EXFO Inc.
Q1 2018 Earnings Call Transcript

Published: 10 Jan 2018

[Operator:]

Good day and welcome to the EXFO's First Quarter Financial Results for Fiscal 2018 Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. 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 2018. 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 be available to answer questions during the Q&A period as well. 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-F 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 our IFRS results is available in the Q1 2018 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. Thank you, Vance, and good afternoon, everyone. I would like to take this opportunity to actually wish everyone a happy new year filled with health, success and happiness. So, now turning to our Q1 2018 financial results. EXFO delivered a solid quarter with strong execution across our sales, bookings, gross margins and earnings. Sales increased 2.6% year-over-year to $63.4 million and above the midpoint of our guidance range. And our adjusted EBITDA, $6.1 million or 9.6% of sales in our first quarter 2018. On the bookings side, we were also robust at $65.9 million for a book-to-bill ratio of 1.04 while our gross margin improved at 63.3%. In addition, we generated positive cash flow from operations at $2.4 million. So, as a result, most key indicators are pointing in the right direction. Now, let's focus on product line basis. Our physical-layer bookings increased by $4.3 million year-over-year, reflecting our strong position in the ongoing 100-gig investment cycle and our two months revenue contribution from Yenista Optics. The Yenista acquisition has not only complemented our existing optical portfolio with high-end test instruments for the lab and manufacturing markets, but it also has consolidated our number one position in the global fiber optic test equipment market. On the protocol-layer side, our bookings meanwhile were down $4.7 million year-on-year after a relatively strong fourth quarter, this decrease can be attributed to the timing and closing of large system deals and our annual maintenance contract renewals, and as well as the streamlining of our passive monitoring business that we did in the second half of 2017. Now in the first quarter of 2018 EXFO's overall success was largely predicated on taking advantage of the 100-gig optical investment cycle as fiber is being rolled out closer to the network edge, inside the data center, and more and more into subsea deployments. Our optical solutions for example resonated with large web scale operators through substantial deals for testing their data center interconnects while our fiber monitoring systems also enjoy continuing traction with our customers and communications service providers worldwide. On the innovation side, we have launched a new product that we call EX1, which is a multipurpose test solution for validating bandwidth speed up to full line rate Gigabit Ethernet. Now, the beauty of this open and scalable solution is that it can actually be used for a turn up of a service while being used as well and continue its monitoring for residential and business services which is obviously providing operational efficiencies to our customers. So, without surprise, fiber connectivity is one of the major investment cycles impacting the telecom industry today. The other driving -- the other driver quickly gathering steam is high-speed mobility as 4G will give soon -- give way to 5G. Already, fiber and small cell deployments are widespread to support upcoming 5G rollouts. I view fiber connectivity and high-speed mobility as two overlapping drivers for fiber deployment moving from 10-gig to 100-gig and now 400-gig over the next five years while high-speed mobility investment will repickup in 2018 as 5G standards are fully ratified and test trials begin in earnest. So looking ahead, both of these drivers will require significant capital investment on the part of our communication service provider customers and as well our web scale operators’ customers in order to build high-speed, low latency network infrastructures of tomorrow. The good news is that EXFO is well-positioned for these dual investment cycles, both organically as the number one player globally in optical testing and now through the recent acquisitions of Absolute Analysis, Ontology Systems, Yenista Optics and as well as the pending Astellia transaction. The Astellia deal is particularly important for EXFO to gain a much stronger position in the fixed wireless broadband and high-speed mobility cycles. Now, speaking of Astellia, Pierre will provide you with an update on our public tender offer for Astellia’s remaining shares. For my part, I can tell you that EXFO will be diligently preparing a structured integration plan in order to fully leverage the complementary technologies and customer bases of both companies to increase our scale and our market position. Let’s focus now on 2Q 2018 guidance, which is typically marked by seasonality due to the holiday season and usual delays in CapEx budget approvals. We’re forecasting sales between $59 million and $64 million for the reporting period extending from December 1, 2017 to February 28, 2018. Looking at the bottom-line, IFRS net loss is expected to range between minus $0.08 per share to minus $0.04 per share for the second quarter of 2018. IFRS net loss includes $0.02 per share in after-tax amortization of intangible assets of intangible assets and as well as stock-based compensation costs, but also $0.02 per share for an anticipated foreign exchange loss due to the recent strength of the Canadian dollar. We are also expecting exceptional one-time items in the second quarter of 2018, namely, a $0.03 per share for the acquisition expenses related to the Astellia deal and a $0.03 per share to account for the effects of the new U.S. tax reform on EXFO's deferred U.S. tax assets. It should also be noted that this guidance excludes the financial impact of the pending Astellia acquisition on our sales and IFRS results for the second quarter. So, at this point, I would like to turn the call over to Pierre to discuss our financials.

