Delhivery Ltd (DELHIVERY) Q2 FY23 Earnings Concall Transcript

Delhivery Ltd  (NSE:DELHIVERY) Q2 FY23 Earnings Conference Call dated Nov. 14, 2022

Corporate Participants:

Sahil Barua — Managing Director and Chief Executive Officer

Sandeep Barasia — Executive Director and Chief Business Officer

Analysts:

 

Mukesh Saraf — Spark Capital Advisors (India) Private Limited — Analyst

Rishi Iyer — Citi — Analyst

Gaurav Rateria — Morgan Stanley — Analyst

Pulkit Patni — Goldman Sachs Research — Analyst

Aditya Mongia — Kotak Securities — Analyst

Alok Deshpande — Edelweiss Financial Services — Analyst

Sachin Dixit — JM Financial Ltd — Analyst

Abhishek Ghosh — Quadrant Knowledge Solutions — Analyst

Abhijit Mitra — ICICI Securities — Analyst

Presentation:

Rishi Iyer — Citi — Analyst

Ladies and gentlemen, on behalf of the Citi Equities team, I welcome you all to the second quarter FY ’23 Earnings Conference Call of Delhivery Limited. From Delhivery’s management team, we are joined today by Mr. Sahil Barua, the MD and Chief Executive Officer; Mr. Sandeep Barasia, ED and Chief Business Officer; Mr. Amit Agarwal, Chief Financial Officer; and Mr. Varun Bakshi, the Head of Investor Relations.

Before we start, we would like to point out that some of the statements made in today’s call may be forward-looking in nature, and a disclaimer to this effect has been included in the earnings presentation shared with you earlier. Kindly note that this call is meant for investors and analysts only. If there are any representatives from the media, we request you to drop off this call immediately. [Operator Instructions]

I thank the management team for providing us the opportunity to host this call. I now invite Mr. Sahil Barua to take us through the key highlights for the quarter, post which we open the floor for Q&A. With that, over to you, Sahil.

Sahil Barua — Managing Director and Chief Executive Officer

Thank you, Rishi, and thank you to the Citi team for organizing this. Just a quick check that I’m perfectly audible.

Rishi Iyer — Citi — Analyst

Yes, sir, we can hear you.

Sahil Barua — Managing Director and Chief Executive Officer

Excellent. Thank you. Thank you all for joining our earnings presentation for quarter two fiscal ’23 today. I’ll start with a quick 15- to 20-minute presentation on quarter two, and then we’ll open the floor for questions. For those of you who’ve joined afresh, Apar, if we can move to the first slide, just a quick refresh on Delhivery. The aim of Delhivery is to build the operating system for commerce in India, which means we essentially provide the logistics infrastructure, technology and services that enable buyers and sellers to transact with each other in the physical world.

These buyers and sellers, who are customers of Delhivery, could be businesses transacting with businesses, businesses transacting with consumers, or consumers transacting with consumers within India or from India to the world or the world to India. In terms of a quick snapshot of quarter two, Delhivery continues to be India’s largest integrated logistics platform.

We recorded revenues of about INR1,796 crores in quarter two of financial ’23, which represents a 9.3% year-on-year growth rate over quarter two in financial year ’22. Adjusted EBITDA margins have improved to negative 7%, which is an improvement of about 547 basis points from quarter one financial ’23. We delivered about 161 million packages in our express delivery network, which represents a 19% growth year-on-year from quarter two in financial ’22. We remain the leading independent express player in India and have delivered close to about 1.7 billion packages since our inception.

Our part truckload business continues to be one of the largest PTL businesses in India. We recorded 20% quarter-on-quarter growth from quarter one when we had seen a decline in volumes versus quarter four due to our integration with Spoton. We’ve delivered close to about 2.7 million tonnes since our inception in financial ’19. We continue to be one of the largest players from an infrastructure and reach standpoint across the country. We operate close to about 18.5 million square feet of logistics infrastructure, which includes trucking terminals, automated sortation centers and gateways, freight service stations, collection points and delivery centers.

Over 28,000 customers depend on Delhivery’s network for a variety of different services. Over half of our revenue today comes from customers who use two or more of our services, and we cover 18,454 pin codes across the country of India based on the definition of pin codes provided by the Indian Post. In terms of a quick snapshot on operating metrics. Our pin code reach has increased to 18,454 pin codes at the end of quarter two, as I mentioned. We continue to service 220 countries from both an imports and an exports standpoint through our global partnerships with FedEx and Aramex. Over 28,000 customers, as I mentioned, use one or more of Delhivery’s various services.

From an infrastructure standpoint, we operate close to about 18.4 million square feet of infrastructure across the country. The key change from financial ’22 and from quarter one financial ’23 to quarter two is that our integration with Spoton and consolidation of infrastructure between Delhivery and Spoton, as we had mentioned, is underway and continues as per plan. We’ve seen a reduction in total number of gateways from 123 at the end of financial ’22 to 96 as of quarter two fiscal ’23, and a reduction in the total freight service centers that we operated as independent networks from 267 as of financial ’22 to 188 as of quarter two financial ’23. These are the two lines that are highlighted in red on your screen.

And the team size overall has reduced from a total team size of 60,373 to close to about 56,500 people as of quarter two fiscal ’23. We expect this integration and the benefits of consolidation to continue through the rest of this financial year. Moving to the next slide; some highlights since the last earnings call. Our Express Parcel business continues to remain robust. We remain the largest independent express logistics company in India.

We saw 19% growth in volumes year-on-year in quarter two of this year, but more importantly, in the festive season towards the end of the quarter, we saw an 80% growth in festive season daily volumes versus the rest of the quarter. We continue to have a unique capability and a dominant position in fulfillment of heavy goods with a 30% growth in volume over the previous quarter, in quarter one. We also continue to regain market share in the part truckload business post our integration with Spoton. We are today one of the largest PTL freight networks in the country. We saw 20% growth in volumes in quarter two compared to quarter one.

More importantly, network service levels have remained stable across all business lines and above 90% as clients measure us. The integration issues and operational issues that sprang from our integration with Spoton in quarter one have been conclusively resolved as of quarter two, and the network footprint rationalization is underway as per plan and as you can see in the numbers I have shared earlier.

While our core businesses, which are Express and PTL, continue to maintain position or grow rapidly, we’re also seeing momentum across our newer businesses. Our Supply Chain Services business and our full truckload business have shown significant growth since the same quarter last year. Client acquisition momentum in the SCS business continues to be robust with large enterprises trusting us to run their entire supply chain operations, and we continue to also see strong growth in our cross-border express and freight businesses despite a global slowdown and a decline in air and ocean freight yields.

A quick snapshot of what volumes in the Express business look like. This represents three-day average pickup volumes over the last quarter, July, August, September. As you can see, towards the end of September, we saw a seasonal spike in volumes as part of the e-commerce sales season. This pipe was about 2.3 times of quarter two financial ’22 and 1.9 times of quarter two financial ’23, the average volumes that we saw prior to the peak. We expect to continue to see growth in quarter three and some growth in quarter four as well.

In terms of financial performance, as you can see on the bars on the left, revenues from services have grown from INR1,644 crores in quarter two fiscal ’22 to INR1,796 crores, which is a growth of about 9% year-on-year. Express and PTL continue to be the dominant revenue lines, together forming close to 79% of revenues in quarter two; and our newer businesses, which have grown rapidly, continue to form 21% of our overall revenues.

