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

[Audio Gap] to host you, given your and Tyler's like long history in the public markets and our limited time here today, I'll just kind of probably skip over the traditional kind of introduction of the company and maybe kind of get like more into some more kind of actual topics. I guess with that in mind and as we're kind of sitting here exiting the majority of the second quarter earnings period, I think one of the very relevant themes that has been kind of pervasive is the reemergence of kind of the back-office technology centers. You saw Workday, Anaplan, Coupa all have kind of very strong quarters on this theory that through the pandemic, maybe buying cycles were cross, but pipeline generation activities certainly weren't. And now that we're seeing kind of a reemergence or normalization of conversion cycles and time lines on a larger pipeline, you're seeing outsized bookings performance. So I guess, acknowledging that you have a very specific end market in the public sector, I'd be curious if you think you're seeing similar trends. And if not, what's specific to your market that's kind of driving your current success in the environment sale?

No, I think that is definitely similar to what we're seeing. Last year, during the pandemic, we saw pauses in procurement activities. I'd say governments in a lot of cases maybe were even less ready to adapt to shifting to remote work than private sector. So it took a little bit longer for them. They also had, in the short term, a lot of uncertainty around their budgets. They had -- weren't sure what the impacts on revenues would be. They were seeing extraordinary expenses, particularly around things like public health and public safety. So they had -- even if they had budgets in place to buy things, they weren't terribly confident in those budgets. So the underlying demand really wasn't affected. As you know, most of our customers, they're generally buying something because they feel that they have to. They've used an old system until it's on its very last legs. And it's a dying system that needs to be replaced and governments tend to use systems much longer than you see in the private sector, in part because they don't have competition and they don't have the same motivation that a private sector enterprise would have to acquire a new software for a back-office application. So the underlying demand was still there, but processes pause. And as we got into the -- so we saw a pretty significant decline in the number of new RFPs. We saw deals that were in the pipeline kind of stop moving for a while. Bookings slowed, but the underlying demand was still there. As we got into the latter part of the year, deals that were in the latter stages where we'd already been selected, we were in contract negotiations, those generally started moving again. They were budgeted already, people adapted to doing all those things remotely, and we were able to see those go. But we still saw depressed new RFP activity and new activity in the market. We've talked about in the first and second quarters, that has picked up and by the second quarter or by today, most of our product groups are seeing activity that's at sort of pre-COVID levels, in some cases, that's grown from that. I think governments in general, the budget impacts or the revenue impacts weren't nearly as significant as they feared. And obviously, now we've got a really big stimulus program coming along that is pretty widely spread across state and local governments, and it's giving them a lot more confidence in their budgets in the short term and in the long term, we think will provide us with some additional tailwind.

Let's maybe double click on the CARES Act or the fiscal stimulus, things like that. Is this a future benefit? Or is this something that you're actually seeing influence deal cycles today? And have you done any work around kind of like maybe like how much budgetary impact on average this is kind of benefiting your end clients?

Yes. I'd say, first question, it's more of a future impact than the current impact. I'd say the current impact is more -- it's giving them confidence to move forward with projects that were already in the pipeline or already on the table. So I don't think we've seen a lot of new opportunities emerge because of the stimulus. And there were kind of 2 pieces. There was the CARES Act last year, which in our space, has really provided funding for states and for large cities and counties. So it was fairly limited. It was fairly restrictive in terms of primarily being used to offset sort of direct COVID impacts. The American Rescue Plan, which is the newest round of stimulus is much larger. It's $350 billion for state and local governments, $167 billion for schools. There's some other cybersecurity funds and unemployment funds. But those direct federal aid, It's much more broadly distributed. So it really goes to almost every state and local government in different amounts. And it is much more flexible in terms of what they can spend it on. And certainly, IT, infrastructure and IT -- the kinds of systems that we provide are well within the bounds of what they can spend it on. They have until the end of 2024 to spend the money. They got half of hit this year, and they get half of it next year. And so right now, I think a lot of governments are figuring out internally what they want to spend the money on. I think there's clearly been an expectation or a sense that -- or greater awareness that IT -- upgrading IT infrastructure, including aging systems, a lot of which haven't performed well in a remote work environment over the last year where unemployment systems were overwhelmed, where court systems couldn't function because they were a mainframe system, and the employees couldn't come to work at the courthouse, so they were sort of dead in the water. So I think there are a lot of potential opportunities that are emerging. I think you'll see those play out in tailwinds over the next 2 or 3 years really as governments decide where to spend them and what their priorities are. Certainly, our people, especially our inside sales teams are very actively engaged with our clients on pursuing opportunities for additional sales into our customer base and as well as with new customers. So I think it's a longer-term opportunity, but one that I think is a real -- a very real opportunity for tailwinds over a longer period of time.

