Constellation Software Inc.

Good day and welcome to the Constellation Software Inc. conference call and webcast conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by 0. After today's presentation, there will be an opportunity to ask a question. To ask a question, you may press star then 1 on your touchtone phone. To withdraw your question, please press star then 2. Please note this event is being recorded. I would now like to turn the conference over to Mark Miller, President. Please go ahead.

Good morning, everyone. I just wanted to start off by reminding everyone we have the annual general meeting coming up this Friday, and we're hoping today to take some quarterly questions on the financial results for Q1. Thank you all for attending. I have both Bernie and Jamal with me to help answer any of those questions.

Over to you.

Thank you. We will now begin the question and answer session. To ask a question, you may press star then 1 on your touchstone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster. The first question comes from Thomas with BMO Capital.

Hi, good morning. Maybe one for Jamal to start. So just on the margins for the quarter, I know you have the Q1 payroll taxes and that there were some synchronous related costs at Lumen. Is there anything else that you might call out in terms of margin dynamic this quarter or nothing unusual of note?

Yeah, I mean, there were a couple other acquisitions that were a bit of a drag on margins, like the Q1 cohort of acquisitions themselves were actually a negative margin for the quarter, which we totally plan to improve them, and it's a typical thing where we improve margins over time, but it was a bit of a bigger drag this quarter than previous quarters. But if you look down the line items of what's impacting margins, you can also see hardware margins were slightly down. Again, that's not one of our core products, but again, it was 43% margins versus 46%, and that had about a 20 basis point impact on margins. Professional services, again, if we're making acquisitions and using third-party services, and then also on the, sorry, professional services, and then also on third-party maintenance, you can see that's up a bit as well. which, again, nothing material to call out, but as we use a lot more of these third-party providers and, you know, for coding, et cetera, like you'd expect that to pop up a little bit as well.

Great. And then one for Mark. Now that it's been a few more weeks into the SaaSpocalypse, have you been starting to see private market valuations for larger assets come down, or is that not a dynamic that's transpired just as it is?

Not really. Bernie and I were just chatting about it before the call, and he was saying maybe slightly, but Bernie, do you want to elaborate on that at all?

But not really. Not really. It's really at the high end, we could see it maybe plateau a little bit, if not declining slightly in terms of valuations, but at the low end where we play with most of our acquisitions, not at all.

Great. I'll pass the line. Thank you. The next question comes from Stephanie Price with CIBC.

Good morning. Thank you. Just to that morning, just to that comment about the payroll taxes on the last question, just curious if you've been discussing any changes to Constellation's bonus plan, just given the public market reset, and maybe related how you think about employee retention in the current environment.

Yeah, so we haven't made any changes to the plan. And I mean, I think I, me personally, I say this is a great buying opportunity, right? I don't think we need to change the plan as a result of that. So the formulas for the core management team stays the same. We still buy shares in the market, same way we always have. And again, we believe in the company. And so, yeah, there's, no, there haven't been any changes to the plan.

Okay, great. And then Constellation typically sees kind of larger deals in more difficult environments. I know this is us, a very interesting time right now, but can you talk a little bit about the large deal pipeline and the appetite for bigger deals at this point?

Well, we're invited to a lot of, um, uh, auctions that are out there by the investment bankers. And sometimes we're able to play, sometimes we're not, um, valuations are still high. Um, so we try to get what we can, but competition is still fierce. So, um,

Yeah, the only thing I'd add to Stephanie to that is that I think we also have better talent to work on those larger transactions than we would have had, let's say, five to 10 years ago. And you need it because they're complicated. There's some hair on them and they're usually spread out over multiple geographies and sometimes are carve-outs from large companies and having experienced people who are capable of doing that is probably something we didn't have. So that helps us a bit, but again, it does come down to valuation for us. And I do think we're on the field, at least more, let's say, playing and trying to win those than we maybe were five to 10 years ago.

That's great, Colin. Thank you.

Thank you. The next question comes from Jaron Dubroy with Des Jardins.

