EXFO Inc.
Q4 2018 Earnings Call Transcript

Published: 12 Oct 2018

[Operator:]

Please stand by. Good day, and welcome to EXFO's Fourth Quarter and Year-End Conference Call for Fiscal 2018. Today's conference is being recorded. At this time, I would like to turn the conference over to Vance Oliver, Director of Investor Relations. Please go ahead.

[Vance Oliver:]

Good afternoon, and welcome to EXFO's fourth quarter and year-end 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. As 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 which is on file 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 numbers to our IFRS results is available on our Web site at www.exfo.com/investors. All dollar amounts in this conference call are expressed in U.S. dollars, unless otherwise indicated. At this point, I will turn the call over to Philippe.

[Philippe Morin:]

All right. Thanks, everyone. Thanks, Vance, and good afternoon. Fiscal 2018 proved to be a year of strategic transformation for EXFO as we accelerated our development into a supplier of software-intensive end-to-end solutions for fiber, mobile, and virtualized networks. While the communication service providers, which is mainly our biggest base of our customers, weighted fundamental changes to their network infrastructure, EXFO strategically positioned itself for the two main industry growth drivers, mainly fiber build-out to the network and to the network edge and as well getting ready for the 5G wireless cycle. So what does that mean in concrete terms? So first of all, as we develop our highly differentiated solutions to enable fiber build-outs and high-speed deployments, we're doing this as our customers are going closer to the network edge. As the number one supplier in optical and high-speed transport testing in the world, we intend to build on this position by leveraging automation capabilities of our solutions and really capitalizing on new revenue streams. As examples, we've now delivered to the market our new 400 gig compact test solution, which has a key new product set with automation capabilities enabling faster implementation for datacenter build-out, both inside and outside connecting those datacenters. We've also launched our new automated solution called SkyRan, which provides real-time testing and 24/7 monitoring of optical networks, but we've added as well radio frequency spectrum for deployment in wireless solutions. Our optical test portfolio also gained strong traction with mobile network operators who are busy densifying their networks with small cells to meet stringent 5G network requirements. These small cells, which are seeing a tremendous growth, over 40% market growth this year, needs fiber connection, requires extensive optical testing, and no one does it better than EXFO. Our second strategic initiative involves the acquisition of Astellia to increase our scale, our relevancy with mobile network operators as the 5G investment cycle gets underway. Astellia contributed to $16.4 million in revenue during seven months under EXFO, which was reduced by $2.1 million to account for acquisitions-related fair value adjustment of deferred revenue. We will benefit from cross-selling opportunities in 2019 as the combined sales force becomes more knowledgeable and trained on each others' product solutions. From an operations perspective, we also announced in Q4 an important reorganization plan in our fourth quarter of 2018 to accelerate our companywide efficiencies and profitability. If I focus first on the efficiencies enhancement, we're fast-tracking our integration of our newly-acquired monitoring and analytics solutions with Astellia and Ontology to create a unique platform architecture at EXFO. Our platform is to build addressable critical use cases and requirements from the edge of the network to the core, to service field, and to network operations, and now service operations center as well, and with that as well the capability to engage with customer care and marketing teams. We also have this platform based on Big Data framework that will now allow us to leverage artificial intelligent and machine learning solutions to bring value-added solutions to our customers. Now, if I focus on the profitability side, we're consolidating our R&D activities in fewer sites to increase our productivity and lower operating costs while intensifying efforts in business segments that we have truly competitive advantages. Once this reorganization is mostly completed, which is after fiscal Q1 2019, we will benefit from annualized cost savings of $10.5 million, including approximately $8 million in our fiscal 2019. Now, looking at our financial performance in fiscal 2018, EXFO delivered revenue growth of 10.8% to $269.5 million, and as well an adjusted EBITDA of $17.2 million. These double-digit sales