Now historically, you've always talked about your sales cycles really like unlike maybe a commercial company signed to like a traditional enterprise, your market tends to buy when the systems are broken or are end of life, right? And that's when your opportunity comes about. Does the current environment -- I think you could argue the current environment is maybe kind of like accelerating some end-of-life discussions on systems, the way you described the market. But I'd also be curious, do you think that this additional budgetary benefit might kind of lead to a more traditional kind of buying cycle where state mobile government entities aren't just buying what they have to, when they need to, but they're actually thinking about modernization...

Yes. I think that's exactly right. I think some of that was already occurring where governments are thinking about things a little differently and a little more strategically and maybe a little bit more like a private sector enterprise would look at things. And you think about examples like our Socrata Data and analytics platform, which is a very sophisticated platform aimed at -- that sits on top of Tyler or other systems and provides access to data that are sort of in these siloed systems and lets governments make, one, provide it transparency to citizens and others; but also gives them better data to make better decisions with business intelligence, which is a concept that may be newer to government, but not a revolutionary concept. I think in the past, a lot of governments have thought about that as a nice to have, but not something they have to have. But increasingly, and I think accelerated by the pandemic and by some of the challenges they had to face, they realized that having better data to make better decisions is kind of a have to have. And that -- and having additional funds to be able to add a product like our Socrata platform is something we're seeing a lot of activity around. So those kinds of things that could either be add-ons or those sorts of applications, we're certainly seeing a lot of interest around.

Okay. Last question on the demand environment, then we can kind of move to other areas. But I can't help but make at least some sort of analogy to the recessionary environment when you saw a multi-quarter kind of slowdown in bookings, but then a rebound that kind of allowed you to outperform your kind of midterm or long-term kind of expectations historically. I'd be curious do you think we're in for a similar demand period? And any thoughts on how long that period could last? Just drive the parallels there.

Yes. We think there are a lot of parallels there. And certainly, there are parallels in how we managed through the recession where we continue to make as to what we did in the last year. We continued to invest in products. We didn't cut back on R&D. We didn't lay off any people. We want to retain all of our capacity to deliver product and to continue with our development efforts, even though we saw lower revenue growth and some challenges there. So we want to be well positioned, and that's certainly the case and not necessarily the case with all of our competitors. But yes, I think in the recession, we clearly saw it was a slower process. So I think we saw 8 quarters of year-over-year declines in licenses and then a slower recovery, but a multi-quarter similar kind of recovery here. The slowdown was much faster, obviously, as COVID hit early in the year. But the recovery also seems to be faster as well. I think the big difference is -- so I do think we're seeing that now, and we would expect to see higher growth in both bookings and ultimately reflected in revenues. Today, much more of our business is coming just through subscriptions that you don't see that big license right away, but you're seeing higher growth in our subscription or ARR growth. But the recession didn't have a big federal stimulus for governments embedded in the net. And so that's a big difference here, where there are hundreds of billions of dollars being provided to governments, that gives us more opportunity for outsized, not just recovery, but higher growth on the tail end of it.

Makes sense. Let's move to kind of the other major topic of the company today, your acquisition of NIC Systems. I think it's your largest acquisition ever. It clearly moved you, I would say, like outside of maybe your core market in the sense that you're kind of moving into payments, right? I think even pre-acquisition payments was certainly kind of like a core growth area, growth strategy. So I just like asked the question like, why did you acquire NIC Systems? What do you see that the synergies are? Like what was the strategic rationale that maybe you want to acquire as opposed to kind of continue to develop internally?

