Good day and welcome to the CLX Communications AB interim report January to September 2018 conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Thomas Nilsson, Head of Investor Relations. Please go ahead, sir.
Good morning, everyone, and welcome to CLX Communications' third quarter earnings call. My name is Thomas Nilsson, I am Chief Strategy Officer and Head of Investor Relations. With me on the call today is our President and CEO, Oscar Werner, and our CFO, Odd Bolin. I will hand the call over to Oscar for an update on the quarter.
All right. Thank you. Welcome to CLX earnings call. This is my first earnings call as the CEO of CLX, I am really looking forward to this journey. The Q3 summary is, group organic revenue grew 13% in local currency. We had a gross profit up 26%, due to both organic growth and successful M&A. We do see that our M&A transactions done in the previous year and years are developing favorably. Adjusted EBITDA is up 33%. We see strong market growth in certain segments. We see further growth opportunities both organically and through M&A. Our markets are developing to rich media and conversational messaging, where we see a lot of different, interesting opportunities. We will therefore revise our leverage policy to allow for 2.5 times net debt to EBITDA to support our M&A strategy.
As you can understand, we do see interesting M&A opportunities. Organic investments in OpEx may impact our earnings in the coming year, before new initiatives translate into higher revenues and gross profit. We see so many opportunities in the market, in high growth segments, that we want to ensure to capture in order to drive growth in the future. If we look at the organic growth initiatives, we see both sales and new product offerings offering opportunities that will drive organic revenue and gross profit growth, in a couple of different areas. The first one is internal automation and efficiency. We see relatively large opportunities to become more efficient by automation. We see product development around rich media and conversational messaging. This market is developing favorably in many different areas, which will drive market growth.
Of course, as a market leader, we want to capture those increased growth opportunities. We see faster growth market for our personalized video messaging. This is from the Vehicle acquisition. We see a very strong pipeline with very solid customers there. We want to capture the market opportunity. We see sales and marketing initiatives to drive direct sales and channel partner business. Both our direct sales to enterprise sales pipeline is improving favorably. We see strong channel partners that we are using as go-to-market partners, where we have strong opportunities for growth. If we look a little bit on the messaging business, we have the enterprise division gross profit up 26% and the enterprise division EBITDA up 33%. The A2P messaging volume up 6% year-over-year in comparable units.
A difference there is partly M&A and partly that in this quarter, our gross profit per message improved more than the volume, if you will. In certain quarters, we have volume going up more than gross profit. In this quarter, we have gross profit going up and more volume, which I personally see as a very positive trend. You can see that trend in later slides. A little bit of commentary on slide number six, for messaging. We have increased messaging traffic to certain high-margin markets. We see our markets are a little different in characteristics. Some are high margin percentage and some lower margin percentage. In this quarter, we had increased traffic to the high-margin markets. Typically, actually, average gross profit per transaction is relatively similar between the markets, but since the underlying cost structure in the markets are different, the percent margin in different markets may be different.
We see that Unwire is continuing to perform well. We are happy to see that acquisition continuing to perform. We see increased revenue in the Vehicle personalized video, with cross-selling both to operators in Europe. We are taking the same business model from the U.S. to European operators, and we see great interest there. We are taking it to our other enterprise customers in the U.S. with a very strong interest and uptake. I strongly believe that the Vehicle acquisition was a very good move. We are in active dialogue and delivering significant volumes to many of the U.S. global tech companies, and we see that momentum strongly going forward. We see that we both can add more traffic from our existing customers, and we are winning new ones. These projects are long time to market. It is very large customers.
It takes some time to go to market. We see we have good traction on both winning new ones and increasing our market shares with ones that we have. We are focusing our forward-looking investments on, like I said before, rich media, conversational messaging, RCS, OTT chat apps, and personalized video. As you can see, we are moving from a much richer messaging portfolio gradually, and we see a good market uptake from that, and we see the market developing well. We see that this will drive market growth in the years to come due to that the messaging channel becomes richer and more interesting for enterprises to use. If we look at the real-time voice and the video business that we have. Sinch is continuing to build and invest in its real-time voice and customer adaptations.
