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

Thanks, everyone, for spending a little bit of your afternoon with us. I think since our first time at the Baird conference, that may be a fair number of you are fairly new to the Tyler story. So I'm going to go through our overview presentation. And we'll see if there's a little bit of time for Q&A at the end of it. Tyler is a vertical software company focused exclusively on the public sector market. So we are the -- actually the largest company that solely provides software for the public sector. We have a wide range of enterprise software products that manage essential functions of the public sector, primarily focused on local governments, so cities, counties and school districts, they make up about 85% of our business, another 10% to 12% from state governments and 5% or a little less from the federal government. We have been in this business since early -- or about 1998 when we made some acquisitions and set out to -- on our strategy of really creating a company that serves all of the essential needs of primarily local governments. We've had a very consistent long-term revenue growth story. So over the last decade, we've grown at a CAGR of about 14.5%. Most of that organic, close to 10% organic growth over that time period. EPS growing at about 20%. And we still have a huge runway ahead of us. It's a very fragmented market. And so our market share is, in another word, the largest provider in the space is only around 5% today. I'll talk about our track record, the markets we serve, the products we have, a little bit about the financial side and some of our growth opportunities. As I said, we're the largest company in this space, with last year, about $1.1 billion in revenues. This year, we'll be right at $1.6 billion in revenues. Did a large acquisition earlier this year that I'll talk a little bit about. This shows you a little bit about the product set that we have. ERP and financial systems is the largest sector in our -- that we serve, Courts & Justice, public safety, platform technologies includes things like a data and analytics platform, a local development platform that's used in a variety of public sector applications and then our payments and digital government portals through the NIC acquisition, appraisal and tax, property taxes, civic services, things like licensing and permitting. We serve some of the administrative side of K-12 schools, and those are sort of the major product areas. We -- as I said, we have really strong cash flow history. Last year, we were about 73% recurring revenues. Last quarter, we exceeded 80% recurring revenues for the first time. And our customer retention in the space is very, very strong, about 98% of the names, 99% of the dollars on a pretty consistent basis. So very, very sticky customers in the space. Kind of talking about our history a bit. For the first 15 years or so, from '98 through 2014, we really kind of built the portfolio of products that we have. We did a number of acquisitions, some foundational acquisitions and some tuck-ins along the way, invested in those products, brought together a lot of the core foundational technologies and really we're focused on building this broad portfolio of solutions. Starting in 2015, we began accelerating our transition to the cloud. Historically, most of our products were on-premises with a traditional license maintenance model. And over the years, we have increasingly added a subscription model and really now have shifted from sort of a cloud-neutral approach to a cloud-first approach, continuing with tuck-in acquisitions along that time frame, and now as we move forward from here, it's really primarily a SaaS-focused business. As I said, a cloud-first business, and really continuing to execute on our strategy, we have called connected communities, which is really our vision for bringing siloed government systems together, providing better access to data, better transparency for citizens. So I'll talk a little bit more about our vision there. A little bit of the history. As I said, recurring revenues become a much bigger part of our revenues. We've had about an 18% CAGR in our recurring revenues over the last 5 years. And our margins have increased fairly significantly from about 18% in 2010 to 27% last year on a non-GAAP operating margin basis. The market, really, this talks about the market for application and vertical-specific software in the local government and education market. As I said, we have a small presence in the states but growing and a smaller presence in federal, but expect to continue to expand there. But really in the local government software market, it's about a $25 billion market. We think our products today address around half of that market and you see our market share at about $1.2 billion last year. And the market, according to Gartner, is growing in the sort of mid- to high single digits, 6%, 7%, 8%. Tyler obviously has grown faster than that. So we're continuing to pick up market share along the way. The market is very, very fragmented. When you think about local governments, there's about 88,000 local government entities in the country, cities, counties, school districts, local agencies. They all have multiple systems. So there are literally hundreds of thousands of systems being used by local governments across the country. We think if you looked at where all of those systems come from, you'd find that only about 1/3 of them came from a vendor who's competitive in the market today, whether it's Tyler, Oracle or SAP or a local guy who has a niche product in a region of the country, but companies that are competitive in the market today. And you'd find that the other 2/3 of the systems are outdated. They came from a vendor who's no longer in business, a vendor who is in business, but at some point didn't invest in the next generation of technology. So they don't have a product that anyone would buy today or homegrown systems and particularly in larger governments, where you see mainframe COBOL systems that are still being used. Those systems obviously become increasingly difficult to maintain and to manage. A lot of the systems were well-publicized during the early days of COVID when they didn't work remotely, but those still make up the majority of systems that local governments are using. And so it's sort of a long replacement cycle. Governments tend to use these systems until they're just about to die. Probably the average system we replace is more than 20 years old, but it's not uncommon that we replace 30- and 40-year-old systems. So a long runway ahead of us. A little bit about the competition. It's very, very fragmented. We have different competition in each of our subverticals. So the companies we compete with in public safety are different than the companies we compete with in ERP, and those are different than the companies we compete with in property taxes. There are some horizontal companies, mostly on the ERP side and the platform technologies and payment side. But