EXFO Inc.
Q4 2015 Earnings Call Transcript

Published: 8 Oct 2015

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to EXFO's fourth quarter and year-end conference call for fiscal 2015. 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 7, 2015. I would now 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 FY15. 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 Canadian Securities Commissions as well. Please note that non-IFRS numbers may be used during this conference call. A detailed reconciliation of these non-IFRS results to our IFRS results is available on our website at www.exfo.com/investors. All dollar amounts in this conference call are expressed in US dollars unless otherwise indicated. Without further delay, I will turn the call over to Germain.

[Germain Lamonde:]

Thank you, Vance, and good afternoon, everyone. While fiscal 15 is not going to go down in history as EXFO's banner year, as our market continued to be affected by adverse market conditions, market and economic conditions, especially in the EMEA region. Sales have decreased 3.8% to $222.1 million and adjusted EBITDA totaled $13.8 million or 6.2% of sales, the same percentage as last prior year. It should be noted that sales would have been basically stable on a -- if we were looking at it on a constant-currency basis. At the regional level, our bookings have increased in Americas and APAC regions, while bookings were negatively impacted in EMEA, due to well-known devaluation of currencies like the euro and macro-economic situation, as well as geopolitical issues. At the revenue level, sales were relatively flat in America, in fact, at minus 1.9%, and flat in APAC at plus 0.08%, to reach 54% and 20% of sales respectively for total sales in 2015, and this shows that basically the EMEA region experienced trouble as sales were down by 10.5% year on year and accounted for 26% of sales in total versus 28% during fiscal 2014. So, while fiscal ‘15 was not a great year from the financial side, I can assure you it has been a very busy year from a transformations viewpoint, and also very successful year on that front even though many of these important internal transformations have not yet necessarily been visible outside of EXFO. All of these changes had one common denominator, ensuring that EXFO gets clearly much better positioned as we are entering 2016 to significantly drive profitability. Let me share with you some of these initiatives today. So, first of all, sales in our Protocol and product [ph] group of products decreased by 19% year on year, and that's especially true in the areas of 10 gig or less portable transport testing and in the wireless Protocol and analysis [ph] segment. So we have implemented decisive actions to turn the situation around and go back into what EXFO is doing the best, which is gaining market share. So, specifically, talking about the 10-gig transport side, we have introduced a new unified software architecture across the entire transport and telecom product offering in the first half of 2015 to more than double, basically, our R&D productivity, and therefore greatly accelerate the introduction of new features that are so essential in the fast-evolving 10-gig and 100-gig test market. This significant acceleration in new features is already having a meaningful impact now on our results. As a specific point during the second half of our fiscal 2015, we've achieved 40% increase in bookings versus the first half of 2015 in a fairly important product area, while allowing more R&D capacity to be spent towards product development, for clearly a reduced R&D budget. So, this product group should continue to experience clear booking acceleration in the coming year, especially now as we've recently launched to the market, thanks to this new software architecture, a brand new FTB-1 Pro and our brand new FTB-2 880v2 NetBlazer, both of which were launched at the tail end of our fourth quarter and will have the impact starting at the beginning of fiscal 2015, and they both basically show unmatched technology leadership for the Metro Ethernet and the wireless backhaul deployment segments, where we plan to further accelerate our transport telecom sales growth and continue market share gains. So, stay tuned as more important key developments and key new products will continue, and further improvements in the state [ph] should also continue in this very critical segment within the next two quarters. Still within our Protocol product line, sales of our wireless protocol analyzers have been basically on a secular decline over the last few years due to a significant shrinking in the labs [ph] market, and the modest demand for advanced portable troubleshooting solutions for the field. So indeed, there's a strong preference for mobile operators, especially globally to rely more on centralized probe-based and processed automation solutions to manage quality of experience, and resolve the customer-impacting network issues. Therefore, we refocused our efforts in that critical sector during the late fiscal 2014, early fiscal 2015 to transform our best-in-class wireless protocol analyzer technology into a probe-based solution that is now being fully integrated into our market-leading service assurance test platform. So this integration will allow EXFO to deliver unique capabilities that are mission critical to mobile operators as they face explosion in service demand and let's face it, less customers' tolerance now for any network or experience issues. We're therefore, not only expanding but also greatly differentiating our solutions capabilities with the only integrated active and passive service assurance probe-based system in the market, addressing an additional $1 billion market and a fast-growing and a significant growing segment, thanks to this best-in-class protocol and signaling analysis capabilities that we inherited from our NetHawk acquisition back five years ago. Still within our Protocol and product area, you will recall that we announced our new EXFO Xtract analytics solution last March during the Mobile World Congress. Following our ByteSphere and Aito acquisition that we made during 2014 and our initial internal investments both during FY14 and FY15, we brought to market basically a very unique big data solution that provides real-time and detailed end-to-end visibility of network and service performance to assure the best-in-class quality of experience that is so mission critical to mobile and fixed network operators globally. I'm very happy to report an impressive opportunity funnel that will clearly contribute significantly more to revenues in 2016 than they did during 2015, and I'm also very pleased to report a very large-scale deployment that we recently completed at a Tier 1 mobile network operator, where we're processing tens of millions of KPI transactions per hour, really providing real-time visibility of critical performance indicators, and thus helping this operator to provide superior network performance and end-to-end quality of experience. So, with the above important transformations now in place, I am confident our higher-margin Protocol product group is very well positioned, and will positively contribute to revenue growth and market share gains to help us deliver significant adjusted EBITDA improvements in FY16 and beyond within that specific product area. Continuing with segmented information, our Physical-layer product line delivered a solid 9.1% growth in sales year on year, based on our leadership position in portable, optical, and copper testing, and strategic focus on wireless customers. We have an unmatched product portfolio in terms of both the product breadth and depth in which our portable, optical, and access testing, and we've consolidated our leadership position in 2015 with the release of several new features for our patented iOLM software and fiber inspection probes both contributing to automate and accelerate copper [ph] deployment in the wireless access areas. I'm convinced that we're starting our FY16 on a much stronger foot now with both product groups in a great position to both contribute to revenue growth. Continuing on our 2015 transformations, we have continued to reduce our OpEx significantly in 2015, as we are committed in fact to rapid earnings expansion. During 2015, we lowered our OpEx overall by $6.7 million