Sangoma Technologies Corp (SANG) 2021 Q3 法說會逐字稿

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

Good afternoon, everybody. Thank you for joining us, and welcome to Sangoma's investment call to discuss the third quarter results of our fiscal year 2021.

We're recording the call and we'll make it available on our website later today for anybody who's unable to join us live.

I'm here today with Bill Wignall, President and Chief Executive Officer; John Tobia, EVP of Corporate Development; and Larry Stock, Chief Corporate Officer, to take you through the results of the third quarter of fiscal year 2021, which ended on March 31, 2021.

We will discuss the press release that was distributed this afternoon, together with the company's unaudited interim financial statements and MD&A, both of which are available on SEDAR and on our website.

As a reminder, Sangoma reports under International Financial Reporting Standards, IFRS. During this call, we may also refer to a couple of terms such as operating income, 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 or referenced to dollars are to the Canadian dollar. 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 those 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.

As a reminder, we completed the Star2Star transaction on March 31 of this year. As a result, Star2Star was not yet part of Sangoma during our fiscal third quarter.

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

Thanks, David. Good afternoon, everyone, and thank you for joining us today. I have structured my prepared remarks in 5 sections. I will first discuss our third quarter and then move on to year-to-date results. In my third section, I will very briefly close off on the cyber attack with a few comments for the last time.

Fourth, I will share with you an early viewpoint of the Star2Star transaction, and how we see the companies coming together thus far. And finally, I will provide an update on our fiscal '21 guidance as introduced in the press release from earlier today.

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.

With that, let's move to the Q3 results, where I will begin with our P&L. Before I start, just a short reminder to pick up on David's comment. Given the Star2Star transaction did not close until March 31, there's no impact from Star2Star on our income statement for this third quarter, except for the onetime transaction expense and of course, their impact on the net income.

That is revenue and EBITDA were not affected by Star2Star during the third quarter and are thus not included in my P&L remarks for the quarter or year-to-date.

Okay, with that backdrop, sales for the quarter ended March 31 were $35.4 million. For those of you who may have already seen today's press release, you will have noticed that we also made a couple of references to U.S. dollar revenue ended foreign exchange rates this quarter.

As you know, we've not normally spoken much about FX because typically, the exchange rate has helped Canadian dollar revenue just a little in one quarter and then hurt just a little in another, and so it can go up and down, but it's not often been that material.

But for Q3, however, the impact was quite pronounced, and we felt it appropriate to explain the effect so that everyone fully appreciates what's going on. For those of you who have been shareholders for some time, you will recall that although Sangoma does business in well over 100 countries around the globe, we sell almost exclusively in U.S. dollars everywhere in the world.

And yet, at least for now, our financial statements are presented in Canadian dollars. So when the U.S. dollar rate swings as much as it did from Q3 last year, when it was around $1.37 to Q3 this year, when it was around $1.27, a change of that magnitude has a material impact on the comparison between our quarters.

And thus, the $35.4 million in sales is a 2% decrease in Canadian dollars versus Q3 of fiscal '20 and represents a 5% increase in U.S. dollars over the same period a year ago. Stated another way, if the exchange rate that existed in Q3 of fiscal '20 were to have remained unchanged, our Canadian dollar revenue would have been about $38.3 million for the quarter, up from what was $36.3 million last year, an increase of about $2 million for the quarter.

I hope our attempt to explain this transparently has indeed helped as opposed to adding any confusion, and I also hope I don't have to continue talking about FX rates.

As for the breakdown of revenue into our services and our product categories, I am pleased to say that our also critical services business continued to perform well, aligning with our strategic focus and objective. Services grew at 15% in U.S. dollars this quarter or about 6% in Canadian dollars.

Our Services revenue grew to 57% of total sales in Q3, up from 52% in the third quarter of fiscal '20. And this growth in Services is slightly offset by some ongoing softening in product sales, which were down by about 5% in U.S. dollars as impacted by COVID-19.

Gross profit for the third quarter was $23.2 million, representing a $1 million increase in USD, but down very slightly in Canadian dollars for all the FX reasons I've just covered. Gross margin for the quarter was 66% of revenue, a 1% increase from Q3 of last year when we were at 65%, a positive result, given the tightening of the global supply chain that you may have heard about in mass media over the last few months.

Operating expenses for the third quarter this year were $16.6 million, very similar to our immediately prior second quarter. I continue to be pleased that our operating costs are increasing at a slower rate than our revenue growth, which means we're continuing to operate on plan.

EBITDA was $6.6 million for the third quarter, representing an increase of 8% in U.S. dollars or approximately 2% in Canadian dollars versus Q3 of last year. EBITDA margin came in at about 19% of sales, up from about 18% in the same quarter last year. As we've discussed in the past, the 19% level is partly the result of COVID-related cost containment.

As customer demand recovers gradually as we anticipate it should, we will open up spending once again slowly but surely. This prudent careful relaxation of the cost controls over the next little while, should bring EBITDA margins back down slightly, a bit closer to the expected range.

And net income for the third quarter includes a onetime expense of $4.7 million associated with the Star2Star acquisition. This, of course, results in a temporary loss of $2.4 million so if we excluded this onetime charge, net income would be about $2.3 million compared to $1.7 million for the equivalent quarter last year, a more apples-to-apples comparison and an increase of about $0.6 million or 35% from the prior year.

