Descartes Systems Group Inc

TSX:DSG

Earnings Call Transcript 2023-Q2

[Operator]

Welcome to the Descartes Systems Group quarterly results call. My name is Darryl, and I'll be your operator for today's call. [Operator Instructions] As a reminder, this conference is being recorded. I will now turn the call over to Scott Pagan. Scott, you may begin.

[J. Pagan, executive]

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 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 conditions; 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 achievement 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 required by law. And with that, let me turn the call over to Ed.

[Edward Ryan, executive]

Great. Thanks, Scott, and welcome, everyone to the call. We had an excellent second quarter and first half of the year with record financial results. 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 road map for this call. First, I'll start with highlighting some aspects of our financial results and speak to how our business performed in the last quarter. I'll then hand it over to Allan, who will go over the Q2 financial results and some corporate finance matters in more detail. I'll then come back and provide an update on the current business environment and how our business is calibrated. And finally, we'll open it up to the operator to coordinate the Q&A portion of the call.

So let's get started by looking at Q2. We had record high revenues of $123 million, up 18% from a year ago. Net income was $22.9 million. Adjusted EBITDA was a record high of $54 million, up 18% from a year ago. We generated $46.4 million in cash from operations or 86% of our adjusted EBITDA. And this number could have been higher but was reduced since $5.3 million in earn-out consideration from past acquisitions was classified as cash used in operations. Our adjusted EBITDA as a percentage of revenue was up 44% -- was at 44%, excuse me. All of these metrics were ahead of our plan so a very strong financial quarter for us.

And these results happened in a very challenging FX environment. Our revenues would have been $3.9 million higher if we'd used last year's FX rates or $1.7 million higher if we'd used last quarter's FX rates. Allan will go into this in more detail later. However, strong results that would have been even stronger in a different FX environment. At the end of the quarter, we had $189 million in cash, and we're debt-free with an undrawn $350 million line of credit. We remain well capitalized, cash-generating, debt-free and ready to continue to invest in our business.

I'd like to address 3 areas before handing it over to Allan. The first is what parts of our business did well during this past quarter. The second is some focus for running our business, and thirdly, acquisitions. On the first point, our focus at Descartes remains on building a consistent, predictable and sustainable business that is resilient to changes in market conditions. We're operating our business for the long term and strive to keep customers for life.

When we look at our business last quarter, there were a few notable areas of performance to call out. First is market-leading real-time visibility solutions. Several years ago, we invested in bringing MacroPoint's real-time visibility solution into Descartes' Global Logistics Network. By combining MacroPoint's historical strength with the broker and forwarder community for trucks with Descartes' multimodal international strength and gathering and processing information about the real-time status of shipments, we've built a powerful offering that's been recognized by customers as a solution of choice.

As supply chain challenges have heightened over the past few years, knowing the locations of goods in transit has become even more critical, regardless of mode of transport or geography. Location information is now key input for critical decisions being made by businesses every day looking to build efficient, flexible and resilient supply chains. Our real-time visibility solutions performed very well in the quarter as they continue to expand and strengthen by mode and geography.

We're thrilled that we have so many supportive customers who have committed their present and future Descartes -- to the Descartes MacroPoint real-time visibility solution.

Second is strong demand for our optimization solutions. We've long been a leading provider of market-leading delivery optimization solutions. Whether customers have their own fleet of vehicles or are using third-party transportation, we have solutions to make the most efficient use of limited resources. These optimization solutions allow our customers to plan deliveries while considering what's most important to their business and customers. It can be the lowest-cost deliveries, deliveries within a certain time window, deliveries that avoid driver overtime, routes that use the least amount of mileage, choosing transportation providers who have the most environmentally-friendly footprint or any combination of those types of items.

We generally find when fuel costs go up and economic times become potentially more challenging, the demand for these types of solutions goes up. We saw good support for these solutions in the quarter and they contributed well to our results.

And finally, the need for global trade intelligence solutions, as I've commented on the past calls how geopolitical conflicts like the war in Ukraine can drive demand for our global trade intelligence solutions. When this conflict countries started imposing trade sanctions on other countries, people and/or goods being shipped for businesses to comply with an increasingly complex world of sanctions, they need a restricted party streaming solution, a solution that allows them to check shipments before they happen to determine compliance with up-to-date international sanctioned list.

