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, Mr. Stock.

Thank you, operator. Hello, everyone, and welcome to Sangoma's second 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. Joining me today is Bill Wignall, Sangoma's President and Chief Executive Officer, and Samantha Reburn, our General Counsel, to take you through the results of the second quarter of fiscal 2023, which ended on December 31st, 2022. We will discuss press release that was distributed yesterday, together with the company's financial statements and MD&A, which are available on CDAR, 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 loss, adjusted EBITDA, and adjusted cash flow that are non-IFRS measures but which are defined in our MD&A. 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 may 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.

Thanks, Larry. Good morning, everyone, and thank you for joining us today. I've structured my prepared remarks for this call into three sections. I will start with our second quarter financial results. I'll then add some commentary on one strategic topic. 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 the operator for a typical open Q&A session. And just before I begin today, I'd like to point out that you may notice some changes in the call, changes intended to improve the way we interact with you, to get you the information you want in the way you want it. I will talk about that more in a few minutes, but for now, as but one simple example, this call will be noticeably shorter and tighter than in previous quarters. So let's get started with our Q2 results. In this section on financials, I will cover highlights from our second quarter, as well as year to date, and then I'll conclude with a few comments on balance sheet and cash flow. Total revenue for the second quarter was $62.0 million, which is up 17% when compared to the same period in fiscal 22. And this $62 million in total revenue is down just over 3% from the immediately preceding quarter, a drop that I acknowledge was disappointing to us. In order to properly understand that sequential trend, we need to examine the services versus product component because we see very different trends in those two buckets this quarter. Let's start with services, the strategic focus for our company and the long-term driver of growth and value. Services revenue increased 34.5% from Q2 of last year, very healthy indeed. Further, that services revenue is up another 2.3% from Q1. As I stated at the beginning, Sangoma is going to try and be more clear about our organic growth rates and other disclosure, and that's much easier to do this quarter, given we've not had an acquisition in the past three quarters. The 2.3% sequential growth in services is thus equivalent to an annualized growth rate of almost exactly 10% organic growth, short and sweet. Given today's economic climate and Sangoma's commitment to growth with profitability, not growth at any cost, we feel quite good about that 10% organic growth figure. And while services had a solid quarter, our product revenue was down 19.8% sequentially from Q1. We saw the pressure on product sales begin in our first quarter this year, and it continued throughout Q2. While the decline was not unexpected, Given the long-term trend away from on-premise systems towards the cloud, it was accentuated by current macro factors, supply chain, and by FX rates, which impact our international customers because we bill in US dollars, all causing the drop to be larger than anticipated this quarter. And while Sangoma could, of course, invest more to combat such trends, we consciously choose not to over-rotate there. We will not invest reactively in that way and risk suppressing our profitability. Having said that, product revenue at between $12 and $13 million this quarter is back to where it was a few quarters back. We had some modest quarterly upticks over the past while, perhaps surprising given that product sales are not expected to be a long-term growth driver at Sangoma. That was mostly because we had done a good job of managing supply chain disruptions and avoided out-of-stock situations. Possible because Sangoma makes all of our own products. So based upon what we see today, we do not believe product revenue will continue to fall from here and would expect some modest recovery in this area during Q3. The long-term growth and the future of Sangoma is as a SaaS company, and that is where we will remain focused. So seeing services revenue represent over 79% of total sales this quarter, up from 75% in Q1, from 71% in fiscal 22, and from 62% in fiscal 21, demonstrates our continued success towards a pure SaaS company. And an annualized organic growth rate of about 10% in services feels pretty good. Cost of goods sold for Q2 was 31% of revenue, as composed to 32.3% in Q1, reflecting the higher fraction of revenue coming from services. Sangoma does a really good job managing the supply chain that got messier the past couple of years, producing some of the highest gross margins in our industry. Gross profit for the first quarter was $42.7 million. down slightly from 43.3 in the immediately preceding quarter due to the trend in total revenue just covered. Gross margin for the quarter was approximately 69.9% of revenue, which is up slightly from the 67.6% in the last quarter and at the higher end of our expectations for margin in fiscal 23. Operating expenses for the second quarter of fiscal 23 were $44.2 million down slightly from the $44.4 million in the most recent first quarter. Adjusted EBITDA in the second quarter was about the same as that in Q1, coming in at $10.5 million compared to $10.7 million last quarter, despite the dip in total revenue, reflecting our commitment to protecting profitability. As a result, EBITDA margins were up very slightly from the first quarter still at about 17% in line with previously communicated expectations. Now I'd like to turn to a brief update on year-to-date results. Year-to-date revenue stands at $126 million, up 20.4% from the same six-month period last year, driven by the inclusion of Net Fortress, as well as by the growth in compounding in our services business. Services revenue was up 35% year to date versus the first two quarters of fiscal 22, a very solid figure, whereas product revenue was down 12% for the same periods per my prior comments. Gross profit of $86.1 million year to date is up 14.4% from the same period in fiscal 22. Year to date operating expenses for fiscal 23 was 86.6 million dollars up 15.2 million from fiscal 22 and is down as a percentage of revenue year over year all part of our long-term operating leverage to grow spending at a slower rate than revenue in addition we are taking actions in february to further reduce spending going forward given the macro outlook like so many companies are doing these days a decision that should further strengthen operating margins We will have more to say about that on our next call together after Q3. Adjusted EBITDA year to date stands at $21.2 million, up from $20.5 million in the first six months of fiscal 22. That completes my remarks on our second quarter P&L, and I'd now like to turn to a few comments on our balance sheet and cash flow. Our cash balance at the end of the second quarter remains healthy, at $6.8 million. We continue to deleverage. We paid down