year on year. And moreover, we just implemented some additional restructuring in late August to generate additional annual savings of $3.5 million, mostly by selectively reducing costs in R&D and sales, with a one-third cost of this restructuring plan of approximately $1.6 million. So, this measure was meant to allow us to get to the right cost point, while maximizing our long-term growth and efficiency plans. And finally, on the key transformations been implemented, I'm very happy to report that, of course, Philippe Morin will be joining EXFO on November 9 in the new role of COO or Chief Operation Officer. Philippe's global and senior executive contacts, and 25 years of industry experience that he accumulated at both Ciena and at Nortel, will clearly be very terrific asset for EXFO and for me personally, given our increased focus on systems and solutions where our active, our passive service assurance, plus our analytics tool are sitting at the top of these probes, are getting such a great traction in the marketplace. Philippe, whom I've known for more than 15 years now, with our global and sales execution and product strategy, with a very strong focus on growth acceleration. With Philippe coming on board, it will set on me to reduce my too large and too many number of direct reports, which is currently standing at 13, is going to take it down to 8, much more at a right level. And this will also allow me to focus more time on critical long-term and strategic areas while being more active with customers. I'm very happy with Philippe joining with EXFO, and it will strengthen all aspects of our business delivery plan while also allowing me time to add more value. So, over time, I intend to gradually transfer more responsibilities to Philippe, given his very proven record on execution and leadership. And I clearly see him, over time, becoming my successor as EXFO CEO over time, likely within the next 18 to 24 months. My plan, of course, is not to reduce my involvement, but rather to have more time to focus on transformation in key strategic areas. Value creation -- I'd like to talk now a little bit more about our 2016 plan. We clearly intend to leverage the above transformations to significantly improve our financial value-creation performance, coming back at delivering consistent sales growth, earning acceleration, and continue to improve our long-term execution. With all these transformations being implemented in 2015, [first with] Philippe to make [indiscernible], I have strong confidence in our ability to accelerate value creation. Let's be frank, me and my team are highly focused on driving earnings acceleration to maximize shareholder value. So, specifically in 2016, we intend to increase adjusted EBITDA by more than 40% to reach $20 million in 2016, and this should be achieved at revenue level of about $230 million. So, let's take now a quick look at growth plans. There is three main stream of growth within our growth strategy, and that has remained pretty much unchanged from last fiscal year, albeit, of course, some new wrinkle. First and foremost, in 2016 we'll continue to evolve into more and more of an end-to-end solution provider. So, last year we made significant progress with the release of high-margin software solutions, including Xtract, which I talked about, real-time analytics, and provided basically a lot of value for end-to-end network performance and visibility. Network operators on a global basis are adopting new technologies, such as, of course, NAV, to transform their physical infrastructure into a more virtualized and hybrid network, so consequently, they have to deploy new services like VoLTE, much more efficiently and quickly than ever before, in weeks rather than months, and at a far lower cost. On the other hand, virtualized architecture creates heightened complexity for network operators, which is why they are increasingly seeking for network performance and service experience solutions like those that are offered by EXFO. We made some early progress with our push into system solutions in 2015, since our number-one customers in these -- in three of the last four quarters was for a network operator who mainly purchased solutions rather than installments. This is quite a good demonstration of our progress. Related to systems and solutions, there's also a recurring revenue stream in the form of annual maintenance contracts. So in 2015 our service revenues the majority of which was derived for annual maintenance contracts, as amounted to 13% of sales. Secondly, as part of our growth strategy, we want to continue to expand our wireless presence. So, bookings to wireless customers reached an estimated 30% to 32% of total bookings in 2015. Despite a drop in bookings year on year, the bookings to wireless customers have remained essentially flat due to our leadership position in portable optical testing and increased fiber roll-out by mobile network operators to support exponential traffic growth in their access, back-haul, and front-haul network. Looking ahead at 2016, EXFO boasts an extensive offering for wireless networks, from portable instruments for super testing, to real-time monitoring solutions, tracking end-to-end experience quality. So we will continue enhancing the EXFO brand in this area and fine-tuning our activity of setting the strategies to capture market share in this growing but competitive market environment. Thirdly, we want to increase our penetration within the Tier 1 network operators end market, as it's common knowledge that it's a 15 largest telecom operators are still owning the lion's share of all the telecom spending. Now, for that new part, we also wanted to spend even more time moving forward as well to target data centers, cloud and web-scale service providers for additional business, since this trio has increased its capital spending at a much faster rate than traditional network operators in the recent years. LightCounting, an optical and communications market research company is forecasting that increased spending by web-scale service providers will exceed that of the top 15 network operators within the next five years -- five to seven years -- if this spending patterns persist. EXFO has a wealth of solutions from 10 gig to 100 gig for Ethernet and analyzers to meet the emerging needs of data centers, cloud and web-scale service providers. So, it's vital for us to take advantage of these emerging market opportunities. Long-term execution is also very important. Last but not the least, value creation requires flawless execution. Clearly the best laid plan can go to waste if execution is spotty. But I am mainly alluding here to long-term execution that affects the overall positioning of the Company. For example, we'll continue to enhance our global go-to-market initiatives in order to take a revenue to the next level. We will leverage our analytics software capabilities across the entire solution portfolio to become the supplier of choice for network performance and service experience visibility. We'll also raise the bar for executive selling, since this form of selling is based upon identifying the multi-million dollars issues that customer executives are faced with, and providing them with unique and cost-effective solutions. And finally, we intend to be proactive on acquisition front to complement our organic growth. Finally, to provide you with our financial outlook for the first quarter of fiscal year 2016, we are forecasting sales to be between $55 million to $60 million for the first quarter, while our IFRS net results should range between a loss of $0.01 per share to an earnings of $0.03 per share. IFRS net results include $0.01 per share in after-tax amortization of intangible assets and stock-based compensation costs. This quarterly guidance was established by management based on existing backlog as of the date of this conference call, seasonality, expected bookings for the remainder of this quarter, and exchange rates as of this quarter, as well as based on strong bookings we have experienced so far already in September. So, as mentioned earlier, for FY16, we are targeting to increase by more than 40% our adjusted EBITDA to $20 million, and which basically should represent [a revenue level] of about $230 million. So, at this point I'll turn the call over to Pierre to discuss our financials.

