EXFO Inc.
Q4 2017 Earnings Call Transcript

Published: 13 Oct 2017

[Operator:]

Good day and welcome to EXFO's Fourth Quarter and Year End Fiscal 2017 Conference Call. Today's conference is being recorded. At this time, I would 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 fourth quarter and year end conference call for fiscal 2017. With me on the line today are Germain Lamonde, EXFO’s Founder and Executive Chairman; Philippe Morin, Chief Executive Officer; and Pierre Plamondon, Vice President of Finance and CFO. 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 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 numbers to our IFRS results is available on our website 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; will assess the company’s results in fiscal 2017 and outlook for 2018. Germain will cover our acquisition strategy and recent transactions and Pierre will review our financials. So, I will turn the call over to Philippe.

[Philippe Morin:]

Thank you, Vance, and good afternoon everyone. I’m very pleased with our strong financial results in this fourth quarter of our 2017 fiscal year; highlighted by three major points. Number one, our sales were at top of our guidance range at $63 million; number two, even better bookings at $66.3 million for a book-to-bill ratio of 1.05; and number three, we had our actually highest adjusted EBITDA margin in recent memory at 13.6%. These fourth quarter results combined with the recent strategic acquisitions that Germain will cover, are solid foundation to build on our - for our fiscal 2018. Overall, in our fiscal 2017, EXFO delivered a 5% sales growth with $243.3 million of revenue and adjusted EBITDA of $22 million. These annual sales results reflect EXFO’s leadership and continued leadership in optical testing, ongoing 100-gig investment cycle among the communication service providers and the company’s growing business with the web scale operators. On a product line basis, sales from our physical layer solutions increased by 6.6% year-over-year which represented a solid growth for a mature end markets products like optical and copper testing. Once again our market leading optical test solution delivered their best year on record with strong revenue contributions from products like OTDRs, our related iOLM solution software single-end ended PMD and CD Analyzers and as well a fiber inspection probes just to name a few of our key optical related solutions. On the protocol side, the revenues dropped 1.7% year-over-year mainly due to the restructuring of our passive wireless monitoring solutions that we announced in early May. If you recall, we decided to rationalize this product line, because it didn’t have sufficient scale to create a sustainable business case. Our other protocol solutions, which includes our Transport and Datacom test instrumentation, our active service assuring systems and as well as our network simulators had relatively flat or slightly down year. With regards to EXFO’s growth strategy, we’ve made significant investment in 2017 both internally and through acquisitions to position EXFO for the next wave of spending as our communication and service provider customers continue with massive network transformations. Accordingly, our growth strategy for 2018 and beyond is based on investments in four key technology areas, first fiber deployment. Fiber is being deployed everywhere, supporting 1-gig transmission rates to the home, 100-gig in metro links and datacenters and even now we’re starting to see deployment for 400-gig solutions in both lab and field environment. As a market leader in optical and high-speed transport testing EXFO continues to leverage the 100-gig investment cycle. We’re also well-positioned for the latest market requirements with the commercially available 400-gig test solutions and now our high-end lab instruments from our recent Yenista Optics acquisition. In fact, the Yenista acquisition further strengthens EXFO’s position as the number one supplier in global fiber optics test equipment market. The second technology trend, the Cloud. EXFO is helping web scale operators deliver reliable cloud services with a dedicated test offering for both inside and outside their datacenters. For interconnecting datacenters our 100-gig test solution ensures a smooth fiber deployment and faster time to market at quality of service. Inside the datacenters solutions like our new optic, automated multi-fiber inspection probe are significantly boosting efficiency and driving down operating expenses. The third technology trend, network virtualization. As telecom networks are increasingly becoming more virtualized to increase service agility and save on cost EXFO is taking the lead to enable a virtualized world. We have designed virtual verifiers that are released on generic white label servers alongside virtual network functions. And in 2017, we evolved from proof-of-concept to commercially shipping mode for our virtual monitoring solutions. We’ve also acquired real-time network topology solutions from a company Ontology Systems to complement our active service assurance offering. Ontology software use semantic searches to be a real-time use of network services and their related elements. This mapping is essential for automatic root cause analysis and troubleshooting, but especially as networks can change on the fly in a virtualized environment. Finally, the fourth technology and market focus area for us is 5G. 5G represents the next technology milestones for mobile networks. Communication service providers are investing heavily in fiber in front-haul and back-haul network initiatives to get ready for 5G mobility. Early in fiscal 2017, we acquired Absolute Analysis Optical RF technology for testing fiber-based mobile networks. The software solution is critical for analyzing RF interference issues in fiber-to-the-antenna, distribute antenna systems and remote radio heads. We’ve integrated a software now into our FTB-1 professional platform providing EXFO with the only all-in one optical, Ethernet, RF over CPRI test solution in the market, which represents a key competitive advantage especially as the industry migrates towards 5G and deployment of small cells, and new radio technology. We’re also in the process of acquiring Astellia, a leading provider of network and subscriber intelligence for mobile operators and should this friendly takeover be successful we will allow EXFO to strengthen service assurance portfolio in the industry leading passive wireless monitoring. Germain will be providing much more information as we get into the next section of our call. To summarize, EXFO delivered a solid financial results in 2017. We’ve also made significant investments both internally and through acquisitions to position EXFO as the trusted advisor helping communication service providers cope with network transformations. These investments combined with high-end sales efficiency and recent restructuring measures represent a strong foundation for EXFO to generate profitable growth in 2018 and beyond. Now, let me provide you with our financial outlook for the first quarter and fiscal 2018. We’re forecasting sales between $60 million and $65 million for the first quarter, while IFRS results should range between a net loss of $0.01 per share and net earnings of $0.03 per share. IFRS net results include $0.02 per share and after tax amortization of intangible assets and stock-based compensation cost. For fiscal 2018, we are targeting adjusted EBITDA of $26 million which represents a year-over-year increase of 18%. This guidance was established by management based on existing backlog as of date of this conference call, seasonality, expected booking for the remainder of the quarter and exchange rate as of date of this call. So at this point, I will turn over the call to Germain, so he could provide more color on our recent acquisitions.