frequently, we're just competing with specialized companies that compete in one of those niches. So we are unique in terms of the breadth of our product offerings. And that does create value for our customers, from having those products tied closely together. The local government market is a pretty stable market. Again, the needs that drive the demand are consistent and long term. Local governments are primarily funded by property taxes and over a long period of time, that is a pretty stable revenue base. And certainly, today, with strong property values, most places around the country, that's not a revenue source that's under a lot of pressure. But increasingly, as we do continue to grow our state and federal business, different kinds of revenue streams funding those different segments of government. A little bit about what makes us competitively strong. I think primarily it is our singular focus on government. Everything we do, all of our R&D, all of our technology is designed specifically to address the needs of government, and that's the strength really of any vertical software company, but that's really our core strength, that we have this incredible domain expertise both in our products and in our people. Close to 40% of our people have worked in the public sector. We have about 6,700 employees. We have these families of connected solutions that work together and create more value from having each additional system come from Tyler, large and growing R&D base, and we have a huge customer base that we can leverage by selling additional products. We have about 13,000 different local government -- local state and federal government entities that use our products, about 27,000 installations. So the average customer has 2 products from us and could have as many -- or as -- 8 or 10 products from us. So again, a lot -- a big cross-selling opportunity ahead of us and continuing investment in SaaS solutions. Our R&D, as you can see, has really effectively doubled over the last 4 years, and we continue to use a significant amount of our cash flow to continue to invest in our products and innovating through our existing suites and particularly investing in our cloud transition and optimizing our products to be deployed more efficiently in the cloud. As I said, we're mostly focused on local governments, but some of the big opportunities ahead of us are by starting to address more of the state market, starting to dip our toes into the federal market and international. Today, we're only -- we're -- less than 2% of our revenues are international and most of those are from Canada. So we are primarily domestic, but have some international opportunities ahead of us as well. So even though we are the largest provider in our current space, we believe we've got a long runway of continued growth, similar to what we've shown over the last decade. Cash flow generation is strong. You can see that our free cash flow margin last year was 29%. Over the last 5 years, we've generated more than $1 billion in free cash flow. This year, we should be somewhere in the $450 million range. So it has expanded pretty significantly. And talk a little bit about what we do with that cash. Our first priority is investing in organic growth, whether it's R&D, innovation in our existing products. And that's, as I said, we've increased our R&D investment pretty significantly in the last few years. We also have a consistent acquisition program. Most of those tuck-in type acquisitions, finding companies that have products that broaden our solution suite, often around an existing product. We've done some that have got us into whole new subverticals like public safety about 5 years ago and now the NIC acquisition that we completed earlier this year that gets us more heavily into the state market and into the payment space. We also have been an opportunistic buyer of our own stock back. Over the years, we've bought back a fairly significant amount. In the last 5 years, we bought back a little less than 2 million shares, and we bought some earlier this year as well. Acquisitions, as I said, it's a core competency of ours. We believe we're seen as a very good acquirer in this space. Certainly, over the last few years, we've seen more competition from private equity firms who have become much more active in the public sector space. But we've -- this highlights the acquisitions we've made in these last 5 years. Some of these, kind of more key than others. But generally, we're expanding our TAM through acquisitions, we're adding technology and new capabilities and a client base as well. And generally, looking at products then that we can leverage our sales organization, to put more products in the sales reps' bags and that we can leverage our customer base by selling more things into our existing customer base and then increasing the size of new deals by having more applications that we can put into an opportunity. A little bit more about our shift to the cloud. As I said, traditionally, we were an on-premise software company. And going back 20 years ago, we started to offer hosted solutions. So taking the same applications and hosting them in a Tyler data center and having customers pay for those on a subscription basis, but really cloud-neutral, letting customers decide whether they want to be on-prem or in the cloud. And like a lot of things, the public sector has moved much more slowly towards embracing the cloud, but that has been accelerating over recent years. And a couple of years ago, we entered into a major partnership with AWS as our primary public cloud provider, embarked on a strategy of moving really from running our own data centers and hosting those clients in our facilities to a goal of having all those customers be hosted in the public cloud at AWS. And so we've started that process, started investments in our products to make them more efficiently deployed in the cloud, working with AWS on that as well. And our market has increased their appetite for cloud solutions. I think 2019 was the first year that more than half of our new software sales came to us through the cloud. Last quarter, it was 75% of our sales. So an accelerating change there. We still have a lot of on-prem customers that we expect to migrate to the cloud over time, and I'll talk a little bit about that as well. You can see the bookings gone from 28% in 2016 that were in the cloud to last year, a little north of 60%. As I said, last quarter, 75%, and we expect that mix to continue to shift until we are 100% of our new sales in the cloud. Our subscription revenues have grown much more rapidly. You can see north of 20% the last 4 years, north of 30% last year, 26% over the last 5 years as a whole. So our recurring revenues, $850 million of ARR in the fourth quarter of last year, about 10% growth in our ARR. You see it's a combination of maintenance from on-premise customers. SaaS software and transactional revenues from payments and things like electronic filing in the courts where we get paid per transaction. The