The bars on the top right represent the Express business. We’ve seen a 17% growth in revenues year-on-year from INR960 crores in quarter two of financial ’22 to INR1,125 crores in quarter two fiscal ’23 and a 19% growth in volumes from quarter two fiscal ’22 to quarter two fiscal ’23. The PTL business has grown from quarter one financial ’23, which is when we faced operational issues due to the integration of Spoton. However, we’ve grown on the back of improved service levels from INR259 crores in PTL revenues to INR293 crores in quarter two fiscal ’23. And we’ve also seen an increase in volumes from 239,000 metric tonnes of freight to 286,000 metric tonnes of freight in quarter two fiscal ’23.

Our newer businesses, as I mentioned, continue to do well. Supply Chain Services has more than doubled the number of active engagements versus September 21, which is the same time last year. We continue to win accounts across a number of industries, which include quick commerce, baby products, the auto industry, electric vehicles, agri tools. We have leading enterprises who work with us across a number of verticals already, which include auto, consumer durables, consumer electronics, FMCG, and industrial products companies across India.

Our truckload services platform has also nearly doubled from the same time last year. We continue to add new accounts across a variety of different verticals, the key ones obviously being pharmaceuticals, paints, the tire and auto industry and consumer electronics. More importantly, we are seeing product-led growth in this business this year as a significant portion of truck placement and supply is now transacting digitally via our supply-side applications and via our marketplace, which reduces both the cost of supply, improves pricing transparency, and improves service quality in the truckload exchange.

And finally, on the cross-border side, we continue to gain customers both for our Express and our Freight businesses independently and through our partnership with FedEx. We won key accounts across industries such as industrial engineering, electrical equipment, renewables and FMCG. We’ve also launched a new key project which integrates our domestic PTL and FTL trucking solutions with international ocean and airfreight solutions, essentially providing a complete door-to-door delivery service. This is targeted at critical sectors like pharma, auto and engineering.

We have a strong position established on intra-Asia air freight, and also our FedEx partnership continues to scale for Express Parcel exports. In terms of revenues. As I mentioned, newer businesses continue to contribute a meaningful portion of our revenue. They’re today about 21% of total revenue. The FTL business has grown about 90% year-on-year from quarter two fiscal ’22 to fiscal ’23. Supply Chain Services has grown 60% from INR112 crores in quarter two fiscal ’22 to about INR180 crores in fiscal ’23. And cross-border has grown about 33% from quarter two fiscal ’22 from INR80 crores to INR100 crores.

The decline from quarter one to quarter two in the FTL and Supply Chain Services business is a reflection of seasonality in our underlying customers’ businesses. Now while revenues have grown, more importantly, economics have improved sharply in quarter two compared to quarter one. As we discussed on our last earnings call, quarter one earnings were affected by our integration with Spoton, where we continue to run a relatively underutilized network to allow service to recover and to settle claims with customers.

Service EBITDA, however, for quarter two stands at INR86 crores, and service EBITDA margins have improved from negative 0.3% in quarter one fiscal ’23 to nearly 5% in quarter two fiscal ’23, which is a strong reflection of the massive underlying operating leverage in the combined network between Delhivery and Spoton. Overall, at an adjusted EBITDA level, this has improved from negative INR217 crores in quarter one fiscal ’23 to negative INR125 crores in quarter two fiscal ’23. I think the important thing for us to note in that we are pleased to see is that post integration of the Delhivery and Spoton networks, the operating leverages that existed in a pre-integrated Delhivery stand-alone network continue in the combined network as we have integrated successfully.

The key driver of the movement in adjusted EBITDA, as I mentioned, is essentially the massive incremental gross margins that exist in our transportation business. quarter one fiscal ’23 adjusted EBITDA stood at negative INR217 crores. Of this, INR46 crores that we had mentioned in our last earnings call was a onetime integration expense related to provisions and vendor payments as part of the Spoton integration. So excluding that, quarter one fiscal ’23 adjusted EBITDA stood at negative INR171 crores.

The incremental revenue in transportation generated in quarter two, which includes both e-commerce, Express and PTL stands at INR107 crores, and the incremental gross profit in our transportation business stands at INR53 crores, which gives us an incremental gross margin across transportation of approximately 50%, and as I mentioned, reflects the massive operating leverage that exists in the combined Delhivery and Spoton network.

This is what has led to a total improvement in adjusted EBITDA from negative INR217 crores in quarter one to negative INR125 crores in quarter two. And as volumes continue to come into the Delhivery network, from here on, we expect incremental gross margins to behave predictably and profitability to continue to improve. This is just a quick graphical representation of the same point. In quarter one, fiscal ’23, adjusted EBITDA had dropped to negative 12.5% owing to onetime costs and integration costs. This has improved to negative 7%. As volumes continue to come into the network, we expect adjusted EBITDA to continue to improve.

As a quick bridge, if you focus on the column in the middle, which is quarter two fiscal ’23, total revenue from customers increased to INR1,796 crores compared to INR1,746 crores in quarter one fiscal ’23. More importantly, total absolute expenses reduced from INR2,206 crores in quarter one to INR2,158 crores in quarter two. The major adjustment is simply for noncash recurring costs, which add up to INR221 crores. That includes INR142 crores of depreciation and amortization expenses and INR79 crores of ESOP expenses, effectively giving us an adjusted EBITDA of negative INR125 crores, a negative 7%.

In terms of cash PAT, the picture is stronger. Cash PAT for quarter one stood at negative 10.4%. As of quarter two fiscal ’23, adjusted cash PAT has improved to negative 1.7% with an adjusted cash PAT loss of INR32 crores in this period. The cash PAT bridge looks exactly the same as the adjusted EBITDA bridge. Losses after tax for quarter two fiscal ’23 stood at negative INR254 crores compared to negative INR400 crores for quarter one and negative INR600 crores for the same quarter last year. The major adjustment again is for noncash recurring costs, which are depreciation and amortization and ESOP expenses.

The adjusted cash PAT, therefore, stands at negative INR32 crores or minus 1.7%. That covers the presentation. In terms of a quick summary, this quarter has been one of consolidation for Delhivery. We continue to be, as I mentioned, the leading independent express player in the country. We’ve delivered over 161 million packages in the last quarter, and we continue to maintain our strong market position. The PTL business, this was a quarter of recovery. Volumes have grown by 20% compared to quarter one. Service quality and integration has improved and integration issues are now behind us.

We gained market share and we still are one of the largest retail players in the country, expect to continue to gain share. Most importantly, from an economic standpoint, service EBITDA has recovered sharply in quarter two to 4.8%. Our incremental gross margins are at 50%, and the operating leverage in the combined business post integration remains intact. With industry-leading service quality, with the size of our network and our reach, we will continue to evaluate the strategic option to use our incremental gross margin to gain share across all the industries that we operate in.

And finally, our newer businesses continue to see strong demand from customers across various industries. We’ve seen massive year-on-year growth across truckload, Supply Chain Services and the cross-border businesses. We remain optimistic about the rest of the financial year and financial year ’24.

With that, I’ll pause and hand back to the Citi team for questions. Thank You.

Questions and Answers:

Operator

Thanks Sahil. [Operator Instructions] We’ll take the first question from Mukesh Saraf of Spark Capital. Operator, kindly unmute their line.

Mukesh Saraf — Spark Capital Advisors (India) Private Limited — Analyst

Yeah, good evening and thank you for the opportunity. My first question is on the Express Parcel growth of 19% this quarter. Could you indicate some sense on how the industry has been? Have we maintained market share, or have we gained market share, or any change in market share there on the Express Parcel?

