Good morning, ladies and gentlemen. Welcome to Constellation Software Inc. Q3 2012 Conference Call. I would now like to turn the meeting over to Mr. Mark Leonard.
Please go ahead, Mr. Leonard.
Good morning. Welcome to the Q3 call. As you know, we tend to go directly to questions during these sessions. I will remark that John and I are in separate offices today, so the coordination may be a little choppy between the 2 of us as we field your questions. So Anne, if you could tee up the questions, that would be great.
Thank you. We will now take questions from the telephone lines. And our first question is from Thanos Moschopoulos of BMO Capital Markets. Please go ahead.
Hi, good morning. Mark, can you talk about what you're seeing from an organic growth perspective? It looks like your year over year growth was modest outside of PTS, but relative to the June quarter, there was a nice sequential uptick. Would you characterize the environment as stable overall? Or is there anything you're seeing in the business that would point to a change in your organic growth trajectory?
Yes. I always hesitate to forecast organic growth or in fact hesitate to forecast just about anything. The anecdotes that we're hearing as we wander around chatting with the operating businesses are encouraging even amongst the government entities. So I think our folks are feeling reasonably optimistic, but you never know till you see it in the numbers. And John, any comments, thoughts?
No, I'd say that's fair to say. This quarter, contrary to last quarter, we saw more optimism in the public sector business units. So it really isn't the public sector side where you're hearing a little bit more optimism? I guess private sector has been pretty healthy throughout the year.
Yes. No, we've been pretty pleased with the private sector given the state of the economy. I think they've been doing pretty well.
Okay. And we saw a strong margin uptick in the private sector business. I know that your margins are often stronger in the back half of the year relative to the first half. And so was that margin uptick in private sector just a question of seasonality? Or is there something else going on that drove that margin improvement?
John, so? Daniel, nothing comes to mind about that uptick quarter over quarter. And the businesses continue to do well. Usually what happens on margins is acquisition related. So my guess is looking back in Q3 and I'm looking at the acquisitions now, they didn't have any big acquisitions that were a drag on the margins, but that's just pure speculation.
Okay.
I think we've seen in one of our subsidiaries that has large contracts, they went through their percent complete, perhaps a wee bit more diligently than they have from time to time and found a little bit of revenue pickup on a couple of contracts. But so there may be it may have been a wee bit too conservative previously.
Okay. That's helpful. And then, John, I think you made the comment last quarter that your tax rate might start to creep up a little next year. Is that still your expectation? It is.
We haven't as you know, it relates to Shield that we acquire. And our current speculation is towards the end of next year, all things being equal, you'll start to see an uptick. Still within your targeted range, but just a little bit higher within towards the upper end of that range? Yes. And then as we mentioned, 10% to 15%, but then it would creep higher than that if we don't acquire any more shield kind of in the next year timeframe.
And John, European acquisitions, safe to say they're likely to have higher tax rates than some of our North American ones because of our shield situation?
Yes. Safe to say, if we it will be slightly higher. In general though, compared to the U. S, they have lower tax rates in some of those jurisdictions, but
The statutory tax rates,
yes. Okay. Thanks, Greg. We'll pass the line.
Thank you. Our next question is from Scott Penner of TD Securities. Please go ahead.
Thanks. Just a first of all, to come back to the question on margins. Just given the acquisition activity in Q2, I think it was I was certainly expecting a little bit more of a dip in margins. Just curious as to whether the companies that you normally acquire, I mean, are they do they normally run margin profiles that are lower than your own? Or should we not necessarily expect the quarters after a big acquisition expense to normally tip margins?
I think particularly with the larger companies that we're seeing that we've acquired of late, they're not making very much money. And CSWI, the one that we hope to acquire shortly, again, if you look at its recent history, it's actually losing money. So I think there will be margin pressure in those businesses absolutely compared to our average.
Okay. Wanted to ask you as well, Mark, just obviously about your outlook and your ability to acquisitions. So let's just say next year rather than pinning down on a quarter. I mean this year you're looking like you're going to more than double what you spent in a softer year last year. What would your expectations at least at this point be for next year?
We have proved, I think, to you and certainly to ourselves that we're miserable predictors of our ability to usually look at a on 2013 than we've had in the past. I can usually look at a quarter and say that there's a bunch of stuff in the funnel. And certainly for Q4, there is a bunch of stuff in the funnel.
