Welcome to The Descartes Quarterly Results Call. My name is Adrianne and I'll be your operator for today's call. [Operator Instructions] Please note this conference is being recorded. I'll now turn the call over to Scott Pagan. Scott Pagan, you may begin.

Thanks, and good afternoon, everyone. Joining me remotely 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 our assessment of the current and future impact of the COVID-19 pandemic on our business and financial condition, 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 as is required by law. And with that, let me turn the call over to Ed.

Thanks Scott, and welcome everyone to the call. Last quarter, I mentioned how the call was unique for us since we were doing it with each of us remote from each other as opposed to being in one room. Well, we're doing it remotely again this quarter and it may end up being the way we do it in the future. Hopefully, the call will proceed without technical challenges, however, please bear with us in the Q&A portion of the call as we may need to coordinate to provide answers. Similar to past calls, there's a roadmap for the rest of this call. I'll start with some opening comments primarily focused on what happened over the last quarter and some of the trends we've seen. I'll hand it over to Allan who will go over the Q2 financial results in detail. I'll come back and provide some perspective on how we're calibrated and looking at the current quarter and beyond. And I will then open it up to the operator to coordinate the Q&A portion of the call. So with that let's get to it. We had a great quarter especially in light of everything that's been going on in the world; continues to be one of the more challenging business environments that we've ever had to operate in. It's been great to see the logistics industry identified as an essential service industry with emphasis on the continued movement of freight. It's been an active industry with new priorities being placed on different types of goods and goods flowing from different sources via different modes of transport and to different destinations. The industry is not fully recovered from the strains of the pandemic with areas like air cargo still having a way to go to recover, but we've seen the…

Hey thanks Ed. As indicated I'm going to walk you through our financial highlights for our second quarter of fiscal 2021 which ended on July 31st. We're pleased to report revenues of $84.0 million this quarter, up 4% from revenues of $80.5 million in Q2 of last year. Our revenue mix continues to be very strong with services revenue increasing 5% to a record $75.3 million which is now 90% of total revenue in the second quarter. And this compares to services revenue of $71.4 million or 89% of total revenue in the same quarter last year. License revenues came in at $1.3 million or just over 1% of sales in the quarter, while professional service and other revenue came in at $7.4 million or 9% of revenue in the second quarter of this year. Gross margin was solid at 73% of revenue for the second quarter, which is down just slightly from gross margin of 74% in both the second quarter of last year and the first quarter of this year. As we mentioned last quarter and Ed just indicated in order to address the slowdown in our revenue experience in April as the impact of the pandemic started to hit parts of our business; in late May, we completed a restructuring plan where we reduced approximately 5% of our labor force. While we also closed a few of our smaller offices where we concluded that the staff would not need to return to the office even when the pandemics subsides and it's determined safe to do so. We should note that the annual cost savings from this restructuring plan are expected to be approximately $6 million, while we also recorded a $1.9 million special charge in the quarter related to the cost of putting this restructuring plan in…

Great. Thanks Allan. Before I address calibration as we look forward to Q3 and beyond; I thought it would be good to recap some of the principles we use in planning and executing in our business. We plan for our business to grow adjusted EBITDA 10% to 15% annually. We plan to grow through a combination of organic and acquisitions. When we over perform we expect to reinvest that over performance back into our business. We focus on recurring revenues and establishing relationships with customers for life. We thrive on operating a predictable business that allows us forward visibility to our revenues and investment paybacks. But we also know that while there are short-term challenges for all businesses as we deal with the pandemic; there are some medium and longer-term tailwinds. For example, Brexit; there's a new customs regime coming for the UK at a high level that's like having a brand new country for all of our global customers to have to do business with. This impacts imports too and exports from the United Kingdom. When you look at a business like ours whose services include particular strengths in cross-border shipments and in providing tariff and duty databases; there are very good opportunities for growth for us as people ramp up to operate in this new environment. Right now the government is planning for a January 1st, 2020 transition so we'll be working with our customers to hit that or any revised date. Second tailwind is e-commerce, while people have been talking about e-commerce for some time; its relevance as the world has gone through this pandemic has evolved from an emerging issue to a dominant reality. I've seen this impact even in my own extended family. My own parents were not buying very much online and this pandemic…

[Operator Instructions] Our first question comes from Matthew Charles Pfau William Blair. Your line is open.

