Sangoma Technologies Corp (SANG) 2022 Q2 法說會逐字稿

Thank you for standing by. This is the conference operator. Welcome to the Sangoma Technologies Q2 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.

Thank you, operator. Good morning, everyone, and welcome to Sangoma's second 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 us live. I'm here today with Bill Wignall, Sangoma's President and Chief Executive Officer; and Larry Stock, Chief Corporate Officer, to take you through the results of the second quarter of our fiscal year, which started on October 21.

We will discuss the press release that was distributed yesterday, together with the company's unaudited interim Q2 financial statements and MD&A, which are available both on SEDAR and on our website. As a reminder, Sangoma reports under International Financial Reporting Standards, IFRS. And during the call, we may refer to a couple of terms such as 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 reference to dollars are now to the U.S. dollar as we started reporting in U.S. dollars for fiscal '22 and beyond. This includes all prior period comparisons, which have been converted to U.S. dollars as described in Note 2 of our financial statements and in our press release.

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, 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.

Thanks, David. Good morning, everyone, and thank you for joining us today. I have structured my prepared remarks for this call into 4 sections. I will first focus on Q2, then move on to year-to-date results. In my third section, I will give a brief update on strategy, and finally, I will touch on our forward guidance for fiscal '22.

As always, I'll then wrap up with a brief summary and turn the call back over to David for our typical open Q&A session. With that, let's move on to the first section covering our Q2 results. Sales for the quarter ended December 31 were a record $54.24 million, more than double the $27.09 million in the second quarter of fiscal '21. This increase in sales was driven by the Star2Star acquisition, as well as our existing services business continuing to grow and compound together with an uptick in our product sales.

Sequentially, our Q2 revenue grew by approximately 3% from Q1 and our services revenue continues to expand very well right on strategy. In Q2, that services revenue came in at over $37 million. So while total revenue doubled, as you've just heard, or stated another way, grew about 100%. Our services revenue is up by 140% year-over-year and represented over 70% of total sales for the quarter, consistent with our expectations for fiscal '22.

As I did during one of our quarterly calls last year, I'd like to just take a step back in time for a moment and examine the longer-term trend in Services revenue at Sangoma. In fiscal '18, we had Services revenue of under $5 million per quarter typically. In fiscal '19, that had grown to something by $10 million per quarter. By the year following in fiscal '20, we were averaging around $15 million in most quarters. Last year, Sangoma was about $20 million per quarter. And finally, this quarter, we're well over $37 million, hitting greater -- over $30 million, hitting greater than $37 million in Q2.

We think this is a pretty impressive long-term trend and one that has been achieved without any of the more typical significant drops in total revenue as most other companies navigate the transition to recurring revenue normally encounter. Solid, consistent strengthening that is a testament to our strategy and vision for the company. Gross profit for the second fiscal quarter of '22 was $39.4 million, also more than double that of $17.9 million in Q2 of last year.

Gross margin for the quarter was over 72% 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 contribution from Star2Star on this metric. These levels of gross margin amongst the very highest in our industry are even more satisfying given that our cost of goods continues to feel pressure from the global supply chain disruptions.

The Sangoma team continues to do a remarkable job in managing these challenging circumstances, and I will touch on this a bit more in my comments on inventory coming up. Operating expenses for the second quarter this year were $40.24 million versus $15.13 million in the same period last year. The higher operating expenses were primarily driven by the cost that came with the addition of Star2Star, the associated spending and the noncash intangible asset amortization arising from the acquisition. As I've done in prior quarters, I will offer some additional insights on the 3 individual OpEx buckets under IFRS, namely sales and marketing, R&D and G&A.

Regarding sales and marketing, you will notice the portion of our OpEx that is in the sales and marketing category, has increased in the second quarter of this year versus Q2 of the prior year. This was primarily the result of the addition of the Star2Star sales team, the channel partner commissions, the incremental marketing staff and the accompanying marketing program spend. You will notice that percentage of revenue spent on marketing and sales is up this fiscal year for those same reasons.

With respect to R&D, the increase in the second quarter of fiscal '22, from the same quarter in 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 marketing and sales, for customer acquisition and into R&D for product development than we did in the prior year.

But we seek to grow that spending in such a way that in general and over the long term, the percentage of revenue spent in these areas can gradually tick downwards as a fraction of revenue and thus, the operating leverage. You see that trend in R&D spend this quarter.

And finally, the G&A expense also shows an increase from the prior year driven in large part by the intangible amortization associated with the acquisition, as mentioned. As a reminder, this intangible amortization is a noncash expense, so it does not affect our adjusted EBITDA or cash flow, but of course, does appear as an expense in our income statement.

Adjusted EBITDA was a record in the second quarter at $10.43 million, exceeding $10 million for the second consecutive quarter and more than double the $5.14 million from the second quarter of the previous fiscal year. This level of adjusted EBITDA is equivalent to about 19% of sales and is in line with our expectation for this point in fiscal '22. Net income for the second quarter was negative $2.48 million, primarily the result of the noncash intangible asset amortization following the Star2Star acquisition and the onetime expenses associated with the listing on the NASDAQ and TSX exchanges.

That brings my commentary on our Q2 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 very strong. Our cash balance at the end of the second quarter was $16.95 million, which is about $2 million lower than at September 30. This was driven primarily by an increase in accounts receivable and a buildup of inventory ahead of the Chinese New Year and to deal with the supply chain pressure.