growth mainly reflects contributions from acquisitions, mainly the Astellia and Yenista acquisitions, and as well some market share gains in Physical-layer testing. On the profitability side, on the EBITDA side, I am disappointed with our results as our adjusted EBITDA fell below our annual target for two reasons. First, we generated revenue at the low end of our guidance for the fourth quarter of 2018, with $69.2 million, which obviously affected our adjusted EBITDA. This revenue result also reflects a lower performance on our Physical business, and as well on our Protocol side where our orders are being pushed out to our next fiscal year or fiscal year 2019. We clearly need to execute better even though the market dynamics for our Protocol business is being impacted by the slower transition to virtualized network. Now, the second reason for missing our profitability target, Astellia's negative impact on our adjusted EBITDA proved to be higher than anticipated at $5.1 million. And as I mentioned before, I remain very positive by the Astellia acquisition, as it will make EXFO a much more relevant player in the next mobility investment cycle with 5G, with the stronger solutions in monitoring and troubleshooting, richer analytics, and this also brings us better software-based higher margin solutions for our business. On the product line basis, sales for our Physical-layer product family increased by 6.8% in 2018. Our fiber monitoring system, which delivered a record-breaking year, and the Yenista acquisition were mostly responsible for the revenue increase in our Physical-layer testing. On the Protocol side, revenue improved 16.9% year-on-year, mainly due to the seventh month contribution for Astellia. Otherwise, our sales of our Protocol product would have decreased year-over-year as we've streamlined our passive monitoring portfolio in the second-half of 2017. Admittedly, our Protocol product line delivered lower sales than expected in 2018. As I stated earlier, communication service providers are considering major changes to their networks, and we witnessed order pushed out largely due to the complexity of that transition towards virtualized network architectures. Now, virtualization is directly linked with 5G deployment so that you can increase network agility and lower operating costs, so it's not a surprise that service providers are taking their time and taking longer to make their architecture decision in their critical investments. Now, on the subject of virtualization, our aim is to continue to get integrated into solutions. And I'd like to highlight one of the announcements that was made earlier this week at the SDN NFV World Congress in The Hague. Orange, which is one of the world's leading telecom operators has integrated EXFO's passes virtual probes into the Beijing release of the Open Network Automation Platform, or ONAP. Basically what this means is that our service providers will be able to deploy open network infrastructure based on NFV and SDN, with now the capability to monitor and troubleshoot in end-to-end solutions with EXFO's portfolio. To recap the past fiscal year, EXFO underwent strategic transformations. We've made investments, both internally and through acquisitions to position the company as a supplier of choice, to deliver superior network performance, service reliability, and deep and rich subscriber insights for customers. These investments combined with the recent restructuring initiatives represent a solid foundation for EXFO to generate profitable growth in 2019 and beyond. Now, let me provide you with our financial outlook for the first quarter of fiscal 2019. We're forecasting sales between $66 million and $71 million for the first quarter ending November 30, while IFRS net loss should range between negative $0.02 a share to negative $0.16 per share. IFRS net loss include a total of $0.13 per share in after-tax amortization of intangible assets, after-tax restructuring charges, stock-based compensation costs and acquisition-related fair value adjustment of deferred revenue. For fiscal 2019, we're revisiting or revising our adjusted EBITDA target to $24 million. Considering Astellia will be in our books for a full 12 months in 2019, and assuming a larger portion of EXFO's business will be subject to longer sales and revenue recognition cycles, this is countering as well and anticipate cost savings and organic growth, we believe that it's prudent to moderate expectations for 2019. This guidance was established by management based on our existing backlog as of date of this conference call, seasonality, the expected bookings for the quarter for quarter, and for this quarter and fiscal year, and as well the exchange rates as of the date of this call. So, at this point, I would like to turn over to Pierre to discuss our financials.

