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

Hello, everyone, and thank you for joining us for our Growth Stock Conference. My name is Jonathan Ho, and I'm the research analyst here at William Blair that covers Tyler. I'm required to inform you that a complete list of research disclosures or potential conflicts of interests is available at our website at www.williamblair.com. With us today is Lynn Moore, the Chief Executive Officer of Tyler. And Lynn, thank you so much for joining us today for our conference.

For those that are maybe a little bit less familiar with the company, could you maybe give us a bit of a brief overview of Tyler just to maybe level set the audience in terms of the company?

Sure, Jonathan, and thanks, everybody, for those that are participating today. Really appreciate your interest in learning a little bit more about Tyler. Tyler Technologies is -- it's -- as I'd say, in a 50,000 foot level, it's really the largest provider of software and services to the public sector, and that's primarily at the local level, cities and counties. We also do some business at the state level and the federal level, but I'd say about 80% of our business is at the local level. It's important to note that when we talk about Tyler and the public sector, that's all we do. That's our singular focus. It's been our singular focus -- I've been here now 21.5 years, it's been our singular focus since we entered the space back in the fall of 1998. Our enterprise systems really provide what we call essential, mission-critical functionality across all major areas of the public sector. Whether it's running at a city's budgets, it's paying the teachers, it's streamlining court processes, assisting with 911 calls. Everything that really runs a public sector is what our software does. Our core systems really fall into a handful of major functional areas. Our largest being ERP and financial systems. Again, things that are running budgets, payroll, things like that. That's about 45%-ish of our business. Next largest area is really our Courts & Justice suite. These are things like civil case management, criminal case management, probation, supervision, e-filing, where we have, for example, all of the electronic filing and the civil courts in the state of Texas run through our systems. That's roughly 18-ish-percent of our business. Public safety is another major area we're in. This is things like 911 computer-aided dispatch, call management, records management. That's 10-ish, 11-ish-percent of our business. Property tax and appraisal systems, pretty much it is what it sounds like, appraising software, collecting taxes, things of that nature, that's about 10%. Civic services, permits, licensing, things like that. We're also playing at the state and federal level. We're also in schools, both in terms of school information systems. Things like grading, attendance, things like that. Also school transportation systems. Also Land & Vital Records, things like recording documents down at the court's office. We sell our systems, we sell in 2 different ways. We are both on-premise perpetual licenses with annual maintenance as well as we sell in a subscription-based cloud environment. It's a very sticky business. It's a business where our retention rate is really north of 98% for our customers. Our recurring revenues are about -- today about 70% of our total revenues. Coming out of last year, our revenues were about $1.1 billion. We've been in this space -- again, we entered the software space back in the fall of 19 -- or spring of 1998. I think in that first year, our revenues, our software-related revenues were about $25 million. So over 22 years, we've grown from about $25 million-ish to $1.1 billion. We've averaged about a 13% compound annual growth rate over the last 18-ish, 20 years. And that's generally been about 11% organic growth, supplemented by a couple of points through acquisitions. So at a high level, 50,000 feet, Jonathan, that's kind of the business.

Thanks for that, Lynn, it's always great to have a quick overview of the company. I guess maybe starting first with COVID-19, which seems to be an unavoidable subject. Can we maybe start off by talking a little bit about customer behavior, budgets and maybe what you're seeing in terms of the pipeline of opportunities here?

