UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
6-K
Report
of Foreign Private Issuer Pursuant to Rule 13a-16 or
15d-16
Under
the Securities Exchange Act of 1934
For
the
month of November, 2006
EXFO
Electro-Optical Engineering Inc.
(Translation
of registrant’s name into English)
400
Godin Avenue, Quebec City, Quebec, Canada G1M 2K2
(Address
of principal executive offices)
Indicate
by check mark whether the registrant files or will file annual reports under
cover of Form 20-F or Form 40-F.
Form
20-F
x
Form
40-F o
Indicate
by check mark whether the registrant by furnishing the information contained
in
this Form is also thereby furnishing the information to the Commission pursuant
to Rule 12g3-2(b) under the Securities Exchange Act of 1934.
Yes
o No
x
If
“Yes”
is marked, indicate below the file number assigned to the registrant in
connection with Rule 12g3-2(b): 82-______.
Page
1
In
November 2006, EXFO Electro-Optical Engineering Inc., a Canadian corporation,
issued its annual report containing its annual audited financial statements
and
management’s discussion and analysis thereof for its fiscal year ended August
31, 2006. At the same time, it also issued a cover letter, its notice of its
annual shareholders’ meeting, its form of proxy and its management proxy
circular. This report on Form 6-K sets forth said documents.
The
annual report containing the Corporation’s annual audited financial statements
and management’s discussion and analysis for its fiscal year ended August 31,
2006, a cover letter, its notice of annual shareholders’ meeting, its form of
proxy and its management proxy circular are hereby incorporated as documents
by
reference to Form F-3 (Registration Statement under the Securities Act of 1933)
declared effective as of July 30, 2001 and to Form F-3 (Registration Statement
under the Securities Act of 1933) declared effective as of March 11, 2002 and
to
amend certain material information as set forth in these two Form F-3
documents.
Page
2
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant
has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
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EXFO
ELECTRO-OPTICAL ENGINEERING INC.
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By:
/s/ Germain
Lamonde
Name:
Germain Lamonde
Title:
President and Chief Executive
Officer
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Date:
November 29, 2006
Page
3
Annual
Report
2006
Telecom
Test and Measurement
Page
4
Mission
Statement
EXFO’s
mission is to be a world leader in telecommunications test and measurement
equipment. This goal will be achieved through the pursuit of excellence and
the
full commitment of all our employees to exceed customer expectations with
market
driven innovation setting the highest standards.
Corporate
Profile
EXFO
is a
recognized test and measurement expert in the global telecommunications
industry. The Telecom Division, which represents our main business activity,
offers fully integrated and complete test solutions to network service providers
(NSPs), cable TV operators, telecom system vendors and component manufacturers
in approximately 70 countries. We are the global market leader for portable
optical test solutions and a leading supplier of protocol and copper access
test
solutions to enable triple-play services over converged, IP networks. Our
PC/Windows-based modular FTB-200, FTB-400 and IQS-500 test platforms host
a wide
range of test solutions across optical, physical, data and network layers,
while
maximizing technology reuse across several market segments. Our Life Sciences
and Industrial Division, which leverages several core telecom technologies,
offers value-added solutions in the life sciences and high-precision assembly
sectors, such as those required for microelectronics and optoelectronics.
These
solutions are based on advanced spot-curing, fluorescence microscopy and
nanopositioning technologies. For more information about EXFO, visit
www.EXFO.com.
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Forward-looking
statements
This
Annual Report contains forward-looking statements within the meaning of
the U.S.
Private Securities Litigation Reform Act of 1995 and we intend that such
forward-looking statements be subject to the safe harbors created thereby.
Forward-looking statements are statements other than historical information
or
statements of current condition. Words such as may, will, expect, believe,
anticipate, intend, could, estimate, continue, or the negative or comparable
terminology are intended to identify forward-looking statements. In addition,
any statements that refer to expectations, projections or other
characterizations of future events or circumstances are forward looking
statements. They are not guarantees of future performance and involve risks
and
uncertainties. Actual results may differ materially from those in the
forward-looking statements due to various factors, including consolidation
in
the global telecommunications test and measurement industry; capital spending
levels in the telecommunications, life sciences and high-precision assembly
sectors; concentration of sales; fluctuating exchange rates and our ability
to
execute in these uncertain conditions; the effects of the additional actions
we
have taken in response to such economic uncertainty (including our, ability
to
quickly adapt cost structures with anticipated levels of business, and
our
ability to manage inventory levels with market demand); market acceptance
of our
new products and other upcoming products; limited visibility with regards
to
customer orders and the timing of such orders; our ability to successfully
integrate our acquired and to-be-acquired businesses; the retention of
key
technical and management personnel; and future economic, competitive and
market
conditions. Assumptions relating to the foregoing involve judgments and
risks,
all of which are difficult or impossible to predict accurately and many
of which
are beyond our control. Other risk factors that may affect our future
performance and operations are detailed in our Annual Report on Form 20-F
and
our other filings with the U.S. Securities and Exchange Commission and
the
Canadian securities commissions. We believe that the expectations reflected
in
the forward-looking statements are reasonable based on information currently
available to us, but we cannot assure you that the expectations will prove
to
have been correct. Accordingly, you should not place undue reliance on
these
forward-looking statements. These statements speak only as of the date
of this
document. We undertake no obligation to revise or update any of them to
reflect
events or circumstances that occur after the date of this document.
Trademarks
and logos
EXFO
and
the EXFO logo are registered trademarks of EXFO Electro-Optical Engineering
Inc.
in Canada, the United States and/or other countries. Other EXFO product
names or
logos referenced in this document are either trademarks or registered trademarks
of EXFO Electro-Optical Engineering Inc. or of its affiliated companies.
All
other product names and trademarks mentioned herein are trademarks of their
respective owners. However, neither the presence nor absence of the
identification symbols ®
or ™
affects the legal status of any trademark.
All
dollar amounts in this Annual Report are expressed in US dollars, except
as
otherwise noted.
Financial
Highlights
(tabular
amounts in thousands of US dollars, except per share data)
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Consolidated
Statements of Earnings Data
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2006
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2005
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2004
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2003
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2002
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|||||||
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Sales
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$
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128,253
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$
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97,216
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$
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74,630
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$
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61,930
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$
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68,330
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||||||
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Gross
margin (1)
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$
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70,978
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$
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53,157
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$
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40,074
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$
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25,733
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$
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15,964
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||||||
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55.3
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%
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54.7
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%
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53.7
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%
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41.6
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%
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23.4
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%
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|||||||
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Selling
and administrative
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$
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40,298
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$
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31,782
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$
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25,890
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$
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26,991
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$
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33,881
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||||||
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31.4
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%
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32.7
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%
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34.7
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%
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43.6
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%
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49.6
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%
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|||||||
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Net
research and development
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$
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15,404
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$
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12,190
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$
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12,390
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$
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15,879
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$
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12,782
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||||||
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12.0
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%
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12.5
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%
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16.6
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%
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25.6
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%
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18.7
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%
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|||||||
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Earnings
(loss) from operations (2)
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$
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8,062
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$
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(199
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)
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$
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(10,570
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)
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$
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(39,584
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)
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$
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(74,783
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)
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6.3
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%
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(0.2
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%)
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(14.1
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%)
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(63.9
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%)
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(109.4
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%)
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Net
earnings (loss)
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$
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8,135
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$
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(1,634
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$
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(8,424
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$
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(54,950
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$
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(308,524
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)
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6.3
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%
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(1.7
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%)
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(11.3
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(88.7
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(451.5
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%)
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Basic
and diluted net earnings (loss) per share
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$
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0.12
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$
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(0.02
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$
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(0.13
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$
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(0.87
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$
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(5.09
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)
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Consolidated
Balance Sheets Data
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Cash
and short-term investments
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$
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111,290
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$
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112,002
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$
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89,128
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$
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57,376
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$
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49,681
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Working
capital
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$
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143,985
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$
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135,288
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$
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115,141
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$
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77,408
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$
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91,374
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||||||
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Total
assets
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$
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219,159
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$
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190,957
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$
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172,791
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$
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146,254
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$
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177,926
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Long-term
debt (excluding current portion)
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$
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354
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$
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198
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$
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332
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$
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453
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$
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564
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Shareholders’
equity
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$
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196,234
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$
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173,400
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$
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157,327
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$
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129,826
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$
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165,406
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||||||
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(1)
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Including
inventory write-offs of $4,121,000 and $18,463,000 for the years
ended
August 31, 2003 and 2002, respectively, and nil for the years ended
August
31, 2006, 2005 and 2004. Including an unusual gain of $473,000
for the
year ended August 31, 2003, and nil for the years ended August
31, 2006,
2005, 2004 and 2002.
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(2)
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Including
stock-based compensation costs, inventory and tax credit write-offs,
unusual grants recovery, amortization of intangible assets, impairment
of
long-lived assets and goodwill as well as restructuring and other
charges
of $4,723,000, $6,091,000, $7,878,000, $22,943,000 and $57,451,000
for the
years ended August 31, 2006, 2005, 2004, 2003 and 2002,
respectively.
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Following
the completion of fiscal 2006, I am pleased to report significant growth
in
revenue and profitability for your company. I am convinced that these results
compare favorably to those of our peers, and that we’re better positioned than
ever to take advantage of the vibrant telecom industry offering excellent
long-term market perspectives. In the following lines, I would like to comment
on the state of your company, highlight some recent developments and, more
importantly, provide an overview of some of our future directions.
EXFO
was
among the last companies to be impacted by the telecommunications downturn
in
2001 and first to recover with sales growth of 20.5% in fiscal 2004, 30.3%
in
2005 and 31.9% in 2006, including 12 consecutive quarters of growth. This
remarkable performance was accomplished mainly through market-share gains,
since
our
end-markets reportedly experienced negative growth in 2004 and increased
in the
mid-single digits in 2005 and 2006. Looking back at EXFO’s history, capturing
market share has not been the exception but rather the rule, as we believe
that
we have grown faster than our end-markets in each and every one of our 21
years
in existence.
Our
bottom line improved faster than our top line in the last few years with
GAAP
net earnings of $8.1 million in fiscal 2006, or $0.12 per diluted share,
thus
extending our sequence to seven consecutive quarters of GAAP profitability.
GAAP
net earnings in 2006 included $4.4 million in amortization of intangible
assets,
$1.0 million in stockbased compensation costs, $0.6 million in impairment
of
long-lived assets and a government revenue grant of $1.3 million.
Fiscal
2006 was a very productive year as demonstrated by the performance highlights
listed below. These excellent results were achieved despite a strong headwind
from the strengthening Canadian dollar, customers consolidating and competitors
intensifying pricing pressure.
EXCELLENT
PERFORMANCE
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Increased
sales 31.9% to $128.3 million in 2006 mainly through organic
growth;
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Delivered
sales growth of 34.0% and 22.1% year-over-year for our Telecom
Division
and Life Sciences & Industrial Division,
respectively;
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Posted
sales CAGRs of 27.5% and 20.9% over the last three and ten years,
respectively, despite a major telecom crisis in
2001;
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Achieved
GAAP net earnings of $8.1 million and GAAP operating margin of
6.3%;
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Generated
$0.31 in earnings before income taxes for every additional dollar
of
revenue in 2006 over 2005;
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Produced
$12.3 million in cash flows from operating
activities;
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Derived
37.1% of sales from new products on the market two years or
less;
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Acquired
Consultronics for $19.1 million in cash, strategically positioning
EXFO
for the triple-play, broadband access test
market;
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Consolidated
leadership position in the portable optical test market with a
third
consecutive Growth Strategy Leadership Award from Frost & Sullivan for
achieving highest organic market-share
gains;
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Posted
best sales and bookings year in company history for protocol business,
which is growing much faster than our Telecom Division;
and
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Received
Product Differentiation Innovation Award from Frost & Sullivan for new
portfolio of protocol test solutions dedicated to next-generation
and
traditional SONET/SDH networks.
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WHY
WE EXCEL
Given
that hope is not a strategy at EXFO, our performance is not the result of
good
fortune. We choose our battles and win them on the strength of market-driven
innovation, outstanding execution, unique modular platform design and quality
people at every level of our organization.
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Market-driven
innovation.
We are first and foremost a market-driven company, highly focused
on
anticipating market trends and developing value-added solutions
that go
beyond satisfying our customers’ requirements. Our aim is to deliver
targeted products with just the right features to customers on
a global
basis.
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Outstanding
execution. Market-driven
innovation provides us with superior products and early market
advantages
over competitors. But paying meticulous attention to all aspects
of the
customer experience, combined with outstanding product quality
and
proficient technical expertise, enables us to expand our customer
base and
convert these short-term advantages into long-term market-share
gains.
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Unique
modular platform design. A
decade ago, we were the first in our industry to introduce PC-based,
Windows-driven modular test platforms — sharing a common series of test
modules — for different end-markets. We have continued to build on our
first-mover advantage with the launch of next-generation platforms
and
additional best-in-class test modules in order to expand our technology
base. This unique platform strategy provides our customers with
costefficient and scalable test solutions, while allowing us to
leverage
R&D investments across multiple
end-markets.
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Quality
people. Around
the world, we have a long list of employees who share a common
passion for
excellence and a real dedication to serve our customers. These
people,
prominent within all levels of our organization, always place customers
first and spare no efforts to succeed as finishing second is not
an option
for them. I refer to these people as “EXFO bluebloods.” Their hard work,
enthusiasm and commitment are among the main reasons why EXFO is
a winner
in my book.
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EXECUTION
IN FISCAL 2006
A
few
years ago, the Canadian Institute of Chartered Accountants (CICA) recommended
that public companies publish performance metrics to help investors better
evaluate the performance of management teams. As an early adopter of this
guideline, EXFO provided the following metrics for fiscal 2006:
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Goal
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Metric
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Result
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Increase
sales through market-share gains
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25%
sales growth year-over-year*
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31.9%
sales growth year-over-year
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Maximize
profitability
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GAAP
operating margin of 5%
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GAAP
operating margin of 6.3%
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Focus
on innovation
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40%
of sales from new products
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37.1%
of sales from new products
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*
Sales growth metric was updated at the end of the second quarter
in 2006
to reflect mid-year results and Consultronics
acquisition.
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Sales
growth. Given
strong sales growth in our two divisions and the Consultronics acquisition
in
January 2006, we raised our performance metric from 15% to 25% midway through
the fiscal year. We still surpassed the revised goal with 31.9% growth in
2006,
largely due to market-share gains. Frost & Sullivan, a leading market
research firm in the test and measurement industry, confirmed our market-share
gains by naming EXFO recipient of its Growth Strategy Leadership Award for
the
third consecutive year. According to Frost & Sullivan, EXFO increased its
market share from 10.3% in 2004 to 11.0% in 2005 for third place overall
in the
global fiber-optic test equipment market and was the only supplier among
the top
five to deliver significant organic growth. Based on the June 2006 report,
EXFO
also increased its leadership position in the portable field instrumentation
market segment from an estimated 22.2% to 23.0% during the same
period.
Profitability.
We
completed fiscal 2006 with a GAAP operating margin of 6.3% versus our published
metric of 5%. I am particularly pleased by the improvement in our gross margin
for a third consecutive year, reaching 55.3% in 2006 despite pricing pressure
and the strengthening of the Canadian dollar versus the US dollar (29.1%
over
last three years and 7.3% in FY 2006). I remain confident that our gross
margin
will attain 60% in the not-too-distant future as highermargin protocol revenues,
better absorption of fixed costs on higher sales volumes, specific internal
initiatives, and currency stability come into play. For every additional
sales
dollar in 2006 over 2005, $0.31 flowed to earnings before income taxes,
demonstrating excellent leverage in our operating model.
Innovation.
Sales
from new products (on the market two years or less) accounted for 37.1% of
total
sales in 2006 versus our stated goal of 40%. Despite missing this aggressive
innovation target, I am proud of our accomplishments, since new products
with
their built-in superior performance and lower cost of goods contributed
significantly to raising revenues, gross margin and operating margin in 2006.
I
am also pleased that several of our successful FTTx products, moving down
to the
denominator part of the ratio as they’ve been on the market for more than two
years, still strongly contributed to our sales performance. I firmly believe
that our innovation mark is well above the industry average.
EXCITING
MARKET DRIVERS FOR 2007 AND BEYOND
Global
market demand for telecom test and measurement equipment should remain strong
in
the years to come as most network service providers (NSPs) are increasing
capital expenditures to upgrade their networks for converged IP services
and
triple-play offerings. These market forces create needs for differentiated
test
solutions to help NSPs accelerate deployment and ensure service quality in
their
network build-outs.
EXPECTING
IPTV TO DRIVE IP MIGRATION
With
the
ongoing globalization of the world’s economy and the emergence of new consumer
markets, NSPs are poised to capitalize on growing demand for communications
and
entertainment services. Early in 2006, some smaller telecom operators launched
broadcastquality video services based on IP communications. This technology,
better known as IPTV, allows telephone companies (telcos) to efficiently
offer
TV, HDTV and interactive TV services to their broadband subscribers. Tier-1
and
Tier-2 telcos are expected to launch similar IPTV services on a large-scale
basis later in 2007. While Web-based streaming video is offered for free
on a
best-effort basis, IPTV, whom many regard as the broadband “killer application,”
will require a high level of performance to ensure a quality user experience.
NSPs, after all, don’t want customer churn to prevent a meaningful return on
their massive investments.
To
deliver a wide range of differentiated IP services, NSPs will continue
transforming their legacy, circuit-switched networks into highly efficient,
flexible and scalable packet-based IP architectures. NSPs have already proven
they can generate significant revenues from higher-margin services on hybrid
networks, while reducing operating costs. IPTV should only accelerate the
migration towards fully converged, IP-based networks, since it typically
allows
NSPs to nearly double average revenue per user (ARPU).
EXPANDING
BANDWIDTH IN ACCESS NETWORKS
The
increasing reliance on telecom and IP-related services will continue driving
bandwidth consumption, thus pushing the deployment of fiber deeper into access
networks. Competition between telcos and cable TV operators (cablecos) has
intensified as triple-play offerings are announced almost daily. Hybrid
architectures combining copper and fiber (FTTC and FTTN) will keep expanding
worldwide, since this is the quickest and least expensive method to increase
bandwidth. To remain competitive with cablecos, telcos are migrating from
former
ADSL, to current ADSL2+, and onto future VDSL2+ technologies as interoperability
becomes a reality. Telcos, however, will increasingly opt for all-fiber,
PON-based architectures (FTTP) to meet heightened bandwidth requirements
and to
future-proof their networks. These decisions will apply not only to green-field
deployments and high-rise buildings, but also to larger-scale rollouts as
operating costs are less than FTTC and FTTN architectures and costs of
deployments are falling. We are still in the early stages of building access
networks around the world.
EXPLOITING
METRO AND LONG-HAUL NETWORKS
Metro
network deployments, taking advantage of carrier-grade Ethernet and
metro-Ethernet technologies, are moving ahead to handle large increases in
bandwidth consumption in access networks. These network upgrades, in turn,
will
eventually place a strain on long-haul networks, where excess capacity created
by massive overspending in the late-90s is gradually being consumed. NSPs
are
more than ever committed to deploying next-generation SONET/SDH transport
technologies, while 40 Gb/s deployments are not far behind.
EXCELLENT
POSITIONING IN TELECOM MARKETS
We
anticipated these market trends and directed a significant part of our R&D
efforts to bring NSPs the distinctive product offering they have come to
expect
from EXFO for installation and maintenance applications and, increasingly,
for
network quality assurance. In addition, we have increased interaction with
system vendors, both in terms
of
partnerships and product offerings, since they are the key players defining
and
designing the networks of the future. Consequently, we have widened our
competitive advantage, based on our FTB-200, FTB-400 and IQS-500 modular
platforms and extensive line of test modules, and developed new test solutions
for converged, IP
networking. I am confident that we will commercially leverage our technological
leadership in installation and maintenance applications — up to 10 Gb/s Ethernet
and 10 Gb/s next-generation SONET/SDH testing. I also maintain that protocol
sales, substantially above 10% of optical sales in 2006 and growing
significantly faster than the company overall, will equal optical revenues
in
the next three to five years.
On
the
optical testing front, we have strengthened our dominant market position
for
access networks both in terms of new network architectures (FTTH, FTTC, FTTN)
and technologies (BPON, GPON, EPON). Look for us to enhance our presence
with an
expanded offering for twisted-copper-pair testing of IPTV and VoIP services
in
the last mile now that Consultronics has been fully integrated. As well,
we will
take advantage of our technical expertise in optical testing for upcoming
deployments of 40 Gb/s systems in long-haul networks. In a nutshell, we will
expand our product offering from access to core, touching on various levels
of
the network to fuel our long-term growth.
EXPERTISE
IN LIFE SCIENCES AND INDUSTRIAL MARKETS
On
the
life sciences and industrial side, we will continue leveraging technologies
developed or acquired for optical component manufacturing applications into
non-telecom markets. Overall, I am satisfied with the results delivered by
this
division.
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-
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Our
OmniCure product line, focused on UV spot-curing applications,
has enjoyed
significant growth within the medical and optoelectronics industries.
These diverse markets, largely influenced by the miniaturization
trend,
are expanding worldwide with Asia showing the largest year-over-year
growth.
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|
-
|
Our
X-Cite series, an add-on illumination system for high-end microscopes,
has
entrenched itself as a market leader in various research areas.
The global
fluorescence microscopy market is growing in mid-single digits,
while live
cell and quantitative imaging are increasingly gaining
traction.
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|
-
|
Our
Burleigh nanopositioning product line, mainly designed for cellular
micromanipulation, continues to demonstrate strong brandname recognition
and loyal following with electrophysiologists. It targets a stable
growth
market focused on fundamental neuroscience and drug
discovery.
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LOOKING
TO EXCEED OUR OBJECTIVES IN 2007
EXFO
remains committed to best practices in corporate governance and, as such,
I am
pleased to provide the following performance metrics for fiscal 2007. Please
note that these management goals should not be confused with
guidance.
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-
|
Grow
revenues by at least 20%
year-over-year;
|
|
-
|
Generate
a GAAP operating margin of more than 7%;
and
|
|
-
|
Derive
at least 35% of sales from new products (on the market two years
or
less).
|
Looking
ahead to 2007, we will strengthen our competitive position by leveraging
the
aforementioned market drivers, both organically and through strategic
acquisitions if stringent criteria are met. Our strong balance sheet, including
$111.3 million in cash, combined with superior execution and disciplined
management, should enable us to sustain growth. On the operations side, we
will
increasingly take advantage of talent pools around the world to cost-effectively
design and manufacture innovative test solutions. These initiatives will
improve
our ability to face pricing pressure, account consolidation and market expansion
on a global basis, while accelerating product innovation as we privilege
longterm advantages over short-term gains. In doing so, we will continue
to
build one of the most respected brand names in the telecom test and measurement
industry, while bolstering shareholder value.
I
would
be remiss if I did not mention the efforts deployed internally to be compliant
with Section 404 of Sarbanes-Oxley. It has proven to be a major undertaking
during the last two years to ensure that our internal processes meet the
highest
standards, but it also has enabled us to review how and why we do things
at
EXFO. Ultimately, it has improved our overall efficiency.
A
final
word of thanks to the three pillars of our company, namely customers, employees
and shareholders. Without your unwavering belief, support and commitment
to our
long-term vision, EXFO would not be as well-positioned as it is today to
keep
growing on a profitable basis. I would also like to extend my appreciation
to
our Board of Directors, whose wise counsel and staunch support represent
invaluable assets to the company.
Sincerely,
Germain
Lamonde
Chairman,
President and Chief Executive Officer
October
25, 2006
Corporate
Highlights — Fiscal 2006
August
2006
|
-
|
Posts
sales growth of 31.9%
year-over-year
|
|
-
|
Completes
fiscal 2006 with a total of 18 new
products
|
|
-
|
Adds
optical transport network (OTN) testing to protocol
portfolio
|
June
2006
|
-
|
Receives
Growth Strategy Leadership Award from Frost & Sullivan forthird
consecutive year
|
|
-
|
Releases
VoIP/DSL test set
|
May
2006
|
-
|
Introduces
CoLT-450P, an enhanced solution for IPTV-over-DSL and triple-play
testing
|
|
-
|
Launches
compact Ethernet test solution
|
April
2006
|
-
|
Releases
X-Cite®120
XL Fluorescence Illumination System
|
March
2006
|
-
|
Launches
new EPON/GPON power meter for service-activation testing and
troubleshooting of FTTx networks
|
February
2006
|
-
|
Introduces
SONET/SDH test modules for FTB-200 Compact
Platform
|
|
-
|
Launches
next-generation SONET/SDH test modules for FTB-400 Universal Test
System
|
|
-
|
Releases
next-generation SONET/SDH test modules for IQS-500 Intelligent
Test
System
|
January
2006
|
-
|
Acquires
assets of Consultronics
|
|
-
|
Introduces
FTB-200 Compact Platform for multi-layer, multi-medium
testing
|
|
-
|
Launches
AXS-100 OTDR for FTTx test
applications
|
November
2005
|
-
|
Receives
sole-source approval for all fiber deployment applications by Deutsche
Telekom
|
|
-
|
Releases
protocol analysis software for field-test applications on Ethernet
networks
|
September
2005
|
-
|
Launches
10 Gigabit Ethernet test solution for manufacturing and lab
environments
|
|
-
|
Releases
next-generation Fibre Channel test solution for manufacturing and
lab
environments
|
Telecom
Division
BREAKING
NEW GROUND WITH OUR EXPERTISE
EXFO
continues to break new ground in the telecom test and measurement space.
For
several years, network service providers had built up their core and
metropolitan optical networks to handle enormous growth in voice, data and
video
traffic. As a trusted partner, EXFO was there all along to resolve their
complex
testing issues with leading-edge test solutions. By enabling the installation,
maintenance and troubleshooting of these networks, we inevitably assumed
a
leadership position. Now that fiber rollouts have shifted to access networks,
EXFO is once again at the heart of efforts to bring broadband communications
to
homes and businesses. We first work closely with lead customers to define
the
necessary test methods for FTTx deployments and service activation, and then
develop the right products to meet their requirements. Case in point: EXFO
released the industry’s first PON-specific power meter (PPM-350B), a low-cost
handheld instrument designed for service activation and troubleshooting of
FTTx
networks. Our long-standing presence in the industry — 21 years and counting —
facilitates this kind of market-driven innovation.
As
a
result, EXFO has quickly entrenched itself as the dominant player in the
high-growth FTTx market segment. In 2006, we remained attuned to our customers’
needs by launching the handheld AXS-100 OTDR for FTTx applications and GPON/EPON
power meter for higher-bandwidth requirements in access networks. Following
the
fiscal yearend, we introduced FiberFinder™, a handy device to ensure that live
fibers are not inadvertently disconnected in crowded fiber cabinets and patch
panels. EXFO also released the next-generation IQS-12001B Cable Assembly
and
Component Test System, which boasts FTTx component testing capabilities.
Once
again, it all begins by listening to our customers and deploying our
expertise.
EXTRAORDINARY
PLATFORM STRATEGY: GOOD, BETTER AND BEST
EXFO
was
first-to-market with PC-based, Windows-driven test platforms more than 10
years
ago for field-test and manufacturing/lab applications. This common platform
strategy enabled us to develop a high-end test solution for one market segment,
and then leverage it across other segments to maximize revenues. By reusing
technology, we gained the necessary time to develop superior test solutions
and
establish a sizeable market lead through the release of next-generation
platforms (FTB-400 Universal Test System and IQS-500 Intelligent Test System)
as
well as new test modules. In 2006, we continued to build on our first-mover
advantage with the introduction of the cost-effective FTB-200 Compact Platform
for the Supertech. This lightweight handheld unit, which can hold up to two
field-test modules, has been optimized for multi-medium and multi-layer
characterization of access networks. As a result, our “Good, Better and Best”
platform approach enables us to meet various customer needs, performance
levels
and price points more efficiently, while delivering better all-around test
solutions.
EXPANDING
MARKET SHARE, IT’S IN OUR DNA
Market-share
gains have always been an integral part of EXFO’s DNA. We believe that we have
grown faster than our end-markets every year since beginning operations in
1985.
Confirming our internal numbers, Frost & Sullivan, a leading market research
firm in the test and measurement industry, named EXFO recipient of the Growth
Strategy Leadership Award for a third consecutive year in 2006. EXFO was
the
only company to achieve significant organic growth in the fiber-optic test
equipment market in calendar 2005, moving from 10.3% to 11.0% for third place
in
the global industry and from 22.2% to 23.0% for the No. 1 spot in the portable
installation and maintenance test market segment. But there’s no silver bullet
for gaining market share. We will remain diligent in our quest to understand
market requirements, develop innovative test solutions and offer best-in-class
customer service. Sure enough, these traits also happen to be part of our
genetic makeup.
EXCELLENT
FIT WITH CONSULTRONICS
The
Consultronics acquisition has proven to be an excellent fit. EXFO had already
established itself as the supplier of choice for characterizing
fiber-to-the-premises (FTTP) rollouts from the central office to residential
and
business subscribers. On the other hand, we were forced to hand last-mile
testing applications in fiber-to-the-curb (FTTC) and fiber-to-the-node (FTTN)
configurations to competitors, since it involved testing copper local loops
and
related services. Enter Consultronics. This leading supplier of test solutions
for copper-based broadband access networks enables EXFO to offer end-to-end
test
solutions to its customers. Consultronics not only provided a wide range
of DSL
test sets, but also introduced value-added testing features for IPTV, VoIP
and
high-speed Internet. End result: EXFO is now leading the way in triple-play
deployment testing.
EXCLUSIVE
PROTOCOL TEST PORTFOLIO
Timing
is
everything in the test and measurement industry. Witness the worldwide trend
among telcos towards migrating their traditional, circuit-switched voice
networks to packet-based, IP architectures. EXFO, who had the foresight to
invest in next-generation IP test technologies for the past three years,
is now
well-positioned to meet this growing market demand. In 2006, we successively
launched nextgeneration and traditional SONET/SDH test solutions for our
three
modular test platforms — namely, our FTB-200 Compact Platform for field-testing
duties, our FTB-400 Universal Test System for advanced diagnostics in central
offices, and our IQS-500 Intelligent Test System, dedicated to manufacturing
and
R&D applications — for testing transmission rates reaching 10 Gb/s. We also
added optical transport network (OTN) testing capabilities, better known
as
ITU-T G.709, to offer the most compact OTN field-portable test solution on
the
market in tandem with the FTB-200. In recognition of our exclusive product
portfolio for characterizing next-generation and traditional SONET/SDH networks,
Frost & Sullivan named us recipient of the 2006 Product Differentiation
Innovation Award. This award is presented annually to the telecom test and
measurement supplier that best demonstrates the ability to develop products
with
more innovative capabilities than competing vendors.
EXCITING
DEVELOPMENT IN NETWORK MONITORING
Network
service providers are increasingly seeking to improve network reliability
through distributed automated network monitoring. EXFO had been an established
player in this market segment with its remote fiber test system (RFTS) for
monitoring fiber plants. In 2006, we expanded our product offering via turnkey
voice and VoIP monitoring test systems from the Consultronics acquisition
and
gained customer traction, as demonstrated by recent contract wins.
Life
Sciences and Industrial Division
REDEFINING
INNOVATION
Over
the
years, we have acquired and developed technologies that leverage our telecom
expertise into various life sciences and high-tech industrial markets. Our
ability to reuse these core technologies in several adjacent markets
necessitates a different kind of innovation. It requires ingenious,
market-driven people capable of discerning and developing new opportunities.
At
EXFO, we continue to redefine innovation with the following three product
lines:
X-CITE
Ultraviolet
and visible spot-curing technologies were initially brought to market at
EXFO
for bonding optical components. We soon realized we could leverage them for
fluorescence microscopy applications. The end-result is the X-Cite series,
a
family of highintensity light sources providing unmatched performance for
laboratory microscopes. In 2006, we released the X-Cite 120 XL, a
next-generation system delivering superior image quality and 2000 hours of
warranted lamp life — a first in the industry. To put this latest product
development into perspective, the X-Cite 120 XL lasts 60% longer than the
previous model (X-Cite 120) and up to 10 times longer than conventional
illumination systems. The X-Cite 120 XL is a self-contained illumination
unit
separate from a microscope. A simple light-guide attachment through patented
coupling optics ensures a uniform field of view with no heat from the lamp
being
transferred to the sample under study. Most of the major microscope
manufacturers around the world are reselling this innovative solution to
their
existing base of customers.
OMNICURE
Over
the
last two decades, we have become the global leader in light-based curing
and
precision assembly of medical, microelectronic, digital printing and optical
devices. Our ultraviolet/visible spot-curing products deliver precise doses
of
the appropriate spectral light onto photosensitive adhesives and other materials
to significantly reduce curing time. A proprietary closed-loop feedback
technology allows the user to select the required output levels, lock in
the
settings and continuously maintain them to ensure repeatable cures. Our
state-of-the-art OmniCure Series 2000, based on 2000 hours of warranted lamp
life, is a high-end automated system that can easily be controlled externally
from a personal computer. These latest technological enhancements deliver
stronger cures, heightened efficiency and reduced manufacturing costs for
our
customers. Sometimes innovation can be measured by improvements to the bottom
line.
BURLEIGH
Innovation
doesn’t have to be rocket science, but sometimes it reaches those lofty heights.
Our Inchworm motors, offering unmatched nanometer-scale resolution over
relatively long travel, have manifold applications in the semiconductor and
space industry. Even NASA has used our technology. These instruments are
also
highly useful for life science research, manufacturing and other advanced
applications. In addition, we offer a unique line of piezoelectric-based
positioning systems and high-performance mounting solutions — combining
stability with extremely smooth and predictable instrument motion — to enable
ground-breaking research in cell manipulation, electrophysiology and in-vitro
fertilization.
Management’s
Discussion and Analysis of Financial Condition and
Results of Operations
The
following discussion and analysis of the consolidated financial condition
and
results of operations of EXFO Electro-Optical Engineering Inc. for the fiscal
years ended August 31, 2004, 2005 and 2006, should be read in conjunction
with
our consolidated financial statements and the related notes included elsewhere
in this Annual Report. Our consolidated financial statements have been prepared
in accordance with generally accepted accounting principles in Canada, or
Canadian GAAP. Significant differences in measurement and disclosure from
generally accepted accounting principles in the United States, or U.S. GAAP,
are
set out in note 20 to our consolidated financial statements. Our measurement
currency is the Canadian dollar although we report our financial statements
in
US dollars.
The
following discussion and analysis of financial condition and results of
operations is dated November 1, 2006.
All
dollar amounts are expressed in US dollars, except as otherwise noted.
Industry
Overview
Global
market demand for telecom test and measurement equipment should remain strong
in
the years to come as most network service providers (NSPs) are increasing
capital expenditures to upgrade their networks for converged Internet protocol
(IP) services and triple-play (voice, data and video) offerings. These market
forces create needs for differentiated test solutions to help NSPs accelerate
deployment and ensure service quality in their network build-outs.
With
the
ongoing globalization of the world’s economy and the emergence of new consumer
markets, NSPs are poised to capitalize on growing demand for communications
and
entertainment services. Early in 2006, some smaller telecom operators launched
broadcast-quality video services based on IP communications. This technology,
better known as IPTV, allows telephone companies (telcos) to efficiently
offer
TV, HDTV and interactive TV services to their broadband subscribers. Tier-1
and
Tier-2 telcos are expected to launch similar IPTV services on a large-scale
basis starting in 2007. While Web-based streaming video is offered for free
on a
best-effort basis, IPTV, whom many regard as the broadband “killer application,”
will require a high level of performance to ensure a quality user experience.
NSPs, after all, don’t want customer churn to prevent a meaningful return on
their massive investments.
To
deliver a wide range of differentiated IP services, NSPs will continue
transforming their legacy, circuit-switched networks into highly efficient,
flexible and scalable packet-based IP architectures. Telcos and cablecos
have
already proven that they can generate significant revenues from higher-margin
services on hybrid networks, while reducing operating costs. IPTV should
only
accelerate the migration towards fully converged, IP-based networks, since
it
typically allows NSPs to nearly double average
revenue per user (ARPU).
The
increasing reliance on telecom and IP-related services will continue driving
bandwidth consumption, thus pushing the deployment of fiber deeper into access
networks. Competition between telcos and cablecos has intensified as triple-play
offerings are announced almost daily. Hybrid architectures combining copper
and
fiber (fiber-to-the-curb, or FTTC and fiber-to-the-node, or FTTN), will keep
expanding worldwide, since this is the quickest and least expensive method
to
increase bandwidth. To remain competitive with cablecos, telcos are migrating
from former asymmetric digital subscriber line (ADSL), to current ADSL2+,
and
onto future very-high-data-rate digital subscriber line 2+ (VDSL2+) technologies
as interoperability becomes a reality. Telcos, however, will increasingly
opt
for all-fiber, passive optical network (PON)-based architectures
(fiber-to-the-premises, or FTTP) to meet heightened bandwidth requirements
and
to future-proof their networks. These decisions will apply not only to
green-field deployments and high-rise buildings, but also to larger-scale
rollouts as operating costs are less than FTTC and FTTN and cost of deployments
are falling. We are still in the early stages of building access networks
around
the world.
Metro
network deployments, taking advantage of carrier-grade Ethernet and
metro-Ethernet technologies, are moving ahead to handle large increases in
bandwidth consumption in access networks. These network upgrades, in turn,
will
eventually place a strain on long-haul networks, where excess capacity created
by massive overspending in the late-90s is gradually being consumed. NSPs
are
more than ever committed to deploying nextgeneration SONET/SDH transport
technologies, while 40 Gb/s deployments are not far behind.
These
key
market trends affected multiple segments of the global telecommunications
supply
chain in fiscal 2006. System vendors benefited from orders by both telcos
and
cablecos for next-generation, converged IP networks as well as from major
investments by telcos in access networks. Component vendors saw increased
demand
for optical components that support FTTx and IP-based systems. Some test
and
measurement equipment vendors attracted the attention of telcos, cablecos,
system manufacturers and component vendors, especially ones offering test
solutions for IP networking and/or FTTx applications.
Company
Overview
EXFO
is a
recognized test and measurement expert in the global telecommunications
industry. The Telecom Division, which represents our main business activity,
offers fully integrated and complete test solutions to network service providers
(NSPs), cable TV operators, telecom system vendors and component manufacturers
in approximately 70 countries. We are the global market leader for portable
optical test solutions and a leading supplier of protocol and copper access
test
solutions to enable triple-play services over converged, IP networks. Our
PC/Windows-based modular FTB-200, FTB-400 and IQS-500 test platforms host
a wide
range of test solutions across optical, physical, data and network layers,
while
maximizing technology reuse across several market segments. Our Life Sciences
and Industrial Division, which leverages several core telecom technologies,
offers value-added solutions in the life sciences and highprecision assembly
sectors, such as those required for microelectronics and optoelectronics.
These
solutions are based on advanced spot-curing, fluorescence microscopy and
nanopositioning technologies.
We
were
founded in 1985 in Quebec City, Canada. Our original products were focused
on
the needs of installers and operators of fiber-optic networks. Customers
use
these field-portable testing products for the installation, maintenance,
monitoring and troubleshooting of optical networks. In 1996, we supplemented
our
product portfolio with an extensive line of high-end products that are mainly
dedicated to research and development as well as manufacturing activities
of
optical component manufacturers and system vendors.
Over
the
past several years, we have enhanced our competitive position through the
acquisition of two protocol test businesses in order to expand our product
offering and address our customers’ requirements more completely. In November
2001, we acquired Avantas Networks Corporation (renamed EXFO Protocol Inc.),
a
supplier of protocol-testing and optical-network performance management
equipment for NSPs.
This
transaction was highly strategic because it enabled us to combine optical
and
protocol test modules inside a single field-portable test platform to help
our
customers increase revenues and reduce operating costs. In October 2002,
our
wholly-owned subsidiary, EXFO Gnubi, purchased substantially all the assets
of
gnubi
communications, L.P.,
a
supplier of multi-channel telecom and datacom testing solutions for the system
manufacturer market. These strategic acquisitions, which were consolidated
in
Montreal, Canada, in fiscal 2004, enabled us to more than double our addressable
market, as we expanded from optical testing to protocol testing applications,
and to offer a more complete line of test solutions to our
customers.
During
the second quarter of 2006, we announced and subsequently completed the
acquisition of substantially all the assets of Consultronics Limited. Based
in
Toronto, Canada, and with operations in Southampton, United Kingdom, and
Budapest, Hungary, Consultronics is a leading supplier of test equipment
for
copper-based broadband access networks. It ranked among the top three vendors
in
handheld x-digital subscriber line (xDSL) testing with a global market share
of
13.4%, according to an industry report from Frost & Sullivan, a leading
authority in the fiber-optic test and measurement industry. Consultronics
also
boasts a rich product portfolio for testing next-generation technologies,
such
as IPTV (Internet Protocol TV) and VoIP (Voice-over-Internet Protocol), which
are critical for network service providers in their deployment of triple-play
services (voice, data, video) over optical and copper links in access networks.
Other test solutions offered by Consultronics include network monitoring
probes
for VoIP and legacy telephone networks, Gigabit Ethernet analyzers for remote
testing applications, as well as protocol and physical characterization
instruments for local copper loops (copper access networks). This acquisition
is
a strategic initiative to position EXFO as a genuine one-stop shop for broadband
access and triple-play testing, since it greatly complements our market
leadership in the FTTx market.
This
acquisition was settled for a total cash consideration valued at $19.1 million,
or $18.8 million net of cash acquired. Total consideration included
acquisition-related costs of $1.5 million. The estimated fair value of acquired
intangible assets amounts to $8.7 million. These intangible assets, namely
core
technology, are amortized on a straight-line basis over their estimated useful
life of five years. Consultronics, which is now part of our Telecom Division,
contributed about seven months to our consolidated financial results in fiscal
2006.
Previously,
we had completed two acquisitions to bolster growth in the optical component
manufacturing market. We acquired Burleigh Instruments, Inc. (renamed EXFO
Burleigh Products Group Inc.) in December 2000 for its wavelength measurement
instruments and nanopositioning alignment systems. We also added EFOS Inc.
