All participants, please stand by. Your conference is ready to begin. Good morning, ladies and gentlemen. Welcome to Constellation Software, Inc.'s Q4 2011 Conference Call. I would now like to turn the meeting over to Mr. Mark Leonard. P lease go ahead.
Thank you, Wayne. Welcome, everyone, to the Q4 conference call. I'm joined on the call with John Billowits and Jamal Baksh. As you know, we go directly to questions. Wayne, if you could tee those up, we'll launch directly into them.
Thank you. We will now take questions from the telephone lines. If you have a question and you're using a speakerphone, please lift your handset before making your selection. If you have a question, please press star one on your telephone keypad. If at any time you wish to cancel your question, please press the pound sign. Please press star one at this time if you have a question. The first question is from Thanos Moschopoulos from BMO Capital Markets. Please go ahead.
Hi, good morning.
Hi, Thanos.
We obviously saw very strong operating margins in the quarter. You mentioned in the MD&A that you undertook some operational improvements, and it looks like headcount went down a little bit from Q3 to Q4. Were there any one-time costs associated with realizing these improvements, and can you provide some color as to whether this level of margins might be sustainable in the near term?
Yes, Thanos . It's John here. A couple of comments. Part of that margin improvement would be a decline in our bonus expense year- over- year as a percentage of gross revenue. That's nothing to do with operational improvements. There were some improvements in underlying margins in a couple of our businesses that we acquired last year that were, when we acquired them, sizable businesses that were marginally profitable. As you know, it takes us some time to get those businesses up to our required levels of profitability or our desired levels of profitability. A lot of those improvements were in companies we acquired late last year. We didn't have any big acquisitions in Q3, Q4 of this year. What you're seeing is our core business, you know, at a high level of profit.
To sort of comment on culture, Thanos , we don't direct the operating groups nor the individual business units underneath those operating groups to go out and perform. We sort of hope that we have the right incentive programs in place and try and promulgate best practices throughout the organization. We don't say, you know, this quarter we would like 1% more operating margin from everyone. That's not how we operate. It's a very decentralized kind of place.
Right. That's helpful. I think you normally provide this information in Q1, but can you comment on whether there's been any trends of note in your maintenance renewal data and in your price increases on maintenance through 2011, or has that sort of activity been consistent with prior years?
I haven't seen anything new, but that information hasn't yet been compiled. It's a pretty daunting task, and we didn't want to pile it on in the middle of the IFRS conversion. Everyone's been hustling to get out the statements in the new format, and it's been a very busy time for all the finance departments and analytical types. I'll soon have that in hand, and I'll write it up in the president's letter for next quarter.
Okay. Maybe just one more for me. Can you talk about the M&A pipeline specifically as it relates to some of the larger opportunities you're looking at? In recent quarters, it looks like you've been focusing on smaller opportunities, perhaps due to the distraction related to the review process last year. How's the pipeline looking at this point for maybe some of the larger prospects?
Just to correct things, we don't focus on either small nor large. We just sort of generate whatever prospects we can, and if there are big ones in there, that's a wonderful thing. As I look through the data, the number of large prospects that we have in the funnel right now is down quite a bit in terms of dollar value. The number of small midsize prospects is better than it has been for a while. In the short- term, I'm feeling just fine about our acquisition prospects. I don't know what sort of six months from now things will look like. It's very hard to judge. A caveat to all of that: our ability to predict acquisitions is extremely poor.
We can certainly look at the signing of NDAs and LOIs, non-disclosure agreements, and letters of intent as a sort of leading indicator and get some sense of how many we close. The ones that are actually in legal, sometimes they fall apart. People who are selling the business they've built for 20 or 30 years have an implicit belief in it, but their lawyers generally don't and often try to shake their confidence as they are looking at reps and warranties and things of that nature. Particularly in lawyers who've been working with entrepreneurs for many years, they don't really have a huge incentive to help that entrepreneur sell the business. They'd much rather sort of keep them as a client, and they have mixed motives as we go into these sales processes.
I always worry as we get down right to the altar whether these things are going to close.
