The Descartes Systems Group Inc. (NASDAQ:DSGX) Q3 2024 Earnings Call Transcript

The Descartes Systems Group Inc. (NASDAQ:DSGX) Q3 2024 Earnings Call Transcript December 5, 2023

The Descartes Systems Group Inc. misses on earnings expectations. Reported EPS is $0.31 EPS, expectations were $0.32.

Operator: Good afternoon, ladies and gentlemen. And welcome to The Descartes System Group’s Quarterly Results Conference 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 Tuesday, December 5, 2023. I would now like to turn the conference over to Scott Pagan. Please go ahead.

Scott Pagan: Thank you. Good afternoon, everyone. Joining me remotely on the call today are Ed Ryan, the CEO; and Allan Brett, CFO. I trust that everyone has received a copy of our financial results press releases issued earlier. 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 and economic uncertainty 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 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.

Ed Ryan: Hey. Thanks, Scott, and welcome everyone to the call. We’re coming off a great third quarter with record financial results, good organic growth and strong operating margins. We’re excited to go over those with you and give you some perspective about the business environment we see right now. But first, let me give you a roadmap for the call. I’ll start by hitting some highlights of the last quarter and some aspects of how our business performed. I’ll hand it over to Allan, who will go over our Q3 financial results in more detail. I’ll then come back to provide an update on how we see the current business environment and how our business is calibrated as we enter Q4. And finally, we’ll open it up to the Operator to coordinate the Q&A portion of the call.

So let’s start with the quarter that ended on October 31st. Key metrics we monitor include revenue, profits, cash flow from operations, operating margins and returns on our investments. For this past quarter, we again have outstanding performance in each of those areas. Total revenues were up 19% from a year ago, with service revenues up 18%. Adjusted EBITDA was up 17% from a year ago. Adjusted EBITDA margin was at 44%. Back up to the levels before we bought GroundCloud and we generated $56 million in cash from operations, representing 86% of adjusted EBITDA. At the end of the quarter, we had almost $280 million in cash and we were debt free with an under on $350 million line of credit. We remain well capitalized, cash generating, we have strong organic growth and remain ready to continue to invest in our business.

We had a good quarter of organic growth in our core services revenues. Many of the drivers are similar to past periods. The biggest growth areas were in real-time visibility, global trade intelligence and routing and scheduling solutions. So let me touch on each of those here for a minute. First is real-time visibility, when you’re moving goods on other people’s assets, they’re ships, planes and trucks. It’s a challenge to know where your goods are. This is even more difficult if you’re not the one who’s arranged the shipment. If instead you booked through an intermediary like a broker, freight forwarder or third-party logistics provider. To get this visibility, you need to network the sources and information from all these assets and parties and present it in a way that makes business sense.

Knowing the location of a shipment and when it’s going to arrive is critical to serving your customers and running your business. Our visibility and transportation management solutions, which include MacroPoint, provide critical help to customers. We’re winning more time visibility deals and seeing strong demand from our customers, and I think, there’s three key reasons for this. The first reason is our solutions are better at tracking loads. Simply put, we track a greater percentage of loads than our competitors can. Customers pay us based on the number of loads that we track, so we’re motivated to have as many carriers and intermediaries as possible to source location information from. If they’re not already connected, we’ve got self-connected tools that help our customers get even more location coverage across their network of carriers.

We also have customer success personnel who help expand the network in more complex cases. The outcome has been a greater percentage of loads tracked, better data, happier customers and strong growth in our business. Visibility is embedded, the second reason is visibility is embedded in many Descartes solutions. Some customers come to us just for visibility, but visibility is also embedded into many of our Descartes solutions. Our customers can make transportation management decisions, including planning, who they tend to, consolidations and otherwise, and ensure they have visibility while those shipments are executed. We believe we offer a more comprehensive solution than our competitors in this regard. The third reason is we’re a reliable, stable and growing partner.

Our customers take a lot of comfort from working with Descartes as a larger public company with a long track record of financial stability. Also, our customers value our lengthy experience operating secure cloud services across the globe. This makes us a service provider of choice in the real-time visibility market. The second area where we’re seeing strong growth is in global trade intelligence solutions. There’s a lot of geopolitical conflict in the world right now. When that happens, it has an impact on supply chain and logistics. Goods move on new routes away from conflict areas. Sanctions are put in place restricting who you do business with and what types of goods can be shipped. The duties and tariffs are adjusted to incentivize certain trading relationships.

