SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 20-F
[_] REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g)
OF THE SECURITIES EXCHANGE ACT OF 1934; or
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended August 31, 2004
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period ________ to ________
Commission File No. 0-30895
EXFO ELECTRO-OPTICAL ENGINEERING INC. /
EXFO INGENIERIE ELECTRO-OPTIQUE INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CANADA
(JURISDICTION OF INCORPORATION OR ORGANIZATION)
400 GODIN AVENUE
VANIER, QUEBEC G1M 2K2, CANADA
(418) 683-0211
(ADDRESS, INCLUDING ZIP CODE AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
Securities registered or to be registered pursuant to Section 12(b) of the Act:
None
Securities registered or to be registered pursuant to Section 12(g) of the Act:
Subordinate Voting Shares, no par value
Securities for which there is a reporting obligation
pursuant to Section 15(d) of the Act:
None
As of December 31, 2004, the registrant had 30,640,349
Subordinate Voting Shares outstanding.
Indicate by check mark whether EXFO (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that EXFO was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days.
Yes [X] No [_]
Indicate by check mark which financial statement item EXFO has
elected to follow:
Item 17 [_] Item 18 [X]
DISCLOSURE REGARDING FORWARD-LOOKING INFORMATION
This annual report contains or incorporates by reference statements
which constitute forward-looking statements within the meaning of the U.S.
Private Securities Litigation Reform Act of 1995 and we intend that such
forward-looking statements be subject to the safe harbors created thereby.
Forward-looking statements are statements other than historical information or
statements of current condition that refer to expectations, projections or other
characterizations of future events and circumstances. They are not guarantees of
future performance and involve risks and uncertainties. Actual results may
differ materially from those in forward-looking statements due to various
factors including those that are discussed under "Risk Factors" set forth in
Item 3D of this annual report. Assumptions relating to forward-looking
statements involve judgments and risks, all of which are difficult or impossible
to predict and many of which are beyond our control. We believe that the
expectations reflected in the forward-looking statements are reasonable based on
information currently available to us, but we cannot assure you that the
expectations will prove to have been correct. Accordingly, you should not place
undue reliance on these forward-looking statements. These statements speak only
as of the date of this document and shall not be revised or updated to reflect
events after the date of this document.
PART I.
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS
Not Applicable.
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
Not Applicable.
ITEM 3. KEY INFORMATION
A. SELECTED FINANCIAL DATA
The consolidated statements of earnings data for the years ended August
31, 2000 and 2001 and the consolidated balance sheets data as at August 31,
2000, 2001 and 2002 are derived from our audited consolidated financial
statements not included in this annual report. The consolidated statements of
earnings data for each of the three years ended August 31, 2002, 2003 and 2004
and the consolidated balance sheets data as at August 31, 2003 and 2004 are
derived from our audited consolidated financial statements that are included
elsewhere in this annual report.
Our consolidated financial statements are prepared in accordance with
generally accepted accounting principles in Canada ("Canadian GAAP") and
significant differences in measurement and disclosure from generally accepted
accounting principles in United States ("U.S. GAAP") are set out in note 20 to
our consolidated financial statements included elsewhere in this annual report.
The historical results below are not necessarily indicative of the results to be
expected for any future period.
The selected financial data should be read in conjunction with our
audited consolidated financial statements and the related notes included
elsewhere in this annual report, and "Item 5. Operating and Financial Review and
Prospects" of this annual report.
2
YEARS ENDED AUGUST 31,
----------------------------------------------------------
2004 2003 2002 2001 2000
---------- ---------- ---------- ---------- ----------
(IN THOUSANDS OF US DOLLARS, EXCEPT SHARE AND PER SHARE
DATA)
CONSOLIDATED STATEMENTS OF EARNINGS DATA:
AMOUNTS UNDER CANADIAN GAAP
Sales.................................................. $ 74,630 $ 61,930 $ 68,330 $ 146,013 $ 71,639
Cost of sales ......................................... 34,556 36,197 52,366 56,207 25,385
---------- ---------- ---------- ---------- ----------
Gross margin (1)....................................... 40,074 25,733 15,964 89,806 46,254
---------- ---------- ---------- ---------- ----------
Operating expenses
Selling and administrative ............................ 25,890 26,991 33,881 44,975 23,631
Net research and development........................... 12,390 15,879 12,782 13,601 6,402
Amortization of property, plant and equipment (2)...... 4,935 5,210 5,096 3,267 1,414
Amortization of intangible assets (2).................. 5,080 5,676 12,451 10,168 84
Impairment of long-lived assets and goodwill........... 620 7,427 23,657 -- --
Restructuring and other charges........................ 1,729 4,134 2,880 3,288 --
---------- ---------- ---------- ---------- ----------
Total operating expenses............................... 50,644 65,317 90,747 75,299 31,531
---------- ---------- ---------- ---------- ----------
Earnings (loss) from operations........................ (10,570) (39,584) (74,783) 14,507 14,723
Interest and other income.............................. 1,438 1,245 1,456 6,098 1,480
Foreign exchange gain (loss) .......................... (278) (1,552) (458) 3,327 (684)
Earnings (loss) before income taxes and amortization and
write-down of goodwill............................. (9,410) (39,891) (73,785) 23,932 15,519
Income taxes........................................... (986) 15,059 (25,451) 8,150 5,298
---------- ---------- ---------- ---------- ----------
Earnings (loss) before amortization and write-down of
goodwill......................................... (8,424) (54,950) (48,334) 15,782 10,221
Amortization of goodwill............................... -- -- 38,021 31,076 297
Write-down of goodwill................................. -- -- 222,169 -- --
---------- ---------- ---------- ---------- ----------
Net earnings (loss) for the year....................... $ (8,424) $ (54,950) $ (308,524) $ (15,294) $ 9,924
---------- ---------- ---------- ---------- ----------
Basic and diluted net earnings (loss) per share........ $ (0.13) $ (0.87) $ (5.09) $ (0.29) $ 0.25
Basic weighted average number of shares used in per
share calculations (000's)......................... 66,020 62,852 60,666 53,014 39,951
OTHER FINANCIAL DATA:
Gross research and development......................... $ 15,668 $ 17,133 $ 17,005 $ 17,601 $ 9,374
Net research and development........................... $ 12,390 $ 15,879 $ 12,782 $ 13,601 $ 6,402
Dividends per share
Class "A" shares................................... $ - $ - $ - $ - $ 0.45
Class "F" shares................................... $ - $ - $ - $ - $ 0.45
AMOUNTS UNDER U.S. GAAP
Net earnings (loss) for the year....................... $ (9,571) $ (48,201) $ (382,893) $ (29,478) $ 7,922
Basic and diluted net earnings (loss) per share........ $ (0.14) $ (0.77) $ (6.31) $ (0.56) $ 0.20
Basic weighted average number of shares used in per
share calculations (000's)......................... 66,020 62,852 60,666 53,014 39,951
Dividends per share
Class "A" shares................................... $ -- $ -- $ -- $ -- $ 0.45
Class "F" shares................................... $ -- $ -- $ -- $ -- $ 0.45
AS AT AUGUST 31,
-----------------------------------------------------------
2004 2003 2002 2001 2000
---------- ---------- ---------- ---------- ----------
(IN THOUSANDS OF US DOLLARS)
CONSOLIDATED BALANCE SHEETS DATA:
AMOUNTS UNDER CANADIAN GAAP
Cash................................................... $ 5,159 $ 5,366 $ 9,128 $ 7,729 $ 729
Short-term investments................................. 83,969 52,010 40,553 66,861 162,659
Working capital (3) ................................... 115,141 76,659 91,374 130,289 194,167
Total assets........................................... 172,791 146,254 177,926 442,577 219,723
Long-term debt (excluding current portion) ............ 332 453 564 664 16
Share capital.......................................... 521,733 492,452 489,611 429,995 198,459
Shareholders' equity................................... $ 157,327 $ 129,826 $ 165,406 $ 414,805 $ 206,994
AMOUNTS UNDER U.S. GAAP
Cash................................................... $ 5,159 $ 5,366 $ 9,128 $ 7,729 $ 729
Short-term investments................................. 83,969 52,010 40,553 66,861 162,719
Working capital (3) ................................... 117,116 78,304 91,305 129,987 194,204
Total assets........................................... 164,758 138,020 161,314 499,436 219,760
Long-term debt (excluding current portion) ............ 332 453 564 664 16
Share capital.......................................... 596,309 565,291 560,943 498,121 201,151
Shareholders' equity................................... $ 149,294 $ 121,592 $ 150,999 $ 471,117 $ 207,031
_________________________
(1) Includes inventory write-offs of nil, $4,121, $18,463, nil and nil for the
years ended August 31, 2004, 2003, 2002, 2001 and 2000, respectively, and
an unusual gain of $473 for the year ended August 31, 2003.
(2) Certain comparative figures have been reclassified to conform to the
current-year presentation.
(3) Includes 800,000 mandatorily redeemable preferred shares with a carrying
value of $543,000 as at August 31, 2000.
3
B. CAPITALIZATION AND INDEBTEDNESS
Not Applicable.
C. REASONS FOR THE OFFER AND USE OF PROCEEDS
Not Applicable.
D. RISK FACTORS
RECENT SIGNS OF MARKET STABILITY ARE NOT NECESSARILY INDICATIVE OF LONG-TERM
GROWTH. IF MARKET CONDITIONS SIGNIFICANTLY DETERIORATE OR IF OPTICAL FIBER IS
REPLACED BY ANOTHER MEDIUM AS THE PRIMARY SOLUTION FOR BANDWIDTH-INTENSIVE
APPLICATIONS, DEMAND FOR OUR PRODUCTS MAY DECREASE, WHICH COULD HAVE A MATERIAL
ADVERSE EFFECT ON OUR BUSINESS, RESULTS OF OPERATIONS AND FINANCIAL CONDITION.
Notwithstanding recent signs of market stability and generally increasing demand
for our products, average selling prices may decline and revenue and
profitability targets are subject to uncertainty and variability. Any downturn
in our markets or in general economic conditions, additional bankruptcies and
decreased capital expenditures, or if optical fiber is replaced by a
higher-performance medium, would result in a reduction in demand for our
products as well as low visibility, and could harm our consolidated financial
condition, results of operations, cash flows and stock price.
WE HAVE ADOPTED MEASURES AND MAY ADOPT ADDITIONAL MEASURES THAT ALIGN OUR COST
STRUCTURE TO EXISTING MARKET CONDITIONS. IF DEPRESSED MARKET CONDITIONS RETURN,
IT COULD HAVE MATERIAL ADVERSE LONG-TERM EFFECTS ON OUR BUSINESS, RESULTS OF
OPERATIONS AND FINANCIAL CONDITION.
In June 2001, we re-aligned our cost structure to market conditions by
implementing various measures including postponement of plans to build a new
facility in the Quebec Metro High-Tech Park, termination of non-core operations
at a subsidiary that specialized in manufacturing fiber-optic temperature
sensors, and a 15% workforce reduction. In December 2001, we announced the
lowering of our operating expenses, a freeze in employee salaries, and the
further reduction of our workforce by 10%.
In May 2002, we reduced our global workforce by an additional 20% and
definitively cancelled our plans to build the new facility in the Quebec Metro
High-Tech Park. In June 2003, we further reduced our workforce by 30%,
streamlined the number of our production facilities and exited the optical
component manufacturing automation business.
At the end of fiscal 2003, we reorganized our business under two divisions -
Telecom Division and Photonics and Life Sciences Division - to better serve our
diverse customer base and maximize shareholder value. Later in the fiscal year,
we approved a restructuring plan to consolidate EXFO Burleigh's operations,
transferring them mainly to EXFO Photonic Solutions' facilities in Toronto. The
consolidation process started in August 2004 and should extend into the first
two quarters of fiscal 2005.
4
These and, if needed, subsequent measures could have material adverse, long-term
effects on our business, results of operations and financial condition if we
deplete our pool of highly qualified personnel or are unable to retain key
personnel; if we are unable to sustain sufficient research and development
efforts for the launch of new products; if we are unable to meet the needs of
our customers; if we are incapable of ramping up manufacturing when market
conditions improve; and if we do not ensure a smooth transition in the
consolidation of our operations. In addition, if we fail to adopt and implement
adequate and pertinent measures on a timely basis to align our cost structure to
further possibly declining market conditions, it could have a material adverse
long-term effect on our business, results of operations and financial condition.
WE MAY MAKE MISJUDGMENTS IN OUR STRATEGIC PLANNING THAT COULD HAVE MATERIAL
ADVERSE EFFECTS ON OUR BUSINESS, RESULTS OF OPERATIONS AND FINANCIAL CONDITION.
We devise a strategic business plan on an annual basis and review it Quarterly
that is based on market research and analysis update relating to future market
trends and demands. In our strategic plans, we have made, and will continue to
make, judgments based on our analysis of future market trends and demands which
may involve, for example, substantial investments by us in the development of
new product lines or the diversification of our activities, either organically
or through acquisitions. These strategies involve numerous risks, including:
o Unanticipated costs or liabilities;
o Diversion of management's attention from our core business; and
o Risks associated with entering markets in which we have no or limited
prior experience.
FLUCTUATIONS IN THE EXCHANGE RATES BETWEEN THE CANADIAN DOLLAR, US DOLLAR AND
OTHER CURRENCIES MAY ADVERSELY AFFECT OUR OPERATING RESULTS.
Most of our sales are denominated in currencies other than the Canadian dollar
(principally US dollars and Euros). However, a large portion of our operating
expenses and capital expenditures are denominated in Canadian dollars. As a
result, even though we manage at some extent our exposure to currency risk with
forward exchange contract, we are exposed to fluctuations in the exchange rates
between the Canadian dollar on the one hand and the US dollar and the Euro on
the other. As of December 31, 2004, the Canadian dollar increased approximately
7% versus the US dollar and less then 0.1% versus the Euro, compared to December
31, 2003. Any increase in the value of the Canadian dollar relative to other
currencies, especially the US dollar, could have a material adverse effect on
our operating results and provide strategic advantages to our competitors.
WE MUST CONTINUE TO OVERCOME SIGNIFICANT COMPETITION IN OUR TARGETED INDUSTRIES
IN ORDER TO GAIN MARKET SHARE AND ACHIEVE OUR GROWTH STRATEGY.
The market for our primary business activity, designing, manufacturing and
marketing telecommunications test and measurement equipment, is rapidly evolving
and is marked by intense competition and technical innovation. Likewise, the
market for our selected photonics and life sciences solutions is very
competitive. We anticipate the pace of change will accelerate for our targeted
industries in the future. We expect new competitors to emerge or current
competitors to consolidate, as the markets for telecommunications test and
measurement equipment as well as for photonics and life sciences solutions
evolve in response to technical innovations and economic conditions. Our key
performance indicator of 20% sales growth in fiscal 2005 largely depends on our
ability to gain market share by increasing sales of current
5
products to existing accounts, expending into new accounts, introducing new
products and product enhancements, and exploiting new markets opportunities.
In fiscal 2002 and 2003, we acquired technologies that enabled us to expand into
protocol testing and, thereby, doubled the addressable market for our Telecom
Division. This new market brings additional competition. Moreover, our
competitors may have more experience operating in this market and be better
established with customers in this sector.
Some of our current and potential competitors are test and measurement
manufacturers who complement their broad range of products with
telecommunications test and measurement equipment. Major competitors, such as
Acterna Corporation, Agilent Technologies Inc., ANDO Corporation, Anritsu
Corporation, IXIA, NetTest, Sunrise Telecom Inc. and Tektronix, Inc., may have
greater financial, technical and/or marketing resources than us. Consequently,
these competitors may be able to devote greater resources to the development,
marketing, manufacturing, selling and support of their products.
They also may be better positioned than we are to acquire companies and new
technologies that would potentially displace our products or render them
obsolete. We cannot predict whether current or future competitors will develop
or market products that offer higher performance, more features, or are more
cost-effective than our current or future products. To remain competitive and
achieve our growth strategy, we must increase our sales and develop
cost-effective products and product enhancements that offer higher performance
and more functionality, in current and new sectors, so that we can increase our
market share. Our failure to do so may harm our business, results of operations
and financial condition.
IF WE ARE UNABLE TO ADAPT TO CURRENT AND FUTURE CHANGES IN TECHNOLOGY OR IF WE
ARE UNABLE TO INTRODUCE NEW AND ENHANCED PRODUCTS ON A TIMELY BASIS, OUR
PRODUCTS MAY BECOME OBSOLETE, WHICH COULD PREVENT US FROM ACHIEVING OUR GROWTH
STRATEGY AND ADVERSELY AFFECT OUR OPERATING RESULTS.
The industries that we target are characterized by rapidly evolving technology
and industry standards that result in frequent new product introductions. Any
failure by us to anticipate or respond to new technological developments,
customer requirements or evolving standards could have a material adverse effect
on our business, results of operations and financial condition. The development
of proprietary technology entails significant technical and business risks and
requires substantial expenditures and lead-time. The success of our new product
introductions will depend on several factors, including our ability to:
o Properly identify customer needs;
o Innovate and develop new products;
o Gain timely market acceptance for new products;
o Manufacture and deliver our new products on time and in sufficient
volume;
o Price our products competitively;
o Continue investing in our research and development program; and
o Anticipate competitors' announcements of new products.
Failure to do the above could be exploited by our competitors. If we lose market
share as a result of lapses in our product development, our business would
suffer.
6
OUR PRODUCTS MAY HAVE UNFORESEEN DEFECTS THAT COULD HARM OUR REPUTATION, IMPEDE
MARKET ACCEPTANCE OF OUR PRODUCTS AND NEGATIVELY IMPACT OUR BUSINESS, RESULTS OF
OPERATIONS AND FINANCIAL CONDITION.
As a result of their complexity, our products may contain undetected software or
hardware defects, inaccurate calibration or compatibility problems or regulatory
compliance issues, particularly when they are first introduced or when new
versions are released. There can be no assurance that, despite our testing,
defects will not be found in new products after they have been fully deployed
and operated under peak stress conditions or that customized products meet
customer sign-off acceptance requirements. If we are unable to fix defects or
other problems or meet custom requirements, we could experience, among other
things:
o Costly repairs;
o Product returns or recalls;
o Damage to our brand reputation;
o Loss of customers, failure to attract new customers or achieve market
acceptance;
o Diversion of development and engineering resources;
o Legal actions by our customers, including claims for consequential
damages and loss of profits; and
o Legal actions by governmental entities, including actions to impose
product recalls and/or forfeitures.
The occurrence of any one or more of the foregoing could seriously harm our
business, results of operations and financial condition.
WE CANNOT ASSURE YOU THAT WE WILL SUCCESSFULLY INTEGRATE THE BUSINESSES,
PRODUCTS, TECHNOLOGIES OR PERSONNEL OF OUR PAST AND FUTURE ACQUISITIONS, WHICH
MAY HARM OUR BUSINESS.
Mergers and acquisitions of high-technology businesses are inherently risky. For
our past and future transactions to be successful, we must appropriately
integrate the businesses, products, technologies and personnel already acquired
as well as those of any future acquisitions--with our own business, product
portfolios and personnel--in a manner that anticipates or responds to new
technological developments and customer requirements on a timely basis. In
addition, we must coordinate the operations and product portfolios of newly
acquired companies with our own and manage all aspects of geographically
dispersed operations. Integration requires the dedication of management
resources, which may distract their attention from our day-to-day business and
operations. If we fail to integrate the companies quickly and efficiently, we
may not be able to realize the benefits end synergies that we expect from these
transactions and may be required to shut down, rationalize or exit such
activities.
We cannot guarantee that any past or future acquisition will achieve anticipated
net sales and profits. In May 2002, as part of our review of financial results
and due to the continued downturn in the telecommunications industry, the
persisting unfavorable market conditions affecting our subsidiaries' industries,
and the decline in technology valuations, we performed an assessment of the
carrying value of goodwill and intangible assets recorded in conjunction with
the acquisitions of EXFO Burleigh, EXFO Photonic Solutions and EXFO Protocol. We
concluded that the carrying value of goodwill and certain acquired intangible
assets was impaired and we recorded a US$222.2 million write-down of goodwill
and a US$23.7 million write-down of acquired core technology, which had a
negative impact on our reported earnings.
7
In May 2003, we carried out a similar assessment, resulting in an impairment
charge of US$4.5 million for goodwill and US$2.9 million for acquired core
technology. Further write-downs may be necessary in the future.
All of these factors could materially harm our business, results of operations
and financial condition.
WE MAY NOT BE ABLE TO MAKE THE NECESSARY ACQUISITIONS NEEDED FOR THE DEVELOPMENT
OF OUR BUSINESS AND ANY ACQUISITION WE MAKE COULD DISRUPT OUR BUSINESS AND HARM
OUR FINANCIAL CONDITION.
We intend to seek acquisitions of businesses, products and technologies that are
complementary to ours or that will expand our markets. There can be no assurance
that we will ultimately make any such acquisition. The consolidation of our
competitors may improve their capacity to acquire the same businesses, products
and technologies that we wish to acquire. In addition, our fluctuating stock
price or our cash position at the time of an acquisition may affect our ability
to complete such acquisition.
We have made strategic acquisitions in the past and we intend to continue making
acquisitions of businesses, products and technologies as part of our overall
growth strategy. In the event of any future acquisition, we could:
o Issue shares that would dilute individual shareholder percentage
ownership;
o Incur debt;
o Assume liabilities and commitments;
o Incur expenses related to amortization of additional intangible assets;
and
o Incur significant impairment losses of goodwill and intangible assets
related to such acquisitions.
These acquisitions also involve numerous risks, including:
o Problems combining the acquired operations, technologies, products and
personnel;
o Risks associated with the transfer of acquired know-how and technology;
o Unanticipated costs or liabilities;
o Diversion of management's attention from our core business;
o Adverse effects on existing business relationships with suppliers and
customers;
o Risks associated with entering markets in which we have no or limited
prior experience; and
o Potential loss of key employees, particularly those of acquired
organizations.
IF WE FAIL TO ADAPT APPROPRIATELY TO THE CHALLENGES ASSOCIATED WITH OPERATING
INTERNATIONALLY, THE EXPECTED GROWTH OF OUR BUSINESS MAY BE IMPEDED AND OUR
OPERATING RESULTS MAY BE AFFECTED.
For the fiscal year ended August 31, 2004, customers outside of the United
States and Canada accounted for 39% of our sales and for the fifteen months
ended November 30, 2004, these customers accounted for 37% of our sales. Our
international sales will be limited if we cannot establish relationships with
international distributors, set up additional foreign operations, expand
international sales channel management, hire additional personnel, develop
relationships with international service providers and operate adequate
after-sales support internationally. Even if we are able to successfully
continue our international operations, we may
8
not be able to maintain or increase international market demand for our
products. Our international operations are subject to a number of risks,
including:
o Challenges in staffing and managing foreign operations due to the
limited number of qualified candidates, employment laws and practices
in foreign countries, any of which could increase the cost and reduce
the efficiency of operating in foreign countries;
o Our ability to comply with customs, import/export and other trade
compliance regulations of the countries in which we do business,
together with unexpected changes in such regulations;
o Difficulties in establishing and enforcing our intellectual property
rights;
o Tariffs and other trade barriers;
o Economic instability in foreign markets;
o Wars, acts of terrorism and political unrest;
o Language and cultural barriers;
o Integration of foreign operations;
o Currency fluctuations;
o Potential foreign and domestic tax consequences;
o Technology standards that differ from those on which our products are
based, which could require expensive redesign and retention of
personnel familiar with those standards;
o Longer accounts receivable payment cycles and possible difficulties in
collecting payments which, may increase our operating costs and hurt
our financial performance; and
o Certification requirements.
Any of these factors could harm our international operations and negatively
affect our business, results of operations and financial condition. The
recurrence of weakness in these economies or of weakness in other foreign
economies could have a significant negative effect on our future operating
results.
OUR PRODUCTS MAY BE REQUIRED TO CONFORM TO NEW AND UNFORESEEN REGULATORY
REQUIREMENTS THAT COULD INCREASE OUR COSTS AND REDUCE OUR MARKET SHARE.
Our products are designed to conform to the regulatory requirements of the
countries in which they are marketed. In the event that the technical
regulations applicable in a given country are in any way changed, we may be
required to modify, redesign or recall some or all of our products in order to
continue participating in that market. These changes may prove costly and
time-consuming and could create technical advantages for products marketed by
our competitors. We cannot assure that our products will continue to meet
evolving standards in the future. In addition, failure to comply or delays in
compliance with such regulatory requirements, or delays in receipt of
certifications, could delay the introduction of new products or cause our
existing products to become obsolete. We are also subject to environmental
statutes and regulations. We might not be able to adopt our products in a timely
matter to fully comply with all environmental requirements.
RECENTLY ENACTED AND PROPOSED REGULATORY CHANGES WILL CAUSE US TO INCUR
INCREASED COSTS.
Recently enacted and proposed changes in the laws and regulations affecting
public companies, including the provisions of the Sarbanes-Oxley Act of 2002,
will increase our expenses as we evaluate the implications of new rules and
devote resources to respond to
9
these new requirements. In particular, we expect to incur additional selling and
general administrative expenses as we implement Section 404 of the
Sarbanes-Oxley Act, which requires management to report on, and our independent
registered public accounting firm to attest to, our internal controls.
Compliance with these new rules could also result in continued diversion of
management's time and attention, which could prove to be disruptive to normal
business operations. Furthermore, the impact of these events could make it more
difficult for us to attract and retain qualified persons to serve on our Board
of Directors or as executive officers, which could harm our business.
We are currently performing the system and process evaluation required to ensure
compliance as of August 31, 2005 with the management certification and auditors'
attestation requirements of Section 404 of the Sarbanes-Oxley Act. While we
currently anticipate that we will complete all such actions on time and
according to rules, we cannot at this time provide absolute assurance that all
such actions will be timely completed and in compliance with rules, with the
possible consequence that our auditors may not be able to provide a clean
attestation report under Rule 404 of the Securities Exchange Act of 1934, as
amended.
IF CUSTOMERS FAIL TO MEET THEIR FINANCIAL COMMITMENTS TO US, IT COULD HAVE A
MATERIAL ADVERSE EFFECT ON OUR BUSINESS, RESULTS OF OPERATIONS AND FINANCIAL
CONDITION.
Some of our customers have experienced, or may experience, cash flow problems.
Consequently, we may have customers who delay payments or may not be able to
meet their financial commitments to us. Furthermore, they may not order as many
products from us as originally forecasted or they may cancel their orders
outright. The failure of customers to order products would result in decreased
revenues for us. We attempt to reduce the possibility of large outstanding bills
remaining unpaid by carrying out credit checks on customers and by having a
diversified customer base. For example, no customer represented more than 13.8%
of our sales in fiscal 2004. However, there is no assurance that such measures
will reduce our exposure to customer credit risks. If customers fail to meet
their financial commitments to us, it could have a material adverse effect on
our business, results of operations and financial condition.
WE HAVE FACED PRICING PRESSURE ON OUR EXISTING PRODUCTS AND EXPECT THAT THIS
PRESSURE WILL CONTINUE. IF WE DO NOT CONTROL OUR MANUFACTURING COSTS OR
INTRODUCE NEW PRODUCTS WITH HIGHER MARGINS, OUR GROSS MARGINS MAY DECREASE AND
OUR OPERATING RESULTS MAY BE ADVERSELY AFFECTED.
We implemented several measures to improve our gross margin to 53.7% of total
sales in fiscal 2004. However, increased competitiveness in the
telecommunications test and measurement industry will likely result in
continuing downward pressure on average selling prices, which may in turn
negatively affect our gross margins. Pricing pressure can result from a number
of factors such as:
o Increased competition for business;
o Reduced demand;
o Limited number of potential customers;
o Competition from companies with lower production costs, including
companies operating in lower cost environments;
o Introduction of new products by competitors;
o Greater economies of scale for higher-volume competitors;
o Resale of used equipment; and
o Equipment sales resulting from manufacturing and rental company
bankruptcies.
10
In addition, gross margins may also be negatively affected by increased costs of
raw materials as well as obsolescence and excess costs in product mix and
under-absorption of fixed manufacturing costs.
As pricing pressure will likely continue to affect our existing products, we may
have to increase the number of units sold to maintain our existing sales levels.
If we are unable to increase our sales levels, lower our manufacturing costs, or
introduce new products with higher margins, our gross margins may decline and
our operating results may suffer.
OUR QUARTERLY REVENUES AND OPERATING RESULTS ARE SUBJECT TO SIGNIFICANT
FLUCTUATIONS AND YOU SHOULD NOT RELY ON THEM AS AN INDICATION OF OUR FUTURE
PERFORMANCE.
Our sales and operating results have fluctuated from quarter to quarter in the
past and significant fluctuations may occur in the future. In addition, our
sales and operating results generally depend on the volume and timing of the
orders we receive from customers as well as our ability to fulfill received
orders. Our operating expenses, which include research and development, selling
and administrative, and amortization expenses, are relatively fixed in the short
term. If we sell fewer products than anticipated, if there is a delay in the
launch of new products, or if prices for our products decline, we may not be
able to quickly reduce our operating expenses in response to lower sales.
Factors that could affect the amount and timing of our sales, and cause
quarterly fluctuations in our revenue and operating results include:
o Length of the product sales cycle for certain products, especially
those that are higher priced and more complex;
o Timing of the introduction and market acceptance of new products by us
as well as our competitors;
o Our ability to sustain product volumes and high levels of quality
across all product lines;
o Timing of shipments for large orders;
o Effect of potential seasonality in sales; and
o Loosing key accounts and not successfully develop new ones.
Our sales and operating results could also be affected by the following factors,
some of which we have little or no control over:
o Fluctuating demand for telecommunications test and measurement
equipment as well as photonics and life sciences solutions;
o Changes in the capital spending and operating budgets of our customers,
which may cause seasonal or other fluctuations in product mix, volume,
timing and number of orders we receive from our customers;
o Order cancellations or rescheduled delivery dates;
o Pricing changes by our competitors or suppliers;
o Customer bankruptcies and difficulties in collecting accounts
receivable;
o Level of used telecommunications test and measurement equipment
available for resale;
o Restructuring and impairment charges; and
o General economic conditions.
In addition, we may in the future choose to reduce prices, increase spending, or
modify our product portfolio in response to actions by competitors or as an
effort to pursue new market opportunities. These actions may also adversely
affect our business and operating results and may cause our quarterly results to
be lower than the results of previous quarters. Due to these
11
factors, you should not rely on quarter-to-quarter comparisons of our results of
operations as an indication of our future performance.
AS OUR CUSTOMERS CONSOLIDATE, THEY MAY REDUCE OR HALT PURCHASES OF OUR PRODUCTS,
WHICH WOULD HARM OUR SALES AND OPERATING RESULTS.
Consolidation in the telecommunications industry could reduce the number of
customers to whom our products are sold. Some of our customers have been subject
to consolidation and could obtain products from a vendor other than us, or
demand more favorable terms and conditions from us, which would harm our sales
and operating results. In addition, some customers may merge with or acquire our
competitors and discontinue their relationships with us.
WE DEVOTE CONSIDERABLE TIME AND RESOURCES TO SECURING NEW CUSTOMERS AND
IMPROVING SALES TO EXISTING CUSTOMERS. IF WE ARE UNSUCCESSFUL, OUR FUTURE
OPERATING RESULTS MAY SUFFER.
The long sales cycle for some of our products may cause our sales and operating
results to vary significantly from period to period. Many of our products are
complex, and customers for these products may require substantial time to make
purchase decisions. Some customers perform exhaustive evaluations and testing of
new instruments--and require us to carry out extensive product
demonstrations--before purchasing them. The period of time between our initial
contact with a customer and the receipt of a purchase order may span a year or
more. If we are unable to satisfy customer demands, considerable resources would
have been expended without deriving corresponding sales. In addition, some of
our customers and potential customers require that a bidding process be followed
or that our products be pre-approved. Both of these situations involve inherent
risks over which we have little control; for example, missing the approval
opportunity or deploying an unsuccessful pricing strategy.
OUR CUSTOMERS ARE NOT OBLIGATED TO BUY MATERIAL AMOUNTS OF OUR PRODUCTS AND MAY
CANCEL OR DEFER PURCHASES ON SHORT NOTICE.
Our customers typically purchase our products under individual purchase orders
and may cancel or defer purchases on short notice without significant penalties.
Accordingly, sales for a particular period are difficult to predict. Decreases
in purchases, cancellations of purchase orders, or deferrals of purchases may
have a material adverse effect on our operating results, particularly if we do
not anticipate them.
IF WE FAIL TO PREDICT OUR SUPPLY REQUIREMENTS ACCURATELY, WE WILL HAVE EXCESS
INVENTORY OR INSUFFICIENT INVENTORY, EITHER OF WHICH COULD CAUSE US TO INCUR
ADDITIONAL COSTS AND/OR EXPERIENCE MANUFACTURING DELAYS.
We provide non-binding forecasts of our requirements to some of our suppliers up
to six months prior to scheduled delivery of products to our customers. If we
overestimate our forecasted requirements, we may have excess inventory, which
could harm our relationships with our suppliers due to reduced future orders,
increase our costs and require inventory write-offs. In the fiscal year ended
August 31, 2002, we recorded inventory write-offs totaling US$18.5 million for
excess and obsolete inventories. We recorded an additional US$4.1 million for
excess and obsolete inventories in fiscal 2003. If we underestimate our
requirements, we may have an inadequate inventory of parts, which could
interrupt manufacturing of our products and result in shipment delays. In
addition, lead times for materials and parts that we order may be long and
12
depend on factors such as the procedures of, or supply terms with, a specific
supplier and demand for each part at a given time.
WE DEPEND ON A SINGLE SUPPLIER OR A LIMITED NUMBER OF SUPPLIERS FOR SOME KEY
COMPONENTS AND MATERIALS IN OUR PRODUCTS, WHICH MAKES US SUSCEPTIBLE TO SUPPLY
SHORTAGES OR PRICE FLUCTUATIONS THAT COULD ADVERSELY AFFECT OUR OPERATING
RESULTS.
We depend on a limited number of suppliers for some of the parts used to
manufacture our products for which alternative sources may not be readily
available. In addition, all our orders are placed through individual purchase
orders and, therefore, our suppliers may stop supplying parts to us at any time.
The reliance on a single source or limited number of suppliers could result in
increased costs, delivery problems and reduced control over product pricing and
quality. Financial difficulties of suppliers could also affect our ability to
obtain necessary parts in a timely manner. Any interruption or delay in the
supply of any of these parts could significantly harm our ability to meet
scheduled product deliveries to our customers and cause us to lose sales.
Furthermore, the process of qualifying a new manufacturer for complex parts,
designed to our specifications, such as our optical and mechanical parts, is
lengthy and would consume a substantial amount of time of our technical
personnel and management. If we were required to change manufacturers in a short
period of time, our business would be disrupted. In addition, we may be
unsuccessful in identifying a new manufacturer capable of meeting and willing to
meet our needs on terms that we would find acceptable. Consolidation involving
suppliers could further reduce the number of alternatives available to us and
affect the cost of parts, which would make our products less competitive and
result in lower margins.
WE ARE SUBJECT TO LAWS, REGULATIONS AND CONTRACTUAL OBLIGATIONS AND REQUIREMENTS
RELATING TO OUR CUSTOMER CONTRACTS, AND OUR FAILURE TO ADDRESS THESE LAWS,
REGULATIONS, OBLIGATIONS AND REQUIREMENTS OR COMPLY THEREWITH COULD HARM OUR
BUSINESS.
We have agreements relating to the sale of our products to our customers and, as
a result, we are subject to various statutes and regulations and contractual
obligations and requirements. We are also subject to environmental statutes and
regulations. We may also be subject to investigation for compliance with such
statutes, regulations, obligations and requirements. Any failure to comply
therewith could harm our business.
THE PRICE OF OUR SECURITIES IS VOLATILE AND MAY DECLINE.
The market price of our securities has been, and is likely in the future to be,
subject to substantial and rapid fluctuations. Such fluctuations may be due to
factors specific to us, such as changes in our operating results or new product
introductions, or caused by our competitors, changes in analysts' ratings, or
the liquidity of our stock. Fluctuations in stock price may also be due to
factors related to the global telecommunications industry or the securities
markets in general. These fluctuations have often been unrelated or
disproportionate to the operating performance of the specific companies whose
stocks are traded. These broad market and industry factors may have a material
adverse effect on the market price of our securities, regardless of our actual
operating performance. Shareholders should be willing to incur the risk of such
fluctuations.
13
WE REQUIRE EMPLOYEES WHO ARE KNOWLEDGEABLE ABOUT THE SPECIALIZED NATURE OF OUR
BUSINESS. IF WE ARE UNABLE TO ATTRACT AND RETAIN SUFFICIENT NUMBERS OF HIGHLY
SKILLED TECHNICAL, SALES, MARKETING, SENIOR MANAGEMENT AND OTHER PERSONNEL, OUR
OPERATIONS AND FINANCIAL RESULTS WILL SUFFER.
Due to the specialized nature of our business, we are highly dependent on the
continued service of and on the ability to attract qualified engineering, sales,
marketing, senior management and other personnel. If we are unable to attract
and retain such qualified personnel, it could have a material adverse effect on
our business, results of operations and financial condition.
We must also provide significant training for our employee base due to the
highly specialized nature of telecommunications test and measurement as well as
photonics and life sciences technologies. Our current personnel may be
inadequate and we may fail to assimilate and train new employees. Highly skilled
employees with the education and training that we require--especially employees
with significant experience and expertise, international business development,
product management, sales, engineering and operation--may be difficult to find.
Once trained, our employees may also be hired by our competitors or leave the
organization.
OUR BUSINESS STRATEGY AND ABILITY TO MAINTAIN OUR COMPETITIVE POSITION DEPEND ON
THE CONTINUED SERVICES OF GERMAIN LAMONDE, OUR CHAIRMAN OF THE BOARD, PRESIDENT
AND CHIEF EXECUTIVE OFFICER. HIS LOSS COULD ADVERSELY AFFECT OUR BUSINESS.
Our ability to maintain our competitive position depends to a significant extent
on the efforts and abilities of Germain Lamonde, our Chairman of the Board,
President and Chief Executive Officer. His managerial, technical and other
services could be difficult to replace. We do not have "key person" life
insurance policies covering any employee.
OUR INTELLECTUAL PROPERTY AND PROPRIETARY TECHNOLOGY ARE IMPORTANT TO THE
CONTINUED SUCCESS OF OUR BUSINESS. OUR FAILURE TO PROTECT THIS PROPRIETARY
TECHNOLOGY MAY SIGNIFICANTLY IMPAIR OUR COMPETITIVE POSITION.
Our success and ability to compete depend to a significant extent on our
proprietary technology, since that is how we attempt to keep others from using
the innovations that are central to our existing and future products. We
currently hold 28 U.S., 5 Canadian and 6 European-issued patents and have 10
U.S., 14 Canadian and 3 European patent applications pending, along with 2
patent applications pending under the Patent Cooperation Treaty. We also rely on
a combination of copyright and trademark laws, trade secrets, confidentiality
procedures, contractual provisions and license agreements to protect our
proprietary technology. We may have to engage in litigation in order to protect
our patents and other intellectual property rights, or to determine the validity
or scope of the proprietary rights of others. This kind of litigation can be
time-consuming and expensive, regardless of whether we win or lose. Because it
is critical to our success that we are able to prevent competitors from copying
our innovations, we intend to continue to seek patent and trade secret
protection for our technologies.
The process of seeking patent protection can be long and expensive and we cannot
be certain that any currently pending or future applications will actually
result in issued patents, or that, even if patents are issued, they will be of
sufficient scope or strength to provide meaningful protection or any commercial
advantage to us. We also rely on trade secret protection for our technology, in
part through confidentiality agreements with our employees, consultants,
distributors and third parties. However, these agreements may be breached or
otherwise not
14
effective and we may not have adequate remedies for any breach or shortfall of
these agreements. In any case, others may come to know about our trade secrets
through a variety of methods. In addition, the laws of some territories in which
we sell our products may not protect our intellectual property rights to the
same extent as do the laws of Canada and the United States.
Despite our efforts, our intellectual property rights, particularly our existing
or future patents, may be invalidated, circumvented, challenged or required to
be licensed to others. Furthermore, others may develop technologies that are
similar or superior to our technology, duplicate or reverse engineer our
technology, or design around the patents owned or licensed by us. We cannot be
sure that the steps that we take to protect our technology will prevent
misappropriation or infringement. If we fail to protect our technology so that
others may copy or use it, we will be less able to differentiate our products
and our sales will decline.
OTHERS MAY CLAIM THAT OUR PRODUCTS INFRINGE UPON THEIR INTELLECTUAL PROPERTY
RIGHTS, OR THEY MAY INFRINGE OUR INTELLECTUAL PROPERTY, AND WE MAY EXPEND
SIGNIFICANT RESOURCES ENFORCING OR DEFENDING OUR RIGHTS OR SUFFER COMPETITIVE
INJURY.
Litigation regarding intellectual property rights is common in the technology
industry and, for this reason, we expect that third-party infringement claims
involving technologies may increase. If an infringement claim is filed against
us, we may be prevented from using some of our technologies and may incur
significant costs to resolve the claim. Conversely, we may be required to spend
significant resources to monitor and police our intellectual property rights.
We could incur substantial costs in defending ourselves and our customers
against infringement claims or in bringing infringement claims against others.
Litigation could also adversely affect sales of the challenged product or
technology and divert the efforts of our management and technical personnel. In
the event of an infringement claim, we may be required to obtain one or more
licenses from third parties. We cannot assure you that we, or our customers,
could obtain necessary licenses from third parties at a reasonable cost or at
all. If we fail to obtain a license where one is required, we could incur
substantial liabilities and be forced to suspend the marketing of the challenged
products.
OUR INSURANCE MAY NOT BE SUFFICIENT TO COVER ALL POTENTIAL LIABILITY. A
SUCCESSFUL CLAIM EXCEEDING OUR POLICY LIMITS WILL REDUCE OUR CASH POSITION,
INCREASE OUR EXPENSES AND HAVE A NEGATIVE EFFECT ON OUR BUSINESS, OPERATING
RESULTS AND FINANCIAL CONDITION.
Our products are designed to help network service providers and manufacturers of
optical networks and components ensure network reliability. We also leverage our
core telecom technologies for high-precision assembly and life sciences
applications. The failure of our products to perform to client expectations
could give rise to product liability and warranty claims. We carry insurance for
product liability and take accounting reserves for warranty claims that we
consider adequate in view of industry practice.
In addition, we may face other types of claims by third parties in relation to
the conduct of our business; a successful claim against us for an amount
exceeding our policy limits would force us to use our own resources to pay the
claim, which could result in a reduction of our cash available for other uses,
increase our expenses and have a negative effect on our business, results of
operations and financial condition.
15
WE MAY BECOME INVOLVED IN COSTLY AND TIME-CONSUMING LITIGATION THAT MAY
SUBSTANTIALLY INCREASE OUR COSTS AND HARM OUR BUSINESS.
We may from time to time become involved in various lawsuits and legal
proceedings. For example, EXFO is a defendant in a putative securities class
action filed in the United States District Court for the Southern District of
New York involving approximately 300 other issuing companies. Litigation is
subject to inherent uncertainties, and an adverse result in these or other
matters that may arise from time to time could have a material adverse effect on
our business, results of operations or financial condition. Any litigation to
which we are subject could require significant involvement of our senior
management and may divert management attention from our business and operations.
IF WE SUFFER LOSS TO OUR FACTORIES OR FACILITIES, OUR OPERATIONS COULD BE
SERIOUSLY HARMED.
Our factories and facilities are subject to catastrophic loss due to fire,
vandalism, terrorism or other natural or man-made disasters. We do not have
redundant multiple site capacity and if any of our facilities or factories were
to experience a catastrophic loss, it would disrupt our operations, delay
production, shipments and revenue and result in large expenses, thereby harming
our results of operation.
UNEXPECTED DECLINES IN OUR RESEARCH AND DEVELOPMENT AND OTHER TAX CREDITS AND
GRANTS MAY HAVE AN ADVERSE EFFECT ON OUR BUSINESS.
Our historical operating results reflect substantial benefits from programs
sponsored by federal and provincial governments for the support of research and
development activities, as well as in relation to other activities. For example,
research and development tax credits and grants represented 21% of our gross
research and development expenses for the year ended August 31, 2004 and 22% for
the fifteen months ended November 30, 2004.
If unexpected changes in the laws or government policies terminate or adversely
modify the Canadian and Quebec government programs, under which we receive the
majority of our research and development and other tax credits and grants, or if
we unexpectedly become unable to participate in or take advantage of these
programs, then our net research and development and other expenses will
materially increase or we may decrease our research and development activities.
In addition, to the extent that we increase our research and development
activities outside Canada or Quebec, which could result from, among other
things, future acquisitions, the increased activities may not be eligible for
these programs. If we were required to decrease our research and development
activities, or were unable to benefit from other tax credits and grants, this
could have a material adverse effect on our business, results of operations and
financial condition.
OUR CURRENT PRINCIPAL STOCKHOLDER HAS EFFECTIVE CONTROL OVER OUR BUSINESS.
As of December 31, 2004, Germain Lamonde, our Chairman of the Board, President
and Chief Executive Officer, held approximately 55.4% of the voting rights in
our stock. By virtue of such stock ownership, Mr. Lamonde has effective control
over all matters submitted to our stockholders, including the election of our
directors, and exercises significant control over our policies and affairs. Such
concentration of voting power could have the effect of delaying, deterring or
preventing a change in control or other business combinations that might
otherwise be beneficial to our stockholders.
16
WE MAY NEED ADDITIONAL CAPITAL, AND MAY NOT BE ABLE TO RAISE ADDITIONAL CAPITAL
ON FAVORABLE TERMS OR AT ALL, WHICH COULD LIMIT OUR ABILITY TO GROW AND COULD
INCREASE OUR COSTS.
Our future liquidity and capital requirements are difficult to predict because
they depend on numerous factors, including the success of our existing and new
product offerings as well as competing technological and market developments. As
a result, we may not be able to generate sufficient cash from our operations to
meet additional working capital requirements, support additional capital
expenditures or take advantage of acquisition opportunities. Accordingly, we may
need to raise additional capital in the future.
Our ability to obtain additional financing will be subject to a number of
factors, including market conditions and our operating performance. These
factors may render the timing, amount, terms and conditions of additional
financing unattractive for us. If we raise additional funds by selling equity
securities, the relative ownership of our existing investors could be diluted or
the new investors could obtain terms more favorable than previous investors. In
February 2004, we closed a public offering of 5.2 million subordinate voting
shares to a syndicate of Canadian-based underwriters for net proceeds of US$29.2
million. If we raise funds through debt financing, we could incur significant
borrowing costs. If we are unable to raise additional funds when needed or at
terms satisfactory to us, our ability to operate and grow our business could be
impeded.
OUR BUSINESS AND OPERATIONS WOULD SUFFER IN THE EVENT OF A FAILURE OF OUR
INFORMATION TECHNOLOGY INFRASTRUCTURE.
We rely upon the capacity, efficiency and security of our information technology
hardware and software infrastructures as well as our ability to expand and
update these infrastructures in response to our evolving needs. Any failure to
manage, expand or update our information technology infrastructures or any
failure in the operation of this infrastructure could harm our business.
Despite implementing security measures, our information systems are vulnerable
to damages from computer viruses, natural disasters, unauthorized access and
other similar disruptions. Any system failure, accident or security breach could
result in disruptions to our operations. To the extent that any disruption or
security breach results in a loss or damage to our data, or inappropriate
disclosure of our confidential information, it could harm our business. In
addition, these events may force us to devote more money and resources in order
to protect ourselves against damages caused by these disruptions or security
breaches in the future.