Another consequence of sanctions is that businesses need to research and alter their supply chains to find businesses and companies that may continue to supply still economically viable. When businesses are doing this kind of research, they're often relying on our tariff and duty database and calculators and looking at our inventory of historic trading activity to determine their alternatives. We continue to see a complex and changing international trade environment right now, which is driving more and more customers to use our global trade intelligence solutions.

So these are some of the areas that were strong in the business last quarter. The second area I wanted to address were some of the focus areas in running the business. One of the mantras that our customer success team uses in helping our business is retention, growth and advocacy. And I thought that was a good way to look at our focuses from last quarter.

First, with retention. As I mentioned last quarter, we've made a concerted effort to invest in the customer success function. This investment has been made with a view to both improving customer retention while also expanding our wallet share by introducing complementary solutions. We want to operate our business with the type of -- with the goal of customers for life. We run our business for the long term. We invest in our products for the long term. We want to be the long-term home for our customers.

To do this, we've invested in customer success to regularly interact with our customers and ensure that they're able to take full advantage of the comprehensive functionality of the Global Logistics Network. We've invested in our own infrastructure and security. We've implemented solutions to make it easier for our customers to work with us, be it customer support or billing. And we've been focused -- we've been forward-looking in developing our solutions so that our customers can get the advantage of evolving technologies and assurance of compliance with new trading standards. We want customers for life. We want them to serve today, tomorrow and every day after that.

And finally, growth. As Allan will describe in more detail soon, our results this quarter show continued growth in our business from our past investments. Specifically, we've made technological and people investments into sales and marketing functions in the company. We go to market in a customer-centric way by understanding our customers' challenges, ensuring knowledgeable personnel are available on both a geographic and solution basis and leveraging our vast network of customers to provide reliable best practices, both from an industry perspective and in using Descartes' solutions. Overall, this approach has resulted in more customers choosing Descartes and using our solutions. Given these results, I anticipate you'll see continued investment focus from us in these areas to drive future growth.

And then advocacy. We've stepped up our advocacy for our business and what we can do to help our customers. We're fortunate to have many talented people within our business, many with expertise in different geographies, modes of transportation or logistics functions. We've heard from our customers that they want more information from Descartes, our views on the industry, our perspectives on emerging trends and regulations, how we're contributing to sustainability and logistics and supply chains and our successes with customers solving logistics challenges.

We've increased our efforts in publication. We've held powered virtual online customer events. We've revamped our methods of communication, and we've restructured our communication style to be even more customer-centric. We're getting the message out about how Descartes can help its customers.

So those are some of the things that we're focused on in our organic business. However, we haven't taken our eye off also growing our business through acquisitions. Acquisitions remain a core part of what we do. We probably acquired 3 to 4 businesses a year historically, and we've already combined with 3 this fiscal year. Our goal is to operate a business that has the capital and people resources to be able to complete acquisitions that complement our primary goals of profitable growth and customers for life.

We have the resources to be acquisitive. We have a strong balance sheet with almost $190 million in cash, a $350 million undrawn line of credit and an unlimited shelf perspective that can be leveraged if additional capital is needed. We also have a track record of successfully finding, executing and integrating acquired businesses. We have a passionate employee base who often have either joined or participated in our prior acquisitions. We're an ideal home for technology businesses that care about logistics.

The XPS acquisition that we completed this past quarter is reflective of that. We continue to believe that the growth -- in the growth and future of e-commerce so the acquisition of XPS was logical for us. XPS is a multi-carrier shipping platform, much like the ShipRush platform that we currently operate. You can import order information, check the rates from various carriers who could move that package, select carriers, print shipping labels and track your order. XPS has technology solutions for all sizes of shippers and even has solutions for logistics service providers. It also integrates with major e-commerce marketplaces, RP providers and supply chain platforms. With XPS, the Global Logistics Network has even more scale and e-commerce solutions. XPS contributed well to our profits within the partial quarter and we anticipate the same going forward. A hearty welcome to all the XPS customers and employees.

To wrap up my preliminary comments, we had a great financial quarter. We've had good success in multiple areas of our business. However, we're still focused on investing financially and culturally to drive future growth. Right now, we're having good success driving both organic and inorganic growth. My thanks to all the Descartes' team members for everything they've done to contribute to a great financial quarter and continuing to have the business in an enviable position for future success. With that, I'll turn the call over to Allan to go through Q1 (sic) [ Q2 ] financial results in detail.