[Pierre Plamondon:]

Thank you, Philippe. Good afternoon, everybody. Sales increased 2.6% to $63.4 million in the first quarter of 2018, from $61.8 million in the first quarter of 2017, and were relatively flat compared to $63 million in the fourth quarter of 2017. As Philippe mentioned, we increased our sales year-over-year by taking advantage of 100-gig investment cycle and recently revenue contribution from recently acquired Yenista Optics procurement as well as Ontology Systems. We also benefited from a decrease in the average value of the U.S. dollars, our reporting currency, against all the currencies in the first quarter of 2018 compared to Q1 2017. On the other hand, large sale of copper testing solutions which are characterized by irregular [ph] large orders and streamlining our passive monitoring product line negatively affected our regular sales. Overall, both our physical and protocol-layer families delivered a slight increase in sales year-over-year. Gross margin improved to 63.3% of sales in the first quarter of 2018 from 63.1% in the first quarter of 2017 and 61.9% in the fourth quarter 2017. On a year-over-year basis, our gross margin strength increased due to a more favorable product use. In terms of operating expenses, selling and administrative expenses totaled $23.2 million or 36.6% of sales in the first quarter of 2018, compared to $21.6 million or 35% of sales in the same period last year and $20.8 million or 33.1% of sales in the fourth quarter of 2017. The increase in SG&A dollars year-over-year can be attributed to expenses from the Yenista Optics and Ontology acquisition, inflation and salary increases as well as $0.8 million related to the Yenista Optics and Astellia transactions. In addition, the decrease in the average value of the U.S. dollar, our reporting currency against other currencies, in the first quarter 2018 compared to Q1 2017, negatively affected our expenses level. Net R&D expenses reached $11.3 million or 17.8% of sales in the first quarter 2018 compared to $11.3 million or 18.3% of sales in the same period last year, and $11.3 million or 17.9% of sales in the fourth quarter of 2017. Net R&D dollar was flat year-over-year despite headcount [ph] and related R&D expenses from Yenista Optics and Ontology acquisitions, as well as inflation and salary increases. Like our SG&A expenses, the strength of the Canadian dollar and euro, compared to the U.S. dollar year-over-year increased also our net R&D expenses. These expenses however were reduced by our restructuring plan implemented last May. IFRS net earnings in the first quarter 2018 totaled $2.7 million or $0.05 per diluted share, compared to $3.3 million or $0.06 per diluted share in the same period last year and $0.8 million or $0.02 per diluted share in the fourth quarter of 2017. IFRS net earnings in the first quarter of 2018 included $0.9 million in after-tax amortization of intangible assets, $0.4 million in stock-based compensation costs, $0.2 million in the positive change in the fair value of the cash contingent consideration related to the Ontology acquisition and a foreign exchange gain of $1.2 million. As previously mentioned, we also incurred M&A expenses of $0.8 million in the first quarter of 2018. Adjusted EBITDA amounted to $6.1 million or 9.6% of sales in the first quarter of 2018 compared to $6.2 million or 10.2% of sales in the first quarter of 2017 and $8.5 million or 13.6% of sales in the fourth quarter of 2017. Geographically, the Americans accounted for 53% of total sales in Q1 2018; Europe, Middle East, Africa represented 23%, while Asia Pacific totaled 24%. In comparison, the sales split worth 56%, 23% and 21% among the three geographic regions in the first quarter of 2017. In terms of customer mix, our top customer accounted for 13.8% of total sales in Q1 2018 while our top three customers represented 21.6%. Turning to a few key points on the balance sheet. Our cash position decreased by $19.5 million at the end of Q1 2017 from $39.2 million in the previous quarter. This $19.8 million decrease is mainly due to the $10.3 million in cash paid for the 33.1% stake in Astellia, $9.5 million for the accretion of Yenista Optics and $2 million for depreciation of capital asset. These cash amounts were partially offset by $2.4 million in cash flow from operations in the first quarter of 2018. It should be noted that EXFO has now replaced its existing credit lines for operations by new revolving credit facility up to C$70 million and $9 million, which amounts for a total of approximately $63.3 million. This new credit facility would be used to finance the accretion of Astellia remaining equity, working capital and general corporate needs. Our tender offer intended to acquire the remaining share of Astellia was officially launched on December 15 and will be open for days of 25 trading days through January 23rd 2018. Given Astellia is a public company listed on the Euronext Growth market, the latest and only publicly available information [ph] is dated June 30, 2017. Therefore, based on previous year available information, we determine that EXFO share in profit or loss of Astellia for the quarter ended November 30, 2017 was nominal and the equity net income is nil [ph] of that period. Assuming a successful tender offer by the end of January, EXFO will gain access on that day to Astellia financial information and we will account for Astellia operations in our Q2 2018 financial statement as follows. First, we will make adjustment if any to EXFO share of Astellia profit or loss for the period from September 8, 2017 to the November 30, 2017, which has been estimated a nil in our Q1 results. Second, EXFO share of Astellia profit or loss for the period December 1 to the announcement date of the tender offer results will be accounted in our Q2 results. Finally, on the announcement date of the public tender offer results and assuming that EXFO acquires more than 50% of total shares, Astellia financial results will be consolidated from that date with EXFO financial statement until the end of our second quarter on February 28, 2018. Since at this date it is impossible to estimate the impact of such financial information today, this is not reflected in our Q2 guidance as Philippe mentioned. At this point, I will turn the call over to the operator for the start of the Q&A.

