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.