EXFO Inc.
Q2 2018 Earnings Call Transcript

Published: 11 Apr 2018

[Operator:]

Good day, everyone, and welcome to EXFO's Second Quarter Financial Results for Fiscal 2018 Conference Call. At this time, I would like to turn the call over to Vance Oliver. Please go ahead.

[Vance Oliver:]

Good afternoon, and welcome to EXFO's Second 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 also be available to answer questions during the Q&A period. A reminder that this conference call will include certain forward-looking statements and are 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 the 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 our IFRS numbers is available in the Q2 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. Thanks, Vance, and good afternoon, everyone. EXFO made significant progress against its long-term growth strategy during the second quarter of 2018 based on its solid performance from our Physical-layer product line and strength in position from the upcoming 5G wireless investment cycle with the closing of the Astellia acquisition. We delivered robust sales, solid sales of $64.7 million, up 7.8% year-on-year on the strength of our leadership position in optical testing and revenue contributions from our recent acquisitions, including $1.8 million from Astellia's for one month. The results were more striking on the bookings front, with orders of up to 17.3% year-on-year to $65.6 million, which includes a $2.5 million contribution from Astellia. Now in terms of the bottom line, net loss attributable to the parent interest totaled $4.7 million in the second quarter, including an Astellia negative impact of $2.7 million. As previously indicated in our guidance for Q2 2018, there were also one-time events, such as acquisition-related costs of $1.5 million and income tax expenses of $1.5 million due to account for the recent U.S. tax reform that affected our profitability. Now on the other hand, I'm pleased we generated $6.3 million in cash flows from operations in the second quarter, which I consider a good start to replenish our cash position after the Astellia acquisition. Now if you recall, EXFO achieved majority control of Astellia on January 26, 2018, and then 100% ownership one month later following a successful public tender offer. The total cash conservation amounted to $32.1 million or 0.7x sales for Astellia, which are a global leader in performance analysis of mobile networks and subscriber experience. Clearly, Astellia represents a transformative acquisition for EXFO. So allow me to outline the rationale of the transaction, the deal synergies and also the financial implications. So let's start with the rationale of the deal. First, we acquired Astellia because it brings significant scale to EXFO with IFRS revenues of $45.7 million in calendar 2017, 120-plus customers, largely in Europe, Middle East and Africa and then 400 employees mostly in France and Spain. With this acquisition, EXFO will be in a better position to absorb selling cost and leverage incremental R&D capabilities across the organization. Second. Astellia's monitoring offering, customer base and end market focus are highly complementary to EXFO, with very to little no overlap in terms of technology – in technology portfolio, customer footprint or geography concentration. Astellia's monitoring platform is fundamentally customer centric, bolstered by a rich subscriber analytics while our platform, EXFO's platform, is much more focused on network and service performance. As I said earlier, Astellia's customer base is mainly located in EMEA, while EXFO's monitoring customers are mostly based in the Americas and, to a lesser extent, Asia Pacific. Therefore, a highly complementary deal. Third, the timing of the acquisition is ideal as it best positions EXFO from the upcoming 5G investment cycle with standalone 5G new radio standards that are being ratified in 2018 and we view commercial deployment beginning in 2019. Now today's Astellia provides solutions for 3G and 4G/LTE wireless networks, which still are seeing significant investments globally. They also offer solutions for future 5G architectures that will be largely virtualized for cloud-based services. In fact, Astellia's monitoring solution supports both physical and virtualized architectures as reflected by one of the most important deals that took place in 2017 with a multimillion dollar deal with Three UK that took place in October. Three UK which carries almost 40% of mobile data traffic in the United Kingdom was searching for a monitoring solution allowing them to fully virtualize their traditional network, using NFV and SDN along with cloud technologies. Astellia's virtualized monitoring solution checked all the boxes on Three UK's list of criteria, its software-based probes are monitoring traffic across Three UK's network, raising alarms for performance degradation and troubleshooting persistent issues. As a result, Astellia's virtualized monitoring solution enables Three UK to improve network performance