(renamed EXFO Photonic Solutions Inc.) in March 2001 for its precision
light-based, adhesive spot-curing technology. We have since exited the optical
component manufacturing automation business and EXFO Burleigh’s operations have
been mostly consolidated with those of EXFO Photonic in Toronto,
Canada.
During
the first quarter of 2006, we were selected as sole-source supplier by Deutsche
Telekom for all its fiber deployment test applications - including
FTTx.
Early
in
the fourth quarter of 2006, Frost & Sullivan released new marketshare
numbers for calendar 2005. According to the industry report, EXFO was the
only
company to report significant organic growth in the global fiber-optic test
equipment (FOTE) market, moving from 10.3% in 2004 to 11.0% in 2005 for third
place overall in the FOTE market.
Based
on
this report, we estimate that we improved our leadership position in our
core
installation and maintenance test market segment from 22.2% in 2004 to 23.0%
in
2005.
We
launched 18 new products in fiscal 2006, including among others the two-slot
FTB-200 Compact Platform for multi-layer and multi-medium testing; the handheld
AXS-100 OTDR for fiber-to-the-x (FTTx) test applications; SONET/SDH test
modules
measuring transmission rates up to 10 Gb/s for the FTB-200 Compact Platform;
next-generation SONET/SDH test modules for the FTB-400 field-test and IQS-500
R&D/manufacturing platforms; 10 Gigabit Ethernet and Fibre Channel test
solutions for our IQS-500 R&D/manufacturing platform; the nextgeneration
CoLT-450P, a handheld IPTV and xDSL test solution for highspeed, copper-based
networks; and the PPM-352B-EG Passive Optical Network (PON) Power Meter,
optimized for Ethernet PON and Gigabit PON architectures.
In
fiscal
2006, in addition to reporting significant growth in sales with $128.3 million,
compared to $97.2 million in 2005, we renewed with GAAP profitability and
reported GAAP net earnings of $8.1 million, or $0.12 per diluted share, compared
to a net loss of $1.6 million, or $0.02 per diluted share in 2005. Also,
the
fourth quarter of fiscal 2006 marked the seventh consecutive quarter of GAAP
profitability. GAAP net earnings in fiscal 2006 included $4.4 million in
amortization of intangible assets, $1.0 million in stock-based compensation
costs, $604,000 in impairment of long-lived assets and a non-recurring revenue
grant of $1.3 million.
Sales
We
sell
our products to a diversified customer base in approximately 70 countries
through our direct sales force and channel partners like sales representatives
and distributors. Most of our sales are denominated in US dollars and
Euros.
Over
the
last three fiscal years, we had one customer that accounted for more than
10% of
our global sales with 13.8%, 23.3% and 13.8% in fiscal 2006, 2005 and 2004,
respectively. We believe the significant sales concentration in fiscal 2005
was
largely due to our leadership position in the FTTx test market, as a large
portion of our sales to our top customer was for a series of products related
to
FTTx deployments. Although this sales concentration significantly decreased
in
fiscal 2006, as this customer migrated to lower-priced test solutions, we
still
maintained our leadership position with this customer, while strongly developing
other accounts, especially on the international scene. This allowed us to
reach
a level of concentration closer to our historical pattern, which reflects
the
improved diversification of our customer base. All in all, our year-over-year
sales growth in fiscal 2006 stands at 48.2% excluding major account mentioned
above. We expect this sales concentration to further decrease in fiscal 2007,
as
we continue efforts to diversify our customer base and expand on international
markets.
We
believe that we have a vast array of products and a diversified customer
base,
both in terms of industry sector and geographical area, which provides us
with
reasonable protection against concentration of sales and credit
risk.
Cost
of Sales
Cost
of
sales includes raw materials, salaries and related expenses for direct and
indirect manufacturing personnel (net of government grants) as well as overhead
costs. Excess, obsolete and scrapped materials are also included in cost
of
sales. However, cost of sales is exclusive of amortization, which is shown
separately in the statements of earnings.
Operating
Expenses
We
classify our operating expenses into three main categories: selling and
administrative expenses, research and development expenses and amortization
expenses.
Selling
and administrative expenses consist primarily of salaries and related expenses
for personnel, sales commissions, travel expenses, marketing programs,
professional services, information systems, human resources and other corporate
expenses.
Gross
research and development expenses consist primarily of salaries and related
expenses for engineers and other technical personnel, material component
costs
as well as fees paid to third-party consultants. We are eligible to receive
research and development tax credits and government grants on research and
development activities carried out in Canada. All related research and
development tax credits and government grants are recorded as a reduction
of
gross research and development expenses.
Operating
charges related to our restructuring plans and impairment of long-lived assets
are recorded as a separate component of operating expenses. Charges related
to
restructuring plans consist primarily of severance expenses, costs to exit
leased facilities as well as write-offs of long-lived assets.
Our
Strategy
Strategic
Objectives for Fiscal 2006
In
our
fiscal 2005 Annual Report, we had established three strategic objectives
for
fiscal 2006. We planned to increase sales through marketshare gains, maximize
profitability and focus on innovation. The following section reviews our
strategic objectives for fiscal 2006 and the results achieved for each of
these
objectives.
Increase
sales through market-share gains
In
fiscal
2006, we focused on continued market-share gains to achieve medium- and
long-term growth. We posted our second-best sales performance in history,
growing sales 31.9% to $128.3 million in 2006, thus outperforming our revised
growth metric of 25%. Given strong sales growth in our two Divisions and
the
Consultronics acquisition, we raised our growth metric from 15% to 25% midway
through the fiscal year. Considering that the telecommunications market
increased in the mid single digits in fiscal 2006, this is a clear indication
that we gained market share overall. For fiscal 2006, our Telecom Division
and
our Life Sciences and Industrial Division reported strong sales increases
of
34.0% and 22.1%, respectively.
Maximize
profitability
Returning
to profitability was a top priority for EXFO in fiscal 2006. During the year,
we
posted earnings from operations of $8.1 million, or 6.3% of sales, compared
to a
loss from operations of $199,000 in 2005. This also compares to our stated
goal
of earnings from operations of 5% for fiscal 2006. This marks the first year
that EXFO generated earnings from operations since fiscal 2001, when the
telecommunications industry went through a major downturn. To that point,
EXFO
had historically been profitable. This significant improvement in earnings
from
operations is even more impressive considering the strengthening of the Canadian
dollar compared to the US dollar (7.3% increase in fiscal 2006 in terms of
average rate), and the significant pricing pressure we faced during the year.
Also, earnings from operations for fiscal 2006 included additional amortization
expenses for intangible assets of $1.0 million following the acquisition
of
Consultronics in January 2006. However, earnings from operations of 2006
included a non-recurring gain of $703,000, comprised of a revenue grant of
$1.3
million, and an impairment loss for long-lived assets of $604,000.
Focus
on innovation
In
fiscal
2006, innovation was a key driver at EXFO. We maintained a significant level
of
research and development investments and introduced 18 new products to the
marketplace. We invested $19.5 million, or 15.2% of sales, in gross research
and
development expenses, compared to $15.9 million, or 16.3% of sales in 2005.
Net
of research and development tax credits, those expenses stand at 12.0 % and
12.5% in fiscal 2006 and 2005, respectively. In fiscal 2006, 37.1% of our
sales
originated from products that have been on the market for two years or less,
which is below our aggressive goal of 40% for fiscal 2006 and the 42.4% level
reached in 2005. Our successful FTTx products, moving down to the denominator
part of the ratio as they have been on the market for more than two years,
still
strongly contributed to our sales performance. However, we believe this
innovation mark reached in fiscal 2006 is well above the market
average.
Strategic
Objectives for Fiscal 2007
Global
market demand for telecom test and measurement equipment should
remain strong in the years to come as most network service providers (NSPs)
are
increasing capital expenditures to upgrade their networks for converged IP
services and triple-play offerings. These market forces create needs for
differentiated test solutions to help NSPs accelerate deployment and ensure
service quality in their network buildouts. In fiscal 2007, we will strengthen
our competitive position by leveraging revenue and earnings from operations,
both organically and through strategic and selected acquisitions if stringent
criteria are met.
As
we
remain committed to best practices in financial reporting, once again this
year,
we are providing our investors with our strategic objectives for fiscal 2007
along with key performance metrics. The strategic objectives for fiscal 2007
are
the continuity of those of 2006. As always, we are highly focused on creating
value for our shareholders, providing the highest degree of profitable growth.
In fiscal 2007, we intend to maintain our long-term focus on profitable growth
by increasing sales in both divisions through market-share gains; maximize
profitability through proper execution and efficiency of our cost-reduction
programs; and focus on innovation to positively position the organization
for
the long-term growth opportunities that exist in our space.
Increase
sales through market-share gains
In
fiscal
2007, we intend to continue increasing sales through marketshare gains. We
were
among the last companies to be impacted by the telecommunications downturn
in
2001 and the first to recover with significant sales growth of 20.5% in fiscal
2004, 30.3% in 2005 and 31.9% in 2006, including 12 consecutive quarters
of
growth. This remarkable recovery was accomplished mainly through market-share
gains, since our end-markets reportedly experienced negative growth in fiscal
2004 and increased in the mid single digits in 2005 and 2006. On the strength
of
our past and current research and development investments, as well as our
market
position in key areas, we intend to maintain a high growth rate in 2007;
more
specifically, we aim to achieve this by further increasing our market share
in
telecom testing — especially in the rapidly growing protocol test segment — and
by leveraging core technologies in targeted life sciences and industrial
markets.
Maximize
profitability
In
fiscal
2007, we will focus on accelerating our profitability by increasing our earnings
from operations, according to our expected sales growth and our strong focus
on
operations. In the last few years, our bottom-line improved even faster than
our
top-line with earnings from operations of 6.3% of sales in fiscal 2006, which
included a non-recurring gain of 0.5%. We remain confident that our earnings
from operations will continue to improve as various factors are expected
to come
into play namely, higher-margin protocol and copper access revenues; better
absorption of fixed costs on higher sales volumes; specific internal
initiatives; and currency stability. This assumes no acquisitions.
Focus
on innovation
For
fiscal 2007, we will keep our focus on innovation by devoting significant
efforts to the development of new and differentiated solutions that support
long-term growth and profitability as well as deliver added value to our
customers. Over the past few years, our new products, with their built-in
superior performance and lower cost of goods, contributed significantly to
raising our gross margin and earnings from operations, while being able to
overcome considerable pricing pressure in our industry. In fiscal 2007, we
intend to significantly increase our investment in research and development
activities in dollars and slightly as a percentage of sales. We also intend
to
increasingly take advantage of talent pools around the world to cost-effectively
design innovative test solutions. Our numerous but focused research and
development initiatives should enable our new products to continue gaining
traction with customers and lead to further growth, market-share gains and
increased profitability in the coming years.
Key
Performance Indicators
As
measures to assess the realization of our strategic plan and its objectives,
we
have set out three consolidated key performance indicators for fiscal 2007.
They
are summarized as follows:
|
Strategic
objectives for for fiscal 2007
|
Key
performance indicators fiscal 2007
|
|
Increase
sales through market-share gains
|
20%
sales growth year-over-year
|
|
Maximize
profitability
|
7%
in earnings from operations
|
|
Focus
on innovation
|
35%
of sales from new products
|
|
(on
the market two years or less)
|
Capability
to Deliver Results
At
EXFO,
we believe that we have the capabilities to deliver expected results thanks
to
outstanding products, an excellent reputation in the marketplace, a sound
financial position, as well as an experienced workforce and management
team.
Critical
Accounting Policies and Estimates
Management’s
discussion and analysis of financial conditions and results of operations
is
based on our consolidated financial statements included elsewhere in this
Annual
Report. As previously mentioned, they have been prepared in accordance with
Canadian GAAP. The preparation of financial statements in accordance with
GAAP
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosures of contingent assets
and
liabilities at the date of the financial statements, as well as the reported
amounts of revenues and expenses during the reporting years. On an ongoing
basis, we evaluate these estimates and assumptions, including those related
to
revenue recognition, the allowance for doubtful accounts, the amount of tax
credits recoverable, the allowance for excess and obsolete inventories, the
useful lives of capital assets, the valuation of long-lived assets, the
valuation allowance of future income tax assets, the amount of certain accrued
liabilities and deferred revenue as well as stockbased compensation costs.
We
base our estimates and assumptions on historical experience and on other
factors
that we believe to be reasonable under the circumstances, the result of which
form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results
could differ from these estimates.
The
following summarizes our critical accounting policies as well as other policies
that require the most significant judgment and estimates in the preparation
of our consolidated financial statements.
Revenue
recognition.
For
products in which software is incidental, we recognize revenue when persuasive
evidence of an arrangement exists, the product has been delivered, the price
is
fixed and determinable and collection of the resulting receivable is reasonably
assured. In addition, provisions are made for estimated returns, warranties
and
support obligations.
For
products in which software is not incidental, revenues are separated into
two
categories: product and post-contract customer support (PCS) revenues, based
upon vendor-specific objective evidence of fair value. Product revenues for
these sales are recognized as described above. PCS revenues are deferred
and
recognized ratably over the years of the support arrangement. PCS revenues
are
recognized at the time the product is delivered when provided within one
year of
delivery; the costs of providing this support are insignificant (and accrued
at
the time of delivery) and no software upgrades are provided.
For
all
sales, we use a binding purchase order as evidence that a sales arrangement
exists.
Delivery
generally occurs when the product is handed over to a transporter for
shipment.
At
the
time of the transaction, we assess whether the price associated with our
revenue
transaction is fixed and determinable, and whether or not collection is
reasonably assured. We assess whether the price is fixed and determinable
based
on the payment terms associated with the transaction. We assess collection
based
on a number of factors, including past transaction history and the
creditworthiness of the customer. Generally, collateral or other security
is not
requested from customers.
Most
sales arrangements do not generally include acceptance clauses. However,
if a
sales arrangement does include an acceptance provision, acceptance occurs
upon
the earliest of the receipt of a written customer acceptance or the expiration
of the acceptance period. For these sales arrangements, the sale is recognized
when acceptance occurs.
Revenue
for extended warranties is recognized on a straight-line basis over the warranty
period.
Allowance
for doubtful accounts.
We
estimate collectibility of accounts receivable on an ongoing basis by reviewing
balances outstanding over a certain period of time. We determine our allowance
for doubtful accounts receivable based on our historical accounts receivable
collection experience and on the information that we have about the status
of
our accounts receivable balances. If the financial conditions of our customers
deteriorate, resulting in an impairment of their ability to make required
payments, additional allowance may be required, which could adversely affect
our
future results.
Allowance
for excess and obsolete inventories.
We
state our inventories at the lower of cost, determined on an average cost
basis
and replacement cost or net realizable value, and we provide reserves for
excess
and obsolete inventories. We determine our reserves for excess and obsolete
inventories based on the quantities we have on hand versus expected needs
for
these inventories, so as to support future sales of our products. It is possible
that additional inventory reserves may occur if future sales are less than
our
forecasts or if there is a significant shift in product mix compared to our
forecasts, which could adversely affect our future results.
Research
and development tax credits and government grants.
We
record research and development tax credits and government grants based on
our
interpretation of tax laws and grant programs, especially regarding related
eligible projects and expenses, and when there is reasonable assurance that
we
have complied and will continue to comply with all conditions and laws. Also,
our judgment and estimates are based on historical experience. It is possible,
however, that the tax authorities or the sponsors of the grant programs have
a
different interpretation of laws and application of conditions related to
the
programs or that we do not comply with all conditions related to grants in
the
future, which could adversely affect our future results. Furthermore, a
significant part of our tax credits are refundable against income taxes payable,
causing their ultimate realization to be dependent upon the generation of
taxable income. If we obtain information that causes our forecast of future
taxable income to change or if actual taxable income differs from our forecast,
we may have to revise the carrying value of these tax credits, which would
affect our results in the period in which the change was made. We review
the
recoverability of such tax credits on a quarterly basis.
Impairment
of long-lived assets and goodwill.
We
assess impairment of goodwill on an annual basis, or more frequently, if
events
or circumstances indicate that it might be impaired. Recoverability of goodwill
is determined at the reporting-unit level using a two-step approach. First,
the
carrying value of a reporting unit is compared to its fair value, which is
determined based on a combination of discounted future cash flows and a market
approach. If the carrying value of a reporting unit exceeds its fair value,
the
second step is performed. In this step, the amount of impairment loss, if
any,
represents the excess of the carrying value of goodwill over its fair value
and
the loss is charged to earnings in the period in which it is incurred. For
the
purposes of this impairment test, the fair value of goodwill is estimated
in the
same way as goodwill is determined in business combinations; that is, the
excess
of the fair value of a reporting unit over the estimated fair value of its
net
identifiable assets.
We
assess
impairment of long-lived assets when events or circumstances indicate that
costs
may not be recoverable. Impairment exists when the carrying value of an asset,
or a group of assets, is greater than the pre-tax undiscounted future cash
flows
expected to be provided by the asset or the group of assets. The amount of
impairment loss, if any, is the excess of the carrying value over the fair
value. We assess fair value of long-lived assets based on discounted future
cash
flows.
Future
income taxes.
We
account for income taxes using the liability method of tax allocation. Under
this method, future income tax assets and liabilities are determined based
on
deductible or taxable temporary differences between financial statement values
and tax values of assets and liabilities, using enacted income tax rates
for the
years in which the differences are expected to reverse. In assessing the
recoverability of our future income tax assets, we consider whether it is
more
likely than not that some or all of the future income tax assets will not
be
realized. The ultimate realization of our future income tax assets is dependent
upon the generation of future taxable income during the periods in which
those
temporary differences will become deductible. As at August 31, 2006, we had
established a full valuation allowance against our future income tax assets.
The
valuation allowance will be reversed once management will have concluded
that
realization of future income tax assets is more likely than not.
Stock-based
compensation costs.
We
account for all forms of employee stock-based compensation using the fair
value-based method. This method requires that we make estimates about the
risk-free interest rate, the expected volatility of our shares and the expected
life of the awards.
In
January 2005, the Canadian Institute of Chartered Accountants (CICA) issued
four
new accounting standards in relation to financial instruments: Section 3855,
"Financial Instruments - Recognition and Measurement"; Section 3865, "Hedges";
Section 1530, "Comprehensive Income"; and Section 3251, "Equity".
Section
3855 expands on Section 3860, "Financial Instruments - Disclosure and
Presentation", by prescribing when a financial instrument is to be recognized
on
the balance sheet and at what amount. It also specifies how financial instrument
gains and losses are to be presented in the financial statements.
Section
3865 provides an alternative to Section 3855 for entities that choose to
designate qualifying transactions as hedges for accounting purposes. It replaces
and expands on Accounting Guideline 13, "Hedging Relationships", and on the
hedging guidance in Section 1650, "Foreign Currency Translation", by specifying
how hedge accounting is applied and what disclosures it requires.
Section
1530, "Comprehensive Income", introduces a new requirement to temporarily
present certain gains and losses outside net income.
Consequently,
Section 3250, "Surplus", has been revised as Section 3251,
"Equity".
Sections
1530, 3251, 3855 and 3865 apply to fiscal years beginning on or after October
1,
2006. We will adopt these new standards on September 1, 2007. While we are
currently assessing the effects of these new standards, impacts consistent
with
the adjustments described under note 20 item b) of these consolidated financial
statements are expected.
Results
of Operations
The
following table sets forth certain Canadian GAAP consolidated financial
statements data in thousands of US dollars, except per share data and as
a
percentage of sales for the years indicated:
|
Consolidated
statements of earnings data:
|
2006
|
|
2005
|
|
2004
|
|
2006
|
|
2005
|
|
2004
|
||||||||
|
Sales
|
$
|
128,253
|
$
|
97,216
|
$
|
74,630
|
100.0
|
%
|
100.0
|
%
|
100.0
|
%
|
|||||||
|
Cost
of sales (1)
|
57,275
|
44,059
|
34,556
|
44.7
|
45.3
|
46.3
|
|||||||||||||
|
Gross
margin
|
70,978
|
53,157
|
40,074
|
55.3
|
54.7
|
53.7
|
|||||||||||||
|
Operating
expenses
|
|||||||||||||||||||
|
Selling
and administrative
|
40,298
|
31,782
|
25,890
|
31.4
|
32.7
|
34.7
|
|||||||||||||
|
Net
research and development
|
15,404
|
12,190
|
12,390
|
12.0
|
12.5
|
16.6
|
|||||||||||||
|
Amortization
of property, plant and equipment
|
3,523
|
4,256
|
4,935
|
2.7
|
4.4
|
6.6
|
|||||||||||||
|
Amortization
of intangible assets
|
4,394
|
4,836
|
5,080
|
3.4
|
5.0
|
6.8
|
|||||||||||||
|
Impairment
of long-lived assets
|
604
|
−
|
620
|
0.5
|
−
|
0.8
|
|||||||||||||
|
Government
grants
|
(1,307
|
)
|
−
|
−
|
(1.0
|
)
|
−
|
−
|
|||||||||||
|
Restructuring
and other charges
|
−
|
292
|
1,729
|
−
|
0.3
|
2.3
|
|||||||||||||
|
Total
operating expenses
|
62,916
|
53,356
|
50,644
|
49.0
|
54.9
|
67.8
|
|||||||||||||
|
Earnings
(loss) from operations
|
8,062
|
(199
|
)
|
(10,570
|
)
|
6.3
|
(0.2
|
)
|
(14.1
|
)
|
|||||||||
|
Interest
and other income
|
3,253
|
2,524
|
1,438
|
2.5
|
2.6
|
1.9
|
|||||||||||||
|
Foreign
exchange loss
|
(595
|
)
|
(1,336
|
)
|
(278
|
)
|
(0.5
|
)
|
(1.4
|
)
|
(0.4
|
)
|
|||||||
|
Earnings
(loss) before income taxes
|
10,720
|
989
|
(9,410
|
)
|
8.3
|
1.0
|
(12.6
|
)
|
|||||||||||
|
Income
taxes
|
2,585
|
2,623
|
(986
|
)
|
2.0
|
2.7
|
(1.3
|
)
|
|||||||||||
|
Net
earnings (loss) for the year
|
$
|
8,135
|
$
|
(1,634
|
)
|
$
|
(8,424
|
)
|
6.3
|
%
|
(1.7
|
)%
|
(11.3
|
)%
|
|||||
|
Basic
and diluted net earnings (loss) per share
|
$
|
0.12
|
$
|
(0.02
|
)
|
$
|
(0.13
|
)
|
|||||||||||
|
Segment
information
|
|||||||||||||||||||
|
Sales:
|
|||||||||||||||||||
|
Telecom
Division
|
$
|
107,376
|
$
|
80,120
|
$
|
58,882
|
83.7
|
%
|
82.4
|
%
|
78.9
|
%
|
|||||||
|
Life
Sciences and Industrial Division
|
20,877
|
17,096
|
15,748
|
16.3
|
17.6
|
21.1
|
|||||||||||||
|
$
|
128,253
|
$
|
97,216
|
$
|
74,630
|
100.0
|
%
|
100.0
|
%
|
100.0
|
%
|
||||||||
|
Operating
earnings (loss):
|
|||||||||||||||||||
|
Telecom
Division
|
$
|
6,679
|
$
|
763
|
$
|
(5,557
|
)
|
5.2
|
%
|
0.8
|
%
|
(7.4
|
)%
|
||||||
|
Life
Sciences and Industrial Division
|
1,383
|
(962
|
)
|
(5,013
|
)
|
1.1
|
(1.0
|
)
|
(6.7
|
)
|
|||||||||
|
$
|
8,062
|
$
|
(199
|
)
|
$
|
(10,570
|
)
|
6.3
|
%
|
(0.2
|
)%
|
(14.1
|
)%
|
||||||
|
Research
and development data:
|
|||||||||||||||||||
|
Gross
research and development
|
$
|
19,488
|
$
|
15,878
|
$
|
15,668
|
15.2
|
%
|
16.3
|
%
|
21.0
|
%
|
|||||||
|
Net
research and development
|
$
|
15,404
|
$
|
12,190
|
$
|
12,390
|
12.0
|
%
|
12.5
|
%
|
16.6
|
%
|
|||||||
|
Consolidated
balance sheets data:
|
|||||||||||||||||||
|
Total
assets
|
$
|
219,159
|
$
|
190,957
|
$
|
172,791
|
|||||||||||||
|
(1)
|
The
cost of sales is exclusive of amortization, shown
separately.
|
Sales
Fiscal
2006 vs. 2005
In
fiscal
2006, our global sales increased 31.9% to $128.3 million from $97.2 million
in
2005, with an 84%-16% split in favor of our Telecom Division.
Telecom
Division
In
fiscal
2006, sales of our Telecom Division increased 34.0% to $107.4 million from
$80.1
million in 2005.
In
fiscal
2006, we leveraged our portfolio of new products and an increased demand
for our
test solutions, especially in Europe, Middle East and Africa (EMEA) and
Asia-Pacific (APAC), to increase our yearover- year sales in our Telecom
Division. We also consolidated our dominant FTTx market position in the Americas
by enabling a Tier-1 carrier to migrate to less expensive test solutions.
Although revenues were down at this customer year-over-year, we maintained
our
market share through the sales of cost-effective test solutions, such as
our
handheld AXS-100 OTDR, to help it reduce cost of deployments. In addition,
the
positive spending environment, as well as the market share we believe that
we
gained in fiscal 2006 for our optical and protocol products, helped us increase
our sales of that division year-over-year. Also, Consultronics contributed
about
seven months to our Telecom Division, which had a positive impact on our
consolidated sales during fiscal 2006. Consultronics’ results have been included
in our consolidated statements of earnings since the closing of the acquisition
on January 26, 2006. Finally, in fiscal 2006, our top customer accounted
for
16.5% of our Telecom sales, compared to 28.2% of sales in 2005, reflecting
the
diversification of our customer base. In fact, excluding sales to our top
customer, our sales to this Division would have increased 56.0% in fiscal
2006,
compared to 2005.
Although,
in the past few years, our market share in the protocol test market has been
modest, our protocol-product results in the second half of fiscal 2006 increased
substantially year-over-year, making this sector our fastest-growing line
of
business. We expect continued strong growth in fiscal 2007 based on our solid
product offering in next-generation solutions, which are at the basis of
the
whole trend toward IP convergence. During the second half of fiscal 2006,
we
reached a key milestone in our protocol-product development program. More
specifically, this consisted in the launch of legacy and next-generation
SONET/SDH network test modules for our FTB-200, FTB-400 and IQS-500 platforms.
These latest product launches, combined with our existing offering for Ethernet
(from 10 Mb/s up to 10 Gb/s), Gigabit Ethernet and Fibre Channel test solutions,
provide us with an extensive product portfolio to compete against the incumbent
players in protocol testing, especially in the network service provider (NSP)
market segment, but also to a lesser degree, with system vendors. Among many
key
differentiators, we believe EXFO now offers the most complete and advanced
compact test solutions combining legacy and next-generation SONET/SDH as
well as
Ethernet test modules for rates up to 10 Gb/s within the same portable platform
(i.e., our FTB-400 mainframe and GP- 404 module receptacle). In fiscal 2006,
sales of our protocol products, which almost doubled compared to 2005, increased
to their highest historical levels, representing well above 10% of our optical
sales. Based on these data points and given the much larger addressable market
for protocol test solutions, we believe that protocol revenues will increase
and
grow faster than our optical revenues. On a medium- and long-term basis,
we
anticipate that revenues from these segments will eventually be
equal.
As
our
newly acquired copper access product line is now better leveraged by EXFO’s
global sales channels and improved innovation processes, we intend to strengthen
our offering in this market segment.
Life
Sciences and Industrial Division
In
fiscal
2006, sales of our Life Sciences and Industrial Division increased 22.1%
to
$20.9 million from $17.1 million in 2005. The increase in sales in fiscal
2006,
compared to 2005, is mainly due to increased sales activities in the curing
market as well as market-share gains in the fluorescence illumination market,
following our efforts to expand international markets, mainly in Europe and
Asia.
Overall,
for the two divisions, net accepted orders increased 27.2% to $129.4 million
in
fiscal 2006 from $101.7 million in 2005, for a book-tobill ratio of 1.01
in
fiscal 2006. Our increase of 27.2% in net accepted orders in fiscal 2006,
compared to 2005 reflects the impact of the Consultronics acquisition, an
increased demand for our test solutions (especially in EMEA and APAC regions),
market-share gains in the telecommunications and life sciences markets as
well
as the improvement in the telecommunications market environment.
Fiscal
2005 vs. 2004
In
fiscal
2005, our global sales increased 30.3% to $97.2 million from $74.6 million
in
2004, with an 82%-18% split in favor of our Telecom Division.
Telecom
Division
In
fiscal
2005, sales of our Telecom Division increased 36.1% to $80.1 million from
$58.9
million in 2004. Since the second half of fiscal 2004, we have benefited
from an
increased demand for our test solutions following the deployment of fiber
deeper
into access networks (FTTx). In fiscal 2005, we consolidated our leadership
position in the FTTx test market by recognizing significant revenue from
two
leading U.S. carriers deploying fiber in their access networks. Our top
customer, who purchased several orders of FTTx test equipment, accounted
for
28.2% of telecom sales in fiscal 2005 (17.5% in 2004). In addition, the positive
spending environment helped us increase our sales in 2005.
Although
sales of our protocol test products increased sequentially each quarter in
fiscal 2005 and reached more than 10% of Telecom Division revenues in the
fourth
quarter of 2005, they still fell below 10% for the whole fiscal
year.
Life
Sciences and Industrial Division
In
fiscal
2005, sales of our Life Sciences and Industrial Division increased 8.6% to
$17.1
million from $15.7 million in 2004. The increase in sales in fiscal 2005,
compared to 2004, is mainly due to market-share gains in the fluorescence
illumination market as well as increased sales activities in the curing
market.
Geographic
distribution
Fiscal
2006 vs. 2005
During
fiscal 2006, sales to the Americas, Europe-Middle East-Africa (EMEA) and
Asia-Pacific (APAC) accounted for 60%, 25% and 15% of global sales,
respectively, compared to 68%, 20% and 12%, respectively in 2005. Although
our
sales increased in dollars in every geographic area, we made greater progress
in
EMEA and APAC in fiscal 2006, compared to 2005, where we gained market share
in
both divisions. Global sales to these two markets increased 66.9% and 66.4%,
respectively in fiscal 2006, compared to 2005. In comparison, our sales to
the
Americas increased 15.6% year-over-year.
The
significant increase in sales in the EMEA market is mainly due to improved
market penetration by both divisions, following our efforts to develop this
market in the last several quarters. Namely, since the second quarter of
fiscal
2006, we were selected as sole-source supplier by a Tier-1 network service
provider for all its fiber deployment test applications - including FTTx
—
further increasing our sales to this market year-over-year.
Over
the
last several quarters, we strengthened our product offering in APAC,
specifically by implementing a multi-tiered platform strategy to meet different
customer demands and different price points and by expanding our sales and
marketing activities in this region. Our increased focus on and interaction
with
this market, combined with our enhanced capability to win tenders (which
may
vary in number and importance), contributed to our growth in the APAC
region.
In
the
Americas, sales to our top customer, who is located in the United States,
decreased in fiscal 2006, compared to 2005, as it migrated to lower-priced
test
solutions, thus affecting our sales to the Americas yearover- year. However,
we
were able to leverage our customer base and increase our sales to this region
in
fiscal 2006, compared to 2005. Also, Consultronics, whose customers are mainly
in the Americas, helped increase our sales to the Americas in fiscal 2006.
In
fact, excluding sales to our top customer, our sales to the Americas would
have
increased 35.1% year-over-year, which is quite remarkable considering that
our
endmarkets increased in mid-single digits in 2006.
Fiscal
2005 vs. 2004
During
fiscal 2005, sales to the Americas, EMEA and APAC accounted for 68%, 20%
and 12%
of global sales, respectively, compared to 66%, 18% and 16%, respectively
in
2004. Our sales to the Americas, which increased 34% year-over-year, benefited
from the recent deployments of fiber deeper in access networks (mainly in
the
United States). Our sales to EMEA increased more significantly (42%)
year-over-year, mainly due to market-share gains in both divisions, following
our efforts to develop this important end-market. Finally, our sales to APAC
remained flat in dollars year-over-year. A significant portion of our sales
to
this region of the world are made through price-driven tenders that may vary
in
number and importance from quarter to quarter. Also, the competitive landscape
in this market led to pricing pressure, which prevented us from increasing
our
sales year-over-year.
Through
our two divisions, we sell our products to a broad range of customers, including
NSPs, cable TV operators, optical system and component manufacturers, as
well as
customers in the life sciences and high-precision assembly sectors. In fiscal
2006, our top customer accounted for 13.8% of our total sales, compared to
23.3%
in 2005 and 13.8% in 2004. In fiscal 2006, our top three customers accounted
for
19.4% of our global sales, compared to 28.4% in fiscal 2005 and 20.8% in
2004.
Our significant sales increase, despite the fact that our revenue from our
top
customer was significantly reduced, is a good sign that we continued to
strengthen our market acceptance, diversify our customer base and reduce
our
sales concentration with a single customer. This also indicates that our
second
and third most important customers, who may vary from quarter to quarter,
have
gained importance as we continue our diversification efforts.
Gross
Margin
Gross
margin amounted to 55.3%, 54.7% and 53.7% of sales for fiscal 2006, 2005
and
2004, respectively.
Fiscal
2006 vs. 2005
The
increase in our gross margin in fiscal 2006, compared to 2005, can be explained
by the following factors. First, we succeeded in increasing the market
acceptance of our new products (designed in the last few years) on which
we had
focused our research and development efforts to simultaneously create lower
cost
of goods and the most advanced solutions. Second, the significant rise in
sales
year-over-year resulted in an increase in manufacturing activities, allowing
us
to better absorb our fixed manufacturing costs. Also, we were able to reduce
our
cost of goods sold by better leveraging our supplier base. Furthermore,
streamlined operations following our consolidation action in fiscal 2005
and
continued cost-reduction programs allowed us to further improve our gross
margin. However, the shift in the geographic distribution of our sales resulted
in more sales, in percentage of total sales, made to the EMEA and APAC markets,
where gross margins tend to be lower as most of our sales to these markets
are
made through distribution channels. In addition, we are facing aggressive
pricing pressure worldwide. Furthermore, in fiscal 2006, we incurred one-time
charges related to the integration of Consultronics manufacturing activities,
which reduced our gross margin year-over-year. Finally, a stronger Canadian
dollar, compared to the US dollar, prevented us from further improving our
gross
margin as some cost of sales items are denominated in Canadian
dollars.
On
an
ongoing basis, we adjust the design of our products and, over the past few
years, we experienced higher sales than expected. Consequently, we were able
to
reuse excess inventories that were written off during the telecom downturn
in
2001 and 2002. Excess inventory reuse accounted for approximately $1.2 million,
or 0.9% of sales in fiscal 2006, compared to approximately $1.6 million,
or 1.7%
of sales in 2005 and approximately $600,000, or 0.8% of sales in 2004. Inventory
writeoffs recorded during the telecom downturn were based on our best estimate
at that time.
Fiscal
2005 vs. 2004
The
increase in our gross margin in fiscal 2005, compared to 2004, can be explained
by the following factors. First, we were able to reduce our cost of goods
sold
by better leveraging our supplier base and by developing innovative new products
with a cost-effective design. Also, the significant rise in sales resulted
in an
increase in manufacturing activities, allowing us to better absorb our fixed
manufacturing costs. Furthermore, streamlined operations following our
consolidation actions in fiscal 2004 and 2005 and cost-reduction programs
allowed us to further improve our gross margin. In addition, the shift in
the
geographic distribution of our sales resulted in more sales made to the Americas
market, where gross margins tend to be higher because we sell direct to the
customers. However, a stronger Canadian dollar, compared to the US dollar,
prevented us, to some extent, from further improving our gross margin as
some
cost of sales elements are denominated in Canadian dollars. As well, the
different customer mix and aggressive pricing pressure observed in fiscal
2005
also prevented us from further improving our gross margin.
Outlook
for Fiscal 2007
Considering
the expected sales growth in fiscal 2007, the expected increase in sales
of
protocol products (which tend to generate higher margins), the cost-effective
design of our products, our tight control on operating costs as well as the
full
contribution of Consultronics, whose products have slightly higher margins
than
our existing ones, we expect our gross margin to improve in 2007 and beyond.
However, our gross margin may fluctuate quarter-over-quarter as our sales
may
fluctuate. Furthermore, our gross margin can be negatively affected by increased
competitive pricing pressure, customer concentration and/or consolidation,
increased obsolescence costs, shifts in customer and product mix,
under-absorption of fixed manufacturing costs and increases in product offerings
by other suppliers in our industry. Finally, any further increase in the
strength of the Canadian dollar would have a negative impact on our gross
margin
in fiscal 2007.
Selling
and Administrative
Selling
and administrative expenses were $40.3 million, $31.8 million and $25.9 million
for fiscal 2006, 2005 and 2004, respectively. As a percentage of sales, selling
and administrative expenses amounted to 31.4%, 32.7% and 34.7% for fiscal
2006,
2005 and 2004, respectively.
Fiscal
2006 vs. 2005
The
increase in our selling and administrative expenses in dollars in fiscal
2006,
compared to 2005, is mainly due to our decision to increase our sales activities
to better leverage the significant research and development investments of
the
prior years, which resulted in higher sales and marketing expenditures
(including number of employees). In addition, our commission expenses increased
year-over-year due to the increase in sales. Furthermore, a stronger Canadian
dollar, compared to the US dollar yearover- year, caused our selling and
administrative expenses to increase, as more than half of these are incurred
in
Canadian dollars. Finally, in fiscal 2006, Consultronics contributed about
seven
months to our selling and administrative expenses, increasing these expenses
year-over-year.
Fiscal
2005 vs. 2004
During
fiscal 2005, we also significantly increased our sales activities around
the
world, which resulted in higher sales and marketing expenditures. In addition,
increased sales activities, especially in the Americas market, resulted in
higher commission expenses year-over-year. Furthermore, as witnessed in fiscal
2006, the strengthening of the Canadian dollar, compared to the US dollar
year-over-year, caused our selling and administrative expenses to increase.
Also, stock-based compensation costs were higher in fiscal 2005 ($626,000)
than
in 2004 ($265,000), further increasing our selling and administrative expenses
year-over-year. Finally, costs to comply with Section 404 of the Sarbanes-
Oxley
Act further increased our selling and administrative expenses
yearover-
year.
For
both
fiscal 2005 and 2006, we were able to mitigate the increase in our selling
and
administrative expenses as well as reduce these expenses in percentage of
sales
year-over-year due to tight cost-control measures. In addition, our significant
increase in revenues allowed us to reduce our selling and administrative
expenses on a percentage basis.
Outlook
for Fiscal 2007
For
fiscal 2007, we expect our selling and administrative expenses to increase
in
dollars, while remaining relatively stable as a percentage of sales. In
particular, in fiscal 2007, we will have the full impact of the acquisition
of
Consultronics on our selling and administrative expenses. Also, we expect
our
commission expenses to increase as sales volume increases. Furthermore,
considering our goal of becoming the leading player in the telecom test and
measurement space, we will intensify our sales and marketing efforts, both
domestic and international, which will also cause our expenses to rise. Finally,
any further increase in the strength of the Canadian dollar would also cause
our
selling and administrative expenses to increase, as more than half of these
expenses are incurred in Canadian dollars.
Research
and Development
Gross
research and development expenses
Gross
research and development expenses totaled $19.5 million, $15.9 million and
$15.7
million for fiscal 2006, 2005 and 2004, respectively. As a percentage of
sales,
gross research and development expenses amounted to 15.2%, 16.3% and 21.0%
for
fiscal 2006, 2005 and 2004, respectively, while net research and development
expenses accounted for 12.0%, 12.5% and 16.6% of sales for these respective
periods.
Fiscal
2006 vs. 2005
The
increase in our gross research and development expenses in dollars in fiscal
2006, compared to 2005, is due to the following reasons. First, in fiscal
2006,
Consultronics contributed about seven months to our gross research and
development expenses, which caused these expenses to increase year-over-year.
In
addition, in fiscal 2006, our gross research and development expenses were
negatively affected by the increased strength of the Canadian dollar, compared
to the US dollar year-over-year. This can be explained by the fact that,
following the consolidation of most of our research and development activities
in Canada, the majority of our expenses are incurred in Canadian dollars.
Finally, mix and timing of research and development projects in fiscal 2006
resulted in more gross research and development expenses during that year
compared to 2005 for both divisions.
The
decrease in gross research and development expenses as a percentage of sales
in
fiscal 2006, compared to 2005, is directly related to the significant increase
in sales year-over-year.
Fiscal
2005 vs. 2004
As
mentioned above, we incur most of our gross research and development expenses
in
Canadian dollars. Consequently, the significant increase in the strength
of the
Canadian dollar, compared to the US dollar year-over-year, caused our gross
research and development expenses to increase in fiscal 2005, compared to
2004.
However, this increase was mostly offset by the decrease in our gross research
and development expenses in our Life Sciences and Industrial Division following
the consolidation of this division in Toronto. The decrease in our gross
research and development expenses as a percentage of sales in fiscal 2005,
compared to 2004, is directly attributable to the significant increase in
sales
year-over-year while these expenses remained relatively flat.
Tax
credits and grants
Tax
credits and grants from the Canadian federal and provincial governments for
research and development activities were $4.1 million, $3.7 million and $3.3
million for fiscal 2006, 2005 and 2004, respectively. As percentage of gross
research and development expenses, tax credits and grants amounted to 21.0%,
23.2% and 20.9% for fiscal 2006, 2005 and 2004, respectively.
Fiscal
2006 vs. 2005
The
increase in our tax credits in dollars in fiscal 2006, compared to 2005,
is
mainly related to the increase in our eligible gross research and development
expenses in Canada, since we were also entitled to similar grant programs
and
tax credits year-over-year. In addition, the increased strength of the Canadian
dollar, compared to the US dollar, year-overyear, resulted in higher tax
credits
since these credits are earned in Canada. However, our tax credits decreased
as
a percentage of gross research and development expenses. Indeed, following
the
acquisition of Consultronics, we incurred less gross expenses entitling to
tax
credits since a part of Consultronics research and development activities
were
held outside Canada and Quebec. In addition, a mix of research and development
projects resulted in a lower proportion of expenses being eligible
for tax credits in fiscal 2006, compared to 2005.
