EXFO Inc.
Q4 2016 Earnings Call Transcript

Published: 13 Oct 2016

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to EXFO's Fourth Quarter and Year-End Conference Call for Fiscal Year 2016. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. [Operator Instructions]. As a reminder, this conference is being recorded Wednesday, October 12, 2016. I would now like to turn the conference over to Vance Oliver, Director of Investor Relations. Please go ahead, sir.

[Vance Oliver:]

Good afternoon, and welcome to EXFO's fourth quarter conference call for fiscal 2016. With me on the line today are Germain Lamonde, EXFO's Chairman, President and CEO; 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 file 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 results is available in the Q4 2016 press release on our Web site. 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 Germain.

[Germain Lamonde:]

Thank you very much, Vance. Good afternoon, everyone. Thank you for joining for this conference call. So at the beginning of fiscal 2016, we had planned our profitable growth strategy based on higher sales volume, enhanced gross margin and disciplined spending to drive our strong profitability growth. In my view, our fourth quarter 2016 and full 2016 results do demonstrate we delivered on these. Firstly, I’m pleased to report that EXFO delivered a strong fourth quarter 2016, double-digit year-on-year growth in bookings, revenue and EBITDA to respectively 13.7% growth in bookings at $62.4 million, 11% improvement in revenue at $62.9 million and a growth of 24.4% in adjusted EBITDA to $6.2 million in the quarter. So with these solid fourth quarter results, I’m very pleased and happy to report that our fiscal 2016 has also concluded on excellent performance against almost all of our financial metrics, while we continue to strengthen our long-term competitive advantages and market position. Let’s take a look at a few of these essential metrics. First and foremost, we surpassed our profitability target of $20 million that was set at the beginning of this fiscal year by increasing adjusted EBITDA by 60% year-on-year to $22 million or 9.4% of revenues. Bookings grew 7.7% year-on-year to $240.3 million by delivering market share gains in several areas of our product and solution offerings, increasing our leadership position in Protocol optical and high-speed 100 Gig transport testing. With this in turn, we delivered a sales increase of 4.7% year-on-year to $232.6 million or 6.6% on a constant currency basis and delivered therefore a book-to-bill ratio of 1.03 for the full fiscal year. We also improved our gross margin by 900 basis points to 62.6% based on higher intrinsic value of new products, higher sales volume and richer sales mix within our Protocol-layer product line. We reduced our operating expenses by 3% year-on-year due to disciplined spending and have favorable currency exchange rates. We generated $24.4 million in cash flow from operating activities which enabled EXFO to close fiscal 2016 with a healthy cash position that is up to nearly $20 million year-on-year to $47.3 million and no debt at the end of the fiscal year. And we delivered bookings and revenue growth of both our Physical-layer and Protocol-layer product groups as we had initially predicted for fiscal 2016. So let me talk a little bit deeper now in these two product areas. In terms of Physical-layer solution, we’ve announced our competitive position through market share gains in optical and copper testing as reflected by a 70.4% year-on-year booking growth and 5.4% sales growth. We leveraged our leadership position in optical testing and 100 Gig network upgrade cycle to perform very well in this end market. We again gained first-mover advantage by introducing the first industry’s market technology copper test set that supports the new G.fast standard. We’re gaining approval already at several Tier 1, Tier 2 operators globally for their residential ultra-broadband copper deployment initiatives. On the Protocol-layer side, I’m pleased that we generated better results in our fourth quarter with nearly 25% year-on-year booking growth and revenue growth of nearly 22% driven by our solutions business and high-speed optical transport products. For the whole fiscal year, booking grew by 8.3% and sales grew by 3.4% while we reported two large contract wins for our EXFO Xtract analytic solution with Tier 1 communication service providers. If you’ll recall, Xtract provides unique real-time correlation capabilities between a wider range of data sources to