Thank you very much, operator. Good morning, and welcome everyone to Sinch AB's Q2 2019 Conference Call. My name is Thomas Heath. I am Chief Strategy Officer and Head of Investor Relations. With me on the call today, I have our CEO, Oscar Werner, and our CFO, Roshan Saldanha. With those welcoming remarks, I will pass the word over to Oscar.
Thank you, Thomas. Welcome to this call for the Q2 report. I will start at the slide two or first slide, Sinch at a glance. That said, we have seen this slide a couple of times, but just to repeat for any newcomers. Our main business is delivering customer engagement through mobile technology.
We have a scalable cloud communications platform for messaging, voice, and video. Basically, by reaching people on the mobile phone, our customers can engage their customers or partners or employees via messaging, voice, and video services. Interesting thing about this market that always strikes me is it has got 100% consumer penetration. I have yet to meet one single person that is not a user.
That is, everyone that I have met so far have either used mobile technology to make a call to the doctor, to call their favorite taxi service app, or to receive messages for web check-in or something like that. It is a very broad penetration at the scale of mobile phones. It is a growing global multi-billion dollar market. It strikes me as well that whatever country you go to, these type of services are used by a very large number of enterprises.
We serve eight out of 10 of the largest U.S. tech companies. We are serving some of the absolute biggest companies in the world, and we have done that organically from Sweden due to very high quality of service. When somebody wants to deliver these type of services at a global scale with very low latency at very high quality, we are one of the absolute top choices.
We also do software for mobile operators based on the same underlying platform. Let us move to next slide, growth markets. The market continues to grow, and that is apparent in pretty much all categories. We got the messaging market, even though we are present in messaging, voice, and video, our biggest portion of our revenue is in messaging. The messaging market is a SEK 17 billion market as of today, and it is growing.
It is growing actually both on the text messaging side, but also on the newer forms of messaging, the rich messaging formats, RCS, OTT channels. There are various reports showing different growth rates in that, but it is definitely a growth market. We have got what is called CPaaS. More the software as a service on top of the communication channels, which is projected by pretty much all parties to grow at very rapid rates.
We're at the intersection of the CPaaS software as a service. We're adding more software on the messaging side, which is growing both on the base, on text messaging, but also on the new formats. Market-wise, we're in a good spot. All right, go to the next slide. April to June 2019. We saw gross profit rise with 29%, up to SEK 321 million from SEK 248.6. That's a healthy growth that we're happy with.
We saw adjusted EBITDA rise with 17%, up to SEK 114 million from SEK 97.4, we're also happy about that. Adjusted EBIT excluding acquisition-related amortization to SEK 104. You can see that our EBITDA to EBIT conversion is high if you exclude the acquisition-related amortizations. The profit after tax being SEK 53, and there you obviously have the acquisition-related amortizations.
In local currency, our gross profit growth 26%, a little lower effect on currency in this quarter. This is also a clean quarter from an M&A perspective. As we said many quarters now, we continue investments to capture new market growth opportunities, and that affects our earnings before these new initiatives translate into higher revenues and gross profits. The logic here is very simple. We see a very good growth market.
We see a lot of growth opportunities in the newer formats and in the more SaaS-related software. Therefore, given that we have a strong trajectory, we think it's good to invest in those areas in order to set us up for a very solid growth in the coming years. That's the very simple calculation. If we move on to the next slide, to the key growth drivers. We have four main growth drivers today.
One is the rising message volumes with the large U.S. tech companies, a big growth driver for us. We see our growth in personalized video. This is one of the areas of the newer formats where we are definitely the leader. We see strong traction with a large number of brands in this area, and we're investing in order to continue growing at a rapid rate.
We see, as we have seen in previous quarters, strong growth in voice and video. That's also an area where we invest and serve very large customers. We see the operator business doing well, and has been doing for some time. I'm happy to see that it continues to do well. That's our current main growth drivers, and then we're working on a couple of others for the future in order to set us up for future growth.
If we move on to the investment areas to explain a little bit with what we are doing and where we are investing. Obviously, when you're growing gross profit with 45%, you have to grow the organization just to keep up with the new number of client wins and the new traffic and volume. That's a basic area which we don't cover on this slide, but that's obviously true.
