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

All right. Well, good morning, and welcome to the Needham Growth Conference. My name is Josh Reilly and I'm an analyst on the enterprise software team here. Excited to have Tyler Technologies this morning and CFO, Brian Miller.

Thanks. Good to be here.

So Brian, maybe we can start off with an overview of Tyler and maybe touch on what specific end markets your products serve as -- as we -- those of us familiar with the story know that the mix has changed a bit over the last several years.

Yes. Sure, we're a vertical software company focused exclusively on the public sector. Within the public sector, we're pretty broad in terms of the -- about the sizes of government and the different levels of government that we serve. Historically, Tyler was really focused on the local government market, so primarily providing mission-critical back-end systems for local governments, cities, counties, school districts, local agencies. We've, in more recent years, expanded more into the state government, especially through the acquisition of NIC, which was a large acquisition we did coming up on 3 years ago, and a little bit in the federal space, again, through an acquisition that we did a few years ago. So today, we're probably 70%, 75% local, maybe 20% to 25% state and 5% or so federal. And we're about 98% domestic most of our international business in Canada.

Got it. So one of the questions I get is about the health of your customer, which, as you just highlighted, is primarily local government entities and their ability to spend. So my work, and it's been pretty widely reported is that local government budgets are the strongest that they've been in a long time. What do you think, if anything, could change that? And then do you expect any change to budgets in either direction in 2024?

Generally, our commentary around the backdrop of the environment has been pretty strong over the last couple of years. And I think through the last year and recent quarters, it's been increasingly positive. Government budgets are really pretty much at most levels, in pretty solid shape. Obviously, a lot of different governments. And so each has a different situation. But generally, with local governments, property taxes are often their biggest single revenue stream. And those are not under much pressure right now. Generally, values are -- property values are pretty high. Rates are pretty high. So -- and they don't move in real time. So they're kind of slow to move, but those sources sales taxes, income taxes, generally most the licensing and permitting, those sorts of fees are at pretty high levels. So we've said the market is definitely in terms of the activity we're seeing, a number of RFPs, the number of demos we're doing, all those kind of early-stage leading indicators of market activity are very strong. They're definitely at or above pre-pandemic highs. So a really active market and for us, a very strong competitive position within that market. And the indications we see around 2024 budgets seem to be pretty consistent with what we're currently seeing a lot of local governments have June year ends. I think 30, some of the states have June year ends and generally the local governments followed that state that you're in. So a lot of this are kind of in the early stages of starting to work on their budgets that will go into place in the middle of the year, but most of the indicators we see, seem to indicate a lot of stability at this kind of elevated level.

Got it. This kind of segues into the next question, which is trying to understand the pipeline. And maybe can you give us a sense of how that looks on a year-over-year basis? I know that I've seen some data around ERP, RFPs that are pretty strong entering the year. Would you say the pipelines across product lines are similar to entering 2023 or maybe even stronger?

I mean a little bit stronger. I mean I think they strengthened through the year, and they were already on an uptick as we recovered from not from a lack of demand during COVID, but just the general disruption that slowed down the processes and everybody had to adapt to doing things differently. And there were a lot of distractions on government. So a lot of processes sort of paused for a while. But demand actually, I think coming out of COVID has increased because governments are increasingly seeing the need to have better system, systems that support remote work that typically wasn't a factor in most government operations before and the ability to do more things online, provide more citizen self-service. All those things are drivers of replacing aging systems that have increased since COVID. So yes, I think, like I said, we're clearly at or above pre-pandemic highs across most of our product portfolio. And as we come into this year, I think the strength in the pipelines are at least at or above where they were a year ago.

Got it. So some investors may not be familiar with the impact of the stimulus funds over the last couple of years to the industry. How would you summarize the impact of Tyler? And as those funds are fully allocated throughout 2024, do you foresee any impact to the business on the back end of that?

Yes. I certainly think the federal stimulus is a factor in that market being really active and has been over the last couple of years. It's really hard to quantify exactly what the impact is. But just at a high level, the ARPA, the American Rescue Plan Act provided for really significant direct aid to state and local governments. So about $360 billion of direct aid to state and local governments and another, I want to say, about $150 billion for schools. So a massive amount of stimulus going -- really everybody gets something, pretty why they distributed and pretty flexible in terms of what they can use on effectively anything they would want to buy from Tyler would meet the requirements. They have until the end of 2024 to commit the funds and until the end of 2026 to spend them. And even to the -- we believe that at this point, probably 75% or so of the funds have been committed, but that doesn't mean spend. So committed sort of an internal commitment that they've said, okay, we're going to use a certain amount of our ARPA funds to do X, Y and Z. That doesn't mean they've even started the buying process, perhaps they're going to use those funds to replace a software system or something like that. So we see each quarter maybe a large handful of deals that are specifically identified as being funded with ARPA funds. But that doesn't mean that Those deals wouldn't have taken place without the ARPA funds. So you can't necessarily say that's all incremental business and in other cases, funds are used for something else, which might free up money for an incremental spend with us. So we think it's a factor in the market being active. We don't think it's the biggest factor. We don't -- we think it will continue to be a tailwind of some sort through '26 as those funds are spent. But we don't think it's a -- like the biggest driver and that there's expected to be a big drop off once those funds are kind of all in the process. And to the extent that they use those funds, for example, to enter into a new SaaS agreement, they might be using those funds to pay for the first 3 years of the SaaS fees on a new ERP system, but there's a recurring engagement after that.

