Sangoma Technologies Corporation

Thank you for standing by. This is the conference operator. Welcome to the Sangoma 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 Larry Stock, Chief Financial Officer. Please go ahead.

Thank you, operator. Hello, everyone, and welcome to Sangoma's first quarter fiscal 2023 investor call. We are recording this call and we will 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, and Samantha Reburn, General Counsel, to take you through the results of the first quarter of fiscal year 2023, which ended on September 30, 2022. We will discuss the press release that was distributed yesterday, together with the company's unaudited interim financial statements and MD&A, which are available on CDARC, 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 non-IFRS measures, but which are defined in our MD&A. Also, please note that unless otherwise stated, all references to dollars are to the U.S. dollar, as we have started reporting in U.S. dollars now for FY22 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 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, estimates, plans, 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 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 CDAR and EDGAR. And with that, I'll hand the call over to Bill.

Thank you, Larry. Good morning, everyone, and thanks for joining us today. I typically keep my prepared remarks a little shorter for our Q1 calls together, and this one is no exception. If there is anyone joining us on these calls for the first time today, I would invite you to listen to the recording of our Q4 fiscal 22 results from September 30, just a few weeks ago, which is available on our website. On that year-end call, I provided a very extensive update on our business, and that call would also give you a more detailed explanation of adjustments made in Q4 that have some impact on certain year-over-year comparisons. Okay, so I've structured my prepared remarks for this call into three sections. I will first discuss our first quarter operating results, and then I'll add some commentary on a few strategic topics. And finally, I will review forward guidance for fiscal 23. As always, I'll then wrap up with a brief summary and turn the call back over to Larry for our typical open Q&A session. So let's get started with Q1 results. In this first section on operating results, I'll cover highlights from our first quarter. I'll skip my normal year-to-date remarks, of course, given it's Q1, and I'll conclude with a few comments on the balance sheet and cash flow. Sales for the first quarter of fiscal 23 were $64.1 million, which is up 24% when compared to the same period in fiscal 22. This substantial year-over-year increase is driven primarily by the growth in compounding in our services business, where the recurring revenue is generated, which I'll discuss a bit more in a moment, and also, of course, by the acquisition of Net Fortress. And this $64.1 million for Q1 is down 3% from the $66.3 million in the immediately preceding fourth quarter of fiscal 22. It's not surprising for us to see our first quarter dip slightly from Q4 of the prior year as Sangoma has indeed felt the impact of seasonality in most years. That doesn't always show up because in some years it can be masked a bit depending upon the timing of certain acquisitions. But in general, Q4 has been our strongest quarter and the summer months have always been a bit weaker, especially in the European markets where summer holidays impact order flow, causing that small dip from Q4 to Q1. Such trends naturally affect our capital P product business, more so than our services business, given the product revenue is lumpier and not recurring. In addition to seasonality, we've also seen this quarter that sales of our product business were impacted by some of the macro effects we all see out there these days. General economic headwinds have a more noticeable effect on product sales than on services, because such purchases are usually seen as capex purchases by our customers. whereas our service subscriptions are OPEX, of course. And if those economic headwinds are a second-order effect, then outside of North America, we also see a smaller third-order effect from FX rates. I just want to be a little bit careful as I explain this one. In calls like these a few years ago, we'd often talk about the effects of FX on the top line and in the middle of our income statement because we reported in Canadian dollars. The top line due to the sale of a widget for 100 US dollars converting to 130 Canadian or 110 Canadian depending upon prevailing rates at the time. And in the middle of our P&L from the revaluation of balance sheet items like inventory or receivables as their value in Canadian dollars fluctuated with the US dollar rate. All that is gone now given we've been reporting in US dollars as Larry just mentioned. So that is not what I'm referring to, and given several of our analysts wrote about this extensively in the past, I just wanted to clarify. What we're referring to today is the effect on a possible customer in Europe or Asia or Latin America from the strong US dollar recently. That is, given we sell almost exclusively in US dollars around the globe, the perceived cost in most local currencies has gone up. For example, When we sell a Sangoma widget for 100 US