Yes. NIC, clearly, our largest acquisition, roughly $2.3 billion purchase price. First time we've acquired another public company. So that was a different process for us as well. I think the big thing is that companies are highly complementary and almost no overlap other than we both exclusively serve public sector and governments. But both in terms of the sectors of government that we serve and the products or the services that we provide for government, they're very different but very complementary. So while Tyler primarily provides historically, the back-end software that governments use to run essential functions and mostly at the local level. So we're about 84%, 85% local government, cities, going school districts and global agencies at about, I don't know, 12%, 13% state and a small percentage of federal. Whereas NIC is about 85% -- I'm sorry, 95% state and about 5% federal, almost no local presence. And NIC doesn't -- they have a small software business, but mostly they are providing digital access to systems at the state level or to government at the state level. So they provide the digital front end, the website, the portals to transact business or access information at the state level through these very broad state enterprise contracts. There's 28 states they work with under enterprise contracts and a couple more that they just provide payment services for us. So think about renewing a driver's license or your motor vehicle registration or applying -- renewing your CBA license or insurance companies accessing motor vehicle records to determine insurance rates for their policyholders. Those are the kinds of things NIC provides access for. And they generally do it on a transaction fee basis. So they get a fee for renewing that license or a fee for providing access to those records. Generally, they're providing the payment processing as well and getting a share of the revenue on that. So mostly transaction-based or highly recurring revenue mostly at the state level. So really, the opportunities -- it's a great business on its own, great cash flow, really solid kind of this long-term 8-ish percent organic growth in their existing customer relationships, adding new states and adding new services within those states and growing their payment business. We believe there are really a couple of major cross-selling opportunities. One is the opportunity for us to leverage those relationships and leverage those contracts to sell more Tyler software at the state level. And we have a number of products that are -- have statewide potential applications, but Tyler hasn't historically had those relationships, hasn't been plugged in the state governments like we are with local governments. We have some touch points. So for example, our MicroPact platform that we acquired a couple of years ago, there's a fair amount of state business. But we believe that we can, through these NIC relationships and contracts, we'll know earlier about what needs state governments have because NIC has have very close relationships with the governor's offices, with the CIOs, with the agency heads, and that we'll be able to access those opportunities earlier and potentially to bypass full-blown competitive processes by leveraging the NIC contracts and selling software into those. The other side is that we believe, as you mentioned, that we've had an initiative or a goal of expanding Tyler's payment processing at the local level. So we have a lot of systems where we provide portals at the local level, things like utility billing, traffic tickets, where customers or citizens are making payments to local governments through a Tyler system. And Tyler has historically been a reseller of payment processing services and getting a cut of that, but really small penetration in our customer base. Last year, Tyler processed about $3 billion or participated in about $3 billion worth of payments. NIC processed $24 million of payments at the state level. So we've had a goal and have had a strategy of working towards expanding our payments business. But now NIC gives us a very robust platform with a lot of capabilities that we would have looked to have built out in the coming years. NIC has those capabilities. And -- so we'll look to leverage our local government relationships and bring that NIC platform in to provide processing not only for Tyler front-end systems, but enterprise-wide at a city or a county level much as they do at the state level today. We also believe that under some of these NIC contracts that local governments can piggyback. So for example, NIC won a contract late last year that will kind of go into effect later this year to provide all the payment processing for the state of Florida. And that should add north of $50 billion of payment volume to the $24 million that NIC did last year. So a big increase in volume, but it also -- under that contract, local governments in Florida can piggyback on that. And Tyler has some 400 local government customers in the state of Florida that we'll be working with to try to bring their payment processing online under the NIC contract. So there's an ability for us to take our relationships and leverage the NIC processing capabilities to greatly expand and accelerate the expansion of Tyler's payment processing.

Makes a lot of sense. I guess a couple of different ways we can go here. Like I guess my first question would be, what's the focus today? Is it integrating the companies from a product perspective? Or is it kind of cross-pollinating the sales, go-to-market structure? Or is it both? And then, I guess, since we're kind of financial analysts here, how are you thinking about this combination, you plus NIC, the impact on the financial model? You mentioned they're historically an 8% grower. Should we logically expect that to accelerate at least kind of like over the medium term given the synergies that you're going to extract? And then clearly, I think payments most people think of very different kind of margin structures than kind of historical kind of like [ SaaS heavy ]. So like, what's that impact going to be on your business as well?

Yes. It's mostly the latter. This is different than some of our other -- most of our other acquisitions where we're acquiring a software product or a suite of products that we integrate with other Tyler products. So you think back to our next biggest acquisition, the New World acquisition, where we acquired a public safety product that needed to be integrated with our courts and justice products. So a lot of product integration, a lot of investment in that software product. That's not really the case here. We're not integrating Tyler products and the NIC software products. It's more around the sales organization and building that go-to-market routine. So what's going on right now is really kind of laying the groundwork for that, and we've been going out working for a couple of months on this, where to facilitate this cross-selling, we both need to understand what each other does. So we've been doing these product showcases. So NIC has these -- each state organization is fairly independent. There's a state general manager who's kind of a combination of the sales and the primary relationship contact with the state. Customer has the relationships with the governor's office, CIO's office, agency heads and also manages the functions like the software development organization within that state. So we have been showcasing all of the Tyler products in a handful a week to the NIC organization, so they understand what are all the Tyler applications that could potentially be sold -- excuse me.

