Good morning, ladies and gentlemen. Welcome to Constellation Software Inc.'s 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 two of us as we field your questions. Anne, if you could tee up the questions, that'd be great.
Thank you. We'll now take questions from the telephone lines. Thank you for your patience. 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?
Yeah, 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. I think our folks are feeling reasonably optimistic, but you never know till you see it in the numbers. 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.
It really is on the public sector side where you're hearing a little bit more optimism. I guess private sector has been pretty healthy throughout the year.
Yeah, 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. 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. 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, thoughts?
You know, Thanos, nothing comes to mind about that uptick quarter-over-quarter. You know, the businesses continue to do well. Usually what happens on margins is it's acquisition related. 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 drive on the, on the margins, that's just pure speculation.
Okay.
I think we did 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. There may have been a wee bit too conservative previously.
Okay, that's helpful. 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, you know, as you know, it relates to shield that we acquire, and, our current speculation is towards the end of next year, you know, 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?
Yeah. Otherwise we mentioned 10 to 15, but then it would creep higher than that, if we don't acquire any more shields kind of in the next year timeframe.
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?
Yeah. Safe to say, you know, if [Constellation] appropriately, they will be slightly higher. In general, though, compared to the U.S., they have lower tax rates in some of those jurisdictions.
The statutory tax rates. Yeah.
Statutory rates. Yeah.
Okay. thanks, guys. We'll pass the line.
Thank you. Our next question is from Scott Penner of TD Securities. Please go ahead.
Thanks. 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, big acquisition expense to normally dip 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. CSWI, the one that we hope to acquire shortly, again, if you look at its recent history, it's actually losing money. 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 deploy capital to acquisitions. Let's just say next year rather than pin you down on a quarter. I mean, this year you're looking like you're gonna 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 deploy capital on acquisitions. I wouldn't want to give you any sense that we have any better view on 2013 than we've had in the past. I can usually look at a quarter and say that, you know, there's a bunch of stuff in the funnel, and certainly for Q4, there is a bunch of stuff in the funnel.
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 CAD 5 million currently. Bernie had some stats in our most recent board package. That's good in that it's less effort, less M&A effort to deploy capital. You know, these larger companies, particularly in Europe, come with pros and cons. Maybe easier to get a large 1 done, but maybe harder to fix.
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? 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&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. There's no reason why Q4 should be a strong cash flow quarter every year. However, they are predicting this Q4, they're hopeful that they will have a stronger cash flow. They'll hopefully be positive year to date, whereas right now they're slightly negative, so they're predicting to be positive cash flow. Again, it's hard to predict, Scott, because you have some big milestone payments that is reliant upon. Your question about working capital, yes. I mean, you know, there's pros and cons.
I mean, they're hopeful that they can 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 Liston of Cantor Fitzgerald. Please go ahead.
All right. Thank you. Good morning. If I can dive into the public sector comments, ex-PTS, I guess, because of variability. You know, that's a little bit contrary to what some and many other vendors are saying. Obviously, it's the nature of your mix. What parts would you highlight? I know you've announced a few deals, but what parts would you highlight as particularly strong? I assume within the mix, some of the assets are looking a little weaker. Can you parse out that a bit for us?
I think it was pretty much across the board, Tom, that people were optimistic.
Yeah, we're hearing, you talk about fiscal cliff in the U.S. Obviously, Europe and some jurisdictions, it's generally down. Is it What's the differentiators, I guess, with you that it's looking a little better if you?
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. I think there's certainly other vendors in the public space who are doing okay.
Okay. Some of the bigger vendors are, they're showing weakness in right now. The more the traditional enterprise software vendors are certainly struggling in this sector.
Okay.
The I think Europe for us in the public sector I didn't hear a whole lot of optimism.
Okay.
there as we went around. again, anecdotal, I don't have any.
U.S. feels fine. Okay.
Yeah, U.S. feels fine.
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. The guys seemed a little more optimistic last quarter.
Okay. Just finally, John, can you update us on capital deployed to date with the last couple acquisitions, including today? I guess CSWI will close this current quarter, correct?
Yeah. I think in our statements, we said we deployed about CAD 4 million as of yesterday. We closed the deal after market last night.
That's right.
And, uh-
Does that include that? Sorry.