dollars in the UK, the product was seen by a local buyer as costing them about 65 pounds a few years ago, and it would cost them about 85 pounds today, purely due to the strong dollar and weaker pound. And that's not unique to the UK, of course. If the buyer were in India, that same $100 widget, which cost them 6,300 rupees a few years ago, would cost them over 8,000 rupees today. And such trends have an impact on purchases of our capital P products abroad. So the cumulative effects of seasonality, general economic headwinds, and effects on the sales of our products caused the product revenue to dip by about 9% this quarter from Q4. And that's what drove the overall drop in total sales sequentially. While our product sales dropped a bit, given all that's going on in the world, our services business held up pretty well, and that's good. It makes sense, and it's what we expect, given it's the services business which is the driver of Sangoma's growth, not our product side. So let's look a little deeper, too, at our services revenue. The long-term trend as Sangoma has successfully evolved their business to a SaaS model continues to produce success. Not only was our total revenue up 24% year over year in the quarter, but our services revenue more specifically was up 35% as compared to the same period in fiscal 22. And just as importantly, our services revenue as a fraction of total sales crossed 75% for the first time. This is a big accomplishment and an indicator that our long-term strategy is working just as intended. More on that in the strategy section coming up. Our cost of goods sold came in at 32.3% of revenue, which is down slightly from the 32.9% in the most recently completed Q4 of fiscal 22. Supply chain disruptions remain an impact on cost of goods, as I've discussed at length on recent calls, so I won't go into it again on this one. Suffice to say that Sangoma does a really good job in this area, producing some of the highest gross margins in the industry, while we continue to be able to fill most orders without the other stock issues that many of our competitors have been contending with. Gross profit for the first quarter was $43.3 million, up 18% from the $36.9 million in Q4 of last year. Gross margin for the quarter was approximately 68% of revenue, which is up slightly from the 67% last quarter. As we previously indicated, this is generally in line with our expectations for fiscal 23. Operating expenses for the first quarter were $44.4 million versus $45.7 million in the most recent fourth quarter. The reduction from the prior quarter by another $1 million per quarter is the result of the second and final stage of the net fortress integration and restructuring. Adjusted EBITDA on the first quarter of fiscal 23 came in at $10.7 million, an increase of 6% from the first quarter of the previous fiscal year, and a decrease of 3% from the immediately preceding Q4 consistent with the 3% sequential revenue dip already covered. This EBITDA result translates to 17% of sales for the first quarter of fiscal 23. With the net fortress integration and restructuring now in place, we expect EBITDA margins to continue in that range. And as mentioned in our press release from last night, we've built a resilient business with the inherent flexibility that enables us to adjust OPEX if it were necessary in order to protect profitability. Net loss for the first quarter of fiscal 23 was $1.98 million versus a net loss of $2.3 million in the same period last year. That completes my remarks on our P&L results and I now like to turn to a few comments on our balance sheet and cash flow. Our cash balance at the end of the first quarter was $8.3 million down from the prior quarter as we continue to pay down debt each quarter. In fact, I'd like to pause here for a moment just to definitively reassure Sangoma shareholders regarding our debt levels and debt service. I hear a lot of questions these days from investors and other companies, questions that make perfect sense and the debt levels in some other companies' businesses. Please know that Sangoma has always taken a prudent approach to managing our business, our P&L, and our balance sheet. We have believed in a balanced growth approach, not growth at any cost, and have done so from the very beginning since I took over, not in a reactive response to some recently changed market sentiment by those who have now somehow seen the light. That means we prioritize profitable growth above maximum possible growth. That means we prioritize prudent use of debt to help manage dilution, but not exposing your company to undue leverage. And that means we now have a company in which we repay almost $4.5 million of principal each quarter, an approach we feel makes more sense now than ever, delivering assertively during increasing uncertain economic times. Our gross debt level is now sitting at about $100 million, and with EBITDA guidance of about $50 million at the midpoint of the range, you can do the math. As a result, our balance sheet continues to remain strong. Our debt load is reasonably modest given EBITDA levels. We have the resilient business model I touched on earlier that enables us to adjust op-ex, if required, to protect profitability during these unpredictable economic times, and we are de-levering, as I just mentioned. Finally, of course, we are also comfortably