UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 6-K
REPORT OF FOREIGN PRIVATE ISSUER PURSUANT TO RULE 13a-16 OR 15d-16
UNDER THE SECURITIES EXCHANGE ACT OF 1934
For the month of March, 2004
EXFO ELECTRO-OPTICAL ENGINEERING INC.
(Translation of registrant's name into English)
400 GODIN AVENUE, VANIER, QUEBEC, CANADA G1M 2K2
(Address of principal executive offices)
Indicate by check mark whether the registrant files or will file annual reports
under cover of Form 20-F or Form 40-F.
Form 20-F [X] Form 40-F [_]
Indicate by check mark whether the registrant by furnishing the information
contained in this Form is also thereby furnishing the information to the
Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of 1934.
Yes [_] No [X]
If "Yes" is marked, indicate below the file number assigned to the registrant in
connection with Rule 12g3-2(b): 82-______.
On March 24, 2004, EXFO Electro-Optical Engineering Inc., a Canadian
corporation, reported its results of operations for the second fiscal quarter
ended February 29, 2004. This report on Form 6-K sets forth the news release
relating to EXFO's announcement and certain information relating to EXFO's
financial condition and results of operations for the second fiscal quarter of
the 2004 fiscal year. This press release and information relating to EXFO's
financial condition and results of operations for the second fiscal quarter of
the 2004 fiscal year are hereby incorporated as a document by reference to Form
F-3 (Registration Statement under the Securities Act of 1933) declared effective
as of July 30, 2001 and to Form F-3 (Registration Statement under the Securities
Act of 1933) declared effective as of March 11, 2002 and to amend certain
material information as set forth in these two Form F-3 documents.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
By: /s/ Germain Lamonde
---------------------------------------
Name: Germain Lamonde
Title: President and Chief Executive Officer
Date: March 31, 2004
[GRAPHIC OMITTED]
[LOGO - EXFO]
================================================================================
1 800 683-3936 info@exfo.com o www.exfo.com
Tel: 1 418 683-0211
Fax: 1 418 683-2170
EXFO REPORTS SALES GROWTH OF 14.4% YEAR-OVER-YEAR AND 5.8%
QUARTER-OVER-QUARTER
o SALES REACH US$16.9 MILLION IN THE SECOND QUARTER OF FISCAL 2004
o GROSS MARGIN CLIMBS TO 55.4% FROM 51.0% IN THE PREVIOUS QUARTER
o NET BOOK-TO-BILL RATIO AT 1.05
QUEBEC CITY, CANADA, March 24, 2004--EXFO Electro-Optical Engineering Inc.
(NASDAQ: EXFO, TSX: EXF) reported today sales growth of 14.4% year-over-year and
5.8% quarter-over-quarter for the second quarter ended February 29, 2004.
Sales reached US$16.9 million in the second quarter of fiscal 2004 compared to
US$14.8 million in the second quarter of 2003 and US$16.0 million in the first
quarter of 2004. The net book-to-bill ratio was 1.05 for the second quarter of
fiscal 2004 compared to 0.80 for the same period last year and 1.06 for the
first quarter of 2004.
Gross margin amounted to 55.4% of sales in the second quarter of fiscal 2004
compared to 46.2% in the second quarter of 2003 and 51.0% in the first quarter
of 2004.
GAAP net loss for the second quarter of fiscal 2004 totaled US$2.9 million, or
US$0.04 per share, compared to a net loss of US$4.2 million, or US$0.07 per
share, for the second quarter of 2003 and a net loss of US$2.0 million, or
US$0.03 per share, for the first quarter of 2004.
"At the mid-point of our fiscal year, I am pleased with our execution as
demonstrated by the trend in our gross margin, bookings, and already fourteen
new product launches," said Germain Lamonde, Chairman, President and CEO of
EXFO. "Our deep innovation pipeline, fuelled by steady R&D investments during
the last three years, the strengthening of our datacom test solutions, and our
positioning as an early technology provider of fiber-to-the-premises (FTTP) test
solutions make me confident that we are on the right track to keep growing
market share, as demonstrated in a recent market research report."
SEGMENTED RESULTS
(IN MILLIONS OF DOLLARS)
SALES LOSS FROM OPERATIONS*
----------------------------------------- --------------------------
Q2 2004 Q1 2004 Q2 2003 Q2 2004 Q1 2004
----------- ----------- ----------- ----------- -----------
BUSINESS SEGMENT
Telecom Division US$13.4 US$12.2 US$11.8 (US$2.4) (US$2.4)
Photonics and Life
Sciences Division US$3.5 US$3.8 US$3.0 (US$1.1) (US$0.7)
* Segmented loss from operations is not available for comparative periods in
fiscal 2003.
[GRAPHIC OMITTED]
[LOGO - EXFO]
================================================================================
1 800 683-3936 info@exfo.com o www.exfo.com
Tel: 1 418 683-0211
Fax: 1 418 683-2170
SECOND-QUARTER BUSINESS HIGHLIGHTS
o Among the new product introductions in the second quarter, EXFO
launched a new line of handheld test instruments for the FTTP
installation market, meeting the technical requirements established by
leading standards bodies. The company also recognized revenue for
existing products used in FTTP applications and continued working with
lead customers to develop solutions for efficient network deployments
along the last mile.
o EXFO enhanced its protocol-layer product offering by launching its new
Packet Blazer(TM) Ethernet test solution for central offices. In
addition, the company introduced a new software feature set for its
portable Packet Blazer module to improve test effectiveness and
troubleshooting capabilities in the field. EXFO also is in the process
of consolidating its protocol-layer operations in Montreal to
accelerate product development.
o Subsequent to the quarter end, Frost and Sullivan, an independent
leading market research firm in the telecommunications industry,
announced that EXFO had been named recipient of the 2004 Growth
Strategy Excellence Award in recognition of its market-share growth in
the fiber-optic test equipment market. Frost and Sullivan also
confirmed EXFO's standing as the market leader for portable
physical-layer test solutions in the network service provider market.
o EXFO successfully closed a public offering of 5.2 million subordinate
voting shares on a bought-deal basis for net proceeds of US$29.2
million (C$38.4 million), resulting in a cash position of US$85.8
million and still negligible debt at the end of the second quarter.
This latest offering strengthens EXFO's position with regard to making
potential acquisitions.
OPERATING EXPENSES
Selling and administrative expenses amounted to US$6.8 million, or 40.0% of
sales, for the second quarter of fiscal 2004 compared to US$6.6 million, or
45.0% of sales, for the same period last year and US$5.9 million, or 36.7% of
sales, for the first quarter of 2004.
Gross research and development expenses totaled US$4.3 million, or 25.4% of
sales, in the second quarter of fiscal 2004 compared to US$4.4 million, or 29.9%
of sales, in the second quarter of 2003 and US$3.6 million, or 22.4% of sales,
in the first quarter of 2004.
BUSINESS OUTLOOK
EXFO forecasted sales between US$16.0 million and US$19.0 million and a GAAP net
loss between US$0.06 and US$0.03 per share for the third quarter of fiscal 2004.
CONFERENCE CALL AND WEBCAST
EXFO will host a conference call today at 5 p.m. (Eastern time) to review its
financial results for the second quarter of fiscal 2004. To listen to the
conference call and participate in the question period via telephone, dial
1-416-695-6120. Germain Lamonde, Chairman, President and CEO, and Pierre
Plamondon, CA, Vice-President of Finance and Chief Financial Officer, will
participate in the call. An audio replay of the conference call will be
available between 7 a.m. and 11 p.m. until March 31, 2004. The replay number is
1-416-695-5275. The audio Webcast of the conference call will also be available
on EXFO's Website at WWW.EXFO.COM, under the Investors section.
[GRAPHIC OMITTED]
[LOGO - EXFO]
================================================================================
1 800 683-3936 info@exfo.com o www.exfo.com
Tel: 1 418 683-0211
Fax: 1 418 683-2170
ABOUT EXFO
EXFO is the recognized test and measurement expert in the global
telecommunications industry through the design and manufacture of advanced and
innovative solutions as well as best-in-class customer support. The Telecom
Division, which represents the company's 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 EXFO's
strongest competitive advantages is its 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. For more information about EXFO,
visit WWW.EXFO.COM.
FORWARD-LOOKING STATEMENTS
This news release contains forward-looking statements within the meaning of the
U. S. Private Securities Litigation Reform Act of 1995 and we intend that such
forward-looking statements be subject to the safe harbors created thereby.
Forward-looking statements are statements other than historical information or
statements of current condition that refer to expectations, projections or other
characterizations of future events and circumstances. They are not guarantees of
future performance and involve risks and uncertainties. Actual results may
differ materially from those in forward-looking statements due to various
factors including global geo-political, economic, competitive and market
uncertainty and our ability to execute successfully in these uncertain
conditions; capital spending levels in the telecommunications sector; market
acceptance of new products and upcoming new products; limited visibility of
customer orders and the timing thereof; the competitive landscape; and
successful integration of our acquired and to-be-acquired companies. Assumptions
relating to the foregoing involve judgments and risks, all of which are
difficult or impossible to predict and many of which are beyond our control.
Other risk factors that may affect our future performance and operations are
detailed in our Annual Report on Form 20-F and our other filings with the U. S.
Securities and Exchange Commission and the Canadian securities commissions. We
believe that the expectations reflected in the forward-looking statements are
reasonable based on information currently available to us, but we cannot assure
you that the expectations will prove to have been correct. Accordingly, you
should not place undue reliance on these forward-looking statements. These
statements speak only as of the date of this document and shall not be revised
or updated to reflect events after the date of this document.
-30-
FOR MORE INFORMATION
Vance Oliver
Manager, Investor Relations
(418) 683-0211
vance.oliver@exfo.com
---------------------
EXFO ELECTRO-OPTICAL ENGINEERING INC.
