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

Excellent. All right. We will go ahead and get started. Good morning, everyone. My name is Joe Goodwin. I'm a research analyst here at JMP Securities. Today, we are very pleased to have Tyler Technologies. And from Tyler, we have CFO, Brian Miller. Brian, thank you so much for being here.

You bet. Thank you for having me.

Excellent. I guess, first off, for those who may not be familiar with the story, could you just give us a high-level overview of who Tyler is?

Sure. Tyler is an enterprise software company, vertically focused on the public sector market. We have a very wide range of software products that automate mission-critical functions of government, historically primarily focused on the local government level, but increasingly in recent years have added more business at the state and even to some extent, the federal level. We have what we think is the broadest line of products for the public sector and the biggest customer base in the public sector with about 27,000 implementations across around 12,000 or 13,000 different jurisdictions.

Great. Thank you for that. I guess we'll start off with how's business? What would you say?

Business is really pretty good. The public sector tends to be, in general, a pretty stable and steady market. There's never explosive growth, never hyper growth, but it also doesn't really go backwards. Governments have typically lagged behind the private sector in a lot of things, including adopting new technology because governments are not profit motivated. They don't have competition. They don't buy systems based on an ROI case. They really typically wait until their systems are at end of life before they replace them. So that tends to not be affected as much by more general economic conditions or other factors. So we certainly saw a pause in new business. Things slowed down during 2020. Going into 2020, we were expecting to have north of 10% organic growth, and we ended up about 2%. But mostly, deals that were just delayed as governments were dealing with the pandemic, concerned about budgets, focusing their attention elsewhere. But now really, things are kind of back to normal. And we've seen activity return to or exceed pre-COVID levels, have seen a nice uptick in RFPs and market activity, governments. We weren't as affected as much by the pandemic as they feared, I think, in 2020. And so the economic background is really pretty good. Local governments are primarily funded by property taxes. Typically, more than half of their budgets come from property taxes. And as everybody knows, real estate values are pretty strong in most places. There's not a lot of pressure on property taxes these days, and so the demand is good. The backdrop is good, and we're seeing a lot of activity.

Excellent. Excellent. And then I guess there is obviously a component of the federal stimulus money. Can you just kind of remind us, I know there's 2 kind of tranches of that, what those are? And then how much of it was dedicated to state and local governments and how much is available now and when must it be spent?

Sure. There have been a couple of rounds. The CARES Act was in the early days of COVID. It was really limited to state governments and about 150 of the largest cities and counties. And it was more restrictive in what it could be used for. So I don't think we saw a lot of direct impact from that, although it did provide some relief to governments and give them more confidence around their budgets. The rescue plan from last year is a much bigger stimulus program, provides about $350 billion of direct aid to state and local governments and about $167 billion for schools. It's very widely distributed. So basically, every government gets something. It's not very restrictive on what they can use it for. They got half of it last year, they get half of it this year, and they've got until the end of 2024 to spend it. So we expect that it will be a tailwind to some extent over really the next 2 or 3 years. Our sense is that most governments have not spent or even committed most of the money yet. They're still going through the process of evaluating what they want to use it for. We do believe that IT upgrades, software systems improvements will get probably more than their proportional share of the stimulus money. Certainly during the pandemic, the shift of remote work was something that governments in general were probably less prepared for even than the private sector. A lot of issues that had resolved around a lot of these aging systems that governments had. And so our sense is that systems that a government might have thought they knew was old, was not state-of-the-art, didn't have features and functionality they'd like to have, but it was good enough to get by for maybe another 5 years or 10 years or 15 years. But in the environment we've been in for the last couple of years, they're finding that those just are not functioning effective, where you think about a court system that is a 40-year-old mainframe COBOL system that only works if the users are at their desks in the courthouse. And that wasn't possible. So those systems were sort of dead in the water, the courts couldn't operate remotely. And so I think what we're seeing are governments saying, I'm going to need to replace this sooner than I thought. There still is a lengthy sales process, a lengthy evaluation process typically. But the fact that this really large amount of stimulus is available as well as the increased focus on some of the shortfalls in these systems, I think, will potentially provide some acceleration of replacements sooner and then we're likely to see that over the next 2 or 3 years.

