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Germain Lamonde

Founder and Executive Chairman

Germain Lamonde
Germain Lamonde

Dear shareholders,

Fiscal 2018 will mark EXFO’s history for the strategic transformations that we implemented, even though our financial performance was less than satisfactory. As these manifold transformations take form, I firmly believe we will significantly improve profitability in 2019 and the years ahead.

We boldly moved ahead with four acquisitions in the last two years to bolster our market-leading position in test and measurement, while creating a top-five leader in network service assurance and analytics. Let me shed some light on these deals.

Test market

We acquired Yenista Optics in October 2017 and the assets of Absolute Analysis in October 2016. Yenista added to our optical test leadership by strengthening our lab and manufacturing offering, right at the time 400G shipments were beginning to ramp and 800G/1TB research was moving ahead. From Absolute Analysis, we obtained portable RF technology that assesses the quality of wireless coverage and interference issues. We have since leveraged this technology into a system-level, RF monitoring solution.

EXFO was already the No.1 global supplier in optical testing, joint market leader in high-speed testing (100G/200G/400G) and technology leader in the field test automation segment that we’re creating. With these two acquisitions, we significantly expanded our addressable test market to $900M, delivering highly differentiated benefits at the time fiber, 400G and 5G/IoT are in growth mode. I believe these relatively small acquisitions will bring revenue and earnings growth for us in the test market – covering the optical, copper and high-speed field, manufacturing and lab test segments – where the EXFO brand is widely recognized.

Systems market

This is where we made our most important moves in the last two years with the ambition of creating a new global leader in service assurance and analytics for hybrid physical and virtualized architectures, spanning mobile and fixed networks as well as data centers.

We’re fully integrating the Systems activities of Astellia (top 3 in passive wireless monitoring, acquired in February 2018), Ontology (top 3 in topology and service chain mapping, acquired in March 2017) with EXFO’s offering (top 2 in fiber, active and RF monitoring) into the most comprehensive technology platform correlating the widest range of data. This advanced platform will provide network operators with significant differentiation and unrivaled benefits. It will allow operators to take advantage of their physical and virtualized network investments in the delivery of optimal quality of experience and service agility, as they push ahead with critical fiber deep, 5G, small cell and cloud transformations.

Moreover, EXFO’s combined Systems organization now serves more than 250 monitoring and analytics customers in which we’re leveraging relationships to maximize technology-based, cross-selling opportunities. For example, we plan on replicating the previously announced $10.0 million-plus contract with 3UK with other mobile operators, since we’re convinced our solution is second to none for fully virtualized, cloud-based monitoring and analytics.

Our strategic push into monitoring and analytics allows EXFO to address a global $2.6B market in which we have a good footprint in the Americas and EMEA regions. This move is not a blind bet, but rather a carefully orchestrated plan allowing EXFO to accelerate its long-term growth. We have essentially progressed from being a smaller player, with a limited customer and technology base in the systems market, to a top-five supplier with a much stronger position to compete against incumbent players.

Looking ahead

As announced in late August, our restructuring plan is aimed at accelerating our aforementioned Systems transformation, increasing efficiency and reducing costs. We expect to achieve $8.0 million in cost savings for fiscal 2019 and $10.5 million annually thereafter, once restructuring efforts are completed by mid-year 2019.

Given our laser focus on driving profitability in 2019, we do not plan on making further acquisitions in the short term. On the other hand, we have implemented corrective actions and enhanced our focus on internal execution, since we had an unusual hiccup in our test business in the past fiscal year due to the high level of activity related to acquisitions, transformations and integration.

While our balance sheet remains healthy with low net debt1 of $4.5 million and $52.5 million in available revolving credit facilities, we will also pay strong attention to free cash flow generation during 2019 to replenish our cash position. Note that we generated $14.4 million in cash flows from operations in 2018.

To enhance transparency and simplify communication with investors, we will report revenue and bookings results for our Test and Systems product groups, as described above, beginning in the first quarter of fiscal 2019. This breakdown will replace our former Physical and Protocol grouping which became less relevant.

We will continue providing annual adjusted EBITDA2 guidance with a heightened emphasis on achieving and even surpassing our announced metric, established at $24.0 million2 for fiscal 2019. We also remain committed to reaching a 15%2 adjusted EBITDA margin in the upcoming years.

Final words

Our highly committed senior management team, CEO Philippe Morin, the Board of Directors and I are confident that our Test and Systems product families are both well positioned to take advantage of current investment cycles. We are also mindful that industry transformations like network virtualization, 5G and IoT do not happen overnight.

As EXFO’s founder, Executive Chairman and majority shareholder, I share everybody’s disappointment with our financial performance in 2018. I remain confident we made the right trade-offs and action plans to drive earnings and revenues back onto the right growth curve for 2019 and beyond.

Sincerely,

Germain Lamonde,
Founder and Executive Chairman

November 27, 2018

 

1 Net debt is a non-IFRS measure and represents bank loan and long-term debt, less cash and short-term investments.
2 Adjusted EBITDA is a non IFRS measure and represents net earnings before interest, income taxes, depreciation and amortization, stock-based compensation costs, restructuring charges, acquisition-related deferred revenue fair value adjustment, and foreign exchange gain.
These adjusted EBITDA targets are forward-looking statements. In addition, as they exclude items that pertain to future events that are not currently estimable with a reasonable degree of accuracy, such as foreign exchange gain or loss and income taxes, no corresponding IFRS measure has been provided. Refer to our Annual Report on Form 20-F filed with the U.S. Securities and Exchange Commission and our Annual Information Form filed with the Canadian securities commissions for assumptions used in the establishment our adjusted EBITDA targets.