Sangoma Technologies Q3 2023 Earnings Call Transcript

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May 11, 2023

There are 9 speakers on the call.

Operator

Thank you for standing by. This is the conference operator. Welcome to the Sangoma Investor Conference Call. As a reminder, all participants are in a listen only mode and the conference is being recorded. I would now like to turn the conference Over to Samantha Reburn, Chief Legal Officer.

Operator

Please go ahead.

Speaker 1

Thank you, operator. Hello, everyone, and welcome to Sangoma's Q3 fiscal 2023 investor call. We are recording the call and will make it available on our website for anyone who is unable to join us I'm here today with Nora Worthington, Sangoma's Interim Executive Chair and Larry Fox, Chief Financial Officer, to take you through the results of the Q3 of fiscal year 2023, which ended on March 31. We will discuss the press release that was distributed earlier this afternoon, together with the company's financial statements and MD and A, which are available on SEDAR, EDGAR and our website. As a reminder, Sangoma reports under International Financial Reporting Standards, IFRS.

Speaker 1

And during the call, we may refer to terms such as adjusted EBITDA and adjusted cash flow that are non IFRS measures, but which are defined in our MD and 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 might differ materially from those projected in the Important factors that could cause actual results to differ materially from those in the forward looking statements are discussed in the accompanying MD and A, our annual information form and our annual audited financial statements posted on SEDAR, EDGAR and our website. With that, I'll hand the call over to Norm.

Speaker 2

Thanks, Sam. Good afternoon, everyone, and thank you for joining us today. Before we jump in, I'd like to introduce myself. For those of you who don't know me, I joined Sangoma's Board as part of the Star 2 Star acquisition, which closed in March of 2021. Prior to joining the Board, I served as Founder, Chairman and Chief Executive Officer of Star2Star Communications and I have over 30 years of Since assuming the role of Interim Executive Chairman, my top Priority has been connecting with our terrific customers, partners and employees around the globe.

Speaker 2

I have been in direct contact with these constituents through in person engagement, Phone calls, countless Sangoma video meetings, town halls and the like. My first responsibility has been to understand what is going well And what areas of our business need to incorporate change? My job in listening and thinking about these things is ongoing. However, What I've heard to date has validated my confidence in the opportunity that lies ahead for Sangoma and better equips me to provide our incoming CEO with a full comprehensive briefing of Sangoma's operations. Before I turn it over to Larry to discuss our Q3 results, let me briefly touch upon CEO succession.

Speaker 2

While I'm humbled that the Board has asked me to step in during this transition period, I'd like to make it clear that it's neither my plan nor ambition I have served in that role in the past at other companies and more recently have enjoyed working with Sangoma as Chairman And it is my intent to continue in that latter role. The search for our next CEO is well underway and it is a top priority for myself and the Board to find the right individual to lead Sangoma on a permanent basis. I look forward to the opportunity to introduce our next Chief Executive will follow with you sometime in the near future. In terms of strategy, we are pleased that our results continue to show traction as evidenced by 2 Executive quarters of organic growth in services at approximately a 10% annualized rate. While it remains true that Product revenue has slipped recently.

Speaker 2

It is now settling into a range more in line with historical levels. Going forward, 24, as we continue to fine tune the most appropriate metrics to communicate our message and story. And of course, on an ongoing basis, We shall continue to identify opportunities for improved efficiency and effectiveness throughout our operations. With that, I'll turn it over to Larry to Larry?

Speaker 3

Thank you, Norm, and thanks everyone for joining us today. Before we get to the numbers themselves, I'd like to thank Norm for his engagement as Interim Executive Chairman. As you know, Norm brings a wealth of experience to the table that not only helps guide us through the change in leadership, It will ensure a smooth and complete transition to our next CEO. I'd also like to thank our entire Sangoma team We remain focused on delivering results for our customers and shareholders. Now let's get to the Q3 results.

Speaker 3

Revenue for the Q3 of fiscal 2023 was $62,760,000 up 18% compared to the same period a year ago and up 1% sequentially. Services revenue increased to $50,540,000 up 37% in Q3 of fiscal 2022 and up 2.25% from the previous quarter. Notably, this growth is consistent with the Revenue in the quarter as well as the first time services has reached 81% of total revenue, up from 69% in the year ago period, The meaningful strides in our strategic objectives. Product revenue showed a modest decline from $12,600,000 in Q2 to $12,220,000 in Q3 as customers exhibited greater sensitivity to CapEx purchases given current economic headwinds further impacted by the strong U. S.

