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

It's like records management systems, CAD 911 systems, platform technologies. That's something that's somewhat new to us. That really entails our -- what we call our data analytics platform. It also encompasses our web portal business that's really done at the state level. That was through a recent acquisition of NIC as well as some platform business that we do at the federal level through our entellitrak platform. Appraisal & Tax, about 6% of our business. Civic services, things like permitting and licensing, a little bit smaller. K-12 schools, it's a little bit assist. It's mostly school transportation business and then other things just like recording and things like that. Because what we do is really essential to the operations of the public sector, our business is a very sticky model. And you can see here that our customer retention rate on a name basis, named client basis, is about 98%. If you actually look at what our retention rate is on a dollar basis, on a pure gross dollar, it's more like 99%. But if you think about a net dollar, which is added increases in maintenance, increases in SaaS, cross-sells back in the base, it's well over 100%. So when I look -- think about Tyler and I think about the last 24 years, I sort of think about different phases of our history and to us, we're sort of going into what I'd call a more -- a new phase. And in the early years, we were really focused on building out sort of our core application products, the things that were going to be the foundation for Tyler's success. These are our flagship products in enterprise ERP software, courts, tax like -- and tax systems. And our approach, really, through the early years, really, until most recently was -- our goal was really to capture the customer base. And in the public sector, capturing the customer is great. As I mentioned, how sticky they are, once you get them, as long as you continue to take care of them and service them, they really don't leave you. And so our approach to the market was what we used to call a cloud-agnostic approach. So we would sell traditionally on-premise licenses with traditional maintenance. We've also sold, for many years, I think going back 20, 21 years a SaaS. I think, back then, it was called ASP, but generally, that was our approach. We just sort of reacted to the market, whichever way the market wanted to go, we were there, because we wanted to get that customer, and we thought it was a competitive advantage because there were some companies out there that really just focused on one or the other and being able to offer both models served us well. So over the last several years, the public sector has been moving more and more to the cloud. And of those who aren't really familiar with public sector, you'd say, boy, it's only been the last couple of years. What's been going on? Because the rest of the world has been doing it for some time. But when you do business in the public sector, 1 thing you realize is that they move a little more slowly than the commercial sector. They want things that are reliable. They want things that work. They're not always looking for the next greatest gadget. They're not looking for the newest camera on the phone. They want things that are reliable and that works. But over the last several years, that shift has been happening. And inside of Tyler, as we talk about the new era, really, it -- the decision -- internal decision came in, I think, early 2019 when we decided we wanted to really change our approach to the market from a cloud agnostic approach to a cloud-first approach. And so that's what we've been working on the last couple of years and really everything that, that entails. And I'll talk a little bit about more about that in just a little bit. So we see a little bit of our growth and our transformation. As part of our transformation, it was on one of the earlier slides, our recurring revenues continue to increase. And if you see, you look here back in 2010, we did about $290 million in revenues, only about 55% of those were recurring. Last year, we did just shy of $1.6 billion revenues and our recurring revenues were up to 79%. And I expect in 2022, our recurrings will cross 80%. And historically, while we've been really focused on top line growth, one of the things we've also been focused on is margin expansion. And one of the things that we we've talked about, I think, historically and traditionally what the markets is trying to get 50, 100 basis points of margin expansion every year. You can see, as the model has changed, over the years, we get more and more recurring revenues, higher margin revenues. Our margins have grown by over 700 basis points in the last 12 years. And we can talk a little bit in our -- in just a few minutes about margins and where they're going. As part of the cloud transformation right now, we are experiencing some short-term margin headwinds, not surprising people who follow cloud transitions. For example, in 2019, we did $100 million in licenses, so things that fell right to the bottom line. And that was also a year -- the first year that our new business actually crossed 50% in the SaaS business. This year, we're going to do only $70 million in licenses. So as our licenses continue to decrease and our subscriptions continue to increase, we've experienced some short-term pressure on the margins. But then you get to the point in the model where that flips