Fiscal
2005 vs. 2004
The
increase in our tax credits in fiscal 2005, compared to 2004, is mainly related
to the increase in our eligible gross research and development expenses in
Canada, since we were entitled to similar grant programs and tax credits
year-over-year. Following the consolidation of our research and development
activities in Canada, we incurred most of our research and development expenses
in Canada, where we are entitled to research and development tax credits.
In
addition, the increased strength of the Canadian dollar, compared to the
US
dollar, year-over-year, resulted in higher tax credits since these credits
are
earned in Canada.
We
still
invested significantly in research and development activities in fiscal 2006
as
we firmly believe that innovation and new product introductions are key in
gaining market share in the current economic environment and ensuring the
long-term growth and profitability of EXFO.
Outlook
for Fiscal 2007
For
fiscal 2007, we intend to significantly increase our research and development
expenses in dollars and slightly in percentage of sales, given our focus
on
innovation, our desire to gain market share, our goal to exceed customer
needs
and expectations and the full impact of the acquisition of Consultronics.
We
also intend to increasingly take advantage of talent pools around the world
to
cost-effectively design innovative test solutions. Finally, any further increase
in the strength of the Canadian dollar would cause our net research and
development expenses to increase, as most of these are incurred in Canadian
dollars.
Amortization
of Property, Plant and Equipment
For
fiscal 2006, amortization of property, plant and equipment was $3.5 million,
compared to $4.3 million in 2005 and $4.9 million in 2004. The decrease in
amortization expenses over the last two fiscal years, despite the increase
in
the strength of the Canadian dollar compared to the US dollar as well as
the
acquisition of Consultronics in 2006 is mainly due to the fact that some
of our
property, plant and equipment became fully amortized over the last three
years.
Outlook
for Fiscal 2007
For
fiscal 2007, despite a potential increase in the strength of the Canadian
dollar
and the full impact of the acquisition of Consultronics, we expect the
amortization of property, plant and equipment to decrease compared to 2006
considering that some of these assets became fully amortized in 2006 or will
become fully amortized in 2007.
Amortization
of Intangible Assets
In
conjunction with the business combinations we completed over the past several
years, we recorded intangible assets, primarily consisting of core technology.
These intangible assets resulted in amortization expenses of $4.4 million,
$4.8
million and $5.1 million for fiscal 2006, 2005 and 2004, respectively. The
decrease in amortization expenses in the last two fiscal years, despite the
increased strength of the Canadian dollar, compared to the US dollar, and
the
acquisition of Consultronics in 2006 is mainly due to the fact that some
of our
core technologies became fully amortized during fiscal 2005 and 2006; namely,
those related to the acquisition of EXFO Burleigh and EXFO Photonics
Solutions.
Outlook
for Fiscal 2007
For
fiscal 2007, despite a potential increase in the strength of the Canadian
dollar
and the full impact of the acquisition of Consultronics, we expect the
amortization of intangible assets to approximate $3.0 million, considering
that
some core technologies will become fully amortized in 2007; namely, those
related to our protocol business. This assumes no acquisitions will be made
during this period.
Impairment
of Long-Lived Assets
Fiscal
2006
In
June
2006, we entered into an agreement to sell our building located in Rochester,
NY, along with some equipment, and we recorded an impairment charge of $604,000
in the third quarter of fiscal 2006, representing the excess of the carrying
value of these assets over the net expected selling price of $1.2 million.
The
sale of these assets was finalized in the fourth quarter of 2006 for the
net
expected selling price. This amount is included in other receivables in the
balance sheet as at August 31, 2006, and will be recovered in the first quarter
of fiscal 2007. These assets report to the Life Sciences and Industrial
Division. As at August 31, 2005, this building was shown as a long-lived
asset
held for sale in the balance sheet.
Fiscal
2004
In
fiscal
2004, we put one of our buildings located in Quebec City, Canada, up for
sale
and received, at the beginning of 2005, a formal purchase offer for this
building. Based on that offer, we concluded that the building was impaired
and
we recorded an impairment charge of $620,000 in fiscal 2004, representing
the
excess of the carrying value of the building over its expected selling price.
However, during the first quarter of fiscal 2005, some conditions of the
formal
offer were not met and the offer was declined. During fiscal 2005, we withdrew
the building from the market. This building reports to the Telecom Division.
In
May of
each of the reporting years, we performed our annual impairment test for
goodwill and concluded that it was not impaired. Goodwill will be reviewed
for
impairment in May 2007, or prior if events or circumstances indicate it might
be
impaired.
Government
Grants
During
1998, we entered into an agreement with the Quebec Minister of Industry,
Commerce, Science and Technology (“The Minister”). Pursuant to this agreement,
the Minister agreed to contribute, in the form of grants, up to CA$2.2 million
(US$2.0 million) over the period from January 1, 1998, through December 31,
2002, payable based on the number of full-time jobs created during that
period.
Since
the
beginning of the program, we have claimed and received the maximum amount
of
CA$2.2 million. However, these grants were subject to the condition that
jobs
created pursuant to the agreement be maintained for a period of at least
five
years from the date of creation. Since the beginning of the program, we deferred
in the balance sheet CA$1.5 million (US$1.3 million) until we received the
final
approval by the sponsor of the program related to jobs created. In fiscal
2006,
the sponsor of the program granted us with its final approval and we recorded
non-recurring revenue of CA$1.5 million (US$1.3 million) in the earnings
from
operations in the statement of earnings for that period.
Restructuring
and Other Charges
Fiscal
2004 and 2005
In
fiscal
2004, the Board of Directors approved a restructuring plan to consolidate
the
operations of our Life Sciences and Industrial Division, transferring our
Rochester, NY, operations mainly to EXFO Photonic Solutions facilities in
Toronto. The consolidation process, which started in August 2004, was completed
during fiscal 2005.
Overall,
for that process, we incurred $2.5 million in restructuring and other charges,
from which $2.0 million was recorded in fiscal 2004 and the remaining of
$482,000 was recorded in fiscal 2005. The overall costs, which were recorded
in
the restructuring and other charges in the statements of earnings of the
corresponding years, are detailed as follows: $855,000 for severance expenses
for the layoff of all employees at the Rochester facilities; $1.3 million
mainly
for the impairment of the EXFO Burleigh building; and the remaining $399,000
for
other expenses such as training and recruiting expenses and transfer of
assets.
Finally,
in fiscal 2005 and 2004, we recorded adjustments of $190,000 and $304,000,
respectively, to the fiscal 2003 and 2001 plans because actual charges, mainly
for leased equipment, were lower than expected.
Our
restructuring plans and cost-reduction measures represented our best efforts
to
respond to the difficult market conditions of recent years. Although we believe
that such restructuring actions were appropriate and delivered the expected
results, changes in market or industry conditions may lead us to incur
additional restructuring actions and cost-reduction measures in the coming
years.
Interest
and Other Income
Our
interest income mainly resulted from our short-term investments, less interests
and bank charges. Interest and other income amounted to $3.3 million, $2.5
million and $1.4 million for fiscal 2006, 2005 and 2004, respectively. The
increase in our interest income in fiscal 2006, compared to 2005, is mainly
due
to the increase in interest rates yearover- year. Also, despite the cash
payment
of $18.1 million for the acquisition of Consultronics in January 2006, our
average cash position increased in fiscal 2006 due to cash flows from operating
activities, which contributed to the further increase in interest revenue
year-over-year.
The
increase in interest income in fiscal 2005, compared to 2004, is due in part
to
the increase in our average cash position following our public offering in
February 2004, the cash flows from operating activities and the increase
in interest rates year-over-year.
Outlook
for fiscal 2007
Assuming
no acquisitions are made in fiscal 2007, we expect our interest income to
remain
relatively flat, compared to 2006, assuming stability in interest
rates.
Foreign
Exchange Loss
Foreign
exchange gains and losses are the result of the translation of operating
activities denominated in currencies other than the Canadian
dollar.
Foreign
exchange loss amounted to $595,000, $1.3 million and $278,000 for fiscal
2006,
2005 and 2004, respectively.
The
significant exchange losses recorded in fiscal 2005 and 2006 are the result
of
the significant increase in the value of the Canadian dollar, compared to
the US
dollar, during these periods. However, the increase in the value of the Canadian
dollar was more significant in fiscal 2005, compared to 2006, which resulted
in
a higher exchange loss in 2005. For instance, the year-end exchange rate
was
CA$1.3167 = US$1.00 in fiscal 2004, compared to CA$1.1889 = US$1.00 in 2005,
representing an increase of 10.7% year-over-year. This compares to a year-end
exchange rate of CA$1.1066 = US$1.00 in fiscal 2006, which resulted in an
increase of 7.4%, compared to 2005. Also, the average exchange rate was
CA$1.2315 = US$1.00 in fiscal 2005, compared to CA$1.1481 = US$1.00 in 2006.
On
the other hand, higher levels of activity in fiscal 2006, compared to 2005,
contributed to the increase in exchange loss in 2006.
During
fiscal 2004, the Canadian dollar value remained relatively stable compared
to
the US dollar, throughout the year, resulting in a slight exchange loss during
that year.
It
should
be noted that additional foreign exchange rate fluctuations flow through
the
P&L line items as a significant portion of our operating items are
denominated in Canadian dollars, and we report our results in US
dollars.
We
manage
our exposure to currency risks with forward exchange contracts. In addition,
some of our Canadian entities’ operating activities are denominated in US
dollars or other currencies, which further hedges these risks. However, any
further increase in the value of the Canadian dollar, compared to the US
dollar,
would have a negative impact on our operating results.
Income
Taxes
Our
income tax expenses totaled $2.6 million in fiscal 2006 and 2005, compared
to an
income tax recovery of $986,000 in 2004.
Most
of
the income tax expenses recorded in fiscal 2005 and 2006 represent income
taxes
payable at the Canadian federal level, which are reduced by research and
development tax credits that are recorded against gross research and development
expenses in the statements of earnings.
The
income tax recovery recorded in fiscal 2004 is mainly due to the $1.4 million
of
unusual income tax recovery recorded during that year, offset in part by
income
taxes payable in some specific tax jurisdictions, mainly at the Canadian
federal
level. These taxes were also reduced by research and development tax credits
recorded against gross research and development expenses. The unusual tax
recovery was due to the receipt, during that period, of income taxes paid
in
previous periods following the reception of a tax assessment.
We
record
a full valuation allowance against our future income tax assets because it
is
more likely than not that these assets will not be recovered. The valuation
allowance will be reversed once we will have concluded that realization of
future income tax assets is more likely than not. Consequently, our income
tax
rates are distorted compared to statutory rates. Please refer to note 16
of our
consolidated financial statements included elsewhere in this Annual Report
for a
full reconciliation of the income tax provision.
Liquidity
and Capital Resources
Cash
Requirements and Capital Resources
As
at
August 31, 2006, cash and short-term investments consisted of $111.3 million,
almost flat compared to 2005, while our working capital was at $144.0 million.
During fiscal 2006, operating activities generated $12.3 million in cash.
In
addition, we recorded an unrealized foreign exchange gain of $7.9 million
on our
cash and short-term investments. This unrealized foreign exchange gain resulted
from the translation, in US dollars, of our Canadian-dollar-denominated cash
and
short-term investments and was recorded in the cumulative translation adjustment
in the balance sheet. On the other hand, we made cash payments of $18.1 million
and $3.4 million for the acquisition of Consultronics and for the purchase
of
property, plant and equipment, respectively.
Our
short-term investments consist of commercial paper issued by nine (six as
of
August 31, 2005) quality, high-credit corporations and trusts; therefore,
we
consider the risk of non-performance of these financial instruments to be
remote. For the purposes of managing our cash position, we have established
a
cash management policy, which we follow and monitor on a regular basis. These
short-term investments will be used for working capital and other general
corporate purposes, including other potential acquisitions.
We
believe that our cash balances and short-term investments will be sufficient
to
meet our liquidity and capital requirements for the foreseeable future. In
addition to these assets, we have unused available lines of credit of $11.2
million for working capital and other general corporate purposes and an unused
line of credit of $11.2 million for foreign currency exposure related to
forward
exchange contracts. However, possible operating losses and/or possible
investments in or acquisitions of complementary businesses, products or
technologies may require additional financing. There can be no assurance
that
additional debt or equity financing will be available when required or, if
available, that it can be secured on satisfactory terms. Our lines of credit
bear interest at prime rate.
The
following table summarizes our commitments as at August 31, 2006:
|
Years
ending August 31,
|
2007
|
2008
|
2009
|
2010
|
2011
and later
|
Total
|
|||||||||||||
|
Long-term
debt
|
$
|
107,000
|
$
|
113,000
|
$
|
118,000
|
$
|
123,000
|
$
|
−
|
$
|
461,000
|
|||||||
|
Operating
leases
|
1,748,000
|
1,223,000
|
1,177,000
|
1,200,000
|
1,540,000
|
6,888,000
|
|||||||||||||
|
Total
commitments
|
$
|
1,855,000
|
$
|
1,336,000
|
$
|
1,295,000
|
$
|
1,323,000
|
$
|
1,540,000
|
$
|
7,349,000
|
|||||||
Sources
and Uses of Cash
We
finance our operations and meet our capital expenditure requirements mainly
through cash flows from operating activities, the use of our cash and short-term
investments as well as the issuance of subordinate voting shares.
Operating
Activities
Cash
flows provided by operating activities were $12.3 million in fiscal 2006,
compared to $14.0 million in 2005 and $751,000 in 2004. Cash flows provided
by
operating activities in fiscal 2006 were mainly attributable to the net earnings
before items not affecting cash of $16.9 million, less the negative net change
in non-cash operating items of $4.7 million. Our accounts receivable and
our
inventories increased in fiscal 2006, resulting in negative effects on cash
flows of $2.6 million and $2.3 million, respectively. The increase in sales
year-over-year explains the increase in accounts receivable. Also, larger
sales
activities in fiscal 2006 resulted in higher inventory levels in 2006 in
order
to sustain these increased sales activities.
Cash
flows provided by operating activities in fiscal 2005 were mainly attributable
to the net earnings before items not affecting cash of $9.1 million and the
positive net change in non-cash operating items of $4.9 million. This net
change
in non-cash operating items is mainly due to the decrease of $6.1 million
in our
income taxes and tax credits recoverable following the recovery, during that
year, of income taxes and tax credits from previous periods. On the other
hand,
our accounts receivable and our inventories increased by $838,000 and $699,000,
respectively. The increase in our accounts receivable is related to the increase
in sales year-over-year. Our inventories slightly increased despite the
significant rise in sales due to tight inventory management.
Investing
Activities
Cash
flows used by investing activities were $13.2 million in fiscal 2006, compared
to $13.0 million in 2005 and $29.7 million in 2004.
In
fiscal
2006, we made cash payments of $18.1 million and $3.4 million for the
acquisition of Consultronics and the purchase of property, plant and equipment,
respectively. In order to finance a part of these payments, we disposed of
$8.2
million worth of short-term investments. We paid the remaining with cash
flows
from operating activities and cash on-hand.
In
fiscal
2005, we acquired $11.5 million worth of short-term investments with cash
flows
from operating activities and cash on-hand and paid $1.5 million for the
purchase of property, plant and equipment as well as intangible
assets.
Forward
Exchange Contracts
We
utilize forward exchange contracts to manage our foreign currency exposure.
Our
policy is not to utilize those derivative financial instruments for trading
or
speculative purposes.
Our
forward exchange contracts, which are used to hedge anticipated
US-dollar-denominated sales, qualify for hedge accounting; therefore, foreign
exchange translation gains and losses on these contracts are recognized as
an
adjustment of the revenues when the corresponding sales are
recorded.
As
at
August 31, 2006, we held forward exchange contracts to sell US dollars at
various forward rates, which are summarized as follows:
|
Expiry
dates
|
Contractual
amounts
|
Weighted
average
contractual
forward
rates
|
|||||
|
September
2006 to August 2007
|
$
|
37,000,000
|
1.1676
|
||||
|
September
2007 to June 2009
|
26,800,000
|
1.1261
|
|||||
As
at
August 31, 2006, the fair value of our forward exchange contracts, which
represents the difference between their contractual amounts and their current
trading value, amounted to an unrecognized gain of $5.5 million ($2.9 million
as
at August 31, 2005).
Contingency
As
discussed in note 12 to our consolidated financial statements, EXFO was named
as
a defendant in a U.S. securities class action related to its initial public
offering (IPO) in June 2000. The complaints allege that the prospectus and
the
registration statement for the IPO failed to disclose that the underwriters
allegedly received excessive commissions and that the underwriters and some
investors collaborated in order to inflate the price of EXFO’s stock in the
after-market.
In
June
2003, a committee of the EXFO’s Board of Directors conditionally approved a
proposed settlement between the issuer defendants, the individual defendants,
and the plaintiffs. If approved, the settlement would provide, among other
things, a release of EXFO and of the individual defendants for the conduct
alleged in the action to be wrongful in the amended complaint. EXFO would
agree
to undertake other responsibilities under the settlement, including agreeing
to
assign away, not assert, or release certain potential claims EXFO may have
against its underwriters. Any direct financial impact of the proposed settlement
is expected to be borne by EXFO’s insurance carriers.
On
June
25, 2004, the Plaintiffs moved for preliminary approval of the settlement.
The
court granted the preliminary approval motion on February 15, 2005, subject
to
certain modifications. On August 31, 2005, the court issued a preliminary
order
further approving the modifications to the settlement and certifying the
settlement classes. The court also appointed the Notice Administrator for
the
settlement and ordered that notice of the settlement be distributed to all
settlement class members beginning on November 15, 2005. A settlement fairness
hearing was held on April 24, 2006; however, no ruling has been issued yet
by
the court. If the court determines that the settlement is fair to the class
members, the settlement will be approved. The settlement provides that, if
the
plaintiffs do not obtain any recovery from the underwriter defendants, the
members of the class action would receive an amount not expected to exceed
$2,507,678. Any direct financial impact plus any legal fees are expected
to be
borne by EXFO’s insurance carriers. However, there can be no assurance that this
proposed settlement would be approved and implemented in its current form,
or at
all. Therefore, it is not possible to predict the final outcome of the case,
nor
to determine the amount of any possible losses. If the settlement process
fails,
EXFO will continue to defend its position in this litigation that the claims
against it, and its officers, are without merit. Accordingly, no provision
for
this case has been made in the consolidated financial statements as at August
31, 2006.
Share
Capital and Stock-Based Compensation Plans
Share
Capital
As
at
November 1, 2006, EXFO had 37,143,000 multiple voting shares outstanding,
entitling to 10 votes each and 31,632,857 subordinate voting shares outstanding.
The multiple voting shares and the subordinate voting shares are unlimited
as to
number and without par value.
Long-Term
Incentive Plan and Deferred Share Unit Plan
The
aggregate number of subordinate voting shares covered by stock options,
restricted share units (RSUs) and deferred share units (DSUs) granted under
the
Long-Term Incentive Plan and the Deferred Share Unit Plan was 2,882,369 as
at
November 1, 2006. The maximum number of subordinate voting shares issuable
under
these two plans cannot exceed 6,306,153 shares. The following tables summarize
information about stock options, RSUs and DSUs granted to the members of
the
Board of Directors and to Management and Corporate Officers of the company
and
its subsidiaries as at November 1, 2006:
|
Stock
Options
|
Number
|
%
of issued and outstanding
|
Weighted
average exercise price
|
|||||||
|
Chairman
of the Board, President and CEO (one individual)
|
179,642
|
7
|
%
|
$
|
9.05
|
|||||
|
Board
of Directors (five individuals)
|
194,375
|
8
|
%
|
$
|
6.23
|
|||||
|
Management
and Corporate Officers (eight individuals)
|
313,836
|
13
|
%
|
$
|
15.42
|
|||||
|
687,853
|
28
|
%
|
$
|
11.16
|
||||||
|
Restricted
Share Units (RSUs)
|
Number
|
%
of issued and outstanding
|
|||||
|
Chairman
of the Board, President and CEO (one individual)
|
59,913
|
14
|
%
|
||||
|
Management
and Corporate Officers (ten individuals)
|
255,616
|
60
|
%
|
||||
|
315,529
|
74
|
%
|
|||||
|
Deferred
Share Units (DSUs)
|
Number
|
%
of issued and outstanding
|
|||||
|
Board
of Directors (five individuals)
|
43,290
|
100
|
%
|
||||
Off-Balance
Sheet Arrangements
As
at
August 31, 2006, our off-balance sheet arrangements consisted of letters
of
guarantee and forward exchange contracts. These off-balance sheet arrangements
are respectively described in detail in note 12 and 18 to our consolidated
financial statements, included elsewhere in this Annual Report.
Variable
Interest Entity
As
of
August 31, 2006, we did not have interests in any variable interest
entities.
Risks
and Uncertainties
Over
the
past few years, we have managed our business in a difficult environment;
focused
on research and development programs for new and innovative products aimed
at
expected growth pockets in our sector; continued the development of our domestic
and international markets; and made strategic acquisitions. However, we operate
in a highly competitive sector that is in constant evolution and, as a result,
we encounter various risks and uncertainties that must be given appropriate
consideration in our strategic management policies.
We
are
exposed to currency risks due to the export of our Canadianmanufactured
products, the large majority of which are denominated in US dollars. These
risks
are partially hedged by operating expenses denominated in US dollars, the
purchase of raw materials in US dollars and forward exchange contracts. The
increased strength of the Canadian dollar, compared to the US dollar, over
the
last two years caused our operating expenses and our foreign exchange loss
to
increase. Any further increase in the value of the Canadian dollar in the
coming
months would negatively affect our results of operations.
In
addition, risks and uncertainties related to the telecommunications test
and
measurement industry involve the rapid development of new products that may
have
short life cycles and require extensive research and development; the difficulty
of adequately predicting market size and trends; the difficulty of retaining
highly skilled employees; and the ability to quickly adapt our cost structure
to
changing market conditions in order to achieve profitability.
Furthermore,
given our strategic goals for growth and competitive positioning in our
industry, we are continuously expanding into international markets. This
exposes
us to certain risks and uncertainties related to changes in local laws and
regulations, multiple technological standards, protective legislation and
pricing pressure.
Also,
while strategic acquisitions, like those we have made in the past, the recent
acquisition of Consultronics and possibly others in the future, are essential
to
our long-term growth, they also expose us to certain risks and uncertainties
related to the rapid and effective integration of these businesses as well
as
their products, technologies and personnel. Finally, integration requires
the
dedication of management resources, which may detract their attention from
our
day-to-day business and operations.
The
economic environment of our industry could also result in some of our customers
experiencing difficulties and, consequently, this could have a negative effect
on our results especially in terms of future sales and recoverability of
accounts receivable. However, the sectorial and geographic diversity of our
customer base provides us with a reasonable level of protection in this area.
Finally, other financial instruments, which potentially subject us to credit
risks, consist mainly of cash, short-term investments and forward exchange
contracts. Our short-term investments consist of debt instruments issued
by nine
quality high-credit corporations and trusts. Our cash and forward exchange
contracts are held with or issued by quality high-credit financial institutions;
therefore, we consider the risk of non-performance on these instruments to
be
remote.
For
a
more complete understanding of risk factors that may affect us, please refer
to
the risk factors set forth in our disclosure documents published with securities
commissions at www.sedar.com in Canada or www.edgar.com in the U.S.
Quarterly
Summary Financial Information (unaudited)
(tabular
amounts in thousands of US dollars, except per share data)
|
1st
quarter
|
2nd
quarter
|
3rd
quarter
|
4th
quarter
|
Years
ended August 31,
|
||||||||||||
|
2006
|
||||||||||||||||
|
Sales
|
$
|
27,044
|
$
|
30,066
|
$
|
35,410
|
$
|
35,733
|
$
|
128,253
|
||||||
|
Cost
of sales
|
$
|
12,064
|
$
|
13,440
|
$
|
15,453
|
$
|
16,318
|
$
|
57,275
|
||||||
|
Gross
margin
|
$
|
14,980
|
$
|
16,626
|
$
|
19,957
|
$
|
19,415
|
$
|
70,978
|
||||||
|
Earnings
from operations
|
$
|
683
|
$
|
1,408
|
$
|
3,608
|
$
|
2,363
|
$
|
8,062
|
||||||
|
Net
earnings
|
$
|
355
|
$
|
1,366
|
$
|
3,504
|
$
|
2,910
|
$
|
8,135
|
||||||
|
Basic
and diluted net earnings per share
|
$
|
0.01
|
$
|
0.02
|
$
|
0.05
|
$
|
0.04
|
$
|
0.12
|
||||||
|
2005
|
||||||||||||||||
|
Sales
|
$
|
21,597
|
$
|
23,135
|
$
|
26,180
|
$
|
26,304
|
$
|
97,216
|
||||||
|
Cost
of sales
|
$
|
10,225
|
$
|
10,431
|
$
|
11,478
|
$
|
11,925
|
$
|
44,059
|
||||||
|
Gross
margin
|
$
|
11,372
|
$
|
12,704
|
$
|
14,702
|
$
|
14,379
|
$
|
53,157
|
||||||
|
Earnings
(loss) from operations
|
$
|
(1,337
|
)
|
$
|
(182
|
)
|
$
|
509
|
$
|
811
|
$
|
(199
|
)
|
|||
|
Net
earnings (loss)
|
$
|
(2,373
|
)
|
$
|
9
|
$
|
276
|
$
|
454
|
$
|
(1,634
|
)
|
||||
|
Basic
and diluted net earnings (loss) per share
|
$
|
(0.03
|
)
|
$
|
—
|
$
|
—
|
$
|
0.01
|
$
|
(0.02
|
)
|
||||
|
2004
|
||||||||||||||||
|
Sales
|
$
|
15,962
|
$
|
16,880
|
$
|
20,456
|
$
|
21,332
|
$
|
74,630
|
||||||
|
Cost
of sales
|
$
|
7,815
|
$
|
7,528
|
$
|
9,637
|
$
|
9,576
|
$
|
34,556
|
||||||
|
Gross
margin
|
$
|
8,147
|
$
|
9,352
|
$
|
10,819
|
$
|
11,756
|
$
|
40,074
|
||||||
|
Loss
from operations
|
$
|
(3,145
|
)
|
$
|
(3,485
|
)
|
$
|
(1,888
|
)
|
$
|
(2,052
|
)
|
$
|
(10,570
|
)
|
|
|
Net
loss
|
$
|
(2,008
|
)
|
$
|
(2,885
|
)
|
$
|
(1,188
|
)
|
$
|
(2,343
|
)
|
$
|
(8,424
|
)
|
|
|
Basic
and diluted net loss per share (1)
|
$
|
(0.03
|
)
|
$
|
(0.04
|
)
|
$
|
(0.02
|
)
|
$
|
(0.03
|
)
|
$
|
(0.13
|
)
|
|
|
(1)
|
Per
share data is calculated independently for each of the quarters
presented.
Therefore, the sum of this quarterly information does not equal
the
corresponding annual information.
|
Fourth-Quarter
Results
In
the
fourth quarter of fiscal 2006, sales were $35.7 million, compared to $26.3
million for the same period last year. In fiscal 2006, we leveraged our
portfolio of new products and an increased demand for our test solutions
especially in Europe, Middle East and Africa (EMEA) and Asia- Pacific (APAC)
to
increase our year-over-year sales. We also consolidated our dominant FTTx
market
position in the Americas by enabling a Tier-1 carrier to migrate to less
expensive test solutions. In addition, the positive spending environment,
as
well as the market share we believe that we gained in fiscal 2006 for our
optical and protocol products, helped us increase our sales year-over-year.
In
fact, during the second half of fiscal 2006, sales of our protocol products
increased substantially year-overyear, making this sector our fastest-growing
line of business in 2006. Furthermore, Consultronics, which we acquired in
January 2006, contributed to our increase in sales during the second half
of
fiscal 2006, compared to the same period last year. Finally, we gained market
share in the fluorescence illumination market in fiscal 2006 and we increased
our sales activities in the curing market year-over-year.
In
the
fourth quarter of fiscal 2006, gross margin amounted to 54.3% of global sales,
compared to 54.7% for the same period last year. Despite significant increase
in
sales year-over-year, gross margin decreased 40 basis points due to increased
pricing pressure in fiscal 2006; one-time charges related to the integration
of
Consultronics manufacturing activities incurred in the fourth quarter of
2006; a
different customer mix; and the increased strength of the Canadian dollar,
compared to the US dollar, yearover- year.
In
the
fourth quarter of fiscal 2006, earnings from operations were $2.4 million,
compared to $811,000 for the same period last year. Net earnings amounted
to
$2.9 million, or $0.04 per diluted share, in the fourth quarter of fiscal
2006,
compared to $454,000, or $0.01 per diluted share, for the same period last
year.
Management’s
Reports
Responsibility
for Financial Information
EXFO
management is responsible for the preparation, integrity and objectivity
of the
consolidated financial statements and other financial information presented
in
this Annual Report. These consolidated financial statements have been prepared
in accordance with Canadian generally accepted accounting principles and
include
some amounts that are based on estimates and judgments. Management has
determined such amounts on a reasonable basis in order to ensure that the
financial statements are presented fairly in all material respects.
EXFO’s
policy is to maintain systems of internal accounting, and administrative
and
disclosure controls — reinforced by standards of conduct and ethics set out in
written policies — to provide reasonable assurance that the financial
information is relevant, accurate and reliable, and that assets are
appropriately accounted for and adequately safeguarded.
The
Board
of Directors is responsible for ensuring that management fulfills its
responsibilities for financial reporting and is ultimately responsible for
reviewing and approving the financial statements. The Board carries out this
responsibility principally through its Audit Committee. The Audit Committee
is
appointed by the Board and is composed of independent outside directors.
The
Committee meets periodically with management and external auditors to review
accounting, auditing and internal control matters. These consolidated financial
statements have been reviewed and approved by the Board of Directors
on the recommendation of the Audit Committee.
The
consolidated financial statements have been audited by PricewaterhouseCoopers
LLP, the external auditors, in accordance with the Canadian generally accepted
auditing standards and the standards of the Public Company Accounting Oversight
Board (United States) on behalf of the shareholders. The external auditors
have
full and free access to the Audit Committee.
Internal
Control over Financial Reporting
EXFO
management is responsible for establishing and maintaining adequate internal
control over financial reporting. EXFO’s internal control over financial
reporting is a process designed to provide reasonable assurance regarding
the
reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with accounting principles generally
accepted in Canada.
EXFO’s
internal control over financial reporting includes those policies and procedures
that (i) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets
of
EXFO; (ii) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with
accounting principles generally accepted in Canada, and that receipts and
expenditures of the company are being made only in accordance with
authorizations of management and directors of EXFO; and (iii) provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition,
use, or disposition of EXFO’s assets that could have a material effect on the
financial statements.
Because
of its inherent limitations, internal control over financial reporting may
not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may
become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
The
recent acquisition of Consultronics has been excluded from management’s
assessment of internal controls as at August 31, 2006, because it was acquired
by the company on January 26, 2006, and it was not possible for management
to
conduct an assessment of Consultronics’ internal control over financial
reporting in the period between the consummation date and the date of
management’s assessment. The acquired business of Consultronics represented less
than 10% of the company’s total consolidated assets and revenues as at and for
the year ended August 31, 2006.
Management
conducted an evaluation of the effectiveness of EXFO’s internal control over
financial reporting based on the criteria established in Internal
Control-Integrated Framework issued
by
the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Based on this evaluation, management concluded that EXFO’s internal control over
financial reporting was effective as at August 31, 2006.
|
Germain
Lamonde
|
Pierre
Plamondon, CA
|
|
|
Chairman,
President and CEO
|
Vice-President,
Finance and Chief Financial
Officer
|
Report
of Independent Auditors
To
the Shareholders of
EXFO
Electro-Optical Engineering Inc.
We
have
audited the consolidated balance sheets of EXFO
Electro-Optical Engineering Inc.
as at
August 31, 2006 and 2005 and the consolidated statements of earnings, deficit
and contributed surplus and cash flows for each of the years in the three-year
period ended August 31, 2006. These financial statements are the responsibility
of the Company’s management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We
conducted our audits in accordance with Canadian generally accepted auditing
standards and the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform an audit
to
obtain reasonable assurance whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation.
In
our
opinion, these consolidated financial statements present fairly, in all material
respects, the financial position of the company as at August 31, 2006 and
2005
and the results of its operations and its cash flows for each of the years
in
the three-year period ended August 31, 2006 in accordance with Canadian
generally accepted accounting principles.
Chartered
Accountants
Quebec,
Quebec, Canada
October
25, 2006
Consolidated
Balance Sheets
(in
thousands of US dollars)
The
accompanying notes are an integral part of these consolidated financial
statements.
|
As
at August 31,
|
2006
|
2005
|
|||||
|
Assets
|
|||||||
|
Current
assets
|
|||||||
|
Cash
|
$
|
6,853
|
$
|
7,119
|
|||
|
Short-term
investments (notes 8 and 18)
|
104,437
|
104,883
|
|||||
|
Accounts
receivable (notes 8 and 18)
|
|||||||
|
Trade
|
20,891
|
13,945
|
|||||
|
Other
(note 4)
|
2,792
|
2,007
|
|||||
|
Income
taxes and tax credits recoverable (note 8)
|
2,201
|
2,392
|
|||||
|
Inventories
(notes 5 and 8)
|
24,623
|
17,749
|
|||||
|
Prepaid
expenses
|
1,404
|
1,112
|
|||||
|
163,201
|
149,207
|
||||||
|
Income
taxes recoverable
|
476
|
459
|
|||||
|
Property,
plant and equipment (notes
4, 6 and 8)
|
17,392
|
13,719
|
|||||
|
Long-lived
asset held for sale (note
4)
|
—
|
1,600
|
|||||
|
Intangible
assets (notes
7 and 8)
|
10,948
|
5,602
|
|||||
|
Goodwill
(note
7)
|
27,142
|
20,370
|
|||||
|
$
|
219,159
|
$
|
190,957
|
||||
|
Liabilities
|
|||||||
|
Current
liabilities
|
|||||||
|
Accounts
payable and accrued liabilities (note 9)
|
$
|
17,337
|
$
|
12,201
|
|||
|
Deferred
revenue
|
1,772
|
1,584
|
|||||
|
Current
portion of long-term debt
|
107
|
134
|
|||||
|
19,216
|
13,919
|
||||||
|
Deferred
revenue
|
2,632
|
1,568
|
|||||
|
Government
grants (note
15)
|
723
|
1,872
|
|||||
|
Long-term
debt (note
10)
|
354
|
198
|
|||||
|
22,925
|
17,557
|
||||||
|
Commitments
(note
11)
|
|||||||
|
Contingencies
(note
12)
|
|||||||
|
Shareholders’
Equity
|
|||||||
|
Share
capital (note 13)
|
148,921
|
521,875
|
|||||
|
Contributed
surplus
|
3,776
|
2,949
|
|||||
|
Deficit
(note 13)
|
—
|
(381,846
|
)
|
||||
|
Cumulative
translation adjustment
|
43,537
|
30,422
|
|||||
|
196,234
|
173,400
|
||||||
|
$
|
219,159
|
$
|
190,957
|
||||
|
On
behalf of the Board
|
Germain
Lamonde
|
André
Tremblay
|
|
|
Chairman,
President and CEO
|
Chairman,
Audit Committee
|
Consolidated
Statements of Earnings
(in
thousands of US dollars, except share and per share data)
The
accompanying notes are an integral part of these consolidated financial
statements.
|
Years
ended August 31,
|
2006
|
2005
|
2004
|
|||||||
|
Sales
(note
19)
|
$
|
128,253
|
$
|
97,216
|
$
|
74,630
|
||||
|
Cost
of sales (1,2)
|
57,275
|
44,059
|
34,556
|
|||||||
|
Gross
margin
|
70,978
|
53,157
|
40,074
|
|||||||
|
Operating
expenses
|
||||||||||
|
Selling
and administrative (1)
|
40,298
|
31,782
|
25,890
|
|||||||
|
Net
research and development (1)
(note
15)
|
15,404
|
12,190
|
12,390
|
|||||||
|
Amortization
of property, plant and equipment
|
3,523
|
4,256
|
4,935
|
|||||||
|
Amortization
of intangible assets
|
4,394
|
4,836
|
5,080
|
|||||||
|
Impairment
of long-lived assets (note 4)
|
604
|
—
|
620
|
|||||||
|
Government
grants (note 15)
|
(1,307
|
)
|
—
|
—
|
||||||
|
Restructuring
and other charges (note 4)
|
—
|
292
|
1,729
|
|||||||
|
Total
operating expenses
|
62,916
|
53,356
|
50,644
|
|||||||
|
Earnings
(loss) from operations
|
8,062
|
(199
|
)
|
(10,570
|
)
|
|||||
|
Interest
and other income
|
3,253
|
2,524
|
1,438
|
|||||||
|
Foreign
exchange loss
|
(595
|
)
|
(1,336
|
)
|
(278
|
)
|
||||
|
Earnings
(loss) before income taxes (note
16)
|
10,720
|
989
|
(9,410
|
)
|
||||||
|
Income
taxes (note
16)
|
2,585
|
2,623
|
(986
|
)
|
||||||
|
Net
earnings (loss) for the year
|
$
|
8,135
|
$
|
(1,634
|
)
|
$
|
(8,424
|
)
|
||
|
Basic
and diluted net earnings (loss) per share
|
$
|
0.12
|
$
|
(0.02
|
)
|
$
|
(0.13
|
)
|
||
|
Basic
weighted average number of shares outstanding
(000’s)
|
68,643
|
68,526
|
66,020
|
|||||||
|
Diluted
weighted average number of shares outstanding (000’s)
(note
17)
|
69,275
|
68,981
|
66,615
|
|||||||
|
(1)
Stock-based
compensation costs included in:
|
||||||||||
|
Cost
of sales
|
$
|
127
|
$
|
143
|
$
|
62
|
||||
|
Selling
and administrative
|
701
|
626
|
265
|
|||||||
|
Net
research and development
|
204
|
194
|
122
|
|||||||
|
$
|
1,032
|
$
|
963
|
$
|
449
|
|||||
|
(2)
|
The
cost of sales is exclusive of amortization, shown
separately.
|
Consolidated
Statements of Deficit and Contributed Surplus
(in
thousands of US dollars)
The
accompanying notes are an integral part of these consolidated financial
statements.
|
Deficit
|
||||||||||
|
Years
ended August 31,
|
2006
|
2005
|
2004
|
|||||||
|
Balance
- Beginning of year
|
$
|
(381,846
|
)
|
$
|
(380,212
|
)
|
$
|
(371,788
|
)
|
|
|
Deduct
(add)
|
||||||||||
|
Net
earnings (loss) for the year
|
8,135
|
(1,634
|
)
|
(8,424
|
)
|
|||||
|
Elimination
of deficit by reduction of share capital (note 13)
|
373,711
|
-
|
-
|
|||||||
|
Balance
- End of year
|
$
|
-
|
$
|
(381,846
|
)
|
$
|
(380,212
|
)
|
||
|
Contributed
surplus
|
||||||||||
|
Years
ended August 31,
|
2006
|
2005
|
2004
|
|||||||
|
Balance
- Beginning of year
|
$
|
2,949
|
$
|
1,986
|
$
|
1,519
|
||||
|
Add
(deduct)
|
||||||||||
|
Stock-based
compensation costs
|
1,027
|
963
|
449
|
|||||||
|
Reclassification
of stock-based compensation costs to share capital upon exercise
of stock
awards (note 13)
|
(200
|
)
|
-
|
-
|
||||||
|
Premium
on resale of share capital
|
-
|
-
|
18
|
|||||||
|
Balance
- End of year
|
$
|
3,776
|
$
|
2,949
|
$
|
1,986
|
||||
Consolidated
Statements of Cash Flows
(in
thousands of US dollars)
The
accompanying notes are an integral part of these consolidated financial
statements.
|
Years
ended August 31,
|
2006
|
|
2005
|
|
2004
|
|||||
|
Cash
flows from operating activities
|
||||||||||
|
Net
earnings (loss) for the year
|
$
|
8,135
|
$
|
(1,634
|
)
|
$
|
(8,424
|
)
|
||
|
Add
(deduct) items not affecting cash
|
||||||||||
|
Discount
on short-term investments
|
(229
|
)
|
(302
|
)
|
197
|
|||||
|
Stock-based
compensation costs
|
1,032
|
963
|
449
|
|||||||
|
Amortization
|
7,917
|
9,092
|
10,015
|
|||||||
|
Impairment
of long-lived assets
|
604
|
-
|
620
|
|||||||
|
Restructuring
and other charges
|
-
|
-
|
1,261
|
|||||||
|
Government
grants
|
(1,307
|
)
|
-
|
154
|
||||||
|
Deferred
revenue
|
786
|
977
|
1,404
|
|||||||
|
16,938
|
9,096
|
5,676
|
||||||||
|
Change
in non-cash operating items
|
||||||||||
|
Accounts
receivable
|
(2,637
|
)
|
(838
|
)
|
(2,677
|
)
|
||||
|
Income
taxes and tax credits
|
329
|
6,096
|
(2,464
|
)
|
||||||
|
Inventories
|
(2,287
|
)
|
(699
|
)
|
1,016
|
|||||
|
Prepaid
expenses
|
79
|
544
|
(449
|
)
|
||||||
|
Accounts
payable and accrued liabilities
|
(144
|
)
|
(164
|
)
|
(351
|
)
|
||||
|
12,278
|
14,035
|
751
|
||||||||
|
Cash
flows from investing activities
|
||||||||||
|
Additions
to short-term investments
|
(673,289
|
)
|
(585,665
|
)
|
(653,348
|
)
|
||||
|
Proceeds
from disposal and maturity of short-term investments
|
681,500
|
574,207
|
624,722
|
|||||||
|
Additions
to property, plant and equipment and intangible assets
|
(3,378
|
)
|
(1,501
|
)
|
(851
|
)
|
||||
|
Business
combinations, net of cash acquired
|
(18,054
|
)
|
-
|
(241
|
)
|
|||||
|
(13,221
|
)
|
(12,959
|
)
|
(29,718
|
)
|
|||||
|
Cash
flows from financing activities
|
||||||||||
|
Repayment
of long-term debt
|
(415
|
)
|
(121
|
)
|
(109
|
)
|
||||
|
Net
proceeds of offering (note 13)
|
-
|
-
|
29,164
|
|||||||
|
Exercise
of stock options
|
557
|
148
|
254
|
|||||||
|
Share
issue expenses
|
-
|
(6
|
)
|
(137
|
)
|
|||||
|
Redemption
of share capital
|
-
|
-
|
(5
|
)
|
||||||
|
Resale
of share capital
|
-
|
-
|
23
|
|||||||
|
142
|
21
|
29,190
|
||||||||
|
Effect
of foreign exchange rate changes on cash
|
535
|
863
|
(430
|
)
|
||||||
|
Change
in cash
|
(266
|
)
|
1,960
|
(207
|
)
|
|||||
|
Cash
- Beginning of year
|
7,119
|
5,159
|
5,366
|
|||||||
|
Cash
- End of year
|
$
|
6,853
|
$
|
7,119
|
$
|
5,159
|
||||
|
Supplementary
information
|
||||||||||
|
Interest
paid
|
$
|
65
|
$
|
30
|
$
|
408
|
||||
|
Income
taxes paid (recovered)
|
$
|
2,541
|
$
|
(669
|
)
|
$
|
120
|
|||
(tabular
amounts in thousands of US dollars, except share and per share data and as
otherwise noted)
| 1. |
Nature
of Activities
|
EXFO
Electro-Optical Engineering Inc. (“EXFO”) designs, manufactures and markets a
comprehensive line of test and measurement solutions for the global
telecommunications industry. The Telecom Division, which represents the
company’s main business activity, offers integrated test solutions to network
service providers, cable TV operators, system vendors and optical component
manufacturers. The Life Sciences and Industrial Division mainly leverages
core
telecom technologies to offer value-added solutions for life sciences
applications and high-precision assembly processes, such as those required
for
microelectronics, optoelectronics and medical devices. EXFO’s products are sold
in approximately 70 countries around the world.
| 2. |
Summary
of Significant Accounting
Policies
|
Basis
of presentation
These
consolidated financial statements have been prepared in accordance with
generally accepted accounting principles (“GAAP”) in Canada and significant
differences in measurement and disclosure from U.S. GAAP are set out in note
20.