If you look a little bit more to the forward-looking investments, they fall into three main categories. One area is just operational efficiency, where we invest in our own systems. It's internal automation for improved scalability. It is improving our COGS, and it's improving automation for our clients, like client self-service tools, and that's a relatively large area for us.
We see at the growth rates we have, we need to continue to invest in our own scalability in order to have a good scalable business going forward. We are investing in sales and marketing. We've done the new brand, we're now focusing efforts a lot more to strengthen lead generation and to generate more leads into our sales force.
We are investing in international expansion of the personalized video product. We see the first launches now in Europe. This is a U.S. acquisition in Seattle, and we have brought it over to Europe. We see the first launches with operators and customers in Europe of the personalized video product, which is very strong. We also see how we can bring a technology from one area where we made a technology investment and bring it out to other markets.
We see the proof points of that and how effective that is right now, which we're very happy with. We have a great focus on new sales in Europe, adding a new sales team and being more aggressive on outreach onto new customers into Europe. We're investing in geographic expansion into Asia, where we have local sales teams in China and a couple of new countries, where we see good opportunities in the market.
The third area is new technology. Software for advanced interactive messaging, such as RCS, OTT, WhatsApp, et cetera. New channels like WhatsApp and RCS. Sorry, the first point is, this is both investing in channels and in the way to handle an interactive conversation over messaging. Our current base is very much notifications and one-way messages.
We're seeing the markets now turning into conversations, consumers are starting to answer on the outbound messages, and that requires a more advanced software to handle those responses in a good way for our customers. We're also investing in RCS as a service for mobile operators. That's the three main areas where we're making investments in forward-looking, apart from just supporting, obviously, the gross profit growth.
Operational efficiency, sales and marketing, and new technology. We think all of those will drive to our bottom line in the medium to longer term. If we move on to the next slide. Continued growth in messaging. We see rising message volumes this quarter as well. We see higher growth on the gross profit side than in transactions, which we'll see on the next slide, we see rising message volumes.
We see the U.S. tech companies fueling growth, we see personalized video fueling growth, we see that we are investing in the next-generation messaging as the plan we have communicated and had for quite some quarters now. Again, the reason is very simple. We just see very rapid growth in new areas, and I think it is responsible of us to invest in those areas in order to capture that type of growth.
On the next slide, the rising message volumes. We're growing both with existing customers, new customers, and new use cases. This quarter, we see a 7% organic growth in transactions. On the other hand, we see a 22% organic growth in gross profits. We're on a track to move to more advanced messaging and more value add.
As we can see, the customers we win and where the highest amount of growth is in our base right now is in the higher value transactions, and where the lower amount of growth is in the lower value transactions. Therefore you see a skewness here to higher growth in gross profit and lower growth in transactions, which is to be expected.
We're focusing more on the higher value than on the wholesale part of our business. If we then go on to the next slide, the gross profit per transaction. This is painting the same picture. The gross profit per transaction is growing and has been growing for quite some quarters. Then we see the OpEx per transaction is also growing. As we're investing in the new services, we get more software to sell, and we do more advanced things.
Then both of those curves are growing. And both of them are also affected by FX effect, of course. Specifically, the GP per transaction is rising due to us investing in growing faster than average on the personalized video. We also have a carrier tailwind and increased traffic to profitable markets. Going into the harder-to-serve markets, we can generally make more money per transaction than we can in the easy-to-serve market.
Now we're serving global companies in a lot of hard-to-serve markets, and we're proving good to do that, and therefore we see gross profit grow as well as the new services. Next one, the OpEx investments to capture growth. This is a graph where we think is very powerful. This is the messaging EBITDA per gross profit. We are around between 40% and 50% of the gross profit we generate turn into EBITDA.
I think this shows very well the scalability in our business. It's a very strong metric, which we're happy with. You see here that the revenue gross margin depend on the mix on the terminating markets. When we have the good mix of terminating market, this graph goes up. This EBITDA per gross profit shows margin excluding the mobile operators charges.
This is the clean margin. As you can see a little bit on the slide, the growth initiatives weigh on the profitability before they translate into high revenue earnings. I think this slide is strong, and it shows a little bit of the trend that we've been talking about in the previous slides as well. If we move on to the next, voice and video. We see high growth in voice and video.