[Germain Lamonde:]

Good afternoon everyone and thank you, Philippe and congrats for the good results, great quarter for Q4. But as you all know basically my decision to move into the Executive Chairman role in early April, was to devote more time to long-term initiatives like M&A, internal subject initiatives and corporate governance. So Philippe, whom I’ve known for many years has come from CNR and now assumes full responsibility on the day-today basis of EXFO as CEO. So, this planned change in the Executive Management structure served EXFO very well in fiscal 2017 given a very positive results just covered and highlighted by Philippe and with the closing of the Absolute Analysis and Ontology System deals while laying out the ground work and foundation for the Yenista Optics and Astellia transactions to keep transforming EXFO according to our three year growth strategy. So they were aligning with Philippe’s earlier comments on EXFO’s four key strategic imperatives let me add a few words about our recent acquisitions. First, we acquired Absolute Analysis to get ready for the upcoming 5G play Philippe described, especially now that mobile network operators are upgrading their wireless infrastructure with centralized RAN and soon to be virtualized RAN infrastructure virtually and significantly boost their network capacity while reducing latency for 5G and IoT. So this acquisition has been -- as laid also the foundation of our new [Skyra] [ph] offering by which EXFO will provide unprecedented real-time visibility into RF interference and pin problems that are critical to -- so critical to MNO, mobile network operators user experience and effective use of their expensive spectrum. Second, we’ve acquired Ontology’s real-time network topology and service chain discovery solutions to strengthen our network virtualization play earlier discussed by Philippe. So and while completing the same time -- complementing at the same time our active self-assurance offering. As discussed in the past Ontology’s software and user semantic searches to be at real time use of network services and their related elements. This mapping is greatly strategic and synergistic to our active solutions and essential to automate root cause analysis especially as network are going to be changing on deploying the virtual environment. Thirdly, the Yenista acquisition et cetera is EXFO’s fiber play by providing EXFO’s with complementary technology in our fiber test portfolio. It also raises EXFO’s position to the position of clear market leader in the fiber optic testing all market combined and we intend to gaining market share in this additional $100 million addressable market that Yenista brings to EXFO to expand our presence in the system vendors and company manufacturers markets. Fourth and not the least to greatly accelerate our position in both virtualization and 5G play as Philippe as mentioned before. We have announced at the end of August our acquisition of 33.1% of the shares of Astellia with the intent to farther remaining shares of the company through a public process. Should this friendly takeover to be successful it would bring to EXFO’s service assurance portfolio, the industry’s leading passive wireless monitoring, professional services and subscriber analytics capabilities that Astellia has developed over the last 17 years. It should provide EXFO with the strong footboard and bodes well with mobile operators who are investing in high speed low latency 5G wireless infrastructure. Astellia would clearly fall in the category of transformative acquisition should it be completed, this supplier of network and subscriber intelligent for mobile, reported sales of nearly $60 million in calendar 2016. The France-based company also as global, globally more than 120 customers and 400 employees located mostly in France and Spain. We are currently preparing a public tender offer to purchasing the remaining -- for the purchasing of the remaining Astellia shares on the market, should the final takeover bid to be successful, it would provide EXFO with the scale and significant differentiation to become the top-tier player in this [assurance] [ph] and analytic space globally. All these transactions are the results of the well planned acquisition strategy where we selected a few markets and technologies areas in which we have specific interest and proceeded to a detailed analysis in terms of both market landscape and technology before we are setting the targets with the discipline of assuring that we have the right parameters to bring value to our shareholders. Should be noted that we have secured additional credit facilities to meet the financing requirements of these acquisitions. I’m very excited in my new role as Executive Chairman as reflected by our recent board strategic announcements. And I really do trust that we have the right executive structure supported by very solid senior management team and very committed workforce to allow for acceleration to our growth in revenue, but also more importantly in EBIT. At this point, I will turn the call over to Pierre for the financials of 2017.

