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, 2005; or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period ________ to ________; or
[_] SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Date of event requiring this shell company report.......
FOR THE TRANSITION PERIOD FROM SEPTEMBER 1, 2004 TO AUGUST 31, 2005
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 November 1, 2005, the registrant had 30,672,617 Subordinate Voting
Shares outstanding.
Indicate by check mark whether the registrant (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 the
registrant 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 the registrant has
elected to follow:
Item 17 [ ] Item 18 [X]
If this is an annual report, indicate by check mark whether the registrant is
a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [_] No [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. We undertake no
obligation to revise or update any of them to reflect events or circumstances
that may occur 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, 2001 and 2002 and the consolidated balance sheets data as at August
31, 2001, 2002 and 2003 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, 2003, 2004 and 2005
and the consolidated balance sheets data as at August 31, 2004 and 2005 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 21 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 periods.
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,
----------------------------------------------------------
2005 2004 2003 2002 2001
---- ---- ---- ---- ----
(IN THOUSANDS OF US DOLLARS, EXCEPT SHARE AND PER SHARE
DATA)
CONSOLIDATED STATEMENTS OF EARNINGS DATA:
AMOUNTS UNDER CANADIAN GAAP
Sales.................................................. $ 97,216 $ 74,630 $ 61,930 $ 68,330 $ 146,013
Cost of sales (1) ..................................... 44,059 34,556 36,197 52,366 56,207
---------- ---------- ---------- ---------- ----------
Gross margin........................................... 53,157 40,074 25,733 15,964 89,806
---------- ---------- ---------- ---------- ----------
Operating expenses
Selling and administrative............................. 31,782 25,890 26,991 33,881 44,975
Net research and development........................... 12,190 12,390 15,879 12,782 13,601
Amortization of property, plant and equipment.......... 4,256 4,935 5,210 5,096 3,267
Amortization of intangible assets...................... 4,836 5,080 5,676 12,451 10,168
Impairment of long-lived assets and goodwill........... -- 620 7,427 23,657 --
Restructuring and other charges........................ 292 1,729 4,134 2,880 3,288
---------- ---------- ---------- ---------- ----------
Total operating expenses............................... 53,356 50,644 65,317 90,747 75,299
---------- ---------- ---------- ---------- ----------
Earnings (loss) from operations........................ (199) (10,570) (39,584) (74,783) 14,507
Interest and other income.............................. 2,524 1,438 1,245 1,456 6,098
Foreign exchange gain (loss) .......................... (1,336) (278) (1,552) (458) 3,327
---------- ---------- ---------- ---------- ----------
Earnings (loss) before income taxes and amortization
and write-down of goodwill......................... 989 (9,410) (39,891) (73,785) 23,932
Income taxes........................................... 2,623 (986) 15,059 (25,451) 8,150
---------- ---------- ---------- ---------- ----------
Earnings (loss) before amortization and write-down of
goodwill......................................... (1,634) (8,424) (54,950) (48,334) 15,782
Amortization of goodwill...............................
-- -- -- 38,021 31,076
Write-down of goodwill.................................
-- -- -- 222,169 --
---------- ---------- ---------- ---------- ----------
Net loss for the year.................................. $ (1,634) $ (8,424) $ (54,950) $ (308,524) $ (15,294)
========== ========== ========== ========== ==========
Basic and diluted net loss per share................... $ (0.02) $ (0.13) $ (0.87) $ (5.09) $ (0.29)
Basic weighted average number of shares used in per
share calculations (000's)......................... 68,526 66,020 62,852 60,666 53,014
OTHER CONSOLIDATED STATEMENTS OF EARNINGS DATA:
Gross research and development......................... $ 15,878 $ 15,668 $ 17,133 $ 17,005 $ 17,601
Net research and development........................... $ 12,190 $ 12,390 $ 15,879 $ 12,782 $ 13,601
AMOUNTS UNDER U.S. GAAP
Net loss for the year.................................. $ (2,920) $ (9,571) $ (48,201) $ (382,893) $ (29,478)
Basic and diluted net loss per share................... $ (0.04) $ (0.14) $ (0.77) $ (6.31) $ (0.56)
Basic weighted average number of shares used in per
share calculations (000's)......................... 68,526 66,020 62,852 60,666 53,014
AS AT AUGUST 31,
-----------------------------------------------------------
2005 2004 2003 2002 2001
---- ---- ---- ---- ----
(IN THOUSANDS OF US DOLLARS)
CONSOLIDATED BALANCE SHEETS DATA:
AMOUNTS UNDER CANADIAN GAAP
Cash................................................... $ 7,119 $ 5,159 $ 5,366 $ 9,128 $ 7,729
Short-term investments................................. 104,883 83,969 52,010 40,553 66,861
Working capital........................................ 135,288 115,141 76,659 91,374 130,289
Total assets........................................... 190,957 172,791 146,254 177,926 442,577
Long-term debt (excluding current portion) ............ 198 332 453 564 664
Share capital.......................................... 521,875 521,733 492,452 489,611 429,995
Shareholders' equity................................... $ 173,400 $ 157,327 $ 129,826 $ 165,406 $ 414,805
AMOUNTS UNDER U.S. GAAP
Cash................................................... $ 7,119 $ 5,159 $ 5,366 $ 9,128 $ 7,729
Short-term investments................................. 104,883 83,969 52,010 40,553 66,861
Working capital........................................ 138,225 117,116 78,225 91,305 129,987
Total assets........................................... 182,852 164,758 138,020 161,314 499,436
Long-term debt (excluding current portion) ............ 198 332 453 564 664
Share capital.......................................... 597,664 596,309 565,291 560,943 498,121
Shareholders' equity................................... $ 165,295 $ 149,294 $ 121,592 $ 150,999 $ 471,117
------------------------
(1) The cost of sales is exclusive of amortization, shown below. Includes inventory write-offs of nil, nil,
$4,121,000, $18,463,000 and nil for the years ended August 31, 2005, 2004, 2003, 2002 and 2001, respectively,
and an unusual gain of $473,000 for the year ended August 31, 2003.
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B. CAPITALIZATION AND INDEBTEDNESS
Not Applicable.
C. REASONS FOR THE OFFER AND USE OF PROCEEDS
Not Applicable.
D. RISK FACTORS
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 - namely designing,
manufacturing, selling 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 life sciences and
industrial solutions is very competitive. We anticipate the pace of change to
remain high or even accelerate for our targeted industries in the future. We
might see the emergence of new competitors or the consolidation of current
competitors, as the markets for telecommunications test and measurement
equipment as well as for life sciences and industrial solutions might evolve
in response to technical innovations and economic conditions. Surpassing our
key performance indicator of 15% sales growth in fiscal 2006 will largely
depend on our ability to gain market share by increasing sales of current
products to existing accounts, expanding into new accounts, introducing new
products and product enhancements, and exploiting new market opportunities.
During the past year, the telecommunications test and measurement
industry witnessed consolidation. Anritsu Corporation announced the
acquisition of NetTest A/S in August 2005 and JDS Uniphase Corporation (JDSU)
completed its acquisition of Acterna Corporation during the same month.
Agilent Technologies Inc., meanwhile, announced it was divesting itself of its
semiconductor division to refocus its efforts on test and measurement. With
the exception of JDSU (which also sells optical components), these competitors
are global test and measurement vendors who complement their broad range of
products with telecommunications test and measurement equipment. Similarly,
ANDO Corporation and Tektronix, Inc. are global test and measurement vendors
who compete against us. Other competitors, such as Digital Lightwave Inc.,
IXIA and Sunrise Telecom Inc., compete against us in niche markets. Some
competitors in both groups may have greater financial, technical and/or
marketing resources than us. Consequently, they may be able to devote greater
resources to the development, marketing, manufacturing, selling and support of
their products in order to capture market share.
Competitors also may be better positioned than us to capture market
share or 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.
4
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 to some extent our exposure to
currency risk with forward exchange contracts and certain operating expenses
denominated in currencies other than the Canadian dollar, 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 October 31, 2005, the
Canadian dollar increased approximately 7.5% versus the US dollar and
decreased 1.6% versus the Euro, compared to October 31, 2004. 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.
A CUSTOMER HAS ACCOUNTED FOR A HIGH PERCENTAGE OF OUR SALES IN THE
PAST TWO YEARS, AND ANY ADVERSE FACTOR AFFECTING THIS CUSTOMER OR OUR
RELATIONSHIP WITH THIS CUSTOMER COULD CAUSE OUR SALES TO DECREASE.
Although customer base has been well diversified on a historical
basis, a Tier-1 carrier in the US accounted for 23.3% of our sales in fiscal
2005 and 13.8% in fiscal 2004. Even if this customer has a supply contract
with us, it could change its purchasing practice, force us to renegotiate
prices and is not obligated to purchase a specific amount of products from us
or provide us with binding purchase forecasts for any period. In addition, our
customers typically purchase our products under individual purchase orders and
may cancel or defer purchases on short notice without significant penalties.
The loss of such a customer or the reduction, delay, or cancellation
of orders from this customer or other significant customers could cause our
sales and, therefore, net earnings to decline.
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 may be 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 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.
5
We continued implementing measures to protect our gross margin, which
reached 54.7% of sales in fiscal 2005 compared to 53.7% in fiscal 2004,
despite the negative impact of the exchange rate between US and Canadian
currencies. 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 Large customers, who buy in high volumes, can exert substantial
negotiating leverage over us;
o Resale of used equipment; and
o Equipment sales resulting from manufacturing and rental company
bankruptcies.
In addition, gross margins may also be negatively affected by
increased costs of raw materials as well as obsolescence and excess costs,
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 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.
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The occurrence of any one or more of the foregoing could seriously
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 carefully seek 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. Our
competitors may be in a better position 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 an acquisition.
We have made strategic acquisitions in the past and we intend to
continue making acquisitions of businesses, products and technologies as part
of our overall growth strategy. In the event of any future acquisition, we
could:
o Issue shares that would dilute individual shareholder percentage
ownership;
o Incur debt;
o Assume liabilities and commitments;
o Incur significant expenses related to amortization of additional
intangible assets;
o Incur significant impairment losses of goodwill and intangible assets
related to such acquisitions; and
o Incur losses from operations.
These acquisitions also involve numerous risks, including:
o Risk of not realizing the expected benefits or synergies of such
acquisition;
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.
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 the integration process takes longer than expected
7
or if we fail to integrate the businesses, we may not be able to realize the
benefits and synergies that we expect from these transactions and may be
required to shut down, rationalize or exit such activities.
All of these factors could materially harm our business, results of
operations and financial condition.
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 product launches and market acceptance of new products for
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 Losing 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 life sciences and industrial 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 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 factors, you should not rely on quarter-to-quarter comparisons of our
results of operations as an indication of our future performance.
8
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.
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, 2005, customers outside of the
United States and Canada accounted for 35.1% of our sales. Our international
sales will be limited if we cannot establish relationships with international
distributors, set up additional foreign operations, expand international sales
channel management, hire additional personnel, develop relationships with
international service providers and operate adequate after-sales support
internationally. Even if we are able to successfully continue our
international operations, we may not be able to maintain or increase
international market demand for our products. Our international operations are
subject to a number of risks, including:
o Challenges in staffing and managing foreign operations due to the
limited number of qualified candidates, employment laws and practices
in foreign countries, any of which could increase the cost and reduce
the efficiency of operating in foreign countries;
o 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;
9
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 AND ORGANIZATION 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 technical
regulations applicable in a given country are in any way changed - such as
those prescribed by the European Union for the disposal of electrical and
electronic equipment (Waste Electrical and Electronic Equipment or WEEE) - 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.
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 an annual strategic business plan, which is prepared by
management and approved by our Board of Directors. This strategic plan,
reviewed by management on a regular basis, is mainly based on market research
and analysis related 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.
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.
We implemented a number of restructuring plans during the telecom
downturn to re-align our cost structure to existing market conditions. Such
plans and, if needed, subsequent plans 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
10
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.
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. 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.
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 which 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.
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. If
we underestimate our requirements, we may have an inadequate inventory of
parts, which could interrupt manufacturing of our products and result in
shipment delays. In addition, lead times for materials and parts that we order
may be long and depend on factors such as the procedures of, or supply terms
with, a specific supplier and demand for each part at a given time.
WE DEPEND ON A SINGLE SUPPLIER OR A LIMITED NUMBER OF SUPPLIERS FOR
SOME KEY COMPONENTS AND MATERIALS IN OUR PRODUCTS, WHICH MAKES US SUSCEPTIBLE
TO SUPPLY SHORTAGES OR PRICE FLUCTUATIONS THAT COULD ADVERSELY AFFECT OUR
OPERATING RESULTS.
11
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.
RECENTLY ENACTED REGULATORY CHANGES MAY CAUSE US TO INCUR INCREASED
COSTS.
Recently enacted 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 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 external auditor to attest to, our internal controls over
financial reporting. 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
changes 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.
In March 2005, foreign issuers, such as us, were given an extra
year's grace by the Securities and Exchange Commission to comply with Section
404 of Sarbanes-Oxley, which means August 31, 2006 for EXFO. 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 external auditors may not be able to provide an
unqualified attestation report under Section 404 of Sarbanes-Oxley, as
amended.
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.
12
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, contract wins with major customers or new product introductions, or
caused by our competitors, changes in analysts' ratings, or the liquidity of
our stock. Fluctuations in stock price may also be due to factors related to
the global telecommunications industry or the securities markets in general.
These fluctuations have often been unrelated or disproportionate to the
operating performance of the specific companies whose stocks are traded. These
broad market and industry factors may have a material adverse effect on the
market price of our securities, regardless of our actual operating
performance. Shareholders should be willing to incur the risk of such
fluctuations.
WE REQUIRE EMPLOYEES WHO ARE KNOWLEDGEABLE ABOUT THE SPECIALIZED
NATURE OF OUR BUSINESS. IF WE ARE UNABLE TO ATTRACT AND RETAIN SUFFICIENT
NUMBERS OF HIGHLY SKILLED TECHNICAL, SALES, MARKETING, 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 life sciences and industrial 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 32 U.S., six Canadian, six European and one Chinese-issued
patents and have 15 U.S., 14 Canadian and one European patent applications
pending, along with two patent applications pending under the Patent
Cooperation. 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 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, cable
operators and manufacturers of optical networks and components ensure network
reliability. We also leverage our core telecom technologies for life sciences
14
and industrial 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.
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, we are 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 23.2% of our gross research and development expenses for the year
ended August 31, 2005.
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
16
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 November 1, 2005, Germain Lamonde, our Chairman of the Board,
President and Chief Executive Officer, held 92.54% of the voting rights in our
stock. By virtue of such stock ownership, Mr. Lamonde has effective control
over all matters submitted to our stockholders, including the election of our
Directors, and exercises significant control over our policies and affairs.
Such concentration of voting power could have the effect of delaying,
deterring or preventing a change in control or other business combinations
that might otherwise be beneficial to our stockholders.
WE MAY NEED ADDITIONAL CAPITAL, AND MAY NOT BE ABLE TO RAISE
ADDITIONAL CAPITAL ON FAVORABLE TERMS OR AT ALL, WHICH COULD LIMIT OUR ABILITY
TO GROW AND COULD INCREASE OUR COSTS.
Our future liquidity and capital requirements are difficult to
predict because they depend on numerous factors, including the success of our
existing and new product offerings as well as competing technological and
market developments. As a result, we may not be able to generate sufficient
cash flows 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 operations 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.
16
ITEM 4. INFORMATION ON THE COMPANY
A. HISTORY AND DEVELOPMENT OF THE COMPANY
Our legal name and commercial name is EXFO Electro-Optical
Engineering Inc. /EXFO Ingenierie electro-optique inc. Our head office is
located at 400 Godin Avenue, Vanier, Quebec, Canada, G1M 2K2 and our main
telephone number is (418) 683-0211. Our e-mail address is info@exfo.com and
our website is www.exfo.com. Information on our website 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. Our
Transfer Agents and Registrars is CIBC Mellon Trust Company, 2001 University
Street, Suite 1600, Montreal, Quebec, Canada, H3A 2A6. This annual report
contains trademarks and registered trademarks of us 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 legal and corporate names and our share
capital.
On December 20, 2000, we acquired all of the shares 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 US$189.3 million, comprised of 6,488,816 of our
subordinate voting shares and US$42.5 million in cash pursuant to the terms of
an Agreement of Merger and Plan of Reorganization among us, EXFO Sub, Inc. and
the selling shareholders, dated November 4, 2000, as amended on December 20,
2000. In April 2002, the name of Burleigh Instruments, Inc. was changed to
EXFO Burleigh Products Group Inc. On November 12, 2002, Burleigh Instruments
(UK) Ltd. was dissolved. EXFO Burleigh is a U.S. company, which was
manufacturing precision scientific instruments used in basic and applied
research engineering and production test applications in a variety of fields.
On March 15, 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 November 1 2005, 15 patents
and 12 patents pending.
Also on March 16, 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 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
17
comprehensive solution for the assembly, alignment and testing of optical
components and subsystems. Since September 2001, Burleigh Automation has
ceased operations and we have transferred all material intellectual property
assets and most of the physical assets of Burleigh Automation to EXFO
Burleigh.
In November 2001, we acquired all of the shares of Avantas Networks
Corporation and simultaneously changed the name of that company to EXFO
Protocol Inc. ("EXFO Protocol"). We paid a total consideration of 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.
During fiscal 2001, we were forced to align our cost structure to
market conditions. On June 27, 2001, we announced the reduction of
non-customer-related expenses, postponement of plans to build a new facility
in the Quebec Metro High-Tech Park, termination of non-cure operations of
Nortech, a subsidiary that specialized in manufacturing fiber-optic
temperature sensors, and reduction of our work force by 15%.
During fiscal 2002, 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 eighteen (18) months. 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 provided for an additional funding of US$1.7
million and extended 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.
Furthermore, 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.
During fiscal 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 US$4.1 million. The rationalization and consolidation initiatives involved
the reorganization of our business into two new reportable market segments:
18
Telecom Division and Photonics and Life Sciences Division and the exiting of
the optical component manufacturing automation business. Our Telecom Division
consists of the former Portable and Monitoring and telecom related Industrial
and Scientific product lines. Our Photonics and Life Sciences Division
includes previous non-telecom Industrial and Scientific product lines. Each
division has been structured with its own sales, marketing, manufacturing,
research and development and management teams.
In May 2003, we performed our annual impairment test on goodwill
recorded in conjunction with the acquisitions 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$4.5 million to write down goodwill and
a pre-tax charge of US$2.9 million to write down acquired core technology. Of
the total impairment loss of US$7.4 million, US$6.9 million is related to EXFO
Burleigh for goodwill and acquired core technology and US$0.6 million 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).
Furthermore in fiscal 2004, we 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.
During fiscal 2005, our Photonics and Life Sciences Division was
renamed the Life Sciences and Industrial Division to better reflect its market
focus.
Finally, during fiscal 2005, we completed the consolidation of our
Life Sciences and Industrial Division in Toronto and we recorded $482,000 in
restructuring expenses. Altogether, we incurred $2.5 million in restructuring
and other charges since the fourth quarter of 2004 in conjunction with this
consolidation process. Following this process all of the operating activities
of EXFO Burleigh were transferred mainly in Toronto.
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 a complete range of dedicated and integrated test
19
solutions to network service providers (NSPs), cable operators, system vendors
and component manufacturers in approximately 70 countries. One of our strong
competitive advantages is our modular test platform design - based on a
PC/Windows-centric architecture - which offers a series of test modules that
maximize technology reuse across multiple market segments at minimal redesign
cost. The Life Sciences and Industrial Division, formerly called 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.
We were founded in 1985 in Quebec City, Canada. Our original products
were focused on the needs of installers and operators of fiber-optic networks.
Customers use these field-portable testing products for the installation,
maintenance, monitoring and troubleshooting of optical networks. In 1996, we
supplemented our product portfolio with an extensive line of high-end products
that are mainly dedicated to research and development as well as manufacturing
activities of optical component manufacturers and system vendors.
In the last four years, we have enhanced our competitive position
through the acquisition of two protocol test businesses in order to expand our
product offering and address our customers' requirements more completely. In
November 2001, we acquired Avantas Networks Corporation (renamed EXFO Protocol
Inc.), a supplier of protocol-testing and optical-network performance
management equipment for NSPs. This transaction was highly strategic because
it enabled us to combine optical and protocol test modules inside a single
field-portable test platform to help our customers increase revenues and
reduce operating costs. In October 2002, our wholly-owned subsidiary, EXFO
Gnubi, purchased substantially all the assets of gnubi communications, L.P., a
supplier of multi-channel telecom and datacom testing solutions for the system
manufacturer market. These strategic acquisitions, which were consolidated in
Montreal in fiscal 2004, enabled us to more than double our addressable
market, as we expanded from optical testing to protocol testing applications,
and to offer a more complete line of test solutions to our customers.
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.
In fiscal 2005, we launched 15 new products, including a
next-generation SONET/SDH analyzer for characterizing converged, IP-based
networks; a 10 Gigabit Ethernet (GigE) test solution to assess quality of
service in core and metro networks; a new software suite for remote Ethernet
testing and commissioning applications; an all-band component analyzer for
FTTx and coarse wavelength-division multiplexing (CWDM) applications in the
manufacturing/R&D market; a series of three handheld test instruments for the
installation and maintenance market; and an optical spectrum analyzer (OSA)
for CWDM applications in metro and access networks. In addition, we formed an
alliance with ADC Telecom to provide a unique remote Ethernet test solution
for first-mile applications.
In 2005, we also consolidated our leadership position in the FTTx
test market by recognizing significant revenue from two leading carriers in
the United States deploying fiber in their access networks. Our top customer
accounted for 23.3% of sales in 2005. Subsequent to the year-end, we were
20
selected as sole-source supplier for all fiber deployment test applications by
Deutsche Telecom AG - including FTTx.
We recorded a foreign exchange loss of $1.3 million in fiscal 2005
due to the significant increase in the value of the Canadian dollar versus the
US dollar during that year. In addition to this foreign exchange loss, our P&L
(profits and losses) line items in 2005 were also negatively affected by the
appreciation of the Canadian dollar, since a significant portion of our
expenses are incurred in Canadian dollars while we report our results in US
dollars.
In the third quarter of fiscal 2005, EXFO was named recipient of the
2005 Growth Strategy Leadership Award by Frost & Sullivan, a leading market
research firm in the telecommunications test sector. The award is presented
annually to the company whose visionary growth strategy generates the largest
market-share gains in the global fiber-optic test equipment market in the
previous year. Based on a report by Frost & Sullivan, we increased our market
share from 8.4% in 2003 to 10.3% in 2004. This marked the second consecutive
year that we earned this industry award.
Finally, during fiscal 2005, we completed the consolidation of our
Life Sciences and Industrial Division in Toronto and we recorded $482,000 in
restructuring expenses. Altogether, we incurred $2.5 million in restructuring
and other charges since the fourth quarter of 2004 in conjunction with this
consolidation process.
INDUSTRY OVERVIEW
Leading telecom operators (telcos), mostly in the United States,
accelerated fiber deployments deeper in their access networks during the last
year because of competition from cable TV operators (cablecos) to offer
consumers bundled voice, data and video services. This broadband competition
between telcos and cablecos contributed to an increase in wireline capital
expenditures in 2005, especially in the United States.
Leading US telcos, along with a number of Tier-II and Tier-III
players, opted for an assortment of deployment strategies, including
fiber-to-the-node (FTTN), fiber-to-the-curb (FTTC), fiber-to-the-home (FTTH)
or its equivalent fiber-to-the premises (FTTP), depending on their estimates
of how much bandwidth will be required to meet the challenge from the
cablecos. These deployments, which fall under the generic FTTx name, are not
as prevalent in Europe and Asia. However, test trials are underway in these
regions as a means to increase revenues by delivering video services to
undercut competition. Note that Japan and Korea already have FTTx deployment
programs, aimed at delivering 100 Mb/s to every home, well underway.
As the demand for broadband services increases worldwide, voice, data
and video are becoming mere applications on converged, IP-based networks.
Telcos around the world are migrating from public switched telephone networks
(PSTN) to packet-based, IP networks in order to achieve substantial reductions
in operating expenses and increased profitability. British Telecom Group, for
example, announced it will spend (British Pound)10 billion over five years on
its 21st Century Network to reduce operating expenses by up to (British
Pound)1.0 billion per year through a single network carrying voice, data and
video signals.
Legacy SONET/SDH networks were designed in the late 1970s to carry
voice traffic. Their efficiency however can often times drop to as low as 30%
when combining voice, data and video services. Next-generation networks, such
as those announced by British Telecom, represent a major technological
improvement, since they can deliver triple-play services at near 100%
21
efficiency, regardless of the payload content, while significantly reducing
the cost of operating and maintaining networks.
These key market trends affected multiple segments of the global
telecommunications supply chain in 2005. System manufacturers benefited from
orders by both telcos and cablecos for next-generation, converged IP networks
as well as from major investments by telcos in access networks. Component
vendors saw incremental demand for optical components that support FTTx and
IP-based systems. Some test and measurement equipment vendors attracted the
attention of telcos, cablecos, system manufacturers and component vendors,
especially ones offering test solutions for IP optical networking and/or FTTx
applications.
KEY INDUSTRY TRENDS AND STRATEGY
As a market-driven company, we try to identify the key industry
trends in order to leverage technological discontinuities and convert them
into value-creating market opportunities. Following are key market trends for
fiscal 2006 and beyond and how we intend to take advantage of them.
BROADBAND COMPETITION LEADING TO ACCESS INVESTMENTS
Intense competition between telcos and cablecos continues unabated in
North America. Both industries are competing to increase revenue and
profitability through bundled offerings, while reducing churn. This broadband
competition is prompting massive capital investments in access networks in
order to increase bandwidth, flexibility and scalability, while continuing
metro ring expansion. Telcos are deploying fiber-to-the-node (FTTN; ~20 Mb/s),
fiber-to-the-curb (FTTC; ~40 Mb/s) or fiber-to-the-premises (FTTP; ~100 Mb/s),
depending on estimates of which video compression techniques will be adopted
and how much bandwidth will be required to meet the challenge from the
cablecos (~40 Mb/s). The closer the fiber is to the premises and the higher
the transmission rates, the better it is for EXFO, which offers the most
comprehensive line of FTTx test solutions on the market. Following agreements
with Verizon and SBC Communications, we are increasingly leveraging our
leadership in passive optical network (PON) testing and broad portfolio of
FTTx-ready technologies outside North America, given our long-established
customer relationships in Europe and Asia. We are participating in several
FTTx trials worldwide and recently were selected as sole-source supplier for
all fiber deployment test applications by Deutsche Telecom AG - including
FTTx. While our FTTx market penetration was excellent in 2005, we believe this
is just the beginning of a long-term deployment trend.