Sahil Barua — Managing Director and Chief Executive Officer

Thanks, Mukesh. We believe that we have continued to retain the market share that we had as of last year. I think our position, as we look at each of our individual client accounts, remains intact. Depending on which clients, obviously, see different levels of growth over the year, our consolidated market share position may change accordingly. We obviously have larger share with some customers and less share of wallet with some customers. But overall, our competitive position on the express industry remains intact. We continue to have the same cost and technology advantages that we had as of last year and continue to exercise that to defend market share.

Mukesh Saraf — Spark Capital Advisors (India) Private Limited — Analyst

Right. Would you be able to comment on, say, a large e-commerce platform such as Meesho, which have on media been kind of commenting that their growth has been significant, much higher maybe, than say 40%, 50% kind of a number. So any wallet share shifts in such large accounts?

Sahil Barua — Managing Director and Chief Executive Officer

None that we have seen. We continue to maintain sort of [Indecipherable] share with each of our individual accounts. And overall, if you look, as I’ve mentioned, we saw massive dips in volume with seasonality.

Mukesh Saraf — Spark Capital Advisors (India) Private Limited — Analyst

Right, right. Thanks for that. And secondly, on the PTL business, we see, on an average, we have done probably about 3,200 tonnes a day. Last year same quarter, we were about 4,500 tonnes, and in the fourth quarter, we approached 5,000 tonnes. Could you give some sense on at what rate we exited second quarter and probably some indication of how October, November has been?

Sahil Barua — Managing Director and Chief Executive Officer

So we’re currently at a rate which is close to about 3,400 to 3,600 metric tonnes of freight a day. I should add some context over here. On the PTL business, our first port of call was really stabilizing service issues post the integration in quarter one. I think we successfully navigated that period in quarter two, and service levels, in fact, are better than they were in a pre-integration world, not just in terms of network speed and reach, but also in terms of quality metrics, which include shortage deliveries, damage deliveries and so on.

So this has actually been a pretty good quarter from a service level standpoint. Also, the other sort of exercise that we undertook post integration was to take a look at all of the individual client accounts that we had both at Delhivery and at Spoton. We evaluated accounts which were unprofitable for Delhivery and Spoton and either renegotiated pricing or eventually stopped services, and also to get out of certain accounts where we had to provide highly bespoke services, where it made more sense for us to stop it instead of a standard-less PTL platform.

Mukesh Saraf — Spark Capital Advisors (India) Private Limited — Analyst

Sure. And just last one if I may squeeze. We did get some sense from the industry participants that some of the large e-commerce platforms are looking to split the services across first mile, mid-mile and last mile between different vendors. While Delhivery does provide end-to-end logistics, do you think this in any ways is happening? And will this impact Delhivery’s positioning in the market?

Sahil Barua — Managing Director and Chief Executive Officer

Not at all. Because when we established the fact that we are the lowest cost operator in this space, we are not just the lowest cost when bundled, we are also the lowest cost at each individual leg of the transaction. Our first mile cost is the lowest, our mid-mile cost is the lowest, and our last mile cost is the lowest. So this is actually a structural advantage, and I think it makes more sense to outsource it. So Delhivery, essentially, what I’m saying is it’s impossible to unbundle Delhivery.

Mukesh Saraf — Spark Capital Advisors (India) Private Limited — Analyst

Right, right. Got that. Thanks a lot Sahil. I’ll get back in the queue.

Rishi Iyer — Citi — Analyst

The next question is from Gaurav from Morgan Stanley. Please go ahead.

Gaurav Rateria — Morgan Stanley — Analyst

Hi. Thank you for taking my question. So first question again is on the Express Parcel business. How should we think about recovery from here? Going by the commentary that you made on the festive season, it appears that we are likely to be under 20% growth for the next two quarters. So how should we think about transition back from 20% number to like 30%, like we have been doing sustainably for the last several, several years? How should one think about that?

Sahil Barua — Managing Director and Chief Executive Officer

See, I think in the Express business, it’s a pretty simple answer. We monitor our share of wallet with every single account that we work with. We also manage our overall client portfolio to make sure we’re not unnecessarily concentrated with any single account. We will maintain our share of wallet with every single account that we have. And depending on the underlying growth that each of these accounts will see in the market, our consolidated market share will change as a consequence of that.

The other important thing to note is that, ultimately, we are the highest quality network. We are the largest network from a reach standpoint. And we also have the lowest cost structure. Our incremental gross margins I have shared with you. And so our ability to use our gross margins to protect our share, if we have to, is also, in some senses, unlimited. So that’s sort of the way I would think about it. We will essentially maintain our leadership in this space.

Gaurav Rateria — Morgan Stanley — Analyst

Got it. Secondly.

Sandeep Barasia — Executive Director and Chief Business Officer

If I can add, if I can add we will periodically go back and look at what we believe is the market size and scale and what our share is with each player. And obviously, we triangulate it through various sources. It’s not something that is given to us or we don’t have a Nielsen in our industry as such. And as Sahil said, think we will make adjustments. And if we feel like if there’s any count where we feel like our share position has changed, we will actually do what we need to do to defend our share under any circumstances.

Gaurav Rateria — Morgan Stanley — Analyst

All right. That’s very helpful. You had given a number a couple of quarters back, I think, that your market share in the overall Express Parcel business is around 21% to 22% or even higher than that. Where do we stand as of now in your broad estimate?

Sahil Barua — Managing Director and Chief Executive Officer

Not significantly changed at all.

Gaurav Rateria — Morgan Stanley — Analyst

Got it. Last question on the 50% incremental gross margin. Should we think about going forward that kind of a ratio holding up or in the sense that correlation holding up or is it also the fact that we created a lot of capacity this year and that is why the incremental gross margin is very high. So how should one think about the more like a sustainable incremental gross margin in this business of transportation?

Sahil Barua — Managing Director and Chief Executive Officer

That’s actually a very good question, Gaurav. In fact, today, as I look at the network, our incremental gross margins could have been higher, which means we continue to carry a little bit of capacity that is underutilized in different segments. Obviously, when you look at capacity, it’s a complicated sort of decision because there are different points of capacity. As an example, the automated sort stations continue to be quite heavily capacity utilized. The hubs and the line haul network are still slightly underutilized.

And the last mile network can probably absorb another 30% volumes overall. So the capacity answer is sort of split across different legs for Delhivery. So one, I think our overall incremental gross margins could increase from here. The second is this is based on historical precedent. Obviously, as we start getting to capacity utilizations of close to 85% to 90% and have to reinvest, we see incremental gross margins at that point coming down to maybe about 45% or so. But there’s basically a massive underlying operating leverage in our business.

Gaurav Rateria — Morgan Stanley — Analyst

That’s very helpful. Thank you so much.

Rishi Iyer — Citi — Analyst

The next question is from Pulkit Patni. Please go ahead.

Pulkit Patni — Goldman Sachs Research — Analyst

Yeah. Thank you for taking my question. My first question is when I look at the slide where you talk about your key operating metrics, and between Q1 and Q2 we’ve seen some reduction in capacity. Now while this is clearly for better integration of Spoton, just want to understand, does it in any way also indicate our thoughts about growth? Because for a company which is in a high-growth sector to actually cut capacity at this stage, how should one look at this in terms of growth for us, say, over the next few quarters going forward? That would be my question number one.

Sahil Barua — Managing Director and Chief Executive Officer

Sure. You should not view this in any way as compromising our estimates of growth going forward. This is the number of freight service centers that we run. If you look at the overall infrastructure that we run, as of the end of financial ’22, we had 18.15 million square feet of infrastructure, that has risen to 18.46 million square feet as of quarter two.