enable end-to-end visibility of network services and subscriber dimensions to help operators to first prioritize most critical issues to be addressed within a network; second, to really allow a very deep root cause analysis as a result of these problems faster. And third is to often time predict problems before they actually start impacting customers. As part of our solutions offering, we’ve also released TestFlow, a unique cloud-based field test automation solution that allows service providers to automate complex labor-intensive tasks during fiber-to-the-antenna or distributed antenna systems or small cell rollouts or fiber-to-the-home kind of deployments. So our deal funnel on these two advanced solutions is growing quite nicely. Combining these with our active and passive assurance offering of both hardware or conventional hardware centric or next generation NFV/SDN enabled capabilities. These are making EXFO uniquely positioned as the solution provider and trusted advisors to operators in the midst of virtualizing or increasingly virtualized network functions within the technology mix as they seek to drive deployment of automation to accelerate time to market while reducing costs. In the process we are creating stickiness in these accounts through repeat business, software upgrades and professional services to gradually increase recurring revenues which accounted for about 12% of revenues during our 2016. Now looking ahead to fiscal 2017, we will maintain our strong focus on delivering strong EBITDA growth even in a context of a potentially more moderate revenue growth. The overall market environment is one where we see very important for transformation and it is clear how EXFO can play a significant role in helping communication service providers globally to build and operate smarter networks, improve the quality of services and do this increasingly more efficiently way both on the test and solution standpoint. EXFO has established a robust foundation and reputation in high-speed optical testing and will continue to build on that position as CSPs around the world are pushing ahead with their 100 Gig upgrade plans given the accelerating growth over the top video [indiscernible] and the proliferation of smartphones or tablets. Whether this is in America or in China or globally, whether this is with fixed mobile or Web scale operators, all are investing in their cloud-based infrastructure and data center capabilities to render these services in a more effective way. We’re also taking increasingly advantage of the long-term transformation of service providers moving forward, as they’re moving towards virtualizing to the network functions and cloud-based services to become far more agile at a much lower cost of operation. The increase in network’s complexity when you mix and match physical and virtualized environment into hybrid networks is calling for an increased role in advanced analytics capabilities across the mains and EXFO is committed and uniquely positioned to increasingly become the trusted advisor to leading service providers. We anticipate heightened customer traction as service providers are increasingly realizing the importance of such assurance and analytics to their long-term success and profitability, as CSPs – if you can’t properly deploy and monetize a new service, you will not subdue that unless you can properly deliver it and thus you have people to monitor it adequately. Looking out at our 2017 guidance now, let me provide you with some outlook for the first quarter of fiscal 2017. We are forecasting sales to stand between $59 million and $64 million for the reporting period that will be extending from September 1 to November 30 2016. As the midpoint of this guidance, this is up 10% versus the same quarter last year. Looking at the bottom line IFRS net result are expected to range between a loss of $0.01 per share to earnings of $0.03 per share for the first quarter of 2017. IFRS net earnings include $0.01 per share in after-tax amortization of intangible assets and stock-based compensation costs. For the whole fiscal 2017, we anticipate that our gross margin will continue to progress and we intend to continue to improve profitability through continued discipline around basically spending areas and increasing focus on revenue growth. As a result, I am confident we will increase adjusted EBITDA faster than revenue and we intend on delivering at least $26 million in adjusted EBITDA for the whole fiscal 2017. At this point, let me turn over the call directly to our CFO, Pierre Plamondon. Pierre?

