Earnings Call Transcript - DSGX Q2 2020

Operator, Operator

Welcome to the quarterly results call. My name is Erin, and I will be your operator for today's call. At this time, all participants are in a listen-only mode, later we will conduct a question-and-answer session. Please note that this conference is being recorded. I will now turn the call over to Scott Pagan. Scott, you may begin.

Scott Pagan, Moderator

Thanks, and good afternoon everyone. Joining me on the call today are Ed Ryan, CEO, and Allan Brett, CFO. I trust that everyone has received a copy of our financial results press release that was issued earlier today. Portions of today's call other than historical performance include statements of forward-looking information within the meaning of applicable securities laws. These statements are made under the Safe Harbor provisions of those laws. These forward-looking statements include statements related to Descartes' operating performance, financial results and condition, Descartes' gross margins and any growth in those gross margins, cash flow and use of cash, business outlook, baseline revenues, baseline operating expenses, and baseline calibration, anticipated and potential revenue losses and gains, anticipated recognition and expensing of specific revenues and expenses, potential acquisitions and acquisition strategy, cost reduction and integration initiatives, and other matters that may constitute forward-looking statements. These forward-looking statements involve known and unknown risks, uncertainties, assumptions and other factors that may cause the actual results, performance, or achievements of Descartes to differ materially from the anticipated results, performance or achievements implied by such forward-looking statements. These factors are outlined in the press release and in the section entitled Certain Factors That May Affect Future Results in documents filed and furnished with the SEC, the OSC, and other securities commissions across Canada, including our Management's Discussion and Analysis filed today. We provide forward-looking statements solely for the purpose of providing information about management's current expectations and plans relating to the future. You're cautioned that such information may not be appropriate for other purposes. We don't undertake or accept any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements to reflect any change in our expectations or any change in events, conditions, assumptions, or circumstances on which any such statement is based, except if it's required by law. And with that, let me turn the call over to Ed.