Our network team continuously reevaluates the structure of the underlying network and decides what is best for us to consolidate. Let me give you an example, Pulkit. As an example, even today, because of Delhivery and Spoton having independent hubs in Pune, we continue to run two hubs in Pune, over the next 18 months those two hubs will be consolidated into a single hub.

Now while that may not reduce our overall infrastructure footprint because we may continue to operate the same space, what it does is bring massive efficiencies to the operation in Pune because, essentially, we can eliminate several of the costs that we have to duplicate between the two facilities and also the interhub connections that we have to run at this point because we run two facilities. So essentially, all of this consolidation is to drive better efficiency. As our volumes go up, we make automated decisions on how to expand the network and nothing will change on that front.

Pulkit Patni — Goldman Sachs Research — Analyst

Okay. That’s useful. My second question is on competition. I think somebody did touch upon this. Whether it is Flipkart or Amazon who are talking about doing logistics for third party, Meesho in an interview mentioned that they don’t look at this as a cost center — as a profit center. I mean, just wanted to get your thoughts that in the last, say, 6-odd months, do you think that the competition metrics have changed for us in any way or you think this was something which was anyways in works and really doesn’t change much? Because I think it has implications in terms of our ASPs, and that’s why I wanted to get a better understanding of this aspect.

Sahil Barua — Managing Director and Chief Executive Officer

Certainly, I think it’s a very topical question. Let me begin with competition. I think the state of competition that you referred to is a state of competition that has existed for several years. It’s been pretty much the same players are going for pretty much the same strategies for nearly half a decade now. And so in terms of either competitive intensity or in terms of sort of various competitive players’ strategies, nothing has fundamentally changed in the market. The express market is a competitive market.

But to be clear, it is not determined purely by one factor, which is price. It is determined by the reach of the network. It is determined by the quality of delivery and the speed of delivery. There are several auxiliary service metrics that customers use to decide. And finally, with all of these being a hygiene factor, there’s a question of price. As we’d mentioned, Delhivery has a strategic competitive advantage, which is that our cost structure is significantly lower than either our listed or our unlisted peers and certainly lower than captive arms of e-commerce companies.

More importantly, we’re actually designed to service third parties as opposed to being fundamentally designed to serve first parties and then trying to externalize. So I think nothing weakens our competitive advantages in any way. Different players obviously will try different strategies over the next couple of years. It’s a large market. But from our standpoint, we have the leading cost structure. We have a massive balance sheet. We have a fully invested in network and an experienced team. So in that regard, for us, competitive intensity is something that we watch, but not something that gives us any sleepless nights.

Pulkit Patni — Goldman Sachs Research — Analyst

Fair point. Maybe I’ll take the liberty of asking one more. Can you give us a sense of the PTL freight tonnage? When should we expect us to get back above the 400,000 quarterly run rate?

Sahil Barua — Managing Director and Chief Executive Officer

Certainly, I think on PTL, as I mentioned, the first and most important thing for us to do was to put the operational issues of the Spoton integration conclusively behind us. And as I mentioned, I think we’re quite happy with where we are now. Overall, if I look at service quality across the network, which includes both service speed as well as quality metrics, we are trending at levels that are ahead of where we were even pre-integration in quarter three and quarter four of last year. That really was step number 1.

Step number 2 for us was then to take a long hard look at all of the different customers that both Delhivery and Spoton serviced. While it would have been easy for us to simply show volume growth, I think we went ahead and looked at each of the accounts individually, looked at accounts which made sense for us from a gross margin and an EBITDA standpoint, and also looked at the kinds of loads that we were transacting and whether they required any special services or any special handling that doesn’t necessarily fit well into the Delhivery scheme of things.

And I think if you think about it, we took a leaf out of the page of Old Dominion and studied it quite carefully. And that’s going to be our approach going forward. So internally, a target for us right now is not immediately to figure out how to get to a specific volume number, but to get the unit economics to where we need them to be. As I mentioned, we’ve seen a sharp recovery to 4.8% on service EBITDA. We’ll continue to grow that over the next couple of quarters, be quite selective about the clients that we onboard and make sure we continue to operate with the same service quality that we’re at right now.

Pulkit Patni — Goldman Sachs Research — Analyst

Fair point. Thank you so much Sahil for those answers.

Rishi Iyer — Citi — Analyst

Thank you. We’ll take the next question from Aditya Mongia.

Aditya Mongia — Kotak Securities — Analyst

Thank you for the opportunity. The first question that I had was more linked to the part truckload business. Now on a Q-on-Q basis, it seems as if there has been some reduction on the per kg revenue number or the yield number. Just wanted to get a sense of whether we today are starting to offer more discounts which will become lesser over time or if there’s something else which is maybe more seasonal associated with this Q-on-Q movement?

Sahil Barua — Managing Director and Chief Executive Officer

No. So we are not offering any additional discounts. The optical change in the yield that you can see per kg is due to, one, there is an Ind AS adjustment that we have made. The second is that for Spoton, earlier a certain percentage of the revenue was being recognized on pickup volumes. Delhivery, however, operates on a conservative approach, where we recognize based on closures, and that has also led to a change in the overall yields. I think as you see quarter three and beyond, you will see yields normalize to where they were in the quarter one timeframe, which is somewhere between INR10 and INR11 a kilogram.

Aditya Mongia — Kotak Securities — Analyst

Sure. That clarifies. And the second question that I had was on the Express Parcel segment. Now as both of us are understanding, there is a modulation in the industry growth, maybe from high 20s to high teens in this point of time. I wanted to get a sense of how much of this would, in your opinion, be more cyclical in nature. And how much of it in your opinion could be actually structural from here on? Just trying to get a sense of when things normalize, will they completely go back to where they were or will there be a metal ground achieved?

Sahil Barua — Managing Director and Chief Executive Officer

Yes, I think when you look at the underlying market for e-commerce in India sort of over the medium or long arc of time, the underlying growth in e-commerce volumes is undeniable. I think the reason why growth in this year perhaps looks moderated when viewed externally is really because a lot of growth was pulled forward during the COVID period. And this is sort of growth that otherwise would naturally have manifested later.

I think the end point for e-commerce remains pretty much exactly the same. It is a growing convenience category. We continue to see penetration in Tier 2, Tier 3, Tier 4 cities and beyond. As an example, our Heavy Goods business, which has seen a 30% growth from quarter one to quarter two, represents sort of a pretty interesting and widening array of categories that are available online.

Now whether a specific quarter or a specific year in e-commerce will be distorted, like COVID, as an example, when e-commerce companies saw 40%, 50% growth rates, or a year like this year, where Shopee has exited the market and growth therefore looks somewhat moderated or muted. I think overall, our view is that the structural shift to e-commerce will remain intact. More importantly, from our standpoint, it is somewhat irrelevant because we will continue to maintain share with all of the accounts that we have.

And as I mentioned, our structural cost advantages are not dependent nearly on scale. They’re not dependent on delivery growing at 30% a year. The underlying cost advantages that we have make us the most efficient player at 161 million packages a quarter. That will continue, whether we are doing 161 million packages, 200 million packages, or 140 million packages a quarter going forward. And so from our standpoint, irrespective of how the growth curve pans out in the short term, in the long term, our competitive advantages remain intact.

Aditya Mongia — Kotak Securities — Analyst

Just one last question from my side.

Sandeep Barasia — Executive Director and Chief Business Officer

Sorry, Aditya, if I can just add on top of that. It’s Sandeep. If you go back and look at e-commerce over the last 11, 12 years, you will find that this story has played out before, because you’ve had periods where — the long-term trajectory continues to hold, but you’ve had periods where when discounting — for the first time when aggressive discounting became sort of less popular, you had a couple of years of soft and then it came back and fully run, became truly a convenience category.