[Operator:]

Thank you. [Operator Instructions] And we'll take our first question today from Thanos Moschopoulos with BMO Capital Markets.

[Thanos Moschopoulos:]

Hi. Good afternoon. Maybe I'll start with a couple for Pierre. Firstly, could you clarify what the year-over-year contribution to revenue was from the recent acquisitions?

[Pierre Plamondon:]

I have the information for Yenista. Yenista contributed $1.4 million -- $1.4 million in sales from Yenista in the first quarter for two months.

[Thanos Moschopoulos:]

Okay. Would you be able to clarify for Ontology and Absolute Analysis year-over-year?

[Pierre Plamondon:]

Those numbers have been blended with the other numbers and we don't have that information readily available.

[Thanos Moschopoulos:]

Fair enough. As far as the tax rate was higher this quarter, can you clarify what drove that? And then, as we look forward with the impact of U.S. tax reform, what tax rate should we model, going forward?

[Pierre Plamondon:]

This is a good question. As you know, we still have some uncertainty [ph] at last, where we cannot recognize any different revenues. So, probably our tax will continue to vary depending where we are making our profit. So, it's very difficult to forecast. But in our model, we have forecasted tax expense about between $2.5 million and $3.5 million of income tax expenses.

[Thanos Moschopoulos:]

Sorry, that's for the upcoming quarter?

[Pierre Plamondon:]

Yes.

[Thanos Moschopoulos:]

For different quarter. Okay, that's helpful. And then, for Philippe, you made some commentary regarding the current state of the end markets, maybe if you could expand a little in terms of what you're seeing, any hearing from your clients with respect to CapEx budgets for this year? I understand, it's obviously very early in the year, but at a preliminary basis, what kind of commentary you’re hearing from your clients with respect to what their budgets might look like this year?