Trade receivables increased finishing the second quarter at $15.98 million as compared to the $14.07 million at September 30. The increase this quarter was in part due to the fact that December is often a month when some customers wish to use up their budget before their year-end. This can lead to us getting some orders quite late in the quarter, as such customers have naturally not yet been paid by December 31. This is not unusual, not a problem for us. And as always, we continue to monitor receivables on an ongoing basis.

Inventories were $14.34 million on December 31, $1.65 million then at September 30, reflecting the current supply chain pressure. This includes several factors that many, many companies around the world are contending with these things, such as component supply shortages, longer lead times and sometimes higher prices for such parts, extended manufacturing periods at our contract manufacturers, delays in shipping and some increased shipping costs.

Sangoma expects such challenges to continue for the next few quarters until the supply chain stabilizes. More importantly, the positive manner in which our supply chain operations and logistics teams have been dealing with such challenges has been just excellent, enabling us to ship almost all customer orders and in fact, at times becoming a competitive advantage when Sangoma had product in stock that our competitors did not.

From a cash flow perspective, during the second quarter, we generated adjusted cash flow from operations of $3.90 million. This measure of adjusted cash flow excludes the impact of acquisitions, financing and other nonoperating anomalies. I will touch on cash flow a bit more in my year-to-date remarks coming up next. That brings my comments on our Q2 financial results to a close. So let's now turn to those year-to-date results.

Sales for the 6 months of fiscal '22 were $106.71 million, double that of the $53.3 million in the same period of fiscal '21. The increase in sales was due to the same factors I covered in Q1, namely the Star2Star acquisition, the continued growth and 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 6 months of fiscal '22, a solid increase from the 56% in the same period last year.

Gross profit for the 6 months of 2022 was $77.26 million, more than double the $35.24 million realized last year. Gross margin was over 72% of sales on a year-to-date basis, up from 66% in the same period of '21. It's especially gratifying during a much tighter global supply chain to see Sangoma at these levels of gross margin, a level at or near the very top of our industry. Operating expense for the first 6 months of fiscal '22 was $78.95 million as compared to $29.9 million during the same period last year. This was expected with the incremental expense associated with the addition of Star2Star and the company's continuing investments to drive growth.

EBITDA was $20.52 million for the year so far, and is more than double the $10.09 million of the same period last year. This is equivalent to about 19% of sales for the first 6 months, which was similar to the prior year. Finally, year-to-date net income is negative $4.78 million, which as noted earlier, is primarily the result of the noncash intangible asset amortization following the Star2Star acquisition.

And that brings my commentary on our year-to-date income statement to a close. We've already covered the balance sheet in my Q2 remarks, so I'd like to just touch briefly on cash flow. For the first 6 months of fiscal '22, we have generated adjusted cash flow of just over $9 million compared to just over $7.8 million in the same year-to-date period of the prior year. This figure is always lower in the first half of our fiscal year, with cash flow expected to be materially higher in the second half, of course, and it's a bit lower year-to-date than it would otherwise be as a result of our spending in response to the supply chain pressures.

Finally, as was the case with prior quarters, we have, of course, comfortably within the debt covenants and our overall balance sheet remains strong. This brings my comments on our fiscal results to a close. Let's now move to our third section today on strategy. I will touch on 3 things in this section, competitive differentiation and positioning first, then M&A; and finally, Investor Relations work this quarter, including Sangoma's graduation from the Venture Exchange.

So let's start with competitive differentiation. The cloud communication space or what is sometimes just called UCaaS, a significant oversimplification in our view, is competitive. It's this way precisely because it's exciting, transforming a rather old state telecom industry, growing well with a huge total addressable market. In that competitive space, it's important for any player, especially the key players in the upper echelon like Sangoma to have a competitive distinction. We are clear about what makes us stand out and we work hard to ensure our customer-facing teams communicate this consistently to customers, prospects and partners.

You can imagine that in a technically advanced specialty that can sometimes be challenging, but I think we're quite good at this. Those of you who have joined us on other calls may have heard me talk about the first 3, the most important 3, unique selling points. They are: Sangoma has the widest set of cloud communication services in the industry. This has been a very conscious goal for some time, and the Star2Star acquisition has helped us round out this broad set. We now offer UCaaS, Trunking as a Service, Contact Center as a Service, Video Meetings as a Service, Collaboration as a Service, CPaaS, Desktop as a Service, Access Control, et cetera.

Sangoma fundamentally believes that most customers do not want to go to one company for video meetings, another supplier for contact center, another vendor for voice, another for collaboration, et cetera. They prefer a single solution from 1 vendor that they trust, 1 bill each month all nicely integrated together.

Secondly, Sangoma is the only real cloud communication player with an equally strong on-premise offering. We know that most companies around the globe still use on-premise communications. We wish to be able to tell the world that we want you as a customer, whether you're ready for all cloud right now, still need on-prem or prefer a hybrid solution. It is not uncommon for a company with multiple offices to start some locations in the cloud and then do the others a bit later.

For instance, they might say our IT competency is strongest at our corporate headquarters. So please upgrade this location to cloud first, we'll get comfortable with that and then do our other locations. And we also hear the opposite. Our headquarters location is not our testing ground. So go operate all of our satellite offices this year, get us comfortable with that and then we'll do our headquarters next year.

