Tyler Technologies Inc.

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

Tyler Technologies, Inc. is the largest provider of software and technology services dedicated to the public sector, serving municipalities, counties, states, school districts, and other government agencies across the United States, Canada, and internationally.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Tyler Technologies operates as a full-service provider, offering software development, hosting, implementation, training, data migration, and support. They are well-positioned within the public sector, especially due to specialized accounting and legal processes that governments adhere to.

Business Overview

Tyler Technologies operates in the Government IT industry with a focus on providing software solutions and related services. The company targets local, state, and federal government agencies as well as school districts. It primarily provides systems in five major categories: Financial Management, Planning, Land and Records Management, Courts and Justice Systems, and Property and Tax Administration.

The company operates through two main segments:

  1. Software Segment: This includes the sale of software licenses, cloud-based offerings, and related services such as maintenance, support, and training.
  2. Services Segment: This involves implementing their solutions, which includes software implementations, data conversion, and project management.

Tyler’s services and products involve a lot of integration and long term planning with their client and it creates very sticky clients.

Competitive Landscape

The competitive landscape is diverse with a mix of large and small players.

  1. Large players include other enterprise software companies which also serve other markets and industries.
  2. Small players include niche specialists that offer specialized solutions within a specific government sector.

Tyler’s key competitive differentiators are their exclusive focus on the public sector and their high level of integration into clients operations.

Moat Assessment

Tyler Technologies possesses a narrow moat, rating 3/5 based on several factors:

  1. Switching Costs: Tyler’s products, especially the integrated system ones, creates a lock-in situation for their customers. Replacing a whole system involves a lot of integration and training and that is too much of a hassle for municipalities to undertake when they already invested so much in Tyler. Switching costs in the form of data migration and disruption to workflow are significant which creates a moat in itself.
  2. Customer Relationships: Tyler works with a lot of municipalities, county and state governments, and this requires establishing long term relationships with the clients as there is no standardized procedure and a level of compliance that must be adhered to. These long lasting relationships also creates a barrier for entry.
  3. Scale of Economy: Tyler is the biggest player in the market and the scale and experience they have in implementing the technology can be difficult to replicate for competitors.
  4. Intangible Assets: Tyler has been in the market for long and they developed expertise and name recognition among the governments which gives them a little edge over new entrants. It’s a very niche market which makes it difficult for the non-government focused company to thrive in this market, therefore companies that have a significant presence in this field are insulated from the competition.

However, they do not have strong enough brand strength, patented products or economies of scale (especially compared to giants like Microsoft or Oracle) to make it a wide moat company, so its a narrow moat.

Risks to Moat and Business Resilience

While Tyler has some competitive advantages, there are factors that can threaten their moat:

  1. Government Budget Constraints: Government agencies are subject to budget constraints and can decide to cut costs and not increase their spending on technology which might hurt the business. This is an important risk, but also the business is considered essential and even in times of crisis, government is more likely to continue the projects.
  2. Competition from Disruptive Technologies: Emergence of new, innovative solutions that simplify or lower costs may challenge Tyler’s traditional approach of providing highly complex systems. We have already seen that cloud based technology is becoming more prominent.
  3. Change in Regulations: The public sector is subjected to laws and regulations which change often, this constant change may require them to update their existing software to a new framework, thus creating a risk of increase in costs and decreasing revenues if they don’t do it properly.
  4. Security and Privacy Concerns: As a key government services provider, Tyler is susceptible to cybersecurity risks. Any big data breach or misuse may lead to public concerns, loss in business and can damage their reputation.

A point to note here is, Tyler is a highly profitable business and a critical part of every government’s administration. They serve in a niche sector with few competitors. All these factors would result into business resiliency when the company encounters these risks.