[Pierre Plamondon:]

Good afternoon. Thank you, Philippe. Annual sales increased by 10.8% to $269.5 million in 2018 from $243.3 million in 2017. As previously mentioned, revenue contribution from the Astellia and Yenista acquisitions, market share gains in Physical testing as well as the positive currency impact generated a double-digit sale increase. Bookings meanwhile improved 6.2% to $267.7 million in 2018 from $251.8 million. In the fourth quarter of 2018, sale reached $68.2 million, while booking attained $63.1 million. Gross margin before depreciation and amortization amounted to 61% of sale in fiscal 2018, compared to 61.2% in 2017. In the fourth quarter of 2018, gross margins, which included restructuring charges of 0.7% reached 60.4% of sales. Our gross margin slightly decreased in 2018 mainly due to lower -- mainly due to revenue from Astellia, which include lower margin professional services. We believe that our gross margin will range between 59% and 61% in fiscal 2019 based on full-year contribution from Astellia, Astellia sales by higher sales volume. Moving to operating expenses, selling and administrative expenses totaled $98.8 million in 2018, compared to $86.2 million in 2017. In the fourth quarter of 2018, SG&A expenses totaled $24.7 million. The $12.5 million increase in SG&A expenses in 2018 is attributed to a seven month submission from Astellia, 11 months from Yenista, and a full-year from Ontology versus six months in 2017. EXFO also incurred an increase of $1.1 million in acquisition-related costs in 2018 with the two acquisitions that we closed during the year. As a percent of our sales, SG&A expenses reached 36.7% in 2018. Excluding acquisition-related costs and restructuring charges, our SG&A expense would have a same 35.7% of savings in 2018. We expect our SG&A expenses will range between 33% and 35%, excluding the remaining restructuring charges to be incurred in fiscal 2019. R&D expenses totaled $57.2 million in fiscal '18, compared to $47.2 million in '17. In the fourth quarter of 2018, net R&D expenses amounted to $16.7 million. Likewise, the $10 million increase in net R&D expenses in 2018 is attributed to the Astellia, Yenista, and Ontology acquisition, as well as higher restructuring expense year-over-year. As a percentage of sales net R&D expenses reached 21 20% in 2018, or 20% excluding restructuring charges. We expect that net R&D expenses including remaining restructuring charges will range between 17% and 19% of sales in 2019. In 2018, IFRS net loss totaled $11.9 million or $0.22 per share, net loss in 2018 included net expenses totaling $17.1 million, namely $9.4 million in after-tax amortization or intangible assets, $1.7 million in stock-based compensation costs, $3.4 million in after-tax restructuring charges, $2.1 million for deferred revenue fair value adjustment related to the Astellia acquisition, $700,000 for the positive change in the fair value of the cash contingent consolidated related to the Ontology acquisition, $2.5 million in after-tax acquisition-related costs, and a foreign exchange gain of $1.3 million. In the fourth quarter 2018 IFRS net loss amounted to $4 million or $0.07 per share. In terms of geography, sale in the EMEA and Asia-Pacific region increased by 36.4% and 6.5% respectively in 2018, while sale in the Americas remain flat year-over-year. Looking at the sales split, the Americas accounted for 50% of sales in 2018; EMEA represented 32%, while Asia-Pacific totaled 18%. Of particular note, sale in EMEA increased from 26% in total sales in 2017 to 32% in [technical difficulty] largely due to the impact of the Astellia acquisition. Turning to customer diversification, our fair customer accounted for 9.1% of sales in 2018, while our top three represented 15.9% of sales. Moving on to a few key points on the balance sheet, our cash position decreased by $24.2 million year-over-year to $15 million at the end of 2018. We made cash payment of $35.3 million for the acquisition of Astellia and Yenista in 2018, $10.5 million for depreciate of capital assets, $3.1 million for the repayment of long-term debt acquired from Astellia, and $500,000 for the payment of cash contingent consolidation related to Ontology. These cash outlays were partially offset by $14.4 million in cash flow from operating activities, and a bank loan of $11.1 million. At this point, I will turn the call over to the operator for the start of the Q&A session.

[Operator:]

Thank you. [Operator Instructions] And we'll go first to Thanos Moschopoulos with BMO Capital Markets.

[Thanos Moschopoulos:]

Hi, good afternoon. Philippe, in your discussions with customers, when do you think that the current pause you're seeing with respect to virtualization deployments, when do you think that might start to alleviate? Will we have to wait until we're much closer to the 5G deployments, or maybe some sign of improvement prior to that?

[Philippe Morin:]

Yes, Thanos, I think the 2019 for us is we're going to continue to start seeing two main activities. One is the whole activity of doing proof-of-concept, especially in the context of the real value of virtualization is when you start bringing the additional level of automation, and that's when we're starting to see that proof-of-concept activity starting to happen now with the automation piece becoming more a part of the proof-of-concept. We are also starting to see -- well, we'll see some deployments as well. I think you're aware that certain carriers are starting to put actually 5G networks now as we speak in service, Verizon being one of them. So, I do think that as we head into our fiscal year here, we're going to start seeing some more live deployment. Continue to state that in terms of real volume for 5G and impact in our business, that's more of a 2020 timeframe.

[Thanos Moschopoulos:]

Okay. Then just a couple for Pierre, can you clarify, is it $3.6 million of restructuring charges that we should anticipate left in the current program or what would the number be?

[Pierre Plamondon:]

The old program is $8 million. We did incur $4.6 million in this quarter, we would add $3 million in the first quarter of 2019, and the remaining will be mostly in Q2 and Q3.

[Thanos Moschopoulos:]

Okay. And in terms of the restructuring charge that you took in the quarter, could you just break that out between SG&A versus R&D?

[Pierre Plamondon:]

Yes, we have it somewhere, just need to find the right page to answer to your questions.

[Thanos Moschopoulos:]

Maybe in the meantime, Philippe, on the Physical-layer side, any change there in terms of your outlook or should that business perform sort of consistently through the balance of '19, kind of sort of the single-digit growth we’ve talked about previously?

