Letter to Shareholders

Fiscal 2013 in Review

2013 Annual Review

Germain Lamonde
Chairman of the Board,
President and CEO

Fiscal 2013 was marked by internal investments in key technology platforms that will contribute to long-term revenue growth and value creation at EXFO. While the telecom market proved to be challenging during the past year, as evidenced by our sales decrease of 3.1% to $242.2 million, we nonetheless gained market share and delivered adjusted EBITDA* of $17.3 million.

At a more granular level, sales of our Physical-layer test solutions increased 4.3% (+$5.8 million) in 2013 based on our expanding market leadership in portable Optical testing and robust growth from our Copper Access products. This, however, was not sufficient to offset an 11.3% (-$12.9 million) decrease in our Protocol-Layer product group, marking the first decline for a segment that has grown at a CAGR of 24.5% during the past five years. This pause in Protocol sales growth was mainly caused by unexpected delays in the introduction of aforementioned key long-term technology platforms, which reduced resources on short-term roadmaps, and by difficult market conditions. While I am clearly unhappy with the impact these delays had on our 2013 financial results, I am convinced we endured short-term pain for long-term gain and that EXFO’s proven track record in innovation and R&D execution will improve even further. As a result, I fully expect both our Physical and Protocol-layer product groups will deliver growth in 2014.

Growth Strategy

Looking back at our performance in 2013, we made significant strides against our growth strategy while enhancing our overall competitive position.

  • Increase Wireless Presence.

    Wireless ProgressSales to wireless customers increased to an estimated 28% of total sales in 2013 from 24% in 2012 on the strength of our comprehensive portfolio spanning wireless access, mobile backhaul and core networks for mobile network operators (MNOs) and network equipment manufacturers (NEMs). EXFO made a conscientious decision more than five years ago to expand into the wireless market, since the much-anticipated proliferation of smart phones and video usage pointed towards exponential bandwidth growth over an extended investment cycle. As a result, we combined our strong technology and market leadership in Optical, Transport and Ethernet testing with strategic acquisitions in IMS, service assurance and wireless test to transform EXFO into a major supplier of end-to-end field test and monitoring solutions. Our future in this market looks brighter than ever with the recent releases of Brix Mobile Agent, TravelHawk Pro and PowerHawk Pro analyzers, QA-800 wireless simulators and several other solutions. Consequently, I expect EXFO to continue delivering robust revenue growth for several years in this area — as we have done in each of the last five years starting with almost no revenues in that segment at the time.
  • Expand Share of Wallet with Tier-1 Operators.

    A fundamental part of EXFO’s strategy is to expand share of wallet with tier-1 network operators on a global basis. Once again in 2013, we made significant progress on this front with key new product approvals, contract wins and expanded account penetration. For example, our TravelHawk Pro, a troubleshooting tool for 4G/LTE networks, was selected by three of the top-five LTE operators in the world. Our 100G test solutions, including the new FTB-88100 NGE Power Blazer, earned the favor of seven out of the top-15 network operators worldwide due to multiservice test capabilities supporting transmission rates up to 100G. For its part, our MaxTester Copper/DSL series was approved by three tier-1 North American operators to qualify broadband copper links. In terms of optical testing, our OTDR portfolio, equipped with award-winning iOLM intelligent characterization capabilities, reached an estimated 50% of global market share. Altogether, EXFO serves about 80 of the top-100 network operators worldwide. As the clear No. 2 supplier in the portable telecom test market, EXFO has plenty of room for growth, the most advanced solutions to gain market share and strong brand equity in terms of excellence and execution.
  • Enable Operators to Reduce OPEX.

    In 2013 we strengthened our market leadership in the area of productivity solutions, or innovative solutions that enable fixed and mobile operators to accelerate deployment, allow field technicians to do it right the first time, and provide better systems to improve up-time and quality of experience (QoE). In short, we provide network operators with smart test and service assurance solutions that enable them to better spend their CAPEX budgets toward addressing their two most critical issues: reducing OPEX and increasing QoE. For example, we added a one-click diagnostic capability on our portable protocol analyzers to render them the industry’s easiest to use and fastest troubleshooting solutions for complex 3G/4G network issues. We extended our intelligent optical link mapper (iOLM) technology to accelerate fiber deployments for distributed antenna systems (DAS), fiber to the antenna (FTTA) and fiber to the home, curb or node (FTTx). We expanded the feature set on our family of FTB test platforms and EXFO Connect, the only suite of cloud-based solutions that literally transform individual test boxes into integral parts of an overall productivity ecosystem. These individual instruments are in constant communication with a central system to automatically handle work tickets, manage test results, run test scripts, optimize travel routes and many other imaginable applications. The common benefits of all these solutions are increased network uptime, improved customer experience and reduced training time. Ultimately, our strategy to help network operators reduce OPEX resonates loud and clear with them, placing EXFO well ahead of its peers on this front.
  • Accelerate Profitability.