MIGRATION TOWARDS CONVERGED, IP-BASED NETWORKING
Network operators around the world are migrating from public switched
telephone networks (PSTN) to packet-based, Internet protocol (IP) networks in
order to achieve substantial reductions in operating expenses and increased
profitability. For example, British Telecom Group announced it will spend
(British Pound)10 billion over five years on its 21CN initiative (21st Century
Network) to reduce operating expenses by up to (British Pound)1 billion per
year, while enabling revenue expansion into differentiated, higher-margin new
services - all thanks to a single network carrying voice, data and video
signals.
Legacy SONET/SDH networks were designed in the late 1970s to optimize
voice traffic, but they can drop to 30% efficiency when data and video
applications are added. Next-generation networks, such as those announced by
British Telecom, represent a major technological improvement, since they can
deliver triple-play services at almost 100% efficiency while significantly
22
reducing operating and maintenance costs.
Anticipating this market opportunity, we shifted our focus from
legacy SONET/SDH and Ethernet technologies to next-generation protocol test
solutions aimed at the deployment of converged, IP-based networks. Product
launches in 2005 included a next-generation SONET/SDH analyzer, featuring the
latest in generic framing procedure (GFP), virtual concatenation (VCAT) and
link-capacity adjustment scheme (LCAS); a 10 Gigabit Ethernet (GigE) test
solution, a remote Ethernet tester to ensure quality of service (QoS); and
additional Ethernet test capabilities to help carriers operate their
high-performance core, metro and edge networks. We also formed an alliance
with ADC Telecom to provide a unique remote Ethernet test solution for
first-mile applications. Subsequent to the year-end, we launched 10 GigE and
Fibre Channel test solutions for the system vendor market.
Given the protocol test market is significantly larger than the
optical test market, our rich product pipeline in protocol testing, and four
consecutive quarters of sales growth in protocol testing with the last quarter
exceeding 10% of Telecom Division revenues, we have high expectations for this
product line. We expect that protocol sales will outgrow optical sales to
eventually account for 50% of our Telecom Division revenues, even though our
optical segment will continue to increase.
On the life sciences and industrial side:
Fluorescence imaging is one of the fastest-growing segments of the
microscope industry. To take advantage of this market opportunity, we have
partnered with major microscope manufacturers in the last two years to deliver
the leading fluorescence illumination system in North America. We're now
seeking similar penetration in Europe and Asia through regional partnerships
with microscope manufacturers.
The aging baby-boomer market is placing stringent demands on
manufacturers of medical equipment for devices like in-vitro balloon
catheters, hearing aids and asthma inhalers. Similarly, high-tech consumers
are pushing for the continued miniaturization of devices such as digital
cameras, personal digital assistants (PDAs) and cellular phones. Given the
demand for higher volumes and miniature sizes, manufacturers of medical and
electronic devices are requiring exceptional control and repeatability for
their precision assembly applications. EXFO has responded to this dual trend
by bringing to market an automated spot-curing platform that can be controlled
via a personal computer.
KEY PERFORMANCE INDICATORS FOR FISCAL 2006
As expected, our strategic directions for fiscal 2006, and
consequently our key performance indicators (KPIs), will not be radically
different from those in 2005. Since we are highly focused on creating value
for our shareholders, delivering the highest level of profitable growth is at
the heart of our actions. We intend to:
o INCREASE SALES MORE THAN 15% YEAR-OVER-YEAR MAINLY THROUGH
MARKET-SHARE GAINS. To achieve this goal, we intend to exploit
the aforementioned market opportunities (See "Key Industry
Trends and Strategy") and concentrate on solid execution.
23
o GENERATE MORE THAN 5% IN EARNINGS FROM OPERATIONS. Higher sales
volumes, increased contribution from higher-margin protocol test
solutions, improved operating efficiencies and continued cost
controls should help us reach our objective. This metric assumes
no significant currency fluctuations nor closed acquisitions in
fiscal 2006. If an acquisition is completed in 2006, this metric
will be revised accordingly.
o DERIVE AT LEAST 40% OF SALES FROM PRODUCTS ON THE MARKET TWO
YEARS OR LESS. At EXFO, we remain attuned to customer and market
requirements, not to technology for the sake of it. This
ambitious innovation target is fully aligned with our
fundamental goals of differentiating ourselves from the
competition, increasing market share and revenue, as well as
improving gross margin and profitability.
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 20 years. In fact, we
believe this attribute represents a key differentiator for us within a
competitive marketplace. Following are some of our industry firsts:
24
o The first PC-based modular test platform for field applications;.
o The first all-in-one optical loss test set combining several
instruments;.
o The first portable polarization mode dispersion (PMD) analyzer;
o The first modular platform to combine optical and protocol test
solutions; and
o The first line of portable test instruments designed for FTTx
testing.
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, received ISO 9001/2000 certification on November 16, 2005.
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.
Our product designs comply with Directive 2002/96/EC, a legislation
enacted by the European Union regarding the disposal of waste electrical and
electronic equipment (WEEE), for all products exported to Europe. In regard to
the Directive 2002/96/EC (RoHs), we and other test and measurement
manufacturers have been warranted an unlimited exemption.
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
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
UTS MODULES HANDHELDS ITS MODULES EPX MODULES INSTRUMENTS
----------- --------- ----------- ----------- -----------
Broadband source Used for testing wavelength
dependent behavior of fiber
cables and DWDM optical com-
ponents. X X
Channel selector Selects and isolates any
International Telecommunication
Union (ITU) DWDM channel in the
CBand for bit-error-rate testing X X
and protocol-layer analysis.
25
FORMAT
--------------------------------------------------------------
INSTRUMENT TYPE TYPICAL APPLICATION NSP MARKET MANUFACTURER/R&D MARKET
----------------- -------------------------------- ---------------------- -------------------------------------
FTB 400 IQS-500
UTS MODULES HANDHELDS ITS MODULES EPX MODULES INSTRUMENTS
----------- --------- ----------- ----------- -----------
Chromatic Measures increasing levels of
dispersion chromatic dispersion in high-
analyzer capacity optical networks. Chrom-
atic dispersion is a physical
phenomenon inherent to optical
fiber and optical components that
causes information bits to spread X
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.
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 timing
information and buffer credit X X
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, absolute
meter wavelength measurements of con-
tinuous wave (CW) and/or pulsed X
laser sources
Laser spectrum Performs high-resolution, spec
analyzer tral characterization of con- 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 set 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.
Multiwavelength Measures the power and drift
meter for multiple wavelengths in a X X X
DWDM system.
Narrowly tunable A laser that can be precisely
laser tuned to simulate a DWDM light
sources. Used primarily in
testing optical amplifiers. X
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
and calibration of test systems. X
Optical coupler Used in test system to combine
sources or signals. Also used X
as splitters to monitor signals.
26
FORMAT
--------------------------------------------------------------
INSTRUMENT TYPE TYPICAL APPLICATION NSP MARKET MANUFACTURER/R&D MARKET
----------------- -------------------------------- ---------------------- -------------------------------------
FTB 400 IQS-500
UTS MODULES HANDHELDS ITS MODULES EPX MODULES INSTRUMENTS
----------- --------- ----------- ----------- -----------
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 applica-
tions.
Optical power meter Measures the power of an
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 meter meter to measure the amount of
potentially degrading back X X X X
reflection.
Optical spectrum Produces a graphical
analyzer representation of power versus
wavelength for an optical
signal. Useful for measuring the
drift, power and signal-to-noise
ratio for each wavelength in a X X
DWDM system.
Optical switch Provides switching between
fibers. Used to provide
flexible and automated test
setups such as the measurement
of multiple fibers or X X
components with multiple ports
with one instrument.
Optical time Like a radar, it measures the
domain time of arrival of reflections
reflectometer of an optical signal to
(OTDR) 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
next generation networks. X
Passive component Characterizes passive
analyzer wavelength-selective devices,
such as multiplexers,
demultiplexers and add/drop
filters, with respect to
absolute wavelength in order to
guarantee their performance X
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
rates are covered, ranging from
155 Mb/s to 2.5 Gb/s, for both
synchronous and non-synchronous X
signals.
Polarization- Measures the difference in loss
dependent loss of power for the different X
meter states of polarization.
Polarization mode Measures the dispersion of
dispersion analyzer light that is caused by
polarization. Generally used to
determine the speed-distance X X
limitation of fiber and cables.
27
FORMAT
--------------------------------------------------------------
INSTRUMENT TYPE TYPICAL APPLICATION NSP MARKET MANUFACTURER/R&D MARKET
----------------- -------------------------------- ---------------------- -------------------------------------
FTB 400 IQS-500
UTS MODULES HANDHELDS ITS MODULES EPX MODULES INSTRUMENTS
----------- --------- ----------- ----------- -----------
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 source Emitting diode or lasers used
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 set 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
attenuator setups to provide calibrated
variable reduction of the X X X
strength of an optical signal.
Visual fault A visible laser that can be
locator connected to an optical fiber
network to help locate breaks X X
or points of excessive loss.
Widely tunable Can produce laser light across
laser a broad range of wavelengths.
Used to test DWDM components and X X
value-added optical modules.
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. Our portable platforms are
PC-centric, Windows-based, highly flexible and fully scalable. Their large
robust touchscreens are very practical for field use.
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.
In 2005, we launched a new family of value-added handhelds to perform
optical loss testing in the outside plant environment. Furthermore, we
expanded our OTDR product line by adding a new four-lambda OTDR to better suit
the installers' market.
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 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
28
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 2005, we introduced a new FTTH/CWDM passive component test system
that allows manufacturers to measure insertion loss (IL),
polarization-dependent loss (PDL) and optical return loss (ORL) in a single
test sequence.
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 we provide for characterizing optical components,
sub-systems and networks:
o CWDM/FTTH passive optical Used to automatically characterize
component test system all critical specifications,
including spectral insertion loss,
polarization-dependent loss and
optical return loss of a CWDM
passive component or a FTTH
splitter with a high degree of
accuracy, ease of use and speed.
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 measure-
ments with the highest degree of
accuracy and repeatability on
short fiber assemblies.
29
o Optical calibration test Used to calibrate power meters,
system light sources, variable
attenuators and optical time
domain reflectometers.
o DWDM passive component test Used to automatically characterize
system all critical specifications,
including spectral insertion loss,
polarization-dependent loss and
optical return loss of a DWDM
passive component with a high
degree of accuracy, ease of use
and speed.
PRODUCTS FOR LIFE SCIENCES AND INDUSTRIAL APPLICATIONS
Over the years, we have developed and acquired a number of core
technologies that we leverage 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, in order 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, thermal control, 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 2005, our X-Cite(TM) 120 Fluorescence Illumination System, which
offers 1,500 hours of lamp life, established itself as the leading
fluorescence microscopy solution in North America. We have created
partnerships with major microscope manufacturers, who resell this microscope
accessory to their new and installed base of customers through their own sales
channels.
On the light-based curing side, we introduced an automated
spot-curing platform, the OmniCure(TM) Series 2000 that can be controlled via
a personal computer.
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
Omnicure(R) S2000 manufacturing of 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
X-Cite(R) 120 PC to most microscopes currently sold by Nikon,
Zeiss, Olympus and Leica.
-------------------------------------------------------------------------------------------------------------
Computer Control Module ACS-1000 Electronic interface module used to connect EXFO
UV light sources to computers or computer
networks for process automation.
-------------------------------------------------------------------------------------------------------------
30
-------------------------------------------------------------------------------------------------------------
LIGHT SOURCES AND ACCESSORIES
-------------------------------------------------------------------------------------------------------------
PRODUCT TYPE PRODUCT TYPICAL APPLICATION
-------------------------------------------------------------------------------------------------------------
Optical Accessories Optional custom delivery optics used with EXFO
UV 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 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
-------------------------------------------------------------------------------------------------------------
Precise Motors/Stages IW-700 Inchworm Motors High resolution optical alignment, fiber-optic
TSE-820 Inchworm Stages alignment, semiconductor positioning, materials
UHVL Inchworm Motors research
-------------------------------------------------------------------------------------------------------------
PRECISION POSITIONING INSTRUMENTS
-------------------------------------------------------------------------------------------------------------
PRODUCT TYPE PRODUCT LINE TYPICAL APPLICATION
-------------------------------------------------------------------------------------------------------------
Micromanipulators PCS-6000 Micromanipulators Electrophysiology research such as patch clamp
PCS-5000 Micromanipulators recording 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
Manipulator and 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 Life Sciences and Industrial Division has a Director of
Research and Development. As of November 1, 2005, our research and development
departments included 188 full-time engineers, scientists and technicians, of
whom 26 hold post-graduate degrees. Gross research and development
expenditures in fiscal 2005 reached $15.9 million, compared to $15.7 million
in 2004 and $17.1 million in 2003. We launched 15 new products in fiscal 2005
compared to 20 in 2004 and 15 in 2003. Approximately 42% of sales in fiscal
2005 originated from products that have been on the market two years or less
31
compared to 32% in 2004 and 49% in 2003.
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:
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 life
science and industrial activities in Toronto, Canada. 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 life science and industrial 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 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, mechanical
design and rapid prototyping.
32
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 life science and industrial customers consist of major manufacturers of
medical devices, microelectronics, optical displays, electronic storage
systems and photonic components, as well as universities, medical schools,
governments, as well as private and industrial research laboratories. In
fiscal 2005, our top customer accounted for 23.3% of our sales and our top
three customers represented 28.4% of our sales. In comparison, our top
customer accounted for 13.8% of sales and top three customers 20.8% in 2004,
while in 2003, our top customer accounted for 9.2% of sales and our top three
customers 17.5%.
With regard to geographic distribution, sales to customers in the
Americas (US, Canada and Central & South America) represented 68% of our sales
in fiscal 2005, while sales to customers in EMEA (Europe, Middle East and
Africa) and Asia-Pacific accounted for 20% and 12% of sales, respectively. In
2004 and 2003, the sales split was 66% for the Americas, 18% for EMEA and 16%
for Asia-Pacific.
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 volumes or
might potentially represent high sales volumes in the future. These key
account managers are supplemented by regional sales managers, sales
representatives and distributors in US metropolitan areas and regional sales
managers in Canada.
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, and Quebec City, Canada. They are supplemented by a
regional presence in cities across the US 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 additional sales
offices 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 acts as a service center to better serve our customer base
33
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 a network of more than 90 distributors worldwide to work
with us in supporting mostly our international sales and to participate in 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 five regional sales Directors that are leading a widely
distributed team of more than 55 people acting as key account managers,
regional sales managers, sales engineers and application engineers. They are
located throughout major metropolitan areas around the world. This group of
sales professionals has on average more than 12 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.
The main office for our Life Sciences and Industrial Division is
located in Toronto, Canada. We use mixed sales channels to serve various
markets supported by this division, 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
distributors. The X-Cite 120 Fluorescence Illumination System is sold through
value-added reseller agreements with major microscope companies and system
integrators 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 product line and the other for our Protocol
product line - 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, strategic marketing specialists
analyze our markets, compile competitive information and identify macro-trends
in our sector.
34
Our Life Sciences and Industrial Group consists of a Director -
responsible for both life sciences and precision assembly sectors - as well
as product managers who have various degrees in engineering, science and
business administration. Product managers, under the direction of the
Director, 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
The Telecom Division's Marketing-Communications team, which consists
mainly of project managers, marketing 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. This Marketing-Communications team is also responsible for all
sales tools required by our worldwide sales force and for updating the
marketing contents of our website.
The Life Sciences & Industrial Division's Marketing-Communications
team shares a variety of marketing initiatives. This group is assisted by
product managers, who provide the technical data and collaborative support
required to produce product specification sheets, catalogues, application
notes and multimedia marketing tools. This Marketing-Communications team is
also responsible for all advertising material, Website updates, events
planning (including trade shows) and direct promotional marketing such as mass
mailings and telemarketing. This team also provides the sales tools required
by the Life Sciences and Industrial Division's worldwide sales channels,
including maintaining our elite partner program.
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 and 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 November 1, 2005, we had 250 employees involved in our manufacturing
35
operations. Most of our manufacturing activities, which occupy a total of
approximately 61,300 square feet, are spread among four buildings in three
cities.
Our Telecom Division occupies 50,000 square feet in Quebec City,
Canada, spanning two sites, 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 our Montreal site received the same certification on November 16,
2005.
o SUPPLY-CHAIN MANAGEMENT. This department is responsible for sales
forecasting, raw material procurement, material-cost reduction and
vendor performance management. Our products consist of optical,
electronic and mechanical parts, which are purchased from suppliers
around the world. Approximately one-third of our parts are
manufactured to our specifications. Materials represent the biggest
portion of our cost of goods and will continue to grow as we rely
more and more on outsourcing our manufacturing. Our performance is
tightly linked to vendor performance, requiring greater emphasis on
this critical aspect of our business.
Our Life Sciences and Industrial Division's manufacturing operations
occupy 8,000 square feet in Toronto, Canada. This group 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 ongoing
36
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;
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 Agilent Technologies, Inc., Ando Corporation, Anritsu Corporation, JDS
Uniphase Corporation, Spirent plc and Tektronix, Inc.
The second category refers to niche companies in the test and
measurement industry. 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., Ixia and Sunrise Telecom
Incorporated.
Competition for our life sciences and industrial 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
37
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 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.
In Europe, with the implementation of the WEEE directives for
recycling of electronic products in selected European Countries (2002-96-CE),
we have appointed a task force committee consisting of our management and
employees, distributors and other partners as the case may be, to ensure full
compliance with regulations and oversee the management, logistics, recycling
rate, disposal services and activities related to recycling of electronic
equipment and products within the member states.
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.
38
We currently hold 32 from U.S., six from Canada, two from Germany,
two from the United Kingdom, two from France, and one from China-issued
patents and we have 15 from U.S., 14 from Canada, two from China, one from
Germany and two 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,
2011 to October 5, 2025.
We consider eight of our inventions for which patents have either
been granted or are pending to be material. These inventions are:
o a method and apparatus for identification and characterization of
multiple fibers using an OTDR. This invention targets
fiber-to-the-home testing applications where a single technician
needs to verify that the multiple fibers in a distribution cable are
correctly identified and then measure their loss;
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, bidirectional 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 and a Chinese patent have been
granted and applications are in process in the United States, Canada,
and Europe (pursuant to PCT);
o the light-curing system with closed-loop control and work-piece
recording which is at the heart of the spot-curing systems
manufactured by EXFO Photonic Solutions and for which patents were
granted in the United States and Canada;
o Intelli-lampTM patents used in the spot curing and fluorescence
microscopy illumination systems optimize lamp performance in EXFO
Photonic Solutions 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 a number of 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.
39
C. ORGANIZATIONAL STRUCTURE
As of November 1, 2005, 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% 100% 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 Non-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 (France) (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
| Non-Operating
| / \
| -------------------------------------------
| 71.5% 100%
| ------------- -------------
| Burleigh Burleigh
| 28.5% Instruments Automaton
----------------------------------- (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, New York and are presently for sale.
In addition, we maintain sales offices and/or have regional sales
managers located in China, France, Germany, Great Britain, Italy, Japan,
Singapore 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).
40
The following table sets forth information with respect to the main
facilities that we occupy as of November 1, 2005.
LOCATION USE OF SPACE SQUARE FOOTAGE TYPE OF INTEREST
-------- ------------ -------------- ----------------
436 Nolin Street Manufacturing of telecom products 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 of Life
Science and Industrial products and
Administrative
2650 Marie-Curie Research and Development, Manufacturing 26,000 Leased
St-Laurent (Quebec) and Administrative
7647 Main Street Fishers Unoccupied 0 (2) Owned
Victor (New York)
1) 10,672 square feet have been subleased to a third party. The total square
footage leased is 36,000.
2) The total square footage owned is 40,000, is unoccupied and is presently
for sale.
41
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion and analysis of the consolidated financial
condition and results of operations of EXFO Electro-Optical Engineering Inc.
for the fiscal years ended August 31, 2003, 2004 and 2005, 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
21 to our consolidated financial statements.
The following discussion and analysis of financial condition and
results of operations is dated November 3, 2005.
INDUSTRY OVERVIEW
Leading telecom operators (telcos), mostly in the United States,
accelerated fiber deployments deeper in their access networks during the last
year because they are involved in a triple-play war (even quadruple-play with
wireless telephony) against cable TV operators (cablecos) to offer consumers
bundled voice, data and video services. This broadband war between telcos and
cablecos contributed to an increase in wireline capital expenditures in 2005,
especially in the United States.
Leading US telcos, along with a number of Tier-II and Tier-III
players, opted for an assortment of deployment strategies, including
fiber-to-the-node (FTTN), fiber-to-the-curb (FTTC), fiber-to-the-home (FTTH)
or its equivalent fiber-to-the premises (FTTP), depending on the bets they
placed in terms of how much bandwidth will be required to meet the challenge
from the cablecos. These deployments, which fall under the generic FTTx name,
are not as prevalent in Europe and Asia. However, test trials are underway in
these regions as a means to increase revenues by delivering video services to
undercut competition. Note that Japan and Korea already have FTTx deployment
programs, aimed at delivering 100 Mb/s to every home, well underway.
As the demand for broadband services increases worldwide, voice, data
and video are becoming mere applications on converged, IP-based networks.
Telcos around the world are migrating from public switched telephone networks
(PSTN) to packet-based, IP networks in order to achieve substantial reductions
in operating expenses and increased profitability. British Telecom Group, for
example, announced it will spend (British Pound)10 billion over five years on
its 21st Century Network to reduce operating expenses by up to (British Pound)
1.0 billion per year through a single network carrying voice, data and video
signals.
Legacy SONET/SDH networks were designed in the late 1970s to carry
voice traffic. Their efficiency however can often times drop to as low as 30%
when combining voice, data and video services. Next-generation networks, such
as those announced by British Telecom, represent a major technological
improvement, since they can deliver triple-play services at near 100%
efficiency, regardless of the payload content, while significantly reducing
the cost of operating and maintaining networks.
42
These key market trends affected multiple segments of the global
telecommunications supply chain in 2005. System manufacturers benefited from
orders by both telcos and cablecos for next-generation, converged IP networks
as well as from major investments by telcos in access networks. Component
vendors saw incremental demand for optical components that support FTTx and
IP-based systems. Some test and measurement equipment vendors attracted the
attention of telcos, cablecos, system manufacturers and component vendors,
especially ones offering test solutions for IP optical networking and/or FTTx
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 network service providers (NSPs), cable operators, system vendors
and component manufacturers in approximately 70 countries. One of our strong
competitive advantages is our modular test platforms design, based on a
PC/Windows-centric architecture, which offers a series of test modules that
maximize technology reuse across multiple market segments at minimal redesign
cost. The Life Sciences and Industrial Division, formerly called 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.
This year marked EXFO's 20th anniversary, as the company was founded
in 1985 in Quebec City, Canada. Our original products were focused on the
needs of installers and operators of fiber-optic networks. Customers use these
field-portable testing products for the installation, maintenance, monitoring
and troubleshooting of optical networks. In 1996, we supplemented our product
portfolio with an extensive line of high-end products that are mainly
dedicated to research and development as well as manufacturing activities of
optical component manufacturers and system vendors.
In the last four years, we have enhanced our competitive position
through the acquisition of two protocol test businesses in order to expand our
product offering and address our customers' requirements more completely. In
November 2001, we acquired Avantas Networks Corporation (renamed EXFO Protocol
Inc.), a supplier of protocol-testing and optical-network performance
management equipment for NSPs. This transaction was highly strategic because
it enabled us to combine optical and protocol test modules inside a single
field-portable test platform to help our customers increase revenues and
reduce operating costs. In October 2002, our wholly-owned subsidiary, EXFO
Gnubi, purchased substantially all the assets of GNUBI COMMUNICATIONS, L.P., a
supplier of multi-channel telecom and datacom testing solutions for the system
manufacturer market. These strategic acquisitions, which were consolidated in
Montreal in fiscal 2004, enabled us to more than double our addressable
market, as we expanded from optical testing to protocol testing applications,
and to offer a more complete line of test solutions to our customers.
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.
43
In fiscal 2005, we launched 15 new products, including a
next-generation SONET/SDH analyzer for characterizing converged, IP-based
networks; a 10 Gigabit Ethernet (GigE) test solution to assess quality of
service in core and metro networks; a new software suite for remote Ethernet
testing and commissioning applications; an all-band component analyzer for
FTTx and coarse wavelength-division multiplexing (CWDM) applications in the
manufacturing/R&D market; a series of three handheld test instruments for the
installation and maintenance market; and an optical spectrum analyzer (OSA)
for CWDM applications in metro and access networks. In addition, we formed an
alliance with ADC Telecom to provide a unique remote Ethernet test solution
for first-mile applications.
In 2005, we also consolidated our leadership position in the FTTx
test market by recognizing significant revenue from two leading U.S. carriers
deploying fiber in their access networks. Our top customer accounted for 23.3%
of sales in 2005. Subsequent to the year-end, we were supplier for all fiber
deployment test applications by Deutsche Telecom AG - including FTTx.
We recorded a foreign exchange loss of $1.3 million in fiscal 2005
due to the significant increase in the value of the Canadian dollar versus the
US dollar during that year. In addition to this foreign exchange loss, our P&L
(profits and losses) line items in 2005 were also negatively affected by the
appreciation of the Canadian dollar, since a significant portion of our
expenses are incurred in Canadian dollars while we report our results in US
dollars.
In the third quarter of fiscal 2005, EXFO was named recipient of the
2005 Growth Strategy Leadership Award by Frost & Sullivan, a leading market
research firm in the telecommunications test sector. The award is presented
annually to the company whose visionary growth strategy generates the largest
market-share gains in the global fiber-optic test equipment market in the
previous year. Based on a report by Frost & Sullivan, we increased our market
share from 8.4% in fiscal 2003 to 10.3% in 2004. This marked the second
consecutive year that we earned this industry award.
Finally, during fiscal 2005, we completed the consolidation of our
Life Sciences and Industrial Division in Toronto and we recorded $482,000 in
restructuring expenses. Altogether, we incurred $2.5 million in restructuring
and other charges since the fourth quarter of 2004 in conjunction with this
consolidation process.
SALES
We sell our products to a diversified customer base in approximately
70 countries through our direct sales force and, indirectly, through
distribution channels. Most of our sales are denominated in US dollars and
Euros.
Historically, it has been very unusual to have any customer account
for more than 10% of our sales. However, in both fiscal 2004 and 2005, we had
one customer that accounted for 13.8% and 23.3% of our sales, respectively. In
fiscal 2005, our top three customers accounted for 28.4%, compared to 20.8% in
2004. We believe the sales concentration in fiscal 2005 is largely due to our
leadership position in the FTTx test market, as a large portion of our sales
to our top customer was for a series of products related to FTTx deployment.