These consolidated financial statements include the accounts of the company
and
its domestic and international subsidiaries. All significant intercompany
accounts and transactions have been eliminated.
Accounting
estimates
The
preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions
that
affect the reported amounts of assets and liabilities and the disclosures
of
contingent assets and liabilities at the date of the financial statements,
as
well as the reported amounts of revenues and expenses during the reporting
years. Significant estimates include the allowance for doubtful accounts
receivable, the amount of tax credits recoverable, the provision for excess
and
obsolete inventories, the useful lives of capital assets, the valuation of
long-lived assets, the future income taxes valuation allowance, the amount
of
certain accrued liabilities and deferred revenue as well as stock-based
compensation costs. Actual results could differ from those
estimates.
Reporting
currency
The
measurement currency of the company is the Canadian dollar. The company has
adopted the US dollar as its reporting currency. The financial statements
are
translated into the reporting currency using the current rate method. Under
this
method, the financial statements are translated into the reporting currency
as
follows: assets and liabilities are translated at the exchange rate in effect
on
the date of the balance sheet, while revenues and expenses are translated
at the
monthly average exchange rate. Foreign exchange gains and losses arising
from
such translation are included in the cumulative translation adjustment in
shareholders’ equity.
In
the
event that management decides to declare dividends, such dividends would
be
declared in Canadian dollars.
Foreign
currency translation
Foreign
currency transactions
Transactions
denominated in currencies other than the measurement currency are translated
into the measurement currency as follows: monetary assets and liabilities
are
translated at the exchange rate in effect on the date of the balance sheet,
and
revenues and expenses are translated at the exchange rate in effect on the
date
of the transaction. Non-monetary assets and liabilities are translated at
historical rates. Foreign exchange gains and losses arising from such
translation are reflected in the statements of earnings.
Foreign
subsidiaries
The
financial statements of integrated foreign operations are remeasured into
the
measurement currency using the temporal method. Under this method, monetary
assets and liabilities are remeasured at the exchange rate in effect on the
date
of the balance sheet. Non-monetary assets and liabilities are remeasured
at
historical rates, unless such assets and liabilities are carried at market,
in
which case, they are remeasured at the exchange rate in effect on the date
of
the balance sheet. Revenues and expenses are remeasured at the monthly average
exchange rate. Foreign exchange gains and losses arising from such remeasurement
are reflected in the statements of earnings. The company has no selfsustaining
foreign subsidiary for which the functional currency is not the US
dollar.
Forward
exchange contracts
Forward
exchange contracts are utilized by the company to manage its foreign currency
exposure. The company’s policy is not to utilize those derivative financial
instruments for trading or speculative purposes.
The
company’s forward exchange contracts, which are used to hedge anticipated
US-dollar-denominated sales, qualify for hedge accounting; therefore, foreign
exchange translation gains and losses on these contracts are recognized as
an
adjustment of the revenues when the corresponding hedged sales are
recorded.
Realized
and unrealized foreign exchange gains or losses associated with forward exchange
contracts, which have been terminated or cease to be effective prior to
maturity, are deferred in the balance sheet and recognized in the earnings
of
the period in which the underlying hedged transaction is
recognized.
Short-term
investments
Short-term
investments are valued at the lower of cost and market value. Cost consists
of
acquisition cost plus amortization of discount or less amortization of premium.
All investments with original maturity of three months or less and that are
not
required for the purposes of meeting short-term cash requirements are classified
as short-term investments.
Inventories
Inventories
are valued on an average cost basis, at the lower of cost and replacement
cost
for raw materials and at the lower of cost and net realizable value for work
in
progress and finished goods.
Property,
plant and equipment and amortization
Property,
plant and equipment are recorded at cost less related government grants and
research and development tax credits. Amortization is provided on a
straight-line basis over the estimated useful lives as follows:
|
Term
|
|
|
Land
improvements
|
5
years
|
|
Buildings
|
25
years
|
|
Equipment
|
2
to 10 years
|
|
Leasehold
improvements
|
The
lesser of useful life and remaining lease
term
|
Intangible
assets, goodwill and amortization
Intangible
assets primarily include the cost of core technology and software, net of
accumulated amortization. Core technology represents the existing technology
acquired in business combinations that has reached technological feasibility.
Amortization is provided on a straightline basis over the estimated useful
lives
of five years for core technology and four and ten years for
software.
Goodwill
represents the excess of the purchase price of acquired businesses over the
estimated fair value of net identifiable assets acquired. Goodwill is not
amortized but must be tested for impairment on an annual basis or more
frequently if events or circumstances indicate that it might be impaired.
Recoverability of goodwill is determined at the reporting unit level using
a
two-step approach. First, the carrying value of a reporting unit is compared
to
its fair value, which is determined based on a combination of discounted
future
cash flows and a market approach. If the carrying value of a reporting unit
exceeds its fair value, the second step is performed. In this step, the amount
of impairment loss, if any, represents the excess of the carrying value of
goodwill over its fair value and the loss is charged to earnings in the period
in which it is incurred. For the purposes of this impairment test, the fair
value of goodwill is estimated in the same way as goodwill is determined
in
business combinations; that is, the excess of the fair value of a reporting
unit
over the estimated fair value of its net identifiable assets.
The
company elected to perform its annual impairment test in May of each fiscal
year
for all its existing reporting units.
Impairment
of long-lived assets
Long-lived
assets are reviewed for impairment when events or circumstances indicate
that
cost may not be recoverable. Impairment exists when the carrying value of
an
asset or group of assets is greater than the undiscounted future cash flows
expected to be provided by the asset or group of assets. The amount of
impairment loss, if any, is the excess of the carrying value over the fair
value. The company assesses fair value of long-lived assets based on discounted
future cash flows.
Warranty
The
company offers its customers warranties of one to three years, depending
on the
specific products and terms of the purchase agreement. The company’s typical
warranties require it to repair or replace defective products during the
warranty period at no cost to the customer. Costs related to original warranties
are accrued at the time of shipment, based upon estimates of expected rework
and
warranty costs to be incurred. Costs associated with separately priced extended
warranties are expensed as incurred.
Revenue
recognition
For
products in which software is incidental, the company recognizes revenue
when
persuasive evidence of an arrangement exists, the product has been delivered,
the price is fixed and determinable, and collection of the resulting receivable
is reasonably assured. In addition, provisions are made for estimated returns,
warranties and support obligations.
For
products in which software is not incidental, revenues are separated into
two
categories: product and post-contract customer support (PCS) revenues, based
upon vendor-specific objective evidence of fair value. Product revenues for
these sales are recognized as described above. PCS revenues are deferred
and
recognized ratably over the years of the support arrangement. PCS revenues
are
recognized at the time the product is delivered when provided within one
year of
delivery; the costs of providing this support are insignificant (and accrued
at
the time of delivery) and no software upgrades are provided.
For
all
sales, the company uses a binding purchase order as evidence that a sales
arrangement exists.
Delivery
generally occurs when the product is handed over to a transporter for
shipment.
At
the
time of the transaction, the company assesses whether the price associated
with
its revenue transaction is fixed and determinable and whether or not collection
is reasonably assured. The company assesses whether the price is fixed and
determinable based on the payment terms associated with the transaction.
The
company assesses collection based on a number of factors, including past
transaction history and the creditworthiness of the customer. Generally,
collateral or other security is not requested from customers.
Most
sales arrangements do not generally include acceptance clauses. However,
when a
sales arrangement does include an acceptance provision, acceptance occurs
upon
the earliest of receipt of a written customer acceptance or expiration of
the
acceptance period. For these sales arrangements, the sale is recognized when
acceptance occurs.
Revenue
for extended warranties is recognized on a straight-line basis over the warranty
period.
Advertising
costs
Advertising
costs are expensed as incurred.
Government
grants
Grants
related to operating expenses are included in earnings when the related expenses
are incurred. Grants related to capital expenditures are deducted from the
related assets. Grants are included in earnings or deducted from the related
assets, provided there is reasonable assurance that the company has complied
and
will comply with all the conditions related to the grant.
Research
and development expenses
All
expenses related to research, as well as development activities that do not
meet
generally accepted criteria for deferral are expensed as incurred, net of
related tax credits and government grants. Development expenses that meet
generally accepted criteria for deferral, in accordance with the Canadian
Institute of Chartered Accountants (CICA) handbook Section 3450, “Research and
Development”, are capitalized, net of related tax credits and government grants,
and are amortized against earnings over the estimated benefit period. Research
and development expenses are mainly comprised of salaries and related expenses,
material costs as well as fees paid to third-party consultants.
As
at
August 31, 2006, the company had not deferred any development
costs.
Income
taxes
The
company provides for income taxes using the liability method of tax allocation.
Under this method, future income tax assets and liabilities are determined
based
on deductible or taxable temporary differences between financial statement
values and tax values of assets and liabilities, using enacted income tax
rates
for the years in which the differences are expected to reverse.
The
company establishes a valuation allowance against future income tax assets
if,
based on available information, it is more likely than not that some or all
of
the future income tax assets will not be realized. Since 2003, the company
records a full valuation allowance against future
income
tax assets (note 16).
Earnings
per share
Basic
earnings per share are determined using the weighted average number of common
shares outstanding during the year.
Diluted
earnings per share are determined using the weighted average number of common
shares outstanding during the year, plus the effect of dilutive potential
common
shares outstanding during the year. This method requires that diluted earnings
per share be calculated (using the treasury stock method) as if all dilutive
potential common shares had been exercised at the latest at the beginning
of the
year or on the date of issuance, as the case may be, and that the funds obtained
thereby (plus an amount equivalent to the unamortized portion of related
stock-based compensation costs) be used to purchase common shares of the
company
at the average market price of the common shares during the year.
Stock-based
compensation costs
Since
September 1, 2003, the company accounts for all forms of employee stock-based
compensation using the fair value-based method. Stock-based compensation
costs
are amortized to expense over the vesting periods.
Prior
to
fiscal 2004, no stock-based compensation costs were recognized for employee
stock-based compensation. However, the company is required to disclose pro
forma
information with respect to net earnings (loss) and net earnings (loss) per
share as if stock-based compensation costs were recognized in the financial
statements for all reporting years using the fair value-based method for
outstanding stock options granted prior to September 1, 2003 (note
14).
New
accounting standards and pronouncements
In
January 2005, the CICA issued four new accounting standards in relation to
financial instruments: Section 3855, "Financial Instruments - Recognition
and
measurement"; Section 3865, "Hedges"; Section 1530, "Comprehensive Income";
and
Section 3251, "Equity".
Section
3855 expands on Section 3860, "Financial Instruments - Disclosure and
Presentation", by prescribing when a financial instrument is to be recognized
on
the balance sheet and at what amount. It also specifies how financial instrument
gains and losses are to be presented in the financial statements.
Section
3865 provides an alternative to Section 3855 for entities that choose to
designate qualifying transactions as hedges for accounting purposes. It replaces
and expands on Accounting Guideline 13, "Hedging Relationships", and on the
hedging guidance in Section 1650, "Foreign Currency Translation", by specifying
how hedge accounting is applied and what disclosures it requires.
Section
1530, "Comprehensive Income", introduces a new requirement to temporarily
present certain gains and losses outside net income.
Consequently,
Section 3250, "Surplus", has been revised as Section 3251,
"Equity".
Sections
1530, 3251, 3855 and 3865 apply to fiscal years beginning on or after October
1,
2006. The company will adopt these new standards on September 1, 2007. While
the
company is currently assessing the effects of these new standards, impacts
consistent with the adjustments described under note 20 item b) of these
consolidated financial statements are expected.
| 3. |
Business
Combination
|
On
January 26, 2006, the company acquired substantially all the assets of
Consultronics Limited. Based in Toronto, Canada, and with operations in the
United Kingdom and Hungary, Consultronics was a privately held company
specializing in x-Digital Subscriber Line (xDSL), Internet Protocol TV and
Voice-over-Internet Protocol (VoIP) test solutions for broadband access
networks.
This
acquisition was settled for a total cash consideration valued at $19,093,000
or
$18,838,000 net of $255,000 of cash acquired. The total consideration includes
severance expenses of $660,000 for the termination of employees of the acquired
business as well as other acquisition-related costs of $822,000. As at August
31, 2006, a portion of the total consideration, in the amount of $816,000,
was
not yet paid. From this amount, $631,000 is related to severance expenses
and
has been recorded as restructuring charges payable (note 4), while the remainder
of $185,000, relating to acquisition-related costs, has been recorded as
an
account payable related to a business combination (note 9). Severance expenses
will be fully paid in fiscal 2007.
This
acquisition was accounted for using the purchase method and, consequently,
the
results of operations of the acquired business have been included in the
consolidated statement of earnings of the company
since
January 26, 2006; that is being the date of acquisition.
The
purchase price, including acquisition-related costs, was allocated based
on the
estimated fair value of acquired net assets at the date of acquisition as
follows:
|
Assets
acquired
|
||||
|
Current
assets
|
$
|
5,135
|
||
|
Property,
plant and equipment
|
3,115
|
|||
|
Core
technology
|
8,709
|
|||
|
Current
liabilities assumed
|
(2,826
|
)
|
||
|
Loans
assumed
|
(402
|
)
|
||
|
Net
identifiable assets acquired
|
13,731
|
|||
|
Goodwill
|
5,107
|
|||
|
Purchase
price, net of cash acquired
|
$
|
18,838
|
||
Acquired
core technology is amortized on a straight-line basis over its estimated
useful
life of five years.
This
business, including acquired goodwill, reports to the Telecom Division. Acquired
goodwill is deductible for tax purposes.
| 4. |
Special
Charges
|
Impairment
of long-lived assets
Fiscal
2004
In
fiscal
2004, the company put one of its buildings (located in Quebec City) up for
sale
and received, at the beginning of fiscal 2005, a formal purchase offer for
this
building. Based on that offer, the company concluded that the building was
impaired and it recorded an impairment loss of $620,000 in fiscal 2004,
representing the excess of the carrying value of the building over its expected
selling price. However, during the first quarter of fiscal 2005, some conditions
of the formal purchase offer were not met and the offer was declined. During
fiscal 2005, the company withdrew the building from the market and continued
to
use it. This building reported to the Telecom Division.
Fiscal
2006
In
June
2006, the company entered into an agreement to sell its building (located
in
Rochester, NY) along with some equipment and it recorded an impairment charge
of
$604,000 in the third quarter of fiscal 2006, representing the excess of
the
carrying value of these assets over the net expected selling price of
$1,200,000. The sale of these assets was finalized in the fourth quarter
of 2006
for the net expected selling price. This amount is included in the other
receivables in the balance sheet as at August 31, 2006, and it will be recovered
in the first quarter of fiscal 2007. These assets report to the Life Science
and
Industrial Division.
Restructuring
and other charges
Fiscal
2004 and 2005
During
fiscal 2004, the company approved a restructuring plan to consolidate the
operations of its Life Sciences and Industrial Division, transferring its
Rochester, NY, operations mainly to its facilities in Toronto. This
consolidation process, which started in August 2004, was completed during
fiscal
2005.
Overall,
for that process, the company incurred $2,515,000 in restructuring and other
charges, from which $2,033,000 was recorded in fiscal 2004 and the remaining
$482,000 was recorded in 2005. The overall costs, which were recorded in
the
restructuring and other charges in the statements of earnings of the
corresponding years, are detailed as follows: $855,000 for severance expenses
for the layoff of all employees at the Rochester facilities, $1,261,000 mainly
for the impairment of the building in Rochester and the remaining $399,000
for
other expenses such as training and recruiting expenses and transfer of
assets.
Finally,
in fiscal 2005 and 2004, the company recorded adjustments of $190,000 and
$304,000, respectively, to the fiscal 2003 and 2001 plans because actual
charges, mainly for leased equipment, were lower than expected.
The
following tables summarize changes in the restructuring charges payable since
August 31, 2003:
|
Year
ended August 31, 2006
|
||||||||||||||||
|
Balance
as at
August
31,
2005
|
Additions
|
Payments
|
Adjustments
|
Balance
as at
August
31,
2006
|
||||||||||||
| Fiscal 2006 plan (note 3) | ||||||||||||||||
|
Severance
expenses
|
$
|
—
|
$
|
660
|
$
|
(29
|
)
|
$
|
—
|
$
|
631
|
|||||
| Fiscal 2003 plan | ||||||||||||||||
|
Exited
leased facilities
|
150
|
—
|
(90
|
)
|
—
|
60
|
||||||||||
|
Total
for all plans (note 9)
|
$
|
150
|
$
|
660
|
$
|
(119
|
)
|
$
|
—
|
$
|
691
|
|||||
|
Year
ended August 31, 2005
|
||||||||||||||||
|
Balance
as at
August
31,
2004
|
Additions
|
Payments
|
Adjustments
|
Balance
as at
August
31,
2005
|
||||||||||||
|
Fiscal
2004 plan
|
||||||||||||||||
|
Severance
expenses
|
$
|
467
|
$
|
83
|
$
|
(550
|
)
|
$
|
—
|
$
|
—
|
|||||
|
Other
|
—
|
399
|
(399
|
)
|
—
|
—
|
||||||||||
|
467
|
482
|
(949
|
)
|
—
|
—
|
|||||||||||
|
Fiscal
2003 plan
|
||||||||||||||||
|
Severance
expenses
|
109
|
—
|
(77
|
)
|
(32
|
)
|
—
|
|||||||||
|
Exited
leased facilities
|
386
|
—
|
(229
|
)
|
(7
|
)
|
150
|
|||||||||
|
Other
|
197
|
—
|
(46
|
)
|
(151
|
)
|
—
|
|||||||||
|
692
|
—
|
(352
|
)
|
(190
|
)
|
150
|
||||||||||
|
Fiscal
2001 plan
|
||||||||||||||||
|
Exited
leased facilities
|
10
|
—
|
(10
|
)
|
—
|
—
|
||||||||||
|
Total
for all plans (note 9)
|
$
|
1,169
|
$
|
482
|
$
|
(1,311
|
)
|
$
|
(190
|
)
|
$
|
150
|
||||
|
Year
ended August 31, 2004
|
||||||||||||||||
|
Balance
as at
August
31,
2003
|
Additions
|
Payments
|
Adjustments
|
Balance
as at
August
31,
2004
|
||||||||||||
|
Fiscal
2004 plan
|
||||||||||||||||
|
Severance
expenses
|
$
|
—
|
$
|
772
|
$
|
(305
|
)
|
$
|
—
|
$
|
467
|
|||||
|
Fiscal
2003 plan
|
||||||||||||||||
|
Severance
expenses
|
1,233
|
—
|
(870
|
)
|
(254
|
)
|
109
|
|||||||||
|
Exited
leased facilities
|
748
|
—
|
(362
|
)
|
—
|
386
|
||||||||||
|
Other
|
295
|
—
|
(90
|
)
|
(8
|
)
|
197
|
|||||||||
|
2,276
|
—
|
(1,322
|
)
|
(262
|
)
|
692
|
||||||||||
|
Fiscal
2002 plans
|
||||||||||||||||
|
Other
|
68
|
—
|
(68
|
)
|
—
|
—
|
||||||||||
|
Fiscal
2001 plan
|
||||||||||||||||
|
Exited
leased facilities
|
124
|
—
|
(72
|
)
|
(42
|
)
|
10
|
|||||||||
|
Total
for all plans
|
$
|
2,468
|
$
|
772
|
$
|
(1,767
|
)
|
$
|
(304
|
)
|
$
|
1,169
|
||||
| 5. |
Inventories
|
|
As
at August 31,
|
2006
|
2005
|
|||||
|
Raw
materials
|
$
|
14,353
|
$
|
9,373
|
|||
|
Work
in progress
|
1,043
|
934
|
|||||
|
Finished
goods
|
9,227
|
7,442
|
|||||
|
$
|
24,623
|
$
|
17,749
|
||||
| 6. |
Property,
Plant and Equipment
|
|
As
at August 31,
|
|
|
|
2006
|
2005
|
||||||||
|
Cost
|
Accumulated
amortization
|
Cost
|
Accumulated
amortization
|
||||||||||
|
Land
and land improvements
|
$
|
4,249
|
$
|
1,082
|
$
|
3,179
|
$
|
815
|
|||||
|
Buildings
|
14,417
|
6,262
|
9,206
|
2,250
|
|||||||||
|
Equipment
|
33,562
|
28,263
|
33,216
|
29,553
|
|||||||||
|
Leasehold
improvements
|
2,788
|
2,017
|
2,395
|
1,659
|
|||||||||
|
55,016
|
$
|
37,624
|
47,996
|
$
|
34,277
|
||||||||
|
Less:
|
|||||||||||||
|
Accumulated
amortization
|
37,624
|
34,277
|
|||||||||||
|
$
|
17,392
|
$
|
13,719
|
||||||||||
As
at
August 31, 2005 and 2006, unpaid purchases of property, plant and equipment
amounted to $111,000 and $176,000, respectively.
| 7. |
Intangible
Assets and Goodwill
|
|
As
at August 31,
|
2006
|
2005
|
|||||||||||
|
Cost
|
Accumulated
amortization
|
Cost
|
Accumulated
amortization
|
||||||||||
|
Core
technology
|
$
|
47,629
|
$
|
38,972
|
$
|
35,554
|
$
|
32,214
|
|||||
|
Software
|
6,781
|
4,490
|
6,607
|
4,345
|
|||||||||
|
54,410
|
$
|
43,462
|
42,161
|
$
|
36,559
|
||||||||
|
Less:
|
|||||||||||||
|
Accumulated
amortization
|
43,462
|
36,559
|
|||||||||||
|
$
|
10,948
|
$
|
5,602
|
||||||||||
Amortization
expenses for intangible assets in each of the next five fiscal years will
amount
to $2,877,000 in 2007, $2,337,000 in 2008, $2,252,000 in 2009, $2,200,000
in
2010 and $1,099,000 in 2011.
Changes
in the carrying value of goodwill are as follows:
|
As
at August 31,
|
2006
|
2005
|
|||||
|
Balance
- Beginning of year
|
$
|
20,370
|
$
|
18,393
|
|||
|
Addition
from business combination (note 3)
|
5,107
|
-
|
|||||
|
Foreign
currency translation adjustment
|
1,665
|
1,977
|
|||||
|
Balance
- End of year (note 19)
|
$
|
27,142
|
$
|
20,370
|
|||
| 8. |
Credit
Facilities
|
The
company has a line of credit that provides for advances of up to CA$10,000,000
(US$9,037,000). This line of credit bears interest at prime rate (prime rate
in
2005). As at August 31, 2006, this line of credit was unused.
The
company also has another line of credit, which provides for advances of up
to
CA$4,500,000 (US$4,067,000) for letters of guarantee. As at August 31, 2006,
an
amount of CA$2,073,000 (US$1,873,000) was reserved from this line of credit
(note 12).
Finally,
the company has a third line of credit of $12,000,000 for the foreign currency
exposure related to its forward exchange contracts. As at August 31, 2006,
an
amount of $751,000 was reserved from this line of credit.
These
lines of credit are renewable annually. Short-term investments, accounts
receivable, inventories and all tangible and intangible assets of the company
are pledged as collateral against these lines of credit.
| 9. |
Accounts
Payable and Accrued
Liabilities
|
|
As
at August 31,
|
2006
|
2005
|
|||||
|
Trade
|
$
|
7,487
|
$
|
5,781
|
|||
|
Salaries
and social benefits
|
5,991
|
4,526
|
|||||
|
Warranty
|
1,006
|
725
|
|||||
|
Commissions
|
835
|
211
|
|||||
|
Restructuring
charges (note 4)
|
691
|
150
|
|||||
|
Business
combination (note 3)
|
185
|
-
|
|||||
|
Other
|
1,142
|
808
|
|||||
|
$
|
17,337
|
$
|
12,201
|
Changes
in the warranty provision are as follows:
|
As
at August 31,
|
2006
|
2005
|
|||||
|
Balance
- Beginning of year
|
$
|
725
|
$
|
390
|
|||
|
Provision
|
895
|
869
|
|||||
|
Settlements
|
(708
|
)
|
(583
|
)
|
|||
|
Addition
from business combination
|
31
|
-
|
|||||
|
Foreign
currency translation adjustment
|
63
|
49
|
|||||
|
Balance
- End of year
|
$
|
1,006
|
$
|
725
|
|||
| 10. |
Long-Term
Debt
|
|
As
at August 31,
|
2006
|
2005
|
|||||
|
Loans
collateralized by equipment, bearing interest at 4.9%, repayable
in
monthly installments of $10,600 including principal and interest,
maturing
in 2010
|
$
|
461
|
$
|
—
|
|||
|
Loans
collateralized by equipment, bearing interest at 9.6%, fully repaid
in
fiscal 2006
|
—
|
332
|
|||||
|
461
|
332
|
||||||
|
Less:
Current portion
|
107
|
134
|
|||||
|
$
|
354
|
$
|
198
|
||||
As
at
August 31, 2006, minimum principal repayments required in each of the next
four
years will amount to $107,000 in 2007, $113,000 in 2008, $118,000 in 2009
and
$123,000 in 2010.
| 11. |
Commitments
|
The
company entered into operating leases for certain of its premises and equipment,
which expire at various dates through September 2013. As at August 31, 2006,
minimum rentals payable under these operating leases in each of the next
five
years will amount to $1,748,000 in 2007, $1,223,000 in 2008, $1,177,000 in
2009,
$1,200,000 in 2010 and $990,000 in 2011 for total commitments of
$6,888,000.
For
the
years ended August 31, 2004, 2005 and 2006, rental expenses amounted to
$1,219,000, $1,370,000 and $1,523,000, respectively.
| 12. |
Contingencies
|
Class
action
On
November 27, 2001, a class action suit was filed in the United States District
Court for the Southern District of New York against the company, four of
the
underwriters of its Initial Public Offering and some of its executive officers
pursuant to the Securities Exchange Act of 1934 and Rule 10b-5 promulgated
thereunder and Sections 11, 12 and 16 of the Securities Act of 1933. This
class
action alleges that the company’s registration statement and prospectus filed
with the Securities and Exchange Commission on June 29, 2000, contained material
misrepresentations and/or omissions resulting from (i) the underwriters
allegedly soliciting and receiving additional, excessive and undisclosed
commissions from certain investors in exchange for which they allocated material
portions of the shares issued in connection with the company’s Initial Public
Offering; and (ii) the underwriters allegedly entering into agreements with
customers whereby shares issued in connection with the company’s Initial Public
Offering would be allocated to those customers in exchange for which customers
agreed to purchase additional amounts of shares in the after-market at
predetermined prices.
On
April
19, 2002, the plaintiffs filed an amended complaint containing master
allegations against all of the underwriters in all of the 310 cases included
in
this class action and also filed an amended complaint containing allegations
specific to four of the company’s underwriters, the company and two of its
executive officers. In addition to the allegations mentioned above, the amended
complaint alleges that the underwriters (i) used their analysts to manipulate
the stock market; and (ii) implemented schemes that allowed issuer insiders
to
sell their shares rapidly after an initial public offering and benefit from
high
market prices. As concerns the company and its two executive officers in
particular, the amended complaint alleges that (i) the company’s registration
statement was materially false and misleading because it failed to disclose
the
additional commissions and compensation to be received by underwriters; (ii)
the
two named executive officers learned of or recklessly disregarded the alleged
misconduct of the underwriters; (iii) the two named executive officers had
motive and opportunity to engage in alleged wrongful conduct due to personal
holdings of the company’s stock and the fact that an alleged artificially
inflated stock price could be used as currency for acquisitions; and (iv)
the
two named executive officers, by virtue of their positions with the company,
controlled the company and the contents of the registration statement and
had
the ability to prevent its issuance or cause it to be corrected. The plaintiffs
in this suit seek an unspecified amount for damages suffered.
In
July
2002, the issuers filed a motion to dismiss the plaintiffs’ amended complaint
and a decision was rendered on February 19, 2003. Only one of the claims
against
the company was dismissed. On October 8, 2002, the claims against its officers
were dismissed pursuant to the terms of Reservation of Rights and Tolling
Agreements entered into with the plaintiffs.
In
June
2003, a committee of the company’s Board of Directors conditionally approved a
proposed settlement between the issuer defendants, the individual defendants,
and the plaintiffs. If approved, the settlement would provide, among other
things, a release of the company and of the individual defendants for the
conduct alleged in the action to be wrongful in the amended complaint. The
company would agree to undertake other responsibilities under the settlement,
including agreeing to assign away, not assert, or release certain potential
claims the company may have against its underwriters.
On
June
25, 2004, the Plaintiffs moved for preliminary approval of the settlement.
The
court granted the preliminary approval motion on February 15, 2005, subject
to
certain modifications. On August 31, 2005, the court issued a preliminary
order
further approving the modifications to the settlement and certifying the
settlement classes. The court also appointed the Notice Administrator for
the
settlement and ordered that notice of the settlement be distributed to all
settlement class members beginning on November 15, 2005. A settlement fairness
hearing was held on April 24, 2006; however, no ruling has been issued yet
by
the court. If the court determines that the settlement is fair to the class
members, the settlement will be approved. The settlement provides that, if
the
plaintiffs do not obtain any recovery from the underwriter defendants, the
members of the class action would receive an amount not expected to exceed
$2,507,678. Any direct financial impact plus any legal fees are expected
to be
borne by the company’s insurance carriers. However, there can be no assurance
that this proposed settlement would be approved and implemented in its current
form, or at all. Therefore, it is not possible to predict the final outcome
of
the case, nor to determine the amount of any possible losses. If the settlement
process fails, the company will continue to defend its position in this
litigation that the claims against it, and its officers, are without merit.
Accordingly, no provision for this case has been made in the consolidated
financial statements as at August 31, 2006.
Letters
of guarantee
As
at
August 31, 2006, in the normal course of its operations, the company had
outstanding letters of guarantee of CA$2,073,000 (US$1,873,000), which expire
at
various dates through fiscal 2010 and that were reserved from one of the
lines
of credit (note 8).
| 13. |
Share
Capital
|
Authorized
- unlimited as to number, without par value
Subordinate
voting and participating, bearing a non-cumulative dividend to be determined
by
the
Board
of
Directors, ranking pari passu with multiple voting shares
Multiple
voting and participating, entitling to ten votes each, bearing a non-cumulative
dividend to be determined by the Board
of
Directors, convertible at the holder’s option into subordinate voting shares on
a one-for-one basis, ranking pari
passu with
subordinate voting shares
The
following table summarizes the share capital activity since August 31,
2003:
|
Multiple
voting shares
|
Subordinate
voting shares
|
|||||||||||||||
|
Number
|
|
Amount
|
|
Number
|
|
Amount
|
|
Total
amount
|
||||||||
|
Balance
as at August 31, 2003
|
37,900,000
|
$
|
1
|
$
|
25,139,908
|
$
|
492,451
|
492,452
|
||||||||
|
Public
offering (1)
|
-
|
-
|
5,200,000
|
29,164
|
29,164
|
|||||||||||
|
Exercise
of stock options (note 14)
|
-
|
-
|
111,071
|
254
|
254
|
|||||||||||
|
Exercise
of restricted stock awards (note 14)
|
-
|
-
|
89,504
|
-
|
-
|
|||||||||||
|
Redemption
|
-
|
-
|
(5,340
|
)
|
(5
|
)
|
(5
|
)
|
||||||||
|
Resale
|
-
|
-
|
5,340
|
5
|
5
|
|||||||||||
|
Share
issue expenses
|
-
|
-
|
-
|
(137
|
)
|
(137
|
)
|
|||||||||
|
Balance
as at August 31, 2004
|
37,900,000
|
1
|
30,540,483
|
521,732
|
521,733
|
|||||||||||
|
Exercise
of stock options (note 14)
|
-
|
-
|
71,699
|
148
|
148
|
|||||||||||
|
Exercise
of restricted stock awards (note 14)
|
-
|
-
|
53,592
|
-
|
-
|
|||||||||||
|
Share
issue expenses
|
-
|
-
|
-
|
(6
|
)
|
(6
|
)
|
|||||||||
|
Balance
as at August 31, 2005
|
37,900,000
|
1
|
30,665,774
|
521,874
|
521,875
|
|||||||||||
|
Exercise
of stock options (note 14)
|
-
|
-
|
182,425
|
557
|
557
|
|||||||||||
|
Exercise
of restricted share units (note 14)
|
-
|
-
|
4,770
|
-
|
-
|
|||||||||||
|
Conversion
of multiple voting shares into subordinate voting shares
|
(757,000
|
)
|
-
|
757,000
|
-
|
-
|
||||||||||
|
Reclassification
of stock-based compensation cost to share capital upon exercise
of stock
awards
|
-
|
-
|
-
|
200
|
200
|
|||||||||||
|
Elimination
of deficit by
reduction of share capital (2)
|
-
|
-
|
-
|
(373,711
|
)
|
(373,711
|
)
|
|||||||||
|
Balance
as at August 31, 2006
|
37,143,000
|
$
|
1
|
31,609,969
|
$
|
148,920
|
$
|
148,921
|
||||||||
|
(1)
|
On
February 12, 2004, pursuant to a Canadian public offering, the
company
issued 5,200,000 subordinate voting shares for net proceeds of
$29,164,000
(CA$38,438,400), after deduction of underwriting commission of
$1,215,000
(CA$1,601,000).
|
|
(2)
|
Upon
the approval of the Board of Directors dated August 31, 2006, the
company
eliminated its deficit against its share
capital.
|
| 14. |
Stock-Based
Compensation Plans
|
The
maximum number of additional subordinate voting shares issuable under the
Long-Term Incentive Plan and the Deferred Share Unit Plan cannot exceed
6,306,153 shares. The maximum number of subordinate voting shares that may
be
granted to any individual on an annual basis cannot exceed 5% of the number
of
outstanding subordinate voting shares.
Long-term
incentive plan
In
May
2000, the company established a Stock Option Plan for directors, executive
officers and employees and those of the company’s subsidiaries, as determined by
the Board of Directors. In January 2005, the company made certain amendments
to
the existing Stock Option Plan, including the renaming of the plan to Long-Term
Incentive Plan, which includes stock options and restricted share units.
Stock
Options
The
exercise price of stock options granted under the Long-Term Incentive Plan
is
the market price of the common shares on the date of grant. Stock options
granted under the plan generally expire ten years from the date of grant and
generally vest over a four-year period, with 25% vesting on an annual basis
commencing on the first anniversary of the date of grant. The Board of Directors
may accelerate the vesting of any or all outstanding stock options upon the
occurrence of a change of control.
The
following table summarizes stock option activity since August 31,
2003:
|
Years
ended August 31,
|
|
2006
|
|
2005
|
|
2004
|
|||||||||||||
|
|
Number
|
Weighted
Average
exercise
price
(CA$)
|
Number
|
Weighted
average
exercise
price
(CA$)
|
Number
|
Weighted
average
exercise
price
(CA$)
|
|||||||||||||
|
Outstanding
- Beginning of year
|
2,763,759
|
$
|
19
|
2,934,518
|
$
|
21
|
3,176,613
|
$
|
23
|
||||||||||
|
Granted
|
31,992
|
6
|
246,233
|
6
|
536,500
|
5
|
|||||||||||||
|
Exercised
|
(182,425
|
)
|
(4
|
)
|
(71,699
|
)
|
(3
|
)
|
(111,071
|
)
|
(3
|
)
|
|||||||
|
Forfeited
|
(173,951
|
)
|
(18
|
)
|
(345,293
|
)
|
(27
|
)
|
(667,524
|
)
|
(23
|
)
|
|||||||
|
Outstanding
- End of year
|
2,439,375
|
$
|
20
|
2,763,759
|
$
|
19
|
2,934,518
|
$
|
21
|
||||||||||
|
Exercisable
- End of year
|
1,852,870
|
$
|
25
|
1,650,404
|
$
|
28
|
1,331,707
|
$
|
32
|
||||||||||
The
intrinsic value of stock options exercised during the year ended August 31,
2006, was CA$552,000.
The
weighted average grant-date fair value of stock options granted during fiscal
2004, 2005 and 2006 amounted to $2.73, $3.51 and $4.76,
respectively.
The
fair
value of stock awards granted in fiscal 2004, 2005 and 2006 was estimated
using
the Black-Scholes options valuation model with the following weighted average
assumptions:
|
Years
ended August 31,
|
2006
|
2005
|
2004
|
|||||||
|
Risk-free
interest rate
|
3.9%
|
|
3.6%
|
|
2.7%
|
|
||||
|
Expected
volatility (based on historical volatility)
|
87%
|
|
95%
|
|
100%
|
|
||||
|
Dividend
yield
|
Nil
|
Nil
|
Nil
|
|||||||
|
Expected
life
|
66
months
|
66
months
|
49
months
|
|||||||
The
company is required to make pro forma disclosures of net earnings (loss)
and net
earnings (loss) per share for any periods included in the financial statements,
as if the fair value-based method of accounting had been applied to outstanding
unvested awards granted prior to September 1, 2003. Consequently, if the
fair
value-based method had been applied to unvested stock options granted prior
to
September 1, 2003, and outstanding as at August 31, 2004, 2005 and 2006,
the net
earning (loss) per share and the pro forma net earning (loss) per share would
have been the same for all reporting years.
The
following table summarizes information about stock options as at August 31,
2006:
|
Stock
options outstanding
|
Stock
options exercisable
|
|||||||||||||||||||||
|
Exercise
price
(CA$)
|
Number
|
|
Weighted
average
exercise
price
(CA$)
|
|
Aggregate
intrinsic
value
(CA$)
|
|
Weighted
average
remaining
contractual
life
|
|
Number
|
|
Weighted
average
exercise
price
(CA$)
|
|
Aggregate
intrinsic
value
(CA$)
|
|||||||||
|
$2.50
to $3.36
|
419,655
|
$
|
2.50
|
$
|
1,402
|
6.1
years
|
273,313
|
$
|
2.50
|
$
|
913
|
|||||||||||
|
$3.96
to $5.84
|
547,687
|
5.07
|
422
|
7.6
years
|
206,464
|
4.92
|
190
|
|||||||||||||||
|
$6.22
to $9.02
|
193,200
|
6.52
|
—
|
7.4
years
|
94,260
|
6.82
|
—
|
|||||||||||||||
|
$14.27
to $20.00
|
476,396
|
15.78
|
—
|
5.2
years
|
476,396
|
15.78
|
—
|
|||||||||||||||
|
$29.70
to $43.00
|
564,436
|
36.27
|
—
|
4.2
years
|
564,436
|
36.27
|
—
|
|||||||||||||||
|
$51.25
to $68.17
|
199,771
|
65.76
|
—
|
4.0
years
|
199,771
|
65.76
|
—
|
|||||||||||||||
|
$83.66
|
38,230
|
83.66
|
—
|
4.0
years
|
38,230
|
83.66
|
—
|
|||||||||||||||
|
2,439,375
|
$
|
20.26
|
$
|
1,824
|
5.7
years
|
1,852,870
|
$
|
25.19
|
$
|
1,103
|
||||||||||||
Restricted
Share Units (RSUs)
RSUs
are
“phantom” shares that rise and fall in value based on the value of the company’s
subordinate voting shares and are redeemable for actual subordinate voting
shares or cash at the discretion of the Board of Directors on the vesting
dates
established by the Board of Directors at the time of grant. The vesting dates
are subject to a minimum term of three years and a maximum term of ten years
from the award date. RSUs granted under the plan expire at the latest ten
years
from the date of grant.
