Good morning, ladies and gentlemen. Welcome to the Constellation Software Inc's Q1 2012 conference call. I would now like to turn the meeting over to Mr. Mark Leonard. Please go ahead, Mr. Leonard.
Thank you, Jesse. Good morning, everyone. Welcome to the call. As you know, our practice is to go directly to questions, so Jesse's gonna start teeing them up now. Jesse?
We do have a question from Thanos Moschopoulos of BMO Capital Markets. Please go ahead.
Hi. Good morning. We saw a slowdown in the public sector's organic growth this quarter, and you had cautioned us that we should be expecting a slowdown relative to last year. Can you provide some color as to what parts of the segment drove that slowdown, be it from a regional perspective or from a vertical perspective?
John, any thoughts?
Thank you. John here. I don't think, Thanos, it's anything in particular, i.e., regional. I'm looking at by division here as well. It's more of a slowdown across all the units. Obviously, PTS didn't grow as quickly as last year. Nonetheless, the growth excluding PTS and public sector was, I think it was about 1% or 2%.
Yeah. Yeah. Nothing jumps to mind, Thanos, as to particular sectors or hotspots.
Pretty much just across the board?
Yeah. I mean, inside of our utilities business, we do have a very rapid growth situation that relates to advanced metering. You know, there are little pockets here and there of things that are going particularly well. For the most part, it's fairly quiet.
Your commentary would remain that, growth overall for that segment is likely to remain a bit challenging in the near term?
Yeah, but, you know, things can turn around fairly quickly. All it takes is a couple of big deals, right? I'm not particularly good at projecting near-term organic growth. It's not something we've ever tried to do. For a long time, we had a 5% organic growth forecast as a long-term objective. Over the last decade, we've done 6%. Going forward, I don't think we'll do 6%, but I think we'll beat GNP. Yeah, I don't really see a whole lot of upside in trying to predict organic growth by the quarter.
Okay, fair enough. On the margin front, we saw some, you know, improvement in the operating margin year-over-year, although down from Q4 levels. Now just looking historically, it seems that Q1 margins tend to be lighter than the rest of the year. Based on that historical trend, is there something sort of seasonal that's going on there? Or when I look at that history, has that just been more coincidence than anything as far as Q1 being a weaker margin quarter?
No. It is the trend. Usually Q1's a little bit depressed compared to the rest of the year. There's a couple of things there. One is, we do have a lot of In certain jurisdictions, we have payroll taxes that we pay in Q1 that we max out and don't have those taxes going forward. Just our businesses is it's a heavy trade show season, a heavy marketing season for them, so you incur a lot of travel and marketing-related expenses in Q1.
Notwithstanding, I guess, your commentary that hiring might accelerate this year and M&A is likely to pick up this year, both of which could weigh on margins, would it be possible though that just given the seasonality, we might see some improvement in margins through the year from these levels?
I think if you follow the seasonal pattern, you could argue that, for sure.
Okay. Just finally, on the tax front, are we still looking at sort of a 10%-15% tax rate as far as your guidance?
Yeah, that would be our guidance for this year and for next year as well.
Okay. Thanks. I'll pass the line.
Thank you. The next question is from Scott Penner of TD Securities. Please go ahead.
Thank you. Good morning. Just wanted to ask, I guess, first of all on the deployment of acquisition capital. The CAD 20 million that you've spent, I guess, to date versus the CAD 31 million in the first couple quarters of last year. Just if you could speak in general, I guess, to your pipeline of acquisitions, one of the, one of the stories I guess, investors are looking for is an increase in that, in that deployment of capital. How do you feel about that this year when you're looking at your pipeline?
I think you've heard us say before that our ability to predict acquisitions is very, very poor. We do track all of the stages of the funnel, so to speak, as we pursue acquisition prospects, but it isn't a very good predictor other than the very late stages of the funnel. If you actually look at the letters of intent that we've signed over the last quarter, it's been really good compared to the prior five quarters, and hence, our bullishness about short-term prospects. You may have noticed overnight that we announced another one.
Right.
I guess, you know, somewhat optimistic about the short term. Long term, very hard to predict.
Can you just update me, Mark, on the timeline of the Computer Software Innovations, what the status is there?
We, we're not commenting on that particular process, Scott.
Okay. They, they still have a poison pill in place at this time, right?
I believe so.
Next, I just wanted to ask about the change in a little bit of the % of the deals that are being done in the private versus the public sector, whether that's a function of the number of propositions you're getting from the operating groups or any changes that you're making in hurdle rates at head office. Just how are you thinking about those two divisions against each other?