We’ve continued to see strong demand from our customers for help with these challenges. Our solutions help them in three principal areas. The first is competitive intelligence. Our data mine solutions provide information on trade flows, historical classifications of goods and other logistics and supply chain intelligence. This information can be used to help make decisions about your own supply chain, but also to see how competitive you are with other companies’ supply chains. The second area is tariff and duty data to make intelligence shipping decisions. We provide up-to-date data about tariff and duty rates and rules around the world, which can be used by leading global trade management systems to help run international supply chains.

The third area is compliance. These solutions help our customers make sure they’re not shipping things to people they should not be shipping them to. This may be to specific people, to specific companies, to specific geographies, or in some cases, specific goods being shipped. The final area we’re seeing high growth at the moment that I outlined at the beginning is in our routing and scheduling solutions. These solutions help you manage your own fleet of vehicles rather than hiring space on other people’s vehicles. We believe we have the premier routing and scheduling solutions in the market. Our customers have faced pressure to use their vehicles efficiently, whether it’s due to cost pressures, limited labor or environmental concerns, so we’ve seen continued good demand.

Also, our customers recognize that the delivery experience is a key part of the consumer’s purchase experience. So they’re very interested in being able to provide delivery recipients with time-definite delivery windows and an Uber-like delivery visibility experience in the final miles. Our innovations in this area continue to drive customers with complex delivery challenges to us for our solutions. We were able to show good organic growth in the quarter, even with some broader macro-economic challenges in the supply chain and logistics market. As we went into the quarter, the market was bracing for reduced transportation volumes. In the quarter, we did see lower volumes, but not as bad as may have been initially expected. Our supply chain messaging and customers filing businesses saw something impact with lower transaction volumes, but not inconsistent with our plans.

Overall, our business is designed to grow through fluctuations in transportation volumes and the superior performance of the parts of our business that are less volume sensitive, combined with the addition of new customers, continued to drive our organic growth. Our organic growth was complimented by the contribution of recently completed acquisitions. Several of the acquisitions are performing better than we originally planned for, resulting in more earn-out being accrued in the quarter. Allan will get into that and more to talent his section, but let me touch on the two most recent acquisitions. The first is GroundCloud. We’ve got about eight months experience with GroundCloud’s safety and compliance solutions. GroundCloud helps us identify safety incidents faced by drivers and provides responsive and targeted video training on the challenges that drivers face.

They also help companies manage delivery obligations as they have as subcontractors to other delivery brands such as FedEx. When we first combined with GroundCloud, we indicated we anticipated some impact on our overall adjusted EBITDA margin, which we did in fact see in Q1 and Q2. We’ve made good progress on integration and our aggregate adjusted EBITDA margin is back up to 44% for Q3. We’re also seeing good opportunity for cross-sell of the safety solutions into our existing routing customer base and we’re monitoring the impact of FedEx and increasing the number of shipments it moves through the independent contractor network as that may increase demand from customers looking to help FedEx. The second acquisition was Localz. I spoke to this a bit earlier as Localz helps with the Uber-like delivery experience for the final mile.

If you’re receiving a delivery, you can track the vehicle in real time on a map as the goods arrive. The Localz has been immediately incorporated into our routing solutions and we saw good demand for combined Localz Descartes solutions. We’re very happy with the technical capabilities and initial performance and hope to be able to share more on progress in the upcoming quarters. With that, let me just summarize as I handed over to Allan to give the full financial in the quarter — details in the quarter. We had record financial results, the business performed well and we believe that’s a good reflection of the value that our customers continue to get from our solutions and the hard work that our team continues to put in for our customers.

We ended the quarter with almost $280 million in cash, $350 million in available credit and a market opportunity where we can continue to grow the business for our customers, both organically and through acquisition. We remain focused on profitable growth so that we continue to ensure that our customers have a secure, stable and growing technology partner that can help them with their challenges well into the future. Many thanks to all The Descartes team members for everything they’ve done to contribute to a great quarter and continue to have our business in an enviable position for future success. With that, I’ll turn the call over to Allan to go through our Q3 financial results in more detail. Allan?

Allan Brett: Hey. Thanks, Ed. As indicated, I’m going to take you through our financial highlights for our third quarter, which ended on October 31st. We are pleased to report record quarterly revenue of $144.7 million this quarter, an increase of 19% from revenue of $121.5 million in Q3 last year. While revenue from acquisitions completed in the past 12 months contributed nicely to this growth, similar to the past several quarters, our growth in revenue from new and existing customers from our existing solutions was the main driver in growth again this quarter when compared to last year. Looking at our revenue details further, our revenue mix in the quarter continued to be very strong, with services revenue increasing 18% to $130.4 million, compared to $110.1 million in the same quarter last year, representing approximately 90% of total revenues in the third quarter.