The
following table summarizes RSUs activity since January 2005:
|
Years
ended August 31,
|
|
2006
|
|
2005
|
|||
|
Outstanding
- Beginning of year
|
176,185
|
-
|
|||||
|
Granted
|
173,803
|
176,185
|
|||||
|
Exercised
|
(4,770
|
)
|
-
|
||||
|
Forfeited
|
(17,341
|
)
|
-
|
||||
|
Outstanding
- End of year
|
327,877
|
176,185
|
|||||
None
of
the RSUs outstanding as at August 31, 2005 and 2006 were redeemable. As at
August 31, 2006, the weighted average remaining contractual life of the
outstanding RSUs was 8.9 years. The weighted average grant-date fair value
of
RSUs granted during fiscal 2005 and 2006 amounted to $4.68 and $5.39,
respectively.
Deferred
share unit plan
In
January 2005, the company established a Deferred Share Unit (DSU) Plan for
the
members of the Board of Directors as part of their annual retainer fees.
Each
DSU entitles the Board members to receive one subordinate voting share. DSUs
are
acquired on the date of grant and will be redeemed in subordinate voting
shares
when the Board member will cease to be Director of the company.
The
following table summarizes DSU activity since January 2005:
|
Years
ended August 31,
|
2006
|
2005
|
|||||
|
Outstanding
- Beginning of year
|
23,734
|
-
|
|||||
|
Granted
|
19,556
|
23,734
|
|||||
|
Outstanding
- End of year
|
43,290
|
23,734
|
|||||
None
of
the DSUs outstanding as at August 31, 2005 and 2006 were redeemable. The
weighted average grant date fair value of DSUs granted during fiscal 2005
and
2006 amounted to $4.47 and $5.81.
Stock
appreciation rights plan
In
August
2001, the company established the Stock Appreciation Rights Plan for certain
employees. Under that plan, eligible employees are entitled to receive a
cash
amount equivalent to the difference between the market price of the common
shares on the date of exercise and the exercise price determined on the date
of
grant. Stock appreciation rights granted under the plan generally expire
ten
years from the date of grant and vest over a four-year period, with 25% vesting
on an annual basis commencing on the first anniversary of the date of
grant.
The
following table summarizes stock appreciation rights activity since August
31,
2003:
|
Years
ended August 31,
|
|
|
2006
|
|
|
|
2005
|
|
|
|
2004
|
|
|||||||
|
|
|
|
|
Weighted
|
|
|
|
Weighted
|
|
|
|
Weighted
|
|
||||||
|
|
|
|
|
average
|
|
|
|
average
|
|
|
|
average
|
|
||||||
|
|
|
|
|
exercise
|
|
|
|
exercise
|
|
|
|
exercise
|
|
||||||
|
|
|
Number
|
|
price
|
|
Number
|
|
price
|
|
Number
|
|
price
|
|||||||
|
Outstanding
- Beginning of year
|
19,000
|
$
|
12
|
13,000
|
$
|
16
|
9,000
|
$
|
24
|
||||||||||
|
Granted
|
5,500
|
6
|
6,000
|
4
|
6,000
|
5
|
|||||||||||||
|
Forfeited
|
-
|
-
|
-
|
-
|
(2,000
|
)
|
(19
|
)
|
|||||||||||
|
Outstanding
- End of year
|
24,500
|
$
|
11
|
19,000
|
$
|
12
|
13,000
|
$
|
16
|
||||||||||
|
Exercisable
- End of year
|
11,000
|
$
|
18
|
7,500
|
$
|
24
|
4,250
|
$
|
30
|
||||||||||
The
following table summarizes information about stock appreciation rights as
at
August 31, 2006:
|
Stock
appreciation
rights
outstanding
|
Stock
appreciation
rights
exercisable
|
|||||||||
|
Exercise
price
|
Number
|
Weighted
average
remaining
contractual
life
|
Number
|
|||||||
|
$2.21
|
2,000
|
6.6
years
|
1,500
|
|||||||
|
$4.51
to $6.50
|
17,500
|
8.4
years
|
4,500
|
|||||||
|
$22.25
|
2,500
|
4.4
years
|
2,500
|
|||||||
|
$45.94
|
2,500
|
4.0
years
|
2,500
|
|||||||
|
24,500
|
7.4
years
|
11,000
|
||||||||
Restricted
stock award plan
In
December 2000, the company established a Restricted Stock Award Plan for
employees of EXFO Burleigh. This plan expired in December 2004. Each stock
award
entitled employees to receive one subordinate voting share at a purchase
price
of nil. Stock awards granted under the plan vested over a four-year period,
with
25% vesting on an annual basis commencing on the first anniversary of the
date
of grant. According to the plan, upon the involuntary termination of a member
of
the defined management team, all outstanding restricted stock awards granted
to
such an employee automatically vested.
The
following table summarizes restricted stock awards activity since August
31,
2003:
|
Years
ended August 31,
|
2005
|
2004
|
|||||
|
Outstanding
- Beginning of year
|
53,592
|
143,096
|
|||||
|
Exercised
|
(53,592
|
)
|
(89,504
|
)
|
|||
|
Outstanding
- End of year
|
-
|
53,592
|
|||||
| 15. |
Other
Disclosures
|
Net
research and development expenses
Net
research and development expenses comprise the following:
|
Years
ended August 31,
|
2006
|
2005
|
2004
|
|||||||
|
Gross
research and development expenses
|
$
|
19,488
|
$
|
15,878
|
$
|
15,668
|
||||
|
Research
and development tax credits and grants
|
(4,084
|
)
|
(3,688
|
)
|
(3,278
|
)
|
||||
|
$
|
15,404
|
$
|
12,190
|
$
|
12,390
|
|||||
Government
grants
During
1998, the company entered into an agreement with the Quebec Minister of
Industry, Commerce, Science and Technology (“The Minister”). Pursuant to this
agreement, the Minister agreed to contribute, in the form of grants, up to
CA$2,220,000 (US$1,995,000) over the period from January 1, 1998, through
December 31, 2002, payable based on the number of full-time jobs created
during
that period.
Since
the
beginning of the program, the company has claimed and received the maximum
amount of CA$2,220,000. However, these grants were subject to the condition
that
jobs created pursuant to the agreement be maintained for a period of at least
five years from the date of creation. Since the beginning of the program,
the
company deferred in the balance sheet CA$1,450,000 (US$1,307,000) from the
amounts received until it received the final approval by the sponsor of the
program related to jobs created. In fiscal 2006, the sponsor of the program
granted the company with its final approval and the company recorded a
non-recurring revenue of CA$1,450,000 (US$1,307,000) in the earnings from
operations in the statement of earnings of fiscal 2006.
Furthermore,
since 2000, companies operating in the Quebec City area are eligible for
a
refundable credit granted by the Quebec provincial government. This credit
is
earned based on the increase of eligible production and marketing salaries
incurred in the Quebec City area at a rate of 40%. From the total amount
received by the company so far under this program, CA$774,000 (US$700,000)
was
deferred and was included in government grants in the balance sheet. This
amount
will be recognized in the statement of earnings upon the final approval of
eligible salaries by the sponsor of the program. Should repayments of any
amounts received pursuant to this program be required, such repayments, less
related deferred revenue, will be charged to earnings as the amount of any
repayment becomes known.
Following
is a summary of the classification of these and certain other grants and
credits
(government grants) in the statements of earnings of the reporting
years.
Cost
of
sales for the years ended August 31, 2004, 2005 and 2006, is net of government
grants of $3,000, $89,000 and $262,000, respectively.
Selling
and administrative expenses for the years ended August 31, 2004, 2005 and
2006,
are net of government grants of $5,000, $32,000 and $76,000,
respectively.
Research
and development expenses for the years ended August 31, 2004, 2005 and 2006,
are
net of government grants of $80,000, $22,000 and $4,000,
respectively.
Defined
contribution plans
The
company maintains separate defined contribution plans for certain eligible
employees. These plans, which are accounted for on an accrual basis, are
summarized as follows:
| • |
Deferred
profit-sharing plan
|
|
The
company maintains a plan for certain eligible Canadian resident
employees,
under which the company may elect to contribute an amount equal
to 2% (1%
prior to June 2005) of an employee’s gross salary, provided that the
employee has contributed at least 2% of his/her gross salary to
a
tax-deferred registered retirement savings plan. Cash contributions
to
this plan and expenses for the years ended August 31, 2004, 2005
and 2006,
amounted to CA$141,000 (US$106,000), CA$221,000 (US$179,000) and
CA$363,000 (US$316,000),
respectively.
|
| • |
401K
plan
|
|
The
company maintains a 401K plan for eligible U.S. resident employees.
Under
this plan, the company must contribute an amount equal to 3% of
an
employee’s current compensation. During the years ended August 31, 2004,
2005 and 2006, the company recorded cash contributions and expenses
totaling $187,000, $134,000 and $126,000,
respectively.
|
| 16. |
Income
Taxes
|
The
reconciliation of the income tax provision calculated using the combined
Canadian federal and provincial statutory income tax rate with the income
tax
provision in the financial statements is as follows:
|
Years
ended August 31,
|
2006
|
2005
|
2004
|
|||||||
|
Income
tax provision at combined Canadian federal and provincial statutory
tax
rate (32% in 2006, 31% in 2005 and 32% in 2004)
|
$
|
3,430
|
$
|
307
|
$
|
(3,011
|
)
|
|||
|
Increase
(decrease) due to:
|
||||||||||
|
Foreign
income taxed at different rates
|
(85
|
)
|
(580
|
)
|
(767
|
)
|
||||
|
Non-taxable
income
|
(207
|
)
|
(827
|
)
|
(128
|
)
|
||||
|
Non-deductible
expenses
|
527
|
784
|
1,205
|
|||||||
|
Tax
deductions
|
-
|
(81
|
)
|
(169
|
)
|
|||||
|
Change
in enacted rates
|
497
|
-
|
274
|
|||||||
|
Effect
of consolidation of subsidiaries
|
61
|
(209
|
)
|
(1,384
|
)
|
|||||
|
Previous
year tax recovery
|
-
|
-
|
(1,406
|
)
|
||||||
|
Other
|
239
|
(146
|
)
|
446
|
||||||
|
Change
in valuation allowance
|
(1,877
|
)
|
3,375
|
3,954
|
||||||
|
$
|
2,585
|
$
|
2,623
|
$
|
(986
|
)
|
||||
|
The
income tax provision consists of the following:
|
||||||||||
|
Current
|
||||||||||
|
Canadian
|
$
|
2,573
|
$
|
2,513
|
$
|
(577
|
)
|
|||
|
Other
|
12
|
110
|
(409
|
)
|
||||||
|
2,585
|
2,623
|
(986
|
)
|
|||||||
|
Future
|
||||||||||
|
Canadian
|
2,687
|
(1,445
|
)
|
(1,104
|
)
|
|||||
|
United
States
|
(601
|
)
|
(1,723
|
)
|
(2,448
|
)
|
||||
|
Other
|
(209
|
)
|
(207
|
)
|
(402
|
)
|
||||
|
1,877
|
(3,375
|
)
|
(3,954
|
)
|
||||||
|
Valuation
allowance
|
||||||||||
|
Canadian
|
(2,687
|
)
|
1,445
|
1,104
|
||||||
|
United
States
|
601
|
1,723
|
2,448
|
|||||||
|
Other
|
209
|
207
|
402
|
|||||||
|
(1,877
|
)
|
3,375
|
3,954
|
|||||||
|
$
|
2,585
|
$
|
2,623
|
$
|
(986
|
)
|
||||
|
Details
of the company’s income taxes:
|
||||||||||
|
Earnings
(loss) before income taxes
|
||||||||||
|
Canadian
|
$
|
13,202
|
$
|
3,092
|
$
|
(7,740
|
)
|
|||
|
United
States
|
(2,103
|
)
|
(953
|
)
|
(5,879
|
)
|
||||
|
Other
|
(379
|
)
|
(1,150
|
)
|
4,209
|
|||||
|
$
|
10,720
|
$
|
989
|
$
|
(9,410
|
)
|
||||
Most
of
the company’s income tax provision for fiscal 2005 and 2006 represents income
taxes payable at the Canadian federal level, which are reduced by research
and
development tax credits that are recorded against gross research and development
expenses in the statements of earnings.
Significant
components of the company’s future income tax assets and liabilities are as
follows:
|
As
at August 31,
|
2006
|
2005
|
|||||
|
Future
income tax assets
|
|||||||
|
Long-lived
assets
|
$
|
4,453
|
$
|
4,902
|
|||
|
Provisions
and accruals
|
7,315
|
7,406
|
|||||
|
Government
grants
|
-
|
209
|
|||||
|
Deferred
revenue
|
486
|
318
|
|||||
|
Share
issue expenses
|
531
|
590
|
|||||
|
Research
and development expenses
|
8,527
|
7,292
|
|||||
|
Losses
carried forward
|
18,118
|
18,424
|
|||||
|
39,430
|
39,141
|
||||||
|
Valuation
allowance
|
(38,543
|
)
|
(38,406
|
)
|
|||
|
887
|
735
|
||||||
|
Future
income tax liabilities
|
|||||||
|
Research
and development tax credits
|
(887
|
)
|
(735
|
)
|
|||
|
Future
income tax assets, net
|
$
|
-
|
$
|
-
|
|||
As
at
August 31, 2006, the company had available operating losses in several tax
jurisdictions, against which a full valuation allowance of $18,118,000 was
recorded. The following table summarizes the year of expiry of these operating
losses by tax jurisdiction:
|
Canada
|
United
States
|
|||||||||
|
Year
of expiry
|
Federal
|
Provinces
|
and
Other
|
|||||||
|
2008
|
$
|
1,252
|
$
|
92
|
$
|
1,857
|
||||
|
2009
|
5,186
|
394
|
599
|
|||||||
|
2010
|
4,677
|
327
|
266
|
|||||||
|
2011
|
168
|
86
|
-
|
|||||||
|
2013
|
-
|
-
|
876
|
|||||||
|
2015
|
1,666
|
1,670
|
-
|
|||||||
|
2022
|
-
|
-
|
9,406
|
|||||||
|
2023
|
-
|
-
|
11,621
|
|||||||
|
2024
|
-
|
-
|
6,700
|
|||||||
|
2025
|
-
|
-
|
6,690
|
|||||||
|
2026
|
1,694
|
1,696
|
2,737
|
|||||||
|
Indefinite
|
1,702
|
1,775
|
1,996
|
|||||||
|
$
|
16,345
|
$
|
6,040
|
$
|
42,748
|
|||||
As
at
August 31, 2006, in addition to operating losses, the company had available
research and development expenses in Canada amounting to $33,745,000 at the
federal level and $15,276,000 at the provincial level, against which a full
valuation allowance of $8,527,000 was recorded. These expenses can be carried
forward indefinitely against future years’ taxable income in their respective
tax jurisdiction.
Finally,
as at August 31, 2006, the company had available research and development
tax
credits at the Canadian federal level in the amount of $3,697,000 that can
be
carried forward against future years’ income taxes payable over the next ten
years. These tax credits were not recorded in the balance sheet as at August
31,
2006.
| 17. |
Earnings
per Share
|
The
following table summarizes the reconciliation of the basic weighted average
number of shares outstanding and the diluted weighted average number of shares
outstanding:
|
Years
ended August 31,
|
2006
|
2005
|
2004
|
|||||||
|
Basic
weighted average number of shares outstanding (000’s)
|
68,643
|
68,526
|
66,020
|
|||||||
|
Plus
dilutive effect of:
|
||||||||||
|
Stock
options (000’s)
|
502
|
422
|
502
|
|||||||
|
Deferred
share units (000’s)
|
31
|
8
|
-
|
|||||||
|
Restricted
share units (000’s)
|
99
|
8
|
-
|
|||||||
|
Restricted
stock awards (000’s)
|
—
|
17
|
93
|
|||||||
|
Diluted
weighted average number of shares outstanding (000’s)
|
69,275
|
68,981
|
66,615
|
|||||||
|
Stock
awards excluded from the calculation of the diluted weighted average
number of shares outstanding because their exercise price was greater
than
the average market price of the common shares (000’s)
|
1,628
|
1,962
|
2,128
|
|||||||
The
diluted net loss per share for the years ended August 31, 2004 and 2005,
was the
same as the basic net loss per share since the dilutive effect of stock options,
deferred share units, restricted share units and restricted stock awards
should
not be included in the calculation; otherwise, the effect would be
anti-dilutive. Accordingly, diluted net loss per share for those years was
calculated using the basic weighted average number of shares
outstanding.
| 18. |
Financial
Instruments
|
Short-term
investments
Short-term
investments consist of the following:
|
As
at August 31,
|
2006
|
2005
|
|||||
|
Commercial
paper denominated in Canadian dollars, bearing interest at annual
rates of
3.92% to 4.31% in 2006 and 2.44% to 2.75% in 2005, maturing on
different
dates between September 2006 and January 2007 in fiscal 2006, and
September 2005 and January 2006 in fiscal 2005
|
$
|
104,437
|
$
|
104,883
|
|||
Fair
value
Cash,
accounts receivable, accounts payable and accrued liabilities as well as
long-term debt, are financial instruments whose carrying values approximate
their fair values.
The
fair
value of short-term investments, based on market value, amounted to $104,883,000
and $104,437,000 as at August 31, 2005 and 2006, respectively.
The
fair
value of forward exchange contracts, which represents the difference between
their contractual amounts and their current trading value, amounted to
unrecognized gains of $2,937,000 and $5,451,000 as at August 31, 2005 and
2006,
respectively.
Credit
risk
Financial
instruments that potentially subject the company to credit risk consist
primarily of cash, short-term investments, accounts receivable and forward
exchange contracts. The company’s short-term investments consist of debt
instruments issued by nine (six in 2005) quality high-credit corporations
and
trusts. The company’s cash and forward exchange contracts are held with or
issued by quality high-credit financial institutions; therefore, the company
considers the risk of non-performance on these instruments to be
remote.
Generally,
the company does not require collateral or other security from customers
for
trade accounts receivable; however, credit is extended to customers following
an
evaluation of creditworthiness. In addition, the company performs ongoing
credit
reviews of all its customers and establishes an allowance for doubtful accounts
receivable when accounts are determined to be uncollectible. Allowance for
doubtful accounts amounted to $352,000 and $451,000 as at August 31, 2005
and
2006, respectively.
Interest
rate risk
As
at
August 31, 2006, the company’s exposure to interest rate risk is summarized as
follows:
|
Cash
|
Non-interest
bearing
|
|
Short-term
investments
|
As
described above
|
|
Accounts
receivable
|
Non-interest
bearing
|
|
Accounts
payable and accrued liabilities
|
Non-interest
bearing
|
|
Long-term
debt
|
As
described in note 10
|
Forward
exchange contracts
The
company is exposed to currency risks as a result of its export sales of products
manufactured in Canada, substantially all of which are denominated in US
dollars. These risks are partially hedged by forward exchange contracts and
certain operating expenses. As at August 31, 2005 and 2006, the company held
contracts to sell US dollars at various forward rates, which are summarized
as
follows:
|
Contractual
amounts
|
|
Weighted
average contractual forward rates
|
|||||
|
As
at August 31, 2005
|
|||||||
|
September
2005 to August 2006
|
$
|
26,000
|
1.2630
|
||||
|
September
2006 to November 2007
|
7,600
|
1.2500
|
|||||
|
As
at August 31, 2006
|
|||||||
|
September
2006 to August 2007
|
$
|
37,000
|
1.1676
|
||||
|
September
2007 to June 2009
|
26,800
|
1.1261
|
|||||
| 19. |
Segment
Information
|
The
company is organized under two reportable segments: the Telecom Division
and the
Life Sciences and Industrial Division. The Telecom Division offers integrated
test solutions to network service providers, cable TV operators, system vendors
and component manufacturers throughout the global telecommunications industry.
The Life Sciences and Industrial Division mainly leverages developed and
acquired core telecom technologies for high-precision assembly and research
sectors.
The
reporting structure reflects how the company manages its business and how
it
classifies its operations for planning and measuring performance.
The
following tables present information by segment:
|
Year
ended August 31, 2006
|
Telecom
Division
|
Life
Sciences and
Industrial
Division
|
Total
|
|||||||
|
Sales
|
$
|
107,376
|
$
|
20,877
|
$
|
128,253
|
||||
|
Earnings
from operations
|
$
|
6,679
|
$
|
1,383
|
$
|
8,062
|
||||
|
Unallocated
items:
|
||||||||||
|
Interest
and other income
|
3,253
|
|||||||||
|
Foreign
exchange loss
|
(595
|
)
|
||||||||
|
Earnings
before income taxes
|
10,720
|
|||||||||
|
Income
taxes
|
2,585
|
|||||||||
|
Net
earnings for the year
|
$
|
8,135
|
||||||||
|
Government
grants (note 15)
|
$
|
(1,307
|
)
|
$
|
—
|
$
|
(1,307
|
)
|
||
|
Amortization
of capital assets
|
$
|
6,689
|
$
|
1,228
|
$
|
7,917
|
||||
|
Stock-based
compensation costs
|
$
|
962
|
$
|
70
|
$
|
1,032
|
||||
|
Impairment
of long-lived assets (note 4)
|
$
|
—
|
$
|
604
|
$
|
604
|
||||
|
Capital
expenditures
|
$
|
3,049
|
$
|
329
|
$
|
3,378
|
||||
|
Year
ended August 31, 2005
|
Telecom
Division
|
Life
Sciences and
Industrial
Division
|
Total
|
|||||||
|
Sales
|
$
|
80,120
|
$
|
17,096
|
$
|
97,216
|
||||
|
Earnings
(loss) from operations
|
$
|
763
|
$
|
(962
|
)
|
$
|
(199
|
)
|
||
|
Unallocated
items:
|
||||||||||
|
Interest
and other income
|
2,524
|
|||||||||
|
Foreign
exchange loss
|
(1,336
|
)
|
||||||||
|
Earnings
before income taxes
|
989
|
|||||||||
|
Income
taxes
|
2,623
|
|||||||||
|
Net
loss for the year
|
$
|
(1,634
|
)
|
|||||||
|
Amortization
of capital assets
|
$
|
6,504
|
$
|
2,588
|
$
|
9,092
|
||||
|
Stock-based
compensation costs
|
$
|
897
|
$
|
66
|
$
|
963
|
||||
|
Capital
expenditures
|
$
|
1,408
|
$
|
93
|
$
|
1,501
|
||||
|
Year
ended August 31, 2004
|
Telecom
Division
|
Life
Sciences and
Industrial
Division
|
Total
|
|||||||
|
Sales
|
$
|
58,882
|
$
|
15,748
|
$
|
74,630
|
||||
|
Loss
from operations
|
$
|
(5,557
|
)
|
$
|
(5,013
|
)
|
$
|
(10,570
|
)
|
|
|
Unallocated
items:
|
||||||||||
|
Interest
and other income
|
1,438
|
|||||||||
|
Foreign
exchange loss
|
(278
|
)
|
||||||||
|
Loss
before income taxes
|
(9,410
|
)
|
||||||||
|
Income
taxes
|
(986
|
)
|
||||||||
|
Net
loss for the year
|
$
|
(8,424
|
)
|
|||||||
|
Amortization
of capital assets
|
$
|
6,643
|
$
|
3,372
|
$
|
10,015
|
||||
|
Stock-based
compensation costs
|
$
|
417
|
$
|
32
|
$
|
449
|
||||
|
Impairment
of long-lived assets (note 4)
|
$
|
620
|
$
|
—
|
$
|
620
|
||||
|
Restructuring
and other charges (note 4)
|
$
|
—
|
$
|
1,261
|
$
|
1,261
|
||||
|
Capital
expenditures
|
$
|
607
|
$
|
244
|
$
|
851
|
||||
Total
assets by reportable segment are detailed as follows:
|
As
at August 31,
|
2006
|
2005
|
|||||
|
Telecom
Division
|
$
|
93,853
|
$
|
64,655
|
|||
|
Life
Sciences and Industrial Division
|
11,339
|
11,449
|
|||||
|
Unallocated
assets
|
113,967
|
114,853
|
|||||
|
$
|
219,159
|
$
|
190,957
|
||||
Unallocated
assets are comprised of cash, short-term investments and income taxes and
tax
credits recoverable.
Carrying
value of goodwill by reportable segment is detailed as follows:
|
As
at August 31,
|
2006
|
2005
|
|||||
|
Telecom
Division
|
$
|
22,545
|
$
|
16,092
|
|||
|
Life
Sciences and Industrial Division
|
4,597
|
4,278
|
|||||
|
$
|
27,142
|
$
|
20,370
|
||||
Sales
to
external customers by geographic region are detailed as follows:
|
Years
ended August 31,
|
2006
|
2005
|
2004
|
|||||||
|
United
States
|
$
|
59,457
|
$
|
56,282
|
$
|
40,019
|
||||
|
Canada
|
8,767
|
6,830
|
5,818
|
|||||||
|
Latin
America
|
8,380
|
3,127
|
3,547
|
|||||||
|
76,604
|
66,239
|
49,384
|
||||||||
|
Europe,
Middle East and Africa
|
32,379
|
19,396
|
13,706 | |||||||
|
Asia-Pacific
|
19,270
|
11,581
|
11,540
|
|||||||
|
$
|
128,253
|
$
|
97,216
|
$
|
74,630
|
|||||
Sales
were allocated to geographic regions based on the country of residence of
the
related customers. In fiscal 2004, 2005 and 2006, one customer represented
more
than 10% of sales with 13.8% of sales ($10,325,000) in fiscal 2004, 23.3%
of
sales ($22,629,000) in 2005 and 13.8% of sales ($17,706,000) in 2006. For
fiscal
2004, 2005 and 2006, the most important customer purchased from the Telecom
Division.
Long-lived
assets by geographic region are detailed as follows:
|
As
at August 31,
|
2006
|
2005
|
|||||
|
Canada
|
$
|
51,724
|
$
|
35,690
|
|||
|
United
States
|
3,758
|
5,601
|
|||||
|
$
|
55,482
|
$
|
41,291
|
||||
Long-lived
assets consist of property, plant and equipment, the long-lived asset held
for
sale, intangible assets and goodwill.
| 20. |
United
States Generally Accepted Accounting
Principles
|
As
a
registrant with the Securities and Exchange Commission in the United States
(SEC), the company is required to reconcile its financial statements for
significant differences between generally accepted accounting principles
as
applied in Canada (Canadian GAAP) and those applied in the United States
(U.S.
GAAP). Furthermore, additional significant disclosures required under U.S.
GAAP
and Regulation S-X of the SEC are also provided in the accompanying financial
statements and notes. The following summarizes the significant quantitative
differences between Canadian and U.S. GAAP, as well as other significant
disclosures required under U.S. GAAP and Regulation S-X of the SEC not already
provided in the accompanying financial statements.
Reconciliation
of net earnings (loss) to conform to U.S. GAAP
The
following summary sets out the significant differences between the company’s
reported net earnings (loss) and net earnings (loss) per share under Canadian
GAAP as compared to U.S. GAAP. Please refer to corresponding explanatory
notes
in the Reconciliation Items section.
|
Years
ended August 31,
|
2006
|
2005
|
2004
|
|||||||
|
Net
earnings (loss) for the year in accordance with Canadian GAAP
|
$
|
8,135
|
$
|
(1,634
|
)
|
$
|
(8,424
|
)
|
||
|
Stock-based
compensation costs
|
a) |
-
|
-
|
(867
|
)
|
|||||
|
Unrealized
losses on forward exchange contracts
|
b) |
-
|
(1,286
|
)
|
(280
|
)
|
||||
|
Net
earnings (loss) for the year in accordance with U.S. GAAP
|
8,135
|
(2,920
|
)
|
(9,571
|
)
|
|||||
|
Other
comprehensive income (loss)
|
||||||||||
|
Foreign
currency translation adjustment
|
12,322
|
15,669
|
5,969
|
|||||||
|
Unrealized
gains on forward exchange contracts
|
b) |
5,394
|
2,313
|
689
|
||||||
|
Reclassification
of realized gains on forward exchange contracts
in
net earnings (loss)
|
b) |
(2,880
|
)
|
(65
|
)
|
-
|
||||
|
Comprehensive
income (loss)
|
$
|
22,971
|
$
|
14,997
|
$
|
(2,913
|
)
|
|||
|
Basic
and diluted net earnings (loss) per share in accordance with
U.S. GAAP
|
$
|
0.12
|
$
|
(0.04
|
)
|
$
|
(0.14
|
)
|
||
|
Basic
weighted average number of shares outstanding (000’s)
|
68,643
|
68,526
|
66,020
|
|||||||
|
Diluted
weighted average number of shares outstanding (000’s)
|
69,275
|
68,981
|
66,615
|
|||||||
Reconciliation
of shareholders’ equity to conform to U.S. GAAP
The
following summary sets out the significant differences between the company’s
reported shareholders’ equity under Canadian GAAP as compared to U.S. GAAP.
Please refer to the corresponding explanatory note in the Reconciliation
Items
section.
|
As
at August 31,
|
2006
|
2005
|
2004
|
|||||||
|
Shareholders’
equity in accordance with Canadian GAAP
|
$
|
196,234
|
$
|
173,400
|
$
|
157,327
|
||||
|
Forward
exchange contracts
|
b) |
5,451
|
2,937
|
1,975
|
||||||
|
Goodwill
|
(11,908
|
)
|
(11,042
|
)
|
(10,008
|
)
|
||||
|
Shareholders’
equity in accordance with U.S. GAAP
|
$
|
189,777
|
$
|
165,295
|
$
|
149,294
|
||||
The
following table summarizes the shareholders’ equity activity under U.S. GAAP
since August 31, 2003:
|
Share
capital
|
Contributed
surplus
|
Deficit
|
Deferred
stock-based compensation costs
|
Other
capital
|
Accumulated
other comprehensive income
|
Shareholders’
equity
|
||||||||||||||||
|
Balance
as at August 31, 2003
|
$
|
565,291
|
$
|
1,519
|
$
|
(454,588
|
)
|
$
|
(1,278
|
)
|
$
|
5,429
|
$
|
5,219
|
$
|
121,592
|
||||||
|
Net
loss for the year
|
—
|
—
|
(9,571
|
)
|
—
|
—
|
—
|
(9,571
|
)
|
|||||||||||||
|
Stock-based
compensation costs
|
1,737
|
—
|
—
|
339
|
(760
|
)
|
—
|
1,316
|
||||||||||||||
|
Foreign
currency translation adjustment
|
—
|
—
|
—
|
—
|
—
|
5,969
|
5,969
|
|||||||||||||||
|
Unrealized
gains on forward exchange contracts
|
—
|
—
|
—
|
—
|
—
|
689
|
689
|
|||||||||||||||
|
Public
offering (note 13)
|
29,164
|
—
|
—
|
—
|
—
|
—
|
29,164
|
|||||||||||||||
|
Exercise
of stock options (note 13)
|
254
|
—
|
—
|
—
|
—
|
—
|
254
|
|||||||||||||||
|
Share
issue expenses (note 13)
|
(137
|
)
|
—
|
—
|
—
|
—
|
—
|
(137
|
)
|
|||||||||||||
|
Premium
on resale of share capital
|
—
|
18
|
—
|
—
|
—
|
—
|
18
|
|||||||||||||||
|
Balance
as at August 31, 2004
|
596,309
|
1,537
|
(464,159
|
)
|
(939
|
)
|
4,669
|
11,877
|
149,294
|
|||||||||||||
|
Net
loss for the year
|
—
|
—
|
(2,920
|
)
|
—
|
—
|
—
|
(2,920
|
)
|
|||||||||||||
|
Stock-based
compensation costs
|
1,213
|
—
|
—
|
(776
|
)
|
425
|
—
|
862
|
||||||||||||||
|
Foreign
currency translation adjustment
|
—
|
—
|
—
|
—
|
—
|
15,669
|
15,669
|
|||||||||||||||
|
Unrealized
gains on forward exchange contracts
|
—
|
—
|
—
|
—
|
—
|
2,248
|
2,248
|
|||||||||||||||
|
Exercise
of stock options (note 13)
|
148
|
—
|
—
|
—
|
—
|
—
|
148
|
|||||||||||||||
|
Share
issue expenses (note 13)
|
(6
|
)
|
—
|
—
|
—
|
—
|
—
|
(6
|
)
|
|||||||||||||
|
Balance
as at August 31, 2005
|
597,664
|
1,537
|
(467,079
|
)
|
(1,715
|
)
|
5,094
|
29,794
|
165,295
|
|||||||||||||
|
Net
earnings for the year
|
—
|
—
|
8,135
|
—
|
—
|
—
|
8,135
|
|||||||||||||||
|
Stock-based
compensation costs
|
—
|
—
|
—
|
344
|
610
|
—
|
954 | |||||||||||||||
|
Foreign
currency translation adjustment
|
—
|
—
|
—
|
—
|
—
|
12,322
|
12,322
|
|||||||||||||||
|
Unrealized
gains on forward exchange contracts
|
—
|
—
|
—
|
—
|
—
|
2,514
|
2,514
|
|||||||||||||||
|
Exercise
of stock options
|
557
|
—
|
—
|
—
|
—
|
—
|
557
|
|||||||||||||||
|
Reclassification
of stock-based compensation costs upon exercise of stock awards
(note 13)
|
200
|
—
|
—
|
—
|
(200
|
)
|
—
|
—
|
||||||||||||||
|
Balance
as at August 31, 2006
|
$
|
598,421
|
$
|
1,537
|
$
|
(458,944
|
)
|
$
|
(1,371
|
)
|
$
|
5,504
|
$
|
44,630
|
$
|
189,777
|
||||||
Accumulated
other comprehensive income is comprised of the following:
|
As
at August 31,
|
2006
|
|
2005
|
|
2004
|
|||||
|
Foreign
currency translation adjustment
|
||||||||||
|
Current
year
|
$
|
12,322
|
$
|
15,669
|
$
|
5,969
|
||||
|
Cumulative
effect of prior years
|
26,857
|
11,188
|
5,219
|
|||||||
|
39,179
|
26,857
|
11,188
|
||||||||
|
Unrealized
gains on forward exchange contracts
|
b) | |||||||||
|
Current
year
|
2,514
|
2,248
|
689
|
|||||||
|
Cumulative
effect of prior years
|
2,937
|
689
|
—
|
|||||||
|
5,451
|
2,937
|
689
|
||||||||
|
$
|
44,630
|
$
|
29,794
|
$
|
11,877
|
|||||
Statements
of cash flows
For
the
years ended August 31, 2004, 2005 and 2006, there were no significant
differences between the statements of cash flows under Canadian GAAP as compared
to U.S. GAAP, except for the subtotal before change in non-cash operating
items,
whose presentation is not permitted under U.S. GAAP.
Reconciliation
items
a)
Accounting for stock-based compensation
Until
August 31, 2003, and to conform to U.S. GAAP, the company measured stock-based
compensation costs using the intrinsic value method (APB 25, "Accounting
for
Stock Issued to Employees"). However, since September 1, 2003, and as described
in item e) below, the company accounts for stock-based compensation costs
for
awards granted after that date, using the fair value-based method to conform
to
Statement of Financial Accounting Standard (SFAS) 123, “Accounting for
Stock-Based Compensation” and subsequently, SFAS123(R), “Share-Based
Payments”.
Stock
Purchase Plan
Under
APB
25, compensation costs related to the stock purchase plan were measured as
the
difference between the fair value of the purchased stock and the purchase
price
paid by plan participants. Compensation costs were amortized to expense over
a
period of five years, being the restriction period. This plan terminated
at the
time of the Initial Public Offering on June 29, 2000. Compensation costs
related
to this plan became fully amortized during fiscal 2004.
Long-Term
Incentive Plan
Until
August 31, 2003, and under APB 25, compensation costs related to the long-term
incentive plan were measured as the difference between the market price of
the
underlying stock at the date of grant and the exercise price of the stock
option. These compensation costs were amortized to expense over the estimated
vesting period up to a maximum of four years. Compensation costs related
to
stock options granted prior to September 1, 2003, and accounted for under
APB 25
became fully amortized during fiscal 2004.
Restricted
Stock Award Plan
Under
APB
25, compensation costs related to the restricted stock award plan were measured
as the difference between the market price of the underlying stock at the
date
of grant and the exercise price of the stock award, which was nil. These
compensation costs were amortized to expense over the estimated vesting period
up to a maximum of four years, being the acquisition period. Compensation
costs
related to this plan, which were accounted for under APB 25, became fully
amortized during fiscal 2004.
Until
August 31, 2003, no compensation costs were recognized for these stock-based
compensation plans under Canadian GAAP.
b)
Forward exchange contracts
The
forward exchange contracts entered into by the company prior to September
1,
2003, did not qualify for hedge accounting treatment under SFAS 133, “Accounting
for Derivative Instruments and Hedging Activities”; accordingly, changes in the
fair value of these derivatives were charged to earnings. However, on September
1, 2003, the company implemented the documentation for the designation,
documentation and assessment of the effectiveness of its forward exchange
contracts, for the purposes of applying hedge accounting. With this
documentation in place, the forward exchange contracts entered into by the
company since September 1, 2003, qualify for hedge accounting treatment under
U.S. GAAP. Consequently, under U.S. GAAP, changes in the fair value of these
contracts are charged to other comprehensive income. Upon the recognition
of the
hedged sales, accumulated changes in fair value are reclassified in the
statements of earnings.
Under
Canadian GAAP, foreign exchange translation gains and losses on forward exchange
contracts are recognized as an adjustment of the revenue when the corresponding
sales are recorded, regardless of whether the contracts were entered into
before
or after September 1, 2003.
Based
on
the portfolio of forward exchange contracts as at August 31, 2006, the company
estimates that the portion of the unrealized gain on forward exchange contracts
as of August 31, 2006, and that will be realized and reclassified to net
earnings over the next fiscal year amounts to $2,872,000.
c)
Research and development tax credits
Under
Canadian GAAP, all research and development tax credits are recorded as a
reduction of gross research and development expenses in the statements or
earnings. Under U.S. GAAP, tax credits that are refundable against taxable
income are recorded in the income taxes. These tax credits amounted to
$1,761,000, $2,169,000 and $2,546,000 for fiscal 2004, 2005 and 2006,
respectively. This difference has no impact on the net earnings (loss) and
the
net earnings (loss) per share figures for the reporting years.
d)
Elimination of deficit by reduction of share capital
As
at
August 31, 2006, under Canadian GAAP, the company proceeded to eliminate
its
deficit against its share capital (note 13). However, under U.S. GAAP, such
elimination is not permitted, which creates a permanent difference of
$373,711,000 in the deficit and the share capital between the Canadian GAAP
and
U.S. GAAP figures. This difference has no impact on the total amount of the
shareholders’ equity.
e)
New accounting standards and pronouncements
Adopted
in fiscal 2006
In
November 2004, the Financial Accounting Standard Board (FASB) issued SFAS
151,
“Inventory Costs”, an amendment to ARB No. 43, Chapter 4. The amendments made by
SFAS 151 improves financial reporting by clarifying that any abnormal amount
of
idle facility expenses, freight, handling costs and wasted materials (spoilage)
should be recognized as current-period charges and by requiring the allocation
of fixed production overheads to inventory based on the normal capacity of
the
production facilities. This SFAS is effective for inventory costs incurred
during fiscal years beginning after June 15, 2005. The company adopted this
new
statement on September 1, 2005, and its adoption had
no
significant impact on its financial statements.
In
December 2004, the FASB issued SFAS 123(R), “Share-Based Payments”. This
statement supersedes ABP 25, “Accounting for Stock Issued to Employees” and
related implementation guidance, and revises SFAS 123 in a number of areas.
Under SFAS 123(R), all forms of sharebased payment to employees result in
compensation cost recognized in financial statements. This statement is
effective for fiscal years beginning after June 15, 2005. The company adopted
this statement on September 1, 2005, using the modified prospective application
method of transition and its adoption had no significant impact on its financial
statements.
Under
U.S. GAAP, until August 31, 2003, the company elected to measure compensation
costs related to grants of stock options and stock awards using the intrinsic
value method of accounting. In this instance, however, under SFAS 123(R),
the
company is required to make pro forma disclosures of net earnings (loss)
and net
earnings (loss) per share for any periods included in the financial statements
that ended prior to the adoption of SFAS 123(R) (i.e., fiscal 2004 and 2005)
as
if the fair value-based method of accounting had been applied to outstanding
unvested awards granted prior to September 1, 2003. Consequently, if the
fair
value-based method had been applied to these awards, the pro forma net earnings
(loss) per share would have been the same as the net earnings (loss) per
share
for all reporting periods.
The
fair
value of options or awards granted was estimated using the Black-Scholes
options
pricing model.
To
be
adopted after fiscal 2006
In
May
2005, the FASB issued SFAS 154, “Accounting Changes and Errors Corrections - a
replacement of APB Opinion No. 20 and FASB Statement No. 3”. This statement
replaces APB 20, “Accounting Changes”, and SFAS 3, “Reporting Accounting Changes
in Interim Financial Statements”, and changes the requirements for the
accounting for and reporting of a change in accounting principle. This statement
applies to all voluntary changes in accounting principle. It also applies
to
changes required by an accounting pronouncement in the unusual instance that
the
pronouncement does not include specific transition provisions. In general,
this
statement requires a company to account for the adoption of a new accounting
policy by applying the new principle to prior accounting periods as if that
principle had always been adopted. This statement is effective for accounting
changes or corrections of errors in fiscal years beginning after December
15,
2005.
In
June
2006, the FASB issued FASB Interpretation No. 48 (FIN 48), “Accounting to
Uncertainty in Income Taxes”, which clarifies the accounting for uncertainties
in income taxes recognized in accordance with SFAS 109, “Accounting for Income
Taxes”. The interpretation is effective for fiscal years beginning after
December 15, 2006. The company will adopt this interpretation on September
1,
2007, and has not yet assessed the impact its adoption will have on its
financial statements.
Board
of Directors
|
Germain
Lamonde
Chairman
of the Board,
President
and CEO, EXFO
Electro-Optical
Engineering Inc.
Germain
Lamonde, a company founder, has been Chairman of the Board, President
and
CEO of EXFO since its inception in his apartment in 1985. Mr.
