Sangoma Technologies Corporation

Thank you for standing by. This is the conference operator. Welcome to the Sangoma Technologies Investor Conference Call. As a reminder, all participants are in listen-only mode and the conference is being recorded. I would now like to turn the conference over to David Moore, Chief Financial Officer. Please go ahead, Mr. Moore.

Good afternoon, everybody. Thank you for joining us and welcome to Sangoma's Investment Call to discuss the third quarter results of our fiscal year 2021. We're recording the call and we'll make it available on our website later today for anybody who's unable to join us live. I'm here today with Bill Wignall, President and Chief Executive Officer, John Tobiah, EVP of Corporate Development, and Larry Stock, Chief Corporate Officer. to take you through the results of the third quarter of fiscal year 2021, which ended on March 31st, 2021. We will discuss the press release that was distributed this afternoon, together with the company's unaudited interim financial statements and MD&A, both of which are available on CDAR and on our website. As a reminder, Sangoma reports under International Financial Reporting Standards, IFRS. During this call, we may also refer to a couple of terms such as operating income, EBITDA, and adjusted cash flow that are not IFRS measures but which are defined in RMDNA. Also, please note that unless otherwise stated or referenced to dollars out of the Canadian dollar. Before we start, I'd like to remind you that the statements made during the course of this call that are not purely historical are forward-looking statements regarding the company or management's intentions, hopes, beliefs, expectations, and strategies for the future. Because such statements deal with future events, they are subject to various risks and uncertainties, and actual results might differ materially from those projected in those forward-looking statements. Important factors that could cause actual results to differ materially from those in the forward-looking statements are discussed in the accompanying MD&A our annual information form, and in the company's annual audited financial statements posted on CEDA. As a reminder, we completed the Star-to-Star transaction on March 31st of this year. As a result, Star-to-Star was not yet part of Sango during our fiscal third quarter. And with that, I'll hand the call over to Bill.

