Thank you for standing by. This is the conference operator. Welcome to the Sangoma Technologies first quarter fiscal 2021 results conference call. As a reminder, all participants are in listen-only mode, and the conference is being recorded. I would now like to turn the conference over to Mr. David Moore, Chief Financial Officer. Please go ahead, Mr. Moore.
Thank you, operator. Hello, everyone, and welcome to Sangoma's first investment call of our fiscal year 2021. We're recording the call, and we'll make it available on our website tomorrow for anybody who was unable to join us today. I'm here with Bill Wignall, Sangoma's President and Chief Executive Officer, and John Tobia, EVP Corporate Development, to take you through the results of the first quarter of our fiscal year 2021, which started on July 1.
We will discuss the press release that was distributed this afternoon, together with the company's unaudited interim financial statements and Q1 MD&A, which are available both on SEDAR and our website at www.sangoma.com.
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, 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 to the Canadian dollar.
While this is same as in past years, the growing percentage of costs and debt that's denominated in U.S. dollars has caused us to change the functional currency of the holding company and one of its subsidiaries to U.S. dollars. This means that as described in note two of our financial statements from July 1 of this year, all of the company's transactions are recorded in U.S. dollars and then converted to Canadian dollars for our quarterly reporting and filings.
Before we start, I'd like to remind you that the statements made during the course of this call that are not purely historical and which are therefore 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 that are posted on SEDAR. With that, I'll hand the call over to Bill.
Thanks, David. Good afternoon, everyone, and thank you for joining us today. I've consciously kept my prepared remarks succinct because I provided a very extensive update on our year-end call just three weeks ago. As I mentioned then, this can be a rather confusing time in Sangoma's fiscal year for new investors. That's because of the timing of our Q4 results in October, followed so soon afterwards by our Q1 results in November, just a few weeks later.
If there is anyone on today's call that has not joined us before, I would encourage you to please listen to the October 20 recording of our fiscal 2020 results from our website, as that will give you a much fuller picture of Sangoma than you will get purely from my remarks here today. Okay, back to the shorter call for today. I have structured my prepared remarks into three sections.
I will start by taking you through our Q1 results. Second, I will share a brief update on Sangoma's strategy, and finally, I will touch on our forward guidance for fiscal 2021. You'll note that there's no additional year-to-date section given we're here to discuss Q1 results. 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 to section one on Q1. Sales for the quarter ended September 30 were CAD 35.0 million, up 25% from the CAD 28 million in the first quarter of fiscal 2020. The increase in sales resulted from the continued growth and compounding of the company's services business, where the recurring revenue was generated. The acquisition of VoIP Innovations are partly offset by the slightly softer demand for one-time product sales.
This modest softening in one-time product revenue was mostly due to the ongoing impact of COVID-19 as it impacts demand for these products, which are CapEx type decisions for our customers and makes it more challenging for Sangoma's channel partners to get physically on site to do installations. More importantly for us is our focus on the continuing growth of our services business, which we have worked so hard to build the past several years.
Overall services revenue as a percentage of total sales continues to increase at Sangoma and hit 56% in the first quarter this year. Gross profit for the first fiscal quarter of fiscal 2021 was CAD 23.2 million, 33% higher than the CAD 17.5 million realized in the first quarter of last year. Gross margin for the quarter was 66% of revenue, 4% higher than the 62% in the same quarter a year ago.
This results from the steady increase in the percentage of revenue from services, as well as the positive impact of the VI acquisition on margin. Operating expenses for the first quarter this year were CAD 19.6 million versus CAD 15.9 million in the same period last year. This was primarily driven by the additional OpEx that came with the acquisition of VI, our more general investment in R&D and marketing and sales to drive growth, all partly offset by COVID-related cost controls.
EBITDA was a record CAD 6.7 million in the first quarter, 83%, or CAD 3 million above last year, when Sangoma generated CAD 3.7 million in Q1. This level of EBITDA is equivalent to about 19% of sales, and as many of you will realize, is slightly higher than our expectation for fiscal 2021, as you can glean from our guidance for the year.
This 19% figure, as mentioned, is partly the result of COVID-related cost containment. As customer demand continues to recover gradually as we anticipate it should, we will begin to carefully open up spending again, slowly but surely. This prudent, gradual relaxation of the cost controls should bring EBITDA back closer to the range expected in our fiscal 2021 guidance to around 17% of revenue.
Net interest for the quarter ended September 30th was CAD 0.5 million, compared to CAD 0.4 million in the same period last year. This slight increase is due to the additional debt taken on to finance the VI acquisition, partly offset by the reduction in interest rates, as shared in prior calls, through the wise restructuring of our debt using an interest rate swap during fiscal 2020. Net income for the first quarter was CAD 2.2 million, compared to CAD 0.9 million for the equivalent quarter last year.
For the final portion of my commentary on first quarter results, I'd like to briefly touch on a couple of highlights from our balance sheet and cash flow. Let's start with the balance sheet, given there are significant changes there in Q1.
Obviously, the biggest change was the result of our equity raise. As you will recall, shortly after fiscal year-end in July, we raised a net CAD 75 million from the sale of approximately 35 million shares. This was done in a bought deal by Cormark, Acumen, PI, CIBC, INFOR, Beacon, and Canaccord Genuity.
