Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the interim report, January-March 2019 conference call. At this time, all participants are in a listen-only mode. There will be a presentation followed by a question and answer session. At which time, if you wish to ask a question, you will need to press star one on your telephone and wait for your name to be announced. I must advise you that this conference is being recorded today, on Friday the 17th of May, 2019. I'd now like to turn the conference over to your presenter today, Thomas Heath. Please go ahead, sir.
Thank you very much, and welcome everyone to this Q1 2019 conference call with Sinch. My name is Thomas Heath. I'm Chief Strategy Officer and Head of Investor Relations. With me in the room today, I have our CEO, Oscar Werner, and our CFO, Roshan Saldanha. Welcome, everyone. I'll hand the word over to Oscar.
All right. This is Oscar Werner. Welcome to this quarter's Q1 presentation. Without further ado, let's start. First, Sinch, just to position what we do. Many of you have heard this before, but I just have one slide of this so we position ourselves. We deliver customer engagement for enterprises to consumers via mobile technology. We have a cloud communication platform to do this via messaging, via voice, and via video. What fascinates me about this market is that it has a 100% consumer penetration. I've yet to find one single adult person that has not used these type of services. I think we all have received an appointment from our dentist or a reminder from an airline, or getting the ticket from somewhere, or we have called Uber, or we have called our doctor via video message.
That fascinates me that it has so high degree of penetration, and I think that's the same in any country that I go to across the globe. This means that this is a growing, and it's a global, and it's a multi-billion dollar market. We are truly in a market where you can sell to any country there are customers, and a very large amount of enterprises can be customers, and it's a growing large market. One thing that sticks out about Sinch, but not the only thing, but we serve the eight out of the 10 of the largest U.S. tech companies. Around about five of those are live with significant traffic, and we're working on the others.
Given that we have a highly scalable platform, we have managed to win and keep the largest customers on the planet here, and that's probably where we stand out the most. We also deliver software for mobile operators based on the same underlying platforms. We have a very deep technical competence all the way up from the enterprise down to the operator network. Right. Next slide, please. Growth markets, just to make this point again, we have showed this slide before. Messaging, which is our core market as you've seen, we have changed the report a little bit. We talk about messaging, we talk about voice and video, and we talk about the operator segment. On this slide, to shorten it a little bit, we only talk about messaging and CPaaS. The messaging market is a large market. You can pick a number of different reports.
We used to think that Mobilesquared has a good estimate of this market. They estimate this market to SEK 17 billion round about. You can find estimates from SEK 15 billion to SEK 50 billion. The reason for the size is firstly, text messaging has been extremely effective, reaches everybody in the world in a very cost-effective manner and has a very high open rate. Now the growth is very much driven by the new messaging formats, making it possible to send more advanced forms of messaging to your consumers. On the CPaaS side, this can be interpreted as the software layer on top of the termination fees on top of the message you send. That part of the market is growing very fast. Market estimates range between 35%-60% CAGR.
That part of the market is growing very fast, and this is basically all the software value add that it can add on top of just sending a message for an enterprise. All in all, global market, large market, and a growth market in many segments, and certain segments grow faster than others. All right, next slide, please. Looking at the quarter results, in Q1 2019, we had a strong gross profit growth of 45%, getting up to SEK 289.5 million. As you know, we focus primarily on gross profit. That's what we think is our value add. We had adjusted EBITDA rising to SEK 112 million, which is around about a 73% growth since last quarter on a yearly basis.
We have an adjusted EBIT, if we exclude acquisition-related amortization of SEK 102 million, and profit after tax of SEK 57.8 million. We have rising gross profit and EBITDA in all business units, and we have both organic and from acquired businesses. We also say that we are continuing our investments to capture new market growth opportunities in the new markets. We see a technology shift in the market, and that we see the market going from, you can imagine it being 160 characters, text messages, to almost being able to send an app-like experience to your inbox. That obviously drives a market growth opportunity. You can imagine being at an airport, instead of just getting a reminder for your flight is delayed, you get a message which behaves like an app stating, "Your flight is delayed. These are your three options for rebooking. Press this button and you can rebook.
