Back to Annual Review 2015

Letter to Shareholders

Germain Lamonde
Founder, Chairman of the Board
and CEO

Dear Shareholders

Fiscal 2015 will best be remembered in EXFO’s history for the meaningful transformations that we implemented and our increased strategic focus on high-growth vectors rather than financial performance due to the significant headwinds we faced. Let me expand on these three aspects below.

Financial Performance

Fiscal 2015 was marked by challenging market conditions and turbulent macro-economic environments in China as well as in Europe, Middle East and Africa (EMEA), and the devaluation of several of our sales currencies versus the US dollar. Given this context, revenue dropped 3.8% to $222.1 million (but remained flat on a constant currency basis) and adjusted EBITDA* reached $13.8 million (flat year-over-year as a percentage of sales at 6.2%). Clearly, EMEA was the hardest hit region with sales decreasing 10.5% year-over-year to account for only 26% of total revenue in 2015, while the Americas and Asia-Pacific regions remained relatively stable.

Our Physical-layer product group (optical and copper testing) delivered a strong performance in 2015 with sales increasing 9.1% year-over-year and market-share gains confirmed by third-party Frost & Sullivan. I expect this product group to continue delivering robust growth in 2016 and beyond. On the other hand, sales of our Protocol-layer product group decreased 19.1% year-over-year, partially due to market issues and the completion of strategic internal transformations that had a short-term, negative effect on our financial results.

Transformations

We implemented key transformations during 2015 that, while not necessarily yet visible to shareholders, will have a significant impact in returning our Protocol-layer product group to growth. Let me shed some light on these transformations.

  • Following our acquisitions of ByteSphere (Boston, United States) and Aito Technologies (Espoo, Finland) for a total of less than $4 million in 2014, we integrated their leading technologies, along with our internal service assurance developments, to introduce a unique analytics software solution at Mobile World Congress in March 2015. While this new solution did not contribute to sales in 2015, it represents a critical part of our 2016 growth strategy that will be outlined in greater detail below.
  • Sales of our NetHawk protocol analyzers steadily declined over the last three years due to a shrinking laboratory market among wireless network equipment manufacturers (NEMs) and limited demand for portable 4G/LTE troubleshooting solutions among mobile network operators (MNOs). Consequently, we started converting this instrument technology into leading-edge, rack-mounted, passive probes that are now almost fully integrated into our end-to-end (E2E) service assurance offering. This transformation has allowed us to expand into a new, billion-dollar market with a highly differentiated solution that is critical for MNOs in order to assure network performance and quality of experience (QoE). Additional revenue decreases are expected from our protocol analyzers, but it will be insignificant as they now account for less than 2% of total revenue.
  • We invested significantly in 2014 and 2015 on a new, unified software architecture for our 10G to 100G transport and datacom (T&D) products that resulted in a more than 150% increase in R&D productivity. This new software environment, which was released at end of the second quarter of 2015, temporarily delayed the introduction of new technology features and consequently negatively affected sales in the first half of 2015. The T&D product line has since recovered, posting a 40% sequential bookings increase in the second half of 2015 and should continue delivering growth moving forward. More importantly, these significant productivity gains have resulted in a substantial edge in time-to-market for EXFO, while allowing us to reduce R&D investments.

Strategic Focus on High-Growth Vectors

Clear Focus on Value CreationThe major transformations that we implemented should not only steer both of our product groups to revenue growth in 2016, but they will also greatly enhance success in our three strategic high-growth vectors: systems and solutions, wireless industry and selected tier-1 customers.

View CEO Video
  • Systems and Solutions is certainly an exciting focus area in which we delivered significant bookings growth in the Americas during 2015 and where overall revenue acceleration is expected in 2016. EXFO has developed test instruments for field and lab applications for the last 30 years and has been involved with probe-based, service assurance systems for more than seven. Systems and solutions have become a far more important strategic focus for EXFO in recent years with our offering expanding into a collection of probe-based, probe-less and instrument-based solutions for fixed, mobile and web-scale operators. EXFO’s key differentiator is to provide network operators with significant productivity gains and new heights in E2E visibility at the network, service and consumer levels – truly fundamental drivers in the operators’ quest to enhance QoE and increase profitability.

    We demonstrated significant progress in this area in 2015 as evidenced by the fact our No. 1 customer in three of four quarters mostly purchased systems and solutions rather than test instruments. Interestingly, this portfolio of solutions, which is a part of our Protocol product group, is characterized by higher margins, recurring revenue streams (13% of EXFO total sales in 2015), customer stickiness and stronger long-term partnerships. We earned important wins among tier-1 network operators in 2015 that are linked to critical, new technologies like visibility in large-scale NFV deployments, in end-to-end VoLTE rollouts, and in the automation of commercial data-services delivery. I could list several more examples, but in all cases network operators deployed new services more efficiently, provided better QoE, and improved the prioritization and predictability of service-impacting issues.