17
ITEM 4. INFORMATION ON THE COMPANY
A. HISTORY AND DEVELOPMENT OF THE COMPANY
Our legal name and commercial name is EXFO Electro-Optical Engineering
Inc. /EXFO Ingenierie electro-optique inc. Our head office is located at 400
Godin Avenue, Vanier, Quebec, Canada, G1M 2K2 and our main telephone number is
(418) 683-0211. Our e-mail address is info@exfo.com and our Web site is
www.exfo.com. Information on our Web site is not incorporated by reference in
this annual report. Our agent for service in the United States is CT Corporation
System, 111 Eighth Avenue, New York, New York 10011. This annual report contains
trademarks and registered trademarks of EXFO and other companies.
We were incorporated on September 18, 1985 pursuant to the CANADA
BUSINESS CORPORATIONS ACT. Since that date, we have amended our articles on
various occasions mainly to modify our corporate name and our share capital.
On December 20, 2000, we acquired all of the issued and outstanding
shares of common stock of EXFO Burleigh Products Group Inc. (formerly Burleigh
Instruments, Inc.) ("EXFO Burleigh"), Burleigh Instruments GmBH and Burleigh
Instruments (U.K.) Ltd. for an aggregate purchase price of approximately
US$189.3 million, comprised of 6,488,816 of our subordinate voting shares and
approximately US$42.5 million in cash pursuant to the terms of an Agreement of
Merger and Plan of Reorganization among us, EXFO Sub, Inc. and the selling
shareholders, dated November 4, 2000, as amended on December 20, 2000. In April
2002, the name of Burleigh Instruments, Inc. was changed to EXFO Burleigh
Products Group Inc. On November 12, 2002, Burleigh Instruments (UK) Ltd. was
dissolved.
In March 2001, we acquired all of the shares of EXFO Photonic Solutions
Inc. (formerly EFOS Inc.) ("EXFO Photonic"), a privately held company in
Toronto, Canada, for a total consideration of US$110.1 million, of which US$25.1
million was paid in cash. We also issued 3,700,000 of our subordinate voting
shares in connection with the acquisition. In September 2001, the name EFOS Inc.
was changed to EXFO Photonic Solutions Inc.
EXFO Photonic, operating since 1984, is a supplier of precision
light-based adhesive spot curing products as well as curing process control for
the global optical component manufacturing market and other non-telecom markets.
Its products deliver precise doses of the appropriate spectral light into
photo-sensitive and heat-cured adhesives to significantly reduce bonding time
and increase repeatability in optical component and other manufacturing
activities. EXFO Photonic light-based curing technologies are supported by an
extensive understanding of bonding and material sciences and by a broad
intellectual property portfolio, including, as of December 15, 2004, 14 patents
and 9 patents pending.
Also in March 2001, our wholly owned subsidiary, Burleigh Automation
Inc. ("Burleigh Automation"), acquired substantially all the assets of Vanguard
Technical Solutions, Inc., a wholly owned subsidiary of DT Industries, Inc. for
a purchase price of approximately US$600,000 paid in cash. Vanguard, an
automation equipment manufacturer in Tucson, Arizona, specialized in the design
and manufacturing of ultra-precision assembly equipment for sensitive process
and critical assembly challenges on the production floor. This acquisition,
which complemented our acquisition of Burleigh, was planned to fit with our
overall strategy at that time of providing customers with a comprehensive
solution for the assembly, alignment and testing of optical components and
subsystems. Since September 2001, Burleigh Automation
18
has ceased operations and we have transferred all material intellectual property
assets and most of the physical assets of Burleigh Automation to EXFO Burleigh.
In November 2001, we acquired all of the shares of Avantas Networks
Corporation and simultaneously changed the name of that company to EXFO Protocol
Inc. ("EXFO Protocol"). We paid a total consideration of approximately US$69.4
million (or US$95.0 million for the equity minus US$25.6 million of cash in the
hands of the acquired company) to acquire EXFO Protocol. Consideration paid
consisted of 4,374,573 of our subordinate voting shares and US$9.8 million in
cash, net of cash acquired. EXFO Protocol, a company based in Montreal, Canada
operating since 1998 is a supplier of fiber-optic testing and optical network
performance management equipment that supports a wide range of protocols and
data transmission rates.
In the fiscal year commencing September 1, 2001, we were forced to
re-align our cost structure to market conditions. First, on December 5, 2001, we
announced the lowering of our operating expenses, a freeze in employee salaries,
and the reduction of our workforce by 10%. Then, on May 15, 2002, we announced a
further 20% reduction of our global workforce in an effort to lower our cost
structure. In May 2002, we performed an assessment of the carrying value of
goodwill and intangible assets recorded in conjunction with the three
acquisitions made during the previous two years. Considering the ongoing
unfavourable market conditions, we recorded a charge of US$222.2 million to
write down a significant portion of goodwill and a charge of US$23.7 million to
write down a significant portion of acquired core technology. Also, overall for
fiscal 2002, we wrote off US$18.5 million in excess and obsolete inventories.
In August 2002, EXFO Burleigh received confirmation of the extension of
its contract with the U.S. Air Force Research Laboratory into phase 2 of a
project for the development by EXFO Burleigh of new high-precision actuator
system. The contract for phase 2 provides for an additional funding of US$1.7
million and will extend through the first quarter of 2005.
In October 2002, our newly created, wholly owned subsidiary, EXFO Gnubi
Products Group Inc. ("EXFO Gnubi"), acquired substantially all the assets of
gnubi communications L.P., including its technology, expertise, customer base,
inventories and capital assets. Consideration paid consisted of US$1.9 million
in cash and 1,479,290 of our subordinate voting shares. In addition, an
additional cash amount of US$241,000, based on sales volumes, was paid in fiscal
2004 in accordance with earn out provisions. With the acquisition of these
assets, EXFO Gnubi, based in Dallas, Texas, continues the operations of gnubi
communications, L.P., as a supplier of multi-channel telecom and datacom testing
solutions serving optical transport equipment manufacturers and research and
development laboratories. At the time of the asset acquisition, 30 employees of
gnubi communications transferred to EXFO Gnubi.
In the fiscal year ended August 31, 2003, we were required to implement
further restructuring measures as a result of depressed spending levels in the
telecommunications industry and geo-political and economic uncertainty. We
reduced our workforce by 30%, rationalized our business activities and
consolidated certain manufacturing operations. These measures incurred charges
of approximately US$4.1 million. The rationalization and consolidation
initiatives involved the reorganization of our business into two new reportable
market segments: Telecom Division and Photonics and Life Sciences Division and
the exiting of the optical component manufacturing automation business. Our
Telecom Division consists of the former Portable and Monitoring and telecom
related Industrial and Scientific product lines. Our Photonics and Life Sciences
Division includes previous non-telecom Industrial and Scientific product lines.
Each division has been structured with its own sales, marketing, manufacturing,
research and development and management teams.
19
In May 2003, we performed an annual impairment test on goodwill in
conjunction with the acquisition of EXFO Burleigh, EXFO Photonic and EXFO
Protocol and also reviewed the carrying value of intangible assets related to
these acquisitions. As a result of this assessment, we concluded that the
carrying value of goodwill related to EXFO Burleigh and the carrying value of
intangible assets related to EXFO Burleigh and EXFO Photonic was impaired and we
recorded a charge of US$4,505,000 to write down goodwill and a pre-tax charge of
US$2,922,000 to write down acquired core technology. Of the total impairment
loss of US$7,427,000, US$6,872,000 is related to EXFO Burleigh for goodwill and
acquired core technology and US$555,000 is related to EXFO Photonic for acquired
core technology.
In addition, in an effort to simplify our structure and stream-line our
operations, the operations of EXFO Protocol were merged with those of the
Corporation as of September 1, 2003 and effective December 1, 2003, the
operations of EXFO Gnubi were merged with those of EXFO America Inc.
In fiscal 2004, EXFO also closed a 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).
We also consolidated our protocol test operations (EXFO Protocol and
EXFO Gnubi) in Montreal, Canada to improve efficiency and reduce costs.
In addition, we renewed our collective bargaining agreement with
unionized manufacturing employees in Quebec City, Canada. Such agreement will
expire in February 2009.
Near the end of the fiscal year, we reached the decision to consolidate
operations of our Photonics and Life Sciences Division in order to improve its
market focus and efficiency. Consequently, we have begun transferring EXFO
Burleigh's operations mainly to Toronto. Once fully implemented, we expect to
incur restructuring and other charges of $2.7 million, of which $1.7 million was
recorded in the fourth quarter of fiscal 2004 and the remainder in 2005. We
estimate that we will derive $1.5 million in annual savings from these
streamlined operations.
B. BUSINESS OVERVIEW
COMPANY OVERVIEW
EXFO is a recognized expert in the global telecommunications industry
through the design and manufacture of advanced and innovative test and
measurement solutions. The Telecom Division, which represents our main business
activity, offers fully integrated and complete test solutions to network service
providers (NSPs), system vendors and component manufacturers in approximately 70
countries. One of our most distinctive offering is our PC/Windows-based modular
platforms that host a wide range of tests across optical, physical, data and
network layers, while maximizing technology reuse across several market
segments. The Photonics and Life Sciences Division mainly leverages core telecom
technologies to offer value-added solutions in the life sciences and
high-precision assembly sectors.
We were founded in Quebec City, Canada in 1985. Our original products
were focused on the needs of installers and operators of optical networks.
Customers use these field-testing products for the installation, maintenance,
monitoring and troubleshooting of networks. In 1996,
20
we supplemented our product portfolio with an extensive line of high-end
products that are mainly dedicated to research and development as well as
manufacturing activities.
In the last three years, we have enhanced our competitive position
through the acquisition of two protocol test businesses. In November 2001, we
acquired Avantas Networks Corporation (renamed EXFO Protocol), a supplier of
protocol testing and optical-network-performance management equipment for NSPs.
This transaction was highly strategic because it enabled us to combine optical
and protocol test modules inside a single platform--the FTB-400 Universal Test
System--to help our customers increase revenues and reduce operating costs.
In October 2002, our wholly-owned subsidiary, EXFO Gnubi, purchased
substantially all the assets of gnubi communications, L.P., a supplier of
multi-channel telecom and datacom testing solutions for the system manufacturer
market. EXFO Gnubi's protocol test equipment targeted the system manufacturer
market, while EXFO Protocol's offering focused on the NSP market. These
strategic acquisitions, which were consolidated in Montreal in fiscal 2004,
enabled us to double our addressable market as we expanded from optical testing
into protocol testing applications, and to offer a more complete test solution
to customers.
Previously, we had completed two acquisitions to bolster growth in the
optical component manufacturing market. We acquired Burleigh Instruments, Inc.
(renamed EXFO Burleigh Products Group) in December 2000 for its wavelength
measurement instruments and nanopositioning alignment systems. We also added
EFOS Inc. (renamed EXFO Photonic Solutions) in March 2001 for its precision
light-based, adhesive spot-curing technology. We have since exited the optical
component manufacturing automation business.
To better serve the needs of end-customers in different markets and
simplify our business model, we reorganized our company under two new divisions
at the beginning of fiscal 2004. Our Telecom Division consists of former
Portable and Monitoring and telecom-related Industrial and Scientific product
lines. This division is focused on NSPs, telecommunication system manufacturers
and optical component vendors on a global basis. Our Photonics and Life Sciences
Division, which mainly leverages our core technologies, includes former
Industrial and Scientific non-telecom product lines. This division was created
to maximize value from developed and acquired telecom technologies. Following
this reorganization, our two new divisions have respective sales, marketing,
R&D, manufacturing and management teams and, therefore, are presented as two
separate operating segments.
EXFO launched 20 new products in fiscal year 2004, including seven
aimed at establishing leadership in the emerging fiber-to-the-premises (FTTP)
market and others dedicated to expanding our life sciences product portfolio. We
also strengthened our competitive position in protocol testing through the
introduction of a next-generation Fibre Channel test set for security-intensive
applications and, subsequent to the year-end, we released a next-generation
SONET/SDH analyzer for data-centric IP networks as well as a Gigabit Ethernet
solution with Voice-over-Internet Protocol (VoIP) test capabilities.
EXFO also closed a 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) in fiscal 2004. EXFO finished the fiscal year with a
cash position of $89.1 million.
In addition, we successfully renewed our collective bargaining
agreement with unionized manufacturing employees in Quebec City, Canada.
21
Near the end of the fiscal year, we reached the decision to consolidate
operations of our Photonics and Life Sciences Division in order to improve its
market focus and efficiency. Consequently, we have begun transferring EXFO
Burleigh's operations mainly to Toronto. Once fully implemented, we expect to
incur restructuring and other charges of $2.7 million, of which $1.7 million was
recorded in the fourth quarter of fiscal 2004 and the remainder in 2005. We
estimate that we will derive $1.5 million in annual savings from these
streamlined operations.
INDUSTRY OVERVIEW
Following three years of reductions in capital expenditures (CAPEX)
among NSPs, some measure of stability returned to the marketplace in 2004. Both
telecom carriers and we believe cable multiple-system operators (MSOs), which
fall under the NSP designation, began investing in growth pockets like FTTP and
VoIP to ultimately gain better access to the consumer's pocketbook for video,
data and voice services. These investments, however, were offset by CAPEX
reductions in other areas of the network to produce relatively flat spending
patterns year-over-year.
This relative stability in CAPEX spending was witnessed in multiple
segments of the global telecommunications supply chain. System manufacturers
benefited from NSP orders for next-generation, converged IP networks and fiber
deployments in access areas. Component vendors, who we believe had been hardest
hit by the downturn, began seeing incremental demand for optical components that
support IP-based systems. Some test and measurement equipment vendors, whose
products enable customers to reduce CAPEX and operating expenses (OPEX),
attracted the attention of NSPs, system manufacturers and component vendors,
especially ones offering test solutions for VoIP and/or FTTP applications.
KEY INDUSTRY TRENDS AND STRATEGY
The telecom space is currently undergoing major transformations with
technological discontinuities and market shifts serving as important drivers for
market-driven companies like EXFO. We intend to leverage these new requirements
and opportunities to generate value in upcoming years. We have conscientiously
been preparing for this industry upheaval through a steady level of R&D
investments, well-defined product roadmaps and selected strategic acquisitions
over the last few years. Key market trends include:
o Globally, bandwidth demand will continue instigating backbone
construction in developing countries, further Internet penetration in
other parts of the world and facilitate rapid applications evolution in
the most advanced nations. Accessing the Web directly through wireline
(or its wireless extension) has become an essential part of our online
lives for business travel, home entertainment and schoolwork. Consumers
just cannot get enough bandwidth. Carriers in advanced countries like
South Korea and Japan, for example, are on the verge of offering 100
Mb/s to homes, enabling the delivery of multiple high-definition
television (HDTV) channels, online gaming and a host of other
bandwidth-intensive applications.
o As long-haul utilization increases and metro-ring construction
progresses in most advanced countries, the access network, or so-called
"last mile", will be the cornerstone of the network service providers'
(NSPs) strategy to increase or maintain their consumer base. This
market reality will inevitably lead to much deeper and richer fiber
penetration into the network, whether NSPs intend to leverage their
existing copper plant or deploy fiber-to-the-whatever (FTTx).
22
o IP networking. SONET/SDH telecom transport standards were defined
almost 30 years ago to optimize voice traffic, but they are largely
inefficient in today's data-centric world. A highly flexible and
scalable, next-generation SONET/SDH platform is required for the
efficient and high-quality delivery of several new applications like
VoIP and IP video, while achieving significant OPEX reductions through
the management of a single network architecture. NSPs will be
streamlining their operations, deployment and maintenance processes as
well as moving to higher-margin service revenues.
o System vendors are back driving the telecom innovation curve in this
post-DWDM era, whereby data networking is a primary catalyst. As a
result, these vendors are heightening their focus on delivering
ubiquitous, consumer-friendly networking solutions and highly
differentiated product offerings in order to partner with public and
private network operators. System vendors are focusing more than ever
on shortening their innovation cycle and improving operating
performance--from the design phase all the way to network deployment.
o Competition between incumbent telecom carriers and cable
multiple-system operators (MSOs), especially in North America, is
intensifying as they race to increase revenue streams. Both groups are
deploying triple-play services (voice, data and video) as a pre-emptive
measure to retain customers and as an offensive means to secure new
ones.
On the photonics and life sciences side:
o Industrial manufacturing sectors like microelectronics, optoelectronics
and medical devices remain strong. The distinct trend of moving
high-tech manufacturing to Asia continues, while the global market is
driven by innovative new products and stronger customer intimacy. The
life sciences market trend is towards application-based, total-solution
selling and taking advantage of new, disruptive technologies.
To reach our ultimate goal of becoming the leading player in the telecom test
and measurement space, we will intensify our sales and marketing efforts, both
domestic and international, in 2005 to further leverage our strong technology
base and innovation pipeline. We will also focus on strengthening and expanding
our business relationships with major accounts. Finally, we will continue
building EXFO into one of the most respected brand names in the industry by
allowing our recognized expertise to reach out to customers where and when it is
needed. In an increasingly competitive landscape, we are counting on these
actions, combined with our strategies related to the aforementioned industry
trends, to provide our shareholders with long-term growth and profitability.
KEY PERFORMANCE INDICATORS FOR 2005
As we did in fiscal 2004, we have spelled out corporate objectives for 2005 and
tagged key performance indicators to each goal. Such transparency reflects
management's confidence in our strategic direction and speaks volumes about our
commitment to best disclosure practices. It should be specified that these are
metrics, not guidance, for fiscal 2005. Not surprisingly, our goals reflect
continuity from last year with a renewed focus on profitable growth.
23
To summarize our fiscal 2005 key performance indicators, we plan to
increase sales by 20% year-over-year, return to profitability on a pro forma
basis, and focus on innovation with at least 45% of revenues derived from new
products (on the market two years or less).
o SALES GROWTH OF 20%. As we have since our founding in 1985, we intend to
grow sales faster than the market by leveraging our sustained R&D
investments in areas, such as next-generation IP and FTTP testing, as well
as increase our sales and marketing footprint worldwide.
o PROFITABILITY ON A PRO FORMA BASIS. We believe higher sales volumes, richer
business mix, improved manufacturing efficiency and consolidation efforts
will support our return to profitability on a pro forma basis in 2005. At
EXFO, pro forma net earnings represent GAAP net earnings excluding
stock-based compensation costs, amortization of intangible assets,
restructuring charges and other unusual items.
o AT LEAST 45% OF REVENUES FROM NEW PRODUCTS. Our relentless focus on product
differentiation, time-to-market and astute product portfolio
management--combined with a heightened sales focus and product traction--
is expected to achieve this result in 2005.
THE EXFO SOLUTION
We offer an extensive range of test and measurement solutions to the
global telecommunications industry. Our success has been largely predicated on
our core expertise in optical telecommunications. We also leverage this
expertise to develop products for life sciences and high-precision assembly
applications. Our solution is based on the following key attributes:
MODULAR SYSTEM DESIGN. In 1996, we established an industry first by
launching the original modular optical test platform. This system design
consists of a PC-based, Windows-driven platform that can accommodate several
test modules performing various types of measurements. We have since developed
new compatible test platforms and extended our test module offering for both
NSPs and system manufacturers based on the same modular design. Our modular
design provides the following advantages:
o Unlike stand-alone units, new test modules can be rapidly developed to
address changing industry requirements.
o As customers' testing requirements change, they can purchase additional
modules that are compatible with their previously purchased platforms,
thus protecting their initial investments.
o Our standard graphical user interface reduces training costs because
customers are familiar with previously acquired software products.
o The flexibility of our systems allows customers to develop customized
and automated solutions for their specific test requirements.
o Our test platforms are PC-based and Windows-driven, thus they can
support third-party software solutions.
HIGH DEGREE OF TECHNOLOGICAL INNOVATION. We have established a strong
reputation for technological innovation over the last 19 years. In fact, we
believe this attribute represents a key differentiator for us within a
competitive marketplace. Following are some of our industry firsts in recent
years:
24
o FTTP RELATED PRODUCT.In fiscal 2004, we established ourselves as the
leading supplier of test equipment for FTTP networks by launching a
number of products dedicated to characterizing optical fiber all the
way to the home or enterprise. FTTP-related product launches include a
passive optical network (PON) power meter for installation, maintenance
and service-activation requirements; a next-generation automated loss
test set; a comparable multi-function module housed inside the FTB-400
field-testing platform; a new line of handheld instruments; and a
next-generation OTDR module that is necessary for installation
requirements.
o NEXT-GENERATION POLARIZATION MODE DISPERSION (PMD) ANALYZER. In 2003,
we released the patent-pending PMD Analyzer, the only portable
instrument on the market that can sweep through erbium-doped fiber
amplifiers (EDFAs) to characterize PMD levels in a high-speed optical
network. Optical links must be measured for PMD, especially when
upgrading to transmission rates of 10 Gb/s or when deploying a cascade
of amplifiers. We had introduced the industry's first portable PMD
analyzer in 1996 and added a Chromatic Dispersion test module in 2002
to offer the most comprehensive dispersion test solution on the market.
o ALL-IN-ONE TEST SOLUTION. In 2002, we launched the first all-in-one
solution for optical and protocol testing to enable customers to
increase efficiency and reduce costs in the field. The added value of
this concept means that field technicians no longer need to carry
separate instruments like bit-error-rate testers (BERTs), optical
spectrum analyzers (OSAs) and optical time-domain reflectometers
(OTDRs) to fulfill their testing requirements. All they need is the
next-generation FTB-400 field-testing platform and related modules to
handle all their testing, storage and retrieval needs.
o OPTICAL WAVEGUIDE ANALYZER. In 2001, we released our Optical Waveguide
Analyzer, which represents the industry's first commercial refractive
index profiler for planar and arrayed waveguides. The refractive index
profile of next-generation optical devices like arrayed waveguides is a
critical parameter to measure in order to control and optimize the
manufacturing process.
HIGH-QUALITY PRODUCTS. Product quality is an integral part of our
solution. Our Quebec City-based operations have maintained ISO 9001
certification since 1994 and they are now certified to the new 2000 edition of
the standard, as are our Toronto operations. Our manufacturing plant in
Montreal, Quebec, is working towards ISO9001/2000 certification. All of our
products meet required industry standards, and some of our products meet
additional voluntary standards, such as those set by Telcordia, formerly
Bellcore, IEC, and other industry-leading standards bodies. During
manufacturing, each product has a related quality assurance plan, with rigorous
checkpoints, to ensure product conformity. Various tasks in the quality
assurance process among all our facilities include quality control, conformity
testing, product documentation, product improvement, regulatory compliance,
metrology and calibration.
PRODUCTS
Our test platforms, namely the FTB-400 Universal Test System (UTS),
IQS-500 Intelligent Test System (ITS) and EPX Multi-Channel Test Systems, are at
the core of our product portfolio. The FTB-400 field-testing platform provides
NSPs with a simple, yet efficient way to perform multiple, advanced test
operations for installation, maintenance and troubleshooting applications. Our
IQS-500 ITS and EPX Multi-Channel Test Systems, which are
25
designed for manufacturing and R&D applications, test converging telecom and
datacom networks increasingly based on IP technology. All platforms and related
test modules are supported by integrated and highly intuitive graphical user
interfaces (GUIs), enabling the user to easily store, handle and retrieve a
large amount of data.
The following table summarizes the principal types of test instruments
for the telecommunications industry, typical applications and the format in
which we offer them:
FORMAT
-------------------------------------------------------------
INSTRUMENT TYPE TYPICAL APPLICATION NSP MARKET MANUFACTURER/R&D MARKET
----------------- -------------------------------- ---------------------- -------------------------------------
FTB 400 IQS-500 BENCHTOP
UTS MODULES HANDHELDS ITS MODULES EPX MODULES INSTRUMENTS
----------- --------- ----------- ----------- -----------
Broadband source Used for testing wavelength
dependent behavior of fiber
cables and DWDM optical
components. X X
Channel selectors Selects and isolates any
International Telecommunication
Union (ITU) DWDM channel in the
C-Band for bit-error-rate X X
testing and protocol-layer
analysis.
Chromatic Measures increasing levels of
dispersion chromatic dispersion in
analyzer high-capacity optical
networks. Chromatic dispersion
is a physical phenomenon
inherent to optical fiber and
optical components that causes X
information bits to spread
along a network. This degrades
the quality of the transmission
signal and, in turn, limits the
transmission speed carried by
optical networks.
Clip-on coupling Clips to an optical fiber and X
device allows non-invasive testing.
Digital frequency Used to automatically or
locker manually lock the frequency of
a laser source to a reference X
optical filter.
Femtosecond Measures very small levels of
polarization mode polarization mode dispersion in
dispersion analyzer DWDM and broadband components X
in the simplest, fastest and
most repeatable manner.
Fiber Bragg Carried out high-accuracy
Grating (FBG) analysis of FBG-based optical X
Sensor Interrogator sensors
Fibre Channel Brings FC-0, FC-1 and FC-2
tester logical layer Fiber Channel
testing to services delivered
via transport protocols, such
as DWDM, SONET/SDH and dark
fiber. It provides valuable X X
timing information and buffer
credit estimation for Fiber
Channel network deployment.
Gigabit Ethernet Measures data integrity for
tester high-speed internet protocol
telecommunications in metro and
edge networks. X X X
Laser wavelength Performs high-accuracy,
meter absolute wavelength
measurements of continuous wave X
(CW) and/or
26
FORMAT
-------------------------------------------------------------
INSTRUMENT TYPE TYPICAL APPLICATION NSP MARKET MANUFACTURER/R&D MARKET
----------------- -------------------------------- ---------------------- -------------------------------------
FTB 400 IQS-500 BENCHTOP
UTS MODULES HANDHELDS ITS MODULES EPX MODULES INSTRUMENTS
----------- --------- ----------- ----------- -----------
pulsed laser sources
Laser spectrum Performs high-resolution,
analyzer spectral characterization of X
continuous CW laser sources
Live fiber detector Clips on to a fiber and is used
to detect the presence and
direction of a signal without
interrupting the traffic. X
Loss test sets Integrates a power meter and a
light source to manually or
automatically measure the loss X X X X
of optical signal along a fiber.
Multi-wavelength Measures the power and drift
meters for multiple wavelengths in a X X X
DWDM system.
Narrowly tunable A laser that can be precisely
lasers tuned to simulate a DWDM light
sources. Used primarily in X
testing optical amplifiers.
Next-generation Full SONET/SDH protocol testing
SONET/SDH Analyzer functionality, including
support for GFP, V.CAT, and X X
LCAS next generation
enhancements.
Optical amplifier Boosts the power of laser
sources. Used for the testing X
and calibration of test systems.
Optical couplers Used in test system to combine
sources or signals. Also used X
as splitters to monitor signals.
Optical fiber Measures the geometric and
parameter analyzer light guiding properties of an
optical fiber. Used in new
fiber research and development X
and quality control
applications.
Optical power Measures the power of an
meters optical signal. It is the
basic tool for the verification
of transmitters, amplifiers and X X X X
optical transmission path
integrity.
Optical power Provides a highly accurate and
reference module traceable measurement of power
for the calibration or X
verification of other power
measurement instruments.
Optical return Combines a laser and a power
loss meters meter to measure the amount of
potentially degrading back X X X X
reflection.
Optical spectrum Produces a graphical
analyzers representation of power versus
wavelength for an optical
signal. Useful for measuring X X
the drift, power and
signal-to-noise ratio for each
wavelength in a DWDM system.
Optical switches Provides switching between
fibers. Used to provide
flexible and automated test
setups such as the measurement
of multiple fibers or X X
components with multiple ports
with one instrument.
27
FORMAT
-------------------------------------------------------------
INSTRUMENT TYPE TYPICAL APPLICATION NSP MARKET MANUFACTURER/R&D MARKET
----------------- -------------------------------- ---------------------- -------------------------------------
FTB 400 IQS-500 BENCHTOP
UTS MODULES HANDHELDS ITS MODULES EPX MODULES INSTRUMENTS
----------- --------- ----------- ----------- -----------
Optical time Like a radar, it measures the
domain time of arrival of reflections
reflectometers of an optical signal to
(OTDRs) determine the distance to the
breaks or points of excessive X
loss in a fiber network.
Optical waveguide Provides the refractive index
analyzer profile of glass and fused
silica-based devices used in X
next generation networks.
Passive component Characterizes passive
analyzer wavelength-selective devices,
such as multiplexers,
demultiplexers and add/drop
filters, with respect to X
absolute wavelength in order to
guarantee their performance
within DWDM systems.
Passive optical Determines the power level of
network (PON) different signal types,
power meter including continuous (e.g., TV
signal at 1550 nm) and framed
(e.g., ATM or Ethernet at 1490
nm or 1310 nm) within a passive
optical network. Various baud X
rates are covered, ranging from
155 Mb/s to 2.5 Gb/s, for both
synchronous and non-synchronous
signals.
Polarization Measures the difference in loss
dependent loss of power for the different X
meters states of polarization.
Polarization mode Measures the dispersion of
dispersion light that is caused by
analyzers polarization. Generally used to X X
determine the speed-distance
limitation of fiber and cables.
SONET/SDH Provide accurate bit-error rate
analyzer and performance analysis of
SONET/SDH overhead format that
reflect the quality of a X X X
transmission system.
Stable light Emitting diode or lasers used
sources in connection with a power X X X X
meter to measure signal loss.
Synchronization Portable, stand-alone tester
analyzer for network synchronization
analysis and wander measurement X
in wireless and wireline
transport networks.
Talk sets A device that attaches to an
optical fiber and serves as a
temporary voice link X X
facilitating coordination of
work among installation crews.
Variable optical Used in network simulation
attenuators setups to provide calibrated
variable reduction of the X X X
strength of an optical signal.
Visual fault A visible laser that can be
locators connected to an optical fiber
network to help locate breaks X X
or points of excessive loss.
Widely tunable Can produce laser light across a
lasers broad range of wavelengths. Used
to test DWDM components and X X
value-added optical modules.
28
PRODUCTS FOR NETWORK SERVICE PROVIDERS
We offer an extensive range of field-portable optical test, measurement and
monitoring solutions that are mainly used by NSPs, but can also be utilized by
system vendors. These products are available as handheld test instruments,
portable platforms with related modules, and as rack-mount chassis with related
modules. Our handheld instruments are durable, compact and easy to use. Our
second-generation field-testing platform, the FTB-400 UTS, is available in three
configurations: The two-slot option is ideal for OTDR, OLTS and GigE
applications, while the seven-slot option is used for dispersion
characterization (PMD and CD), DWDM testing (OSA and MWM) and protocol
(SONET/SDH/datacom) testing. Our newest addition, the eight-slot option, is a
high-performance, multiple-protocol configuration that allows users to combine
Next-Generation SONET/SDH functions with Ethernet, Fibre Channel and
optical-layer testing capabilities.
In addition, we offer the FTB-100 Mini-OTDR with an integrated power
meter option. This cost-effective platform provides field technicians with basic
OTDR testing capabilities. Our portable platforms are PC-centric, Windows-based,
highly flexible and fully scalable. Their large environmentally robust
touchscreens are very practical for field use.
EXFO also offers stand-alone, autonomous solutions for real-time
monitoring applications. Our Fiber Guardian solution carries out real-time
monitoring 24 hours per day, seven days per week on up to 32 fibers within an
optical network. This monitoring solution displays a message on its embedded
screen and sends out an alarm if a measurement falls outside a user-defined
threshold. Through state-of-the-art instrumentation, Fiber Guardian can specify
the location of a fault to reduce downtime to a minimum, or it can identify
minor degradations to prevent loss of service.
Optical Guardian continuously monitors critical parameters of optical
channels within DWDM or coarse wavelength division multiplexing (CWDM) networks.
Likewise, an alarm is automatically generated when a measurement falls outside
user-defined thresholds.
Network Guardian is a network performance management system that
supports a wide range of protocols like SONET, T-Carrier, SDH, PDH, 10/100
Ethernet and Gigabit Ethernet. It remotely carries out tests on points of
presence, handoff points, co-location sites and customer premise equipment
sites.
In 2004, we launched seven new products dedicated to FTTP testing. We
also introduced a next-generation Fibre Channel test solution for
security-intensive storage area networks (SANs). Subsequent to the year-end, we
released a next-generation SONET/SDH test solution and enhanced our Gigabit
Ethernet offering with voice-over-Internet protocol (VoIP) test capabilities to
help NSPs migrate towards converged, IP-based networks. We also introduced a
synchronization analyzer, which is a comprehensive wander measurement tool for
assuring critical network synchronization in wireless and wireline telecom
transport networks. It can operate as a standalone instrument, or as a
monitoring probe suitable for central office applications.
PRODUCTS FOR SYSTEM/COMPONENT MANUFACTURERS
Our system/component vendor solutions, mainly built around our IQS-500
ITS and EPX platforms, are available as test modules or stand-alone benchtop
instruments. The next-generation IQS-500 platform can efficiently run as many as
100 optical test modules using a
29
single controller unit. The IQS-500 platform is equipped with the software and
hardware technology to support single-button operation for automated testing.
Its system-based approach--one box, several test modules--combined with an open
architecture (PXI, Windows, LabVIEW(TM), etc.) and ease of programming, produces
a highly flexible test environment.
The IQS-500 also provides backward compatibility with recent
IQ-generation test modules, while delivering all the power and advantages of a
next-generation platform. EXFO's wide selection of high-performance test modules
includes high-speed power meters, light sources, WDM laser sources, tunable
laser sources, variable attenuators, optical spectrum analyzers, polarization
mode dispersion (PMD) analyzers, multi-wavelength meters, channel selectors,
polarization dependent loss (PDL) and optical return loss (ORL) meters,
polarization controllers and optical switches.
The highly flexible EPX platforms are available in two formats. With up
to 17 protocol test modules per unit, the EPX16 performs numerous tasks within
one hardware platform. The EPX8 uses the same upgradeable, multi-channel design
in a smaller footprint. Combining multiple rates, protocols and channels within
a single unit, these systems are ideal for cross-connect, ADM, DWDM, production
and load testing. Direct Ethernet access capability and a Java-based GUI make
the EPX platforms powerful test solutions that are easy to use. Other
user-friendly features include saving and restoring test configurations,
connecting remotely with a Web browser, scripting, logging and sharing test
resources with other users.
In 2004, we introduced a high-end, rack-mountable 10/100/1000 Mb/s IQS
Ethernet module for the characterization of transport, access, and enterprise
datacom networks. We also released the 10+ Gigabit Multi-Rate Transceiver with
deep channelization and mixed payload concatenations for next-generations
networks. In addition, we launched a tunable external cavity laser (ECL) module
for the IQS platform, whose broad wavelength range is optimized for coarse
wavelength division multiplexing (CWDM) and FTTP testing.
Our system/component vendor products also address testing issues that
cannot be handled by standard test modules or stand-alone bench-top instruments.
We have developed a number of integrated test systems and offer them as
off-the-shelf solutions to suit a wide range of customer needs. In addition, we
have created a software development kit for developers who prefer writing their
own programs for our instruments. Following is list of integrated test systems
that EXFO provides for characterizing optical components, sub-systems and
networks:
30
o Multifiber test system Used for quality-assurance
testing of multifiber
patchcords and interconnect
assemblies. These devices,
including hybrid and fan-out
patchcords, are commonly used
in fiber systems.
o Cable assembly test system Used to perform insertion
loss and mandrel-free
reflection measurements with
the highest degree of
accuracy and repeatability on
short fiber assemblies.
o Optical calibration test system Used to calibrate power
meters, light sources,
variable attenuators and
optical time domain
reflectometers.
o Environmental test system Allows users to perform
long-term qualification
testing of optical components
and sub-systems under varying
environmental conditions
primarily to ensure
compliance with industry
standards.
o DWDM passive component test system Used to automatically
characterize all critical
specifications, including
spectral insertion loss,
polarization-dependent loss,
and optical return loss, of a
DWDM passive component with a
high degree of accuracy, ease
of use, and speed.
o Multi-wavelength comb controller Used to adjust the power of a
bank of DFB-ITU lasers in
order to test loading
conditions of optical
amplifiers.
PRODUCTS FOR PHOTONICS AND LIFE SCIENCE APPLICATIONS
Over the years, EXFO has developed and acquired a number of core
technologies that we are leveraging in selected high-precision assembly and life
sciences markets. For example, we offer several light-based curing solutions for
optical component manufacturing and have optimized our approach for other
industries, such as semiconductor, microelectronic, and medical device
manufacturing, to maximize revenues. Our Novacure(R), Acticure(R), and
Omnicure(R) systems deliver precise doses of the appropriate spectral light onto
photosensitive adhesives to significantly reduce bonding time and increase
repeatability. These light-based curing systems, supported by patented optical
feedback and radiometry technology, produce a high-quality bonding solution that
is unmatched in the industry. Our technology and application knowledge place us
at the forefront of this market.
In 2004, our X-Cite(TM) 120 Fluorescence Illumination System, which
offers three times the average lamp life than conventional lighting systems, not
only gained market acceptance among microscope manufacturers, but it was
upgraded for automated applications. An RS-232 connection and a software
interface enable end-users to control the X-Cite 120's iris, lamp, shutter and
timer via a personal computer. Industry leaders like Leica, Nikon Instruments,
Olympus and Zeiss MicroImaging have embraced this microscope accessory,
reselling it to customers through their own sales channels.
On the light-curing side, we continued our migration towards a single
platform with the release of the OmniCure(TM) Series 1000, an entry-level system
for manual-precision assembly
31
environments. In addition, we introduced two new accessories to complement our
curing systems. First, we launched a high-power fiber light guide, which
provides an equal distribution of light energy to multiple cure sites with 50%
more throughput than standard fiber guides. We also released a cure-ring
radiometer, which measures light output at the cure site, to ensure a repeatable
process when bonding devices that require a uniform 360-degree exposure.
Subsequent to the year-end, we introduced the OmniCure(TM) Series 2000, a
light-based curing platform for automated manufacturing applications.
On the nanotechnology side, we launched the PCS-6000 and PCS-4100
Micromanipulators, which feature piezoelectric smoothness plus motorized long
travel for electrophysiology research. In addition, we offered new motor/memory
capabilities on our Gibraltar(R) platform to enable the prompt return of
fixed-stage, upright microscopes to their original position with a single touch
of a button.
The following table summarizes the principal types of high-precision
assembly and life science solutions we provide and their typical applications:
-----------------------------------------------------------------------------------------------------------------------
LIGHT SOURCES AND ACCESSORIES
-----------------------------------------------------------------------------------------------------------------------
PRODUCT TYPE PRODUCT TYPICAL APPLICATION
-----------------------------------------------------------------------------------------------------------------------
UV Light Sources Novacure(R) Used to initiate photo chemistry reactions in
Acticure(R) polymer-based materials for a variety of end use
Omnicure(R) S1000 applications such as adhesive curing for manufacturing of
Omnicure(R) S2000 high value-added items such as medical devices,
micro-electronic and opto-electronic components,
displays, and data storage devices.
-----------------------------------------------------------------------------------------------------------------------
Fluorescent Light Sources X-Cite(R) 120 Fluorescence light source that attaches directly
to most microscopes currently sold by Nikon, Zeiss,
Olympus and Leica.
-----------------------------------------------------------------------------------------------------------------------
Computer Control Module ACS-1000 Electronic interface module used to connect EXFO UV and IR
light sources to computers or computer networks for
process automation.
-----------------------------------------------------------------------------------------------------------------------
Optical Accessories Optional custom delivery optics used with EXFO UV and IR
light sources to tailor the properties of the light beam
to end-user applications.
-----------------------------------------------------------------------------------------------------------------------
High Power Fiber Light Guide Provides an equal distribution of light energy to multiple
cure sites with 50% more throughput than standard fiber
guides
-----------------------------------------------------------------------------------------------------------------------
OPTICAL INSTRUMENTS
-----------------------------------------------------------------------------------------------------------------------
PRODUCT TYPE PRODUCT TYPICAL APPLICATION
-----------------------------------------------------------------------------------------------------------------------
Radiometer R5000 Handheld, broadband optical radiometer used in conjunction
with EXFO UV and fluorescent light sources to ensure
process quality control at the end-user location.
-----------------------------------------------------------------------------------------------------------------------
Cure-Ring Radiometer Measures the output power of light from an EXFO cure ring;
ideal for applications that requires a uniform 360(degree)
exposure
-----------------------------------------------------------------------------------------------------------------------
32
-----------------------------------------------------------------------------------------------------------------------
PRECISION POSITIONING INSTRUMENTS
-----------------------------------------------------------------------------------------------------------------------
PRODUCT TYPE PRODUCT LINE TYPICAL APPLICATION
-----------------------------------------------------------------------------------------------------------------------
Precise Motors/Stages IW-700 Inchworm Motors High resolution optical alignment, fiber-optic alignment,
TSE-820 Inchworm Stages semiconductor positioning, materials research
UHVL Inchworm Motors
-----------------------------------------------------------------------------------------------------------------------
Micromanipulators PCS-6000 Micromanipulators Electrophysiology research such as patch clamp recording
PCS-5000 Micromanipulators experiments on the brain and central nervous system
-----------------------------------------------------------------------------------------------------------------------
Microscope Platforms Gibraltar Platform/Stage Applications using upright microscopes
-----------------------------------------------------------------------------------------------------------------------
Microinjection Systems MIS-5000 Microinjection Microinjection and nuclear transfer for genetics and
Manipulator reproductive sciences research
PiezoDrill Inertial Impact
Drill
-----------------------------------------------------------------------------------------------------------------------
Microelectrode Positioner LSS-8000 Inchworm System Electrophysiology research such as intracellular recording
experiments
-----------------------------------------------------------------------------------------------------------------------
RESEARCH AND DEVELOPMENT
We believe that our future success largely depends on our ability to
maintain and enhance our core technology and product functionality. To keep
developing new products and enhancements, it is important that we retain and
recruit highly skilled personnel. Our Telecom Division's research and
development department is headed by a Vice-President of Research and
Development, while our Photonics and Life Sciences Division has a Director of
Research and Development. As of December 31, 2004, our research and development
departments included 188 full-time engineers, scientists and technicians, of
whom 35 hold post-graduate degrees. Gross research and development expenditures
in fiscal 2004 reached $15.7 million compared to $17.1 million in 2003 and $17.0
million in 2002. Although we implemented restructuring plans during the last few
years, none of our major product development initiatives were significantly
impacted. We launched 20 new products in fiscal 2004 compared to 15 in 2003 and
25 in 2002. Approximately 32% of sales in fiscal 2004 originated from products
that have been on the market two years or less compared to 49% in 2003 and 48%
in 2002.
Through market-oriented product portfolio review processes at our
telecom sites in Quebec City, Canada and Montreal, Canada, we ensure that our
investments in research and development are aligned with our market
opportunities and customers' needs. This process enables us to maximize our
returns on R&D investments by focusing our resources on prioritized projects.
Quarterly product portfolio review meetings enable us to choose a realistic,
balanced mix of new products and allocate the necessary resources for their
development. All our projects, including those already underway, are reviewed,
given a priority rating and allocated budgets and resources. Our existing
projects can be stopped or substantially redefined if there have been
significant changes in market conditions, or if the project development schedule
or budget have significantly changed.
To manage our research projects once they are underway, we use a
structured management process known as the stage-gate approach. The stage-gate
approach is based on a systematic review of a project's progress at various
stages of its life cycle. The following are the key review stages of the
stage-gate approach:
33
o market study and research feasibility;
o product definition;
o development feasibility;
o development;
o qualification; and
o transfer to production.
At each stage, we review our project risks, costs and estimated
completion time. We compare our design to anticipated market needs and ensure
that our new product development is synchronized with other internal departments
and external industry events. Adherence to these inter-related portfolio review
and stage-gate processes enabled us to be named winners of the Outstanding
Corporate Innovator Award in 2000 by the U.S.-based Product Development and
Management Association.
We also maintain research and development programs for our photonics
and life science activities in Toronto, Canada and in Victor in the state of New
York until the consolidation of Burleigh's R&D to Toronto. The product
development process is managed using a similar stage-gate process, and projects
are reviewed and approved through a quarterly portfolio review. The future
success of our photonics and life science operations largely depends on our
ability to maintain and enhance our core technology in light-based curing,
fluorescence illumination systems and piezoelectric positioning.
Strong R&D capabilities in Toronto and in Victor in the state of New
York have made it possible to bring a number of successful new products to
market quickly and retain customer intimacy. In the process, it has enhanced our
ability to customize products for special applications and to develop original
equipment manufacturing (OEM) products under partnerships and exclusive
contracts. Outside consultants are often used for added support in areas like
software development and mechanical design.
CUSTOMERS
Our global and diversified telecom customer base relies on our test and
measurement solutions to enable optical networks to perform impeccably during
their complete life cycles: research, development, manufacturing, installation,
maintenance and real-time monitoring. We also have selected customers in
high-precision assembly and life science sectors that require our solutions to
render them more efficient in their respective fields. Our telecom customers
include carriers, cable television companies, public utilities, private network
operators third-party installers, equipment rental companies, system
manufacturers, component vendors and laboratory researchers. Our photonics and
life science customers consist of major manufacturers of medical devices,
microelectronics, optical displays, electronic storage systems and photonic
components, as well as universities, medical schools, governments, private and
industrial research laboratories. In fiscal 2004, our top customer accounted for
13.8% of our sales and our top three customers represented 20.8% of our sales.
In comparison, our top customer accounted for 9.2% and 10.2% of sales in fiscal
2003 and 2002, respectively.
With regard to geographic distribution, sales to customers in the
Americas (USA, Canada, and Central & South Amerericas) represented 66% of our
sales in fiscal 2004, while sales to customers in EMEA (Europe, Middle East and
Africa) and Asia-Pacific accounted for 18% and 16% of total sales, respectively.
In 2003, the sales split was identical to 2004. In 2002, sales to customers in
the Americas represented 61% of total sales, while EMEA and Asia-Pacific
customers accounted for 20% and 19%, respectively.
34
SALES
We sell our telecom test and measurement solutions through direct and
indirect sales channels in North America and around the world.
In North America, we use a hybrid model, combining key account
management with direct and indirect sales coverage. We typically use key account
managers to serve large customers that generate high sales volume. These key
account managers are supplemented by regional sales managers, sales
representatives and distributors in U.S. and Canadian metropolitan areas.
We opt for a direct sales approach when selling higher-end highly
technical products to sophisticated buyers. Sales of low- to medium-level
complexity products to less stringent technical buyers are usually done through
a manufacturer representative organization supported by regional sales managers.
Our main sales offices and service centers in North America are located in
Addison, Texas, Quebec City, Canada and Toronto, Canada supplemented by a series
of regional presence in cities across USA and Canada.
On the international front, we have sales personnel covering strategic
areas such as EMEA (Europe, Middle East and Africa), APAC (Asia-Pacific region)
and Latin America. Our sales network in EMEA is supported by a main office and
service center in Paris, France, which maintains our head of European sales
operations and also provides repair and calibration services for our EMEA
customers. We also have a series of additional sales presence in multiple
countries across EMEA to serve and support our various customers and
distributors.
As for APAC, our main sales offices for South East Asia is located in
Singapore, while our main office for mainland China is located in Beijing,
China, which also act as a service center to better serve our customer base in
the whole Asia-Pacific region. In addition, we have other sales offices in
strategic locations around the world to support our network of distributors and
various customers.
We rely on the contribution of a network of more than 90 distributors
around the world to work with us in supporting mostly our international sales
and to participate to a large number of our international events. We believe
that the local presence and cultural attributes of our distributors allow us to
better serve our global markets.
Our direct telecom sales team consists of a Vice-President of Global
Sales supported by 5 regional sales directors that are leading a widely
distributed team of more than 50 people acting as key account managers, regional
sales managers, sales engineers and application engineers, located throughout
major metropolitan areas around the world. This group of sales professionals has
on average more than 10 years of experience in the fields of telecommunications,
fiber optics, or test and measurement. We also have an in-house Customer Service
Group to meet the needs of existing and new customers. This group is responsible
for providing quotations to customers, supporting our sales force, managing
demonstration units, order management, technical support and training as well as
calibration and repair services.
For our photonics and life sciences solutions, we use mixed sales
channels to serve various markets, depending on product line and geography.
Optical light sources and related accessories used for industrial applications
are sold in North America through a network of more than 10 manufacturer
representatives and, internationally, through a network of more than 20
35
distributors. The X-Cite 120 Fluorescence Illumination System is sold through
value-added reseller agreements with major microscope companies in North
America; negotiations are underway to extend these agreements worldwide.
