Sangoma Technologies Corp

TSX:STC

Earnings Call Transcript 2024-Q1

[Operator]

Thank you for standing by. This is the conference operator. Welcome to the Sangoma Investor Conference Call.

[Operator Instructions] And the conference is being recorded.

I would now like to turn the conference over to Samantha Reburn, Chief Legal Officer. Please go ahead, Ms. Reburn.

[Samantha Reburn, executive]

Thank you, operator. Hello, everyone, and welcome to Sangoma's First Quarter Fiscal 2024 Investor Call. We are 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 Charles Salameh, Sangoma's Chief Executive Officer; Larry Stock, Chief Financial Officer; and Jamie Minner, Chief Revenue Officer, to take you through the results of the first quarter of fiscal year 2024, which ended on September 30, 2023.

We will discuss the press release that was distributed earlier today, together with the company's financial statements and MD&A, which are available on EDGAR and our website and which will be available on SEDAR+ as soon as it's back online. As a reminder, Sangoma reports under International Financial Reporting Standards, IFRS. And during the call, we may refer to terms such as adjusted EBITDA and adjusted cash flow, which are non-IFRS measures that 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 closed on SEDAR+, EDGAR and our website.

With that, I'll hand the call over to, Charles.

[Charles Salameh, executive]

Thank you, Sam, and good afternoon, everyone, and thank you for joining today's call. Before I share my updated thoughts on the business, I'd like to point you all to the press release we issued earlier this afternoon detailing our fiscal first quarter results.

During the quarter, we generated $63 million in total revenue. Revenue in our Services business grew 6% on the year to $51.2 for a record high of 81.1% of total revenue. We posted our first quarter adjusted EBITDA of $9.9 million, representing 16% of revenue, which confirms our focus on profitability and cash flow generation.

A few weeks ago, our Chairman of Norm Worthington, introduced me to all of you on our fiscal 2023 fourth quarter earnings call. While I shared a little bit about myself and my reasons for taking on the role, today marks my first opportunity to speak to all of you in more detail about my excitement for being here as well as my thoughts and longer-term vision for Sangoma.

As of today, I've been on the job for just over 2 months, and I've been able to meet [ scores ] of our dedicated employees, many of our global partners, key customers as well as members of the investment community, some of which -- whom I [ respect ] on the call this afternoon. These discussions are so important as the new CEO because they provide me with a rare opportunity to hear with fresh years, what's working and what's not, what's been tried before and what has it.

For all of you who have spent time and shared your experiences with me over the past couple of months. Thank you. I was listening. In nearly every one of those interactions, I, in turn, conveyed my own passion for an industry where I've spent my entire career and how I view Sangoma's position in this changing and dynamic market. I spoke about the tremendous opportunity that lie ahead for Sangoma and why I felt its assets are so unique. I spoke about the dedication I see in our employees, the strength of our Board and executive leadership and the untapped value of our assets, which I will share more with you in a few moments.

However, during these same conversations, I also spoke to many of you about the value of candor and integrity and authenticity. These are personal attributes that I commit to everyone listening to this call today and personal attributes that I expect each one of our employees to show up with that work every morning.

In that vein, it's only right then to share with you those listening in very clear terms that change is upon Sangoma. The dynamic paid of the SMB market, coupled with the evolving channel model to access them requires constant change to remain relevant and competitive. I fully understand that depending on who, how, what the idea of change can be unsettling. But I don't view it as on settling at all, rather a standard mode of operating in today's rapidly changing IoT space. And the reason I believe that is because I have experienced firsthand at scale. I know full well both the hazards of resting on the business' laurels as well as a compounding benefit and value created for all constituents by self-evaluation and embracing change.

We will be operating Sangoma at the speed of the market versus the speed of the organization. These markets are simply moving way too fast, especially in the SMB. And when you step back and look at the asset base of Sangoma, at our ingenuity, our employees, our ability to integrate acquired technologies and the unique value proposition presented to the market when compared to our measurable results, change not only should be expected, but is welcomed and embraced. That is exactly what is underway right now. If we recall, I mentioned this last quarter as part of my first 100-day plan.

So let's talk about where we are today and where we recognize the need for change. When I accepted the offer to join as Sangoma's CEO, I was aware that the company had assembled a rich portfolio of both on-premise cloud-based solutions that offered a wider range of communication capabilities than anyone in the industry.