[Philippe Morin:]

Yes. Thanos, I guess, the feedback we're getting obviously from our customers is they continue to see the needs to do the fiber deployments whether it's driven by -- driving 100-gig closer to the edge and to the metro, bringing fiber-to-the-home, to the antennas and also getting ready from a -- as I said earlier from a high-speed mobility 5G deployment with more small cells being deployed and then fiber all the way up to the top of the antenna. That trend continues. We are seeing that to continue from a 2018 point of view. For me, the question will be on the mix, how quickly do they start allocating CapEx to 5G mobility, what I call 5G network increase -- network infrastructure increase on the radio side. You are starting to see some of the standards being -- obviously the March 3GPP standard will be a key this year in 2018. So that will also be interesting to see what will be the impact in terms of the network upgrades and network infrastructure upgrades in mobility side.

[Thanos Moschopoulos:]

Okay. I know that better penetration of the Tier 1s has been a big focus for EXFO. Can you provide an update on that front? I mean, looking at the percentage of revenue from the top three customers, you can use strong number. So, would that imply that you are getting further traction on the Tier 1s?

[Philippe Morin:]

Yes. So, I think the strategy for us to continue to focus on our top 20 accounts has continued to be paying some good results this quarter. Our top customer accounted for 13.8%. So that’s a bit of an increase based on the previous quarter and our top three now represented 21.6%. So, that’s continuing to be a main focus for us. We do feel that strength in our account relationship with them especially as they go through these network transformations is important. So, as you know, we’ve dedicated a go-to-market strategy, dedicated resources to go after these particular accounts, and we are continuing to see positive return on that investment and that strategy.

[Thanos Moschopoulos:]

Great. And then, may be just one last one for Pierre. Just given the recent acquisitions, is there any change to your gross margin outlook or should it remain kind of consistent with your historical guidance on that that front?

[Pierre Plamondon:]

We remain comfortable with we are going to end the rate given for our gross margin going forward. So, again, if the [indiscernible] will continue to drive -- that our margin will be within the range that we had given at that time.

[Philippe Morin:]

And the range was 62 to 64.

[Operator:]

Next, we will hear from Richard Tse with National Bank Financial.

[Unidentified Analyst:]

Thanks. It’s actually Steven [ph] in for Rich. I was wondering if you could provide any color from a geographic perspective. I think I remember last quarter there was some softness in China relating to like 5G deployments. I was wondering if you could provide an update on that.

[Philippe Morin:]

So, what you saw from our split by geography, you saw that good performance out of Americas and a softer performance on Asia Pac. And again, we saw a similar softness that we had mentioned in our Q4. And if you remember, we also mentioned that we expected that to happen -- continue to be fairly softened for the first half of our fiscal year. So, yes, and then -- so that’s on the booking side is what I just provided an update. So, we do see China continue to be a bit of a challenge. Although we’ll have to see how quickly now that we are getting into the New Year. You got the holiday period that can also create a bit of a seasonality. But, I think it will be interesting to see if we are going to start seeing a pickup in that particular region. But Americas per se continues to be performing really well and that's where you're seeing a lot of the fiber deployment obviously being fairly -- being strong and because of our number one position in optical fiber deployment solutions, we're obviously getting the benefit of that.

[Unidentified Analyst:]

So, I was wondering if you could provide the FX impact on EBITDA margin. I know you mentioned FX had a benefit on the top line, but it had a headwind for your expenses. So, what was the net impact of that on your EBITDA margin?

[Pierre Plamondon:]

On year-over-year you mean or sequentially?

[Unidentified Analyst:]

Year-over-year.

[Pierre Plamondon:]

Year-over-year, so on the top line that has a positive impact of $1.4 million in sales. So that increased our sales, okay. On the OpEx side, that had OpEx by $1.2 million. So, net-net on the results, it’s about 200k, but it's [indiscernible] impact. Because the average rate in U.S. last quarter or this quarter was 1.25, 1.41 [ph] and last year Q1 2017 it was 1.32, 1.52, [ph] so a big gap between the strength -- or the weakness of the Canadian dollar.

[Operator:]

Our next question comes from Justin Keywood with GMP Securities.

[Justin Keywood:]

Just on the Astellia acquisition, I am wondering is the -- the benefits are going to come more from scale or is there significant cross selling opportunities, just given geographic diversity of the customers?