[Pierre Plamondon:]

Thank you, Germain. Good afternoon everybody. Annual sale increased by 4.6% to $243.4 million in fiscal 2017 from $232.6 million in 2017. As previously mentioned, our leadership in optical testing the 100-gig investment cycle and growing business with web scale company [indiscernible] to grow faster than its end markets. Booking meanwhile increased 4.8% to $251.8 million in 2017 from $240.3 million in 2016. In the fourth quarter of 2017 sale reached $62 million while booking obtained $66.3 million for a book-to-bill ratio of 1.05. Gross margin amounted to 61.2% of sales in fiscal 2017 or 61.9% excluding restructuring cost compared to 62.6% in 2016. In the fourth quarter of 2017 gross margin reached 61.9% of sales. Our gross margin decreased in 2017 mainly due to the restructuring charges involving severance expenses and inventory write-offs and less sale of higher margin protocol solutions. We believe that our gross margin be in a range between 62% and 64% in fiscal 2018 based on higher sales volume including revenue from recent acquisition as well as improved sales mix. Moving to operating expenses, selling and administrative expenses totaled $86.3 million in fiscal 2017 compared to $82.2 million in 2016. In the fourth quarter of 2016, SG&A expenses totaled $20.8 million. The annual increase in SG&A dollars can be attributed to the restructuring charges of $1.2 million, our expenses following the Absolute Analysis and Ontology System acquisition during the year as well as one-time cost related to the acquisition totaling $1.1 million. As a percentage of sales SG&A expenses reached 35.5% in 2017 or 34.6% excluding restructuring charges and acquisition related cost. We expect our annual SG&A expenses will range between 32% and 35% in 2018, but they will likely be higher in the first half of the year due to the acquisition related cost of Astellia and Yenista. Net R&D expenses totaled $47.2 million in fiscal 2017 compared to $42.7 million in 2016. In the fourth quarter of 2017, net R&D expense amounted to $11.3 million. The increase in net R&D dollars in 2017 can be attributed to restructuring charges of $2.2 million, our expenses following the Absolute Analysis and Ontology System acquisition as well as the shift in the mix and timing of projects. As a percentage of sale, net R&D expenses obtained 19.4% in 2017 or 18.5% excluding restructuring charges. We expect that net R&D expenses will range between 18% and 20% of sale in fiscal 2018. However, it should be noted that our Q1 2018 operating expenses would be higher sequentially like in previous year given our Q4 operating expenses is reduced by the seasonal effect of summer holidays which significantly lower our payroll and benefit expenses. In addition a stronger Canadian dollar today compared to the previous quarter will likely increase our operating expenses. Finally, we will incur additional expenses for the ongoing Astellia transaction particularly in Q1 and Q2 as well as operating expenses related to the Yenista acquisition that closed in early October. In fiscal 2017, IFRS net earnings totaled $0.9 million or $0.02 per diluted share. Net earnings in 2017 included net expenses totaling $10.6 million notably $2.7 million in after tax amortization of intangible asset, $1.4 million in stock-based compensation costs, $4.8 million in after tax restructuring charges, $0.4 million for the positive change in the favorable year of the cash contingent consideration related to the Ontology acquisition. $1.1 million in after tax acquisition related cost and a foreign exchange loss for the year of $1 million. In the fourth quarter of 2017 IFRS net earnings amounted to $0.8 million or $0.02 per diluted share. In terms of geography, sale in the America as well as Europe, Middle East, Africa increased 5.6% and 8.6% respectively in 2017, while sale in Asia Pacific dropped 2.9% largely due to a slowdown in China. Looking at the sale split, the Americas accounted for 55% of sale in 2017, Europe, Middle East, Africa represented 26%, while Asia Pacific totaled 19%. Turning to customer diversification, our top customer accounted for 10.1% of sale in 2017, while our top three represented 18.4%. Moving on to few key points on the balance sheet. Our cash position decreased by $8.1 million year-over-year to $39.2 million at the end of 2017. We made cash payment of $12.8 million for the acquisition of Absolute Analysis and Ontology System, $7.2 million for per share of capital asset and the $1.5 million for the repayment of the long-term debt assumed as part of the Ontology deal. These cash outlay where partially offset by $12.9 million in cash from operating activity. At this point, I would turn the call over to the operator for the start of the Q&A.