By the way, here's a voucher, so you can get a free meal." That's a better experience for you, and it's a cost saver for the airline. That obviously becomes much better service, but it also takes a bit more software and a different go-to-market model in order to approach the customers with that type of service. Therefore, we are investing in positioning ourselves for the growth opportunities that we see are coming. Good. Next slide. If we then look at our three segments that you see we have organized the report around, we have the messaging segment, we have the voice and video segment, and we have the operator segment. If we start with messaging, we see rising message volumes, and this is driven by a couple of different factors. Partly it is U.S. big tech companies is fueling a strong growth in this area.
We manage to be a partner to the biggest companies in the world, therefore we do see strong growth driven by those companies. We also see a very high demand for our personalized video services. That is basically sending video messages directly to inbox, personalized to your own preference. This is driven by the acquisition with the Vehicle, and we see strong growth for that. We also see positive currency effects in this quarter, which is giving us a tailwind here, which is affecting growth in a positive way. Again, we are investing in the next generation, next generation messaging and next generation technologies. All right, next slide. On the volume side, we do see a rising number of transactions on a trend basis. We're growing both with existing customers, with new customers, and new use cases.
We are seeing a 13% organic growth in number of transactions in local currencies and a 15% in organic growth in local currencies in gross profit. We're seeing those following each other in a good way, and we're happy with that growth. Next slide. Gross profit per transaction is something that is very important for us. Looking at all times, looking at how much value add do we make per transaction. Here we're trading both the gross profit per transaction and the OpEx per transaction. What you can see here on this slide is that the gross profit transaction depends on the mix of the terminating markets, where are we terminating. It also depends on how much value add are we adding per transaction. In the personalized video case, we're adding a lot more value add and a lot more software on top.
That gives us a higher gross profit per transaction. That's something we're consistently working on and across our business unit to add more value in software on top of the message transmission. We're also seeing here a currency tailwind, which is increasing gross profit per transaction. You can, in this graph also see that we're doing investments for the future on the OpEx side. That's following the gross profit increase relatively nicely in this slide. Okay, next slide. We have the messaging. Messaging EBITDA per gross profit is a very key metric for us. We see that for every gross profit dollar or crown that we generate, we generate a EBITDA of roughly 45%. That's been stable. We're following this graph, and we want to be a highly profitable company and generate a lot of cash flow.
That is core to our strategy. Therefore, we manage this graph carefully. In this quarter, as you have seen the gross profit rise, we also see an investments rise in order to position ourselves for the future. Therefore, we have managed to keep this graph stable. All right. Next slide. As we have reported in previous quarters, we have a strong momentum on the voice and video side. That has continued during this quarter. We had a really good Q4. The Q1 is on the gross profit and revenue side even better. Growth fueled by the number masking service that we do for ride hailing and also the verification services that we do. Here we are working with key operators to offer our service in more markets and in the markets where we see demand.
As you can imagine in this type of hyper growth situation, it is a lot of work to scale the systems, have the systems in order and keep up the good quality for customers, et cetera. It is a lot of hard work in this area that we are doing in order to keep this type of growth. We are very happy to see that the turn to profit has continued on the voice and video side that we saw in Q4. That is continuing out in Q1. Obviously again, then focusing on stabilizing and setting this business up on a higher level. All right. Next slide. Also very happy to see the improved conversion to orders in the operator business.
We had a couple of weaker quarters in the operators. Now we are seeing that we have a stronger pipeline and also a stronger conversion of pipeline or sales to orders in the operator business. Super happy to see that. You can see in the results in Q1. This, as you know, it is a business that does fluctuate depending on when does projects actually come in and when can we report them as profit. It is a strong trend in the pipe. We also see the partnership with Ericsson. You see that generating a lot of sales to us, which is very positive. As you noted during the quarter, we also announced that we will target operators with an RCS as a service offering. That is basically enabling operators to offer RCS services to enterprises. We are doing that from the operator business.
Then in the enterprise business, we are then enabling the enterprises. There is no impact of that initiative in this quarter's results on the revenue side. That is a future investment. We see a strong pipe and a strong demand for operators on that side as well. All in all, we have the U.S. big tech driving growth. We have personalized video driving growth. We have voice and video driving growth. We have operator driving growth. We also have a currency tailwind in this quarter. If you take that all together, we have a very strong quarter. We are super happy with that.
