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

Good morning, everyone, or good afternoon depending on where you are joining us from today. I'm very pleased to be hosting Brian Miller from Tyler Technologies. He's the CFO there. I'm Jen Lowe. I am on the U.S. software team here at UBS. [Operator Instructions] But otherwise, we'll jump into the list that I have prepared. So Brian, thank you again for being here.

Maybe just to start off, I think we've all experienced how challenging a year it's been for state and local governments. Those are your customers. So maybe we could just start off, could you give us a quick overview of what you're seeing in your customer base at this point? And how the current pandemic has either negatively or positively impacted what they're spending on?

Yes. Thanks for having me here. It's great to be here, and great to be able to spend some time with investors. Yes, the -- there's clearly some pressures on government budgets. As you said, most of our customers are mostly local governments, some state and about 5% federal. But most of our focus is historically on local governments. So it's a very broad group and conditions vary from place to place. But certainly, they're seeing pressures, both from lower revenues and extraordinary expenses associated with dealing with the pandemic. There's typically a lag in when pressures and outside circumstances manifest themselves in government budgets, a lot of new budgets went into place July 1, others, October 1, others will be January 1. So it takes a while before it may be -- fully takes effect in government budgets across the country. Most local governments, their biggest revenue source is property taxes, and that's actually largely unaffected. Property values remain pretty strong. And generally, that's kind of a slow process before that shows up in revenues, even if they start to weaken. So property tax are generally more than half of most local governments' budgets. And so that's largely unaffected. So that's a good place to start from. But the things like traffic tickets, licensing and permitting, in some cases -- in some places where income tax or sales tax are part of their revenue base, there certainly are some pressures there. And we'd expect to see that have some impact as we go forward over the next year. Generally, deals that were already in process have, after some initial pauses around adapting to remote work, have been moving forward, and we actually had a really, really strong bookings quarter last quarter. But we're starting to see a little bit of slowness in new RFPs, and we think those delays are, to some extent, related to budgets as well as they're general issues with working remotely.

And maybe just to follow-up on that thought. I think on the last earnings call, Lynn mentioned that pipelines were still kind of unchanged, but the pace at which deals was moving was slower. And going back to the budgets, I'm curious if it's a function of the budgets there, but states are being, and local municipalities are being a bit slower, just to make sure they have money, if they need it versus the money is just not there at all right now. Can you just give a little context around -- assuming we get a vaccine, assuming things get a little bit more back to normal, how quickly things could potentially recover in your view?

Yes, it's a little of both, but it's probably more of the former. It's more around timing. I mean I don't think there's really an effect on fundamental demand. As we've talked about frequently, generally, our customers are buying something from us because they think they have to. The systems we provide are all software that automates mission-critical essential functions of government, whether it's property taxes or payroll or 911 or jails or courts, so -- and they're generally replacing a system that's at end of life that they've had often for decades. And that, for some reason, has finally reached the point where they think it -- that replacing it is a very high priority. So in our view, it's really a matter of timing. That these are not things that can be put off indefinitely. And generally, they're a very high priority in the budget. In some cases, they can say, I'm going to put this off for a budget cycle or I'm going to wait a quarter or 2 until I have more clarity around my budget situation. So our view is that it's not a lack of demand or things that can be put off indefinitely, but things where there is -- even when budget -- places that had budgets that went into place in, say, July or October, even if they have a budget, a lot of those places have maybe not a lot of confidence in that budget and are waiting to see more indication of things starting to return to normal. And certainly, I think, just as in the private sector, the closer we get to a vaccine, the more confidence they have that things will return to normal, the more likely that some of these projects can sort of loosen up and start to move forward. And then there's the whole stimulus or additional federal relief that we believe would have an impact on starting to move things along a little faster and get back to normal. But we do believe that this could recover faster, say, than we saw in the recession a decade ago.

And maybe just to round the point out because it does seem like one of the sticking points right now in Washington is funding for state and local governments and what that looks like. Well, I mean, I guess if you think about your own guidance and sort of the outlook you present, how sensitive is that to whether or not Washington comes through and gets some additional funding to some of the areas that are in need right now?

