Thank you for standing by. This is the conference operator. Welcome to the Sangoma investor 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 Samantha Reburn, Chief Legal Officer. Please go ahead.
Thank you, operator. Hello, everyone, and welcome to Sangoma's third quarter fiscal 2023 investor call. We are recording the call and will make it available on our website for anyone who is unable to join us live. I'm here today with Norman Worthington, Sangoma's Interim Executive Chair, and Larry Stock, Chief Financial Officer, to take you through the results of the third quarter of fiscal year 2023, which ended on March 31st. We will discuss the press release that was distributed earlier this afternoon, together with the company's financial statements and MD&A, which are available on SEDAR, EDGAR, and our website. As a reminder, Sangoma reports under International Financial Reporting Standards, IFRS, and during the call, we may refer to terms such as adjusted EBITDA and adjusted cash flow that are non-IFRS measures, but which are defined in our MD&A.
Before we start, I'd like to remind you that the statements made during the course of this call that are not purely historical are forward-looking statements regarding the company or management's intentions, estimates, plans, expectations, and strategies for the future. Because such statements deal with future events, they are subject to various risks and uncertainties, and actual results might differ materially from those projected in the forward-looking statement. 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 our annual audited financial statements posted on SEDAR, EDGAR, and our website. With that, I'll hand the call over to Norman.
Thanks, Sam. Good afternoon, everyone. Thank you for joining us today. Before we jump in, I'd like to introduce myself. For those of you who don't know me, I joined Sangoma's board as part of the Star2Star acquisition, which closed in March of 2021. Prior to joining the board, I served as Founder, Chairman, and Chief Executive Officer of Star2Star Communications. I have over 30 years of experience in the software and software-enabled services industry. Since assuming the role of Interim Executive Chairman, my top priority has been connecting with our terrific customers, partners, and employees around the globe. I have been in direct contact with these constituents through in-person engagements, phone calls, countless Sangoma video meetings, town halls, and the like. My first responsibility has been to understand what is going well and what areas of our business need to incorporate change.
My job in listening and thinking about these things is ongoing. However, what I've heard to date has validated my confidence in the opportunity that lies ahead for Sangoma and better equips me to provide our incoming CEO with a full, comprehensive briefing of Sangoma's operations. Before I turn it over to Larry to discuss our third quarter results, let me briefly touch upon CEO succession. While I'm humbled that the board has asked me to step in during this transition period, I'd like to make it clear that it's neither my plan nor ambition to serve as Sangoma's permanent chief executive. I have served in that role in the past at other companies, and more recently have enjoyed working with Sangoma as chairman, and it is my intent to continue in that latter role.
The search for our next CEO is well underway, and it is a top priority for myself and the board to find the right individual to lead Sangoma on a permanent basis. I look forward to the opportunity to introduce our next chief executive to all of you sometime in the near future. In terms of strategy, we are pleased that our results continue to show traction as evidenced by two consecutive quarters of organic growth in services at approximately a 10% annualized rate. While it remains true that product revenue has slipped recently, it is now settling into a range more in line with historical levels.
Going forward, we also have the intent and desire to share additional financial and operational metrics and drivers. You'll hear more about this beginning in fiscal 2024 as we continue to fine-tune the most appropriate metrics to communicate our message and story. Of course, on an ongoing basis, we shall continue to identify opportunities to improve efficiency and effectiveness throughout our operations. With that, I'll turn it over to Larry to discuss our Q3 results. Larry?
Thank you, Norm, and thanks everyone for joining us today. Before we get to the numbers themselves, I'd like to thank Norm for his engagement as Interim Executive Chairman. As you know, Norm brings a wealth of experience to the table that not only helps guide us through the change in leadership, but will ensure a smooth and complete transition to our next CEO. I'd also like to thank our entire Sangoma team, who have remained focused on delivering results for our customers and shareholders. Let's get to the Q3 results. Revenue for the third quarter of fiscal 2023 was $62.76 million, up 18% compared to the same period a year ago and up 1% sequentially. Services revenue increased to $50.54 million, up 37% from Q3 of fiscal 2022 and up 2.25% from the previous quarter.
Notably, this growth is consistent with the 10% annualized revenue growth rate services we anticipated last quarter. This also marks the first time we exceeded $50 million in services revenue in a quarter, as well as the first time services has reached 81% of total revenue, up from 69% in the year-ago period, the meaningful stride in our strategic objective. Product revenue showed a modest decline from $12.6 million in Q2 to $12.22 million in Q3, as customers exhibited greater sensitivity to CapEx purchases, given current economic headwinds, further impacted by the strong US dollar exchange rate from some international order flow. Cost of sales for the three months ended March 31st increased by 13% to $18.34 million, compared to $16.17 million a year earlier.
