Sangoma Technologies Corporation

Thank you for standing by. This is the conference operator. Welcome to Syngoma Technologies' third quarter fiscal year 2022 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.

Thank you, operator. Hello, everyone, and welcome to Sangoma's third quarter investor call of our fiscal year 2022. We're recording the call and we'll make it available on our website for anyone who is unable to join us live. I'm here today with Bill Wignall, Sangoma's president and chief executive officer, Larry Stock, chief corporate officer, and Samantha Reburn, general counsel, to take you through the results of the third quarter, which started on January 1st, And we will also discuss the press release that was distributed yesterday, together with the company's unaudited interim Q3 financial statements and MD&A, which are available on CEDAR, EDGAR, and our website. As a reminder, Sangoma reports under International Financial Reporting Standards, IFRS, and during the call we may refer to terms such as adjusted operating income, adjusted EBITDA, and adjusted cash flow, that are not IFRS measures, but which are defined in our MD&A. Also, please note that unless otherwise stated, all references to dollars are now to the U.S. dollar, as we've started reporting U.S. dollars now for fiscal 22 and beyond. This includes all prior period comparisons, which have been converted to USD, as described in Note 2 of our financial statements. Before we start, I'd like to remind you that 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're subject to various risks and uncertainties, and actual results might differ materially from those projected in the 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 CEDAW. With that, I'll hand the call over to Bill.

Thank you, David. Good morning, everyone, and thanks for joining us today. I have structured my prepared remarks for this call into five sections. I will first focus on Q3 and then move on to year-to-date results. In my third section, I'll give a brief update on the recent net fortress acquisition. Fourth, I will provide an update on our overall strategy. And finally, I'll touch on our guidance for the remainder of fiscal 22. 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. Just before I begin, I simply wanted to offer a short reminder regarding the timing of the Net Fortress acquisition. Given the transaction did not close until March 28th, there is minimal impact from Net Fortress on our income statement for Q3, except for the transaction expenses and, of course, their impact on net income. With that, let's move on to the first section covering Q3 results. Sales for the quarter ended March 31st were a record $55.13 million, almost double that of the $27.95 million in the third quarter of fiscal 21. This increase in sales was primarily driven by the acquisition of Star to Star last year in Q3 of fiscal 21, such that it is included in this year's Q3 results, but not last year's. By the continuing growth and compounding in our existing services business, and by an uptick in our product sales. And sequentially, our Q3 revenue grew by approximately 2% from the immediately preceding second. Okay, everyone, sorry for this technical difficulties. I'll start back again at the beginning of fiscal Q3 results, since it's not entirely clear to us which section you guys lost us at. Sales for the quarter ended March 31st were a record $55.13 million, almost double that of $27.95 million in the third quarter of fiscal 21. This increase in sales was primarily driven by the acquisition of Star to Star last year in Q3 of fiscal 21, such that it is included in this year's Q3 results, but not last year's, and by the continuing growth in compounding in our existing services business as well as by an uptick in product sales. Sequentially, our Q3 revenue grew by approximately 2% from the immediately preceding second quarter. Our recurring revenue through our services business continues to be our strategic focus, and we've seen significant growth year over year. In Q3, our services revenue came in at approximately $39 million this year, about 2.5 times the 15.8 million from the same quarter last year. This $39 million represents 70% of total sales for the quarter. As discussed during last quarter's call, our long-term trend of consistent strengthening in services revenue going from under $5 million per quarter in fiscal 18 to about $39 million per quarter now has truly been a milestone achievement in your company and one that will continue to accelerate with the Net Fortress acquisition. Close profit for the third quarter of fiscal 22 was $38.96 million, also more than double that of $18.31 million in Q3 of last year. Gross margin for the quarter was over 71% of revenue, up from 66% in the same quarter a year ago. This is driven principally by the steady increase in the percentage of revenue that comes from services, including the positive higher margin contributions from start to start. These levels of gross margin amongst the highest in our industry are even more satisfying given that our cost of goods continues to feel pressure from the global supply chain disruptions that are affecting so many companies and industries around the world. Although we've touched on this ongoing supply chain pressure in previous quarters, I thought it would be useful to discuss the impact a little further today, given all the media attention on it and given that some of our analysts are now commenting on it as well. Most importantly, I wanted to start by pointing out the fact that my comments in the prior section on revenue, and more