Yes. I think it's more around the timing. It could loosen things up a bit faster. And -- but I don't think that's really the major factor in whether business will reaccelerate. It's more around the priority of needing to replace these systems or in some cases, add new functionality or new solutions that help them work with the environment that they're in today with need to work remotely, running courts remotely, accepting online payments, things like that. There's -- the CARES Act included a fair amount of funding for, I think, a couple of hundred billion dollars for mostly states and larger local governments. So it wasn't distributed just widely. Some of that was then passed down. And we're seeing a fair number of clients that are trying to get deals done before the end of the year to use the CARES Act funding to pay for solutions. There clearly is a very current debate going on about the next round of stimulus and whether it will or won't include, at least in the first round, funding for government. I think the bipartisan proposal that's out there has $160 billion for state and local governments, but there's clearly a debate around that. There's also a piece of legislation that was introduced in August, I believe, called the State and Local Government IT Modernization Act, which is a separate piece of legislation that would provide $28 billion of funding over 5 years, specifically to modernize state and local government IT systems. So there's a pretty clear recognition that there are a lot of aging systems that haven't functioned well during the pandemic. And so that funding targeted specifically to IT upgrades would certainly, I think, be of benefit to us and our clients in terms of giving them better confidence in their ability to spend money on the projects with us.

And maybe on the flip side of that, and you got to the IT modernization point, but certainly, governments had to respond like the rest of us, do things more remotely, digitize a bit more and maybe systems are even more broken than a large European bank, not naming any names. It was a pretty big -- a big shift. And just I mean, personally, my dad works on a planning committee in the county I grew up in. And they weren't even sure virtual meetings were legal. So he's in his late 70s, lifetime smoker having to go to Board meetings, it was definitely causing a lot of agita in the family [indiscernible]. So I'm just curious, are you seeing, I guess, that in 2 phases of change, are you seeing more focus on how things can be done virtually and digitally, maybe even accelerating certain types of projects? And to the extent that you are, is it purely a budget and cultural set of gates that you're now getting through? Or are there sort of legal things that need to happen in order to enable more digitization that might take a little longer?

Yes, it's probably more on the budget/cultural side. They're figuring out how to -- here in Collin County, Texas, earlier in the year, they had the first virtual jury trial, maybe in the country, but certainly in the state. So they're figuring out how to do those things in the scheme of the rules they live under. But a lot of it's cultural, to some extent, budget, but just dealing with the processes that governments go through to implement new processes, and that can be lengthy even at a time of -- like we've seen in the last year. But I would say that in general, governments were probably less prepared to deal with remote work environment than the private sector. And we saw that early and how that impacted our ability to move forward with implementation projects that are underway, sales processes that were underway. And those have largely adapted pretty well. I mean, we're delivering virtually all of our professional services remotely. We've conducted dozens if not hundreds of go-lives remotely, most without any Tyler people on site. Sales processes are moving forward with remote demos and all of those things, they're figuring it out. But in terms of their operations, things like running a court hearing remotely, that's an example of areas where they really have not been prepared, and a lot of it is because underlying systems just don't allow that. You've got a court that has a '70s era mainframe COBOL system that only works if the clerks and the judge are at terminals on their desks in the courthouse. And so they just don't have the underlying technology that lets them work remotely. We have solutions that provide that technology and in some cases, we've seen clients adopt those rapidly. Customers that didn't have e-filing in the courts or didn't accept online payments have moved fairly quickly to adopt those things. In other cases, where it really requires a more complex replacement of a core system, those we would expect to take place over a longer period of time. But I do think that there will be some system replacements that will be accelerated. So I talked about the systems aren't replaced until they're just about dead. But there will be systems that people thought had 5 years or 10 years left in them, they knew they were old. They weren't current technology. But this environment has exposed flaws in them that are causing them to rethink that time frame. There still has to be a process, there still has to be budget. So it's not something that over the next 3 or 6 months, we expect there to be a flood of new business around replacing systems sooner than they would have. But if you look out over a 2-, 3-, 4-year period, we do expect that there could be some acceleration of demand around the -- these new aspects or new problems that have arisen and flaws that are uncovered in these systems.

