EXFO Inc.
Q1 2019 Earnings Call Transcript

Published: 9 Jan 2019

[Operator:]

Good day, and welcome to EXFO's First Quarter Conference Call for Fiscal 2019. Today's conference is being recorded. At this time, I'd 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 first quarter conference call for fiscal 2019. With me on the line today are Philippe Morin, EXFO's Chief Executive Officer; and Pierre Plamondon, CFO and Vice President of Finance. 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 will be affected by risks and/or uncertainties which 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-Follow-up, filed with the Securities and Exchange Commission. Our annual information form is available with Canadian Securities Commissions 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 Q1 2019 press 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:]

All right. I'll move the microphone here to take it closer guys. So thanks, Vance, and good afternoon, everyone. I'd like to take the opportunity here to wish everyone a happy new year filled with health and happiness. So turning to our Q1 2019 financial results, EXFO delivered a solid quarter, that sailed at $69.2 million above the midpoint of our guidance and bookings of $81.2 million, the second highest level in our company's history. Overall, thanks to strong bookings, our book-to-bill ratio was $1.17 in the first quarter of 2019, same pacing EXFO into an enviable position to deliver strong results for its second quarter of 2019. Bookings, which increased $23.3 year-on-year were particular robust for our portable 100 gig test solutions as EXFO benefited from ongoing fiber deployment closer to the edge and high-speed upgrades and access networks and within datacenters. Our bookings in the first quarter -- our bookings in the first quarter were positively affected by calendar year end spending on the part of the US communication service providers. EXFO is well known for having a broad and deep test portfolio that meets the needs of our most demanding customers and due to the timing of these orders, we were unable to convert all of them into revenues in Q1 2019, which obviously is helpful to build up our backlog for upcoming quarters. We also witnessed increased traction for our lab and manufacturing solutions, including optical spectrum analyzers from our latest Yenista acquisitions. These advanced test solutions resonated with component, subsystems and network equipment manufacturers, especially in overseas market as fiber rollout continues to cope with exponential bandwidth growth and bandwidth demand. Finally Astellia contributed $7.8 million in bookings in our first quarter of 2019. The integration of Astellia continued to progress as planned with the services assurance and analytics technologies slated to be combined with EXFO on a common platform in the second half of fiscal 2019. We're also maximizing cross-selling opportunities amongst the combined sales force in 2019. As announced earlier, EXFO is stating -- starting with its first quarter of 2019 to report revenues and bookings based on two newly defined product families; test and measurement or T&M as well as service assurance systems and services or SASS or SaaS. Optical transport and copper test solutions make up the T&M product family, including portable equipment for the field and bench-top units for the lab and manufacturing environment. On the system side, the family consists of fiber monitoring, service assurance and monitoring analytics, professional services as well as other systems related solution like our network simulation and network topology discovery solutions. This classification replaces the former physical and protocol layer product groups. Following our recent strategy, strategically our innovation, we believe this breakdown better reflects our product portfolio, better reflects our addressable markets, while enhancing our transparency with investors. In the first quarter of 2019, sales of our test and measurement product group decreased 0.8% year-on-year. Now this slight decrease was mainly because of our back-ended orders I've talked earlier since bookings were up 21.1% for that particular product group during that period. On the service assurance systems and services side, our sales and bookings increased 49.7% and 34.7% respectively I our Q1 2019 mainly due to Astellia's contribution. Following the quarter end, we also announced this morning a $4.9 million contract win with a major Tier 1 US service providers for a real-time activist topology solution that it helped them accelerate their network transformations. The effects of the software solution, mapped network resources both from their legacy and next-generation equipment with related services to provide a comprehensive view of service providers network inventory; basically our solutions assure service delivery to the end user thus significantly reducing the level of complexity for the network operations team, especially in the context of networks consolidation that this customer is going through. This high-margin $4.9 million deal is a good demonstration that EXFO's strategy to transition towards software and services-based solution is starting to work. We're expecting to secure additional business from this Tier 1 service provider in the future. Moving on to our strategic reorganization, we reported $2.7 million in pretax restructuring charges in the first quarter of 2019 and $7.3 million since the plan was announced in late August. Most of the remaining restructuring charges in our $8 million plans should be incurred in our second quarter of 2019 as we complete the transition, the knowledge transfer and the closure of two of our facilities. As previously communicated, we plan to benefit from $8 million in cost savings from our restructuring plan in our fiscal 2019 and $10.5 million in subsequent years. Now let me provide you with our guidance for second quarter 2019. We're forecasting sales between $70 million and $75 million for the reporting period extending from December 01, 2018 to February 28, 2019. Looking at the bottom line, IFRS net earnings are expected to range between $0.05 and $0.09 per share for the second quarter of 2019. Now IFRS net earnings include net expenses of $6 per share -- $0.06 per share and after-tax amortization of intangible assets, stock-based compensation cost, acquisition-related fair value adjustment of deferred revenue, after-tax restructuring charges and an anticipated foreign exchange gain. IFRS net earnings also include $0.03 per share for an after-tax gain of the disposal of the capital asset and $0.04 per share for a one-time deferred income tax recovery. Now Pierre will provide you with more information about these one-time item in his prepared comments. So at this point, I'll turn the call over to Pierre to cover our financials.