We see our ride-hailing business developing favorably with plans to launch number masking in further markets this year, as we have a strong pipeline of good markets for the number masking voice product. We also have a strong pipe for the verification business with customers in multiple industries. We also do see improved cross-selling, where voice and video is marketed alongside messaging. We see the cross-selling between the different teams, and we have, during the quarter, integrated the teams more thoroughly, with good effect also in customer engagements. Truly, as a customer, you want to both engage with us in voice and in real-time voice and video. Oh, I'm sorry, in messaging and real-time voice and video. That's a natural but very good development to see. If we switch to slide 8, our operator division, the underlying business is developing as planned.
We have continued improvement in EBITDA compared to Q1 and Q2 this year. We should note that the earnings in the 2017 Q3 is an unusually high quarter due to certain capacity expansion projects, which are periodic. In Q3 2017, we had a very high earning due to such capacity expansions. The comparison in operator becomes a little bit skewed. We have a strong sales pipeline, but unfortunately, too slow conversions to projects and revenue in the operator division. We're working to reach the 15% medium-term EBITDA target during 2019. With that, I will hand the word over to Odd to run us through some of the numbers for the quarters. Odd.
Thank you. Oscar has already given you all the basics. We are quite happy with the development during the quarter. We have seen a considerable growth. We were very close to doing our first SEK 1 billion quarter, and we believe that will happen soon, hopefully. We have seen a stable gross margin, in our enterprise division. We've also seen existing customers developing very well. The operator division is, as Oscar pointed out, still suffering from some slow conversion of existing orders into revenue and projects. Vehicle is performing very well. If we go on to the next slide and look at the gross profit and the EBITDA quarter-over-quarter. Starting with the gross profit, we maintained the level we had in the second quarter, even though the third quarter seasonally is a slightly weaker quarter normally. We have a very good momentum with some key U.S. clients.
As I said, Vehicle continued to perform well. This is the effect of these effects on both EBITDA and gross profit, and I'm not going to spend time on both these pictures individually. Let's move on to the year-over-year comparison, gross profit and EBITDA. What we can see here is that apart from the, what you see as a solid organic growth, underlying organic growth, we also had a very significant contribution from the acquired businesses, Unwire and Vehicle. Both of them are performing very well. We do have an unhealthy underlying organic growth, which is obviously a very important factor for us. Moving on to operational efficiency, slide 16. The gross profit is, as I'm sure all of you know, the primary bottom-line driver for us. Gross profit per transaction has been rising, as the traffic we've seen has increased to some high-margin markets.
The revenue and gross margin, however, at the end of the day, depends very much on the mix of terminating markets. We've seen recently some increase in traffic to markets where we have a higher gross margin. Well, we take all the questions afterwards, right?
Yes.
I'll give the word back to you, Oscar.
Thanks. We thought we'd spend a few minutes talking about our company in a wider setting, especially as Oscar's just joined as CEO. With that, a few words on our overall story, Oscar.
Okay, moving to the story. I must say, I'm super excited to get into CLX and understanding the business and understanding the opportunities. I do believe that there are strong opportunities in many different areas for CLX. The way we see this is if we look at slide at CLX at a glance, we deliver customer engagement. We're basically using mobile technology to help businesses engage people through mobile technology, and the bottom line to that is very simple. The mail channel is very hard to use. It doesn't work that well, and the phone, hard, and TV advertising, all of these kind of other channels that you have is very hard. Then you have this channel directly to everybody's pocket, to a medium and to device they always carry with them. That's obviously a very strong channel to the business, or to the consumers.
That's basically why this market has grown so large over the last couple of years. Sorry. Therefore, we address a growing multi-billion US dollar market, in both messaging and SMS and richer media formats, in voice, and in video. Counting this up, it's a large growing multi-billion dollar U.S. market. Interestingly, when I thought about this business, it has 100% penetration among consumers. I've asked everybody that I met since I started, and I've yet to find one single person that has not been exposed to this type of services. I've not found one single person that I met that has never received a text message from, "Don't be late for your doctor's appointment," or, "Here is your flight ticket or ticket information, or delivery information," or something like that.