And our third critical unique selling point is our suite of cloud services is complemented by our own set of built in-house products. That round out the offering and allow Sangoma to offer the industry's only true full end-to-end solution. That means we don't need to rely upon some third-party vendor for phones or if you want a Session Border Controller to secure your voice network, like you would use a firewall to secure your data network, we don't send you to someone else. We do it all. And you as a customer, have 1 number to call, 1 throat to choke. A common but somewhat unpleasant phrase that often one hears for such capabilities.

And not only are these 3 things so critical to Sangoma's success in getting ourselves into the top tier of a growing cloud communications industry and driving our SaaS recurring revenue model, they are also resonating with customers. As an example, we recently put a customer on to our CCaaS or Contact Center as a Service product. Sangoma is no longer just a UCaaS company. This customer, a last-mile logistics provider had previously used a competitor's solution and switched to our CCaaS service for its enhanced capabilities.

Taking upwards of 90,000 calls per month, the customer was able to realize significant savings in labor and license costs, while getting a fully integrated solution. We're an automotive dealership company with dozens of locations in Texas and surrounding states, this was an example of a company that was originally an on-premise customer for us and migrated their hundreds of seats to our cloud offerings in a simple, elegant upgrade.

The second part of my strategy section today is a very short update on M&A. We are starting to get more frequent questions from investors these days that all go something like what or when is your next acquisition? I know that you know, I'm unable to be very precise about those kinds of topics until we have something quite specific to announce. Suffice to say for today that given the integration of Star2Star has gone well, and we are most of the way through that, we are now once again very active working on prospects for the next acquisition.

There were absolutely good opportunities in front of us. Sangoma is well respected as a proven buyer who does what we say we will do, and we are financially well positioned to act and I'm afraid I can't say a whole lot more on this today as you'll understand, and I fully realize that's not wholly satisfying. Please just stay tuned.

And my third part of today's strategy update is on our Investor Relations activity. I'm not completely sure this is the optimal title for what I wanted to share in this section, but I really just wanted to speak for a moment about the activities your company is taking to raise our profile in the public equities market given our really solid operating and financial performance.

Your Board of Directors continues to believe strongly that our stock is very dramatically undervalued. A viewpoint that I know most of you will undoubtedly share. Even more so given what has happened with share price the past several months. And while Sangoma may have fared better than many of our peers, that's no consolation. So we've been actively working on multiple initiatives in this area and I'd like to take you through 2 of them.

First, as previously announced, of course, we successfully graduated from the Venture Exchange to the Toronto Stock Exchange. We also announced our cross listing to NASDAQ in December, trading under the symbol S-A-N-G or SANG. This is obviously a major milestone for our company, a testament to our continued progress and an important step in our growth. And just a quick reminder of the reverse stock split we also undertook in Q2 using the 7:1 consolidation ratio.

Secondly, we've been focused on increasing our research coverage. I'm pleased to point out that over the past few months, we've added coverage from 3 excellent analysts at each of TD, BMO and most recently, Canaccord just this week, really good progress. So while the cloud communications sector has seen share prices declined sharply from their highs of 1 year ago. And of course, Sangoma is not fully immune to this trend despite of our share price somewhat outperforming our peers. We remain optimistic that completing major steps such as these should help trading volumes and our share price as well.

That concludes my comments on strategy, and I'll now move on to my fourth and final section today about guidance for fiscal '22. On the last call, at the end of our first quarter, I reiterated our fiscal '22 guidance. At the time, we reconfirmed expected revenue of between USD 209 million and USD 213 million and adjusted EBITDA in the range of $41 million to $43 million. With our performance through 2 quarters, we have now increased guidance for this year, as you may have seen yesterday.

We now expect revenue to be between $215 million and $219 million for fiscal '22 and adjusted EBITDA of $42 million to $43 million. This increase in guidance factors in many considerations as outlined more fully in our press release but includes assumptions regarding revenue continuing along on the trends we've experienced year-to-date, demand and subscriber growth for our products and services, no additional material impact on our supply chain and the increased costs associated with our NASDAQ listing, such as much higher D&O insurance premiums.

With that, I'd now like to bring my prepared remarks to a close with a quick summary. Your team here continues to do a remarkable job across the company, which is evidenced by another solid quarter. We have demonstrated proven top line growth over an extended period, solid and expanding EBITDA, a consistent increase in our services business, where the recurring revenue is generated, the successful integration of our largest acquisition to date and an adept handling of the global supply chain crisis, a challenge that has snookered many, many other companies. An exceptional job all around while continuing to exceed our customers' expectations during uncertain times and on a competitive playing field. So a special thank you to everyone at Sangoma for all your hard work.

I'd also like to highlight our capital markets maturation in addition to delivering solid operational and corporate development success. Our listings with the premier exchanges in the market, namely the TSX and NASDAQ along with expanding research coverage from 3 excellent banks recently, bode well for Sangoma as we seek to get our story and our track record out to more investors in Canada and the U.S.

Our long-term strategy of transforming your company from a squeaky little hardware company with 1 product, no recurring revenue and a nano-cap stock into a cloud communications powerhouse with a SaaS business model is remarkable for both its boldness and its success. Sangoma is very well positioned to take advantage of a growing industry and the macro trend of moving to the cloud.

Finally, throughout my prepared remarks, both today and on prior calls, you've heard me emphasize growth. Sangoma utilizes what we call a total growth model, which I have described as a combination of organic growth with prudent disciplined M&A activity. We believe this strategy of organic and growth via acquisition serves us particularly well in today's consolidating industry. These recent achievements have me excited about the future of Sangoma and the path we are on as a company. I'd like to thank you, our shareholders, for your continued support.