Speaker 3

Dollar exchange rate of some international order flow. Cost of sales for the 3 months ended March 31 Increased by 13% to $18,340,000 compared to $16,170,000 a year earlier. The increase in cost of sales is driven primarily by the addition of the NetFortress business and the continuing supply chain Sangoma's cost of sales continues to be impacted by global supply chain disruption for both electronic components And for shipping. In some cases, we've needed to order further ahead, pay more for certain components and ship products by air versus by sea Nevertheless, Sangoma was able to fill most customer orders in the quarter despite these supply chain challenges. Gross profit for the 3 months ended March 31 was $44,420,000 up 19% from the $37,200,000 realized a year ago.

Speaker 3

Gross margin for the Q3 of fiscal 2023 was approximately 71% of revenue. This is up slightly from the same quarter last to a slight increase in sales of our higher margin cloud services. While gross margin will naturally fluctuate slightly from quarter to quarter, Fiscal 3rd quarter gross margins landed on the higher end of the expected range. In the Q3 of fiscal 'twenty three, operating expenses Consisting of sales and marketing, research and development, general and administration and foreign exchange were $43,370,000 versus 40 $14,000,000 during the equivalent period a year ago. The primary driver of the increase was the incremental expense associated with the addition of the NetFortress business, partly offset by the cost savings from the integration, which began in the Q4 of fiscal 2022 and carried through the 1st 9 months Overall, operating expenses increased by 8% year over year, whereas revenue was up by 18 Consistent with our long term approach of growing expenses at a slower rate in revenue, demonstrating the meaningful operating leverage in our business.

Speaker 3

The The company's total operating expense for the Q3 represented approximately 69% of revenue, a decrease from approximately 75% In the same period last year, again reflecting operating leverage and increased expense management. Adjusted EBITDA during the 3 9 month periods ended March 31 came in at $12,240,000 33.5 $3,000,000 respectively, up from $10,470,000 $31,000,000 in the equivalent periods of the prior year. The primary drivers of adjusted EBITDA growth are the addition of NetFortress, the underlying growth in our services business and cost restructuring as part of the integration of NetFortress. Net loss for the Q3 was $690,000 which is $0.02 loss per Fully diluted share compared with a net loss of $6,760,000 which is a $0.21 loss per fully diluted share for the equivalent period And now let's discuss a few balance sheet items as well as our cash flow. Inventories were $18,650,000 in the 3rd quarter, which is down by $650,000 when compared to the 2nd quarter at 19,300,000 This reduction in inventory reflects our ongoing focus on balance sheet management to drive our inventory to appropriate levels.

Speaker 3

Trade receivables $16,990,000 in our Q3 were slightly higher than the $16,670,000 in the 2nd quarter, primarily as a result The company closed the 3rd quarter with $8,010,000 of cash compared to $6,800,000 at the end of our 2nd quarter. The company used a portion of its cash to continue paying down the debt associated With the most recent acquisition and investment in capitalized development funds, we generated $8,860,000 of adjusted cash flow from Operations during the Q3 of fiscal 2023 compared to $7,430,000 in the same quarter last year and to $4,770,000 in the immediately This increase in adjusted cash flow further demonstrates our focus on balance sheet management and prudent spending. Now let's turn to guidance With the reporting of our 2nd quarter results based on what we best estimated at the time, We updated our guidance to anticipate revenue for our fiscal year 'twenty three to land in a range of $250,000,000 $260,000,000 With adjusted EBITDA landing in the range of $46,000,000 to $49,000,000 Given the results for the 1st 3 quarters of fiscal 2023 and our current assumptions regarding macroeconomic conditions. We are narrowing our revenue guidance to $250,000,000 to $254,000,000 and adjusted EBITDA guidance of $46,000,000 to $48,000,000 This updated guidance reflects our best estimate of many challenging factors in an increasingly Including but not limited to longer install cycles, macroeconomic considerations such as historic inflation, Thanks failures, threats of governmental default, increasingly tight monetary policy in many countries around the world, as well as trends in FX rates, The potential impacts thereof on demand, continuing supply chain challenges, our ability to retain and attract talent, international conflict, lingering effects of the pandemic and a constant risk of global recession.