Now fast forward to today, having absorbed what I have in 2 very busy months. I see a company with a clear potential of becoming a predominant full-service managed cloud communications and technology provider for small medium businesses, underpinned by a strong brand with global reach. The SMB market is rapidly changing. Technology has become mainstream, and this segment has become increasingly more aware of the value technology plays in running and securing their businesses. There are more demands from this segment to have enterprise-like services for all of their technology needs, graphs in a predictable, affordable, easy to access, bundled and align to their specific business needs. Providing this full stack solution set from one provider is a sweet spot for Sangoma to capitalize on.

Today, Sangoma delivers many of the solutions needed to be that predominant full-service provider to the SMBs, given our industry and geographic and market diversification. Our existing clients recognize this as evidenced by the very low churn rates that are well below industry norms. Both our growth and our reach are not where they need to be but we intend to fix that.

So let me describe how we will get there. First, it's important to remember that a one-size-fits-all solution does not work in our business anymore. And so having a broad portfolio and the flexibility to deliver on-prem, cloud and hybrid solutions uniquely positions Sangoma to serve clients across many verticals, locations and customer types, including business, wholesale and the open-source community.

Our commitment will be making our range of offerings available through various options, à la carte, bundles or packaged in ways tailored specifically to industries and their needs. We are actively developing industry-specific solutions to tackle the unique issues and disruptions these sectors encounter. We also intend to position the portfolio with the white-labeled offering to be used to tap in the new large-scale buying centers and partners.

By tapping our existing capabilities, we will target industries with unique challenges like distributed enterprise, retail, health care and education, amongst others, to enhance our brand and recognition and build our reputation as a nimble, end-to-end provider serving the unique needs of the SMBs in ways our competitors simply cannot.

Think full stock solution capability delivered as a service, wrapped in managed services and bundled with network and hardware technology. This is a meaningful competitive advantage and a value differentiator to our clients, our partners and our brand, and we need to leverage it far more effectively.

Now to accomplish this, I've initiated a company-wide comprehensive review across all business processes. We will examine and enhance our existing competencies and skill sets with a focus on managed cloud-based communication services and technology. We will leverage our existing partner ecosystem with a focus driving a pull strategy with end clients to support the push strategy to our partners.

And we will also thoroughly reinvigorate our brand to clearly convey our key tenants, which underpin this brand, innovation, service and support, determined by a safe pair of hands, partner reach and people. Now make no mistake, that's a lot. Not only is -- it is a lot but this work is both technically challenging and strategically critical. Thankfully, I'm surrounded by an extremely experienced management team who have significant transformational experience and some of the most talented technical experts I've seen in my 30-year plus career.

I should note that in the weeks and months ahead, and you hear me speak about innovation, which I plan to use quite a bit. It isn't about features, innovation for me is about our processes, our partnerships, both personal and technological. To me, innovation is how we align these processes and partnerships to the market in a way that places us on a firm footing and becoming the preeminent provider of choice. There are many areas internally where I see clear opportunities for improved innovation and the team has already begun work to address these in earnest.

In addition to a thorough portfolio review, I have already initiated significant cost savings program, a go-to-market segmentation analysis and a prioritization of key growth investments such as AI-enabled product capabilities, all designed to improve both top and bottom-line efficiencies. Building profitable, sustainable growth requires a relentless focus on innovation and change, and we intend to do that here at Sangoma.

In the spirit of my earlier remarks on candor, integrity, these changes are overdue and the thorough transformation is required to capture our full potential will take us some time. I look forward to engaging with all of you and sharing our progress, which will include more relevant KPIs as we earn our rightful place as a best-in-class full-service, managed cloud communication and technology provider.

Now finally, before I hand it over to Larry to walk through our financial results in more detail, I'd like to take a moment to touch upon a few financial considerations. I want to point out that our financial position as a company is healthy, supported by consistent profitability and cash flow generation, our balance sheet supports both our needed investments for growth as well as debt servicing.

Further, while legacy M&A has served Sangoma well, my priority for the time being is to sustain organic profitable growth and build our cash reserves to provide growth investment optionality in the near future. I want to thank all of you for your time and interest in Sangoma. I am absolutely invigorated and excited for Sangoma's future, and I look forward to engaging with you all.

And with that, I'll turn it over to Larry to discuss our first quarter results. Larry?

[Lawrence Stock, executive]

Thank you, Charles, and hello, everyone. Before we jump in, I want to share my excitement and optimism as Charles steps into the role. In the short time that he's been here, I've enjoyed our partnership, the value of the depth of this industry experience and look forward to what lies ahead for all of us.

Now let's get to the Q1 results. Sangoma Services revenue increased to $51.2 million, up 6% from the same quarter of the prior year and up 2% sequentially, representing 81.1% of total revenue. Product revenue declined from $13.5 million in Q4 to $11.9 million in Q1. The decreased product revenue is now more in line with the product revenue we experienced prior to the COVID-19 outbreak and the corresponding hold on CapEx spending by customers given the resulting global economic conditions.