That's how it becomes when all the major areas we focus on go in the right direction, you have that type of strong quarters, and we have two of those now, which we're very proud over, and we're very happy to see those results. That said, I'm going to leave over to Roshan to go a little bit deeper into the financials. Roshan, please.
Thank you, Oscar. Good morning, and hello to all of you on the call. It's a pleasure to present Sinch's financial results for the first quarter 2019. A very strong set of results that we can talk about today. On slide 12, called continued high gross profit growth, you'll find a bridge explaining our gross profit development. A significant part of our revenues are passed on as cost of goods to mobile operators. We pay them to send our customers messages and place calls, but the rates they charge vary greatly between markets. Since pass-through revenues do not contribute to our profits, we focus almost exclusively on gross profit when we assess and steer our business. Changes in our gross margin often reflect changes in geographical mix rather than underlying performance or competitiveness.
Organic growth and currency effect are hence calculated against an adjusted comparison period in this graph, where we are adding the acquired businesses, Unwire and Vehicle from the first quarter 2018 to our reported Q1 2018 gross profit. Growth in the acquired businesses, Unwire and Vehicle, are included in the messaging segment. Consolidated gross profit rose by 45% during the quarter to SEK 289.5 million. Counting from the adjusted base in Q1 2018, which was SEK 225 million, gross profit grew by 28%. Positive exchange rate movements explain 7% of this increase. Organic growth in gross profit in local currency and comparable units was 21%. This change is explained by changes in traffic mix and growth in products with higher gross margin, as Oscar explained, such as personalized video messaging. Moving on.
Slide 13, where we summarize the effects of IFRS 16, the new accounting standard for leases, which we have implemented from the 1st of January, on our financial results. We have applied the modified retrospective approach to the transition, meaning that the competitive year has not been restated. With the introduction of IFRS 16, lease costs of SEK 6.6 million are now excluded from EBITDA in Q1 2019. These lease costs show up further down in our income statement as amortization. The group's right of use assets are recognized at cost and are reported both on the current liabilities and current assets parts of the statement. Here you see also net debt increases by SEK 83.8 million due to this reclassification of IFRS 16. Moving on to the next slide 14, for the condensed income statement. Consolidated net sales grew by 28% in the quarter to SEK 1.1 billion.
The growth rate in the quarter was positively affected by the depreciation of the Swedish krona, primarily against the euro, pound, and dollar. Positive currency effect on consolidated net sales was 6%. Besides the currency effects on revenue and COGS, we also have currency effects in our OpEx, as a significant portion of our OpEx is related to employees and contractors outside Sweden. Finally, we also have realized and unrealized currency effects on our current assets and current liabilities that affect our income statement. When looking at the individual segments, we saw particularly strong performance in operator segment. We are now seeing successful conversion of orders to revenue. Bear in mind that revenues and earnings in the operator segment can vary considerably between quarters. Reported EBIT was SEK 69 million in the quarter versus SEK 20 million last year.
We have a new definition of adjusted EBIT from this quarter and going forward. Previously, adjusted EBIT excluded only items affecting comparability, primarily related to one-off items from M&A transactions. From this quarter, adjusted EBIT excludes both items affecting comparability as defined previously, and amortization of acquisition-related intangible assets, since these do not affect cash flow. Adjusted EBIT amounted to SEK 102 million, compared to SEK 59 million previous year. Acquisition-related amortization, which does not affect cash flow, reduced EBIT by SEK 33 million. The amortization relates mainly to planned amortization of acquired brand, customer, and operator relationships, as well as software. Please turn to slide 15 for the cash flow statement. Cash flow from operating activities was SEK 38 million. Cash flow in relation to operating profit fluctuates from quarter to quarter because many of our customers maximize their liquidity by postponing payments to suppliers.
Actual customer losses remain low, and cash flow in relation to operating profit is slightly improving over time. Net debt amounted to SEK 484 million, down from SEK 547 million a year ago. The implementation of IFRS 16 on 1st of January 2019 increased the company's net debt by SEK 83 million. Net debt to EBITDA was 1.2, down from 1.9 a year ago. With the previous accounting principles before IFRS 16, the ratio would have been 1.0. Finally, on the financial targets, just summarizing our financial targets. The financial targets of the company are unchanged from what we have previously stated, where we aim to grow adjusted EBITDA per share by 20% per year and maintain net debt below 2.5 times adjusted EBITDA over time. Measured on a rolling 12-month basis, we grew adjusted EBITDA per share by 45% at the end of first quarter 2019.
