Sangoma Technologies Corp

TSX:STC

Earnings Call Transcript 2022-Q3

[Operator]

Thank you for standing by. This is the conference operator. Welcome to Sangoma Technologies Third Quarter Fiscal Year 2022 Investor Conference Call. [Operator Instructions] And the conference is being recorded.

I would now like to turn the conference over to David Moore, Chief Financial Officer. Please go ahead, Mr. Moore.

[David Moore, executive]

Thank you, operator. Hello, everyone, and welcome to Sangoma's third quarter investor call of our fiscal year 2022. We are recording the call and we'll make it available on our website for anyone who is unable to join the slide.

I'm here today with Bill Wignall, Sangoma's President and Chief Executive Officer; Larry Stock, Chief Corporate Officer; and Samantha Reburn, General Counsel to take you through the results of the third quarter, which started on January 1 and we will discuss -- also discuss the press release that was distributed yesterday, together with the company's unaudited interim Q3 financial statements and MD&A, which are available on SEDAR, EDGAR and our website.

As a reminder, Sangoma reports under International Financial Reporting Standards, IFRS. And during the call, we may refer to terms such as adjusted operating income, adjusted EBITDA and adjusted cash flow that are not IFRS measures, but which are defined in our MD&A.

Also please note that unless otherwise stated, all references to dollars are now to the U.S. dollar as we started reporting U.S. dollars now for fiscal '22 and beyond. This includes all prior period comparisons, which have been converted to USD as described in Note 2 of our financial statements.

Before we start, I'd like to remind you that statements made during the course of this call that are not purely historical are forward-looking statements regarding the company or management's intentions, hopes, beliefs, expectations and strategies for the future. Because such statements deal with future events, they 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 SEDAR.

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

[Bill Wignall, executive]

Thank you, David. Good morning, everyone, and thanks for joining us today. I have structured my prepared remarks for this call into 5 sections. I will first focus on Q3 and then move on to year-to-date results. In my third section, I'll give a brief update on the recent NetFortris acquisition. Fourth, I will provide an update on our overall strategy. And finally, I'll touch on our guidance for the remainder of fiscal '22. As always, I'll then wrap up with a brief summary and turn the call back over to David for a typical open Q&A session.

Just before I begin, I simply wanted to offer a short reminder regarding the timing of the NetFortris acquisition. Given the transaction did not close until March 28, there is minimal impact from NetFortris on our income statement for Q3, except for the transaction expenses and, of course, their impact on net income.

With that, let's move on to the first section, covering Q3 results. Sales for the quarter ended March 31 were a record $55.13 million, almost double that up to $27.95 million in the third quarter of fiscal '21. This increase in sales was primarily driven by the acquisition of Star2Star last year in Q3 of fiscal '21, such that it is included in this year's Q3 results, but not last year's, by the continuing growth in compounding in our existing services business and by an uptick in our product sales.

And sequentially, our Q3 revenue grew by approximately 2% from the immediately preceding second quarter.

[Technical Difficulty]

[Operator]

Pardon me, this is the operator. Please stand by while we get Mr. Moore reconnected. Pardon me, I have Mr. Moore on the line.

[Bill Wignall, executive]

Okay, everyone. Sorry for this technical difficulties. I'll start back again at the beginning of fiscal Q3 results since it's not entirely clear to us which section you guys lost us at.

Sales for the quarter ended March 31 were a record $55.13 million, almost double that of $27.95 million in the third quarter of fiscal '21. This increase in sales was primarily driven by the acquisition of Star2Star last year in Q3 of fiscal '21, such that it is included in this year's Q3 results but not last year's and by the continuing growth in compounding in our existing services business as well as by an uptick in product sales.

Sequentially, our Q3 revenue grew by approximately 2% from the immediately preceding second quarter. Our recurring revenue through our services business continues to be our strategic focus. And we've seen significant growth year-over-year.

In Q3, our services revenue came in at approximately $39 million this year, about 2.5x to $15.8 million from the same quarter last year. And this $39 million represents 70% of total sales for the quarter. As discussed during last quarter's call, our long-term trend of consistent strengthening in services revenue growing from under $5 million per quarter in fiscal '18 to about $39 million per quarter now has truly been a milestone achievement in your company and one that will continue to accelerate with the NetFortris acquisition.

Gross profit for the third quarter of fiscal '22 was $38.96 million, also more than double that of $18.31 million in Q3 of last year. Gross margin for the quarter was over 71% of revenue, up from 66% in the same quarter a year ago. This is driven principally by the steady increase in the percentage of revenue that comes from services, including the positive higher margin contributions from Star2Star.

These levels of gross margin, amongst the highest in our industry, are even more satisfying given that our cost of goods continues to feel pressure from the global supply chain disruptions that are affecting so many companies and industries around the world. Although we've touched on this ongoing supply chain pressure in previous quarters, I thought it would be useful to discuss the impact a little further today, given all the media attention on it and given that some of our analysts are now commenting on it as well.