The offering was oversubscribed and earmarked for possible future acquisitions, debt repayment, and general corporate purposes. Accordingly, during Q1, we did indeed repay the operating lines that we'd drawn in April as the COVID outbreak was hitting.
It wasn't quite clear what the impact of the pandemic might be and whether there would be a liquidity crunch. We drew on those lines simply to ensure the company was ready for anything. Once it was a bit more clear that the impact on Sangoma was manageable, we repaid the CAD 10 million in full, and those two operating lines remain fully available to us at any time.
In addition to the more impactful topic of our capital raise, I'd like to now cover briefly two less significant balance sheet items of inventory and receivables. Last year, during fiscal 2020, we undertook a significant supply chain project to consolidate some contract manufacturing as our services business began to dominate over our product segment. That project involved moving some manufacturing and warehousing to simplify and reduce costs, as I covered in a couple of our quarterly calls together.
These changes caused some temporary increase in inventory levels as we pre-built buffer stock. We explained at the time that we expected this to stabilize around fiscal year-end. Well, we exited fiscal 2020 with about CAD 12.6 million in inventory, and you now see that in Q1, our level of inventory was down just a bit from that figure at under CAD 12 million, a level that should become fairly consistent over the next few quarters going forward.
As I indicated in my Q4 commentary, we've been watching receivables carefully the past couple of quarters because some folks feared AR could become a higher risk for companies generally if customers were unable to pay or perhaps significantly delay payments due to COVID-19. We have not seen this to any material degree amongst the Sangoma customer base, so that's good. In fact, overall receivables declined slightly from Q4.
This is partly a result of the growing fraction of revenue that comes from services where more customers pay via fairly automatic, repeatable methods each month. Rather than in our product business, where many customers buy on terms. Nevertheless, we remain watchful and continue to maintain a higher AR provision than we would have done pre-pandemic, just in case.
As of December 31st, we had a receivables provision at about CAD 350,000, and it's now around CAD 600,000, just to be careful. Finally, for a few remarks on cash flow. In Q1, we generated a solid adjusted cash flow from operations of CAD 3.9 million, about CAD 1 million above last year's first quarter. This measure of adjusted cash flow excludes the impact of acquisitions, financing, and other non-operating anomalies.
For the first quarter, this level of adjusted cash flow was around 60% of EBITDA, a little lower than we average, primarily because our annual tax bill, now approaching CAD 2 million per year with growing profitability, was paid in the quarter. It is quite normal for Sangoma's conversion of EBITDA to operating cash flow to fluctuate somewhat from quarter to quarter, as you see historically.
With that cash flow from operations, together with our starting cash position, the equity raise, and our repayment of the operating lines, Sangoma ended the quarter with almost CAD 94 million on hand, positioning us very well to continue our growth trajectory in fiscal 2021. This results in working capital of CAD 84 million, and of course, we continue to make our principal and interest payments comfortably meeting all debt covenant ratios.
This brings my comments on Q1 financial results to a close, and I'll now move to our section on strategy. In this section today, I plan to cover three topics for you, a short COVID update, a refresher on our customer or market-facing corporate strategy, and finally, a few remarks on M&A. Let's start with the COVID update.
While I'd not planned to discuss this today, to be honest, given the lengthy treatment I gave it in our call just three weeks ago, I've actually had emails from two new investors asking me to do so. My compromise is that I will discuss COVID and Sangoma's response in a much-abridged version than I did on our last call together so as not to duplicate things too much.
Again, for those of you unable to attend the year-end call just a few weeks back, may I suggest you listen to the replay on our website if you'd like more details on this topic. On that call, I discussed what we've been referring to as the three phases of COVID impact. First on supply chain, then on internal day-to-day operations, and finally, on demand. I will not repeat that explanation today.
Instead, I will focus solely on the reasons that we believe strongly Sangoma is well-positioned to withstand this COVID pandemic and its impact on the global economy. Those reasons involve a lengthy list, one which includes the following key points. We have proven we can operate in a business as normal manner in spite of COVID. We have transitioned to a work-from-home model ahead of government requirements to do so, and have been operating seamlessly since then.
We have a long track record of adapting very successfully at Sangoma, whether it be transitioning from a single-product company to a full portfolio, from hardware to software, from software to services, or from a domestic company to a global one. Your company is flexible and has the management depth to navigate this one, too. We have a very large and diversified customer base.
We have a broad portfolio of products that appeal to many different user needs, from connectivity to premise-based UC to cloud, especially important these days. An ever-present focus on the customer that enables us to respond quickly with empathy towards our clients. Sangoma's supply chain and our operations team continued to build and ship around the world to fulfill all customer orders just as we've always done.
Ongoing investment in innovation and an ability to reprioritize roadmaps to quickly launch new products, including those in demand during this crisis, such as video meeting services. Last, but certainly not least, our proven financial strength, such as consistently growing our top line over many years, generating over half of our sales in services revenue, which is more insulated from economic shock.
Very healthy profitability, producing over CAD 6 million in EBITDA these past two quarters. Strongly cash flow positive, with over CAD 10 million in adjusted operating cash flow during the two COVID-impacted quarters. A well-capitalized balance sheet with over CAD 90 million in cash to act on opportunities that we feel are a good strategic fit. For all these reasons, both financial and strategic, we believe strongly that Sangoma is unusually well-positioned to weather the ongoing COVID storm.