Net debt to EBITDA was 1.2, down from 1.9 a year ago. With the earlier accounting principles, as I said before, the ratio would have been 1.0. With that, I would like to hand back over to Oscar to summarize today's presentation.
Thank you, Roshan. To summarize, we're obviously seeing a strong quarter. We're obviously seeing the majority of our businesses doing well, and when those are impacting well at the same quarter in the same direction, all of them, we have a very strong quarter. The big-ticket items are we have a strong pipeline and performance with the U.S.-based tech companies. Considerable interest and revenue growth in personalized video. Strong pipeline and growth in voice and video, and a strong pipeline in growth on the operator business in this quarter. We also see on the future side, we're doing investments on the rich media and the conversational messaging. We're seeing a shift in the market. We're seeing market growth opportunities which are large, and therefore we think it's very important to position ourselves for growth.
Therefore, as you can see in our numbers, we take relatively large investments in those areas. As long as we can grow the gross profit in the way we do today, I'd have to say we continue to do in good profits, of course. We're generally very positive to the market growth. We're very positive to the market outlook. Positive to market growth, positive market outlook, the key thing for us now is to really position ourselves into the new formats that are coming, because we think that will drive this market growth and our own growth in many years going forward. With that said, I will leave it over to questions.
If you wish to ask a question, please press star one on your telephone keypad and wait for your name to be announced. To cancel your request, please press the hash key. Once again, to ask a question, please press star one and wait for your name to be announced. Your first question comes from the line of Staffan Eyberg from Carnegie.
Thank you. The organic growth within the messaging division was 14% in Q1, and you state now that the key driver for this growth was the U.S. tech companies. Now, excluding this group of clients, what would you roughly estimate the organic growth to be in Q1 within the messaging division? Is it 10%, flat, or -10%?
Thomas here. Thanks for the question, Staffan. It's correct that the U.S. big tech is an important growth driver for our group. It's also true that the U.S. market as a whole is an important growth driver. We see significantly higher growth rates in the U.S. than we do in other parts of the world. It's an advanced market, and where we perform very well. We also purposefully built up a strong position as one of very few amount of global competitors who can take on really large global deals and serve these very large customers. I'm afraid I can't go into much more detail than that other than to say that's an important source of growth. Both today and we expect also in the future, there is lots of value we can bring to these companies, and that journey has only started.
Okay. Another question then. We've been talking back and forth about the RCS potential. We've been talking about that for a while now, but it seems like it's always pushed forward a little bit. Now, surely, of the recent launches, you must have a better view of when the meaningful volumes might start to come. Do you still see a risk of further postponements?
First, it depends on how you see risk. I believe and I think a lot of us believe after I've been in the tech space for a long time, the rate or the time that it takes for a change to impact is always longer than you think. The impact is almost always larger than you think. I think all of these new messaging formats are, it will take time. The two drivers for it to take time, apart that is for operators to roll it out. We can see that in any quarter, in any year, it takes time. They roll it out. They roll it out half. There is a problem with this phone, and they need to do interoperability, et cetera.
It will take time for the operators. They typically take a little bit of time to roll out things. The other reason it will take time is for enterprises. For enterprises to really benefit from these type of new messaging formats, they will need to change their processes. They will need to go into the customer journey. They will need to, "Oh, suddenly I can rebook my flight by a message. How do I do that? How do I integrate that into my own system?" It will take time. I want to be cautious again. I think it will take time before we see significant portions of revenue on the rich messaging formats. On the other hand, we need to be sure to communicate to you now because we're taking the investments now in order to position ourselves.
I believe it will take time, but we're doing investments now and therefore we talk about it. Ideally, I could have waited to talk about it until the revenue came, then you would wonder why I do the investments. That's the balance.
Thank you. That's very clear, and a good bridge to my next and final question. You've been talking a lot about the need to reinvest the gains back into your operations in order to leverage opportunities in the market, such as RCS. What exactly are you targeting in your investment plan now? For example, do you have any top three areas where you currently want to focus your resources?