Most importantly, I wanted to start by pointing out the fact that my comments in the prior section on revenue and more specifically that our services revenue at $39 million this past quarter or 70% of sales really helps us on this topic of supply chain disruption. Only 30% of our revenue is in products now, and only a part of that is physical goods like phones.

Everything else, which means the remainder of the product bucket, for example our on-premise UC software, and all of our services revenue is totally sheltered from such supply chain issues, of course. For the part that is subject to supply chain pressure, indeed, like our desk phones, we continue to contend with several factors that many companies around the world are facing these days, such as component supply shortages, longer lead times for these components, often higher prices for such parts extended manufacturing periods at our contract manufacturers or new lockdowns in some regions, including China, delays in shipping and some increased shipping costs.

While the disruptions have been impacting us for several quarters now, we still saw a slight increase in supply chain costs for this most recent quarter as well, affecting our gross margin by 1% or 2%. And yet despite all of these headwinds, we were still able to meet all of our customers' orders in the third quarter, which is our top priority, even if it costs us a point or 2 in margin this quarter.

Further, we continue to find instances where our ability to manage the supply chain has become a competitive advantage, enabling Sangoma to ship products when our competitors could not. And it's worthwhile mentioning that such a competitive advantage is a benefit not only to the capital P product part of our business, but also to our centrally strategic services business. Given that, for example, being able to ship desk phones to customers is an essential step in turning up a new UCaaS subscriber and beginning revenue recognition for that new customer win.

Finally, I'd like to finish up my supply chain detail with the observation that we do expect these constraints to continue in the upcoming quarters. But I'm confident that the Sangoma team will continue to do a remarkable job in managing these challenging circumstances.

Operating expenses for the third quarter this year were $41.9 million versus $15.76 million in the same period last year. The higher operating expenses were primarily driven by the costs that came with the addition of Star2Star. As I've done in recent quarters, I will offer some insights into the 3 individual OpEx buckets, namely sales and marketing, R&D and G&A.

Regarding sales and marketing, you'll notice that the portion of our OpEx that is in the sales and marketing category has continued to be significantly higher versus the prior year. This was primarily the result of the Star2Star sales team, the channel partner commissions, the incremental marketing staff and the accompanying marketing program spend.

With respect to R&D, the increase in the third quarter of fiscal '22 from the same quarter of the prior year is largely due to the addition of the Star2Star engineering teams and our continued investment in innovation. This follows our general approach to OpEx spending. As measured in absolute dollars, Sangoma continues to invest more money every year into R&D for product development than we spent in the prior year. But we closely control that spending as a percentage of revenue.

And finally, the G&A expense also shows a significant increase year-over-year, which, as in recent quarters, was driven primarily by the addition of the Star2Star admin groups and the noncash amortization of the intangible assets acquired at the time of that transaction, stock-based compensation expenses and higher D&O insurance premiums following our listing on NASDAQ, which took place in mid-December.

Net income for the third quarter was negative $6.76 million primarily due to interest expense, which was up because of the additional debt taken on to finance Star2Star and the onetime transaction costs for the acquisition of NetFortris at about $3.1 million.

Adjusted EBITDA was a record in the third quarter at $10.47 million, almost double to $5.35 million from the third quarter of the previous fiscal year and exceeding $10 million for the third consecutive quarter. This level of adjusted EBITDA is equivalent to about 19% of sales.

That brings my commentary on our Q3 income statement to a close. And I'd now like to cover a few highlights from our balance sheet and cash flow. As you will see, our overall balance sheet remains strong. Our cash balance at the end of the third quarter was $16.24 million, which is slightly lower than on December 31. This was due primarily to the funding of the NetFortris acquisition, a modest increase in accounts receivable, an increase in inventory, both of which I'll explain now.

Trade receivables increased finishing the third quarter at $18.42 million as compared to just under $16 million on December 31. The increase this quarter was primarily due to receivables added as part of the NetFortris acquisition. Inventories were $16.47 million on March 31, $2.13 million higher than on December 31, which reflects the current supply chain pressures mentioned earlier as well as the additional inventory taken on from NetFortris. We expect elevated inventory levels to continue for the next few quarters.

From a cash flow perspective, during the third quarter, we generated adjusted cash flow from operations of $5.06 million. And this measure of adjusted cash flow excludes the impact of acquisitions, financing and other non-operating anomalies.

That brings my comments on Q3 financial results to a close. So let's now turn to the year-to-date results. Sales for the 9 months of fiscal '22 were $161.84 million, almost double that of the $81.26 million in the same period of fiscal '21. The increase in sales was due to the same factors I covered in my comments on Q3 a few moments ago, namely the Star2Star acquisition, the continued growth in compounding of the company's services business and an uptick in the product business.

As a percentage of total sales, our services revenue is 70% for the first 9 months of fiscal '22, a solid increase from the 56% in the same period last year. Gross profit for the 9 months of fiscal '22 was $116.22 million, more than double the $53.56 million realized last year. Gross margin was approximately 72% of sales on this year-to-date basis, up from 66% in the same period of fiscal '21.