That has never made a voice call, for example, from an Uber app, or any such other services. That has never done a real-time video call, for example, with a doctor. So far I've not met one single person, so I'm kind of making the statement that it's roughly 100% consumer penetration among users in the world. It's the same type of penetration for this market as for mobile phones, and it's very few markets that has that characteristics. We reach five billion users worldwide, and we reach them within seconds. A typical statistic is that 90% of messages to mobile phones are almost read within 90 seconds?
Sorry, three minutes.
Three minutes. 90% of messages to mobile phones are read within three minutes and reach five billion. We deliver 25 billion transactions a year. That is five engagements to each mobile phone globally in the world per year. If we take in our core market, that figure is going to be significantly higher. We probably, in the U.S. and Europe, deliver some 10, 15 engagements to each mobile phones across all of those geographies per year. Customer satisfaction is generally very high, due to this type of messages primarily is integrated into the customer journeys of big enterprises. This is an airline who wants to communicate, "This is your ticket." That is not seen as spam. This is you wanting to contact a ride-hailing business and you call them. That is not seen as spam.
That's kind of part of your customer journey, part of your engagement with that business already. Customer satisfaction is generally very high. We see that cloud communications via mobile technology is becoming business critical, and it's moving from early adopter to early majority. A large portion of our revenue as of today has been driven by the digital natives, the true online companies improving their customer journeys, and we see that kind of development going out into the mainstream. Our chairman was at the hairdresser the other day, and he got a text message from the hairdresser saying, "Don't be late for your appointment." Then he asked the hairdresser, "How does this work?
What benefit does this give me?" The hairdresser said, "Well, these type of messages, they reduce two no-shows per week for me, and I pay," whatever, "SEK 5 a week," or something like that. I think that's a very good example of how this type of business has really, truly affect the no-show reduction for the hairdresser on the corner. With that type of business, you have a very large addressable market. To her, this hairdresser, the business case of using this type of services is an absolute no-brainer. Reducing two no-shows per week for her is hardcore money, and the cost to do so is very small compared to the benefit. Then you can imagine the amount of businesses that will or are already engaging in this type of communication. We are one of the world leaders.
We're leading communication platform for messaging, voice, and video. We're one of the leaders in this market. We are a preferred partner to the world's most demanding enterprises. We're serving eight out of 10 of the largest U.S. big tech companies. You take a list of all the brands that you know, the biggest tech brands from the U.S., we serve eight out of 10. It's a very strong statement, and it's a statement to our quality and to our ability to deliver this type of services on a global level. Talking to these companies, we're truly top-tier. We also, very interestingly, do software solutions to mobile operators based on the same underlying platform, which I think is a very strong point for us, which singles us out from the competition.
I do think there are increased opportunities for cooperation between these business units in the future. Moving to the next slide. Here's slide 19. Growth markets. Our main market, as you know, is messaging. We believe that the market for messaging as of today is right about $10 billion. There are market estimates, it vary between $10 billion and $50 billion. We choose to take the lower part of this range to be conservative. This is primarily text messaging, and seeing a market from a relatively simple technology as text messaging growing to that size, that has something. The reason is very simple: 100% consumer penetration, 98% open rate, and everybody's a trained user. The power of the mobile channel, I think, is proven by this figure.
What's happening now, though, is the text messaging market is moving to richer media messaging and more conversational messaging, which we'll show a little bit later, which we believe naturally, given that the messaging channel becomes more powerful, it will grow market growth in the coming years. We have another part to this market, which is traditionally called CPaaS or Communications Platform as a Service. This is basically when you add a layer of software intelligence on top of the actual messaging transaction. First, this market was just send a message to my user. That's one part. You can also start to add a layer of software intelligence. I was talking before about verification and number masking. In the verification business, we would sell, we verify that this number belongs to this user or that this mail address is connected to this phone number.