As you can see, continued growth in Q2, while we're turning on the clients that we have won. We're also seeing, as you can see on the EBITDA side, we are, given the rapid rise in revenue and transactions, we need to invest quite a bit in this area in order to keep up with the customers that we have signed.
This is a core focus here. Like you know, we have worked hard to turn this into profit. We have signed a set of very large customers, when those customers are ramping their traffic, we need to work hard in order to expand into new markets, in order to keep a high quality of service.
That is what we see on the EBITDA front there, where we just need to make sure we have a good quality of service and follow our customers into new markets in this type of a rapid ramp. If we look on the next slide here, the operators. We also have a healthy profit in operators. We have had improved conversions of order to sales.
In this type of business, as you know, it is a fluctuation, quarterly fluctuations as projects are realized. We are investing in RCS as a service for mobile operators. Generally, the trajectory here has been good, and has been good in the previous quarter, and we see a good pipe going forward as well. With that said, I am going to leave over to Roshan to do a little bit of a deeper dive into the Q2 financials.
Thank you, Oscar. Good morning to all of you, taking time on this summer day to join us on this call. Turn to page 14 for the condensed income statement. This was a stable quarter with no extraordinary items in the income statement. Consolidated net sales grew by 18% in the quarter to 1,177,000,000 SEK. The growth rate in the quarter was positively affected by the movement of the Swedish krona, primarily against the EUR.
The organic growth of net sales in local currency was 15%. EBIT came in at 73 million SEK versus 40 million SEK in the same period previous year. Acquisition-related amortization, which does not affect cash flow, was 31 million SEK. This amortization relates mainly to planned amortization of acquired brand, customer, and operator relationships, as well as software.
Adjusted EBIT, which excludes both items affecting comparability and amortization of acquisition-related intangible assets, amounted to 204 million SEK, which gives, I think, a better reflection of our strong cash flow generation capability in the business. Moving on to slide 15. Slide 15 shows a bridge explaining our underlying gross profit development. A significant part of our revenues are passed on as cost of goods sold to mobile operators. We pay them to send 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 reflects changes in geographical mix rather than underlying performance or competitiveness. This bridge explains the different components in our gross profit growth, and the organic growth in local currency in comparable units.
We have had no acquisitions since the second quarter of 2018. Consolidated gross profit rose by 29% during the quarter to 321 million SEK. Positive exchange rate movement explained 9 million or 3% of this increase. Organic growth in gross profit in local currency and comparable units was 26%, which we believe is a very strong development in line with the previous trends.
Organic gross profit growth was 22% in the messaging segment, contributing 45 million SEK, 100% from a small base in the voice and video segment, contributing 11 million SEK, and 26% in the operator segment, contributing 8 million SEK.
In messaging, the growth is coming both from a shift in mix of our customer base to more enterprise customers, which has been a focus of the company to drive, as well as from newly added products such as personalized messaging through the acquisition of Vehicle in 2018.
Moving on to slide 16. Slide 16 shows the scalability in our growth within the messaging segment. We grew volumes by 7% year-over-year, which also reflects a shift in our customer base as we gradually increase our enterprise customer base, as well as grow more with our existing enterprise customers, whereas our wholesale customer base continues to be stable to slightly weak.
This is reflected in our revenues, which grow faster organically than the volumes as we sell more software and value through, for example, personalized messaging. We can also add differentiation and quality to our service delivery through offering different routing options. Finally, this shift is most visible in our gross profit, which reflects the higher value add that we deliver to our customers.
Serving more demanding customers and being able to deliver traffic globally at a high quality through our Super Network has made this gross profit growth possible. Oscar earlier talked about investing for continued growth and highlighting the main areas of growth being driving internal operational efficiency and quality, increasing our sales and marketing efforts, as well as investment in new technology.
Please turn to slide 17 to see a summary of the number of resources at Sinch. I would like to talk about the size of our investment as a company and what we believe will deliver growth during the coming periods here. Our headcount is distributed in many different locations across the globe, but the majority of our resources are situated in Sweden, with the U.S.A., Poland, and U.K. being other locations with significant concentration of resources.
