SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 20-F
[_] REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g)
OF THE SECURITIES EXCHANGE ACT OF 1934; or
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended August 31, 2003
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period ________ to ________
Commission File No. 0-30895
EXFO ELECTRO-OPTICAL ENGINEERING INC. /
EXFO INGENIERIE ELECTRO-OPTIQUE INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CANADA
(JURISDICTION OF INCORPORATION OR ORGANIZATION)
400 GODIN AVENUE
VANIER, QUEBEC G1M 2K2, CANADA
(418) 683-0211
(ADDRESS, INCLUDING ZIP CODE AND TELEPHONE NUMBER, INCLUDING
AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
Securities registered or to be registered pursuant to Section
12(b) of the Act:
None
Securities registered or to be registeredpursuant to
Section 12(g) of the Act:
Subordinate Voting Shares, no par value
Securities for which there is a reporting obligation pursuant to
Section 15(d) of the Act:
None
As of December 15, 2003, the registrant had 25,180,783 Subordinate
Voting Shares outstanding.
Indicate by check mark whether EXFO (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that EXFO was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days.
Yes [X] No [_]
Indicate by check mark which financial statement item EXFO has elected to
follow:
Item 17 [_] Item 18 [X]
DISCLOSURE REGARDING FORWARD-LOOKING INFORMATION
This annual report contains or incorporates by reference statements
which constitute 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 those that are discussed under "Risk Factors" set forth in
Item 3D of this annual report. Assumptions relating to forward-looking
statements involve judgments and risks, all of which are difficult or impossible
to predict and many of which are beyond our control. 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.
PART I.
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ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS
Not Applicable.
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
Not Applicable.
ITEM 3. KEY INFORMATION
A. SELECTED FINANCIAL DATA
The consolidated statements of earnings data for the years ended August
31, 1999 and 2000 and the consolidated balance sheets data as at August 31,
1999, 2000 and 2001 are derived from our audited consolidated financial
statements not included in this annual report. The consolidated statements of
earnings data for each of the three years ended August 31, 2001, 2002 and 2003
and the consolidated balance sheets data as at August 31, 2002 and 2003 are
derived from our audited consolidated financial statements that are included
elsewhere in this annual report.
Our consolidated financial statements are prepared in accordance with
generally accepted accounting principles in Canada ("Canadian GAAP"), which
differ in certain respects from generally accepted accounting principles in the
United States ("U.S. GAAP"). For a description of the significant differences
between Canadian and U.S. GAAP in regard to our consolidated financial
statements, see note 20 to our consolidated financial statements included
elsewhere in this annual report. The historical results below are not
necessarily indicative of the results to be expected for any future period.
The selected financial data should be read in conjunction with our
audited consolidated financial statements and the related notes included
elsewhere in this annual report, and "Item 5. Operating and Financial Review and
Prospects" of this annual report.
2
YEARS ENDED AUGUST 31,
----------------------------------------------------------
2003 2002 2001 2000 1999
---------- ---------- ---------- ---------- ----------
(IN THOUSANDS OF US DOLLARS, EXCEPT SHARE AND PER SHARE DATA)
CONSOLIDATED STATEMENTS OF EARNINGS DATA:
AMOUNTS UNDER CANADIAN GAAP
Sales.................................................. $ 61,930 $ 68,330 $ 146,013 $ 71,639 $ 42,166
Cost of sales (1)...................................... 36,197 52,366 56,207 25,385 15,458
---------- ---------- ---------- ---------- ----------
Gross margin (2)....................................... 25,733 15,964 89,806 46,254 26,708
---------- ---------- ---------- ---------- ----------
Operating expenses
Selling and administrative (1)......................... 26,991 33,881 44,975 23,631 12,819
Net research and development........................... 15,879 12,782 13,601 6,402 4,315
Amortization of property, plant and equipment.......... 6,139 5,932 3,559 1,451 857
Amortization of intangible assets...................... 4,747 11,615 9,876 47 41
Write-down of intangible assets........................ 2,922 23,657 -- -- --
Restructuring and other charges........................ 4,134 2,880 3,288 -- --
---------- ---------- ---------- ---------- ----------
Total operating expenses............................... 60,812 90,747 75,299 31,531 18,032
---------- ---------- ---------- ---------- ----------
Earnings (loss) from operations........................ (35,079) (74,783) 14,507 14,723 8,676
Interest income - net.................................. 1,245 1,456 6,098 1,480 136
Foreign exchange gain (loss) .......................... (1,552) (458) 3,327 (684) (506)
---------- ---------- ---------- ---------- ----------
Earnings (loss) before income taxes and amortization and
write-down of goodwill............................. (35,386) (73,785) 23,932 15,519 8,306
Income taxes........................................... 15,059 (25,451) 8,150 5,298 2,492
---------- ---------- ---------- ---------- ----------
Earnings (loss) before amortization and write-down of
goodwill......................................... (50,445) (48,334) 15,782 10,221 5,814
Amortization of goodwill............................... -- 38,021 31,076 297 --
Write-down of goodwill................................. 4,505 222,169 -- -- --
---------- ---------- ---------- ---------- ----------
Net earnings (loss) for the year....................... $ (54,950) $ (308,524) $ (15,294) $ 9,924 $ 5,814
---------- ---------- ---------- ---------- ----------
Basic and diluted net earnings (loss) per share........ $ (0.87) $ (5.09) $ (0.29) $ 0.25 $ 0.14
Basic weighted average number of shares used in per
share calculations (000's)......................... 62,852 60,666 53,014 39,951 38,001
OTHER FINANCIAL DATA:
Gross research and development......................... $ 17,133 $ 17,005 $ 17,601 $ 9,374 $ 6,390
Net research and development........................... $ 15,879 $ 12,782 $ 13,601 $ 6,402 $ 4,315
Dividends per share
Class "A" shares................................... $ -- $ -- $ -- $ 0.45 $ 0.08
Class "C" share.................................... $ -- $ -- $ -- $ -- $ 340
Class "F" shares................................... $ -- $ -- $ -- $ 0.45 $ --
AMOUNTS UNDER U.S. GAAP
Net earnings (loss) for the year....................... $ (48,201) $ (382,893) $ (29,478) $ 7,922 $ 5,901
Basic and diluted net earnings (loss) per share........ $ (0.77) $ (6.31) $ (0.56) $ 0.20 $ 0.15
Basic weighted average number of shares used in per
share calculations (000's)......................... 62,852 60,666 53,014 39,951 38,001
Dividends per share
Class "A" shares................................... $ -- $ -- $ -- $ 0.45 $ 0.08
Class "C" share.................................... $ -- $ -- $ -- $ -- $ 333
Class "F" shares................................... $ -- $ -- $ -- $ 0.45 $ --
AS AT AUGUST 31,
----------------------------------------------------------
2003 2002 2001 2000 1999
---------- ---------- ---------- ---------- ----------
(IN THOUSANDS OF US DOLLARS)
CONSOLIDATED BALANCE SHEETS DATA:
AMOUNTS UNDER CANADIAN GAAP
Cash................................................... $ 5,366 $ 9,128 $ 7,729 $ 729 $ 423
Short-term investments................................. 52,010 40,553 66,861 162,659 1,371
Working capital (3) ................................... 76,659 91,374 130,289 194,167 12,745
Total assets........................................... 146,254 177,926 442,577 219,723 22,840
Long-term debt (excluding current portion) ............ 453 564 664 16 --
Share capital.......................................... 492,452 489,611 429,995 198,459 87
Shareholders' equity................................... $ 129,826 $ 165,406 $ 414,805 $ 206,994 $ 14,679
AMOUNTS UNDER U.S. GAAP
Cash................................................... $ 5,366 $ 9,128 $ 7,729 $ 729 $ 423
Short-term investments................................. 52,010 40,553 66,861 162,719 1,430
Working capital (3) ................................... 78,304 91,305 129,987 194,204 12,781
Total assets........................................... 138,905 161,314 499,436 219,760 22,899
Long-term debt (excluding current portion) ............ 453 564 664 16 --
Share capital.......................................... 565,291 560,943 498,121 201,151 132
Shareholders' equity................................... $ 122,477 $ 150,999 $ 471,117 $ 207,031 $ 14,715
--------------------------
(1) Certain comparative figures have been reclassified to conform to the
current year's presentation.
(2) Includes inventory write-offs of $4,121, $18,463, nil, nil and nil for the
years ended August 31, 2003, 2002, 2001, 2000 and 1999, respectively, and a
non-recurring gain of $473 for the year ended August 31, 2003.
(3) Includes 800,000 mandatorily redeemable preferred shares with a carrying
value of $543,000 as at August 31, 2000.
3
B. CAPITALIZATION AND INDEBTEDNESS
Not Applicable.
C. REASONS FOR THE OFFER AND USE OF PROCEEDS
Not Applicable.
D. RISK FACTORS
RISKS RELATED TO OUR INDUSTRY AND BUSINESS
IF THE DOWNTURN IN THE TELECOMMUNICATIONS INDUSTRY CONTINUES TO PERSIST OR
WORSENS, OR IF OPTICAL FIBER IS REPLACED BY ANOTHER MEDIUM AS THE PRIMARY
SOLUTION FOR BANDWIDTH-INTENSIVE APPLICATIONS, DEMAND FOR OUR PRODUCTS MAY
FURTHER DECREASE WHICH COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS,
RESULTS OF OPERATIONS AND FINANCIAL CONDITION.
The ongoing difficult environment in the global telecommunications
industry has resulted in significant bankruptcies, reduced purchasing and
decreased capital expenditures in the markets that we serve worldwide. Our sales
and orders have been affected by this downward cycle, which is characterized by
diminished product demand, excess manufacturing capacity and the erosion of
average selling prices. These conditions have also caused a lack of visibility,
which reduces our capacity to plan. The ultimate severity of the current
downturn and how long it will last remains unknown. Any further downturn in our
markets or in general economic conditions, additional bankruptcies and decreased
capital expenditures, or if optical fiber is replaced by a higher-performance
medium, would likely result in a further reduction in demand for our products as
well as low visibility, and could harm our consolidated financial position,
results of operations, cash flows and stock price.
WE HAVE ADOPTED MEASURES AND MAY ADOPT ADDITIONAL MEASURES THAT ALIGN OUR COST
STRUCTURE TO EXISTING MARKET CONDITIONS. IF DEPRESSED MARKET CONDITIONS PERSIST,
IT COULD HAVE MATERIAL ADVERSE, LONG-TERM EFFECTS ON OUR BUSINESS, RESULTS OF
OPERATIONS AND FINANCIAL CONDITION.
In June 2001, we re-aligned our cost structure to market conditions by
implementing various measures including postponement of plans to build a new
facility in the Quebec Metro High-Tech Park, termination of non-core operations
at a subsidiary that specialized in manufacturing fiber-optic temperature
sensors, and a 15% workforce reduction. In December 2001, we announced the
lowering of our operating expenses, a freeze in employee salaries, and the
further reduction of our workforce by 10%.
In May 2002, we reduced our global workforce by an additional 20% and
definitively cancelled our plans to build the new facility. In June 2003, we
further reduced our workforce by 30%, streamlined the number of our production
facilities and exited the optical component manufacturing automation business.
We also reorganized our business under two new divisions - Telecom Division and
Photonics and Life Sciences Division - to better serve our diverse customer base
and maximize shareholders value. If we do not ensure a smooth transition from
our former business structure to our new one, it could have a material adverse
effect on our business, results of operations and financial condition.
4
These and, if needed, subsequent measures could have material adverse,
long-term effects on our business, results of operations and financial condition
if we deplete our pool of highly qualified personnel or are unable to retain key
personnel; if we are unable to sustain sufficient research and development
efforts for the launch of new products; if we are unable to meet the needs of
our customers; and if we are not capable of ramping up manufacturing when market
conditions improve. In addition, if we fail to adopt and implement adequate and
pertinent measures on a timely basis to align our cost structure to further
possibly declining market conditions, it could have a materially adverse,
long-term effect on our business, results of operations and financial condition.
WE MAY MAKE MISJUDGMENTS IN OUR STRATEGIC PLANNING THAT COULD HAVE MATERIAL
ADVERSE EFFECTS ON OUR BUSINESS, RESULTS OF OPERATIONS AND FINANCIAL CONDITION.
We devise a strategic business plan on an annual basis. Such strategic
plan is based on market research and analysis relating to future market trends
and demands. In our strategic plans, we have made, and will continue to make,
judgments based on our analysis of future market trends and demands which may
involve, for example, substantial investments by us in the development of new
product lines or the diversification of our activities, either organically or
through acquisitions. These strategies involve numerous risks, including:
o unanticipated costs or liabilities;
o diversion of management's attention from our core business;
o risks associated with entering markets in which we have no or
limited prior experience.
IF CUSTOMERS FAIL TO MEET THEIR FINANCIAL COMMITMENTS TO US, IT COULD HAVE A
MATERIAL ADVERSE EFFECT ON OUR BUSINESS, RESULTS OF OPERATIONS AND FINANCIAL
CONDITION.
With the continuing economic slowdown, some of our customers are
experiencing, or may experience, serious cash flow problems. Consequently, we
have had customers who delayed payment or were not able to meet their financial
commitments to us. Furthermore, they may not order as many products from us as
originally forecasted or they may cancel their orders outright. The failure of
customers to order products would result in decreased revenues for us. We
attempt to reduce the possibility of large outstanding bills remaining unpaid by
carrying out credit checks on customers and by having a diversified customer
base. For example, no customer represented more than 9.2% of our sales in fiscal
2003. However, there is no assurance that such measures will reduce our exposure
to customer credit risks. If customers fail to meet their financial commitments
to us, it could have a material adverse effect on our business, results of
operations and financial condition.
WE MUST CONTINUE TO OVERCOME SIGNIFICANT COMPETITION IN OUR TARGETED INDUSTRIES
IN ORDER TO GAIN MARKET SHARE AND ACHIEVE OUR GROWTH STRATEGY.
The market for our primary business activity, designing, manufacturing
and marketing telecommunications test and measurement equipment, is rapidly
evolving and is marked by intense competition and technical innovation.
Likewise, the market for our selected photonics and life sciences solutions is
very competitive. We anticipate the pace of change will accelerate for our
targeted industries in the future. We expect new competitors to emerge or
current competitors to consolidate, as the markets for telecommunications test
and measurement equipment as well as photonics and life sciences solutions
evolve in response to technical innovations and economic conditions. Our sales
objective of 10% growth in fiscal 2004 largely
5
depends on our ability to gain market share by increasing sales of current
products, introducing new products and product enhancements, and exploiting new
markets.
In fiscal 2002 and 2003, we acquired technologies that enabled us to
expand into protocol-layer testing and, thereby, almost double the addressable
market for our Telecom Division. This new market brings additional competition.
Moreover, our competitors may have more experience operating in this market and
be better established with customers in this sector. Some of our current and
potential competitors are test and measurement manufacturers who complement
their broad range of products with telecommunications test and measurement
equipment. Major competitors, such as Acterna Corporation, Agilent Technologies
Inc., ANDO Corporation, Anritsu Corporation, IXIA, NetTest, Sunrise Telecom Inc.
and Tektronix, Inc., may have greater financial, technical and/or marketing
resources than us. Consequently, these competitors may be able to devote greater
resources to the development, marketing, sale and support of their products.
They also may be better positioned than we are to acquire companies and new
technologies that would potentially displace our products or render them
obsolete. We cannot predict whether current or future competitors will develop
or market products that offer higher performance, more features, or are more
cost-effective than our current or future products. To remain competitive and
achieve our growth strategy, we must increase our sales and develop
cost-effective products and product enhancements that offer higher performance
and more functionality, in current and new sectors, so that we can increase our
market share. Our failure to do so may harm our business, results of operations
and financial condition.
WE HAVE FACED PRICING PRESSURE ON OUR EXISTING PRODUCTS AND EXPECT THAT THIS
PRESSURE WILL CONTINUE. IF WE DO NOT CONTROL OUR MANUFACTURING COSTS OR
INTRODUCE NEW PRODUCTS WITH HIGHER MARGINS, OUR GROSS MARGINS WILL NOT INCREASE
AND OUR OPERATING RESULTS WILL BE ADVERSELY AFFECTED.
We have implemented several measures to improve our gross margin to at
least 50% of total sales in fiscal 2004. However, reduced demand for
telecommunications test and measurement equipment, coupled with increased
competitiveness in this industry, will likely result in a continuing downward
pressure on average selling prices, which may in turn negatively affect our
gross margins. Pricing pressure can result from a number of factors such as:
o increased competition for business;
o reduced demand;
o limited number of potential customers;
o competition from companies with lower production costs;
o introduction of new products by competitors;
o greater economies of scale for higher-volume competitors;
o resale of used equipment; and
o equipment sales resulting from manufacturing and rental
company bankruptcies.
In addition, gross margins may also be negatively affected by increased
cost of raw materials as well as obsolescence and excess costs in product mix
and under-absorption of fixed manufacturing costs.
As pricing pressure will likely continue to affect our existing
products, we may have to increase the number of units sold to maintain our
existing sales levels. If we are unable to
6
increase our sales levels, lower our manufacturing costs, or introduce new
products with higher margins, our gross margins may decline and our operating
results may suffer.
OUR QUARTERLY REVENUES AND OPERATING RESULTS ARE SUBJECT TO SIGNIFICANT
FLUCTUATIONS AND YOU SHOULD NOT RELY ON THEM AS AN INDICATION OF OUR FUTURE
PERFORMANCE.
Our sales and operating results have fluctuated from quarter to quarter
in the past and significant fluctuations may occur in the future. In addition,
our sales and operating results generally depend on the volume and timing of the
orders we receive from customers as well as our ability to fulfill received
orders. Our operating expenses, which include research and development, selling
and administrative, and amortization expenses, are relatively fixed in the short
term. If we sell fewer products than anticipated, if there is a delay in the
launch of new products, or if prices for our products decline, we may not be
able to quickly reduce our operating expenses in response to lower sales.
Factors that could affect the amount and timing of our sales, and cause
quarterly fluctuations in our revenue and operating results include:
o the length of the product sales cycle for certain of our
products, especially those that are higher priced and more
complex;
o the timing of the introduction and market acceptance of new
products by us, our competitors;
o our ability to sustain product volumes and high levels of
quality across all product lines;
o the timing of shipments for large orders; and
o the effect of potential seasonality in sales.
Our sales and operating results could also be affected by the following
factors, some of which we have little or no control over:
o fluctuating demand for telecommunications test and measurement
equipment as well as photonics and life sciences solutions;
o changes in the capital spending and operating budgets of our
customers, which may cause seasonal or other fluctuations in
product mix, volume, timing and number of orders we receive
from our customers;
o order cancellations or rescheduled delivery dates;
o pricing changes by our competitors or suppliers;
o customer bankruptcies and difficulties in collecting accounts
receivable;
o the level of used telecommunications test and measurement
equipment available for resale;
o restructuring charges; and
o general economic conditions.
In addition, we may in the future choose to reduce prices, increase
spending, or modify our product portfolio in response to actions by competitors
or as an effort to pursue new market opportunities. These actions may also
adversely affect our business and operating results and may cause our quarterly
results to be lower than the results of previous quarters. Due to these factors,
you should not rely on quarter-to-quarter comparisons of our results of
operations as an indication of our future performance.
7
AS OUR CUSTOMERS CONSOLIDATE, THEY MAY REDUCE OR HALT PURCHASES OF OUR PRODUCTS,
WHICH WOULD HARM OUR SALES AND OPERATING RESULTS.
Consolidation in the telecommunications industry could reduce the
number of customers to whom our products are sold. Some of our customers have
been subject to consolidation and could obtain products from a vendor other than
us, or demand more favorable terms and conditions from us, which would harm our
sales and operating results. In addition, some customers may merge with or
acquire our competitors and discontinue their relationships with us.
WE DEVOTE CONSIDERABLE TIME AND RESOURCES TO SECURING NEW CUSTOMERS AND
IMPROVING SALES TO EXISTING CUSTOMERS. IF WE ARE UNSUCCESSFUL, OUR FUTURE
OPERATING RESULTS MAY SUFFER.
The long sales cycle for some of our products may cause our sales and
operating results to vary significantly from period to period. Many of our
products are complex, and customers for these products may require substantial
time to make purchase decisions. Some customers perform exhaustive evaluations
and testing of new instruments --and require us to carry out extensive product
demonstrations--before purchasing them. The period of time between our initial
contact with a customer and the receipt of a purchase order may span a year or
more. If we are unable to satisfy customer demands, considerable resources would
have been expended without deriving corresponding sales. In addition, some of
our customers and potential customers require that a bidding process be followed
or that our products be pre-approved. Both of these situations involve inherent
risks over which we have little control; for example, missing the approval
opportunity or unsuccessful pricing.
OUR CUSTOMERS ARE NOT OBLIGATED TO BUY MATERIAL AMOUNTS OF OUR PRODUCTS AND MAY
CANCEL OR DEFER PURCHASES ON SHORT NOTICE.
Our customers typically purchase our products under individual purchase
orders and may cancel or defer purchases on short notice without significant
penalties. Accordingly, sales for a particular period are difficult to predict.
Decreases in purchases, cancellations of purchase orders, or deferrals of
purchases may have a material adverse effect on our operating results,
particularly if we do not anticipate them.
WE CANNOT ASSURE YOU THAT WE WILL SUCCESSFULLY INTEGRATE THE BUSINESSES,
PRODUCTS, TECHNOLOGIES OR PERSONNEL OF OUR RECENT AND FUTURE ACQUISITIONS, WHICH
MAY HARM OUR BUSINESS.
Mergers and acquisitions of high-technology businesses are inherently
risky. For our past and future transactions to be successful, we must
appropriately integrate the businesses, products, technologies and personnel
already acquired as well as those of any future acquisitions--with our own
business, product portfolios and personnel--in a manner that anticipates or
responds to new technological developments and customer requirements on a timely
basis. In addition, we must coordinate the operations and product portfolios of
newly acquired companies with our own and manage all aspects of geographically
dispersed operations. Integration requires the dedication of management
resources, which may distract their attention from our day-to-day business and
operations. If we fail to integrate the companies quickly and efficiently, we
may not be able to realize the benefits that we expect from these transactions
and may be required to shut down, rationalize or exit such activities.
8
We cannot guarantee that any recent or future acquisition will achieve
anticipated net sales and profits. In May 2002, as part of our review of
financial results and due to the continued downturn in the telecommunications
industry, the persisting unfavorable market conditions affecting our
subsidiaries' industries, and the decline in technology valuations, we performed
an assessment of the carrying value of goodwill and intangible assets recorded
in conjunction with the acquisitions of EXFO Burleigh, EXFO Photonic and EXFO
Protocol. We concluded that the carrying value of goodwill and certain acquired
intangible assets was impaired and we recorded a US$222.2 million write-down of
goodwill and a US$23.7 million write-down of acquired core technology, which had
a negative impact on our reported earnings. In May 2003, we carried out a
similar assessment, resulting in an impairment charge of US$4.5 million for
goodwill and US$2.9 million for acquired core technology. Further write-downs
may become necessary in the future.
All of these factors could materially harm our business, results of
operations and financial condition.
We may not be able to make the necessary acquisitions needed for the
development of our business and any acquisition we make could disrupt our
business and harm our financial condition.
We intend to seek acquisitions of businesses, products and technologies
that are complementary to ours or that will increase or expand our markets.
There can be no assurance that we will ultimately make any such acquisition. The
consolidation of our competitors may improve their capacity to acquire the same
businesses, products and technologies that we wish to acquire. In addition, our
fluctuating stock price or our cash position at the time of the acquisition may
affect our ability to complete an acquisition.
We have made strategic acquisitions in the past and we intend to
continue making acquisitions of businesses, products and technologies as part of
our overall growth strategy. In the event of any future acquisition, we could:
o issue shares that would dilute individual shareholder
percentage ownership;
o incur debt;
o assume liabilities and commitments;
o incur expenses related to amortization of additional
intangible assets; or
o incur significant impairment losses of goodwill and intangible
assets related to such acquisitions.
These acquisitions also involve numerous risks, including:
o problems combining the acquired operations, technologies,
products and personnel;
o unanticipated costs or liabilities;
o diversion of management's attention from our core business;
o adverse effects on existing business relationships with
suppliers and customers;
o risks associated with entering markets in which we have no or
limited prior experience; and
o potential loss of key employees, particularly those of
acquired organizations.
9
IF WE FAIL TO PREDICT OUR SUPPLY REQUIREMENTS ACCURATELY, WE WILL HAVE EXCESS
INVENTORY OR INSUFFICIENT INVENTORY, EITHER OF WHICH COULD CAUSE US TO INCUR
ADDITIONAL COSTS AND/OR EXPERIENCE MANUFACTURING DELAYS.
We provide non-binding forecasts of our requirements to some of our
suppliers up to six months prior to scheduled delivery of products to our
customers. If we overestimate our forecasted requirements, we may have excess
inventory, which could harm our relationships with our suppliers due to reduced
future orders, increase our costs and require inventory write-offs. In the
fiscal year ended August 31, 2002, we recorded inventory write-offs totaling
US$18.5 million for excess and obsolete inventories. We recorded an additional
US$4.1 million for excess and obsolete inventories in fiscal 2003. If we
underestimate our requirements, we may have an inadequate inventory of parts,
which could interrupt manufacturing of our products and result in shipment
delays. In addition, lead times for materials and parts that we order may be
long and depend on factors such as the procedures of, or supply terms with, a
specific supplier and demand for each part at a given time.
WE DEPEND ON A SINGLE SUPPLIER OR A LIMITED NUMBER OF SUPPLIERS FOR SOME OF THE
KEY COMPONENTS AND MATERIALS IN OUR PRODUCTS, WHICH MAKES US SUSCEPTIBLE TO
SUPPLY SHORTAGES OR PRICE FLUCTUATIONS THAT COULD ADVERSELY AFFECT OUR OPERATING
RESULTS.
We depend on a limited number of suppliers for some of the parts used
to manufacture our products for which alternative sources may not be readily
available. In addition, all our orders are placed through individual purchase
orders and, therefore, our suppliers may stop supplying parts to us at any time.
The reliance on a single source or limited number of suppliers could result in
increased costs, delivery problems and reduced control over product pricing and
quality. Financial difficulties of suppliers could also affect our ability to
obtain necessary parts in a timely manner. Any interruption or delay in the
supply of any of these parts could significantly harm our ability to meet
scheduled product deliveries to our customers and cause us to lose sales.
Furthermore, the process of qualifying a new manufacturer for complex parts,
designed to our specifications, such as our optical and mechanical parts, is
lengthy and would consume a substantial amount of time of our technical
personnel and management. If we were required to change manufacturers in a short
period of time, our business would be disrupted. In addition, we may be
unsuccessful in identifying a new manufacturer capable of and willing to meet
our needs on terms that we would find acceptable. Consolidation involving
suppliers could further reduce the number of alternatives available to us and
affect the cost of parts, which would make our products less competitive and
result in lower margins.
IF WE ARE UNABLE TO ADAPT TO CURRENT AND FUTURE CHANGES IN TECHNOLOGY OR IF WE
ARE UNABLE TO INTRODUCE NEW AND ENHANCED PRODUCTS ON A TIMELY BASIS, OUR
PRODUCTS MAY BECOME OBSOLETE, WHICH COULD PREVENT US FROM ACHIEVING OUR GROWTH
STRATEGY AND ADVERSELY AFFECT OUR OPERATING RESULTS.
The industries that we target are characterized by rapidly evolving
technology and industry standards that result in frequent new product
introductions. Any failure by us to anticipate or respond to new technological
developments, customer requirements or evolving standards could have a material
adverse effect on our business, results of operations and financial condition.
The development of proprietary technology entails significant technical and
business risks and requires substantial expenditures and lead-time. The success
of our new product introductions will depend on several factors, including our
ability to:
10
o properly identify customer needs;
o innovate and develop new products;
o gain timely market acceptance for new products;
o manufacture and deliver our new products on time and in
sufficient volume;
o price our products competitively; and
o anticipate competitors' announcements of new products.
In addition, failure to do so could be exploited by our competitors. If
we lose market share as a result of lapses in our product development, our
business would suffer.
OUR PRODUCTS MAY HAVE UNFORESEEN DEFECTS THAT COULD HARM OUR REPUTATION, IMPEDE
MARKET ACCEPTANCE OF OUR PRODUCTS AND NEGATIVELY IMPACT OUR BUSINESS, RESULTS OF
OPERATIONS AND FINANCIAL CONDITION.
As a result of their complexity, our products may contain undetected
software or hardware defects, inaccurate calibration or compatibility problems
or regulatory compliance issues, particularly when they are first introduced or
when new versions are released. There can be no assurance that, despite our
testing, defects will not be found in new products after they have been fully
deployed and operated under peak stress conditions or that customized products
meet customer sign-off acceptance requirements. If we are unable to fix defects
or other problems or meet custom requirements, we could experience, among other
things:
o costly repairs
o product returns or recalls;
o damage to our brand reputation;
o loss of customers, failure to attract new customers or achieve
market acceptance;
o diversion of development and engineering resources;
o legal actions by our customers, including claims for
consequential damages and loss of profits; and
o legal actions by governmental entities, including actions to
impose product recalls and/or forfeitures.
The occurrence of any one or more of the foregoing could seriously harm
our business, results of operations and financial condition.
OUR PRODUCTS MAY BE REQUIRED TO CONFORM TO NEW AND UNFORESEEN REGULATORY
REQUIREMENTS THAT COULD INCREASE OUR COSTS AND REDUCE OUR MARKET SHARE.
Our products are designed to conform to the regulatory requirements of
the countries in which they are marketed. In the event that the technical
regulations applicable in a given country are in any way changed, we may be
required to modify, redesign or recall some or all of our products in order to
continue participating in that market. These changes may prove costly and
time-consuming and could create technical advantages for products marketed by
our competitors. We cannot assure that our products will continue to meet
evolving standards in the future. In addition, failure to comply, or delays in
compliance with such regulatory requirements or delays in receipt of
certifications, could delay the introduction of new products or cause our
existing products to become obsolete.
11
IF WE FAIL TO ADAPT APPROPRIATELY TO THE CHALLENGES ASSOCIATED WITH OPERATING
INTERNATIONALLY, THE EXPECTED GROWTH OF OUR BUSINESS MAY BE IMPEDED AND OUR
OPERATING RESULTS MAY BE AFFECTED.
For the fiscal year ended August 31, 2003, customers outside of the
United States and Canada accounted for 41% of our sales and for the fifteen
months ended November 30, 2003, these customers accounted for 42% of our sales.
Our international sales will be limited if we cannot establish relationships
with international distributors, set up additional foreign operations, expand
international sales channel management, hire additional personnel, develop
relationships with international service providers and operate adequate
after-sales support internationally. Even if we are able to successfully
continue our international operations, we may not be able to maintain or
increase international market demand for our products. Our international
operations are subject to a number of risks, including:
o challenges in staffing and managing foreign operations due to
the limited number of qualified candidates, employment laws
and practices in foreign countries, any of which could
increase the cost and reduce the efficiency of operating in
foreign countries;
o technology standards that differ from those on which our
products are based, which could require expensive redesign and
retention of personnel familiar with those standards;
o longer accounts receivable payment cycles and possible
difficulties in collecting payments which may increase our
operating costs and hurt our financial performance; and
o certification requirements.
Any of these factors could harm our international operations and
negatively affect our financial performance. The recurrence of weakness in these
economies or of weakness in other foreign economies could have a significant
negative effect on our future operating results.
ECONOMIC, POLITICAL AND OTHER RISKS ASSOCIATED WITH INTERNATIONAL SALES AND
OPERATIONS COULD ADVERSELY AFFECT OUR BUSINESS, RESULTS OF OPERATIONS AND
FINANCIAL CONDITION.
We maintain operations worldwide. As a result, our business is subject
to global economic and market condition risks generally associated with doing
business, such as fluctuating exchange rates, the instability of international
monetary conditions, tariff and trade policies, domestic and foreign tax
policies, foreign governmental regulations, political unrest, wars, acts of
terrorism and changes in economic or political conditions. These factors, among
others, could influence our ability to succeed in global markets and could
adversely affect our results of business, results of operations and financial
condition.
WE ARE SUBJECT TO LAWS, REGULATIONS AND CONTRACTUAL OBLIGATIONS AND REQUIREMENTS
RELATING TO OUR CUSTOMER CONTRACTS, AND OUR FAILURE TO ADDRESS THESE LAWS,
REGULATIONS, OBLIGATIONS AND REQUIREMENTS OR COMPLY THEREWITH COULD HARM OUR
BUSINESS.
We have agreements relating to the sale of our products to our
customers and, as a result, we are subject to various statutes and regulations
and contractual obligations and requirements. We may also be subject to
investigation for compliance with such statutes, regulations, obligations and
requirements. Any failure to comply therewith could harm our business.
12
THE PRICE OF OUR SECURITIES IS VOLATILE AND MAY DECLINE.
The market price of our securities has been, and is likely in the
future to be, subject to wide and rapid fluctuations. Such fluctuations may be
due to factors specific to us, such as changes in our operating results or new
product introductions, or caused by our competitors, changes in analysts'
ratings, or the liquidity of our stock. Fluctuations in stock price may also be
due to factors related to the global telecommunications industry or the
securities markets in general. These fluctuations have often been unrelated or
disproportionate to the operating performance of the specific companies whose
stocks are traded. These broad market and industry factors may have a material
adverse effect on the market price of our securities, regardless of our actual
operating performance. Shareholders should be willing to incur the risk of such
fluctuations.
WE REQUIRE EMPLOYEES WHO ARE KNOWLEDGEABLE ABOUT THE SPECIALIZED NATURE OF OUR
BUSINESS. IF WE ARE UNABLE TO ATTRACT AND RETAIN SUFFICIENT NUMBERS OF HIGHLY
SKILLED TECHNICAL, SALES, MARKETING AND OTHER PERSONNEL, OUR OPERATIONS AND
FINANCIAL RESULTS WOULD SUFFER.
Due to the specialized nature of our business, we are highly dependent
on the continued service of and on the ability to attract and retain, qualified
engineering, sales, marketing and senior management personnel. During the
prolonged downturn in the telecommunications industry, a number of skilled
personnel and people on our senior management team have departed or were
terminated in our cost-reduction efforts. If we are unable to effectively
replace these members of our senior management team, or if managers cannot
adequately assume resulting added responsibilities, it could have a material
adverse effect on our business, results of operations and financial condition.
In addition, the loss of other key employees could have a material adverse
effect on our business and operating results. We may not be able to continue to
attract and retain the qualified personnel necessary for the development of our
business.
We must provide significant training for our employee base due to the
highly specialized nature of telecommunications test and measurement as well as
photonics and life sciences technologies. Our current engineering personnel may
be inadequate and we may fail to assimilate and train new employees. Highly
skilled employees with the education and training that we require--especially
employees with significant experience and expertise, international business
development and product management--may be difficult to find. Once trained, our
employees can also be hired by our competitors.
OUR BUSINESS STRATEGY AND ABILITY TO MAINTAIN OUR COMPETITIVE POSITION DEPEND ON
THE CONTINUED SERVICES OF GERMAIN LAMONDE, OUR CHAIRMAN OF THE BOARD, PRESIDENT
AND CHIEF EXECUTIVE OFFICER. HIS LOSS COULD ADVERSELY AFFECT OUR BUSINESS.
Our ability to maintain our competitive position depends to a
significant extent on the efforts and abilities of Germain Lamonde, our Chairman
of the Board, President and Chief Executive Officer. His managerial, technical
and other services could be difficult to replace. We do not have "key person"
life insurance policies covering any employee.
OUR INTELLECTUAL PROPERTY AND PROPRIETARY TECHNOLOGY ARE IMPORTANT TO THE
CONTINUED SUCCESS OF OUR BUSINESS. OUR FAILURE TO PROTECT THIS PROPRIETARY
TECHNOLOGY MAY SIGNIFICANTLY IMPAIR OUR COMPETITIVE POSITION.
13
Our success and ability to compete depend to a significant extent on
our proprietary technology, since that is how we attempt to keep others from
using the innovations that are central to our existing and future products. We
currently hold 21 U.S. and 6 Canadian-issued patents and have 21 U.S. and 16
Canadian patent applications pending, along with 8 patent applications pending
under the Patent Cooperation Treaty. We also rely on a combination of copyright
and trademark laws, trade secrets, confidentiality procedures, contractual
provisions and license agreements to protect our proprietary technology. We may
have to engage in litigation in order to protect our patents and other
intellectual property rights, or to determine the validity or scope of the
proprietary rights of others. This kind of litigation can be time-consuming and
expensive, regardless of whether we win or lose. Because it is critical to our
success that we are able to prevent competitors from copying our innovations, we
intend to continue to seek patent and trade secret protection for our
technologies. The process of seeking patent protection can be long and expensive
and we cannot be certain that any currently pending or future applications will
actually result in issued patents, or that, even if patents are issued, they
will be of sufficient scope or strength to provide meaningful protection or any
commercial advantage to us. Furthermore, others may develop technologies that
are similar or superior to our technology, or design around the patents that we
own. We also rely on trade secret protection for our technology, in part through
confidentiality agreements with our employees, consultants, distributors and
third parties. However, these agreements may be breached or otherwise not
effective and we may not have adequate remedies for any breach or shortfall of
these agreements. In any case, others may come to know about our trade secrets
through a variety of methods. In addition, the laws of some territories in which
we sell our products may not protect our intellectual property rights to the
same extent as do the laws of Canada and the United States.
Despite our efforts, our intellectual property rights, particularly our
existing or future patents, may be invalidated, circumvented, challenged or
required to be licensed to others. Furthermore, others may develop technologies
that are similar or superior to our technology, duplicate or reverse engineer
our technology, or design around the patents owned or licensed by us. We cannot
be sure that the steps that we take to protect our technology will prevent
misappropriation or infringement. If we fail to protect our technology so that
others may copy or use it, we will be less able to differentiate our products
and our sales will decline.
OTHERS MAY CLAIM THAT OUR PRODUCTS INFRINGE UPON THEIR INTELLECTUAL PROPERTY
RIGHTS, OR THEY MAY INFRINGE OUR INTELLECTUAL PROPERTY, AND WE MAY EXPEND
SIGNIFICANT RESOURCES ENFORCING OR DEFENDING OUR RIGHTS OR SUFFER COMPETITIVE
INJURY.
Litigation regarding intellectual property rights is common in the
technology industry and, for this reason, we expect that third-party
infringement claims involving technologies may increase. If an infringement
claim is filed against us, we may be prevented from using some of our
technologies and may incur significant costs to resolve the claim. Conversely,
we may be required to spend significant resources to monitor and police our
intellectual property rights.
We could incur substantial costs in defending ourselves and our
customers against infringement claims or in bringing infringement claims against
others. Litigation could also adversely affect sales of the challenged product
or technology and divert the efforts of our management and technical personnel.
In the event of a claim of infringement, we may be required to obtain one or
more licenses from third parties. We cannot assure you that we, or our
customers, could obtain necessary licenses from third parties at a reasonable
cost or at all. If we fail to obtain a license where one is required, we could
incur substantial liabilities and be forced to suspend the marketing of the
challenged products.
14
OUR INSURANCE MAY NOT BE SUFFICIENT TO COVER ALL POTENTIAL LIABILITY. A
SUCCESSFUL CLAIM EXCEEDING OUR POLICY LIMITS WILL REDUCE OUR CASH POSITION,
INCREASE OUR EXPENSES AND HAVE A NEGATIVE EFFECT ON OUR BUSINESS, OPERATING
RESULTS AND FINANCIAL CONDITION.
Our products are designed to help network service providers and
manufacturers of optical components, value-added optical modules and optical
networking systems ensure network reliability. We also leverage our core telecom
technologies in selected photonics and life sciences applications for high-tech
industrial manufacturing and research markets. The failure of our products to
perform to client expectations could give rise to product liability and warranty
claims. We carry insurance for product liability and take accounting reserves
for warranty claims that we consider adequate in view of industry practice. In
addition, we may face other types of claims by third parties in relation to the
conduct of our business; a successful claim against us for an amount exceeding
our policy limits would force us to use our own resources to pay the claim,
which could result in a reduction of our cash available for other uses, increase
our expenses and have a negative effect on our business, results of operations
and financial condition.
WE MAY BECOME INVOLVED IN COSTLY AND TIME-CONSUMING LITIGATION THAT MAY
SUBSTANTIALLY INCREASE OUR COSTS AND HARM OUR BUSINESS.
We may from time to time become involved in various lawsuits and legal
proceedings. For example, EXFO is a defendant in a putative securities class
action filed in the United States District Court for the Southern District of
New York involving approximately 300 other issuing companies. In addition, we
have instituted a claim against a former employee of one of our subsidiaries, in
relation to a breach of contractual confidentiality obligations. Litigation is
subject to inherent uncertainties, and an adverse result in these or other
matters that may arise from time to time could have a material adverse effect on
our business, results of operations or financial condition.
Any litigation to which we are subject could require significant
involvement of our senior management and may divert management attention from
our business and operations. For more information about current legal
proceedings, see "Item 8B - Legal Proceedings".
IF WE SUFFER LOSS TO OUR FACTORIES OR FACILITIES, OUR OPERATIONS COULD BE
SERIOUSLY HARMED.
Our factories and facilities are subject to catastrophic loss due to
fire, vandalism, terrorism or other natural or man-made disasters. We do not
have redundant multiple site capacity and if any of our facilities or factories
were to experience a catastrophic loss, it could disrupt our operations, delay
production, shipments and revenue and result in large expenses, thereby harming
our results of operation.
FLUCTUATIONS IN THE EXCHANGE RATES BETWEEN THE CANADIAN DOLLAR AND OTHER
CURRENCIES MAY ADVERSELY AFFECT OUR OPERATING RESULTS.
Most of our sales are denominated in currencies other than the Canadian
dollar (principally US dollars and Euros). However, a large portion of our
operating expenses and capital expenditures is denominated in Canadian dollars.
As a result, we are exposed to fluctuations in the exchange rates between the
Canadian dollar on the one hand and the U.S. dollar and the Euro on the other.
Such fluctuations in the value of the Canadian dollar relative to other
currencies could have a material adverse effect on our operating results and
provide strategic advantages to our competitors.
15
UNEXPECTED DECLINES IN OUR RESEARCH AND DEVELOPMENT AND OTHER TAX CREDITS AND
GRANTS MAY HAVE AN ADVERSE EFFECT ON OUR BUSINESS.
Our historical operating results reflect substantial benefits from
programs sponsored by federal, provincial and state governments for the support
of research and development activities, as well as in relation to other
activities. For example, research and development tax credits and grants
represented 21% of our gross research and development expenses for the year
ended August 31, 2003 and 21% for the fifteen months ended November 30, 2003.
If unexpected changes in the laws or government policies terminate or
adversely modify the Canadian and Quebec government programs, under which we
receive the majority of our research and development and other tax credits and
grants, or if we unexpectedly become unable to participate in or take advantage
of these programs, then our net research and development and other expenses will
materially increase or we may decrease our research and development activities.
In addition, to the extent that we increase our research and development
activities outside Canada or Quebec, which could result from, among other
things, future acquisitions, the increased activities may not be eligible for
these programs. If we were required to decrease our research and development
activities, or were unable to benefit from other tax credits and grants, this
could have a material adverse effect on our business, results of operations and
financial condition.
OUR CURRENT PRINCIPAL STOCKHOLDER HAS EFFECTIVE CONTROL OVER OUR BUSINESS.
As of December 15, 2003, Germain Lamonde, our Chairman of the Board,
President and Chief Executive Officer, held approximately 93.8% of the voting
rights in our stock. By virtue of such stock ownership, Mr. Lamonde has
effective control over all matters submitted to our stockholders, including the
election of our directors, and exercises significant control over our policies
and affairs. Such concentration of voting power could have the effect of
delaying, deterring or preventing a change in control or other business
combinations that might otherwise be beneficial to our stockholders.
WE MAY NEED ADDITIONAL CAPITAL, AND MAY NOT BE ABLE TO RAISE ADDITIONAL CAPITAL
ON FAVORABLE TERMS OR AT ALL, WHICH COULD LIMIT OUR ABILITY TO GROW AND COULD
INCREASE OUR COSTS.
Our future liquidity and capital requirements are difficult to predict
because they depend on numerous factors, including the success of our existing
and new product offerings as well as competing technological and market
developments. As a result, we may not be able to generate sufficient cash from
our operations to meet additional working capital requirements, support
additional capital expenditures or take advantage of acquisition opportunities.
Accordingly, we may need to raise additional capital in the future.
Our ability to obtain additional financing will be subject to a number
of factors, including market conditions and our operating performance. These
factors may render the timing, amount, terms and conditions of additional
financing unattractive for us. If we raise additional funds by selling equity
securities, the relative ownership of our existing investors could be diluted or
the new investors could obtain terms more favorable than previous investors. If
we raise additional funds through debt financing, we could incur significant
borrowing costs. If we are unable to raise additional funds when needed or at
terms satisfactory to us, our ability to operate and grow our business could be
impeded.
16
ITEM 4. INFORMATION ON THE COMPANY
A. HISTORY AND DEVELOPMENT OF THE COMPANY
Our legal name and commercial name is EXFO Electro-Optical Engineering
Inc. /EXFO Ingenierie electro-optique Inc. Our head office is located at 400
Godin Avenue, Vanier, Quebec, Canada, G1M 2K2 and our telephone number is (418)
683-0211. Our e-mail address is info@exfo.com and our Web site is www.exfo.com.
Information on our Web site is not incorporated by reference in this annual
report. Our agent for service in the United States is CT Corporation System, 111
Eighth Avenue, New York, New York 10011. This annual report contains trademarks
and registered trademarks of EXFO and other companies.
We were incorporated on September 18, 1985 pursuant to the CANADA
BUSINESS CORPORATIONS ACT. Since that date, we have amended our articles on
various occasions mainly to modify our corporate name and our share capital.
