EXFO Inc.
Q3 2020 Earnings Call Transcript

Published: 9 Jul 2020

[Operator:]

Please standby, we're about to begin. Operator Good day, and welcome to EXFO's Third Quarter Conference Call for Fiscal 2020. Today's conference is being recorded. At this time, I would like to turn the conference over to Vance Oliver, Director of Investor Relations. Please go ahead, sir.

[Vance Oliver:]

Good afternoon, and welcome to EXFO's third quarter conference call for fiscal 2020. With me on the line today are Philippe Morin, EXFO's Chief Executive Officer; and Pierre Plamondon, CFO and Vice President of Finance. Mr. Germain Lamonde, EXFO's Founder and Executive Chairman will also be available to answer questions during the Q&A period. A reminder that this conference call will include certain forward-looking statements and/or estimates concerning our intents, beliefs or expectations regarding future events that may affect EXFO. Please note that such comments may be affected by risks and/or uncertainties, including the impact of the coronavirus pandemic on our employees, customers and global operations. This may cause the actual results of the company to be materially different from those expressed or implied today. For more information about EXFO, I encourage you to review our Form 20-F filed with the Securities and Exchange Commission. Our annual information form is available with Canadian Securities Commission as well. Please note that non-IFRS numbers may be used during this conference call. A reconciliation of these non-IFRS results with IFRS numbers is available in the Q3, 2020 news release on our website. All dollar amounts in this conference call are expressed in U.S. dollars unless otherwise indicated. So without further delay, I will turn the call over to Philippe.

[Philippe Morin:]

Thanks, Vance, and good afternoon everyone. So despite constraints and restrictive measures in many countries, EXFO navigated through the coronavirus pandemic with a solid financial performance in the third quarter of 2020. We delivered sales of $66 million and an IFRS net earnings of $3.2 million in the third quarter. In terms of adjusted EBITDA, it amounted to $10.7 million or 16.1% of our sales. These encouraging results were achieved by proactively implementing cost controls and also benefiting from a wage subsidy of $3.3 million, from the Canadian government to help maintain employment during the pandemic. Now had EXFO not benefited from the government wage subsidy, our adjusted EBITDA margin would still have been in double digit in this quarter. Now our bookings were down 15% year-over-year for a softer book-to-bill ratio below one. However, we are pleased that our tests and measurement bookings dropped nearly 7% year-over-year, while our SASS-related business was more severely affected by the pandemic. Now on the other hand, we have potentially significant SASS deals closing in our fourth quarter, which I will address a bit later. But now let's take a closer look at how our two major product families performed in the third quarter of 2020. In terms of test and measurement, sales were down moderately 7.5% year-over-year, and again, mainly due to the impact of the coronavirus pandemic. More specifically, the government imposed restriction in several countries within mainly Americas and Europe during our quarter, limited our ability to ship test instruments and deliver services. We also saw a pause in large scale fiber installations with communication service providers, such as fiber-to-the-home and fiber-to-the-antenna, mainly while our service providers were mainly focusing during that period on maintenance work. However, as economies are gradually reopening around the world, we are witnessing an increase in our funnel in our opportunities for optical and high-speed test solutions. In addition, our advanced optical test solutions for our manufacturing and lab market continues to deliver healthy growth, mainly in China, where we've seen an acceleration of 5G investment. On our service assurance systems and services side, sales decreased 16% year-over-year, and again, largely due to the coronavirus pandemic. Market dynamics however are different for this business. It has longer selling and revenue recognition cycles than obviously our test business, when with the pandemic affecting our ability to close deals and install new systems. Despite the coronavirus impact, our current customer engagements on our automated end-to-end troubleshooting solutions for cloud native network continues to expand. In fact, our proof of concept trials for our Nova SensAI monitoring and troubleshooting solutions have now increased from three to seven in the third quarter. Nova SensAI uses machine learning to detect, predict network anomalies in real time. And it can pinpoint which subscriber is impacted, where it has happened and for how long, as well as helping diagnostic the root cause for rapid resolution. The solution is an integral part of EXFO's recently launched Nova Adaptive Service Assurance platform, the first intelligent automation solution, enabling mobile network operators to deliver ultra-reliable and high-quality service experience in 4G and 5G environment. So looking ahead, it remains difficult to forecast the pandemic impact on the global economy. But given that the long-term drivers like fiber and 5G deployments remain intact, we're optimistic that EXFOs revenue levels will improve in upcoming quarters, and the operating leverage of our business model will be fully demonstrated. We continue to witness increased RFP activities and trials for our service assurance solutions for 5G core applications. We expect positive decisions on a number of these RFPs to be made in this fourth quarter of our fiscal '2020. So at this point, I'd like to turn the call over to Pierre, so he can cover our financials.