[Pierre Plamondon:]

Thank you, Germain. Good afternoon, everybody. Annual sales increased 4.7% to 232.6 million in fiscal '16 from 222.1 million in 2015. As previously mentioned, EXFO leveraged its leadership in portable optical testing and 100 Gig investment cycle especially in the United States to grow faster than [end] [ph] market in 2016. Bookings meanwhile increased 7.7% to 240.3 million in 2016 from 223.1 million in 2015 for an annual book-to-bill ratio of 1.03. Likewise, bookings were positively affected by our strength in optical testing and the 100 Gig investment cycle. In our fourth quarter 2016, sales surged 11.1% year-over-year to 62.9 million while bookings increased 13.7% to 62.4 million for a book-to-bill ratio of 0.99. Gross margin improved to 62.6% of sales in 2016 from 61.7% in 2015. In the fourth quarter, gross margin reached 61.6%. Our gross margin increased in fiscal 2016 mainly due to a richer product mix within our Protocol-layer group, especially more sales with our higher margin 100 Gig [indiscernible] test solution as well as the recognition that EXFO Xtract analytics which is [clearly] [ph] a software solution. We believe that our gross margin will continue to improve and range between 63% and 65% in fiscal 2017 based on higher sales volume and the improved same mix. Moving to operating expenses, annual selling and administrative expenses were flat year-over-year at 82.2 million since inflation and salary raises were offset by an increase in the average value of the U.S. dollar compared to the Canadian dollar and the euro year-over-year as well as the positive impact of 2015 restructuring plan. In the fourth quarter of 2016, SG&A expenses totaled 21.6 million. As a percentage of sales, SG&A expenses reached 35.2% in 2016. We expect our SG&A expenses will range between 34% and 36% in fiscal 2017. Net R&D expenses decreased to 42.7 million in 2016 from 44 million in 2015. In the fourth quarter of 2016, net R&D expenses amounted to 11.3 million. The decrease in net R&D dollars in 2016 can be attributed to the year-over-year increase in the average value of the U.S. dollar compared to the Canadian dollar and euro as well our 2015 restructuring plan, this factor more than [offset] [ph] inflation and salary raises. As a percentage of sales, net R&D expenses attained 14.4% in 2016. We expect that our net R&D expenses will range between 17% and 19% of sales in fiscal 2017. In fiscal 2016, our IFRS net earnings totaled 8.9 million or $0.16 per diluted share including 1.1 million in after-tax amortization of intangible assets, 1.4 million in stock-based compensation cost and a foreign exchange gain of 0.2 million. In comparison, we reported IFRS net earnings of 5.3 million for fiscal '15 which includes a foreign exchange gain of 7.2 million. In the fourth quarter of 2016, IFRS net earnings amounted to 2.3 million or $0.04 per diluted share, included 0.3 million in after-tax amortization of intangible assets, 0.3 million in stock-based compensation cost and a foreign exchange loss of 0.3 million. In comparison, we reported IFRS net earnings of 2.3 million in fiscal '15 which includes a foreign exchange gain of 2.4 million. In terms of geography, sales in the Americas and Asia-Pacific region increased 6.7% and 5.6% respectively while sales in Europe, Middle East, Africa remain relatively stable. Looking in the sales split, Americas accounted for 55% of sales in 2016. Europe, Middle East, Africa represented 25% while Asia-Pac totaled 20%. Turning to customer diversification, our top customer accounted for 7.1% of sales in 2016 while our top three represented 15.6% of sales. Moving on to a few key points on the balance sheet, our cash position increased 19.9 million year-over-year to 47.2 million at the end of 2016 due to 24.4 million in cash flow from operating activities and an unrealized foreign exchange gain of 1.6 million on our cash and short-term investments denominated in Canadian dollar. These positive effects are partially offset by payment of 4.4 million for [indiscernible] capital asset and 1.6 million for redemption of share capital under our share buyback. Finally, DSOs decreased to 65 days in the fourth quarter of 2016 from 66 days in the third quarter while inventory turns increased to 2.9x in Q4 '16 from 2.7x in the previous quarter. Now, I will turn the call over to the operator for the start of Q&A. Thank you.

[Operator:]

[Operator Instructions]. Your first question comes from Deepak Kaushal with GMP Securities.

[Deepak Kaushal:]

Hi. Good morning, guys. Thanks for taking my questions. Sorry, good evening. I had a question, Germain. You talked about guidance for strong EBITDA growth in '17 in the context of perhaps slowing revenue growth. I was wondering if you could elaborate on what you’re seeing in terms of the growth environment going out to next year.

[Germain Lamonde:]

Well, of course, everyone is going to be very careful talking about a 12 months forecast. One thing that is very clear to us is that we have the ability within our model to continue to extract more value for our shareholders and our focus on profitability is certainly very, very important. So that’s the reason why we’re providing basically on the back of a 60% year-on-year improvement, we’re providing basically an annual guidance of doing at least 18% year-on-year to $26 million. I think that’s a good start. Secondly, when it comes to a revenue environment, a lot of variables and we’re not really giving a guidance from a revenue standpoint. What we’re saying is first of all, we don’t need a really big growth in revenue to allow us to reach this 26 million in EBITDA. So basically more or less like a mid-single digit will actually be sufficient to get us to this $26 million. Looking at the whole environment without making guidance on that front, we see of course an environment where there is challenges in a way and of course there’s no question about it. I would say today there’s announcements that was done from some of the system vendors, one of the system vendors called back on their numbers and it shows that there is a lot of transformation. Transformation for us can be a big risk, it can also be a big opportunity and we see it more that way. Network operators are transforming at a rate that’s probably unequated in a long time. There’s massive demand for more high-speed with a decision to fixed, mobile or Web scale operators for more bandwidth, more speed. The 100 Gig upgrade cycle is still in the first innings I would say. There’s still a long way to go in that cycle. Data centers have been build every day basically at a very increasing pace. Operators are transforming what used to be central offices into now more of a data center environment, if you will, because they’re putting in the cloud a lot more of the services they need to deliver to customers. And as they’re going more towards virtualization that it can actually provide an accelerated rate of transformation for the services they need to deliver and put more in the hand of the consumers basically in the end to consumer services and capabilities basically on the clients they see fit, the virtualization environment is a radical transformation that’s really going to create also tremendous amount of opportunities for companies like EXFO. With that being said, I think we see it with basically the eyes of how we can transform these or utilize this transformation for the benefit of EXFO, and we really believe we’re well positioned to take advantage of that.