Yes. Sure, and not surprising. I think it's impacting everybody's life. It's certainly been an interesting time right now. What we've been seeing really is our customers have been dealing with the same issues that we've all been dealing with, which is how do we continue to provide services while we're adjusting the shelter-in-place and other local type orders. I'd say on the sales side, what we have been seeing is certainly a pause in sales. We've seen a number of demos that have been postponed. We've had to deal with just logistical difficulties of trying to get contracts signed. As you can imagine, we need city council meetings to approve contracts, and maybe they're not actually having those meetings, just getting contract signatures when people are working from home. Trade shows have been canceled. Our Tyler Connect, our user conference, we canceled that this year. That's a conference attended by about over 5,000 clients. But what we're also starting to see is we're starting to see clients adapt. And we are starting to seeing clients engage a little bit more in the sales process. They're becoming more accepting of virtual remote sales. I'd say at a high level, stepping back, deals that were in process, sort of mid-stage deals, late-stage deals, those have tended to continue on. Deals that are more -- have been more early-stage have been somewhat paused. And for those not familiar with our business, when I talk about the sales process, dealing in the public sector, these are generally long sales cycles. These are things that can take several months and times -- at times, a couple of years. So when I talk about late-stage deals, these are things that had been in the works, things that had already been in our clients' budgets and things of that nature. I think you asked also about pipeline. I think the best way to probably answer that is to really sort of look back at our experience during the Great Recession and also think about what it is that we do. As I mentioned at the top, I say, what we provide is essential functionality. These are mission-critical systems, they are not discretionary purchases. These are things that the public sector has to do. Typically, we are replacing aging technology, aging systems, some as much as 30 years old and older. These are systems that either simply don't work or no longer supported by a viable vendor. And generally speaking, and again, leaning back on the Great Recession, these buying decisions don't go away. The pipeline doesn't go away. There may be a pause, as I mentioned earlier, in some of the decisions to move forward, but these are things that have to be done. At the end of the day, these -- our clients have to run their budgets, they've got to collect their taxes. They've got to pay their teachers. So again, there may be a pause in these decisions, but we don't believe the pipeline goes away, and we saw that 12 years ago. We saw a pause. And then when we saw when the markets returned back to normal, we saw that pent-up demand and it really sort of unleashed and exploded and actually led to accelerated growth rates a few years later.

Got it. Got it. Thanks for that color. I mean if we kind of dig a little bit deeper, Tyler does sell a number of different systems like ERP, courts, these seem to be pretty complex implementation projects that involve a lot of professional services. Are you may be seeing these types of projects hit a little bit harder than other areas of spending? Or is this something that you can also continue to remotely implement as well?

No, that's a great question. And you're right, these are -- these can be complex implementations. Some of these implementations can last -- span multiple years. And one of the things that's unique, going back to sort of the high-level overview what Tyler does, one of the things that's unique about Tyler and someone of our size is, is that we actually do perform all of our own services. We don't engage third-party service providers. And while we don't really make a lot of money on our services, we do it because we think it's a long-term competitive advantage. We really want to own the customer relationship from the initial sales through the implementation, through long-term maintenance and support. Implementations have definitely been impacted. Traditionally, clients have been, I think, more reluctant to accept virtual or remote implementations. And I think what you're starting to see is you're seeing them adapt, just like we're all trying to adapt and learn how to live in the "new world" that we found ourselves in. I think people are starting to challenge some of their own business practices. They're beginning to accept virtual remote implementations. We've had a number of go-lives go recently in the last couple of months. I wouldn't necessarily say it will be the new normal going forward, but it's something that I'm encouraged about. I think for Tyler's long-term business model, it's -- we are -- we would be more efficient and our employees will be better served, the extent we can start delivering these more remotely. I'd probably make an analogy similar to the sales processes. Again, these implementations are difficult processes. And these processes that were sort of underway, those have continued on, these large multi process -- multiyear processes have continued. Some of the earlier ones have been delayed. They've been a little bit slow to get started, but we are starting to see more and more clients be willing to accept virtual remote delivery of services and things like that.

That makes a ton of sense. There's been a lot of stimulus funding that's been directed at the cities and then additional stimulus may be coming down the pipe as well as grant programs. How long does this typically take to kind of filter down to the municipal level? And can you talk a little bit about maybe funding sources? Are most of your projects funded more by property taxes? Or is this kind of use of -- use it in sales taxes?

