EXFO's (EXFO) CEO Germain Lamonde on Q1 2017 Results - Earnings Call Transcript

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EXFO Inc (NASDAQ:EXFO) Q1 2017 Earnings Conference Call January 10, 2017 5:00 PM ET

Executives

Vance Oliver - IR

Germain Lamonde - CEO

Pierre Plamondon - CFO

Philippe Morin - COO

Analysts

Deepak Kaushal - GMP Securities

Thanos Moschopoulos - BMO Capital Markets

Operator

Ladies and gentlemen, thank you for standing by and welcome to EXFO’s First Quarter Conference Call for Fiscal 2017. 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 Tuesday, January 10th, 2017.

I would now like to turn the conference over to Mr. Vance Oliver, Director of Investor Relations. Please go ahead, sir.

Vance Oliver

Good afternoon, and welcome to EXFO’s first quarter conference call for Fiscal 2017. With me on the line today are Germain Lamonde, EXFO’s Founder, Chairman and CEO; Pierre Plamondon, Vice President of Finance and CFO and Philippe Morin, Chief Operating Officer. 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 amended Form 20-F filed on January 9th, 2017 with the Securities and Exchange Commission. Our annual information form is available with 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 Q1 2017 press release on our website. All dollar amounts in this conference call are expressed in U.S. dollars, unless otherwise indicated.

So without further delay, I will turn the call over to Germain.

Germain Lamonde

Well, thank you very much, Vance. Good afternoon, everyone, and let me first wish every one of you a wonderful 2017, and very prosperous New Year. For EXFO, fiscal 2017 is very off on a good start, with double-digit increase in sales, in bookings, and adjusted EBITDA in the first quarter.

Sales have increased 11.9% year on year to $61.8 million, and that's about the midpoint of our guidance.

Bookings rose 12.6% year on year to $65.9 million. This makes for a robust book-to-bill ratio of 1.7 in the first quarter of 2017, which follows a book-to-bill ratio of 1.03 in fiscal 2016. And our adjusted EBITDA has improved 19.6% year on year to $6.2 million, or 10.2% of sales, which is really in line with our initial target of achieving at least 18% growth to reach $26 million in fiscal 2017.

Sales have increased 11.9% year on year to $61.8 million, and that's about the midpoint of our guidance. Bookings rose 12.6% year on year to $65.9 million. This makes for a robust book-to-bill ratio of 1.7 in the first quarter of 2017, which follows a book-to-bill ratio of 1.03 in fiscal 2016. And our adjusted EBITDA has improved 19.6% year on year to $6.2 million, or 10.2% of sales, which is really in line with our initial target of achieving at least 18% growth to reach $26 million in fiscal 2017.

Let me first provide you with a brief market update, and how we have taken advantage of these key trends. So EXFO continues to benefit from the global 100-gig optical investment cycle for both major infrastructure and data center build outs that are led by communication service providers and web scale operators, respectively. As the clear number one in portable optical testing, and have a lexico [ph] in the 100-gig transport market, EXFO is capturing a growing share of this 100-gig investment cycle. EXFO's unique capability and contribution, by combining optical and high speed testing solutions in the same platform, remains unmatched in the industry. And the good news is that we're only in the early stage of this high speed investment cycle.

Some leading service providers have ramped up their 100-gig deployment in their metro networks, and the metro market is at least two or three times larger than the long-haul market, and far more complex. As a result, we believe this market trend has legs for a few years to come. As well, web scale operators like Google and Facebook are just spending as much in higher rate than traditional service providers to connect their massive number of data centers.

Again here, EXFO is leveraging its leadership in optical and high speed transport, to gain share in a new and fast-growing market segment. The end result, Q1's 2017 was EXFO's best bookings quarter ever for optical testing, and a very strong quarter in high speed transport. Second, increased penetration at Tier 1 network operators bolstered our sales in Q1 2017, highlighting the depth and breadth of our portfolio. EXFO serves more than 90 of the top 100 communication service providers globally and consequently one of our key growth initiatives is to expand share of wallet within these accounts.

So we have accomplished just that in the first quarter of 2017 with a Tier 1 Service Provider accounting for an unusually high level of 13.8% of sales, or $8.6 million. And this resulted from the wide range of products and solutions sold, including software functionalities with our recent acquisition of Absolute Analysis. A stronger focus on Tier 1 Operators also enabled our top three customers to reach 23.4% of sales in the quarter. The goal of course for us is to repeat this type of success at several additional accounts over time. While our top customer at 13.8% of sales in Q1 is unusually high, I expect our top three customers over time to gradually ramp up and become higher than our historical 15% we've been standing at for the last several years.