Ed Ryan, CEO

Great. Thank you, Scott. Good afternoon, everyone, and welcome to the call. We appreciate you being here today. We maintained our strong momentum from the first quarter into the second quarter, achieving another set of record results. Our commitment to providing value for our customers is clearly paying off, as they are entrusting us with an increasing share of their business. We believe the market is currently more dynamic than ever. Global trade regulations can evolve daily, especially given the heightened state of trade sanctions and disputes. Economic and operating conditions can shift rapidly, leaving companies at risk if they cannot adapt quickly, and consumers are increasingly expecting higher levels of service. They often want something now, delivered within 24 hours, and at a convenient time for themselves. This environment creates significant supply chain and logistics challenges, even for the most sophisticated operators. Managing spikes in demand while maintaining efficiency during quieter periods is a delicate balancing act. We see this as an opportunity for companies that can stay agile and utilize the right technology systems, backed by timely and reliable information. Furthermore, businesses often need to connect with a broad community of supply chain participants to operate effectively and respond quickly. This is why we continue to invest in the Global Logistics Network, allowing shippers, carriers, and logistics intermediaries to connect, collaborate, and execute shipments in real-time. I will discuss the challenges and opportunities in today’s market and how our customers are using our network to turn these challenges into opportunities. Additionally, I'll provide updates on our recent acquisitions. Following our market update, Allan will give a detailed overview of our financial results, and I will conclude the call by discussing our plans for the third quarter and beyond. First, let’s review some key financial highlights for the second quarter of fiscal 2020. We had another exceptional quarter, and we are pleased with our key metrics driven by continued organic growth and successful acquisition integration. Our revenue reached $80.5 million for the quarter, reflecting a 20% increase compared to Q2 last year. Our adjusted EBITDA also showed strong growth, amounting to $30.2 million, which is a 32% increase from the same quarter last year. The digital compliance segment continues to significantly contribute to this growth, surpassing our initial EBITDA growth expectations. We converted 89% of our EBITDA to cash, generating a record $26.9 million in cash during the quarter. In line with our long-term operational plans, we have reinvested this cash back into our business through targeted research and development and by merging with complementary firms. Recently, we combined with CORE and STEPcom in Q2 and with BestTransport in August. I will elaborate on these acquisitions later. We also completed a public share offering this quarter, raising $245 million, which enhances our ability to make strategic investments as suitable opportunities arise. Overall, we have had another great quarter at Descartes, capping off a strong first half of the year. Our business is stable and cash-generating, and we have a solid balance sheet that allows for continued acquisitions and growth. Now, let’s discuss current market conditions and the tools we can provide to assist customers in navigating today’s complex dynamics. I would like to begin with some reflections on the North American freight market. If you recall the summer of 2018, we faced a capacity crunch, meaning there weren't enough trucks to meet demand, and rates kept rising. This summer, however, we are witnessing many carriers going out of business, indicating that some have struggled to adapt quickly to sudden changes in demand. Efficiency during market fluctuations is critical for survival. Historically, freight movement has been cyclical; what's different now is the speed with which market conditions can change and the technology available to optimize resource use during these fluctuations. During high-demand periods, improving resource capacity is necessary, which requires accurate information about current movements and available resources. In low-demand periods, leveraging that same information can aid in maximizing efficiency and maintaining profitability. Our MacroPoint capacity matching solution is particularly effective in supporting carriers and freight brokers with these challenges. Designed for collaboration between freight brokers and carriers, our solution facilitates sharing of capacity and load history to enhance network alignment and utilization. As I have mentioned before, our goal is not to cut logistics service providers out of the equation, but to empower them. We aim to assist logistics providers in responding to market fluctuations and self-organizing to identify opportunities for collaboration, reduce friction, and adapt to market pressures. We are expanding our capacity matching solutions and adding more users to our community, which is leading to growing opportunities to benefit our customers and help them succeed in this environment. Additionally, we are observing how this solution can facilitate sub-communities, which influenced our recent acquisition of BestTransport. BestTransport specializes in cloud-based transportation management systems for flatbed-intensive manufacturers and distributors. Operating within the flatbed sector requires expert knowledge of specialized equipment and transport management processes, creating a niche community within the broader freight market with its own unique challenges and cycles. BestTransport has built a solid business serving this specialized community with the necessary tools for shippers, carriers, and logistics intermediaries. Managing assets in a dynamic market can be particularly difficult for smaller specialized communities. We see a significant opportunity to introduce Descartes MacroPoint visibility and capacity matching to this segment. We are already generating interest from some BestTransport customers, and we are eager to explore the potential growth this partnership can bring. I’d also like to take a moment to welcome the BestTransport employees and community to Descartes. Moving on, I want to discuss our acquisition of STEPcom. As I consistently highlight, our network solutions cater to all supply chain participants—shippers, carriers, and logistics intermediaries. Logistics presents a multi-party, multi-process challenge, and success in building a network relies on providing valuable tools for every participant. By assisting this community in executing various processes throughout the shipment lifecycle, we enhance their business engagement and attract new members via network effects. Rapid onboarding of trading partners is crucial in the fast-evolving supplier and customer landscape. STEPcom has spent 15 years facilitating connections and collaborations among supply chain participants to automate business documentation and related processes. They excel in this area. With every shipment commencing with a purchase order, STEPcom helps automate processes leading to actual shipments. By merging with the Global Logistics Network, we can now assist this community in executing shipments with effective tools for real-time booking and tracking. So, a warm welcome to all STEPcom employees and customers. Through integrations like this, we are advancing our three-part vision for supply chain information processing. First, we focus on collecting source data, a process traditionally done manually but increasingly automated in today's IoT landscape. Second, we create a reliable network for storing and communicating that source data in a way that benefits the entire supply chain. Finally, we provide applications that harness this data to support better business decision-making. Our recent acquisition of CORE exemplifies these principles. CORE operates an electronic transportation network delivering shipment scanning and tracking solutions to global air carriers and ground handlers. Customers utilize CORE to track international mail, parcel, and cargo shipments effectively. CORE’s expertise in air cargo tracking identified IoT opportunities to enhance tracking of containers used by air carriers, known as ULDs—unit load devices. Managing ULDs is complex; CORE employs Bluetooth-enabled IoT technology to aid air carriers in asset management. Furthermore, integrating CORE’s IoT solutions with the Global Logistics Network will link shipment tracking to ULD tracking due to our possession of shipment data, leading to more real-time data events for the broader Descartes community, benefiting not just air carriers, but also forwarders and shippers. CORE also offers applications to visualize ULD and mail activities, ensuring accurate visibility of air cargo logistics. Collecting source data from ULDs via the Global Logistics Network, and applying information analysis through our applications, positions us favorably to enhance our services for the air cargo sector as we integrate CORE into our business. So again, welcome to the CORE employees and customers, and we are glad to have you with us. Speaking of integration, I know many are interested in updates on Visual Compliance. Earlier, I mentioned the constantly evolving regulatory landscape facing our customers. Trade complexities are rising, and the pace of changes is accelerating. To navigate duties, tariffs, taxes, and sanction lists, customers need timely, reliable information and systems capable of processing that information. We have been enhancing our content offerings in recent years to ensure customers receive accurate data when necessary. Visual Compliance offers software solutions, content, and services aimed at automating customs, trade, and fiscal compliance processes, prioritizing denied and restricted party screening procedures and export licensing. This acquisition complements our prior investments in trade content including Datamyne, Customs Info, and MK Data, another firm focused on denied party screening. Integrating Visual Compliance has expanded our capabilities in this area and added valuable functionality to our offerings. We are now six months into the integration process, and everything is proceeding well. We are beginning to see the benefits of collaboration between our content teams, which are now standardized with best practices, working together effectively. We are making solid strides in aligning our operations and streamlining content collection and normalization. Additionally, as we consider future product synergies, we envision leveraging Visual Compliance solutions alongside our Customs Info offering, for example. From a market access perspective, we have already observed synergies in our European operations. Our team there has secured several Visual Compliance contracts following successful cross-training efforts in the initial months. Financially, we are pleased with the ongoing growth in recurring revenue, and the overall financial profile of the business remains strong. The company is performing beyond our expectations, contributing to our overall growth exceeding our planned targets. Before handing the call over to Allan for insights into the financials, I’d like to take a moment to express gratitude to those who continue to fortify our business. Thank you to our employees for their dedication to ensuring our customers achieve results. Our customers are experiencing continued success, which underpins our business model. Thank you to our customers for placing their trust in Descartes as their preferred network. Whether you are a shipper, logistics intermediary, carrier, or even part of a governmental organization, thank you for engaging with us and aiding in the growth of our community. I also want to thank our partners for helping us broaden our ecosystem and thank our shareholders, both new and long-term, for your ongoing trust and support. Now, I'll turn the call over to Allan to discuss the financial highlights for Q2.