Lamonde, who
is responsible for the overall management and strategic direction
of EXFO
and its subsidiaries and divisions, has grown the company from
the ground
up into a global leader in the telecommunications test and measurement
industry. Mr. Lamonde has served on the boards of several organizations
such as the Canadian Institute for Photonic Innovations, the
Pole QCA
Economic Development Corporation and the National Optics Institute
of
Canada to name a few. Germain Lamonde holds a bachelor’s degree in physics
engineering from the University of Montreal’s School of Engineering (École
Polytechnique), a master’s degree in optics from Laval University, and is
also a graduate of the Ivey Executive Program offered by the
University of
Western Ontario.
|
Dr.
David A. Thompson 2
Vice-President
and Director
Hardware
& Equipment Technology
Corning
Cable Systems
Dr.
David A. Thompson is Vice-President and Director of Hardware
&
Equipment Technology at Corning Cable Systems, where he has held
this
position since January 2006. Prior to this, he was Vice-President
and
Director of Hardware & Equipment Technology Strategy for Corning Cable
Systems from January 2002 to December 2005. Dr. Thompson first
joined
Corning Incorporated in 1976 and later took on several technology
directorship and strategic planning roles. His last position
at Corning
prior to transferring to Corning Cable Systems in January 2002 was
Division Vice-President for the Strategic Planning & Innovation
Effectiveness in Research, Development and Engineering. Dr. David
Thompson
holds a bachelor’s degree in chemistry from Ohio State University and a
doctorate in inorganic chemistry from the University of
Michigan.
|
|||
|
Pierre
Marcouiller 1,2
Chairman
of the Board and CEO,
Camoplast
Inc.
Pierre
Marcouiller is Chairman of the Board and CEO of Camoplast Inc.,
an
industrial manufacturer specializing in rubber tracks, molded
composites,
thermoplastic components and off-road tracked vehicles. Prior
to joining
Camoplast, Mr. Marcouiller was President and General Manager
of Venmar
Ventilation Inc. (1988-1996), where he was the controlling shareholder
from 1991 to 1996. Mr. Marcouiller is also a Director of Héroux- Devtek
Inc., a public company specialized in the design, development
and
manufacturing of aerospace, defense and industrial products.
Pierre
Marcouiller holds a bachelor’s degree in business administration from the
Université
du Québec à Trois-Rivières and
an MBA from the Université
de Sherbrooke.
|
André
Tremblay 1,2
Founder
and Managing Partner, Trio Capital
André
Tremblay is a Founder and Managing Partner of Trio Capital Inc.,
a private
equity fund management company. He has more than 20 years’ experience in
the telecommunications industry, having been actively involved
in the
conception, financing and management of several companies. As
a special
advisor to the President of Telesystem Ltd., and as President
of
Telesystem Enterprises Ltd. from 1992 to 1998, he managed a portfolio
of
telecommunication companies under control. For almost 10 years,
he served
as President and Chief Executive Officer of Microcell Telecommunications,
a wireless network and service provider, which he led from its
inception
on through the different phases of its evolution. During that
time, he has
also provided early-stage financing, along with strategic advice
and
direction, for start-up technology firms. In 2005, he was appointed
by
Canada’s Industry Minister as member of the Telecommunications Policy
Review Panel to make recommendations on how to modernize Canada’s
telecommunication policies and regulatory framework. André Tremblay holds
bachelor’s degrees in management and in accounting from Laval University,
a master’s degree in taxation from the Université
de Sherbrooke,
and is also a graduate of Harvard Business School’s Advanced Management
Program.
|
|||
|
Guy
Marier 1,2
Corporate
Director
Formerly
President of Bell Québec (1999 to 2003), Guy Marier completed his
successful 33-year career at Bell as Executive Vice-President
of the
Project Management Office before retiring at the end of 2003.
From 1988 to
1990, Mr. Marier headed Bell Canada International’s investments and
projects in Saudi Arabia and, for the three following years,
served as
President of Télébec. He then returned to the parent company to hold
various senior management positions. Mr. Marier currently sits
on the
board of Bell Nordiq, a wholly-owned subsidiary of Bell Canada.
Guy Marier
holds a Bachelor of Arts from the University of Montreal and
a Bachelor of
Business Administration from the Université
du Québec à Montréal.
|
Michael
Unger 1,2,3
Executive
Consultant
Michael
Unger had a distinguished career with Nortel Networks (1962 to
2000),
where he held a number of key executive positions in the switching
and
transmission business units over the years. Mr. Unger’s most recent
position was President of Nortel’s Optical Networks Business Unit (1998 to
2000). Prior to this appointment, he was Nortel’s Group Vice-President,
Transport Networks (1990 to 1998). Currently, Mr. Unger serves
on the
boards of directors and committees of several companies active
in the
areas of network management software, photonic and optical components,
optical network systems and solutions for cable operators, as
well as
other communications network service providers. Namely, he is
a board
member and chairs the audit committee of Nakina Systems, and
he is also
part of the board of directors and human resources committee
of Tundra
Semiconductor Corporation. Michael Unger holds a Bachelor of
Science from
Concordia University and has successfully completed several accounting
credits, also given by Concordia University in Montreal, Canada.
In
addition, Mr. Unger holds an executive MBA from the University
of Western
Ontario.
|
(1)
Audit Committee
(2)
Human Resources Committee
(3)
Independent Lead Director
Management
and Corporate Officers
|
Germain
Lamonde
Chairman,
President and
Chief
Executive Officer
|
Étienne
Gagnon
Vice-President,
Product Management
Optical
and Protocol Products
|
|||
|
Stephen
Bull
Vice-President,
Research and Development
Telecom
Division
|
Luc
Gagnon
Vice-President,
Telecom
Manufacturing
Operations
|
|||
|
Normand
Durocher
Vice-President
Human
Resources
|
Juan
Felipe González
Vice-President,
Telecom Sales
International
|
|||
|
Allan
Firhoj
Vice-President
and General Manager
Life
Sciences and Industrial Division
|
Pierre
Plamondon, CA
Vice-President,
Finance and
Chief
Financial Officer
|
|||
|
Robert
Fitts
Vice-President,
Product Management
Copper
Access Products
|
Dana
Yearian
Vice-President,
Telecom Sales
North
America
|
|||
|
Benoît
Ringuette
Legal
Counsel and
Corporate
Secretary
|
Corporate
Governance Practices
Corporate
governance practices have always been a priority at EXFO. We implemented
and/or
updated several corporate policies during fiscal 2005, making fiscal 2006
the
first full year during which all policies were applied. The following policies
and charters have been in force since March 2005: the Ethics and Business
Conduct Policy; Code of Ethics for Our Principal Executive Officer and Senior
Financial Officers; Board of Directors Corporate Governance Guidelines;
Statement on Reporting Ethical Violations (“whistle-blowing”); Audit Committee
Charter; Human Resources Committee Charter; Disclosure Guidelines and Securities
Trading Policy. All these policies are readily available from EXFO’s Web site,
with the exception of our Disclosure Guidelines and Securities Trading Policy.
In
addition to the above-mentioned policies, the Board of Directors and management
continued to keep abreast of new Canadian and U.S. regulatory
requirements.
The
Audit
Committee was also very active throughout the year with the implementation
of
and compliance with Sections 302 and 404 of the Sarbanes-Oxley Act of 2002,
that
apply to Canadian companies with shares registered in the U.S.
As
achieving best practices in corporate governance is an ongoing process in
an
ever-changing context, this past year, the Board of Directors also reviewed
procedures to monitor the effectiveness of the Board. The Board of Directors
believes that EXFO’s corporate governance practices do comply with current
regulatory requirements. As new guidelines come into effect, we will continue
to
comply with these requirements. Further details about our corporate governance
practices, policies and guidelines are published in the Management Proxy
Circular and on EXFO’s Web site.
Pursuant
to the General By-Laws of the Corporation, the present Board members were
elected at our last Annual and Special Meeting of Shareholders, held on January
11, 2006.
Responsibilities
of the Board
The
Board
is responsible for the stewardship of our business and affairs by reviewing,
discussing and approving our strategic direction and organizational structure,
as well as for the review and approval of management’s strategic plan on an
annual basis. The Board also identifies the principal risks of our business
and
reviews our risk management systems on an annual and ongoing basis.
In
addition to matters requiring Board approval under applicable laws, the Board
grants final approval with respect to each of the following: (i) the strategic
direction of EXFO; (ii) material contracts, acquisitions or dispositions
of our
assets; and (iii) the annual operational plan, as well as capital and operating
budgets.
The
Board
of Directors assumes direct responsibility for corporate governance
practices and for monitoring the powers, the mandates and the
performance of the committees.
The
Board
is also responsible for the establishment and functioning of all Board
committees, the appointment of members to serve on such committees, their
compensation and their good standing. At regularly scheduled meetings of
the
Board, the Directors receive, consider and discuss committee
reports.
During
the fiscal year ended August 31, 2006, the Board met a total of seven (7)
times.
Attendance was satisfactory, as all members attended all meetings except
for Mr.
Thompson, who was absent for three (3) meetings and Mr. Tremblay who was
absent
for one (1) meeting.
Mr.
Michael Unger, Chairman of the Human Resources Committee and independent
Director of EXFO, is the Lead Director. As such, he is responsible for ensuring
that the Board properly discharges its duties, independent of management.
The
Lead Director is required to hold as many Board of Directors meetings as
necessary without management members present, and additional meetings of
independent Board members may be held at any member's request.
In
March
2005, the Corporation also adopted a Human Resources Committee Charter, which
integrates the Compensation Committee Charter and the Nominating and Governance
Committee Charter. Therefore, the Corporation has a formal procedure in place
for recruiting new Directors.
Composition
of the Board
Our
articles of incorporation provide for a Board of Directors with a minimum
of
three (3) and a maximum of twelve (12) Directors. Our Board presently consists
of six (6) Directors, five (5) of whom are independent of management and
free
from any interest and any business or other relationship which could, or
could
reasonably be perceived to, materially interfere with a Director’s ability to
act with a view to the best interests of EXFO, other than interests arising
from
non-significant shareholding. Our Directors are elected at the Annual General
Meeting of Shareholders for one-year terms and serve until their successors
are
elected or appointed, unless they resign or are removed earlier.
Our
Chairman of the Board and Chief Executive Officer, Mr. Germain Lamonde, is
a
significant shareholder of EXFO as he has the ability to exercise a majority
of
the votes for the election of the Board of Directors. Since the other five
(5)
Board members do not have interests in EXFO or relationships with either
EXFO or
Mr. Lamonde, except for non-significant shareholding in the company, we believe
that the interests of investors in EXFO, other than Mr. Lamonde’s, are fairly
represented.
Committees
of the Board
Board
committees play a significant role in the discharge of Board duties and
obligations; committee chairs submit items for Board agendas and report on
committee activities. The members of these committees are appointed annually,
and the Board may appoint additional ad hoc committees periodically, as needed.
EXFO has a practice of permitting the Board, any committee thereof, and any
individual Director to hire independent, external advisors at our expense.
The
Audit Committee and the Human Resources Committee are entirely comprised
of
independent Directors.
The
following is a general description of the composition and general duties
of each
Board committee, as contained in its mandate as at fiscal year ended August
31,
2006.
Audit
Committee
The
Board
of Directors updated and amended the Audit Committee Charter to fully comply
with all applicable regulations. The Audit Committee reviews interim in-house
financial statements and annual audited financial statements and related
disclosure documents, including “Management’s Discussion and Analysis of
Financial Condition and Results of Operations”, with management and external
auditors and approves them prior to public release. The Audit Committee is
responsible for reviewing our internal control systems with regard to finance,
accounting, legal compliance and ethical behavior. The Committee meets regularly
with external auditors, with and without management, to consider the scope
and
results of their audits, including analysis of the adequacy of the internal
controls and the effect of the procedures relating to the outside auditors’
independence. The Committee also recommends to the shareholders the selection
of
external auditors for their appointment by the shareholders. The Audit Committee
is comprised of the following independent Directors: Mr. Pierre Marcouiller,
Mr.
Guy Marier, Mr. André Tremblay and Mr. Michael Unger. The Chair of the Audit
Committee is Mr. Tremblay. During the fiscal year ended August 31, 2006,
the
Audit Committee met a total of five (5) times and attendance was exemplary
as
all members attended all meetings, except for Mr. Unger who was absent for
one
(1) meeting.
Human
Resources Committee
In
March
2005, the Company implemented its Human Resources Committee Charter, which
integrates the Compensation Committee Charter and the Nominating and Governance
Committee Charter to fully comply with all applicable regulations.
In
accordance with these charters, the Human Resources Committee is responsible
for
assessing the performance and establishing the annual compensation of all
our
senior officers, including the CEO.
This
Committee also reviews and submits to the Board the salary structure and
the
short-term and long-term incentive compensation programs for all our
employees.
The
Committee is responsible for the review and approval of the employees who
will
receive restricted share units (RSUs) and options to purchase EXFO shares
in
accordance with policies established by the Board and the terms of the Long-Term
Incentive Plan. In addition, the Committee reports annually to the Board
regarding the organizational structure and succession plan for senior
management. The remuneration to be paid by EXFO to the Directors, either
in cash
or in the form of deferred share units (DSUs) pursuant to the Deferred Share
Unit Plan, is recommended to the Board by the Human Resources Committee.
The
Human Resources Committee is comprised of the following independent Directors:
Mr. Pierre Marcouiller, Mr. Guy Marier, Dr. David A. Thompson, Mr. André
Tremblay and Mr. Michael Unger. The Chair of the Human Resources Committee
is
Mr. Unger. During the fiscal year ended August 31, 2006, the Human Resources
Committee met a total of five (5) times and attendance was satisfactory,
as all
members attended all meetings except for Mr. Thompson, who was absent for
three
(3) meetings and Mr. Tremblay who was absent for one (1) meeting.
Disclosure
Committee
The
Board
of Directors also updated the Disclosure Guidelines to fully comply with
all
applicable regulations. The Disclosure Committee is responsible for overseeing
our disclosure practices. The Disclosure Committee consists of the Chief
Executive Officer, Chief Financial Officer, Investor Relations Manager, Manager
of Financial Reporting and Accounting, as well as Legal Counsel and Corporate
Secretary.
During
the year ended August 31, 2006, the Disclosure Committee ensured that the
corporate governance and disclosure policies adopted by the Board of Directors
in March 2005 were made publicly available. This was done by posting the
following documents on our Web site: The Audit Committee Charter; Board of
Directors Corporate Governance Guidelines; Code of Ethics for Our Principal
Executive Officer and Senior Financial Officers; Ethics and Business Conduct
Policy; Human Resources Committee Charter; and Statement on Reporting Ethical
Violations. The Disclosure Committee also ensured that a contact to the Lead
Director and the Legal Counsel was made available via the Corporation’s Web
site.
Shareholder/Investor
Communications and Feedback
The
Chief
Financial Officer assumes responsibility for investor relations. He is
responsible for facilitating communications between senior management and
EXFO’s
shareholders and financial analysts. Information to shareholders is disseminated
through annual and quarterly reports, press releases, proxy circular, the
Annual
General Shareholders’ Meeting and investor presentations. EXFO receives and
responds to all shareholders’ inquiries in an appropriate and timely manner. In
communications to senior management, the Chief Financial Officer also provides
feedback from shareholders.
Securities
Trading Policy
In
March
2005, the Board of Directors of the Corporation updated the Securities Policy
to
fully comply with applicable regulations. This policy is among the necessary
measures to prevent trading by persons in possession of Material
Information.
Glossary
Asymmetric
Digital Subscriber Line (ADSL): Transmission
technology that consists of modems attached to twisted-pair copper wiring
that
transmit from 1.5 Mb/s to 8 Mb/s downstream (to the subscriber) and up to
1.5
Mb/s upstream, depending on line distance. See also Digital Subscriber Line
and
Twisted-Pair Copper.
Circuit-Switched
Network: A
type of
network in which a continuous link is established between a source and a
receiver. Circuit-switching is used for voice and video to ensure that
individual parts of a signal are received in the correct order by the
destination site.
Digital
Subscriber Line (DSL): The
generic term that refers to the entire family of DSL technologies. DSL refers
to
digital modems placed at either end of a local loop. DSL bypasses the
circuit-switched lines that make up that network and yields much faster data
transmission rates than analog modem technologies.
Ethernet:
Protocol
for data networking. Ethernet networks typically operate at
10,
100 or 1000 Mb/s.
Ethernet
Passive Optical Network (EPON): A
type of
PON technology that runs on the Ethernet protocol. EPON is applicable for
data-centric networks, as well as full-s ervice voice, data and video networks.
See Passive Optical Network.
Fiber-to-the-x
(FTTx) Technology: The
x in
fiber-to-the-x is a variable indicating the point at which the fiber in a
network stops and copper (coaxial or twisted-pair) cabling takes over. The
further the fiber goes, the wider the bandwidth, the quicker the speed, and
the
more applications and services can be offered.
Fiber-to-the-Curb
(FTTC): Network
in which fiber is installed typically within 1000 feet of the premises, leaving
the curb-to-building section made out of twisted-pair copper cable.
Fiber-to-the-Node
(FTTN): Network
in which fiber is used for part, but not all, of the link from the fiber
distribution hub to the end-user. An optical-toelectrical conversion takes
place
at an active device called a node, which typically serves a neighborhood
or
geographically similar area. Most current cable TV and telephony networks
have
FTTN architectures.
Gigabit
Passive Optical Network (GPON): A
further
evolution of PON technology. The GPON is optimized to support higher data
rates,
greater distances and higher split ratios than other PON technologies, and
it is
particularly useful for delay-sensitive traffic such as voice and video
communications. See Passive Optical Network.
Internet
Protocol (IP): Method
or
protocol by which data is sent from one computer to another on the Internet.
Each computer on the Internet has at least one IP address that uniquely
identifies it from all other computers on the Internet. Because of these
standardized IP addresses, the gateway receiving the data can keep track
of,
recognize and route messages appropriately.
Metropolitan
Network: Metropolitan
area network (MAN). A network, often ringed in structure, that covers an
entire
city and its suburbs.
Optical
Time-Domain Reflectometer (OTDR): Instrument
for evaluating optical fiber based on detecting and measuring backscattered
(reflected) light. Used to measure fiber length and attenuation, evaluate
splice
and connector joints, locate faults and certify cabling systems.
Nanometer-Scale
Positioning: Also
known as nanopositioning. A positioning technique used during optical component
manufacturing to align components with a precision measured in nanometers
(one
billionth of a meter).
Packet:
Bits
grouped serially in a defined format, containing a command or data message
sent
over a network. Same as a frame.
Passive
Optical Network (PON): Network
in which fiber-optic cabling (instead of copper) brings signals all or most
of
the way to the end-user. It is described as passive because no active equipment
(electrically powered) is required between the central office (or hub) and
the
customer premises. Depending on where the PON terminates, the system can
be
described as an FTTx network, which typically allows a point-to-point or
point-to-multipoint connection from the central office to the subscriber’s
premises; in a point-tomultipoint architecture, a number of subscribers (for
example, up to 32) can be connected to just one of the various feeder fibers
located in a fiber distribution hub, dramatically reducing network installation,
management and maintenance costs.
Piezoelectric
(PZT) Technology: Technology
of piezoelectricity, which refers to the electrical field created by some
ceramic materials when subjected to pressure. Precision positioning devices
use
the inverse effect; that is, when an electric field is applied to a
piezoelectric material, it changes shape, and this shape change is used to
create precise mechanical movements.
Protocol:
A
formal
set of rules governing the format, timing, sequencing and error control of
data
exchange across a network. Many protocols may be required and used on a single
network.
SDH:
Synchronous
Digital Hierarchy. Standardized by the International Telecommunication Union
(ITU-TSS). A protocol for transmitting information over optical fiber.
SONET:
Synchronous
Optical NETwork. Standardized by the American National Standards Institute
(ANSI). A protocol for backbone networks capable of transmitting at extremely
high speeds and accommodating gigabit-level bandwidth.
Spot
Curing: Technology
by which a dose of energy of a specific wavelength band and irradiance is
used
to cause an adhesive, encapsulant or sealant to change from a liquid to a
solid
in a small area.
Triple-Play
Services: Also
known as bundled services. The ability of a telecommunications carrier to
supply
voice, data and video applications at once. A typical example of a triple-play
proposal would include one or multiple phone lines, a high-speed Internet
connection and television/video services (such as HDTV), all offered by the
same
provider.
Twisted-Pair
Copper: The
set
of two copper wires used to connect a telephone customer with a switching
office. A twisted pair is loosely wrapped around each other to minimize
interference from other twisted pairs in the same bundle.
Very-High-Data-Rate
Digital Subscriber Line (VDSL): A
developing technology that promises much higher data rates over relatively
short
distances (up to 52 Mb/s over lines up to 1,000 ft or 300 m in length). It
is
envisioned that VDSL may emerge somewhat after ADSL is widely deployed and
coexist with it.
Voice-over-Internet-Protocol
(VoIP): Refers
to
communications services— voice, facsimile and/or voice-messaging
applications—that are transported via the Internet, rather than the public
switched telephone network. In an Internetbased telephone call, the voice
signals are converted to digital format and compressed/translated into Internet
protocol (IP) packets for transmission over the Internet; the process is
reversed at the receiving end.
Shareholder
Information
The
subordinate voting shares of EXFO are listed on the Toronto Stock Exchange
under
the stock symbol “EXF” and on the NASDAQ Global Market under the stock symbol
“EXFO”.
Annual
General Meeting
The
Annual General Meeting of Shareholders of EXFO Electro-Optical Engineering
Inc.
will be held on January 10, 2007, 10 a.m., at the NASDAQ MarketSite, 4 Times
Square, New York, NY.
Transfer
Agents and Registrars
|
Canada
|
United
States
|
|
CIBC
Mellon Trust Company
|
Mellon
Investor Services, LLC
|
|
2001
University Street
|
Overpeck
Center
|
|
Suite
1600
|
85
Challenger Road
|
|
Montreal,
Quebec H3A 2A6
|
Ridgefield
Park, New Jersey 07660
|
|
Tel.:
(514) 285-3600
|
Tel.:
(201) 296-4000
|
Independent
Auditors
PricewaterhouseCoopers
LLP
Place
de
la Cité, Tour Cominar
2640
Blvd. Laurier, Suite 1700
Sainte-Foy,
Quebec G1V 5C2
Tel.:
(418) 522-7001
Contact
Information
|
General
Access
|
Investor
Relations
|
|
EXFO
Electro-Optical Engineering Inc.
|
Vance
Oliver
|
|
400
Godin Avenue
|
Manager,
Investor Relations
|
|
Quebec,
Quebec G1M 2K2
|
Tel.:
(418) 683-0913, Ext. 3733
|
|
Tel.:
(418) 683-0211
|
E-mail:
vance.oliver@exfo.com
|
|
E-mail:
ir@exfo.com
www.EXFO.com
|
The
Annual Report is available in English and in French, both in print and on
our
Web site at www.EXFO.com.
Stock
Performance for Fiscal 2006
Notes
Worldwide
Offices
|
EXFO
Corporate Headquarters
400
Godin Avenue
Quebec
City (Quebec) G1M 2K2 CANADA
Tel.:
1 800 663-3936 (USA and Canada)
or
1 418 683-0211 Fax: 1 418 683-2170
|
EXFO
Europe
Omega
Enterprise Park, Electron Way
Chandlers
Ford, Hampshire S053 4SE ENGLAND
Tel.:
+44 2380 246810 Fax: +44 2380 246801
|
|
EXFO
Protocol
2650
Marie-Curie West
St-Laurent
(Quebec) H4S 2C3 CANADA
Tel.:
1 888 972-7666 (USA and Canada)
or
1 514 856-2222 Fax: 1 514 856-2232
|
EXFO
Asia
151
Chin Swee Road, #03-29
Manhattan
House SINGAPORE 169876
Tel.:
+65 6333 8241 Fax: +65 6333 8242
|
|
EXFO
Photonic Solutions Inc.
2260
Argentia Road
Mississauga
(Ontario) L5N 6H7 CANADA
Tel.:
(905) 821-2600 Fax: (905) 821-2055
|
EXFO
China
No.88
Fuhua First Road
Central
Tower, Room 801
Futian
District
Shenzhen
518048, P.R. CHINA
Tel.:
+86 (755) 8203 2300 Fax: +86 (755) 8203 2306
|
|
EXFO
Consultronics
160
Drumlin Circle
Concord
(Ontario) L4K 3E5 Canada
Tel:
905-738-3741 Fax: 905-738-3712
|
Beijing
New Century Hotel Office Tower
Room
1754-1755
No.
6 Southern Capital Gym Road
Beijing
100044 P. R. CHINA
Tel.:
+86 (10) 6849 2738 Fax: +86 (10) 6849 2662
|
|
EXFO
America
3701
Plano Parkway, Suite 160
Plano,
TX 75075 USA
Tel.:
1 800 663-3936
or
1 972 907-1505 Fax: 1 972 836-0164
|
EXFO
Japan
4-6-3-202
Akasaka, Minato-ku
Tokyo
107-0052, JAPAN
Tel.:
+81-3-5562-5344 Fax:
+81-3-5562-5777
|
|
Telecom
Test and Measurement
|
www.EXFO.com
|
|
|
©
2006
EXFO Electro-Optical Engineering Inc. All rights
reserved. Printed in Canada.
|
Quebec
City, November 1, 2006
RE:
Annual General Meeting of Shareholders
Dear
Shareholder:
Following
the completion of fiscal 2006, I am pleased to report significant growth in
revenue and profitability for your company. I am convinced that these results
compare favorably to those of our peers, and that we’re better positioned than
ever to take advantage of the vibrant telecom industry offering excellent
long-term market perspectives.
Fiscal
2006 was a very productive year as demonstrated by the performance highlights
listed below. These excellent results were achieved despite a strong headwind
from the strengthening Canadian dollar, customers consolidating and competitors
intensifying pricing pressure.
Performance
Highlights
| · |
Increased
sales 31.9% to $128.3 million in 2006 mainly through organic
growth;
|
| · |
Delivered
sales growth of 34.0% and 22.1% year-over-year for our Telecom Division
and Life Sciences & Industrial Division,
respectively;
|
| · |
Posted
sales CAGRs of 27.5% and 20.9% over the last three and ten years,
respectively, despite a major telecom crisis in 2001;
|
| · |
Achieved
GAAP net earnings of $8.1 million and GAAP operating margin of
6.3%;
|
| · |
Generated
$0.31 in earnings before income taxes for every additional dollar
of
revenue in 2006 over 2005;
|
| · |
Produced
$12.3 million in cash flows from operating
activities;
|
| · |
Derived
37.1% of sales from new products on the market two years or
less;
|
| · |
Acquired
Consultronics for $19.1 million in cash, strategically positioning
EXFO
for the triple-play, broadband access test
market;
|
| · |
Consolidated
leadership position in the portable optical test market with a third
consecutive Growth Strategy Leadership Award from Frost & Sullivan for
achieving highest organic market-share
gains;
|
| · |
Posted
best sales and bookings year in company history for protocol business,
which is growing much faster than our Telecom Division;
and
|
| · |
Received
Product Differentiation Innovation Award from Frost & Sullivan for new
portfolio of protocol test solutions dedicated to next-generation
and
traditional SONET/SDH networks.
|
Fiscal
2007 Corporate Objectives
EXFO
remains committed to best practices in corporate governance and, as such, I
am
pleased to provide the following performance metrics for fiscal 2007. Please
note that these management team goals should not be confused with guidance.
| · |
Grow
revenues by 20% year-over-year;
|
| · |
Generate
a GAAP operating margin of 7%; and
|
| · |
Derive
35% of sales from new products (on the market two years or
less).
|
I
will
discuss these objectives in greater detail at our upcoming Annual General
Meeting of Shareholders. Please consider this letter as a formal invitation
to
attend our Meeting, which will be held on January 10, 2007, 10 a.m.,
at the NASDAQ MarketSite, 4 Times Square, New York. (The entrance is located
on
Broadway between 42nd
and
43rd
streets).
Details
of the business to be conducted at the Meeting are provided in the attached
Management Proxy Circular and Notice of Annual General Meeting of
Shareholders.
It
is
important that your shares be represented at the Meeting. WHETHER
OR NOT YOU PLAN TO ATTEND THE MEETING, PLEASE COMPLETE, SIGN, DATE AND PROMPTLY
RETURN THE ACCOMPANYING PROXY IN THE ENCLOSED POSTAGE-PAID
ENVELOPE.
If
you
send in your proxy card and then decide to attend the Meeting to vote your
shares in person, you may still do so. Your proxy is revocable in accordance
with the procedures set forth in the Management Proxy Circular.
On
behalf
of the Board of Directors, I would like to express our appreciation for your
continued interest in EXFO. We look forward to seeing you at the
Meeting.
Sincerely,
/s/
Germain Lamonde
Germain
Lamonde
Chairman,
President and
Chief
Executive Officer
EXFO
Electro-Optical Engineering Inc.
EXFO
ELECTRO-OPTICAL ENGINEERING INC.
_________________________
NOTICE
OF
ANNUAL GENERAL MEETING OF
SHAREHOLDERS
NOTICE
IS HEREBY GIVEN that
the
Annual General Meeting (the "Meeting") of shareholders of EXFO Electro-Optical
Engineering Inc. (the "Corporation") will be held at 10:00 a.m. (Eastern
Standard Time), on Wednesday, January 10, 2007, at the NASDAQ MarketSite,
4
Times Square (MarketSite entrance is located on Broadway between 42nd
and
43rd
Street),
New York, NY 10036, USA for the following purposes:
| 1. |
to
receive the consolidated financial statements of the Corporation
for the
financial year ended August 31, 2006, and the Auditor’s report
thereon;
|
| 2. |
to
elect Directors of the Corporation;
|
| 3. |
to
appoint PricewaterhouseCoopers LLP as auditors and to authorize the
Audit
Committee to fix their remuneration;
|
| 4. |
to
transact such further or other business as may properly come before
the
Meeting or any adjournment or adjournments
thereof.
|
Enclosed
is a copy of the 2006 Annual Report of the Corporation including the
consolidated financial statements and the Auditor’s Report thereon, together
with the Management Proxy Circular and a form of Proxy.
DATED
at
Quebec, Province of Quebec, this 1st
day of
November, 2006.
BY
ORDER OF THE BOARD OF DIRECTORS
/s/
Benoit Ringuette
Benoit
Ringuette
Secretary
Shareholders
unable to attend the Meeting are requested to complete the enclosed proxy
form
and return it in the envelope provided. To be valid, proxies must reach the
office of CIBC Mellon Trust Company, 2001 University Street, Suite 1600,
Montreal, Quebec, Canada, H3A 2A6, no later than the last day prior to the
date
of the Meeting or any reconvening of the Meeting in case of adjournment.
Shareholders may also have the proxy form delivered to the Chairman of the
Meeting prior to the time of voting on the day of the Meeting or any adjournment
thereof.
MANAGEMENT
PROXY CIRCULAR OF THE CORPORATION
FOR
THE
ANNUAL GENERAL MEETING OF SHAREHOLDERS
THIS
PROXY IS SOLICITED BY THE MANAGEMENT OF THE CORPORATION
The
undersigned shareholder of EXFO ELECTRO-OPTICAL ENGINEERING INC. hereby appoints
(CHECK EITHER (A) or (B)):
|
o
(A)
|
Mr.
Germain Lamonde of Cap-Rouge, Quebec, or failing him, Mr. Pierre
Plamondon
of Quebec, Quebec;
|
o
(B) ___________________________________________
of ______________________________________________;
(Name) (Address)
as
the
representative of the undersigned to attend, act and vote on behalf of the
undersigned at the Annual
General Meeting of the shareholders (the "Meeting") of the Corporation to
be
held at the NASDAQ MarketSite, 4 Times Square (MarketSite entrance is located
on
Broadway between 42nd
and 43rd
Street, New York, NY 10036, USA, on January 10, 2007, at 10:00 o’clock a.m.
(Eastern Standard Time) and at any adjournments of such
meeting.
The
undersigned wishes that all shares represented by this proxy be voted in
accordance with the instructions hereinbelow. All shares represented by this
proxy will be voted for or be the subject of abstentions, as specified by
the
shareholder. However, in the absence of instructions, the shares represented
by
proxy will be voted in favor of each of the proposals set forth
herein.
(MARK
WITH AN X)
|
To
elect Germain Lamonde, Pierre Marcouiller, Guy Marier, David A.
Thompson,
André Tremblay and Michael Unger, whose cities of residence are indicated
in the Management Proxy Circular, as Directors of the
Corporation.
|
FOR
ABSTENTION
|
o
o
|
|
To
appoint PricewaterhouseCoopers LLP as auditors and to authorize
the Audit
Committee to fix their remuneration.
|
FOR
ABSTENTION
|
o
o
|
A
DISCRETIONARY POWER IS HEREBY CONFERRED as to any amendment or change made
to
the matters mentioned in the Notice of Meeting or as to such other matters
as
may legally come before the Meeting. The Management of the Corporation is
not
aware of any amendments, changes or other matters that may come before the
Meeting.
|
*
A shareholder is entitled to appoint, to attend and act for and
on behalf
of such shareholder at the Meeting, a person other than the person
mentioned in (A) herein above and may do so by checking (B) hereinabove
and adding the name of such other person in the space reserved
for such
purpose.
|
DATED
this day of
__________________________________________
SIGNATURE
OF SHAREHOLDER
[ ]
name
of shareholder
[
]
|
This
proxy must be signed by the shareholder or his proxyholder authorized in
writing
or, if the shareholder is a corporation, under its corporate seal, by a duly
authorized officer or proxyholder of the corporation. Please remember to
date
and sign this proxy. If this proxy is not dated, it will be deemed to bear
the
date of its mailing by Management.
YOU
ARE REFERRED TO THE MANAGEMENT PROXY CIRCULAR APPENDED.
Français
au verso
EXFO
Electro-Optical Engineering Inc.
MANAGEMENT
PROXY CIRCULAR
SOLICITATION
OF PROXIES
This
Management Proxy Circular is provided in connection with the solicitation by
the
Management of EXFO Electro-Optical Engineering Inc. (the "Corporation" or
"EXFO") of proxies to be used at the Annual Meeting of Shareholders (the
"Meeting") of the Corporation to be held at the time and place and for the
purposes stated in the accompanying Notice of Meeting and at any adjournment
thereof. Unless otherwise indicated, the information contained herein is given
as of November 1, 2006.
It
is
expected that the solicitation will be made primarily by mail but proxies may
also be solicited personally by officers, employees or agents of the
Corporation. The Corporation may also reimburse brokers and other persons
holding shares in their names, or in the names of nominees, for their costs
incurred in sending proxy material to principals and obtaining their proxies.
The cost of solicitation will be borne by the Corporation and is expected to
be
nominal.
APPOINTMENT
AND REVOCATION OF PROXIES AND ATTENDANCE OF BENEFICIAL
SHAREHOLDERS
The
persons named in the enclosed Form of Proxy (the "Form
of
Proxy")
are
officers of the Corporation. A shareholder
desiring to appoint some other person (who need not be a shareholder) to
represent him or her at the Meeting may do so by inserting such person’s name in
the blank space provided in the Form of Proxy and checking item
(B).
To
be
valid, proxies must be received at the Montreal, Canada office of CIBC Mellon
Trust Company, 2001 University Street, Suite 1600, Montreal, Quebec,
Canada, H3A 2A6, the transfer agent of the Corporation, no later than the close
of business on the last business day preceding the day of the Meeting or any
adjournment thereof, or proxies may be delivered to the Chairman of the Meeting
on the day of the Meeting or any adjournment thereof. A beneficial shareholder
who completes a Form of Proxy and who wishes to attend and vote at the Meeting
personally must appoint himself or herself proxy holder in the foregoing
manner.
A
proxy
given pursuant to this solicitation may be revoked by instrument in writing
executed by the shareholder or by his or her attorney authorized in writing
if
such instrument is deposited either at the registered office of the Corporation
to the attention of the Secretary no later than the close of business on the
last business day preceding the day of the Meeting or any adjournment thereof
or
with the Chairman of the Meeting on the day of the Meeting or any adjournment
thereof.
VOTING
OF PROXIES
The
shares represented by proxies appointing the persons, or any one of them,
designated by Management thereon to represent the shareholder at the Meeting
will be voted in accordance with the instructions given by the shareholder.
Unless
otherwise indicated, the voting rights attaching to the shares represented
by a
Form of Proxy will be voted “FOR” in respect of all the proposals described
herein.
The
Form
of Proxy confers discretionary authority upon the persons named therein with
respect to amendments or variations to matters identified in the accompanying
Notice of Meeting. As at the date hereof, Management is not aware that any
other
matter is to be presented at the Meeting. If, however, other matters properly
come before the Meeting, the persons designated in the Form of Proxy will vote
thereon in accordance with their judgment pursuant to the discretionary
authority conferred by such proxy with respect to such matters.
VOTING
SHARES AND PRINCIPAL HOLDERS THEREOF
As
at
November 1, 2006, 31,632,857 Subordinate Voting Shares and 37,143,000 Multiple
Voting Shares were outstanding, being the only classes of shares entitled to
be
voted at the Meeting. Each holder of Subordinate Voting Shares is entitled
to
one vote and the holder of Multiple Voting Shares is entitled to 10 votes for
each share registered in his or her name at the close of business on
November
21,
2006, being the date fixed by the Board of Directors for the purpose of
determining registered shareholders entitled to receive the accompanying Notice
of Meeting and to vote (the “Record Date”). A list of shareholders entitled to
vote as of the Record Date, showing the number of shares held by each
shareholder, shall be prepared within 10 days of the Record Date. This list
of
shareholders will be available for inspection during normal business hours
at
the Montreal, Canada office of CIBC Mellon Trust Company, the transfer agent
of
the Corporation, 2001 University Street, Suite 1600, Montreal, Quebec, Canada,
H3A 2A6, and at the Meeting.
Unless
otherwise indicated, the resolutions submitted to a vote at the Meeting must
be
passed by a majority of the votes cast by the holders of Subordinate Voting
Shares and Multiple Voting Shares, as a single class, present at the Meeting
in
person or by proxy and voting in respect of all resolutions to be voted on
by
the shareholders of the Corporation.
To
the
knowledge of executive officers and directors of the Corporation, as of November
1, 2006, the only persons who are beneficial owners or who exercise control
or
direction, directly or indirectly, over shares carrying more than 10% of the
voting rights attaching to any class of shares of the Corporation
are:
|
Name
of Shareholder
|
Number
of Subordinate Voting Shares
|
Percentage
of Voting Rights Attached to All Subordinate Voting
Shares
|
Number
of Multiple Voting Shares (1)
|
Percentage
of Voting Rights Attached to All Multiple Voting
Shares
|
Percentage
of Voting Rights Attached to All Subordinate and Multiple Voting
Shares
|
|
Germain
Lamonde
|
483,500(2)
|
1.53%
|
37,143,000(3)
|
100%
|
92.27%
|
|
FMR
Corporation
|
4,624,700(4)
|
14.62%
|
-
|
-
|
1.15%
|
|
Kern
Capital Management LLC
|
4,596,700(5)
|
14.53%
|
-
|
-
|
1.14%
|
| (1) |
The
holder of Multiple Voting Shares is entitled to 10 votes for each
share.
|
| (2) |
Mr.
Lamonde exercises control over this number of Subordinate Voting
Shares
through G. Lamonde Investissements Financiers inc., a company
controlled by Mr. Lamonde.
|
| (3) |
Mr.
Lamonde exercises control over this number of Multiple Voting Shares
through G. Lamonde Investissements Financiers inc., a company
controlled by Mr. Lamonde and through Fiducie Germain Lamonde, a
family
trust for the benefit of Mr. Lamonde’s
family.
|
| (4) |
As
of September 30, 2006, Fidelity
Management and Research Company, a wholly-owned subsidiary of FMR
Corporation, is the beneficial owner of this number of subordinate
voting
shares as a result of acting as investment advisor to various investment
companies.
|
| (5) |
As
of September 30, 2006, Kern Capital Management LLC controls the voting
rights attached to this number of subordinate voting shares through
relationships with several clients and does not beneficially own
directly
this number of subordinate voting
shares.
|
ELECTRONIC
DELIVERY
The
Corporation has a voluntary program for e-mail notification to our shareholders
that documents which must be delivered pursuant to securities legislation are
available on EXFO’s website. Every year, EXFO delivers documentation to
shareholders, such as this Management Proxy Circular and its Annual Report
that
must be delivered to shareholders of a public company by law. EXFO has made
this
process more convenient for its shareholders, as shareholders who so wish,
may
be notified by e-mail when the Corporation’s documentation is posted in the
"Investors"
section
on its website (www.exfo.com).
Accordingly such documentation will not be sent in paper form by mail. The
Corporation believes that electronic delivery will benefit the environment
and
reduce its costs. Shareholders who do not consent to receive documentation
by
e-mail will continue to receive such documentation by mail.
Registered
shareholders can consent to electronic delivery by completing and returning
the
consent form accompanying this Circular to CIBC Mellon Trust Company.
Unregistered shareholders (i.e. shares are held through a securities
broker, bank, trust company or other nominee) can consent to electronic delivery
by completing and returning the appropriate form received from the applicable
intermediary.
BUSINESS
TO BE TRANSACTED AT THE MEETING
Presentation
of the Financial Statements
The
consolidated financial statements of the Corporation for the financial year
ended August 31, 2006 and the Auditors’ report thereon contained in
EXFO’s Annual Report accompanying this Circular will be submitted to
shareholders at the Meeting but no vote with respect thereto is required or
proposed to be taken.
Election
of the Directors
According
to the articles of the Corporation, the Board of Directors shall consist of
a
minimum of three (3) and a maximum of twelve (12) directors. At the Meeting,
Management proposes the 6 persons named hereafter on pages 3 and 4 as nominees
for election as directors to hold office until the next annual meeting or until
the office is otherwise vacated in accordance with the Corporation’s
by-laws.
Management
does not anticipate that any of the nominees will be unable, or for any reason
whatsoever, be reluctant to fulfill their duties as directors. Should this
occur
for any reason whatsoever before the election, the persons named in the Form
of
Proxy reserve the right to vote for another nominee of their choice unless
the
shareholder specified on the Form of Proxy to abstain from voting for the
election of the directors. The election of the directors must be approved by
a
majority of the votes cast on the matter at the Meeting.
