Tyler Technologies Inc Q4 FY2020 Earnings Call

Hello. And welcome to today’s Tyler Technologies Fourth Quarter 2020 Conference Call. Your host for today’s call is Lynn Moore, President and CEO of Tyler Technologies. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. And as a reminder, this conference is being recorded today, February 10, 2021. I’d like to turn the call over to Mr. Moore. Please go ahead.

Thank you, Grant, and welcome to our call. With me today is Brian Miller, our Chief Financial Officer. As you have seen, in addition to our fourth quarter earnings, we made another very significant announcement this morning. So we have a lot to talk about today. I’d like to point out that we posted on our Investor Relations website and filed with our 8-K, a presentation on the acquisition and we will refer to some of those slides later in the call. First, I’d like for Brian to give the safe harbor statement. Next, I will have some preliminary comments on our fourth quarter results and Brian will review the details. After that, we will return to our announcement today of our agreement to acquire NIC Inc. I will have some comments on the proposed acquisition and then we will take questions.

Thanks, Lynn. During the course of this conference call, management may make statements that provide information other than historical information and may include projections concerning the company’s future prospects, revenues, expenses and profits. Such statements are considered forward-looking statements under the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995 and are subject to certain risks and uncertainties, which could cause the actual results to differ materially from these projections. We would refer you to our Form 10-K and other SEC filings for more information on those risks. Please note that all growth comparisons we make on the call today will relate to the corresponding period of last year unless we specify otherwise. Lynn?

Thanks, Brian. Our team executed well in a challenging environment during the fourth quarter and we concluded 2020 with solid earnings and record cash flows. Recurring revenues, which comprise 75% of our fourth quarter revenues were strong, led by a 17% growth in subscription revenues. However, software licenses and services revenues continue to be pressured by longer sales cycles and delays in projects, as clients deal with the effects of the pandemic, along with the near elimination of billable travel. Our revenue mix and cost efficiencies contributed to 120-basis-point expansion of our non-GAAP operating margin to 26.9%. Cash flow has been very robust throughout the year, and both cash from operations and free cash flow ended the year strong, growing 16.5% and 25.8%, respectively. This was our highest fourth quarter and full year cash flow ever, and for the year, free cash flow grew 53.6% to $326.6 million. Bookings for the quarter were relatively flat with the prior year at approximately $333 million. Our largest deal of the quarter, which was also the largest single contract in our history, was a five-year extension of our e-filing arrangement with the Texas Office of Court Administration, valued at approximately $98 million. The extension also included e-filing insights, a Socrata-based interactive reporting layer that eliminates hundreds of hours of manual reporting activities and gets clerks in all 254 counties, the ability to monitor 50,000 daily filings, so they can identify bottlenecks inefficiencies and improve the experience for the public. However, due to certain contract provisions, only a very small portion of the value of this contract was included in backlog and bookings. If the entire value of this contract had been included in the backlogs, bookings growth for the fourth quarter would have been approximately 28%. Our largest new SaaS deal in the fourth quarter was with Jackson County, Missouri, for our iasWorld appraisal and tax solution, as well as Appraisal Services valued at approximately $18 million. Other significant contracts signed this quarter included a multi-suite license arrangement for our Munis ERP, EnerGov civic services and Socrata Data Insights solutions, with the Commonwealth of the Northern Mariana Islands valued at approximately $5 million. SaaS agreements with the city of Jacksonville, Florida for EnerGov civic services solution and with Stark County, Ohio for our public safety solutions, each valued at approximately $4 million. And 10 SaaS deals and three license contracts for various Tyler solutions, each valued at over $1 million. Brian will discuss our guidance for 2021, but I’d like to update you on some of our plans surrounding our strategic initiatives to accelerate our move to the cloud. Our 2021 plan includes accelerated and new cloud investments across the spectrum of our products. Our plan includes approximately $23 million of investments in cloud product development in 2021 and a total investment of more than $52 million over the next three years, with the majority of that expensed. As a result of these investments, we expect by the end of 2023, all of our major applications to be cloud native or cloud efficient for deployment at AWS. We have also made some organizational changes, some of which were announced earlier this week to focus additional leadership on our cloud initiatives, as well as streamlining internal technology and security operations and driving other technology efficiency objectives. Now, I’d like for Brian to provide more detail on the results for the quarter.

