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 July, 2003
EXFO ELECTRO-OPTICAL ENGINEERING INC.
(Translation of registrant's name into English)
465 GODIN AVENUE, VANIER, QUEBEC, CANADA G1M 3G7
(Address of principal executive offices)
Indicate by check mark whether the registrant files or will file annual
reports under cover Form 20-F or Form 40-F.
Form 20-F [X] Form 40-F [_]
Indicate by check mark if the registrant is submitting the Form 6-K in
paper as permitted by Regulation S-T Rule 101(b)(1). [_]
Note: Regulation S-T Rule 101(b)(1) only permits the submission in
paper of a Form 6-K if submitted solely to provide an attached annual report to
security holders.
Indicate by check mark if the registrant is submitting the Form 6-K in
paper as permitted by Regulation S-T Rule 101(b)(7): [_]
Note: Regulation S-T Rule 101(b)(7) only permits the submission in
paper of a Form 6-K if submitted to furnish a report or other document that the
registrant foreign private issuer must furnish and make public under the laws of
the jurisdiction in which the registrant is incorporated, domiciled or legally
organized (the registrant's "home country"), or under the rules of the home
country exchange on which the registrant's securities are traded, as long as the
report or other document is not a press release, is not required to be and has
not been distributed to the registrant's security holders, and, if discussing a
material event, has already been the subject of a Form 6-K submission or other
Commission filing on EDGAR.
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 [_] No [X]
If "Yes" is marked, indicate below the file number assigned to the
registrant in connection with Rule 12g3-2(b): 82-___________.
On June 26, 2003, EXFO Electro-Optical Engineering Inc., a Canadian corporation,
reported its results of operations for the third fiscal quarter ended May 31,
2003. This report on Form 6-K sets forth the news release relating to EXFO's
announcement and certain information relating to EXFO's financial condition and
results of operations for the third fiscal quarter of the 2003 fiscal year. This
press release and information relating to EXFO's financial condition and results
of operations for the third fiscal quarter of the 2003 fiscal year are hereby
incorporated as a document 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.
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.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
By: /s/ Germain Lamonde
-----------------------------------
Name: Germain Lamonde
Title: President and Chief
Executive Officer
Date: July 3, 2003
[GRAPHIC OMITTED -- COMPANY LOGO]
EXFO
PRESS RELEASE
================================================================================
1 800 663-3936 info@exfo.com - www.exfo.com Fiber-optic test,
Tel: (418) 683-0211 measurement and
Fax: (418) 683-2170 monitoring equipment
EXFO REPORTS MODEST SALES GROWTH QUARTER-OVER-QUARTER
o SALES INCREASE OF 2% QUARTER-OVER-QUARTER
o SALES IMPROVEMENT FOR PORTABLE AND MONITORING PRODUCT LINES OF
14% FOR THIRD QUARTER OF 2003 COMPARED TO SAME PERIOD IN 2002
o STRONG BALANCE SHEET WITH A CASH POSITION OF US$61.8 MILLION
QUEBEC CITY, CANADA, June 26, 2003--EXFO Electro-Optical Engineering Inc.
(NASDAQ: EXFO, TSX: EXF) reported today modest sales growth for the third
quarter ended May 31, 2003 compared to the previous quarter.
Sales increased 2% to US$15.1 million in the third quarter of fiscal 2003 from
US$14.8 million in the second quarter of 2003, but decreased 8% from US$16.3
million in the third quarter of 2002.
"We are pleased that our increased focus on the network service provider (NSP)
market, especially with heightened traction in protocol-layer testing, generated
sales increases for our Portable and Monitoring product lines of 14% for the
third quarter of fiscal 2003 compared to the same period in 2002 and 10% for the
first three quarters of 2003 versus the same time last year," said Germain
Lamonde, Chairman, President and CEO of EXFO. "These sales increases amidst a
shrinking market lead us to believe that we're continuing to gain market share.
"Overall, our net bookings for the first three quarters of fiscal 2003 have been
stable compared to the same period in 2002. However, third-quarter results fell
below our expectations given the lower-than-expected positive seasonal effect on
capital expenditures in the global telecommunications industry, geo-political
and economic uncertainty, the outbreak of SARS as well as significant currency
fluctuations that negatively impacted our operating expenses."
Pro forma net loss* for the third quarter of fiscal 2003 amounted to US$4.1
million, or US$0.06 per share, compared to a pro forma net loss of US$3.4
million, or US$0.05 per share, for the previous quarter and a pro forma net loss
of US$3.9 million, or US$0.06 per share, for the third quarter of 2002.
Net loss for the third quarter of fiscal 2003 totaled US$38.4 million, or
US$0.61 per share, compared to a net loss of US$4.2 million, or US$0.07 per
share, for the second quarter of 2003 and a net loss of US$263.8 million, or
US$4.29 per share, for the third quarter of 2002.
The net loss in the third quarter of fiscal 2003 is largely due to US$35.6
million in impairment of assets, namely US$24.3 million in future income tax
assets, US$4.5 million in goodwill, US$2.9 million in intangible assets, US$2.3
million in R&D tax credits and US$1.6 million in inventories.
Gross margin, excluding the inventory write-off, amounted to 45.6% of sales for
the third quarter of fiscal 2003. Including the inventory write-off, gross
margin dropped to 34.7%.
[GRAPHIC OMITTED -- COMPANY LOGO]
EXFO
================================================================================
1 800 663-3936 info@exfo.com - www.exfo.com Fiber-optic test,
Tel: (418) 683-0211 measurement and
Fax: (418) 683-2170 monitoring equipment
As prescribed by generally accepted accounting principles (GAAP), EXFO reviewed
the carrying value of its assets in the third quarter and determined there was
some impairment. It should be noted, however, that these are one-time, non-cash
charges that do not affect the company's day-to-day operations. EXFO has a
strong balance sheet with a cash position of US$61.8 million to ensure its
long-term growth.
Following the end of the third quarter, EXFO announced a restructuring plan that
will provide approximately US$10 million in annualized pre-tax savings, which
will begin to produce an impact in early fiscal 2004. The company reduced its
workforce by 30%, rationalized its business operations and consolidated some of
its manufacturing operations. These cost-reduction initiatives will incur
charges of approximately US$4.8 million, including US$348,000 in the quarter
ended and substantially all the rest in the fourth quarter.
BUSINESS HIGHLIGHTS
EXFO introduced 10 new products in the third quarter including the 2.5+ Gigabit
Multi-Rate Transceiver for protocol-layer test applications, the Packet
Blazer(TM) Fibre Channel test module for installation and commissioning of
storage area networks, and the Integrated Applications Suite which automates the
operation of test modules within the FTB-400 field-testing platform.
EXFO has turned its business around in the last two years from two-thirds
Industrial and Scientific product lines--mostly with the collapse of the
component manufacturer end-market--to two-thirds Portable and Monitoring product
lines. As part of its restructuring plan, the company also announced that it was
exiting the optical component manufacturing automation business.
OPERATING EXPENSES
Selling and administrative expenses amounted to US$7.7 million, or 50.7% of
sales, in the third quarter of fiscal 2003 compared to US$7.0 million, or 47.7%
of sales, in the second quarter of 2003 and US$8.8 million, or 53.5% of sales,
in the third quarter of 2002.
Gross research and development expenses totaled US$4.6 million, or 30.7% of
sales, in the third quarter of fiscal 2003 compared to US$4.4 million, or 29.9%
of sales, in the previous quarter and US$4.7 million, or 28.9% of sales, in the
third quarter of 2002.
BUSINESS OUTLOOK
EXFO forecasted sales between US$13.0 million and US$16.0 million and a pro
forma net loss* between US$0.04 and US$0.07 per share (GAAP net loss between
US$0.14 and US$0.20 per share) for the fourth quarter of fiscal 2003.
CONFERENCE CALL AND WEBCAST
EXFO will host a conference call today at 5 p.m. (EDT) to review its
third-quarter results for fiscal 2003. To listen to the conference call and
participate in the question period via telephone, dial 1-416-695-7896. Germain
Lamonde, Chairman, President and CEO, and Pierre Plamondon, CA, Vice-President
of Finance and Chief Financial Officer, will participate in the call. An audio
replay of the conference call will be available between 7 a.m. and 11 p.m. until
July 3, 2003. The replay number is 1-416-252-1143. The audio Webcast of the
conference call will also be available on EXFO's Website at
www.exfo.com/investors.
-----------------------
[GRAPHIC OMITTED -- COMPANY LOGO]
EXFO
================================================================================
1 800 663-3936 info@exfo.com - www.exfo.com Fiber-optic test,
Tel: (418) 683-0211 measurement and
Fax: (418) 683-2170 monitoring equipment
*PRO FORMA NET LOSS REPRESENTS NET LOSS EXCLUDING AMORTIZATION AND
WRITE-DOWN OF GOODWILL, FUTURE INCOME TAX ASSETS VALUATION ALLOWANCE, AND
THE AFTER-TAX EFFECT OF AMORTIZATION AND WRITE-DOWN OF INTANGIBLE ASSETS,
RESTRUCTURING AND OTHER CHARGES AS WELL AS INVENTORY AND TAX CREDIT
WRITE-OFFS. ALL FIGURES ARE IN THOUSANDS OF US DOLLARS EXCEPT PER SHARE
DATA.
THREE MONTHS ENDED
MAY 31,
-----------------------------
ACTUAL RESULTS
2003 2002
------------- ------------
(UNAUDITED)
NET LOSS IN ACCORDANCE WITH GAAP $ (38,427) $ (263,826)
PRO FORMA ADJUSTMENTS:
AMORTIZATION OF GOODWILL -- 12,472
AMORTIZATION OF INTANGIBLE ASSETS 1,264 3,236
WRITE-DOWN OF GOODWILL 4,505 222,169
WRITE-DOWN OF INTANGIBLE ASSETS 2,922 23,657
TAX EFFECT ON AMORTIZATION OF INTANGIBLE ASSETS (430) (1,086)
TAX EFFECT ON WRITE-DOWN OF INTANGIBLE ASSETS (993) (7,942)
RESTRUCTURING AND OTHER CHARGES AND INVENTORY AND TAX CREDIT
WRITE-OFFS 4,291 11,124
TAX EFFECT ON RESTRUCTURING AND OTHER CHARGES AND
INVENTORY AND TAX CREDIT WRITE-OFFS (1,459) (3,734)
FUTURE INCOME TAX ASSETS VALUATION ALLOWANCE 24,260 --
------------- ------------
PRO FORMA NET LOSS $ (4,067) $ (3,930)
============= ============
BASIC AND DILUTED NET LOSS PER SHARE IN ACCORDANCE WITH GAAP $ (0.61) $ (4.29)
BASIC AND DILUTED PRO FORMA NET LOSS PER SHARE $ (0.06) $ (0.06)
THREE MONTHS ENDED
AUGUST 31, 2003
-----------------------------
OUTLOOK
(UNAUDITED)
BASIC AND DILUTED NET LOSS PER SHARE IN ACCORDANCE WITH
GAAP FROM $ (0.14) $ (0.20)
PRO FORMA ADJUSTMENTS:
AMORTIZATION OF INTANGIBLE ASSETS 0.02 0.02
TAX EFFECT ON AMORTIZATION OF INTANGIBLE ASSETS (0.01) (0.01)
RESTRUCTURING AND OTHER CHARGES AND TAX CREDIT WRITE-OFF 0.06 0.08
TAX EFFECT ON RESTRUCTURING AND OTHER CHARGES AND TAX CREDIT
WRITE-OFF (0.02) (0.03)
FUTURE INCOME TAX ASSETS VALUATION ALLOWANCE 0.05 0.07
------------- ------------
BASIC AND DILUTED PRO FORMA NET LOSS PER SHARE FROM $ (0.04) $ (0.07)
============= ============
EXFO PROVIDES PRO FORMA FINANCIAL INFORMATION TO HELP THE INVESTOR BETTER
UNDERSTAND ITS OPERATING RESULTS. THIS INFORMATION IS NOT IN ACCORDANCE
WITH, OR AN ALTERNATIVE FOR, GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND
MAY NOT BE COMPARABLE TO SIMILARLY TITLED MEASURES REPORTED BY OTHER
COMPANIES.
[GRAPHIC OMITTED -- COMPANY LOGO]
EXFO
================================================================================
1 800 663-3936 info@exfo.com - www.exfo.com Fiber-optic test,
Tel: (418) 683-0211 measurement and
Fax: (418) 683-2170 monitoring equipment
ABOUT EXFO
EXFO is a leading designer and manufacturer of fiber-optic test, measurement and
monitoring solutions for the global telecommunications industry. EXFO markets
more than 90 product families to 2000 customers in 70 countries around the
world.
EXFO develops products for two main markets. The Portable and Monitoring
Division provides handheld and modular instruments for the physical-, optical-
and protocol-layer testing needs of telecommunications carriers and network
service providers. The Industrial and Scientific Division offers an extensive
line of high-performance instruments and test systems for optical transmission
system and component vendors as well as for research and development labs.
This news release 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 that refer to expectations, projections or other
characterizations of future events and circumstances. They are not guarantees of
future performance and involve risks and uncertainties. Actual results may
differ materially from those in forward-looking statements due to various
factors including global geo-political, economic, competitive and market
uncertainty and our ability to execute successfully in these uncertain
conditions; capital spending levels in the telecommunications sector; market
acceptance of new products and upcoming new products; limited visibility of
customer orders and the timing thereof; the competitive landscape; and
successful integration of our acquired and to-be-acquired companies. Assumptions
relating to the foregoing involve judgments and risks, all of which are
difficult or impossible to predict 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 and shall not be revised
or updated to reflect events after the date of this document.