It's especially gratifying as the global supply chain has been strained this year to see Sangoma at these levels of gross margin 9 months into fiscal '22, a level that's near the top of our industry. Operating expense for the 9 months of fiscal '22 was $120.85 million as compared to $45.65 million during the same period last year. The increase was mainly due to the incremental expense associated with the addition of Star2Star and the increase in G&A outlined earlier.

EBITDA is almost $31 million for the year so far and it is about double the $15.43 million of the same period last year. This is equivalent to about 19% of sales for the first 9 months. And finally, year-to-date net income is negative $11.53 million, which was impacted by the factors outlined earlier in my prepared remarks about the third quarter.

That brings my commentary on the year-to-date income statement to a close. We've already touched on the balance sheet in my Q3 remarks. So I'd like to just briefly mention cash flow.

For the 9 months of fiscal '22, we've generated adjusted cash flow of $14.1 million. This is quite similar to that generated in the same period of the prior year despite our higher adjusted EBITDA. This is for a few reasons in fiscal '22. For example, we needed to use working capital to build incremental inventory and pay in advance to secure critical parts in response to the global supply chain pressures to fund receivables as our sales have grown, to draw down deferred revenue somewhat as we move more and more away from a product company to a SaaS model, such that on-premise maintenance gradually declines and gets replaced for cloud MRR.

We've increased modestly our development cost initiatives and had to pay higher taxes. As indicated earlier and as you will have heard from other companies, we expect the supply chain pressures to continue for some time. But we fully expect to manage through them successfully as we've been doing in order to continue meeting our customers' expectations.

Finally, as was the case with prior quarters, we are, of course, comfortably within all of our debt covenants and our overall balance sheet remains healthy. That brings my comments on year-to-date financial results to a close.

So let's now move to our third section today, a quick update on the NetFortris acquisition. As most of you on this call will know, NetFortris represents Sangoma's 11th acquisition in 11 years. As we've noted when we announced the acquisition, it's an exciting transaction for us because it further accelerates Sangoma into the upper echelon of SaaS communications providers and it extends our industry-leading suite of cloud services with new MSP capabilities, thereby delivering even more one-stop shopping for our customers and providing a larger share of wallet for Sangoma at a time when we're hearing more clients seek more of the communications they need from fewer trusted vendors.

So while it's only been a few weeks since the transaction closed, and thus, it is indeed very early to provide a substantive report on integration. I did want to give you a short update based upon what's transpired thus far. I'll provide that short update by touching on 4 things about NetFortris: customers and channels, products, the integration of the organization and cost synergies.

From a customer and channel perspective, the integration is just beginning. We have now held multiple sessions with our channels from each predecessor company, both former webinars and one-on-one meetings. We've introduced the strategic fit and explained to them how the broader product portfolio can benefit their sales and their customers.

In general, the reaction from the channels has been overwhelmingly positive, with many partners agreeing with the approach of more communications products from fewer trusted suppliers being exactly what they're being asked for. And as for end customers, our sales teams are starting the outreach. And that customer contact goes right up through all levels of our customer-facing organization right to me.

I've personally now spoken with many of the largest NetFortris customers myself, clients who spend tens or hundreds of thousands of dollars per month in MRR with us. For sure, I can confirm that they understand and were excited by the broader suite of products, of course. But it was also reassuring to hear from many of them that they also appreciated knowing NetFortris is now part of a much larger, financially healthy, stable, growing public company. That was good to hear.

Next regarding products, it really is extremely soon after the acquisition to say too much on this one. The early attention in the product area is on a couple of things. We need to explain the complementary products now available to each prior customer base, whether it's the full suite of cloud services now becoming available to the NetFortris base or the new MSP services to the Sangoma customers. This is more product management and product marketing work than it is engineering or software development at this early stage.

The other key product work is on network planning as we started thinking about how to bring the Sangoma network and the NetFortris network more together. This is all the data centers where the SaaS software is hosted all the switching and routing, all the databases, the security and the traffic handling. And in fact, on that last point, we are already beginning to work on traffic engineering by looking at the ways in which we can save costs in that area.

And now for organizational alignment and the integration of the NetFortris team into Sangoma. I'll start by saying that I'm very pleased with how the companies are coming together early on. We've already made truly significant progress on bringing the people together. Our general approach at Sangoma has always been to gradually integrate the acquired businesses into our broader company rather than have it continue as a stand-alone operating entity.

And that is precisely how it's playing out this time as well. We have already integrated most all of the functional groups from NetFortris into their respective departments at Sangoma. This includes finance, legal, HR, marketing, product management, engineering, network operations, et cetera, all in less than 2 months. The one department that we are integrating more slowly in this case is sales.

For the next couple of quarters, it will remain business as usual for our 2 sales organizations from each prior company simply to avoid disrupting sales momentum to give the needed time for cross training and to support the earn-out structure inherent in the transaction.