[Deepak Kaushal:]

Okay, great. You mentioned --

[Germain Lamonde:]

Yes. You still there, Deepak? I think we’ve lost him.

[Operator:]

Okay. The next question comes from Tim Savageaux with KET.

[Germain Lamonde:]

Hello, Tim.

[Tim Savageaux:]

Hello. Can you hear me?

[Germain Lamonde:]

Hello. We got you on the line now.

[Tim Savageaux:]

Okay, great. Apologies there. I wanted to follow back up on the growth question because I think you’re – a bit of a mixed message here. I hear you on Ericsson and that’s wireless and not really the main focus of your business and I’ll follow up on a question there. But the quarter you reported solidly better than expected, double-digit revenue and bookings growth and you’re guiding to at least similar on the revenue growth standpoint. So from our perspective that speaks to more of an acceleration than a moderation in revenue growth with regard to your outlook for '17 and also setting all of the positive drivers around 100 Gig and obviously 400 Gig and beyond in terms of the optical networking environment. So I guess I want to push back on the growth commentary a little bit and understand a bit better, (a) whether your commentary about moderating revenue growth has to do with moderating from current double-digit levels or from last year’s 5% just ask that specifically? On the one hand and, two, outside of kind of broad based caution to the sort that we see and have seen frankly, why your business has gotten better for the last few quarters, Ericsson’s been struggling the whole time. So I don’t know that that’s really coincident, but is there anything beyond that that you can cite that gives you any caution? Thanks.

[Germain Lamonde:]

Okay. Very good question, Tim, and I’m going to try to summarize there’s multiple facets to it. First, you’re right stating that the Ericsson business and the EXFO business are quite different. Not only is this around like – strictly around wireless while EXFO is a bit more like diversified from the fixed and mobile standpoint. So that’s one differentiation. There’s also a big differentiation in the fact we are playing in the test measurements business and service assurance solutions business while from the system vendor standpoint the transformation to NFV/SDN is probably more the big undertaking. And with that being said, I’m not judging [anyway we should perform] [ph] the performance of system vendors. We’re just in different spaces. So that’s why I think [the panel here][ph] we have to need to be very careful in trying to write one against the other. Now to your second question that’s more linked to we’re reporting the fourth quarter with double digit and we’re giving a guidance where the midpoint of revenue for the next quarter is about 10%. So I can actually argue with you this is still double digits here. But basically – so that means that from the mid to the top of the range we’re going to be from 6-ish to a 14-ish percentage point more or less. So I think it’s still a very, very good guidance. And within the last fiscal year I would say great results and quite happy with that. Bookings grew by 7.7% for the whole year. I think within our industry this is a very good result. And we finished with a strong Q4 and very happy about that. So with that being said, I really believe that the guidance we’re providing for the next quarter are good guidance. I think it requires us to execute well, to keep gaining market share and the things actually taken for granted. So I think it’s a good point and I’m quite happy with the guidance. So we can actually – if we were to add more, people will be happy but let’s be making sure we can deliver on these numbers. And if you’re question maybe was for the annual guidance growth, we didn’t give an annual guidance growth. We are providing basically an annual EBITDA growth, Tim, to your question. So as we said, $26 million is 18% year-on-year EBITDA enhancements. I think it speaks volumes about our confidence in our ability to deliver continuous growth in EBITDA. 2016 was phenomenon at 60% growth in EBITDA. Taking that now with 18% I think is actually also a very good number. All we stated is the fact that to reach to that level of 18% EBITDA growth, which hopefully will make many of our shareholders happy, is we don’t need a very significant growth in revenue. And we said maybe like mid-single digit. We’re not giving a guidance for revenue growth but hopefully as the year goes on, we will actually be able to give more visibility on revenue 12 months out in a market that’s changing very fast. You will understand that every CEO these days in the industry tend to be a bit more careful.