[Operator:]

Thank you. [Operator Instructions] And we’ll now take our first question from Todd Coupland with CIBC.

[Todd Coupland:]

Hello. Good evening, everyone.

[Philippe Morin:]

Hi, Todd.

[Todd Coupland:]

I was wondering if you could clean up the fourth quarter items like you did for the year. So, after tax items of amortization, FX and restructuring if you could please?

[Pierre Plamondon:]

Yes. We’ll do. The after tax for the -- give me a minute to get my file, so the -- for Q4 the amortization of intangible asset is $1 million, the stock-based compensation cost is 400k, restructuring charge is $1.3 million and net income tax effect on those item is 0.3 - 300k.

[Philippe Morin:]

Information is also on our press release Todd.

[Todd Coupland:]

No, I saw all of those items, I was just wondering if you had the total including the FX and the net tax. So, the amortization - the FX there is no tax effects to that total number?

[Pierre Plamondon:]

No, the foreign exchange loss of $2.9 million, this is mostly untaxed.

[Todd Coupland:]

Untaxed. Okay, thank you. What does a pro forma balance sheet look like for the company assuming you closed the current acquisition in France?

[Pierre Plamondon:]

Yes. Maybe on the cash balance what I can say is we closed the year with $39 million in cash available right now. We have done $21 million in U.S. payment so far for the acquisition of Yenista and Astellia that leave us with $80 million in cash; if we exceed we will have to pay about $21 million for the remaining of the share of Astellia probably in January. So, it would be a negative cash of $3 million, we have actually -- actual line of credit of $15 million and as Germain mentioned we have already extended our credit line to increase our availability of cash.

[Todd Coupland:]

Okay. So less than $5 million drawn on the – on, do you say $15 million or $50 million on the line of credit?

[Pierre Plamondon:]

15, 1-5.

[Todd Coupland:]

15, okay. Thank you. And then are you providing any type of pro forma commentary around what that $60 million might look like if it were included for outlook fiscal 2018?

[Pierre Plamondon:]

It would depend on the timing of the when we would close the deal, it would be if we can close the takeover bid our expectation to close it at the beginning of calendar 2018 sometime in January, February. So we would have to consolidate those results at the time that we get the takeover bid completed. So, it would be -- let’s say from January to August that we would have to account for the reviews.

[Todd Coupland:]

No, I just, I get that but, in terms of like synergies or EBITDA target would that be consistent with targets for 2018 for the overall company, what might that look like?

[Germain Lamonde:]

Thanks Todd for your question. If you just -- in supplement here what I would say is that the, there are no synergy that have been basically at this stage communicated or announced or discussed. We’re in the stage of publicly -- public process if you will. The [default] [ph] synergy and this and this and that should - will be analyzed in the months to come. And the guidance that Philippe has talked about in terms of adjusted EBITDA target for the new fiscal year $26 million is in exclusion of the Astellia acquisition.

[Todd Coupland:]

Do you see what -- just conceptually do you see this business as a comparable business, once you’ve folded it into EXFO?

[Germain Lamonde:]

Well, the best thing we could see in terms of financial model, the public statements that were published by Astellia are available on their Web site, we can quite comment on this point not net in terms of, the way they have been modeled, neither in a way of what kind of synergies or how we can actually project the growth rates in the future for that business. So, but basically I think what you find in their Web site is that they are well managed organization that is in line with industry practice within that segment.

[Todd Coupland:]

And then just last question if I could, just on the optical trends, so I guess it’s strong robust market, is there any comments you can provide either on the U.S. or China and what trends you’re seeing as we those two regions as we go into the end of the year? Thanks very much.

