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Constellation Software, Inc. (OTCPK:CNSWF) Q1 2017 Results Earnings Conference Call April 28, 2017 8:00 AM ET

Executives

Mark Leonard – President and Chairman of the Board

Jamal Baksh – Chief Financial Officer

Analysts

Thanos Moschopoulos – BMO Capital Markets

Paul Steep – Scotia Capital

Stephanie Price – CIBC

Blair Abernethy – Industrial Alliance

Operator

Good morning, ladies and gentlemen. Welcome to Constellation Software, Inc. Q1 Results Conference Call.

I’d like to turn the meeting over to Mr. Mark Leonard. Please go ahead, Mr. Leonard.

Mark Leonard

Thank you, Donna. Good morning, everyone. Welcome to the Q1 call. As you know, we go directly to questions. So Donna is going to instruct you now on how line up for this.

Question-and-Answer Session

Operator

Thank you. We will not take questions from the telephone lines. [Operator Instructions] And the first question is from Thanos Moschopoulos from BMO Capital Markets. Please go ahead.

Thanos Moschopoulos

Hi, good morning. Mark, in the president’s letter you talked about the increased competition from private equity and Constellation lookalikes. Yet despite that you’ve been reasonably successful with your capital deployment so far this year, at least I think relative to what many of us were expecting.

And so can you help us reconcile that. Is that perhaps reflective of the success you’ve had in expanding the universal employees they’re involved in finding and sourcing M&A opportunities?

Mark Leonard

Yeah, believe so. I think that’s the major reason, they are roughly double the amount of full time M&A people at this point in the year that they were at this point last year. And so that’s the primary reason.

Thanos Moschopoulos

Okay. Turning to the maintenance revenue, the maintenance revenue keeps increasing as a proportion of the overall mix, which of course isn’t a surprise given that that’s the revenue line that you’re most focused on growing.

As you look across your business units is there a specific feeling you’ve encountered in terms of how hard that maintenance mix can become or does that feeling is very tremendously across the various verticals?

Mark Leonard

Yes, when I was writing about that in the president’s letter Jamal sort of bridled and said, well, you know, what if you buy a company that’s got high professional services, your mix is going to drop dramatically in that particular business unit at least for a while.

And so I think the issue comes down to the fact that big customers with big budgets would much rather have a custom solution that’s tailored to their needs.

And so if you hated solely to those kind of clients you’re going to have very high professional services and much lower maintenance, whereas if you have many small client you’re much more likely to have a sense like model with very low PS or no PS and almost entirely recurring revenues.

So those are the two sorts of ends of the spectrum and obviously some of our business units are much more like the former and some are much more like the latter. So I would say it varies a lot and based on the client base you’re serving.

Thanos Moschopoulos

Okay. And finally a year ago you said that you’re going to place more focus on public company investments. It doesn’t seem like you’ve been terribly active on that front other than your involvement with Regni [ph]. Has that been due to a lack of opportunity in terms of public market valuations or are public company investments always going to be more of an ad-hoc and opportunistic endeavour?

Mark Leonard

I think the ad hoc slash opportunistic is the right way to view it. The announcement a year ago was just that we were getting back into the business after having been out of the business for a number of years.

It’s an ancillary business for us. It’s never going to dominate what we do. There will be points in time when markets aren’t happy and there will be lots of investment opportunities. But the competing investment opportunities will be the chance to buy companies to long haul that are not public at the same time. And so it’s – I don’t think they’ll ever be a big part of our business. I just think it’s a nice by-product business.

Thanos Moschopoulos

Great. Thanks, Mark. I’ll pass the line.

Operator

Thank you. The next question is from Paul Steep from Scotia Capital. Please go ahead.

Paul Steep

Great. Thanks, Mark, maybe you could talk just a bit about the cash growth and the pace of the cash growth and I guess the question that comes to mind is how much is too much you know, in terms of being able to fully deploy it. It obviously built at a rapid pace over the last few quarters. How should we think about that? I know you touched on it a little bit in the letter?

Mark Leonard

What do they call those first, well problems? Yes. You’d obviously like to be patient with your opportunities. And the issue is if it’s sitting around doing nothing, isn’t earning returns for your shareholders then you could return it to them, but then invest it.

And so I think I’ve characterized it previously as the amount of embarrassment that the board is willing to put up with. As we sit on cash and people start clamouring for it to be distributed either via dividends or share buybacks. And I think you know my views on most share buybacks.

And so my preference would be to hang on to the cash. We seem to be ramping our M&A activities and to some extent it seems to be paying off. And so rather than returning it to shareholders, rather hang on to it at least for the time being and see if perhaps we can deploy it.

Paul Steep

Okay. That makes sense. Just one quick follow up either for you or Jamal. From the quarter you did a sizable amount more of that seemed to be regular for acquisitions of businesses that came with a bunch more working capital versus asset purchases. I’m not sure if there’s anything in particular that sort of drove that, but it just sort of stood out to us that there was a big jump in working capital, anything specific there? I know you’ve seem to historically sort of prefer the latter?

Mark Leonard

I mean, nothing is jumping out to the two of us, so as we look at each other a slightly dazed fashion. But I think we have a strong preference for asset purchases for tax reasons. If you can buy them in a tax advantage way you can write them off and that helps. And as you know our cash tax rate has been climbing and is up considerably from a couple of years ago and it’s just one of the things we try to manage.

So our preference would be to do asset purchases. But at the same time many vendors would prefer to sell shares and so we end up with a mix of those two depending upon whose need is greatest.

Jamal Baksh

But I think with the Telecom acquisition, like I think $10 million of WIPP [ph] that we acquired, I’m not sure if you’re referring to that.