Nanopositioning products are sold directly to customers in North America, which
includes the United States and Canada, and internationally through a network of
technical distributors. To gain additional access to the nanopositioning life
science research market in the United States and Canada, distributor agreements
are in place with major microscope manufacturers, which include Leica, Nikon,
Olympus and Zeiss. These companies often combine the sale of their microscopes
with our product.
PRODUCT MANAGEMENT, MARKETING/COMMUNICATIONS AND CUSTOMER SUPPORT
PRODUCT MANAGEMENT
Our telecom Product Management Group consists of two Vice-Presidents --
one responsible for our Optical and the other for our Protocol lines & Products
-- as well as product managers who have various degrees in engineering, science
and business administration. Product managers, under the direction of the
respective Vice-Presidents, are responsible for all aspects of our telecom
marketing program including product strategy, new product introductions,
definition of new features and functions, pricing, product launches and
advertising campaigns. We follow up our marketing initiatives by attending
industry trade shows. Furthermore, we have a customer relationship management
(CRM) system to compile market and customer information including forecasts,
opportunities, leads and competitive data. We use this information to make
strategic business decisions. Finally, a strategic marketing specialist analyzes
markets, market trends, compiles competitive information and identifies
macro-trends in our sector.
Our Photonics and Life Sciences Product Management Group consists of
two Directors - one responsible for precision assembly (spot curing) and the
other for Life Sciences - as well as product managers who have various degrees
in engineering, science and business administration. Product managers, under the
direction of the respective Directors, are responsible for all aspects of their
business line marketing programs including product strategy, new product
introductions, definition of new features and functions, pricing, product
launches and advertising campaigns.
MARKETING/COMMUNICATIONS
Our Marketing-Communications Group, which consists of project managers,
commercial writers, translators and graphic artists, supports our Product
Management Group by producing marketing and corporate documentation. Literature
includes specification sheets, application notes, product catalogues,
advertising copy and an electronic corporate newsletter. Our
Marketing/Communications Group is also responsible for all sales tools required
by our worldwide sales force and for updating our Web site.
CUSTOMER SUPPORT
Customer support is deemed a corporate mandate at EXFO. As such, our
Customer Support Group handles requests from customers worldwide. Our Customer
Support Department consists of three distinct units: Inside Sales, Technical
Support and After-Sales Service.
Inside Sales is mainly responsible for guiding customers in purchasing
the correct equipment for their respective applications, issuing quotations and
promoting our Flexcare service program. In order to provide customers with one
central point of contact, our service representatives work with the customer
from purchasing equipment to helping them service the equipment, if necessary.
These services are provided in English, French, Spanish or Chinese.
Within our Technical Support team, we have agents who provide
troubleshooting support to our customers as well as trainers and installers who
offer on-site servicing for more complex equipment.
To offer superior After-Sales Service worldwide, we have service
centers based in North America, Europe and Asia. These service centers provide,
technical support, software upgrades, calibration and repairs for our customers.
MANUFACTURING
Our manufacturing operations consist mainly of material planning,
procurement, sub-assembly, final assembly and test, software loading,
calibration, quality assurance, shipping, billing and customs management. As of
December 15, 2004, we had 246 employees involved in our manufacturing
operations. Most of our manufacturing activities, which occupy a total of
approximately 61,300 square feet, are spread among four buildings in three
cities.
First, we occupy 50,000 square feet in Quebec City, Canada, in two
locations and 3,300 square feet in Montreal, Canada. These manufacturing
operations include the following responsibilities:
o PRODUCTION. From production planning to product shipment, our
production department is responsible for manufacturing high-quality
products on time. Factories are organized in work cells; each cell
consists of specialized technicians and equipment and has full
responsibility over a product family. Technicians are cross-trained and
versatile enough, so that they can carry out specific functions in more
than one cell. This allows shorter lead times by alleviating
bottlenecks.
o PRODUCT ENGINEERING AND QUALITY. This department, which supports our
production cells, acts like a gatekeeper to ensure the quality of our
products and the effectiveness of our manufacturing processes. It is
responsible for the transfer of products from research and development
to manufacturing, product improvement, documentation, metrology, and
the quality assurance and regulatory compliance process. Quality
assurance represents a key element in our manufacturing operations.
Quality is assured through product testing at numerous stages in the
manufacturing process to ensure that our products meet stringent
industry requirements and our customers' performance requirements. Our
quality assurance program has been certified ISO 9001/2000 at our two
locations in Quebec City, Canada and is in the process of being
certified at our other site in Montreal, Canada.
o SUPPLY-CHAIN MANAGEMENT. This department is responsible for sales
forecasting, raw material procurement, material-cost reduction and
vendor performance management. Our products consist of optical,
electronic and mechanical parts, which are purchased from suppliers
around the world. Approximately one-third of our parts are manufactured
to our specifications. Materials represent the biggest portion of our
37
cost of goods and will continue to grow as we rely more and more on
outsourcing our manufacturing. Our performance is tightly linked to
vendor performance, requiring greater emphasis on this critical aspect
of our business.
We also occupy 8,000 square feet in Toronto, Canada. Following the
consolidation of EXFO Burleigh's operation to Toronto, our operations group in
Toronto manufactures light sources and related accessories, fluorescence
illumination systems and precise positioning equipment for the life sciences and
high-precision assembly markets. Operations consist of manufacturing,
procurement, warehousing, quality control and document control managed by
various elements of the ISO 9001 certified quality system. Recognizing the
importance of reduced time-to-market for our solutions, we have focused efforts
on designing products with an emphasis on standardization, modularity, as well
as ease of fabrication and assembly. Following are key manufacturing
responsibilities in Toronto:
MANUFACTURING - consists primarily of assembly and test capabilities
where all major manufacturing elements are subcontracted to various key
suppliers. These components are integrated into assemblies and tested in order
to ensure all operating specifications have been met for each product
manufactured. Capacity and production planning are utilized on an on-going basis
to ensure that adequate resources are available to meet forecasted and actual
demand.
PROCUREMENT - activities are focused on developing key suppliers that
are able to manufacture components to our specifications and ensuring the most
competitive price has been attained. Supplier evaluation is the joint
departmental effort of operations, engineering and the quality group.
WAREHOUSE - RECEIVING, in-coming inspection and warehousing of
components used for product realization, along with shipping and custom
transactions, are controlled in this area.
DOCUMENT CONTROL - configuration control on all released products is
maintained by managing the system for engineering change.
QUALITY CONTROL - Receiving inspection, final product verification,
control of non-conforming product, control of inspection, test and measurement
equipment are control by in area.
COMPETITION
The telecommunications test and measurement industry is highly
competitive and subject to rapid change as a result of technological
developments and market conditions. We compete with many different companies,
depending on product family and geographical market. We believe that the main
competitive factors in the industry include the following:
o product performance and reliability;
o price;
o level of technological innovation;
o product lead times;
o breadth of product offering;
o ease of use;
o brand-name recognition;
38
o customer service and technical support;
o strength of sales and distribution relationships; and
o financial stability.
Generally, competitors fall into two categories. The first category
consists of global test and measurement vendors, who complement their broad
range of products with optical test and measurement equipment. These companies
include Acterna Corporation, Agilent Technologies, Inc., Ando Corporation,
Anritsu Corporation, NetTest, Spirent plc and Tektronix, Inc.
The second category refers to niche companies in the test and
measurement industry or other significant telecommunications players operating
inside a niche test and measurement market. These companies typically have
limited product lines and in some cases may be geographically limited in their
customer base. Such companies include Digital Lightwave, Inc., Finisar
Corporation, Ixia, JDS Uniphase Corporation and Sunrise Telecom Incorporated.
Competition for our photonics and life science solutions is quite
varied, depending upon product line. Competitors that sell light-based curing
products include Hamamatsu, Ushio and Matsushita (Panasonic) in Asia, with
Hamamatsu increasing its presence in North America. With regard to our X-Cite
120 Fluorescence Illumination System, main competitors consist of microscope
manufacturers who have developed lamp housings for low-wattage mercury burners
in-house. Finally, our motion control Life Science instruments, which are
designed for various life science applications, compete against products from
companies like Sutter Instruments and Narishige.
REGULATORY ENVIRONMENT
In most countries where our products are sold, our products must comply
with the regulations of one or more governmental entities. These regulations
often are complex and vary from country to country. Depending upon the country
and the relevant product, the applicable regulations may require product
testing, approval, registration, marking and unique design restrictions.
Accordingly, we have appointed a team of engineers who are responsible for
ensuring that our products comply with all applicable regulations.
In the United States, our products must comply with the regulations of
several agencies of the U.S. federal government, including the Federal
Communications Commission (FCC), the Food and Drug Administration (FDA) and the
Occupational Safety and Health Administration (OSHA). Under the FCC's
regulations, our products must comply with certain electro magnetic
compatibility (EMC) requirements to insure they do not generate and are immune
from electrical noise which could possibly cause undesirable operation, as well
as affect other surrounding devices. Depending upon the product, compliance with
these rules may necessitate applying for and obtaining an FCC equipment
authorization prior to importing into the United States, or marketing, any units
of the relevant product. Additionally, some of our products must comply with the
FDA's non-medical performance standards and related rules concerning
light-emitting products, such as lasers. The FDA's regulations are intended to
promote safety by limiting human exposure to harmful non-iodizing radiation.
Similarly, our products must comply with safety standards adopted by OSHA.
Similar regulations apply in other countries. For example, in Canada
our products must comply with the applicable standards adopted by the Standards
Council of Canada (SCC). These include product safety standards developed by the
Canadian Standards association as well as EMC requirements adopted by Industry
Canada. Countries in the European Union
39
require product compliance as dictated by an applicable directive, often
referred to as CE marking. This includes testing to ensure compliance with
harmonized European Norm (EN) standards for both product safety and EMC
requirements. Other significant types of regulations not described in this
annual report also may apply, depending upon the relevant product and country of
destination.
INTELLECTUAL PROPERTY
Our success and ability to compete are dependent in part on our ability
to develop and protect our proprietary technology. We file U.S. and Canadian
patent applications to protect technology, inventions and improvements important
to the development of our business. We also rely on a combination of copyright,
trademark, trade secret rights, licensing and confidentiality agreements.
We currently hold 28 U.S.-issued and five Canadian-issued patents and
we have 10 U.S., 14 Canadian and 2 Patent Cooperation Treaty patent applications
pending. These issued and pending patents cover various aspects of our products
and processes. The expiration dates of our issued patents range from April 19,
2005 to March 31, 2021.
We consider eight of our inventions for which patents have either been
granted or are pending to be material. These inventions are:
o the optical time domain reflectometer with internal reference reflector
for which a patent was granted in the United States and is pending in
Canada. This invention permits the control of the optical time domain
reflectometer detector gain and the determination of the loss of the
initial optical connector and is used in most of our optical time
domain reflectometer-based products;
o the measurement of attenuation of optical fibers using bidirectional
transmission of information via the fiber for which patents were
granted in the United States and Canada. This invention forms the basis
of our FOT-930 and FTB-3920 products;
o a method and apparatus for characterizing optical power levels in
three-wavelength, bi-directional Fiber-to-the-Home systems. This
invention describes how the optical power can be measured at the
two-downstream and one upstream wavelengths used to connect a residence
or business customer, while maintaining the signal continuity necessary
to keep the home-based Optical Network Terminal operating. A PCT patent
application has been filed and is in process. This invention forms the
basis of the two-port version of our PPM-350B PON power meter.
o a method and apparatus to determine optical phase delay, which forms
the basis of our new FTB-5800 product for the measurement of chromatic
dispersion in field-installed optical fibers. A US patent has been
granted, and applications have been submitted in Canada, Europe
(pursuant to PCT), and China;
o an optical spectrum analyzer using optical fibers as input and output
"slits". This invention forms the basis of our FTB-5240, FTB-5240B and
IQ-5250 products. A US patent has been granted and applications are in
process in the United States, Canada, Europe (pursuant to PCT) and
China;
o the light cure system with closed loop control and work piece recording
which is at the heart of the spot-curing systems manufactured by EXFO
Photonic Solutions for which patents were granted in the United States
and Canada;
o Intelli-lamp(TM) patents used in the spot curing and fluorescence
microscopy illumination systems optimize lamp performance in EXFO
Photonic Solutions
40
systems. Two patents have been granted in the US, and applications are
pending in Canada and Germany.
o the portable test gear for TDM and packet based communications for
which patent applications have been filed in Canada, the United States
and pursuant to the Patent Cooperation Treaty form the basis of the
technology used by EXFO Protocol for its protocol testing products.
Confidentiality and proprietary information agreements with our senior
management, employees and others generally stipulate that all confidential
information developed or made known to these individuals by us during the course
of their relationship is to be kept confidential and not disclosed to third
parties, except in specific circumstances. The agreements also generally provide
that all intellectual property developed by the individual in the course of
rendering services to us belongs exclusively to us. These efforts afford only
limited protection.
C. ORGANIZATIONAL STRUCTURE
As of December 15, 2004, the following chart presents our corporate
structure, the jurisdiction of incorporation of our subsidiaries and the
percentage of shares that we hold in those subsidiaries.
[GRAPHIC OMITTED -- ORGANIZATIONAL CHART]
--------------------
EXFO Electro-Optical
Engineering Inc.
18/09/1985
(Canada)
Operating
--------------------
|
|
|
100% 100% 100% 85% 100% 100% 100% 100%
--- --------------- ------------- -------------- ------------ ---------- ---------------- ---------------- ----------------
| EXFO UK Limited EXFO Photonic GEXFO GAP Optique EXFO Asia Nortech Fibronic EXFO Protocol Burleigh
| (United Kingdom) Solutions Inc. Distribution SA Pacific Inc. Inc.(formerly) Instruments GmbH
| Dissolved (formerly Efos Internationale 17/05/1994 PTE Ltd. 14/08/1991 Avantas Networks (Germany)
| 25/11/2003 Inc.) Inc. (Switzerland) 18/01/2001 (Canada) Corporation) Non-operating
| 20/02/1984 17/12/1992 Operating (Singapore) Non-operating 02/11/2001
| (Ontario) (Quebec) Operating (Canada)
| Operating Holding Dissolved
| 12/09/2003
| | |
| -------------------------------------------- -------------
| 100% 100% 100% 100%
| ------------------ ----------- ---------- -------------
| EXFO Spain Holding EXFO Europe EXFO USA [Nortech
| S.L. 08/02/1994 SARL Inc. Fibronic Inc.
| (Spain) 08/02/1994 07/12/2000 (Texas)
| Holding (Franc) (Delaware) Dissolved
| Operating Holding 07/09/2001]
| | |
| ------------------- -------------------------------------------
| 100% 100% 100% 100%
| ------------------- ------------ --------- -------------
| EXFO International EXFO America EXFO EXFO Gnubi
| Services Management Inc. Burleigh Products
| LLC 15/12/1992 Products Group Inc.
| 22/11/2000 (Delaware) Group Inc. 04/09/2002
| (Hungary)-Operating Operating 25/08/1972 (Delaware)
| (New York) Non-Operating
| Operating
| / \
| -------------------------------------------
| 71.5% 100%
| ------------- -------------
| [Burleigh Burleigh
| 28.5% Instruments Automation
------------------------------------ (UK) Ltd. Inc.
(United (Delaware)
Kingdom) Non-operating
Dissolved
12/11/2002]
D. PROPERTY, PLANT AND EQUIPMENT
Our main offices and facilities are located in Quebec City, Canada
where we now occupy two buildings. These buildings house our executive and
administrative offices, research and development facilities and production
facilities. We also have facilities in Montreal, Canada (formerly EXFO Protocol)
and in Toronto, Canada (EXFO Photonic). EXFO Burleigh's facilities are located
in Victor, in the state of New York and are presently for sale.
41
In addition, we maintain sales offices in China, France, Germany, Great
Britain, Japan, Singapore, Mexico and the United States.
In September 2002, we obtained ownership of one of the buildings
housing production facilities in Quebec City that was previously leased from a
company controlled by EXFO's president and chief executive officer. In September
2003, due to down-sizing efforts, we were able to move all of our Quebec City
activities into two buildings, rather than three. Though we no longer occupy the
facilities at 465 Godin Avenue in Vanier, we remain bounded by the lease until
November 30, 2006. However, on September 1, 2004, we were released from our
obligations under the lease with a final payment of $194,000 (CA$250,000).
The following table sets forth information with respect to the main
facilities that we occupy as of December 31, 2004.
LOCATION USE OF SPACE SQUARE FOOTAGE TYPE OF INTEREST
-------- ------------ -------------- ----------------
436 Nolin Street Manufacturing 44,164 Owned
Vanier (Quebec)
400 Godin Avenue Research and Development, Manufacturing, 128,800 Owned
Vanier (Quebec) Executive and Administrative
2260 Argentia Road Partially occupied for Research and 25,328 (1) Leased
Mississauga (Ontario) Development, Manufacturing and
Administrative
2650 Marie-Curie Research and Development, Manufacturing 26,000 Leased
St-Laurent (Quebec) and Administrative
7647 Main Street Fishers Partially occupied, for Research and 5,100 (2) Owned
Victor (New York) Development, Services, Administrative
and Sales.
1) 10,672 square feet have been subleased to a third party. The total square
footage leased is 36,000.
2) 34,900 square feet is unoccupied. The total square footage owned is 40,000
which is presently for sale.
42
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion and analysis of the consolidated financial condition
and results of operations of EXFO Electro-Optical Engineering Inc. for the
fiscal years ended August 31, 2002, 2003 and 2004, should be read in conjunction
with our consolidated financial statements and the related notes included
elsewhere in this Annual Report. Our consolidated financial statements are
reported in US dollars and have been prepared in accordance with generally
accepted accounting principles in Canada, or Canadian GAAP. Significant
differences in measurement and disclosure from generally accepted accounting
principles in the United States, or U.S. GAAP, are set out in note 20 to our
consolidated financial statements.
The following discussion and analysis of financial condition and results of
operations is dated September 30, 2004.
INDUSTRY OVERVIEW
Following three years of reductions in capital expenditures (CAPEX) among
network service providers (NSPs), some measure of stability returned to the
marketplace in 2004. Telecom carriers and cable multiple-system operators
(MSOs), which fall under the NSP designation, resumed investing in their
networks to ultimately gain stronger access to the consumer's pocketbook with
their triple-play offering of video, data and voice services. Investments in IP
networking were particularly prevalent among these groups, as this will allow
them to provide more cost-effective delivery of voice services (i.e., VoIP).
Telecom carriers also invested in network architectures like
fiber-to-the-premises (FTTP) in order to extend their available bandwidth to the
home, which will enable them to offer video services as well. These investments,
however, were offset by CAPEX reductions in other areas of the network to
produce relatively flat spending patterns year-over-year.
This relative stability in CAPEX spending was witnessed in multiple segments of
the global telecommunications supply chain. System manufacturers benefited from
NSP orders for next-generation, converged IP networks and fiber deployments in
access areas. Component vendors, who had been hardest hit by the downturn, began
seeing incremental demand for optical components that support IP-based systems.
Some test and measurement equipment vendors, whose products enable customers to
reduce CAPEX and operating expenses (OPEX), attracted the attention of NSPs,
system vendors and component manufacturers, especially ones offering test
solutions for VoIP and/or FTTP applications.
COMPANY OVERVIEW
EXFO is a recognized expert in the global telecommunications industry through
the design and manufacture of advanced and innovative test and measurement
solutions. The Telecom Division, which represents our main business activity,
offers a complete range of dedicated and integrated test solutions to NSPs,
system vendors and component manufacturers in approximately 70 countries. One of
our strongest competitive advantages is our modular platform design, based on a
PC/Windows-centric architecture to offer a series of test solutions that
maximize technology reuse across multiple market segments. The Photonics and
Life Sciences Division mainly leverages core telecom technologies to offer
value-added solutions for life sciences applications and high-precision assembly
processes, such as those required for microelectronics and optoelectronics.
43
EXFO was founded in Quebec City, Canada in 1985. Our original products were
focused on the needs of installers and operators of fiber-optic networks.
Customers use these field-portable testing products for the installation,
maintenance, monitoring and troubleshooting of optical networks. In 1996, we
supplemented our product portfolio with an extensive line of high-end products
that are mainly dedicated to research and development as well as manufacturing
activities.
In the last three years, we have enhanced our competitive position through the
acquisition of two protocol test businesses in order to extend our product
offering and address our customers' requirements more completely. In November
2001, we acquired Avantas Networks Corporation (renamed EXFO Protocol Inc.), a
supplier of protocol testing and optical-network-performance management
equipment for NSPs. This transaction was highly strategic because it enabled us
to combine optical and protocol test modules inside a single field-portable test
platform to help our customers increase revenues and reduce operating costs. In
October 2002, our wholly-owned subsidiary, EXFO Gnubi, purchased substantially
all the assets of GNUBI COMMUNICATIONS, L.P., a supplier of multi-channel
telecom and datacom testing solutions for the system manufacturer market. These
strategic acquisitions, which were consolidated in Montreal in fiscal 2004,
enabled us to double our addressable market, as we expanded from optical testing
into protocol testing applications, and to offer a more complete test solution
to customers.
Previously, we had completed two acquisitions to bolster growth in the optical
component manufacturing market. We acquired Burleigh Instruments, Inc. (renamed
EXFO Burleigh Products Group Inc.) in December 2000 for its wavelength
measurement instruments and nanopositioning alignment systems. We also added
EFOS Inc. (renamed EXFO Photonic Solutions Inc.) in March 2001 for its precision
light-based, adhesive spot-curing technology. We have since exited the optical
component manufacturing automation business.
At the beginning of fiscal 2004, we reorganized our business under two
divisions: the Telecom Division and the Photonics and Life Sciences Division.
Our objectives behind this new structure 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 the former Portable and Monitoring and telecom-related Industrial and
Scientific product lines, is focused on NSPs, telecommunication system
manufacturers and optical component vendors on a global basis. Our Photonics and
Life Sciences Division, which includes previous non-telecom Industrial and
Scientific product lines, mainly leverages developed and acquired core telecom
technologies for diverse high-precision assembly and life sciences markets.
Following this reorganization, our two divisions now have respective sales,
marketing, manufacturing, research and development as well as management teams
and are, therefore, presented as two corresponding reportable segments in the
financial statements. We have disclosed segmented information about each of
these segments in our consolidated financial statements for fiscal 2004.
However, we did not provide comparative information for previous periods about
each reportable segment (except for sales and long-lived assets) because this
information is not available and it is impracticable to determine. Please refer
to note 18 to our 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.
44
In fiscal 2004, we launched 20 new products, including several aimed at
establishing leadership in the emerging FTTP market and others dedicated to
expanding our life sciences product portfolio. We also strengthened our
competitive position in protocol testing through the introduction of a
next-generation Fibre Channel test set for security-intensive applications and,
subsequent to the year-end, we released a next-generation SONET/SDH analyzer for
data-centric IP networks as well as a Gigabit Ethernet test solution with VoIP
test capabilities.
In February 2004, we closed a 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). EXFO closed the fiscal year with cash and short-term
investments amounting to $89.1 million.
In May 2004, we successfully renewed our collective bargaining agreement with
unionized manufacturing employees in Quebec City, Canada.
In the third quarter of fiscal 2004, we performed our annual impairment test for
goodwill and reviewed the carrying value of certain acquired intangible assets
for impairment. Based on our impairment tests, we concluded that goodwill and
these intangible assets were not impaired.
Near the end of the fiscal year, we reached the decision to consolidate
operations of our Photonics and Life Sciences Division in order to improve its
market focus and efficiency. Consequently, we have begun transferring EXFO
Burleigh's operations mostly to Toronto. To fully implement this consolidation,
we expect to incur restructuring and other charges of $2.7 million, of which
$1.7 million was already recorded in the fourth quarter of fiscal 2004; the
remainder will be recorded in 2005. We estimate that we will derive $1.5 million
in annual savings from these streamlined operations.
Finally, in August 2004, we reviewed the carrying value of one of our buildings
that has been put up for sale and we concluded that the building was impaired.
We recorded an impairment charge of $620,000. This building reports to the
Telecom Division.
SALES
We sell our products to a diversified customer base in approximately 70
countries through our direct sales force and, indirectly, through distribution
channels. As mentioned above, our customers are comprised of NSPs, manufacturers
of communication systems and optical components, as well as research and
development laboratories. We have a diversified customer base, both in terms of
industry sector and geographical area, which provides us with reasonable
protection against concentration of credit risk.
COST OF SALES
Cost of sales includes raw materials, salaries and related expenses for direct
and indirect manufacturing personnel (net of government grants) as well as
overhead costs. Excess, obsolete and scrapped materials are also included in
cost of sales. However, cost of sales is exclusive of amortization, which is
shown separately in the statement of earnings.
OPERATING EXPENSES
We classify our operating expenses into three main categories: selling and
administrative expenses, research and development expenses and amortization
expenses.
45
Selling and administrative expenses consist primarily of salaries and related
expenses for personnel (net of government grants), sales commissions, travel
expenses, marketing programs, professional services, information systems, human
resources and other corporate expenses.
Gross research and development expenses consist primarily of salaries and
related expenses for engineers and other technical personnel, material component
costs as well as fees paid to third-party consultants. We are eligible to
receive research and development tax credits and government grants on research
and development activities carried out in Canada. All related research and
development tax credits and government grants are recorded as a reduction of
gross research and development expenses. Tax credit write-offs are also included
in net research and development expenses.
Operating charges related to our restructuring plans have been recorded as a
separate component of operating expenses. These charges consist primarily of
severance expenses, costs to exit leased facilities as well as write-offs of
long-lived assets.
OUR STRATEGY
STRATEGIC OBJECTIVES FOR FISCAL 2004
In our fiscal 2003 Annual Report, we had established four strategic objectives
for fiscal 2004. We planned to increase sales through market-share gains;
maximize profitability and growth on a long-term basis by focusing on gross
margin improvements; innovate our way out of the downturn by successfully
bringing to market differentiated products that allow us to seize targeted
market opportunities; and maintain a sound financial position both as a
strategic and defensive asset. We had also established key performance
indicators as measures to assess the realization of our objectives. The
following table summarizes these objectives and key performance indicators as
well as the results achieved in fiscal 2004:
---------------------------------------------------------------------------------------------------------------------
STRATEGIC OBJECTIVES KEY PERFORMANCE INDICATORS ACTUAL RESULTS GOAL ACHIEVED
---------------------------------------------------------------------------------------------------------------------
Increase sales through 10% sales growth 20.5% sales growth v
market-share gains year-over-year year-over-year
---------------------------------------------------------------------------------------------------------------------
Maximize profitability and growth 50% gross margin 53.7% gross margin v
on a long-term basis
---------------------------------------------------------------------------------------------------------------------
Innovate our way out of the 45% of our sales from new 31.7% of our sales from x
downturn products (on the market for two new products
years or less)
---------------------------------------------------------------------------------------------------------------------
Maintain a sound Positive cash flows from Cash flows from operating v
financial position operating activities for at activities at $751,000 for
least one quarter fiscal 2004
---------------------------------------------------------------------------------------------------------------------
46
INCREASE SALES THROUGH MARKET-SHARE GAINS
We posted our second-best sales performance in history, growing sales 20.5% to
$74.6 million in fiscal 2004, compared to our KPI of 10%. Considering that the
marketplace remained relatively flat in 2004, we believe this means that we
gained market share overall. For fiscal 2004, our Telecom Division and Photonics
and Life Sciences Division reported sales increases of 20.8% and 19.5%,
respectively.
MAXIMIZE PROFITABILITY AND GROWTH ON A LONG-TERM BASIS
We sought to maximize profitability with a focus on raising our gross margin
above 50%. In fact, for fiscal 2004, we achieved a gross margin of 53.7%. We
surpassed our objective mainly due to our increased sales volume and because we
paid close attention to our supply chain. We focused our R&D not only on being
first to market, but also on achieving the lowest possible cost of goods
required to meet the highest performance criteria. In addition, we streamlined
manufacturing operations into fewer sites, while continuing to deliver superior
value to customers.
INNOVATE OUR WAY OUT OF THE DOWNTURN
Ever since we founded EXFO in 1985, innovation strategies have focused on being
first to market with unique solutions that anticipate and better address
customer requirements. Our market-driven approach can be demonstrated through a
long history of industry firsts. This focus on delivering a unique value
proposition to the marketplace is of strategic importance to improve our gross
margin. As a KPI for this strategic objective, we anticipated that sales of new
products (on the market two years or less) would reach 45% of global sales for
fiscal 2004. However, in fiscal 2004, new products represented 31.7% of total
sales mainly because key customers in our space were more conservative than
expected, as they were more active planning their future strategies than
deploying them.
We believe that the 20 new products and key innovations brought to market in the
last 12 months are well targeted for market opportunities and we expect that our
percentage of sales from new products is going to increase in the quarters and
year to come. Incidentally, for the fourth quarter of 2004, this innovation rate
was at 38%.
MAINTAIN A SOUND FINANCIAL POSITION
In fiscal 2004, cash flows provided by operating activities were positive at
$751,000, enabling us to meet our KPI of attaining positive cash flows from
operations in at least one quarter in the fiscal year. In fact, cash flows from
operating activities were positive for the last three quarters of 2004. We
believe that our solid balance sheet (including cash on hand and short-term
investments amounting to $89.1 million and minimal debt) is not only reassuring
to customers but, more importantly, will help ensure our long-term development
and allow for possible acquisitions.
STRATEGIC OBJECTIVES FOR FISCAL 2005
For fiscal 2005, we believe general market conditions will be relatively similar
to fiscal 2004 as CAPEX spending is expected to remain fairly tight for wireline
operators overall. However, we expect that wireline operators will spend within
certain growth vectors (namely IP networking and FTTP deployments), for which we
have already begun positioning ourselves.
As you might expect, our strategic directions, and therefore our KPIs, for
fiscal 2005 will not be radically different from those of fiscal 2004. Since we
are highly focused on creating value for our shareholders, providing the highest
degree of profitable growth is at the heart of our actions.
47
We intend to maintain our long-term focus on profitable growth by increasing
sales through further market-share gains; maximize profitability through proper
execution and efficiency of our cost-reduction programs; and focus on innovation
to positively position the organization for the long-term growth opportunities
that exist in our space.
INCREASE SALES THROUGH MARKET-SHARE GAINS
In fiscal 2005, we plan to focus on continued market-share gains to achieve
growth, assuming the stability or slight growth of our addressable
telecommunications market. We expect the CAPEX environment to be relatively
stable with a few clear shifts made by carriers towards their key strategic
initiatives. In fiscal 2004, we believe that our 20.5% sales growth in a stable
market indicated that we gained market share. For fiscal 2005, we intend once
again to grow sales faster than the market by leveraging our sustained R&D
investments in areas such as next-generation Internet protocol (IP) and
fiber-to-the-premises (FTTP) testing, by intensifying our sales and marketing
efforts, both domestic and international, and by strengthening and expanding our
business relationships with major accounts.
MAXIMIZE PROFITABILITY
Returning to profitability remains a top priority at EXFO. We anticipate that
our expected sales growth combined with a series of internal initiatives will
bring us to profitability on a pro-forma basis in fiscal 2005. At EXFO, pro
forma net earnings represent GAAP net earnings excluding stock-based
compensation costs, amortization of intangible assets, restructuring charges and
other unusual items. Recent consolidation efforts of our protocol activities in
Montreal and our life sciences operations in Toronto are expected to bear fruit
in fiscal 2005. We also applied strategies to maximize supply chain efficiency,
overall execution, and R&D (focusing on cost of goods, rather than strictly on
being first to market).
FOCUS ON INNOVATION
In fiscal 2005, we expect that innovation will continue to be a key driver for
us. Although we fell short of this strategic objective for fiscal 2004, we
beleive that our commitment to innovation will pay off in the long term and
support our growth and profitability targets. We have maintained a significant
level of R&D investment since the telecom peak in 2001 and brought 20 new
products to the marketplace in fiscal 2004--several of which were released in
the second half of the fiscal year and have therefore not yet reached their
market potential. For fiscal 2005, we intend to invest a similar amount in R&D
compared to fiscal 2004. We believe these initiatives will enable our new
products to continue gaining traction with customers and lead to further
market-share gains in the coming years.
KEY PERFORMANCE INDICATORS
As measures to assess the realization of our strategic plan and its objectives,
we have set out three consolidated key performance indicators for fiscal 2005.
They are summarized as follows:
--------------------------------------------------------------------------------
STRATEGIC OBJECTIVES KEY PERFORMANCE INDICATORS
--------------------------------------------------------------------------------
Increase sales through market-share gains 20% sales growth year-over-year,
assuming a stable
telecommunications market
--------------------------------------------------------------------------------
Maximize profitability Profitability on a pro-forma basis
--------------------------------------------------------------------------------
Focus on innovation 45% of sales from new products
(on the market two years or less)
--------------------------------------------------------------------------------
48
CAPABILITY TO DELIVER RESULTS
At EXFO, we believe that we have the capabilities to deliver expected results
thanks to outstanding products, an excellent reputation in the marketplace, a
sound financial position, as well as an experienced workforce and management
team.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's discussion and analysis of financial conditions and results of
operations is based on our consolidated financial statements included elsewhere
in this Annual Report. As previously mentioned, they have been prepared in
accordance with Canadian GAAP. The preparation of financial statements in
accordance with GAAP requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosures of
contingent assets and liabilities at the date of the financial statements, as
well as the reported amounts of revenues and expenses during the reporting
years. On an ongoing basis, we evaluate these estimates and assumptions,
including those related to revenue recognition, allowance for doubtful accounts,
allowance for excess and obsolete inventories, research and development tax
credits and government grants, impairment of long-lived assets and goodwill,
valuation allowance of future income tax assets, warranty obligations,
restructuring charges as well as contingencies and other obligations. We base
our estimates and assumptions on historical experience and on other factors that
we believe to be reasonable under the circumstances, the result of which form
the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results
could differ from these estimates.
The following summarizes our critical accounting policies as well as other
policies that require the most significant judgment and estimates in the
preparation of our consolidated financial statements.
REVENUE RECOGNITION. For products in which software is incidental, we recognize
revenue when persuasive evidence of an arrangement exists, the product has been
delivered, the price is fixed and determinable and collection of the resulting
receivable is reasonably assured. In addition, provisions are made for estimated
returns, warranties and support obligations.
For products in which software is not incidental, revenues are separated into
two categories: product and post-contract customer support (PCS) revenues, based
upon vendor-specific objective evidence of fair value. Product revenues for
these sales are recognized as described above. PCS revenues are deferred and
recognized ratably over the years of the support arrangement. PCS revenues are
recognized at the time the product is delivered when provided within one year of
delivery; the costs of providing this support are insignificant (and accrued at
the time of delivery) and no software upgrades are provided.
For all sales, we use a binding purchase order as evidence that a sales
arrangement exists.
Delivery generally occurs when the product is handed over to a transporter for
shipment.
At the time of the transaction, we assess whether the price associated with our
revenue transaction is fixed and determinable, and whether or not collection is
reasonably assured. We assess whether the price is fixed and determinable based
on the payment terms associated with the transaction. We assess collection based
on a number of factors, including past transaction
49
history and the creditworthiness of the customer. Generally, collateral or other
security is not requested from customers.
Most sales arrangements do not generally include acceptance clauses. However, if
a sales arrangement includes an acceptance provision, acceptance occurs upon the
earliest of the receipt of a written customer acceptance or the expiration of
the acceptance period. For these sales arrangements, the sale is recognized when
acceptance occurs.
Revenue for extended warranties is recognized on a straight-line basis over the
warranty period.
ALLOWANCE FOR DOUBTFUL ACCOUNTS. We estimate collectibility of accounts
receivable on an ongoing basis by reviewing balances outstanding over a certain
period of time. We determine our allowance for doubtful accounts receivable
based on our historical accounts receivable collection experience and on the
information that we have about the status of our accounts receivable balances.
If the financial conditions of our customers deteriorate, resulting in an
impairment of their ability to make required payments, additional allowance may
be required, which could adversely affect our future results.
ALLOWANCE FOR EXCESS AND OBSOLETE INVENTORIES. We state our inventories at the
lower of cost, determined on an average cost basis and replacement cost or net
realizable value, and provide reserves for excess and obsolete inventories. We
determine our reserves for excess and obsolete inventories based on the
quantities we have on hand versus expected needs for these inventories, so as to
support future sales of our products. It is possible that additional inventory
reserves may occur if future sales are less than our forecasts or if there is a
significant shift in product mix compared to our forecasts, which could
adversely affect our future results.
RESEARCH AND DEVELOPMENT TAX CREDITS AND GOVERNMENT GRANTS. We record research
and development tax credits and government grants based on our interpretation of
tax laws and grant programs, especially regarding related eligible projects and
expenses, and when there is reasonable assurance that we have complied and will
continue to comply with all conditions and laws. Also, our judgment and
estimates are based on historical experience. It is possible, however, that the
tax authorities have a different interpretation of laws and application of
conditions related to the programs or that we do not comply with all conditions
related to grants in the future, which could adversely affect our future
results. Furthermore, a large part of our tax credits are refundable against
income taxes payable, causing their ultimate realization to be dependent upon
the generation of taxable income. If we obtain information that causes our
forecast of future taxable income to change or if actual taxable income differs
from our forecast, we may have to revise the carrying value of these tax
credits, which would affect our results in the period in which the change was
made. We review the recoverability of such tax credits on a quarterly basis.
IMPAIRMENT OF LONG-LIVED-ASSETS AND GOODWILL. We assess impairment of goodwill
on an annual basis, or more frequently, if events or circumstances occur that
more likely than not reduce the fair value of a reporting unit below its
carrying value. Goodwill impairment exists when the carrying value of a
reporting unit exceeds its fair value. The fair value of a reporting unit is
determined based on a combination of discounted future cash flows and a market
approach. The amount of impairment loss, if any, is the excess of the carrying
value of goodwill over its fair value.
We assess impairment of long-lived assets when events or circumstances indicate
that costs may not be recoverable. Impairment exists when the carrying value of
the asset is greater than
50
the pre-tax undiscounted future cash flows expected to be provided by the asset.
The amount of impairment loss, if any, is the excess of the carrying value over
its fair value. We assess fair value of intangible assets based on discounted
future cash flows.
FUTURE INCOME TAXES. We account for income taxes using the liability method of
tax allocation. Under this method, future income tax assets and liabilities are
determined based on deductible or taxable temporary differences between
financial statement values and tax values of assets and liabilities, using
enacted income tax rates for the years in which the differences are expected to
reverse. In assessing the recoverability of our future income tax assets, we
consider whether it is more likely than not that some or all of the future
income tax assets will not be realized. The ultimate realization of certain
future income tax assets is dependent upon the generation of future taxable
income during the periods in which those temporary differences will become
deductible. As at August 31, 2004, we had established a full valuation allowance
against our future income tax assets. The valuation allowance will be reversed
once management will have concluded that realization of future income tax assets
is more likely than not.
During fiscal 2004, we also adopted the following new Canadian Institute of
Chartered Accountants (CICA) handbook section and guideline:
o Section 3870, "Stock-Based Compensation and Other Stock-Based Payments"
o Accounting Guideline 13, "Hedging Relationship"
On September 1, 2004, we adopted new CICA handbook sections 1100 and 1400,
"Generally Accepted Accounting Principles" and "General Standards of Financial
Statement Presentation". The adoption of these new standards had no significant
impact on our financial statements.
Please refer to note 2 to our consolidated financial statements included
elsewhere in this Annual Report for further information about these new
standards and their impact on our financial statements.
51
RESULTS OF OPERATIONS
The following table sets forth certain Canadian GAAP consolidated financial
statements data in thousands of US dollars, except per share data, and as a
percentage of sales for the years indicated:
CONSOLIDATED STATEMENTS OF EARNINGS
DATA: 2004 2003 2002 2004 2003 2002
-----------------------------------------------------------------------------------------------------------------------
Sales............................. $ 74,630 $ 61,930 $ 68,330 100.0% 100.0% 100.0%
Cost of sales (1)................. 34,556 36,197 52,366 46.3 58.4 76.6
-----------------------------------------------------------------------------------------------------------------------
Gross margin ..................... 40,074 25,733 15,964 53.7 41.6 23.4
-----------------------------------------------------------------------------------------------------------------------
Operating expenses
Selling and administrative...... 25,890 26,991 33,881 34.7 43.6 49.6
Net research and development ... 12,390 15,879 12,782 16.6 25.6 18.7
Amortization of property, plant
and equipment (2)............ 4,935 5,210 5,096 6.6 8.4 7.4
Amortization of intangible
assets (2)................... 5,080 5,676 12,451 6.8 9.2 18.3
Impairment of long-lived assets
and goodwill................. 620 7,427 23,657 0.8 12.0 34.6
Restructuring and other charges. 1,729 4,134 2,880 2.3 6.7 4.2
-----------------------------------------------------------------------------------------------------------------------
Total operating expenses.......... 50,644 65,317 90,747 67.8 105.5 132.8
-----------------------------------------------------------------------------------------------------------------------
Loss from operations.............. (10,570) (39,584) (74,783) (14.1) (63.9) (109.4)
Interest and other income......... 1,438 1,245 1,456 1.9 2.0 2.1
Foreign exchange loss............. (278) (1,552) (458) (0.4) (2.5) (0.7)
-----------------------------------------------------------------------------------------------------------------------
Loss before income taxes and
amortization and write-down of
goodwill........................ (9,410) (39,891) (73,785) (12.6) (64.4) (108.0)
Income taxes...................... (986) 15,059 (25,451) (1.3) 24.3 (37.3)
-----------------------------------------------------------------------------------------------------------------------
Loss before amortization and
write-down of goodwill.......... (8,424) (54,950) (48,334) (11.3) (88.7) (70.7)
Amortization of goodwill.......... -- -- 38,021 -- -- 55.7
Write-down of goodwill............ -- -- 222,169 -- -- 325.1
-----------------------------------------------------------------------------------------------------------------------
Net loss for the year............. $ (8,424) $ (54,950) $(308,524) (11.3)% (88.7)% (451.5)%
=======================================================================================================================
Basic and diluted net loss per share $ (0.13) $ (0.87) $ (5.09)
Segment information (3)
Sales:
Telecom Division $ 58,882 $ 48,753 $ 54,452 78.9% 78.7% 79.7%
Photonics and Life Sciences Division 15,748 13,177 13,878 21.1% 21.3% 20.3%
-----------------------------------------------------------------------------------------------------------------------
$ 74,630 $ 61,930 $ 68,330 100.0% 100.0% 100.0%
=======================================================================================================================
Operating loss:
Telecom Division $ (5,557) $ -- $ -- (7.4)% --% --%
Photonics and Life Sciences Division (5,013) -- -- (6.7) -- --
-----------------------------------------------------------------------------------------------------------------------
$ (10,570) $ -- $ -- (14.1)% --% --%
=======================================================================================================================
Research and development data:
Gross research and development.. $ 15,668 $ 17,133 $ 17,005 21.0% 27.7% 24.9%
Net research and development.... $ 12,390 $ 15,879 $ 12,782 16.6% 25.6% 18.7%
OTHER STATEMENTS OF EARNINGS DATA
(UNAUDITED):(4)
Pro forma net loss.............. $ (1,952) $ (10,879) $ (10,702) (2.6)% (17.6)% (15.7)%
Basic and diluted pro forma net
loss per share............... $ (0.03) $ (0.17) $ (0.18)
CONSOLIDATED BALANCE SHEETS DATA:
Total assets $ 172,791 $ 146,254 $ 177,926
=======================================================================================================================
(1) Including inventory write-offs of nil, $4,121 and $18,463 for the years
ended August 31, 2004, 2003 and 2002, respectively, and an unusual gain of
$473 for the year ended August 31, 2003. Excluding inventory write-offs and
the unusual gain, gross margin would have reached 47.4% for the year ended
August 31, 2003. Excluding inventory write-offs, gross margin would have
reached 50.4% for the year ended August 31, 2002. This latter information
is unaudited and is a non-GAAP measure. The cost of sales is exclusive of
amortization, shown separately.
(2) Certain comparative figures were reclassified to conform to the
current-year presentation.
(3) Comparative information for the loss from operations is not available and
is impracticable to determine.
(4) Net loss excluding stock-based compensation costs, amortization and
write-down of goodwill, unusual tax recovery, future income tax assets
valuation allowance and the after-tax effect of amortization of intangible
assets, impairment of long-lived assets, restructuring and other charges,
inventory and tax credit write-offs and unusual grants recovery. This
information may not be comparable to similarly titled measures reported by
other companies because it is non-GAAP information. Please refer to page 61
of this Annual Report for a detailed quantitative reconciliation.
52
SALES
FISCAL 2004 VS. 2003
In fiscal 2004, our global sales increased 20.5% to $74.6 million from $61.9
million in 2003, with a 79%-21% split in favor of our Telecom Division.
TELECOM DIVISION
In fiscal 2004, sales of our Telecom Division increased 20.8% to $58.9 million
from $48.8 million in 2003. In 2004, despite a relatively stable carrier
spending environment, compared to the previous year, we continued to gain market
share, which helped us increase our sales year-over-year. We believe these
market-share gains are mainly attributable to our optical field-testing
products, which represent our traditional core business, since sales of our
protocol-layer test solutions represented just over 10% of our Telecom sales in
fiscal 2004. In addition, we benefited from a slight recovery in the telecom
system and optical manufacturing markets. Finally, revenues from FTTP test
solutions were higher than expected, especially with a tier-one customer, which
contributed to our sales increase.
The current protocol-layer test market proves to be highly competitive as it
prepares for deployment of next-generation SONET/SDH and new IP-intensive
architectures. We remain confident that the solid product portfolio we are
building for this crucial end-market will lead to long-term growth for EXFO.
Over the last few months, we have also been offering new and enhanced
extended-warranty programs, which have significantly increased extended-warranty
sales. Revenues from these sales are deferred and recognized over the warranty
period, causing our deferred revenue to increase year-over-year.
PHOTONICS AND LIFE SCIENCES DIVISION
In fiscal 2004, sales of our Photonics and Life Sciences Division increased
19.5% to $15.7 million from $13.2 million in 2003. The increase in sales is due
to the greater demand for our high-tech industrial manufacturing solutions.
Overall, for the two divisions, net accepted orders increased 34.6% to $75.0
million in fiscal 2004 from $55.7 million in 2003. Our net book-to-bill ratio
rose to 1.00 in fiscal 2004, from 0.90 in 2003.
For the upcoming quarters, we expect the sales split between the two divisions
to remain in the same range as for fiscal 2004.
FISCAL 2003 VS. 2002
In fiscal 2003, our global sales decreased 9.4% to $61.9 million from $68.3
million in 2002, with a 79%-21% split in favor of our Telecom Division.
TELECOM DIVISION
In fiscal 2003, sales of our Telecom Division decreased 10.5% to $48.8 million
from $54.5 million in 2002. Most of the decrease is attributable to the
collapsed market for optical components and the resulting gray market. Also,
increased pricing pressure by vendors and the continued slowdown in the global
telecommunications industry affected our sales. However, despite depressed
spending levels in the telecommunications industry, our sales of field-testing
53
products increased 3%, compared to 2002, mainly because of heightened traction
in the protocol-layer testing sector.
PHOTONICS AND LIFE SCIENCES DIVISION
In fiscal 2003, sales of our Photonics and Life Sciences Division decreased 5.1%
to $13.2 million from $13.9 million in 2002. The markets addressed by this
division were relatively stable, thus explaining the relative stability in this
division's sales year-over-year.
GEOGRAPHIC DISTRIBUTION
During fiscal 2004 and 2003, sales to the Americas, Europe-Middle East-Africa
(EMEA) and Asia-Pacific (APAC) accounted for 66%, 18% and 16% of global sales,
respectively. During 2002, sales to the Americas, EMEA and APAC accounted for
61%, 20% and 19% of global sales, respectively.
The geographic distribution of our sales remained unchanged as a percentage of
sales in fiscal 2004, compared to 2003, since all geographic areas had the same
growth level.
