Good morning, ladies and gentlemen. Welcome to Constellation Software Incorporated Q2 2012 Conference Call. I would now like to turn the meeting over to Mr. Mark Leonard. Please go ahead, Mr.
Leonard.
Good morning, everyone. Thank you for joining our Q2 conference call. As you know, we generally just go directly to questions. So Audrey is going to give you some instructions on how to get in the queue for your question. Thank you.
Audrey, go
ahead. Thank
you. We'll now take questions from the telephone lines. We have a question from Scott Tenner from TD Securities. Please go ahead.
Thanks. Good morning, everyone. Just I guess, first of all, Mark, just to broach the subject of the organic growth overall, especially in the public sector businesses. I know last quarter you made the comment there was a general slowdown in public sector spending. Just wondering whether that would stay again this quarter?
Our sense in wandering around to the various groups was that they had a pretty good quarter of bookings. So they're feeling more optimistic perhaps than they were 2 or 3 months ago. So we get the sense that there's any fundamental change in the public sector, however. So it could just be a good quarter in a series of bad quarters, but I really don't have any way of judging that.
And in the just in that context, I'm just wondering how we should think of the 3 sort of significant significant deals that have been announced at the end of the quarter and then just past the quarter? I mean does that signal and you comment on the bookings in Q2 signal a snapback positive in Q3? Or would you not want to go there?
Yes. Are you asking about organic growth or
Yes, sorry, organic growth. Sorry? Organic growth, yes.
Our sense is as we talk to the groups that they feel that organic growth will be better, but they tend to be optimistic. Most operating managers do. So very hard to judge. Things can slip so easily from 1 quarter to the next as you're working through a contract. The same complete accounting is such that if you hit a milestone and you have issues, you may not you may have to add hours to a project.
It's just very hard to predict, Scott.
Okay. I just wanted to ask as well just an update both anecdotally on the acquisition environment and prospects that you're seeing and then if you have anything quantitative on the letters of intent out there either versus last quarter or last year?
Yes. So we track all that stuff. And as we've said, we're not very good predictors of what's going to happen. Lots of things can happen between letter of intent and closing. It's been a great half year for us in terms of acquisitions and in particular the last quarter has been super.
We are feeling good about it, but there's not a whole lot in the data to give you tremendous optimism about the next 3, 6, 9, 12 months. There are some larger deals, which is great and that really helps, but they tend to be harder to close.
Okay. So you said there's not a lot in the data to make one optimistic, but nevertheless you do feel pretty good about the back half?
I would say we're feeling pretty good right now. Yes.
Okay.
But it isn't because the data points you there. As you look at the number of letter of intent signed, number that are going out there as NDAs and indications of interest. There's no crisp trends in the data.
Okay. Lastly and I'll pass it along. It's just the given the amount of capital that you have been able to deploy specifically in Q2, should we expect some level of margin pressure related to that in Q3?
Certainly a number of the companies that we bought had margins that were lower than Prevail in Constellation as a whole. So it would contribute to margin pressure.
And how does your I mean, obviously, you're having a good year as far as capital deployed. At what point I mean, this is a better question for John. At what point does the bonus accrual start to kick in against as an offset to any increment to margin?
Yes. Well, our bonus is driven by 2 things return on capital and growth, Scott. So normally in high growth years, you will see the bonus accrual pickup. We've had inquisitive growth, but it's been offset by the negative growth organically and the bonus is driven by overall growth.
Okay. Appreciate it. Thank you.
Thank you. Our next question is from Thanos Mitropoulos from BMO Capital Markets. Please go ahead.
Hi, good morning. Can you talk about how the geographic distribution of the M and A pipeline is evolving? Are you seeing more opportunities in Europe, for example, given the macro backdrop there?
We're certainly working harder in Europe Thanos and head office in particular has been working harder in Europe. So we're having a little contest with the branches to see who can generate the most leads in Europe. I'd like to see more. They do appear harder to close than our North American ones and we've less track record there and we're feeling our way more. There are less levers to pull when you do a European acquisition in terms of getting them to perform better than there are in North America.
So it's something that we want to do more of, but it's not necessarily something that's going to be a radical change in what we do. We don't anticipate there being dozens of European acquisitions over the course of the next year.
Okay. And can you provide
a little more color in terms of your comments regarding some of the larger opportunities you're seeing in the pipeline? Would these be sort of assets from larger companies as you've acquired in the past? Would these be in newer verticals or in some of your existing ones? How are those shaping up?
Nearly always larger tends to mean new platform.
Okay. And
some of them are corporate, but many of them are retiring individuals as well. Just bought a lovely business in the South of England that I think we announced this morning, an agricultural dealership software business and it was 3 individuals that we're looking to sell after having built the business for many years.
Okay. And then a question for John. We saw negative working capital from PTS this quarter. I think you talked about that previously. And so remind us when we might expect to see that reverse?
Yes. It's very binary as you know. It's basically based on milestones. I'm excluding the impact of the bonuses which we normally pay in Q1. So currently the group is forecasting to have some working capital improvement I.
E. Some cash flow from working capital in the second half of the year. But again, it is it's very large project milestone base. So we hope to see it by the end of the year, but it might be early next year. Okay.
Thanks guys. I'll pass the line.
Thank you. Our next question is from Paul Treiber from RBC Capital Markets. Please go ahead, sir.
Good morning, Mark and John. Could you comment on the pricing that you saw in M and A in the last quarter? Are you seeing any better pricing versus historical as a result of the economic environment?
Really hard to judge. I mean, on the ones that we're closing, the pricing is similar. On the ones that we don't close, I really have no sense of sort of where it's at. I suspect the banks are a little less aggressive than they had been a couple of years ago or probably more than that now, probably 3 or 4 years ago. And that does affect private equity buyers and the prices that they're willing to pay.