Allan Brett, CFO

Thank you, Ed. I'm here to discuss our financial results for the second quarter ending July 31. We are excited to announce record quarterly revenues of $80.5 million for this quarter, which is a 20% increase compared to $67.1 million in the same quarter last year. This revenue growth stems from strong organic performance as well as our recent acquisitions, despite facing a negative foreign exchange impact of about $900,000 compared to Q2 of last year. Our revenue composition remains robust, with services revenue increasing by 20% to $71.4 million, accounting for 89% of total revenue this quarter, up from $59.7 million and maintaining the same percentage as last year. License revenue was $1.1 million, or just over 1% of total sales this quarter, slightly down from $1.3 million or 2% of revenue in Q2 last year. Professional service and other revenue amounted to $8.0 million, making up 10% of revenue, a significant increase from $6.1 million or 9% in the same quarter last year. Our gross margin is healthy at 74% of revenue for this quarter, slightly rising from 73% in the second quarter last year. This growth is primarily due to the addition of the Visual Compliance business we acquired in mid-February and sustained revenue growth from both new and existing customers. Thanks to robust revenue growth and effective cost management, we achieved strong adjusted EBITDA growth of around 32% to $30.2 million, which is 37.5% of revenue, compared to $22.8 million or 34% of revenue in the same period last year. Consistent with earlier quarters, the foreign exchange impact on adjusted EBITDA was minimal, as we remain well-hedged against fluctuations. Consequently, our cash flow from operations reached $26.9 million, representing approximately 89% of adjusted EBITDA this quarter, an increase of 48% from $18.2 million or 80% of adjusted EBITDA in Q2 last year. Moving forward, barring any unusual events and quarterly variations, we anticipate maintaining strong operating cash flow conversion of between 80% to 90% of our adjusted EBITDA throughout the rest of fiscal 2020. In terms of GAAP earnings, our net income was $8.6 million, or $0.10 per diluted share, slightly up from $8.5 million or $0.11 per diluted share in the same quarter last year. Overall, we are satisfied with our second quarter operations, as strong revenue growth enabled us to invest further in our business, achieving 32% adjusted EBITDA growth and generating solid cash flow. Looking at our balance sheet, we reported cash balances of $27.4 million at the end of the second quarter, with borrowings under our credit facility at $22.8 million, leaving us with a net cash position of just under $5 million. As Ed mentioned, we completed an equity offering this quarter, issuing 6.9 million shares at $35.50 each, yielding gross proceeds of $245 million. After deducting issuance costs, we had net proceeds of about $237 million, which were largely used to pay down part of our credit facility. Additionally, we utilized our operational cash flow to reduce the credit facility by around $30 million, while we drew about $43.8 million from it to fund the CORE Transport and STEPcom acquisitions. After the quarter ended, we also borrowed around $11 million to fund the BestTransport acquisition. Currently, we have roughly $320 million available under the credit facility. Moreover, we can offer over $500 million in capital under the current base shelf prospectus, indicating that we are in a strong capital position to pursue acquisition opportunities aligned with our business strategy. Looking to the second half of the year, after incurring about $2.4 million in capital expenditures in the first half, we expect to incur an additional $2.5 million to $3.5 million for the remainder of the year, which will support further investments in network security and infrastructure. We anticipate amortization expenses to be around $27 million for the remainder of FY 2020, subject to potential adjustments for foreign exchange changes and future acquisitions. Our effective income tax rate was 26.3% of pretax revenue in the first half, closely aligned with our statutory rates in Canada and the U.S. We project that our tax rate will continue to range from 25% to 28% of pretax income for the remainder of the year, though there may be fluctuations due to one-time adjustments from our international operations. Lastly, we expect stock-based compensation to be approximately $2.6 million to $2.8 million for the rest of fiscal 2020, depending on any forfeitures of stock options or share units. I will now turn it back to Ed to conclude.