and customer experience within a more agile, more cost-effective network architecture. Clearly, Three UK's cloud-based monitoring capabilities with very specific-related subscriber analytics represents a big reason – another key reason why we acquired Astellia. Turning to deal synergies now. We will definitely benefit from increased sales volume from Astellia, but the aim is to make the whole greater than the sum of the parts. First, we intend to maximize cross-selling opportunities across the combined organizations. We already merged our global sales team in March, and we fully expect to leverage our combined base of 250-plus customers worldwide. We will be offering them a wealth of technology solutions, including active and passive service assurance for mobile network, but along with our fiber and RF monitoring solutions like SkyRAN and our market-leading optical test solution. Already an Astellia's sales person at a facility of $0.5 million deal for an EXFO optical test solutions in the third quarter of 2018. Our second major synergy consists of combining our respective active and passive technology platforms. We're in the final planning stages of this joint integration effort which will provide mobile network operators with real-time network and customer-centric monitoring capability, all enriched with big data analytics. As a result, end users, whether from field operations, network or service operation centers, customer or marketing – customer care or marketing teams will be able to mine, correlate information from various data sources to better manage and better troubleshoot their next-generation networks. This highly differentiated value proposition from EXFO to our customers will consist of a comprehensive monitoring solution covering critical use cases like root cause analysis and quality of subscriber experience. In addition, it will also leverage cross-domain topology visibility from Ontology Systems that we acquired last year. And in the words of Analysys Mason's analyst, Anil Rao, the acquisition, as he said, "the acquisitions of Astellia and Ontology now plays places EXFO in the major league of players in assurance market to solve the real-world problems of today." Third, we plan to extend Astellia's professional services offering across EXFO's global customer base, providing several value-added services like system installations, network audits, software support and consultation work. Altogether, services revenue account for more than 50% of total revenue at Astellia. Consequently, this represents an additional revenue stream, summing the – of recurring annual maintenance contract that the combined organization intends to leverage. Now moving onto the financial implications. These identified synergies are highly attractive for EXFO but we are facing a short-term seasonal impact as Astellia before fully monetizing synergies. Astellia is a very – historically generated higher sales in the second half of their calendar year. As an example, in 2017, it reached almost 60% of their total revenue in the second half. Consequently, this will affect EXFO sales and profitability of the next couple of quarters and necessarily impact our adjusted EBITDA target for fiscal 2018. EXFO had been on a track to achieve its $26 million adjusted EBITDA goal prior to the acquisition. But based on Astellia's expected sales over the next two quarters and the relatively fixed cost structure, we're now forecasting $22 million in adjusted EBITDA for the combined company in our fiscal 2018. Now Astellia's management acted responsibly by reducing their operating expenses in the second half of calendar 2017. These restructuring efforts, combined with increased sales volume allowed them to lower their IFRS net loss from $7.2 million for their first half of 2017 to $1 million in the second half. So looking ahead, we expect that the additional sales volume, the cross-selling opportunities, the efficiencies and as well as the complementary technology and services offering that Astellia brings, it will contribute to earnings growth in our fiscal 2019. More specifically, we anticipate that these synergies should allow EXFO to return to profitable growth mode and generate at least $30 million in adjusted EBITDA in our fiscal 2019. So finally, let me provide you with our guidance for Q3 2018, which will include a full three months contribution from Astellia. We are forecasting IFRS sales between $68 million and $73 million for the reporting period extending from March 1, 2018, to May 31, 2018. It should be noted that we anticipate IFRS sales will be reduced by $0.9 million to account for the acquisition-related fair value adjustment of deferred revenue. Looking at the bottom line, IFRS net loss is expected to range from $0.19 to $0.15 per share for the third quarter of 2018. IFRS net loss includes a $0.09 per share in after-tax amortization of intangible assets and stock-based compensation costs. So at this point, I will turn the call over to Pierre, so he can discuss financials in more detail.