[Philippe Morin:]

Yes. Todd, so and the trends are as I mentioned earlier that around the fiber build out whether is for fiber build out to the home, fiber build out in metro infrastructure or datacenter is continuing to be really strong specially in Americas what we’ve also seen and we’ve mentioned that Pierre mentioned that earlier that there is a China slowdown that we have experienced in the Q4 and actually the matter of fact the last two quarters of fiscal year. But, really when you look at the progress we’ve made by region both in Europe and the Americas that is around the 100-gig cycle fiber deployment, fiber to the home that we being a strong number one market share in that market where we’re able to benefit from that market growth.

[Todd Coupland:]

Okay. Just one last question if I could sneak in it on China. Do you have a view on when that market might reaccelerate or is it difficult to tell at this point?

[Philippe Morin:]

I think the fundamentals behind the market in China with regards to fiber deployment and then as well getting ready for more 5G, getting ready for 5G deployment for me ultimately we were expecting that market to start regaining again into our fiscal 2018. But again very harder to predict.

[Todd Coupland:]

Okay, thanks gentlemen appreciate the color.

[Operator:]

And we’ll now take our next question from Richard Tse with National Bank Financial.

[Andrew McGee:]

Hi guys it’s actually Andrew McGee in place of Richard. Just looking at your protocol layer bookings in the quarter, they are particularly strong, my question is whether there is maybe anything more to that number and maybe if a couple orders are pulled in or if there is a change in the macro environment any color around that would be very helpful? Thank you.

[Philippe Morin:]

In our protocol business there as I mentioned earlier in my opening statements, there are multiple what I would call solutions that we can provide from test and datacom to service assurance to simulator, again some of our solution around 100 gig some of our optical RF discussions that we’ve talked about highlighted as well, some good strength in as well, and what I would call longer sales cycle solutions around service assurance and monitoring. So, overall we had a strong finish into Q4 around a few of these businesses.

[Andrew McGee:]

Okay, but you wouldn’t characterize the quarter as anything out of characteristic in terms of maybe a couple of orders pulled in it was just overall strength in the multiple solutions that you have in the portfolio?

[Philippe Morin:]

The only thing I would comment a bit more is that they tend to be again longer sales cycle than they tend to be bigger deal. So when we see kind of progress like that they are some deals that were bigger size and which had a positive impact. So there is a bit of that factoring in our growth in Q4.

[Andrew McGee:]

Okay, thank you very much. That’s helpful. I’ll pass the line.

[Philippe Morin:]

Thank you.

[Operator:]

And we’ll now take our next question from Tim Savageaux with Northland Capital Markets.

[Tim Savageaux:]

Hi, good afternoon. I got a number of questions and then congrats on a solid quarter. Just to follow-on that protocol strength question, what we have also seen a corresponding strength out of Europe which looks to have been the case some pretty extreme strength in Europe, almost I’m getting my numbers wrong, but are there is some overlap there between a rebound on the protocol side, just maybe among European carriers or you have any other comments on geography or it looks like you saw a takedown in the Americas and a pretty sharp increase in Europe in Q4?

[Philippe Morin:]

Yes, as Pierre highlighted we had a good quarter Tim in Europe in terms of growth and as well in Americas and the decline in Asia due to China. On the EMEA growth I would say it was good solid performance again on our physical kind of performance, but as well on the protocol that we’ve secured. A few deals around service assurance in particular and that created that pattern that we’ve seen. So, I do think that when we look at our geography kind of coverage some of these deals have coming into Q4, but we do again both Americas and EMEA I think that’s where we continue to see good progress on both protocol and physical while we think that Asia is going to again maybe with because of the China situation, a bit more of a challenge.

[Tim Savageaux:]

Okay and then, when you did see protocol sorry physical layer booking done after a very strong quarter last quarter it does look like you have some seasonality there historically, but at least on a sequentially basis and I’m talking year-over-year now. Anything to comment on there with regard to sequential step down on the physical layer side from a booking standpoint?

[Philippe Morin:]

Yes so I think, first of all you had to look at it year-on-year we’ve actually increased slightly. So we’ve gotten from 35 sorry from $39 million to $40 million. So there is some growth year-on-year sequentially, I think that you there is a slight decline and that’s as you said Tim that’s the seasonality aspect of that business, when you go through the, especially on the physical side of our solution.

[Tim Savageaux:]

Okay great. Let me move on to comments around the acquisition, so if I hear you correctly, I assume Yenista is included given that it’s closed in the guidance for the year, but Astellia is not, either from a and this is kind of where my question is going either from a accretion or dilution standpoint, noting that the company is currently at least was in the first half of 2017 EBITDA negative and with the revenue run rate it looks like it’s close to 40 million then 60 million actually on an annualized basis. So, you know seeing some pretty good year-over-year revenue declines. So there is nothing factored in and that is to say I mean there was reference, I guess there were some reference in Pierre’s commentary in terms of the gross margin and maybe OpEx guide to some impact from expenses from acquisitions. So, I just want to, I’m a little confused there and I want to try and clearing that out are you seeing a neutral impact or what are you?