[Pierre Plamondon:]

Thank you, Philippe. Sales decreased 10.1% to $66.1 million in the third quarter of 2020, from $73.6 million in the third quarter of 2019, mainly due to the ongoing impact of the coronavirus pandemic and negative currency fluctuation year-over-year. Bookings, as Philippe mentioned decreased 15% to $59.1 million in the third quarter of 2020, from $69.6 million in the same period last year for book-to-bill ratio of 0.89. Likewise, the drop in booking can be attributed to the COVID-19 pandemic and negative currency impact. Gross margin before depreciation and amortization amounted to 57.7% of sales in the third quarter of 2020, compared to 58.6% in the third quarter of 2019. Our gross margin was negatively affected by lower sales level year-over-year, as a result of the coronavirus pandemic, which permitted us for better absorbing of fixed costs. This was partially offset by the wage subsidy of the Canadian government in Q3, 2020. In terms of operating expenses, selling and administrative expenses totaled $18.9 million, or 28.6% of sales in the third quarter of 2020, compared to $23.8 million or 32.3% of sales in the same period last year. This $4.9 million decrease in SG&A expenses year-over-year, mainly reflects $1.1 million wage subsidy by the Canadian government to mitigate the effect of the pandemic. The adoption of IFRS-16 had a positive impact of $0.4 million on our SG&A expense year-over-year. In addition, world-wide restriction of various forms and transportation, due to the pandemic resulted in lower travel expenses year-over-year. Net R&D expenses reached $9.2 million or $13.9 million of sales in the third quarter of 2020, compared to $12 million or 16.3% of sales in the same period last year. Likewise, the $2.8 million decrease in the net R&D expenses can be attributed to the Canadian wage subsidy program and the positive impact of the adoption of IFRS-16 in the net R&D expenses year-over-year. IFRS net earnings totaled $3.2 million or $0.06 per share in the third quarter of 2020. Net earnings in the third quarter of 2020 included, $1.4 million in after tax amortization of intangible assets, $0.5 million in stock-based compensation costs and $0.1 million in foreign exchange loss. Net earnings in the third quarter of 2020 also include $2.4 million for after tax wage subsidy by the Canadian government, to help maintaining employment during the pandemic. In comparison, IFRS net earnings amounted to $21,000 or $0.0 per share in the third quarter of 2019. Geographically, the America has accounted for 45% of total sales in Q3, '20. Europe, Middle East, Africa represented 33%, while Asia-Pacific totaled 22%. In comparison the sales split was 51%, 30% and 19% among the three geographic regions in the third quarter 2019. In terms of customer mix, our top customer accounted for 9.6% of total sale in Q3, '20, while our top three represented 18.2%. Turning to a few key points of the balance sheet, our cash position decreased to $20.5 million at the end of Q3, '20 from $20.9 million in the previous quarter. This $0.4 million decrease is mainly due to $16.9 million in cash flow used by operation, which is largely related to the increase of our receivables to our more normal level compared to previous quarters to $1.9 million for the purchase of capital assets, and $1.1 million for the repayment of lease obligation and long-term debt. These cash outflow were mostly offset by an increase in our bank loan by $19.9 million. At the end of Q3, '20, EXFO had a net debt position of $17.5 million and available revolving credit facility up to $39.7 million. During the third quarter, we extended our revolving facility by CAD20 million, until May 31, 2021. At this point, I will turn the call over to the operator for the start of the Q&A. Thank you.