Thirdly, we made significant inroads in network equipment manufacturers or the system vendors, if you will, via our LTB-8 rackmount platform, and expanded high speed transport and optical offering. Last year, we refreshed our product portfolio for MEMS with the launch of our LTB-8 platform and a series of related high-speed transport test modules. We strengthened our optical -- our product offering as well in the fall with introduction of optical and test modules, including power meters, variable attenuators and optical switches, that are really complementary to our existing offering. These solutions can be remotely managed via EXFO Multilink, a unique lab test management system with a multi user interface that offers remote access to multiple modules and multiple chassis across several locations.

The end result is that NEMs, we're also now assimilating 200-gig and 400-gig network in their labs, can streamline testing, accelerate time to market, and maximize their return on investment with this new EXFO solution. Already, five leading NEMs have approved our LTB-8 platform, and submitted orders today. We expect this new lab platform will accelerate market traction in 2017 and beyond, to expand our business in both the optical and the high speed transport segments.

Now, turning to specific product related initiatives. Our unique value proposition for testing fiber based, radio access network helped EXFO deliver strong sales in Q1 2017. Prior to acquiring the assets of Absolute Analysis we had an OEM agreement with them to sell their optical RF software as an option with our optical and Ethernet testing, on top of our FTB-1 Pro test platform. Given the very strong market response among service providers, we decided it was better off for us to acquire Absolute Analysis, and as a result, during the first quarter that we've acquired Absolute Analysis Technology their expertise in solutions for Q1 during the first quarter for the amount of $5 million in cash and $3.5 million in shares.

So today we have the only all-in-one optical, Ethernet and RF test solution in the market, which really represents a key competitive advantage in the industry, as it migrates towards 5G and small cell deployments. Going forward, this acquisition will help us bolster sales at higher margin, since we now own the optical RF technology out right.

Finally, we received our first commercial order for virtual verifiers from a Tier 1 service provider in the first quarter. Although this is relatively low value order, this represents a very highly strategic service assurance order for EXFO, as a service assurance provider worldwide, as all the operators are gradually moving towards the proof of concept to commercial deployment stage for their NEV initiatives. Consequently they are seeking ways to render their networks far more agile and cost effective, and populate a hybrid world with physical and virtual networks co-existing side by side, for a very long time to come.

As the saying goes in the industry, if you can't monitor a service, you can't monetize it. You really have to prove you have the ability to deliver quality of service before you monetize it. As a result, EXFO's virtual probes represent a key building block within our system assurance business for all of the communication service providers seeking to monetize their networks, while assuring quality of experience at the same time.

So at this stage, before we talk about guidance, and in anticipation of our AGM or Annual General Meeting that will take place tomorrow here in Toronto I'd like to take the moment to thank Darryl Edwards, CEO of ECI and former President of Nortel Global Sales for his five years tenure on our Board, so thank you very much Darryl, for your strong contribution. I'd also like to take a moment to welcome Angela Logothetis, VP and Head of Network Technology and Services at Amdocs. She ran basically a very large practice on the OSS product and product management side.

We would like to welcome Angela to join our Board officially as of tomorrow. I firmly believe that with her strong experience, knowledge and contacts within the industry, will clearly help EXFO to continue in its journey to expand its business around communications service providers, especially in the areas of service assurance.

Now let's turn to our guidance for Q2 2017. So our second quarter is typically the most challenging, due to seasonality. But this is also counteracted with a renewal of annual maintenance contracts, although they are recognized over 12 months, and also by a strong book-to-bill ratio of 1.07 in the first quarter of 2017. So given this information, we are forecasting sales between $58 million to $63 million for the reporting period, that extends from December 1, to February 28, 2017. In comparison, we delivered $53.6 million in sales for the same quarter in the last fiscal year.

Looking at the bottom line, IFRS net results are expected to range between a loss of $0.01 per share to an earnings of $0.03 per share for the second quarter of 2017, and IFRS net earnings includes $0.01 per share in after-tax amortization of intangible assets, and stock-based compensation costs, as well as anticipated foreign exchange loss of $500,000 based on today's exchange rate.

So at this point, I'll turn the call over to our CFO, Pierre Plamondon, to talk about our financials.

Germain Lamonde

Thank you, Germain.