Paul Steep

That’s where we were heading. So, okay.

Jamal Baksh

Yes. And when I followed up with the subs on that it was you know, it’s a cyclical type of business and it’s a WIPP balance and they expect to drop down. So, just happened to be that large implementations to that one acquisition, but I would say it’s a shift or anything in terms of what we’re buying.

Paul Steep

Okay. Great. See you at 10:30. Thanks, guys.

Operator

Thank you…

Mark Leonard

Just adding little bit, I mean WIPP is one of the things I worry about a lot. Some businesses structurally have big work in process and assets on the books and you always worry obviously about the collectability of those. And so we do age with to try and keep a handle on it and review it on a regular basis. Next caller

Operator

Thank you. [Operator Instructions] And the next question is from Stephanie Price from CIBC. Please go ahead.

Stephanie Price

Good morning.

Mark Leonard

Morning.

Stephanie Price

Could you talk a bit about employee retention? You mentioned more Constellation like PE firm’s emerging and how do you keep employees and how do you think about employee retention here?

Mark Leonard

I think in verticals, that vertical specific experience is very, very important. So down in the ranks of the business units there are probably two or three competitors that each of those business unit has, they are usually in a different geography. And so the mobility of those managers who are vertical specific isn’t huge and they generally have to uproot their families if they want to take a job elsewhere.

So I don’t worry too much about those people being poached, other than to a local business that isn’t in the same vertical. So it’s not a function of competitors stealing those people, it’s just them being becoming dissatisfied with their job and seeking another IT job, which is there’s lots of those available. And so we recognize that and know that we have to be competitive.

In terms of CSI look alikes trying to poach more senior people. They can wave around very large checks and make great promises. And if you’ve ever dealt with venture capital, so PE firms that they talk a great story the front end, but if you ever get down into the contracts that’s where the rubber meets the road and I’m hoping that our guys who are being courted sufficiently sophisticated to examine those offers that they receive very carefully.

And on the other side the way you keep people is by making sure that their current needs are satisfied and their dreams and aspirations are provided for. And what we can offer is a degree of autonomy that people don’t tend to get inside of PE companies and the opportunity for mastery of the craft that they probably don’t get inside of most PE companies.

If you’re focused on a playbook that requires you to in a two to three year period make dramatic improvements to profitability then settle it down for a year or two and then flog it to some unsuspecting buyer, which seems to me the PE model.

You’re not going to be learning how to invest for the long haul. Learning how to build a team for the long haul, it becomes a much more short term oriented endeavour. And I think a number of our key employees are focused on building great businesses for the long haul and surrounding themselves with great teams.

And so I think we have certain natural advantages versus those firms that are trying to come and get some of our accomplished employees. But at the end of the day if they put enough cash on the table and make enough promises about autonomy you know, they may be able to lose some of those people away.

Stephanie Price

Okay. Fair enough. Can you talk a bit about M&A from a geographic perspective as well, it seems like you’re going a little bit at five day kind of typical North America and Europe profile with the Japanese JV last quarter and then helping [ph] customer base this quarter?

Mark Leonard

We’ve been expanding geographic coverage for a long period of time. If you look at our lead generation its still North America dominated, but Europe is a strong and relatively stable component of what we do. And for the first time as we look at the region the Japanese leads are showing up visibly. So we’re making a little bit of progress there.

And we’re increasingly having employees in some far flung places and when you’ve got employees then you tend to get opportunities and leads, ultimately it’s our employees that find the best opportunities for us.

Stephanie Price

Okay, great. Thanks you very much.

Operator

Thank you. The next question is from Blair Abernethy from Industrial Alliance. Please go ahead

Blair Abernethy

Thanks. Mark, just on – further on the Japanese venture or Japanese market if you will. What’s it looking like there in terms of deals done so far and how fast do you think that business can ramp up on the one hand. On the other hand, you know, what does the PE competition look like for deals in Japan?

Mark Leonard

We’ve done zero deals so far. And the PE competition arrived long before we did. And I don’t know intimately, I’m going to be there in a few weeks time and I’m going to visit with some of local VCs and PE first and we do get a portion of our acquisitions from PEs and VCs and I’ll know more then. So some maybe bring up the question next time around there.

Blair Abernethy

Okay, okay. Also just on the hardware side of things you know, obviously hardware is – I know it bounces around and I’m just wondering I mean, you do get very good margins on the hardware you do have. Is it a you know – do you think the hardware will grow with the business over time. Or do you think that if you’re given a choice between two companies in front of you to buy you know would you not take the hardware one because of – because of the volatility in the margin structure?

Mark Leonard

If it’s proprietary hardware, I’d take it every time.

Blair Abernethy

Okay. All right. Great, thank you for that. And then Jamal, just on the tax rate, do you have a view on the tax rate for this year as its came in a little bit higher this quarter then we’ve been looking for?

Jamal Baksh

That is in line with what I’ve been saying. So you know, it was around 17%, 18% last year I was saying it was going to ramp up to more than 24 over a couple of years, so it seems to be coming in around 2021 this year, which is what I was expecting.

Blair Abernethy

Okay, great. Thanks, guys.

Jamal Baksh

Yes.

Operator

Thank you. There are no further questions registered at this time. I’d like to turn the meeting back over to Mr. Leonard.

Question-and-Answer Session

Operator

Thank you, Donna. Thank you very much for hosting the call. We have our AGM kicking off at 10:30 and we welcome any of you to join us and we’ll have the Operating Group General Managers and most of the board there and would welcome questionings for those people during the course of the AGM. So hope to see a number of you quite soon. Bye-bye, now.

Operator

Thank you. The conference has now ended. Please disconnect your lines at this time. And thank you for your participation.

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