[Pierre Plamondon:]

Thank you, Philippe. Sales increased 7.8% to $64.7 million in the second quarter 2018 from $60 million in the second quarter 2017. Astellia, which acquired majority control during the second quarter of 2018 contributed $1.8 million in sales for one month. Astellia sales were also reduced by $0.3 million to account for the fair value adjustment of deferred revenues. As Philippe mentioned, we increased our sales year-over-year due to our ongoing leadership in optical testing, revenue contribution from Astellia, Yenista and Ontology as well as the positive impact of the decrease in the average value of the U.S. dollars compared to other currencies. Gross margin before depreciation and amortization reached 60.9% of sales in the second quarter 2018 compared to 61.7% in the second quarter 2017. The decrease in gross margin can be mainly attributed to an unfavorable product mix with higher sales of Physical-layer solutions. Astellia also negatively affected our gross margin by 0.7% in the second quarter 2018. Given the Astellia acquisition, we are now expecting a gross margin between 61% and 62% for fiscal 2018. In terms of operating expenses, selling and amortization expenses totaled $24.9 million or 38.5% of sales in the second quarter 2018 compared to $21.3 million or 35.4% of sales in the same period last year. The year-over-year increase in SG&A is largely due to actual expenses related to Astellia for one month as well as three-month contribution from Yenista and Ontology and M&A-related costs. In addition, the decrease in the average value of the U.S. dollars compared to other currency has also a negative impact on our total SG&A expenses. Following the Astellia acquisition, we are expecting SG&A expense to range between 34% and 36% of sales for fiscal 2018. Net R&D expenses amounted to $13.1 million or 20.2% of sales in the second quarter 2018 compared to $11.3 million or 18.8% of sales in the same period in 2017. Likewise, the increase in net R&D expenses year-over-year can be explained by one-month contribution of Astellia and the full three months from Yenista and Ontology. Also given the Astellia acquisition, we are now expecting our net R&D expenses to remain between 18% and 20% of sales for fiscal 2018. IFRS net loss attributable to the parent interest in the second quarter 2018 totaled $4.7 million or minus $0.08 per share compared to net earnings of $1 million or $0.02 per share in the same period last year. EXFO's share of Astellia net loss amounted to $2.7 million for one month in the second quarter 2018, including one year in amortization of intangible assets. IFRS net loss attributable to the parent interest in the second quarter 2018 included $2.7 million in after-tax amortization of intangible assets, $0.4 million in stock-based compensation costs, $0.6 million for the positive change in fair value of the cash contingent consideration related to Ontology, $1.5 million in after-tax acquisition costs related to Astellia, $0.3 million for the acquisition-related fair value adjustment of deferred revenue and finally, $1.5 million in actual income tax expenses to account for the effects of the recent U.S. tax reform. Adjusted EBITDA totaled $2.5 million or 3.9% of sales in the second quarter 2018 compared to $4.9 million or 8.1% of sales in the second quarter of 2017. Astellia negatively affected adjusted EBITDA by $1.3 million for one month in the second quarter '18. In addition, adjusted EBITDA in the second quarter of 2018 include acquisition-related costs of $1.4 million. Geographically, the Americas accounted for 49% of total sales in Q2 '18, Europe, Middle East and Africa represented 33%, while Asia Pacific totaled 18%. In comparison, the sales split was 50%, 29% and 21% among the three geographic regions in the third quarter of 2017. The year-over-year increase in EMEA sales is mainly due to the revenue contribution from Astellia. In terms of customer mix, our top customer accounted for 9.6% of total sales in Q2 '18 while our top three represented 16.9%. Turning to a few key points on the balance sheet. Our cash position decreased to $13.6 million at the end of Q2 '18 from $19.5 million in the previous quarter. This $5.9 million decrease is mainly due to $11.8 million in cash paid for the Astellia share under the public tender offer, $2.3 million for the purchase of capital assets and $0.2 million for the repayment of long-term debt. This cash amount were partially offset by $6.2 million in cash flow from operation and a bank loan of $2.1 million in the second quarter of 2018. Our cash position of $13.6 million combined with available revolving credit facility will be sufficient to meet liquidity and capital requirements for the foreseeable future. At this time, I will turn the call over to the operator for the start of the Q&A.

[Operator:]

[Operator Instructions]. We'll take our first question from Thanos Moschopoulos from BMO Capital Markets.

[Thanos Moschopoulos:]

Hi, good afternoon. Maybe just a point of clarification. Philippe, did you say that you were targeting $30 million of EBITDA in 2019? Did I hear that correctly?

[Philippe Morin:]

That's correct. Yes.

[Thanos Moschopoulos:]

Okay. And I realize you're only providing guidance for the upcoming quarter and then the longer-term target. But as we think about modeling Astellia, clearly, there's some volatility in the revenues. I appreciate your commentary about the stronger second half in the calendar year. But overall, as we look out at calendar '18 versus calendar '17, what can you say qualitatively or quantitatively about the type of growth you're expecting in the business?