INTERIM CONSOLIDATED BALANCE SHEET
(in thousands of US dollars)
AS AT AS AT
FEBRUARY 29, AUGUST 31,
2004 2003
--------- ---------
(UNAUDITED)
ASSETS
CURRENT ASSETS
Cash $ 3,566 $ 5,366
Short-term investments (note 6) 82,187 52,010
Accounts receivable
Trade, less allowance for doubtful accounts of $644
($568 as at August 31, 2003) 8,886 9,639
Other 1,645 834
Income taxes and tax credits recoverable 4,023 6,003
Inventories (note 3) 17,069 15,602
Prepaid expenses 1,108 2,041
--------- ---------
118,484 91,495
INCOME TAXES AND TAX CREDITS RECOVERABLE 3,230 1,377
PROPERTY, PLANT AND EQUIPMENT 20,207 21,641
INTANGIBLE ASSETS 11,737 14,068
GOODWILL 18,072 17,673
--------- ---------
$ 171,730 $ 146,254
========= =========
LIABILITIES
CURRENT LIABILITIES
Accounts payable and accrued liabilities (note 4) $ 11,282 $ 12,026
Income taxes payable -- 2,200
Deferred revenue 524 148
Current portion of long-term debt 110 110
--------- ---------
11,916 14,484
DEFERRED REVENUE 761 352
DEFERRED GRANTS 965 1,139
LONG-TERM DEBT 400 453
--------- ---------
14,042 16,428
--------- ---------
CONTINGENCY (note 9)
SHAREHOLDERS' EQUITY
Share capital (note 6) 521,668 492,452
Contributed surplus 1,618 1,519
Cumulative translation adjustment 11,083 7,643
Deficit (376,681) (371,788)
--------- ---------
157,688 129,826
--------- ---------
$ 171,730 $ 146,254
========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
INTERIM UNAUDITED CONSOLIDATED STATEMENTS OF EARNINGS
(in thousands of US dollars, except share and per share data)
THREE MONTHS SIX MONTHS THREE MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
FEBRUARY 29, 2004 FEBRUARY 29, 2004 FEBRUARY 28, 2003 FEBRUARY 28, 2003
----------------- ----------------- ----------------- -----------------
SALES $ 16,880 $ 32,842 $ 14,753 $ 32,501
COST OF SALES * 7,528 15,343 7,939 15,970
-------- -------- -------- --------
GROSS MARGIN 9,352 17,499 6,814 16,531
-------- -------- -------- --------
OPERATING EXPENSES
Selling and administrative * 6,759 12,616 6,641 13,903
Net research and development * (note 7) 3,492 6,321 3,488 6,799
Amortization of property, plant and
equipment 1,295 2,616 1,296 2,568
Amortization of intangible assets 1,291 2,576 1,474 2,908
-------- -------- -------- --------
TOTAL OPERATING EXPENSES 12,837 24,129 12,899 26,178
-------- -------- -------- --------
LOSS FROM OPERATIONS (3,485) (6,630) (6,085) (9,647)
Interest and other income 514 670 294 550
Foreign exchange gain (loss) 427 (43) (737) (710)
-------- -------- -------- --------
LOSS BEFORE INCOME TAXES (2,544) (6,003) (6,528) (9,807)
-------- -------- -------- --------
INCOME TAXES (note 8)
Current 341 (1,110) (79) 3,681
Future -- -- (2,203) (7,084)
-------- -------- -------- --------
341 (1,110) (2,282) (3,403)
-------- -------- -------- --------
NET LOSS FOR THE PERIOD $ (2,885) $ (4,893) $ (4,246) $ (6,404)
======== ======== ======== ========
BASIC AND DILUTED NET LOSS PER SHARE $ (0.04) $ (0.08) $ (0.07) $ (0.10)
BASIC WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING (000'S) 64,129 63,594 62,998 62,678
DILUTED WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING (000'S) (note 10) 64,772 64,217 63,436 63,094
* STOCK-BASED COMPENSATION COSTS
INCLUDED IN: (note 2)
Cost of sales $ 8 $ 8 $ -- $ --
Selling and administrative 54 59 -- --
Net research and development 22 22 -- --
-------- -------- -------- --------
$ 84 $ 89 $ -- $ --
======== ======== ====== ======
The accompanying notes are an integral part of these consolidated financial
statements.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
INTERIM UNAUDITED CONSOLIDATED STATEMENTS OF DEFICIT
AND CONTRIBUTED SURPLUS
(in thousands of US dollars)
DEFICIT
SIX MONTHS SIX MONTHS
ENDED ENDED
FEBRUARY 29, FEBRUARY 28,
2004 2003
------------ ------------
BALANCE - BEGINNING OF PERIOD $ (371,788) $ (316,838)
ADD
Net loss for the period (4,893) (6,404)
---------- ----------
BALANCE - END OF PERIOD $ (376,681) $ (323,242)
========== ==========
CONTRIBUTED SURPLUS
SIX MONTHS SIX MONTHS
ENDED ENDED
FEBRUARY 29, FEBRUARY 28,
2004 2003
------------ ------------
BALANCE - BEGINNING OF PERIOD $ 1,519 $ 1,487
ADD
Premium on resale of share capital 10 11
Stock-based compensation plans (note 2) 89 --
---------- ----------
BALANCE - END OF PERIOD $ 1,618 $ 1,498
========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
INTERIM UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands of US dollars)
THREE MONTHS SIX MONTHS THREE MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
FEBRUARY 29, 2004 FEBRUARY 29, 2004 FEBRUARY 28, 2003 FEBRUARY 28, 2003
----------------- ----------------- ----------------- -----------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss for the period $ (2,885) $ (4,893) $ (4,246) $ (6,404)
Add (deduct) items not affecting cash
Discount on short-term investments 101 332 6 221
Stock-based compensation costs 84 89 -- --
Amortization 2,586 5,192 2,770 5,476
Future income taxes -- -- (2,203) (7,084)
Deferred revenue 252 783 (32) (306)
Deferred grants (90) (212) (43) (85)
Change in non-cash operating items
Accounts receivable 2,088 227 3,733 3,358
Income taxes and tax credits 1,231 (1,916) 5,336 10,641
Inventories (1,818) (968) 1,788 3,983
Prepaid expenses 284 (62) 76 107
Accounts payable and accrued
liabilities (224) 61 (605) (492)
--------- --------- --------- ---------
1,609 (1,367) 6,580 9,415
--------- --------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to short-term investments (166,987) (246,912) (122,436) (211,185)
Proceeds from disposal of short-term
investments 135,668 218,509 115,903 203,292
Additions to property, plant and equipment
and intangible assets (171) (576) (367) (2,016)
Business combination -- -- (26) (1,867)
--------- --------- --------- ---------
(31,490) (28,979) (6,926) (11,776)
--------- --------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Repayment of long-term debt (27) (52) (42) (78)
Net proceeds of offering (note 6) 29,164 29,164 -- --
Share issue expenses (166) (166) -- 4
Exercise of stock options 157 218 -- --
Redemption of share capital (1) (3) (1) (7)
Resale of share capital 5 13 4 18
--------- --------- --------- ---------
29,132 29,174 (39) (63)
--------- --------- --------- ---------
CHANGE IN CASH (749) (1,172) (385) (2,424)
EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON
CASH (1,007) (628) 609 601
CASH - BEGINNING OF PERIOD 5,322 5,366 7,081 9,128
--------- --------- --------- ---------
CASH - END OF PERIOD $ 3,566 $ 3,566 $ 7,305 $ 7,305
========= ========= ========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
1 INTERIM FINANCIAL INFORMATION
The financial information as at February 29, 2004, and for the three and
six-month periods ended February 28, 2003 and February 29, 2004, is
unaudited. In the opinion of management, all adjustments necessary to
present fairly the results of these periods in accordance with generally
accepted accounting principles in Canada have been included. The
adjustments made were of a normal recurring nature. Interim results may not
necessarily be indicative of results anticipated for the entire year.
These interim consolidated financial statements are prepared in accordance
with generally accepted accounting principles in Canada and use the same
accounting policies and methods used in the preparation of the company's
most recent annual consolidated financial statements, except for changes as
described in note 2. All disclosures required for annual financial
statements have not been included in these financial statements. These
interim consolidated financial statements should be read in conjunction
with the company's most recent annual consolidated financial statements.
Certain comparative figures have been reclassified to conform to the
current periods' presentation.
2 NEW ACCOUNTING STANDARDS AND PRONOUNCEMENTS
On September 1, 2003, the company implemented the documentation required by
Accounting Guideline 13 of the Canadian Institute of Chartered Accountants
(CICA) handbook, "Hedging Relationship", which concerns the identification,
designation and effectiveness of its forward exchange contracts for the
purposes of applying hedge accounting. Consequently, the company's forward
exchange contracts, which are used to hedge anticipated US-dollar
denominated sales, continue to qualify for hedge accounting; foreign
exchange translation gains and losses on these contracts continue to be
recognized as an adjustment of the revenue when the sales are recorded.
On September 1, 2003, the company prospectively adopted the amendments made
to handbook section 3870, "Stock-Based Compensation and Other Stock-Based
Payments". These amendments require an expense to be recognized in
financial statements for all forms of employee stock-based compensation,
including stock options, using a fair value-based method. During the three
months ended November 30, 2003 and February 29, 2004, the company granted
60,000 and 274,000 stock options to its employees, respectively. The
aggregate fair value of these stock options amounts to $662,000. The
corresponding stock-based compensation costs were amortized using the
graded vesting method, resulting in stock-based compensation costs of
$84,000 and $89,000 for the three months and the six months ended February
29, 2004, respectively.