We have grown headcount in the company with 23% during the previous 12 months. Please note that these numbers are quarterly averages. A lot of the work that is being done is to support our gross profit growth in the current periods, but there are also investments in the areas that Oscar described earlier. These investments are taken through our income statement as OpEx, and we have very limited capitalization of resource costs, which I believe to be a prudent handling.
We also continue to maintain our financial targets of growth in adjusted EBITDA per share by 20% per year and are using part of the current growth in gross profit to secure growth in the coming periods, as has been stated previously. Please turn to page 18 for the cash flow statement. Cash flow from operating activities was 130 million SEK in the quarter.
Change in working capital fluctuates from quarter to quarter. I think it was negative previous quarter, and it's positive this quarter because many of our customers maximize their liquidity by postponing payments to suppliers at quarter end. Actual customer losses remain very low at 0.05%, and cash flow in relation to operating profit is slightly improving over time.
Net debt at the end of the quarter amounted to 441 million SEK, down from 484 million SEK at the end of the first quarter this year. The implementation of IFRS 16 on 1st January 2019 has increased the company's net debt by 84 million SEK, as we also informed at the end of the first quarter.
The company has made a payment of $8 million or 74 million SEK, which is reflected on the line acquisition of [Subscription] in this statement, which relates to the earn-out clauses from the acquisition of Vehicle a year ago. Net debt to EBITDA is at 1.0. With the previous accounting principles before IFRS 16, the net debt to EBITDA would be 0.9, down from 1.4 a year ago.
We have also previously received questions regarding the differences between our operating result or adjusted EBITDA and cash flow before changes in working capital. We are now adding a bridge on slide 19 to explain the effects between these items. We have no non-recurring items this quarter, and our adjusted EBITDA and reported EBITDA are both at 114 million SEK, giving an EBITDA margin of 9.7%.
The most important items to deduct are of course our finance net, which is the net of finance income and finance expenses, as well as paid taxes. Paid taxes can vary between quarters depending on the local practices in individual jurisdictions. In Q2, we have the effect of tax payments in the U.S. each year.
We have the effect of unrealized exchange rate differences both on operating activities as well as on our intercompany and external borrowing. These are minor in the quarter, but as you can see for Q2 2018, they can vary between quarters. Hopefully, this bridge and this page gives you some additional insight into our cash flow from operations. Slide 20 summarizes our financial targets.
The financial targets for 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 two and a half times adjusted EBITDA over time. Measured on a rolling 12-month basis, we grew adjusted EBITDA per share by 41% in this quarter.
Net debt to EBITDA was down to 1.4x a year ago. With that comment, I would like to hand back to Oscar to summarize the presentation. Oscar, I think we can't hear you there.
Sorry, I had to unmute. As you've seen, we're in a good market, and we're focusing now on just delivering results now at the same time as setting ourselves up for the future. If we look forward on the future, we continue to have a strong pipeline with U.S.-based global tech companies, both growing with existing customers and targeting new.
We have a larger field organization as a result of these investments, and now we see that we have teams in place, a larger amount of people focusing on new sales, which we are seeing starting to generate leads, which we have not seen in the numbers yet. We see them in the cost numbers, of course, but we don't see them in the revenue numbers in a measurable way. We see them are in place, and we're very happy with them.
We believe that's going to drive future growth for the future. As you can see, this point is new on this. We did believe a couple of quarters ago that we had too few new salespeople, and therefore, we did make investments to do so, which should turn into growth in the future.
We further growth in personalized video, further growth in voice and video. Both of those markets are strong. As you see, as we've said many times, we're investing in the rich media, conversational messaging, RCS, and OTT chat apps to capture the new growth market potential. We're increasingly convinced about how strong those markets are.
Looking at our own performance in personalized video, looking at other companies' performance in those areas, we see a strong growth, well above our average in the new messaging areas. Therefore, we feel confident in investing in those areas, both on the go-to-market sales marketing side and on the technology side. With that said, I want to thank you all for participating on this call and open up for questions.
Your first question comes from the line of Fredrik Lithell from Handelsbanken . Please go ahead. Your line is open.
Thank you. Good morning. Two questions, if I may, then. On messaging, you talk about your pushing the focus away a little bit from wholesale and on to directly to end enterprise customers. Can you describe a little bit more over the two-year period or three-year period how that will progress and how we should see that?