And finally, in the last part of my NetFortris update, I want to touch on synergies. Some of you may recall that when we announced this acquisition, we explained that we expected about USD 4 million in annualized cost savings. I'm pleased to report that we are already off to a very good start on that project because based upon the department integration I've just covered we have already begun realizing such synergies in our current quarter Q4, even a bit earlier than anticipated.

We are now well on track to hit that target. And we may even do slightly better. We still expect to be at or maybe even slightly above the $4 million within 6 months. These savings are coming from the areas we outlined when we announced the transaction, namely efficiencies, removing duplication and staff, consolidating traffic, amalgamating data centers, getting rid of duplicate marketing programs or audits or insurance, et cetera.

And that brings my NetFortris update to a close for today. I fully realized that this one was an initial preliminary level, given it's only been a short while since we closed. But I'll provide you with further integration details on our Q4 call once we've been together for a bit longer.

I'll now turn to a few comments on strategy. Today I'll focus my strategy remarks on our competitive differentiation and on our investor relations activity in the public equity markets. As I've highlighted on previous calls, the cloud communication space is competitive and to see increased consolidation. For a company to remain a top player in this sector, they have to have competitive destination.

We are clear about what makes Sangoma stand out. And we work hard to ensure our customer-facing teams communicate this consistently to customers, prospects and partners. Those of you who have joined us on other calls have heard me explained our differentiation in the following way.

First, we have the widest set of cloud communication services in the industry. From UCaaS to Trunking as a Service, to Contact Center as a Service, the Video Meetings as a Service, Collaboration as a Service, CPaaS, Desktop as a Service, Access Control as a Service now our new MSP services.

Nobody else comes close. Second, our ability to offer multiple deployment options from pure cloud to on-premise to hybrid solutions. The Sangoma is arguably the only significant communications SaaS Company that can say this. And third, we make the entire product portfolio, complementing our cloud services with our own set of products, such as desk phones or SBCs or headsets now more common in work from home settings. That allow us to make these products do things our competitors cannot since they buy them simply from other third-party firms and enable us to offer a true one stroke digital commitment to customers.

Further, Sangoma increasingly believes that customers want the integrated buying experience for one-stop shopping. This approach has been our focus for some time and is the basis for the first competitive differentiation strategy I just explained because we believe that customers do not want to buy 5 different cloud services from 5 different vendors.

It was that existing competitive differentiation strategy that made the acquisition of NetFortris such a good fit specifically for Sangoma as we further expanded that approach with our new MSP offerings. This is a fairly new concept in our industry, one that few UCaaS companies have yet embraced and one that we believe will be a lucrative model for us, securing larger share of wallets and ARPU, while being much appreciated by our customers and channel partners.

Our differentiation in the industry plays an important role in my next topic about public equity markets and your company's IR efforts to secure the recognition we believe Sangoma deserves and that we feel we've earned. We continue to focus on raising our profile on the TSX and NASDAQ markets and with investors there given a very solid performance. With Sangoma's transformation story, our total growth model, delivering greater than 50% CAGR over the last 7 years and our impressive growth with profit commitment -- we have believed for quite some time that our stock has been dramatically undervalued a perspective that I know a lot of you on this call share.

Given today's macro environment, economic trends and the current equity market conditions, Sangoma's share price has indeed taken a beating. It is very upsetting to us as a company, as a board, to your executive team and the staff that worked extremely hard for your company every day, and yes, admittedly to me personally.

In such volatile times, many market players contends to focus their buying on large cap names and mid-market companies can suffer, get caught up into technical downdraft. We firmly believe Sangoma provides a phenomenal buying opportunity for investors, especially given recent share prices, combined with our strategic and operational results.

With that said, we've been actively working on multiple initiatives in this area, including increasing our research coverage. As you may have heard me say last quarter, we've added coverage for each of TD, BMO and Canaccord recently. And in the near future, we understand that we'll be seeing new excellent coverage from multiple analysts in the U.S. very shortly, more to come on that in Q4, so please stay tuned because you'll appreciate, I can't say much more about it just now.

We've also been focused on inclusion in several key indexes. And I'm pleased to say that Sangoma will have an opportunity to be added to a few important ones very soon. For example, with our cost listing to NASDAQ, the upcoming reconstitution periods happening next summer, should place us in an index or 2 there, we believe. A similar opportunity exists on the TSX with our listing there, having now met the minimum 6-month timeframe to be considered.

But I don't want to get too far out in front of myself here. We feel these steps will help garner more exposure for Sangoma in the public equity markets.

That concludes my comments on our strategy and while Sangoma is, of course, not immune to market trends, we remain optimistic that completing major steps such as these should help trading volumes and share price as well.

With that, I'll move on to my fifth and final section today on guidance for fiscal '22. On the last call, covering Q2 results, I explained that we changed our guidance for the year based upon performance for the first 2 quarters. At that time, in February, we increased our expected revenue to a range of between $215 million and $219 million for fiscal '22 and adjusted EBITDA of to $42 million to $44 million for the year.