And then maybe just to stay on that point for a bit. One of the things that I found really impressive is how quickly Tyler was able to spin up a virtual courtroom system and get that in front of customers and kind of help them in this time of dramatic change. Can you touch on that a little bit? First, kind of how quickly you were able -- how were you able to get that out there so quickly with the free trial? And then secondly, as you move through that period, how does that convert to potential revenue opportunity for Tyler down the road?

Yes. And virtual courts was good timing for us. We didn't just start on it when COVID came along. It was actually well underway in development. We were able to release it, sort of accelerate finishing it up and release it, but it was a product that we had well underdeveloped -- or under development well before COVID came along. So even without the pandemic, we believed that efficiencies of being able to operate courts remotely was something that they had appeal in the market. This certainly accelerated that. We started -- we were able to release it more rapidly shortly after sort of the onset of everyone moving to remote. Courthouses are generally closed. A lot of them remain closed other than for really essential cases. So -- and a lot of them don't have a very good timetable for reopening. So we offered it on a free-trial basis. It's mostly around municipal courts. We do expect that we can expand it to our civil and criminal courts, but it's mostly around municipal courts, which tend to be higher volume, lower complexity types of cases. I think we had north of 70 customers that took advantage of the free trial and are -- were, generally within kind of a 30- to 60-day period, up and running. Most of those, if not all, have converted -- not all, but the vast majority have converted to paying customers. It's a subscription basis, cloud-based offering that integrates with the underlying municipal court system, whether it's -- which could either be on-prem or in the cloud. And it's a revenue stream that today is in -- a lot of them are on the smaller side of customers that today is in the hundreds of thousands of dollars of ARR, but we have a very big base of municipal court customers, and we expect that we'll continue to see that penetrate more broadly. One of the other offerings we have, online dispute resolution, which is also a part of our -- primarily used in our civil court system, which allows -- it was an acquisition a couple of years ago, which allows parties to resolve a dispute through an online process, even including an online mediator, rather than in a courtroom. And we've seen an acceleration of interest in that as well. The thing is, obviously, it solves a problem of courts not being open and not having that environment and it was something that was starting to gain traction in the market, but we've seen certainly increased interest in that as well.

Great. And one of the things that came up on the Q3 call was that public service -- or Public Safety was a relative area of strength. Can you talk a little bit about what's happening in that product set? And what some of the drivers there are helping that be a little bit more resilient?

Yes. Public Safety is an area that's been an area of significant investment for us over the last few years. We really just came up on the fifth anniversary of our acquisition of New World Systems, which really got us into the Public Safety market in a big way, complementing the significant presence we already had in the courts and justice space. Since that acquisition, we've made a lot of investment in the Public Safety product really starting -- the first year, we made a lot of investment around the organization and creating the foundations for growth and creating the roadmap for the product. And then in 2017, '18, '19, we had significant R&D investment aimed at both separating ourselves from the competition, adding new features and functionality in the mid-market, where New World traditionally played. And then adding features and functionality to be able to compete in the upper end of the market in Tier 1 and Tier 2 opportunities, where New World really didn't have much of a presence and really significantly expand the TAM. And so now having gone through that investment process, releasing a lot of those features a year-or-so ago, going through sales processes, now we're starting to see the benefits of that. We won our first new Tier 1 deal in Jacksonville, Florida, the 12th largest city in the country. I think in the second quarter, we went live this year with period dispatch system in Orlando, also a Tier 1 market. Last quarter was the first quarter where we've had [ $2 million-plus ] licenses in the same quarter in Public Safety, and our average deal size year-to-date is up 94% over last year. So clearly, winning bigger deals, I think a lot of that is around the investments we've made. Also, we've done a number of tuck-in acquisitions. And so we're able to bundle more products, which makes our Public Safety solution more competitive, but also makes the average deal larger, and we've executed at a really high level as well. And we've got the integration with our court system that provides some additional competitive benefit. So we're in a really good place in the Public Safety space. Public Safety generally, despite talk of defunding the police, is really a pretty well-funded area. They have some unique revenue streams, including a charge that appears on every phone bill and every cell phone bill to fund 911 systems. They have forfeiture money or property and money that's seized that they can often use to fund their operations. So it tends to be relatively well funded, and also a lot of needs in terms of updating technology there. So it's a reasonably strong market. It is one of the areas where we're seeing actually an uptick in number of RFPs we're responding to compared to the last year. Our win rates are improving, and as I said, doing larger deals. So it's an area that we believe will grow faster than Tyler's core growth rate over the next few years and really kind of good example of after we make an acquisition, the investments we make, sort of the patience we need to get to that point where the growth accelerates, and we start to see the benefits of that.