[Allan Brett, executive]

Thanks, Ed. As indicated, I'm going to take you through our financial highlights for our second quarter, which ended on July 31. We are pleased to report record quarterly revenue of $123.0 million this quarter, an increase of 18% from revenue of $104.6 million in Q2 last year. As Ed mentioned, the impact of a stronger U.S. dollar compared to all other currencies that we operate in, namely the euro, the British pound and Canadian dollar, had a negative impact on our revenue this quarter. Excluding the impact of FX changes, our revenue would have been almost $4 million higher and our growth rate would have been closer to 21% over the same period last year.

While revenue from new acquisitions, including the recently completed XPS acquisition, contributed nicely to this growth, similar to the first quarter, growth in revenue from new and existing customers from our existing solution set were the main drivers for growth this quarter when compared to last year.

Looking at the numbers further, our revenue mix in the quarter continued to be very strong, with services revenue increasing 70% to $109.4 million compared to $93.5 million in the same quarter last year and consistent at 89% of revenue in both periods. Service revenue was also up nicely sequentially, increasing just over 6% from Q1 this year despite the FX changes. License revenue came in at $3.3 million or just under 3% of revenue in the quarter, up from license revenues of $1.2 million in the second quarter last year, as we had a couple of larger license deals closed during the quarter.

Professional services and other revenue came in at $10.3 million or 8% of revenue in the second quarter. And so for the first half of this year, revenue came in at $239.4 million, an increase of 18% from revenue of $203.4 million in the first 6 months of last year. Again, excluding FX, revenue growth for the first 6 months would have been closer to 21% over the same period last year.

Gross margin for the second quarter was 77% of revenue, up slightly from gross margin of 76% in both the first quarter of this year and the second quarter of last year. Gross margin continued to increase with a strong growth from new and existing customers that we experienced in the quarter. Operating expenses increased by approximately 20% in the second quarter over the same period last year. And this was primarily related to the impact of recent acquisitions but also from additional labor related to costs as we continue to invest in the areas of our business as Ed described.

In particular, sales and marketing expenses were higher by approximately $3 million, increasing from 11% of revenue in Q2 last year to 12% of revenue in the current quarter as a result of the additional headcount added to this area as previously planned. R&D as well as general and administration expenses also saw increases, but those were more and less in line with the growth in revenue this quarter. So as a result of both revenue growth, offset slightly by our planned investments in the business, we continue to see strong adjusted EBITDA growth of 18% to a record of $54.0 million, up from $45.9 million and consistent at 43.9% of revenue in both the second quarter of last year as well as the current quarter.

As a reminder, while we are fairly naturally hedged on adjusted EBITDA, as a result -- mainly as a result of our success with Brexit and the sharp decline in the British pound to the U.S. dollar, we did experience a negative impact on -- from FX on adjusted EBITDA this quarter. Without the negative impact of FX, our adjusted EBIT growth would have been closer to 20% in the quarter.

For the 6 months year-to-date, adjusted EBITDA came in at $105.2 million or 44% of revenue, up from just over 20% from $87.4 million or 43% of revenue last year. With these strong operating results and strong collection from customers, cash flow generated from operations came in at $46.4 million or 86% of adjusted EBITDA in the second quarter. However, as a result of the stronger-than-expected performance of a few of our acquisitions, we paid an additional $5.3 million in consideration for earn-outs above and beyond our initial estimates of those acquisitions. And this added amount ended up flowing through our cash flow from operations this quarter. With these additional earn-out payments -- without these additional earn-out payments, cash flow from operations would have been closer to 96% of adjusted EBITDA this quarter.

For the 6 months year-to-date, operating cash flow has been $90.8 million or 86% of adjusted EBITDA, which again would have been closer to 91% of adjusted EBITDA without the impact of those additional earnouts that I just mentioned. And we should mention, as always, going forward, 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 85% and 95% of our adjusted EBITDA in the periods ahead.

We should also note that the income tax expense for the second quarter came in at $8.8 million or 28% of pretax income, which is close to our blended statutory tax rate. It is also, though, much higher than the tax expense of $2.7 million or only 10% of pretax income in the second quarter last year when we benefited from the reversal of certain valuation allowances. With our higher operating profits, offset by the higher income tax expense, from a GAAP earnings perspective, net income came in at $22.9 million or $0.27 per diluted common share in the second quarter, consistent with net income of $23.2 million or $0.27 per diluted common share in the second quarter last year.

