Good morning, ladies and gentlemen. Welcome to the Constellation Software Inc. Annual and Q2 results conference call. I would now like to turn the meeting over to Mr. Marc Leonard.
Please go ahead, Mr. Leonard.
Thank you, Valerie. Good morning, everyone. Welcome to the Q2 call. As you know, we go directly to questions in these conference calls. And so Valerie is now going to tee up the callers.
Go ahead, Valerie.
Thank you, sir. Our first question is from Scott Penner from TD Newcross. Please go ahead.
Thanks and good morning. Just on the PTS business, Mark, just if you could, I guess, kind of review for me why the revenue line is still running so far above what was called out to be the core recurring element? I mean presumably there's still not a lot of new business being bid?
There was a very large backlog when we took over the business, a couple of major contracts and we continue to chew through those. There has been some new business. So it's above and beyond the core recurring, there'll always be some business competing every day for new contracts. There are lots of them out there. We actually think that the American market could see a bit of a renaissance in this sector and that there could be quite a bit of business to bid on over the course of the next couple of years.
Okay.
And just in looking at that large the large backlog that you talked about, is the revenue that we're seeing quarterly right now, is that a good indication of where it's likely to sustain over the next little while? Or is that backlog something that as it burns off will substantially change the numbers?
I think we're thinking that the business will probably continue to contract over the course of the next year or so, but it's very dependent upon the business that we win.
Okay. And just on the Harris business segment, can you just, I guess, remind us of the exposure of Canadian International versus the U. S? And then given the concerns, I guess, over public sector spending that are out there, what to what extent is the growth that we're seeing in that business market share versus overall market?
So, Harris has very little international business. The vast preponderance of their business is Canadian and U. S. They're one of our groups with the largest Canadian exposure, very, very strong Canadian revenues and obviously quite a few Canadian expenses. A lot of their utility and municipal and school sales are in the U.
S. In those sectors, they're highly fragmented, and we would hope to be able to continue to take share over the course of many years to come. There are literally 100, maybe even 1000 of different vendors who compete in a multitude of sectors in which Harris competes.
And do you think the overall market as far as spending in your categories remains relatively healthy?
I think the utilities tend to be relatively robust, the municipalities less so and the schools less so.
Okay. That's helpful. And then just looking at the, I guess, the conversations about the purchase price on PTS, I just want to understand whether the result of this could actually be hard cash that you get back or just a tweaking of the allocations?
That's not a topic that we want to talk about a lot at this stage in the process, Scott. I think it will probably become clear over the course of the next quarter or so.
Okay. Thanks. I'll turn it over.
Thank you. Our next question is from Mike Abramsky from RBC Capital Markets. Please go ahead.
Yes, thanks. Good morning. You slightly adjusted your 5 year outlook
so that most of the growth is going
to come from acquisitions. Have you seen could you give us a little color on your pipeline relative to prior quarters and current situations both near term and in the outlook for the year? And is there any metrics you can give us about your acquisition pipeline that can help us kind of understand what you're seeing? And also any increased competition that you discussed private equity firms out there last quarter? And has that changed or is
it the same? Thanks. Okay. The adjustment was meant to be an adjustment to our regional 5 year outlook, which we came out with at the time of the IPO, and that was for the period January 1, 2006 through December 31, 20 10. And as you know, we've far exceeded our original forecast or outlook or goals, I think we called them at the time of the IPO.
But a lot more of it ended up coming from acquisition than organic. And we just wanted to adjust that so that it reflected the reality of the recent downturn as opposed to what we've said now 4 years ago. So that was the adjustment, Mike. It wasn't a 5 year outlook from here on out. And we aren't having to do that again despite the fact that we exceeded it.
It was probably hubris on our part to put that out there in the first place. Back to the underlying question regarding acquisitions and pipeline, we track the pipeline every quarter. This quarter, it was up slightly. Last quarter, it was down a chunk. We don't share what those are, but at any point in time, we probably have 30, 40, 50 companies in the pipeline at some stage of development.
And as you know, we have 5000 or 6000 that we track as prospects or suspects that one day might be potential acquisitions for us. No acquisitions that we can share, just that we're feeling that this has been a good year so far and we can only see out a quarter or 2 in terms of acquisition prospects. And if there were anything huge pending, we might talk about it. But at this stage, it's just a normal run of the mill constellation type acquisitions, which tend to be small and don't individually move the needle a lot.
Okay. But it just doesn't sound like the dynamics have changed with regard to the kind of makeup of acquisitions and potential opportunities you see out there such as size or potential competition?
I'd say the size is edging up a wee bit. We did 9 acquisitions. It was closer to an average of $3,000,000 purchase price during Q2. Historically, we've been closer to the $2,000,000 range. Obviously, that is a bit of a bimodal distribution.
There are many, many small ones and then there tend to be a few larger ones that
we do. Okay. And then ex PTS, excluding PCS, organic growth was slightly up this quarter from last quarter. Is there anything that we can read into that improvement or would you still characterize organic growth as
challenging? Yes. It's not a wonderful environment out there. All of the companies are fighting for every piece of incremental revenue, but things are looking slightly better. The metric I like best is the sort of sense of optimism that we get from our homebuilder software group.
And it's definitely up slightly from where it has been over the last 2 or 3 years.
Okay. And then lastly on MAXIMUS, EBITDA margins were at a high and you generated strong cash flow. Is that a sustainable situation? Are there any headwinds that could derail that profitability and cash flow for MAXIMUS?
I think we've mentioned before that it's a tougher business than some of our businesses. And when exceptional management is being applied to the business, you can get spectacular performance as we are now, but they maintenance base as many of our businesses. And if bookings should slow, they could have much more volatility in their earnings than some of our other businesses.