Financial Analysis

Tyler Technologies’ financials shows that they are a healthy company. The revenue is consistent in growth with a great amount of recurring revenues from the subscription based model, the company has a high profit margin, the debt is in control and the company is also growing its free cash flows. All this point towards a strong company and business model. The latest earnings reports and transcripts have given some further insights on the financial performance of the company. For the period ending in September 2023:

  1. Revenue: Total revenue of $547.1M, up from $482.9M in the previous year, this is a growth of 13.3%. For the first three quarters of 2023, revenue totaled $1,541.3 million, up 11.6% from the same period last year. This growth can be attributable to new contracts and the expansion of their current client base.
  2. Software Segment: Revenues were $412.7M, a 14.6% increase from the last year.
  3. Service Segment: Revenues were $134.5M, an 9.5% increase from the last year.
  4. Gross Profit: Gross profit for the three months ended was $329.8M a 60.3% margin. And, for the 9 months period, it was $939.1M (a 60.9% gross margin).
  5. Net Income: Net income of $108.7 million, compared to $66.2 million in the previous year for the 3 month period, implying a solid increase in profitability. Similarly, for the 9 month period, it was $348.2 compared to $201.4 for the last year. This is a solid increase.
  6. Recurring Revenues: 80.4 percent of total revenues are reoccurring in the latest reports. This is very important because they come from subscriptions and therefore, they are highly reliable.
  7. Cash: Total cash was $196M. A decrease of $51.8 from the last year which was 247.8M. This decrease is caused by acquisitions and investments, a common action for growing companies.
  8. Net Debt: total debt is at $1.24 billion. A reasonable level considering the size and revenue of the company.
  9. Earnings Growth: While the company’s earnings grew substantially in the latest report, the projected earnings growth seems to be stable for the next 10 years, ranging between 10 to 20%.
  10. Share Repurchases: The company has a share repurchases program, repurchasing $76 million worth of shares in the first three months of this year.
  11. Dividend: Although the company does not pay any dividend, it is more focused on reinvesting the profits to drive further growth.

From the analysis of the financials, the business seems to be doing well and is in a very healthy state.

Understandability

Tyler’s business is relatively complex, giving it an Understandability Score of 3 / 5.

  1. The core business of providing software to government agencies is straightforward, but the various solutions and their technical nature can be tough to understand.
  2. Understanding the intricacies of their contracts with governments, their implementation strategies and their long term outlook takes an investor a lot of time.
  3. It is not as simple as selling a product directly to a consumer, it involves complex long term relationship and maintenance contracts which requires more scrutiny.
  4. There are various new accounting standards that can make it hard to determine how profitable the company really is.
  5. It requires one to get an understanding of the governments working and their specific needs.

Balance Sheet Health

Tyler Technologies’ balance sheet shows relative strength with a rating of 4/5.

  1. The company has a healthy cash balance, although it has decreased recently as a result of acquisitions.
  2. It has a moderate debt-to-equity level, which does not cause concerns.
  3. The liability levels are controllable and well managed.
  4. It also consistently generates positive cash flows from operations, which can help it to navigate tough economic environment and continue their investments into the business. The financials of the company are in good standing and do not indicate any serious problems. However, the debt and the cash level must be watched closely.

Recent Concerns and Management’s Response

The company has faced concerns regarding declining organic growth, which is why acquisitions has been a core part of their business. The company mentioned that there are factors that cause variance in the organic growth number and should not be taken at face value. They are continuing to invest in their product and improve implementation, training and sales which they expect to result in increased organic growth. Furthermore, the company did mention that they are not relying on acquisitions for revenue growth, rather they are looking into new ways to generate value and acquire new customers.

Another area of concern is regarding the long term debt, however management has mentioned that they have no debt maturities until 2026 and they are not immediately worried about interest hikes, although they will take action if the rates become too high.

Final Thoughts

Tyler Technology is a reasonably healthy company with a narrow moat, strong earnings potential and decent balance sheet. The business model is complex but has some key underlying benefits such as high switching costs and good customer relationships.

The company must continue to adapt and develop innovative solutions and also control costs and competition to be successful in the long term.