and we'll show you some of that. So let's talk a little about our markets. As I mentioned earlier, we're going to do about $1.85 billion this year. Gartner estimates that the total spending on applications in the local and regional government market, which includes primary and secondary education to be about $30 billion. We estimate, inside of Tyler, that our solutions that we currently sell that are current in our portfolio really address about half of that market. So there's still quite a bit of headway to go. And the demand for our solutions is really as high as it's ever been. And it may surprise some of you, maybe it doesn't. Some of you go to the DMV or do other -- we don't do business with DMV, but go down and work with the public sector is -- the public sector really is consisting of a bunch of siloed antiquated systems, even today. You watch TV shows and you think that the courts operates perfectly with the police and information just flows. That's really not the way the public sector operates. Most of the systems out there are really antiquated. And as these systems continue to get antiquated and they need modernization, that's where we step in. Governments are moving faster and faster to the cloud, as we've talked about. And I think one thing that we've seen from the pandemic was as the public sector was already starting to move to the cloud, that's really started to accelerate even more during the pandemic as governments really started putting more of an emphasis on digital services, digital interaction with their citizens, and we'll talk about that a little bit more. So for example, we believe simply, really, in the local government market that there are over 450,000 systems out there in -- running today. Our estimates, based on what we've been looking at over the last, I don't know, probably a decade plus is really only about 2/3 of those are what we call antiquated deployments. And when I talk about antiquated deployments, what do I mean? These, again, are really old systems, 20-year old systems, 30-year-old systems, a lot of them green screen, a lot of them are still programmed in COBOL. They may be systems that were built internally or there were systems that were put in by a vendor that at one time was competitive, but either no longer in existence or actually does -- no longer really actively invest in that product. An example of that is, I don't know if you all remember when COVID first hit. I remember an article in the Wall Street Journal. And I think it was the state of New Jersey who was basically putting out 1 ads throughout op-eds in the journal about how they needed to recruit COBOL programmers, because they were unable to process some disability claims, and they didn't have anybody to operate their systems. It's kind of incredible really. So our market's steady. And we talk about what funds these systems. There's -- the demand is there. As these systems continue to age, we have to -- the governments have to work in good times and bad. And I think we saw that, really, during the pandemic. The very definition of essential services was the public sector. Everybody was staying home, but there were some people who were not really allowed to stay home. They had to get to their job and do their work, and that was the public sector. And so if one thing I want you to take away from this meeting is, is that our market, it's very steady. It's very predictable, it's growing, and it generates a lot of cash. And so what helps fund these systems, even in good times and bad. And the vast majority of the base that funds these revenues really is property taxes. That's the primary revenue source for local governments. And I don't know about you, but I know in good times and bad, I pay my property taxes. My property taxes don't seem to go down every year. They seem to go up. So there is a steady base of revenue to continue to fund these essential services. And we talk about macroeconomic events, which, obviously, there's a lot of choppiness out there right now. I've been here 24 years, and I've seen different business cycles. I've been through the pandemic. And one thing that I've said about doing business in the public sector is you're a little more insulated from macroeconomic factors. And that's both positive and negative. So what I used to tell people is if somehow GDP starts running at 5% and the economy is running super-hot, it doesn't mean our business is going to take off and run at 25%. Alternatively, when the economy slows down, our business may slow down some, but it doesn't fluctuate and be in tune with the same economic factors that are impacting other businesses, partly because what we do is essential and the funding is there. They have to do it. These are things -- these are systems they have to have to do what they do day in and day out. So who are Tyler's competitors? We compete with a variety of players. A lot of them are sort of -- what we call local niche players. These are small regional companies, and they may tend to focus on a single subvertical of the public sector. So for example, they may have a tax system, but they don't necessarily have a finance system or a permitting licensing system. You may have a workdays in the financials. You may have a good HR system. But again, they don't have utility billing. They don't have permitting and licensing. And those larger players tend to not just focus on the public sector. And so what differentiates us really is that broad