Please stand by. Your meeting is about to begin. Good morning, ladies and gentlemen. Welcome to the Constellation Software Inc.'s fourth quarter conference call. I would like to turn the meeting over to Mr. Mark Leonard. Please go ahead, Mr. Leonard.
Thank you, Donna. Welcome, everyone. As most of you know, we go directly to questions during these conference calls, Donna's going to provide you with instructions for how to queue up. Donna, please go ahead.
Thank you. If you have a question and you're using a speakerphone, please lift the handset before making your selection. To ask a question, please press star one on your telephone keypad. To cancel the question, please press the pound sign. Please press star one at this time if you have a question. There will be a brief pause while participants register. Thank you for your patience. The first question is from Tom Liston from Canaccord Genuity. Please go ahead.
Hi. Thank you. Good morning, Mark and John. Just on the organic growth in the quarter, probably above trend, is there anything you can specifically highlight that was strong in the quarter?
Nothing really jumped out at me, Tom. It was positive in all the
Yeah. It's very diversified, if that's a fair statement, or was there any one jurisdiction or vertical that seemed to be stronger than those?
No, it seemed to be across the board in the subs. We had pretty good backlogs throughout the North American operations. Europe was a little less optimistic about the outlook, but for the Q itself, for the quarter itself, I think it was pretty good.
Okay. Any comments or year-end budget type flushes? Not that there's a material amount in your business per se, but nothing, no themes there?
Yeah, I always wonder about that myself and try and keep my eyes open for it. That when people take revenue but don't get cash, it usually turns up in extended receivables or WIP. We're pretty vigilant about that kind of thing, and nothing outstandingly obvious.
Okay. Very good. Just on the guidance for next quarter, can you give us a little bit of high-level color around, obviously, hardware and such can affect the margins. Can you give us a little bit of color around what's in that guidance? Maybe there's some seasonality around expenses as well.
We build up our numbers from the ground up, and when we looked at them, they were considerably different than what the analysts had in their models. We figured we should remark upon it. Two things appear to be driving it from our perspective. One is new acquisitions, which have come in with lower margins than our overall average for existing businesses. Secondly, European margins aren't as strong. My sense is the European economy isn't as buoyant as the North American one. In fact, in North America, we're doing some hiring to deal with the backlog and initiatives, so we're fairly bullish.
Okay, how much of the new acquisitions is more transition-type margin, then some of that will improve over time versus, for whatever reason, that vertical or what have you may have lower margins in it?
Yeah. I was having lunch with Stephen Sadler from Enghouse a week or so ago. We were talking about Europe. They've just done an acquisition over there. There seems to be an accepted wisdom that margins in Europe are lower.
When I look at it, I do tend to see higher revenues per person in much of Europe, although that's not always the same in the U.K. Obviously, social costs are higher in many of the countries. I don't really see a reason for margins to be lower over the long haul in those countries. Like, the barriers to entry, if anything, are higher. The markets are more prescribed and smaller. What we've experienced ourselves is that margins have been lower in Europe, in our longest tenure European subsidiaries. I don't know if it's fundamental or just tradition.
Okay. A question I get a lot on your pipeline, I don't know if you can categorize this well, I assume there's a nice ranking of most attractive opportunities and certainly must be a matrix around availability. Obviously, that relates to price. You've done a lot of acquisitions over the last quarter and last year. Are we getting into the kind of A minus, B plus type opportunities, or is it more just about availability and timing?
As a rule, we've generally had more resources than opportunities. I think that's still the case.
Okay. Finally, John, I think you are, I think it is CAD 44-ish million in debt. The facility is about CAD 300 million, is that correct? Is that still the number?
Yeah, CAD 300 million for four years starting last year.
Okay. Very good. Thanks. I will pass the line.
Thank you. The next question is from Thanos Moschopoulos from BMO Capital Markets. Please go ahead.
Hi. Good morning. Just some follow-up questions on the European acquisitions. In your press release, you mentioned that some of the European acquisitions aren't initially profitable. How should we think about the timeframe it might take and the work involved to get those back to profitability?
We don't have that much experience in Europe, plus a number of the acquisitions are in sectors that right now are not in great shape in Europe. For instance, we bought our largest business in the marine sector. We picked up one recently in the flat glass processing sector. We have, as you know, a bunch in the public sector in Europe, and that also has been under a lot of pressure. A lot of the sectors that we're in are not doing great, and the timing in the sector will certainly have an impact on how quickly they improve. Obviously, if we're losing money, we're not happy, and we're going to do what we can on the expense side, but you can't always move quickly in Europe.
Okay. From a working capital perspective, is there anything we should be aware about? Should we expect to see DSOs creep up by virtue of these European acquisitions?