Right. As you can see in our report, we have divided the business in messaging, voice and video, and operator. The by far biggest business for us is messaging. Therefore, our number one area is various forms of rich messaging formats. RCS is one, but we sometimes focus a little bit too much on that. We think that the OTT channel, such as WhatsApp or Facebook or WeChat, from an enterprise perspective, they have a similar characteristic. We as a business, we don't really care which channel it goes through. They may have different characteristics, but it's like we see all of those messages. We say we're building one platform to handle all of those type of rich messages. That is the number one.
Another area which we obviously see is the personalized video, which is, by the way, a form of a rich message or a next-generation message. When you talk about next-generation message, that's where we see the growth today. That's a portion of rich messaging that's growing very fast. Obviously, we will invest heavily there. Then you see voice and video. We are seeing growth there, we're investing there. As you saw, we made a statement in this quarter that we will target operators with an RCS as a service offering, basically enabling operators to offer RCS because we see a big demand. That's another investment area. I think that's the main ones. If you would pick out one, it's the rich messaging area, including the personalized video business.
Thank you. Very clear.
Your next question comes from the line of Daniel Djurberg from Handelsbanken.
Thank you very much, good morning to you, all three, and congratulations to strong report. My first question would be on, we could go back to RCS again. I guess you need to connect also to operators in terms of to get their APIs with RCS as you have with SMS. I think you have 250 direct connections, et cetera. Do you see this uptake to be in progress with your own plans, or do you see a risk to miss the potential future RCS raise because of fewer connections? That was my first question.
Do we see in line with plans? As I said before, it's always very hard to make exact plans in the tech industry when things will actually hit. I'm very confident on the trend as a whole that this will happen. It will drive a lot of our value to enterprises. I'm very confident on the direction on where we're going. The exact timing is so hard to judge. There we need to continue to invest and be very diligent on it. On the ability to make money, I assume that's what you're asking, will it become fewer operator connections, and therefore will it become harder to, as a middleman, make money? I assume that's what you're saying.
Yeah.
I think two things that are happening. One, there are multiple technologies rolled out. We have RCS, where there are a set of connections, fewer than we would have in the SMS space. You have OTTs, where there are a set of other connections, well again, fewer. To WhatsApp, you only need one connection to do globally. On the other hand, there are multiple WhatsApps and there are multiple different formats.
Yeah.
There are fewer connections, which would make it harder to make money as a middleman. On the other hand, the connections are more different, so the differences in between them are relatively large. You have on top of this, you have a software layer. In order to create this type of more advanced message formats, you need a more advanced software layer, which is countering that, which makes it easier to make money because you provide more value. All in all, we believe that it's a good market going forward. We believe that the ability to make money going forward is strong, and that's why we're making those investments.
Okay.
Is there risk? There is always risk, of course. We believe we're doing the right investments in order to capture this market.
May I just ask on the software layer you talked about, is that fairly generic or is it highly sector-adjusted to, or do you get good leverage out of the investments you do from a level of-
It's a good question. Our strategy is to be a SaaS platform. Our strategy is to do it a cross-industry. I wouldn't call it generic, but cross-industry, in order to go for scale. We're a scale business, so we want to be a cross-industry, have a SaaS platform for it, and we want to have partners, that is resellers or application service providers that do the industry-specific or customer-specific adaptations. That's our strategy, and that's what we are pursuing.
Okay.
Yes. That's it, sure.
Yeah. May I ask also on growth potential. We see the PSD2 directive has, I guess, started here in Europe. I think one of your U.S. competitor highlighted this as a potential growth trigger ahead. I guess you also have quite good strength in the finance sector. Can you comment on this PSD2 directive as a potential volume trigger in Europe?
I think you refer to the regulation that asks-
Yeah
banks to send notifications about certain thresholds for transactions.
Correct.
I think you're correct in that this is a potential market driver in that sector. You're also correct that we have large exposure to financial sector. That said, when you come into a particular use case of some sort, there are multiple technology options. That varies also geographically, which options are viable and workable for different banks in this instance. I think, yes, this is a potential. We haven't quantified it. We haven't seen it yet, but there is some logic to what you're saying.
Okay, thanks. The last question from me to Roshan, it would be on, I might have missed this on the prepared remarks. On the working capital build, you explained this as cash management among customers, mainly, I guess. Any specific happenings in Q1? Should we expect this to normalize here in terms of DSO coming quarter, or are we at higher levels because cash management, they will be more aggressive going forward as well?