The increase in cost of sales was driven primarily by the addition of the NetFortris business and the continuing supply chain pressures. Sangoma's cost of sales continues to be impacted by global supply chain disruption for both electronic components and for shipping. In some cases, we've needed to order further ahead, pay more for certain components, and ship products by air versus by sea at a higher cost. Nevertheless, Sangoma was able to fill most customer orders in the quarter despite these supply chain challenges. Gross profit for the three months ended March 31st was $44.42 million, up 19% from the $37.2 million realized a year ago. Gross margin for the third quarter of fiscal 2023 was approximately 71% of revenue. This is up slightly from the same quarter last year due to a slight increase in sales of our higher-margin cloud services.
While gross margin will naturally fluctuate slightly from quarter to quarter, fiscal third quarter gross margins landed on the higher end of the expected range. In the third quarter of fiscal 2023, operating expenses, consisting of sales and marketing, research and development, general and administration, and foreign exchange, were $43.37 million versus $40.14 million during the equivalent period a year ago. The primary driver of the increase was the incremental expense associated with the addition of the NetFortris business, partly offset by the cost savings from the integration, which began in the fourth quarter of fiscal 2022 and carried through the first nine months of fiscal 2023.
Overall operating expenses increased by 8% year-over-year, whereas revenue was up by 18%, consistent with our long-term approach of growing expenses at a slower rate than revenue, demonstrating the meaningful operating leverage in our business. The company's total operating expense for the third quarter represented approximately 69% of revenue, a decrease from approximately 75% in the same period last year, again reflecting operating leverage and prudent expense management. Adjusted EBITDA during the three and nine-month periods ended March 31st came in at $12.24 million and $33.53 million respectively, up from $10.47 million and $31 million in the equivalent periods of the prior year. The primary drivers of adjusted EBITDA growth are the addition of NetFortris, the underlying growth in our services business, and cost restructuring as part of the integration with NetFortris.
Net loss for the third quarter was $0.69 million, which is $0.02 loss per fully diluted share, compared with a net loss of $6.76 million, which is a $0.21 loss per fully diluted share for the equivalent period in the prior year. Now let's discuss a few balance sheet items as well as our cash flow. Inventories were $18.65 million in the third quarter, which is down by $0.65 million when compared to the second quarter at $19.3 million. This reduction in inventory reflects our ongoing focus on balance sheet management to drive our inventory to appropriate levels.
Trade receivables of $16.99 million in our third quarter were slightly higher than the $16.67 million in the second quarter, primarily as a result of the growth in our business and continued focus on accounts receivable collection. The company closed the third quarter with $8.01 million of cash, compared to $6.8 million at the end of our second quarter. The company used a portion of its cash to continue paying down the debt associated with the most recent acquisition and investment in capitalized development costs. We generated $8.86 million of adjusted cash flow from operations during the third quarter of fiscal 2023, compared to $7.43 million in the same quarter last year, and to $4.77 million in the immediately preceding second quarter.
This increase in adjusted cash flow further demonstrates our focus on balance sheet management and prudent spending. Let's turn to guidance for the remainder of our fiscal year. With the reporting of our second quarter results, based on what we best estimated at the time, we updated our guidance to anticipate revenue for our fiscal year 2023 to land in a range of between $250 million and $260 million, with adjusted EBITDA landing in the range of $46 million-$49 million. Given the results for the first three quarters of fiscal 2023 and our current assumptions regarding macroeconomic conditions, we are narrowing our revenue guidance to $250 million-$254 million and adjusted EBITDA guidance to $46 million-$48 million.
This updated guidance reflects our best estimate of many challenging factors in an increasingly difficult world, including but not limited to longer install cycles, macroeconomic considerations such as historic inflation, bank failures, threats of governmental default, increasingly tight monetary policy in many countries around the world, as well as trends in FX rates, the potential impacts thereof on demand, continuing supply chain challenges, our ability to retain and attract talent, international conflict, lingering effects of the pandemic, and a constant risk of global recession. Sangoma is not immune to these factors, and visibility and forecasting have become more challenging. Overall, we are pleased with another quarter of solid financial results for Sangoma, and it remains gratifying to see our growth in services continuing, further reinforcing the belief that the transition to a more staff-based model is the right strategy to continue moving Sangoma forward.
