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

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Hey, there. Thanks, everyone. Good morning. I appreciate you joining us this Day 3 of the Wells Fargo TMT Summit. I'm Michael Turrin, software analyst here at Wells. Joining us for our next session this morning is Brian Miller, CFO of Tyler Technology. I'll start off with some questions. If anyone tuned in has a question and like me to ask, you can shoot me an e-mail. It's [email protected]. I'll do my best to add those into the conversation as well. Brian, thank you very much for joining us this morning. I appreciate it.

Yes, you bet. Good to be here.

Excellent. I mean you've been at the company for a while. The company has been around for a long while, but still maybe a little under the radar in software. So let's just start with the high level, and you can describe Tyler's technology, the customer base you're serving and what you're typically replacing? And then we can just kind of follow on with the conversation from there.

Sure. We're a vertical software company focused on enterprise software for the public sector market. We exclusively serve the public sector that we're very broad in terms of the breadth of products we offer the public sector and the various segments of the public sector that we serve. Historically, we have been primarily focused on the local government market. So providing essential back-office systems that run essential flexions of cities, counties, school districts, local agencies. More recently, we've expanded into the state market on a bigger way, particularly through the acquisition of NIC earlier this year. And we have a pretty small presence. Less than 5% of our revenues are from the federal space, but that's also a market we expect to grow in. So when you think about our products there, things like property tax systems, systems that assess your value of your property, that bill and collect your property taxes. Public safety, we do 911 systems, computer-aided dispatch, policed by an ambulance record systems. In the court space, we're the leading provider of systems there. So things like court case management systems, jails, prosecutor, jury, probation, kind of that whole process. ERP systems, financial management, administration is a big part of our business. We do licensing and permitting, things like business licenses, building permits. We're also pretty big in the property -- well, I mentioned the property tax area. In schools, we do grades, attendance, scheduling, school bus transportation, things like that. More recently, the acquisition of NIC got us into the more of the digital access to government, so providing portals and facilitating transactions, primarily the state governments as well as the payment processing business. We'll be close to $1.6 billion in revenues this year, very profitable EBITDA margin in the high 20s and about 80% recurring revenues now. So kind of in the -- well along in a SaaS transition, but have a mixture of both SaaS and on-premises clients, but moving towards really a SaaS-first approach. Typically, we're replacing really old systems. So government -- as you can imagine, not surprisingly, is a little slow to change often. And they really approach software differently than the private sector. They're not ROI-driven or profit motivated. Effectively, they have no competition. So they're the exclusive provider of the things they do in your jurisdiction. So they're not typically looking to replace the system to become more efficient or make more money. They'd like to provide better service to the citizens. They'd like to be more efficient, but they really don't have to, and they tend to resist change. So typically, we're replacing systems that are really old, often 20-years-plus old, generations old. It's not uncommon that we replace mainframe global systems that are 40 or 50 years old, so -- and in some very large projects. So it's a market that as a result tends to be very steady but never explosive, and it's provided us with the ability to have a double-digit CAGR for 15 years.

Yes. It all sounds very sticky once you get through that process. So I mean you mentioned it's a patient market. There's not necessarily a major catalyst for change. But I mean the last couple of years have been a little different than the many before. And so I'm wondering if either the pandemic and forcing some of that employee base to move remote and figure out how to do work or just what happened with stimulus throughout the past couple of years has changed engagement or buying behavior within your target customer at all?