[Tim Savageaux:]

Understood. So that’s the contrast I was looking to point out, which is your achieving accelerating double-digit growth and guiding to mid-single digit. Let me follow up just quickly on the operating expense or really more to the point operating leverage front. You’ve cited various restructuring efforts and I think if I look very quickly at your expense targets and I think it’s fairly consistent what you’re targeting with the current sort of percentage of revenues from the expense lines growing about as fast as revenue, you don’t seem to be getting a lot of operating leverage there, despite the restructuring. Obviously, OpEx has ticked up here the last couple of quarters from an absolute dollar perspective. I wondered if you could talk about that overall dynamic of revenue growth versus expense growth and kind of how you’re managing that.

[Germain Lamonde:]

Well, I think when you look at financial results for the last fiscal year, the fact that we did it well [indiscernible] that’s so great in a context of an overview growth I think speaks volumes. Now the fact that we maintained SG&A from a percentage point of view at a flat level, so basically we’ll be able to do more with the review given the fact that inflation and all of this, I think it’s an amazing result. And we’ve also been able to constrain our R&D investment to a smaller, smaller level in 2016 we did in 2015 so we’ve maintained and reduced operating expenses of 3 million. And the same way we did all of this, we also improved gross margin by 900 basis points and that really transferred into what I consider to be an excellent leverage in our operating model of delivering 60% growth in EBITDA for barely 5% growth in revenues. So I think basically I tend to take this as a good result there at that level.

[Tim Savageaux:]

Thank you. I’ll pass it along.

[Germain Lamonde:]

So basically a 3% OpEx reduction I was mentioning in fact the business back in dollar, this is $4 million of OpEx reduction overall.

[Pierre Plamondon:]

And despite inflation, it’s an increase.

[Germain Lamonde:]

Does that make sense to you? Thank you very much for your questions.

[Operator:]

The next question comes from Robin Manson-Hing with CIBC.

[Robin Manson-Hing:]

Hi, guys. Germain, what are your thoughts about deploying cash?

[Germain Lamonde:]

Very good question, Robin. Well, first of all I’m quite happy that we’ve announced our cash position by more than 20 million for the whole fiscal year and with basically a strong result from operation at $24.4 million, so I think it’s good. We have a good cash position, no debt and the fixed stability in fact in moving forward with strategically both from an organic investment point of view but also from an inorganic or acquisition standpoint. But as you’ve seen in the past from EXFO is we’ve tended to be looking at smart acquisition, which we call our SSS acquisition. So we’re looking at typically it doesn’t have to be big, so small for me doesn’t really scare us to do small acquisitions. We’re looking at acquisitions that have got various logistic capabilities to deliver more revenue and EBITDA acceleration for us. So synergistic for us is extremely important, so what we want to create is a one plus one equal three or four and I prefer even five when we can meet this. And last but not the least is to be very strategic because we don’t take acquisition for the sake of adding revenues or business standards. It’s really for moving basically the needle when it comes to where and how we can position towards our long-term goal. So that’s what we’ve done in the past. The last two acquisitions were in fiscal 2014 with ByteSphere and Aito. We’re quite pleased with this. This is the foundation of our Xtract strategy. That’s also the very strong foundation for our global business solutions strategy that we’ve described during the Analyst Day. So we do have the flexibility in doing more acquisitions. Don’t expect us to go like in a buying spree. We’ll more be focused on bringing acquisitions we believe will quickly create value for shareholders and that’s really our plan. We have no plan on going aggressively in buying back shares. We’ve done some share buyback in the past. Mostly it’s a strategy to support our shares because we believe in the value of the company rather than trying to just buy back shares. I hope that answers the question properly, Robin.

[Robin Manson-Hing:]

Yes, it does. Okay. Is there a headcount that you can provide?

[Germain Lamonde:]

Yes. Pierre would like to --

[Pierre Plamondon:]

It’s about 1,560.

[Germain Lamonde:]

Yes, finishing around 1,560 and we began the year at around 1,500. So the headcount net add in the year is around 60 people.

[Robin Manson-Hing:]

Okay. And I didn’t see in the press release year end numbers for product sales and service sales. Do you have those numbers?

[Pierre Plamondon:]

Yes, that number is given I think in the financial statement. It will be about 12% -- just below 12%. It’s 7.1% [ph] services on top of sales.

