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

Good afternoon, everyone. This is Pete Heckmann with D.A. Davidson. I'm one of the research analysts on the tech team here. I'm joined by my associate, Alexis Huseby as well as long-time CFO of Tyler Technologies, Brian Miller. Welcome, Brian.

Thanks, Pete. Good to be here.

Would -- before we get started, would you like to just give any high-level comments on -- just to get us started?

Yes. Sure. Just as a very high-level summary of what Tyler does, we're an enterprise software company focused exclusively on the public sector. So we provide a wide range of mission-critical software applications that power the operations of public sector entities, mostly local governments, cities, counties, school districts, local agencies. We have some presence at the state level as well and a relatively new presence at the federal level through an acquisition about a year ago. We have what we believe is the -- by a wide margin, the largest set of product solutions for public sector entities, have been a low double-digit grower for about 20 years. And really have a very strong leadership position in the vertical that we're in.

Definitely. Definitely. Well, maybe we'll just start off and talking a little bit more current events. With the pandemic and the related economic pressures on the company, can you talk about some of the puts and takes on how the company has been affected? Areas where you may have seen some deferral or delay, but as well and maybe some other areas that we may have seen some spending catalyzed?

Yes. I think really in the short term, we've certainly revised our guidance and increased our revenue growth expectations for the year. Pre-COVID, as we came into the year, our guidance was for -- the midpoint of our guidance was for roughly 10% organic growth for the year, a little bit of a step-up from last year, but similar to the rate we exited last year at. We expected to have relatively flat operating margins in 2020 after 2 years of pullbacks in margins as a result of a really accelerated increase in our R&D spend. Now our expectations are more for kind of mid-single-digit growth. I think the midpoint of our guidance would imply around 4% growth for the year. We're actually expecting margins to be up a bit, given -- and those 2 are related. The revenues that we've lost have primarily been lower, no margin revenues. So things like our user conference, which was canceled -- was about -- would have accounted for about $6 million of basically no margin sort of pass-through revenues. Significant amount of billable travel associated with implementation projects, again, mostly a pass-through at little or no margin. But we're now performing the vast majority of those services remotely, so we don't have that travel associated with it. That is a margin boost because we do gain significant efficiencies from not putting a lot of people on airplanes a couple of times a week. And we do believe that some of that will be a permanent gain. So although a lower growth expectation, upside on the margin. I think more on the demand side. Typically, our customers are buying something because they generally feel like they have to, that their old system, they've really used as long as they can in the public sector. Because they're not profit motivated, don't have competition, they tend to use systems much, much longer than you see in the private sector. And when they really have to replace the system when it's really at end of life, it's typically when they make that move. And so it's not really dependent on the economy, that underlying demand. So processes that have already been underway are generally continuing normally. We really haven't seen any meaningful cancellations of buying processes that are underway. Most of these things are funded already. But as governments deal with the budget pressures that have been brought on by the current situation, we certainly expect that we will see some processes that are likely to be pushed out and maybe moved out a few months, maybe moved out of budget cycle. That's certainly consistent with what we saw during the recession a decade ago. But we ultimately believe that everything that was -- every system that was going to be acquired will still be acquired. It will be a matter of some of the timing changing. But that will play out over the next few quarters as we see how long this lasts, how deep it goes, how much federal stimulus may come to help offset some of the pressures they have. But generally, the underlying demand drivers don't really change with the economy.

Right. Right. And so where do you find are the areas where spend is the strongest, either by your functional area of software, the grouping of county, city, state, et cetera? But where are you seeing some relatively better spending activity? And are there any catalysts? Are there anything that's catalyzing that spend or some sort of legislation or the sunset of some sort of hardware platform or software? Talk a little bit about that and then how you think that changes in -- over the next couple of years?

Yes. I think across our product areas, there's not really any significant difference in the strength. I'd say by market segment, probably the strongest right now is federal. We're in the last quarter of the federal fiscal year, which is typically the strongest where there's a lot of budget flush and spend that happens in this quarter. Federal budget seems to be less affected by COVID. Now that's only roughly 5% of our revenues. And as you move down into state and local, it varies a lot from jurisdiction to jurisdiction. And again, we're still pretty early. A lot of governments have new budgets that went into place July 1, others will go into place October 1. So it's still kind of early as they're adopting here. All of our products are really automate, essential, mission-critical functions, whether it's public safety and 911 systems or courts or jails or property taxes, which are generally the biggest revenue stream for local governments or financials, things like payroll and licensing and permitting. So sort of the crucial nature of the product really applies across the board. I think where we're seeing -- within those product groups, maybe where there's an elevated level of demand that we expect to continue would be around, as you might expect, those applications that help facilitate remote work or remote access to systems by the public. So kind of consistent with what I told you about how -- the nature of how governments use their systems and replace them. We have a lot of systems that are in government that don't provide features and functionality that would be almost table stakes in the private sector. So online access to make payments. A lot of -- we provide utility billing systems, traffic tickets. We provide municipal court systems. So a lot of places don't -- surprisingly, today wouldn't accept online payments for utility bills or traffic tickets in an environment where there aren't people at the courthouse to process those or they're finding those things to be more important. Courts is a great example where someone could have a mainframe court system that is old and old technology, works fine if the clerk can be at their desk in the court house at a terminal, but doesn't work at all in a remote environment. So you've got a lot of courts that are literally shut down because the court house isn't open, and they're only managing the most essential lines of cases. So we have products that -- for example, a Virtual Courts product that we rolled out pretty early in COVID that lets municipal courts conduct hearings, operate -- continue normal operations remotely. We have certainly online payment systems. We have a relatively new product for online dispute resolution that enables parties to resolve a dispute, maybe a small claims kind of a case outside of a courtroom in a virtual environment. And that's certainly an area that we're seeing heightened interest in. So those things that provide -- enable governments to operate remotely in this new environment. And I think that, that actually, over time, will result in some acceleration of the purchase of new systems. So kind of the flip side of where I said where they wait as long as they possibly can, they may find that, that is a little bit sooner than they thought because of this added layer of complication around remote work. I think the other -- one of the other areas that has been increasing in importance is really around data and analytics, sort of the business intelligence side and transparency. So transparency is increasingly important around governments. And governments being able to use data and analytics to make better decisions, whether it's around staffing their first responders or broader budget decisions. Our solutions have -- we -- in recent years, particularly since the acquisition of Socrata 2 years ago have given us capabilities that we believe distinguish our products from our competitors by enhancing our data and analytics capabilities and help officials make better decisions with data that often resides in silos and isn't very accessible to them.