Yes. So you're absolutely right. The stimulus funding will definitely help the state and local government market. The timing question that you asked is really the $64,000 question. The way I sort of have viewed it is really our clients have had their hands full. They've been so focused on how are we just doing day-to-day operations within the city. We're trying to enforce and impose shelter-in-place and other orders. And I think while there has been a lot of actions taken by the federal government, I'm not sure our clients have fully appreciate and understand exactly how to best take advantage of that and utilize it because they've been so focused on just sort of running day-to-day stuff. We are entering into a new budget cycle. I think the overwhelming majority of our state and local clients are on the June 30 budget cycle. And so I think you're going to start seeing them really focus a little bit more on that. You're right, the initial stimulus program had almost $500 billion available for state and local governments. There's been discussions of additional stimulus there. In addition, the Fed has announced a debt buying program so -- for state and local governments. That's an additional resource. And I think as we get into this new budget year, you're going to see these cities and counties really focus better on how to take -- best take advantage of that and really focus there. I'm trying to think, you had another question.

It was -- the sources of funding, is this from mainly use taxes, sales taxes? Or is this mainly a property tax-driven for your -- for the budgets that support your projects?

Yes. So at the local government level, there's obviously a lot of different revenue sources. And it's going to vary by jurisdiction. Some get revenues from income taxes, some from sales taxes, but you also get a lot of hospitality-type-driven taxes like hotel tax and rental car tax and a lot of that revenue has dried up. But when you step back at the -- particularly at the local level, the overwhelming majority of -- or the largest, I guess, revenue source for state and local government -- for local budgets is property tax. And what we've seen in the past during the Great Recession and other times of economic uncertainty is those revenues tend to be fairly stable. In good times and bad, people are paying their property taxes, they need to keep their homes even as some of more variable revenue sources fluctuate. I think, for example, sales tax, which is certainly going to be impacting a lot of local budgets, is typically less than 10% of a local government budget.

Got it. And if we can talk a little bit about maybe your unique positioning. I mean, clearly, the company has a lot of recurring revenue, a massive backlog and a lot of maintenance revenue from the permanent license deals. What kind of advantage does that provide for you, especially relative to maybe smaller or -- competitors that have been acquired recently in terms of your ability to invest?

Yes. No, that's a great question. And again, I'm going to harken back to the Great Recession, which is -- it's certainly a different time, but it's somewhat of a similar time. And when you talk about where Tyler is today versus where we were then, it's one of the things that makes me excited about the future. Where -- to me, we used the time during the Great Recession. We invested heavily in our products. And we really came out of the other end a stronger company and more competitive company. And sitting here today, I think our position is even better than it was 12 years ago. And as for the points that you just mentioned, our balance sheet is the strongest it's ever been. We have over $400 million in cash, and we have no debt. As you've mentioned, backlog, we've got a record backlog, about $1.5 billion in backlog recurring revenue base to lean on. About 70% of our revenues are recurring. When you look back 12 years ago, it was more like 45%. We've got a management team that's experienced -- that's been through this before, and it's not going to be rattled by these current circumstances and understands that everything we do is we're focused on the long term. And so we're going to continue to make all of our long-term strategic investments. We're positioned to do that. When you look at some of our competitors, certainly, there are some startups. You look in some -- particularly in some of our niche places like public safety, you get these smaller companies that don't enjoy the balance sheet that we have or don't have the stability of the recurring revenue base. And when you have a short-term blip in business, it makes them make very difficult decisions. Can they invest at the same level? Can they keep their staff? One thing that we've done is we're keeping all of our employees. You look at PE firms that have entered our space, a company like CentralSquare, which is a competitor of ours. They're carrying debt at about 11x EBITDA, they've got over $1 billion in debt. And again, you get a blip in the business, and they have to make those tough decisions. What do I do with my personnel? What do I do with investments? And now I've got -- what I got to do is servicing this debt. And it's -- at the end of the day, that's what they have to do. So we think we're in a great position to capitalize on this opportunity. That's not to diminish the short-term challenges that are ahead of us. It's definitely a challenging time. But as -- again, if you look out 2, 3, 4 years, we think we're well positioned to come out of this actually even stronger than going into it.