We expect this sales concentration to decrease in fiscal 2006, as we continue
efforts to diversify our customer base.
44
Despite the fact that we had one customer that accounted for a
substantial part of our sales in fiscal 2005, we believe that we have a vast
array of products and a diversified customer base, both in terms of industry
sector and geographical area, which provides us with reasonable protection
against concentration of sales and credit risk.
COST OF SALES
Cost of sales includes raw materials, salaries and related expenses
for direct and indirect manufacturing personnel (net of government grants) as
well as overhead costs. Excess, obsolete and scrapped materials are also
included in cost of sales. However, cost of sales is exclusive of
amortization, which is shown separately in the statements of earnings.
OPERATING EXPENSES
We classify our operating expenses into three main categories:
selling and administrative expenses, research and development expenses and
amortization expenses.
Selling and administrative expenses consist primarily of salaries and
related expenses for personnel (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 2005
In our fiscal 2004 Annual Report, we had established three strategic
objectives for fiscal 2005. We planned to increase sales through market-share
gains, maximize profitability and focus on innovation. The following section
reviews our strategic objectives for fiscal 2005 and the results achieved for
each of these objectives.
INCREASE SALES THROUGH MARKET-SHARE GAINS
In fiscal 2005, we focused on continued market-share gains to achieve
growth. We posted our second-best sales performance in history, growing sales
30.3% to $97.2 million in fiscal 2005, compared to a stated goal of 20%.
Considering that the telecommunications market slightly improved in fiscal
2005, this is a clear indication that we gained market share overall. For
45
fiscal 2005, our Telecom Division and our Life Sciences and Industrial
Division reported sales increases of 36.1% and 8.6%, respectively.
MAXIMIZE PROFITABILITY
Returning to profitability remains a top priority at EXFO. In fiscal
2005, we substantially reduced our loss from operations from $10.6 million in
fiscal 2004 to $199,000 in 2005. The loss from operations incurred in fiscal
2005 includes restructuring and other charges of $292,000, recorded in
conjunction with the consolidation of the operations of our Life Sciences and
Industrial Division and stock-based compensation costs of $963,000.
FOCUS ON INNOVATION
In fiscal 2005, innovation was a key driver at EXFO. We maintained a
significant level of research and development investments and introduced 15
new products to the marketplace. We invested $15.9 million in gross research
and development expenses, an amount similar to 2004. In fiscal 2005, 42.4% of
our sales originated from products that have been on the market for two years
or less, which is slightly below our stated goal of 45% for fiscal 2005. While
we slightly missed our target, this represents a significant improvement over
the prior year (31.7%), thanks to the 20 new products brought to the
marketplace in fiscal 2004 - several of which were released in the second half
of the fiscal year - and the 15 new ones launched in fiscal 2005.
STRATEGIC OBJECTIVES FOR FISCAL 2006
For fiscal 2006, we believe general market conditions will moderately
improve as carriers around the world will intensify triple-play investments in
an effort to bolster revenues and/or provide a defensive/offensive measure in
the telcos vs. cablecos battle to deliver video, data and voice services to
residential and business customers. This ongoing trend will prompt increased
capital expenditures (CAPEX) mainly in the access network market, likely over
several years to come. On a more global basis, the migration of these services
onto a single, IP-based network to reduce operating expenditures will
instigate increased CAPEX in the network core. On the strength of our
market-driven R&D program, we are well-positioned for these latest industry
trends.
As one might expect, our strategic directions, and therefore our key
performance indicators, will not be radically different from those of 2005.
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. 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 2006, we will continue focusing on market-share gains and
growing faster than our end markets. In fiscal 2005, our 30.3% sales growth in
a slightly increasing market condition clearly indicated that we gained market
share. As mentioned earlier, EXFO was named recipient of the 2005 Growth
Strategy Leadership Award by Frost & Sullivan.The award is presented annually
to the company whose visionary growth strategy generates the largest
market-share gains in the global fiber-optic test equipment market in the
previous year. Based on Frost & Sullivan, we increased our market share from
8.4% in fiscal 2003 to 10.3% in 2004. For fiscal 2006, we intend once again to
46
grow sales faster than the market by leveraging our sustained R&D investments
in areas such as next-generation Internet protocol (IP) and FTTx testing, by
intensifying our sales and marketing efforts, both domestic and international,
as well as by strengthening and expanding our business relationships with
major accounts.
MAXIMIZE PROFITABILITY
Profitability remains a top priority and we expect that sales growth
combined with a strong focus on operations will increase our earnings from
operations in fiscal 2006, assuming no acquisition.
FOCUS ON INNOVATION
In fiscal 2006, innovation will continue to be a major growth vehicle
for us, as it significantly drives not only revenue and profitability but also
allows us to better position ourselves in the long term. We remain convinced
that our commitment to innovation will pay off in the long term and support
our growth and profitability targets as demonstrated during the last fiscal
year. We have maintained a significant level of R&D investment since the
telecom peak in 2001 and brought 15 new products to the marketplace in fiscal
2005. Now that our net R&D investments as a percentage of sales are right in
line with our long-term model, we intend, for fiscal 2006 and beyond, to
increase our investment in R&D activities in proportion to our sales growth.
Our numerous but focused R&D initiatives should enable our new products to
continue gaining traction with customers and lead to further growth,
market-share gains and increased profitability in the coming years.
KEY PERFORMANCE INDICATORS
As measures to assess the realization of our strategic plan and its
objectives, we have set out three consolidated key performance indicators for
fiscal 2006. They are summarized as follows:
----------------------------------------------------------------------------------------
STRATEGIC OBJECTIVES FOR FISCAL 2006 KEY PERFORMANCE INDICATORS FOR FISCAL 2006
----------------------------------------------------------------------------------------
Increase sales through market-share gains 15% sales growth year-over-year
----------------------------------------------------------------------------------------
Maximize profitability 5% in earnings from operations
----------------------------------------------------------------------------------------
Focus on innovation 40% of sales from new products
(on the market two years or less)
----------------------------------------------------------------------------------------
CAPABILITY TO DELIVER RESULTS
At EXFO, we believe that we have the capabilities to deliver expected
results thanks to outstanding products, an excellent reputation in the
marketplace, a sound financial position, as well as an experienced workforce
and management team.
47
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, contingencies and other obligations, as
well as stock-based compensation costs. We base our estimates and assumptions
on historical experience and on other factors that we believe to be reasonable
under the circumstances, the result of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results could differ from these
estimates.
The following summarizes our critical accounting policies as well as
other policies that require the most significant judgment and estimates in the
preparation of our consolidated financial statements.
REVENUE RECOGNITION. For products in which software is incidental, we
recognize revenue when persuasive evidence of an arrangement exists, the
product has been delivered, the price is fixed and determinable and collection
of the resulting receivable is reasonably assured. In addition, provisions are
made for estimated returns, warranties and support obligations.
For products in which software is not incidental, revenues are
separated into two categories: product and post-contract customer support
(PCS) revenues, based upon vendor-specific objective evidence of fair value.
Product revenues for these sales are recognized as described above. PCS
revenues are deferred and recognized ratably over the years of the support
arrangement. PCS revenues are recognized at the time the product is delivered
when provided within one year of delivery; the costs of providing this support
are insignificant (and accrued at the time of delivery) and no software
upgrades are provided.
For all sales, we use a binding purchase order as evidence that a
sales arrangement exists.
Delivery generally occurs when the product is handed over to a
transporter for shipment.
At the time of the transaction, we assess whether the price
associated with our revenue transaction is fixed and determinable, and whether
or not collection is reasonably assured. We assess whether the price is fixed
and determinable based on the payment terms associated with the transaction.
We assess collection based on a number of factors, including past transaction
history and the creditworthiness of the customer. Generally, collateral or
other security is not requested from customers.
48
Most sales arrangements do not generally include acceptance clauses.
However, if a sales arrangement does include an acceptance provision,
acceptance occurs upon the earliest of the receipt of a written customer
acceptance or the expiration of the acceptance period. For these sales
arrangements, the sale is recognized when acceptance occurs.
Revenue for extended warranties is recognized on a straight-line
basis over the warranty period.
ALLOWANCE FOR DOUBTFUL ACCOUNTS. We estimate collectibility of
accounts receivable on an ongoing basis by reviewing balances outstanding over
a certain period of time. We determine our allowance for doubtful accounts
receivable based on our historical accounts receivable collection experience
and on the information that we have about the status of our accounts
receivable balances. If the financial conditions of our customers deteriorate,
resulting in an impairment of their ability to make required payments,
additional allowance may be required, which could adversely affect our future
results.
ALLOWANCE FOR EXCESS AND OBSOLETE INVENTORIES. We state our
inventories at the lower of cost, determined on an average cost basis and
replacement cost or net realizable value, and provide reserves for excess and
obsolete inventories. We determine our reserves for excess and obsolete
inventories based on the quantities we have on hand versus expected needs for
these inventories, so as to support future sales of our products. It is
possible that additional inventory reserves may occur if future sales are less
than our forecasts or if there is a significant shift in product mix compared
to our forecasts, which could adversely affect our future results.
RESEARCH AND DEVELOPMENT TAX CREDITS AND GOVERNMENT GRANTS. We record
research and development tax credits and government grants based on our
interpretation of tax laws and grant programs, especially regarding related
eligible projects and expenses, and when there is reasonable assurance that we
have complied and will continue to comply with all conditions and laws. Also,
our judgment and estimates are based on historical experience. It is possible,
however, that the tax authorities or the sponsors of the grant programs have a
different interpretation of laws and application of conditions related to the
programs or that we do not comply with all conditions related to grants in the
future, which could adversely affect our future results. Furthermore, a
significant part of our tax credits are refundable against income taxes
payable, causing their ultimate realization to be dependent upon the
generation of taxable income. If we obtain information that causes our
forecast of future taxable income to change or if actual taxable income
differs from our forecast, we may have to revise the carrying value of these
tax credits, which would affect our results in the period in which the change
was made. We review the recoverability of such tax credits on a quarterly
basis.
IMPAIRMENT OF LONG-LIVED ASSETS AND GOODWILL. We assess impairment of
goodwill on an annual basis, or more frequently, if events or circumstances
indicate that it might be impaired. Recoverability of goodwill is determined
at the reporting unit level using a two-step approach. First, the carrying
value of a reporting unit is compared to its fair value, which is determined
based on a combination of discounted future cash flows and a market approach.
If the carrying value of a reporting unit exceeds its fair value, the second
step is performed. In this step, the amount of impairment loss, if any,
represents the excess of the carrying value of goodwill over its fair value
and the loss is charged to earnings in the period in which it is incurred. For
the purposes of this impairment test, the fair value of goodwill is estimated
in the same way as goodwill is determined in business combinations; that is,
the excess of the fair value of a reporting unit over the estimated fair value
of its net identifiable assets.
49
We assess impairment of long-lived assets when events or
circumstances indicate that costs may not be recoverable. Impairment exists
when the carrying value of an asset, or a group of assets, is greater than the
pre-tax undiscounted future cash flows expected to be provided by the asset or
the group of assets. The amount of impairment loss, if any, is the excess of
the carrying value over the fair value. We assess fair value of long-lived
assets based on discounted future cash flows.
FUTURE INCOME TAXES. We account for income taxes using the liability
method of tax allocation. Under this method, future income tax assets and
liabilities are determined based on deductible or taxable temporary
differences between financial statement values and tax values of assets and
liabilities, using enacted income tax rates for the years in which the
differences are expected to reverse. In assessing the recoverability of our
future income tax assets, we consider whether it is more likely than not that
some or all of the future income tax assets will not be realized. The ultimate
realization of our future income tax assets is dependent upon the generation
of future taxable income during the periods in which those temporary
differences will become deductible. As at August 31, 2005, we had established
a full valuation allowance against our future income tax assets. The valuation
allowance will be reversed once management will have concluded that
realization of future income tax assets is more likely than not.
STOCK-BASED COMPENSATION COSTS. Since September 1, 2003, we account
for all forms of employee stock-based compensation using the fair value-based
method. This method requires that we make estimates about the risk-free
interest rate, the expected volatility of our shares and the expected life of
the awards.
On September 1, 2004, we prospectively adopted the following new
Canadian Institute of Chartered Accountants (CICA) handbook sections:
o Section 1100, "Generally Accepted Accounting Principles"
o Section 1400, "General Standards of Financial Statement Presentation"
Furthermore, in January 2005, the CICA issued four new accounting
standards in relation to financial instruments: Section 3855, "Financial
Instruments - Recognition and measurement"; Section 3865, "Hedges"; Section
1530, "Comprehensive Income"; and Section 3251, "Equity". These new standards
apply to fiscal years beginning on or after October 1, 2006, and we will adopt
them on September 1, 2007.
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.
50
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: 2005 2004 2003 2005 2004 2003
-----------------------------------------------------------------------------------------------------------------------
Sales............................. $ 97,216 $ 74,630 $ 61,930 100.0% 100.0% 100.0%
Cost of sales (1)................. 44,059 34,556 36,197 45.3 46.3 58.4
-----------------------------------------------------------------------------------------------------------------------
Gross margin ..................... 53,157 40,074 25,733 54.7 53.7 41.6
-----------------------------------------------------------------------------------------------------------------------
Operating expenses
Selling and administrative...... 31,782 25,890 26,991 32.7 34.7 43.6
Net research and development ... 12,190 12,390 15,879 12.5 16.6 25.6
Amortization of property, plant
and equipment ............... 4,256 4,935 5,210 4.4 6.6 8.4
Amortization of intangible
assets ...................... 4,836 5,080 5,676 5.0 6.8 9.2
Impairment of long-lived assets
and goodwill................. -- 620 7,427 -- 0.8 12.0
Restructuring and other charges. 292 1,729 4,134 0.3 2.3 6.7
-----------------------------------------------------------------------------------------------------------------------
Total operating expenses.......... 53,356 50,644 65,317 54.9 67.8 105.5
-----------------------------------------------------------------------------------------------------------------------
Loss from operations.............. (0.2) (14.1) (63.9)
(199) (10,570) (39,584)
Interest and other income......... 2,524 1,438 1,245 2.6 1.9 2.0
Foreign exchange loss............. (1,336) (278) (1,552) (1.4) (0.4) (2.5)
-----------------------------------------------------------------------------------------------------------------------
Earnings (loss) before income taxes 989 (9,410) (39,891) 1.0 (12.6) (64.4)
Income taxes...................... 2,623 (986) 15,059 2.7 (1.3) 24.3
-----------------------------------------------------------------------------------------------------------------------
Net loss for the year............. $ (1,634) $ (8,424) $ (54,950) (1.7)% (11.3)% (88.7)%
=======================================================================================================================
Basic and diluted net loss
per share....................... $ (0.02) $ (0.13) $ (0.87)
Segment information
Sales:
Telecom Division............... $ 80,120 $ 58,882 $ 48,753 82.4% 78.9% 78.7%
Life Sciences and
Industrial Division.......... 17,096 15,748 13,177 17.6% 21.1% 21.3%
-----------------------------------------------------------------------------------------------------------------------
$ 97,216 $ 74,630 $ 61,930 100.0% 100.0% 100.0%
=======================================================================================================================
Operating earnings (loss): (2)
Telecom Division............... $ 763 $ (5,557) $ -- 0.8% (7.4)% --%
Life Sciences and Industrial
Division..................... (962) (5,013) -- (1.0) (6.7) --
-----------------------------------------------------------------------------------------------------------------------
$ (199) $ (10,570) $ -- (0.2)% (14.1)% --%
=======================================================================================================================
Research and development data:
Gross research and development.. $ 15,878 $ 15,668 $ 17,133 16.3% 21.0% 27.7%
Net research and development.... $ 12,190 $ 12,390 $ 15,879 12.5% 16.6% 25.6%
-----------------------------------------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS DATA:
Total assets...................... $ 190,957 $ 172,791 $ 146,254
=======================================================================================================================
(1) The cost of sales is exclusive of amortization, shown separately. Including inventory write-offs of $4,121,000 and
an unusual gain of $473,000 for the year ended August 31, 2003.
(2) Comparative information for fiscal 2003 for the loss from operations is not available and is impracticable to
determine.
51
SALES
FISCAL 2005 VS. 2004
In fiscal 2005, our global sales increased 30.3% to $97.2 million
from $74.6 million in 2004, with an 82%-18% split in favor of our Telecom
Division.
TELECOM DIVISION
In fiscal 2005, sales of our Telecom Division increased 36.1% to
$80.1 million from $58.9 million in 2004. Since the second half of fiscal
2004, we have benefited from an increased demand for our test solutions
following the deployment of fiber deeper into access networks (FTTx). In
fiscal 2005, we consolidated our leadership position in the FTTx test market
by recognizing significant revenue from two leading U.S. carriers deploying
fiber in their access networks. Our largest customer, who purchased several
orders of FTTx test equipment, accounted for 28.2% of telecom sales in fiscal
2005 (17.5% in 2004). In addition, the positive spending environment helped us
increase our sales in 2005.
Although sales of our protocol test products increased sequentially
each quarter in fiscal 2005 and reached more than 10% of Telecom revenues in
the fourth quarter of 2005, they still fell below 10% for the whole fiscal
year. Our penetration of the protocol test market has been modest since, in
2003, we refocused our efforts onto next-generation solutions, which are at
the basis of the whole trend toward IP convergence. We expect that protocol
sales will equal optical sales on a medium- to long-term basis given that the
protocol test market is more than double the size of the optical test market,
our rich product pipeline in protocol testing, and increasing customer
traction. We remain confident that the solid product portfolio we are building
for this crucial end-market will lead to long-term growth for EXFO.
LIFE SCIENCES AND INDUSTRIAL DIVISION
In fiscal 2005, sales of our Life Sciences and Industrial Division
increased 8.6% to $17.1 million from $15.7 million in 2004. The increase in
sales in fiscal 2005, compared to 2004, is mainly due to market-share gains in
the fluorescence illumination market as well as increased sales activities in
the curing market.
Overall, for the two divisions, net accepted orders increased 35.6%
to $101.7 million in fiscal 2005 from $75.0 million in 2004. Our net
book-to-bill ratio rose to 1.05 in fiscal 2005, from 1.00 in 2004. The
increased demand for our test solutions for FTTx applications, market-share
gains in the telecommunications and life sciences markets as well as the
slight improvement in the telecommunications market environment helped us
increase our bookings year-over-year.
For the upcoming quarters, we expect the sales split between the two
divisions to remain in the same range as for fiscal 2005.
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.
52
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 FTTx test solutions were higher than expected, especially with a leading
U.S. carrier, which contributed to our sales increase.
LIFE SCIENCES AND INDUSTRIAL DIVISION
In fiscal 2004, sales of our Life Sciences and Industrial 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-precision assembly solutions.
GEOGRAPHIC DISTRIBUTION
During fiscal 2005, sales to the Americas, Europe-Middle East-Africa
(EMEA) and Asia-Pacific (APAC) accounted for 68%, 20% and 12% of global sales,
respectively. Our sales to the Americas, which increased 34% year-over-year,
benefited from the recent deployments of fiber deeper in access networks
(mainly in the United States). Our sales to EMEA increased more significantly
(42%) year-over-year, mainly due to market-share gains in both divisions,
following our efforts to develop this important end-market. Finally, our sales
to APAC remained flat in dollars year-over-year. A significant portion of our
sales to this region of the world are made through price-driven tenders that
may vary in number and importance from quarter to quarter. Also, the
competitive landscape in this market led to pricing pressure, which prevented
us from increasing our sales year-over-year.
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. Sales to Americas, EMEA and APAC accounted
for 66%, 18% and 16% of global sales, respectively, for both fiscal years.
Through our two divisions, we sell our products to a broad range of
customers, including network service providers, cable operators, optical
system and component manufacturers, as well as customers in the life sciences
and high-precison assembly sectors. In fiscal 2004 and 2005, one customer
represented more than 10% of our sales with 13.8% of sales ($10.3 million) in
fiscal 2004 and 23.3% of sales ($22.6 million) in 2005. During 2003, no
customer accounted for more than 10% of our sales. In fiscal 2005, our top
three customers accounted for 28.4% of sales, compared to 20.8% in 2004.
GROSS MARGIN
Gross margin amounted to 54.7%, 53.7% and 41.6% of sales for fiscal
2005, 2004 and 2003, respectively.
53
FISCAL 2005 VS. 2004
The increase in our gross margin in fiscal 2005, compared to 2004,
can be explained by the following factors. First, we were able to reduce our
cost of goods sold by better leveraging our supplier base and by developing
innovative new products with a cost-effective design. Also, the significant
rise in sales (30.3% year-over-year) resulted in an increase in manufacturing
activities, allowing us to better absorb our fixed manufacturing costs.
Furthermore, streamlined operations following our consolidation actions in
fiscal 2004 and 2005 and cost-reduction programs allowed us to further improve
our gross margin. In addition, the shift in the geographic distribution of our
sales resulted in more sales made to the Americas market, where gross margins
tend to be higher because we sell direct to the customers. However, a stronger
Canadian dollar, compared to the US dollar, prevented us, to some extent, from
further improving our gross margin as some cost of sales elements are
denominated in Canadian dollars. As well, the different customer mix and
aggressive pricing pressure observed in fiscal 2005 also prevented us from
further improving our gross margin.
Over the past months, we adjusted the design of some of our products
and we experienced higher sales than expected. Consequently, we were able to
reuse excess inventories that were written off during the telecom downturn for
approximately $1.6 million in fiscal 2005, or 1.7% of sales, compared to
approximately $600,000 or 0.8% of sales in 2004. Inventory write-offs recorded
during the telecom downturn were based on management best estimate at that
time.
FISCAL 2004 VS. 2003
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) 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 further improving our gross
margin as some cost of sales elements are denominated in Canadian dollars.
Finally, the gross margin recorded in fiscal 2003 included a charge of $4.1
million, or 6.7% of sales, for excess and obsolete inventories and an unusual
gain of $473,000, or 0.7% of sales.
OUTLOOK FOR FISCAL 2006
Considering the expected sales growth in 2006, the effect of our
recent consolidation actions, the cost-effective design of our products and
our tight control on operating costs, we expect our gross margin to improve in
fiscal 2006. 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, a potential increase in the strength of the Canadian dollar would
have a negative impact on our gross margin in 2006.
54
SELLING AND ADMINISTRATIVE
Selling and administrative expenses were $31.8 million, $25.9 million
and $27.0 million for fiscal 2005, 2004 and 2003, respectively.
As a percentage of sales, selling and administrative expenses
amounted to 32.7%, 34.7% and 43.6% for fiscal 2005, 2004 and 2003,
respectively.
FISCAL 2005 VS. 2004
The increase in our selling and administrative expenses in dollars in
fiscal 2005, compared to 2004, is mainly due to our decision to significantly
increase our sales activities to better leverage the significant R&D
investments of the prior years which resulted in highest sales and marketing
expenditures (including head-counts). In addition, our significant increase in
revenues allowed us to reduce our selling and administrative expenses on a
percentage basis. In addition, our commission expenses increased
year-over-year, especially due to the increase in sales to the Americas
market; which resulted in higher sales and marketing expenditures (including
head-counts). Furthermore, a stronger Canadian dollar, compared to the US
dollar year-over-year, as more than half of these are incurred in Canadian
dollars. Also, stock-based compensation costs were higher in fiscal 2005
($626,000) than in 2004 ($265,000), further increasing our selling and
administrative expenses year-over-year. Finally, costs to comply with Section
404 of the Sarbanes-Oxley Act of 2002 further increased our SG&A (selling and
administrative) year-over-year. However, we were able to mitigate the increase
in our selling and administrative expenses as well as reduce these expenses in
percentage of sales year-over-year due to tight cost-control measures and the
consolidation of our Life Sciences and industrial Division. In addition, our
significant increase in revenues allowed us to reduce our selling and
administrative expenses on a percentage basis.
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 stock-based compensation costs related
to awards granted to our employees, which caused our selling and
administrative expenses to increase 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 more than half
of these are incurred in Canadian dollars.
OUTLOOK FOR FISCAL 2006
For fiscal 2006, we expect our selling and administrative expenses to
increase in dollars and remain 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, a potential increase in the strength of the Canadian dollar
would also cause our selling and administrative expenses to increase.
55
RESEARCH AND DEVELOPMENT
GROSS RESEARCH AND DEVELOPMENT EXPENSES
Gross research and development expenses totaled $15.9 million, $15.7
million and $17.1 million for fiscal 2005, 2004 and 2003, respectively. As a
percentage of sales, gross research and development expenses amounted to
16.3%, 21.0% and 27.7% for fiscal 2005, 2004 and 2003, respectively, while net
research and development expenses accounted for 12.5%, 16.6% and 25.6% for
these respective periods.
FISCAL 2005 VS. 2004
We incurred most of our gross research and development expenses in
Canadian dollars as we have consolidated most of our research and development
activities in Canada. Consequently, the significant increase in the strength
of the Canadian dollar, compared to the US dollar year-over-year, caused our
gross research and development expenses to increase in fiscal 2005, compared
to 2004. However, this increase was mostly offset by the decrease in our gross
research and development expenses in our Life Sciences and Industrial Division
following the consolidation of this Division in Toronto. The decrease in our
gross research and development expenses as a percentage of sales in fiscal
2005 compared to 2004, is directly attributable to the significant increase in
sales year-over-year while these expenses remained relatively flat.
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, before the end of the year,
we refocused the research and development activities of our Life Sciences and
Industrial 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.
TAX CREDITS AND GRANTS
Tax credits and grants from the Canadian federal and provincial
governments for research and development activities were $3.7 million, $3.3
million and $3.6 million for fiscal 2005, 2004 and 2003, respectively.
FISCAL 2005 VS. 2004
The increase in our tax credits in fiscal 2005, compared to 2004, is
mainly related to the increase in our eligible gross research and development
expenses in Canada, since we were entitled to similar grant programs and tax
credits year-over-year. Following the consolidation of our research and
development activities in Canada, we incurred most of our research and
development expenses in Canada, where we are entitled to research and
development tax credits.
56
FISCAL 2004 VS. 2003
The decrease in our tax credits and 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.
We still invested significantly in research and development
activities in fiscal 2005 as we firmly believe that innovation and new product
introductions are key in gaining market share in the current economic
environment and ensuring the long-term growth and profitability of the
company.
OUTLOOK FOR FISCAL 2006
For fiscal 2006, we expect to increase our gross research and
development expenses in proportion to our revenues, as a reflection of our
focus on innovation, our desire to gain market share and our goal to exceed
customer needs and expectations. Also, a potential increase in the strength of
the Canadian dollar would cause our net research and development expenses to
increase, as most of these are incurred in Canadian dollars.
AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT
For fiscal 2005, amortization of property, plant and equipment was
$4.3 million, compared to $4.9 million in 2004 and $5.2 million in 2003. The
decrease in amortization expenses in fiscal 2005, compared to 2004, despite
the significant increase in the strength of the Canadian dollar compared to
the US dollar, is mainly due to the fact that some of our property, plant and
equipment became fully amortized during fiscal 2004.
OUTLOOK FOR FISCAL 2006
For fiscal 2006, despite a potential increase in the strength of the
Canadian dollar, we expect the amortization of property, plant and equipment
to decrease compared to 2005 considering that some of these assets became
fully amortized in 2005 or will become fully amortized in 2006.
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 $4.8
million, $5.1 million and $5.7 million for fiscal 2005, 2004 and 2003,
respectively. The decrease in amortization expenses in fiscal 2005, compared
to 2004, is mainly due to the fact that some of our core technologies became
fully amortized during fiscal 2005.
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.
57
OUTLOOK FOR FISCAL 2006
For fiscal 2006, we expect the amortization of intangible assets to
approximate $3.3 million, assuming no acquisitions are made during this
period.
IMPAIRMENT OF LONG-LIVED ASSETS AND GOODWILL
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 at
that time, 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.
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 value, 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 AND 2005
In fiscal 2004, we put one of our buildings located in Quebec City up
for sale and received, at the beginning of fiscal 2005, a formal purchase
offer for this building. Based on that offer, we concluded that the building
was impaired and we recorded an impairment charge of $620,000 in fiscal 2004,
representing the excess of the carrying value of the building over its
expected selling price. However, during the first quarter of fiscal 2005, some
conditions of the formal offer were not met and the offer was declined. During
fiscal 2005, we withdrew the building from the market. As at August 31, 2004,
the building was not shown as a long-lived asset held for sale in the balance
58
sheet because it was still used and, consequently, it was not available for
immediate sale. This building reports to the Telecom Division.
In May 2004 and 2005, we performed our annual impairment test for
goodwill and concluded that it was not impaired. Goodwill will be reviewed for
impairment in May 2006, or prior if events or circumstances indicate it might
be impaired.
RESTRUCTURING AND OTHER CHARGES
FISCAL 2003
In fiscal 2003, we implemented a restructuring plan to align our cost
structure with market conditions. Under that plan, we recorded 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.
FISCAL 2004 AND 2005
In fiscal 2004, the Board of Directors approved a restructuring plan
to consolidate the operations of our Life Sciences and Industrial Division,
transferring EXFO Burleigh's operations mainly to EXFO Photonic Solutions
facilities in Toronto. The consolidation process, which started in August
2004, was completed during fiscal 2005.
Overall, for that process, we incurred $2.5 million in restructuring
and other charges from which $2.0 million were recorded in fiscal 2004 and the
remaining $482,000 were recorded in fiscal 2005. The overall costs, which were
recorded in the restructuring and other charges in the statements of earnings
of the corresponding years, are detailed as follows: $855,000 for severance
expenses for the layoff of all employees of EXFO Burleigh; $1.3 million mainly
for the impairment of the EXFO Burleigh building; and the remaining $399,000
for other expenses such as training and recruiting expenses and transfer of
assets.
The EXFO Burleigh building was put up for sale in fiscal 2004, but it
is not yet sold because of the difficult real estate market in Rochester, NY.
The building is available for sale in its present condition and we expect to
sell the property within the next twelve months. Consequently, in accordance
with CICA handbook, section 3475, "Disposal of Long-Lived Assets and
Discontinued Operations", it was shown in the balance sheet as a long-lived
asset held for sale. The fair value used to determine the impairment loss of
the building represents our best estimate of its selling price based upon the
municipal valuation. Since September 1, 2004, the building is no longer
amortized.
Finally, in fiscal 2005, we recorded adjustments of $190,000 to the
fiscal 2003 plan because actual charges, mainly for leased equipment, were
lower than expected.
Our restructuring plans and cost-reduction measures represented our
best efforts to respond to the difficult market conditions of the past years.
Although we believe that such restructuring actions were appropriate and
delivered the expected results, changes in market or industry conditions may
lead us to incur additional restructuring actions and cost-reduction measures
in the coming years.
59
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 $2.5
million, $1.4 million and $1.2 million for fiscal 2005, 2004 and 2003,
respectively. The increase in interest income in fiscal 2005, compared to
2004, is due in part to the increase in our cash and short-term investments
following our public offering in February 2004, the cash flows from operating
activities and the increase in interest rates year-over-year. Also, in fiscal
2005, we recovered R&D tax credits earned in previous years and we were
granted $249,000 in interest by the tax authorities.
In fiscal 2004, we recorded one-time revenue of $265,000 for the sale
of non-core technologies. Without this revenue, interest and other income
would have been relatively flat compared to 2003.
Assuming no acquisitions are made in fiscal 2006, we expect our
interest income to increase during that fiscal year should interest rates
increase and because our cash and short-term investments should increase with
cash flows from operating activities.
FOREIGN EXCHANGE LOSS
Foreign exchange loss amounted to $1.3 million, $278,000 and $1.6
million for fiscal 2005, 2004 and 2003, respectively.
Foreign exchange gains and losses are the result of the translation
of operating activities denominated in currencies other than the Canadian
dollar. The significant exchange loss recorded during fiscal 2005 is the
result of the significant increase in the value of the Canadian dollar
compared to the US dollar in fiscal 2005. For instance, the year-end exchange
rate was Cdn$1.3167 = US$1.00 in fiscal 2004 compared to Cdn$1.1889 = US$1.00
in 2005, representing an increase of nearly 10% in the value of the Canadian
dollar. The average exchange rate for fiscal 2005 was Cdn$1.2315 = US$1.00,
compared to Cdn$1.3301 = US$1.00 in 2004.
During the same period last year, the Canadian dollar value remained
relatively stable throughout the year, resulting in a slight exchange loss
during that period. In addition, higher levels of activity in fiscal 2005,
compared to 2004, further increased the foreign exchange loss in 2005.
It should be noted that additional foreign exchange rate fluctuations
flow through the P&L line items as a significant portion of our operating
elements are denominated in Canadian dollars and and we report our results in
US dollars.
We manage our exposure to currency risks with forward exchange
contracts. In addition, some of our Canadian entities' operating activities
are denominated in US dollars or other currencies, which further hedges this
risk. However, a potential increase in the value of the Canadian dollar,
compared to the US dollar, would have a negative impact on our operating
results.
60
INCOME TAXES
Our income tax expense was $2.6 million for fiscal 2005, compared to
an income tax recovery of $986,000 for 2004, and an income tax expense of
$15.1 million for 2003.
The income tax expense recorded in fiscal 2005 represents income
taxes payable in some specific tax jurisdictions, mainly at the Canadian
federal level. Income taxes payable at this specific level is reduced by
research and development tax credits that are recorded against gross research
and development expenses.
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, mainly at the
Canadian Federal level. 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 fiscal 2003, we have been recording a full valuation allowance
against our future income tax assets because it is more likely than not that
these assets will not be recovered. The valuation allowance will be reversed
once management will have concluded that realization of future income tax
assets is more likely than not. Consequently, our income tax rates are
distorted compared to statutory rates. Please refer to note 16 of our
consolidated financial statements included elsewhere in this Annual Report for
a full reconciliation of the income tax provision.
LIQUIDITY AND CAPITAL RESOURCES
CASH REQUIREMENTS AND CAPITAL RESOURCES
As at August 31, 2005, cash and short-term investments consisted of
$112.0 million, while our working capital was at $135.3 million. Our cash and
short-term investments increased $22.9 million in fiscal 2005, compared to
2004, mainly due to the cash flows from operating activities of $14.0 million
as well as an unrealized foreign exchange gain of $10.0 million on cash and
short-term investments. However, this increase was partially offset by the
cash payment of $1.5 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.
Our short-term investments consist of commercial paper issued by six
high-credit quality corporations and trusts; therefore, we consider the risk
of non-performance of these financial instruments to be remote. For the
purposes of managing our cash position, we have established a cash management
policy, which we follow and monitor on a regular basis. These short-term
investments will be used for working capital and other general corporate
purposes, including potential acquisitions.
We believe that our cash on hand and short-term investments, combined
with an available line of credit of $5.8 million, will be sufficient to meet
our liquidity and capital requirements for the foreseeable future. However,
possible additional operating losses and/or possible investments in or
acquisitions of complementary businesses, products or technologies may require
additional financing. There can be no assurance that additional debt or equity
61
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, 2005:
YEARS ENDING 2010 AND
AUGUST 31, 2006 2007 2008 2009 LATER TOTAL
-------------------------------------------------------------------------------------------------------------
Long-term debt $ 134,000 $ 147,000 $ 51,000 $ -- $ -- $ 332,000
Operating
leases 1,050,000 952,000 632,000 584,000 1,029,000 4,247,000
-------------------------------------------------------------------------------------------------------------
Total
commitments $ 1,184,000 $ 1,099,000 $ 683,000 $ 584,000 $ 1,029,000 $ 4,579,000
=============================================================================================================
SOURCES AND USES OF CASH
We finance our operations and meet our capital expenditure
requirements mainly through cash flows from operating activities, the use of
our cash and short-term investments as well as the issuance of subordinate
voting shares.
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 were recorded as short-term investments.
Cash flows provided by financing activities in fiscal 2004 were attributable
to the net proceeds of this offering.
OPERATING ACTIVITIES
Cash flows provided by operating activities amounted to $14.0 million
in fiscal 2005, compared to $751,000 in 2004 and $5.6 million in 2003.
Cash flows provided by operating activities in fiscal 2005 were
mainly attributable to the net earnings after items not affecting cash of $9.1
million and the positive net change in non-cash operating items of $4.9
million. This net change in non-cash operating items is mainly due to the
decrease of $6.1 million of our income taxes and tax credits recoverable
following the collection, during the year, of income taxes and tax credits
recoverable from previous periods. On the other hand, our accounts receivable
increased by $838,000 and our inventories increased by $699,000. The increase
of our accounts receivable is related to the increase in sales. Our
inventories slightly increased despite the significant rise in sales due to
tight inventory management.
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 non-cash 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 decreased by $1.0 million. The increase in our accounts receivable
is directly related to the significant sales growth in fiscal 2004. 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 research and development tax credits not yet recovered. On the other
hand, our increased sales level combined with tight inventory management
enabled us to reduce our inventories overall.
62
We have delivered positive cash flows from operating activities for
the last three fiscal years, despite the fact that we posted a net loss in
each of these years.
INVESTING ACTIVITIES
Cash flows used by investing activities totaled $13.0 million in
fiscal 2005, compared to $29.7 million in 2004 and $9.9 million in 2003.
In fiscal 2005, we acquired $11.5 million worth of short-term
investments with cash flows from operating activities and cash on-hand and
paid $1.5 million for the purchase of property, plant and equipment as well as
intangible assets.
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 as well as
intangible assets.
FORWARD EXCHANGE CONTRACTS
We utilize forward exchange contracts to manage our foreign currency
exposure. Our policy is not to utilize those derivative financial instruments
for trading or speculative purposes.
Our forward exchange contracts, which are used to hedge anticipated
US-dollar-denominated sales, qualify for hedge accounting; therefore, foreign
exchange translation gains and losses on these contracts are recognized as an
adjustment of the revenues when the corresponding hedged sales are recorded.
As at August 31, 2005, we held contracts to sell US dollars at
various forward rates, which are summarized as follows:
CONTRACTUAL WEIGHTED AVERAGE
EXPIRY DATES AMOUNTS CONTRACTUAL FORWARD RATES
------------------------------------------------------------------------------
September 2005 to August 2006 $ 26,000,000 1.2630
September 2006 to November 2007 7,600,000 1.2500
As at August 31, 2005, the fair value of our forward exchange
contracts, which represents the difference between their contractual amounts
and their current trading value, amounted to an unrecognized gain of $2.9
million.
RELATED-PARTY TRANSACTIONS
In fiscal 2003, we 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 independent appraisal.
63
In addition, for the years ended August 31, 2003 and 2004, we leased
facilities from the company owned by the President of EXFO. The annual rental
expense amounted to $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 the President of 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.
CONTINGENCY
As discussed in note 12 to our consolidated financial statements
included elsewhere in this Annual Report, EXFO was named as a defendant in a
U.S. securities class action related to its initial public offering (IPO) in
June 2000. The complaints allege that the prospectus and the registration
statement for the IPO failed to disclose that the underwriters allegedly
received excessive commissions and that the underwriters and some investors
collaborated in order to inflate the price of EXFO's stock in the
after-market.
In June 2003, a committee of the EXFO's Board of Directors
conditionally approved a proposed settlement between the issuer defendants,
the individual defendants, and the plaintiffs. If approved, the settlement
would provide, among other things, a release of the EXFO and of the individual
defendants for the conduct alleged in the action to be wrongful in the amended
complaint. EXFO would agree to undertake other responsibilities under the
settlement, including agreeing to assign away, not assert, or release certain
potential claims EXFO may have against its underwriters. Any direct financial
impact of the proposed settlement is expected to be borne by EXFO's insurance
carriers.
On June 25, 2004, the Plaintiffs moved for Preliminary Approval of
the settlement. The court granted the preliminary approval motion on February
15, 2005, subject to certain modifications. On August 31, 2005, the court
issued a preliminary order further approving the modifications to the
settlement and certifying the settlement classes. The court also appointed the
Notice Administrator for the settlement and ordered that the notice of the
settlement be distributed to all settlement class members beginning on
November 15, 2005, and completed by January 15, 2006. The settlement fairness
hearing has been set for April 26, 2006. Following the hearing, if the court
determines that the settlement is fair to the class members, the settlement
will be approved. There can be no assurance that this proposed settlement
would be approved and implemented in its current form, or at all. Therefore,
it is not possible to predict the final outcome of the case, nor determine the
amount of any possible losses. If the settlement process fails, EXFO will
continue to defend its position in this litigation that the claims against it,
and its officers, are without merit. Accordingly, no provision for this case
has been made in the consolidated financial statements as at August 31, 2005.
64
SHARE CAPITAL AND STOCK-BASED COMPENSATION PLANS
SHARE CAPITAL
As at November 3, 2005, EXFO had 37,900,000 multiple voting shares
outstanding, entitling to ten votes each, and 30,674,617 subordinate voting
shares outstanding. The multiple voting shares and the subordinate voting
shares are unlimited as to number and without par value.
LONG-TERM INCENTIVE PLAN
In January 2005, EXFO made certain amendments to the existing Stock
Option Plan, including the renaming of the plan to Long-Term Incentive Plan,
which now includes restricted share units (RSUs) in addition to stock options.
RSUs are "phantom" shares that rise and fall in value based on the value of
EXFO's subordinate voting shares and are redeemable for actual subordinate
voting shares or cash, at the discretion of the Board of Directors, on the
vesting dates established by the Board of Directors at the time of grant. The
vesting dates are subject to a minimum of three years and a maximum of ten
years from the award date. RSUs granted under the plan expire at the latest
ten years from the date of grant.
DEFERRED SHARE UNIT PLAN
In January 2005, EXFO established a Deferred Share Unit (DSU) Plan
for the members of the Board of Directors as part of their annual retainer
fees. Each DSU entitles the Board members to receive one subordinate voting
share. DSUs are acquired on the date of grant and will be redeemed in
subordinate voting shares when the Board member will cease to act as Director
of EXFO.
The aggregate number of subordinate voting shares covered by stock
options, RSUs and DSUs granted under the Long-Term Incentive Plan and the
Deferred Share Unit Plan was 2,963,678 as at August 31, 2005. The maximum
number of subordinate voting shares issuable under these two plans cannot
exceed 6,306,153 shares.
The following tables summarize information about stock options, RSUs
and DSUs granted to the members of the Board of Directors and to Management
and Corporate Officers of the company and its subsidiaries as at August 31,
2005:
WEIGHTED
% OF ISSUED AND AVERAGE
STOCK OPTIONS NUMBER OUTSTANDING EXERCISE PRICE
--------------------------------------------- --------------- ----------------- ---------------
Chairman of the Board, President and CEO
(one individual) 168,424 6% $ 9.34
Board of Directors (five individuals) 194,375 7% $ 6.23
Management and Corporate Officers
(nine individuals) 340,091 12% $ 14.39
--------------- ----------------- ---------------
702,890 25% $ 10.92
=============== ================= ===============
65
RESTRICTED SHARE UNITS NUMBER % OF ISSUED AND
OUTSTANDING
-------------------------------------------- --------------- -----------------
Chairman of the Board, President and CEO
(one individual) 13,089 7%
Management and Corporate Officers
(nine individuals) 151,096 86%
--------------- -----------------
164,185 93%
=============== =================
DEFERRED SHARE UNITS NUMBER % OF ISSUED AND
OUTSTANDING
-------------------------------------------- --------------- -----------------
Board of Directors (five individuals) 23,734 100%
=============== =================
OFF-BALANCE SHEET ARRANGEMENTS
As of August 31, 2005, our off-balance sheet arrangements consisted
of letters of guarantee and forward exchange contracts, which are respectively
described in details in note 12 and 18 to our consolidated financial
statements, included elsewhere in this Annual Report.
VARIABLE INTEREST ENTITY
As of August 31, 2005, we did not have significant interests in any
variable interest entities.
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 November 1, 2005.
NAME AND MUNICIPALITY OF RESIDENCE POSITIONS WITH EXFO
----------------------------------- ----------------------------------------------------------
STEPHEN BULL Vice-President, Research and Development, Telecom Division
Cap-Rouge, Quebec
NORMAND DUROCHER Vice-President Human Resources
St-Sauveur, Quebec
ALLAN FIRHOJ Vice-President and General Manager, Life Sciences and
Georgestown, Ontario Industrial Division
BENOIT FLEURY Vice-President, Protocol-Layer Product Management and
Saint-Lazare, Quebec Business Development
ETIENNE GAGNON Vice-President, Optical-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 Independent Director
Magog, Quebec
GUY MARIER Independent 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 Independent Director
Newton, North Carolina
ANDRE TREMBLAY Independent Director
Outremont, Quebec
MICHAEL UNGER Independent 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, Life
Sciences and Industrial Division in July 2003. Prior to that, he held the
position of General Manager of EXFO Photonic Solutions Inc. since November
2001. He is responsible for the overall strategic direction and management of
the Life Sciences and Industrial Division. Mr. Firhoj joined EFOS Inc. in
1996, where 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 Solutions Inc.
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, Protocol-Layer 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 Optical-Layer Product
Management and Customer Service in May 2003. Mr. Etienne Gagon is not related
to Mr. Luc Gagnon. 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. Mr. Luc Gagnon is not related to Mr. Etienne Gagnon.
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, a company founder, has been Chairman of the Board,
President and CEO of EXFO since its inception in 1985. Mr. Lamonde is
responsible for the overall management and direction of EXFO and its
subsidiaries. Mr. Lamonde has served on the boards of several organizations
such as the Canadian Institute for Photonic Innovations, the Pole QCA Economic
Development Corporation and the National Optics Institute of Canada. He is
also a founding member and Governor of the Canadian-based International
Institute of Telecommunications and an Emeritus Member of the Canadian Academy
of Engineering. Mr. Lamonde holds a bachelor's degree in physics engineering
from the University of Montreal's School of Engineering, a master's degree in
optics from Laval University, and is also a graduate of the Ivey Executive
Program offered by the University of Western Ontario.
PIERRE MARCOUILLER has served as our Director since May 2000. Mr.
Marcouiller is Chairman of the Board and Chief Executive Officer of Camoplast
Inc., an international manufacturer specialized in industrial manufacturing of
rubber tracks, molded composite and thermoplastic components and off-road
tracked vehicles. He is the founder and has been the sole shareholder of
Nexcap Inc., an investment company in the manufacturing sector, since December
69
1996. Mr. Marcouiller worked with Venmar Ventilation Inc., a private
ventilation equipment manufacturer, from January 1983 to December 1996. From
1991 to 1996, he was the controlling shareholder of Venmar, where he also held
the position of President and General Manager from 1986 to 1996. Mr.
Marcouiller is also a Director of Heroux-Devtek Inc., a public company
specialized in the design, development and manufacturing of aerospace, defense
and industrial products; more specifically in landing gear, aerostructure and
gas turbine components. Mr. Marcouiller also holds Directorships in other
privately held companies. Pierre Marcouiller holds a bachelor's degree in
business administration from Universite du Quebec in Trois-Rivieres and a MBA
from Universite de Sherbrooke, both 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 the 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, 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 Quebec City, 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.
David A. Thompson is currently Vice-President and Director of Hardware &
Equipment Technology Strategy at Corning Cable Systems, where he has held this
position since January 2002. Prior to this nomination, he acted as Corning
Incorporated's Division Vice-President for the Strategic Planning & Innovation
Effectiveness in Research, Development and Engineering. Dr. Thompson first
joined Corning Incorporated's Research and Development Division in 1976 as a
Senior Chemist in glass research. He then took on several technology
Directorship and strategic planning roles for Corning's Component and
Photonics Technologies Divisions between 1988 and 1998; and, in 1999, he was
appointed technical leader for the creation of the new Samsung-Corning
Micro-Optics joint venture. David A. Thompson holds a Bachelor of Science in
chemistry from Ohio State University and a doctorate in inorganic chemistry
from the University of Michigan. He holds 13 patents and has over 20 technical
publications in the areas of inorganic chemistry, glass technology and
telecommunications.
70
ANDRE TREMBLAY has served as our Director since June 2000. Andre
Tremblay has more than 20 years experience in the telecommunications industry,
where he has been actively involved in the conception, financing and
management of several companies. For almost 10 years, Mr. Tremblay served as
President and Chief Executive Officer of Microcell Telecommunications Inc.,
which he led from its formation on through the different phases of its
evolution. He has also provided early-stage financing, along with strategic
advice and direction, for start-up technology firms and sits on the Boards of
Directors of a number of corporations and non-profit organizations. Andre
Tremblay holds bachelor's degrees in management and in accounting from Laval
University, a master's degree in taxation from the Universite de Sherbrooke
and is also a graduate of Harvard Business School's Advanced Management
Program.
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 Board of
Directors 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 ended August 31, 2005, each director who are
not employees of the Corporation or any of its subsidiaries received the level
of compensation set forth in the table below as annual compensation payable in
a combination of cash and Deferred Share Units ("DSU") as chosen by the
Director pursuant to the Deferred Share Unit Plan.
--------------------------------------------------------------------------------------------
Annual Retainer for Directors: (1) CDN$50,000(2) US$40,600 (3)
--------------------------------------------------------------------------------------------
Annual Retainer for Committee Chairman: CDN$5,000 US$4,060 (3)
--------------------------------------------------------------------------------------------
Annual Retainer for Committee Members: CDN$3,000 US$2,436 (3)
--------------------------------------------------------------------------------------------
Fees for all Meetings Attended per day in Person: CDN$1,000 US$812 (3)
--------------------------------------------------------------------------------------------
Fees for all Meetings Attended per day by Telephone: CDN$500 US$406 (3)
------------------------- ------------------------------------------------------------------
-------------------------
(1) All the Directors elected to receive 50% of their Annual Retainer in form
of Deferred Share Units.
(2) The Annual Retainer for Mr. David A. Thompson is US$50,000 (CDN$61,575).
(3) The compensation information has been converted from Canadian dollars to
U.S. dollars based upon an average foreign exchange rate of $CDN1.2315 =
US$1.00 for 2005.
71
In the financial year ended August 31, 2005, the Directors who are
not employees received the following compensation in the form indicated:
--------------------------------------------------------------------------------------------------------------------
ANNUAL FAIR VALUE OF DSUS AT TOTAL ATTENDANCE
COMPENSATION PAID ANNUAL COMPENSATION THE TIME OF GRANT FEES PAID IN CASH
NAME IN CASH (US$) (1) PAID IN DSUS (#) (2) (US$)(3) (US$) (1)
--------------------------------------------------------------------------------------------------------------------
Pierre Marcouiller (4) 25,173 4,537 20,300 4,466
--------------------------------------------------------------------------------------------------------------------
Guy Marier (5) 25,173 4,537 20,300 4,466
--------------------------------------------------------------------------------------------------------------------
Dr. David A. Thompson (6) 27,440 5,586 25,000 3,256
--------------------------------------------------------------------------------------------------------------------
Andre Tremblay (7) 26,797 4,537 20,300 4,466
--------------------------------------------------------------------------------------------------------------------
Michael Unger (8) 26,797 4,537 20,300 4,466
--------------------------------------------------------------------------------------------------------------------
--------------------------
(1) The compensation information has been converted from Canadian dollars to
U.S. dollars based upon an average foreign exchange rate of $CDN1.2315 =
US$1.00 for 2005 except for Mr. David A. Thompson who is paid in US
currency. The Annual Compensation includes, as the case may be, the
retainer for Director, Committee Members and Committee Chairman.
(2) Indicates the number of Subordinate Voting Shares granted under the
Deferred Share Unit Plan. A DSU is converted in a Subordinate Voting
Share when a Director ceases to be a member of the Board.
(3) The value at the time of grant of a DSU is determined based on the
highest of the closing prices of the Subordinate Voting Shares on the
Toronto Stock Exchange and the NASDAQ National Market on the last trading
day preceding the grant date, using the noon buying rate of the Federal
Reserve Bank of New York on the grant date to convert the NASDAQ National
Market closing price to Canadian dollars, as required. The value at
vesting of a DSU is equivalent to the market value of a Subordinate
Voting Share when a DSU is converted to such Subordinate Voting Share.
(4) Member of the Audit Committee and the Human Resources Committee.
(5) Member of the 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, 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, the Chairman of
the Board, President and Chief Executive Officer of the Corporation, Mr.
Pierre Plamondon, the Vice-President Finance and Chief Financial Officer, the
three other most highly compensated executive officers of the Corporation and
its subsidiaries who were serving the Corporation at the end of the financial
year (collectively, the "Named Executive Officers"). This information includes
the US dollar value of base salaries, bonus awards and long-term incentive
plan payments, the number of options or Restricted Share Units ("RSUs")
granted, and other compensation, if any, whether paid or deferred.