With that somewhat lengthy description of Q3 this time, now let's turn to our year-to-date results. Sales for the first 9 months of fiscal '21 were $105.8 million, up about 10% from the $96.6 million in the same period of fiscal '20. And my narrative for this year-to-date section, I don't plan to keep bouncing back and forth between Canadian dollars and U.S. dollars, like I did in the Q3 section because the FX impact is less material over the 9-month period.

For example, the 10% year-to-date growth figure that I just cited would have been about 12% in U.S. dollars. So I won't keep commenting on this. The increase in year-to-date sales was due to the same factors I covered in my section on Q3, namely the continued growth and compounding of the company's services business, partly offset by some softening in demand for onetime product sales, which continues to be impacted by COVID-19.

As a percentage of sales, our Services revenue was up to 56% for the 9 months of fiscal '21, a nice increase from 47% in the same period last year.

Gross profit for the first 9 months of 2021 was $69.9 million, 12% higher than the $62.3 million realized last year. Gross margin was 66% of sales on a year-to-date basis, about 2% higher than the same period a year ago when it was around 64%, a further benefit of the steady increase in the percentage of revenue coming from Services.

As stated about the quarter, while we expect to continue seeing gross margin increase as the fraction of sales that comes from Services grows, it's especially gratifying during a time of a much tighter global supply chain, leading to higher costs for components and shipping.

Operating expense for the first 9 months of fiscal '21 was $49.7 million, up by about 6% from the same year-to-date period last year, as expected to drive growth. EBITDA was $20.2 million for the year so far and is 31% higher than the same period last year. This is equivalent to about 19% of sales for the first 9 months compared to about 16% for the same period last year.

And finally, year-to-date net income is $2.3 million, inclusive of the onetime cost associated with the Star2Star acquisition, up from $1.3 million last year. This brings my commentary on our income statement to a close.

And so I'd like to now cover a few highlights from our balance sheet and cash flow. Please note that while there was little impact on the income statement, the balance sheets of Sangoma and Star2Star have now been combined as of March 31. So there are some significant changes to a few key items such as inventory or receivables.

I will start my balance sheet comments with cash. As a reminder, we began Q3 with the cash raised in the bought deal late last year. We kept that cash in U.S. dollars because it would be used principally to fund some of the cash portion of the consideration being paid for Star2Star, which was needed in U.S. dollars.

We used cash on the balance sheet of $63 million and added about $66 million of debt to fund the remaining cash portion of the Star2Star acquisition. As a result, we ended this quarter with a cash balance of nearly $29 million.

Inventory is up slightly from $12.6 million on June 30 to $13.9 million on March 31, representing an increase of $1.3 million. This includes $1.8 million from Star2Star, without which inventory levels would have decreased slightly. Looking forward, it's possible we may increase inventory levels slightly temporarily to help us deal with the significantly tighter global supply chain.

Trade receivables increased from $11.2 million on June 30 to $19.1 million on March 31st with the addition of the Star2Star AR, representing the majority of that increase.

And now I'll comment on cash flow. During the third quarter, we generated adjusted cash flow from operations of $4.9 million, well above the $3.7 million for the same period of the prior year. For the 9 months of fiscal '21, we have generated adjusted cash flow of $15.1 million, almost double the $7.6 million in the same period last year.

That means that after 9 months of fiscal '21, we have already generated more operating cash flow than the $15 million we generated in the full year of fiscal '20. This measure of adjusted cash flow excludes the impact of acquisitions, financing or other nonoperating anomalies and reflects how well Sangoma is deploying and managing our capital.

Finally, as was the case before the Star2Star deal, we are now, of course, comfortably within the debt covenants and our balance sheet remains strong. That brings my comments on our financial results to a close, and I will now touch briefly on the cyberattack from late 2020 one last time.

Well, what can I say about ransomware attacks that you're not already hearing about every day in your preferred newspaper or website or the evening news, be it Apple last month or Colonial 2 weeks ago or Toshiba last week. It's clearly a very concerning and growing problem, none of which is an excuse, of course.

I just thought I'd take a short minute or 2 to bring the Sangoma cyber attack story to a close. As you've now heard multiple times from us in press releases and also in our last quarterly call with investors during February, the ransomware attack we announced in December led Sangoma to engage third-party cybersecurity experts to assist us in performing a comprehensive investigation.

I can reiterate that this very experienced team of experts did not uncover any compromise of our IP nor any indication of security threats to customers who are using our products. Further, no Sangoma clients experienced any service interruptions or difficulty in using our products as a result of this cyber attack.

And since we last spoke, the detailed assessment of the stolen data has now been completed. We are in the process of notifying all those affected by the data loss, most of which is now done. And finally, we have also notified the authorities in many jurisdictions as is not only appropriate and responsible but also required by law or regulation.

As I mentioned last time, many talented people at Sangoma and that our outside experts worked tirelessly throughout this period, including over holidays, and I want to thank them for all their dedication to bringing the investigation to a close.

I'd now like to turn to a more positive topic and an update on the Star2Star acquisition. I'll start off that with a thank you. Sangoma shareholders approved the Star2Star transaction with a vote of 98% to 99% of investors in favor, a level I've never seen before and a very positive affirmation of the deal as well as our strategy.