FOR MORE INFORMATION:
Vance Oliver
Investor Relations
(418) 683-0211
vance.oliver@exfo.com
EXFO ELECTRO-OPTICAL ENGINEERING INC.
INTERIM CONSOLIDATED BALANCE SHEET
(in thousands of US dollars)
AS AT AS AT
MAY 31, AUGUST 31,
2003 2002
------------- -------------
(UNAUDITED)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 6,036 $ 9,128
Short-term investments 55,797 40,553
Accounts receivable
Trade, less allowance for doubtful accounts of $550
($520 as at August 31, 2002) 10,629 9,881
Other 1,120 3,267
Income taxes and tax credits recoverable (note 4) 2,771 13,473
Inventories (notes 4 and 5) 20,245 23,822
Prepaid expenses 1,622 1,280
Future income taxes (note 4) 214 1,272
------------- -------------
98,434 102,676
INCOME TAXES AND TAX CREDITS RECOVERABLE (note 4) 3,339 6,234
PROPERTY, PLANT AND EQUIPMENT 26,518 26,246
INTANGIBLE ASSETS (notes 4 and 6) 11,838 16,464
GOODWILL (notes 3 and 4) 17,827 17,576
FUTURE INCOME TAXES (note 4) 434 8,730
------------- -------------
$ 158,390 $ 177,926
============= =============
LIABILITIES
CURRENT LIABILITIES
Accounts payable and accrued liabilities (note 7) $ 11,556 $ 10,699
Income taxes payable 2,977 --
Deferred revenue 283 503
Current portion of long-term debt 100 100
------------- -------------
14,916 11,302
DEFERRED GRANTS 1,884 654
LONG-TERM DEBT 490 564
------------- -------------
17,290 12,520
------------- -------------
CONTINGENCY (note 9)
SHAREHOLDERS' EQUITY
SHARE CAPITAL 492,428 489,611
CONTRIBUTED SURPLUS 1,498 1,487
CUMULATIVE TRANSLATION ADJUSTMENT 8,843 (8,854)
DEFICIT (361,669) (316,838)
------------- -------------
141,100 165,406
------------- -------------
$ 158,390 $ 177,926
============= =============
The accompanying notes are an integral part of
these consolidated financial statements.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
INTERIM UNAUDITED CONSOLIDATED STATEMENTS OF EARNINGS
(in thousands of US dollars, except share and per share data)
THREE MONTHS NINE MONTHS THREE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
MAY 31, 2003 MAY 31, 2003 MAY 31, 2002 MAY 31, 2002
------------------ ------------------- ------------------- -------------------
SALES $ 15,103 $ 47,604 $ 16,348 $ 51,087
COST OF SALES* 9,858 25,087 17,080 42,497
------------------ ------------------- ------------------- -------------------
GROSS MARGIN (LOSS) 5,245 22,517 (732) 8,590
------------------ ------------------- ------------------- -------------------
OPERATING EXPENSES
Selling and administrative 7,654 22,298 8,750 28,327
Net research and development
(notes 4 and 8) 5,882 12,681 3,454 10,272
Amortization of property, plant and
equipment 1,594 4,588 1,544 4,379
Amortization of intangible assets 1,264 3,746 3,236 9,976
Write-down of intangible assets (note 4) 2,922 2,922 23,657 23,657
Restructuring and other charges (note 4) 348 348 2,023 2,880
------------------ ------------------- ------------------- -------------------
TOTAL OPERATING EXPENSES 19,664 46,583 42,664 79,491
------------------ ------------------- ------------------- -------------------
LOSS FROM OPERATIONS (14,419) (24,066) (43,396) (70,901)
Interest income, net 379 929 261 1,239
Foreign exchange loss (600) (1,310) (801) (714)
------------------ ------------------- ------------------- -------------------
LOSS BEFORE INCOME TAXES AND AMORTIZATION
AND WRITE-DOWN OF GOODWILL (14,640) (24,447) (43,936) (70,376)
------------------ ------------------- ------------------- -------------------
INCOME TAXES
Current 2,206 5,887 (787) (8,602)
Future (7,184) (14,268) (13,964) (15,718)
Future income tax assets valuation
allowance (note 4) 24,260 24,260 -- --
------------------ ------------------- ------------------- -------------------
19,282 15,879 (14,751) (24,320)
------------------ ------------------- ------------------- -------------------
LOSS BEFORE AMORTIZATION AND WRITE-DOWN
OF GOODWILL (33,922) (40,326) (29,185) (46,056)
AMORTIZATION OF GOODWILL (note 2) -- -- 12,472 37,331
WRITE-DOWN OF GOODWILL (note 4) 4,505 4,505 222,169 222,169
------------------ ------------------- ------------------- -------------------
NET LOSS FOR THE PERIOD $ (38,427) $ (44,831) $ (263,826) $ (305,556)
================== =================== =================== ===================
BASIC AND DILUTED LOSS PER SHARE
Loss before amortization and write-down
of goodwill $ (0.54) $ (0.64) $ (0.47) $ (0.76)
Net loss $ (0.61) $ (0.71) $ (4.29) $ (5.06)
BASIC WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING (000'S) 63,014 62,791 61,443 60,391
DILUTED WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING (000'S) (note 10) 63,506 63,232 61,677 60,719
* Including inventory write-offs of $1,646 for the periods ended May 31,
2003, and of $9,101 and $18,463 for the three months and the nine months
ended May 31, 2002, respectively (note 4).
The accompanying notes are an integral part
of these consolidated financial statements.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
INTERIM UNAUDITED CONSOLIDATED STATEMENTS OF DEFICIT
AND CONTRIBUTED SURPLUS
(in thousands of US dollars)
DEFICIT
NINE MONTHS ENDED
MAY 31,
---------------------------
2003 2002
------------ ------------
BALANCE - BEGINNING OF PERIOD $ (316,838) $ (8,314)
ADD
Net loss for the period (44,831) (305,556)
------------ ------------
BALANCE - END OF PERIOD $ (361,669) $ (313,870)
------------ ------------
CONTRIBUTED SURPLUS
NINE MONTHS ENDED
MAY 31,
---------------------------
2003 2002
------------ ------------
BALANCE - BEGINNING OF PERIOD $ 1,487 $ 1,457
ADD
Premium on resale of share capital 11 26
------------ ------------
BALANCE - END OF PERIOD $ 1,498 $ 1,483
------------ ------------
The accompanying notes are an integral part
of these consolidated financial statements.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
INTERIM UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands of US dollars)
THREE MONTHS NINE MONTHS THREE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
MAY 31, 2003 MAY 31, 2003 MAY 31, 2002 MAY 31, 2002
------------------ ------------------ ------------------- -------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss for the period $ (38,427) $ (44,831) $ (263,826) $ (305,556)
Add (deduct) items not affecting cash and
cash equivalents
Discount on short-term investments (37) 226 (14) 527
Inventory and tax credit write-offs 3,943 3,943 9,101 18,463
Restructuring and other charges -- -- 741 741
Amortization 2,858 8,334 17,252 51,686
Foreign exchange loss (gain) on
disposal of short-term investments -- (42) 2 (74)
Future income taxes (7,184) (14,268) (13,964) (15,718)
Future income tax assets valuation
allowance 24,260 24,260 -- --
Write-down of goodwill and intangible
assets 7,427 7,427 245,826 245,826
Change in non-cash operating items
Accounts receivable (581) 2,777 279 15,382
Income taxes and tax credits 5,051 15,692 (415) (16,715)
Inventories 1,539 5,522 1,679 1,652
Prepaid expenses (242) (135) 126 220
Accounts payable and accrued
liabilities 17 (475) 670 (4,777)
Deferred revenue 59 (247) (85) (304)
Deferred grants 1,225 1,140 -- (334)
------------------- ------------------- ------------------- ------------------
(92) 9,323 (2,628) (8,981)
------------------- ------------------- ------------------- ------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Repayment of long-term debt (30) (108) (23) (82)
Issuance of share capital 17 17 -- --
Redemption of share capital -- (7) -- (2)
Resale of share capital -- 18 -- 28
Share issue expenses -- 4 -- (14)
------------------- ------------------- ------------------- ------------------
(13) (76) (23) (70)
------------------- ------------------- ------------------- ------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to short-term investments (135,708) (346,893) (108,709) (491,755)
Proceeds from disposal of short-term
investments 134,619 337,911 110,527 514,658
Additions to property, plant and equipment
and intangible assets (234) (2,250) (369) (4,669)
Business combinations (note 3) -- (1,867) -- (9,756)
------------------- ------------------- ------------------- ------------------
(1,323) (13,099) 1,449 8,478
------------------- ------------------- ------------------- ------------------
CHANGE IN CASH AND CASH EQUIVALENTS (1,428) (3,852) (1,202) (573)
EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON
CASH AND CASH EQUIVALENTS 159 760 224 (29)
CASH AND CASH EQUIVALENTS - BEGINNING OF
PERIOD 7,305 9,128 8,105 7,729
------------------- ------------------- ------------------- ------------------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 6,036 $ 6,036 $ 7,127 $ 7,127
=================== =================== =================== ==================
SUPPLEMENTARY INFORMATION
Interest paid $ 22 $ 108 $ 73 $ 169
Income taxes paid (recovered) $ (2,033) $ (7,495) $ (381) $ 5,837
The accompanying notes are an integral part
of these consolidated financial statements.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
1 INTERIM FINANCIAL INFORMATION
The financial information as at May 31, 2003, and for the periods ended May
31, 2002 and 2003, is unaudited. In the opinion of management, all
adjustments necessary to present fairly the results of these periods in
accordance with generally accepted accounting principles have been
included. The adjustments made were of a normal recurring nature. Interim
results may not necessarily be indicative of results anticipated for the
entire year.
These interim consolidated financial statements are prepared in accordance
with generally accepted accounting principles in Canada and use the same
accounting policies and methods used in the preparation of the company's
most recent annual consolidated financial statements, except for changes as
described in note 2. All disclosures required for annual financial
statements have not been included in these financial statements. These
interim consolidated financial statements should be read in conjunction
with the company's most recent annual consolidated financial statements.
2 NEW ACCOUNTING STANDARDS
In November 2001, the Canadian Institute of Chartered Accountants (CICA)
issued section 3870, "Stock-Based Compensation and Other Stock-Based
Payments", which is effective for fiscal years beginning on or after
January 1, 2002. The new section applies to awards granted on or after the
date of adoption, and requires that stock-based payments to non-employees
and direct awards of stock to employees be accounted for using a fair
value-based method. The new section also encourages, but does not require,
the use of a fair value-based method to account for stock-based
compensation costs arising from awards to employees. The new section
requires pro forma disclosures with respect to net earnings and net
earnings per share if a fair value-based method of accounting is not
adopted for awards granted to employees. The company adopted this new
standard prospectively on September 1, 2002. The company elected not to
account for stock-based compensation costs arising from awards to employees
using the fair value-based method and consequently, the adoption of this
new standard had no impact on the company's financial results. However, the
company complied with the standard by providing the required pro forma
disclosures.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
Therefore, if the fair value-based method had been used to account for
stock-based compensation costs related to stock options granted to
employees since the adoption of the standard on September 1, 2002, the net
loss and the related net loss per share figures would be as follows on a
pro forma basis:
THREE MONTHS ENDED NINE MONTHS ENDED
MAY 31, 2003 MAY 31, 2003
------------------- --------------------
(UNAUDITED) (UNAUDITED)
Net loss for the period $ (38,427) $ (44,831)
Pro forma adjustment for stock-based compensation costs (103) (266)
------------------- --------------------
Pro forma net loss for the period $ (38,530) $ (45,097)
=================== ====================
Net loss per share $ (0.61) $ (0.71)
Pro forma net loss per share $ (0.61) $ (0.72)
These options, which have a weighted average fair value of $0.83, will
generate aggregate stock-based compensation costs of $1,002,400 over their
vesting periods. Those costs will be amortized over their vesting periods
using the graded vesting method resulting in annual stock-based
compensation costs of $403,500 in 2003, $307,300 in 2004, $190,700 in 2005,
$91,900 in 2006 and $9,000 in 2007.
The fair value of options granted was estimated using the Black-Scholes
options valuation model with the following weighted average assumptions:
THREE MONTHS ENDED NINE MONTHS ENDED
MAY 31, 2003 MAY 31, 2003
-------------------- --------------------
(UNAUDITED) (UNAUDITED)
Risk-free interest rate 4.5% 4.2%
Expected volatility 80% 80%
Dividend yield Nil Nil
Weighted average expected life 29 months 29 months
The Black-Scholes options valuation model was developed for use in
estimating the fair value of traded options and awards which have no
vesting restrictions, and are fully transferable. In addition, option and
award valuation models require the input of highly subjective assumptions,
including the expected stock price volatility. Because the company's
employee stock options have characteristics significantly different from
those of traded options, and because changes in the subjective input
assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
In August 2001, the CICA issued section 3062 "Goodwill and Other Intangible
Assets", which is effective for fiscal years beginning on or after January
1, 2002. Section 3062 changes the accounting for goodwill from an
amortization method to an impairment-only approach. Thus, amortization of
goodwill, including goodwill recorded in past business combinations ceased
upon the adoption of this section. For any acquisitions completed after
June 30, 2001, goodwill is not amortized.