Thanks, Lynn. This morning Tyler Technologies reported its results for the fourth quarter ended December 31, 2020. In our earnings release, we have included non-GAAP measures that we believe facilitate understanding of our results and comparisons with peers in the software industry. A reconciliation of GAAP to non-GAAP measures is provided in our earnings release. We have also posted on the Investor Relations section of our website under the Financial Reports tab schedules with supplemental information provided on this call, including information about quarterly bookings backlog and recurring revenues. Our revenues continued to be impacted by the COVID-19 pandemic. GAAP revenues for the quarter were $283.3 million, down 1.9%. On a non-GAAP basis, revenues were $283.4 million, down 1.4%. Software license revenues declined 46%, reflecting both extended sales cycles and a very high mix of subscription deals at 73%. Software services revenues declined 18%, as some projects slowed as a result of COVID-19 and our shift to remote delivery of most services also resulted in a $5 million decline in billable travel revenue. On the positive side, subscription revenues rose 17%. We added 118 new subscription-based arrangements and converted a quarterly high of 50 existing on-premises clients, representing approximately $73 million in total contract value. In Q4 of last year, we added 164 new subscription-based arrangements and had 18 on-premises conversions, representing approximately $74 million in contract value. Subscription contract value comprised approximately 73% of total new software contract value signed this quarter, compared to 54% in Q4 of last year. The value weighted average term of new SaaS contracts this quarter was 3.5 years, compared to 4.4 years last year. Revenues from e-filing and online payments, which are included in subscriptions were $24.6 million, up 13.3%. That amount includes e-filing revenue of $15.5 million, up 5.1% and e-payments revenue of $9.1 million, up 30.6%. For the fourth quarter, our annualized non-GAAP total recurring revenue or ARR was approximately $850 million, up 10.4%. Non-GAAP ARR for SaaS arrangements for Q4 was approximately $278 million, up 17.9%. Transaction-based ARR was approximately $98 million, up 13.3% and non-GAAP maintenance ARR was approximately $474 million, up 5.8%. Our backlog at the end of the quarter reached a new high of $1.59 billion, up 9.4%. As Lynn noted, our bookings in the quarter were relatively flat at $333 million. For the trailing 12 months, bookings were approximately $1.3 billion, down 1.3%, against a tough comparison that included the two large North Carolina Courts deals totaling approximately $105 million in the prior trailing 12 months. If the full amount of the Texas e-filing extension had been included in our backlog, Q4 bookings would have grown 28% and trailing 12 month bookings would have grown 5.8%. Our software subscription bookings in the fourth quarter added $11 million in new annual recurring revenue. The bookings growth rate was also affected by the shorter average term for new subscription contracts. As it was throughout the year, cash flow was robust in the fourth quarter as cash from operations increased 16.5% to $88.8 million and free cash flow grew 25.8% to $83.7 million. We ended the quarter with approximately $758 million in cash and investments, and no outstanding debt. Our earnings release has the full details of our 2021 guidance, which excludes the impact of NIC and any other acquisitions that may be completed during the year. We expect to update our guidance to include the NIC transaction after it closes. With regard to revenue and earnings, we expect 2021 GAAP and non-GAAP revenues will both be between $1.190 billion and $1.220 billion, representing a range of growth from 6.6% to 9.3%. We expect 2021 GAAP diluted EPS will be between $4.03 and $4.21, and may vary significantly due to the impact of stock incentive awards on our GAAP effective tax rate. We expect 2021 non-GAAP diluted EPS will be between $5.65 and $5.77, representing an increase of 2.4% to 4.5%. Fully diluted shares for the year are expected to be between 42.5 million and 43 million shares. As we look ahead to 2021, it’s clear that we won’t be back to normal for some time. We have said on prior calls that we anticipate that the impact of COVID-19 would continue into 2021 and our plan for this year anticipates this ongoing uncertainty. Nonetheless, we are excited about our opportunities to accelerate revenue growth and achieve our margin objectives for this year. Revenue growth while below our normal targets is expected to be significantly above the 2020 level. Just to refresh your memory, as we entered 2020, our guidance was for non-GAAP revenue growth of approximately 10% to 12% and for margins to be relatively flat with 2019 with an expectation of resuming our margin expansion trajectory in 2020. COVID-19 obviously resulted in the 2020 performance that was very different from our initial guidance, as we finished with low-single digit revenue growth and 150 basis points of non-GAAP operating margin expansion. We have talked before about how some of the factors that led to margin improvement in 2020 are sustainable while others are not. Those factors include a favorable change in our revenue mix from a decline in low margin revenues like professional services and billable travel, as well as cost savings in areas like travel, marketing and employee healthcare. I’d like to point out a few of the factors that are expected to impact our margins this year. Employee healthcare expense will have a significant impact on operating margins in 2021. During 2020, we saw an unexpected decline in our healthcare costs as the pandemic curtailed elective surgeries, checkups and much of our employees’ non-urgent healthcare and our net health claims expense per employee declined 8.4% for the year. As those costs return to normal pre-pandemic levels in 2021 coupled with inflation, we are expecting an increase of approximately $13 million or 21% over the reduced level in 2020. Also our diluted share count is expected to be 575,000 to 1.1 million shares higher than in 2020. We issued approximately 1.3 million shares under our stock compensation plans in 2020, including 1.2 million shares from the exercise of stock options granted in previous years. Our higher stock price also impacts the dilution calculation. If our diluted share count in 2021 was the same as 2020, our non-GAAP EPS guidance would be about $0.18 higher. As a reminder, beginning in 2018, we began a shift in our long-term incentive equity to a mix of options, restricted stock units and performance stock units. As that shift continues, we anticipate a significantly less dilutive impact of long-term stock incentives going forward. Our guidance implies operating margins that are modestly below the 2020 level, but above our 2019 operating margins. That trend is generally in line with the trajectory we targeted at the beginning of 2020 and if we achieve our plan, we will finish 2021 with margins in line with or above what we would have expected pre-pandemic. So, to conclude, our 2021 plan reflects a solid combination of organic revenue growth and strategic growth investments, especially around our cloud transition. Now, I’d like to turn the call back over to Lynn.

