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Edited Transcript of EXF.TO earnings conference call or presentation 7-Jan-20 10:00pm GMT

Q1 2020 EXFO Inc Earnings Call

QUEBEC Jan 13, 2020 (Thomson StreetEvents) -- Edited Transcript of EXFO Inc earnings conference call or presentation Tuesday, January 7, 2020 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Philippe Morin

EXFO Inc. - CEO & Director

* Pierre Plamondon

EXFO Inc. - CFO & VP of Finance

* Vance Oliver

EXFO Inc. - Director of IR

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Conference Call Participants

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* Christian Sgro

Canaccord Genuity Corp., Research Division - Associate

* Thanos Moschopoulos

BMO Capital Markets Equity Research - VP & Analyst

* Todd Adair Coupland

CIBC Capital Markets, Research Division - MD of Institutional Equity Research

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Presentation

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Operator [1]

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Good day, everyone. Welcome to EXFO's first quarter conference call for fiscal 2020. Today's conference is being recorded. At this time, I'd like to turn the conference over to Vance Oliver, Director of Investor Relations. Please go ahead, sir.

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Vance Oliver, EXFO Inc. - Director of IR [2]

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Good afternoon, and welcome to EXFO's first quarter conference call for fiscal 2020. With me on the line today are Philippe Morin, EXFO's Chief Executive Officer; and Pierre Plamondon, CFO and Vice President of Finance. Germain Lamonde, EXFO's Founder and Executive Chairman, will also be available to answer questions during the Q&A period.

A reminder that this conference call will include certain forward-looking statements and our 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 filed 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 reconciliation of these non-IFRS results with IFRS numbers is available in the Q1 2020 news 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 Philippe.

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Philippe Morin, EXFO Inc. - CEO & Director [3]

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All right. Thank you, Vance, and good afternoon, everyone. First of all, I'd like to take the opportunity to wish everyone on the call here a happy new year.

Now turning to our financial results. EXFO opened fiscal 2020 with a strong first quarter performance with sales increasing 6.3% year-over-year to $73.6 million. Now this marked the fifth consecutive quarter that our sales results finished above the midpoint of our management guidance. We're also pleased with our reported adjusted EBITDA of $7.5 million or 10.3% of sales, which sets EXFO on the right path to achieve our profitability target of $33 million for the fiscal year.

Our organic sales increase is mainly due to a steady influx of Test & Measurement orders that were booked and shipped in Q1 2020 versus a back-end loaded Q1 2019. Now notably, we benefited from strong demand from EXFO's optical test solutions in our Asia Pac region in our first quarter of 2020, an increased appetite of our 400-gig test equipment along with our high-end lab solution. Our bookings, however, were down versus the same period last year. And if you recall, we had reported our second highest bookings level of $81.2 million in Q1 2019, which was due to unprecedented calendar year -- year-end spending on the part of service providers in Americas for our Test & Measurement products. Now given less year spending -- year-end spending and some annual maintenance contracts renewal being pushed out into second quarter, our bookings totaled $69.9 million for a book-to-bill ratio of 0.95 in the first quarter of 2020.

Now we're not overly concerned about the data point as we secured 3 SASS orders totaling more than $2.5 million in the first quarter of December -- sorry, the first week of December related to our RAN optimization, real-time network topology and as well active monitoring for mobile backhaul networks. Now these deals would have narrowed the bookings gap had they been obtained a few days earlier and are still proof points that we're increasing our relevancy with our SASS offering.

Now speaking of our SASS offering, we've recently rebranded all of their solutions under the new Nova name for -- Nova name brand for better consistency and positioning clarity. I'm confident these solutions will increasingly gain traction as we get closer to deployment of 5G networks later in the fiscal 2020.

So in short, our Test & Measurement business with sales of up to 12.4% year-over-year continues to thrive based on our innovation we bring to the market and ongoing tailwinds related to fiber build-outs and high-speed deployments. On the SASS side, sales were down 8.6% year-over-year. As we expected, we witnessed order lumpiness as we build scale and navigate through complex customer requirements related to 5G and virtualized networks.

Now let me provide you with our guidance for Q2 2020. We're forecasting sales between $66 million and $71 million for the reporting period extending from December 1, 2019 to February 29, 2020. It should be noted that EXFO recognized into revenue a $5 million network topology order in Q2 2019, but we don't anticipate a similar high-margin software deal in Q2 2020.

