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

Hi, everyone. Thanks for joining us this morning, and welcome to Needham's 24th Annual Growth Conference. My name is Scott Berg. I lead our enterprise software and SaaS research efforts here at Needham. Today with us, we have Brian Miller from Tyler Technologies, the company's long-time CFO. Thanks for joining us today, Brian.

You bet. Glad to be here.

I guess to kick things off, why don't you give a brief overview of Tyler for the 1 or 2 people here that might not know who the company is?

Sure, happy to. Tyler Technologies is an enterprise software company, focused on the public sector vertical, exclusively on the public sector. We provide a wide range of essential applications that function -- that power mission-critical applications in the public sector. We have a pretty wide presence across the public sector, historically, primarily focused on the local government levels, cities, counties and school districts but have increased our presence at the state level in recent years, most particularly through acquisition of NIC last year, and have a somewhat small but growing presence in the federal sector as well. We have what we believe is the widest range of software products of any provider for the public sector and the largest customer base in the public sector. So we've got about 27,000 installations of our software products across various levels of government, and we've got a very wide range of products. They range from things like ERP systems, accounting, human resources, payroll, public safety, 911 systems, police, fire and ambulance systems, courts and justice, property taxes, land records and community development, so -- and a number of products for schools as well, so very wide range of products. We've been around for -- in the space for since about 1998. We'll be approaching $2 billion in revenues in the coming year and generate a lot of cash and have a very strong balance sheet. So...

Great. Just a bit of housekeeping, Brian and I are going to run through several questions here, and then we will leave time for audience Q&A. [Operator Instructions]

All right. I guess first one, Brian, you just mentioned NIC in particular. It's been not quite a year since you made that acquisition. Why was NIC such a good fit for Tyler?

Yes. So made the acquisition at the end of April, so about 9 months ago. It was, by far, the largest acquisition in Tyler's history. It's a $2.3 billion purchase price, first time we've acquired another public company. We've done a lot of acquisitions, probably approaching 50 acquisitions over the 24 years I've been at Tyler. And it was really intriguing for us in that it was almost -- even though both companies were exclusively focused on the public sector, we're almost entirely complementary. There's almost no overlap between the 2 companies. So from a customer base perspective, as I said, Tyler is -- primarily serves local governments. About 85% of our business is local; and a little north of 10% with states; and about 5%, federal. NIC is about 95% state government and about 5% federal and almost no presence at the local government. The -- what we offer local governments is also pretty much completely complementary, whereas Tyler provides the back-end systems that actually manage applications for governments. The NIC is really the largest provider of digital government services, so they provide at the -- primarily at the state level digital access to governments, so the -- all of these back-end systems that governments are using at the state level. And I see through these very broad enterprise -- state enterprise contracts provides access for citizens or businesses to transact business with governments. So as you think about renewing your driver's license or your motor vehicle registration or getting a hunting and fishing license or applying for a professional license, those kinds of things that you would do with government, NIC provides the portal for you to conduct that transaction. So it provides the interface to those back-end systems, some of which could be a Tyler system. And in the future, we think a lot more of those will be Tyler systems. And they get paid through transaction fees, so getting a convenience fee or a transaction fee associated with that. And they also are the largest payment -- provider of payment processing for state governments, so they generally would also process that payment and make a fee on the payment processing as well. So 2 different types of revenue streams, very different from what Tyler does but very complementary. So we believe there's significant cross-sell opportunities, kind of going in both directions. So a tremendous opportunity for Tyler to leverage these very broad contract vehicles that NIC has and these very deep relationships across their 26 state enterprise contracts to sell more Tyler software in the state governments. We have a lot of Tyler products that have applicability at the state level, but we haven't had the same penetration that we do at the local level because it really hasn't been our focus for a long time. So we don't have those deep relationships at Tyler. We don't have those sales organizations. So we believe we can leverage the NIC relationships to accelerate the sale of Tyler software products in the state governments behind those NIC contracts. And then Tyler for a long time has had a very small payments revenue stream with our local government customer base, mostly involving reselling payment processing services and mostly involving systems that Tyler has at the back end, like utility billing or traffic tickets. So we have provided payment processing and have a revenue stream of -- a little north of $30 million from convenience fees and our share of payment processing fees. But we've had a desire to grow that but, again, really haven't had that deep technology platform around payments or that deep experience that NIC brings us. So they've got a very robust payment platform. They processed in 2020 about $24 billion of payments versus about $3 billion that Tyler participated in the processing of, so a much different level of technology, a different level of volume and experience. And so our goal is to take that NIC payment platform and drive it into the local government market through our relationships and significantly broaden the payment processing business that we have at Tyler.