Appointment
and Remuneration of Auditors
A
firm of
auditors is to be appointed by vote of the shareholders at the Meeting to serve
as auditors of the Corporation until the close of the next annual meeting.
The
Audit Committee is to be authorized to fix the remuneration of the auditors
so
appointed. The Board of Directors and Management, upon the advice of the Audit
Committee, recommend that PricewaterhouseCoopers LLP be re-appointed as Auditors
of the Corporation. The re-appointment of PricewaterhouseCoopers LLP must be
approved by a majority of the votes cast on the matter at the
Meeting.
NOMINEES
FOR ELECTION AS DIRECTORS AND THEIR BENEFICIAL OWNERSHIP OF VOTING
SECURITIES
The
following table and notes set out the name of each of the individuals whom
is
proposed to be nominated at the Meeting for election as a director of the
Corporation, all other positions and offices with the Corporation and its
subsidiaries now held by each such individual, if any, the principal occupation
or employment of each such individual, their respective period of service as
a
director and the approximate number of shares of the Corporation beneficially
owned by each such individual or over which each of them exercised control
or
direction.
|
Name
and Position or Office with the Corporation
|
Principal
Occupation or Employment
|
Residence
|
Director
Since
|
Number
of Subordinate Voting Shares
|
Number
of Multiple Voting Shares
|
|
Germain
Lamonde
Chairman
of the Board, President and Chief Executive Officer
|
Chairman
of the Board, President and Chief Executive Officer, EXFO Electro-Optical
Engineering Inc.
|
Cap-Rouge,
Quebec,
Canada
|
September
1985
|
483,500(1)
|
37,143,000(2)
|
|
Name
and Position or Office with the Corporation
|
Principal
Occupation or Employment
|
Residence
|
Director
Since
|
Number
of Subordinate Voting Shares
|
Number
of Multiple Voting Shares
|
|
Pierre
Marcouiller(3)
(4)
Independent
Director
|
Chairman
of the Board and Chief Executive Officer,
Camoplast
Inc. (a supplier of automotive and recreational vehicle
parts)
|
Magog,
Quebec,
Canada
|
May
2000
|
5,000
|
-
|
|
Guy
Marier (3)
(4)
Independent
Director
|
Executive
Consultant
|
Lakefield
Gore, Quebec,
Canada
|
January
2004
|
1,000
|
-
|
|
André
Tremblay(3)
(4)
Independent
Director
|
Founder
and Managing Partner,
Trio
Capital Inc. (a private equity fund management company)
|
Outremont,
Quebec,
Canada
|
May
2000
|
6,650(5)
|
-
|
|
Dr.
David A. Thompson, Ph.D.(4)
Independent
Director
|
Vice-President&
Director, Hardware & Equipment Technology Strategy, Corning Cable
Systems (involved in manufacturing innovative products for the
telecommunications industry) (6)
|
Newton,
North
Carolina,
USA
|
June
2000
|
2,100
|
-
|
|
Michael
Unger(3)
(4)
Independent
Lead Director
|
Executive
Consultant
|
Richmond
Hill, Ontario,
Canada
|
May
2000
|
-
|
-
|
| (1) |
Mr.
Lamonde exercises control over this number of Subordinate Voting
Shares
through G. Lamonde Investissements Financiers inc., a company
controlled by Mr. Lamonde.
|
| (2) |
Mr.
Lamonde exercises control over this number of Multiple Voting Shares
through G. Lamonde Investissements Financiers inc., a company
controlled by Mr. Lamonde and through Fiducie Germain Lamonde, a
family
trust for the benefit of Mr. Lamonde’s family.
|
| (3) |
Member
of the Audit Committee.
|
| (4) |
Member
of the Human Resources Committee.
|
| (5) |
Mr.
Tremblay exercises control over this number of Subordinate Voting
Shares
through 9104-5559 Quebec inc. a company controlled by Mr.
Tremblay.
|
| (6) |
Corning
Incorporated is a diversified technology company that concentrate
its
efforts on high-impact growth opportunities. Corning combines its
expertise in specialty glass, ceramic materials, polymers and the
manipulation of the properties of light, with strong process and
manufacturing capabilities to develop, engineer and commercialize
significant innovative products for the telecommunications, flat
panel
display, environmental, semiconductor, and life sciences
industries.
|
The
information as to Subordinate Voting Shares and Multiple Voting Shares
beneficially owned or over which the above-named individuals exercise control
or
direction is not within the direct knowledge of the Corporation and has been
furnished by the respective individual.
COMPENSATION
OF DIRECTORS AND EXECUTIVE OFFICERS
In
the
financial year ended August 31, 2006, each director who are not employees of
the
Corporation or any of its subsidiaries received the level of compensation set
forth in the table below as annual compensation payable in a combination of
cash
and Deferred Share Units (“DSUs”) as chosen by the director pursuant to the
Deferred Share Unit Plan.
|
Annual
Retainer for Directors: (1)
|
CA$50,000
(2)
|
US$43,550
(3)
|
|
Annual
Retainer for Committee Chairman:
|
CA$5,000
|
US$4,355
(3)
|
|
Annual
Retainer for Committee Members:
|
CA$3,000
|
US$2,613
(3)
|
|
Fees
for all Meetings Attended per day in Person:
|
CA$1,000
|
US$871
(3)
|
|
Fees
for all Meetings Attended per day by Telephone:
|
CA$500
|
US$436
(3)
|
| (1) |
All
the Directors elected to receive 50% of their Annual Retainer in
form of
Deferred Share Units.
|
| (2) |
The
Annual Retainer for Mr. David A. Thompson is US$50,000
(CA$57,405).
|
| (3) |
The
compensation information has been converted from Canadian dollars
to U.S.
dollars based upon an average foreign exchange rate of CA$1.1481
= US$1.00
for 2006.
|
In
the
financial year ended August 31, 2006, the Directors who are not employees
received the following compensation in the form indicated:
|
Name
|
Annual
Compensation Paid in Cash (US$) (1)
|
Annual
Compensation Paid in DSUs (#) (2)
|
Estimated
Value of DSUs at the time of grant (US$) (3)
|
Total
Attendance Fees Paid in Cash (US$) (1)
|
|
Pierre
Marcouiller (4)
|
27,001
|
3,812
|
21,775
|
6,533
|
|
Guy
Marier (4)
|
27,001
|
3,812
|
21,775
|
6,968
|
|
Dr.
David A. Thompson (5)
|
27,613
|
4,308
|
25,000
|
3,049
|
|
André
Tremblay (6)
|
28,743
|
3,812
|
21,775
|
6,097
|
|
Michael
Unger (7)
|
28,743
|
3,812
|
21,775
|
6,533
|
| (1) |
The
compensation information has been converted from Canadian dollars
to U.S.
dollars based upon an average foreign exchange rate of CA$1.1481
= US$1.00
for 2006 except for Mr. David A. Thompson who is paid in U.S. dollar
for
the portion of his annual retainer for Director. The Annual Compensation
includes, as the case may be, the retainer for Director, Committee
Members
and Committee Chairman.
|
| (2) |
Indicates
the number of Subordinate Voting Shares granted under the Deferred
Share
Unit Plan. A DSU is converted in a Subordinate Voting Share when
a
Director ceases to be a member of the
Board.
|
| (3) |
The
estimated value at the time of grant of a DSU is determined based
on the
highest of the closing prices of the Subordinate Voting Shares on
the
Toronto Stock Exchange and the NASDAQ National Market on the last
trading
day preceding the grant date, using the noon buying rate of the Federal
Reserve Bank of New York on the grant date to convert the NASDAQ
National
Market closing price to Canadian dollars, as required. The value
at
vesting of a DSU is equivalent to the market value of a Subordinate
Voting
Share when a DSU is converted to such Subordinate Voting
Share.
|
| (4) |
Member
of the Audit Committee and the Human Resources
Committee.
|
| (5) |
Member
of the Human Resources Committee.
|
| (6) |
Member
of the Human Resources Committee and Chairman of the Audit
Committee.
|
| (7) |
Member
of the Audit Committee, Chairman of the Human Resources Committee
and Lead
Director.
|
Compensation
of Named Executive Officers
The
table
below shows compensation information during the three most recently completed
financial years for Mr. Germain Lamonde, the Chairman of the Board,
President and Chief Executive Officer of the Corporation, Mr. Pierre
Plamondon, the Vice-President Finance and Chief Financial Officer and the three
other most highly compensated executive officers of the Corporation and its
subsidiaries who were serving the Corporation at the end of the financial year
(collectively, the "Named Executive Officers"). This information includes the
US
dollar value of base salaries, bonus awards and long-term incentive plan
payments, the number of options or Restricted Share Units granted, and other
compensation, if any, whether paid or deferred.
|
Name
and Principal
Position
|
Financial
Years
|
Salary
(1)
($)
|
Bonus
(2)
($)
|
Other
Annual Compensation ($)
|
Securities
Under Options (3)
(#)
|
Restricted
Share Units (4)
(#)
|
All
Other
Compensation
($)
|
|
Germain
Lamonde,
President
and Chief Executive Officer
|
2006
|
271,753 (US)
312,000 (CA)
|
147,558 (US)
169,412 (CA)
|
-
|
11,218
|
21,477
|
-
|
|
2005
|
243,605 (US)
300,000 (CA)
|
121,729 (US)
149,909 (CA)
|
-
|
17,942
|
13,089
|
-
|
|
|
2004
|
206,751 (US)
275,000 (CA)
|
57,115 (US)
75,969 (CA)
|
-
|
-
|
-
|
-
|
|
Name
and Principal
Position
|
Financial
Years
|
Salary
(1)
($)
|
Bonus
(2)
($)
|
Other
Annual Compensation ($)
|
Securities
Under Options (3)
(#)
|
Restricted
Share Units (4)
(#)
|
All
Other
Compensation
($)
|
|
Pierre
Plamondon,
Vice-President
Finance and Chief Financial Officer
|
2006
|
165,691 (US)
190,230 (CA)
|
60,167 (US)
69,078 (CA)
|
-
|
3,653
|
6,994
|
4,283 (US)
(5)
4,918 (CA)
|
|
2005
|
151,441 (US)
186,500 (CA)
|
48,735 (US)
60,017 (CA)
|
-
|
5,383
|
33,927
|
2,316 (US)
(5)
2,852 (CA)
|
|
|
2004
|
135,328 (US)
180,000 (CA)
|
17,451 (US)
23,211 (CA)
|
-
|
-
|
-
|
1,429 (US)
(5)
1,901 (CA)
|
|
|
Juan-Felipe
Gonzalez,
Vice-President
Telecom Sales - International
|
2006
|
272,518 (US)
312,878 (CA)
|
12,891 (US)
14,800 (CA)
|
-
|
3,505
|
6,716
|
-
|
|
2005
|
246,323 (US)
303,347 (CA)
|
6,015 (US)
7,407 (CA)
|
-
|
5,482
|
33,998
|
-
|
|
|
2004
|
231,597 (US)
308,047 (CA)
|
563,867 (US)
750,000 (CA)
(6)
|
-
|
-
|
-
|
-
|
|
|
Allan
Firhoj,
Vice-President
and General Manager, Life Sciences and Industrial Division
|
2006
|
139,361 (US)
160,000 (CA)
|
40,632 (US)
46,650 (CA)
|
-
|
2,404
|
4,602
|
-
|
|
2005
|
123,153 (US)
151,663 (CA)
|
18,355 (US)
22,604 (CA)
|
-
|
2,512
|
12,443
|
-
|
|
|
2004
|
107,796 (US)
143,379 (CA)
|
18,890 (US)
25,125 (CA)
|
-
|
-
|
-
|
-
|
|
|
Dana
Yearian,
Vice-President
Telecom Sales - North America
|
2006
|
173,424 (US)
(7)
199,109 (CA)
|
-
-
|
-
|
-
|
5,000
|
236 (US)
(5)
270 (CA)
|
|
2005
|
-
-
|
-
-
|
-
|
-
|
-
|
-
|
|
|
2004
|
-
-
|
-
-
|
-
|
-
|
-
|
-
|
| (1) |
The
compensation information for Canadian residents has been converted
from
Canadian dollars to U.S. dollars based upon an average foreign exchange
rate of CA$1.1481 = US$1.00 for 2006, CA$1.2315 = US$1.00 for 2005
and
CA$1.3301 = US$1.00 for 2004. The currency conversions cause these
reported salaries to fluctuate from year-to-year because of the
fluctuation in exchange rate.
|
| (2) |
A
portion of the bonus amounts is paid in cash in the year for which
they
are awarded and the balance is paid in cash in the year following
the
financial year for which they are
awarded.
|
| (3) |
Indicates
the number of Subordinate Voting Shares underlying the options granted
under the Long-Term Incentive Plan during the financial year
indicated.
|
| (4) |
Indicates
the number of Restricted Share Units granted under the Long-Term
Incentive
Plan during the financial year
indicated.
|
| (5) |
Indicates
the amount contributed by the Corporation during the financial year
indicated to the Deferred Profit Sharing Plan, as applicable, for
the
benefit of the Named Executive Officer. Mr. Lamonde is not eligible
to
participate in the Deferred Profit Sharing Plan and Mr. Gonzalez did
not participate.
|
| (6) |
Pursuant
to the terms of his employment agreement, Mr. Juan-Felipe Gonzalez
receive
a cash payment of CA$750,000 because he did not voluntarily resign
and was
not dismissed with cause prior to September 2003. An amount of CA$500,000
was disbursed on October 17 2003 and the remaining CA$250,000
was disbursed on January 25, 2004.
|
| (7) |
This
amount represents Mr. Yearian’s annual base salary. Since Mr. Yearian
joined the Corporation on August 14, 2006, the base salary paid to
Mr.
Yearian for the financial year ended August 31, 2006 amounted to
US$7,851
(CA$9,014).
|
Other
than its Long-Term Incentive Plan, Deferred
Share Unit Plan, Restricted Stock Award Plan and Stock Appreciation Rights
Plan,
which are described below in the "Report on Executive Compensation by the Human
Resources Committee - Long-Term Incentive Compensation", the Corporation does
not have any other formal long-term incentive plans for its directors, officers
and employees.
Share
Purchase Plan
In
September 1998, prior to becoming a public company, the Corporation adopted
a
share purchase plan for officers, directors and key employees, as amended in
April 2000. On April 3, 2000, the Corporation adopted a share plan which
replaced the 1998 share plan and on June 29, 2000, at the time of the
Corporation’s initial public offering, all of the 707,264 Class “F” shares
issued under this plan to Officers, directors and key employees and fully paid
by them were converted into Subordinate Voting Shares. No additional shares
will be issued under this share plan. This share plan required the Subordinate
Voting Shares previously acquired by participants to be held in trust by a
trustee until August 31, 2004, except for 249,977 Subordinate Voting Shares,
of
which 216,548 Subordinate Voting Shares were released on October 21, 2003,
6,020
Subordinate Voting Shares were released on December 23, 2003 and 27,409
Subordinate Voting Shares were released on January 20, 2004.
For
further information regarding this share plan, please refer to the Corporation’s
Management Proxy Circular dated November 1, 2004 in the section named "Share
Plan" available on SEDAR website at www.sedar.com
under
"This Public’s Company’s Documents" - Management Information Circular - English
filed on November 29, 2004.
Deferred
Profit Sharing Plan
The
Corporation maintains a deferred profit sharing plan for certain eligible
Canadian resident employees. Under this plan, the Corporation may contribute
an
amount equal to 1% until May 31, 2005 and 2% from June 1, 2005 of each
employee’s gross salary to that employee’s individual deferred profit sharing
plan to the extent that such employee contributes at least 2% of his or her
gross salary to his or her individual tax-deferred registered retirement savings
plan. In the financial year ended August 31, 2006, the aggregate amount of
contributions paid under the plan was US$316,000 (CA$363,000). Mr. Germain
Lamonde is not entitled to participate in this plan.
401K
Plan
The
Corporation maintains a 401K plan for eligible United States resident employees
of its subsidiaries. Under this plan, the Corporation must contribute an amount
equivalent to 3% of an employee’s current compensation, subject to certain
legislated maximum contribution limits. During the financial year ended August
31, 2006, the Corporation paid contributions totaling US$126,000.
Deferred
Share Unit Grants in Last Financial Year
The
aggregate number of Deferred Share Units (“DSUs”) credited to non-employee
directors during the financial year ended August 31, 2006 was 19,556. The
estimated value at the time of grant of a DSU is determined based on the highest
of the closing prices of the Subordinate Voting Shares on the Toronto Stock
Exchange and the NASDAQ National Market on the last trading day preceding the
grant date, using the noon buying rate of the Federal Reserve Bank of New York
on the grant date to convert the NASDAQ National Market closing price to
Canadian dollars, as required. The value at vesting of a DSU is equivalent
to
the market value of a Subordinate Voting Share when a DSU is converted to such
Subordinate Voting Share. At the end of the financial year ended August 31,
2006, there were a total of 43,290 DSUs credited to directors pursuant to the
Deferred Share Unit Plan having an estimated value at the time of grant of
US$219,662 (CA$258,617).
DSUs
attract dividends in the form of additional DSUs at the same rate as dividends
on Subordinate Voting Shares. The DSUs are converted and paid in Subordinate
Voting Shares at the time a director ceases to be a member of the
Board.
Therefore,
the value at vesting of a DSU, when converted to Subordinate Voting Shares,
is
equivalent to the market value of a Subordinate Voting Share at the time the
conversion takes place. The table below shows information regarding DSU grants
made under the Deferred Share Unit Plan during the financial year ended August
31, 2006.
See
“Report on Executive Compensation by the Human Resources Committee - Long-Term
Incentive Compensation - Deferred Share Unit Plan” for a description of the
Deferred Share Unit Plan.
During
the financial year ended August 31, 2006, the following DSUs were granted to
the
directors:
|
DSUs
#
|
Weighted
Average Estimated Value at the
Time
of Grant US$/DSU
|
Vesting
|
|
19,556
|
5.81
|
At
the time director cease to be a member of the Board of the
Corporation
|
Restricted
Share Unit Grants in Last Financial Year
The
aggregate number of Restricted Share Units (RSUs) granted during the financial
year ended August 31, 2006 was 173,803 having a weighted average fair value
at the time of grant of US$5.39 (CA$6.18) per RSU. The fair value at the time
of
grant of a RSU is equal to the market value of Subordinate Voting Shares at
the
time RSUs are granted. At the end of the financial year ended
August 31, 2006, there were a total of 327,877 RSUs granted and
outstanding pursuant to the Long-Term Incentive Plan having a weighted average
fair value at the time of grant of US$5.03 (CA$5.95) per RSU. All RSUs first
vesting can not be earlier than the third anniversary date of their grant.
Some
RSUs granted in the financial year ended August 31, 2006, vest at a rate of
1/2
annually commencing on the third anniversary date of the grant in February
2006
and in June 2006 and others at a rate of 1/3 annually on the third, fourth
and
fifth anniversary dates of the grant in August 2006. Some RSUs granted in the
financial year ended August 31, 2005 vest at a rate of 1/3 annually commencing
on the third anniversary date of the grant in February 2005 and others at a
rate
of 55%, 35% and 10%, on the third, fourth and fifth anniversary dates of the
grant in January 2005. Some RSUs granted in the financial years ended August
31,
2006 and August 31, 2005 vest on the fifth anniversary date of the
grant respectively in December 2005 and in January 2005 but are subject to
early
vesting on the third and fourth anniversary dates of the grant on the attainment
of performance objectives as determined by the Board of Directors of the
Corporation. Accordingly, subject to the attainment of performance objectives,
the first early vesting is up to 1/3 of the units on the third anniversary
date
of the grant and the second early vesting is up to 50% of the remaining units
on
the fourth anniversary date of the grant.
RSUs
attract dividends in the form of additional RSUs at the same rate as dividends
on Subordinate Voting Shares. The RSUs are redeemed for actual Subordinate
Voting Shares or the equivalent in cash at the discretion of the Board of
Directors of the Corporation on the vesting dates established by the Board
of
Directors of the Corporation at the time of grant in its sole discretion.
Therefore,
the value at vesting of a RSU, when converted to Subordinate Voting Shares,
is
equivalent to the market value of a Subordinate Voting Share at the time the
conversion takes place. The table below shows information regarding RSU grants
made under the Long-Term Incentive Plan during the financial year ended August
31, 2006. See “Report on Executive Compensation by the Human Resources Committee
- Long-Term Incentive Compensation - Long-Term Incentive Plan” for a description
of the Long-Term Incentive Plan.
During
the financial year ended August 31, 2006, the following RSUs were
granted:
|
RSUs
#
|
Fair
Value at the Time of Grant US$/RSU
|
Vesting (1)
|
|
61,253
|
4.76
|
100%
on the fifth anniversary date of the grant in December 2005 subject
to
early vesting up to 1/3 on the third anniversary date of the grant
and up
to 50% of the remaining units on the fourth anniversary date of the
grant
if the performance objectives are fully attained. (2)
|
|
86,700
|
5.59
|
50%
on the third and fourth anniversary dates of the grant in February
2006.
(3)
|
|
1,500
|
6.50
|
50%
on the third and fourth anniversary dates of the grant in February
2006.
(3)
|
|
13,850
|
6.58
|
50%
on the third and fourth anniversary dates of the grant in February
2006.
(3)
|
|
3,500
|
5.90
|
50%
on the third and fourth anniversary dates of the grant in June 2006.
(4)
|
|
2,000
|
6.27
|
50%
on the third and fourth anniversary dates of the grant in June 2006.
(4)
|
|
5,000
|
5.16
|
1/3
on each of the third, fourth and fifth anniversary dates of the grant
in
August 2006 (5)
|
|
(1)
|
All
RSUs first vesting can not be earlier than the third anniversary
date of
their grant.
|
| (2) |
Those
RSUs granted in the financial year ended August 31, 2006 vest on
the fifth
anniversary date of the grant in December 2005 but are subject to
early
vesting on the third and fourth anniversary dates of the grant on
the
attainment of performance objectives as determined by the Board of
Directors of the Corporation. Accordingly, subject to the attainment
of
performance objectives, the first early vesting is up to 1/3 of the
units
on the third anniversary date of the grant and the second early vesting
is
up to 50% of the remaining units on the fourth anniversary date of
the
grant.
|
| (3) |
Those
RSUs granted in the financial year ended August 31, 2006 vest at
a rate of
1/2 annually commencing on the third anniversary date of the grant
in
February 2006.
|
| (4) |
Those
RSUs granted in the financial year ended August 31, 2006 vest at
a rate of
1/2 annually commencing on the third anniversary date of the grant
in June
2006.
|
| (5) |
Those
RSUs granted in the financial year ended August 31, 2006 vest at
a rate of
1/3 annually commencing on the third anniversary date of the grant
in
August 2006.
|
During the financial year ended August 31, 2006, the following RSUs were granted to the following Named Executive Officers:
|
Name
|
RSUs
#
|
Percentage
of Net Total of RSUs Granted to Employees in Financial
Year
(%)
|
Fair
Value at the Time of Grant US$/RSU
|
Vesting
(1)
|
|
Germain
Lamonde
|
21,477
|
12.36
|
4.76
|
100%
on the fifth anniversary date of the grant in December 2005 subject
to
early vesting up to 1/3 on the third anniversary date of the grant
and up
to 50% of the remaining units on the fourth anniversary date of
the grant
if the performance objectives are fully attained. (2)
|
|
Pierre
Plamondon
|
6,994
|
4.02
|
4.76
|
100%
on the fifth anniversary date of the grant in December 2005 subject
to
early vesting up to 1/3 on the third anniversary date of the grant
and up
to 50% of the remaining units on the fourth anniversary date of
the grant
if the performance objectives are fully attained. (2)
|
|
Juan-Felipe
Gonzalez
|
6,716
|
3.86
|
4.76
|
100%
on the fifth anniversary date of the grant in December 2005 subject
to
early vesting up to 1/3 on the third anniversary date of the grant
and up
to 50% of the remaining units on the fourth anniversary date of
the grant
if the performance objectives are fully attained. (2)
|
|
Allan
Firhoj
|
4,602
|
2.65
|
4.76
|
100%
on the fifth anniversary date of the grant in December 2005 subject
to
early vesting up to 1/3 on the third anniversary date of the grant
and up
to 50% of the remaining units on the fourth anniversary date of
the grant
if the performance objectives are fully attained. (2)
|
|
Dana
Yearian
|
5,000
|
2.88
|
5.16
|
1/3
on each of third, fourth and fifth anniversary dates of the grant
in
August 2006. (3)
|
| (1) |
All
RSUs first vesting can not be earlier than the third anniversary
date of
their grant.
|
| (2) |
Those
RSUs granted in the financial year ended August 31, 2006 vest on
the fifth
anniversary date of the grant in December 2005 but are subject to
early
vesting on the third and fourth anniversary date of the grant on
the
attainment of performance objectives as determined by the Board of
Directors of the Corporation. Accordingly, subject to the attainment
of
performance objectives, the first early vesting is up to 1/3 of the
units
on the third anniversary date of the grant and the second early vesting
is
up to 50% of the remaining units on the fourth anniversary date of
the
grant.
|
| (3) |
Those
RSUs granted in the financial year ended August 31, 2006 vest at
a rate of
1/3 annually commencing on the third anniversary date of the grant
in
August 2006.
|
Aggregated
RSUs vested in Last Financial Year and Financial Year-End RSU
Values
The
following table summarizes, for each of the Named Executive Officers, the number
of RSUs, if any, vested during the financial year ended August 31, 2006, the
aggregate value realized upon vesting and the total number of unvested RSUs,
if
any, held at August 31, 2006. Value realized upon vesting is the
market value of the Subordinate Voting Shares on the vesting date. The value
of
unvested RSUs at financial year-end is the market value of the Subordinate
Voting Shares on August 31, 2006, which was US$5.25 per share. These values,
unlike the amounts set forth in the column "Aggregate
Value Realized",
have not
been and may never be realized. The actual gains on vesting will depend on
the
value of the Subordinate Voting Shares on the date of vesting. There can be
no
assurance that these values will be realized. See “Report on Executive
Compensation by the Human Resources Committee - Long-Term Incentive Compensation
- Long-Term Incentive Plan.”
|
Name
|
Securities
Acquired on Vesting (#)
|
Aggregate
Value Realized (US$) (1)
|
Unvested
RSUs
at
August 31, 2006 (#)
|
Value
of Unvested RSUs
at
August 31, 2006 (US$) (2)
(3)
|
|
Germain
Lamonde
|
-
|
-
|
34,566
|
181,472
|
|
Pierre
Plamondon
|
-
|
-
|
40,921
|
214,835
|
|
Juan-Felipe
Gonzalez
|
-
|
-
|
40,714
|
213,749
|
|
Allan
Firhoj
|
-
|
-
|
17,045
|
89,486
|
|
Dana
Yearian
|
-
|
-
|
5,000
|
26,250
|
| (1) |
The
aggregate value realized is equivalent to the market value of the
securities underlying the RSUs at vesting. This value, as the case
maybe,
has been converted from Canadian dollars to U.S. dollars based upon
the
average foreign exchange rate on the day of
vesting.
|
| (2) |
The
value of RSUs is calculated using the highest of the closing prices
of the
Subordinate Voting Shares on the Toronto Stock Exchange and on the
NASDAQ
National Market on August 31, 2006 using the noon buying rate of
the
Federal Reserve Bank of New York to convert the NASDAQ National Market
closing price to Canadian dollars, as
required.
|
| (3) |
The
actual gains on vesting will depend on the value of the Subordinate
Voting
Shares on the date of vesting. There can be no assurance that these
values
will be realized.
|
Option
Grants in Last Financial Year
The
aggregate number of Subordinate Voting Shares covered by options granted during
the financial year ended August 31, 2006 was 31,992 at a weighted average
exercise price of US$4.76 (CA$5.50) per Subordinate Voting Share. At the end
of
the financial year ended August 31, 2006, there were a total of 2,439,375
Subordinate Voting Shares covered by options granted and outstanding pursuant
to
the Long-Term Incentive Plan having a weighted average exercise price of
US$13.56 (CA$20.26). The table below shows information regarding stock option
grants made to the Named Executive Officers under the Long-Term Incentive Plan
during the financial year ended August 31, 2006. See “Report on Executive
Compensation by the Human Resources Committee - Long-Term Incentive
Compensation” for a description of the Long-Term Incentive Plan.
During
the financial year ended August 31, 2006, the following options were granted
to
the following Named Executive Officers:
|
Name
|
Securities
Under Options
Granted(1)
(#)
|
Percentage
of Net Total of Options Granted to Employees in Financial
Year
(%)
|
Exercise
or Base Price (2)
(US$/
Security)
|
Market
Value of Securities Underlying Options on the Date of Grant (US$/Security)
(3)
|
Expiration
Date
|
|
Germain
Lamonde
|
11,218
|
35.07
|
4.76
(4)
|
4.85
(5)
|
December
6, 2015
|
|
Pierre
Plamondon
|
3,653
|
11.42
|
4.76
(4)
|
4.85
(5)
|
December
6, 2015
|
|
Juan-Felipe
Gonzalez
|
3,505
|
10.96
|
4.76
(4)
|
4.85
(5)
|
December
6, 2015
|
|
Allan
Firhoj
|
2,404
|
7.51
|
4.76
(4)
|
4.85
(5)
|
December
6, 2015
|
|
Dana
Yearian
|
-
|
-
|
-
|
-
|
-
|
|
(1)
|
Underlying
securities: Subordinate Voting Shares.
|
| (2) |
The
exercise price of options granted is determined based on the highest
of
the closing prices of the Subordinate Voting Shares on the Toronto
Stock
Exchange and the NASDAQ National Market on the last trading day preceding
the grant date, using the noon buying rate of the Federal Reserve
Bank of
New York on the grant date to convert the NASDAQ National Market
closing
price to Canadian dollars, as required. These options vest at a rate
of
25% annually commencing on the first anniversary date of the
grant.
|
| (3) |
Based
on the closing price on the NASDAQ National Market on the date of
the
grant.
|
| (4) |
Being
CA$5.50.
|
| (5) |
Being
CA$5.60.
|
Aggregated
Option Exercises in Last Financial Year and Financial Year End Option Values
The
following table summarizes, for each of the Named Executive Officers, the number
of stock options, if any, exercised during the financial year ended August
31,
2006, the aggregate value realized upon exercise and the total number of
unexercised options, if any, held at August 31, 2006. Value realized
upon exercise is the difference between the market value of the underlying
Subordinate Voting Shares on the exercise date and the exercise or base price
of
the option. The value of unexercised in-the-money options at financial year-end
is the difference between its exercise or base price and the market value of
the
underlying Subordinate Voting Shares on August 31, 2006, which was US$5.25
(CA$5.84) per share. These values, unlike the amounts set forth in the column
“Aggregate Value Realized,” have not been, and may never be, realized. The
underlying options have not been, and may never be exercised, and actual gains,
if any, on exercise will depend on the value of the Subordinate Voting Shares
on
the date of exercise. There can be no assurance that these values will be
realized. Unexercisable options are those that have been held for less than
the
time required for vesting. See “Report on Executive Compensation by the Human
Resources Committee - Long-Term Incentive Compensation.”
|
Name
|
Securities
Acquired on Exercise (#)
|
Aggregate
Value Realized (US$) (1)
(4)
|
Unexercised
Options
at
August 31, 2006
|
Value
of Unexercised
“In-the-Money”
Options at
August
31, 2006 (2)
(3) (4)
|
||
|
Exercisable
(#)
|
Unexercisable
(#)
|
Exercisable
(US$)
|
Unexercisable
(US$)
|
|||
|
Germain
Lamonde
|
-
|
-
|
142,468
|
37,174
|
114,157
|
44,093
|
|
Pierre
Plamondon
|
5,000
|
31,497
|
67,035
|
13,941
|
41,501
|
19,986
|
|
Juan-Felipe
Gonzalez
|
7,500
|
47,246
|
83,900
|
15,117
|
-
|
23,714
|
|
Allan
Firhoj
|
8,337
|
47,058
|
18,000
|
8,666
|
-
|
12,057
|
|
Dana
Yearian
|
-
|
-
|
-
|
-
|
-
|
-
|
| (1) |
The
aggregate value realized is equivalent to the difference between
the
market value of the securities underlying the options at exercise
and the
exercise price of the options. This value, as the case maybe, has
been
converted from Canadian dollars to U.S. Dollars based upon the average
foreign exchange rate on the day of the
exercise.
|
| (2) |
“In-the-money”
options are options for which the market value of the underlying
securities is higher than the price at which such securities may
be bought
from the Corporation.
|
| (3) |
The
value of unexercisable “in-the-money” options is calculated using the
highest of the closing prices of the Subordinate Voting Shares on
the
Toronto Stock Exchange and on the NASDAQ National Market on August
31,
2006 using the noon buying rate of the Federal Reserve Bank of New
York to
convert the NASDAQ National Market closing price to Canadian dollars,
as
required, less the exercise price of “in-the-money”
options.
|
| (4) |
This
value has been converted from Canadian to US dollars based upon the
foreign exchange rate on August 31, 2006 of
1.1066.
|
Number
of Subordinate Voting Shares reserved for future issuance
During
the financial year ended August 31, 2006, 19,556 Deferred Share Units, 173,803
Restricted Share Units and 31,992 options were granted to directors, officers
and employees. Such awards were issued from the same pool of Subordinate Voting
Shares reserved for issuance pursuant to the Long-Term Incentive Plan which
is
9.2% of the total and outstanding voting shares as of November 1, 2006.
Therefore, as of November 1, 2006 the number of Subordinate Voting Shares
reserved for future issuance is 3,423,784.
Termination
of Employment, Change in Responsibilities and Employment
Contracts
The
Corporation has an employment agreement with Mr. Germain Lamonde. The agreement
is for an indeterminate period and the compensation is reviewed annually. In
the
event of the termination of Mr. Lamonde’s employment without cause, Mr.
Lamonde will be entitled to severance payments (in no case exceeding
24 months of remuneration) and the vesting of all stock options and RSUs.
In addition, in the event that Mr. Lamonde’s employment is terminated
following a merger or an acquisition by a third party of substantially all
of
the Corporation’s assets or of the majority of its share capital or if
Mr. Lamonde voluntarily resigns, he will be entitled to the vesting of all
stock options and RSUs.
The
Corporation also has employment agreements with Mr. Pierre Plamondon, Mr.
Juan-Felipe Gonzalez, Mr. Allan Firhoj and Mr. Dana Yearian.
The
Corporation has an employment agreement with Mr. Pierre Plamondon, the
Corporation’s Vice-President, Finance and Chief Financial Officer. The agreement
is for an indeterminate period and the compensation is reviewed annually. In
the
event of termination of Mr. Plamondon’s employment without cause, Mr. Plamondon
will be entitled to severance payments (in no case exceeding 18 months of the
current base salary). In addition, in the event Mr. Plamondon’s employment is
terminated following a merger or an acquisition by a third party of
substantially all of the Corporation’s assets or of the majority of its share
capital, he will be entitled to the immediate vesting of all stock options
and
RSUs.
The
agreement with Mr. Gonzalez provided for Mr. Gonzalez’s employment as
Vice-President, Telecom Sales - International. In the event Mr. Gonzalez’s
employment terminates for any reason whatsoever and he is unable to accept
new
employment due to his non-competition obligations to the Corporation,
Mr. Gonzalez may receive compensation for a period of 18 months following
the date of termination in amounts varying from 5% to 50% of his base monthly
salary at the time of termination depending on the cause of the termination.
The
employment agreement is for an indeterminate period and compensation is reviewed
annually.
The
Corporation has an employment agreement with Mr. Allan Firhoj, the
Vice-President and General Manager, Life Sciences and Industrial Division.
The
agreement is for an indeterminate period and the compensation is reviewed
annually. In the event of termination of Mr. Firhoj’s employment without cause,
Mr. Firhoj will be entitled to severance payments (in no case exceeding 12
months of the current base salary). In addition, in the event Mr. Firhoj’s
employment is terminated following a merger or an acquisition by a third party
of substantially all of the Corporation’s assets or of the majority of its share
capital, he will be entitled to the immediate vesting of all stock options
and
RSUs.
The
Corporation has an employment agreement with Mr. Dana Yearian, the Corporation’s
Vice-President, Telecom Sales - North America. The agreement is for an
indeterminate period and the compensation is reviewed annually. In the event
of
termination of Mr. Yearian’s employment without cause, Mr. Yearian will be
entitled to severance payments (in no case exceeding 18 months of the current
base salary). In addition, in the event Mr. Yearian’s employment is terminated
following a merger or an acquisition by a third party of substantially all
of
the Corporation’s assets or of the majority of its share capital, he will be
entitled to the immediate vesting of all stock options and RSUs.
REPORT
ON EXECUTIVE COMPENSATION BY THE HUMAN RESOURCES COMMITTEE
Members
of the Human Resources Committee
During
the financial year ended August 31, 2006, the Human Resources Committee was
composed of Michael Unger, as Chairman, Pierre Marcouiller, Guy Marier, David
A.
Thompson and André Tremblay, none of whom were officers or employees, or former
officers or employees of the Corporation or its subsidiaries. All of the members
of the Human Resources Committee are considered “independent”, as defined by the
Canadian Securities Administration Guidelines.
Human
Resources Committee Mandate
The
Human
Resources Committee of the Board of Directors is responsible for establishing
the annual compensation and overseeing the assessment of the performance of
all
the Corporation’s executive officers, including the President and Chief
Executive Officer. This Committee also reviews and submits to the Board the
salary structure and the short-term and long-term incentive compensation
programs for all employees of the Corporation. The
Committee also evaluates and makes recommendations to the Board regarding the
compensation of directors, including
the
number of Deferred Share Units credited to the non-employee directors pursuant
to the Deferred Share Unit Plan.
The
Committee’s goal is to develop and monitor executive compensation programs that
are consistent with strategic business objectives and shareholder interests.
Though
the Committee is responsible for the review and approval of the employees that
will receive Restricted Share Units or options to purchase shares of the
Corporation, in accordance with policies established by the Board and the terms
of the Long-Term Incentive Plan, these functions have been shared by the Board
of Directors and the Human Resources Committee during the period from September
1, 2005 to August 31, 2006.
Since
September 1, 2005, the Human Resources Committee held six (6) meetings prior
to
November 1, 2006, which were attended by all the members of the Committee,
except Mr. Thompson who was absent at four (4) meetings and Mr. Tremblay
who was also absent at one (1) meeting.
Key
Elements and Policies for Compensation of Executive
Officers
The
Corporation’s executive compensation plans are designed to attract, retain and
motivate key executives who directly impact the Corporation’s long-term success
and the creation of shareholder value. In determining executive compensation,
the Committee considers the following four principles:
| · |
Performance-based:
Executive compensation levels reflect both corporation and individual
results based on specific quantitative and qualitative objectives
established at the start of each financial year in keeping with
Corporation’s long-term strategic objectives.
|
| · |
Aligned
with shareholder interests:
A
significant proportion of incentive compensation for executives is
composed of equity awards to ensure that executives are aligned with
the
principles of sustained long-term shareholder value
growth.
|
| · |
Market
competitive:
Compensation of executives is designed to be externally competitive
when
compared against executives of comparable peer companies, and in
consideration of Corporation results relative to the results of
peers.
|
| · |
Individually
equitable:
Compensation levels are also designed to reflect individual factors
such
as scope of responsibility, experience, and performance against individual
measures.
|
The
key
elements of the Corporation’s 2006 executive compensation program were Base
Salary, the Short Term
Incentive Plan, and stock-based incentive compensation delivered through the
Long Term Incentive Plan.
To
determine appropriate compensation levels for each pay component, the Committee
considered all elements of the executive compensation program. The
Committee did not assign specific weightings to any key element of the
Corporation’s 2006 executive compensation program.
Base
Salaries
In
establishing the base salaries of senior officers, including the President
and
Chief Executive Officer, the Corporation takes into consideration
responsibilities, job descriptions and salaries paid by other similar Canadian
organizations for positions similar in magnitude, scope and complexity. The
Committee’s objective is to align executive compensation levels with the median
compensation offered within a reference group of comparable companies that
are
similar in size to the Corporation, with a particular focus on those within
the
High-Technology/Telecommunications and Manufacturing-Durable Goods industries.
The Committee reviews the base salary of each senior officer on an annual basis
and recommends that the Board approve appropriate adjustments, if required,
within the salary range in order to maintain a competitive position within
the
market place.
Short-Term
Incentive Compensation
The
short-term incentive plan (“STIP”) provides senior executives with the
opportunity to earn annual bonuses based on the Corporation’s financial
performance and the achievement of strategic corporate and business unit
objectives established on a yearly basis.
Target
payout levels for Named
Executive Officers eligible for incentive bonuses in the year ended
August 31, 2006 were
established to be in line with the objective of the Committee to align
compensation with the median compensation offered in the reference group. The
minimum, target and maximum payouts to senior officers under the STIP (expressed
as a percentage of their base salary) for 2006 were as follows:
Our
President and Chief Executive Officer, Mr. Germain Lamonde, has a short term
incentive target of 50% of his annual base salary. That bonus is based on the
achievement of financial, strategic and individual objectives as shown in the
following table.
Our
Chief
Financial Officer, Mr. Pierre Plamondon, has a short term incentive target
of
35% of his annual base salary. That bonus is based on the achievement of
financial, strategic and individual objectives as shown in the following table.
Our
Vice-President and General Manager, Life Sciences and Industrial Division,
Mr.
Allan Firhoj, has a short term incentive target of 30% of his annual base
salary. That bonus is based on the achievement of financial, strategic and
individual objectives as shown in the following table.
|
Measure
|
Weighting
Mr. Lamonde and Mr. Plamondon
|
Weighting
Mr. Firhoj
|
|
Sales
|
35%
|
30%
|
|
Earnings
|
15%
|
25%
|
|
Gross
margin
|
25%
|
25%
|
|
Customer
satisfaction (quality and on time delivery)
|
25%
|
20%
|
|
Personal
objectives (multiplier)
|
0%
- 125%
|
0%
- 125%
|
Our
Vice-President, Telecom Sales - International, Mr. Juan-Felipe Gonzalez, and
Vice-President, Telecom Sales - North America, Mr. Dana Yearian, do not
participate in the short term incentive plan that is available to the company’s
other senior executives. Instead, Mr. Gonzalez and Mr. Yearian participate
in
the company’s sales incentive plan (SIP). Under the SIP, Mr. Gonzales and Mr.
