Capital Senior Living Corporation

Thank you, Jesse. Good morning, everyone.

Welcome to the call. As you know our practice is to go directly to questions.

So Jesse is going to start teaming them up now. Jesse?

So 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?

I don’t think, Thanos, there is anything in particular, i.e. regional.

I'm looking at by division here as well as it's more of a slowdown across the units. Obviously PTIs didn’t grow as quickly as last year.

Um, but none the less the, the growth excluding PTI in the public sector was 1% to 2%.

Yes, so nothing jumps to mind Thanos as the particular sectors are hot spots.

But pretty much it's across the board?

Yes, inside of our utilities business we do have a very rapid growth situation and it relates to advanced metering but there are little pockets here and there, things that are going particularly well but for the most part it still requires it.

And so your comments would remain that growth overall for that segment is likely to remain a bit challenging in the near term?

Yes, but things can turn around fairly quickly. All it takes is a couple of big deals, right?

So 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 and over the last decade we've done 6% and going forward I don’t think we'll do 6% but I think we'll beat GNP. So don’t really see a whole lot of upside in trying to predict organic growth by the quarter.

Okay. And then on the margin front, we saw some 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 the historical trend, is there something seasonal playing on there or when I look at that history, is that just been more co-incidence than anything as far as Q1 being a weaker margin quarter.

Yes, it is the trend. Usually Q1 is a little bit depressed compared to the rest of the year and there's a couple of things there.

One is we do have a lot in certain jurisdictions. We have payroll taxes that we pay in Q1 that we max out and don’t have those taxes going forward.

Also just our business, it's a heavy, heavy tradeshow season, a heavy marketing season for them. So you incur a lot of travel and marketing related expenses in Q1.

So not withstanding 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.

And just finally, on the tax front, are we still looking at sort of a 10% to 15% tax rate as far as your guidance?

Yes, that would be our guidance for this year and for next year as well.

Just wanted to ask first of all on the deployment of acquisition capital, the $20 million that you spent I guess to date versus the $31 million in the first couple of quarters of last year, if you could speak in general I guess to your pipeline of acquisitions, one of the stories that investors are looking for is an increase in that deployment. So 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 and so if you actually look at the letters of intent that were signed over the last quarter it's been really good compared to the prior five quarters and hence our bullishness about short term prospects and you may have noticed overnight that we announced another one.

So I guess somewhat optimistic about the short term. Long term, very hard to predict.

And can you just update me Mark on the timeline of the computer software innovations, what the status is there?

We're not commenting on that particular process Scott.

Okay, they still have a poison pill in place at this time, right?

I believe so.

Okay. Next I just wanted to ask about the change a little bit of the percentage 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 are making in hurdle rates at head office, just how are you thinking about those two divisions against each other.

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 the homebuilders which is a misnomer now because they are in several different sectors for us. Dexter, what are you seeing in terms of deal flow?

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 that might be because we've deployed more resources to keep those going but 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 lot of difference between the Private and Public sector in terms of sort of deal activities Scott.

Okay, just one question on the accounting for the PTS, just on these contracts that are currently getting the balance sheet treatment. What is the remaining life in that on those contracts?

Scott, its John here. We were expecting to be through most of them by the end of this year but I don’t think that's going to be the case.

They're going to probably go into next year as well and every quarter we look at it, it does seem to stretch out another quarter. So it's difficult to say but we currently anticipate to be through most of them by sometime next year.

And just lastly John, the working capital, well it seems to be a pretty huge swing, half 1 to half 2 specific to the PTS business last year. I guess a part of that is the function of 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. So 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.

Thanks for the presidents letter Mark. I think it will help with potentially aggressive forecasts out there.

Relating to that can you tell us where you are on two fronts. Obviously in the letter you talked about and it made sense that manager is during the process, the strategic process, maybe whole backing on some investments that had 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 over investment? Is there any catch up to do and the same thing with acquisitions?

How many would have kind of totally gone away, if you can roughly measure that versus how many were part of their own rule 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 and that pool tends to be reasonably deep and the issue is really one of people and financial resources that you want to deploy chasing them and 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 and the economic environment has an impact upon that as well.

We're not in the middle of a recession right now so 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 but I don’t get the sense that it's the primary focus of the guys.

I think they're still very focused on acquisitions as well and 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, in those challenges in those businesses happen.

It's hard to precipitate those events. It really is something to which we respond rather than create and I'm sure we missed some during the course of the year but there will be lots of others to come.

Would you generally characterize because, like you kind of hinted at it anyway, the nature what you're going after, it isn’t maybe less typical of wholesale process where they open it up and more of just timing of when say a founder may just…. So do you have a sense of how it went away as part of a process versus, is it still fairly active even though you slowed down in the second half of the year?

I think we've gone through our final looking at where our acquisitions came from over the course of the last 18 months or so and I think it was about a six of our acquisitions were broker led processes.

And finally can you make any other commentary on the division 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 the margin profile there?

The information you got is sort of the information that we're sharing at this stage. We love the business, think it's a really good fit our existing businesses in this space and um, have a terrific installed base, new products.