On December 20, 2000, we acquired all of the issued and outstanding
shares of common stock of EXFO Burleigh Products Group Inc. (formerly Burleigh
Instruments, Inc.) ("EXFO Burleigh"), Burleigh Instruments GmBH and Burleigh
Instruments (U.K.) Ltd. for an aggregate purchase price of approximately
US$189.3 million, comprised of 6,488,816 of our subordinate voting shares and
approximately US$42.5 million in cash pursuant to the terms of an Agreement of
Merger and Plan of Reorganization among us, EXFO Sub, Inc. and the selling
shareholders, dated November 4, 2000, as amended on December 20, 2000. In April
2002, the name of Burleigh Instruments, Inc. was changed to EXFO Burleigh
Products Group Inc. On November 12, 2002, Burleigh Instruments (UK) Ltd. was
dissolved.
EXFO Burleigh, which has been in operation for 31 years, has received
industry recognition for its high-performance optical wavelength meters and
precision positioning equipment. Its Wavemeter (R) instruments offer one of the
highest wavelength measurement accuracy in the industry. These products are able
to determine the absolute wavelength of a laser under test within 0.3 picometers
at 1500 nm. Its Inchworm (R) precision positioning equipment provides nanometer
accuracy, which is critical for precision alignment in the optical component
manufacturing process. Both of these product lines are supported by a broad
proprietary intellectual property portfolio.
In March 2001, we acquired all of the shares of EXFO Photonic Solutions
Inc. (formerly EFOS Inc.) ("EXFO Photonic"), a privately held company in
Toronto, Canada, for a total consideration of US$110.1 million, of which US$25.1
million was paid in cash. We also issued 3,700,000 of our subordinate voting
shares. In September 2001, the name EFOS Inc. was changed to EXFO Photonic
Solutions Inc.
EXFO Photonic, operating since 1984, is a supplier of precision
light-based adhesive spot curing products as well as curing process control for
the global optical component manufacturing market and other non-telecom markets.
Its products deliver precise doses of the appropriate spectral light into
photo-sensitive and heat-cured adhesives to significantly reduce bonding time
and increase repeatability in optical component and other manufacturing
activities. EXFO Photonic light-based curing technologies are supported by an
extensive understanding of bonding and material sciences and by a broad
intellectual property portfolio, including 11 patents and 15 patents pending.
17
Also in March 2001, our wholly owned subsidiary, Burleigh Automation
Inc. ("Burleigh Automation"), acquired substantially all the assets of Vanguard
Technical Solutions, Inc., a wholly owned subsidiary of DT Industries, Inc. for
a purchase price of approximately US$600,000 paid in cash. Vanguard, an
automation equipment manufacturer in Tucson, Arizona, specialized in the design
and manufacturing of ultra-precision assembly equipment for sensitive process
and critical assembly challenges on the production floor. This acquisition,
which complemented our acquisition of Burleigh, was planned to fit with our
overall strategy at that time of providing customers with a comprehensive
solution for the assembly, alignment and testing of optical components and
subsystems. Since September 2001, Burleigh Automation has ceased operations and
we have transferred all material intellectual property assets and most of the
physical assets of Burleigh Automation to EXFO Burleigh.
In November 2001, we acquired all of the shares of Avantas Networks
Corporation and simultaneously changed the name of that company to EXFO Protocol
Inc. ("EXFO Protocol"). We paid a total consideration of approximately US$69.4
million (or US$95.0 million for the equity minus US$25.6 million of cash in the
hands of the acquired company) to acquire EXFO Protocol. Consideration paid
consisted of 4,374,573 of our subordinate voting shares and US$9.8 million in
cash, net of cash acquired. EXFO Protocol, a company based in Montreal, Canada
operating since 1998 is a supplier of fiber-optic testing and optical network
performance management equipment that supports a wide range of protocols and
data transmission rates.
In the fiscal year commencing September 1, 2001, we were forced to
re-align our cost structure to market conditions. First, on December 5, 2001, we
announced the lowering of our operating expenses, a freeze in employee salaries,
and the reduction of our workforce by 10%. Then, on May 15, 2002, we announced a
further 20% reduction of our global workforce in an effort to lower our cost
structure. In May 2002, we performed an assessment of the carrying value of
goodwill and intangible assets recorded in conjunction with the three
acquisitions made during the previous two years. Considering the ongoing
unfavourable market conditions, we recorded a charge of US$222.2 million to
write down a significant portion of goodwill and a charge of US$23.7 million to
write down a significant portion of acquired core technology. Also, overall for
fiscal 2002, we wrote off US$18.5 million in excess and obsolete inventories.
In August 2002, EXFO Burleigh received confirmation of the extension of
its contract with the U.S. Air Force Research Laboratory into phase 2 of a
project for the development by EXFO Burleigh of new high-precision actuator
system. The contract for phase 2 provides for an additional funding of US$1.7
million and will extend through the first quarter of 2005.
In October 2002, our newly created, wholly owned subsidiary, EXFO Gnubi
Products Group Inc. ("EXFO Gnubi"), acquired substantially all the assets of
gnubi communications L.P., including its technology, expertise, customer base,
inventories and capital assets. Consideration paid consisted of US$1.9 million
in cash and 1,479,290 of our subordinate voting shares. In addition, a further
cash amount of approximately US$241,000, based on sales volumes, will be paid
out during the first part of 2004 in accordance with earn out provisions. With
the acquisition of these assets, EXFO Gnubi, based in Dallas, Texas, continues
the operations of gnubi communications, L.P., as a supplier of multi-channel
telecom and datacom testing solutions serving optical transport equipment
manufacturers and research and development laboratories. At the time of the
asset acquisition, 30 employees of gnubi communications transferred to EXFO
Gnubi.
In the fiscal year ended August 31, 2003, we were required to implement
further restructuring measures as a result of depressed spending levels in the
telecommunications
18
industry and geo-political and economic uncertainty. We reduced our workforce by
30%, rationalized our business activities and consolidated certain manufacturing
operations. These measures incurred charges of approximately US$4.1 million. The
rationalization and consolidation initiatives involved the reorganization of our
business into two new reportable market segments: Telecom Division and Photonics
and Life Sciences Division and the exiting of the optical component
manufacturing automation business. Our Telecom Division consists of the former
Portable and Monitoring and telecom related Industrial and Scientific product
lines. Our Photonics and Life Sciences Division includes previous non-telecom
Industrial and Scientific product lines. Each division has been structured with
its own sales, marketing, manufacturing, research and development and management
teams.
In May 2003, we performed an annual impairment test on goodwill in
conjunction with the acquisition of EXFO Burleigh, EXFO Photonic and EXFO
Protocol and also reviewed the carrying value of intangible assets related to
these acquisitions. 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 was impaired and we
recorded a charge of US$4,505,000 to write down goodwill and a pre-tax charge of
US$2,922,000 to write down acquired core technology. Of the total impairment
loss of US$7,427,000, US$6,872,000 is related to EXFO Burleigh for goodwill and
acquired core technology and US$555,000 is related to EXFO Photonic for acquired
core technology.
In addition, in an effort to simplify our structure and stream-line our
operations, the operations of EXFO Protocol were merged with those of the
Corporation as of September 1, 2003 and effective December 1, 2003, the
operations of EXFO Gnubi were merged with those of EXFO America Inc.
B. BUSINESS OVERVIEW
COMPANY OVERVIEW
EXFO is a recognized expert in the global telecommunications industry
through the design and manufacture of advanced and innovative test and
measurement solutions. The Telecom Division, which represents our main business
activity, offers fully integrated and complete test solutions to network service
providers, system vendors and component manufacturers in approximately 70
countries. One of our strongest competitive advantages is our modular platform
design, providing PC-based, Windows-centric test solutions that maximize
technology reuse across several market segments. The Photonics and Life Sciences
Division mainly leverages core telecom technologies to offer value-added
solutions in high-tech industrial manufacturing and research sectors.
EXFO was founded in Quebec City, Canada, in 1985. Our original products
were focused on the needs of installers and operators of fiber-optic networks.
Customers use these field-testing products for the installation, maintenance,
monitoring and troubleshooting of optical networks. In 1996, we supplemented our
product portfolio with an extensive line of high-end products that are mainly
dedicated to research and development as well as manufacturing activities. These
products, namely modular and benchtop units, tend to be more complex and
higher-priced than field-testing ones. In 1999, we entered the remote fiber test
system (RFTS) market. This type of system allows network service providers to
monitor the integrity of their fiber-optic systems in real time, twenty-four
hours a day, seven days a week.
In the last two years, we have strengthened our competitive position
through the acquisition of two protocol-layer test businesses. In November 2001,
we expanded into protocol-
19
layer testing with the acquisition of Avantas Networks Corporation (renamed EXFO
Protocol Inc.), a supplier of fiber-optic testing and
optical-network-performance management equipment for network service providers.
This transaction was highly strategic because it enabled us to combine
protocol-, optical- and physical-layer testing inside a single platform--the
FTB-400 Universal Test System-- to help our customers increase revenues and
reduce operational costs.
In October 2002, our newly created wholly-owned subsidiary, EXFO Gnubi,
purchased substantially all the assets of gnubi communications, L.P., a supplier
of multi-channel telecom and datacom testing solutions for the system
manufacturer market. EXFO Gnubi's protocol-layer test equipment targets the
fully complementary system manufacturer market, while EXFO Protocol's offering
focuses on the network service provider market. Jointly, these strategic
acquisitions enabled us to double our addressable market as we expanded from
physical- and optical-layer testing to also cover protocol-layer testing
applications in the telecom and datacom market, while offering a more complete
fiber-optic test solution to customers.
Previously, we completed two acquisitions to bolster growth in the
optical component manufacturing market. We acquired Burleigh Instruments, Inc.
(renamed EXFO Burleigh Products Group Inc.) in December 2000 for its wavelength
measurement instruments and nanopositioning alignment systems. We also added
EFOS Inc. (renamed EXFO Photonic Solutions Inc.) in March 2001 for its precision
light-based, adhesive spot-curing technology. We have since exited the optical
component manufacturing automation business, a market addressed by an EXFO
Burleigh product line.
One of our strongest competitive advantages is our modular platform
design, which we first launched in 1996. Following the introduction in 2002 of
all-in-one test sets that cover physical-, optical- and protocol-layer test
requirements, we believe that we remain the industry leader in this area. In
2003, we raised our field-testing platform to a new level by enabling field
technicians to seamlessly automate their test applications.
As described below in "Industry Overview," we have faced difficult
market conditions in the telecommunications industry during the last few years.
We experienced a decrease in sales and incurred significant operating losses. To
cope with these realities, we implemented several restructuring actions since
the last quarter of fiscal 2001. These actions resulted in workforce reductions
of 245, 350 and 172 employees in fiscal 2001, 2002 and 2003, respectively. We
also adopted rigorous cost-control measures and rationalized our business model.
In addition, we incurred significant asset impairment charges related to these
market conditions, namely for inventories, goodwill, intangible assets and
future income tax assets.
To better serve the needs of end-customers in different markets and
simplify our business model, we reorganized our business under two new divisions
at the beginning of fiscal 2004. Our Telecom Division consists of former
Portable and Monitoring and telecom-related Industrial and Scientific product
lines. This division is focused on network service providers, telecommunication
system manufacturers and optical component vendors on a global basis. Our
Photonics and Life Sciences Division, which mainly leverages our core
technologies, includes former Industrial and Scientific non-telecom product
lines. This division has been created to maximize value from developed and
acquired telecom technologies.
Following this reorganization, our two new divisions now have
respective sales, marketing, R&D, manufacturing and management teams and will,
therefore, be presented under two corresponding operating segments. Under CICA
handbook section 1701, we will provide the
20
required segmented disclosures in our interim consolidated financial statements
beginning in the first quarter of fiscal 2004. However, we will not provide
comparative information for previous periods about each reportable segment,
except for sales and total assets, because this information is not available and
impracticable to determine.
INDUSTRY OVERVIEW
Telecommunications companies, still dealing with reduced spending
levels, were affected by a number of external forces during fiscal 2003,
including geo-political and economic uncertainty, the outbreak of SARS in Asia,
as well as the declining strength of the US dollar. To cope with these market
realities, network service providers, the first link in the telecommunications
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, network service providers turned their attention to
operating expenditures (OPEX) for further savings.
Lower spending levels necessarily produced a trickle-down effect
throughout the telecommunications industry, namely for system vendors, component
manufacturers as well as for test and measurement 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, the relative stability
of technology and the excess manufacturing capacity in this sector. The ongoing
consolidation within the component manufacturing market provides an inkling of
its weaker health.
Test and measurement equipment vendors also felt the impact of reduced
network service provider spending with less demand for orders. In addition, some
competitors increasingly applied pricing pressure to obtain contracts, which
eroded margins across the board. The gray market for test and measurement
instruments, especially involving optical component manufacturing applications,
further compounded the soft market. On the other hand, test and measurement
vendors--whose products enable customers to lower CAPEX and OPEX, as well as
deploy next-generation architecture--still attracted the attention of network
service providers and system manufacturers for certain projects.
OUR STRATEGY
We are more than ever committed to becoming a dominant player in the
global telecommunications test and measurement industry, while leveraging our
technology base in targeted photonics and life science markets. To summarize our
fiscal 2004 strategy, we plan to increase sales through market-share gains,
maximize profitability and growth on a long-term basis, innovate our way out of
this downturn, and maintain a sound financial position.
INCREASE SALES THROUGH MARKET-SHARE GAINS
In fiscal 2004, we will focus on continued market-share gains to
achieve growth, considering a scenario based on a stable or slightly declining
telecommunications market. In 2003, we believe that we gained market share among
network service providers by strengthening the leadership position of our
FTB-400 field-testing platform and by extending its reach to telecom and datacom
protocol-layer test applications.
We also leveraged our protocol-layer acquisitions (formerly Avantas
Networks and gnubi communications) to enhance our strategic position and sales
results in this mission-critical
21
sector for our targeted end-markets. Evidence of this newfound traction is
reflected in our protocol-layer test sales, which accounted for more than 10% of
total revenues in each of the last three quarters of 2003. With continued
quality of execution, protocol-layer activities are expected to play a larger
role and contribute to our growth in 2004.
Looking ahead, we intend to further expand our presence with network
service providers, who are increasingly focusing on reducing operating
expenditures (OPEX) as capital expenditures (CAPEX) draw nearer to
maintenance-level run rates. The unique value proposition inherent to our
flexible, PC-based FTB-400 modular test platform and related suite of test
technologies reduces both CAPEX and OPEX, aptly matching the priorities of
network service providers and installation teams of system vendors.
Speaking of system vendors, we also started to target their R&D and
manufacturing teams in fiscal 2003--as evidenced by the acquisition of GNUBI
COMMUNICATIONS. Following significant balance sheet restructuring, system
vendors are gradually recovering, showing positive cash flow and even profits.
We believe they will continue to recover in 2004 and will represent a major
end-market for EXFO in the long term.
In addition, we intend to leverage synergies across our entire protocol
R&D activities to accelerate the development of innovative, advanced and
differentiated test solutions that maximize the reuse of technologies over
multiple market segments. The design, manufacturing and deployment of
next-generation SONET/SDH networks, combined with the convergence of multiple
applications on simplified architectures and our strong market position on the
physical-layer side, represent a significant market opportunity for our Telecom
Division as we continue to expand our addressable markets.
As indicated by the realignment of our operations, we also intend to
maximize revenue streams by leveraging our core telecom expertise into select
adjacent markets. For example, we recently launched the X-Cite 120 Fluorescence
Illumination System that was based on our adhesive curing technology for optical
component manufacturing. Through joint development and reseller agreements with
market-leading microscope manufacturers, we plan to take advantage of their
large sales organizations and established base of microscopes to grow revenues
in our Photonics and Life Sciences Division.
MAXIMIZE PROFITABILITY AND GROWTH ON A LONG-TERM BASIS
Returning to profitability is also a key priority for EXFO. We intend
to design differentiated, higher-margin products in our R&D labs, streamline our
manufacturing operations and review our supply chain in order to reduce our cost
of goods. As well, we will keep fine-tuning our sales process to offset ongoing
pricing pressure by some competitors. These initiatives should help us improve
our gross margin, which fell to 47.4% (excluding inventory write-offs and a
non-recurring gain) in fiscal 2003, to at least 50% in fiscal 2004 and
accelerate our return to profitability. A balance between profitability and
growth, however, is critical to ensure the long-term success of the company. We
believe that our operating expenses have reached a level in which we cannot make
additional significant reductions without compromising our medium- and long-term
growth prospects. We reduced our selling and general administrative expenses by
20% to $27.0 million in fiscal 2003, from $33.9 million in 2002 and by 25% in
2002, from $45.0 million in 2001. On the other hand, we maintained our gross R&D
expenses at $17.1 million in 2003 compared to $17.0 million in 2002 and $17.6
million in 2001. We plan to keep a tight control on operating costs with leaner
and more flexible operations.
22
However, the ongoing strength of the Canadian dollar (compared to the US dollar)
may have a negative impact on our operating costs in 2004 and may offset some of
our restructuring efforts.
INNOVATE OUR WAY OUT OF THE DOWNTURN
Ever since we founded EXFO in 1985, innovation strategies were focused
on being first to market with unique solutions that anticipate and better
address customer requirements. Our market-driven approach can be demonstrated
through a long history of industry firsts--first modular optical test platform,
first all-in-one field-testing platform, first portable polarization mode
dispersion (PMD) analyzer, etc. This focus on delivering a unique value
proposition to the marketplace is of strategic importance to improve our gross
margin in the upcoming year. Our strong product pipeline delivered 15 new
products to the marketplace in 2003, most of which include telecom-related
solutions such as a next-generation PMD analyzer that can characterize PMD
levels in high-speed optical networks, a Fibre Channel test module for
installation and commissioning of storage area networks, and a 2.5+ Gigabit
multi-rate transceiver for protocol-layer test applications. Sales of new
products (on the market two years or less) accounted for 49% of total sales in
2003. These numbers reflect our commitment to the future and indicate that our
innovation strategy is working at EXFO. We intend to keep innovating our way out
of this downturn in 2004. As network service providers and system manufacturers
turn their attention to metro, access and fiber-to-the-home networks and as
systems converge toward data-centric, Internet Protocol-based technologies, we
are developing the sophisticated test solutions required to match heightened
network complexity.
MAINTAIN A SOUND FINANCIAL POSITION
For more than 18 years, we have maintained a solid balance sheet and,
at the end of fiscal 2003, we had a cash position of $57.4 million and
practically no debt. This fiscal responsibility provides our customers with the
assurance that they can count on EXFO as a solid, long-term partner.
Our cash position will allow us to continue investing significantly in
R&D in order to develop new solutions and tap into new markets, while some of
our competitors face more significant financial pressure.
KEY PERFORMANCE INDICATORS
As measures to assess the realization of our strategic plan and its
objectives, we have set out four consolidated key performance indicators, which
are summarized as follows:
Strategic objectives Key performance indicators
--------------------------------------------------------------------------------
Increase sales through market-share 10% sales growth year-over-year,
gains assuming a stable or slightly
declining telecommunications market
Maximize profitability and growth on 50% gross margin in fiscal 2004
a long-term basis
Innovate our way out of the downturn 45% of our sales from new products
(on the market two years or less)
during fiscal 2004
Maintain a sound financial position Positive cash flows from operating
activities during fiscal 2004*
--------------------------------------------------------------------------------
* Assuming no major acquisitions of businesses and/or technologies and
stability in the value of the Canadian dollar compared to the US dollar.
23
THE EXFO SOLUTION
We offer an extensive range of test and measurement products to the
global telecommunications industry. Our success has been largely predicated on
our core expertise in optical telecommunications. We also leverage this
expertise to develop products for high-tech industrial manufacturing and
research applications. Our solution is based on the following key attributes:
MODULAR SYSTEM DESIGN. In 1996, we established an industry first by
launching the original modular optical test platform. This system design
consists of a PC-based, Windows-driven platform that can accommodate several
test modules performing various types of measurement. We have since developed
new test platforms and extended our test module offering for both NSPs and
system manufacturers based on the same modular design. Our modular design
provides the following advantages:
o Unlike stand-alone units, new test modules can be rapidly
developed to address changing industry requirements.
o As customers' testing requirements change, they can purchase
additional modules that are compatible with their previously
purchased platforms, thus protecting their initial
investments.
o Our standard graphical user interface reduces training costs
because customers are familiar with previously acquired
software products.
o The flexibility of our systems allows customers to develop
customized and automated solutions for their specific test
requirements.
o Our test platforms are PC-based and Windows-driven, thus they
can support third-party software solutions.
HIGH DEGREE OF TECHNOLOGICAL INNOVATION. We have established a strong
reputation for technological innovation over the last 18 years. In fact, this
attribute represents a key differentiator for EXFO within a competitive
marketplace. Following are some of our industry firsts in recent years:
o INTEGRATED APPLICATION SUITE. In fiscal 2003, we introduced
fully integrated software suites that automate the operation
of test modules within our FTB-400 field-testing platform.
This latest innovation allows complex testing routines to be
carried out with a single touch of a button.
o NEXT-GENERATION POLARIZATION MODE DISPERSION (PMD) ANALYZER.
In 2003, we released the patent-pending PMD Analyzer, the only
portable instrument on the market that can sweep through
erbium-doped fiber amplifiers (EDFAs) to characterize PMD
levels in a high-speed optical network. Optical links must be
measured for PMD, especially when upgrading to transmission
rates of 10 Gb/s or when deploying a cascade of amplifiers. We
had introduced the industry's first portable PMD analyzer in
1996 and added a Chromatic Dispersion test module in 2002 to
offer the most comprehensive dispersion test solution on the
market.
o ALL-IN-ONE TEST SOLUTION. In 2002, we launched the first
all-in-one solution for protocol-, optical- and physical-layer
testing to enable customers to increase efficiency and reduce
costs in the field. The added value of this concept means that
field technicians no longer need to carry separate instruments
like bit-error-rate
24
testers ("BERTs"), optical spectrum analyzers ("OSAs") and
optical time-domain reflectometers ("OTDRs") to fulfill their
testing requirements. All they need is the next-generation
FTB-400 field-testing platform and related modules to handle
all their testing, storage and retrieval needs.
o OPTICAL WAVEGUIDE ANALYZER. In 2001, we released our Optical
Waveguide Analyzer, which represents the industry's first
commercial refractive index profiler for planar and arrayed
waveguides. The refractive index profile of next-generation
optical devices like arrayed waveguides is a critical
parameter to measure in order to control and optimize the
manufacturing process.
HIGH-QUALITY PRODUCTS. Product quality is an integral part of our
solution. Our Quebec City-based operations have maintained ISO 9001
certification since 1994 and they are now certified to the new 2000 edition of
the standard, as are our Toronto operations. Our subsidiaries in Victor, New
York, and Montreal, Quebec, are presently working toward ISO9001/2000
registration. All of our products meet required industry standards, and some of
our products meet additional voluntary standards, such as those set by
Telcordia, formerly Bellcore, IEC, and other industry-leading standards bodies.
During manufacturing, each product has a related quality assurance plan, with
rigorous checkpoints, to ensure product conformity. Various tasks in the quality
assurance process in all our facilities include quality control, conformity
testing, product documentation, product improvement, regulatory compliance,
metrology and calibration.
PRODUCTS
Our test platforms, namely the FTB-400 UTS, IQS-500 Intelligent Test
System (ITS) and EPX Multi-Channel Test Systems, are at the core of our product
portfolio. The FTB-400 field-testing platform provides NSPs with a simple, yet
efficient way to perform multiple, advanced test operations for installation,
maintenance and troubleshooting applications. Our IQS-500 ITS and EPX
Multi-Channel Test Systems, which are designed for manufacturing and R&D
applications, test converging telecom and datacom networks increasingly based on
Internet Protocol (IP) technology. All platforms and related test modules are
supported by integrated and highly intuitive graphical user interfaces (GUIs),
enabling the user to easily store, handle and retrieve a large amount of data.
The following table summarizes the principal types of test instruments
for the telecommunications industry, typical applications and the format in
which we offer them:
FORMAT
--------------------------------------------------------------
INSTRUMENT TYPE TYPICAL APPLICATION NSP MARKET MANUFACTURER/R&D MARKET
---------------- -------------------------------- ---------------------- -------------------------------------
FTB 400 IQS-500 BENCHTOP
UTS MODULES HANDHELDS ITS MODULES EPX MODULES INSTRUMENTS
----------- --------- ----------- ----------- -----------
Broadband source Used for testing wavelength
dependent behavior of fiber
cables and DWDM optical
components. X X
Channel selectors Selects and isolates any
International Telecommunication
Union (ITU) DWDM channel in the
C-Band for bit-error-rate X X
testing and protocol-layer
analysis.
Chromatic Measures increasing levels of
dispersion chromatic dispersion in high-
analyzer capacity optical networks. X
Chromatic dispersion is a physical
25
FORMAT
--------------------------------------------------------------
INSTRUMENT TYPE TYPICAL APPLICATION NSP MARKET MANUFACTURER/R&D MARKET
---------------- -------------------------------- ---------------------- -------------------------------------
FTB 400 IQS-500 BENCHTOP
UTS MODULES HANDHELDS ITS MODULES EPX MODULES INSTRUMENTS
----------- --------- ----------- ----------- -----------
phenomenon inherent to optical
fiber and optical components
that causes information bits to
spread along a network. This
degrades the quality of the
transmission signal and, in turn,
limits the transmission speed
carried by optical networks.
Clip-on coupling Clips to an optical fiber and X
device allows non-invasive testing.
Digital frequency Used to automatically or
locker manually lock the frequency of
a laser source to a reference X
optical filter.
Femtosecond Measures very small levels of
polarization mode polarization mode dispersion in
dispersion analyzer DWDM and broadband components X
in the simplest, fastest and
most repeatable manner.
Gigabit Ethernet Measures data integrity for
tester high-speed internet protocol
telecommunications in metro and
edge networks. X X
Live fiber detector Clips on to a fiber and is used
to detect the presence and
direction of a signal without
interrupting the traffic. X
Loss test sets Integrates a power meter and a
light source to manually or
automatically measure the loss X X X X
of optical signal along a fiber.
Multi-wavelength Measures the power and drift
meters for multiple wavelengths in a X X X
DWDM system.
Narrowly tunable A laser that can be precisely
lasers tuned to simulate a DWDM light
sources. Used primarily in X
testing optical amplifiers.
Optical amplifier Boosts the power of laser
sources. Used for the testing X
and calibration of test systems.
Optical couplers Used in test system to combine
sources or signals. Also used X
as splitters to monitor signals.
Optical fiber Measures the geometric and
parameter analyzer light guiding properties of an
optical fiber. Used in new
fiber research and development X
and quality control
applications.
Optical power Measures the power of an
meters optical signal. It is the
basic tool for the verification
of transmitters, amplifiers and X X X X
optical transmission path
integrity.
Optical power Provides a highly accurate and
reference module traceable measurement of power
for the calibration or X
verification of other power
measurement instruments.
Optical return Combines a laser and a power
26
FORMAT
--------------------------------------------------------------
INSTRUMENT TYPE TYPICAL APPLICATION NSP MARKET MANUFACTURER/R&D MARKET
---------------- -------------------------------- ---------------------- -------------------------------------
FTB 400 IQS-500 BENCHTOP
UTS MODULES HANDHELDS ITS MODULES EPX MODULES INSTRUMENTS
----------- --------- ----------- ----------- -----------
loss meters meter to measure the amount of
potentially degrading back X X X X
reflection.
Optical spectrum Produces a graphical
analyzers representation of power versus
wavelength for an optical
signal. Useful for measuring X X
the drift, power and signal-to-
noise ratio for each wavelength
in a DWDM system.
Optical switches Provides switching between
fibers. Used to provide
flexible and automated test
setups such as the measurement
of multiple fibers or X X
components with multiple ports
with one instrument.
Optical time Like a radar, it measures the
domain time of arrival of reflections
reflectometers of an optical signal to
(OTDRs) determine the distance to the
breaks or points of excessive X
loss in a fiber network.
Optical waveguide Provides the refractive index
analyzer profile of glass and fused
silica-based devices used in X
next generation networks.
Passive component Characterizes passive
analyzer wavelength-selective devices,
such as multiplexers,
demultiplexers and add/drop
filters, with respect to X
absolute wavelength in order to
guarantee their performance
within DWDM systems.
Polarization Measures the difference in loss
dependent loss of power for the different X
meters states of polarization.
Polarization mode Measures the dispersion of
dispersion light that is caused by
analyzers polarization. Generally used to X X
determine the speed-distance
limitation of fiber and cables.
SONET/ SDH Provide accurate bit-error rate
Analyzers and performance analysis of
SONET/SDH overhead format that
reflect the quality of a X X
transmission system.
Stable light Emitting diode or lasers used
sources in connection with a power X X X X
meter to measure signal loss.
Talk sets A device that attaches to an
optical fiber and serves as a
temporary voice link X X
facilitating coordination of
work among installation crews.
Variable optical Used in network simulation
attenuators setups to provide calibrated
variable reduction of the X X X
strength of an optical signal.
Visual fault A visible laser that can be
locators connected to an optical fiber
network to help locate breaks X X
or points of excessive loss.
27
FORMAT
--------------------------------------------------------------
INSTRUMENT TYPE TYPICAL APPLICATION NSP MARKET MANUFACTURER/R&D MARKET
---------------- -------------------------------- ---------------------- -------------------------------------
FTB 400 IQS-500 BENCHTOP
UTS MODULES HANDHELDS ITS MODULES EPX MODULES INSTRUMENTS
----------- --------- ----------- ----------- -----------
Widely tunable Can produce laser light across
lasers a broad range of wavelengths.
Used to test DWDM components X X
and value-added optical modules.
PRODUCTS FOR NETWORK SERVICE PROVIDERS (PORTABLE AND MONITORING PRODUCT LINES)
We offer an extensive range of fiber-optic test, measurement and
monitoring products for field applications that are mainly used by NSPs, but
also can be utilized by system vendors. These products are available as handheld
test instruments, portable platforms with related modules, and as rack-mount
chassis with related modules. Our handheld instruments are durable, compact and
easy to use. Our second-generation field-testing platform, the FTB-400 UTS, is
available in a two-slot configuration for basic OTDR and optical loss testing,
or a seven-slot configuration for high-end DWDM testing, Gigabit Ethernet
bit-error-rate testing, protocol-layer analysis, Fiber Channel testing, PMD and
CD characterization, spectral analysis testing as well as OTDR and optical loss
testing. A SONET/SDH add-on can be integrated to handle data rates from 64 Kb/s
to 10 Gb/s. In addition, we offer the FTB-100 Mini-OTDR with an integrated power
meter option. This cost-effective platform provides field technicians with basic
OTDR testing capabilities. Our portable platforms are PC-centric, Windows-based,
highly flexible and fully scalable. Their large environmentally robust
touchscreens are very practical for field use.
In 2003, we introduced fully integrated software suites that automate
the operation of test modules within our FTB-400 field-testing platform. This
latest innovation allows complex testing routines to be carried out with a
simple touch of a button. Our FTB-400 platform, supported by more than a dozen
of next-generation test technologies, addresses complete service provisioning
needs for DWDM, SONET/SDH, Gigabit Ethernet and, most recently, storage area
network (SAN) applications. We released a Fibre Channel test module in 2003 that
provides NSPs with a high-performance characterization tool to reflect the
quality of their SAN networks.
We also offer stand-alone, autonomous solutions for physical-, optical-
and protocol-layer monitoring. Our physical-layer monitoring solution, Fiber
Guardian, carries out constant real-time monitoring on up to 32 fibers within an
optical network. This monitoring solution displays a message on its embedded
screen and sends out an alarm if a measurement falls outside a user-defined
threshold. Through state-of-the-art instrumentation, Fiber Guardian can specify
the location of a fault to reduce downtime to a minimum, or it can identify
minor degradations to prevent loss of service.
Our optical-layer monitoring product, Optical Guardian, continuously
monitors critical parameters of optical channels within DWDM or coarse
wavelength division multiplexing (CWDM) networks. Likewise, an alarm is
automatically generated when a measurement falls outside user-defined
thresholds.
Finally, our protocol-layer monitoring solution, Network Guardian, is
an optical network performance management system that supports a wide range of
protocols like SONET, T-Carrier, SDH, PDH, 10/100 Ethernet and Gigabit Ethernet.
It remotely carries out tests on points of presence, handoff points, co-location
sites and customer premise equipment sites.
28
PRODUCTS FOR SYSTEM/COMPONENT MANUFACTURERS (INDUSTRIAL AND SCIENTIFIC PRODUCT
LINES)
Our system/component vendor solutions, mainly built around our IQS-500
ITS and EPX platforms, are available as test modules or stand-alone benchtop
instruments. The next-generation IQS-500 platform can efficiently run as many as
100 physical-layer test modules using a single controller unit. The IQS-500
platform is equipped with the latest in software and hardware technology to
support single-button operation for automated testing. Its system-based
approach--one box, several test modules--combined with an open architecture
(PXI, Windows, LabVIEW(TM), etc.) and ease of programming, produces a highly
flexible test environment.
The IQS-500 also provides backward compatibility with recent
IQ-generation test modules, while delivering all the power and advantages of a
next-generation platform. EXFO's wide selection of high-performance test modules
includes high-speed power meters, light sources, WDM laser sources, tunable
laser sources, variable attenuators, optical spectrum analyzers, polarization
mode dispersion (PMD) analyzers, multi-wavelength meters, channel selectors,
polarization dependent loss (PDL) and optical return loss (ORL) meters,
polarization controllers and optical switches.
The highly flexible EPX platforms are available in two formats. With up
to 17 protocol-layer test modules per unit, the EPX16 performs numerous tasks
within one hardware platform. The EPX8 uses the same upgradeable, multi-channel
design in a smaller footprint. Combining multiple rates, protocols and channels
within a single unit, these systems are ideal for cross-connect, ADM, DWDM,
production and load testing. Direct Ethernet access capability and a Java-based
GUI make the EPX platforms powerful test solutions that are easy to use. Other
user-friendly features include saving and restoring test configurations,
connecting remotely with a Web browser, scripting, logging and sharing test
resources with other users.
In 2003, we leveraged our IQS-500 platform to design a new Cable
Assembly Test System for multimode patchcord assemblies and added three test
modules to our high-performance power meter series. We also introduced the 2.5+
Gigabit Multi-Rate Transceiver for our EPX platforms to help system
manufacturers reduce test time and increase test thoroughness on the production
floor. This protocol-layer test module simulates and monitors live traffic on
each individual channel, enabling customers to carry out critical tests like
bit-error-rate (BER), hybrid concatenation and service-disruption switch time.
Subsequent to the year-end, we released the 10+ Gigabit Muli-Rate Transceiver
with deep channelization and mixed payload concatenations for next-generations
networks. We also launched a tunable external cavity laser (ECL), whose broad
wavelength range is optimized for coarse wavelength division multiplexing (CWDM)
and fiber-to-the-premises (FTTP) testing.
Our system/component vendor products also address testing issues that
cannot be handled by standard test modules or stand-alone benchtop instruments.
We have developed a number of integrated test systems and offer them as
off-the-shelf solutions to suit a wide range of customer needs. In addition, we
have created a software development kit for developers who prefer writing their
own programs for our instruments. Following is list of integrated test systems
that EXFO provides for characterizing optical components, sub-systems and
networks:
o Multifiber test system Used for quality-assurance testing
of multifiber patchcords and
interconnect assemblies. These
devices, including hybrid and
fan-out patchcords, are commonly
used in fiber systems.
29
o Cable assembly test system Used to perform insertion loss and
mandrel-free reflection
measurements with the highest
degree of accuracy and
repeatability on short fiber
assemblies.
o Optical calibration test system Used to calibrate power meters,
light sources, variable
attenuators and optical time
domain reflectometers.
o Environmental test system Allows users to perform long-term
qualification testing of optical
components and sub-systems under
varying environmental conditions
primarily to ensure compliance
with industry standards.
o DWDM passive component Used to automatically characterize
test system all critical specifications,
including spectral insertion loss,
polarization-dependent loss, and
optical return loss, of a DWDM
passive component with a high
degree of accuracy, ease of use,
and speed.
o Multi-wavelength comb Used to adjust the power of a bank
controller of DFB-ITU lasers in order to test
loading conditions of optical
amplifiers.
PRODUCTS FOR PHOTONICS AND LIFE SCIENCE APPLICATIONS (INDUSTRIAL AND SCIENTIFIC
PRODUCT LINES)
Over the years, EXFO has developed and acquired a number of core
technologies that we are leveraging in selected photonics and life science
applications for high-tech industrial manufacturing and research markets. For
example, we offer several light-based curing solutions for optical component
manufacturing and have optimized our approach for other industries, such as
semiconductor, electronic, and medical device manufacturing, to maximize
revenues. Our Novacure(R), Acticure(R), Omnicure(R) and Lite(R) spot-curing
systems deliver precise doses of the appropriate spectral light onto
photosensitive adhesives to significantly reduce bonding time and increase
repeatability. These light-based curing systems, supported by patented optical
feedback and radiometry technology, produce a high-quality bonding solution that
is unmatched in the industry. Our technology and application knowledge place us
at the forefront of this market.
In 2003, we took advantage of our light-based curing technology to
develop a unique fluorescence microscopy light source. This product was
developed in cooperation with leading microscope manufacturers. The X-Cite 120
Fluorescence Illumination System is quickly becoming an indispensable microscope
accessory, offering greater image quality, convenience and lamp life than
conventional solutions in the fluorescence microscopy market. Market response
proved to be very positive following the signing of reseller agreements with
industry leaders such as Zeiss MicroImaging, Nikon Instruments, Olympus America
and Leica, who are offering the X-Cite 120 System through their own sales
channels to new and existing microscope owners.
To meet the growing demand for precision positioning instrumentation in
life science research, we have drawn on our telecom expertise in nanometer-scale
positioning to offer a unique array of piezoelectric-based positioning systems.
The stability of piezoelectric (PZT) technology provides extremely smooth and
predictable instrument motion used for applications
30
as varied as micromanipulation and patch-clamp experimentation, ultra-fast
solution switching, nuclear transfer and intracytoplasmic sperm injection.
Our Wavemeter(R) test solutions are recognized around the world for
characterizing optical networks with the highest degree of accuracy. We take
full advantage of our leading-edge technology by extending it to non-telecom
applications that require the use of a laser. Scientists and engineers, after
all, need to know the absolute wavelength of a laser for their particular line
of work such as high-resolution laser spectroscopy, photochemistry and optical
remote sensing.
As demonstrated in the above examples, we're constantly finding new
ways to leverage our technology base and maximize revenues. The following table
summarizes the principal types of photonics and life science solutions we
provide, their typical applications and the format in which we offer them:
-----------------------------------------------------------------------------------------------------------------------
LIGHT SOURCES AND ACCESSORIES
-----------------------------------------------------------------------------------------------------------------------
PRODUCT TYPE PRODUCT TYPICAL APPLICATION
-----------------------------------------------------------------------------------------------------------------------
UV Light Sources Novacure(R) Used to initiate photo chemistry reactions in
Acticure(R) polymer-based materials for a variety of end use
Lite(R) applications such as adhesive curing for manufacturing of
Omnicure(R)S1000 high value-added items such as medical devices,
micro-electronic and opto-electronic components, displays,
and data storage devices.
-----------------------------------------------------------------------------------------------------------------------
Infrared Light sources Novacure(R)IR Infrared Spot-Curing System that extends the flexibility
and speed of UV spot curing processes to thermally cured
materials
-----------------------------------------------------------------------------------------------------------------------
Fluorescent Light Sources X-Cite(R)120 Fluorescence light source that attaches directly to the
all the microscopes currently sold by Nikon, Zeiss,
Olympus and Leica.
-----------------------------------------------------------------------------------------------------------------------
Computer Control Module ACS-1000 Electronic interface module used to connect EXFO UV and
IR light sources to computers or computer
networks for process automation.
-----------------------------------------------------------------------------------------------------------------------
Optics Optical accessories Optional custom delivery optics used with EXFO
UV and IR light sources to tailor the properties of the
light beam to end-user applications.
-----------------------------------------------------------------------------------------------------------------------
OPTICAL INSTRUMENTS
-----------------------------------------------------------------------------------------------------------------------
PRODUCT TYPE PRODUCT TYPICAL APPLICATION
-----------------------------------------------------------------------------------------------------------------------
Radiometer R5000 Handheld, broadband optical radiometer used in
conjunction with EXFO UV and fluorescent light sources to
ensure process quality control at the end-user location.
-----------------------------------------------------------------------------------------------------------------------
Laser Wavelength Meters - WA-1500/1000 Wavemeter High accuracy absolute wavelength measurement of CW and/or
- WA-4550 Wavemeter pulsed laser sources
-----------------------------------------------------------------------------------------------------------------------
Laser Spectrum Analyzers - SAPlus Series High resolution spectral characterization of CW laser
- TL Series sources
-----------------------------------------------------------------------------------------------------------------------
FBG Sensor Interrogator - WA-5900 Wavemeter High accuracy analysis of FBG-based fiber optic sensors
-----------------------------------------------------------------------------------------------------------------------
31
-----------------------------------------------------------------------------------------------------------------------
PRECISION POSITIONING INSTRUMENTS
-----------------------------------------------------------------------------------------------------------------------
PRODUCT TYPE PRODUCT LINE TYPICAL APPLICATION
-----------------------------------------------------------------------------------------------------------------------
Precise Motors/Stages IW-700 Inchworm Motors High resolution optical alignment, fiber-optic alignment,
TSE-820 Inchworm Stages semiconductor positioning, materials research
UHVL Inchworm Motors
-----------------------------------------------------------------------------------------------------------------------
Micromanipulators PCS-6000 Micromanipulators Electrophysiology research such as patch clamp recording
PCS-5000 Micromanipulators experiments on the brain and central nervous system
-----------------------------------------------------------------------------------------------------------------------
Microscope Platforms Gibraltar Platform/Stage Applications using upright microscopes
-----------------------------------------------------------------------------------------------------------------------
Microinjection Systems MIS-5000 Microinjection Microinjection and nuclear transfer for genetics and
Manipulator reproductive sciences research
PiezoDrill Inertial Impact
Drill
-----------------------------------------------------------------------------------------------------------------------
Microelectrode Positioner LSS-8000 Inchworm System Electrophysiology research such as intracellular recording
experiments
-----------------------------------------------------------------------------------------------------------------------
RESEARCH AND DEVELOPMENT
We believe that our future success largely depends on our ability to
maintain and enhance our core technology and product functionality. To keep
developing new products and enhancements, it is important that we recruit and
retain highly skilled personnel. Since September 1, 2003, our new Telecom
Division research and development department is headed by a Vice President of
Research and Development and the new Photonic and Life Sciences Division has a
Director of Research and Development at our Toronto office and at our Rochester
location the Director of Operations is responsible for development and the
Director of Technology is responsible for research. As of December 15, 2003, our
research and development departments included 154 full-time engineers,
scientists and technicians, of whom 54 hold post-graduate degrees. Gross
research and development expenditures for fiscal 2003 reached $17.1 million
compared to $17.0 million in 2002 and $17.6 million in 2001. Although we
implemented restructuring plans during the last couple of years, none of our
major product development initiatives were significantly impacted. We launched
15 new products in fiscal 2003 compared to 25 in 2002 and 20 in 2001. Forty-nine
percent of sales in fiscal 2003 originated from products that have been on the
market two years or less compared to 48% in 2002 and 46% in 2001.
Through our market-oriented product portfolio review process at our
Quebec City, Montreal, Canada and Dallas, TX locations, we ensure that our
investments in research and development are aligned with our customers' needs.
This process enables us to maximize our returns on R&D investments by focusing
our resources on prioritized projects. Quarterly product portfolio review
meetings enable us to choose a realistic, balanced mix of new products and
allocate the necessary resources for their development. All our projects,
including those already underway, are reviewed, given a priority rating and
allocated budgets and resources. Our existing projects can be stopped or
substantially redefined if there have been significant changes in market
conditions, or if the project development schedule or budget has been
significantly exceeded.
To manage our research projects once they are underway, we use a
structured management process known as the stage-gate approach. The stage-gate
approach is based on
32
a systematic review of a project's feasibility at various stages of its life
cycle. The following are the key review stages of the stage-gate approach:
o market study and research feasibility;
o product definition;
o development feasibility;
o development;
o qualification; and
o transfer to production.
At each stage, we review our project risks, costs and estimated
completion time. We compare our design to anticipated market needs and ensure
that our project is synchronized with other internal departments and external
industry events. Adherence to these inter-related portfolio review and
stage-gate processes enabled us to be named winners of the Outstanding Corporate
Innovator Award in 2000 by the U.S.-based Product Development and Management
Association.
We also maintain research and development programs at both its Toronto,
Canada and Victor, NY, locations. The product development process is managed
using a similar stage-gate process, and projects are reviewed and approved
through a quarterly portfolio. The future success of the Toronto and Victor
plans largely depends on their ability to maintain and enhance core technology
of high-intensity light sources, radiometry, optics, interferometry and
piezoelectric positioning.
A strong internal R&D capability within the Toronto and Victor
locations has made it possible to bring many successful new products to market
quickly and retain customer intimacy. They have enhanced our ability to
customize products for special applications and to develop OEM products under
partnerships and exclusive contracts. Outside consultants are often used for
added support in areas like software development and mechanical design.
CUSTOMERS
Our global and diversified telecom customer base relies on our test and
measurement solutions to enable optical networks to perform impeccably during
their complete life cycles: research, development, manufacturing, installation,
maintenance and real-time monitoring. We also have select customers in high-tech
industrial manufacturing and research sectors that require photonics and life
science solutions to render them more efficient in their respective fields. Our
telecom customers include carriers, cable television companies, public
utilities, private network operators, third-party installers, equipment rental
companies, system manufacturers, component vendors, and laboratory researchers.
Our photonics and life science customers consist of major manufacturers of
medical devices, microelectronics, optical displays, electronic storage systems
and photonic components, as well as universities, medical schools, and
governments, private and industrial research laboratories. In fiscal 2003, our
top customer accounted for 9.2% of our sales and our top three customers
represented 17.5% of our sales. In comparison, our top customer accounted for
10.2% and 6.4% of sales in fiscal 2002 and 2001, respectively.
With regard to geographic distribution, North American customers
represented 59% of our sales in fiscal 2003, while international customers
accounted for 41%. In fiscal 2002 and 2001, North American sales accounted for
57% and 58% of total sales and international sales for 43% and 42%,
respectively.