Ed Ryan, CEO

Okay, great. Thanks, Allan. Before talking about calibration, I just wanted to highlight to everyone that we now set up the conference website and registration site for Evolution 2020, our Annual User and Partner Conference. Evolution 2020 will be held at the Diplomat Beach Resort in Ft. Lauderdale, Florida from Tuesday March 17 to Thursday March 19, 2020. It's a great opportunity to meet the people that build and deploy our solutions, as well as the customers that use them. What you will learn about Descartes is a really good investment of your time and I would encourage you to book early. With that, let's move on to our calibration for Q3 FY 2020. Similar to previous quarters, we don't provide guidance, but we use our baseline calibration as a key metric relating to the ongoing health and strength of our business. Our calibration for Q3 includes the addition of BestTransport of the business for a partial quarter and assumes the following exchange rates: CAD 0.75, €1.11 to U.S. dollar and £1.21 to U.S. dollar. Our calibration for Q2 is $78.2 million in visible recurring contracted revenues, otherwise known as our baseline revenues. Our baseline operating expenses are $53.4 million. This gives us a baseline calibration of $24.8 million for adjusted EBITDA for Q3. Some other key points related to how we're positioned for fiscal 2020. We have a solid financial footing. We have a healthy business that's well calibrated and we have a healthy balance sheet. We're profitable and cash-generating. We have low capital needs within our organic business. And as you've seen from our recent historical financial results, we have solid growth in our organic business. Our primary uses of capital are for continued use in acquisitions. We've completed 45 acquisitions since 2006. And we have access to additional capital quickly, should we need it. Before the acquisition of BestTransport at July 31, we had $23 million drawn on our $350 million line of credit and we have the ability to expand that line of credit to $500 million if needed. We also have a preliminary shelf prospectus for up to $750 million, of which just over $500 million remains unused. To raise capital by other mechanisms and in short, we have good capacity for our planned acquisition activity. We also have a strong acquisition pipeline. There continues to be a lot of industry activity right now with consolidation continuing in our market. With our capital capacity and our execution capabilities, there are still a number of acquisition opportunities to expand the geographic reach, functional capabilities, trade data and content or community of participants on our network. We continue to see a lot of interesting opportunities out there to continue or even accelerate our pace of profitable growth. We're seeing both larger and smaller opportunities. And while we review everything as it comes our way, we're not just buyers for buyer's sake. The fact that we have an acquisition line of credit and a shelf finally in place doesn't change how we view acquisitions. We intend to continue to be prudent on valuation, but we're confident in our ability to deploy capital effectively. Furthermore, we don't see the recent larger acquisitions of Visual Compliance impacting our ability to continue executing on our plan. As I've just said, we're confident in our ability to deploy capital as you've just seen with our recent acquisitions of CORE, STEPcom and BestTransport and we have a robust integration methodology in place to help us quickly and efficiently integrate incoming businesses. As a reminder for our plans for the remainder of fiscal 2020, as we've said in the past, our belief for sustainable growth in the long term is a 10% to 15% growth in adjusted EBITDA. However, given the scale of Visual Compliance for fiscal 2020, we indicated we would grow in the mid to high 20s. Given our performance in the first half of the year, we're now confident that we'll be at or just be on the top end of that range. As in the past, we intend to invest any over-performance back in the business. Our growth is planned to come through a combination of organic and inorganic activities, and as always, acquisitions are not incremental to this plan. We intend to continue to focus on recurring revenue and de-emphasize onetime license sales. Given the current performance of the business and mindful of the FX environment our planned operating margin range remains at 35% to 40%. But please keep in mind this could vary if we buy other businesses that need fixing up or if the FX environment changes, both of which would impact that metric in the short run. And finally, as always, we'll continue to make ourselves available to shareholders to answer any questions. We believe we've got a great business. We want to be available to help people learn about our business. We'll continue to spend time and resources to get the word out and we hope you'll do the same. So, with that, operator, I'd like to open the call up to questions.

Operator, Operator

And your first question comes from Raimo Lenschow with Barclays. Your line is open.

Unidentified Analyst, Analyst

Hey, this is Mike on for Raimo. Congrats on the quarter, guys. Just wanted to touch base on the kind of the strong acquisition pipeline that you talked about, when you think about just the puts and takes behind that right now for your business and kind of expanding those EBITDA margins to more like 35% to 40% for the rest of the year? Can you talk a little bit about like kind of the balance you're seeing between maybe reinvestment back into the business, which, obviously, you guys have been doing on the R&D side and acquisitions? Has anything changed with Visual Compliance there and kind of that being stepped up at least for the kind of the short term?

Ed Ryan, CEO

No, I think you're going to see us operate the same way we have for the last number of years. We continue to see a strong market for potential acquisitions. We look at every one of them. Sometimes they are overpriced. I mean there's a lot of stuff in this market is overpriced because everyone thinks it's a great time to sell their business, that's true for some and not for others. We're just trying to manage our business as well as we can and deploy our capital efficiently. And I don't think in our minds, there is any material change in that belief. Sometimes more acquisitions come along that look like great fits for us and we're able to get a deal done with someone and sometimes they don't, and we don't push if it is not there.

Unidentified Analyst, Analyst

Great. And then just a little bit more detail hopefully on the cash conversion, which was especially impressive this quarter at 89%. Can you talk about kind of the puts and takes there and what drove that up, because that's a lot higher than what we've seen over the last couple of quarters or significantly higher? Is there anything specific that you wanted to call out on that end?

Allan Brett, CFO

Yes, we're typically seeing conversions in the 80% to 90% range of adjusted EBITDA, and we're right at the top of that range this time. Interest expense decreased in the quarter compared to the last quarter. The second quarter can often be a better collection quarter, so fluctuations are common. Last second quarter, we were at 80%, which was a weaker quarter due to a couple of receivables not coming in, but it’s more of the same. Generally, we expect to fluctuate within that 80% to 90% range, and there's nothing particularly unusual about that.

Unidentified Analyst, Analyst

Okay. And then just kind of going off of that with interest expense kind of coming down in the back half of the year, should we kind of expect maybe some similar trends or it's a little bit more on the higher side of that part?

