Constellation Software Inc. (CSU.TO) Q3 2026 Earnings Call Transcript

Operator: Good day, and welcome to the Constellation Software 2026 Third Quarter Results Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mr. Mark Miller, President and COO. Please go ahead, sir.

Mark Miller: Well, good morning, everyone. Looking forward to chatting through our Q3 results with you and taking some questions. So I'll keep some opening remarks short, and then we'll move into questions. Just as you could see from our release, revenue for the quarter was $3.5 billion, which was up 19%. Our organic growth was 2% and I want to spend a little bit of time just sort of speaking to how we think about organic growth and what's underneath that 2%. In itself, it doesn't tell you the whole story. The measure we actually care a lot about is watching maintenance and other recurring revenue. And that's important because that's where the customer base shows up and how our customers are continuing to use our systems over time. So it's something in my decades at Constellation, I spent a lot of time thinking about and watching. And our maintenance and recurring revenue organic growth was 4% in the quarter. And the gap between the 2%, which was the overall organic growth and our recurring revenue organic growth was pretty much because licenses were down 17%, which is -- licenses are pretty immaterial to us these days, and professional services were down 5% and both of those numbers are fairly lumpy. So the actual 4% recurring revenue growth in the quarter was a reasonable outcome for us. Underneath the number, it's important you understand a little bit about some of the businesses we have in there. So -- and if you look to the MD&A, you can sort of see that if you took out our U.S. health care businesses and in particular, Altera, maintenance and recurring revenue growth would have been about 5% which is pretty much a similar outcome to what we've had since 2016, which is a series that we published for you in the MD&A. And it generally vary between 5% and 7%. So it's a pretty normal quarter for us in pretty much every year, but I think one in 2020 where it was 1%. So we thought it would be useful to put that table in for you, so you could actually see and understand that. Health care is an area where we have seen more shrinkage than we normally would. And there's been a lot of consolidation in that space. In fact, our whole U.S. health care businesses were down by about 10% in the quarter against the 1% last quarter. And in actuality, most of that step down was 2 new businesses we acquired that we knew when we acquired them were going to shrink. And actually, the way we measure shrinkage in our business, organic growth is we take into account the businesses prior to our ownership of them. So we really weren't even responsible for the shrinkage of those particular businesses. And we're working really hard with all of our health care team to make sure that our businesses do provide great service to their customers and hopefully will organically grow at some point. But it's pretty important to understand that we did model that into the investment thesis. And all of our actually health care investments that I've mentioned today are expected to perform to our IRR expectations that we underwrote, including the 2 where we've seen that shrinkage in the quarter. Excluding the 2 businesses that we recently acquired, the healthcare group would have been down about 3% overall. So not as bad. So now I thought it would be useful to talk a little bit about cash. Cash from operations was $717 million, which was really up 5%. Now we use a calculation called free cash flow available to shareholders, and that was at $443 million, which was down 16%. But I think it's important that I explain to you how that actually works. For those of you who do not follow the mechanics, we have an obligation to the minority partners in Topicus, and we have to revalue it every quarter. Its value moves with 2 things: Topicus' recurring revenue and the Polish shares Topicus holds in a company called companies Sygnity and Asseco. When either goes up, the obligation goes up, and we deduct that reevaluation arriving at free cash flow available to shareholders. The quarter's charge was $117 million. A year ago, it was $16 million. Hold that one line flat and free cash flow was up about 3%. And of this quarter's $117 million, roughly $77 million is simply the Sygnity and Asseco share prices rising. The rest is Topicus' recurring revenue growing. So the charge went up because Topicus grew and because something we own became more valuable. It is noncash in the period, and I'm not going to tell you it is meaningless because there's a real obligation sitting behind it, but it is not a deterioration in the business. And I didn't want anyone reading down who read the 16% down and concluding that's what it was. One last thing is I would expect that we might get asked about AI today. On AI, there is an enormous amount of work going on across our businesses and nearly all the learning is happening inside of them rather than at head office. We have more than 1,600 businesses across the world in dozens and dozens of vertical markets, and many of them are running experiments right now in their products, and how they support their customers and how they write software. Some of those experiments are already paying for themselves and plenty of them are not. The part I would actually like to point out to you is the best practice sharing, and I've mentioned this before. That has been the engine of this company for 3 decades, managers teaching each other what worked and more usually what didn't. And I've never seen it run as hard as it is running on this. A company with one product or a handful of products runs some experiments at one time. We have many, many, many running at once and the results travel. That is a real advantage, I would want you to understand, and it's not one that you can buy. So I'm very, very proud of the team and how hard they're working on AI. I would describe us as experimenting hard, running quickly and still early. The spend is not currently material to our results, and I'm not going to give you a forecast. What I can tell you is that nobody here is waiting to be told what to do about it. With that, we'll take your questions.