Hey, good morning. Thanks for taking my question. So I just want to ask about the broader software strategy there. We've seen Salesforce launch a headless solution. They're focusing on offering API access that can be leveraged by agents. I understand horizontal and vertical solutions might be very different in terms of how they will approach their integration in the AI world, but do you expect this strategy, you could take this one as well, or maybe VMS is so different that you don't need or you don't anticipate as much change to the UI paradigm over time?

Well, it's like I would say it always depends on which business you're in inside of Constellation. We have many, many businesses and some will have to build agents and some will have to modify the user interfaces, but many won't. I mean, customers are obviously hesitant to change their user experience because it's something that their team uses all day to run their business, right? So changing user interface is a way to interact with the software is a big decision for a client and they take some consideration before they do that. And one of the things that I always find talking about artificial intelligence and the changes in technology is essentially you have to convince customers to change their user experience as well, which in some cases it requires budgeting, approvals, multiple levels of discussion inside of that customer for our mid- to large-size customers in particular. So it will evolve as the market evolves, and we just make sure our people are as educated as they can be on these new ways of building software and adjusting to those changes. And we'll talk a little bit more about that at the ATM as well, get a chance to talk about some real examples on Friday.

That's great. Thanks. And then the second one, another one on the evolution of the software model going forward on the forward-deployed engineering. Is this something you believe in? Could it be initially maybe bringing a bit more cost when you kind of adjust to the new model and have some BU started leveraging the strategy more?

Definitely. Yeah, there'll be some more cost in doing that initially because you're going to be kind of retooling where they need to do it. And some are doing it in advance just to make sure that if there are some changes inside of their markets and new needs for new ways of interacting with our products, they're using it. They're also using it to also try to expand inside of the customers as well, which is what I'm hoping to see more of for our more... are more, let's say, close to customer innovative businesses across the world, that they use it to step into other areas of the customer and interact with them more because we do have, because we're so vertical, we have so many different teams in this decentralized environment of Constellation who are out really close to customers in many countries around the world in many different markets trying to figure out how to make customers' businesses run better.

Great. Thank you.

The next question comes from David Kwan with TD Common.

Thank you. Good morning. I was wondering if you could talk about how the first couple of months have gone with Sabre. How are you working with their leadership team in terms of strengthening their business and how receptive, I guess, and cooperative have they been?

Yeah, I think Generically, we really don't want to comment on Sabre, David. It's just something that is left to our – we have a representative on the board there, and the conversations between Sabre and our director are, I think, kept private and confidential.

Okay. From an M&E standpoint, you obviously had a pretty strong start to the year, and also for Q2. As it relates to the Q2 to date closing pending deals, other than the Derby soft deal, are there kind of any larger, chunkier deals that I guess weren't large enough for Constellation to press lease, but maybe were much larger than your typical run-of-the-mill deal?

Yeah, there were a couple of larger ones. I think, yeah, we're not going to disclose the amounts, but there was a couple of larger ones and a whole bunch of small ones. Great. Yeah.

Yeah. Thanks, Jamal. And then are you guys just seeing anything different in the M&A environment that's allowed you to be this active on the M&A front over the last few quarters you're here? Or is it really just kind of like the ebbs and flows of your M&A strategy in the overall market and you're just kind of going through a good patch here?

Yeah, it really is the latter. It just comes and goes up and down as the market evolves. We don't see more transactions than usual. We don't see less transactions than usual. It's just the same amount across the market as we've always seen. So nothing's changed. There's a real disconnect between the cesspocalypse publicly traded stuff and private markets. But yeah, it's just ebbs and flow of the market.

And it's like any, you know, sorry, David, go ahead.

No, I was just wondering, like, are you seeing maybe changes in the behavior of the targets, the sellers, you know, particularly given what's going on with AI that maybe being part of the Constellation family is a better place to be? Or is there anything else that's maybe drawing this elevated activity? Yeah.

No, I think we've remained patient. We deploy capital very, very carefully. And I think we, as I think I said to Stephanie earlier on, I think we do have a bit more talent who are able to think about those larger transactions than we previously did. That might give us a little bit of a better coverage and close rate on some of those, but it's still, the world has not changed from our viewpoint. It has not. So we'll just continue to plug away at this problem and keep working on it.