Got it. Got it. And maybe if we take this opportunity to shift gears to kind of more of the higher level discussion and the longer-term view. Tyler seems to be expanding into more opportunities around U.S. federal and other adjacencies. How do you think about moving into new areas to expand the addressable market as well? And given the market dynamics, what are the types of investments you have to make to kind of bring those to fruition?

Yes. That's a good question. I'd say stepping back and someone who's followed us for a long time, we're always looking for growth. We're always looking to ways to expand our TAM. Internally, we have what we call our white space initiative. And that's something where we really step back and take a really objective look at our entire portfolio of products. We've taken an entirely objective look at the markets we serve. And we're really looking for voids or gaps in those offerings or voids or gaps in the markets that we serve. And when we look at our white space initiative and as we go through that analysis, we look at things like, what's the overall TAM on a potential investment? What's the annual recurring revenue opportunity? What's the competitive landscape? Is there a dominant player? And we go through that analysis, and it really helps us inform as we make our investment decisions, whether they're internal build R&D initiatives or acquisition initiatives, whether it's entering a new market like we did a year ago when we acquired MicroPact entering into the federal space or whether it's going to be an adjacent market to one of our core offerings, something like our CaseloadPRO acquisition, where really it was a probation supervision product that ran adjacent to our core courts offering. So we look at this all the time. We have a history of M&A. We've -- over the 20 years I've been here, we've done over 40 acquisitions. I often say for every acquisition we do, there's probably 20 that we look at and we don't do for a variety of reasons. But every time we're making those investments, whether they're internal or foreign acquisition, we are looking for ways to do things that are going to accelerate our overall growth rate, expand our TAM.

That's a great answer. When we look at sort of the R&D spending side, I did want to dig a little bit deeper into this because this has historically been an area where I think investors have had some trouble understanding how you think about maybe the time frame for the investments. When you guys are typically looking to improve or add capabilities in a certain area, how long does it take to kind of show up in the market? Like, this has never really struck me as being like a 12- to 18-month time frame, which we typically see for a lot of commercial companies. Can you talk a little bit about the dynamics of when your spending translates into opportunity?

Yes. That's a good observation. And you're right. I mean one of the characteristics of the market we serve being the public sector is it is a slow-moving market. At the same time, it's a very consistent market. And one of the things I've said to people is, I'll hold up my iPhone here, and I'll say, I can't have people spend $20 million and go build one of these and create demand and sell a billion of them next year. That's not the way our market works. Typically, when we go through an investment, either an internal build or even if we bring in a company that we're going to invest in because we see the growth opportunities, it could take multiples of years for those investments to pay off. And in part, again, because of the market that we serve. We have to go through the project process of creating the product, then you've got to go out and prove that product out in the market. Everything we do by being in the public sector is out in the open and that we are 100% a reference business. There's nothing that we do that's not shared. One of the things that's unique about our space is that our clients don't compete with each other. In fact, they share information. So to the extent that if we have a product that's not working or we're not performing our services, it's known throughout the market. And so when you think about the cycle of investments is we got to go through the cycle of creating the product, then we've got to go out, and we've got to get a couple of customers to get online and get them to start using it and get that traction. And that takes time to build that market acceptance out there. Once it does, then it starts taking off. But it can take a number of years. And I think as people start to understand that, and they see Tyler and how we are always looking long term, I think that's one of our strengths, is that we have the patience to follow those initiatives.

And we had the opportunity to sit in a few years ago on the City of Chicago's evaluation in their commissioner meeting of their courts and justice system, and they definitely took a look at reference accounts and they looked at other opportunities as well where Tyler was involved already with the city. I guess when we look at the public safety market, your win rates have clearly improved in this space, and it's become more competitive over time as well. I mean clearly, there's been some smaller entrants, and then there have been some other companies that have started to make up -- make waves into this space. What's made the most difference in terms of the investments that you've made in order to improve that market share?