In fiscal 2003, sales to the Americas stayed relatively stable in dollars
compared to 2002, while sales to the EMEA and APAC markets decreased
year-over-year. The EMEA market was the most affected by the downturn in the
telecommunications industry, which caused our sales to this market to decrease
year-over-year. In addition, most of our sales to the APAC market are made
through tenders, which may vary in number and significance from period to
period. Finally, the SARS outbreak also affected our sales to this market to
some extent.
Through our two divisions, we sell our products to a broad range of customers,
including network service providers, optical component and system manufacturers,
as well as high-tech industrial manufacturers and research and development
laboratories. During fiscal 2004, we had only one customer that accounted for
more than 10% of sales, representing 13.8% of sales ($10.3 million). During that
same year, our top three customers accounted for 20.8% of our sales. During
2003, no customer accounted for more than 10% of our sales. In fiscal 2002, we
had one customer that accounted for more than 10% of sales, with 10.2% ($7.0
million).
GROSS MARGIN
Gross margin amounted to 53.7%, 41.6% and 23.4% of sales for fiscal 2004, 2003
and 2002, respectively.
FISCAL 2004 VS. 2003
In fiscal 2003, we recorded write-offs for excess and obsolete inventories of
$4.1 million and an unusual gain of $473,000 related to a grant recovery.
Excluding these special items, gross margin would have reached 47.4% of sales
for that year.
The increase in our gross margin in fiscal 2004, compared to 2003, can be
explained by several factors. First, the rise in sales (20.5% year-over-year)
undoubtedly helped increase our gross margin. Increased manufacturing activities
allowed us to better absorb our fixed manufacturing costs. In addition, our
cost-reduction measures, the consolidation of manufacturing sites and our
enhanced efficiency further contributed to the increase in gross margin.
However, a stronger Canadian dollar, compared to the US dollar year-over-year,
prevented us, to some extent, from
54
further improving our gross margin as some cost of sales elements are
denominated in Canadian dollars.
FISCAL 2003 VS. 2002
In fiscal 2002, we also recorded write-offs for excess and obsolete inventories
of $18.5 million. Excluding these special charges, our gross margin would have
reached 50.4% of sales. The decrease in our gross margin in fiscal 2003,
compared to 2002, on an adjusted basis, is attributable to several factors.
First, the market condition and competitive landscape inevitably led to
increased pricing pressure. This, combined with a lower sales level in fiscal
2003, prevented a better absorption of our fixed manufacturing costs, which
ultimately caused margin erosion. In addition, shift in product mix in favor of
our field-testing products caused our gross margin to decrease, as these
products tend to have lower margins than our modular and benchtop products.
However, the decrease in our gross margin was offset in part by our increased
efficiency and restructuring efforts in 2002 and 2003.
OUTLOOK FOR FISCAL 2005
Considering the current state of the telecommunications industry, our recent
cost-cutting measures, our tight control on operating costs as well as our
expected sales growth, we believe that our gross margin will improve in fiscal
2005. 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. Finally, the expected
increased strength of the Canadian dollar should have, to some extent, a
negative impact on our gross margin in 2005.
SELLING AND ADMINISTRATIVE
Selling and administrative expenses were $25.9 million, $27.0 million and $33.9
million for fiscal 2004, 2003 and 2002, respectively. As a percentage of sales,
selling and administrative expenses amounted to 34.7%, 43.6% and 49.6% for
fiscal 2004, 2003 and 2002, respectively.
FISCAL 2004 VS. 2003
In fiscal 2004, thanks to our restructuring actions and tight cost-control
measures, we were able to reduce our selling and administrative expenses by 4%
year-over-year, while our sales increased 20.5% in that same period. However,
several factors prevented us from further reducing these expenses
year-over-year. A higher sales volume in fiscal 2004, compared to 2003, caused
our commission and marketing expenses to increase. In addition, since September
1, 2003, we account for non-cash stock-based compensation costs related to
awards granted to our employees, which caused our selling and administrative
expenses to increase $265,000 year-over-year. Furthermore, in fiscal 2003, we
recorded an unusual gain of $239,000 related to a grant recovery. Finally, a
stronger Canadian dollar, compared to the US dollar year-over-year, further
increased our selling and administrative expenses, as some of these are incurred
in Canadian dollars.
FISCAL 2003 VS. 2002
In fiscal 2003, as a result of our restructuring plans implemented in 2002 and
2003, we were able to significantly reduce our selling and administrative
expenses year-over-year (20%). Also,
55
the decrease in sales in fiscal 2003 resulted in lower commission and marketing
expenses during that year. Finally, in 2003, as mentioned above, we recorded an
unusual gain of $239,000 related to a grant recovery. However, this significant
decrease in our selling and administrative expenses was offset in part by the
impact of the acquisitions of EXFO Protocol and EXFO Gnubi in November 2001 and
October 2002, respectively. Also, the increased strength of the Canadian dollar,
compared to the US dollar, in fiscal 2003, prevented us from further reducing
our selling and administrative expenses, as some of these are incurred in
Canadian dollars.
OUTLOOK FOR FISCAL 2005
For fiscal 2005, we expect our selling and administrative expenses to increase
in dollars and be relatively stable as a percentage of sales. In particular, we
expect our commission expenses to increase as sales volume increases. Also,
considering our goal of becoming the leading player in the telecom test and
measurement space, we will intensify our sales and marketing efforts, both
domestic and international, which will also cause our expenses to rise. Finally,
the expected increased strength of the Canadian dollar should also cause our
selling and administrative expenses to increase, as some of these are incurred
in Canadian dollars.
RESEARCH AND DEVELOPMENT
Gross research and development expenses totaled $15.7 million, $17.1 million,
$17.0 million for fiscal 2004, 2003 and 2002, respectively. As a percentage of
sales, gross research and development expenses amounted to 21.0%, 27.7% and
24.9% for fiscal 2004, 2003 and 2002, respectively.
FISCAL 2004 VS. 2003
The decrease in our gross research and development expenses in fiscal 2004,
compared to 2003, both in dollars and as percentage of sales can be explained by
several factors. First, our restructuring actions, the consolidation of our
protocol operations in Montreal, as well as tight cost-control measures,
contributed to the reduction of our gross research and development expenses
year-over-year. In addition, we refocused our research and development
activities in our Photonics and Life Sciences Division. Finally, mix and timing
of our research and development projects, especially in our Telecom Division,
caused our gross research and development expenses to decrease year-over-year.
On the other hand, a stronger Canadian dollar, compared to the US dollar
year-over-year, increased our gross research and development expenses, as most
of these are incurred in Canadian dollars.
Although we reduced our gross research and development expenses year-over-year,
we still invested significantly in R&D activities in fiscal 2004, mainly in our
Telecom Division for IP-based convergence and FTTP deployments. 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. As mentioned above, in fiscal 2004, we
launched 20 new products, including several aimed at establishing leadership in
the emerging FTTP market and others dedicated to expanding our life sciences
product portfolio.
FISCAL 2003 VS. 2002
In fiscal 2003, our dollar-amount gross research and development expenses
remained flat compared to 2002. The savings related to our restructuring actions
were fully offset by the
56
impact of the acquisitions of EXFO Protocol and EXFO Gnubi, which carried out a
significant level of research and development activities, and by the strength of
the Canadian dollar, compared to the US dollar, since a large portion of our R&D
expenses are incurred in Canadian dollars. The percentage increase in fiscal
2003, compared to 2002, can be explained by the fact that despite challenging
market conditions, we continued investing heavily in research and development,
especially in the protocol-layer sector. In fact, in 2003, we launched 15 new
products, most of which were telecom-related solutions.
Tax credits and grants from the Canadian federal and provincial governments for
research and development activities were $3.3 million, $3.6 million and $4.2
million for fiscal 2004, 2003 and 2002, respectively. The decrease in our tax
credits and government grants in fiscal 2004, compared to 2003, is mainly
related to the decrease in our eligible gross research and development expenses
incurred in Canada, since we were entitled to similar tax credits
year-over-year. The decrease in tax credits and grants in fiscal 2003, compared
to 2002, is due to several reasons. First, our government grant programs came to
an end. Second, the acquisition of U.S.-based EXFO Gnubi, early in 2003, led to
a larger portion of our R&D activities being conducted in the U.S., where such
activities are not eligible for tax credits. Finally, we did not record Canadian
federal tax credits for EXFO Protocol in the fourth quarter of 2003 because it
was more likely than not that those credits would be recovered in the medium
term.
Also, in fiscal 2003, we wrote off $2.3 million of Canadian federal tax credits
because it was more likely than not that these credits would not be recoverable.
These tax credits can be carried forward against future years' taxable income
over the next nine years.
OUTLOOK FOR FISCAL 2005
During fiscal 2005, we expect to continue investing significantly in research
and development activities, reflecting our focus on innovation, our desire to
gain market share and our goal to exceed customer needs and expectations.
AMORTIZATION OF INTANGIBLE ASSETS
In conjunction with the business combinations we completed over the past few
years, we recorded intangible assets, primarily consisting of core technology.
These intangible assets resulted in amortization expenses of $5.1 million, $5.7
million and $12.5 million for fiscal 2004, 2003 and 2002, respectively. The
decrease in amortization expenses in fiscal 2004, compared to 2003, is the
result of the $2.9 million impairment charge recorded in the third quarter of
fiscal 2003. The decrease in amortization expenses in fiscal 2003, compared to
2002, is the result of the impairment charge recorded in 2003, as discussed
above, and the significant impairment charge of $23.7 million recorded in 2002.
Also, acquired in-process R&D was fully amortized at the end of 2002, which
reduced amortization expenses in 2003.
OUTLOOK FOR FISCAL 2005
For fiscal 2005, we expect the amortization of intangible assets to approximate
$1.1 million per quarter, assuming no acquisitions are made during that time.
57
IMPAIRMENT OF LONG-LIVED ASSETS AND GOODWILL
FISCAL 2002
In May 2002, as part of our review of financial results, we performed an
assessment of the carrying value of goodwill and intangible assets recorded in
conjunction with the acquisitions of EXFO Burleigh Products Group Inc. (EXFO
Burleigh), EXFO Photonic Solutions Inc. (EXFO Photonic Solutions) and EXFO
Protocol Inc. (EXFO Protocol). The assessment was performed because of the
severe and continued downturn in the telecommunications industry, the persisting
unfavorable market conditions affecting our subsidiaries' industries and the
decline in technology valuations. The growth prospects for our subsidiaries were
significantly lower than previously expected and less than those of historical
periods. In addition, the decline in market conditions affecting the
subsidiaries was significant and other than temporary. As a result, we concluded
that the carrying value of goodwill and certain acquired intangible assets was
impaired and we recorded a charge of $222.2 million to write down a significant
portion of goodwill and a pre-tax charge of $23.7 million to write down a
significant portion of acquired core technology. Of the total impairment charge
of $245.8 million, $125.0 million was related to EXFO Burleigh for goodwill and
acquired core technology, $71.5 million was related to EXFO Photonic Solutions
for goodwill and acquired core technology and $49.3 million was related to EXFO
Protocol for goodwill.
The impairment charge was calculated based upon the then-existing accounting
rules and represented the excess of the carrying value of the assets over the
pre-tax undiscounted future cash flows. The pre-tax undiscounted future cash
flows were estimated at the subsidiaries' level, since we had distinct cash
flows for each of them and because they were not fully integrated into our
activities. The cash flow periods used ranged from three to five years and the
annual growth rates ranged between 15% and 30%.
FISCAL 2003
In May 2003, we performed our annual impairment test of goodwill for all our
reporting units, except for newly acquired EXFO Gnubi. Also, considering market
conditions in the telecommunications industry and the persisting unfavorable
conditions affecting our subsidiaries' industries, we reviewed the carrying
value of intangible assets related to these reporting units, consisting
primarily of acquired core technology.
As a result of this assessment, we concluded that the carrying value of goodwill
related to EXFO Burleigh and the carrying value of intangible assets related to
EXFO Burleigh and EXFO Photonic Solutions were impaired and we recorded an
impairment charge of $4.5 million to write down goodwill and a pre-tax
impairment charge of $2.9 million to write down acquired core technology. Of the
total impairment charge of $7.4 million, $6.9 million was related to EXFO
Burleigh for goodwill and acquired core technology and $555,000 was related to
EXFO Photonic Solutions for acquired core technology.
The write-down of goodwill and acquired core technology of EXFO Burleigh was
required, considering that we exited the optical component manufacturing
automation business, whose revenue potential represented a long-term prospect.
The write-down of acquired core technology from EXFO Photonic Solutions was
required because revenue potential related to this long-lived asset was less
than expected in the short and medium term due to the state of the market at the
time.
58
However, no impairment of goodwill and intangible assets was required for EXFO
Protocol since we believed that revenue potential from the protocol-layer
testing market would remain strong in the short and medium term.
For the purposes of estimating fair values, we used a combination of discounted
future cash flows and a market approach (sales multiples). The discounted future
cash flows were estimated using periods ranging between eight and ten years,
discount rates ranging between 15% and 20%, and an annual growth rate ranging
between nil and 35%. The sales multiples used in the market approach ranged
between 0.7 and 2.3. The assumptions used reflected our best estimates.
FISCAL 2004
In May 2004, we performed our annual impairment test and concluded that goodwill
was not impaired. Goodwill will be reviewed for impairment in May 2005, or prior
to that date if events or circumstances occur that more likely than not reduce
the fair value of a reporting unit below its carrying value.
Also, at the end of fiscal 2004, we reviewed the carrying value of one of our
buildings that was put up for sale and we concluded that the building was
impaired. We recorded an impairment charge of $620,000, representing the excess
of the carrying value of the building over its expected selling price. The
building did not meet the criteria of CICA handbook section 3475, `'Disposal of
Long-Lived Assets and Discontinued Operations", because it was not available for
sale in its existing condition. Consequently, it was not shown as a long-lived
asset held for sale in the balance sheet as at August 31, 2004. The decision to
sell this building was made in order to consolidate our Quebec City
manufacturing operations in a single location, which will allow us to increase
efficiency and reduce costs. This building reports to our Telecom Division.
After the end of fiscal 2004, we received a formal offer to buy this building;
the offer is conditional upon the usual building inspections. The sale price
proposed in the offer represents the fair value used by management to determine
the decrease in the value of the building as at August 31, 2004.
RESTRUCTURING AND OTHER CHARGES
FISCAL 2002
In fiscal 2002, we implemented restructuring plans to reduce our costs. Under
these plans, we recorded charges of $2.9 million, including $2.0 million in
severance expenses for the 350 employees who were terminated throughout the
company and $868,000 for impaired long-lived assets.
FISCAL 2003
In fiscal 2003, we implemented an additional restructuring plan to realign our
cost structure to market conditions. Under that plan, we recorded additional
charges of $4.1 million, including $2.8 million in severance expenses for the
172 employees who were terminated throughout the company, $512,000 for impaired
long-lived assets and $855,000 for future payments on exited leased facilities
located around the world. Our estimation of the fair value of such future
payments took into account the estimated sublease rentals over the remaining
terms of the exited leases.
59
FISCAL 2004
In fiscal 2004, the Board of Directors approved a restructuring plan to
consolidate EXFO Burleigh's operations, transferring them mainly to EXFO
Photonic Solutions facilities in Toronto. The consolidation process started in
August 2004 and should extend through the first two quarters of fiscal 2005. We
estimate that the overall costs to be incurred under this plan should amount to
$2.7 million during the implementation period. From this amount, $772,000,
representing severance expenses, was recorded in fiscal 2004 for the layoff of
all employees of EXFO Burleigh. In addition, we recorded an impairment charge of
$1.3 million, mainly for the building. We expect to incur most of the remaining
$667,000 during the first two quarters of fiscal 2005 for different types of
consolidation expenses such as training, recruiting and other special
termination benefits.
The EXFO Burleigh building is for sale in its present condition and we expect to
sell the property within the next twelve months. Consequently, as per CICA
handbook section 3475, `'Disposal of Long-Lived Assets and Discontinued
Operations", the building was shown in the balance sheet as a long-lived asset
held for sale. The fair value used to determine the impairment charge for the
building represents our best estimate of its selling price based upon the
municipal valuation. Since September 1, 2004, this building is no longer
amortized.
Expenses incurred in relation with our restructuring plans have been recorded in
the restructuring and other charges in the statements of earnings of the
reporting years.
Our cost-reduction measures represented our best efforts to respond to the
difficult market conditions of the past years and we expect that they will lead
us to profitability on a pro-forma basis in fiscal 2005. However, these efforts
may be inappropriate or insufficient. Our actions in this regard may not be
successful in achieving the cost reductions or other benefits expected, may be
insufficient to align our cost structure to market conditions, or may be more
costly or extensive than anticipated.
INTEREST AND OTHER INCOME
Our interest income mainly resulted from our short-term investments, less
interests and bank charges. Interest and other income amounted to $1.4 million,
$1.2 million and $1.5 million for fiscal 2004, 2003 and 2002, respectively. In
fiscal 2004, we recorded a one-time revenue of $265,000 for the sale of non-core
technologies. Without this one-time revenue, interest and other income would
have been relatively flat year-over-year.
We expect our interest income to slightly increase in fiscal 2005 as our cash
position increased during 2004 following our public offering in February 2004.
FOREIGN EXCHANGE LOSS
Foreign exchange loss amounted to $278,000, $1.6 million and $458,000 for fiscal
2004, 2003 and 2002, respectively.
Foreign exchange gains and losses are the result of the translation of operating
activities denominated in currencies other than the Canadian dollar. In fiscal
2004, the Canadian dollar fluctuated less than in the previous year, resulting
in a smaller foreign exchange loss during that year compared to 2003. In fiscal
2003, the Canadian dollar value increased significantly through the year
compared to the US dollar, resulting in a significant exchange loss during that
year.
60
We manage our exposure to currency risk with forward exchange contracts. In
addition, some of our Canadian entities' operating activities are denominated in
currencies other than the Canadian dollar, which further hedges this risk.
INCOME TAXES
Our income tax recovery was $986,000 for fiscal 2004, compared to an income tax
expense of $15.1 million in 2003 and an income tax recovery of $25.5 million in
2002.
The income tax recovery recorded in fiscal 2004 is mainly due to the $1.4
million unusual income tax recovery recorded during that year, offset in part by
income taxes payable in some specific tax jurisdictions. The unusual tax
recovery was due to the receipt, during that period, of income taxes paid in
previous periods following the reception of a tax assessment.
Since the third quarter of fiscal 2003, we have been recording a full valuation
allowance against our future income tax assets. In fiscal 2003, considering
market conditions as well as the fact that we recorded losses for fiscal 2002
and 2003, we concluded that it was more likely than not that these assets would
not be recovered and that a full valuation allowance was required. Even though
the carrying periods of our future income tax assets were very long or
indefinite, we recorded a full valuation allowance against our future income tax
assets, mainly related to the parent company, EXFO Protocol and EXFO Burleigh.
Future income tax assets written off consisted mainly in deferred tax losses,
research and development expenses, share issue expenses as well as
non-deductible provisions and accruals. In fiscal 2004, we also recorded a full
valuation allowance on new future income tax assets created during the year.
Please refer to note 15 to our consolidated financial statements included
elsewhere in this Annual Report for details about our future income tax assets
and valuation allowance.
The valuation allowance will be reversed once management will have concluded
that realization of future income tax assets is more likely than not.
Consequently, our future periods' income tax rates will be distorted compared to
statutory rates.
AMORTIZATION OF GOODWILL
In conjunction with the business combinations completed over the past few years,
we have recorded goodwill. The goodwill related to the acquisitions of EXFO
Burleigh and EXFO Photonic Solutions was amortized over five years until August
31, 2002. This resulted in amortization expenses of $38.0 million in fiscal
2002. The acquisitions of EXFO Protocol and EXFO Gnubi have been accounted for
using new accounting standards contained in CICA handbook sections 1581,
`'Business Combinations" and 3062, `'Goodwill and Other Intangible Assets" and,
consequently, goodwill resulting from these acquisitions was not amortized.
Since September 1, 2002, goodwill related to the acquisitions of EXFO Burleigh
and EXFO Photonic Solutions is no longer amortized under new accounting
standards. Consequently, we no longer have amortization expenses for goodwill.
NET LOSS AND PRO FORMA NET LOSS
Net loss amounted to $8.4 million, $55.0 million and $308.5 million in fiscal
2004, 2003 and 2002, respectively. In terms of per share amounts, we recorded a
net loss of $0.13, $0.87 and $5.09 in fiscal 2004, 2003 and 2002, respectively.
61
Also, as a measure to assess financial performance, we use pro forma net loss
and pro forma net loss per share. Pro forma net loss represents net loss
excluding stock-based compensation costs, amortization and write-down of
goodwill, unusual tax recovery, future income tax assets valuation allowance and
the after-tax effect of amortization of intangible assets, impairment of
long-lived assets, restructuring and other charges, inventory and tax credits
write-offs and unusual grants recovery.
Pro forma net loss amounted to $2.0 million, $10.9 million and $10.7 million in
fiscal 2004, 2003 and 2002, respectively. In terms of pro forma per share
amounts, we recorded a net loss of $0.03, $0.17 and $0.18 in fiscal 2004, 2003
and 2002, respectively.
Pro forma net loss is reconciled to net loss as follows:
Years ended August 31, 2004 2003 2002
------------------------------------------------------------------------------------------------------------------
(UNAUDITED) (unaudited) (unaudited)
Net loss according to GAAP $ (8,424) $ (54,950) $ (308,524)
Pro forma adjustments:
Stock-based compensation costs 449 -- --
Amortization and write-down of goodwill -- 4,505 260,190
Amortization of intangible assets 5,080 5,676 12,451
Tax effect on amortization of intangible assets -- (2,031) (4,296)
Impairment of long-lived assets 620 2,922 23,657
Tax effect on impairment of long-lived assets -- (1,046) (8,161)
Restructuring and other charges and inventory and tax
credit write-offs 1,729 10,549 21,343
Tax effect on restructuring and other charges and
inventory and tax credit write-offs -- (3,777) (7,362)
Unusual tax and grants recovery (1,406) (1,357) --
Tax effect on unusual grants recovery -- 245 --
Future income tax assets valuation allowance -- 28,385 --
------------------------------------------------------------------------------------------------------------------
Pro forma net loss $ (1,952) $ (10,879) $ (10,702)
==================================================================================================================
Basic and diluted net loss per share $ (0.13) $ (0.87) $ (5.09)
Basic and diluted pro forma net loss per share $ (0.03) $ (0.17) $ (0.18)
We disclose pro forma financial data in order to provide supplemental
information regarding our results of operations and to enhance our investors'
overall understanding of our core financial performance and our prospects for
the future. We believe that our investors benefit from seeing our results
through the eyes of management in addition to seeing the GAAP information. This
non-GAAP information facilitates management's comparison of current results with
the company's historical results of operations and with those of our peers. This
information is not in accordance with, or an alternative to, GAAP and should be
considered in addition to, but not as a substitute for, other measures of
financial performance reported in accordance with GAAP, such as net loss. In
addition, not all companies calculate pro forma net loss in the same manner. As
a result, our pro forma net loss may not be comparable to similarly titled
measures presented by other companies.
62
LIQUIDITY AND CAPITAL RESOURCES
We finance our operations and meet our capital expenditure requirements mainly
through cash flows from operating activities, the use of our cash and short-term
investments as well as the issuance of subordinate voting shares.
In fiscal 2004, pursuant to a public offering in Canada, we issued 5.2 million
subordinate voting shares for net proceeds of $29.2 million (Cdn$38.4 million)
after deducting underwriting commissions of $1.2 million (Cdn$1.6 million).
These net proceeds will be used for working capital and other general corporate
purposes, including potential acquisitions, although we currently have no
commitments or agreements regarding any acquisitions. Cash flows provided by
financing activities in fiscal 2004 are attributable to the net proceeds of this
offering.
One of the four main objectives of our strategic plan for fiscal 2004 was 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 August 31, 2004,
cash and short-term investments consisted of $89.1 million, while our working
capital was at $115.1 million. Our cash and short-term investments increased
$31.8 million in fiscal 2004, compared to 2003, mainly due to the net proceeds
of the public offering of $29.2 million, the cash flows from operating
activities of $751,000 as well as an unrealized foreign exchange gain of $2.9
million on cash and short-term investments. However, this increase was partially
offset by the cash payment of $1.1 million for the purchase of property, plant
and equipment as well as intangible assets. The unrealized foreign exchange gain
resulted from the translation, in US dollars, of our Canadian-dollar-denominated
cash and short-term investments and was recorded in the cumulative translation
adjustment in the balance sheet.
We believe that our cash balances and short-term investments, combined with an
available line of credit of $4.8 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, that it can be secured on
satisfactory terms. Our line of credit bears interest at prime rate.
The following table summarizes our commitments as at August 31, 2004:
YEARS ENDING 2009 AND
AUGUST 31, 2005 2006 2007 2008 LATER TOTAL
-----------------------------------------------------------------------------------------------
Long-term debt $ 121,000 $ 135,000 $ 146,000 $ 51,000 $ -- $ 453,000
Operating leases 938,000 875,000 780,000 484,000 1,305,000 4,382,000
Total commitments $1,059,000 $1,010,000 $ 926,000 $ 535,000 $1,305,000 $4,835,000
===============================================================================================
OPERATING ACTIVITIES
Cash flows provided by operating activities amounted to $751,000 in fiscal 2004,
compared to $5.6 million in 2003 and cash flows used of $8.7 million in 2002.
Cash flows provided by operating activities in fiscal 2004 were mainly
attributable to the net earnings after items not affecting cash of $5.7 million,
offset in part by the net increase of our operating items of $4.9 million; that
is, our accounts receivable increased by $2.7 million, our income taxes and tax
credits recoverable increased by $2.5 million and our inventories
63
decreased by $1.0 million. The increase in our accounts receivable is directly
related to the significant sales growth in fiscal 2004 (20.5%). The increase in
our income taxes and tax credits recoverable is mainly due to the payment during
the year of income taxes and to the recognition, during the year, of R&D tax
credits not yet recovered. On the other hand, our increased sales level combined
with tight inventory management enabled us to reduced our inventories overall.
Cash flows provided by operating activities in fiscal 2003 were mainly the
result of a decrease in some of our operating items; that is, our accounts
receivable decreased by $4.0 million, our income taxes and tax credits
recoverable decreased by $13.5 million and our inventories decreased by $7.9
million (excluding write-offs). These positive effects on cash were offset in
part by the net loss after items not affecting cash of $18.9 million. The
decrease in our accounts receivable is directly related to the reduction in our
sales during that year. The decrease in our income taxes and tax credits
recoverable is related to the recovery, during the year, of income taxes and
research and development tax credits recoverable from previous periods. Finally,
the decrease in our inventories is due to our efforts to maintain them at the
lowest acceptable level considering the decrease in sales.
With positive cash flows from operating activities for three quarters in a row
and for fiscal 2004, we met one of our four annual strategic objectives, which
consisted in maintaining a sound financial position.
INVESTING ACTIVITIES
Cash flows used by investing activities totaled $29.7 million in fiscal 2004,
compared to $9.9 million in 2003 and cash flows provided of $10.5 million in
2002.
In fiscal 2004, we acquired $28.6 million worth of short-term investments with
the net proceeds of the public offering. In addition, we paid $1.1 million for
the purchase of property, plant and equipment and intangible assets.
In fiscal 2003, we acquired $5.4 million worth of short-term investments with
the proceeds from the recovery of income taxes and tax credits. We also made
cash payments of $1.9 million and $2.6 million for the acquisition of EXFO Gnubi
and the purchases of property, plant and equipment, respectively.
FORWARD EXCHANGE CONTRACTS
We utilize forward exchange contracts to manage our foreign currency exposure.
Our policy is not to utilize those derivative financial instruments for trading
or speculative purposes.
Our forward exchange contracts, which are used to hedge anticipated
US-dollar-denominated sales, qualify for hedge accounting; therefore, foreign
exchange translation gains and losses on these contracts are recognized as an
adjustment of the revenues when the corresponding sales are recorded.
As at August 31, 2004, we held contracts to sell US dollars at various forward
rates, which are summarized as follows:
64
WEIGHTED AVERAGE
CONTRACTUAL CONTRACTUAL FORWARD
EXPIRY DATES: AMOUNTS RATES
------------------ -------------------
September 2004 to August 2005 $ 7,480 1.5427
September 2005 to March 2007 8,400 1.3622
As at August 31, 2003 and 2004, these forward exchange contracts generated
deferred unrealized gains of US$1.8 million and US$1.5 million, respectively.
Deferred unrealized gains were calculated using year-end exchange rates of
Cdn$1.3851 = US$1.00 for fiscal 2003 and Cdn$1.3167 = US$1.00 for fiscal 2004.
RELATED-PARTY TRANSACTIONS
In fiscal 2003, we acquired a building from a company owned by our President for
a cash consideration of $930,000. This transaction was measured at the fair
market value since it was not conducted during the normal course of operations,
the change in ownership interest in the building was substantive and the fair
market value was supported by independent appraisal.
In addition, for the years ended August 31, 2002, 2003 and 2004, we leased
facilities from a company owned by our President. The annual rental expense
amounted to $234,000, $331,000 and nil, respectively. The rental expense for
fiscal 2003 included $234,000 for future payments on an exited leased facility.
As at August 31, 2004, restructuring charges payable included $194,000 due to
the company owned by our President in connection with this exited leased
facility. In September 2004, we were released from our obligations under that
lease, and we paid the full amount due to the related company. These rental
expenses were measured at the fair market value since they were incurred during
the normal course of operations.
CONTINGENCY
As discussed in note 12 to our consolidated financial statements, in November
2001, we were named as a defendant in a U.S. securities class action related to
our 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
our stock in the aftermarket.
In June 2003, a committee of our Board of Directors conditionally approved a
proposed settlement between the issuer defendants, the individual defendants,
and the plaintiffs. On June 25, 2004, the Plaintiffs moved for Preliminary
Approval of the settlement, and the Underwriter defendants have opposed that
motion. If approved, the settlement would provide, among other things, a release
of us and of the individual defendants for the conduct alleged in the action to
be wrongful in the amended complaint. We would agree to undertake other
responsibilities under the settlement, including agreeing to assign away, not
assert, or release certain potential claims we may have against its
underwriters. Any direct financial impact of the proposed settlement is expected
to be borne by our 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,
65
nor determine the amount of any possible losses. If the settlement process
fails, we will continue to defend our position in this litigation that the
claims against us, and our officers, are without merit. Accordingly, no
provision for this case has been made in the consolidated financial statements
as at August 31, 2004.
SHARE CAPITAL AND STOCK-BASED COMPENSATION PLANS
SHARE CAPITAL
As at November 3, 2004, we had 37,900,000 multiple voting shares outstanding,
entitled to ten votes each, and 30,581,696 subordinate voting shares
outstanding.
The multiple voting shares and the subordinate voting shares are unlimited as to
number and without par value.
STOCK OPTION PLAN
The aggregate number of subordinate voting shares covered by options granted
under the stock option plan was 2,934,518 as at August 31, 2004. The weighted
average exercise price of those stock options was $13.89 compared to the market
price of $4.36 per share as at August 31, 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 August 31, 2004:
WEIGHTED
% OF ISSUED AVERAGE
AND EXERCISE
NUMBER OUTSTANDING PRICE
-------- ------------ --------
Chairman of the Board, President and CEO
(one individual) 150,482 5.1% $ 9.91
Board of Directors (five individuals) 194,375 6.6 6.23
Management and Corporate Officers
(seven individuals) 315,300 10.7 15.03
---------- ------------ --------
660,157 22.5% $ 11.27
========== ============ ========
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 53,592 as at August 31, 2004. Each
restricted stock award entitles employees to receive one subordinate voting
share at a purchase price of nil.
66
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
A. DIRECTORS AND SENIOR MANAGEMENT
The following table sets forth information about our executive
officers, senior managers and directors as of December 31, 2004.
NAME AND MUNICIPALITY OF RESIDENCE POSITIONS WITH EXFO
---------------------------------- ----------------------------------------------------------
STEPHEN BULL Vice-President, Research and Development, Telecom Division
Ile-des-Soeurs, Quebec
NORMAND DUROCHER Vice-President Human Resources
St-Sauveur, Quebec
ALLAN FIRHOJ Vice-President and General Manager, Photonics and Life
Mississauga, Ontario Sciences Division
BENOIT FLEURY Vice-President, Protocol Product Management
Saint-Lazare, Quebec
ETIENNE GAGNON Vice-President, Physical Layer Product Management and
Sillery, Quebec Customer Service
LUC GAGNON Vice-President, Telecom Manufacturing Operations
St-Augustin de Desmaures, Quebec
JUAN-FELIPE GONZALEZ Vice-President, Global Telecom Sales
Montreal, Quebec
GERMAIN LAMONDE Chairman of the Board, President and Chief Executive
Cap-Rouge, Quebec Officer
PIERRE MARCOUILLER Director
Magog, Quebec
GUY MARIER Director
Lakefield Gore, Quebec
PIERRE PLAMONDON, CA Vice-President, Finance and Chief Financial Officer
Quebec City, Quebec
BENOIT RINGUETTE Corporate Secretary and Legal Counsel
Quebec City, Quebec
DAVID A. THOMPSON Director
Newton, North Carolina
ANDRE TREMBLAY Director
Outremont, Quebec
MICHAEL UNGER Lead Director
Woodbridge, Ontario
The address of each of our executive officers, senior managers and
directors is c/o EXFO Electro-Optical Engineering Inc., 400 Godin Avenue,
Vanier, Quebec, Canada. The following is a brief biography of each of our
executive officers, senior managers and directors.
67
STEPHEN BULL was appointed our Vice-President, Research and Development
in December 1999. He joined us in July 1995 and held the positions of Assistant
Director-Engineering from September 1997 to December 1999 and Group Leader
(Engineering Management) from July 1995 to September 1997. From June 1990 to
March 1995, Mr. Bull held the position of General Manager and Managing Director
for Space Research Corporation, a military engineering company in Belgium. Mr.
Bull holds a bachelor's degree in Electrical Engineering from Laval University
in Quebec City, Canada.
NORMAND DUROCHER was appointed Vice-President of Human Resources in
April 2004. In addition to managing the company's human resources team, his main
responsibility is to develop and implement a human resources plan that supports
EXFO's business strategy. Mr. Durocher began his career in labor relations in
the Cable division of Nortel and then took on several key roles at Nortel
Networks and Nordx/CDT, all relating to human resources and operations. Since
then, Normand Durocher has accumulated more than 25 years' experience in
operations and human resources management within the telecommunications
industry. Prior to joining EXFO, Mr. Durocher ran his own human resources
consulting business. Normand Durocher holds a Bachelor of Science from the
Universite de Montreal and also completed the Advanced Human Resources program
at Dalhousie University in Halifax, Nova Scotia, Canada
ALLAN FIRHOJ was appointed Vice-President and General Manager,
Photonics and Life Sciences Division in July 2003. Prior to that, he held the
position of General Manager of EXFO Photonic since November 2001. He is
responsible for the overall strategic direction and management of the Photonics
and Life Sciences Division. When Mr. Firhoj joined EFOS in 1996, he was
responsible for Sales, Marketing and Business Development of the Dental
Curing-Products Division. Following the sale of this division to Dentsply
International in 1997, he was appointed Director of Marketing and Business
Development. Mr. Firhoj continued in this capacity until being appointed to the
position of General Manager of EXFO Photonic. Prior to joining the company, Mr.
Firhoj spent six years with The Horn Group, a plastics business involved in
medical devices/instrumentation and office communication equipment. He
successively held the positions of ISO 9000 Implementation Manager, Technical
Sales Manager as well as Marketing and Business Development Manager. In this
latter role, he successfully contributed to increasing sales in their medical
market by an annual average of 60% during a three-year period. Mr. Firhoj holds
a bachelor's degree in Political Science from Bishop's University in
Lennoxville, Quebec.
BENOIT FLEURY was appointed Vice-President, Product Management and
Business Development for our protocol-layer product line in February 2004. His
main responsibility consists in defining the product line strategy and
developing strategic partnerships to enhance our presence in this market
segment. Mr. Fleury has 20 years of experience in the optical telecommunications
industry. He began his career as a systems engineer at Northern Telecom, and
then progressed to various key positions in the areas of product management,
operations engineering, product development, account marketing and product
marketing - all associated with Nortel's leading optical systems. From 2001 to
2003, prior to joining EXFO, Mr. Fleury was Vice-President of Product Line
Management and Marketing at Ceyba, an Ottawa-based optical systems startup. Mr.
Fleury holds a bachelor's degree in Electrical Engineering from McGill
University as well as a master's degree, also in Electrical Engineering, from
Concordia University. He also completed a Marketing Management Program from Duke
University.
68
ETIENNE GAGNON was appointed Vice-President of Physical-Layer Product
Management and Customer Service in May 2003. He is responsible for EXFO's
general marketing direction, on both the product level and communications level,
and also oversees our customer service department. For nearly three years,
before returning to EXFO in early 2003, Mr. Gagnon was Vice-President of Sales
and Marketing at TeraXion, an optical component manufacturer based in Quebec
City. Mr. Gagnon began his career as a design engineer for Bombardier/Canadair,
where he worked on the Canadian Regional Jet project between 1990 and 1993.
Later, he held the position of Business Development Manager for France Telecom
in Hungary. In 1994, he joined EXFO's European office as a Regional Sales
Manager, and in 1996, he was brought back to Quebec City to head the OSP
marketing group. Mr. Gagnon then went on to become the director of our Outside
Plant division in 1998, and remained in that function until he joined TeraXion
in 2000. Mr. Gagnon holds a bachelor's degree in Mechanical Engineering from the
Ecole Polytechnique School of Engineering (University of Montreal), and a
master's degree in European Business from the Ecole nationale superieure des
telecommunications in France.
LUC GAGNON was appointed Vice-President, Telecom Manufacturing
Operations in May 2003. He is responsible for ensuring the smooth operation of
all manufacturing activities, which include production, purchasing, product
engineering, quality assurance, planning, manufacturing engineering, product
configuration, transportation and customs, as well as material resources. Prior
to his recent nomination, Mr. Gagnon held the position of Production Director
since 2000. Before joining EXFO, he had similar roles in several other
high-technology companies. He worked for Mendes from 1999 to 2000, for C-MAC
from 1997 to 1999, for STERIS from 1993 to 1997 and for MITEL from 1991 to 1993.
Mr. Gagnon holds a bachelor's degree in electrical engineering and master's
degree in engineering, both from the Universite de Sherbrooke, in Canada.
JUAN-FELIPE GONZALEZ assumed the position of Vice-President, Global
Telecom Sales in July 2003. Prior to that he had been our Vice-President,
International Sales since September 1998. From January 1997 to September 1998,
he was our International Sales Director and, from September 1993 to January
1997, our Sales Manager for Latin America and the Caribbean. Prior to joining us
in September 1993, Mr. Gonzalez was Marketing and Sales Director at Reyde,
Barcelona, a plastics technical product corporation in Spain. Mr. Gonzalez holds
a bachelor's degree in Industrial Chemistry from Complutense University of
Madrid in Spain and a master's degree in Business Administration from the School
of Industrial Organization in Spain.
GERMAIN LAMONDE is one of our founders. Germain Lamonde has been our
Chairman of the Board, President and Chief Executive Officer since our inception
in 1985. Mr. Lamonde holds a bachelor's degree in Physics Engineering from Ecole
Polytechnique, University of Montreal in Canada and a master's degree in Optics
from Laval University in Canada.
PIERRE MARCOUILLER has served as our director since May 2000. Mr.
Marcouiller is Chairman of the Board and Chief Executive Officer of Camoplast
Inc., a supplier of components to the recreational and motorized vehicle and
automotive parts markets. He is the founder and has been sole shareholder of
Nexcap Inc., an investment company in the manufacturing sector, since December
1996. Mr. Marcouiller worked with Venmar Ventilation Inc., a private ventilation
equipment manufacturer, from January 1983 to December 1996. Mr. Marcouiller was
the controlling shareholder of Venmar from 1991 to 1996 and held the position of
President and General Manager of Venmar from December 1986 to December 1996. Mr.
Marcouiller is also a director of Heroux-Devtek Inc., a publicly traded company
that manufactures aerospace and industrial turbines, and holds directorships in
other privately held companies. Mr. Marcouiller holds a bachelor's degree in
Business Administration from Universite du Quebec a
69
Trois-Rivieres in Canada and a Master in Business Administration from Sherbrooke
University in Canada.
GUY MARIER has served as our director since January 2004. Formerly
President of Bell Quebec between 1999 and 2003, Guy Marier completed his
successful 33-year career at Bell as Executive Vice-President of the Project
Management Office of Bell Quebec, before retiring at he end of 2003. Mr. Marier
began at Bell Canada in 1970 and quickly became an executive. From 1988 to 1990,
he headed up Bell Canada International's investments and projects in Saudi
Arabia and, for the three following years, served as President of Telebec, a
subsidiary of Bell Canada. He then returned to the parent company to hold
various senior management positions. Mr. Marier was appointed to our Board of
Directors in January 2004 and also sits on the Board of Bell Nordiq, a
wholly-owned subsidiary of Bell Canada that manages the business and affairs of
both Telebec L.P. and NorthernTel L.P. Mr. Marier holds a bachelor of Arts from
the University of Montreal and a Bachelor of Business Administration from the
UNIVERSITE DU QUEBEC A MONTREAL.
PIERRE PLAMONDON has been our Vice-President, Finance and Chief
Financial Officer since January 1996 and was a director from December 1999 to
May 2000. Prior to joining us, Mr. Plamondon served as senior manager for Price
Waterhouse, now PricewaterhouseCoopers LLP, from September 1981 to December 1995
in Canada and France. Mr. Plamondon holds a bachelor's degree in Business
Administration and a license in Accounting, both from Laval University in
Canada. Mr. Plamondon has been a member of the Canadian Institute of Chartered
Accountants since 1983 and a member of the Board of Directors of SOVAR Inc.
(Societe de valorisation des applications de la recherche de l'Universite Laval)
since December 2000.
BENOIT RINGUETTE has been our in-house Legal Counsel and Corporate
Secretary since April 2004. Prior to joining EXFO, Mr. Ringuette practiced
mainly in commercial, corporate and securities law from 1998 to 2003 as an
associate in the law firms of O'Brien, Flynn Rivard in Quebec City and
Desjardins Ducharme Stein Monast in Quebec City. Mr. Ringuette has been a member
of the Quebec Bar since 1998. Mr. Ringuette holds a bachelor's degree in Civil
Law from Laval University in Quebec City, Canada.
DAVID A. THOMPSON has served as our director since June 2000. Dr.
Thompson joined Corning's Research and Development Division in 1976 as a Senior
Chemist in glass research. Most recently, he was named Division Vice-President
for strategic Planning and Innovation Effectiveness in Research, Development and
Engineering. Between 1988 and 1998, Dr. Thompson held technology Director and
Strategic Planning roles for Corning's Component and Photonics Technologies
Divisions. In 1999, he was named Technical Leader for the creation of the new
Samsung-Corning Micro-Optics joint venture. Dr. Thompson received a bachelor's
degree in Chemistry from Ohio State University and a doctorate in Inorganic
Chemistry from the University of Michigan. He holds 13 patents and has more than
20 technical publications in the areas of inorganic chemistry, glass technology
and telecommunications.
ANDRE TREMBLAY has been President and Chief Executive Officer of
Microcell Telecommunications from May 1995 to November 2004, and has also been a
member Microcell's Board of Directors since November 1995. In addition to his
role at Microcell, Mr. Tremblay sits on the Board of Directors of the
Communications Research Centre (a research arm of the federal government's
Department of Industry) as well as the boards of other private and public
corporations. Andre Tremblay began his career in the telecommunications industry
in 1985, as an advisor to the Chairman and Chief Executive Officer of Telesystem
Ltd. He subsequently
70
held various executive positions within that company. Mr. Tremblay holds
bachelor's degrees in Management and in Accounting from Laval University, as
well as a master's degree in Taxation from the UNIVERSITE DE SHERBROOKE, both in
Canada. He also completed the Advanced Management Program offered by the Harvard
Business School in the United States.
MICHAEL UNGER has served as our director since May 2000. He worked with
Nortel Networks Limited, now Nortel Networks Corporation, from 1962 to 2000. Mr.
Unger's most recent position was President of Nortel's Optical Networks Business
Unit, a position he held from May 1998 to April 2000. Prior to this appointment,
Mr. Unger was Nortel's Group Vice-President, Transport Networks from March 1990
to May 1998. Mr. Unger also serves on the board of Tundra Semiconductor
Corporation a publicly traded company with its shares listed on The Toronto
Stock Exchange that designs, develops and markets networking and network access
technology for use by communications infrastructure equipment companies. He is
also a member of the boards of a number of privately-held companies active in
the areas of photonic and optical components, optical network systems and
solutions for cable operators and other communications service providers. Mr.
Unger holds a bachelor's degree in Science from Concordia University in Canada.
TERM OF EXECUTIVE OFFICERS
Executive officers are appointed annually by the board of directors and
serve until their successors are appointed and qualified or until earlier
resignation or removal.
B. COMPENSATION
DIRECTOR COMPENSATION
In the financial year terminated August 31, 2004, our directors who are
not officers or employees receive the level of compensation set forth in the
table below as annual compensation payable in the form of cash, stock, or stock
options as chosen by the director. In addition, each director is granted 12,500
stock options under our stock option plan as part of his annual compensation.
-------------------------------------------------------------------------------
Annual Retainer for Directors: CDN$25,000 US$18,796
-------------------------------------------------------------------------------
Annual Retainer for Committee Chairman: CDN$5,000 US$3,759
-------------------------------------------------------------------------------
Annual Retainer for Committee Members: CDN$3,000 US$2,255
-------------------------------------------------------------------------------
Fees for all Meetings Attended per day in Person: CDN$1,000 US$752
-------------------------------------------------------------------------------
Fees for all Meetings Attended per day by Telephone: CDN$500 US$376
-------------------------------------------------------------------------------
-----------------------
Note: The compensation information has been converted from Canadian dollars
to U.S. Dollars based upon an average foreign exchange rate of 1.3301
for 2004.
71
In the financial year ended August 31, 2004, the directors who were not
employees received the following compensation in the form indicated:
-----------------------------------------------------------------------------------------------------------------
ANNUAL
COMPENSATION ANNUAL COMPENSATION EXERCISE EXPIRATION TOTAL ATTENDANCE
PAID IN CASH PAID IN STOCK PRICE OF DATE OF FEES PAID IN
NAME (US$)(1) OPTIONS (#) (2) OPTIONS (3) OPTIONS CASH (US$)(1)
-----------------------------------------------------------------------------------------------------------------
Pierre Marcouiller (4) 23,307 12,500 US$3.51 Oct. 27, 2013 5,639
-----------------------------------------------------------------------------------------------------------------
Guy Marier (5) 16,352 12,500 US$4.65 March 24, 2014 4,887
-----------------------------------------------------------------------------------------------------------------
Dr. David A. Thompson (6) 21,051 12,500 US$3.51 Oct. 27, 2013 5,639
-----------------------------------------------------------------------------------------------------------------
Andre Tremblay (7) 24,810 12,500 US$3.51 Oct. 27, 2013 6,766
-----------------------------------------------------------------------------------------------------------------
Michael Unger (8) 24,810 12,500 US$3.51 Oct. 27, 2013 6,016
-----------------------------------------------------------------------------------------------------------------
-------------------------
(1) The compensation information has been converted from Canadian dollars to
U.S. Dollars based upon an average foreign exchange rate of 1.3301 for
2004.
(2) Indicates the number of Subordinate Voting Shares underlying the options
granted under the Stock Option Plan.
(3) The exercise price of options is determined based on the highest of the
closing prices of the Subordinate Voting Shares on the Toronto Stock
Exchange and the NASDAQ National Market on the last trading day preceding
the grant date, using the noon buying rate of the Federal Reserve Bank of
New York on the grant date to convert the NASDAQ National Market closing
price to Canadian dollars, as required. These options vest at a rate of
12.5% after the first 6 months, 12.5% after 12 months and 25% annually
thereafter commencing on the second anniversary date of the grant.