33
SALES
We sell our telecom test and measurement solutions as well as photonics
and life science products through direct and indirect sales channels in North
America and around the world. In North America, we use a hybrid model (direct
and indirect sales), depending on technological requirements and buyer
sophistication. We typically use a direct sales approach when selling higher-end
technological products to sophisticated buyers. Sales of low- to medium-level
products to less stringent technical buyers are usually done through a
manufacturer representative organization supported by local regional sales
managers. Our main sales offices and service centers in North America are
located in Quebec City, Canada, Toronto, Canada and Addison, Texas. We also
maintain sales personnel in numerous U.S. and Canadian metropolitan areas and
rely on sales representatives and distributors situated throughout the
continent. On the international front, we have key sales personnel covering
strategic areas such as Europe, Asia and Latin America. Our sales network in
Europe is supported by a main office and service center in Paris, France, which
maintains our head of European sales operations and also provides repair and
calibration services for our European, Middle East and African customers. Our
main sales offices in Asia are located in Singapore, Beijing and Shenzhen,
China, and we also have service centers at these latter two sites to better
serve our customer base in that region. In addition, we have other sales offices
in strategic locations around the world to support our network of distributors
and customers. We rely on more than 90 distributors to support our international
sales. We believe that the local presence and cultural attributes of our
distributors allow us to better serve our global markets.
Our direct telecom sales team consists of a Vice-President of Global
Sales supported by 38 sales directors, regional sales managers, account
managers, sales engineers and application engineers, who are located throughout
major metropolitan areas around the world. This group of sales professionals has
an average of 10 years of experience in the fields of telecommunications, fiber
optics, or test, measurement and monitoring. We also have an in-house Customer
Service Group to meet the needs of existing and new customers. This group is
responsible for providing quotations to customers, supporting our sales force,
managing demonstration units, order management, technical support and training
as well as calibration and repair services.
For our photonics and life sciences solutions, we use mixed sales
channels to serve its markets, depending on product line and geography. Optical
light sources and related accessories used for industrial applications are sold
in North America through a network of more than 10 manufacture representatives,
and internationally through a network of more than 20 distributors. The X-Cite
120 Fluorescence Illumination System is sold through value-added reseller
agreements with major microscope companies in North America; negotiations are
underway to extend these agreements worldwide. Nanopositioning products are sold
directly to customers in North America, which includes the United States and
Canada, and internationally through a network of technical distributors. To gain
additional access to the nanopositioning life science research market in the
United States and Canada, distributor agreements are in place with major
microscope manufacturers, which include Leica, Nikon, Olympus, and Zeiss. These
companies often combine the sale of their microscopes with our product.
34
PRODUCT MANAGEMENT, MARKETING/COMMUNICATIONS AND CUSTOMER SUPPORT
PRODUCT MANAGEMENT
Our telecom Product Management Group consists of two Vice-Presidents --
one responsible for physical-layer and the other for protocol-layer testing --
as well as product managers who have various degrees in engineering, science and
business administration. Product managers, under the direction of the respective
Vice-Presidents, are responsible for all aspects of our telecom marketing
program including product strategy, new product introductions, definition of new
features and functions, pricing, product launches and advertising campaigns. We
follow up our marketing initiatives by attending industry trade shows.
Furthermore, we have implemented a customer relationship management (CRM) system
to compile market and customer information including forecasts, leads and
competitive data. We use this information to make strategic business decisions.
Finally, a strategic marketing specialist analyzes markets, market trends,
compiles competitive information and identifies macro-trends in our sector.
Product management for our photonics and life science solutions is
managed by product managers out of Toronto, Canada and Victor, NY. Toronto
handles product management for light sources and related accessories, including
the X-Cite 120 Fluorescence Illumination System. Product management for
nanopositioning and optical instruments is handled at our Victor, NY, location.
Responsibilities include product strategy, new product introductions, definition
of new features and functions, pricing, product launches, and advertising
campaigns.
MARKETING/COMMUNICATIONS
Our Marketing-Communications Group, which consists of project managers,
commercial writers, translators and graphic artists, supports our Product
Management Group by producing marketing and corporate documentation. Literature
includes specification sheets, application notes, product catalogues,
advertising copy and an electronic corporate newsletter. Our
Marketing/Communications Group is also responsible for all sales tools required
by our worldwide sales force and for updating our Web site.
CUSTOMER SUPPORT
Customer support is deemed a corporate mandate at EXFO. As such, our
Customer Support Group handles requests from our customers worldwide. Our
Customer Support Group consists of three distinct units: Inside Sales, Technical
Support and After-Sales Service.
Inside Sales is mainly responsible for guiding customers in purchasing
the correct equipment for their respective applications, issuing quotations and
promoting our Flexcare service program. In order to provide customers with one
central point of contact, our service representatives work with the customer
from purchasing equipment to helping them service the equipment, if necessary.
These services are provided in English, French, Spanish or Chinese.
35
Within our Technical Support team, we have agents who provide
troubleshooting support to our customers as well as trainers and installers who
offer on-site servicing for more complex equipment.
To offer superior After-Sales Service worldwide, we have service
centers based in North America, Europe and Asia. These service centers provide,
technical support, software upgrades, calibration and repairs for our customers.
MANUFACTURING
Our manufacturing operations consist mainly of material planning,
procurement, sub-assembly, final assembly and test, software loading,
calibration, quality assurance, shipping, billing and customs management. As of
December 15, 2003, we had 218 employees involved in our manufacturing
operations. Most of our manufacturing activities, which occupy a total of
approximately 76,910 square feet, are spread among five buildings in four
cities.
First, we occupy 50,000 square feet in Quebec City, Canada, and 3,300
square feet in Montreal, Canada. These manufacturing operations include the
following responsibilities:
o PRODUCTION. From production planning to product shipment, our
production department is responsible for manufacturing
high-quality products on time. Factories are organized in work
cells; each cell consists of specialized technicians and
equipment and has full responsibility over a product family.
Technicians are cross-trained and versatile enough, so that
they can carry out specific functions in more than one cell.
This allows shorter lead times by alleviating bottlenecks.
o PRODUCT ENGINEERING AND QUALITY. This department, which
supports our production cells, acts like a gatekeeper to
ensure the quality of our products and the effectiveness of
our manufacturing processes. It is responsible for the
transfer of products from research and development to
manufacturing, product improvement, documentation, metrology,
and the quality assurance and regulatory compliance process.
Quality assurance represents a key element in our
manufacturing operations. Quality is assured through product
testing at numerous stages in the manufacturing process to
ensure that our products meet stringent industry requirements
and our customers' performance requirements. Our quality
assurance program has been certified ISO 9001/2000 at two
locations and is in the process of being certified at other
sites.
o SUPPLY-CHAIN MANAGEMENT. This department is responsible for
sales forecasting, raw material procurement, material-cost
reduction and vendor performance management. Our products
consist of optical, electronic and mechanical parts, which are
purchased from suppliers around the world. Approximately
one-third of our parts are manufactured to our specifications.
Materials represent the biggest portion of our cost of goods
and will continue to grow as we rely more and more on
outsourcing our manufacturing. Our performance is tightly
linked to vendor performance, requiring greater emphasis on
this critical aspect of our business.
36
We also occupy 10,000 square feet in Toronto, Canada, and 13,610 square
feet in Victor, NY. Our operations group in Toronto manufactures light-based
curing products and related accessories for the semiconductor, electronic, and
medical device manufacturing markets. Operations in Toronto consist of
manufacturing, procurement, warehousing, quality control and document control
managed by various elements of the ISO 9001 certified quality system. Our
facility in Victor, NY, manufactures optical instrumentation and precise
positioning equipment that is used in research, engineering and production
applications across a variety of fields. Recognizing the importance of reduced
time-to-market for our solutions, we have focused efforts on designing products
with an emphasis on standardization, modularity, as well as ease of fabrication
and assembly. Similar to operations at our Toronto location, manufacturing at
Victor, NY, is focused on high value-added areas such as assembly and testing,
with major manufacturing elements subcontracted to various key suppliers.
Following our key responsibilities in our Toronto and Victor manufacturing
process:
MANUFACTURING - consists primarily of assembly and test capabilities
where all major manufacturing elements are subcontracted to various key
suppliers. These components are integrated into assemblies and tested in order
to ensure all operating specifications have been met for each product
manufactured. Capacity and production planning are utilized on an on-going basis
to ensure that adequate resources are available to meet forecasted and actual
demand.
PROCUREMENT - activities are focused on developing key suppliers that
are able to manufacture components to our specifications and ensuring the most
competitive price has been attained. Supplier evaluation is the joint
departmental effort of operations, engineering and the quality group.
WAREHOUSE - RECEIVING, in-coming inspection and warehousing of
components used for product realization, along with shipping and custom
transactions, are controlled in this area.
DOCUMENT CONTROL - configuration control on all released products is
maintained by managing the system for engineering change.
QUALITY CONTROL - Receiving inspection, final product verification,
control of non-conforming product, control of inspection, test and measurement
equipment are control by in area.
COMPETITION
The telecommunications test and measurement industry is highly
competitive and subject to rapid change as a result of technological
developments and market conditions. We compete with many different companies,
depending on product family and geographical market. We believe that the main
competitive factors in the industry include the following:
o product performance and reliability;
o level of technological innovation;
o product lead times;
o breadth of product offering;
o ease of use;
o brand-name recognition;
37
o customer service and technical support;
o strength of sales and distribution relationships;
o financial stability; and
o price.
The telecommunications test and measurement industry has recently
undergone, and will continue to undergo, significant restructuring and
consolidation. We have seen, and expect to continue to see, some competitors
opting for a strategic retreat, redirecting their research and development to
other sectors, divesting or merging.
Generally, competitors fall into two categories. The first category
consists of global test and measurement vendors, who complement their broad
range of products with optical test and measurement equipment. These companies
include Acterna Corporation, Agilent Technologies, Inc., Ando Corporation,
Anritsu Corporation, NetTest, Spirent plc and Tektronix, Inc.
The second category refers to niche companies in the test and
measurement industry or other significant telecommunications players operating
inside a niche test and measurement market. These companies typically have
limited product lines and in some cases may be geographically limited in their
customer base. Such companies include Digital Lightwave, Inc., Finisar
Corporation, Ixia, JDS Uniphase Corporation, and Sunrise Telecom Incorporated.
Competition for our photonics and life science solutions is quite
varied, depending upon product line. Competitors that sell light-based curing
products include Hamamatsu, Ushio and Matsushita (Panasonic) in Asia, with
Hamamatsu increasing its presence in North America. With regard to our X-Cite
120 Fluorescence Illumination System, main competitors consist of microscope
manufacturers who have developed lamp housings for low-wattage mercury burners
in-house. Finally, our nanopositioning and optical instruments, which are
designed for various life science applications, compete against products from
companies like Sutter Instruments, High Finesse and ATOS.
REGULATORY ENVIRONMENT
In most countries where our products are sold, our products must comply
with the regulations of one or more governmental entities. These regulations
often are complex and vary from country to country. Depending upon the country
and the relevant product, the applicable regulations may require product
testing, approval, registration, marking and unique design restrictions.
Accordingly, we have appointed a team of engineers who are responsible for
ensuring that our products comply with all applicable regulations.
In the United States, our products must comply with the regulations of
several agencies of the U.S. federal government, including the Federal
Communications Commission, or the FCC, the Food and Drug Administration, or the
FDA and the Occupational Safety and Health Administration, or OSHA. Under the
FCC's regulations, our products must comply with certain EMC (electro magnetic
compatibility) requirements to insure they do not generate/and are immune from
electrical noise which could possibly cause undesirable operation, as well as
affect other surrounding devices. Depending upon the product, compliance with
these rules may necessitate applying for and obtaining an FCC equipment
authorization prior to importing into the United States, or marketing, any units
of the relevant product. Additionally, some of our products must comply with the
FDA's non-medical performance standards and related rules
38
concerning light-emitting products, such as lasers. The FDA's regulations are
intended to promote safety by limiting human exposure to harmful non-iodizing
radiation. Similarly, our products must comply with safety standards adopted by
OSHA.
Similar regulations apply in other countries. For example, in Canada
our products must comply with the applicable standards adopted by the SCC
(Standards Council of Canada). These include product safety standards developed
the Canadian Standards association as well as EMC requirements adopted by
Industry Canada. Countries in the European Union require product compliance as
dictated by an applicable directive, often referred to as CE marking. This
includes testing to ensure compliance with harmonized EN (European Norm)
standards for both product safety and EMC requirements. Other significant types
of regulations not described in this annual report also may apply, depending
upon the relevant product and country of destination.
INTELLECTUAL PROPERTY
Our success and ability to compete are dependent in part on our ability
to develop and protect our proprietary technology. We file U.S. and Canadian
patent applications to protect technology, inventions and improvements important
to the development of our business. We also rely on a combination of copyright,
trademark, trade secret rights, licensing and confidentiality agreements.
We currently hold 21 U.S.-issued and six Canadian-issued patents and we
have 21 U.S., 16 Canadian and eight Patent Cooperation Treaty patent
applications pending. These issued and pending patents cover various aspects of
our products and processes. The expiration dates of our issued patents range
from April 19, 2005 to March 31, 2021.
We consider six of our inventions for which patents have either been
granted or are pending to be material. These inventions are:
o the optical time domain reflectometer with internal reference
reflector for which a patent was granted in the United States
and is pending in Canada. This invention permits the control
of the optical time domain reflectometer detector gain and the
determination of the loss of the initial optical connector and
is used in most of our optical time domain reflectometer-based
products;
o the measurement of attenuation of optical fibers using
bidirectional transmission of information via the fiber for
which patents were granted in the United States and Canada.
This invention forms the basis of our FOT-920 and FTB-3920
products;
o an apparatus and method to determine optical phase delay,
which forms the basis of our new FTB-5800 product for the
measurement of chromatic dispersion in field-installed optical
fibers. A US patent has been granted, and applications have
been submitted in Canada, Europe (pursuant to PCT), and China;
o an optical spectrum analyzer using optical fibers as input and
output "slits". This invention forms the basis of our
FTB-5240, FTB-5240B and IQ-5250 products. This patent
application is in process in the United States, Canada, Europe
(pursuant to PCT) and China;
o the light cure system with closed loop control and work piece
recording which is at the heart of the spot-curing systems
manufactured by EXFO Photonic Solutions for which patents were
granted in the United States and Canada; and
39
o the portable test gear for TDM and packet based communications
for which patent applications have been filed in Canada, the
United States and pursuant to the Patent Cooperation Treaty
form the basis of the technology used by EXFO Protocol for its
protocol testing products.
Confidentiality and proprietary information agreements with our senior
management, employees and others generally stipulate that all confidential
information developed or made known to these individuals by us during the course
of their relationship is to be kept confidential and not disclosed to third
parties, except in specific circumstances. The agreements also generally provide
that all intellectual property developed by the individual in the course of
rendering services to us belongs exclusively to us. These efforts afford only
limited protection.
C. ORGANIZATIONAL STRUCTURE
As of December 15, 2003, the following chart presents our corporate
structure, the jurisdiction of incorporation of our subsidiaries and the
percentage of shares that we hold in those subsidiaries.
[GRAPHIC OMITTED -- ORGANIZATIONAL CHART]
EXFO Electro-Optical Engineering Inc.
18/09/1985
(Canada)
Operating **
100% 100% 100% 85% 100% 100% 100%
--------------- ------------- -------------- ------------ ---------- ---------------- ---------------- ----------------
EXFO UK Limited EXFO Photonic GEXFO GAP Optique EXFO Asia Nortech Fibronic EXFO Protocol Burleigh
27/02/2001 Solutions Inc. Distribution SA Pacific Inc. Inc.(formerly) Instruments GmbH
(United Kingdom) (formerly Efos Internationale 17/05/1994 PTE Ltd. 14/08/1991 Avantas Networks (Germany)
Non-operating Inc.) Inc. (Switzerland) 18/01/2001 (Canada) Corporation) Non-operating
20/02/1984 17/12/1992 Operating (Singapore) Non-operating 02/11/2001
(Ontario) (Quebec) Operating (Canada)
Operating Holding Dissolved
12/09/2003
/ /
------------------------------------------ ---------------
100% 100% 100% 100%
----------- ------------- ---------- -------------
EXFO Europe EXFO EXFO USA [Nortech
SARL International Inc. Fibronic Inc.
08/02/1994 Services 07/12/2000 (Texas)
(France) Management LLC (Delaware) Dissolved
Operating 22/11/2000 Holding 07/09/2001]
(Hungary) -
Operating
/
-------------------------------------------
100% 100% 100%
------------ --------- -------------
EXFO America EXFO EXFO Gnubi
Inc. Burleigh Products
15/12/1992 Products Group Inc.
(Delaware) Group Inc. 04/09/2002
Operating 25/08/1972 (Delaware)
(New York) Non-Operating
Operating
/ \
-------------------------------------------
71.5% 100%
------------- -------------
** [Burleigh Burleigh
28.5% Instruments Automation
(UK) Ltd. Inc.
(United (Delaware)
Kingdom) Non-operating
Dissolved
12/11/2002]
40
D. PROPERTY, PLANT AND EQUIPMENT
Our main offices and facilities are located in Quebec City, Canada
where we now occupy two buildings. These buildings house our executive and
administrative offices, research and development facilities and production
facilities. We also have facilities in Montreal, Canada (formerly EXFO
Protocol). In addition, we maintain sales offices in China, France, Germany,
Great Britain, Japan, Singapore, Mexico and the United States. EXFO Burleigh's
facilities are located in Victor, in the state of New York, EXFO Gnubi and EXFO
America are located near Dallas, Texas and EXFO Photonic is located near
Toronto.
In September 2002, we obtained ownership of one of the buildings
housing production facilities in Quebec City that was previously leased from a
company controlled by EXFO's president and chief executive officer. In September
2003, due to down-sizing efforts, we were able to move all of our Quebec City
activities into two buildings, rather than three. Though we no longer occupy the
facilities at 465 Godin Avenue in Vanier, we remain bound by the lease until
November 30, 2006.
The following table sets forth information with respect to the main
facilities that we occupy as of December 15, 2003.
LOCATION USE OF SPACE SQUARE FOOTAGE TYPE OF INTEREST
-------- ------------ -------------- ----------------
436 Nolin Street Manufacturing 44,164 Owned
Vanier (Quebec)
400 Godin Avenue Research and Development, Manufacturing, 128,800 Owned
Vanier (Quebec) Executive and Administrative
465 Godin Avenue Unoccupied 24,000 Leased
Vanier (Quebec)
2260 Argentia Road Research and Development, Manufacturing 36,000 Leased
Mississauga (Ontario) and Administrative
2650 Marie-Curie Research and Development, Manufacturing 26,000 Leased
St-Laurent (Quebec) and Administrative
7647 Main Street Fishers Research and Development, Manufacturing 40,000 Owned
Victor (New York) and Administrative
4275 Kellway Circle Research and Development, 10,894 Leased
Addison (Texas) Manufacturing and Administrative
41
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion and analysis of the consolidated financial
condition and results of operations of EXFO Electro-Optical Engineering Inc. for
the fiscal years ended August 31, 2003, 2002 and 2001, should be read in
conjunction with our consolidated financial statements and the related notes
included elsewhere in this annual report. Our consolidated financial statements
are reported in US dollars and have been prepared in accordance with generally
accepted accounting principles in Canada, or Canadian GAAP. To the extent
applicable to our consolidated financial statements included elsewhere in this
annual report, these principles conform in all material respects with generally
accepted accounting principles in the United States, or U.S. GAAP, except for
significant differences, as described in Note 20 to our consolidated financial
statements.
INDUSTRY OVERVIEW
Telecommunications companies, still dealing with reduced spending
levels, were affected by a number of external forces during fiscal 2003,
including geo-political and economic uncertainty, the outbreak of SARS in Asia,
as well as the declining strength of the US dollar. To cope with these market
realities, network service providers, the first link in the telecommunications
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, network service providers turned their attention to
operating expenditures (OPEX) for further savings.
Lower spending levels necessarily produced a trickle-down effect
throughout the telecommunications industry, namely for system vendors, component
manufacturers as well as for test and measurement 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, the relative stability
of technology and the excess manufacturing capacity in this sector. The ongoing
consolidation within the component manufacturing market provides an inkling of
its weaker health.
Test and measurement equipment vendors also felt the impact of reduced
network service provider spending with less demand for orders. In addition, some
competitors increasingly applied pricing pressure to obtain contracts, which
eroded margins across the board. The gray market for test and measurement
instruments, especially involving optical component manufacturing applications,
further compounded the soft market. On the other hand, test and measurement
vendors--whose products enable customers to lower CAPEX and OPEX, as well as
deploy next-generation architecture--still attracted the attention of network
service providers and system manufacturers for certain projects.
COMPANY OVERVIEW
EXFO is a leading designer and manufacturer of fiber-optic test,
measurement and monitoring solutions for the global telecommunications industry.
We market more than 90 product families to a diverse customer base in
approximately 70 countries around the world. We develop 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
42
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.
EXFO was founded in Quebec City, Canada, in 1985. Our original products
were focused on the needs of installers and operators of fiber-optic networks.
Customers use these field-testing products for the installation, maintenance,
monitoring and troubleshooting of optical networks. In 1996, we supplemented our
product portfolio with an extensive line of high-end products that are mainly
dedicated to research and development as well as manufacturing activities. These
products, namely modular and benchtop units, tend to be more complex and
higher-priced than field-testing ones. In 1999, we entered the remote fiber test
system (RFTS) market. This type of system allows network service providers to
monitor the integrity of their fiber-optic systems in real time, twenty-four
hours a day, seven days a week.
In the last two years, we have strengthened our competitive position
through the acquisition of two protocol-layer test businesses. In November 2001,
we expanded into protocol-layer testing with the acquisition of Avantas Networks
Corporation (renamed EXFO Protocol Inc.), a supplier of fiber-optic testing and
optical-network-performance management equipment for network service providers.
This transaction was highly strategic because it enabled us to combine
protocol-, optical- and physical-layer testing inside a single platform--the
FTB-400 Universal Test System-- to help our customers increase revenues and
reduce operational costs.
In October 2002, our newly created wholly-owned subsidiary, EXFO Gnubi,
purchased substantially all the assets of gnubi communications, L.P., a supplier
of multi-channel telecom and datacom testing solutions for the system
manufacturer market. EXFO Gnubi's protocol-layer test equipment targets the
fully complementary system manufacturer market, while EXFO Protocol's offering
focuses on the network service provider market. Jointly, these strategic
acquisitions enabled us to double our addressable market as we expanded from
physical- and optical-layer testing to also cover protocol-layer testing
applications in the telecom and datacom market, while offering a more complete
fiber-optic test solution to customers.
Previously, we completed two acquisitions to bolster growth in the
optical component manufacturing market. We acquired Burleigh Instruments, Inc.
(renamed EXFO Burleigh Products Group Inc.) in December 2000 for its wavelength
measurement instruments and nanopositioning alignment systems. We also added
EFOS Inc. (renamed EXFO Photonic Solutions Inc.) in March 2001 for its precision
light-based, adhesive spot-curing technology. We have since exited the optical
component manufacturing automation business, a market addressed by an EXFO
Burleigh product line.
One of our strongest competitive advantages is our modular platform
design, which we first launched in 1996; and with the introduction of all-in-one
test sets that cover physical-, optical- and protocol-layer test requirements in
2002, we believe that we remain the industry leader in this area. In 2003, we
raised our field-testing platform to a new level by enabling field technicians
to seamlessly automate their test applications. The first software product
within EXFO's Integrated Applications Suite, the Lambda Auto-Sweeper, automates
the interaction and common reporting of three test modules within our FTB-400
field-testing platform: SONET/SDH Analyzer, Optical Spectrum Analyzer and DWDM
Channel Selector.
As described above, we have faced difficult market conditions in the
telecommunications industry in the last two years; we experienced a decrease in
sales and incurred significant
43
operating losses. To cope with these realities, we implemented several
restructuring actions since the last quarter of fiscal 2001. These actions
resulted in workforce reductions of 245, 350 and 172 employees in fiscal 2001,
2002 and 2003, respectively. We also adopted rigorous cost-control measures and
rationalized our business model. In addition, we incurred significant asset
impairment charges related to these market conditions, namely for inventories,
goodwill, intangible assets and future income tax assets.
To better serve the needs of end-customers in different markets and
simplify our business model, we reorganized our business under two new divisions
at the beginning of fiscal 2004. Our Telecom Division consists of former
Portable and Monitoring and telecom-related Industrial and Scientific product
lines. This division is focused on network service providers, telecommunication
system manufacturers and optical component vendors on a global basis. Our
Photonics and Life Sciences Division, which mainly leverages our core
technologies, includes former Industrial and Scientific non-telecom product
lines. This division has been created to maximize value from developed and
acquired telecom technologies.
Following this reorganization, our two new divisions now have
respective sales, marketing, R&D, manufacturing and management teams and will,
therefore, be presented under two corresponding operating segments. We will
provide the required segmented disclosures in our interim consolidated financial
statements beginning in the first quarter of fiscal 2004. However, we will not
provide comparative information for previous periods about each reportable
segment, except for sales and total assets, because this information is not
available and is impracticable to determine.
SALES
We sell our products to a diversified customer base in approximately 70
countries around the world through our direct sales force and, indirectly,
through distribution channels. Our customers are comprised of telecommunications
carriers, network service providers, system and optical component manufacturers,
as well as research and development laboratories. We have a diversified customer
base, both in terms of sector and geographical area, which provides us with
reasonable protection regarding concentration of credit risk. As for customer
breakdown, no customer accounted for more than 9.2%, 10.2% and 6.4% of sales in
fiscal 2003, 2002 and 2001, respectively. In fiscal 2003, our three most
significant customers represented 17.5% of sales, compared to 15.4% of sales in
2002 and 12.8% of sales in 2001.
COST OF SALES
Cost of sales includes raw materials, salaries and related expenses for
direct and indirect manufacturing personnel (net of government grants) as well
as overhead costs. Excess, obsolete or scrapped materials are also included in
cost of sales.
In 2003, we reclassified certain expenses from selling and
administrative expenses to cost of sales. Comparative figures have been
reclassified accordingly.
OPERATING EXPENSES
We classify our operating expenses into three general categories:
selling and administrative expenses, research and development expenses and
amortization expenses.
Selling and administrative expenses consist primarily of salaries and
related expenses for personnel (net of government grants), sales commissions,
travel expenses, marketing
44
programs, professional services, information systems, human resources and other
corporate expenses.
Gross research and development expenses consist primarily of salaries
and related expenses for engineers and other technical personnel, material
component costs as well as fees paid to third-party consultants. We are eligible
to receive research and development tax credits and government grants on
research and development carried out in Canada. Related research and development
tax credits and government grants are recorded as a reduction of gross research
and development expenses. Tax credit write-offs are included in net research and
development expenses.
Operating expenses related to our restructuring plans have been
recorded as a separate component of operating expenses. These expenses consist
primarily of severance expenses, costs to exit leased facilities as well as
write-offs of unused long-lived assets.
OUR STRATEGY
We are more than ever committed to becoming a dominant player in the
global telecommunications test and measurement industry, while leveraging our
technology base in targeted photonics and life science markets. To summarize our
fiscal 2004 strategy, we plan to increase sales through market-share gains,
maximize profitability and growth on a long-term basis, innovate our way out of
this downturn, and maintain a sound financial position.
INCREASE SALES THROUGH MARKET-SHARE GAINS
In fiscal 2004, we will focus on continued market-share gains to
achieve growth, considering a scenario based on a stable or slightly declining
telecommunications market. In 2003, we believe that we gained market share among
network service providers by strengthening the leadership position of our
FTB-400 field-testing platform and by extending its reach to telecom and datacom
protocol-layer test applications.
We also leveraged our protocol-layer acquisitions (formerly Avantas
Networks and gnubi communications) to enhance our strategic position and sales
results in this mission-critical sector for our targeted end-markets. Evidence
of this newfound traction is reflected in our protocol-layer test sales, which
accounted for more than 10% of total revenues in each of the last three quarters
of 2003. With continued quality of execution, protocol-layer activities are
expected to play a larger role and contribute to our growth in 2004.
Looking ahead, we intend to further expand our presence with network
service providers, who are increasingly focusing on reducing operating
expenditures (OPEX) as capital expenditures (CAPEX) draw nearer to
maintenance-level run rates. The unique value proposition inherent to our
flexible, PC-based FTB-400 modular test platform and related suite of test
technologies reduces both CAPEX and OPEX, aptly matching the priorities of
network service providers and installation teams of system vendors.
Speaking of system vendors, we also started to target their R&D and
manufacturing teams in fiscal 2003--as evidenced by the acquisition of GNUBI
COMMUNICATIONS. Following significant balance sheet restructuring, system
vendors are gradually recovering, showing positive cash flow and even profits.
We believe they will continue to recover in 2004 and will represent a major
end-market for EXFO in the long term.
45
In addition, we intend to leverage synergies across our entire protocol
R&D activities to accelerate the development of innovative, advanced and
differentiated test solutions that maximize the reuse of technologies over
multiple market segments. The design, manufacturing and deployment of
next-generation SONET/SDH networks, combined with the convergence of multiple
applications on simplified architectures and our strong market position on the
physical-layer side, represent a significant market opportunity for our Telecom
Division as we continue to expand our addressable markets.
As indicated by the realignment of our operations, we also intend to
maximize revenue streams by leveraging our core telecom expertise into select
adjacent markets. For example, we recently launched the X-Cite 120 Fluorescence
Illumination System that was based on our adhesive curing technology for optical
component manufacturing. Through joint development and reseller agreements with
market-leading microscope manufacturers, we plan to take advantage of their
large sales organizations and established base of microscopes to grow revenues
in our Photonics and Life Sciences Division.
MAXIMIZE PROFITABILITY AND GROWTH ON A LONG-TERM BASIS
Returning to profitability is also a key priority for EXFO. We intend
to design differentiated, higher-margin products in our R&D labs, streamline our
manufacturing operations and review our supply chain in order to reduce our cost
of goods. As well, we will keep fine-tuning our sales process to offset ongoing
pricing pressure by some competitors. These initiatives should help us improve
our gross margin, which fell to 47.4% (excluding inventory write-offs and a
non-recurring gain) in fiscal 2003, to at least 50% in fiscal 2004 and
accelerate our return to profitability. A balance between profitability and
growth, however, is critical to ensure the long-term success of the company. We
believe that our operating expenses have reached a level in which we cannot make
additional significant reductions without compromising our medium- and long-term
growth prospects. We reduced our selling and general administrative expenses by
20% to $27.0 million in fiscal 2003, from $33.9 million in 2002 and by 25% in
2002, from $45.0 million in 2001. On the other hand, we maintained our gross R&D
expenses at $17.1 million in 2003 compared to $17.0 million in 2002 and $17.6
million in 2001. We plan to keep a tight control on operating costs with leaner
and more flexible operations. However, the ongoing strength of the Canadian
dollar (compared to the US dollar) may have a negative impact on our operating
costs in 2004 and may offset some of our restructuring efforts.
INNOVATE OUR WAY OUT OF THE DOWNTURN
Ever since we founded EXFO in 1985, innovation strategies were focused
on being first to market with unique solutions that anticipate and better
address customer requirements. Our market-driven approach can be demonstrated
through a long history of industry firsts--first modular optical test platform,
first all-in-one field-testing platform, first portable polarization mode
dispersion (PMD) analyzer, etc. This focus on delivering a unique value
proposition to the marketplace is of strategic importance to improve our gross
margin in the upcoming year. Our strong product pipeline delivered 15 new
products to the marketplace in 2003, most of which include telecom-related
solutions such as a next-generation PMD analyzer that can characterize PMD
levels in high-speed optical networks, a Fibre Channel test module for
installation and commissioning of storage area networks, and a 2.5+ Gigabit
multi-rate transceiver for protocol-layer test applications. Sales of new
products (on the market two years or less) accounted for 49% of total sales in
2003. These numbers reflect our commitment to the future and indicate that our
innovation strategy is working at EXFO. We intend to keep innovating our way out
of this downturn in 2004. As network service providers and system manufacturers
turn their
46
attention to metro, access and fiber-to-the-home networks and as systems
converge toward data-centric, Internet Protocol-based technologies, we are
developing the sophisticated test solutions required to match heightened network
complexity.
MAINTAIN A SOUND FINANCIAL POSITION
For more than 18 years, we have maintained a solid balance sheet and,
at the end of fiscal 2003, we had a cash position of $57.4 million and
practically no debt. This fiscal responsibility provides our customers with the
assurance that they can count on EXFO as a solid, long-term partner.
Our cash position will allow us to continue investing significantly in
R&D in order to develop new solutions and tap into new markets, while some of
our competitors face more significant financial pressure.
KEY PERFORMANCE INDICATORS
As measures to assess the realization of our strategic plan and its
objectives, we have set out four consolidated key performance indicators, which
are summarized as follows:
Strategic objectives Key performance indicators
--------------------------------------------------------------------------------
Increase sales through market-share 10% sales growth year-over-year,
gains a stable or slightly declining
telecommunications market
Maximize profitability and growth on 50% gross margin in fiscal 2004
a long-term basis
Innovate our way out of the downturn 45% of our sales from new products (on
the market two years or less) during
fiscal 2004
Maintain a sound financial position Positive cash flows from operating
activities during fiscal 2004*
--------------------------------------------------------------------------------
* Assuming no major acquisitions of businesses and/or technologies and
stability in the value of the Canadian dollar compared to the US dollar.
CAPABILITY TO DELIVER RESULTS
At EXFO, we believe that we have the capabilities to deliver expected
results thanks to outstanding products, an excellent reputation in the
marketplace, a sound financial position, as well as an experienced workforce and
management team.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's discussion and analysis of financial conditions and
results of operations is based on our consolidated financial statements included
elsewhere in this annual report. As previously mentioned, they have been
prepared in accordance with Canadian GAAP. The preparation of financial
statements in accordance with GAAP requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, the
disclosures of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting years. On an ongoing basis, we evaluate these estimates and
assumptions, including those related to revenue recognition, allowance for
doubtful accounts, allowance for excess and obsolete inventories, research and
47
development tax credits and government grants, impairment of long-lived assets
and goodwill, valuation allowance of future income tax assets, warranty
obligations, restructuring charges as well as contingencies and other
obligations. We base our estimates and assumptions on historical experience and
on other factors that we believe to be reasonable under the circumstances, the
result of which form the basis for making judgments about the carrying values of
assets and liabilities that are not readily apparent from other sources. Actual
results could differ from these estimates.
The following summarizes our critical accounting policies as well as
those that require the most significant judgment and estimates in the
preparation of our consolidated financial statements.
REVENUE RECOGNITION. For products in which software is incidental, we
recognize revenue when persuasive evidence of an arrangement exists, the product
has been delivered, the price is fixed and determinable and collection of the
resulting receivable is reasonably assured. In addition, provisions are made for
estimated returns, warranties and support obligations.
For products in which software is not incidental, revenues are
separated into two categories: product and customer support revenues based upon
vendor-specific objective evidence of fair value. Product revenues for these
sales are recognized as described above. Customer support revenues are deferred
and recognized ratably over the years of the support arrangement. Except when
provided within one year of delivery, costs of providing this support are
insignificant and accrued at the time of delivery and no software upgrades are
provided.
For all sales, we use a binding purchase order as evidence that a sales
arrangement exists.
Delivery generally occurs when the product is shipped to a transporter.
At the time of the transaction, we assess whether the price associated
with our revenue transaction is fixed and determinable, and whether or not
collection is reasonably assured. We assess whether the price is fixed and
determinable based on the payment terms associated with the transaction. We
assess collection based on a number of factors, including past transaction
history and the creditworthiness of the customer. Generally, collateral or other
security is not requested from customers.
Most sales arrangements do not generally include acceptance clauses.
However, if a sales arrangement includes an acceptance provision, acceptance
occurs upon the earliest of the receipt of a written customer acceptance or the
expiration of the acceptance period. For these sales arrangements, the sale is
recognized when acceptance occurs.
ALLOWANCE FOR DOUBTFUL ACCOUNTS. We estimate collectibility of accounts
receivable on an ongoing basis by periodically reviewing balances outstanding
over a certain period of time. We determine our allowance for doubtful accounts
receivable based on our historical accounts receivable collection experience and
on the information that we have about the status of our accounts receivable
balances. If the financial conditions of our customers deteriorate, resulting in
an impairment of their ability to make required payments, additional allowance
may be required, which could adversely affect our future results.
ALLOWANCE FOR EXCESS AND OBSOLETE INVENTORIES. We state our inventories
at the lower of cost, determined on an average cost basis and replacement cost
or net realizable value, and
48
provide reserves for excess and obsolete inventories. We determine our reserves
for excess and obsolete inventories based on the quantities we have on hand
versus expected needs for these inventories, so as to support future sales of
our products. It is possible that additional inventory reserves may occur if
future sales are less than our forecasts or if there is a significant shift in
product mix compared to our forecasts, which could adversely affect our future
results.
RESEARCH AND DEVELOPMENT TAX CREDITS AND GOVERNMENT GRANTS. We record
research and development tax credits and government grants based on our
interpretation of tax laws and grant programs, especially regarding related
eligible projects and expenses, and when there is reasonable assurance that we
have complied and will continue to comply with all conditions and laws. Also,
our judgment and estimates are based on historical experience. It is possible,
however, that the tax authorities have a different interpretation of laws and
application of conditions related to the programs or that we will not comply
with all conditions related to grants in the future, which could adversely
affect our future results. Furthermore, a large part of our tax credits are
refundable against income taxes payable, causing their ultimate realization to
be dependent upon the generation of taxable income. If we obtain information
that causes our forecast of future taxable income to change or if actual taxable
income differs from our forecast, we may have to revise the carrying value of
these tax credits, which would affect our results in the period in which the
change was made. We review the recoverability of such tax credits on a quarterly
basis. Please refer to the "Research and development" section further in this
item.
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 (CICA) handbook, "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 sales multiples 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, on September 1, 2002, we prospectively adopted section
3063 of the CICA handbook, "Impairment of Long-Lived Assets". Based on this new
standard, 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,
based on the recoverability test, 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 the third quarter of fiscal 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 item.
FUTURE INCOME TAXES. We account for income taxes using the liability
method of tax allocation. Under this method, future income tax assets and
liabilities are determined based on deductible or taxable temporary differences
between financial statement values and tax values of assets and liabilities,
using enacted income tax rates for the years in which the differences
49
are expected to reverse. In assessing the recoverability of our future income
tax assets, we consider whether it is more likely than not that some or all of
the future income tax assets will not be realized. The ultimate realization of
certain future income tax assets is dependent upon the generation of future
taxable income during the periods in which those temporary differences will
become deductible. If we obtain information that causes our forecast of future
taxable income to change or if actual taxable income differs from our forecast,
we may have to revise the carrying value of our future income tax assets, which
would affect our results in the period in which the change was made. We review
the recoverability of our future income tax assets on a quarterly basis. Please
refer to the "Income Taxes" section further in this item.
In addition to the two above-mentioned CICA handbook sections, we also
adopted the following new handbook sections and guideline in fiscal 2003:
o Section 3475 "Disposal of Long-Lived Assets and Discontinued
Operations"
o Section 3870 "Stock-Based Compensation and Other Stock-Based
Payments"
o Accounting Guideline 14 "Disclosure of Guarantees"
Please refer to note 2 to our consolidated financial statements
included in item 18 of this annual report for further information about these
new standards and their impact on our financial statements.
50
RESULTS OF OPERATIONS
The following table sets forth certain Canadian GAAP consolidated
statements of earnings data in thousands of US dollars, except per share data,
and as a percentage of sales for the years indicated:
YEARS ENDED AUGUST 31, 2003 2002 2001 2003 2002 2001
----------------------------------------------------------------------------------------------------------------
Sales .............................. $ 61,930 $ 68,330 $ 146,013 100.0% 100.0% 100.0%
Cost of sales (1) .................. 36,197 52,366 56,207 58.4 76.6 38.5
----------------------------------------------------------------------------------------------------------------
Gross margin (2) ................... 25,733 15,964 89,806 41.6 23.4 61.5
----------------------------------------------------------------------------------------------------------------
Operating expenses
Selling and administrative (1) ... 26,991 33,881 44,975 43.6 49.6 30.8
Net research and development ..... 15,879 12,782 13,601 25.6 18.7 9.3
Amortization of property, plant
and equipment ................. 6,139 5,932 3,559 9.9 8.7 2.4
Amortization of intangible assets 4,747 11,615 9,876 7.7 17.0 6.8
Write-down of intangible assets .. 2,922 23,657 -- 4.7 34.6 --
Restructuring and other charges .. 4,134 2,880 3,288 6.7 4.2 2.3
----------------------------------------------------------------------------------------------------------------
Total operating expenses ........... 60,812 90,747 75,299 98.2 132.8 51.6
----------------------------------------------------------------------------------------------------------------
Earnings (loss) from operations .... (35,079) (74,783) 14,507 (56.6) (109.4) 9.9
Interest income, net ............... 1,245 1,456 6,098 2.0 2.1 4.2
Foreign exchange gain (loss) ....... (1,552) (458) 3,327 (2.5) (0.7) 2.3
----------------------------------------------------------------------------------------------------------------
Earnings (loss) before income taxes
and amortization and write-down
of goodwill ...................... (35,386) (73,785) 23,932 (57.1) (108.0) 16.4
Income taxes ....................... 15,059 (25,451) 8,150 24.3 (37.2) 5.6
----------------------------------------------------------------------------------------------------------------
Earnings (loss) before amortization
and write-down of goodwill ....... (50,445) (48,334) 15,782 (81.4) (70.8) 10.8
Amortization of goodwill ........... -- 38,021 31,076 -- 55.6 21.3
Write-down of goodwill ............. 4,505 222,169 -- 7.3 325.1 --
----------------------------------------------------------------------------------------------------------------
Net loss for the year .............. $ (54,950) $(308,524) $ (15,294) (88.7)% (451.5)% (10.5)%
=================================================================================================================
Basic and diluted net loss per share $ (0.87) $ (5.09) $ (0.29)
Research and development data:
Gross research and development ... $ 17,133 $ 17,005 $ 17,601 27.7% 24.9% 12.1%
Net research and development ..... $ 15,879 $ 12,782 $ 13,601 25.6% 18.7% 9.3%
----------------------------------------------------------------------------------------------------------------
OTHER DATA (UNAUDITED)(3):
Pro forma net earnings (loss) .... $ (11,476) $ (11,248) $ 24,500 (18.5)% (16.5)% 16.8%
Basic and diluted pro forma net
earnings (loss) per share ..... $ (0.18) $ (0.19) $ 0.46
(1) Certain comparative figures have been reclassified to conform with the
current year's presentation.
(2) Including inventory write-offs of $4,121, $18,463 and nil for the years
ended August 31, 2003, 2002 and 2001, respectively and a non-recurring gain
of $473 for the year ended August 31, 2003. Excluding inventory write-offs
and the non-recurring gain, gross margin would have reached 47.4% for the
year ended August 31, 2003. Excluding inventory write-offs, gross margin
would have reached 50.4% for the year ended August 31, 2002. This latter
information is unaudited and is a non-GAAP measure.
(3) Net earnings (loss) excluding amortization and write-down of goodwill,
non-recurring tax recovery, future income tax assets valuation allowance
and the after-tax effect of amortization and write-down of intangible
assets, restructuring and other charges, inventory and tax credits
write-offs and non-recurring grants recovery. This information may not be
comparable to similarly titled measures reported by other companies because
it is non-GAAP information. Please refer to page 61 of this item for a
detailed quantitative reconciliation.
51
SALES
Sales totaled $61.9 million, $68.3 million and $146.0 million in fiscal
2003, 2002 and 2001, respectively.
Compared to fiscal 2002, sales decreased 9% in 2003 due to increased
pricing pressure by vendors and the continued slowdown in the global
telecommunications industry.
Despite depressed spending levels in the telecommunications industry
and the overall decrease of our sales in fiscal 2003, our sales of Portable and
Monitoring products increased 3%, compared to 2002, mainly because of heightened
traction in the protocol-layer test sector. On the other hand, our Industrial
and Scientific product sales decreased 26% in fiscal 2003, compared to 2002,
mainly due to the collapsed market for optical components and the resulting gray
market. Overall for fiscal 2003, it was a 65%-35% sales split in favor of our
Portable and Monitoring products compared to a 57%-43% split in favor of our
Portable and Monitoring products in 2002.
It should be noted that the exited component manufacturing automation
business generated nominal sales in fiscal 2003. Therefore, the exit of this
business will not have a significant impact on our future sales.
With respect to the new business organization outlined earlier in this
document, it would have been a 79%-21% sales split in favor of our Telecom
Division in fiscal 2003. We expect this split to remain relatively unchanged in
fiscal 2004.
Net accepted orders decreased 4% to $55.7 million in fiscal 2003 from
$58.3 million in 2002. Our net book-to-bill ratio increased to 0.90 in fiscal
2003 compared to 0.85 in 2002. In fiscal 2003, our net accepted orders were more
stable quarter-over-quarter, compared to fiscal 2002, despite the continued
decline in most of our end-markets. We believe that this is a clear indication
that we gained market share overall.
Sales decreased 53% in fiscal 2002, compared to 2001, due to a reduced
demand for our products and pricing pressure attributable to the severe downturn
in the telecommunications industry. Despite the acquisitions of EXFO Burleigh,
EXFO Photonic Solutions and EXFO Protocol, we were not able to maintain our
sales level year-over-year. Both our Portable and Monitoring products and our
Industrial and Scientific products suffered from this lack of demand and pricing
pressure. Our Industrial and Scientific products, however, were the most
affected by the downturn, especially the optical component manufacturer
end-market, given significant industry consolidation and reduced sales volume
following the telecom peak. With regard to sales distribution, it was a 57%-43%
sales split in favor of our Portable and Monitoring products in fiscal 2002
compared to 52%-48% in favor of our Industrial and Scientific products in 2001.
Net accepted orders decreased 56% to $58.3 million in fiscal 2002 from
$132.1 million in 2001. Our book-to-bill ratio decreased to 0.85 in fiscal 2002
from 0.90 in 2001.
