Capital Senior Living Corporation

Good morning and welcome to the Q3 call. As you know, we tend to go directly to questions.

During these sessions I will remark that John and I are in separate offices today, so the coordination may be a little choppy between the two of us as we field your questions.

So Ann, if you could tee up the questions, that would be great.

Mark, can you talk about what you are seeing from an organic growth perspective. It looks like your year-over-year growth was modest outside of PTS, but relative to the June quarter there was a nice sequential uptick.

Would you characterize the environment as stable overall or is there anything you're seeing in the business that would point to a change in your organic growth trajectory?

Yes, I always hesitate to forecast organic growth, in fact, hesitate to forecast just about anything. The anecdotes that we are hearing as we wander around chatting with the operating businesses are encouraging, even amongst the government entities.

So I think our folks are feeling reasonably optimistic, but you never know till you see it in the numbers.

John, any comments or thoughts?

No, I think that’s fair to say. This quarter contrary to last quarter, we saw more optimism in the public sector business units.

So, it really is in a public sector side where you’re hearing a little bit more optimism. I guess private sector has been pretty healthy throughout the year.

Yes. No we’ve been pretty pleased with the private sector.

Given the state of the economy, I think we've been doing pretty well.

Okay. And we saw a strong margin uptick in the private sector business.

I know that your margins are often stronger in the back half of the year relative to the first half and so was that margin uptick in private sector just a question of seasonality or is there something else going on that drove that margin improvement?

John, thoughts?

Thanos, nothing comes to mind about that uptick quarter-over-quarter and the businesses continue to do well. Usually what happens on margins is its acquisition related.

So my guess is looking back in Q3 or looking at the acquisitions now, they didn’t have any big acquisitions that were a driver on the margins, but that’s just pure speculation.

I think did in one of our subsidiaries that has large contracts, they went through their same complete [ph] perhaps a wee bit more diligently than they have from time and time and found a little bit of revenue pick up on a couple of contracts. But, so they may have been a wee bit too conservative previously.

Okay, that’s helpful. And then John I think you made the comment last quarter that your tax rate might start to creep up a little next year.

Is that still your expectation?

It is. As you know it relates to shield [ph] that we acquire and our current speculation is toward the end of next year, all things being equal, you'll start to see an uptick.

Still within your targeted range, but just a little bit higher towards the upper end of that range.

Yes, and then as we mentioned 10 to 15, but then it would creep higher than that if we don't acquire any more shield [ph] in the next year time frame.

And John, your opinion on acquisition is safe to say they are likely to have higher tax rates than some of our North American ones, because of our shield situation?

Yes, safe to say if their constructed appropriately they would be slightly higher. In general though compared to the U.S., they have lower tax rates in some of those jurisdictions.

The statutory tax rates.

Statutory rates, yes.

Just first of all to come back to the question on margins, just given the acquisition activity in Q2, I think I was certainly expecting a little bit more of a dip in margins. Just curious as to whether the companies that you normally acquire, I mean do they normally run margin profiles that are lower than your own or should we not necessarily expect the quarters after a big acquisition expense to normally dip margins?

I think particularly with the larger companies that we’ve acquired of late, they are not making very much money and CSWI, the one that we hope to acquire shortly, again, if you look at its recent history, it's actually losing money and so I think there will be margin pressure in those businesses, absolutely, compared to our average.

Okay. I wanted to ask you as well, Mark, about your outlook and your ability to deploy capital to acquisitions, so let's just say next year rather than pin it down on a quarter.

I mean this year you're looking like you're going to more than double what you spent in a softer year last year. What would your expectations, at least at this point be for next year?

We have proved I think to you and certainly to ourselves that we are miserable predictors of our ability to deploy capital on acquisitions and so I wouldn’t want to give you any sense that we have any better view on 2013 than we’ve had in the past. I can usually look at a quarter and say that there’s a bunch of stuff in the funnel and certainly for Q4 there is a bunch of stuff in the funnel.