[Philippe Morin:]

Yes, I know, I think the Physical-layer [technical difficulty] mentioned that I was disappointed on kind of the execution piece, and that's mainly on that Physical-layer side. If you look at our bookings, Thanos, we actually showed a decrease of $39 million last year to $37 million on the Physical-layer piece. The market is strong. This is where, as a team, we need to perform better, we need to execute better because we do continue to see strong fiber build-outs taking place in the market, and plus, if you couple that with the acquisition of Yenista, we need to get back into a growth right here that's more in line with the market.

[Pierre Plamondon:]

Okay, Thanos, I can give you the breakdown. So, the net after-tax cost for restructuring is $3.4 million. So we have $500,000 in cost of goods sold – 670k -- sorry, 500k in cost of goods sold, 673k in SG&A, $3.2 million in net R&D costs, $150,000 in interest and other expense, and a tax recovery of $1.1 million.

[Thanos Moschopoulos:]

Okay, that's very helpful, thank you. Maybe one last one for me is just as far as the gross margins near-term, similar range to what we saw this quarter or what we should be expecting?

[Pierre Plamondon:]

And the thing that we are going to have more and more Astellia revenue, which include profit on services with lower margins, so this is why the guidance that we had given for the next fiscal year on the gross margin has been reduced to 59 from 61.

[Thanos Moschopoulos:]

Sorry, I missed that earlier. Okay, thank you. I'll pass the line.

[Philippe Morin:]

Thank you.

[Operator:]

And we'll go next to Robert Young with Canaccord Genuity.

[Robert Young:]

Hi, good evening. Maybe I'll just continue that last line. The 59% to 61% range for gross margin, is that drop, you gave some reasons for it but I missed it. You just highlighted Astellia has maybe some lower elements to do with the service component of their business. Is that the big driver of the lower margins or are you thinking of push-outs in the Protocol side of the business as a factor there as well?

[Pierre Plamondon:]

No, the main impact is the Astellia business. The average margin for Astellia is about 50 to 55 blended, let's say, between the other product line and services, okay, while our offering on the test numbers [ph] remains more on the 60 -- around 60-61, and the - in our Protocol business, it is more the 70%, so that didn't change. It's only the fact that the proportion of the revenue coming from Astellia will be much higher in fiscal '19, and this will have an impact on the blended gross margin for the business.

[Philippe Morin:]

And Robert, the professional services aspect, for me is a really critical aspect of our business going forward. If you look at the wins we're getting right now in some of the mobility service assurance piece having the expertise that Astellia has brought forward with the professional services, the knowledge around wireless network, the knowledge around RAN optimization, the knowledge around effectively, mobility type of solution is very valued by our customers. And to me, even though it's got a gross margin impact, as Pierre just explained, it is a key part of our solutions going forward.

[Robert Young:]

Okay. And then I just had a couple mechanical questions about the Astellia contribution just to back into the organic growth. You said $16.4 million for the seven months. What would be the contribution from the one month in this quarter?

[Pierre Plamondon:]

For the one-month, I'm not sure I understand. So, we're not going to disclose this quarter -- for the one month or for the quarter, you mean?

[Robert Young:]

Yes, so if it's seven months I was thinking, to back in to what the revenue is for -- the contribution for this quarter?

[Pierre Plamondon:]

This quarter, being Q4?

[Robert Young:]

Yes.

[Pierre Plamondon:]

Yes, it's $5.7 million in sales.

[Robert Young:]

Okay. And Yenista didn't have much of a contribution I think you said in the press release. Was that essentially zero or -?

[Pierre Plamondon:]

No, they bring a negative EBITDA of $1.7 million in the quarter, the Astellia business by itself.

[Robert Young:]

And then I think you said that Astellia was a $5.2 million drag, that's over the seven months, I think. What would've it have been in the quarter?

[Pierre Plamondon:]

Okay, just to recap. The negative EBITDA over seven months from Astellia amount to $5.1 million, okay, of which $1.7 million has been incurred in the fourth quarter.

[Robert Young:]

Okay, great. Okay, I get it. Okay, and then last question --

[Philippe Morin:]

Okay, go ahead. Go ahead, Robert.

[Robert Young:]

If you want to clarify that, go ahead. I think…

[Philippe Morin:]

No, it's good.

[Robert Young:]

Okay. And then on the push-out, I don't want to belabor this too much, but I think you'd said that -- the last quarter you said that you'd expected some push-outs, but clearly they are bigger than you thought. And so I was wondering if you could give us a sense of how confident you are that you've got a good handle on the degree of push-outs you expect to see going forward? And then the second element would be, I think you'd said that Astellia, the integration, had a bit of a negative impact on bookings, and is that continuing to be an impact? And then I'll pass the line.