  • Particularly noteworthy within our systems and solutions offering is EXFO Xtract, a highly scalable analytics software tool that can best be described as a vendor-agnostic, Big Data analytics solution. It correlates massive amounts of network, service and consumer data to provide unmatched E2E visibility in order to drive improvements in QoE. Data can originate from our probe-based solutions, our standards-based polling capabilities from almost any network element, as well as from data sources provided by network operators or other probe vendors. EXFO Xtract, which addresses a new, fast-growing $1-billion market, also offers highly differentiated predictive capabilities to help anticipate upcoming issues and prioritize them before they affect consumer experience.

    I am pleased to report that we completed in early fiscal 2016 a large-scale deployment of EXFO Xtract at a tier-1 MNO to process the measurements of tens of millions of key performance indicators per hour, thus allowing this network operator to deliver superior network performance and end-user experience. This analytics software solution was also selected by a few additional customers in the first quarter of 2016. These important reference wins, combined with an impressive opportunity funnel, demonstrate the strong customer traction this unique solution has garnered in a short period of time.

  • Wireless Industry. As people worldwide increasingly turn to mobility when it comes to consuming telecom services at work, rest or play, it is no surprise that MNOs are commanding a greater share of global telecom investments. With this in mind, EXFO brought to market several new offerings in 2015: from all-in-one portable instruments, combining optical, Ethernet and CPRI testing, to advanced solutions as exemplified by EXFO Xtract and passive-probe capabilities that highly complement our active service assurance offering. Overall in 2015, bookings to wireless customers reached an estimated 30-32% of total bookings. We expect to continue our progress in this critical end-market based on new solutions and technologies that we brought to market in 2015 as well as a series of new initiatives that we recently presented to thought-leading MNOs.

  • Selected Tier-1 Network Operators, Data Centers and Web-Scale Operators. We will keep expanding our share of wallet with selected tier-I network operators, since they represent a very large portion of telecom investments where EXFO is generally under-represented. We will also strengthen our focus on the fast-growing data center, Cloud and web-scale operator markets based on their significant increase in infrastructure spending during recent years. It is forecasted that capital spending by web-scale operators will exceed that of the top-15 network operators within the next five to seven years if this spending pattern persists.

    We have witnessed growing business traction among these key customer groups, especially given our wealth of solutions like EXFO Xtract, high-speed optical and transport product offerings, and new FOT-940/950 MaxTester Fiber Certifiers aimed at data centers. More specifically for larger network operators, we have reworked our focus account program to accelerate penetration and become more effective at developing higher-level relationships and longer-term partnerships, both for our systems and instruments businesses.

Value Creation

Value creation remains fundamental to me as EXFO’s largest shareholder. The transformations outlined above, which are all related to our higher-margin Protocol product group, are just a few of the critical initiatives that we implemented in 2014 and 2015 to greatly improve EXFO’s position and strategically expand our addressable markets. While these transformations required significant investments that did not contribute to revenue in 2015, they will have a meaningful impact to ensure that both product groups grow in 2016 and beyond.

These key transformations not only enabled us to sharpen our strategic focus; they allowed us to reduce costs, especially in the R&D and go-to-market areas, while improving our overall efficiency. Talking about cost controls and efficiency, we lowered our cost structure by $6.7 million in 2015 due to a strengthening US dollar, tighter control of all budget items and the impact of the above transformations. We followed up with a restructuring last August that generated additional cost savings of $3.5 million per year without affecting our go-to-market and innovation capabilities.

In terms of our three strategic high-growth vectors, EXFO is extremely well positioned with a strong and differentiated product offering that addresses the most critical opportunities in these fast-growing segments. In short, we have the products, solutions and expertise to deliver stronger growth and market-share gains.

As we bolster sales and go-to-market capabilities within these three high-growth areas, it is not surprising that we require sales optimization and channel tweaking to maximize revenue growth. EXFO, for example, is increasingly turning to executive selling due to our focus on systems and solutions, wireless industry and tier-1 operators. It is with this objective in mind that I selected Philippe Morin, formerly at Ciena and Nortel, to join EXFO in a new role as Chief Operating Officer (COO). His initial responsibilities include global sales and go-to-market leadership to improve our market reach and better capitalize on some of the unique market opportunities within our three key focus areas. Philippe will undoubtedly add tremendous value to EXFO and greatly contribute to revenue growth in 2016 and beyond given his impressive sales track record, industry relationships that are critical for selling high-end solutions to company executives, and past experience in the high-speed optical networking and system businesses.

  • Finally, our profitability target for 2016 is to expand adjusted EBITDA* by more than 40% to reach at least $20 million. Given the cost reductions and relative currency values, we believe this goal can be achieved by merely increasing revenue 3.5% year-over-year to $230 million. Based on the transformations that we implemented, our three strategic growth vectors, new markets that we address, and manifold initiatives Philippe is already introducing to improve EXFO's sales and go-to-market capabilities, I am confident this modest revenue growth will be achieved. And rest assured that we have no intention of stopping there.

 

Germain Lamonde
Founder, Chairman of the Board and CEO
Germain Lamonde

 

November 25, 2015

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