You're doing a lot of transactions on the wholesale basis. How will that develop? If you could expand on that would be great. The second thing, investments. You talk about the investments. We can see the headcount and the consultants coming in and helping. When do you think you're on a correct level to facilitate for all the investments you want to do?
Should we expect that the headcount will continue to increase with 15%-20% per year because you will always get into a situation you see new investments? Or do you feel you're coming to a situation where you have a platform that will be able to cater for the investments you see for a two, three, four-year period? Would be great. Thank you.
Thank you, Fredrik. I think we'll leave the first question to Roshan and then have Oscar answer the second one.
I think, Fredrik, on your first question, on the shift to enterprise, I think it's good to remember that this company has actively been growing its enterprise customer base for quite some time, and we see the good results of that in the gross profit growth. If we talk about the U.S. big tech companies, for example, or also mainly in the U.S. actually, where we've had good success in getting enterprise customers.
I think it's difficult to forecast exactly how this development will take place, but our aim is to keep and continue to be relevant in our cost leadership in the wholesale customer base. What we are seeing is that we can add more enterprise customers and definitely deliver more software and value and at higher margins to the enterprise customer base, which will drive future growth. I think that's all.
Sorry, if I can just follow up there. Is it fair to assume then that the transaction volumes and maybe your revenue, your top line, will grow slower, irrespective of how much it will grow, but it will grow slower than your gross profit will grow? Is that a fair assumption if you take a 2 - 4-year horizon on it?
I think it's difficult to forecast so long forward.
Yeah.
I think if we look in the near term, that's definitely that trend that we are seeing.
Yeah.
The good part is that the messaging market is continuing to grow, and we will continue to play a strong role in this, and I think our focus will be on winning more enterprise customers. We want to keep our wholesale customer base and our cost leadership. I think looking at over a three-year period, it's really difficult to forecast how that plays out. In the near term, yes, absolutely. That's probably how it will be.
Thank you.
All right, on the second question, well, I can't make forward-looking statements, but I can comment on our logic when we make those investments, which will probably guide you in how we think. What we're doing is obviously, now we're looking at what is the payback and what is the traction of the investments we're doing. A couple of quarters ago, we thought we needed to start investing in those areas because we see a lot of traction.
Now we have done that, and the level of investment, how successful are we driving a profit based on those investments, basically. If we see very high growth in those investments, we're likely to invest. If we see lower growth, we're likely to take it down. I think it's going to be very much down to the market traction on the new investment area.
The other constraining or fact that we're obviously living within is, what is the general gross profit growth in our company? If we continue to grow gross profits, and EBITDA in general in a good way, we have obviously a larger space to decide, do we want profit today or the likelihood for profits tomorrow?
That's the two factors that we're scaling with here. We are, as you can imagine, now we have pushed pretty hard on the investment area, and we're right now in a discussion of what's the right level going forward for shareholder value. We're doing that in a responsible way. It's really those two factors.
How much EBITDA do we want to generate today or tomorrow, if that do well? How much do we want to increase the likelihood of high growth in a couple of quarters out? That's the balance we're trying to strike, in the way that is best for the shareholders. I think that's the two things that you're seeing and the two things that we are weighing.
Okay. Thank you. Thank you. Very clear. Just a housekeeping question, if I may. In the cash flow, the earn-outs you had in this quarter, are there any earn-outs left due to the contracts and acquisitions before, or do we have them behind us?
I think there is some information in the report on that. We can come back, but it's clearly stated, but we'll connect offline with details there. It's all in the report.
Thank you.
Thank you. There are currently no further questions. Please continue. Oh, we've just had another question from Fredrik Lithell from Handelsbanken . Please go ahead. Your line is open.
Thank you. I can continue if you don't have any other ones asking questions then. A little bit on the other two segments besides messaging. On operator side, you are up at a higher gross margin now for two quarters. Is this sort of the level just above 90% we should expect? Q2 wasn't the strongest of quarters, but you had a higher gross margin. Could you put some time on the gross margin for operator division going forward, please?
Give us one moment there, Fredrik.
Thank you.
Yeah. I think, Fredrik, just a very quick response on that one. The operator segment is, of course, depending on to mobile operators to enable them to provide value-added services to their end customers, as well as for policy and charging reasons.