Thanks, Brian. As I look back on 2020, I marvel at how our team of professionals performed in the extraordinary environment of the last few months. We were laser-focused on continuing to take care of our clients’ needs as we always do, while taking care of each other at the same time. While our financial results certainly weren’t what we expected at the start of the year, we adapted to the new realities of the pandemic with very good results. As I have said numerous times during last year, I couldn’t be prouder to lead our incredible company and its people. While 2020 presented a myriad of challenges, we view many of those challenges as creating opportunities that Tyler is well positioned to take advantage of. Our financial position is stronger than it was a year ago with more than $800 million in cash and investments and no debt on our balance sheet today. We have been able to continue to invest in and in some cases accelerate all of our long-term strategic initiatives and they are all on track. As a result, our competitive position has also continued to strengthen. We believe the pandemic will further accelerate the public sector's move to the cloud and we are in great position to support that move. Our client base is large and diverse, with more than 27,000 implementations and it represents our greatest asset for both future sales opportunities and the dependable revenue stream it produces, and we have a deep and experienced management team that has weathered difficult economic times in the past. All of these factors make us confident that we are exceptionally well-positioned to capitalize as markets return to normal. With that, I’d like to turn to this morning’s extremely exciting announcement that Tyler has entered into a definitive agreement to acquire NIC Inc. in an all-cash transaction for a purchase price of approximately $2.3 billion. We are going to spend a bit of time today walking you through why NIC is an exceptional addition to the Tyler family and we will leave time at the end of the presentation for your questions. But before we begin, I will remind you that we have posted a presentation on the acquisition on our IR website and I will refer to some of the slides in my remarks. I would draw your attention to the disclosures on slide three related to solicitation materials and remind you that additional information is available on the websites of both Tyler and NIC. So, with that out of the way, I’d like to start by highlighting the significant benefits of this acquisition, the largest in Tyler’s history by a wide margin brings to our business. NIC is a leading digital solutions provider to state and federal government entities and will meaningfully increase Tyler’s presence in both of those sectors, building on the entry points we achieved via acquisitions of MicroPact and Socrata a couple of years ago. NIC also brings to Tyler a very large incremental payments processing business for governments, allowing us to meaningfully grow our revenue stream that is highly recurring in nature. NIC’s unique state-wide contract structure and complementary portfolio of offerings will allow Tyler to better serve a broader customer base with a more complete set of solutions. And perhaps most importantly, Tyler and NIC are two companies whose cultures are complementary and well-aligned, which I will touch on more in a moment. In terms of the transaction specifics, this is an all-cash transaction for a purchase price of $34 per share, which equates to an equity value of $2.3 billion or an enterprise value of approximately $2.1 billion, inclusive of NIC balance sheet cash. We have committed financing to fund the transaction in the form of cash on hand and a $1.6 billion bridge facility, which we anticipate replacing with permanent capital between signing and closing. The transaction has been unanimously approved by both Boards of Directors and is expected to close in the second quarter, subject to customary closing conditions, including regulatory approvals and approval by the NIC shareholders. We expect this combination to be accretive to our non-GAAP earnings and EBITDA, as well as to our recurring revenue mix and free cash flow per share in the first year. It’s important to note that we will continue to maintain a strong balance sheet post-transaction with a very reasonable balance of leverage and liquidity. I’d like to briefly touch again on the point around culture and how that played into the rationale for this acquisition. NIC is a company that’s been on Tyler’s radar screen for quite some time and we have admired their reputation in the marketplace from a distance. As I and the rest of the Tyler management team got to know our counterpart NIC over the last few weeks and months, it became increasingly clear how similar our two organizations are, as you can see from the similarities in our respective missions. Tyler and NIC are two companies built on integrity and focused on delivering differentiated value for all of our respective constituents, governments, businesses, citizens, employees and shareholders. I view this combination as a continued realization of our mission of empowering the public sector to create smarter, safer and stronger communities. The pandemic has accelerated the shift by governments to online services and electronic payments as more citizens and businesses are interacting digitally with government. NIC is uniquely positioned with deep expertise and robust digital solutions to partner with us in making government more efficient and more accessible to citizens. NIC’s capabilities and vision align with and are complementary to our connected communities vision and will advance our efforts to bring that to our clients. On slide six, we have included a bit more information on NIC, as well as some key relevant statistics. The company is a leading digital solutions