So I think you’ll have those cycles. In today’s funding environment, you will have some cycles on individual players feeling some pressure and things like that. But as Sahil said, as a channel, the penetration is still so low, of e-commerce. There’s no reason to believe that the long-term growth in e-commerce should be any different.

Aditya Mongia — Kotak Securities — Analyst

Understood. Just one last question from my side. The question is more on this 50% gross margin piece that one is thinking through. If I kind of extrapolate this argument from your current revenue base and go into more towards, let’s say, 3Q, 4Q, it seems as if that can help you, at an adjusted EBITDA margin level, reach high single-digit levels. Is this something that you believe can happen, let’s say, by the end of the fourth quarter? That the company starts reporting closer to 10%, at least for that kind of 2,300, 2,400, 2,500 kind of top line, a decent and a marked improvement in adjusted EBITDA margin?

Sahil Barua — Managing Director and Chief Executive Officer

Actually, Apar, if you are on the presentation still, can I ask you to please go to the adjusted EBITDA slide. Not this one, the bar chart, please. That’s right. So this is just a quick snapshot of how adjusted EBITDA was trending prior to this and services EBITDA obviously before this. I think — so one is we clearly know how to get to where we were in quarter three and quarter four, as you mentioned, because there’s sort of a sense of predictability because the incremental gross margin is at 50%.

As volumes come in both in the Express and the PTL business, we expect overall that the company’s adjusted EBITDA will continue to improve. So far in quarter three, I think we’re quite satisfied with where we are and we expect this to continue. But when will we get to exactly 10% adjusted EBITDA I think is a function of the choices we make in terms of the customers we onboard in PTL and how soon we bring PTL volumes back. But the important thing to note, I think, is that it’s a relatively predictable business from here on.

Aditya Mongia — Kotak Securities — Analyst

Got that. I have no questions. I’ll come back into the queue. Thank you.

Rishi Iyer — Citi — Analyst

We’ll take the next question from Alok Deshpande. Alok, you can proceed with your question.

Sahil Barua — Managing Director and Chief Executive Officer

Please go ahead Alok. I think you unmuted yourself.

Alok Deshpande — Edelweiss Financial Services — Analyst

Yeah, okay, okay. So I just wanted to refer to a couple of statements that you had mentioned in your Q2 business update, which had come out a few days back. So one was you mentioned that while the festive season sales surge and shipment volume will spill over to Q3, we anticipate moderate growth in shipment volumes through the rest of financial year. Now this moderate growth that we are talking about, is it more because of a much higher base in the H2 of last year or is it a general sequential growth which you think will be quite moderate in nature? So I was just.

Sahil Barua — Managing Director and Chief Executive Officer

Certainly. I think Alok, the big change — that’s an important question actually, and we should have called it out. The big change obviously when you look at H2 of last year is that H2 volumes were somewhat distorted by the presence of Shopee in the market. And so overall volumes, not just for Delhivery, but overall for the e-commerce industry, were significantly higher. And with Shopee disappearing, while some of that volume has obviously been retained and has gotten spread out across other e-commerce companies, some of that volume has basically simply disappeared.

And so that’s really the reason. I think if you look at our growth in volumes overall, we’ve seen about a 6%, 7% growth in quarter two over quarter one. We would expect a similar range or maybe slightly higher or slightly lower than that in quarter three over quarter two. And overall, for the year, therefore, somewhere between sort of an 18% to 30% kind of growth rate overall.

Alok Deshpande — Edelweiss Financial Services — Analyst

Okay. So when you say 18% to 20%, that is including Shopee last year, right or you’re saying like-to-like?

Sahil Barua — Managing Director and Chief Executive Officer

Including Shopee last year, overall.

Alok Deshpande — Edelweiss Financial Services — Analyst

Okay, understood. And my second question was regarding PTL. So you mentioned that you’re currently doing about 3,000, 3,500-odd sort of tonnes a day. as this number sort of starts creeping up towards slightly higher levels in Q4 or so, do you think that at an overall level, at a group level, the adjusted EBITDA can go in green based on this?

Sahil Barua — Managing Director and Chief Executive Officer

Yes, of course. Yes, absolutely. See, it’s an extremely important component of our business. When we say that we run an integrated network, that means our mid-mile and our line haul are — sort of for them, PTL and Express are indistinguishable. And therefore, growth in volumes in either of the two, obviously, improves unit economics in both. It improves utilization of the hubs. It improves utilization of the vehicles that we’re transacting. More importantly, it allows us to make one of the big strategic shifts that only integrated players can really pull off, which is a shift away from more inefficient truck sizes to far more efficient truck sizes that we use across our network. And so in fact, the faster PTL volumes recover, the better it is, obviously, for our mid-mile utilization.

Alok Deshpande — Edelweiss Financial Services — Analyst

Sure, sure. Thanks. Thanks Sahil for that. That is very helpful. Thanks a lot.

Rishi Iyer — Citi — Analyst

We’ll take the next question from Sachin Dixit. Sachin, go ahead.

Sachin Dixit — JM Financial Ltd — Analyst

Yeah, hi. Congratulations on results. I had a quick question with regards to the steady state service EBITDA margins, right? So while I do understand that Delhivery is decently dominant in terms of the Express Parcel business, as well as the PTL business been growing since the integration, but it remains a cost line item for most of your clients, right, and who might not be happy with giving you insane amount of margins. So where do you think your service EBITDA margins stabilize? And how is the journey to it?

Sahil Barua — Managing Director and Chief Executive Officer

So Sachin, actually, the point that you make is precisely the point that we believe is our strategic advantage, which is that this is a cost for our customers. Our objective is not just to state that we’re building the highest quality transportation player in India, we’re also building the lowest cost transportation player in India. And in the Express Parcel industry, I think if you were to do a benchmarking, you would find that we have the lowest cost structure out of our competitors. And so the fact that our customers are extremely price-sensitive is, in fact, a competitive advantage for Delhivery.

And as I had mentioned, with our incremental gross margins, our ability to use our gross margins to drive up market share in the underlying industries that we’re in is massive. We have done this in the Express Parcel space. We evaluate every one of our customer contracts continuously and make sure efficiencies are passed on to them. And essentially, we get rewarded for that in the form of excess market share. So the risk that you’re pointing out, we actually think of as the fundamental opportunity at Delhivery, because when you think about it, direct costs of logistics in India have to reduce. And only large integrated players will have the ability to reduce it, which is sort of what the core of our business is all about.

In terms of service EBITDA margins, as I had mentioned, if you were to look at the overall incremental margins that we’re generating, it is possible to actually model out what margins for Delhivery will look like going forward. In our experience so far, the service EBITDA margins for our transportation businesses can reach levels of close to about 17% to 20% based on the utilization of the network without service degradation. Obviously, as we continue to introduce more trailers, as we continue to introduce more automation across our hubs, there is the opportunity to fundamentally disrupt our cost structure further as well.

Sachin Dixit — JM Financial Ltd — Analyst

Sure. Thank you. And can you also give some understanding on how the supply chain services business is going on? And how are you acquiring customers there?

Sahil Barua — Managing Director and Chief Executive Officer

Sure. In the Supply Chain Services business, essentially, it is an end-to-end fulfillment services business that we run, where, as an example, one of India’s large consumer durables players came to us and said, look, we want to focus on manufacturing and running sort of our retail footprint, whereas we want you to run the entire supply chain. So we handle warehousing, we handle inventory management, we handle primary distribution, secondary distribution across the country for them. So the typical engagement will include warehousing, full truckload freight, part truckload freight and express delivery as well.