Operator: [Operator Instructions] And our first question for today will come from Doug Taylor with National Bank.

Analyst Doug Taylor: Question for Mark. I think you articulated the Altera situation well last quarter, and I appreciate the added disclosure about the broader U.S. health care unit, even excluding Altera. I know you said Altera was expected to be a managed sort of runoff for the next couple of years. Does that same time line and discussion apply to the broader challenges with the U.S. health care unit?

Jamal Baksh: I mean the U.S. health care unit is made up of probably like 50 different small businesses, and each of them have their own pros and cons, et cetera. Like, I broke out the group combined, which is sizable. But yes, I wouldn't be able to generalize the same way like the dynamics that were happening in Altera across the entire U.S. health care group. I think what we said in there, though, is we continue to invest and support our customers. And we just -- it's just a very difficult market because of the consolidation that happens because of Epic, et cetera.

Mark Miller: Yes, I personally wouldn't extrapolate that at all. Like I really would look to our business leaders to continue to think about how they could grow those businesses. Generally, when we're acquiring shrinking businesses, they shrink for a period of time because you want to stop doing some things. And hope that you -- at the point you stop doing the things that aren't working out as well for you that you can then use that as a basis to grow it. So we're very careful to make sure we're getting good returns on those investments. And I'm perpetually preached we want to grow those businesses when the time is right, but not at -- not irrationally generating low returns on the incremental capital we're investing in those businesses. So we'll make that rational decision, if that makes any sense.

Analyst Doug Taylor: I'll ask one more. I mean, clearly, a very strong year for capital deployment, which looks set to continue here in the near term. I mean given the sentiment towards software has had such a roller coaster ride this year, climbing out of it. I guess I'm curious if some of the behavior of some of the owners of software assets that you speak to regularly has continued to evolve. I know you don't think of these things in terms of quarters, but it's been quite a year. So any comment there would be helpful.

Mark Miller: Yes, Bernie, I'll let you speak.

Bernard Anzarouth: We've been very busy, as you could see for the first 3 quarters of the year, and that activity is still ongoing. I don't know that there's a massive trend for everyone throwing in the towel in a software business. I think they're just selling as they feel like selling. In the public markets, you see the big fear that happened at the beginning of the year. Prices have bounced back since then. So I just feel that there's more activity for us in general. I think our people in the M&A world and the BD world are stepping up, and they're doing an excellent job against competition. We still have a very healthy amount of competition. I understand from just what I read in the press that large platforms are selling less, harder to unload these days, but private equity and those platforms that exist today are still adding tuck-ins and still competing with us. So still a healthy amount of competition in the software world.

Mark Miller: And there's many businesses that don't transact either, right? Like during 2008, it was a tough time out there for people to be very nervous about what the future held, right, as through COVID and good businesses don't want to sell unless there's another reason because they feel -- they know their customers just as our businesses do, they listen to them, and they continue to see their business in doing okay. So it's -- I don't think any of that's changed. It really hasn't changed.

Bernard Anzarouth: And M&A generally is lumpy for us, and it always will be. And so we've got a great year so far, and hopefully, it will continue.

Operator: The next question will come from Thanos Moschopoulos with BMO Capital Markets.

Thanos Moschopoulos: Daan was appointed Chief AI Officer, and that's interesting as a central head office role. And as you alluded to, you have a decentralized organization. Can you provide more color on how he'll be approaching that role? Will his focus primarily be about propagating those best practices?

Mark Miller: It will be mostly about best practice sharing for sure. Daan is a really smart guy, and he's respected by all of our leaders across Constellation. And any way he can help transmit best practices from an AI perspective is well worth his time doing that. And I'm super happy he's taken on that role. It's a classic head office role where you're really not in control of anything, but you share information as much as you can to help people do what they do better. So I'm really happy he took that on.