Thanks, David. Good afternoon, everyone, and thank you for joining us today. I have structured my prepared remarks in five sections. I will first discuss our third quarter and then move on to year to date results. In my third section, I will very briefly close off on the cyber attack with a few comments for the last time. Fourth, I will share with you an early viewpoint of the star to star transaction and how we see the companies coming together thus far. And finally, I will provide an update on our fiscal 21 guidance as introduced in the press release from earlier today. As always, I'll then wrap up with a brief summary and turn the call back over to David for a typical open Q&A session. With that, let's move to the Q3 results, where I will begin with our P&L. Before I start, just a short reminder to pick up on David's comment. Given the Star to Star transaction did not close until March 31st, there's no impact from Star to Star on our income statement for this third quarter, except for the one-time transaction expense, and of course their impact on the net income. That is, revenue and EBITDA were not affected by Star to Star during the third quarter and are thus not included in my P&L remarks for the quarter or year to date. Okay, with that backdrop, sales for the quarter ended March 31st were $35.4 million. For those of you who may have already seen today's press release, you will have noticed that we also made a couple of references to U.S. dollar revenue and foreign exchange rates this quarter. As you know, we've not normally spoken much about FX because typically the exchange rate has helped Canadian dollar revenue just a little in one quarter and then hurt just a little in another, and so it can go up and down, but it's not often been that material. But for Q3, however, the impact was quite pronounced, and we felt it appropriate to explain the effect so that everyone fully appreciates what's going on. For those of you who have been shareholders for some time, you will recall that although Sangoma does business in well over 100 countries around the globe, we sell almost exclusively in U.S. dollars everywhere in the world. And yet, at least for now, our financial statements are presented in Canadian dollars. So when the U.S. dollar rate swings as much as it did from Q3 last year, when it was around 1.37%, to Q3 this year when it was around 1.27, a change of that magnitude has a material impact on the comparison between our quarters. And thus, the $35.4 million in sales is a 2% decrease in Canadian dollars versus Q3 of fiscal 20 and represents a 5% increase in U.S. dollars over the same period a year ago. Stated another way, if the exchange rate that existed in Q3 of fiscal 20 were to have remained unchanged, our Canadian dollar revenue would have been about $38.3 million for the quarter, up from what was $36.3 million last year, an increase of about $2 million for the quarter. I hope our attempt to explain this transparently has indeed helped, as opposed to adding any confusion, and I also hope I don't have to continue talking about FX rates. As for the breakdown of revenue into our services and our product categories, I am pleased to say that our also critical services business continued to perform well, aligning with our strategic focus and objective. Services grew at 15% in US dollars this quarter, or about 6% in Canadian dollars. Our services revenue grew to 57% of total sales in Q3, up from 52% in the third quarter of fiscal 20. And this growth in services is slightly offset by some ongoing softening in product sales, which were down by about 5% in U.S. dollars as impacted by COVID-19. Gross profit for the third quarter was $23.2 million, representing a million dollar increase in USD, but down very slightly in Canadian dollars for all the FX reasons I've just covered. Gross margin for the quarter was 66% of revenue, a 1% increase from Q3 of last year when we were at 65%, a positive result given the tightening of the global supply chain that you may have heard about in mass media over the last few months. Operating expenses for the third quarter this year were $16.6 million, very similar to our immediately prior second quarter. I continue to be pleased that our operating costs are increasing at a slower rate than our revenue growth, which means we're continuing to operate on plan. EBITDA was 6.6 million for the third quarter, representing an increase of 8% in U.S. dollars or approximately 2% in Canadian dollars versus Q3 of last year. EBITDA margin came in at about 19% of sales, up from about 18% in the same quarter last year. As we've discussed in the past, the 19% level is partly the result of COVID-related cost containment. As customer demand recovers gradually, as we anticipate it should, we will open up spending once again, slowly but surely. This prudent, careful relaxation of the cost controls over the next little while should bring EBITDA margins back down slightly a bit closer to the expected range. And net income for the third quarter includes a one-time expense of $4.7 million associated with the Star to Star acquisition. This, of course, results in a temporary loss of $2.4 million, though if we excluded this one-time charge, net income would be about $2.3 million compared to $1.7 million for the equivalent quarter last year. A more apples-to-apples comparison, and an increase of about $0.6 million or 35% from the prior year. With that somewhat lengthy description of Q3 this time, now let's turn to our year-to-date results. Sales for the first nine months of fiscal 21 were $105.8 million, up about 10% from the $96.6 million in the same period of fiscal 20. In my narrative for this year-to-date section, I don't plan to keep bouncing back and forth between Canadian dollars and U.S. dollars like I did in the Q3 section because the FX impact is less material over the nine-month period. For example, the 10% year-to-date growth figure that I just cited would have been about 12% in U.S. dollars, so I won't keep commenting on this. The increase in year-to-date sales was due to the same factors I covered in my section on Q3, namely the continued growth and compounding of the company's services business, partly offset by some softening in demand for one-time product sales, which continues to be impacted by COVID-19. As a percentage of sales, our services revenue is up to 56% for the nine months of fiscal 21, a nice increase from 47% in the same period last year. Gross profit for the first nine months of 2021 was $69.9 million, 12% higher than the $62.3 million realized last year. Gross margin was 66% of sales on a year-to-date basis, about 2% higher than the same period a year ago when it was around 64%, a further benefit of the steady increase in the percentage of revenue coming from services. As stated about the quarter, while we expect to continue seeing gross margin increase as the fraction of sales that comes from services grows, it's especially gratifying during a time of a much tighter global supply chain, leading to higher costs for components and shipping. Operating expense for the first nine months of fiscal 21 was $49.7 million, up by about 6% from the same year-to-date period last year. as expected to drive growth. EBITDA was $20.2 million for the year so far and is 31% higher than the same period last year. This is equivalent to about 19% of sales for the first nine months compared to about 16% for the same period last year. And finally, year-to-date net income is $2.3 million, inclusive of the one-time costs associated with the star-to-star acquisition up from 1.3 million last year. This brings my commentary on our income statement to a close, and so I'd like to now cover a few highlights from our balance sheet and cash flow. Please note that while there was little impact on the income statement, the balance sheets of Sangoma and Star to Star have now been combined as of March 31st, so there are some significant changes to a few key items such as inventory or receivables. I will start my balance sheet comments with cash. As a reminder, we began Q3 with the cash raised in the bought deal late last year. We kept that cash in US dollars because it would be used principally to fund some of the cash portion of the consideration being paid for Star to Star, which was needed in US dollars. We used cash on the balance sheet of $63 million and added about $66 million of debt to fund the remaining cash portion of the Star to Star acquisition. As a result, we ended this quarter with a cash balance of nearly $29 million. Inventory is up slightly from $12.6 million on June 30 to $13.9 million on March 31, representing an increase of $1.3 million. This includes $1.8 million from