(4) Member of the Audit Committee and the Human Resources Committee.
(5) Member of the Audit Committee and the Human Resources Committee.
(6) Member of the Human Resources Committee.
(7) Member of the Human Resources Committee and Chairman of the Audit
Committee.
(8) Member of the Audit Committee and Chairman of the Human Resources Committee
and Lead Director.
EXECUTIVE COMPENSATION
The table below shows compensation information during the three most
recently completed financial years for Mr. Germain Lamonde, our Chairman of the
Board, President and Chief Executive Officer, Mr. Pierre Plamondon,
Vice-President Finance and Chief Financial Officer, our other three other most
highly compensated executive officers who were serving at the end of the
financial year, and two other executive officers who would have been included
within the three most highly compensated executive officers had they been in our
employ, at the year end (collectively, the "Named Executive Officers"). This
information includes the US dollar value of base salaries, bonus awards and
long-term incentive plan payments, the number of options granted, and other
compensation, if any, whether paid or deferred.
72
-------------------------------------------------------------------------------------------------------------------
SECURITIES
OTHER ANNUAL UNDER
NAME AND PRINCIPAL FINANCIAL SALARY COMPENSATION OPTIONS(3) ALL OTHER
POSITION YEAR (1) ($) BONUS(2) ($) ($) (#) COMPENSATION ($)
-------------------------------------------------------------------------------------------------------------------
Germain Lamonde, 2004 206,751 (US) 57,115 (US) -- -- --
President and Chief 275,000 (CDN) 75,969 (CDN))
Executive Officer
2003 185,848 (US) 25,247 (US) -- 50,000 --
275,000 (CDN) 37,359 (CDN)
2002 174,758 (US) 21,329 (US) -- 70,000 --
275,000 (CDN) 33,563 (CDN)
-------------------------------------------------------------------------------------------------------------------
Pierre Plamondon, 2004 135,328 (US) 17,451 (US) -- -- 1,429 (US) (4)
Vice-President Finance and 180,000 (CDN) 23,211 (CDN) 1,901(CDN)
Chief Financial Officer
2003 118,267 (US) 9,547 (US) -- 25,000 866 (US) (4)
175,000 (CDN) 14,127 (CDN) 1,281 (CDN)
2002 95,323 (US) 5,817 (US) -- 19,000 886 (US) (4)
150,000 (CDN) 9,153 (CDN) 1,394 (CDN)
-------------------------------------------------------------------------------------------------------------------
Juan-Felipe Gonzalez, 2004 231,597 (US) 563,867 (US) -- -- --
Vice-President, 308,047 (CDN) 750,000 (CDN)(5)
Global Telecom Sales
2003 163,896 (US) 7,500 (US) -- 30,000 --
2002 158,193 (US) -- -- 30,000 --
-------------------------------------------------------------------------------------------------------------------
Stephen Bull 2004 112,773 (US) 12,437 (US) -- -- 16,221 (US) (6)
Vice-President Research & 150,000 (CDN) 16,543 (CDN) 21,576 (CDN)
Development
2003 81,098 (US) 8,138 (US) -- 15,000 588 (US) (4)
120,000 (CDN) 12,042 (CDN) 871 (CDN)
2002 73,081 (US) 4,425 (US) -- 17,930 577 (US) (4)
115,000 (CDN) 6,964 (CDN) 908 (CDN)
-------------------------------------------------------------------------------------------------------------------
Benoit Fleury 2004 112,773 (US) 8,656 (US) -- 15,000 15,036 (US) (8)
Vice-President, Protocol (7) 11,421 (CDN) 20,000 (CDN)
Product Management 150,000(CDN)
-------------------------------------------------------------------------------------------------------------------
NAMED EXECUTIVES NOT IN THE EMPLOY OF THE CORPORATION AT YEAR END
-------------------------------------------------------------------------------------------------------------------
James Stevens, 2004 175,000 (US) -- -- -- 4,016 (US) (4)
Vice-President Product (9)
Management and Chief
Technology Officer 2003 175,000 (US) -- -- 12,000 4,624 (US) (4)
(Protocol) (10)
-------------------------------------------------------------------------------------------------------------------
2004 140,000 (US) 10,385 (US) -- -- 22,996 (US) (12)
John Holloran Jr., (11)
Interim General Manager
and Special Projects 140,000 (US)
2003 (13) 12,692 (US) -- 9,000 4,114 (US) (4)
-------------------------------------------------------------------------------------------------------------------
------------------------------
(1) The compensation information for Canadian residents has been converted from
Canadian dollars to U.S. dollars based upon an average foreign exchange
rate of 1.3301 for 2004, 1.4797 for 2003 and 1.5736 for 2002. The currency
conversions cause these reported salaries to fluctuate from year-to-year
because of the conversion of Canadian dollars to U.S. dollars.
(2) A portion of the bonus amounts is paid in cash in the year for which they
are awarded and the balance is paid in cash in the year following the
financial year for which they are awarded.
(3) Indicates the number of Subordinate Voting Shares underlying the options
granted under the Stock Option Plan during the financial year indicated.
(4) Indicates the amount we contributed during the financial year indicated to
the Deferred Profit Sharing Plan or the 401K plans, as applicable, for the
benefit of the Named Executive Officer. Mr. Lamonde is not eligible to
participate in the Deferred Profit Sharing Plan and Mr. Gonzalez did not
participate.
(5) Pursuant to the terms of his employment agreement, Mr. Juan-Felipe Gonzalez
received a cash payment of CDN$750,000 since he did not voluntarily resign
and was not dismissed with cause prior to September 2003. An amount of
CDN$500,000 was disbursed on October 17, 2003 and the remaining CDN$250,000
was disbursed on January 25, 2004.
(6) Indicates the amount we paid during the financial year for relocation
allowance (CDN$20,000) (US$15,036) plus the amount referred in note 4 above
(CDN$1,576) (US$1,185).
(7) This amount represents Mr. Fleury annual base salary. Since Mr. Fleury
joined us on February 16, 2004, the base salary paid to Mr. Fleury for the
financial year ended August 31, 2004 amounted to US$ 58,555 (CDN$ 77,884).
(8) Indicates the amount we paid during the financial year for relocation
allowance (CDN$20,000) (US$15,036 ).
(9) This amount represents Mr. Stevens' base annual salary. Since he left us on
May 21, 2004, the base salary paid to him for the financial year ended
August 31, 2004 amounted to US$147,654.
73
(10) This amount represents Mr. Stevens' base annual salary. Since he joined us
on October 7, 2002, the base annual salary paid to him for the financial
year ended August 31, 2003 amounted to US$154,135.
(11) This amount represents Mr. Holloran's base annual salary. Since he left us
on December 31, 2003, the base annual salary paid to him for the financial
year ended August 31, 2004 amounted to US$55,346.
(12) Indicates the amount we paid during the financial year for severance
package (US$21,231) plus the amount referred in note 4 above (US$1,765).
(13) This amount represents Mr. Holloran's base annual salary. Since he joined
us on October 7, 2002, the base annual salary paid to him for the financial
year ended August 31, 2003 amounted to US$124,462.
The following table indicates additional information on the options
granted to our Named Executive Officers during the 2004 fiscal year.
--------------------------------------------------------------------------------------------------------------------
SECURITIES PERCENTAGE OF NET MARKET VALUE OF
UNDER TOTAL OF OPTIONS SECURITIES UNDERLYING
OPTIONS GRANTED TO EMPLOYEES EXERCISE OR OPTIONS ON THE DATE
GRANTED(1) IN FINANCIAL YEAR BASE PRICE (2) OF GRANT
NAME (#) (%) (US$/ SECURITY) (US$/SECURITY) (3) EXPIRATION DATE
--------------------------------------------------------------------------------------------------------------------
Benoit Fleury 15,000 2.80 % 4.65US 4.63 US March 24, 2014
--------------------------------------------------------------------------------------------------------------------
---------------------
(1) Underlying securities: Subordinate Voting Shares.
(2) The exercise price of options granted is determined based on the highest of
the closing prices of the Subordinate Voting Shares on The Toronto Stock
Exchange and the NASDAQ National Market on the last trading day preceding
the grant date, using the noon buying rate of the Federal Reserve Bank of
New York on the grant date to convert the NASDAQ National Market closing
price to Canadian dollars, as required. These options These options vest at
a rate of 12.5% 6 months after the grant date, 12.5% 12 months after the
grant date, and 25% annually thereafter commencing on the second
anniversary date of the grant.
(3) Based on the closing price on the NASDAQ National Market on the date of the
grant.
EMPLOYMENT AGREEMENTS
We have an employment agreement with Mr. Germain Lamonde. The agreement
is for an indeterminate period and the salary is reviewed annually. In the event
of the termination of Mr. Lamonde's employment without cause, Mr. Lamonde will
be entitled to severance payments (in no case exceeding 24 months of
remuneration) and the vesting of all stock options. In addition, in the event
that Mr. Lamonde's employment is terminated following a merger or an acquisition
by a third party of substantially all our assets or of the majority of our share
capital or if Mr. Lamonde voluntarily resigns, he will be entitled to the
vesting of all stock options.
We also have employment agreements with Mr. Juan-Felipe Gonzalez, Mr.
Pierre Plamondon, Mr. Stephen Bull and Mr. Benoit Fleury.
The agreement with Mr. Gonzalez provided for Mr. Gonzalez's employment
as Vice-President Global Telecom Sales. In the event Mr. Gonzalez's employment
terminates for any reason whatsoever and he is unable to accept new employment
due to his non-competition obligations to us Mr. Gonzalez may receive
compensation for a period of 18 months following the date of termination in
amounts varying from 5% to 50% of his base monthly salary at the time of
termination depending on the cause of the termination. The employment agreement
is for an indeterminate period and salary and bonuses are reviewed annually.
We have an employment agreement with Mr. Pierre Plamondon, our Vice
President, Finance and Chief Financial Officer. The agreement is for an
indeterminate period and the salary is reviewed annually. In the event of
termination of Mr. Plamondon's employment without cause, Mr. Plamondon will be
entitled to severance payments (in no case exceeding 18 months of the current
base salary). In addition, in the event Mr. Plamondon's employment is terminated
74
following a merger or an acquisition by a third party of substantially all of
our assets or of the majority of our share capital, he will be entitled to the
immediate vesting of all stock options.
We have an employment agreement with Mr. Stephen Bull, the
Corporation's Vice President, Research & Development. The agreement is for an
indeterminate period and the salary is reviewed annually. In the event of
termination of Mr. Bull's employment without cause, Mr. Bull will be entitled to
severance payments (in no case exceeding 18 months of the current base salary).
In addition, in the event Mr. Bull's employment is terminated following a merger
or an acquisition by a third party of substantially all of our assets or of the
majority of our share capital, he will be entitled to the immediate vesting of
all stock options.
We have an employment agreement with Mr. Benoit Fleury, our Vice
President, Protocol Product Management. The agreement is for an indeterminate
period and the salary is reviewed annually. In the event of termination of Mr.
Fleury's employment without cause, Mr. Fleury's will be entitled to severance
payments (in no case exceeding 18 months of the current base salary). In
addition, in the event Mr. Fleury's employment is terminated following a merger
or an acquisition by a third party of substantially all of our assets or of the
majority of our share capital, he will be entitled to the immediate vesting of
all stock options.
STOCK OPTION PLAN
We have a stock option plan for our directors, executive officers,
employees and consultants and those of our subsidiaries as determined by our
board of directors, to attract and retain competent directors, executive
officers, employees and consultants motivated to work toward ensuring our
success and to encourage them to acquire our shares.
All of the options that will be granted under the plan must be
exercised within a maximum period of ten years following the grant date of the
options or they will be forfeited. The board of directors will designate the
recipients of options and determine the number of subordinate voting shares
covered by each of these options, the date of vesting of each option, the
exercise price of each option, the expiry date and any other conditions relating
to these options, in each case in accordance with the applicable legislation of
the securities regulatory authorities. The price at which the subordinate voting
shares may be purchased under the plan will not be lower than the highest of the
closing prices of the subordinate voting shares on the stock exchanges where the
subordinate voting shares are listed at the date preceding the date of grant.
The maximum number of subordinate voting shares that is issuable under
the plan may not exceed 6,306,153 shares, which represents 9.2% of our issued
and outstanding share capital as at December 31, 2004. The maximum number of
subordinate voting shares that may be granted to any individual may not exceed
5% of the outstanding subordinate voting shares. The board of directors may
accelerate the vesting of any or all outstanding options of any or all options
upon the occurrence of a change of control.
The aggregate number of subordinate voting shares covered by options
granted during the financial year ended August 31, 2004 was 536,500 at a
weighted average exercise price of $ 3.94 (CA$ 5.24) per subordinate voting
share. At the end of the financial year ended August 31, 2004, there were
2,934,518 subordinate voting shares covered by options granted and outstanding
pursuant to the stock option plan having a weighted average exercise price of
US$13.89 (CDN$20.89) per option. As of August 31, 2004, there were 3,371,635
options
75
available for future grants under the plan. Since August 31, 2004 we granted
30,291 options to employees on October 26, 2004.
Options granted in the financial year ended August 31, 2004 vest at a
rate of 12.5% 6 months after the date of grant, 12.5% 12 months after the date
of grant and 25% annually thereafter commencing on the second anniversary date
of the grant. All options may be exercised in whole or in part once vested. All
of the options that are granted under the Plan must be exercised within a
maximum period of 10 years following the date of their grant or they will be
forfeited.
RESOLUTION FOR THE APPROVAL OF AMENDMENTS TO THE STOCK OPTION PLAN
Our Stock Option Plan is designed to increase the performance of our
employees, senior management, officers and directors and those of our
subsidiaries, and persons and companies providing ongoing management or
consulting services ("consultants") to us and our subsidiaries.
On October 26, 2004, our Board of Directors, on the recommendation of
outside consultants and the Human Resources Committee in alignment with the
practice in the industry and in the best interest of the shareholders,
authorized, subject to regulatory and shareholders' approvals, certain
amendments to the current Stock Option Plan, including the renaming of the Stock
Option Plan to Long Term Incentive Plan (the "Proposed Amendments").
Accordingly, a resolution has been submitted to our shareholders for
voting at the Annual and Special Shareholders Meeting to be held on January 12,
2005, to approve the Proposed Amendments.
Under the Proposed Amendments, Restricted Share Units ("RSU") are
granted to designated directors, officers, employees and consultants. The RSU
are "phantom" shares that rise and fall in value based on the value of our
Subordinate Voting Shares, and are redeemed for actual Subordinate Voting Shares
or cash equivalent at the discretion of our Board of Directors on the vesting
dates established by our Board of Directors at the time of grant in its sole
discretion. Such Subordinate Voting Share will be issued from the pool of
Subordinate Voting Shares reserved for issuance pursuant to the Stock Option
Plan, which shall not exceed 10% of the total issued and outstanding voting
shares.
The Proposed Amendments are meant to modify our existing Stock Option
Plan to offer, through combinations of equity-based incentive programs, optimal
alignment of the interest of our management and employees to that of our
shareholders. The choice of amending the existing Stock Option Plan was taken by
our Board of Directors after an analysis of various alternative equity-based
plans. The Proposed Amendments were considered to provide the best balance
between alignment with shareholder interests, protection against downside risk,
share price volatility protection and employee retention.
RESOLUTION FOR THE APPROVAL OF THE DEFERRED SHARE UNIT PLAN
On October 26, 2004, our Board of Directors, on the recommendation of
outside consultants and the Human Resources Committee in alignment with the
practice in the industry, in the best interest of the shareholders and in order
to align more closely the interests of its non-employee directors with those of
its shareholders, authorized, subject to regulatory and shareholders' approvals,
a Deferred Share Unit Plan.
76
Accordingly, a resolution has been submitted to our shareholders for
voting at the Annual and Special Shareholders Meeting to be held on January 12,
2005, to approve the Deferred Share Unit Plan.
Under the Deferred Share Unit Plan, non-employee directors shall
receive up to 100 % of their retainer fees in the form of Deferred Share Units
("DSUs"), each of which has an initial value equal to the market value of a
Subordinate Voting Share at the time DSUs are credited to the directors. The
value of a DSU, when converted to a Subordinate Voting Share, is equivalent to
the market value of a Subordinate Voting Share at the time the conversion takes
place. DUSs attract dividends in the form of additional DSUs at the same rate as
dividends on Subordinate Voting Share. When a director ceases to be a member of
the Board, the DSUs are converted and paid in Subordinate Voting Shares
purchased on the open market or issued by the Corporation. Such Subordinate
Voting Shares will be issued from the same pool of Subordinate Voting Shares
reserved for issuance pursuant to the Stock Option Plan, which shall not exceed
10% of the total issued and outstanding voting shares.
SHARE PLAN
In September 1998, we established a stock purchase plan for officers,
directors and key employees as amended in April 2000. A total of 707,264
subordinate voting shares were issued and fully paid under the 1998 Stock
Purchase Plan, having a weighted average cash consideration of $0.67 (CA$0.98)
per share. The plan provides that all shares issued under the plan are
restricted as to sale and transferability for a minimum period of five years
upon the date of acquisition.
On April 3, 2000, we adopted a share plan that replaced the 1998 Stock
Purchase Plan. No additional shares will be issued under the share plan. The
share plan established restrictions on the rights of the holders of subordinate
voting shares who hold those shares as a result of the conversion of the Class
"F" shares issued under the 1998 Stock Purchase Plan. The share plan also
requires the subordinate voting shares to be held in trust by a trustee until
August 31, 2004, except for 249,977 subordinate voting shares that will be
released between October 21, 2003 and January 20, 2004. The share plan also
provides for the earlier release of shares in the event that the employment of a
holder of shares is terminated or upon the occurrence of a change of control.
The new share plan does not permit any transfer, except within the trust to a
registered retirement savings plan or a registered retirement income fund or to
a trustee in bankruptcy. The share plan also established the conditions pursuant
to which the shares of a shareholder are to be sold by the trustee on the public
market. As of August 31, 2004, all the remaining subordinate voting shares that
were held in trust under the share plan were released.
77
RESTRICTED STOCK AWARD PLAN
The EXFO Electrical-Optical Engineering Restricted Stock Award Plan
(the "Plan") was established to provide a means through which employees of EXFO
Burleigh can be granted awards of restricted shares ("Restricted Shares") of our
subordinate voting shares to promote retention and foster identity of interest
between our stockholders and employees of EXFO Burleigh.
The effective date of the Plan is December 20, 2000. The expiration
date of the Plan is the business day next following the final grant of
Restricted Shares under the Plan. However, the administration of the Plan shall
continue until all awards of Restricted Shares have been forfeited or settled.
The aggregate number of shares subject to the Plan is 360,000. Grants of
Restricted Shares are to be made in accordance with a pre-determined schedule.
The Plan is administered by the committee that is designated to administer our
Stock Option Plan.
Awards of Restricted Shares are subject to forfeiture and restrictions
on transfer until the Restricted Shares become vested at which point a stock
certificate will be issued to a participant with respect to the number of vested
shares, which are then freely transferable. Restricted Shares become vested,
subject to a participant's continued employment with the Company or its
affiliates, on each of the first four anniversaries of the date of grant of an
award of Restricted Shares. Accordingly, we issued an aggregate of 349,517
subordinate voting shares to participants in accordance with the vesting
schedule under the Plan. The remaining subordinate voting shares were issued to
three of the four founding shareholders.
Upon a participant's termination of employment with us, or any of our
affiliates due to the participant's death, disability or retirement on or after
age 60, the participant's award of restricted shares becomes fully vested and is
no longer subject to forfeiture. However, the transfer restrictions remain in
place until the occurrence of the vesting dates originally contemplated by the
award.
Upon the voluntary resignation of a participant, the termination of a
participant's employment for cause, the termination of a participant who is not
designated a member of EXFO Burleigh's "Management Team" without cause prior to
a change in control of us or a termination without cause of a participant who is
designated a member of EXFO Burleigh's Management Team that is initiated by EXFO
Burleigh prior to a change in control of us, the unvested portion of the
participant's award of Restricted Shares will be forfeited. However, the Plan
provides for discretion in the application of the forfeiture provisions where a
change in circumstances renders such action appropriate. During the financial
year ended August 31, 2003, we were required to lay-off 22 participants and 7
during the financial year ended August 31, 2004 as a result of restructuring. At
that time, we decided that the awards of the Plan participants affected by the
lay-offs would not be subject to forfeiture, though the transfer restrictions
would remain in place until the occurrence of the vesting dates originally
contemplated by the award.
Upon the termination without cause of a participant who is designated a
member of EXFO Burleigh's Management Team that is initiated by us or a
termination of a participant's employment without cause following a change in
control of us, a participant's award of Restricted Stock will become fully
vested and all restrictions will lapse.
78
In the event of a change in control, the committee administering the
Plan may in its discretion remove restrictions on Restricted Shares or provide
for the cancellation of awards in exchange for payment in respect of the
Restricted Shares subject to an award.
STOCK APPRECIATION RIGHTS PLAN
On August 4, 2001, the Corporation established a Stock Appreciation
Rights Plan ("SAR Plan") for the benefit of certain employees residing in
countries where the granting of options under the Stock Option Plan is not
feasible in the opinion of the Corporation. The Board has full and complete
authority to interpret the SAR Plan and to establish the rules and regulations
applying to it and to make all other determinations it deems necessary or useful
for the administration of the SAR Plan.
Under the SAR Plan, eligible employees are entitled to receive a cash
amount equivalent to the difference between the market price of the subordinate
voting shares on the date of exercise and the exercise price determined on the
date of grant. No subordinate voting shares are issuable under the SAR Plan.
The Board of Directors has delegated to Management the task of
designating the recipients of stock appreciation rights, the date of vesting,
the expiry date and other conditions. Under the terms of the SAR Plan, the
exercise price of the stock appreciation rights may not be lower than the
highest of the closing prices of the subordinate voting shares on The Toronto
Stock Exchange and on the NASDAQ National Market on the last trading day
preceding the grant date, using the noon buying rate of the Federal Reserve Bank
of New York on the grant date to convert the NASDAQ National Market closing
price to Canadian dollars. Stock appreciation rights are non-transferable.
The stock appreciation rights vest over a four-year period, with 25%
vesting annually commencing on the first anniversary date of the date of grant.
Once vested, stock appreciation rights may be exercised between the second and
the fifteenth business day following each release of our quarterly financial
results. All of the stock appreciation rights that are granted under the SAR
Plan may be exercised within a maximum period of 10 years following the date of
their grant. Any stock appreciation rights granted under the SAR Plan will lapse
immediately upon the termination of the relationship with us or one of our
subsidiaries for a good and sufficient cause or at the date on which an employee
resigns or leaves his employment with us or one of our subsidiaries (or within
30 days if the holder is dismissed without cause). In the event of retirement or
disability, any stock appreciation right held by an employee lapses 30 days
after the date of any such disability or retirement. In the event of death, any
stock appreciation right lapses 6 months after the date of death.
As of December 15, 2004, there were 13,000 SAR's outstanding.
DEFERRED PROFIT SHARING PLAN
We maintain a deferred profit sharing plan for certain eligible
Canadian resident employees. Under the plan, we may contribute an amount equal
to 1% of each employee's gross salary to that employee's individual deferred
profit sharing plan to the extent that such employee contributes at least 2% of
his or her gross salary to his or her individual tax-deferred registered
retirement savings plan. As a cost control measure, we temporarily suspended our
contributions under this plan commencing in June 2002 and re-established
contributions
79
commencing January 2003. In the year ended August 31, 2004, the aggregate amount
of contributions under the plan was $106,000 (CA$141,000).
401(K) PLAN
We maintain a 401(k) plan for eligible United States resident employees
of our subsidiaries. Employees become eligible to participate in the 401(k) plan
on the first day of the month following the completion of three months of
continuous service. Employees may elect to defer their current compensation up
to the lesser of 1% of eligible compensation or the statutorily prescribed
annual limit and have the deferral contributed to the 401(k) plan. The 401(k)
plan permits, but does not require, us to make additional matching contributions
to the 401(k) plan on behalf of the eligible participants, subject to a maximum
of 50% of the first 6% of the participant's current compensation subject to
certain legislated maximum contribution limits. In the year ended August 31,
2004, we made an aggregate of $187,000 in matching contributions to the 401(k)
plan. Contributions by employees or by us to the 401(k) plan and income earned
on plan contributions are generally not taxable to the employees until withdrawn
and contributions by us are generally deductible by us when made. At the
direction of each participant, the trustees of the 401(k) plan invest the assets
of the 401(k) plan in selected investment options.
INDEMNIFICATION OF DIRECTORS AND EXECUTIVE OFFICERS AND LIMITATION OF LIABILITY
Our by-laws require us, subject to the limitations provided by law, to
indemnify our present or former directors and officers or any persons who act or
acted at our request as directors or officers of a body corporate for all costs,
losses, charges and expenses that arose or may arise by reason of their status
as directors or officers of EXFO or such body corporate. A policy of directors'
and officers' liability insurance is maintained by us which insures our
directors and officers and those of our subsidiaries against liability incurred
by, arising from or against them for certain of their acts, errors or omissions.
C. BOARD PRACTICES
BOARD OF DIRECTORS
Our directors are elected at the annual meeting of shareholders for
one-year terms and serve until their successors are elected or appointed, unless
they resign or are removed earlier. Our articles of incorporation provide for a
board of directors of a minimum of three (3) and a maximum of twelve (12)
directors. Our board presently consists of six directors. Under the CANADA
BUSINESS CORPORATIONS ACT, twenty-five percent of the directors and of the
members of any committee of the board of directors must be resident Canadians.
We have no arrangements with any of our directors providing for the payment of
benefits upon their termination of service as director.
During the fiscal year ended August 31, 2004, the Board met a total of
ten times. Attendance at all meetings was perfect, with the exception of the
absence of Mr. David Thompson and Mr. Michael Unger at one meeting and the
absence of Mr. Pierre Marcouiller at two meetings.
80
COMMITTEES OF THE BOARD OF DIRECTORS
Our board of directors has established an audit committee, a human
resources committee and a disclosure committee.
Our audit committee will recommend a firm to be appointed as
independent auditors to audit financial statements and to perform services
related to the audit, review the scope and results of the audit with the
independent auditors, review with management and the independent auditors our
annual operating results and consider the adequacy of the internal accounting
procedures and the effect of the procedures relating to the auditors'
independence. Further to changes to NASDAQ corporate governance rules and new
Securities and Exchange rules flowing from the adoption of the SARBANES-OXLEY
ACT, our audit committee charter is being revised every financial year to ensure
that we comply with all new requirements. The audit committee is composed of
four independent directors: Andre Tremblay, Michael Unger, Guy Marier and Pierre
Marcouiller. The chairperson of the audit committee is Andre Tremblay.
During the fiscal year ended August 31, 2004, the Audit Committee met a
total of five times and attendance was perfect at all meetings, with the
exception of one meeting missed by Mr. Pierre Marcouiller.
Our human resources committee will evaluate, review and supervise our
procedures with regards to human resources and will assess the performance of
our executive officers and the chief executive officer. This committee will also
review annually the remuneration of the directors and will recommend to the
board of directors general remuneration policies regarding salaries, bonuses and
other forms of remuneration for our directors, executive officers and employees
as a whole. Finally, the human resources committee will review our
organizational structure annually and the development and maintenance of a
succession plan. The human resources committee is composed of five independent
directors: Pierre Marcouiller, Guy Marier, David A. Thompson, Andre Tremblay and
Michael Unger. The chairperson of the human resources committee is Michael
Unger.
During the fiscal year ended August 31, 2004, the Human Resources
committee met a total of two times and attendance was perfect at all meetings.
The disclosure committee is responsible for overseeing our disclosure
practices. This committee consists of the chief executive officer, the chief
financial officer, investor relations the manager of financial reporting and
accounting as well as our legal counsel and corporate secretary.
In addition, in order to deal with issues arising from our implication
in the IPO class action suit, in October 2002, the Board of Directors appointed
a litigation committee composed of four of our independent directors.
D. EMPLOYEES
We have fostered a corporate culture where growth and change are
strongly encouraged. In fact, employees are constantly evolving with the rapid
pace of technology to meet new challenges and realities. We believe that we
possess a good cross-section of experience and youth to handle these inevitable
changes in the industry.
81
As of December 15, 2004, we had a total of 649 employees, up from a
total of 627 on December 15, 2003. We have 563 employees in Canada, primarily
based in Quebec, and 86 employees based outside of Canada. 188 are involved in
research and development, 246 in manufacturing, 99 in sales and marketing, 68 in
general administrative positions and 48 in communications and customer support.
We have agreements with almost all of our employees covering confidentiality and
non-competition. Only manufacturing employees based in Quebec City plants are
represented by a collective bargaining agreement, which expires in 2009. We have
never experienced a work stoppage. We believe that relations with our employees
and bargaining unit are good.
E. SHARE OWNERSHIP
The following table presents information regarding the beneficial
ownership of our share capital as of December 15, 2004 by our directors, our
Chief Executive Officer, Chief Financial Officer and our three highest
compensated executive officers; and all of our directors and executive officers
as a group.
Each multiple voting share is convertible at the option of the holder
into one subordinate voting share. Holders of our subordinate voting shares are
entitled to one vote per share and holders of our multiple voting shares are
entitled to ten votes per share.
TOTAL
MULTIPLE VOTING SHARES SUBORDINATE VOTING SHARES PERCENTAGE OF
BENEFICIALLY OWNED (1) BENEFICIALLY OWNED (1) VOTING POWER
----------------------- -------------------------- -------------
NAME NUMBER PERCENT NUMBER PERCENT PERCENT
-------------------------------- ---------- ------- ---------- ------- -------
Germain Lamonde (2)............. 37,900,000 100 199,712 * 55.6
Pierre Plamondon (3)............ -- -- 92,807 * *
Stephen Bull .................. -- -- 48,421 * *
Benoit Fleury ................. -- -- 1,875 * *
Juan Felipe Gonzalez............ -- -- 133,725 * *
Pierre Marcouiller.............. -- -- 32,268 * *
Guy Marier .................... -- -- 2,563 * *
David A. Thompson............... -- -- 25,376 * *
Andre Tremblay (4).............. -- -- 31,393 * *
Michael Unger ................. -- -- 25,401 * *
-----------------------------------------------------------------------
TOTAL........................... 37,900,000 100 593,541 1.9 56.2
--------------------------------
* Less than 1%.
(1) Beneficial ownership is determined in accordance with the rules of the SEC
and generally includes voting or investment power with respect to
securities. Options that are currently exercisable (including options that
have an exercise price above the market price) are deemed to be outstanding
and to be beneficially owned by the person holding such options for the
purpose of computing the percentage ownership of such person, but are not
treated as outstanding for the purpose of computing the percentage
ownership of any other person.
(2) The number of shares held by Germain Lamonde includes 1,900,000 multiple
voting shares held of record by Fiducie Germain Lamonde, 36,000,000
multiple voting shares held of record by G. Lamonde Investissements
Financiers inc. and 93,000 subordinate voting shares held of record by
Placements Lamonde SENC.
(3) The number of shares held by Pierre Plamondon includes 6,874 subordinate
voting shares held of record by Fiducie Pierre Plamondon.
(4) The number of subordinate voting shares held of record by Andre Tremblay
are held by 9044-6451 Quebec Inc, a company controlled by Mr. Tremblay.
The following table presents information regarding stock options held
as of December 31, 2004 by our directors, our Chief Executive Officer, our Chief
Financial Officer and our three highest compensated executive officers.
82
SECURITIES UNDER OPTIONS EXERCISE PRICE (2)
NAME GRANTED (1) (#) (US$/SECURITY) EXPIRATION DATE
------------------------ ------------------ ------------------
Germain Lamonde.............. 25,402 $26.00 June 29, 2010
5,080 $22.25 January 10, 2011
70,000 $9.13 October 10, 2011
50,000 $1.58 September 25, 2012
Pierre Plamondon............. 8,700 $26.00 June 29, 2010
10,000 $45.94 September 13, 2010
5,000 $34.07 October 11, 2010
9,240 $22.25 January 10, 2011
19,000 $9.13 October 10, 2011
25,000 $1.58 September 25, 2012
5,383 $5.13 October 26, 2014
Stephen Bull................. 900 $26.00 June 24, 2010
5,000 $45.94 September 13, 2010
2,930 $22.25 January 10, 2011
15,000 $9.13 October 10, 2011
15,000 $1.58 September 25, 2012
3,589 $5.13 October 26, 2014
Benoit Fleury................ 15,000 $4.65 March 24, 2014
3,708 $5.13 October 26, 2004
Juan Felipe Gonzalez......... 6,900 $26.00 June 29, 2010
15,000 $45.94 September 13, 2010
15,000 $34.07 October 11, 2010
15,630 $22.25 January 10, 2011
15,000 $9.13 October 10, 2011
15,000 $12.22 January 3, 2012
30,000 $1.58 September 25, 2012
5,482 $5.13 October 26, 2014
Pierre Marcouiller........... 2,000 $26.00 June 29, 2010
400 $22.25 January 10, 2011
17,966 $9.13 October 10, 2011
1,037 $12.69 December 1, 2011
2,479 $5.65 March 1, 2012
12,500 $1.58 September 25, 2012
12,500 $3.51 October 27, 2013
Guy Marier................... 12,500 $4.65 March 24, 2014
David A. Thompson............ 2,000 $26.00 June 29, 2010
400 $22.25 January 10, 2011
15,334 $9.13 October 10, 2011
12,500 $1.58 September 25, 2012
12,500 $3.51 October 27, 2013
Andre Tremblay............... 2,000 $26.00 June 29, 2010
400 $22.25 January 10, 2011
17,291 $9.13 October 10, 2011
12,500 $1.58 September 25, 2012
12,500 $3.51 October 27, 2013
Michael Unger................ 2,000 $26.00 June 29, 2010
400 $22.25 January 10, 2011
18,168 $9.13 October 10, 2011
12,500 $1.58 September 25, 2012
12,500 $3.51 October 27, 2013
-------------------------------
(1) Underlying securities: subordinate voting shares
(2) The exercise price of options granted is determined based on the highest of
the closing prices of the subordinate voting shares on the Toronto Stock
Exchange and the NASDAQ National Market on the last trading day preceding
the grant date, using the noon buying rate of the Federal Reserve Bank of
New York on the grant date to convert the NASDAQ National Market closing
price to Canadian dollars, as required.
83
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
A. MAJOR SHAREHOLDERS
The following table presents information regarding the beneficial
ownership of our share capital as of December 15, 2004 by persons or groups of
affiliated persons known by us to own more than 5% of our voting shares.
MULTIPLE VOTING SHARES SUBORDINATE VOTING SHARES TOTAL PERCENTAGE OF
BENEFICIALLY OWNED (1) BENEFICIALLY OWNED (1) VOTING POWER
------------------------- -------------------------- -------------------
NAME NUMBER PERCENT NUMBER PERCENT PERCENT
------------------------------- ---------- ------- --------- ------- -------
Germain Lamonde (2) 37,900,000 100 % 199,712 * 55.6%
Fiducie Germain Lamonde (3) 1,900,000 5 % Nil Nil 2.8%
G. Lamonde Investissements
Financiers inc. (4) 36,000,000 95 % Nil Nil 52.5%
Placements Lamonde, SENC (5) Nil Nil 93,000 * *
FMR Corporation (6) Nil Nil 4,922,800 16.1% 7.2%
Kern Capital Management, LLC (7) Nil Nil 4,658,000 15.2% 6.8%
---------------------------------------
* Less than 1%
(1) Beneficial ownership is determined in accordance with the rules of the SEC
and generally includes voting or investment power with respect to
securities. Options that are currently exercisable (including options that
have an exercise price above the market price) are deemed to be outstanding
and to be beneficially owned by the person holding such options for the
purpose of computing the percentage ownership of such person, but are not
treated as outstanding for the purpose of computing the percentage
ownership of any other person.
(2) The number of shares held by Germain Lamonde includes 1,900,000 multiple
voting shares held of record by Fiducie Germain Lamonde and 36,000,000
multiple voting shares held of record by G. Lamonde Investissements
Financiers inc. and 93,000 subordinate voting shares held of record by
Placements Lamonde, SENC.
(3) Fiducie Germain Lamonde is a family trust for the benefit of Mr. Lamonde
and members of his family.
(4) G. Lamonde Investissements Financiers inc. is a company controlled by Mr.
Lamonde.
(5) Placements Lamonde, SENC is a parternship controlled by Mr. Lamonde.
(6) Fidelity Management and Research Company, a wholly owned subsidiary of FMR
Corporation, is the beneficial owner of this number of subordinate voting
shares as a result of acting as investment advisor to various investment
companies.
(7) Kern Capital Management LLC controls the voting rights attached to this
number of subordinate voting shares through relationships with several
clients and does not beneficially own directly this number of subordinate
voting shares.
Each multiple voting share is convertible at the option of the holder
into one subordinate voting share. Holders of our subordinate voting shares are
entitled to one vote per share and holders of our multiple voting shares are
entitled to ten votes per share.
As of December 31, 2004, approximately 90% of our subordinate voting
shares were held in bearer form and the remainder (2,963,508 subordinate voting
shares) were held by 260 record holders. As of December 31, 2004, we believe
approximately 56% of our outstanding subordinate voting shares were held in the
United States.
B. RELATED PARTY TRANSACTIONS
INDEBTEDNESS OF DIRECTORS, EXECUTIVE OFFICERS AND EMPLOYEES
We have guaranteed the repayment of loans granted to employees by a
financial institution for the purchase of our Class "F" shares that were
converted into subordinate voting
84
shares immediately prior to our initial public offering. As of August 31, 2004,
the total principal amount guaranteed by us was CDN$12,500 ($9,493) and $56,200.
As at December 15, 2004, the total amount guaranteed by us was $56,200 since we
were released from our guarantee in the amount of CDN$12,500 in September 2004.
Except as disclosed in this section, none of our directors, executive
officers, associates or affiliates had any material interest in any transaction
with us during the past three years or in any proposed transaction which has
materially affected or could materially affect us.
LEASES
Until September 1, 2004, we had a lease agreement with G. Lamonde
Investissements financiers inc., a company controlled by Mr. Germain Lamonde,
for premises located at 465 Godin Avenue in Vanier, Quebec. Until September 1,
2003, these premises were used for our executive and administrative offices
which were, since then, moved into a building that we own. For fiscal year 2004,
this space was unoccupied. This lease was renewed in December 2001 for five
years, with all terms and conditions remaining the same. However, on September
1, 2004, we were released from our obligations under the lease with a final
payment of $194,000 (CA$250,000). The annual rent for this lease was $CA144,000.
LOCATION SQUARE FOOTAGE ANNUAL RENT EXPIRY DATE
-------- -------------- ----------- -----------
465 Godin 24,000 CA$144,000 November 30, 2006
Based on third-party valuations of the property values, we believe this
lease agreement was at prevailing market terms.
In September 2002, we acquired from G. Lamonde Investissements
financiers inc. the building located at 436 Nolin Street that houses some of our
manufacturing activities. Previous to this acquisition, we had a lease agreement
with this company for these premises. We paid CA$1,450,000 for the building and
this purchase price is based on an independent third party valuation and the
transaction was approved by our audit committee and the board of directors with
Mr. Lamonde abstaining.
ITEM 8. FINANCIAL INFORMATION
A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION
SEE ITEM 18, "FINANCIAL STATEMENTS".
Valuation and qualifying accounts as well as Export sales are as follows (in
thousands of US dollars);
85
ALLOWANCE FOR DOUBTFUL ACCOUNTS
YEARS ENDED AUGUST 31,
-------------------------------------------------------
2004 2003 2002
--------------- -------------- --------------
Balance - Beginning of year $ 568 $ 520 $ 893
Addition charged to earnings 403 619 1,097
Write-offs of uncollectible accounts (186) (288) (925)
Reversal of collectible accounts (318) (315) (538)
Foreign currency translation adjustment 43 32 (7)
--------------- -------------- --------------
Balance - End of year $ 510 $ 568 $ 520
=============== ============== ==============
WARRANTY PROVISION
YEARS ENDED AUGUST 31,
-------------------------------------------------------
2004 2003 2002
--------------- -------------- --------------
Balance - Beginning of year $ 687 $ 849 $ 901
Addition charged to earnings 564 520 609
Settlement (889) (749) (655)
Foreign currency translation adjustment 28 67 (6)
--------------- -------------- --------------
Balance - End of year $ 390 $ 687 $ 849
=============== ============== ==============
VALUATION ALLOWANCE ON FUTURE INCOME TAX ASSETS
YEARS ENDED AUGUST 31,
-------------------------------------------------------
2004 2003 2002
--------------- -------------- --------------
Balance - Beginning of year $ 28,846 $ 359 $ 362
Addition charged to earnings 3,954 28,385 -
Foreign currency translation adjustment (187) 102 (3)
--------------- -------------- --------------
Balance - End of year $ 32,613 $ 28,846 $ 359
=============== ============== ==============
EXPORT SALES
Export and domestic sales in dollars and as a percentage of total sales are as
follows:
YEARS ENDED AUGUST 31,
-----------------------------------------------------------------------------
2004 2003 2002
---------------------- ----------------------- ----------------------
Export Sales $ 68,812 92% $ 57,124 92% $ 64,359 94%
Domestic Sales 5,818 8 4,806 8 3,971 6
---------------------- ----------------------- ----------------------
$ 74,630 100% $ 61,930 100% $ 68,330 100%
====================== ======================= ======================
86
B. SIGNIFICANT CHANGES
No significant changes occurred since the date of our annual consolidated
financial statements included elsewhere in this Annual Report.
LEGAL PROCEEDINGS
On November 27, 2001, a class action suit was filed in the United States
District Court for the Southern District of New York 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.
Approximately 300 other issuers and their underwriters have had similar suits
filed against them, all of which are included in a single coordinated proceeding
in the Southern District of New York (the "IPO Litigations"). 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 two amended complaints: one containing
master allegations against all of the underwriters in the IPO Litigations, and
the other 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. The Court granted the
company's motion to dismiss the claims against it under Section 11 of the
Securities Act. The Court denied the company's motion to dismiss the claims
against it under Rule 10b-5. In October 2002, the claims against its officers
were dismissed without prejudice pursuant to the terms of the Reservation of
Rights and Tolling Agreements entered into with the plaintiffs.
In June 2003, a committee of the company's Board of Directors conditionally
approved a proposed settlement between the issuer defendants, the individual
defendants, and the plaintiffs. On June 25, 2004, the Plaintiffs moved for
Preliminary Approval of the settlement, and
87
the Underwriter defendants have opposed that motion. If approved, the settlement
would provide, among other things, a release of the company and of the
individual defendants for the conduct alleged in the action to be wrongful in
the amended complaint. The company would agree to undertake other
responsibilities under the settlement, including agreeing to assign away, not
assert, or release certain potential claims the company may have against its
underwriters. Any direct financial impact of the proposed settlement is expected
to be borne by the company's insurance carriers.
Since the settlement process is subject to a fairness hearing and final court
approval, it is possible that it could fail. Therefore, it is not possible to
predict the final outcome of the case, nor determine the amount of any possible
losses. If the settlement process fails, the company will continue to defend its
position in this litigation that the claims against it, and its officers, are
without merit. Accordingly, no provision for this case has been made in the
consolidated financial statements as at August 31, 2004.
There are no other legal or arbitration proceedings pending or threatened of
which we are aware which may have or have had a significant effect on our
financial position.
DIVIDEND POLICY
We do not currently anticipate paying dividends for at least the three next
years. Our current intention is to reinvest any earnings in our business
long-term growth. Any future determination by us to pay dividends will be at the
discretion of our board of directors and in accordance with the terms and
conditions of any outstanding indebtedness and will depend on our financial
condition, results of operations, capital requirements and such other functions
as our board of directors considers relevant.
ITEM 9. OFFER AND LISTING
Not Applicable, except for Item 9A (4) and Item 9C.
Our subordinate voting shares have been quoted on the NASDAQ National Market
under the symbol EXFO and listed on The Toronto Stock Exchange under the symbol
EXF.SV since our initial public offering on June 29, 2000. Prior to that time,
there was no public market for our subordinate voting shares. The following
table sets forth, for the periods indicated, the high and low closing sales
prices per subordinate voting share as reported on the NASDAQ National Market
and the Toronto Stock Exchange.
On January 12, 2005, the last reported sale price for our subordinate voting
shares on the NASDAQ National Market was US$4.90 per share and the last reported
sale price for our subordinate voting shares on the Toronto Stock Exchange was
CA$5.93 per share.
88
NASDAQ (US$) TSX (CDN$)
HIGH LOW HIGH LOW
June 29, 2000 to August 31, 2000 85.25 40.44 125.25 60.25
September 1, 2000 to August 31, 2001 57.75 11.80 85.00 17.82
September 1, 2001 to August 31, 2002 15.00 1.35 23.80 2.05
September 1, 2002 to August 31, 2003 3.63 1.40 5.60 2.30
September 1, 2003 to August 31, 2004 7.09 2.71 9.15 3.75
2003 1st Quarter 3.53 1.40 5.40 2.30
2003 2nd Quarter 3.63 2.07 5.60 3.15
2003 3rd Quarter 3.13 1.94 4.28 2.86
2003 4th Quarter 3.00 2.52 4.11 3.47
2004 1st Quarter 4.26 2.71 5.53 3.75
2004 2nd Quarter 7.09 3.29 9.15 4.40
2004 3rd Quarter 5.23 4.08 6.90 5.68
2004 4th Quarter 5.38 4.11 6.95 5.50
2005 1st Quarter 5.51 4.27 6.90 5.73
2004 July 5.38 4.44 6.95 5.95
2004 August 4.71 4.19 6.16 5.50
2004 September 4.80 4.27 6.08 5.73
2004 October 5.51 4.81 6.90 6.02
2004 November 5.49 5.06 6.70 5.95
2004 December 5.15 4.29 6.15 5.35
89
ITEM 10. ADDITIONAL INFORMATION
A. SHARE CAPITAL
Not Applicable
B. MEMORANDUM AND ARTICLES OF ASSOCIATION
Incorporated by reference to our registration statement on Form F-1
(Reg. No. 333-38956).
C. MATERIAL CONTRACTS
Except as otherwise disclosed in this annual report and our financial
statements and notes included elsewhere in this annual report, we have no other
material contracts.
D. EXCHANGE CONTROLS
Subject to the following paragraph, there is no law or governmental
decree or regulation in Canada that restricts the export or import of capital,
or affects the remittance of dividends, interest or other payments to
non-resident holders of our subordinate voting shares, other than withholding
tax requirements.
There is no limitation imposed by Canadian law or by our articles of
incorporation or our other charter documents on the right of a non-resident to
hold or vote subordinate voting shares, other than as provided by the INVESTMENT
CANADA ACT, the NORTH AMERICAN FREE TRADE AGREEMENT IMPLEMENTATION ACT (Canada)
and the WORLD TRADE ORGANIZATION AGREEMENT IMPLEMENTATION ACT. The INVESTMENT
CANADA ACT requires notification and, in certain cases, advance review and
approval by the Government of Canada of an investment to establish a new
Canadian business by a non-Canadian or of the acquisition by a "non-Canadian" of
"control" of a "Canadian business", all as defined in the INVESTMENT CANADA ACT.
Generally, the threshold for review will be higher in monetary terms for a
member of the World Trade Organization or North American Free Trade Agreement.