The company is required to disclose pro forma information with respect to
net loss and net loss per share as if stock-based compensation costs were
recognized in the financial statements using the fair value-based method
for options granted in fiscal 2003. However, if the fair value-based method
had been used to account for these costs, there would have been no
significant differences in the net loss and net loss per share figures,
compared to the net loss and net loss per share figures on a pro forma
basis. Consequently, no pro forma information is provided in these interim
consolidated financial statements.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
The fair value of options granted in fiscal 2004 was estimated using the
Black-Scholes options valuation model with the following weighted average
assumptions:
THREE MONTHS ENDED SIX MONTHS ENDED
FEBRUARY 29, 2004 FEBRUARY 29, 2004
------------------ -----------------
(UNAUDITED)
Risk-free interest rate 3.01% 3.03%
Expected volatility 101% 101%
Dividend yield Nil Nil
Expected life 53 months 51 months
In July 2003, the CICA issued handbook sections 1100 and 1400, "Generally
Accepted Accounting Principles" and "General Standards of Financial
Statements Presentation", which are effective for fiscal years beginning on
or after October 1, 2003. Among other things, these new sections define
generally accepted accounting principles (GAAP), establish the relative
authority of various types of CICA Accounting Standards Board
pronouncements and clarify the role of "industry practice" in applying
GAAP. The company will adopt these new standards on September 1, 2004 and
it does not expect significant impacts on its financial statements.
3 INVENTORIES
AS AT AS AT
FEBRUARY 29, AUGUST 31,
2004 2003
----------- ---------
(UNAUDITED)
Raw materials $ 8,302 $ 8,188
Work in progress 1,772 1,022
Finished goods 6,995 6,392
----------- ---------
$ 17,069 $ 15,602
=========== =========
4 ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
AS AT AS AT
FEBRUARY 29, AUGUST 31,
2004 2003
----------- ---------
(UNAUDITED)
Trade $ 4,827 $ 4,227
Salaries and social benefits 3,020 3,462
Warranty (note 5) 348 687
Tax on capital 685 381
Restructuring charges 1,374 2,468
Other 1,028 801
----------- ---------
$ 11,282 $ 12,026
=========== =========
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
The following table summarizes the changes in the restructuring charges
payable since August 31, 2003:
BALANCE AS AT FOREIGN CURRENCY BALANCE AS AT
AUGUST 31, 2003 PAID TRANSLATION ADJUSTMENT FEBRUARY 29, 2004
-------------------- -------------- ----------------------- ------------------
(UNAUDITED)
Severance expenses $ 1,233 $ (943) $ 56 $ 346
Exited leased facilities 872 (196) 53 729
Other 363 (80) 16 299
-------------------- -------------- ----------------------- ------------------
$ 2,468 $ (1,219) $ 125 $ 1,374
-------------------- -------------- ----------------------- ------------------
5 WARRANTY
The company offers its customers warranties of one to three years,
depending on the specific product and terms of the customer purchase
agreement. The company's typical warranties require it to repair or replace
defective products during the warranty period at no cost to the customer.
Costs related to original warranties are accrued at the time of shipment,
based upon estimates of expected rework rates and warranty costs to be
incurred. Costs associated with extended warranties are charged to expense
as incurred. Revenue for these extended warranties is recognized on a
straight-line basis over the warranty period.
The following table summarizes the changes in the warranty provision since
August 31, 2003:
BALANCE AS AT FOREIGN CURRENCY BALANCE AS AT
AUGUST 31, 2003 ISSUED SETTLED TRANSLATION ADJUSTMENT FEBRUARY 29, 2004
------------------ ---------- ----------- ------------------------- -------------------
(UNAUDITED)
Warranty $ 687 202 (564) 23 $ 348
6 SHARE CAPITAL
On February 12, 2004, pursuant to a Canadian public offering, the company
issued 5,200,000 subordinate voting shares for net proceeds of $29,164,000
(Cdn$38,438,400), after deduction of underwriting commission of $1,215,000.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
7 NET RESEARCH AND DEVELOPMENT EXPENSES
THREE MONTHS SIX MONTHS THREE MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
FEBRUARY 29, 2004 FEBRUARY 29, 2004 FEBRUARY 28, 2003 FEBRUARY 28, 2003
----------------- ----------------- ----------------- -----------------
(UNAUDITED) (UNAUDITED)
Gross research and development
expenses $ 4,286 $ 7,859 $ 4,415 $ 8,622
Research and development tax
credits and grants (794) (1,538) (927) (1,823)
--------- --------- --------- ---------
$ 3,492 $ 6,321 $ 3,488 $ 6,799
========= ========= ========= =========
8 INCOME TAXES
During the three months ended November 30, 2003, the company recorded
$1,406,000 for the non-recurring recovery of income taxes paid in previous
periods following the receipt of a tax assessment during that period.
Furthermore, considering current market conditions and because the company
recorded operating losses for the current six-month period and for the last
two fiscal years, the company has recorded a full valuation allowance
against future income tax assets on deductible temporary differences, tax
losses carried forward and tax deductions. This causes its income tax
recovery to be distorted in relation to its pre-tax accounting income.
9 CONTINGENCY
On November 27, 2001, a class action suit was filed in the United States
District Court for the Southern District of New York against the company,
four of the underwriters of its Initial Public Offering and some of its
executive officers pursuant to the Securities Exchange Act of 1934 and Rule
10b-5 promulgated thereunder and sections 11, 12 and 16 of the Securities
Act of 1933. This class action alleges that the company's registration
statement and prospectus filed with the Securities and Exchange Commission
on June 29, 2000, contained material misrepresentations and/or omissions
resulting from (i) the underwriters allegedly soliciting and receiving
additional, excessive and undisclosed commissions from certain investors in
exchange for which they allocated material portions of the shares issued in
connection with the company's Initial Public Offering; and (ii) the
underwriters allegedly entering into agreements with customers whereby
shares issued in connection with the company's Initial Public Offering
would be allocated to those customers in exchange for which customers
agreed to purchase additional amounts of shares in the after market at
pre-determined prices.
On April 19, 2002, the plaintiffs filed an amended complaint containing
master allegations against all of the underwriters in all of the 310 cases
included in this class action and, also filed an amended
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
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 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 interim consolidated financial statements as of
February 29, 2004.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
10 LOSS PER SHARE
The following table summarizes the reconciliation of the basic weighted
average number of shares outstanding and the diluted weighted average
number of shares outstanding:
THREE MONTHS SIX MONTHS THREE MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
FEBRUARY 29, 2004 FEBRUARY 29, 2004 FEBRUARY 28, 2003 FEBRUARY 28, 2003
----------------- ----------------- ----------------- -----------------
(UNAUDITED) (UNAUDITED)
Basic weighted average number of
shares outstanding (000's) 64,129 63,594 62,998 62,678
Dilutive effect of stock options
(000's) 551 504 293 236
Dilutive effect of restricted stock
awards (000's) 92 119 145 180
------ ------ ------ ------
Diluted weighted average number of
shares outstanding (000's) 64,772 64,217 63,436 63,094
====== ====== ====== ======
Stock options excluded from the
calculation of diluted weighted
average number of shares because
their exercise price was greater
than the average market price of
the common shares (000's) 2,085 2,028 2,684 2,630
===== ===== ===== =====
The diluted loss per share for the periods ended February 28, 2003 and
February 29, 2004, was the same as the basic loss per share since the
dilutive effect of stock options and restricted stock awards should not be
included in the calculation; otherwise, the effect would be anti-dilutive.
Accordingly, diluted loss per share for those periods was calculated using
the basic weighted average number of shares outstanding.
11 SEGMENT INFORMATION
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.
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 is managed separately. Earnings (loss) from operations represent
the primary measure used by the CEO in assessing performance of the
reportable segments. The accounting policies of the reportable segments are
the same as those applied in the consolidated financial statements.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
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.
The following tables present information by segment:
THREE MONTHS ENDED FEBRUARY 29, 2004 SIX MONTHS ENDED FEBRUARY 29, 2004
--------------------------------------------- ----------------------------------------------
PHOTONICS PHOTONICS
AND LIFE AND LIFE
TELECOM SCIENCES TELECOM SCIENCES
DIVISION DIVISION TOTAL DIVISION DIVISION TOTAL
----------- ------------- ------------- ----------- -------------- -------------
(UNAUDITED) (UNAUDITED)
Sales $ 13,340 $ 3,540 $ 16,880 $ 25,482 $ 7,360 $ 32,842
Loss from operations $ (2,464) $ (1,021) $ (3,485) $ (4,844) $ (1,786) $ (6,630)
Unallocated items:
Interest and other income 514 670
Foreign exchange gain (loss) 427 (43)
------------- -------------
Loss before income taxes (2,544) (6,003)
Income taxes 341 (1,110)
------------- -------------
Net loss for the period $ (2,885) $ (4,893)
============= =============
Comparative information for the loss from operations is not provided for
each reportable segment because this information is not available and is
impracticable to determine.
THREE MONTHS ENDED FEBRUARY 28, 2003 SIX MONTHS ENDED FEBRUARY 28, 2003
------------------------------------------------ -----------------------------------------------
PHOTONICS PHOTONICS
AND LIFE AND LIFE
TELECOM SCIENCES TELECOM SCIENCES
DIVISION DIVISION TOTAL DIVISION DIVISION TOTAL
-------------- ------------- ------------- ------------- -------------- ------------
(UNAUDITED) (UNAUDITED)
Sales $ 11,733 $ 3,020 $ 14,753 $ 25,937 $ 6,564 $ 32,501
AS AT
AS AT AUGUST 31,
FEBRUARY 29, 2004 2003
---------------------- ----------------------
(UNAUDITED)
TOTAL ASSETS
Telecom Division $ 59,754 $ 61,783
Photonics and Life Sciences Division 22,536 25,081
Unallocated assets 89,440 59,390
---------------------- ----------------------
$ 171,730 $ 146,254
====================== ======================
Unallocated assets are comprised of short-term investments and income taxes
and tax credits recoverable.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
12 DIFFERENCES BETWEEN CANADIAN AND U.S. GAAP
These interim consolidated financial statements are prepared in accordance
with Canadian GAAP, which differ in certain respects from U.S. GAAP. Note
20 to the company's most recent annual consolidated financial statements
describes the significant differences between Canadian and U.S. GAAP that
affect the company. This note describes the additional significant changes
that have occurred since the most recent consolidated annual financial
statements and provides a quantitative analysis of all significant
differences. All disclosures required in annual financial statements under
U.S. GAAP have not been provided in these interim consolidated financial
statements.