specifically that our services revenue hit $39 million this past quarter, or 70% of sales, really helps us on this topic of supply chain disruption. Only 30% of our revenue is in products now, and only a part of that is physical goods like phones. Everything else, which means the remainder of the product bucket, for example, our on-premise UC software, and all of our services revenue, is totally sheltered from such supply chain issues, of course. For the part that is subject to supply chain pressure, indeed like our desk phones, we continue to contend with several factors that many companies around the world are facing these days, such as component supply shortages, longer lead times for these components, often higher prices for such parts, extended manufacturing periods at our contract manufacturers, renewed lockdowns in some regions, including China, delays in shipping, and some increased shipping costs. While the disruptions have been impacting us for several quarters now, we still saw a slight increase in supply chain costs for this most recent quarter as well, affecting our gross margin by a percent or two. And yet, despite all of these headwinds, we were still able to meet all of our customers' orders in the third quarter, which is our top priority, even if it cost us a point or two in margin this quarter. Further, we continue to find instances where our ability to manage the supply chain has become a competitive advantage, enabling Sangoma to ship products when our competitors could not. And it's worthwhile mentioning that such a competitive advantage is a benefit not only to the capital P product part of our business, but also to our centrally strategic services business. Given that, for example, being able to ship desk phones to customers, and this is an essential step in turning up a new UCAS subscriber and beginning revenue recognition for that new customer win. Finally, I'd like to finish up my supply chain detail with the observation that we do expect these constraints to continue in the upcoming quarters, but I'm confident that the Sangoma team will continue to do a remarkable job in managing these challenging circumstances. Operating expenses for the third quarter this year were $41.9 million versus $15.76 million in the same period last year. The higher operating expenses were primarily driven by the costs that came with the addition of Star to Star. As I've done in recent quarters, I will offer some insights into the three individual OPEX buckets, namely sales and marketing, R&D, and GMA. Regarding sales and marketing, you'll notice that the portion of our OpEx that is in the sales and marketing category has continued to be significantly higher versus the prior year. This was primarily the result of the Star to Star sales team, the channel partner commissions, the incremental marketing staff, and the accompanying marketing program spent. With respect to R&D, the increase in the third quarter of fiscal 22 from the same quarter of the prior year is largely due to the addition of the Star-to-Star engineering teams and our continued investment in innovation. This follows our general approach to OPEC spending. As measured in absolute dollars, Sangoma continues to invest more money every year into R&D for product development than we spent in the prior year, but we closely control that spending as a percentage of revenue. And finally, the G&A expense also shows a significant increase year over year, which, as in recent quarters, was driven primarily by the addition of the Star-to-Star admin groups and the non-cash amortization of the intangible assets acquired at the time of that transaction, stock-based compensation expenses, and higher D&O insurance premiums following our listing on NASDAQ, which took place in mid-December. Net income for the third quarter was negative $6.76 million, primarily due to interest expense, which was up because of the additional debt taken on to finance Star to Star, and the one-time transaction costs for the acquisition of Net Fortress at about $3.1 million. Adjusted EBITDA was a record in the third quarter at $10.47 million, almost double the $5.35 million from the third quarter of the previous fiscal year and exceeding $10 million for the third consecutive quarter. This level of adjusted EBITDA is equivalent to about 19% of sales. That brings my commentary on our Q3 income statement to a close, and I'd now like to cover a few highlights from our balance sheet and cash flow. As you will see, our overall balance sheet remains strong. Our cash balance at the end of the third quarter was $16.24 million, which is slightly lower than on December 31st. This was due primarily to the funding of the net fortress acquisition, a modest increase in accounts receivable, an increase in inventory, both of which I'll explain now. Trade receivables increased, finishing the third quarter at $18.42 million, as compared to just under $16 million on December 31st. The increase this quarter was primarily due to receivables added as part of the Net Fortress acquisition. Inventories were $16.47 million on March 31st, $2.13 million higher than on December 31st, which reflects the current supply chain pressures mentioned earlier, as well as the additional inventory taken on from Net Fortress. We expect elevated inventory levels to continue for the next few quarters. From a cash flow perspective, during the third quarter, we generated adjusted cash flow from operations of $5.06 million, and this measure of adjusted cash flow excludes the impact of acquisitions, financing, and other non-operating anomalies. That brings my comment on Q3 financial