Good morning, ladies and gentlemen. Welcome to Constellation Software Inc. 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 is going to tee those up right now.
Thank you, Mr. Our first question is from Blair Abernathy with Cantor. Please go ahead.
Thanks very much. Good morning, gentlemen. Good morning. Mark, just wanted to focus on the TSS business for a second. You made good progress on your margins sequentially.
Just want to see how that restructuring is looking as we kind of move into the back half. And so if you have any or what your margin targets are there for the year firstly? And then I guess secondly, how with any of the 5 acquisitions made down in the TSS business? Or how is their acquisition pipeline looking?
Okay. A couple of questions there. One is a plaintiff request for forecast, which we don't give. What we said in the past is that CSS is a business that has a much higher component of professional services activities inside of it. That isn't going to change anytime soon, although we hope for sure that they will build their recurring revenues over time.
The hence, we tend to believe that they will ultimately have lower margins than our other pure software type plays. But when we get there and whether we get there is to be seen. And 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. So 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. And 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 is 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 and 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 Finner with TD Securities. Please go ahead.
Thanks. Just 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?
So the funnel looks better, but the proof is in the pudding, right? It's getting things across the finish line. And 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. And but one would hope to I would have hoped that we would have invested more capital in the first half.
And when you look at that hope versus the reality, I mean, is there any maybe holdup is 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 5 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.
And then the margins in 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. And then in the public sector in general, the guys are cautious, but it seems to be going well.
Okay. Just a couple of questions on the standalone TSS financing. Are there any other assets other than TSS in that Constellation Netherlands business?
Not right now.
Okay. And then what is there any the filing may allude to some limitations. Are the future acquisitions of TSS limited 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. And so to the extent that they the partners can or can't come up with the capital, We'll have to figure out how we handle larger transactions if we're going to try and do them through the management team at TSS.
Okay. That's all. Appreciate it. Thanks.
Thank you. Our next question is from Thanos Moskopoulos 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 and A. And so in the healthy climate, do your managers perhaps spend a little bit more focus in terms of capitalizing on organic opportunities, which slowdowns M and A? Or are the 2 activities sort of really independent
of each other? Yes. We've talked about this at the Board and with the operating groups. And 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 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. And so they can be doing one or the other. It's hard to do both. And so I think there is a natural trade off. I think that's I think we've seen it.
Okay. And a question for Jamal. Taxes were higher this quarter and you explained that that was due to the Australian tax credits. And so to be clear going forward should we 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 2 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.
So I still think the upper limit holds, but we're probably trending closer to that upper limit than the lower that we have been in the past.
And long term, unless we're acquiring increasing amounts, I think you're going to see the tax rate trend upwards.
Okay. And 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. So just curious as to what your threshold for materiality would be?
So we're using sort of what the OSC uses as so 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. Good morning. Mark, maybe talk just a little bit about if we drill down into public for a minute, the transportation group particularly Trapeze looks like they had a record user conference this year. Is that how should we think about organic growth in that area? And you've talked a little bit more about R and 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. So 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. So in other words, creating a group that takes ideas and win us through them and helps the people who generate those ideas put elevator pitches around them and determine whether they're going to pursue them or not and then flesh out the ideas and look for sponsors among the user community and things of that nature. So 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.
But 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. And I think the Trapeze guys are trying to be as close to their customers as they can.
Understood. Yes. I wasn't trying to single out one person. I'm just looking more as this is the prototype for the group. I was thinking about more was 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 larger companies because Trapeze is clearly a large standalone software company even in its own right at this point?
Yes. 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. And they're managing assets that are much smaller than the transit authorities.
So you're never going to see a market size in that particular space that's comparable. But 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. And 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. And we sort of run the gamut from 20 person businesses to 400 person businesses.
And we think we understand how to work at both ends at that extreme.
Okay.
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 going to evaluate that process as to whether or not you do not just that deal, but specifically in the future, as I'm thinking about private equity firms, for example, may or may not be good partners, but 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 2 year evaluation for the Board to sort of see how this one works out first? Or would you move before that?
Yes. I'm hoping both the Board and the shareholders are evaluating it. 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.