Thanos Moschopoulos: Great. And can you update us on your verticalization strategy and where things stand as far as the implementation of that?

Mark Miller: Yes. It's -- we're mostly through it. So there's a few loose ends we're kind of working through, but we're mostly through it. And yes, it's been a big effort for the team here on top of also spending a lot of energy on AI this year as well. So I'm very happy with that. They've done a great job. Our operating leaders getting that.

Thanos Moschopoulos: For context, would that -- would the majority of your revenue fall into buckets that are now verticalized or -- just to get a sense in terms of the order of magnitude of this initiative.

Mark Miller: It'd be substantially more than -- let's just say more than half would, right? So just to give you a rough idea. So yes. And of course, there's -- when you're doing verticalization, there's a bit of beauty is in the eye of the beholder situation as to how crisp that is. So there's still some flexibility around that. But there's just a better focus. It was kind of putting businesses sort of in the same format as my expression to use being Constellation so that they still can do what they need to do. And yes, so that's sort of the situation there.

Operator: The next question will come from Jerome Dubreuil with Desjardins.

Jerome Dubreuil: Maybe first question, goes in line in the MD&A talking about an increase in expenses on professional services fees paid to advisers in relation to certain larger, more complex transactions. Are these deals done now? And is this something new that is being explored by the team or just larger deals kind of in the line of the things that were done in the past?

Jamal Baksh: Yes. I mean the expenses I'm talking about like for tax analysis or legal analysis, different countries, et cetera, it wasn't -- yes, it's not that we're paying advisers to bring us deals, et cetera, it's just more third-party advice as we're doing diligence.

Jerome Dubreuil: And the second one is on free cash, I guess, lumpiness. Mark, you talked about the IRGA valuation that is well noted. The other one that we noticed is on working cap. Just something that is typically lumpy. Is there something new there? Or we should be expecting some sort of reversals in the coming quarters?

Jamal Baksh: Yes. I mean that number, like you said, it is a lot to do with timing. I mean we do a ton of analysis around AR, WIP, aging, et cetera, and there's no concerns there. I always point out one thing with that line item, like if we buy a business with a ton of positive working capital, we might pay more for that business, and you'd have the price an increased price go through cash flow from investing. And then we could collect that cash the next day and you get cash flow from ops. You could buy that same business had negative working capital. Let's just say we bought it 2 days after the collections. You pay less for it, but then you wouldn't get that pop in working capital, right? So it's not purely like an organic number, like it is influenced by the timing of what the type of businesses we're buying and when we buy them in their cycle of cash flow.

Mark Miller: Yes. We're carefully including in the ROIC calculations, too for that business, right? So you're right on, Jamal.

Operator: The next question will come from Stephanie Price with CIBC.

Stephanie Price: Just want to circle back on a few topics we've covered already. Just on U.S. health care, hoping you walk through your thoughts a little bit more on the opportunities in that vertical and how you think about the investment opportunity in U.S. health care despite organic declines here?

Mark Miller: Well, the way our leaders look at investments is on an opportunistic basis. So they're designing products that they believe might attract more growth inside of their business units. So I think Jamal put it correctly, like it's a number of businesses in health care. And you have to look at each one of them individually as to what the opportunity is and if it makes sense to invest our shareholders' capital in building something new for those particular businesses. So it's a difficult question to ask generally. It's nice to kind of group U.S. health care together and say, but it really is a bunch of businesses. Altera is a large disproportionate business. So it kind of sways the whole group a little bit more.

Stephanie Price: Yes. Okay. And then just on M&A, obviously, nice to see the deployment year-to-date. Just curious, amid efficiency gains, how should we think about the time line to bring these businesses onto the CSU model? Has there been any change there? Or how are you thinking about improving margins once you acquire these businesses?

Bernard Anzarouth: I would maintain the same time line. Of course, once we bring these businesses in, we're infusing them with all of our AI best practices as well. And really, time will tell if that will accelerate in terms of changing the time line towards higher margins in the shorter term. And so we're not ready to say that yet.