Again, I don't think there's anything fundamental that would make that the case.
Okay. Can you quantify the proportion of revenue coming from Europe at this point? I know that it was 19% for 2012, but I'm assuming, on a run rate basis, are you more sort of in the 25%-30% range, or?
I don't think it's that high, we have people beavering through wads of paper here to see if we've got a crisper answer.
Okay. Also, historically, we've seen some seasonality whereby your Q1 margins just tend to be weaker than subsequent quarters. As we look at the margin guidance you provided, is that sort of an additional factor in there, or would that impact be pretty modest relative to the other factors you highlighted?
No, the seasonal variation occurs because of how we pay our bonuses. It tends to drive payroll deductions to the maximums, often in the first quarter, and so subsequent payroll deductions to which we contribute are not as significant in the later quarters. You'll always get a sort of seasonal blip in margins in Q1, downward blip.
Okay. All right. I'll pass the line. Thank you.
Thank you. The next question is from Nikhil Thadani from National Bank Financial. Please go ahead.
Great. Thanks. Just to follow up on the margin guidance here. Could you maybe highlight what your thinking is for some of the drivers that could move margin from 14% to 18% in Q1? Is it mostly just a function of Europe, or is it a function of the bodies being hired? How should we think about the breakdown for that range?
All of those things are going to affect it. We always forecast hiring. It always takes us longer than we'd hope to actually bring people on board and get them trained and deployed. That could be a factor. The revenue recognition on hardware transactions tends to be a ship-and-recognize kind of revenue rec, and so that can drive top line and to some extent, bottom line. On the licenses and services side, we tend to do % complete for the vast majority of those, and so it tends to be less volatile and a little more predictable. Obviously for maintenance, it's pretty predictable.
Okay, just switching gears to the revenue side a little bit. It looks like professional services was pretty strong in Q4. Should we read into that as a good positive leading indicator for organic growth in Q1 and maybe the rest of 2013?
I didn't read that into it.
Okay. Then just a quick question for John here. In terms of the tax rate, is 15% sort of a good rate that we can use going forward?
It's averaged that in 2012, I think we've given that indication in the past that that's the range we're using. It's difficult to predict because our losses are in various jurisdictions.
Yep.
For 2013, we're reasonably comfortable with the same range we've given in the past.
Okay. Just one final one before I pass the line here. The customer dispute sort of thing that you [audio distortion] in December. I'm just wondering how that CAD 10 million, if you were to collect that, would that flow through the income statement, or how would that sort of look in the financials?
I guess I don't care as long as we get the cash.
Okay, great. Thanks.
Thank you. The next question is from Scott Penner from TD Securities. Please go ahead.
Thanks. Good morning. Doug Taylor on for Scott Penner. Another follow-up on the European acquisitions. Are these acquisitions being made with the same ROI hurdles as your other deals, or are they somewhat lower?
We're using the same ROI hurdles and a slightly more jaundiced eye when we look to the future.
Fair enough. John, a question for you. Are there any charges related to these deals in your adjusted EBITDA guidance for Q1?
No. We expensed our transaction costs for all the deals. Q4 was a very active quarter, you would've seen all the expenses flow through in Q4. In Q1 year-to-date, we've only done one significant European acquisition.
Okay. You stated your intention to increase investments in North America, address backlog, and staff new growth initiatives. Can you provide a little more color onto what those growth initiatives are? When you expect to see that contributing to organic growth?
They tend to be manyfold, very hard to sort of say it's this initiative, it's that initiative. We've obviously got some larger ones and some smaller ones. When we embark on initiatives, we've discovered that if you have dedicated staff, they tend to work way better than if you're trying to timeshare a bunch of people. The old homily about taking 20% of your time and building brilliant new initiatives does not, in our experience, work. Many of our operating groups and business units have carved out small teams to work on things that they think have potential. I've been seeing more and more of that over the course of the last couple of years. That's starting to gather some momentum and experience some success.
In addition to that, as backlog builds, we tend to hire PS-related people. They take a little while to come up to speed. They tend not to be as productive in the short term, a year or two in, they tend to sort of start generating decent margins on the incremental investment.
Okay. You've had a very active couple quarters or even a year for acquisitions. What about the current environment has made it attractive to get deals done, and do you expect these conditions to prevail in the near term?
I think we're optimistic that there will be opportunities for us in Europe. We're deploying resources there to find them. We believe that as long as the economy there is less buoyant, there's more likely to be more opportunities. So I'm kind of keen on spending time and money in that space. In North America, we haven't seen as good a pipeline of opportunities. We've also been able to do some deals or investments where we've bought from corporations. Those are always attractive to us because they tend to be a little bigger and may not be viewed as core assets for the corporations that are selling. Whereas entrepreneurs, when we buy from them, it's often their single biggest asset, and they are more likely to time their exits to when the economy is doing better.