In today's strategy section, I will cover our customer-facing corporate positioning and its competitive differentiation, one that we describe using the phrase Communications as a Service or CaaS, building on the SaaS terminology. This is the second call with shareholders in which we've referred to this term as we seek to introduce the concept to our investors.
For us, CaaS is an overarching umbrella of cloud communications with a number of applications or individual cloud services under it. At Sangoma, cloud communications does not equal UCaaS. Sure, the applications under this umbrella, of course, include UCaaS for voice. CaaS also incorporates Trunking as a Service or TaaS, as well as CPaaS and video meetings as a service and collaborations as a service, et cetera.
Sangoma's differentiated strategy is to offer all of these capabilities from a single cloud provider, us, integrated elegantly with one GUI, single sign-on, and a consistent user experience. We don't believe most normal companies want five different tools from five different vendors, such as video meetings from Zoom or voice from Ring or CPaaS from Twilio or collaboration from Slack, et cetera.
Sure, if you're a Fortune 100 company with enormous IT departments capable of integrating five different tools on your own, maybe that's practical. In our view and that of our customers, it's not practical for most companies, and at Sangoma, we're indeed focused on most companies, not the biggest 100 in the world. This is where Sangoma is headed. We have UCaaS, CaaS, video meetings as a service, CPaaS, fax as a service, et cetera, all under the CaaS umbrella.
We host these cloud services in our data centers, enabling us to provide monthly subscriptions for customers who prefer a cloud-based service. It's easier for them versus an on-premise model. It costs less, requires less distraction from the core business of running a courier or a florist business. Their software is always up to date, lessening the risks of security breaches and such things.
This strategy commenced our rapidly growing services business, which you are now very familiar with, and which has proven so successful. In fact, if you look back over the past few years, the trends are actually pretty amazing. In fiscal 2018, we were generating about CAD 5 million per quarter in services. In fiscal 2019, that grew to about CAD 10 million per quarter. Last year, it had expanded to about CAD 15 million per quarter.
Now in fiscal 2021, you see we are hitting almost $20 million per quarter in services revenue. Quite an impressive trend. Finally, I'd like to draw your attention to a modest change we've started in today's MD&A. In the upfront section of that document, the large one entitled Description of the Business, we have now rewritten it to capture the framework of a CaaS company.
That section had not been updated for some time, and in our view, was now too tilted towards our more mature product portfolio rather than our newer growing services business. For those investors who may be interested, we'd encourage you to go through this new section of our MD&A to help familiarize yourself with the CaaS concepts. Now, for the final third portion of my remarks on strategy, I'd like to share a few comments on M&A.
Many of you will have heard me say that Sangoma employs two approaches to scaling. One is organic growth and the other is prudent acquisitions to complement and accelerate that growth. We use these acquisitions either to get needed technology or get it faster than we'd be able to do in-house, or to secure new customer segments, or to access new paths to win such customers.
Sometimes an acquisition gives us two or all three of those strategic attributes. We plan to continue on this path via our mix of organic growth and M&A while balancing growth and the investments that drive it with a desire for reasonable profitability and the financial stability that provides.
As you have seen, we've used a mixture of debt and equity to accomplish this, and after each acquisition, we've begun to pay down debt in order to reduce our debt to EBITDA ratio in advance of the next opportunity. This too will continue. As mentioned earlier, Sangoma raised approximately CAD 80 million in our July equity raise, providing us over CAD 75 million of net proceeds.
That has left us with over CAD 90 million of cash on our balance sheet at the end of Q1, and has put your company in a very strong position to fund future acquisitions, as well as enabling future debt payments and general corporate usage.
We are actively engaged in the M&A activity. While I'm not in a position to be able to share additional information with you today, I just wanted to reiterate that we're confident Sangoma will put the money that many of you folks on this call have entrusted us with to very good use.
Before I leave my update on strategy, I just wanted to share a bit of information about the escrows and equity lock-ups associated with the VI acquisition since a few of you have been asking. As we explained at the time of that deal, there was an escrow set up to cover some telecom taxes that Sangoma had identified at the time. All of these back taxes have now been paid and closed off with the U.S. Tax and Regulatory Agency and at zero cost to Sangoma.
The remaining balance of this escrow will be released to the sellers of VI this quarter. Also, the shares that the VI owners received as part of the consideration paid became free trading last month in October.
I'm pleased to confirm that all of those shares were sold last week so that these shareholders have no ongoing ownership in Sangoma, removing any concern that some of you had regarding a possible overhang on share price. That concludes my comments on Sangoma's strategy, and I'll move on to forward guidance.
On the last call, I shared our guidance for fiscal 2021. That was for revenue of between CAD 143 million and CAD 147 million, and for EBITDA of between CAD 24 million and CAD 26 million. While many companies are not providing forward projections and the pandemic continues to be an evolving concern for everyone, Sangoma was confident enough in our business to continue issuing guidance.
We assessed the expected growth in our services business, the FX rate outlook, trends in Europe, Asia, North America, and CALA, likely GDP growth, the COVID-19 pandemic, the ongoing decline of PSTN networks on our product sales. You have now seen our fiscal 2021 results for this first quarter and heard me describe today some color around those results.