[Pierre Plamondon:]

What you’re assuming are continually the legal cost and due diligence cost to complete the transaction, okay only that.

[Germain Lamonde:]

And let me add a little bit Tim that, well first of all it’s a pleasure for me to be here today, in fact specifically results about the acquisitions, the team is actually doing a great job and I am joining this call as more of an exception basis here to cover that. But, fundamentally what -- I’m not going to comment too much on the press release that say just published in the first semester. You have to read historical results from Astellia that their first semester is always [substantially] [ph] with the second semester is all about. And when you look at their press release they are talking about historical best booking ever and revenue wise this is their second book year -- best revenues in their history. But beyond this what you have to look at is their annual results of 2016 to get a better view for H1 and H2 and so on and so forth. So, we can’t comment much on the next stages of acquisition of course this is an acquisition process that we’ve done with the positive support from management. This is a perspective acquisition for the time being, you are right assuming the dollar is included in our models, but we have not included a stereo effect at this stage is an acquisition of the process which we can’t confirm or we can’t predict the outcome of the acquisition.

[Tim Savageaux:]

Okay and final question from me and its following on the initial question on the balance sheet, I mean on operating basis, to the extend you bring this asset in and you know somewhere in that range cost $15 million in revenue and you are up over $300 million most likely, what kind of cash do you need to run the business under those circumstances and what sort of run rate cash balance should we think about the company targeting given…

[Pierre Plamondon:]

Okay, thank you Tim. The target is to have in excess of $20 million, $25 million of cash to smoothly run the businesses and have the liquidity to finance our expenses, investments and so on, which is roughly the minimum cash that we need to run the business.

[Germain Lamonde:]

And we clearly have to access to more than we did in terms of additional financial capability if we need to.

[Tim Savageaux:]

Okay. Thanks very much.

[Germain Lamonde:]

Thank you very much, Tim.

[Philippe Morin:]

Thank you, Tim.

[Operator:]

And we’ll now take our next question from Justin Keywood with GMP Securities.

[Justin Keywood:]

Hi. Thanks for taking my questions. Just given the positive trends mentioned and assuming two on picks up so these recent acquisitions the guidance seems a little conservative they had $60 million to $65 million or am I missing something here?

[Philippe Morin:]

You’re right that the, we have a combination of the acquisitions kicking in Yenista and Apply, Ontology but we also have to remember that we are taking decision around our passives portfolio that actually contributed to our business last year in Q1 that we’re no longer going to have that contributing to the business. So it’s a combination of seasonality, combination of what we are seeing in both our physical and protocol-layer acquisitions and some of the year end money that is -- if could potentially be available. We don't know it will be available at this point. So again, based on the data points we have, we felt that was protagonist to provide for our Q1.

[Justin Keywood:]

Okay. And do you have any expectations for the organic growth of the business given product segments going into next year?

[Philippe Morin:]

So overall, I think the organic growth it tends to be in -- when you look especially on some of the physical product, we have been showing some before Yenista as an example, we have seen providing 6% kind of view I think. Overall, the 4% to 6% type of growth, organic growth on the physical layer makes sense. And now, we have got Yenista that's obviously helping. On the protocol side it's a bit more of a challenge just to now start splitting out the pure organic especially now that we have got -- made decisions around as I mentioned, the restructuring of the passive, you've got the new acquisitions coming in and as well the good progress we are getting on our 100-gig, 400-gig solutions and optical RF. So, not as clean in terms of providing you a view that it is on the physical layer side.

[Justin Keywood:]

Okay. That's helpful though. And then, the press release mentioned sales efficiency and I think you spoke about this in the past. Now, notwithstanding the acquisitions, is it where you want to be or is there still work to be done there?

[Philippe Morin:]

There are work to be done. I think as I mentioned in the past, this is a multiyear transformation of our sales team from focusing on our top-20 accounts leveraging some of our key partners and making sure that we have got the right sales coverage. As I mentioned in the past we've increased our sales coverage for the web scale which is paying off. We've also made the right optimization, so from a sales coverage and by regions. And we have continued to also make some further transformation in both 2018 that will positively impact our sales efficiency.

[Justin Keywood:]

Okay. And then, maybe a question for Germain. I think you mentioned in your opening remarks, in your new role as Executive Chairman, it will be primarily around M&A, well, first is that correct?