Got it. On the NIC side, the one thing that I think is interesting is I've always talked about how your customers kind of stayed for a long -- really long time, your core ERP customers, along with others. But NIC might be the one company in the space that has customer relationships that maybe -- or even longer than Tyler's. I think you just renewed a 17-year relationship at Colorado. I think you've extended another year. But why do those customers tend to stay so long on the NIC platform?

Well, I'd say for starters, NIC is really good. They've been doing this for a long time as Tyler has. We're a public company for quite a while before the acquisition, and they've just built out a very robust platform. Each state organization has a dedicated team that's on site at the capital location that is focused on the needs of that state, and they work very, very closely with the CIOs, with the governors' offices, with the heads of agencies to provide them with the services they need, and some of those things are common across states. So one of the common services is providing access to driver history records for insurance companies. That's one of the big revenue generators that helps fund these overall portal relationships. But I see us invested significantly in technology. We believe we can help them continue to increase the efficiency by bringing some of the Tyler software platforms, particularly our MicroPact platform, to bear in some of their development efforts. But they have these very strong relationships. They perform at a very high level. It's a self-funding model. So typically, the state is not writing them a check. These are being funded by users. And NIC continues to work with the states to build out new services and connections to more back-end systems. NIC has also built out a relatively small software business within their portal business around some applications like outdoor recreation, hunting and fishing licenses, cannabis licensing, prescription drug monitoring where they actually have software applications that are common across states, and we look to kind of grow that as well. But I'd say the short answer is they do it really well. They have a high customer touch. And then, as you said, they've had a lot of success in developing very long-term relationships. You pointed out the one of the recent renewals that we've also renewed in the last year, Utah, Idaho, both 22-year relationships or in a 10-year relationship. They typically has, like Tyler, low customer attrition and nice organic growth within a state contract once they become a customer.

Okay. Moving on from NIC just a little bit. I think the question I've received most frequently as of late is the impact of the stimulus funds in the '21 COVID stimulus bill and what it might have to both your business and your customers there. I guess there's a couple of questions here is, one, do you know if these customers have received any of these funds? And if they have, how are they thinking about maybe deploying these? Is it a -- maybe a straightforward ERP upgrade? Or is it going to be something a little bit more on the minutia, some smaller bite-size opportunities for you?