Net income for the 6-month period year-to-date was $46.0 million or $0.53 per diluted common share compared to $41.6 million or $0.48 per diluted common share last year in the first half, again with the higher operating profits being partially offset with higher income tax expense. Overall, we are once again very pleased with our operating results in the quarter. And a strong organic growth and solid performance from our recent acquisitions resulted in 18% growth in both revenue and adjusted EBITDA for the quarter while we continue to invest nicely in our business.

If we turn our attention to the balance sheet, our cash balances totaled $189 million at the end of July, down approximately $23 million from the end of the first quarter. While we generated $46 million in cash flow from operations, we also used approximately $61 million of our existing cash balances in the second quarter to complete the acquisition of XPS while also using cash to pay out certain earnout payments related to past acquisitions.

We should note that while we put in place a normal course issuer bid, or NCIB program, at the beginning of the second quarter, we were not active with the NCIB during the second quarter. As a result of the above, we still have almost $190 million in cash as well as a $350 million available on our line of credit available for us to use to deploy towards future acquisitions or the NCIB as conditions dictate. So we continue to be well capitalized to allow us to consider all opportunities in our market, consistent with our business plan.

As we look to the balance of fiscal 2023, we should note the following: after incurring approximately $3.4 million in capital additions in the first half of the year, we expect to incur approximately $2.5 million to $3.5 million in additional capital expenditures for the balance of this year. After incurring amortization expense of $31.1 million in the first half of the year, we expect amortization expense will be approximately $29.5 million for the second half of the year, with this figure being subject to adjustment for foreign exchange changes and future acquisitions. Our income tax rate for the first half of the year came in at approximately 26% of pretax income, which again is very close to our blended statutory tax rate.

Looking into the second half of the year, we currently expect our tax rate will continue to be in the range of 25% to 30% of our pretax income. However, as always, we should state that our tax rate may fluctuate quarter-to-quarter from onetime tax items that may arise as we operate internationally across multiple countries.

And finally, after incurring stock-based compensation expense of $6.5 million in the first half of the year, we currently expect this compensation will be approximately $7.5 million for the balance of this year, subject to any forfeitures of stock options or share units. I will now turn it back over to Ed to wrap up and with some closing comments and our baseline calibration for Q3.

[Edward Ryan, executive]

Great. Thanks, Allan. While we had a great financial quarter that ended in July, we're already more than a month into our quarter that will end at the end of October. We're operating in an interesting and unpredictable business environment that I'd like to provide some more context on.

First, we're seeing strong volumes. In Q2, we continued to see strong shipping volumes across our Global Logistics Network in all modes of transportation. In July, public information shows that there were again record ocean imports into the United States when compared to a year-ago statistics. So while there are many concerns about the global economy, it doesn't appear to be making its way into shipment volumes yet.

Second, there's some shipping capacity coming back. For last year and the first quarter of this year, shippers experienced tight capacity to book transportation, usually resulting in much higher freight rates in both contract and spot markets. There appears to be more capacity available now and we're hearing some of the softening of freight rates. As a reminder, for Descartes, rises and falls in freight rates don't impact us financially. We have a portion of our revenues tied to the number of shipping transactions but not the price that those transactions are completed at. However, more affordable shipping benefits our many shipper customers and their ability and willingness to contract for logistics services.

But there's still backlogs. While additional vehicle capacity would seem to indicate that goods would flow more smoothly, that does not appear to be the case. Unfortunately, logistics infrastructure is just not able to efficiently handle the volume of shipments that are moving right now. In the United States, we're used to vessel backlogs in the West Coast ports, but those backlogs have now also moved to East Coast ports as businesses try to avoid West Coast delays. Throughput at all ports has been challenged for various reasons, including availability of human resources, with West Coast ports struggling with union negotiations and the California AB 5 law that makes independent trucking contractors employees.

This is further compounded by shortages in assets such as ocean carriers and truck chassis. Backlogs have even moved further inland with various rail hubs and intermodal touch points facing large processing delays. All in all, there are lots of shipment volumes and a logistics infrastructure that's really struggling to keep things moving, causing unpredictable shipping timing.