North American sales accounted for 59%, 57% and 58% of global sales in
fiscal 2003, 2002 and 2001, respectively. International sales represented 41%,
43% and 42% of global sales in fiscal 2003, 2002 and 2001, respectively. Despite
the relative stability in our international sales between fiscal 2003 and 2002,
as a percentage of total sales, sales to the Asian market decreased to 16% of
global sales in fiscal 2003 compared to 19% in 2002. On the other hand, sales to
the Latin American market increased to 7% of global sales in fiscal 2003
compared to
52
4% of sales in 2002. Most of our sales to these two markets 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.
The increase in international sales in fiscal 2002, compared to 2001,
mainly reflects our sustained efforts to develop the Asian market. Sales to the
Asian market reached 19% of global sales in fiscal 2002 compared to 13% in 2001.
We expect a similar split in favor of our North American sales in
fiscal 2004, considering the current state of the market and our past results.
GROSS MARGIN
Gross margin amounted to 41.6%, 23.4% and 61.5% of sales for fiscal
2003, 2002 and 2001, respectively.
In fiscal 2003, we recorded inventory write-offs of $4.1 million for
obsolete and excess inventories. These special charges were required considering
product phase-outs, reduced needs for the 12 months following the time of the
write-offs, current market conditions as well as our exit from the optical
component manufacturing automation business. In 2003, we also recorded a
non-recurring gain of $473,000 related to a grant recovery upon a tax assessment
received in 2003. Excluding these special items, gross margin would have reached
47.4% of sales. Even excluding these special items, gross margin decreased 3% in
fiscal 2003, compared to 2002, as adjusted on the same basis. The decrease is
attributable to several reasons. First, existing market conditions and the
competitive landscape inevitably led to increased pricing pressure. This,
combined with a lower sales level in fiscal 2003, prevented a better absorption
of our fixed manufacturing costs, which ultimately caused margin erosion. In
addition, shift in product mix in favor of our Portable and Monitoring products
caused our gross margin to decrease, as these products tend to have lower
margins than our Industrial and Scientific products. However, the decrease in
our gross margin was offset in part by our increased efficiency and
restructuring efforts in 2002 and 2003.
In fiscal 2002, we recorded inventory write-offs of $18.5 million for
obsolete and excess inventories. These special charges were recorded due to
weaker demand for our products and our expected needs for the 24 months
following the time of the write-offs. Excluding these special charges, our gross
margin would have reached 50.4% of sales. Even excluding these special charges,
our gross margin decreased 11.1% in fiscal 2002, from 61.5% in 2001, mainly
because of the significant decrease in sales in 2002. Weaker demand for our
products and pricing pressure prevented a better absorption of our fixed
manufacturing costs. Also, our manufacturing capacity in Quebec City, Quebec,
and Victor, New York, almost doubled in fiscal 2001, while sales decreased
significantly in 2002.
With our recent cost-reduction measures and tight control on operating
costs, we believe that our gross margin should improve to at least 50% of sales
in fiscal 2004 compared to 47.4% in fiscal 2003. However, our gross margin may
fluctuate quarter-over-quarter as our sales may fluctuate. Furthermore, our
gross margin can be negatively affected by increased competitive pricing
pressure, increased obsolescence and excess costs, shifts in product mix,
under-absorption of fixed manufacturing costs and increases in product offerings
by other suppliers in the telecommunications test and measurement industry.
53
It should be noted that a new presentation was adopted in 2003, in
which certain expenses were reclassified from selling and administrative
expenses to cost of sales. Consequently, comparative figures have also been
reclassified, resulting in cost of sales increases of 2.3% and 0.9%,
respectively for fiscal 2002 and 2001, with comparable decreases in selling and
administrative expenses for these same years.
SELLING AND ADMINISTRATIVE
Selling and administrative expenses reached $27.0 million, $33.9
million and $45.0 million for fiscal 2003, 2002 and 2001, respectively. As a
percentage of sales, selling and administrative expenses amounted to 43.6%,
49.6% and 30.8% for fiscal 2003, 2002 and 2001, respectively.
As a result of our restructuring plans implemented during the second
and the third quarters of fiscal 2002 and in the third quarter of 2003, we were
able to reduce our selling and administrative expenses by 20% year-over-year.
The decrease in sales in fiscal 2003 also resulted in lower commissions and
marketing expenses. Finally, in fiscal 2003, we recorded a non-recurring gain of
$239,000, related to a grant recovery upon a tax assessment. However, the
decrease in our selling and administrative expenses was offset in part by the
impact of the acquisitions of EXFO Protocol and EXFO Gnubi in November 2001 and
October 2002, respectively.
Also, the increased strength of the Canadian dollar, compared to the US
dollar, in fiscal 2003, prevented us from further reducing our selling and
administrative expenses. A large portion of our selling and administrative
expenses are incurred in Canadian dollars. Consequently, the increase in the
average value of the Canadian dollar, compared to the US dollar, in 2003, caused
our selling and administrative expenses to increase since we report our
financial results in US dollars. Overall, despite the latter reasons, we were
able to reduce our selling and administrative expenses by nearly $7 million
year-over-year, mainly because of the impact of our recent restructuring efforts
and cost-control measures on these expenses.
As a result of the restructuring plans we implemented since June 2001,
combined with the significant sales decrease in fiscal 2002, we were able to
reduce our selling and administrative expenses, including lower commission
expenses in fiscal 2002 compared to 2001. However, this decrease was offset in
part by the impact of the acquisition of EXFO Protocol in November 2001. On the
other hand, the significant drop in sales in fiscal 2002 caused the selling and
administrative expenses percentage to increase since a large portion of these
expenses tend to be fixed and because sales decreased at a faster rate than
selling and administrative expenses.
For fiscal 2004, we expect our selling and administrative expenses in
US dollars to remain flat compared to 2003. We believe that such a level
represents a good balance between cost reduction and an acceptable cost
structure to improve sales, provide quality service to customers, as well as
integrate and run our acquired businesses, thus strategically positioning our
company. Overall, our selling and administrative expenses in Canadian dollars
will decrease as a result of our recent restructuring efforts and tight
cost-control measures. However, the rapid and significant 6.9% increase of the
Canadian dollar at the end of fiscal 2003, compared to its average value of
US$0.675 during that same year, will negatively affect our selling and
administrative expenses.
54
RESEARCH AND DEVELOPMENT
Gross research and development expenses totaled $17.1 million, $17.0
million and $17.6 million for fiscal 2003, 2002 and 2001, respectively. As a
percentage of sales, gross research and development expenses amounted to 27.7%,
24.9% and 12.1% for fiscal 2003, 2002 and 2001, respectively.
Although restructuring actions were fully offset by the impact of the
acquisitions of EXFO Protocol and EXFO Gnubi, our dollar-amount gross research
and development expenses remained flat in fiscal 2003 compared to 2002. These
two subsidiaries' significant level of research and development activities,
combined with the strength of the Canadian dollar, compared to the US dollar,
increased our research and development costs in Canada. The percentage increase
in fiscal 2003, compared to 2002, can be explained by the fact that despite
challenging market conditions, we continued investing heavily in research and
development, especially in the protocol-layer sector. In fact, in 2003, we
launched 15 new products, most of which were telecom-related solutions.
Furthermore, in that same year, 49% of sales originated from products that have
been on the market two years or less.
The slight decrease in gross research and development dollars in fiscal
2002, compared to 2001, is mainly due to the mix and timing of research and
development projects and the effect of our restructuring plans implemented in
2002; these factors were partially offset by the impact of the acquisition of
EXFO Protocol. In fiscal 2002, we released 25 new products and 48% of sales
originated from products that have been on the market two years or less.
Tax credits and grants from Canadian federal and provincial governments
for research and development activities were $3.6 million, $4.2 million and $4.0
million for fiscal 2003, 2002 and 2001, respectively. The dollar-amount decrease
in tax credits and grants in fiscal 2003, compared to fiscal 2002, is mainly due
to three reasons. First, our government grant programs came to an end. Second,
the recent acquisition of U.S.-based EXFO Gnubi led to a larger portion of our
R&D activities being conducted in the U.S., where such activities are not
eligible for tax credits. And, finally, we did not record Canadian federal tax
credits for EXFO Protocol in the fourth quarter of 2003 because it is more
likely than not that those credits will be recovered in the medium term.
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 some tax credits will not be recovered and that a write-off was
required. Accordingly, in the third quarter of fiscal 2003, we wrote off $2.3
million in Canadian federal tax credits related to EXFO Protocol and, as
mentioned above, we did not record such credits for this subsidiary in the
fourth quarter of 2003. All tax credits written off can be carried forward
against future years' income taxes payable over the next ten years. Canadian
federal tax credits are only refundable against income taxes payable.
Our tax credits and grants remained relatively flat between fiscal 2002
and 2001 since our gross research and development expenses were relatively
unchanged year-over-year and since we were entitled to the same grant programs
and tax credits.
Although we intend to reduce our research and development expenses (as
a percentage of sales) in the future and despite our recent cost-reduction
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
55
expectations. This investment in R&D will be focused on solutions for the
network-service-provider and system-vendor markets as they are the first two
links in the global telecommunications supply chain that are expected to
recover. More specifically, we intend to expand our protocol-layer product
offering to complement our physical-layer product portfolio and selectively
reduce our cost of goods while improving performance.
AMORTIZATION OF INTANGIBLE ASSETS
In conjunction with the four strategic acquisitions we completed in the
last three fiscal years, we recorded $62.0 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 respective dates
of acquisition, resulted in amortization expenses of $4.7 million, $11.6 million
and $9.9 million in fiscal 2003, 2002 and 2001, respectively.
Considering respective impairment charges of $2.9 million and $23.7
million for intangible assets recorded in fiscal 2003 and 2002, the amortization
expense decreased by approximately $6.4 million year-over-year. Also, as at
August 31, 2002, acquired in-process research and development and workforce
related to the acquisitions made in fiscal 2001 and 2002 were fully amortized,
reducing current-year amortization expenses as well.
We expect the amortization of intangible assets to be approximately
$1.0 million per quarter in fiscal 2004, assuming no acquisitions are made
during this time.
WRITE-DOWN OF GOODWILL AND INTANGIBLE ASSETS
In May 2003, we performed our annual impairment test of goodwill for
all our reporting units, except for newly acquired EXFO Gnubi. Also, considering
the persisting unfavorable market conditions affecting our subsidiaries'
industries, 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 an impairment charge of $4.5 million for goodwill and a pre-tax
impairment charge of $2.9 million for acquired core technology. Of the total
impairment charge, an amount of $6.9 million was related to EXFO Burleigh for
goodwill and acquired core technology and $555,000 was related to EXFO Photonic
Solutions for acquired core technology.
The write-down of goodwill and acquired core technology of EXFO
Burleigh was required, considering that we exited the optical component
manufacturing automation business, whose revenue potential represented a
long-term prospect. The write-down of acquired core technology from EXFO
Photonic Solutions was required because revenue potential related to this
long-lived asset was less than expected in the short and medium term due to the
current state of the market.
However, no impairment of goodwill and intangible assets was required
for EXFO Protocol since we believe that revenue potential from the
protocol-layer testing market will remain strong in the short and medium term.
For the purposes of estimating fair values, we used a combination of
discounted future cash flows and a market approach (sales multiples). The
discounted cash flows were estimated
56
using periods ranging between eight and ten years, discount rates ranging
between 15% and 20%, and an annual growth rate ranging between nil and 35%. The
sales multiples used in the market approach 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.
In May 2002, as part of our review of financial results, we performed
an assessment of the carrying value of goodwill and intangible assets recorded
in conjunction with the acquisitions of EXFO Burleigh, EXFO Photonic Solutions
and EXFO Protocol. The assessment was performed because of the severe and
continued downturn in the telecommunications industry, the persisting
unfavorable market conditions affecting our subsidiaries' industries and the
decline in technology valuations. The growth prospects for our subsidiaries were
significantly lower than previously expected and less than those of historical
periods. In addition, the decline in market conditions affecting the
subsidiaries was significant and other than temporary. As a result, we concluded
that the carrying value of goodwill and certain acquired intangible assets was
impaired and we recorded a charge of $222.2 million to write down a significant
portion of goodwill and a pre-tax charge of $23.7 million to write down a
significant portion of acquired core technology. Of the total impairment loss of
$245.8 million, an amount of $125.0 million was related to EXFO Burleigh for
goodwill and acquired core technology, $71.5 million was related to EXFO
Photonic Solutions for goodwill and acquired core technology and $49.3 million
was related to EXFO Protocol for goodwill.
The impairment loss was calculated as the excess of the carrying value
of the assets over the pre-tax undiscounted future cash flows. The pre-tax
undiscounted future cash flows were estimated at the subsidiaries' level, since
we had distinct cash flows for each of them and because they were not fully
integrated into our activities. The cash flow periods used ranged from three to
five years and the annual growth rates ranged between 15% and 30%.
RESTRUCTURING AND OTHER CHARGES
In fiscal 2001, we implemented a structured plan to reduce our costs
and increase our efficiency. Under that plan, we recorded charges of $3.3
million, including $0.8 million in severance expenses for the 245 employees who
were terminated throughout the company, $1.5 million for unused long-lived
assets and $1.0 million for future payments on exited leased facilities located
in the United States.
In fiscal 2002, we implemented additional structured plans to further
reduce our costs. Under these plans, we recorded charges of $2.9 million,
including $2.0 million in severance expenses for the 350 employees who were
terminated throughout the company and $900,000 for unused long-lived assets.
In fiscal 2003, we implemented another structured plan to realign our
cost structure to current market conditions. Under this new plan, we recorded
additional charges of $4.1 million, including $2.8 million in severance expenses
for the 172 employees who were terminated throughout the company, $512,000 for
unused long-lived assets and $855,000 for future payments on exited leased
facilities located around the world. Our estimation of the fair value of such
future payments takes into account the estimated sublease rentals over the
remaining terms of the exited leases.
57
All these special charges are included in the restructuring and other
charges in the statements of earnings of the reporting years.
Our cost-reduction measures represent our best efforts to respond to
the difficult market conditions and we expect that they will enable us to reach
positive cash flows from operating activities at the end of fiscal 2004.
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
Our interest income mainly resulted from our short-term investments,
less interest and bank charges. Net interest income amounted to $1.2 million,
$1.5 million and $6.1 million for fiscal 2003, 2002 and 2001, respectively. Our
net interest income remained relatively flat in fiscal 2003, compared to 2002,
while it significantly decreased in 2002 compared to 2001. This decrease was due
to the decline in interest rates during 2002 as well as our use of short-term
investments to finance strategic acquisitions, operating activities and the
purchase of property, plant and equipment.
We expect our net interest income to remain relatively flat in fiscal
2004, compared to 2003, as we anticipate our cash position and interest rates to
remain relatively unchanged.
FOREIGN EXCHANGE GAIN (LOSS)
Foreign exchange loss amounted to $1.6 million in fiscal 2003 compared
to a foreign exchange loss of $458,000 in 2002 and a foreign exchange gain of
$3.3 million in 2001.
The foreign exchange losses in fiscal 2003 and 2002 are the result of
the translation of operating activities denominated in currencies other than the
Canadian dollar. During fiscal 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.
The foreign exchange gain in fiscal 2001 can be mostly attributed to
the disposal of short-term investments denominated in US dollars and the
translation of operating activities denominated in currencies other than the
Canadian dollar.
We manage our exposure to currency risk with forward exchange contracts
and operating activities of Canadian entities denominated in currencies other
than the Canadian dollar. Please refer to note 18 to our consolidated financial
statements included elsewhere in this annual report.
INCOME TAXES
Our effective income tax recovery rate was 35.8% (before the future
income tax assets valuation allowance and the non-recurring tax recovery) in
fiscal 2003, compared to 34.5% in 2002 and compared to our effective income tax
rate in fiscal 2001, which was 34.1%.
Compared to fiscal 2002, our effective income tax recovery rate
increased in 2003 because a larger portion of our tax losses were incurred in
jurisdictions, such as in the U.S., where the recovery rates were higher.
58
In the third quarter of 2003, we reviewed the carrying value of our
future income tax assets. Considering existing market conditions, as well as the
fact that we recorded losses for the current and past years, and that we exited
the optical component manufacturing automation business, we concluded that it
was more likely than not that all our future income tax assets will not be
recoverable and that a valuation allowance was required. Even though the
carrying periods of our future income tax assets are very long or indefinite, we
recorded a valuation allowance of $28.4 million to write off all 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, share issue expenses as well as
non-deductible provisions and accruals.
From the $28.4 million valuation allowance, most of which is related to
our domestic and U.S. companies, an amount of $13.8 million is related to
deferred tax losses that can be carried forward against taxable income in
several jurisdictions and $13.4 million is related to research and development
expenses as well as provisions and accruals that can be carried forward
indefinitely against future years' taxable income. Note 15 to our consolidated
financial statements outlines significant components of future income tax assets
and liabilities and the valuation allowance.
The valuation allowance recognized in fiscal 2003 will be reversed once
management concludes that realization of these assets is more likely than not.
Consequently, our future period tax rates will be distorted compared to previous
periods.
AMORTIZATION OF GOODWILL
In conjunction with the four strategic acquisitions that we completed
over the last three fiscal years, 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 $38.0 million and $31.1 million in fiscal 2002 and
2001, respectively. The acquisitions of EXFO Protocol and EXFO Gnubi have been
accounted for using new accounting standards contained in CICA handbook sections
1581 and 3062 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 expenses for goodwill.
NET LOSS AND PRO FORMA NET EARNINGS (LOSS)
Net loss amounted to $55.0 million, $308.5 million and $15.3 million in
fiscal 2003, 2002 and 2001, respectively. In terms of per share amounts, we
recorded a net loss of $0.87, $5.09 and $0.29 in fiscal 2003, 2002 and 2001,
respectively.
Also, as a measure to assess financial performance, we use pro forma
net earnings (loss) and pro forma net earnings (loss) per share. Pro forma net
earnings (loss) represent net earnings (loss) excluding amortization and
write-down of goodwill, non-recurring tax recovery, future income tax assets
valuation allowance and the after-tax effect of amortization and write-down of
intangible assets, restructuring and other charges, inventory and tax credit
write-offs and non-recurring grants recovery.
59
Pro forma net loss amounted to $11.5 million and $11.2 million in
fiscal 2003 and 2002 compared to pro forma net earnings of $24.5 million in
2001. In terms of pro forma per share amounts, we recorded a net loss of $0.18
and $0.19 in fiscal 2003 and 2002 compared to net earnings of $0.46 in 2001.
Pro forma net earnings (loss) is reconciled as follows:
YEARS ENDED AUGUST 31, 2003 2002 2001
----------------------------------------------------------------------------------------------
(UNAUDITED) (UNAUDITED) (UNAUDITED)
Net loss in accordance with GAAP $ (54,950) $(308,524) $ (15,294)
Pro forma adjustments:
Amortization of goodwill -- 38,021 31,076
Amortization of intangible assets 4,747 11,615 9,876
Write-down of goodwill 4,505 222,169 --
Write-down of intangible assets 2,922 23,657 --
Tax effect on amortization and write-down of
intangible assets (2,745) (12,167) (3,363)
Restructuring and other charges and inventory and tax
credit write-offs 10,549 21,343 3,288
Tax effect on restructuring and other charges and
inventory and tax credit write-offs (3,777) (7,362) (1,083)
Non-recurring tax and grants recovery (1,357) -- --
Tax effect on non-recurring grants recovery 245 -- --
Future income tax assets valuation allowance 28,385 -- --
----------------------------------------------------------------------------------------------
Pro forma net earnings (loss) $ (11,476) $ (11,248) $ 24,500
==============================================================================================
Basic and diluted net loss per share $ (0.87) $ (5.09) $ (0.29)
Basic and diluted pro forma net earning (loss) per
share $ (0.18) $ (0.19) $ 0.46
The financial information we provide is pro forma, thus helping the
investor better understand our normalized operating results as non-recurring and
special items are excluded. 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.
LIQUIDITY AND CAPITAL RESOURCES
Over the past years, we have financed our operations and major
investments and met our capital expenditure requirements mainly through cash
flows from operating activities, the use of cash and short-term investments and
the issuance of subordinate voting shares. For the upcoming year, we will
finance our operations and capital expenditure requirements mainly through cash
flows from operating activities and cash and short-term investments.
As mentioned earlier, maintaining a sound financial position is one of
the four main objectives of our strategic plan. We believe that such an
objective is in line with a strong cash position. As at August 31, 2003, our
cash and short-term investments amounted to $57.4 million and we had almost no
debt. Our working capital was at $76.7 million. Our cash and short-term
investments increased by $7.7 million in fiscal 2003, compared to 2002, mainly
due to an
60
unrealized foreign exchange gain on cash and short-term investments of $6.8
million and cash flows from operating activities of $5.6 million, less cash
payments of $1.9 million and $2.7 million for the acquisition of EXFO Gnubi and
the purchase of property, plant and equipment. The unrealized foreign exchange
gain resulted from the translation of our cash and short-term investments in US
dollars, which is our reporting currency, and was recorded in the cumulative
translation adjustment in the balance sheet.
We believe that our cash balances and short-term investments, combined
with an available line of credit of $6.2 million, will be sufficient to meet our
expected liquidity and capital requirements for at least the next 18 months. Our
line of credit bears interest at prime rate.
However, 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.
The following table summarizes our commitments as at August 31, 2003:
YEARS ENDING 2008 AND
AUGUST 31, 2004 2005 2006 2007 LATER TOTAL
-------------------------------------------------------------------------------------------------------
Long-term debt $ 110,000 $ 122,000 $ 135,000 $ 146,000 $ 50,000 $ 563,000
Operating leases 1,078,000 908,000 898,000 764,000 1,668,000 5,316,000
Contingent cash
consideration in
business combination* 200,000 -- -- -- -- 200,000
-------------------------------------------------------------------------------------------------------
Total commitments $1,388,000 $1,030,000 $1,033,000 $ 910,000 $1,718,000 $6,079,000
=======================================================================================================
* estimated amount
OPERATING ACTIVITIES
Cash flows provided by operating activities amounted to $5.6 million in
fiscal 2003, compared to cash flows used of $8.7 million in 2002 and cash flows
provided of $3.9 million in 2001.
Cash flows provided by operating activities in fiscal 2003 were mainly
the result of a decrease in some of our working capital items; that is, our
accounts receivable decreased by $4.0 million, our income taxes and tax credits
recoverable decreased by $13.9 million and our inventories decreased by $7.9
million (excluding write-offs). These positive effects on cash were offset in
part by the net loss after items not affecting cash of $19.7 million. The
decrease in our accounts receivable is directly related to the reduction in our
sales. The decrease in our income taxes and tax credits recoverable is related
to the recovery, during the year, of income taxes and research and development
tax credits recoverable from previous periods. Finally, the decrease in our
inventories is due to our efforts to maintain them at the lowest acceptable
level considering the decrease in sales.
Cash flows used by operating activities in fiscal 2002 were primarily
due to the net loss after items not affecting cash of $1.1 million, combined
with the increase of income taxes and tax credits receivable of $19.7 million
and the decrease in accounts payable and accrued liabilities of $7.5 million.
These figures were partially offset by the result of the net decrease in
accounts receivable and inventories of $19.7 million. The increase in our income
taxes and tax credits receivable is related to income tax recoverable following
the carry-back to previous
61
years' taxable income of our consolidated tax loss, while the decrease in our
accounts payable and accrued liabilities is due to the reduction in our
purchases following the slowdown in our industry. The decrease in our accounts
receivable is due to the reduction in our sales level and to the improvement in
our days of sales outstanding ("DSOs"), while the decrease in our inventories is
due to our efforts to maintain them at the lowest acceptable level considering
the decrease in sales.
FINANCING ACTIVITIES
Cash flows used by financing activities amounted to $56,000, $90,000
and $4.6 million in fiscal 2003, 2002 and 2001, respectively. Cash flows used by
financing activities over the last two years were mainly due to the repayment of
our long-term debt. As at August 31, 2003, our long-term debt amounted to
$563,000.
INVESTING ACTIVITIES
Cash flows used by investing activities totaled $9.9 million in fiscal
2003 compared to cash flows provided of $10.5 million and $8.4 million in 2002
and 2001.
In fiscal 2003, we acquired $5.4 million in short-term investments with
proceeds from the recovery of income taxes and tax credits. We also made cash
payments of $1.9 million and $2.6 million for the acquisition of EXFO Gnubi and
the purchases of property, plant and equipment.
In fiscal 2002, we disposed of $25.5 million in short-term investments
to finance operating activities of $8.7 million as well as the respective cash
payments of $9.8 million and $5.2 million for the acquisition of EXFO Protocol
and the purchase of property, plant and equipment.
CONTINGENCY
As discussed in note 12 to our consolidated financial statements
included elsewhere in this annual report, in November 2001, the company was
named as a defendant in a U.S. securities class action related to its initial
public offering (IPO) in June 2000. The complaints allege that the prospectus
and the registration statement for the IPO failed to disclose that the
underwriters allegedly received excessive commissions and that the underwriters
and some investors collaborated in order to inflate the price of EXFO's stock in
the aftermarket.
On June 26, 2003, the Plaintiff's Executive Committee announced that a
proposed settlement between the issuers and their directors and officers and the
plaintiffs had been structured. A Memorandum of Understanding ("MOU") to settle
the plaintiffs' claims against the issuers and their directors and officers has
now been approved as to form and the process of obtaining approval by all
parties to the MOU is now underway. The parties will be required to prepare many
complex documents necessary to consummate the settlement, which will be
submitted to the Court for preliminary approval. Final approval will be required
by the Court following notice to class members and a fairness hearing. If this
tentative settlement is successfully finalized, the company and the individual
defendants will be released from the litigation. Any direct financial impact of
the proposed settlement is expected to be borne by our insurance carriers.
62
Since the settlement process is subject to a fairness hearing and final
court approval, it is possible that it could fail. Therefore, it is not possible
to predict the final outcome of the case, nor determine the amount of any
possible losses. If the settlement process fails, the company will continue to
defend its position in this litigation that the claims against EXFO, and its
officers, are without merit. Accordingly, no provision for this case has been
made in the consolidated financial statements as of August 31, 2003.
STOCK OPTION PLAN
The aggregate number of subordinate voting shares covered by options
granted under the stock option plan was 3,176,613 as at August 31, 2003. The
weighted average exercise price of those stock options was $15, compared to the
market price of $2.64 per share as at August 31, 2003. A total of 1,068,095
options were exercisable as at August 31, 2003, with a weighted average exercise
price of $22. 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
August 31, 2003:
NUMBER % OF ISSUED WEIGHTED AVERAGE
AND OUTSTANDING EXERCISE PRICE
---------------------------------------------------------------------------------------------
Chairman of the Board, President and CEO
(one individual) 150,482 4.74% $ 9.91
Board of Directors (four individuals) 131,875 4.15 7.41
Management and Corporate Officers
(nine individuals) 350,775 11,04 13.90
---------------------------------------------------------------------------------------------
633,132 19.93% $ 11.60
=============================================================================================
For the year ended August 31, 2003, as permitted by section 3870 of the
CICA handbook, we chose not to account for stock-based compensation costs
arising from awards to employees. However, we complied with the required pro
forma disclosures with respect to net loss and net loss per share in our
consolidated financial statements. In September 2003, the CICA released
amendments to handbook section 3870, "Stock-Bases Compensation and Other
Stock-Based Payments". These amendments, which are effective for fiscal years
beginning on or after January 1, 2004, require an expense to be recognized in
financial statements for all form of employees stock-based compensation,
including stock options, using a fair value-based method. We prospectively
adopted these amendments on September 1, 2003 and consequently, we will
recognize an expense for all awards granted to employees commencing on September
1, 2003.
Please refer to note 13 to our consolidated financial statements
included elsewhere in this annual report for further disclosure about our
stock-based compensation plans.
OFF-BALANCE SHEET ARRANGEMENTS
For the years ended August 31, 2002, 2002 and 2003, there were no
off-balance sheet arrangements.
63
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
A. DIRECTORS AND SENIOR MANAGEMENT
The following table sets forth information about our executive
officers, senior managers and directors as of December 31, 2003.
NAME AND MUNICIPALITY OF RESIDENCE POSITIONS WITH EXFO
------------------------------------ -------------------------------------
STEPHEN BULL Vice-President, Research and
Ile-des-Soeurs, Quebec Development
ALLAN FIRHOJ Vice-President and General Manager,
Mississauga, Ontario Photonics and LifeSciences Division
ETIENNE GAGNON Vice-President, Physical Layer
Sillery, Quebec Product Management andCustomer Service
LUC GAGNON Vice-President, Telecom Manufacturing
St-Augustin de Desmaures, Quebec Operations
JUAN-FELIPE GONZALEZ Vice-President, Global Telecom Sales
Singapore
GERMAIN LAMONDE Chairman of the Board, President and
Cap-Rouge, Quebec Chief Executive Officer
PIERRE MARCOUILLER Director
Magog, Quebec
KIMBERLEY ANN OKELL Secretary and Legal Counsel
Quebec City, Quebec
PIERRE PLAMONDON, CA Vice-President, Finance and Chief
Quebec City, Quebec Financial Officer
JAMES STEVENS Vice-President, Protocol Layer
Dallas, Texas Product Management and Chief
Technology Officer
DAVID A. THOMPSON Director
Newton, North Carolina
ANDRE TREMBLAY Director
Outremont, Quebec
MICHAEL UNGER Director
Woodbridge, Ontario
The address of each of our executive officers, senior managers and
directors is c/o EXFO Electro-Optical Engineering Inc., 400 Godin Avenue,
Vanier, Quebec, Canada. The following is a brief biography of each of our
executive officers, senior managers and directors.
STEPHEN BULL was appointed our Vice-President, Research and Development
in December 1999. He joined us in July 1995 and held the positions of Assistant
Director-Engineering from September 1997 to December 1999 and Group Leader
(Engineering Management) from July 1995 to September 1997. From June 1990 to
March 1995, Mr. Bull held the position of General Manager and Managing Director
for Space Research Corporation, a military engineering company in Belgium. Mr.
Bull holds a bachelor's degree in Electrical Engineering from Laval University
in Canada.
64
ALLAN FIRHOJ was appointed Vice-President and General Manager,
Photonics and Life Sciences Division in July 2003. Prior to that, he held the
position of General Manager of EXFO Photonic since November 2001. He is
responsible for the overall strategic direction and management of the Photonics
and Life Sciences Division. When Mr. Firhoj joined EFOS in 1996, he was
responsible for Sales, Marketing and Business Development of the Dental
Curing-Products Division. Following the sale of this division to Dentsply
International in 1997, he was appointed Director of Marketing and Business
Development. Mr. Firhoj continued in this capacity until being appointed to the
position of General Manager of EXFO Photonic. Prior to joining the company, Mr.
Firhoj spent six years with The Horn Group, a plastics business involved in
medical devices/instrumentation and office communication equipment. He
successively held the positions of ISO 9000 Implementation Manager, Technical
Sales Manager as well as Marketing and Business Development Manager. In this
latter role, he successfully contributed to increasing sales in their medical
market by an annual average of 60% during a three-year period. Mr. Firhoj holds
a bachelor's degree in Political Science from Bishop's University in
Lennoxville, Quebec.
ETIENNE GAGNON was appointed Vice-President of Physical-Layer Product
Management and Customer Service in May 2003. He is responsible for EXFO's
general marketing direction, on both the product level and communications level,
and also oversees our customer service department. For nearly three years,
before returning to EXFO in early 2003, Mr. Gagnon was Vice-President of Sales
and Marketing at TeraXion, an optical component manufacturer based in Quebec
City. Mr. Gagnon began his career as a design engineer for Bombardier/Canadair,
where he worked on the Canadian Regional Jet project between 1990 and 1993.
Later, he held the position of Business Development Manager for France Telecom
in Hungary. In 1994, he joined EXFO's European office as a Regional Sales
Manager, and in 1996, he was brought back to Quebec City to head the OSP
marketing group. Mr. Gagnon then went on to become the director of our Outside
Plant division in 1998, and remained in that function until he joined TeraXion
in 2000. Mr. Gagnon holds a bachelor's degree in Mechanical Engineering from the
Ecole Polytechnique School of Engineering (University of Montreal), and a
master's degree in European Business from the Ecole nationale superieure des
telecommunications in France.
LUC GAGNON was appointed Vice-President, Telecom Manufacturing
Operations in May 2003. He is responsible for ensuring the smooth operation of
all manufacturing activities, which include production, purchasing, product
engineering, quality assurance, planning, manufacturing engineering, product
configuration, transportation and customs, as well as material resources. Prior
to his recent nomination, Mr. Gagnon held the position of Production Director
since 2000. Before joining EXFO, he had similar roles in several other
high-technology companies. He worked for Mendes from 1999 to 2000, for C-MAC
from 1997 to 1999, for STERIS from 1993 to 1997 and for MITEL from 1991 to 1993.
Mr. Gagnon holds a bachelor's degree in electrical engineering and master's
degree in engineering, both from the Universite de Sherbrooke, in Canada.
JUAN-FELIPE GONZALEZ assumed the position of Vice-President, Global
Telecom Sales in July 2003. Prior to that he had been our Vice-President,
International Sales since September 1998. From January 1997 to September 1998,
he was our International Sales Director and, from September 1993 to January
1997, our Sales Manager for Latin America and the Caribbean. Prior to joining us
in September 1993, Mr. Gonzalez was Marketing and Sales Director at Reyde,
Barcelona, a plastics technical product corporation in Spain. Mr. Gonzalez holds
a bachelor's degree in Industrial Chemistry from Complutense University of
Madrid in Spain and a master's degree in Business Administration from the School
of Industrial Organization in Spain.
65
GERMAIN LAMONDE is one of our founders. Germain Lamonde has been our
Chairman of the Board, President and Chief Executive Officer since our inception
in 1985. Mr. Lamonde holds a bachelor's degree in Physics Engineering from Ecole
Polytechnique, University of Montreal in Canada and a master's degree in Optics
from Laval University in Canada.
PIERRE MARCOUILLER has served as our director since May 2000. Mr.
Marcouiller is Chairman of the Board and Chief Executive Officer of Camoplast
Inc., a supplier of components to the recreational and motorized vehicle and
automotive parts markets. He is the founder and has been sole shareholder of
Nexcap Inc., an investment company in the manufacturing sector, since December
1996. Mr. Marcouiller worked with Venmar Ventilation Inc., a private ventilation
equipment manufacturer, from January 1983 to December 1996. Mr. Marcouiller was
the controlling shareholder of Venmar from 1991 to 1996 and held the position of
President and General Manager of Venmar from December 1986 to December 1996. Mr.
Marcouiller is also a director of Heroux-Devtek Inc., a publicly traded company
that manufactures aerospace and industrial turbines, and holds directorships in
other privately held companies. Mr. Marcouiller holds a bachelor's degree in
Business Administration from Universite du Quebec a Trois-Rivieres in Canada and
a Master in Business Administration from Sherbrooke University in Canada.
KIMBERLEY ANN OKELL has been our in-house legal counsel since February
2000 and our Secretary since May 2000. Prior to joining us, Ms. Okell was
Vice-President Legal Affairs and Secretary with Groupe Equiconcept Inc. from
October 1999 to February 2000 and Director of Legal Services and Secretary with
Informission Group Inc., now nurun Inc., an information technology company, from
December 1997 to October 1999. Prior to that, Ms. Okell was an associate with
the law firm McCarthy Tetrault from August 1994 to December 1997. Ms. Okell has
been a member of the Quebec Bar since September 1993. Ms. Okell holds a
bachelor's degree in Civil Law from Laval University in Canada, a bachelor's
degree in Common Law from The University of Western Ontario in Canada and an
Honors bachelor of Arts degree from York University in Canada.
PIERRE PLAMONDON has been our Vice-President, Finance and Chief
Financial Officer since January 1996 and was a director from December 1999 to
May 2000. Prior to joining us, Mr. Plamondon served as senior manager for Price
Waterhouse, now PricewaterhouseCoopers LLP, from September 1981 to December 1995
in Canada and France. Mr. Plamondon holds a bachelor's degree in Business
Administration and a license in Accounting, both from Laval University in
Canada. Mr. Plamondon has been a member of the Canadian Institute of Chartered
Accountants since 1983 and a member of the Board of Directors of SOVAR Inc.
(Societe de valorisation des applications de la recherche de l'Universite Laval)
since December 2000.
JAMES STEVENS co-founded gnubi communications in 1994, and now acts as
Vice-President Protocol Layer Product Management and Chief Technology Officer.
He is responsible for the overall product management of EXFO's protocol product
line. Mr. Stevens began his professional career with E-Systems, where he spent
several years in engineering development. In 1987, he started his own company,
which specialized in the design of application-specific integrated circuits
(ASICs) and electro-optic devices. During the seven-year life of his firm, at
the request of two of his customers (Perkins Manufacturing and Antel) Mr.
Stevens temporarily stepped into the role of engineering director for these
companies. James Stevens' desire to develop innovative products for the
telecommunications industry ultimately resulted in the foundation of gnubi
communications and the unique re-configurable test systems still manufactured by
EXFO Gnubi Products Group. Mr. Stevens received a bachelor's degree in
66
Electrical Engineering from the University of Illinois, where he also spent
three years working as a technician for the department of Electrical
Engineering.
DAVID A. THOMPSON has served as our director since June 2000. Dr.
Thompson joined Corning's Research and Development Division in 1976 as a Senior
Chemist in glass research. Most recently, he was named Division Vice-President
for strategic Planning and Innovation Effectiveness in Research, Development and
Engineering. Between 1988 and 1998, Dr. Thompson held technology Director and
Strategic Planning roles for Corning's Component and Photonics Technologies
Divisions. In 1999, he was named Technical Leader for the creation of the new
Samsung-Corning Micro-Optics joint venture. Dr. Thompson received a bachelor's
degree in Chemistry from Ohio State University and a doctorate in Inorganic
Chemistry from the University of Michigan. He holds 13 patents and has more than
20 technical publications in the areas of inorganic chemistry, glass technology
and telecommunications.
ANDRE TREMBLAY has been President and Chief Executive Officer of
Microcell Telecommunications since May 1995, and has also been a member
Microcell's Board of Directors since November of that same year. In addition to
his role at Microcell, Mr. Tremblay sits on the Board of Directors of the
Communications Research Centre (a research arm of the federal government's
Department of Industry) as well as the boards of other private and public
corporations. Andre Tremblay began his career in the telecommunications industry
in 1985, as an advisor to the Chairman and Chief Executive Officer of Telesystem
Ltd. He subsequently held various executive positions within that company. Mr.
Tremblay holds bachelor's degrees in Management and in Accounting from Laval
University, as well as a master's degree in Taxation from the UNIVERSITE DE
SHERBROOKE, both in Canada. He also completed the Advanced Management Program
offered by the Harvard Business School in the United States.
MICHAEL UNGER has served as our director since May 2000. He worked with
Nortel Networks Limited, now Nortel Networks Corporation, from 1962 to 2000. Mr.
Unger's most recent position was President of Nortel's Optical Networks Business
Unit, a position he held from May 1998 to April 2000. Prior to this appointment,
Mr. Unger was Nortel's Group Vice-President, Transport Networks from March 1990
to May 1998. Mr. Unger also serves on the board of Tundra Semiconductor
Corporation a publicly traded company with its shares listed on The Toronto
Stock Exchange that designs, develops and markets networking and network access
technology for use by communications infrastructure equipment companies. He is
also a member of the boards of a number of privately-held companies active in
the areas of photonic and optical components, optical network systems and
solutions for cable operators and other communications service providers. Mr.
Unger holds a bachelor's degree in Science from Concordia University in Canada.
TERM OF EXECUTIVE OFFICERS
Executive officers are appointed annually by the board of directors and
serve until their successors are appointed and qualified or until earlier
resignation or removal.
B. COMPENSATION
DIRECTOR COMPENSATION
In the financial year terminated August 31, 2003, our directors who are
not officers or employees receive the level of compensation set forth in the
table below as annual compensation payable in the form of cash, stock, or stock
options as chosen by the director. In
67
addition, each director is granted 12,500 stock options under our stock option
plan as part of his annual compensation.
--------------------------------------------------------------------------------------------------------------------
Annual Retainer for Directors: CDN$25,000 US$16,895
--------------------------------------------------------------------------------------------------------------------
Annual Retainer for Committee Chairman: CDN$5,000 US$3,379
--------------------------------------------------------------------------------------------------------------------
Annual Retainer for Committee Members: CDN$3,000 US$2,027
--------------------------------------------------------------------------------------------------------------------
Fees for all Meetings Attended per day in Person: CDN$1,000 US$675
--------------------------------------------------------------------------------------------------------------------
Fees for all Meetings Attended per day by Telephone: CDN$500 US$338
--------------------------------------------------------------------------------------------------------------------
In the financial year ended August 31, 2003, the directors who were not
employees received the following compensation in the form indicated:
--------------------------------------------------------------------------------------------------------------------
ANNUAL ANNUAL TOTAL
COMPENSATION COMPENSATION EXERCISE EXPIRATION ATTENDANCE FEES
PAID IN CASH PAID IN STOCK PRICE OF DATE OF PAID IN CASH
NAME (US$) OPTIONS (#) (1) OPTIONS (2) OPTIONS (US$)
--------------------------------------------------------------------------------------------------------------------
Pierre Marcouiller (3) 20,950 12,500 US$1.58 Sept. 25, 2012 7,434
--------------------------------------------------------------------------------------------------------------------
Dr. David A. Thompson (4) 18,923 12,500 US$1.58 Sept. 25, 2012 7,771
--------------------------------------------------------------------------------------------------------------------
Andre Tremblay (5) 22,302 12,500 US$1.58 Sept. 25, 2012 7,434
--------------------------------------------------------------------------------------------------------------------
Michael Unger (6) 22,302 12,500 US$1.58 Sept. 25, 2012 8,110
--------------------------------------------------------------------------------------------------------------------
---------------
(1) Indicates the number of Subordinate Voting Shares underlying the options
granted under the Stock Option Plan.
(2) The exercise price of options is determined based on the highest of the
closing prices of the Subordinate Voting Shares on the Toronto Stock
Exchange and the NASDAQ National Market on the last trading day preceding
the grant date, using the noon buying rate of the Federal Reserve Bank of
New York on the grant date to convert the NASDAQ National Market closing
price to Canadian dollars, as required. These options vest at a rate of
12.5% after the first 6 months, 12.5% after 12 months and 25% annually
thereafter commencing on the second anniversary date of the grant.
(3) Member of the Audit Committee and the Human Resources Committee.
(4) Member of the Human Resources Committee.
(5) Member of the Human Resources Committee and Chairman of the Audit
Committee.
(6) Member of the Audit Committee and Chairman of the Human Resources
Committee.
EXECUTIVE COMPENSATION
The table below shows compensation information during the three most
recently completed financial years for Mr. Germain Lamonde, our Chairman of the
Board, President and Chief Executive Officer, our other four other most highly
compensated executive officers who were serving at the end of the financial
year, and three other executive officers who would have been included within the
four most highly compensated executive officers had they been in our employ, at
the year end (collectively, the "Named Executive Officers"). This information
includes the US dollar value of base salaries, bonus awards and long-term
incentive plan payments, the number of options granted, and other compensation,
if any, whether paid or deferred.
68
-----------------------------------------------------------------------------------------------------------------------
SECURITIES
OTHER ANNUAL UNDER ALL OTHER
NAME AND PRINCIPAL FINANCIAL SALARY(1) BONUS(2) COMPENSATION OPTIONS(3) COMPENSATION
POSITION YEAR ($) ($) ($) (#) ($)
-----------------------------------------------------------------------------------------------------------------------
Germain Lamonde, 2003 185,848 (US) 25,247 (US) -- 50,000 --
President and Chief 275,000 (CDN) 37,359 (CDN)
Executive Officer 2002 174,758 (US) 21,329 (US) -- 70,000 --
275,000 (CDN) 33,563 (CDN)
2001 180,044 (US) 99,024 (US) -- 5,080 --
275,000 (CDN) 137,500 (CDN)
-----------------------------------------------------------------------------------------------------------------------
Juan-Felipe Gonzalez, 2003 163,896 (US) 7,500 (US) -- 30,000 --
Vice-President,
Global Telecom Sales 2002 158,193 (US) -- -- 30,000 --
2001 204,781 (US)(4) 129,629 (US)(5) -- 45,630 --
-----------------------------------------------------------------------------------------------------------------------
James Stevens,
Vice-President Product
Management and Chief
Technology Officer 2003 175,000 (US)(6) -- -- 12,000 4,624 (US)(7)
(Protocol)
-----------------------------------------------------------------------------------------------------------------------
John Holloran Jr.,
Interim General Manager
and Special Projects 2003 140,000 (US)(8) 12,692 (US) -- 9,000 4,114 (7)
-----------------------------------------------------------------------------------------------------------------------
Pierre Plamondon, 2003 118,267 (US) 9,547 (US) -- 25,000 866 (US)(7)
Vice-President Finance and 175,000 (CDN) 14,127 (CDN) 1,281 (CDN)
Chief Financial Officer 2002 95,323 (US) 5,817 (US) -- 19,000 886 (US)
150,000 (CDN) 9,153 (CDN) 1,394 (CDN)
2001 98,206 (US) 21,783 (US) -- 24,240 1,830 (US)(7)
150,000 (CDN) 33,271 (CDN) 2,795 (CDN)
-----------------------------------------------------------------------------------------------------------------------
NAMED EXECUTIVES NOT IN THE EMPLOY OF THE CORPORATION AT YEAR END
-----------------------------------------------------------------------------------------------------------------------
Bruce Bonini, 2003 200,160 (US) -- -- 40,000 265,824 (US)
Vice-President North
American Sales (9) 2002 217,500 (US) -- -- 20,000 7,042 (US)(7)
2001 272,678 (US)(10) 33,450 (US) -- 82,780 4,565 (US)(7)
-----------------------------------------------------------------------------------------------------------------------
David J. Farrell, 2003 186,346 (US) -- -- 15,000 152,938 (US)
President, EXFO Burleigh
Products Group Inc. (11) 2002 184,500 (US) -- -- 10,000 3,193 (US)(7)
2001 184,500 (US)(12) 16,326 (US) -- 40,000 4,513 (US)(7)
-----------------------------------------------------------------------------------------------------------------------
Sami Yazdi, 2003 71,196 (US) -- -- 25,000 158,249 (US)
President, EXFO Protocol Inc. 105,350 (CDN) 234,162 (CDN)
(13) 2002 111,210 (US)(14) 5,550 (US) -- 50,000 --
175,000 (CDN) 8,735 (CDN)
-----------------------------------------------------------------------------------------------------------------------
-----------------
(1) The compensation information for Canadian residents has been converted from
Canadian dollars to U.S. dollars based upon an average foreign exchange
rate of 1.4797 for 2003, 1.5736 for 2002, and 1.5274 for 2001. The currency
conversions cause these reported salaries to fluctuate from year-to-year
because of the conversion of Canadian dollars to U.S. dollars.