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

(Operator Instructions) The first question is from Deepak Kaushal from BMO Capital Markets.

It's Deepak here. A couple of questions for me. Good uptick in revenue, particularly continued strength on the product sales. Can you just give us a sense qualitatively or intuitively, is this still coming from a rebound following a bit of a slowdown a year ago? Or are you seeing some increased momentum there on the product side? Or are we now at a steady state for that side of the business?

Yes, that's a very good question. And in fact, even for us, it's a little bit tough to know. We've only had this 1 or 2 quarters now. In general, we've said to the markets over quite a long period, a large number of quarters, certainly multiple years that we do not see the product business as a high-growth business. It contains products that generally, for instance, the premise UC business is being gradually transitioned to cloud or it contains products that connect into the old PSTN.

So I don't think we want you guys to take a message away from here, which is product is all of a sudden, reinvigorated and going to become a growth engine. I think more what has happened is the disruptions from COVID on the economy, government responses to COVID with shutdowns, the impacts of the global supply chain have just disrupted a lot of things. And so that's changed the kinds of products that some people needed.

If they were working from home that we had a spike in headset sales as example, and it's meant some of the products in our capital p Products portfolio have been hard to get from our competitors. And that's kind of what I was referring to when I said a good job managing the supply chain has meant turned into a bit of an advantage. But I just don't think we want you to extrapolate that to something that is -- it's just a bit too early to know.

Okay. Okay. That's helpful. And then when I think on the services side, the synergies with Star2Star, I think there are several categories, whether it's cross-selling on-prem versus software, international markets or some cross-sales in the channel. How would you kind of say rank the progress of achieving those synergies? What inning are we in, in terms of progress to your plan for driving these synergies? And when might we start to see accelerating services growth as a result of those synergies?

Yes. I think synergies means 2 different things, whether we're talking about revenue synergies or cost synergies. And I think which inning we're in is quite different between the 2 that's why I'm drawing the distinction. But on the cost side, as we think about, I don't know, 2 marketing groups coming together, right? That stuff is in the latter end innings. We've been through that process. That's what we mean when we say most of the integration is complete. And I just picked one. It was the same with people or systems or putting 2 HR teams together, et cetera.

The revenue synergies are in much earlier innings, of course, right? Where we've just put the sales teams together. We've only had 1 meeting with the partners. There were separate meetings at the beginning, one with the Star2Star partners, one with the Sangoma partners. The next partner event we do to kick off our new fiscal year will be with everyone together. So I guess the bottom line is the definition of synergies as costs, later innings, the definition of synergies as revenue earlier earnings.

Okay. Got it. And then just for my last question, perhaps just a bigger-picture question. And I think one of your competitors undertook a recent rebranding exercise for the entire company. I know that you're in the process of bringing your teams together from Star2Star and Sangoma and communicating that to your channel. What do you think about the merits of that kind of rebranding strategy?

And I know in your guidance, you've maintained a 20% EBITDA margin discipline. Is branding something that you can significantly invest in under the current cost structure? Is that something that might -- you might consider more investment in somewhere down the line?

Yes. I think it depends upon what you have in mind when you say branding. We've absolutely thought about, we've talked about, we've analyzed should we rename the company as like the very biggest potential rebranding, Sangoma and Star2Star coming together. We're not quite ready to make that decision yet. It's a big decision, it's an expensive investment. We're thinking about branding at a slightly lower level than that. Can we invest in the brand and tell the market in a better, stronger, clearer way what we stand for.

So that one, I feel like we are prepared to invest in. But if what you pictured was is Sangoma going to completely rename itself, while we do consider it, we've done some work on it. We've worked with an agency. I don't think it's something we're about to jump into right now.

So nice to talk to you. And guys, by the way, David just told me that I screwed up on the script at 1 point, I guess in the guidance section, I said 42, would you say, David, it's 43? And of course, I should have said 42 to 44, my apologies. It's been a late night.

The next question is from Eric Martinuzzi of Lake Street.

Yes. Just curious, and it may be kind of picking on a minor issue. But in the guidance revision -- by the way, I appreciate the fact that it is upward revision to guidance, and that's always a good thing. But just seeing that the revenue moves up $6 million at the midpoint and the adjusted EBITDA moves up $1 million at the midpoint. Just curious to know, that's a 17% incremental margin. What's going on as far as the cost of goods or the OpEx that's causing that to maybe be less than what I would have expected for incremental margin?

Yes. That's a good question. I don't think that's really nitpicking, Eric. It's perfectly fair. I think it's pretty simple. But it's not a singular explanation. It is -- this conscious decision at Sangoma, not to take all the growth that's available and all of the cost savings that we generate and have those simply drop to the bottom line. As I've mentioned in prior calls, we're prepared to balance our wish for growth with our wish for ever-growing EBITDA.

And while we want more EBITDA, we don't want more EBITDA at the expense of revenue growth and vice versa. So while revenue is growing nicely, as did EBITDA, you're right, not quite as fast in our guidance increase. We're also investing in things like more marketing, to the prior question about branding.

Our return to business travel as the COVID restrictions lessen around the world, we're starting to do large sales events where we bring larger teams of people together and those are expensive, right? We just did a large internal sales kickoff with, I don't know, 250 people or something there. There are costs associated with the TSX and NASDAQ listings, the ongoing expense of D&O coverage, which is super expensive, of course, most of you know. Just means that it's not like we don't understand it, Eric, we're just choosing not to plow every possible dollar of revenue growth back into amping up every last point of EBITDA margin increase. That's all.