Next is inventory turnover. When shipping times are unpredictable, it presents big inventory challenges for shippers. Part of the art of inventory management is knowing what to order, when to order it and how much to order. Shippers have been unable to accurately predict the in-transit shipping time of goods, and as a result, have often either missed or mistimed the market and have excess inventory. For some, this excess inventory is now being moved out to discount retailers and retailers are having to replenish their stock. Overall, we believe the predictability of transit times is going to continue to create inventory challenges for shippers, and that real-time visibility to shipments is going to become even more important.

As the war in Ukraine continues, our customers continue to adapt their supply chains to a conflict that does not appear that it will end in the short term. Financial and trading sanctions continue to be imposed by many parties. Supply of commodities from the regions such as grain are unpredictable. For the region, it's become easier to understand what you can't do than what you can do. China continues to battle COVID with more than 60 million people currently in lockdown. There are other geopolitical tensions developing, including between the U.S. and China relating to Taiwan.

More specifically to Descartes, there's new leadership in the U.K., which influences the uncertainty around the post-Brexit customs and security filing requirements for goods coming into Northern Ireland. There also seems to be a lot of uncertainty around the state of the global economy. Some countries are seeing reduced growth or recessionary economic signals. Interest rates have risen steadily as central banks try to get inflation under control. Fuel costs have also increased. And in some geographies, there have been energy shortages, particularly in Europe, where energy and commodities have been impacted by the war in Ukraine. This economic uncertainty creates challenges for our customers and for Descartes to predict what the future business environment will be like.

Before I hit calibration, I just want to hit on some other areas of corporate development for Descartes. We're mindful of this uncertainty in the business environment when we consider how our own business is calibrated for the upcoming quarter and how accurately it will reflect our financial results for the quarter. In particular, the foreign exchange environment has already gotten worse since we calibrated on August 1. Also, last quarter, our financial results ended up higher than we would have expected based on our calibration, in part because of higher-than-normal license revenues in Q2 and the acquisition of XPS, which is now in our baseline calibration. All that to say that this quarter, we would therefore expect a tighter range on the actuals as compared to the baseline calibration.

So for calibration, our business is designed to be predictable and consistent. We believe the 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 for our business is 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, 2022, using foreign exchange rates of $0.78 to the Canadian dollar, $1.02 to the euro and $1.22 to the pound, we estimate that our baseline revenues for the third quarter of '23 are approximately $107 million, and our baseline operating expenses are approximately $66.5 million. We consider this to be our baseline calibration of approximately $40.5 million for the third quarter of 2023 or approximately 38% of our baseline revenues as at August 1, 2022.

Our targeted adjusted EBITDA operating margin range for our business remains at 38% to 43% for fiscal 2023. In Q1 and Q2, we were at 44% above this range. However, in light of the broader uncertainty in the markets, including in the foreign exchange markets, we're not looking a change in our targeted range but we'll revisit that in future quarters if we continue to overperform and the market stabilizes.

We're already very hard at work on having our customers deal with these very complex times. We believe that if we focus on making our customers successful, it's our own best chance at achieving our own goal of being strong and trusted business, delivering superior results for our customers and shareholders.

I want to thank 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 to you. And with that, I'll turn the call over to questions for the operator. Thank you.

[Operator]

[Operator Instructions] And our first question comes from Matt Pfau.

[Matthew Pfau, analyst]

Nice quarter, guys. Wanted to ask in terms of the demand that you're seeing. The context on shipping volumes was really helpful. But in terms of selling products and demand, has there been any change there? How have discussions with customers been at any lengthening of sales cycles that you're seeing?

[Edward Ryan, executive]

No, we still continue to see strong support from our customer base. We see lots of sales processes in place. You can see that in the numbers that we just put up. And I think our customers see some of the uncertainty out there, but they also recognize, as I probably mentioned in the past, that supply chain and logistics is crucial for their business and they need to make investments to be better and better at that in the future. And I think those investments continue to this day.

[Matthew Pfau, analyst]

Great. And then on the shipping volumes within being at record levels or at least in terms of imports into the U.S., how do you view the sustainability of that add? And how does that impact your business?

[Edward Ryan, executive]

Well, I mean, 40% of our recurring revenue is related to those transportation transactions and we're still continuing to see strong demand out there. I mentioned that in the beginning of the call. That continues. We'll see what happens in the future and we're reading the same newspaper you are. With the global economy, it seems there's a lot of uncertainty out there. There's a big debate about whether we're in a recession or if we are, how much of one it is.