The company adopted section 3062 prospectively on September 1, 2002. Since
the adoption of this new section, goodwill recorded prior to July 1, 2001,
is no longer subject to amortization. Also, under the transitional
provisions of the section, the company performed an initial impairment test
in September 2002 to identify goodwill impairment using a fair value-based
method. Under the new section, a goodwill impairment exists when the
carrying value of a reporting unit exceeds its fair value. For the purposes
of the impairment test, the company allocated its existing goodwill to its
reporting units and completed an evaluation of the fair value of such
reporting units. Based on the comparison of the fair value of the reporting
units to their carrying value, goodwill of the reporting units was not
considered impaired.
Furthermore, under this new section, goodwill must be tested for impairment
on an annual basis or more frequently if events or circumstances occur that
more likely than not reduce the fair value of a reporting unit below its
carrying value. Any impairment loss arising from this test will be charged
to earnings in the period in which it is incurred. The company elected to
perform its annual impairment test in May of each fiscal year for all its
existing reporting units (note 4).
This change in accounting policy has been applied prospectively and,
consequently, the amounts presented for prior periods have not been
restated. The consolidated statements of earnings for the periods ended May
31, 2002, show the net loss and the net loss per share figures before the
amortization of goodwill.
In November 2002, the CICA issued section 3063 "Impairment of Long-Lived
Assets", which is effective for fiscal years beginning on or after April 1,
2003. This new section changes existing rules for recognition and
measurement of long-lived assets held for use. The section requires that an
impairment charge be measured as the excess of the carrying value of an
intangible asset over its fair value. The company adopted this new section
prospectively on April 1, 2003, and tested its intangible assets under its
new provisions (note 4).
In November 2002, the CICA issued section 3475, "Disposal of long-lived
Assets and Discontinued Operations", which is effective for disposal
activities initiated by an enterprise's commitment to a plan on or after
May 1, 2003. Under the new section, a long-lived asset to be disposed of
other than by a sale continues to be classified as held and used until it
is disposed of; a long-lived asset classified as held for sale is measured
at the lower of its carrying value or fair value less cost to sell; a loss
recognized on classification of long-lived assets as held for sale or a
group of assets as a discontinued operation does not include future
operating losses, other than to the extent they are included in the fair
value of the asset; and discontinued operations are defined more broadly
than under existing rules. The company adopted this new standard
prospectively on May 1, 2003, and its adoption had no impact on the
company's financial statements.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
3 BUSINESS COMBINATION
On October 7, 2002, a newly created wholly-owned subsidiary of the company,
EXFO Gnubi Products Group Inc. ("EXFO Gnubi"), acquired substantially all
the assets of GNUBI COMMUNICATIONS, L.P., a U.S. company which supplies
multi-channel telecom and datacom testing solutions for optical transport
equipment manufacturers as well as research and development laboratories.
This acquisition was made to fully complement the company's offering, to
enhance its competitive position with network service providers and system
vendors as well as to expand its presence in the data communications test
market.
This acquisition was settled for a total consideration valued at $4,663,000
including acquisition-related costs of $162,000. The consideration paid
consisted of $1,867,000 in cash, $2,796,000 by the issuance of 1,479,290
subordinate voting shares and a cash contingent consideration up to a
maximum of $2,900,000, based on sales volume of EXFO Gnubi for the twelve
months following the acquisition.
The cash contingent consideration to be paid upon the realization of the
defined sales volume is accounted for as additional acquisition cost and is
recognized as additional cost of acquired core technology as sales occur.
Since October 7, 2002, the company recognized $155,000 as additional cost
of acquired core technology based on realized sales of EXFO Gnubi.
The fair value of the subordinate voting shares issued was determined based
on the market price of the shares beginning three days before and ending
three days after the number of shares became fixed based on a formula; that
is, September 10, 2002.
This acquisition has been 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
October 7, 2002; i.e., the date of acquisition.
The purchase price, including acquisition-related costs, has been allocated
based on the estimated fair value of net assets at the date of acquisition
as follows:
(UNAUDITED)
Assets acquired
Current assets $ 755
Property, plant and equipment 334
Core technology 750
Current liabilities assumed (134)
-----------
Net identifiable assets acquired 1,705
Goodwill 2,958
-----------
Purchase price 4,663
Less: Subordinate voting shares issued 2,796
-----------
Cash paid $ 1,867
===========
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
Core technology, which represents the existing technology that has reached
technological feasibility, is amortized on a straight-line basis over its
estimated useful life of five years. Goodwill, which will be fully
deductible for income tax purposes, is not amortized but is reviewed for
impairment on an annual basis or more frequently if events or circumstances
occur that more likely than not reduce the fair value of EXFO Gnubi below
its carrying value.
4 SPECIAL CHARGES
WRITE-DOWN OF GOODWILL AND INTANGIBLE ASSETS
In May 2003, the company performed its annual impairment test on goodwill
for all its reporting units, except for newly acquired EXFO Gnubi. Also,
considering current market conditions in the telecommunications industry
and the persisting unfavorable conditions affecting the subsidiaries'
industry, the company reviewed the carrying value of intangible assets
related to these reporting units.
As a result of this assessment, the company concluded that the carrying
value of goodwill related to EXFO Burleigh and the carrying value of
intangible assets related to EXFO Burleigh and EXFO Photonic Solutions was
impaired and it recorded a charge of $4,505,000 to write down goodwill and
a pre-tax charge of $2,922,000 to write down core technology. Of the total
impairment charge, $6,872,000 related to EXFO Burleigh for goodwill and
core technology and $555,000 relates to EXFO Photonic Solutions for core
technology.
RESTRUCTURING AND OTHER CHARGES AND INVENTORY WRITE-OFFS
In November 2001, the company incurred restructuring charges to reduce
costs and increase efficiency. The company recorded $410,000 in severance
expenses for the 101 employees who were terminated, which are included in
the restructuring and other charges in the statement of earnings for the
nine months ended May 31, 2002. The company also recorded $3,500,000 in
inventory write-offs for excess and obsolete inventories, which are
included in the cost of sales in the statement of earnings for that same
period.
In February 2002, the company incurred additional restructuring charges in
order to align its cost structure to market conditions. The company
recorded $447,000 in severance expenses for the additional 57 employees who
were terminated, which are included in the restructuring and other charges
in the statement of earnings for the nine months ended May 31, 2002. The
company also recorded $5,862,000 in additional inventory write-offs for
excess and obsolete inventories, which is included in the cost of sales in
the statement of earnings for that same period.
In May 2002, the company incurred additional charges to further reduce its
costs. Under an additional structured plan, the company recorded $1,155,000
in severance expenses for the additional 192 employees who were terminated
and $868,000 for the write-off of property plant and equipment. These
charges are included in the restructuring and other charges in statements
of earnings for the periods ended May 31, 2002. The company also recorded
$9,101,000 in additional inventory write-offs for excess and obsolete
inventories, which is included in the cost of sales for these same periods.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
In May 2003, the company implemented an additional restructuring plan to
realign its cost structure to current market conditions. The first part of
this plan, which was effective in May, resulted in 13 employees being
terminated and severance expenses of $348,000 recorded in the restructuring
and other charges in the statements of earnings for the periods ended May
31, 2003. The second part of this plan, which will occur mainly in the
fourth quarter of 2003, will reduce its workforce by 30% overall and
related restructuring and other charges will be recorded as incurred.
Furthermore, in May 2003, the company recorded $1,646,000 in inventory
write-offs for excess and obsolete inventories, which is included in the
cost of sales in the statements of earnings for the periods ended May 31,
2003.
As at May 31, 2003, accrued liabilities for these and past plans amounted
to $312,000.
FUTURE INCOME TAX ASSETS AND RESEARCH AND DEVELOPMENT TAX CREDITS
In May 31, 2003, the company reviewed the carrying value of its future
income tax assets and its research and development tax credits. Considering
current market conditions and because the company recorded losses for
current and past fiscal years, it concluded that it is more likely than not
that some of its future income tax assets and research and development tax
credits will not be recoverable and that a valuation allowance and
write-off were required. Accordingly, the company recorded a valuation
allowance of $24,260,000 to write off most of its future income tax assets
mainly related to the parent company, EXFO Protocol and EXFO Burleigh and
wrote off $2,297,000 in research and development tax credits related to
EXFO Protocol. The valuation allowance was recorded in the income tax
expense in the statements of earnings for the periods ended May 31, 2003,
and the write-off of research and development tax credits was recorded in
the net research and development expenses in the statements of earnings for
these same periods.
From the $24,260,000 valuation allowance for future income tax assets,
$12,120,000 represent tax assets that can be carried forward indefinitely
against future years taxable income, while $12,140,000 represent tax assets
that can be carried forward against future years taxable income mainly over
the next seven years. All tax credits written off can be carried forward
indefinitely against future years taxable income.
5 INVENTORIES
AS AT AS AT
MAY 31, AUGUST 31,
2003 2002
--------------- -----------------
(UNAUDITED)
Raw materials $ 9,702 $ 13,507
Work in progress 1,408 1,382
Finished goods 9,135 8,933
---------------- ----------------
$ 20,245 $ 23,822
================ ================
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
6 INTANGIBLE ASSETS
AS AT MAY 31, 2003
------------------------------------------------------------------
ACCUMULATED
COST AMORTIZATION NET
------------------- -------------------- --------------------
(UNAUDITED)
Core technology (note 4) $ 31,347 $ 19,629 $ 11,718
Acquired in-process research and development 4,524 4,524 --
Work force 2,271 2,271 --
Other 589 469 120
------------------- -------------------- --------------------
$ 38,731 $ 26,893 $ 11,838
=================== ==================== ====================
AS AT AUGUST 31, 2002
------------------------------------------------------------------
ACCUMULATED
COST AMORTIZATION NET
------------------- -------------------- --------------------
Core technology $ 31,086 $ 14,816 $ 16,270
Acquired in-process research and development 4,195 4,195 --
Work force 2,148 2,148 --
Other 498 304 194
------------------- -------------------- --------------------
$ 37,927 $ 21,463 $ 16,464
=================== ==================== ====================
7 ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
AS AT AS AT
MAY 31, AUGUST 31,
2003 2002
------------------- ------------------
(UNAUDITED)
Trade $ 4,700 $ 4,738
Salaries and social benefits 4,708 2,638
Warranty 823 849
Tax on capital 310 856
Restructuring charges (note 4) 312 782
Other 703 836
------------------- ------------------
$ 11,556 $ 10,699
=================== ==================
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
8 NET RESEARCH AND DEVELOPMENT EXPENSES
THREE MONTHS NINE MONTHS THREE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
MAY 31, 2003 MAY 31, 2003 MAY 31, 2002 MAY 31, 2002
------------------- ------------------- ------------------ ------------------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
Gross research and development
expenses $ 4,639 $ 13,261 $ 4,723 $ 13,756
Research and development tax credits (1,038) (2,995) (1,159) (3,176)
Government grants (16) (46) (110) (308)
Write-off of research and
development tax credits (note 4) 2,297 2,297 -- --
------------------- ------------------- ------------------ ------------------
$ 5,882 $ 12,517 $ 3,454 $ 10,272
=================== =================== =================== ==================
9 CONTINGENCY
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
pre-determined 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
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
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 judgment 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 Telling Agreements entered into with the plaintiffs.
Management believes that the company and its executive officers have fully
complied with all applicable securities laws and that the claims against it
are without merit. The company has referred this matter to its insurers and
is vigorously defending its position in this litigation. However, at this
time, it is not possible to predict the final outcome of this case, nor
determine the amount of possible losses. Accordingly, no provision for this
case has been made in the consolidated financial statements as of May 31,
2003.
10 LOSS 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 used in the diluted loss per share
calculation:
THREE MONTHS NINE MONTHS THREE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
MAY 31, 2003 MAY 31, 2003 MAY 31, 2002 MAY 31, 2002
------------------- ------------------- ------------------ ------------------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
Basic weighted average number of
shares outstanding (000's) 63,014 62,791 61,443 60,391
Stock options (000's) 347 273 -- 41
Restricted stock awards (000's) 145 168 234 287
------------------- ------------------- ------------------ ------------------
Diluted weighted average number of
shares outstanding (000's) 63,506 63,232 61,677 60,719
=================== =================== ================== ==================
Stock options excluded from the
calculation of diluted loss per
share because their exercise
price was greater than the
average market price of the
common shares (000's) 2,638 2,633 3,098 2,728
=================== =================== ================== ==================
The diluted loss per share for the periods ended May 31, 2002 and 2003, was
the same as the basic loss per share since the dilutive effect of stock
options and restricted stock awards should not be included in the
calculation; otherwise, the effect would be anti-dilutive. Accordingly,
diluted loss per share for those periods was calculated using the basic
weighted average number of shares outstanding.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
11 DIFFERENCES BETWEEN CANADIAN AND U.S. GAAP
These interim consolidated financial statements are prepared in accordance
with Canadian GAAP, which differ in certain respects from U.S. GAAP. Note
19 to the company's most recent annual consolidated financial statements
describes the significant differences between Canadian and U.S. GAAP that
affect the company. This note describes significant additional changes
occurring since the most recent consolidated annual financial statements
and provides a quantitative analysis of these significant differences. All
disclosures required in annual financial statements under U.S. GAAP have
not been provided in these interim consolidated financial statements.