Yearian have target incentives of 40% of their annual base salaries. The SIP
is
based 40% on the achievement of revenue targets (billings), 40% on margin
targets and 20% on sales quotas achievements.
Long-Term
Incentive Compensation
Long-Term
Incentive Plan
The
principal component of the long-term incentive compensation offered by
the
Corporation is made up of the Long-Term Incentive Plan for directors,
officers,
employees and
consultants of
the
Corporation and its subsidiaries. As
disclosed under the caption ‘’Restricted Share Unit Grants in Last Financial
Year’’, the Named Executive officers were granted RSUs and options during the
last fiscal year. The Corporation did not take into account the amount and
terms
of outstanding options or RSUs neither the restrictions on resale of such units,
when determining the grant mentioned above.
Introduced
in May 2000, amended in October 2004 and effective in January 2005, the
Long-Term Incentive Plan is designed to provide directors, officers, employees
and consultants with an incentive to create value and accordingly ensures that
their interests are aligned with those of the Corporation’s shareholders. The
LTIP is subject to Human Resources Committee review to ensure maintenance of
its
market competitiveness. The Board has full and complete authority to interpret
the Plan and to establish the rules and regulations applying to it and to make
all other determinations it deems necessary or useful for the administration
of
the Plan, provided that such interpretations, rules, regulations and
determinations are consistent with the rules of all stock exchanges on which
the
securities of the Corporation are then traded and with all relevant securities
legislation.
The
Long-Term Incentive Plan provides for the issuance of options to purchase
Subordinate Voting Shares and the issuance of Restricted Share Units (“RSUs”)
redeemable for actual Subordinate Voting Shares or the equivalent in cash to
directors, officers, employees and consultants. The Board of Directors upon
recommendation of the Human Resources Committee designates the recipients of
options or RSUs and determines the number of Subordinate Voting Shares covered
by each option or RSU, the dates of vesting, the expiry date and any other
conditions relating to these options or RSUs, in each case in accordance with
the applicable legislation of the securities regulatory authorities. During
the
financial year ended August 31, 2006, target awards for eligible officers
under the LTIP were established to be in line with the objective of the
Committee to align compensation with the median compensation offered in the
reference group.
A
portion of the target RSU awards are fixed, in order to encourage executive
retention over the longer term, and the balance are made at, above, or
below target levels based on merit, as determined by each executive's individual
performance over the previous year.
The
exercise price of the options is determined by the Board of Directors at the
time of granting the options, subject to compliance with the rules of all stock
exchanges on which the Subordinate Voting Shares are listed and with all
relevant securities legislation. In any event, the price at which the
Subordinate Voting Shares may be purchased may not be lower than the highest
of
the closing prices of the Subordinate Voting Shares on the Toronto Stock
Exchange and the NASDAQ National Market on the last trading day preceding the
grant date, using the noon buying rate of the Federal Reserve Bank of New York
on the grant date to convert the NASDAQ National Market closing price to
Canadian dollars. Any option issued is non-transferable. At the end of financial
year ended August 31, 2006, there were a total of 2,439,375 options
granted and outstanding pursuant to the Long-Term Incentive Plan having a
weighted average exercise price of US$13.56 (CA$20.26).
The
fair
value at the time of grant of a RSU is equal to the market value of Subordinate
Voting Shares at the time RSUs are granted. At the end of financial year ended
August 31, 2006, there were a total of 327,877 RSUs granted and outstanding
pursuant to the Long-Term Incentive Plan having a weighted average fair value
at
the time of grant of US$5.03 (CA$5.95) per RSU.
The
maximum number of Subordinate Voting Shares that are issuable under the Plan
shall not exceed 6,306,153 Subordinate Voting Shares, which represents 9.2%
of the Corporation’s issued and outstanding voting shares as of November 1,
2006. The maximum number of Subordinate Voting Shares that may be granted to
any
one individual shall not exceed 5% of the number of outstanding Subordinate
Voting Shares.
Some
options granted to Directors and employees vest on the first anniversary date
of
their grant. Some options granted in the financial year ended August 31, 2004
and 2005 vest at a rate of 12.5% six (6) months after the date of grant, 12.5%
twelve (12) months after the date of grant and 25% annually thereafter
commencing on the second anniversary date of the grant in October 2005.
Otherwise all options vest a rate of 25% annually commencing on the first
anniversary date of the grant. All options may be exercised in whole or in
part
once vested. All of the options that are granted under the Plan must be
exercised within a maximum period of ten (10) years following the date of their
grant or they will be forfeited.
All
RSUs
first vesting can not be earlier than the third anniversary date of their grant.
Some RSUs granted in the financial year ended August 31, 2006 vest at a rate
of
1/2 annually commencing on the third anniversary date of the grant in February
2006 and in June 2006 and others at a rate of 1/3 annually commencing on the
third anniversary date of the grant in August 2006. Some RSUs granted in the
financial year ended August 31, 2005 vest at a rate of 1/3 annually commencing
on the third anniversary date of the grant in February 2005 and others at a
rate
of 55%, 35% and 10%, on the third, fourth and fifth anniversary dates of the
grant in January 2005. Some RSUs granted in the financial years ended August
31,
2006 and August 31, 2005 vest on the fifth anniversary date of the grant
respectively in December 2005 and in January 2005 but are subject to early
vesting on the third and fourth anniversary dates of the grant on the attainment
of performance objectives as determined by the Board of Directors of the
Corporation. Accordingly, subject to the attainment of performance objectives,
the first early vesting is up to 1/3 of the units on the third anniversary
date
of the grant and the second early vesting is up to 50% of the remaining units
on
the fourth anniversary date of the grant. If such vesting date falls into any
black-out period or any other restrictive period during which the RSU holder
is
not entitled to trade the Corporation’s Subordinate Voting Shares, then the
units shall vest on the first trading day the RSU holder is entitled to trade
after such black-out period or restrictive period.
Any
option granted pursuant to the Long-Term Incentive Plan will lapse (i)
immediately upon the termination of the relationship with the Corporation or
one
of its subsidiaries for a good and sufficient cause for employees or officers
or
at the date on which an employee or an officer resigns or leaves his employment
with the Corporation or one of its subsidiaries (or within 30 days if the
holder’s employment is terminated for reasons not related to cause); and
(ii) 30 days after a Director ceases to be a member of the Board of
Directors of the Corporation or one of its subsidiaries. In the event of
retirement or disability, any option held by an employee lapses 30 days after
the date of any such disability or retirement. In the event of death, any option
held by the optionee lapses 6 months after the date of death.
Any
RSU
granted pursuant to the Long-Term Incentive Plan will lapse (i) immediately,
where vesting of a unit is subject to the attainment of performance objectives,
if such performance objectives have not been attained (or postponed at a
further vesting date as determined by the Board of Directors.); (ii)
immediately, whether or not subject to attainment of performance objectives,
upon the termination of the relationship with the Corporation or one of its
subsidiaries for a good and sufficient cause for employees or officers or at
the
date on which an employee or an officer resigns or leaves his employment with
the Corporation or one of its subsidiaries.
Any
RSU
granted pursuant to the Long-Term Incentive Plan will vest immediately, to
a
certain proportion as determined by the Plan, upon the termination of the
relationship of an employee or officer with the Corporation or one of its
subsidiaries (i) for reasons not related to cause; (ii) because of death or
permanent disability and (iii) retirement.
The
following table summarizes information about stock options granted to the
members of the Board of Directors, and to Management and Corporate Officers
of
the Corporation and its subsidiaries as at August 31, 2006:
|
Number
of Options
|
%
of Issued and
Outstanding
Options
|
Weighted
Average Exercise Price ($US/Security)
|
|
|
President
and CEO (one individual)
|
179,642
|
7.36%
|
9.05
|
|
Board
of Directors (five individuals)
|
194,375
|
7.97%
|
6.23
|
|
Management
and Corporate Officers (eight individuals)
|
313,836
|
12.87%
|
15.42
|
The
following table summarizes information about RSUs granted to the members of
the
Board of Directors and to Management and Corporate Officers of the Corporation
and its subsidiaries as at August 31, 2006:
|
Number
of RSUs
|
%
of Issued and
Outstanding
RSUs
|
Weighted
Average Fair Value at the Time of Grant
$US/RSU
|
|
|
President
and CEO (one individual)
|
34,566
|
10.54%
|
4.73
|
|
Board
of Directors (five individuals)
|
-
|
-
|
-
|
|
Management
and Corporate Officers (ten individuals)
|
184,161
|
56,17%
|
4.66
|
Compensation
of Chief Executive Officer
In
establishing Mr. Lamonde’s compensation for the year ending August 31, 2006, the
Corporation relied on a study completed by an independent consulting firm
(Mercer Human Resource Consulting). Such study indicated average salaries and
bonuses, median salaries and bonuses and maximum salaries and bonuses paid
to
chief executive officers by Canadian and American computer hardware and software
companies as well as by a specific group of companies active in the fiber optics
industry identified by the Corporation that it considers to be the best
available comparisons. It was decided that Mr. Lamonde’s compensation
should reflect the median of Canadian computer hardware and software companies
and of the specific group of companies in fiber optics identified by the
Corporation. In the financial year ended August 31, 2006, Mr.
Lamonde’s compensation was adjusted accordingly.
In
the
financial year ended August 31, 2006, the bonus portion of Mr. Lamonde’s
compensation was tied to the financial and strategic objectives of the
Corporation based on the following factors:
|
Measure
|
Weighting
ALL
|
|
Sales
|
35%
|
|
Earnings
|
15%
|
|
Gross
margin
|
25%
|
|
Customer
satisfaction (quality and on time delivery)
|
25%
|
|
Personal
objectives (multiplier)
|
0%
- 125%
|
Mr. Lamonde’s
bonus is payable in the same proportion at which the Corporation attains such
objectives. When the objectives are exceeded, the bonus is higher; when
objectives are not met, the bonus is lower.
Deferred
Share Unit Plan
Introduced
in October 2004 and effective as of January 2005, the Deferred Share Unit Plan
is designed to align more closely the interests of its non-employee directors
with those of the Corporation’s shareholders.
Under
the
Deferred Share Unit Plan, non-employee directors shall receive up to 100 %
of
their retainer fees in the form of Deferred Share Units (“DSUs”), each of which
has
an
estimated value determined based on the highest of the closing prices of the
Subordinate Voting Shares on the Toronto Stock Exchange and the NASDAQ National
Market on the last trading day preceding the grant date, using the noon buying
rate of the Federal Reserve Bank of New York on the grant date to convert the
NASDAQ National Market closing price to Canadian dollars, as required. The
value
at vesting of a DSU is equivalent to the market value of a Subordinate Voting
Share when a DSU is converted to such Subordinate Voting Share.
The
value of a DSU, when converted to Subordinate Voting Shares, is equivalent
to
the market value of a Subordinate Voting Share at the time the conversion takes
place. DUSs attract dividends in the form of additional DSUs at the same rate
as
dividends on Subordinate Voting Share. When a director ceases to be a member
of
the Board, the DSUs are either converted and paid in Subordinate Voting Shares
purchased on the open market or issued by the Corporation. Such Subordinate
Voting Shares issued by the Corporation will be issued from the same pool of
Subordinate Voting Shares reserved for issuance pursuant to the Long-Term
Incentive Plan, which is 9.2% of the total issued and outstanding voting
shares.
The
following table summarizes information about DSUs granted to the non-employee
members of the Board of Directors as at August 31, 2006:
|
Number
of DSUs
|
%
of Issued and
Outstanding
DSUs
|
Weighted
Average Estimated Value at the Time of Grant
$US/DSU
|
|
|
Board
of Directors (five individuals)
|
43,290
|
100%
|
5.07
|
Restricted
Stock Award Plan
The
EXFO
Electrical-Optical Engineering Restricted Stock Award Plan (the "RSAP") was
established to provide a means through which employees of EXFO Burleigh Products
Group Inc. can be granted awards of restricted shares ("Restricted Shares")
of
Subordinate Voting Shares to promote retention and foster identity of interest
between stockholders and employees of EXFO Burleigh Products Group
Inc.
The
effective date of the RSAP was December 20, 2000. The expiration date of the
RSAP is the business day next following the final grant of Restricted Shares
under the RSAP, which was December 20, 2000. However, the administration of
the
RSAP did continue until all awards of Restricted Shares have been forfeited
or
settled. The aggregate number of shares subject to the RSAP was 360,000. Stock
awards granted under the RSAP vest over a 4 year period, with 25% vesting
on an annual basis commencing on the first anniversary of the date of grant.
The
last vesting occurred on December 20, 2004, the Human Resources Committee
administered the RSAP until that date. Therefore the administration of the
RSAP
terminated on December 20, 2004.
Awards
of
Restricted Shares were subject to forfeiture and restrictions on transfer until
the Restricted Shares became vested at which point a stock certificate was
issued to a participant with respect to the number of vested shares, which
are
then freely transferable. Restricted Shares become vested, subject to a
participant's continued employment with the Corporation or its affiliates,
on
each of the first four anniversaries of the date of grant of an award of
Restricted Shares.
Upon
a
participant's termination of employment with the Corporation or any of its
affiliates due to the participant's death, disability or retirement on or after
age 60, the participant's award of restricted shares became fully vested and
was
no longer subject to forfeiture. However, the transfer restrictions remained
in
place until the occurrence of the vesting dates originally contemplated by
the
award.
Upon
the
voluntary resignation of a participant, the termination of a participant's
employment for cause, the termination of a participant who is not designated
a
member of EXFO Burleigh Products Group Inc. "Management Team" without cause
prior to a change in control of the Corporation or a termination without cause
of a participant who is designated a member of EXFO Burleigh Products Group
Inc.
Management Team that is initiated by EXFO Burleigh Products Group Inc. prior
to
a change in control of the Corporation, the unvested portion of the
participant's award of Restricted Shares were forfeited. However the RSAP
provided discretion to the Human Resources Committee in the application of
the
forfeiture provisions where a change in circumstances rendered such action
appropriate. During the financial year ended August 31, 2005, EXFO Burleigh
Products Group Inc. was required to lay off the remaining of the participants
(excluding a few that were transferred to our other offices) as a result of
a
consolidation due to a sharp downturn in its market. The Human Resources
Committee decided that the awards of RSAP participants affected by the lay-offs
would not be subject to forfeiture, though the transfer restrictions remained
in
place until the occurrence of the vesting dates originally contemplated by
the
award.
Upon
the
termination without cause of a participant who was designated a member of EXFO
Burleigh Products Group Inc. Management Team that was initiated by the
Corporation or a termination of a participant's employment without cause
following a change in control of the Corporation, a participant's award of
Restricted Stock became fully vested and all restrictions lapsed.
In
the
event of a change in control, the committee administering the RSAP could in
its
discretion remove restrictions on Restricted Shares or provide for the
cancellation of awards in exchange for payment in respect of the Restricted
Shares subject to an award.
Stock
Appreciation Rights Plan
On
August
4, 2001, the Corporation established a Stock Appreciation Rights Plan (“SAR
Plan”) for the benefit of certain employees residing in countries where the
granting of options under the Stock Option Plan is not feasible in the opinion
of the Corporation. The Board has full and complete authority to interpret
the
SAR Plan and to establish the rules and regulations applying to it and to make
all other determinations it deems necessary or useful for the administration
of
the SAR Plan.
Under
the
SAR Plan, eligible employees are entitled to receive a cash amount equivalent
to
the difference between the market price of the Subordinate Voting Shares on
the
date of exercise and the exercise price determined on the date of grant. No
Subordinate Voting Shares are issuable under the SAR Plan.
The
Board
of Directors has delegated to Management the task of designating the recipients
of stock appreciation rights, the date of vesting, the expiry date and other
conditions. Under the terms of the SAR Plan, the exercise price of the stock
appreciation rights may not be lower than the highest of the closing prices
of
the Subordinate Voting Shares on the Toronto Stock Exchange and on the NASDAQ
National Market on the last trading day preceding the grant date, using the
noon
buying rate of the Federal Reserve Bank of New York on the grant date to convert
the NASDAQ National Market closing price to Canadian dollars. Stock appreciation
rights are non-transferable.
The
stock
appreciation rights vest over a four-year period, with 25% vesting annually
commencing on the first anniversary date of the date of grant. Once vested,
stock appreciation rights may be exercised between the second and the fifteenth
business day following each release of the Corporation’s quarterly financial
results. All of the stock appreciation rights that are granted under the SAR
Plan may be exercised within a maximum period of 10 years following the
date of their grant. Any stock appreciation rights granted under the SAR Plan
will lapse immediately upon the termination of the relationship with the
Corporation or one of its subsidiaries for a good and sufficient cause or at
the
date on which an employee resigns or leaves his employment with the Corporation
or one of its subsidiaries (or within 30 days if the holder is dismissed
without cause). In the event of retirement or disability, any stock appreciation
right held by an employee lapses 30 days after the date of any such disability
or retirement. In the event of death, any stock appreciation right lapses 6
months after the date of death.
Compensation
Plan Control and Review
As
a
general practice, the Corporation’s relative position in terms of compensation
levels is determined annually through studies performed by independent
consulting firms using a selected reference market of comparable companies.
In
addition, internal pay equity studies are a key factor to complete the
compensation review process and indicate where necessary adjustments may be
required. During the fiscal year ended August 31, 2006, this practice continued
and certain compensation adjustments that became necessary were
made.
Conclusion
By
way of
application of the Corporation’s executive compensation policy, an important
part of executive compensation is linked to corporate performance and long-term
value creation. The Human Resources Committee continuously reviews executive
compensation programs to ensure that they maintain their competitiveness and
continue to focus on the Corporation’s objectives, values and business
strategies.
Depending
on specific circumstances, the Committee may also recommend employment terms
and
conditions that deviate from the policies and the execution by the Corporation
or its subsidiaries of employment contracts on a case-by-case
basis.
By
the
Human Resources Committee:
Michael
Unger, Chairman
Pierre
Marcouiller
Guy
Marier
David
A.
Thompson
André
Tremblay
PERFORMANCE
GRAPH
The
performance graph presented below compares the cumulative total shareholder
return of a $100 investment in the Subordinate Voting Shares and the cumulative
total return of the S&P/TSX Stock Index for the five (5) years period
commencing August 31, 2001 and ending August 31, 2006.
The
Corporation’s Stock Performance
(August
31, 2001 to August 31, 2006)
DIRECTORS
AND OFFICERS’ LIABILITY INSURANCE
The
Corporation maintains insurance protection against liability incurred by its
officers and directors as well as those of its subsidiaries in the performance
of their duties. The entire premium, amounting to US$228,000 from September
30,
2006 to September 30, 2007, is paid by the Corporation. The aggregate limit
of
liability in respect of any and all claims is US$10 million per year. The policy
provides for the indemnification of directors and officers in the case of claims
for which the Corporation has not indemnified or is not permitted by law to
indemnify them, and for the reimbursement of the Corporation, subject to a
deductible of US$100,000, except for securities claims where the deductible
is
US$500,000.
REPORT
ON CORPORATE GOVERNANCE PRACTICES
Recent
Corporate Governance Developments in Canada
In
January 2004, the Canadian Securities Administrators (the “CSA”) adopted
Multilateral Instrument 52-110 — Audit Committees, which was amended as of June
30, 2005 (“MI 52-110”). MI 52-110 sets forth certain requirements
regarding audit committee composition and responsibilities, as well as reporting
obligations with respect to audit-related matters. The disclosure of the MI
52-110 requirements is included in our 2006 Annual Information Form in Form
20-F
available as described below.
Effective
June 30, 2005, the CSA also adopted Multilateral Instrument 58-101 —
Disclosure of Corporate Governance Practices (“MI 58-101”) and National
Policy 58-201 — Effective Corporate Governance (“NP 58-201” and,
together with MI 52-110, the “CSA Corporate Governance Standards”).
NP 58-201 provides guidance to Canadian issuers with respect to corporate
governance practices, while MI 58-101 requires issuers to make certain
disclosures regarding their governance practices. The CSA Corporate Governance
Standards, particularly MI 58-101 and NP 58-201, have replaced the
former guidelines of the Toronto Stock Exchange that had, prior to the coming
into force of the CSA Corporate Governance Standards, served as the primary
source of codified recommendations in respect of corporate governance practices
in Canada.
EXFO’s
Corporate Governance Practices
In
accordance with MI 58-101, we are required to disclose information with
respect to our system of corporate governance. Over the past few years, we
have
undertaken a comprehensive review of our corporate governance practices in
order
to best comply with and, whenever practicable, exceed the CSA
Standards.
We
updated and adopted in March 2005 a number of charters and policies, including
an Audit Committee Charter; a Board of Directors Corporate Governance
Guidelines, a Code of Ethics for our Principal Executive Officer and Senior
Financial Officers, a Disclosure Guidelines, an Ethics and Business Conduct
Policy, a Human Resources Committee Charter, a Securities Trading Policy and
a
Statement on Reporting Ethical Violations (Whistle Blower). We also adopted
in
October 2006 a policy regarding Hiring Employees and Former Employees of
Independent Auditor. We refer to our Board and Committee Charters as our
“Corporate Governance Rules”.
We
are of
the view that adopting and implementing good corporate governance practices
is a
cornerstone of our corporate and management practices and policies and that
our
existing corporate governance practices already meet or surpass the prevailing
corporate governance standards. We further believe that the measures we have
adopted with respect to corporate governance comply substantially with the
CSA
Standards.
We
encourage our shareholders to consult our Corporate Governance Rules and Code
of
Ethics and Business Conduct available on our website at www.EXFO.com
and also
available in print to any shareholder who requests copies by contacting our
Corporate Secretary.
Our
2006
Annual Information Form in Form 20-F (also filed with the SEC), which will
be
available on or before November 29, 2006 and which may be obtained upon request
from our Corporate Secretary or at www.sedar.com,
will
also contain certain information with respect to our corporate governance
practices.
We
are
dedicated to updating our corporate governance practices on an ongoing basis
in
order to respond to the evolution of best practices. We and our Board of
Directors are of the view that our corporate governance practices, as summarized
in the Schedule A attached to this Management Proxy Circular, are in substantial
compliance with the CSA Corporate Governance Standards. Copies of our Corporate
Governance Rules and all related policies (including those mentioned above)
are
available on our website at www.EXFO.com
as
mentioned in Schedule A.
ADDITIONAL
INFORMATION
Additional
information relating to the Corporation is on SEDAR at www.sedar.com.
The
Corporation shall provide to any person or company, upon request to the
Secretary of the Corporation, at 400 Godin Avenue, Quebec, Province of Quebec,
Canada, G1M 2K2, phone number (418) 683-0913 ext. 3704 or fax number
(418) 683-9839:
| (a) |
one
copy of the Annual Report on Form 20-F of the Corporation filed with
the
Securities and Exchange Commission (the “SEC”) in the United States
pursuant to the Securities
Exchange Act of 1934,
and with securities commissions or similar
authorities;
|
| (b) |
one
copy of the comparative consolidated financial statements of the
Corporation for its most recently completed financial year and the
Auditors report thereon, included in the Annual Report of the Corporation
and one copy of any interim consolidated financial statements of
the
Corporation subsequent to the consolidated financial statements for
its
most recently completed financial
year;
|
| (c) |
one
copy of this Management Proxy
Circular.
|
Additional
information relating to the Corporation is also included in the Corporation’s
Annual Report for the year ended August 31, 2006. The Annual Report containing
the consolidated audited financial statements, the report of the auditor and
management’s discussion and analysis is being mailed to shareholders with the
Notice of Meeting and this Management Proxy Circular. Additional copies of
the
Annual Report are available on SEDAR at www.sedar.com
and may
be obtained free of charge from the Corporation upon request and will be
available at the Meeting.
DIRECTORS’
APPROVAL
The
contents and the sending of this Management Proxy Circular have been approved
by
the Directors of the Corporation.
DATED
at
Quebec,
Province of Quebec, Canada, this 1st
day of
November, 2006.
/s/
Benoit Ringuette
Benoit
Ringuette
Corporate
Secretary
EXFO
ELECTRO-OPTICAL ENGINEERING INC.
400
Godin
Avenue
Quebec,
Province of Quebec, Canada, G1M 2K2
SCHEDULE A
|
CSA
Guidelines
|
EXFO
Electro-Optical Engineering’s Corporate Governance
Practices
|
|
1. Board
of Directors
|
|
|
(a) Disclose
the identity of directors who are independent.
|
The
following directors are independent:
Mr.
Pierre Marcouiller
Mr.
Guy Marier
Mr.
André Tremblay
Dr.
David A. Thompson
Mr.
Michael Unger
|
|
(b) Disclose
the identity of directors who are not independent, and describe
the basis
for that determination.
|
Mr.
Germain Lamonde - non-independent - is President and Chief Executive
Officer of the Corporation and a significant shareholder of the
Corporation as he has the ability to exercise a majority of the
votes for
the election of the Board of Directors.
|
|
(c) Disclose
whether or not a majority of directors are independent. If a majority
of
directors are not independent, describe what the board of directors
does
to facilitate its exercise of independent judgement in carrying
out its
responsibilities.
|
The
majority of directors are independent.
|
|
(d) If
a director is presently a director of any other issuer that is
a reporting
issuer (or the equivalent) in a jurisdiction or a foreign jurisdiction,
identify both the director and the other issuer.
|
Michael
Unger is a director of Tundra Semiconductor Corporation, a public
corporation of Ottawa. Guy Marier is a Director of Bell Nordic
Income
Fund. Pierre Marcouiller is a Director of Héroux-Devtek
Inc.
|
|
(e) Disclose
whether or not the independent directors hold regularly scheduled
meetings
at which non-independent directors and members of management are
not in
attendance. If the independent directors hold such meetings, disclose
the
number of meetings held since the beginning of the issuer’s most recently
completed financial year. If the independent directors do not hold
such
meetings, describe what the board does to facilitate open and candid
discussion among its independent directors.
|
The
independent Directors hold as many meeting, as needed, annually
and any
Director may request such meeting at any time. Since September
1, 2005 and
prior to November 1, 2006, three (3) meetings of independent Directors
without management occurred.
|
|
(f) Disclose
whether or not the chair of the board is an independent director.
If the
board has a chair or lead director who is an independent director,
disclose the identity of the independent chair or lead director,
and
describe his or her role and responsibilities. If the board has
neither a
chair that is independent nor a lead director that is independent,
describe what the board does to provide leadership for its independent
directors.
|
The
Chair of the Board is not an independent director. During the financial
year ended August 31, 2002, the Board of Directors designated Mr.
Michael
Unger to act as the independent “Lead Director”.
The
Lead Director is an outside and unrelated director appointed by
the Board
of Directors to ensure that the Board can perform its duties in
an
effective and efficient manner independent of management. The appointment
of a Lead Director is part of EXFO’s ongoing commitment to good corporate
governance. The Lead Director will namely:
· provide
independent leadership to the Board;
· facilitate
the functioning of the Board independently of the Corporation’s
management;
· maintain
and enhance the quality of the Corporation’s corporate governance
practices.
· in
the absence of the Executive Chair, act as chair of meetings of
the
Board;
· recommend,
where necessary, the holding of special meetings of the
Board;
· serve
as Board ombudsman, so as to ensure that questions or comments
of
individual directors are heard and addressed;
· manage
and investigate any report received through the Corporation website
pursuant to the Corporation’s Statement on reporting Ethical Violations
and Ethics and Business Conduct Policy;
· work
with the Board of Directors to facilitate the process for developing,
monitoring and evaluating specific annual objectives for the Board
each
year.
|
||||||
|
(g) Disclose
the attendance record of each director for all board meetings held
since
the beginning of the issuer’s most recently completed financial
year.
|
The
table below indicates the directors’ record of attendance at meetings of
the Board of Directors and its committees during the financial
year ended
August 31, 2006:
|
||||||
|
Director
|
Board
meetings
attended
|
Audit
Committee
meetings
attended
|
Human
Resources Committee meetings attended
|
Independent
Directors meetings attended
|
Total
Board and
Committee
meetings
attendance
rate
|
||
|
Lamonde,
Germain
|
7
of 7
|
n/a
|
n/a
|
n/a
|
100%
|
||
|
Marcouiller,
Pierre
|
7
of 7
|
5
of 5
|
5
of 5
|
3
of 4
|
95%
|
||
|
Marier,
Guy
|
7
of 7
|
5
of 5
|
5
of 5
|
4
of 4
|
100%
|
||
|
Thompson,
David
|
4
of 7
|
n/a
|
2
of 5
|
1
of 4
|
44%
|
||
|
Tremblay,
André
|
6
of 7
|
5
of 5
|
4
of 5
|
4
of 4
|
90%
|
||
|
Unger,
Michael
|
7
of 7
|
4
of 5
|
5
of 5
|
4
of 4
|
95%
|
||
|
Attendance
Rate:
|
90%
|
95%
|
84%
|
80%
|
88%
|
||
|
2. Board
Mandate -
Disclose the text of the board’s written mandate. If the board does not
have a written mandate, describe how the board delineates its role
and
responsibilities.
|
|
|
(a) Assuring
the integrity of the executive officers and creating a culture
of
integrity throughout the organisation.
|
The
Board is committed to maintaining the highest standards of integrity
throughout the organisation. Accordingly, the Board adopted an
Ethics and
Business Conduct Policy and a Statement on Reporting Ethical Violations
(“Whistleblower Policy”) which are available on EXFO website at www.
EXFO.com to all employees and formerly distributed to every new
employees
of the Corporation.
|
|
(b) Adoption
of a strategic planning process
|
The
Board provides guidance for the development of the strategic planning
process and approves the process and the plan developed by management
annually. In addition, the Board carefully reviews the strategic
plan and
deals with strategic planning matters that arise during the
year.
|
|
(c) Identification
of principal risks and implementing of risk management
systems
|
The
Board works with management to identify the Corporation’s principal risks
and manages these risks through regular appraisal of management’s
practices on an ongoing basis.
|
|
(d) Succession
planning including appointing, training and monitoring senior
management
|
The
Human Resources Committee is responsible for the elaboration and
implementation of a succession planning process and its updates
as
required. The Human Resources Committee is responsible to monitor
and
review the performance of the Chief Executive Officer and that
of all
other senior officers.
|
|
(e) Communications
policy
|
The
Chief Financial Officer of the Corporation is responsible for
communications between Management and the Corporation’s current and
potential shareholders and financial analysts. The Board adopted
and
implemented Disclosure Guidelines to ensure consistency in the
manner that
communications with shareholders and the public are managed. The
Audit
Committee reviews press releases containing the quarterly results
of the
Corporation prior to release. In addition, all material press releases
of
the Corporation are reviewed by the President and Chief Executive
Officer,
Chief Financial Officer, Investor Relations Manager, Manager of
Financial
Reporting and Accounting and Internal Legal Counsel. The Disclosure
Guidelines have been established in accordance with the relevant
disclosure requirements under applicable Canadian and United States
securities laws.
|
|
(f) Integrity
of internal control and management information systems
|
The
Audit Committee has the responsibility to review the Corporation’s systems
of internal controls regarding finance, accounting, legal compliance
and
ethical behaviour. The Audit Committee meets with the Corporation’s
external auditors on a quarterly basis. Accordingly, the Corporation
fully
complies with Sarbanes-Oxley Act requirements within the required
period
of time.
|
|
(g) Approach
to corporate governance including developing a set of corporate
governance
principles and guidelines that are specifically applicable to the
issuer
|
The
Board assumes direct responsibility for the monitoring of the Board’s
corporate governance practices, the functioning of the Board and
the
powers, mandates and performance of the committees. These responsibilities
were previously assumed by the Human Resources Committee. Accordingly,
the
Board updated and adopted in March 2005 the following policies
to fully
comply with these responsibilities:
· Audit
Committee Charter*;
· Board
of Directors Corporate Governance Guidelines*;
· Code
of Ethics for our Principal Executive Officer and Senior Financial
Officers*;
· Disclosure
Guidelines;
· Ethics
and Business Conduct Policy*;
· Human
Resources Committee Charter*;
· Securities
Trading Policy;
· Statement
on Reporting Ethical Violations (Whistle Blower)*.
The
Board also adopted in October 2006 the Policy Regarding Hiring
Employees
and Former Employees of Independent Auditors which is also available
on
EXFO website at www.EXFO.com.
*
available on EXFO website at www.EXFO.com.
|
|
(h) Expectations
and responsibilities of Directors, including basic duties and
responsibilities with respect to attendance at board meetings and
advance
review of meeting materials
|
The
Board is also responsible for the establishment and functioning
of all
Board committees, their compensation and their good standing. At
regularly
scheduled meetings of the Board, the Directors receive, consider
and
discuss committee reports. The Directors also receive in advance
of any
meeting, all documentation required for the upcoming meetings and
they are
expected to review and consult this
documentation.
|
|
3. Position
Descriptions
|
|
|
(a) Disclose
whether or not the board has developed written position descriptions
for
the chair of the board and the chair of each board committee. If
the board
has not developed written position descriptions for the chair and/or
the
chair of each board committee, briefly describe how the board delineates
the role and responsibilities of each such position.
|
There
is no specific mandate for the Board, however the Board of Directors
is,
by law, responsible for managing the business and affairs of the
Corporation. Any responsibility which is not delegated to senior
management or to a committee of the Board remains the responsibility
of
the Board. Accordingly, the chair of the Board, of the Audit Committee
and
of the Human Resources Committee will namely:
· provide
leadership to the Board or Committee;
· ensure
that the Board or Committee can perform its duties in an effective
and
efficient manner;
· facilitate
the functionary of the Board or Committee;
· promote
best practices and high standards of corporate governance.
|
|
(b) Disclose
whether or not the board and CEO have developed a written position
description for the CEO. If the board and CEO have not developed
such a
position description, briefly describe how the board delineates
the role
and responsibilities of the CEO.
|
No
written position description has been developed for the CEO. The
President
and Chief Executive Officer, along with the rest of management
placed
under his supervision, is responsible for meeting the corporate
objectives
as determined by the strategic objectives and budget as they are
adopted
each year by the Board of Directors.
|
|
4. Orientation
and Continuing Education
|
|
|
(a) Briefly
describe what measures the board takes to orient new directors
regarding
(i) the
role of the board, its committees and its directors, and
(ii) the
nature and operation of the issuer’s business.
|
The
Human Resources Committee Charter foresees that the Human Resource
Committee maintain an orientation program for New Directors.
Presentations
and reports relating to the Corporation’s business and affairs are
provided to new Directors. In addition, new Board members meet
with senior
management of the Corporation to review the business and affairs
of the
Corporation.
|
|
(b) Briefly
describe what measures, if any, the board takes to provide continuing
education for its directors. If the board does not provide continuing
education, describe how the board ensures that its directors maintain
the
skill and knowledge necessary to meet their obligations as
directors.
|
The
Human Resources Committee Charter foresees that the Human Resources
Committee maintains a continuing education programs for
Directors.
|
|
5. Ethical
Business Conduct
|
|
|
(a) Disclose
whether or not the board has adopted a written code for the directors,
officers and employees. If the board has adopted a written
code:
i. disclose
how a person or company may obtain a copy of the code;
ii. describe
how the board monitors compliance with its code, or if the board
does not
monitor compliance, explain whether and how the board satisfies
itself
regarding compliance with its code; and
iii. provide
a cross-reference to any material change report filed since the
beginning
of the issuer’s most recently completed financial year that pertains to
any conduct of a director or executive officer that constitutes
a
departure from the code.
|
The
Corporation is committed to maintaining the highest standard of
business
conduct and ethics. Accordingly, the Board updated and established
(i) a
Board of Directors Corporate Governance Guidelines (ii) a Code
of Ethics
for our Principal Executive Officer and senior Financial Officers
(iii)
Ethics and Business Conduct Policy and (iv) a Statement on Reporting
Ethical Violations “Whistleblower Policy” which are available on the
Corporation’s website at www.EXFO.com.
The
Board of Directors will determine, or designate appropriate persons
to
determine, appropriate actions to be taken in the event of a violation
of
the Code of Ethics for our Principal Executive Officer and senior
Financial Officers. Someone that does not comply with this Code
of Ethics
will be subject to disciplinary measures, up to and including discharge
from the Corporation. Furthermore, a compliance affirmation must
be filled
in a written form agreeing to abide by the policies of the Code
of
Ethics.
No
material change report has been required or filed during our financial
year ended August 31, 2006 with respect to any conduct constituting
a
departure from our Code of Ethics.
|
|
(b) Describe
any steps the board takes to ensure directors a material
interest,
exercise independent judgement in considering transactions and
agreements
in respect of which a director or executive officer has a material
interest.
|
Activities
that could give rise to conflicts of interest are prohibited. Board
members should contact the Lead Director or in-house legal counsel
regarding any issues relating to possible conflict of interest.
If such
event occurs, the implicated Board member will not participate
in the
meeting and discussion with respect to such possible conflict of
interest
and will not be entitled to vote on such matter. Senior executives
should
also contact the in-house legal counsel regarding any issues relating
to
possible conflict of interest.
|
|
(c) Describe
any other steps the board takes to encourage and promote a culture
of
ethical business conduct.
|
The
Corporation has instituted and follows a “Whistleblower Policy” where each
member of the Board as well as any senior officer, every employee
of the
Corporation and any person is invited and encouraged to report
anything
appearing or suspected of being non-ethical to our Lead Director,
in
confidence. The Lead Director has the power to hire professional
assistance to conduct an internal investigation should he so fell
required.
|
|
6. Nomination
of Directors
|
|
|
(a) Describe
the process by which the board identifies new candidates for board
nomination.
|
The
Board adopted and implemented a Human Resources Committee Charter
which
integrates the Compensation Committee Charter and the Nominating
and
Governance Committee Charter. The Human Resources Committee is
responsible
for nomination, assessment and compensation of directors and
Officers.
|
|
(b) Disclose
whether or not the board has a nominating committee composed entirely
of
independent directors. If the board does not have a nominating
committee
composed entirely of independent directors, describe what steps
the board
takes to encourage an objective nomination process.
|
The
Human Resources Committee consists of five members all of who are
independent Directors. The Chairman of the Human Resources Committee
is
Mr. Michael Unger.
The
Human Resources Committee Charter namely foresees:
· The
Committee to identify individuals qualified to become members of
the
Board, to conduct background checks respecting such individuals,
to
recommend that the Board select the director nominees for the next
annual
meeting of shareholders;
|
|
(c) If
the board has a nominating committee, describe the responsibili-ties,
powers and operation of the nominating committee.
|
|
|
7. Compensation
|
|
|
(a) Describe
the process by which the board determines the compensation for
the
issuer’s directors and officers.
|
The
Human Resources Committee reviews periodically compensation policies
in
light of market conditions, industry practice and level of
responsibilities. Only independent Directors are compensated for
acting as
a Director of the Corporation.
|
|
(b) Disclose
whether or not the board has a compensation committee composed
entirely of
independent directors. If the board does not have a compensation
committee
composed entirely of independent directors, describe what steps
the board
takes to ensure an objective process for determining such
compensation.
|
The
Human Resources Committee consists of five members all of who are
independent Directors. The Chairman of the Human Resources Committee
is
Mr. Michael Unger.
|
|
(c) If
the board has a compensation committee, describe the responsibili-ties,
powers and operation of the compensation committee.
|
The
Human Resources Committee Charter namely foresees:
· The
Committee to review and approve on an annual basis with respect
to the
annual compensation of all senior officers;
· The
Committee to review and approve, on behalf of the Board of Directors
(“the
Board”) or in collaboration with the Board as applicable, on the basis
of
the attribution authorized by the Board, to whom options to purchase
shares of the Corporation, RSUs or DSUs shall be offered as the
case may
be and if so, the terms of such options, RSUs or DSUs in accordance
with
the terms of the Corporation’s Long-Term Incentive Plan or the Deferred
Share Unit Plan provided that no options, RSUs or DSUs shall be
granted to
members of this committee without the approval of the Board;
· The
committee to recommend to the Board from time to time the remuneration
to
be paid by the Corporation to Directors;
· The
Committee to make recommendations to the Board with respect to
the
Corporation’s incentive compensation plans and equity-based
plans.
|
|
(d) If
a compensation consultant or advisor has, at any time since the
beginning
of the issuer’s most recently completed financial year, been retained to
assist in determining compensation for any of the issuer’s directors and
officers, disclose the identity of the consultant or advisor and
briefly
summarize the mandate for which they have been retained. If the
consultant
or advisor has been retained to perform any other work for the
issuer,
state that fact and briefly describe the nature of the work.
|
In
2004, the Corporation hired Mercer Human Resource Consulting to
conduct a
full market benchmarking and review of the Corporation’s executive
compensation plans. In 2006, Mercer provided data regarding market
competitive annual base salary increases, which were applied to
the
executive compensation structure developed in 2004. In addition,
Mercer
completed mandates on the following topics in 2006:
· Job
classification structure & salary scales (Define Job positions vs
comparable market including salary scale);
· Development
of compensation management policies & practices (to manage employee
progression through the salary scale).
|
|
8. Other
Board Committees -
If the board has standing committees other than the audit, compensation
and nominating committees, identify the committees and describe
their
function.
|
The
Board has no other standing
committee.
|
|
9. Assessments -
Disclose whether or not the board, its committees and individual
directors
are regularly assessed with respect to their effectiveness and
contribution. If assessments are regularly conducted, describe
the process
used for the assessments. If assessments are not regularly conducted,
describe how the board satisfies itself that the board, its committees,
and its individual directors are performing effectively.
|
The
Board assumes direct responsibility for the monitoring of the Board’s
corporate governance practices, the functioning of the Board and
the
powers, mandates and performance of the Committee. The Human Resources
Committee, composed solely of independent Directors, initiates
a
self-evaluation of the Board’s performance on an annual
basis.
|