and payments provider serving more than 7,100 federal, state and local government agencies across the nation. NIC has enterprise-wide partnerships with 31 states and a robust payments business that currently processes $24 billion in payments annually and that amount will increase significantly with the implementation of the payments processing contract NIC recently signed with the State of Florida. The company’s broad set of solutions and a unique go-to-market contracting model allow NIC to become deeply embedded with their clients, resulting in predictable, highly recurring revenue growth. For the fiscal year ended 2020, NIC delivered revenue of more than $460.5 million and adjusted EBITDA of about $108.8 million. NIC’s complete fourth quarter earnings were also released this morning and you will find their complete results on their website. On slide seven, you can see the breadth of NIC’s leading portfolio of digital government solutions. At a high level, the company is focused on delivering user-friendly digital services that make it easier and more efficient to interact with government, providing valuable conveniences like applying for unemployment insurance, submitting business filings, renewing licenses, accessing information and making secure payments without visiting a government office. NIC serves both businesses and citizens with solutions to tackle information, interactions and payments for a wide range of government agencies, and importantly, including a variety of delivery methods such as Gov2Go. NIC’s unique proprietary cross agency mobile platform is designed specifically for citizens to interact with governments. We drill down a bit further into NIC’s focus areas on slide eight, and importantly, how NIC’s solutions map to our existing portfolio. As we assessed NIC’s fit with Tyler, we thought about their portfolio of offerings through a number of lenses. Certain of NIC’s end markets such as their solutions for businesses, courts and healthcare are highly complementary with Tyler’s. NIC’s presence in these sectors at the state and federal level are naturally aligned with Tyler’s established presence at the local level. Other areas such as outdoor recreation and taxes represent natural adjacencies to expand Tyler’s current business, while a sector like motor vehicles is a clear growth opportunity. The key takeaway from our assessment of NIC’s portfolio is that there are a number of areas where Tyler’s existing businesses will benefit from NIC quickly and were avenues of growth should open up organically for both of us over time. A similar fact pattern emerges if you look at NIC’s geographic footprint, which is shown on slide nine. NIC has established relationships across the nation including geographic alignment with Tyler in several complementary solution areas with 16 states where both companies have active contracts at different agencies. NIC’s State Enterprise and Platform Solutions businesses, both of which we will touch on in greater detail in a moment, already have great breadth and depth, and we see a number of white space opportunities to expand these platforms as part of the Tyler portfolio. We also view NIC’s federal client relationships as a natural fit to meaningfully expand our existing Tyler Federal business. On slide 10, we provide a more detailed overview of NIC’s State Enterprise business, including a look at the long-term relationships the company has built over time. NIC’s State Enterprise Solution offers a unique approach to working with governments by putting dedicated local teams in capital cities for support and developing services and solutions that are relevant to all agencies within a state government. NIC is able to deploy best practices gleaned over a number of decades and leverage a deep foundation of technological capabilities in tailoring solutions to fit specialized needs. The company’s flexible state-wide contract vehicles allow governments to avoid cumbersome procurement processes by authorizing NIC to develop and implement a wide range of solutions across a number of different agencies. These long-term contracts lead to clear line of sight both operationally and from a revenue perspective, as evidenced by NIC’s historic ability to grow same-state revenue at 8% plus. NIC’s Platform Solutions business, which is illustrated on slide 11, includes comprehensive agency-specific vertical solutions that are the product of significant investments NIC has made in recent years, both organically and inorganically, and represent scalable solutions designed to address specific areas of market demand. On the payment side, NIC has built a comprehensive platform specifically designed for governments that can be integrated into state enterprise systems or offered standalone. Recently acquired solutions in licensing and healthcare are already showing early wins with new contracts awards across five states while NIC has successfully deployed various outdoor recreation solutions in 12 states. The early momentum in this piece of NIC’s business is clearly evident and is very exciting for Tyler. We see significant opportunity to drive outsized growth with these platform technologies. Turning to slide 12, I would like to reiterate how strongly we believe in the merits of this transaction and view the addition of NIC as a combination of complementary strengths. With this acquisition, we will create a public sector technology solutions leader that furthers our goal of connecting governments with constituents and businesses in a way that is seamless and transparent. I’d close by noting how delighted we are to soon welcome NIC and their employees to the Tyler family. I remind you that we expect the transaction to close in the second quarter of this year and it is subject to customary closing conditions, including regulatory reviews and approval by NIC stockholders.