Allan Brett, CFO

It's possible. I think we did say in the notes that we still expect 80% to 90%. There is a number of moving parts there. We are a victim of our success in some ways where cash taxes are slightly higher than they've been in other years for us. But, overall, we'll update you as we go through the quarters. But I would, at this point, if I had to best guess it would be right at 85% going forward, and we'll see how that plays out for the second half of the year.

Unidentified Analyst, Analyst

Great. That’s all I had. Thanks guys. Congrats on the quarter.

Ed Ryan, CEO

Okay, thanks, Mike. Appreciate it.

Operator, Operator

And your next question is from Matt Pfau with William Blair. Matt, your line is open.

Matt Pfau, Analyst

Hey guys. Thanks for taking my questions. I wanted to ask a few on MacroPoint. So first of all, are you gaining any more traction with shippers? My understanding is that your primary exposure with MacroPoint was traditionally with brokers, but have you seen anything on the shipper side? And then also at your user event earlier this year I think it was discussed about entering the European market with MacroPoint sometime during 2019. So just was wondering what the update on that is?

Ed Ryan, CEO

Certainly. We work with many shippers through MacroPoint, primarily serving freight brokers and 3PLs. As these larger customers seek to enhance the information they receive from their brokers, our main goal is to support them in that effort. Additionally, we have seen a number of significant shippers approach us in recent years to subscribe to our service, typically looking to complement what they are already doing with their brokers by consolidating their tracking data in one location. Regarding our expansion into European markets, we are proceeding cautiously due to existing privacy regulations and language challenges. We are starting our efforts in English-speaking countries and are being careful to comply with all local regulations while collecting information from drivers.

Matt Pfau, Analyst

Got it. And then also wanted to ask on the capacity matching solution and related to some of the dynamics that you mentioned going on in the trucking industry currently, how are those impacting the demand for capacity matching from the broker side? And then from the supply side with the actual carriers, how does the current environment impact that for capacity matching?

Ed Ryan, CEO

It's tough for me to tell really. We're just in the early innings of this, so we're just getting started. Not enough for us to see massive trends in it other than the customers that have gone through this pilot process and now we're kind of opening that up to other mid-sized brokers and 3PLs continue to expand their usage of the service as they get into it. It's not clear to me what the impact of the market is yet on that, how it's affecting it, it's not a big enough representative sample. But I can tell you that the customers are using and getting a lot of benefit out of it. And everyone that started in this pilot is rolling the solution out and using it more and more effectively every day, so we're really excited about that.

Matt Pfau, Analyst

Great. That's all I had. Thanks guys.

Ed Ryan, CEO

Thanks. Thanks, Matt.

Operator, Operator

And your next question comes from Paul Steep with Scotia Capital. Paul, your line is open.

Paul Steep, Analyst

Great. Thanks. Hey Ed, can you talk a little bit about the e-commerce side of the business in terms of the uptake of a number of the solutions that you've pulled together over the last few years there in terms of where you're at in terms of feeding that into the base and growing that part of the business?

Ed Ryan, CEO

Yes, absolutely. You've likely noticed our organic revenue has been trending upward over the past couple of years, and the growth in e-commerce has significantly contributed to that organic increase. Our initiatives, including ShipRush and a few others, have been effectively executed by our team, and the revenue from those businesses has risen substantially, possibly even more than we anticipated when we acquired them. I don't expect this momentum to slow down soon. Currently, it appears to be something customers really desire, and I believe we are well-positioned to capitalize on it. We are quite pleased with the progress.

Paul Steep, Analyst

Great. The other area we haven't discussed much in recent calls is customs. What's your perspective, Ed, on the U.S. conducting the ACE trial for low value goods? I understand it's a small trial just starting, but does it have the potential to provide the significant step forward we've been talking about for years in the customs business?

Ed Ryan, CEO

It will help. The major factor that has contributed to our progress in the past six months is ACAS entering the penalty phase, which means non-compliance leads to penalties. We have assisted numerous customers in preparing for this, and it has driven our performance recently. There are still over 100 countries that have announced plans to implement similar programs but have yet to do so, so we remain optimistic about their follow-through. The current small-scale test regarding low-value goods presents a potential opportunity for us, but it remains a minor pilot at this stage. I don't expect significant developments in the next two or three quarters; it will likely take years before it becomes impactful. Our long-term prospects lie in export filings, especially from major countries that have already adopted import filings, as well as new nations implementing their own import processes globally. While the smaller countries, like Argentina, which went live last year, do not generate massive business for us, each one adds value, and our customers appreciate our coverage across these regions, relieving them of the burden.

Paul Steep, Analyst

Perfect. Thanks guys.

Ed Ryan, CEO

Thank you, Paul.

Operator, Operator

Okay. And your next question comes from David Hynes with Canaccord. David, your line is open.

David Hynes, Analyst

Hey, thanks guys. Nice set of numbers. Ed, I wanted to ask you just generically around trade volumes on the GLN, it's hard to parse out given the diversity of the business. So are you seeing any slowdown at all given the ongoing trade disputes? And I guess as part of that maybe you can remind us kind of exposure to China that you have there?