As some of you will know, Star2Star represents Sangoma's 10th acquisition and is transformational, placing us clearly into the top-tier of the growing cloud communications industry and fully cementing our transition to a SaaS business. As a very short reminder from our last call, the combined company will have revenue of about $245 million with over 70% of that being high-value recurring services revenue, gross margin of over 70%, among the highest in our space and EBITDA of over $40 million delivering EBITDA margins that are also at the very top of our industry.

Please note that those figures are all based on the pro forma view more fully captured in the information circular mailed out to shareholders prior to the vote. And while it's only been 7 weeks since the transaction closed, I'm very pleased with how the companies are coming together. We have begun a series of integration projects, each covering a key part of the integration, such as people or product or customers and channels or back-office systems or customer-facing cloud network consolidation.

I will touch on a few of these today at an initial preliminary level given, as I just mentioned, it's only been a short while since we closed and Star2Star was not even formally part of Sangoma in Q3. And I'll then cover additional detail after Q4, of course, once we've been together for a bit longer.

Regarding the people part of our integration plan, our cultures were quite similar, which is one of the things that attracted the 2 companies to each other. So it has become quickly apparent that we were gelling nicely. That is an often overlooked aspect to an effective integration and given Sangoma has done many acquisitions successfully, I think we're pretty decent at it and Star2Star just makes it easier given our fit.

I feel this is even more impressive since many of us have never even been in the same room together, although that is slowly starting to change, thankfully, as a few staff begin to move between our U.S. offices once again.

You may recall from our prior call with shareholders that we intended to handle the people integration in 2 steps: what some folks call staff functions, so think finance or HR or legal, are departments that we expected to integrate quite soon after closing. However, the line functions and here, think sales or engineering or marketing or operations were not to integrate right away. It's always harder to do those departments immediately at the best of times, and given everything going on in the world, it's far from the best of times with the pandemic lingering on, especially in some countries.

And thus, we're going to take our time to get to know each other for a while during the integration phase, and then combine those teams. And that plan shared with you on our last call is indeed precisely how it is playing out. We have now already fully integrated the 2 finance organizations, we have combined our 2 legal departments and the HR groups are now together, too, all within the first month.

In addition, we've had our first Board meeting of the newly constituted Board of Directors, and I'm very excited about that. But for the next few months, it will continue to be pretty much business as usual for our sales organizations or engineering teams or our operation staff in both companies as the integration discussions take place.

And I'll now share a few comments on progress with customer and channel integration. Since the last time we spoke together, our teams have remained focused on clients. That sounds obvious or perhaps easy, but during a time of deal negotiations and now integration, especially on larger transactions like this one, it could be anxiety provoking for staff and all these extra meetings can be distracting when they all have normal critical day jobs to do.

So I would just like to thank everyone at Sangoma and Star2Star for continuing to take excellent care of our customers, without which there is no business.

Regarding customers, specifically, we have now started the early stages of integration. For instance, we are in the process of cross training, each of the sales team, on the other part of the company's product lines. And while the teams continue to work separately during this integration period, they are fully integrated -- before they're fully integrated, we've now worked out a way to handle cross-selling during that time.

In that case, if, for instance, the Star2Star salesperson has an opportunity for an on-premise customer, that would be satisfied by the Sangoma premise system, she will reach out to her Sangoma counterpart. They will tag team the sales cycle together. The order will need to be placed on the Sangoma systems for now. They will both work with the channel partner who uncovered the opportunity, and they will both be compensated.

And I've even now had the chance to speak personally with some of the larger Star2Star customers, which has been great. We're also starting to work on channel integration. We've had the initial meetings and webinars with channel partners from each company to explain that we need them all and that the complementary mix of channels was one of the key benefits of the deal.

We have also just started work on bringing the channel programs together, which is a longer-term project that involves things like how partners buy through which systems, pricing or discounting, and compensating the channel, who from our combined company services those partners, et cetera. And we're planning live events with such partners for the fall on the assumption we will all be traveling by then.

Next, I'd like to touch on the early focus for product integration. Sangoma now has the industry's most complete, internally developed suite of products and cloud communication services, bar none. This includes UCaaS, Trunking as a Service, Video Meetings as a Service, Contact Center as a Service, CPaaS, Access Control as a Service, Collaboration as a Service, Trunking as a Service, et cetera, all together, with the Capital P product line that you see as our second revenue category, in addition to services. These products cover on-premise UC connectivity lines like SBCs or gateways and endpoints such as phones or headsets, all available from a single supplier and all part of a one throat to choke solution, unlike the partial solutions offered by our competitors.

Priority One in the product integration work is to decide upon which product to keep for any categories where both Sangoma and Star2Star had a similar offering. That work is well underway, and while it will take some time, we've already made decisive progress. For instance, we've concluded that we will be standardizing on Sangoma's video meeting as a service product called Sangoma Meet, and we will keep both companies UCaaS services, Sangoma's as well as Star2Star's.

And finally, with respect to CPaaS, we are standardizing on the Star2Star product line. More work in these areas is obviously still to come.

The other high priority in product integration is how best to tightly integrate our various cloud services into one cohesive suite, so that they all share a common look and feel for customers. This involves work in areas like UI or user interface, UX or the user experience as they navigate through our tools, or single sign-on, so customers register with us once to buy a product or identify themselves and don't have to do it multiple times or differently for each product in our suite. We want one clean integrated suite so that when customers use our products, they have a consistent experience, whether that product initially came from Star2Star or from Sangoma.