RECONCILIATION OF NET LOSS TO CONFORM WITH U.S. GAAP
THREE MONTHS NINE MONTHS THREE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
MAY 31, 2003 MAY 31, 2003 MAY 31, 2002 MAY 31, 2002
------------------- ------------------- ------------------ ------------------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
Net loss for the period in accordance
with Canadian GAAP $ (38,427) $ (44,831) $ (263,826) $ (305,556)
Non-cash stock-based compensation
costs related to stock option plan (34) (89) (138) (569)
Non-cash stock-based compensation
costs related to stock purchase
plan 368 228 (231) (590)
Non-cash stock-based compensation
costs related to restricted stock
award plan (201) (769) (415) (2,442)
Unrealized gains on forward exchange
contracts 1,809 1,809 617 397
Future income taxes on forward
exchange contracts (597) (597) (204) (131)
Acquired in-process research and
development -- -- 420 (420)
Future income taxes on acquired
in-process research and development -- -- (133) (312)
Write-down of goodwill and intangible
assets 6,178 6,178 (62,557) (62,557)
Future income taxes on write-down of
intangible assets -- -- 1,154 1,154
Amortization of intangible assets 239 717 -- --
Future income taxes on amortization of
intangible assets (80) (240) -- --
Valuation allowance on future income
tax assets (237) (237) -- --
Amortization of goodwill -- -- (3,244) (9,723)
------------------- ------------------- ------------------- ------------------
Net loss for the period in accordance
with U.S. GAAP (30,982) (37,831) (328,557) (380,749)
Other comprehensive income
Foreign currency translation
adjustments 10,272 18,528 13,360 2,459
------------------- ------------------- ------------------- ------------------
Comprehensive loss $ (20,710) $ (19,303) $ (315,197) $ (378,290)
=================== =================== =================== ==================
Basic and diluted net loss per share
in accordance with U.S. GAAP $ (0.49) $ (0.60) $ (5.35) $ (6.30)
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
SHAREHOLDERS' EQUITY
As a result of the aforementioned adjustments to net loss, significant
differences with respect to shareholders' equity under U.S. GAAP are as
follows:
SHARE CAPITAL
AS AT AS AT
MAY 31, AUGUST 31,
2003 2002
--------------------- --------------------
(UNAUDITED)
Share capital in accordance with Canadian GAAP $ 492,428 $ 489,611
Stock-based compensation costs related to stock purchase
plan
Current period (552) (64)
Cumulative effect of prior periods 5,748 2,542
Reclassification from other capital upon exercise of restricted stock
awards 1,582 3,270
Shares issued upon business combinations 65,584 65,584
--------------------- --------------------
Share capital in accordance with U.S. GAAP $ 564,790 $ 560,943
===================== ====================
DEFERRED STOCK-BASED COMPENSATION COSTS
AS AT AS AT
MAY 31, AUGUST 31,
20003 2002
--------------------- --------------------
(UNAUDITED)
Deferred stock-based compensation costs in accordance with Canadian
GAAP $ -- $ --
Stock-based compensation costs related to stock-based compensation
plans
Cumulative effect of prior periods (2,867) (7,968)
Amortization for the period 1,375 4,698
Reduction of stock-based compensation costs 106 403
--------------------- --------------------
Deferred stock-based compensation costs in accordance with U.S. GAAP $ (1,386) $ (2,867)
===================== ====================
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
OTHER CAPITAL
AS AT AS AT
MAY 31, AUGUST 31,
2003 2002
--------------------- --------------------
(UNAUDITED)
Other capital in accordance with Canadian GAAP $ -- $ --
Stock-based compensation costs related to stock-based compensation
plans
Cumulative effect of prior periods 7,693 12,350
Reduction of stock-based compensation costs (299) (1,387)
Reclassification to share capital upon exercise of restricted stock
awards (1,582) (3,270)
--------------------- --------------------
Other capital in accordance with U.S. GAAP $ 5,812 $ 7,693
===================== ====================
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
DEFICIT
AS AT AS AT
MAY 31, AUGUST 31,
2003 2002
--------------------- -------------------
(UNAUDITED)
Deficit in accordance with Canadian GAAP $ (361,669) $ (316,838)
Stock-based compensation costs related to stock-based compensation
plans
Current period (630) (3,650)
Cumulative effect of prior periods (10,574) (6,924)
Unrealized gains on forward exchange contracts, net of related
future income taxes
Current period 1,212 232
Cumulative effect of prior periods 349 117
Future income taxes on acquired in-process research and development
Current period -- (444)
Cumulative effect of prior periods (1,380) (936)
Write-down of goodwill and intangible assets
Current period 6,178 (62,557)
Cumulative effect of prior periods (62,557) --
Future income taxes on write-down of intangible assets
Current period -- 1,154
Cumulative effect of prior periods 1,154 --
Amortization of intangible assets
Current period 717 239
Cumulative effect of prior periods 239 --
Future income taxes on amortization of intangible assets
Current period (240) (80)
Cumulative effect of prior periods (80) --
Valuation allowance on future income tax assets
Current period (237) --
Amortization of goodwill
Current period -- (9,263)
Cumulative effect of prior periods (17,716) (8,453)
Change in reporting currency
Cumulative effect of prior periods 1,016 1,016
--------------------- -------------------
Deficit in accordance with U.S. GAAP $ (444,218) $ (406,387)
===================== ===================
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
AS AT AS AT
MAY 31, AUGUST 31,
2003 2002
--------------------- -------------------
(UNAUDITED)
Foreign currency translation adjustments
Balance - Beginning of period $ (12,227) $ (9,349)
Change during the period 18,528 (2,878)
--------------------- -------------------
Balance - End of period $ 6,301 $ (12,227)
===================== ===================
BALANCE SHEETS
The following table summarizes the significant differences in balance sheet
items between Canadian GAAP and U.S. GAAP.
AS AT MAY 31, 2003 AS AT AUGUST 31, 2002
--------------------------------------- ----------------------------------------
AS REPORTED U.S. GAAP AS REPORTED U.S. GAAP
(UNAUDITED) (UNAUDITED)
Intangible assets
Cost $ 38,731 $ 33,293 $ 37,927 $ 30,301
Accumulated amortization (26,893) (21,652) (21,463) (17,030)
------------------- ------------------- ------------------- --------------------
$ 11,838 $ 11,641 $ 16,464 $ 13,271
=================== =================== =================== ====================
Goodwill
Cost $ 90,123 $ 98,583 $ 87,025 $ 92,747
Accumulated amortization (72,296) (90,365) (69,449) (87,251)
------------------- ------------------- ------------------- --------------------
$ 17,827 $ 8,218 $ 17,576 $ 5,496
=================== =================== =================== ====================
Shareholders' equity
Share capital $ 492,428 $ 564,790 $ 489,611 $ 560,943
Contributed surplus 1,498 1,498 1,487 1,487
Cumulative translation
adjustment 8,843 -- (8,854) --
Deferred stock-based
compensation costs -- (1,386) -- (2,867)
Other capital -- 5,812 -- 7,693
Deficit (361,669) (444,218) (316,838) (406,387)
Accumulated other
comprehensive income
(loss) -- 6,301 -- (12,227)
------------------- ------------------- ------------------- --------------------
$ 141,100 $ 132,797 $ 165,406 $ 148,642
=================== =================== =================== ====================
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
STATEMENTS OF CASH FLOWS
For the periods ended May 31, 2002 and 2003, there are no significant
differences between the statements of cash flows under Canadian GAAP as
compared to U.S. GAAP.
UNAUDITED PRO FORMA INFORMATION ON BUSINESS COMBINATION
Under U.S. GAAP, pro forma information must be provided as though the
business combination had occurred at the beginning of the reported periods.
The following unaudited pro forma information reflects the results of
operations as if the acquisition of substantially all the assets of GNUBI
COMMUNICATIONS, L.P., had been completed on September 1, 2001 and 2002.
Such information is not necessarily indicative of the actual results which
would have been achieved, nor is it necessarily indicative of future
consolidated results of the company.
THREE MONTHS NINE MONTHS THREE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
MAY 31, 2003 MAY 31, 2003 MAY 31, 2002 MAY 31, 2002
------------------- ------------------- ------------------ ------------------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
Sales $ 15,103 $ 47,804 $ 17,947 $ 57,583
Net loss $ (30,982) $ (38,029) $ (330,989) $ (388,053)
Basis and diluted net loss per share $ (0.49) $ (0.61) $ (5.26) $ (6.27)
NEW ACCOUNTING STANDARDS
In July 2001, the Financial Accounting Standard Board (FASB) issued SFAS
142 "Goodwill and Other Intangible Assets", which is effective for fiscal
years beginning on or after January 1, 2002. SFAS 142 changes the
accounting for goodwill from an amortization method to an impairment-only
approach. Thus, amortization of goodwill, including goodwill recorded in
past business combinations, ceased upon the adoption of this statement. For
any acquisitions completed after June 30, 2001, goodwill is not amortized.
The company adopted SFAS 142 prospectively on September 1, 2002. Since the
adoption of this new statement, goodwill recorded prior to July 1, 2001, is
no longer subject to amortization. Also, under the transitional provisions
of SFAS 142, the company performed an initial impairment test to identify
goodwill impairment using a fair value-based method. Under SFAS 142, a
goodwill impairment exists when the carrying value of a reporting unit
exceeds its fair value. For the purposes of the impairment test, the
company allocated its existing goodwill to its reporting units and
completed an evaluation of the fair value of such reporting units. Based on
the comparison of the fair value of the reporting units to their carrying
value, goodwill of the reporting units was not considered impaired.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
Goodwill is also tested for impairment on an annual basis or more
frequently if events or circumstances occur that more likely than not
reduce the fair value of a reporting unit below its carrying value. Any
impairment loss arising from this test will be charged to earnings in the
period in which it is incurred. The company elected to perform its annual
impairment test in May of each fiscal year for all its existing reporting
units.
The following table summarizes the impact of this change in accounting
policy on the net loss and the net loss per share for the comparative
previous periods on a pro forma basis:
THREE MONTHS ENDED NINE MONTHS ENDED
MAY 31, 2002 MAY 31, 2002
-------------------- --------------------
(UNAUDITED) (UNAUDITED)
Net loss for the period $ (328,557) $ (380,749)
Add-back:
Amortization of goodwill for the period 15,716 47,054
-------------------- --------------------
Pro forma net loss for the period $ (312,841) $ (333,695)
==================== ====================
Pro forma basic and diluted net loss per share $ (5.09) $ (5.53)
In June 2001, the FASB issued SFAS 143, "Accounting for Asset Retirement
Obligation", which is effective for fiscal years beginning on or after June
15, 2002. This standard requires that the fair value of a liability for an
asset retirement obligation be recognized in the period in which it is
incurred if a reasonable estimate of fair value can be made. The company
adopted this new standard prospectively on September 1, 2002, and its
adoption had no impact on the company's financial statements.
In October 2001, the FASB issued SFAS 144, "Accounting for Impairment or
Disposal of Long-Lived Assets", which supersedes SFAS 121 and the
provisions of APB 30, "Reporting the Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions" with regard to
reporting the effects of a disposal of a segment of a business. SFAS 144
retains many of the provisions of SFAS 121, but significantly changes the
criteria that would have to be met to classify an asset as held for
disposal such that long-lived assets to be disposed of other than by sale
are considered held and used until disposed of. In addition, SFAS 144
retains the basic provisions of APB 30 for presentation of discontinued
operations in the statement of earnings but broadens that presentation to a
component of an entity. This new standard is effective for fiscal years
beginning on or after December 15, 2001. The company adopted this new
standard prospectively on September 1, 2002, and its adoption had no impact
on the company's financial statements.
In April 2002, the FASB issued SFAS 145, "Rescission of FASB Statements No.
4, 44 and 64, Amendment of FASB Statement No. 13 and Technical
Corrections". This new standard is effective for fiscal years beginning on
or after May 15, 2002, or for transactions occurring after May 15, 2002,
related to SFAS 13, paragraph 8 and 9 (c). This statement rescinds SFAS 4
"Reporting Gains and Losses from Extinguishment of Debt" and an amendment
of that Statement, SFAS 64,
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
"Extinguishments of Debt Made to Satisfy Sinking-Funds Requirements". This
Statement also rescinds SFAS 44 "Accounting for Intangible Assets of Motor
Carriers". This Statement amends SFAS 13 "Accounting for Leases" to
eliminate an inconsistency between the required accounting for
sale-leaseback transactions. This Statement also amends other existing
authoritative pronouncements to make various technical corrections, clarify
meanings, or describe their applicability under changed conditions. The
company adopted this new standard prospectively on September 1, 2002, and
its adoption had no impact on the company's financial statements.
In June 2002, the FASB issued SFAS 146, "Accounting for Costs Associated
with Exit or Disposal Activities". This Statement addresses financial
accounting and reporting for costs associated with exit or disposal
activities and nullifies EITF No. 94-3, "Liability Recognition of Certain
Employee Termination Benefits and Other Costs to Exit an Activity". This
Statement improves financial reporting by requiring that a liability for a
cost associated with an exit or disposal activity be recognized and
measured initially at fair value only when the liability is incurred. This
Statement specifies that a liability for a cost associated with an exit or
disposal activity is incurred when the definition of a liability in SFAS 6
is met. This Statement is effective for exit or disposal activities that
are initiated after December 31, 2002. The company adopted this new
standard prospectively on January 1, 2003, and its adoption had no impact
on the company's financial statements.
In November 2002, the FASB issued FIN 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others, an interpretation of FASB Statements No. 5, 57 and
107 and Rescission of FASB Interpretation No. 34", with disclosure
requirements effective for periods ending after December 15, 2002 and
recognition and measurement requirements effective on a prospective basis
for guarantees that are issued or modified after December 31, 2002.
FIN 45 provides a definition and examples of a guarantee and requires
disclosure of the nature of the guarantee, the maximum potential amount of
future payments, the carrying amount of the related liability, if any, the
recourse provisions and assets held as collateral under the terms of the
guarantee and the extent to which the proceeds of collateral would cover
the maximum potential liability.