Total revenue was $63 million, down 2% from the same period a year ago and 1% sequentially. Cost of sales for the 3 months ended September 30 decreased 8% to $19 million compared to $20.7 million a year earlier. The decrease in cost of sales was primarily due to the revenue mix and supply chain management.

Gross profit for the 3 months ended September 30 was $44 million, up 2% from the $43.3 million realized a year ago. Gross profit for the first quarter of fiscal '24 was approximately 70% of revenue. This is up 2% from the same quarter last year due to favorable revenue mix with a higher proportion of cloud services revenue. While gross margin will fluctuate from quarter-to-quarter due to mix, our Q1 gross margins were at the higher end of our typical range.

In the first quarter, operating expenses consisting of sales and marketing, research and development, general and administration and foreign exchange were $45 million versus $44.4 million during the equivalent period a year ago, and $43.7 million in the immediately preceding quarter, representing a 1.4% dollar increase over the prior year. Consistent with recent history, first quarter OpEx contains certain onetime annual expenses.

Adjusted EBITDA during the 3-month period ended September 30 came in at $9.9 million, down from $10.7 million for the equivalent period of the prior year. The prior year included a $1.5 million gain in consideration payable. Net loss for the first quarter was $2.44 million, which is a $0.07 loss per fully diluted share compared with a net loss of $1.98 million, which is a $0.06 loss per fully diluted share for the equivalent period of the prior year.

And now let's discuss a few balance sheet items as well as our cash flow. Inventories were $17.9 million in the first quarter, which is down by $80,000 when compared to the fourth quarter at $18 million. This reduction in inventory, while modest, reflects our continuing focus on inventory management.

Trade receivables of $20.4 million in our first quarter were down from $21.9 million in the fourth quarter, primarily as a result of the continued emphasis on accounts receivable collections. The company closed the first quarter with $11.1 million in cash compared with $11.2 million at the end of our fourth quarter of fiscal '23. The company used a portion of its cash to continue paying down the debt associated with its most recent acquisitions and investment in capitalized development costs.

We generated $7.6 million of adjusted cash flow from operations during the first quarter of fiscal '24, compared to $3.2 million in the same quarter last year. This increase in year-over-year adjusted cash flow was primarily driven by a working capital management and prudent approach to cash spending. Cash conversion of adjusted cash flow to adjusted EBITDA for the quarter is 77%, which is more than double the 30% in the same quarter last year, significantly higher than the full year 54% in fiscal '23.

Moreover, we finished the quarter with net cash provided by operating activities of $7.9 million, reflecting a strong quarterly progression of cash flow, and we continue to remain comfortably within our debt covenants.

Overall, while product revenue is lower than we expected, we are pleased to see our growth in Services continuing, providing another quarter of solid financial results for Sangoma. We are seeing our differentiated strategy yield success, and we'll continue to pursue strong organic growth by investing wisely in our people and the tools they need to be successful. Before we close, I'd also like to thank all the dedicated and hard-working employees of Sangoma, our partners and our investors as we continue on this transformation journey.

And with that, operator, we're ready to take some questions.

[Operator]

[Operator Instructions] Our first question comes from David Kwan of TD Securities.

[David Kwan, analyst]

I appreciate Charles, the color you gave on the 100-day plan, the different -- or changing strategies and what you're planning to do over the next coming quarters and in years. I was curious, when you look at the business right now, and one of the things you kind of touched on was AI. I think you talked about looking at -- we're starting to work more on AI-enabled product capabilities. We've seen several announcements from your peers on that front. Is there any more details you can provide?

[Charles Salameh, executive]

No. I can't provide you more details on the technical aspects of it. What I'd tell you is that there's -- one of the things of the first 8 weeks of being here was uncovering all the facets of the company and what was going on in the company. There's a pretty significant amount of work already underway within our engineering team. You may -- you've probably heard you comment about the fact that I think we have exceptionally strong technical resources in the company. And what I'm trying to do to take them out of the sort of the closets that [indiscernible], bringing them to the forefront, embedding them into the integrated portfolio package that we're now configuring to build as we shape this company into a more of a full-stack solutions provider firm and embedding the AI capabilities, mostly at the beginning into our contact center space. That will be a fairly significant, I think, first start, and then moving into the video chat and video side of the business.