Yeah. I think as a general comment, we see enterprises being more tough with how they're managing their own cash. We can also see that on the operator side where we have a large portion of our COGS. At the same time, working capital is an item that does tend to swing from positive to negative on a regular basis. If you look back at our historical results, I think it has been positive development four quarters in a row. This was a swing in the other direction, I don't think we are ready yet to give you good guidance on how that will develop from quarter to quarter, but that will definitely be an ambition to get there.
Given that we are mid-May now, would you have seen a normalization since last March?
Yeah. Again, it's very difficult to stand here and to say exactly how the working capital will look like when we come out with our Q2 results.
Fair enough.
I think I can stay with the fact that it tends to swing quarter to quarter.
Thank you very much, and good luck in Q2.
Thank you.
Once again, to ask a question, please press star one on your telephone. Your next question comes from the line of Frederik Lithell from Danske Bank.
Thank you very much. Congrats for a good report. My first housekeeping question to Roshan is the IFRS 16, SEK 6.6 million in the quarter. Is that mostly derived in the enterprise division? That's a small question. For Oscar, the larger question, you stated in the beginning of your prepared remarks that five of eight of 10 largest tech companies, you have significant traffic. At five of the eight, you have relationship with today. Could you elaborate a little bit on the five that you have high traffic today? Do you work with them on new projects? Can you see additional potential deals coming through the next coming maybe one to three years? Is that something you're running for? And then also, what will it take for the five to go to eight? Where are you on that timeline, and can you elaborate a little bit on that? Thank you.
I can start with the simpler one. A large portion of that is, of course, affecting our enterprise business. If you want more details on that, we can take that offline as well.
Thank you.
On my question, we, of course, try always to work with our customers to win more projects and win more traffic within any customers we have. We have a specific focus on these big ones, of course. We have specific focus to make us more strategic and to understand more what opportunities are there in them, because there are. These companies are very, very large, and you find new departments, not every day, but they're very, very large, and they have traffic and opportunities in many, many different places, and that's a key strategic focus area of us. We'll do that. There is potential. Is it certain that we will win it? No. That's obviously what we're working on.
On the ones that are not there, what you got to understand, working with these customers, even if you would sign them, there is no commitment ever to, "All right, I will give you this much traffic," or, "This is exactly how I'll run it." Tomorrow they may do something different. You don't know when the traffic and how much traffic will come. It is only based on your performance. If you perform well quarter by quarter, day by day, then you tend to build good relationships with them, and you build up traffic volumes. The ones that we haven't gotten significant traffic with are either in a stage of do we want to sign them, or it's in a stage of having been signed, but for various reasons, traffic hasn't ramped to a significant level yet.
Okay.
It's really hard to predict.
Yeah, understand. Elaborating on that, the three that remains, there's up to eight of them. Is it so that you have signed those three completely with agreements, and you have also done the necessary implementations of technology. The platforms are in place and everything. They know they can use you, and sometimes they maybe try off, but it's not really volumes. Is that how I should read it?
I think what we said previously is that we have these five, we have the six which had meaningful volume. The remaining ones were in some form of dialogue or commercial relationship, where we are working, of course, with the ambition to over time increase volumes. It's a little bit hard to be more specific than that, we're afraid.
Okay. Thank you very much.
We have no further questions.
Okay. As a summary, we're very happy to report this type of strong results. It's a quarter where we have a strong tailwind from all of the different areas. We have U.S. big tech, we have personalized video, we have voice and video, we have the operator business, and we have the currency tailwind. All of that all taken together gives a very strong quarter result. We're proud of that, we're very happy to be able to report that. Obviously, you know our financial targets, we continue to work on a long-term basis to reach the financial targets of 20% adjusted EBITDA per share growth. That's what we're working hard to hit on in long run. Going forward, as we have said, this business is good. It's good today.
There's a lot of traffic and revenue and opportunity to make money today, as you can see in our figures. There's also a combination of a growth market tomorrow. The big thing there now is to position ourselves to take the growth market. It requires significant investments, which we're doing, but it's very hard to know exactly when they will hit. We're very confident on the market, on the bets we're making. It's the right bets. Exactly timing-wise, it's hard to time when it will come. That said, thanks a lot for this call.