[Philippe Morin:]

Yes, I think, Thanos, when you look at the planning, the financial planning of bringing in Astellia, the seasonality as you highlighted is obviously a key aspect of helping us try and predict the business. They are very back ended, as you mentioned, in the calendar year. They've made some right decisions in terms of where they're targeting with regards to their cost structures in to their second half of 2017. And when you look at it, our Q3 and Q4 is effectively almost into their first-half equivalent to calendar year. But we do expect as we work with them that the overall calendar 2017, if you look at their performance, that we will be able to manage and work with them on bringing the seasonality to a better profile as we head into 2018. So again, the challenge for me is how do we integrate the company which we've now done already in some aspects with, as I mentioned, we brought the sales together. And really get to a point where we can start getting a better predictability and then less seasonality into their overall performance as we go into our 2019 fiscal year.

[Thanos Moschopoulos:]

But maybe I'll ask the question a different way. If you think about the upcoming quarter, what kind of growth are you assuming in the Astellia business relative to what they would have reported last year?

[Philippe Morin:]

Yes. So what we have assumed into our Q3 number is Astellia's going to contribute $8 million in the guidance that we've provided, Thanos, in Q3.

[Thanos Moschopoulos:]

Okay. That's helpful. And then a couple of questions on the financial side. Is there any ForEx gain or loss assumed in the Q3 guidance?

[Pierre Plamondon:]

Not really because the current rate is almost flat. So the loss or the gain is minimal in the guidance.

[Thanos Moschopoulos:]

Okay. And then what tax rate should we be modeling for 2018?

[Pierre Plamondon:]

This is a good question because the Astellia is bringing losses that we cannot recognize as well, so it won't help very much on that. So on the guidance, you can assume a tax charge between probably $0.5 million to $1.2 million from the...

[Thanos Moschopoulos:]

Sorry, that would be on a full year basis?

[Pierre Plamondon:]

This is for Q3. Okay?

[Thanos Moschopoulos:]

For Q3 specifically, sorry. Okay.

[Pierre Plamondon:]

Yes. That's the tax expense for Q3 in our guidance is between $0.5 million to $1.2 million tax expense.

[Thanos Moschopoulos:]

Okay. All right. Thanks for that one.

[Pierre Plamondon:]

Thank you.

[Operator:]

We'll go next to Richard Tse with National Bank Financial.

[Richard Tse:]

Yes. Thank you. Just following up on to Thanos' question. Just wondering how you're thinking about sizing the revenue opportunity from a cross-selling perspective as we sort of look out over the next, call it, two or three years? Just kind of give us a sense of how you see this business growing to.

[Philippe Morin:]

Yes, I think, Richard, the best way – I mean, when you're asking for the next two or three years, I think we need to do further work and – really to understand it. But when you look at the model for 2019, we kind of look at cross-selling right now opportunities around the $10 million to $20 million range that we've looked at. And that's really from a point of view of looking at leveraging their installed base, their customer base and selling EXFO's product, especially the fiber monitoring solution is getting a lot of attention. And then for us, to leverage the Three UK example, right, where they've got really in our mind a market-leading solution virtualized cloud-based passive-based solution that we believe we'll be able to leverage that. So we kind of have a visibility on we think what we can achieve as I mentioned for 2019. But as we work into the year two and year 3, as we continue to go through our integration process, we'll probably get a better visibility further down the road on that one.

[Richard Tse:]

Okay. I guess related to that question. Can you maybe give us some color on the go-to-market strategy? Like, I'm guessing they probably had a different strategy than you guys. And what are you going to take away from what they did that was good and bring it together what you did that was good?

[Philippe Morin:]

They actually have a fairly similar kind of model, a direct sales approach. What's interesting is, as I mentioned in my opening comments, very little overlap in our customer base, very little overlap in geography. So part of it is leveraging their knowledge and how they've actually were able to succeed in selling monitoring solutions, run wireless and then implementing that into as an example our North American sales team that has been very successful at selling active service assurance monitoring solutions. So we'll be able to leverage their product and platform by leveraging our go-to-market, which is actually fairly similar but different geographies with a direct sales approach. And in addition, we'll leverage their relationship. And as I mentioned, leveraging their relationship and selling our market-leading optical test solutions. Because I do think, that as we saw already, we've been able to benefit from that point of view. So very similar go-to-market approach, very focused on the kind of key what I would call market-leading customers in those specific regions that we leverage our respective solutions and leveraging their relationship in those accounts.

