Sinch AB (publ)

STO:SINCH

Earnings Call Analysis

Sinch's Q2 2024: Solid Cash Flow, Debt Reduction, and Growth Plan Execution

Sinch continues to excel in its financial performance in Q2 2024. The company generated a record SEK 1 billion in operating cash flow for the quarter, enhancing its financial stability by reducing net debt to 1.7x EBITDA from 2.4x a year earlier. Despite organic revenue declining slightly, gross profit grew by 2%. The growth acceleration plan is on track with SEK 58 million in quarterly cost savings, progressing towards the SEK 300 million annual target. Market conditions remain challenging, yet Sinch is optimistic about future growth driven by product and sales integration efforts and significant development in RCS technology.

Strong Communication Infrastructure

Sinch AB is a global leader in customer communication services, handling over 800 billion unique interactions annually for more than 150,000 business customers. In the last 12 months, the company generated SEK 28.6 billion in net sales and SEK 9.7 billion in gross profit, along with SEK 3.6 billion in adjusted EBITDA. This robust foundation sets Sinch in a strong position within the rapidly evolving communication landscape.

Record Cash Generation

In Q2, Sinch reported record cash flow with more than SEK 1 billion generated from operating activities, bringing the total cash flow for the last twelve months to SEK 3.2 billion. This translates to a cash conversion rate of 72%, exceeding the company’s target of 40% to 50%. Sinch's strong cash flow enables continued debt repayment, with SEK 881 million paid off this quarter and a total of SEK 3.1 billion in the past year. The net debt-to-adjusted EBITDA ratio has also improved significantly from 2.4x to 1.7x over the past year.

Operating Performance and Margin Stability

The company's EBITDA margin remains stable at 11%, although a slight organic revenue decline of 1% was observed this quarter. Gross profit grew 2% organically, aided by a shift towards higher-margin products. Despite inflationary pressures affecting their cost structure, Sinch has managed to protect its overall profitability during this transition towards improved efficiencies and higher commercial velocity.

Growth Acceleration Plan

Sinch is implementing a growth acceleration plan aimed at boosting its long-term growth potential. The plan focuses on market strategy transformation, product integration, and operational excellence. This quarter, the company realized gross savings of SEK 58 million aligning with a target run rate of SEK 300 million in expense reductions by the end of the year. However, these changes have led to some redundancies as staff efficiency is prioritized.

Regional Performance Variability

The Americas region stabilized with flat year-on-year growth, while APAC saw significant growth at 19%, driven by a robust demand for API platforms and applications. However, EMEA faced an 8% decline attributed to prior exits from fixed-price contracts. The ongoing impacts of 8YY reforms in the U.S. have also influenced network connectivity revenues, resulting in a 12% decline over the year, though negotiations are progressing positively to stabilize future profit.

Market Dynamics and Customer Spending

Currently, customer spending is slower than desired, with market indicators suggesting low single-digit growth rates in the near term, driven by reduced investments in customer experience and digital communication by clients. Sinch does not anticipate a significant change in this trend in the immediate future but sees potential for improvement as market conditions evolve.

Future Outlook and Strategic Initiatives

Looking forward, Sinch is optimistic about the integration of Rich Communication Services (RCS) and the company's growing leadership in the Communication Platform as a Service (CPaaS) arena, bolstered by favorable market trends. By effectively leveraging its existing customer base of over 150,000 clients, Sinch envisions improved cross-selling capabilities as part of its transformation efforts. The upcoming Capital Markets Day scheduled for November 20 will further outline strategic focuses and growth trajectories.

Earnings Call Transcript 2024-Q2

[Operator]

Welcome to the Sinch Q2 Report for 2024. [Operator Instructions] Now I will hand the conference over to the speakers. Please go ahead.

[Thomas Heath, executive]

Thank you, operator, and welcome, everyone, to this Q2 earnings call with Sinch AB. My name is Thomas Heath, I'm Chief Strategy Officer. And with me today, I have our CEO, Laurinda Pang, and our CFO, Roshan Saldanha. And with these opening remarks, I want to hand the word over to Laurinda.

[Laurinda Pang, executive]

Thank you, Thomas. Let's turn briefly to Slide 2, please. Sinch is pioneering the way the world communicates. Our Customer Communications Cloud enables businesses throughout the world to reach and interact with their customers through all channels, including messaging, voice, calling and e-mail. We're built for scale and handle more than 800 billion unique customer interactions per year for more than 150,000 business customers. .

We are a global leader in our industry. And over the last 12 months, we generated SEK 28.6 billion in net sales, SEK 9.7 billion in gross profit and SEK 3.6 billion in adjusted EBITDA.

Slide 3, please. We'll cover some of the financial highlights in the second quarter. Cash generation reached an all-time high level as we generated more than SEK 1 billion of operating cash flow in Q2 alone. This high level of cash flow is healthy even if we deduct around SEK 240 million of payments that were received from some of our larger customers earlier than due.

Looking at the last 12 months, the business has generated SEK 3.2 billion in operating cash flow. Cash conversion from adjusted EBITDA, which, again, we measure on a rolling 12-month basis is now at 72%. We're very proud of this performance, which well exceeds the 40% to 50% target range. Our strong cash generation also benefits our balance sheet and reduces our leverage.

We repaid SEK 881 million of debt in Q2 and a full SEK 3.1 billion over the last 12 months. Our net debt to adjusted EBITDA ratio is now 1.7x and compared to 2.4x 1 year ago.