I think the gross margin can vary depending on exactly which customers, which part of the world, and which products that we are selling from quarter to quarter. In general, we see a very good, strong gross margin within this area at around 90%. I think we have a strong sales pipeline both within our traditional products, but also now when we offer RCS as a service, we have a strong interest in that product as well.
Sorry. Is it so that SaaS is not a very big share of revenues right now, but when it grows, it will also help the gross margin, I guess, because every time you get the monthly revenue in a SaaS model, you don't really have any costs associated to that. Will that help gross margin when that becomes more relevant?
If we're staying, are you referring to the operator division?
Yes, exactly. Sorry.
Yeah. I think you're correct in the sense that there's a gradual shift in business model in parts of that business, but we shouldn't exaggerate the pace there. RCS as a service has that logic, in the way that commercial offer is phrased, exactly as you described. It's at a very early stage. We launched this product offer in spring, so it will take some time before that has a material impact.
Okay. Thank you.
Thank you. Your next question comes from the line of Daniel Djurberg from Handelsbanken. Please go ahead. Your line is open.
Thank you very much. Daniel Djurberg, Handelsbanken. Sorry for coming late into this call, there was another call I had to take. The question might already been asked, but I was thinking a little bit about voice and video. You talk about the growth you have had there in number masking and verification.
Is that pure connected to a handful of customers, or is it like one or two? Should we expect this growth to continue out of more of a positive trend from a number of customer, or will it start to decelerate the course so that we have comparing apples with apples year-over-year?
Oscar, we'll leave that to you.
Yeah, I didn't really understand the last comment. The first is the difference, that we're comparing apples to apples. I don't understand.
No. The growth prospects you see in voice and video from the number masking verification, we have seen really strong.
Yeah. We are seeing strong growth prospects in number masking and verification. As we alluded to, we're also seeing when you sign up a handful, it's not one, it's a handful of big customers that when you do this type of turn, you focus on a handful of big customers in order to get focused. We also say that we need to focus a lot on these customers in this period in order to serve them with new product and market requests and in order to serve their growth. It's a handful or a set of customers.
It's a very good customer base, and we see good growth prospects, but we also see that we need to focus on these customers to nail them home in 100% in the type of growth scenarios, before we can fully unleash the full sales power in order to hunt a very large number of new customers. We are signing new customers, and we are focused on new customers, but it's a little bit less focused right now due to wanting to serve the existing customers in a very good way.
Okay, thanks. Jumping over to operators, just a question on two things really. The first thing is you mentioned the improved conversion of orders to sales. Can you say something about pipeline in operator segment year-over-year, et cetera? Also, the RCS as a service, your model there really in terms of revenue model, how is it working?
Thank you. Oscar, if you want to answer those.
Pipeline, yes, we see a good and strong pipeline in operators, on a historic high level. It's as you know, in those type of businesses, it's then all about the conversion into orders.
Yeah.
Yes, we see a strong pipeline. Now we need to turn it into orders for H2. That's what we see. We also see that we're able to address larger operators, when combining the brands, and from Sinch, it becomes a more credible partner for larger operators. We see that possibility of doing so. Larger operators obviously come with a higher cost to serve and obviously higher revenue as well. We see that shift is clear.
Interesting.
With regards to RCS as a service, what's your question about the pipeline or at the revenue model?
More about the revenue model. Is it pure, do you get different kind of both upfront and then revenue share, or how is it working?
Yeah. It's all of the above. We try to set the revenue model as an upfront to cover the cost and as a monthly fee to cover the upfront to cover the upfront cost and a monthly fee to cover the monthly costs or the recurring costs, then have the upside based on the revenue share or SaaS fee, if you will. It's a Software as a Service offering, it's a tick-based fee-
Yeah
-where you have the majority of the upside. We try to set it up so that we can cover the cost, then have a significant upside if things go well.
Can you remind us if you have announced any official orders there, on any names or references as of yet?
On RCS as a service, we have not announced an official.
Okay. Good luck with that. Good luck in Q3.
Thank you.
Thank you.
Thank you. There are currently no further questions. Please continue.
If there are no further questions, I think we'll wrap up here. Thank you everyone on behalf of all of us here in the management team for listening in, and looking forward to speak again after our Q3 results. Thank you very much, and goodbye for now.