Star to Star, without which inventory levels would have decreased slightly. Looking forward, it's possible we may increase inventory levels slightly temporarily to help us deal with the significantly tighter global supply chain. Trade receivables increased from $11.2 million on June 30 to $19.1 million on March 31, with the addition of the Star-to-Star AR representing the majority of that increase. And now a comment on cash flow. During the third quarter, we generated adjusted cash flow from operations of 4.9 million, well above the 3.7 million for the same period of the prior year. For the nine months of fiscal 21, we have generated adjusted cash flow of $15.1 million, almost double the 7.6 in the same period last year. That means that after nine months of fiscal 21, we have already generated more operating cash flow than the 15 million we generated in the full year of fiscal 20. This measure of adjusted cash flow excludes the impact of acquisitions, financing, or other non-operating anomalies and reflects how well Sangoma is deploying and managing our capital. Finally, as was the case before the start-to-start deal, we are now, of course, comfortably within the debt covenants and our balance sheet remains strong. That brings my comments on our financial results to a close, and I will now touch briefly on the cyber attack from late 2020 one last time. Well, what can I say about ransomware attacks that you're not already hearing about every day in your preferred newspaper or website or the evening news? Be it Apple last month or Colonial two weeks ago or Toshiba last week, it's clearly a very concerning and growing problem, none of which is an excuse, of course. I just thought I'd take a short minute or two to bring the Sangoma cyber attack story to a close. As you've now heard multiple times from us in press releases and also in our last quarterly call with investors during February, the ransomware attack we announced in December led Sangoma to engage third-party cybersecurity experts to assist us in performing a comprehensive investigation. I can reiterate that this very experienced team of experts did not uncover any compromise of our IP nor any indication of security threats to customers who were using our products. Further, no Sangoma clients experienced any service interruptions or difficulty using our products as a result of this cyber attack. And since we last spoke, the detailed assessment of the stolen data has now been completed. We are in the process of notifying all those affected by the data loss, most of which is now done. And finally, we have also notified the authorities in many jurisdictions as is not only appropriate and responsible, but also required by law or regulation. As I mentioned last time, many talented people at Sangoma and that are outside experts worked tirelessly throughout this period, including over holidays. And I want to thank them for all their dedication to bringing the investigation to a close. I'd now like to turn. to a more positive topic and an update on the Star-to-Star acquisition. I'll start off that with a thank you. Sangoma shareholders approved the Star-to-Star transaction with a vote of 98 to 99% of investors in favor, a level I've never seen before and a very positive affirmation of the deal as well as our strategy. As some of you will know, Star-to-Star represents Sangoma's 10th acquisition and is transformational, placing us clearly into the top tier of the growing cloud communications industry and fully cementing our transition to a SaaS business. As a very short reminder from our last call, the combined company will have revenue of about $245 million with over 70% of that being high value recurring services revenue, gross margin of over 70% among the highest in our space, and EBITDA of over $40 million delivering EBITDA margins that are also at the very top of our industry. Please note that those figures are all based on the pro-form review, more fully captured in the information circular mailed out to shareholders prior to the vote. And while it's only been seven weeks since the transaction closed, I'm very pleased with how the companies are coming together. We have begun a series of integration projects, each covering a key part of the integration, such as people or product, or customers and channels, or back office systems, or customer-facing cloud network consolidation. I will touch on a few of these today at an initial preliminary level, given, as I just mentioned, it's only been a short while since we closed, and Star2Star was not even formally part of Sangoma in Q3. And I'll then cover additional detail after Q4, of course, once we've been together for a bit longer. Regarding the people part of our integration plan, our cultures were quite similar, which is one of the things that attracted the two companies to each other. So it has become quickly apparent that we were gelling nicely. That is an often overlooked aspect to an effective integration. And given Sangoma has done many acquisitions successfully, I think we're pretty decent at it. And star to star just makes it easier, given our fit. I feel this is even more impressive since many of us have never even been in the same room together, although that is slowly starting to change, thankfully, as a few staff begin to move between our U.S. offices once again. You may recall from our prior call with shareholders that we intended to handle the people integration in two steps, what some folks call staff functions, so think finance or HR or legal, are departments that we expected to integrate quite soon after closing. However, the line functions, and here think sales or engineering or marketing or operations, were not to integrate right away. It's always harder to do those departments immediately at the best of times, and given everything going on in the world, it's far from the best of times with the pandemic lingering on, especially in some countries. And thus, we're going to take our time to get to know each other for a while during the integration phase, and then combine those teams. And that plan, shared with you on our last call, is indeed precisely how it is playing out. We have now already fully integrated the two finance organizations. We have combined our two legal departments, and the HR groups are now together too, all within the first month. In addition, we've had our first board meeting of the newly constituted board of directors, and I'm very excited about that. But for the next few months, it will continue to be pretty much business as usual for our sales organizations or engineering teams or operations staff in both companies as the integration discussions take place. And I'll now share a few comments on progress with customer and channel integration. Since the last time we spoke together, our teams have remained focused on clients. That sounds obvious or perhaps easy, But during a time of deal negotiations and now integration, especially on larger transactions like this one, it can be anxiety provoking for staff and all these extra meetings can be distracting when they all have normal critical day jobs to do. So I would just like to thank everyone at Sangoma and Star to Star for continuing to take excellent care of our customers without which there is no business. Regarding customers specifically, we have now started the early stages of integration. For instance, we are in the process of cross-training each of the sales team on the other part of the company's product lines. And while the teams continue to work separately during this integration period, before they're fully integrated, we've now worked out a way to handle cross-selling during that time. In that case, if for instance, the star to star salesperson has an opportunity for an on-premise customer that would be satisfied by the Sangoma premise system, she will reach out to her Sangoma counterpart. They will tag team the sales cycle together. The order will need to be placed on the Sangoma systems for now. They will both work with the channel partner who uncovered the opportunity and they will both be compensated. And I've even now had the chance to speak personally with some of the larger Star-to-Star customers, which has been great. We're also starting to work on channel integration. We've had the initial meetings and webinars with channel partners from each company to explain that we need them all and that the complementary mix of channels was one of the key benefits of the deal. We have also just started work on bringing the channel programs together, which is a longer-term project that involves things like how partners buy, through which systems, pricing or discounting and compensating the channel, who