results to a close. So let's now turn to the year-to-date results. Sales for the nine months of fiscal 22 were $161.84 million, almost double that of the $81.26 million in the same period of fiscal 21. The increase in sales was due to the same factors I covered in my comments on Q3 a few moments ago. namely the start-to-start acquisition, the continued growth and compounding of the company's services business, and an uptick in the product business. As a percentage of total sales, our services revenue is 70% for the first nine months of fiscal 22, a solid increase from the 56% in the same period last year. Gross profit for the nine months of fiscal 22 was $116.22 million, more than double the $53.56 million realized last year. Gross margin was approximately 72% of sales on this year-to-date basis, up from 66% in the same period of fiscal 21. It's especially gratifying as the global supply chain has been strained this year to see Sangoma at these levels of gross margin nine months into fiscal 22, a level that's near the top of our industry. Operating expense for the nine months of fiscal 22 was $120.85 million as compared to $45.65 million during the same period last year. The increase was mainly due to the incremental expense associated with the addition of Star to Star and the increase in G&A outlined earlier. EBITDA is almost $31 million for the year so far and is about double the $15.43 million of the same period last year. This is equivalent to about 19% of sales for the first nine months. And finally, year-to-date net income is negative $11.53 million, which was impacted by the factors outlined earlier in my prepared remarks about the third quarter. That brings my commentary on the year-to-date income statement to a close. We've already touched on the balance sheet in my Q3 remarks, so I'd like to just briefly mention cash flow. For the nine months of fiscal 22, we've generated adjusted cash flow of $14.1 million. This is quite similar to that generated in the same period of the prior year, despite our higher adjusted EBITDA. This is for a few reasons in fiscal 22. For example, we needed to use working capital to build incremental inventory and pay in advance to secure critical parts in response to the global supply chain pressures, to fund receivables as our sales have grown, to draw down deferred revenue somewhat as we move more and more away from a product company to a SaaS model, such that on-premise maintenance gradually declines and gets replaced with cloud MRR, We've increased modestly our development cost initiatives and had to pay higher taxes. As indicated earlier, and as you will have heard from other companies, we expect these supply chain pressures to continue for some time, but we fully expect to manage through them successfully, as we've been doing, in order to continue meeting our customers' expectations. Finally, as was the case with prior quarters, we are, of course, comfortably within all of our debt covenants. and their overall balance sheet remains healthy. That brings my comments on year-to-date financial results to a close, so let's now move to our third section today, a quick update on the Net Fortress acquisition. As most of you on this call will know, Net Fortress represents Sangoma's 11th acquisition in 11 years. As we've noted when we announced the acquisition, It's an exciting transaction for us because it further accelerates Sangoma into the upper echelon of SaaS communications providers, and it extends our industry-leading suite of cloud services with new MSP capabilities, thereby delivering even more one-stop shopping for our customers and providing a larger share of wallet for Sangoma. at a time when we're hearing more clients seek more of the communications they need from fewer trusted vendors. So while it's only been a few weeks since the transaction closed, and thus it is indeed very early to provide a substantive report on integration, I did want to give you a short update based upon what's transpired thus far. I'll provide that short update by touching on four things about NetFortress, customers and channels, product, the integration of the organization and cost synergies. From a customer and channel perspective, the integration is just beginning. We have now held multiple sessions with our channels from each predecessor company, both formal webinars and one-on-one meetings. We've introduced the strategic fit and explained to them how the broader product portfolio can benefit their sales and their customers. In general, the reaction from the channels has been overwhelmingly positive, with many partners agreeing with the approach of more communications products from fewer trusted suppliers being exactly what they're being asked for. And as for end customers, our sales teams are starting the outreach. And that customer contact goes right up through all levels of our customer-facing organization right to me. I've personally now spoken with many of the largest Net Fortress customers, myself, clients who spend tens or hundreds of thousands of dollars per month in MRR with us. For sure, I can confirm that they understand and were excited by the broader suite of products, of course, but it was also reassuring to hear from many of them that they also appreciated knowing Net Fortress is now part of a much larger, financially healthy, stable, growing public company. That was good to hear. Next, regarding products, it really is extremely soon after the acquisition to say too much on this one. The early attention in the product area is on a couple of things. We need to explain the complementary products now available to each prior