But from what I'm reading, I don't see terrible times at the moment. It seems maybe it's just a little trepidation in people's decision-making process to buying goods and services. But at the same time, there's a big backlog in most of the world's supply chain, which is forcing big retailers and manufacturers to continue to ship goods around the world as they have in the past. And I think you saw that in the numbers we put up this past quarter.

[Operator]

And our next question comes from Raimo Lenschow from Barclays.

[Jeremy Campbell, analyst]

This is Jeremy on for Raimo. So I just wanted to ask about also on shipment volumes across the different transportation modes. So between ocean, air and rail, is there anything to kind of call out? Or was it pretty consistent from last quarter?

[Edward Ryan, executive]

Yes. No, the shipping volumes in all 4 modes of transport: ocean, air, truck, rail continue to be fairly strong. I think there's backlogs in various areas where I've mentioned here. Maybe some of the backlogs of what we're reading in the newspapers and some of the trade reports have -- there's a little less congestion out there. But in terms of shipping volumes we're seeing on our network in the past quarter, they were still going strong as ever.

[Operator]

Our next question comes from Justin Long from Stephens.

[Justin Long, analyst]

I wanted to start with a question on organic growth. I was wondering if you could share your estimate for that number in the quarter. And then following up on transaction volumes, is there a way to think about a stress test of the model, taking those transaction volumes to recessionary levels and what that would mean for organic growth relative to where you are today?

[Allan Brett, executive]

Sure. It's Allan here. So on the first part of the question, organic growth, we don't break it out completely. We don't have -- we integrate the businesses we buy, as you know. But our best estimate would be in the 12% to 13% range, pretty consistent with last quarter. So that's the first part of the question. Ed, you want to take the second?

[Edward Ryan, executive]

You wanted me to relate that to a stress test of what would happen if the world went to a recession? Is that what you're asking?

[Justin Long, analyst]

Correct. So if we just took transaction volumes back down to where they were in prior recessions, what kind of impact that would have.

[Edward Ryan, executive]

Yes. I mean I don't know numerically what kind of impact it would have. It would obviously impact us, as we probably told you in the past. About 40% of our business is transaction volumes. And certainly, if the world's shipping volumes went down, we'd be impacted by that. In terms of putting numbers behind it, I'm not going to do that because I don't know where -- I don't know how bad a recession we're talking about or whatever.

I can tell you in '08, and I probably told you and most of the people on the calls in the past, we were down about 8% in transaction volume, so which is interesting to me because if you think about it, that was a pretty bad recession and still, most of the world's goods were still moving around the world. And we saw some degradation on our network and it impacted us and, obviously, it would impact our growth rates at that point.

But even in that worst case scenario, which I don't feel like we're anywhere near that kind of scenario right now or looking at that kind of scenario in the future, we were still able to grow in a small way but still able to grow through it. So we'll see what happens. I'm not sure if we're even headed into a recession or if we are, what it looks like. But I think our business is well positioned to do well even in a down environment.

[Justin Long, analyst]

Okay, helpful. And secondly on acquisitions, just curious in the pipeline if you've seen a change in the number of deals or valuation multiples over the last few months?

[Edward Ryan, executive]

We continue to see a lot of deals out there. A lot of companies we're interested in buying as always. I think there's a little settling out that's probably going on in the larger deals more than the midsize and smaller deals. We're trying -- people are trying to figure out what the right price for some of these things are. You've seen on some of the larger deals, deals get stalled or held. But on our normal tuck-in type of business, we still see a nice pipeline as we have for the past several years.

[Justin Long, analyst]

Okay, great. Congrats on the quarter.

[Operator]

Our next question comes from Scott Group from Wolfe Research.

[Scott Group, analyst]

Can you talk about the revenue and margin run rates for XPS? And then just more broadly on the acquisition environment, it feels like earnouts have become a bigger part of the approach to acquisitions. I guess the earnouts are just getting a little bit bigger relative to initial purchase price. Do you think that's a new trend, new normal, Ed?

[Edward Ryan, executive]

Want to take the first one?