And is there a change in the profile, I guess, or the number of larger versus smaller acquisitions that are in that funnel?
We've seen our average size tick up quite a bit. I think it's approaching $5,000,000 currently. And Bernie had some stats in our most recent board package. And so that's good in that it's less effort, less M and A effort to deploy capital. And these larger companies, particularly in Europe, come with pros and cons.
Maybe you get a large one done, but maybe harder to fix.
And one last one for John. Maybe just the on the PTS side, I know Q4 last year was a big working capital positive quarter. Is that likely to happen again this year? And just more of a general question, is PTS still in a mode that you're trying to take working capital out of it overall?
I think similar to M and A, as Mark alluded to, we're finding it quite difficult to forecast cash flow in that business and it's primarily due to the nature of the very large contracts, which have milestone payments. So and there's no reason why Q4 should be a strong cash flow quarter every year. However, they are predicting this Q4, they're year to date, whereas right now they're slightly negative. So they're predicting to be positive year to date, whereas right now, they're slightly negative. So they're predicting to be positive cash flow.
But again, it's hard to predict, Scott, because you've got some big milestone payments that is reliant upon. And your question about working capital, yes, I mean, there's pros and cons. I mean, they're hopeful that they could backfill the large contracts, which are declining over time, so that the business continues to grow. However, if it does continue to shrink, it should release working capital over time. Okay.
Thank you.
Thank you. Our next question is from Tom Laston of Cantor Fitzgerald. Please go ahead.
Hi, thank you. Good morning. If I can dive into the public sector comments ex PTS, I guess, because of variability, but that's a little bit contrary to what some and many other vendors are saying. Obviously, it's the nature of your mix. Is there what parts would you highlight?
And I know you've announced a few deals, but what parts would you highlight as particularly strong? And I assume within the mix, some of the assets are looking a little weaker. So can you parse out that a bit for us?
I think it was pretty much across the board, Tom, that people were optimistic. I'm trying to think of
We're hearing are you talking about fiscal cliff in the U. S? Obviously, Europe in some jurisdictions, it's generally down. What's the differentiators, I guess, with you that it's looking a little better, if you Well, I
don't think it's just with us. I mean, if you listen to the Tyler conference call or looked at their results, you'd be pretty impressed by their organic growth. So I think there's certainly other vendors in the public space who are doing okay.
Okay. Some of the bigger vendors are showing weakness in right now. So the more the traditional enterprise software vendors are certainly struggling in this sector. So I
think Europe for us in the public sector isn't I didn't hear a whole lot of optimism there as we went around. But again, anecdotal, I don't have any
But U. S. Feels fine. Okay.
Yes, U. S. Feels fine.
And on the construction side, at least some new housing data is good, some of the sales data is not so good. What are you seeing or hearing in the field there?
I think we were feeling a little more bullish in Q2 than right now, but it's not like we've had any particularly bad news. But the guys seemed a little more optimistic last quarter. Okay.
And just finally, John, can you update us on capital deployed to date with the last couple of acquisitions including today? And I guess, CSWI will close this current quarter, correct?
Yes. I think in our statements, we said we deployed about $4,000,000 as of yesterday. We closed the deal aftermarket last night.
That's right. And Does that include that, sorry?
No, it would exclude that.
Okay.
And then CWI, as you can see in our disclosures, we're hopeful that it closes next week.
Next week, okay. And that's 15, okay. Okay, that's it for me. Thank you.
Thank you. Our next question is from Richard Tse of Cormark Securities. Please go ahead.
Yes, thanks. So Mark, just curious to see whether you guys are going to reinstate some targets for growth. I know that your pipeline is active, but what
do you think is sort of
a reasonable expectation for growth over the next 12 months?
We don't have any sort of reasonable expectations. It really depends how much money we deploy, Richard. And the pace of that will depend upon obviously availability, but also upon the performance of the existing portfolio of companies. So having bought a number of European things, if they work out well that will be fabulous news and we can focus on trying to buy other European companies. If we run into unique issues that we haven't faced before, we'll have to learn how to work through those.
Similarly, we're starting to get into the payment space, which isn't one that we've played in before. You probably saw the press release about LNZ. We had started to do a payments business organically, a greenfield business, because we felt it was a good ancillary offering for our clients. And now we've done an acquisition in the space and we're looking at others. It will also be a learning curve for us.
