger deals. We've won a couple of Tier 1 deals, notably Jacksonville, Florida, which is a top, I think, the 12th largest city in the country. So we have had some success and wins. We've been able to respond. That is the one area where -- that sort of bucked the trend last year, where we responded to a higher level of RFPs because we were addressing a broader market than we had historically and seen some success. But a lot of those processes slowed down, along with the rest of the market last year. And so typically, the fourth quarter is pretty big for us in public safety. It was still a good fourth quarter, but didn't have the same kind of bookings that we would have expected. But those deals are still in the pipeline, and we're looking forward to a strong 2021. There's a lot of activity in the public safety space, and we feel really good about the product set. The early implementations are working really well. And so we would expect, over the next 2 or 3 years, to continue to build on that momentum and to see public safety really sort of growing above Tyler's core growth rate. So a little bit of a pause there, but still a lot of momentum and very positive for the public safety outlook.

All right. It looks like we'll take a couple from the audience here is -- the first one is on go-to-market strategy. How does the NIC acquisition change your go-to-market strategy, if at all?

It's not really a change. I mean what we're working on now is we go to market primarily through a direct sales organization, don't have a lot of partner sales other than with MicroPact in the state and primarily federal market where we do have a pretty well-developed partner network. NIC -- what we are working on is really how our sales organization and NIC sales organizations work together. And right now, there certainly is an abundance of ideas and opportunities for us. And our focus, really, is on prioritizing those and determining -- don't want to just scatter shoot, but really want to have a focused approach and identify those with the highest potential to really execute on the strategy I talked about earlier in being able to leverage the NIC relationships to sell more Tyler software into the state governments. So those are all underway. It's really more about cooperation and a joint sales effort going forward, but it really doesn't change how we go to market.

Great. Last one here is on your current M&A appetite. Obviously, you spent a lot of cash on this transaction. Should we expect the company to be further acquisitive here over the short term?

Yes. I would say, we believe there are a lot of opportunities in the M&A market. We have done -- on March 31, actually, we did 2 other acquisitions, much different size. The combined purchase price of about $12 million for those 2, but they were more a typical tuck-in acquisitions. One was a small company that provides software for administering veterans' benefits, and that fits in with our MicroPact platform. And the second was a company called ReadySub that provides software that schools use to administer substitute teachers, schedule them and work through that whole process, and that fits in with our other offerings on the administrative side of schools. We still have a number of opportunities that we're talking to. I would expect that, this year, we'll have other acquisitions. And I don't think, in the near term, we'll see anything near the size of NIC because we really have a lot of focus on -- a lot of work to do there in terms of just organizational integration, all the kinds of things that we'll look to do over the next year, things like benefits and IT and systems and those sorts of things. But we've got a super strong balance sheet, even with the debt we took on for NIC, and we had 0 debt before that. But on a net leverage basis, we're just barely above 3x adjusted EBITDA. And with our combined cash flow, we expect to delever pretty quickly. We've got $500 million in cash or well north of that. So we've still got a lot of flexibility to be able to pursue acquisitions, where we find things at reasonable values and that fulfill a strategic need; and as well as to continue to make all the investments we need to make internally, particularly around our accelerated transition to the cloud; and to buy stock back, when those opportunities present themselves as well.

Sure. Well, I want to thank everyone for joining us this morning. Good luck, and enjoy the rest of the conference, everyone. And thanks so much to Brian and to Tyler for joining us. We highly appreciate it.

Thanks, Scott.

Thanks, everyone.