And then maybe just to -- well, I have another question, but maybe just around that discussion around [ unity ] investments and now really delivering returns. If we think about the investment cycle around that product, it's sort of the second derivative that now it's more sort of maintaining what you've got, maybe yielding a little bit of a better, call it, LTV to CAC or whatever the right metric is. But you should start to see that ROI contribute a bit more to leverage in the model as you move forward?

That's correct. Yes. I mean as it scales, we expect to see margins improve. We expense virtually all of our development expense. So a lot of that investment now is behind us and has gone through the income statement. And so we start to see leverage on the development of the R&D line as well. But certainly larger average deal size, higher win rates, all of those things contribute to margin growth as well as revenue expansion.

And then just on the demand environment around Public Safety. It seems like with a lot of -- you mentioned to fund the police but just with some of the social attention on law enforcement and how they help the community versus some of the more controversial things. This seems like transparency is a big part of that. I mean, is that something that's contributing to some of the increase you're seeing in RFPs that public safety agencies feel like they need to have better community relations, be more transparent and technology is one way to accomplish them?

Yes, it absolutely is. And that's where the Socrata acquisition we did a couple of years ago really is providing us with the technology and the ability to address those needs for transparency as well as better use of data to make better decisions around how they manage their public safety operations. So Socrata is a data and insights platform, sort of business intelligence as well as transparency that was designed exclusively for governments. We acquired it a couple of years ago. We have, over those last couple of years, really invested a lot in integrating it with our core Tyler products, whether it's financials and creating open budget, open checkbook portals, whether it's property taxes. And in Public Safety, it's really added a lot of value, and we think really some unique capabilities beyond what our competitors have. So the transparency would be things like crime mapping in real time, where you can go to a map and see the crimes, see the -- filter it by type, filter it by area, get notifications and provide a lot of information around what's going on in your community, where money is being spent as well and where efforts are being dedicated. And then creating really usable data in a very easy manner for police organizations, fire, to really allocate resources, determine the best way to use their resources by looking at the data about where crime is happening using even the data for investigative purposes and becoming much more efficient. And we think our capabilities there are really second to none in our space and the Public Safety scenario where it's really added a lot of value to our product.

I think it makes -- anyway, I did want to ask about Socrata as well. And there, you sort of mentioned the Public Safety use case, but certainly, public health has also been a big opportunity for data transparency, real-time information from governments on what's going on and case rates and hospital fill rates and things like that. Has that created any new opportunities or incremental demand for Tyler as state and local governments just generally try and make that data more accessible in real time to a very hungry public.

Yes. Our Socrata data and insights organization has done a great job of spinning out dashboards and platforms to provide a lot of information around -- related to the COVID pandemic and really at all levels, federal, state and local, whether it's providing information about where testing facilities are available, cases, hospital bed usage, all kinds of information that we've been able to deploy very rapidly. And often, in places where we already have relationships, but also often sort of starting new customer relationships because of our capabilities there. And so that's an area where I think we've been able to have a significant impact very rapidly. The platform lends itself to rapid deployment and it's very flexible, and our teams have done a great job of addressing rapidly changing needs in our customer base.

And in those scenarios where there's a very immediate and very real pain point around a need to know that's particularly acute. When you get in the door with that type of use case, I know it's still probably pretty early. But I guess, 2 questions. One, how do you kind of ensure that, that isn't a solution that maybe gets switched off once there's a vaccine, and we all go back to normal? And two, to the extent you're in the door on those, how quickly do you think that could potentially start to move into other use cases that maybe weren't being thought about before but now there's the familiarity, meaning are there any proof points at this point that you can -- once you're in the door, you can get that expansion?