There we're having a service where we may first send out the text message, but if the text message is not answered to, we may make a voice call, and then we may do something else, and we sell the actual verification, and we have added a software module on top that does that type of verification. In the number masking business that I talked about before, we are not only connecting and delivering the voice call, but we also mask the number, which for a ride-hailing business is super important, because the masked number means that the user don't know which phone number the driver has, which is very important for a ride-hailing business, because otherwise users may contact the drivers directly in order to get the lower price. That's a super business-critical revenue assurance feature for a ride-hailing business. Other such services.
In the CPaaS part, that is adding the software layer, there are various degrees of market estimate. Juniper sees a 35% CAGR. Gartner expects a 50%, and IDC forecasts a 57% CAGR. We're seeing that this part of the business is growing strongly. We're seeing a large demand from our customers, and this is why we, obviously being a messaging leader here, need to focus quite a bit of investment to capture this type of market growth and this type of segment. It's a very, very natural step for us, being as profitable as we are. Looking down to the next slide. I touched on this before, but in principle, I do mean it when I say it's a 100% consumer penetration.
I yet to meet one single person or consumer that has not used this type of services, which means that the use cases are infinite, or the number of use cases that we're delivering and see in the future, it's a very, very long list. It can be banking, healthcare, internet commerce, e-commerce, utilities, media, ride-hailing, transportation and travel. I can probably go on and on and on here about the use cases we are delivering and can deliver in the future here, because a very large portion of the world's enterprises can actually be our customers or our channel partners' customers. We're also seeing growth here. I think we're seeing a trend shift in the world of CLX, where we're moving to a broader set of services than messaging, both from SMS only to more than messaging and also richer media messaging.
I'm going to talk a little bit about those. Voice and video. We're doing cloud-based capabilities for voice and real-time video. That is, somebody has an app, sorry about that. Somebody has an app and they want to make a call from that app. That type of calling system is something that we do deliver. We see that we can win the world's largest brands on this type of services as well. We're seeing the top brands in the world actually coming to us on the voice business as well, which I see is very possible. We're focusing very much on the ride-hailing business. We have traction in that business, and we're focusing on penetrating that market selectively. Here, like I said, we're doing number masking with temporary phone numbers, which safeguards privacy and improves revenue assurance for ride-hailing businesses.
The other very interesting area is personalized video, where we have a unique personalized video to each recipient. This is, if it's a messaging 1.0 or 1.5, we would, instead of sending a text message, we're doing this program in the U.S. today, we're sending a video message. Unfortunately, I cannot show this video on the call here today, but it's a very powerful video. We work with customers, they map out the customer journey, and instead of sending a text message, the users receive a video message into their inbox. We have worked this through a couple of big companies, and we see very good stats from this. Sorry about that. I got a call. Sorry about that. Doing this type of video message, we see a 17% annualized churn reductions for a major U.S.-based wireless carrier.
They basically mapped out their customer journey, and they said, "All right, I have an issue with the customers not understanding my phone bill." They mapped out and said, "Let's send a personalized video message describing the lines of the phone bill to the users when they receive their device." This video message explains the phone bill to the users, and thereby reducing churn with 17%. You can imagine, to an operator, reducing churn with 17% is a huge amount of money. Churn reduction is the most important metric for the marketing organization of a carrier. You can imagine how many carriers we can sell this to. If you expand this, how many subscription-based businesses can we sell these type of services to? I think the list there is very long as well, as we see by the pipeline.
It also has the highest improvement in Net Promoter Score of any marketing effort that this carrier has done in the last year, due to this being a very direct message. The interesting thing here, what we mean by personalized is that we actually, on the fly, create different variations of this message. We actually connect into the CRM of this particular carrier and pick up when user A has selected product A, B, and C, and there we, on the fly, create a personalized message to this carrier. It has 36 different variations of the video, making it very directly targeted to this individual user. I think that's very powerful. The next thing that we see is next-generation messaging. If we move to the next slide 13. We call this the post-app era, as we're seeing new messaging formats coming out.