We are seeing our competitively differentiated strategy yield success. We'll continue to pursue strong organic growth by investing wisely in our people and the tools they need to be successful. Organic growth is a top priority. We look forward to introducing you to a new CEO who we believe can take us there in the very near future. I would again like to thank our Sangoma team for staying strong and focused. We'd like to thank all of you, the extended Sangoma family, as we continue to strive to build your company around the core principle of growth with profitability. With that, operator, we're ready to take some questions.
Certainly. We'll now begin the question-and-answer session. To join the question queue, you may press star then one on your telephone keypad. You'll hear 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'll pause for a moment as callers join the queue. The first question comes from Eric Martinuzzi from Lake Street Capital Markets. Please go ahead.
Hey, Max.
Oh, sorry, guys, I was on mute. That's my fault. First question here, is, yeah, is about the guide. Just in terms of the services segment, you guys increased sequentially again by 2.25%. Do you have consistent view on that going into Q4? Is that your expectation, or, should we be thinking something else here?
Max, given, you know, given where we are right now and seeing how we see services grow, yeah, we do believe that's gonna continue at that annualized 10% rate for services, in the near term for sure.
Okay. My second question here is, I know you guys gave a sequential, growth rate on cloud bookings last quarter of around 5%. What was that this quarter?
We continue to see growth in bookings, Max, and that's one of the items that for sure will be considered as we look at fiscal 2024 and how we'll talk about certain SaaS metrics moving forward. We do continue to see increases though, quarter-on-quarter. We're also pleased that, you know, our time to activation continues to improve. From a metrics perspective, that's, you know, on the list of things we'll consider talking about as we move forward.
Okay. That's it for me, guys. Thank you.
All right, Max. Thanks.
The next question comes from Matthew Stotler from William Blair. Please go ahead.
Hey there. Thank you for taking the questions. Maybe just one. Would love to get maybe a little bit more on what color you're seeing in terms of trends and some of the KPIs you discussed previously. You know, customer and revenue churn, maybe the trends you're seeing in, you know, average deal size, ACV, net retention. Just some color there would be helpful.
Sure, Matt. For sure, all those items are on the list of items as we move forward and start talking more from a financial and operational metric perspective. We've talked about in the past that, you know, we enjoy a very good churn rate, and we continue to see that. You know, that's evident in the net numbers that we're talking about. Certainly, talking about net retention, gross retention, stickiness, are all on the list as we move that forward into FY 2024.
Got it. Understood. Maybe just one follow-up here. In terms of the integration of NetFortris, you know, I'd love to maybe get a little more color on how that business performed in the quarter. Then, the integration there and, you know, whether you're seeing the cross-sell of MSP services paying off at this point and what the trajectory of that looks like.
Yeah. You know, we're pleased with how network services performed during the quarter. I can tell you, we are seeing more interest and sort of a higher take rate within new Sangoma customers. We're also seeing network opportunities increase for our legacy Sangoma customers as well. The integration has gone really well from that point of view. From a sales perspective in bringing that all together, our CRO is driving that really hard. You know, as we move that forward into more of the legacy items, we're seeing a much higher take rate.
That's helpful. Thank you very much.
Thanks, Matt.
The next question comes from Deepak Kaushal from BMO. Please go ahead.
Oh, hi. Good evening, guys. Thanks for taking my question.
Deepak.
Can you hear me okay?
You're fine.
Excellent. Norm, you mentioned, that you spent a lot of time talking to your stakeholders. Is it too early to ask what you're hearing, what some of your findings are, anything relevant to this stage, and maybe some thoughts on what you're looking for in a new CEO?
Yeah. I'd be happy to address that. You know, I think that, you know, last quarter, you know, we mentioned here that what we wanna be thinking about is less focus on M&A and more focus on growing organically. We're looking for a CEO that has a lot of experience leading a public technology company at scale, who's very comfortable and familiar with hitting organic growth targets. Great communication presence to tell the story very well, all while aligning to our company goals and objectives.
We want someone who's got a track record of recruiting, developing, retaining top talent, understands how to build culture in an organization that has acquired its talent through acquisition. Now we've got to bring everybody together, all working together. You know, I think we're focused right now on someone not really has the main experience in undertaking M&A, but really understands how to integrate what has come through M&A. Those are the key attributes, I think, as we're searching for our new CEO, and we're well along in that search.