Hey guys. Thanks for taking my questions. I just wanted to ask on the outperformance that you saw relative to your expectations in the quarter. Was that driven by some of the positive areas that you highlighted being unexpected or performing better than expected because it seems like on the transaction volume side that that kind of trended with what your expectations were and didn't really improve that much in the quarters. So just curious what drove that out performance relative to your expectations.

Yes. I think a little of both. We certainly had some really good performance in the global trade areas, in e-commerce areas and most of the rest of the business held in pretty strong. We obviously had some weaker air cargo results as a lot of planes that fly passengers weren't in the air and therefore, the bellies of those planes wasn't available for cargo which hurts our air cargo numbers.

Okay. And within your broker customer base, just curious, prior to the pandemic, there was obviously a need for these businesses to digitize; they were under pressure, various factors, one of them start-ups trying to sort of disintermediate them. So wondering how they're reacting in this type of environment. Are they putting some of those digitization initiatives on hold? Are they accelerating them? And then how does that relate to like MacroPoint Capacity Matching and then the Kontainers business that you acquired that would help them digitize?

I think not just brokers I assume you're talking about freight brokers not customs brokers, but not just brokers really a whole bunch of our customers I think realized they needed to automate everything in their business come April when they had to send their employees home. And anything that wasn't automated became a real problem. And I think you could see that in some of our results, right? They gravitated towards systems like ours that enabled them to do that and I think that's going to continue for the foreseeable future, maybe perhaps even outside this pandemic.

And the next question comes from Paul Treiber from RBC Capital.

Thanks very much and good afternoon. Ed, I mean last quarter you indicated baseline was based on April's volume. What's your assumption for Q3 baseline? Are you using a single month as the average for last quarter? Anything there could be helpful.

Yes and I'll jump in and take that. I think we gave that baseline Paul as of August 1st, so it's really reflective of what we see in the business to that point. We'd see -- we continue to see some improvement in parts of the network and slower recovery in other parts of the network. So it's really the current information including a stronger July that we saw. So it incorporates everything we know to August 1st.

And in your comments on the linearity of transaction volumes to the quarter are very helpful. You mentioned recovery in June and July, was, it was down 5% below your expectations. How is June and July? What -- could quantify that a little bit further in terms of how that compares versus what you'd normally see through June and July?

Yes. I'll start and Ed can jump in. We're seeing I think it really touches on Ed's comments earlier in the prepared statements. I mean you're seeing certain product lines where our numbers are better than June, July last year certainly in the e-commerce area in parts of our content space. And we're seeing other parts like air traffic which just reflect of anything you read out there in the air freight world. We're not seeing those numbers come back to the levels that they were at. Overall, we've seen a step up from April in both June and July but wouldn't say we're back to full pre-pandemic levels. Ed, anything you want to add there?

No. I think that's a pretty good description of it.

Okay. Last one for me in regards to comment on M&A valuations, it seems like valuations have been going up for a couple years or several years. And it has been area that's been a challenge. Is that uniform across the board or is it -- are you seeing more expansion in certain segments and less than others? And how are you looking in terms of prioritizing and allocating capital? Are there segments where you're willing to pay higher multiples? Or you think it's attractive and strategic? And others where you think it's less relevant to your business? Or are you looking at potentially putting slowing the pace of M&A just given that the valuations across the board are more expensive.

Well, there's more for sale now than ever. I think some of that's a function of valuation and bankers and therefore companies seeing that people are paying up for some assets right now. And as a result everyone's rushing to market. We try to ignore that although it's nice for us to get a look at a whole lot of businesses at once. Certainly the larger assets as we've seen in the past are demanding top dollar. Any asset that is doing well right now in the pandemic; they're out selling and they're trying to sell for premium valuation because a lot of other businesses have been harmed by this pandemic, some in a significant way; so the ones that are out and performing well maybe even better than normal are certainly going for higher rates. In our typical tuck-in type smaller acquisitions the ones where we've known the people for a while, the prices are still in a range that we think is competitive. And just to address the last part of your question, I think, we've always looked at all these businesses and said what we think they're worth. We're willing to pay up for something like a MacroPoint and maybe some of the other assets that we bought. When we think one plus one equals three or four and we say, okay, well this may look expensive to everyone right now but we know enough to know that's actually a good price. And so we continue to look at everything that comes up for sale and evaluate it. It's very similar metrics to the way we have in the past. e-commerce has done very well for us, so that's something that if we look to add an e-commerce business we may be willing to pay more for that because we kind of think we've done quite well and we suspect we could do well in the next one as well. Other businesses where we don't see any kind of growth or any kind of significant step changing growth, our evaluation metrics remain the same.

