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

Hi. Good morning, everybody. Welcome to day 2 of the 2021 Deutsche Bank TMT Investor Conference. We are pleased to have Tyler Technology (sic) [ Tyler Technologies ] for the next, I guess, 0.5 hour or so in a fireside chat format. Brian wants to make this as conversational as we can. We do have opportunities to submit questions on the system. Brian is the Chief Financial Officer at Tyler Technologies. He's been with the company a long time, Brian, what 1997?

Yes. 25 years this year.

Yes. And as I said, we're excited to have Brian. [Operator Instructions] My name is Sean McCarthy. I'm in the technology investment banking team at Deutsche Bank.

Let's kick it off. Brian, let's just start macro. Big theme yesterday in the conference was obviously the pandemic, and all of our hearts still go out to the different folks and areas that are still suffering from this. But as we think about maybe lessons learned, maybe start from the Tyler organization, just curious how you and Lynn and the team, how may have changed your thinking? What have you learned about the workforce, maybe about the product set? And how different might things be for Tyler in the future?

Sure. I think in a lot of ways, we're probably not too different from a lot of other companies. There are certainly other software companies. But there certainly have been some lessons learned, some experiences from the past that we were able to apply and some changes that I think will be long-term changes. I think one of the things that we've talked about is that Lynn and I and John Marr and much of our executive team have been together here for a long time and have been through other -- certainly not pandemics, but other challenging times. And one of the things we look back to was the recession a decade or so ago and how Tyler responded to that, more economic challenges but not a pandemic, but some parallels there. I think Tyler, for the most part, really tried to stay the course. So we generally think about things in a long-term way. Certainly, we had short-term problems and issues to deal with, but we continue to keep the eye on the long-term goals. So we didn't lay off any people. We actually continued to hire. We continued forward with all of our strategic initiatives, particularly our development initiatives. So even though sales process has slowed or paused in a lot of cases, certainly, our revenue growth was a lot slower than we expected with low single-digit revenue growth as opposed to and expectation of low double-digit revenue growth. But we continue forward with all of our investments, all of our initiatives. And that's similar to what we did during the recession, where we didn't lay off people, we continued investments. And as we came out of that and things returned to normal, we thought ourselves in a stronger competitive position than we were going into the challenging times. And I think that's the case here. We, I think, will emerge from this year, as a stronger company, a stronger competitor and continuing to widen the gap between ourselves and some of our key competitors. With remote -- the full shift to remote work was something also we, like virtually everyone else, put into place. Lynn has talked about how proud he is of our team and how they've responded, supporting each other as well as our clients really without a break. And so we shifted to remote work pretty rapidly. One of the more challenging things was shifting to remote delivery of professional services, which we also did rapidly. And while we adapted to that pretty quickly, it took a little bit longer for our customers in the public sector to sort of be ready to accept remote delivery of services. But that's something that we have found to be very effective. It's improved the utilization of our professional services teams where we're not putting a lot of people on airplanes every Monday morning and having them come back every Friday afternoon. So it creates more billable hours basically, but also better quality of life and job satisfaction for those people, who previously traveled almost 100%. We did lose about $20 million a year of billable travel revenues, which are pretty close to 0 margin, mostly pass-through. But -- so that actually was one of the things that contributed to improve margins on lower revenues. And I expect that that's going to be sort of a permanent change, but remote delivery of professional services will be our primary business model, and in most cases, on-site services will carry a premium cost. I think the other thing is how we've shifted to -- for our people who primarily worked in office. We're certainly currently working through kind of what our long-term model will be, but I expect that from most jobs, it will be a model with some time in the office where you can collaborate in person with your coworkers and some time on a more flexible schedule. I think we had about 1/3 of our employees working remotely prior to the pandemic. So it's not a new concept to us, but being more broadly implemented across the company.

That's interesting, Brian, the 1/3. That's -- I think that's more certainly than the broader economy, but you've -- this wasn't -- you weren't starting on a pivot here when this hit from a workforce standpoint. That's great. It's good color internally. Maybe just sort of sticking to the COVID theme. Talk maybe about the portfolio Brian, and what -- across the portfolio where some of the COVID headwinds were 6 months ago and maybe how you're thinking about that in the future. Maybe specifically just around a few of the product sets, whether it's a public admin side, the public safety side, but just broadly, the portfolio and the COVID sort of look back and go-forward.