And there is naturally a lot of other work going on in several other integration areas, but it is just a bit too early to provide details on those yet. These include such things as back office, like the internal systems we use and that our customers and partners access to do things like quoting or ordering or software licensing and enabling or cloud network integration, which is the software and infrastructure in data centers or public cloud-like AWS, that both Sangoma and Star2Star operate and which underpins a cloud based service.

I plan to provide you with further integration details on other key projects such as these over the coming months as we get further into those areas.

And finally, the last integration topic I wanted to touch on is synergies. I would just like to remind you that Star2Star was already a financially healthy, well-run company. As a result and as I shared last call, we did not expect large cost reductions, and that was not why we did this deal.

This transaction is all about positioning the combined company and the upper echelon of the industry with the full product suite and completing our transition to a SaaS company. Having said that, I do expect the teams to uncover some cost saving opportunities, of course. Including in areas such as traffic consolidation or data centers or duplicate marketing spend. However, we have now decided that most such savings that may get identified are expected to be reinvest back into R&D and sales and marketing to help drive Sangoma's growth.

This brings my Star2Star update to a conclusion, and I'll now turn to a few comments on fiscal '21 guidance. While many companies are still not issuing guidance, given the economic uncertainty, Sangoma has continued to do so. And given the recent addition of Star2Star to the Sangoma family, I'd like to share our perspective on how the fiscal '21 year is likely to unfold with the inclusion of Star2Star in our fourth quarter.

I realize that timing is a little confusing given the deal closed March 31, and thus Star2Star was not included in our Q3 results, and those results are getting released mid-May, and the end of our fiscal year is not that far away. Nevertheless, we can't control that awkward timing and have chosen to update fiscal '21 guidance at this point.

As such, you may have already seen in our press release today that we indicated revenue would be around $166 million and EBITDA about $30 million this year, up from prior guidance of $143 million to $147 million and $24 million to $26 million, respectively. While it is close to our fiscal year-end, the increased uncertainty that has existed for some time now, unfortunately, continues to exist to some extent. And that uncertainty stems for more than one source now in our view.

First, the FX rates that we discussed earlier in our call are still moving around quite a lot, including since the end of our third quarter. And this naturally makes the estimation of Canadian dollar revenue more tricky than in prior years. Our estimate assumes the FX rate is relatively stable for the next few weeks through the end of June.

Second, COVID remains a factor. Many countries are beginning to ease restrictions while others that we operate in remain in various stages of lock down and/or serious health crises. It would be hard to miss the tragedy unfolding in India these days, for instance. Such conditions make the sale and installation of the product portion of our portfolio more challenging on a region-by-region basis.

And third, you may have heard simply in mass media, of the significant uptick in demand for electronic components, which has triggered some shortages and supply chain issues, as I mentioned earlier. This leads to slightly higher costs for those parts. And for shipping, raw materials or finished goods around the world.

Sangoma is carefully and prudently acting to mitigate the effects of these shifts where necessary and when possible in order to maintain delivery to customers.

Okay. With that, I'll bring my prepared remarks to a close with a brief summary. Overall, I'm very pleased with another solid quarter for Sangoma and what we accomplished in Q3 for your company.

We signed a transformative deal with Star2Star in January, received overwhelming support from you, our shareholders, and ultimately completed the transaction on March 31. We don't take that support for granted. And so for those of you on this call, I would like to once again say thank you for your vote of confidence.

The combined organization has an extremely large total addressable market in a space that is growing well. The macro trend of moving to the cloud is still relatively new in communications, and we expect to benefit from this for many, many years to come, both in North America and internationally as well where cloud is still in its infancy.

So notwithstanding some modest headwinds in the quarter that are beyond our control, things such as FX rates or COVID, we continue to execute our strategic plan with ongoing sales growth, nice compounding in the recurring services revenue, growing EBITDA and healthy cash flow.

We completed the transformational acquisition that catapults our company into the top-tier of cloud communications. And I think I can speak for the whole team when I tell you how excited we are to keep this momentum going. I hope the way we explained our financial results and the impact of FX rates on this quarter was helpful and allowed you to see the ongoing compounding of our Services business, up 15% year-over-year in U.S. dollars remains on track.

Year-to-date, revenue is up 10%, services reached 57% of total revenue, up from about 47% last year. EBITDA at 19% of revenue is 30% above last year, all very positive signs given the global economic uncertainty this year.

We will absolutely continue with our dual-pronged growth strategy, one that most investors and STC have become familiar with over the past several years. First, we will seek attractive organic growth by investing in R&D and customer acquisition; and second, we will keep augmenting that growth with deliberate and disciplined M&A.

And finally, we've indicated that the company is preparing to uplist to a senior exchange in the U.S. or Canada or both. This is not a small undertaking, but I can assure you, we're working hard on it, and we will keep investors posted. That concludes my prepared remarks. So thank you for joining us all today. And with that, I will turn the call back over to David for questions.

Thank you, Bill. Operator, could I ask you to please explain how to ask questions, and we'll get people in the queue.

(Operator Instructions) The first question comes from Gavin Fairweather with Cormark Securities.