Turning to our operational performance, I would characterize our overall performance is stable. Our gross margin continues to increase as our higher-margin products grew faster and improved the overall mix. Our EBITDA margin is stable at 11% despite inflationary headwinds, which affect our cost base. We recorded a slight organic revenue decline in the quarter with gross profit growing 2% on an organic basis. This low single-digit level is lower than we aspire to deliver on a longer-term basis, but it is the rate of growth we expect to see until our growth acceleration plan delivers results where customers, again, start to increase their investments in customer experience and digital communications.

Our growth acceleration plan includes several initiatives across go-to-market transformation, product integration and operational excellence. It is a transformation program for increased focus, higher commercial velocity and improved efficiencies. Since the costs associated with driving this change are incurred earlier than the anticipated benefits, the timing of which is aligned with our plans, we are now offsetting with efficiencies that allow us to protect our overall profitability whilst executing on our transformation agenda. Unfortunately, these measures have meant that a number of colleagues were made redundant during the quarter.

We have been able to execute faster than originally envisaged and realized gross savings of SEK 58 million in Q2. This corresponds to SEK 232 million on a full year basis, and we are confident that we will reach the target SEK 300 million run rate in the second half of the year. Executing on these cost reductions allows us to reallocate our spend towards growth initiatives and to offset inflationary pressures so that our overall profitability remains healthy.

We have netted a 5% reduction in full-time equivalent head count over the last 12 months. Behind these numbers are further movements as we are reducing even more headcount, but adding resources back in areas where we see greater growth opportunities.

Let's pause briefly on Slide 4 for an overview of our business mix. We changed from a business unit structure to a more integrated organization on the first of January 2024. As required under IFRS, we updated our reporting to reflect this change in governance starting from the first quarter this year. The 3 regions, Americas, EMEA and APAC now form our operating segments, with Americas contributing more than 60% of total gross profit. We also introduced new product categories and now refer to our API platforms, applications and network connectivity.

To add visibility into our cost base, we also now disclose adjusted OpEx by function where R&D is the largest category.

Let's now move on to Slide 5 to look at performance by segment. In the Americas, we are reporting stable gross profit on a year-over-year basis in constant currencies. Lower campaign activities compared to the comparison period in 2023 caused growth in applications to slow. The year-on-year growth rate slowed also for the API platform, but we have reduced the rate of decline in network connectivity.

During the quarter, we were again recognized as a global leader in Gartner's updated Magic Quadrant for CPaaS. EMEA recorded a 4% decline in gross profit on an organic basis compared to Q2 2023. This is an unsatisfactory growth rate, but an improvement compared to Q1. That's due mainly to the API platform. Our commercial focus in EMEA is now focused on RCS and the cross-selling of messaging and e-mail. I also want to highlight the strong development of our network connectivity offering in EMEA.

The product mix here is focused on software for mobile operators rather than voice interconnection services, and I'm very pleased with our performance here.

Turning to Asia Pac. lastly, which recorded a very strong quarter. Net sales were up 7% organically and gross profit growth was at 19%. We continue to see healthy growth in India and successfully leveraged partnerships to win new customers across the APAC region. You will recall, we have referenced our integration with the Adobe ecosystem in the past and our collaboration with TPG, the Australian telecom operator is also developing well.

Slide 6 looks at the financial development by product category, whereas we see our API platform and applications offerings as our future-oriented growth drivers, the network connectivity products are managed more for profitability. Organic growth in gross profit was 5% year-over-year for both our API platform and applications this quarter.

This is a lower growth rate than in Q1 and for applications and it is -- has to do with some larger marketing campaigns by specific customers, which contributed to last year's Q2, but did not make a corresponding contribution in 2024. For the API platform, we continue to see a slow market for SMS, which is a large contributor to gross profit in that category.

Offsetting some of these pressures is a positive development in network connectivity, where the rate of decline has been significantly reduced for our Americas-based voice interconnection products and the EMEA-based software business is performing really well. Roshan will add some further details to this development in a minute when he reviews the financials.

Next slide, please. We recently published primary research where we interviewed hundreds of consumers and businesses in the U.S. to hear their view of what it takes to build meaningful and long-lasting customer relationships. You're familiar with the adage, you never get a second chance to make a first impression. First impressions last and more than 3 in 4 consumers say 1 bad experience can end their relationship with the brand.

Effective communications is a key component of a positive customer experience. For more than 54% of the consumers we surveyed, convenience is what makes the biggest impact. 20% of the consumers want to work with a company who is easy to work with. 11% say the company should provide more useful information, 13% expect a quick start for delivering. Trust also appears to be a key factor in making a positive first impression with 30% of our respondents citing reputation is the main focus.

A brand's reputation and their ability to build trust is a constant quest, which brings us to Slide 8 for an update on RCS and the new features that Apple are adding to their next version of iOS. Shown on this slide is a screenshot from the public beta version of iOS 18, which Apple released a few weeks back. It will be made generally available this autumn and add a range of new features to existing and new iPhones.

As you can see, Apple is adding support for RCS messaging and importantly, for RCS business messaging. Since this is a carrier service, it will be made available for users when supported and switched on by each mobile operator. Already now this service is enabled for iOS data users by Verizon, AT&T and T-Mobile in the U.S. and by a range of mobile operators across Europe.

As we've mentioned before, Google made RCS enabled by default on the new Android phones back in August 2023. This means that the share of RCS capable mobile handsets is now rising steadily, which is a development that will accelerate further when iOS 18 is made generally available. RCS will greatly improve the messaging experience when iPhone and Android users are texting each other. For businesses, there are even more benefits, which are showcased again here on Slide 9.

