Ladies and gentlemen, welcome to The Descartes Systems Group Quarterly Results Call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions]. This call is being recorded on Wednesday, September 4 of 2024. I would now like to turn the call over to Scott Pagan. Please go ahead.

Thanks, and good afternoon, everyone. Joining me on the call today are Ed Ryan, CEO; and Allan Brett, CFO. And 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 geopolitical, trade and economic uncertainty on our business and financial conditions, 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 Securities and Exchange Commission, the Ontario Securities Commission 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 required by law. And with that, let me turn the call over to Ed.

Thanks, Scott, and welcome, everyone, to the call. Today, we're reporting record second quarter results, continued strong revenue and adjusted EBITDA growth and a new business that has joined the Descartes team. We're excited to go over these results with you and give you some perspective about the business environment we see right now. But first, let me give you a road map for this call. I'll start by hitting some highlights of the last quarter and some aspects of how our business performed. I'll then hand it over to Allan, who will go over the Q2 financial results in more detail. And after that, I'll come back and provide an update on how we see the current business environment and how our business was calibrated as we entered our third fiscal quarter, and we'll then open it up to the operator to coordinate the Q&A portion of the call. So let's start with the quarter that ended July 31. Key metrics we monitor include revenues, profits, cash flow from operations, operating margins and returns on our investments. For this past quarter, we again had very good performance in each of those areas. Total revenues were up 14% from a year ago, with services up 12% from a year ago. Net income was up 23% from a year ago with adjusted EBITDA up 17% from 1 year ago. Our headline targets are 10% to 15% adjusted EBITDA growth per year. So it's great to see this performance. Adjusted EBITDA margin was up a percentage point from a year ago to 43%, and we had a unique item that prevented it from being even higher. Our GroundCloud business entered an accelerated hardware replacement cycle with our customers in Q2 to get AI-enabled cameras to them. This resulted in more low-margin hardware…

Thanks, Ed. As indicated, I'm going to take you through our financial highlights for our second quarter, which ended July 31. We are pleased to report record quarterly revenue of $163.4 million this quarter, an increase of 14% from revenue of $143.4 million in Q2 last year. While revenue from new acquisitions, including the recently acquired OCR, ASD and BoxTop businesses contributed nicely to this growth, similar to the past number of quarters, growth in revenues from our existing solutions were the main drivers in growth this quarter when compared to last year. Our best guess is that growth in sales to new and existing customers or organic revenue growth came in at about 9% in the second quarter. Looking further at our numbers, our revenue mix in the quarter continued to be solid, with services revenue increasing 12% to $146.2 million or 89% of total revenue, compared to $130.7 million or 91% of total revenue in the same period last year. Service revenue was also up nice sequentially, increasing just over 6% from the first quarter of this year as we continue to help our customers expand with new services. License revenue came in at $1.4 million or 1% of revenue in the quarter, consistent with the second quarter of last year. And professional services and other revenue came in at $15.8 million or 10% of revenue, up from $11.3 million or 8% of revenue in Q2 last year. For us, other revenue includes hardware revenue. And while it's generally quite small each quarter, we had an unusual increase in hardware revenue in our GroundCloud business this quarter. During the second quarter, as Ed mentioned, our GroundCloud business entered an accelerated hardware replacement cycle to implement new AI-enabled camera technology, and this resulted in approximately $2.5 million of additional…