Sales increased 11.9% to $61.8 million in the first quarter 2017 from $55.2 million in the first quarter 2016, but decreased 1.7% from $62.9 million in the fourth quarter 2016. Bookings increased 12.6% to $65.9 million in the first quarter of 2017, from $58.5 million in the same period last year, and increased 5.5% from $62.4 million in the fourth quarter 2016.

Our book-to-bill ratio amounted to 1.07 for the first quarter 2017, which includes $6 million, mainly for the renewal of annual maintenance contracts. Our double-digit sales and bookings increase year-over-year can mainly be attributed to strong market demand for optical solutions in the Americas and EMEA. Gross margin amounted to 63.1% of sales in the first quarter of 2017 compared to 63.5% in the first quarter of 2016, and 61.6% in the fourth quarter 2016. On a year-over-year basis, our gross margin slightly decreased, due to an unfavorable product mix within our physical layer for the group. This drop was partially offset by a richer mix within our project line, namely a large wireless deal recognized in Q1 2017.

In terms of operating expenses, selling and amortization expenses totaled $21.6 million or 35% of sales in the first quarter of 2017, compared to $20.3 million or 36.7% of sales in the same period last year, and flat at $21.6 million or 34.2% of sales in the fourth quarter of 2016. The increase in SG&A dollars year-over-year can be attributed to higher commission expenses paid out on higher sales, as well as additional head counts for the Company growth and personnel from Absolute Analysis acquisition. As a percentage of sales, our SG&A expenses decreased year-over-year due to higher revenues.

Net R&D expenses reached $11.3 million or 18.2% of sales in the first quarter of 2017, compared to $9.9 million or 18% of sales in the same period last year, and again flat to $11.3 million or 18% of sales in the fourth quarter 2016. Likewise, net R&D dollars increased year-over-year, due to additional head count to support the Company growth and as well, personnel from Absolute Analysis. And as well as a shift in the mix and timing of R&D development projects.

IFRS net earnings in the first quarter of 2017 totaled $3.3 million or $0.06 per diluted share, compared to $1.8 million or $0.03 per diluted share in the same period last year, and $2.3 million or $0.04 per diluted share in the fourth quarter of 2016. IFRS net earnings in the first quarter of 2017 included $0.4 million in after-tax amortization of intangible assets, $0.3 million in stock-based compensation costs, and a foreign exchange gain of $0.5 million. Adjusted EBITDA amounted to $6.3 million or 10.2% of sales in the first quarter of 2017, compared to $5.3 million or 9.6% of sales in the first quarter 2016, and $6.2 million or 9.8% of sales in the fourth quarter of 2016.

Geographically, the Americas accounted for 56% of total sales in Q1 2017. Europe, Middle East, Africa represented 23% while Asia Pacific totaled 21%. In comparison the same space was 56%, 26%, and 18% among those three geographic regions in the first quarter of 2016.

Turning to a few key points on the balance sheet. Our cash position decreased to $39.3 million at the end of Q1 2017 from $47.2 million in the previous quarter. This $8 million decrease is mainly due to the $5 million in cash paid out for the Absolute Analysis acquisition, $1.2 million for the purchase of kept-on-sale [ph] and $9.9 million used by our operating activities, and finally an unrealized foreign exchange loss of CAD0.8 million on our cash and short-term investments, denominated in Canadian dollars.

Finally, I would like to address the filing of our amended 2016 Annual Report. During the preparation of financial statements for the first quarter of 2017, we identified a material weakness in our internal control over financial reporting, resulting in the improper aging of our trained accounts receivable ledgers. This led to an incorrect assessment of bad debt expenses, again as single trade accounts receivable in previous years. The remediation plan is already underway to correct this material weakness. Although, with this, I'll remind that these were not material to our previously issued consolidated initial statement, we decided to revise our financial statement to properly record bad debt expenses. Again this single trade accounts receivable in the proper period.

This revision are non-cash and therefore do not affect our statement of cash flow for any of the prior periods, and do not affect our consolidated statement of earnings for fiscal 2016. The impact on net earnings for fiscal 2015 and fiscal 2014 amount to a decrease of $441,000 [ph] and $527,000 respectively. It will be noted these revisions do not constitute a restatement of prior-year financial statement.

At this time, I will turn the call to the operator for the start of the Q&A.

Question-and-Answer Session

Operator

[Operator Instructions]. And your first audio question comes from the line of Deepak Kaushal.

