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

Hello, everyone, and thank you for joining us for our virtual growth stock conference and today's session with Tyler Technologies. My name is Jonathan Ho, and I'm a research analyst for William Blair & Company. With us today are Lynn Moore, Chief Executive Officer of Tyler; and Brian Miller, the Chief Financial Officer. Before we begin, I am required to inform you that a complete list of research disclosures or potential conflicts of interest is available at our website at www.williamblair.com. Lynn and Brian, thank you so much for joining us today for our conference. For those that are maybe a little bit less familiar with the company, could you provide maybe a brief overview of Tyler just to help level set the audience. Thank you.

Thank you, Jonathan. And again, this is Lynn Moore. And I'll start, and Brian, anytime, you can just jump in to correct me like you -- I know you'll do that at one point when needed. But thanks, Jonathan, and thanks to William Blair, for having us today. And Jonathan, actually, thanks to you for your long-term interest in Tyler. So at a high level, Tyler Technologies, what we do is we're the largest provider of software and services that's really 100% focused on the public sector. And that's all we do, and I think that's what differentiates us from a lot of people out there. Historically, our focus has been probably more at the local level: cities, counties, schools. And over the last couple of years, through some acquisitions, we've actually opened up state and federal markets. The solutions that we do -- essentially, what we try to provide is what we call essential functionality in the public sector. So these are all the things that are really necessary for the public sector to operate on a day-to-day basis. And they're really not discretionary items. They're things that they have to have, things they've got to do. And our solutions really encompass all major functional areas of public sector, things like ERP software, enterprise resource planning software, finance, budgeting, HR, payroll, civic services, things like permitting and licensing, appraisal and tax solutions, recording. We've got school information systems. On the justice side, we've got court case management systems, both civil case management, critical case management, e-filing, probation, supervision, public safety solutions, things around CAD, 911 and record systems corrections, jail management systems. Our state and federal solutions are solutions for agencies, things like case management solutions, things around like veterans benefits and claims processing. We also do a fair -- a burgeoning part of our business is around payments where we assist citizens and the government's public sector with online payment transactions, either things like utility bills and court fees and licensing fees, hunting, fishing licensing, parks and rec fees, data and insights. So at a broad level, those are sort of our solutions, again, 100% targeted at the public sector. We have about 11,000 public sector customers today with more than about 27,000 installations. About 75% of our revenues are recurring in nature, either through maintenance or subscription agreements. And again, I think our differentiator really is that we're 100% focused on the public sector.

Excellent. Excellent. Well, thank you for that introduction. As we start to see sort of the reopening of the economy and perhaps signs of the pipeline starting to recover, can you help us understand your philosophy in investing during the downturn? And maybe contrast that with what you've seen with competitors and what they've had to do during a challenging period.

Yes. That's a good question, Jonathan. And we kind of took a playbook from what we did back in the Great recession. And there's only been a couple of times in our market, our history, where the macroeconomic events have really impacted our business: one was sort of post Y2K; one was the Great Recession; and now, of course, COVID. And the reason for that, generally, why it's -- our market is generally pretty steady. It's pretty stable. And again, it goes back to what I was talking earlier about the fact that we provide really essential functionality. And so we knew that even though while there was going to be some impact, that demand doesn't go away. And so one of the things that we did back during the Great Recession is we actually spent that time really accelerating a lot of investments. And so when that -- when the demand eventually returned, as the markets returned back to normal, we were even in a much better competitive position than we were going into it. And our management team has been around for -- I've been there 23 years. Brian has been there 24 years. We've been through these storms. We've weathered them in the past. And I think we took some of those lessons learned. We were already going through a period of some elevated investments going into COVID. We also took that opportunity to sort of put the foot on the pedal and accelerate those investments but also accelerate our move to the cloud. And I think that was timely given that I think COVID has further pushed the public sector towards the cloud. When you talk about some of our competitors, Jonathan, we saw that during the Great Recession, some of our competitors may not have had the financial stability that we have, may not have had that recurring revenue base, that broad customer base to lean on during those times because, while new business may have slowed, they're still paying their maintenance bills, they're still paying their subscriptions because they have to stay open. They've got to keep running things. And we've seen that. We saw that back in 2008, '09, '10, and we're seeing a little bit today by what we're seeing with -- as the market is starting to return: the win rates, our competitive position and how deals are falling. So again, it's a playbook we ran 12, 13 years ago. It was successful for us, and so we've run it again.

Absolutely. Absolutely. And maybe just to dig into that point, when we think about sort of those advantages translating to win rates, what does that typically look like? And where do you see I guess, those investments that you've made sort of allowing you to now outpace the competition?

