Capital Senior Living Corporation

Good morning, everyone. Thank you for joining our Q2 conference call.

As you know, we generally just go directly to questions, so Audrey is going to give you some instructions on how to get in the queue for your question. Thank you.

Audrey, go ahead.

First of all, Mark, just to broach the subject of the organic growth overall, especially in the public sector businesses. I know last quarter you made the comment there was a general slowdown in public sector spending.

I’m just wondering whether that would stay again this quarter?

Our sense in wandering around to the various groups was that they had a pretty good quarter of booking, so they’re feeling more optimistic perhaps than they were 2 or 3 months ago. Don’t get the sense that there’s any fundamental change in the public sector however.

So it could just be a good quarter in a series of bad quarters, but I really don’t have any way of judging that.

In that context then, just wondering how we should think of the 3 sort of “significant” deals that have been announced at the end of the quarter, and then just past the quarter, does that signal, and your comment on the bookings toward Q2, signal a snapback positive in Q3, or would you not want to go there.

Yes, are you asking about organic growth or...

Yes, sorry, organic growth.

Sorry?

Organic growth, yes.

Our sense is as we talk to the groups that they feel that organic growth will be better, but they tend to be optimistic, most operating managers do. So very hard to judge, things can slip so easily from one quarter to the next as you are working through a contract.

[indiscernible] complete accounting is such that if you hit a milestone and you have issues, you may have to add hours to a project. It’s just very hard to predict, Scott.

Okay. I just wanted to ask as well, just an update both anecdotally on the acquisition environment and prospects that you’re seeing, and then if you have anything quantitative on the letters of intent out there, either versus last quarter or last year.

Yes, so we track all that stuff, and as we’ve said we’re not very good predictors of what is going to happen. Lots of things can happen between letter of intent and closing.

It’s been a great half year for us in terms of acquisitions, and in particular, last quarter has been super. We are feeling good about it, but there is not a whole lot in the data to give you tremendous optimism about the next 3, 6, 9, 12 months.

There are some larger deals, which is great, and that really helps, but they tend to be harder to close.

Okay. So, you said there’s not a lot in the data to make one optimistic, but nevertheless, you do feel pretty good about the back half?

I would say we’re feeling pretty good right now. Yes.

But it isn’t because the data points you there as you look at the number of letter of intents signed, number that are going out there as NDAs, and indications of interest. There’s no crisp trends in the data.

Okay. Lastly, and I'll pass it along.

It's just given the amount of capital that you have been able to deploy, specifically in Q2, should we expect some level of margin pressure related to that in Q3?

Certainly, a number of the companies that we've bought had lower margins that were lower than Prevail and Constellation as a whole. So, it would contribute to margin pressure.

How does your -- I mean obviously, you're having a good year, as far as the capital deployed. At what point, maybe this is a better question for John, at what point does the bonus accrual start to kick in as an offset to any incremental margin?

Well, our bonus is driven by 2 things, return on capital and growth, Scott. So normally, in high growth years, we will see, the bonuses will pick up.

We've had acquisitive growth, but it's been off-set by the negative growth, organically. The bonuses are driven by overall growth.

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Can you talk about how to beat geographic distribution of the M&A pipelines evolving? Are you seeing more opportunities in Europe, for example, given the macro backdrop there?

We're certainly working harder in Europe, Thanos. The head office, in particular has been working harder in Europe.

We're having a little contest with the branches, to see who can generate the most leads in Europe. I would like to see more, they do appear harder to close than our north American ones; and we have less track record there, and we're feeling our way more.

There are less levers to pull when you do a European acquisition, in terms of getting them to perform better than there are in North America. So it's something that we want to do more of, but it's not necessarily something that's going to be a radical change in what we do.

We don't anticipate there being dozens of European acquisitions over the course of the next year.

Okay. Can you provide a little more color, in terms of your comments regarding some of the larger opportunities you're seeing in the pipeline?

Would these be assets from larger companies that you've acquired in the past? Would these be newer verticals or some of your existing ones?

How are those shaping up?

Really, always, larger tends to mean new platforms. Some of them are corporate, but many of them are retiring individuals, as well.

We just bought a lovely business in the south of England, that I think we announced this morning, an agricultural dealership software business. It was 2 individuals that were looking to sell after having built the business for many years.

Okay. Then a question for John.

We saw negative working capital from PTS this quarter, I think you talked about that previously. Just remind us when we might expect to see that reverse.

It's very binary, as you know. It's basically built on milestones, and I'm excluding the impact of the bonuses which we normally pay in Q1.

So early in, the group is forecasting to have some working capital improvement, i.e., cash from working capital in the second half of the year. Again, it's very large project, milestone-based, so we hope it's by the end of the year, but it might be early next year.

you comment on the pricing that you saw in M&A in the last quarter? Are you seeing any better pricing versus historical, as a result of the economic environment?

It's really hard to judge. I mean, on the ones that we're closing, the pricing is similar.

On the ones that we don't close, I really have no sense of sort of where it's at. I suspect the banks are a little less aggressive than they had been a couple of years ago, or probably more than that now, probably 3 or 4 years ago.

That does affect private equity buyers, and the prices that they're willing to pay.