Deepak Kaushal

Germain, I was wondering if you could comment on what you're hearing from your customers' major carriers across the world, through the end of the year, and I know that it's early in the New Year, but perhaps you could give us a sense of if you detect any changes in their outlook for the telecom industry as a whole, and their capital spending budget plans?

Germain Lamonde

It's a very good question and I'll actually summarize the answer, stating that of course by the end of the calendar 2016, we saw some yearend money, but not to a very large degree. Now we're looking at where is it that the operators would want to be investing in the networks moving into 2017 and beyond. We believe that we will see that the investment plan towards upgrading the metro to higher speed and continuous investment into the data centers, at the same time, continuing on the deployment of 4G remains important, while getting ready for 5G which although this is a 2018-2019, 2020 plan, operators that are like the thought leaders in our book are starting to invest now in making sure their backhaul is heading into capacity.

We see significant interest in getting ready for LEV and SDN, although many of the operators will continue to invest in both before the NAV segment becomes the majority, their investment is going to take time. I really believe there's still a lot of investments taking place in more of a traditional industry, and therefore, we are very well positioned for that, especially with the fact that we can deal with both the LEV and the traditionally more hardware centric business.

So fundamentally I would say that while the segment remains very robust in terms of investment, there's always a risk that we see the market with whenever we see consolidation is a slowdown in investments or a slowdown into deployment, we haven't quite experienced any of that as of now, but we are really very cautious.

Deepak Kaushal

Okay, and then you mentioned good progress with a large customer, and winning a greater share of wallet. Can you comment on what particular products or segments of your business are driving that growth in the wallet share, specifically perhaps for that customer?

Germain Lamonde

For that particular customer the good news is that it's widespread. It's not like a single product. It's a succession, it's a massive range of products that we got basically approved. And fundamentally we're getting very good traction for various aspects, whether it is on the wireless deployment as well as fixed line and their traditional businesses, if you will.

So a lot of activity around building the capacity on the wireless segment which means operators are globally and not only for that account but globally as well, back to your first question, looking at how they get more efficiency in the wireless deployment that goes towards of course only getting the electronics to the base, build at the base station, the flow level, but to get more towards centralized and eventually a cloud run architecture.

That Operator is going in the direction, that's really very positive for us in terms of our recent acquisition of Absolute Analysis, which is going really according to plan if not better. So I'm quite pleased with that aspect of it. With that particular customer, we had pretty much across-the-board from optical to access to transport, including sales assurance, very good successes.

Deepak Kaushal

Okay, and perhaps, I think on the real-time analytics front, you had penetrated one major customer in North America. Any progress on that front?

Germain Lamonde

Well we have more than one account, we have, I wouldn't say like hundreds, but we have multiple accounts. In all of these accounts basically, the solution we brought to the marketplace remains, in our book, the most capable, the most advanced. And we continue to add capabilities and features and functions to that particular analytics platform.

We think especially when it comes to active sales assurance, we really have a very good position in the marketplace, and we're engaging with a greater number of customers, both our active but as well for the native exposure that comes with it.

Deepak Kaushal

But sorry to interrupt, if we just considered Tier 1 operators then, how are you faring there with the real-time analytics proposals?

Germain Lamonde

I'm sorry?

Deepak Kaushal

For just the Tier 1 market, can you comment on the progress for the Tier 1 customers with respect to real-time analytics?

Germain Lamonde

Well we have a number of engagements, we have a few deployments with Tier 1s, based on our own internal definition, and again I'd like to say that Tier 1s basically for us, our own definition is there's only 15 customers around the world. So we have engagement with more, within this list of 15, right? So basically it's all a matter of definition for who is and who is not a Tier 1.

In our definition, there's only 15 Tier 1 Operators globally, and we have basically a mass deployment with one of those, and we have engagement with others and some small scale or some scale of deployments with others as well, so I think we're making good progress. I'm quite pleased with the progress we're making.

Deepak Kaushal

Okay and the typical sales cycle for that is what?

Germain Lamonde

Well a typical sales process goes, in fact the stronger is our established base of probes, the faster it's going. But I will say our typical process is six to nine months, typically we will see the marketplace.

Deepak Kaushal

Okay, so should we expect another Tier 1 win some time this year in this calendar year?

Germain Lamonde

Well I'm not going to make necessarily a guidance on this, but yes, we do expect to get additional large customers to sign in. The dollar amounts, sometime of the initial deployment might not be super large, but what's very interesting here is that while the initial implement might not be a massive amount of dollars, it really is a plan in which once we are in, we can just go and expand over time, and expand not only on the analytics portion, but also expand on our active test probes, with moving from hardware centric and add eventually more virtualized probes, and so on and so forth. So basically once you're in it on this, unless we do something wrong, it's a market where these are accounts where we should be expanding over time.