So those are probably the 2 areas where we'll see it pop up. I guess what I can leave you with is I'm a little more surprised here. I was more surprised pleasantly of the advancements in AI technology that have already been built here. And we'll also -- we'll continue to look for partners. Again, the market is moving very fast in this space that might accelerate our ability to inject that technology into our portfolio.

[David Kwan, analyst]

Yes. I guess those are the 2 areas like the contact center space and the meeting space where we've seen a lot of these announcements. Like do you have a time line as to when we could start to hear kind of specific product features announcements and that type of thing?

[Charles Salameh, executive]

I think it's safe for me to tell you that within the next quarter in our next quarterly briefing, and Jeremy just came on board as the Chief Product Marketing Officer here at the company. He needs to get his legs underneath him as he rolls out his road map of all the product road maps and putting them into priorities. So I think you look to see some advancements in our portfolio and announcements around the technology capabilities that we have, both in AI and other areas that we're looking at right now, likely moving into the second quarter.

[David Kwan, analyst]

Great. And the changes that you've been talking about changes to go-to-market, changes and kind of how you enter packaging the solutions and what not. Do you see a change though in terms of the mix coming from direct versus indirect sales?

[Charles Salameh, executive]

Direct sales -- we don't do much in the way of direct sales.

[David Kwan, analyst]

Yes. I know you don't have a big but I didn't know whether something you were looking to do more of. I know the channel is obviously the predominant source of revenue for you and your peers. But I didn't know if you guys were maybe changing strategies and looking to build up more of a direct sales team.

[Charles Salameh, executive]

No. So we're not going to the direct sales motion, I can be pretty clear with you on that. However, what I can share with you in terms of directional, and I said it in my statements, is that the opportunity in this company, I think, is quite unique is the ability to bundle the solution set and offers the white label model to new buying centers, new channel partners that are not traditional. So as you think about the UCaaS market and those traditional type of players in the UCaaS market, we're looking at actually bigger and larger, more strategic players, tapping into their larger ecosystems of the SMB market and we're labeling our offering there.

Secondly, when I say we're going to reinvigorate the brand at the company, we are going to reinvigorate the brand not only to our partners, but to the end customer. So that is not going to be a direct sales model but the end customer will begin to understand the value proposition Sangoma brings to the table and then use that as a pull strategy to have them come into our partner ecosystem, whether locally or regionally in every small town and city across the Americas and be able to come in with a reference of, I want Sangoma.

And so this idea of adding a full strategy is an indirect way to go direct. It's going to be in that we're not selling direct but we want the direct customers to understand, who we are, what our propositions are and to come in with a notion of bringing Sangoma to their partners for them to come to us to look to fulfill that. [indiscernible] David?

[David Kwan, analyst]

Yes, it does. One last question. Just on the margin front, we've obviously seen the margins come off here in the last couple of quarters here. I know you're not providing guidance but could you at least maybe talk about how you see the trajectory of the margins throughout the balance of this year? Is Q1 expected to be the low point?

[Lawrence Stock, executive]

David, I miss you. You said the market...

[David Kwan, analyst]

Margins, the EBITDA margins.

[Charles Salameh, executive]

Yes. So based on where we're at, and obviously, we've not issued guidance as it doesn't related to that. I still though -- I see that the increase in gross margin does track closely to for our mix of Services revenue and product revenue, which is a big driver of that, right? Cloud services, typically higher-margin offerings. So as we see changes to the split, we could see some changes to things like gross margin, which would certainly drive to the bottom line.

And then growth, of course, in MSP services has somewhat of a lower margin as we know and have talked about in the past. But I think we have a good handle on our costs. We're looking at those as Charles gets [indiscernible] under him. And I think that's probably the most I can say on that and just know that we're looking at it.

[David Kwan, analyst]

Maybe a different way to ask the question, and I understand the impact of gross margins. But let's say, from an OpEx perspective, I think there was some talk about looking at cost optimization. But do you see a material change in how much you're spending, at least from a cash OpEx perspective?

[Lawrence Stock, executive]

So our goal, of course, and what we've been very good at is cash preservation and generating positive operating cash flow, and I do see that continuing.

[Operator]

Our next question comes from Vivek Palani of Northland Capital.

[Unknown Analyst]

I'm Vivek on from my [indiscernible] of Northland Capital. I have a couple of questions with me. And the first one is, how about the churn rate? Like, did it change from the last quarter?

[Lawrence Stock, executive]

No. We've not seen a change in churn rate. We actually have one of the best churns rates in the industry. We continue to enjoy that, and we expect that to continue as well.

[Unknown Analyst]

All right. And my next question is, what percentage of revenue is international? And do you expect the international revenue to grow faster than the overall the company?