Jamal Baksh: I mean I think I pointed out in Q1 that we had what was a negative 16% margins with that cohort of the Q1 acquisitions, like that cohort is now at 27%. And the same thing like the Q2 cohort went from 12% to 21%. So they are improving. It's just that we're making so many acquisitions that it's still a drag on our overall. But no, they are being improved. It's not a different pattern.

Operator: The next question will come from Kevin McVeigh with UBS.

Kevin McVeigh: Congratulations on the results. Just to follow up on that, it's great to see the accelerated pace of M&A. Is that just valuation opportunistic? Just any thoughts because it's great to see the incremental capital deployed, but what's giving you that confidence, I guess? Or is it just opportunistic transactions?

Bernard Anzarouth: Still opportunistic transactions where we've got a lot of M&A people out there globally. And so we hope to be the first ones there when a business is for sale and hopefully beat the competition. And so there still is very robust competition out there, and we'll see what the next few quarters look like. But right now, I'm very pleased with the way things are going.

Mark Miller: Yes. I always add to that is I really think we've built better muscle to do larger transactions as well. We wouldn't have had that capacity in like a decade ago, Kevin. So it's kind of nice, we have a good team who are able to make these fairly large complicated transactions happen when still at least we can be in the game and on the field, and we might win one of those that we maybe wouldn't have had the capacity to do previously.

Bernard Anzarouth: And all the knowledge we built up over the history of our M&A, we use all of that knowledge to help us make new acquisitions, and it seems to be working out really well for us.

Mark Miller: So true. Yes, the best practice sharing in acquisitions is crazy.

Kevin McVeigh: That's great. And then just real quick, are you seeing any client behavioral patterns? I mean the AI debate has been out there for a while. It seems like the business is steady as it's ever been. But are you seeing anything underneath in terms of clients looking to leverage maybe certain best practices from you folks or certain capabilities more than others as they not only respond to, obviously, AI efficiencies, but as they work through that in their own business models?

Mark Miller: Kevin, I wish I could say there's some big trend to see, but it's -- there'll be individual clients who are trying to maybe do a little bit more with AI that you hear about. But across the board, we're not seeing that, right? So I think our stronger businesses can get stronger. Our weaker businesses that have high churn rates, and that's a small percentage of recurring revenues. I think they'll always -- they've always had such a lower long-term -- like a lower LTV like to keep the customers around. So I wonder about some of those businesses. But overall, I wish I could say there's any like general trends we're seeing. So nothing really.

Operator: Your next question will come from David Kwan with TD Cowen.

David Kwan: So for acquisition targets that are kind of more outside of the traditional VMS businesses that you've targeted, especially maybe areas where you don't have much current exposure, can you maybe talk about how your approach is in terms of building out the investment cases for these types of opportunities? Like do you take a different and maybe more conservative approach to the forecast or maybe you're using a higher hurdle rate to account for that greater risk with these types of businesses because your playbook probably doesn't line up great versus more traditional targets?

Bernard Anzarouth: Well, as you know, we do build 4 scenario models. And any time we go outside of our little patch of VMS, we build more dispersion in the models. So your wipe out is going to be a lot worse. Your winner is going to be a bit better. And we use that with the probably-weighted model to figure out what price to pay. And we believe that the models or the scenarios capture the upside and the downside. And where we're less comfortable, we make the lower cases just a bit worse. Hope that helps.

Mark Miller: Yes. I think one of the things we're looking at more horizontal businesses, you got to really think about the size of the addressable market. The addressable market is outrageously large. You got to really think about that, right? Like how are you going to be able to cover it properly, what have you. So we go through all that in kind of our modeling exercise and debate that stuff as far as what it could be, right?

Bernard Anzarouth: But it's not like we're buying businesses that compete with Microsoft and Oracle maybe. But we try to find niche businesses even in horizontals, even in geographies, anything that has a moat and a few moats is what we're looking for. So in that sense, we believe that those businesses are relatively well protected. So we're not going into the wilderness buying anything that moves. So...

Mark Miller: The behavior looking at that stuff hasn't really changed over the past few quarters, right, Bernie?

Bernard Anzarouth: No.

Mark Miller: We always do, the one we always have.

David Kwan: No, that's helpful. There was actually kind of -- I assume it was a tuck-in, but a smaller maybe managed services businesses that I think you guys acquired in Brazil. So like I said a little bit more outside of your traditional hunting ground. So I was kind of curious how you would approach a business like that.