Okay. And then my second question has to do with the gross margin. If I look back a year ago, that kind of -- the pro forma analysis of the gross margin of the combined businesses, legacy Sangoma and Star2Star. I want to say gross margins were in the neighborhood of -- they were north of 75%.

And I'm certainly mindful of the supply chain pressures that you're dealing with but here we are just above 72%. There was a time when we were well north of 75%. Based on what you know now and what you see in the supply chain, is there -- do you have a time line that's realistic for when we could get back to that legacy gross margin or something north?

Yes. Two thoughts. First of all, I would say for certain Sangoma has never been at 75%, right? The only time you see numbers above where we are now is some kind of smashing companies together, financial model. And secondly, I think this goes partly back to my answer to your first question. What are we choosing to spend on, where do we invest. And so spending on things like cost of goods is something Sangoma's prepared to do because while sure, 73% is better than 72%, 72% is arguably the top gross margin in the entire industry, looking at all of our competitors.

And so we're just conscious of the need to drive growth versus the need to invest to drive that growth and the offsetting expense that affects if it's COGS gross margin and if it's OpEx EBITDA margin. So it's absolutely possible that we could be at 73% or 74%, no doubt. And yet we've chosen not to do that in order to better position the company for the future, including things like, I touched on, which may not be 2 or 3 years of future, but 2 or 3 quarters of future, how we've invested in inventory during the supply chain problem.

That has contributed to the uptick in product sales because our customers could get stuff from us, they couldn't get from someone else. So that's what's going on there, Eric. Totally get the point that a couple of extra points of gross margin is attractive to everyone. But it's a metric where we feel like we're already doing super well and at the very top. And so goosing up that further is probably not our top priority.

Yes, it was really more about if you had visibility into a time line rather than -- I certainly appreciate the accomplishment of the backward looking and as well as the best use of the word snookered in the prepared remarks with any company in the industry.

Okay. Thank you for that.

But it doesn't sound like you do have a view into that time line. So I'll leave it there.

Next the next question is from Gavin Fairweather from Cormark.

I thought I'd start out on the fiscal '22 guide and I thought I'd come on the product angle a little bit differently. Maybe you can just share your expectations for product in the back half of your fiscal year as you're coming up with that fiscal '22 guide? And then what does that imply for services?

Say the very last part of the question again, the implication of -- I'm sorry, product expectations and?

Services. And I'm just trying to figure out like when you're setting up with your fiscal '22, what assumptions did you make for both lines?

Yes. I don't think we want to try and break that out. We've not done that for guidance in any prior period, Gavin. I don't think we want to do it here. What I will say is we don't really know exactly what to expect about product sales, consistent with my earlier comment to the first question. It's caught us by a little bit by surprise, too, to be honest. You've heard me say on multiple calls that it wasn't expected to be up. We kind of treat it -- maybe it's flat, maybe it's minus 2%, maybe it's plus 2%, maybe is minus 4%. And so we're not assuming product is going to stay up and be a growth business. But it could, it could for a quarter or 2 or maybe there is something structural, maybe people are never returning to the office and the levels we thought they were and more work from home employees are going to need to keep buying things they use at their home office that they used to get from their employer at their office.

It's just really, really hard to know, only a quarter or 2 into that trend. All I can say, Gavin, is we are going to continue investing in areas that we think support it. So if having the right products on the shelf to help a little bit of extra product sales be realized needs slightly more investment in COGS, that's okay by us. And if that means we're 72% gross margin instead of 73%, that's okay by us. But I don't think we want to get into what's the growth rate over the next 2 quarters in product versus the growth rate over the next 2 quarters in services.

That's fair. I thought I'd try. It's been a couple of years since you've been talking about the strategy of being a one-stop shop for your clients. And obviously, that took a step forward with Star2Star. Maybe you can just provide us with an update on your customer success efforts, how conversations with clients are on -- are going on buying more than 1 product from you and how that's influencing your ARPU in the business?

Yes. Perfectly fair. I would say it's going well, but it's consistent with my earlier comment, the early innings of this, right? We're seeing customers buy into it. We're seeing excitement from the partners. I was just talking to one of our largest partners in Florida yesterday, and they're all over this. This is what they see as the big benefit from bringing together Star2Star and Sangoma.

But Sangoma is a bigger ship now, and it takes a little bit of time to turn that ship. We're seeing some of the sales team get it immediately start embracing it. We're spending a lot of time talking to our frontline customer-facing people about it. But for sure, it's still the minority of the existing customer base that has the full suite. And that's the big opportunity for us, as you just said, going in and increasing ARPU by having a new customer adoption be not UCaaS, but UCaaS plus CCaaS like the one I cited or UCaaS plus Video Meetings plus collaboration. And also improving existing customer expansion by being able to go back to customers that purchased UCaaS 2 years ago and say, are you interested in any of these other ex-cloud services?

So like we're all over it, but it's just a little early to comment on it quantitatively. I can say we're seeing lots of adoptions of it. We're even hearing little signs in the marketplace about it going beyond cloud services into other things. I read a report from Frost & Sullivan this month about maybe companies want not only cloud communication services but other communication services from the same vendor. So we're very confident. It's a trend that's here to stay, but it's early stages for us still, Gavin.