Speaker 3

Sangoma is not immune to these factors Visibility and forecasting have become more challenging. Overall, we are pleased with another quarter of solid financial results for Sangoma And it remains gratifying to see our growth in services continuing, further reinforcing the belief that the transition to a more SaaS based model It's the right strategy to continue moving Sangoma forward. We are seeing our competitively differentiated strategy yield And we'll continue to pursue strong organic growth by investing wisely in our people and the tools they need to be successful. Organic growth is a top priority and we look forward to introducing you to a new CEO, who we believe can take us there in the very near future. I would again like to thank our Sangoma team for staying strong and focused, and we'd like to thank all of you, the extended Sangoma family,

Operator

Certainly, we will now begin the question and answer session. As callers join the queue. The first question comes from Max McCallies from Lake Street Capital Markets. Please go ahead.

Speaker 3

Hey, Max.

Speaker 4

Sorry, guys. I was on mute. That's my fault. First question here is about the guide. Just in terms of the services You guys increased sequentially again by 2.25%.

Speaker 4

Do you have consistent view on that going into Q4? Is that your expectation? Or Should we be thinking something else here?

Speaker 3

Yes. Max, given where we are right now and seeing how we see services grow, Yes. We do believe that's going to continue with that annualized 10% rate for services in the near term for sure.

Speaker 4

Okay. And then my second question here is, I know you guys gave a sequential growth rate on cloud bookings last quarter of around 5

Speaker 3

So we continue to see growth in bookings, Zach, and that's one of the items that for Sure will be considered as we look at fiscal 2024 and how we'll talk about certain SaaS metrics moving forward. We do continue to see increases though quarter on quarter. And we're also pleased that our time to activation continues to improve. From a metrics perspective, that's on the list of things we'll consider as talking about as we move forward.

Speaker 4

Okay. That's it for me, guys. Thank you.

Speaker 3

All right, Max. Thanks.

Operator

The next question comes from Matt Ochsler from William Blair. Please go ahead.

Speaker 5

Hey, there. Thank you for taking the Maybe just one, I would love to get maybe a little bit more color on what you're seeing in terms of trends and some of the KPIs you discussed previously. Customer revenue churn, maybe the trends you're seeing in average deal size, ACV, net retention,

Speaker 3

Yes, sure. So for sure, all those items are on the list of items as we move forward and start talking more from a financial and operational metric perspective. We've talked about in the past that we enjoy Very good churn rate and we continue to see that. That's evident in the net numbers that we're talking about. But certainly talking about Gross retention stickiness are all on the list as we move that forward into FY 2024.

Speaker 5

Got it. Understood. And maybe just one follow-up here. In terms of the integration of NetFortress, I'd love to maybe get a little more color on how that business performed in the quarter. And then the integration there and Whether you're seeing the cross sell of MSP services playing out at this point and what exactly that looks like?

Speaker 3

Yes. We're pleased with how network services performed during the quarter. And I can tell you, we are seeing more interest in sort of a higher take rate within new Sangoma customers. So we'll also see network opportunities increase for our legacy Sangoma customers as well. So the integration has gone really well From that point of view and from a sales perspective and bringing that all together, our CRO is driving that really hard.

Speaker 3

And As we move that forward into more of the legacy items, we're seeing a much higher take rate.

Speaker 5

That's helpful. Thank you very much.

Speaker 3

Thanks, Matt.

Operator

The next question comes from Deepak Kausho from BMO. Please go ahead.

Speaker 6

Hi, good evening guys. Thanks for taking my questions. Can you hear me okay?

Speaker 3

We are fine.

Speaker 6

Excellent. So, Maury, you mentioned that you spent a lot of time talking to your stakeholders. Is it too early to ask what you're hearing, what some of your findings are, anything relevant to this stage and maybe some thoughts on what you're looking for in your CEO?

Speaker 2

Yes, I'd be happy to address that. So I think that Last quarter, we mentioned here that what we want to be thinking about is less focus on M and A and more focus I'm growing organically. And so we're looking for a CEO that has A lot of experience leading a public technology company at scale, who is very comfortable and familiar with hitting organic growth targets. Great communications presence. I tell this story very well, all while aligning to our company goals and objectives.

Speaker 2

We want someone who's got a track record of recruiting, developing, retaining top talent, understands How to build culture in an organization that has acquired its talent through acquisition. Now we've got to bring everybody together, all working together. And I think we're focused right now on someone who's not Well, it's not really the main experience in undertaking M and A, but really understands how to integrate What has come through M and A? Those are the key attributes I think as we're searching for our new CEO and we'll let along in that search.

Speaker 6

Excellent. That's really helpful. I appreciate that. And then the first part of the question was What you're hearing from stakeholders in terms of the business, the environment, anything surprise you or anything new or unusual that You can share with us?