Yes. Again, I'd say it's probably no specific area of those investments. We really have invested across all of our major product lines. Again, we were -- we had some elevated investments going into COVID. And so we already had a head start on that. And -- but again, also, I think what we've been doing with the cloud and making our core applications more cloud efficient, more cloud optimized as we shift our model from what was historically more of a cloud-agnostic approach to the market to one of more of a cloud-preferred and eventually a cloud-only approach, we're seeing that the public sector is embracing the cloud more than ever. It's a process that's been evolving over the last several years. And I think COVID has accelerated it. We're actually starting to see some of that in the deals this year. I've talked about it with some of these investor calls -- meetings today. Financials is our largest business unit. And our high-end financials business, that business was starting to move to the cloud, it had -- moving that way over the last year or 2, more than 50% of our new deals were going there. But we're seeing rates now, Jonathan. We're in the -- upper 80% of new deals right now are going to the cloud. So what we're seeing is -- it's still early as the new business is coming back, but as I look at our competitive position, I look at our win rates, they're as high as they've ever been. And I think that's a testament to the investments we've been making and continue to make during COVID.

Excellent. Excellent. Well, you said that the pipeline is starting to thaw, can you talk a little bit about how the timing unfolds between when RFPs are typically issued and when that translates into bookings activity for Tyler. So what does that contract cycle sort of look like?

Yes. It's -- I talked earlier about our market business being very steady, and it is very steady. It's also a very slow-moving market, which is both good and bad. It's -- I think it's -- it helps provide a competitive moat and -- for those that have been around and established. And what I mean by slow-moving is just that, as the sales cycles move slow, they're not always necessarily looking for the latest and greatest gadget. But sales cycles will vary a little bit differently across our product lines, but it's not uncommon for a sales cycle RFP to hit the street, and it takes 6 to 9 months before that turns into contract. And that can take -- once you get a contract, it can be -- an implementation can take anywhere from several quarters. And so in some cases, a couple of years before the client's really up and running. So what that really translates to is, I think we talked about it, Jonathan, on the last earnings call, is while there was a little bit of a slowdown after COVID, because of that long sales cycle, we don't actually start feeling some of that impacts on new business for a couple of quarters. And I think we saw that even looking at Q1, and there was some discussion about bookings and bookings being down in Q1, but part of a function of that sales cycle.

That makes sense. There have been a lot of funds that have been set aside in the most recent stimulus package for technology modernization in the federal as well as the local government vertical. How do you think about that opportunity? And were there any sort of grant pools of funding that were directly applicable to Tyler that you expect to benefit from?

Yes. That's a question we get asked a lot. People worry about public sector budgets and certainly going into -- when COVID first hit, I think there was a lot of uncertainty primarily from our clients. And what's interesting about COVID, as we're coming out of it and in some of the reports that we're seeing, some of the things that you see in The Journal and stuff, is that some of the budgets, the state budgets and even some of the local jurisdictional budgets, were not impacted nearly to the degree that I think a lot of people thought this time last year they would be. And so I think when I look at this funding and the stimulus, I look at it in 2 ways. One is people -- our clients are starting to get their feet back under themselves. They're realizing that financially, they were not hit quite as hard. And so I think knowing that this funding is coming and it's there, it helps them with confidence that they can go out and make new purchasing decisions. It helps them -- as most of our clients are on a June 30, July 1 budget season, so it helps them going in there, knowing that they're -- that that's there and also knowing that things weren't as bad. When you talk about -- your question also about specific funding, there is some of that out there. For example, schools were hit particularly hard last year. That was an area of our business that was hit hard. Different parts of our business were impacted differently, and schools were certainly hit hard. I think there's about $167 billion that was set aside just for schools. I think there was well over $1 billion set for just general federal IT modernization. And I think some of that has been specifically set aside. And then you just have a lot that's just been earmarked specifically, like so many billions of dollars for this state. And they turn around and they've already earmarked, in many cases, how much specific local jurisdictions are going to get. And I think part of it is our clients trying to figure out best how to capitalize and use that. But I'd go back to my first point, the fact that it was there has really helped, I think, the morale and confidence of our clients as they continue to move forward and need to make some purchases to keep their governments up and running.

Yes. That definitely sounds promising in terms of things continuing to normalize and the pipeline continuing to thaw. With the EGOV acquisition, it seems like they are pretty complementary from many perspectives. Can you maybe give us a sense of what some of the early cross-sell opportunities are that excite you the most? And could there -- where are some of the strongest synergies that you see between EGOV and Tyler now that you've had the company for a little bit of time?