[Robin Manson-Hing:]

Okay. And then what about wireline versus wireless revenue?

[Germain Lamonde:]

Basically the numbers stood about the same as last prior year’s – last fiscal year. No radical change basically.

[Robin Manson-Hing:]

Okay, that’s it for me. Thanks a lot.

[Germain Lamonde:]

Thank you very much, Robin.

[Operator:]

The next question will come from the line of Lee Edwards with Canaccord Genuity.

[Lee Edwards:]

Hi, Germain. Congrats on the quarter. Just to get a little bit more into your EBITDA targets, I believe previously you were targeting about a 15% margin as a long-term target. Are you still holding to that? Do you think it’s something you can achieve this year or is that more looking further down the road?

[Germain Lamonde:]

Thanks first of all for the comments on the fiscal year. I think these are good results. I’m pleased with that. And we are remaining very committed on the 15% EBITDA target. We’re not committing to this number to be a 2017 target. I think it’s more of to the next couple of years that we’re looking at that. I still believe we can actually do good progress in our fiscal '17. Our target going to fiscal '17 at $26 million is a very good number and we are firm believers that it doesn’t take a lot of additional volume as we said. It takes basically barely 5% growth in revenues for us to deliver this increase of 18% EBITDA. So the name of the game for us is through acceleration of revenues to be delivering basically increased percentage of EBITDA and eventually reach that 15%. We’re still believers it’s an achievable target.

[Lee Edwards:]

Great, thank you. And if you could add a bit of color on the Xtract product. Are you still seeing interest continue to build there? And maybe just a bit on what you’re seeing?

[Germain Lamonde:]

Yes, very strong interest on Xtract. We see that the very differentiation that we bring to the market is actually quite good. We have very strong interest and very strong funnel. We’re closing deals. It takes a little bit more time than we thought the time it would take, but overall that solution is really like a big eye opener. I think the nature of what we’re doing is highly differentiated within the industry. And we’re looking at a wider base of correlation of set of data to really help the operators in this – we call it sometimes internally 3D analytics or it’s 3-dimensional analytics. We’re looking at the network angle, we’re looking at the services angle and we’re also looking at the subscriber angle. And all of this basically in a real time application is something that’s very, very unique within the industry. Most analytics tool will take basically refresh rate every 15, 20 minutes; we’re like couple of seconds, two seconds. We can deal with millions and tens of millions of KPIs for our network the size of some of the biggest operators in the U.S., for example, whether it’s AT&T or Verizon we have that system to put on there. And what we see increasingly is that this is a tool that really makes a difference in helping them to prioritize problems, understand exactly how to best fix them and faster through better root cause analysis and even predicting problems. So I really believe we’ve got something that’s extremely valuable within the industry for where the operators are trying to go right now.

[Lee Edwards:]

Excellent, thanks. With that, I’ll pass the line.

[Germain Lamonde:]

Thank you for your questions.

[Operator:]

The next question comes from Deepak Kaushal with GMP Securities.

[Deepak Kaushal:]

Hi, guys. Can you hear me?

[Germain Lamonde:]

Very well, Deepak.

[Deepak Kaushal:]

Yes, sorry, I don’t know what happened to the line there, but I appreciate the opportunity for a follow-up. I did want to ask you more about the service assurance business. I think in the past you talked about penetrating and targeting some Tier 1 telcos. I was wondering if you could give me an update on your progress with respect to penetrating new customers there. How many do you have and how many do you see as opportunities over the next year?

[Germain Lamonde:]

Okay, very good question, Deepak. I would say on this front we are looking at not only Tier 1s and in our own definition of Tier 1s, which is like the top 15 largest telecom marketers basically. We’re looking at Tier 1s and we do have Tier 1 wins. We’re also looking at Tier 2 and Tier 3 wins where we believe that there is a gigantic amount of a need in the industry for scalable solution we were offering it. So basically our solutions – some of the value points of our solution or some of the benefits of our solution is we can actually easily go in from a smaller midscale and scale up to a massive scale like a Tier 1 operator and that’s a big differentiation. Many of the systems available in the industry will turn to is they are very well suited for Tier 1 but do not like scale back or basically go to a smaller scale good enough or at a good price. We can actually do that very nicely. So I think our progress in the last fiscal year is good. It’s never as good as I like it to be. I think we reported on Q3 there was a bit of disappointment. Q4 was slightly better but not exactly as good as we wanted it to be. It takes a bit of time. But we are clearly making traction and we have a number of very good engagements that are moving along very well. So I believe that our funnel is the strongest it’s ever been and deals are basically moving along this funnel very nicely. So it takes a bit of time but I’m still very confident we’re going to succeed within this particular segment.