Great. Thanks, Allan. We've done three acquisitions so far this year that we believe will contribute more to our calibration as we become more experienced and operating them together. We're mindful of some weakness in U.S. domestic truck that I mentioned earlier, but also mindful of some recent signals of potential recovery of volumes. We keep these things in mind as we set our calibration for the quarter. Our business is designed to be predictable and consistent. We believe that stability and reliability are valuable to our customers, employees and our broader stakeholders. To deliver this consistency, we continue to operate from the following principles. Our long-term plan is for our business to grow adjusted EBITDA 10% to 15% annually. We grow through a combination of organic growth and acquisitions. We take a neutral party approach to building and operating solutions on our global logistics network. We don't favor any particular party. We run our business for all supply chain participants connecting shippers, carriers, logistics service providers and customs authorities. When we overperform, we try to reinvest that overperformance back into our business. We focus on recurring revenues and establishing relationships with customers for life and we thrive on operating a predictable business that allows us forward visibility to our revenues and investment paybacks. In our quarterly report, we've provided a comprehensive description of baseline revenues, baseline calibration and their limitations. As of August 1, 2024, using foreign exchange rates of $0.72 to the Canadian dollar, $1.08 to the euro and $1.28 to the pound, we estimate that our baseline revenues for the third quarter of fiscal 2025 are approximately $141 million and our baseline operating expenses are approximately $87.5 million. We consider this to be our baseline adjusted EBITDA calibration of approximately $53.5 million for the third quarter of fiscal '25 or approximately 38% of our baseline revenues as at August 1, 2024. We continue to expect that we'll operate in an adjusted EBITDA operating margin range of 40% to 45%. Our margin can vary in that range, given such things as revenue mix, like we saw with hardware this quarter, foreign exchange movements and the impact of acquisitions as we integrate them into our business like we previously saw with GroundCloud. We expect the GroundCloud hardware replacement cycle will continue in Q3, so that revenue mix may impact margins slightly again this quarter. We've got lots of exciting things planned for our business. It remains a challenging economic supply chain and compliance environment for our customers, but we believe our proven track record of execution, solid capital structure and customer focus will help us serve them well. Thanks to everyone for joining us on the call today. As always, we're available to talk to you about our business in whatever manner is most convenient for you. And with that, operator, I'll turn it back to you for questions.

Thank you. Ladies and gentlemen, we will not begin the question and answer session. [Operator Instructions]. Your first question comes from Dylan Becker of William Blair.

Hi, guys. This is Faith on for Dylan. Can you just remind us, as you're talking about some of the different macro puts and takes, your transactional exposure, you guys continue to operate well despite some of the headwinds that you called out? So maybe could you just help us think about the banded range of outcomes that are possible as volumes either pick up or decline more substantially?

Sure. Our -- as a portion of overall revenue, our transactional revenues in the low 30s, 31% roughly. And they are fairly consistent performers. There are obviously variations when volumes go up and down. But compared to most transactional businesses, I think, and certainly given the underlying minimums that we have in our business, in a normal time, including minor ups and downs in the ocean, air, truck and rail markets, those numbers are fairly consistent, I'd say, compared to most transactional business.

Okay, great. And then just one more quick one. You guys called out you have three acquisitions to date you talked earlier about having that 3% to 6% target every year. Any color on the outlook for the second half of what you guys may be looking at or the broader M&A landscape?

Yes. We see a pretty good environment for acquisitions. I think over the last year, people's expectations for what they should sell their companies for the come down into what we would consider reasonable level in a lot of cases, and you can see us get more acquisitions done this year, and I expect that to continue for the foreseeable future.

All right. Awesome. Congrats again on the quarter.

Thank you.

Your next question comes from Paul Treiber of RBC Capital Markets. Your lines already open.

Thanks very much and good afternoon. Just a couple of clarification questions. First, just on the organic growth, the 9%, is that referring to services only? Or does it also take into account the onetime hardware revenue in the quarter?

Yes, Paul, your line is a little crackly, but the 9% is the estimated organic growth in the total business.

Okay. And then secondly, for baseline for Q3, does that include the $2.5 million that you expect in low-margin hardware? Or is it excluded not be in addition to the baseline?

It's a great question. It includes some element of that hardware. We do have some orders already for some that we know will be delivered in Q3. We're estimating that the total amount will be $2.5 million, but we don't have all those orders yet. So it is included for what we know about at this point in time or what we knew about for August.

Okay. And then just lastly for me, just on the ASD acquisition, the remaining 5%, the cost of it, I think you mentioned its $3.5 million. It seems like there's quite a premium there. Can you just walk through the structure of that acquisition and some of the moving parts there?

Yes. There's -- so essentially, what happened from a deal structure perspective, we bought 95% of that business in the first quarter for reasons that were personal to the sellers, they wanted some piece of it deferred. We are committed and expect -- fully expected to purchase the remaining 5% before the end of our fiscal '25. There is no additional premium. The number I gave you should line up as being the 5% element that's remaining in that business.

Okay. Thanks for taking the questions.