We are pleased with your company's performance in Q1 this year, and hence, we remain comfortable with the guidance for fiscal 2021 issued at the time we released fiscal 2020 results. With that, I'd now like to bring my short and prepared remarks to a close with a quick summary.
Sangoma has grown from a very small nano cap company with about CAD 10 million in sales to a strong growing business with CAD 140 million in revenue, a level we fully expect to continue adding on to, and a market cap of over CAD 300 million. We have demonstrated proven top-line growth over an extended period.
Solid and expanding EBITDA, an increase in our services business where the recurring revenue was generated to over 50% of sales, positive cash flow, and an ability to cope with COVID headwinds. All in all, our recent acquisitions are bearing fruit as expected. Share price has been strengthening, albeit more slowly than I would like. We are cashed up on our balance sheet, and we are comfortable enough to provide guidance in spite of one of the worst economic disasters in our lives.
We feel we are well-positioned for a number of conceivable scenarios, including possible future acquisitions, and we plan to put the money that you invested in Sangoma to very good use during fiscal 2021.
Finally, before I close off my remarks, just a reminder that we have our annual general meeting coming up in a few weeks. It will take place on December 17th. This year, in order to ensure the safety of our shareholders and the Sangoma team, we have decided to have a hybrid meeting. We will hold a meeting in our boardroom as we have in the past. However, to comply with COVID requirements and health department recommendations, this year, we will also broadcast it virtually in parallel at the same time.
We simply do not have space here in the Sangoma offices or boardroom to provide adequate social distancing if many of you were to attend in person. We will be issuing the circular shortly with all of the details, but I just wanted to take a moment on this quarterly call to request two things when we're all together.
First, that you please vote by proxy in advance this year, and second, to request that you also please join our AGM remotely, not in person, just for everyone's safety. You will be able to dial in so that you can listen to the formal matters and then participate in our regular Q&A afterwards, but you won't be able to vote virtually by phone in real time, and thus the request that you vote by proxy ahead of time. We hope you understand.
We apologize for the inconvenience this year since we always like seeing shareholders at our AGMs, which were getting larger and more crowded over recent years. This is the prudent approach during the second wave of COVID. With that, I'll turn the call back over to David for questions.
Thank you, Bill. To make sure everyone knows how to ask questions, I'll ask the operator to go over the instructions. Operator, we're ready to take questions now.
Thank you. We will now begin the question and answer session. To join the question queue, you may press star then one on your telephone keypad. You will hear a tone acknowledging your request. If you're using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press star then two. We will pause for a moment as callers join the queue. The first question comes from Nick Corcoran from Acumen Capital Partners. Please go ahead.
Hey, guys, congratulations on the strong quarter.
Hey, Nick. Good afternoon.
My first question has to do with product sales. I think you were prepared much. You said that they were softer due to your channel partners not being able to go on site due to COVID-19. Have you seen any improvements subsequent to quarter end?
Not to an extent that I would describe as material, Nick. To be completely candid with you, I kind of expected we might, but that was on the basis that COVID would continue on the trajectory it was a couple of months ago. As we said together three weeks back on the last call, it looks like it's actually gone the other way.
If anything, I think people have retrenched a little bit and those that were returning to the office maybe have stopped going back to any further degree. Some people seem to have called people back. I wouldn't say it's now easier to get on customer sites than it was a month ago, no.
A related question would be, do you see any potential for product sales to see any catch-up once the situation with COVID normalizes and people kind of return to normal?
Yeah, for sure. Whatever the impact of COVID is will eventually subside, and I would fully expect whatever that negative impact has been to disappear. The way we think about it internally is there are three quite independent influences on product sales right now. One is the long-term migration away from the PSTN to IP-based or packet networks. Two is the more recent but gradual and consistent trend from premise to cloud.
Third is the COVID impact you asked about. Those three independent variables are hard to forecast with any precision. To know whether removing the COVID impact will lead to a couple of points up in product sales or whether it'll add a couple of points, but the migration to cloud will pull it down by a point. It's just very hard to know.
I would just say that product sales are not the focus of the future. We know the growth there is GDP at best, and whether it is up four points or down one or up three or flat, it is not the biggest deal for us. We do what we can to maintain that business and grow it a bit. The drivers of the business are the services line, and that is where most of the company is focused right now.
Great. Just thinking about the full year, you said your margin will go back down to, I think you said 17%. How much of that is the services bringing your margins up versus cost control, and how should we maybe think about that in Q1?
As I said, in Q1, I think the biggest driver was the cost containment that we started a quarter or two back as COVID was hitting. The reason I said that is, the 17% versus 19% is obviously a discussion about EBITDA margins. The question of product versus services mix is really a factor which affects gross margin, not EBITDA margin.
Of course, that leads to an impact on EBITDA for obvious reasons. They're very different. Long term, as you've seen services go from 0 to 20% to 40% to 50%, and now 56%, we do see that trending continuing. As more of the revenue is generated in services which have higher gross margin in general, not in every case, but as a generalization, than product, we should see some benefit to gross margin, which, of course, will then fall through to EBITDA.
The point I was really commenting on in my narrative was, we made a pretty conscious decision a couple of quarters ago to be careful with spending. We planned to hire quite a lot to support growth, and we slowed that down. We put a salary freeze in place. We slowed down marketing. Travel was slowing and then stopped all on its own.