[Richard Tse:]

Okay. And just one last one from me. I'm guessing so the sales models that were slightly different with the two companies, so can you maybe comment on any changes in the sales compensation structures with the combined sales force now?

[Philippe Morin:]

Yes. I think the sales compensation is actually not that different, Richard. I think as we already integrated the sales team together at the beginning of March, we've already set the compensation plan associated to our fiscal year. And as we head into our 2019, we'll probably end up getting even more synergies and more commonality as we're going to continue to draft and design the compensation plan. But it's very similar to our – it's not that different with our compensation plan and structure.

[Richard Tse:]

Okay, that’s great. All the best for the integration.

[Philippe Morin:]

Thank you, Richard.

[Operator:]

We'll go next to Todd Coupland with CIBC.

[Todd Coupland:]

Good evening, everyone. I have a couple of questions, if I could. I'll start with your assumption for sales on $30 million of EBITDA. What kind of margin are you building into to get to that level of EBITDA?

[Philippe Morin:]

Yes, what we wanted to provide here is really a view of what we wanted from a 2019 what we felt early into the integration process, what we felt we can get to into an EBITDA point of view. And that's why we're pretty comfortable with the $30 million, especially when you look at the bit of the progress we went from $26 million. Now in 2018, we'll bring it down to $22 million, and then we'll have significant growth to bring it back to $30 million EBITDA. At this point, we're not in a position to really talk about where the margins are going to come from. As I mentioned earlier to Thanos' questions, we expect that we are going to get $10 million to $20 million of incremental cross-selling to help drive to that new EBITDA. But in terms of margins, in terms of these kind of more detailed information, we're not at this point ready to really get into those details.

[Pierre Plamondon:]

And then I'll add a point. Maybe just on top of what Philippe has been saying, very clearly, I would say we have a very interesting acquisition for which we have paid basically $0.60 on the dollar with a great technology asset, with clearly like a leading solution to be the best system of deployment over in Europe from a virtualization standpoint. We are in the systems of – in the business of systems, of course, the sales cycle and the implementation cycle tends to be a little lengthy. But that's why we're believers that the impact in this fiscal year in terms of our planning, the numbers that Philippe has provided to you, meaning that we would be doing clearly a $26 million of EBITDA on our own without Astellia. With Astellia, given the fact that we're picking up two quarters in the first half of Astellia's fiscal year which isn't their best year – the best time for them, typically it's going to have a negative impact in this fiscal year which we can't pretend would eventually compensate, thanks to synergies because it's too short term to be able to fix that. Now with that being said, when we're looking at 2019, we're firm believers, as was mentioned that $10 million to $20 million of additional revenues, is something we can feel comfortable with. We think that once – by the time we finalized the models, we create basically the communication for our fiscal year 2019 numbers. We're going to give you more details of it. But we're firm believers at this stage that delivering $30 million of EBITDA or more is clearly at sight right now, given the fact that we see significant revenue synergies and the ability, in fact, to run the business very effectively, very efficiently, we'll be, of course, very careful about expenses and everything but we're firm believers that we can be above that and the model and, of course, the guidance for EBITDA for 2019 will be set in early October as we typically do. But at this stage, we at least wanted to give you, account for it, that we're firm believers we're going to be in the $30 million plus. Does that make sense?

[Todd Coupland:]

Yes. That does make sense. And so this $10 million to $20 million in cross-selling. Of course, that will be incremental above whatever it is the Astellia run rate business is currently or exit this year at. That's how you're thinking about it, right?

[Philippe Morin:]

Yes, that's correct. And cross-selling, right? So it's really cross-selling opportunities, meaning Astellia team selling our EXFO's products and EXFO team selling the Astellia current portfolio in accounts that they're not there.

[Todd Coupland:]

That make sense. I wanted to ask you about if I did my math right about a 13% increase in the bookings in the quarter, excluding Astellia. Where did you see that? What kinds of networks were driving that kind of growth in the bookings?