[Germain Lamonde:]

One of the primary role that I really want to play is to really give additional credibility to the whole organization in terms of long-term development. The example, I would give is probably for those of you know that companies like CGI, there has been probably more growth in CGI in terms of acquisition post Serge Godin taking over as Executive Chairman. It's a bit where we want to go and I think what we have shown in the last 12 months is a good example of that.

[Philippe Morin:]

As an example, Justin, just to try to correct me, I really strongly believe that closing the two the strategic investment in Astellia and Yenista at the end of the quarter without that structure that we have with Germain and I would have been really difficult to finish on a strong quarter like we did and perform on the acquisition.

[Germain Lamonde:]

That's a great team work.

[Justin Keywood:]

That's good to hear. And then, just a follow-up, how do you view acquisitions going into this year, is the focus just on integration or is there still opportunities out in the market?

[Germain Lamonde:]

On the short-term, of course, what we will be doing is focusing a lot more into data bring the synergies from some of these acquisitions whether this is -- we have a lot of good things to come from an Absolute Analysis, Ontology and Yenista standpoint. So making sure, we did with the synergies with these deals and making sure that we generate cash and help basic to refund our balance sheet in fact to some degree. A lot of focus around of course the integration and to make sure that we can bring these synergies. When it comes to Astellia, this is basically longer term process; we said months before we can -- perform, no, if we close successfully or not. So, we have months ahead of us that we are going to be working on and making sure drive the businesses as a whole if success to be -- did we bring the expected kind of result. So, on the shorter term don't expect to see as many results -- as many acquisitions. Expect us to be focusing on internal execution and execution we did with the synergies and making sure that we reveal the balance sheet NAV. But, we are going to remain acquisitive especially on the T&M side where we very much believe in the -- typically a small strategic and highly synergistic acquisition strategy we have deployed and we have mentioned in the last few years. With a very strong focus around the four axis that were described by Philippe on the fiber, 5G, virtualization and cloud where we believe we can actually make a huge impact in the marketplace.

[Justin Keywood:]

Okay. Thank you for taking my questions. That's good to hear.

[Germain Lamonde:]

My pleasure Justin.

[Justin Keywood:]

Thank you.

[Operator:]

And we will now take our next question from Robert Young with Canaccord Genuity.

[Robert Young:]

Hi, good evening. I wanted to ask -- there are a lot of questions about the bookings and protocol and I think you said that there was some larger deals that might have closed through at the end of the quarter, I'm not sure if I've heard that correctly. And then, just sort of put an umbrella on top of that, are you still seeing any delays or spending delays on the protocol side or is that pretty much clear, are you seeing a better market now going forward.

[Philippe Morin:]

Yes. We have had Robert as you mentioned some contracts work that we actually close in Q4 that helped in creating that type of growth that we saw on the SE side or on the protocol side, sorry. And to your point, these contracts tend to be a longer and larger cycle as well. So, and that when you look at the timing of this, obviously, Q4 had a very strong quarter and then that's the bit of the nature of having these deals that tend to be a bit bigger than on the physical layer side, it had to be better margins but at the same time as well it tend to take a bit longer and sometimes create a bit of a seasonal aspect or a stronger quarter aspect.

[Robert Young:]

Right. And like are there other large deals that you would have in the pipe that you think would be still at risk to spending delays or are those starting to move more better?

[Philippe Morin:]

Yes. I think overall, again, there is multiple business units in that protocol. I think overall what I would say Robert is that there is a bit of a pause that I think we talked about last time around this whole virtualization aspect of -- especially when you look at service assurance and the similar business around, would you -- should people are looking at, what were the implication of the virtualization as the [NNAV] [ph] and so on. And I think that for our case, what I would tell you is the funnel is now gone a better -- it's a better visibility and bigger funnel opportunity that probably what we have seen in the past. So, we are starting to see that trend starting to occur. I think as the service providers are making decisions now on what they want to deploy in terms of solutions. And then, ultimately we are very focused on converting those that funnel into our wins.

[Robert Young:]

And then, on the to go market improvements that you were talking earlier in the call, is there any -- maybe, if there is any kind of color you can provide around traction with the top-20, the Web 2.0 targets that you wanted to focus on. How is that moving and is that any part of this the bookings growth?