[Deepak Kaushal:]

So are you willing to offer up a metric? Are you 30% penetrated amongst those top 15 telcos or are you below that --?

[Germain Lamonde:]

We won’t be able to provide necessarily a metric today but if I have to provide a metric today, I would say that if we’re looking at the top 15 operators which we described as a Tier 1, we’re not at the 30% if we’re being fair. It’s not a bad penetration. We have a good number of accounts but it’s hard for us to put really a metric right now. We’re still in the early game and we believe that the transformation that are occurring are exactly where EXFO is strongly positioned. So we have what it takes to have operators do these transformations right now.

[Deepak Kaushal:]

Okay. And then let’s say on your earliest Tier 1 win, have you seen the business with that Tier 1 win grow over the period that they’ve been using your product?

[Germain Lamonde:]

Can you repeat your question? I’m not sure I fully grasped.

[Deepak Kaushal:]

So for one of your end-to-end service assurance solutions, let’s take your first Tier 1 win, for example. Have you seen your business with that customer grow since they began using the product or does it reach a certain level and stabilize?

[Germain Lamonde:]

No. In fact we keep getting additional business with that Tier 1 operator because once the system is in, there’s no requirements, there’s no areas of services and there’s new transformations there ongoing. Once we’re in, basically it’s more of a business for us to expand with. And as we’re strengthening basically our go-to-market models and now we can interface with Tier 1 operators and focus accounts basically at large, we’re basically increasingly able to take a footprint and expand on that footprint and make it to be – making it increasingly relevant and increasingly basically deployed either through more services, to wider regions, to more people who are getting into the system, to bigger among data that we deal with. So basically these systems once they’re in, unless we do something wrong we’re going to be able to grow these systems and make initial reviews through the years on that.

[Deepak Kaushal:]

Perfect, great, I appreciate that. And then one last question for Pierre, if I may. On the CapEx side, you’ve brought that down quite a bit over the last several years. Are we at a good run rate at the 5 million annual level or should we expect some changes over the next year?

[Pierre Plamondon:]

It’s a bit higher this year. We are expecting about 8 million as we have to do some building improvement in Quebec. That business has not been – put anything on that over the last 15 years, so we have some work to do on the building itself. And we have two leases that will be terminated this year that we will move out from those locations and move to new locations. So that is the main explanation on why we would have a little bit more CapEx this year because of that.

[Deepak Kaushal:]

Okay. Thank you. I appreciate that and I’ll pass the line.

[Germain Lamonde:]

Thank you very much, Deepak. Wonderful evening.

[Operator:]

The next question comes from Robin Manson-Hing with CIBC.

[Robin Manson-Hing:]

Hi, guys. I just thought of a follow-up. Is that 26 million EBITDA more of a hard target, where if revenue is worse than you’re expecting, you will reduce your spending to approach 26 million, or is EBITDA just a byproduct of your internal revenue where if revenue goes up, that 26 million EBITDA also goes up?

[Germain Lamonde:]

It’s a very good question. In fact, our intent is to at least do that 26 million net of EBITDA. We believe we can actually get there thanks to basically volume growth as it doesn’t take much as we said. The scenario of would we do expense reductions if we’re not going to hit the $26 million, if we’re in a model to be able to continue to generate more value for shareholders we would be adapting and transforming our cost base. That’s something we’re always committed in doing making sure that we have the right cost structure given the business environment. We believe the business environment is supportive of growth strategy and supportive of us delivering the EBITDA growth through revenue growth more than through just like radical expense cuts.

[Robin Manson-Hing:]

So it sounds like if for some reason – if you don’t for some reason see any revenue growth, you will make potentially more cuts to try to approach the 26 million in EBITDA, sounds like?

[Germain Lamonde:]

Yes. If we really had to that would be the plan but that’s not what we believe will be the plan for fiscal 2017.

[Robin Manson-Hing:]

Okay. Thanks a lot.

[Germain Lamonde:]

Thanks, Robin. That’s a good question.

[Operator:]

The next question will come from Tim Savageaux with Northland Capital Markets.