[Philippe Morin:]

Yes. I think, the bookings really came from – the growth came from our Physical-layer products. Mainly as I mentioned, our optical strength. We continue to see fiber deployment into three main areas that's really leveraging our market-leading product. So fiber monitoring being deployed whether it's to prepare for 5G so in the fronthaul whether it's fiber between data centers, especially data centers get more and more into the edge and then fiber-to-the-home. And actually interestingly this quarter, we also got some – get some interesting revenue associated to our access copper business. So all in all, our carrier customers are modernizing the network. As long as they deploy fiber like they're doing, it's good news for EXFO. As they're getting prepared for upgrading their backhaul and fronthaul from a point of view of wireless and putting fiber all the way up to the antenna, that's also good for us and that's reflected in the growth of nearly 14% that we highlighted here in terms of without Astellia. And effectively, a 17% year-on-year growth just on the Physical – our Physical business. So we continue to, we believe, steal market share there and continue to leverage our market-leading position in optical.

[Todd Coupland:]

And is that mostly in North America, that pickup in bookings?

[Philippe Morin:]

I would say that North America and Europe, both of the regions have strong performance.

[Todd Coupland:]

And then I just wanted to ask you one more question on 5G, if I could. So when you listen to the carriers and the handset providers, it feels like pilot networks and maybe some first handsets beginning in next year. So what kind of – so A, do you agree with that? And B, when are you thinking we're going to start to see some scaled up spending for wider deployments in 5G? Is that early in 2019? Is that 2020? How are you thinking and planning for that?

[Philippe Morin:]

Okay. I'll make another comment before I move on to the 5G. And just to really reiterate, that there is still – tend to be really focused about 5G and the future of 5G. But as I mentioned again, there is still LTE deployment taking place. There's still carriers migrating and adding voice-over-LTE, which in the context of Astellia and the context of our monitoring solution as well is also an important type of business that is going on. Now with 5G as you said, we believe there will be trial this year. The next-generation radio centers are now being finalized. We do believe that volume, although we expect it might start in 2019, the real volume will happen for 5G in 2020. But again, we felt that the timing and the context of us we believe we have a very, very strong position. We continue to have a strong position in fiber deployment and fiber monitoring system. But we wanted to make sure, as a company, that we strengthen our wireless portfolio, our wireless position because we do believe that there's going to be an infrastructure investment cycle about to take place in wireless. And therefore, that's why we thought that the Astellia acquisition from a timing point of view gives us time to integrate, gives us time to leverage and take the position that we need on our portfolio so that we can be ready for the 2019 early decision process and effectively get into the volume deployment in 2020.

[Todd Coupland:]

I appreciate that color. Thanks very much.

[Philippe Morin:]

Thank you.

[Operator:]

We'll go next to Justin Keywood with GMP Securities.

[Justin Keywood:]

Hi. Thanks for taking my call. Just first, a point of clarification. The reported adjusted EBITDA of $2.5 million in the quarter that includes $1.4 million in acquisition costs, if I'm reading that correctly.

[Pierre Plamondon:]

This is correct. And also the Astellia contribution for $1.3 million.

[Justin Keywood:]

Okay. So it adjusted for some items, but didn't adjust for the acquisition cost?

[Philippe Morin:]

Yes. If you take the $2.5 million. So what I mean if we didn't have Astellia, our EBITDA would have been $1.3 million higher. And with the acquisition costs, it would be been even higher by $1.4 million.

[Philippe Morin:]

So there's two items that the Astellia acquisition are impacting our EBITDA.

[Justin Keywood:]

Okay, makes sense. And then there's mention of the cost basis for Astellia being relatively fixed. I'm just wondering if there's an opportunity to rationalize some costs in other areas of the business?

[Philippe Morin:]

When we look at our overall situation, Justin, I mean the first thing that I want to reiterate is that we are very complementary right now in terms of our portfolio and with very little overlap with regards to portfolio and with regards to our customer base. If you recall, Justin, we do make – we did make a decision last – in Q3 of 2017 to restructure our passive business because that's where we felt that there was actually the most overlap in our portfolio and that's when we made a decision that effectively gave us the $8 million of savings into fiscal 2018. So that's been done now. As we continue to the integration, we continue to look at the portfolio and the cross-selling opportunities. We're obviously going to be very due diligent with the cost and get as many most efficiencies that we can get, so that we can get more than the $30 million of EBITDA that we've talked about earlier.