Yes, that's right. Because what I just described is kind of the basic underlying premise that, that has -- there have been impacts on that because of the events of the last couple of years. I think what we've seen is that like the public -- like the private sector, governments had to move to remote work and changing the way they operated. And in many cases, they were probably less prepared or had fewer tools to enable that, particularly when you look at some of the legacy systems they were using. So there were some -- just like in the private sector, there were a lot of challenges, but a lot of issues. So for example, if you had a court that has a mainframe legacy system that only works if the users are at their desks, at a terminal, then -- and that court house was closed, then the court [ tend to ] elaborate. We have products, for example, virtual courts product that enables remote operations. We have a state-of-the-art SaaS jury system that we actually acquired a couple of years ago that provides the ability to do a remote jury pool and not have to have 500 people come down and sit in a room at the courthouse. So the interest -- I'd say what we're seeing is that in a number of situations where they have products that they might have thought -- they knew they were old, they weren't state-of-the-art, but they might have thought they had years of life left in them, they're rethinking that, saying this just didn't work in this environment. You've seen, I mean, some major, well-publicized situations like I think it was the state of New Jersey, the unemployment system was an old mainframe system. It just wouldn't work. It wouldn't handle the volume, didn't have remote capabilities. And so it just really wasn't -- didn't meet their needs at a time when there was a lot of demand on the system. So we believe that there will be systems that are replaced much sooner than they would have otherwise been. That still is a process of purchasing process and evaluation process and the budgeting process, but we do believe that there'll be some acceleration in systems. There's just much more of a spotlight on aging systems and some of its flaws in government systems that wasn't previously there. The availability of the stimulus, we believe, certainly helps facilitate that. There's -- it's really -- there hasn't been a stimulus or a relief package for state and local governments like this in the past. The CARES Act had about $150 billion of aid for mostly state -- for states and mostly large local governments. Fairly restrictive, but the American Rescue Plan provides $350 billion of direct aid to state and local governments. And it's -- there are very few restrictions on what they can use it for, and we believe a significant amount of that will be used on IT modernization, system upgrades. There's also $167 billion for schools, which are also a segment of our market. So it's just a massive amount of money. It's -- they get half of it this year and half of it next year, and they've got until the end of 2024 to spend it. So we don't see it as a floodgate that's going to open, but we do see it as a potential tailwind over the next 3 years or so. We've already started tracking deals that are identified as specifically funded by stimulus money. You don't always know, sometimes it just frees up money from somewhere else. But we had a couple of dozen deals last quarter that were identified as sort of stimulus funded. We certainly have inside sales organization that's very actively engaged with our existing customers about additional things they could acquire from Tyler and also very involved with new customers as well. So the market, after pauses because of logistics and funding concerns in 2020, really, the activity is picking up. And we're seeing RFPs, market activity at or above pre-COVID levels at this point.

It's all really useful context. With what you just laid out and just some -- just nuance, some change, does that impact what you would expect from a seasonal perspective at all? I mean is your typical target customer, are they on a general evaluation cycle that is tilted towards Q3 or a certain time of the year? Or is that not the case given what you're selling is critical, and they're just longer processes in the...

Yes, it's not so much the case anymore. We used to be a little bit more seasonal. Local governments, the majority of them, I don't know, it's 60% or 70% of local governments have June year-end, so different than the federal government with a September year-end. But they kind of happen all over the place. The evaluation cycles, purchasing cycles are long. So we tend to have -- some of our areas like public safety tends to be a market that's very heavy in the fourth quarter. But generally, sales are pretty well spread through the year, and we're much less seasonal than we were several years ago.

Very helpful from a CFO perspective. The other thing that's very helpful from a CFO perspective is to transition to recurring revenue. So you mentioned 80% recurring revenue now. Can you just kind of help level set where you are in that transition? And what's opened up, appetite from the customer side for you and just willingness to adopt cloud-based solutions?

Yes. Another example of the government market being slower to adopt, things that are pretty common in the private sector. So historically, our roots were as a traditional license on-prem model, very sticky maintenance customers. And I think we go back about 20 years when we started providing hosted solutions in our private cloud through our private data centers. I think 2000 was when we started that. We -- over the last 20 years in that hosted solution, we've continued to add customers and customer acceptance or openness to putting systems in the cloud, really in the last 3 or 4 years has accelerated quite a bit. We were always -- described ourselves as cloud neutral or cloud agnostic. We offered products either in the cloud through our hosted model or in a traditional on-prem model, and we let the customer decide. 2019 was the first year that more than half of our new contract volume for new software deals came to us through the cloud. Last quarter, it was 75%. So the market, sort of on its own, has been shifting that way. There are a number of reasons. I think just generally, it's much more accepted. I think cybersecurity concerns and their concerns about their ability to protect some of those systems on their own networks helped drive people there. Generally, governments, like the private sector but maybe even more so, struggled to retain higher-paid market rates for highly skilled IT professionals. And competing with the private sector is often very difficult for them in that area, and they've got a lot of aging workforce that retires. So they really struggled with the resources to running systems in-house. So I think we're increasingly -- those are the things that are helping drive that market demand. At the same time, Tyler has shifted to really a cloud-first approach. And a couple of years ago, we entered into a partnership with AWS to be our public cloud provider -- or our primary public cloud provider, doing a lot of collaboration with them around moving out of Tyler data centers into the public cloud, both with our existing customers and new customers. We've also embarked on projects around our products to optimize them to be deployed in the cloud more efficiently to lower our hosting costs, improve margins around the cloud customers. So as I said, today, the majority of our new customers are coming to us through the cloud. We've changed things like sales compensation. So the sales rep now gets a great -- a bigger commission for selling the same deal in the cloud than they would on-prem. We've got a number of products that are only offered in the cloud, anything we've bought or built in the last 5 years or so, but increasingly are moving to only selling some of our major products in the cloud to new customers. The mix of existing customers is about 4,000 installations in the cloud and about 23,000 on-prem. So we still have $475 million a year in maintenance from on-prem customers. We still have a lot of customers to move. As we've said, by the end of 2023, we expect that all of our major products will be cloud efficient or cloud optimized. And that's really kind of the point where we expect to start to accelerate moving those on-prem customers with an uplift in the revenues. But we really expect that almost all of our new business over the next couple of years will be coming to us in the cloud on the software side. Public safety is probably the one area that is slower in terms of their concerns or their willingness to move to the cloud, especially in -- think about a remote or rural area, where there's not great connectivity and having the 911 system cloud-based is a concern for some of them. I think that will resolve itself in the coming years, but that's the one area that we expect to continue to see more of a licensed business for a while.