Following the acquisition of NetFortris and the results of our third quarter, we are increasing revenue guidance further for fiscal '22. We now expect revenue to be between $230 million and $232 million. The increase in revenue guidance factors in many considerations as outlined more fully in our press release and MD&A, but includes assumptions regarding supply chain constraints and our ongoing ability to manage them as in the past, revenue trends continuing as well as demand and subscriber growth.

We are also reconfirming our guidance for adjusted EBITDA of between $42 million and $44 million for fiscal '22. This decision also factors in several considerations, including the ongoing supply chain challenges and the inclusion of NetFortris in our fiscal Q4 results.

We expect NetFortris will contribute adjusted EBITDA at about the breakeven level in our fourth quarter, during which we are implementing many of the synergies you just heard me speak about earlier, such that we're confident we'll have material positive EBITDA already going into fiscal '23.

With that, I'd now like to bring my prepared remarks to a close with a quick summary. This quarter was another testament to the hard work and dedication of the Sangoma team, a team that continues to rise to the occasion despite the macro level challenges we faced, delivering consistent, excellent, growing financial results for our shareholders, all while continuing to provide the best service to our customers.

And it's a team that's growing through the NetFortris acquisition. We are excited about the services; talent, customers, channel and growth there. And we look forward to extending our already widest set of communication SaaS products in the industry.

This quarter also saw Sangoma meet our strategic and operational goals. From an operational perspective, we've seen our services business, where the recurring revenue was generated expand nicely year-over-year, with Q3 at about $39 million, up about $1 million from the preceding quarter. Our services business is, of course, supplemented by our product business, which has maintained its solid revenue quarter-over-quarter.

From a strategic perspective, we continue to emphasize growth utilizing what we call our total growth model, which I've described as a combination of organic growth and prudent disciplined M&A activity.

The NetFortris acquisition is a perfect example of this model. Our ability to cross-sell will help us see additional growth, positioning us to take advantage of a growing industry and the macro trend of moving to the cloud. The strategic direction and success at Sangoma has been excited for the future and the trajectory of your company.

And with that, I'll turn the call back over to David for questions.

[David Moore, executive]

Thank you, Bill. To make sure everybody knows how to ask questions, I'll ask the operator to go over the instructions. Operator, we're ready to take questions now.

[Operator]

[Operator Instructions] Our first question comes from Eric Martinuzzi of Lake Street.

[Eric Martinuzzi, analyst]

Congratulations on the good execution in Q3 and on completing the NetFortris acquisition. I wanted to specifically start with the legacy business and just talk about the competitive landscape on the services side of that business.

Just if you're seeing any more aggressive behavior and this would be maybe another way of asking the question is to see what your retention or churn was like in the most recent quarter?

[Bill Wignall, executive]

Yes. Good question. Thank you, Eric. I would say that there was not any form of material change from Q2 to Q3 in the competitive landscape. Our churn did not increase at all unlike some of our competitors. I read your coverage of Crescendo this morning here. What I would say is -- as I mentioned in my prepared remarks, it's a competitive industry.

You guys know that. We have several strong competitors out there. But Sangoma has never tried to go head-to-head and just bang our head against the wall doing the same thing in an exact duplicative way that the competitors do. We've tried to take how the positioning that's unique and defendable that seems to be working based upon the results you see.

We're not trying to be pumps here and suggest that the competition is irrelevant. It's real and it's serious and it's strong. But our performance in Q3 vis-a-vis those competitors was not different or negatively impacted versus Q2 and our churn results reflect that.

[Eric Martinuzzi, analyst]

Okay. And then shifting over to NetFortris. Remind me again, where do we expect the recurring rents to go as a percent of total revs kind of on a pro forma basis here?

[Bill Wignall, executive]

Well, as you heard me say, we're around 70%, 71% right now. NetFortris is over 90% recurring revenue. So based upon the trajectory of those 2 revenue streams, I don't want to get into fiscal '23 guidance, but giving you a general answer to your question.

We think that brings the number from 70% or 71%, up closer to 73% to 75%, depending upon how those 2 revenue streams unfold for the next year. And we'll talk about that in a little bit more detail when we give guidance at the end of fiscal '22.

[Eric Martinuzzi, analyst]

And then last question for me. In your conversations, as you're going out and talking to customers on the NetFortris side, channel partners, NetFortris side. What are they really finding on the product side, the most interest? Is it managed security? Is it SD-WAN? What does appeal to them?

[Bill Wignall, executive]

Yes, also a good question. Thank you. I think you can probably imagine that the answer is totally different, whether it's a traditional Sangoma channel partner or a NetFortris traditional partner, right? So, on the first of those 2, if you're a partner that has been selling Sangoma products for some time, which is kind of the question you've asked, Eric.

They generally have said we like all 3, whether it's managed SD-WAN or managed access or managed security. But I think no surprise to you that the one of those 3 that's getting the most attention right now, just given everything that's going on in the world is managed security, right?