(2) A portion of the bonus amounts is paid in cash in the year for which they
are awarded and the balance is paid in cash in the year following the
financial year for which they are awarded.
(3) Indicates the number of Subordinate Voting Shares underlying the options
granted under the Stock Option Plan during the financial year indicated.
(4) This amount includes an amount of US$4,935 paid as a retroactive adjustment
to salary for the financial year ended August 31, 2000.
(5) This amount includes an amount of US$2,771 paid as a retroactive adjustment
to bonus for the financial year ended August 31, 2000.
(6) This amount represents Mr. Stevens' base annual salary. Since he joined the
Corporation on October 7, 2002, the base annual salary paid to him for the
financial year ended August 31, 2003 amounted to US$154,135.
(7) Indicates the amount contributed by the Corporation during the financial
year indicated to the Deferred Profit Sharing Plan or the 401K plans, as
applicable, for the benefit of the Named Executive Officer. Mr. Lamonde is
not eligible to participate in the Deferred Profit Sharing Plan and Mr.
Gonzalez and Mr. Yazdi did not participate.
69
(8) This amount represents Mr. Holloran's base annual salary. Since he joined
the Corporation on October 7, 2002, the base annual salary paid to him for
the financial year ended August 31, 2003 amounted to US$124,462.
(9) For the 2003 financial year, salary shown for Mr. Bonini indicates full
salary to termination date, being August 15, 2003, and All Other
Compensation includes an amount of US$244,352 in severance and an amount of
US$6,499 contributed by the Corporation to the 401K plan.
(10) This amount includes an amount of US$28,654 paid as a retroactive
adjustment to salary for the financial year ended August 31, 2000.
(11) For the 2003 financial year, salary shown for Mr. Farrell indicates full
salary to termination date, being August 29, 2003, and All Other
Compensation includes an amount of US$127,687 in severance and an amount of
US$5,774 contributed by the Corporation to the 401K plan.
(12) This amount represents Mr. Farrell's base annual salary. Since he joined
the Corporation on December 20, 2000, the base annual salary paid to him
for the financial year ended August 31, 2001 amounted to US$134,097.
(13) For the 2003 financial year, salary shown for Mr. Yazdi indicates full
salary to termination date being March 21, 2003, and All Other Compensation
represents an amount of US$158,249 in severance.
(14) This amount represents Mr. Yazdi's base annual salary. Since he joined the
Corporation on November 2, 2001, the base salary paid to him for the
financial year ended August 31, 2002 amounted to US$90,959 (CDN$143,134).
The following table indicates additional information on the options
granted to our Named Executive Officers during the 2003 fiscal year.
--------------------------------------------------------------------------------------------------------------------
PERCENTAGE OF NET
TOTAL OF OPTIONS MARKET VALUE OF
SECURITIES GRANTED TO SECURITIES UNDERLYING
UNDER OPTIONS EMPLOYEES IN EXERCISE OR OPTIONS ON THE DATE
GRANTED(1) FINANCIAL YEAR BASE PRICE(2) OF GRANT
NAME (#) (%) (US$/ SECURITY) (US$/SECURITY)(3) EXPIRATION DATE
--------------------------------------------------------------------------------------------------------------------
Germain Lamonde 50,000 4.98 1.58 1.66 September 25, 2012
--------------------------------------------------------------------------------------------------------------------
Juan-Felipe Gonzalez 30,000 2.99 1.58 1.66 September 25, 2012
--------------------------------------------------------------------------------------------------------------------
James Stevens 12,000 1.20 3.53 3.63 December 2, 2012
--------------------------------------------------------------------------------------------------------------------
John Holloran 9,000 0.90 3.53 3.63 December 2, 2012
--------------------------------------------------------------------------------------------------------------------
Pierre Plamondon 25,000 2.49 1.58 1.66 September 25, 2012
--------------------------------------------------------------------------------------------------------------------
Named Executives Not in the Employ of the Corporation at Year End
--------------------------------------------------------------------------------------------------------------------
Bruce Bonini 40,000 4.00 1.58 1.66 Cancelled (4)
--------------------------------------------------------------------------------------------------------------------
David J. Farrell 15,000 1.49 1.58 1.66 Cancelled (4)
--------------------------------------------------------------------------------------------------------------------
Sami Yazdi 25,000 2.49 1.58 1.66 Cancelled (4)
--------------------------------------------------------------------------------------------------------------------
---------------
(1) Underlying securities: Subordinate Voting Shares.
(2) The exercise price of options granted is determined based on the highest of
the closing prices of the Subordinate Voting Shares on The Toronto Stock
Exchange and the NASDAQ National Market on the last trading day preceding
the grant date, using the noon buying rate of the Federal Reserve Bank of
New York on the grant date to convert the NASDAQ National Market closing
price to Canadian dollars, as required. Some of these options vest at a
rate of 25% annually commencing on the first anniversary date of the grant
and some vest at a rate of 12.5% 6 months after the grant date, 12.5% 12
months after the grant date, and 25% annually thereafter commencing on the
second anniversary date of the grant.
(3) Based on the closing price on the NASDAQ National Market on the date of the
grant.
(4) In accordance with the terms of the Stock Option Plan, remaining
unexercised options were cancelled thirty days after the respective
termination dates of each of these persons.
EMPLOYMENT AGREEMENTS
We have an employment agreement with Mr. Germain Lamonde. The agreement
is for an indeterminate period and the salary is reviewed annually. In the event
of the termination of Mr. Lamonde's employment without cause, Mr. Lamonde will
be entitled to severance payments
70
(in no case exceeding 24 months of remuneration) and the vesting of all stock
options. In addition, in the event that Mr. Lamonde's employment is terminated
following a merger or an acquisition by a third party of substantially all our
assets or of the majority of our share capital or if Mr. Lamonde voluntarily
resigns, he will be entitled to the vesting of all stock options.
We also have employment agreements with Mr. Juan-Felipe Gonzalez and
Mr. Pierre Plamondon, and our subsidiary, EXFO Gnubi Products Group Inc. has
employment agreements with Mr. James Stevens and Mr. John Holloran Jr.
The agreement with Mr. Gonzalez provided for Mr. Gonzalez's employment
as Vice-President International Sales but in July 2003, Mr. Gonzalez assumed the
position of Vice-President Global Telecom Sales. Mr. Gonzalez earned a long-term
incentive bonus of CDN$750,000 as he did not voluntarily resign and was not
dismissed with cause prior to September 2003. An amount of CDN$500,000 was
disbursed on October 17, 2003 and the remaining CDN$250,000 is scheduled for
disbursement in January 2004. In the event Mr. Gonzalez's employment terminates
for any reason whatsoever and he is unable to accept new employment due to his
non-competition obligations to us Mr. Gonzalez may receive compensation for a
period of 18 months following the date of termination in amounts varying from 5%
to 50% of his base monthly salary at the time of termination depending on the
cause of the termination. The employment agreement is for an indeterminate
period and salary and bonuses are reviewed annually.
Mr. Stevens was the Chief Executive Officer of gnubi communications,
L.P. when the assets of this company were acquired by EXFO Gnubi Products Group
Inc. on October 7, 2002. Further to this acquisition, Mr. Stevens entered into
an employment agreement with EXFO Gnubi Products Group Inc. that provided for
Mr. Stevens' employment as Vice President, Director of Dallas Operations.
However in July 2003, Mr. Stevens assumed the position of Vice President,
Protocol Layer Product Management and Chief Technology Officer. The agreement is
for an indeterminate period and the salary is reviewed annually. In the event of
termination of the agreement by EXFO Gnubi Products Group Inc. for reasons other
than just cause, Mr. Stevens must be given at least 6 months' prior notice.
Mr. Holloran held the position of Executive Vice President and Chief
Operations Officer of gnubi communications, L.P. when the assets of this company
were acquired by EXFO Gnubi Products Group Inc. on October 7, 2002. Further to
this acquisition, Mr. Holloran became employed by EXFO Gnubi Products Group
Inc., but did not have a written employment agreement. However, in May 2003, Mr.
Holloran entered into a written agreement with us whereby Mr. Holloran assumed
the position of Interim General Manager and Special Projects at the same base
annual salary, and a monthly bonus of US$2,500 for the period from March 24,
2003 to December 26, 2003. The agreement further provides that Mr. Holloran's
employment will terminate on December 26, 2003, at which time he will receive a
severance payment equivalent to 6 weeks of base annual salary plus the prorata
bonus amount applicable to a 6 week period. In the event that Mr. Holloran
voluntarily leaves his employment prior to December 26, 2003, he will forfeit
the severance payment.
We have an employment agreement with Mr. Pierre Plamondon, our Vice President,
Finance and Chief Financial Officer. The agreement is for an indeterminate
period and the salary is reviewed annually. In the event of termination of Mr.
Plamondon's employment without cause, Mr. Plamondon will be entitled to
severance payments (in no case exceeding 18 months of the current base salary).
In addition, in the event Mr. Plamondon's employment is terminated
71
following a merger or an acquisition by a third party of substantially all of
our assets or of the majority of our share capital, he will be entitled to the
immediate vesting of all stock options.
STOCK OPTION PLAN
We have a stock option plan for our directors, executive officers,
employees and consultants and those of our subsidiaries as determined by our
board of directors, to attract and retain competent directors, executive
officers, employees and consultants motivated to work toward ensuring our
success and to encourage them to acquire our shares.
All of the options that will be granted under the plan must be
exercised within a maximum period of ten years following the grant date of the
options or they will be forfeited. The board of directors will designate the
recipients of options and determine the number of subordinate voting shares
covered by each of these options, the date of vesting of each option, the
exercise price of each option, the expiry date and any other conditions relating
to these options, in each case in accordance with the applicable legislation of
the securities regulatory authorities. The price at which the subordinate voting
shares may be purchased under the plan will not be lower than the highest of the
closing prices of the subordinate voting shares on the stock exchanges where the
subordinate voting shares are listed at the date preceding the date of grant.
The maximum number of subordinate voting shares that is issuable under
the plan may not exceed 4,470,961 shares, which represents 7% of our issued and
outstanding share capital as at November 30, 2003. The maximum number of
subordinate voting shares that may be granted to any individual may not exceed
5% of the outstanding subordinate voting shares. The board of directors may
accelerate the vesting of any or all outstanding options of any or all options
upon the occurrence of a change of control.
The aggregate number of subordinate voting shares covered by options
granted during the financial year ended August 31, 2003 was 1,268,450 at a
weighted average exercise price of $1.94 (CA$2.96) per subordinate voting share.
At the end of the financial year ended August 31, 2003, there were 3,176,613
subordinate voting shares covered by options granted and outstanding pursuant to
the stock option plan having a weighted average exercise price of US$15.36 per
option. As of August 31, 2003, there were 1,294,348 options available for future
grants under the plan. Since August 31, 2003 we granted 60,000 options to
employees and directors on October 27, 2003.
Some options granted to Directors vest on the first anniversary date of
their grant. Some options granted in the financial year ended August 31, 2003
vest at a rate of 12.5% 6 months after the date of grant, 12.5% 12 months after
the date of grant and 25% annually thereafter commencing on the second
anniversary date of the grant. Otherwise all options vest a rate of 25% annually
commencing on the first anniversary date of the grant. All options may be
exercised in whole or in part once vested. All of the options that are granted
under the Plan must be exercised within a maximum period of 10 years following
the date of their grant or they will be forfeited.
A resolution has been submitted to our shareholders for voting at the
Annual and Special Shareholders Meeting to be held on January 7, 2004, to
increase the number of subordinate voting shares that are issuable under our
stock option plan to a maximum of 6,306,153 subordinate voting shares, which
represents 10% of our issued and outstanding share capital as
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of November 7, 2003. In addition, this increase is subject to the final approval
of regulatory authorities.
SHARE PLAN
In September 1998, we established a stock purchase plan for officers,
directors and key employees as amended in April 2000. A total of 707,264
subordinate voting shares were issued and fully paid under the 1998 Stock
Purchase Plan, having a weighted average cash consideration of $0.67 (CA$0.98)
per share. The plan provides that all shares issued under the plan are
restricted as to sale and transferability for a minimum period of five years
upon the date of acquisition.
On April 3, 2000, we adopted a new share plan that replaced the 1998
Stock Purchase Plan. No additional shares will be issued under the new share
plan. The new share plan established restrictions on the rights of the holders
of subordinate voting shares who hold those shares as a result of the conversion
of the Class "F" shares issued under the 1998 Stock Purchase Plan. The new share
plan also requires the subordinate voting shares to be held in trust by a
trustee until August 31, 2004, except for 256,017 subordinate voting shares that
will be released between October 21, 2003 and January 20, 2004. The new share
plan also provides for the earlier release of shares in the event that the
employment of a holder of shares is terminated or upon the occurrence of a
change of control. The new share plan does not permit any transfer, except
within the trust to a registered retirement savings plan or a registered
retirement income fund or to a trustee in bankruptcy. The new share plan also
established the conditions pursuant to which the shares of a shareholder are to
be sold by the trustee on the public market. As of August 31, 2003, 635,118
subordinate voting shares were being held in trust under the new share plan.
RESTRICTED STOCK AWARD PLAN
The EXFO Electrical-Optical Engineering Restricted Stock Award Plan
(the "Plan") was established to provide a means through which employees of EXFO
Burleigh can be granted awards of restricted shares ("Restricted Shares") of our
subordinate voting shares to promote retention and foster identity of interest
between our stockholders and employees of EXFO Burleigh.
The effective date of the Plan is December 20, 2000. The expiration
date of the Plan is the business day next following the final grant of
Restricted Shares under the Plan. However, the administration of the Plan shall
continue until all awards of Restricted Shares have been forfeited or settled.
The aggregate number of shares subject to the Plan is 360,000. Grants of
Restricted Shares are to be made in accordance with a pre-determined schedule.
The Plan is administered by the committee that is designated to administer our
Stock Option Plan.
Awards of Restricted Shares are subject to forfeiture and restrictions
on transfer until the Restricted Shares become vested at which point a stock
certificate will be issued to a participant with respect to the number of vested
shares, which are then freely transferable. Restricted Shares become vested,
subject to a participant's continued employment with the Company or its
affiliates, on each of the first four anniversaries of the date of grant of an
award of Restricted Shares. On December 20, 2001, on December 20, 2002 and on
December 20, 2003, we issued an aggregate of 83,657 subordinate voting shares,
69,935 subordinate voting shares and 68,254 subordinate voting shares
respectively in accordance with the vesting schedule under the Plan.
73
Upon a participant's termination of employment with us, or any of our
affiliates due to the participant's death, disability or retirement on or after
age 60, the participant's award of restricted shares becomes fully vested and is
no longer subject to forfeiture. However, the transfer restrictions remain in
place until the occurrence of the vesting dates originally contemplated by the
award.
Upon the voluntary resignation of a participant, the termination of a
participant's employment for cause, the termination of a participant who is not
designated a member of EXFO Burleigh's "Management Team" without cause prior to
a change in control of EXFO or a termination without cause of a participant who
is designated a member of EXFO Burleigh's Management Team that is initiated by
EXFO Burleigh prior to a change in control of EXFO, the unvested portion of the
participant's award of Restricted Shares will be forfeited. However, the Plan
provides for discretion in the application of the forfeiture provisions where a
change in circumstances renders such action appropriate. During the financial
year ended August 31, 2003, we were required to lay-off 22 participants as a
result of restructuring. At that time, we decided that the awards of the Plan
participants affected by the lay-offs would not be subject to forfeiture, though
the transfer restrictions would remain in place until the occurrence of the
vesting dates originally contemplated by the award.
Upon the termination without cause of a participant who is designated a
member of EXFO Burleigh's Management Team that is initiated by us or a
termination of a participant's employment without cause following a change in
control of EXFO, a participant's award of Restricted Stock will become fully
vested and all restrictions will lapse.
In the event of a change in control, the committee administering the
Plan may in its discretion remove restrictions on Restricted Shares or provide
for the cancellation of awards in exchange for payment in respect of the
Restricted Shares subject to an award.
STOCK APPRECIATION RIGHTS PLAN
On August 4, 2001, the Corporation established a Stock Appreciation
Rights Plan ("SAR Plan") for the benefit of certain employees residing in
countries where the granting of options under the Stock Option Plan is not
feasible in the opinion of the Corporation. The Board has full and complete
authority to interpret the SAR Plan and to establish the rules and regulations
applying to it and to make all other determinations it deems necessary or useful
for the administration of the SAR Plan.
Under the SAR Plan, eligible employees are entitled to receive a cash
amount equivalent to the difference between the market price of the subordinate
voting shares on the date of exercise and the exercise price determined on the
date of grant. No subordinate voting shares are issuable under the SAR Plan.
The Board of Directors has delegated to Management the task of
designating the recipients of stock appreciation rights, the date of vesting,
the expiry date and other conditions. Under the terms of the SAR Plan, the
exercise price of the stock appreciation rights may not be lower than the
highest of the closing prices of the subordinate voting shares on The Toronto
Stock Exchange and on the NASDAQ National Market on the last trading day
preceding the grant date, using the noon buying rate of the Federal Reserve Bank
of New York on the grant date to convert the NASDAQ National Market closing
price to Canadian dollars. Stock appreciation rights are non-transferable.
74
The stock appreciation rights vest over a four-year period, with 25%
vesting annually commencing on the first anniversary date of the date of grant.
Once vested, stock appreciation rights may be exercised between the second and
the fifteenth business day following each release of the Corporation's quarterly
financial results. All of the stock appreciation rights that are granted under
the SAR Plan may be exercised within a maximum period of 10 years following the
date of their grant. Any stock appreciation rights granted under the SAR Plan
will lapse immediately upon the termination of the relationship with the
Corporation or one of its subsidiaries for a good and sufficient cause or at the
date on which an employee resigns or leaves his employment with the Corporation
or one of its subsidiaries (or within 30 days if the holder is dismissed without
cause). In the event of retirement or disability, any stock appreciation right
held by an employee lapses 30 days after the date of any such disability or
retirement. In the event of death, any stock appreciation right lapses 6 months
after the date of death.
As of December 15, 2003, there were 9,000 SAR's outstanding.
DEFERRED PROFIT SHARING PLAN
We maintain a deferred profit sharing plan for certain eligible
Canadian resident employees. Under the plan, we may contribute an amount equal
to 1% of each employee's gross salary to that employee's individual deferred
profit sharing plan to the extent that such employee contributes at least 2% of
his or her gross salary to his or her individual tax-deferred registered
retirement savings plan. As a cost control measure, we temporarily suspended our
contributions under this plan commencing in June 2002 and re-established
contributions commencing January 2003. In the year ended August 31, 2003, the
aggregate amount of contributions under the plan was $63,000 (CA$93,000).
401(K) PLAN
We maintain a 401(k) plan for eligible United States resident employees
of our subsidiaries. Employees become eligible to participate in the 401(k) plan
on the first day of the month following the completion of three months of
continuous service. Employees may elect to defer their current compensation up
to the lesser of 1% of eligible compensation or the statutorily prescribed
annual limit and have the deferral contributed to the 401(k) plan. The 401(k)
plan permit, but do not require, us to make additional matching contributions to
the 401(k) plan on behalf of the eligible participants, subject to a maximum of
50% of the first 6% of the participant's current compensation subject to certain
legislated maximum contribution limits. In the year ended August 31, 2003, we
made an aggregate of $253,000 in matching contributions to the 401(k) plan.
Contributions by employees or by us to the 401(k) plan and income earned on plan
contributions are generally not taxable to the employees until withdrawn and
contributions by us are generally deductible by us when made. At the direction
of each participant, the trustees of the 401(k) plan invest the assets of the
401(k) plan in selected investment options.
INDEMNIFICATION OF DIRECTORS AND EXECUTIVE OFFICERS AND LIMITATION OF LIABILITY
Our by-laws require us, subject to the limitations provided by law, to
indemnify our present or former directors and officers or any persons who act or
acted at our request as directors or officers of a body CORPORATE for all costs,
losses, charges and expenses that arose or may arise by reason of their status
as directors or officers of EXFO or such body corporate. A
75
policy of directors' and officers' liability insurance is maintained by us which
insures our directors and officers and those of our subsidiaries against
liability incurred by, arising from or against them for certain of their acts,
errors or omissions.
C. BOARD PRACTICES
BOARD OF DIRECTORS
Our directors are elected at the annual meeting of shareholders for
one-year terms and serve until their successors are elected or appointed, unless
they resign or are removed earlier. Our articles of incorporation provide for a
board of directors of a minimum of three and a maximum of 12 directors. Our
board presently consists of five directors. Under the CANADA BUSINESS
CORPORATIONS ACT, twenty-five percent of the directors and of the members of any
committee of the board of directors must be resident Canadians. We have no
arrangements with any of our directors providing for the payment of benefits
upon their termination of service as director.
During the fiscal year ended August 31, 2003, the Board met a total of
ten times. Attendance at all meetings was perfect, with the exception of the
absence of Mr. Pierre Marcouiller at one meeting.
COMMITTEES OF THE BOARD OF DIRECTORS
Our board of directors has established an audit committee, a human
resources committee and a disclosure committee.
Our audit committee will recommend a firm to be appointed as
independent auditors to audit financial statements and to perform services
related to the audit, review the scope and results of the audit with the
independent auditors, review with management and the independent auditors our
annual operating results and consider the adequacy of the internal accounting
procedures and the effect of the procedures relating to the auditors'
independence. Further to changes to Nasdaq corporate governance rules and new
Securities and Exchange rules flowing from the adoption of the SARBANES-OXLEY
ACT, our audit committee charter has been revised during the past financial year
to ensure that we comply with all new requirements. The audit committee is
composed of three independent directors: Andre Tremblay, Michael Unger and
Pierre Marcouiller. The chairperson of the audit committee is Andre Tremblay.
During the fiscal year ended August 31, 2003, the Audit Committee met a
total of five times and all members attended all meetings.
Our human resources committee will evaluate, review and supervise our
procedures with regards to human resources and will assess the performance of
our executive officers and the chief executive officer. This committee will also
review annually the remuneration of the directors and will recommend to the
board of directors general remuneration policies regarding salaries, bonuses and
other forms of remuneration for our directors, executive officers and employees
as a whole. Finally, the human resources committee will review our
organizational structure annually and the development and maintenance of a
succession plan. The human resources committee is composed of four independent
directors: Pierre Marcouiller, David A. Thompson, Andre Tremblay and Michael
Unger. The chairperson of the human resources committee is Michael Unger.
76
During the fiscal year ended August 31, 2003, the Human Resources
committee met a total of five times and attendance was perfect at all meetings,
with the exception of one meeting missed by Dr. David Thompson.
The disclosure committee is responsible for overseeing our disclosure
practices. This committee consists of the chief executive officer, the chief
financial officer, investor relations the manager of financial reporting and
accounting as well as our legal counsel and corporate secretary.
In addition, in order to deal with issues arising from our implication
in the IPO class action suit, in October 2002, the Board of Directors appointed
a litigation committee composed of our four independent directors.
D. EMPLOYEES
We have fostered a corporate culture where growth and change are
strongly encouraged. In fact, employees are constantly evolving with the rapid
pace of technology to meet new challenges and realities. We believe that we
possess a good cross-section of experience and youth to handle these inevitable
changes in the industry.
As of December 15, 2003, we had a total of 627 employees, down from a
total of 805 on December 31, 2002. We have 515 employees in Canada, primarily
based in Quebec, and 112 employees based outside of Canada. Two hundred and five
are involved in research and development, 218 in manufacturing, 95 in sales and
marketing, 74 in general administrative positions and 35 in communications and
customer support. In the financial year ended August 31, 2003, we reduced our
workforce by 270 through lay-offs and attrition as part of our efforts to reduce
costs in response to a general slowdown in the telecommunications industry. We
have agreements with almost all of our employees covering confidentiality and
non-competition. Only manufacturing employees are represented by a collective
bargaining agreement, which expires in 2004. In December 2002, we implemented a
temporary work sharing program for these employees as a further cost reduction
measure which terminated on May 31, 2003. We have never experienced a work
stoppage. We believe that relations with our employees are good.
E. SHARE OWNERSHIP
The following table presents information regarding the beneficial
ownership of our share capital as of December 15, 2003 by our directors, our
Chief Executive Officer and our four highest compensated executive officers; and
all of our directors and executive officers as a group.
Each multiple voting share is convertible at the option of the holder
into one subordinate voting share. Holders of our subordinate voting shares are
entitled to one vote per share and holders of our multiple voting shares are
entitled to ten votes per share.
77
TOTAL
MULTIPLE VOTING SHARES SUBORDINATE VOTING SHARES PERCENTAGE OF
BENEFICIALLY OWNED (1) BENEFICIALLY OWNED (1) VOTING POWER
------------------------ ------------------------- -------------
NAME NUMBER PERCENT NUMBER PERCENT PERCENT
-------------------------------- ---------- ------- ---------- ------- -------
Germain Lamonde (2)............. 37,900,000 100 162,092 * 93.8
Juan Felipe Gonzalez............ -- -- 105,592 * *
John Holloran Jr................ -- -- 1,125 * *
Pierre Marcouiller.............. -- -- 20,647 * *
Pierre Plamondon (3)............ -- -- 73,572 * *
James Stevens .................. -- -- 1,500 * *
David A. Thompson............... -- -- 15,292 * *
Andre Tremblay (4).............. -- -- 21,171 * *
---------- ------- ---------- ------- -------
TOTAL........................... 37,900,000 100 400,991 1.63 93.85
----------------------
* Less than 1%.
(1) Beneficial ownership is determined in accordance with the rules of the SEC
and generally includes voting or investment power with respect to
securities. Options that are currently exercisable are deemed to be
outstanding and to be beneficially owned by the person holding such options
for the purpose of computing the percentage ownership of such person, but
are not treated as outstanding for the purpose of computing the percentage
ownership of any other person.
(2) The number of shares held by Germain Lamonde includes 1,900,000 multiple
voting shares held of record by Fiducie Germain Lamonde, 36,000,000
multiple voting shares held of record by G. Lamonde Investissements
Financiers inc. and 93,000 subordinate voting shares held of record by
Placements Lamonde SENC.
(3) The number of shares held by Pierre Plamondon includes 6,874 subordinate
voting shares held of record by Fiducie Pierre Plamondon.
(4) The number of subordinate voting shares held of record by Andre Tremblay
includes 6,650 subordinate voting shares held of record by 9044-6451 Quebec
Inc. and 350 subordinate voting shares held of record by 9089-3082 Quebec
Inc., companies controlled by Mr. Tremblay.
The following table presents information regarding stock options held
as of December 15, 2003 by our directors, our Chief Executive Officer and our
four highest compensated executive officers.
SECURITIES UNDER OPTIONS EXERCISE PRICE(2)
NAME GRANTED(1) (#) (US$/SECURITY) EXPIRATION DATE
----------------------------- ------------------------ ----------------- -------------------
Germain Lamonde.............. 25,402 $26.00 June 29, 2010
5,080 $22.25 January 10, 2011
70,000 $9.13 October 10, 2011
50,000 $1.58 September 25, 2012
Juan Felipe Gonzalez......... 6,900 $26.00 June 29, 2010
15,000 $45.94 September 13, 2010
15,000 $34.07 October 11, 2010
15,630 $22.25 January 10, 2011
15,000 $9.13 October 10, 2011
15,000 $12.22 January 3, 2012
30,000 $1.58 September 25, 2012
John Holloran Jr............. 9,000 $3.53 December 2, 2012
Pierre Plamondon............. 8,700 $26.00 June 29, 2010
10,000 $45.94 September 13, 2010
5,000 $34.07 October 11, 2010
9,240 $22.25 January 10, 2011
19,000 $9.13 October 10, 2011
25,000 $1.58 September 25, 2012
James Stevens................ 12,000 $3.53 December 2, 2012
78
SECURITIES UNDER OPTIONS EXERCISE PRICE(2)
NAME GRANTED(1) (#) (US$/SECURITY) EXPIRATION DATE
----------------------------- ------------------------ ----------------- -------------------
Pierre Marcouiller........... 2,000 $26.00 June 29, 2010
400 $22.25 January 10, 2011
17,966 $9.13 October 10, 2011
1,037 $12.69 December 1, 2011
2,479 $5.65 March 1, 2012
12,500 $1.58 September 25, 2012
12,500 $3.51 October 27, 2013
David A. Thompson............ 2,000 $26.00 June 29, 2010
400 $22.25 January 10, 2011
15,334 $9.13 October 10, 2011
12,500 $1.58 September 25, 2012
12,500 $3.51 October 27, 2013
Andre Tremblay............... 2,000 $26.00 June 29, 2010
400 $22.25 January 10, 2011
17,291 $9.13 October 10, 2011
12,500 $1.58 September 25, 2012
12,500 $3.51 October 27, 2013
Michael Unger................ 2,000 $26.00 June 29, 2010
400 $22.25 January 10, 2011
18,168 $9.13 October 10, 2011
12,500 $1.58 September 25, 2012
12,500 $3.51 October 27, 2013
----------------------------
(1) Underlying securities: subordinate voting shares
(2) The exercise price of options granted is determined based on the highest of
the closing prices of the subordinate voting shares on the Toronto Stock
Exchange and the NASDAQ National Market on the last trading day preceding
the grant date, using the noon buying rate of the Federal Reserve Bank of
New York on the grant date to convert the NASDAQ National Market closing
price to Canadian dollars, as required.
79
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
A. MAJOR SHAREHOLDERS
The following table presents information regarding the beneficial
ownership of our share capital as of December 15, 2003 by persons or groups of
affiliated persons known by us to own more than 5% of our voting shares.
TOTAL PERCENTAGE OF
MULTIPLE VOTING SHARES SUBORDINATE VOTING SHARES ---------------------
BENEFICIALLY OWNED (1) BENEFICIALLY OWNED (1) VOTING POWER
-------------------------- -------------------------- ---------------------
NAME NUMBER PERCENT NUMBER PERCENT PERCENT
--------------------------- ---------- ---------- ----------- ----------- ---------------------
Germain Lamonde (2) 37,900,000 100 % 162,092 * 93.83 %
Fiducie Germain Lamonde (3) 1,900,000 5 % Nil Nil 4.71 %
G. Lamonde Investissements
Financiers inc. (4) 36,000,000 95 % Nil Nil 89.1 %
Placements Lamonde, SENC Nil Nil 93,000 * *
FMR Corporation (6) Nil Nil 3,283,100 13 *
The Bessemer Group, Inc. (7) Nil Nil 2,064,046 8.2 *
---------------------------
* Less than 1%
(1) Beneficial ownership is determined in accordance with the rules of the SEC
and generally includes voting or investment power with respect to
securities. Options that are currently exercisable are deemed to be
outstanding and to be beneficially owned by the person holding such options
for the purpose of computing the percentage ownership of such person, but
are not treated as outstanding for the purpose of computing the percentage
ownership of any other person.
(2) The number of shares held by Germain Lamonde includes 1,900,000 multiple
voting shares held of record by Fiducie Germain Lamonde and 36,000,000
multiple voting shares held of record by G. Lamonde Investissements
Financiers inc. and 93,000 subordinate voting shares held of record by
Placements Lamonde, SENC.
(3) Fiducie Germain Lamonde is a family trust for the benefit of Mr. Lamonde
and members of his family.
(4) G. Lamonde Investissements Financiers inc. is a company controlled by Mr.
Lamonde.
(5) Placements Lamonde, SENC is a parternship controlled by Mr. Lamonde.
(6) Fidelity Management and Research Company, a wholly owned subsidiary of FMR
Corporation, is the beneficial owner of this number of subordinate voting
shares as a result of acting as investment advisor to various investment
companies.
(7) Bessemer Trust Company of Florida and Bessemer Trust Company wholly owned
by the Bessemer Group, Inc., are the beneficial owners of this number of
subordinate voting shares as account managers for the benefit of others.
Each multiple voting share is convertible at the option of the holder
into one subordinate voting share. Holders of our subordinate voting shares are
entitled to one vote per share and holders of our multiple voting shares are
entitled to ten votes per share.
As of December 15, 2003, approximately 34% of our subordinate voting
shares were held in bearer form and the remainder (16,615,350 subordinate voting
shares) were held by 239 record holders. As of December 15, 2003, we believe
approximately 66% of our outstanding subordinate voting shares were held in the
United States.
B. RELATED PARTY TRANSACTIONS
INDEBTEDNESS OF DIRECTORS, EXECUTIVE OFFICERS AND EMPLOYEES
We have guaranteed the repayment of loans granted to employees by a
financial institution for the purchase of our Class "F" shares that were
converted into subordinate voting shares immediately prior to our initial public
offering. As of August 31, 2003, the total principal
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amount guaranteed by us is CA$94,025 (approximately $63,500) and $56,200. We
have outstanding loans to some of our employees up to $7,000 to finance the
acquisition of our Class "F" shares. These loans are to be reimbursed no later
than five years from the date of the loans. These loans accrue interest at prime
rate and are secured by a pledge of the employees' shares to us.
Except as disclosed in this section, none of our directors, executive
officers, associates or affiliates had any material interest in any transaction
with us during the past three years or in any proposed transaction which has
materially affected or could materially affect us.
LEASES
We have a lease agreement with G. Lamonde Investissements financiers
inc., a company controlled by Mr. Germain Lamonde, for premises located at 465
Godin Avenue in Vanier, Quebec. These premises were previously used for our
executive and administrative offices, however, in September 2003, these were
moved into a building that we own. This space is presently unoccupied. This
lease was renewed in December 2001, with all terms and conditions remaining the
same. The table below sets forth the leased space and annual rent:
LOCATION SQUARE FOOTAGE ANNUAL RENT EXPIRY DATE
-------- -------------- ----------- -----------
465 Godin 24,000 CA$144,000 November 30, 2006
Based on third-party valuations of the property values, we believe this
lease agreement is at prevailing market terms.
In September 2002, we acquired from G. Lamonde Investissements
financiers inc. the building located at 436 Nolin Street that houses some of our
manufacturing activities. Previous to this acquisition, we had a lease agreement
with this company for these premises. We paid CA$1,450,000 for the building and
this purchase price is based on an independent third party valuation and the
transaction was approved by our audit committee and the board of directors with
Mr. Lamonde abstaining.
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ITEM 8. FINANCIAL INFORMATION
A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION
SEE ITEM 18, "FINANCIAL STATEMENTS".
Valuation and qualifying accounts as well as Export sales are as follows (in
thousands of US dollars);
ALLOWANCE FOR DOUBTFUL ACCOUNTS
YEARS ENDED AUGUST 31,
-------------------------------------------------------
2003 2002 2001
--------------- -------------- --------------
Balance - Beginning of year $ 520 $ 893 $ 149
Addition charged to earnings 619 1,097 1,134
Write-offs of uncollectible accounts (288) (925) (184)
Reversal of collectible accounts (315) (538) (268)
Foreign currency translation adjustment 32 (7) 62
--------------- -------------- --------------
Balance - End of year $ 568 $ 520 $ 893
=============== ============== ==============
VALUATION ALLOWANCE ON FUTURE INCOME TAX ASSETS
YEARS ENDED AUGUST 31,
-------------------------------------------------------
2003 2002 2001
--------------- -------------- --------------
Balance - Beginning of year $ 359 $ 362 $ --
Addition charged to earnings 28,385 -- 362
Foreign currency translation adjustment 102 (3) --
--------------- -------------- --------------
Balance - End of year $ 28,846 $ 359 $ 362
=============== ============== ==============
EXPORT SALES
Export and domestic sales in dollars and as a percentage of total sales are as
follows:
YEARS ENDED AUGUST 31,
-----------------------------------------------------------------------------
2003 2002 2001
----------------------- ----------------------- -----------------------
Export Sales $ 57,124 92% $ 64,359 94% $ 133,482 91%
Domestic Sales 4,806 8 $ 3,971 6 $ 12,531 9
----------------------- ----------------------- -----------------------
$ 61,930 100% $ 68,330 100% $ 146,013 100%
======================= ======================= =======================
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B. SIGNIFICANT CHANGES
See note 21 to the Consolidated Financial Statements in Item 18 and the
stock option section in item 5 for information on significant changes.
LEGAL PROCEEDINGS
On November 27, 2001, a class action suit was filed in the United
States District Court for the Southern District of New York by John Williams,
and others similarly situated, against us, four of the underwriters of our
initial public offering (Merrill Lynch, Pierce, Fenner & Smith, Inc., RBC
Dominion Securities Inc., Wit Soundview Corporation and CIBC World Markets Inc.)
and Messrs. Germain Lamonde and Pierre Plamondon pursuant to the SECURITIES
EXCHANGE ACT OF 1934 and Rule 106-5 promulgated thereunder and sections 11, 12
and 16 of the SECURITIES ACT OF 1933. This class action, involving more than 300
other public companies, alleges that our 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 our shares issued in connection with our initial public offering;
and (ii) the underwriters allegedly entering into agreements with customers
whereby our shares issued in connection with our initial public offering would
be allocated to those customers in exchange for which such customers agreed to
purchase additional amounts of our 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 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 on October 8, 2002, the claims against Messrs. Lamonde and
Plamondon were dismissed pursuant to the terms of Reservation of Rights and
Tolling Agreements entered into with the plaintiffs.
On June 26, 2003, the Plaintiff's Executive Committee announced that a
proposed settlement between the issuers and their directors and officers and the
plaintiffs had been structured. A Memorandum of Understanding ("MOU") to settle
the plaintiffs' claims against the
83
issuers and their directors and officers has now been approved as to form and
the process of obtaining approval by all parties to the MOU is now underway. The
parties will be required to prepare many complex documents necessary to
consummate the settlement, which will be submitted to the Court for preliminary
approval. Final approval will be required by the Court following notice to class
members and a fairness hearing. If this tentative settlement is successfully
finalized, the company and the individual defendants will be released from the
litigation. Any direct financial impact of the proposed settlement is expected
to be borne by the company's insurance carriers.
Since the settlement process is subject to a fairness hearing and final
court approval, it is possible that it could fail. Therefore, it is not possible
to predict the final outcome of the case, nor determine the amount of any
possible losses. If the settlement process fails, the company will continue to
defend its position in this litigation that the claims against it, and its
officers, are without merit. Accordingly, no provision for this case has been
made in the consolidated financial statements as of August 31, 2003.
On December 12, 2000, GAP Optique instituted legal proceedings with the
Juridiction des Prud'hommes in Geneva, Switzerland against an ex-employee for
breach of a confidentiality obligation as stipulated in his employment contract.
GAP is claiming monetary damages only since Swiss law does not allow injunctive
relief in this case. Mr. Patrick Stamp was hired by our subsidiary, GAP Optique
on May 1, 1998. Mr. Stamp's employment contract contained a confidentiality
clause that prohibits disclosure or use of any confidential information he may
obtain during the course of his work. The contract provides that this obligation
continues for a period of one year following termination of the employment
agreement. Mr. Stamp left GAP Optique in February 2000 to create a start-up
company called LUCIOL Instruments, S.A ("LUCIOL") with the help of two former
employees of the University of Geneva. LUCIOL presently manufactures and sells
fiber optic test instruments, of which two (a chromatic dispersion analyzer and
a photon-counting OTDR) were developed jointly by GAP Optique and the University
of Geneva. Mr. Stamp participated in the development of these instruments during
employment with GAP Optique and the University. Therefore, it is the contention
of GAP Optique that Mr. Stamp is now using illegally, through LUCIOL, the
proprietary and confidential information he obtained during his employment in
order to market the particular test instruments. A preliminary hearing was held
on November 1, 2001 and the proceedings resumed on January 15, 2002, at which
time the court ordered the preparation and filing of an independent expert
report. Both parties have submitted to the court a list of questions and issues
to be addressed by the expert. The Court's ruling provided that the report be
filed by November 30, 2002, however, we still have not received confirmation of
the filing.
On November 28, 2002, EXFO, GAP Optique and the University of Geneva
filed a joint motion for provisional measures, with the District Court in the
Canton Vaud, Switzerland, against LUCIOL. The joint plaintiffs are seeking an
order to prohibit LUCIOL from manufacturing and selling the chromatic dispersion
analyzer and the photon-counting OTDR that are both described in the preceding
paragraph.
On January 9, 2003, the District Court handed down a decision whereby
LUCIOL was prohibited from manufacturing and selling the chromatic dispersion
analyzer and EXFO, GAP Optique and The University of Geneva were required to
file a surety with the District Court. This decision was appealed by both
parties and on October 29, 2003 a decision was handed down whereby the
injunction against LUCIOL to market and sell the chromatic dispersion analyzer
was confirmed and the surety provided by EXFO, GAP Optique and the University of
Geneva was restituted to them. The District Court also ordered that the
University of Geneva must file a
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claim on the merits of the case prior to January 14, 2004. EXFO, GAP Optique and
the University of Geneva are considering the best course of action in this
regard in order to adequately protect the interests of all the plaintiffs.
There are no other legal or arbitration proceedings pending or
threatened of which we are aware which may have or have had a significant effect
on our financial position.
DIVIDEND POLICY
We do not currently anticipate paying dividends for at least the three
next years. Our current intention is to reinvest any earnings in our business
long-term growth. Any future determination by us to pay dividends will be at the
discretion of our board of directors and in accordance with the terms and
conditions of any outstanding indebtedness and will depend on our financial
condition, results of operations, capital requirements and such other functions
as our board of directors considers relevant.
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ITEM 9. THE OFFER AND LISTING
Not Applicable, except for Item 9A (4) and Item 9C.
Our subordinate voting shares have been quoted on the NASDAQ National Market
under the symbol "EXFO" and listed on The Toronto Stock Exchange under the
symbol "EXF" since our initial public offering on June 29, 2000. Prior to that
time, there was no public market for our subordinate voting shares. The
following table sets forth, for the periods indicated, the high and low closing
sales prices per subordinate voting share as reported on the NASDAQ National
Market and The Toronto Stock Exchange.
On January 8, 2004, the last reported sale price for our subordinate voting
shares on the NASDAQ National Market was US$4.90 per share and the last reported
sale price for our subordinate voting shares on The Toronto Stock Exchange was
CA$6.31 per share.
NASDAQ (US$) TSE (CA$)
PERIOD HIGH LOW HIGH LOW
------ ------- ------- --------
June 29, 2000 to August 31, 2000 92.50 26.00 134.00 51.00
September 1, 2000 to August 31, 2001 57.75 11.80 85.00 17.82
September 1, 2001 to August 31, 2002 15.00 1.35 23.80 2.05
September 1, 2002 to August 31, 2003 3.63 1.40 5.60 2.30
2002 1st Quarter 15.00 8.51 23.80 13.49
2002 2nd Quarter 14.00 5.58 22.10 9.02
2002 3rd Quarter 8.54 2.59 13.55 3.85
2002 4th Quarter 2.83 1.35 4.20 2.05
2003 1st Quarter 3.53 1.40 5.40 2.30
2003 2nd Quarter 3.63 2.07 5.60 3.15
2003 3rd Quarter 3.13 1.94 4.28 2.86
2003 4th Quarter 3.00 2.52 4.11 3.47
2004 1st Quarter 4.26 2.71 5.53 3.75
2003 July 2.90 2.58 3.97 3.63
2003 August 2.83 2.58 3.94 3.66
2003 September 3.99 2.71 5.49 3.75
2003 October 2.91 3.94 5.13 3.94
2003 November 4.26 3.67 5.53 4.82
2003 December 3.93 3.29 5.13 4.40
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ITEM 10. ADDITIONAL INFORMATION
A. SHARE CAPITAL
Not Applicable
B. MEMORANDUM AND ARTICLES OF ASSOCIATION
Incorporated by reference to our registration statement on Form F-1
(Reg. No. 333-38956).
C. MATERIAL CONTRACTS
Except as otherwise disclosed in this annual report and our financial
statements and notes included elsewhere in this annual report, we have no other
material contracts.
D. EXCHANGE CONTROLS
Subject to the following paragraph, there is no law or governmental
decree or regulation in Canada that restricts the export or import of capital,
or affects the remittance of dividends, interest or other payments to
non-resident holders of our subordinate voting shares, other than withholding
tax requirements.
There is no limitation imposed by Canadian law or by our articles of
incorporation or our other charter documents on the right of a non-resident to
hold or vote subordinate voting shares, other than as provided by the INVESTMENT
CANADA ACT, the NORTH AMERICAN FREE TRADE AGREEMENT IMPLEMENTATION ACT (Canada)
and the WORLD TRADE ORGANIZATION AGREEMENT IMPLEMENTATION ACT. The INVESTMENT
CANADA ACT requires notification and, in certain cases, advance review and
approval by the Government of Canada of an investment to establish a new
Canadian business by a non-Canadian or of the acquisition by a "non-Canadian" of
"control" of a "Canadian business", all as defined in the INVESTMENT CANADA ACT.
Generally, the threshold for review will be higher in monetary terms for a
member of the World Trade Organization or North American Free Trade Agreement.
E. TAXATION
UNITED STATES TAXATION
The information set forth below under the caption "United States
Taxation" is a summary of the material U.S. federal income tax consequences of
the ownership and disposition of subordinate voting shares by a U.S. Holder, as
defined below. These discussions are not a complete analysis or listing of all
of the possible tax consequences of such transactions and do not address all tax
considerations that may be relevant to particular holders in light of their
personal circumstances or to persons that are subject to special tax rules. In
particular, the information set forth under the caption "United States Taxation"
deals only with U.S. Holders that will hold subordinate voting shares as capital
assets within the meaning of the Internal Revenue Code of 1986, as amended, and
who do not at any time own individually, nor are treated as owning 10% or more
of the total combined voting power of all classes of our stock entitled to vote.