My comment was really about that. We do not choose to do anything to accelerate product trends. We're trying to maintain them, grow them a little bit, but we're not going to over-invest there. Gross margin will tick up as services grows, but we will loosen the purse strings a bit to spend more on R&D and marketing and sales.
We just didn't want you guys to see the results from Q1, update your models, everybody goes and adds 2 points EBITDA margin, and the next quarter it's back down to 17, and you say, "Oh, why didn't you say something?" That's really what I was commenting on, not the gross margin line.
Great. That's good color. Thanks for the comments.
Sure.
Once again, if you have a question, please press star then one on your telephone keypad. The next question comes from David Kwan from PI Financial. Please go ahead.
Hey, guys.
Hey, David.
Hey. I guess getting back to Nick's comment about the spending and the margins. When I look at the MD&A, you kind of talk about when the crisis starts to subside, and that's when you look at increase your spending. I think, Bill, in your commentary, you kind of talk more about increasing your spend as customer demand picks up.
Given, I think, theoretically you could possibly see customer demand improve despite the crisis kind of staying where it is or even getting worse here. What's really, I guess, are you focusing on more in terms of when you would start to maybe increase some of these investments?
Yeah. I guess I would encourage you, David, not to tease those apart quite so finely as you've done there. My point was really meant to say, we think that as COVID is understood and the world adapts to it and has adjusted to whatever extent we can, and we kind of see the impact, we will be able to begin making decisions that allow us to spend a bit more on OpEx.
We're feeling that way now. We haven't really done a whole lot yet, but we're starting to. It will be gradual. We're not going to go from OpEx now to OpEx of six months ago in a week. It'll be gradually phased in. We'll monitor the impact, see how COVID's doing over the course of colder months. We're not waiting for some particular metric, if that's kind of what you're asking.
Cases have to drop below X or demand has to grow by Y%. We feel like we kind of understand the impact COVID has had. We've managed to adjust to it. The growth is still very solid. Gross margins are good. EBITDA is healthy. We're going to loosen up a little bit from where we were over the last quarter or two, and it'll be gradual. For us, it's not really different when I say the impact of COVID starts to decline a bit or demand starts to pick up a bit. We kind of think of them together.
Okay. No, that's helpful. I guess just given the surge in cases, obviously here in North America and abroad, it seems that things are kind of heading in the wrong direction. Wondering, given that, whether you would still look to increase that spend or whether the timing as it relates to that might get pushed out another quarter or two?
Yeah, it could easily be a quarter, not two, I don't think, David. We're going to start a little bit, and you might not even notice whatever that would be in November, and then a little bit more in December. It's not going to be this step function where we take 2% of revenue and add it to OpEx and 19 becomes 17, and oh my gosh, Dave, what a big surprise.
The second wave got worse as the weather got colder and were we ever stupid. It's much more gradual. I was really just trying to caution you guys away from looking at Q1 results, seeing 19% and saying, "Okay, that's the way to build the model going forward." That's all.
No, that's definitely helpful. I guess, if you were to generate, I think roughly 17% margins this quarter, that would have translated into spending, I think of roughly three quarters of a million bucks. Can you maybe talk about where you would spend that money? I know you kind of talked about SG or G&A, sales and marketing, R&D, is there anything a priority amongst kind of the three line items in particular?
Yeah, I can make two comments, I guess. The first one is we don't really use the phrase SG&A. Not because we don't understand it, of course. We report in IFRS, and frankly, even before companies started using IFRS, I've always preferred those three buckets. I feel like SG&A lumps things together that are really quite independent investments. Thinking about marketing and sales separate from R&D is really important to us.
Those are the two drivers of growth in tech companies, and most of the investment in R&D and marketing and sales is people, right? It's not a fixed asset business. We don't build another factory or buy another piece of equipment or whatever. CapEx is modest. It's investment in capacity in data centers to support cloud services. What we really mean is could we add another person or 10? Could we release salary freezes over time?
Secondly, I was going to say, I said I'd make two comments. The other one is discretionary spending in the marketing area, right? Marketing is one of the first places that gets cut back when companies are worried about demand. The other one we would normally talk about is travel, but that's kind of thrust upon us right now rather than us choosing to reduce it. If we could travel more, we would be.
Being in front of customers is really helpful for us. At Sangoma, I think, we will slowly start investing more back into marketing as well, and I don't really want to get more granular than that. Those are the two pieces of an answer that I think makes sense at this point anyway. R&D and marketing and sales, which really means people, and a bit more on marketing programs there.
Bill, that's helpful. Thanks, Bill. Last question, just on the services revenue, saw stronger move-up sequentially this quarter versus last quarter. Obviously last quarter mitigated a bit by COVID-19. How much of that was driven by new customer additions versus just expansion with existing customers?
In general, although, of course, in any one narrowly defined period, looking at a week or a month, this may not apply, but over a reasonable period of time, much more of our growth comes from new customer wins than it does expansion from existing customers.
Great. Thanks, guys.
Okay.
The next question comes from Gabriel Leung from Beacon Securities Limited. Please go ahead.
Good evening, and thanks for taking my questions.
Hey, Gabe.
