Good morning, ladies and gentlemen. Welcome to Constellation Software Incorporated's Q3 2011 Conference Call. I would now like to turn the meeting over to Mr. Mark Leonard. Please go ahead, Mr. Leonard.
Thank you, Michael. Good morning, everyone. Welcome to the Q3 call, as Michael had mentioned. As you all know, we go directly to questions, so Michael is going to handle that process. Michael?
Yes, sir. Ladies and gentlemen, we will now take questions from the telephone line. If you have a question and you are using a speaker phone, please lift your handset before dialing your selection. If you have a question, please press Star, one on your telephone keypad, and you can cancel your question if you wish by dialing the pound sign. Please press Star, one at this time if you have a question. The first question is from Scott Penner at TD Securities. Please go ahead, your line is now open.
Good morning. I just wanted to ask, first of all, I guess, Mark, on the acquisition environment, the pipeline of deals right now overall, and then specifically on the larger deals. I guess last quarter you said there were some larger deals in the pipeline. Are these any closer to happening?
The acquisition pipeline in general, not bad. In aggregate numbers, sort of similar to what it's been the last little while. The number that are down at the bottom of the funnel ready for either winning or losing is a bit light. The larger ones that were in the funnel last quarter, we did not close. We either lost them or else they've been deferred.
Is the valuation on some of these larger deals, I mean, is it either more competitive, or are sellers asking for prices you're not willing to pay?
Nearly always on the larger deals, we have trouble competing with leveraged competitors for the very large ones. Because we don't use the same amounts of leverage, sort of 4x EBIT, 3x EBITDA, when we buy, we hopefully buy with equity. We don't tend to be as competitive for those larger transactions. For the mid-sized transactions, we just haven't seen any. Most of those mid-sized companies can probably defer selling if it's for estate or other reasons for a while and don't want to sell at the bottom of the market. Pretty much the same thing for, I'd say, the smaller transactions. People have the ability to time when they exit. They're in these things for 20 years. They built them and they choose when they sell. They don't often want to sell when markets are in turmoil.
Okay. Fair enough. I wanted to ask just on the strategic view to approach the subject. The MDA says you're looking still at a range of alternatives. You clearly, the performance of the business is doing very well. Could you give us any sort of insight as to what the committee or the board may now be looking at?
Can't really give you any insight at this stage, Scott.
Okay. John, if you're there, just a question on the working capital. I know this is quite a positive result in the quarter, but PTS itself was negative. It looks like a big increase in payables and accrued. I just wondered if you can give us any insight on that.
Yeah. Overall, the increase in accrued and payables primarily relates to our bonus plans. We accrue throughout the year and pay in March of the following year. Over the course of the year, that generates cash from working capital. In addition, in the quarter, we had some pretty good collections in some of our business units, excluding PTS. Probably one of our best quarters ever in terms of AR collections. That was after a pretty poor Q2, if you remember. We were simply just catching up from last quarter. PTS had a big billings quarter, which would have increased their working capital. We're hopeful that converts into cash in the next few quarters.
Okay. John, while I have you, what should we expect for the tax pay? It's probably lower than most would have expected. What should we expect now?
Yeah. We were suggesting 15%- 20% about a year ago, and then we lowered that to 10%- 15% based on some tax shield that we've acquired. You can use that for the foreseeable future, i.e., the next few quarters, 10%- 15% of adjusted net income before tax.
Okay. Last thing for me, Mark. On the PTS business itself, it's obviously driving a lot of organic growth, and the EBITDA looks, you know, comfortably on pace to more than double this year. Yet you'd say in the MD&A, you're hoping to fly back to total CFO neutral for this year. The acquisition has obviously been a good deal for you, but have the economics of the industry improved any since you've done the acquisition?
I think that the economics of the industry, particularly when you're bidding for new name business, tend to be tough. If we win large new name accounts, you can expect those economics to look grimmer than they currently do.
Is that something that you're now in a position to more effectively go after, the new name business?
We always bid on new name business. We don't always win, and it really comes down to what percentage of your total revenues new name ends up being.
Okay, thanks. I'll pass the line.
Just one observation on the working capital issue. John , and the finance people at the various operating groups have launched an initiative over the course of the last little while to try and squeeze down the amount of cash we carry inside the business as well. That appears to have been effective, and I'm hoping that it will continue to decrease.