Thank you. The following question is from Paul Treiber from RBC Capital Markets. Please go ahead.
Thanks and good morning. I was just hoping to clarify in terms of your threshold for press leasing acquisitions, have you changed the threshold that you'd consider press leasing acquisitions this year versus prior years?
I think it was the beginning of this year we went to 10,000,000 dollars as the size and it used to be $5,000,000
Okay. That's good to know. And then also I think in July, Trapeze acquired a company called Stigtec Holdings in Australia, but I didn't see a disclosure in the MD and A about that deal. Is that because it was below the threshold?
Yes. It would have been part of the group of the acquisition though that we group everything together. In July. Oh, in July. Close one in July.
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, Ali. Yes. Joel is 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?
I don't have that at my fingertips. And what I 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 and A about the interest cost in the standalone debt.
Okay. That would be helpful. And then just lastly, the rights offering you
put out
the preliminary perspective, have you had feedback from your investors on that? And what sort of if you could just sort of elaborate on your the structure around the rights offering?
Sure. So 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.
And so it's been a much slower process than I'd hoped. Hoping we will get the final file shortly. And vis a vis interest, the market will tell us, right? The rights will trade and there'll either be lots of interest or they won't.
Okay. Thanks a lot. I'll pass the line.
And Paul just you know, the SigTech closed on June 30.
So it is included in Q2? Yes. Okay. Thank you.
Thank you. Our next question is from Andre Cronulla with Oropacific Canada. Please go ahead.
Yes. Hi, good morning. Just a couple of housekeeping questions for 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% plus. Has that been the case so far this year?
And if we can get a comment maybe on breaking that down a bit in terms of what's driving that recurring revenue organic growth?
Yes. So we give you the breakdown of organic revenue growth once a year in the May timeframe in the President's letter. So 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.
And 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% 5% came from that you're quoting.
I see. And 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?
TSS? No, no. It's their plan and they're executing it. And obviously, we are trying to share what we know about vertical market software businesses with them and they are fast learners. And 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.
But basically it's their plan.
I see. And just one last one for me. Really has your experience with European labor laws and the integration of FTSS over the last few months influence sort of your future plans in doing business there? And 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 the I think it's something that you build into your models and your investment thesis. And so if there's a higher cost of shifting staff around in Europe, you build that in. So 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. 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?
So our European pipeline well, shouldn't call it a pipeline because these are to us what we call suspects. So we contact companies. We start to engage in conversation. Hopefully, a decade later, we have a transaction. So they are very long plays.
And in terms of those generation of suspects, we've been doing reasonably well in Europe. I'd say somewhere between 20% 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 going to be important to us long term.
And just switching gears a little bit. On the maintenance renewal rates, has there been any change in terms of how that's trended over the past little while? And what's the ability like lately to get to price increases on those maintenance renewals?
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. But 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.
So it's not a central activity Richard.
Okay. But once a year. Okay. And then just one question. I think you touched on R and D at the beginning of the call.
But TSS has a greater proportion in R and D. Are you it sounds like you're just going to let that kind of operate as a standalone, but I guess would you sort of consider upping your own R and D? Or like how do you think about R and D in general as you sort of looked at organic growth going forward?
Yes. So R and D isn't a dial or lever that I have my hand on. It's one obviously that I monitor. It's an investment generally in both sustaining R and D and in initiatives things that are aimed at future revenue generation. And it's the latter component that I believe is the toughest part of running a software business.
So 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. And so 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.
Yes. That's great. Thank you.
Thank you. Our next question is from Ralph Garcia with Global Markets. Please go ahead.
Yes, good morning. Just following up on the 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.
And they're all rational in their expectations or?
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. And 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. So I mean we from a CSI perspective, there's been some deterioration in working capital from a WIP and inventory perspective, but nothing obviously, TSS is causing any of our working capital equal.
Grow. Okay. Thank you.
Thank you. There are no further questions registered at this time. I would like to turn the meeting back over to Mr. Leonard.
Thank you, Valerie. Thanks everyone for joining the call. Look forward to chatting with you in 3 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.