Your first question comes from Kirk Materne with Evercore ISI. Please go ahead.

Thank you very much and congratulations on the acquisition. Lynn, I have two questions for you. First, regarding the Tyler business, are you noticing any positive signs from your clients about their budgets? Specifically, are there any changes in activity levels at the top end of the funnel? I'm trying to understand if there is any indication of market improvement. You mentioned that it’s a nice deal this quarter, but it's still tough. How do you think this will develop throughout 2021? Secondly, concerning the NIC deal, it seems you plan to keep the business stable in the near-term. Could you discuss any potential synergies you foresee from a revenue perspective over the next year or two? What are some of the easier opportunities you think might be available? Thank you.

Thank you, Kirk. Regarding your question about budgets and activity levels, as mentioned in our last quarterly call, we expected COVID to continue impacting us into 2021. Most of our clients are currently in their budget seasons, which typically end on June 30. Looking at last year, the pandemic affected various parts of our business in different ways. We noticed a more significant impact in our ERP segment, especially at the mid and higher end, as well as in the appraisal and tax sectors. However, we had a record sales year in our courts and justice area, which was a positive highlight. The slowdown in RFPs and demos really impacted some business areas more than others. Now that we are just one month into 2021, particularly on the ERP side, while we don't discuss awards and wins extensively, contract values in January are certainly up compared to the past eight months, which is encouraging. In the appraisal and tax sectors, several substantial projects and large RFPs that were delayed in Q2 of last year are starting to emerge again. This doesn’t immediately translate to contracts or deals, but there is some progress. We anticipate headwinds in 2021, especially considering the recent COVID relief measures, which create uncertainty. We’re experiencing continued pushes and delays. However, in terms of your comment about a thawing market, while it’s still anecdotal, I sense a potential shift, but we’ll have a clearer picture at the end of Q1 as the vaccine rollout progresses and people become more comfortable. Regarding the NIC transaction, I've mentioned stockholder and regulatory approvals in my opening remarks. There are limitations on what I can share right now; I want to be cautious about overstepping my bounds because this is significant, and I'm excited. We see numerous revenue opportunities for both NIC and Tyler. Like with all acquisitions, it will take time. Our primary goal is to ensure we maintain the integrity of the company they've built. We’ll work closely with them to identify opportunities and establish the best timeline while preserving their strong business. When we analyze the complementary nature of both our businesses, including their statewide contracts and payment systems, we see a lot of potential to learn from each other, which is very exciting. I look forward to sharing more details as we move forward, but for now, I’ll keep my comments at a high level.

Got it. Thanks, Lynn.

Our next question will come from Keith Housum. He is with Northcoast Research. Please go ahead.

Yeah. Lynn congratulations on the acquisition. As you guys know, I cover NIC and they are a quality company with some really good people there. So great job there. Just I completely respect the limits that you have on in terms of talking about the deal. But just to be clear though, you guys see this clearly from a revenue synergy standpoint as opposed to any type of significant cost cutting synergies, correct?

Yes, that's absolutely correct, Keith. Our history at Tyler shows that when we pursue an acquisition for strategic reasons, it's about investing and growing that business to align it with ours, rather than creating synergies through cost-cutting. You’ve seen this with other Tyler acquisitions, and it's something I take great pride in. For instance, I mentioned earlier how C&J had a record year in sales last year, largely due to our previous acquisitions, how we integrated them, opened up new markets, and aligned them with our business. This is exactly what we envision with the NIC acquisition. It's a fantastic company built on integrity, and they have a strong management team, as expected. We're really excited to welcome them into Tyler and start collaborating.

Great. Thanks. Maybe if I just turn it over to Tyler business in the fourth quarter, so clearly software licenses, I guess, no real surprise there, some delays are still continuing. Is there a point in 2021 or maybe even 2022 that we are actually going to see the release of some pent-up demand or is it the ability by the clients that sweat their assets where they probably won’t it would be more blood in. How can we kind of think about a recovery from COVID? I hope that as a return to a more normalized world toward the end of the year?

It's a bit challenging to pinpoint exactly when we'll see a release of pent-up demand. As we've mentioned in previous calls, the demand hasn't disappeared. Our central functionalities and essential services remain available. Last year, we faced some difficulties in sales within our mid to upper-level ERP space, primarily because companies were able to hold onto their systems for an additional year. I anticipate that this pent-up demand will eventually be realized, though I can't specify when that will be. We've reflected on our experiences during the great recession, which, while not a perfect comparison, shows some similarities. We experienced a depressed market for a couple of years before it opened up significantly. Our investments and improvements during that time positioned us well to take advantage of the market surge, and we feel similarly optimistic about our current situation. I maintain the same level of optimism about the future as I had going into 2020.

Great. Thanks. Appreciate it. Good luck.

Our next question will come from Peter Heckmann. He is with D.A. Davidson. Please go ahead.

Hey. Good morning, gentlemen, and let me echo those congratulations. I have covered you guys since 2005 and I agree there is a very nice complementary fit here both culturally and from a business perspective and so I think it’s going to be a nice deal. I know you don’t want to talk too much about the details, but could you let us know, is there a go shop provision with the deal any type of termination fees involved? And then just back of the envelope, it looks like the deal might get you to around 2.5 times levered post-deal. Is that about the right ballpark?

Thank you for the insights on NIC. We fully agree about the importance of cultural fit, which I want to highlight briefly before addressing your other questions. Over the years, we've gone through many acquisitions, and one key lesson we've learned is the significance of cultural alignment. No matter how good an acquisition might look on paper, if the cultures don't align, it's unlikely to succeed; that's the exciting aspect of this deal. Having spent time with Harry, their CEO, and gotten to know their management team, it's clear that their culture and business approach align well with ours and their vision is a crucial factor. Regarding the agreement itself, I believe it was filed or will be filed today. The no shop provisions and termination fees you mentioned are standard in these public company transactions, and I would characterize the terms in this agreement as quite typical. Feel free to look those up. Overall, they align with what you would expect in a stock transaction. On the financing front, I am glad you mentioned that. We have consistently highlighted our strong balance sheet, and you are correct. When examining our net debt to EBITDA ratio, we believe it will be quite manageable, likely around 3 times, in the high 2s or low 3s, which we consider reasonable. I also want to emphasize that this represents a significant amount of debt that we haven't held for a long time. As we progress towards more committed financing, my goal is to maintain substantial flexibility, ensuring that our balance sheet remains very strong. It’s one of the things I am committed to doing and putting this permanent financing together. I spoke to our Board about it two days ago. It’s really important that how we structure this debt allows us to continue to do the things that we have done so successfully for so many years and have been a big part of our success. Things like the flexibility to continue and invest in all of our R&D initiatives that continue to do acquisitions as they arise and opportunistic share repurchases. It’s my anticipation that we will still have that flexibility over the next several years as we work with the debt and I believe to be very manageable. So I appreciate that question.