[Pierre Plamondon:]

Thank you. Sales increased 9.2% to $69.2 million in the first quarter of 2019 from $63.4 million in the first quarter of 2018. We increased our sales year-over-year, mainly due to the $7.5 million revenue recognition from Astellia. This was especially offset by a negative currency impact based on the stronger US dollar as we have some sale in Canadian dollars and euros, but report in U.S. dollars. We also add portion of orders that were backend loaded in the first quarter of '19 as demonstrated by our book-to-bill ratio of 1.17, which prevented us from completing some of them into revenue in the first quarter. Gross margin before depreciation and amortization, amounted to 58.2% of sales in the first quarter of 2019, compared to 63.2% in the first quarter of 2018. The decrease in our gross margin can be attributed to Astellia, which carries lower gross margin than our corporate average, due to higher proportion of sales coming from professional services. Our gross margin in Q1 '19 was also affected by a less favorable product mix compared to last year and $23 million in restructuring charges. In terms of operating expenses, selling and amortization expenses totaled $26.4 million or 38.4% of sales in the first quarter of 2019 compared to $23.2 million or 36.6% of sales in the same period last year. The $3.2 million increase in engineering expenses reflecting the Astellia acquisition, as well as some increase year-over-year and also restructuring charges of $0.3 million. Net R&D expenses reached $15.2 million or 22% of sales in the first quarter of '2019, compared to $11.2 million or 17.8% of sales in the same period last year. Likewise, the $4 million increase in net R&D expenses in mainly related to the Astellia acquisition and some increases year-over-year as well as restructuring charges of $2.1 in the first quarter 2019. On the other hand, SG&A and net R&D expenses, were positively affected by our recent restructuring plans, which estimate a saving of $1.2 million in the first quarter of 2019 as well as positive currency impact as the Canadian dollar and euro decreased compared to the US dollar year-over-year. IFRS net loss in the first quarter of 2018 totaled $7.5 million or $0.14 per share including $5.1 million for our newly acquired Astellia. In comparison, IFRS net earnings reached $2.7 million or $0.05 per share in the first quarter of 2018. IFRS net loss in the first quarter of 2019 included $2.5 million in after-tax amortization of intangible assets, $0.4 million in stock-based compensation cost, $2.7 million in after-tax restructuring charges, $0.9 million for acquisition-related fair value adjustment on deferred revenue and a foreign change gain of $0.2 million. Adjusted EBITDA amounted to $2.7 million or 2.9% of sales in the first quarter of 2019, compared to $6.1 million or 9.6% of sales in the first quarter of 2018. Geographically, the Americas accounted for 51% of total sales in Q1 '19, Middle East and Africa represented 33%, while Asia-Pacific totaled 16%. In comparison, the sales split was 52%, 22% and 24% among the three geographic region in the first quarter of 2018. In terms of customer mix, our first customer accounted for 9% of total sales in Q1 '19, while our top three, represented 19.6%. Turning to a few key points on the balance sheet. Our cash position increased to $20.1 at the end of Q1 '19 from $15 in the previous quarter. This $5 million increase is mainly due to the increase in our bank loan of $11.3 million in the first quarter of 2019. This cash amount was partially offset by $2.5 million of cash flow yields by operation, $2.9 million for the purchase of capital assets and $0.7 million for the repayment of long-term debt. At the end of Q1 '19, EXFO added a net debt position of $9.3 million and evitable revolving credit facility up to $40.6 million. To conclude my comments, it should be noted that EXFO is expected to one-time gain for the second quarter of 2019 that are included in the guidance provided by Philip. First, we have reached a binding agreement to share our Toronto business for net proceeds of $3.2 million. The transfer ownership is expected to occur in the second quarter of 2019 and would result in a pretax gain of $1.8 million in the same quarter in our earnings statement. Second, we expect to benefit from a deferred income tax recovery of $2.4 million in the second quarter based on fiscal reorganization in our business. This tax planning incentive is part of our overall reorganization plan announced last August. Finally, EXFO's Board of Directors has authorized a share repurchase program by way a normal share bid on the open market up 1.2 million of share within the next 12 months. At this point, I'll turn the call over to the operator for the start of the Q&A.