Well, I mean, Socrata is -- even before Tyler acquired it, their whole model really was built around land and expand. The Tyler client base certainly gave them a much better, faster entrée into a lot of governments where already had relationships with some of these core systems that made it easier for them to start that relationship with the data and insights product. So that's kind of core to our model there anyhow. But yes, I think we would expect that some of these new relationships that have come out as COVID specific, even though that the specific need for a COVID dashboard may go away at some point. But being able to showcase our agility, the technology behind the platform and be able to kind of be in the door and show them a lot of interesting use cases and the value of both, again, having the data to be able to make better data-driven decisions, but be able to provide really great transparency for citizens, I do expect that as we have historically, that we'll be able to build on these new relationships. And we're seeing some interesting things evolve, I think, through some of this, we've recently launched some new capabilities around property taxes and being able to provide better insights to decision makers around data related to properties, what's happening with those and enabling them to do a better job of maybe projecting future tax revenues and looking at data around properties and economic conditions in an area to give them better insights into future outlook for a significant revenue stream.

And just shifting gears a bit to another end market that Tyler has strengthened, and that's the education market. And another industry that's dealing with change, I have a second-grade virtual class happening in the next room, thankfully not in here yet. But how are you -- I guess, maybe 2 questions here. First, as education pivots to virtual/remote, is that something that helps you or hurts you in terms of your ability to sell? And maybe we'll start with that and then go from there.

Yes. We're not directly involved in curriculum or the classroom side of schools. What we do in schools, and we do have a significant presence in K-12 schools, ERP is one of the major areas where we're involved in schools. And I think in terms of virtual work there, it's not any different than the city or the county, their need to be able to have access to systems, whether it's payroll or their typical financial management situations have remote access to those. Also, we just did an information management, which will be grades attendance scheduling. I think having those systems in the cloud and having those systems that are available regardless of whether they're in the classroom or at home continues to be more important. And then the other area where we're really a leader in the space is in the school bus transportation area where we're the leading provider of all the systems that manage school transportation, whether it's fleet management, school bus routing optimization, field trip scheduling. There's not a lot going on there. The buses in a lot of places aren't running, or at least at full capacity, but the ability to have that system to just sort of, on the fly, to rapidly changing routes or demand is important. And they've done some really interesting things with schools using buses to deliver lunches rather than to drive the kids to school, using buses as WiFi hotspots -- positioning or have communities to provide WiFi for students who are working remotely. So there's some interesting stuff going on where our systems have pivoted to be able to address some of these different needs and also been able to highlight the strength of our technology and the abilities that our teams are able to provide.

And then on just a related note, I would imagine that the limited budgets school have available for technology are probably kind of, in some ways, consumed with Zoom learning and things like that right now. But at some point, hopefully, sooner than later, from my perspective, the kids will start to go back to school, maybe some of that budget gets freed up a bit. Like any market, this environment shows the limitations of being on-prem having legacy systems. Do you see sort of a scenario where some of this modernization effort in the schools could start to pick up a bit more in the back-office side once the need to invest in remote support eases?

Yes, I think that's the case. And it's really that kind of case not just in schools but across all of government. We talked about in the short term, there are likely to be some delays where people hold off on starting a new project, whether it's replacing a system or adding new capabilities. But we expect there's sort of a catch-up period on the other side. When we look at our experience in the recession 10 years ago, we had, one, there was a lag. So our worst year, that was a slower decline. It wasn't any -- the financial crisis was different from the pandemic, which brought this slowdown much faster. But our worst year was a flat year. We were about 50% recurring revenues then. Today, we're more than 70%. And the recurring revenues are really pretty solid, pretty much unaffected. But the licenses and services were more affected. But our worst year was a flat year that was followed by a year with -- we returned to, I think, 7% growth. But then the next year, there was a 17% growth year when a lot of this pent-up demand really kind of hit the market. And we were in a great position to address that demand. And I think that's -- maybe the recovery is a little faster here. The slowdown was faster and the recovery is faster if we get back to normal and COVID starts to be addressed through the vaccine. So I think there's an opportunity for a faster recovery. But I think the -- one of the keys there that is also the case today is that we're able to invest at a high level through the downturn. We haven't cut back at all on R&D, and we have a very elevated level of R&D at the current time. A lot of that around the ongoing acceleration of our -- of the shift of our products to the cloud. We haven't laid off a person. We've continued to add staff through this year. And we're still investing at a very high level. And all of our competitors can't say the same thing, where, particularly in some cases where we've got PE-owned competitors that are highly leveraged, they've had significant layoffs and staff reductions. It's hard to see them investing a lot incrementally during this period of time. So we think that as the demand returns and potentially accelerates, that we're going to be in a better position from a product standpoint, from a resource standpoint to be able to have extended our competitive advantage or in some cases, to have closed on competitors that -- where we haven't been the leader. And so I think where we think our competitive position will be 6 months from now, a year from now, 2 years from now, relative to some of our major competitors, we really like where we think we'll be.