from our combined company services those partners, et cetera. And we're planning live events with such partners for the fall on the assumption we'll all be traveling by then. Next, I'd like to touch on the early focus for product integration. Sangoma now has the industry's most complete internally developed suite of products and cloud communication services bar none. This includes UCaaS, trunking as a service, video meetings as a service, contact center as a service, CPaaS, access control as a service, collaboration as a service, trunking as a service, et cetera, all together with the capital P product line that you see as our second revenue category in addition to services. These products cover on-premise UC, connectivity lines like SBCs or gateways, and endpoints such as phones or headsets, all available from a single supplier and all part of a one throat to choke solution, unlike the partial solutions offered by our competitors. Priority one in the product integration work is to decide upon which product to keep for any categories where both Sangoma and Star to Star had a similar offering. That work is well underway, and while it will take some time, we've already made decisive progress. For instance, we've concluded that we will be standardizing on Sangoma's video meeting as a service product called Sangoma Meet. And we will keep both companies' UCAS services, Sangoma's as well as Star to Star's. And finally, with respect to CPaaS, we are standardizing on the star-to-star product line. More work in these areas is obviously still to come. The other high priority in product integration is how best to tightly integrate our various cloud services into one cohesive suite so that they all share a common look and feel for customers. This involves work in areas like UI or user interface, UX or the user experience as they navigate through our tools, or single sign-on so customers register with us once to buy a product or identify themselves and don't have to do it multiple times or differently for each product in our suite. We want one clean, integrated suite so that when customers use our products, they have a consistent experience whether that product initially came from Star to Star or from Sangoma. And there is naturally a lot of other work going on in several other integration areas, but it is just a bit too early to provide details on those yet. These include such things as back office, like the internal systems we use and that our customers and partners access to do things like quoting or ordering or software licensing and enabling, or cloud network integration, which is the software and infrastructure in data centers or public cloud like AWS that both Sangoma and Star-to-Star operate and which underpins a cloud-based service. I plan to provide you with further integration details on other key projects such as these over the coming months as we get further into those areas. And finally, the last integration topic I wanted to touch on is synergies. I would just like to remind you that Star-to-Star was already a financially healthy, well-run company. As a result, and as I shared last call, we did not expect large cost reductions and that was not why we did this deal. This transaction is all about positioning the combined company and the upper echelon of the industry with the full product suite and completing our transition to a SaaS company. Having said that, I do expect the teams to uncover some cost-saving opportunities, of course, including in areas such as traffic consolidation or data centers or duplicate marketing spends. However, we have now decided that most such savings that may get identified are expected to be reinvested back into R&D and sales and marketing to help drive Sangoma's growth. This brings my Star to Star update to a conclusion, and I'll now turn to a few comments on fiscal 21 guidance. While many companies are still not issuing guidance given economic uncertainty, Sangoma has continued to do so. And given the recent addition of Star to Star to the Sangoma family, I'd like to share a perspective on how the fiscal 21 year is likely to unfold with the inclusion of Star to Star in our fourth quarter. I realize that timing is a little confusing given the deal closed March 31st and thus Star to Star is not included in our Q3 results, and those results are getting released mid-May, and the end of our fiscal year is not that far away. Nevertheless, we can't control that awkward timing and have chosen to update fiscal 21 guidance at this point. As such, you may have already seen in our press release today that we indicated revenue would be around $166 million and EBITDA about $30 million this year, up from prior guidance of $143 to $147 million and 24 to 26 million, respectively. While it is close to our fiscal year end, the increased uncertainty that has existed for some time now unfortunately continues to exist to some extent. And that uncertainty stems from more than one source now in our view. First, the FX rates that we discussed earlier in our call are still moving around quite a lot, including since the end of our third quarter, and this naturally makes the estimation of Canadian dollar revenue more tricky than in prior years. Our estimate assumes the FX rate is relatively stable for the next few weeks through the end of June. Second, COVID remains a factor. Many countries are beginning to ease restrictions, while others that we operate in remain in various stages of lockdown and or serious health crises. It would be hard to miss the tragedy unfolding in India these days, for instance. Such conditions make the sale and installation of the product portion of our portfolio more challenging on a region by region basis. And third, you may have heard simply in mass media of the significant uptick in demand for electronic components, which has triggered some shortages and supply chain issues, as I mentioned earlier. This leads to slightly higher costs for those parts and for shipping raw materials or finished goods around the world. Sangoma is carefully and prudently acting to mitigate the effects of these shifts where necessary and when possible in order to maintain delivery to customers. Okay, with that, I'll bring my prepared remarks to a close with a brief summary. Overall, I'm very pleased with another solid quarter for Sangoma and what we accomplished in Q3 for your company. We signed a transformative deal with Star to Star in January, received overwhelming support from you, our shareholders, and ultimately completed the transaction on March 31st. We don't take that support for granted, and so for those of you on this call, I would like to once again say thank you for your vote of confidence. The combined organization has an extremely large total addressable market in a space that is growing well. The macro trend of moving to the cloud is still relatively new in communications, and we expect to benefit from this for many, many years to come, both in North America and internationally as well, where cloud is still in its infancy. So notwithstanding some modest headwinds in the quarter that are beyond our control, things such as FX rates or COVID, we continue to execute our strategic plan with ongoing sales growth, nice compounding in the recurring services revenue, growing EBITDA, and healthy cash flow. We completed the transformational acquisition that catapults your company into the top tier of cloud communications. And I think I can speak for the whole team when I tell you how excited we are to keep this momentum going. I hope the way we explained our financial results and the impact of FX rates on this quarter was helpful and allowed you to see the ongoing compounding of a services business up 15% year-over-year in U.S. dollars remains on track. Year-to-date revenue is up 10%. Services reached 57% of total revenue, up from about 47% last year. EBITDA at 19% of revenue is 30% above last year, all very positive signs given the global economic uncertainty this year. We will absolutely continue with our dual-pronged growth strategy, one that most investors in STC have become familiar with over the past several years. First, we will seek attractive organic growth by investing in R&D and customer acquisition. And second, we will keep augmenting that growth with deliberate and disciplined M&A. And finally, we've indicated that the company is preparing to uplist to a senior exchange in the US or Canada or both. This is not a small undertaking, but I can assure you we're working hard on it and we will keep investors posted. That concludes my prepared remarks. So thank you for joining us all today. And with that, I will turn the call back over to David for questions.