Speaker 2

I wouldn't say it's unusual. I think we're gratified that just as Larry said a few moments ago That increasing awareness of the full range of our solutions and how they work together and starting More cross sell and up sell opportunities, whether that's with a new logo or with our existing customers. I think that's That's very encouraging and we hope we're going to see that trend continue and accelerate as well.

Speaker 6

Okay. And then more specifically, with this Regional Banking Crisis in the U. S. Are you seeing any concerns on the credit side? Are you hearing anything from the channel or customers at this stage?

Speaker 6

What's kind of your pulse on the latest regarding that dynamic in the market right now?

Speaker 2

I'll let Larry handle that one.

Speaker 3

Hey, Deepak. We're not seeing any concerns

Speaker 6

at the moment.

Speaker 3

We certainly ping both the channel and the customers routinely. And we're not seeing anything cause any concern on our side from the customer's ability to pay or to expand. And we're also not seeing anything at this point from the channel. So right now, we're not seeing any effect from that at all, Deepak.

Speaker 6

Okay. That's great color. I appreciate you answering all those questions and we're looking forward to seeing the new CEO and Your take on the story.

Speaker 4

Thank you.

Operator

Your next question comes from Gavin Fairweather from Cormark Securities. Please go ahead.

Speaker 4

Hey, good afternoon. Thanks for taking my questions. You guys have announced a couple of new partner relationships over the past Couple of months, curious to what extent there's kind of more low hanging fruit on the partner side and whether We could see some additional relationships being announced and how you think about upside within the channel there.

Speaker 2

Yes, for sure.

Speaker 3

Yes. Sure, Gavin. We've talked about a couple of new larger partner relationships, They're called TSBs. We continue to see that as a positive avenue for what we're selling. There's a lot of interest in the Sangoma suite And what we can provide as that full suite of services largely in that SMB and mid market And we expect to grow that significantly with MST and all of the others.

Speaker 3

So We continue to see much more interest in that from both sides of CSPs and we've been successful with that and I'd expect you'll see more of that

Speaker 4

Great. And then just secondly on the EBITDA margin. The Q4 guide at the It seems to imply another kind of couple of points of margin expansion over the Q3 level. It kind of feels like maybe it's Over and above the cost reductions that are working their way through the system. So have you made any other changes to the cost structure or discretionary spending?

Speaker 4

Or what will be driving

Speaker 3

So we're always looking for and we've always been good at finding efficiencies. So no large scale Plans that are driving that other than continued plans that we put in place and talked to you about last quarter, starting to see that take hold. And then always being very prudent with how efficient we are with our spend. So it's been a core competency And Sangoma and as Sarta said previously, so more of the same with that showing profit for us

Speaker 4

Okay, great. And then just lastly for me, growth is becoming a little bit harder to come by for the industry as a whole. Maybe just Thoughts on any shifts that you've seen in competitive dynamics around kind of pricing or channel commissions or anything else that you're seeing? And that's it for me. Thank you.

Speaker 3

Sure. Well, we continue to see good growth in our services as we talked about at that annualized rate, which we're quite happy with. From a competitive landscape perspective, we're not seeing as much pressure on price as you might think. And we're seeing increased opportunities to get in there largely because of what we can offer and the ability to talk to 1 company. So I know it's a little unsatisfying.

Speaker 3

I'm not going to match and be able to say, no, we're X percent cheaper or this is happening, but we're not losing out on price And we're not losing out on an opportunity. I think that's why you see something like a 10% annualized rate as opposed to

Speaker 6

That's great.

Speaker 3

Thanks so much. You bet, Kevin.

Operator

The next Question comes from David Kwan from TD Securities. Please go ahead.

Speaker 7

Hey, guys. I was curious on the growth side, particularly on the services. You talked about this 10% annual growth target. I assume there is an aspiration to drive that higher, but I was curious to what extent you're willing to invest

Speaker 3

Well, I think we're always looking to make smart investments to grow that more rapidly However, what we're seeing today is without having a large gap in product and with increasing opportunities, The natural effects of that and its compounding alone, while I can't give you a number, I certainly expect to see Let trends continue and we'll always be looking for prudent opportunities to invest, where that makes sense to grow that rapidly. Well, right now, we're focused on the organic growth because that's where we really see the playback and that's where we're seeing the results today, Especially some other giant.

Speaker 7

So I guess maybe another way to ask the question is to get that growth into, say, The teens as it's below teens, mid teens, which do you think you'd have we'd see margins come in a bit Get to there or do you think you can get there with your existing cost structure?