[Allan Brett, executive]

Yes. So I'll answer your second one first. So earnouts, we typically use earnouts, and this has been consistent in our past, to bridge the gap between price differences, obviously. And so I think what we're seeing here, a couple of larger earnouts are unique. It maybe is a symbol of the time that we're in here, the uncertainties that Ed has talked about. We don't think that's the norm. But we will continue to use those earnouts to bridge a gap between what a seller thinks their business is worth and what we think it's worth.

Our approach is whether we pay 0 on the earnout or we pay 100% of the earnout, we're happy. The business will meet our financial metrics either way. So whether -- again, whether it's 0, 50%, 100%, it will meet our financial metrics and we design the deals that way.

To your first question on XPS, we don't break out details on the various acquisitions. But suffice to say, the multiples paid on XPS were pretty consistent with what we've been paying historically, so pretty much down the middle of a typical type of deal that Ed just described, the tuck-in type of deals that we see.

[Scott Group, analyst]

Okay. I think this was the first time in like 4 years where EBITDA margins didn't improve year-over-year. Just any thoughts there and where we go from here on margin.

[Allan Brett, executive]

Yes. I think as I said in the prepared comments, we grew nicely from a revenue perspective. Acquisitions contributed but the organic growth continue to be very solid. So that helped us. However, we are also making investments in our business. We've talked about this over the last 5 or 6 quarters that we would invest in the business. And certainly, that would be something that where the cost structure would go up. So there's also an impact of FX that's happened here in the numbers.

Put all that together, we're still operating at very, very strong EBITDA margins of 43.9%. So that's really what's happened, a combination of the organic growth, investments in the business and an FX change leading to consistent margins.

[Edward Ryan, executive]

I'm not going to explain about 44% of EBITDA margin, either, Scott. So we're happy with that.

[Scott Group, analyst]

Okay. And if I can just clarify one last thing. Your comment, Ed, about not seeing any slowdown in volume, I think you talked about July imports being at a record level. Is that a real-time comment through August, beginning of September? Just like when we look at the ocean rates, it feels like they've really taken a big step-down over the last month. I know you don't care about the rate but I'm guessing that's indicative of the demand environment. Are you not seeing any drop-off in transactional?

[Edward Ryan, executive]

I'm commenting on our numbers from last quarter. I'm not really able to comment on our networks from this quarter, but I'm commenting on things I'm reading in the paper and talking to customers about how they're doing. And yes, the rates are coming down. I think it's partially because there's more capacity coming in. But I think the shipping volumes [ only not ] externally are saying that they're still doing pretty well.

[Scott Group, analyst]

Would your baseline, though, for Q3 reflect your view of transactional?

[Edward Ryan, executive]

Yes, it's what we think. Yes, that's certainly part of calibration for sure.

[Operator]

And our next question comes from Nick Agostino.

[Nick Agostino, analyst]

Ed, I think in the past, you guys, I guess, did a little bit of a shift on your sales strategy going from -- or going towards more customer-centric as opposed to an account and geography approach. And on the call, you highlighted that you're obviously focusing more on customer retention, customer success and just overall increasing your customer count and having those customers stay with you longer.

Are there other metrics that you guys are looking at? And specifically, how are you guys measuring the financial impact from that shift in strategy? And maybe if there's a way to quantify what that strategy has meant for this quarter just in terms of top line dollars, if that's something you guys are looking at.

[Edward Ryan, executive]

Well, first, let me just correct one thing you said. It was in -- the customer-centric focus was an addition to the structure that we already have in place, not a replacement of it or not a revamping. We were adding customer-focused people to our existing sales structure. The cost was minor. You probably wouldn't have noticed it if we didn't call it out in terms of our actual costs. But I think the thing we're trying to do is keep our customers doing more stuff with us for longer. And I think the thing that we look at is our organic growth rates and doing that.

How much our customers spending with us every month and are we able to get them to buy more stuff from us because they think our stuff is useful for them and their business and trying to help improve their businesses, we can look at our -- you can look at the uptick over the past years. We've been making these investments in our growth rates, our organic growth rates, I think that's somewhat telling. It's probably also partially due to the strong economy.

But certainly, we're very happy and pleased with the investments we made and how our sales force has responded since then. And hopefully, we continue to make these investments and we see more of that in the future.

[Operator]

We have no more questions at this time. I'll turn it back to the speakers for closing comments.

[Edward Ryan, executive]

Great. Thanks, everyone. We appreciate your time today and look forward to reporting back to you next quarter.

[Operator]

And thank you. Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.