within all of our debt covenants, and I hope those comments are sufficiently reassuring to you so that you do not need to worry about Sangoma's debt servicing. Moving on with other items on the balance sheet, trade receivables ended the first quarter at $17.2 million, as compared to $14.1 million for the same period last year, and $16.1 million for the end of the prior quarter. The growth in receivables year over year at 22% aligns appropriately with our revenue growth of 24%. inventory balances at the end of the first quarter were 19.1 million dollars compared to 12.7 million in the same period last year and up slightly from the 17.4 million in the immediately preceding fourth quarter of fiscal 22. as we have discussed previously the increase in inventory is driven in part by strategic purchases to combat supply chain challenges and specifically in q1 we had some larger purchases to get the new line of P Series desk phones in stock, a product line we're all very excited about. And finally, I'd like to offer a short comment on adjusted cash flow. This quarter, we generated adjusted cash flow of $3.2 million. Historically, during the first part of the year, net cash from operating activities has run a bit lower than in the latter parts of the year. During this first quarter, That number came in at $3.6 million as compared to an average of $3.3 million for the first two quarters of fiscal 22. It has been common that the timing of some payments has occurred early in the year, and for instance, in this quarter, we saw a bump in audit-related fees as we transitioned to a larger audit firm, slightly higher professional fees, and a significant income tax payment all having an impact on adjusted cash flow in Q1. That brings my commentary on our first quarter financial results to a close, and I'll move to my second section, the strategic topics for today. In this part of today's call, I will touch on Sangoma's competitive differentiation strategy in the industry, our positioning to the public equity markets, a quick update on the integration of Net Fortress, I'll offer a comment on our share price and finally a word or two about M&A in this climate. Okay, let's start with a reminder of our competitive differentiation. As Sangoma has rounded out its product portfolio over the past few years, via good solid in-house engineering augmented by strategic M&A, the breadth of our product suite has grown. This was entirely conscious, of course, as we sought to build out our cloud services to deliver on our stated strategy. That strategy involved getting Sangoma to the point where we had all the pieces of a cloud communication solution that would enable a customer to buy everything from us in a one-stop shopping experience. As we hear time and time again, businesses of all sizes are looking for a single vendor to provide most of their communications needs instead of needing to buy five different products from five different vendors with five different bake-offs five different contracts, five different invoices each month, five different tech support lines to call, and five different products that they then need to integrate. We now have that capability and we leverage it every day when describing our three key points of competitive differentiation to a customer. One, Sangoma has the widest suite of cloud communication services in the industry. UCAS, trunking as a service, contact center as a service, video meetings as a service, collaboration as a service, CPaaS, managed SD-WAN, et cetera. Sangoma has solutions for cloud, on-prem, and hybrid. We find the path to yes, no matter which deployment option the customer prefers, something that no cloud or on-prem competitor can match. And third, Sangoma makes all of its own products right down to the desk phones. Better functionality, better network uptime, better engineering velocity, better supply chain, better integration, one throat to choke. Second, I'd like to touch on our positioning to the public equity markets. That positioning includes our total growth model, in which organic growth is augmented with strategic M&A, a commitment to growth with profitability, not growth at any cost, which so many of our competitors tried, tapping into the enormous TAM that remains very under-penetrated all backed by the clear, competitively differentiated strategy in our industry that I just covered. Sangoma is now large enough to be disruptive with about 750 staff and nimble enough to pivot quickly and is becoming a destination employer as our growth provides career opportunities for our valued staff and underpinning all of this, a company that customers and channel partners want to do business with. Third, I'd like to offer a quick update on the integration of NetFortress. On our last call together, I explained in some detail the integration plan and that much of it was completed during Q4. There were two primary pieces remaining that I mentioned, the integration of the sales organization as well as the second and final stages of restructuring. I'm pleased to report that both are now complete, full stop. Further, that sales team has recently landed a couple of really interesting orders from enterprise customers with many locations each. Each of these orders deliver us over $100,000 in MRR, which is a large order for any company in the industry, including our new MSP