That's great. And then maybe just curious if I could check in on some of the conversations you're having with private companies. Given what's going on in the public markets and cloud communications. Are you seeing that maybe access to capital is drawing up for some of your smaller private competitors and that's driving more deal flow? Any thoughts on what those private dynamics are like?

Well, for sure, right? Like there's no doubt and why would communications generally or cloud communications specifically be any different, that's true. So if you are a private company running at losses, making use of readily available capital over the last few years, that gets harder now. Or if the capital you tapped was equity capital, as I just said, you fall into that bucket, the way you paid for operating losses was adding debt, the cost of debt is getting more expensive. And so one's ability to service the debt gets harder.

So I think in general, our industry will not be different than others, companies that don't have a path to profitability, we'll find it harder. We're starting to see that a little bit in our industry. I wouldn't say it's the focus of our M&A efforts but for sure, there are visible signs of it starting to emerge, yes.

The next question is from Robert Young from Canaccord Genuity.

Maybe just a simple one to start. The guidance, the second half is implied at a higher level of EBITDA margin. I think the bottom end, if you calculate, it looks like 19.2%, which is precisely what you just reported. So you're expecting the second half to be a little better. And just at a high level, are there any things that you suggest would be drivers for that if supply chain is still expected to be a headwind?

Yes. I think there's a couple of things going on there, Rob. As I said, we absolutely have this lever visible to us in expense, right? And so we can turn up the OpEx and COGS to invest and turn it down a little bit. And as revenue continues to scale, the amount by which we have to turn it up can drop a little notch. And so we do think the margins in the back half might be a little bit better. But it's very fine-tuning, right?

And the only caution I would offer is we've been careful through this call and on prior ones, I know this is the first time after you've launched your coverage that you've been on the call. And we don't really want to guide people to just expect continuing EBITDA margin increases every quarter. We've guided towards a 19% number for the year. Maybe the back half will be a little bit more, next year might be a little bit higher. But we'll see.

What I really care about is using that lever to adjust the outcome on growth. And so that's what's on our mind. We'll see how that goes. If we see growth coming in a little bit stronger than we might have expected, we'll put a little bit more in but if you think back to my answer to the product question, we have that small piece of our business in a mode that's just a little bit unpredictable right now. And we're just trying to acknowledge that to you guys. As I said, it even caught us a little bit by surprise. The thing that's much more predictable that we have a stronger feel for where to put that lever on is the services business.

Okay. Great. another -- maybe another question or extension, but Gavin asked around cross-selling with Star2Star, I mean, are you seeing any benefit from Star2Star customers being in engagement with your engineering talent on the non-cloud side? Is that sort of deeper engineering pool, helping them solve problems that they've had in the past? Are they seeing the benefit of the broader organization that Sangoma is able to bring to bear, just beyond the addition of hardware in the end to end? Are there any other engineering benefits you're able to bring?

Yes. So I mean I think the answer to that is yes, both in the services and the product category. On product, for example, if we think about the kinds of things that go on a customer premise, whether it's an SD-WAN or something like that. Sangoma has a number of appliances that are capable of doing that. It's not the focus of our company anymore, but we're good at it. Sangoma is able to design and manufacture our own desk phones, which was not possible at Star2Star, and that gives us opportunities both in terms of the functionality that can be delivered through that phone if you own both the endpoint and the software stack. As well as managing the unit economics of situations that involve giving away a phone with a contracted subscription.

So for sure, we see that benefit in the Star2Star world. On the services side, what we see is a larger engineering pool with deeper talent being able to address things that maybe never got to the top of the priority list or something. And so making one product integrate more elegantly with the other or continuing to ratchet up network uptime as customers get bigger and accept less and less friction in the way one operates the network.

So all of those are working. I hear that very explicitly from Star2Star customers, even from Star2Star partners who will reach out and say, like, wow, we really do see the difference, the impact of the larger engineering team. And so you asked more specifically about the products getting some benefit. I would just say, Rob, it's in both buckets.

Okay. Okay. And last question, maybe a quick one. Just to summarize the use of the balance sheet, you gave us a bunch of information already on that. It sounds as though M&A is the priority. You paid down some debt and said the Board sees the share price is undervalued. So maybe there's some thought around buyback. And just maybe you can talk about where the priorities for cash are and balance sheet and then I'll pass line.

Yes. Thank you. Good question. You may not know that Sangoma did tried a share buyback many years ago. I would say shareholders didn't love, it to be honest, Rob. I think we have good uses for cash. So I don't see that at the very top of the priority list. Whether it's investing as you just hinted that from my earlier comments, things like cost of goods and inventory to help us position ourselves better or investment in R&D or marketing and sales for customer acquisition or as you just said, number one, M&A, I think that's where we're more likely to use the capital.

And my reference to the prior NCIB is just I don't know, to give you some visibility to the fact that we do know about it. We understand that we did it. And I would just say it's probably not in the top 1 or 2 priorities for our use of cash right now.

The next question is from David Kwan from TD Securities.

How should we think about the trajectory in the services revenue line in the coming quarters here? Understanding, I guess, there can be some fluctuations quarter-to-quarter, but do you expect to see quarter-over-quarter growth trending upward as maybe your direct sales routes and channel partners get even more familiar with the combined suite of solutions and you see some more success from a cross-selling perspective?

Yes. I mean I think, David, it depends how precise you're trying to get me to be, right? It borders very close to Gavin's call question, right? What's the growth trajectory for services versus product? But I just don't think we want to get into that. I will say qualitatively, what we can tell you is, yes, absolutely, we expect services to be growing sequentially.