[Operator:]

[Operator Instructions] One first question will come from Thanos Moschopoulos from BMO Capital Markets.

[Thanos Moschopoulos:]

Hi. Good afternoon. Philippe, can you expand a little bit on what you're seeing in terms of the spending environment? It sounds like the environment is picking up from what you've seen last quarter, but last quarter there was a lot of discussion about how carriers were pausing virtualization deployments. Has some of that started to fill up now as evidenced by the deal you announced today? Or what are you seeing on that front?

[Philippe Morin:]

Yes, I think that the two main vectors of spend that remains what we've talked in the past of fiber deployment continues to be very strong and we've seen this with 100 gig on the test and measurement side for us, 100 gig orders that's gone really strongly and then you see it in the growth percentage and that we've highlighted. And the second is on the overall system side where we continue to see both fiber monitoring business going through maybe not as strong this quarter, but in terms of engagement and market -- future market spend and as well, where it continued to see our service providers transform their net network, whether it's on the OSS side, which is part of the announcements we made this morning with the Tier 1 or as well continuing to look at some of the especially now with thanks to our Astellia acquisition, RAN optimization and RAN geolocation. So we are starting to see a good pattern there. Again the same dynamic remains, Thanos. These deals are longer sales cycle. It takes longer to close and engage. So that's also the same dynamic though that we've seen in the past.

[Thanos Moschopoulos:]

Okay. And as far as the Tier 1 deal, what would be the delivery timeframe for a deal like that?

[Philippe Morin:]

Delivery on the alternative solution will happen obviously into our fiscal 2019. And as I mentioned, we are going to -- we're hoping that we're going to be also able to close further business with them as they continue to expand their network transformation.

[Thanos Moschopoulos:]

Okay. Last quarter you had disclosed the 2019 EBITDA target of $24 million. Where does that stand currently?

[Philippe Morin:]

Yeah, I think that based on our Q1 results, where we would have obviously liked to see a stronger EBITDA, but because of our gross margin, we get into that level. We're still confident that we are going to meet the guidance we've provided for the full year of $24 million.

[Thanos Moschopoulos:]

Okay. And just a question in terms of the Q2 guidance, what's the level of ForEx gain that you're assuming in the guidance?

[Pierre Plamondon:]

It's minimal about 100-K for FX gain or losses. It will be -- it's FX gain.

[Thanos Moschopoulos:]

Okay. All right, thanks a lot.

[Philippe Morin:]

Thank you.

[Operator:]

[Operator Instructions] Next, we'll take a question from Christian Sgro with Canaccord Genuity.

[Christian Sgro:]

Hi there. Thanks for taking my question. Just one from me, wanted to follow-up on the target set last quarter. Would you frame the gross margin targets of 59% to 61% for our fiscal 2019? Just wondering Q1 was a little bit short of this. Wondering if that's still the target or if we want to revise that?

[Pierre Plamondon:]

No, this is still the target. So Q1 was a bit less favorable for us. We still have to account for the mainly for the adjustment for the fair value of the deferred revenue that also impact the gross margin. So keeping the 59% to 61% as a target for fiscal '19 is still okay.

[Christian Sgro:]

Perfect. Glad to hear it. What have -- before here I'll ask one more quick question. With the two new product lines, the test and measurement and then the service assurance systems and services, just getting a head start in the modeling, could you guide to the margins loosely for those two segments? What we should be thinking about even comparatively between the two and then I'll leave it there, thank you?

[Pierre Plamondon:]

So I can answer that. The T&M business is closer to their physical business that we have, where the margin where more the 60% profile, we are adding the T&D business with a better margin. So this is probably around 65% margin profile on the T&M, while the system business is more software intensive and with a were much higher margin.

[Christian Sgro:]

Perfect. Thanks for taking my questions.

[Operator:]

Our next question will come from Justin Keywood with GMP Securities.

[Justin Keywood:]

Hi. Thanks for taking my call. On the working capital use in the quarter, it seemed a little high. Is that just normal seasonality there or was there anything unusual?

[Pierre Plamondon:]

It's mostly the reflection of some capping that has been there in Q1 as we have done some improvement in our main operation in Québec city, okay. So that's mostly the one-time item that are remaining for the year, the capital budget for the year and more in line with best practice that we went about for $4 million to $6 million per year for CapEx.

[Justin Keywood:]

Okay. And then sorry, what was the amount for that one-time item?

[Pierre Plamondon:]

This is including the amount that we have in the cash flow statement of $2.5 million that has been used for paying capital expense of the amount and the main portion of that is related to the building in Quebec city.

[Justin Keywood:]

Okay. Thank you. And then there is mention of some currency headwinds and in the quarter. Do you have the constant currency growth?