Removing the impact of both the recent acquisitions, as well as the impacts from foreign exchange on a like-for-like basis, we would estimate that our growth in services revenue from new and existing customers would have been just over 9% this quarter when compared to the same quarter last year and fairly consistent with the first half this year. License revenue came in at $1.5 million or 1% of revenue in the quarter, up slightly from last year, while professional services and other revenue came in at $12.8 million, up 24% to 9% of total revenue, compared to $10.3 million or 8% of total revenue in the third quarter last year as both professional service hours and hardware revenues were higher this quarter. For the nine months this year revenue came in at $425 million, an increase of 18% from revenue of $361 million in the first nine months last year.

Gross margin came in at 76% of revenue for the third quarter, down slightly from gross margin of 77% in the third quarter last year, but very consistent with the gross margins we’ve experienced since the completion of the GroundCloud acquisition earlier this year. Operating expenses increased by approximately 19.5% in the third quarter over the same period last year and this was heavily related to the cost impact from recent acquisitions, primarily the GroundCloud business, but also operating costs increased from some additional investments we made in labor and non-labor costs as we managed the organic growth that we continue to see in our business. So as a result of both revenue growth and solid cost control, balance with targeted investments in our business to manage growth.

We continued to see strong adjusted EBITDA growth of 16.5% to a record $63.5 million or 43.9% of revenue up from $54.5 million or 44.9% of revenue in the third quarter last year. We should mention as a reminder that while adjusted EBITDA margins are down slightly from Q3 last year to the diluted impact of recent acquisitions, we did see a sharp increase in our adjusted EBITDA ratio in Q3 over Q2 of this year, increasing from 42.3% of revenue in Q2 to 43.9% of revenue in Q3. This increases the direct result of the continued operating leverage from organic growth, as well as a steady improvement in the margins from our recent acquisitions. For the first three quarters of the year, adjusted EBITDA has increased 14% to $182 million from $160 million in the same nine-month period last year.

Looking at the other GAAP line items on our income statement this quarter, other charges increased to $9.7 million up from only $200,000 in Q3 last year and this increases the result of two unique items. First, we accrued an additional $7.8 million in anticipated earn-out payments related to recent acquisitions as these businesses have performed better than our original expectations and therefore better than the estimates that were made at the time of the acquisitions. In addition, as part of our ongoing efforts to maintain an effective cost structure, we initiated a restructuring plan early in Q3 at a point of heightened macro uncertainty. The restructuring involved a reduction of just under 2% of our labor force and the closing in whole or in part of four of our offices as we continue to adopt a flexible work model for our employees and realize that we had certain facilities that were not going to be actively reused by our employees going forward.

We would estimate that the cost savings from these completed restructuring efforts would be in the area of $4 million annually and the resulting charge to P&L in the third quarter was approximately $1 million. As a result of the increased profits from the growth in the business, offset by this increase in other charges, from a GAAP earnings perspective, net income came in at $26.6 million or $0.31 per diluted common share in the third quarter, very consistent with net income of $30 — $26.5 million or $0.31 per diluted common share in the third quarter last year. We should also note that the income tax expense for the third quarter came in at $8.2 million or 23.5% of free tax income, which is slightly lower than our blended statutory tax rate of 26.5%, mainly as a result of recognizing certain unrecorded tax benefits from past periods.

Net income for the nine-month period year-to-date was $84.1 million or $0.97 per diluted common share, compared to $72.5 million or $0.82 per diluted common share in the first nine months last year. Again, with the higher offering profits from our growing business being partially offset with the higher amount of other charges from the earn out adjustments and the FY 2024 restructuring plan. With these solid operating results, strong AR collections as an offset partially by the higher cash tax payments we incurred, cash flow generated from operations came in at $56.1 million or 88% of adjusted EBITDA in the third quarter, an increase of 10%, compared to $50.9 million of cash flow from operations in the third quarter last year. For the nine-month year-to-date, operating cash flow has been $157 million or 86% of adjusted EBITDA up 11% from $142 million in the same nine-month period last year.

And we should mention that subject to unusual events and quarterly fluctuations, we expect to continue to see strong cash flow conversion and generally expect cash flow from operations to be between 80% and 90% of our adjusted EBITDA in the quarters ahead. As a reminder, the additional earn out payments that we’ve expensed in other charges in the income statement of these past few quarters will be one of those types of unusual events as these amounts will show as a reduction to cash flow from operations in future quarters when these higher earn out payments are made. Overall, as Ed said, we are once again very pleased with our quarterly operating results in the quarter as strong organic growth and solid performance from our recent acquisitions resulted in strong growth in both revenue and adjusted EBITDA for the quarter.