Well, let's take the first part of that question. I've got Dexter Salna in the office with me, and so I might as well pick on him. Dexter runs Home Builders, which is a misnomer now because they're in several different sectors for us. Dexter, what are you seeing in terms of deal flow?
You know, what I see in deal flow is it's pretty consistent, although this year it's a lot better than last year, I would feel. We have a lot more deals on the go, but, you know, that might be because we've deployed, you know, more resources to, you know, to keep those going. I'm optimistic for this year that we should be able to get a few deals in, a lot more than we did last year.
I don't see a whole lot of difference between the private and public sector in terms of sort of deal activity, Scott.
Okay. Just a one question on the accounting for the PTS. Just on these, the contracts that are currently getting the balance sheet treatment, what is the remaining life in that on those contracts?
Scott, it's John here. I mean, we were expecting to be through most of them by the end of this year, but I don't think that's gonna be the case. They're gonna probably go into next year as well. Every quarter we look at it does seem to stretch out another quarter. It's difficult to say, but we're currently anticipating to be through most of them by sometime next year.
Just lastly, John, the working capital, what seems to be a pretty huge swing, half 1 to half 2, specific to the PTS business last year, do you, I guess a part of that is the function of the bonus accruals, but is that likely to happen again this year?
It's almost impossible to predict, Scott. If you back out the bonus, what drives their working capital is big milestone payments primarily. You know, they invest in inventory and accounts receivable, and then they wait for the big payments, and that could happen at any time of the year.
Okay. Appreciate it. Thanks, guys.
Thank you. The next question is from Tom Liston of Versant Partners. Please go ahead.
Hi. Thank you. Good morning. Thanks for the president's letter, Mark. I think it'll help with some potentially aggressive forecasts out there. Relating to that, can you tell us where you're on at two fronts? Obviously, in the letter you talked about, and it made sense that managers during the process, the strategic review process, would maybe hold back on some investments that had, you know, longer term payback, which is typical. Can you comment on where the activity is now? Is it kind of fully back to normal type investment? Is it a slight overinvestment? Is there any catch-up to do? The same thing with acquisitions.
How many would have, kind of totally gone away, if you can roughly measure that, versus how many are, you know, were part of their own real process and are still out there that you can execute on?
I think we look at initiatives as a pool of ideas that you can pursue. That pool tends to be reasonably deep, and the issue is really one of people and financial resources that you wanna deploy chasing them. I think we're seeing general managers spending more time thinking about and talking about initiatives than they certainly were a year ago. How it is versus two years ago or three years ago, really hard to say. The economic environment has an impact upon that as well. You know, we're not in the middle of a recession right now. That tends to make people a little more bullish. I'd say we're investing more heavily than we have on average for a few years, and certainly better than last year.
I don't get the sense that it's, you know, the primary focus of the guys. I think they're still very focused on acquisitions as well. On the acquisition front, literally, we chase thousands of companies. We try and build relationships with them, get to know them, and over the years, the opportunities arise as major events in the lives of those companies and those founders and those businesses happen. It's hard to precipitate those events. It really is something to which we respond rather than create. I'm sure we missed some during the course of the year, there'll be lots of others to come.
Well, would you generally characterize, because, well, you kinda hinted at it anyway, the nature of what you're going after is maybe less typical of a full sale process where they open it up and more of, you know, just timing of when, say, a founder may just, you know? How do you have a sense on how many would've went away as part of a process versus, you know, are still fairly active even though you slowed down the second half of the year?
I think Bernie was going through our funnel looking at where our acquisitions came from over the course of the last, I don't know, 18 months or so. I think it was about a sixth of our acquisitions were broker-led processes.
Okay. That's helpful.
Okay. Finally, is there, can you make any other commentary on the vision of the Lender Processing Services that you've acquired today? 140 employees looks like it's probably a sizable organization. Could you comment just kind of roughly on the size and margin profile there?
The information you've got is sort of the information that we're sharing at this stage. We love the business. Think it's a really good fit with our existing businesses in the space and have a terrific install base, new products. Very excited about it.
Okay. I assume it has closed, it looks like.
Yeah, yeah.
Okay.
Closed today.
Great, guys. Thanks. I'll pass the line.
Thank you. The next question is from Richard Tse of Cormark Securities. Please go ahead.
Yeah, thank you. Mark, yeah, very interesting shareholders letter here. I sort of, I was interested in kind of reading the part about keeping employees and that being a fairly big risk. You know, the fact that you call that out, is that something that you're seeing as an issue here? Just curious about that.