Got it. Got it. I want to touch on NIC as well at $2-plus billion, larger size in terms of acquisitions for Tyler, closed earlier this year. Can you just talk through the vision, the complementary aspects there and just the observations you've had since coupling those 2 as the deal closed?

Sure. We closed the NIC deal late April. As you said, the largest deal in the company's history by a wide margin, $2.3 billion purchase price, little north of $400 million a year in revenues. First time we've acquired a public company, so a little bit different process. And certainly doing that all from the time we approached them to the time we closed the deal and financed it, doing everything virtually was an interesting experience. But a really compelling acquisition for us. The 2 companies are highly complementary, almost no overlap in terms of we don't compete. We both serve the public sector exclusively, but mostly different levels of the public sector and we provide different things. So whereas Tyler provides the back-end software that runs these applications. And we're about 85% local government, 12% or so state and less than 5% federal. NIC is 95% state government. And NIC really is sort of the digital front door for government. So they provide the -- generally, under these, they have 26 statewide enterprise contracts. And they'll generally provide the state website and they provide the integration of the connections to all of the back-end systems to facilitate transactions or accessing information with the state governments, often using legacy systems. And if you think about something like a driver's license renewal system, your motor vehicle registration, professional license, hunting or fishing license or campground reservation, unemployment claim, anything you would access the state government for, NIC will provide that access. NIC does that under a transaction sort of model, so they get paid a convenience fee. And generally, if there's a payment involved, they're also doing the payment processing. So there's a payments component as well, and those fees fund that access. So they are very high recurring. Most of the revenues are transactional-based recurring revenues, roughly 95%. They have a handful of software products, an outdoor recreation, hunting and fishing license type system, cannabis management system or cannabis regulatory system, prescription drug monitoring system for state governments, but they're mostly transactional. So highly complementary. And really the -- what we see as the benefits, besides it being a very good company on a stand-alone basis, is the opportunity from a sales synergy or go-to-market opportunities. So we see 2 major opportunities for cross-selling. One is, as I said, Tyler has a number of products that have applicability in the state market, but we haven't really focused on that market in the past. We don't have a well-developed state sales channel. We don't have those long-term relationships. NIC is deeply embedded with the state governments they serve. They work hand-in-hand daily with the CIOs, with the agency heads. They're part of the strategic planning with the governors and the CIOs. So we believe that we can leverage those relationships and leverage their very broad contract vehicles to sell software -- Tyler software into the state market, and that we can accelerate that process by using their relationships and their contract vehicles, which often could bypass the competitive process. On the other side, they have a really well-developed payment business. And that's something that Tyler has talked about for some time about wanting to expand, like a lot of software companies seeing an opportunity to be involved in payments around their customers. Tyler has historically had a pretty limited payments presence, although something we've had a strategy to grow, mostly as ISO, we're a reseller of payment processing services. And so last year, we were involved in about $3 billion of payments for our customers, a really small piece of our local government customer bases' payments, mostly around things like utility billing or traffic tickets, where we have that back-end system. NIC has a really robust payment platform. They processed about $24 billion of payments last year for their state government customers. They have -- are just in the process of getting ramped up on a new contract with the state of Florida to do all of the state of Florida's payment processing. That will add about another $50 billion of payment processing volume to what they're doing. So we want to take their platform, and using our relationships at the local government level, take that processing down to the local level and look to provide enterprise level processing at a city or a county or a school district level. We're in the process of sort of integrating our 2 payments teams and developing that go-to-market strategy, but we think that's something we can start executing on. We've seen a few early successes there. But we -- that's something we think we can start to push down into our customer base in the coming year.