[indiscernible]

Sold into the state organizations. So what are the products? What do they do? What are the competitive strengths to our customers, to our competitors? And those are already starting to identify opportunities that where the state -- one of the state organization says, yes, we -- our customer has a need for that, that aligns with an initiative that I've got. So we're starting to surface those opportunities through that education process. The other side is on the NIC side, so we're also having -- I think we do 3 a week where we're doing showcases each for all of the Tyler organization so that -- where we showcase a -- NIC showcases one of their states or 3 other states. So what are the current relationships, what are the political considerations, what are the governor's initiatives, what are the CIO's priorities, what do we currently provide there. And so those are also helping raise a lot of opportunities. So we'll talk about something and then one of our products will say, "Hey, we're -- we have something that would fit there. We are already having conversations with them. Can you point us towards the right -- help us get in front of the right people." So right now, we're building all that groundwork and starting to build real things in the pipeline, but we're just in the very first stages. So that's the kind of the integration process that we're doing today. There's still back-office integration, our benefits plans, our financial systems. But NIC was a public company, pretty sophisticated there. So there's not a great deal of urgency around having to consolidate those things. We're able to move fairly deliberately on that kind of side of the operation.

And then, I guess, just the second half of my question, you have this kind of like framework that you've talked about for a long time where you can deliver 8% to 10% low double-digit top line growth, modest margin expansion, which yields kind of like mid-teens earnings growth and probably similar growth in kind of free cash flow, right? What does NIC do to that philosophy, if anything, over the long term? And are there any kind of near-term headwinds that we need to be aware of as well just over the next quarters?

Yes. I'd say both of those -- yes, you're right in terms of all those metrics. I'd say the addition of NIC because most of the cross-selling opportunities would be incremental to what we would have done otherwise. And we still would have sold some MicroPact products in the state governments but we would expect all this -- the relationships to accelerate all of that. We still would have grown Tyler's payment processing but we certainly expect that this will enable us to accelerate that. So we do expect that, that will be -- that these kinds of cross-selling synergies will be largely incremental to the growth that both Tyler and NIC would have had on their own. And so it's all additive. So you'd expect that we would be -- that it would push us more towards the high end of those targets or potentially beyond that. I'd say also sort of factored into that in the near term is what we're seeing in terms of some of the pent-up demand that we talked about earlier, pushing through the pipeline as well as NIC's organic growth is well above their historic numbers right now. I think we talked about it in Q2 that their full quarter organic growth was mid-teens or higher than the after teens, I think. Obviously, people are -- both want to and, in some cases, have to do more business with state governments digitally instead of going down to the DMV to renew a license, they have to do it online now. So volumes are up, payment volumes were up, I think, 15%. So we're seeing a very strong growth on their side as well. The -- so yes, I'd say that puts us on the higher end. They also had a very good cash flow characteristics as Tyler does. So I would say that would tend to put us towards the high end of our growth targets, and over time, provide meaningful upside to that. The short-term headwinds, and we've called these out, is that NIC has some fairly significant revenues from direct COVID-related opportunities around -- they have a partnership where they're providing actual COVID testing in some states and some clients as well as providing some pandemic-related unemployment services around staffing call centers and helping the State of Virginia with their unemployment volumes. All of those, we expect to go away. We actually expected them to go away sooner, but the resurgence of the Delta variant has led to those -- particularly the COVID testing revenues going on longer. They're low margin. They're kind of 10% to 15% margin revenues. So they're actually dilutive to margins. But we've -- NIC, prior to the acquisition and us post acquisition, have made it very clear, what those revenues are. We've called them out. We've talked about growth excluding those because they won't be there next year. So optically, they're going to be a headwind to growth, although the core growth is -- excluding those revenues is very strong as well. So we just want people to be mindful of that as they look out at next year, that those revenues aren't expected to be there. But the converse is that it will have a positive impact on margins.

Got it. Makes sense. I think we're at our time here, Brian. Thanks so much for joining us. Appreciate it. We'll talk soon.

Yes, thank you for having me.

Yes. Bye.

Thank you.