Thank you, Bill. Operator, could I ask you to please explain how to ask questions and we'll get people in the queue?

Absolutely. We will now begin the question and answer session. To join the question queue, you may press star then one on your telephone keypad. You will hear a tone acknowledging your request. If you are using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press star, then two. We will pause for a moment as callers join the queue. The first question comes from Gavin Fairweather with Cormark Securities. Please go ahead. Oh, hey there. Good afternoon.

Hi, Gavin. Bill, maybe just to start, in your prepared remarks, you talked about demand improving gradually in relation to your growth investment levels. Maybe you could just unpack that a little bit. Is that kind of your read on the overall current environment? Do you see it? And maybe just speak to any differences that you've identified in certain markets that perhaps are further along on the reopening path.

Yeah. You know, I have to say this is one, Gavin, that's been up and down for us, depending, as you say, on various ways of breaking it down. I think you asked about different geographies, but you could also look at different product categories or different customer markets as well. And it seems like, at least from what we're seeing, some segments, and again, this could be geography or product or customer segments, might be up a bit and some other one goes down a bit. So the comment that I was alluding to is, in general, the trend that everyone expects and why should Sangoma be any different is things should continue to gradually get better and open up. But it's not consistent, right? And that's really what I was saying. We manage, for example, our Asia business in out of two main locations, Hong Kong and India. And the Hong Kong team sells and services customers in what you traditionally think of as APAC, right? So think Japan, China, Hong Kong, Taiwan, Australia. And the team in India services South Asia, Southeast Asia, the Near East, the Middle East. And if you're based in India right now, you know, we of course want everybody to do their best and keep working. Not a very good situation, right? And, you know, that's kind of what I was getting at, Gavin. There are segments of the economy, you could even look at it in verticals, right, that are starting to reopen. And so if you're in a part of the world where the economy is beginning to reopen, we fully expect that that will start to help product sales again. But on balance, it's been kind of a mixed bag. And you can see that product sales were still down a little bit this past quarter. And so we're being a little bit careful. We're investing where we think it makes sense, but not pushing before we think the demand is there for which pushing would make sense. And that's what I was getting at, I guess.

Got it. That makes sense. And then just secondly, for me, just from star to star, you know, obviously in Circular, we got the September kind of quarter out of them. I suspect you don't want to get kind of too specific in terms of, you know, the numbers or anything, but can you just talk us through, you know, kind of qualitatively, perhaps how the business has been performing in the December and March quarters, you know, in terms of just, you know, kind of revenue, new logo success, kind of their spending and investment levels, anything kind of commentary that you could provide there would be quite helpful.

Yeah, sure. Yeah, I don't feel like I don't want to be too specific. I'm happy to try and explain.

Don't let me hold you back then. Be as specific as you want.

I mean, I'm not going to be, you know, quantitatively precise, but I also don't want you to feel like, you know, we're avoiding it or anything. It's just that Star to Star wasn't in Q3, right? So, you know, I think things generally are unfolding correctly. Pretty much as we expected. It doesn't mean, you know, just like at Sangoma, that every single piece is exactly on plan. Some pieces are a bit over and some pieces are a bit under, as you would expect, and some channels are a little bit over and some channels are... But that's kind of what one anticipates. So, you know, revenue for the quarter was kind of what we were looking for. Nothing big, huge, you know, out of the realm of... what we thought would happen based upon all the due diligence that we did. You know, the kinds of customers that were being won in the quarter look exactly like the kinds of customers start to start targets and has won in prior quarters. You know, some big, some medium, some small. It was across multiple product categories, whether it's, you know, UCAS or CCAS or whatever. You know, it's all North America, right, for Star to Star. Yeah, I mean, that's what I would be comfortable sharing at this stage, Gavin.

Okay, great. And then maybe just quickly for David, you know, obviously a big intangible kind of bump coming in here with the Star to Star. Can you help us out on how to think about how quickly you'll amortize that down just from a modeling perspective?

So, Kevin, this is the output of a multi-week exercise by a big accounting firm doing the evaluation. So what we've done is we've used the very preliminary information and shared that with you to give you some idea. But to be honest, that work is still four or five weeks out. We will have it ready for our Q4 results, and we'll have the whole thing tied up by then. But to be honest, that exercise takes weeks, not days.

Okay, that's fair. I'll pass it along. Thank you.

Thanks.

The next question comes from Gabriel Leung with Deakin Securities. Please go ahead.

Good evening, everyone, and thanks for taking my questions. Gabe, a couple of questions. Hey there. A couple things for you, Bill. In your prepared remarks, your comment is that you've spoken to a number of star-to-stars, larger customers, obviously. I'm curious what the feedback has been from those large customers as it relates to the combination of the two companies and perhaps talk a little bit about what are those guys looking for from the consolidated entity? What are they hoping to get out of it?

Yeah. That's actually a good question. I would say it's the natural mix of human nature, right, Gabe? In general, it's predominantly positive. Oh, that's amazing. You have a broader set of products. I can get everything I need from one place if I want that. You have a bigger team to support me with people around the world. So if we have an office in a different place, you know, you're likely to have somebody there. The public company stability is reassuring. The, what do I call it, larger company, nothing to do with being public, scale provides them with this view of OK, there's probably a different set of skills available from the larger company that might have existed in the smaller company. Right. So, you know, if we have, I don't know, a network outage or something like that, now you've got a whole set of new people that can be brought to bear to figure out what's going on. On the other side, what I meant when I said, you know, this natural mix of human nature is there's always a little bit of trepidation, right? There's nothing strange or unusual about the start to start transaction that way. It's exactly what we've seen in earlier transactions. It's exactly what the start to start team told us to expect. So, you know, the initial questions might include things like, you know, please confirm for me, you're not going to cancel or end of life this product. No, no, no. Stop worrying. 100% in. You're good. Yeah, we're good. So there's some of that. But please tell me if, you know, the person I really like dealing with in, you know, fill in the department, right, Gabe, the salesperson I deal with or the tech support person or, you know, the professional service. No, we're not coming in and changing, you know, the mapping of people to customers. So there's a little bit of that in any of the first calls. But that's how it's gone. I would say if, you know, if there's five questions or comments, four real positive, and one comes with the natural anxiety, and if there's 10 comments or questions, eight of them are real positive, and one or two are, you know, please reassure me, because I'm a bit nervous about this.