Every day, we hear about some new company getting hacked. And so the channel is particularly sensitive to that because in general, they tried to position themselves appropriately in this trusted adviser role to the end customer. And so their end customers are asking them, "Hey, I read about security, what do you think we should do?" And so that's the one of the 3, they seemed a little bit more locked into.

On the other side of the fence, if it's a NetFortris channel partner, and we're telling them about the Sangoma product suite, there's 2 things they seem interested in at the top of the list. One is the general set of cloud services and it's not one above any others, whether it's -- we know how the CCaaS product to sell.

We now have video meetings where we now have collaboration or we now have CPaaS. They're interested in all of that because NetFortris treating was a UCaaS specific cloud company. But they're also a little bit surprisingly, but not totally quite intrigued by the on-premise software. They're not like us, not because they take on-premises the future 10 years from now. But they do know that some of their customers still prefer prem or they're not ready to move 100% to cloud.

And so hearing that, we can get the prem solution from the same company we get our cloud. So we should -- seems to have been intriguing to several of them that I've spoken to.

[Operator]

Our next question comes from Gavin Fairweather of Cormark Securities.

[Gavin Fairweather, analyst]

I think from the outside looking in, your execution has been very strong and very steady. And I think your commentary on the retention that you're seeing was quite helpful.

But just given kind of what's going on in the market, I wanted to check in just generally on a couple of other factors and see if you're sensing any real shift in kind of the demand picture or pricing behaviors or channel commission kind of out there in the industry.

[Bill Wignall, executive]

Okay. I would say we're not seeing a shift in demand, Gavin. The demand is solid and continuing the transition to cloud is not going away. There are certainly small fluctuations up or down, sometimes by region. There's been some crazy renewed COVID shutdowns again in some parts of the world that clearly can slow things temporarily, but demand doesn't seem to be a concern at this point.

The other part of your question about price and commissions, we do see more shifts in. So for sure, over time, like any technology or product, especially as they begin to mature, price should be expected to gradually come down and you certainly would see that in the UCaaS. It's not a huge material come down. But we're seeing a little bit more discounting in the market each quarter or each year as companies, especially the weaker competitors struggle to find a way to make a name for themselves.

And I would say the same thing is true on channel commissions. Of course, it's not a decrease in channel commissions to fight for space, it's an increase. And so, most companies in our space would acknowledge that over the last several years, you've seen a gradual uptick in commissions that's continuing. We're hearing a few more companies here and there paying higher commission rates or higher upfront fits than in quarters before.

I wouldn't say it's a hugely material shift. It's just the continuing trend of the last many quarters.

[Gavin Fairweather, analyst]

That's helpful. Now that you've had kind of Star2Star under your belt for a bit over a year and you've kind of done the integration. Can you just speak to how your perception in the channel change and whether maybe just qualitatively, whether you've seen that kind of influence your win rates at all?

[Bill Wignall, executive]

Yes, sure. Of course, we can. I would say it depends a little bit upon which product and which size customer, Gavin. It's definitely increased our win rate. So we have more ad bats with more larger customers than Sangoma had prior to the Star2Star acquisition.

We're working on several now that are many thousands of seats that would be different than in the past. And by the way, not to go off on attention, that's equally true for NetFortris. And the types of customers or verticals also look a little bit different.

So Star2Star had some particular expertise in servicing customers with multiple sites and in some cases, many, many sites, hundreds of sites, chains of retail stores or restaurants. And that was also new for Sangoma. We had very few, if any, of those. So not only has it increased our win rate with new ones. It's also taught the combined company, what it's like servicing those kinds of customers, what they're looking for, how you deal with the fact that decision-making and complexity of the deployments at the corporate headquarters for such customers looks so different than the deployment at 1,000 stores or small restaurants where it's a very small simple deployment team.

That's also new for Sangoma. That latter one is also something by pure coincidence that NetFortris has good experience in. So we're intrigued by the fact that the most recent 2 acquisitions both have some skillsets and experience in that area. It's a growing opportunity for us.

I would say that those kinds of customers were slower to move to cloud and are starting more and more of those transitions these days than they did a year ago or 3 years ago. So timing might be pretty good there.

[Gavin Fairweather, analyst]

Yes. And you kind of touched on a little bit on my next question. That was just around kind of the on-prem base and just given shifting preferences towards cloud. Are you getting more kind of uptick on your marketing efforts? Are you seeing more inbounds in terms of those migrations? And is that starting to contribute to the recurring revenue growth that we're seeing in that set?

[Bill Wignall, executive]

Yes. In general, the answer is yes. And the drivers of that opportunity have not really changed at all. The on-prem base is gradually changing to cloud. Some of those proactively we want to move calling into Sangoma asking for help, others may be a little bit more reluctantly. I already have this thing. I bought it.

Okay. I guess I'm going to have to move to cloud. The rest of the world is maybe that's us reaching out to them. And then there's that third part, which is just a little bit more entrenched, right? They're less willing to move. It's a sunk cost during times of economic stress.