The ability to send messages from a branded and verified center is a clear improvement compared to SMS. Businesses can send images and video in high resolution and benefit from improved analytics as RCS messaging supports [indiscernible] receipts. A brand can also include clear calls to action with prepopulated action buttons to trigger phone calls, open websites or maps app on the phones.

Add to this, the rapid development of generative AI, which enables brands to engage in personalized one-to-one interactions with every unique customer. We have invested in technology for conversational messaging over several years, and we're excited about these prospects. However, it's important to recognize that RCS adds tangible value also to a more straightforward use case like text notifications.

On Slide 10, we share one such customer story. Easy Park Group is a global leader in digital parking, serving millions of users in over 20 countries. Before partnering with Finch, Easy Park faced significant challenges in delivering SMS parking reminders and onetime pass codes across diverse markets. Managing multiple vendors led to inconsistent delivery rates and a lot of times spent troubleshooting, which negatively impacted the user experience.

To streamline operations and enhance service quality, Easy Park consolidated their messaging infrastructure with Sinch. This move allowed them to maintain high delivery rates and simplify their processes, which greatly improved efficiency. RCS has offered opportunities to build on this partnership. Sending messages as RCS instead of MAS allows Easy Park to enhance security with verified centers, boosting user trust and engagement even further.

Today, 40% of Easy Park's messaging is in Germany are sent via RCS, achieving an impressive delivery rate of 97.4%. This success has encouraged Easy Park to plan the expansion of RCS to more markets. They're also exploring other opportunities with RCS, such as enabling users to chat with support or extend their parking time without opening the app. This case shows how Sinch's messaging solutions and in particular, RCS can transform user experience and operational efficiency.

Our reliability and scalable technology not only meets but exceeds the evolving meanings of our clients. It's partnerships like these that drive our success and solidify our leadership in the CPaaS market. With these remarks, I want to hand the word over to Roshan.

[Roshan Saldanha, executive]

Thank you, Laurinda, and a very good afternoon to all on the call. Let me start reviewing our financial development for the quarter by moving to Page 12. Net sales for the second quarter were marginally up year-on-year and with a slight currency tailwind. This meant that organic net sales growth was a decline of 1%. Out of the regions, Americas came in flat year-on-year, APAC grew 7% and EMEA was down 8%. Reduced revenues from the 8YY total free reform affected the network connectivity product category in the Americas region by SEK 42 million.

Within network connectivity, sales to operators of voice products have seen continued decline in volume as observed during the first quarter.

Turning to Page 13, please. Gross profit increased 3% on a reported basis to SEK 2.4 billion. Organic growth in gross profit was at 2%. Growth in the Americas region came in unchanged versus Q2 last year. EMEA was down 4%, whereas APAC grew at a strong 19%. If we start with a strong GP growth in APAC, it is driven by net sales organic growth of 7% and a weaker-than-usual comparison quarter.

In EMEA, as we said in Q1, messaging development is hampered by us exiting certain fixed price contracts that we had last year. This is something we expect will diminish towards the end of the year. In Americas, API platform and applications continue to contribute positively to growth, while network connectivity had a negative impact on growth. This decline is driven by reduced voice traffic and Y-o-Y impact of SEK 38 million on gross profit and increased network costs, as we said last quarter.

The effect of increased network cost remains in this quarter, but is slightly lower. Let's do a deep dive. Next Page 14, please. One of our main product categories in network connectivity is network connectivity, which accounts for 21% of gross profit globally. Specifically, network connectivity in Americas accounted for 18% of gross profit for the group and consisted largely of products within the U.S. voice business targeting telecom operators.

In Q1, we informed you that the reason for the 18% decline in year-on-year gross profit that you see in this graph was related to the 8YY wide reform impact, increased network cost for voice connectivity services in the U.S. as well as reduced demand from operators.

We have stemmed this decline in the quarter to minus 12% due to good progress in our negotiations with those operators. Above all, we have reduced the risk for large increases of costs going forward. We are also reducing reliance on legacy connectivity through service virtualization and will use pricing as a tool to manage profitability, which is the key focus for this product area.

We still have the year-on-year effect of the 8YY reform on network connectivity in the Americas, causing a decline of SEK 38 million in the quarter compared to prior year. The reductions contemplated by the reform were completed as of first August 2023, but caused year-on-year headwinds until 12 months later.

All in all, we expect gross profit from network connectivity in the Americas for the second half of 2024 to be roughly the same as for the first half year. This means we will expect a year-on-year gross profit decline also in Q3 and Q4.

Turning to Page 15. This slide shows gross and EBITDA margin development for the business. Gross margin increased by 80 basis points over last year and remained stable compared to previous quarter. This change is driven by a favorable shift in revenue mix as the applications product category, which has higher gross margins, see strong enterprise demand in all regions.

EBITDA margin is up 1% year-on-year, driven by currency movements and lower cost for share-based incented programs. Compared to previous quarter, EBITDA margin is [indiscernible]. Operating expenses, excluding adjustment items are flat over the previous quarter as sustained investment into our transformation programs continues through the quarter.

These investments, together with inflation, offset realized savings during the period. Personnel costs continue to be our largest cost accounting for over 70% of our operating expenses. Historically, the impact from annual merit increases has been spread out during the calendar year, but with a concentration in the second quarter. In the new operating model, we have now aligned the [indiscernible] cycles with a consequence that the increase will be in the third quarter of 2024.

