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

It's Kirk Materne with Evercore ISI. Thanks for joining us for a fireside chat with Brian Miller, CFO of Tyler. Really excited to have Brian here with us. Obviously, Brian, the company just closed the NIC deal. Brian and his team gave some new guidance yesterday. So there's a lot to talk about. [Operator Instructions] And we'll go for about 25, 30 minutes and then I'll open it up to Q&A, if there's any out there, and we'll go from there.

But Brian, thanks for joining us. Nice to see you virtually. A lot going on for you over the last 6 months, if not a little bit longer since you guys announced the NIC deal, and you guys gave new guidance yesterday or updated guidance, rather, with the deal closed. I guess just maybe to start, was there anything sort of surprising as you went through the final closing from a positive/negative perspective, things were surprising? Frankly, I thought the guidance seemed about in line, I think, with what most of us were expecting because both companies were obviously public. But anything you would add on that front, that was kind of interesting as you closed up the deal and you're able to sort of get your hands around the data?

Yes. I don't think there were any really big surprises. There was a long time leading up to, it's the first time we acquired another public company. So that was certainly a different process and a lot of nuances around that. But I guess, for the good, there haven't been any major surprises. We -- I would say as we have worked through the sort of developing the -- fleshing out the strategy and how we're bringing these companies together and what the opportunities for us as a combined company are, that we've been pleasantly surprised that there are more opportunities and deeper opportunities than I think either of us realized. It made a ton of sense from a lot of perspectives, bringing together 2 companies, both exclusively serving the public sector, but really serving different areas of the public sector. We're about 84%, 85% local government. They're about 95% state government, and we both have a small federal presence. And then what we provide to governments is very different and -- but very complementary, whereas we provide the back office essential systems that run applications, and they provide more the front end digital presence and payment processing that goes with that. So we continue to uncover and develop a lot of opportunities where we've not been surprised around the cultures of the companies, which are very compatible. That was a big factor in us making the decision to approach them and ultimately consummate a transaction. And I think from their perspective as well. So very similar cultures, super impressed with their team, deep leadership. The CEO retired Harry Herington, at the time of the acquisition, but they have a very deep team with a lot of experience that continue to impress us the more we get to know them. And so a lot of activity taking place since the acquisition, but both sides of the deal are very excited about how we move forward.

Yes. No, I thought -- as mentioned before, we came on. But I got the presentation yesterday that you guys outlined a lot of the synergies, revenue synergies in a little bit more detail was really helpful. So maybe can you walk through some of those just when people think about I mean Payments, when you think about sort of the master service agreements they have on the state-wide level? And kind of how do you think the cadence is in terms of when you might start? What are the ones you think you can see sort of a more immediate uplift on in terms of 1 plus 1 equals 3 context? Or where are the ones that are going to take some -- a little bit longer sort of to get your sales orgs together, match up with RPs, things like that?