Speaker 3

No, I think we can get there with our existing cost Sure. And I'd actually be pushing our guys to see margin expansion, not contraction, whether it's ARPU or more services Or what have you. As we expand within the customer base, both existing and new, I look at that almost the opposite way, to be honest with you, David.

Speaker 2

David, this is Norm. One of the advantages we're having We're seeing and I think we're going to be able to continue to exploit is as the awareness of this Related set of solutions, the cost of the engagement with any particular customer is about the same whether you sell them one thing And we're starting to I'm saying we're always going to sell the 10 things, but we're selling more to each of those customers. The average Revenue per user, we see beginning to climb. We think we'll continue on that trend. And the total cost of ownership for those Customers is very positive.

Speaker 2

So we're winning and they're winning. And I think that's kind of the approach I think we're going to be able to pick more of in the future.

Speaker 7

No, that's helpful, Norm. Thanks. On the gross margins, I think last quarter you said that was I think it was 69%. It was The upper end is kind of what you were expecting for this year and then you came in at almost 71 this quarter. I understand that some of that's Coming from revenue mix or whatnot, but just trying to get a better understanding of how we can be modeling out your gross margins.

Speaker 7

I know you don't break them down at this point at least Product versus services gross margins, but if you make the assumption that services revenue kind of stays in the low 80s, What is a reasonable gross margin assumption?

Speaker 3

Yes. So some good insight there, David. The increase in gross margin Certainly tracks closely to our growth in services revenue, right? Cloud services typically higher margin offerings. So as we see changes to the split Between products and services, as you said, low 80s in Q3, it's not really unexpected to see some of the changes in gross margin tracking with those.

Speaker 3

Growth in MSP services being lower margin, of course, right? And that can have some impact in the opposite direction, but not enough to overcome that. As you see more services, you would certainly expect to see margins within that range. We don't guide necessarily to a margin range, but I'm comfortable with where we ended Q3 being something like that.

Speaker 7

Okay. That's helpful. Larry. And just the last question, just on the AI side, particularly generative AI, we've seen many of your Peers come out with announcements about incorporating it into their platforms or solutions. So I was curious To what extent that's in your plans?

Speaker 7

I know in the past, it sounds like you've been kind of dabbling in some stuff on the AI side, but Yes, especially given kind of the competitive dynamic. I'm curious to see, A, what you're doing and kind of what opportunities at risk do you see with it?

Speaker 2

Yes. Hi, David. This is Norm again. We definitely are looking at this and it's on the roadmap for some near term implementation in fact. The kind of the approach we're taking, as you're kind of suggesting, a lot of hype about this right now.

Speaker 2

We're taking approach we're calling internally practical AI. So things that really work, A really functional and don't have some of the emerging problems with some of this The bleeding edge stuff where it seems like it's giving you the right answers, but it actually isn't. We want to make sure that the kind of machine learning Enhancements that are driven by AI work well and work reliably. You'll

Speaker 3

start to see this

Speaker 2

show up In some of our communications products and in some of the network services products as well.

Speaker 7

That's helpful. Thanks

Speaker 3

Thanks, David.

Operator

The next question comes from Robert Young from Canaccord Genuity. Please Go ahead.

Speaker 4

Hi, good evening. Maybe just

Speaker 8

a couple of simple ones. In this interim period until you have a full time CEO, just curious about it sounds like M and A is not going to be a priority going forward, but what are you going to do with the cash? Should we think debt pay down is the priority in this period? Is there anything else you'd like to do with cash?

Speaker 3

Yes. So certainly, Rob, we're always going to look at capital allocation and how we look at that. Paying down on debt is certainly high on our list. We typically pay that down quickly, and we'll continue to look at that As the means and then of course investing in the company as we continue with the organic growth are all things that are top of mind for As we look at that, debt repayment being high on that list just as you start.

Speaker 8

Okay. And then maybe for my second question, the weakness that highlighting on the product side. Is that having any impact on the services? It seems like you're Happy with the 10% growth profile continuing. But is the product weakness sort of a gate there on

Speaker 3

No, we're not seeing it that way, Rob, at all. We don't see it. And I think what you're really seeing is kind of a return of more historical kind of levels as it relates to the We're probably excited at the current time and it has declined, but at a much slower rate than the previous two quarters. And it's really not having any impact on the service side. Okay.

Speaker 3

That's it for me. Thanks. All right, Rob. We appreciate it.

Operator

This concludes the question and answer session and today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.

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Sangoma Technologies Q3 2023
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