The margins that we see in that business on all the transportation businesses are equal to or higher than the margins that we see on the transportation business as stand-alone. And then on warehousing, we take a strategic call account by account as to what kind of margins or pricing we want to offer to customers. Typically, these are long-term contracts to run either entire regions or the entire supply chain for the customers that we have. The reason customers choose us is very simple. One is the underlying philosophy of our business model is it allows our customers to variabilize their supply chain costs and, obviously, at the same time, have access to the highest quality transportation partner in the country and to centralize procurement of logistics with a single partner.

So you don’t need to run multiple sort of 40, 50 different partners helping you with either trucking or with express delivery or with warehousing. So it brings predictability, it brings transparency, it brings speed. Our focus, obviously, is on sectors like, for instance, where obviously, supply chain complexity is high. So obviously, e-commerce is one of them, consumer durables, consumer electronics, auto and auto spare parts, FMCG, pharma, some parts of industrial goods. These are sort of the industries that we remain highly focused on.

Sandeep Barasia — Executive Director and Chief Business Officer

If I may add, what has happened over the last 6 months is that the number of industries that we serve has widened. The number of use cases that we have proven out that this model works in actually have increased. And so we now actually have a much larger scope that we can actually go after in the market and more success examples that we can share with the customers. The other thing that you should also note is that Supply Chain Services revenue, when we report it, it includes a decent chunk of part truckload and full truckload, not just warehousing. We just don’t double count it. It is actually reported within Supply Chain Services. So our underlying part truckload volume that we probably handle is actually significantly higher as well as the underlying full truckload volume.

Sachin Dixit — JM Financial Ltd — Analyst

Good. That sounds perfect. Just one final question on this ONDC that the government is pushing. What are Delhivery’s plans to like participate or not participate? How do you think of it? Just last question.

Sahil Barua — Managing Director and Chief Executive Officer

We are discussing integration with ONDC. And I think we obviously will be integrated and will be a logistics partner of choice for all of the sellers on the ONDC platform. But as of now, I think the platform itself is still maturing. And as it gains traction, I think some of our plans with regards to ONDC will become a little clearer. From our standpoint, though, our services are easily accessible. We’ll integrate with ONDC. And if it’s feasible, we’re happy to be sort of a big partner.

Sandeep Barasia — Executive Director and Chief Business Officer

Yes. So we have already submitted our application to ONDC. And as Sahil mentioned, as the platform picks up, we will start seeing the app on their platform. And you’ll see that app on the platform very soon over there. The testing is done.

Sachin Dixit — JM Financial Ltd — Analyst

Got it. Thank you.

Rishi Iyer — Citi — Analyst

The next question is from Abhishek Ghosh.

Abhishek Ghosh — Quadrant Knowledge Solutions — Analyst

Yeah, hi. Am I audible?

Rishi Iyer — Citi — Analyst

Yes Abhishek.

Abhishek Ghosh — Quadrant Knowledge Solutions — Analyst

Yeah, hi. Thanks for the opportunity. Just since you’re on the Supply Chain business thing, just one observation. Q-on-Q, we have seen a decline in revenues by almost about 20, 25-odd percent. Any change in accounting? Because we usually thought this is a seasonally strong quarter. How should we look at it? Any thoughts there?

Sahil Barua — Managing Director and Chief Executive Officer

Yes, sure. It’s basically just underlying seasonality for a couple of our customers for whom quarter two is not historically sort of a strong quarter. As an example, in consumer durables, one of our customers have significant seasonality in quarter two, and that’s what has affected overall revenues for the quarter. But that will rebound in quarter three and quarter four as ship-outs increase. No change in accounting standards. It’s an underlying sort of reflection of the customer mix that we have.

Abhishek Ghosh — Quadrant Knowledge Solutions — Analyst

Okay. But is the dependence on one particular client a little higher? I’m saying over a period should we see this thing going up because the market opportunity is quite high and your market shares are pretty low. So how should one look at it?

Sahil Barua — Managing Director and Chief Executive Officer

Obviously, that’s actually the right observation. We do expect over time the impact of the seasonality in any single customer to reduce. I think the other thing in our Supply Chain Services business is that revenue — while accounts begin, the full sort of impact of revenue growth takes typically anywhere from about two to 6 months to reflect, because that’s sort of the period that we take to stabilize operations, to grow operations across various different warehouses because, typically, these customers will either be shifting from in-house operations or from a different third-party partner to Delhivery.

So it takes a little bit of time for these accounts to reach their full potential. Even the setup time for us could be anywhere from sort of 30 to 90 days for different customers. So I think the growth that we’ve seen in customer name accounts in quarter one and quarter two, we will start seeing the revenue impact of that in quarter three, quarter four and beyond.

Abhishek Ghosh — Quadrant Knowledge Solutions — Analyst

Okay. That’s helpful. Sahil, the other thing is, on the Express Parcel business, while there’s just about 1% or so increase in realization in the current quarter, how should one read this? Are we towards the end of the cost benefits being passed on or was there a product mix impact this quarter? And any thoughts on our realization per shipment as far as the Express Parcel business is concerned?

Sahil Barua — Managing Director and Chief Executive Officer

Yes, sure. See, realization overall is a function of basically two or three different things. One is it’s a function of the customer mix. The second is it’s a function of the distances that we are shipping. The third is it’s a function of the COD versus prepaid ratio and sort of the extent of returns that the network is handling, and the speed choices that various customers make. There’s no underlying change in our pricing philosophy in quarter two versus quarter one.

That said we evaluate every customer account differently. We have target gross margins and target EBITDA margins for every account that we operate. And as we continue to gain efficiency, we proactively pass those benefits on to our customers. One of our stated strategies is to commoditize the space that we’re in. We believe that every customer should have access to low-cost, high-quality logistics. That’s the foundational idea of Delhivery, and we will continue to sort of exercise that judgment with our customers. In terms of the question about whether we’re close to the end of the cost curve, I’d have to say the answer to that is no. Because as I mentioned, incremental gross margins right now are at 50%.

Our belief is that incremental gross margins actually could be higher as utilization of the network continues to improve. So we’re not necessarily at the end of that cost curve. We still have underutilized capacity at the last mile, for example, and in certain sections of our mid-mile and hub operations. As volumes scale up, that will get utilized. The other benefit, of course, when running an integrated network, is that because our mid-mile and our hub operations do not distinguish between PTL, freight and express, growth in either of those businesses contributes to an improvement in economics in the other.

So as PTL volumes go up, express becomes more efficient; as express volumes go up, PTL becomes more efficient, because we’re able to run more docks across our hubs, we’re able to run larger trucks, we’re able to run greater frequencies, and we expect that to continue. So over the next couple of quarters, I think we will introduce more tractor trailers across all of the critical routes. We will increase utilization of the trucks. And as that happens, overall cost per shipment will continue to come down, and at an account-to-account level, we will make the call on how much we want to pass on to our customers.

Abhishek Ghosh — Quadrant Knowledge Solutions — Analyst

Okay. Sahil, just one more question. If you look at the PTL business, as it’s already visible, you’re almost about 20%, 25% down or maybe a little higher on number of shipments from the last peak that you had done. So there has been some business loss because of the integration and other things. So how difficult it is now to get back those customers? Because somebody would have got that share in the meanwhile.