Yes. The stimulus has had a -- just a couple of components to it. Early in COVID, there was the CARES Act, which provided, I want to say, around $125 billion of aid to state governments and very large local governments. So it wasn't as widely dispersed. It was more limited or restrictive in what it could be used for. It's really meant to help them offset some direct costs related to the pandemic. And that was really kind of used -- received and used through last year, so it wasn't as widely distributed. And I think the impact of that, as well as the next round, the American Rescue Plan Act, initially helped our customers have more confidence in their budget and be comfortable that they weren't going to have big shortfalls that they feared kind of early on in the pandemic. The second round, which was in 2021 or passed in 2021, the American Rescue Plan Act, provided a much larger pool of direct relief to state and local governments. It was about $350 billion of aid to state and local governments, another $167 billion of aid for schools, and then there's some cats and dogs for cybersecurity and unemployment modernization. It is pretty widely distributed. Basically, every state and local government in the country is getting some piece of that, obviously depending on their size. It's not very restrictive in terms of what it can be used for. They can't use it for things like funding pension plan shortfalls, but it's really very widely -- other than that, it's really pretty -- not very restrictive on what they can use it for. They got half of the money in 2021. They get the other half in 2022, and they've got until the end of 2024 to spend it. So what we've seen to date appears to be that very little of it has been spent or even really committed at this point. I think they're still -- in most governments, there's still a lot of discussion in -- around how that's going to be spent. I think they've started spending some bits and pieces of it, but it's largely unallocated yet given that they've got until the end of 2024 to spend it. So we really see it as being a tailwind in our business. It's clearly being a positive because pretty much anything they could get from Tyler would be fair game for spending under their stimulus funds. We believe that the sort of IT modernization, systems upgrades will get at least its proportionate share relative to a budget. But very likely in a lot of governments, it would get more than its share. There's certainly been a lot of focus through the pandemic, increased focus on something that's certainly not a surprise to us. But there are a lot of aging government systems out there, many of which have not functioned effectively during the pandemic in a remote work environment, in a -- where online access is more important, remote access, a lot of these systems. 40- or 50-year old mainframe systems just have not had the capabilities to provide that kind of access, and we believe that a lot of systems that might have otherwise soldiered on within the government for many more years are now going to be replaced sooner. That doesn't mean in the next quarter or 2, but we believe some of those processes will start. And as we look out over the next roughly 3 years that these rescue plan funds are available that it will provide a tailwind to our business. We have seen certainly some early sales that have been identified as specifically funded with stimulus funds. We're trying to do as good a job as we can of tracking those. It's not always apparent that it's directly funded by stimulus funds. Maybe they're used for something else that helps free up funds for a project from Tyler. We have a very active inside sales organization that's engaged with our existing customers. They're selling them additional things from Tyler, and we certainly circle back to customers that we've had discussions with about products already where there may have been a budget issue in the past and seeing if those can move forward more quickly; and then also with new customers and prospects, seeing if there are opportunities to accelerate some of these things that might already be on their road map. I think we said at the end of last quarter, we had identified in the quarter a couple of dozen deals that were specifically identified as funded with stimulus funds. But as I said, I think we're just kind of at the very beginning of seeing those funds spent. We still go through, what, in our space are typically pretty long buying cycles. So we'd expect that even as there's interest in some of these things with new customers more so that you might be a year away from actually seeing contracts on some of those. With existing customers, inside sales that's -- that can be a little bit quicker, and I think that's where we've seen most of the early activity.

So it sounds like you're not expecting all of the spend to come out maybe in a quarter or 2. It's something that will come out over a multiyear period to benefit the overall part of the business. That's a question -- I know I've received a lot of this. It will be a big bang or something that will be more of a slow drip probably.

Yes, absolutely. It's more the latter.

I guess as you look across your product portfolio today, how normal is, I guess, your general demand trends across each of the individual areas versus what you saw maybe in '18 and '19 before we got ourselves in this -- into this fun?

Yes. The demand is -- I think we generally characterize it as pretty normal. The activity in the marketplace, the pace of sales, we certainly -- starting in 2020, we saw a slowdown in those as governments were focused on other priorities like public health and public safety. Governments were adapting to remote work, which, in many cases, they struggle with, just like the private sector, so a lot of deals. And they had budget concerns. And so even though they might have had a budget in place and have been prepared to start moving forward with the implementation of a new software system, they didn't have a lot of confidence in those, around their concerns around what the impacts might be on revenues and what the extraordinary expenses might be. And so we saw sales processes paused, slowed down. On-site demos and on-site sales activity ceased. We saw particularly early-stage opportunities where we expected an RFP to come out in 2020 but it didn't because of those conditions I described. And then as it became apparent that things weren't going to be back to normal in a few months and also it became apparent that the impacts on local government budgets weren't as bad as they feared. Most local governments would be primarily funded by property taxes. And in many cases, more than half of their budgets come from property taxes. And as we all know, property values in most places remain very strong, and property tax are not under a lot of pressure. Other revenues weren't as deeply affected as governments feared. And of course, now there's stimulus money that gives them a lot more confidence that they're sort of being made whole for any issues they've had. And certainly, the amount of the stimulus is much, much greater than the actual impact of COVID on government budgets. So as those fears sort of start to be alleviated, the activity resumed remotely. Those processes that were already underway resumed and sort of returned to normal. And what we said over the last 2 or 3 quarters is now we've seen the new business activity, sort of those pent-up RFPs, coming back out, things starting to move along. We've done remote demos, remote site visits. Those things, we've all adapted to pretty well. And now actually, on-site sales activities have resumed. Trade shows, which pretty much stopped during 2020 and through most of 2021, are now coming back. So we've said across most parts of our business, we described the activity as at least back to pre-pandemic levels or normal. And in some cases, it's above pre-pandemic levels. So as a broad characterization, I'd say, it's at least normal now, and in some cases, a little bit above that.