Gotcha, no, thanks for that. Just moving on to the margin profile for the complying company going forward. Profile right now, based on the guidance you provided, fiscal Q4, we're looking at about 16-odd percent EBITDA margins, down a little bit from what you've been reporting. I always ask you about the profitability versus growth argument. I'm curious where your thought is at on that front. Do you feel the 60% range is the appropriate range for the combined company today in terms of your growth aspirations for the combined company? Is that a good way to think about it?

Well, it is something we talk about all the time. We've just had a board meeting, and that was one of the main discussion topics, which I know won't surprise you at all. It's tricky because on one hand, I would say if you look back over the last few years and the equity markets rewarded growth at all costs. And we felt like, you know, a good balance between healthy growth and reasonable profitability was wise. And we've watched some of our competitors pick up to revenue multiples that are much above us. And so, you know, for sure we're, you know, paying attention and noticing, you know, on the other hand, I think most of the shareholders, especially larger institutional shareholders who've bought into Sangoma, you know, liked some of that reasonable balance, you know, and so, If you're talking to a U.S. fund who might say take positive $40 or $50 million of EBITDA and turn it into negative $50 and grow faster, there are other investors who say, please don't go that far. Maybe you can go from 20% EBITDA to $50, and that might be tolerable. So that's, I think, the set of boundary conditions, Gabe. We're not going to go and incur these huge losses, although to make it a bit more tangible rather than just fuzzy abstract stuff you heard me say in my prepared comments that we are starting to see some cost savings opportunities, even though that wasn't what motivated the deal. And, you know, for sure we could just take those cost savings and, you know, put them in our pocket and watch 15% go to 18% or 18% go to 20% EBITDA. And we're not going to do that. We're going to take those savings and reinvest them into R&D and marketing and sales for customer acquisition and and see if that can help revenue a little bit. So that's a little bit more pointed than I've been prepared to be in the past, and that's kind of where we are at this stage.

Gotcha. And just moving over to the revenue segmentation for a second, I want to talk about the product division, I guess, specifically. Obviously, there's been a bunch of headwinds, COVID, supply chain issues, But I'm curious, as we look at the product division, including both Sangoma and Star to Star's product lines, I'm curious, how are you planning to manage this product division? And factoring also sort of the structural demand for products versus SaaS now, are you managing this business to be kind of a flattish growth business? Is that the aspiration at this point? versus sort of medium to high growth for the business?

Yeah, I think that's right, Gabe. I think in fairness to the problems with the FX rate that we talked about, or the economic uncertainty, or as you just pointed out, the impact of COVID, generally feels like the product business capital P product here as opposed to you know the services business is a flat you know minus five plus two minus three plus one it varies from quarter to quarter it varies from region to region but but that is right it's not a high growth business and we don't manage it as such The way we think about it is, A, it generates cash that we can reinvest in other parts of our business to grow the services business and or service the debt. And strategically, it's really important for two reasons. One is it completes the full suite that lets us offer that one throat to choke. We don't have to give a customer a bunch of software or hardware that comes from some other vendor that we can't control. oh, you know, you got your phones from Vendor X or you installed this offer on someone else's server and now we have to worry and troubleshoot or the customer has to figure out who they're calling. So that's the first big one. The second big one is, you know, the product bucket includes one-time on-premise systems. And while the fraction of new purchases that goes to on-premise declines every year, it's still a very large fraction. It's something like half in North America, depending on who you listen to. And that means half the new purchases are cloud. And, you know, you've heard me say in Europe, you know, it's much less than half of the new purchases that are cloud, you know, again, depends, but let's say it's 20 or 25%, but I mean, 75% is on-prem, right. And, and the positioning that our sales team knows to use, and you would see it in, pitch decks and things like that, says, we just want the customer, right? Sure, we'd like the customer to be on cloud and recurring revenue, and that's where it's going to be over time. But if the customer says, no, no, hang on, I've decided I'm buying a premise system, we don't want to turn them over to one of those old competitors, you know? Or if they say, I don't know, Gabe, we'd like the corporate headquarters location to be on prem and the, you know, seven satellite offices to be in cloud. We want them. And whether they buy Prem just for the headquarters or for the entire company, in a year or three, they're going to change. And they're going to move to cloud. And so maybe we've done a good job, which I think we generally do. They're going to be positively predisposed to taking the cloud service from us. And so we think of product that way. It's not high growth for sure, but it's a good business. We're not going to jettison it. It generates a lot of cash. We reinvest it in high-growth businesses and service the debt. And there are really good strategic reasons for having a complete portfolio and an on-premise system that lets us satisfy any deployment model.

I appreciate that. One last question maybe for David. Just curious, David, do you have a Forex sensitivity system just as it relates to the U.S. dollar, Canadian dollar against revenues and EBITDA. So what does a change in the penny changing exchange rates, what does that do to revenue and EBITDA? And if you don't have that handy, maybe you could just help confirm based on the guidance you provided for the full fiscal year. It looks like that would imply, call it constant currency change. growth of about 10% in terms of Q4 revenues. Can you confirm that for me?

So we're not explaining the revenue between the different businesses at this point. Let's get the quarter finished. We've got a lot of balls in the air. So I think we factored in exchange rate as best we can. It made a big impact this quarter. The exchange rate is already down compared to last quarter, but we're just working to maximize the revenue this quarter. And we've given our best estimate of what we think it might be at this point.