That's a good question. And people ask a lot about Public Safety and they should, it was our largest acquisition. We did about 4.5 years ago. We had a small Public Safety business, but we really weren't playing in that space. And to your question earlier about TAM, this is a good example of what Tyler -- as Tyler's viewed it historically. We saw that opportunity. And when we bought New World, it's not unlike when you buy a lot of companies, in particularly companies that are there for sale is what you generally find is that they have probably not been investing at the levels that they needed to have been as they get their companies ready for sale. And when you talk about what's been the differentiator over the last several years, I'd say it's 3 things in terms of our investments. First, we made -- at first, we made really a lot of investments in the organization itself. Organizations in the support organization, the dev organization. We just talked about how it's a referenceability business everything we do. And when we had first acquired them, they had some problem accounts. There were some noise, some chatter within their customer base. And it was extremely important for us to devote our early resources to shore that up, so that those all became referenceable clients. And so that's what we did. So that's one. I would say, two, we've really done a rewrite of their CAD and their record systems, a complete rewrite, a complete -- a lot of new features, a lot of functionality, things that would allow them to compete in bigger markets. And then third, I would say, and this is probably more recently. It's interesting, the public safety space is a space that is probably a little bit more technology-focused than some of our other markets than, say, our ERP market. And I think one of the things that we've done recently is really invest highly in mobility and having products that allow the police officers to do their business effectively, not just in the squad car tied to a laptop or not just from their desk, but actually out in the field, whether it's on-site collection of evidence, whether it's wristwatches, where they're getting CAD calls from their wristwatch, they don't have to be tied to the car. This is really cool, high-tech stuff. I think we're kind of -- right now, we're the leader in the space in terms of mobility technology. And I think it's a big differentiator in a lot of our new deals.

Absolutely. That makes a ton of sense. And just given all the unrest that's out there, it seems like there will be significant opportunities as well. Can we dig a little bit into some of the cross-sell opportunities that you have with the business? I mean you've acquired in areas like Brazos, EnerGov, MyCivic and Socrata. And these are -- first of all, can you talk a little bit about these products and what they add to your portfolio? And number two, how easy is it for you to sort of upsell these into your existing base of customers?

Yes. So just stepping back, and we've done a lot of acquisitions. I think we've done recently, from the beginning of 2018 through early 2019, we did about 9 acquisitions, and I could probably spend the rest of this time and everybody else's rest of the day going through all those products. But it's an example of what we talked before about voids or gaps in our offerings. These were either things that were on our investment horizon or they were products that were part of our portfolio, but we had invested in them significantly. And so we thought it was an opportunity to bring something in that was a little bit more advanced. I think you're right, the cross-selling opportunity is, to me, one of our greatest opportunities going forward. I think our greatest asset is our customer base. We have -- I think I've mentioned at the top of the interview, we have over 10,000 clients and over 26,000 installations. And that kind of customer penetration in our space, as I mentioned earlier, it's a slow-moving space, that doesn't take just years to develop, that takes decades to develop. And so I think one of our opportunities is still to go back to that base with these new products as well as do things like generate new revenue streams from that base, things like Tyler Payments, we've talked a little bit about that on some of the earnings calls. I think a great example of the leverage that we can get by cross-selling and these products that we brought in through acquisition is really what's happened with the state of North Carolina. Last summer, we announced a statewide North Carolina courts deal. It was the largest contract in Tyler's history. It was a SaaS contract valued at about $85 million over a 10-year period. At the time, we talked about there was going to be some opportunities to -- additional upside selling opportunities in there, things like our Brazos solution, which is our e-citation solution, things in public safety, Socrata, data insights. And in January of this year, we announced a corresponding 10-year SaaS deal for Brazos. And that deal was valued at about $14.5 million over 10 years. That, in turn, was the largest contract in Brazos' history. And if you look at Brazos, this is a company we bought back in, I believe, back in 2015, at the time they were doing as a company, all in, about $10 million in revenues, and here's a contract 4.5 years later, 5 years later, for $14.5 million. So it was really a good example of taking an acquisition, bringing it in, making some investments in it, Tylerizing the product and then giving it to our sales channels to get back into our installed base as well as our new customer base and give us more power to our sales resources.