Bill, maybe just to start, in your prepared remarks, you talked about demand improving gradually in relation to your growth investment levels. Maybe you could just unpack that a little bit. Is that kind of your read on the overall current environment? Do you see it? And maybe just speak to any differences that you've identified in certain markets that perhaps are further along on the reopening path?

Yes. I have to say this is one, Gavin, that's been up and down for us, depending, as you say, on various ways of breaking it down. I think you asked about different geographies, but you could also look at different product categories or different customer markets as well.

And it seems like, at least from what we're seeing some segments, and again, this could be geography or product or customer segments might be up a bit and some other one goes down a bit.

So the comment that I was alluding to is, in general, the trend that everyone expects and why should Sangoma be any different is things should continue to gradually get better and open up. But it's not consistent, right? And that's really what I was saying. We manage, for example, our Asia business out of 2 main locations: Hong Kong and India. And the Hong Kong team sells and services customers and what would you traditionally think of as APAC rate? So I think Japan, China, Hong Kong, Taiwan, Australia, and the team in India services, South Asia, Southeast Asia, the near East, the Middle East.

And if you're based in India right now, while we, of course, want everybody to do their best and keep working, not a very good situation, right? And that's kind of what I was getting at, Gavin. There are segments of the economy, you could even look at in verticals, right, that are starting to reopen. And so if you're in a part of the world where the economy is beginning to be reopen, we fully expect that, that will start to help product sales again.

But on balance, it's been kind of a mixed bag, and you could see that product sales were still down a little bit this past quarter. And so we're being a little bit careful. We're investing where we think it makes sense, but not pushing before we think the demand is there for which pushing would make sense, and that's what I was getting at, I guess.

Got it. That makes sense. And then just secondly for me, just on Star2Star. Obviously, in circular, we got the September kind of quarter out of them. I suspect you don't want to get kind of too specific in terms of the numbers or anything, but can you just talk us through kind of qualitatively, perhaps how the business has been performing in the December and March quarters in terms of just kind of revenue, new logo success, kind of their spending and investment levels, any kind of commentary that you could provide there would be quite helpful.

Yes, sure. I don't feel like I don't want to be too specific. I'm happy to try and explain it.

So don't let me hold you back, be as specific as you want.

I mean, I'm not going to be quantitatively precise, but I also don't want you to feel like we're avoiding it or anything. It's just that Star2Star wasn't in Q3, right? So I think things generally are unfolding pretty much as we expected. It doesn't mean just like at Sangoma that every single piece is exactly on plan. Some pieces are a bit over and some pieces are a bit under, as you would expect, and some channels are a little bit over and some channels, but that's kind of what one anticipates. So revenue for the quarter was kind of what we were looking for. Nothing big, huge, out of the realm of what we thought would happen based upon all the due diligence that we did. The kinds of customers that were being won in the quarter look exactly like the kinds of customers Star2Star targets and has won in prior quarters, some big, some medium, some small, it was across multiple product categories, whether its UCaaS or CCaaS or whatever, it's all North America, right for Star2Star, yes, that's what I would be comfortable sharing at this stage Gavin.

Okay. Great. And then maybe just quickly for David. Obviously, a big intangible kind of bump coming in here with the Star2Star. Can you help us out on how to think about how quickly you'll amortize that down from a modeling perspective?

So Gavin, this is the output of a multi-week exercise by a big accounting firm during the evaluation. So what we've done is we've used the very preliminary information and shared that with you to give you some idea. But to be honest, that work is still 4 or 5 weeks out. We will have it ready for our Q4 results, and we'll have the whole thing tied up by then. But to be honest, that exercise takes weeks on that pace.

The next question comes from Gabriel Leung with Beacon Securities.

Couple of things for you, Bill. In your prepared remarks, you commented that you've spoken to a number of Star2Star's larger customers, obviously. I'm curious what the feedback has been from those large customers as it relates to the combination of the 2 companies? And perhaps talk a little bit about what are those guys looking forward from the consolidated entity? What are they hoping to get out of it?

Yes. That's actually a good question. I would say, it's the natural mix of human nature, right Gabe. In general, it's predominantly positive. Oh, that's amazing. You have a broader set of products, I can get everything I need from one place if I want that. You have a bigger team to support me with people around the world. So if we have an office in a different place, you're likely to have somebody there. The public company stability is reassuring the -- I call it, a larger company, nothing to do with being public.

Scale provides them with this view, okay, there's probably a different set of skills available from the larger company that might have existed in the smaller company, right? So if we have, I don't know, a network, I would address something like that. Now you got a whole set of new people that can be brought to bear to figure out what's going on.

On the other side, what I meant when I said this natural mix of human nature is there's always a little bit of trepidation, right? There's nothing strange or unusual about the Star2Star transaction that way. It's exactly what we've seen in earlier transactions. It's exactly what the Star2Star team told us to expect.

So the initial questions might include things like please confirm for me, you're not going to cancel or end-of-life this product? No, no, no, stop worrying 100% and, you're good. Yes, we're good. So the sum of that, please tell me if the person I really like dealing with in fill in the department right, Gabe, the salesperson, I deal with or the tech support person or the professional service, no, we're not coming in and changing the mapping of people to customers.

So there's a little bit of that in any of the first calls. But that's how it's gone. I would say if there's 5 questions or comments for real positive and one comes with the natural anxiety. And if there's 10 comments or questions, 8 of them are real positive and 1 or 2 are please reassure me because I'm a bit nervous about this.