[Justin Keywood:]

Okay. And then the guidance for the Q3, the IFRS loss does that include any significant acquisition charges or other one-time items aside from the revaluation of the deferred revenue?

[Pierre Plamondon:]

Beside that and beside the $0.09 for the amortization of intangible assets, stock comp and this is no specific item. We just – to get back to this, I mean, Astellia where this is not the best time of the year for them to deliver profit. They are really back-end loaded. So we have some bad – negative effect on that in Q3 for us.

[Justin Keywood:]

Okay. And then you mentioned the sales efficiency opportunity. But I also think you said in your prepared remarks on leveraging the R&D between the two businesses. I was just wondering if you could expand on that a bit more.

[Philippe Morin:]

Well, we can actually compare it and look at the two platforms around our monitoring solution. And actually when you add on top of that our successful fiber monitoring platform as well, we have actually a great opportunity to create a much more richer network but as well a customer-centric capability with the acquisition that Astellia is providing. So really strengthening our overall portfolio. There are gaps that we felt we needed to be a stronger player in wireless. We felt we really need to complement our portfolio. And that's what we mean by the R&D capability to really leverage what Astellia's done and what they've done with regards as an example to some of their big data capabilities. EXFO had a very strong – we had a very strong real-time network and service analytic platform that we're going to combine with the Astellia product. So ultimately leveraging the two R&D capabilities, we believe, will strengthen our overall portfolio and help us get more cross-selling and then ultimately integrated selling opportunities in the future.

[Pierre Plamondon:]

I'll probably add to this. These are very good comments. But if I probably add to this, one that's quite important. We talked about develop Astellia as one – certainly the biggest and the most prestigious NFV deployment over in Europe, which is basically they've got a tremendous technology capability that's pretty unmatched in the industry in our book. There's very few cases that have been made public. This one is certainly one of the most prominent deployment of passive assurance in the industry. EXFO also has on its own a number of customers where we've got active virtualized assurance [indiscernible] right now in operation with the leading telecom operators. We believe the combination of virtualized passive, virtualized active will provide very new visualization of the performance of networks when you move into a virtualized environment. So this is just one example of what Philippe was mentioning like the synergy that exists between the outstanding technology that Astellia brings to EXFO in combination with what EXFO can bring, the ability to have real-time, full-time visualization of virtualized test function, if you will, as they're being deployed into the network, while at the same time being able to monitor the real state – permanent state of network, whether they're combining just passive – just virtualized or virtualized and hybrid. So I think that's going to give us an unmatched set of capabilities which will allow us to bring solutions that are very advanced to take market share in this segment. Jointly, the two organizations jointly are becoming a top five ender but with the ability to really move the needle and accelerate basically in terms of growth moving forward.

[Justin Keywood:]

That’s very helpful. Thank you for the additional color.

[Pierre Plamondon:]

My pleasure.

[Operator:]

We'll go next to Tim Savageaux with Northland Capital Markets.

[Tim Savageaux:]

Hi. Good afternoon. I've got a lot of questions, a lot of moving parts here so I'll try to keep it straight. And I know your taxes are de minimis now so I'll just ask a question kind of out of left field about FY '19 tax rate. Historically, you've been a pretty full taxpayer, at least the crazy way I do my numbers, mid 30s. You mentioned some kind of impact in the quarter for tax reform. Assuming you get to that solid profitability that's implied in the $30 million EBITDA guide, can we assume that the tax rate heading forward will be like we're seeing across several other companies, I don't know, 5, 10 points underneath what you had historically? Or have you given that any thought?

[Pierre Plamondon:]

Yes. The question is, where are we going to make our profit? And as we have some tax losses carried forward that's being recognized in the book so this is one element. So the normal tax rate for Canadian company is about 30% – 28% to 30%, okay? We have some country where we have to pay more than that, okay? And we have some expenses now that are not deductible, for example, the intangible assets that we have acquired won't be tax-deductible. So you need to take out this element as a deductible expenses. So I still expect to have a tax expenses pretty high next year as well to because of that.