It also clarifies the requirement of SFAS 5, "Accounting for
Contingencies", relating to the guarantor's accounting for, and disclosure
of, the issuance of certain types of guarantees. It requires that the
guarantor recognize a liability for the guarantee at its inception equal to
its fair value at that time and that the liability is reduced as the risk
under the guarantee reduces. The liability may be reduced at the end of the
guarantee period, on a systematic amortization basis or as the fair value
changes as appropriate.
The company has adopted the disclosure requirements of FIN 45 for the
periods ended May 31, 2003.
In December 2002, the FASB issued Statement 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure", revising the
transition and disclosure provisions of SFAS 123. SFAS 148 allows companies
to adopt SFAS 123 under three different methods. In addition, SFAS 148
requires increased disclosure for all companies, including those choosing
not to adopt the accounting provision of SFAS 123. The transition and
disclosure changes are effective for fiscal years ending after December 15,
2002. The company will disclose the information required in its annual
financial statements.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
In January 2003, the FASB issued FIN 46, "Consolidation of Variable
Interest Entities - an Interpretation of ARB No. 51." The primary
objectives of FIN 46 are to provide guidance on the identification of
entities for which control is achieved through means other than through
voting rights and how to determine when and which business enterprise
should consolidate the variable interest entities. This interpretation
applies immediately to variable interest entities created after January 31,
2003, and to variable interest entities in which an enterprise obtains an
interest after that date. It applies in the first quarter beginning after
June 15, 2003, to variable interest entities in which an enterprise holds a
variable interest it acquired before February 1, 2003. The company does not
hold variable interest entities; consequently, the adoption of this new
standard had no impact on the company's financial statements.
In April 2003, the FASB issued SFAS 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities". The statement amends and
clarifies accounting for derivatives instruments, including certain
derivative instruments embedded in other contracts, and for hedging
activities under SFAS 133. The amendments set forth in Statement 149
improve financial reporting by requiring that contracts with comparable
characteristics be accounted for similarly. In particular, this Statement
clarifies under what circumstances a contract with an initial net
investment meets the characteristics of a derivative as discussed in
Statement 133. In addition, it clarifies when a derivative contains a
financing component that warrants special reporting in the statement of
cash flows. Statement 149 amends certain other existing pronouncements.
This statement is effective for contracts entered into or modified after
June 30, 2003, and for hedging relationships designated after June 30,
2003. The company will adopt this new standard prospectively on June 30,
2003, and its adoption will have no impact on the company's financial
statements.
In May 2003, the FASB issued SFAS 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity". The
statement improves the accounting for certain financial instruments such as
mandatorily redeemable preferred shares that, under previous guidance,
issuers could account for as equity. The new Statement requires that those
instruments be classified as liabilities in statements of financial
position. In addition to its requirements for the classification and
measurement of financial instruments in its scope, this statement also
requires disclosures about alternative ways of settling the instruments and
the capital structure of entities, all of whose shares are mandatorily
redeemable. Most of the guidance provided in this statement is effective
for all financial instruments entered into or modified after May 31, 2003,
and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. The company will adopt this new standard
prospectively on June 1, 2003, and its adoption will have no impact on the
company's financial statements.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
THIS DISCUSSION AND ANALYSIS MAY CONTAIN 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" OR
"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. FORWARD-LOOKING STATEMENTS ARE NOT
GUARANTEES OF FUTURE PERFORMANCE AND INVOLVE RISKS AND UNCERTAINTIES, AND ACTUAL
RESULTS MAY DIFFER MATERIALLY FROM THOSE IN THE FORWARD-LOOKING STATEMENTS AS A
RESULT OF VARIOUS FACTORS, INCLUDING INCREASED GLOBAL GEO-POLITICAL AND ECONOMIC
UNCERTAINTY AND OUR ABILITY TO EXECUTE SUCCESSFULLY IN THESE UNCERTAIN
CONDITIONS; CAPITAL SPENDING LEVELS IN THE TELECOMMUNICATIONS SECTOR; 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 COMPANIES; THE
COMPETITIVE LANDSCAPE; THE RETENTION OF KEY TECHNICAL AND MANAGEMENT PERSONNEL;
AND FUTURE ECONOMIC, GEO-POLITICAL, 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 OUR
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. ALTHOUGH WE BELIEVE THAT THE EXPECTATIONS REFLECTED IN THE
FORWARD-LOOKING STATEMENTS ARE REASONABLE BASED ON INFORMATION CURRENTLY
AVAILABLE TO US, 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. IN ANY EVENT, 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 AFTER THE DATE OF THIS DOCUMENT.
ALL DOLLAR AMOUNTS ARE EXPRESSED IN US DOLLARS, EXCEPT AS OTHERWISE
NOTED.
OVERVIEW
Fiber-optic telecommunications companies, still dealing with reduced
spending levels, were affected by a number of external forces during the past
quarter including geo-political and economic uncertainty, the outbreak of SARS
in Asia, as well as the declining strength of the U.S. dollar. To cope with
market realities, network service providers (NSPs), the first link in the
fiber-optic telecom supply chain, continued to service their debt-loads and
preserve cash. Moreover, as capital expenditure (CAPEX) budgets increasingly
drew nearer to maintenance-level run rates, NSPs turned their attention to
operating expenditures (OPEX) for further savings. As a result, there is little
evidence of an imminent recovery in the global fiber-optic telecom industry.
Lower spending levels necessarily produced a trickle-down effect
throughout the fiber-optic telecom industry; namely, for optical system and
component manufacturers as well as for test, measurement, and monitoring
equipment vendors. System manufacturers were negatively affected by the
significant reduction in the deployment of long-haul optical networks, but
1
benefited from some activity in metro and access networks. Optical component
manufacturers were hardest hit by the downturn, given their position in the
supply chain, relative stability of technology and excess manufacturing capacity
in this sector. The ongoing consolidation within the optical component
manufacturing market provides an inkling of its weaker health.
Test, measurement and monitoring equipment vendors also felt the impact
of reduced NSP spending with less demand for orders. In addition, distressed
vendors increasingly applied pricing pressure to obtain contracts, which eroded
margins across the board. The grey market for test and measurement instruments,
especially involving optical component manufacturing applications, further
compounded the soft market. On the other hand, test, measurement and monitoring
vendors, whose products enable customers to lower OPEX, still attracted the
attention of NSPs and system manufacturers for certain projects.
Against this backdrop, EXFO adopted a two-fold approach in order to
return to profitability: increase sales and reduce costs. To increase our sales,
we deployed efforts to gain market share, especially in the NSP market. We also
further leveraged our acquisitions of Avantas Networks and gnubi communications
to heighten traction in the protocol-layer test sector. In addition, we
maintained our focus on innovation with the introduction of 10 new products
during the last quarter including the 2.5+ Gigabit Multi-Rate Transceiver for
protocol-layer test applications, the Packet Blazer Fiber Channel test module
for installation and commissioning of storage area networks, and the Integrated
Applications Suite, which automates the operation of test modules within the
FTB-400 field-testing platform. A common characteristic of these products is
that it helps customers lower their OPEX. Our strategy has proven to be on
target with a 10% increase in sales for our Portable and Monitoring product
lines during the first three quarters of fiscal 2003 versus the same period last
year.
Although we undertook several steps to bolster our top line during this
unprecedented market downturn -- gain market share, leverage our protocol-layer
test acquisitions and introduce new products -- it wasn't enough due to
continued depressed spending levels in the global fiber-optic telecom industry
and the aforementioned external forces.
With no signs of an imminent market recovery, we announced a major
restructuring plan following the end of the third quarter. We reduced our
workforce by 30%, exited the optical component manufacturing automation business
and consolidated some of our manufacturing operations. The restructuring plan is
expected to provide us with approximately $10 million in annualized pre-tax
savings. Conversely, it will incur charges of approximately $4.8 million,
including $348,000 in the quarter ended and substantially all the rest in the
fourth quarter.
During the second quarter of 2003, we launched the FTB-5500B
Polarization Mode Dispersion (PMD) Analyzer, an essential test instrument for
upgrading optical networks to 10 Gb/s and deploying a cascade of amplifiers.
This patent-pending PMD Analyzer represents the only portable instrument that
can characterize PMD levels in a network by sweeping through erbium-doped fiber
amplifiers (EDFAs). Our PMD Analyzer can test an entire link with the utmost
accuracy and repeatability in less than five seconds.
In October 2002, we completed, through our newly created wholly-owned
subsidiary EXFO Gnubi Products Group Inc., the acquisition of substantially all
the assets of GNUBI COMMUNICATIONS, L.P., a multi-channel telecom and datacom
testing solutions supplier with an established customer base of Tier-1 system
vendors and research and development laboratories. This acquisition was made to
fully complement our offering, to enhance our competitive position with network
service providers and system vendors as well as to expand
2
our presence in the data communications test market. This acquisition was
settled for a total consideration of $4.7 million. The consideration paid
consisted in $1.9 million in cash, $2.8 million by the issuance of 1.5 million
subordinate voting shares and a cash contingent consideration up to a maximum of
$2.9 million, based on sales volume for the twelve months following the
acquisition. This acquisition has been accounted for using the purchase method
and resulted in goodwill of $3.0 million.
During the first quarter of 2003, we reached a base of more than 10,000
test platforms on the global market. We also launched two new products,
including the FTB-9310 Channel Selector, for commissioning and lighting channels
in dense wavelength-division multiplexing (DWDM) networks, and the X-Cite 120
Illumination System, for fluorescence microscopy applications.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
For a complete description of our critical accounting policies and
estimates, please refer to the critical accounting policies and estimates in our
most recent annual report filed with securities commissions. The following
details the changes in critical accounting policies that occurred since our most
recent annual report.
IMPAIRMENT OF GOODWILL AND INTANGIBLE ASSETS. We assess impairment of
goodwill on an annual basis or more frequently if events or circumstances occur
that more likely than not reduce the fair value of a reporting unit below its
carrying value. Goodwill impairment exists when the carrying value of a
reporting unit exceeds its fair value. The amount of impairment loss, if any, is
the excess of the carrying value of goodwill over its fair value. On September
1, 2002, upon the adoption of section 3062 of the Canadian Institute of
Chartered Accountants Handbook (CICA) `'Goodwill and Other Intangible Assets",
we performed an initial impairment test of goodwill based on a fair value
method. For the purposes of this test, we allocated our existing goodwill to our
reporting units and completed an evaluation of the fair value of such reporting
units. For the purposes of this evaluation, we used discounted future cash flows
as well as multiple of sales to estimate the fair value of each reporting unit.
The assumptions used reflect our best estimates. Based on the comparison of the
fair value of the reporting units to their carrying value, goodwill was not
considered impaired at that moment.
Furthermore, we assess impairment of intangible assets when events or
circumstances indicate that costs may not be recoverable. Impairment exists when
the carrying value of the asset is greater than the pre-tax undiscounted future
cash flows expected to be provided by the asset. The amount of impairment loss,
if any, is the excess of the carrying value over its fair value. We assess fair
value of intangible assets based on discounted future cash flows.
In May 2003, we assessed impairment of goodwill and intangible assets
based on these new standards. Please refer to the `'Write-down of goodwill and
intangible assets" section further in this document.
3
RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and
results of operations for the three months and the nine months ended May 31,
2002 and 2003, should be read in conjunction with our interim consolidated
financial statements and the related notes thereto. All figures are expressed in
thousands of US dollars, except per share data and as otherwise noted. Our
interim consolidated financial statements have been prepared in accordance with
Canadian GAAP, which conform in all material respects with U.S. GAAP, except as
described in note 11 to our interim consolidated financial statements.
THREE MONTHS ENDED NINE MONTHS ENDED
MAY 31, MAY 31,
-------------------------------- --------------------------------
2003 2002 2003 2002
--------------- ---------------- --------------- ----------------
(UNAUDITED)
Sales $ 15,103 $ 16,348 $ 47,604 $ 51,087
Cost of sales 9,858 17,080 25,087 42,497
--------------- ---------------- --------------- ----------------
Gross margin (loss)* 5,245 (732) 22,517 8,590
--------------- ---------------- --------------- ----------------
Operating expenses
Selling and administrative 7,654 8,750 22,298 28,327
Net research and development 5,882 3,454 12,681 10,272
Amortization of property, plant and
equipment 1,594 1,544 4,588 4,379
Amortization of intangible assets 1,264 3,236 3,746 9,976
Write-down of intangible assets 2,922 23,657 2,922 23,657
Restructuring and other charges 348 2,023 348 2,880
--------------- ---------------- --------------- ----------------
Total operating expenses 19,664 42,664 46,583 79,491
--------------- ---------------- --------------- ----------------
Loss from operations (14,419) (43,396) (24,066) (70,901)
Interest income, net 379 261 929 1,239
Foreign exchange loss (600) (801) (1,310) (714)
--------------- ---------------- --------------- ----------------
Loss before income taxes and amortization and
write-down of goodwill (14,640) (43,936) (24,447) (70,376)
Income taxes 19,282 (14,751) 15,879 (9,569)
--------------- ---------------- --------------- ----------------
Loss before amortization and write-down of
goodwill (33,922) (29,185) (40,326) (46,056)
Amortization of goodwill -- 12,409 -- 24,859
Write-down of goodwill 4,505 222,169 4,505 222,169
--------------- ---------------- --------------- ----------------
Net loss for the period $ (38,427) $ (263,826) $ (44,831) $ (305,556)
=============== ================ =============== ================
Basic and diluted net loss per share $ (0.61) $ (4.29) $ (0.71) $ (5.06)
Research and development data:
Gross research and development $ 4,639 $ 4,723 $ 13,261 $ 13,756
Net research and development $ 5,882 $ 3,454 $ 12,517 $ 10,272
Other data:**
Pro forma net loss $ (4,067) $ (3,930) $ (8,843) $ (9,966)
Basic and diluted pro forma net loss per share $ (0.06) $ (0.06) $ (0.14) $ (0.17)
* Including inventory write-offs of $1,646 for the periods ended May 31,
2003, and of $9,101 and $18,463 for the three months and the nine months
ended May 31, 2002, respectively.