So are you having to discount it? While you mentioned you’re not discounting it. So what are the challenges? Is there a change in the medium-term growth rates for this business given the whole integration issue? Just some thoughts there? Because once the customer goes away, to get him back, you have to offer them something extra, because it’s a customer experience. So just from that perspective, your thoughts?

Sahil Barua — Managing Director and Chief Executive Officer

Absolutely. I think the first thing is we looked at all of the accounts that we currently are active with and, fortunately, accounts representing nearly 90% of our revenue pre-integration are active with us and are working with us. Some of the accounts that are not active with us include retail partners where we felt that the loads that were being tendered into our network were not appropriate for our network. And there are certain customers, like I had mentioned, who continue to operate other parts of their requirements with us, but where we felt that the PTL requirements were not ones that fit the Delhivery network. And we’ve consciously decided not to continue with some of those accounts.

I think the important thing that customers look for is service quality, which includes not just network speed and reach, but also quality in terms of shortages and damages and potential claims. As I had mentioned, what we’re particularly happy about is the fact that service quality as of now is better than we were at pre-integration levels, which means the integration not only has been conclusively completed, but in fact, some of the service gains that we expected to see have played out as of now. Obviously, we continue to remain quite watchful because it’s only been a couple of months since the integration has stabilized. But that’s the leading indicator of share gain.

While customers are price-sensitive in this market, I think it is important to recognize that freight as a percentage of value of goods shipped is not very large. And so customers are sensitive to quality of service. The second thing is that different logistics companies at different points in time are affected by operational constraints. I wish I could sit here and tell you that there are no further operational constraints which will ever affect Delhivery going forward. But as an example, if you happen to build your hub in a part of Bhiwandi, which goes underwater when it rains in Bombay, you are bound to have service issues. And at that point in time, customers will select an alternative.

Customers are also understanding of the fact that they have to shift loads across different logistics partners when various networks have issues in specific locations. That’s why they run redundant partners. And that’s why it’s not exactly a winner-take-all market. But it is possible for somebody to build dominant scale, and that’s really what we’re going after. So long answer to your question, no, we don’t have to offer discounts to regain customers. Our service quality is what gets us those customers along with our reach. We’re becoming more selective about the kinds of customers we want to admit to make sure we can maintain that service quality and the margins that we want to generate. And overall, I think we are going to see recovery in this business over the next couple of quarters.

Abhishek Ghosh — Quadrant Knowledge Solutions — Analyst

Great Sahil. Thank you so much and wish you all, all the best. Thank you so much.

Rishi Iyer — Citi — Analyst

The next question is from Abhijit Mitra.

Abhijit Mitra — ICICI Securities — Analyst

Yeah, hi. Am I audible?

Rishi Iyer — Citi — Analyst

Yes Abhijit. If you can speak up a bit please. Thanks.

Abhijit Mitra — ICICI Securities — Analyst

Yeah, sure. Thanks. I have three questions actually, [Indecipherable]. The number of customers has dropped by almost 1,000, 1,100 on a quarterly basis. So how do you sort of — I mean, what are your thoughts and how do you see these numbers as we move ahead? So Q1, probably the number of customers was closer to 29,300, now it’s 28,400. So how would you feel this number to move as we move ahead? That’s question number one.

Question number two is again on the supply chain side. A drop in revenue is something which we can understand. But, again, on quarterly basis, if we look at the revenue per square feet which was reported between Q1 and Q2 of this [Indecipherable]. Revenue per square footage under management is down by almost [Indecipherable]. Why should the square footage under management in a supply chain business be down on a quarterly basis? That was the second question.

And third is I think [Indecipherable] is more structured, but what we’re seeing now is that the penetration as well as the growth in U.S. is also coming down and our market is also sort of showing the weakness or the slowdown. So is it connected? Do you feel — would you like to reconsider that, that was indeed a COVID bump, that we’re coming out of it, and we are slowly seeing a sort of slowdown happening. So these are the three issues and topics if you can shed more light on.

Sahil Barua — Managing Director and Chief Executive Officer

Certainly. Thanks, Abhijit. Let me sort of answer these very quickly. One is in terms of number of customers, As I had mentioned, in the PTL business, specifically, we have become more selective about the various kinds of shippers we allow to move goods through us. I think one of the things that we evaluated as part of the integration was how many different customers were tendering loads that weren’t necessarily transit-worthy or which didn’t necessarily fit the Delhivery express, PTL product from either a sort of handling standpoint, operational standpoint or from a margin standpoint.

And so it’s a sort of exercise that we undertake on a regular basis. As a stand-alone company, Delhivery would do this anyway every quarter. I think the first time we did it once we had integrated Delhivery and Spoton post the integration was in quarter one. And therefore, there were accounts that we decided proactively that we could not continue. This is a quarterly exercise that we’ll continue for the combined business. So not very worried about this at this point. As I mentioned, the customers who are active with us represented over 90% of the revenue that we made in the PTL business as Delhivery and Spoton separately pre-integration.

In terms of revenue per square foot in Supply Chain Services, this is also driven by the fact that if ship-outs, for instance, happen to be lower in a specific quarter, while the square foot area continues to be active, since we bill only on ship-outs, whenever there’s a quarter where ship-outs happen to be lower, since we aren’t booking any revenue, the revenue per square foot in that matter will appear to be slightly lower. So I think this is the same seasonality impact that you’re seeing. We have maintained the same amount of overall warehousing space.

Also on top of that, there are new starts that are built in over here, where it takes a little bit of time for the revenue to come in. So as an example, when we start putting a new warehouse for a customer, typically, inventory will start arriving and will take anywhere from sort of 15 days to 60 days to arrive. Whereas billing on outbound will begin with a little bit of a lag or a delay, so in that sense, this isn’t something that I think is particularly alarming. And especially if you sort of look at it from FY ’20, all the way to quarter two FY ’23, the trend is sort of pretty secular.

Your third question was around e-commerce growth structurally. I think it’s a very good question. There are some differences though in dynamics between the U.S. and India. In the U.S., you’re fundamentally talking about, first of all, a significantly more penetrated market from an e-commerce standpoint. I think when you look at India overall, as I’ve mentioned, over the medium or long arc of time, it’s hard to argue that e-commerce will not become a significant portion of consumption. New categories will come in. We do continue to see, by the way, growth in Tier 2, Tier 3, Tier 4 cities and beyond. We also see increasing frequency in the metros.

Like I mentioned, I think there certainly was a bump during the COVID period. There’s absolutely no doubt. And if you look at the end state today, in the absence of COVID, perhaps the growth would have looked more uniform over fiscal 2021, ’22, instead of which it sort of got bunched up in ’21, ’22, and therefore, looks a little lower in this financial year. But I don’t fundamentally believe that there is a structural alteration in people’s desire to purchase online or the e-commerce company’s ability to sort of create new categories and bring greater assortment to people. One of the easy ways to look at it is to see sort of the expansion to some extent of some of the direct-to-consumer brands and the sort of speed at which these D2C companies have been able to grow.

So I think overall, while this year may look bumpy, when looked at over a medium-term period over the last three years, I think growth in e-commerce has been solid. We don’t see any structural reasons for that to not continue. And the last piece that I would point out is why we are a little more sort of insulated from small periods of low growth in e-commerce is, as I mentioned, because of our cost structure. Our competitors struggle with periods of low growth because typically, in those periods, they do not have the ability to reduce pricing if they want to continue to grow.