[Philippe Morin:]

So, I'll let Germain answer that question.

[Germain Lamonde:]

Excellent question, Justin. Thanks for the interest. I think it's a very interesting acquisition. Here, there's multiple aspects to it. We will not get into all the details until this deal is completed. But we talked openly about the fact that there is synergies in terms of scale. We believe basically it's going to give -- some of its organization when we look at the systems business to be more scale and to be amongst the top in the world basically within that industry in a way. And second, we think the confirmatory nature of the offering, the fact that our respective customer base are in both sides of the Americas and the EMEA markets will also provide additional cross-selling synergies. So, we think that's a -- once we can complete this acquisition, we're going to complete integration plan, and we are going to drive basically we believe additional shareholder value on that front.

[Justin Keywood:]

And just as a reminder, there's not many duplications of customers between…

[Germain Lamonde:]

Almost none, not at this point. Yes.

[Justin Keywood:]

And then, just on protocol bookings, you mentioned that there's some timing issues in closing these deals. Should we expect a rebound in Q2 or is that maybe a bit too soon and is this going to play out maybe a bit later in the year?

[Philippe Morin:]

Yes. As I mentioned, there's a few factors that played into if you compare ourselves to Q4 and then also in Q1. I do think that some of the maintenance contract and timing associated with it that has come in into Q2 Justin. So, part of it was timing, as you know, some of -- lot of our customers are booking some of these maintenance contracts as the calendar year end, and that's where we saw the timing coming into play.

[Justin Keywood:]

And then, just one final one, I am wondering if there's any update on annual EBITDA expectations for 2018, I think it was $26 million as of last quarter.

[Philippe Morin:]

So, we've -- as exactly you said, Justin, we guided to 26 million and as after Q1, I would say we are continuing to guide to that $26 million for the full year.

[Operator:]

[Operator Instructions] We will now hear from Tim Savageaux with Northland Capital Markets.

[Tim Savageaux:]

I wanted to focus on the booking strength in physical-layer with the 1.14, book to bill. And I imagine there was that acquisition contribution on the booking side as well. I don’t know if that meaningfully impacted book to bill. But, in general, I think you mentioned cloud and it does look like your top customer had a pretty substantial uptake in the quarter, at least sequentially. So, I wonder if you could maybe a dig a little deeper into either Tier 1 or cloud divers of booking strength on the physical-layer side. And I suppose I will ask my quarterly question about may be estimating, if you will, how significant the cloud operators are becoming as a group for EXFO from a customer standpoint, any metrics around that or free to estimate?

[Philippe Morin:]

So, Tim, on your first question around that the growth that we've seen in the bookings with regards to the physical aspect of the business. The main contributing factor continues, as I said. So, fiber deployment, 100-gig being deployed more and more into, as I said the metro, [ph] inside the data center interconnect, that continues to also have a good impact for us. And then you get, one of the aspects, I think, Tim we’ve mentioned to you last time, the fiber monitoring business continues to get good traction in the market and we saw a good benefit -- good impact of that in our physical business with the fiber monitoring product that we've got. So, that’s continuing. I think it's just the reflection, as you highlighted, of where fiber is being deployed and what solutions are being deployed and therefore we're leveraging the strong position we have in the market for those solutions. With regards to the cloud operators or what we actually talked about in our statements, the web scale operators, it continues to be a strong growth market segment for us. Obviously they start from a lower percentage because of the fact that we tend to [indiscernible] mainly to the service providers but we do sell to the top five web scale vendors and we’re selling them solutions for their data center interconnect. We're also getting involved with them in some of their subsea deployments and that continues to be an important market growth for us as we’re continuing to get traction with them.

[Tim Savageaux:]

Okay. And I guess quickly on that, any commentary around cable TV MSOs as vertical driver of fiber deployment or business for EXFO?

[Philippe Morin:]

The MSO market, obviously, especially in North America, Tim, is a good market segment for us and they are deploying a lot of fiber. So, every time you see any announcements from these, the Charter, the Comcast, the Roger, they are talking about fiber deployment and fiber deep programs; that’s also a good contributor for our physical business. And that's partially some of the reaction that you saw in the growth in our Q1 business.

