Good morning, ladies and gentlemen. Welcome to Constellation Software Inc.'s Q2 2014 Results Conference Call. I would now like to turn the meeting over to Mr. Mark Leonard. Please go ahead, Mr. Leonard.
Thank you, Valerie. Welcome everyone to the Q2 call. I've got Jamal here with me, and we're happy to take your questions. Valerie's gonna tee those up right now.
Thank you, Mr. Leonard. We will now take questions from the telephone lines. There will be a brief pause while the participants register for questions. Thank you for your patience. Our first question is from Blair Abernethy with Cantor Fitzgerald. Please go ahead.
thanks very much. Good morning, gentlemen.
Morning.
Mark, just wanted to focus on the TSS business for a second. Made good progress on your margins sequentially. Just wanna see how that restructuring is looking as we kinda move into the back half and sort of, if you have any, or what your margin targets are there for the year, firstly. I guess secondly, were any of the 5 acquisitions made down in the TSS business, or how's their acquisition pipeline looking?
Okay, a couple of questions there. One is a plaintive request for a forecast, which we don't give. What we've said in the past is that TSS is a business that has a much higher component of professional services activities inside of it, that that isn't gonna change anytime soon, although we hope for sure that they will build their recurring revenues over time. We tend to believe that they will ultimately have lower margins than our other pure software-type plays. When we get there and whether we get there is to be seen. Regarding acquisitions, they have done an acquisition, and they have a couple of full-time folks looking for acquisitions, as well as the management team participating in that activity.
We anticipate that, like our other businesses, they will be serial acquirers of local vertical market software businesses and gradually will branch out from the Netherlands to other geographies.
Okay, great. Thank you. Just one other quick question, if I could, just on the organic growth in the public sector in particular, looked strong this quarter, up about 7%. Any commentary or color you can give us there in terms of how the spending environment's looking at state and local levels?
For sure, there is the environment, issue, but I think what you're seeing here is a deliberate attempt to invest in and cultivate organic growth inside of our businesses. If you track our R&D and sales and marketing spending and look at what's happening to the headcount in those functions as a proportion of our spending and our headcount, it's been going up, and that's hopefully designed to drive organic growth. Whether we get the returns on those investments or not is yet to be seen, but I think we are seeing some early signs.
Okay, great. Thanks very much.
Thank you. Our next question is from Scott Penner with TD Securities. Please go ahead.
Thanks. Just to, Mark, probably top of mind, is any comments you would make on the acquisition environment right now? Your own funnel, how would you characterize it versus, let's say, last quarter?
The funnel looks better, but the proof is in the pudding, right? It's getting things across the finish line. We didn't close that many transactions of good size over the course of the last little while. They've been quite small. Nothing wrong with nice, small acquisitions. We'd love to do a bunch of them. You know, I would have hoped that we would have invested more capital in the first half.
When you look at that, hope versus the reality, I mean, is there any, maybe holdup's the wrong word, but is there anything in particular that you would call out as a factor in not getting some of those deals done?
I think maybe expectations, Scott. If you look at the market, we're five years into a bull. I think people's expectations are very high. We are signing lots of NDAs, getting into conversations with a number of companies, but not closing the percentage that we have historically.
The margins in the public sector business look like they jumped up quarter-over-quarter, excluding the TSS. It did look like a higher license mix this quarter, but is there anything else that was sort of unusual in your mind?
There was a very good license deal signed down in Australia that, we announced, that I believe helped. Then in the public sector in general, the guys are cautious, but it seems to be going well.
Okay. Just a couple questions on the standalone TSS financing. Are there any other assets other than TSS in that Constellation Netherlands business?
Not right now.
Okay. The filing alludes to some limitations. Are the future acquisitions of TSS Limited just to some extent to the cash that they themselves generate, or can you still funnel capital over there?
We can funnel capital over there once we get the minority shareholding agreement signed and sealed. Obviously we'll have a partner and, you have with any partnership to make sure that you work within the constraints of your partner. So to the extent that they, the partners can or can't come up with the capital, you know, we'll have to figure out how we handle larger transactions if we're gonna try and do them through the management team at TSS.
Okay, that's all. Appreciate it. Thanks.
Yeah.
Thank you. Our next question is from Thanos Moschopoulos with BMO Capital Markets. Please go ahead.