offerings, further evidence of the strategic rationale behind our Net Fortress acquisition. This comment today on the integration of Net Fortress will be my last, as it is now fully integrated. So no more net fortress, one team, one Sangoma. Next, at the risk of stating the obvious, I'd just like to confirm that Sangoma's share price is absolutely front and center in the minds of your board of directors and every single member of the senior executive team here. We know it's upsetting for you to see Sangoma trading at these prices, and please know it's equally disturbing to us seeing Sangoma dramatically undervalued like this on almost any metric. For instance, one of the trends we monitor closely is the progress we seek to derive more and more of our revenue from recurring services. And it's actually a really impressive story. Growing from zero historically to reach 25% of sales in fiscal 18, to 33% in fiscal 19, to 49% in 20, to 62% in 21, to 71% last year, and now crossing the 75% threshold this quarter for the first time. My point is not that the figure in any one quarter has not fluctuated a bit, or even the precise figure in a particular year, but that long-term trend is exactly where we want to see it, and that's but one way to see our share price is so obviously undervalued in today's market conditions. We are doing everything we can, though as I realize many of the people on this call know even better than me, many institutional investors have pulled back from small cap these days. And my last comment in the strategic topics section today is on M&A. We've had a few calls from shareholders about this, asking whether acquisitions are still on the table in this situation, so I just wanted to answer it officially for everyone to hear. And that answer is yes. Sangoma is still interested in and working on possible acquisition opportunities. However, I think it goes without saying that we need to be highly selective right now, even more than ever before as we consider any possible deals. We are very cognizant of share price, keenly aware of everyone's sensitivity to dilution at these prices. We realize that our use of debt should factor in the uncertainties in the macro environment, and will thus only consider opportunities that are accretive. In the meantime, we are fully committed to running your company prudently, as we always have, with a heightened sense of caution these days. So now let's move to my third and final section today on fiscal 23 guidance. As you recall, the last time we were all together in late September, we provided fiscal 23 guidance for the first time in keeping with our traditional policy of issuing guidance for the new year as we release results for the year that has just closed. As a reminder that guidance forecasted revenue to be between $275 and $285 million and adjusted EBITDA in the $48 to $52 million range. Based upon Q1 results and what we see out there so far today, we are maintaining those ranges for revenue and adjusted EBITDA in fiscal 23. This guidance reflects our best assessment of many challenging factors in an increasingly uncertain world, including but not limited to the macroeconomic considerations such as historic inflation and hawkish monetary policy in many countries around the world, as well as trends in FX rates, the potential impacts thereof on demand, the continuing supply chain, challenges, our ability to retain and attract talent, international conflict, lingering effects of the pandemic, and the growing risk of global recession. As such, visibility and forecasting has become more difficult for everyone and Sangoma is not immune. We will therefore be monitoring such trends very carefully over the next few months. And with that, I'd like to bring my prepared remarks for today to a close with a quick summary. Overall, I'm very pleased with another quarter of solid financial results for Sangoma and what we've accomplished. We continue to see our well-defined, competitively differentiated strategy yield success and are pursuing attractive organic growth by investing in sales and marketing, R&D, and customer expansion. We also remain uniquely positioned to augment that organic growth with deliberate, prudent, highly selective M&A, using a very disciplined approach that reflects an astute awareness of share price, ensuring Sangoma would only consider acquisitions in this climate if they are accretive. We have built your company with a core belief in growth with profitability, even when it was out of fashion, and we, of course, hold that belief even more strongly today. Further, we have a resilient business and financial model, one that allows us to protect our profitability even if faced with the kind of uncertainty we all see these days. We've utilized debt conservatively, maintaining modest debt to EBITDA ratios, and avoiding over-laboring, even when others encouraged us to take on more debt. That commitment to using debt cautiously has served us well, and we will maintain that approach as we continue to delever and pay down debt. Finally, I will close off my prepared remarks today by saying that you have a team here at Sangoma that works extremely hard for you every day and that is determined to continue that work to improve share price and create shareholder value. And with that, Larry, I think we're ready to take questions now. Thank you, Bill.