It's going to be a different business than the software business per se. And whenever you're learning, you're probably making some mistakes. So that could slow us down as well. So very, very hard to predict what growth will be for the coming year. That's fair.
If excuse me, when you look at the
cloud landscape, what are your customers saying about that as a potential opportunity?
Customers as an opportunity. To me, the cloud is a delivery mechanism and sometimes gets confused with an economic model. To the extent that people don't have the ability to manage IT infrastructure internally, moving stuff out to the cloud can be appealing. To the extent that they view IT as a part of their special source and something that's proprietary to them, outsourcing it to the cloud can be less appealing. And so it varies a lot by client.
And I suspect you'll see departmental systems moving to the cloud before you see full enterprise systems going there. I suspect you'll see small companies using it before large ones do. So it'll be a sort of slow adoption. We obviously track it and participate And we hope that we'll be able to break out our recurring revenues of a non traditional maintenance nature starting next year. We're tracking them this year and seeing how they're progressing and they are growing much faster than our conventional maintenance business.
Okay. And then a last question on return on debt to capital. We're trying to sort of replicate number that you put out in your annual shareholders letter, but we're having a tough time doing it. So if you look at the current ROIC based on your definition,
what has it been in
the last trailing 12 months?
I don't have that at my fingertips. It would have been in the sort of mid-20s kind of range. John, that sound about right?
Yes. Last 4 months been to high 20s.
Great. Thank you. We'll try and be more descriptive of how we calculate that when we do our letter in the spring. Okay, great. Thanks.
Thank you. Our next question is from Blair Abernethy of Stifel Nicolaus. Please go ahead.
Thanks very much. Just want to follow-up on the LNZ acquisition, Mark. I wonder if you could just give us maybe a little more color on what you like about the payment space and sort of what I mean, the payment space is a pretty broad term. What kind of areas or kind of aspects of that are you interested in?
So the broad thesis is that when you do more for your clients, they tend to be happier and hang around longer and pay more. And when you provide software for them to do business to business type transactions invariably or even business to consumer transactions invariably there is a payment stream and it needs to get handled. And if it's integrated that's a good thing. What we observed in one of our high turnover verticals, one of the high attrition verticals is that payments appears to help. It appears to be associated with lower attrition clients when we have both payments and software.
And so we believe this might be a generic observation that if you can do both, that's a good thing. Certainly, there are some big players who have that same thesis as you know. And so we're getting into the payments business. Now payments you can be fully integrated all the way back or you can just be partly in the value channel. And it will vary by vertical exactly how much of a slice of that payment stream we'll be getting.
But it's a very different business than anything else that we do. It's a very low margin, high volume kind of business, although it is recurring.
So would it be fair to say you're looking at this as a to build a platform that can then be cross sold into the tier a lot of your other businesses?
I think that's the objective. We however are not very prescriptive to our other businesses and we like to run them as individual standalone business units with 100 plus of them. And so there is I cannot foresee me ever dictating to our business units that they will use Payment Platform X to do their payments. I can certainly encourage them to explore it and tell them about the benefits of it. But as soon as you start dictating, you own the problem and you don't have general managers who are running their own businesses.
So is it a little bit akin to maybe the 3M model where they have a technology that can be pulled into the different divisions, but they don't force it? Is that what you're thinking
of? I hope so, yes.
Okay, great.
Just on the PTS, a follow-up question. If I kind of look at the last 3 years, you've noted you pulled off around $33,000,000 in cash flow, so around $10,000,000 a year. Is that I know it's lumpy, but is $10,000,000 a year kind of what you foresee for the next few years? Or is there potential for that to go up? It's
a very talented management team. I believe they will build a great business for us. It may or may not involve the same amount of hardware as it has historically. I hope that it's a much, much bigger business for us in terms of cash flows as we go forward. But the core offering that we started with will not constitute the bulk of the future cash flows 5 years, 10 years hence.
Okay.
Yes. That's great. Sorry, no problem. Thank you for that. One last one, just in terms of your dividend level, is there can you just remind us, are you looking at this quarterly?
And or is there a you look at it at the beginning of next year for resetting it for next year? And also any policy or kind of guidance in terms of how you're going to determine the level for 2013?
Right now, I think it's an annual policy review and we're planning to review it during the course of next quarter.