------------------------------------------------------------------------------------------------------------------------
OTHER ANNUAL SECURITIES RESTRICTED ALL OTHER
NAME AND PRINCIPAL FINANCIAL SALARY (1) COMPENSATION UNDER OPTIONS SHARE COMPENSATION
POSITION YEARS ($) BONUS (2) ($) ($) (3) (#) UNITS (4) ($)
------------------------------------------------------------------------------------------------------------------------
Germain Lamonde, 2005 243,605 (US) 121,729 (US) -- 17,942 13,089 --
President and Chief 300,000 (CDN) 149,909 (CDN)
Executive Officer
2004 206,751 (US) 57,115 (US) -- -- -- --
275,000 (CDN) 75,969 (CDN)
2003 185,848 (US) 25,247 (US) -- 50,000 -- --
275,000 (CDN) 37,359 (CDN)
------------------------------------------------------------------------------------------------------------------------
72
------------------------------------------------------------------------------------------------------------------------
OTHER ANNUAL SECURITIES RESTRICTED ALL OTHER
NAME AND PRINCIPAL FINANCIAL SALARY (1) COMPENSATION UNDER OPTIONS SHARE COMPENSATION
POSITION YEARS ($) BONUS (2) ($) ($) (3) (#) UNITS (4) ($)
------------------------------------------------------------------------------------------------------------------------
Pierre Plamondon, 2005 151,441 (US) 48,735 (US) -- 5,383 33,927 2,316 (US)(5)
Vice-President 186,500 (CDN) 60,017 (CDN) 2,852 (CDN)
Finance and Chief
Financial Officer 2004 135,328 (US) 17,451 (US) -- -- -- 1,429 (US)(5)
180,000 (CDN) 23,211 (CDN) 1,901 (CDN)
2003 118,267 (US) 9,547 (US) -- 25,000 -- 866 (US)(5)
175,000 (CDN) 14,127 (CDN) 1,281 (CDN)
------------------------------------------------------------------------------------------------------------------------
Juan-Felipe 2005 246,323 (US) 6,015 (US) -- 5,482 33,998 --
Gonzalez, 303,347 (CDN) 7,407 (CDN)
Vice-President,
Global Telecom Sales 2004 231,597 (US) 563,867 (US) -- -- -- --
308,047 (CDN) 750,000 (CDN)(6)
2003 163,896 (US) 7,500 (US) -- 30,000 -- --
------------------------------------------------------------------------------------------------------------------------
Stephen Bull 2005 121,803 (US) 32,559 (US) -- 3,589 32,618 1,758 (US)(5)
Vice-President 150,000 (CDN) 40,097 (CDN) 2,165 (CDN)
Research &
Development 2004 112,773 (US) 12,437 (US) -- -- -- 16,221 (US)(7)
150,000 (CDN) 16,543 (CDN) 21,576 (CDN)
2003 81,098 (US) 8,138 (US) -- 15,000 -- 588 (US)(5)
120,000 (CDN) 12,042 (CDN) 871 (CDN)
------------------------------------------------------------------------------------------------------------------------
Etienne Gagnon 2005 113,683 (US) 34,389 (US) -- 3,158 9,804 1,067 (US)(5)
Vice-President, 140,000 (CDN) 42,349 (CDN) 1,314 (CDN)
Optical-Layer
Product Management 2004 99,241 (US) 7,540 (US) -- -- -- --
and Customer Service 132,000 (CDN) 11,157 (CDN)
2003 81,098 (US)(8) 2,550 (US) -- 20,000 -- --
120,000 (CDN) 4,013 (CDN)
------------------------------------------------------------------------------------------------------------------------
----------------------
(1) The compensation information for Canadian residents has been converted
from Canadian dollars to U.S. dollars based upon an average foreign
exchange rate of CDN$1.2315 = US$1.00 for 2005, CDN$1.3301 = US$1.00 for
2004 and CDN$1.4797 = US$1.00 for 2003. The currency conversions cause
these reported salaries to fluctuate from year-to-year because of the
fluctuation in exchange rate.
(2) A portion of the bonus amounts is paid in cash in the year for which they
are awarded and the balance is paid in cash in the year following the
financial year for which they are awarded.
(3) Indicates the number of Subordinate Voting Shares underlying the options
granted under the Long-Term Incentive Plan during the financial year
indicated.
(4) Indicates the number of Restricted Share Units granted under the
Long-Term Incentive Plan during the financial year indicated.
(5) Indicates the amount contributed by the Corporation during the financial
year indicated to the Deferred Profit Sharing Plan, as applicable, for
the benefit of the Named Executive Officer. Mr. Lamonde is not eligible
to participate in the Deferred Profit Sharing Plan and Mr. Gonzalez did
not participate.
(6) Pursuant to the terms of his employment agreement, Mr. Juan-Felipe
Gonzalez did receive 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.
(7) Indicates the amount paid by the Corporation during the financial year
for relocation allowance (CDN$20,000) (US$15,036) plus the amount
referred in note 5 above (CDN$1,576) (US$1,185).
(8) This amount represents Mr. Gagnon annual base salary. Since Mr. Gagnon
joined the Corporation in January 13, 2003, the base salary paid to Mr.
Gagnon for the financial year ended August 31, 2003 amounted to US$49,906
(CDN$73,846).
EMPLOYMENT AGREEMENTS
We have an employment agreement with Mr. Germain Lamonde. The
agreement is for an indeterminate period and the compensation is reviewed
annually. In the event of the termination of Mr. Lamonde's employment without
cause, Mr. Lamonde will be entitled to severance payments (in no case
exceeding 24 months of remuneration) and the vesting of all stock options and
73
RSUs. In addition, in the event that Mr. Lamonde's employment is terminated
following a merger or an acquisition by a third party of substantially all of
the Corporation's assets or of the majority of our share capital or if Mr.
Lamonde voluntarily resigns, he will be entitled to the vesting of all stock
options and RSUs.
We also have employment agreements with Mr. Pierre Plamondon, Mr.
Juan-Felipe Gonzalez, Mr. Stephen Bull and Mr. Etienne Gagnon.
The employment agreement with Mr. Pierre Plamondon, our
Vice-President, Finance and Chief Financial Officer is for an indeterminate
period and the compensation is reviewed annually. In the event of termination
of Mr. Plamondon's employment without cause, Mr. Plamondon will be entitled to
severance payments which in no case exceeding 18 months of the current base
salary. In addition, in the event Mr. Plamondon's employment is terminated
following a merger or an acquisition by a third party of substantially all of
our assets or of the majority of its share capital, he will be entitled to the
immediate vesting of all stock options and RSUs.
The agreement with Mr. Gonzalez provided for Mr. Gonzalez's
employment as Vice-President 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 compensation is
reviewed annually.
The agreement with Mr. Stephen Bull, our Vice-President, Research and
Development is for an indeterminate period and the compensation 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 and RSUs.
The employment agreement with Mr. Etienne Gagnon, our Vice-President,
Optical-Layer Product Management and Customer Service is for an indeterminate
period and the compensation is reviewed annually. In the event of termination
of Mr. Gagnon's employment without cause, Mr. Gagnon's will be entitled to
severance payments (in no case exceeding 18 months of the current base
salary). In addition, in the event Mr. Gagnon'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 and RSUs.
LONG-TERM INCENTIVE COMPENSATION
LONG-TERM INCENTIVE PLAN
We have a Long-Term Incentive Plan for our Directors, executive
officers, employees and consultants and those or 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.
74
The principal component of the long-term incentive compensation
offered by us is made up of the Long-Term Incentive Plan for Directors,
officers, employees and consultants of the Corporation and its subsidiaries.
Introduced in May 2000, amended in October 2004 and effective in
January 2005, the Long-Term Incentive Plan is designed to motivate Directors,
officers, employees and consultants to share interest with our shareholders
over the long-term. A copy of the Long-Term Incentive Plan has been filed as
exhibit 4.35 to this annual report. It is subject to Human Resources Committee
review to ensure maintenance of its market competitiveness. Our Board has full
and complete authority to interpret the Plan and to establish the rules and
regulations applying to it and to make all other determinations it deems
necessary or useful for the administration of the Plan, provided that such
interpretations, rules, regulations and determinations are consistent with the
rules of all stock exchanges on which our securities are then traded and with
all relevant securities legislation.
The Long-Term Incentive Plan provides for the issuance of options to
purchase Subordinate Voting Shares and the issuance of Restricted Share Units
("RSUs") redeemable for actual Subordinate Voting Shares or the equivalent in
cash to Directors, officers, employees and consultants. Our Board of Directors
upon recommendation of the Human Resources Committee designates the recipients
of options or RSUs and determines the number of Subordinate Voting Shares
covered by each option or RSU, the dates of vesting, the expiry date and any
other conditions relating to these options or RSUs, in each case in accordance
with the applicable legislation of the securities regulatory authorities.
During the financial year ended August 31, 2005, options and RSUs were granted
based on merit.
The exercise price of the options is determined by our Board of
Directors at the time of granting the options, subject to compliance with the
rules of all stock exchanges on which the Subordinate Voting Shares are listed
and with all relevant securities legislation. In any event, the price at which
the Subordinate Voting Shares may be purchased may not be lower than the
highest of the closing prices of the Subordinate Voting Shares on the Toronto
Stock Exchange and the NASDAQ National Market on the last trading day
preceding the grant date, using the noon buying rate of the Federal Reserve
Bank of New York on the grant date to convert the NASDAQ National Market
closing price to Canadian dollars. Any option issued is non-transferable.
The aggregate number of subordinate voting shares covered by options
granted during the financial year ended August 31, 2005 was 246,233 at a
weighted average exercise price of $4.59 (CDN$5.68) per subordinate voting
share. At the end of the financial year ended August 31, 2005, there were
2,763,759 subordinate voting shares covered by options granted and outstanding
pursuant to the Long-Term Incentive Plan having a weighted average exercise
price of US$12.87 (CDN$19.22) per option. Since August 31, 2005 and until
November 15, 2005 no options were granted.
The fair value at the time of grant of a RSU is equal to the market
value of Subordinate Voting Shares at the time RSUs are granted. At the end of
financial year ended August 31, 2005, there were a total of 176,185 RSUs
granted pursuant to the Long-Term Incentive Plan having a weighted average
fair value at the time of grant of US$4.68 (CDN$5.72) per RSU. Since August
31, 2005 and until November 15, 2005 we did not grant any RSUs.
The maximum number of Subordinate Voting Shares that are issuable
under the Plan shall not exceed 6,306,153 Subordinate Voting Shares, which
represents 9.2% of our issued and outstanding voting shares as of November 1,
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2005. The maximum number of Subordinate Voting Shares that may be granted to
any one individual shall not exceed 5% of the number of outstanding
Subordinate Voting Shares.
Some options granted to Directors vest on the first anniversary date
of their grant. Some options granted in the financial year ended August 31,
2004 and 2005 vest at a rate of 12.5% six (6) months after the date of grant,
12.5% twelve (12) months after the date of grant and 25% annually thereafter
commencing on the second anniversary date of the grant in October 2005.
Otherwise all options vest a rate of 25% annually commencing on the first
anniversary date of the grant. All options may be exercised in whole or in
part once vested. All of the options that are granted under the Plan must be
exercised within a maximum period of ten (10) years following the date of
their grant or they will be forfeited.
All RSUs first vesting can not be earlier than the third anniversary
date of their grant. Some RSUs granted in the financial year ended August 31,
2005 vest at a rate of 1/3 annually commencing on the third anniversary date
of the grant in February 2005 and others at a rate of 55%, 35% and 10%, on the
third, fourth and fifth anniversary dates of the grant in January 2005. Some
RSUs granted in the financial year ended August 31, 2005 vest on the fifth
anniversary date of the grant in January 2005 but are subject to early vesting
on the third and fourth anniversary dates of the grant on the attainment of
performance objectives as determined by our Board of Directors. Accordingly,
subject to the attainment of performance objectives, the first early vesting
is up to 1/3 of the units on the third anniversary date of the grant and the
second early vesting is up to 50% of the remaining units on the fourth
anniversary date of the grant. If such vesting date falls into any black-out
period or any other restrictive period during which the RSU holder is not
entitled to trade our Subordinate Voting Shares, then the units shall vest on
the first trading day the RSU holder is entitled to trade after such black-out
period or restrictive period.
Any option granted pursuant to the Long-Term Incentive Plan will
lapse (i) immediately upon the termination of the relationship with us or one
of our subsidiaries for a good and sufficient cause for employees or officers
or at the date on which an employee or an officer resigns or leaves his
employment with us or one of our subsidiaries (or within 30 days if the
holder's employment is terminated for reasons not related to cause); and (ii)
30 days after a Director ceases to be a member of our Board of Directors or
one of our subsidiaries. In the event of retirement or disability, any option
held by an employee lapses 30 days after the date of any such disability or
retirement. In the event of death, any option held by the optionee lapses 6
months after the date of death.
Any RSU granted pursuant to the Long-Term Incentive Plan will lapse
(i) immediately, where vesting of a unit is subject to the attainment of
performance objectives, if such performance objectives have not been attained
(or postponed at a further vesting date as determined by the Board of
Directors); (ii) immediately, whether or not subject to attainment of
performance objectives, upon the termination of the relationship with us or
one of our subsidiaries for a good and sufficient cause for employees or
officers or at the date on which an employee or an officer resigns or leaves
his employment with us or one of our subsidiaries.
Any RSU granted pursuant to the Long-Term Incentive Plan will vest
immediately, to a certain proportion as determined by the Plan, upon the
termination of the relationship of an employee or officer with us or one of
our subsidiaries (i) for reasons not related to cause; (ii) because of death
or permanent disability and (iii) retirement.
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The following table summarizes information about stock options
granted to the members of the Board of Directors, and to Management and
Corporate Officers of us and our subsidiaries as at August 31, 2005:
--------------------------------------------------------------------------------------------------------------
% OF ISSUED AND WEIGHTED AVERAGE EXERCISE
NUMBER OF OPTIONS OUTSTANDING OPTIONS PRICE ($US/SECURITY)
--------------------------------------------------------------------------------------------------------------
President and CEO (one individual) 168,424 6.09% 9.34
--------------------------------------------------------------------------------------------------------------
Board of Directors (five individuals) 194,375 7.03% 6.23
--------------------------------------------------------------------------------------------------------------
Management and Corporate Officers
(nine individuals) 340,091 12.31% 14.39
--------------------------------------------------------------------------------------------------------------
The following table summarizes information about RSUs granted to the
members of the Board of Directors and to Management and Corporate Officers of
us and our subsidiaries as at August 31, 2005:
------------------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE FAIR
% OF ISSUED AND VALUE AT THE TIME OF
NUMBER OF RSUS OUTSTANDING RSUS GRANT $US/RSU
------------------------------------------------------------------------------------------------------------
President and CEO (one individual) 13,089 7.43% 4.69
------------------------------------------------------------------------------------------------------------
Board of Directors (five individuals) -- -- --
------------------------------------------------------------------------------------------------------------
Management and Corporate Officers 151,096 85.76% 4.69
(nine individuals)
------------------------------------------------------------------------------------------------------------
DEFERRED SHARE UNIT PLAN
Introduced in October 2004 and effective as of January 2005, the
Deferred Share Unit Plan is designed to align more closely the interests of
its non-employee Directors with those of our shareholders. A copy of the
Deferred Share Unit Plan has been filed as exhibit 4.36 to this annual report.
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 a fair value at the time of grant 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 Subordinate Voting
Shares, is equivalent to the market value of a Subordinate Voting Share at the
time the conversion takes place. DUSs attract dividends in the form of
additional DSUs at the same rate as dividends on Subordinate Voting Share.
When a Director ceases to be a member of our Board of Directors, the DSUs are
either converted and paid in Subordinate Voting Shares purchased on the open
market or issued by us. Such Subordinate Voting Shares issued by us will be
issued from the same pool of Subordinate Voting Shares reserved for issuance
pursuant to the Long-Term Incentive Plan, which is 9.2% of the total issued
and outstanding voting shares.
The following table summarizes information about DSUs granted to the
non-employee members of our Board of Directors as at August 31, 2005:
77
---------------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE FAIR
% OF ISSUED AND VALUE AT THE TIME OF
NUMBER OF DSUS OUTSTANDING DSUS GRANT $US/DSU
---------------------------------------------------------------------------------------------------------
Board of Directors (five individuals) 23,734 100% 4.47
---------------------------------------------------------------------------------------------------------
DEFERRED SHARE UNIT GRANTS IN LAST FINANCIAL YEAR
The aggregate number of Deferred Share Units ("DSUs") credited to
non-employee Directors during the financial year ended August 31, 2005 was
23,734. The fair value at the time of grant of a DSU is equal to the market
value of a Subordinate Voting Share at the time DSUs are credited to the
Directors. At the end of the financial year ended August 31, 2005, there were
a total of 23,734 DSUs credited to Directors pursuant to the Deferred Share
Unit Plan having a fair value at the time of grant of US$105,998
(CDN$130,421).
DSUs attract dividends in the form of additional DSUs at the same
rate as dividends on Subordinate Voting Shares. The DSUs are converted and
paid in Subordinate Voting Shares at the time a Director ceases to be a member
of our Board of Directors.
Therefore, the value at vesting of a DSU, when converted to
Subordinate Voting Shares, is equivalent to the market value of a Subordinate
Voting Share at the time the conversion takes place. The table below shows
information regarding DSU grants made under the Deferred Share Unit Plan
during the financial year ended August 31, 2005.
During the financial year ended August 31, 2005, the following DSUs
were granted to the Directors:
-------------------------------------------------------------------------------------------
WEIGHTED AVERAGE FAIR VALUE
DSUS # AT THE TIME OF GRANT US$/DSU VESTING
-------------------------------------------------------------------------------------------
23,734 4.47 At the time Director cease to be a member of the
Board of the Corporation
-------------------------------------------------------------------------------------------
RESTRICTED SHARE UNIT GRANTS IN LAST FINANCIAL YEAR
The aggregate number of Restricted Share Units (RSUs) granted during
the financial year ended August 31, 2005 was 176,185. The fair value at the
time of grant of a RSU is equal to the market value of Subordinate Voting
Shares at the time RSUs are granted. At the end of the financial year ended
August 31, 2005, there were a total of 176,185 RSUs granted pursuant to the
Long-Term Incentive Plan having a weighted average fair value at the time of
grant of US$4.68 (CDN$5.72) per RSU. All RSUs first vesting can not be earlier
than the third anniversary date of their grant. Some RSUs granted in the
financial year ended August 31, 2005 vest at a rate of 1/3 annually commencing
on the third anniversary date of the grant in February 2005 and others at a
rate of 55%, 35% and 10%, on the third, fourth and fifth anniversary dates of
the grant in January 2005. Some RSUs granted in the financial year ended
August 31, 2005 vest on the fifth anniversary date of the grant in January
2005 but are subject to early vesting on the third and fourth anniversary
dates of the grant on the attainment of performance objectives as determined
by our Board of Directors. Accordingly, subject to the attainment of
performance objectives, the first early vesting is up to 1/3 of the units on
the third anniversary date of the grant and the second early vesting is up to
50% of the remaining units on the fourth anniversary date of the grant.
RSUs attract dividends in the form of additional RSUs at the same
rate as dividends on Subordinate Voting Shares. The RSUs are redeemed for
actual Subordinate Voting Shares or the equivalent in cash at the discretion
78
of our Board of Directors on the vesting dates established by our Board of
Directors at the time of grant in its sole discretion.
Therefore, the value at vesting of a RSU, when converted to
Subordinate Voting Shares, is equivalent to the market value of a Subordinate
Voting Share at the time the conversion takes place. The table below shows
information regarding RSU grants made under the Long-Term Incentive Plan
during the financial year ended August 31, 2005.
During the financial year ended August 31, 2005, the following RSUs
were granted:
--------------------------------------------------------------------------------
FAIR VALUE AT
THE TIME OF
RSUS # GRANT S$/RSU VESTING (1)
--------------------------------------------------------------------------------
129,000 4.69 55%, 35% and 10%, on the third, fourth and
fifth anniversary dates of the grant in January
2005 (2)
--------------------------------------------------------------------------------
35,185 4.69 100% on the fifth anniversary date of the grant
in January 2005 subject to early vesting up to
1/3 on the third anniversary date of the grant
and up to 50% of the remaining units on the
fourth anniversary date of the grant if the
performance objectives are fully attained (3)
--------------------------------------------------------------------------------
12,000 4.51 1/3 on each of the third, fourth and fifth
anniversary dates of the grant in February 2005
(4)
--------------------------------------------------------------------------------
-------------
(1) All RSUs first vesting can not be earlier than the third anniversary date
of their grant.
(2) Those RSUs granted in the financial year ended August 31, 2005 vest at a
rate of 55%, 35% and 10% on the third, fourth and fifth anniversary dates
of the grant in January 2005.
(3) Those RSUs granted in the financial year ended August 31, 2005 vest on
the fifth anniversary date of the grant in January 2005 but are subject
to early vesting on the third and fourth anniversary dates of the grant
on the attainment of performance objectives as determined by our Board of
Directors. Accordingly, subject to the attainment of performance
objectives, the first early vesting is up to 1/3 of the units on the
third anniversary date of the grant and the second early vesting is up to
50% of the remaining units on the fourth anniversary date of the grant.
(4) Those RSUs granted in the financial year ended August 31, 2005 vest at a
rate of 1/3 annually commencing on the third anniversary date of the
grant in February 2005.
NUMBER OF SUBORDINATE VOTING SHARES RESERVED FOR FUTURE ISSUANCE
During the financial year ended August 31, 2005, 23,734 Deferred
Share Units, 176,185 Restricted Share Units and 246,233 options were granted
to Directors, officers and employees. Such awards were issued from the same
pool of Subordinate Voting Shares reserved for issuance pursuant to the
Long-Term Incentive Plan which is 9.2% of the total and outstanding voting
shares. Therefore, as of November 1, 2005 the number of Subordinate Voting
Shares reserved for future issuance is 3,182,504.
SHARE PURCHASE 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
79
plan also required the subordinate voting shares to be held in trust by a
trustee until August 31, 2004, except for 249,977 subordinate voting shares
that were released between October 21, 2003 and January 20, 2004. The share
plan also provided 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 share plan did 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.
RESTRICTED STOCK AWARD PLAN
The EXFO Electrical-Optical Engineering Restricted Stock Award Plan
(the "RSAP") was established to provide a means through which employees of
EXFO Burleigh Products Group Inc. can be granted awards of restricted shares
("Restricted Shares") of Subordinate Voting Shares to promote retention and
foster identity of interest between stockholders and employees of EXFO
Burleigh Products Group Inc.
The effective date of the RSAP was December 20, 2000. The expiration
date of the RSAP is the business day next following the final grant of
Restricted Shares under the RSAP, which was December 20, 2000. However, the
administration of the RSAP did continue until all awards of Restricted Shares
have been forfeited or settled. The aggregate number of shares subject to the
RSAP was 360,000. Stock awards granted under the RSAP vest over a 4 year
period, with 25% vesting on an annual basis commencing on the first
anniversary of the date of grant. The last vesting occurred on December 20,
2004, the Human Resources Committee administered the RSAP until that date.
Therefore the administration of the RSAP terminated on December 20, 2004.
Awards of Restricted Shares were subject to forfeiture and
restrictions on transfer until the Restricted Shares became vested at which
point a stock certificate was issued to a participant with respect to the
number of vested shares, which are then freely transferable. Restricted Shares
become vested, subject to a participant's continued employment with us or our
affiliates, on each of the first four anniversaries of the date of grant of an
award of Restricted Shares.
Upon a participant's termination of employment with 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 became fully vested
and was no longer subject to forfeiture. However, the transfer restrictions
remained in place until the occurrence of the vesting dates originally
contemplated by the award.
Upon the voluntary resignation of a participant, the termination of a
participant's employment for cause, the termination of a participant who is
not designated a member of EXFO Burleigh Products Group Inc. "Management Team"
without cause prior to a change in control of us or a termination without
cause of a participant who is designated a member of EXFO Burleigh Products
Group Inc. Management Team that is initiated by EXFO Burleigh Products Group
Inc. prior to a change in control of us, the unvested portion of the
participant's award of Restricted Shares were forfeited. However the RSAP
provided discretion to the Human Resources Committee in the application of the
forfeiture provisions where a change in circumstances rendered such action
appropriate. During the financial year ended August 31, 2005, EXFO Burleigh
80
Products Group Inc. was required to lay off the remaining of the participants
(excluding a few that were transferred to our other offices) as a result of a
consolidation due to a sharp downturn in its market. The Human Resources
Committee decided that the awards of RSAP participants affected by the
lay-offs would not be subject to forfeiture, though the transfer restrictions
remained in place until the occurrence of the vesting dates originally
contemplated by the award.
Upon the termination without cause of a participant who was
designated a member of EXFO Burleigh Products Group Inc. Management Team that
was initiated by us or a termination of a participant's employment without
cause following a change in control of the Corporation, a participant's award
of Restricted Stock became fully vested and all restrictions lapsed.
In the event of a change in control, the committee administering the
RSAP could in its discretion remove restrictions on Restricted Shares or
provide for the cancellation of awards in exchange for payment in respect of
the Restricted Shares subject to an award.
STOCK APPRECIATION RIGHTS PLAN
On August 4, 2001, we 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 our
opinion. 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.
Our 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 November 1, 2005, there were 19,000 SAR's outstanding.
81
DEFERRED PROFIT SHARING PLAN
We maintain a deferred profit sharing plan for certain eligible
Canadian resident employees. Under this plan, we may contribute an amount
equal to 1% until May 31, 2005 and 2% starting June 1, 2005, of each
employee's gross salary to that employee's individual deferred profit sharing
plan to the extent that such employee contributes at least 2% of his or her
gross salary to his or her individual tax-deferred registered retirement
savings plan. As a cost control measure, we temporarily suspended our
contributions under this plan commencing in June 2002 and re-established
contributions commencing January 2003. In the year ended August 31, 2005, the
aggregate amount of contributions under the plan was $179,000 (CA$221,000).
Mr. Germain Lamonde is not entitled to participate in this plan.
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, 2005, we made an aggregate of $134,000 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 us 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. Accordingly, we maintain insurance protection against
liability incurred by our officers and Directors as well as those of our
subsidiaries in the performance of their duties. The entire premium, amounting
to US$245,000 from September 30, 2005 to September 30, 2006, is paid by us.
The aggregate limit of liability in respect of any and all claims is US$10
million per year. The policy provides for the indemnification of Directors and
officers in the case of claims for which we have not indemnified or are not
permitted by law to indemnify them, and for the reimbursement of us, subject
to a deductible of US$100,000, except for securities claims where the
deductible is US$500,000.
82
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 of Directors 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 except for the vesting of their respective Deferred Share Units as
detailed above.
Since September 1, 2004 until November 1, 2005, the Board met a total
of seven (7) times. Attendance at all meetings was perfect, except Mr. David
A. Thompson who was absent two times and Mr. Andre Tremblay who was absent one
time.
