Sinch AB (publ)

STO:SINCH

Earnings Call Transcript 2018-Q2

[Operator]

Please go ahead.

[Thomas Heath]

Ladies and gentlemen, warmly welcome to CLX Communications' Q2 2018 Conference Call. On the call today, we have Johan Hedberg, our President and CEO; Odd Bolin, our Chief Financial Officer; and myself, Thomas Heath, Head of Strategy and Investor Relations. With that introduction, I'll hand over to Johan.

[Johan Hedberg, Co]

Thank you, Thomas. Good morning, and welcome to CLX Q2 Earnings Call. So just a quick overview of the CLX group before we dive into the quarter. CLX is the global leader in enterprise messaging. Through our service, businesses can reach 5 billion users instantly across the globe. We are investing in communication platform as a service, adding new services to our offering like voice and video, and CPaaS allows enterprises to easily embed communications into its applications. We have an impressive customer list across the globe, some of the largest enterprises in the world are our customers, and they have demanding needs that we fulfill, among others adding, for example, GDPR support to our service. We also have Operator Division, supplying software to mobile operators in the group. Today, using our services, enterprises send 25 billion messages per year. That is the scale we are at currently. Enterprises use our service for many different use cases: to improve processes, to reduce cost or for marketing to drive sales. We see new use cases added every week, and it's fascinating to see how enterprises use our cloud-based APIs to drive efficiencies or new sales. So jumping into the 2018 Q2 highlights. We grew organically revenues 18% in local currencies. Gross profit up 30%, both due to organic growth and successful M&A. Adjusted EBITDA, up 32%. See a strong performance in the Enterprise Division, slight improvement in the Operator Division versus last quarter on EBITDA. On Sinch, we continue to focus on the ride-hailing segment. Unwire acquisition has been very successful from a financial standpoint and developing better than expected. We're also seeing and very excited about the Vehicle acquisition, and start to see revenue synergies already now from that acquisition. So diving into the Enterprise Division. So continued growth in messaging traffic both from new and existing customers. Mblox and Dialogue traffic successfully migrated onto the new Nova platform, and that's a big milestone for the business. Had a strong pipeline, especially in the U.S., both with global tech companies but also throughout the value chain with application service providers and more traditional enterprises like banks. We see a flat or slightly higher OpEx ahead as resources from the Nova platform project are redirected to product development and new sales, and also to specific customer project implementations. So over the last couple of years, we've seen a dramatic uptick in transactions on our platform and also in revenues and gross profit. Out of the 10 biggest U.S. tech companies, we have signed 8. We now have live traffic from 5 of them, up from 4 in the last quarter. We're seeing in this quarter, very pleased to see growth in both traffic volumes and gross profit. Total traffic volume's up around 21% in this quarter, including Unwire. And then some comments on the Operator Division. The underlying business has developed as planned. We see a slight EBITDA improvement from first quarter. No significant capacity expansion contributed to the result in this quarter. We have a good strong sales pipeline, but at the moment it's a slower conversion to projects and revenues. We're seeing slight improvements -- we expect slight improvements for second half of 2018, and work ongoing to reach our target of 15% EBITDA margin, as earlier communicated. And some comments on Sinch and Vehicle. Sinch is continuing to invest in broadening their product portfolio and offering to the marketplace. We are performing some customer adaptations to large ride-hailing customers in the marketplace. We're seeing a strong interest in the Vehicle offering, especially with mobile operators on a global basis; but also from enterprises, where we target in North America. And we expect to see a breakthrough in revenues in H2 from the ride-hailing segment, where we currently are seeing an increased activity level.Good. And with that, I will hand over to Odd for a deep dive into the financials.

[Odd Bolin, Chief Financial Officer]