Adjusted EBITDA for the quarter came in at SEK 867 million, which is coincidentally almost exactly the amount from a year ago.

Let's move on to Page 16. I where we show the continued strong free cash flow generation after investments. In the quarter, we generated SEK 903 million and SEK 2.6 billion on a rolling 12-month basis. Our cash conversion is helped by unlocking working capital to the tune of SEK 851 million during the rolling 12-month period ending at Q2.

Cash flow for the quarter was also helped by payments of SEK 240 million that were received from a few large customers earlier than [indiscernible]. In the graph to the right, we show cash conversion from adjusted EBITDA on a rolling 12 months basis, which in the quarter was at 72%. While we still believe that our target range is 40% to 50%, we are delivering above that range due to optimization of working capital.

Our business continues to operate in a very asset-light fashion with total working capital at negative SEK 470 million at quarter end. We paid SEK 130 million in interest during the quarter, equating to an effective interest rate close to 6.5%, including fees. Interest paid during the quarter was flat compared to the first quarter due to the successful continuous deleveraging despite increasing effective interest rates.

Please move on to Page 17. Here, we see the financial leverage ratio for Sinch, which is net debt over adjusted EBITDA. We are glad to report a continued deleveraging as expected with leverage now down at 1.7 turns compared to 2.4 turns a year ago and 2 turns at the end of the first quarter.

The KPI is measured excluding the impact of IFRS 16-related lease debt on both net debt and adjusted EBITDA. Deleveraging continues to remain a focus area for Sinch and we expect this ratio to continue to decline through underlying cash flow generation from operations and increase in adjusted EBITDA.

During the quarter, we used the cash generated from the business to repay SEK 881 million of debt bringing the total repayment over the last 12 months to SEK 3.1 billion. It's especially heartening to see that since the second quarter of 2022, we have now paid down debt by close to SEK 4 billion.

Please turn to Page 18, where we give details on our debt portfolio. We had cash and cash equivalents of SEK 734 million at quarter end, in addition to the unutilized [indiscernible] facilities of SEK 5 billion. As you see on this page, our available cash and committed credit facilities more than exceed maturities during '24 and '25 of SEK 3.5 billion even before considering any further cash flow generation from the business.

On Page 19, we are reiterating our financial targets. Adjusted EBITDA per share measured on a rolling 12-month basis grew 1% at the end of the quarter compared to a target to grow 20% per year. Our change in operating model and growth plan is intended to help to accelerate growth and thereby achieve margin expansion. Laurinda will shortly provide an update on progress in this area.

Net debt over adjusted EBITDA at 1.7 turns excluding the effect of IFRS 16 related leases is well below our threshold of 3.5 turns, and we expect to continue to deleverage. With those words, I would like to hand back to Laurinda to take us through the Growth Acceleration Plan for Sinch.

[Laurinda Pang, executive]

Thanks, Roshan. Let's turn briefly to Slide 21, please. As you will recall, we started this year in a new organizational structure, and we have brought together our customer-facing teams into a new regional structure where sellers are tasked to sell our full product portfolio. We have created global functions for product and technology as well as for our support functions and have launched a growth acceleration plan to increase our growth rate.

Next slide, please. Slide 22 illustrates the phasing of investments and their returns as we execute this plan. We've revised this visualization slightly as we were able to realize initial savings ahead of plan. With the progress made in Q2, we are certain to reach the targeted $300 million gross savings run rate before the end of the year. We also expect our work around go-to-market transformation to yield results in the coming year. We are starting to see traction in cross-selling with new customer wins leveraging multiple products and positive pipeline development for cross-selling to the base. Key leading indicators that give us confidence that we are moving in the right direction.

Slide 23 documents [indiscernible] the more practical progress made during the quarter. Within the scope of our go-to-market transformation, we have built customer visibility dashboards and set up a joint account planning framework. Joint account planning is a key part in the integration of our sales teams, improving the visibility into how customers use our different products is a key enabler that allows our salespeople to drive and track cross-selling.

We've also made progress in our product integration where we have launched a single Sinch ID for our API platform products. This allows our thousands of customers to transition more seamlessly between products. without signing up again as a new user and is a step towards increased cross-sells in our product-led growth motions.

During the quarter, we have also deployed our message media products within the EU or in Germany more specifically, which will allow us to broaden the geographic reach of that offering. Within operational excellence, lastly, we have made good progress in the alignment of global customer operations. As we've touched on earlier, we have also made good progress in reducing our costs, which is work that will continue over the coming quarters.

Please turn to Slide 24, where we ask you to save the date for our upcoming Capital Markets Day on the 20th of November. We look forward to spending more time with you to discuss our market offering and strategy for continued value creation.

Before we take questions, I want to take this opportunity to offer some closing remarks. In the second quarter, we delivered record cash flow and solid profitability. Operating cash flow exceeded SEK 1 billion in the quarter and totaled SEK 3.2 billion over the last 12 months. We continued to pay down debt. And this quarter, we paid down SEK 881 million alone and our net debt is now at 1.7x EBITDA, down from 2.4x 1 year ago.

Growth rates remain lower than our longer-term aspirations and to address this, we continue to execute on our growth acceleration plan. An important part of that plan is to identify savings and efficiencies so that we can invest in growth initiatives without impacting profitability. This quarter, we realized a large part of our targeted SEK 300 million saving target with a gross savings of SEK 58 million corresponding to SEK 233 million on a full year basis.