Okay, that's helpful. Maybe just sort of as a related question, what's the typical sort of cycle from the time you identify an opportunity, maybe in terms of the smaller acquisitions, to the time that it actually closes? I realize it's probably a huge standard deviation around that, but what would it sort of trend to?
With 10,000 odd suspects, people that we've identified in the sales in that sort of prospecting funnel, you can imagine that the lead time is many, many, many years. We only look at a few hundred a year that actually come through a sale process. Many of the ones that we approach are just exploring, and they want to get a sense of what the value of their business is. They aren't necessarily committed to a sale. It's a very hard thing to judge, Thanos. It's not like a sales cycle for a software system.
Right. Okay, I appreciate the color. I'll pass the line.
Thank you. The next question is from Stephanie Price from CIBC. Please go ahead.
Morning, gentlemen.
Hi, Stephanie.
You recently announced a $4.00 a share dividend, which is about 65% of your 2011 free cash flow. Can you talk a bit about the dividend in relation to the acquisition strategy in the past? You spent all your free cash flow on acquisitions. Is this dividend going to impact that at all?
I think if you actually go back and look at the 2011 free cash flow and the amount that we spent on acquisitions, we fell far short of our free cash flow. Although historically we had been able to keep pace with free cash flow.
Should we see 2011 as sort of the new benchmark then in terms of acquisition amounts that you do?
I think 2011 was down from the prior year, so I'm hoping not.
Okay.
We have more people working on M&A than we've ever had before. We're trying to get better at it. It's a process that has relatively long feedback cycles, so getting better at it takes time. I think we already do some unique things in that we do many small transactions, let's call it $3 million type transactions, which very few other software or any other businesses do for that matter. We're fairly unique in that respect. Ramping up the volume of those is an obvious way to deploy more capital, and making sure that we do a great job on the filling the funnel end of the spectrum is something that we're going to work out this year.
Okay. In terms of organic growth, 2011 was stronger than it has been in recent years despite a continuing difficult market. Can you talk a bit about what's driving that and whether you're seeing more organic initiatives internally than you have in the past?
I think there's more of an organic focus than there has been for a few years, partly because people are getting a little more optimistic about the economy and our client base's spending intentions. I think in a number of our businesses, we're wrapping some process around the initiatives that hadn't been there previously, and that helps. When senior management gets focused on organic growth, invariably other people further down the organization also tend to turn their eyes to that. I'm hopeful that we'll see more activity on initiatives. I would happily trade a couple of points of EBIT for a couple of points more of organic growth.
Okay. Great. Thank you.
Thank you. The next question is from Scott Penner from TD Securities. Please go ahead.
Thanks. Good morning. Doug Taylor in here for Scott Penner. On the M&A environment, maybe you could talk a little bit about what you've seen for pricing and competition on the deals in the last couple of months.
You know, we don't really view it as changing over months. The things that we compete for are relatively inefficient markets because they're relatively small deals. The people who sell their businesses are making a decision that they make once every decade or two. The intriguing thing is what do those entrepreneurs do with their proceeds? Right now, if you're an entrepreneur and you've sold your business, you first of all pay a whack of tax. You secondly go out and look for some sort of portfolio of investments, probably. The yield on any kind of interest-bearing instrument kind of sucks. The stock market hasn't performed particularly well over the last few years. It isn't a great environment for an entrepreneur to redeploy capital.
They look at their own business, which they know and love, and the amount of money that it generates for them, plus the amount of lifestyle they can put through the income statement. Selling bread now probably isn't as good an alternative as when the rates of return they can get on, let's say, government securities are much more attractive. I'd say that we are in a quieter environment than we have been, but that's been the case for several years.
That's helpful. Thank you. Keying in on the PTS business a little bit, you mentioned that you expect growth to moderate there. Do you see it being stable year- over- year? Is there a risk that it pulls back from the strong 2011 performance?
It's a large contract business. If you get large contracts, then you're likely to grow. If you don't get large contracts, you're likely to shrink. It is very much dependent upon signing elephants. Obviously, the back-to-base business is important and tends to be attractive. We expect there to be a baseline of that kind of activity. You know we're always out there bidding on new contracts.