** Net loss excluding amortization and write-down of goodwill, future income
tax assets valuation allowance and the after-tax effect of amortization and
write-down of intangible assets, restructuring and other charges as well as
inventory and tax credit write-offs. This information may not be comparable
to similarly titled measures reported by other companies because it is
non-GAAP information. Please refer to page 14 of this document for the
detailed quantitative reconciliation.
4
THREE MONTHS ENDED NINE MONTHS ENDED
MAY 31, MAY 31,
-------------------------------- --------------------------------
2003 2002 2003 2002
--------------- ---------------- --------------- ----------------
(UNAUDITED)
Sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 65.3 104.5 52.7 83.2
--------------- ---------------- --------------- ----------------
Gross margin (loss)* 34.7 (4.5) 47.3 16.8
--------------- ---------------- --------------- ----------------
Operating expenses
Selling and administrative 50.7 53.5 46.8 55.4
Net research and development 38.9 21.1 26.7 20.1
Amortization of property, plant and
equipment 10.6 9.4 9.7 8.6
Amortization of intangible assets 8.4 19.8 7.9 19.5
Write-down of intangible assets 19.3 144.7 6.1 46.3
Restructuring and other charges 2.3 12.4 0.7 5.6
--------------- ---------------- --------------- ----------------
Total operating expenses 130.2 260.9 97.9 155.5
--------------- ---------------- --------------- ----------------
Loss from operations (95.5) (265.4) (50.6) (138.7)
Interest income, net 2.5 1.6 2.0 2.4
Foreign exchange loss (4.0) (4.9) (2.8) (1.4)
--------------- ---------------- --------------- ----------------
Loss before income taxes and amortization and
write-down of goodwill (97.0) (268.7) (51.4) (137.7)
Income taxes (127.6) (90.2) (33.3) (47.6)
--------------- ---------------- --------------- ----------------
Loss before amortization and write-down of
goodwill (224.6) (178.5) (84.7) (90.1)
Amortization of goodwill - 76.3 - 73.1
Write-down of goodwill 29.8 1,359.0 9.5 434.9
--------------- ---------------- --------------- ----------------
Net loss for the period (254.4)% (1,613.8)% (94.2)% (598.1)%
=============== ================ =============== ================
Research and development data:
Gross research and development 30.7 % 28.9 % 27.9 % 26.9 %
Net research and development 38.9 % 21.1 % 26.3 % 20.1 %
Other data:**
Pro forma net loss (8.5)% (24.0)% (18.6)% (19.5)%
* Including inventory write-offs of 10.9% and 3.5% for the three months and
the nine months ended May 31, 2003, respectively and of 40.1% and 26.9% for
the three months and the nine months ended May 31, 2002, respectively.
Excluding these inventory write-offs, gross margin would have reached 45.6%
and 50.8% of sales for the three months and the nine months ended May 31,
2003, respectively and 51.2% and 53.0% of sales for the three months and
the nine months ended May 31, 2002, respectively. This latter information
is a non-GAAP measure.
** Net loss excluding amortization and write-down of goodwill, future income
tax assets valuation allowance and the after-tax effect of amortization and
write-down of intangible assets, restructuring and other charges as well as
inventory and tax credit write-offs. This information may not be comparable
to similarly titled measures reported by other companies because it is
non-GAAP information. Please refer to page 14 of this document for the
detailed quantitative reconciliation.
5
SALES
For the three months ended May 31, 2003, sales decreased 7.6% to $15.1
million from $16.3 million for the same period last year. The decrease in our
sales in the third quarter of 2003 is mainly related to the continued slowdown
in the telecommunications industry and the increase pricing pressure by vendors,
which inevitably reduced our top line. Despite the acquisition of EXFO Gnubi, we
were not able to maintain our sales level quarter over quarter.
Fiber-optic telecommunications companies, still dealing with reduced
spending levels, were affected by a number of external forces during the past
quarter including geo-political and economic uncertainty, the outbreak of SARS
in Asia, as well as the declining strength of the U.S. dollar. To cope with
market realities, network service providers (NSPs), the first link in the
fiber-optic telecom supply chain, continued to service their debt-loads and
conserve cash. Moreover, as capital expenditure (CAPEX) budgets increasingly
drew nearer to maintenance- level run rates, NSPs turned their attention to
operating expenditures (OPEX) for further savings. As a result, there is little
evidence of an imminent recovery in the global fiber-optic telecom industry.
Lower spending levels necessarily produced a trickle-down effect
throughout the fiber-optic telecom industry; namely, for optical system and
component manufacturers as well as for test, measurement, and monitoring
equipment vendors. System manufacturers were negatively affected by the
significant reduction in the deployment of long-haul optical networks, but
benefited from some activity in metro and access networks. Optical component
manufacturers were hardest hit by the downturn, given their position in the
supply chain, relative stability of technology and excess manufacturing capacity
in this sector. The ongoing consolidation within the optical component
manufacturing market provides an inkling of its weaker health.
Test, measurement and monitoring equipment vendors also felt the impact
of reduced NSP spending with less demand for orders. In addition, distressed
vendors increasingly applied pricing pressure to obtain contracts, which eroded
margins across the board. The grey market for test and measurement instruments,
especially involving optical component manufacturing applications, further
compounded the soft market. On the other hand, test, measurement and monitoring
vendors, whose products enable customers to lower OPEX, still attracted the
attention of NSPs and system manufacturers for certain projects.
With regard to sales distribution, it was a 66%-34% split in favor of
our Portable and Monitoring products for the three months ended May 31, 2003,
compared to 53%-47% for the same period last year. We expect the sales split to
be in the same range in upcoming quarters, given the state of the
telecommunications industry.
Net accepted orders decreased 9.6% to $14.1 million in the third
quarter of 2003 from $15.6 million for the same period last year. Our net
book-to-bill ratio decreased to 0.93 in the third quarter of 2003, compared to
0.95 for the same period last year.
North American sales accounted for 59% and 51% of global sales for the
three months ended May 31, 2003 and 2002, respectively. International sales
represented 41% and 49% of global sales for the three months ended May 31, 2003
and 2002, respectively. The decrease in our international sales quarter over
quarter is mainly due to the decrease in our sales to the Asian market. Most of
our sales in this market are made through tenders, which may vary in number and
significance from quarter to quarter. In addition, the SARS outbreak also
affected our sales in Asia to some extent.
6
We sell our products to a broad range of customers including
telecommunications carriers, network service providers, optical component and
system manufacturers, as well as research and development laboratories. For the
three months ended May 31, 2003, we had two customers accounting for more than
10%, with our top three customers representing 25.9% of our sales. For the three
months ended May 31, 2002, no customer accounted for more than 7.8% of our
sales.
For the nine months ended May 31, 2003, sales decreased 6.7% to $47.6
million from $51.1 million for the same period last year. The decrease in sales
for the nine months ended May 31, 2003, is mainly related to the continued
slowdown in the telecommunications industry and the increased pricing pressure
by distressed vendors, which inevitably reduced our top line. Despite the
acquisitions of EXFO Protocol and EXFO Gnubi, we were not able to maintain our
sales level year over year.
With regard to sales distribution, it was a 66%-34% split in favor of
our Portable and Monitoring products for the nine months ended May 31, 2003,
compared to 56%-44% in favor of our Portable and Monitoring products for the
same period last year.
North American sales accounted for 57% and 52% of global sales for the
nine months ended May 31, 2003, and 2002, respectively. International sales
represented 43% and 48% of global sales for the nine months ended May 31, 2003
and 2002, respectively. The shift in the geographic distribution of our sales is
due to the decrease in sales to the Asian market, where most of our sales are
made through tenders, which may vary in number and significance from period to
period. In addition, the SARS outbreak also affected our sales in Asia to some
extent.
For the nine months ended May 31, 2003, no customer accounted for more
than 9.5% of our sales, with our top three customers representing 19.4% of our
sales. For the nine months ended May 31, 2002, no customer accounted for more
than 6.5% of our sales.
GROSS MARGIN (LOSS)
Gross margin amounted to 34.7% of sales for the three months ended May
31, 2003, compared to a gross loss of 4.5% for the same period last year.
For the three months ended May 31, 2003 and 2002, we recorded
write-offs for excess and obsolete inventories of $1.6 million and $9.1 million,
respectively. These special charges were required considering our expected needs
for the next 12 to 24 months and our exit from the automation business. Without
these special charges, gross margin would have reached 45.6% and 51.2% of sales
for these two periods, respectively. The percentage decrease quarter over
quarter is due to the following reasons. First, current market conditions and
the competitive landscape inevitably led to increased pricing pressure. Combined
with a lower sales level in the third quarter of 2003, this prevented a better
absorption of our fixed manufacturing costs, which ultimately caused margin
erosion. Also, shift in product mix caused our gross margin to decrease. Our
Portable and Monitoring products represented a larger portion of our sales in
the third quarter of 2003, compared to the same period last year; these products
tend to be lower-margin products. However, the decrease in our gross margin was
offset in part by our restructuring efforts implemented in 2002 and our
increased efficiency, as well as the shift in the geographic distribution of our
sales. In the third quarter of 2003, this shift resulted in more sales in North
America, where gross margins tend to be higher, and less sales made
internationally, where gross margins tend to be lower.
7
Gross margin amounted to 47.3% of sales for the nine months ended May
31, 2003, compared to 16.8% for the same period last year.
For the nine months ended May 31, 2003 and 2002, we recorded write-offs
for excess and obsolete inventories of $1.6 million and $18.5 million,
respectively. As mentioned above, these special charges were required
considering our expected needs for the next 12 to 24 months and our exit from
the automation business. Without these special charges, gross margin would have
reached 50.8% and 53.0% of sales for these two periods, respectively. The
percentage decrease year over year is due the following reasons. First, current
market conditions and the competitive landscape inevitably led to increased
pricing pressure. Combined with a lower sales level in the first three quarters
of 2003, this prevented a better absorption of our fixed manufacturing costs,
which ultimately caused margin erosion. Also, shift in product mix caused our
gross margin to decrease. Our Portable and Monitoring products represented a
larger portion of our sales for the nine months ended May 31, 2003, compared to
the same period last year; these products tend to be lower-margin products.
However, the decrease in our gross margin was offset in part by our
restructuring efforts implemented in 2002 and our increased efficiency, as well
as the shift in the geographic distribution of our sales. For the nine months
ended May 31, 2003, this shift resulted in more sales in North America, where
gross margins tend to be higher, and less sales made internationally, where
gross margins tend to be lower.
We expect our gross margin to fluctuate in the upcoming quarters as our
sales may fluctuate. Our gross margin can be negatively affected by increased
competitive pricing pressure, increased obsolescence costs, shifts in product
mix, under-absorption of fixed manufacturing costs and increases in product
offerings by other suppliers in the fiber-optic test, measurement and monitoring
industry.
SELLING AND ADMINISTRATIVE
For the three months ended May 31, 2003, selling and administrative
expenses were $7.7 million, or 50.7% of sales, compared to $8.8 million, or
53.5% of sales for the same period last year. The dollar decrease is mainly
related to lower expenses resulting from our restructuring plans, mainly
implemented during the second and the third quarter of 2002 and lower commission
expenses since our sales decreased quarter over quarter. However, this decrease
was offset in part by the impact of the acquisition of EXFO Gnubi in October
2002. Overall, despite the acquisition EXFO Gnubi, we were able to reduce our
selling and administrative expenses by more than $1 million, mainly because of
our recent restructuring efforts and our cost-control measures.
For the nine months ended May 31, 2003, selling and administrative
expenses were $22.3 million, or 47.1% of sales, compared to $28.3 million, or
55.4% of sales for the same period last year. The dollar decrease is directly
related to lower expenses resulting from our restructuring plans, mainly
implemented during the second and the third quarter of 2002 and from lower
commission expenses since our sales decreased year over year. However, this
decrease was offset in part by the impact of the acquisitions of EXFO Protocol
and EXFO Gnubi in November 2001 and October 2002, respectively. Overall, despite
the decrease in sales for the nine months ended May 31, 2003, compared to the
same period last year and the effects of the acquisitions of EXFO Protocol and
EXFO Gnubi, we were able to reduce our selling and administrative expenses by
more than $6.0 million, mainly because of our recent restructuring efforts and
our cost control measures.
8
In June 2003, we announced additional cost-cutting measures that should
enable us to reduce our selling and administrative expenses as a percentage of
sales in upcoming quarters.
Considering the challenging market conditions, we will continue to
maintain our selling and administrative expenses at an acceptable level without
impeding our efforts to strategically position our company, improve our sales,
as well as provide quality service to customers and integrate our acquired
businesses.