[Pierre Plamondon:]

Thank you, Germain. Annual sales decreased 3.8% to $222.1 million in fiscal ’15, from $33.8 million in 2014. As previously mentioned the strength of the U.S. dollar versus the Canadian dollar and euro prove to be a significant headwind on our sales in FY15. On a constant-currency basis, our sales would have been stable year over year. Bookings, meanwhile, decreased 7.2% to $223.1 million in 2015 from $240.4 million in 2014, for an annual book-to-bill ratio of 1. Likewise, our bookings were negatively affected by the strength of the U.S. dollars, as well as less orders from our Protocol-layer solution. In the fourth-quarter of 2015, sales totaled $66.6 million, while bookings reached $54.9 million for a book-to-bill ratio of 0.97. Gross margin amounted to 61.7% of sales in 2015, compared to 62.4% in 2014. In the fourth quarter of 2015, gross margin reached 61.2% of sales. Our gross margin decreased on an annual basis mainly due to product mix, since we sold a higher proportion of Physical-layer solutions in 2015 than we did in 2014. In addition, losses on our foreign exchange contract of $2.6 million further reduced our sales, and restructuring charges of $0.3 million incurred in cost of sales in Q4 had a total negative impact of 0.4% annually on our gross margins. We believe that our gross margin will range between 62% and 64% in fiscal ‘16, based on higher sales volume and improved product mix. Moving to operating expenses, selling and administrative expenses decreased 4.9% to $82.2 million in 2015 from $86.4 million in 2014. In the fourth quarter of 2015, SG&A expenses totaled $20.5 million. Selling and administrative expenses included $0.6 million in restructuring charges in 2015, both in Q4 and for the whole fiscal year. Excluding restructuring charges, SG&A would have decreased 5.6% year over year. The decrease in SG&A dollars in 2015 can be largely attributed to an increase in the average value of the U.S. dollar versus the Canadian dollars and the euro year over year, since a portion of these expenses are incurred in Canadian dollars and euros, and we report our results in U. S. dollars. We have also kept a tight control of all our expenses. As a percentage of sales, SG&A expenses reached 37% in 2015. We expect our SG&A expenses will range between 34% and 36% in fiscal ‘16. Net R&D expenses totaled $44 million in 2015, compared to $44.8 million in 2014. In the fourth quarter 2015, net R&D expenses amounted to $10.9 million, which includes $0.8 million in restructuring charges. The decrease in net R&D dollars in 2015 is mainly due to the year-over-year increase in the average value of the US dollar compared to the Canadian and euro and the rupee, since most of our R&D expenses are incurred in theses line of currencies, while we report our results in US dollars. This decrease was partially offset by restructuring charges, as well as the shift in the mix and timing of R&D projects. As a percentage of sales, net R&D expenses attained 19.8% in 2015. We expect that our net R&D expenses will range between 17% and 19% of sales in FY16. Altogether, OpEx, including depreciation and amortization expenses, decreased by $6.7 million in 2015 due to the strength of the US dollar and tight cost control measures on our expenses. In FY15, IFRS net earnings totaled $5.3 million or $0.09 per diluted share, including $2.7 million in after-tax amortization of intangible assets, $1.3 million in after-tax restructuring charges, and $1.3 million in stock-based compensation costs, and a foreign exchange gain of $7.2 million. In the fourth quarter of 2015, IFRS net earnings amounted to $2.3 million or $0.04 per diluted share, including $1.3 million in after-tax restructuring charges, $0.3 million in after-tax amortization of intangible assets, $0.1 million in stock-based compensation costs, and a foreign exchange gain of $2.4 million. In terms of geography, sales in the Americas and Asia-Pacific regions were relatively stable in 2015, while sales in Europe, Middle East, Africa decreased 10.5%. Looking at the sales split, the Americas accounted for 54% of sales in 2015; EMEA represented 26% of sales, while Asia-Pacific totaled 20%. Turning to customer diversification, our top customer accounted for this year for 7.1% of sales, while our top three represented 14.4% of sales. Moving on to a few key points on the balance sheet, our cash position decreased to $27.4 million at the end of 2015 from $59.8 million at the end of 2014, largely due to the redemption of shares under our share repurchase program totaling $25.5 million. We also made cash payments of $5.9 million for depreciation of capital assets, and recorded an unrealized foreign exchange loss of $7.6 million on our cash and short-term investments, denominated in Canadian dollars. These elements were partially offset by $6.5 million in cash flow from operating activities. Finally, DSO decreased to 78 days in the fourth-quarter 2015, from 79 days in the third quarter, while inventory turns increased to 3.1 times in Q4 2015 from 2.8 times in the previous quarter. Now I will turn the call over to the operator for the start of the Q&A. Thank you.