Ed Ryan, CEO

We haven't noticed any significant impact on our network. While we're keeping an eye on developments, companies affected by trade restrictions are often relocating manufacturing. From our network's standpoint, the origin of shipments is not a concern; what matters is that they are produced. Whether shipments come from China or Vietnam, they still utilize our network. While this might affect operations locally in those countries, it does not materially impact our processing of global shipments. Additionally, our trade data content business, which focuses on databases and tariffs, has seen substantial growth. The increasing global focus on trade data over the past few years has made this segment one of the fastest-growing in our company, and we are quite enthusiastic about its future prospects.

David Hynes, Analyst

Yeah. That makes sense. One housekeeping for Allan and then I'm going to come back to you Ed for one. Just share count expected, the diluted shares for Q3 like just over 85, 85.2 is that kind of the right spot we should be?

Allan Brett, CFO

For Q2, that might be a little high. We did the share issuance right in the middle of the quarter. So a dilution of 3 million, let's say 3.5 million shares essentially for Q2. It will be fully effective in Q3. I think it's about 84 million shares outstanding. You can check the balance sheet for the actual numbers, but both have the dilution effect for this quarter. For Q2, that just passed, and the second part will come through in Q3.

David Hynes, Analyst

Okay. Understood. Ed, earlier Matt asked about capacity matching and the associated opportunities. It appears there are two strategies in the market. Some competitors are attempting to bypass the 3PLs and freight brokers, while your approach is to provide technology that supports them. Can you explain your perspective on the challenges these competitors may encounter and why you believe your strategy is the right one?

Ed Ryan, CEO

Thanks for your question. I’ve seen this trend before, similar to what happened in the late 1990s and early 2000s when many dot-com companies claimed they would disrupt the entire market. Looking back, none of those companies succeeded, particularly in our sector. They didn't manage to eliminate freight forwarders and third-party logistics providers; in fact, those markets have grown significantly since then. Managing freight is complex, and it’s not a simple matter of setting up a website to solve those issues. With our MacroPoint technology, we have visibility into hundreds of thousands of trucks daily and can predict their locations for several days ahead, which provides valuable insights for companies in selecting their carriers or drivers for upcoming loads. For instance, if we can identify several trucks available nearby for pickup in a few days, that information could save a freight worker between $150 to $250 per move by eliminating the cost of backhauls or deadheading. There are two approaches to this. One is to become a freight broker and claim that cost saving. The other, which we are pursuing, involves leveraging our relationships with thousands of freight brokers across North America to provide them with this information, allowing them to profit while we receive a share. We do not intend to become a freight broker ourselves. Observing others who have attempted this makes me skeptical, as they have not fared well, despite attracting substantial investment and reaching impressive valuations while generating minimal revenue. This leads to high expectations that I doubt they can meet. Our strategy seems much more sustainable and customer-focused, contributing to greater market efficiency. I believe those trying to capture this market inefficiency solely for personal gain may end up facing significant setbacks.

David Hynes, Analyst

Yeah, okay. That’s helpful. Thanks guys.

Ed Ryan, CEO

Okay. Thanks, David. Appreciate it.

Operator, Operator

And your next question comes from Justin Long with Stephens. Justin your line is open.

Justin Long, Analyst

Thanks and congrats on the quarter. So, maybe to start with the adjusted EBITDA growth guidance for this year. I just wanted to be clear on what drove that upward revision. Was that just a function of Visual Compliance outpacing expectations? Or has your assumption on organic growth improved as well? And maybe if we think about that EBITDA growth in the high 20s or something around that this year, could you speak to the rough split of that between organic and acquisition-driven growth?

Ed Ryan, CEO

Sure. I'll share a few thoughts on this before handing it over to Allan for any additional insights. At a high level, prior to acquiring Visual Compliance, we were nearing the upper limit of our previously set range of 32% to 37%. We're approaching that limit. You're right, Visual Compliance is a highly profitable company and has contributed to our decision to raise the range to 35% to 40%. However, before that acquisition, our business was already performing well and consistently improving each quarter. After buying Visual Compliance, we became confident that we would stay within that new range for the foreseeable future. Now I'll pass it to Allan.

Allan Brett, CFO

Ed was discussing EBITDA as a percentage of revenue, which is accurate. From an EBITDA growth standpoint, we reported 32% for the quarter, and as Ed pointed out earlier, we had indicated in the previous quarter that we expected growth rates in the mid to high 20s for this year. We're feeling more confident about the business overall. We've been operating Visual Compliance for 5.5 months and have added a few more small items to our portfolio. The business is performing well organically, which gives us more assurance that we will be at the higher end of that growth range, around 30% for EBITDA growth. So you have updates on both the EBITDA growth and EBITDA as a percentage of revenue, both benefiting from improvements in our core business and Visual Compliance. Regarding your last question about the split between organic growth and acquisitions, typically, we see a growth model of 10% to 15% a year, with a 10-year average of 17%. This would generally be about a 50/50 split between organic growth and acquisitions. However, in a year like this, where we expect growth around 30%, a larger portion is coming from acquisitions. Our core business is performing as anticipated, which is excellent and contributing to solid EBITDA growth, while the remainder is driven by acquisitions.

Justin Long, Analyst

Great. That's really helpful. And maybe following up just organic growth, I think if you adjust for FX in the quarter, I get to organic revenue growth of around 6%. Any reason to expect that growth rate to accelerate or decelerate in the next couple of quarters?