Having messaging formats where you can both do real-time feedback, or you can have a conversation with the brand. It is not only a one-off like text message is. You can have a conversation with the brand in a chat-like experience. As you know, the younger generation, they prefer chatting or messaging-based communications over voice-based communications. That type of communication in the customer journey in a message being very powerful. It also provides a rich dynamic content, so it can have pictures or videos like you saw in the previous slide. It becomes an app-like experience. You can actually have buttons or action buttons in the message. Imagine your phone and in your inbox, you get almost, when you click on that message, you get into an app.
You no longer need to download the app because suddenly you get a text message in the right time, targeted to you only with the right information for the thing that you want to do right now, and it looks like an app. You click on the message, in an airline case, it would look a little bit like this. Boom, check-in or change seat. You have that directly available in your inbox. A large portion of our customers believe that this will replace a portion of the app traffic, because the 27th airline you have, you do not want to download the app. You just want to get the message through inbox and have the same type of experience like an app.
The post-app era is something that is discussed highly in the customer excellence, customer journey organizations when you present this type of messaging formats to them. Obviously seeing both voice growth and then personalized video and this next-generation messaging formats, we see strong market growth in the coming years, and we see a very interesting development for this market going forward. Future growth, like we said before, we have a strong pipeline with several U.S.-based global digital-native companies. These are one of our core bases. We have a lot of customers, but we see we are very strong with the world's largest enterprises. We see considerable interest in increasing revenue with the Vehicle personalized video. We see the Sinch business that we acquired before. It was the number masking for ride hailing developing well.
We also see an improving pipeline in key customer engagements for the Sinch number verification business.
We see us investing in the rich media conversation messaging, RCS, and over-the-top chat apps. It's a necessity to capture the market growth potential going forward, something we feel very strongly we'll do in the coming quarters.
Thank you, Oscar. With that, we'll open up for Q&A.
Thank you, sir. If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star one to ask a question. We'll just pause for a moment to allow everyone an opportunity to signal for questions. We will take our first question from Susanne Ebner from Carnegie. Please go ahead. Your line is open.
Hi, good morning. I'm looking at the operator division. I hope you can help me understand how to think about how future-proof it is. For example, how much of sales year-to-date in the operator division relates to legacy products that won't recur when networks modernize, and how much of the sales do you believe will remain and possibly grow over the next few years, for example, software for fraud and security? Also on operators, the Q3 margin was above the 15% you are targeting. Is there any particular reason for that?
Question relating to our operator division. You'll know from previous press releases, we've focused our agenda somewhat in our operator division, moving away from certain areas and focusing on areas where we feel we have a stronger offer. Generally speaking, our product portfolio has a mix of maturity level, if you so like. Some aspects are forever, our products around security and signaling and so forth. Some are more tied to a particular technology. I think it's worth highlighting the very or extremely long sort of timelines in this type of business if we compare to our other business. Operators do not make swift decisions, and these businesses sort of tick on for a very long time. When we look at this particular quarter, we see good orders from a few select customers. That's the sort of normal name of the game. We'll have some variation between quarters.
We're glad to see an underlying improvement over the past few quarters, we work to reach our 15% EBITDA target.
To fill in a little bit about that. We do see and explore interesting future opportunity, which are combining the operator business and the enterprise business in a better way. That is also the reason for the decision about CloudCore and IoT, who made those decisions. We see opportunities in aligning those business in a better way, where they frankly, one plus one equals three in a better way. That's our focus right now on aligning this organization. Cannot talk exactly about what that is right now, but we're exploring a couple opportunities for that.
Okay. Thank you. My second question relates to you raising the gearing target. Does that mean that you have circled in on a potential target? If you don't want to answer that, I have a more general question on this topic. What type of companies are you mainly looking at this moment? Is it expanding your current portfolio offering by adding new services or functionalities, or is it more bolt-on acquisitions, both in an existing market, but also expanding to new geographies?
It's a well-focused agenda. We have mainly three focus areas. One is the bolt-on acquisitions, expanding EBITDA growth volume size. The other one is the new technology or go to market, think Vehicle or Sinch. The third one is geographical market access, where we may, if we want to target a specific geographic area, acquiring a team or a company in that geographical area.