RESEARCH AND DEVELOPMENT
For the three months ended May 31, 2003, gross research and development
expenses totaled $4.6 million, or 30.7% of sales, compared to $4.7 million, or
28.9% of sales for the same period last year. The decrease in gross research and
development dollars quarter over quarter is due to the effects of our recent
restructuring actions mainly offset by the effects of the acquisition of EXFO
Gnubi, which carried out research and development activities. The percentage
increase can be explained by the fact that despite challenging market
conditions, we continue investing heavily in research and development, which
reflects our strong focus on innovation. We firmly believe that innovation and
new product introductions are the key to gaining market share in this current
economic environment and ensuring the long-term growth and profitability of the
company. In the third quarter of 2003, 48% of sales originated from products
that have been on the market for two years or less.
For the three months ended May 31, 2003, tax credits and grants from
federal and provincial governments for research and development activities were
$1.1 million, or 22.7% of gross research and development expenses, compared to
$1.3 million, or 26.9% of gross research and development expenses for the same
period last year. The decrease in our tax credits and grants, in dollar amounts,
is mainly related to the end of certain government grant programs and the
decrease in our gross research and development expenses. The primary reasons for
the percentage decrease are the end of certain government grant programs and the
recent acquisition of U.S.-based EXFO Gnubi, as we carried out more research and
development activities in the U.S., where such activities are not eligible for
tax credits.
In the third quarter of 2003, we wrote off $2.3 million of Canadian
federal tax credits for EXFO Protocol and will not record such credits for EXFO
Protocol in the fourth quarter of 2003. Considering current and past year tax
losses as well as current market conditions, we concluded (according to GAAP)
that it was more likely than not that those tax credits will not be recovered
and that a write-off was required. All tax credits written off can be carried
forward indefinitely against future taxable income.
As for net research and development expenses, they amounted to 38.9%
and 21.1% of sales for the three months ended May 31, 2003 and 2002,
respectively. This large increase is mainly due to the write-off of research and
development tax credits. Although we intend to reduce our research and
development expenses as a percentage of sales in the future and despite our
recently announced cost-cutting measures, we expect to continue investing
significantly in research and development in the next year, reflecting our focus
on innovation, our desire to gain market share and our goal to exceed customer
needs and expectations. However, we expect our net research and development
expenses to be reduced, as we will not record Canadian federal tax credits for
EXFO Protocol in the fourth quarter.
9
For the nine months ended May 31, 2003, gross research and development
expenses totaled $13.3 million, or 27.9% of sales, compared to $13.8 million, or
26.9% of sales for the same period last year. The slight decrease in gross
research and development dollars year over year is due to the effects of our
recent restructuring actions, mostly offset by the effects of the acquisitions
of EXFO Protocol and EXFO Gnubi, which carried out a significant level of our
research and development activities. The percentage increase can be explained by
the fact that despite challenging market conditions, we continue investing
heavily in research and development, which reflects our strong focus on
innovation despite the decrease in sales. For the nine months ended May 31, 2002
and 2003, 50% of sales originated from products that have been on the market for
two years or less.
For the nine months ended May 31, 2003, tax credits and grants from
federal and provincial governments for research and development activities were
$3.0 million, or 22.9% of gross research and development expenses, compared to
$3.5 million, or 25.3% of gross research and development expenses for the same
period last year. The decrease in our tax credits and grants, in dollar amounts,
is mainly related to the end of certain government grant programs and the slight
decrease in our gross research and development expenses. The primary reasons for
the percentage decrease are the end of certain government grant programs and the
recent acquisition of U.S.-based EXFO Gnubi, as we carried out more research and
development activities in the U.S., where such activities are not eligible for
tax credits.
During the nine months ended May 31, 2003, we wrote off $2.3 million of
Canadian federal tax credits for EXFO Protocol and will not record such credits
for EXFO Protocol in the fourth quarter of 2003. Considering current and past
year tax losses as well as current market conditions, we concluded according to
GAAP that it was more likely than not that those tax credits will not be
recovered and that a write-off was required.
As for net research and development expenses, they amounted to 26.3%
and 20.1% of sales for the nine months ended May 31, 2003 and 2002,
respectively.
AMORTIZATION OF INTANGIBLE ASSETS
In conjunction with the four strategic acquisitions that we made over
the last two fiscal years and in the first quarter of 2003, we recorded $62
million in intangible assets, primarily consisting of core technology. These
intangible assets, which are amortized over periods from five months to five
years from the date of acquisitions, resulted in amortization expenses of $1.3
million and $3.2 million for the three months ended May 31, 2003 and 2002,
respectively, and of $3.7 million and $10.0 million for the nine months ended
May 31, 2003 and 2002, respectively.
Intangible assets related to the acquisitions of EXFO Burleigh and EXFO
Photonic Solutions were reviewed for impairment in May 2002 and this resulted in
a pre-tax impairment charge of $23.7 million in the third quarter of 2002.
Considering this write-down, the amortization of intangible assets decreased by
approximately $1.6 million in each of the three quarters of 2003, compared to
the same periods last year. Also, as at August 31, 2002, acquired in-process
research and development and work force related to the acquisitions made over
the last two fiscal years were fully amortized, reducing current year
amortization expense.
10
WRITE-DOWN OF GOODWILL AND INTANGIBLE ASSETS
In May 2002, we performed an impairment test for goodwill and
intangible assets, which resulted in impairment charges of $222.2 million for
goodwill and $23.7 million for intangible assets.
In May 2003, we performed our annual impairment test for goodwill for
all our reporting units, except for our newly acquired EXFO Gnubi. Also,
considering the persisting unfavorable market conditions affecting our
subsidiaries' industry, we reviewed the carrying value of intangible assets
related to these reporting units.
As a result of this assessment, we concluded that the carrying value of
goodwill related to EXFO Burleigh and the carrying value of intangible assets
related to EXFO Burleigh and EXFO Photonic Solutions were impaired and we
recorded a charge of $4.5 million to write down goodwill and a pre-tax charge of
$2.9 million to write down core technology. Of the total impairment charge, $6.9
million related to EXFO Burleigh for goodwill and core technology and $555,000
related to EXFO Photonic Solutions for core technology.
The write-down of goodwill and intangible assets of EXFO Burleigh was
required considering that we will exit the optical manufacturing automation
business since revenue potential represented a long-term prospect. The
write-down of intangible assets of EXFO Photonic Solutions was required because
revenue potential related to its acquired core technology were less than
expected in the short and medium-term.
However, no impairment of goodwill and intangible assets was required
for EXFO Protocol since revenue potential from the protocol-layer testing market
remains strong in the short and medium-term.
For the purposes of estimating fair values, we used discounted future
cash flows and multiple of sales. The discounted cash flows were estimated using
periods ranging between 8 and 10 years, discount rate ranging between 15% and
20% and annual growth rate ranging between 5 and 35%. The multiple of sales used
ranged between 0.7 and 2.3. The assumptions used reflect our best estimates.
Goodwill will be reviewed for impairment in May 2004, or prior to that
date if events or circumstances occur that more likely than not reduce the fair
value of a reporting unit below its carrying value.
RESTRUCTURING AND OTHER CHARGES
During the first three quarters of 2002, we implemented structured
plans to align our cost structure to market conditions. Under these plans, we
lowered our operating expenses, froze employee salaries, reduced our global work
force and wrote down property, plant and equipment.
As a result, we recorded restructuring and other charges of $2.9
million, consisting of $410,000 in severance expenses for the 101 employees who
were terminated in the first quarter of 2002; $447,000 in severance expenses for
the 57 employees who were terminated in the second quarter of 2002; $1.2 million
in severance expenses for the 192 employees who were
11
terminated as well as $868,000 for the write-down of property, plant and
equipment in the third quarter of 2002.
In the third quarter of 2003, we implemented an additional
restructuring plan to realign our cost structure to current market conditions.
The first part of this plan, which was effective in May 2003, resulted in 13
employees being terminated and severance expenses of $348,000. The second part
of this plan, which will occur mainly in the fourth quarter of 2003, will reduce
our workforce by 30% overall and related restructuring charges will be recorded
as incurred.
Our cost-cutting measures represented our best efforts to respond to
the difficult market conditions. However, these efforts may be inappropriate or
insufficient. Our actions in this regard may not be successful in achieving the
cost reductions or other benefits expected, may be insufficient to align our
cost structure to market conditions, or may be more costly or extensive than
anticipated.
INTEREST INCOME, NET
Net interest income amounted to $379,000 and $261,000 for the three
months ended May 31, 2003 and 2002, respectively. The increase in our net
interest income in the third quarter of 2003, compared to the same period last
year is directly related to the increase in our short-term investments as well
as increase in interest rates.
Net interest income amounted to $929,000 and $1.2 million for the nine
months ended May 31, 2003 and 2002, respectively. The decrease in our net
interest income for the first three quarters of 2003, compared to the same
period last year, is directly related to the use of short-term investments to
finance the strategic acquisitions of EXFO Protocol and EXFO Gnubi, our
operating activities of fiscal 2002 and the purchases of property, plant and
equipment.
We expect our net interest income to remain relatively flat over the
next quarter.
FOREIGN EXCHANGE LOSS
Foreign exchange loss amounted to $600,000 for the three months ended
May 31, 2003, compared to $801,000 for the same period last year. Foreign
exchange loss amounted to $1.3 million for the nine months ended May 31, 2003,
compared to $714,000 for the same period last year.
The foreign exchange losses are the result of the translation of
operating activities denominated in currencies other than the Canadian dollar.
During the last two quarters of 2003, the Canadian dollar value increased
significantly, as compared to the US dollar resulting in significant foreign
exchange losses during the second and third quarters of 2003. However, we were
able to mitigate these losses with forward exchange contracts.
We manage our exposure to currency risk with forward exchange contracts
and operating activities denominated in currencies other than the Canadian
dollar.
12
INCOME TAXES
Our effective income tax recovery rate was 34.0% (before the future
income tax assets valuation allowance) and 33.6% for the three months ended May
31, 2003 and 2002, respectively and 34.3% (before the future income tax assets
valuation allowance) and 34.6% for the nine months ended May 31, 2003 and 2002,
respectively.
In the third quarter of 2003, we reviewed the carrying value of our
future income tax assets. Considering current market conditions, as well as the
fact that we recorded losses for the current and past year, and that we are
exiting the automation business, we concluded that it was more likely than not
that some of our future income tax assets will not be recoverable and that a
valuation allowance was required. Even though the carrying period of our future
income tax assets are very long or indefinite, GAAP requires future income tax
assets to be recovered in short periods, especially for companies evolving in
industries such as ours. Accordingly, we recorded a valuation allowance of $24.3
million to write off most of our future income tax assets mainly related to the
parent company, EXFO Protocol and EXFO Burleigh. Future income tax assets
written off consisted mainly in deferred tax losses, research and development
expenses, as well as share issue expenses and provisions and accruals.
From the $24.3 million valuation allowance, $12.1 million represent tax
assets that can be carried forward indefinitely against future years' taxable
income, while $12.2 million represent tax assets that can be carried forward
against future years' taxable income mainly over the next seven years.
The valuation allowance will be reversed accordingly as profits are
generated, but the full amount will not be reversed until we demonstrate the
ability to sustain long-term profitability.
AMORTIZATION OF GOODWILL
In conjunction with the four strategic acquisitions that we made over
the last two fiscal years and in the first quarter of 2003, we recorded $312.0
million in goodwill. The goodwill related to the acquisitions of EXFO Burleigh
and EXFO Photonic Solutions was amortized over five years until August 31, 2002.
This resulted in amortization expenses of $12.5 million and $37.3 million for
the three and the nine months ended May 31, 2002, respectively. The acquisitions
of EXFO Protocol and EXFO Gnubi have been accounted for using new accounting
standards contained in sections 1581 and 3062 of the CICA handbook and,
consequently, goodwill resulting from these acquisitions was not amortized.
Since September 1, 2002, goodwill related to the acquisitions of EXFO
Burleigh and EXFO Photonic Solutions is no longer amortized under new accounting
standards. Consequently, we no longer have amortization expense for goodwill.
NET LOSS
Net loss amounted to $38.4 million and $263.8 million for the three
months ended May 31, 2003 and 2002, respectively. In terms of per share amounts,
we recorded a net loss of $0.61 and $4.29 for the three months ended May 31,
2003 and 2002, respectively.
13
Net loss amounted to $44.8 million and $305.6 million for the nine
months ended May 31, 2003 and 2002, respectively. In terms of per share amounts,
we recorded a net loss of $0.71 and $5.06 for the nine months ended May 31, 2003
and 2002, respectively.
PRO FORMA NET LOSS
As a measure to assess financial performance, we use pro forma net loss
and pro forma net loss per share. Pro forma net loss represents net loss
excluding amortization and write-down of goodwill, future income tax assets
valuation allowance and the after-tax effect of amortization and write-down of
intangible assets, restructuring and other charges as well as inventory and tax
credit write-offs.
Pro forma net loss amounted to $4.1 million and $3.9 million for the
three months ended May 31, 2003 and 2002, respectively. In terms of pro forma
per share amounts, we recorded a net loss of $0.06 for the three months ended
May 31, 2003 and 2002. Pro forma net loss amounted to $8.8 million and $10.0
million for the nine months ended May 31, 2003 and 2002, respectively. In terms
of pro forma per share amounts, we recorded a net loss of $0.14 and $0.17 for
the nine months ended May 31, 2003 and 2002, respectively.