Great. Yes, you covered a lot of ground there. I wanted to go back and dig in a little bit on public safety. I mean I think investors in Tyler, even casual observers with Tyler, know that Tyler has done a phenomenal job with Odyssey court case management systems, has been winning 8 or 9 of 10 -- 8 to 9 of 10 different procurements. Very strong player there. It kind of feels like within public safety, that's where we may see that wave start to really build. And with the win of Jacksonville earlier this year. Do you think we can see a notable step-up in deals in public safety? And can you talk a little bit about how -- what does the Tier 1 market need to see from Tyler in order to decide that you're ready for that level of scalability?

Yes. Public safety is a strategically important market for us. And we really entered that market, I guess, now going on 5 years ago through the acquisition of New World Systems, the biggest acquisition in the company's history. It was about a $700 million purchase. Clearly, public safety was the big gap in our product portfolio. It was strategically important because we do have such a really strong if not dominant position in the court case management space. And courts and public safety are clearly adjacent to each other. But it's interesting in that primarily their competitor sets are completely different. So we're really the only significant company who has both courts and public safety solutions. And we believe that is sort of the basis of a real competitive advantage for us. Since we acquired New World, we've made significant investments in the public safety product. There's kind of 2 major -- or I guess 3 major parts to the public safety solution. There's the computer-aided dispatch of the 911 side. There's a records management side, and then there's the whole mobile capability side. We've made major investments in all 3 of those over the last 3 or 4 years. Some of that investment aims at integrating the New World Public Safety system with the Tyler Courts & Justice Solutions. Some of that aimed at just adding features and functionality that separate ourselves from the other competitors in the mid-market, which is primarily where New World competed. And then thirdly, adding features and functionality that position us to compete at the upper end of the market in the Tier 1 and Tier 2 opportunities, which really was not the space for New World in the past, but is the market that we have a really strong position in, in the court space. We've been -- made a lot of progress over the last 2 years in adding those capabilities, really started to pursue our first Tier 1 opportunities over the last year or so. And so this win we had last quarter in Jacksonville, Florida was really sort of a milestone win for us. It's the first sort of new name Tier 1 competitor for us in public safety. Jacksonville is the largest city in Florida. I think it's the 12th largest city in the country. So really a nice competitive win for us against the key competitors that we normally see or expect to see more often at the upper end of the market. It also included a number of products that Tyler has acquired over the last 2 or 3 years, including our Socrata Data and analytics platform, our Brazos electronic citations product and a couple of others. So it really was a broad set of solutions there. So we do expect to continue to increase our penetration into the upper end of the market, which significantly increases the TAM that we could go after in that public safety space. And we expect that public safety will be a product within Tyler that will grow above Tyler's growth core rate over, call it, the next 3 to 5 years.

I think that's right. And how much of that integration -- I think one thing the management has talked about in the past that represents a bit of a hurdle was that there may be 2 separate decision-makers, one for courts, one for public safety. How do you bridge that?

Yes. It is -- as in a lot of local government entities, these are sort of siloed decisions. And even between public safety and courts or -- we have different departments within that jurisdiction and sometimes cross jurisdictions that you can have the city police department, but that system interfaces with the county court system or the county jail system. So if the city police arrests somebody and they did something pretty bad, they're going to take them to the county jail. So those are 2 different systems that were bought by different decision-makers out of different budgets at different times. But the advantage is that we have the ability to create those integrations even across jurisdictions or across departments. And so you can have the city's police department system that is integrated out of the box to the county's court system. And that creates a lot of operational efficiency. If they are going to put someone into jail, for example, they don't have to duplicate a lot of the data entry or the data flows seamlessly throughout the whole process. So it creates an advantage, even though those systems might be bought at different times, if one of those is from Tyler, it creates an advantage to make that next system for Tyler. So we may not sell them all at the same time, but over time, we have a significant advantage in being able to add on sales, even if they're not in the same jurisdiction or same department.