Now whether it grows at 5% or 3% or 2%, like, I don't think we can forecast that with that level of precision. We don't have a very long sales cycle or installed cycle that allows us to use bookings received in 1 month or 1 quarter to inform our judgment about billings 3 months or 6 months out.

But in general, like yes, you're completely right. This is the driver of growth for our business. So it absolutely has to be growing quarter-to-quarter. But it absolutely can bounce around a couple of points here and there. And whether it's up 5% 1 quarter or up 3% the next and whether it will be up 4% or up 2% or up 5%, that just is not something I think we want to get into quarter-by-quarter guidance and then quarter-by-quarter guidance between services or products. So I totally get the question. I don't want to evade it, but it's something I think we're not going to get into on this call.

Okay. That's fair. One other question, just given where the share price is right now, I think for -- I assume, I guess, for acquisitions, you'd probably look to lean more on debt in terms of funding them. But would you maybe target kind of smaller deals now that you could possibly completely or mostly fund through debt while still kind of maintaining a manageable level total?

Yes. I think we would probably not use as a first or second screen on a possible acquisition, go find small ones. Our screens, as we've talked about on prior calls, involve much more things like what products exist, what strategically does that product help with, what customers does that company have access to, what channels do they have that might be useful to us. And all of those things are more important than can you find a company that's $20 million versus $50 million versus $80 million.

Having said that, sure if a company was small enough that it made sense to use more debt given where our share price is, I think you're completely right. Whether it would be all that, David, I don't know. I think that depends on a bunch of factors, right, including what the selling company is interested in. And whether we want to use all of the leverage available to us at that point in time. So there's a number of factors. My sense is, though, that in general, you're right, maybe a little bit more debt as a percentage of the sources of funding than in prior deals.

Yes. I guess I was just trying to get a sense of your willingness to issue equity, especially a significant amount of equity at these levels and that maybe if you got an acquisition target -- a couple of acquisition targets that were essentially nearly identical, at least from a strategic standpoint, as you pointed out, would you look at maybe the smaller one, given that you probably would have to issue was a maker equity for it.

Yes. I mean -- I don't want you to think I had a comprehension problem, I didn't understand your question. I totally get it. I'm just saying to you, it has never happened and I do not think it will happen that we'll find 2 companies that are equally attractive at the same point in time that we both want to do, and they're for similar reasons and one's smaller and one's bigger. So we pick the smaller one and can do it with more debt.

We don't really see that. I guess, in that extreme hypothetical example, sure, but I think it's really, really unlikely, right? The acquisition opportunities we see are typically not 2 identical companies where everything is very similar, except that different scales. And so that's why I said it makes sense what you're asking, but in practice, I think wouldn't play out exactly like that.

The next question is from Jeff Schacter from TD Bank.

Actually, your last couple of callers had some questions that I'll probably overlap on. But just really on the sales pipeline first. Are you seeing with your well-talked-about diversified product suite, are you seeing the sales pipeline move to larger deals? Are you seeing opportunities for like competitor -- entrenching on competitive territory and then bringing over new clients. Is that starting to play out yet? And or are you just -- are you happy with the speed of adoption? Or do you think it can be better?

I think we are happy with the speed of adoption. When you say could it be better, I think, for sure, everybody would love it to be better. But for us, as I've said to you one on one, Jeff, and into that, in one of the prior questions, we have this delicate balancing act between why is an EBITDA going up a little bit faster given revenue growth? And then the next question is, why can't you get it adopting a bit faster?

And we're constantly balancing those 2. I'm quite sure we could ramp up adoption a little bit more if we took EBITDA from 19% of revenue to 15% or to 10%. But generally, that's not where we're going. That's not what most of our shareholders want. That's not what our Board is directing us to do. To the first part of your question, are we seeing larger customers? The answer is yes, but more from the point of view of going up a little bit in ARPU as we see more customers that adopt more than 1 service.

Then we see it going up in customer size. We're not yet deeply into that enterprise segment that some of our competitors are, Star2Star helps there because they have and have some larger customers and channel partners who specialize there. But we're still more in the mid-market than the enterprise market. That's an opportunity for us over time.

But that hasn't shifted in a material way yet, whereas a customer of 100 seats buying just UCaaS versus UCaaS plus CCaaS or UCaaS plus Video Meetings or UCaaS plus CPaaS or UCaaS plus collaboration that that's a larger customer. But I don't think that's quite what you meant when you said larger, right?

No, I just mean like just large corporate clients that can come on and be significant either newsworthy or help momentum forward with wins and just really increasing your profile in the United States given that -- I mean, one of the things is you've had this NASDAQ listing and there's next to no volume on the 100 NASDAQ.

So clearly, it demonstrates to me that there's still a little bit of unawareness of who you are maybe. And maybe even on that front, we've had some Canadian coverage is there plans for U.S. coverage or some more recognition through just coverage in the U.S. and utilizing that NASDAQ symbol?

Yes. So I think that's right, Jeff. The answer is yes. I would say that expecting that to get solved by all of a sudden announcing 100 customers with 10,000 seats each, it's not realistic. That's not how we're going to crack that nut. But the way to get better visibility in the U.S. with institutional investors is a bunch of other initiatives, including, as you've just asked about, U.S. research coverage. So we're absolutely working on that. We have a couple of U.S. analysts on this call. We're speaking with them regularly, working on that.