And is there a change in the profile I guess or the number of larger versus smaller acquisitions that are in that funnel?

We’ve seen our average size pick up quite a bit. I think it's approaching $5 million currently, Bernie had some stats in our most recent board package.

And so that’s good in that it’s less effort, less M&A effort to deploy capital. These larger companies, particularly in Europe, come with pros and cons and it may be easier to get a large one done, but it may be harder to fix.

And one last one for John, maybe just on the PTS side, I know Q4 of last year was a big working capital positive quarter. Is that likely to happen again this year and just more of a general question is, is PTS still in a mode that your trying to take working capital out of it overall.

I think similar to M&A as Mark alluded to, we are finding it quite difficult to forecast cash flow in that business and its primarily due to the nature of the very large contracts, which have milestone payments. And there’s no reason why Q4 should be a strong cash flow quarter every year.

However they are predicting this Q4, they are hopeful that they will have a stronger cash flow.

They're hope it'll be positive year-to-date, whereas right now they are slightly negative, so they are predicating it to be positive cash flow. But again, it's hard to predict, Scott, because you have some big milestone payments that, that is reliant upon.

And your question about working capital, yes. I mean there is pros and cons, and they are hopeful that they can backfill various large contracts, which are declining over time, so that the business continues to grow.

However if it does continue to shrink, it should release working capital over time.

If I can dive into the public sector comments, x PTS I guess because of the variability, but it’s a little bit contrary to what many of the vendors are saying. Obviously it’s the nature of your mix.

What parts would you highlight, and I know you’ve announced a few deals, but what parts would you highlight as particularly strong and I assume within the mix some of the assets are looking a little weaker. So can you parse that out a bit for us?

I think it was pretty much across the board Tom that people were optimistic. I’m trying to think of…

We are hearing that they are talking about fiscal cliffs in the U.S. I mean obviously Europe in some jurisdictions it's generally down.

What’s the differentiator I guess with you that it’s looking a little better?

Well, I don’t think it’s just with us. I mean if you listen to the Tyler conference call or look to their results, you’d be pretty impressed by their organic growth.

I think there is certainly other vendors in the public space who are doing okay.

Okay, some of the bigger vendors are showing weakness in -- right now, so. The more, the traditional enterprise software vendors, they are certainly struggling in this sector, so okay.

I think Europe for us in the public sector, I didn’t hear a whole lot of optimism there, as we went around, but again anecdotal I don’t have any…

_

But U.S. feels fine, okay.

Yes, U.S. feels fine.

And on the construction side, at least some new housing data is good; some of the sales data is not so good. What are you seeing or hearing in the field there?

I think we were feeling a little more bullish in Q2 than right now, but it's not like we’ve had any particularly bad news, but the guys seemed a little more optimistic last quarter.

Okay. And finally John, can you update us on capital deployed to date with the last couple of acquisitions, including today, and I guess CSWI will close this current quarter, correct?

Yes, I think in our statements we said we deployed about $4 million as of yesterday. We closed the deal after market last night and…

That’s right. That includes that, sorry.

No it excludes that. And then CSWI as you can see in our disclosures, we are hopeful that it closes next week.

Next week, and that 15, okay.

So Mark, I’m just curious to see whether you guys are going to reinstate some targets for growth. I know that your pipeline is active, but what do you think is sort of a reasonable expectation for growth over the next 12 months?

We don’t have any sort of reasonable expectation, it really depends how much money we deploy, Richard. And the pace of that will depend upon obviously availability, but also upon the performance of the existing portfolio of companies.

So having bought a number of European things, if they work out well that will be fabulous news and we can focus on trying to buy other European companies and if we run into unique issues that we haven’t faced before, we’ll have to learn how to work through those.

And similarly we are starting to get into the payment space, which isn’t one that we’ve played in before. You probably saw the press release about L&Z.

We had started to do a payments business organically, a Greenfield business, because we felt it was a good ancillary offering for our clients and now we have done an acquisition in this space and we are looking at others.