Which one of these three focus areas do you find most interesting right now?
All of the above. That's why we have them. I think all of the above, when we selected between the long list of different focus area, these are the top three. Which of them we find most interesting, it's interesting in a couple of different categories. How we execute on that agenda is obviously also where do we find targets at a suitable price that has the right characteristics. It's very hard to answer that question. They all have various interest in different ways.
Okay, thank you. That's all for me for now.
As you can see from before, if we talk about the post acquisitions, if we think about the mBlox acquisition, fantastic acquisition. Bringing us into the U.S., putting us on a global scale, making us much bigger. That's more on the bolt-on scale or also geographical access.
That's probably these two. Of course, that was the right decision for us to do. If we look at the Vehicle and real-time voice, we did those adding product and adding go-to-market in two new markets. All of these three, if we take those, are very good acquisitions. Having a strategy to only execute on one tangent, I think would be the wrong strategy. The strategy should be to take a market position and the right market position, and then you need to execute on several different aspects. Saying that one is the only priority, I think is a limiting strategy.
Perfect. Thank you.
Thank you. If you find that your question has been answered, you may remove yourself from the queue by pressing star two. Once again, as a reminder, if you wish to ask a question, please press star one. We will take our next question from Fredrik Lithell from Danske Bank. Please go ahead.
Thank you. Good morning. I just have a question on, maybe two questions. The first one is really on your wording around you want to push up investments, and that may impact your earnings the coming year. Can you translate that into the divisions you have, and where we should expect you to maybe increase the pace of investments? In combination with that, the earlier acquisitions you have taken on and now the Nova platform since last winter being fully in place, do you have any further efficiencies to take out from those on earlier M&As, or are we fully done in terms of the cost you have in the quarter? Thank you.
I think Oscar mentioned a few areas on slide four in the deck. It's correct that we've migrated our traffic to new transaction platform that's truly built for scale. That doesn't mean we're by any means finished in targeting internal efficiency and driving automation. Absolutely, a share of our efforts here will be focusing on areas which just improve our business as it looks today. The second focus area is messaging in a broader sense. We talked about conversational messaging, about handling rich media. It's more complex for an enterprise to handle and send a rich media message and deal with replies than it is to send a text string. There are various tech assets around that you need to provide in order to enable customers to use this successfully. We'll continue to work on that.
We've talked about personalized video messaging, which is both product but also a lot of go-to-market. It's a product which is receiving rave reviews whenever we go to clients with it. That's a simpler go-to-market sales investment. Lastly, it's an overall effort in improving our marketing, branding position, and channel partner business. We see genuinely quite a lot of opportunities, mainly messaging, also real-time voice and video. We think those opportunities are large enough. It's enough of a scope that we want to concentrate our investments on these areas. I think it's a very natural move. You see certain market segments like was mentioned, the CPaaS added software, added software intelligence growing with 35%-50%, 60% per year. Us being the, or one of the messaging leaders in the world, it's an obvious focus area to capture part of that market growth.
In such type of markets, obviously, growing that fast, you need to be on your toes in order to capture market growth. I think it's a very natural step to take a portion of the EBITDA growth investment in those type of markets to drive further growth in the business.
Thank you.
As a reminder, if you wish to ask a question, please signal by pressing star one. We will just take another brief pause for everyone to speak. It appears there are no further questions at this time. I would like to turn the conference back to the host for any additional or closing remarks.
We want to thank you everyone for calling in, listening to our story, and seeing our progress. Very glad and warmly welcome to our next event. That will be Q4. Oscar, if you want, any other last final remark?
My last final remark is probably I am very excited about this business. Coming into an area which has, like I said, 100% consumer penetration, is very interesting. Seeing the type of market growth that we are seeing is very exciting, and seeing the type of customers that we engage with and the volumes that the customers engage with, it is a very strong position to be in, and I am looking forward to drive the business further in the coming quarters. Hope to see you all on the next earnings call. Thanks a lot.
Thank you very much.
Ladies and gentlemen, this concludes today's conference call. Thank you all for your participation. You may now disconnect.