[Operator:]

[Operator Instructions] We'll take our first question from Daniel Chan with TD Securities. Please go ahead.

[Daniel Chan:]

Well, hi guys. Thanks for taking my question. These numbers were definitely better than I expected, so congratulations on that. Was there any kind of expansion CapEx from your customers in the quarter? And would you say that was a large driver for some of the better than expected results in the T&M space this quarter?

[Philippe Morin:]

As I mentioned, I think we've seen some, again, continuing positive trends on our successful market penetration around the manufacturing and lab environment. As you know, we made an acquisitions almost two years ago, it starting to really -- it is paying off, allowing us to gain market share. And we're continuing as well to see more investments going into the latter part of that quarter of people going in with fiber-to-the-home and fiber-to-the-antenna. Now, if you look at our customer base, we've seen customers announcing increase in our CapEx, Verizon mainly being one where they've announced a $500 million CapEx increase for their network build out. And we've seen other service providers do the same, to really respond to the bandwidth growth that they've seen since the beginning of the pandemic. But overall on our T&M, I do see it's the same kind of business growth that we've seen in our high-speed solutions, our manufacturing solutions. And we're getting the benefit of the decisions we made a few years back and leveraging that position in the market.

[Daniel Chan:]

Okay. That's helpful. Now you mentioned that 5G investment in China seems to be ramping up aggressively. Any changes to timelines on 5G and SDN rollouts in your other markets in Europe and North America?

[Philippe Morin:]

Yes. I think you're going to see a different responses that based on per countries and per customers. I think we've seen customers that actually have decided to accelerate 5G, because they think it's so critical. And again, I'll restate Verizon and AT&T. In certain countries in Europe, you've seen a bit of delays, mainly as well as auctions being delayed and so on. So, while in China, we all know we've seen as well some acceleration of that. But ultimately, I still go back with the two growth vectors we are focusing on from our service provider customers and our web scale customer providers around fiber infrastructure investment and 5G. To me, they remain strong and that's why we're optimistic about getting some growth in our revenue going forward?

[Daniel Chan:]

Yes, that's going to be actually my next question. You sound pretty confident in winning some 5G RFPs in Q4. Just wondering how those discussions are going and what's driving some of that confidence?

[Philippe Morin:]

Yes. As I mentioned is we're seeing a lot of activities in RFPs. They do take especially with this pandemic crisis, they take a bit more time to close. But we feel pretty confident that we are getting some of our fair share of these wins. And the fact that we do expect that our backlog will be able to also -- we're going to be able to grow our backlog both for our SASS and T&M business that will really help in the predictability of our revenue profile. We do keep in mind that usually our fourth quarter for which is really summer months are a bit of slower on T&M, as we know, as because of just some of the constructions activities in summer being a bit slower down. So that's a bit of a seasonality and that we have to deal with.

[Daniel Chan:]

Okay. Thanks, I'll pass the line.

[Philippe Morin:]

Okay. Thank you.

[Operator:]

Thank you. We'll take our next question from Thanos Moschopoulos with BMO Capital Markets. Please go ahead.

[Thanos Moschopoulos:]

Hi. Good afternoon. Philippe, can you comment on how the supply chain and logistics issues are looking now? I mean, I presume it's starting to get a bit better. But to what extent might that still be a constraint do you think in the current quarter?

[Philippe Morin:]

Well, so first of all, let's talk about our supply chain. Our factories are up and running. And then like I mentioned in the previous quarter, so we're fully operational on all our factories. And that's obviously benefiting us in terms of being able to respond quickly to our customers in need. In terms of our overall -- our own supply chain and when you look from orders all the way to shipments, I do think that we've seen the recovery. And the last phase, I guess what's really a thing that we got to continue to really navigate through is around the whole logistics side of things. So being able to deliver equipment to our customers, we have to schedule and make sure they have people over there. There's still some challenges in terms of flights and trucks and so on. But overall manageable, and we've been able to really work around those in our Q3.