Okay. Also, on PTS, EBITDA there was down pretty significantly quarter- over- quarter. Can you speak a bit about that decline? Is it just because the top line softened up a little bit?
Yeah. Most of the decline in Q4 was due to a bonus adjustment we had there. The business did very well in 2011, as you can see. Hence, we had a big accrual for bonuses in Q4. Other than that, the business performed well in terms of EBIT.
Great. Thanks. Last question for me. The 10%- 15% adjusted tax rate you mentioned, is that still a good number for 2012?
Yeah, that's still the number that we're using, and we're comfortable with.
Thanks. I'll pass the line.
Thank you. Once again, please press star one if you have a question. The next question is from Shivalika Honda from RBC Capital Markets. Please go ahead.
Thank you. Shivalika Honda here on behalf of Michael Bramski. I was just wondering if you could talk a bit about your expanded credit facility. What do you expect now to be able to have more flexibility to compete with the larger acquisitions? Is that a result of the dividend? Could you talk about your strategy around that?
Yeah. The expanded financing facility was we took advantage of good markets in terms of credit. As you know, it's a very good time to refinance. Our existing facility was also coming due this year. It wasn't really a function of building up our capacity to compete better on larger deals. It was a function of markets. The credit markets are in good shape. It obviously gives us the flexibility if those deals were to come up to compete. We're happy with the facility. It's a lower borrowing cost, and it's a long-term one, four years. We're reasonably pleased with that.
Great. Excluding PTS, were you pleased with what you saw in terms of organic growth in the quarter and for the full year? Do you see it being sustainable going forward?
Very pleased with the organic growth for the year. Would hope that it would go forward. I'm not as optimistic about that for the next year or so as I hope to be a year hence. I don't get the sense that the economy is booming and that our clients are awash in cash and profits, in particular in the public sector. It could be tough slogging for a while.
Okay. That's fair. I guess on that note, if we do start to see signs of a recovering economy, what's sort of the lag time between the macro backdrop and what you see in your business? Would you say, you know, it'll get better in H2, or is it really going to get pushed out into F13?
I think we tend to be a laggard as the economy rebounds. We're capital goods. Most of the businesses that we serve tend to be folks who have other needs for their capital, generally working capital needs, as they start to expand and grow again. In the public sector, they're a little bit kind of cyclical. When times are tough, they tend to open up their spigots and spend some money. That tends to help us when things are really tough. When things start to recover, the public sector tends to start dialing back their spending and worrying about their deficits. I'd say we're a laggard. I'm not sure exactly how much we're a laggard by, but it'd be a year or two, I think.
Okay. Great. I think that's all for me. I'll pass the line. Thank you.
Thank you. The next question is from Nikhil Vadani from National Bank Financial. Please go ahead.
Great. Thanks, guys. Just two quick ones for me here. As you sort of look ahead to 2012 and 2013, is 5% organic growth still a good benchmark, or has that changed with all these moving parts you've spoken about?
The 5% is our long-term sort of five-year, yeah, pinned us down and said, "What do we hope for?" That's the number that we're targeting.
Okay. Perfect. As you look through your M&A pipeline, is that skewed more towards public or private or North America? How has that changed over the past three months or so, or has it changed at all?
You know, we don't even look at it that way. It's just the stuff that we generate and sort of move along through the process. It's not like we have a strategic focus to go do particular deals in the southern U.S. We try and cover everywhere.
Okay. Perfect. Thanks.
Thank you. Once again, please press star one if you wish to ask a question. There are no further questions registered at this time. I would like to return the meeting to Mr. Leonard.
Thank you, Wayne. Thanks, everyone, for joining the call. Look forward to seeing all of you for the Q1 AGM. You'll be receiving both the President's letter and the Q1 results prior to that. Hopefully, the attrition data that we'll have in there will be useful to both the analysts and the investors in understanding the business a little better. Thanks very much. Bye-bye now.
Thank you. That concludes today's conference call. Please disconnect your lines at this time, and we thank you for your time.