It works. I don't want to change it. So we see that a little bit more, too, Gavin. But the first 2 groups continue to move along. But how entrenched that third group is, is a little bit stronger now. So if we call someone who's in that third group, they're less likely to move these days given what's going on out there in the world than they might have been 1.5 years ago when there was a little bit more confidence about the economic outlook.

[Operator]

Our next question comes from David Kwan of TD Securities.

[David Kwan, analyst]

I appreciate Bill, the color on NetFortris. That was very helpful. Wondering about the EBITDA margins continue to be quite solid. But obviously, with the NetFortris acquisition here, set to see some moderation there.

Do you think it's reasonable that we could see them get back to kind of current pre-acquisition levels kind of in a year's timeframe like we saw with Digium.

[Bill Wignall, executive]

Yes. It's a little bit hard for me to answer that without it's sounding exactly like fiscal '23 guidance, which I know from prior discussions you and I have had, you'd appreciate we want to stop just short of.

But the general answer is yes. Whether we get to '19 or '18 or '20 or something like -- that's harder for me to answer at this point in fiscal '22, having owned the company for 6 weeks. But I shared in my comments that we've made better and faster progress on that even than we expected during due diligence and at the time we announced the deal. So that's reassuring.

And the kinds of synergies we've seen have been exactly what we expected. So where we expected to save money is proving to be true. The precision in your question is the only tricky part, right, David? As I said, the answer is yes.

But whether it's '19 or '17 or '20 or that I don't want to get into. But I think we're feeling pretty bullish that we can keep our margins healthy in and around where they are, plus or minus a point or 2. And that includes the factoring in of NetFortris.

[David Kwan, analyst]

No, that's fair. I appreciate that, Bill. And just one more question. Maybe you could talk about your priorities as it relates to capital allocation. Obviously, you talked about kind of where the shares are trading right now. Like would you look at some point implementing at the share buyback?

And maybe how would you balance that versus building out more capital to help fund your next acquisition?

[Bill Wignall, executive]

Yes. We had our Board meeting this week, of course, as you would realize. And this was one of the topics that we talked about. Historically, you may remember that Sangoma did use an NCIB. Some of our shareholders loved it, some not as much.

In general, I would say the recommendation from management to the Board over the last couple of years has been, don't do it. We have better uses for our capital. But I have to say, you heard me comment on in my prepared remarks, how upsetting it is to see our share price where it is these days.

And so, the lower the price drops, the more compelling doing the buyback might be. We're seeing more companies in our space and the markets generally do it for obvious reasons. So there was a willingness to consider it from our Board's point of view. We did not make a final decision about it. But we're looking at that option for the first time in a couple of years. Whereas in the past, we've kind of descended and said that's not the best use of capital.

But seeing share price at $12 a share is very upsetting. And so we're a little bit more open-minded to it than we've been recently.

[David Kwan, analyst]

No, that's good to hear. I appreciate that, Bill, and congrats on the great solid execution.

[Operator]

Our next question comes from Deepak Kaushal of BMO Capital Markets.

[Deepak Kaushal, analyst]

I've got a follow-up question and then a couple of new ones. Bill, just on the margin, it sounds like if I interpret this correctly, maybe I misunderstood. You see good upside with NetFortris on the gross margin side to 73%, 75% from 70s today, but less so on the EBITDA side. Can you just talk about the difference in cost structure for NetFortris between cost of goods sold versus OpEx? And in particular, where is it people heavy versus automated?

[Bill Wignall, executive]

Okay. Let's talk about that. I think you might have been mixing my comments on 73% to 75% between the fractions of revenue coming from services versus gross margin.

So NetFortris has a higher fraction of recurring revenue than Sangoma and will thus bring up our 70% or 71% services contribution, up closer towards the 75%. And that's what I was commenting on.

On the way you phrased your question, you were asking, will it bring gross margin up to 73% or 75%? And I would say probably not. NetFortris is above us on services contribution percentage, but slightly below Sangoma on gross margin.

So I wouldn't expect that the consolidation of NetFortris into Sangoma is going to bump up our gross margin. We're working on improving and strengthening their gross margin. We're having some early success in that area. But it's too early for me to quantify it right now.

We'll, of course, know that by the time we give guidance for fiscal '23, but that will be at the end of Q4, not at the end of Q3 Deepak. Is that helpful?

[Deepak Kaushal, analyst]

Yes, that's very helpful. I appreciate that clarification and sometimes my brain is spoiling in the morning. Just on the NetFortris business, how people heavy versus automated in that business? And is wage pressure risk and the ability to pass on cost to customers? How does that dynamic work for MSP?

[Bill Wignall, executive]

I would say -- I'll give you 2 parts to my answer. One is the piece which is unique to NetFortris. And then a comment about NetFortris that's not unique to them at all. It applies to the rest of Sangoma too.

NetFortris has about 90 people in the Philippines in Manila. And that is one of the strong, very wise ways that the company had even before Sangoma acquired them, of course, worked strategically to control cost of labor. And we like that very much.