No, it would exclude that.
Okay.
CSWI as you can see in our disclosures, we're hopeful that it closes next week.
Oh, next week. Okay. That's CAD 15 million. Okay.
Yeah.
Good. Okay, that's it for me. Thank you.
Thank you. Our next question is from Richard Tse of Cormark Securities. Please go ahead.
Yeah, thanks. Mark, just curious to see, you know, whether you guys are going to reinstate, some targets, for growth. You know, I know that, you know, 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. The pace of that will depend upon obviously availability, but also upon the performance of the existing portfolio of companies. 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 L&Z. We had started to do a payments business organically, a greenfield business, because we felt it was a good ancillary offering for our clients.
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 gonna be a different business than the software business per se. Whenever you're learning, you're probably making some mistakes, so that could slow us down as well. Very, very hard to predict what growth will be for the coming year.
That's fair. Excuse me. If you look at the cloud landscape, you know, what are your existing customers, you know, 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. It varies a lot by client. 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. It'll be a sort of slow adoption. We obviously track it and participate.
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. They are growing much faster than our conventional maintenance business.
A last question on return on invested capital. We're trying to sort of replicate a number that you put out in your annual shareholders letter, but we're having a tough time doing it. 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've been in the sort of mid-twenties kinda range. John, that sound about right?
Yeah. In the last 12 months, mid to high twenties.
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 wanna follow up on the L&Z acquisition, Mark. Wonder if you could just give us maybe a little more color on what you like about the payments space and sort of what, I mean, the payments space is a pretty broad term. You know, what kinda areas or kinda aspects of that are you interested in?
The, the broad thesis is that when you do more for your clients, they tend to be happier and hang around longer and pay you more. 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. 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.
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. 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.
Would it be fair to say you're looking at this as a, to build a platform that can then be cross-sold to your, a lot of your other businesses?
I think that's the, 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.
There's 100+ of them. 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. As soon as you start dictating, you own the problem. You don't have General Managers who are running their own businesses.
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. Yeah.
Okay, great. Just on the PTS, a follow-up question. If I kinda look at the last three years, you've noted you've pulled off around CAD 33 million in cash flows, so around CAD 10 million a year. Is that, I know it's lumpy, but, you know, is CAD 10 million a year kinda 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. The core offering that we started with will not constitute the bulk of the future cash flows, five years, 10 years hence.
Okay. Yep. That's great.
Yeah, sorry.
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, or is there a You look at it at the beginning of next year for resetting it for next year? Also, you know, any policy, or kinda guidance in terms of how you're gonna determine the level for 2013?
Right now, I think it's an annual policy, review. We're planning to review it during the course of next quarter.
Okay. All right. Thanks very much.
Thank you. Once again, please press star one if you have a question. 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. With CSWI, it looks like you're probably on track to exceed CAD 100 million 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. I feel like we're very busy but not yet frantic on the acquisition front. John, any-
I think that's a, 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 a catch-up due to the low capital deployed last year. Also our increased exposure in Europe is creating a kind of a new level of expectations of about, you know, 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. 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. I worry that it would be easy to consume our GMs in acquisitions and divert them from an organic growth focus. I believe organic growth adds tremendous value if done well. I just think it's incredibly hard to do it well.
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.
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. The, the sort of obvious focus on it is there for those managers. 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, through via acquisition.
The two focuses, the two foci would be. Share of wallet through organic and share of market through acquisition. I think that message is fairly clear to all of our business unit managers as they go about their day-to-day job. I think a number of them have been able to do tuck-in acquisitions.
Okay. 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. 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. 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 quarters?
From 30,000 ft, I'd say you're right. John, do we have any crisp numbers on that?
I don't have crisp numbers other than, you know, I would start with maintenance in terms of, you know, that would be the most resilient area of organic growth. Work your way through the other revenue streams you mentioned. We don't have crisp 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. We break out the organic growth and maintenance for you.
Okay. Lastly, one question. You're a large holder of Mediware, which has been acquired by or being acquired by Thoma Bravo. There's a CAD 9 million 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?
Yeah, I'll take this one, Mark. If the company is sold in Q4, I mean, it's going through a tender process. You know, 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. That'll flow through the P&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. Appreciate it. 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.