Looking at the bottom line, IFRS net loss is expected to range between negative $0.09 to negative $0.05 per share for the second quarter of 2020. IFRS net loss includes $0.05 per share in after-tax amortization of intangible assets, stock-based compensation costs and anticipated foreign exchange loss.

So at this point, I would like to turn the call over to Pierre to cover our financials.

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Pierre Plamondon, EXFO Inc. - CFO & VP of Finance [4]

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Thank you, Philippe. Sales increased 6.3% to $73.6 million in the first quarter 2020 from $69.2 million in the first quarter of 2019. As previously mentioned, we increased our sales year-over-year, mainly due to a more steady flow of Test & Measurement order in Q1 2020 compared to the same period last year, in which a significant portion of our order was back-end loaded and only recognized into revenue in the following quarters. We also benefited from stronger demand for our solution in the Asia Pac region in Q1 '20 compared to Q1 '19. Bookings meanwhile decreased 13.9% year-over-year to $69.9 million in the first quarter of 2020 for a book-to-bill ratio of 0.95.

Gross margin before depreciation and amortization improved to 58.9% of sales in the first quarter of 2020 from 58.2% in the first quarter of 2019. The adoption of IFRS 16 raised our gross margin by 0.4% in Q1 2020, while our Q1 '19 gross margin included 0.4% for restructuring expenses.

In terms of operating expenses, selling and administrative expenses decreased to $24.5 million or 33.3% of sales in the first quarter of 2020 from $26.4 million or 38.1% of sales in the first quarter of 2019. The $1.9 million decrease in SG&A expenses reflect the full impact of our 2018 restructuring plan, the adoption of IFRS 16 and no restructuring charges in Q1 2020.

Net R&D expenses dropped to $11.7 million or 16% of sales in the first quarter of 2020 from $15.2 million or 22% of sales in the same period last year. Likewise, the $3.5 million decrease in net R&D expenses is linked to the positive impact of our 2018 restructuring plan, the adoption of IFRS 16 and no restructuring charges in Q1 2020 compared to $2.1 million expense in Q1 2019. On the other hand, SG&A and net R&D expenses were negatively affected by inflation and 2019 salary increases.

IFRS net loss totaled $0.1 million or $0.00 per share in the first quarter of 2020 compared to a loss of $7.5 million or $0.14 per share in the first quarter 2019. IFRS net loss in the first quarter 2020 included $1.4 million in after-tax amortization of intangible assets, $0.5 million in stock-based compensation costs and a foreign exchange loss of $0.1 million. IFRS net loss was impacted by restructuring charges of $2.7 million in the first quarter of 2019.

Adjusted EBITDA totaled $7.5 million or 10.3% of sales in the first quarter of 2020 compared to $2.7 million or 3.9% of sales in the first quarter of 2019. EXFO adopted IFRS 16 related to leases on September 1, 2019, which had a positive impact on adjusted EBITDA of $0.9 million or 1.2% of sales in the first quarter of 2020. Prior period amounts were not adjusted.

Geographically, the Americas accounted for 54% of total sales in Q1 '20; Europe, Middle East and Africa represented 29%; while Asia Pacific totaled 17%. In comparison, the sales split was 51%, 32% and 16% among the 3 geographic regions in the first quarter of 2019. In terms of customer mix, our top customer accounted for 11.9% of total sales in Q1 '20, while our top 3 represented 19.7%.

Turning to a few key points on the balance sheet. Our cash position decreased by $1.9 million to $17.5 million at the end of the first quarter 2020. This decrease is mainly due to $6.5 million in cash flow used by operations, $2 million for the purchase of capital assets, $1.5 million for the repayment of lease liabilities and long-term debt and $0.2 million for the redemption of share capital. These cash amounts were partially offset by an $8.4 million increase in our backlog in the first quarter of 2020. At the end of Q1 '20, EXFO has a net debt position of $0.8 million and available revolving credit facilities up to $47.7 million.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll go first to Thanos Moschopoulos with BMO Capital Markets.

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Thanos Moschopoulos, BMO Capital Markets Equity Research - VP & Analyst [2]

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So Philippe, if I look at your results this quarter and the guidance for next quarter, it would seem you're looking for the first half of the fiscal year to be relatively flat year-over-year. So I mean, based on your commentary, should we attribute that primarily to a tough year-over-year comp? Or what's the bigger picture here? Is it maybe that you're still seeing some pause from operators as they sort out through their 5G requirements?