Hi, good morning. Mark, I'm wondering if there's any natural trade-offs between organic growth and M&A. In a healthy climate, do your managers perhaps spend a little bit more focus in terms of capitalizing on organic opportunities which slow down M&A, or are the two activities sort of really independent of each other?
Yeah. We've talked about this at the board and with the operating groups, I think there's definitely a diversion of attention that you see with acquisitions. A number of our operating groups are now getting to the stage where some of the smaller acquisitions can happen without the involvement of the general manager of those operating groups. If it's anything sizable, it's gonna suck those guys in. They're also the ones that tend to make change happen around the organic processes inside the business. It isn't that they come up with the ideas that will create organic growth, but they create the environment and the processes that foster organic growth. They can be doing one or t'other. It's hard to do both. So I think there is a natural trade-off.
I think that's, I think we've seen it.
Okay. A question for Jamal. Taxes were higher this quarter. You explained that that was due to the Australian tax credits. To be clear, going forward, should we still be looking at a 10% to 15% rate, or is your guidance changing on that front?
I mean, I still think we're in that range. It definitely is starting to trend up. In terms of the differential between Q1 and Q2, I would say it is truly like about 1.5 to two points that it's gone up just because we've got business now that are fully taxable in the U.S. and the rates are going up. You know, I still think the upper limit holds, but we're probably trending closer to the upper limit than the lower that we have been in the past.
Long- term, unless we're acquiring increasing amounts, I think you're gonna see the tax rate trend upwards.
Okay. Just one last one. In the notes to the financials, you didn't disclose the contribution from the 2014 acquisitions because it wasn't material. Just curious as to what your threshold for materiality would be.
We're using sort of what the OSC uses as in, you know, if it's 20% of our net income, for example, on a consolidated, aggregated basis, we would consider that material.
Okay. Thanks. I'll pass the line.
Thank you. Our next question is from Paul Steep with Scotia Capital. Please go ahead.
Great. Morning. Mark, maybe talk just a little bit about if we drilled down into public for a minute, you know, the transportation group, particularly Trapeze, looks like they had a record user conference this year. You know, how should we think about organic growth in that area? You've talked a little more about R&D. It looks like they've obviously hired a CTO in that business, and the business appears to be ramping. Maybe talk specifically about Trapeze for a minute and the growth prospects there.
Sure. I think the processes I was talking about earlier to foster organic growth, I think they're the most advanced of our groups in terms of doing that as a centrally managed activity. In other words, creating a group that takes ideas and winnows through them and helps the people who generate those ideas put elevator pitches around them and determine whether they're gonna pursue them or not, and then flesh out the ideas and look for sponsors among the user community and things of that nature. The whole innovation process at Trapeze, I'd say, is more advanced. That doesn't mean that in some of our other individual businesses, they don't bubble up some great ideas and make them happen without a whole lot of process.
I'd say as a repeatable activity, Trapeze is definitely ahead of most of the other groups. I don't think that necessarily comes down to a CTO, by the way. I think product ideas come from customer intimacy, not cutting-edge code. I think the Trapeze guys are trying to be as close to their customers as they can.
Understood. Yeah, I wasn't trying to single out one person. I'm just looking more as this is the prototype for the group. What I was thinking about more was, you know, if you look at the size of their user conference, the size and sort of development of this group, is there a logical investment here where actually maybe even take margins down for a little bit and you build, I know you don't like cost structure, but you build some of that into the core and then try to drop some of those processes back into other groups like Harris and sort of build up, you know, larger companies? Trapeze is clearly a large standalone software company even in its own right at this point.
Yeah. It's our North American transit business is amongst our largest individual business units and hence can afford a level of infrastructure that many of the other business units can't afford. That's partially because the addressable market in that particular vertical is quite large. If you take one of our small verticals, let's say the galleries software business, it's a small addressable market that doesn't have the same kind of cash to throw around that the transit authorities do. They're managing assets that are much smaller than the transit authorities, so you're never gonna see a market size in that particular space that's comparable. My sense is that they are trying to innovate and using a lot of the same processes that Trapeze uses inside the galleries business to grow their business organically.
I think you'll see the same across many of our smaller verticals as well. So the trick is to scale those processes so that they work in tiny little verticals and very large verticals. We sort of run the gamut from 20-person businesses to 400-person businesses. We think we understand how to work at both ends of that extreme.