But that's just a caution you're not seeing that risk?
It's something we worry about. They sell into some government sectors and they too could be affected by government spending related
issues. Is that federal or state and local?
They do state. They do some federal. They do quite a bit of local government, and they do transit authorities as well.
Our next question is from Thanos Moschopoulos from BMO Capital Markets.
Looks like the adjusted EBITDA margins outside of the MAXIMUS and PTS business declined just a little bit relative to Q1. It seems like some of that was in the private sector side. Does that reflect ongoing pressure from the dollar? Or is that more a function of the recent acquisitions you've made?
I'll turn to the Brain Trust on this one.
Hi, Thad. This is John here. It's slightly down. There's a couple of things. You mentioned the foreign exchange, the Canadian dollar relative to last year again is up 14%.
We also did quite a few acquisitions in the quarter in the private sector. And as always, when we do an acquisition, it usually comes with EBITDA margins that are less than our core business. So it takes us a bit of time to get it back up to what we're used to.
We don't do that significantly. We're also taking these transaction costs through the P and L now. We've early adopted on that particular IFRS
requirement. Okay. And remind us, let's call it to the G and A line typically? It would, yes, mostly. Okay.
Could you expand a bit further on your comments regarding PTS? It sounds like you're a bit more optimistic as far as the potential pipeline and the prospects for that business going forward. You mentioned that there's some improvements in the U. S. Environment there?
Yes. We don't generally talk about the prospects of the individual businesses in any sort of detail, Thanos. We just think there's going to be system replacements, a new generation of product taking out older generations in the U. S. And that will lead to a number of hits over the course of the next few years.
Okay. And saw very strong working capital generation from both MAXIMUS and PTS in the quarter. Can you remind us on the PTS side, does that reflect hardware inventory reduction? And would there be further opportunity to take working capital out of that business?
Yes. When we bought that business, Thanos, it came with much more working capital than we're used to. And part of the investment thesis was to try to drive that down over time. In the quarter specifically, it wasn't due to inventory and work in process. It had to do with accounts receivable.
And that did come down in the quarter. Previous quarter, though, it was the other way. So a bit of seasonality there, but there was strong, in Q2, there was strong generation of cash from accounts receivable.
Our next question is from Paul Leggam from CIBC. Please go ahead.
Thank you. Good morning. Maybe just to follow-up on Hans' question there on the accounts receivable and the working capital with PTS. You've made the comment before that you hope to be able to drive the working capital usage down. How much more can you give us an order of magnitude of how much more you could maybe ring out of working capital from DTS?
Depends how the business evolves, Paul. If it becomes a business where we are winning high market share on new name sales, then the working capital requirements will be extremely high compared to our other businesses. It's a business where we are not winning high share on new name sales, then I could see us getting more working capital out of the business.
Okay. On those name sales, I think
in the past you've mentioned that prior to your acquisition of PTS, the market for new name sales was quite requiring performance bonds and the likes?
We're certainly seeing the requirement for performance bonds in a number of the bids, which isn't something that we care for a lot. It tends to tie up your financial resources. We're also seeing, however, some increased profitability among some of the competitors where we can get at the numbers. And we're also seeing some troubled competitors go through restructuring. So there may be opportunity there for improved profitability for the industry as a whole.
We're certainly hoping so.
You purchased a couple of quarters ago a business called Easy Facility, I think it was called. It was sort of a low ticket item type business. Are you seeing more opportunity? Are you looking around in that space? What are you seeing there?
And how is that I mean, maybe you can't get specifics of how is the EZ facility performing for you?
I think we're enjoying learning about the ticket, higher churn software business. We've got some good metrics and some really good people focused on it. We are flirting with a variety of other opportunities that have those same sets of economics. Personally, I believe it's a less attractive economic model for the vendor than the traditional sale and maintenance type model. But it's intriguing, and we're going to continue dabbling in the space.
I wouldn't count on those jumping into it with both feet, but we're learning a bunch.
Okay. Last question.
The maintenance revenues jumped significantly in the quarter. Was that entirely related to all your acquisition activity? Or was there a sort of a large renewal or something unusual that might have pushed it up?
We've got tens of thousands of clients on maintenance and we don't have any real big client dependence time thing. So I can't imagine that it would be the latter. I think it's just the march of maintenance and recurring revenues forward.
Thank you. We have a follow-up question from Scott Tenner from KB Newcrest. Please go ahead.
Thanks. I felt like I really like the call go without asking John a really arcane accounting question. On the IFRS, specifically on the revenue recognition changes that will presumably be effective Jan 1, 2011. Any additional insight that you can give us on what the impact will be of switching to percentage completion on some of the contracts that I guess are a mix of balance sheet and income statement right now?
Yes, it's a good question. We're going through the IFRS implementation now. So we're going through that analysis. And so with our core business, And there are certain you will have the opportunity to switch those contracts to percent complete or other revenue recognition methods under certain criteria. We're just going through that evaluation now.
So I would envision by Q3, Q4, in our filings, we'll be providing some guidance on what will happen to those significant contracts.
Again, I encourage you to look to the cash flows when you're examining our business because of the PTS and the MAXIMUS acquisitions. There's a bunch of acquisition accounting going through the financial statements, which make them less easy to interpret than the cash flows. Leonard.
Thank you
very much. Appreciate you all attending and Leonard.
Thank you very much. Appreciate you all attending and look forward to speaking with you next quarter.
Thank you, gentlemen. The conference has now ended. Please disconnect your lines at this time.