Thank you. Good morning, everyone. I'll start by mentioning a little bit more about Vehicle. We had an initial purchase price of $8 million that we paid in April. We -- another $4 million as an earnout now in July due to the positive performance the company has showed during this period. And we have also another upcoming potential earnout of another -- of a total of $18 million over the next years if growth targets are met. We have seen a very positive development recently that has made us more positive about the potential for the company actually meeting this growth -- these very aggressive growth targets, and we hope to see that they will be met in such a way that they will be forced to actually pay out it [indiscernible].All right. Let's a bit -- talk a little about -- a little bit about the quarter as such. As Johan has mentioned, the gross profit increased considerably and that was due to both acquisitions and organic growth. Organically, we've seen slightly better prices in some markets. We have seen good profitability in some large U.S.-based companies' traffic, and that has contributed to the considerable organic growth. That was -- it was a record quarter for us. Adjusted EBITDA of SEK 97 million was higher than we've ever seen before. So we're quite happy with that. EBITDA was SEK 80 million, with an EBIT of SEK 40 million. The difference between the EBIT and EBITDA is almost entirely due to the fact that we are doing depreciation of customer and supply relationships from former acquisitions. And this obviously, not cash flow -- impacting cash flow. Net profit for the quarter was SEK 29 million, with a tax rate of a little more than 30%. That is due to the fact that we had some nondeductible costs for acquisitions and also the fact that we have some tax loss gross carryforwards in the U.K. that we are not utilizing at the moment. It's [indiscernible], they are not very large. And we are in the process of confirming whether we can use them or not. So -- temporarily, it gives us slightly higher taxes. The Operator Division is improving, although the conversion of pipeline revenue is still impacting, the slower conversion that we've seen during the winter and early spring, it's still impacting the figures. Sinch and Vehicle are developing as planned. Vehicle is, as I mentioned, developing very well. We're very happy and so excited with our [ package too ]. And we will reallocate some of the resources from the Nova project in order to drive future growth. Looking at the diagram on Page 12, the gross profit quarter-over-quarter. We can see that acquisitions has increased our gross profit by 13%, while organic growth has contributed 11%. We have very strong momentum in Unwire, where we've seen a considerable gross profit contribution. And then once again, some large U.S. clients are driving organic growth. And so far, they are -- we've seen good gross margin development on those clients for the quarter. Looking at the EBITDA bridge, the organic growth is 28%. Most of that, obviously, coming from the Enterprise Division, with a little bit of [ profit ] from Operator; while Sinch is -- close to 0, but we do see improvement going forward. Looking at it on a year-over-year basis. Acquisitions have contributed the lion's share of the growth, 18%; while the organic part is 12%. And on the EBITDA level, organic growth has been 6%, due to the increase in OpEx that is an effect of the [indiscernible] of Nova project. Just a few words about key metrics that we're using. In the Enterprise Division, gross profit is the most important metric for us. As we have explained several times, gross margin is very much dependent on the traffic mix that we see, which is out of our control. So gross profit -- actually, gross profit is our key metric. Adjusted EBITDA to gross profit measures operational efficiency, and we see a continuing good trend there. OpEx per transaction is also important. We need and we want to be a low -- have lower cost per transaction than our competitors. So an efficient process -- efficient processes and systems and a large scale. Operator Division, we measure revenue and EBITDA. And in the new investments, such as Sinch and Vehicle, we measure gross profit growth. Now looking at those figures a little bit more. Operational efficiency, we do see a continuing good trend in EBITDA to gross profit and also OpEx to transaction. We do believe that even though we will use some of the resources that has been used for the Nova project for further development, OpEx per transaction will continue to show a falling trend. So with that, I give the word back to Johan.

[Johan Hedberg, Co]

Thank you. Thank you, Odd. So Q2 was a strong and successful quarter for CLX and we see good potential for future growth, mainly driven by a strong pipeline with some of the largest digital-native companies, tech companies in the world. So today, we have 5 out of 8 live. We target to have 2 additional live in 2018. But we also have a very strong pipeline overall in North America, not only from big tech. Sinch, for the ride-hailing segment, we expect to see larger revenues from this in H2 and 2018. We're seeing good interest and increasing interest from the personalized messaging video experience that Vehicle provide. And we are using now our mobile operator relationships and also cross-selling that to our Enterprise customer base, and having good conversations in that area and around that service. We also see RCS, especially in North America, probably not revenues that we will see in 2018 or that those would be small; but for 2019, this is a growth area, we believe, for us. We're also coming out of the Nova platform project. So now we have most of our customers on one platform. It's been a long and -- project for us. That is now finalized. And now having all customers -- almost all customers on one platform means that we'll get more efficient. So I'm confident that this will result in a positive development on gross profit, both through higher sales but also through some reductions in COGS as we optimize our network. Good. Some more words on the personalized messaging video experience from Vehicle. And this is a service that is rendered in real time, where you take customer information from an enterprise and create a personalized experience for the customer. We also see this as a stepping stone, through a richer media experience, as a stepping stone to RCS. The first use case in the marketplace that have adopted this is onboarding of new customers as a welcome message, but also to educate them about the service and invoicing processes. And as I said earlier, the focus are on mobile operators globally and enterprises in North America. Finalizing this call with some words on RCS. It's a very powerful, I would say, extension to SMS both through rich media and the functionality that you can use it. It will be much more of a conversational experience. Can, to some extent, replace applications, apps on smartphones. We expect rollout, to have all mobile operators onboard in late 2018 in the U.S.; and then gradually roll out over the next 2 to 3 years across the globe. There are still some hurdles to overcome. We're expecting Apple to make an announcement on RCS, hopefully, in 2018. But this could be a major revenue contributor for CLX over the coming next years. All right. So with that, we'll finalize the presentation. And I hand over to Thomas to -- for Q&A.