[Philippe Morin:]

I think Robert, I mean, again, probably first time you are seeing this as a data point, we haven't shared this in the past, but, when we started our top-20 focus that was around 35% of our business were top-20 and I think as we looked at 2017, we brought that up to 42% of our overall revenue into the top-20. So, we are starting to see the impact of that focus globally. And then, again, part of it is putting a team in place and living and breathing with what those accounts are doing. And we are going to continue to go through that transformation and to increase our efficiency overall as well not just with the top-20. But, what we are doing on the regional customers, some of the specific market segments, and as well supporting our key partners.

[Robert Young:]

Okay. And to -- I just wanted to challenge that sale efficiency, I was just looking at the guidance of 33% to 35% SG&A, which -- it doesn't look like there is a lot of efficiency in that number and so, I was wondering is there acquisition doing pack in there or because is it the first half should be model that materially higher, I was just trying to figure out, how we would expect to see that efficiency come through in that metric?

[Philippe Morin:]

Yes. Now, you have hit the two points that effectively. So, all the acquisitions coming in had an impact. So obviously as we brought in Ontology, we brought in Yenista and Absolute Analysis, obviously has had an impact on that as we absorbed those. There is also the emergence in acquisition cost associated with it of the acquisition. And then, the ultimately the currency. The impact of the Canadian dollar also had an impact on our SG&A. So you are right, it doesn't show reflection of some of the benefits we have had. But, I do expect that as we continue to focus on this, we will get to a better arrangement.

[Robert Young:]

Okay. And then, the part of that would -- in the past you -- that can be talked about targeting 15% EBITDA margin as longer term goal, and if I look at the ranges you provide, you are still little below the targets. The high end of all the targets wouldn't get you there. Is 15% still a longer term target for the company and maybe if you can talk about, how long it might take to get there? And then, I will pass the line. Thanks.

[Philippe Morin:]

Yes. So, Robert the answer is absolute yes. We just have gone through our strategic multiyear strategic review. The plan is absolutely to deliver 15% EBITDA into the medium term and that's where we are going to be really working and focusing obviously, we needed on the -- on our monitoring solutions like service assurance, we needed to get better scale, get better differentiating solution that's why some of these acquisitions are going to be really keen for us to get to that EBITDA target along with being a stronger player in 5G. And as well continuing to be a clear number one in optical and Yenista is helping us continue on that trend.

[Robert Young:]

Thanks and congratulations on the numbers.

[Philippe Morin:]

Thank you, Robert.

[Operator:]

We will now take our next question from Tim Savageaux with Northland Capital Markets.

[Tim Savageaux:]

Hi. Just a quick follow-up and a couple of points that I think you touched on but I didn't quite get all of. One on the -- I think you mentioned decline in operating expense in Q4 and expectations for a bounce back up in Q1 -- R&D expenses for their primary driver of the declining Q4. Did you provide any color around that?

[Pierre Plamondon:]

The main explanation is the – in fact that in Q4 we have the vacation period, so salary and benefits tend to be lower because people are taking the vacation. Now, in Q1 we are back on track and we have the full quarter of salary expenses, so this is a significant amount. And at the same time, the currency can get stronger and right now in Q1 compared with what we have in Q4. So, that also increases our operating expenses. Finally, we have Yenista, it will kick in for two months that we have assumed our numbers. And finally, with the take over bid, we had to increase some legal and advisory costs that also been reflected in our guidance.

[Tim Savageaux:]

Got it. And on the top customer metrics, I think top customer where at 10.1, what was the other metric for the top three and what was that percentage again?

[Pierre Plamondon:]

Yes. The top three is 18.4% of sales, 18.4.

[Tim Savageaux:]

All right. Thanks very much. That was it.

[Pierre Plamondon:]

Okay, Tim.

[Operator:]

And it appears there are no further questions in the queue at this time. I would now like to turn the conference back over to Mr. Philippe Morin, Chief Executive Officer for closing remarks.

[Philippe Morin:]

Thank you. So, just a few takeaway as we wrap up the call today. First, EXFO delivered strong financial results in Q4 2017, highlighted by sales at the top of our guidance range of $63 million and our adjusted EBITDA of 13.6%. Second, we have established a strong growth strategy including both organic and acquisitions that are focusing on key market segment growth areas fiber deployment, cloud, network virtualization and 5G wireless network. And then, finally our solid fiscal 2017 results combined with the strategic acquisitions are an early indication of what the new executive management structure at EXFO can accomplish with Germain obviously as an Executive Chairman duties and then me moving into that CEO role, in my eye it certainly bodes well for our fiscal 2018. So, at this point this concludes our Q4 2017 conference call. On behalf of the entire EXFO team, thank you very much for joining us today.

[Operator:]

And ladies and gentlemen, that concludes today's conference call. We thank you for your participation.