customer base, whether it's the full suite of cloud services now becoming available to the Net Fortress base or the new MSP services to the Sangoma customers. This is more product management and product marketing work than it is engineering or software development at this early stage. The other key product work is on network planning as we start thinking about how to bring the Sangoma network and the Net Fortress network more together. This is all the data centers where the SaaS software is hosted, all the switching and routing, all the databases, the security and the traffic handling. And in fact, on that last point, we are already beginning the work on traffic engineering by looking at the ways in which we can save costs in that area. And now for organizational alignment and the integration of the Net Fortress team into Sangoma. I'll start by saying that I'm very pleased with how the companies are coming together early on. We've already made truly significant progress on bringing the people together. Our general approach at Sangoma has always been to gradually integrate the acquired business into our broader company rather than have it continue as a standalone operating entity. And that is precisely how it's playing out this time as well. We have already integrated most all of the functional groups from Net Fortress into their respective departments at Sangoma. This includes finance, legal, HR, marketing, product management, engineering, network operations, etc. All in less than two months. The one department that we are integrating more slowly in this case is sales. For the next couple of quarters, it will remain business as usual for our two sales organizations from each prior company, simply to avoid disrupting sales momentum, to give the needed time for cross-training, and to support the earned-out structure inherent in the transaction. And finally, in the last part of my Net Fortress update, I want to touch on synergies. Some of you may recall that when we announced this acquisition, we explained that we expected about $4 million in annualized cost savings. I'm pleased to report that we are already off to a very good start on that project, because based upon the department integration I've just covered, we have already begun realizing such synergies in our current quarter, Q4, even a bit earlier than anticipated. We are now well on track to hit that target, and we may even do slightly better. we still expect to be at or maybe even slightly above the $4 million within six months. These savings are coming from the areas we outlined when we announced the transaction, namely efficiencies, removing duplication in staff, consolidating traffic, amalgamating data centers, getting rid of duplicate marketing programs or audits or insurance, et cetera. And that brings my Net Fortress update to a close for today. I fully realize that this one was an initial preliminary level given it's only been a short while since we closed. But I'll provide you with further integration details on our Q4 call once we've been together for a bit longer. I'll now turn to a few comments on strategy. Today I'll focus my strategy remarks on our competitive differentiation and on our investor relations activity in the public equity markets. As I've highlighted on previous calls, the cloud communication space is competitive and to see increased consolidation. For a company to remain a top player in this sector, they have to have competitive distinction. We are clear about what makes Sangoma stand out and we work hard to ensure our customer facing teams communicate this consistently to customers, prospects and partners. Those of you who have joined us on other calls have heard me explain our differentiation in the following way. First, we have the widest set of cloud communication services in the industry. From UCAS to trunking as a service to contact center as a service to video meetings as a service, collaboration as a service, CPaaS, desktop as a service, access control as a service, and now our new MSP services. Nobody else comes close. Second, our ability to offer multiple deployment options from pure cloud to on-premise to hybrid solutions means Sangoma is arguably the only significant communications SaaS company that can say this. And third, we make the entire product portfolio complementing our cloud services with our own set of products, such as desk phones or SBCs or headsets, now more common in work from home settings. that allow us to make these products do things our competitors cannot, since they buy them simply from other third-party firms, and enable us to offer a true one-throat-to-choke commitment to customers. Further, Cengom increasingly believes that customers want an integrated buying experience or one-stop shopping. This approach has been our focus for some time, and it's the basis for the first competitive differentiation strategy I just explained, because we believe that customers do not want to buy five different cloud services from five different vendors. It was that existing competitive differentiation strategy that made the acquisition of Net Fortress such a good fit specifically for Sangoma, as we further expanded that approach with our new MSP offerings. This is a fairly new concept in our industry, one that few UCaaS companies have yet embraced, and one that we believe will be a lucrative model for us securing larger share of wallets and ARPU while being much appreciated by our customers and channel partners. Our differentiation in the industry plays an important role in my next topic about public equity markets and your company's IR efforts to secure