You know, I don't think the risk has changed, Richard. We have had very low turnover in those employees, and the trick is to create an environment in which they can prosper and do well and feel good about what they're doing and to not wreck that. I certainly felt that the process didn't help. At the same time, these guys have personal capital to deploy, which they generated in the course of being Constellation managers. Much of it tends to be invested in Constellation shares, and we don't wanna give them the incentive to sell those shares either. If they perceive that there's a great opportunity in holding the shares and that they can avoid paying capital gains tax by continuing to hold them, well, that's a good thing.
If they perceive that the stock is highly overvalued, then that's a bad thing. We have to walk a line somewhere between a stock price that doesn't attract another process and a stock price that is overpriced. I don't think that's particularly difficult to do. It's just something that we've got to actively manage. I wanted to call it out because, obviously, the process happened and the stock price has appreciated a lot since then. I didn't do a great job of maintaining the stock price, a level which was sufficient to avoid a process. I think the opposite is also something you have to avoid.
Okay. I guess in a related question, you know, you're certainly a lot bigger company now. So if you look at the company today versus, you know, what it was three or four years ago, you know, can you give us a sense of what the nuances today would be in terms of running a bigger business? I guess more specifically, how that would translate into some of your financial metrics.
Because we're a collection of very small businesses, we're much more like a portfolio, and I don't think the financial metrics are gonna drift a lot unless we let creeping overhead sort of pop into the middle. So with that caveat, I don't think it drives a lot of the metrics. There are, however, questions of organizational design. How do you run a business like this? How do you configure it? How do you pay people? How do you incent them? How do you continue to build the business deploying capital? Those are fascinating discussions 'cause we can't find many businesses that are structured like ourselves. There's a company called ITW that has, I believe, 800 operating groups inside the business. We right now are running about 98 P&Ls.
You know, that's up significantly year over year, and I think it's gonna continue to go up. How do you run those tiny little businesses? You know, with revenues of $ 800 odd million, obviously, those are not big businesses. They're little businesses. You do need to have some wisdom somewhere in the ranks that can help the guys running relatively small businesses do it better. At the same time, you don't wanna overburden it with overhead. Really fun questions to think about and work on, we're feeling our way forward. We don't have all the answers.
Right. Okay. John, I don't know if this is a question for you. I was going through the MD&A, and I noticed there's a shift in terms of professional service costs to R&D. Can you give us a little bit of rationale why that shift was made? My guess is that, and I could be wrong here, that the professional services is the sort of revenue-generating cost item, no?
Yeah, I mean, you hit it on the head. It is a revenue-generating item. There is some fluidity amongst professional services and R&D staff and maintenance as well. A coder could be producing custom code for a customer which is chargeable, and that's professional services revenue. One quarter, they're in professional services. The next quarter, they could go back into R&D. What we saw in Q1 was a couple of things. One is we did have some reductions in PS in some of our business units. Principally, that drop was people moving from PS over into R&D and working on some R&D projects. It wasn't really a reduction in overall cost. It was more of a shift from PS to R&D.
Okay, great. Thank you.
Thank you. Once again, if you do have a question, you may press star one on your telephone keypad. The next question is from Stephanie Price of CIBC. Please go ahead.
Morning.
Morning.
In your President's letter, you talked about the attrition rate in 2011, and it looks lower than previous years. Can you talk about what factors affected that and whether it's sustainable going forward?
You know, Stephanie, this is the addition of the 98 business units attrition numbers sort of added up, and we can drill down and talk about any one of those individually. When you look at the summary numbers, very hard to sort of come up with any easy answers. We have some divisions that are structurally high turnover. Our fitness division is a business where you have clients coming into and out of business all the time, and you run that in a very different way. You expect attrition that is trouble what we have in our other businesses, but you also expect customer acquisition costs to be a fraction of what we normally spend in our other businesses. Really, you've got to go at it case by case. There's no 80/20 answer, I'm afraid.
Obviously, economy's better, less people going bankrupt, more home builders surviving from last year to this year than the prior couple of years, that sort of thing.
Always good. In terms of the private sector, it looks like organic growth was down a bit, this quarter versus some prior quarters. Could you talk about what you're seeing there? Is that just seasonality or what are you seeing in that business?
I think that's the government spending money. You know, they're not spending as much as they did during the course of the recession. I think there's a little bit of pullback, sort of across the board. That would be the most obvious thing, I think.
Oh, okay. Sorry, I was asking the private sector.
Oh, sorry. Hmm. I hadn't noticed any trend in that particular area. The numbers may be down slightly, but my sense is that things are going pretty well.
Okay, great. Thank you.
Thank you. The next question is from Paul Treiber with RBC Capital Markets. Please go ahead.