Operator

[Operator Instructions] Your next question comes from the line of Thanos Moschopoulos with BMO Capital Markets.

Thanos Moschopoulos

Maybe as a follow-up to Deepak's questions on Extract, has your traction with Extract been primarily focused on the North American market, or are you getting penetration with other types of global customers in other regions as well?

Germain Lamonde

We really have a lot of engagement, so around the globe. And in fact I have our COO with us here so I'll actually allow him to just add to this answer.

Philippe Morin

Yes, it's Philippe here. The success from Extract has gone global, and as Germain highlighted earlier, it tends to start with customers that we already sold a service assurance solution, then that's an easier path to migrate them to bring real-time analytics with it. So we have seen our success across the globe.

Thanos Moschopoulos

That's encouraging. And remind us, would these deployments be large lumpy deals, or would they probably be more spread out over several quarters, when a customer chooses to deploy?

Germain Lamonde

Once we win a deal we will actual had it have typically a gradual amount of revenues, meaning that there is a moment where we can recognize the revenues from the software itself but typically there will be deployment of probes and additional ancillary type of deployments with these accounts, so we don't expect necessarily to see a big one-time big dollar amount, but we say these will typically be customers where we spread additional probe deployments, more service deployments, more software deployments, and some analytics.

Thanos Moschopoulos

So in other words, sorry go ahead --.

Germain Lamonde

Expect it to be more of a gradual type of revenue stream.

Thanos Moschopoulos

So as you get more traction in this area, then presumably that should help smooth out the volatility we've seen historically in the protocol business?

Germain Lamonde

Well I think this is an area that suddenly creates a lot of traction and we have fraction for additional areas within our product group. We talked extensively around the analytic segment, which is really getting a lot of traction, and we have specific additional areas that are really causing very good traction within the marketplace. But we feel quite strong that both product groups delivered the revenue growth and bookings growth in Q1, and in the same vein they both did during our fiscal 2016.

Thanos Moschopoulos

Okay and can you provide color in terms of what you're seeing in China, obviously a lot of CapEx investment going on there right now. Remind us to what extent you're participating in some of that?

Germain Lamonde

We're getting good traction in the China market, we are quite happy with how we're starting our fiscal 2017, and I'll just remind the audience that we have a very strong long-term presence in China. We've been basically heading our own staff on site, ever since the mid 1990s. We've grown our footprint in the region, we have multiple sales offices across the country. We have five or six sales offices across the country.

So our presence in China is quite strong. China accounts to be second largest country from a revenue standpoint, and I firmly believe we are in a strong position, and continuously strengthening our positions against any additional brands in the marketplace.

Philippe Morin

It's Philippe again. The thing about China that Germain highlighted in his opening statement around the LTB-8 platform, the NEM specific, we've had some good success as well with some of the NEM vendors obviously in China, where we've been able to penetrate with that new platform.

Thanos Moschopoulos

Was China the key driver of the year-over-year growth we saw in your APAC segment this quarter?

Germain Lamonde

The widespread basically all regions contributed very strongly.

Germain Lamonde

Thank you very much. At this stage, since there's no additional questions on the line. I'd like to take a few minutes to provide some key takeaways before we conclude this particular call. First of all, I think you'll join me in saying we delivered strong financial results in the first-quarter 2017, with double digit increase in sales, in bookings, and adjusted EBITDA year on year. This marked the second consecutive quarter where we reported double-digit increases across the whole board.

Secondly, our success based on combination of market, product-related factors and including all regions, that includes our positioning in the 100-gig optical investment cycle, increased penetration at key focus accounts, and strategic market acceptance of our LTB-8 platform. We also benefited from the introduction of our all-in one optical and RF test solution, from the base radio access network from our recent acquisition. Consequently, we are really very confident about achieving our $26 million in adjusted EBITDA for fiscal 2017.

Finally, I want to remind you that EXFO will be holding its Annual Meeting of shareholders tomorrow at 9:00 AM at the St. Andrews Club and Conference Center Canada Room here on the 27th floor in Toronto, and both shareholders and analysts are welcome to attend.

This concludes our first-quarter 2017 conference call, and on behalf of the entire EXFO team, thank you very much for joining us today.

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