[Operator:]

[Operator Instructions] Your first question comes from Thanos Moschopoulos with BMO Capital Markets.

[Thanos Moschopoulos:]

Hi, good afternoon. Germain, maybe starting off with the guidance that you provided, can you talk about what sort of market environment is implicit in your guidance? Are you assuming that the current demand backdrop remains stable or are you assuming improvement on that front?

[Germain Lamonde:]

No, I'm really counting on the environment, it remains about the same, frankly. I think it's really very risky for me to bank on a radical change on the market conditions. I think the market will remain what it is, and if it gets better then that's good news. I'm very, very pleased with the transformations we've implemented during FY15. The main area that didn't deliver what we were hoping to deliver is really our Protocol. That is really gross margin-rich Protocol segment, and we made basically a series of very decisive implementation in-house to drive that business back to growth the way it should be.

[Thanos Moschopoulos:]

I am also a little surprised that you're providing such specific guidance for the year given that your visibility in the past has been a little challenging. Is that because -- has your visibility at all improved as you look forward maybe as a result of the pipeline you talked about?

[Germain Lamonde:]

Yes, I think one of the reasons for this is that, first of all, we've implemented a lot of measures to drive the growth, not only in revenues but really on profitability. We talked about the restructuring, the cost reduction, the strong and tight OpEx controls, and all that. We have a very strong funnel, as I mentioned, especially in the areas of solutions, systems, and so forth. So all of these factors are giving me confidence we can actually provide this long-term view for our business.

[Thanos Moschopoulos:]

Okay. And then regarding Philippe joining the Company, congratulations on that. Certainly Philippe has a very strong background. I think you sort of alluded to this in your prepared remarks, but can you comment on the timing of why you felt this was a good time to create the COO position and bring Philippe on board? Is it, as you said, in large part because you're now transitioning to more of a solution sale type of Company or were there other factors as well?

[Germain Lamonde:]

Exactly, I would say that the main reason of it is the fact that our transition to be more and more systems and solutions-centric means -- and especially with the fact we're getting more and more towards Tier 1 to large operators of the market -- we need to really continue to expand our executive relationships and sell more in the C-suite, if you will. And that's an area where basically EXFO can benefit tremendously from the venue of a guy like Philippe, who's got a tremendous amount of experience. His capabilities are very well proven, so I think that's a very strong message. The second element is also the fact that we are increasingly, on a global basis, developing a series of accounts that requires stronger amount of coordination and execution. We look at a business like EXFO that is so global. So we have to have strengthening, basically, our best practices, assuring that we're becoming more effective at deploying new strategies around the globe in a much faster fashion. Right now, it may take a bit too much time for us to do this. Given the fact that I have currently like 13 direct reports, inclusive of 3 direct sales VPs, it's very difficult for me to think to spend enough time to be dealing with a lot of day-to-day things that needs to get done to help drive business faster, and that's the name of the game here, it's about revenue acceleration.

[Operator:]

The next question comes from Deepak Kaushal with GMP Securities.

[Deepak Kaushal:]

Hi, guys, thanks for taking my questions. Germain, you mentioned bookings in the wireless segment. I don't think I quite caught it. Did you guys give a revenue for the wireless business?

[Germain Lamonde:]

Yes, we give every year a number that represents our best estimation of bookings that we've done during the fiscal year for wireless and industry. As an industry, basically we sell to the wireless NIMs, the wireless operators, and we sell basically a wide range of products that are inclusive of optical products, transport products, and many of these products can be sold, the same product can be sold to -- we say sometimes as an example, we can sell to the AT&T fixed side of the network or to the AT&T wireless side of the network. So once a year, we do an estimation with all the tools that we have. We do our best estimation we can as to what percentage of our business was done with wireless end customers by going through a full analysis. And basically, what we said this year is that it's been about flat to 30% to 32% of our business was done with the wireless end industry as end customers. About flat to last year which is a bit of a disappointment in a way, but I think you picked up in the prepared remarks, the fact that our Protocol analyzer basically has been on a secular decline in business, so that means the NIMs portion of that business was actually going south and we couldn't basically get enough growth with operators to offset that. But our business growth with operators is actually still there, and I'm very confident we're going to continue to deliver growth in bookings and growth in revenues in the wireless industry over time.

[Deepak Kaushal:]

Okay, great. Also on the growth front, you talked about the weakness in EMEA during the year. Have you seen any improvement in that in recent months? And maybe if I could follow that up with some comments on what you're seeing and what the outlook is for Asia-Pacific.