Lastly, we saw Apple enable support for RCS messaging in the latest beta version of iOS, which makes us more optimistic about the long-term trajectory of our messaging businesses. We are the market leader in several key RCS markets already today. And during the quarter, Partner reaffirmed our status as a global leader in their Magic Quadrant for CPaaS.

With those closing remarks, we're happy to take your questions now.

[Operator]

[Operator Instructions] The next question comes from Akhil Dattani from JPMorgan.

[Unknown Analyst]

I've got 2, please. First, Laurinda, you mentioned in the press release that you're expecting growth over the coming quarters to stay in the low single-digit range in the near term. I just wondered if you could comment on any puts and takes as we look at Q3 and Q4, and in the release, you talk about the reason for this lower growth than we're expecting midterm to be a function of customers not yet reaccelerating investment. So I guess I wanted to understand what are you seeing there -- and how much is down to that versus maybe execution? So that's the first piece.

And then the second one is on the longer term. You've obviously given us a date for the Capital Markets Day, which is obviously very welcome. I'm sure you're not going to want to give away too much just yet. But maybe high level, if you could comment on, as you're now running into that event, what we might want to think about in terms of key focus areas.

[Laurinda Pang, executive]

Thank you, Akhil, for the questions. So with regards to the near-term growth in Q3 and Q4, I think to your point, there are definitely puts and takes. We certainly have some tailwinds with regards to 8YY reform starting to diminish the impact on a year-over-year basis. And having said that, we had some fairly strong comps in Q3 and Q4 of last year. So again, there are puts and takes.

My comment about customers returning to increasing their spend with regards to customer experience. That's just a normal market trend, in my opinion, right? The market is somewhat slow right now, and we don't expect that to dramatically change in the near term. So it's really -- it's not about things changing, and it's certainly not about our execution. In my comments in my prepared comments today, you heard me talk about the leading indicators or the early indicators.

Obviously, we can't translate that to big big growth numbers at this point because they are exactly that. They're leading indicators, but they're important for us to watch carefully. So as we bring these sales teams together, the expectation is a salesperson who is single threaded to a particular product now has the ability to sell multiple products. So watching cross-sell activity from a pipeline creation standpoint is incredibly important, and we are seeing those trends.

So as you think about the CMD, our longer-term focus is absolutely about execution against the entirety of the Growth Acceleration Plan, which is a combination of the go-to-market transformation, but importantly, product integration and continuing to improve from an operational expense standpoint, which has everything to do with a lot of the back office systems process and being able to deliver on the business in a more simplified and efficient way. But our focus absolutely will be on returning this business to growth.

[Operator]

The next question comes from Erik Lindholm-Rojestal from SEB.

[Unknown Analyst]

Wanted to start on APAC accelerated very nicely here in the quarter. This looks to be driven by sort of very high growth in the API platform. Is there any sort of key drivers here? And do you expect this to continue in the coming quarters as well? And then a second question, I mean, working capital had some temporary effects in it, very strong there, of course. But I mean how should we think about working capital for the full year here? Should it reverse fully or just partly from this level?

[Unknown Executive]

Thanks, Eric. I'll start with a portion of the APAC answer, and then I'll hand it over to Roshan. To your point, it was a very strong quarter for APAC with gross profit expanding by 19% on a year-over-year basis. So we're extremely pleased with that. We noted in the CEO word of the report that we saw continued strength from India very specifically. But we also saw continued or good strength from our message media businesses as well.

[Roshan Saldanha, executive]

Yes. I mean, Eric, this is Rohan. Just building on that answer. As I said in my comments on the gross profit performance, I think you should look at -- this performance is made definitely on a high level for APAC and realistically looking forward, the revenue growth was at 7%. We should definitely do better than that, but not maybe as high as gross profit was due to a weak comparison quarter in Q2.

So if I take your second question on working capital, yes, I mean, working capital is, as I've said before, right, we have both large customers and on suppliers. So can be a bit volatile as we receive or pay close to the quarter. And in this case, a bit of a positive surprise. But even without that, excluding that is really good development. And in general, the business is very asset-light.

I mean, there's no reason for us to believe excluding then this one-off effect that we've had in the second quarter that working capital deteriorates significantly seen over a period of time.

[Operator]

The next question comes from Daniel Thorsson from ABG Sundal Collier.

[Unknown Analyst]

Yes. Two questions from me as well. First one, I'm a little bit curious about terms of growth rates per customer groups. Do you see any meaningful differences between large enterprises and SMBs across the regions? And then secondly, in terms of head count decreases, are you more active in any region like Europe with negative growth rate? Or can you reduce overhead head count so that you can still turn the business around to growth again when the market turns.

[Unknown Executive]

Okay. Thank you Daniel. Sorry about that. So I'll take the head count question first, and then we'll come back to the customer growth. I think your question was around is there a difference between customer groups from a growth rate standpoint. So thank you for clarifying. So on the head count side, I mentioned in my comments the fact that we -- while you see a 5% net reduction year-over-year, we certainly -- there's a lot of movement underneath of that, right? So we are being more aggressive in certain areas, and we're investing in other areas. So this is very much about allocating our resources more appropriately to the areas where we see good opportunity for achieving the transformation plans or to accelerate growth.

And -- so specifically, India would be a great example, where we are growing headcount. It's obviously a high-growth market for us already. And so we want to continue to invest in that market. But like I mentioned, underneath of that net 5, there's a lot of puts and takes and movement and allocation decisions that we're making. On the customer segment piece from a growth standpoint, there are no real changes as far as we know, the SMB or the mid-market are still growing faster than enterprise in general.