Right now, I'd love to see some more small entrepreneur real businesses in the acquisition pipeline, but we're not seeing a whole lot of them.
Okay, thanks. Last one from me. How often does the board review the dividend payout? Quarterly, annually, and when would the next review be?
We did this quarterly dividend for this quarter, and we will do the same thing next quarter.
Okay, thanks. I'll pass the line.
Thank you. The next question is from Paul Steep from Scotia Capital. Please go ahead.
Thanks. Mark, maybe you could talk about the key product initiatives, particularly Trapeze and Harris, in terms of if there's any major product redevelopments or launches planned on those two businesses in the year.
Paul, we don't do a lot of major stuff. Occasionally, we do rewrites. Trapeze has been pretty good about consistently updating their technology and their platforms over the years without sort of any big blips up and down. At Harris, they have done rewrites on a number of their platforms over the years. I can't think of any sort of CAD 10 million initiative to do a rewrite on a major platform. It tends to be more piecemeal. We rewrite one module, we rewrite the next, we gradually move them in, that sort of thing. The same thing applies to the add-on product. They tend not to be anywhere near as large in terms of potential as the core products, and hence the size of the initiatives isn't as great, and the risk of failure isn't as great, and you sort of edge your way into it.
Pretty much what I would have guessed, but it's fair to say that R&D spend this year, the plans that you guys have submitted, looks largely more aimed towards the core maintenance and then some add-ons, and those selective add-ons are likely in the larger groups?
No, I don't think so. For instance, we have major add-ons in a number of the groups. Yeah. It isn't a top-down driven R&D approach. It's very much bottoms up. If the clients want it, that always gets the highest priority because if people are willing to write checks, it's the best indication there's a market.
Fair enough. On the hardware side of things, John, is it fair to think that with the agreement you concluded in February, that once we get through sort of a partial quarter here, that hardware expense should tick down fairly materially post Q1? Is there something else that we're missing here in terms of some of the European deals?
There's nothing you're missing. There is a significant hardware component which we've had for a couple of years, which relates to our PTS business in Switzerland. That obviously will not go away. The incremental hardware expense in Q4, which we broke out for you in the MD&A, that will go away.
Okay. That's what we thought. The last one on my side would be, with the M&A moving to Europe, Mark, is there any more infrastructure investment you need to sort of make in Europe to deal with localization infrastructure there? I know you're going to run the businesses separately, but any shift or thought to basing more in Europe?
No, we try. As you know, it's a very small head office. I think we're 13 or 14 people. We're not about to establish a European venue in Brussels or anything. Particularly not Brussels. I don't see a whole lot of buildup. There'll be a few guys who work virtually out of one of our offices or another doing M&A.
Got it. Nothing, all the tax stuff, everything else, no major incremental lift on that.
We have been adding tax personnel largely here, but some of our operating groups are adding them as well.
The last one on the legal dispute, the only thing you left off that was just any wild guess on timing in terms of when that eventually resolves. Is it sort of hopefully clear its way through in FY 2013?
The judicial system is a constant learning opportunity for me. I cannot predict how it will play out.
Fair enough. Thanks, guys.
Thank you. The next question is from Paul Treiber from RBC Capital Markets. Please go ahead.
Thanks very much. It's an interesting comment that you're looking to continue to acquire in Europe, and that the ROI hurdle is in line with your historical metrics. Is there anything that you're seeing at these recent European acquisitions that you didn't foresee when you made the acquisitions?
Not yet, but give me time.
Okay. Related to that, like PTS, I think in the first quarter did negative 7% margins, and then you ramped that business up to double-digit margins in a couple of quarters. Could you outline how you were able to improve the margins on PTS so quickly? What factors may or may not apply to some of the recent European acquisitions?
On PC-Soft, acquisition accounting is a very nasty thing. It tends to smooth out margins and give you good margins right off the bat. One of the reasons why we always gave you cash flow accounting as well as financial accounting, GAAP-based financial accounting at the time we did PTS, was because you just can't look at GAAP/IFRS accounting on acquisitions. That aside, obviously the cash flows from the acquisition have been good. Part of the thesis was that we could get some working capital out of the business, but it didn't need to be quite as capital-intensive as when we bought it.
Part of the thesis was that the recurring revenues were a very attractive portion of that business, and it had been very focused on new name sales, and that it and a number of its competitors had been pricing new name sales for perfection, which many of them had not experienced, and that pricing would improve in that particular market. Obviously, the local management have done a spectacular job with the business. It wasn't like we loaded up a crack team of folks from North America and flew them over. It was a made-in-Switzerland solution, and the guys did a great job with the business.