Last one for me is just, we touched a little bit on the fact that with TSS you have a partner involved there. How should we think about how you're gonna evaluate that process as to whether or not you do, not just that deal, but specifically in the future, as I'm thinking about, you know, I know private equity firms, for example, may or may not be good partners, but, you know, there's a large number of vintage deals out there that are likely looking for a new home at this point or refunding. How would you think about partnering with another organization, private equity or otherwise, going forward? Like, is this sort of a two-year evaluation for the board to sort of see how this one works out first, or would you move before that?
I'm hoping both the board and the shareholders are evaluating it. The free cash flow ultimately will be the determinant of whether this has been a success or not. We paid a lot of money for TSS. We've been able to make that slightly less burdensome by using standalone debt inside the acquisition. That cuts both ways, right? Leverage makes things better when you run the thing well and makes it worse when you run it poorly. We anticipate that things will go well, and we hope that inside of a couple of years we'll be very happy with the experiment and we'll consider others. Finding the right partners is non-trivial. I think anyone who's partnered understands that.
Absolutely. Thanks, guys.
Yeah.
Thank you. The following question is from Paul Treiber from RBC Capital Markets. Please go ahead.
Oh, thanks. Good morning. I was just hoping to clarify, in terms of your threshold for press releasing acquisitions, have you changed the threshold that you would consider press releasing acquisitions this year versus prior years?
I think it was the beginning of this year, we went to CAD 10 million as a size, and it used to be CAD 5 million.
Okay. That's good to know. Also, I think in July, Trapeze acquired a company called Sigtec Holdings in Australia, but I didn't see a disclosure in the MD&A about that deal. Is that because it was below the threshold?
Yeah. It would have been part of the group of, you know, the acquisition, though, that we group everything together.
The July.
Oh, in July. What was the one in July? Sigtec.
Maybe it's just timing on the press release that came out in July, but the deal closed in June.
Let me double-check that, Paul.
Yeah. John was looking right now.
Okay. Moving on to that. Just on the standalone debt financing for TSS, the interest rate is based on a leverage table. What sort of the base case we should be thinking about for the interest on that debt?
You know, I don't have that at my fingertips, and what I've found historically with these tables is, they never work out quite as you think they do. You sort of end up tripping up a step or 2 on the tables. I tell you what, why don't we try and get something in the next MD&A about the interest cost in the standalone debt?
Okay. That would be helpful. Just lastly, the rights offering, you put out the preliminary prospectus. Have you had feedback from your investors on that? What's, if you could just sort of elaborate on the structure around the rights offering.
Sure. We filed the prelim. We're working on the final. We hope to get it done soon. The problem with non-traditional instruments is there aren't good precedents, and you have to ask about everything to the appropriate authorities. It's been a much slower process than I'd hoped. Hoping we will get the final file shortly. Vis-a-vis interest, you know, the market will tell us, right? The rights will trade. There'll either be lots of interest or there won't.
Okay. Thanks a lot. I'll pass the line.
Paul, just so you know, SIGTECH closed on June thirtieth.
It is included in Q2?
Yeah.
Okay. Thank you.
Thank you. Our next question is from Andre Cornada with Euro Pacific Canada. Please go ahead.
Hi. Yes. Hi, good morning. Just a couple of housekeeping questions from me, if I could. We've heard in the past that 5% year-to-year organic growth is hard to come by without recurring organic growth growing at 7%+. Has that been the case so far this year? If we can get a comment maybe on breaking that down a bit in terms of what's driving that recurring revenue organic growth.
Yeah. We give you the breakdown of organic revenue growth once a year in the May timeframe in the president's letter. If you go back to that, you'll see it. It's a really difficult process to carve up all of the recurring revenue and understand what's happening inside of it, so we only do it once a year. Since maintenance tends to be a very significant piece of our overall revenues, and we try to grow the maintenance component as a percentage of revenues, that may be where the 7% and 5% came from that you're quoting.
I see. Just on the TSX side, TSS side, sorry. The restructuring that was being completed this quarter, we've heard on the previous call that the restructuring being completed in the last quarter was part of the management initiative there before the acquisition. Is this still the case, or is this restructuring part of your initiative at TSS?