Awesome. Okay. Thank you for that. And I guess just staying on the end market. How would you characterize kind of the appetite change of your clients to go lean into cloud solutions over the past couple of years? And then that will kind of segue us into -- obviously, you're communicating on your last call entering a more accelerated kind of SaaS transition. And you discussed a lot of the key points there around the financials on the last call, but what are the key things you're putting out today?

Yes, a common theme, like a lot of things, government has been much slower to embrace the cloud than the private sector. And so we've had, I guess, what I'd describe as a very gradual transition to the cloud over more than 15 years. We started offering sometime back some of our solutions in a hosted model paid for on a subscription. Traditionally, we were more of a license and maintenance model with on-premise deployments. That -- and we were -- we've been cloud neutral or cloud agnostic. We've let customers decide they can either have the product on-prem with a license or they can have it in the cloud and a subscription for the most part, a hosted model. We have a couple of data centers where we host our cloud customers. It's a private network. They're mostly single-tenant architecture. So we're not really getting all of the full benefits of a cloud deployment. But that adoption by our customer base has been very gradual over a long period of time. 2019 was the first year that more than half of our new customers chose the cloud. That has accelerated pretty rapidly over the last couple of years. Last quarter, I think it was more than 75%, and we expect it to be more than 80% this coming year. And so really, a couple of years ago, as part of that transition, we really signaled that we were adopting a cloud-first approach as opposed to a cloud-neutral approach. I would say that pretty much anything we have bought or built in the last 5 years has been cloud-native, multi-tenant applications. But our -- a lot of our core products that were originally designed to be deployed on-premises aren't really cloud efficient. They have a heavy footprint. They're single tenant, as I said. And so we, a couple of years ago, launched several work streams. One of those was entering into a partnership with AWS to be our primary public cloud provider and to work towards really migrating from having our own data centers to having customers deployed at AWS. And so over the last couple of years, we've been working on sort of piloting each of our products, and we have a lot of products. So we've been working on piloting those in AWS environment. We're now starting to put new customers into AWS, very early stages of migrating existing customers out of our data centers into AWS. We also launched some major development efforts around optimizing our products to be more efficiently deployed in the cloud. And in some cases, that's rewriting products in a cloud-native, multi-tenant architecture. In other cases, it's making changes to the existing architecture to take advantages of some of the features in the cloud and be more efficient and run at lower cost. And we're pretty well along with that. We said by the end of 2023, we expect that all of our products will be optimized for the cloud. So we're really starting to accelerate that move of both new customers into the cloud and to start the process of moving at a faster pace our existing on-premises customers. So we have about, as I said, about 27,000 installations of our products. About 5,000 or so are currently in the cloud and 22,000, 23,000 are on-premises. So we've got a big revenue uplift opportunity over time as we move those on-prem customers. Typically, the subscription is, I'd say, anywhere from 1.7x, 1.8x to a little more than 2x what the maintenance is. So we have about $475 million of annual maintenance right now that should become closer to $1 billion of subscriptions as those move over. This year, actually, our subscription, our SaaS revenues should either be very close to or exceed our maintenance revenues for the first time. So there's some investments involved around that. There's some margin pressure in the short term. We've said over the next couple of years, we're going to see some margin pressure from a couple of things. One is duplication of costs because we've got fixed costs around running our own data centers. And until we can get out of one of those fully, we've got some costs that are being duplicated in AWS. And then the impact of declining licenses. Even though it's a mid-single-digit portion of our revenues today, it's virtually all margin. And so as those shift, as we go through this transition over the next couple of years, there's a little bit more margin pressure. We've said that -- we think that the trough or the bottom of that impact will be in 2023, and then we would expect to see accelerating revenue growth and accelerating margins from that point forward. But even given this transition and the acceleration, we feel really good about our revenue growth. I think the midpoint of our guidance for this year is about 9.5% organic growth, mid-teens overall growth. So I think we're managing through that revenue pressure pretty well, and that really reflects the activity we're seeing in the market.