RECONCILIATION OF NET LOSS TO CONFORM WITH U.S. GAAP
THREE MONTHS SIX MONTHS THREE MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
FEBRUARY 29, 2004 FEBRUARY 29, 2004 FEBRUARY 28, 2003 FEBRUARY 28, 2003
----------------- ----------------- ----------------- -----------------
(UNAUDITED) (UNAUDITED)
Net loss for the period in accordance
with Canadian GAAP $ (2,885) $ (4,893) $ (4,246) $ (6,404)
Stock-based compensation costs
related to stock option plan 42 140 (2) (55)
Stock-based compensation costs
related to stock purchase plan (60) (121) (69) (140)
Stock-based compensation costs
related to restricted stock award
plan (21) (194) (221) (568)
Unrealized gains (losses) on forward
exchange contracts a) (346) 255 -- --
Amortization of intangible assets -- -- 239 478
Future income taxes on amortization
of intangible assets -- -- (80) (160)
-------- -------- --------- --------
Net loss for the period in accordance
with U.S. GAAP (3,270) (4,813) (4,379) (6,849)
Other comprehensive income (loss)
Foreign currency translation
adjustment (4,266) 3,348 7,195 6,594
-------- -------- --------- --------
Comprehensive income (loss) $ (7,536) $ (1,465) $ 2,816 $ (255)
======== ======== ========= ========
Basic and diluted net loss per share
in accordance with U.S. GAAP $ (0.05) $ (0.08) $ (0.07) $ (0.11)
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
SHAREHOLDERS' EQUITY
As a result of the aforementioned adjustments to net loss and other
comprehensive income (loss), significant differences with respect to
shareholders' equity under U.S. GAAP are as follows:
SHARE CAPITAL
AS AT AS AT
FEBRUARY 29, AUGUST 31,
2004 2003
----------- ---------
(UNAUDITED)
Share capital in accordance with Canadian GAAP $ 521,668 $ 492,452
Stock-based compensation costs related to stock purchase plan
Current period (26) (75)
Cumulative effect of prior periods 2,403 2,478
Reclassification from other capital upon exercise of
restricted stock awards
Current period 1,544 1,582
Cumulative effect of prior periods 4,852 3,270
Shares issued upon business combinations
Cumulative effect of prior periods 65,584 65,584
----------- ---------
Share capital in accordance with U.S. GAAP $ 596,025 $ 565,291
=========== ==========
DEFERRED STOCK-BASED COMPENSATION COSTS
AS AT AS AT
FEBRUARY 29, AUGUST 31,
2004 2003
----------- ---------
(UNAUDITED)
Deferred stock-based compensation costs in accordance with Canadian
GAAP $ -- $ --
Stock-based compensation costs related to stock-based compensation
plans
Current period (662) --
Cumulative effect of prior periods (1,278) (2,867)
Amortization for the period 562 1,483
Reduction of stock-based compensation costs for the period upon
departure of employees 27 106
----------- ---------
Deferred stock-based compensation costs in accordance with U.S. GAAP $ (1,351) $ (1,278)
=========== ==========
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
OTHER CAPITAL
AS AT AS AT
FEBRUARY 29, AUGUST 31,
2004 2003
----------- ---------
(UNAUDITED)
Other capital in accordance with Canadian GAAP $ -- $ --
Stock-based compensation costs related to stock-based compensation
plans
Current period 662 --
Cumulative effect of prior periods 10,281 10,963
Reduction of stock-based compensation costs upon departure of employees (299) (682)
Reclassification to share capital upon exercise of restricted stock
awards
Current period (1,544) (1,582)
Cumulative effect of prior periods (4,852) (3,270)
----------- ---------
Other capital in accordance with U.S. GAAP $ 4,248 $ 5,429
=========== ==========
DEFICIT
AS AT AS AT
FEBRUARY 29, AUGUST 31,
2004 2003
----------- ---------
(UNAUDITED)
Deficit in accordance with Canadian GAAP $ (376,681) $ (371,788)
Stock-based compensation costs related to stock-based compensation
plans
Current period (175) (832)
Cumulative effect of prior periods (11,406) (10,574)
Unrealized gains on forward exchange contracts, net of related
future income taxes
Current period 255 1,102
Cumulative effect of prior periods 1,451 349
Change in reporting currency
Cumulative effect of prior periods 1,016 1,016
Future income taxes on acquired in-process research and development
Cumulative effect of prior periods (1,380) (1,380)
Amortization of intangible assets
Current period -- 832
Cumulative effect of prior periods 1,071 239
Future income taxes on amortization of intangible assets
Current period -- (279)
Cumulative effect of prior periods (359) (80)
Write-down of goodwill and intangible assets
Current period -- 6,178
Cumulative effect of prior periods (56,379) (62,557)
Future income taxes on write-down of intangible assets
Cumulative effect of prior periods 1,154 1,154
Valuation allowance on future income tax assets
Current period -- (252)
Cumulative effect of prior periods (252) --
Amortization of goodwill
Cumulative effect of prior periods (17,716) (17,716)
----------- ---------
Deficit in accordance with U.S. GAAP $ (459,401) $ (454,588)
=========== ==========
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
ACCUMULATED OTHER COMPREHENSIVE INCOME
AS AT AS AT
FEBRUARY 29, AUGUST 31,
2004 2003
----------- ---------
(UNAUDITED)
Foreign currency translation adjustment
Balance - Beginning of period $ 6,104 $ (9,870)
Change during the period 3,348 15,974
----------- ---------
Balance - End of period $ 9,452 $ 6,104
=========== ==========
BALANCE SHEETS
The following table summarizes the significant differences in balance sheet
items between Canadian GAAP and U.S. GAAP:
AS AT FEBRUARY 29, 2004 AS AT AUGUST 31, 2003
--------------------------------------- ----------------------------------------
AS REPORTED U.S. GAAP AS REPORTED U.S. GAAP
(UNAUDITED)
Goodwill
Cost $ 93,199 $ 102,384 $ 89,721 $ 101,397
Accumulated amortization (75,127) (93,259) (72,048) (92,610)
------------------- ------------------- ------------------- --------------------
$ 18,072 $ 9,125 $ 17,673 $ 8,787
=================== =================== =================== ====================
Shareholders' equity
Share capital $ 521,668 $ 596,025 $ 492,452 $ 565,291
Deferred stock-based
compensation costs -- (1,351) -- (1,278)
Other capital -- 4,248 -- 5,429
Contributed surplus 1,618 1,529 1,519 1,519
Cumulative translation
adjustment 11,083 -- 7,643 --
Deficit (376,681) (459,401) (371,788) (454,588)
Accumulated other
comprehensive income -- 9,452 -- 6,104
------------------- ------------------- ------------------- --------------------
$ 157,688 $ 150,502 $ 129,826 $ 122,477
=================== =================== =================== ====================
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
STATEMENTS OF CASH FLOWS
For the periods ended February 28, 2003 and February 29, 2004, there are no
significant differences between the statements of cash flows under Canadian
GAAP as compared to U.S. GAAP.
RECONCILIATION ITEM
a) Forward exchange contracts
On September 1, 2003, the company implemented the documentation
required by Accounting Guideline 13 of the CICA handbook "Hedging
Relationship" for the identification, designation and effectiveness of
its forward exchange contracts, for the purposes of applying hedge
accounting, as described in note 2.
With this documentation in place, the forward exchange contracts
entered into by the company after September 1, 2003 will qualify for
hedge accounting treatment under U.S. GAAP. Consequently, under U.S.
GAAP, changes in the fair value of these contracts will be charged to
other comprehensive income. However, changes in the fair value of
contracts entered into prior to September 1, 2003 continue to be
charged to the statements of earnings. Since September 1, 2003, the
company did not enter into new forward exchange contracts. Under
Canadian GAAP, foreign exchange translation gains and losses on
contracts entered into either before or after September 1, 2003, are
recognized as an adjustment of the revenue when the sales are recorded.
NEW ACCOUNTING STANDARD
On September 1, 2003, the company prospectively adopted Statement of
Financial Accounting Standard (SFAS) 123, "Accounting for Stock-Based
Compensation", under the revised transition provisions of SFAS 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure". Upon
the adoption of SFAS 123 and SFAS 148, the company recognized stock-based
compensation costs for stock options granted to employees since September
1, 2003, using the fair value-based method. The company adopted this
Statement in order to conform to the newly adopted rules under Canadian
GAAP, as described in note 2. As a result of the adoption of the fair
value-based method, the accounting for stock-based compensation under
Canadian GAAP and U.S. GAAP is the same.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
THIS DISCUSSION AND ANALYSIS MAY CONTAIN FORWARD-LOOKING STATEMENTS
WITHIN THE MEANING OF THE U.S. PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
AND WE INTEND THAT SUCH FORWARD- LOOKING STATEMENTS BE SUBJECT TO THE SAFE
HARBORS CREATED THEREBY. FORWARD-LOOKING STATEMENTS ARE STATEMENTS OTHER THAN
HISTORICAL INFORMATION OR STATEMENTS OF CURRENT CONDITION. WORDS SUCH AS "MAY,"
"WILL," "EXPECT," "BELIEVE," "ANTICIPATE," "INTEND," "COULD," "ESTIMATE" OR
"CONTINUE" OR THE NEGATIVE OR COMPARABLE TERMINOLOGY ARE INTENDED TO IDENTIFY
FORWARD-LOOKING STATEMENTS. IN ADDITION, ANY STATEMENTS THAT REFER TO
EXPECTATIONS, PROJECTIONS OR OTHER CHARACTERIZATIONS OF FUTURE EVENTS OR
CIRCUMSTANCES ARE FORWARD-LOOKING STATEMENTS. FORWARD-LOOKING STATEMENTS ARE NOT
GUARANTEES OF FUTURE PERFORMANCE AND INVOLVE RISKS AND UNCERTAINTIES, AND ACTUAL
RESULTS MAY DIFFER MATERIALLY FROM THOSE IN THE FORWARD-LOOKING STATEMENTS AS A
RESULT OF VARIOUS FACTORS, INCLUDING ECONOMIC UNCERTAINTY, CAPITAL SPENDING
LEVELS IN THE TELECOMMUNICATIONS AND HIGH-TECH INDUSTRIAL MANUFACTURING SECTORS,
FLUCTUATING EXCHANGE RATES AND OUR ABILITY TO EXECUTE IN THESE UNCERTAIN
CONDITIONS; THE EFFECTS OF THE ADDITIONAL ACTIONS WE HAVE TAKEN IN RESPONSE TO
SUCH ECONOMIC UNCERTAINTY (INCLUDING WORKFORCE REDUCTIONS, ABILITY TO QUICKLY
ADAPT COST STRUCTURES TO ALIGN WITH ANTICIPATED LEVELS OF BUSINESS, ABILITY TO
MANAGE INVENTORY LEVELS TO ADAPT TO SLOWDOWNS); MARKET ACCEPTANCE OF OUR NEW
PRODUCTS AND OTHER UPCOMING PRODUCTS; LIMITED VISIBILITY WITH REGARDS TO
CUSTOMER ORDERS AND THE TIMING OF SUCH ORDERS; OUR ABILITY TO SUCCESSFULLY
INTEGRATE OUR ACQUIRED AND TO-BE-ACQUIRED BUSINESSES; OUR ABILITY TO
SUCCESSFULLY REALIGN OUR STRATEGIC BUSINESS PLAN; THE RETENTION OF KEY TECHNICAL
AND MANAGEMENT PERSONNEL; ABILITY TO NEGOTIATE THE RENEWAL OF OUR COLLECTIVE
BARGAIN AGREEMENT; AND FUTURE ECONOMIC, COMPETITIVE AND MARKET CONDITIONS.