Yes, sure. Yes. We saw challenges mostly around the sales side. And just to sort of reset, people who aren't terribly familiar with Tyler, we sell a wide range of enterprise software applications that automate essential back-office functions for the most part of the public sector, a lot of local governments, cities, counties, school districts, some at the state level and a little bit at the federal level. So things like public admin, ERP, finance, human resources, payroll, public safety, things like 911, police, fire and ambulance property taxes, licensing and permitting, Courts & Justice. So a really broad portfolio of products but all focused on the public sector. I'd say in general -- and in general, sort of the demand driver in our business is that customers have or governments have aging software systems that replacing them is almost nondiscretionary. So governments are very different than the private sector in that they are not profit-motivated. They're not ROI-driven. They effectively don't have competition. So they tend to use software much longer than private sector entities would and really kind of wait until their software systems are almost that end of life or at end of life or maybe beyond end of life before they think about replacing them. But when they get to that point, then replacing them is sort of nondiscretionary. They may be able to put things off for a little bit, but these are all essential systems that ultimately will have to be replaced. So we really didn't see demand go away as a result of the pandemic, but we did see delays in sales processes, as governments struggled with shifting to remote work with -- and for the most part, I'd say governments were probably less prepared for that, maybe even in the private sector. So that took a while. So sales processes that were underway took pauses in a lot of cases and -- but the demand stayed in the pipeline. And as we got into -- moved through the year of 2020, we saw RFPs down fairly significantly from sort of normal levels of the prior year levels. Bookings fell as well. We're now with the NIC edition close to -- or north of 80% recurring revenue. So those really continued uninterrupted. But in terms of new sales, there were some challenges. As we got into the second half of the year, a lot of the sales processes that were already fairly far along in latter stages at the onset of the pandemic picked back up again. We were doing demos remotely. Sales processes continued remotely, and those processes started moving. But a lot of the new processes, new RFPs, we would have expected to see during the year were held up. And so not only the challenges of remote work, but the challenges or concerns that governments had about their budget situations also caused delays. As we got towards the end of the year and moving into this year, we've seen a pickup in those. I think there are a couple of things. One, I think governments in general, the impacts on their revenues were not nearly as severe as they feared, so they're more comfortable about their budget situations. There's obviously enormous federal government stimulus, direct aid coming to state and local governments that gives them a lot more comfort around their budgets. So things are -- we've said that for the most part, across our product portfolios, that RFPs are generally back to or close to sort of normal or pre-pandemic levels, and in some cases, are above those levels. So that's sort of the broad set of where the market is. Across products, I'd say the -- probably one of the other things is that -- I described kind of how governments think about replacing systems, but there have been some changes to that as a result of the pandemic. And those really kind of span our products as well. But I think on one hand, a lot of governments have discovered that systems that they knew were old, that they knew weren't state-of-the-art, but they might have thought had many years of life left in them, have had to rethink that because those systems didn't work in a remote environment, didn't support online transactions or online access to data. So you think about a mainframe court system that really only worked if the users are at their desk at a terminal that's wired to the mainframe. And so with courthouses closed because of the pandemic, they weren't able to continue to have normal court activity to have a trial remotely, to have to pick a jury pool remotely. We have tools that enable that to happen. And so I think a lot of governments have -- are rethinking how soon that some of these aging systems are going to need to be replaced. We have seen some of those add-on products gain a lot of traction, things like our remote court application. But we do believe that that, over the coming years, will continue to accelerate maybe some demand that wouldn't have happened until further down the road. I think the need for better data and analytics is something that's also emerged that governments have probably, in a lot of cases, lagged the private sector in terms of adopting business intelligence tools, analytics tools, and we have some pretty sophisticated tools. Our acquisition of Socrata a couple of years ago gave us a lot of capabilities there. And I think things that governments might have thought were nice to have pre-pandemic, they're seeing as things that are now high value and things that they really need to have. And so seeing a lot of traction around our data and analytics capabilities in those products being added on to existing solutions and helping increase the competitiveness of our solutions in the market as well.