Hi, Mark and John. I just wanted to focus on your comment on margins moderating this year versus last year in your letter. Do you think there's been a fundamental change in your business going forward? Like, for example, are you seeing a change in the economics of the acquisitions that you make, or in your existing business? Do you just believe that 2011 was a very good year for margins based on a lower pace of acquisitions in the strategic review?
I think 2011 was a particularly good year for margins, partly driven by the strategic review. I think that there is something to your original question, which is that we're not maintaining the hurdle rate as strictly as we used to when we look at acquisitions. We're now trying to vary it a little bit by quality. If our guys come to us with something that is below the hurdle rate that we would apply generally, but for a very specific situation that we think is a particularly attractive business, we might make concessions that we wouldn't have made previously.
On that, in regards to the organic initiatives and the higher pace of them, have you lowered the hurdle rate for organic initiatives as well?
Although when we originally tracked the initiatives, we used to actively use a hurdle rate, we don't review the initiatives at head office anymore. It's done out of the branches. My gut feel is that people use still very high hurdle rates for initiatives because they are incredibly risky compared to acquisitions. We use a multi-scenario probability weighted approach to it, but, you know, you still tend to build something in.
Okay. Then on managing investor expectations, have you thought about providing a guidance around your long-term model, or margins, and other metrics to sort of give investors a range as to what would be a good year and what would be a softer year?
I think the maintenance revenues is a great number to look at if you're looking for something that's a metric for what's happening with fundamental value over the long haul. Obviously the cash flows are also very, very important, although somewhat seasonal. Adjusted net income is a number that I like to look at barring acquisition accounting, which always sort of can throw that out. You fall back to the cash flow and the sort of what's happening with maintenance approach to life.
One last question. Last year, you gave guidance and implied EBITDA margins in the range of 20%-23%. Did that include the possible uplift that you may have saw from the lower pace of acquisitions that you experienced in 2011? Then if it didn't, is that how we should think about margins? Should we think about margins in that range going forward?
We don't forecast margins. Last year, we took our internal forecast. We applied a factor that John and I applied based on experience to the internal forecast. Then we came out with the guidance that we did. We did it because there was a process running, and we wanted our existing shareholders to have the best possible information about the intrinsic value of the business if they had to consider a bid. We knew that all the bidders would have almost perfect information 'cause they'd be inside the tent. It just seemed unfair that our existing shareholders who had been supportive for so long didn't have that information. That's why we did guidance, and that's the method that we used.
Okay, thanks. Thanks for the responses.
Thank you. The next question is from Niklofed Tarami with NBF. Please go ahead.
Great. Thanks, guys. I was just wondering if you could comment on your staffing costs and if there were sort of any one-time catch-ups in terms of hiring in Q1, given the sort of slower pace in 2011. How should we think about hiring for the rest of the year?
Once again, we don't have a top-down approach to that. Each business unit will have its own, you know, expectations and about what they need to do on the hiring front. Some of the divisions are hiring aggressively, others are contracting. I don't have a view, I'm afraid.
Okay. Then, looking ahead longer term, is that 5% organic growth forecast, still sort of in the range, or has that changed given your comments this morning?
Historically, we had a 5% organic growth forecast for many years. I think that's non-trivial to achieve. I think we will beat GNP, you know, it's just very hard to pick a number.
You know, history is a guide for sure and, then you can look to what's happening with the major software companies, and I think that probably gives you some indication as well.
Okay.
I think we do a good job. I don't think we concede share. I think we gain share in most of the markets that we're in. I think our maintenance gives you a sense that we tend to grow our businesses, not shrink them. I feel pretty good about organic growth in the long haul, but I don't see it being 10% again.
Okay. The public sector organic growth in Q1, was that sort of within the range that you were expecting going into the quarter, or was that a surprise to you or any sort of deviations there from what you were expecting?
Remember, John?
It was pretty much what we were expecting.
Yeah. I thought it was pretty close. Which isn't to say that we can look out three or four quarters and tell you exactly what it is, but this particular quarter, it came very close.
Okay. I'll pass the line. Thanks.
Thank you. There are no further questions registered at this time. I would now like to turn the meeting back over to Mr. Leonard.
Okay. Thank you, Jesse. Thanks everyone for attending. Appreciate it. As you know, we have our annual general meeting coming up at 11:00 A.M. If any of you can join us there, we'd really appreciate it and look forward to introducing you to our directors and our managers, many of whom will be in attendance. I hope you'll be able to turn out. Thanks very much now.
Thank you. The conference has ended. Please disconnect your lines at this time, and we thank you for your participation.