Yes. Certainly, one of the highest priorities is getting our sales organizations working together. And sort of the precursor to that is what we're doing right now with in-depth meetings, really sort of educating the NIC teams about what Tyler products -- what are all of the Tyler products, and there are a lot of them. What they do, what applications they have to the NIC customer base and how we can drive those more deeply and us learning more about what NIC does, how their relationships work and what their customers need. We -- there's really kind of 2 major opportunities. One is for us to sell Tyler software products into the NIC customer base. And as you noted, they have these very comprehensive enterprise contracts with 28 states, and they provide -- really under those contracts, they tend to be very broad, and they have the ability to provide broadly digital government services. Most of what NIC does today is providing that front-end access to these myriad of systems at the state level. So to enable citizens and businesses to transact business with government, whether it's renewing a driver's license and insurance company accessing driver's records to set rates, getting a hunting and fishing license, making a park campground reservation, any kind of interaction you would have with the state customers would come through the NIC portal. And in most cases, NIC is also facilitating the payments that accompany those transactions. So providing the payment processing. They typically do not provide the back-end systems that actually run those applications. They have a handful 4, 5 applications that they have acquired or developed sort of as an outgrowth of those contracts, some around prescription drug monitoring, outdoor recreation, hunting and fishing licenses and campgrounds, those sorts of things. But generally, they're providing access to other people's back-end systems or custom systems, legacy systems. So the opportunity is for Tyler to have a bigger presence in providing those back end systems, as the opportunities come up as those systems, many of which are aging systems as is common across government. So if those need to be replaced, we have an opportunity under those contracts, we think, in many cases, potentially to have sole-source opportunities. And certainly, to have -- sort of get a quicker look at those opportunities as they come up to be able to get in there sooner and to provide those systems. And as I said, NIC had 4 or 5 of those. We've got a whole set of applications that some of which are currently running in state environments, but many that are currently running at the local level, but could have applicability at the state level. So that's one of the opportunities. And we've already identified more than a handful of those that we're actively pursuing. So that's -- but those will play out over time. Right now, it's a lot of education. There are some specific opportunities that have come up where NIC customers are looking for solutions or might have already been engaged with a Tyler -- with Tyler on a potential solution, and now we can potentially run that through the NIC contract vehicle. So -- but those will play out over time. There's opportunities, as you know, from covering us. Our markets tend to move slowly. Their purchasing decisions are long. Sales cycles are long. So hopefully, we can quicken those. But that's something we'll continue to see. The other big opportunity is really on the payment side, where NIC has a substantial presence that really is sort of the leader in government payments today. Last year, NIC processed about $24 billion of payments for their customers. Many of those are customers who have their portal and where they provide their state enterprise services, but they have a couple where they just provide payment services, Texas being the biggest. And then late last year, they signed a contract with the state of Florida to provide all of the state government's payment services. And that will add another $50 billion of payment volume to what they're processing. And that will start to take effect towards the end of this year. By contrast, Tyler is a much smaller payments business, although one that we've talked about for a while that, that's something that is strategically important to us to grow. Last year, we processed about $3 billion of payments for our local government customers, much more fragmented customer base. Most of those payments are around systems where Tyler has the back-end system, utility bills being the biggest traffic where it also being one where people are paying their traffic tickets online through the Tyler system. So the opportunity really is to use the NIC platform, their technology, their scale and their experience, to drive our payment -- the Payments business at the local level to drive growth in that much more rapidly than we would have done on our own. The technology and the platform, we're really good at the portals and the front end, having the portal into our systems, but they're really good on the payment processing side. And so a lot of what NIC already has in terms of technology and capabilities or things we would have looked to have built out over the coming years and particularly to be able to move beyond just providing payment services around a Tyler system, but to do an enterprise payment platform for a local government like they do at the state level. And that is an opportunity we believe we can take advantage of more quickly that we can start -- we already have the relationships with the local governments. In many cases, the local governments have very fragmented payment strategies of their own or relationships. And so we believe it's a compelling proposition that saves money for the local government, provides them with a great platform. But NIC didn't really approach the local government market because it's so fragmented, and they didn't really have the relationships there. So we're -- that's something that we believe we can start to see progress on more rapidly. I guess the other thing is really sort of around -- it's sort of a combination of NIC contracts and the Tyler -- their payments. Florida is a really good example. We talked about that on the guidance call yesterday. So the Florida contract that's coming up, NIC will provide the statewide payment processing for the state government, state agencies. That I think will generate somewhere around $5 million a year, $5.5 million of ARR, kind of when it's fully running, and they record just on a net basis on that contract. So that's just the piece that they keep. That contract allows them to provide payment services to local governments across Florida as part of that contract. And they have about 90, 94, I think, local governments that are currently under the state program with another vendor that presumably will come over to Tyler. And that would add $2.5 million to $4 million in ARR. But Tyler has another 400 local government clients in Florida. And if we can bring their payments under this NIC contract, that can add anywhere from $12 million to $20 million of additional ARR. So it's really a great example of how much incremental business Tyler can bring at the local level under one of these state contracts. And that will be certainly a priority for us to pursue those.

Yes. And maybe a couple of just quick follow-ups on a few of your points you made. These master service agreements that you can now tap into, are they a huge advantage to be on one of those in terms of just the procurement process? Meaning, I think we all see this at a high level, we don't understand how the sausage is made necessarily in some of these contracts. Does it grease the skids? And is there an incumbency bias almost to them to a certain degree? I mean there is some of that in software historically. I was wondering if that's applicable to state and local or state governance as well.

Yes. That's a fair comment. Yes. I think that's a fair observation. Different processes run differently. Some might even -- even though they have the ability to sole source it under these contracts, they still might run a competitive process. It doesn't mean you'll completely bypass it. But certainly, the relationships being in there sooner, being able to presell. And then we believe, in many instances, at least having the opportunity to bypass the more extended procurement process is an advantage under these contracts. And most of those are structured such that we believe that Tyler products can roll through those contracts as with a direct purchase.