Got it. Excellent. Thank you for that. And I guess you've talked about a framework in the past around that kind of high single digits, low double digits organic growth. As we get through this transition, will that hold true? Or do you expect it to be above? Or is this kind of the...

No. I mean, historically, we've been kind of in that kind of 8% to 11% organic growth and in a market that grows maybe 5%, 6%-ish, we think that's pretty good. We typically have -- win more than our share of business. We have high win rates, continue to expand our product offerings, whether through acquisitions or internal builds, have a lot of cross-sell opportunities with our existing base. So yes, we think that as we get to the transition, that still holds true and that there's the potential opportunity for us to be more on the high end of that or potentially exceed that. We talked about Munis, which is our sort of our high-end ERP product, and it's a little bit further along on that transition than some of our other products. But they grew about 8.5% last year. About -- they'll grow about 8% this year, so below Tyler's overall growth rate. But we've announced it starting January 1 of this year, we will no longer offer that product in a license model, so they'll see the impact of that this year. But in our early look at kind of 2023 is that they grow 11%. So kind of as you get through that, we've got different products that are on different time lines that we think there's an opportunity to accelerate. And as we move customers to the cloud, when we've got this uplift from maintenance to subscription, so we also -- it creates an upsell opportunity, an opportunity to sell more products to that client as they move on from on-prem to the cloud. So someone, for example, that has a court system from us that's on-prem, as they move into the cloud, gives us an opportunity to add something like our jail system or our jury system or our probation system that they might not have that might be from other vendors that might also be on-prem. And now they've got an opportunity to have that all in one integrated solution that's all hosted in the cloud. So we think -- and again, without a big upfront capital outlay. So we think that it should have a positive impact on the upsell opportunities.

Excellent. And obviously, you do have a ton of products. You've recently done a new brand architecture just last month. I guess, what is the key points you make around that [ opportunity ]?

Yes, we just announced a few weeks ago this launching of a new brand architecture. It's really about, one, naming our products and grouping them in portfolios that more accurately sort of represent the sub-verticals we serve and the end markets that we serve. So we have a lot of product names that have come from acquisitions or just have been around for a long time that don't really -- don't necessarily mean something. So Odyssey is our court system. Now that's the prior name. Now it's Enterprise Justice. And so we have names that maybe make our products a little bit more easily understood by our customers and our prospects, and it scales better. As we make more acquisitions, we have more names and more product logos. And so it's really an architecture that reflects how the company is structured today and how our products have come together over the last few years.

Got it. So it just kind of cleans it all out?

Yes.

Got it. Okay. And then you closed the NIC transaction in April last year. It seems to be going very nicely. I guess, how would you say it's going? What are some of the key points you make around the combination of the 2 businesses?