spectrum of products and the fact that we are singularly focused on the public sector. I was in a meeting earlier today. I'm sorry, my voice -- I don't usually talk this much. I'm already, like, 3 hours into talking today. At a meeting today, and I was explaining the public sector. And I said, it's not necessarily intuitive. People, they ask, well, why don't people just come in and do it? While Tyler has been in existence for 24 years, a lot of our divisions and operating units have been doing this for 30 years, 40 years. There's a lot of deep domain expertise. We have 35% of our workforce used to work in the public sector, understanding the needs of the public sector is a very, very unique differentiator. One of the things that I think also separates us is, again, the market that we serve, they want consistency. They want reliability. They want to know that you're going to be there, and that's one of our strengths is our longevity. All of our clients know that we're long-term partners. When they sign up with Tyler, they're customers, hopefully, all for life, not quite. Our number wasn't 100%. But generally speaking, we view them as relationships for life. And part of that relationship for life business means we have to continue to invest in our products. We got to continue to make them -- add new features, new functionality, take care of legislative updates as well as create new products that they're going to need in the future. And you can see, in the last 5 years, we've actually -- we've doubled our R&D spend. I'll probably have to speed up a bit, aren't I? So shift to the cloud. I've already talked a little bit about how our market has been moving, and I talked about how back in 2019, we made the internal strategic decision to become a cloud-first company. And so what does that mean? And what are some of the things that we're doing around that? First is we entered into a strategic collaboration agreement with AWS, so they're going to be our public cloud provider of choice. It's not an exclusive agreement, but it is our cloud provider of choice. We've been investing significantly in the last few years in all of our core flagship products to make them into a more cloud efficient or more cloud optimized state so that when we move them into AWS, they will be running more efficiently and more cost effectively than if we just lifted and shifted them today. We've been acquiring companies, companies that round out our portfolio, expand markets and all of our acquisitions over the last several years really are cloud-native products, generally speaking, running in AWS. We continue to connect our suite of offerings and continue to provide value by integrating our offerings so that we have a common unified suite that we can sell into the public sector. We've been developing plans to exit our own Tyler data center. So while we've been in the in the cloud business for some time, we've been operating out of our own private cloud data centers. And as I look to the future, we have plans to get out of those data centers, something that I think -- it's important to me to do that for a lot of reasons. We're not in the data center business. I don't think we should be in the data center business. And so that's part of our overall strategy. We've also done a lot of things around -- acquisitions around things like data and our payments initiative and citizen engagement. These are all things that are part of our future, part of our vision for the public sector. And these are things that really only operate best when in the cloud. So here's an example of the shift in the business that I've been -- was talking about. If you go back to 2017, 37% of our new business value was subscription business or SaaS business, just a little bit more than 1 in 3. If you look at the first quarter of this year, that number was 80%. So you can see the market is moving. We think we're taking the position to help lead the market. And again, I think the pandemic has accelerated that growth. Our subscriptions obviously have gone up significantly at the same time. You go back to 2017, they were about 20% of revenues. Last year, they were approaching 50% of revenues, and our subscriptions have been growing at about a 41% CAGR over that time. So as part of this transition, we are becoming more and more AR business. And when I talk about AR and I talk about our recurring revenues, I'm talking about 3 real buckets of our business. One is our new subscription business. The other is what we call our transactional business and our payments business. And the third is our legacy maintenance business, I should say, legacy. It's good business, but it's from the old on-premise maintenance model. So what does it mean when a client moves to the cloud? And so here's just a high-level example of a new deal, but the same metrics apply when we talk about our existing $470 million of maintenance business. So typically, in the old days, if we would have sold a $1 million license deal, that would have come with a 20% annual maintenance tag that would then grow at about 5% a year. And when we now sell that same deal on a subscription basis, we're essentially getting 2x what the annual maintenance will be. So when a deal would have been $1 million with $200,000 annual, it turns into a $400,000 deal, again, with 5% annual increases in that maintenance. So the revenue potential over the long term is significantly greater. You lose some of that short-term impact from