At a very high level, do you have any metrics that you could share, maybe just anecdotally, on historical performance on your ability or the acquired company's ability to improve the margins post-acquisition? Is it something like you're able to improve them, I don't know, 10 basis points or anything along those lines that you could provide?
It's all over the map. Some of the businesses we buy are so awesome that all we hope is that we don't screw it up. Those are often really tight businesses run by entrepreneurs who've been doing it for years. Some of the others are orphans inside of large corporations that aren't much loved and have performed poorly for years. It varies all over the map.
Okay. One more question from me. In regards to Q1 revenue guidance, the sequential decline, is there any CSI tech revenue for the full quarter in that guidance?
The only portion in Q1 is up until the day we sold it, Paul. I think it's about a month worth of revenue in Q1.
Okay, thanks very much.
In terms of sequential drops, Q1 margins nearly always lower than Q4 margins in our business historically.
Thank you. Once again, please press star one at this time if you have a question. The next question is from Richard Tse from Cormark. Please go ahead.
Yeah, thank you. Mark, can you maybe give us a bit of color on your target growth rates maybe for one, two, three years out? We're trying to get a better handle on modeling the business on a longer-term basis, it'd be kind of helpful to have some sort of order of magnitude on that side.
If I had a hope and an aspiration for the company around organic growth, it would be 5% plus. That's hard to do. It certainly adds tremendously to both intrinsic value and the quality of the business if you achieve it. Generally means you're taking market share in the kind of markets in which we compete, that's a very healthy sign. In addition to that, the acquired growth is really a function of the opportunities that are out there. If we were awash in opportunities, we'd grow very quickly. If we weren't, we'd grow much less quickly and deploy the capital by returning it to shareholders.
There is no real targeted growth rate that's internal?
No. I hate the idea of having arbitrarily targeted a particular growth rate because it tends to influence behavior and takes away from the discipline around return on capital employed.
Okay, fair enough. If you look at your base of acquisitions you made over the past number of years, my guess is that a bulk of it is actually in the small medium enterprise market. You look at some of the common themes that have been around for the past few years, and you and I have talked about this before, is that cloud SaaS offerings are certainly getting more presence. What are your clients saying about that? Are you guys doing anything to position your products into that market, or are you just going to kind of go with what you have right now?
No, we're definitely investing in it. It's getting a lot of buzz, we're having to respond to the fact that clients are asking for it. Sometimes when we do those rewrites and offer the solutions in a cloud form, we find that it's something that clients like the idea of being available but aren't immediately willing to adopt and change from their legacy systems. I think you've got to be very careful about putting the cart before the horse, spending way too much money on SaaS rewrites that unfortunately don't end up paying back for long periods of time. I suspect that many of the cloud-centric plays that are out there are going to fall into that category.
Okay. One final question in regards to more at your operating level. Has there been any turnover or is the retention pretty good here still? I just want to get a bit of perspective on that.
Yeah, the senior-level retention is extremely good.
Okay, great. Thank you.
Welcome.
Thank you. The next question is from Blair Abernethy from Stifel. Please go ahead.
Thanks very much. Mark, I just wonder if you could comment a bit on the public sector market. I apologize if you went over this early in the call. I missed the first couple of minutes. I guess what I'm looking at is sort of what is the potential impact in the U.S. on any sequestration at the federal level and also just what's sort of the market looking like to you guys on a state-level budgets in the U.S.?
We do extremely little with state-level government or even for that matter, federal government directly. We largely work with municipalities. There are also housing authorities with whom we work, and they do get a chunk of their funding from the feds, just as the municipal transit authorities get a chunk of their funding from the feds. I don't doubt there'll be some trickle-down effect. We haven't yet seen it.
Okay, great. In terms of the PTS business, how's the pipeline looking in that business today versus sort of a year ago? Is it expanding? Obviously, you won a contract in Germany recently. Are you seeing more strength in Europe than you are in the U.S. in that business?
Can't really talk to the growth pipeline. I just don't follow what the contracts that are under bid are for that particular sector.
Okay, great. Thanks very much.
Thank you. Mr. Leonard, there are no further questions registered at this time.
Okay, Donna. Thank you very much. Thank you everyone for attending the call. Look forward to seeing you at the AGM, if you can make it out. It's, at least for me, always a great opportunity to talk to shareholders individually and to have you meet a bunch of the management team from Constellation. Bye-bye now. Thank you.
Thank you, Mr. Leonard. The conference has now ended. Please disconnect.