Next question comes from Raimo Lenschow from Barclays.

Hey. This is Frank on for Raimo. Thanks for taking my question and congrats on the quarter. Just one for me; I know that you mentioned the continued tailwinds even as the reopening pickup on the e-commerce side. I was wondering if you could dig a little bit deeper and talk about what the reopenings, what kind of an impact they have on the rest of the areas of your business?

Yes, sure. I mean I mentioned a little this in the calls but as almost everything in the world was shut down in April so e-commerce was booming in that period of time. And it is I still say doing very well but slowed down since then when all the other stores around the world opened up and people had more choices as to where to buy things. And I think you might see some of that flow through to the rest of the businesses, right? A lot of our retailers that weren't open during the pan -- first month or two of the pandemic; as they opened back up their revenue started to come back and improve. Things that are laggard, I mentioned airlines earlier; there are planes in the air, there's just not nearly as many as they used to be and there are not nearly specifically as many international flights as they used to be. Now airlines have switched some of their planes to handle cargo, but that's not enough to bring them back to the steady state of normal. I think air cargo demand is every bit as robust as it was before. What you see right now is air cargo prices have gone up considerably but the volumes are down because they don't have capacity available to them. They still have customers that want to buy it; they just don't have planes to fly them in because there are no passenger flights or not enough passenger flights moving. So without getting into every specific business most of them are business as usual frankly. But those are some of the ones that I might highlight as being a little different than normal.

And your next question comes from Deepak Kaushal from Stifel.

Hey, guys. Good evening. Thanks for taking my questions. Can you hear me? Excellent, good, cheers. So, yes, a couple of follow-ups just on the M&A side, Ed, with valuation and expectations getting higher for some of the quality assets. Does that change the way you look to deploy capital you think you might lean on a bit more debt or even use your own valuable paper to make acquisitions instead of cash? And any shifts on that front?

No, nothing's changed in our mind. We would prefer to use our own cash from operations to buy companies and only when we need more than that would we look to finance in some other way. Our first choice with interest rates where they are would be to use our debt facility and after that distant third would be an equity offering to pay for it, but that all depends on the size of the deals, right? And if we buy something very large that all changes because we can't only use our cash flow, we can't only use debt to do it; but for our normal deals our first, second, third choices is cash from operations and with interest rates where they are right now debt is a clear second choice to us. And an equity offering is a distant third.

All right and then you mentioned that you're seeing some high quality assets for sale. Is there something new here that's come out as a result of COVID or is it just the general because valuations are going up? That's bringing some more things for you.

Well, I think there's been a rush to technology because people think technology companies or businesses are going to benefit from this some more than others, right? You're an e-commerce business right now; you're rushing out and trying to sell your company right now. We're a little wary of that, right? We see in our own business that there was a massive jump in April and maybe May but that's come off a bit; it's still a step function up from normal but it's come up as other stores have opened up. Those businesses are trying to sell as fast as they can and for more money than people might think they're worth. We try to bring the same logic to the table that we've always had which is you know how are we going to get our money back from our shareholders on this deal. If you want more money from your -- for your company we need to know how we're going to get more money back and quickly. And so that's the argument we're looking for when someone says they want a lot of money for their business, well, show me what I'm missing here. Is there some way that I'm going to get the money back even faster now that COVID happened? If that's the case, we're interested; if it's not the case, we would say sell to somebody else.

Got it. So it's not putting a new piece of the puzzle on the table that wasn't necessarily there before that becomes a new opportunity for you guys to grab that piece.