Just as a reminder for everyone, we're going to take audience Q&A in about 10 minutes. [Operator Instructions] I guess along the pandemic lines is did the pandemic caused customers to maybe reevaluate their depreciation schedules? Your customers tend to take a long time to make upgrades and squeeze a real last drop out of it. But knowing that some of those kind of older products probably were not "maybe cutting it" in a work-from-home world, do you see maybe any of that today? Or is that not quite trickling in maybe?

Yes. I think we've seen some early signs of that. I kind of allude to that a little bit earlier. But yes, in our space, it's typically normal that governments wait to replace the system until it's just about on its last legs. Governments are not profit motivated. They're not ROI driven. They would like to be more efficient. They'd like to provide better service to the public. And the public, I think, increasingly demands a more consumer-like experience when they deal with governments. But at the end of the day, governments don't have competition, and they don't have to have to provide those things. You don't get a choice where you pay your traffic ticket or your property tax bill. But -- so they typically are waiting until systems are very close to end of life before they look to replace them. What I do think we've seen in the last couple of years is that some of these systems that were old and admittedly not state of the art, not providing some services or functionality that would be considered pretty normal today, but they might have thought those had 5 or 10 years of life left in them. But they did not proved to work effectively in a remote environment or during the pandemic. So you think about a mainframe court system that is 40 years old that only works if the users are at their desks, at a terminal that's wired to the mainframe. It doesn't have online access for citizens, doesn't provide the capability to do a remote jury pool selection or to hold a virtual trial. That -- courts in a lot of places were pretty much dead in the water. They were shut down, except for trying to keep very essential things going, as long as the building was shut down and workers couldn't come in and work in person. So those -- and Tyler has applications like a virtual ports application that we had rolled out that many of our customers were able to implement pretty quickly. But in terms of these -- a full system replacement, I think there's been a lot of patching and some workarounds. But we do believe that there will be systems that otherwise might have been 5 or 10 years down the road before they were seriously considered for replacement that are being considered for a replacement much sooner than that. And certainly, the stimulus funds give them additional capability to think about doing that. We've seen a lot of add-ons of -- and opportunities around things like our Socrata data and analytics platform that works with our systems to provide better data, to make better decisions, and we've seen that become a much higher priority. And governments sort of moved from thinking of that as a nice to have to something that is more crucial, so we've seen a lot of add-on sales around that. And I think around the NIC business, it's also been -- clearly, a positive there. What they do is provide digital access. And so often, they're providing that access online to something that -- someone would have gone down to the DMV office, for example, to do in person. And so now they either don't want to do that or can't do that, so it is driving higher volumes in many of the NIC services. And we expect that, that will only continue. But more and more people will want to do business with government the way they do business with the private sector, and that's online.