the license. I mentioned a little bit of the short-term margin pressure until that business reaches the point of scale and flips over. But this is our experience in the market. And it's also our experience with respect to our existing customers. When you look at potential growth opportunities at Tyler, I just showed you a slide where we had $470 million of still on-premise maintenance business, good business, profitable business, grows at 5% a year. But one of our strategic drivers is when we go back into that base and flipping that base into a subscription model. And generally speaking, we're seeing that same 2x uplift of subscriptions. Okay. Powerful and predictable cash generation engine. So the few things I want you all to talk -- to take away from today is that it's a steady business, it's predictable business, and it generates a lot of cash. And I think one of the things over my last 24 years at Tyler that I'm really proud of is how we've taken that cash and reinvested it to really drive shareholder value. And we really look at 3 things when we do that. We look at investing back into our products to help drive organic growth. I showed you a slide earlier about our investments in R&D and how that has continued to expand over time. We also look at doing strategic acquisitions. Generally, when we look at acquisitions, we're looking at things to either get into a new market or we may look at our current portfolio of offerings and say, we've got this product. We need to make some investment in it. It's on our R&D road map, but here's this company out here that's got a really good product, a cloud-native already. We can accelerate that process, accelerate go-to-market by bringing them in and then share repurchases. So over the last 5 -- since 2017, we've generated about $1.4 billion in cash from operations, which is about 1.3x our non-GAAP income. And you can see how we've deployed that cash over those last 4 years. Now I want to caution you when you look at this acquisition line, the number is actually a lot higher. This number is net of debt and net of cash received. So really since 2017, we spent closer to $3 billion on acquisitions including a large acquisition we did last year of NIC, which I'll talk about in just a minute. And so when you step back, I talk about us being a significant cash generator. Historically, we've had a very strong balance sheet. I'd say today, our balance sheet is still very strong. We're carrying about $1.3 billion in debt from those 3 acquisitions. $600 million of that is on a convertible at a fixed 25 basis points that's due in 2026. The other is traditional term loan debt. Our net leverage right now is right at about 2.1. So again, acquisitions have really been a part of Tyler's history going back to 1998. In fact, that's why I'm standing here today, I was originally hired because that was my background was M&A. I was actually -- I don't like admitting this, a law degree. I'm a lawyer. But that's my history. And I was brought on to help them grow the company and originally, it was through acquisition. We've done, since 1998, about 52 acquisitions. If you look just over the last 4 years since 2018, we've actually done about 14 acquisitions. Again, the reasons that we do these acquisitions, expand our TAM, ad technology and capabilities and also widen our client base. I say a lot of times, our greatest asset at Tyler is our client base. We have right now over 20,000 clients, over 37,000 installations. I mentioned earlier, how this is a slow-moving market. So when I talk about our client base, what I tell people is that's not something that just takes years to develop. It takes decades to develop. And so as we look out to the future, we look at that strong stable client base is providing these high amounts of recurring revenue, it's also one of our greatest opportunities. Because our opportunity is to take all of our other existing products and sell them back through these channels at really an accelerated rate. So the existing client base, both from a from an uplift on their maintenance to SaaS, but also the ability to take our broad portfolio of products and sell it back through that base is a really significant opportunity. I'm going to have to speed up just a little bit. So just real briefly, last year, we did an acquisition of a company called NIC. They were another publicly traded company. That acquisition was for about $2.3 billion. NIC, if -- for those of you who are not familiar with them, they are the leading digital government solutions and payments company. They already serve more than 8,100 agencies at the federal state and local level. And I think one of the things that was most compelling to us really was this whole concept around payments and what we can do with payments. They were already doing a significant job at the state level. We had identified, several years before, that was a strategic opportunity of growth at more at the local level. We were already running a lot of payments through our systems. We had some R&D efforts going away. We had our own payments initiative, but really bringing these 2 companies together and creating what really is the leader in payments. It's a public sector. It's something that's really exciting to us. There's a lot of other things that we're leveraging with NIC. They have these statewide enterprise contracts, which allow us to take our existing Tyler products and run those through them. They also were very heavily