Sangoma Quick Update - $STC.to & $SANG

Quick update after fiscal Q4

STC reported yesterday. Results were behind my already low expectations and the stock sold off by 12%%

The new CEO has been on the job for a few weeks and new COO even less time, so the amount of context given on strategy was going to be minimal. Having said that, there are some things worth going over.

Quarter Recap

• Rev down 4% to 63.68 mil on a consolidated basis for the quarter.

  • Weakness was in the product side of the business which was 3.7 mil lower vs the increase in services of 1.1 mil.

  • Services were 79% of total revenue this quarter.

  • I’m assuming much of the increase in full year revenue was the inclusion of NetFortis for all 4 quarters vs just 1 quarter in the prior year.

• Gross Profit was down 5% and opex was down 4%

• EBITDA came in at 10.86 mil vs 11.1 mil last year.

• Using the Q3 “narrowed guidance” the company gave, the revenue range was 61-65 mil and adjusted EBITDA was 12.5-14.5. So revenue was in line and EBITDA was below target.

• Full year guide of 250-254 mil in revenue was met with 252.5. Full year guide of 46-48 mil EBITDA was met with 44.4 mil.

• Inventory and ticked down a bit and so did receivables.

• The company did not give any guidance for 2024, although they committed to revisiting guidance for fiscal 2025.

• NetFortis did not meet the terms for the final earn out. This is good and bad for me. Good - less cash going out the door. Bad - the business unit is not performing as well as it was projected.

• Something caught me eye in the controls section of the MD&A:

We disclosed in our our Fiscal 2022 Annual MD&A that management identified a material weakness with respect to Fiscal 2022 related to aggregated deficiencies in the areas of standardized policies and procedures, inadequate segregation of duties, and a combination of information technology general control across multiple system was identified.

They go on to list the control measures they put in place for fiscal 2023. Then note this:

During Fiscal 2023, the Company's management tested the controls related to the material weakness described above for a sufficient period of time, and has concluded, through testing, that by the end of the fourth quarter of Fiscal 2023, the majority of the controls related to the material weakness from the prior fiscal year were operating effectively. However, with the new acquisition of Netfortris/Fonality and the creation of business process narratives, ITGC narratives and the identified issues in access to programs and data as well as IT change management, the Company's management has concluded that the material weakness previously identified in the Company’s internal control over financial reporting has been downgraded to a significant deficiency as of June 30, 2022.

Call Notes

There wasn’t a ton of context given on the call.

• Wholesale trunking faced some pricing pressure during the quarter that has since stabilized.

• Bookings are growing.

• The supply chain issues mentioned in the MD&A didn’t sound like anything new.

• Revenue and gross margin is trending in line with their internal projections. Their Q1 ends September, so they should have a ton of visibility to what Q1 2024 would look like at this point.

• Stated that they will have profitable growth in 2024.

Closing Thoughts

I’m honestly not sure what to think of this one anymore. The business isn’t performing bad per se. Revenue was down although some of that was expected. EBITDA margin is coming in lower than I was expecting, so I would point that as a negative. However, they are done with the share issuance related to the Star2Star acquisition. This was a large overhang on the company. To me STC is a reasonable business, but the stock itself has some warts to remove:

• Lack of strategy and leadership. To me this comes in the form of business strategy and capital allocation. What’s the plan for the business? And then what is the priority for the cash being generated?

  • I will give the new CEO some time to come up with a vision for the company.

• Visibility on the business. Things are unpredictable with any business. Much of the justification that came with the prior acquisitions was increased business visibility due to the large percentage of revenue derived from services. Removal of guidance after continuing to meet or beat it doesn’t invoke confidence especially given how much of the business is services vs the past.

  • In their defense the lower than anticipated top line has been a result of product sales. Service revenue has been stable.

• Relatively high debt.

  • Though the business can handle the debt levels here, I think paying it down and being flexible if there is a well suited acquisition would be prudent.

• The continued sales by the chairman (former owner of S2S).

  • The company has tried to give color to the sales and has even accelerated the share issuance that was committed to. These are steps in the right direction, but the chair selling large amounts of shares when the stock is down over 80% from it’s highs is never a good look.

• Lack of insider ownership. A big vote of confidence would be a large purchase from the incoming CEO and COO in the open market.

• The internal controls need to be sorted.

• I think the company needs to go some time without some major acquisition expenses, impairment or restructuring charges so investors can see what the cash generating potential of the business is.

It feels like the company has been going through an identity crisis as of late. The last 3 years have been painful to be a holder of the common. Multiple contraction feels worse than a dozen root canals.

STC has been painful for me. There are so many lessons I should have learned with the company during the go-go days of 2021. But we are where we are today and beating myself up about the past won’t pay the bills. There is lots of uncertainty with STC, but does that mean it has lots of risk? I’m not sure. The message boards have become more and more bearish if that is an indicator of sentiment. I continue to hold my position.

They say knowing when to sell is the hardest, but I think the sell decision should have been pretty straightforward. Multiple contraction sucks.

Thanks for reading.

Dean

* long STC.to