No, it's their plan, and they're executing it. Obviously, we are trying to share what we know about vertical market software businesses with them, and they are fast learners. I'm sure there are nuances of what we think and do that are being incorporated into their plan as they recast it each year. You know, basically, it's their plan.
I see. Just one last one from me. Really has your experience with the European labor laws and the integration of TSS over the last few months influenced sort of your future plans in doing business there? Can we expect that if there are any larger acquisitions coming down the pipe, they will be more North American-focused?
I don't think I think it's something that you build into your models and your investment thesis. If there's a higher cost of shifting staff around in Europe, you know, you build that in. I don't think it influences whether we would do a large acquisition there or here.
Okay. Thank you. I'll pass the line.
Yeah.
Thank you. Once again, please press star one at this time if you have a question. Our next question is from Richard Tse with Cormark Securities. Please go ahead.
Yes. Thank you, Mark, could you maybe talk about the on the opportunity side with respect to acquisitions, what the geographic split may be in that pipeline and how that's different on a year-over-year basis?
Our European pipeline. Well, shouldn't call it a pipeline because these are, to us, what we call suspects. We contact companies, we start to engage in conversation. Hopefully, a decade later, we have a transaction. They are very long plays. In terms of those generation of suspects, we've been doing reasonably well in Europe. I'd say somewhere between 20% and 35%, depending upon the month, are coming out of Europe. We're certainly active there. We believe there's opportunity there.
Okay
I think it's gonna be important to us long -term.
just switching gears a little bit. you know, on the maintenance renewal rates, has there been any change in terms of how that's trended over the past little while? What's the ability like lately to get price increases on those maintenance renewals?
You know, those aren't things that I monitor personally. I'm sure someone somewhere inside the organization does, but it's not a real focus. I tend to look at the attrition once a year as we get the stats in. The way we run is highly decentralized. We've got this large number of individual business units with general managers running them, and I'm hoping that they know which of their clients are thinking about leaving and are following their maintenance renewals and are trying to decide if they've added enough value that they can put through price increases, things of that nature. It's not a central activity, Richard.
Okay.
Once a year.
Okay. Just one question. I think it touched on R&D at the beginning of the call. TSS has a greater proportion in R&D. It sounds like you're just gonna let that kind of operate as a standalone entity. I guess, would you sort of consider, you know, upping your own R&D? How do you think about R&D in general, as you sort of looked at organic growth going forward?
Yeah. R&D isn't a dial or a lever that I have my hand on. It's one obviously that I monitor. It's an investment generally in both sustaining R&D and in initiatives, things that are aimed at future revenue generation. It's the latter component that I believe is the toughest part of running a software business. I'm really keen on understanding how our people do that initiative investment, and I encourage them to try and do it as rationally as possible. Measurement is the only way you end up doing that well. I encourage them to track initiatives and to recognize the fact that some of them aren't working and to triage them and to try and get customers involved in financing such things as much as possible.
Yeah, that's great. Thank you.
Yeah.
Thank you. Our next question is from Ralph Garcia with Global Maxfin. Please go ahead.
Yes, good morning. Just following up on a European question, I guess, for Mark. I mean, do you have any preferences on areas where you're looking or where the better opportunities are valuation-wise between, let's say, Nordics, Benelux, U.K., from a pipeline perspective?
No, really not. Those all sound like good places to do business.
They're all rational in their expectations or.
You know, when you're selling the business that you've built over 20 or 30 years, you think it's the prettiest thing out there and hence looking for big prices and there's a process of sort of coming down to reality, and sometimes we end up being the winner as the expectations ratchet down, and sometimes we don't.
Okay. Then I guess for Jamal, I mean, have you seen any issues on the collection side or from a DSO perspective between the TSS customer base and what you're historically used to from a North American perspective?
No. I mean, the metrics at TSS are actually pretty stellar from that perspective. I mean, from a CSI perspective, there's been some deterioration in working capital from a WIP and inventory perspective. Nothing that I would say TSS is causing any of our working capital.
Okay. Thank you.
Thank you. There are no further questions registered at this time. I would like to turn the meeting back over to you, Mr. Leonard.
Thank you, Valerie. Thanks, everyone for joining the call. Look forward to chatting with you in three months' time. Bye-bye now.
Thank you, gentlemen. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.