In addition, this description of U.S. tax consequences does not address the tax
treatment of special classes of U.S. Holders, such as financial institutions,
regulated investment companies, traders in securities who elect to
mark-to-market their securities, tax-exempt
87
entities, insurance companies, persons holding subordinate voting shares as part
of a hedging, integrated or conversion transaction or as part of a "straddle,"
U.S. expatriates, persons subject to the alternative minimum tax, persons who
acquired their subordinate voting shares through the exercise or cancellation of
employee stock options or otherwise as compensation for services, dealers or
traders in securities or currencies and holders whose "functional currency" is
not the U.S. dollar. This summary does not address estate and gift tax
consequences or tax consequences under any foreign, state or local laws other
than as provided in the section entitled "Canadian Federal Income Tax
Considerations" provided below.
As used in this section, the term "U.S. Holder" means:
(a) an individual citizen or resident of the United States for
U.S. federal income tax purposes;
(b) a corporation created or organized under the laws of the
United States or any state thereof including the District of
Columbia;
(c) an estate the income of which is subject to United States
federal income taxation regardless of its source;
(d) a trust if (1) a court within the United States is able to
exercise primary jurisdiction over its administration and one
or more U.S. persons have authority to control all substantial
decisions of the trust or (2) the trust has a valid election
in effect under applicable U.S. Treasury regulations to be
treated as a U.S. person;
(e) any other person whose worldwide income or gain is otherwise
subject to U.S. federal income taxation on a net income basis;
or
(f) a partnership or other flow-through entity to the extent the
interests therein are owned by any of the persons described in
clauses (a), (b), (c), (d) or (e) above.
If a partnership or other flow-through entity holds subordinate voting
shares, the U.S. federal income tax treatment of a partner will generally depend
upon the status of the partner or other owner and upon the activities of the
partnership or other flow-through entity. If you are a partner of a partnership
holding subordinate voting shares, you should consult your tax advisor.
Holders of subordinate voting shares who are not U.S. Holders,
sometimes referred to as "Non-U.S. Holders", should also consult their own tax
advisors, particularly as to the applicability of any tax treaty.
The following discussion is based upon:
o the Internal Revenue Code;
o U.S. judicial decisions;
o administrative pronouncements;
o existing and proposed Treasury regulations; and
o the Canada-- U.S. Income Tax Treaty.
Any of the above is subject to change, possibly with retroactive
effect, so as to result in U.S. federal income tax consequences different from
those discussed below. We have not requested, and will not request, a ruling
from the U.S. Internal Revenue Service with respect to any of the U.S. federal
income tax consequences described below, and as a result, there can be no
assurance that the U.S. Internal Revenue Service will not disagree with or
challenge any of the conclusions we have reached and describe here.
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The following discussion is for general information only and is not
intended to be, nor should it be construed to be, legal or tax advice to any
holder of subordinate voting shares and no opinion or representation with
respect to the U.S. federal income tax consequences to any holder is made.
Holders of subordinate voting shares are urged to consult their tax advisors as
to the particular consequences to them under U.S. federal, state, local and
applicable foreign tax laws of the acquisition, ownership and disposition of
subordinate voting shares.
DIVIDENDS
Subject to the discussion of passive foreign investment companies
below, the gross amount of any distribution paid by us to a U.S. Holder will
generally be subject to U.S. federal income tax as foreign source dividend
income to the extent paid out of our current or accumulated earnings and
profits, as determined under U.S. federal income tax principles. Such income
will be includable in the gross income of a U.S. Holder on the day received by
the U.S. Holder. The amount of any distribution of property other than cash will
be the fair market value of such property on the date of the distribution. In
the case of a taxable corporate U.S. Holder, such dividends will be taxable as
ordinary income and will not be eligible for the corporate dividends received
deduction, which is generally allowed to U.S. corporate shareholders on
dividends received from a domestic corporation. In the case of an individual
U.S. Holder, under recently enacted tax legislation such dividends should
generally be eligible for a maximum tax rate of 15% for dividends received
before January 1, 2009, provided such holder holds the subordinate voting shares
for at least 60 days and certain other conditions are satisfied, including, as
we believe to be the case, that we are not a "passive foreign investment
company" or a "foreign personal holding company." To the extent that an amount
received by a U.S. Holder exceeds such holder's allocable share of our current
and accumulated earnings and profits, such excess will be applied first to
reduce such U.S. Holder's tax basis in his subordinate voting shares, thereby
increasing the amount of gain or decreasing the amount of loss recognized on a
subsequent disposition of the subordinate voting shares. Then, to the extent
such distribution exceeds such U.S. Holder's tax basis, it will be treated as
capital gain. We do not currently maintain calculations of our earnings and
profits for U.S. federal income tax purposes.
The gross amount of distributions paid in Canadian dollars, or any
successor or other foreign currency, will be included in the income of such U.S.
Holder in a U.S. dollar amount calculated by reference to the spot exchange rate
in effect on the day the distributions are paid regardless of whether the
payment is in fact converted into U.S. dollars. If the Canadian dollars, or any
successor or other foreign currency, are converted into U.S. dollars on the date
of the payment, the U.S. Holder should not be required to recognize any foreign
currency gain or loss with respect to the receipt of Canadian dollars as
distributions. If, instead, the Canadian dollars are converted at a later date,
any currency gains or losses resulting from the conversion of the Canadian
dollars will be treated as U.S. source ordinary income or loss for foreign tax
credit purposes. U.S. Holders are urged to consult their own tax advisors
concerning the U.S. tax consequences of acquiring, holding and disposing of
Canadian dollars.
A U.S. Holder may be entitled to deduct, or claim a foreign tax credit
for, Canadian taxes that are withheld on dividends received by the U.S. Holder,
subject to applicable limitations in the Code. Any amounts recognized as
dividends will generally constitute foreign source "passive income" or, in the
case of certain U.S. Holders, "financial services income" for U.S. foreign tax
credit purposes. A U.S. Holder will have a basis in any Canadian dollars
distributed equal to their U.S. dollar value on the payment date. The rules
governing the foreign tax credit are complex, and additional limitations on the
credit apply to individuals receiving dividends from
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foreign corporations if the dividends are eligible for the 15% maximum tax rate
on dividends described above. U.S. Holders are urged to consult their tax
advisors regarding the availability of the foreign tax credit under their
particular circumstances.
A Non-U.S. Holder of subordinate voting shares generally will not be
subject to U.S. federal income or withholding tax on dividends received on
subordinate voting shares unless such income is effectively connected with the
conduct by such Non-U.S. Holder of a trade or business in the United States.
SALE OR EXCHANGE
A U.S. Holder's initial tax basis in the subordinate voting shares will
generally be cost to the holder. A U.S. Holder's adjusted tax basis in the
subordinate voting shares will generally be the same as cost, but may differ for
various reasons including the receipt by such holder of a distribution that was
not made up wholly of earnings and profits as described above under the heading
"Dividends." Subject to the discussion of passive foreign investment companies
below, gain or loss realized by a U.S. Holder on the sale or other disposition
of subordinate voting shares will be subject to U.S. federal income taxation as
capital gain or loss in an amount equal to the difference (if any) between the
U.S. Holder's adjusted tax basis (determined in U.S. dollars) in the subordinate
voting shares and the U.S. dollar value of the amount realized on the
disposition of such subordinate voting shares. Capital gains of non-corporate
taxpayers, including individuals, derived with respect to a sale, exchange or
other disposition prior to January 1, 2009 of subordinate voting shares held for
more than one year are subject to a maximum federal income tax rate of 15%. The
deductibility of capital losses is subject to limitations. In the case of a
non-corporate U.S. Holder, the federal tax rate applicable to capital gains will
depend upon:
o the holder's holding period for the subordinate voting shares,
with a preferential rate available for subordinate voting
shares held for more than one year; and
o the holder's marginal tax rate for ordinary income.
Any gain realized will generally be treated as U.S. source gain and
loss realized by a U.S. Holder generally also will be treated as from sources
within the United States.
The ability of a U.S. Holder to utilize foreign taxes as a credit to
offset U.S. taxes is subject to complex limitations and conditions. The
consequences of the separate limitation calculation will depend upon the nature
and sources of each U.S. Holder's income and the deductions allocable thereto.
Alternatively, a U.S. Holder may elect to claim all foreign taxes paid as an
itemized deduction in lieu of claiming a foreign tax credit. A deduction does
not reduce U.S. tax on a dollar-for-dollar basis like a tax credit, but the
availability of the deduction is not subject to the same conditions and
limitations applicable to foreign tax credits.
If a U.S. Holder receives any foreign currency on the sale of
subordinate voting shares, such U.S. Holder may recognize ordinary income or
loss as a result of currency fluctuations between the date of the sale of
subordinate voting shares and the date the sale proceeds are converted into U.S.
dollars.
A Non-U.S. Holder of subordinate voting shares generally will not be
subject to U.S. federal income or withholding tax on any gain realized on the
sale or exchange of such subordinate voting shares unless:
90
o such gain is effectively connected with the conduct by such
Non-U.S. Holder of a trade or business in the United States;
or
o in the case of any gain realized by an individual Non-U.S.
Holder, such Non-U.S. Holder is present in the United States
for 183 days or more in the taxable year of such sale and
certain other conditions are met.
Personal Holding Company
We could be classified as a personal holding company for U.S. federal
income tax purposes if both of the following tests are satisfied:
o if at any time during the last half of our taxable year, five
or fewer individuals own or are deemed to own more than 50% of
the total value of our shares; and
o we receive 60% or more of our U.S. related gross income from
specified passive sources, such as royalty payments.
A personal holding company is taxed on a portion of its undistributed
U.S. source income, including specific types of foreign source income which are
connected with the conduct of a U.S. trade or business, to the extent this
income is not distributed to shareholders. We do not believe we are a personal
holding company presently and we do not expect to become one. However, we can
not assure you that we will not qualify as a personal holding company in the
future.
FOREIGN PERSONAL HOLDING COMPANY
We could be classified as a foreign personal holding company if in any
taxable year both of the following tests are satisfied:
o five or fewer individuals who are United States citizens or
residents own or are deemed to own more than 50% of the total
voting power of all classes of our shares entitled to vote or
the total value of our shares; and
o at least 60%, 50% in some cases, of our gross income, as
adjusted, consists of "foreign personal holding company
income", which generally includes passive income such as
dividends, interests, gains from the sale or exchange of
shares or securities, rent and royalties.
If we are classified as a foreign personal holding company and if you
hold shares in us, you may have to include in your gross income as a dividend
your pro rata portion of our undistributed foreign personal holding company
income. If you dispose of your shares prior to such date, you will not be
subject to tax under these rules. We do not believe we are a foreign personal
holding company presently and we do not expect to become one. However, we can
not assure you that we will not qualify as a foreign personal holding company in
the future.
PASSIVE FOREIGN INVESTMENT COMPANY
We believe that our subordinate voting shares should not currently be
treated as stock of a passive foreign investment company for United States
federal income tax purposes, but this conclusion is a factual determination made
annually and thus may be subject to change based on future operations and
composition and valuation of our assets. In general, we will be a
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passive foreign investment company with respect to a U.S. Holder if, for any
taxable year in which the U.S. Holder holds our subordinate voting shares,
either:
o at least 75% of our gross income for the taxable year is
passive income; or
o at least 50% of the average value of our assets is
attributable to assets that produce or are held for the
production of passive income.
For this purpose, passive income includes income such as:
o dividends;
o interest;
o rents or royalties, other than certain rents or royalties
derived from the active conduct of trade or business;
o annuities; or
o gains from assets that produce passive income.
If a foreign corporation owns at least 25% by value of the stock of
another corporation, the foreign corporation is treated for purposes of the
passive foreign investment company tests as owning its proportionate share of
the assets of the other corporation and as receiving directly its proportionate
share of the other corporation's income.
If we are treated as a passive foreign investment company, a U.S.
Holder that did not make a qualified electing fund election or, if available, a
mark-to-market election, as described below, would be subject to special rules
with respect to:
o any gain realized on the sale or other disposition of
subordinate voting shares; and
o any "excess distribution" by us to the U.S. Holder.
Generally, "excess distributions" are any distributions to the U.S.
Holder in respect of the subordinate voting shares during a single taxable year
that are greater than 125% of the average annual distributions received by the
U.S. Holder in respect of the subordinate voting shares during the three
preceding taxable years or, if shorter, the U.S. Holder's holding period for the
subordinate voting shares.
Under the passive foreign investment company rules,
o the gain or excess distribution would be allocated ratably
over the U.S. Holder's holding period for the subordinate
voting shares;
o the amount allocated to the taxable year in which the gain or
excess distribution was realized would be taxable as ordinary
income;
o the amount allocated to each prior year, with certain
exceptions, would be subject to tax at the highest tax rate in
effect for that year; and
o the interest charge generally applicable to underpayments of
tax would be imposed in respect of the tax attributable to
each such year.
A U.S. Holder owning actually or constructively "marketable stock" of a
passive foreign investment company may be able to avoid the imposition of the
passive foreign investment company tax rules described above by making a
mark-to-market election. Generally, pursuant to this election, such holder would
include in ordinary income, for each taxable year during which such stock is
held, an amount equal to the increase in value of the stock, which increase
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will be determined by reference to the value of such stock at the end of the
current taxable year compared with their value as of the end of the prior
taxable year. Holders desiring to make the mark-to-market election should
consult their tax advisors with respect to the application and effect of making
such election.
In the case of a U.S. Holder who does not make a mark-to-market
election, the special passive foreign investment company tax rules described
above will not apply to such U.S. Holder if the U.S. Holder makes an election to
have us treated as a qualified electing fund and we provide certain required
information to holders. For a U.S. Holder to make a qualified electing fund
election, we would have to satisfy certain reporting requirements. We have not
determined whether we will undertake the necessary measures to be able to
satisfy such requirements in the event that we were treated as a passive foreign
investment company.
A U.S. Holder that makes a qualified electing fund election will be
currently taxable on its pro rata share of our ordinary earnings and net capital
gain, at ordinary income and capital gains rates, respectively, for each of our
taxable years, regardless of whether or not distributions were received. The
U.S. Holder's basis in the subordinate voting shares will be increased to
reflect taxed but undistributed income. Distributions of income that had
previously been taxed will result in a corresponding reduction of basis in the
subordinate voting shares and will not be taxed again as a distribution to the
U.S. Holder. U.S. Holders desiring to make a qualified electing fund election
should consult their tax advisors with respect to the advisability of making
such election.
UNITED STATES BACKUP WITHHOLDING AND INFORMATION REPORTING
A U.S. Holder will generally be subject to information reporting with
respect to dividends paid on, or proceeds of the sale or other disposition of,
our subordinate voting shares that are paid within the United States or through
some U.S. related financial intermediaries to U.S. Holders, unless the U.S.
Holder is a corporation or comes within certain other categories of exempt
recipients. A U.S. Holder that is not an exempt recipient will generally be
subject to backup withholding with respect to the proceeds from the sale or the
disposition of, or with respect to dividends on, subordinate voting shares
unless the U.S. Holder provides a taxpayer identification number and otherwise
complies with applicable requirements of the backup withholding rules. In
addition, backup withholding may apply if the U.S. Holder fails to provide an
accurate taxpayer identification number, or to report interest and dividends
required to be shown on its federal income tax returns. Backup withholding is
not an additional tax. Any amount withheld under these rules will be creditable
against the U.S. Holder's U.S. federal income tax liability or refundable to the
extent that it exceeds such liability. A U.S Holder who does not provide a
correct taxpayer identification number may be subject to penalties imposed by
the United States Internal Revenue Service.
Non-U.S. Holders will generally be subject to information reporting and
possible backup withholding with respect to the proceeds of the sale or other
disposition of subordinate voting shares effected within the United States,
unless the holder certifies to its foreign status or otherwise establishes an
exemption if the broker does not have actual knowledge that the holder is a U.S.
holder. Payments of dividends on or proceeds from the sale of subordinate voting
shares within the United States by a payor within the United States to a
non-exempt U.S. or Non-U.S. Holder will be subject to backup withholding if such
holder fails to provide appropriate certification. In the case of such payments
by a payor within the United States to a foreign partnership other than a
foreign partnership that qualifies as a "withholding foreign partnership" within
the meaning of such Treasury regulations, the partners of such partnership
93
will be required to provide the certification discussed above in order to
establish an exemption from backup withholding tax and information reporting
requirements.
CANADIAN FEDERAL INCOME TAX CONSIDERATIONS
The following is a summary of the material Canadian federal income tax
considerations generally applicable to a U.S. person who holds subordinate
voting shares and who, for the purposes of the INCOME TAX ACT (Canada) (the
"ITA"), and the CANADA-UNITED STATES INCOME TAX CONVENTION (1980) (the
"Convention"), as applicable and at all relevant times:
o is resident in the United States and not resident in Canada,
o holds the subordinate voting shares as capital property,
o does not have a "permanent establishment" or "fixed base" in
Canada, as defined in the Convention; and
o deals at arm's length with us. Special rules, which are not
discussed below, may apply to "financial institutions", as
defined in the ITA, and to non-resident insurers carrying on
an insurance business in Canada and elsewhere.
This discussion is based on the current provisions of the ITA and the
Convention and on the regulations promulgated under the ITA, all specific
proposals to amend the ITA or the regulations promulgated under the ITA
announced by or on behalf of the Canadian Minister of Finance prior to the date
of this annual report and the current published administrative practices of the
Canada Customs and Revenue Agency. It does not otherwise take into account or
anticipate any changes in law or administrative practice nor any income tax laws
or considerations of any province or territory of Canada or any jurisdiction
other than Canada, which may differ from the Canadian federal income tax
consequences described in this document.
Under the ITA and the Convention, dividends paid or credited, or deemed
to be paid or credited, on the subordinate voting shares to a U.S. person who
owns less than 10% of the voting shares will be subject to Canadian withholding
tax at the rate of 15% of the gross amount of those dividends or deemed
dividends. If a U.S. person is a corporation and owns 10% or more of the voting
shares, the rate is reduced from 15% to 5%. Subject to specified limitations, a
U.S. person may be entitled to credit against U.S. federal income tax liability
for the amount of tax withheld by Canada.
Under the Convention, dividends paid to specified religious,
scientific, charitable and similar tax exempt organizations and specified
organizations that are resident and exempt from tax in the United States and
that have complied with specified administrative procedures are exempt from this
Canadian withholding tax.
A capital gain realized by a U.S. person on a disposition or deemed
disposition of the subordinate voting shares will not be subject to tax under
the ITA unless the subordinate voting shares constitute taxable Canadian
property within the meaning of the ITA at the time of the disposition or deemed
disposition. In general, the subordinate voting shares will not be "taxable
Canadian property" to a U.S. person if they are listed on a prescribed stock
exchange, which includes The Toronto Stock Exchange, unless, at any time within
the five-year period immediately preceding the disposition, the U.S. person,
persons with whom the U.S. person did
94
not deal at arm's length, or the U.S. person together with those persons, owned
or had an interest in or a right to acquire more than 25% of any class or series
of our shares.
If the subordinate voting shares are taxable Canadian property to a
U.S. person, any capital gain realized on a disposition or deemed disposition of
those subordinate voting shares will generally be exempt from tax by virtue of
the Convention if the value of the subordinate voting shares at the time of the
disposition or deemed disposition is not derived principally from real property,
as defined by the Convention, situated in Canada. The determination as to
whether Canadian tax would be applicable on a disposition or deemed disposition
of the subordinate voting shares must be made at the time of the disposition or
deemed disposition.
Holders of subordinate voting shares are urged to consult their own tax
advisors to determine the particular tax consequences to them, including the
application and effect of any state, local or foreign income and other tax laws,
of the acquisition, ownership and disposition of subordinate voting shares.
F. DIVIDENDS AND PAYING AGENTS
Not Applicable
G. STATEMENT BY EXPERTS
Not Applicable
H. DOCUMENTS ON DISPLAY
Any statement in this annual report about any of our contracts or other
documents is not necessarily complete. If the contract or document is filed as
an exhibit to the registration statement, the contract or document is deemed to
modify the description contained in this annual report. You must review the
exhibits themselves for a complete description of the contract or document.
You may review a copy of our filings with the SEC, including exhibits
and schedules filed with it, at the SEC's public reference facilities in Room
1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 and at the
regional offices of the SEC located at 233 Broadway, New York, New York 10279
and at the Northwestern Atrium Center, 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661. You may also obtain copies of such materials from the
Public Reference Section of the SEC, Room 1024, Judiciary Plaza, 450 Fifth
Street, N.W., Washington, D.C. 20549, at prescribed rates. You may call the SEC
at 1-800-SEC-0330 for further information on the public reference rooms. The SEC
maintains a Web site (HTTP://WWW.SEC.GOV) that contains reports, proxy and
information statements and other information regarding registrants that file
electronically with the SEC. Although we make many of our filings with the SEC
electronically as a foreign private issuer, we are not obligated to do so.
You may read and copy any reports, statements or other information that
we file with the SEC at the addresses indicated above and you may also access
them electronically at the Web site set forth above. These SEC filings are also
available to the public from commercial document retrieval services.
95
We are required to file reports and other information with the SEC
under the Securities Exchange Act of 1934. Reports and other information filed
by us with the SEC may be inspected and copied at the SEC's public reference
facilities described above. As a foreign private issuer, we are exempt from the
rules under the Exchange Act prescribing the furnishing and content of proxy
statements and our officers, directors and principal shareholders are exempt
from the reporting and short-swing profit recovery provisions contained in
Section 16 of the Exchange Act. Under the Exchange Act, as a foreign private
issuer, we are not required to publish financial statements as frequently or as
promptly as United States companies.
I. SUBSIDIARY INFORMATION
See Item 4.C. of this annual report.
96
ITEM 11. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK
CURRENCY RISK
We are exposed to currency risk as a result of the export of our
products manufactured in Canada, substantially all of which are denominated in
US dollars. Our exposure to foreign exchange rate fluctuations is partially
hedged by operating expenses of certain international subsidiaries and the
purchase of raw materials in US dollars. In addition, we frequently enter into
forward exchange contracts to sell US dollars at fixed forward rates in exchange
for Canadian dollars. We enter into such contracts to manage the risk of
exchange rate fluctuations between the Canadian and US dollars on cash flows
related to anticipated future revenue streams denominated in US dollars. We do
not enter into forward exchange contracts for trading purposes.
The following table summarizes the forward exchange contracts in effect
as at August 31, 2003, classified by expected transaction dates, none of which
exceed two years, as well as the notional amounts of such contracts (in
thousands of US dollars) along with the weighted average contractual forward
rates under such contracts. The notional amounts of such contracts are used to
calculate the contractual payments to be made under these contracts.
YEARS ENDING AUGUST 31,
--------------------------
2004 2005
----------- ----------
Forward exchange contracts to sell US dollars in exchange
for Canadian dollars
Contractual amounts......................................... $ 6,470 $ 6,680
Weighted average contractual exchange rates................. 1.5869 1.5647
FAIR VALUE
The fair value of these contracts as at August 31, 2003, based on the
current trading value, amounted to CA$18,550,000 compared to a contractual value
of CA$20,719,439.
INTEREST RATE RISK
We are exposed to the impact of interest rate changes and changes in
the market values of our available-for-sale securities. We do not use derivative
financial instruments for our available-for-sale securities. Our
available-for-sale securities consist of debt instruments issued by high-credit
quality corporations. The debt instruments bear interest at fixed rate and may
have their fair market value adversely impacted due to a rise in interest rate.
However, due to their very short-term maturity, we consider this risk to be
insignificant.
97
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES.
Not Applicable
PART II.
--------
ITEM 13. DEFAULTS, DIVIDENDS ARREARAGES AND DELINQUENCIES
Not Applicable
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF
PROCEEDS
Not Applicable
ITEM 15. CONTROLS AND PROCEDURES
Prior to the adoption of the SARBANES-OXLEY ACT OF 2002, we maintained
formal and informal procedures that were designed to ensure that we comply with
disclosure obligations and that there is a flow of important information to the
appropriate collection and disclosure points in a timely manner.
The evaluation of our disclosure controls and procedures, which
occurred on December 19, 2003, was supervised and reviewed by our senior
management. In doing so, they considered the controls and procedures that we
have implemented, and evaluated the existence of any material weaknesses or
deficiencies that would significantly and adversely affect our ability to
collect, process or disclose required information on a timely basis, all in the
context of our relatively small size (627 employees as of December 15, 2003),
and the hands-on role that is played by our chief executive officer and our
chief financial officer in our day-to-day operations. As a result, our chief
executive officer and our chief financial officer have concluded that the
procedures and controls that we have implemented ensure timely collection and
evaluation of information potentially subject to disclosure under applicable
securities laws, and that such procedures and controls capture information that
is relevant to an assessment of the need to disclose developments and risks that
pertain to our business.
Finally, we confirm that there were no significant changes in our
internal controls or in other factors that would significantly affect these
controls and procedures subsequent to the date of their evaluation.
ITEM 16. [RESERVED]
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT
Our board of directors has determined that Mr. Andre Tremblay, CA,
chairman of our audit committee is an audit committee financial expert. Mr.
Tremblay is independent of management.
98
ITEM 16B. CODE OF ETHICS
In 2003, we adopted a code of ethics that applies to our chief
executive officer, our chief financial officer and our manager of financial
reporting and accounting. A copy of this code of ethics has been filed as
exhibit 11.1 to this annual report. As reported at item 7B of this annual
report, previous to the coming into force of the requirement for a code of
ethics, we had entered into a lease agreement with G. Lamonde Investissements
financiers inc., a company controlled by our chief executive officer, for
premises located at 465 Godin Avenue in Vanier, Quebec. In addition, in
September 2002, we acquired from G. Lamonde Investissements financiers inc. the
building located at 436 Nolin Street. The purchase price paid was based on an
independent third party valuation and the transaction was approved by our audit
committee and board of directors with Mr. Lamonde abstaining.
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
AUDIT FEES
During the financial years ended August 31, 2002 and August 31,
2003,our principal accountant, PricewaterhouseCoopers LLP, billed us aggregate
amounts of $160,000 and $202,459 respectively for the audit of our annual
financial statements and services in connection with statutory and regulatory
filings.
AUDIT RELATED FEES
Not applicable.
TAX FEES
During the financial years ended August 31, 2002 and August 31, 2003,
our principal accountant, PricewaterhouseCoopers LLP, billed us aggregate
amounts of $275,000 and $233,660 respectively for services related to tax
compliance, tax advice and tax planning.
ALL OTHER FEES
Not applicable.
AUDIT COMMITTEE PRE-APPROVAL POLICIES AND PROCEDURES
On September 25, 2002, our audit committee adopted a policy requiring
prior approval by the audit committee of the annual audit plan and fees. In the
event any adjustments to audit fees may be required during the course of a
financial year, such adjustments shall be approved by the chairman of the audit
committee, acting alone, and shall be reported to the full audit committee at
its next meeting.
In the case of non-audit fees (excluding tax matters), the policy
provides that proposals shall be submitted to the chairman of the audit
committee and our chief financial officer at the same time and the chairman of
the audit committee will be responsible for approval of such proposal, subject
to any modifications that he may require. The chairman will make a report to the
full audit committee at its next meeting.
99
As concerns tax services to be provided by our principal accountant,
our policy provides that the principal accountant will present to the audit
committee for pre-approval, on or before the beginning of each financial year,
an engagement for tax matters that are foreseeable for the upcoming year and the
audit committee shall be responsible for pre-approval thereof, subject to any
modifications it may make to such proposals. In the event tax services are
required that were not pre-approved by the audit committee, the procedure set
forth in the previous paragraph will apply.
During the financial year ended on August 31, 2003, 100% of tax fees
were approved by the audit committee pursuant to this policy. During the
financial year ended on August 31, 2003, only full-time permanent employees of
our principal accountant, PricewaterhouseCoopers LLP, performed work to audit
our financial statements.
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
Not Applicable
PART III.
---------
ITEM 17. FINANCIAL STATEMENTS
Not Applicable.
ITEM 18. FINANCIAL STATEMENTS
See pages F-2 to F-46.
100
ITEM 19. EXHIBITS
NUMBER EXHIBIT
--------------- --------------------------------------------------------------
1.1 Amended Articles of Incorporation of EXFO (incorporated by
reference to Exhibit 3.1 of EXFO's Registration Statement on
Form F-1, File No. 333-38956).
1.2 Amended By-laws of EXFO (incorporated by reference to Exhibit
1.2 of EXFO's annual report on Form-20F dated January 15,
2003).
1.3 Amended and Restated Articles of Incorporation of EXFO
(incorporated by reference to Exhibit 1.3 of EXFO's annual
report on Form 20-F dated January 18, 2001).
2.1 Form of Subordinate Voting Share Certificate (incorporated by
reference to Exhibit 4.1 of EXFO's Registration Statement on
Form F-1, File No. 333-38956).
2.2 Form of Registration Rights Agreement between EXFO and Germain
Lamonde dated July 6, 2000 ) (incorporated by reference to
Exhibit 10.13 of EXFO's Registration Statement on Form F-1,
File No. 333-38956).
3.1 Form of Trust Agreement among EXFO, Germain Lamonde, GEXFO
Investissements Technologiques inc., Fiducie Germain Lamonde
and G. Lamonde Investissements Financiers inc. (incorporated
by reference to Exhibit 4.2 of EXFO's Registration Statement
on Form F-1, File No. 333-38956).
4.1 Agreement of Merger and Plan of Reorganization, dated as of
November 4, 2000, by and among EXFO, EXFO Sub, Inc., EXFO
Burleigh Instruments, Inc., Robert G. Klimasewki, William G.
May, Jr., David J. Farrell and William S. Gornall
(incorporated by reference to Exhibit 4.1 of EXFO's annual
report on Form 20-F dated January 18, 2001)
4.2 Amendment No. 1 to Agreement of Merger and Plan of Agreement,
dated as of December 20, 2000, by and among EXFO, EXFO Sub,
Inc., EXFO Burleigh Instruments, Inc., Robert G. Klimasewski,
William G. May, Jr., David J. Farrell and William S. Gornall
(incorporated by reference to Exhibit 4.2 of EXFO's annual
report on Form 20-F dated January 18, 2001).
4.3 Agreement of Merger, dated as of August 20, 2001, by and among
EXFO, Buyer Sub, and Avantas Networks Corporation and
Shareholders of Avantas Networks corporation (incorporated by
reference to Exhibit 4.3 of EXFO's annual report on Form 20-F
dated January 18, 2002).
4.4 Amendment No. 1 dated as of November 1, 2002 to Agreement of
Merger, dated as of August 20, 2001, by and among EXFO,
3905268 Canada Inc., Avantas Networks Corporation and
Shareholders of Avantas Networks (incorporated by reference to
Exhibit 4.4 of EXFO's annual report on Form 20-F dated January
18, 2002).
4.5 Offer to purchase shares of Nortech Fibronic Inc., dated
February 6, 2000 among EXFO, Claude Adrien Noel, 9086-9314
Quebec inc., Michel Bedard, Christine Bergeron and Societe en
Commandite Capidem Quebec Enr. and Certificate of Closing,
dated February 7, 2000 among the same parties (including
summary in English) (incorporated by reference to Exhibit 10.2
of EXFO's Registration Statement on Form F-1, File No.
333-38956).
4.6 Share Purchase Agreement, dated as of March 5, 2001, among
EXFO Electro-Optical Engineering, Inc., John Kennedy, Glenn
Harvey and EFOS Corporation (incorporated by reference to
Exhibit 4.1 of EXFO's Registration Statement on Form F-3, File
No. 333-65122).
4.7 Amendment Number One, dated as of March 15, 2001, to Share
Purchase Agreement, dated as of March 5, 2001, among EXFO
Electro-Optical Engineering, Inc., John Kennedy, Glenn Harvey
and EFOS Corporation. (incorporated by reference to Exhibit
4.2 of EXFO's Registration Statement on Form F-3, File No.
333-65122).
4.8 Share Purchase Agreement, dated as of November 2, 2001 between
JDS Uniphase Inc. and 3905268 Canada Inc. (incorporated by
reference to Exhibit 4.8 of EXFO's annual report on Form 20-F
dated January 18, 2002).
4.9 Intellectual Property Assignment and Sale Agreement between
EFOS Inc., EXFO Electro-Optical Engineering, Inc., John
Kennedy, Glenn Harvey and EFOS Corporation. (incorporated by
reference to Exhibit 4.3 of EXFO's Registration Statement on
Form F-3, File No. 333-65122).
4.10 Offer to acquire a building, dated February 23, 2000, between
EXFO and Groupe Mirabau inc. and as accepted by Groupe Mirabau
inc. on February 24, 2000 (including summary in English)
(incorporated by reference to Exhibit 10.3 of EXFO's
Registration Statement on Form F-1, File No. 333-38956).
4.11 Lease Agreement, dated December 1, 1996, between EXFO and
GEXFO Investissements Technologiques inc., as assigned to
9080-9823 Quebec inc. on September 1, 1999 (including summary
in English) (incorporated by reference to Exhibit 10.4 of
EXFO's Registration Statement on Form F-1, File No.
333-38956).
101
NUMBER EXHIBIT
--------------- --------------------------------------------------------------
4.12 Lease Agreement, dated March 1, 1996, between EXFO and GEXFO
Investissements Technologiques inc., as assigned to 9080-9823
Quebec inc. on September 1, 1999 (including summary in
English) (incorporated by reference to Exhibit10.5 of EXFO's
Registration Statement on Form F-1, File No. 333-38956).
4.13 Lease renewal of the existing leases between 9080-9823 Quebec
inc. and EXFO, dated November 30, 2001(incorporated by
reference to Exhibit 4.13 of EXFO's annual report on Form 20-F
dated January 18, 2002).
4.14 Loan Agreement between EXFO and GEXFO Investissements
Technologiques inc., dated May 11, 1993, as assigned to
9080-9823 Quebec inc. on September 1, 1999 (including summary
in English) (incorporated by reference to Exhibit 10.9 of
EXFO's Registration Statement on Form F-1, File No.
333-38956).
4.15 Resolution of the board of directors of EXFO, dated September
1, 1999, authorizing EXFO to acquire GEXFO Distribution
Internationale inc. from GEXFO Investissements Technologiques
inc. (including summary in English) (incorporated by reference
to Exhibit 10.10 of EXFO's Registration Statement on Form F-1,
File No. 333-38956).
4.16 Form of Promissory Note of EXFO issued to GEXFO
Investissements Technologiques inc. dated June 27, 2000 )
(incorporated by reference to Exhibit 10.12 of EXFO's
Registration Statement on Form F-1, File No. 333-38956).
4.17 Term Loan Offer, dated March 28, 2000, among EXFO and National
Bank of Canada as accepted by EXFO on April 3, 2000 (including
summary in English) (incorporated by reference to Exhibit
10.11 of EXFO's Registration Statement on Form F-1, File No.
333-38956).
4.18 Employment Agreement of Germain Lamonde dated May 29, 2000
(incorporated by reference to Exhibit 10.15 of EXFO's
Registration Statement on Form F-1, File No. 333-38956).
4.19 Employment Agreement of Bruce Bonini dated as of September 1,
2000 (incorporated by reference to Exhibit 4.24 of EXFO's
annual report on Form 20-F dated January 18, 2002).
4.20 Employment Agreement of Juan-Felipe Gonzalez dated as of
September 1, 2000 (incorporated by reference to Exhibit 4.25
of EXFO's annual report on Form 20-F dated January 18, 2002).
4.21 Employment Agreement of David J. Farrell dated as of December
20, 2000 (incorporated by reference to Exhibit 4.26 of EXFO's
annual report on Form 20-F dated January 18, 2002).
4.22 Deferred Profit Sharing Plan, dated September 1, 1998
(incorporated by reference to Exhibit 10.6 of EXFO's
Registration Statement on Form F-1, File No. 333-38956).
4.23 Stock Option Plan, dated May 25, 2000 (incorporated by
Reference to Exhibit 10.7 of EXFO's Registration Statement on
Form F-1, File No. 333-38956).
4.24 Share Plan, dated April 3, 2000 (incorporated by reference to
Exhibit 10.8 of EXFO's Registration Statement on Form F-1,
File No. 333-38956).
4.25 Directors' Compensation Plan (incorporated by reference to
Exhibit 10.17 of EXFO's Registration Statement on Form F-1,
File No. 333-38956).
4.26 Restricted Stock Award Plan, dated December 20, 2000
(incorporated by reference to Exhibit 4.21 of EXFO's annual
report on Form 20-F dated January 18, 2001).
4.27 Asset Purchase Agreement by and Among EXFO Electro-Optical
Engineering Inc., EXFO Gnubi Products Group Inc., gnubi
communications, L.P., gnubi communications General Partner,
LLC, gnubi communications Limited Partner, LLC, gnubi
communications, Inc., Voting Trust created by The Irrevocable
Voting Trust Agreement Among Carol Abraham Bolton, Paul
Abraham and James Ray Stevens, James Ray Stevens and Daniel J.
Ernst dated September 5, 2002 (incorporated by reference to
Exhibit 4.30 of EXFO's annual report on Form 20-F dated
January 15, 2003).
4.28 EXFO Protocol Inc. Executive Employment Agreement with Sami
Yazdi signed November 2, 2001 (incorporated by reference to
Exhibit 4.31 of EXFO's annual report on Form 20-F dated
January 15, 2003).
4.29 Second Amending Agreement to the Employment Agreement of Bruce
Bonini dated as of September 1, 2002.
4.30 Severance and General Release Agreement with Bruce Bonini
dated August 8, 2003.
4.31 Separation Agreement and General Release with Sami Yazdi dated
April 1, 2003.
4.32 Executive Employment Agreement of James Stevens dated as of
October 4, 2003.
4.33 Termination Terms for John Holloran Jr. dated May 28, 2003.
4.34 Employment Agreement of Pierre Plamondon dated as of September
1, 2002.
8.1 Subsidiaries of EXFO (list included in Item 4C of this annual
report).
11.1 Code of Ethics for senior financial officers.
102
SIGNATURES
The registrant hereby certifies that it meets all of the requirements for filing
on Form 20 -F and that it has duly caused and authorized the undersigned to sign
this annual report on its behalf.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
By: /s/ Germain Lamonde
--------------------------------
Name: Germain Lamonde
Title: Chairman of the Board, President
and Chief Executive Officer
Date: January 9, 2004.
CERTIFICATIONS
I, Germain Lamonde, Chairman of the Board, President and Chief
Executive Officer, certify that:
1. I have reviewed this annual report on Form 20-F of EXFO
Electro-Optical Engineering Inc. ("EXFO");
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statement made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other
financial information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of EXFO
as of, and for, the periods presented in this report;
4. EXFO's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for EXFO and have:
a) Designed such disclosure controls and procedures, or caused
such disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to EXFO, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) Evaluated the effectiveness of EXFO's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation;
5. EXFO's other certifying officer and I have disclosed, based on
our most recent evaluation of disclosure controls and procedures, to EXFO's
auditors and the audit committee of EXFO's board of directors (or persons
performing the equivalent function):
103
a) All significant deficiencies and weaknesses in the design or
operation of internal controls which are reasonable likely to adversely affect
EXFO's ability to record, process, summarize and report financial information;
and
b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in EXFO's internal controls.
Date: January 9, 2004.
/s/ Germain Lamonde
-------------------------------------
Germain Lamonde
Chairman of the Board,
President and Chief Executive Officer
Pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and
(b) of section 1350, chapter 63 of title 18, United States Code), the
undersigned officer of EXFO, hereby certifies, to such officer's knowledge,
that:
1. The annual report of Form 20-F for the year ended August 31,
2003 of EXFO fully complies with the requirements of section 13(a) or 15(d) of
the Securities Exchange Act of 1934; and
2. The information contained in this annual report fairly
presents, in all material respects, the financial condition and results of
operations of EXFO.
Date: January 9, 2004.
/s/ Germain Lamonde
-------------------------------------
Germain Lamonde
Chairman of the Board,
President and Chief Executive Officer
The foregoing certification is being furnished solely pursuant to
section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of
section 1350, chapter 63 of title 18, United States Code) and is not being filed
as part of the Report or as separate disclosure document.
104
I, Pierre Plamondon, Vice-President Finance and Chief Financial
Officer, certify that:
1. I have reviewed this annual report on Form 20-F of EXFO
Electro-Optical Engineering Inc. ("EXFO");
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statement made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other
financial information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of EXFO
as of, and for, the periods presented in this report;
4. EXFO's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for EXFO and have:
a) Designed such disclosure controls and procedures, or caused
such disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to EXFO, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) Evaluated the effectiveness of EXFO's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation;
5. EXFO's other certifying officer and I have disclosed, based on
our most recent evaluation of disclosure controls and procedures, to EXFO's
auditors and the audit committee of EXFO's board of directors (or persons
performing the equivalent function):
a) All significant deficiencies and weaknesses in the design or
operation of internal controls which are reasonable likely to adversely affect
EXFO's ability to record, process, summarize and report financial information;
and
b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in EXFO's internal controls.
Date: January 9, 2004.
/s/ Pierre Plamondon
---------------------------
Pierre Plamondon, CA
Vice-President Finance
and Chief Financial Officer
105
Pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and
(b) of section 1350, chapter 63 of title 18, United States Code), the
undersigned officer of EXFO, hereby certifies, to such officer's knowledge,
that:
1. The annual report of Form 20-F for the year ended August 31,
2003 of EXFO fully complies with the requirements of section 13(a) or 15(d) of
the Securities Exchange Act of 1934; and
2. The information contained in this annual report fairly
presents, in all material respects, the financial condition and results of
operations of EXFO.
Date: January 9, 2004.
/s/ Pierre Plamondon
---------------------------
Pierre Plamondon, CA
Vice-President Finance
and Chief Financial Officer
The foregoing certification is being furnished solely pursuant to
section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of
section 1350, chapter 63 of title 18, United States Code) and is not being filed
as part of the Report or as separate disclosure document.
106
REPORT OF INDEPENDENT AUDITORS
TO THE SHAREHOLDERS OF
EXFO ELECTRO-OPTICAL ENGINEERING INC.
We have audited the consolidated balance sheets of EXFO ELECTRO-OPTICAL
ENGINEERING INC. as at August 31, 2003 and 2002 and the consolidated statements
of earnings, retained earnings (deficit) and contributed surplus and cash flows
for each of the years in the three-year period ended August 31, 2003. These
financial statements are the responsibility of the company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with Canadian and United States generally
accepted auditing standards. Those standards require that we plan and perform an
audit to obtain reasonable assurance whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation.
In our opinion, these consolidated financial statements present fairly, in all
material respects, the financial position of the company as at August 31, 2003
and 2002 and the results of its operations and its cash flows for each of the
years in the three-year period ended August 31, 2003 in accordance with Canadian
generally accepted accounting principles. Furthermore, in our opinion, the
financial statement schedules on the variation in the allowance for doubtful
accounts and on the variation in the valuation allowance of future income tax
assets included in Form 20-F present fairly, in all material respects, the
information set forth therein when read in conjunction with the related
consolidated financial statements.
/s/ PricewaterhouseCoopers LLP
CHARTERED ACCOUNTANTS
Quebec, Quebec, Canada
September 26, 2003
COMMENTS BY AUDITORS FOR U.S. READERS ON CANADA-U.S. REPORTING DIFFERENCES
In the United States of America, reporting standards for auditors require the
addition of an explanatory paragraph (following the opinion paragraph) when
there are changes in accounting principles that have a material effect on the
comparability of the company's financial statements, such as the changes
described in note 2 to the consolidated financial statements. Our report to the
Shareholders dated September 26, 2003 is expressed in accordance with Canadian
reporting standards which do not require a reference to such changes in
accounting principles in the auditors' report when the changes are properly
accounted for and adequately disclosed in the financial statements.
/s/ PricewaterhouseCoopers LLP
CHARTERED ACCOUNTANTS
Quebec, Quebec, Canada
September 26, 2003
F-1
EXFO ELECTRO-OPTICAL ENGINEERING INC.
CONSOLIDATED BALANCE SHEETS
(in thousands of US dollars)
AS AT AUGUST 31,
----------------------
2003 2002
--------- ---------
ASSETS
CURRENT ASSETS
Cash $ 5,366 $ 9,128
Short-term investments (notes 8 and 18) 52,010 40,553
Accounts receivable (notes 8 and 18)
Trade 9,639 9,881
Other 834 3,267
Income taxes and tax credits recoverable (notes 4 and 8) 6,003 13,473
Inventories (notes 4, 5 and 8) 15,602 23,822
Prepaid expenses 2,041 1,280
Future income taxes (notes 4 and 15) -- 1,272
--------- ---------
91,495 102,676
INCOME TAXES AND TAX CREDITS RECOVERABLE (notes 4 and 8) 1,377 6,234
PROPERTY, PLANT AND EQUIPMENT (notes 6 and 8) 24,931 26,246
INTANGIBLE ASSETS (notes 4, 7 and 8) 10,778 16,464
GOODWILL (notes 4 and 7) 17,673 17,576
FUTURE INCOME TAXES (notes 4 and 15) -- 8,730
--------- ---------
$ 146,254 $ 177,926
========= =========
LIABILITIES
CURRENT LIABILITIES
Accounts payable and accrued liabilities (note 9) $ 12,026 $ 10,699
Income taxes payable 2,200 --
Deferred revenue 500 503
Current portion of long-term debt 110 100
--------- ---------
14,836 11,302
DEFERRED GRANTS (note 14) 1,139 654
LONG-TERM DEBT (note 10) 453 564
--------- ---------
16,428 12,520
--------- ---------
COMMITMENTS (note 11)
CONTINGENCIES (note 12)
SHAREHOLDERS' EQUITY
SHARE CAPITAL (note 13) 492,452 489,611
CONTRIBUTED SURPLUS 1,519 1,487
CUMULATIVE TRANSLATION ADJUSTMENT 7,643 (8,854)
DEFICIT (371,788) (316,838)
--------- ---------
129,826 165,406
--------- ---------
$ 146,254 $ 177,926
========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
F-2
EXFO ELECTRO-OPTICAL ENGINEERING INC.