[Lawrence Stock, executive]

Yes. So it's -- international is relatively small relative to all the other revenue that we have. And while we continue to look the revenues to grow that, I would expect similar results as we move into the next year.

[Charles Salameh, executive]

A lot of more of a strategic flavors of that question. So as you heard in my remarks, Sangoma has got the asset pool to be able to do things that are a little different than what we've been doing in today. We have a fairly significant ecosystem of partners that we sell to, whether they're ours or MSPs or selling partners and -- or TSPs. I mean it is a whole slew of partners who are selling our services. But there are new partners and new channels to market, and one of those channels is international. We have international reach now. We've got an infrastructure in place. There are mostly product sales in that space right now but there's an opportunity now to take this entire portfolio as we bring the portfolio together, as we consolidate our process, as we modernize our systems and tools, the ability for us to take that globally is upon us.

So this will be something that you should watch out for with us because as part of the new market expansion program that we have. And we'll continue to find new markets, whether the new partners or new markets, whether they're geographic markets, it's all sort of part of our growth plan as we march through this transformation over the coming 3 or 4 quarters.

[Operator]

Our next question comes from Robert Young of Canaccord Genuity.

[Robert Young, analyst]

I know that you're not giving guidance but there was that 10% annualized organic growth in Services number that you talked about last quarter. Is that something to think about? I know Services a little bit below that this quarter. But is that -- is that not relevant as well? Or can we look at that as a guidance?

[Lawrence Stock, executive]

Yes, Rob, we were pleased to see Service revenue grow in this quarter, and it remains to be an organic growth focus for us for the company for sure. And that's probably the most I can say about that.

[Robert Young, analyst]

You talked about bundling offerings specific to industry. I know Sangoma has had, for example, maybe a health care solution bundle but is this -- are you talking about a deeper bundled solution that you maybe go through like through center or something like that to a hospital or something like that? Like maybe if you could just give a little more color around what the bundled offerings mean?

[Charles Salameh, executive]

So just thinking about it this way, Robert. We're still obviously shaping all of the very unique bundles and making them quite -- making the technology contextually meaningful to the discontinuity that particular industry have to face. And as we deeply understand some of these indies, some of which we have a lot of experience, retail distributed enterprise will be a really good example. Sangoma has some wonderful customers in this space, great partners who understand this space and the collaboration of their knowledge, with our knowledge and our capabilities and assets allows us to be very unique with these bundles.

What I don't envision is hard and fast bundles that are just here, there's a whole package for business in a box for a distributed enterprise that happens to be in retail. What I do see is the ability for industry relevant components that are able to be assembled together and that meet the particular needs of health care, whether it's hospital IT, retail, whether it's distributed retail, like some of the partners we have right now, whether it's education like school campuses, things of that nature.

They all require some basic components, all of which we have here at the company. They require communications, they require hardware and technology, they require a managed communication set of capabilities and applications, which again, we have. They require collaboration tools and tool sets that we have. They want it as a service model without the burden of capital on their balance sheet. And they want to provide with a support infrastructure on top, which we also have.

So these are all the wonderful assets I talked about in my opening remarks. And when you have those. The only thing you're trying to do now is create a value proposition that's contextually meaningful to a particular industry. So you're speaking their language. And that's the big transition that we're making here. And as I said earlier, there are segments in industry, the ones I mentioned, health care and retail and education that have -- we have competencies in this company that are already delivering services in that area, and we have partners who are highly focused in this area that we're going to double down our efforts with.

So that's the way we see the industry move. There'll be lots of things for you to see from the company over the coming quarters as we modernize our website and begin to position our offerings in that fashion, where we you'll be able to see clearly what the bundles look like for retail, what they look like for health care and education. And so these are some of the dynamic changes that are coming into the company. The nice thing about it is I'm not having to go build all this stuff and find it all. It is already here. It's just a matter of assembling it in a way that's contextually meaningful to the industry we want to focusing on.

[Robert Young, analyst]

Okay. Very interesting. One last little question. Last quarter, you said that wholesale trunking was subject to some pricing pressure. I think that might have been part of the reason why the Services revenue was under a bit of pressure. Maybe if you could confirm that? And is that something that's gone away? Or is that something that's still a factor? And then I'll just pass the line.

[Jamie Minner, executive]

Yes. This is Jamie Minner here. While we're not providing guidance right now, we have seen growth in our wholesale trunking business due to a variety of in-flight initiatives that we have going on, includes network optimization, improved costs. And those missions haven't really kind of allow Sangoma to be more aggressive in our positioning with our wholesale customers as well as looking for more responsive suppliers.

[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.