[Tim Savageaux:]

Great. And as we look forward in terms of your Q2 guidance, I guess, is there anything -- obviously you saw -- I guess your bookings have been bouncing around some volatility on both sides of the business. So, over the last quarter in the phase system, kind of weaker fiber bookings, physical-layer bookings, you're nonetheless pretty confident about the continued growth of that business. And we've seen that kind of reflected in this quarter's booking results. Any similar commentary with regard to protocol or fiber or any expected change in mix, as you are looking into Q2 whether that has a gross margin impact or any other impact as you swung back during this quarter to pretty physical-layer centric mix, do you expect that to change markedly in Q2?

[Philippe Morin:]

Q2, as you know, there is a seasonality aspect to that quarter being the month of December – November, December and January. And that tends to -- and as well being the calendar year for a lot of our customer base. So, I do think that you look at that and that tends to create a bit of fluctuations on our physical business, as you know it's pretty quick turnaround, Q2 tends to be a quarter that's a bit more difficult for the physical while on protocol you tend to benefit because of the calendar year for maintenance contract renewals on the booking side as well. So, they tend to even know that at the full year, but I think as you understand, Tim, we do have a bit of a seasonality aspect especially with Q2.

[Tim Savageaux:]

Got it. And last question for me and this is on the operating expense front. I don't -- seems like you did quantify the acquisition impact. I don't know if I -- on SG&A, I'm not sure if I heard you quantify currency. But it seems that some of the leverage you've been looking for even considering acquisitions on the operating expense side has been relatively illusive. That number seems kind of stuck in the high-30% range. I'm wondering if you could talk -- and this is a Astellia acquisition notwithstanding about the kind of trajectory for SG&A expenses in particular or maybe OpEx overall that you expect for the year.

[Philippe Morin:]

Yes. And again at a high level, Tim, as you know, when we made the announcements around our passive restructuring order where we're seeing that from a 2018 we were going to be looking at about $8 million of overall savings across all OpEx. And when you look at -- and part of our strategy is also leveraging acquisitions. So, bringing in Yenista, Ontology and the FX impact that's kind of evened out in Q1, in particular evened the savings that we're getting, but it allowed us to do two acquisitions that allowed us to obviously bring that into our books. I do think that from an SG&A in particular, I think you're aware that we've -- we're on our second year of our go-to-market transformation. We're bringing more focus on top-20 more focus on our partners and we're doing this without increasing really the envelope of existing SG&A envelope that we add. Obviously with the acquisitions, we do add a bit of that. And I do expect that as we continue to get the leverage of that strategy that we'll get a better percentage to revenue, obviously not counting Astellia, but we should get an improvement on percentage of revenue around our SG&A envelope.

[Operator:]

That will conclude today’s question-and-answer session. I will now turn the conference over to Philippe Morin for any additional or closing comments.

[Philippe Morin:]

So, thank you. And just a few key takeaways to conclude this call today. First of all, EXFO delivered a solid quarter Q1 2018. Again, as I mentioned, strong execution on our sales, bookings, gross margins and earnings. Second, EXFO has strategically positioned itself for the fiber connectivity and high-speed mobility cycles through our organic investment and as well from now our acquisitions. And third, EXFO will be diligently preparing an integration plan in order to fully leverage the complementary technologies in customer bases of Astellia and EXFO, once the acquisition of Astellia closes. And finally, I would like to remind you that EXFO will be holding its Annual General and Special Meeting session on Monday 9

[Vance Oliver:]

Wednesday.

[Philippe Morin:]

Wednesday, sorry, Wednesday, tomorrow, at the Vantage Venues, Caledonia Room on the 27th floor, located at 150 King Street West in Toronto. Obviously both shareholders and analysts are welcome to attend. And with this, we conclude our Q1 2018 conference call. On behalf of the entire EXFO team, thank you for joining us today.

[Operator:]

That does conclude today’s conference call. Thank you for your participation. You may now disconnect.