That's a fair question. Just to follow up quickly, regarding the main areas of government funding—federal, state, and local—are you noticing that one of these, perhaps federal, has fewer budget restrictions at this time? Are you observing improved activity there for MicroPact or Socrata compared to what you're seeing at the state level, given the need for balanced budgets?

It's interesting to note that throughout 2020, there was more pressure on state budgets compared to the federal level, which we observed with our MicroPact and Socrata solutions. As we entered the fourth quarter, state budgets began to stabilize, and we are currently witnessing a shift. Looking ahead to 2021, we anticipate state budgets to improve and new opportunities to arise. However, at the federal level, the situation is more cautious due to the change in administration, which has led to a slight pause in deals. We did see some deals occurring in Q4 following the election, but with the change in administration, organization, leadership, and priorities, there was naturally a bit of a pause. I expect that as the year progresses, particularly with some of the initiatives emerging from Congress, activity will pick back up.

Great. I appreciate it.

Our next question will come from Scott Berg with Needham & Company. Please go ahead.

Hi, Lynn and Brian. Congrats on the acquisition and thanks for taking my questions. I guess, kind of two here, Lynn, starting with the acquisition is, I haven’t covered NIC, obviously, looked at them from afar and this probably ends a 10-year rumor that you guys might ultimately acquire them. But on their business at least from how I understand it a little bit, correct me if I am wrong. But some of their state and federal opportunities have a little bit more of a custom software kind of component to it, the pure pre-packaged software, which is predominantly what Tyler sells today. How do you deal with that going forward or is that kind of maybe a misconception in terms of what their products may look like to those larger customers?

I’d say, Scott, and I think, that was probably more their business model when they started. It’s obviously there is still a part of that I think what they have been doing is they have been evolving their business to make it less custom and to make it more leverageable across their client base. You are also seeing what they have done the last several years where they have started to get some more vertical solutions. They have done a couple of small acquisitions and starting to push those. I mean, I think, part of their overall growth plan absent Tyler, was to sort of continue to move in that direction and that’s the direction they are moving on and we would expect that to continue.

Got it. Helpful. And then, I guess, congratulations to Jeff for leading the new accelerated move to your cloud platform. But I guess, as we think about that movements at the end of 2023 is only roughly a three years weight to have all your apps to be cloud native or I guess cloud efficient is just kind of a two-part question there is. First, how do we think about margin structure and what the new platform looks like, now that you are getting more visibility around kind of time frames, etc., gross margin structure obviously on those customers? And then two, how do you migrate those customers? Is this something that you try to push relatively quickly to get some of your current subscription based customers to move over that or do you allow them to kind of naturally migrate there over a longer timeframe? Thanks.

Thank you, Scott. I believe it will be a combination of both approaches. As we pursue a cloud transformation, specifically at Tyler, it involves more than just transitioning our products to a different state. It fundamentally alters how we develop, deploy, and support those products. A key part of this strategy, as you noted, is moving our customers from the Tyler systems to AWS. However, the main focus is ensuring that our products operate in at least as efficient, if not more efficient, manner than they currently do in our existing Tyler cloud centers. This is our current focus. Over the next three years, we aim to see progress, but that doesn't mean everything will suddenly be in place by December 31, 2023. We'll achieve this in stages, with some customers transitioning sooner than others. As we plan for the future, we may well direct new customers exclusively into the AWS environment. We will also identify areas where our products already exhibit greater cloud efficiency, allowing us to be more proactive with our existing customers. This approach will be a mix of strategies. Furthermore, the reason we formed this group is multifaceted and exciting. Jeff, who has nearly 30 years of experience here, understands our business thoroughly and is ideal for overseeing and coordinating this effort. His role involves orchestrating various initiatives across the company. This encompasses not just getting our products to AWS but also managing migration plans, exiting Tyler data centers, enhancing our IT infrastructure, and establishing robust information security measures. This comprehensive effort will shape how we deploy and support our offerings. We will keep you updated on our progress every three or six months as our plans become more defined. In a broader sense, we anticipate significant margin and revenue enhancements as we transition customers to the cloud. Getting them on subscription models and improving product efficiency will support margin growth. With fewer releases and easier deployments, we expect overall improvement, which is central to our cloud transformation efforts in the coming years.

Great. Congrats again. Thank you.

Our next question will come from Charlie Strauzer with CJS Securities. Please go ahead.

Hi. Good morning. Couple of quick questions for you. Lynn, you were talking about the balance sheet structure post the transaction and the type of debt you wanted to take on. Are you thinking more in terms of like a term loan or credit facility where you could use your strong free cash flow to quickly pay down the debt?

Hi, Charlie. This is Brian. We are actually considering a number of alternatives there. So we are not ready to quite specify one. But it’s clear that the way interest rates are, the way some of the specific debt markets are, it’s a very, very attractive time for a company with our profile with the transaction as financially compelling as this one to be looking to raise their debt. And so, we have got a lot of options, as Lynn said, maintaining flexibility and not limiting our ability to execute on other initiatives is key in that decision. But you will see more about that in the next few weeks from us.