[Pierre Plamondon:]

The currency growth -- so in fact the Canadian dollar get weaker compared to the U.S. okay year-over-year. So that's created some headwind on the topline, but that creates benefit on the expense line.

[Justin Keywood:]

So overall I guess not much of a impact, is that fair to assume?

[Pierre Plamondon:]

Net, net, between the two, it's a wash I would say.

[Justin Keywood:]

Okay. All right. Thank you. And then on the revenue synergy goals between Astellia and the organic business, is this kind of backend weighted or how do you see that pointing out over the rest of the year?

[Philippe Morin:]

Yeah actually on the test and measurement family, we are starting also already to see the benefit of that because there is the shorter sales cycle. So their accounts as an example where Astellia had a strong presence and we've been now able to sell some of our fiber monitoring system or our portable test and measurement business. And so we're starting to see the benefit of that and this is reflection of the growth on the bookings that we've shown. On the system side, obviously that takes a bit more time and that will be more into our second half of our 2019 that we will start to see some impact there, but as I said, we've started seeing some cross-selling benefit of being the Astellia customers on Board.

[Justin Keywood:]

Okay. And then just given there is some seasonal weak, or at least there was some seasonal weakness, I think it was in Q3, Q4 last year, should -- is that a bit of a headwind to achieve these synergies in the back half of the year?

[Philippe Morin:]

You're right. If I look at the stat that we just had as I mentioned really happy with the bookings and the fact that we were at 1.17 book-to-bill ratio. We're building our backlog. It allows us to manage where I'll call the seasonal aspect of some of our quarters. So I do think that for the full year, the start that we've had here is really helping us to manage some of these peaks and troughs that we may have throughout the year. And then, which is going to key critical as we head into our second half of the year.

[Justin Keywood:]

Okay. I appreciate that. Thanks for taking my call.

[Philippe Morin:]

Thank you.

[Operator:]

[Operator Instructions] Our next question will come from Tim Savageaux with Northland Capital Markets.

[Tim Savageaux:]

Hi there and I apologize for the likely blare of CES in Las Vegas in the background. So I'll make it quick and jump back on mute. I want to focus in on and congrats on the strength in test and measurement book-to-bill. Philippe, I wonder if you could characterize that is your more traditional budget flush, I assume something you would probably didn't anticipate, if you could comment on that? And whether that's sort of seasonality of the type that we had seen in the past on and off or whether there is something secular on your part in terms of 100 gig product cycle market share or whatever that was also driving that strength, thanks.

[Philippe Morin:]

Yeah, so Tim thanks. Yeah three aspects of the good, strong bookings. One is as you said, we have seen a stronger than last year budget flush or year-end money on the test and measurement side, that's number one. Number two, we have seen now the impact of the Yenista acquisitions. So we have some strong performance around that portfolio as we now strengthen our go-to-market solution to go after that market segments, whether it's for the manufacturing or the components research in the lab. So that also benefited our overall performance. And the third one is 100 gig as you mentioned. That market continues to be really strong, driven by fiber deployment for people getting ready for 5G. Datacenters being built out and getting closer to the edge and our strong solution there on 100 gig, whereas getting a lot of momentum this quarter in particular. So those three aspects generated a nice growth that we've seen on bookings for our T&M.

[Tim Savageaux:]

Got it. Make sense. And if I could do one quick follow-up, was the budget flush aspect of what you saw across multiple US Tier 1 service providers are driven by one or two in particular?

[Philippe Morin:]

I'd say it's across the majority of the Tier 1.

[Tim Savageaux:]

Thanks And congrats again.

[Philippe Morin:]

Thank you, Tim.

[Operator:]

[Operator Instructions] That does conclude our Q&A session and at this time, I'd like to turn the conference over to Philippe Morin for closing remarks.

[Philippe Morin:]

All right. So thank you. Just a few key takeaways before we conclude this call today. So first, EXFO delivered a solid quarter in Q1 based on strong sales, but even better bookings that we just talk about. Our book-to0bill ratio of 1.17 really gives us conference for a stronger guidance for the second quarter, even though second quarter has historically been a more weaker quarter for us. Second, EXFO's reorganization plan remains on track with the acceleration for its progressing as expected, to strengthen our service assurance systems and services value proposition as we also expect most of the restructuring efforts to be completed in the second quarter of 2019 and as per plan. We intend to benefit from cost savings of $8 million in our fiscal 2019 and $10.5 million in the following year -- in the following years. Third, EXFO announced a $4.9 million contract win after the quarter end with a Tier 1 US service provider for our real-time active network topology solution. Now this contract win is a strong endorsement of EXFO's strategic transition to our higher margin software-based solutions provider. And finally, we will be holding our Annual General and Special Meeting on Wednesday, 09

[Operator:]

Once again, that does conclude our conference for today. Thank you for your participation.