Low growth periods are good for us, but as I mentioned, even at 161 million shipments, we have a profitable express business and high incremental gross margins. We have the ability to continue to improve our cost structure. We have the ability to continue to pass those benefits on to customers and gain more market share at that point in time. So in that sense, we’re a little more insulated from any short-term events that happen in e-commerce than anyone else. But again, as I mentioned, structurally, I don’t think there is any reason to believe that e-commerce is sort of not going to grow quickly in India going forward as well.

Rishi Iyer — Citi — Analyst

Thanks, Sahil. We have reached the top of the hour, but we have received a few questions on the chat window. If you can take a couple of them pretty quickly before closing this call. The first one is what is being adjusted while arriving at adjusted EBITDA versus EBITDA?

Sahil Barua — Managing Director and Chief Executive Officer

Apar, if you can just bring up that slide again, please. Yes. So as you can see in the middle column, in quarter two fiscal ’23, total expenses were at INR2,158 crores. This included INR221 crores of noncash recurring costs, which includes depreciation and amortization and ESOP expenses. These are the two costs that are excluded when calculating adjusted EBITDA or the ones that have major impact. There are obviously minor adjustments which are for finance cost on borrowings and some adjustments due to Ind AS. Rishi, should I just read out the rest of the questions and answer them?

Rishi Iyer — Citi — Analyst

Sure. This just next one is on the ESOP expense road map for the next 5 years. If you can share some color around that?

Sahil Barua — Managing Director and Chief Executive Officer

Sure. Again, Apar, I think we have a backup slide on this. And Amit, our CFO, is on the call. Amit, would you like to answer this, please?

Amit Agarwal — Chief Financial Officer

Sure, Sahil. Can you go back to the previous slide, Apar? So we have a total of about 43 million ungranted stock options, which will be granted and it will be costed in our P&L over the next 5 to 6 years. We also have unvested, but granted 30.236 million — 30.2 million stock options. Now the stock option accounting is done based on a model where the price of a share at the time of grant is taken. And for these 30.2 million shares, we’ll just show you the schedule for the cost that is expected over the next 4, 5 years. And for the remaining 43.45 million shares, the costing will be based on the prevailing share price at the time of the grant. The important thing to note here is that a significant majority of these 43.45 million shares, nearly 26.3 million shares will vest only if company achieves a stock price of INR800 a share, INR1,000 a share and INR1,200 a share. So that’s an important part that you should note.

Move to the next slide, Apar. So the costing which is expected for the options that have already been granted, based on time-based performance, is INR469 crores over next 5 years, including the current year. And for the performance-based stock options, it is INR97 crores over the next 5 years. So a total of about INR566 crores is expected based on the grants that have happened so far.

Sahil Barua — Managing Director and Chief Executive Officer

Thank you, Amit. The next question that I can see says, what is the timeline for Delhivery to become EBITDA positive. As I mentioned, the service EBITDA has seen a strong rebound from negative 0.3% to 4.8%, and adjusted EBITDA has improved from negative 12.5% to 7%. I think as our incremental margins, as I had mentioned, are close to about 50%, even if you don’t assume an improvement, I think it’s quite easy to model out what incremental revenues we will need to target adjusted EBITDA levels. And therefore, sort of based on volume recovery, my sense is that it’s quite easy to model out over the next couple of quarters when we will turn EBITDA positive. To some extent, obviously, it depends on how quickly we decide to increase the tap on the LTL side.

Which is linked to the next question which is what is the economic benefit expected from the Spoton acquisition? And in what timeframe is the full benefit from Spoton expected to be realized? I think the economic benefit from the Spoton acquisition for us was clear, which is we are ultimately building an integrated hub and mid-mile operation which is shared across our express and our part truckload freight business. Spoton was one of the leading independent is in the PTL freight business. They were larger than Delhivery, but we were growing faster. I think bringing these two networks together has given us operational heft, has given us scale, the integration issues of quarter one, notwithstanding.

And more importantly, as I look at our service levels today and I look at the size of our network today, I think it provides a better service to all of the customers that Delhivery and Spoton had stand-alone. More importantly, as I mentioned, because we share our hub and mid-mile operations across these two businesses, which is a complicated thing to build, but I think we’re at a stage where we have built it out, any increase in volumes in either of these businesses ultimately is accretive to both of them. So as volumes in the express business increase, we see cost advantages in the PTL business, and also actually, frankly, better speeds.

And as we see volumes increase in the PTL business, we see cost advantages in our express business and speed improving in our express business. It also allows us to deploy a larger fleet of tractor-trailer operations across the entire country, which brings down our line haul cost, improves overall speed of the network, allows us to do more dynamic routing, and therefore, improve customer experience.

The question on timeframe, I think, as I’ve mentioned, we had intended to begin rationalizing the consolidated footprint of Delhivery and Spoton by quarter two. That has already begun as was reflected in the reduction in overall freight service centers and reduction in gateways that happened in quarter one. I think that process will continue over the next couple of quarters. Our intention was to discover the benefits of synergy value between Delhivery and Spoton going into the next financial year. And so far, I think we’re on target for that.

The next question is from Anuja which is, could we comment on plans to use more EV fleets or any other significant ESG initiatives that could be financially material. We already do use electric vehicles, CNG vehicles and LNG vehicles across our network. In the first and last mile operations, it’s actually been reasonably prevalent in different cities for several years now. These are cargo vehicles that we use for pickup and drop-off operations. We have also begun trials of LNG trucks and EVs in our mid-mile operations, which are our long-haul trucks. Our belief is that in the long run, the benefits of electric vehicles will accrue only by using these for mid-mile operations as opposed to sort of electric bikes. And so that’s where our focus has been.

Obviously, this derisks us from increases in fuel costs. And so as these experiments and trials mature, I think we will introduce more and more EVs. So as an example, we’re working with Volvo, which is one of our trucking partners, to experiment with electric vehicles in our mid mile. From an ESG standpoint, the other area, obviously, is we continue to introduce solar power across all of our major gateways. That’s sort of the other big ESG initiative that we’re running internally.

The next question, I believe I’ve already answered, which is context around growth in October — sorry, growth in October relative to Q2. So first of all, just to be clear, the volumes that Delhivery reports in any quarter are based on shipments delivered, not shipments picked up. And so do expect that October will be a high month as well because significant number of shipments that were picked up towards the last week of September will be recognized as delivered in October.

I think overall volumes in quarter three remain in line with our expectations overall. The festive peak of September was a big high point. And then volumes sort of returned to normal, start growing again towards the end of the year. We don’t see any fundamental change in industry structure overall. How should we think about capex and lease additions going forward considering the revised growth expectations? I think as I had mentioned, right now, we continue to consolidate infrastructure between Delhivery and Spoton. That remains the major focus. There are still a couple of cities where we continue to run redundant infrastructure because we had lease lock-ins.

We will continue to sort of combine those facilities. I took Pune as an example, similar situation in Chennai and a couple of other places. From a capex standpoint, I think typically, our capex has come in at close to between about 5.5% and 6.5% of revenue. Over time, we expect that to stabilize at between about 3% and 3.5% of revenue, which will include both new capex for new sortation centers and new gateways that are being built as well as maintenance capex for existing sortation centers and gateways. Great. I think that answers the questions that we have on chat, Rishi.

Rishi Iyer — Citi — Analyst

Thank you once again. Sahil, Sandeep, Amit, Varun and the entire Delhivery team. You have spent well over an hour answering these questions, and also for this opportunity to host you on this call. We would also like to thank all the investors and analysts for your interest in the company and making this an engaging session. We can conclude the earnings call here. Have a good evening.

Sahil Barua — Managing Director and Chief Executive Officer

Thank you. Thank you all for joining. Thank you Citi team for hosting us.