the recognition we believe Sangoma deserves and that we feel we've earned. We continue to focus on raising our profile on the TSX and NASDAQ markets and with investors there, given a very solid performance. With Sangoma's transformation story, our total growth model delivering greater than 50% CAGR over the last seven years, and our impressive growth with profit commitment, we have believed for quite some time that our stock has been dramatically undervalued, a perspective that I know a lot of you on this call share. Given today's macro environment, economic trends and the current equity market conditions, Sangoma's share price has indeed taken a beating. It is very upsetting to us as a company, as a board, to your executive team and the staff that work extremely hard for your company every day. And yes, admittedly, to me personally, in such volatile times, many market players contend to focus their buying on large cap names and bid market companies can suffer. get caught up in the technical down draft. We firmly believe Sangoma provides a phenomenal buying opportunity for investors, especially given recent share prices combined with our strategic and operational results. With that said, we've been actively working on multiple initiatives in this area, including increasing our research coverage. As you may have heard me say last quarter, we've added coverage from each of TD, BMO and Canaccord recently. And in the near future, we understand that we'll be seeing new excellent coverage from multiple analysts in the US very shortly. More to come on that in Q4, so please stay tuned because you'll appreciate I can't say much more about it just now. We've also been focused on inclusion in several key indexes, and I'm pleased to say that Sangoma will have an opportunity to be added to a few important ones very soon. For example, with our cross listing to NASDAQ, The upcoming reconstitution periods happening in summer should place us in an index or two there, we believe. A similar opportunity exists on the TSX, with our listing there having now met the minimum six-month timeframe to be considered. Well, I don't want to get too far out in front of myself here. We feel these steps will help garner more exposure for Sangoma in the public equity markets. That concludes my comments on our strategy and while Sangoma is of course not immune to market trends, we remain optimistic that completing major steps such as these should help trading volumes and share price as well. With that, I'll move on to my fifth and final section today on guidance for fiscal 22. On the last call covering Q2 results, I explained that we changed our guidance for the year based upon performance for the first two quarters. At that time in February, we increased our expected revenue to a range of between $215 and $219 million for fiscal 22 and adjusted EBITDA up to $42 to $44 million for the year. Following the acquisition of Net Fortress and the results of our third quarter, we are increasing revenue guidance further for fiscal 22. We now expect revenue to be between $230 and $232 million. The increase in revenue guidance factors in many considerations as outlined more fully in our press release and MD&A, but includes assumptions regarding supply chain constraints and our ongoing ability to manage them as in the past, revenue trends continuing, as well as demand and subscriber growth. We are also reconfirming our guidance for adjusted EBITDA up between 42 and 44 million per fiscal 22. This decision also factors in several considerations, including the ongoing supply chain challenges and the inclusion of net fortress in our fiscal Q4 results. We expect net fortress will contribute adjusted EBITDA at about the breakeven level in our fourth quarter, during which we are implementing many of the synergies you just heard me speak about earlier. such that we're confident we'll have material positive EBITDA already going into fiscal 23. With that, I'd now like to bring my prepared remarks to a close with a quick summary. This quarter was another testament to the hard work and dedication of the Sangoma team, a team that continues to rise to the occasion despite the macro-level challenges we face, delivering consistent, excellent, growing financial results for our shareholders all while continuing to provide the best service to our customers. And it's a team that's growing through the Net Fortress acquisition. We are excited about the services, talent, customers, channel, and growth there, and we look forward to extending our already widest set of communications SaaS products in the industry. This quarter also saw Sangoma meet our strategic and operational goals. From an operational perspective, we've seen our services business, where the recurring revenue is generated, expand nicely year over year, with Q3 at about $39 million, up about $1 million from the preceding quarter. Our services business is, of course, supplemented by our product business, which has maintained its solid revenue quarter over quarter. From a strategic perspective, we continue to emphasize growth, utilizing what we call our total growth model, which I've described as a combination of organic growth and prudent, disciplined M&A activity. The Net Fortress acquisition is a perfect example of this model. Our ability to cross-sell will help us see additional growth, positioning us to take advantage of a growing industry and the macro trend of moving to the cloud. The strategic direction and success at Sangoma has me excited for the future and the trajectory of your company. And with that, I'll turn the call back over to David for questions.