Okay, excellent. That really helps. I appreciate that. Then the first part of the question was, you know, what you're hearing from stakeholders in terms of the business, the environment, anything surprise you or anything new or unusual that you can share with us?
I wouldn't say it's unusual. I think we're gratified that, you know, just as Larry said a few moments ago, that increasing awareness of the full range of our solutions and how they work together and starting to see that, you know, more cross-sell and up-sell opportunities, whether that's with a new logo or with our existing customers. I think that's very encouraging, and we hope we're gonna see that trend continue and accelerate as well.
Okay. more specifically, you know, with this kind of brewing regional banking crisis in the U.S., are you seeing any concerns on the credit side? Are you hearing anything from the channel or customers at this stage? What's kind of your pulse on the latest regarding that dynamic in the market right now?
I'll let Larry handle that one.
Hey, Deepak. You know, we're not seeing any concerns at the moment. We certainly ping both the channel and the customers routinely, and we're not seeing anything cause any concern on our side from, you know, the customer's ability to pay or to, you know, expand. We're also not seeing anything at this point from the channel. Right now we're not seeing any effects from that at all, Deepak.
Okay. That's great color. You know, I appreciate you answering all those questions and we're looking forward to, you know, seeing the new CEO and their take on the story.
Thank you.
Cheers.
The next question comes from Gavin Fairweather for Cormark Securities. Please go ahead.
Oh, hey, good afternoon. Thanks for taking my questions. You guys have announced a couple new partner relationships over the past couple months. To what extent there's kinda more low-hanging fruit on the partner side and whether, you know, we could see some additional relationships being announced and how you think about upside within the channel there?
For Lars.
Yeah, for sure. Yeah. Sure, Gavin. We've talked about a couple of new, you know, larger partner relationships. You know, they're called CSPs. We continue to see that as a positive avenue for what we're selling. There's a lot of interest in the Sangoma suite and what we can provide as that full, you know, full suite of services, you know, largely in that SMB and mid-market space. You know, we expect to grow that significantly with MSP and all of the others. We continue to see much more interest in that from those size CSPs, and we've been successful with that, and I'd expect you'll see more of that to come.
Great. Then just, secondly on EBITDA margins. The Q4 guide at the midpoint, seems to imply another kinda couple points of margin expansion over the Q3 level, which kinda feels like maybe it's over and above the cost reductions that are working their way through the system. Have you made any other changes to the cost structure or discretionary spending? What would be driving that?
you know, we're always looking for, and we've always been good at finding efficiencies. no large scale, you know, plans that are driving that other than continued plans that we put in place and talked to you about last quarter. Starting to see that take hold. always being very prudent with how efficient we are with our spend. it's always been a core competency at Sangoma and at Star2Star previously. you know, more of the same with that showing, you know, profit for us there.
Okay, great. Just lastly for me, growth is becoming, you know, a little bit harder to come by for the industry as a whole. Maybe just touch on any shifts that you've seen in competitive dynamics around kind of pricing or channel commissions or anything else that you're seeing. That's it for me. Thank you.
Sure. Well, you know, we continue to see good growth in our services as we talked about at that annualized rate, which we're quite happy with. You know, from a competitive landscape, perspective, we're not seeing as much pressure on price as you might think, and we're seeing increased opportunities to get in there largely because of what we can offer and the ability to talk to one you know, one company. You know, I know it's a little unsatisfying. I'm not gonna match and be able to say, "No, we're X% cheaper or this is happening." We're not losing out on price, and we're not losing out on an opportunity. I think that's why you see something like a 10% annualized rate as opposed to less.
That's great. Thanks so much.
You bet, Gavin.
The next question comes from David Kwan from TD Securities. Please go ahead.
Hey, guys.
Hi, David.
I was curious on the growth side, particularly on the services. You know, you talked about this 10% annual growth target. I assume it is an aspiration to drive that higher. I was curious to what extent you're willing to invest more to get there.
Well, I, you know, I think we're always looking to make smart investments to grow that more rapidly when it happens. However, what we're seeing today is, you know, without having a large gap in product and with increasing opportunities, the natural effects of that and its compounding alone, you know, while I can't give you a number, I certainly expect to see that trend continue. We'll always be looking for prudent opportunities to invest where that makes sense to grow that rapidly. Right now we're focused on the organic growth because that's where we really see the payback, and, that's where we're seeing the results today, especially as some others aren't.
I guess maybe another way to ask the question is to get that growth into, say, the teens, whether it's the low teens, mid-teens, do you think you'd have we'd see margins come in a bit to get to there, or do you think you can get there with your existing cost structure?