Yes. I mean you mentioned there are many software companies that are aiming to sort of articulate a payment story or kind of move in that direction, but it feels like a very natural extension for Tyler given back-office processes and just all of the sort of core attributes that you're handling for these businesses. So is it a similar story in payments where you're most often replacing something that is just very old or manual? Certainly it feels like, from my perspective, you're probably writing checks still in some of those places. So I'd imagine a payment solution is very attractive from an efficiency standpoint for them.

Yes, we think so. At the local level, it is often replacing a -- it's often a new solution or we would be looking to create an enterprise solution. So if you think about a city or a town, they might be using -- Tyler might have brought them Chase as the processor for traffic tickets. The utility might be using a different processor. The parks and recreation department might have someone else. The licensing department might not take credit cards or online payments. They only get to bring a check down to the office or mail it in. So the idea to bring that all together on one platform, NIC also has a great mobile platform called Gov2Go that facilitates those payments. We're able to facilitate a payment -- a single payment -- a single transaction that might involve payments to different levels of government, some to the cities, some to the county. So yes, we think we can bring a really attractive solution. And in general, we don't think that most local governments are particularly religious about what their payment processing system is, they just haven't had a very cohesive strategy and that we can bring them something really attractive with good economics and with integration already built into Tyler back-end systems as well. So we serve about 13,000 different local governments today and think that there are big opportunities there for us. And for example, in the NIC Florida contract, the contract already provides that local governments in the state can piggyback on that contract at the same terms the state is getting. And Tyler has 400 local government customers in Florida. So those are part of what we're actively engaged with today. And I think last quarter, we signed up a couple, but we're just getting started there. So we're excited about that opportunity.

Great. I think we only have time for one more. There's a lot going on. I think you characterized the business as a long stream, long-standing historical double-digit revenue growth with the EBITDA margins. When we just think about what keeps that going, it sounds like you have a lot of opportunity in front of you. But what would you highlight for investors to just kind of help sustain that profile in the years ahead?

Yes. I'd say we expect to continue to, as I said, to move forward with this sort of long-term cloud transition but to see that accelerate in the next few years, particularly with respect to our existing customer base. We expect our organic growth to continue to be kind of in that high single, low double-digit range. As I said, we think the stimulus is a potential tailwind over the next few years. M&A continues to be a part of our -- in our DNA. We have historically done a lot of tuck-in acquisitions, more on the smaller side with some of the larger acquisitions like NIC or new world a few years ago in the public safety space. And I expect we'll continue to be active in acquisitions. Besides NIC, we've done 4 other acquisitions this year. We're really busy with integrations and all the work that goes around that. So I'd say in the very near term, the bar is pretty high for acquisitions, at least really big acquisitions. But we've got a really strong balance sheet. The new world -- or the NIC acquisition, we had no debt before that. We were fortunately at a really good time in the market and have great financials, and we're able to do a convert, which Wells Fargo participated in. And also 2 tranches of term loans that Wells Fargo also led. So we've got -- we have paid down some of that debt already. We've got -- we're levered at just, I think, 2.4x last quarter of the under 2 at the end of the year. So still a lot of flexibility, and we generate a lot of cash. So we expect to continue to do acquisitions to supplement our growth. And when we buy somebody, it's generally somebody we think we can grow their business faster than Tyler's core growth rate by leveraging our customer base and our sales force. So continuing to invest in both M&A and in our internal product development at a high level over the near term. And we've elevated our R&D spend quite a bit in the last few years, and we're kind of growing into that new level but have a lot of exciting development opportunities underway.

Brian, that's a great note to close on. This is fantastic. You've got a lot in front of you. So I appreciate you spending time, stepping through it with us and appreciate everyone for joining as well. Thank you.

Thank you very much.