Roshan, do you want to share some thoughts?

[Roshan Saldanha, executive]

Yes. Just to add a little bit to that, what Laurinda said I think it will then just going back to the commentary on [indiscernible], where we referred to, for example, the fixed-price contracts. I mean -- that is, for example, an impact mostly on large customers. So we do see, as we've said before, more of an impact on our large customer segments who have been more cost conscious [indiscernible] and less sold in the SMB segment, which is heavier in our applications product category or heavier users of our application or category. So yes.

[Operator]

The next question comes from Thomas Nielsen from Nordea.

[Unknown Analyst]

My first question is whether you see any early positive signs from your cross-selling efforts and experiences you could share from that would be very helpful. And my second question would be what would be a reasonable tax rate to expect for 2025? And what adjustments should be made to pretax profit to arrive at a realistic estimate for tax next year?

[Unknown Executive]

Okay. Thank you, Thomas. As far as cross-selling, to your point, we are looking at early signs and it comes in the form of behavior shifts, conversations that the account teams are having with one another, how they're making progress against the account planning framework that we've put forward. But on a measured basis, we're looking at how the pipeline is starting to change. And we are -- as I mentioned, we are starting to see some good indication that cross-sell pipeline is growing year-over-year. and it differs in each of the markets.

But at the end of the day, at the highest of levels, we are seeing some good leading indicators from a pipeline creation standpoint. That's both in terms of cross-selling as well as pipeline creation for customers that we are considering priority accounts within the base. These are customers where we believe that there is good growth potential. There's good white space. And what I mean by that is opportunities to sell a multitude of products into that particular customer. And that could be because they're in a particular industry because they're with a particular competitor.

We've done a lot of analysis on the base to understand who the priority accounts are and the fact that we should put additional focus there. Roshan, do you want to take the technical question.

[Unknown Executive]

I thought you might pass that one to me. I think on the tax, I think just taking 2 sub questions [indiscernible] there, profit before tax. The one thing that you should definitely adjust -- or is the amortization of acquisition-related assets. As you know, we have quite significant acquisition values on our balance sheet that we most of which are amortized with the exception of goodwill over 3 to 5 periods of time, those amortizations are not tax deductible to the largest extent in the countries in which we operate.

The tax rate is a bit tricky because, of course, it depends on where we make profits in the world. So -- but I think a historical average of effective tax rate has been in the 27% to 28% range, and we don't see why that should change significantly in the short term.

[Operator]

The next question comes from Predrag Savinovic from Carnegie.

[Unknown Analyst]

Laurinda, you specifically called out R&D as your largest cost item in OpEx. If you could discuss some more on how you allocate this R&D? And are you happy with the position of your product portfolio right now? Are there any products that you feel you're lacking to be able to reach your target of returning this business to growth.

[Unknown Executive]

Thanks, [indiscernible]. I was just writing down your questions. So as far as R&D is concerned, it is the largest group -- this does include both engineering as well as operations. And we do have operations around the globe, both in terms of technical operations and customer operations. So that's hopefully, that's answering your question in terms of what's within that.

And as we look at continuing to bring these organizations together, we'll continue to get better at serving our customers, but we'll also look for opportunities to have efficiencies there as well. As far as the product portfolio is concerned, I think we've often said that we have an amazing product portfolio and it's -- it's well rounded to serve the needs of customers looking to improve the experience they deliver to their customers at the end of the day.

So I think the highest of levels, the portfolio is well defined, it's well suited to help us achieve the growth expectations that we have. The opportunity for us is to pull those products together so that our customers have an experience that is much more seamless and unified than it is today. And we have over 150,000 customers today in our base. That is -- that's a pot of gold, quite frankly, because the -- most of those customers, the vast majority of them still only purchased one product from us. So our ability to make the user experience much more easy and friendly for them to procure and use our services across the platform is where the opportunity is.

So it's not necessarily adding product, although, of course, we never say never, but it's not necessarily about that. It's about bringing them together.

[Unknown Analyst]

Okay. Makes sense. And then finally, based on the market conditions, are you happy with the organic growth performance in this quarter? And would you say that this is representative of what can be seen in the coming quarters? I think we are -- it's certainly a slower market. And I would say, in spite of that, we grew 2% organically. However, it does not meet our longer expectations of ourselves and our aspirations ultimately. And as far as the coming quarters are concerned, what I've said is that I expect it to be roughly about the same rate.

[Operator]

The next question comes from Fredrik Lithell from Handelsbanken. Please go ahead.

[Unknown Analyst]

I hope you are all well. I would like to have one on what you talked about in Q1 where you referred to that you had closed a few contracts in EMEA? It would be interesting to hear if that has been followed by other sort of rescoping or other of volume contracts that has not worked or if that was a onetime situation you had in Q1.

And the second question I would like to talk a little bit about network connectivity. We talk a lot about 8YY. I would like to understand a little bit more about the dynamics underneath in the market, especially in the U.S. and what you see there, what customers do, what your competitors do and all that stuff. So it would be interesting to get a bit more in depth on that.

[Unknown Executive]

Sure. Patrick, I'm going to ask Roshan to take the fixed price contracting question, Q1 to Q2, and then I'll come back and talk about network connectivity in the U.S.