No. I don't think, yes, that's not normally we're looking for. I mean if something comes across the table that we think is interesting. I mean e-commerce came across like that five years ago to us, right? We started looking at it; we saw a couple businesses for sale and we thought we think we can make something of this and we added it. I don't know if we're out looking for that so much and we're out looking for good businesses that we think will be good fits with our business. And in the process if we see something that's close to what we do and maybe a little different obviously consider as we always have. Now you see us expand the number of pillars that we have in our arsenal over the years. And that's kind of how it happens; I don't know that we're out looking for that so much. We're out looking for good businesses and when ideas come up we start thinking about it and seeing if we should take the next step. So for us it's kind of business as usual even though sometimes people are asking us to change our mindset because they want, banker wants more money for his asset and he's trying to get us to think of it differently, but we'll listen to it but not necessarily inclined to change our way of thinking.

Shocking, a banker wants more money. I did have a question about your data content business particularly Datamyne. I know that you made an announcement of a deal recently, if I'm not mistaken. Given that there's been such a demand for greater visibility with all the moving parts with COVID, how's that business progressing? Are you seeing a pickup on the content side generally from your existing customers and even your customer bases?

Yes, all the data content businesses are really doing well right now. Datamyne is no exception. As people source goods from different places because of this pandemic; they need access to that information to make good decisions. As they do that they need to then move it across borders that they're not used to moving it across. And they need our content to figure out what the tariffs and duties are on that. As they're shipping to new suppliers they might not have done in the pandemic; they need to do more restricted party screening and so that data content business all three aspects of it has been performing quite well in this pandemic.

Your next question comes from Scott Group from Wolfe Research.

Hey, thanks. Good afternoon, guys. So just a couple of follow-ups here on the calibration as of August 1st, is it fair to assume that you've seen some further improvement in trends throughout August and in early September just as freight broadly has improved?

No. That calibration is done as of August 1st and all the knowledge we had as of August 1st. We definitely saw June and July a slight upticks and we kind of to provide that calibration we took everything we knew through the end of July.

Okay but do you think we're -- are we missing something with an assumption that things in as of September 1 in theory are better than they were as of August 1?

Well, the calibration is not intended to be a commentary on it. That's why we picked the date.

Okay and then on the 35% to 40% EBITDA margins target. And I understand we're a little bit above that now so maybe some caution on spending but do you think there should be some operating leverage as revenue improves that should give you some confidence in sustaining 40% plus outside of a large acquisition.

Look, it's -- I think I said in the prepared comments why we think it's there right now, right? We cut costs to deal with the pandemic and then revenue improved and then we're being very prudent about adding incremental costs not knowing what's going to happen in the future. I think you can see us continue with that thought process, right? We will continue to add costs to grow our business when we're comfortable that the revenue is growing and the growth is here to stay and there are a lot of unknowns right now. If you followed us for a while you know that we perceive pretty cautiously compared to most tech companies and that's why we kind of have the profit margins that we have. And if we can you see this continue, yes, I think you'd see our margins continue to approval. We've always said we thought this number could improve over time, just weren't sure exactly when it's going to happen maybe some of the things that happened in the pandemic caused this growth in EBITDA margin to accelerate a little faster than normal. But I think you're going to see us continue to be cautious about adding costs back into the business until we have more certainty about what's going to happen in the revenue side.

Okay. And then just last question, curious your views about near-shoring or reshoring back to the US or Mexico. Do you think this is going to be a big supply chain theme going forward the next few years and how do you think your position positively or negatively if that happens?

I mean the concept to bringing everything back in the United States seems little farfetched to me. I see stuff moving around right now but it's really moving from China to Southeast Asia and so that will continue especially Southeast Asia gets more sophisticated in their manufacturing processes. From our perspective, we get paid transaction fees to help people move stuff all around the world and we do better when they keep changing where the places are, right? Because they have to use our services to figure out how to best do that, how to deal with the change that's been created. This pandemic accelerated some of that change. You see that in some of our results and I think in the long run, that if people keep moving manufacturing sites around and I think they will probably benefits us. If they're talking about moving it back to the United States, I'm not saying no one's going to move back to the United States but I suspect if you're making Yoyos and you can make them for $0.20 in Vietnam and you have to make them for $1.59 United States, you're probably not moving it back to the United States. It's a cute story on CNN, but it's not really a something I think it's going to have a massive impact in our industry.

And our next question comes from Steven Li from Raymond James.