Do you generally agree that the silver lining of the economic environment is that you may see a greater number of opportunities in pricing?

Certainly, with the economy bumping along and no real sense that things are going to be thriving over the next few years, people have delayed selling their businesses are more likely to reconsider bringing them to market. If they feel that now is the time to be thinking about retirement, or things of that nature.

I don't think it's bad enough that corporates are having lawn sales of their software businesses, but for retiring individuals looking at a prospect of relatively slow growth, I think it's probably affecting their decisions on when to sell.

Okay. Moving to organic growth.

You must look at organic growth by maintenance versus other segments. So, despite the negative headline around organic growth, are you continuing to see organic growth in your core maintenance revenue that's in line with historical rates?

That would be, really, a question about attrition and price increases and new maintenance being added; there are many components to organic growth in maintenance. I certainly haven't heard anything, as we've trotted around branches, about decreasing organic growth in maintenance, per se.

John, you?

No, and the overall maintenance is growing at quite a healthy pace this year, compared to our overall growth. I think it might be north of 20% maintenance growth, so that would project that it's bumping along quite nicely.

Okay. Just lastly, on margins.

You did 21% adjusted EBITDA margins this quarter, is that a reasonable expectation for the business going forward? Then, looking at the seasonality of margins over the last couple of years, it looked like margins are up in the second half of the year; versus the first half.

Is there any fundamental drivers of that seasonality, or does it relate to the mix of acquisitions during the year?

I'll give you my impressions and then we'll get Johns. I think there is some seasonality, in that we have payroll-type deductions that tend to be front-end loaded in a number of the geographies in which we operate.

So, that tends to depress Q1, and a little bit of Q2 margins, and some of that is tied to the bonus that we pay during that sort of period at the end of Q1.

There's also a teeing up of all of the provisions and the R&D tax credits and things of that nature. Which I'm sure people do assiduously during the year, but are particularly careful within Q4, as the bonuses are calculated annually.

I suspect there's a little bit of pushing to close sales as we come to the end of the year. As you know we do percent complete revenue recognition, which tends to dampen that Q4 effect that you see in other software companies; but it still happens to some extent, I would say in our business.

So bonus does drive a little bit of the seasonality that you see.

I think just to overlay that, there is a degree of optimism that everyone has in January/February, in terms of their growth prospects for the year. So they tend to hire people, they tend to invest and as those growth prospects don't materialize, they tend to cut back the hiring in the second half of the year, and you get an increase in margins.

It was implicit in the question, or early on in the questions, a concern about whether the current margins are maintainable or not, and that sort of implies a sense of central control, which doesn't really exist at Constellation. We provide the operating groups, and they provide the business units under the operating groups, with a lot of leeway to invest in R&D and sales and marketing: things which don't pay off for many years to come.

Obviously, we try and track how well those investments play out, and make sure that people learn and get feedback from those investments. But, if one of the general managers were to come to us tomorrow with a multi-million dollar investment that looked like a slam dunk, high rate of return investment and it was going to depress short-term profits, we would be delighted.

We don't prescribe margins or R&D spending or sales and marketing spending, or anything of that nature. We do monitor those investments and try to make sure they're rational ones.

Most of my questions have been answered, but a few follow up questions here. I was just wondering if you could perhaps comment on the M&A pipeline, and the makeup of that funnel.

Is it more skewed toward people retiring right now, or is it more deals from companies? How is that skew looking going into Q3 versus Q2?

Right now it's more the former than the corporate deals.

Yeah. In Q2 we had a couple of corporate deals.

Looking forward though, it's more the owner retiring.

Okay. Perfect.

You're team that looks at M&A, has that team sort of expanded sequentially, in Q3 over Q2? Or do you have enough capacity to deal with the pipeline right now?

I can't think of any additions during the last quarter. Certainly, year-over-year, we're adding people, and folks are working really hard right now.

It's been a very, very busy time for us, and we're delighted by that.

Okay. Then, lastly, just quickly.

I was wondering if you could perhaps comment on the tax rate going forward? I think Q2 was a little higher than usual, so should we expect that going forward, or was Q2 sort of a phenomenon?

From our perspective, it was tied in line with what we've been saying, which is about 10% to 15% cash tax, which should beef up over the next year. That's always contingent on acquisitions and our ability to structure them, but that's a range we've been discussing, and I think it fell into that range in Q2.

I just wanted to actually loop back on one topic, and that is the MBNA makes mention of a potential $9 million issue, with-- I'm trying to find the page. I think it was maybe the Magus Assets.

I'm just wondering whether that is, if it does come to pass, if that is payable by you, or payable by Maximus.

On the liability we mentioned in there would be from our perspective, our liability associated with that issue.

The $15 million that's still listed as contingent against those assets, that's obviously got a pretty long tail on it. I think I asked you this last quarter too, John, but is there any enhanced visibility on when that $15 million is going to go away?

I think you might have asked us a few years ago, Scott. Our visibility is obviously more enhanced, but it's not significantly more enhanced.

So the projects though that liability relates to are still ongoing. We would hope we would get through them in the next year or 2, but we're not certain of that.

Thank you Audrey. Thank you all for joining us on this call, and we look forward to having this opportunity again in two months’ time.

Bye-bye.