Great. Thank you.
Thank you. The next question is from Mike Bramsky at RBC Capital Markets. Please go ahead. Your line is now open.
Thank you. I realize you know you're not going to make a lot of comments on the strategic process, but I'm just trying to understand, is it, are we done on the sale of the company side, or is that going to rear its head again if market conditions improve? How much would you characterize as a distraction has this process been or will be to running the business?
I don't think you're ever done as a CEO of a public company. If you're approached by someone with a premium price, you know, you got to pay attention. You got to respond appropriately, and you got to take into account the interests of all the shareholders. You're never done. When you've got two large shareholders who've indicated a desire for liquidity, you know you're in a particularly uncomfortable position. We're not done. It'll always be hanging out there. We are working on other alternatives at this point in time. Michael, there's a second part to your question. I got to, oh, yes, distraction. Yes, I got distracted. Definitely been a distraction. I think to some extent, the amount of acquisitions we've done has been influenced by their process. Our heads have been elsewhere.
You know.
Certainly, morale issues. You know, people are concerned.
Yeah, I understand. I guess, you know, there's a trade-off between pursuing the process of selling the asset and, at the same time, the process itself affecting the asset. I'm just wondering, is there discussions about that balance being struck, including at that investor level?
Yeah. Absolutely. It's a physical law, right, Michael? It's the Heisenberg Uncertainty Principle.
I'm sorry, I missed that day in physics.
I'll send you the quote.
Okay. Essentially, these like in terms of your distraction now, has that been reduced, or is that still a factor?
I'd say until the entire process is over, distraction will continue, but hopefully not at quite the same levels as it has been during the course of the last seven months.
Does that suggest, on your point about acquisitions, that we should be muted with regard to our expectation for your typical acquisition run rate given the ongoing distraction of the process?
I think there's no direct correlation, Michael. It's activity-based. You know, if I'm not out having lunch with an entrepreneur who might someday sell, is that a problem? The same thing applies to all of the other managers and business unit managers. When you're busy compiling information or thinking through other alternatives, you're not doing those things. I haven't answered your question, but I think that's as far as I can go.
Okay, have you, just on software generally, there's been a lot of mixed signals with regard to macro-economic headwinds, and you still have obviously, you know, housing exposure in the U.S. Also, could you just talk a little bit about, is that playing through or will it play through in an unusual way in terms of your sell-in, both with existing and new contracts, and also in terms of your mix of, you know, maintenance versus license going for the next little while?
Good question. I also noticed your write-up that you remarked on our organic growth being below where you had forecast it might be. I think, as John and I wander around visiting with the operating groups and their managers, we get a sense that times are tough out there, that organic growth isn't going to be as good in the coming year as it was in the past year. Not a dramatic difference, but just a sort of softening that we're feeling out there in the marketplace. I think there are macro-economic headwinds, and I think people are cautious and nervous.
Yet at the same time, you've upward revised your F2011 outlook. How do you kind of square that with your current comments? Next quarter, will we see you providing F2012 outlook?
no plans to do an outlook for F2012. How do we square it? We didn't actually change the upper end of the range. Let's just assume that by putting in the lower end of the range, we were being conservative previously. As things have evolved, we've ended up at the top end of the range. Plus, we've done a few small acquisitions.
Is that just a matter of lower visibility and extra conservatism, or is that actually reflecting a more moderate sense of uptake?
The swing is in the licenses and services, not in the underlying maintenance and attrition. We're still very confident about our recurring revenues. The confidence, I think, revolves around what licenses are likely to be and services are likely to be in the coming year.
Okay. Thanks, Mark.
Thank you. Once again, ladies and gentlemen, please press Star, one on your telephone keypad if you have a question at this time. The next question is from Stephanie Price at CIBC. Please go ahead.
Good morning.
Morning, Stephanie.
Could you talk a bit more about EBITDA margins? You talked about it in terms of PTS, but can you talk in terms of the general business? Obviously, there's been margin expansion this year. How much more do you believe there is in the business?