[Philippe Morin:]

Yes. So if you look at our Q4 performance, Robert, and we'll focus still on the Protocol side, you can see that versus last year, even though we have Astellia, you saw a decrease from $27 million to $25 million on our bookings on the Protocol side. And you included Astellia, so the -- or what I would call EXFO Protocol business did not perform as well for two reasons. One was execution on some of these deals that we've had on some of our field TND [ph] portables protocol, and then the deals being pushed out. And this is back to where I was disappointed with our performance. Some of there projects we really thought we were going to be able to pull them into the latter part of the month -- of the quarter, being August. Again, you get into the summertime period and that did impact some of these contracts that got pushed out. And to Thanos questions, I do expect that as we head into this year now, 2019, that we'll be able to start getting back into more of a better visibility and better predictability in our Protocol business. But we did get, part of it is the learnings of Astellia, but also the market itself. And if you look at our peers, some of peers are experiencing the same challenges with regards to their protocol business into virtualization deployment.

[Robert Young:]

Okay, great. That's very helpful. I'll pass the line, thank you.

[Operator:]

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

[Justin Keywood:]

Thanks for taking my call. Just want to come back to the seasonality, and you mentioned this being pushed out of the summer months. And just given the guidance in Q1, should we expect a bigger uptick in Q2 of next year, or how should we model the revenue over the next four quarters?

[Philippe Morin:]

Yes, Justin, so the guidance with Q1, as you can see when you looked at our book-to-bill ratio of 0.91, and what happened in Q4, 2018. You see now the impact of that as we move into our revenue guidance for Q1. And that's a reflection of we need to have a stronger backlog especially when you start looking at the Protocol business to really be able to convert that into that end quarter revenue. There is some seasonality as we head into the -- for our Q1 and our Q2 because your end-of-the-year on the Physical-layer side, we tend to sometimes see some end-of-the-year projects that we're hoping to be able to leverage from that. And same thing on the Protocol side, where we do think that as we move into our Q1 and Q2 we'll be able to close them and really get the bookings into more at the level that we're planning for.

[Justin Keywood:]

Got it. Is there any overall revenue target goals for the 2019?

[Philippe Morin:]

I think with the history with EXFO, as we've provided guidance for the EBITDA for the full-year, and not other factors such as revenue.

[Justin Keywood:]

Okay. And then there's been some announcements by France with aggressive 5G rollouts, and I assume Astellia is pretty good to capture some of that. Is that more of a 2020 type of item where we might see some impact?

[Philippe Morin:]

Yes, our view, Justin, of the market is that the 5G deployment from a point of view on the wireless 5G network deployment, the volume will really kickoff in 2020. We are seeing some companies already starting to deploy 5G deployment in, as you mentioned, in Americas, in Europe. We are starting to see, as an example on the fiber side, more deployments on getting the front-haul and the back-haul ready for 5G, so more small-cell deployments which needs fiber connectivity. But in terms of our solutions for monitoring and troubleshooting in terms of into our business and same thing with fixed wireless access business, we're seeing those deployments happening now, and we're playing in some of these networks. One of them we made public is the 3 UK, in the 3 UK, where we have actually done a pretty market-leading solution that's a fully virtualized monitoring solution, and that's happening in Europe. And we're also engaged with other accounts on a global basis.

[Justin Keywood:]

Okay, thanks for taking my questions.

[Operator:]

We'll go next to Todd Coupland with CIBC.

[Todd Coupland:]

Good evening everyone. I want to ask about 5G as well. So there's obviously a little bit of activity in the U.S. with the first cities starting to roll. How do you think about field trials in 2019, and whether or not that will give you decent indications on volume deployments in '20 and beyond? What are the types of things we should be watching for that'll give us confidence that that timeline will be stuck to?

[Philippe Morin:]

Yes, so as you said, 2019, there will field trials, will be proof of concept, will be, like the Orange announcement we just made yesterday around integration of our solutions into ONAP, which is one of the platform for automation. So you're going to see activities taking place in 2019 for that, and in preparation for more larger deployment. You are going to see also some activity, in our case, with some of the fixed wireless access deployment that's starting to take place, whether it's the installation of those plans or of these deployments. And as well, I think ultimately we're hoping we're going to be able to translate that in terms of momentum for us in 2020.