Yes. Obviously, Jonathan, you've followed us for a long time, and for those that are listening that haven't, I mean -- so we closed this acquisition, not a public company. And I see their name, their ticker was EGOV. Their primary focus was really at the state level. And that was an area that we really didn't have a strong focus in, going back a few years ago. And we really saw this as a very complementary acquisition. Certainly, it was the largest acquisition we've ever done. It was a couple of billion dollars. And they bring a lot to the table. And as I think about the opportunities there, I think one of the largest opportunities that we're focused on right now is around payments. They are the leading provider of payments at the state level. Last year, I think they've processed about $24 billion in payments, give or take. Payments is a growth strategic initiative of ours. It's something we've been focusing on really more in the last couple of years. And we, by comparison, last year, processed about $2.5 billion, $3 billion worth of payments. So they're significantly more mature and more robust. And as we think about expanding our payment business and leveraging their payments platform, I think that's something that we're all pretty excited about. They've recently won a contract in the state of Florida last year, which will get up in line -- running online later this year, to do all the payments business in the state of Florida. That's about adding another $50 billion worth of payments. That contract allows them to also do payments at the local level. But they don't really have the context at the local level that we do. And so we're already starting to see opportunities. For example, we're selling our systems, say, our EnerGov permitting licensing system. We've got clients who are wanting to add payments but also wanting to have a single payment provider. And as of today, we don't really have that full capability that they have, and so it's something that we can bring them in. So payments is obviously a big initiative. I think the ability for us to be able to bring some of our vertical solutions into the state agencies. They've got -- their statewide enterprise contracts are really we call [ fitting ] licenses. And they historically really provided more front-end solutions, and they don't really have the back end vertical-specific solutions. And so our ability to push some of our solutions in -- through those contracts is also something we're interested in. They've got a very big citizen engagement piece. And that's, as you know, Jonathan, something that's part of our Connected Communities vision, so we see that. Our data and analytics is another example of an area where we think we can push a lot of our Socrata data and insights solutions into those state agencies.

That makes a ton of sense. With EGOV's go-to market, they also seem to have a little bit of a different, I guess, maybe a stronger presence at the statewide level given that they have offices in typically many of the states that they operate in as well as these blank cheque contracts. What can you potentially learn from them? And how do you think about expanding into maybe some business areas that are different from your traditional sort of back-end core systems as we sort of further move down this acquisition path?

Yes. And you're right, Jonathan. They -- their approach to the state market has really been to put a dedicated team on-site at the state that really is -- their sole focus is really to develop and foster those relationships and then sort of do the sort of the land-and-expand approach, so get these big, statewide enterprise contracts and then be able to sort of go out and expand through different agencies. And I think as we think about sales going forward, our ability to collaborate with their sales teams, get their sales teams educated more on our products and looking for joint opportunities and then leveraging their deep relationships at the state level, to push some of our more vertical solutions, I think it's pretty exciting for us. And it's certainly an initiative. We're already working on that. Our sales teams have been meeting on a periodic basis. Right now, we're working on joint opportunities in those business drivers. So that's something that's pretty exciting for us.

Got it. Got it. Brian, I didn't want to leave you out of the conversation. And so when we look at some of the financials here, when we look at the technology investments, including the transition of your solutions to the public cloud, what does this mean from a cross-sell and potentially a margin perspective as well?

Well, from a margin perspective, I think the investments we're making in optimizing our products for the cloud -- and we really talked about that going back about a year ago and even a little further when we entered into the AWS relationship and, last year, we talked about the incremental investments we'll be making around that cloud transition over the next, say, 2, 3 years. We expect to have all of our core products either in a cloud-native environment or optimized for deployment at AWS by the end of 2023. We're largely able to do that while still maintaining our target of returning to a margin expansion trajectory. Some of that is reallocation of development resources that we've had on other projects in recent years. And some smaller portion of those investments are going to be capitalized around that cloud. But our expectation going into 2021, excluding NIC was for R&D to grow in the mid-single digits. So it's actually in line with or slightly below our overall revenue growth. So whereas those investments have been somewhat of a headwind to margin expansion in recent years, now they're -- we're able to really make those investments and still move forward with our expansion objectives. That makes sense.

As you sort of, I guess, shift over to the AWS platform, are there higher costs involved in supporting both maybe your legacy on-prem clients as well as those that are kind of moving on to the new platform? Or is this really going to be one single platform that you can get that leverage out?