We don't really focus on EBITDA margins as an indicator of how well the business is being run. We believe there are R&D and sales and marketing investments that you make in the long term, things that pay off over 5 or 10-year type horizons, and that they should be viewed totally separately from the day-to-day operations of the business. We have a core profitability excluding initiatives that we focus on, and then we have initiatives. If our managers came to us with an extra $50 million worth of initiatives that we thought were great initiatives, we would be delighted, and our EBITDA margins would go down, and hopefully, over a period of several years, our organic growth would go up. Do I think the process has gotten people a little more focused on producing bottom line and maximizing bonuses over the very short term?
Certainly and is that bad for the long term in terms of organic growth? Absolutely. It's one of those costs that you run into when you enter into a process of this nature. I don't see margins expanding as we go forward unless our growth rate drops, in which case our bonuses tend to come down, and then you might get a little bit of a pop in the margins. If the growth rate continued and the business was not sold, we wouldn't be looking for margin expansion.
Great. In terms of the public sector environment, you've kind of said on a macro level the software environment is difficult out there. The public sector business seems to be sort of chugging along, even though you read all sorts of reports about budget constraints. Can you kind of talk about what you're seeing in that business?
It varies a lot by segment, Stephanie. The school business has a much higher recurring revenue component. It's very, very hard to sell new licenses into the school business, and when we do, they tend to be more SaaS-based. You wouldn't actually, it's a tough part of the government space. Other government areas do somewhat better. It depends place by place. The U.K., was tough, for instance, for us versus North America. John, any sort of thoughts on?
No, no. I mean, some of our government sector is not necessarily funded through tax dollars, so utilities. You know some are more insulated than some other parts of the government sector. Stephanie, I will comment on your margin question. We haven't done as many large acquisitions this year compared to last year. There is a period of time when we acquire a company that we've improved the performance of it. Hence, you do see a bit of margin improvement this year over last year because of some of the large acquisitions we did last year.
We do, for instance, in the utility space, have a very rapidly growing division in meter data management. There are bright spots in government as well.
Okay, great. Thanks a lot.
Thank you. The next question is from Richard C. at Cormark Securities. Please go ahead. Your line is now open.
Thanks. Mark, in regards to your earlier comments about some of your competitors using more leverage to compete at the bigger transactions, why are you guys the first to do that on your own? Like, as you get bigger, I think to maintain the growth rate, you need to get into some bigger deals. You don't allow debt on the balance sheet today. Is that sort of a hard philosophy you're going forward with, that you don't want debt, or any perspective on that?
Yeah. I believe that you are offered opportunities from time to time that are unique bargains, and it's usually during very difficult times. If you can move on those, if you have the ability to pick those up, then you will do extremely well over the long term. If we were leveraged to the hilt the way many private equity deals are, we wouldn't have that flexibility. On top of which, when you're carrying a pile of debt and you're reporting monthly to the bank and you've got all kinds of covenants to worry about, you stop focusing on initiatives and what your revenues could be 5, 10 years out. In our business, that's the cycle. If you're not investing in R&D today, you're not going to have those products at maturity 5- 10 years out.
I believe that a lot of leverage is actually a bad thing in our business. It will make you short-term oriented. I believe that the companies in our space that get bought by private equity tend to subsequently lose market share and become everyone's target in the software realm. You can pick share off of them. That's certainly been the case in our utility space where one of our major competitors was owned by private equity and subsequently sold to a corporate. They've been the largest conceder of market share in that space.
Right. So.
I believe that debt is a distraction. It's something that you may use from time to time for very specific circumstances, but it isn't something that I would seek long term.
If you're averse to doing that, and if you see a lot of opportunities with respect to the bigger transactions, would you consider maybe raising some equity to do that to give you, you know, kind of the capital to move on some of these things?
If you're willing to take 10% or 15% rates of return, we could deploy probably billions. Most of us have the bulk of our net worth tied up in the company and believe that the stock won't appreciate at a rate any faster than the return on equity that we have. We're kind of keen on having, you know, 20-plus returns on our incremental capital. It's hard to get there unless you use lots of leverage or are very astute buyers. We don't see ourselves stretching for those big deals.
Okay. A final question here with respect to the strategic review. Can you give us any idea of, you know, sort of how many players that, you know, order of magnitude that who are, I guess, kicking the tires, so to speak?
Maybe a year from now, we'll have a coffee.
Okay, I'll leave it at that.
Okay. Thanks.
Thanks.