[Tim Savageaux:]

Okay. That's fair enough. Sticking with '19 for a moment. And given your very helpful, by the way, specific guidance for Astellia contribution for Q3, if you assume that increases a little bit in Q4 and gross that up, that's kind of about sort of the run rate we've been seeing in the $45 million range. As you sort of contemplate the top line that goes along with that $30 million EBITDA guide, should we assume that you're assuming kind of a flattish core Astellia contribution from where they've been maybe with the cross-selling opportunities on top of that and then whatever core EXFO growth we might model? Is that a reasonable way to look at it?

[Philippe Morin:]

Yes. That's a good way to model it, Tim, obviously. So we assume kind of a base kind of level. And then on top of that, we have the cross-selling opportunities. And that's kind of plus what we believe our test and measurement business is going to continue to do and that's how we kind of model the – what our EBITDA target there.

[Tim Savageaux:]

That makes sense. And that would seem to imply something on the order of a high single-digit EBITDA margin. You've talked about kind of a 15% target at least pre-Astellia. Do you maintain that target? And any thoughts on your ability to work toward achieving that through the end of fiscal '19? Or how do you think about EBITDA margin targets in general?

[Philippe Morin:]

Yes. No, we're still maintaining our 15% medium-term for the next three years, medium-term 15% EBITDA target.

[Tim Savageaux:]

Okay. Great. And from '19 to the very short term, you mentioned a revenue contribution for Astellia in Q3. I don't know if you mentioned kind of a comparable negative EBITDA impact to the $1.3 million that you saw for the partial quarter.

[Pierre Plamondon:]

No. Astellia being a press company, they report only half the year. So we don't have comparative figure to – for the previous quarter for them, okay? So unfortunately, we can't get this information.

[Tim Savageaux:]

Okay. But I think you've implied a pretty substantial kind of bump up from an OpEx standpoint. Let me just go back to the EBITDA guidance for fiscal '18. I think you said – well, there's a $22 million – is that EXFO with no Astellia impact, either dilution or acquisition expenses? Or what was that number?

[Philippe Morin:]

Yes. Let me just reiterate again. And so what we said is without the Astellia acquisition, we're on the path to do a $26 million of EBITDA. And after Q2 without the Astellia acquisition, we're still at the path to get to $26 million of EBITDA. With the Astellia acquisition now for the next two quarters and the seasonality impact of that acquisition, we're now saying that we are now guiding with our fiscal year to $22 million. So therefore, Astellia's impacting it by $4 million. And then from $26 million down to $22 million, Tim, and then for 2019, we're saying we're going to recover that and get back to at least a $30 million EBITDA performance, all in...

[Tim Savageaux:]

Okay. Well, without beating a dead horse in there, I assume you're going to be EBITDA negative overall for Q3, right? So I mean, that would imply at least some pretty substantial rebound in Q4 from an EBITDA standpoint?

[Pierre Plamondon:]

Yes. And typically in Q4 because it is summertime, our EBITDA tends to be much higher.

[Tim Savageaux:]

Okay. That would maybe be seasonal impact in the core business.

[Pierre Plamondon:]

Yes. Correct.

[Philippe Morin:]

And that's typical for expense. Yes.

[Tim Savageaux:]

All right. Thank you, Tim.

[Operator:]

And with no further questions in the queue, I would like to turn the call back over to EXFO's CEO, Philippe Morin, for any additional or closing remarks.

[Philippe Morin:]

All right. So thanks. Thank you for joining us. Just let me finalize with a few key takeaways before we conclude our call today. So first of all, I really believe that EXFO delivered a solid second quarter. And as you saw from our sales growth and bookings growth into the, what I would call the EXFO business. Second, we closed the Astellia acquisition, which represents a very transformative transaction positioning EXFO now, not just in the fiber business but now getting into a much stronger hold into wireless market which has a higher growth potential, especially when you now take into account NFV, IoT and 5G. And then finally, based on our forecasted synergies, cross-selling opportunities, we expect that the Astellia acquisition will allow EXFO to generate at least $30 million of EBITDA, in adjusted EBITDA, in our fiscal 2019. So at this point, I'd like to, on behalf of the entire EXFO team, to thank you for joining us today. Thank you.

[Operator:]

And this does conclude today's conference. We thank you for your participation. You may now disconnect.