Okay. All right. Thanks very much.
Thank you. Our next question is from Paul Treiber of RBC Capital Markets. Please go ahead.
Hi, good morning. I just wanted to focus on the pace of acquisitions and maybe I'll ask it in another way. So with CSWI, it looks like you're probably on track to exceed $100,000,000 in capital deployed in acquisitions this year, which is a historical high. How would you characterize this year in terms of acquisitions? Would you say it's an ideal year in line with targets?
Or would you call it more of a fantastic year coming off the depressed levels? Or any other way you'd characterize it?
I think I'd rather characterize it in terms of our capacity. So I feel like we're very busy, but not yet frantic on the acquisition front. John, any
I think that's a fair way to portray it. I mean, we obviously increased our effort last year near the end of the strategic review, and part of that is the catch up due to the low capital deployed last year. And also our increased exposure in Europe is creating a kind of a new level of expectations of about of the amount of capital we can deploy.
One of the things I worry about with acquisitions is they tend to be in the instant and exciting. And so they tend to attract management attention and activity, whereas organic growth tends to be a very long pull and is probably the hardest thing that we do in the vertical market software business or in most software businesses. And so I worry that it would be easy to consume our GMs in acquisitions and divert them from an organic growth focus. And I believe organic growth adds tremendous value if done well. I just think it's incredibly hard to do it well.
And so if you'd like to have an effort split amongst your general managers, you'd certainly like to see them still putting considerable effort into the organic growth to try and get it to be more and more efficient.
And just following up on that, in terms of capacity, what are some of the things you've done in the past year to expand your capacity to make acquisitions?
My sense is that we've increased the engagement of senior managers down below the operating group level so that we have folks looking to deploy capital down at the business unit level and viewing it as an important part of what they do. In a number of instances that's become part of their compensation deploying capital or at least part of their objectives. And so the sort of obvious focus on it is there for those managers. But I think it's also become part of the playbook. As we discover how incredibly hard it is to take clients in a lot of our verticals and we see that in our own attrition numbers where we keep clients for many, many years decades.
It's very tempting to pick up market share the other way via acquisition. So the 2 focuses, the 2 foci would be share of wallet through organic and share of market through acquisition. And I think that message is fairly clear to all of our business unit managers as they go about their day to day job. And I think a number of them have been able to do tuck in acquisitions.
Okay. And then moving on to organic growth,
you break out PTS from organic
One other commentary before I leave. I don't want to give you the impression that we haven't stepped out elsewhere in the acquisition process because in Europe we certainly have. John was posted over here for a while. We have hired a number of folks in Germany. We're working hard in Europe to beef up our acquisition activities.
Okay. Thank you. That's helpful. On organic growth, you segment out PTS from organic growth. I was just hoping if you could look at it on a revenue segment basis.
So without getting into specific numbers, would you say that organic growth on the software business, so license and maintenance, is more resilient and perhaps has been positive this year, whereas services and hardware organic growth is much more volatile and perhaps that's been the drag in organic growth over the last couple of quarters?
From 30,000 feet, I'd say you're right. But John, do you have any crisp numbers on that?
I don't have crisp numbers other than I would start with maintenance in terms of that would be the most resilient area of organic growth and then work your way through the other revenue streams you mentioned. But we don't have CRISS data at this stage, Paul, year to date?
You'll be
able to get
some of that when we do our attrition analysis in the spring because we break out the organic growth in maintenance for you.
Okay. Lastly, one question. You're a large holder of Mediware, which has been acquired by or being acquired by Toma Bravo. And there's a $9,000,000 net change in the fair value of available for sale equity securities in your Q3 results. How much of that gain will you recognize on the Q4 income statement?
Yes, I'll take this one, Mark. If the company is sold in Q4, I mean, it's going through a tender process. Our gain that gain that you recognize is only in Q3, we'll have a gain much larger than that based on our cumulative gain since we acquired those shares and that will flow through the P and L.
All right. Thank you very much.
Thank you. We have no further questions registered at this time. I would like to return the meeting back over to Mr. Leonard.
Thank you, Anne. Well, thank you all for attending. I appreciate it. And I look forward to chatting with you again after the Q4 results. Bye bye now.
Thank you. The conference has now ended. Please disconnect your lines at this time and we thank you for your participation.