Bernard Anzarouth: Same approach, higher dispersion. That's really how it works.

Mark Miller: Yes. Calculated. Yes, but just think it through.

David Kwan: Okay. And then just one other question on M&A. Are you seeing the valuations start to come down for the private companies? Or are they kind of staying fairly resilient? Is there any impact from -- I know the 10-year yields come down recently, but still quite above where it was at the start of the year. So are you seeing any impact from higher rates?

Bernard Anzarouth: Not really. I mean there's some movement, but really generally, there's so much competition that's out there, whether it's a transaction that's leveraged or not, maybe that will be spelling out a slightly lower price, but not really that much because people still do have capital out there and they have to put it out. So prices really haven't been dropping that much.

Mark Miller: And some people don't want to sell the businesses...

Bernard Anzarouth: Some people don't want to sell...

Mark Miller: At this valuation.

Operator: The next question will come from Paul Treiber with RBC Capital Markets.

Paul Treiber: Just a question on the IRGA, particularly in regards to the fair value of Asseco and Sygnity. I think that agreement expires in 2031. At that point, yes, there's the liability. The fair value, is that set purely by the market price? Like if you disagree with the market value at that time, do you have an exit? Or is that entirely your liability?

Jamal Baksh: Yes. The agreement there and actually spending hours like finalizing a revised agreement on this is that Joday will get their proportion of the Sygnity and Asseco shares. So it's actually not a cash obligation. They will just get them. And they're valued for accounting purposes at the market rates, right? So it is what it is, and it's not that we will pay them that dollar amount. They will just get the shares.

Paul Treiber: Okay. That's helpful. Just secondly, just on Robin's retirement and then the appointment of Ramon. The -- you've gone through retirements of general managers of operating groups in the past. Can you walk through typically what you've seen with the change in management? Is it typically like a smooth handoff? Is there some adjustment or changes that typically occurs?

Mark Miller: Yes. I mean it's usually pretty smooth because most people have been around for a while, and we run CSI in such a decentralized way, you end up inheriting more portfolios to oversee. So I think that's generally how it works because we're sort of a large tree of capital allocators around the world, if you want. And you hope you have a lot of successors sitting there that will bump up into that role, and they do a very similar job to what they've historically done, just have an over -- a larger, we would say, capital base to oversee and to make sure they're sharing best practice, what have you. In the case -- in Ramon's case, pick up a little bit of more shareholder and investor relations that he wouldn't really have been involved in at all as in his role at Topicus. So it works really well at CSI because of the way we're structured. There's no like single points of failure.

Operator: Our next question will come from Teddy Farley with Jefferies.

Thomas Farley: This is Teddy on for Samad Samana. Congrats on another strong quarter. Just a few quick ones from me. So with some of our industry channel checks, particularly among vertical software companies on the smaller end, we've started to hear more cases of AI disintermediation. So within your portfolio of companies, are you seeing any evidence of this yet?

Mark Miller: Really not to any large degree. I mean there's some things happening, but it's not nonmaterial. I think I said before, I think really, continue your next question, Teddy.

Thomas Farley: So this is smaller, but on license revenue, I know you noted it's lumpy quarter-to-quarter, but was there anything in the 3Q '25 comp period that's worth calling out?

Jamal Baksh: Yes. Because it's so immaterial, I did not do a deep dive on that, so I couldn't even tell you.

Mark Miller: Trying to get most people moved over to subscription, if you can, in some form or another recurring. So...

Thomas Farley: Awesome. And then last one for me. Is there anything you would highlight on specific sectors you're seeing either more or less transaction volume on and it could be over the full year just because I know there's some amount of noise quarter-to-quarter.

Mark Miller: It's all over the place, right, Bernie.

Bernard Anzarouth: It's very generalized. I mean we go into all areas, all verticals, and it's opportunistic. So no trend in any one sector that I could see.

Operator: And this will conclude our question-and-answer session. I would like to turn the conference back over to Mr. Mark Miller for any closing remarks. Please go ahead.

Mark Miller: Well, thank you, everyone, for attending. And of course, I have to thank our whole team at Constellation for working so hard and continue to push ahead. So thank you very much over and out from Toronto.

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