Got it. We do have a few questions from the audience. I wanted to make sure I addressed those while we have remaining time. Do you expect a more competitive environment for solutions over the next 5 years?

More competitive? Do I expect more competitors to come into our space? One of the things -- I'm not quite sure I know exactly what they mean…

Yes. I think that's what they're asking, is do you expect the space to see more competition or the existing competitors to improve any of those types of dynamics?

Yes. So our competition will vary across each of our major functional areas. When you talk about, say, our ERP systems, that's an area where what we call -- where we get some crossover competition. That's where you may get companies that aren't purely focused on public sector. You may get a Workday, you may get an SAP, they may come in there. When you talk about areas like, for example, courts or tax. These are things that are extremely unique to the public sector. And this is where our years and years and decades of deep domain, functional expertise really serves as a moat to really protect against some of that competition. In addition, we have about 1/3 of our employees have public sector experience. So we know what it really takes to run a public sector. And I guess one way I would analogize it is if I'm sitting in a boardroom with a bunch of VC money, and I'm thinking, how am I going to invest $20 million? And I say, well, hey, this company, Tyler Technologies is doing pretty well in courts. Maybe we should develop a court system. Well, what does that really involve? That means I need to go out and I need to develop a court system, which could take a number of years. And as we said, well, you got to get references, you got to get clients up on board, and it could take 6, 7 years to get that referenceability, get that customer base going. By the way, there's a company in that space right now that already enjoys an 80% win rate. So am I going to go take my money and am I going to go invest and try to create a new court system? Or am I going to go put it somewhere else? You certainly can't be arrogant. We certainly take our competition seriously. We keep our eyes out for all potential competitive threats. But in that instance, if I'm sitting in that boardroom, I'm going to say, let's invest somewhere else.

That makes a ton of sense. Another question from the audience. Just given some of the cost savings that are coming from COVID, how much are you potentially saving on things like travel, which I believe you guys use as a pass-through?

Yes. So that's a good question. I think when we talked about our guidance at the year or last quarter, we actually talked about suspending our guidance. What we did say is we expect our revenue growth to be lower. We do expect to grow this year, but we expect margins to be somewhat flat. And the reason for that is, is because some of the revenues that we are losing are low to no margin revenues. I think in the second quarter, we typically would have had about $5 million of just billable travel, which is not the time on the site, but the time getting back and forth to the site, which we don't really make any money on. So that's a $20 million a year revenue stream that goes away, but does not impact our margins.

Got it. And then what percentage of revenues are currently coming from federal government as well as overseas clients?

So right now, international is about less than 3%. It's certainly a -- it's a long-term growth opportunity. I wouldn't say it's something that we're focused significantly on or in a material way right now, but we're doing things. We do have some of that business and it is an opportunity for us. In terms of the federal business, it's probably about 5% to 6% of our business right now.

Got it. Let me just sneak one last one, Lynn, because I know we're running at the top of the hour. Are there any risks to the payment terms in terms of existing recurring revenue, particularly from challenged budgets?

So that's something that I've been thinking about for some time. A large percentage of our recurring revenues are out in conjunction with the annual budget cycle. So they're June 30, July 1. Those maintenance bills had gone out -- they went out 6 weeks ago. We have not seen significant pushback. We are pushing through our normal raises. And I think some of the things that we've been doing during COVID have also helped prove the value of those maintenance dollars. It's not just the releases and the upgrades. But we've been there. I think one of the things that's positive about this crisis is I think our bonds with our clients are getting stronger. They're leaning on us more. They never missed a beat with us. We were up and running. Even as we send all our people home over a weekend, we had all our people up manning phones, doing support calls and things like that. Sorry, I know we're running out of time, but I don't expect there to be any early material change in our recurring revenues or our approach to that. That's one thing that's near and dear to my heart and something that we're always going to try to protect.

Fantastic. Well, Lynn, this has been extremely helpful, extremely informative. I want to thank you again for participating in our conference and wish the audience a fantastic rest of the conference as well. Take care. Feel free to reach out if you have any follow-up questions.

Thanks, I appreciate it for your time. Thank you.