It will also be a learning curve for us. It's going to be a different business than the software business per say and whenever you are learning you’re probably making some mistake, so that can slow us down as well.

So very, very hard to predict what growth will be for the coming year.

That’s fair. When you look at the cloud landscape, what are your existing customers saying about that as a potential opportunity?

Customers, as an opportunity. To me the cloud is a delivery mechanism and sometimes gets confused with an economic model to the extent that people don’t have the ability to manage IT infrastructure internally, moving stuff out to the cloud can be appealing.

To the extent that they view IT as a part of their special sauce and something that’s proprietary to them, outsourcing it to the cloud could be less appealing. And so it varies a lot by client and I suspect you will see departmental systems moving to the cloud before you see full enterprise systems going there.

I suspect you will see small companies using it before large ones do and so it will be a sort of slow adoption.

We obviously track it and participate and we hope that we will be able to breakout our recurring revenues of a nontraditional maintenance nature starting next year. We are tracking them this year and seeing how they are progressing and they are growing much faster than our conventional maintenance business.

Okay and then a last question on return on invested capital. I was trying to sort of replicate a number that you’d put out in your annual shareholders letter, but we are having a tough time doing it.

So if you look at the current ROIC, based on your definition, what has it been on the last trailing 12 months?

I don’t have that at my fingertips. It would have been in the sort of mid-20’s kind of range.

John that sound about right?

Yes, for the last quarter, last 12 months mid to high 20s.

We’ll try and be more descriptive of how we calculate that when we do our letter in the spring.

Just want to follow up on the L&Z acquisition Mark. I wonder if you could just give us may be a little more color on what you like about the payment space and sort of what -- I mean the payment space is a pretty broad term.

What kind of areas or kind of aspects of that are you interested in?

So the broad thesis is that when you do more for your clients, they tend to be happier and hang around longer and pay you more. And when you provide software for them to do business or business type transactions invariably -- or business to consumer transactions, invariably there is a payment stream and it needs to get handled and if its integrated, that’s a good thing.

What we observed in one of our high turnover of verticals, one of the high attrition verticals, is that payments appears to help, it appears to be associated with lower attrition clients when we have both payments and software and so we believe this might be a generic observation that if you can do both that’s a good thing. Certainly there are some big players; you have that same thesis as you know, and so we are getting into the payments business.

Now payments you can be fully integrated all the way back or you can just be partly in the value-channel and it will vary by vertical, exactly how much of a slice of that payment stream we’ll be getting. But it’s a very different business than anything else that we do.

It’s a very low margin, high volume kind of business although it is recurring.

So, would it be fair to say you are looking at this as a -- to build a platform that can then be cross-sold into a lot of your other businesses?

I think that’s the objective. We however are not very prescriptive to our other business and we like to run them as individual stand-alone business units.

There’s a 100-plus of them and so I cannot foresee me ever dictating to our business units that they will use payment platform X to do their payments. I can certainly encourage them to explore it and tell them about the benefits of it, but as soon as you start dictating you own the problem and you don’t have general managers who are running their own businesses.

So is it a little bit of akin to maybe the 3M model where they have a technology that can be pulled into the deferent divisions, but they don’t force it. Is that what you are thinking of?

I hope so, yes.

Okay, great. Just on the PTS, a follow-up question.

If I kind of look at the last 3 years, you've noted that you pulled off around $33 million in cash, so sort of around $10 million a year. I know it’s lumpy, but is $10 million a year kind of what you foresee for the next few years or is it potential for that to go up.

A very talented management team. I believe they will build a great business for us.

It may or may not involve the same amount of hardware as it has historically. I hope that it’s a much, much bigger business for us in terms of cash flow as we go forward, but the core offering that we started with will not constitute the bulk of the future cash flows, 5 years, 10 years hence.

Okay. No problem.

One last one, just in terms of your dividend level, can you just remind us, are you looking at this quarterly or you're looking at it to the beginning of next for resetting it for next year. And also any policy or kind of guidance in terms of how you are going to determine the level for 2013?