[Germain Lamonde:]

Well, EMEA, I think, has been a widely reported situation, like across industries, and within telecom it's been the same. It's been very challenging. That's why many organizations are talking more on a constant currency basis. We're glad to state that on a constant currency basis, our business is doing very fine. It's not doing bad. But really, revenues in Europe, in EMEA region overall, has been deeply impacted. We stated that revenues were down by 10.5% in that region during the fiscal year, and it's mostly linked to the currencies; the euro alone has been basically down quite substantially. Sales in countries, like Russia for example, it's something we've talked about in the past, but Russia's economy has been deeply impacted. Being a supplier to Russia may not be the best thing like now for various political reasons. But at the end of the day, the Russia market has been deeply collapsing. There has been hot spots or cold spots across EMEA as well. So the overall market conditions in the EMEA region as a whole has not been super easy. So we've been south in US dollars in the region by about 10% in this last fiscal year.

[Deepak Kaushal:]

And then in Asia-Pacific, are you seeing signs of stability there or improvement or cracks in --?

[Germain Lamonde:]

Yes, good point. Sorry I missed that part of your question. So I really believe that we've reached now, a bit of a stabilization for business in EMEA. Are we going to talk about a massive recovery? I don't think anyone would love to make that call. I think it would be a risky call to make. We believe we're in a position to get back into growth on our own by focusing more on market share gains. I think that's the best thing we can actually do. So I think the EMEA zone from an end market, is probably going to remain a little bit challenging for a bit of time to come. I see personally us being able to make movements and progress in the region. I see that we are doing very well and I'm very, very pleased with a lot of indicators that we have for our advanced indicators for 2016 when I look at our Asia-Pacific region and I am also fairly bullish when I look at our America region. I think Americas and APAC will actually be the easiest regions for us to grow into.

[Deepak Kaushal:]

Okay, great. And then one last question for Pierre. Pierre, should we expect any restructuring costs spilling into Q1? And what should we expect for tax rates in the coming year?

[Pierre Plamondon:]

Yes most of the restructuring cost has been provided in Q4, so I don't expect significant amount to be incurred in the first quarter. Tax rate, this is always the tricky question. But I might say that you need to forecast, probably I would say, a tax spend between $800,000 to $1.2 million because of the nondeductible expense and then so on.

[Operator:]

Your next question comes from Robin Mason-Hing with CIBC.

[Robin Manson-Hing:]

Good evening. Pierre, I'm not sure if I caught -- was it $2.6 million FX loss on forward contracts, was that for the year?

[Pierre Plamondon:]

This is for the --

[Robin Manson-Hing:]

…for revenue.

[Pierre Plamondon:]

Correct, yes, that's amount reduced our revenues.

[Robin Manson-Hing:]

So that's flat on a constant currency basis. Excluding the FX contracts, what would that be?

[Pierre Plamondon:]

Excluding the FX contracts, our sales would have been $2.6 million higher, let's say. But on constant currency we removed that and we would have been flat year over year using the same rate that we had in FY14.

[Robin Manson-Hing:]

And that is excluding the FX contract as well?

[Pierre Plamondon:]

Yes, yes.

[Robin Manson-Hing:]

Okay. And Germain, what in particular -- you talked about your three drivers for growth in 2016. Which of those three, wireless, Tier 1s and your solutions, which do you think will be the strongest driver? In particular I'm interested in what you see in terms of your Xtract? Do you see that as being picked be up by Tier 1s? And how far are we along in the NFV transition?

[Germain Lamonde:]

Very good questions, Robin. So first of all, let me say that the solutions part of our business is an area that I expect very strong growth in FY16. And I'm backing this on the fact that not only do we have an outstanding product and great technology, we can always say that, but really on the fact that we built a tremendous amount of impact in the marketplace. We have a very solid funnel of opportunities right now within that segment. And basically the Xtract analytics is not only going to drive additional penetration of large accounts, both Tier 1, Tier 2 and Tier 3, but Tier 2 and Tier 1 specifically. But it's also going to drive more sales of our probes-based business. We're clearly the market leader in the active service assurance test. We can generate basically millions and millions of tests. We can test to basically every wireless point of presence across America, if you will, and we do this for one of our key customers. We can test every wireless point of presence for a number of various services and we can do that 10 times a second and really bring back now, with analytics, an incredibly flexible and agile way to get any one of the KPIs that you can actually dream of. In fact, we're measuring close to 20 million KPIs per hour, or key performance indicators per hour, to get visibility. I'm very bullish on that segment. I'm also very bullish on the wireless segment overall. Clearly, I think this is where the action is taking place and where many of the solutions that we're really taking to the marketplace are so much in demand. Our position for the wireless industries has never been better. So I really believe we have a lot of room to grow in that segment. That's a very important PR for us. The third very critical PR for us is really about the Tier 1 and the larger network operators, where increasingly this is a game of deepening our penetration by strengthening our ability to sell to executive level. So on all three fronts, basically the venue of a COO helping us to drive that business with experience, will actually be a very, very critical factor in being successful in these three segments.

[Robin Manson-Hing:]

It's fair to say, though, your FTB platform is still -- I know you don't disclose it -- but is still likely a vast majority of your revenue. Would that be fair to say? Platform plus…

[Germain Lamonde:]

Platform modules are still accounting for a significant portion of our business, absolutely. And we keep basically adding very substantial differentiation, some of which we've actually started to introduce privately to a number of key telecom operators. We have some very exciting things that will be announced in the very near future, which we've already introduced now privately to a number of [settled] accounts. I think what we're trying to do here with the FTB system, is to continue to transform the way operators are getting the job done in the field. We'll do it internally with their own staff or they're contracting out to basically using contractors to help them do the job faster. I mean the name of the game is about speed of quality of the work being done day one. So you don't want to go back to a test site or to a construction site for any reason. It's about traceability and automation. So what I think we're trying to do here, stay tuned, there's some very exciting announcements to come in the very near future and already the reaction to the customers we've talked to privately about this solution is exciting, very exciting as well.