[Tim Savageaux:]

Good afternoon, again. A couple of questions; one addressing at least what looks to have been a nice acceleration in terms of year-over-year revenue growth on the physical side the last couple of quarters, again, around double-digits. I wonder if you could talk to growth drivers. You mentioned in your commentary the100 Gig test being strong in terms of both growth and also margins. I wonder if you could speak to kind of your latest views on both carrier metro and cloud service provider deployments, and what role that might be playing in driving some of this growth for EXFO?

[Germain Lamonde:]

Okay. Well, these are very good questions basically. First on the carrier metro deployment, this has been a segment that’s been quite active now for I’ll say for a great 18 months going onto 24 months. We’re still believers that despite the fact that there’s been a lot of activity in America, there’s a lot of activity still to be made around the world. So we’re still in the early innings on that front. Cloud may throw in the same vein the whole aspect of going cloud is also very much in the first innings. And again, Americas is in the lead position from that angle. What EXFO is very strong at is to be very global supplier. As you can see basically while we did well in America in fiscal '16, we’ve been about flattish let’s say in EMEA from a revenue standpoint in 2016. The good news is we’ve got a very wide distribution of revenue going from barely about 55 – around 55% for the Americas in the last fiscal year and we were basically in the range of 25% and 20% basically for EMEA and APAC. We’re highly diversified. We have a wide range of customers, so that’s also another area. So basically 100 Gig is on the rise in a lot of areas, in a lot of geographies for a lot of used cases and I really believe we have a very, very good position in this segment. One thing I didn’t really mention is in calendar 2015 as reported basically we’ve again gained market share in the overall optical test industry. EXFO is again doing well in this particular segment and it’s basically driven by a number of used cases of course going further deeper into the wireless networks into the fiber-to-the-home deployments and this and that. But it’s also very much driven by more capacity in metro and towards the edge, if you will.

[Tim Savageaux:]

Okay. So it sounds like the business drivers remain pretty much intact. I just want to follow-up, one final question. I think I heard the gross margin guidance at 64% midrange, is that correct?

[Pierre Plamondon:]

That’s correct.

[Tim Savageaux:]

63 to 65? That implies a nice – again, a nice increase year-over-year. I wonder given at least baseline expectations for fairly modest revenue growth, I would say quite conservative. Is there a mix effect there? Are you expecting greater amounts of growth on the Protocol side than the Physical side as a major contributor of that planned gross margin increase?

[Pierre Plamondon:]

Yes, the main increase would come from the mix with a richer mix from Protocol side business. But at the same time we’ll continue to reduce our cap to be more efficient on the cost of goods sold and so on. So the real of the two should continue to grow the gross margins from – we were at 62.6 this year and be able to reach the 63, 65 and maybe the mean range at 64 for next year. So it will be a job of working hard to reduce our cost of goods sold and have an enhanced mix and better margin with each product line.

[Tim Savageaux:]

Great. Thank you very much and nice quarter.

[Germain Lamonde:]

Thank you, Tim.

[Operator:]

At this time, there are no further questions. I’ll now turn the floor back over to Germain Lamonde, CEO, for closing remarks.

[Germain Lamonde:]

Thank you very much, operator, and thank you very much everyone for joining this call today and for the good questions that were asked. And maybe in terms of net takeaway from this call, I’d like to say that we’re very pleased that we have delivered very solid financial results both in fourth quarter and for the whole of fiscal 2016. We’ve improved sales, bookings and gross margin and as well reached basically the 60% increase in adjusted EBITDA to just about $22 million. And in this we will surpass our target we have set at the beginning of the year for $20 million. Second, I’m very glad that as we announced at the beginning of the fiscal year, we did deliver bookings growth and revenue growth in both our product groups, the physical layer and protocol layer product groups on that front and firm believers that we are positioning – we’re positioned very well and we’ve gained market share in both of these segments. Thirdly, we are being keeping a very strategic focus in sustaining profitable growth in fiscal 2017 as well and as such basically all of our plans are making us confident. We can actually increase our adjusted EBITDA again on the back of that 60% growth by growing EBITDA faster than revenue to achieve at least $26 million in EBITDA in fiscal 2017. So at this stage, that concludes our Q4 2016 conference call. On behalf of the entire EXFO team, thank you very much all for joining today.

[Operator:]

Thank you for your participation. You may now disconnect.