Right now I think it’s an annual policy review and we are planning to review it during the course of next quarter.

I just wanted to focus on the pace of acquisitions and maybe I’ll ask it in another way. So with CSWI, it looks like you are probably on track to exceed $100 million in capital deployed in acquisitions this year, which is a historical high.

How do you characterize this year in terms of acquisitions? Would you say it's an ideal year in line with targets or would you call it more of a fantastic year coming off the depressed levels or any other way you would characterize it.

I think I’d rather characterize it in terms of our capacity. So I feel like we are very busy but not yet frantic on the acquisition front.

John any…

I think that’s a fair way to portray it. I mean we obviously increased our effort last year and we are at the end of the strategic review and part of that is the catch up due to the low capital deployed last year, and also our increased exposure in Europe is creating a kind of a new level of expectations of about -- of the amount of capital we can deploy.

One of the things I worry about with acquisitions is they tend to be in the instant and exciting and so they tend to attract management attention and activity. Whereas organic growth tends to be a very long pull and is probably the hardest thing that we do in the vertical market software business or in most software businesses.

And so I worry that it would be easy to consume our GMs in acquisitions and divert them from an organic growth focus.

I believe organic growth adds tremendous value if done well. I just think it’s incredibly hard to do it well.

And so if you'd like to have an effort split amongst your general managers, you’d certainly like to see them still putting considerable effort into the organic growth to try and get it to be more and more efficient.

And just following up on that, in terms of capacity, what are some of the things you have done in the past year to expand your capacity to make acquisitions?

My sense is that we have increased the engagement of senior mangers down below the operating group level, so that we have folks looking to deploy capital down at the business unit level and viewing it as an important part of what they do.

In a number of instances that’s become part of their compensation, deploying capital or at least part of their objectives and so the sort of obvious focus on it is there for those mangers. But I think it's also become part of the playbook as we discover how incredibility hard it is to take clients in a lot of our verticals and we see that in our own attrition numbers where we keep clients for many, many years, decades.

It's very tempting to pick up market share the other way, via acquisitions. So the 2 focuses, the 2 foci, would be share of wallet through organic and share of market through acquisition, and I think that message is fairly clear to all our business unit managers as they go about their day-to-day job, and I think a number of them have been able to do tuck-in acquisitions.

And then moving on to organic growth, you break out PTS from organic…

One other commentary before I leave. I don’t want to give you the impression that we haven’t stepped out elsewhere in the acquisition process, because in Europe we certainly have.

John was posted over here for a while. We have hired a number of folks in Germany.

We are working hard in Europe to beef up our acquisition activities.

Okay, that’s helpful. On organic growth, you segment out PTS from organic growth.

I was just hoping if you could look at it on a revenue segment basis. So without getting into specific numbers, would you say that organic growth on the software business, so license and maintenance, is more resilient and perhaps has been positive this year, whereas services and hardware organic growth is much more volatile and perhaps that’s been the drag in organic growth over the last couple of quarters.

From 30,000 feet I’d say you are right, but John, do we have any crisp numbers on that?

I don’t have fresh numbers, other than I would start with maintenance in terms of that would be the most resilient area of organic growth and then work your way through the other revenue streams you mentioned, but we don’t crisp data at this stage, Paul.

You’ll be able to get some of that when we do our attrition analysis in the spring, because we break out the organic growth and maintenance for you.

Okay, and lastly one question, you’re a large holder of Mediware, which has been acquired by or being acquired by Thoma Bravo and there is a $9 million net change in the fair value of available for sale equity securities in your Q3 results. How much of that gain will you recognize on the Q4 income statement?

I’ll take this one, Mark. If the company is sold in Q4, it’s going through a tender process, our gain, that gain that you recognize as only in Q3 we’ll have a gain much larger than that based on our cumulative gains since we acquired those shares, and that will flow through the P&L.

Thank you Ann. Well, thank you all for attending, I appreciate it and I look forward to chatting with you again after the Q4 results.

Bye-bye now.