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
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. Accordingly, in March 2005,
the Board updated and adopted an Audit Committee Charter. A copy of this Audit
Committee Charter has been filed as Exhibit 11.6 to the annual report and is
also readily available from EXFO's website at www.exfo.com. 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, 2005, the Audit Committee met
a total of four (4) times and attendance was perfect at all meetings, as all
members attended all meetings.
Our human resources committee will evaluate, review and supervise our
procedures with regards to human resources and will assess the performance of
our executive officers and the chief executive officer. This committee will
also review annually the remuneration of the Directors and will recommend to
the Board of Directors general remuneration policies regarding salaries,
bonuses and other forms of remuneration for our Directors, executive officers
and employees as a whole. Finally, the human resources committee will review
our organizational structure annually and the development and maintenance of a
succession plan. Accordingly, in March 2005, the Board updated and adopted a
Human Resources Committee Charter which integrates the Compensation Committee
Charter and the Nominating and Governance Committee Charter. A copy of this
Human Resources Committee Charter has been filed as Exhibit 11.7 to the annual
report and is also readily available from EXFO's website at www.exfo.com. The
83
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, 2005, the Human Resources
committee met a total of two times and attendance was perfect at all meetings,
with the excepton of one meeting missed by Mr. David A. Thompson.
The disclosure committee is responsible for overseeing our disclosure
practices. This committee consists of the chief executive officer, the chief
financial officer, investor relations the manager of financial reporting and
accounting as well as our legal counsel and corporate secretary.
In addition, in order to deal with issues arising from our
implication in the IPO class action suit, in October 2002, our 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.
As of November 1, 2005, we had a total of 685 employees, up from a
total of 649 on December 15, 2004. We have 614 employees in Canada, primarily
based in Quebec, and 71 employees based outside of Canada. 194 are involved in
research and development, 250 in manufacturing, 128 in sales and marketing, 72
in general administrative positions and 41 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 ownership of
Subordinate Voting Shares, Exercisable "in-the-money" and "out-the-money"
options and the beneficial ownership of our share capital as of November 1,
2005 by our Chief Executive Officer, Chief Financial Officer, our Directors,
our three other most highly compensated executive officers, our other
executive officers as a group 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 (1) vote per share and holders of our multiple voting
shares are entitled to ten (10) votes per share.
84
---------------------------------------------------------------------------------------------------------------------------
TOTAL
CURRENTLY EXERCISABLE OPTIONS SUBORDINATE TOTAL
NAME SUBORDINATE OWNED AS OF NOVEMBER 1, 2005 VOTING SHARES MULTIPLE VOTING PERCENTAGE
VOTING SHARES --------------------------------- BENEFICIALLY SHARES BENEFICIALLY OF VOTING
OWNED IN-THE-MONEY(1) OUT-THE-MONEY(2) OWNED (3) OWNED (3) POWER
---------------------------------------------------------------------------------------------------------------------------
NUMBER PERCENT NUMBER PERCENT NUMBER PERCENT NUMBER PERCENT NUMBER PERCENT PERCENT
----------------------------------------------------------------------------------------------------------------------------
Germain Lamonde 93,000 * 37,500 * 100,482 * 230,982 * 37,900,000 100 92.6
(4)
----------------------------------------------------------------------------------------------------------------------------
Pierre Plamondon 35,427(5) * 18,750 * 53,285 * 107,462 * -- -- *
----------------------------------------------------------------------------------------------------------------------------
Pierre 5,000 * 15,625 * 23,003 * 43,628 * -- -- *
Marcouiller
----------------------------------------------------------------------------------------------------------------------------
Guy Marier 1,000 * -- * 3,125 * 4,125 * -- -- *
----------------------------------------------------------------------------------------------------------------------------
David A. 2,100 * 15,625 * 17,734 * 35,459 * -- -- *
Thompson
----------------------------------------------------------------------------------------------------------------------------
Andre Tremblay 6,650(6) * 15,625 * 19,691 * 41,966 * -- -- *
----------------------------------------------------------------------------------------------------------------------------
Michael Unger -- * 15,625 * 20,568 * 36,193 * -- -- *
----------------------------------------------------------------------------------------------------------------------------
Juan-Felipe 50,752 * 7,500 * 80,150 * 138,402 * -- -- *
Gonzalez
----------------------------------------------------------------------------------------------------------------------------
Stephen Bull 21,573 * 11,255 * 24,727 * 57,550 * -- -- *
----------------------------------------------------------------------------------------------------------------------------
Etienne Gagnon 5,000 * 5,000 * 789 * 10,789 * -- -- *
----------------------------------------------------------------------------------------------------------------------------
Other executive
officers as a 8,452 * 18,750 * 45,169 * 72,371 * -- -- *
group
----------------------------------------------------------------------------------------------------------------------------
All of our
Directors and
executive 228,954 * 161,250 * 388,723 1.3 778,927 2.5 37,900,000 100 92.7
officers as a
group
----------------------------------------------------------------------------------------------------------------------------
---------------- ----------
* Less than 1%.
(1) "In-the-money" options are options for which the market value of the
underlying securities is higher than the price at which such securities
may be bought from the Corporation. As of November 1, 2005 the market
value of a Subordinate Voting Share was US$4.43.
(2) "Out-the-money" options are options for which the market value of the
underlying securities is lower than the price of which such securities
may be bought from the Corporation.
(3) Beneficial ownership is determined in accordance with the rules of the
SEC and generally includes voting or investment power with respect to
securities. Options that are currently exercisable (including options
that have an exercise price above the market price) are deemed to be
outstanding and to be beneficially owned by the person holding such
options for the purpose of computing the percentage ownership of such
person, but are not treated as outstanding for the purpose of computing
the percentage ownership of any other person. Accordingly, DSUs and RSUs
are not included.
(4) The number of shares held by Germain Lamonde includes 1,900,000 multiple
voting shares held of record by Fiducie Germain Lamonde, 36,000,000
multiple voting shares held of record by G. Lamonde Investissements
Financiers inc. and 93,000 subordinate voting shares held of record by
Placements Lamonde SENC.
(5) The number of shares held by Pierre Plamondon includes 6,874 subordinate
voting shares held of record by Fiducie Pierre Plamondon.
(6) The number of subordinate voting shares held of record by Andre Tremblay
is held by 9104-5559 Quebec Inc, a company controlled by Mr. Tremblay.
85
The following table presents information regarding stock options held
as of November 1, 2005 by our Chief Executive Officer, Chief Financial
Officer, our Directors, our three other most highly compensated executive
officers and our other executive officers as a group.
SECURITIES UNDER OPTIONS EXERCISE PRICE (2)
NAME GRANTED (1) (#) (US$/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
17,942 $4.51 February 1, 2015
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
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
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
15,000 $1.58 September 25, 2012
5,482 $5.13 October 26, 2014
Stephen Bull.................... 900 $26.00 June 29, 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 $5.13 October 26, 2014
86
SECURITIES UNDER OPTIONS EXERCISE PRICE (2)
NAME GRANTED (1) (#) (US$/SECURITY) EXPIRATION DATE
-------------------------------- ------------------------ ------------------ -------------------
Etienne Gagnon.................. 15,000 $3.19 January 7, 2013
3,158 $5.13 October 26, 2014
Other Executive Officers as a 3,000 $45.94 September 13, 2010
group........................... 4,000 $34.07 October 11, 2010
3,250 $22.25 January 10, 2011
10,000 $23.40 March 15, 2011
18,000 $9.13 October 10, 2011
26,250 $1.58 September 25, 2012
15,000 $4.65 March 24, 2014
12,679 $5.13 October 26, 2014
2,000 $4.51 February 1, 2015
---------------------------------
(1) Underlying securities: subordinate voting shares
(2) The exercise price of options granted is determined based on the highest
of the closing prices of the subordinate voting shares on the Toronto
Stock Exchange and the NASDAQ National Market on the last trading day
preceding the grant date, using the noon buying rate of the Federal
Reserve Bank of New York on the grant date to convert the NASDAQ National
Market closing price to Canadian dollars, as required.
The following table presents information regarding Deferred Share
Units and Restricted Share Units held by our Chief Executive Officer, our
Chief Financial Officer, our Directors, our three other most highly
compensated executive officers, our other executive officers as a group and
all of our Directors and executive officers as a group.
----------------------------------------------------------------------------------------------------------------------
DSUS RSUS
----------------------------------------------------------------------------------------------------------------------
WEIGHTED
AVERAGE FAIR FAIR VALUE AT
VALUE AT THE THE TIME OF
TIME OF GRANT GRANT
NAME NUMBER PERCENTAGE US$/DSU (1) NUMBER PERCENTAGE US$/RSU (2)
----------------------------------------------------------------------------------------------------------------------
Germain Lamonde -- -- -- 13,089 (3) 7.4% 4.69
----------------------------------------------------------------------------------------------------------------------
-- -- -- 3,927 (3) 2.2% 4.69
Pierre Plamondon ------------------------------------------------------------------------------------------------
-- -- -- 30,000 (4) 17.0% 4.69
----------------------------------------------------------------------------------------------------------------------
Pierre Marcouiller 4,537 (5) 19.1% 4.47 -- -- --
----------------------------------------------------------------------------------------------------------------------
Guy Marier 4,537 (5) 19.1% 4.47 -- -- --
----------------------------------------------------------------------------------------------------------------------
David A. Thompson 5,586 (5) 23.6% 4.47 -- -- --
----------------------------------------------------------------------------------------------------------------------
Andre Tremblay 4,537 (5) 19.1% 4.47 -- -- --
----------------------------------------------------------------------------------------------------------------------
Michael Unger 4,537 (5) 19.1% 4.47 -- -- --
----------------------------------------------------------------------------------------------------------------------
-- -- -- 3,998 (3) 2.3% 4.69
Juan-Felipe Gonzalez ------------------------------------------------------------------------------------------------
-- -- -- 30,000 (4) 17.0% 4.69
----------------------------------------------------------------------------------------------------------------------
-- -- -- 2,618 (3) 1.5% 4.69
Stephen Bull ------------------------------------------------------------------------------------------------
-- -- -- 30,000 (4) 17.0% 4.69
----------------------------------------------------------------------------------------------------------------------
-- -- -- 2,304 (3) 1.3% 4.69
Etienne Gagnon ------------------------------------------------------------------------------------------------
-- -- -- 7,500 (4) 4.3% 4.69
----------------------------------------------------------------------------------------------------------------------
Other executives -- -- -- 9,249 (3) 5.2% 4.69
officers as a group ------------------------------------------------------------------------------------------------
-- -- -- 31,500 (4) 17.9% 4.69
----------------------------------------------------------------------------------------------------------------------
All of the directors
and executive officers
as a group -- -- -- 35,185 (3) 20.0% 4.69
----------------------------------------------------------------------------------------------------------------------
23,734 100% 4.47 129,000 (4) 73.2% 4.69
----------------------------------------------------------------------------------------------------------------------
-------------------------
(1) The weighted average fair value at the time of grant is the average of
the fair value at the time of grant of a DSU which is equal to the market
value of a Subordinate Voting Share at the time DSUs are credited to the
Directors.
(2) The fair value at the time of grant of a RSU is equal to the market value
of Subordinate Voting Shares at the time RSUs are granted.
(3) Those RSUs will vest on the fifth anniversary date of the grant in
January 2005 but are subject to early vesting on the third and fourth
anniversary date of the grant on the attainment of performance objectives
as determined by the Board of Directors. Accordingly, subject to the
attainment of performance objectives, the first early vesting is up to
1/3 of the units on the third anniversary date of the grant and the
second early vesting is up to 50% of the remaining units on the fourth
anniversary date of the grant.
(4) Those RSUs will vest at a rate of 55%, 35% and 10%, on the third, fourth
and fifth anniversary dates of the grant in January 2005.
(5) Those DSUs will vest at the time Director cease to be a member of the
Board of the Corporation.
87
ESCROWED SECURITIES
The following table presents information regarding the number of
securities of each class of the Corporation held, to the Corporation's
knowledge as of November 1, 2005, in escrow and the percentage outstanding
securities of that class.
DESIGNATION OF CLASS NUMBER OF SECURITIES HELD IN ESCROW PERCENTAGE OF CLASS
-------------------- ----------------------------------- -------------------
Subordinate Voting Shares 493,096 (1) 1.6%
Multiple Voting Shares -- --
---------------------
(1) CIBC Mellon Trust Company is the Escrow agent. The shares held in Escrow
will be released to shareholder on October 4, 2006.
88
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 November 1, 2005 by persons or groups of
affiliated persons known by us to own more than 5% of our voting shares.
TOTAL PERCENTAGE OF
MULTIPLE VOTING SHARES SUBORDINATE VOTING SHARES -------------------
BENEFICIALLY OWNED (1) BENEFICIALLY OWNED (1) VOTING POWER
------------------------- -------------------------- -------------------
NAME NUMBER PERCENT NUMBER PERCENT PERCENT
---------------------------- ---------- --------- ---------- ---------- -------------------
Germain Lamonde (2) 37,900,000 100% 230,982 * 92.57%
Fiducie Germain Lamonde (3) 1,900,000 5% Nil Nil 4.64%
G. Lamonde Investissements
Financiers inc. (4) 36,000,000 95% Nil Nil 87.88%
Placements Lamonde, SENC (5) Nil Nil 93,000 * *
Kern Capital Management, LLC (6) Nil Nil 4,658,000 15.19% 1.14%
FMR Corporation (7) Nil Nil 4,597,100 14.99% 1.12%
Skyline Asset Management LP (8) Nil Nil 1,893,100 6.17% *
---------------------------
* 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) As of September 30, 2005, 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.
(7) As of September 30, 2005, 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.
(8) As of September 30, 2005, Skyline Asset Management LP apparently controls
the voting rights attached to this number of subordinate voting shares
but we were unable to obtain a confirmation from Skyline.
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 November 21, 2005, 30,674,617 subordinate voting shares were
outstanding. Approximately 96% (29,525,530) of our subordinate voting shares
were held in bearer form and the remainder (1,149,087 subordinate voting
shares) was held by 178 record holders. As of November 21, 2005, we believe
approximately 58% of our outstanding subordinate voting shares were held in
the United States.
89
B. RELATED PARTY TRANSACTIONS
INDEBTEDNESS OF DIRECTORS, EXECUTIVE OFFICERS AND EMPLOYEES
We have guaranteed the repayment of a loan granted to an employee by
a financial institution for the purchase of our Class "F" shares that were
converted into subordinate voting shares immediately prior to our initial
public offering. As of August 31, 2005 and November 1, 2005, the total
principal amount guaranteed by us was $56,200.
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.
90
ITEM 8. FINANCIAL INFORMATION
A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION
See Item 18, "Financial Statements" for certain information required by this
section.
Valuation and qualifying accounts as well as Export sales are as follows (in
thousands of US dollars);
ALLOWANCE FOR DOUBTFUL ACCOUNTS
YEARS ENDED AUGUST 31,
-------------------------------------------------------
2005 2004 2003
--------------- -------------- --------------
Balance - Beginning of year $ 510 $ 568 $ 520
Addition charged to earnings 316 403 619
Write-offs of uncollectible accounts (23) (48) (288)
Recovery of uncollectible accounts (464) (456) (315)
Foreign currency translation adjustment 13 43 32
--------------- -------------- --------------
Balance - End of year $ 352 $ 510 $ 568
=============== ============== ==============
VALUATION ALLOWANCE ON FUTURE INCOME TAX ASSETS
YEARS ENDED AUGUST 31,
-------------------------------------------------------
2005 2004 2003
--------------- -------------- --------------
Balance - Beginning of year $ 32,613 $ 28,846 $ 359
Addition charged to earnings 3,375 3,954 28,385
Foreign currency translation adjustment 2,418 (187) 102
--------------- -------------- --------------
Balance - End of year $ 38,406 $ 32,613 $ 28,846
=============== ============== ==============
EXPORT SALES
Export and domestic sales in thousands of US dollars and as a percentage of
total sales are as follows:
YEARS ENDED AUGUST 31,
--------------------------------------------------------------------------------
2005 2004 2003
------------------------ ------------------------ ------------------------
Export Sales $ 90,386 93% $ 68,812 92% $ 57,124 92%
Domestic Sales 6,830 7 5,818 8 4,806 8
------------------------ ------------------------ ------------------------
$ 97,216 100% $ 74,630 100% $ 61,930 100%
======================== ======================== ========================
91
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. This class action alleges that the company's registration statement and
prospectus filed with the Securities and Exchange Commission on June 29, 2000,
contained material misrepresentations and/or omissions resulting from (i) the
underwriters allegedly soliciting and receiving additional, excessive and
undisclosed commissions from certain investors in exchange for which they
allocated material portions of the shares issued in connection with the
company's Initial Public Offering; and (ii) the underwriters allegedly
entering into agreements with customers whereby shares issued in connection
with the company's Initial Public Offering would be allocated to those
customers in exchange for which customers agreed to purchase additional
amounts of shares in the after-market at pre-determined prices.
On April 19, 2002, the plaintiffs filed an amended complaint containing master
allegations against all of the underwriters in all of the 310 cases included
in this class action and also filed an amended complaint containing
allegations specific to four of the company's underwriters, the company and
two of its executive officers. In addition to the allegations mentioned above,
the amended complaint alleges that the underwriters (i) used their analysts to
manipulate the stock market; and (ii) implemented schemes that allowed issuer
insiders to sell their shares rapidly after an initial public offering and
benefit from high market prices. As concerns the company and its two executive
officers in particular, the amended complaint alleges that (i) the company's
registration statement was materially false and misleading because it failed
to disclose the additional commissions and compensation to be received by
underwriters; (ii) the two named executive officers learned of or recklessly
disregarded the alleged misconduct of the underwriters; (iii) the two named
executive officers had motive and opportunity to engage in alleged wrongful
conduct due to personal holdings of the company's stock and the fact that an
alleged artificially inflated stock price could be used as currency for
acquisitions; and (iv) the two named executive officers, by virtue of their
positions with the company, controlled the company and the contents of the
registration statement and had the ability to prevent its issuance or cause it
to be corrected. The plaintiffs in this suit seek an unspecified amount for
damages suffered.
In July 2002, the issuers filed a motion to dismiss the plaintiffs' amended
complaint and judgment was rendered on February 19, 2003. Only one of the
claims against the company was dismissed. On October 8, 2002, the claims
against its officers were dismissed pursuant to the terms of Reservation of
Rights and Tolling Agreements entered into with the plaintiffs.
In June 2003, a committee of the company's Board of Directors conditionally
approved a proposed settlement between the issuer defendants, the individual
defendants, and the plaintiffs. If approved, the settlement would provide,
among other things, a release of the company and of the individual defendants
for the conduct alleged in the action to be wrongful in the amended complaint.
The company would agree to undertake other responsibilities under the
settlement, including agreeing to assign away, not assert, or release certain
potential claims the company may have against its underwriters. Any direct
financial impact of the proposed settlement is expected to be borne by the
company's insurance carriers.
On June 25, 2004, the Plaintiffs moved for Preliminary Approval of the
settlement. The court granted the preliminary approval motion on February 15,
2005, subject to certain modifications.
92
On August 31, 2005, the court issued a preliminary order further approving the
modifications to the settlement and certifying the settlement classes. The
court also appointed the Notice Administrator for the settlement and ordered
that notice of the settlement be distributed to all settlement class members
beginning on November 15, 2005, and completed by January 15, 2006. The
settlement fairness hearing has been set for April 26, 2006. Following the
hearing, if the court determines that the settlement is fair to the class
members, the settlement will be approved. There can be no assurance that this
proposed settlement would be approved and implemented in its current form, or
at all. Therefore, it is not possible to predict the final outcome of the
case, nor 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, 2005.
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.
B. SIGNIFICANT CHANGES
No significant changes occurred since the date of our annual consolidated
financial statements included elsewhere in this Annual Report.
93
ITEM 9. OFFER AND LISTING
Not Applicable, except for Item 9A (4) and Item 9C.
NASDAQ (US$) TSX (CDN$)
HIGH LOW HIGH LOW
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
September 1, 2004 to August 31, 2005 5.51 3.92 6.90 4.92
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
2005 2nd Quarter 5.24 4.29 6.42 5.35
2005 3rd Quarter 4.99 3.93 6.05 4.95
2005 4th Quarter 5.00 3.92 6.10 4.92
2005 May 4.28 3.93 5.30 4.95
2005 June 4.62 3.92 5.71 4.92
2005 July 4.91 4.12 6.05 5.12
2005 August 5.00 4.61 6.10 5.53
2005 September 5.00 4.76 5.92 5.60
2005 October 5.05 4.32 5.89 5.15
2005 November 4.75 4.43 5.71 5.24
(until November 21)
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 November 21, 2005, the last reported sale price for our
subordinate voting shares on the NASDAQ National Market was US$ 4.72 per share
and the last reported sale price for our subordinate voting shares on the
Toronto Stock Exchange was CA$ 5.62 per share.
94
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
dated June 9, 2000 (File 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-exempt
95
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.
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The following discussion is for general information only and is not
intended to be, nor should it be construed to be, legal or tax advice to any
holder of subordinate voting shares and no opinion or representation with
respect to the U.S. federal income tax consequences to any holder is made.
Holders of subordinate voting shares are urged to consult their tax advisors
as to the particular consequences to them under U.S. federal, state, local and
applicable foreign tax laws of the acquisition, ownership and disposition of
subordinate voting shares.
DIVIDENDS
Subject to the discussion of passive foreign investment companies
below, the gross amount of any distribution paid by us to a U.S. Holder will
generally be subject to U.S. federal income tax as foreign source dividend
income to the extent paid out of our current or accumulated earnings and
profits, as determined under U.S. federal income tax principles. Such income
will be includable in the gross income of a U.S. Holder on the day received by
the U.S. Holder. The amount of any distribution of property other than cash
will be the fair market value of such property on the date of the
distribution. In the case of a taxable corporate U.S. Holder, such dividends
will be taxable as ordinary income and will not be eligible for the corporate
dividends received deduction, which is generally allowed to U.S. corporate
shareholders on dividends received from a domestic corporation. In the case of
an individual U.S. Holder, under recently enacted tax legislation such
dividends should generally be eligible for a maximum tax rate of 15% for
dividends received before January 1, 2009, provided such holder holds the
subordinate voting shares for at least 60 days and certain other conditions
are satisfied, including, as we believe to be the case, that we are not a
"passive foreign investment company" 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
97
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:
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
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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.
FOREIGN PERSONAL HOLDING COMPANY
Under recently enacted legislation, the foreign personal holding
company rules are repealed for taxable years of U.S. shareholders ending after
December 31, 2004.
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 as
well as the composition and valuation of our assets. In particular, a
significant portion of our gross assets are comprised of cash and short-term
investments, which the PFIC rules treat as passive without regard to the
purpose for which we hold those assets. If the proportion of these passive
assets were to increase relative to the fair market value of our other assets,
we may be treated as a passive foreign investment company. 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.
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
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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 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
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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.
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
101
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.
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.
102
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 at 100 F
Street, N.E., 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.
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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 risks due to the export of our Canadian-manufactured products, the
large majority of which are denominated in US dollars. These risks are
partially hedged by operating expenses denominated in US dollars, the purchase
of raw materials in US dollars and forward exchange contracts. The increased
strength of the Canadian dollar, compared to the US dollar, over the last two
years caused our operating expenses, as well as our foreign exchange loss, to
increase. Any further increase in the value of the Canadian dollar in the
upcoming months will negatively affect our results of operations.
We enter into forward exchange contracts to manage the risk of
exchange rate fluctuations between the Canadian and US dollar on cash flows
related to anticipated future revenue streams denominated in US dollars. We do
not enter into forward exchange contracts for hedging purposes.
Considering the significant increase in the value of the Canadian
dollar compared to the US dollar during fiscal 2005, we entered into
additional forward exchange contracts to protect our results of operations. As
at August 31, 2004, we held forward exchange contracts to sell US dollars at
various forward exchange rates with a contractual value of $15.9 million
compared to $33.6 million as at August 31, 2005.
The following table summarizes the forward exchange contracts in
effect as at August 31, 2005, classified by expected transaction dates, none
of which exceed three fiscal years, as well as the notional amounts of such
contracts (in thousands of US dollars) along with the weighted average
contractual exchange 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,
------------------------------------
2006 2007 2008
---------- ---------- ----------
Forward exchange contracts to sell US
dollars in exchange
for Canadian dollars
Contractual amounts................................... $ 26,000 $ 7,000 $ 600
Weighted average contractual exchange rates........... 1.2630 1.2516 1.2314
FAIR VALUE
The fair value of forward exchange contracts, which represents the
difference between their contractual amounts and their current trading values,
amounted to an unrecognized gain of $2,937,000 as at August 31, 2005.
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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. As at
August 31, 2005, our available-for-sale securities consist of debt instruments
issued by six (seven in 2004) 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.
For the purposes of managing our cash position, we have established a cash
management policy, which we follow and monitor on a regular basis. These
available-for-sale securities will be used for working capital and other
general corporate purposes, including potential acquisitions.
CREDIT RISK
Financial instruments that potentially subject us to credit risk
consist primarily of our cash, our short-term investments, our accounts
receivable and our forward exchange contracts. As mentioned in the interest
rate risk section, our short-term investments consist of debt instruments
issued by high-credit quality corporations and trusts. Our cash and forward
exchange contracts are held with or issued by high-credit quality financial
institutions; therefore, we consider the risk of non-performance on these
instruments to be remote.
Generally, we do 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, we perform
ongoing credit reviews of all our customers and establish an allowance for
doubtful accounts receivable when accounts are determined to be uncollectible.
Allowance for doubtful accounts amounted to $510,000 and $352,000 as at August
31, 2004 and 2005, respectively.
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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
Under the supervision and with the participation of our management,
including the Chief Executive Officer and Chief Financial Officer, we have
evaluated the effectiveness of our disclosure controls and procedures as of
the end of the period covered by this annual report. Based on that evaluation,
the Chief Executive Officer and Chief Financial Office have concluded that
these disclosure controls and procedures are effective. There were no changes
in our internal control over financial reporting during the period covered by
this annual report that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.
106
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. For a description of Mr. Tremblay's
education and experience, please refer to Item 6A. The other members of the
Audit Committee are Mr. Pierre Marcouiller, Mr. Guy Marier and Mr. Michael
Unger which are all Independent. For a description of their respective
education and experience, please also refer to Item 6A.
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. In March 2005, the Board updated and
adopted the following policies:
o Board of Directors Corporate Governance Guidelines;
o Code of Ethics for our Principal Executive Officer and Senior
Financial Officers;
o Ethics and Business Conduct Policy;
o Statement of Reporting Ethical Violations (Whistle Blower).