If we turn our attention to the balance sheet, our cash balance is totaled $280 million at the end of October up from approximately $227 million at the end of the second quarter in July. This increase in cash is primarily related to the $56 million in cash flow from operations that we generated in the quarter. As a result, as Ed mentioned, we have $280 million in cash available to us as October 31st, as well as our unused $350 million credit facility available to deploy towards future acquisitions consistent with our business plan. As we look to the final quarter of fiscal 2024, we should note the following. After incurring approximately $4.8 million in capital additions for the first nine months of the year, we expect to incur approximately $1 million to $2 million in additional capital expenditures in the fourth quarter of this year.

At this point, we currently expect that in the fourth quarter, we will use approximately $23.3 million of our cash to pay additional contingent consideration on two past acquisitions. While this entire $23.3 million estimated contingent consideration to be paid as a accrued for on our balance sheet, approximately $12.7 million of this balance relates to the portion of the earn-out arrangements accrued for at the time of the acquisition and will be reflected in cash flow from financing activities, while the remaining $10.6 million expected to be paid will be reflected in cash flow from operating activities, as the financial results from these acquisitions have both been better than our initial expectations, and therefore, the earn-out payments are higher than our original estimates made at the time of the acquisitions.

After incurring amortization costs of $45.4 million in the first nine months of the year, we expect amortization expense will be approximately $14.7 million in the fourth quarter with this figure being subject to adjustment for foreign exchange and future acquisitions. Our income tax rate for the first nine months of the year came in at approximately 24.5% of pre-tax income. Looking ahead into the fourth quarter, we currently expect our overall tax rate will again come in below our blended statutory tax rate of 26.5%, and as a result, we’ll experience a tax rate in the range of 23% to 25% of pre-tax income for the year. After incurring stock-based compensation of expense of $12.4 million in the first nine months of the year, we currently expect stock compensation to be approximately $4.4 million in the fourth quarter, subject to any forfeiture of stock options or shared units.

And with that, I’ll turn it back over to Ed, with — who will give you some closing comments, as well as our baseline calibration for Q4.

Ed Ryan: Great. Thanks, Allan. So we are a month into Q4 and the end of our fiscal year. General areas of our business that benefit from end of year holiday sales such as e-commerce and truck deliveries will see an uptick in volumes. Another area such as ocean transportation are at seasonal low point as inventories are already in store. Our forecasting and plans remain relatively cautious given the general malaise and different volumes in the previous quarters this year. However, we are also mindful of the press reports with initial positive statistics on Black Friday sales 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 even to 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 over perform, we try to reinvest that over performance back into our business, we focus on recurring revenues and establish relationships with customers for life, and we thrive on operating a predictable business that allows us to forward visibility to our revenues and investment payback.

In our Q3 report, we provided a comprehensive description of baseline revenues, baseline calibration and their limitations. As of November 1, 2023, using foreign exchange rates of $0.72 to the Canadian dollar, $1.06 to the euro and $1.21 to the pound, we estimate that our baseline revenues for the fourth quarter of 2024 are approximately $127 million and our baseline operating expenses are approximately $79 million. We consider this to be our baseline adjusted even to calibration of approximately $48 million for the fourth quarter of 2024 or approximately 38% of our baseline revenues as at November 1, 2023. We continue to expect that we’ll operate it in adjusted EBITDA operating margin range of 40% to 45%. Our margin can vary in that range given such things as foreign exchange movements and the impact of acquisitions as we integrate them into our business.

We’ve got lots of extending things planned for our business. It remains an uncertain, broader economic and supply chain environment, but we believe our proven track record of execution, solid capital structure and customer focus will serve us 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 now turn it over to you to manage the Q&A portion of the call. Thank you.

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Q&A Session

Operator: Thank you. [Operator Instructions] Your first question comes from the line of Matt Pfau from William Blair. Your line is now open.

Matt Pfau: Hey. Great. I wanted to ask a question on competition and on the macro. So, one of your public competitors had some notable struggles this past quarter and there’s another private competitor that went out of business. Just wondering if you’re seeing some of the same headwinds that they’re seeing and some of their struggles is having any impact on you competitively? Thanks.