approximately $6 million in Q2 on our loans and about $4.5 million of that in principle. Sangoma remains very comfortably within all covenants, of course, and our Q2 position with respect to such covenants is stronger still than it was exiting Q1. Trade receivables ended the second quarter at $16.6 million, down slightly from the $17.2 million at the end of Q1. Inventory balances at the end of second quarter were $19.3 million, compared to $19.0 million at the end of Q1. As we've discussed previously, the increase in inventory is driven by supply chain challenges and also by softer product sales this quarter. Adjusted cash flow was quite low in Q1, not uncommon at Sangoma early in the year. In Q2, we expected the conversion from EBITDA to adjusted cash flow to return to something more typical for this part of Sangoma's fiscal year, perhaps around 50%. And we now see that with almost $5 million of operating cash flow this quarter. That brings my commentary on our financial results to a close. And I'll now move to my second section today to cover one strategic and operational update. I'd like to start with a short comment on a new strategic initiative we began in Q2. Sangoma has engaged with a very well-respected IR firm, one that has deep experience in the cloud communication space as well. We want to optimize how we interact with the street, both buy side and sell side, to get the Sangoma story out. a story we are very proud of but that we believe can be told better to provide you the information you want in the way you want it, right down to the way we conduct these calls. Here are a few ways we're strengthening this communication with you. First of all, one thing we've been hearing loud and clear is that you want better clarity on our organic growth rate. On that one, asked and delivered. You've heard me speak unequivocally today about the 10% annualized growth rate in our services business this quarter. Full stop. Second, in future calls, you will be hearing not only from me, but also from other members of our excellent executive team. Third, moving forward, we're committed to providing more traditional SaaS-type metrics. We look forward to sharing more of those with you in the coming periods as we further enhance some of our back office systems to do so. That project had already been started, is scheduled to take place gradually over the next 12 or so months, and we will be increasing disclosure along the way. By the way, there's an ancillary benefit to this as well, in that we'll save somewhere between $1 and $2 million in OPEX annually once complete. For today, I can start by sharing some information on important cloud metrics, such as bookings and activation. Our cloud bookings in Q2 were up by over 5% from Q1 sequentially, an encouraging trend in this, the strategic part of our business. And our cloud activations were up by even more than that as we revamped that department in order to accelerate install capacity to keep up with our growing bookings. Fourth, we've heard you say that you want us to be more explicit about our capital allocation and M&A strategy, given our share price, our balance sheets and the drastic shift in public markets over the past year. So here's your clear answer. M&A is unlikely for Sengom at this point. I won't go quite so far as to say impossible, but we are very focused on organic growth as our priority for now. We would be highly, highly selective in any M&A only considering an acquisition that is accretive to both revenue per share and EBITDA per share and only if it did not unduly increase our debt service risk. We are fully cognizant that times have changed, of course, so finding such a target is very difficult right now, and we agree with many of you on this point. After all, Sangoma was arguably the only sizable player in our industry that grew and made money, so we are naturally a little more prudent than most of our competitors. And there will be more changes to come over the next few quarters as we further strengthen the way we communicate with the street and as we increase disclosure. In addition to my comments on that strategic change to our IR approach, I also have one exciting operational initiative to begin sharing with you. Sangoma is increasing our focus on the cost savings benefit to our customer at a time when almost all companies are looking to cut costs. That ability stems from Sangoma's capability to deliver the full suite of cloud communications. I'm going to talk about this more on our next call in order to be more strict with time on this one. But if you want a small early taste, there's already a teaser live on Sangoma's homepage this week. And now let's move to our third and final section today on fiscal 23 guidance. When Sangoma released fiscal 22 full year results last September, we provided guidance for fiscal 23 as we normally do. We chose not to change that guidance after Q1 this year because we really needed to see more of fiscal 23 unfold to determine if an update to guidance was appropriate. We're now at the midpoint of our fiscal year, affording our team a bit more clarity regarding the trajectory of this fiscal period. Given the results for the first half of fiscal 23, our current assumptions regarding the macro environment, industry conditions, and our outlook for the second half, We are revising our fiscal 23 guidance to between 250 and $260 million in revenue and between 46 and $49 million in adjusted EBITDA. This updated guidance reflects our best assessment of many challenging factors in an increasingly difficult world, one where visibility and forecasting have become more difficult for everyone, and CENGOM is not exempt from that uncertainty. Such factors are fully disclosed in our press release and MD&A. And with that, I'd now like to bring my prepared remarks to a close with a quick summary. Overall, I am pleased with another solid financial quarterly result for Sangoma, and while it was strong in the critical areas, such as services, revenue, and profitability, it was admittedly below our expectations on product sales. It is gratifying to see our growth in services at 10% annualized organic growth, stated simply and clearly. That reinforces the point that the transition to SaaS was the right strategy and is the right strategy as we continue to see our competitively differentiated suite of cloud communications services yield success. We continue to build your company with a core belief in growth with profitability, and we, of course, hold that belief even more strongly today. Further, we are focused on delivering that growth, first and foremost these days, organically as our number one priority. We have a resilient business and financial model, one that allows us to protect our profitability, even when faced with the kind of uncertainty we all see these days. And we have always utilized debt conservatively, maintaining modest debt to EBITDA ratios and avoiding over-leveraging, even when others encouraged us to take on more debt. That commitment has served us well, and we will maintain that approach. Finally, I'll close off my personal remarks today by saying that you have a team here at Sangoma that works extremely hard for you every day, one that is determined to continue that work in order to grow the company and create shareholder value. And with that, operator, we are ready to take questions now.