Pro forma net loss is reconciled as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
MAY 31, MAY 31,
-------------------------------- --------------------------------
2003 2002 2003 2002
--------------- ---------------- --------------- ----------------
(UNAUDITED)
Net loss in accordance with GAAP $ (38,427) $ (263,826) $ (44,831) $ (305,556)
Pro forma adjustments:
Amortization of goodwill -- 12,472 -- 37,331
Amortization of intangible assets 1,264 3,236 3,746 9,976
Write-down of goodwill 4,505 222,169 4,505 222,169
Write-down of intangible assets 2,922 23,657 2,922 23,657
Tax effect on amortization of intangible assets (430) (1,086) (1,284) (3,512)
Tax effect on write-down of intangible assets (993) (7,942) (993) (7,942)
Restructuring charges and inventory and tax
credit write-offs 4,291 11,124 4,291 21,343
Tax effect on restructuring charges and
inventory and tax credit write-offs (1,459) (3,734) (1,459) (7,432)
Future income tax assets valuation allowance 24,260 -- 24,260 --
--------------- ---------------- --------------- ----------------
Pro forma net loss $ (4,067) $ (3,930) (8,843) (9,966)
=============== ================ =============== ================
Basic and diluted net loss per share $ (0.61) $ (4.29) $ (0.71) $ (5.06)
Basic and diluted pro forma net loss per share $ (0.06) $ (0.06) $ (0.14) $ (0.17)
We provide pro forma financial information to help the investor better
understand our operating results. This information is not in accordance with, or
an alternative to, generally accepted accounting principles and may not be
comparable to similarly titled measures reported by other companies.
14
LIQUIDITY AND CAPITAL RESOURCES
We finance our major investments and meet our capital expenditure
requirements mainly through cash flows from operations, the use of cash and cash
equivalents and short-term investments and the issuance of subordinate voting
shares.
CASH POSITION AND SHORT-TERM INVESTMENTS
As at May 31, 2003, cash and cash equivalents as well as short-term
investments consisted of $61.8 million. Our working capital was at $83.5
million. Our cash and cash equivalents and short-term investments increased by
$4.0 million since February 28, 2003; this was mainly due to an unrealized
foreign exchange gain on cash and cash equivalents and short-term investments.
This unrealized foreign exchange gain results from the translation of our
financial statements in US dollars, which is our reporting currency and is
recorded in the cumulative translation adjustment in the balance sheet.
As at May 31, 2003, total commitments under operating leases and
long-term debt over the next twelve months amounted to approximately $1.5
million. Also, in accordance with the assets purchase agreement for the
acquisition of EXFO Gnubi, we may have to pay a contingent cash consideration up
to $2.9 million in December 2003. Finally, we expect to pay $3.0 million in
severances expenses in the upcoming months under our restructuring plan
announced last June. On the other hand, we should recover $2.8 million in income
taxes and tax credits over the next twelve months.
OPERATING ACTIVITIES
Cash flows used by operating activities were $92,000 and $2.6 million
for the three months ended May 31, 2003 and 2002, respectively. Cash flows used
by operating activities in the third quarter of 2003 were primarily due to the
net loss after items not affecting cash and cash equivalents of $7.2 million,
offset by the decrease of income taxes and tax credits recoverable of $5.1
million, the decrease of inventories of $1.5 million and the increase of
deferred grants of $1.2 million. The decrease in our income taxes and tax
credits recoverable is related to the recovery, during the quarter, of income
taxes and research and development tax credits recoverable from previous
periods. The decrease in our inventories is due to our efforts to maintain them
at the lowest acceptable level considering the continued slowdown in our
industry. Finally, the increase in our deferred grants is due to the cashing in,
during the quarter, of government grants, for which we have not yet met all
conditions to recognize revenue in the statement of earnings.
During the third quarter of 2003, the major items not affecting cash
and cash equivalents consisted of inventory and tax credit write-offs of $3.9
million, amortization expenses of $2.9 million, future income tax recovery of
$7.2 million, future income tax assets valuation allowance of $24.3 million and
write-down of goodwill and intangible assets of $7.4 million.
Cash flows provided by operating activities were $9.3 million for the
nine months ended May 31, 2003, compared to cash flows used of $9.0 million for
the same period last year. Cash flows provided by operating activities for the
nine months ended May 31, 2003, were primarily due to the decrease of accounts
receivable of $2.8 million, the decrease of income taxes and tax credits
recoverable of $15.7 million, the decrease of inventories of $5.5 million as
well as the
15
increase of deferred grants of $1.1 million, less the net loss after items not
affecting cash and cash equivalents of $15.0 million. The decrease in our
accounts receivable is related to the decrease in our sales level and the
recovery, during the period, of government grants. The decrease in our income
taxes and tax credits recoverable is related to the recovery, during the period,
of income taxes and research and development tax credits recoverable from
previous periods. The decrease in our inventories is due to our efforts to
maintain them at the lowest acceptable level considering the continued slowdown
in our industry. Finally, the increase in our deferred grants is due to the
cashing in, during the quarter, of government grants, for which we have not yet
met all conditions to recognize revenue in the statement of earnings.
During the nine months ended May 31, 2003, the major items not
affecting cash and cash equivalents consisted of inventory and tax credit
write-offs of $3.9 million, amortization expenses of $8.3 million, future income
tax recovery of $14.3 million, future income tax assets valuation allowance of
$24.3 million and write-down of goodwill and intangible assets of $7.4 million.
FINANCING ACTIVITIES
Cash flows used by financing activities were $13,000 and $23,000 for
the three months ended May 31, 2003 and 2002, respectively and $76,000 and
$70,000 for the nine months ended May 31, 2003 and 2002, respectively. Cash
flows used by financing activities in these periods were mainly due to the
repayment of our long-term debt.
As at May 31, 2003, we had credit facilities that provide for advances
of up to CA$10 million (US$7.3 million) under a line of credit. This line of
credit bears interest at prime rate.
The annual minimum principal repayments of our long-term debt over the
next five fiscal years range from $100,000 to $166 000 a year.
INVESTING ACTIVITIES
Cash flows used by investing activities were $1.3 million for the three
months ended May 31, 2003, compared to cash flows provided by investing
activities of $1.4 million for the same period last year.
In the third quarter of 2003, we acquired $1.1 million in short-term
investments and we paid $234,000 for the purchases of property, plant and
equipment and intangible assets.
Cash flows used by investing activities were $13.1 million for the nine
months ended May 31, 2003, compared to cash flow provided by investing
activities of $8.5 million for the same period last year.
For the nine months ended May 31, 2003, we acquired for $9.0 million in
short-term investments and we paid $1.9 million and $2.3 million, respectively,
for the acquisition of EXFO Gnubi and the purchases of property, plant and
equipment and intangible assets.
OUTLOOK
There can be no assurance as to whether and when we will return to
profitability or that our sales will return to prior levels. However, we believe
that our cash balances and short-term investments, combined with cash flows from
operations and available credit facilities, will be
16
sufficient to meet our expected liquidity and capital requirements for at least
the next 12 months. On the other hand, possible additional operating losses
and/or possible investments in or acquisitions of complementary businesses,
products or technologies may require additional financing prior to such time.
There can be no assurance that additional debt or equity financing will be
available when required or, if available, it can be secured on satisfactory
terms.
STOCK OPTION PLAN
The aggregate number of subordinate voting shares covered by options
granted under the stock option plan was 3,550,020 as at May 31, 2003. The
weighted average exercise price of those stock options was $15.49, compared to
the market price of $2.85 per share as at May 31, 2003. The maximum number of
subordinate voting shares issuable under the plan cannot exceed 4,470,961
shares. 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 company and its subsidiaries as at May 31, 2003:
WEIGHTED
% OF ISSUED AVERAGE
AND EXERCISE
NUMBER OUTSTANDING PRICE
--------------- --------------- --------------
Chairman of the Board, President and CEO
(one individual) 150,482 4.24% $ 9.91
Board of Directors (four individuals) 131,875 3.71% $ 7.41
Management and Corporate Officers
(nine individuals) 562,280 15.84% $ 16.42
--------------- --------------- --------------
844,637 23.79% $ 13.86
=============== =============== ==============
On September 1, 2002, we adopted prospectively the new section 3870 of
the CICA handbook, "Stock-Based Compensation and Other Stock-Based Payments" and
the new rules of this section apply to awards granted after that date. As
permitted by the CICA, we choose not to account for the stock-based compensation
costs arising from awards to employees, but we complied with the required pro
forma disclosures with respect to net earnings and net earnings per share in our
interim consolidated financial statements. During the nine months ended May 31,
2003, we granted 1,206,275 options to our employees with an average exercise
price of $2.21. Using the Black-Scholes valuation model, the weighted average
fair value per option is $0.83 and the aggregate stock-based compensation costs
for these options is $1,002,400. These compensation costs will be amortized
using the graded vesting method over the vesting period being four years,
resulting in stock-based compensation costs of $403,500, $307,300, $190,700,
$91,900 and $9,000 over the next five fiscal years, respectively.
Like many other companies, we do not believe that the use of the
Black-Scholes option valuation model provides a reliable single measure of the
fair value of our employees' stock options and stock awards, mainly because this
model was developed for use in estimating fair value of traded options and
because it requires the input of highly subjective assumptions, including the
expected stock price volatility.
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NEW ACCOUNTING STANDARDS
In November 2001, the CICA issued section 3870, "Stock-Based
Compensation and Other Stock-Based Payments", which is effective for fiscal
years beginning on or after January 1, 2002. The new section applies to awards
granted on or after the date of adoption, and requires that stock-based payments
to non-employees and direct awards of stock to employees be accounted for using
a fair value-based method. The new section also encourages, but does not
require, the use of a fair value-based method to account for stock-based
compensation costs arising from awards to employees. The new section requires
pro forma disclosures with respect to net earnings and net earnings per share if
a fair value-based method of accounting is not adopted for awards granted to
employees. We adopted this new standard prospectively on September 1, 2002. We
elected not to account for stock-based compensation costs arising from awards to
our employees using the fair value-based method and, consequently, the adoption
of this new standard had no impact on our financial results. However, we
complied with the standard by providing the required pro forma disclosures.
In August 2001, the CICA issued section 3062 "Goodwill and Other
Intangible Assets", which is effective for fiscal years beginning on or after
January 1, 2002. Section 3062 changes the accounting for goodwill from an
amortization method to an impairment-only approach. Thus, amortization of
goodwill, including goodwill recorded in past business combinations, ceased upon
the adoption of this section. For any acquisitions completed after June 30,
2001, goodwill is not amortized.
We adopted section 3062 prospectively on September 1, 2002. Since the
adoption of this new section, goodwill recorded prior to July 1, 2001, is no
longer subject to amortization. Also, under the transitional provisions of the
section, we performed an initial impairment test to identify goodwill impairment
using a fair value-based method. Under the new section, goodwill impairment
exists when the carrying value of a reporting unit exceeds its fair value. For
the purposes of the impairment test, we allocated our existing goodwill to our
reporting units and completed an evaluation of the fair value of such reporting
units. Based on the comparison of the fair value of the reporting units to their
carrying value, goodwill of the reporting units was not considered impaired at
that moment.
Furthermore, goodwill must be tested for impairment on an annual basis
or more frequently if events or circumstances occur that more likely than not
reduce the fair value of a reporting unit below its carrying value. Any
impairment loss arising from this test will be charged to earnings in the period
in which it is incurred. We elected to perform our annual impairment test in May
of each year for all our reporting units. Please refer to the section entitled
"Write-down of intangible assets and goodwill" of this document for a complete
description of this test.
In November 2002, the CICA issued section 3063, "Impairment of
Long-Lived Assets", which is effective for fiscal years beginning on or after
April 1, 2003. This new section changes existing rules for recognition and
measurement of long-lived assets held for use. The section requires that an
impairment charge be measured as the excess of the carrying value of an
intangible asset over its fair value. We adopted this new section prospectively
on April 1, 2003, and test our intangible assets under its new provisions.
Please refer to the section entitled "Write-down of intangible assets and
goodwill" of this document for a complete description of this test.
In November 2002, the CICA issued section 3475, "Disposal of Long-lived
Assets and Discontinued Operations", which is effective for disposal activities
initiated by an enterprise's commitment to a plan on or after May 1, 2003. Under
the new section, a long-lived asset to be
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disposed of other than by sale continues to be classified as held and used until
it is disposed of; a long-lived asset classified as held for sale is measured at
the lower of its carrying value of fair value less cost to sell; a loss
recognized on classification of long-lived assets as held for sale or a group of
assets as a discontinued operation does not include future operating losses,
other than to the extent they are included in the fair value of the asset; and
discontinued operations are defined more broadly than under existing rules. We
adopted this new standard prospectively on May 1, 2003, and its adoption had no
impact on our financial statements.
RISKS AND UNCERTAINTIES
Over the past few years, we have been able to manage our activities,
focus on research and development of new and innovative products, penetrate
international markets and close important strategic acquisitions. However, we
operate in a highly competitive field 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.
The main risks and uncertainties related to the fiber-optic test,
measurement and monitoring industry involve the rapid development of new
products that have short life cycles and require extensive research and
development; the difficulty of retaining highly skilled employees as well as
offering them effective training programs; and the ability to quickly adapt our
cost structure to changing market conditions in order to achieve profitability.
In addition, given our strategic goals for growth and competitive
positioning in our industry, we are 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.
Furthermore, while the important strategic acquisitions we have made
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.
We are also exposed to currency risks as a result of the export of our
products manufactured in Canada, substantially all of which are denominated in
US dollars. These risks are partially hedged by the operating expenses
denominated in US dollars, the purchase of raw materials in US dollars and
forward exchange contracts.
The economic slowdown in 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 and cash equivalents, short-term
investments and forward exchange contracts. Our short-term investments consist
of debt instruments issued by high-credit quality corporations and trusts. Our
cash and cash equivalents and forward exchange contracts are held with or issued
by high-credit quality 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 disclosures documents
published with securities commissions.
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