A copy of those policies has been filed respectively as exhibits 11.2
to 11.5 inclusively to this annual report. All these policies are also readily
available on our website at www.exfo.com. Accordingly, we believe that our
corporate governance practices are in alignment to current regulatory
requirements.
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, 2004 and August 31, 2005,
our principal accountant, PricewaterhouseCoopers LLP, billed us aggregate
amounts of $189,000 and $214,000, respectively for the audit of our annual
consolidated financial statements and services in connection with statutory
and regulatory filings.
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AUDIT-RELATED FEES
During the financial years ended August 31, 2004 and August 31, 2005,
our principal accountant, PricewaterhouseCoopers LLP, billed us aggregate
amounts of nil and $62,000, respectively for services related to
Sarbanes-Oxley Act.
TAX FEES
During the financial years ended August 31, 2004 and August 31, 2005,
our principal accountant, PricewaterhouseCoopers LLP, billed us aggregate
amounts of $301,000 and $185,000, 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.
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, 2005, 100% of tax fees
were approved by the audit committee pursuant to this policy. During the
financial year ended on August 31, 2005, 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.
108
PART III.
---------
ITEM 17. FINANCIAL STATEMENTS
Not Applicable.
ITEM 18. FINANCIAL STATEMENTS
See pages F-2 to F-42.
109
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 filed on June 9, 2000, 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, File No. 000-30895).
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, File No. 000-30895).
2.1 Form of Subordinate Voting Share Certificate (incorporated by reference to Exhibit 4.1 of EXFO's
Registration Statement on Form F-1 filed on June 9, 2000, 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 filed on
June 9, 2000, 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 filed on June 9, 2000, 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, File No. 000-30895).
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, File No. 000-30895).
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, File No. 000-30895).
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, File No. 000-30895).
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 filed on June 9, 2000, 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 filed on July 13, 2001, 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
filed on July 13, 2001 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, File No. 000-30895).
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 filed on July 13, 2001 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 filed on June 9, 2000,
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 filed on
June 9, 2000, File No. 333-38956).
110
NUMBER EXHIBIT
-------------- ---------------------------------------------------------------------------------------------------
4.12 Lease Agreement, dated March 1, 1996, between EXFO and GEXFO Investissements Technologiques inc.,
as assigned to 9080-9823 Quebec inc. on September 1, 1999 (including summary in English)
(incorporated by reference to Exhibit10.5 of EXFO's Registration Statement on Form F-1 filed on
June 9, 2000, 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, File No. 000-30895).
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 filed on June 9, 2000,
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 filed on June 9, 2000, 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
filed on June 9, 2000, 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 filed on June 9, 2000, 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 filed on June 9, 2000, 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, File No. 000-30895).
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, File No.
000-30895).
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, File No. 000-30895).
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 filed on June 9, 2000, 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 filed on June 9, 2000, 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 filed on June 9, 2000, 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 filed on June 9, 2000, 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, File No. 000-30895).
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, File No. 000-30895).
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, File No. 000-30895).
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, File No. 000-30895).
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, File No.
000-30895).
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, File No.
000-30895).
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, File No.
000-30895).
111
NUMBER EXHIBIT
-------------- ---------------------------------------------------------------------------------------------------
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, File No. 000-30895).
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, File No. 000-30895).
4.35 Long-Term Incentive Plan, dated May 25, 2000, amended in October 2004 and effective January 12,
2005.
4.36 Deferred Share Unit Plan, effective January 12, 2005.
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, File No. 000-30895).
11.2 Board of Directors Corporate Governance Guidelines.
11.3 Code of Ethics for our Principal Executive Officer and Senior Financial Officers.
11.4 Ethics and Business Conduct Policy.
11.5 Statement of Reporting Ethical Violations (Whistle Blower).
11.6 Audit Committee Charter.
11.7 Human Resources Committee Charter.
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.
112
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: November 23, 2005.
113
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 reasonably 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.
114
Date: November 23, 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, 2005 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: November 23, 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.
115
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 reasonably 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.
116
Date: November 23, 2005.
/s/ Pierre Plamondon
----------------------------
Pierre Plamondon, CA
Vice-President Finance
and Chief Financial 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, 2005 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: November 23, 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.
117
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, 2005 and 2004 and the consolidated statements of earnings,
deficit and contributed surplus and cash flows for each of the three years in
the period ended August 31, 2005. 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 financial statements present fairly, in all material
respects, the financial position of the Company as at August 31, 2005 and 2004
and the results of its operations and its cash flows for each of the three
years in the period ended August 31, 2005 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 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, 2005
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, 2005 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, 2005
EXFO ELECTRO-OPTICAL ENGINEERING INC.
CONSOLIDATED BALANCE SHEETS
(in thousands of US dollars)
AS AT AUGUST 31,
-----------------------------
2005 2004
--------- ---------
ASSETS
CURRENT ASSETS
Cash $ 7,119 $ 5,159
Short-term investments (notes 8 and 18) 104,883 83,969
Accounts receivable (notes 8 and 18)
Trade 13,945 12,080
Other 2,007 1,532
Income taxes and tax credits recoverable (notes 4 and 8) 2,392 7,836
Inventories (notes 4, 5 and 8) 17,749 15,371
Prepaid expenses 1,112 1,513
--------- ---------
149,207 127,460
INCOME TAXES AND TAX CREDITS RECOVERABLE (notes 4 and 8) 459 449
PROPERTY, PLANT AND EQUIPMENT (notes 4, 6 and 8) 13,719 15,442
LONG-LIVED ASSET HELD FOR SALE (note 4) 1,600 1,600
INTANGIBLE ASSETS (notes 4, 7 and 8) 5,602 9,447
GOODWILL (notes 4 and 7) 20,370 18,393
--------- ---------
$ 190,957 $ 172,791
========= =========
LIABILITIES
CURRENT LIABILITIES
Accounts payable and accrued liabilities (note 9) $ 12,201 $ 11,393
Deferred revenue 1,584 805
Current portion of long-term debt 134 121
--------- ---------
13,919 12,319
DEFERRED REVENUE 1,568 1,123
GOVERNMENT GRANTS (note 15) 1,872 1,690
LONG-TERM DEBT (note 10) 198 332
--------- ---------
17,557 15,464
--------- ---------
COMMITMENTS (note 11)
CONTINGENCIES (note 12)
SHAREHOLDERS' EQUITY
Share capital (note 13) 521,875 521,733
Contributed surplus 2,949 1,986
Deficit (381,846) (380,212)
Cumulative translation adjustment 30,422 13,820
--------- ---------
173,400 157,327
--------- ---------
$ 190,957 $ 172,791
========= =========
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,
----------------------------------------------
2005 2004 2003
-------- -------- --------
SALES (note 19) $ 97,216 $ 74,630 $ 61,930
COST OF SALES (1,2) 44,059 34,556 36,197
-------- -------- --------
GROSS MARGIN 53,157 40,074 25,733
-------- -------- --------
OPERATING EXPENSES
Selling and administrative (1) 31,782 25,890 26,991
Net research and development (1) (notes 4 and 15) 12,190 12,390 15,879
Amortization of property, plant and equipment 4,256 4,935 5,210
Amortization of intangible assets 4,836 5,080 5,676
Impairment of long-lived assets and goodwill (note 4) -- 620 7,427
Restructuring and other charges (note 4) 292 1,729 4,134
-------- -------- --------
TOTAL OPERATING EXPENSES 53,356 50,644 65,317
-------- -------- --------
LOSS FROM OPERATIONS (199) (10,570) (39,584)
Interest and other income 2,524 1,438 1,245
Foreign exchange loss (1,336) (278) (1,552)
-------- -------- --------
EARNINGS (LOSS) BEFORE INCOME TAXES (note 16) 989 (9,410) (39,891)
INCOME TAXES (notes 4 and 16) 2,623 (986) 15,059
-------- -------- --------
NET LOSS FOR THE YEAR $ (1,634) $ (8,424) $(54,950)
======== ======== ========
BASIC AND DILUTED NET LOSS PER SHARE $ (0.02) $ (0.13) $ (0.87)
BASIC WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING (000'S) 68,526 66,020 62,852
DILUTED WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING (000'S)
(note 17) 68,981 66,615 63,317
(1) STOCK-BASED COMPENSATION
COSTS INCLUDED IN: (note 14)
Cost of sales $ 143 $ 62 $ --
Selling and administrative 626 265 --
Net research and development 194 122 --
-------- -------- --------
$ 963 $ 449 $ --
======== ======== ========
(2) The cost of sales is exclusive of amortization, shown separately. The cost of sales for the year ended
August 31, 2003 includes inventory write-offs of $4,121 (note 4).
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,
-------------------------------------------------
2005 2004 2003
--------- --------- ---------
BALANCE - BEGINNING OF YEAR $(380,212) $(371,788) $(316,838)
ADD
Net loss for the year (1,634) (8,424) (54,950)
--------- --------- ---------
BALANCE - END OF YEAR $(381,846) $(380,212) $(371,788)
========= ========= =========
CONTRIBUTED SURPLUS
YEARS ENDED AUGUST 31,
-------------------------------------------------
2005 2004 2003
--------- --------- ---------
BALANCE - BEGINNING OF YEAR $1,986 $1,519 $1,487
ADD
Premium on resale of share capital -- 18 32
Stock-based compensation costs 963 449 --
------ ------ ------
BALANCE - END OF YEAR $2,949 $1,986 $1,519
====== ====== ======
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,
------------------------------------------------
2005 2004 2003
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss for the year $ (1,634) $ (8,424) $ (54,950)
Add (deduct) items not affecting cash
Discount on short-term investments (302) 197 (96)
Stock-based compensation costs 963 449 --
Inventory and tax credit write-offs -- -- 6,418
Amortization 9,092 10,015 10,886
Impairment of long-lived assets and goodwill -- 620 7,427
Restructuring and other charges -- 1,261 512
Future income taxes -- -- 10,138
Deferred revenue 977 1,404 (24)
Government grants -- 154 817
--------- --------- ---------
9,096 5,676 (18,872)
Change in non-cash operating items
Accounts receivable (838) (2,677) 3,957
Income taxes and tax credits 6,096 (2,464) 13,489
Inventories (699) 1,016 7,925
Prepaid expenses 544 (449) (569)
Accounts payable and accrued liabilities (164) (351) (349)
--------- --------- ---------
14,035 751 5,581
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to short-term investments (585,665) (653,348) (401,105)
Proceeds from disposal and maturity of short-term
investments 574,207 624,722 395,699
Additions to property, plant and equipment and
intangible assets (1,501) (851) (2,652)
Business combination -- (241) (1,867)
--------- --------- ---------
(12,959) (29,718) (9,925)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Repayment of long-term debt (121) (109) (133)
Net proceeds of offering (note 13) -- 29,164 --
Share issue expenses (6) (137) --
Exercise of stock options 148 254 45
Redemption of share capital -- (5) (16)
Resale of share capital -- 23 48
--------- --------- ---------
21 29,190 (56)
EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON CASH 863 (430) 638
--------- --------- ---------
CHANGE IN CASH 1,960 (207) (3,762)
CASH - BEGINNING OF YEAR 5,159 5,366 9,128
--------- --------- ---------
CASH - END OF YEAR $ 7,119 $ 5,159 $ 5,366
========= ========= =========
SUPPLEMENTARY INFORMATION
Interest paid $ 30 $ 408 $ 417
Income taxes paid (recovered) $ (669) $ 120 $ (10,351)
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 line of test and measurement solutions for the
global telecommunications industry. The Telecom Division, which
represents the company's main business activity, offers integrated test
solutions to network service providers, cable operators, system vendors
and optical component manufacturers. The Life Sciences and Industrial
Division mainly leverages core telecom technologies to offer value-added
solutions life sciences applications and high-precision assembly
processes, such as those required for microelectronics, optoelectronics
and medical devices. EXFO's products are sold in approximately 70
countries around the world.
2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
These consolidated financial statements have been prepared in accordance
with generally accepted accounting principles ("GAAP") in Canada and
significant differences in measurement and disclosure from U.S. GAAP are
set out in note 21. These consolidated financial statements include the
accounts of the company and its domestic and international subsidiaries.
All significant intercompany accounts and transactions have been
eliminated.
ACCOUNTING ESTIMATES
The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities
and the disclosures of contingent assets and liabilities at the date of
the financial statements, as well as the reported amounts of revenues and
expenses during the reporting years. Significant estimates include the
allowance for doubtful accounts receivable, tax credits recoverable,
provision for excess and obsolete inventories, useful lives of capital
assets, valuation of intangible assets and goodwill, future income taxes
valuation allowance, certain accrued liabilities and stock-based
compensation costs. Actual results could differ from those estimates.
REPORTING CURRENCY
The functional currency of the company is the Canadian dollar. The
company has adopted the US dollar as its reporting currency. The
financial statements are translated into the reporting currency using the
current rate method. Under this method, the financial statements are
translated into the reporting currency as follows: assets and liabilities
are translated at the exchange rate in effect on the date of the balance
sheet, while revenues and expenses are translated at the monthly average
exchange rate. All gains and losses resulting from the translation of the
financial statements from the functional currency to 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 on the date
of the balance sheet, and revenues and expenses are translated at the
exchange rate in effect on the date of the transaction. Non-monetary
assets and liabilities are translated at historical rates. 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 on the date of the balance sheet. Non-monetary assets and
liabilities are remeasured at historical rates, unless such assets and
liabilities are carried at market, in which case, they are translated at
the exchange rate in effect on the date of the balance sheet. 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 to manage its
foreign currency exposure. The company's policy is not to utilize those
derivative financial instruments for trading or speculative purposes.
The company's forward exchange contracts, which are used to hedge
anticipated US-dollar-denominated sales, qualify for hedge accounting;
therefore, foreign exchange translation gains and losses on these
contracts are recognized as an adjustment of the revenues when the
corresponding hedged sales are recorded.
Realized and unrealized gains or losses associated with forward exchange
contracts, which have been terminated or cease to be effective prior to
maturity, are deferred in the balance sheet and recognized in the
earnings of the period in which the underlying hedged transaction is
recognized.
SHORT-TERM INVESTMENTS
Short-term investments are valued at the lower of cost and market value.
Cost consists of acquisition cost plus amortization of discount or less
amortization of premium. All investments with original maturity of three
months or less and that are not required for the purposes of meeting
short-term cash requirements are classified as short-term investments.
INVENTORIES
Inventories are valued on an average cost basis, at the lower of cost and
replacement cost for raw materials and at the lower of cost and net
realizable value for work in progress and finished goods.
F-7
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share data
and as otherwise noted)
PROPERTY, PLANT AND EQUIPMENT AND AMORTIZATION
Property, plant and equipment are recorded at cost less related
government grants and research and development tax credits. Amortization
is provided on a straight-line basis over the estimated useful lives as
follows:
TERM
Land improvements 5 years
Buildings 25 years
Equipment 2 to 10 years
Leasehold improvements The lesser of useful life and
remaining lease term
INTANGIBLE ASSETS, GOODWILL AND AMORTIZATION
Intangible assets primarily include the cost of core technology and
software, net of accumulated amortization. Core technology represents the
existing technology acquired in business combinations that has reached
technological feasibility. Amortization is provided on a straight-line
basis over the estimated useful lives of five years for core technology
and four and ten years for software.
Goodwill represents the excess of the purchase price of acquired
businesses over the estimated fair value of net identifiable assets
acquired. Goodwill is not amortized but must be tested for impairment on
an annual basis or more frequently if events or circumstances indicate
that it might be impaired. Recoverability of goodwill is determined at
the reporting unit level using a two-step approach. First, the carrying
value of a reporting unit is compared to its fair value, which is
determined based on a combination of discounted future cash flows and a
market approach. If the carrying value of a reporting unit exceeds its
fair value, the second step is performed. In this step, the amount of
impairment loss, if any, represents the excess of the carrying value of
goodwill over its fair value and the loss is charged to earnings in the
period in which it is incurred. For the purposes of this impairment test,
the fair value of goodwill is estimated in the same way as goodwill is
determined in business combinations; that is, the excess of the fair
value of a reporting unit over the estimated fair value of its net
identifiable assets.
The company elected to perform its annual impairment test in May of each
fiscal year for all its existing reporting units and it recorded an
impairment charge for goodwill in fiscal 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 an asset or group of assets is greater
than the undiscounted future cash flows expected to be provided by the
asset or group of assets. The amount of impairment loss, if any, is the
excess of the carrying value over the fair value. The company assesses
fair value of long-lived assets based on discounted future cash flows.
The company recorded impairment charges for long-lived assets in fiscal
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 separately priced extended warranties are
expensed as incurred.
REVENUE RECOGNITION
For products in which software is incidental, the company recognizes
revenue when persuasive evidence of an arrangement exists, the product
has been delivered, the price is fixed and determinable, and collection
of the resulting receivable is reasonably assured. In addition,
provisions are made for estimated returns, warranties and support
obligations.
For products in which software is not incidental, revenues are separated
into two categories: product and post-contract customer support (PCS)
revenues, based upon vendor-specific objective evidence of fair value.
Product revenues for these sales are recognized as described above. PCS
revenues are deferred and recognized ratably over the years of the
support arrangement. PCS revenues are recognized at the time the product
is delivered when provided within one year of delivery; the costs of
providing this support are insignificant (and accrued at the time of
delivery) and no software upgrades are provided.
For all sales, the company uses a binding purchase order as evidence that
a sales arrangement exists.
Delivery generally occurs when the product is handed over to a
transporter for shipment.
At the time of the transaction, the company assesses whether the price
associated with its revenue transaction is fixed and determinable and
whether or not collection is reasonably assured. The company assesses
whether the price is fixed and determinable based on the payment terms
associated with the transaction. The company assesses collection based on
a number of factors, including past transaction history and the
creditworthiness of the customer. Generally, collateral or other security
is not requested from customers.
Most sales arrangements do not generally include acceptance clauses.
However, when a sales arrangement does include an acceptance provision,
acceptance occurs upon the earliest of receipt of a written customer
acceptance or expiration of the acceptance period. For these sales
arrangements, the sale is recognized when acceptance occurs.
Revenue for extended warranties is recognized on a straight-line basis
over the warranty period.
ADVERTISING COSTS
Advertising costs are expensed as incurred.
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
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 during which the created job
must be maintained or training provided. Grants are included in earnings
or deducted from the related assets, provided there is reasonable
assurance that the company has complied and will comply with all the
conditions related to the grant.
RESEARCH AND DEVELOPMENT EXPENSES
All expenses related to research, as well as development activities that
do not meet generally accepted criteria for deferral are expensed as
incurred, net of related tax credits and government grants. Development
expenses that meet generally accepted criteria for deferral, in
accordance with the Canadian Institute of Chartered Accountants (CICA)
handbook Section 3450, "Research and Development", are capitalized, net
of related tax credits and government grants, and are amortized against
earnings over the estimated benefit period. Research and development
expenses are mainly comprised of salaries and related expenses, material
costs as well as fees paid to third-party consultants.
As at August 31, 2005, the company had not deferred any development costs.
INCOME TAXES
The company provides for income taxes using the liability method of tax
allocation. Under this method, future income tax assets and liabilities
are determined based on deductible or taxable temporary differences
between financial statement values and tax values of assets and
liabilities, using enacted income tax rates for the years in which the
differences are expected to reverse.
The company establishes a valuation allowance against future income tax
assets if, based on available information, it is more likely than not
that some or all of the future income tax assets will not be realized.
Since 2003, the company records a full valuation allowance against future
income tax assets (notes 4 and 16).
EARNINGS PER SHARE
Basic earnings per share are determined using the weighted average number
of common shares outstanding during the year.
Diluted earnings per share are determined using the weighted average
number of common shares outstanding during the year, plus the effect of
dilutive potential common shares outstanding during the year. This method
requires that diluted earnings per share be calculated (using the
treasury stock method) as if all dilutive potential common shares had
been exercised at the latest at the beginning of the year or on the date
of issuance, as the case may be, and that the funds obtained thereby
(plus an amount equivalent to the unamortized portion of related
stock-based compensation costs) be used to purchase common shares of the
company at the average market price of the common shares during the year.
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)
STOCK-BASED COMPENSATION COSTS
Since September 1, 2003, the company accounts for all forms of employee
stock-based compensation using the fair value-based method. Stock-based
compensation costs are amortized to expense over the vesting periods.
Prior to fiscal 2004, no stock-based compensation costs were recognized
for employee stock-based compensation. However, the company is required
to disclose pro forma information with respect to net 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 outstanding
stock options granted prior to September 1, 2003 (note 14).
NEW ACCOUNTING STANDARDS AND PRONOUNCEMENTS
ADOPTED IN FISCAL 2005
On September 1, 2004, the company prospectively adopted the CICA handbook
Sections 1100 and 1400, "Generally Accepted Accounting Principles" and
"General Standards of Financial Statement Presentation". 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 adoption of these new standards
had no impact on the financial statements of the company.
TO BE ADOPTED AFTER FISCAL 2005
In January 2005, the CICA issued four new accounting standards in
relation to financial instruments: Section 3855, "Financial Instruments -
Recognition and measurement"; Section 3865, "Hedges"; Section 1530,
"Comprehensive Income"; and Section 3251, "Equity".
Section 3855 expands on Section 3860, "Financial Instruments - Disclosure
and Presentation", by prescribing when a financial instrument is to be
recognized on the balance sheet and at what amount. It also specifies how
financial instrument gains and losses are to be presented in the
financial statements.
Section 3865 provides an alternative to Section 3855 for entities that
choose to designate qualifying transactions as hedges for accounting
purposes. It replaces and expands on Accounting Guideline 13, "Hedging
Relationships", and on the hedging guidance in Section 1650, "Foreign
Currency Translation", by specifying how hedge accounting is applied and
what disclosures it requires.
Section 1530, "Comprehensive Income", introduces a new requirement to
temporarily present certain gains and losses outside net income.
Consequently, Section 3250, "Surplus", has been revised as Section 3251,
"Equity".
Sections 1530, 3251, 3855 and 3865 apply to fiscal years beginning on or
after October 1, 2006. The company will adopt these new standards on
September 1, 2007. While the company is currently assessing the effects
of these new standards, impacts consistent with the adjustments described
under note 21 item b) of these consolidated financial statements are
expected.
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)
3 BUSINESS COMBINATION
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 of $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
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 allocated to 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 have
been 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.
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
==========
Acquired goodwill is deductible for income tax purposes.
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)
4 SPECIAL CHARGES
IMPAIRMENT OF LONG-LIVED ASSETS AND GOODWILL
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
at the time, 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 estimates of the fair values and the
undiscounted future cash flows, including industry conditions, reflected
management's best estimations.
2004
In fiscal 2004, the company put one of its buildings (located in Quebec
City) up for sale and received, at the beginning of fiscal 2005, a formal
purchase offer for this building. Based on that offer, the company
concluded that the building was impaired and it recorded an impairment
loss of $620,000 in fiscal 2004, representing the excess of the carrying
value of the building over its expected selling price. However, during
the first quarter of fiscal 2005, some conditions of the formal offer
were not met and the offer was declined. During fiscal 2005, the company
withdrew the building from the market. As at August 31, 2004, the
building was not shown as a long-lived asset held for sale in the balance
sheet because it was still used by the company and, consequently, it was
not available for immediate sale. This building reports to the Telecom
Division.
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)
RESTRUCTURING AND OTHER CHARGES AND INVENTORY WRITE-OFFS
2003
During fiscal 2003, the company implemented a restructuring plan to align
its cost structure to market conditions. Under that plan, the company
recorded 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 were 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 were
included in the cost of sales in the statement of earnings for that same
year.
2004 AND 2005
During fiscal 2004, the company approved a restructuring plan to
consolidate the operations of its Life Sciences and Industrial Division,
transferring EXFO Burleigh's operations mainly to EXFO Photonic Solutions
facilities in Toronto. This consolidation process, which started in
August 2004, was completed during fiscal 2005.
Overall, for that process, the company incurred $2,515,000 in
restructuring and other charges from which $2,033,000 were recorded in
fiscal 2004 and the remaining $482,000 were recorded in fiscal 2005. The
overall costs, which were recorded in the restructuring and other charges
in the statements of earnings of the corresponding years, are detailed as
follows: $855,000 for severance expenses for the layoff of all employees
of EXFO Burleigh, $1,261,000 mainly for the impairment of the EXFO
Burleigh building and the remaining $399,000 for other expenses such as
training and recruiting expenses and transfer of assets.
The EXFO Burleigh building was put up for sale in fiscal 2004, but it is
not yet sold because of the difficult real estate market in Rochester,
NY. The building is available for sale in its present condition and
management expects to sell the property within the next twelve months.
Consequently, in accordance with CICA handbook, section 3475, "Disposal
of Long-Lived Assets and Discontinued Operations", it was shown in the
balance sheet as a long-lived asset held for sale. The fair value used to
determine the impairment loss of the building represents the company's
best estimate of its selling price based upon the municipal valuation.
Since September 1, 2004, the building is no longer amortized.
Finally, in fiscal 2005, the company recorded adjustments of $190,000 to
the fiscal 2003 plan because actual charges, mainly for leased equipment,
were lower than expected.
F-14
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share data
and as otherwise noted)
The following table summarizes changes in the restructuring charges payable
since August 31, 2002:
YEAR ENDED AUGUST 31, 2005
BALANCE AS AT BALANCE AS AT
AUGUST 31, AUGUST 31,
2004 ADDITIONS PAYMENTS ADJUSTMENTS 2005
------------- --------- ---------- ------------ --------------
FISCAL 2004 PLAN
Severance expenses $ 467 $ 83 $ (550) $ -- $ --
Other -- 399 (399) -- --
------- ------- ------- ------- -------
467 482 (949) -- --
------- ------- ------- ------- -------
FISCAL 2003 PLAN
Severance expenses 109 -- (77) (32) --
Exited leased facilities 386 -- (229) (7) 150
Other 197 -- (46) (151) --
------- ------- ------- ------- -------
692 -- (352) (190) 150
------- ------- ------- ------- -------
FISCAL 2001 PLAN
Exited leased facilities 10 -- (10) -- --
------- ------- ------- ------- -------
10 -- (10) -- --
------- ------- ------- ------- -------
Total for all plans (note 9) $ 1,169 $ 482 $(1,311) $ (190) $ 150
======= ======= ======= ======= =======
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
======= ======= ======= ======= =======
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)
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 $ 782 $ 4,134 $(2,448) $ -- $ 2,468
======= ======= ======= ======= =======
FUTURE INCOME TAX ASSETS AND RESEARCH AND DEVELOPMENT TAX CREDITS
RECOVERABLE
During fiscal 2003, the company reviewed the carrying value of its future
income tax assets and its research and development tax credits
recoverable. 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 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 16).
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 15).