[Thanos Moschopoulos:]

Okay. Do you have any guesstimate as to what the impact would have been in Q3 if you didn't have any of those [indiscernible] or is that kind of hard to assess?

[Philippe Morin:]

No, I think they've been very marginalized. The only comment I will make Thanos, is obviously what the uncertainty associated with the first wave expands -- of the pandemic or even a second wave hitting, that's the part of the bit of the unknown from the point of view of predictability of our business. But in terms of Q3, it was a marginal impact.

[Thanos Moschopoulos:]

Okay. From an OpEx perspective, I guess there's some moving parts here. I guess one question is how long the stimulus lasts. But I mean, putting that aside, if we look at the numbers underlying without the stimulus. Normally, you have a downtick in Q4, due to vacation seasonality. Should we expect the same this quarter? And then looking past that, I mean how should we think about maybe permanent cost reductions versus temporary cost reductions?

[Philippe Morin:]

So, I'll let Pierre answer the first question on vacation and I'll take -- I'll let you go first and I'll answer the other piece.

[Pierre Plamondon:]

Yes. You're right, Thanos. In Q4, we see the benefit of the vacation where the expense tend to be lower. Q3 has been quite low with the wage subsidy that we got for the Canadian government. We won't have those in Q4 as we're no longer qualified for the program. So that's the main point. The main theme that we got in the Q3 also was the reduction in travel. We do expect that that reduction will continue at least for Q4, as most of the countries are still locked down right now. So we could assume some reduction, if you compare to the run rate of Q1, Q2, and really Q3.

[Philippe Morin:]

The point I'll add to that Thanos, is we're going to continue to be very disciplined with regards to our OpEx cost. So we've achieved as just highlighted, obviously travel reduction, but we had a hiring freeze. We're very careful with the contractors we're using. We've gone into a much more virtual engagement when a customers that has actually been interestingly favorable in terms of being able to outreach and bring more experts in front of our customers. All of that new environment where we're going to continue to adapt and see how we can continue to grow our business, while really being, as I mentioned, diligent on our cost and our OpEx.

[Pierre Plamondon:]

Maybe thing to add. Maybe Thanos, one thing to consider as well. So the Canadian dollar was weak in Q3, the average was $1.39 getting a little bit stronger in Q4, so could have some negative impact on our OpEx cost by increasing the OpEx a little bit because of that as well.

[Thanos Moschopoulos:]

Okay. And then it looks -- were there any impact as far as maybe market share shifts? And I'm just curious as to has there been any difference in terms of your ability to maybe respond to customer orders and ship, test and measurement equipment to them versus some of your competition? Or has everyone been kind of an equal footing in that regard?

[Philippe Morin:]

We'll see the impact on us over the full year, but we do think that because our factories were up and running throughout this quarter, especially around the manufacturing and land market that we were able to gain market share. Again, it will be more interesting to really compare those numbers when we get the full year, but we do believe that on the T&M side we have increased our market share. We do believe as well on the high speed 400 gig high speed solutions, we do believe that we've actually gained market share as well, because we're able to respond. As you know, we do our manufacturing with our three factories. And I do believe that it brought us a competitive advantage to respond faster to our customers, and then therefore leading into market share improvement.

[Thanos Moschopoulos:]

Great. Thanks so much.

[Operator:]

Thank you. We'll go ahead and take our next question from Robert Young with Canaccord Genuity. Please go ahead.

[Robert Young:]

I was hoping you could maybe give a bit of insight -- sorry, if I missed something earlier in the call. But is there any cadence of bookings that you can help us with? Last quarter, you had a strong book-to-bill in a tough revenue quarter, now you got a lower book-to-bill and a slightly stronger revenue quarter. Is there any cadence of bookings that you could help us understand there?