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Philippe Morin, EXFO Inc. - CEO & Director [3]

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Yes. No, I think the -- yes, so you're right. So when you look at the first half to first half, it will be roughly around a flat performance. Couple that -- I would say 2 facts. One is the Test & Measurement lumpiness that we had last year, the year-end money was greater than what we've done this year or what we've seen this year; and as well the CenturyLink customer [Nova contracts around topology] that we've announced last year, if you remember, the $5 million purchase order that also came into Q2 that we don't believe we're going to realize a similar type of contract this quarter. So that's kind of a combination of those 2 things.

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Thanos Moschopoulos, BMO Capital Markets Equity Research - VP & Analyst [4]

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Okay. And then if we just look at sort of the SASS business. I mean, the bookings have been a little softer in the last 3 quarters. Now obviously, that's lumpy segments, but how would you characterize the pipeline, your discussions with operators, how -- and how those have evolved over the last while? I mean, would you still expect to see an inflection point maybe later this year as there's more 5G activity? Or is there any change to that time frame?

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Philippe Morin, EXFO Inc. - CEO & Director [5]

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Yes. So we're going to continue to see -- I guess we're predicting an inflection point more into the latter part of our fiscal year. We see some of our -- if you remember, we have 3-phased approach with regards to 5G deployment. The first one is around the whole -- impacting our Test & Measurement for fiber build-out and small cells, and we're seeing the benefit of that. The second phase is the RAN optimization, mobile backhaul, monitoring and so on. And that's continuing, and we do expect to see some demand as I mentioned in my opening remarks. And then the 5G real core deployment, which we expect more as an inflection point into the latter part of 2020. We do see that there's still work being done, RFQs going through that hopefully will convert into our second half or 2020 in terms of our performance from a bookings point of view.

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Thanos Moschopoulos, BMO Capital Markets Equity Research - VP & Analyst [6]

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Okay. Would you still hope to achieve mid-single-digit revenue growth for the fiscal year?

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Philippe Morin, EXFO Inc. - CEO & Director [7]

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Yes. And as I mentioned as well achieving the $33 million of EBITDA as well.

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Thanos Moschopoulos, BMO Capital Markets Equity Research - VP & Analyst [8]

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Okay. And then question for Pierre. Taxes were higher this quarter. What did that relate to?

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Pierre Plamondon, EXFO Inc. - CFO & VP of Finance [9]

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Yes, it's mostly a matter of timing of tax in different countries. But for the next quarter, we're expecting probably again tax expense average of $0.5 million for the quarter.

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Thanos Moschopoulos, BMO Capital Markets Equity Research - VP & Analyst [10]

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Okay. And then looking at your guidance, it would seem that OpEx should be relatively consistent in Q2 relative to Q1. Is that correct?

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Pierre Plamondon, EXFO Inc. - CFO & VP of Finance [11]

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Well, you remember that in Q2, we had the -- some increases starting in January 1, and we do have some benefits like insurance premium and so on that kick on again at the beginning of the year. So, so -- and you have probably mentioned -- noticed that the currency is not playing in our favor in this quarter as the Canadian dollar gets stronger compared to the previous quarter, so all those elements tend to increase our OpEx for next quarter.

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Thanos Moschopoulos, BMO Capital Markets Equity Research - VP & Analyst [12]

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Okay. And what level of FX gain or loss is embedded in your EPS guidance?

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Pierre Plamondon, EXFO Inc. - CFO & VP of Finance [13]

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It's roughly $0.01.

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Operator [14]

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We'll move next to Todd Coupland with CIBC.

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Todd Adair Coupland, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [15]

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I had a question on -- a follow-up question on the 5G. What can we watch for from the outside to see whether the market is moving in line with your expectations over the course of this year? What are some of the signs we should watch for?

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Philippe Morin, EXFO Inc. - CEO & Director [16]

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Yes. So the -- what we're monitoring ourselves is, one, activities associated with antenna, small cells deployment and fiber deployment associated with it. Second is announcements around what I would call the 5G radio -- new radio selection from our customer base, and then the virtualization announcements in terms of what they're looking at modernizing their network. These are kind of the bellwether we're looking at with regards to the activities. Obviously, internally, we see RFQs and RFIs that we receive. But from an external point of view, these are kind of the activities, I would say, that are either leading front end indicators of the 5G deployment about to happen.

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Todd Adair Coupland, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [17]

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And the new -- I mean, it's a good point on the new radios. I mean, this has been something the sector has been watching for, for a while. Would you think that, that happens when some of the later in calendar Q1, early Q2 releases from the carriers come out? Is that the kind of timing that's generally expected right now? And so that will say, yes, the RFQs will turn into orders this year? Or do you have a different view of that?