Thanks for the insights. Regarding NIC's performance in 2020, it appears there were advantages from new programs introduced for COVID-related needs. How should we assess the long-term growth potential for that business's topline? Before 2020, growth was in the low-single digits, so what is your perspective on the future of that business?

Charlie, I’d say two things. You are correct that they received a boost in 2020 from certain COVID pandemic-related products and initiatives. This really highlights their innovation and ability to quickly develop solutions to meet urgent needs. While this boost was closely tied to the pandemic, it's exciting to see that they can execute on such initiatives, and it suggests we can explore similar opportunities in other areas, especially as we combine with some of the Tyler products. Looking at their overall revenue growth moving forward, I expect it to align more with Tyler’s. If you look at their performance over the last couple of years in isolation, it might appear that their overall revenue growth was lower due to a significant contract they inherited, which originally wasn’t sold by them, with the State of Texas. Losing that contract created a significant challenge for year-over-year revenue growth. They have several initiatives underway that are set to grow at accelerated rates, just like we do at Tyler, particularly with some targeted solution initiatives. You should see considerable growth in their payments business. As I mentioned previously, they recently secured a contract with the State of Florida to provide statewide payments, along with opportunities for local-level payments under that contract. That’s how I view the situation overall at this moment.

And I’d also add that over the last decade their same-state revenue growth has been more than 8%, so over a long period of time. That’s been reasonably close to sort of what our organic growth rate has been. So they do have really solid foundation of consistent growth and more than 90% recurring revenues. So that will actually raise our mix in terms of recurring revenues on a combined basis.

Great. Thank you very much. Congratulations.

Our next question will come from Matt Vanvliet with BTIG. Please go ahead.

Yeah. Thanks for taking my questions guys and congrats on the announcement. I guess, on the core business and maybe also how it relates to the acquisition. Curious on how much success in some of these larger deals especially the State of Texas extension. You feel like the Socrata data layer is enabling especially as everything kind of moves more digitally. I guess, how much are those conversations happening on a deal by deal basis? And then looking at NIC, how quickly do you think you can sort of integrate that and start pushing especially at the state layer where maybe greater visibility is even more paramount?

Thanks, Matt. Regarding your first comment, you're correct. The State of Texas contract was an extension of our prior relationship. We've accomplished a lot with the state to enhance our chances of retaining that contract, and there are additional benefits that come with it. I've mentioned over the past few quarters that Socrata plays a role; it adds value across various areas of our company. When we acquired Socrata in 2018, we were excited about its potential to focus on data and insights for the future public sector, which can truly set our products apart. I've discussed its impact in public safety deals, and we're beginning to see its significance in our ERP deals as well. While it's difficult to measure, having that functionality and insight gives us a considerable advantage over competitors. Concerning the integration of NIC, we are still in the early stages and have many discussions ahead with their management team. Although this deal has been developing since I first contacted Harry in September, things have been progressing quickly, and we've explored numerous opportunities. However, there's still considerable work needed to unite our teams and strategize together. Some efforts may be limited due to regulatory constraints, but I want to emphasize how excited I am about the potential for collaboration and the opportunities that lie ahead when we combine our leadership strengths.

Great. And on the transaction side, continuing to see strong growth there, I’d say, I imagine that’s a fairly high demand factor for a lot of local governments now. But from a competitive front, are you seeing maybe non-traditional vendors in terms of this area of the market enter in as a lot more kind of digital payments or FinTech type companies are looking to reach further into other areas of the market. So curious what you are seeing from the trends there and maybe how much that influenced the exact timing of getting this transaction done?

I believe there is some truth to that. What we aim to emphasize, even with this transaction, is that, similar to our core applications where we stand out through data and insights, we want to provide more than just quote payment processing. Our goal is to connect these services with other offerings and value additions, which helps us become more integrated with government agencies. Looking ahead at the public sector market, I see trends like cloud services, subscription-based essential functionalities, digital services, transaction-related revenues, data and insights, and our Connected Communities vision. We want to consolidate all these elements in a way that others cannot. So, to answer your question, while there is some influence from these trends, our focus remains on delivering added value and services to our clients that can't be matched by anyone else.

Great. Thank you. Congrats.

Our next question will come from Jonathan Ho with William Blair. Please go ahead.

Good morning. I just wanted to maybe start out with, understanding, I guess, why is now sort of the right time for the EGOV acquisition given that you have known them for a little bit of time and how does that sort of, I guess, mesh with your M&A strategy like do we sort of see a slowdown in activity. I think you said you wanted to maintain flexibility, but when we think about digestion of something this large, how should we be sort of probably think about that?