Yes. So NIC was an acquisition we made last April, by far, the largest acquisition in the company's history, and I've been with the company for -- this is my 25th year. We've done about 50 acquisitions over that time period, a lot of tuck-in acquisitions. But NIC is the first time we've acquired another public company. It was a $2.3 billion purchase price. NIC was roughly 20% our size. And now we're coming up on the year anniversary. And yes, really, really pleased with the way it's gone. The companies were just incredibly complementary, both in terms of the products we offer and the markets we serve, both solely focused on the public sector. But whereas Tyler provides the back-end solutions that run these functions of government, NIC is more focused on the front end. So NIC provides basically digital access to government mostly at the state level. So Tyler is about 85% local, a little over 10% state and less than 5% federal. NIC is 95% state, about 5% federal and almost no local. So NIC provides the digital access and the digital front end to government to access these back-end systems for citizens or businesses. So they typically provide under a very broad state enterprise contract, and they have, I think, 28 of those provide the state website and then provide the interfaces to all these back-end systems. So for example, to renew your driver's license or your license plates or get a hunting and fishing license or for an insurance company to access motor vehicle records to set rates, NIC provides that access and NIC gets paid by transaction fees. So you may pay a $3 fee to get a new driver's license or $5 to get a fishing license. NIC also has a really big payment processing business in association with that. So they would typically also process the payment and get a percentage of that as well. So in 2020, NIC processed about $25 billion of payments for state governments, primarily state, a little bit of federal. And then has a new contract to do all the payment processing for the state of Florida that will add about another $50 billion of processing on top of that. So really, there's a couple of opportunities for us besides it just being a really nice business that we acquired at a reasonable valuation. One is cross-selling Tyler products into state government. So Tyler has a lot of products that have state government applicability, but we have not focused on that market in the past. We don't have the relationships or the sales organizations there. NIC, as I said, has these very broad contracts, and they are very deeply embedded with the state CIOs, with agency heads, because they're core to the accessibility to information transactions there. So we believe we can leverage those relationships in those contract vehicles to sell Tyler products into the state governments, and we've seen some early successes there. The second sort of cross-sell opportunity is really kind of going the other way. So Tyler has thousands of local government customers. And we had a sort of an early-stage payments business where we had -- we're trying to be more involved in providing payment services to our customers, mostly around Tyler back-end systems like utility bills or traffic tickets. And we were basically a reseller of Chase Paymentech or a couple of other payment processor services, so we'd get a few basis points off of each transaction. NIC is kind of farther up in the payments chain and they actually are the processors so they keep more of the payment. So our goal is to take that NIC payment platform, which is really robust. They've got a really strong mobile platform called Gov2Go. Really strong capabilities that are focused very much just on government needs, really strong reporting. So to take that and drive that into our local government base on an enterprise basis. So not just trying to do payment processing for utility bills, but to do the payment processing for an entire city or a county. And so we have combined our payments teams, mostly under the NIC's leadership, and now we're kind of developing our go-to-market around that. So we look to significantly expand the payment processing business within Tyler for the next couple of years. And now we're kind of actively going after that.

Awesome. It sounds like it's going great. So we have a couple of minutes. I'd love to open it up to the audience if there's any questions. Doesn't look like it. I guess...

There's one.

There we go.

Can you talk about your AWS partnership and maybe the impact that's had on your partnership with [ banking ]?

Yes. The question is about our partnership with AWS. And as I said, we entered into that a couple of years ago. We recognized that we didn't want to keep building out Tyler data centers for a number of reasons. One, it had -- we really were reaching capacity. It was a continuing increase in capital spend, just we're not able to scale at the same rate. The public cloud environment has become much more competitive between AWS and Microsoft and the other providers. So the pricing had gotten a lot better, and we have a very attractive large customer base that they'd like to build relationships with Tyler sort of as the lead-in to that. And cybersecurity continues to be a bigger and bigger issue around our own data centers. And certainly, we have what we think are much stronger capabilities there than our customers believe they would have on their own in their own data centers. But AWS is on a different level as well there. So we talked to all of the providers and ultimately felt a really good fit with AWS. So that gives us now basically unlimited capacity to accelerate both moving new customers into the cloud and that, again, moving that big customer base of ours. So they've also provided us with a lot of resources, whether it's developer training, helping fund some of our product transition, marketing assistance as well. So they've given us some financial support around that as well. And it's been a really good partnership. They have a very strong government cloud and FedRAMP capabilities. And we have a -- we're about 98% domestic, just about 2% international and don't really expect to grow the international business significantly in the near term. But we've also had issues where international customers need to be hosted in the country where they're located. Canada is one of those. And obviously, they give us a capability there. So it's been a good partnership, and we look forward to moving many more customers into AWS.

Great. Well, that basically takes us to time.

Okay.

Thank you so much, Brian. Really appreciate it.

With that, good to see you.

Yes, likewise.

Thanks.