No, I think we can get there with our existing cost structure. I'd actually, you know, be pushing our guys to see margin expansion, not contraction, you know, whether it's ARPU or more services or what have you. You know, as we expand within the customer base, you know, both existing and new, I look at that almost the opposite way, to be honest with you, David, you know?
Yeah. David, this is Norm. You know, one of the advantages we're having, we're seeing, and I think we're gonna be able to continue to exploit, is as the awareness of this related set of solutions, the, you know, the cost of the engagement with any particular customer is about the same, whether you're selling one thing or 10 things. We're starting to, I'm not saying we're always gonna sell the 10 things, but we're selling more to each of those customers. The average revenue per user we see beginning to climb. We think we'll continue on that trend. The total cost of ownership for those customers is very positive. We're winning and they're winning. I think that's kind of the approach I think we're gonna be able to take more of in the future.
No, that's helpful, Norm. Thanks. On the gross margins, I think last quarter you said, you know, that was, I think it was 69%, that it was kind of the upper end of kind of what you were expecting for this year, and then you came in at almost 71% this quarter. I, you know, I understand that some of that's coming from revenue mix or whatnot, but just trying to get a better understanding of how we can be modeling out your gross margins. I know you don't break them down at this point, at least kind of product versus services gross margins. But if you make the assumption that services revenue kind of stays in the low 80s%, you know, what is a reasonable gross margin assumption?
Some good insight there, David. You know, the increase in gross margin certainly tracks closely to our growth in services revenue, right? Cloud services, typically higher margin offerings. You know, as we see changes to the split between products and services, as you said, low eighties in Q3, it's not really unexpected to see, you know, some of the changes in gross margin tracking with those. Growth in MSP services bring lower margin, of course, right? That can have some impact in the opposite direction, but not enough to overcome that. You know, as you see more services, you would certainly, you know, expect to see margins in that range. You know, we don't guide necessarily to a margin range, but I, you know, I'm comfortable with where we ended Q3 being something like that.
Okay. That's helpful. Sorry. The last question, just on the AI side, particularly generative AI. We've seen many of your peers come out with announcements about, you know, incorporating it into their platforms, their solutions. I was curious to what extent, you know, that's in your plans. I know in the past it sounds like you've been kind of dabbling in some stuff on the AI side, but especially given kind of the competitive dynamic, I'm curious to see, A, what you're doing and, you know, kind of what opportunities and risks you see with it.
Yeah. Hi, David, this is Norm again. We definitely are looking at this and it's on the roadmap for some near-term implementation, in fact. The, the kind of the approach we're taking is as you're kind of suggesting, a lot of hype about this right now. We're taking approach we're calling internally practical AI. Things that, you know, really work, are really functional and, you know, don't have some of the emerging problems with, you know, with some of the, some of this leading edge stuff where it's, you know, seems like it's giving you the right answers, but it actually isn't. You know, we wanna make sure that the kind of machine learning and enhancements that are driven by AI, work well and work reliably you'll start to see this show up in some of our communications products, and in some of the network services products as well.
That's all folks. Thanks, guys.
Thanks, David.
The next question comes from Robert Young from Canaccord Genuity. Please go ahead.
Hi, good evening. Maybe just a couple simple ones. In this interim period until you have a full-time CEO, just curious about. Sounds like M&A is not going to be a priority going forward, but what are you gonna do with the cash? Should we think debt pay down is the priority in this period, or is there anything else you'd like to do with cash?
Yeah. Certainly, Rob, we're always gonna look at, you know, capital allocation and how we look at that. You know, paying down on debt is certainly high on our list. We typically pay that down quickly, and we'll continue to look at that as the needs. Then of course, investing in the company as we continue with the organic growth, are all things that are top of mind for us as we look at that. You know, debt repayment being high on that list, just as you said.
Okay. maybe for my second question, the weakness that you're highlighting on the product side, is that having any impact on the services? Seems like you're happy with the 10% growth profile continuing. is the product weakness sort of a gate there on that growth?
No, we're not seeing it, that way, Rob, at all. We don't see it. You know, I think what you're really seeing is kind of a return to more historical kind of levels as it relates to the product side at the current time. You know, it has, you know, declined but at a much slower rate than the previous two quarters. It's really not having any impact on the services side.
Okay. That's it for me. Thanks.
All right, Rob, we appreciate it.
This concludes the question and answer session and today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.