[Thomas Heath]

Thank you very much, Johan, and thank you, Odd. I'll hand over to the operator, and we're glad to take any questions you might have.

[Operator]

[Operator Instructions] We'll now take our first question from Staffan Aberg of Carnegie.

[Staffan Aberg, Financial Analyst]

You talked about the new major U.S.-based tech company that's gone to use your platform, which you say contributes to the strong organic growth in the quarter. Now in more general terms, for these types of large international tech companies, how long does it usually take before they are fully ramped up? Is it a matter of 1 or 2 quarters? Or could this potentially contribute to growth for a longer period for one single client?

[Johan Hedberg, Co]

So I think it varies a little bit depending on who it is, but we see continuous ramp-up over several quarters. So it's not only 1 to 2 quarters, in general. So I think it's about establishing trust and grow that trust over a period of time. So we -- from some of these tech companies, we expect growth throughout, I would say, several years and not only over 1 or 2 quarters.

[Odd Bolin, Chief Financial Officer]

I think, Staffan, what we can add to that is that quite often, there are several different use cases within one organization, and some of these organizations can be quite large and, to some extent, decentralized. When we come in and we establish ourselves as a strong vendor and a trusted partner, it's not unusual that new use cases are added over time, which might increase the scope from what we initially targeted.

[Staffan Aberg, Financial Analyst]

That's very helpful. On the Operator Division, now you guide for 15% operating margin next year. But over the past 3 quarters, you have averaged a margin of roughly 5%. What would you say are the main reasons for this? And what will need to happen in order for you to reach your guidance? For example, is the guidance is fully dependent on you getting larger expansion projects again, or are you working on the cost side of things?

[Johan Hedberg, Co]

So I think the main reason it is we have had a slower conversion from sales to orders. And we're building that pipeline up, and at some point in time the conversion will increase. I think that's the main reason. And then we had -- your follow-up question on that?

[Odd Bolin, Chief Financial Officer]

I think, Staffan, you asked...

[Johan Hedberg, Co]

Expansion projects. Yes, that's what -- yes. So I mean, when we guide around the 15% margin target, that is with a normal rate of capacity expansion projects. We always have a certain rate of capacity expansion projects in the business. Last year, we had a much higher degree on the capacity expansion projects. But guiding for the 15%, we expect a normal degree of capacity expansion projects.

[Odd Bolin, Chief Financial Officer]

I think it's fair to say that this is a bit volatile and the sort of margin target that we have is meant to be a view of what we think this business can sustain sort of on a stable long-term basis. If -- it is likely to continue to be a little bit choppy between the quarters, also, in coming years.

[Staffan Aberg, Financial Analyst]

Okay. And the final question for now, looking at the 1.4 percentage point gross margin expansion in Enterprise Division, how much of that would you say is driven by the Unwire acquisition?

[Odd Bolin, Chief Financial Officer]

I think you can actually -- you can probably figure that out a little bit from the slide, so we can take it offline if you want to ground the numbers a little bit on how that plays out. So let's do that offline.

[Operator]

We'll now take our next question from Daniel Djurberg of Handelsbanken.

[Daniel Djurberg, Research Analyst]

Starting perhaps with technology and RCS. You believe that all these operators will be onboard here in '18 and you expect some -- of that to be coming up. And can you just remind me of the revenue model that, I guess, now is finalized and how it will look like versus your current revenue model on the SMS side? And also how you expect to -- what you have seen so far in terms of fall-back, because you worked with Google as a fall-back supplier; for -- for example, iPhones. Just for now -- you want to just -- can you just comment more on that, that would be great.

[Johan Hedberg, Co]

Yes. So I think -- I mean, the revenue model, to some extent, is still unclear. We're seeing first, mobile operators now launching tariffs for RCS, but I think there is still a landscape that is moving. We're seeing transaction-based, very much similar to how you use SMS today, being priced a bit higher than SMS. And then we're seeing more conversational or more rich media content priced at a higher tariff. I think, currently, we are still awaiting pricing models for conversational RCS where you use it in, for example, a customer support use case. And that is still -- the marketplace is still looking to see what kind of use cases that will be and how to price that together with the mobile operators and the enterprises. But the sort of the transactional -- how you use SMS today and the rich media use case have been priced by 1 or 2 mobile operators to date.