E. TAXATION
UNITED STATES TAXATION
The information set forth below under the caption "United States
Taxation" is a summary of the material U.S. federal income tax consequences of
the ownership and disposition of subordinate voting shares by a U.S. Holder, as
defined below. These discussions are not a complete analysis or listing of all
of the possible tax consequences of such transactions and do not address all tax
considerations that may be relevant to particular holders in light of their
personal circumstances or to persons that are subject to special tax rules. In
particular, the information set forth under the caption "United States Taxation"
deals only with U.S. Holders that hold subordinate voting shares as capital
assets within the meaning of Section 1221 of the Internal Revenue Code of 1986,
as amended, and who do not at any time own individually, nor are treated as
owning 10% or more of the total combined voting power of all classes of our
stock entitled to vote. In addition, this description of U.S. tax consequences
does not address the tax treatment of special classes of U.S. Holders, such as
financial institutions, regulated investment companies, traders in securities
who elect to mark-to-market their securities, tax-
90
exempt entities, insurance companies, partnerships, persons holding subordinate
voting shares as part of a hedging, integrated or conversion transaction or as
part of a "straddle," U.S. expatriates, persons subject to the alternative
minimum tax, persons who acquired their subordinate voting shares through the
exercise or cancellation of employee stock options or otherwise as compensation
for services, dealers or traders in securities or currencies and holders whose
"functional currency" is not the U.S. dollar. This summary does not address
estate and gift tax consequences or tax consequences under any foreign, state or
local laws other than as provided in the section entitled "Canadian Federal
Income Tax Considerations" provided below.
As used in this section, the term "U.S. Holder" means a beneficial
owner of subordinate voting shares that is for U.S. federal income tax puposes:
(a) an individual citizen or resident of the United States;
(b) a corporation created or organized under the laws of the United
States or any state thereof and the District of Columbia;
(c) an estate the income of which is subject to United States federal
income taxation regardless of its source;
(d) a trust if (1) a court within the United States is able to
exercise primary jurisdiction over its administration and one or
more U.S. persons have authority to control all substantial
decisions of the trust or (2) the trust has a valid election in
effect under applicable U.S. Treasury regulations to be treated as
a U.S. person; or
(e) any other person whose worldwide income or gain is otherwise
subject to U.S. federal income taxation on a net income basis;
If a partnership or other flow-through entity holds subordinate voting
shares, the U.S. federal income tax treatment of a partner will generally depend
upon the status of the partner or other owner and upon the activities of the
partnership or other flow-through entity. If you are a partner of a partnership
holding subordinate voting shares, you should consult your tax advisor.
Holders of subordinate voting shares who are not U.S. Holders,
sometimes referred to as "Non-U.S. Holders", should also consult their own tax
advisors, particularly as to the applicability of any tax treaty.
The following discussion is based upon:
o the Internal Revenue Code;
o U.S. judicial decisions;
o administrative pronouncements;
o existing and proposed Treasury regulations; and
o the Canada -- U.S. Income Tax Treaty.
Any of the above is subject to change, possibly with retroactive
effect, so as to result in U.S. federal income tax consequences different from
those discussed below. We have not requested, and will not request, a ruling
from the U.S. Internal Revenue Service with respect to any of the U.S. federal
income tax consequences described below, and as a result, there can be no
assurance that the U.S. Internal Revenue Service will not disagree with or
challenge any of the conclusions we have reached and describe here.
91
The following discussion is for general information only and is not
intended to be, nor should it be construed to be, legal or tax advice to any
holder of subordinate voting shares and no opinion or representation with
respect to the U.S. federal income tax consequences to any holder is made.
Holders of subordinate voting shares are urged to consult their tax advisors as
to the particular consequences to them under U.S. federal, state, local and
applicable foreign tax laws of the acquisition, ownership and disposition of
subordinate voting shares.
DIVIDENDS
Subject to the discussion of passive foreign investment companies
below, the gross amount of any distribution paid by us to a U.S. Holder will
generally be subject to U.S. federal income tax as foreign source dividend
income to the extent paid out of our current or accumulated earnings and
profits, as determined under U.S. federal income tax principles. Such income
will be includable in the gross income of a U.S. Holder on the day received by
the U.S. Holder. The amount of any distribution of property other than cash will
be the fair market value of such property on the date of the distribution. In
the case of a taxable corporate U.S. Holder, such dividends will be taxable as
ordinary income and will not be eligible for the corporate dividends received
deduction, which is generally allowed to U.S. corporate shareholders on
dividends received from a domestic corporation. In the case of an individual
U.S. Holder, under recently enacted tax legislation such dividends should
generally be eligible for a maximum tax rate of 15% for dividends received
before January 1, 2009, provided such holder holds the subordinate voting shares
for at least 60 days and certain other conditions are satisfied, including, as
we believe to be the case, that we are not a "passive foreign investment
company" To the extent that an amount received by a U.S. Holder exceeds such
holder's allocable share of our current and accumulated earnings and profits,
such excess will be applied first to reduce such U.S. Holder's tax basis in his
subordinate voting shares, thereby increasing the amount of gain or decreasing
the amount of loss recognized on a subsequent disposition of the subordinate
voting shares. Then, to the extent such distribution exceeds such U.S. Holder's
tax basis, it will be treated as capital gain. We do not currently maintain
calculations of our earnings and profits for U.S. federal income tax purposes.
The gross amount of distributions paid in Canadian dollars, or any
successor or other foreign currency, will be included in the income of such U.S.
Holder in a U.S. dollar amount calculated by reference to the spot exchange rate
in effect on the day the distributions are paid regardless of whether the
payment is in fact converted into U.S. dollars. If the Canadian dollars, or any
successor or other foreign currency, are converted into U.S. dollars on the date
of the payment, the U.S. Holder should not be required to recognize any foreign
currency gain or loss with respect to the receipt of Canadian dollars as
distributions. If, instead, the Canadian dollars are converted at a later date,
any currency gains or losses resulting from the conversion of the Canadian
dollars will be treated as U.S. source ordinary income or loss for foreign tax
credit purposes. U.S. Holders are urged to consult their own tax advisors
concerning the U.S. tax consequences of acquiring, holding and disposing of
Canadian dollars.
A U.S. Holder may be entitled to deduct, or claim a foreign tax credit
for, Canadian taxes that are withheld on dividends received by the U.S. Holder,
subject to applicable limitations in the Code. Any amounts recognized as
dividends will generally constitute foreign source "passive income" or, in the
case of certain U.S. Holders, "financial services income" for U.S. foreign tax
credit purposes. A U.S. Holder will have a basis in any Canadian dollars
distributed equal to their U.S. dollar value on the payment date. The rules
governing the foreign tax credit are complex, and additional limitations on the
credit apply to individuals receiving dividends from foreign corporations if the
dividends are eligible for the 15% maximum tax rate on dividends
92
described above. U.S. Holders are urged to consult their tax advisors regarding
the availability of the foreign tax credit under their particular circumstances.
A Non-U.S. Holder of subordinate voting shares generally will not be
subject to U.S. federal income or withholding tax on dividends received on
subordinate voting shares unless such income is effectively connected with the
conduct by such Non-U.S. Holder of a trade or business in the United States.
SALE OR EXCHANGE
A U.S. Holder's initial tax basis in the subordinate voting shares will
generally be cost to the holder. A U.S. Holder's adjusted tax basis in the
subordinate voting shares will generally be the same as cost, but may differ for
various reasons including the receipt by such holder of a distribution that was
not made up wholly of earnings and profits as described above under the heading
"Dividends." Subject to the discussion of passive foreign investment companies
below, gain or loss realized by a U.S. Holder on the sale or other disposition
of subordinate voting shares will be subject to U.S. federal income taxation as
capital gain or loss in an amount equal to the difference (if any) between the
U.S. Holder's adjusted tax basis (determined in U.S. dollars) in the subordinate
voting shares and the U.S. dollar value of the amount realized on the
disposition of such subordinate voting shares. Capital gains of non-corporate
taxpayers, including individuals, derived with respect to a sale, exchange or
other disposition prior to January 1, 2009 of subordinate voting shares held for
more than one year are subject to a maximum federal income tax rate of 15%. The
deductibility of capital losses is subject to limitations. In the case of a
non-corporate U.S. Holder, the federal tax rate applicable to capital gains will
depend upon:
o the holder's holding period for the subordinate voting shares,
with a preferential rate available for subordinate voting shares
held for more than one year; and
o the holder's marginal tax rate for ordinary income.
Any gain realized will generally be treated as U.S. source gain and
loss realized by a U.S. Holder generally also will be treated as from sources
within the United States.
The ability of a U.S. Holder to utilize foreign taxes as a credit to
offset U.S. taxes is subject to complex limitations and conditions. The
consequences of the separate limitation calculation will depend upon the nature
and sources of each U.S. Holder's income and the deductions allocable thereto.
Alternatively, a U.S. Holder may elect to claim all foreign taxes paid as an
itemized deduction in lieu of claiming a foreign tax credit. A deduction does
not reduce U.S. tax on a dollar-for-dollar basis like a tax credit, but the
availability of the deduction is not subject to the same conditions and
limitations applicable to foreign tax credits.
If a U.S. Holder receives any foreign currency on the sale of
subordinate voting shares, such U.S. Holder may recognize ordinary income or
loss as a result of currency fluctuations between the date of the sale of
subordinate voting shares and the date the sale proceeds are converted into U.S.
dollars.
A Non-U.S. Holder of subordinate voting shares generally will not be
subject to U.S. federal income or withholding tax on any gain realized on the
sale or exchange of such subordinate voting shares unless:
93
o such gain is effectively connected with the conduct by such
Non-U.S. Holder of a trade or business in the United States; or
o in the case of any gain realized by an individual Non-U.S. Holder,
such Non-U.S. Holder is present in the United States for 183 days
or more in the taxable year of such sale and certain other
conditions are met.
Personal Holding Company
We could be classified as a personal holding company for U.S. federal
income tax purposes if both of the following tests are satisfied:
o if at any time during the last half of our taxable year, five or
fewer individuals own or are deemed to own more than 50% of the
total value of our shares; and
o we receive 60% or more of our U.S. related gross income from
specified passive sources, such as royalty payments.
A personal holding company is taxed on a portion of its undistributed
U.S. source income, including specific types of foreign source income which are
connected with the conduct of a U.S. trade or business, to the extent this
income is not distributed to shareholders. We do not believe we are a personal
holding company presently and we do not expect to become one. However, we can
not assure you that we will not qualify as a personal holding company in the
future.
PASSIVE FOREIGN INVESTMENT COMPANY
We believe that our subordinate voting shares should not currently be
treated as stock of a passive foreign investment company for United States
federal income tax purposes, but this conclusion is a factual determination made
annually and thus may be subject to change based on future operations and
composition and valuation of our assets. In general, we will be a passive
foreign investment company with respect to a U.S. Holder if, for any taxable
year in which the U.S. Holder holds our subordinate voting shares, either:
o at least 75% of our gross income for the taxable year is passive
income; or
o at least 50% of the average value of our assets is attributable to
assets that produce or are held for the production of passive
income.
For this purpose, passive income includes income such as:
o dividends;
o interest;
o rents or royalties, other than certain rents or royalties derived
from the active conduct of trade or business;
o annuities; or
o gains from assets that produce passive income.
If a foreign corporation owns at least 25% by value of the stock of
another corporation, the foreign corporation is treated for purposes of the
passive foreign investment company tests as owning its proportionate share of
the assets of the other corporation and as receiving directly its proportionate
share of the other corporation's income.
94
If we are treated as a passive foreign investment company, a U.S.
Holder that did not make a qualified electing fund election or, if available, a
mark-to-market election, as described below, would be subject to special rules
with respect to:
o any gain realized on the sale or other disposition of subordinate
voting shares; and
o any "excess distribution" by us to the U.S. Holder.
Generally, "excess distributions" are any distributions to the U.S.
Holder in respect of the subordinate voting shares during a single taxable year
that are greater than 125% of the average annual distributions received by the
U.S. Holder in respect of the subordinate voting shares during the three
preceding taxable years or, if shorter, the U.S. Holder's holding period for the
subordinate voting shares.
Under the passive foreign investment company rules,
o the gain or excess distribution would be allocated ratably over
the U.S. Holder's holding period for the subordinate voting
shares;
o the amount allocated to the taxable year in which the gain or
excess distribution was realized would be taxable as ordinary
income;
o the amount allocated to each prior year, with certain exceptions,
would be subject to tax at the highest tax rate in effect for that
year; and
o the interest charge generally applicable to underpayments of tax
would be imposed in respect of the tax attributable to each such
year.
A U.S. Holder owning actually or constructively "marketable stock" of a
passive foreign investment company may be able to avoid the imposition of the
passive foreign investment company tax rules described above by making a
mark-to-market election. Generally, pursuant to this election, such holder would
include in ordinary income, for each taxable year during which such stock is
held, an amount equal to the increase in value of the stock, which increase will
be determined by reference to the value of such stock at the end of the current
taxable year compared with their value as of the end of the prior taxable year.
Holders desiring to make the mark-to-market election should consult their tax
advisors with respect to the application and effect of making such election.
In the case of a U.S. Holder who does not make a mark-to-market
election, the special passive foreign investment company tax rules described
above will not apply to such U.S. Holder if the U.S. Holder makes an election to
have us treated as a qualified electing fund and we provide certain required
information to holders. For a U.S. Holder to make a qualified electing fund
election, we would have to satisfy certain reporting requirements. We have not
determined whether we will undertake the necessary measures to be able to
satisfy such requirements in the event that we were treated as a passive foreign
investment company.
A U.S. Holder that makes a qualified electing fund election will be
currently taxable on its pro rata share of our ordinary earnings and net capital
gain, at ordinary income and capital gains rates, respectively, for each of our
taxable years, regardless of whether or not distributions were received. The
U.S. Holder's basis in the subordinate voting shares will be increased to
reflect taxed but undistributed income. Distributions of income that had
previously been taxed will result in a corresponding reduction of basis in the
subordinate voting shares and will not be taxed again as a distribution to the
U.S. Holder. U.S. Holders desiring to make a
95
qualified electing fund election should consult their tax advisors with respect
to the advisability of making such election.
UNITED STATES BACKUP WITHHOLDING AND INFORMATION REPORTING
A U.S. Holder will generally be subject to information reporting with
respect to dividends paid on, or proceeds of the sale or other disposition of,
our subordinate voting shares that are paid within the United States or through
some U.S. related financial intermediaries to U.S. Holders, unless the U.S.
Holder is a corporation or comes within certain other categories of exempt
recipients. A U.S. Holder that is not an exempt recipient will generally be
subject to backup withholding with respect to the proceeds from the sale or the
disposition of, or with respect to dividends on, subordinate voting shares
unless the U.S. Holder provides a taxpayer identification number and otherwise
complies with applicable requirements of the backup withholding rules. In
addition, backup withholding may apply if the U.S. Holder fails to provide an
accurate taxpayer identification number, or to report interest and dividends
required to be shown on its federal income tax returns. Backup withholding is
not an additional tax. Any amount withheld under these rules will be creditable
against the U.S. Holder's U.S. federal income tax liability or refundable to the
extent that it exceeds such liability. A U.S Holder who does not provide a
correct taxpayer identification number may be subject to penalties imposed by
the United States Internal Revenue Service.
Non-U.S. Holders will generally be subject to information reporting and
possible backup withholding with respect to the proceeds of the sale or other
disposition of subordinate voting shares effected within the United States,
unless the holder certifies to its foreign status or otherwise establishes an
exemption and the broker does not have actual knowledge or reason to know that
the holder is a U.S. holder. Payments of dividends on or proceeds from the sale
of subordinate voting shares within the United States by a payor within the
United States to a non-exempt U.S. or Non-U.S. Holder will be subject to backup
withholding if such holder fails to provide appropriate certification. In the
case of such payments by a payor within the United States to a foreign
partnership other than a foreign partnership that qualifies as a "withholding
foreign partnership" within the meaning of such Treasury regulations, the
partners of such partnership will be required to provide the certification
discussed above in order to establish an exemption from backup withholding tax
and information reporting requirements.
CANADIAN FEDERAL INCOME TAX CONSIDERATIONS
The following is a summary of the material Canadian federal income tax
considerations generally applicable to a U.S. person who holds subordinate
voting shares and who, for the purposes of the INCOME TAX ACT (Canada) (the
"ITA"), and the CANADA-UNITED STATES INCOME TAX CONVENTION (1980) (the
"Convention"), as applicable and at all relevant times:
o is resident in the United States and not resident in Canada,
o holds the subordinate voting shares as capital property,
o does not have a "permanent establishment" or "fixed base" in
Canada, as defined in the Convention; and
o deals at arm's length with us. Special rules, which are not
discussed below, may apply to "financial institutions", as defined
in the ITA, and to non-resident insurers carrying on an insurance
business in Canada and elsewhere.
96
This discussion is based on the current provisions of the ITA and the
Convention and on the regulations promulgated under the ITA, all specific
proposals to amend the ITA or the regulations promulgated under the ITA
announced by or on behalf of the Canadian Minister of Finance prior to the date
of this annual report and the current published administrative practices of the
Canada Customs and Revenue Agency. It does not otherwise take into account or
anticipate any changes in law or administrative practice nor any income tax laws
or considerations of any province or territory of Canada or any jurisdiction
other than Canada, which may differ from the Canadian federal income tax
consequences described in this document.
Under the ITA and the Convention, dividends paid or credited, or deemed
to be paid or credited, on the subordinate voting shares to a U.S. person who
owns less than 10% of the voting shares will be subject to Canadian withholding
tax at the rate of 15% of the gross amount of those dividends or deemed
dividends. If a U.S. person is a corporation and owns 10% or more of the voting
shares, the rate is reduced from 15% to 5%. Subject to specified limitations, a
U.S. person may be entitled to credit against U.S. federal income tax liability
for the amount of tax withheld by Canada.
Under the Convention, dividends paid to specified religious,
scientific, charitable and similar tax exempt organizations and specified
organizations that are resident and exempt from tax in the United States and
that have complied with specified administrative procedures are exempt from this
Canadian withholding tax.
A capital gain realized by a U.S. person on a disposition or deemed
disposition of the subordinate voting shares will not be subject to tax under
the ITA unless the subordinate voting shares constitute taxable Canadian
property within the meaning of the ITA at the time of the disposition or deemed
disposition. In general, the subordinate voting shares will not be "taxable
Canadian property" to a U.S. person if they are listed on a prescribed stock
exchange, which includes The Toronto Stock Exchange, unless, at any time within
the five-year period immediately preceding the disposition, the U.S. person,
persons with whom the U.S. person did not deal at arm's length, or the U.S.
person together with those persons, owned or had an interest in or a right to
acquire more than 25% of any class or series of our shares.
If the subordinate voting shares are taxable Canadian property to a
U.S. person, any capital gain realized on a disposition or deemed disposition of
those subordinate voting shares will generally be exempt from tax by virtue of
the Convention if the value of the subordinate voting shares at the time of the
disposition or deemed disposition is not derived principally from real property,
as defined by the Convention, situated in Canada. The determination as to
whether Canadian tax would be applicable on a disposition or deemed disposition
of the subordinate voting shares must be made at the time of the disposition or
deemed disposition.
Holders of subordinate voting shares are urged to consult their own tax
advisors to determine the particular tax consequences to them, including the
application and effect of any state, local or foreign income and other tax laws,
of the acquisition, ownership and disposition of subordinate voting shares.
97
F. DIVIDENDS AND PAYING AGENTS
Not Applicable.
G. STATEMENT BY EXPERTS
Not Applicable.
H. DOCUMENTS ON DISPLAY
Any statement in this annual report about any of our contracts or other
documents is not necessarily complete. If the contract or document is filed as
an exhibit to the registration statement, the contract or document is deemed to
modify the description contained in this annual report. You must review the
exhibits themselves for a complete description of the contract or document.
You may review a copy of our filings with the SEC, including exhibits
and schedules filed with it, at the SEC's public reference facilities in Room
1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 and at the
regional offices of the SEC located at 233 Broadway, New York, New York 10279
and at the Northwestern Atrium Center, 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661. You may also obtain copies of such materials from the
Public Reference Section of the SEC, Room 1024, Judiciary Plaza, 450 Fifth
Street, N.W., Washington, D.C. 20549, at prescribed rates. You may call the SEC
at 1-800-SEC-0330 for further information on the public reference rooms. The SEC
maintains a Web site (HTTP://WWW.SEC.GOV) that contains reports, proxy and
information statements and other information regarding registrants that file
electronically with the SEC. Although we make many of our filings with the SEC
electronically as a foreign private issuer, we are not obligated to do so.
You may read and copy any reports, statements or other information that
we file with the SEC at the addresses indicated above and you may also access
them electronically at the Web site set forth above. These SEC filings are also
available to the public from commercial document retrieval services.
We are required to file reports and other information with the SEC
under the Securities Exchange Act of 1934. Reports and other information filed
by us with the SEC may be inspected and copied at the SEC's public reference
facilities described above. As a foreign private issuer, we are exempt from the
rules under the Exchange Act prescribing the furnishing and content of proxy
statements and our officers, directors and principal shareholders are exempt
from the reporting and short-swing profit recovery provisions contained in
Section 16 of the Exchange Act. Under the Exchange Act, as a foreign private
issuer, we are not required to publish financial statements as frequently or as
promptly as United States companies.
I. SUBSIDIARY INFORMATION
See Item 4.C. of this annual report.
98
ITEM 11. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK
CURRENCY RISK
Our functional currency is the Canadian dollar. We are exposed to
currency risk as a result of the export of our products manufactured in Canada,
substantially all of which are denominated in US dollars. Our exposure to
foreign exchange rate fluctuations is partially hedged by operating expenses of
certain international subsidiaries and the purchase of raw materials in US
dollars. In addition, we frequently enter into forward exchange contracts to
sell US dollars at fixed forward rates in exchange for Canadian dollars. We
enter into such contracts to manage the risk of exchange rate fluctuations
between the Canadian and US dollars on cash flows related to anticipated future
revenue streams denominated in US dollars. We do not enter into forward exchange
contracts for trading purposes.
The following table summarizes the forward exchange contracts in effect
as at August 31, 2004, classified by expected transaction dates, none of which
exceed three years, as well as the notional amounts of such contracts (in
thousands of US dollars) along with the weighted average contractual forward
rates under such contracts. The notional amounts of such contracts are used to
calculate the contractual payments to be made under these contracts.
YEARS ENDING AUGUST 31,
------------------------------
2005 2006 2007
-------- -------- -------
Forward exchange contracts to sell US dollars
in exchange for Canadian dollars ............... $ 7,480 $ 7,000 $ 1,400
Contractual amounts
Weighted average contractual exchange rates..... 1.5427 1.3621 1.3628
FAIR VALUE
The fair value of these contracts as at August 31, 2004, based on the
current trading value, amounted to CA$20,371,000 compared to their contractual
value of CA$22,982,000.
INTEREST RATE RISK
We are exposed to the impact of interest rate changes and changes in
the market values of our available-for-sale securities. We do not use derivative
financial instruments for our available-for-sale securities. Our
available-for-sale securities consist of debt instruments issued by high-credit
quality corporations and trusts. These debt instruments bear interest at fixed
rates and may have their fair market value adversely impacted due to a rise in
interest rates. However, due to their very short-term maturity, we consider this
risk to be insignificant.
99
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES.
Not Applicable.
PART II.
ITEM 13. DEFAULTS, DIVIDENDS ARREARAGES AND DELINQUENCIES
Not Applicable.
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND
USE OF PROCEEDS
Not Applicable.
ITEM 15. CONTROLS AND PROCEDURES
Prior to the adoption of the SARBANES-OXLEY ACT OF 2002, we maintained
formal and informal procedures that were designed to ensure that we comply with
disclosure obligations and that there is a flow of important information to the
appropriate collection and disclosure points in a timely manner.
The evaluation of our disclosure controls and procedures, which
occurred on January 10, 2005, was supervised and reviewed by our senior
management. In doing so, they considered the controls and procedures that we
have implemented, and evaluated the existence of any material weaknesses or
deficiencies that would significantly and adversely affect our ability to
collect, process record or disclose required information on a timely basis, all
in the context of our relatively small size (649 employees as of December 15,
2004), and the hands-on role that is played by our chief executive officer and
our chief financial officer in our day-to-day operations. As a result, our chief
executive officer and our chief financial officer have concluded that the
procedures and controls that we have implemented ensure timely collection and
evaluation of information potentially subject to disclosure under applicable
securities laws, and that such procedures and controls capture information that
is relevant to an assessment of the need to disclose developments and risks that
pertain to our business.
Finally, we confirm that there were no significant changes in our
internal control over financial reporting or in other factors that would
significantly affect our internal control over financial reporting subsequent to
the date of its evaluation.
ITEM 16. [RESERVED]
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT
Our board of directors has determined that Mr. Andre Tremblay, CA,
chairman of our audit committee is an audit committee financial expert. Mr.
Tremblay is independent of management.
100
ITEM 16B. CODE OF ETHICS
In 2003, we adopted a code of ethics that applies to our chief
executive officer, our chief financial officer and our manager of financial
reporting and accounting. A copy of this code of ethics has been filed as
exhibit 11.1 to this annual report. As reported at item 7B of this annual
report, previous to the coming into force of the requirement for a code of
ethics, we had entered into a lease agreement with G. Lamonde Investissements
financiers inc., a company controlled by our chief executive officer, for
premises located at 465 Godin Avenue in Vanier, Quebec and on September 1, 2004,
we were released from our obligations under this lease with a final payment of
$194,000. In addition, in September 2002, we acquired from G. Lamonde
Investissements financiers inc. the building located at 436 Nolin Street. The
purchase price paid was based on an independent third party valuation and the
transaction was approved by our audit committee and board of directors with Mr.
Lamonde abstaining.
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
AUDIT FEES
During the financial years ended August 31, 2003 and August 31, 2004,
our principal accountant, PricewaterhouseCoopers LLP, billed us aggregate
amounts of $202,459 and $189,000 respectively for the audit of our annual
financial statements and services in connection with statutory and regulatory
filings.
AUDIT-RELATED FEES
Not applicable.
TAX FEES
During the financial years ended August 31, 2003 and August 31, 2004,
our principal accountant, PricewaterhouseCoopers LLP, billed us aggregate
amounts of $233,660 and $301,000 respectively for services related to tax
compliance, tax advice and tax planning.
ALL OTHER FEES
Not applicable.
AUDIT COMMITTEE PRE-APPROVAL POLICIES AND PROCEDURES
On September 25, 2002, our audit committee adopted a policy requiring
prior approval by the audit committee of the annual audit plan and fees. In the
event any adjustments to audit fees may be required during the course of a
financial year, such adjustments shall be approved by the chairman of the audit
committee, acting alone, and shall be reported to the full audit committee at
its next meeting.
In the case of non-audit fees (excluding tax matters), the policy
provides that proposals shall be submitted to the chairman of the audit
committee and our chief financial officer at the same time and the chairman of
the audit committee will be responsible for approval of such proposal, subject
to any modifications that he may require. The chairman will make a report to the
full audit committee at its next meeting.
101
As concerns tax services to be provided by our principal accountant,
our policy provides that the principal accountant will present to the audit
committee for pre-approval, on or before the beginning of each financial year,
an engagement for tax matters that are foreseeable for the upcoming year and the
audit committee shall be responsible for pre-approval thereof, subject to any
modifications it may make to such proposals. In the event tax services are
required that were not pre-approved by the audit committee, the procedure set
forth in the previous paragraph will apply.
During the financial year ended on August 31, 2004, 100% of tax fees
were approved by the audit committee pursuant to this policy. During the
financial year ended on August 31, 2004, only full-time permanent employees of
our principal accountant, PricewaterhouseCoopers LLP, performed work to audit
our financial statements.
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
Not Applicable.
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED
PURCHASERS
Not Applicable.
PART III.
ITEM 17. FINANCIAL STATEMENTS
Not Applicable.
ITEM 18. FINANCIAL STATEMENTS
See pages F-2 to F-46.
102
ITEM 19. EXHIBITS
NUMBER EXHIBIT
------ -----------------------------------------------------------------------
1.1 Amended Articles of Incorporation of EXFO (incorporated by reference to
Exhibit 3.1 of EXFO's Registration Statement on Form F-1, File No.
333-38956).
1.2 Amended By-laws of EXFO (incorporated by reference to Exhibit 1.2 of
EXFO's annual report on Form-20F dated January 15, 2003).
1.3 Amended and Restated Articles of Incorporation of EXFO (incorporated by
reference to Exhibit 1.3 of EXFO's annual report on Form 20-F dated
January 18, 2001).
2.1 Form of Subordinate Voting Share Certificate (incorporated by reference
to Exhibit 4.1 of EXFO's Registration Statement on Form F-1, File No.
333-38956).
2.2 Form of Registration Rights Agreement between EXFO and Germain Lamonde
dated July 6, 2000 ) (incorporated by reference to Exhibit 10.13 of
EXFO's Registration Statement on Form F-1, File No. 333-38956).
3.1 Form of Trust Agreement among EXFO, Germain Lamonde, GEXFO
Investissements Technologiques inc., Fiducie Germain Lamonde and G.
Lamonde Investissements Financiers inc. (incorporated by reference to
Exhibit 4.2 of EXFO's Registration Statement on Form F-1, File No.
333-38956).
4.1 Agreement of Merger and Plan of Reorganization, dated as of November 4,
2000, by and among EXFO, EXFO Sub, Inc., EXFO Burleigh Instruments,
Inc., Robert G. Klimasewki, William G. May, Jr., David J. Farrell and
William S. Gornall (incorporated by reference to Exhibit 4.1 of EXFO's
annual report on Form 20-F dated January 18, 2001)
4.2 Amendment No. 1 to Agreement of Merger and Plan of Agreement, dated as
of December 20, 2000, by and among EXFO, EXFO Sub, Inc., EXFO Burleigh
Instruments, Inc., Robert G. Klimasewski, William G. May, Jr., David J.
Farrell and William S. Gornall (incorporated by reference to Exhibit
4.2 of EXFO's annual report on Form 20-F dated January 18, 2001).
4.3 Agreement of Merger, dated as of August 20, 2001, by and among EXFO,
Buyer Sub, and Avantas Networks Corporation and Shareholders of Avantas
Networks corporation (incorporated by reference to Exhibit 4.3 of
EXFO's annual report on Form 20-F dated January 18, 2002).
4.4 Amendment No. 1 dated as of November 1, 2002 to Agreement of Merger,
dated as of August 20, 2001, by and among EXFO, 3905268 Canada Inc.,
Avantas Networks Corporation and Shareholders of Avantas Networks
(incorporated by reference to Exhibit 4.4 of EXFO's annual report on
Form 20-F dated January 18, 2002).
4.5 Offer to purchase shares of Nortech Fibronic Inc., dated February 6,
2000 among EXFO, Claude Adrien Noel, 9086-9314 Quebec inc., Michel
Bedard, Christine Bergeron and Societe en Commandite Capidem Quebec
Enr. and Certificate of Closing, dated February 7, 2000 among the same
parties (including summary in English) (incorporated by reference to
Exhibit 10.2 of EXFO's Registration Statement on Form F-1, File No.
333-38956).
4.6 Share Purchase Agreement, dated as of March 5, 2001, among EXFO
Electro-Optical Engineering, Inc., John Kennedy, Glenn Harvey and EFOS
Corporation (incorporated by reference to Exhibit 4.1 of EXFO's
Registration Statement on Form F-3, File No. 333-65122).
4.7 Amendment Number One, dated as of March 15, 2001, to Share Purchase
Agreement, dated as of March 5, 2001, among EXFO Electro-Optical
Engineering, Inc., John Kennedy, Glenn Harvey and EFOS Corporation.
(incorporated by reference to Exhibit 4.2 of EXFO's Registration
Statement on Form F-3, File No. 333-65122).
4.8 Share Purchase Agreement, dated as of November 2, 2001 between JDS
Uniphase Inc. and 3905268 Canada Inc. (incorporated by reference to
Exhibit 4.8 of EXFO's annual report on Form 20-F dated January 18,
2002).
4.9 Intellectual Property Assignment and Sale Agreement between EFOS Inc.,
EXFO Electro-Optical Engineering, Inc., John Kennedy, Glenn Harvey and
EFOS Corporation. (incorporated by reference to Exhibit 4.3 of EXFO's
Registration Statement on Form F-3, File No. 333-65122).
4.10 Offer to acquire a building, dated February 23, 2000, between EXFO and
Groupe Mirabau inc. and as accepted by Groupe Mirabau inc. on February
24, 2000 (including summary in English) (incorporated by reference to
Exhibit 10.3 of EXFO's Registration Statement on Form F-1, File No.
333-38956).
4.11 Lease Agreement, dated December 1, 1996, between EXFO and GEXFO
Investissements Technologiques inc., as assigned to 9080-9823 Quebec
inc. on September 1, 1999 (including summary in English) (incorporated
by reference to Exhibit 10.4 of EXFO's Registration Statement on Form
F-1, File No. 333-38956).
4.12 Lease Agreement, dated March 1, 1996, between EXFO and GEXFO
Investissements Technologiques inc., as assigned to 9080-9823 Quebec
inc. on September 1, 1999 (including summary in English) (incorporated
by reference to Exhibit10.5 of EXFO's Registration Statement on Form
F-1, File No. 333-38956).
4.13 Lease renewal of the existing leases between 9080-9823 Quebec inc. and
EXFO, dated November 30,
103
NUMBER EXHIBIT
------ -----------------------------------------------------------------------
2001(incorporated by reference to Exhibit 4.13 of EXFO's annual report
on Form 20-F dated January 18, 2002).
4.14 Loan Agreement between EXFO and GEXFO Investissements Technologiques
inc., dated May 11, 1993, as assigned to 9080-9823 Quebec inc. on
September 1, 1999 (including summary in English) (incorporated by
reference to Exhibit 10.9 of EXFO's Registration Statement on Form F-1,
File No. 333-38956).
4.15 Resolution of the board of directors of EXFO, dated September 1, 1999,
authorizing EXFO to acquire GEXFO Distribution Internationale inc. from
GEXFO Investissements Technologiques inc. (including summary in
English) (incorporated by reference to Exhibit 10.10 of EXFO's
Registration Statement on Form F-1, File No. 333-38956).
4.16 Form of Promissory Note of EXFO issued to GEXFO Investissements
Technologiques inc. dated June 27, 2000 ) (incorporated by reference to
Exhibit 10.12 of EXFO's Registration Statement on Form F-1, File No.
333-38956).
4.17 Term Loan Offer, dated March 28, 2000, among EXFO and National Bank of
Canada as accepted by EXFO on April 3, 2000 (including summary in
English) (incorporated by reference to Exhibit 10.11 of EXFO's
Registration Statement on Form F-1, File No. 333-38956).
4.18 Employment Agreement of Germain Lamonde dated May 29, 2000
(incorporated by reference to Exhibit 10.15 of EXFO's Registration
Statement on Form F-1, File No. 333-38956).
4.19 Employment Agreement of Bruce Bonini dated as of September 1, 2000
(incorporated by reference to Exhibit 4.24 of EXFO's annual report on
Form 20-F dated January 18, 2002).
4.20 Employment Agreement of Juan-Felipe Gonzalez dated as of September 1,
2000 (incorporated by reference to Exhibit 4.25 of EXFO's annual report
on Form 20-F dated January 18, 2002).
4.21 Employment Agreement of David J. Farrell dated as of December 20, 2000
(incorporated by reference to Exhibit 4.26 of EXFO's annual report on
Form 20-F dated January 18, 2002).
4.22 Deferred Profit Sharing Plan, dated September 1, 1998 (incorporated by
reference to Exhibit 10.6 of EXFO's Registration Statement on Form F-1,
File No. 333-38956).
4.23 Stock Option Plan, dated May 25, 2000 (incorporated by Reference to
Exhibit 10.7 of EXFO's Registration Statement on Form F-1, File No.
333-38956).
4.24 Share Plan, dated April 3, 2000 (incorporated by reference to Exhibit
10.8 of EXFO's Registration Statement on Form F-1, File No. 333-38956).
4.25 Directors' Compensation Plan (incorporated by reference to Exhibit
10.17 of EXFO's Registration Statement on Form F-1, File No.
333-38956).
4.26 Restricted Stock Award Plan, dated December 20, 2000 (incorporated by
reference to Exhibit 4.21 of EXFO's annual report on Form 20-F dated
January 18, 2001).
4.27 Asset Purchase Agreement by and Among EXFO Electro-Optical Engineering
Inc., EXFO Gnubi Products Group Inc., gnubi communications, L.P., gnubi
communications General Partner, LLC, gnubi communications Limited
Partner, LLC, gnubi communications, Inc., Voting Trust created by The
Irrevocable Voting Trust Agreement Among Carol Abraham Bolton, Paul
Abraham and James Ray Stevens, James Ray Stevens and Daniel J. Ernst
dated September 5, 2002 (incorporated by reference to Exhibit 4.30 of
EXFO's annual report on Form 20-F dated January 15, 2003).
4.28 EXFO Protocol Inc. Executive Employment Agreement with Sami Yazdi
signed November 2, 2001 (incorporated by reference to Exhibit 4.28 of
EXFO's annual report on Form 20-F dated January 15, 2003).
4.29 Second Amending Agreement to the Employment Agreement of Bruce Bonini
dated as of September 1, 2002, (incorporated by reference to Exhibit
4.29 of EXFO's annual report on Form 20-F dated January 15, 2004).
4.30 Severance and General Release Agreement with Bruce Bonini dated August
8, 2003, (incorporated by reference to Exhibit 4.30 of EXFO's annual
report on Form 20-F dated January 15, 2004)..
4.31 Separation Agreement and General Release with Sami Yazdi dated April 1,
2003, (incorporated by reference to Exhibit 4.31 of EXFO's annual
report on Form 20-F dated January 15, 2004).
4.32 Executive Employment Agreement of James Stevens dated as of October 4,
2003, (incorporated by reference to Exhibit 4.32 of EXFO's annual
report on Form 20-F dated January 15, 2004).
4.33 Termination Terms for John Holloran Jr. dated May 28, 2003,
(incorporated by reference to Exhibit 4.33 of EXFO's annual report on
Form 20-F dated January 15, 2004).
4.34 Employment Agreement of Pierre Plamondon dated as of September 1, 2002,
(incorporated by reference to Exhibit 4.34 of EXFO's annual report on
Form 20-F dated January 15, 2004).
8.1 Subsidiaries of EXFO (list included in Item 4C of this annual report).
11.1 Code of Ethics for senior financial officers, (incorporated by
reference to Exhibit 11.1 of EXFO's annual report on Form 20-F dated
January 15, 2004).
12.1 Certification of the Chief Executive Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
12.2 Certification of the Chief Executive Officer Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
13.1 Certification of the Chief Financial Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
13.2 Certification of the Chief Financial Officer Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
104
SIGNATURES
The registrant hereby certifies that it meets all of the requirements for filing
on Form 20 -F and that it has duly caused and authorized the undersigned to sign
this annual report on its behalf.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
By: /s/ Germain Lamonde
---------------------------------
Name: Germain Lamonde
Title: Chairman of the Board, President
and Chief Executive Officer
Date: January 13, 2005.
105
CERTIFICATIONS
I, Germain Lamonde, Chairman of the Board, President and Chief
Executive Officer, certify that:
1. I have reviewed this annual report on Form 20-F of EXFO
Electro-Optical Engineering Inc. ("EXFO");
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statement made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other
financial information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of EXFO
as of, and for, the periods presented in this report;
4. EXFO's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for EXFO and have:
a. Designed such disclosure controls and procedures, or
caused such disclosure controls and procedures to be
designed under our supervision, to ensure that
material information relating to EXFO, including its
consolidated subsidiaries, is made known to us by
others within those entities, particularly during the
period in which this report is being prepared;
b. Evaluated the effectiveness of EXFO's disclosure
controls and procedures and presented in this report
our conclusions about the effectiveness of the
disclosure controls and procedures, as of the end of
the period covered by this report based on such
evaluation;and
c. Disclosed in this report any change in EXFO's
internal control over financial reporting that
occurred during the period covered by the annual
report that has materially affected, or is reasonably
likely to materially affect, EXFO's internal control
over financial reporting.
5. EXFO's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
EXFO's auditors and the audit committee of EXFO's board of directors (or persons
performing the equivalent functions):
a) All significant deficiencies and material weaknesses
in the design or operation of internal control over
financial reporting which are reasonable likely to
adversely affect EXFO's ability to record, process,
summarize and report financial information; and
b) Any fraud, whether or not material, that involves
management or other employees who have a significant
role in EXFO's internal control over financial
reporting.
106
Date: January 13, 2005.
/s/ Germain Lamonde
-------------------------------------
Germain Lamonde
Chairman of the Board,
President and Chief Executive Officer
Pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and
(b) of section 1350, chapter 63 of title 18, United States Code), the
undersigned officer of EXFO, hereby certifies, to such officer's knowledge,
that:
1. The annual report of Form 20-F for the year ended August 31,
2004 of EXFO fully complies with the requirements of section 13(a) or 15(d) of
the Securities Exchange Act of 1934; and
2. The information contained in this annual report fairly
presents, in all material respects, the financial condition and results of
operations of EXFO.
Date: January 13, 2005.
/s/ Germain Lamonde
-------------------------------------
Germain Lamonde
Chairman of the Board,
President and Chief Executive Officer
The foregoing certification is being furnished solely pursuant to
section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of
section 1350, chapter 63 of title 18, United States Code) and is not being filed
as part of the Report or as separate disclosure document.
107
I, Pierre Plamondon, Vice-President Finance and Chief Financial
Officer, certify that:
1. I have reviewed this annual report on Form 20-F of EXFO
Electro-Optical Engineering Inc. ("EXFO");
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statement made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other
financial information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of EXFO
as of, and for, the periods presented in this report;
4. EXFO's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for EXFO and have:
a) Designed such disclosure controls and procedures, or caused
such disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to EXFO, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) Evaluated the effectiveness of EXFO's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation;
c) Disclosed in this report any change in EXFO's internal control
over financial reporting that occurred during the period covered by the annual
report that has materially affected, or is reasonably likely to materially
affect, EXFO's internal control over financial reporting.
5. EXFO's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
EXFO's auditors and the audit committee of EXFO's board of directors (or persons
performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting which are
reasonable likely to adversely affect EXFO's ability to record, process,
summarize and report financial information; and
b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in EXFO's internal control over
financial reporting.
Date: January 13, 2005.
/s/ Pierre Plamondon
---------------------------
Pierre Plamondon, CA
Vice-President Finance
and Chief Financial Officer
108
Pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and
(b) of section 1350, chapter 63 of title 18, United States Code), the
undersigned officer of EXFO, hereby certifies, to such officer's knowledge,
that:
1. The annual report of Form 20-F for the year ended August 31,
2004 of EXFO fully complies with the requirements of section 13(a) or 15(d) of
the Securities Exchange Act of 1934; and
2. The information contained in this annual report fairly
presents, in all material respects, the financial condition and results of
operations of EXFO.
Date: January 13, 2005.
/s/ Pierre Plamondon
---------------------------
Pierre Plamondon, CA
Vice-President Finance
and Chief Financial Officer
The foregoing certification is being furnished solely pursuant to
section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of
section 1350, chapter 63 of title 18, United States Code) and is not being filed
as part of the Report or as separate disclosure document.
109
REPORT OF INDEPENDENT AUDITORS
TO THE SHAREHOLDERS OF
EXFO ELECTRO-OPTICAL ENGINEERING INC.
We have audited the balance sheets of EXFO ELECTRO-OPTICAL ENGINEERING INC. as
at August 31, 2004 and 2003 and the consolidated statements of earnings,
deficits and contributed surplus and cash flows for each of the three years in
the period ended August 31, 2004. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with Canadian generally accepted auditing
standards and the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform an audit to
obtain reasonable assurance whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation.
In our opinion, these consolidated financial statements present fairly, in all
material respects, the financial position of the Company as at August 31, 2004
and 2003 and the results of its operations and its cash flows for each of the
three years in the period ended August 31, 2004 in accordance with Canadian
generally accepted accounting principles. Furthermore, in our opinion, the
financial statement schedules on the changes in the allowance for doubtful
accounts, in the warranty provision and in the valuation allowance of future
income tax assets included in Form 20-F present fairly, in all material
respects, the information set forth therein when read in conjunction with the
related consolidated financial statements.
/s/ PricewaterhouseCoopers LLP
CHARTERED ACCOUNTANTS
Quebec, Quebec, Canada
September 30, 2004
COMMENTS BY AUDITORS FOR U.S. READERS ON CANADA-U.S. REPORTING DIFFERENCES
In the United States of America, reporting standards for auditors require the
addition of an explanatory paragraph (following the opinion paragraph) when
there are changes in accounting principles that have a material effect on the
comparability of the Company's financial statements, such as the changes
described in note 2 to the consolidated financial statements. Our report to the
Shareholders dated September 30, 2004 is expressed in accordance with Canadian
reporting standards which do not require a reference to such changes in
accounting principles in the auditors' report when the changes are properly
accounted for and adequately disclosed in the financial statements.
/s/ PricewaterhouseCoopers LLP
CHARTERED ACCOUNTANTS
Quebec, Quebec, Canada
September 30, 2004
FOR DISCUSSION WITH MANAGEMENT ONLY - SUBJECT TO AMENDMENT
NOT TO BE FURTHER COMMUNICATED
F-1
EXFO ELECTRO-OPTICAL ENGINEERING INC.
CONSOLIDATED BALANCE SHEETS
(in thousands of US dollars)
AS AT AUGUST 31,
------------------------------------------------------------------------------------
2004 2003
--------- ---------
ASSETS
CURRENT ASSETS
Cash $ 5,159 $ 5,366
Short-term investments (notes 8 and 17) 83,969 52,010
Accounts receivable (notes 8 and 17)
Trade 12,080 9,639
Other 1,532 834
Income taxes and tax credits recoverable (notes 4 and 8) 7,836 6,003
Inventories (notes 4, 5 and 8) 15,371 15,602
Prepaid expenses 1,513 2,041
--------- ---------
127,460 91,495
INCOME TAXES AND TAX CREDITS RECOVERABLE (notes 4 and 8) 449 1,377
PROPERTY, PLANT AND EQUIPMENT (notes 4, 6 and 8) 15,442 21,862
LONG-LIVED ASSET HELD FOR SALE (note 4) 1,600 --
INTANGIBLE ASSETS (notes 4, 7 and 8) 9,447 13,847
GOODWILL (notes 4 and 7) 18,393 17,673
--------- ---------
$ 172,791 $ 146,254
--------- ---------
LIABILITIES
CURRENT LIABILITIES
Accounts payable and accrued liabilities (note 9) $ 11,393 $ 12,026
Income taxes payable -- 1,803
Deferred revenue 805 148
Current portion of long-term debt 121 110
--------- ---------
12,319 14,087
DEFERRED REVENUE 1,123 352
DEFERRED GRANTS (note 14) 1,690 1,536
LONG-TERM DEBT (note 10) 332 453
--------- ---------
15,464 16,428
--------- ---------
COMMITMENTS (note 11)
CONTINGENCIES (note 12)
SHAREHOLDERS' EQUITY
Share capital (note 13) 521,733 492,452
Contributed surplus 1,986 1,519
Cumulative translation adjustment 13,820 7,643
Deficit (380,212) (371,788)
--------- ---------
157,327 129,826
--------- ---------
$ 172,791 $ 146,254
========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-2
EXFO ELECTRO-OPTICAL ENGINEERING INC.