And do you generally agree that the silver lining of the economic environment is that you may see a greater number of opportunities and pricing?
Certainly, with the economy bumping along and no real sense that things are going to be thriving over the next few years. People who have delayed selling their businesses are more likely to reconsider bringing them to market if they feel that now is the time to be thinking about retirement or things of that nature. I don't think it's bad enough that corporates are having loan sales of their software businesses. But for retiring individuals looking at a prospect of relatively slow growth, I think it's probably affecting their decisions on when to sell.
Okay. Moving to organic growth, you must look at organic growth by maintenance versus other segments. So despite the negative headline on organic growth, are you continuing to see organic growth in your core maintenance revenue that's in line with historical rates?
So that would be really a question about attrition and price increases and new maintenance being added. There are many components to organic growth in maintenance. I certainly haven't heard anything as we've trotted around the branches about decreasing organic growth in maintenance per se?
John, you? No. I mean, overall maintenance is growing quite at a healthy pace this year compared to our overall growth. I think it might be north of 20% maintenance growth. So that would suggest that it's bumping along quite nicely.
Okay. And then just lastly on margins, you did 21% adjusted EBITDA margins this quarter. Is that a reasonable expectation for the business going forward? And then looking at the seasonality of margins, over the last couple of years, it looked like margins are up in the second half of the year versus the first half. Is there any fundamental drivers of that seasonality?
Or does it relate to the mix of acquisitions during the year?
So I'll give you my impressions and then we'll get John's. I think there is some seasonality and that we have payroll type deductions that tend to be front end loaded in a number of the geographies in which we operate. So that tends to depress Q1 and a little bit Q2 margins. We've also and some of that is tied to the bonus that we pay during that sort of period at the end of Q1. There's also a teeing up of all of the provisions in the R and D tax credits and things of that nature, which I'm sure people do assiduously during the year, but are particularly careful with being Q4.
As the bonuses are calculated annually. And I suspect there's a little bit of pushing to close sales as we come to the end of the year. As you know, we do percent complete revenue recognition, which tends to dampen that Q4 effect that you see in other software companies. But it still happens to some extent, I'd say in our business. So bonus does drive a little bit of the seasonality that you see.
I think just to overlay that there is a degree of optimism that everyone has in January, February in terms of their growth prospects for the year. So they tend to hire people. They tend to invest. And if those growth prospects don't materialize, they tend to cut back to hiring in the second half of the year and you get some accretion of margin.
Okay. Thanks for taking my questions.
It was implicit in the question or early on in the question a concern about whether the current margins are maintainable or not. And that sort of implies a sense of central control, which doesn't really exist at Constellation. We provide the operating groups and they provide the business units under the operating groups with a lot of leeway to invest in R and D and sales and marketing things which don't pay off for many years to come. Obviously, we try and track how well those investments play out and make sure that people learn and get feedback from those investments. But if one of the general managers were to come to us tomorrow with a multimillion dollar investment that look like a slam dunk high rate of return investment and it was going to depress short term profits, we would be delighted.
So we don't prescribe margins or R and D spending or sales and marketing spending or anything of that nature, but we do monitor those investments and try and make sure they're rational ones.
Okay. Thanks for those responses.
Thank you. Our next question is from Nikhil Sadani from National Bank Financial. Please go ahead, sir.
Thanks, guys. Most of my questions have been answered, but a few follow-up questions here. I was just wondering if you could perhaps comment on the M and A pipeline and the makeup of that funnel. Is it more skewed towards people retiring right now? Or is it more of deals from companies?
How is that skew looking in going into Q3 versus Q2?
Right now, I think it's more the former than the corporate deals.
Yes. And in Q2, we had a couple of corporate deals. So it's kind of looking forward though, it's more the owner retiree.
Okay, perfect. And your team that looks at M and A, has that team sort of expanded sequentially in Q3 over Q2? Or do you have enough capacity to deal with the pipeline right now?
I can't think of any additions during the last quarter. Certainly year over year, we're adding people and folks are working really hard right now. It's been very, very busy time for us and we're delighted by that.
Okay. And then lastly, just quickly, I was wondering if you could perhaps comment on the tax rate going forward. I think Q2 was a little higher than usual. So should we expect that going forward? Or was Q2 sort of an anomaly?
Yes. From our perspective, it was kind of in line with what we've been saying, which is about 10% to 15% cash tax, which should creep up over the next year. That's always contingent on acquisitions and our ability to structure them, but that's the range we've been discussing and I think it fell in that range in Q2. Okay, perfect. I'll pass the line.
Thank you. We have a question from Scott Penner from TD Securities. Please go ahead, sir.
Thanks. I just wanted to actually loop back on one topic and that is the MD and A makes mention of a potential $9,000,000 or $9,000,000 issue with sorry, I'm just trying to find the page. I think it was the I think it was maybe the Magus assets. Just wondering whether that is if it does come to pass whether that is payable by you or payable by MAXIMUS?
The liability we mentioned in there would be from our perspective our liability associated with that issue.
Okay. And that the $15,000,000 that's still listed as contingent against those assets, I mean that that's obviously got a pretty long tail on it. I think I may have asked you this last quarter too, John. But is there any enhanced visibility on when that $15,000,000 is going to go away?
I think you might have asked us a few years ago Scott. Our visibility obviously is more enhanced, but it's not significantly more enhanced.
Okay. The
projects that that liability relates to are still ongoing. And we would hope that we would get through them in the next year or 2, but we're not certain of that.
Okay. Fair enough. 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, Audrey. Thank you all for joining us on the call and look forward to having this opportunity again in 3 months' time.
Bye bye now.
Thank you, sir. The conference call has now ended. Please disconnect your lines at this time and we thank you for your participation.