Hi there. Just a couple of questions I wanted to ask, Bill. First, I kind of want to get your thoughts around growth and profitability. As you mentioned, right now, Q1, I guess, you put up some pretty good EBITDA margins because of cost containment. Looking for the right time to accelerate investments within the operating base to support further growth.
When I look at the services line in particular, even at these contained operating expenses, you're still growing quite sharply. I think organically you're probably up 20%+ on the services side. I just wanted to get your thoughts around if you were to knock EBITDA margins down by a couple of points, what sort of growth rates are you trying to target at the higher level of spending?
Yeah, I'm going to decline that one, Gabe. For two reasons. One, I feel like it's going beyond guidance. Guidance is already something that most companies aren't doing right now. Secondly, I don't feel like we know how to pinpoint that with any level of confidence that I'd feel good about giving to you guys and then finding out we did a bit more or a bit less.
One of the things about Canadian public companies is, in fairness, even you guys who I know because you're trying to help educate many of the institutional clients, there's this very intense focus on profitability.
I'll get questions like, "Please do the calculation for me about what is our ROIC or what's the return on equity?" One of my half-serious, half-joking responses is, "Why don't you go ask that of 8x8, or Ring, or Zoom, or Slack, or Bandwidth where there's no R and see what they tell you?"
Really the reason I share that, Gabe, is we've never been prepared to do anything that would move EBITDA in the opposite direction. We've always said we're going to continue to grow EBITDA both in absolute value and percentage of revenue. It's kind of why I commented that 2019 is not an equilibrium or steady-state number. It's more like 2017. If we took 2017 down to 2015, what would it do to revenue? If we took it down to 2014, what would it do?
I don't think we know the answer to that yet. All we know is we're competing against a bunch of companies who generate zero and negative EBITDA and have valuations that are 10x revenue or 20x revenue or 80x revenue. Here we are generating CAD 25 million of EBITDA trading at 2x revenue.
It really is an important question you're asking. I don't want my answer that I acknowledge was evasive to in any way sound dismissive. I just don't think we know the answer. For the first time, I feel like EBITDA's gotten to a level where it's healthy. We're not going to destroy EBITDA and say we're going from CAD 25 million of EBITDA to zero.
Please don't worry. We are starting to think about is it useful to continue ratcheting up EBITDA margins indefinitely and going from 17 to 19 to 20 to 22, or is 17 fine and 15's fine, and use that investment to drive growth? We haven't made the decision yet. I wouldn't know how to answer your question in a quantitative way, but it is important. You and I have talked about it before, Gabe.
Our view is Sangoma is now at the stage, and especially as we continue to scale and look at future acquisitions, where maybe a little bit of extra investment in marketing and sales and R&D would be wise, even if it means we stay at 17% instead of moving up to 19% one year, which might be what everybody's expecting.
Gotcha. Excuse me. Thanks for the feedback on that question.
I didn't really answer it.
I know it's a tough one, but I appreciate the candor. Focusing on the, going to the services line for a second, obviously some pretty good growth organically on a year-over-year basis and sequentially as well. I'm curious if you're able to talk qualitatively about whether there are any specific solutions within the services division which is helping to drive the growth more so than the others.
Yeah, I can talk about that, as you said, qualitatively. We're building out this suite of CaaS services. During my comments, I tried to introduce you guys for the second call to what that means, what is the concept, how is it different than what other companies are doing, what are those applications under the CaaS umbrella?
We've got the first four or five or six. There's a couple more we're working on. Like I've said about the products in our product portfolio in prior years, it probably won't surprise you that the revenue from the cloud services and the materiality of each kind of follows the length of time it's been in the market. Right?
The two cloud businesses we've had the longest that we've launched multiple years ago and have built up with a little bit of time under our belt are UCaaS and Trunking as a service. The ones we've added more recently, CPaaS, video meetings as a service, we're launching access control as a service, fax as a service.
The ones that are a little bit older, the UCaaS and the CaaS are by far our biggest still. They're the most material. They contribute much more than video meetings, which we're still giving away for free during COVID, although we're about to change that, or fax as a service or CPaaS. As those other service lines become more material, I can talk more about them.
They're right now still in the recently launched phase, any way that we could contribute to that CAD 20 million per quarter is mostly going to be driven from UCaaS and Trunking because the other ones aren't a material enough fraction of that number that an increase of 10% or 20% would really move the needle to a large degree.
Gotcha. Just had one last question on the product side of things. In an earlier question, you mentioned a couple of variables which would, I guess, ultimately help to drive the growth of that business line. I want to talk about one of the variables you mentioned around the transition from on-prem to cloud. I'm just curious, as you're talking to new customers, what is their preference when there's a choice between on-prem and cloud?
What do they naturally gravitate towards, and are your sales guys incentivized to sell them a service cloud-based solution first off? That's the first question. The second question is, with your existing on-prem customers, is there a notable effort by them to move towards a more cloud-based solution, or are they sort of content maintaining their on-prem platform and just continuing to add to that?
Yeah, there's a lot of questions in there. Let me try and unpack them. First one, if I understood correctly, is talk about what fraction of customers are choosing cloud versus prem. My second note to myself was talk about compensation strategy and how we motivate salespeople to do what we want them to do. Number three is, what kinds of things, and if at all, are causing existing prem customers to move to cloud? Did I get the three pieces right?