ASSUMPTIONS RELATING TO THE FOREGOING INVOLVE JUDGMENTS AND RISKS, ALL OF WHICH
ARE DIFFICULT OR IMPOSSIBLE TO PREDICT ACCURATELY AND MANY OF WHICH ARE BEYOND
OUR CONTROL. OTHER RISK FACTORS THAT MAY AFFECT OUR FUTURE PERFORMANCE AND OUR
OPERATIONS ARE DETAILED IN OUR ANNUAL REPORT ON FORM 20-F AND OUR OTHER FILINGS
WITH THE U.S. SECURITIES AND EXCHANGE COMMISSION AND THE CANADIAN SECURITIES
COMMISSION. ALTHOUGH WE BELIEVE THAT THE EXPECTATIONS REFLECTED IN THE
FORWARD-LOOKING STATEMENTS ARE REASONABLE BASED ON INFORMATION CURRENTLY
AVAILABLE TO US, WE CANNOT ASSURE YOU THAT THE EXPECTATIONS WILL PROVE TO HAVE
BEEN CORRECT. ACCORDINGLY, YOU SHOULD NOT PLACE UNDUE RELIANCE ON THESE
FORWARD-LOOKING STATEMENTS. IN ANY EVENT, THESE STATEMENTS SPEAK ONLY AS OF THE
DATE OF THIS DOCUMENT. WE UNDERTAKE NO OBLIGATION TO REVISE OR UPDATE ANY OF
THEM TO REFLECT EVENTS OR CIRCUMSTANCES AFTER THE DATE OF THIS DOCUMENT.
ALL DOLLAR AMOUNTS ARE EXPRESSED IN US DOLLARS, EXCEPT AS OTHERWISE
NOTED.
INDUSTRY OVERVIEW
Network service providers (NSPs), the first link in the global
telecommunications supply chain, had continuously reduced their capital
expenditure (CAPEX) budgets for almost three years. However, during the last six
months some measure of relative stability appeared in the marketplace. Initial
evidence suggested that our 11% quarter-over-quarter sales increase in the first
quarter ended November 30, 2003, was largely due to year-end budget flush-outs
on the part of NSPs. A subsequent 6% sales increase (14% year-over-year) in the
second quarter ended February 29, 2004--which historically has been a
challenging quarter due to delays in NSP budget approvals and the holiday
season--pointed toward continued budget flush outs in December and market-share
gains in a more stable environment. Despite this relative stability, we believe
that NSPs dedicated a certain amount of their global CAPEX budgets to growth
pockets like fiber-to-the-premises (FTTP) networks at the expense of other
segments of capital spending.
1
This relative stability in CAPEX spending was witnessed in multiple
segments of the global telecommunications industry. System manufacturers
benefited from NSP demand for metro and access networks, especially with initial
deployments of FTTP networks. Component vendors, who had been hardest hit by the
downturn, still represent a depressed end-market for EXFO's product lines due to
scarce demand for new types of optical components for next-generation optical
networks. Some test and measurement equipment vendors, whose products enable
customers to reduce both CAPEX and operating expenses (OPEX), attracted the
attention of NSPs and system manufacturers, especially ones offering test
solutions for FTTP applications.
COMPANY OVERVIEW
We recognized revenue for existing products used in FTTP applications
during the second quarter and continue working with lead customers to develop
solutions that enable efficient network deployments along the last mile.
Although it is too early to forecast the size of this new end-market, we have
positioned ourselves as an early technology provider for FTTP testing and
established ourselves as an authority through the latest publication entitled
"FTTX PON GUIDE: TESTING PASSIVE OPTICAL NETWORKS."
We introduced seven new products in the second quarter of fiscal 2004,
including a new line of handheld test instruments that specifically target the
emerging demand for FTTP deployments as well as our new Packet Blazer TM
Ethernet module, a new protocol-based solution for central offices. In the first
quarter of 2004, we also introduced seven new products, including the 10+
Gigabit Multi-Rate Transceiver with deep channelization and mixed payload
concatenations for next-generation optical networks.
In addition, during the second quarter of fiscal 2004, we successfully
closed the public offering of 5.2 million subordinate voting shares to a
syndicate of Canadian-based underwriters for net proceeds of $29.2 million
(Cdn$38.4 million). As a result, we had $85.8 million in cash at the end of this
quarter.
Furthermore, we are consolidating our protocol-layer activities in
Montreal to increase efficiency and optimize cost structure.
In addition, with cash flows from operating activities of $1.6 million
in the second quarter of 2004, we met one of our four strategic annual
objectives, which consisted of maintaining a sound financial position.
Finally, our collective bargaining agreement with our unionized
manufacturing employees in Quebec City, Canada, expired on February 28, 2004,
and negotiation process is currently underway.
NEW BUSINESS STRUCTURE
At the beginning of fiscal 2004, we reorganized our business under two
new divisions: Telecom Division and Photonics and Life Sciences Division. Our
objectives behind this reorganization were to simplify our business model, adopt
a market approach rather than a product approach and increase accountability
throughout the organization. Our Telecom Division, which consists of former
Portable and Monitoring and telecom-related Industrial and Scientific product
lines, meets the physical-, optical- and protocol-layer test and measurement
2
needs of NSPs, system vendors and component manufacturers throughout the global
telecommunications industry. Our Photonics and Life Sciences Division, which
includes previous non-telecom Industrial and Scientific product lines, mainly
leverages developed and acquired technologies for diverse high-tech industrial
manufacturing and research markets.
This simplified business structure - with respective sales, marketing,
manufacturing, research and development and management teams for each division -
enables us to better serve our diverse customer base and maximize shareholder
value.
EXFO's President and Chief Executive Officer ("CEO"), as the chief
operating decision-maker, assesses the performance of the two segments and
allocates resources to the segments. Earnings (loss) from operations represent
the primary measure used by the CEO in assessing performance of the reportable
segments. Please refer to note 11 to our interim consolidated financial
statements for detailed segment information.
Until August 31, 2003, the company was organized under one reportable
segment; that is the development, manufacturing and marketing of fiber-optic
test, measurement and monitoring solutions for the global telecommunications
industry.
As part of this reorganization and consistent with our overall business
strategy, we are continuously reviewing our various assets. As part of this
review, we are presently assessing the potential divestiture of certain assets
of our Photonics and Life Sciences Division. There can be no assurance that we
will complete any such transaction.
OUR STRATEGY, KEY PERFORMANCE INDICATORS AND CAPABILITY TO DELIVER RESULTS
For a complete description of our strategy and the related key
performance indicators as well as our capabilities to deliver results, please
refer to the corresponding sections in our most recent annual report filed with
the securities commissions.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
For a complete description of our critical accounting policies and
estimates, please refer to the critical accounting policies and estimates in our
most recent annual report filed with the securities commissions. The following
details the changes in critical accounting policies that have occurred since our
most recent annual report:
HEDGING RELATIONSHIP. On September 1, 2003, we implemented the
documentation required by Accounting Guideline 13 of the Canadian Institute of
Chartered Accountants (CICA) handbook, "Hedging Relationship", which concerns
the identification, designation and effectiveness of our forward exchange
contracts for the purposes of applying hedge accounting. Consequently, our
forward exchange contracts, which are used to hedge anticipated US-dollar
denominated sales, continue to qualify for hedge accounting; foreign exchange
translation gains and losses on these contracts continue to be recognized as an
adjustment of the revenue when the sales are recorded.
STOCK-BASED COMPENSATION COSTS. On September 1, 2003, we prospectively
adopted the amendments made to handbook section 3870, "Stock-Based Compensation
and Other Stock-Based Payments". These amendments require an expense to be
recognized in financial statements for all forms of employee stock-based
compensation, including stock options, using
3
a fair value-based method. The fair value-based method involves significant
subjective assumptions such as the expected volatility of our stocks and the
expected life of the options. During the first and second quarter of fiscal
2004, we granted 60,000 and 274,000 stock options to our employees,
respectively. The aggregate fair value of these stock options amounted to
$662,000. The corresponding stock-based compensation costs were amortized using
the graded vesting method, resulting in stock-based compensation costs of
$84,000 and $89,000 for the three months and the six months ended February 29,
2004, respectively. Most of these costs have been recorded in selling and
administrative expenses and research and development expenses in the statements
of earnings.