Got it. I think one of the things that's been maybe a little buried with all the pandemic focus the last couple of years is the company's push to be cloud-first company. I remember we did a non-deal road show in person back in calendar '19, fall of '19 when those things were actually in person. And I know that was a big emphasis on that road show was how -- I think it was going to be calendar '20 was the year that you really kind of tried to be a cloud-first entity and pushed that first in your sales processes. But now that we're a couple of years past that, how accepting is the customer base of that delivery model because you've always had some that have been a little reticent to that delivery model? And I think at least some of the investors out there are just trying to understand if those customers are truly ready for a cloud delivery model.

Yes. Tyler's had a sort of a hybrid model for a long time where we've had both what was long ago our traditional history with primarily a license on-premises implementation and the maintenance stream and then began to offer, really going back about 20 years ago, a hosted model, a subscription model where the solutions were hosted at a Tyler data center paid for on a subscription basis. And so we were for many years, sort of neutral or agnostic in terms of how we sold software to customers. We let them choose which way they wanted. Government with this, as with many things, is slower to adopt things that are common in the private sector, slower to change. So it's been a very gradual adoption over a number of years in terms of customers increasingly moving towards the subscription model. I think there are a number of factors around government operations that have increasingly made it more attractive to government customers. Probably, the biggest one being around their ability to manage their IT infrastructure, their ability to hire and retain and pay market rates to people with the IT skills that are needed to run these systems. Just like with the private sector, there's a lot of competition for those jobs. And it's -- I think as governments see more and more retirements of aging workforce in the IT space, it's harder and harder for them to fill those jobs. And so the subscription model or the SaaS model becomes more attractive to them. So I think 2019 was the first year that more than half of our new software business get on this -- close around this cloud-neutral approach came to Tyler through the subscription model. That has continued to increase. Last quarter, I think it was about 75% of our new software contract volume was subscription based. And as you said, really going back to a couple of years ago, we really shifted our approach from cloud neutral to cloud first. And so we had a strong preference for the cloud. Certainly over the life of the customer, it generates roughly twice the revenues and higher margins in the long term. And so we entered into a relationship with AWS a couple of years ago, which became our primary public cloud partner. We're looking to move sort of out of the hosting center business. And ultimately, Tyler has 2 data centers that we would look to shift our existing customers into AWS and then are pretty much putting most new customers into AWS now at this point. So it gives us much more capacity and ability to accelerate that change. We announced a couple of years ago also that we were making significant investments in the products to optimize them to be more efficiently deployed in the cloud. Many of our products were architected to be deployed on premises, so they're not efficiently deployed at AWS and don't really take advantage of all the efficiencies we can get from being in the cloud. So we're working through projects of optimization. We said by the end of 2023, we really expect that all of our major products will be fully optimized. They'll be fully cloud native. We're optimized for deployment in the cloud. And we have increasingly -- pretty much anything we've bought or built in the last 5 years is cloud native or cloud only. But we announced -- over the last couple of months, we've announced to our clients that several of our major products are now only available to new customers in the cloud, so there's no longer a license on-prem option. And so yes, we expect that over these next couple of years that they'll continue to be a more accelerated transition We expect that licenses, which are now a single-digit piece of our revenues, will continue to -- will start to decline, certainly replaced by a much higher level of new subscription growth and that we'll be able to accelerate the migration of the 20-plus-thousand on-prem customers that we have into the cloud and ultimately significantly increase the revenues from that customer base.

All right. Last question for me and happy to turn it over to any audience Q&A is I've been covering Tyler for, I think, 9 years now. It sounds like a long time, I know. But I've had the chance to see a lot of -- I guess a lot of different kind of phases of the company. You -- the company had 20% organic growth quarter or roughly. During the California courts and justice opportunity, that big cycle, I've seen big cash flows. Margins expand a lot. But I think the item that most investors are trying to understand is what's the right organic growth rate of the company maybe over the intermediate term? Because you have a lot of pushes and pulls. Demand seems to be normal. But a cloud transition might give you a little bit of headwind around growth, just in terms of what the rev rec looks like. But we talked about maybe pulling forward some of those demands because some of the sales or usage depreciation cycles might be shortening is. When you kind of balance all of that, how are you all thinking about the next 3 to 5 years?