I appreciate the color and look forward to seeing you guys on Friday.

Thank you. Looking forward to seeing you too.

The next question comes from Graham Rhodes with Long River Investment Partners.

Good morning, everyone. Can you hear me? Yeah, I hear you perfectly.

Excellent. I'm calling all the way from Hong Kong, so I just wanted to make sure. I'm calling to ask, first and foremost, as someone looking from the outside into your business, I'm trying to think about how to categorize the portfolio of companies that make up Constellation Software and the threat that AI might pose to them. And I'm thinking, you know, there's maybe like a low-risk category where we have businesses built around things like mission-critical systems, systems of action, and then maybe there's a higher risk segment of the portfolio, which is more like marketing or lead generation or website construction and that kind of thing. And I was wondering if you guys broadly agree with that classification or categorization, and then maybe as well if you could comment at all on whether the higher risk category makes up a material part of your revenue and FCF, HUS, and that kind of thing.

No, I mean, it's pretty broad, the places we're in, and When you're looking at how defensible a particular business is in any environment, considering whether it was SaaS or threats because of mobile computing came out or now because of AI, I always say it's a beauty is in the eye of the beholder situation. You can kind of try to say, well, this business is more at risk because of this. There's a couple of things that you need to really understand about our businesses is Sometimes, even though they might be in more, let's say, I consider sort of horizontal-esque, if you want to call it, and you think more vulnerable places, it depends on the addressable market size of that particular niche and how defensible it is and how close they are to their customers. And then on the other spectrum, you have ones that generally have lots of departments involved and they appear to be more sticky as well because of that. So it's very difficult to do that in any sort of quantitative way. It really depends on the leaders of that business. We're so decentralized with hundreds and hundreds of businesses around the world. It depends on the leaders of that business to just make sure that they care of the niche they're in. And we're generally not taking on very large, horizontal companies in many of our niche-y verticals, niche-y place, because that's sort of how we defend our market position by being small and intimate with dozens or hundreds of customers, not trying to have tens of thousands of customers. So I don't know if that makes sense to you. And where you're going to get attacked by AI is, if it is a problem, it's going to be maybe where you least expect it. You'd expect any time there's a high-churn, high-attrition business, maybe more so, but that isn't a large percentage of our recurring revenues anyways. Yeah, so it's just a difficult question to answer. You can cut it in so many different ways. We just will depend on our leaders to find the best solutions for our companies in each of the situations they're in.

Excellent. That's really helpful. A follow-up would be, just in the last couple of months, really since the start of the year with the launch of cool code and open core and agentic AI. I was wondering if that's changed your perspective at all on the competitive risk. And if not, like what would it take for you guys to see this less of something that can enhance productivity and more of something which can be a direct threat or even an indirect threat on like pricing and your ability to sell like other modules and that kind of thing.

You know, pricing, like I always say, the way we lose customers is, A, they essentially go out of business, which happens. You can't do much about that. They're acquired by other customers, particularly larger customers. That's another way of losing. You can't do much about that. Other than you hope the other customer that buys them is your customer. Pricing is the third, and pricing, rarely we lose customers on pricing because the switching – painful for customers and it's working and they're using it and retraining all their users and adapting the interfaces to make work and make it harder. Where you lose customers is when you can provide, when the competitor can provide something much different than you can provide that the customer really needs. And that's where I always worry the most, just generically, forgetting about AI. So that's kind of how I sort of look at it. Now, as far as these tools, you know, we're all using them internally. And I've been fortunate enough to travel around. I think each week I've met with a different group across Constellation, different location, and just see what they're using and what they're doing. And they're, you know, they're adapting to these tools, using them internally to help them run their portfolios, their businesses better. But they're also using them to try to develop more software to actually expand our presence inside of customers more so than defend our presence is kind of the thinking. But It's going to depend on our business. So I look at these tools as an opportunity to do more for customers, not do what we currently do more efficiently, although that will happen in some cases.