Yes. Yeah, that's perfect.
Okay. Instead of me trying to cite statistics about what Wignall thinks is happening in the industry, all I'll do is refer you guys to the fact there's a bunch of industry analysts. This is different than research analysts inside an investment bank. These are industry guys, Gartner, DataCross, Forrester, who publish reports.
In general, I would say that most of those suggest the North American communications industry is at the stage where the fraction, and this is important, of new adoptions that are going cloud is somewhere around 40% or 35% or low 40s or something like that. Right?
100 people are buying a unified communication solution, and 40 of them are choosing cloud. That's usually a figure that catches most people by surprise. The surprise reaction is usually because, "Oh, my gosh, that means 60% of people are still buying a premise system?"
That's not what I expected. All of the news is about cloud. That's right, all of the news is about cloud. One of the reasons that we consciously choose to continue offering the prem solution is because more than half of the purchases are still prem.
That 50%-60% today, which is prem, was 60%-70% a year or two ago, and was 70%-80% three or four years ago, and was 80%-90% five years ago. It's clear what the trend looks like. I think that's a meaningful number for shareholders to understand and appreciate. We're no different from the trends, Gabe. For sure, we see a larger fraction of new purchasers each year opting for cloud. That's what we want anyway.
It's where we think the growth is going to come from and why we've doubled down so heavily on this transition to service. It is interesting to note that it's not 80%. The other piece that I sometimes cite when talking about that statistic is, I shared with you at the beginning of it, that that's a North American figure.
In general, North America is the farthest along. Europe is second, but well behind the penetration of North America, and Asia-Pacific and Latin America are well behind Europe. If most of the runway is still in front of us in North America, a much larger fraction of the runway is still in front of us in Europe, and almost all of the runway is in front of us in Asia-Pacific and Latin America. That all feels like good news to me, but an interesting statistic.
That's one of the reasons, as I said, that not only premise matters to us, but hybrid deployments are becoming quite interesting to customers. They may have, I don't know, Gabe, three locations in their company, right? They might say, "We're not ready to move to cloud quite yet. We get it, we like it, we like some of the benefits.
I don't really want to pay for a big IT team to manage communications when what I'm really trying to do is operate, I don't know, a manufacturing business. Our corporate headquarters is going to get a premise system, and our two satellite offices are going to get cloud, and we're going to try that for a year." Right? If you don't have a premise solution, you're locked out of that opportunity.
Getting in there with a deployment which is one prem site and two cloud sites and being able to move to all cloud when they're ready in a year or three, that's really interesting to us. Okay, the second part of your question was about compensation and sales teams. The simple answer is yes. I hope you guys have developed enough confidence in the executive team here to know that we'd be all over this, right?
We understand how to compensate the sales team to focus them on areas we want them focused on. We do it in two ways. In the right geographic areas, we have dedicated teams that focus on cloud, and in areas where we have teams that don't focus purely on cloud, we make sure a portion of their compensation is tied to cloud success, and they can't make it up elsewhere.
They need to have cloud success to get their total commission. I think we're all good there. I think the third part of your question was, are existing prem users, not the percentage of them that might buy prem or cloud this year, but the install base moving to cloud? The answer, yes, slowly but surely, right? It's like talking about resellers. Are resellers adopting cloud?
Yeah, some are. Maybe not as fast as companies like us want, for sure it's moving ahead. That's how I feel about the end user customer base. Instead of just giving you such an abstract, useless answer, I can talk about how we see that happening. Not all of them are prepared to move to a full cloud communication solution all at once. What we're seeing is sometimes it happens in two steps. I have a premise-based solution.
I'm connected to the public switch phone network because that's the way it was done for 80 years. Sangoma has come in with a cloud service called Trunking-as-a-Service, and their TaaS offer sounded pretty good. It lets me get exposure to a monthly subscription model. It lets me see how well their network operates, what their uptime looks like, how do they support me when I have a problem, what does their billing mechanism look like?
I get used to paying them each month. Then in a year, or whatever it is, when I'm ready to move from a Trunking-as-a-Service model to a full UCaaS or a full cloud solution with video meeting and CPaaS and collaboration, we're well-entrenched.
It's no guarantee, we're not locked in, but there's some positive predisposition in that customer that they've touched cloud with Sangoma, and I think they're more likely to then buy other cloud services from us than from someone else. That's how we kind of see the prem world migrating, Gabe.
Awesome. Listen, we appreciate the insightful commentary and congrats on the quarter.
Thank you.
The next question comes from Gavin Fairweather from Cormark Securities. Please go ahead.
Oh, hey, guys. Good evening.
Hi, Gavin.
Just wanted to touch on the product roadmap. Obviously, you had a busy year rolling out video meetings as a service and then also headsets. Can you just touch on kind of the priorities from here with those two pieces out? You mentioned access control. Anything else within maybe the Communications as a Service umbrella that is now kind of more of a priority for you?
Okay. I have a couple of thoughts. I just wrote down five super quick bullets as you were asking me the question to think about what stuff I would share with you. You even mentioned in your question video. The stuff that we're focused on in video meetings as a service includes taking a very solid product that's got good customer reaction, but in a free service that was launched into the market during COVID from a free service to a chargeable model.