We have a lot of international presence around the globe, as you know. I don't know 20 countries or something. So Sangoma is quite comfortable with that. And we plan to expand the presence in the Philippines over time. The elections there this week are a little bit unsettling for us. But other than that, the second part of my answer would be inflation generally, including the hot job market and wages, I think, is affecting everybody, right?

You never mind Sangoma and not even really just tech companies, like just it is a superhot overheated job market. And so for sure, that affects NetFortris. But it affects the rest of Sangoma as much as it affects NetFortris. We deal with it every day, just like all of our competitors and every other company out there is dealing with.

I think we've done a good job of it. Our employees like -- working here generally it's been an inspiring ride. And we treat people well and value them highly. It's very much what's in people's heads business more so than fixed assets. But we do have to contend with that.

There is a little bit of wage inflation. We'll probably use slightly higher salary increases for the next fiscal year than we did the last one, given what was going on with COVID. But my guess is that's not different for you coming for me than you hear from other CEOs when you talk to them as well.

It feels very, very similar to me to what everybody else is dealing with.

[Deepak Kaushal, analyst]

Okay. Okay. That's helpful. I appreciate that. And then my new question is on M&A. You said earlier that the macro and the changing in the macro hasn't changed demand from customers. How is it changing the M&A environment, and particularly related active on private equity side or proprietary ones product businesses? How is the change in that environment for you guys?

[Bill Wignall, executive]

Yes. Well, interestingly, from what we see, there's nothing really about the change in demand or any pricing pressure or commissions pressure that's changing the M&A climate in any noticeable way. We at least -- has not been visible to us. What we do see is the carnage in the equity markets affecting M&A, right?

So a company that was interested in buying or selling when their share price was x, is perhaps less interested in buying or selling when the share price is x over 2. And that has a big effect, right? It affects buyers, it affects sellers. It affects companies that were thinking about starting an M&A cycle. It affects companies that were halfway through M&A cycles.

So there's a lot of disruption in the M&A landscape right now from what we see. I'm very pleased that we've got the NetFortris deal done when we did. But several of the conversations we've been having and that we will continue to have we see companies like that rethinking what is this mean for us?

We see private equity firms circling around weak public companies saying, "Hey, you guys don't have the resources, let us take you private." You see private companies who thought they might be able to go public. We speak to several of those, including some direct competitors thinking, boy, really glad I didn't go to public last year.

So the impact on the M&A climate, I think is less from general economic conditions and more -- much more specifically triggered by what's happening in the stock market.

[Deepak Kaushal, analyst]

So all I could say, would you say that, that's a net positive for the M&A strategy going forward or net negative?

[Bill Wignall, executive]

Yes. I think it's mixed just to be completely candid about it. It's definitely positive in the sense that it opens up some new opportunities for companies that might not have been willing or maybe the prices are a little bit more moderated, but it's not all positive, right?

The negative aspects of it are it just introduces uncertainty and uncertainty makes people wait, right? And so someone who thought they might do something maybe hesitate to do it now or hesitant to do it at the prices that exist now. If you thought your company was worth 4x revenue or 6x revenue or whatever it was and all the public comps have come down by so much, then, you might just wait.

So it's not really one side or the other. I will say that it favors financially healthy, strong buyers. So that's the part that works well for us, Deepak.

[Deepak Kaushal, analyst]

That's very helpful. I always appreciate the detailed thoughtful answers, looking forward to the next call. Thank you.

[Operator]

[Operator Instructions] Our next question comes from James Breen of William Blair.

[James Breen, analyst]

Bill, can you just talk a little bit about where your growth is coming from in terms of your existing customer base, taking more product or just growing their businesses versus sort of taking new clients on?

[Bill Wignall, executive]

Yes. Sure, Jim, of course. The simple answer is it's about equally weighted. It's not exactly equal and it varies from quarter-to-quarter. And it differs from product category one to product category 2.

But in general, at Sangoma, we are looking for both new customer bookings and existing customer expansion. It generally fluctuates between something like half and half, up to 2/3 from new customer bookings, 1/3 from existing customer expansion.

But as I said, that can vary widely from one quarter to another. If you win a particularly large new customer that will influence it, right? If you have an existing customer that is doing really well or we're struggling with the economy or shuts down some stores or something.

So there's no single right answer, but both of those are equally important. We have 2 dedicated sales forces, one for new customers and one for existing customers, just like you would expect both of those have to perform. It's not possible for Sangoma to continue growing the way we are if one of those drops off.

I would say that generally, the trend at Sangoma has been -- let's continue to move up the new customer bookings. That doesn't mean we have success at that every single quarter. But the existing customer expansion is a little bit more predictable, a little bit more tied to the size of the installed base, whereas the new customer bookings are much more, obviously, a reflection of the efficacy of the sales team.

[Operator]

This concludes the question-and-answer session. I would like to turn the conference back over to David Moore for any closing remarks.

[David Moore, executive]

Thank you, operator, and thanks, everybody, for participating this morning. We appreciate your support, and wish you a very good rest of your day.

[Bill Wignall, executive]

Thank you, everyone.

[Operator]

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