CONSOLIDATED STATEMENTS OF EARNINGS
(in thousands of US dollars, except share and per share data)
YEARS ENDED AUGUST 31,
-----------------------------------
2003 2002 2001
--------- --------- ---------
(note 22) (note 22)
SALES (note 16) $ 61,930 $ 68,330 $ 146,013
COST OF SALES* 36,197 52,366 56,207
--------- --------- ---------
GROSS MARGIN 25,733 15,964 89,806
--------- --------- ---------
OPERATING EXPENSES
Selling and administrative 26,991 33,881 44,975
Net research and development (notes 4 and 14) 15,879 12,782 13,601
Amortization of property, plant and equipment 6,139 5,932 3,559
Amortization of intangible assets 4,747 11,615 9,876
Write-down of intangible assets (note 4) 2,922 23,657 --
Restructuring and other charges (note 4) 4,134 2,880 3,288
--------- --------- ---------
TOTAL OPERATING EXPENSES 60,812 90,747 75,299
--------- --------- ---------
EARNINGS (LOSS) FROM OPERATIONS (35,079) (74,783) 14,507
Interest income, net 1,245 1,456 6,098
Foreign exchange gain (loss) (1,552) (458) 3,327
--------- --------- ---------
EARNINGS (LOSS) BEFORE INCOME TAXES AND AMORTIZATION AND
WRITE-DOWN OF GOODWILL (note 15) (35,386) (73,785) 23,932
INCOME TAXES (note 15) 15,059 (25,451) 8,150
--------- --------- ---------
EARNINGS (LOSS) BEFORE AMORTIZATION AND WRITE-DOWN OF
GOODWILL (50,445) (48,334) 15,782
AMORTIZATION OF GOODWILL (note 2) -- 38,021 31,076
WRITE-DOWN OF GOODWILL (note 4) 4,505 222,169 --
--------- --------- ---------
NET LOSS FOR THE YEAR $ (54,950) $(308,524) $ (15,294)
========= ========= =========
BASIC AND DILUTED EARNINGS (LOSS) PER SHARE
Earnings (loss) before amortization and write-down of goodwill $ (0.80) $ (0.80) $ 0.30
Net loss $ (0.87) $ (5.09) $ (0.29)
BASIC WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING (000'S) 62,852 60,666 53,014
DILUTED WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING (000'S) (note 17) 63,317 60,966 53,495
* Including inventory write-offs of $4,121, $18,463 and nil for the years
ended August 31, 2003, 2002 and 2001, respectively (note 4).
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
EXFO ELECTRO-OPTICAL ENGINEERING INC.
CONSOLIDATED STATEMENTS OF RETAINED EARNINGS (DEFICIT) AND CONTRIBUTED SURPLUS
(in thousands of US dollars)
RETAINED EARNINGS (DEFICIT)
YEARS ENDED AUGUST 31,
----------------------------------------
2003 2002 2001
---------- ---------- ----------
BALANCE - BEGINNING OF YEAR $ (316,838) $ (8,314) $ 6,980
ADD
Net loss for the year (54,950) (308,524) (15,294)
---------- ---------- ----------
BALANCE - END OF YEAR $ (371,788) $ (316,838) $ (8,314)
========== ========== =========
CONTRIBUTED SURPLUS
YEARS ENDED AUGUST 31,
----------------------------------------
2003 2002 2001
---------- ---------- ----------
BALANCE - BEGINNING OF YEAR $ 1,487 $ 1,457 $ --
ADD
Premium on resale of share capital 32 30 1,457
---------- ---------- ----------
BALANCE - END OF YEAR $ 1,519 $ 1,487 $ 1,457
========== ========== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
EXFO ELECTRO-OPTICAL ENGINEERING INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands of US dollars)
YEARS ENDED AUGUST 31,
-----------------------------------
2003 2002 2001
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss for the year $ (54,950) $(308,524) $ (15,294)
Add (deduct) items not affecting cash
Discount on short-term investments (54) 271 191
Inventory and tax credit write-offs 6,418 18,463 --
Amortization 10,886 55,568 44,511
Foreign exchange gains on disposal of short-term
investments (42) (74) (3,437)
Restructuring and other charges 512 741 1,083
Future income taxes (18,247) (13,397) (1,779)
Future income tax assets valuation allowance 28,385 -- --
Write-down of goodwill and intangible assets 7,427 245,826 --
Change in non-cash operating items
Accounts receivable 3,957 15,406 447
Income taxes and tax credits 13,886 (19,736) 2,237
Inventories 7,925 4,332 (20,308)
Prepaid expenses (569) 356 (67)
Accounts payable and accrued liabilities (349) (7,470) (3,736)
Deferred revenue (24) (106) 100
Deferred grants 420 (335) (57)
--------- --------- ---------
5,581 (8,679) 3,891
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Bank advances -- -- (2,046)
Repayment of mandatorily redeemable preferred shares -- -- (354)
Repayment of long-term debt (133) (106) (3,355)
Issuance of share capital 45 -- --
Redemption of share capital (16) (6) (33)
Resale of share capital 48 36 1,490
Share issue expenses -- (14) (331)
--------- --------- ---------
(56) (90) (4,629)
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to short-term investments (401,105) (506,228) (772,808)
Proceeds from disposal of short-term investments 395,699 531,733 865,373
Additions to property, plant and equipment and intangible assets (2,652) (5,245) (15,911)
Business combinations (note 3) (1,867) (9,756) (68,255)
--------- --------- ---------
(9,925) 10,504 8,399
--------- --------- ---------
CHANGE IN CASH (4,400) 1,735 7,661
EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON CASH 638 (336) (661)
CASH - BEGINNING OF YEAR 9,128 7,729 729
--------- --------- ---------
CASH - END OF YEAR $ 5,366 $ 9,128 $ 7,729
========= ========= =========
SUPPLEMENTARY INFORMATION
Interest paid $ 417 $ 269 $ 377
Income taxes paid (recovered) $ (10,351) $ 4,172 $ 8,171
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
1 INCORPORATION AND NATURE OF ACTIVITIES
The company, incorporated in 1985 under the Canada Business
Corporations Act, designs, manufactures and markets a full line of
test, measurement and monitoring solutions for the global
telecommunications industry. These solutions characterize the physical,
optical and protocol layers of optical fiber and related hardware. The
company derives substantially all of its revenue from customers located
in the United States, Canada, Europe and Asia. The company's customers
consist primarily of telecommunications carriers, network service
providers, optical component and system manufacturers, as well as
research and development laboratories.
2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
These consolidated financial statements have been prepared in
accordance with generally accepted accounting principles in Canada.
These principles conform, in all material respects, with accounting
principles generally accepted in the United States, except for the
significant differences and additional disclosures provided in note 20.
ACCOUNTING ESTIMATES
The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities, and disclosures of contingent assets and liabilities at
the date of the financial statements and the reported amounts of
revenues and expenses during the reporting years. Actual results could
differ from those estimates.
CONSOLIDATION
These consolidated financial statements include the accounts of the
company and its domestic and international subsidiaries. All
significant intercompany accounts and transactions have been
eliminated.
REPORTING CURRENCY
The functional currency of the company is the Canadian dollar. However,
the company has adopted the US dollar as its reporting currency. The
financial statements are translated into the reporting currency using
the current rate method. Under this method, the financial statements
are translated into the reporting currency as follows: assets and
liabilities are translated at the exchange rate in effect at the date
of the balance sheet, while revenues and expenses are translated at the
monthly average exchange rate. All gains and losses resulting from the
translation of the financial statements into the reporting currency are
included in the cumulative translation adjustment in shareholders'
equity.
In the event that management decides to declare dividends, such
dividends would be declared in Canadian dollars.
F-6
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
FOREIGN CURRENCY TRANSLATION
FOREIGN CURRENCY TRANSACTIONS
Transactions denominated in currencies other than the functional
currency are translated into the functional currency as follows:
monetary assets and liabilities are translated at the exchange rate in
effect at the balance sheet date, while revenues and expenses are
translated at the exchange rate in effect on the date of the
transaction. Non-monetary assets and liabilities are translated at
historical rates. Gains and losses arising from such translation are
reflected in the statements of earnings.
FOREIGN SUBSIDIARIES
The financial statements of integrated foreign operations with a
functional currency other than the Canadian dollar are remeasured into
the functional currency using the temporal method. Under this method,
monetary assets and liabilities are remeasured at the exchange rate in
effect at the balance sheet date. Non-monetary assets and liabilities
are remeasured at historical rates. Revenues and expenses are
remeasured at the monthly average exchange rate. Gains and losses
resulting from remeasurement are reflected in the statements of
earnings.
FORWARD EXCHANGE CONTRACTS
Forward exchange contracts are utilized by the company in the
management of its foreign currency exposure. The company's policy is
not to utilize those derivative financial instruments for trading or
speculative purposes.
Foreign exchange translation gains and losses on forward exchange
contracts, used to hedge anticipated US-dollar-denominated sales, are
recognized as an adjustment of the revenues when the sale is recorded.
Realized and unrealized gains or losses associated with forward
exchange contracts, which have been terminated or cease to be effective
prior to maturity, are deferred in the balance sheet and recognized in
the earnings of the period in which the underlying hedged transaction
is recognized.
SHORT-TERM INVESTMENTS
Short-term investments are valued at the lower of cost and market
value. Cost consists of acquisition cost plus amortization of discount
or less amortization of premium.
INVENTORIES
Inventories are valued on an average cost basis at the lower of cost
and replacement cost for raw materials and at the lower of cost and net
realizable value for work in progress and finished goods.
On September 1, 2002, the company changed its accounting policy for
determining the cost of raw materials and work in progress from the
first-in, first-out method to the average cost method. This change in
accounting policy had no significant impact on the company's financial
statements.
F-7
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
PROPERTY, PLANT AND EQUIPMENT AND AMORTIZATION
Property, plant and equipment are recorded at cost less related
government grants and research and development tax credits.
Amortization is provided on a straight-line basis over the estimated
useful lives as follows:
TERM
Land improvements 5 years
Buildings 15 and 25 years
Equipment 2 to 10 years
Leasehold improvements Remaining lease term
INTANGIBLE ASSETS, GOODWILL AND AMORTIZATION
Intangible assets primarily include the cost of acquired in-process
research and development and core technology, net of accumulated
amortization. Core technology represents the existing technology
acquired in business combinations that has reached technological
feasibility, while acquired in-process research and development
represents the existing technology that has not reached technological
feasibility and has no future alternative use. Intangible assets are
amortized on a straight-line basis over their estimated useful lives,
ranging from five to ten months for in-process research and
development, and five years for core technology.
Goodwill represents the excess of the purchase price of acquired
businesses over the estimated fair value of net identifiable assets
acquired. Goodwill related to business combinations with a date of
acquisition prior to July 1, 2001, was amortized on a straight-line
basis over the estimated useful life of five years until August 31,
2002. Goodwill related to business combinations with a date of
acquisition after June 30, 2001, is not amortized.
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).
IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived assets are reviewed for impairment when events and
circumstances indicate that cost may not be recoverable. Impairment
exists when the carrying value of the asset is greater than the
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. The company has recorded impairment charges
for intangible assets in 2002 and 2003 (note 4).
REVENUE RECOGNITION
For products in which software is incidental, the company recognizes
revenue when persuasive evidence of an arrangement exists, the product
has been delivered, the price is fixed and determinable, and collection
of the resulting receivable is reasonably assured. In addition,
provisions are made for estimated returns, warranties and support
obligations.
F-8
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
For products in which software is not incidental, revenues are
separated into two categories: product and customer support revenues,
based upon vendor-specific objective evidence of fair value. Product
revenues for these sales are recognized as described above. Customer
support revenues are deferred and recognized ratably over the years of
the support arrangement. Except when provided within one year of
delivery, costs of providing this support are insignificant and accrued
at the time of delivery and no software upgrades are provided.
For all sales, the company uses a binding purchase order as evidence
that a sales arrangement exists.
Delivery generally occurs when the product is shipped to a transporter.
At the time of the transaction, the company assesses whether the price
associated with its revenue transaction is fixed and determinable and
whether or not collection is reasonably assured. The company assesses
whether the price is fixed and determinable based on the payment terms
associated with the transaction. The company assesses collection based
on a number of factors, including past transaction history and the
creditworthiness of the customer. Generally, collateral or other
security is not requested from customers.
Most sales arrangements do not generally include acceptance clauses.
However, if a sales arrangement includes an acceptance provision,
acceptance occurs upon the earliest of receipt of a written customer
acceptance or expiration of the acceptance period. For these sales
arrangements, the sale is recognized when acceptance occurs.
Extended warranties are recognized ratably over the service periods.
ADVERTISING COSTS
Advertising costs are expensed as incurred.
GOVERNMENT GRANTS
Government grants are accrued as a receivable when there is reasonable
assurance that the company has complied and will continue to comply
with all the conditions related to the grant. Grants related to
operating expenses are included in earnings when the related expenses
are incurred. Grants related to capital expenditures are deducted from
the related assets. Grants related to job creation and training
programs for extended periods are deferred and amortized on a
straight-line basis over the minimum period for which the created job
must be maintained or training provided.
RESEARCH AND DEVELOPMENT EXPENSES
All expenses related to development activities, which do not meet
generally accepted criteria for deferral, and research are expensed as
incurred, net of related tax credits and government grants. Development
expenses that meet generally accepted criteria for deferral are
capitalized, net of related tax credits and government grants, and
amortized against earnings over the estimated benefit period.
As at August 31, 2003, the company had not deferred any development
costs.
F-9
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
INCOME TAXES
The company provides for income taxes using the liability method of tax
allocation. Under this method, future income tax assets and liabilities
are determined based on deductible or taxable temporary differences
between financial statement values and tax values of assets and
liabilities, using enacted income tax rates for the years in which the
differences are expected to reverse.
The company establishes a valuation allowance against future income tax
assets if, based on available information, it is more likely than not
that some or all of the future income tax assets will not be realized.
In 2003, the company recorded a valuation allowance for all its future
income tax assets (note 4).
EARNINGS PER SHARE
Basic earnings per share are determined using the weighted average
number of common shares outstanding during the year.
Diluted earnings per share are determined using the weighted average
number of common shares outstanding during the year, plus the effect of
dilutive potential common shares outstanding during the year. This
method requires that diluted earnings per share be calculated, using
the treasury stock method, as if all dilutive potential common shares
had been exercised at the latest at the beginning of the year or on the
date of issuance, as the case may be, and that the funds obtained
thereby be used to purchase common shares of the company at the average
fair value of the common shares during the year.
NEW ACCOUNTING STANDARDS
On September 1, 2002, the company prospectively adopted section 3870 of
the Canadian Institute of Chartered Accountants (CICA) handbook,
"Stock-Based Compensation and Other Stock-Based Payments", which
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 company, to continue with its
existing policy, elected not to account for stock-based compensation
costs arising from awards to employees using the fair value-based
method. 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
complied with the standard by providing the required pro forma
disclosures (note 13). The adoption of this new standard had no impact
on the company's financial results.
On September 1, 2002, the company adopted section 3062 of the CICA
handbook, "Goodwill and Other Intangible Assets". This new section
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. Until August 31, 2002, goodwill
recorded in business combinations completed prior to July 1, 2001, was
amortized on a straight-line basis over five years.
F-10
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
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, 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 years have not been
restated. The consolidated statements of earnings for the years ended
August 31, 2001 and 2002, show the net loss and the net loss per share
figures before the amortization and write-down of goodwill.
On September 1, 2002, the company prospectively adopted section 3063 of
the CICA handbook, "Impairment of Long-Lived Assets". This new section
changes existing rules for recognition and measurement of long-lived
assets held for use. The section requires that an impairment loss be
measured as the excess of the carrying value of a long-lived asset over
its fair value. Long-lived assets were tested for impairment in 2003
under these new provisions (note 4).
On March 1, 2003, the company prospectively adopted accounting
guideline 14 of the CICA handbook, "Disclosure of Guarantees". This new
guideline requires certain disclosure about obligations under
guarantees other than product warranties. The adoption of this
guideline had no impact on the company's financial statements since the
company has no guarantee that falls into the scope of this new
guideline.
On May 1, 2003, the company prospectively adopted section 3475 of the
CICA handbook, "Disposal of Long-Lived Assets and Discontinued
Operations". Under this new section, a long-lived asset to be 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 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 to which they
are included in the fair value of the asset; and discontinued
operations are defined more broadly than under existing rules. The
adoption of this new standard had no impact on the company's financial
statements since the company did not have such operations.
In July 2003, the CICA issued new handbook section 1100, "Generally
Accepted Accounting Principles", which is effective for fiscal years
beginning on or after October 1, 2003. This new section defines GAAP,
establishes the relative authority of various types of CICA Accounting
Standards Board pronouncements, says what to do when the handbook does
not cover a particular situation, and clarifies the role of "industry
practice" in setting GAAP. The company will adopt this new standard on
September 1, 2004, and has not yet determined the impact it will have
on its financial statements.
F-11
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
In July 2003, the CICA issued new handbook section 1400, "General
Standards of Financial Statements Presentation", which is effective for
fiscal years beginning on or after October 1, 2003. This new section
confirms that the financial statements of an entity must "present
fairly in accordance with Canadian generally accepted accounting
principles" its financial position, results of operations and cash
flows. The company will adopt this new standard on September 1, 2004,
and has not yet determined the impact it will have on its financial
statements
3 BUSINESS COMBINATIONS
The company completed a number of business combinations in 2001, 2002
and 2003. The fair value allocated to significant intangible assets
acquired in these business combinations was based upon independent
valuations performed in conjunction with the business combinations.
Acquired goodwill, except the one from gnubi communications L.P., is
not deductible for income tax purposes.
BUSINESS COMBINATION DURING 2003
GNUBI COMMUNICATIONS, L.P.
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 supplying 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 an additional acquisition
cost and is recognized as an additional cost of acquired core
technology as sales occur. Since October 7, 2002, the company
recognized $173,000 as an 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, being 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, being the date of acquisition.
F-12
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
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:
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
=======
BUSINESS COMBINATION DURING 2002
AVANTAS NETWORKS CORPORATION (RENAMED EXFO PROTOCOL INC.)
On November 2, 2001, the company acquired a 100% interest in EXFO
Protocol Inc. ("EXFO Protocol"), a Canadian company specializing in
protocol-layer testing, in exchange for a total consideration valued at
$94,952,000 or $69,381,000 net of $25,571,000 of cash and cash
equivalents acquired. The total consideration includes
acquisition-related costs of $1,272,000.
The consideration paid consisted of $9,756,000 in cash, net of cash and
cash equivalents acquired of $25,571,000 and the issuance of 4,374,573
subordinate voting shares valued at $59,625,000. 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 terms of the acquisition were agreed upon and announced,
being August 20, 2001.
This acquisition has been accounted for using the purchase method and,
consequently, the results of operations of EXFO Protocol have been
included in the consolidated statement of earnings of the company since
November 2, 2001, being the date of acquisition.
F-13
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
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:
Assets acquired
Current assets $ 6,040
Property, plant and equipment 2,003
In-process research and development 1,400
Core technology 5,050
Future income tax assets (note 4) 476
Current liabilities assumed (3,575)
-------
Net identifiable assets acquired 11,394
Goodwill (note 4) 57,987
-------
Purchase price 69,381
Less: Subordinate voting shares issued 59,625
-------
Cash paid, net of cash and cash
equivalents acquired $ 9,756
-------
BUSINESS COMBINATIONS DURING 2001
BURLEIGH INSTRUMENTS, INC. (RENAMED EXFO BURLEIGH PRODUCTS GROUP INC.)
On December 20, 2000, the company acquired a 100% interest in EXFO
Burleigh Products Group Inc. ("EXFO Burleigh"), a U.S. company
manufacturing precision scientific instruments used in basic and
applied research, engineering and production test applications in a
variety of fields, in exchange for a total consideration valued at
$189,270,000, including acquisition-related costs of $2,461,000.
The consideration paid consisted of $42,461,000 in cash and the
issuance of 6,488,816 subordinate voting shares valued at $146,809,000.
Furthermore, as part of this acquisition, the company established a
restricted stock award plan for employees of EXFO Burleigh (note 13).
This plan provides that in the event of an employee's voluntary
termination, shares to be issued to this employee under the plan will
be issued to EXFO Burleigh's former shareholders. In such
circumstances, this issuance of shares will be recorded as additional
goodwill. As of August 31, 2003, $5,000 has been recorded as additional
goodwill upon voluntary termination of EXFO Burleigh's employees.
EFOS INC. (RENAMED EXFO PHOTONIC SOLUTIONS INC.)
On March 15, 2001, the company acquired a 100% interest in EXFO
Photonic Solutions Inc. ("EXFO Photonic Solutions"), a Canadian company
specializing in precision light-based adhesive spot-curing technologies
as well as curing process control for the global optical component
manufacturing market. This acquisition was settled for a total
consideration valued at $110,146,000, including acquisition-related
costs of $194,000. The consideration paid consisted of $25,194,000 in
cash and the issuance of 3,700,000 subordinate voting shares valued at
$84,952,000.
F-14
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
The 2001 acquisitions have been accounted for using the purchase method
and, consequently, the results of operations of EXFO Burleigh and EXFO
Photonic Solutions have been included in the consolidated statements of
earnings of the company from the date of acquisition of these
subsidiaries, being December 20, 2000, for EXFO Burleigh and March 15,
2001, for EXFO Photonic Solutions.
The fair value of subordinate voting shares issued as part of these
business combinations was determined based on the market price of the
shares beginning three days before and ending three days after the
dates of acquisition of the subsidiaries.
The purchase price, including acquisition-related costs, has been
allocated based on the estimated fair value of net assets at the dates
of acquisition as follows:
EXFO BURLEIGH EXFO PHOTONIC
SOLUTIONS
------------- -------------
Assets acquired
Current assets $ 7,092 $ 9,195
Property, plant and equipment 4,457 1,054
In-process research and development 1,800 972
Core technology (note 4) 24,000 25,324
Workforce 1,250 907
Trademark -- 421
Liabilities assumed (9,068) (7,169)
Future income tax liabilities (8,342) (983)
--------- ---------
Net identifiable assets acquired 21,189 29,721
Goodwill (note 4) 168,081 80,425
--------- ---------
Purchase price 189,270 110,146
Less: Subordinate voting shares issued 146,809 84,952
--------- ---------
Cash paid, net of cash acquired $ 42,461 $ 25,194
========= =========
VANGUARD TECHNICAL SOLUTIONS, INC.
On March 16, 2001, the company, through one of its subsidiaries,
Burleigh Automation Inc., acquired substantially all the assets of
Vanguard Technical Solutions, Inc., a U.S. company specializing in the
design and manufacturing of ultra-precision assembly equipment for
sensitive process and critical assembly challenges on the production
floor. This acquisition, which was settled for a total cash
consideration of $600,000 allocated to property, plant and equipment,
has been accounted for using the purchase method.
F-15
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
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 market conditions in the telecommunications
industry and the persisting unfavorable conditions affecting the
subsidiaries' industries, the company reviewed the carrying value of
intangible assets related to these reporting units, consisting
primarily in acquired core technology.
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 acquired core
technology. Of the total impairment loss of $7,427,000, $6,872,000 is
related to EXFO Burleigh for goodwill and acquired core technology, and
$555,000 is related to EXFO Photonic Solutions for acquired core
technology.
For the purposes of estimating the fair values, the company used a
combination of discounted future cash flows and a market approach
(sales multiples). The discounted cash flows were estimated using
periods ranging between eight and ten years, discount rates ranging
between 15% and 20% and annual growth rates ranging between nil and
35%. The sales multiples used in the market approach ranged between 0.7
and 2.3.
In May 2002, as part of its review of financial results, the company
performed an assessment of the carrying value of goodwill and
intangible assets recorded in conjunction with the acquisitions of EXFO
Burleigh, EXFO Photonic Solutions and EXFO Protocol. The assessment was
performed because of the severe and continued downturn in the
telecommunications industry, the persisting unfavorable market
conditions affecting the subsidiaries' industries and the decline in
technology valuations. The growth prospects for those subsidiaries were
significantly lower than previously expected and less than those of
historical periods, and the decline in market conditions affecting the
subsidiaries was significant and other than temporary. As a result, the
company concluded that the carrying value of goodwill and certain
acquired intangible assets was impaired and it recorded a charge of
$222,169,000 to write down a significant portion of goodwill and a
pre-tax charge of $23,657,000 to write down a significant portion of
acquired core technology. Of the total impairment loss of $245,826,000,
$125,017,000 was related to EXFO Burleigh for goodwill and acquired
core technology, $71,508,000 was related to EXFO Photonic Solutions for
goodwill and acquired core technology, and $49,301,000 was related to
EXFO Protocol for goodwill.
The impairment loss was calculated based upon existing accounting rules
and represented the excess of the carrying value of the assets over the
pre-tax undiscounted future cash flows. The pre-tax undiscounted future
cash flows were estimated at the subsidiaries' level since the company
had distinct cash flows for each of them and because they were not
fully integrated into the company's activities. The cash flow periods
used ranged from three to five years, using annual growth rates between
15% and 30%.
The assumptions supporting the estimated fair values and undiscounted
future cash flows, including current and future industry conditions,
reflect management's best estimates.
F-16
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
RESTRUCTURING AND OTHER CHARGES AND INVENTORY WRITE-OFFS
During 2001, the company implemented a structured plan to reduce costs
and increase efficiency. Under that plan, the company recorded charges
of $3,288,000, including $844,000 in severance expenses for the 245
employees who were terminated throughout the company, $1,476,000 for
unused long-lived assets and $968,000 for future payments on exited
leased facilities. These charges are included in the restructuring and
other charges in the statement of earnings for the year ended August
31, 2001. As at August 31, 2003, the accrued liabilities related to
this restructuring plan amounted to $124,000 and consisted primarily of
future payments on exited leased facilities.
During 2002, the company implemented additional structured plans to
further reduce its costs. Under these plans, the company recorded
additional charges of $2,880,000, including $2,012,000 in severance
expenses for the 350 employees who were terminated throughout the
company and $868,000 for unused long-lived assets. These charges are
included in the restructuring and other charges in the statement of
earnings for the year ended August 31, 2002. Furthermore, the company
recorded $18,463,000 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 year. As at August 31, 2003, the accrued
liabilities related to these restructuring plans amounted to $68,000
and consisted of accrued cost for unused long-lived assets.
During 2003, the company implemented an additional restructuring plan
to realign its cost structure to current market conditions. Under that
plan, the company recorded additional charges of $4,134,000, including
$2,767,000 in severance expenses for the 172 employees who were
terminated throughout the company, $512,000 for unused long-lived
assets and $855,000 for future payments on exited leased facilities.
Those charges are included in the restructuring and other charges in
the statement of earnings for the year ended August 31, 2003. In
addition, the company recorded $4,121,000 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 year. As at August 31,
2003, the accrued liabilities related to the severance expenses and
exited leased facilities incurred in 2003 amounted to $2,276,000.
FUTURE INCOME TAX ASSETS AND RESEARCH AND DEVELOPMENT TAX CREDITS
During 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 its future income tax assets and some of its
research and development tax credits will not be recoverable and that a
valuation allowance and a write-off were required. Accordingly, the
company recorded a valuation allowance of $28,385,000 to write off all
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 has been included in the income taxes in the statement of
earnings for the year ended August 31, 2003 (note 15). The write-off of
research and development tax credits has been included in the net
research and development expenses in the statement of earnings for that
same year (note 14).
F-17
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
5 INVENTORIES
AS AT AUGUST 31,
---------------------------------------
2003 2002
---------------- -----------------
Raw materials $ 8,188 $ 13,507
Work in progress 1,022 1,382
Finished goods 6,392 8,933
---------------- -----------------
$ 15,602 $ 23,822
================ =================
6 PROPERTY, PLANT AND EQUIPMENT
AS AT AUGUST 31,
--------------------------------------------------------------------------------
2003 2002
-------------------------------------- --------------------------------------
ACCUMULATED ACCUMULATED
COST AMORTIZATION COST AMORTIZATION
Land and land improvements $ 3,323 $ 350 $ 2,124 $ -
Buildings 11,177 1,784 8,043 695
Equipment 33,560 21,790 29,177 14,662
Leasehold improvements 1,837 1,042 4,121 1,862
--------------- ------------------- --------------- -------------------
49,897 $ 24,966 43,465 $ 17,219
=================== ===================
Less:
Accumulated amortization 24,966 17,219
--------------- ---------------
$ 24,931 $ 26,246
=============== ===============
7 INTANGIBLE ASSETS AND GOODWILL
AS AT AUGUST 31,
--------------------------------------
2003 2002
----------------- -----------------
Core technology, net of accumulated amortization of $20,986 ($15,120 in 2002)
(notes 3 and 4) $ 10,778 $ 16,464
In-process research and development, net of accumulated amortization of $4,496
($4,195 in 2002) -- --
--------------- ---------------
$ 10,778 $ 16,464
=============== ===============
F-18
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
Amortization expense for intangible assets in each of the next four
years is $3,932,000 in 2004, $3,932,000 in 2005, $2,497,000 in 2006 and
$417,000 in 2007.
The net carrying value of goodwill is comprised of the following:
AS AT AUGUST 31,
------------------------------
2003 2002
------------- -------------
Balance - Beginning of year $ 17,576 $ 219,172
Business combination (note 3) 2,958 57,987
Amortization (note 2) -- (38,021)
Write-down (note 4) (4,505) (222,169)
Effect of foreign exchange rate 1,644 607
----------- -----------
Balance - End of year $ 17,673 $ 17,576
=========== ===========
8 CREDIT FACILITIES
The company has a line of credit which provides for advances of up to
Cdn$10,000,000 (US$7,220,000). This line of credit, which is renewable
annually, bears interest at prime rate (prime rate in 2002). Short-term
investments, accounts receivable, inventories and all tangible and
intangible assets of the company have been pledged as collateral
against this line of credit. As at August 31, 2003, Cdn$1,400,000
(US$1,000,000) have been reserved from this line of credit for letters
of guarantee (note 12). As at August 31, 2002, this line of credit was
unused.
9 ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
AS AT AUGUST 31,
------------------------------
2003 2002
------------- -------------
Trade $ 4,227 $ 4,738
Salaries and social benefits 3,462 2,638
Warranty 687 849
Tax on capital 381 856
Restructuring charges (notes 4 and 19) 2,468 782
Other 801 836
----------- -----------
$ 12,026 $ 10,699
=========== ===========
F-19
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
10 LONG-TERM DEBT
AS AT AUGUST 31,
------------------------------
2003 2002
------------- -------------
Loans collateralized by equipment, bearing
interest at 9.6%, repayable in
monthly installments of $13,000
including principal and interest,
maturing in 2008 $ 563 $ 664
Less: Current portion 110 100
----------- -----------
$ 453 $ 564
=========== ===========
As at August 31, 2003, minimum principal repayments required in each of
the next five years are $110,000 in 2004, $122,000 in 2005, $135,000 in
2006, $146,000 in 2007 and $50,000 in 2008.
11 COMMITMENTS
The company has entered into operating leases for certain of its
premises and equipment, which expire at various dates through May 2011.
As at August 31, 2003, minimum rentals payable under these operating
leases in each of the next five years are $1,078,000 in 2004, $908,000
in 2005, $898,000 in 2006, $764,000 in 2007 and $448,000 in 2008. As at
August 31, 2003, total commitments under these operating leases
amounted to $5,316,000.
For the years ended August 31, 2001, 2002 and 2003, rental expense
amounted to $1,580,000, $1,936,000 and $1,718,000, respectively (note
19).
12 CONTINGENCIES
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.
F-20
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
On April 19, 2002, the plaintiffs filed an amended complaint containing
master allegations against all of the underwriters in all of the 310
cases included in this class action and also filed an amended complaint
containing allegations specific to four of the company's underwriters,
the company and two of its executive officers. In addition to the
allegations mentioned above, the amended complaint alleges that the
underwriters (i) used their analysts to manipulate the stock market;
and (ii) implemented schemes that allowed issuer insiders to sell their
shares rapidly after an initial public offering and benefit from high
market prices. As concerns the company and its two executive officers
in particular, the amended complaint alleges that (i) the company's
registration statement was materially false and misleading because it
failed to disclose the additional commissions and compensation to be
received by underwriters; (ii) the two named executive officers learned
of or recklessly disregarded the alleged misconduct of the
underwriters; (iii) the two named executive officers had motive and
opportunity to engage in alleged wrongful conduct due to personal
holdings of the company's stock and the fact that an alleged
artificially inflated stock price could be used as currency for
acquisitions; and (iv) the two named executive officers, by virtue of
their positions with the company, controlled the company and the
contents of the registration statement and had the ability to prevent
its issuance or cause it to be corrected. The plaintiffs in this suit
seek an unspecified amount for damages suffered.
In July 2002, the issuers filed a motion to dismiss the plaintiffs'
amended complaint and 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 Tolling Agreements entered into with
the plaintiffs.
On June 26, 2003, the Plaintiff's Executive Committee announced that a
proposed settlement between the issuers and their directors and
officers and the plaintiffs had been structured. A Memorandum of
Understanding ("MOU") to settle the plaintiffs' claims against the
issuers and their directors and officers has now been approved as to
form and the process of obtaining approval by all parties to the MOU is
now underway. The parties will be required to prepare many complex
documents necessary to consummate the settlement, which will be
submitted to the Court for preliminary approval. Final approval will be
required by the Court following notice to class members and a fairness
hearing. If this tentative settlement is successfully finalized, the
company and the individual defendants will be released from the
litigation. Any direct financial impact of the proposed settlement is
expected to be borne by the company's insurance carriers.
Since the settlement process is subject to a fairness hearing and final
court approval, it is possible that it could fail. Therefore, it is not
possible to predict the final outcome of the case, nor determine the
amount of any possible losses. If the settlement process fails, the
company will continue to defend its position in this litigation that
the claims against it, and its officers, are without merit.
Accordingly, no provision for this case has been made in the
consolidated financial statements as of August 31, 2003.
As at August 31, 2003, the company has outstanding letters of guarantee
of $1,232,000, which expire at various dates through 2006. From this
amount, $1,000,000 has been reserved from the line of credit (note 8).
F-21
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
13 SHARE CAPITAL
Authorized - unlimited as to number, without par value
Subordinate voting and participating, bearing a non-cumulative
dividend to be determined by the Board of Directors, ranking
pari passu with multiple voting shares
Multiple voting and participating, entitling to ten votes each,
bearing a non-cumulative dividend to be determined by the Board
of Directors, convertible at the holder's option into
subordinate voting shares on a one-for-one basis, ranking pari
passu with subordinate voting shares
The following table summarizes the share capital activity since August
31, 2000:
MULTIPLE VOTING SHARES SUBORDINATE VOTING SHARES
--------------------------------- -------------------------------
TOTAL
NUMBER AMOUNT NUMBER AMOUNT AMOUNT
Balance as at August 31, 2000 38,000,000 $ 1 8,757,264 $ 198,458 $ 198,459
Business combinations (note 3) -- -- 10,188,816 231,761 231,761
Conversion of multiple voting
shares into subordinate voting
shares (100,000) -- 100,000 -- --
Redemption -- -- (43,999) (33) (33)
Resale -- -- 43,999 33 33
Share issue expenses, net of
related income taxes -- -- -- (225) (225)
---------------- --------------- --------------- --------------- --------------
Balance as at August 31, 2001 37,900,000 1 19,046,080 429,994 429,995
Business combination (note 3) -- -- 4,374,573 59,625 59,625
Exercise of stock awards -- -- 144,532 -- --
Redemption -- -- (7,022) (6) (6)
Resale -- -- 7,022 6 6
Share issue expenses, net of
related income taxes -- -- -- (9) (9)
---------------- --------------- --------------- --------------- --------------
Balance as at August 31, 2002 37,900,000 1 23,565,185 489,610 489,611
Business combination (note 3) -- -- 1,479,290 2,796 2,796
Exercise of stock options -- -- 25,498 45 45
Exercise of stock awards -- -- 69,935 -- --
Redemption -- -- (21,515) (16) (16)
Resale -- -- 21,515 16 16
---------------- --------------- --------------- --------------- --------------
Balance as at August 31, 2003 37,900,000 $ 1 25,139,908 $ 492,451 $ 492,452
================ =============== =============== =============== ==============
STOCK PURCHASE PLAN
The company's stock purchase plan terminated at the time of the initial
public offering, being June 29, 2000. In accordance with that plan,
officers, directors and key employees could purchase Class F shares up
to a maximum of 5% of all participating, issued and outstanding shares
of the
F-22
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
company. The purchase price of shares under that plan was determined as
a multiple of the company's equity as at the end of the preceding
fiscal year. Shares issued under that plan are restricted as to sale
and transferability for a period of at least five years from the date
of acquisition. Prior to its initial public offering, the company
issued 707,264 Class F shares in exchange for a weighted average cash
consideration of Cdn$0.98 (US$0.67) per share. On June 29, 2000, the
707,264 issued and outstanding Class F shares were converted into
707,264 subordinate voting shares on a one-for-one basis.
STOCK OPTION PLAN
In May 2000, the company established a stock option plan for directors,
executive officers, employees and consultants and those of the
company's subsidiaries, as determined by the Board of Directors.
The maximum number of subordinate voting shares issuable under the plan
cannot exceed 4,470,961 shares. The maximum number of subordinate
voting shares that may be granted to any individual cannot exceed 5% of
the number of outstanding subordinate voting shares. The exercise price
is the market price of the common shares on the date of grant. Options
granted under the plan generally expire ten years from the date of
grant. Options granted under the plan generally vest over a four-year
period, with 25% vesting on an annual basis commencing on the first
anniversary of the date of grant. Up to October 10, 2000, the number of
options, which ultimately would become exercisable in any given year,
and in aggregate, was dependent on the degree to which the company's
financial performance objectives were met. Nevertheless, on October 10,
2000, the Board of Directors of the company amended the vesting terms
for options granted pursuant to the option plan to remove the financial
performance criterion. Accordingly, options granted vest over the
four-year period. The Board of Directors may accelerate the vesting of
any or all outstanding options upon the occurrence of a change of
control.
The following table summarizes stock option activity since August 31,
2000:
YEARS ENDED AUGUST 31,
-------------------------------------------------------------------------------------
2003 2002 2001
--------------------------- --------------------------- -----------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
NUMBER PRICE NUMBER PRICE NUMBER PRICE
Outstanding - Beginning of year 2,597,574 $ 22 2,414,231 $ 28 609,734 $ 26
Granted 1,268,450 2 1,039,805 10 2,153,352 29
Exercised (25,498) (2) -- -- -- --
Forfeited (663,913) (17) (856,462) (25) (348,855) (29)
------------- ------------- ------------- ------------- ------------- ---------------
Outstanding - End of year 3,176,613 $ 15 2,597,574 $ 22 2,414,231 $ 28
============= ============= ============= ============= ============= ===============
Exercisable - End of year 1,068,595 $ 22 512,161 $ 28 127,561 $ 26
============= ============= ============= ============= ============= ===============
F-23
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
The following table summarizes information about stock options as at
August 31, 2003:
OPTIONS OUTSTANDING AS AT AUGUST 31, 2003 OPTIONS EXERCISABLE AS AT AUGUST 31, 2003
-------------------------------------------------- --------------------------------------------------
WEIGHTED WEIGHTED
WEIGHTED AVERAGE WEIGHTED AVERAGE
AVERAGE REMAINING AVERAGE REMAINING
EXERCISE PRICE NUMBER EXERCISE PRICE CONTRACTUAL LIFE NUMBER EXERCISE PRICE CONTRACTUAL LIFE
$1.58 to $2.16 873,850 $ 1.59 3.1 years 108,224 $ 1.58 3.1 years
$2.59 to $3.63 224,400 3.39 3.3 years 28,744 3.37 3.3 years
$5.65 35,479 5.65 2.5 years 8,870 5.65 2.5 years
$9.13 to $12.69 676,246 10.12 2.2 years 169,062 10.12 2.2 years
$19.19 to $27.80 1,047,812 23.90 1.2 years 594,282 24.15 1.2 years
$34.07 to $45.94 269,276 43.58 1.1 years 134,638 43.58 1.1 years
$56.75 49,550 56.75 1.0 year 24,775 56.75 1.0 year
-------------- --------------- ----------------- -------------- --------------- -----------------
3,176,613 $ 15.36 2.1 years 1,068,595 $ 22.14 1.6 years
============== =============== ================= ============== =============== =================
RESTRICTED STOCK AWARD PLAN
On December 20, 2000, the company established a restricted stock award
plan for employees of EXFO Burleigh. Each stock award entitles
employees to receive one subordinate voting share at a purchase price
of nil. Stock awards granted under the plan vest over a four-year
period, with 25% vesting on an annual basis commencing on the first
anniversary of the date of grant. According to the plan, upon the
involuntary termination of a member of the defined management team, all
outstanding restricted stock awards granted to such an employee
automatically vest. The plan will expire on December 20, 2004.
The following table summarizes restricted stock awards activity since
December 2000:
YEARS ENDED AUGUST 31,
----------------------------------------------------------
2003 2002 2001
------------------ ------------------ ------------------
Outstanding - Beginning of year 215,249 359,781 --
Granted -- -- 359,781
Exercised (69,935) (144,532) --
Forfeited (2,218) -- --
------------------ ------------------ ------------------
Outstanding - End of year 143,096 215,249 359,781
================== ================== ==================
Exercisable - End of year -- -- --
================== ================== ==================
As of August 31, 2003, the weighted average remaining contractual life
of the outstanding restricted stock awards was 1.3 years.
F-24
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
STOCK APPRECIATION RIGHTS PLAN
On August 4, 2001, the company established a stock appreciation rights
plan for certain employees. Under that plan, eligible employees are
entitled to receive a cash amount equivalent to the difference between
the market price of the common shares on the date of exercise and the
exercise price determined on the date of grant. Stock appreciation
rights granted under the plan generally expire ten years from the date
of grant. Stock appreciation rights vest over a four-year period, with
25% vesting on an annual basis commencing on the first anniversary of
the date of grant.
Considering the market price of the common shares of US$2.64 as at
August 31, 2003, compensation expense for those stock appreciation
rights was nominal as at August 31, 2003.
The following table summarizes stock appreciation rights activity since
August 2001:
YEARS ENDED AUGUST 31,
-------------------------------------------------------------------------------------
2003 2002 2001
--------------------------- --------------------------- -----------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
NUMBER PRICE NUMBER PRICE NUMBER PRICE
Outstanding - Beginning of year 10,000 $ 26 22,400 $ 30 -- $ --
Granted 5,000 2 1,000 12 22,400 30
Forfeited (6,000) (9) (13,400) (31) -- --
------------ -------------- ------------ -------------- ------------ --------------
Outstanding - End of year 9,000 $ 24 10,000 $ 26 22,400 $ 30
============ ============== ============ ============== ============ ==============
Exercisable - End of year 3,500 $ 30 2,250 $ 27 -- $ --
============ ============== ============ ============== ============ ==============
The following table summarizes information about stock appreciation
rights as at August 31, 2003:
STOCK APPRECIATION RIGHTS STOCK APPRECIATION RIGHTS
OUTSTANDING AS AT EXERCISABLE AS AT
AUGUST 31, 2003 AUGUST 31, 2003
-------------------------------------- -------------------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE
REMAINING REMAINING
EXERCISE PRICE NUMBER CONTRACTUAL LIFE NUMBER CONTRACTUAL LIFE
$2.10 2,000 3.7 years -- --
$19.19 to $22.25 4,500 1.3 years 2,250 1.3 years
$45.94 2,500 1.0 year 1,250 1.0 year
----------------- -------------------- ---------------- --------------------
9,000 1.8 years 3,500 1.2 years
================= ==================== ================ ====================
F-25
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
PRO FORMA INFORMATION ON STOCK-BASED COMPENSATION PLANS
The company has elected not to account for stock-based compensation
costs arising from awards to employees using the fair value-based
method as permitted by the new accounting standard (note 2). However,
the company is required to make pro forma disclosures of net loss and
net loss per share as if the fair value-based method of accounting had
been applied.
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 new 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:
YEAR ENDED
AUGUST 31, 2003
----------------
Net loss for the year $ (54,950)
Pro forma adjustment for stock-based
compensation costs (338)
----------------
Pro forma net loss for the year $ (55,288)
================
Basic and diluted net loss per share $ (0.87)
Basic and diluted pro forma net loss per share $ (0.88)
These options, which have a weighted average fair value of $0.81, will
generate aggregate stock-based compensation costs of $887,000 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 $282,000 in 2004, $175,000 in 2005, $84,000 in
2006 and $8,000 in 2007.
The fair value of options granted was estimated using the Black-Scholes
options valuation model with the following weighted average
assumptions:
YEAR ENDED
AUGUST 31, 2003
---------------
Risk-free interest rate 4.2%
Expected volatility 80%
Dividend yield Nil
Expected life 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.
F-26
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
14 OTHER DISCLOSURES
NET RESEARCH AND DEVELOPMENT EXPENSES
Net research and development expenses comprise the following:
YEARS ENDED AUGUST 31,
------------------------------------------------------
2003 2002 2001
----------------- ---------------- -----------------
Gross research and development expenses $ 17,133 $ 17,005 $ 17,601
Research and development tax credits (3,506) (3,890) (3,369)
Government grants (45) (333) (631)
Write-off of research and development tax credits (note 4) 2,297 -- --
--------------- --------------- ---------------
$ 15,879 $ 12,782 $ 13,601
=============== =============== ===============
All tax credits written off can be carried forward against future
years' income taxes payable over the next ten years.
OTHER GRANTS AND TAX CREDITS
During 1998, the company entered into an agreement with the Quebec
Minister of Industry, Commerce, Science and Technology (the
"Minister"). Pursuant to this agreement, the Minister agreed to
contribute, in the form of grants, up to a maximum of Cdn$600,000
(US$433,000) toward interest costs incurred over the period from
January 1, 1998, through December 31, 2002. In addition, the Minister
agreed to provide grants up to a maximum of Cdn$2,220,000
(US$1,603,000) over the period from January 1, 1998, through December
31, 2002, payable based on the number of full-time jobs created during
the period.
The above grants are subject to the condition that jobs created
pursuant to the agreement be maintained for a period of at least five
years from the date of creation. Should this condition not be met by
the company, the Minister may enforce various recourse options, which
include suspension or cancellation of the agreement or requiring the
repayment of amounts received by the company. Since the beginning of
this program, the company recognized the maximum amount of
Cdn$2,820,000 (US$2,036,000), of which Cdn$2,003,000 (US$1,446,000) has
been credited to earnings with the balance of Cdn$817,000 (US$590,000)
having been included in deferred grants in the balance sheet.