4
RESULTS OF OPERATIONS
The following discussion and analysis of our consolidated financial
condition and results of operations for the three months and six months ended
February 28, 2003 and for the three months and six months ended February 29,
2004 should be read in conjunction with our interim consolidated financial
statements and the related notes thereto. Our interim consolidated financial
statements have been prepared in accordance with Canadian generally accepted
accounting principles (Canadian GAAP), which conform in all material respects
with United States generally accepted accounting principles (U.S. GAAP), except
as described in note 12 to our interim consolidated financial statements. The
following table sets forth interim consolidated statements of earnings data in
thousands of US dollars, except per share data, and as a percentage of sales for
the periods indicated:
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
FEBRUARY 29, FEBRUARY 28, FEBRUARY 29, FEBRUARY 28,
2004 2003 2004 2003
--------------- ---------------- --------------- ----------------
(UNAUDITED) (UNAUDITED)
Sales $ 16,880 $ 14,753 $ 32,842 $ 32,501
Cost of sales (1) 7,528 7,939 15,343 15,970
--------------- ---------------- --------------- ----------------
Gross margin 9,352 6,814 17,499 16,531
--------------- ---------------- --------------- ----------------
Operating expenses
Selling and administrative (1) 6,759 6,641 12,616 13,903
Net research and development 3,492 3,488 6,321 6,799
Amortization of property, plant and
equipment (1) 1,295 1,296 2,616 2,568
Amortization of intangible assets (1) 1,291 1,474 2,576 2,908
--------------- ---------------- --------------- ----------------
Total operating expenses 12,837 12,899 24,129 26,178
--------------- ---------------- --------------- ----------------
Loss from operations (3,485) (6,085) (6,630) (9,647)
Interest and other income 514 294 670 550
Foreign exchange gain (loss) 427 (737) (43) (710)
--------------- ---------------- --------------- ----------------
Loss before income taxes (2,544) (6,528) (6,003) (9,807)
Income tax 341 (2,282) (1,110) (3,403)
--------------- ---------------- --------------- ----------------
Net loss for the period $ (2,885) $ (4,246) $ (4,893) $ (6,404)
=============== ================ =============== ================
Basic and diluted net loss per share $ (0.04) $ (0.07) $ (0.08) $ (0.10)
OTHER STATEMENTS OF EARNINGS DATA:
Segment information:
Sales:
Telecom Division $ 13,340 $ 11,733 $ 25,482 $ 25,937
Photonics and Life Sciences Division 3,540 3,020 7,360 6,564
--------------- ---------------- --------------- ----------------
$ 16,880 $ 14,753 $ 32,842 $ 32,501
=============== ================ =============== ================
Loss from operations: (2)
Telecom Division $ (2,464) $ -- $ (4,844) $ --
Photonics and Life Sciences Division (1,021) -- (1,786) --
--------------- ---------------- --------------- ----------------
$ (3,485) $ -- $ (6,630) $ --
=============== ================ =============== ================
Research and development data:
Gross research and development $ 4,286 $ 4,415 $ 7,859 $ 8,622
Net research and development $ 3,492 $ 3,488 $ 6,321 $ 6,799
(1) Certain comparative figures have been reclassified to conform to the
current year's presentation.
(2) Comparative segment information for the loss from operations is not
available and is impracticable to determine.
5
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
FEBRUARY 29, FEBRUARY 28, FEBRUARY 29, FEBRUARY 28,
2004 2003 2004 2003
--------------- ---------------- --------------- ----------------
(UNAUDITED) (UNAUDITED)
Sales 100.0% 100.0% 100.0% 100.0%
Cost of sales (1) 44.6 53.8 46.7 49.2
--------------- ---------------- --------------- ----------------
Gross margin 55.4 46.2 53.3 50.8
--------------- ---------------- --------------- ----------------
Operating expenses
Selling and administrative (1) 40.0 45.0 38.4 42.8
Net research and development 20.7 23.6 19.3 20.9
Amortization of property, plant and
equipment (1) 7.7 8.8 8.0 7.9
Amortization of intangible assets (1) 7.6 10.0 7.8 8.9
--------------- ---------------- --------------- ----------------
Total operating expenses 76.0 87.4 73.5 80.5
--------------- ---------------- --------------- ----------------
Loss from operations (20.6) (41.2) (20.2) (29.7)
Interest and other income 3.0 2.0 2.0 1.7
Foreign exchange gain (loss) 2.5 (5.0) (0.1) (2.2)
--------------- ---------------- --------------- ----------------
Loss before income taxes (15.1) (44.2) (18.3) (30.2)
Income tax 2.0 (15.4) (3.4) (10.5)
--------------- ---------------- --------------- ----------------
Net loss for the period (17.1)% (28.8)% (14.9)% (19.7)%
=============== ================ =============== ================
OTHER STATEMENTS OF EARNINGS DATA:
Segment information:
Loss from operations: (2)
Telecom Division (14.6)% --% (14.8)% --%
Photonics and Life Sciences Division (6.0) -- (5.4) --
--------------- ---------------- --------------- ----------------
(20.6)% --% (20.2)% --%
=============== ================ =============== ================
Research and development data:
Gross research and development 25.4% 29.9% 23.9% 26.5%
Net research and development 20.7% 23.6% 19.3% 20.9%
(1) Certain comparative figures have been reclassified to conform to the
current year's presentation.
(2) Comparative segment information for the loss from operations is not
available and is impracticable to determine.
6
SALES
THREE MONTHS ENDED FEBRUARY 29, 2004, VS. THREE MONTHS ENDED FEBRUARY 28, 2003
For the three months ended February 29, 2004, our global sales
increased 14.4% to $16.9 million from $14.8 million for the same period last
year, with a 79%-21% split in favor of our Telecom Division.
TELECOM DIVISION
For the three months ended February 29, 2004, sales of our Telecom
Division increased 13.7% to $13.3 million from $11.7 million for the same period
last year. In the second quarter of fiscal 2004, continued budget flush-outs in
December and the relative stability in CAPEX spending helped us increase our
sales in this quarter, which historically has been a challenging one due to
delays in NSPs budget approvals and the holiday season. In addition, we believe
that we have gained market share for our physical-layer field-testing products.
Finally, we recognized revenue of existing products used for FTTP deployments in
the second quarter, which increased our sales to some extent.
Despite the increase in our Telecom sales, sales of our protocol-layer
solutions remained relatively stable in dollars year-over-year and represented
more than 10% of our global sales in the second quarter of 2004. Our
protocol-layer activities are a key driver in ensuring our long-term growth.
PHOTONICS AND LIFE SCIENCES DIVISION
For the three months ended February 29, 2004, sales of our Photonics
and Life Sciences Division increased 17.2% to $3.5 million from $3.0 million for
the same period last year. The increase in sales is due to the increased demand
for our high-tech industrial manufacturing solutions, mainly our X-CITETM 120
Fluorescence Illumination System.
Overall, for the two divisions, net accepted orders increased 51% to
$17.8 million in the second quarter of fiscal 2004 from $11.8 million for the
same period last year. As mentioned earlier, we benefited from continued budget
flush-outs and we witnessed a relative stability in CAPEX spending. Furthermore,
we benefited from an increased demand for existing products used in FTTP
deployments. Our net book-to-bill ratio increased to 1.05 in the second quarter
of 2004, from 0.80 year-over-year. In the previous quarter, the net book-to-bill
ratio reached 1.06.
For the upcoming quarter, we expect the sales split between the two
divisions to remain in the same ranges as in the two previous quarters.
SIX MONTHS ENDED FEBRUARY 29, 2004, VS. SIX MONTHS ENDED FEBRUARY 28, 2003
For the six months ended February 29, 2004, our global sales increased
1.0% to $32.8 million from $32.5 million for the same period last year, with a
78%-22% split in favor of our Telecom Division.
7
TELECOM DIVISION
For the six months ended February 29, 2004, sales of our Telecom
Division remained relatively stable at $25.5 million, compared to $25.9 million
for the same period last year. In the first quarter of fiscal 2003, our sales
reached $14.2 million before dropping to $11.7 million in the second quarter of
that same year as we witnessed less year-end budgetary flush-outs in December
2002 and because many NSPs delayed their budget approvals passed February 2003.
In fiscal 2004, we witnessed a relative stability in CAPEX spending and
benefited from larger budget flush-outs in November and December 2003. Our sales
have increased sequentially since the fourth quarter of fiscal 2003.
PHOTONICS AND LIFE SCIENCES DIVISION
For the six months ended February 29, 2004, sales of our Photonics and
Life Sciences Division increased 12.1% to $7.4 million from $6.6 million for the
same period last year. The increase in sales is due to the increased demand for
our high-tech industrial manufacturing solutions, mainly our X-CITETM 120
Fluorescence Illumination System.
GEOGRAPHIC DISTRIBUTION
For the three months ended February 29, 2004, sales to the Americas,
Europe, Middle East and Africa (EMEA) and Asia-Pacific (APAC) accounted for 67%,
18% and 15% of global sales, respectively. For the corresponding period last
year, sales to the Americas, EMEA and APAC accounted for 54%, 26% and 20% of
global sales, respectively. During the three months ended February 29, 2004, we
have benefited from an increased level of activities in the Americas, especially
among the carriers. Our sales to the Americas, especially in the United States,
are increasing sequentially since their significant drop in the second quarter
of fiscal 2003. Our sales to the EMEA market decreased year-over-year, mainly
because our sales to this market were unusually high in the second quarter of
fiscal 2003. Sales to this market for the current quarter were closer to our
normal level in percentage of global sales. Finally, our sales to the
Asia-Pacific market decreased year-over-year. Most of the sales to this market
are made through tenders, which may vary in number and significance from period
to period.