shift to the cloud. We, like a lot of software companies, see a significant increase in the customer value as they move to the cloud. We believe that it's about 2x the revenue from the same customer over the life of the customer being in the cloud. When we have customers that are on-premise and move from maintenance to subscription, it typically doubles what they're paying us on an annual basis. And we have a long runway of those ahead of us to continue to migrate. Only about 4,000 of our existing 27,000 installations are currently in the cloud. So a little bit about our vision for connected communities. We believe this is one of the foundations of Tyler's competitive strength that -- our ability to leverage the broad portfolio of products that we have and the large customer base that we have to provide the ability for governments to significantly improve the way they operate. Local governments as well as state governments and the federal government operate very siloed. So the buying decisions are made in silos. The police chief buys the public safety system, the tax assessor buys the tax system. The data is siloed in those systems. So it's very difficult for them to make good decisions with -- or to access data from multiple systems to make good decisions around. So that's kind of the world as it exists today, and that's the world we live in and what we sell into. But we have a vision of connected communities that we believe we're the only company that's really in a position to execute on it. So you see those back-end systems sort of on the bottom of the pyramid, but really tied together by a digital infrastructure layer, where we have common foundational elements, so common dashboards, common portals, payment engines, security and ID, and then a data layer. So being able to share data. We did an acquisition called -- of a company called Socrata a couple of years ago, that's a data and analytics platform focused on the public sector. And we've started to really integrate that into all of our products and really expand our data and analytics capabilities. And then the engagement layer on the top, so making better engagement between citizens and government through portals and dashboards and transparency applications. So that's our vision. We're -- we really kind of launched this vision about 5 years ago, and it continues to resonate with clients. And we're trying to change the way they think about buying systems and think at a higher level about where they can go and where they -- where Tyler can help take them. So some of our long-term growth drivers. Our market, as I said, grows kind of mid- to mid-single digits, 6%, 7%, 8%. Accelerating the shift in the cloud gives us an opportunity to continue that higher growth in subscription revenues, capturing more share with existing customers. So having more products and being able to cross-sell over a longer period of time and go from 2 products to 10 products with the customer, expanding into adjacent markets like we've done real recently in the state market and using our capital to help drive that growth. An example of that is in the public safety space, where we acquired a company called New World Systems. Before our recent acquisition, NIC was the biggest position in the company's history. Acquired it in 2015, had about a 3-year period of elevated investment. They were focused in the public safety market, mostly in the mid-market. We've invested in that product to sort of separate it from the competition and to add the functionality and features needed to compete at the upper end of the market. Our sales cycles, as you can imagine, are long in this space, so have started to see the results of that in recent years. And so now in 2020, what we saw was our deal size up 94% for that product group. Our first Tier 1 customer in Jacksonville, Florida, a consistent record of starting to sign larger contracts. And so a certain example of the kind of time frame it takes to execute on some of these strategies in this space, but we have a lot of patience as a company, and we've seen the success of that. Payments is an opportunity for us that's fairly significant. And we believe the NIC acquisition will give us the ability to accelerate our objectives there. Today, we process or had about $100 million of revenue potential with our existing customer base, and we believe that we have the opportunity for the next 3 to 5 years to increase that several times over. NIC, I've mentioned a couple of times. The acquisition we did in April, the largest acquisition in the company's history. It was a $2.3 billion deal. First time we've acquired another public company. Whereas Tyler provides really the back-office solutions, NIC is really sort of the digital front door to government, mostly state governments. They provide portals under enterprise-level contracts with 26 states. So they provide the access to -- for citizens or businesses to conduct business with government, whether it's renewing a driver's license or motor vehicle registration or an unemployment claim, and they are primarily funded through transaction fees and payment processing revenues around those interactions. So we're very complementary companies. We don't compete. We believe there are a number of opportunities for both businesses as a result of the combination, primarily the opportunity for Tyler to sell software into NIC state clients through their enterprise contracts and for us to leverage their payments platform and drive more enterprise-level payment processing down into the local government market, where we have a big presence. We'll talk about our midterm financial targets over the next, say, 5 years. We expect to have organic growth in the 10% range. Margin expansion is a long-term continuing opportunity for us. So even though we've had significant expansion over the last few years, we believe that we can generally average 50 to 100 basis points of margin expansion over multiple years, not necessarily always on a straight line, but over several years. Free cash flow margin, 25% to 30% and 15% to 20% growth in EPS. Backlog is now about $1.6 billion. And our results this year to date with the NIC acquisition as well as strong organic growth for the first 9 months, we're up about 38% of revenues, up about 28% in EPS, for the first 9 months, about $1.2 billion in revenues. And our guidance for the full year is for right around $1.6 billion in revenues, which should be a little north of 40% growth and for EPS growth, again, in the high 20% range. Obligatory reconciliation. And that's really -- that's our story. A long-term track record in this space, a leading provider of solutions for the public sector, powerful cash flow generation, a growing cloud story and long-term sustainable growth. With that, I think we just have a few seconds. I don't know if there are any questions. I think we're just about out of time. So I appreciate your attention. Please feel free to contact me or our team if you have any further questions. And again, thank you for being here.