[Todd Coupland:]

And I don't know if you can do this or not, but if you think about for your products, including the recently acquired products, what do you think the 5G TAM is over, let's say, the cycle, whether it's five-10 years or however long it's going to go. Is it $100 million or is it $500 million that's split three or four ways with the various players, how are you actually thinking about that opportunity?

[Philippe Morin:]

When we look at our, again on the service assurance piece, and which is really I think what you're asking, and the acquisition that we did with Astellia and Ontology, and then the solution that we're brining together to help customers with monitoring and then customers with richer analytics. We view that the market today is between $2.5 billion to $2.6 billion depending on analysts in our view. As the mobility 5G cycle starts implementing, there will be obviously some cannibalization of that market that's going to be replaced with the 5G deployment. What's really difficult for us to predict is how much growth will 5G bring to that overall market? So again, from the point of view of our kind of assessment, when we look at our three-year plan, we are assuming some CAGR associated with that particular market that I've just highlighted, and then how is it going to end a playing between monitoring solutions versus analytics versus systems like CM Systems and so on. That's where the granularity becomes a bit more difficult to predict.

[Todd Coupland:]

Okay. That's helpful. Good luck. I appreciate the color.

[Operator:]

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

[Philippe Morin:]

Hi, Tim.

[Tim Savageaux:]

Hi, good afternoon. Couple of questions, first on the annual EBITDA guidance reduction and the sort of the primary drivers there, I mean extensively you had a good sense of where Astellia gross margins were, when you established to the $30 million target. So, in terms of the delta there, is that significantly different mix between the three elements, if you will, Physical, Astellia and kind of the previous Protocol? Then you would have anticipated driving what appears to be the gross margin reduction, which from my standpoint accounts for most of that decline, or -- and is that mix reflective of a lower Physical-layer contribution that you might expect given the higher start in the year? I'll leave it there for now.

[Pierre Plamondon:]

Yes, and I think -- let me just add -- again on the Physical-layer, Tim, and I knew you know that market really well, and you know how -- and you know how we're performing. I really bring that down to an execution piece on our part, as I mentioned earlier in my opening comment, and obviously the team and we are going to do better as we head into 2019 that particular market has got strong momentum still. So really your points around the EBITDA comes from -- again on the Protocol, on the Protocol side, when we -- okay, understand better and when we worked on the projects that we've got in our pipeline and understanding the revenue recognition cycles, along with -- you start factoring the restructuring benefit - the restructuring costs that we've added to this, you start adding some of the -- as well inflations that we're putting in there and the margins associate to that business, it gets us to provide that guidance of 2024. So multiple factors that came into it. Better knowledge now of the Astellia business, better knowledge of the sales cycles that we've got to go through as we move into the revenue recognition portion, and therefore, the EBITDA flowing through, along with all the other activities that we've done with restructuring, inflation, and again the organic growth that we see with the rest of the business.

[Tim Savageaux:]

Okay. So bottom line there -- from your perspective the reduction is primarily Protocol-driven and within that maybe primarily Astellia-driven, it's fair to say?

[Pierre Plamondon:]

Fair to say.

[Tim Savageaux:]

Great. And let's look at the guidance for Q1 as well, because I'm just trying to understand how you get to you know what looks to be mid-range, $0.05 loss. Given the revenue guide, I imagine that implies either or both of gross margins maybe overshooting below your target range for the year or pretty significant step up in OpEx, somewhere if you could comment on either one of those?

[Pierre Plamondon:]

Yes, maybe just to give you some color on that. You need to assume that we have $3 million of restructuring charges that we're winning here in Q1, so that is part of the guidance. As well, you need to remember that Q4 is historically a lower quarter for expenses for us, okay, as this is the summertime and the vacation and so on, so if you -- probably one of the ideas that you may look is probably the better reference for run rate of expenses for SG&A and R&D probably of Q3, which is more probably more comparable at which we should expect for Q1, where the impact of the vacation is not there. So that is the main explanation in your first comment. Yes, in the first quarter, we do expect the margin to be at the low-end of our guidance that we've given for the year.

[Tim Savageaux:]

Great. And just a couple of housekeeping items to wrap-up, I wonder if you could run through the geographic split quickly again, I missed that, and was it 15.9% for the top three?

[Pierre Plamondon:]

Yes, yes, 15.3% I believe. Okay.

[Tim Savageaux:]

15.3%. Okay.

[Philippe Morin:]

For the top three.

[Pierre Plamondon:]

15.9%, sorry, 15.9% for the top three this year.

[Philippe Morin:]

Yes.

[Pierre Plamondon:]

And you want geography as well?