[Robin Manson-Hing:]

Okay, last question. You are expecting operating expenses to decrease, I think it was $3.5 million versus, I believe it was $6.7 million in 2015. Why the slowdown in operating cost reductions and what is the sensitivity? I know for $230 million the assumption was made. What's the sensitivity on that if sales are $250 million or $210 million? Will the new COO have a lot of say in this a lot of discretion in terms of how quickly or how much cost he wants to cut or how many costs he want to potentially add?

[Germain Lamonde:]

There's two parts to your question. I'll let maybe Pierre answer the financial portion of it.

[Pierre Plamondon:]

Yes, so the $6.7 million savings is due to cost reductions as well as currency impacts, as we have the Canadian dollar went lower compared to US and that's reduced our costs. The $3.5 million, this is net savings from the restructuring charges that we have announced. So this is saving, but a fair portion of that will be of sales in the year with salary increase, inflation and so on. So you can't assume that the direct $3.5 million savings in last fiscal year, because it will compensate for the generated increase. Are we going to reduce more the expenses? For sure it will depend how the currency will continue to be. So it depends on the dollar to be weaker, that may have part to further reduce our operating costs in Canadian dollars. And for sure we continue to keep a big eye on our expenses level and keep track of all savings that we can achieve.

[Germain Lamonde:]

Okay. On the second part of the question, which was more like if we were to achieve, basically, like a higher revenue level, what would be the impact on earnings. Of course, that's very critical to us is that we've stated that $20 million in EBITDA is what we're really targeting. And we say that we can reach that level in our view at about $230 million. So your question was what if we can actually reach $250 million. Well, guess what, we will actually be focusing on driving a lot more earnings to the bottom line. And fundamentally, if we're able to deliver $250 million, to go back to your example, the earnings would be above $30 million. So no, not $30 million, but yes, about $30 million if we're at $250 million. So we're clearly focused on doing this. I think you had a flip side of your question; what if we were to be less than that. Well, our COO had a word to say into how we will be managing the issue. I think that's what I understood of the question. If we were to be below the $230 million, deliver the $20 million, we basically as a Management team, myself, the upcoming COO, the CFO, we would actually be taking action, we are committed to drive basically more earnings. The bottom line is really critical to create value for shareholders and that's what we're focused on. We think we have an excellent and outstanding execution plan for 2016, especially with the fact that even though it didn't really show practically that much during FY15, but we've done a lot of significant transformation to get ourselves into a very strong footing as we're getting into this new fiscal year.

[Operator:]

Your next question comes from Robert Young with Canaccord Genuity.

[Robert Young:]

Hello, good afternoon. Maybe I'll continue on one of Robin's questions there about the potential for the bottom line. In the past you've highlighted 15% EBITDA as a two- to five-year target for EBITDA margin. Given where you're pushing the cost structure now, is that still a target if the market improves? Or should we think of the longer run profitability of EXFO below that 15% or even above? If you'd like to comment on that.

[Germain Lamonde:]

Well, I'd like to say that we are remaining as committed, if not more, to reaching our 15% EBITDA target. Frankly, given the fact that it's been challenging the last couple of years in the industry, I don't think it would be very prudent for me right now to give a specific date, Robert, as to when we can actually reach that 15%. But clearly our intent is to get there very quickly. It doesn't require a lot of additional volume into our business to reach that level of earnings. I think we can state right now that if we were at the $245 million, $250 million in revenue, we would be delivering about 12% in EBITDA.

[Robert Young:]

Okay, that's helpful, thank you. Second question is around larger deals. I think you've said that the funnel, you'd had a number of opportunities in the funnel and that some of the deals were getting larger in size. But it looks -- you did close one large deal in August, but it looked like it was an OTDR, so on the Phy side. I was wondering if you'd talk about any difficulty closing some of these large deals? Is that a factor maybe if you could talk about what the frustration is there?

[Germain Lamonde:]

It’s a good question. First of all, clearly our funnel of large deals is clearly growing. And what's really happening in a nice fashion is we're building better and better practices and better and better experience doing it. I would say that we have probably more experience and capabilities and knowledge in doing this in a proper fashion, probably more in the Americas region. And of course the venue of a COO within the organization will probably help us accelerate our ability to keep strengthening our abilities to close and to basically to identify, to nurture and to close large deals. Clearly in America as well, but also to expand our abilities and our processes, and Best-in-Class procedures as well, on the EMEA and APAC front. So I really believe this is a major opportunity for us to accelerate because our solutions offering is clearly unmatched. Our analytics product, which we've talked about, is really generating a lot of interest. I think basically this is for us to execute and bring the value to our shareholders.

[Robert Young:]

Okay. I assume the larger deals predominantly are solution Protocol sales with higher margin profile. Is that why you're confident that the margin's going to expand next year and you'll see that mix grow?

[Germain Lamonde:]

Absolutely.

[Robert Young:]

Okay.

[Germain Lamonde:]

Absolutely. Very good point, Robert. Absolutely.