Got you. Just moving on to I guess the margin profile for the combined company going forward, pro forma right now, I mean, based on the guidance you provided, fiscal Q4, we're looking at about 16 odd percent EBITDA margins, down a little bit from what you've been reporting.

I was asking about the profitability versus growth argument. I'm curious where your thought is that on that front. Do you feel the 60% range is an appropriate range for the combined company today? And then in terms of your growth aspirations for the combined company. Is that a good way to think about it?

Well, it is something we talk about all the time. We've just had a board meeting, and that was one of the main discussion topics, which I know won't surprise you at all.

It's tricky because on one hand, I would say, if you look back over the last few years, the equity markets rewarded growth at all costs, and we felt like a good balance between healthy growth and reasonable profitability was wise, and we watched some of our competitors tick up to revenue multiples that are much above us.

And so for sure, we're paying attention and noticing. On the other hand, I think most of the shareholders, especially larger institutional shareholders who bought into Sangoma liked some of that reasonable balance. And so if you're talking to a U.S. Fund who might say, take positive $40 million or $50 million of EBITDA and turn it into negative $50 million and grow faster.

There are other investors who say, please don't go that far. Maybe you can go from 20% EBITDA to 15% and that might be tolerable. So that's, I think, the set of boundary conditions, Gabe, we're not going to go and incur these huge losses.

Although to make it a bit more tangible rather than just fuzzy abstract stuff. You heard me say in my prepared comments that we are starting to see some cost savings opportunities, even though that wasn't what motivated the deal. And for sure, we could just take those cost savings and put them in our pocket and watch 15% go to 18% or 18% go to 20% EBITDA.

And we're not going to do that. We're going to take those savings and reinvest them into R&D and marketing and sales for customer acquisition and see if that can help revenue a little bit. So that's a little bit more pointed than I've been prepared to be in the past, and that's kind of where we are at this stage.

Got you. And just moving over to the revenue segmentation for a second. I want to talk about the product division, I guess, specifically. Obviously, there's been a bunch of headwinds, COVID, supply chain issues. But I'm curious, as we look at the product division, including both Sangoma and Star2Star's product lines. I'm curious, how are you planning to manage this product division?

Are you -- and then factoring also sort of the structural demand for products versus SaaS now. Are you managing this business to be kind of a flattish growth business? Is that the aspiration at this point? Versus sort of medium to high-growth for the business?

Yes, I think that's right, Gabe. I think in fairness to the problems with the FX rate that we talked about or the economic uncertainty or as you just pointed out, the impact of COVID. It generally feels like the product business, capital P Product here as opposed to the Services business is a flat minus 5%, plus 2%, minus 3%, plus 1%. It varies from quarter-to-quarter. It varies from region to region, but that is right.

It's not a high-growth business. And we don't manage it as such. The way we think about it is, a, it generates cash that we can reinvest in other parts of our business to grow the Services business and/or service the debt. And strategically, it's really important for 2 reasons. One is it completes the full suite that lets us offer that one throat to choke, right?

We don't have to give a customer a bunch of software or hardware that comes from some other vendor that we can't control. You got your phones from vendor X or you installed the software on someone else's server, and now we have to worry and troubleshoot or the customer has to figure out who they're calling.

So that's the first big one. The second big one is the product bucket includes onetime on-premise systems. And while the fraction of new purchases that goes to on-premise declines every year it's still a very large fraction. It's something like half in North America, depending on who you listen to, and that means half the new purchases are cloud.

And you've heard me say in Europe, it's much less than half of the new purchases that are cloud, again, depends. But let's say it's 20% or 25%. But that means 75% is on-prem, right? And the positioning that our sales team knows to use, and you would see it in pitch decks and things like that says, we just want the customer, right?

Sure. We'd like the customer to be on cloud and recurring revenue, and that's where it's going to be over time. But if the customer says, "No, no, hang on, I've decided, I'm buying a premise system." We do want to turn them over to one of those old competitors, or if they say -- I don't know, Gabe, we'd like the corporate headquarters location to be on-prem and the 7 satellite offices to be in cloud.

We want them, right? And whether they buy prem just for the headquarters or for the entire company in a year or three, they're going to change, right? And they're going to move to cloud. And so we've done a good job, which I think we generally do. They're going to be positively predisposed to taking the cloud service from us.

And so we think of product that way. It's not high growth, for sure, but it's a good business. We're not going to jettison it. It generates a lot of cash. We reinvested in high-growth businesses and service the debt. And there are really good strategic reasons for having a complete portfolio and an on-premise system that lets us satisfy any deployment model?

No, I appreciate that. One last question maybe for David. Just curious, David, do you have ForEx sensitivity just as it relates to the U.S. dollar gain against revenues and EBITDA. So what is the change in $0.01 change in exchange rates? What does that do to revenue and EBITDA? And if you don't have that handy, maybe you could just help confirm based on the guidance you provided for the full fiscal year and looks like your -- that would imply, call it, constant currency growth of about 10% in terms of Q4 revenues.

Can you confirm that for me?