Okay, gotcha. I appreciate it. All right, guys, thanks for the feedback, and congrats on all the progress.

Okay, Gabe, thank you.

The next question comes from Josh Nichols with B. Riley. Please go ahead.

Yeah, thanks for taking my question. Glad to hear things are moving along on the integration front. I wanted to ask a little bit, I mean, clearly the services business is continuing to see some good demand here. Could you elaborate a little bit about what some of the bigger drivers are for that? Is it, you know, existing customers that you're cross-selling, growing the customer base more so? And if you could talk a little bit about any offerings that are getting good traction? I know you mentioned like Sangoma meat right in the current environment and anything else you could elaborate on would be helpful.

Yeah, I think, um, good question, Josh. Thank you. Uh, in general, the drivers that are propelling the cloud communications industry are the same ones that are affecting us. I can give you a little bit of color, but which one's more important and which one's less and things like that. Um, but you know, generally, the transition away from people managing their own software on premise to having someone do that for them in the cloud is, you know, the most important driver, right? And so our sales team knows how to talk about that and what they should say to a customer. And, you know, you're a, You've heard me talk about this with you and your colleagues, Josh. You're, I don't know, a manufacturer who makes widgets or a career company who delivers packages or a florist who sells flowers. And why do you want to manage, you know, communication software? You know, it's just not what you do, right? You should, I presume, want to focus on selling flowers or delivering packages or whatever. And, you know, we can take that off of your hands or, I don't know, now we have so much work from home or work from anywhere, which is so elegant in the cloud. Or, you know, do you want to have to be responsible for constantly making sure your on-premise software is patched with the latest security so you're not getting hacked, right? So that's probably the number one driver. Secondly, I would say you're right that we have – a good installed base of premise users that, like any premise user, not just ours, are gradually over time going to move to the cloud. Number three, we have a channel, some of which had traditionally grown up in that old premise world and wanted to build a stream of recurring revenue themselves. And so they're motivated for their own reasons. It's not in conflict with or trying to convince a customer to do something they don't want to do, but you've now got a bunch of channel partners who are interested in selling cloud because they wanted annuity stream too. Right. Um, we, we have, uh, an account management and customer success group that works with customers to try and understand which other cloud services do you need or how many seats, um, do you have now much need in the future? I know when you signed on with us, you bought 186 seats, but it looks like you now have 211 employees that we need to do something. So I don't think it's any one thing. I don't think very many of those are so unique to Sangoma that they're different from what's happening in the industry, but, but those are the kinds of things that are driving it, Josh.

Thanks. So then, um, Clearly, I think you hit on it before. There's been some product headwinds, obviously, associated with the pandemic. But as things start to open up, particularly, you know, in the U.S. and whatnot, is it fair? Do you think that that revenue is probably dropped at this point and that there is some type of an uptick that you can see there or what it would take to get back to, you know, pre-COVID levels? Or do you think that that is going to remain kind of around the current levels as you focus on transitioning more of these clients to the services business as opposed to the on-premise?

Yeah, that's kind of the $64,000 question in dollars that Gabe was asking earlier about qualitatively. Here's the two trend lines that are happening and why it's so hard to answer the question so you don't think we know the answer and don't want to tell you. There's two things happening and they move in opposite directions, right? There is absolutely going to be an upward tick in the demand for product, just like there was a downward tick when COVID hit as economies start to reopen. And at the same time that's happening, there is the longer term unrelated to COVID downward tick in product sales and related to things that are not economic but industry. So think, you know, the movement away from premise to cloud means fewer people are going to buy on-premise systems. Or the movement away from the PSTN means fewer people need to buy a gateway, right? And so, you know, this whole idea of providing guidance and why it's so hard and why so many companies stop doing it is because it's hard to figure out how those two competing curves combine. And, you know, is the one that suggests things will go up in a positive direction slightly bigger, slightly steeper than the one that suggests it's going to decline gradually over time? Or is it the other way? And, you know, gosh, I don't think, Josh, we want to, you know, pin our reputation on it's going to be minus 2% or plus 3%. I think I would prefer just to stick with... If you're buying Sangoma stock, you're buying it because we're a SaaS company. We've gone from no recurring revenue and zero SaaS to 75%. We're now one of the top five or six companies in the world. And we honestly, you know, we don't spend very much time internally trying to figure out, is it going to be minus three or plus two? And so I don't want to hang myself here by telling you that answer and getting it wrong when it's just not something that we focus on. Like, I can't afford to have it drop by 15%, right? But if it goes down by five versus plus one or up by three versus minus two, we just accept that situation. you know, the combination of those trend lines, Josh, and focus on the other one.

Fair enough. I think to your point, people are much more focused on the SaaS business. But I guess one last question for me, then I'll hop back in the queue, is just looking at this star to star, given there's still some COVID restrictions and whatnot, like what's the expected integration timeline? And fair to assume that since they have a lot of these mid-market enterprise customers that that probably come with higher ARPU, I would expect potentially, and what are some of the kind of the biggest cross-selling opportunities and how long do you capitalize on those?