Yes. You're exactly right. There are a lot of puts and takes there. Historically, we've talked about Tyler having an organic growth rate kind of in the high-single, low double-digit range, so kind of 8% to 11%. And going into 2020 pre-pandemic, our guidance was kind of on the high end of that. It was kind of 10%, 11%. NIC has historically had what they call same-state growth, which was sort of a proxy for organic growth. So within a given state, around 8% growth a year, so a similar kind of a growth rate within the NIC business. And so we -- that's kind of where we've historically looked at. You're correct that the SaaS transition has been gradual for us as we accelerate that. Likely, it has been over the last couple of years and will be in the near term a little bit of a headwind to revenue growth because -- as I said, even the licenses are now a single-digit piece of our revenue base. It's still $70 million of almost very high margin revenues. So to the extent those decline and are replaced by a much faster growth in ARR, there's still a little bit of a lag until that ARR catches up. So I think there's a little bit of a headwind there. I'd say the market activity probably puts us a little bit more at the high end with potential tailwinds from the stimulus. So I'd say all that put together still probably puts us in that 8% to 10% growth range. But as we move out of that, there's certainly a potential for outperformance there. But I'd say we're pretty comfortable saying that all those things put together still have us in that low single, high double-digit organic growth range. And we still expect to have an active M&A program, even though -- in addition to NIC, we had 4 other acquisitions in the last year. We're focusing a lot of attention on getting those integrations right. And so the bar is probably a little bit higher on acquisitions for us now. I do expect that we'll continue to supplement it, our growth with acquisitions. We've got a lot of capability around our balance sheet and internal capabilities that I think we'll still be active in M&A as well.

We'll take one question here on international is how has the company's international strategy changed at all? You've had some opportunities to likely get involved with, whether it's Australia or maybe the U.K. or some other English-speaking countries. But with NIC or some of your other acquisitions, is that maybe a higher focus going forward?

Yes. I don't think in the near term it's really a higher focus. We've always been kind of opportunistic about it, where we do have some products that have international opportunities. Primarily in the past, it's been our Courts & Justice suite of products and a property tax suite; as you said, English-speaking countries, Australia, Canada, the U.K., where we've had some opportunities. And I think that's primarily the focus. We've got a lot of runway in the U.S. We've got a lot of focus on the cloud transition. So I'd say we'll still be pretty focused in terms of primarily being domestic and looking for really good fit opportunities for international in a -- in some very targeted product groups. We do have products, particularly some of our SaaS-based products like Socrata data and analytics, the MicroPact platform that I think have some international growth opportunities, but I'd say that's not our highest priority right now.

I guess we'll have time for one more here because we're -- session is almost up is on R&D investments. R&D investments have been at a, we'll call it, an elevated level over the last several years, trying to integrate different acquisitions. Should R&D spend remain at the current level or we grow into it and be able to drive margins higher from that area?

Yes. I think over the mid to long term, there is an opportunity for us to leverage R&D. And we did have an elevated level, particularly around some of the acquisitions like Public Safety. 2018, 2019, we ramped it up quite a bit. We expected that we would sort of start to grow into that new level as we wound down some of those projects. Some of that funding now has been shifted into the -- as we completed some of those projects has shifted into the cloud transition. So there's some additional R&D around that. So I'd say in terms of dollars and percentage of revenue, it's probably going to stay pretty much around where it is in the short term. So I don't think there's another step-up. But I expect that as we move to this cloud transition, we'll continue to have R&D around the current level, particularly as it relates to as a percent of revenues. But I think in the long term, there is an opportunity as -- particularly as we move more of our products in the cloud, we're supporting fewer versions of products, we sort of rationalized our product base around that cloud transition and that there is long-term leverage and margin improvement around the R&D line.

Well, with that, that's all we have time for. Brian, thank you so much for joining us today and wish you luck in all your meetings today. And we'll chat on the fourth quarter call coming up.

Thanks a lot. Good to be here.

Thanks, everyone. Enjoy the conference.

Thank you.