[Philippe Morin:]

Yes. Robert, on the booking side, I would tell you that we are pleased with -- although, it's a decrease, but being 7% down, year-on-year for T&M, considering the COVID impact in Q3, and as you know that quarter in particular was substantially impacted in a lot of countries to be 70% down on T&M. We felt that it was a really good performance, especially in the month of May in particular with the bookings we were able to close. On SASS, I do think that the COVID really impacted us in terms of when you're looking at doing new RFPs, new business trying to displace an incumbent in the COVID environment. It did take a bit more time to close deals. So it's really come down to timing of closing these deals. So they were not lost deals, it just takes more time in this environment to close. And as I mentioned in my opening statement, our funnel is going up. There's more RFPs being happening. And we do believe, we'll be able to close some of these deals, potential deals that we have in Q4 and coming up and mainly on the SASS side. But again, both T&M and SASS, we see the funnel and the opportunities increasing as we speak in our Q4.

[Robert Young:]

Okay, okay. I noticed the accounts receivable jumped up quite a bit. Is there anything in there? Are you seeing any lengthening in payments here?

[Pierre Plamondon:]

Not really, Robert. It's mainly Q2 was very low. The fact that we have been hammered in Q3 -- in February on the shipments, which is why we have a very low February month. So we're more in line with previous quarter in the $50 million, $55 million in the receivable. So we haven't experienced any bad debt, major bad debt or more difficulty. So we need to keep tight control on the credit, but for me being at 50 -- over $50 million, $55 million, this is back to normal which we have seen in the previous quarters.

[Robert Young:]

Okay. And then maybe is there any other color I can get on these deals that might close Q4? Is there any context around size or confidence on closing? I imagine the backlog I think last quarter, you said there was around $60 million in SASS. Are these deals that would have been in the backlog last quarter? Is there any other information you give us there?

[Philippe Morin:]

What I could bring a bit more color, Robert is the backlog is again is pretty sound with regards to our SASS business, but these would be additional, I would actually tell you new logos. So this is winning new customers and that we don't have an existing position. And as you know they take longer these SASS deals to get revenue recognition, because there's always some professional services work that we have to do and get customer acceptance and so on, which is a quite different revenue cycle than we see on T&M.

[Robert Young:]

Right. It's great to hear. I'll pass the line. Thank you.

[Philippe Morin:]

Thank you.

[Operator:]

Thank you. We'll go ahead and take our next question from Tim Savageaux with Northland Capital. Please go ahead.

[Tim Savageaux:]

Hi, good afternoon, and congrats on the better than expected results. And the question, and Philippe I think you referred to this briefly. You've seen what appears to be a lot of strength globally in fiber access markets, 10 PON upgrades, what have you, pretty broad based. And obviously somewhat of an uptick driven by work from home traffic amongst cable operators as well. So I guess my question is, as you look at the access portion of your T&M business, I wonder if you could talk about what you're seeing in terms of either funnel activity orders connected to any increase in fiber-to-the-home deployment globally. I'll follow up from there.

[Philippe Morin:]

Yes. So, Tim, when we look at our T&M business the growth vectors that helped us get the bookings and the revenues were predominantly, as I mentioned, around our manufacturing and lab market, which continues to do really well. Our high speed solutions like 400 gig, which does really, really well. And as well, we're continuing to see solid performance on some of the optical RF solutions that we have and deployed over the past the past quarter. What you highlighted is because of the pandemic a lot of what I would call fiber build-up, whether it's fiber-to-the-home, fiber-to-the-antenna, the densification of fiber-to-the-antenna that we've seen in Americas, North America, they've been obviously impacted by COVID, where the funnel is increasing IS exactly what you've just highlighted. Fiber-to-the-home, especially with COVID, people are realizing that they will get better broadband connectivity with fiber deployment with fiber access, whether it's PON technology, whether it's fiber deep. And we are seeing the impact of the funnel of those that particular market as you highlighted. And it's not just in North America that we're seeing this, but we're seeing this across Europe as well. And we're seeing that in certain countries in Asia-Pac.