That's what we're focused on with video right now. That might sound trivial. What's that got to do with the product roadmap? Just attach a price to it. It's not that simple, of course, from a product roadmap point of view. You got to do stuff. You have to put code into your back office to support that product.
You have to figure out how you're going to structure the price, and what's the role of the channel, and how does the channel get compensated, and make sure that's built into the back office. Much of our video meeting service roadmap work is based upon turning it from a get the product into market during COVID-19, earlier than we might otherwise have planned, and maintain it as a free service to try and do our corporate good during this pandemic to a normal cloud service that people pay for.
The next one I was going to talk about was, you're asking about cloud services generally. I mentioned this idea that in a CaaS model, one needs a fairly common or consistent GUI or graphical user interface. You need single sign-on.
You need a user experience that makes each of those cloud services look like they're coming from the same company. That would be the second major thrust that I'd mentioned to you guys, rather than having a series of cloud services that we've built over time or in some case acquired. How does that get presented to the user in a single amalgamated suite?
Thirdly, I talk about the role of soft phones in the cloud environment. More and more of our customers, especially in a work from home model, are asking to be able to make and receive calls and do all of their communications from the computer and not need a separate desk phone.
That doesn't mean desk phones are going away, but there is more interest in and demand for soft phone clients, and so we have quite a lot of work going on in that area, both on the desktop version and the mobile version. Some of you who are close to this technology understand there's a lot of nuanced complexity.
Once you say the word soft phone, there are usually two different products, one for desktop and one for mobile. Inside mobile, you have to deal with two different operating system, iOS for Apple devices and Android for others. Those are all different little development streams being run in parallel. Next one I talk about is collaboration. We're working on collaboration as a service.
There's lots of debate internally about how that gets packaged up, and is it a separate product or is functionality accessed from inside the other products like UCaaS and video meetings as a service and soft phones. That's receiving both product management work and R&D efforts right now.
Last but not least, I'll touch on access control as a service. This is a little bit of a stretch for us. It's not right in the sweet spot of communications. It's a little bit of try some interesting things like Sangoma has been willing to do over the years. Don't be too constrained to what you do already. Some of those have borne fruit, and we stick with and double down on, and some we say, "Oh, that was an interesting experiment. Hasn't taken off.
Cut your losses and move on to something else." Access control as a service for us is a way to try and take advantage of the fact that we think these kinds of solutions are also ripe for moving from hardware physical devices to virtualized cloud deployments. They happen to make use of apps on soft phones, which we already have for communications purposes on the phones of employees at our customers.
It is the same kind of customer sold through the same kind of channel to the same decision maker as buys communications products. It's usually the IT department. We're in the process of launching that. It's a little bit more work for us because it's not the same intuitive, "Oh, I get it. You're adding a soft phone." It's this whole new product category. I don't know. There's the five first things that came to my mind off the top of my head in 30 seconds, Gavin.
Thanks so much. Very helpful. Congrats on the quarter.
Okay, sure.
The next question comes from Will Witheridge from Witheridge and Company. Please go ahead.
Hi, gentlemen. The balance sheet is locked and loaded, ready to go. Given how much cash you have on the balance sheet, it does suggest you're capable of a pretty sizable acquisition here. There's been a lot of talk on this call about EBITDA margins, which have marched in one direction for years now and in a wonderful way.
How likely is it that the acquisition is large enough and perhaps of low enough margin, it has a significant impact, negative impact on margins, at least in the short term? Then over time, I presume you want to tease costs out to sort of reattain that 17% target over time.
I'm not sure how to answer your question, Will, without saying something I'm not permitted to say. I understand it. You want to know if 17's going to turn into 10 and then ratchet back up. Without disclosing something about any particular acquisition candidates that we're talking to, I don't really see how to answer that. I will tell you that would not be our objective. It's not like that's the profile of the kind of customer we're targeting in acquisition discussions. Sorry, not customer, company.
If it's at all useful to you, although I realize it's not an answer to your direct question, I would say that thinking about EBITDA and EBITDA margins is one of the five financial screens that we perform when looking during M&A funnel conversations. There's the strategic stuff that always comes first, as you guys have heard me discuss on many calls.
I even mentioned it here. We're looking for companies that have products we think are important or customers that are valuable or channels for those customers. When we find a company that looks interesting and meets one or more of those tests, we're looking for things like, is the revenue material enough to matter? Is it growing? How much of it is recurring?
What does EBITDA look like, both on absolute value and percentage of revenue? What do those four things mean for valuation? I share that with you to let you know we do care about it. We know especially Canadian investors pay attention to this. I don't think I could, in any helpful way, tell you that really will not happen.
It really depends upon who that company is that we eventually put into the Sangoma family, and I'm just not at liberty to talk about that quite yet, in spite of the fact that we're in some very interesting M&A conversations.
Great. Thank you.
Okay. Sure.
Thank you. There are no more questions at this time. I would like to turn the conference back over to Mr. David Moore for any closing remarks.
Well, thank you, everybody. Really appreciate your attendance today and some good questions also. Just a reminder that it is our AGM on December 17th. Please do vote by proxy and we will be providing information about how you can listen into that shortly. With that, I wish you a very good evening. Thank you very much.
Thanks, everyone. Good night.
Thank you. This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant evening.