engaged with citizen engagement, something that's part of our Connected Communities vision and bringing our resources and what we have done with citizen engagement with theirs is something very important where citizens can literally interact digitally with their government on a single app and they can go through and be able to have the ability to either pay fees, interact with the government, either be it the local or at the state level is something that we think is going to be very compelling and really the future of the public sector. Okay. We've had a pretty good history of growth. Can we sustain it? I can tell you right now that my excitement for Tyler sitting here today is I'm as excited as I've been for the last 24 years. We just had strategic off-site meetings with all our division presidents. We started talking about, let's talk about Tyler 2030. Where can we go? How big can we be? What can our growth be? Where is that growth going to come from? And what kind of margin expansion can we get over the next 7 or 8 years? And it's really exciting. I'm not here to share that with you today. It's not really a time for public consumption. But it's exciting to see the energy and excitement of our team, who've done a great job of building a company from $25 million to almost $2 billion. And then we start talking about going to $3 billion and $4 billion and is it doable and how are we going to do it. And -- and yes, so it's a pretty exciting time to be at Tyler. So what's going to drive that growth? Again, we're in a steady market. It's growing annually at about 7% to 9%. We talked a little bit about our shift to the cloud and the ability to uplift that $470 million of existing maintenance, continuing to leverage our client base by getting more products into them, as well as expanding our payments opportunity across our base and continuing to make smart investments with our free cash flow, doing the right strategic acquisitions. Again, a lot of drivers behind us that can continue this growth. I started off talking about the way local government is. Again, today, most of government is still very siloed, very back to office. And our vision really is to fundamentally transform the way government works from that siloed vision to what we call one of Connected Communities where departments and agencies that were within a jurisdiction, actually share information, share analytics and start to operate more efficiently and make better decisions through insights and not just within a jurisdiction, but also across jurisdictions. So if you live in a metro place like Dallas-Fort Worth Metroplex that has a dozen cities in it and having, for example, public safety departments within Coppell and Dallas and Plano, we'll be able to share information regarding outstanding warrants for people. It's something that we can only do, and I think it's something that we're committed to doing. I mentioned citizen engagement, having citizens being able to interact more digitally with government, again, as part of that vision. I'm starting to speed up because the clock's winding down. I'm sorry. I can talk about Tyler for a long time, unfortunately. So Q1 results. We did about $456 million in Q1. You can see it's up almost 55%. That's a combination of about 13% organic growth, and the rest is from the NIC acquisition or other acquisitions we did. Our outlook for the year. Again, we did about 1.6 last year. We're looking to do about 1.85-ish this year. Our EPS, which is about 15% to 17% growth. You can see our EPS growth. I'll add there that we're carrying about $0.42 of interest and amortization on our debt in that plan. So if you look at more on an EBITDA and pull out the interest expense, you're looking at closer to $8 a share for 2022. So wrapping up here, I think we spent a lot of time thinking about how we can deliver value to our shareholders and how we use our cash. But along with that is one thing that we're committed to as being a good corporate -- good corporate representative in the community. And so we are committed to sustainability and being responsible. You can see our results in the last 3 years was the Dow Jones Sustainability Index. We last year scored at the 23rd -- 93rd percentile. We've got our own engaged ESG council that really helps us map out our ESG strategy and helps frame it and frame our actions that we're going to do. And finally, we've been putting out a corporate responsibility report. If you all haven't seen it, I'd encourage you to go to our website, our report last year, it's really well done. And a lot of this really is just telling the Tyler story because what we really do is all about sustainability. When you think about us transforming courts and going to paperless and going to e-filing and getting rid of all the paper, when you think about interacting citizens interacting digitally with the government, not getting their cars and going down there, when you think about the way we've changed the way we deliver our services and going from -- towards remote implementations. During the pandemic, we introduced what we call virtual courts where people would actually have court hearings remotely. That's everything that we do and everything that we're driving towards all is based on sustainability. So it's a nice side view of our business. So I'm out of time. Again, I apologize. I maybe ran a minute or 2 over. But again, I appreciate all your attention and interest in Tyler Technologies.

Thank you, man.