[Tim Savageaux:]

Yes, just yet…

[Pierre Plamondon:]

So for the year, the Americas represented 50%, EMEA 32%, and APAC 18%.

[Tim Savageaux:]

Okay. Thanks very much, I'll pass it on.

[Pierre Plamondon:]

Thanks, Tim.

[Operator:]

We will go next to Richard Tse with National Bank Financial.

[Richard Tse:]

Hi. When it comes to those pushed out deals or the revenue shortfall, I'm trying to understand here how much of that was due to your own execution? How much was it related to your customer sort of making a call to push-out those deals? I'm not clear on that.

[Philippe Morin:]

The Physical-layer of push-out or the Physical-layer gap that we've guided, I would summarize that, Richard, by our lack of our execution piece. The Protocol push-out are more customer-related -- customer decision related or the fact that there are longer sales cycles, and then it just takes longer to close the deal. So that's the way I would -- I would really try, I mean, I know to summarize it, but that's pretty much the kind of the way I split the two reasons here.

[Richard Tse:]

Okay. And then, I sort of go back and reflect on the previous quarter, it sounded to me that at that point in time you had a really good handle on Astellia and the acquisition and clearly now with the changes that you're making, it wasn't the case, like, what kind of changed during the quarter that would have that flipped so quickly?

[Philippe Morin:]

There're two things I would say, as we went through the quarter, we all -- and we went through a better understanding of the Astellia business and the outlook that we've had. It became pretty apparent for us that we need to also -- I mean as you can see, [technical difficulty] based on the bookings that we needed to address also our overall profitability and that's what drove us as well and just, Richard, open based on -- as we got a better understanding of business that got us to make the decision with regards to the restructuring. So that we knew that as we head into 2019, we needed to address that point quickly. What also has come through, and it's not just on the Astellia, but when we look at the overall service assurance business, when we look at our existing EXFO solution where we're selling our solutions into much more of virtualized-based solutions, so the combination of Astellia, the combination of our existing service assurance business drove us to see that there is a market, I would say a pause or slowdown in the context of how quickly and how aggressive our customers are going to move to this virtualized-based solution. And that's also another factor that came into play. So I wouldn't want to just you to conclude that it's only Astellia, I think it's a combination of our service assurance business, and the Astellia business that we're going through now this cycle of virtualization and automation with our customer base.

[Richard Tse:]

Okay. And then just going back to the execution challenges, I know you have sort of talked about it broadly, but can you kind of maybe give us a bit more color or elaborate on specifically the challenges, is it sort of a technical issue, is it sort of sales issue, implementation, like, what's the issue there?

[Philippe Morin:]

Richard, I'll summarize, I mean, the Physical-layer side, we are the number one market leader in the world. That market is growing. We know there's a lot of fiber build-out taking place at the funnel for our business as we have a strong funnel there, and as a team, we didn't close those deals as we should have, and we were very back-ended and I would -- again, as I mentioned, that's an execution issue that we want to make sure doesn't get repeated again.

[Richard Tse:]

Okay. Fair enough. Thanks for the color.

[Operator:]

We'll go next to Tim Madey with White Pine Capital.

[Tim Madey:]

Good afternoon, gentlemen. A couple of quick housekeeping questions, what was CapEx in '18, and what do you expect it to be in '19? I'm trying to get us some idea of the free cash flow generation of the business and then the impact on the balance sheet.

[Pierre Plamondon:]

Yes, CapEx this year is $10.5 million, okay, this is typically probably high for us. This typical CapEx expense for us is more than $5 million to $6 million per year and this is what we have in the plan for next fiscal year.

[Tim Madey:]

Okay. So next year, you're saying $5 million to $6 million is embedded in the guide then. And when you look at your Physical-layer business and in the Protocol-layer business, can you help us understand how much of a loss you're taking in Protocol-layer business at the expense of the Physical-layer business say in '19? I mean it sounds like it's not close to EBITDA breakeven? Can you give us a sense of order of magnitude and what that is?

[Pierre Plamondon:]

Unfortunately we don't report on our number by BU like that by division, so this is not something that has been disclosed yet.

[Tim Madey:]

Right, I understand. I mean, I guess I've always modeled the…

[Pierre Plamondon:]

But you can have an idea; we disclosed that Astelia lost $5.1 million EBITDA, so that should give you an idea.

[Tim Madey:]

Right, so I assume that's probably lost about $10 million on an annualized basis, but you're going to be probably reducing that loss with your restructuring and so forth. So I think that gets me into the $5 million or $6 million EBITDA loss at Astellia, just assuming that the Physical-layer business probably runs at a $30 billion EBITDA business, am I in the ballpark with that?