Right. Yes, no. That makes sense. So for those less familiar with the story, you're in the process of a cloud transition and getting all of your products on and ready for the public cloud. You have a partnership with AWS GovCloud, but can also support other public clouds as well. Can you just explain what's the process and an update in terms of where the products are at in this kind of transition?

Yes. So we've had a sort of a long transition to the cloud that has accelerated in the last few years. So for probably -- yes, probably almost 20 years, we offered. We had sort of a hybrid model. We were cloud neutral or cloud agnostic. We offered our products either in a traditional on-premise license and maintenance model, which most of our customers were adopting and then started to offer products in a cloud model, a hosted model, basically in a Tyler private cloud hosted in 1 of 2 Tyler data centers. And so over a long period of time, that mix of new business gradually shifted towards cloud, but like a lot of things in government, they're very slow to embrace new things. And so the adoption was very gradual. And so sort of a gradual transition that wasn't disruptive to our model. We saw a strong growth and good cash flow over a number of years customers given the choice, started to move more towards the cloud. And 2019 was really the first year that more than half of our new business chose the cloud. 2019 was also the year where we said, we're kind of not cloud neutral or cloud agnostic anymore, we're cloud averse. Our future is in the cloud. We entered into our relationship with AWS to be a public cloud provider and said we don't really want to be in the data center business anymore and started to process to move new customers into AWS and move out of our data centers and migrate our existing customers over. We also launched a bunch of projects too, on the development side to optimize our products to be more efficiently deployed in the cloud. So most of our core products were originally built to be deployed on-prem. And so they weren't super efficient in the cloud. They consume a lot of resources, and were expensive to host in the cloud. So we've had projects underway to optimize those products and make them cloud efficient and lower our hosting costs. During 2023, we released most of our cloud versions or cloud efficient versions of our products and those that aren't there yet are pretty close. So since 2019, we've gone from 50% of our new business choosing the cloud to now 85% in that range, choosing the cloud. We only really have a couple of product areas where we have any meaningful on-prem license business anymore. Public Safety has been one that's been slower with systems like 911 systems, slower to become comfortable with putting it in the cloud, although that's moving more rapidly there. And then in our federal and state business, we have a low-code development platform that's used for a variety of case management applications and a lot of those agencies still choose licenses. But most of our products, we don't even offer a license model anymore. And we also have projects underway now, we're also very actively migrating our on-prem customers to the cloud. But if you look at our overall customer base today in terms of dollars, about 1/3 of those customers are in the cloud and about 2/3 are still on-prem.

Got it. That's super helpful. So what's interesting about Tyler is that you serve one customer group, government, but you have a pretty broad product set with the number of product suites that you offer them. As you look at the competitive landscape, I think you could argue that Courts & Justice has the strongest competitive position in some other areas like Public Safety are a bit more competitive. How do you think about the competitive landscape? And any updates to your thinking kind of entering 2024?

Yes, you're right. We have a lot of products that's one of our strengths, that Tyler does have by far the broadest set of product offerings for the public sector. And we have, by far, the biggest customer base of anyone serving the public sector. And those products -- that breadth of products offers us a lot of opportunities for cross-sell and upsell. So we've talked about our average customer, we have about 13,000 different jurisdictions. So [indiscernible] city, county, school district, agency. And those -- and we have about 40,000 installed systems or suites of products. So our average customer has 2 to 3 products from us. And it could have, in most cases, 8 to 10 products from us. So there's a big cross-sell and upsell opportunity that comes with that customer base that we've put together over a number of decades. We have a lot of competition, but typically different competition in each product area. So there is no one company that has the breadth of products that's competing across all those. So typically, our competitors are companies that are generally narrowly focused from a product perspective and even sometimes narrowly focused from a geographic perspective. So a company that just sells court systems in California or property tax systems in New York and New Jersey. So a lot of these are the kind of legacy companies that historically serve the space before Tyler sort of put together and built what we've built. So we have different competition in different segments. Most of these are -- again, companies are just focused on public sector, but just a niche. In a couple of areas, we see more horizontal competition. So in the ERP space, which is our biggest single product area, the accounting, human resources, payroll. We can be with horizontal companies like Oracle, SAP, Workday and more. Some of those larger ones we typically see mostly just in kind of the very high end of the market. They don't dip down thus far. Obviously, our strength there is that we are vertical software company. So we go much deeper in terms of functionality that a government needs as opposed to a healthcare company or a manufacturing company or a retail family or all of the different kinds of businesses that the horizontal companies serve. And then in the federal and state space with our low-code platform, we compete with some of the horizontal companies like ServiceNow or Pegasystems or even Salesforce, but again, we're focused just on government. We have prebuilt modules and applications that serve government functions. Not really a lot of changes more recently -- in the last couple of years around the competitive landscape. There have been, in the last few years, a lot more private equity investments in our space. So we have a number of competitors in different niches that are [ preowned ] and -- versus companies that are always on some timetable changing hands and so there's been a lot of activity there. It's going to be interesting to see kind of what happens with the next round of movements around some of these companies that were bought at peak valuations a few years ago. But yes, we have a lot of competition, but generally, most of our major product areas we're often the clear leader in that spaces and have very high win rate.