Okay. That's good. Let's -- you mentioned NIC. Obviously, a significant acquisition for Tyler. Could you -- let's start from the beginning. Maybe lay out the strategic rationale for what the Tyler-NIC combination is about. And then we are getting a few questions here from the audience about the integration, and more specifically, around the go-to-market and some of the cross-sell synergies between Tyler -- legacy Tyler, NIC. Are we seeing deals where maybe there's multiple elements from both sides being included? So maybe, Brian, just to frame it, NIC strategic rationale, where is that today from an integration and then the go-forward cross-sell power here?

Sure. Yes, so NIC, we closed that acquisition in late April. It's by far the largest acquisition the company's done. And we've been fairly acquisitive over the years, but this is by far the largest acquisition that Tyler has ever done. It was a roughly $2.3 billion purchase price. NIC was a public company, so also the first acquisition of a public company that Tyler's done with revenues north of $400 million. So it's really sizable compared to Tyler. NIC is extremely complementary to Tyler and very little overlap. So both Tyler and NIC exclusively serve the public sector, but we do different things for the public sector, and for the most part, different segments of the public sector. So while Tyler primarily provides the mission-critical back-end software systems for essential functions of local government, NIC is primarily focused on basically providing digital access and facilitating transactions with governments primarily at the state level. So Tyler is close to 85% local government revenues, cities, counties, school districts, 10% or 12% state governments and less than 5% federal government. NIC is about 95% state government, about 5% federal and really very little presence with local governments. So NIC through these enterprise-level or enterprise-wide state contracts that they have was 28 states and another, I think, 3 states where they do only payment processing, they provide access -- digital access to government. So they provide the website, the portal for state government. So if you think about renewing your driver's license or your car registration or CPA license or applying for unemployment benefits, any kind of business you would transact or data you would try to access from a state government, you would do that through the NIC portal. And NIC builds these connections to these back-end systems and really gets paid through a transaction-based model. So you may pay a few dollars of convenience fee to renew a license or get a hunting and fishing license or get a camp ground reservation. And that's how NIC gets paid. So it doesn't really come out of -- it's a self-funding model. It doesn't come out of the state's budget. And then they also, in most cases, provide the payment processing along with that where there's a payment involved and so they get revenues from that as well. And a big piece of the revenue comes from access to driver history records, so insurance companies accessing driver history records from the state to determine how they set premiums for their policyholders. So the models are -- what we do is different. A lot of what we do is different about the level of government but very complementary. NIC has a few software applications, mostly in the outdoor recreation, hunting and fishing license, cannabis licensing. But that's a newer piece of their business and really not much overlap with what Tyler does as well. So the synergies and the opportunities are really mostly around revenues and around the 2 of us or each of us being able to leverage the relationships we have at different levels of government to drive more of our business. So one of the primary opportunities is to leverage NIC's relationships as well as these very broad contracts they have with the state to sell more Tyler software into state governments. So we have a lot of applications that either are or more likely could be used at the state level. But we don't have that history of those relationships, those sales organizations, like we do at a local level, but NIC does. And so we believe that through their relationships, one will know kind of what the needs are of the state governments sooner because in NIC state organizations, they have general managers who are very closely aligned with the CIOs, the agency heads, the governor's office, in helping them achieve their goals for digital government. And they're interfacing with a lot of these back-end systems. So they know kind of where the needs are, what the initiatives are, and we think we can leverage those to be in there sooner with Tyler software and actually use the NIC contract vehicles, in some cases, to sort of bypass a more extended competitive process and put our software into place. So that's sort of one side of it, selling more Tyler software into state governments. The second side is really to leverage our local government relationships. And we have some 27,000 