Okay. And the second part I want to ask you is sort of on -- sort of the combination and the scale that you bring to bear now with NIC and you all. Last time we went through a recession back in 2009, 2010, and I covered you. We talked about that. And one of the advantages, I think, that you really had coming out of it was that you had scale. That you didn't have to sort of retrench. And in the state and local government market, it is a very fragmented market from a technology service provider perspective. So do you feel sort of the same thing coming out of this? I mean you sort of just almost a bigger scale that's your ability to see deals across the country gives you a pretty big advantage on some of the more, either local or I don't know, technology niche vendors that are out there right now. And I guess the question is really about are states and local governments asking or looking to consolidate vendors. I mean it's clearly something on the commercial market. I assume it's the same holds in state and local, but sort of a few things weaved in there. So if you'll touch upon, that would be great.

Yes. I mean we really do think there is a desire on the part of many governments to consolidate some of these services and not have such fragmented sort of web of providers particularly where it's not only easier to have multiple products from 1 vendor. But the products work together and provide more value together. And a lot of that is tied up in what we call our connected communities initiative. So much from a technology standpoint of having common elements like a common dashboard or a common payments engine or security and sign on across multiple products. And we believe NIC certainly adds to that, adding the payments capabilities in their Gov2Go mobile platform, which we believe this thing kind of be the first time that we can ultimately bring together, from a citizen access perspective, applications at the federal level, the state level, the local level, including counties and cities that all could be available on 1 platform. So you wouldn't really have to figure out whether you need to go to your city or your county or the state to apply for some kind of license or conduct some sort of business. So we believe there's a value-add there. Our Socrata Data and Analytics platform that we acquired a couple of years ago, provides another layer of value there in terms of being able to take information out of all these systems and present it and make it easier for governments to analyze and make better data-driven decisions. So that's all part of it. But kind of going back to the first part of your question. Yes, I think there are some similarities. The timing is a little different. The recession 10 years ago was a more gradual decline and a slower recovery than this appears to be. But I think what is common is that we were strong then. We had a lot of scale. It's a multiple of many times that today in terms of our financial strength and the breadth of the things we have. But what we did do during that period because we had that strength, and it certainly was different than a lot of competitors, particularly the niche competitors, the smaller businesses, the start-ups or the sort of narrowing-focused businesses. Then we've had the ability to continue to invest at a high level to continue strategic initiatives. And as we came out of the recession, we had not cut back on R&D. We hadn't laid off people that we had to hire back to be in a position to deliver services or projects. And so our competitive position actually advanced during that time period, and we came out of it as a stronger competitor and better positioned to serve our customers. That's the case here as well. I mean, last year, we didn't lay off anybody. We continued to hire people. There were periods where we weren't fully utilizing everyone, but they're all certainly very busy today. We -- as I said, we continued to hire. We continued all of our R&D initiatives. We actually were able to, I think, speed up some of the projects around our cloud transformation. So again, where we sit today, I think, generally, compared -- from a competitive perspective, compared to a broad group of competitors, we're in a better place today than we were a year ago relative to the competition. Our win rates remain high. And we've got a more compelling story, and now adding NIC further advances that.

You talked about this a little bit in your comment, but the rebound you're seeing today, I think you mentioned earlier that you and NIC are both kind of ahead of your plan, what you thought coming into the year. I guess what are you seeing just in terms of procurement cycles back to -- are we back to pre-COVID? Or where are we on that front? I realize there's probably a lot going on in the summer because I think it's a lot of state and local government budget, reset the budgets at that point in time. So how are you feeling about almost the next cycle going into the back half of this year and into '22. And from a bookings perspective, it sounds like you guys are more upbeat on that front relative to maybe 3 or 6 months ago?