Okay, that's really helpful. And the final question for me is just on PEMS, which you guys introduced last quarter. And I was wondering, when you're thinking about making an investment, a minority investment, Do you have a different hurdle rate for that than you would for your standard wholly owned M&A? And then related to that, you know, for a very long time, we've used free cash flow available to shareholders as, I guess, the yardstick of our company's progress. And I wonder if these minority investments grow over time, would you suggest that we start thinking about something else to anchor valuations on or the company's progress?

Thank you.

Yeah, so in terms of PEMS, the hurdle rate is the same. However, the modeling in terms of the weighting of worst case versus winner case are going to probably be much more dispersed, and so will probably result in a lower price, but the hurdle rate is the same. In terms of going forward and the free cash flow available to shareholder metric, that is something we've been discussing and And internally the way, and many investors know this, the way we bonus ourselves internally is something called like it's an economic net income. It was very close to what we used to have as adjusted net income. And for these types of PEMS investments, we would actually look at our pro rata share of their ultimate cash flows, which doesn't show up in our current statements. So it's something we're thinking through right now to try to maybe give you investors the same metric that we're using internally And again, I haven't finalized, it's going to be a discussion on how we, what we present, but it is, yeah, I understand your point that a free cash flow available to shareholder metric is sort of, it doesn't pick up anything relating to these PEMS investments in most parts.

Thanks guys. That's been very helpful. I appreciate it a lot. Thank you.

Thank you. Once again, if you have a question, please press star then one. The next question comes from Paul Treiber with RBC Capital Markets.

Yeah, thanks, and good morning. Mark, open-ended question, but just overall, how do you characterize the quarter? If you could call out what you think was better than expected or what maybe improved versus the last couple of quarters, and then conversely, what do you think needs some improvement?

M&A, obviously, was positive because I'd rather... be getting capital out now rather than at the end of the year. It's sort of like any business. You'd rather get more capital out sooner. From a performance issue, we were expecting the adjustments to Ipatob because of the acquisitions we made. So I don't think that was unexpected. And I think that's why we actually explained exactly how that happened. I continue to pressure our businesses on organic growth generally, Paul. I really would like to see them doing a better job on organic growth across the board. And I think this is an opportunity to push them harder on that with the advent of some tools to allow you to do things a little bit faster and a little bit better. But that's a generic concern that isn't just in the quarter. So maybe I've not answered your question. So other than that, you have Bernie, Jamal, anything to add to Paul's question?

I'd say it's a pretty big standard quarter, so it was expected, like organic growth in line with historical norms. All of these initiatives, I mean, we're saying that we're doing a lot, but it wasn't an expectation that we're going to translate that into revenue growth right away. It's going to take time, right? And then you have to sell it into your customer, et cetera. So that was always expected to take some time.

And just to reiterate what you said about M&A, happy that the first quarter and the bit seem to be going quite well. Hopefully we can continue throughout the year.

That's helpful. The second question, Mark, you've been in the president role for six months, probably just over six months. Any leadership style changes that you're bringing to the role? And then in particular, how... How has been interacting and managing, you know, the broader operating group leaders versus your prior role at Valeris?

They've been great, Paul. Like, just terrific. You know, we had a board meeting yesterday out near the airport. And, you know, just, you know, all the operating group leaders are fantastic. After the meeting, we're sitting together working on things and talking about how we can improve. I'm just super happy with the team across Constellation. I think the collaboration is at an all-time high between the operating group leaders and everybody's very engaged and working closely together. I'd have to say sharing best practices at a high velocity around anything we're learning about, for example, AI and because there's just so many ways to combat that problem. So I'm super happy, Paul, with where things are at.

All right. Thanks for taking the questions.

Thank you. This concludes our question and answer session. I would like to turn the conference back over to Mark Miller for any closing remarks.

Yeah, I just want to thank everybody for dialing in, and we're really looking forward to seeing everybody at the AGM, and of course, thanking all of our team across the world for helping us deliver Q1. So over, we'll see everybody on Friday that makes it to the AGM, and thank you, Bernie and Jamal as well. Over and out. Thank you.

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.