CONSOLIDATED STATEMENTS OF EARNINGS
(in thousands of US dollars, except share and per share data)
YEARS ENDED AUGUST 31,
-----------------------------------
2004 2003 2002
--------- --------- ---------
SALES (note 18) $ 74,630 $ 61,930 $ 68,330
COST OF SALES(1,2) 34,556 36,197 52,366
--------- --------- ---------
GROSS MARGIN 40,074 25,733 15,964
--------- --------- ---------
OPERATING EXPENSES
Selling and administrative(1) 25,890 26,991 33,881
Net research and development(1)(notes 4 and 14) 12,390 15,879 12,782
Amortization of property, plant and equipment 4,935 5,210 5,096
Amortization of intangible assets 5,080 5,676 12,451
Impairment of long-lived assets and goodwill (note 4) 620 7,427 23,657
Restructuring and other charges (note 4) 1,729 4,134 2,880
--------- --------- ---------
TOTAL OPERATING EXPENSES 50,644 65,317 90,747
--------- --------- ---------
LOSS FROM OPERATIONS (10,570) (39,584) (74,783)
Interest and other income 1,438 1,245 1,456
Foreign exchange loss (278) (1,552) (458)
--------- --------- ---------
LOSS BEFORE INCOME TAXES AND AMORTIZATION
AND WRITE-DOWN OF GOODWILL (note 15) (9,410) (39,891) (73,785)
INCOME TAXES (note 15) (986) 15,059 (25,451)
--------- --------- ---------
LOSS BEFORE AMORTIZATION AND WRITE-DOWN OF GOODWILL (8,424) (54,950) (48,334)
AMORTIZATION OF GOODWILL (note 2) -- -- 38,021
WRITE-DOWN OF GOODWILL (note 4) -- -- 222,169
--------- --------- ---------
NET LOSS FOR THE YEAR $ (8,424) $ (54,950) $(308,524)
--------- --------- ---------
BASIC AND DILUTED LOSS PER SHARE
Loss before amortization and write-down of goodwill $ (0.13) $ (0.87) $ (0.80)
Net loss $ (0.13) $ (0.87) $ (5.09)
BASIC WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING (000's) 66,020 62,852 60,666
DILUTED WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING (000's)
(note 16) 66,615 63,317 60,966
(1) STOCK-BASED COMPENSATION COSTS INCLUDED IN: (note 2)
Cost of sales
$ 62 $ -- $ --
Selling and administrative 265 -- --
Net research and development 122 -- --
--------- --------- ---------
$ 449 $ -- $ --
========= ========= =========
(2) Including inventory write-offs of nil, $4,121 and $18,463 for the years ended August 31, 2004, 2003
and 2002, respectively (note 4). The cost of sales is exclusive of amortization, shown separately.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-3
EXFO ELECTRO-OPTICAL ENGINEERING INC.
CONSOLIDATED STATEMENTS OF DEFICIT AND CONTRIBUTED SURPLUS
(in thousands of US dollars)
DEFICIT
YEARS ENDED AUGUST 31,
-----------------------------------
2004 2003 2002
--------- --------- ---------
BALANCE - BEGINNING OF YEAR $(371,788) $(316,838) $ (8,314)
ADD
Net loss for the year (8,424) (54,950) (308,524)
--------- --------- ----------
BALANCE - END OF YEAR $(380,212) $(371,788) $(316,838)
========= ========= =========
CONTRIBUTED SURPLUS
YEARS ENDED AUGUST 31,
-----------------------------------
2004 2003 2002
--------- --------- ---------
BALANCE - BEGINNING OF YEAR $ 1,519 $ 1,487 $ 1,457
ADD
Premium on resale of share capital 18 32 30
Stock-based compensation costs (note 2) 449 -- --
--------- --------- ---------
BALANCE - END OF YEAR $ 1,986 $ 1,519 $ 1,487
========= ========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-4
EXFO ELECTRO-OPTICAL ENGINEERING INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands of US dollars)
YEARS ENDED AUGUST 31,
-----------------------------------
2004 2003 2002
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss for the year $ (8,424) $ (54,950) $(308,524)
Add (deduct) items not affecting cash
Discount on short-term investments 197 (96) 197
Stock-based compensation costs 449 -- --
Inventory and tax credit write-offs -- 6,418 18,463
Amortization 10,015 10,886 55,568
Impairment of long-lived assets and goodwill 620 7,427 245,826
Restructuring and other charges 1,261 512 741
Future income taxes -- 10,138 (13,397)
Deferred revenue 1,404 (24) (106)
Deferred grants 154 817 (335)
--------- --------- ---------
5,676 (18,872) (1,567)
Change in non-cash operating items
Accounts receivable (2,677) 3,957 15,406
Income taxes and tax credits (2,464) 13,489 (19,736)
Inventories 1,016 7,925 4,332
Prepaid expenses (449) (569) 356
Accounts payable and accrued liabilities (351) (349) (7,470)
--------- --------- ---------
751 5,581 (8,679)
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to short-term investments (653,348) (401,105) (506,228)
Proceeds from disposal of short-term investments 624,722 395,699 531,733
Additions to property, plant and equipment and intangible assets (851) (2,652) (5,245)
Business combinations (241) (1,867) (9,756)
--------- --------- ---------
(29,718) (9,925) 10,504
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Repayment of long-term debt (109) (133) (106)
Net proceeds of offering (note 13) 29,164 -- --
Share issue expenses (137) -- (14)
Exercise of stock options 254 45 --
Redemption of share capital (5) (16) (6)
Resale of share capital 23 48 36
--------- --------- ---------
29,190 (56) (90)
EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON CASH (430) 638 (336)
--------- --------- ---------
CHANGE IN CASH (207) (3,762) 1,399
CASH - BEGINNING OF YEAR 5,366 9,128 7,729
--------- --------- ---------
CASH - END OF YEAR $ 5,159 $ 5,366 $ 9,128
========= ========= =========
SUPPLEMENTARY INFORMATION
Interest paid $ 408 $ 417 $ 269
Income taxes paid (recovered) $ 120 $ (10,351) $ 4,172
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-5
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
1 NATURE OF ACTIVITIES
EXFO Electro-Optical Engineering Inc. ("EXFO") designs, manufactures and
markets a comprehensive suite of test and measurement solutions for the
global telecommunications industry. The Telecom Division, which represents
the company's main business activity, offers integrated test solutions to
network service providers, system vendors and optical component
manufacturers. The Photonics and Life Sciences Division mainly leverages
core telecom technologies to offer value-added solutions in high-tech
industrial manufacturing and research sectors. EXFO sells its products in
approximately 70 countries around the world.
2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
These consolidated financial statements have been prepared in accordance
with generally accepted accounting principles ("GAAP") in Canada and
significant differences in measurement and disclosure from U.S. GAAP are
set out in note 20. These consolidated financial statements include the
accounts of the company and its domestic and international subsidiaries.
All significant intercompany accounts and transactions have been
eliminated.
ACCOUNTING ESTIMATES
The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
the disclosures of contingent assets and liabilities at the date of the
financial statements, as well as the reported amounts of revenues and
expenses during the reporting years. Actual results could differ from
those estimates.
REPORTING CURRENCY
The company has adopted the US dollar as its reporting currency. The
financial statements are translated into the reporting currency using the
current rate method. Under this method, the financial statements are
translated into the reporting currency as follows: assets and liabilities
are translated at the exchange rate in effect at the date of the balance
sheet, while revenues and expenses are translated at the monthly average
exchange rate. All gains and losses resulting from the translation of the
financial statements into the reporting currency are included in the
cumulative translation adjustment in shareholders' equity.
In the event that management decides to declare dividends, such dividends
would be declared in Canadian dollars.
F-6
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
FOREIGN CURRENCY TRANSLATION
FOREIGN CURRENCY TRANSACTIONS
Transactions denominated in currencies other than the functional currency
are translated into the functional currency as follows: monetary assets
and liabilities are translated at the exchange rate in effect at the
balance sheet date, while revenues and expenses are translated at the
exchange rate in effect on the date of the transaction. Non-monetary
assets and liabilities are translated at historical rates. Gains and
losses arising from such translation are reflected in the statements of
earnings.
FOREIGN SUBSIDIARIES
The financial statements of integrated foreign operations are remeasured
into the functional currency using the temporal method. Under this method,
monetary assets and liabilities are remeasured at the exchange rate in
effect at the balance sheet date. Non-monetary assets and liabilities are
remeasured at historical rates. Revenues and expenses are remeasured at
the monthly average exchange rate. Gains and losses resulting from such
remeasurement are reflected in the statements of earnings.
FORWARD EXCHANGE CONTRACTS
Forward exchange contracts are utilized by the company in the management
of its foreign currency exposure. The company's policy is not to utilize
those derivative financial instruments for trading or speculative
purposes.
The company's forward exchange contracts, which are used to hedge
anticipated US-dollar-denominated sales qualify for hedge accounting and
foreign exchange translation gains and losses on these contracts, are
recognized as an adjustment of the revenues when the corresponding sales
are recorded.
Realized and unrealized gains or losses associated with forward exchange
contracts, which have been terminated or cease to be effective prior to
maturity, are deferred in the balance sheet and recognized in the earnings
of the period in which the underlying hedged transaction is recognized.
SHORT-TERM INVESTMENTS
Short-term investments are valued at the lower of cost and market value.
Cost consists of acquisition cost plus amortization of discount or less
amortization of premium. All investments with original maturity of three
months or less that are not required for the purposes of meeting
short-term cash commitments are classified as short-term investments.
INVENTORIES
Inventories are valued on an average cost basis at the lower of cost and
replacement cost for raw materials and at the lower of cost and net
realizable value for work in progress and finished goods.
F-7
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
On September 1, 2002, the company changed its accounting policy for
determining the cost of raw materials and work in progress from the
first-in, first-out method to the average cost method. This change in
accounting policy had no significant impact on the company's financial
statements.
PROPERTY, PLANT AND EQUIPMENT AND AMORTIZATION
Property, plant and equipment are recorded at cost less related government
grants and research and development tax credits. Amortization is provided
on a straight-line basis over the estimated useful lives as follows:
TERM
Land improvements 5 years
Buildings 25 years
Equipment 2 to 10 years
Leasehold improvements Remaining lease term
INTANGIBLE ASSETS, GOODWILL AND AMORTIZATION
Intangible assets primarily include the cost of core technology and
software, net of accumulated amortization. Core technology represents the
existing technology acquired in business combinations that has reached
technological feasibility. Intangible assets are amortized on a
straight-line basis over their estimated useful lives of five years for
core technology and four and ten years for software.
Goodwill represents the excess of the purchase price of acquired
businesses over the estimated fair value of net identifiable assets
acquired. Goodwill related to business combinations with a date of
acquisition prior to July 1, 2001, was amortized on a straight-line basis
over the estimated useful life of five years until August 31, 2002.
Goodwill related to business combinations with a date of acquisition after
June 30, 2001, is not amortized.
Goodwill must be tested for impairment on an annual basis or more
frequently if events or circumstances occur that more likely than not
reduce the fair value of a reporting unit below its carrying value.
Goodwill impairment exists when the carrying value of the reporting unit
exceeds its fair value. The fair value of a reporting unit is determined
based on a combination of discounted future cash flows and a market
approach. The amount of impairment loss, if any, represents the excess of
the carrying value of goodwill over its fair value and this loss is
charged to earnings in the period in which it is incurred. The company
elected to perform its annual impairment test in May of each fiscal year
for all its existing reporting units and recorded impairment charges for
goodwill in fiscal 2002 and 2003 (note 4).
IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived assets are reviewed for impairment when events and
circumstances indicate that cost may not be recoverable. Impairment exists
when the carrying value of the asset is greater than the undiscounted
future cash flows expected to be provided by the asset. The amount of
impairment loss, if any, is the excess of the carrying value over its fair
value. The company assesses fair value of intangible assets based on
discountinued future cash flows. The company recorded impairment charges
for long-lived assets in fiscal 2002, 2003 and 2004 (note 4).
F-8
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
WARRANTY
The company offers its customers warranties of one to three years,
depending on the specific products and terms of the purchase agreement.
The company's typical warranties require it to repair or replace defective
products during the warranty period at no cost to the customer. Costs
related to original warranties are accrued at the time of shipment, based
upon estimates of expected rework and warranty costs to be incurred. Costs
associated with extended warranties are charged to expense as incurred.
REVENUE RECOGNITION
For products in which software is incidental, the company recognizes
revenue when persuasive evidence of an arrangement exists, the product has
been delivered, the price is fixed and determinable, and collection of the
resulting receivable is reasonably assured. In addition, provisions are
made for estimated returns, warranties and support obligations.
For products in which software is not incidental, revenues are separated
into two categories: product and post-contract customer support (PCS)
revenues, based upon vendor-specific objective evidence of fair value.
Product revenues for these sales are recognized as described above. PCS
revenues are deferred and recognized ratably over the years of the support
arrangement. PCS revenues are recognized at the time the product is
delivered when provided within one year of delivery; the costs of
providing this support are insignificant (and accrued at the time of
delivery) and no software upgrades are provided.
For all sales, the company uses a binding purchase order as evidence that
a sales arrangement exists.
Delivery generally occurs when the product is handed over to a transporter
for shipment.
At the time of the transaction, the company assesses whether the price
associated with its revenue transaction is fixed and determinable and
whether or not collection is reasonably assured. The company assesses
whether the price is fixed and determinable based on the payment terms
associated with the transaction. The company assesses collection based on
a number of factors, including past transaction history and the
creditworthiness of the customer. Generally, collateral or other security
is not requested from customers.
Most sales arrangements do not generally include acceptance clauses.
However, if a sales arrangement includes an acceptance provision,
acceptance occurs upon the earliest of receipt of a written customer
acceptance or expiration of the acceptance period. For these sales
arrangements, the sale is recognized when acceptance occurs.
Revenue for extended warranties is recognized on a straight-line basis
over the warranty period.
ADVERTISING COSTS
Advertising costs are expensed as incurred.
F-9
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
GOVERNMENT GRANTS
Government grants are accrued as a receivable when there is reasonable
assurance that the company has complied and will continue to comply with
all the conditions related to the grant. Grants related to operating
expenses are included in earnings when the related expenses are incurred.
Grants related to capital expenditures are deducted from the related
assets. Grants related to job creation and training programs for extended
periods are deferred and amortized on a straight-line basis over the
minimum period for which the created job must be maintained or training
provided.
RESEARCH AND DEVELOPMENT EXPENSES
All expenses related to development activities, which do not meet
generally accepted criteria for deferral, and research are expensed as
incurred, net of related tax credits and government grants. Development
expenses that meet generally accepted criteria for deferral are
capitalized, net of related tax credits and government grants, and
amortized against earnings over the estimated benefit period. Research and
development expenses are mainly comprised of salaries and related
expenses, material costs as well as fees paid to third-party consultants.
As at August 31, 2004, the company had not deferred any development costs.
INCOME TAXES
The company provides for income taxes using the liability method of tax
allocation. Under this method, future income tax assets and liabilities
are determined based on deductible or taxable temporary differences
between financial statement values and tax values of assets and
liabilities, using enacted income tax rates for the years in which the
differences are expected to reverse.
The company establishes a valuation allowance against future income tax
assets if, based on available information, it is more likely than not that
some or all of the future income tax assets will not be realized. Since
2003, the company has recorded a full valuation allowance against future
income tax assets (notes 4 and 15).
EARNINGS PER SHARE
Basic earnings per share are determined using the weighted average number
of common shares outstanding during the year.
Diluted earnings per share are determined using the weighted average
number of common shares outstanding during the year, plus the effect of
dilutive potential common shares outstanding during the year such as the
company's stock options and restricted stock awards. This method requires
that diluted earnings per share be calculated, using the treasury stock
method, as if all dilutive potential common shares had been exercised at
the latest at the beginning of the year or on the date of issuance, as the
case may be, and that the funds obtained thereby be used to purchase
common shares of the company at the average fair value of the common
shares during the year.
F-10
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
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 establishes new rules for
designating, documenting and assessing the effectiveness of hedging
relationships, such as the company's forward exchange contracts. Hedge
accounting can only be applied if these new rules are met. 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 revenue when the
corresponding 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 the
financial statements for all forms of employee stock-based compensation
using a fair value-based method. In fiscal 2004, the company granted
536,500 stock options to its employees with a weighted average exercise
price of $3.94. The weighted average fair value of these stock options
amounted to $2.73. The corresponding stock-based compensation costs were
amortized using the graded vesting method, resulting in stock-based
compensation costs of $449,000 in fiscal 2004.
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 impact
on the net loss per share in fiscal 2004 and the pro forma net loss per
share would have been $0.01 higher than the net loss per share in 2003.
The fair value of options granted in fiscal 2004 was estimated using the
Black-Scholes options valuation model with the following weighted average
assumptions:
YEAR ENDED
AUGUST 31, 2004
---------------
Risk-free interest rate 2.7%
Expected volatility 100%
Dividend yield Nil
Expected life 49 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 any significant impact on its financial statements.
F-11
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
COMPARATIVE FIGURES
Certain comparative figures were reclassified to conform to the
current-year presentation.
3 BUSINESS COMBINATIONS
In fiscal 2002 and 2003, the company completed business combinations in
which it acquired significant intangible assets. The fair value allocated
to these assets was based upon valuations performed in conjunction with
these business combinations. Acquired goodwill, except the one from GNUBI
COMMUNICATIONS L.P., is not deductible for income tax purposes.
BUSINESS COMBINATION DURING 2003
GNUBI COMMUNICATIONS, L.P.
On October 7, 2002, a newly created wholly-owned subsidiary of the
company, EXFO Gnubi Products Group Inc. ("EXFO Gnubi"), acquired
substantially all the assets of GNUBI COMMUNICATIONS, L.P., a U.S. company
supplying multi-channel telecom and datacom testing solutions for optical
transport equipment manufacturers as well as research and development
laboratories.
This acquisition was settled for a total consideration valued at
$4,904,000 including acquisition-related costs of $162,000. The
consideration paid consisted in $2,108,000 in cash (including a cash
contingent consideration of $241,000, paid in fiscal 2004, based on EXFO
Gnubi sales volume for the twelve months following the acquisition) and in
the issuance of 1,479,290 subordinate voting shares, valued at $2,796,000.
The cash contingent consideration was accounted for as an additional
acquisition cost and was recognized as an additional cost of acquired core
technology.
The fair value of the subordinate voting shares issued was determined
based on the market price of the shares beginning three days before and
ending three days after the number of shares became fixed based on a
formula, being September 10, 2002
This acquisition was accounted for using the purchase method and,
consequently, the results of operations of the acquired business were
included in the consolidated statement of earnings of the company since
October 7, 2002, being the date of acquisition.
During fiscal 2004, EXFO Gnubi's operations were consolidated with the
parent company's operations in Montreal, Canada.
F-12
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
The purchase price, including acquisition-related costs, was allocated
based on the estimated fair value of net assets at the date of acquisition
as follows:
Assets acquired
Current assets $ 755
Property, plant and equipment 334
Core technology 750
Current liabilities assumed (134)
--------------
Net identifiable assets acquired 1,705
Goodwill 2,958
--------------
Purchase price 4,663
Less: Subordinate voting shares issued 2,796
--------------
Cash paid on the date of acquisition $ 1,867
==============
BUSINESS COMBINATION DURING 2002
AVANTAS NETWORKS CORPORATION (RENAMED EXFO PROTOCOL INC.)
On November 2, 2001, the company acquired a 100% interest in EXFO Protocol
Inc. ("EXFO Protocol"), a Canadian company specializing in protocol-layer
testing, in exchange for a total consideration valued at $94,952,000 or
$69,381,000 net of $25,571,000 of cash and cash equivalents acquired. The
total consideration includes acquisition-related costs of $1,272,000.
The consideration paid consisted of $9,756,000 in cash, net of cash and
cash equivalents acquired of $25,571,000 and the issuance of 4,374,573
subordinate voting shares valued at $59,625,000. The fair value of the
subordinate voting shares issued was determined based on the market price
of the shares beginning three days before and ending three days after the
terms of the acquisition were agreed upon and announced, being August 20,
2001.
This acquisition was accounted for using the purchase method and,
consequently, the results of operations of EXFO Protocol were included in
the consolidated statement of earnings of the company since November 2,
2001, being the date of acquisition.
As at September 1, 2003, EXFO Protocol was merged with the parent company.
F-13
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
The purchase price, including acquisition-related costs, was allocated
based on the estimated fair value of net assets at the date of acquisition
as follows:
Assets acquired
Current assets $ 6,040
Property, plant and equipment 2,003
In-process research and development 1,400
Core technology 5,050
Future income tax assets (note 4) 476
Current liabilities assumed (3,575)
-------------
Net identifiable assets acquired 11,394
Goodwill (note 4) 57,987
-------------
Purchase price 69,381
Less: Subordinate voting shares issued 59,625
-------------
Cash paid, net of cash and cash equivalents acquired $ 9,756
=============
4 SPECIAL CHARGES
IMPAIRMENT OF LONG-LIVED ASSETS AND GOODWILL
2002
In May 2002, as part of its review of financial results, the company
performed an assessment of the carrying value of goodwill and intangible
assets recorded in conjunction with the acquisitions of EXFO Burleigh
Products Group Inc. ("EXFO Burleigh"), EXFO Photonic Solutions Inc. ("EXFO
Photonic Solutions") and EXFO Protocol Inc. ("EXFO Protocol"). The
assessment was performed because of the severe and continued downturn in
the telecommunications industry, the persisting unfavorable market
conditions affecting the subsidiaries' industries and the decline in
technology valuations. The growth prospects for those subsidiaries were
significantly lower than previously expected and less than those of
historical periods, and the decline in market conditions affecting the
subsidiaries was significant and other than temporary. As a result, the
company concluded that the carrying value of goodwill and certain acquired
intangible assets was impaired and it recorded a charge of $222,169,000 to
write down a significant portion of goodwill and a pre-tax charge of
$23,657,000 to write down a significant portion of acquired core
technology. Of the total impairment loss of $245,826,000, $125,017,000 was
related to EXFO Burleigh for goodwill and acquired core technology,
$71,508,000 was related to EXFO Photonic Solutions for goodwill and
acquired core technology, and $49,301,000 was related to EXFO Protocol for
goodwill.
The impairment loss was calculated based upon the then-existing accounting
rules and represented the excess of the carrying value of the assets over
the pre-tax undiscounted future cash flows. The pre-tax undiscounted
future cash flows were estimated at the subsidiaries' level since the
company had distinct cash flows for each of them and because they were not
fully integrated into the
F-14
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
company's activities. The cash flow periods used ranged from three to five
years, using annual growth rates between 15% and 30%.
2003
In May 2003, the company performed its annual impairment test on goodwill
for all its reporting units, except for newly acquired EXFO Gnubi. Also,
considering market conditions in the telecommunications industry and the
persisting unfavorable conditions affecting the subsidiaries' industries,
the company reviewed the carrying value of intangible assets related to
these reporting units, consisting primarily of acquired core technology.
As a result of this assessment, the company concluded that the carrying
value of goodwill related to EXFO Burleigh and the carrying value of
intangible assets related to EXFO Burleigh and EXFO Photonic Solutions was
impaired and it recorded a charge of $4,505,000 to write down goodwill and
a pre-tax charge of $2,922,000 to write down acquired core technology. Of
the total impairment loss of $7,427,000, $6,872,000 was related to EXFO
Burleigh for goodwill and acquired core technology, and $555,000 was
related to EXFO Photonic Solutions for acquired core technology.
For the purposes of estimating the fair values, the company used a
combination of discounted future cash flows and a market approach (sales
multiples). The discounted future cash flows were estimated using periods
ranging between eight and ten years, discount rates ranging between 15%
and 20% and annual growth rates ranging between nil and 35%. The sales
multiples used in the market approach ranged between 0.7 and 2.3.
The assumptions supporting the estimated fair values and undiscounted
future cash flows, including industry conditions, reflected management's
best estimates.
2004
In fiscal 2004, the company reviewed the carrying value of one of its
buildings that was put up for sale and it concluded that the building was
impaired. The company recorded an impairment charge of $620,000,
representing the excess of the net carrying value of the building over its
expected selling price. The building did not meet the criteria of CICA
handbook section 3475, "Disposal of Long-Lived Assets and Discontinued
Operations" because it was not available for immediate sale in its
existing condition. Consequently, it was not shown as a long-lived asset
held for sale in the balance sheet as at August 31, 2004. This building
reports to the Telecom Division.
RESTRUCTURING AND OTHER CHARGES AND INVENTORY WRITE-OFFS
During fiscal 2002, the company implemented restructuring plans to reduce
its costs. Under these plans, the company recorded charges of $2,880,000,
including $2,012,000 in severance expenses for the 350 employees who were
terminated throughout the company and $868,000 for impaired long-lived
assets. These charges are included in the restructuring and other charges
in the statement of earnings for the year ended August 31, 2002.
Furthermore, the company recorded $18,463,000 in inventory write-offs for
excess and obsolete inventories, which are included in the cost of sales
in the statement of earnings for that same year.
F-15
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
During fiscal 2003, the company implemented an additional restructuring
plan to realign its cost structure to market conditions. Under that plan,
the company recorded additional charges of $4,134,000, including
$2,767,000 in severance expenses for the 172 employees who were terminated
throughout the company, $512,000 for impaired long-lived assets and
$855,000 for future payments on exited leased facilities. Those charges
are included in the restructuring and other charges in the statement of
earnings for the year ended August 31, 2003. In addition, the company
recorded $4,121,000 in inventory write-offs for excess and obsolete
inventories, which are included in the cost of sales in the statement of
earnings for that same year.
During fiscal 2004, the company approved a restructuring plan to
consolidate EXFO Burleigh's operations, transferring them mainly to EXFO
Photonic Solutions facilities in Toronto. The consolidation process
started in August 2004 and should extend into the first two quarters of
fiscal 2005. EXFO Burleigh's operations and assets reported to the
Photonics and Life Sciences Division and all expenses related to this
consolidation process also report to this division.
Management estimates that the overall costs to be incurred under this plan
should amount to $2,700,000. From this amount, $772,000, representing
severance expenses, was recorded in fiscal 2004 for the layoff of all
employees of EXFO Burleigh. In addition, in fiscal 2004, the company
recorded an impairment charge of $1,261,000, mainly for the building.
Management expects to incur most of the remaining $667,000 during the
first two quarters of fiscal 2005 for different types of consolidation
expenses such as training, recruiting and other special termination
benefits.
The EXFO Burleigh building is for sale in its present condition and
management expects to sell the property within the next twelve months.
Consequently, in accordance with section 3475 of the handbook, it was
shown in the balance sheet as a long-lived asset held for sale. The fair
value used to determine the impairment charge for the building represents
the company's best estimate of its selling price based upon the municipal
valuation. Starting September 1, 2004, the building will cease to be
amortized.
In fiscal 2004, we incurred expenses totaling $2,033,000 in relation to
this plan. This amount was recorded in the restructuring and other charges
in the statement of earnings for the year ended August 31, 2004.
F-16
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
The following table summarizes the restructuring charges payable activity
since August 31, 2001:
YEAR ENDED AUGUST 31, 2004
BALANCE AS AT BALANCE AS AT
AUGUST 31, AUGUST 31,
2003 ADDITIONS PAYMENTS ADJUSTMENTS 2004
------------ --------- -------- ----------- -------------
FISCAL 2004 PLAN
Severance expenses $ -- $ 772 $ (305) $ -- $ 467
------- ------- ------- ------- -------
-- 772 (305) -- 467
------- ------- ------- ------- -------
FISCAL 2003 PLAN
Severance expenses 1,233 -- (870) (254) 109
Exited leased facilities 748 -- (362) -- 386
Other 295 -- (90) (8) 197
------- ------- ------- ------- -------
2,276 -- (1,322) (262) 692
------- ------- ------- ------- -------
FISCAL 2002 PLANS
Other 68 -- (68) -- --
------- ------- ------- ------- -------
68 -- (68) -- --
------- ------- ------- ------- -------
Fiscal 2001 plan
Exited leased facilities 124 -- (72) (42) 10
------- ------- ------- ------- -------
124 -- (72) (42) 10
------- ------- ------- ------- -------
Total for all plans (note 9) $ 2,468 $ 772 $(1,767) $ (304) $ 1,169
======= ======= ======= ======= =======
YEAR ENDED AUGUST 31, 2003
BALANCE AS AT BALANCE AS AT
AUGUST 31, AUGUST 31,
2002 ADDITIONS PAYMENTS ADJUSTMENTS 2003
------------- ---------- -------- ----------- ------------
FISCAL 2003 PLAN
Severance expenses $ -- $ 2,767 $(1,534) $ -- $ 1,233
Exited leased facilities -- 855 (107) -- 748
Other -- 512 (217) -- 295
------- ------- ------- ------- -------
-- 4,134 (1,858) -- 2,276
------- ------- ------- ------- -------
FISCAL 2002 PLANS
Severance expenses 231 -- (231) -- --
Other 68 -- -- -- 68
------- ------- ------- ------- -------
299 -- (231) -- 68
------- ------- ------- ------- -------
FISCAL 2001 PLAN
Exited leased facilities 483 -- (359) -- 124
------- ------- ------- ------- -------
483 -- (359) -- 124
------- ------- ------- ------- -------
Total for all plans (note 9) $ 782 $ 4,134 $(2,448) $ -- $ 2,468
======= ======= ======= ======= =======
F-17
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
YEAR ENDED AUGUST 31, 2002
BALANCE AS AT BALANCE AS AT
AUGUST 31, AUGUST 31,
2001 ADDITIONS PAYMENTS ADJUSTMENTS 2002
------------- --------- -------- ----------- -------------
FISCAL 2002 PLANS
Severance expenses $ -- $ 2,012 $(1,781) $ -- $ 231
Other -- 868 (800) -- 68
------- ------- ------- ------- -------
-- 2,880 (2,581) -- 299
------- ------- ------- ------- -------
FISCAL 2001 PLAN
Severance expenses 372 -- (372) -- --
Exited leased facilities 858 -- (375) -- 483
------- ------- ------- ------- -------
1,230 -- (747) -- 483
------- ------- ------- ------- -------
Total for all plans $ 1,230 $ 2,880 $(3,328) $ -- $ 782
======= ======= ======= ======= =======
FUTURE INCOME TAX ASSETS AND RESEARCH AND DEVELOPMENT TAX CREDITS
During fiscal 2003, the company reviewed the carrying value of its future
income tax assets and its research and development tax credits.
Considering market conditions and because the company recorded losses in
fiscal 2002 and 2003, it concluded that it was more likely than not that
its future income tax assets and some of its non-refundable research and
development tax credits were not recoverable and that a full valuation
allowance and a write-off were required. Accordingly, the company recorded
a full valuation allowance of $28,385,000 against its future income tax
assets, mainly related to the parent company, EXFO Protocol and EXFO
Burleigh and wrote off $2,297,000 in non-refundable research and
development tax credits related to EXFO Protocol. The valuation allowance
was included in the income taxes in the statement of earnings for the year
ended August 31, 2003 (note 15). Research and development tax credit
write-offs were included in the net research and development expenses in
the statement of earnings for that same year (note 14).
5 INVENTORIES
AS AT AUGUST 31,
------------------------------
2004 2003
------------- -------------
Raw materials $ 7,244 $ 8,188
Work in progress 1,370 1,022
Finished goods 6,757 6,392
------------- -------------
$ 15,371 $ 15,602
============ ============
F-18
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
6 PROPERTY, PLANT AND EQUIPMENT
AS AT AUGUST 31,
--------------------------------------------------------------------------------
2004 2003
-------------------------------------- --------------------------------------
ACCUMULATED ACCUMULATED
COST AMORTIZATION COST AMORTIZATION
--------------- ------------------- --------------- -------------------
Land and land improvements $ 2,868 $ 558 $ 3,323 $ 350
Buildings 8,311 1,699 11,177 1,784
Equipment 29,110 23,422 27,800 19,099
Leasehold improvements 2,110 1,278 1,837 1,042
--------------- ------------------- --------------- -------------------
42,399 $ 26,957 44,137 $ 22,275
=================== ===================
Less:
Accumulated amortization 26,957 22,275
--------------- ---------------
$ 15,442 $ 21,862
=============== ===============
As at August 31, 2003 and 2004, unpaid purchases of property, plant and
equipment amounted to $156,000 and $358,000, respectively.
The net carrying value of property, plant and equipment as at August 31,
2003 included $2,867,000 for the EXFO Burleigh building shown as a
long-lived asset held for sale as at August 31, 2004 (note 4).
7 INTANGIBLE ASSETS AND GOODWILL
The net carrying value of intangible assets is comprised of the following:
AS AT AUGUST 31,
---------------------------
2004 2003
----------- ------------
Software, net of accumulated amortization of $3,482
($2,691 in 2003) $ 2,365 $ 3,069
Core technology, net of accumulated amortization of
$25,733 ($20,986 in 2003) 7,082 10,778
----------- ------------
$ 9,447 $ 13,847
=========== ============
Amortization expenses for intangible assets in each of the next five
fiscal years will be $4,550,200 in 2005, $2,825,600 in 2006, $735,600 in
2007, $315,900 in 2008 and $296,200 in 2009.
F-19
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
Changes in the net carrying value of goodwill are as follows:
AS AT AUGUST 31,
---------------------------
2004 2003
----------- ------------
Balance - Beginning of year $ 17,673 $ 17,576
Business combination (note 3) -- 2,958
Write-down (note 4) -- (4,505)
Foreign currency translation adjustment 720 1,644
----------- ------------
Balance - End of year $ 18,393 $ 17,673
=========== ============
8 CREDIT FACILITIES
The company has a line of credit which provides for advances of up to
Cdn$10,000,000 (US$7,595,000). This line of credit, which is renewable
annually, bears interest at prime rate (prime rate in 2003). Short-term
investments, accounts receivable, inventories and all tangible and
intangible assets of the company were pledged as collateral against this
line of credit. As at August 31, 2004, an amount of Cdn$3,737,000
(US$2,838,000) is reserved from this line of credit for letters of
guarantee and forward exchange contracts.
9 ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
AS AT AUGUST 31,
---------------------------
2004 2003
----------- ------------
Trade $ 4,484 $ 4,227
Salaries and social benefits 3,932 3,462
Warranty 390 687
Restructuring charges (notes 4 and 19) 1,169 2,468
Other 1,418 1,182
----------- ------------
$ 11,393 $ 12,026
=========== ============
F-20
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
Changes in the warranty provision are as follows:
AS AT AUGUST 31,
---------------------------
2004 2003
----------- ------------
Balance - Beginning of year $ 687 $ 849
Provision 564 520
Settlement (889) (749)
Foreign currency translation adjustment 28 67
----------- ------------
Balance - End of year $ 390 $ 687
=========== ============
10 LONG-TERM DEBT
AS AT AUGUST 31,
---------------------------
2004 2003
----------- ------------
Loans collateralized by equipment, bearing
interest at 9.6%, repayable in monthly
instalments of $13,000 including
principal and interest, maturing in 2008 $ 453 $ 563
Less: Current portion 121 110
----------- ------------
$ 332 $ 453
=========== ============
As at August 31, 2004, minimum principal repayments required in each of
the next four years will amount to $121,000 in 2005, $135,000 in 2006,
$146,000 in 2007 and $51,000 in 2008.
11 COMMITMENTS
The company entered into operating leases for certain of its premises and
equipment, which expire at various dates through May 2011. As at August
31, 2004, minimum rentals payable under these operating leases in each of
the next five years will amount to $938,000 in 2005, $875,000 in 2006,
$780,000 in 2007, $484,000 in 2008 and $467,000 in 2009. As at August 31,
2004, the total commitment under these operating leases amounts to
$4,382,000.
For the years ended August 31, 2002, 2003 and 2004, rental expenses
amounted to $1,936,000, $1,718,000 and $1,219,000, respectively (note 19).
F-21
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
12 CONTINGENCIES
On November 27, 2001, a class action suit was filed in the United States
District Court for the Southern District of New York against the company,
four of the underwriters of its Initial Public Offering and some of its
executive officers pursuant to the Securities Exchange Act of 1934 and
Rule 10b-5 promulgated thereunder and sections 11, 12 and 16 of the
Securities Act of 1933. Approximately 300 other issuers and their
underwriters have had similar suits filed against them, all of which are
included in a single coordinated proceeding in the Southern District of
New York (the "IPO Litigations"). 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 two amended complaints: one
containing master allegations against all of the underwriters in the IPO
Litigations, and the other 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. The
Court granted the company's motion to dismiss the claims against it under
Section 11 of the Securities Act. The Court denied the company's motion to
dismiss the claims against it under Rule 10b-5. In October 2002, the
claims against its officers were dismissed without prejudice pursuant to
the terms of the Reservation of Rights and Tolling Agreements entered into
with the plaintiffs.
In June 2003, a committee of the company's Board of Directors
conditionally approved a proposed settlement between the issuer
defendants, the individual defendants, and the plaintiffs. On June 25,
2004, the Plaintiffs moved for Preliminary Approval of the settlement, and
the Underwriter defendants have opposed that motion. If approved, the
settlement would provide, among other things, a release of the company and
of the individual defendants for the conduct alleged in the action to be
wrongful in the amended complaint. The company would agree to undertake
other responsibilities under the
F-22
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
settlement, including agreeing to assign away, not assert, or release
certain potential claims the company may have against its underwriters.
Any direct financial impact of the proposed settlement is expected to be
borne by the company's insurance carriers.
Since the settlement process is subject to a fairness hearing and final
court approval, it is possible that it could fail. Therefore, it is not
possible to predict the final outcome of the case, nor determine the
amount of any possible losses. If the settlement process fails, the
company will continue to defend its position in this litigation that the
claims against it, and its officers, are without merit. Accordingly, no
provision for this case has been made in the consolidated financial
statements as at August 31, 2004.
As at August 31, 2004, the company has outstanding letters of guarantee of
Cdn$1,273,000 (US$967,000), which expire at various dates through fiscal
2008 and that were reserved from the line of credit.
13 SHARE CAPITAL
Authorized - unlimited as to number, without par value
Subordinate voting and participating, bearing a non-cumulative
dividend to be determined by the Board of Directors, ranking
pari passu with multiple voting shares
Multiple voting and participating, entitling to ten votes each,
bearing a non-cumulative dividend to be determined by the Board
of Directors, convertible at the holder's option into
subordinate voting shares on a one-for-one basis, ranking pari
passu with subordinate voting shares
F-23
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
The following table summarizes the share capital activity since August 31,
2001:
MULTIPLE VOTING SHARES SUBORDINATE VOTING SHARES
--------------------------------- -------------------------------
NUMBER AMOUNT NUMBER AMOUNT TOTAL AMOUNT
--------------------------------- ------------------------------- --------------
Balance as at August 31, 2001 37,900,000 $ 1 19,046,080 $ 429,994 $ 429,995
Business combination (note 3) -- -- 4,374,573 59,625 59,625
Exercise of stock awards -- -- 144,532 -- --
Redemption -- -- (7,022) (6) (6)
Resale -- -- 7,022 6 6
Share issue expenses -- -- -- (9) (9)
---------------- --------------- --------------- --------------- --------------
Balance as at August 31, 2002 37,900,000 1 23,565,185 489,610 489,611
Business combination (note 3) -- -- 1,479,290 2,796 2,796
Exercise of stock options -- -- 25,498 45 45
Exercise of stock awards -- -- 69,935 -- --
Redemption -- -- (21,515) (16) (16)
Resale -- -- 21,515 16 16
---------------- --------------- --------------- --------------- --------------
Balance as at August 31, 2003 37,900,000 1 25,139,908 492,451 492,452
Public offering (1) -- -- 5,200,000 29,164 29,164
Exercise of stock options -- -- 111,071 254 254
Exercise of stock awards -- -- 89,504 -- --
Redemption -- -- (5,340) (5) (5)
Resale -- -- 5,340 5 5
Share issue expenses -- -- -- (137) (137)
---------------- --------------- --------------- --------------- --------------
Balance as at August 31, 2004 37,900,000 $ 1 30,540,483 $ 521,732 $ 521,733
================ =============== =============== =============== ==============
(1) On February 12, 2004, pursuant to a Canadian public offering, the company
issued 5,200,000 subordinate voting shares for net proceeds of $29,164,000
(Cdn$38,438,400), after deduction of underwriting commission of $1,215,000
(Cdn$1,601,000). The net proceeds of this offering were invested in
commercial paper that is presented in the short-term investments in the
balance sheet (note 17).
STOCK PURCHASE PLAN
The company's stock purchase plan terminated at the time of the initial
public offering, being June 29, 2000. In accordance with that plan,
officers, directors and key employees could purchase Class F shares up to
a maximum of 5% of all participating, issued and outstanding shares of the
company. The purchase price of shares under that plan was determined as a
multiple of the company's equity as at the end of the preceding fiscal
year. All 707,264 shares issued under that plan, which were restricted as
to sale and transferability for a period of at least five years from the
date of acquisition, were released in fiscal 2004.
F-24
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
STOCK OPTION PLAN
In May 2000, the company established a stock option plan for directors,
executive officers, employees and consultants and those of the company's
subsidiaries, as determined by the Board of Directors.
The maximum number of subordinate voting shares issuable under the plan
cannot exceed 6,306,153 shares. The maximum number of subordinate voting
shares that may be granted to any individual cannot exceed 5% of the
number of outstanding subordinate voting shares. The exercise price is the
market price of the common shares on the date of grant. Options granted
under the plan generally expire ten years from the date of grant. Options
granted under the plan generally vest over a four-year period, with 25%
vesting on an annual basis commencing on the first anniversary of the date
of grant. The Board of Directors may accelerate the vesting of any or all
outstanding options upon the occurrence of a change of control.
The following table summarizes stock option activity since August 31,
2001:
YEARS ENDED AUGUST 31,
-------------------------------------------------------------------------------------------
2004 2003 2002
----------------------------- ----------------------------- ------------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
NUMBER PRICE NUMBER PRICE NUMBER PRICE
Outstanding - Beginning of year 3,176,613 $ 15 2,597,574 $ 22 2,414,231 $ 28
Granted 536,500 4 1,268,450 2 1,039,805 10
Exercised (111,071) (2) (25,498) (2) -- --
Forfeited (667,524) (15) (663,913) (17) (856,462) (25)
------------- ------------- ------------- ------------- ------------- ---------------
Outstanding - End of year 2,934,518 $ 14 3,176,613 $ 15 2,597,574 $ 22
------------- ------------- ------------- ------------- ------------- ---------------
Exercisable - End of year 1,331,707 $ 21 1,068,595 $ 22 512,161 $ 28
============= ============= ============= ============= ============= ===============
F-25
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
The following table summarizes information about stock options as at
August 31, 2004:
STOCK OPTIONS OUTSTANDING STOCKS OPTIONS EXERCISABLE
-------------------------------------------------- ----------------------------------
WEIGHTED
WEIGHTED AVERAGE WEIGHTED
AVERAGE REMAINING AVERAGE
EXERCISE PRICE NUMBER EXERCISE PRICE CONTRACTUAL LIFE NUMBER EXERCISE PRICE
$1.58 to $2.16 653,254 $ 1.58 8.1 years 118,900 $ 1.58
$2.59 to $3.63 436,250 3.44 9.0 years 63,208 3.39
$4.65 to $5.65 223,979 4.77 9.3 years 13,240 5.65
$9.13 to $12.69 567,396 10.10 7.2 years 283,698 10.10
$19.19 to $27.80 785,608 24.05 6.2 years 651,629 24.24
$34.07 to $45.94 216,601 44.38 6.0 years 162,459 44.38
$56.74 51,430 56.74 6.0 years 38,573 56.74
------------ ------------- ----------------- ------------ ----------------
2,934,518 $ 13.89 7.5 years 1,331,707 $ 21.43
============ ============= ================= ============ ================
RESTRICTED STOCK AWARD PLAN
On December 20, 2000, the company established a restricted stock award
plan for employees of EXFO Burleigh. Each stock award entitles employees
to receive one subordinate voting share at a purchase price of nil. Stock
awards granted under the plan vest over a four-year period, with 25%
vesting on an annual basis commencing on the first anniversary of the date
of grant. According to the plan, upon the involuntary termination of a
member of the defined management team, all outstanding restricted stock
awards granted to such an employee automatically vest. The plan will
expire on December 20, 2004.
The following table summarizes restricted stock awards activity since
August 31, 2001:
YEARS ENDED AUGUST 31,
------------------------------------------
2004 2003 2002
----------- ----------- ------------
Outstanding - Beginning of year 143,096 215,249 359,781
Granted -- -- --
Exercised (89,504) (69,935) (144,532)
Forfeited -- (2,218) --
----------- ----------- ------------
Outstanding - End of year 53,592 143,096 215,249
=========== =========== ============
Exercisable - End of year -- -- --
=========== =========== ============
As at August 31, 2004, the weighted average remaining contractual life of
the outstanding restricted stock awards was four months.
F-26
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
STOCK APPRECIATION RIGHTS PLAN
On August 4, 2001, the company established a stock appreciation rights
plan for certain employees. Under that plan, eligible employees are
entitled to receive a cash amount equivalent to the difference between the
market price of the common shares on the date of exercise and the exercise
price determined on the date of grant. Stock appreciation rights granted
under the plan generally expire ten years from the date of grant. Stock
appreciation rights vest over a four-year period, with 25% vesting on an
annual basis commencing on the first anniversary of the date of grant.
Considering the market price of the common shares of $4.36 as at August
31, 2004, compensation cost for those stock appreciation rights was
nominal as at August 31, 2004.
The following table summarizes stock appreciation rights activity since
August 31, 2001:
YEARS ENDED AUGUST 31,
----------------------------------------------------------------------------------------
2004 2003 2002
-------------------------- --------------------------- ---------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
NUMBER PRICE NUMBER PRICE NUMBER PRICE
Outstanding - Beginning of year 9,000 $ 24 10,000 $ 26 22,400 $ 30
Granted 6,000 5 5,000 2 1,000 12
Forfeited (2,000) 19 (6,000) (9) (13,400) (31)
------------ ------------ ------------ ------------ ------------ ------------
Outstanding - End of year 13,000 $ 16 9,000 $ 24 10,000 $ 26
============ ============ ============ ============ ============ ============
Exercisable - End of year 4,250 $ 30 3,500 $ 30 2,250 $ 27
============ ============ ============ ============ ============ ============
The following table summarizes information about stock appreciation rights
as at August 31, 2004:
STOCK APPRECIATION STOCK APPRECIATION
RIGHTS OUTSTANDING RIGHTS EXERCISABLE
----------------------------------- ---------------------
WEIGHTED AVERAGE
REMAINING
EXERCISE PRICE NUMBER CONTRACTUAL LIFE NUMBER
$2.10 2,000 8.6 years 500
$4.65 6,000 9.6 years --
$22.25 2,500 6.4 years 1,875
$45.94 2,500 6.0 years 1,875
------------- ----------------- ---------------------
13,000 8.1 years 4,250
============= ================= =====================
F-27
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
14 OTHER DISCLOSURES
NET RESEARCH AND DEVELOPMENT EXPENSES
Net research and development expenses comprise the following:
YEARS ENDED AUGUST 31,
-------------------------------------
2004 2003 2002
---------- ----------- ------------
Gross research and development expenses $ 15,668 $ 17,133 $ 17,005
Research and development tax credits and grants (3,278) (3,551) (4,223)
Research and development tax credit write-offs
(note 4) -- 2,297 --
---------- ----------- ------------
$ 12,390 $ 15,879 $ 12,782
========== =========== ============
All tax credits written off can be carried forward against future years'
income taxes payable over the next nine years.
OTHER GRANTS AND TAX CREDITS
During 1998, the company entered into an agreement with the Quebec
Minister of Industry, Commerce, Science and Technology (the "Minister").
Pursuant to this agreement, the Minister agreed to contribute, in the form
of grants, up to a maximum of Cdn$600,000 (US$456,000) towards interest
costs incurred over the period from January 1, 1998, through December 31,
2002. In addition, the Minister agreed to provide grants up to a maximum
of Cdn$2,220,000 (US$1,686,000) over the period from January 1, 1998,
through December 31, 2002, payable based on the number of full-time jobs
created during the period.
The above grants are subject to the condition that jobs created pursuant
to the agreement be maintained for a period of at least five years from
the date of creation. Should this condition not be met by the company, the
Minister may enforce various recourse options, which include suspension or
cancellation of the agreement or repayment of amounts received by the
company. Since the beginning of this program, the company has received the
maximum amount of Cdn$2,820,000 (US$2,142,000), of which Cdn$1,370,000
(US$1,040,000) was credited to earnings, the balance of Cdn$1,450,000
(US$1,102,000) was included in deferred grants in the balance sheet.
Furthermore, since 2000, companies operating in the Quebec City area are
eligible for a refundable tax credit granted by the Quebec provincial
government. This credit is earned based on the increase of eligible
production and marketing salaries incurred in the Quebec City area at a
rate of 40%. Since 2000, the company has received a total of Cdn$5,679,000
(US$4,313,000) under this program, of which Cdn$4,905,000 (US$3,725,000)
was credited to earnings, the balance of Cdn$774,000 (US$588,000) was
included in deferred grants in the balance sheet. The deferred grants will
be recognized in the statement of earnings upon the final approval of
eligible salaries by the sponsor of the program.