And just rounding that point out, M&A has been part of your strategy. You've built out a lot of very interesting product categories through M&A to the extent that some people who might have been competing with you for interesting assets are a little bit more constrained right now and some of those interesting assets might be dealing with their own challenges and being subscale. Does that open the door for you to be a bit more opportunistic about deals in the near term? Or do you feel like you've got the right pieces for the time being? How should we think about that?

Yes. I think we're definitely open for M&A. We've talked about that on recent calls. We took a little bit of a pause or kind of raised the bar maybe over the last year, we did 8 deals in 2018 and '19. And so we really wanted to get the integration right. A couple of those were larger deals, MicroPact and Socrata, where we had significant investments and integration to other Tyler products. So we really focused on that. At the same time, multiples have been high, values, high, PE firms with a lot of money going to the space and willing to pay values that we sometimes felt were -- just weren't reasonable. But I do think, to your point, there may be some additional opportunities whether that's -- whether some of our competition for deals is more constrained or whether some companies that just had kind of held out, some sellers held out for higher valuations that might not be distressed companies, but have a little bit more -- be more challenged with funding growth and see being a part of Tyler as an advantage there. We've got a great balance sheet. We've got -- approaching $750 million in cash. We have no debt. So we're in a really good position to have the capability to be active in M&A, and we're -- I'd say we're looking at a lot of things, and we've got a pretty extensive white space analysis, where we have gaps that we'd like to fill. And I expect that M&A as well as our internal development will both be a significant part of that.

Great. In the last couple of minutes here, I'm going to ask you a question, which might be a little bit of an unfair question, but I'd just be curious to get your thoughts. I think there's been a lot of media attention around demographics and postpandemic seeing maybe an outflow of people from large urban centers into smaller cities. We've certainly seen a couple of big technology companies relocate to Texas, and you're going to have a lot more neighbors down there, I guess. Given what you said earlier about particular strength in smaller municipalities, is that potentially a net positive for Tyler if you see people migrating out of big cities into smaller, more livable cities? Or is it just way too early to know what that means. It just strikes me that the property taxes there probably see some upswell from that.

Yes, that's an interesting concept because it does put -- as these smaller places, which are -- most of the cities are small and mid-size cities. So the cities with more than 0.25 million people is a really small number. And they tend to spend a lot of money, but it's just not as big of a market as the mid-market, and that's kind of where Tyler grew up. Certainly, we have capabilities around most of our core products where we serve New York and L.A. county and places like that, but our bread-and-butter business is in the mid-market. And I think to the extent they grow and have more strains and have more expectations from -- around growth and more expectations of citizens for better service, more transparency, ease of doing business with government, to the extent they've got modern systems that enable them to make it easy to get a business license, easy to conduct a real estate transaction, easy to develop property and build an office building. All of those things make those cities more competitive, and that's really where our bread and butter is. So yes, it's -- I think that's an interesting concept that could have positive benefits for us over the long term.

Okay. Great. Well, Brian, thank you so much. It's always a pleasure to talk with you. And I know I enjoyed the conversation. I know I'm sure others online enjoyed hearing your thoughts. So thank you for being here, and good luck with the rest of your day.

You bet. Thanks a lot. Thanks for having me.

Thank you. Bye, everyone.