Yes, definitely. I think we're more -- as we look at the second half of the year, I think we're not all the way back to pre-COVID. So it's good to -- really no demand went away because of COVID. And in fact, we think there's a number of areas where demand has increased that systems that governments might have thought had -- they were old that they had years of service left in them, had proven not to work effectively in a remote environment, mainframe system that work has to be at their desk at a terminal tied to the mainframe to make it work. So those cracks and flaws have been exposed. And I think there's a -- there will be some systems that will be replaced sooner than they would have otherwise. But that's likely as we move to the second half of this year and on into next year, when we'll see the impact of that. We thought that generally, our customers are buying a new system or subscribing to a new system because their old system is dying. It's really at end of life, and they've used it as long as they can. And so that's not really affected by all of this. What we saw was that sales process has slowed down. There were pauses as governments figured out how to work remotely. As they said, "Well, I've got this RFP out there, but I want to wait until you can come and do the demo in person or to like and do site visits." When that didn't happen, we started to see things start moving again. Late-stage deals moved pretty well last year. They were already budgeted. There is already momentum around those. But early stage deals certainly took some pauses. And that showed up in activity, in RFPs, in demos, those sorts of sales process activities in the second half of last year. And given that our sales cycles are typically 9 months to a year for sort of a normal deal that showed up in bookings in Q1, and I think there'll probably be some impact in Q2 bookings as well. But that stuff is still in the pipeline. And I think the key is really now it's starting to move again. So clearly, although RFPs and demo activity is not all the way back to pre-pandemic levels, it's definitely kicked up from where it was in the second half of last year. And so we're seeing, certainly, a good trend for a couple of quarters here, and our activity trending back to normal. I think the other thing besides just the disruption was that governments, even if they had new budgets that went into place last July, they didn't have a lot of confidence in those. They had a lot of concerns about what revenues were going to be, a lot of extraordinary expenses around public health, public safety that they were seeing. And so again, they didn't have a lot of confidence in those budgets. And so that led to some delays as well. I think as it turned out, revenues generally weren't as affected as they might have feared. We saw some research that sit at the state level from I think April through December, revenues were only off about 2% compared to 2019. Extraordinary expenses were there. But now that the second round of stimulus is coming out, that stimulus for state and local governments is quite a bit more than the actual impact of COVID was. We've seen a study that said the impact of COVID on the '20 through 2022 budgets, fiscal budgets for state and local governments was about a $56 billion shortfall. The stimulus is about $350 billion for state and local governments to be paid out. Some of it now, some of it next year. But they got until the end of 2024 to spend it. And another, I think, $167 billion for schools. So a lot of money that will, I think, in some cases, help them replace some of these systems and some of their IT infrastructure, but also just generally gives them more confidence in where they stand with respect to budgets. And as those new budgets in a lot of jurisdictions go into place July 1, I think it's going to be against a much more optimistic backdrop. And we expect that to, again, as we move into the second half of the year and on into next year to have a positive impact on the business.

That's great. The other question I want to ask was just where are we from sort of an operating leverage perspective? I realize NIC moves a lot of things around. You guys have actually done a lot of M&As. As you mentioned, you haven't stepped off the gas pedal in R&D, which I think was the right move. You've I think rearchitected your GUI a couple of times to try to create a better look and feel, more modern look and feel. So I mean, all of the right things to do from a long-term growth perspective. But with NIC, are you now at a point where sort of you're in a better position to show more, I guess, consistent operating leverage? And I'll leave the M&A stuff out it. So if you do a small deal, I realize that might tweak it a little bit one way or the other. But are we through -- and look, you did all this way, you're also shifting to more of a subscription model, which isn't super helpful in that front, too. So -- but are we at the end of that kind of phase where margins are going to kind of have to take a backseat to some of this, where going forward, they should kind of have a little leverage along with the growth, with the top line growth?

Yes. We really think so. For a long time, we have very consistent margin improvement as we scaled and as we grew. We really took a step back from that in 2018, 2019, when we really ratcheted up R&D, some of it around acquisitions, some of it in response to not being able to buy where we wanted to at a reasonable price, and some of it around the cloud transition. So we increased R&D by roughly 30% in each of those years. We expected as we came into 2020 that we sort of have flattish R&D and that we would have flattish margins. And that then in 2021, we would start to get back on that cadence of margin improvement that we have seen for a number of years and generally thinking about something in the 50 to 100 basis points of operating margin improvement a year as an average -- an ability to accelerate that perhaps as we sort of move through the cloud transition, which does have a little bit of a margin headwind in the short term, but certainly a long-term margin tailwind. COVID sort of messed that up. It -- actually it improved our margins and led to some pretty significant improvement in margin, some of which is sustainable, particularly as we deliver more services remotely and do that more efficiently. I think that will stick around a lot of our business. Some things will return like some of the travel, health claims have come back. So the net-net is we ended up at the end of -- or we expected the end at the end of '21, maybe a little bit ahead of where we thought we would have been pre-COVID. But then I think things sort of normalizing that we get the COVID ups and downs out of the model and that we are back on a margin expansion trajectory. NIC's margins are a tick lower than ours, I think, for this year, excluding there are some COVID-related initiatives that are winding down, but those were lower-margin businesses. Excluding those, I think, for this year, they're about dilutive to our margin by around 60 basis points or something like that. But we do believe that the combination of the companies will lift both companies' margin profiles that we can -- there are certainly some initiatives around standardizing some things, some of those using our MicroPact platform around NIC's development activities. We believe that adding more of the payments business will -- those are relatively high margins for Tyler. And so we do believe that we kind of get back on a more consistent margin increased trajectory as we move through this year into the next couple of years.