Ed Ryan: Thanks, Matt. I mean, I think, we saw some of the things that impacted them. We obviously fought our way through it and ended up with pretty good results. The two companies you’re talking about may have been in a different position in that things went bad, maybe with transportation — transaction volumes and then the customer suffered as a result, and they didn’t have any other products or services to make up for it. We obviously were in a different situation and we’re able to take advantage of that. And sometimes competitors struggle and end up being good news for you, because customers turn elsewhere and that also makes them potentially concerned about, who they’re going business with and when you’re a strong company like Descartes that ends up playing in our favor.

Matt Pfau: Got it. And then just on the services revenue that did tick downs sequentially, was that driven by some of the headwinds on the transaction side that you cited?

Ed Ryan: I think so, yeah. I mean, we had a very strong quarter, but it probably would have been better if some of our customers’ volumes were doing even better. The — whether it was a horrible quarter, I think people were predicting it was going to be a lot worse than it was in terms of our customers’ transportation volumes and we have the benefit of continuing to sign up new customers in the space of that. So we did all right in that period, probably would have been even better if that part had gone well and we had a bunch of other parts of our business that I mentioned on the call that were really doing well, so that kind of more than made up for it. So we’re happy with the results under the circumstances, for sure.

Matt Pfau: Okay. Great. Thank you. Appreciate it.

Ed Ryan: Hey. Thank you, Matt.

Operator: Your next question comes from the line of Justin Long from Stephens. Your line is now open.

Justin Long: Thanks and good afternoon. Ed, maybe building on that last question, could you share what’s your — how your transportation volumes performed on a year-over-year basis in the quarter? And Allan, I heard your commentary around organic growth for the services revenue line, but do you have the estimate for all-in organic growth as well?

Ed Ryan: I don’t know that I have the exact numbers, Allan, year-over-year, but if you get something.

Allan Brett: Yeah. So if we want to talk about organic growth numbers, we’re just over 9% on the services side and just very, very similar to that overall in the business. There is — there was certainly some slight negative impacts on FX that would have affected, the question Matt just had with respect to our services revenue being down slightly quarter-on-quarter. That was — they were up actually neutral with FX, but roughly 9% in both services revenue and total revenue for the quarter.

Justin Long: Okay. And any sense on transactional volumes on a year-over-year basis, even if it’s just kind of directionally, it sounds like maybe there was pressure year-over-year or any additional color you can share there?

Allan Brett: Yeah. There was definitely some pressure year-on-year. We certainly did better with our subscription services for software and databases. But as Ed said a couple times in the prepared comments, we kind of expected that, our businesses built to deal with those types of fluctuations. Those are not new for us. We will see those types of things happen from time-to-time. Quite honestly, we’ve probably seen weaker transactions in the last 12 months. But overall, what matters for us is the overall blended growth rate and then businesses built to grow and the 9% overall is more of our focus.

Justin Long: Got it. And I guess, lastly, Ed, could you just talk about the acquisition pipeline? I am curious what you’re seeing today versus a quarter ago and your level of confidence that we can see capital deployment pick up the next couple of quarters or so?

Ed Ryan: Yeah. Without getting into too much detail on it, we like the environment we’re in right now. A couple years ago there were not many companies for sale and the ones that were, in our estimation, were oftentimes trying to charge too much. We made a difficult acquisition environment for us, but things are certainly softening from that perspective and creating opportunities for us to get more deals done at in-price ranges that we think are a good value. More companies are coming up for sale and as a result and maybe in addition to companies are coming up for sale and with a more reasonable expectation of valuation and that’s creating an environment where we think we’re in a very good position to get more deals done in the future.

Justin Long: Okay. I’ll leave it there. Thanks for the time.

Ed Ryan: Hey. Thank you, Justin.

Operator: Your next question comes from the line of Daniel Chan from TD Cowen. Your line is not open.

Daniel Chan: Yeah. Hi. Good evening. Maybe to follow on that last question, the cash balance continues to grow. You’re now at about $280 million and you do about $200 million of free cash flow here, which is more than you’ve typically spent on acquisitions in prior years. So any other considerations for that capital just given the strong cash balance and the strong cash flows or do you think you’ll be able to deploy that towards acquisitions over the next few years?

Ed Ryan: Listen, I mean, we’re making more and more money every year. That’s great. We only buy companies when we think it’s a good deal and that means we have extra cash and that means we have extra cash. We’re not going to apologize for that. We absolutely think that the winner in our space is going to continue to be acquisitive and we absolutely believe that there are many more companies that are acquisition candidates for us. So while we talk about it at our Board level, we’ll discuss every quarter, should we have a dividend, should we some way give this money back to shareholders to our buyback, whatever. But at the moment and I think for the foreseeable future, well, we believe that that money should go towards acquisitions.