[Roshan Saldanha, executive]

Yes. Thanks, [indiscernible]. So yes, I mean as you noted, we had some fixed cash contracts that we exited mainly due to then not meeting our -- those contracts, not meeting our margin threshold expectations when they came up for renewal. And obviously, that impact has stayed with us in Q2, but there are no additional such contracts, and we don't expect there to be any large or material such impact in the short term. Again, we will continue to evaluate, of course, these contracts will take up for a little, but we don't have any reason to date to be more.

[Unknown Executive]

And then, Fredrik, with regards to network connectivity in the U.S., to your point, there is definitely a lot of dynamics underneath of that big category of network connectivity. So certainly, you called out the 8YY reform that, that reduction or that year-over-year change will be eliminated effectively by Q4. So we'll start to see some improvement in Q3 because part of the quarter returns to comparable period year-over-year. But Q4, you'll see the full benefit of that. I would say in the U.S., as it relates to this part of the business, I want to remind you this is voice connectivity, right? This is for voice services, predominantly sold to other carriers in the U.S. And this infrastructure is fairly legacy as it relates to what we procure from carriers. So this is very much a buy-sell set of relationships that we have in the U.S. And the services that we purchase is on fairly legacy connectivity. And so we have the opportunity to continue to evolve that connectivity and leverage other technologies. Specifically, you hear us talk about virtualization and it's really an opportunity for us to convert from a legacy infrastructure TDM to IT, which will improve the experience but also start to stabilize the cost structure there.

You heard Roshan talk about the fact that we've made some progress with regards to the carrier relationships on the procurement side. So on our buy side, we have strong relationships with all of the carriers in the U.S. And I think we made good progress there to make sure that we are managing our cost on a go-forward basis over the long term.

[Unknown Analyst]

Anything on the competitive landscape, any of your peers, what they are doing, moving leaving or whatever anything.

[Unknown Executive]

As it relates to network connectivity.

[Unknown Analyst]

Yes, in the U.S.

[Unknown Executive]

Nothing unusual.

I would say. I think we're all dealing with the same challenges and that is Voice services continues to be an incredibly important application. People still use the telephone for as much as that might be a surprise. So voice services are still used and will continue to be used and all of the carriers are looking to make sure that they do that in the best way possible. For us, that means we manage this business for cash.

[Operator]

The next question comes from Deepshikha Ogawa from Goldman Sachs.

[Unknown Analyst]

I have 2. The first 1 is you called out India as a high-growth market, and you see a lot of opportunity there. Recently, we saw an announcement from WhatsApp in terms of how they're thinking about making it more utility-based and promoting it like to be more a utility-based application rather than just a marketing software and looking for more as a channel to do authentication using OTP. So what kind of opportunity like you see from there in the Indian market. So -- that will be my first question.

And the second one, can you -- like in terms of cost, when we look at it, there is this -- you have the the growth acceleration program where you're looking at optimizing cost. And then I think Roshan talked about how personal expenses are like will there be more like equalizing through the 4 quarters and there will be -- although there will be an increase in the third quarter. So looking into all of that, how should we think about the cost development over the next few quarters?

[Laurinda Pang, executive]

Thank you, [indiscernible]. I'm going to ask Thomas to cover the India and WhatsApp announcement so that we can share our perspective on where the growth opportunities are, and then I'll ask Roshan to come back to the cost question.

[Thomas Heath, executive]

Thank you, Laurinda. Yes, there are some changes in how Meta is pricing WhatsApp for businesses. This is not the first time. They've changed their pricing model and their pricing levels several times before, and they also vary by country. If we take a step back, WhatsApp is a phenomenal channel, very popular for end users and very worthwhile for businesses as well, especially in markets where WhatsApp usage is broad-based.

India is certainly one of those countries, as is Brazil and several others. Ultimately, what pricing is one component features is another. We think the optionality between WhatsApp and RCS, which is now coming fast, it's really positive for consumers and also really positive for the ecosystem. So more optionality and then an improved position or sort of value chain is what we see from this.

[Roshan Saldanha, executive]

Yes, And [indiscernible], thanks again for the question on the cost development. Again, we're not giving any specific guidance, but I was just trying to clarify a little bit the puts and takes. I mean, as we've said before, we do have a cost reduction program, where we are trying -- where we are aiming to achieve an annual run rate of SEK 300 million in cost savings by the end of the year. We've made good progress, and we actually lead in Q2, we already reached SEK 230 million of those SEK 300 million. So we're satisfied there.

At the same time, we're investing in the transformation program and those investments, of course, timing-wise, are coming a little bit ahead of the cost savings that are being realized. I just specifically wanted to call out on the annual merit cycle for our largest cost which is related to the [indiscernible] than our biggest asset as well that in previous years, we've had it spread out through the year as we've operated in different business units, et cetera. And now we have gone through one operating model across the company, and therefore, this will coming in the third quarter. So there's a timing change related to that cost increase.

I was just calling out that specific item during my comments. I hope that helps you get a better feature of the customer.

[Operator]

The next question comes from Laura Metier from Morgan Stanley.

[Unknown Analyst]

Two questions for me, please. The first one is a follow-up to the other question on the cross-selling. Can you tell us a bit more about how easy is it today for customers to purchase different products from Sinch? Is it a seamless experience or not yet? And then second question is on the market environment depending on products. Are you seeing different trends here, for example, for your e-mail products? Are you still seeing strong growth? Or are you also seeing a challenging environment there.

[Laurinda Pang, executive]

Laura, thanks very much for the question. As far as cross-selling on the user experience for a customer that might be self-servicing, it is not a seamless experience to cross over between all of the different self-serve opportunities or the different products. They can certainly go there individually and purchase and have a good experience on its own. But to traverse between products is not seamless yet.