So we so we're not explaining the revenue between the different businesses at this point. Let's get the quarter finished. We've got a lot of balls in the air. So I think we have -- we factored in exchange rate as best we can. It made a big impact this quarter. The exchange rate is already down compared to last quarter, but we're just working to maximize the revenue this quarter, and we've given our best estimate of what we think it might be at this point.

The next question comes from Josh Nichols with B. Riley.

Glad to hear things are moving along on the integration front. I wanted to ask a little bit. I mean, clearly, the services business is continuing to see some good demand here. Could you elaborate a little bit about what some of the bigger drivers are for that? Is it existing customers? Are you cross-selling, growing the customer base, more so? And if you could talk a little bit about any offerings that are getting good traction? I know you mentioned like Sangoma Meet, right, in the current environment? And anything else you could elaborate on would be helpful.

Yes. I think -- good question, Josh. In general, the drivers that are propelling the cloud communications industry are the same ones that are affecting us. I can give you a little bit of color about which one is more important and which one is less and things like that.

But generally, the transition away from people managing their own software on-premise to having someone do that for them in the cloud is the most important driver, right? And so our sales team knows how to talk about that and what they should say to a customer and you're -- you've heard me talk about this with you and your colleagues, Josh, I don't know, a manufacturer who makes widgets or a carrier company who delivers packages or a florist who sells flowers.

And why do you want to manage communication software? It's just not what you do, right? You should -- I presume, want to focus on selling flowers or delivering packages or whatever, and we can take that off of your hands or, I don't know.

Now we have so much work from home or work from anywhere, which is so elegant in the cloud or do you want to have to be responsible for constantly making sure your on-premise software is patched with the latest security so you're not getting hacked, right? And so that's probably the number one driver.

Secondly, I would say, you're right that we have a good installed base of premise users that like any premises and not just ours, are gradually over time, going to move to the cloud.

Number three, we have a channel, some of which had traditionally grown up in that old premise world and wanted to build a stream of recurring revenue themselves. And so they're motivated for their own reasons.

It's not in conflict with or trying to convince a customer to do something they don't want to do, but you've now got a bunch of channel partners who are interested in selling cloud because they wanted annuity stream too, right?

We have an account management and customer success group that works with customers to try and understand which other cloud services do you need or how many seats do you have now and what you need in the future? I know when you signed on with us, you bought 186 seats, but it looks like you now have 211 employees, do we need to do something.

So I don't think it's any one thing. I don't think very many of those are so unique to Sangoma that they're different from what's happening in the industry, but those are the kind of things that are driving it, Josh.

And then clearly, I think you hit on it before, there's been some product headwinds, obviously associated with the pandemic. But as things start to open up, particularly in the U.S. and whatnot, is it fair -- do you think that, that revenue has probably dropped at this point and that there is some type of an uptick that you can see there? Or what it would take to get back to pre-COVID levels?

Or do you think that, that is going to remain kind of around the current levels as you focus on transitioning more of these clients to the Services business as opposed to the on-premise.

Yes, that's kind of the $64,000 question in dollars that Gabe was asking earlier about qualitatively. Here's the 2 trend lines that are happening and why it's so hard to answer the question. So you don't think we're just like we know the answer, and don't want to tell you, there's 2 things happening, and they move in opposite directions, right?

There is absolutely going to be an upward tick in the demand for product, just like there was a downward tick when COVID hit as economies start to reopen. And at the same time that's happening, there is the longer-term unrelated to COVID, downward tick in product sales related to things that are not economic, but industry.

So think the movement away from premise to cloud means fewer people are going to buy on-premise systems or the movement away from the PSTN means fewer people need to buy a gateway, right? And so this whole idea of providing guidance and why it's so hard and why so many companies stop doing it is because it's hard to figure out how those 2 competing curves combine.

And it's the one that suggests things will go up in a positive direction, slightly bigger, slightly steeper than the one that suggests it's going to decline gradually over time? Or is it the other way? And gosh, I don't think, Josh, we want to pin our reputation on it's going to be minus 2% or plus 3%.

I think I would prefer just to stick with -- if you're buying Sangoma stock, you're buying it because we're a SaaS company. We've gone from no recurring revenue in 0 SaaS to 75%. We're now one of the top 5 or 6 companies in the world. And we honestly -- we don't spend very much time internally trying to figure out, is it going to be minus 3% or plus 2%. And so I don't want to hang myself here by telling you that answer and getting it wrong when it's just not something that we focus on.

Like I can't afford to have it drop by 15%, right. But if it goes down by 5% versus plus 1% or up by 3% versus minus 2%, we just accept that the combination of those trend lines, Josh, and focus on the other one.

Fair enough. I think to your point, people are much more focused on the SaaS business. But I guess, one last question for me, then I'll hop back in the queue. Just looking at the Star2Star, given there's still some COVID restrictions or whatnot, like what's the expected integration time line? And fair to assume that since they have a lot of these mid-market enterprise customers that probably come with higher ARPU, I would expect potentially? And what are some of the kind of the biggest cross-selling opportunities and how long you can capitalize on those?

Yes. Yes. So maybe 2 parts to your question. One is what does the integration time line look like? And what's cross-selling look like? So what we've said internally is we would like the integration process to be bookended at around 6 months. Here's what I mean by 6 months and what can be done within that time window and what can't.