software solutions installed across roughly 11,000 different local government jurisdictions that we have talked about in -- over the last couple of years the desire to increase our payments business. And so we believe that NIC is a very sophisticated, robust payments platform and that they use mostly at the state level, some at the federal level. And we believe that we can use that platform to drive more payments business at the local level. So for example, last year, Tyler in the payment side, we have a lot of systems that facilitate payments for local governments. And primary ones are utility billing and municipal courts or traffic tickets, where our systems are processing those payments. But Tyler has historically been a really a reseller of payment processing services, so an ISO. And we get a small piece of that payment. Sometimes we get a transaction fee as well. But really, those are present in a pretty small number of our customers, a small percentage of our customer base and really around a few applications. So last year, Tyler was involved in processing about $3 billion worth of payments for our customers. Last year, NIC processed about $24 billion worth of payments for its state government customers. So they have a lot of capabilities that we would have -- and experience that we would have looked to have built out in coming years, as we try to broaden our payments business. And we think we can use their platform, and in some cases, their state contracts that allow for local governments to piggyback on those to drive not just payments where we're doing it just for a Tyler utility system or a Tyler court system, but enterprise-wide payments for a whole city or a whole county. So that's an area that we're really looking to expand our business that we think that NIC's platform can be very helpful. NIC also signed a contract last year that will really kind of kick in late this year with the State of Florida, where they'll be providing all of the payment processing for the state government in Florida. And that should add, once it's sort of fully up and running, about $50 billion more of payment volume on top of what they're doing initially. So a lot of really strong capabilities there that we think can help us accelerate our payments business growth. So those are the 2 major areas. And then I'll just touch briefly on kind of where we are on the integration. So a little different than some of our prior acquisitions where they were actually software products that need to be integrated. So a few years ago, our prior biggest acquisition was New World Systems. And that was a public safety product that we integrated with our Courts & Justice product. So there were software integrations. There were investments in product there. So probably a more complex integration even than the NIC given that NIC was already a public company, a pretty sophisticated business on its own and not really software integrations that we have to do. So we've got -- it's really more about integrating the sales organizations, the go-to-market, how we actually execute on leveraging these great relationships that we both have in these client bases that we have. So what we've been doing really over the last couple of months and is ongoing is kind of that education is the starting point. So each week, we have a series of what we call showcases, where the NIC state leadership -- the leadership of each of their state organizations sees presentations from different Tyler products so that they understand -- and we have a very broad portfolio of products. So they understand what does Tyler have, we go through what does the product do, where does it install, who are our competitors, what are our strengths and weaknesses, where are we investing. And so that the NIC teams can understand what we have. And out of these sessions, you hear -- yes, we have -- in our state government, they are looking for that or that could fill a need that might be on their road map. And then going the other way, we are doing sort of showcases for Tyler product and corporate leadership to understand what -- how each of these state organizations that NIC functions. What are their relationships there? How does their contract work? What are the governor's key initiatives? What agencies have major initiatives and understanding where Tyler products could fit into that? We've already generated some actionable items that are in the pipeline, but more of this is sort of laying the groundwork to really be able to start to drive those sales. We did -- we talked about a contract last quarter in Colorado, a pretty broad contract with Colorado's one of NIC's -- I think it's their biggest state relationship in terms of revenues. And we were able to bring some Tyler products in under that contract, including Socrata, the data and analytics platform. And so that's one that -- it's kind of an early example, but as -- the further we get into it, the more excited both of our teams are about what kind of opportunities this combination can bring.