Thanks Paul.

Your next question comes from Stephanie Price of CIBC. Your line is already open.

Hi, good afternoon. Just on the hardware piece with GroundCloud. Just wondering if you can give a bit more detail there and how confident you are that the refresh should be mostly complete in fiscal Q3. I think you mentioned that, Allan.

Yes. I mean what happened here is we started providing AI cameras and we offered a deal up for our customers where if they signed up for a two-year deal that we included a new AI camera in it. We did that mostly to protect our existing customer base. And the good news in that was we had a lot more customers than just our customer -- existing customer base take advantage of it and sign new contracts with us. So we were pleasantly surprised with the reaction to that in the market. And we're estimating that it will be largely over this coming quarter, but I'm not positive to that. I hope great news if it continued, and we kept signing up more customers. But best we can tell right now, we should be done with most of that in the existing quarter. And what we've done here has been pleasantly surprising to us.

Great. And then just on M&A, you mentioned that smaller businesses are being challenged by the freight environment. Just curious what you're seeing on the larger deal side as well?

I think they get challenges too. I think that the small and medium-sized businesses, and really, when I made that comment, I was talking about our customers more, but it's the same for the acquisitions. I think -- there was a time a year or two ago when they had elevated expectations of their work that maybe weren't realistic over time. Same thing I'm seeing in the larger businesses, but -- and we take a look at all of those larger businesses as well when they come up for sale. But there's some dynamics going on that we're not as happy with sometimes with those where they combination by a private equity firm of a bunch of businesses that we already looked at. We thought -- we didn't bid on the first time, so we thought they may have overpaid for them in the first place. And now we're being asked to pay more for them going forward, and that's often frustrating to us. And frankly, we don't always agree with what they put together, and that ends up in a situation where we'll look at a bigger business, but we're not always as interested.

Thank you very much.

Thank you, Stephanie.

Your next question comes from Raimo Lenschow of Barclays. Your line is already open.

Hey, perfect, thank you. Two quick questions. Ed, on the puts and takes, like on the truck side, that seems like late cycle to me because they had the last kind of mile in a way, like not the last mile, but you know what I mean?

Yes.

The -- if you look at previous cycles, like am I kind of overthinking this now or what have you seen historically on there? And then, Allan, if you think about free cash flow or operating cash flow this quarter was the one number that came in slightly below where the rest of the performance was really, really strong. Can you kind of speak to kind of the puts and takes there and probably seasonality? Thank you. Congrats from me as well.

Hi, Raimo, yes. So no, I don't think you're overthinking. I think you're exactly right. Truck tends to follow some of the other modes in particular, ocean and air, that tend to drive a lot of truck volumes. So we were encouraged, and I mentioned briefly in the opening remarks that ocean volume was very, very strong at the end of the quarter. And I am optimistic that that's going to flow into truck volumes in the coming months. That's normally what happens, and I hope to see that. I think you're spot on.

Yes. Okay.

Yes. And Raimo, on your question about cash flow. So as we mentioned in the prepared comments, we had a little unusual event this quarter, which we've been mentioning for the last couple of quarters would happen. On our larger earn-out payments that we had, we made a couple of payments in the quarter, those payments turned out to be larger than the initial estimates we made at the time of the acquisition and U.S. GAAP rules require us to take any of those additional payments that we made above and beyond the original estimates and put those through cash flow from operations. So they're a hit a $25.0 million hit to cash flow from operations. If you exclude that for the quarter, our cash flow was just a notch under $60 million or cash -- adjusted cash flow from operations. About 85% of our adjusted EBITDA, and that's right in the range of what we'd expect. Typically, we expect anywhere from 80% to 90% of our adjusted to become operating cash flow with that one adjustment, which is a very unique item. We're right in that middle of that range. So hopefully, that explains. It's a very unique onetime item should not hit us to this extent in the quarters going forward.

Okay. Makes total sense. Congrats. Thank you.

Thanks Raimo.

There are no further questions at this time. I would hand over the call to Ed Ryan for closing remarks. Please go ahead.

Great. Thanks, everyone, for your time this evening. We look forward to reporting back to you on our Q3 results in December. And otherwise, have a great evening.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. And you may now disconnect.