Have you seen any pullback in the PE-backed competitors since the interest rate dynamics have changed in kind of the last 12 months?

Yes, it's a little harder in the short term. But clearly, we know some of them, their debt is public and their ratings reports and there are some very highly leveraged companies out there that have very high interest rates that -- we have one major competitor that's according to the S&P and Moody's reports is leveraged at 10 or 11x and I see interest rates at [ 10% ], 11%, 12% on their debt. So it...

You would think at some point, they have to pull back.

It would seem like that would make it very difficult to invest a lot in your products and R&D and the kinds of growth initiatives. But some of them have big backers and we'll see. But generally, we've rarely found a PE-backed competitor become a tougher competitor during that ownership, [ after acquired ].

Awesome. So in terms of product innovation, what you've done with layering in data and insights use cases into the individual product suites, seems to be kind of an incremental growth opportunity for you guys. What use cases in 2024 for data and insights are you most excited about in terms of actual incremental revenue dollars added to the business?

Yes. So we have -- we did an acquisition of a company called Socrata a few years ago, which was sort of a business analytics or data and analytics platform designed again, specifically just for government. And we have taken that technology and embedded it or created data and insights layers and applications on top of all of our core products. So kind of serving a couple of functions, providing better transparency to citizens. So things like with our ERP system, Open Budget, Open Checkbook kind of making financial information readily available to citizens, how their government is spending their money. In the Public Safety area, applications for crime mapping and -- so you can go on to your towns website and draw a 5-mile radius around your house and see almost in real-time, all the crime activity and get notifications, those sorts of things. So it's really created. So both public transparency and then internal insights, so surfacing data to make -- enable governments to make better decisions, better data-driven decisions, which -- this concept of business intelligence is not revolutionary in the private sector, but something that's still kind of new to government where they have a lot of systems that are very siloed. So data sits in a silo and it's very difficult to make decisions across departments or agencies. So we provide that now as sort of add-on to our products, but virtually every new software sales from our core products includes a data and analytics subscription now because -- and it's really provided us with a significant competitive edge in things like public safety, where we compete with companies like Motorola and Axon. There's a number of good competitors there, but we think that the analytics capabilities we have really provide us with a strong competitive edge. So public safety is one of those areas where we're excited about how that's impacting our win rates and our competitiveness. We've also been able to use that technology. And I think this is one of the areas where we've really been excited in very specific use cases, leveraging our state government relationships that came to us through the NIC acquisition. And so taking that technology and being able to help our state government partners solve problems that they have. So I'll give you a real quick example. So in the state of Kansas, which is a big NIC state where they provide the website and portal access to most back-end state systems. The state also is a big Tyler property tax customer. So they -- all of the counties in Kansas use Tyler's property tax system. But each county has its own version of that. And so the state has a Board that manages property taxes, but they didn't really have access to the data that sat in these, I think, 50-some county systems. So we were able to bring a solution to them with our data and analytics platform that is able to pull data together out of all of these systems and provide -- give the state access and insights into what was going on in property taxes across the state in realtime. And then also enables the counties to share data. So each county -- 2 counties might each have one Walmart distribution center, but that they're trying to value and tax that they didn't have access to what the other guy was doing. And so being able to marry Tyler back-end systems, our state relationship and our data and insights platform, we're able to solve a problem they have and generate a new revenue stream of, I think, several hundred thousand dollars a year from that one application. So it's given us a lot of flexibility to go in and solve very specific problems for customers. And we have a number of states that have statewide property taxes systems that we think we can replicate that same solution across.

Yes. And theoretically, if the state level has insight into the county property tax and they can aggregate that a lot, they can develop their state budget more effectively, and there's a bunch of benefits there.

Yes. And it helps -- again, make the Tyler Solution more valuable and solidify that relationship and we've got some really powerful technology on the analytics side that's helping us. And then the other thing, I guess, we'll probably talk about AI at some point, everybody does. But we have -- because we have so many systems and so many -- so much data or access to so much data in the state systems that we have tremendous value in the data that's flowing through our systems that can help drive machine learning models and analytics. So we think that gives us an advantage as we start to integrate more AI into products.