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Philippe Morin, EXFO Inc. - CEO & Director [18]

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Yes. No, I think it really depends on -- by countries, and it starts off -- as you know, Todd, first of all, there are going to be auctions for the particular spectrum that -- in each of the respective countries. And then in certain countries, you've seen already deployment of new radios being deployed. Obviously, the U.S., Korea and China are examples of where that's taking place. And then right behind that, you've got the opportunities for not only the new radio, but the modernization or the virtualization of the core and RAN, which follows right behind that. So that's kind of the leading indicator that I think the industry should be looking for.

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Todd Adair Coupland, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [19]

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Okay. And if you were to -- again, just to be -- see if you can be as precise as possible. Characterize your view of the rollout of these indicators now versus 3 months ago. Has it changed at all? And if so, how?

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Philippe Morin, EXFO Inc. - CEO & Director [20]

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What's changed versus 3 months ago, I would say, for -- depending on the regions, again, the level of some of our activities with response to -- responding to RFQs. I think 6 months ago, we were still having discussions around architecture and POCs. Now we're seeing some RFQs for monitoring, for service assurance -- virtual service assurance that are starting to come in and then increasing that -- with that level of increasing activity, depending again on the regions. But that would be the difference between 3 to 6 months ago.

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Todd Adair Coupland, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [21]

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Okay. Last question for me. Is there any way for you to characterize your market share now, let's say, versus last year or the last cycle? Do you -- directionally, can you give any commentary on that?

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Philippe Morin, EXFO Inc. - CEO & Director [22]

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Yes, and I'll answer the market share. I mean, as you know, we have 2 business units. So on the Test & Measurement side, with our optical test solution, we believe we're #1 market share. And with the addition of our lab solutions with the acquisition that we made 2 years ago, Yenista, we actually believe we have increased our position there.

With regards to SASS, as you know, the market is very fluid, very dynamic. There's a lot of solutions involved in this. We like to use -- Analysys Mason did a report about a month ago for the year of 2019, and they put us at #2 at 9% market share for that year behind NetScout. But again, that was probably from a 2019 view, so with -- very focused on the service assurance probe -- virtual probe monitoring capability. But as you know, in our SASS product, we have fiber monitoring, we have simulator products, so it becomes really more complex trying to figure out exactly where we stand in terms of that total market share. But overall, like in the probe market, we've made some improvement in our market share in the last 18 months.

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Todd Adair Coupland, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [23]

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And is it too early to tell whether Astellia is going to help you raise your market share for 5G, particularly in the U.S.?

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Philippe Morin, EXFO Inc. - CEO & Director [24]

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Well, Astellia for sure helps us with regards to being -- adding a solution in the portfolio that we didn't have before, especially a virtualized solution that we've been able to implement into 3 U.K. in Europe. It also provides us with professional services capability that we didn't have before, so absolutely, it will help us in our positioning in North America for 5G and for service assurance deployment for 4G+ and 5G as well in North America.

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Operator [25]

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(Operator Instructions) We'll move next to Tim Savageaux with Northland Capital Markets.

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Unidentified Analyst, [26]

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This is actually [Steven] on for Tim. I was wondering if you guys could give us a little color. Any indication on the drivers for your guide next year in terms of like optical and protocol?

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Philippe Morin, EXFO Inc. - CEO & Director [27]

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For the next quarter, you mean, drivers for the next quarter?

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Unidentified Analyst, [28]

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Yes, correct. And...

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Philippe Morin, EXFO Inc. - CEO & Director [29]

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Okay. I just want to make sure...

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Unidentified Analyst, [30]

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What was that?

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Philippe Morin, EXFO Inc. - CEO & Director [31]

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No, I just want to make sure. I thought you said guidance for next year. So I just want to make sure we're talking about guidance for next quarter.

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Unidentified Analyst, [32]

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Yes, next quarter.

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Philippe Morin, EXFO Inc. - CEO & Director [33]

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Yes. So again, as you may know, Q2 for us is -- from a seasonality point of view is a quarter that goes from November -- sorry, December, January and February, which is a bit more of a challenge for us in terms of both the T&M and SASS because we've got, obviously, the holidays and Chinese New Year and so on. And so that's part of what's taken into account when we do our guidance, the seasonality aspect of that. And as well, when you look at our backlog, you look at the booking level, our book-to-bill ratio being at 0.95, it really got us to a point where that's providing our guidance to make sure, one, we -- it is a realistic guidance for our revenue profile. So it takes into account the seasonality. It takes into account the service provider approval process and budgeting process that they go through at the beginning of the calendar year. And it also take into account the backlog that we walked into the quarter following our bookings that we did in Q1.