[Pierre Plamondon:]

This is…

[Germain Lamonde:]

This is Germain. We're not quite reporting basically the EBITDA number or the bottom line results on the fair part of group's basis, we got two parts of groups that are -- that are not like full-fledged divisions, if you will, but fundamentally what your right thinking is that part of our strategy has been to strengthen both organizations, some of that of course again a lot of good things being done, I am very confident despite the fact that we had short-term execution issues, I think fundamentally we're really heading in the right direction with both sectors of where this is the Physical-layer, that we do you know deep down in the field and as well the relevancy that we've got now with the combined solutions of Ontology plus Astellia plus what EXFO has in the system's point of view to really make it a huge differentiated offering in the marketplace. Now, you're right thinking that some of our initiatives with the cost reduction was aimed to show that we can align both businesses to be in the positive domain. We're not reporting at that level, but fundamentally, we were also aiming at getting six significant efficiency, which by itself, and to the credit of the management team, the efforts that went through in the last few months to complete all of these massive transformations that probably lead to somewhat have less of the short term focus, but I'm actually convinced that these efforts will lead basically to both for a groups to both be in the positive demand with evitable timeframe.

[Tim Madey:]

Right. I understand your long-term focus and the strategy makes sense to me, and you've got this dominant Physical-layer business and it makes sense to invest in another growth engine. I guess, what I was trying to do is highlight or understand some of the underlying value in the Physical-layer business, understanding that you're taking something from there on a cash flow basis to reinvest in maybe a bigger opportunity that has kind of fantastic synergies with the Physical-layer side?

[Pierre Plamondon:]

Taking the financial synergies, when we're looking at the way financials is going to deal that's that be basically public, very deep small cells, the consideration in the marketplace, it's going to require basically a massive amount of fund to deployment all the way up to a wide number and growing number of our point of presence in the wallet segment. The combination of this fiber leading at a market presence, we have around the world combining it with the ability that Astellia export hires, on the system side, the idea really is to bring acceleration, thanks to the plan that was implemented, and despite there was a short-term lead to an execution standpoint .I think EXFO vote on the -- we'll vote that even nice sell of executions, it's always been extremely important and I think we can be assured that this is a short-term blip.

[Tim Madey:]

Right. Have you thought about the -- I think it's a 2021 EBITDA margin target, or do you think regardless of the revenue ramp that you can still maintain kind of that 15% cut?

[Pierre Plamondon:]

We haven't talked 2020-2021 EBITDA target, but I think we have to take one step at a time.

[Tim Madey:]

Yes, the only reason why I ask is because in the past you've included, if not just wanted to understand where you probably on that?

[Pierre Plamondon:]

Yes…

[Philippe Morin:]

I think the overall plan remains -- I mean, I think from a strategy point of view, Tim, as we look at our business we feel really good around the Physical-layer, providing the right growth, organic growth, and in order for us to get to that 15% from that base line up, we absolutely as you said the strategic focus around the Protocol business, the fact that it's that much more software-intensive, the fact that it's got much more solutions base, is how we're going to continue to get that growth and get us to an a 15% EBITDA.

[Tim Madey:]

Okay, great. Thank you, guys. Appreciate it.

[Philippe Morin:]

Thank you.

[Operator:]

At this time, I would like to hand the call back over to CEO, Philippe Morin for final remarks.

[Philippe Morin:]

All right. So just as we conclude the call, just a few key takeaways, first, fiscal 2018 was a pretty critical and transformative year for EXFO, as we have strategically positioned the company now in the two main industry growth drivers, which is fiber build-out to the edge, to the -- the example to the home and to the small cells, and as well getting into that 5G investment cycle. It's also a year that we are somewhat -- we're disappointed with our performance on our profitability, and we're really making sure that we'll put the focus on execution and making sure we're back on track with 2019. Second, we're in the process of implementing a reorganization plan that will increase our efficiencies, it will increase as well our profitability as we imply -- anticipate to have a cost savings of over $10 million on an annual basis -- $10.5 million. Finally, we're targeting a $24 billion EBITDA for fiscal 2019, reflecting the full-year impact of Astellia. A larger proportion of EXFO's business subject to longer sales cycles and revenue recognition cycles, and that's also then therefore countered by our expected cost savings and our organic growth. So, this concludes our Q4 2018 conference call. On behalf of the entire EXFO team, thank you for joining us today.

[Operator:]

That does conclude today's conference. We thank you for your participation.