As I mentioned in my comments and earlier question, I expect that through the product integration work, our aspiration is to provide a much better user experience for that sort of purchasing. Secondly, on the seller-based promotion where the seller led selling motion, I would say that we do -- or we work our hardest to be able to put a unified front in front of our customers now. That really is the point of bringing the sales organizations together as of January 1.

So the sellers are starting to get equipped or enabled to be able to sell the full portfolio. They are now in a position where they can ask the right questions. They can probe for the right opportunities and understand the business challenges that customers return to solve. And while they still may not be necessarily experts in the entire portfolio, they can come back into the organization and find the experts who still exist within the organization to be able to demonstrate and pitch those products to our customers.

So long-winded way of saying, it's a bit mixed at this point, and it is certainly our intention to continue to improve [indiscernible] and make it simpler for both sellers as well as, of course, our customers to both purchase and use all of our products. As far as the market environment by product, I would say -- and you're referring to the old segments that we shared and I think you called out very specifically e-mail. E-mail continues to be a very strong product. It's one of the best in the marketplace. And we still see a big demand for e-mail product. And interestingly, it's a very natural cross-sell opportunity for our messaging customers because anybody that's sending messages or is definitely sending e-mails. And so we're leveraging our relationships, our existing relationships to pitch more e-mail into those same customers.

[Operator]

The next question comes from Victor Cheng from Bank of America.

[Unknown Analyst]

Thank for taking my questions. A number of them have been answered already, but maybe going back to the point on headcount. Obviously, there's a net 5% reduction and there are a lot of movements underneath. And you talk about increasing R&D. But if I -- when I look at the split, which is I think 49% rolling 12 months, is the same as, I think, in financial year 2023. How -- well, my question is, how should we think about head count in terms of these functional areas. And just to be clear, are you still thinking of reducing more head count in net terms or just shifting around across areas?

And then second question is relates to the RCS. Obviously, you've talked about iOS coming in, I guess, I believe it's September, October period typically. How should we think about the ramp-up as it rolls out to iOS in terms of discussions you might have with customers, any kind of intentions and willingness to shift more by Q4 this year.

[Laurinda Pang, executive]

Thanks very much, Victor. I'll try and start on both of these for you and then ask for some support on RCS particular with Thomas. But from a head count perspective, I think it's important to understand that we're doing well with regards to the savings targets that we talked about for this year. When we brought the organization together in January, we said we would look to eliminate duplication and create some efficiency. I think what you've seen us do in Q2, and it will continue now for the next quarter, is we've really simplified or started to eliminate a lot of duplication that existed.

Now we are not at the efficiency point. And the reason being is, is that there's investments and you've seen that with regards to the IT investments very specifically. There are investments that need to happen to consolidate a number of the back-office platforms and systems that exist today. Until we do that, we need to continue to have people and roles here to support that because they're fundamental to our business. So there's a lot of foundational work and tech debt that we're looking to solve here. So when we put up the slide when we talk about what the costs are versus the benefits or where the efficiencies are versus the benefits, the timing you'll see is we look for this initial phasing of savings in 2024, we'll start to see benefits in 2025. But if you look at that chart, it also talks about additional efficiencies and savings in outer periods.

So we do expect that through this process, we will not only return this business to an accelerated pace of gross profit growth. But ultimately, we do expect to expand margins.

As it relates to RCS, we -- you can tell we're very pleased with Apple's announcement, but this is the space that we have been investing in for many years. And so I think that Sinch is very well positioned to have a leading position as it relates to RCS. We have relationships, very strong trusted relationships with over 600 carriers across the globe. That is incredibly important because RCS is dependent on those carriers adopting that technology.

And so the relationships we have with them will allow us to play a role in that. We also are looking to educate our customers initially, our existing messaging customers with the power of RCS, and we've got our sales organizations around the globe already doing that. They have been doing that for quite a while. And so we are starting to see a good ramp up. And Thomas, do you want to kind of give your perspective here?

[Thomas Heath, executive]

Absolutely. And as you said, the next version of iOS, iOS 18, most people expect that to come in September as you put that or September time frame. As Laurinda said, we've invested for many, many years and can leverage our strong operator relationships. As we think about this unfolding, parts of your question was how quickly businesses will embrace this. And you can think of a few different factors. First one is handset support. And here, we've talked about how iOS support rapidly improves that.

The second one is carrier support since this is a carrier service that needs to be switched on. Here, that will take some time too, although we're seeing progress already now. Third one is pricing, which varies by carrier. Here, most operators are pricing basic RCS messaging more or less on par with SMS, maybe a slight premium. But of course, that's an important aspect for for businesses. And then fourth area, of course, is the use case. If you are a business and you're looking to send a one-way notification similar to what you're doing today on SMS then the transition can be quite smooth if you pick a strong vendor.

If you're developing a more advanced use case, you're including pictures, video, interactivity, then there is more work on the enterprise side to enable that to develop a conversational AI experience or conversational messaging experience is a little bit more like developing an app compared to just sending a notification, right? So our expectations is that the more straightforward use cases will lead, and then we'll have a long trajectory of adding more complex and value-enhancing use cases over time.

[Operator]

There are no more questions at this time. So I hand the conference back to the speakers for any closing comments.

[Laurinda Pang, executive]

Thank you, operator. I just wanted to take the opportunity to thank everybody for joining us today and to wish everybody a very happy summer, particularly here in Sweden. We appreciate both your interest, your questions and your support.