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Unidentified Analyst, [34]

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Okay. Great. And then, I mean, do you think you could give us any more color on like the optical compared to like last year and even compared to this quarter?

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Philippe Morin, EXFO Inc. - CEO & Director [35]

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Yes. So the -- so what happened last year, and again, if -- just to remind everybody, Q4 of 2018 was a softer quarter for us from a T&M point of view and Q1 was very strong as I mentioned in my opening statement. If you actually look at it from a 6-month point of view and you compare the 6-month Q4 2019 with Q1 2020 with the same period a year before, what we're seeing is a T&M market that's absolutely, from a bookings point of view, pretty flat. So what we're seeing is more of an even out over 6 months of that particular activity in that particular market segment. We do foresee, as we talk to our service provider customers and our web scale customer that they're continuing to do the fiber build-out. There's -- and on top of that, that's coupled with our 400-gig solution that we're seeing some really nice momentum there, and the ongoing lab -- high-end lab solutions that we have, we continue to foresee a good high demand for that T&M portfolio.

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Operator [36]

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We'll hear next from Christian Sgro with Canaccord.

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Christian Sgro, Canaccord Genuity Corp., Research Division - Associate [37]

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Just one question, Todd (sic) [Philippe]. With a longer-term view, would you point out any seasonality across the 2 business segments? You often comment that the SASS segment is lumpy, but thinking about quarter-to-quarter and the longer term, is there something we should be looking for in spending patterns in the spending environment?

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Philippe Morin, EXFO Inc. - CEO & Director [38]

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So there's more seasonality associated with the T&M business than there is with the SASS business. The SASS business tends to be more lumpiness from the point of view of bigger contracts, longer sales cycles and when we close these deals. As I mentioned earlier, last year, we closed in with a $5 million deal that tend to have multiyear multimillion dollar contract. So there's no seasonality on the SASS side. It's more about closing deals and there are longer sales cycles and more complex type of deal versus T&M. There is more seasonality aspect associated with it and as well, being able to convert those bookings that tends to be more back-ended into the quarter to be able to convert them into revenue.

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Christian Sgro, Canaccord Genuity Corp., Research Division - Associate [39]

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Okay. That's helpful. But when you look quarter-to-quarter across the fiscal year, is there a period in the year where you would see that some new customers are looking to, I think it's called budget flush or clear their budget or spend more? Or is that not so much a theme anymore?

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Philippe Morin, EXFO Inc. - CEO & Director [40]

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And your question on SASS or on T&M or overall?

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Christian Sgro, Canaccord Genuity Corp., Research Division - Associate [41]

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That's all T&M.

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Philippe Morin, EXFO Inc. - CEO & Director [42]

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All T&M, yes. So T&M tend -- so the seasonality, while there are year-end money being spent and we saw some of it this year but not as much as last year, tends to be in Q1 of our fiscal quarter. Now this year, we saw some year-end money, but not as much as the previous year.

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Operator [43]

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And at this time, I'd like to turn things back to CEO Philippe Morin for closing remarks.

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Philippe Morin, EXFO Inc. - CEO & Director [44]

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All right. Thank you. So just a few key takeaways before we conclude this call today. So first, EXFO delivered a strong first quarter based on our sales, mainly all of them are organic sales now, increasing 6.3% year-over-year and an adjusted EBITDA reaching $7.5 million or 10.3% of sales.

Second, we received more than $2.5 million of SASS-related orders in the first week of December, and if we had secured these orders a few days earlier, our book-to-bill ratio would have been closer to 1 in our Q1 2020. And so consequently, timing of orders continues to affect our SASS business as we build the scale of that particular business unit. We evaluate the performance of our SASS business more and more into 6-month period and I would actually encourage you to do likewise.

So finally, EXFO will be holding its annual meeting on Wednesday, 9:00 a.m. at the Vantage Venues, room L2 on the 27th floor located at 150 King Street West in Toronto. Both shareholders and analysts are welcome to attend.

At this point, this concludes our Q1 2020 conference call. On behalf of the entire EXFO team, thank you for joining us today.

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Operator [45]

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Again, that concludes today's conference. Thank you all for joining us.