[Robert Young:]

Last question from me. You don't typically give out any kind of split between the Phy and protocol, but you gave the annual 19% decline in Protocol and 9% growth in the Phy-layer. I was wondering, can you talk about like how that's trending as you're exiting the year? Is it improving? Are you seeing an improvement in Protocol as we're moving into F16 here? Or are you still seeing that same weakness in Protocol? And then I'll pass the line.

[Germain Lamonde:]

Thank you very much, Robert, that's a very good question as well. Basically we give this breakdown only once a year between Physical and Protocol-layer. And indeed, basically, we're not quite satisfied with the 19% in the Protocol-layer side. Quite happy with the 9.1% and high market share we have in the Physical-layer. I really believe we're going to maintain basically that growth in the -- or strong growth -- in the Physical-layer side. I'm very glad, in fact, as I reported basically in one of our product areas, one of the key product areas within Protocol we've had a much stronger second half thanks to a new generation of products. Basically we were counting on this new software architecture, if you will, that's started to -- the time we were working towards implementing this new software architecture negatively impacted the first half of fiscal year ‘15 because that was really needed, in fact, and we were hoping to get it out a bit earlier. But we were starting to get impacted because we were putting a lot of efforts on the longer term foundation structure, to give us basically a more than 2X productivity enhancement in the software development. So now, with that 2X productivity enhancement, we've basically been able to launch a whole series of additional features through the first half of the year. And we've been able to accelerate bookings in the second half, for that specific significant product group, by more than 40% for the second half. So yes, it's clear that the momentum is actually building. The momentum also on the analytics portion is clearly in acceleration as well. So I think it's clearly visible right now within our booking and trends and funnels that this Protocol segment, the key transformation and corrective actions, if you will, that needed to be implemented, have been implemented, and are now starting to have an impact. That's what's giving me the confidence that we will deliver this $20 million of EBITDA in our fiscal 2016.

[Robert Young:]

Okay. If I can squeeze one last one in. The growth on the Phy-layer side, I think you said last quarter that you'd seen some weakness on the field hand-held segment, and now this quarter you're saying that there was a little bit of secular decline in the lab. I've always associated those two more with Phy-layer. Understand there's some wireless growth there. But the 9% growth in my mind doesn't match up with those two areas of weakness. Help me understand that. Then I'll pass the line.

[Germain Lamonde:]

One data point here that probably is clearly the element to put in place is the fact that our wireless Protocol analyzer really is in the Protocol segment. And this is really what a significant part of our business into the labs. We also have instruments sold in the labs like optical equipments, transport. Like we're quite involved with system vendors on their 100 gig deployment or development for new capabilities, with their 200 gig development and 400 gig and so on. But that segment is not -- it's part basically of our Physical-layer for a piece of it, like the optical-layer piece. And the 100 gigabit Protocol testing or transport testing is part of our Protocol testing arena. But the one point I wanted to make clear is the fact that our Protocol analyzers for the wireless industry, which we bought from NetHawk five years ago, has been basically into a decline, which has basically negatively impacted our Protocols business. With the turnaround now of putting that more into a probe and accessing basically a wider market, we have already a very strong funnel. We're already starting to get some very good tractions, and that's also going to be [mainly] contributing to our growth in Protocol business in FY16.

[Operator:]

Next question comes from Kris Thompson with National Bank Financial.

[Kris Thompson:]

Great, thanks. Germain, I was really surprised to hear that you might transition out of the CEO role. I know how passionate you are as an entrepreneur. Does this in any way signal that you might be willing to sell the Company in the next couple years?

[Germain Lamonde:]

That's a good question. Thank you, Kris, for asking that question first. No, no, in fact, the intent is always the same. The public utility organization -- first of all, the Company has always been available for sale, but it has to be at a price that the Board and myself as a large shareholder would think that it makes sense. I don't think there's any change there. The intent is not to run the Company to try to sell it, but the intent is to run the business to keep it stronger, to strengthen its capability, to grow and expand and gain market share and continue basically to build a down in position in key segments. So I really believe in this business and my commitment to it has basically fairly never been stronger. Because my sense that we're finally back out and out of this transition time, if you will, it's becoming very clear right now. So I'm very excited and very passionate about the business. The fact that I said that at some stage I plan on -- I brought a guy like Philippe on board because I wanted to get someone within the team that can be eventually my replacement. I always said that I want to have -- I always needed to have -- a strong plan for what if I was to get hit or what if something happens. I'm 56 in full health, so I'm not going to go anywhere. But at some stage, having 13 direct reports doesn't make sense. I wanted to reduce the number of direct reports on the short term, going from 13, going down to 8, which will be much more manageable on my side. And eventually over time, what I want to do is to transition some of my responsibilities to Philippe. I've known him for a long time and I know that he is really clearly the best guy to have within the organization to become my successor. And the timing, I talked about the timing of 18 to 24 months. It's something that makes sense to me, where at some stage I would like to keep focusing more on longer-term more strategic elements, by at some stage, stepping up to Executive Chairman role, being basically remaining full-time and fully committed and driving the business. Because not only do I have passion for the business, but I really believe it's got a lot of legs for growth in the longer term.

[Kris Thompson:]

Okay, that makes sense. Maybe to shift gears, I want to talk about your sales organization, but start with headcount. How many heads do you have today or at the end of the year? And what's your headcount today?

[Germain Lamonde:]

The number of heads today overall for the organization is about 1,500 on a global basis. Is that answering your question? You asked for the number of heads, that's it. Is there more you wanted to know?