Hey, guys. I have a couple of questions. Allan, how much was the FX headwind this quarter?

Yes. It's fairly minor, Steven, there was a small negative from FX compared to Q2 of last year, but very minor, in around $0.5 million range. And -- but, yes, rate were off a little bit. We're starting to see, I think, if you look at Q3, a little bit strength in the Canadian dollar well, let's call, a weakness in US dollars, so that will reverse itself a little bit, but in minor negative headwind in Q1 compared to Q2.

Okay. Got it. Then just based on your MD&A, it looks like there was a much organic growth and, Ed I know you mentioned weaker air cargo in the quarter. Any other segments struggled or were air cargo the major factor?

Air cargo certainly by far the largest factor in this -- retail sales were weak early on in the quarter but started to come back, but when I look at what was the big headwind that we're facing is air cargo for sure.

Yes. Can you hear me? Yes. Okay. No, I was asking, so how about Visual Compliance? How was it year-over-year?

I don't know about -- I don't know the specific year-over-year numbers maybe Allan could comment on that. But in general, it's doing very well. That business has been everything we hoped for and more. It's been growing, and it was a great fit with our existing MK Denial business and we're making more money than it ever made before and it was pretty darn profitable will begin with. So we've been very happy.

Yes. Ed nailed it. It's been a great performing business to us, Steven. And both on the revenue side as well as Ed mentioned sort of on the cost side as we pulled that business together with -- that product line together with MK Data product line offering.

And your next question comes from Robert Young from Canaccord.

Hey. Two questions, I guess the first one, sorry, if I missed something at the beginning I joined late, but the -- I think you reiterated the 10% to 15% EBITDA growth target and give some information around valuations on M&A. So I guess the first question would be, as you look at the opportunities out there for M&A, are you seeing good opportunities at lower valuation or would you say that it's just a higher valuation everywhere? I'm assuming trade content duty -- tariff and duty, anything in e-commerce is not going to be high valuation but they're likely some other areas. So, are there opportunities for M&A in the near term?

There are -- and listen, a couple of things, one, yes, there's opportunities with our smaller tuck-in businesses and maybe some of the stuff is not booming right now, but moreover given some of the stuff it is booming and is asking for higher valuations. We try to look at each of them and say, hey, is there something we could do with this business that would improve the business and improve its valuation if it became part of the Descartes ecosystem. And so we'll look at them like that. I mean we're looking for -- if some was asking for us to what we think of is overpay in our minds. We're looking at it going, all right, we'll consider that. Does one plus one equal three or four here, because if it does, maybe I'm wrong about it being over paying for it, right? I mean, if you look at some of the ones that we've done where we've paid higher multiples, Visual Compliance, MacroPoint, we were pretty confident going into them that while everyone thought this was a really high price that we were going to be able to make this look like a low price later. And that's certainly happened in those two cases and that was our thesis going in. And we got comfortable enough during the acquisition process to say, yes, okay, we'll pay something a valuation for multiple for something that's outside the normal band that we are comfortable operating in, but we were doing that with the understanding that we thought that was going to be a great business fit with our business and one plus one would equal three or four, and that's why we pulled the trigger. Now, if we go and look, walk in your banker and you walk in and say, hey, I've got this great business and I'm charging on arm and a leg for it and we don't see that one plus one equals three or four, we're not, we're going to walk away. Nothing has changed about that.

Okay. And then, I guess relative to that 10% to 15% EBITDA growth target range, I mean if you are looking into a better environment than organic growth can return that's one driver there. Second driver would be M&A. But if you find yourself in a situation where valuations are high and where organic growth is constrained, where do you start to look at handicapping that 10% to 15% EBITDA growth target or is it something that you can still drive toward? And then I'll pass the line.

No. Thanks. Listen, we reiterated it today. So, I don't -- I'm not going to sit here and guess the circumstances as to why I might not feel that way in the future, but we feel that way now, and I think we're in a position where we can continue to do it, that's why we talked about it. And if that changes, we'll let you know.

And this concludes our question-and-answer session. I will now turn the call back over to Ed Ryan for final remarks.

Hey, great. Thanks everyone. We look forward to reporting back to you on our Q3 results in November and have a great day. Appreciate your time.

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