All of the work on planning and making a decision in each of the integration projects I listed, right, product integration, back office integration, people, customers and channels, IT, et cetera. Cloud network. All of those things can be discussed, understand how each company did it before, make a decision about how it's going to be done in the future. And lots of the actions will be finished within those 6 months.

But not everything can be finished in 6 months. The decisions can, but things like -- I don't know, Josh, we've probably got software and infrastructure in 9 or 10 data centers now between the 2 predecessor companies. It's not likely we need 10 data centers, right? But consolidating them and putting 10 down to whatever it ends up being, let's say, it's going to be 5 or whatever, it's not something that's likely to happen in 6 months.

You got to go through the network architecture and decide what you're doing and standardize on what that will be, and you then have to extract yourself from data center contracts and stuff, and that's just one example. It applies in a whole bunch of ways, right?

If you're, I don't know, using 2 different accounting systems, whether we'll be fully off one and onto the other in 6 months, I don't know. But most of the actions will be done, not all. And I hope all of the thinking and decisions will be made within those 6 months.

On the cross-selling work, I personally think the lowest hanging fruit, and we're just starting this, as you heard me say, we're in the process of cross-training the teams first. Before we can get out there and push hard on cross-selling, I think the lowest hanging fruit, strangely enough, having said that product sales are not our focus is Star2Star did not have an on-premise system at all, and half of the purchases are on-prem.

And if you're a customer or a channel partner, I don't know, something like half of the sales cycles would naturally lead to a conversation about prem that Star2Star had to walk away from the past. And so I'm hoping that will be the earliest uptick. We'll see how that goes. We've already seen some early examples of that where customers were pulling on us because we weren't quite ready to be pushing on them.

But I mentioned we're going to use the Sangoma video meeting service or the Star2Star CPaaS service. So this has to be cross pollinated between the 2 companies as well, and those are the kind of things that I meant when I said 6 or 7 weeks in, it's just too early for me to give you any real tangible feedback, but that's where I see it going.

(Operator Instructions) The next question comes from Eric Martinuzzi with Lake Street Capital Markets.

Congrats on completing the acquisition and the strong quarter there. I wanted to talk about the Q4 guide and kind of come at it from a different angle. Just to -- I just want to understand the momentum in the 2 businesses.

So the delta current guidance versus your old guidance, if we just look at the core business, would there have been any change in this and I know the FX issue is in play here, but would there have been any change to your prior guidance, let's say, the Star2Star transaction had not closed. Will we still be talking about kind of midpoint $145 million on the core on the legacy business and midpoint of $25 million on the EBITDA.

It's a bit hard to know, Eric. It's actually a good question because we didn't approach it that way. We approached it as what does it look like now? If we hadn't have done Star2Star, then we would have had 2 things to figure out. We are performing well against guidance, but the FX rate has totally caught us by surprise.

Last year, you heard me say the FX rate in the quarter was $1.37. It's $1.21 right now, right? It's a very big change. So I'd have to go back and do some arithmetic, and I'm happy to do that and give you a call later, if you would like. But my guess is we would, yes, be doing pretty well and on track as measured in U.S. dollars. But in Canadian dollars, my guess is with the exchange rate, we'd be a little bit below the $143 million number of the guidance.

Okay. I mean that's kind of what I was thinking. I also was paying attention to the FX flow over the past 90 days. And certainly, it is not favorable. One question for you, David. On the gross margin, you have talked about with Star2Star, better than 80% and Sangoma at 66% that the goal is to get above 70% of the combined operations here. Is that the expectation for Q4 that we'll see something 70% or north on the gross margin?

Yes, that's correct. It will be very similar to what we had put into the circular. I'm not expecting any changes from that on a directional basis.

Okay. And then this one is for either Bill or maybe Larry, if he's going to be contributing on the call, but just curious to know about the competitive landscape for Star2Star. I know it would be absolutely normal for competitors to be coming into deals that are live and trying to disrupt the Star2Star pipeline, which maybe would not impact fiscal Q3 or fiscal Q4, but might have some impact on fiscal Q1, Q2.

Are we seeing anything that's disruptive, potentially disruptive or maybe even there was a deal that we were the lead candidate for and we're no longer there running.

Yes, there's no sign of that yet at all, Eric, which doesn't necessarily mean it won't happen here and there. A business like ours that has a very large number of customers and a large number of transactions, it's perfectly common that we lose deals to competitors.

That's why you manage this with the sales funnel or a sales pipeline and look at it statistically rather than can you be definitive with 100% certainty that deal #17 on your pipeline is going to close? So I think it is reasonable to expect that our competitors are doing that. That's what we would be doing. But I haven't heard of a single case where we were in the running and then got pushed down or knocked out. And while I don't want to sound arrogant in any way, it would seem strange to me that a competitor would be able to do that.

The argument one would normally make if you were trying to use a deal like this against us is, oh, you should be worried that your product is not continuing. And we've explicitly stated to the market unambiguously that that's not the case. And any call I've been on where that's been asked, that's what I've said. No fuzziness, no gray area, no wiggle words. Stop worrying. So I'm hopeful that will not become an issue, and I'm quite confident about it actually.

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

Thank you, operator. Bill, we've got no further people in the queue. So let's bring the call to a close. And I want to say a big thank you for all the participants today. Thank you very much for the support you provided us. And we look forward to speaking again on our next call.

Okay. Great. Thank you, everyone. Appreciate it. Have a good night.

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