[Kris Thompson:]

I want to understand what it was at the end of the year and what it is today. Or what is it going to be after you completed the restructuring that you're talking about?

[Germain Lamonde:]

The restructuring is actually completed. I think we went down from the last reported number, which was 1,660 and we were basically at the end of fiscal year 14 we were at 1,610 people. So we've been basically working hard at trimming the organization so we can be in a position to deliver basically more earnings growth. That's very critical to me.

[Kris Thompson:]

And your sales and marketing headcount, how does that compare to last year at the end of August till today?

[Germain Lamonde:]

It has been reduced a little bit. But mostly it's been around optimization, it's been around like better focus and better tweakings and making sure that we have skill set and the right level and the right positions, wherever it takes to be perfectly aligned with strategy. So basically the number of head counts overall has been somewhat close to stable, maybe down a little. But there's no radical transformation happening there besides the fact that we have really worked hard on tweaking our sales organization to be the skill sets required at the right location for the right growth areas.

[Kris Thompson:]

So last year you had 340 people in sales and marketing, about there. How many of those were dedicated to servicing your installed base of customers versus going out there and knocking on doors and trying to win new customers? I'm just trying to understand the structure of your organization, what you're doing right and maybe what Philippe might come in and change?

[Germain Lamonde:]

Well, I would say I'm sure, first of all, that Philippe coming on board is going to certainly do a lot of better management of it maybe than I can do personally with the amount of time that I have available. I think that, without going into any of the speculations of the changes that may happen over time, I don't think radically there's anything fundamentally wrong. I think what we have to be improving is consistency and execution. Consistency in a sense that we have a lot of very good practices that are happening in specific regions that we should be leveraging in all the regions, so whatever good we do somewhere, we need to do it great everywhere. And whatever great customer wins we get into a specific region, we should be sharing better across the regions. And there's a lot of that that needs to happen that is not happening today. So in my book there's a lot of low-hanging fruits in existence right now within the business that a full-time dedicated COO can actually grab, that for me was kind of impossible to spend enough time in grabbing. So that's the first thing really that I want to assure. And as you know between Philippe and I, that's what we agreed on what will be the initial focus and role to help drive this discipline of growing the business. So it's really about execution and also about as we are focusing more and more to be the systems and solutions business, which means increasingly selling to executive level. And that's the same as well with our expansion into Tier 1 and large telecom operators, where we need to increasingly play a role actively at executive level while basically my own time available to them as executive has been a bit too limited given my number of direct reports. What you can expect now moving forward is both Philippe will actually have a lot of time. But it’s also going to free me up as well to a fair degree where I can also spend a fair amount of time moving forward. I can basically expand my own role into executive meetings. So I think what you can see there is that Philippe and I will make a formidable team working together in helping basically to accelerate the business. And that's the main focus that we'll have in the very short term.

[Kris Thompson:]

Okay. Do you track revenue by existing customers versus new wins in the year?

[Germain Lamonde:]

Not quite that simple or not quite that way. What I'd like to point is that since we've been in the business now for 30 years, in fact we just marked our 30th anniversary this September, there is not a whole lot of accounts that we've not been selling to over time. We've sold to the very vast majority of all the telecom operators. Now the question is a lot more how can we execute better, to get deeper market share within these operators? So there's something where EXFO has been historically very strong at, which is more or less where we came from as a business going back 20, 30 years ago, which was to do a bit more of a bottom-up sales process. Like a lot of our instruments business has been sold a bit more like from a bottom-up point of view. Now the direction we're taking with more systems, more solutions, more into the wireless industry, which tends to be more executive-based rather than bottom-up sales, if you will. And the fact that we're going more into Tier 1s, it's really pulling for a lot more need for us to be more aggressive and more successful in the C-suite.

[Kris Thompson:]

Okay. And just my last question here around foreign exchange. Pierre, what rates are you using for your guidance?

[Pierre Plamondon:]

The rates of 130.6, 130.9.

[Kris Thompson:]

And then if we look at your cost of goods sold and all of your OpEx combined, what percentage of that would be CAD, euro and US?

[Pierre Plamondon:]

If we look to cost of goods sold, we have roughly 15%, one-five in Canadian dollars. SG&A exposes about 30% and R&D is about 55%.

[Operator:]

At this time there are no further questions. I'll turn the conference over for any closing remarks. Germain Lamonde So thank you very much, operator. First of all, we've implemented a number of very significant internal transformations to position the Company back into growth mode for 2016 in our very critical Protocol and product area. So we expect the business now to be back into contributing to growth, as well as we're expecting our Physical-layer business to continue in delivering very strong performance. Second, I'm very, very pleased with Philippe Morin will be joining soon in this new role of COO as of early November. As it will clearly strengthen our executive management suite and our ability to aggressively develop the markets better. I believe Philippe's presence will be a major catalyst to EXFO in our quest to become the number-one player in the role of telecom service assurance and visibility market and his capabilities and relationships in the industry will certainly be very major assets. And last but not the least, I have very strong confidence that our value creation plan and strategy, which will be leveraging both the new coming presence of Philippe as well as all the key transformations we did during the last fiscal year, will be allowing us to improve our adjusted EBITDA by more than 40% to $20 million during FY16, and this should be achieved. A goal of $230 million. So at this stage on behalf of the whole, and the entire EXFO Management team, I'd like to thank you all for joining us today for this call.

[Operator:]

Thank you for your participation. This concludes today's conference. You may now disconnect.