Allan Brett, CFO

It's been stable in that range for the past few quarters, from the second half of last year through this year. We are focused on growing our business in a cohesive manner. We are continually adding components and solutions that will benefit our customers, so this is a story of organic growth supplemented by acquisitions. I believe fluctuations in organic growth are natural. Currently, the economic climate is favorable, and we are experiencing robust growth. Let's see how the second half unfolds and what it brings.

Justin Long, Analyst

Okay, fair enough. I appreciate the time.

Ed Ryan, CEO

Thanks, Justin.

Operator, Operator

And your next question comes from Paul Treiber with RBC Capital Markets. Paul, your line is open.

Paul Treiber, Analyst

Thanks very much. Just hoping that you could elaborate more on BestTransport and the TMS strategy in general. You have a number of partnerships with TMS companies. How do you look at/or how do you decide between partnering with these companies and then owning a TMS vendor themselves? And then at what point would you consider moving into the broader TMS market?

Ed Ryan, CEO

BestTransport is a specialized player in the logistics business, particularly in handling flatbed transportation, which is often needed for oddly shaped cargo that cannot fit inside standard trailers. We wanted to include that capability in our transportation management system (TMS) because we believed it would be beneficial for our customers. Our intention was not to compete with existing partners in the broader TMS market. In fact, flatbed transport is generally a minor segment of most customers' shipping needs, according to our partners. Our collaborations are primarily focused on connectivity, which is why we are working with companies like SAP and Oracle, among others, to become the preferred network for their customers, allowing them to connect with carriers. A significant advantage that BestTransport brings us is access to flatbed carriers that might otherwise be hard to reach due to their smaller size in the market. Now that they are part of our network, acquiring BestTransport makes more sense from that angle. We see this acquisition as a way to support our partners, enabling them to connect with flatbed providers through their TMS, and we can facilitate that electronically. This is the primary motivation behind our acquisition.

Paul Treiber, Analyst

And do you see, is there an opportunity for synergies between BestTransport and MacroPoint in capacity matching?

Ed Ryan, CEO

They bring a new group of carriers and shippers into the mix. If users of those solutions are interested in capacity matching, we have brokers in our network who want to utilize it for flatbed moves. I am now much more capable of facilitating that for them following the BestTransport acquisition.

Paul Treiber, Analyst

Okay. And then hoping to clarify something in the notes or just provide more details on it, in regards to performance obligations up quite strongly 60% year-over-year and 10% quarter-over-quarter. What are the drivers of that? And how much is impacted by organic growth versus acquisitions?

Allan Brett, CFO

Sorry Paul, can you repeat that one for me please?

Paul Treiber, Analyst

Performance obligations is up $220 million this quarter.

Allan Brett, CFO

Okay. Throwing a bit of a blank. Performance?

Paul Treiber, Analyst

Sorry, it's in the notes. I can discuss it with you later.

Allan Brett, CFO

Okay. Yeah please do, sorry. You're catching me. I apologize.

Paul Treiber, Analyst

No problem. I’ll pass the line. Thanks a lot guys.

Allan Brett, CFO

Hey, thanks Paul. Appreciate it.

Operator, Operator

And your next question comes from Scott Group with Wolfe Research. Scott, your line is open.

Rob Salmon, Analyst

Good evening, everyone. It's Rob here for Scott. I wanted to follow up on the topic of organic growth. In North America, we've observed some very low railcar load volumes and generally weak truck demand. Could you share your perspective on the sustainability of organic growth as we look ahead, especially considering the potential for a softer freight market?

Ed Ryan, CEO

Well, the short answer is I don't know. But I also don't know what's going to happen to the freight market any better than anyone else in our industry. Other than to say that, if transportation volumes go down, we could pay by the shipments to process transactions and if there is less transactions, there is less revenue for us. And therefore either our organic revenue is going to slow or we're going to have to sell more to keep it growing at the rate that it is. I don't have crystal ball, so we don't put the stats out there about what's going to happen in the future. But we know, over the past couple of years, it has gotten a lot better. You can see that in the results, and I think it's due to us having a better and better network every day with more and more participants on it, I think that's partially due to the quality of some of the acquisitions that we bought in the past few years where they're growing at a faster clip than some of the things that we bought in the past. And then our company is doing a good job of integrating those acquisitions in and getting them to perform even better than they were before we bought them. I hope that continues. If we have to do that with some headwinds in the transportation market, pushing against us, it will make it a little harder. If the transportation market continues to boom as it has over the last couple of years, that's going to make it easier for us and give us the potential to do even better. So, I don't know that I'm prepared to predict what's going to happen for you, but I'm happy it's growing right now and it's been growing nicely over the last couple of years. And we hope it continues and if not, we're going to do our best to manage through it.

Rob Salmon, Analyst

I appreciate your insights and the clarification regarding the concerns in the market about potential shifts in trade volume from China to other Asian countries and its implications for Descartes. I would like you to elaborate on the recent consolidation among forwarders, particularly following the closure by DSV. How does the growth of larger companies affect Descartes as we look ahead?