For the six months ended February 29, 2004, sales to the Americas, EMEA
and APAC accounted for 66%, 17% and 17% of global sales, respectively. For the
corresponding period last year, sales to the Americas, EMEA and APAC accounted
for 63%, 21% and 16%, respectively. Sales to the Americas increased
year-over-year for the above-mentioned reasons. Sales to the EMEA market
decreased 16% for the above-mentioned reasons.
We sell our products to a broad range of customers across our two
divisions, including NSPs, optical component and system manufacturers, as well
as high-tech industrial manufacturers and research and development laboratories.
For the three months ended February 29, 2004, no customer accounted for more
than 8.1% of our sales and our top three customers accounted for 16.5% of our
sales for that same period. For the three months ended February 28, 2003, no
customer accounted for more than 4.5% of our sales and our top three customers
accounted for 12.2% of our sales the same period last year. For the six months
ended February 29, 2004, no customer accounted for more than 6.8% of our sales
and our top three customers accounted for 17.5% of sales for that same period.
For the six months ended February 28, 2003, no customer accounted for more than
8.7% of sales and our top three customers accounted for 18.4% of our sales for
that same period.
8
Considering the sales level and the net book-to-bill ratio for the
first half of fiscal 2004 as well as the expected market-share gain in
protocol-testing and FTTP solutions, we still believe in achieving our KPI of a
10% sales growth year-over-year, in a stable or slightly declining
telecommunications market.
GROSS MARGIN
Gross margin amounted to 55.4% of sales for the three months ended
February 29, 2004, compared to 46.2% for the same period last year. The increase
in our gross margin can be explained by several factors. First, the rise in
sales and in manufacturing operations, has undoubtedly contributed to increasing
our gross margin during the quarter. Increased manufacturing activities allowed
us to better absorb our fixed manufacturing costs. In addition, our
cost-reduction measures and our enhanced efficiency further contributed to
increase the gross margin. Finally, most of our sales to the Americas are made
directly to our customers, which caused our gross margin to be higher as our
sales to this market represented a larger portion of our sales year-over-year.
However, the increased strength of the Canadian dollar, compared to the US
dollar during the second quarter of fiscal 2004, negatively affected our gross
margin to some extent as some cost of sales elements are denominated in Canadian
dollars.
Gross margin amounted to 53.3% of sales for the six months ended
February 29, 2004, compared to 50.8% for the same period last year. The increase
in our gross margin can be explained by the positive effects of our cost-cutting
measures, our enhanced efficiency and increased manufacturing activities, which
led to a better absorption of our fixed manufacturing costs. However, the
increased strength of the Canadian dollar, compared to the US dollar during the
first half of fiscal 2004, prevented us, to some extent, from further improving
our gross margin.
The 53.3% gross margin reached in the first half of fiscal 2004 leads
us to believe that our 50% gross margin objective for fiscal 2004 will be
attained. 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 costs, shifts in
product mix, under-absorption of fixed manufacturing costs and increases in
product offerings by other suppliers in our industry.
It should be noted that a new presentation was adopted, where certain
expenses were reclassified from selling and administrative expenses to cost of
sales. Consequently, comparative figures have also been reclassified, resulting
in a cost of sales increase of 2.7% and 2.3% for the three and six months ended
February 28, 2003, respectively, with comparable percentage of sales decreases
in selling and administrative expenses for these same periods.
SELLING AND ADMINISTRATIVE
For the three months ended February 29, 2004, selling and
administrative expenses were $6.8 million, or 40.0% of sales, compared to $6.6
million, or 45.0% of sales for the same period last year. Higher sales volume in
the second quarter of fiscal 2004, compared to the same period last year caused
our commissions expenses to be higher. In addition, the consolidation of our
protocol-layer activities in Montreal, caused a one-time charge in this quarter.
Furthermore, since September 1, 2003, we account for stock-based compensation
costs for awards granted to our employees, which caused our selling and
administrative
9
expenses to increase year-over-year. Finally, the increased strength of the
Canadian dollar, compared to the US dollar, in the second quarter of fiscal
2004, further increased our selling and administrative expenses year-over-year,
as some of our selling and administrative expenses are incurred in Canadian
dollars.
However, as a result of our restructuring plans and tight cost-control
measures, we were able to mitigate the increase in our selling and
administrative expenses year-over-year.
For the six months ended February 29, 2004, selling and administrative
expenses were $12.6 million, or 38.4% of sales, compared to $13.9 million, or
42.8% of sales for the same period last year. Our restructuring actions combined
with tight cost-control measures contributed to lower our selling and
administrative expenses year-over-year. However, several factors prevented us
from further reducing these expenses in fiscal 2004. First, the increased
strength of the Canadian dollar, compared to the US dollar, in the first half of
fiscal 2004, caused our selling and administrative expenses to be higher.
Furthermore, as mentioned above, we now account for stock-based compensation
costs for awards granted to our employees, increasing our expenses. Finally, as
we acquired EXFO Gnubi in October 7, 2002, this acquisition had a full-period
impact during the six months ended February 29, 2004, compared to five months
for the same period last year, which also contributed to higher overall selling
and administrative expenses.
Considering the challenging market conditions, we will continue to
maintain our selling and administrative expenses at an acceptable level without
impeding our efforts to strategically position our company, improve our sales,
and provide quality service to customers. However, any further increase in the
value of the Canadian dollar will negatively affect our selling and
administrative expenses in the upcoming quarter.
RESEARCH AND DEVELOPMENT
For the three months ended February 29, 2004, gross research and
development expenses totaled $4.3 million, or 25.4% of sales, compared to $4.4
million, or 29.9% of sales for the same period last year. During the second
quarter of fiscal 2004, we increased our investments in research and development
in our Telecom Division, especially for protocol and FTTP solutions. In
addition, the consolidation of our protocol-layer test activities in Montreal,
caused a one-time charge in this quarter. Furthermore, the increased strength of
the Canadian dollar, compared to the US dollar, in the second quarter of fiscal
2004, increased our gross research and development expenses, as most of these
expenses are incurred in Canadian dollars. On the other hand, in fiscal 2004, we
refocused our research and development activities in our Photonics and Life
Sciences Division based on our strategy to leverage existing telecom
technologies. This, combined with our restructuring actions and tight
cost-control measures, contributed to the decrease of our gross research and
development expenses year-over-year.
Although we reduced our gross research and development expenses
year-over-year, we still invested significantly in research and development
activities in the second quarter of fiscal 2004, mainly in our Telecom Division,
as we firmly believe that innovation and new product introductions are the key
to gaining market share in the current economic environment and to ensuring the
long-term growth and profitability of the company.
In the second quarter of fiscal 2004, 30% of sales originated from
products that have been on the market for two years or less. For the second
quarter of 2003, this number reached 58% of sales. This figure is below our
normal results. Quarterly fluctuations are expected;
10
several key products have recently passed the two-year mark and several new
products will boost this figure in following quarters.
For the three months ended February 29, 2004, tax credits and grants
from the Canadian federal and provincial governments for research and
development activities were $794,000, or 18.5% of gross research and development
expenses, compared to $927,000, or 21.0% of gross research and development
expenses for the same period last year. The decrease in our tax credits and
government grants is mainly related to the decrease in our eligible gross
research and development expenses in Canada, since we were entitled to similar
grant programs and tax credits year-over-year.
For the six months ended February 29, 2004, gross research and
development expenses totaled $7.9 million, or 23.9% of sales, compared to $8.6
million, or 26.5% of sales for the same period last year. The decrease in gross
research and development dollars and as percentage of sales year-over-year is
mostly attributable to our restructuring efforts and the fact that we refocused
our research and development activities in our Photonics and Life Sciences
Division based on our strategy to leverage existing telecom technologies.
However, it should be noted that the overall decrease in dollars was offset in
part by the increased value of the Canadian dollar compared to the US dollar,
year-over-year, since a large portion of our research and development expenses
are denominated in Canadian dollars.
For the six months ended February 29, 2004, tax credits and grants were
$1.5 million, or 19.6% of gross research and development expenses, compared to
$1.8 million, or 21.1% of gross research and development expenses for the same
period last year. The decrease in our tax credits and government grants is
mainly related to the decrease in our eligible gross research and development
expenses in Canada, since we were also entitled to almost the same grant
programs and tax credits year-over-year.
Even though our new-product-sales percentage (34%) is below our fiscal
2004 objective for the first half of the fiscal year, we still believe that new
products will represent 45% of our sales in fiscal 2004; namely, products
launched over the last two years and throughout 2004. We expect to continue
investing significantly in research and development in the upcoming quarters,
reflecting our focus on innovation, our desire to gain market share and our goal
to exceed customer needs and expectations.
AMORTIZATION OF INTANGIBLE ASSETS
For the three months and the six months ended February 29, 2004,
amortization of intangible assets was $1.3 million and $2.6 million,
respectively, compared to $1.5 million and $2.9 million, for the same periods
last year, respectively. The decrease in the amortization expense in fiscal 2004
compared to 2003 is the result of the impairment charge recorded in the third
quarter of fiscal 2003.
INTEREST AND OTHER INCOME
For the three months and six months ended February 29, 2004, interest
and other income amounted to $514,000 and $670,000, respectively, compared to
$294,000 and $550,000 for the corresponding periods last year. During the second
quarter of fiscal 2004, we recorded non-recurring revenue of $225,000 for the
sale of a non-core technology to a third
11
party. Without this non-recurring revenue, interest and other income would have
been relatively flat year-over-year.
We expect our interest income to increase in upcoming quarters
following our public offering in this quarter.
FOREIGN EXCHANGE GAIN (LOSS)
For the three months ended February 29, 2004, the foreign exchange gain
amounted to $427,000, compared to a foreign exchange loss of $737,000 for the
same period last year.
For the six months ended February 29, 2004, the foreign exchange loss
amounted to $43,000, compared to $710,000 for the same period last year.
Foreign exchange losses and gains are the result of the translation of
operating activities denominated in currencies other than the Canadian dollar.