It’s a good question, Jonathan. I've been with Tyler since 1998, and EGOV or NIC went public a year later. They had already been in business for several years before that, and they have been on our radar since their IPO. We've had internal discussions about them over the years. We've been very focused on our mission to cover all essential functional areas across local government. As I've mentioned before, we've made acquisitions like MicroPact and Socrata, which reflect areas we’ve been interested in, but we just haven't pursued them until now. I can’t explain why I didn't reach out to Harry three years ago instead of this fall, but I can tell you that we spent considerable time preparing even before I made that call. Our companies have both grown and matured, and as we’ve expanded our solutions and opportunities, and as they’ve enlarged their footprint, it has created a favorable balance between us. For example, payments are a significant strategic focus for both parties, and they have a robust payments business while ours is still emerging. We recognize the opportunities here. We are very excited about the deal we’ve made today. Regarding our M&A strategy, I would be surprised if this is the only acquisition we undertake this year, but this is a substantial acquisition that will demand significant attention from our management teams, and it’s crucial that we execute it well. After the deal closes, I could see us, particularly in the second half of the year, taking a deliberate pause much like we did in 2019. However, we’ll still have the financial capacity to pursue further acquisition opportunities, and we will continue to seek strategic products or ways to expand our total addressable market or offerings in areas where we already have a strong presence. Our overall strategy will remain unchanged, but it may resemble our approach in the latter half of 2019.

Got it. And just as a quick follow-up, you talked about your competitive position strengthening throughout the downturn. Can you give us some concrete examples or some, I guess, greater detail in terms of what you are seeing in the competitive landscape and maybe where you are seeing some folks drop off?

Yeah. So, I’d say, first of all, just initially it goes back to all of our investments and continue to invest in those. And what we have seen in the market is that some of our competitors are not making the investments that they may have historically done and we have seen a little bit of that. But when we see things like in our Incode Group, which is really the lower end of ERP it’s where our schools is, it’s where utility billing and things like that. That group right now is seeing record win rates. I mean, their win rates are approaching 90%, which is just off the chart and so we get really excited about when we think about the market returning. When we see things like I mentioned earlier on the call, our Courts & Justice Group. 2020 was actually the highest sales year for our Courts & Justice Division. Now, they are POC accounting, so it’s not all going to flow in right away. But you remember back in 2014, 2015 when that group had really high sales which is when California opened up. That’s a process of, I mean, not only our Odyssey continues to be strong, but all the investments we have made around there and the expanded products including acquisitions which was your question earlier and being able to sell all those products and have more functionality and be more competitive. We talk about the public safety. Public safety had another 1 million plus license deal this quarter. They are just on a roll. They had a very big win in Genesee County, Michigan against Motorola and CentralSquare. And again, that’s a result of our competitiveness, our ability to check more boxes on the RFPs, our ability to go up market. And again all these acquisitions that are differentiating these offerings, so those are few examples and we just like where we sit right now and we anxiously await for pre-pandemic market.

Congrats on the acquisition. Thank you.

Thanks, Jon.

Our next question will come from Rob Oliver with Baird. Please go ahead.

Great. Thank you. Good morning, guys. Appreciate it. Lynn, I had one for you and then, Brian, a follow up for you. So, Lynn, I guess, a follow up on Scott Berg’s question earlier, just around the details on the SaaS migration. Very helpful color there. I did note in the quarter that conversions were up nicely. So can you talk a little bit about that how you are managing that go-to-market and obviously you guys since your pivot to a subscription-first mindset has really been predominantly landing with subscription, with new business. But it does seem like conversions are starting to kick up nicely there. So I was wondering if you could talk a little bit about that?

Yeah. I think part of that conversion is also just the general market and as we said for a couple of years, the market was moving in this direction, certainly, COVID, I think is accelerating that. We are doing some things internally. It is a focus point for us. I think one of our greatest opportunities is our existing customer base, whether it’s new products that go in there, whether it’s converting them to the SaaS model, continue to push in, inside sales continue to be one of our big growth drivers and so it’s a combination of a lot of things. But you are right, it’s a focus of ours and as we continue to get our products into a more cloud efficient state, it will become even more pronounced. And it’s going to take some time, I mean, I don’t want to say this is all going to happen in the next few quarters, but it’s going to take some time, but it’s definitely the direction we are moving and it’s a significant opportunity.

Okay. Great. That’s helpful. And then, Brian, on the deal that you guys announced this quarter that extension on the Texas Office of Court Admin. Maybe if you could provide some color on what is it within this contract that did not enable you to show that in bookings and backlog and what are the measuring points that we are going to look to see that start to roll into the numbers?

It’s essentially a termination for convenience provision in the contract that neither we nor the State of Texas anticipate will be utilized. The state has expressed positive feedback about our relationship, especially regarding the e-filing services we've provided over the past few years and the enhancements we've made. We secured this renewal in a competitive environment, which includes several enhancements. The contract allows for five one-year extensions, but the termination for convenience provisions prevent us from recognizing the full amount in backlog as we typically would with a fixed fee e-filing arrangement. As a result, less than $5 million of this contract will be reflected in backlog each quarter. While it doesn't impact revenues, it does influence our operating expenses. We've mentioned the inconsistencies in some bookings over time, and this particular contract didn't align well with the accounting rules. Nonetheless, this extension is a strong endorsement of the work we've done with Texas over the years, making it our largest e-filing contract and a significant win for us.

Great. Thanks, Brian. Thanks, Lynn.

Thanks. Thanks everybody for joining us today. We hope you continue to stay safe and healthy, and if you have any further questions, please feel free to reach out to me or Brian Miller. Thanks again.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.