One of the reasons that I wanted to touch on this call on the progress we've made with TD and BMO and Canaccord is we see that as a step along the path with more to come, especially in the U.S., as you just asked, yes, but also other initiatives that we're working on and thinking about how to get more stock trading down there. I'm not at liberty to talk about that right now. But for sure, that's on our radar screen. You're absolutely...

Okay. Okay. And then just finally, there's been a couple of questions on this M&A. I think part of the NASDAQ jump was to try to do an M&A deal. I don't -- it didn't go as planned and now you have to potentially look at equity even at a potentially lower price, hopefully, not too much lower. But how do you -- like how do you see -- like is it -- what wins on the M&A front when you're going up against like companies like Twilio with $5 billion in cash and 8x8 with $250 million in cash.

And like how -- what's -- where does the attractiveness? Is it that you're a smaller entity? Is it like -- what's the -- how do you compete in the game of acquisitions against some of those well-stocked competitors with cash?

Yes. I think we continue to compete in the same way we have. Star2Star was an attractive company known to many of our largest competitors, many of which had spoken to Star2Star. And yet they ended up wanting to be with Sangoma, which was true of many of our other acquisitions and of some of the ones we're looking at next. It's not just about size nor even just about the size of your balance sheet, but you have to have the resources to do the deal. So if you can't do the deal, that's a different problem altogether. But if you do, then they're much more soft factors like: what's the combination we bring to the table. If they join our company, do they feel better about the contribution to the business success being with us versus with someone else? Soft stuff like the people fit.

What's their confidence that if we say we're going to do it, we'll get it done compared to the track record of other companies that are much less experienced with acquisitions? Do they feel like they're getting into a company that's on the upswing and doing well versus just bigger but stagnant? So there's a lot of factors there, Jeff. While we've certainly lost some deals because of size, that generally has not been a common impediment.

I look forward to hearing where you move next and your play to significantly increase top line revenue and possibility going forward.

Okay. Thank you.

The next question is from [Derek Zaremba] a Private Investor.

Congratulations on the quarter. So I was just wondering if you could comment a bit on how headline CPI numbers and inflation impacts revenues? And are the service contracts generally linked to CPI or is that something that happens on contract renewal? And how would that flow through revenue over time?

Yes. In general, I would say, for us and almost all of the other players in our space, the monthly price in a contract is not linked in any inflation or anything else. So there's no normal opportunity or tendency for the price to go up just because there's some inflation, weather in the middle of the contract or at the end. I would say, in general, to the contrary, customers who have been with you for 3 or 5 years are much more likely at the end of the contract to say, hey, I know it's been paying $35 a month, but we've got a quote from someone else at $34 a month and the price goes down $1, not up $1 because of inflation. There's places where inflation does come in, like, I don't know, buying something from suppliers, but it's not subscription agreements to customers.

Perfect. And then I was just wondering if you could provide any, I guess, more general commentary on kind of competitive threats for the company or how they've been evolving over time? Do you see competition in the future are currently coming from more from bigger names like the Microsoft Teams of the world, where they focus a bit more on being kind of a platform that integrates with other services? Or is it still diverse and market dependent?

Well, I think the competition is very diverse. We didn't really talk about that a whole lot on this call other than me just referencing that it is a competitive space and it's competitive because it's attractive. I would say there's a couple of ways to think about competition. One is the direct competition from other cloud service providers and most of the folks on these calls who've joined us repeatedly over quarters and years know who we mean when we say that, that's -- I don't know if it's Twilio thing CPaaS, if it's Video Meetings think Zoom, if it's Collaboration thinks Slack, if it's UCaaS think Ring or 8x8 or what used to be Vonage, right? So those are the direct guys.

And I don't see the competition from those guys changing in a material way. We're there in the marketplace. We fight every day. The most important observation about those kinds of competitors is not them changing their competitive position against us, it was Sangoma getting into that top tier when no one would have seen our ability to do that 5 or 10 years ago.

The second category of competitors, I would talk about would be the much older, more traditional kinds of companies that have been in communications for decades or, in some cases, believe it or not, a century, right? So those are the telcos that used to be 1 per country 50 years ago and now competitive, but you know who those are, right? Or the equipment vendors who use the supply equipment to those telcos upon which the telcos built their networks.

They generally have not been very visible as competitors to companies like Sangoma or any of the direct competitors I talked about in Category 1. We're just starting to see a little emergence as some of those start to realize, well, this cloud thing is real, and it's big, and it's growing fast. And so there's not much competitive activity there to see. But you see, I don't know, a company like RingCentral doing a deal with Avaya, right, to take advantage of that installed base or a company like Ericsson acquiring Vonage. So there are literally merging examples of it.

And then the third kind of competitors are the ones that weren't really in the space at all. And for sure, Microsoft would be an example of that with Teams. And Sangoma has to contend with all 3. We have to know all 3, we have to understand all 3. We have to know how we're different and how we fight against them in the marketplace. Our sales organization has to be able to explain to customers. Our advantages against all 3 of those kinds of competitors. It's much more common that we're asked to talk about how we're unique compared to our direct competitors. But that's how we think of the competitive landscape. I hope that's useful.

So Bill, that's my last question for today, I'm sorry. That's the last question today. So thank you very much for joining us and for your ongoing support for Sangoma. We really appreciate it, and we wish you a good weekend. Operator, could you please bring the call to a close.

Thanks, everyone.

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