During the second quarter of fiscal 2004, the Canadian dollar value decreased
significantly, as compared to the US dollar, resulting in a significant foreign
exchange gain during that period. The average and the closing exchange rates for
the second quarter of fiscal 2004 were Cdn$1.3163 = US$1.00 and Cdn$1.3401 =
US$1.00, respectively, compare to the closing rate of the previous quarter of
Cdn$1.2973 = US$1.00. In contrast, during the second quarter of fiscal 2003, the
Canadian dollar value increased significantly, resulting in a significant
exchange loss during that period. The average and the closing exchange rates for
the second quarter of fiscal 2003 were Cdn$1.5377 = US$1.00 and Cdn$1.4871 =
US$1.00, respectively, compared to the closing rate of the previous quarter of
Cdn$1.5654 = US$1.00.
During the six months ended February 29, 2004, the Canadian dollar
value remained relatively stable resulting in a small exchange loss. For the
same period of last year, the significant exchange loss was mainly the result of
the increased strength of the Canadian dollar.
We manage our exposure to currency risk with forward exchange contracts
and operating activities, denominated in currencies other than the Canadian
dollar, of our Canadian entities
INCOME TAXES
For the three months ended February 29, 2004, we recorded a tax expense
of $341,000. Since the third quarter of fiscal 2003, we recorded a full
valuation allowance on our future income tax assets because it is more likely
than not that these assets will not be recovered. The income tax expense
recorded in the second quarter of fiscal 2004 represents income taxes payable in
some specific tax jurisdictions. For the three months ended February 28, 2003,
we recorded a tax recovery of $2.3 million, representing of effective income tax
recovery rate of 35.0%.
For the six months ended February 29, 2004, we recorded a tax recovery
of $1.1 million mainly due to the $1.4 million non-recurring income tax recovery
recorded in the first quarter of 2004. This non-recurring gain was due to the
recovery, during that period, of income taxes paid in previous periods following
the receipt of a tax assessment.
12
LIQUIDITY AND CAPITAL RESOURCES
We finance our operations and meet our capital expenditure requirements
mainly through cash flows from operating activities, the use of cash and
short-term investments as well as the issuance of subordinate voting shares.
During the three months ended February 29, 2004, pursuant to a public
offering in Canada, we issued 5,200,000 subordinate voting shares for a net
proceeds of $29.2 million (Cdn$38.4 million) after deducting underwriting
commissions of $1.2 million. The net proceeds will be used for working capital
and other general corporate purposes, including potential acquisitions, although
we currently have no commitments or agreements for any acquisitions. Cash flows
provided by financing activities for the three months and the six months ended
February 29, 2004 are attributable to the net proceeds of this offering, which
amounted to $29.2 million.
One of the four main objectives of our strategic plan for fiscal 2004
is to maintain a sound financial position. We believe that such an objective is
in line with a strong cash position and working capital. As at February 29, 2004
cash and short-term investments consisted of $85.8 million, while our working
capital was at $106.6 million. Our cash and short-term investments increased
$28.1 million compared to November 30, 2003, mainly due to the net proceeds of
our public offering of $29.2 million and cash flows from operating activities of
$1.6 million. However, an unrealized foreign exchange loss of $2.3 million on
cash and short-term investments partly offset that increase. The unrealized
foreign exchange loss resulted from the translation in US dollars of our
Canadian-dollar-denominated cash and short-term investments, and was recorded in
the cumulative translation adjustment in the balance sheet. It should be noted
that any decline in the Canadian dollar value compared with the US dollar, in
future periods will negatively affect the value of our cash and short-term
investments.
We believe that our cash balances and short-term investments, combined
with an available line of credit of $6.6 million, will be sufficient to meet our
liquidity and capital requirements for the foreseeable future. However, possible
additional operating losses and/or possible investment in or acquisition of
complementary businesses, products or technologies may require additional
financing. There can be no assurance that additional debt or equity financing
will be available when required or, if available, it can be secured on
satisfactory terms. Our line of credit bears interest at prime rate.
OPERATING ACTIVITIES
Cash flows provided by operating activities were $1.6 million for the
three months ended February 29, 2004, compared to $6.6 million for the same
period last year. Cash flows provided by operating activities in the second
quarter of fiscal 2004 were mainly the result of the decrease in some of our
operating items; that is, our accounts receivable decreased by $2.1 million and
our income taxes and tax credits recoverable decreased by $1.2 million. However,
these positive effects on cash were offset in part by an inventory increase of
$1.8 million. The decrease in our accounts receivable is directly related to the
timing in our sales, which were front-end loaded during this quarter while they
were backend-loaded in the previous quarter. The decrease in our income taxes
and tax credits recoverable is due to the recovery, during the quarter, of
income taxes and tax credits from previous periods. Finally, the timing of
orders and shipments combined with the fact that the third quarter is typically
a more active period, caused our work in progress and finished goods to
increase.
13
In the second quarter of fiscal 2004, with positive cash flows from
operating activities, we met one of our four annual strategic objectives, which
consisted of maintaining a sound financial position.
Cash flows used by operating activities were $1.4 million for the six
months ended February 29, 2004, compared to cash flows provided of $9.4 million
for the same period last year. Cash flows used by operating activities in the
first half of fiscal 2004 were mainly the result of the increase of some of our
operating items; that is, income taxes and tax credits recoverable increased by
$1.9 million and inventories increased by $1.0 million. The increase in our
income taxes and tax credits recoverable is due to the payment, during the
period, of income taxes payable for previous periods and the recognition of tax
credits earned during the period but not yet recovered. The increase in our
inventories is due to the timing of orders and shipments combined with the fact
that the third quarter is typically a strong period. The decrease of these two
items was offset in part by the net earnings after items not affecting cash of
$1.3 million.
INVESTING ACTIVITIES
Cash flows used by investing activities were $31.5 million for the
three months ended February 29, 2004, compared to $6.9 million for the same
period last year. In the second quarter of fiscal 2004, we acquired $31.3
million of short-term investments with the net proceeds of the second public
offering completed during the quarter and cash flows provided by operating
activities.
Cash flows used by investing activities were $29.0 million for the six
months ended February 29, 2004, compared to $11.8 million for the same period
last year. During the first half of fiscal 2004, we acquired $28.4 million of
short-term investments with the net proceeds of the public offering.
CONTINGENCY
As discussed in note 9 to our interim consolidated financial
statements, 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. Even though
the process is continuing in this class action, we have no significant
developments to report in this quarter.
SHARE CAPITAL AND STOCK-BASED COMPENSATION PLANS
SHARE CAPITAL
As at February 29, 2004, EXFO had 37,900,000 multiple voting shares
outstanding, entitling to ten votes each and 30 502 712 subordinate voting
shares outstanding. The multiple voting shares and the subordinate voting shares
are unlimited as to number and without par value.
14
STOCK OPTION PLAN
The aggregate number of subordinate voting shares covered by options
granted under the stock option plan was 2,994,229 as at February 29, 2004. The
weighted average exercise price of those stock options was $14.19 compared to
the market price of $4.86 per share as at February 27, 2004. The maximum number
of subordinate voting shares issuable under the plan cannot exceed 6,306,153
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 February 29, 2004:
WEIGHTED
% OF ISSUED AVERAGE
AND EXERCISE
NUMBER OUTSTANDING PRICE
--------------- --------------- --------------
Chairman of the Board, President and CEO
(one individual) 150,482 5.03% $ 9.91
Board of Directors (five individuals) 181,875 6.07% $ 6.34
Management and Corporate Officers
(nine individuals) 326,800 10.91% $ 14.53
--------------- --------------- --------------
659,157 22.01% $ 11.22
=============== =============== ==============
RESTRICTED STOCK AWARD PLAN
In addition to the stock option plan, we maintain a restricted stock
award plan for some U.S.-based employees. The aggregate number of subordinate
voting shares covered by restricted stock awards was 77,279 as at February 29,
2004. Each restricted stock award entitles employees to receive one subordinate
voting share at a purchase price of nil.
RISKS AND UNCERTAINTIES
Over the past few years, we have managed our business, focused on
research and development of new and innovative products, prospered in
international markets and closed strategic acquisitions. However, we operate in
a highly competitive field that is in constant evolution and, as a result, we
encounter various risks and uncertainties that must be given appropriate
consideration in our strategic management policies.
The main risks and uncertainties related to the telecommunication test
and measurement industry involve the rapid development of new products that have
short life cycles and require extensive research and development; the difficulty
of predicting market size and trends; the difficulty of retaining highly skilled
employees; and the ability to quickly adapt our cost structure to changing
market conditions in order to achieve profitability. In addition, given our
strategic goals for growth and competitive positioning in our industry, we are
expanding into international markets. This exposes us to certain risks and
uncertainties related to changes in local laws and regulations, multiple
technological standards, protective legislation and pricing pressure.
Furthermore, while some strategic acquisitions we have completed are
essential to our long-term growth, they also expose us to certain risks and
uncertainties related to the rapid and effective integration of these businesses
as well as their products, technologies and personnel.
15
We are also exposed to currency risks as a result of the export of our
products manufactured in Canada, substantially all of which are denominated in
US dollars. These risks are partially hedged by operating expenses denominated
in US dollars, the purchase of raw materials in US dollars and forward exchange
contracts.
The economic slowdown in our industry could also result in some of our
customers experiencing difficulties and, consequently, this could have a
negative effect on our results especially in terms of future sales and
recoverability of accounts receivable. However, the sectorial and geographic
diversity of our customer base provides us with a reasonable level of protection
in this area. Finally, other financial instruments, which potentially subject us
to credit risks, consist mainly of cash, short-term investments and forward
exchange contracts. Our short-term investments consist of debt instruments
issued by high-credit quality corporations and trusts. Our cash and forward
exchange contracts are held with or issued by high-credit quality financial
institutions; therefore, we consider the risk of non-performance on these
instruments to be remote.
For a more complete understanding of risk factors that may affect us,
please refer to the risk factors set forth in our disclosures documents
published with securities commissions.
16