[Tim Savageaux:]

Okay. I imagine that will take a little while to develop, as you mentioned, it's sort of activity in the funnel. But is that kind of part of what's behind your stated optimism for increasing revenue levels? And exactly how you meant that? It looks like there's maybe some seasonality of play as we look at fiscal Q4. But to the extent that you're optimistic about growth heading into fiscal '21, would it be kind of a continuation of some of these current trends you're seeing around lab and production and high speed, with maybe some of the access, and speaking of T&M here coming up to be a more significant driver as you kind of look forward?

[Philippe Morin:]

Yes. So, Tim, my comment was really more than just what I would call next quarter optimism. It's exactly what you said. When we look at our fiscal year 2020 and the fundamentals behind where we're investing, where we've made acquisitions, we are feeling optimistic about the opportunity to respond to the customer's needs around fiber deployment, high-speed solutions lab manufacturing. And on the SASS side, we're starting to see, as I mentioned, a lot more activities around 5G deployment, 5G core deployment. The caveat is obviously the global economy and what will happen, and with potential recession or slowdown and an impact on GDP and this is the challenge that we have. We spent a lot of time talking to our customers where we're trying to get a better feel of their CapEx spend, and where they go ahead with their investments in terms of build out and so on. Our business around -- with the web scale by the way, is also increasing, whether it's between the data centers or within the data centers, and we see that continuing. And as you know, there's a whole discussion around edge data center built out, that we do believe will be based on interconnected, inside and outside with optical technology. And again, giving us the optimism that focusing on fiber and focusing on 5G is the right strategy for us.

[Tim Savageaux:]

Okay. Thanks very much.

[Operator:]

[Operator Instructions] We’ll take our next question from Richard Tse with National Bank Financial. Please go ahead.

[Richard Tse:]

Yes, thank you. So, you referred to strength here in China, I'm kind of curious on a relative basis prior to this pandemic, would you say that kind of scale or momentum is back to where it was?

[Philippe Morin:]

I do think that it's a bit difficult to answer, but I do think there's two answers to your question. The first one is, we are seeing the Chinese government making a priority in infrastructure build out for 5G and that we do see the impact of that. We do a lot of, again, the manufacturing business we do, we help transceivers manufacturers. We help people building optical components. And I do feel that that is not just necessarily to the Chinese market, but overall the global need for those type of products. So, I would say there's a bit of combination of both. So a real infrastructure investment build out in China and then, ultimately, as well as high demand for optical components.

[Richard Tse:]

Okay. And it sort of dovetails into this other question. Like on a global basis, how would you serve rank the relative strength of the other regions having sort of come back here?

[Philippe Morin:]

Richard it's really, again, it's interesting to see within the quarter how the regions were gradually reopening up. Obviously, China being the first one being hit, but the first one to be reopening, we saw some of the activities going there. EMEA was more impacted for our business. I mean we saw obviously a countries being closed down, economy is being closed down for a big part of that particular quarter. And we saw that as a big, a bigger impact. Americas was interesting. The U.S. performed better, especially in the month of May for us, Canada as well, but Latin America, obviously, as I'm sure you've seen the news, was a softer quarter.

[Richard Tse:]

Okay, great. Thank you.

[Operator:]

[Operator Instructions] I think as we have no further questions at this time, I'd like to turn the call back over to CEO, Philippe Morin, for any additional or closing remarks.

[Philippe Morin:]

Thank you. So, just a few key takeaways before we conclude the call today. So again, first we're very pleased with our solid financial performance in the third quarter of 2020. We delivered a double digit adjusted EBITDA margin during a pretty important pandemic crisis here. Second, our proof of concepts for our Nova SensAI monitoring solutions continues to gain traction with customers, as we have increased the trials from three to seven in the third quarter. And then finally, despite the pandemic the fiber and 5G growth drivers remain intact, with some countries, as I mentioned, even accelerating their investments. So given our market driven focus on the two long-term drivers, EXFO's revenue levels should improve in the upcoming quarters, and the operating leverage of our business model will also be fully demonstrated there. At this point, this concludes our Q3, 2020 conference call. And on behalf of the entire EXFO team, thank you very much for joining us today.

[Operator:]

Once again, that does conclude today's conference. Thank you very much for your participation. You may now disconnect your phone lines.