[Daniel Djurberg, Research Analyst]

Perfect. And that's good. I guess the fall-back revenues is not as big -- visible today and -- but I guess it could be interesting in '19 and '20, or do you see it...

[Johan Hedberg, Co]

Yes, I think we should not expect any larger revenues that would be visible in our numbers in 2018. That is for 2019 and 2020. And we expect the same business model as for SMS today. So that we would connect and we would pay the mobile operators to provide the service.

[Daniel Djurberg, Research Analyst]

Perfect. And then if I can -- sorry.

[Odd Bolin, Chief Financial Officer]

Well, what we can add is that in a simple use case, where you use RCS similarly as you'd use SMS today, so if you just send a text message, then the choice of technology to the end-user isn't that interesting, right? So you could see some migration from SMS to RCS on these sort of traditional use cases, that will just be a function of price, probably, it would fall back to regular SMS when necessary. Where it becomes more incremental is when you add the richer functionality, action buttons, carousels and rich media and so forth, which will come over time.

[Daniel Djurberg, Research Analyst]

Yes. Another question, if I may, on the Nova platform and if you can comment a bit on your view on how that has strengthened your competitiveness versus your peers. And also, if I may ask about how you aim to refocus -- you talk about changing your focus from internal integration to tech development and marketing. If you could comment more on that, how large -- how many people are you talking about more or less and what do you expect there?

[Johan Hedberg, Co]

Yes. So I think it's -- and when we talk about this, and I can give you a couple of example. Our customer account managers and salespeople have been focused on migrating customers for the last couple of quarters, handholding customers to migrate from our old platform to the Nova platform. Now they can start spending much more time on growing the customer base, talking about new services, talking about more use cases rather than migration. We also see in our customer support and other parts of the organization that's been occupied by the migration of customers to the Nova platform, just free up more time and resources for forward-looking activities. It's, of course, difficult to quantify that and how much that will mean. But we're also optimizing -- one major effect that I want to talk a little bit about is optimizing the network, of view to the -- our operations and support departments have been very busy with the customer migrations, we have a sort of a catch-up effect now that those resources can be applied for more normal business, to integrate more mobile operators onto our network and reduce COGS. But again, it's difficult to quantify what that means more specifically to our numbers.

[Operator]

There are no further questions over the audio at this time. [Operator Instructions] We now have a follow-up question from Staffan Aberg of Carnegie.

[Staffan Aberg, Financial Analyst]

Yes, just to more or less sum it up, but your financial target of delivering an adjusted EBITDA per share growth of 20%. At this point in time, how confident are you to deliver on that target this year?

[Odd Bolin, Chief Financial Officer]

Thank you. It depends a little bit on how you measure. We typically say this is an annual target. You'd normally measure this on a rolling 12-month basis. And obviously, then it takes some time to catch up. I think if you make that calculation, Q2 this year over Q2 last year, it looks a bit more cheerful. But other than that, I think we leave it to you to figure out where those numbers will end up a year from now.

[Operator]

We will now take a follow-up question from Daniel Djurberg of Handelsbanken.

[Daniel Djurberg, Research Analyst]

Yes, one more from me as well. I just saw that you commented a little bit on the U.K. pricing trends being more stable. Can we expect this to continue? If you could comment a little bit more of the trends in pricing and perhaps on the mix effect you've seen in Enterprise in the quarter, et cetera. If you also had a positive effect from geography.

[Johan Hedberg, Co]

Sorry, just -- can you please repeat the question?

[Daniel Djurberg, Research Analyst]

Yes. I think you wrote somewhere about the positive trend in the pricing in U.K, if I'm not misread that. And if you also could comment a bit on the overall impact of the geography mix in the quarter with regard to gross margin and Enterprise?

[Odd Bolin, Chief Financial Officer]

Well, as you know, we made it very clear that gross margin is highly dependent on the terminating markets. And prices are different between different terminating markets. Gross margins are different, but we also see, obviously, shorter-term price changes in different markets. And as you've pointed out, we've seen slightly better conditions in the U.K. market in the quarter. It's nothing dramatic, but it has contributed to the increase in gross margin. And we've also seen traffic from a number of major U.S. clients with good profitability. That is obviously both an effect of pricing and the terminating markets. But we don't really want to go into more detail than that, if you don't mind.

[Operator]

[Operator Instructions] There are no further questions over the audio at this time.

[Thomas Heath]

Thank you. If there are no further question, we'll just take the opportunity to thank those who called in. Feel free to reach out and get in touch if you want to discuss our company, our figures and our future prospects. We're ready to help. So thanks for today, and have a good summer.

[Operator]

This concludes today's call. Thank you for your participation. You may now disconnect.