So very excited about it.

And I assume it has closed by the looks of it?

Yes, yes.

So Mark, very interesting shareholders letter here. I was interested in kind of reading the part about keeping employees and that being a fairly big risk.

The fact that you call that out, is that something that you're seeing as an issue here, just curious about that?

Well 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 and I certainly felt that the process didn’t help but at the same time these guys have personal capital to deploy which was generated in the course of being Constellation managers.

Much of it tends to be invested in Constellation shares and we don’t want to give them the incentive to sell those shares either and so if they perceive there is 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 see that the stock is highly overvalued, then that's a bad thing. So 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, just something that we've got to actively manage and call it out because obviously the happened and the stock prices appreciated a lot since then. So I didn’t do a great job of maintaining the stock price at a level which was sufficient to avoid a process but I think the opposite is also something you have to avoid.

And a related question, you're certainly a lot bigger company now. So if you look at the company today versus what it was three or four years ago, can you give us a sense of what the nuances today would be in terms of running a bigger business and I guess more specifically how that would translate into some of your financial metrics?

Because we are collection of very small businesses, we're much more like a portfolio and I don’t think the financial metrics are going to drift a lot unless we let creeping overheads 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? And how do you continue to build the business deploying capital?

And those are fascinating discussions because 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&L.

And that's up significantly year-over-year and I think it's going to continue to go up. How do you run those tiny little businesses with revenues of $800-odd million and obviously those are not big businesses, the little businesses and you do need to have some wisdom somewhere in the range that can help the guys running relatively small businesses do it better but at the same time you don’t want to overburden it with overhead.

So really fun questions to think about and work on and we're feeling our way forward. We don’t have all the answers.

And John I don’t know if this was a question for you. I was going through the NDA and I noticed there was 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 because my guess is that and I could be wrong here, that the professional services is the sort of revenue generating cost item, no?

Yes, 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. So a coder could be producing custom code for a customer which is chargeable and that’s professional services revenue.

So one quarter they are in professional services, the next quarter they could go back into R&D. So what we saw in Q1 was a couple of things.

One is we did have some reductions in PS and some of our business units but principally that drop was people 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.

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?

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, 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 triple what we have in our other businesses but you also expect customer acquisition cost to be a fraction of what we normally spend in our other business. So really you got to go at it case by case.

There is no ready 20 answer I'm afraid. But obviously the economy is 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.

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 that business?

I think that's the government spending money. They are not spending as much as they did during the course of the recession and I think there's a little bit of pullback, sort of across the board.

That would be the most obvious thing I think.

Sorry, I was asking in the private sector.

Oh sorry. I haven't noticed any tend in that particular area.

The numbers may be down slightly but my sense is that things are going pretty well.

Just wanted to focus on your comment on margins moderating this year versus last year in your letter. Do you think there has been a fundamental change in your business going forward?

For example are you seeing a change in the economics of the acquisitions that you make or in your existing business or do you just believe that 2011 was a very good year for margins based on a slower pace of acquisitions and the strategic review?

I think '11 was a particularly good year for margins and partly driven by the strategic review but I think 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.

So 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 and we might make concessions that we wouldn’t have made previously.

And 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 track the initiatives we used to actively use a hurdle rate. We don’t review the initiatives at head office any more.

It's done out of the branches and 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 probable weighted approach to it but we still tend to build something in.

Okay and then on managing investor expectations, have you thought about providing a guidance around your long term model or margins in 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 are 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 and adjusted net income is a number that I like to look at barring acquisition accounting which always sort of can throw that out.

So then you fall back to the cash flow and 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 I think about 20% to 23%.

Did that include the possible uplift that you may have saw from the lower pace of acquisitions that you experienced in 2011 and 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 and 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 and we knew that all the bidders would have almost perfect information because they would be inside the tent.

It just seemed unfair that our existing shareholders who have been supported for so long didn’t have that information. So that's why we did guidance and that's the method that we used.

Okay, thanks for the responses.

I was just wondering if you could comment on your staffing costs and if there was any one time catch ups in terms of hiring in Q1 given the sort of slower pace in 2011 and 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 expectations about what they need to do on the hiring front.

Some of the divisions are hiring aggressively, others are contracting. So I don’t have a view I'm afraid.

Okay. And 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?

So 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 but it's just very hard to pick a number. 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.

And I think we do a good job. I don’t think we conceded share.

I think we gained share in most of the markets that we're in, like how maintenance gives you a sense but we tend to grow our businesses, not shrink them. So I feel pretty good about organic growth in the long haul but I don’t see it being 10% again.

And then the public sector organic growth in Q1 was that sort of within the range that you are expecting going into the quarter or was that a surprise to you or any sort of deviation there from what you were expecting?

It was pretty much what we were expecting.

Yes, 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.

Thank you Jesse. Thanks everyone for attending, appreciate it.

As you know we have our annual general meeting coming up at 11:00 o'clock. If any of you can join us there we would really appreciate it and look forward to introducing you to our directors and our managers, many of whom will be in attendance.

So I hope you will be able to turn up. Thanks very much now.