Yes. Yes. And sticking on NIC, let's just talk a little bit on growth. Relative to core Tyler, NIC -- and NIC, as the audience has noted here, has some puts and takes, right, with around some COVID products. So maybe how do we think about NIC just from a growth potential here and what that can do for Tyler's sort of overall growth trajectory?

Yes. Yes, Tyler has -- just Tyler pre-NIC, we typically talked about targeted organic growth of kind of 8% to 10%. We've had higher growth than that, certainly on the subscription side, where our business is transitioning to more of a subscription model. Our subscription growth has been north of 20% pretty consistently. And last year, our overall growth -- pre-COVID, our expectations were really for low double-digit growth, and we were on track to that at the beginning of the year. Didn't quite hit those targets, but that's kind of where our expectations have been around. NIC has historically grown what they call same-state revenues or -- it's like same-store sales. Within a state contract and existing contract over kind of a decade or so, they've averaged about 8% growth organically within those states. And from time to time, they've added new states. And occasionally, rarely but occasionally, lost the customer as well. But generally, they kind of have that sort of 8% organic growth within their -- in their state businesses. We -- I think both are kind of growing kind of now more on the high end of our expectations. So NIC's growth -- and then as you noted, they've got some really direct COVID-related revenues. They have a business called TourHealth, which is a partnership for COVID testing, which was sort of an opportunistic solution they put in place with some partners in response to client needs. In some states, the states were saying we need some help in putting this to place. NIC is a very sophisticated platform called Gov2Go, which is a mobile platform. So combining that with a COVID testing partner, we were able to put these things into place. And then they also have some pandemic-related unemployment services that they're doing mostly in the state of Virginia to solve the need there. Those are expected to go away. They've been very clear, and we continue to be very clear about what those revenues are so that people can sort of know that those are things that we don't expect to be there, hopefully, next year. They've gone on a little bit longer than we would have expected. We thought that by the end of the second quarter, they'd be gone. But ex those, NIC's organic growth rate in Q2 was 17%. Tyler's was about 12%. But NIC is certainly benefiting from not only the desire but the need for people to do more business digitally with government. The things that they used to do in person, they would go down to the DMV or mail in a check for something. And so those payments are happening online. I think their payment volumes are up roughly 15%. And so it's good timing for us to be in the middle of certainly a trend towards more digital interaction with government. So I'd say over the long term, we'd expect that -- or the medium term, we'd be on the kind of higher end of our traditional growth objectives. And then when I talk about the revenue synergies, those are all things that would be expected to be incremental to what we would have done on our own, taking advantage of the cross-selling opportunities. And those, I'd say, are mostly yet to come.

Yes. Good, good. That was helpful, Brian. We've got -- let's see. We've got about 4 minutes left. One of the questions, I guess, being a banker is the M&A environment, Brian. Tyler traditionally, as you said, tuck-in M&A, very tactical in its approach around M&A. And I see a different story. I think -- help us think about M&A going forward, how you're looking at M&A obviously through patients or through the doctor. Maybe just for the last couple of minutes, how you're thinking about that over the next year or 2 in the context of what is a very, very frothy M&A market in software?

Yes. It is an active market, and we expect to continue to be active. Even besides NIC, we've done, I think, it's 4 other acquisitions in the last year, called ReadySub, which was in the -- an application. And these are mostly tuck-in type acquisitions that -- a company that was in the -- kind of provides application for managing substitute teachers for schools; a company called DataSpec, which is around veterans' benefits, which fits in with our MicroPact business unit. We just closed on September 1, VendEngine, which is a little bit larger, north of $20 million of ARR, about an $84 million acquisition, sort of a little bit of a fintech company but in the corrections market, in the jails market, so providing services around inmates in jails and providing -- helping them manage their finances and providing other services like video visitation and things like that. Really nice fit with our Public Safety and Courts & Justice market, really, really good company. And then just yesterday closed on a business called Arx, which provides some -- it fits in with our Public Safety, provides some SaaS solutions around sort of internal affairs-type processes for police departments. So we have been active. I'd say, given the size of NIC and the other acquisitions we've done, probably the bar's a little bit higher for us right now. We want to really focus on making sure that we get these integrations right, that we're taking advantage of all the kinds of opportunities we've described. So we'll continue to pursue things. But I'd say, at least in terms of large M&A, I'd expect there'd be a little bit of a pause. But we continue to be very opportunistic. We engage with lot of companies, mostly. Often, these are companies that aren't for sale, that aren't being shopped, we've had more success there. And sometimes those relationships and processes take a while. There is a lot of private equity investment going on in software. So we have competition there that is much more active than a few years ago. But we think we're seen as a good acquirer, and some of the opportunities these present for sellers, we think, are compelling. So I expect -- and our balance sheet, I'd say it continues to be very strong. Even with the debt we've taken on with NIC, we're leveraged about -- net leveraged about 2.7x. We expect that to come down pretty quickly. Our blended interest rate on $1.5 billion of debt is 1%. So it's been a good time to be a buyer, and we've got a lot of -- still a lot of, I'd say, dry powder and capabilities. But again, bar's kind of high for us right now.

Sure. Sure. No, very helpful, Brian. With that, I think we are out of time. Thank you so much for the insights here. And have a great day, everybody.

Thank you. Appreciate the opportunity to be here.