Yep, yep. So maybe two parts to your question. One is, you know, what does the integration timeline look like and what's cross-selling look like? So what we've said internally is we would like the integration process to be bookended at around six months. Here's what I mean by six months and what can be done within that time window and what can't. All of the work on planning and making a decision in each of the integration projects I listed, right, product integration, back office integration, people, customers and channels, IT, et cetera, cloud network, all of those things can be discussed understand how each company did it before, make a decision about how it's going to be done in the future, and lots of the actions will be finished within those six months. But not everything can be finished in six months. The decisions can, but things like, I don't know, Josh, we've probably got software and infrastructure in nine or ten data centers now between the two predecessor companies. it's not likely we need 10 data centers, right? But consolidating them and putting 10 down to whatever it ends up being, let's say it's going to be five or whatever, it's not something that's likely to happen in six months. You got to go through the network architecture and decide what you're doing and standardize on what that will be. And you then have to extract yourself from data center contracts and stuff. And that's just one example. It applies in a whole bunch of ways, right? If you're, I don't know, using... two different accounting systems, whether we'll be fully off one and onto the other in six months. I don't know. But most of the actions will be done, not all. And I hope all of the thinking and decisions will be made within those six months. On the cross-selling work, I personally think the lowest hanging fruit, and we're just starting this, as you heard me say, we're in the process of cross-training the teams first before we can get out there and push hard on cross-selling. I think the lowest hanging fruit, strangely enough, having said that product sales are not our focus, is Star to Star did not have an on-premise system at all. And half of the purchases are on-prem. And if you're a customer or a channel partner, I don't know, something like half of the sales cycles would naturally lead to a conversation about prem that Star to Star had to walk away from in the past. And so I I'm hoping that will be the earliest uptick. We'll see how that goes. We've already seen some early examples of that where customers were pulling on us because we weren't quite ready to be pushing on them. But, you know, I mentioned we're going to use the Sangoma Video Meeting Service or the Star-to-Star CPaaS service. So this has to be cross-pollinated between the two companies as well. And those are the kind of things that I meant when I said you know, six or seven weeks in. It's just too early for me to give you any, you know, real tangible feedback. But that's where I see it going.

Thanks. I'll hop back into the queue. Okay.

Once again, if you have a question, please press star, then one. The next question comes from Eric Martinuzzi with Lake Street Capital Markets. Please go ahead.

Hey, congrats on completing the acquisition and the strong quarter there. I wanted to talk about the Q4 guide and kind of come at it from a different angle. I just want to understand the momentum in the two businesses. So the Delta current guidance versus your old guidance, if we just look at the core business, would there have been any change? And I know the FX issue is in play here, but would there have been any change to your prior guidance? Let's say the start of start transaction had not closed. Would we still be talking about kind of midpoint $145 million on the core on the legacy business and midpoint of $25 million on the EBITDA?

It's a bit hard to know, Eric. It's actually a good question because... You know, we didn't approach it that way. We approached it as, what does it look like now? If we hadn't have done star to star, then we would have had two things to figure out. We are performing well against guidance, but the FX rate has, you know, totally caught us by surprise. You know, last year you heard me say the FX rate in the quarter was 1.37. It's 1.21 right now, right? Very big change. So I'd have to go back and do some arithmetic and I'm happy to do that and give you a call later if you would like. But my guess is we would, yes, be doing pretty well and on track as measured in U.S. dollars. But in Canadian dollars, my guess is with the exchange rate, we'd be a little bit below the 143 number of the guidance.

Okay. I mean, that's kind of what I was thinking. I also was paying attention to the FX flow over the past 90 days, and certainly it was not favorable. I wanted a question for you, David. On the gross margin, you had talked about, you know, with Star to Star better than 80% and Sangoma at 66%, that the goal was to get above 70% on the combined operations here. Is that the expectation for Q4 that we'll see something 70% or north on the gross margin?

Yes, that's correct. It will be very similar to what we had put into the circular. I'm not expecting any changes from that on a directional basis.

Okay. And then this one's for either Bill or maybe Larry if he's going to be contributing on the call, but Just curious to know about the competitive landscape for Star to Star. I know it would be absolutely normal for competitors to be coming into deals that are live and trying to disrupt the Star to Star pipeline, which maybe would not impact fiscal Q3 or fiscal Q4, but might have some impact on fiscal Q1, Q2. Are we seeing anything that's disruptive

potentially disruptive or maybe even there was a deal that we were the lead candidate for and we're no longer the running yeah there's no sign of that yet at all Eric which doesn't necessarily mean it won't happen here and there you know and a business like ours that has a very large number of customers and a large number of transactions it's perfectly common, you know, that we, we, we lose deals to competitors. That's why you manage this with a sales funnel or a sales pipeline and look at it statistically rather than, you know, can you be definitive with a hundred percent certainty that deal number 17 on your pipeline is going to close. So I think it is reasonable to expect that our competitors are doing that, you know, that's what we would be doing. Um, But I haven't heard of a single case where we were in the running and then got pushed down or knocked out. And while I don't want to sound arrogant in any way, it would seem strange to me that a competitor would be able to do that. The argument one would normally make if you were trying to use a deal like this against us is, oh, you should be worried that your product's not continuing. And we've explicitly stated to the market that unambiguously that that's not the case. You know, and any call I've been on where that's been asked, that's what I've said. You know, no fuzziness, no gray area, no wiggle words. Stop worrying. So I'm hopeful that will not become an issue, and I'm quite confident about it, actually.

Okay. Well, that covers my questions. Congrats on that strong services number, and good luck on your first quarter together.

Okay.

Thank you.

This concludes the question and answer session. I would like to turn the conference back over to David Moore for any closing remarks.

Thank you, Operator. Bill, we've got no further people in the queue, so let's bring the call to a close, and I want to say a big thank you for all the participants today. Thank you very much for your support. You provided us, and we look forward to speaking to you again in our next call.

Okay, great. Thank you, everyone. I appreciate it. Have a good night.

This concludes today's conference call. You may disconnect your line. Thank you for participating and have a pleasant day.