Thank you. Once again, ladies and gentlemen, please press Star, one on your telephone keypad if you have a question at this time. The next question is from Scott Penner at TD Securities. Please go ahead. Your line is now open.
Mark, just one additional one. I'm not sure how much color you can really give on that, but just in terms of your investments in initiatives outside the core, as you say, can you comment on whether the investment in initiatives is down year over year by how much? Is it up? Any parameters around that?
I can comment by giving you a sort of history of what we did. When we started doing the initiative program, we tracked everything. There was a whole host of initiatives, and people were pretty excited because it took the pressure off of short-term performance, and you could sort of load all your R&D and sales and marketing into the initiatives. They then discovered that it was really hard to track these things, and it was a lot of work, and you had to confront every quarter how you were doing versus how you thought you were going to do. Some of the smaller initiatives sort of slid back into the core business as long as it was doing well enough to paper over the money that was being spent on the smaller initiatives. The bigger ones still tended to get broken out.
Over time, as we tracked the initiatives that we initially started tracking, the rates of return on those were relatively poor compared to what we were getting on the acquisition side. That shifted the focus of the managers inside of our businesses to acquisitions. I think they became, all of them, very focused on acquisitions, much less focused on initiatives. I think there was a swing back again as people started saying, "Hey, we've got to keep investing in add-on products and keeping our core systems moving forward so that they're state of the art." I think we saw another round of investment, and those new larger initiatives, the complete rewrites and things of that nature, major new additions, were broken out as separate initiatives. We track far fewer than we used to, Scott. I don't know that we're doing massively less than we have previously.
I think the discipline of tracking the big ones is absolutely the right thing to do. Probably we should be tracking more of the small ones because I think there's old lessons to be learned from doing so, but we don't have as many that we're tracking as previously. I can't really answer your question because our systems and our approach to how we do it have changed. I'd say we're better at initiatives than nearly all software companies I come across because we do think of them as standalone projects.
Okay. The only other question is just on, you mentioned, some of your business in going to the SaaS-based model. I just wanted to ask, as you look at things right now, are more of your customers in the various verticals looking for hosted solutions? Is this something you can manage just in the course of business, or do you see any real discontinuity of the core of the premise base going to a hosted model?
I don't see a discontinuity. I think it's a sort of continuous flux. Right now, I follow Salesforce, and I enjoy sort of watching what it's doing. It's supposedly the best of those cloud-based solutions, and, you know, it isn't like they're making gobs of money. Their growth rate has certainly slowed. I think they're a bellwether for what's happening out there. It's a growth sector. We're totally bombarded with the cloud. Everyone talks about it. I think it's not getting anywhere near as much traction as press. Our SaaS-based solutions are growing very quickly and becoming an increasingly important portion of our maintenance and recurring revenues. We will at some stage break it out and start presenting it, but it's not going to dominate our maintenance line for many years.
Okay. Appreciate it. Thank you.
Yep.
Thank you. The next question is from Patrick Horan at Agilif. Please go ahead. Your line is now open.
Oh, hi, guys. I wanted to revisit the dividend that you issued last year and whether I thought at that time you thought you might issue an annual dividend, and how you based that dividend amount, which parameters, whether cash flow or earnings or something else. Thank you. I'm casting my mind back to that time, and things changed quite significantly very shortly after the dividend, when we embarked on the process. I had no knowledge at the time when we were considering the dividend that the process was coming. In that context, it was a reasonably comfortable amount of money given what we thought our acquisition prospects were and our borrowing capacity was, and still left us with enough dry powder to do that occasional good big deal that came along.
All other things being equal, I don't think we'd have a problem paying out a similar dividend on an annual basis, maybe spread out over the quarters as opposed to the annual big bang. Part of the thinking was that it might broaden the appeal of our shares to a broader audience. Does that answer your question, or are there?
Yes, it does. I appreciate that, guys. Thank you.
Nice to see you on the conference call, Patrick. I think you're our only investor who phones up with any frequency.
Thank you. Once again, please press Star, one on your telephone keypad if you have a question at this time. If there are no other questions, I would like to turn the conference back over to you, Mr. Leonard.
Thank you, Michael. Thanks, everyone, for attending. Look forward to speaking with you at the Q4 call. Bye-bye now.
Thank you. Ladies and gentlemen, your conference is now ended. All callers are asked to hang up their lines at this time, and thank you for your participation.