Ed Ryan, CEO

DSV has been a strong partner for us. They acquired Panalpina, which was also an important customer, and we hope to see them integrate Panalpina’s operations with their own. If that happens, it should be beneficial for us, as they are currently indicating. We have a positive relationship with DSV, and they have evolved from a midsize company to one of the largest logistics providers globally. We are looking forward to supporting them in their growth.

Rob Salmon, Analyst

That's helpful. So, we should more be thinking about the potential as if you've got a relationship with the acquirer as being accretive or not per se relative to the target?

Ed Ryan, CEO

I believe you will see that in the freight forwarding sector, we will have connections with most of the acquirers. The strength of those connections varies. In the case of DSV, we have a very strong relationship. Over the past decade, as the market has consolidated, the larger companies have become our best customers. They have been more successful in leveraging our services compared to the smaller and mid-sized firms. Generally, this has worked out well for us, as they often acquire smaller freight forwarders that utilize some of our offerings. When these smaller firms are integrated into a larger operation that uses a wider range of our services, we tend to benefit.

Rob Salmon, Analyst

Really appreciate the color guys.

Ed Ryan, CEO

Great. Thanks.

Operator, Operator

And your next question comes from Deepak Kaushal with GMP Securities. Your line is open.

Deepak Kaushal, Analyst

Hey guys, good evening. A couple of follow-up questions for me on the recent acquisitions. Ed, just on BestTransport. Was kind of the opportunity to sell capacity matching into a niche network, the motivation behind acquiring BestTransport?

Ed Ryan, CEO

It's certainly one of them. We saw that opportunity as a pretty good one and to add something that's not otherwise there in the capacity matching space at the moment, right, because it's kind of a unique space, flatbed is. So that was certainly a big help. I think more broadly, we wanted to add these flatbed carriers to our network and add the ability to manage a flatbed move to our network. And there's not a lot of networks out there that can do that. Most of that stuff is done manually today. And now we have a chance to automate it not only for ourselves, but as someone mentioned earlier on the call for our partners as well.

Deepak Kaushal, Analyst

Okay. And do you see like similar or parallel niche networks that could be well suited for capacity matching? And is that a reasonable strategy to go forward on some M&A? Or am I stretching too far?

Ed Ryan, CEO

Well, I think there are a couple of opportunities to do that, but I wouldn't say that's going to be a core driver to our M&A strategy. BestTransport came along as bit of an opportunistic thing for us. We saw it for sale and went, oh that actually might be a good idea. And then we went and talked to them and started to like what we hear and thought we could prove that thesis out and did so. I don't know that you're going to see us continue to look for those opportunities. If they're around, we'll take a look at it and see if we think it's a good fit. In BestTransport's case, we thought it was, so we did it. I think you're more likely to see us go after stuff in the trading space and some of the areas that we've been investing in over the last couple of years. Sorry Deep.

Deepak Kaushal, Analyst

Got it. But in terms of driving capacity matching adoption, not necessary to find these close networks you can do it?

Ed Ryan, CEO

No. I think the biggest thing that's going to drive capacity matching is going to be us going out and getting more and more of our brokers heads around using a third party to provide them with this information and using that as a competitive advantage for their competitors and maybe for some of these dot-coms or things that they're going to do it without a broker.

Deepak Kaushal, Analyst

Got it. And then just on STEPcom, you gave some good color on the supply chain integration networks that they have. And I wanted to know, if you can go a bit further in terms of how different it is from integrating a transportation network, supply chain versus transportation? And in terms of supply chain, how penetrated are you? How much of your GLN is related to supply chain specifically? And what could the opportunity become? Like could it be a 10% type of business?

Ed Ryan, CEO

We are primarily focused on logistics and have nearly every major transportation provider on our network, making us a significant player in the logistics space, though we are smaller in the supply chain area. We believe that logistics and supply chain management need to be integrated. While they involve different processes—like handling purchase orders, ASNs, bills of lading, bookings, and transportation status messages—they all require coordination. Ideally, a single entity should manage these elements to provide retailers and manufacturers with complete visibility. This way, they can track their orders from purchase to shipping, receiving timely updates on their inventory on a detailed level rather than just general location information about shipments. Companies that can combine these processes can offer specific insights on SKU-level tracking of inventory worldwide, enhancing supply chain management. This is the rationale behind our acquisition of STEPcom, and we anticipate pursuing similar opportunities in the future.

Deepak Kaushal, Analyst

Got it. And are there certain industries that are more receptive to bringing both of these things under one network and one house?

Ed Ryan, CEO

I don't know. I don't know if industries are more or less. Certainly, the bigger industries out there, retail just take for example, is one of the groups of people that seem to have the most to gain by doing this. So, I think you'll see us go after that group more than most in that they have an awful lot of inventory. Their buyings are extremely high. And if they can start to think of some of these things, they can really save a lot of money. So that's certainly I think been something that's driven a lot not only of our acquisitions, but visibility and things like that into the supply chain space.

Deepak Kaushal, Analyst

Okay. Got it. Thank you. That’s it for me. Very helpful, thanks.

Ed Ryan, CEO

Hey great. Thanks Deep.

Operator, Operator

Okay. And there are no more questions at this time.

Ed Ryan, CEO

Okay. Great. Thank you, guys. Appreciate your time and we look forward to reporting back to you next quarter on our Q3 results.

Operator, Operator

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.