    EXFO generated $17.3 million in adjusted EBITDA in 2013, down by $1.0 million despite a 3% drop in revenues. This was achieved mainly by reducing operating expenses $9.0 million year-over-year and maintaining a tight control on costs. Our leaner organization, combined with a sharper R&D focus and streamlined go-to-market approach, will contribute significant earnings leverage as we return to revenue growth in 2014. As such, I am confident our Physical-layer product group will continue delivering growth, while our high-margin Protocol-layer segment will resume its history of expansion as our new technology platforms are mostly all out on the market. The entire EXFO management team is wholly committed to raising our adjusted EBITDA margin to 15% in the not-too-distant future, maintaining a balance between sales growth and profitability for the benefit of all stakeholders.

Looking to the Future

 
View CEO video: Stay the Course
I firmly believe that we have the right plan, the right people and the right market positioning to reach new heights in 2014. Consequently, we are staying the course with our strategy, while heightening focus on quality of execution in three key areas: innovation, operational excellence and profitable growth.

While many industry observers are debating the actual tipping point for increased capital spending in the telecom industry, our focus at EXFO is to be positioned right now where operators are about to increase their spending in order for us to deliver healthy revenue growth. Even if the market environment remains flat in 2014, I am convinced we will generate growth based on market-share gains — something we have consistently achieved in our 28-year history.

Looking ahead at upcoming growth vectors:

  • High-Speed Networks.

    Given fixed and mobile operators worldwide are facing explosive demand for bandwidth, moving to higher speeds is proving to be the most cost-effective solution — from 1G, to 10G, to short-lived 40G, to 100G, and soon to 400G which is just entering field trials. This is not simply a matter of ratcheting up transmission rates to 100G or 400G; it also involves upgrading legacy, point-to-point voice networks to packetized/OTN-based network infrastructures carrying a myriad of Ethernet services. In short, we are talking about major network upgrades on a global basis that require high-performance test and service assurance solutions like those offered by EXFO.
  • 4G/LTE Mobile Networks and Small Cells.

    While 4G/LTE deployments are just getting underway in Europe, wireless operators in North America and Asia-Pacific are still in the early innings of their deployments (with LTE-Advanced not far behind). Accommodating both 3G and 4G/LTE technologies is an industry requirement for wireless operators due to the growing number and assortment of smart phones, tablets and wireless dongles on the market. Consequently, operators will continue spending on their 3G and 4G networks for data and upcoming voice-over-LTE (VoLTE) for years to come. New investments will take place in the front haul where small cells and distributed antenna systems are complementing macro-cell deployments in order to deliver the required capacity. Cost-effectively adding capacity in front-haul, backhaul and core networks is creating enormous issues for operators and opportunities for EXFO.

Dedicated Leadership

I am privileged to be supported by a disciplined and experienced executive team boasting more than 15 years on average in key areas like product line strategy, sales, R&D, operations and finance. Altogether, this dedicated team is responsible for approximately 1600 employees in 25 countries.

I am also honored to rely on a committed Board of Directors with seasoned executives like Pierre-Paul Allard, Senior Vice-President of Worldwide Sales and President of Global Field Operations at Avaya; Darryl Edwards, former President of Global Sales at Nortel Networks and current CEO at ECI Telecom; and Guy Marier, former President of Bell Québec. During the past fiscal year, we also welcomed Claude Séguin, Senior Vice-President of Corporate Development and Strategic Investments at CGI Group and Randy Tornes, former Vice-President of Sales at Nortel and Ericsson and current Head of Sales (AT&T account) at Juniper Networks. As well, I would like to thank Pierre Marcouiller for his 12 years of service and guidance on our Board.

Wrap-Up

In closing, I am thankful for the effort and dedication demonstrated by our global workforce in 2013. I also want to express my thanks to our loyal customers for their trust in allowing EXFO to become a genuine partner in their quest to build and maintain better networks. Finally, I want to thank our shareholders for their confidence in EXFO. We are more than ever committed to delivering not only increased revenue, but also earnings growth with a medium-term target of 15% adjusted EBITDA margin.

Germain Lamonde

Sincerely,
Germain Lamonde,
Chairman of the Board, President and CEO
October 8, 2013

  • *
  • Adjusted EBITDA represents net earnings before interest, income taxes, depreciation and amortization, restructuring charges, stock-based compensation costs and foreign exchange gain.