Okay. That's great. We've about 8 minutes left, if anybody has a question, please feel free to shoot it over. Otherwise, we've got a couple of last ones, and we'll let Brian go. But I guess the next one for me, Brian, would be I got 2 floating in my head. I guess, first, maybe on the NIC deal, just to sort of toggle back to that for one last thing. Were there deals that you felt like you weren't seeing that you feel like you'll see more of? I mean in the public sector, it's a little weird because most things have to be sort of public RFP and things like that. So I'd imagine you weren't missing many, but I was kind of curious it's such a fragmented market. Maybe that's not a correct assumption.

Well, yes, I don't think in our core market, certainly, at the local level, certainly where we have existing products, most of which have a leadership position that we missed many deals. But -- and actually, today about -- in the traditional Tyler business, about 1/3 of our business takes place without a formal RFP in the sole-source model. Generally, they're piggybacking off another Tyler product that they already have or off of the state contract. But in terms of broadening our market and really expanding our presence both at state and federal, that's where I think NIC really adds benefit to us. And to some extent, MicroPact, we did an acquisition of MicroPact 2 years ago. That was really kind of our first entree into the state and federal markets. They're about half state and about half federal. And actually they -- that business unit really championed the NIC acquisition as an ability for them to drive their state and federal business. There'd probably be the shorter term beneficiary where we have products that slot in. So I think -- and we said, we didn't buy MicroPact for that to be our only presence in state and local, and NIC -- state and federal. And NIC certainly advances that and I think we'll continue -- it really gives us an opportunity to grow those businesses faster. And as we said on the call yesterday, I wouldn't be surprised that we look in the future at more acquisitions in some of the application software products that are focused on the state and federal markets in addition to what we already do in local.

Okay. That's helpful. Last one for me. Where are we in the state of sort of the cloud transition in state and local government? For a while, it's almost like they had to have you hosted because the person who understood the system retired. So it's almost like a demographic shift as much as it was anything else. But you obviously partnered with AWS now, which I think probably adds a lot from just an infrastructure perspective. Where are people on that front? Is -- I assume it's still a sort of customer-by-customer discussion. But has this made people more, I guess, willing to have the conversation around cloud and hosted versus a couple of years ago? I assume those could continue anyways, but has it accelerated, I guess, is the question?

Yes. It's absolutely accelerated. And I think 2019 was the first year that more than half of our new business came to us through a subscription model on the software side. That has continued to accelerate and much more rapidly. It took us 20 years to kind of get to that point in offering a hosted solution on a subscription basis. And we have shifted from being sort of cloud neutral or cloud agnostic and letting customers pick, whether they want to be on-prem or in the cloud to really being cloud first. And so we're helping push that. But certainly, the market is moving that way. COVID also had a role in accelerating that where, like I said, a lot of systems didn't function -- on-prem systems didn't function effectively or have the capabilities for remote work. Security concerns is certainly another driver where they have concerns about being able to maintain the security around their infrastructure and feel more comfortable in the cloud and in the public cloud. Our relationship with AWS gives us the ability, certainly unlimited capacity to move customers to the cloud. We talked about the product transition. So we're going through a lot of our products, our core products were built to be deployed on-prem. So they're not in a cloud or a hosted environment, they're not super efficient. And so we have projects underway to either write those products or rewrite them in a cloud-native environment or at least modify the products to be cloud efficient to be deployed at AWS. And we said, we expect that to be the case for all of our major products by the end of 2023. And -- but this year, yes, some of our products where we expected, for example, around our higher-end ERP products. It expected to be maybe in the 60% range in terms of cloud adoption this year, we were closer to 90%. So it's been a pretty fundamental shift. Public safety is probably the 1 area that's moving more slowly. But that we're also migrating our products to the cloud there, and we expect that will follow along as well.

That is super helpful. I think we have a couple of minutes left, but I think I'll just end it there. Brian, thanks for joining us. Congrats on getting the NIC deal over and done with. A lot going on at Tyler right now. So really exciting. Glad to see how well you all are doing. I remember when we first started covering you all. It was a lot smaller, a lot different company. So it's been great to watch your progress over the years. So thanks for taking some time to meet with us. And I hope everybody else has a question. And I guess, if there's any follow-up questions, please feel free to reach out to Brian and Hala in IR. You can reach out to me, and I can route you to them. So have a great afternoon, everyone.

Thanks a lot. Appreciate it.