Furthermore, in 1999, the company entered into another agreement with
the Minister. Pursuant to this agreement, the Minister agreed to
provide grants over the period from February 1998 to June 2002, payable
based on the number of jobs created and certain specific training
expenses related to such jobs. The above grant is subject to the
condition that the new employees continue to participate in the
specific training program for a period of at least ten consecutive
months. Should this condition not be met by the company, the Minister
may enforce various recourse options, which include suspension or
cancellation of the agreement or requiring the repayment of amounts
received by the company. Since 1998, the company has recognized a total
of Cdn$2,965,000 (US$2,141,000) under this program, which has been
credited to earnings.
F-27
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
Should repayments of any amounts received pursuant to these agreements
be required, such repayments will be charged to earnings as the amount
of any repayment becomes known.
Finally, since 2000, companies operating in the Quebec City area are
eligible for a refundable tax credit granted by the Quebec provincial
government. This credit is earned on the increase of production and
marketing salaries incurred in the Quebec City area at a rate of 40%.
Since 2000, the company has recognized a total of Cdn$5,664,000
(US$4,089,000) under this program, of which Cdn$4,905,000
(US$3,540,000) has been credited to earnings with the balance of
Cdn$759,000 (US$549,000) having been included in deferred grants in the
balance sheet.
The reduction in the company's workforce described in note 4 had no
effect on amounts already recognized in the statements of earnings
under these programs.
Following is a summary of the classification of these and certain other
grants and tax credits (government grants) in the statements of
earnings of the reporting years.
Cost of sales for the years ended August 31, 2001, 2002 and 2003, is
net of government grants of $1,742,000, $546,000 and $518,000,
respectively.
Selling and administrative expenses for the years ended August 31,
2001, 2002 and 2003, are net of government grants of $260,000, $213,000
and $286,000, respectively.
Research and development expenses for the years ended August 31, 2001,
2002 and 2003, are net of government grants of $631,000, $333,000 and
$45,000, respectively.
DEFINED CONTRIBUTION PLANS
The company maintains separate defined contribution plans for certain
eligible employees. These plans, which are accounted for on an accrual
basis, are summarized as follows:
o Deferred profit-sharing plan
The company maintains a plan for certain eligible Canadian
resident employees, under which the company may elect to
contribute an amount equal to 1% of an employee's gross
salary, provided that the employee has contributed at least 2%
of his/her gross salary to a tax-deferred registered
retirement savings plan. From June 2002 to December 2002, the
company suspended its contributions to the plan as part of its
cost-reduction efforts. Contributions to this plan during the
years ended August 31, 2001, 2002 and 2003, amounted to
Cdn$407,000 (US$266,000), Cdn$136,000 (US$86,000) and
Cdn$93,000 (US$63,000), respectively.
o 401K plan
The company maintains a 401K plan for eligible U.S. resident
employees. Under this plan, the company may elect to
contribute an amount equal to 3% of an employee's current
compensation. During the years ended August 31, 2001, 2002 and
2003, the company recorded contributions totaling $285,000,
$317,000 and $253,000, respectively.
F-28
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
15 INCOME TAXES
The reconciliation of the income tax provision calculated using the
combined Canadian federal and provincial statutory income tax rate to
the provision for income taxes per the financial statements is as
follows:
YEARS ENDED AUGUST 31,
------------------------------------------------------
2003 2002 2001
----------------- ---------------- -----------------
Income taxes at combined Canadian federal and provincial
statutory tax rate (34% in 2003, 36% in 2002 and 37% in 2001) $ (12,031) $ (26,563) $ 8,855
Increase (decrease) due to:
Manufacturing and processing deduction 307 525 (1,201)
Difference between combined Canadian federal and provincial
statutory tax rate and foreign subsidiaries statutory tax
rates (999) (1,101) 60
Non-taxable income (298) (143) (144)
Non-deductible expenses 77 334 274
Reduction of Canadian federal statutory tax rate 92 168 --
Effect of consolidation of subsidiaries 184 1,325 (276)
Tax deductions (80) (518) (136)
Previous year tax recovery upon a tax assessment (645) -- --
Other 67 522 356
Change in valuation allowance 28,385 -- 362
--------------- --------------- ---------------
$ 15,059 $ (25,451) $ 8,150
--------------- --------------- ---------------
The provision for income taxes consist of the following:
Current
Canadian $ 4,829 $ (10,816) $ 8,416
United States (247) (1,232) 1,305
Other 339 (6) 208
--------------- --------------- ---------------
4,921 (12,054) 9,929
Future
Canadian (13,553) (4,475) 578
United States (4,307) (8,694) (2,719)
Other (387) (228) --
--------------- --------------- ---------------
(18,247) (13,397) (2,141)
Valuation allowance
Canadian 20,359 -- --
United States 7,374 -- --
Other 652 -- 362
--------------- --------------- ---------------
28,385 -- 362
--------------- --------------- ---------------
$ 15,059 $ (25,451) $ 8,150
=============== =============== ===============
Details of the company's income taxes:
Earnings (loss) before income taxes and amortization and
write-down of goodwill
Canadian $ (20,449) $ (47,431) $ 28,202
United States (8,611) (28,228) (5,356)
Other (6,326) 1,874 1,086
----------------- ---------------- -----------------
$ (35,386) $ (73,785) $ 23,932
================= ================ =================
F-29
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
Significant components of the company's future income tax assets and
liabilities are as follows:
AS AT AUGUST 31,
-----------------------------------------
2003 2002
------------------ -------------------
Future income tax assets
Property, plant and equipment and intangible assets $ 3,287 $ 3,725
Provisions and accruals 9,786 1,339
Government grants 185 206
Deferred revenue 140 --
Share issue expenses 1,434 1,069
Restructuring charges -- 715
Research and development expenses 3,621 1,178
Losses carried forward 13,770 6,911
---------------- ----------------
32,223 15,143
Valuation allowance (28,846) (359)
---------------- ----------------
$ 3,377 $ 14,784
================ ================
Future income tax liabilities
Property, plant and equipment and intangible assets $ (2,848) $ (4,566)
Research and development tax credits (497) (150)
Provisions and accruals (32) (66)
---------------- ----------------
(3,377) (4,782)
---------------- ----------------
Future income tax assets, net $ -- $ 10,002
================ ================
As at August 31, 2003, the company had available operating losses in
several tax jurisdictions, for which a valuation allowance was
established. The following table summarizes the year of expiry of these
operating losses by tax jurisdiction:
CANADA UNITED STATES
YEAR OF EXPIRY FEDERAL PROVINCIAL AND OTHER
-------------------- ------------------- ----------------------
2005 $ 40,000 $ 7,000 $ --
2006 189,000 233,000 --
2007 1,467,000 1,799,000 155,000
2008 4,959,000 5,259,000 1,431,000
2009 2,390,000 2,070,000 --
2010 12,261,000 1,585,000 --
2022 -- -- 9,102,000
2023 -- -- 11,115,000
Indefinite -- -- 1,267,000
----------------- ---------------- -------------------
$ 21,306,000 $ 10,953,000 $ 23,070,000
================= ================ ===================
Also, as at August 31, 2003, the company had available research and
development expenses in Canada of $11,982,000 at the federal level and
$12,330,000 at the provincial level, for which a valuation allowance
was established. These expenses can be carried forward indefinitely
against future years' taxable income.
F-30
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
16 SEGMENT INFORMATION
Management has organized the company under one operating segment, being
the development, manufacturing and marketing of fiber-optic test,
measurement and monitoring solutions. This operating segment is
composed of Portable and Monitoring products and the Industrial and
Scientific products (note 21).
Product sales are detailed as follows:
YEARS ENDED AUGUST 31,
-------------------------------------------------------
2003 2002 2001
----------------- ----------------- -----------------
Portable and Monitoring products $ 40,069 $ 38,887 $ 69,399
Industrial and Scientific products 21,861 29,443 76,614
--------------- --------------- ---------------
$ 61,930 $ 68,330 $ 146,013
=============== =============== ===============
Sales to external customers by geographic region are detailed as
follows:
YEARS ENDED AUGUST 31,
-------------------------------------------------------
2003 2002 2001
----------------- ----------------- -----------------
United States $ 31,561 $ 35,129 $ 72,604
Canada 4,806 3,971 12,531
Europe 9,584 9,539 30,568
Asia 10,004 12,971 19,059
Latin America 4,467 2,581 5,838
Other 1,508 4,139 5,413
--------------- --------------- ---------------
$ 61,930 $ 68,330 $ 146,013
=============== =============== ===============
Sales have been allocated to geographic regions based on the country of
residence of the related customers. In 2003 and 2001, there were no
customers from which 10% or more of sales were derived, while in 2002,
one customer represented more than 10% of sales with 10.2% of sales
($6,965,000).
Long-lived assets by geographic region are detailed as follows:
AS AT AUGUST 31,
-----------------------------------------
2003 20022
------------------ -------------------
Canada $ 43,402 $ 44,145
United States 9,980 16,141
---------------- ----------------
$ 53,382 $ 60,286
================ ================
Long-lived assets consist of property, plant and equipment, intangible
assets and goodwill.
F-31
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
17 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
calculations:
YEARS ENDED AUGUST 31,
-------------------------------------------------------
2003 2002 2001
----------------- ----------------- -----------------
Basic weighted average number of shares outstanding (000's) 62,852 60,666 53,014
Dilutive effect of stock options (000's) 301 31 231
Dilutive effect of restricted stock awards (000's) 164 269 250
----------------- ----------------- -----------------
Diluted weighted average number of shares outstanding (000's) 63,317 60,966 53,495
================= ================= =================
Stock options excluded from the calculation of diluted
loss per share because the exercise price was greater than
the average market price of the common shares (000's) 2,533 2,734 953
================= ================= =================
The diluted loss per share for the years ended August 31, 2001, 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 years was
calculated using the basic weighted average number of shares
outstanding.
18 FINANCIAL INSTRUMENTS
SHORT-TERM INVESTMENTS
Short-term investments consist of the following:
AS AT AUGUST 31,
-----------------------------------------
2003 2002
------------------ -------------------
Commercial paper denominated in Canadian dollars, bearing
interest at annual rates of 2.61% to 2.93% in 2002 and 2.65% to
3.10% in 2003, maturing on different dates between September
2002 and November 2002 in 2002, and October 2003 and January
2004 in 2003 $ 52,010 $ 40,553
================ ================
F-32
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
FAIR VALUE
Cash, accounts receivable, accounts payable and accrued liabilities and
long-term debt are financial instruments whose fair values approximate
their carrying values.
The fair value of short-term investments, based on market value,
amounted to $40,553,000 and $52,010,000 as at August 31, 2002 and 2003,
respectively.
The fair value of forward exchange contracts, based on the current
trading value, amounted to Cdn$13,510,000 and Cdn$18,550,000 as at
August 31, 2002 and 2003, respectively. As at August 31, 2002, these
forward exchange contracts generated deferred unrealized losses of
US$39,000, compared to deferred unrealized gains of US$1,800,000 as at
August 31, 2003. Deferred unrealized gains or losses were calculated
using year-end exchange rates.
CREDIT RISK
Financial instruments which potentially subject the company to credit
risk consist primarily of cash, short-term investments, accounts
receivable and forward exchange contracts. The company's short-term
investments consist of debt instruments issued by high-credit quality
corporations. The company's cash and forward exchange contracts are
held with or issued by high-credit quality financial institutions;
therefore, the company considers the risk of non-performance on these
instruments to be remote.
Due to the geographic distribution of the company's customers, there is
no particular concentration of credit risk. Generally, the company does
not require collateral or other security from customers for trade
accounts receivable; however, credit is extended to customers following
an evaluation of creditworthiness. In addition, the company performs
ongoing credit reviews of all its customers and establishes an
allowance for doubtful accounts receivable when accounts are determined
to be uncollectible. Allowance for doubtful accounts amounted to
$520,000 and $568,000 as at August 31, 2002 and 2003, respectively.
INTEREST RATE RISK
As at August 31, 2003, the company's exposure to interest rate risk is
summarized as follows:
Cash Non-interest bearing
Short-term investments As described above
Accounts receivable Non-interest bearing
Accounts payable and accrued liabilities Non-interest bearing
Long-term debt As described in note
F-33
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
10 FORWARD EXCHANGE CONTRACTS
The company is exposed to currency risks as a result of its export
sales of products manufactured in Canada, substantially all of which
are denominated in US dollars. These risks are partially hedged by
forward exchange contracts and certain operating expenses. As at August
31, 2002 and 2003, the company held contracts to sell US dollars at
various forward rates, which are summarized as follows:
CONTRACTUAL WEIGHTED AVERAGE
AMOUNTS CONTRACTUAL FORWARD RATES
----------- -------------------------
As at August 31, 2002
September 2002 to August 2003 $ 6,400 1.5464
September 2003 to June 2004 2,200 1.5679
As at August 31, 2003
September 2003 to August 2004 $ 6,470 1.5869
September 2004 to August 2005 6,680 1.5647
19 RELATED PARTY TRANSACTIONS
In 2003, EXFO acquired a building from a company owned by the President
of the company for a cash consideration of $930,000. This transaction
was measured at the fair market value since it was not in the normal
course of operations, the change in ownership interest in the building
was substantive and the fair market value was supported by an
independent appraisal.
For the years ended August 31, 2001, 2002 and 2003, EXFO leased
facilities from a company owned by the President of the company. The
annual rental expense amounted to $238,000, $234,000 and $331,000,
respectively. The rental expense for 2003 included $234,000 for future
payments on an exited leased facility; this expense has been recorded
in the restructuring and other charges in the statement of earnings
(notes 4 and 9). This lease will not be renewed at expiry. These rental
expenses were measured at the fair market value since they were made in
the normal course of operations.
20 UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
As a registrant with the Securities and Exchange Commission in the
United States, the company is required to reconcile its financial
statements for significant differences between generally accepted
accounting principles as applied in Canada (Canadian GAAP) and those
applied in the United States (U.S. GAAP). Additional significant
disclosures required under U.S. GAAP have also been provided in the
accompanying financial statements and notes. The following summarizes
the significant differences between Canadian and U.S. GAAP and other
significant required disclosures under U.S. GAAP not already provided
in the accompanying financial statements.
F-34
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
RECONCILIATION OF NET LOSS TO CONFORM WITH U.S. GAAP
The following summary sets out the significant differences between the
company's reported net loss and net loss per share under Canadian GAAP
as compared to U.S. GAAP. Please see corresponding explanatory notes in
the Reconciliation Items section.
YEARS ENDED AUGUST 31,
------------------------------------------------------
2003 2002 2001
----------------- ----------------- -----------------
Net loss for the year in accordance with Canadian GAAP $ (54,950) $ (308,524) $ (15,294)
Non-cash stock-based compensation costs related to stock
option plan a) 216 49 (954)
Non-cash stock-based compensation costs related to stock
purchase plan a) (61) (661) (477)
Non-cash stock-based compensation costs related to
restricted stock award plan a) (987) (3,038) (3,481)
Unrealized gains on forward exchange contracts b) 1,645 444 97
Future income taxes on forward exchange contracts b) (543) (212) 20
Future income taxes on acquired in-process research and
development d) -- (444) (936)
Amortization of intangible assets e) 832 239 --
Future income taxes on amortization of intangible assets e) (279) (80) --
Valuation allowance on future income tax assets f) (252) -- --
Amortization of goodwill d), e) -- (9,263) (8,453)
Write-down of goodwill and intangible assets e) 6,178 (62,557) --
Future income taxes on write-down of intangible assets e) -- 1,154 --
--------- ---------- ---------
Net loss for the year in accordance with
U.S. GAAP (48,201) (382,893) (29,478)
Other comprehensive income (loss)
Foreign currency translation adjustments 15,974 (521) (9,888)
--------- ---------- ---------
Comprehensive loss $ (32,227) $ (383,414) $ (39,366)
========= ========== =========
Basic and diluted net loss per share in accordance with
U.S. GAAP g) $ (0.77) $ (6.31) $ (0.56)
F-35
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO 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 AUGUST 31,
---------------------------------------------------
2003 2002 2001
----------------- ----------------- --------------
Share capital in accordance with Canadian GAAP $ 492,452 $ 489,611 $ 429,995
Stock-based compensation costs related to stock
purchase plan a), h)
Current year (75) (64) (150)
Cumulative effect of prior years 2,478 2,542 2,692
Reclassification from other capital upon exercise of
restricted stock awards
Current year 1,582 3,270 --
Cumulative effect of prior years 3,270 -- --
Shares issued upon business combinations d)
Cumulative effect of prior years 65,584 65,584 65,584
--------- ---------- ---------
Share capital in accordance with U.S. GAAP $ 565,291 $ 560,943 $ 498,121
========= ========== =========
DEFERRED STOCK-BASED COMPENSATION COSTS
AS AT AUGUST 31,
-----------------------------------------------------
2003 2002 2001
----------------- ----------------- ---------------
Deferred stock-based compensation costs in accordance
with Canadian GAAP $ -- $ -- $ --
Stock-based compensation costs related to stock-based
compensation plans a), h)
Current year -- -- (8,145)
Cumulative effect of prior years (2,867) (7,968) (19,429)
Amortization for the year 1,483 4,698 4,912
Reduction of stock-based compensation costs 106 403 14,694
----------- ----------- ------------
Deferred stock-based compensation costs in accordance
with U.S. GAAP $ (1,278) $ (2,867) $ (7,968)
=========== =========== ============
F-36
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
OTHER CAPITAL
AS AT AUGUST 31,
----------------------------------------------------
2003 2002 2001
----------------- ----------------- --------------
Other capital in accordance with Canadian GAAP $ -- $ -- $ --
Stock-based compensation costs related to stock-based
compensation plans a), h)
Current year -- -- 8,145
Cumulative effect of prior years 10,963 12,350 18,749
Reduction of stock-based compensation costs (682) (1,387) (14,544)
Reclassification to share capital upon exercise of
restricted stock awards
Current year (1,582) (3,270) --
Cumulative effect of prior years (3,270) -- --
------------- ------------ -------------
Other capital in accordance with U.S. GAAP $ 5,429 $ 7,693 $ 12,350
============= ============ =============
F-37
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
DEFICIT
AS AT AUGUST 31,
----------------------------------------------------
2003 2002 2001
----------------- ----------------- --------------
Deficit in accordance with Canadian GAAP $ (371,788) $ (316,838) $ (8,314)
Stock-based compensation costs related to stock-based
compensation plans a)
Current year (832) (3,650) (4,912)
Cumulative effect of prior years (10,574) (6,924) (2,012)
Unrealized gains on forward exchange contracts, net
of related future income taxes b)
Current year 1,102 232 117
Cumulative effect of prior years 349 117 --
Change in reporting currency c)
Cumulative effect of prior years 1,016 1,016 1,016
Future income taxes on acquired in-process research
and development d)
Current year -- (444) (936)
Cumulative effect of prior years (1,380) (936) --
Amortization of intangible assets e)
Current year 832 239 --
Cumulative effect of prior years 239 -- --
Future income taxes on amortization of intangible
assets e)
Current year (279) (80) --
Cumulative effect of prior years (80) -- --
Write-down of goodwill and intangible assets e)
Current year 6,178 (62,557) --
Cumulative effect of prior years (62,557) -- --
Future income taxes on write-down of intangible assets e)
Current year -- 1,154 --
Cumulative effect of prior years 1,154 -- --
Valuation allowance on future income tax assets f)
Current year (252) -- --
Amortization of goodwill d), e)
Current year -- (9,263) (8,453)
Cumulative effect of prior years (17,716) (8,453) --
------------- ------------ ------------
Deficit in accordance with U.S. GAAP $ (454,588) $ (406,387) $ (23,494)
============= ============ =============
F-38
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO 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 AUGUST 31,
----------------------------------------------------
2003 2002 2001
----------------- ----------------- --------------
Foreign currency translation adjustments c)
Balance - Beginning of year $ (9,870) $ (9,349) $ 539
Change during the year 15,974 (521) (9,888)
------------- ------------ ------------
Balance - End of year $ 6,104 $ (9,870) $ (9,349)
============= ============ ============
BALANCE SHEETS
The following table summarizes the significant differences in balance
sheet items between Canadian GAAP and U.S. GAAP:
AS AT AUGUST 31, 2003 AS AT AUGUST 31, 2002
--------------------------------------- ----------------------------------------
AS REPORTED U.S. GAAP AS REPORTED U.S. GAAP
Intangible assets d), e)
Cost $ 36,260 $ 32,322 $ 37,927 $ 30,301
Accumulated amortization (25,482) (21,652) (21,463) (17,030)
----------------- ---------------- ------------------ -----------------
$ 10,778 $ 10,670 $ 16,464 $ 13,271
================= ================ ================== =================
Goodwill d), e)
Cost $ 89,721 $ 99,137 $ 87,025 $ 92,747
Accumulated amortization (72,048) (90,350) (69,449) (87,251)
----------------- ---------------- ------------------ -----------------
$ 17,673 $ 8,787 $ 17,576 $ 5,496
================= ================ ================== =================
Shareholders' equity
Share capital a), d), 565,291 489,611 560,943
h) $ 492,452 $ $ $
Contributed surplus 1,519 1,519 1,487 1,487
Cumulative translation
adjustment c) 7,643 -- (8,854) --
Deferred stock-based
compensation costs a), h) -- (1,278) -- (2,867)
Other capital a) -- 5,429 -- 7,693
AS AT AUGUST 31, 2003 AS AT AUGUST 31, 2002
--------------------------------------- ----------------------------------------
AS REPORTED U.S. GAAP AS REPORTED U.S. GAAP
Deficit a), b),
c), d),
e), f) (371,788) (454,588) (316,838) (406,387)
Accumulated other
comprehensive income
(loss) c) -- 6,104 -- (9,870)
----------------- ---------------- ------------------ -----------------
$ 129,826 $ 122,477 $ 165,406 $ 150,999
================= ================ ================== =================
F-39
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO 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 years ended August 31, 2001, 2002 and 2003, there are no
significant differences between the statements of cash flows under
Canadian GAAP as compared to U.S. GAAP.
RECONCILIATION ITEMS
a) ACCOUNTING FOR STOCK-BASED COMPENSATION
To conform with U.S. GAAP, the company measures stock-based
compensation costs using the intrinsic value method (APB 25
"Accounting for Stock Issued to Employees").
STOCK PURCHASE PLAN
Under APB 25, compensation cost related to the stock purchase
plan is measured as the difference between the fair value of
the purchased stock and the purchase price paid by plan
participants. Compensation cost is amortized to expense over a
period of five years, being the restriction period. This plan
terminated at the time of the Initial Public Offering on June
29, 2000.
STOCK OPTION PLAN
In accordance with APB 25, the company's stock option plan was
considered to be a variable plan until October 10, 2000. As a
result of the amendment to the stock option plan described in
note 13, the performance criterion was removed and the number
of shares to be issued under the plan was fixed and the
company recorded, in 2001, a net reduction of the compensation
cost and deferred compensation cost previously recognized of
$467,000 and $14,544,000, respectively. Compensation cost
under this plan is measured as the difference between the fair
value of the underlying stock at the date of grant and the
exercise price of the option. Compensation cost is amortized
to expense over the estimated vesting period up to a maximum
of four years.
RESTRICTED STOCK AWARD PLAN
Under APB 25, compensation cost related to the restricted
stock award plan is measured as the difference between the
fair value of the underlying stock at the date of grant and
the exercise price, which is nil. Compensation cost is
amortized to expense over the estimated vesting period up to a
maximum of four years, being the acquisition period.
Under Canadian GAAP, no compensation cost is recognized for
these stock-based compensation plans.
b) FORWARD EXCHANGE CONTRACTS
On September 1, 2000, the company prospectively adopted
Statement of Financial Accounting Standard No. 133,
"Accounting for Derivative Instruments and Hedging Activities"
(SFAS 133) and its amendments (SFAS 138), which require all
derivatives to be carried onto the balance sheet at fair
value. The forward exchange contracts used by the company have
not qualified for hedging accounting treatment during the
years ended August 31, 2001, 2002 and 2003
F-40
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
under U.S. GAAP; accordingly, changes in the fair value of the
derivatives have been charged to earnings during these years.
Under Canadian GAAP, the company's forward exchange contracts
held for the purpose of hedging anticipated sales qualified
for hedge accounting and any foreign exchange translation
gains or losses on those contracts were recognized as an
adjustment of the revenues when the sale was recognized.
c) CHANGE IN REPORTING CURRENCY
On September 1, 1999, the company adopted the US dollar as its
reporting currency. Under U.S. GAAP, the financial statements,
including prior years, are translated according to the current
rate method. Under Canadian GAAP, at the time of change in
reporting currency, the historical financial statements are
presented using a translation of convenience. This difference
between U.S. GAAP and Canadian GAAP created a permanent
difference of $1,016,000 affecting the cumulative translation
adjustment and the retained earnings.
d) BUSINESS COMBINATIONS
Under Canadian GAAP, until June 30, 2001, the value of shares
issued upon a business combination was determined based on the
market price of the shares over a reasonable period of time
before and after the date of acquisition. Under U.S. GAAP, the
value of shares was determined based on the market price of
the shares over a reasonable period of time before and after
the companies had reached an agreement on the purchase price;
the significant terms of the agreement were known and the
proposed transaction was announced.
Consequently, the measurement dates of the acquisitions of
EXFO Burleigh and EXFO Photonic Solutions for U.S. GAAP
purposes occurred on December 14, 2000, and on March 6, 2001,
respectively; that is, the dates on which all significant
terms of the agreements were known. The average market price
of the shares a few days before and after those dates was
$31.09 and $25.84, respectively. Considering the number of
shares issued upon those acquisitions, the total consideration
for U.S. GAAP purposes amounts to $244,198,000 ($189,270,000
under Canadian GAAP) for EXFO Burleigh and $120,802,000
($110,146,000 under Canadian GAAP) for EXFO Photonic
Solutions, thus increasing share capital and goodwill under
U.S. GAAP.
However, since July 1, 2001, the shares issued upon a business
combination are valued under Canadian GAAP using the same
method as used under U.S. GAAP.
Furthermore, under U.S. GAAP, in-process research and
development acquired in a business combination is written off
at the time of acquisition and no future income taxes are
recognized on this asset in the purchase price allocation
process. Under Canadian GAAP, in-process research and
development acquired in a business combination is capitalized
and amortized over the estimated useful life. Future income
taxes are recognized on the acquisition date on that asset in
the purchase price allocation process. As at August 31, 2001,
2002 and 2003, in-process research and development recorded
under Canadian GAAP was fully amortized.
F-41
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
e) WRITE-DOWN OF GOODWILL AND INTANGIBLE ASSETS
2002
Under U.S. GAAP, until the adoption of SFAS 142, when assets
being tested for recoverability were acquired in business
combinations accounted for by the purchase method, the
goodwill that arose in that transaction had to be included as
part of the assets grouping in determining recoverability. The
intangible assets tested for recoverability in 2002 were
acquired in business combinations accounted for using the
purchase method and, consequently, the company allocated
goodwill to those assets on a pro rata basis using the
relative fair values of the long-lived assets and identifiable
intangible assets acquired as determined at the date of
acquisition. The carrying value of goodwill identified with
the impaired intangible assets was written down before any
reduction was made to the intangible assets. Intangible assets
were then written down to their fair value.
The fair value of intangible assets was determined based on
discounted future cash flows. The cash flow periods used were
ten and eleven years, using annual growth rates ranging
between 10% and 30% and discount rates between 15% and 18%.
The assumptions supporting discounted cash flows, including
the cash flow periods, the annual growth rates and the
discount rates, reflect management's best estimates. The
discount rates were based upon the company's weighted average
cost of capital as adjusted for the risks associated with
operations.
The unallocated portion of goodwill was tested for
recoverability at the subsidiaries' level based on the related
pre-tax undiscounted future cash flows using the same
assumptions and methodology as used for Canadian GAAP
purposes.
Under U.S. GAAP, the company recorded a charge of $281,278,000
to write down a significant portion of goodwill and a pre-tax
charge of $27,105,000 to write down a significant portion of
acquired core technology. Of the total charge of $308,383,000,
$170,079,000 was related to EXFO Burleigh for goodwill and
acquired core technology, $83,637,000 was related to EXFO
Photonic Solutions for goodwill and acquired core technology
and $54,667,000 was related to EXFO Protocol for goodwill.
Under Canadian GAAP, no allocation of goodwill was required
and each asset was tested for recoverability separately based
on its pre-tax undiscounted future cash flows over its
expected period of use.
Also, under Canadian GAAP, the impairment loss for intangible
assets was measured as the difference between the carrying
value and the pre-tax undiscounted future cash flows.
Finally, under U.S. GAAP, the carrying value of goodwill
reviewed for impairment was $46,380,000 higher than the
carrying value of the same goodwill tested under Canadian GAAP
because the measurement dates used to account for the business
combinations were different between Canadian GAAP and U.S.
GAAP as explained in item d).
F-42
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
2003
In 2003, Canadian and U.S. GAAP were harmonized to eliminate
the existing differences in the assessment and measurement of
impairment loss for goodwill and intangible assets. Thus, in
2003, goodwill and intangible assets were tested for
impairment using similar methodologies. However, considering
that the existing carrying value of goodwill and intangible
assets was lower under U.S. GAAP than under Canadian GAAP, the
required impairment loss under U.S. GAAP was lower.
Consequently, under U.S. GAAP, the company recorded a charge
of $872,000 to write down goodwill of EXFO Burleigh and a
pre-tax charge of $377,000 to write down acquired core
technology of EXFO Burleigh, compared to a write-down of
$4,505,000 for goodwill and a write-down of $2,922,000 for
intangible assets under Canadian GAAP, creating a
reconciliation item of $6,178,000 in the statement of
earnings.
Furthermore, considering differences in the carrying value of
intangible assets between Canadian GAAP and U.S. GAAP due to
impairment losses, adjustments to amortization of such assets
and related future income taxes were required as well.
f) INCOME TAXES
Considering the tax effects of the adjustments discussed in
items b), d) and e), the valuation allowance required under
U.S. GAAP was $252,000 higher than under Canadian GAAP.
g) LOSS PER SHARE
Under U.S. GAAP, the presentation of per share figures for
loss before amortization and write-down of goodwill is not
permitted.
h) SHARE CAPITAL
Under Canadian GAAP, restricted shares reacquired from
employees under the stock purchase plan are treated as arm's
length repurchases of shares, whereas under U.S. GAAP, the
reacquisition of shares would be accounted for as a forfeiture
by the employee, which means that any difference between the
amount originally credited to share capital and the remaining
deferred compensation cost will be credited to compensation
expense in the current period. The subsequent resale of the
shares would be treated as an issuance of shares for the
proceeds received.
i) RESEARCH AND DEVELOPMENT TAX CREDITS
Under Canadian GAAP, all research and development tax credits
are recorded as a reduction of research and development
expenses. Under U.S. GAAP, tax credits that are refundable
against taxable income are recorded in the income taxes. This
difference had no impact on the net loss and the net loss per
share figures for the reporting years.
F-43
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
j) NEW ACCOUNTING STANDARDS
On September 1, 2002, the company prospectively adopted SFAS
142, "Goodwill and Other Intangible Assets", which is similar
to CICA handbook section 3062 described in note 2.
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 an adjusted basis:
YEARS ENDED AUGUST 31,
------------------------------------------
2002 2001
-------------------- ------------------
Net loss for the year $ (382,893) $ (29,478)
Add-back:
Amortization of goodwill for the year 47,284 39,529
---------------- ----------------
Adjusted net earnings (loss) for the year $ (335,609) $ 10,051
================ ================
Basic and diluted net loss per share $ (6.31) $ (0.56)
Basic and diluted adjusted net earnings (loss) per share $ (5.53) $ 0.19
UNAUDITED PRO FORMA INFORMATION ON BUSINESS COMBINATIONS
Under U.S. GAAP, pro forma information must be provided as though the
business combinations had occurred at the beginning of the reported
periods.
The following unaudited pro forma information reflects the results of
operations as if the 2002 acquisition had been completed on September
1, 2001:
YEAR ENDED
AUGUST 31, 2002
---------------
(UNAUDITED)
Sales $ 75,282
Net loss $ (393,039)
Basic and diluted net loss per share $ (6.25)
The acquisition of EXFO Gnubi in 2003 was considered insignificant for
the purposes of the pro forma information.
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.
F-44
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
ACCOUNTING FOR STOCK-BASED COMPENSATION
Under U.S. GAAP, the company has elected to measure compensation costs
related to grants of stock options and stock awards using the intrinsic
value method of accounting. In this instance, however, under SFAS 123,
"Accounting for Stock-Based Compensation", the company is required to
make pro forma disclosures of net loss, basic and diluted net loss per
share as if the fair value-based method of accounting had been applied.
The fair value of options or awards granted was estimated using the
Black-Scholes options pricing model with the following weighted average
assumptions:
YEARS ENDED AUGUST 31,
-----------------------------------------------------------------------
2003 2002 2001
----------------------- ----------------------- -----------------------
Risk-free interest rate 4.83% 4.50% 5.36%
Expected volatility 80% 80% 75%
Dividend yield Nil Nil Nil
Expected life 36 months 40 months 33 months
If the fair value-based method had been used to account for stock-based
compensation costs related to stock options and stock awards issued to
employees, the net loss and related net loss per share figures under
U.S. GAAP would be as follows:
YEARS ENDED AUGUST 31,
-------------------------------------------------------
2003 2002 2001
----------------- ----------------- -----------------
Net loss for the year $ (48,201) $ (382,893) $ (29,478)
Add-back:
Stock-based compensation costs under APB 25 (216) (49) 954
Deduction:
Stock-based compensation costs under SFAS 123 (683) (4,618) (10,585)
---------------- ---------------- ---------------
Pro forma net loss for the year $ (49,100) $ (387,560) $ (39,109)
================ ================ ===============
Basic and diluted net loss per share $ (0.77) $ (6.31) $ (0.56)
Basic and diluted pro forma net loss per share $ (0.78) $ (6.39) $ (0.74)
21 SUBSEQUENT EVENT
In September 2003, the company reorganized its business under two
reportable segments: Telecom Division and Photonics and Life Sciences
Division. The Telecom Division meets the physical-, optical- and
protocol-layer test and measurement needs of network service providers,
system vendors and component manufacturers throughout the global
telecommunications industry. The Photonics and Life Sciences Division
mainly leverages developed and acquired technologies for high-tech
industrial manufacturing and research markets.
F-45
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
EXFO's President and Chief Executive Officer ("CEO") has been
identified as the chief operating decision-maker in assessing the
performance of the two segments and the allocation of resources to the
segments. Each reportable segment will be managed separately. Earnings
from operations represent the primary measure used by the CEO in
assessing performance of the reportable segments. Costs associated with
shared services and corporate costs will be allocated to segments.
Starting September 1, 2003, the company will provide the required
information about each reportable segment. However, the company will
not provide comparative information for previous periods about each
segment because this information is not available and it is
impracticable to do so. The accounting policies of the reportable
segments will be the same as those applied in the consolidated
financial statements.
Until August 31, 2003, the company was organized under one reportable
segment, being the development, manufacturing and marketing of
fiber-optic test, measurement and monitoring solutions for the global
telecommunications industry (note 16).
22 COMPARATIVE FIGURES
Certain comparative figures have been reclassified to conform with the
current-year presentation.
F-46
TABLE OF CONTENTS
Page
PART I. ..................................................................2
Item 1. Identity of Directors, Senior Management and Advisors.............2
Item 2. Offer Statistics and Expected Timetable...........................2
Item 3. Key Information...................................................2
Item 4. Information on the Company.......................................17
Item 5. Operating and Financial Review and Prospects.....................42
Item 6. Directors, Senior Management and Employees.......................64
Item 7. Major Shareholders and Related Party Transactions................80
Item 8. Financial Information............................................82
Item 9. The Offer and Listing............................................86
Item 10. Additional Information...........................................87
Item 11. Qualitative and Quantitative Disclosures about Market Risk.......97
Item 12. Description of Securities Other than Equity Securities...........98
PART II. .................................................................98
Item 13. Defaults, Dividends Arrearages and Delinquencies.................98
Item 14. Material Modifications to the Rights of Security Holders
and Use of Proceeds..............................................98
Item 15. Controls and Procedures..........................................98
Item 16. [Reserved].......................................................98
PART III. ................................................................100
Item 17. Financial Statements............................................100
Item 18. Financial Statements............................................100
Item 19. Exhibits........................................................101
EXHIBIT INDEX
NUMBER EXHIBIT
--------------- --------------------------------------------------------------
1.1 Amended Articles of Incorporation of EXFO (incorporated by
reference to Exhibit 3.1 of EXFO's Registration Statement on
Form F-1, File No. 333-38956).
1.2 Amended By-laws of EXFO (incorporated by reference to Exhibit
1.2 of EXFO's annual report on Form-20F dated January 15,
2003).
1.3 Amended and Restated Articles of Incorporation of EXFO
(incorporated by reference to Exhibit 1.3 of EXFO's annual
report on Form 20-F dated January 18, 2001).
2.1 Form of Subordinate Voting Share Certificate (incorporated by
reference to Exhibit 4.1 of EXFO's Registration Statement on
Form F-1, File No. 333-38956).
2.2 Form of Registration Rights Agreement between EXFO and Germain
Lamonde dated July 6, 2000 ) (incorporated by reference to
Exhibit 10.13 of EXFO's Registration Statement on Form F-1,
File No. 333-38956).
3.1 Form of Trust Agreement among EXFO, Germain Lamonde, GEXFO
Investissements Technologiques inc., Fiducie Germain Lamonde
and G. Lamonde Investissements Financiers inc. (incorporated
by reference to Exhibit 4.2 of EXFO's Registration Statement
on Form F-1, File No. 333-38956).
4.1 Agreement of Merger and Plan of Reorganization, dated as of
November 4, 2000, by and among EXFO, EXFO Sub, Inc., EXFO
Burleigh Instruments, Inc., Robert G. Klimasewki, William G.
May, Jr., David J. Farrell and William S. Gornall
(incorporated by reference to Exhibit 4.1 of EXFO's annual
report on Form 20-F dated January 18, 2001)
4.2 Amendment No. 1 to Agreement of Merger and Plan of Agreement,
dated as of December 20, 2000, by and among EXFO, EXFO Sub,
Inc., EXFO Burleigh Instruments, Inc., Robert G. Klimasewski,
William G. May, Jr., David J. Farrell and William S. Gornall
(incorporated by reference to Exhibit 4.2 of EXFO's annual
report on Form 20-F dated January 18, 2001).
4.3 Agreement of Merger, dated as of August 20, 2001, by and among
EXFO, Buyer Sub, and Avantas Networks Corporation and
Shareholders of Avantas Networks corporation (incorporated by
reference to Exhibit 4.3 of EXFO's annual report on Form 20-F
dated January 18, 2002).
4.4 Amendment No. 1 dated as of November 1, 2002 to Agreement of
Merger, dated as of August 20, 2001, by and among EXFO,
3905268 Canada Inc., Avantas Networks Corporation and
Shareholders of Avantas Networks (incorporated by reference to
Exhibit 4.4 of EXFO's annual report on Form 20-F dated January
18, 2002).
4.5 Offer to purchase shares of Nortech Fibronic Inc., dated
February 6, 2000 among EXFO, Claude Adrien Noel, 9086-9314
Quebec inc., Michel Bedard, Christine Bergeron and Societe en
Commandite Capidem Quebec Enr. and Certificate of Closing,
dated February 7, 2000 among the same parties (including
summary in English) (incorporated by reference to Exhibit 10.2
of EXFO's Registration Statement on Form F-1, File No.
333-38956).
4.6 Share Purchase Agreement, dated as of March 5, 2001, among
EXFO Electro-Optical Engineering, Inc., John Kennedy, Glenn
Harvey and EFOS Corporation (incorporated by reference to
Exhibit 4.1 of EXFO's Registration Statement on Form F-3, File
No. 333-65122).
4.7 Amendment Number One, dated as of March 15, 2001, to Share
Purchase Agreement, dated as of March 5, 2001, among EXFO
Electro-Optical Engineering, Inc., John Kennedy, Glenn Harvey
and EFOS Corporation. (incorporated by reference to Exhibit
4.2 of EXFO's Registration Statement on Form F-3, File No.
333-65122).
4.8 Share Purchase Agreement, dated as of November 2, 2001 between
JDS Uniphase Inc. and 3905268 Canada Inc. (incorporated by
reference to Exhibit 4.8 of EXFO's annual report on Form 20-F
dated January 18, 2002).
4.9 Intellectual Property Assignment and Sale Agreement between
EFOS Inc., EXFO Electro-Optical Engineering, Inc., John
Kennedy, Glenn Harvey and EFOS Corporation. (incorporated by
reference to Exhibit 4.3 of EXFO's Registration Statement on
Form F-3, File No. 333-65122).
4.10 Offer to acquire a building, dated February 23, 2000, between
EXFO and Groupe Mirabau inc. and as accepted by Groupe Mirabau
inc. on February 24, 2000 (including summary in English)
(incorporated by reference to Exhibit 10.3 of EXFO's
Registration Statement on Form F-1, File No. 333-38956).
4.11 Lease Agreement, dated December 1, 1996, between EXFO and
GEXFO Investissements Technologiques inc., as assigned to
9080-9823 Quebec inc. on September 1, 1999 (including summary
in English) (incorporated by reference to Exhibit 10.4 of
EXFO's Registration Statement on Form F-1, File No.
333-38956).
NUMBER EXHIBIT
--------------- --------------------------------------------------------------
4.12 Lease Agreement, dated March 1, 1996, between EXFO and GEXFO
Investissements Technologiques inc., as assigned to 9080-9823
Quebec inc. on September 1, 1999 (including summary in
English) (incorporated by reference to Exhibit10.5 of EXFO's
Registration Statement on Form F-1, File No. 333-38956).
4.13 Lease renewal of the existing leases between 9080-9823 Quebec
inc. and EXFO, dated November 30, 2001(incorporated by
reference to Exhibit 4.13 of EXFO's annual report on Form 20-F
dated January 18, 2002).
4.14 Loan Agreement between EXFO and GEXFO Investissements
Technologiques inc., dated May 11, 1993, as assigned to
9080-9823 Quebec inc. on September 1, 1999 (including summary
in English) (incorporated by reference to Exhibit 10.9 of
EXFO's Registration Statement on Form F-1, File No.
333-38956).
4.15 Resolution of the board of directors of EXFO, dated September
1, 1999, authorizing EXFO to acquire GEXFO Distribution
Internationale inc. from GEXFO Investissements Technologiques
inc. (including summary in English) (incorporated by reference
to Exhibit 10.10 of EXFO's Registration Statement on Form F-1,
File No. 333-38956).
4.16 Form of Promissory Note of EXFO issued to GEXFO
Investissements Technologiques inc. dated June 27, 2000 )
(incorporated by reference to Exhibit 10.12 of EXFO's
Registration Statement on Form F-1, File No. 333-38956).
4.17 Term Loan Offer, dated March 28, 2000, among EXFO and National
Bank of Canada as accepted by EXFO on April 3, 2000 (including
summary in English) (incorporated by reference to Exhibit
10.11 of EXFO's Registration Statement on Form F-1, File No.
333-38956).
4.18 Employment Agreement of Germain Lamonde dated May 29, 2000
(incorporated by reference to Exhibit 10.15 of EXFO's
Registration Statement on Form F-1, File No. 333-38956).
4.19 Employment Agreement of Bruce Bonini dated as of September 1,
2000 (incorporated by reference to Exhibit 4.24 of EXFO's
annual report on Form 20-F dated January 18, 2002).
4.20 Employment Agreement of Juan-Felipe Gonzalez dated as of
September 1, 2000 (incorporated by reference to Exhibit 4.25
of EXFO's annual report on Form 20-F dated January 18, 2002).
4.21 Employment Agreement of David J. Farrell dated as of December
20, 2000 (incorporated by reference to Exhibit 4.26 of EXFO's
annual report on Form 20-F dated January 18, 2002).
4.22 Deferred Profit Sharing Plan, dated September 1, 1998
(incorporated by reference to Exhibit 10.6 of EXFO's
Registration Statement on Form F-1, File No. 333-38956).
4.23 Stock Option Plan, dated May 25, 2000 (incorporated by
Reference to Exhibit 10.7 of EXFO's Registration Statement on
Form F-1, File No. 333-38956).
4.24 Share Plan, dated April 3, 2000 (incorporated by reference to
Exhibit 10.8 of EXFO's Registration Statement on Form F-1,
File No. 333-38956).
4.25 Directors' Compensation Plan (incorporated by reference to
Exhibit 10.17 of EXFO's Registration Statement on Form F-1,
File No. 333-38956).
4.26 Restricted Stock Award Plan, dated December 20, 2000
(incorporated by reference to Exhibit 4.21 of EXFO's annual
report on Form 20-F dated January 18, 2001).
4.27 Asset Purchase Agreement by and Among EXFO Electro-Optical
Engineering Inc., EXFO Gnubi Products Group Inc., gnubi
communications, L.P., gnubi communications General Partner,
LLC, gnubi communications Limited Partner, LLC, gnubi
communications, Inc., Voting Trust created by The Irrevocable
Voting Trust Agreement Among Carol Abraham Bolton, Paul
Abraham and James Ray Stevens, James Ray Stevens and Daniel J.
Ernst dated September 5, 2002 (incorporated by reference to
Exhibit 4.30 of EXFO's annual report on Form 20-F dated
January 15, 2003).
4.28 EXFO Protocol Inc. Executive Employment Agreement with Sami
Yazdi signed November 2, 2001 (incorporated by reference to
Exhibit 4.31 of EXFO's annual report on Form 20-F dated
January 15, 2003).
4.29 Second Amending Agreement to the Employment Agreement of Bruce
Bonini dated as of September 1, 2002.
4.30 Severance and General Release Agreement with Bruce Bonini
dated August 8, 2003.
4.31 Separation Agreement and General Release with Sami Yazdi dated
April 1, 2003.
4.32 Executive Employment Agreement of James Stevens dated as of
October 4, 2003.
4.33 Termination Terms for John Holloran Jr. dated May 28, 2003.
4.34 Employment Agreement of Pierre Plamondon dated as of September
1, 2002.
8.1 Subsidiaries of EXFO (list included in Item 4C of this annual
report).
11.1 Code of Ethics for senior financial officers.