F-28
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
Should repayments of any amounts received pursuant to these agreements be
required, such repayments, less related deferred revenue, if any, will be
charged to earnings as the amount of any repayment becomes known.
Following is a summary of the classification of these and certain other
grants and tax credits (government grants) in the statements of earnings
of the reporting years.
Cost of sales for the years ended August 31, 2002, 2003 and 2004, is net
of government grants of $546,000, $518,000 and $3,000, respectively.
Selling and administrative expenses for the years ended August 31, 2002,
2003 and 2004, are net of government grants of $213,000, $286,000 and
$5,000, respectively.
Research and development expenses for the years ended August 31, 2002,
2003 and 2004, are net of government grants of $333,000, $45,000 and
$80,000, respectively.
DEFINED CONTRIBUTION PLANS
The company maintains separate defined contribution plans for certain
eligible employees. These plans, which are accounted for on an accrual
basis, are summarized as follows:
o Deferred profit-sharing plan
The company maintains a plan for certain eligible Canadian resident
employees, under which the company may elect to contribute an amount
equal to 1% of an employee's gross salary, provided that the employee
has contributed at least 2% of his/her gross salary to a tax-deferred
registered retirement savings plan. From June 2002 to December 2002,
the company suspended its contributions to the plan as part of its
cost-reduction efforts. Contributions to this plan for the years
ended August 31, 2002, 2003 and 2004, amounted to Cdn$136,000
(US$86,000), Cdn$93,000 (US$63,000) and Cdn$141,000 (US$106,000),
respectively.
o 401K plan
The company maintains a 401K plan for eligible U.S. resident
employees. Under this plan, the company must contribute an amount
equal to 3% of an employee's current compensation. During the years
ended August 31, 2002, 2003 and 2004, the company recorded
contributions totaling $317,000, $253,000 and $187,000, respectively.
F-29
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
15 INCOME TAXES
The reconciliation of the income tax provision calculated using the
combined Canadian federal and provincial statutory income tax rate with
the income tax provision in the financial statements is as follows:
YEARS ENDED AUGUST 31,
------------------------------------------
2004 2003 2002
-------- -------- --------
Income tax provision at combined Canadian federal and provincial
statutory tax rate (32% in 2004, 34% in 2003 and 36% in 2002) $ (3,011) $(13,563) $(26,563)
Increase (decrease) due to:
Manufacturing and processing deduction 6 307 525
Foreign income taxed at different rates (767) (999) (1,101)
Non-taxable income (128) (298) (143)
Non-deductible expenses 1,205 1,609 334
Tax deductions (169) (80) (518)
Reduction of Canadian federal statutory tax rate 274 92 168
Effect of consolidation of subsidiaries (1,384) 184 1,325
Previous year tax recovery upon a tax assessment (1,406) (645) --
Other 440 67 522
Change in valuation allowance 3,954 28,385 --
-------- -------- --------
$ (986) $ 15,059 $(25,451)
======== ======== ========
The income tax provision consists of the following:
Current
Canadian $ (577) $ 4,829 $(10,816)
United States -- (247) (1,232)
Other (409) 339 (6)
-------- -------- --------
(986) 4,921 (12,054)
Future
Canadian (1,104) (13,553) (4,475)
United States (2,448) (4,307) (8,694)
Other (402) (387) (228)
-------- -------- --------
(3,954) (18,247) (13,397)
Valuation allowance
Canadian 1,104 20,359 --
United States 2,448 7,374 --
Other 402 652 --
-------- -------- --------
3,954 28,385 --
-------- -------- --------
$ (986) $ 15,059 $(25,451)
======== ======== ========
Details of the company's income taxes:
Loss before income taxes and amortization and write-down of
goodwill
Canadian $ (7,740) $(20,449) $(47,431)
United States (5,879) (13,116) (28,228)
Other 4,209 (6,326) 1,874
-------- -------- --------
$ (9,410) $(39,891) $(73,785)
======== ======== ========
F-30
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
Significant components of the company's future income tax assets and
liabilities are as follows:
AS AT AUGUST 31,
--------------------------
2004 2003
----------- ------------
Future income tax assets
Long-lived assets $ 3,291 $ 2,053
Provisions and accruals 8,755 9,786
Government grants 188 185
Deferred revenue 336 140
Share issue expenses 657 1,434
Research and development expenses 5,064 3,621
Losses carried forward 15,110 13,770
----------- ------------
33,401 30,989
Valuation allowance (32,613) (28,846)
----------- ------------
$ 788 $ 2,143
=========== ============
Future income tax liabilities
Long-lived assets $ - $ (1,614)
Research and development tax credits (788) (497)
Provisions and accruals - (32)
----------- ------------
(788) (2,143)
----------- ------------
Future income tax assets, net $ -- $ --
=========== ============
As at August 31, 2004, the company had available operating losses in
several tax jurisdictions, against which a full valuation allowance was
established. The following table summarizes the year of expiry of these
operating losses by tax jurisdiction:
CANADA UNITED STATES
YEAR OF EXPIRY FEDERAL PROVINCIAL AND OTHER
-------------- ------------- ----------------
2005 $ 643,000 $ 955,000 $ -
2006 199,000 199,000 -
2007 1,544,000 1,609,000 207,000
2008 4,278,000 4,313,000 1,916,000
2009 5,346,000 3,256,000 575,000
2010 3,802,000 1,996,000 -
2014 182,000 - -
2022 - - 9,044,000
2023 - - 11,943,000
2024 - - 6,225,000
Indefinite 631,000 - 1,651,000
-------------- ------------- ----------------
$ 16,625,000 $ 12,328,000 $ 31,561,000
============== ============= ================
Also, as at August 31, 2004, the company had available research and
development expenses in Canada amounting to $16,110,000 at the federal
level and $16,600,000 at the provincial level,
F-31
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
against which a full valuation allowance was established. These expenses
can be carried forward indefinitely against future years' taxable income
in their respective tax jurisdiction.
16 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:
YEARS ENDED AUGUST 31,
---------------------------------------------
2004 2003 2002
------------- ------------- -------------
Basic weighted average number of shares outstanding (000's) 66,020 62,852 60,666
Dilutive effect of stock options (000's) 502 301 31
Dilutive effect of restricted stock awards (000's) 93 164 269
------------- ------------- -------------
Diluted weighted average number of shares outstanding (000's) 66,615 63,317 60,966
============= ============= =============
Stock options excluded from the calculation of the diluted
weighted average number of shares because their exercise
price was greater than the average market price of the
common shares (000's) 2,128 2,533 2,734
============= ============= =============
The diluted loss per share for the years ended August 31, 2002, 2003 and
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 years was calculated using the basic
weighted average number of shares outstanding.
F-32
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
17 FINANCIAL INSTRUMENTS
SHORT-TERM INVESTMENTS
Short-term investments consist of the following:
AS AT AUGUST 31,
------------------------------
2004 2003
------------ ------------
Commercial paper denominated in Canadian dollars, bearing interest at
annual rates of 2.00% to 2.14% in 2004 and 2.65% to 3.10% in
2003, maturing on different dates between October 2004 and
January 2005 in fiscal 2004, and October 2003 and January 2004
in fiscal 2003 $ 65,359 $ 52,010
Mutual funds denominated in Canadian dollars 18,610 -
------------ ------------
$ 83,969 $ 52,010
============ ============
F-33
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
FAIR VALUE
Cash, accounts receivable, accounts payable and accrued liabilities and
long-term debt are financial instruments whose carrying values approximate
their fair values.
The fair value of short-term investments, based on market value, amounted
to $52,010,000 and $83,969,000 as at August 31, 2003 and 2004,
respectively.
The fair value of forward exchange contracts, based on the current trading
value, amounted to Cdn$18,550,000 and Cdn$20,371,000 as at August 31, 2003
and 2004, respectively.
CREDIT RISK
Financial instruments that potentially subject the company to credit risk
consist primarily of cash, short-term investments, accounts receivable and
forward exchange contracts. The company's short-term investments consist
of debt instruments issued by high-credit quality corporations and trusts.
The company's cash and forward exchange contracts are held with or issued
by high-credit quality financial institutions; therefore, the company
considers the risk of non-performance on these instruments to be remote.
Due to the geographic distribution of the company's customers, there is no
particular concentration of credit risk. Generally, the company does not
require collateral or other security from customers for trade accounts
receivable; however, credit is extended to customers following an
evaluation of creditworthiness. In addition, the company performs ongoing
credit reviews of all its customers and establishes an allowance for
doubtful accounts receivable when accounts are determined to be
uncollectible. Allowance for doubtful accounts amounted to $568,000 and
$510,000 as at August 31, 2003 and 2004, respectively.
INTEREST RATE RISK
As at August 31, 2004, the company's exposure to interest rate risk is
summarized as follows:
Cash Non-interest bearing
Short-term investments As described above
Accounts receivable Non-interest bearing
Accounts payable and accrued liabilities Non-interest bearing
Long-term debt As described in note 10
F-34
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
FORWARD EXCHANGE CONTRACTS
The company is exposed to currency risks as a result of its export sales
of products manufactured in Canada, substantially all of which are
denominated in US dollars. These risks are partially hedged by forward
exchange contracts and certain operating expenses. As at August 31, 2003
and 2004, the company held contracts to sell US dollars at various forward
rates, which are summarized as follows:
CONTRACTUAL WEIGHTED AVERAGE
AMOUNTS CONTRACTUAL FORWARD RATES
-------------- -------------------------
As at August 31, 2003
September 2003 to August 2004 $ 6,470 1.5869
September 2004 to August 2005 6,680 1.5647
As at August 31, 2004
September 2004 to August 2005 $ 7,480 1.5427
September 2005 to March 2007 8,400 1.3622
As at August 31, 2003 and 2004, these forward exchange contracts generated
deferred unrealized gains of US$1,800,000 and US$1,500,000, respectively.
Deferred unrealized gains were calculated using year-end exchange rates of
Cdn$1.3851 = US$1.00 and Cdn$1.3167 = US$1.00 in fiscal 2003 and 2004,
respectively.
18 SEGMENT INFORMATION
In September 2003, the company reorganized its business under two
reportable segments: the Telecom Division and the Photonics and Life
Sciences Division. The Telecom Division offers integrated test solutions
to network service providers, system vendors and component manufacturers
throughout the global telecommunications industry. The Photonics and Life
Sciences Division mainly leverages developed and acquired core telecom
technologies for high-tech industrial manufacturing and research markets.
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. 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.
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.
F-35
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
The following tables present information by segment:
YEAR ENDED AUGUST 31, 2004
--------------------------------------------------------------------------------
PHOTONICS AND LIFE
TELECOM DIVISION SCIENCES DIVISION TOTAL
--------------------------- ------------------------ ---------------------
Sales $ 58,882 $ 15,748 $ 74,630
Loss from operations $ (5,557) $ (5,013) $ (10,570)
Unallocated items:
Interest and other income 1,438
Foreign exchange loss (278)
---------------------
Loss before income taxes (9,410)
Income taxes (986)
---------------------
Net loss for the year $ (8,424)
=====================
Amortization of capital assets $ 6,643 $ 3,372 $ 10,015
=========================== ======================== =====================
Stock-based compensation costs $ 417 $ 32 $ 449
=========================== ======================== =====================
Capital expenditures $ 607 $ 244 $ 851
=========================== ======================== =====================
YEAR ENDED AUGUST 31, 2003
--------------------------------------------------------------------------------
PHOTONICS AND LIFE
TELECOM DIVISION SCIENCES DIVISION TOTAL
--------------------------- ------------------------ ---------------------
Sales $ 48,753 $ 13,177 $ 61,930
YEAR ENDED AUGUST 31, 2002
--------------------------------------------------------------------------------
PHOTONICS AND LIFE
TELECOM DIVISION SCIENCES DIVISION TOTAL
--------------------------- ------------------------ ---------------------
Sales $ 54,452 $ 13,878 $ 68,330
Comparative information for the loss from operations and related
information as well as capital expenditures is not provided for each
reportable segment because this information is not available and is
impracticable to determine.
AS AT AUGUST 31,
----------------------------------------------
2004 2003
---------------------- ----------------------
TOTAL ASSETS
Telecom Division $ 59,463 $ 59,466
Photonics and Life Sciences Division 15,915 22,032
Unallocated assets 97,413 64,756
---------------------- ----------------------
$ 172,791 $ 146,254
====================== ======================
Unallocated assets are comprised of cash, short-term investments and
income taxes and tax credits recoverable.
As at August 31, 2004, the net carrying value of goodwill that reported to
the Telecomunication test Division and the Photonics and Life Sciences
Division amounted to $14,530,000 and $3,863,000, respectively.
F-36
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
Sales to external customers by geographic region are detailed as follows:
YEARS ENDED AUGUST 31,
-------------------------------------------------------
2004 2003 2002
----------------- ----------------- -----------------
United States $ 40,019 $ 31,561 $ 35,129
Canada 5,818 4,806 3,971
Latin America 3,547 4,467 2,581
----------------- ----------------- -----------------
49,384 40,834 41,681
Europe, Middle East and Africa 13,706 11,092 13,678
Asia-Pacific 11,540 10,004 12,971
----------------- ----------------- -----------------
$ 74,630 $ 61,930 $ 68,330
================= ================= =================
Sales were allocated to geographic regions based on the country of
residence of the related customers. In fiscal 2002 and 2004, one customer
represented more than 10% of sales with 10.2% of sales ($6,965,000) in
fiscal 2002 and 13.8% of sales ($10,325,000) in fiscal 2004. In fiscal
2003, no single customer accounted for 10% of sales or more. For fiscal
2004, the most important customer reported to the Telecom Division.
Long-lived assets by geographic region are detailed as follows:
AS AT AUGUST 31,
-----------------------------------------
2004 2003
------------------ -------------------
Canada $ 37,948 $ 43,402
United States 6,934 9,980
------------------ -------------------
$ 44,882 $ 53,382
================== ===================
Long-lived assets consist of property, plant and equipment, the long-lived
asset held for sale, intangible assets and goodwill.
19 RELATED PARTY TRANSACTIONS
In fiscal 2003, the company acquired a building from a company owned by
the President of EXFO for a cash consideration of $930,000. This
transaction was measured at the fair market value since it was not
conducted during the normal course of operations, the change in ownership
interest in the building was substantive and the fair market value was
supported by an independent appraisal.
F-37
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
For the years ended August 31, 2002 and 2003 and 2004, the company leased
facilities from the company owned by the President of EXFO. The annual
rental expense amounted to $234,000, $331,000 and nil, respectively. The
rental expense for fiscal 2003 included $234,000 for future payments on an
exited leased facility; this expense was recorded in the restructuring and
other charges in the statement of earnings for that year (notes 4 and 9).
As at August 31, 2004, restructuring charges payable included $194,000 due
to the company owned by the President of the EXFO in connection with this
exited leased facility. In September 2004, EXFO was released from its
obligations under that lease, and it paid the full amount due to the
related company. These rental expenses were measured at the fair market
value since they were incurred during the normal course of operations.
20 UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
As a registrant with the Securities and Exchange Commission in the United
States (SEC), the company is required to reconcile its financial
statements for significant differences between generally accepted
accounting principles as applied in Canada (Canadian GAAP) and those
applied in the United States (U.S. GAAP). Furthermore, additional
significant disclosures required under U.S. GAAP and Regulation S-X of the
SEC are also provided in the accompanying financial statements and notes.
The following summarizes the significant quantitative differences between
Canadian and U.S. GAAP, as well as other significant disclosures required
under U.S. GAAP and Regulation S-X not already provided in the
accompanying financial statements.
F-39
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
RECONCILIATION OF NET LOSS TO CONFORM TO U.S. GAAP
The following summary sets out the significant differences between the
company's reported net loss and net loss per share under Canadian GAAP as
compared to U.S. GAAP. Please see corresponding explanatory notes in the
Reconciliation Items section.
YEARS ENDED AUGUST 31,
------------------------------------------------------
2004 2003 2002
----------------- ----------------- -----------------
Net loss for the year in accordance with Canadian GAAP $ (8,424) $ (54,950) $ (308,524)
Stock-based compensation costs related to stock option plan a) 146 216 49
Stock-based compensation costs related to stock purchase
plan a) (611) (61) (661)
Stock-based compensation costs related to restricted stock
award plan a) (402) (987) (3,038)
Unrealized gains (losses) on forward exchange contracts b) (280) 1,645 444
Future income taxes on forward exchange contracts b) -- (543) (212)
Future income taxes on acquired in-process research and
development d) -- -- (444)
Amortization of intangible assets e) -- 832 239
Future income taxes on amortization of intangible assets e) -- (279) (80)
Amortization of goodwill d), e) -- -- (9,263)
Write-down of goodwill and intangible assets e) -- 6,178 (62,557)
Future income taxes on write-down of intangible assets e) -- -- 1,154
Valuation allowance on future income tax assets f) -- (252) --
----------------- ----------------- -----------------
Net loss for the year in accordance with
U.S. GAAP (9,571) (48,201) (382,893)
Other comprehensive loss
Foreign currency translation adjustment 5,969 15,089 (521)
Unrealized gains on forward exchange contracts b) 689 -- --
----------------- ----------------- -----------------
Comprehensive loss $ (2,913) $ (33,112) $ (383,414)
================= ================= =================
Basic and diluted net loss per share in accordance with
U.S. GAAP h) $ (0.14) $ (0.77) $ (6.31)
F-39
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
SHAREHOLDERS' EQUITY
As a result of the aforementioned adjustments to net loss and other
comprehensive loss, significant differences with respect to shareholders'
equity under U.S. GAAP are as follows:
SHARE CAPITAL
AS AT AUGUST 31,
-------------------------------------------------------
2004 2003 2002
----------------- ----------------- -----------------
Share capital in accordance with Canadian GAAP $ 521,733 $ 492,452 $ 489,611
Stock-based compensation costs related to stock
purchase plan a), g)
Current year (47) (75) (64)
Cumulative effect of prior years 2,403 2,478 2,542
Reclassification from other capital upon exercise of
restricted stock awards
Current year 1,784 1,582 3,270
Cumulative effect of prior years 4,852 3,270 -
Shares issued upon business combinations d)
Cumulative effect of prior years 65,584 65,584 65,584
----------------- ----------------- -----------------
Share capital in accordance with U.S. GAAP $ 596,309 $ 565,291 $ 560,943
================= ================= =================
DEFERRED STOCK-BASED COMPENSATION COSTS
AS AT AUGUST 31,
-------------------------------------------------------
2004 2003 2002
----------------- ----------------- -----------------
Deferred stock-based compensation costs in accordance
with Canadian GAAP $ -- $ -- $ --
Stock-based compensation costs related to stock-based
compensation plans a), g)
Current year (1,463) -- --
Cumulative effect of prior years (29,576) (29,576) (29,576)
Amortization
Current year 1,718 1,483 4,698
Cumulative effect of prior years 13,095 11,612 6,914
Reduction of stock-based compensation costs
Current year 84 106 403
Cumulative effect of prior years 15,203 15,097 14,694
----------------- ----------------- -----------------
Deferred stock-based compensation costs in accordance
with U.S. GAAP $ (939) $ (1,278) $ (2,867)
================= ================= =================
F-40
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
OTHER CAPITAL
AS AT AUGUST 31,
-------------------------------------------------------
2004 2003 2002
----------------- ----------------- -----------------
Other capital in accordance with Canadian GAAP $ -- $ -- $ --
Stock-based compensation costs related to stock-based
compensation plans a), g)
Current year 1,463 -- --
Cumulative effect of prior years 26,894 26,894 26,894
Reduction of stock-based compensation costs
Current year (439) (682) (1,387)
Cumulative effect of prior years (16,613) (15,931) (14,544)
Reclassification to share capital upon exercise of
restricted stock awards
Current year (1,784) (1,582) (3,270)
Cumulative effect of prior years (4,852) (3,270) -
----------------- ----------------- -----------------
Other capital in accordance with U.S. GAAP $ 4,669 $ 5,429 $ 7,693
================= ================= =================
F-41
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
DEFICIT
AS AT AUGUST 31,
-------------------------------------------------------
2004 2003 2002
----------------- ----------------- -----------------
Deficit in accordance with Canadian GAAP $ (380,212) $ (371,788) $ (316,838)
Stock-based compensation costs a)
Current year (867) (832) (3,650)
Cumulative effect of prior years (11,406) (10,574) (6,924)
Unrealized gains (losses) on forward exchange
contracts, net of income taxes b)
Current year (280) 1,102 232
Cumulative effect of prior years 1,451 349 117
Change in reporting currency c)
Cumulative effect of prior years 1,016 1,016 1,016
Future income taxes on acquired in-process research
and development d)
Current year -- -- (444)
Cumulative effect of prior years (1,380) (1,380) (936)
Amortization of intangible assets, net of income taxes e)
Current year -- 553 159
Cumulative effect of prior years 712 159 --
Write-down of goodwill and intangible assets, net of e)
incomes taxes
Current year -- 6,178 (61,403)
Cumulative effect of prior years (55,225) (61,403) --
Valuation allowance on future income tax assets f)
Current year -- (252) --
Cumulative effect of prior years (252) -- --
Amortization of goodwill d), e)
Current year -- -- (9,263)
Cumulative effect of prior years (17,716) (17,716) (8,453)
----------------- ----------------- -----------------
Deficit in accordance with U.S. GAAP $ (464,159) $ (454,588) $ (406,387)
================= ================= =================
F-42
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
AS AT AUGUST 31,
-------------------------------------------------------
2004 2003 2002
----------------- ----------------- -----------------
Accumulated other comprehensive income in accordance
with Canadian GAAP $ - $ - $ --
Foreign currency translation adjustment
Current year 5,969 15,089 (521)
Cumulative effect of prior years 5,219 (9,870) (9,349)
Unrealized gains on forward exchange contracts
Current year b) 689 -- --
----------------- ----------------- -----------------
Accumulated other comprehensive income (loss) in
accordance with U.S. GAAP $ 11,877 $ 5,219 $ (9,870)
================= ================= =================
BALANCE SHEETS
The following table summarizes the significant differences in balance
sheet items between Canadian GAAP and U.S. GAAP:
AS AT AUGUST 31, 2004 AS AT AUGUST 31, 2003
--------------------------------------- ----------------------------------------
AS REPORTED U.S. GAAP AS REPORTED U.S. GAAP
Goodwill d), e)
Cost $ 93,967 $ 102,138 $ 91,982 $ 100,512
Accumulated amortization (75,574) (93,753) (74,309) (92,610)
-------------------- ------------------- -------------------- ------------------
$ 18,393 $ 8,385 $ 17,673 $ 7,902
==================== =================== ==================== ==================
Shareholders' equity
Share capital a), d)
g)$ 521,733 $ 596,309 $ 492,452 $ 565,291
Contributed surplus 1,986 1,537 1,519 1,519
Cumulative translation
adjustment c) 13,820 -- 7,643 --
Deficit a),
b),
c),
d),
e), f) (380,212) (464,159) (371,788) (454,588)
Deferred stock-based
compensation costs a), g) -- (939) -- (1,278)
Other capital a) -- 4,669 -- 5,429
Accumulated other
comprehensive income c) -- 11,877 -- 5,219
-------------------- ------------------- -------------------- ------------------
$ 157,327 $ 149,294 $ 129,826 $ 121,592
==================== =================== ==================== ==================
F-43
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
STATEMENTS OF CASH FLOWS
For the years ended August 31, 2002, 2003 and 2004, there were no
significant differences between the statements of cash flows under
Canadian GAAP as compared to U.S. GAAP.
RECONCILIATION ITEMS
a) ACCOUNTING FOR STOCK-BASED COMPENSATION PLANS
Until August 31, 2003, and to conform to U.S. GAAP, the company
measured stock-based compensation costs using the intrinsic value
method (APB 25, "Accounting for Stock Issued to Employees"). However,
since September 1, 2003, and as described in item j) below, the
company accounts for stock-based compensation costs for awards
granted after that date, using the fair-value based method to conform
to Statement of Financial Accounting Standard (SFAS) 123, "Accounting
for Stock-Based Compensation". As at August 31, 2004, deferred
stock-based compensation costs related to awards accounted for under
SFAS 123 amounted to $939,000.
STOCK PURCHASE PLAN
Under APB 25, compensation costs related to the stock purchase plan
were measured as the difference between the fair value of the
purchased stock and the purchase price paid by plan participants.
Compensation costs were amortized to expense over a period of five
years, being the restriction period. This plan terminated at the time
of the Initial Public Offering on June 29, 2000. As at August 31,
2004, compensation costs related to this plan were fully amortized.
STOCK OPTION PLAN
Until August 31, 2003, and under APB 25, compensation costs related
to the stock option plan were measured as the difference between the
fair value of the underlying stock at the date of grant and the
exercise price of the option. These compensation costs were amortized
to expense over the estimated vesting period up to a maximum of four
years. As at August 31, 2004, compensation costs related to stock
options granted prior to September 1, 2003, and accounted for under
APB 25 were fully amortized.
RESTRICTED STOCK AWARD PLAN
Under APB 25, compensation costs related to the restricted stock
award plan were measured as the difference between the fair value of
the underlying stock at the date of grant and the exercise price,
which is nil. These compensation costs were amortized to expense over
the estimated vesting period up to a maximum of four years, being the
acquisition period. As at August 31, 2004, compensation costs related
to this plan were fully amortized.
Until August 31, 2003, no compensation costs were recognized for
these stock-based compensation plans under Canadian GAAP.
F-44
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
b) FORWARD EXCHANGE CONTRACTS
On September 1, 2000, the company prospectively adopted SFAS 133,
"Accounting for Derivative Instruments and Hedging Activities", and
its amendments (SFAS 138), which require all derivatives to be
carried onto the balance sheet at fair value. The forward exchange
contracts used by the company did not qualify for hedge accounting
treatment during the years ended August 31, 2002 and 2003 under U.S.
GAAP; accordingly, changes in the fair value of the derivatives were
charged to earnings during these years.
However, on September 1, 2003, the company implemented the
documentation required by Accounting Guideline 13 of the CICA
handbook, "Hedging Relationship", for the designation, documentation
and assessment of the 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, qualify for
hedge accounting treatment under U.S. GAAP. Consequently, under U.S.
GAAP, changes in the fair value of these contracts are charged to
other comprehensive loss. Upon settlement of the forward exchange
contracts, changes in fair value are reclassified in the statement of
earnings.
Under Canadian GAAP, foreign exchange translation gains and losses on
contracts are recognized as an adjustment of the revenue when the
corresponding sales are recorded, regardless of whether the contracts
were entered into before or after September 1, 2003.
c) CHANGE IN REPORTING CURRENCY
On September 1, 1999, the company adopted the US dollar as its
reporting currency. Under U.S. GAAP, the financial statements,
including those of prior years, are translated according to the
current rate method.
Under Canadian GAAP, at the time of change in reporting currency, the
historical financial statements are presented using a translation of
convenience. This difference between U.S. GAAP and Canadian GAAP
created a permanent difference of $1,016,000 affecting the cumulative
translation adjustment and the retained earnings.
d) BUSINESS COMBINATIONS
Under Canadian GAAP, until June 30, 2001, the value of shares issued
upon a business combination was determined based on the market price
of the shares over a reasonable period of time before and after the
date of acquisition. Under U.S. GAAP, the value of shares was
determined based on the market price of the shares over a reasonable
period of time before and after the companies had reached an
agreement on the purchase price; the significant terms of the
agreement were known and the proposed transaction was announced.
Consequently, the measurement dates of the acquisitions of EXFO
Burleigh and EXFO Photonic Solutions for U.S. GAAP purposes occurred
on December 14, 2000, and on March 6, 2001, respectively; that is,
the dates on which all significant terms of the agreements were
known. The average market price of the shares a few days before and
after those dates was $31.09 and
F-45
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
$25.84, respectively. Considering the number of shares issued upon
those acquisitions, the total consideration for U.S. GAAP purposes
amounts to $244,198,000 ($189,270,000 under Canadian GAAP) for EXFO
Burleigh and $120,802,000 ($110,146,000 under Canadian GAAP) for EXFO
Photonic Solutions, thus increasing share capital and goodwill under
U.S. GAAP.
However, since July 1, 2001, the shares issued upon a business
combination are valued under Canadian GAAP using the same method as
used under U.S. GAAP.
Furthermore, under U.S. GAAP, in-process research and development
acquired in a business combination is written off at the time of
acquisition and no future income taxes are recognized on this asset
in the purchase price allocation process. Under Canadian GAAP,
in-process research and development acquired in a business
combination is capitalized and amortized over the estimated useful
life. In the purchase price allocation process, future income taxes
are recognized for that asset on the acquisition date. As at August
31, 2002, 2003 and 2004, in-process research and development recorded
under Canadian GAAP was fully amortized.
e) WRITE-DOWN OF GOODWILL AND INTANGIBLE ASSETS
2002
Under U.S. GAAP, until the adoption of SFAS 142, "Goodwill and Other
Intangible Assets", when assets being tested for recoverability were
acquired in business combinations accounted for by the purchase
method, the goodwill that arose in that transaction had to be
included as part of the assets grouping in determining
recoverability. The intangible assets tested for recoverability in
fiscal 2002 were acquired in business combinations that were
accounted for using the purchase method and, consequently, the
company allocated goodwill to those assets on a pro rata basis using
the relative fair values of the long-lived assets and identifiable
intangible assets acquired as determined at the date of acquisition.
The carrying value of goodwill identified with the impaired
intangible assets was written down before any reduction was made to
the intangible assets. Intangible assets were then written down to
their fair value.
The fair value of intangible assets was determined based on
discounted future cash flows. The cash flow periods used were ten and
eleven years, using annual growth rates ranging between 10% and 30%
and discount rates between 15% and 18%. The assumptions supporting
discounted cash flows, including the cash flow periods, the annual
growth rates and the discount rates reflected management's best
estimates. The discount rates were based upon the company's weighted
average cost of capital as adjusted for the risks associated with
operations.
The unallocated portion of goodwill was tested for recoverability at
the subsidiaries' level based on the related pre-tax undiscounted
future cash flows using the same assumptions and methodology used for
Canadian GAAP purposes.
Under U.S. GAAP, the company recorded a charge of $281,278,000 to
write down a significant portion of goodwill and a pre-tax charge of
$27,105,000 to write down a significant portion of acquired core
technology. Of the total charge of $308,383,000, $170,079,000 was
related to EXFO Burleigh for goodwill and acquired core technology,
$83,637,000 was related to EXFO Photonic Solutions for goodwill and
acquired core technology and $54,667,000 was related to EXFO Protocol
for goodwill.
F-46
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
Under Canadian GAAP, no allocation of goodwill was required and each
asset was tested for recoverability separately based on its pre-tax
undiscounted future cash flows over its expected period of use.
Also, under Canadian GAAP, the impairment loss for intangible assets
was measured as the difference between the carrying value and the
pre-tax undiscounted future cash flows.
Finally, under U.S. GAAP, the carrying value of goodwill reviewed for
impairment was $46,380,000 higher than the carrying value of the same
goodwill tested under Canadian GAAP because the measurement dates
used to account for the business combinations were different between
Canadian GAAP and U.S. GAAP as explained in item d).
2003
In fiscal 2003, Canadian and U.S. GAAP were harmonized to eliminate
the existing differences in the assessment and measurement of
impairment loss for goodwill and intangible assets. Thus, in fiscal
2003, goodwill and intangible assets were tested for impairment using
similar methodologies. However, considering that the existing
carrying value of goodwill and intangible assets was lower under U.S.
GAAP than under Canadian GAAP, the required impairment loss under
U.S. GAAP was lower.
Consequently, under U.S. GAAP, the company recorded a charge of
$872,000 to write down the goodwill of EXFO Burleigh and a pre-tax
charge of $377,000 to write down the acquired core technology of EXFO
Burleigh, compared to a write-down of $4,505,000 for goodwill and a
write-down of $2,922,000 for intangible assets under Canadian GAAP,
creating a reconciliation item of $6,178,000 in the statement of
earnings for the year ended August 31, 2003.
Furthermore, considering differences in the carrying value of
intangible assets between Canadian GAAP and U.S. GAAP due to
impairment losses, adjustments to the amortization of such assets and
related future income taxes were also required in fiscal 2002 and
2003.
f) INCOME TAXES
In fiscal 2003, considering the tax effects of the adjustments
discussed in items b), d) and e), the valuation allowance required
under U.S. GAAP was $252,000 higher than under Canadian GAAP.
g) SHARE CAPITAL
Under Canadian GAAP, restricted shares reacquired from employees
under the stock purchase plan are treated as arm's length repurchases
of shares, whereas under U.S. GAAP, the reacquisition of shares would
be accounted for as a forfeiture by the employee, which means that
any difference between the amount originally credited to share
capital and the remaining deferred compensation cost will be credited
to compensation expense in the current period. The subsequent resale
of the shares would be treated as an issuance of shares for the
proceeds received.
F-47
h) LOSS PER SHARE
Under U.S. GAAP, the presentation of per share figures for loss
before amortization and write-down of goodwill is not permitted.
i) RESEARCH AND DEVELOPMENT TAX CREDITS
Under Canadian GAAP, all research and development tax credits are
recorded as a reduction of research and development expenses. Under
U.S. GAAP, tax credits that are refundable against taxable income are
recorded in the income taxes. These tax credits amounted to
$1,761,000 and $2,599,000 for fiscal 2004 and 2002, respectively. In
fiscal 2003, we had a net expense of $176,000 following the write-off
of tax credits. This difference had no impact on the net loss and the
net loss per share figures for the reporting years.
j) NEW ACCOUNTING STANDARD
On September 1, 2003, the company prospectively adopted 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 for awards granted after
September 1, 2003.
ACCOUNTING FOR STOCK-BASED COMPENSATION
Under U.S. GAAP, until August 31, 2003, the company elected to measure
compensation costs related to grants of stock options and stock awards
using the intrinsic value method of accounting. In this instance, however,
under SFAS 123, the company is required to make pro forma disclosures of
net loss, and net loss per share as if the fair value-based method of
accounting had been applied. If the fair value based method had been
applied, the pro forma net loss per share would have been lower than the
net loss per share by $0.02 in fiscal 2004 and higher by $0.01 and $0.08
in 2003 and 2002, respectively.
The fair value of options or awards granted was estimated using the
Black-Scholes options pricing model with the following weighted average
assumptions:
F-48
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
YEARS ENDED AUGUST 31,
----------------------------------------
2004 2003 2002
------------ ------------ --------------
Risk-free interest rate 2.7% 4.8% 4.5%
Expected volatility 100% 80% 80%
Dividend yield Nil Nil Nil
Expected life 49 months 36 months 40 months
F-49
TABLE OF CONTENTS
PART I.........................................................................2
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS..........2
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE........................2
ITEM 3. KEY INFORMATION................................................2
A. SELECTED FINANCIAL DATA........................................2
B. CAPITALIZATION AND INDEBTEDNESS................................4
C. REASONS FOR THE OFFER AND USE OF PROCEEDS......................4
D. RISK FACTORS...................................................4
ITEM 4. INFORMATION ON THE COMPANY....................................18
A. HISTORY AND DEVELOPMENT OF THE COMPANY........................18
B. BUSINESS OVERVIEW.............................................20
C. ORGANIZATIONAL STRUCTURE......................................41
D. PROPERTY, PLANT AND EQUIPMENT.................................41
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES....................67
A. DIRECTORS AND SENIOR MANAGEMENT...............................67
B. COMPENSATION..................................................71
C. BOARD PRACTICES...............................................80
D. EMPLOYEES.....................................................81
E. SHARE OWNERSHIP...............................................82
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS.............84
A. MAJOR SHAREHOLDERS............................................84
B. RELATED PARTY TRANSACTIONS....................................84
ITEM 8. FINANCIAL INFORMATION.........................................85
A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION.......85
B. SIGNIFICANT CHANGES...........................................87
ITEM 10. ADDITIONAL INFORMATION........................................90
ITEM 10. ADDITIONAL INFORMATION........................................90
A. SHARE CAPITAL.................................................90
B. MEMORANDUM AND ARTICLES OF ASSOCIATION........................90
C. MATERIAL CONTRACTS............................................90
D. EXCHANGE CONTROLS.............................................90
E. TAXATION......................................................90
F. DIVIDENDS AND PAYING AGENTS...................................98
G. STATEMENT BY EXPERTS..........................................98
H. DOCUMENTS ON DISPLAY..........................................98
I. SUBSIDIARY INFORMATION........................................98
ITEM 11. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK....99
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES.......100
PART II......................................................................100
ITEM 13. DEFAULTS, DIVIDENDS ARREARAGES AND DELINQUENCIES.............100
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS
AND USE OF PROCEEDS..........................................100
ITEM 15. CONTROLS AND PROCEDURES......................................100
ITEM 16. [RESERVED]...................................................100
PART III.....................................................................102
ITEM 17. FINANCIAL STATEMENTS.........................................102
ITEM 18. FINANCIAL STATEMENTS.........................................102
ITEM 19. EXHIBITS.....................................................103
IMPAIRMENT OF LONG-LIVED ASSETS................................................8
EXHIBIT INDEX
NUMBER EXHIBIT
------ -----------------------------------------------------------------------
1.1 Amended Articles of Incorporation of EXFO (incorporated by reference to
Exhibit 3.1 of EXFO's Registration Statement on Form F-1, File No.
333-38956).
1.2 Amended By-laws of EXFO (incorporated by reference to Exhibit 1.2 of
EXFO's annual report on Form-20F dated January 15, 2003).
1.3 Amended and Restated Articles of Incorporation of EXFO (incorporated by
reference to Exhibit 1.3 of EXFO's annual report on Form 20-F dated
January 18, 2001).
2.1 Form of Subordinate Voting Share Certificate (incorporated by reference
to Exhibit 4.1 of EXFO's Registration Statement on Form F-1, File No.
333-38956).
2.2 Form of Registration Rights Agreement between EXFO and Germain Lamonde
dated July 6, 2000 ) (incorporated by reference to Exhibit 10.13 of
EXFO's Registration Statement on Form F-1, File No. 333-38956).
3.1 Form of Trust Agreement among EXFO, Germain Lamonde, GEXFO
Investissements Technologiques inc., Fiducie Germain Lamonde and G.
Lamonde Investissements Financiers inc. (incorporated by reference to
Exhibit 4.2 of EXFO's Registration Statement on Form F-1, File No.
333-38956).
4.1 Agreement of Merger and Plan of Reorganization, dated as of November 4,
2000, by and among EXFO, EXFO Sub, Inc., EXFO Burleigh Instruments,
Inc., Robert G. Klimasewki, William G. May, Jr., David J. Farrell and
William S. Gornall (incorporated by reference to Exhibit 4.1 of EXFO's
annual report on Form 20-F dated January 18, 2001)
4.2 Amendment No. 1 to Agreement of Merger and Plan of Agreement, dated as
of December 20, 2000, by and among EXFO, EXFO Sub, Inc., EXFO Burleigh
Instruments, Inc., Robert G. Klimasewski, William G. May, Jr., David J.
Farrell and William S. Gornall (incorporated by reference to Exhibit
4.2 of EXFO's annual report on Form 20-F dated January 18, 2001).
4.3 Agreement of Merger, dated as of August 20, 2001, by and among EXFO,
Buyer Sub, and Avantas Networks Corporation and Shareholders of Avantas
Networks corporation (incorporated by reference to Exhibit 4.3 of
EXFO's annual report on Form 20-F dated January 18, 2002).
4.4 Amendment No. 1 dated as of November 1, 2002 to Agreement of Merger,
dated as of August 20, 2001, by and among EXFO, 3905268 Canada Inc.,
Avantas Networks Corporation and Shareholders of Avantas Networks
(incorporated by reference to Exhibit 4.4 of EXFO's annual report on
Form 20-F dated January 18, 2002).
4.5 Offer to purchase shares of Nortech Fibronic Inc., dated February 6,
2000 among EXFO, Claude Adrien Noel, 9086-9314 Quebec inc., Michel
Bedard, Christine Bergeron and Societe en Commandite Capidem Quebec
Enr. and Certificate of Closing, dated February 7, 2000 among the same
parties (including summary in English) (incorporated by reference to
Exhibit 10.2 of EXFO's Registration Statement on Form F-1, File No.
333-38956).
4.6 Share Purchase Agreement, dated as of March 5, 2001, among EXFO
Electro-Optical Engineering, Inc., John Kennedy, Glenn Harvey and EFOS
Corporation (incorporated by reference to Exhibit 4.1 of EXFO's
Registration Statement on Form F-3, File No. 333-65122).
4.7 Amendment Number One, dated as of March 15, 2001, to Share Purchase
Agreement, dated as of March 5, 2001, among EXFO Electro-Optical
Engineering, Inc., John Kennedy, Glenn Harvey and EFOS Corporation.
(incorporated by reference to Exhibit 4.2 of EXFO's Registration
Statement on Form F-3, File No. 333-65122).
4.8 Share Purchase Agreement, dated as of November 2, 2001 between JDS
Uniphase Inc. and 3905268 Canada Inc. (incorporated by reference to
Exhibit 4.8 of EXFO's annual report on Form 20-F dated January 18,
2002).
4.9 Intellectual Property Assignment and Sale Agreement between EFOS Inc.,
EXFO Electro-Optical Engineering, Inc., John Kennedy, Glenn Harvey and
EFOS Corporation. (incorporated by reference to Exhibit 4.3 of EXFO's
Registration Statement on Form F-3, File No. 333-65122).
4.10 Offer to acquire a building, dated February 23, 2000, between EXFO and
Groupe Mirabau inc. and as accepted by Groupe Mirabau inc. on February
24, 2000 (including summary in English) (incorporated by reference to
Exhibit 10.3 of EXFO's Registration Statement on Form F-1, File No.
333-38956).
4.11 Lease Agreement, dated December 1, 1996, between EXFO and GEXFO
Investissements Technologiques inc., as assigned to 9080-9823 Quebec
inc. on September 1, 1999 (including summary in English) (incorporated
by reference to Exhibit 10.4 of EXFO's Registration Statement on Form
F-1, File No. 333-38956).
4.12 Lease Agreement, dated March 1, 1996, between EXFO and GEXFO
Investissements Technologiques inc., as assigned to 9080-9823 Quebec
inc. on September 1, 1999 (including summary in English) (incorporated
by reference to Exhibit10.5 of EXFO's Registration Statement on Form
F-1, File No. 333-38956).
4.13 Lease renewal of the existing leases between 9080-9823 Quebec inc. and
EXFO, dated November 30, 2001(incorporated by reference to Exhibit 4.13
of EXFO's annual report on Form 20-F dated January 18, 2002).
NUMBER EXHIBIT
------ -----------------------------------------------------------------------
4.14 Loan Agreement between EXFO and GEXFO Investissements Technologiques
inc., dated May 11, 1993, as assigned to 9080-9823 Quebec inc. on
September 1, 1999 (including summary in English) (incorporated by
reference to Exhibit 10.9 of EXFO's Registration Statement on Form F-1,
File No. 333-38956).
4.15 Resolution of the board of directors of EXFO, dated September 1, 1999,
authorizing EXFO to acquire GEXFO Distribution Internationale inc. from
GEXFO Investissements Technologiques inc. (including summary in
English) (incorporated by reference to Exhibit 10.10 of EXFO's
Registration Statement on Form F-1, File No. 333-38956).
4.16 Form of Promissory Note of EXFO issued to GEXFO Investissements
Technologiques inc. dated June 27, 2000 ) (incorporated by reference to
Exhibit 10.12 of EXFO's Registration Statement on Form F-1, File No.
333-38956).
4.17 Term Loan Offer, dated March 28, 2000, among EXFO and National Bank of
Canada as accepted by EXFO on April 3, 2000 (including summary in
English) (incorporated by reference to Exhibit 10.11 of EXFO's
Registration Statement on Form F-1, File No. 333-38956).
4.18 Employment Agreement of Germain Lamonde dated May 29, 2000
(incorporated by reference to Exhibit 10.15 of EXFO's Registration
Statement on Form F-1, File No. 333-38956).
4.19 Employment Agreement of Bruce Bonini dated as of September 1, 2000
(incorporated by reference to Exhibit 4.24 of EXFO's annual report on
Form 20-F dated January 18, 2002).
4.20 Employment Agreement of Juan-Felipe Gonzalez dated as of September 1,
2000 (incorporated by reference to Exhibit 4.25 of EXFO's annual report
on Form 20-F dated January 18, 2002).
4.21 Employment Agreement of David J. Farrell dated as of December 20, 2000
(incorporated by reference to Exhibit 4.26 of EXFO's annual report on
Form 20-F dated January 18, 2002).
4.22 Deferred Profit Sharing Plan, dated September 1, 1998 (incorporated by
reference to Exhibit 10.6 of EXFO's Registration Statement on Form F-1,
File No. 333-38956).
4.23 Stock Option Plan, dated May 25, 2000 (incorporated by Reference to
Exhibit 10.7 of EXFO's Registration Statement on Form F-1, File No.
333-38956).
4.24 Share Plan, dated April 3, 2000 (incorporated by reference to Exhibit
10.8 of EXFO's Registration Statement on Form F-1, File No. 333-38956).
4.25 Directors' Compensation Plan (incorporated by reference to Exhibit
10.17 of EXFO's Registration Statement on Form F-1, File No.
333-38956).
4.26 Restricted Stock Award Plan, dated December 20, 2000 (incorporated by
reference to Exhibit 4.21 of EXFO's annual report on Form 20-F dated
January 18, 2001).
4.27 Asset Purchase Agreement by and Among EXFO Electro-Optical Engineering
Inc., EXFO Gnubi Products Group Inc., gnubi communications, L.P., gnubi
communications General Partner, LLC, gnubi communications Limited
Partner, LLC, gnubi communications, Inc., Voting Trust created by The
Irrevocable Voting Trust Agreement Among Carol Abraham Bolton, Paul
Abraham and James Ray Stevens, James Ray Stevens and Daniel J. Ernst
dated September 5, 2002 (incorporated by reference to Exhibit 4.30 of
EXFO's annual report on Form 20-F dated January 15, 2003).
4.28 EXFO Protocol Inc. Executive Employment Agreement with Sami Yazdi
signed November 2, 2001 (incorporated by reference to Exhibit 4.28 of
EXFO's annual report on Form 20-F dated January 15, 2003).
4.29 Second Amending Agreement to the Employment Agreement of Bruce Bonini
dated as of September 1, 2002, (incorporated by reference to Exhibit
4.29 of EXFO's annual report on Form 20-F dated January 15, 2004).
4.30 Severance and General Release Agreement with Bruce Bonini dated August
8, 2003, (incorporated by reference to Exhibit 4.30 of EXFO's annual
report on Form 20-F dated January 15, 2004)..
4.31 Separation Agreement and General Release with Sami Yazdi dated April 1,
2003, (incorporated by reference to Exhibit 4.31 of EXFO's annual
report on Form 20-F dated January 15, 2004).
4.32 Executive Employment Agreement of James Stevens dated as of October 4,
2003, (incorporated by reference to Exhibit 4.32 of EXFO's annual
report on Form 20-F dated January 15, 2004).
4.33 Termination Terms for John Holloran Jr. dated May 28, 2003,
(incorporated by reference to Exhibit 4.33 of EXFO's annual report on
Form 20-F dated January 15, 2004).
4.34 Employment Agreement of Pierre Plamondon dated as of September 1, 2002,
(incorporated by reference to Exhibit 4.34 of EXFO's annual report on
Form 20-F dated January 15, 2004).
8.1 Subsidiaries of EXFO (list included in Item 4C of this annual report).
11.1 Code of Ethics for senior financial officers, (incorporated by
reference to Exhibit 11.1 of EXFO's annual report on Form 20-F dated
January 15, 2004).
12.1 Certification of the Chief Executive Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
12.2 Certification of the Chief Executive Officer Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
13.1 Certification of the Chief Financial Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
13.2 Certification of the Chief Financial Officer Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.