5 INVENTORIES
AS AT AUGUST 31,
-------------------------
2005 2004
------- -------
Raw materials $ 9,373 $ 7,244
Work in progress 934 1,370
Finished goods 7,442 6,757
------- -------
$17,749 $15,371
======= =======
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)
6 PROPERTY, PLANT AND EQUIPMENT
AS AT AUGUST 31,
--------------------------------------------------------------------------------
2005 2004
-------------------------------------- --------------------------------------
ACCUMULATED ACCUMULATED
COST AMORTIZATION COST AMORTIZATION
--------------- ------------------- --------------- -------------------
Land and land improvements $ 3,179 $ 815 $ 2,868 $ 558
Buildings 9,206 2,250 8,311 1,699
Equipment 33,216 29,553 29,110 23,422
Leasehold improvements 2,395 1,659 2,110 1,278
--------------- ------------------- --------------- -------------------
47,996 $ 34,277 42,399 $ 26,957
=================== ===================
Less:
Accumulated amortization 34,277 26,957
--------------- ---------------
$ 13,719 $ 15,442
=============== ===============
As at August 31, 2004 and 2005, unpaid purchases of property, plant and
equipment amounted to $358,000 and $111,000, respectively.
7 INTANGIBLE ASSETS AND GOODWILL
AS AT AUGUST 31,
--------------------------------------------------------------------------------
2005 2004
-------------------------------------- --------------------------------------
ACCUMULATED ACCUMULATED
COST AMORTIZATION COST AMORTIZATION
--------------- ------------------- --------------- -------------------
Core technology $ 35,554 $ 32,214 $ 32,815 $ 25,733
Software 6,607 4,345 5,847 3,482
--------------- ------------------- --------------- -------------------
42,161 $ 36,559 38,662 $ 29,215
=================== ===================
Less:
Accumulated amortization 36,559 29,215
--------------- ---------------
$ 5,602 $ 9,447
=============== ===============
Amortization expenses for intangible assets in each of the next five
fiscal years will amount to $3,190,000 in 2006, $893,000 in 2007,
$429,000 in 2008, $352,000 in 2009 and $325,000 in 2010.
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)
Changes in the carrying value of goodwill are as follows:
AS AT AUGUST 31,
----------------------------
2005 2004
------------ ------------
Balance - Beginning of year $ 18,393 $ 17,673
Foreign currency translation adjustment 1,977 720
------------ ------------
Balance - End of year (note 19) $ 20,370 $ 18,393
============ ============
8 CREDIT FACILITIES
The company has a line of credit which provides for advances of up to
Cdn$10,000,000 (US$8,411,000). This line of credit, which is renewable
annually, bears interest at prime rate (prime rate in 2004). 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, 2005, an amount of Cdn$3,163,000
(US$2,661,000) was reserved from this line of credit for letters of
guarantee and forward exchange contracts.
9 ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
AS AT AUGUST 3
------------------------------
2005 2004
------------ --------------
Trade $ 5,781 $ 4,484
Salaries and social benefits 4,526 3,932
Warranty 725 390
Tax on capital 538 526
Restructuring charges (notes 4 and 20) 150 1,169
Other 481 892
------------ --------------
$ 12,201 $ 11,393
============ ==============
Changes in the warranty provision are as follows:
AS AT AUGUST 31,
------------------------------
2005 2004
------------ --------------
Balance - Beginning of year $ 390 $ 687
Provision 869 564
Settlements (583) (889)
Foreign currency translation adjustment 49 28
------------ --------------
Balance - End of year $ 725 $ 390
============ ==============
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)
10 LONG-TERM DEBT
AS AT AUGUST 31,
------------------------------
2005 2004
------------ --------------
Loans collateralized by equipment, bearing interest at 9.6%,
repayable in monthly instalments of $13,000 including
principal and interest, maturing in 2008 $ 332 $ 453
Less: Current portion 134 121
------------ --------------
$ 198 $ 332
============ ==============
As at August 31, 2005, minimum principal repayments required in each of
the next three years will amount to $134,000 in 2006, $147,000 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, 2005, minimum rentals payable under these operating leases in each of
the next five years will amount to $1,050,000 in 2006, $952,000 in 2007,
$632,000 in 2008, $584,000 in 2009 and $594,000 in 2010. As at August 31,
2005, the total commitment under these operating leases amounts to
$4,247,000.
For the years ended August 31, 2003, 2004 and 2005, rental expenses
amounted to $1,718,000, $1,219,000 and $1,370,000, respectively (note
20).
12 CONTINGENCIES
CLASS ACTION
On November 27, 2001, a class action suit was filed in the United States
District Court for the Southern District of New York against the company,
four of the underwriters of its Initial Public Offering and some of its
executive officers pursuant to the Securities Exchange Act of 1934 and
Rule 10b-5 promulgated thereunder and Sections 11, 12 and 16 of the
Securities Act of 1933. This class action alleges that the company's
registration statement and prospectus filed with the Securities and
Exchange Commission on June 29, 2000, contained material
misrepresentations and/or omissions resulting from (i) the underwriters
allegedly soliciting and receiving additional, excessive and undisclosed
commissions from certain investors in exchange for which they allocated
material portions of the shares issued in connection with the company's
Initial Public Offering; and (ii) the underwriters allegedly entering
into agreements with customers whereby shares issued in connection with
the company's Initial Public Offering would be allocated to those
customers in exchange for which customers agreed to purchase additional
amounts of shares in the after-market at pre-determined prices.
On April 19, 2002, the plaintiffs filed an amended complaint containing
master allegations against all of the underwriters in all of the 310
cases included in this class action and also filed an amended complaint
containing allegations specific to four of the company's underwriters,
the company and two of its executive officers. In addition to the
allegations mentioned above, the amended complaint alleges that the
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)
underwriters (i) used their analysts to manipulate the stock market; and
(ii) implemented schemes that allowed issuer insiders to sell their
shares rapidly after an initial public offering and benefit from high
market prices. As concerns the company and its two executive officers in
particular, the amended complaint alleges that (i) the company's
registration statement was materially false and misleading because it
failed to disclose the additional commissions and compensation to be
received by underwriters; (ii) the two named executive officers learned
of or recklessly disregarded the alleged misconduct of the underwriters;
(iii) the two named executive officers had motive and opportunity to
engage in alleged wrongful conduct due to personal holdings of the
company's stock and the fact that an alleged artificially inflated stock
price could be used as currency for acquisitions; and (iv) the two named
executive officers, by virtue of their positions with the company,
controlled the company and the contents of the registration statement and
had the ability to prevent its issuance or cause it to be corrected. The
plaintiffs in this suit seek an unspecified amount for damages suffered.
In July 2002, the issuers filed a motion to dismiss the plaintiffs'
amended complaint and judgment was rendered on February 19, 2003. Only
one of the claims against the company was dismissed. On October 8, 2002,
the claims against its officers were dismissed pursuant to the terms of
Reservation of Rights and Tolling Agreements entered into with the
plaintiffs.
In June 2003, a committee of the company's Board of Directors
conditionally approved a proposed settlement between the issuer
defendants, the individual defendants, and the plaintiffs. If approved,
the settlement would provide, among other things, a release of the
company and of the individual defendants for the conduct alleged in the
action to be wrongful in the amended complaint. The company would agree
to undertake other responsibilities under the settlement, including
agreeing to assign away, not assert, or release certain potential claims
the company may have against its underwriters. Any direct financial
impact of the proposed settlement is expected to be borne by the
company's insurance carriers.
On June 25, 2004, the Plaintiffs moved for Preliminary Approval of the
settlement. The court granted the preliminary approval motion on February
15, 2005, subject to certain modifications. On August 31, 2005, the court
issued a preliminary order further approving the modifications to the
settlement and certifying the settlement classes. The court also
appointed the Notice Administrator for the settlement and ordered that
notice of the settlement be distributed to all settlement class members
beginning on November 15, 2005, and completed by January 15, 2006. The
settlement fairness hearing has been set for April 26, 2006. Following
the hearing, if the court determines that the settlement is fair to the
class members, the settlement will be approved. There can be no assurance
that this proposed settlement would be approved and implemented in its
current form, or at all. Therefore, it is not possible to predict the
final outcome of the case, nor 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,
2005.
LETTERS OF GUARANTEE
As at August 31, 2005, in the normal course of its operations, the
company had outstanding letters of guarantee of Cdn$1,418,000
(US$1,193,000), which expire at various dates through fiscal 2008 and
that were reserved from the line of credit.
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)
13 SHARE CAPITAL
Authorized - unlimited as to number, without par value
Subordinate voting and participating, bearing a non-cumulative
dividend to be determined by the Board of Directors, ranking
pari passu with multiple voting shares
Multiple voting and participating, entitling to ten votes each,
bearing a non-cumulative dividend to be determined by the Board
of Directors, convertible at the holder's option into
subordinate voting shares on a one-for-one basis, ranking pari
passu with subordinate voting shares
The following table summarizes the share capital activity since August
31, 2002:
MULTIPLE VOTING SHARES SUBORDINATE VOTING SHARES
--------------------------------- -------------------------------
TOTAL
NUMBER AMOUNT NUMBER AMOUNT AMOUNT
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 (note 14) - - 25,498 45 45
Exercise of stock awards (note 14) - - 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 (note 14) - - 111,071 254 254
Exercise of stock awards (note 14) - - 89,504 - -
Redemption - - (5,340) (5) (5)
Resale - - 5,340 5 5
Share issue expenses - - - (137) (137)
---------------- --------------- --------------- --------------- --------------
Balance as at August 31, 2004 37,900,000 1 30,540,483 521,732 521,733
Exercise of stock options (note 14) - - 71,699 148 148
Exercise of stock awards (note 14) - - 53,592 - -
Share issue expenses - - - (6) (6)
---------------- --------------- --------------- --------------- --------------
Balance as at August 31, 2005 37,900,000 $ 1 30,665,774 $ 521,874 $ 521,875
================ =============== =============== =============== ==============
(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 18).
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)
14 STOCK-BASED COMPENSATION PLANS
The maximum number of subordinate voting shares issuable under the
Long-Term Incentive Plan and the Deferred Share Unit Plan cannot exceed
6,306,153 shares. The maximum number of subordinate voting shares that
may be granted to any individual on an annual basis cannot exceed 5% of
the number of outstanding subordinate voting shares.
LONG-TERM INCENTIVE PLAN
In May 2000, the company established a Stock Option Plan for Directors,
executive officers, employees and consultants and those of the company's
subsidiaries, as determined by the Board of Directors. In January 2005,
the company made certain amendments to the existing Stock Option Plan,
including the renaming of the plan to Long-Term Incentive Plan, which
includes stock options and restricted share units.
STOCK OPTIONS
The exercise price of stock options granted under the Long-Term Incentive
Plan is the market price of the common shares on the date of grant. Stock
options granted under the plan generally expire ten years from the date
of grant. Stock 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 stock options upon the
occurrence of a change of control.
The following table summarizes stock option activity since August 31, 2002:
YEARS ENDED AUGUST 31,
-------------------------------------------------------------------------------------
2005 2004 2003
--------------------------- -------------------------- --------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
NUMBER PRICE NUMBER PRICE NUMBER PRICE
(CDN$) (CDN$) (CDN$)
Outstanding - Beginning of year 2,934,518 $ 21 3,176,613 $ 23 2,597,574 $ 34
Granted 246,233 6 536,500 5 1,268,450 3
Exercised (71,699) (3) (111,071) (3) (25,498) (3)
Forfeited (345,293) (27) (667,524) (23) (663,913) (25)
------------- ------------ ------------ ----------- ------------ -----------
Outstanding - End of year 2,763,759 $ 19 2,934,518 $ 21 3,176,613 $ 23
============= ============ ============ =========== ============ ===========
Exercisable - End of year 1,650,404 $ 28 1,331,707 $ 32 1,068,595 $ 33
============= ============ ============ =========== ============ ===========
The weighted average grant-date fair value of stock options granted
during fiscal 2004 and 2005 amounted to $2.73 and $3.51, respectively.
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)
The fair value of stock options granted in fiscal 2003 (for pro forma
only), 2004 and 2005 was estimated using the Black-Scholes options
valuation model with the following weighted average assumptions:
YEARS ENDED AUGUST 31,
-------------------------------------------------------
2005 2004 2003
-------------- ---------------- -----------------
Risk-free interest rate 3.6% 2.7% 4.8%
Expected volatility 95% 100% 80%
Dividend yield Nil Nil Nil
Expected life 66 months 49 months 36 months
If the fair value-based method had been applied to stock options granted
prior to September 1, 2003 and outstanding as at August 31, 2003, 2004
and 2005, the net loss and the net loss per share would have been as
follows on a pro forma basis:
YEARS ENDED AUGUST 31,
----------------------------------------------------------
2005 2004 2003
------------------ ------------------ ------------------
Net loss for the year $ (1,634) $ (8,424) $ (54,950)
Pro forma adjustment for stock-based compensation costs 131 (174) (683)
------------------ ------------------ ------------------
Pro forma net loss for the year $ (1,503) $ (8,598) $ (55,633)
================== ================== ==================
Basic and diluted net loss per share $ (0.02) $ (0.13) $ (0.87)
Basic and diluted pro forma net loss per share $ (0.02) $ (0.13) $ (0.88)
The following table summarizes information about stock options as at August 31, 2005:
STOCK OPTIONS OUTSTANDING STOCKS OPTIONS EXERCISABLE
----------------------------------------------------------- ------------------------------------
WEIGHTED WEIGHTED AVERAGE WEIGHTED
AVERAGE REMAINING AVERAGE
EXERCISE PRICE NUMBER EXERCISE PRICE CONTRACTUAL LIFE NUMBER EXERCISE PRICE
(CDN$) (CDN$) (CDN$)
$2.50 to $3.36 542,054 $ 2.50 7.1 years 226,993 $ 2.50
$3.96 to $5.60 620,342 5.04 5.2 years 122,275 4.78
$6.22 to $9.02 243,770 6.53 8.4 years 70,397 7.01
$14.27 to $20.00 507,446 15.87 6.2 years 380,592 15.87
$29.70 to $43.00 600,846 36.29 5.2 years 600,846 36.29
$51.25 to $68.17 205,771 65.83 5.0 years 205,771 65.83
$83.66 43,530 83.66 5.0 years 43,530 83.66
--------------- ------------------ -------------------- --------------- -------------------
2,763,759 $ 19.22 6.0 years 1,650,404 $ 28.28
=============== ================== ==================== =============== ===================
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)
RESTRICTED SHARE UNITS (RSUS)
RSUs are "phantom" shares that rise and fall in value based on the value
of the company's subordinate voting shares and are redeemable for actual
subordinate voting shares or cash at the discretion of the Board of
Directors on the vesting dates established by the Board of Directors at
the time of grant. The vesting dates are subject to a minimum term of
three years and a maximum term of ten years from the award date. RSUs
granted under the plan expire at the latest ten years from the date of
grant.
During fiscal 2005, the company granted 176,185 RSUs that were
outstanding as at August 31, 2005. However, none of them were exercisable
at that date. As at August 31, 2005, the weighted average remaining
contractual life of the outstanding RSUs was 9.4 years. The weighted
average grant-date fair value of these RSUs was $4.68.
DEFERRED SHARE UNIT PLAN
In January 2005, the company established a Deferred Share Unit (DSU) Plan
for the members of the Board of Directors as part of their annual
retainer fees. Each DSU entitles the Board members to receive one
subordinate voting share. DSUs are acquired on the date of grant and will
be redeemed in subordinate voting shares when the Board member will cease
to be Director of the company.
During fiscal 2005, the company granted 23,734 DSUs that were outstanding
as at August 31, 2005 to the members of the Board of Directors.
The weighted average grant-date fair value of these DSUs was $4.47.
STOCK APPRECIATION RIGHTS PLAN
In August 2001, the company established the Stock Appreciation Rights
Plan for certain employees. Under that plan, eligible employees are
entitled to receive a cash amount equivalent to the difference between
the market price of the common shares on the date of exercise and the
exercise price determined on the date of grant. Stock appreciation rights
granted under the plan generally expire ten years from the date of grant.
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 $4.67 as at August
31, 2005, compensation cost for those stock appreciation rights was
nominal as at August 31, 2005.
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)
The following table summarizes stock appreciation rights activity since
August 31, 2002:
YEARS ENDED AUGUST 31,
-------------------------------------------------------------------------------------
2005 2004 2003
--------------------------- -------------------------- --------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
NUMBER PRICE NUMBER PRICE NUMBER PRICE
Outstanding - Beginning of year 13,000 $ 16 9,000 $ 24 10,000 $ 26
Granted 6,000 4 6,000 5 5,000 2
Forfeited - - (2,000) (19) (6,000) (9)
----------- --------- ---------- ---------- ---------- ----------
Outstanding - End of year 19,000 $ 12 13,000 $ 16 9,000 $ 24
=========== ========= ========== ========== ========== ==========
Exercisable - End of year 7,500 $ 24 4,250 $ 30 3,500 $ 30
=========== ========= ========== ========== ========== ==========
The following table summarizes information about stock appreciation
rights as at August 31, 2005:
STOCK APPRECIATION STOCK APPRECIATION
RIGHTS OUTSTANDING RIGHTS EXERCISABLE
-------------------------------------------- -----------------------------
WEIGHTED AVERAGE
REMAINING CONTRACTUAL
EXERCISE PRICE NUMBER LIFE NUMBER
$2.10 2,000 7.6 years 1,000
$4.51 to $4.65 12,000 9.0 years 1,500
$22.25 2,500 5.4 years 2,500
$45.94 2,500 5.0 years 2,500
----------------- ---------------------- -----------------------------
19,000 7.9 years 7,500
================= ====================== =============================
RESTRICTED STOCK AWARD PLAN
In December 2000, the company established a Restricted Stock Award Plan
for employees of EXFO Burleigh. This plan expired in December 2004. Each
stock award entitled employees to receive one subordinate voting share at
a purchase price of nil. Stock awards granted under the plan vested over
a four-year period, with 25% vesting on an annual basis commencing on the
first anniversary of the date of grant. According to the plan, upon the
involuntary termination of a member of the defined management team, all
outstanding restricted stock awards granted to such an employee
automatically vested.
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 restricted stock awards activity since
August 31, 2002:
YEARS ENDED AUGUST 31,
----------------------------------------------------------
2005 2004 2003
------------------ ------------------ ------------------
Outstanding - Beginning of year 53,592 143,096 215,249
Exercised (53,592) (89,504) (69,935)
Forfeited - - (2,218)
------------------ ------------------ ------------------
Outstanding - End of year - 53,592 143,096
================== ================== ==================
15 OTHER DISCLOSURES
NET RESEARCH AND DEVELOPMENT EXPENSES
Net research and development expenses comprise the following:
YEARS ENDED AUGUST 31,
------------------------------------------------------
2005 2004 2003
----------------- ---------------- -----------------
Gross research and development expenses $ 15,878 $ 15,668 $ 17,133
Research and development tax credits and grants (3,688) (3,278) (3,551)
Research and development tax credit write-offs
(note 4) - - 2,297
----------------- ---------------- -----------------
$ 12,190 $ 12,390 $ 15,879
================= ================ =================
Tax credits written off in fiscal 2003 can be carried forward against
future years' income taxes payable over the next eight years.
GOVERNMENT GRANTS
During 1998, the company entered into an agreement with the Quebec
Minister of Industry, Commerce, Science and Technology (the "Minister").
Pursuant to this agreement, the Minister agreed to contribute, in the
form of grants, up to a maximum of Cdn$2,220,000 (US$1,867,000) 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 claimed the maximum amount of Cdn$2,200,000 (US$1,867,000), of which
Cdn$770,000 (US$647,000) was credited to earnings. The balance of
Cdn$1,450,000 (US$1,220,000) was included in government grants in the
balance sheet. This latter amount will be recognized upon the final
approval by the sponsor of the program.
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)
Furthermore, since 2000, companies operating in the Quebec City area are
eligible for a refundable credit granted by the Quebec provincial
government. This credit is earned based on the increase of eligible
production and marketing salaries incurred in the Quebec City area at a
rate of 40%. Since 2000, the company has claimed a total of Cdn$5,815,000
(US$4,891,000) under this program, of which Cdn$5,041,000 (US$4,239,000)
was credited to earnings, the balance of Cdn$774,000 (US$652,000) was
included in government grants in the balance sheet. This latter amount
will be recognized in the statement of earnings upon the final approval
of eligible salaries by the sponsor of the program.
Should repayments of any amounts received pursuant to these agreements be
required, such repayments, less related deferred revenue, will be charged
to earnings as the amount of any repayment becomes known.
Following is a summary of the classification of these and certain other
grants and credits (government grants) in the statements of earnings of
the reporting years.
Cost of sales for the years ended August 31, 2003, 2004 and 2005, is net
of government grants of $518,000, $3,000 and $89,000, respectively.
Selling and administrative expenses for the years ended August 31, 2003,
2004 and 2005, are net of government grants of $286,000, $5,000 and
$32,000, respectively.
Research and development expenses for the years ended August 31, 2003,
2004 and 2005, are net of government grants of $45,000, $80,000 and
$22,000, 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% (until May 2005 and 2% thereafter) of an employee's
gross salary, provided that the employee has contributed at least 2%
of his/her gross salary to a tax-deferred registered retirement
savings plan. Cash contributions to this plan and expenses for the
years ended August 31, 2003, 2004 and 2005, amounted to Cdn$93,000
(US$63,000), Cdn$141,000 (US$106,000) and Cdn$221,000 (US$179,000),
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, 2003, 2004 and 2005, the company recorded cash
contributions and expenses totaling $253,000, $187,000 and $134,000,
respectively.
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)
16 INCOME TAXES
The reconciliation of the income tax provision calculated using the
combined Canadian federal and provincial statutory income tax rate with
the income tax provision in the financial statements is as follows:
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)
YEARS ENDED AUGUST 31,
-----------------------------------------------------
2005 2004 2003
---------------- ----------------- ----------------
Income tax provision at combined Canadian federal and provincial $ 307 $ (3,011) $ (13,563)
statutory tax rate (31% in 2005, 32% in 2004 and 34% in 2003)
Increase (decrease) due to:
Foreign income taxed at different rates (580) (767) (999)
Non-taxable income (827) (128) (298)
Non-deductible expenses 784 1,205 1,609
Tax deductions (81) (169) (80)
Reduction of Canadian federal statutory tax rate - 274 92
Effect of consolidation of subsidiaries (209) (1,384) 184
Previous year tax recovery upon a tax assessment - (1,406) (645)
Other (146) 446 374
Change in valuation allowance 3,375 3,954 28,385
---------------- ----------------- ----------------
$ 2,623 $ (986) $ 15,059
---------------- ----------------- ----------------
The income tax provision consists of the following:
Current
Canadian $ 2,513 $ (577) $ 4,829
United States 6 - (247)
Other 104 (409) 339
---------------- ----------------- ----------------
2,623 (986) 4,921
Future
Canadian (1,445) (1,104) (13,553)
United States (1,723) (2,448) (4,307)
Other (207) (402) (387)
================ ================= ================
(3,375) (3,954) (18,247)
Valuation allowance
Canadian 1,445 1,104 20,359
United States 1,723 2,448 7,374
Other 207 402 652
---------------- ----------------- ----------------
3,375 3,954 28,385
---------------- ----------------- ----------------
$ 2,623 $ (986) $ 15,059
================ ================= ================
Details of the company's income taxes:
Earnings (loss) before income taxes
Canadian $ 3,092 $ (7,740) $ (20,449)
United States (953) (5,879) (13,116)
Other (1,150) 4,209 (6,326)
---------------- ----------------- ----------------
$ 989 $ (9,410) $ (39,891)
================ ================= ================
Most of the company's income tax provision for fiscal 2005 represents
income taxes payable at the Canadian federal level, which are reduced by
research and development tax credits that are recorded against gross
research and development expenses.
F-29
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share data
and as otherwise noted)
Significant components of the company's future income tax assets and
liabilities are as follows:
AS AT AUGUST 31,
-----------------------------------------
2005 2004
------------------ -------------------
Future income tax assets
Long-lived assets $ 4,902 $ 3,291
Provisions and accruals 7,406 8,755
Government grants 209 188
Deferred revenue 318 336
Share issue expenses 590 657
Research and development expenses 7,292 5,064
Losses carried forward 18,424 15,110
------------ ------------
39,141 33,401
Valuation allowance (38,406) (32,613)
------------ ------------
735 788
Future income tax liabilities
Research and development tax credits (735) (788)
------------ ------------
Future income tax assets, net $ - $ -
============ ============
As at August 31, 2005, the company had available operating losses in
several tax jurisdictions, against which a full valuation allowance of
$18,424,000 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
--------------- ---------------- -----------------
2006 $ 63,000 $ - $ -
2007 1,710,000 73,000 206,000
2008 5,614,000 61,000 1,916,000
2009 5,921,000 3,563,000 571,000
2010 4,211,000 2,211,000 257,000
2014 81,000 - -
2015 1,775,000 1,778,000 -
2022 - - 9,025,000
2023 - - 10,517,000
2024 - - 6,818,000
2025 - - 8,207,000
Indefinite 2,041,000 2,349,000 1,750,000
--------------- ---------------- -----------------
$ 21,416,000 $ 10,035,000 $ 39,267,000
=============== ================ =================
In addition to operating losses, as at August 31, 2005, the company had
available research and development expenses in Canada amounting to
$24,420,000 at the federal level and $20,668,000 at the provincial level,
against which a full valuation allowance of $7,292,000 was established.
These expenses can be carried forward indefinitely against future years'
taxable income in their respective tax jurisdiction.
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)
17 LOSS PER SHARE
The following table summarizes the reconciliation of the basic weighted
average number of shares outstanding and the diluted weighted average
number of shares outstanding:
YEARS ENDED AUGUST 31,
-----------------------------------------------------
2005 2004 2003
--------------- ------------- -----------
Basic weighted average number of shares
outstanding (000's) 68,526 66,020 62,852
Dilutive effect of stock options (000's) 422 502 301
Dilutive effect of restricted stock awards (000's) 17 93 164
Dilutive effect of deferred share units (000's) 8 - -
Dilutive effect of restricted share units (000's) 8 - -
--------------- ------------- -----------
Diluted weighted average number of shares outstanding (000's) 68,981 66,615 63,317
=============== ============= ===========
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) 1,962 2,128 2,533
=============== ============= ===========
The diluted net loss per share for the years ended August 31, 2003, 2004
and 2005, was the same as the basic net loss per share since the dilutive
effect of stock options, restricted stock awards, deferred share units
and restricted share units should not be included in the calculation;
otherwise, the effect would be anti-dilutive. Accordingly, diluted net
loss per share for those years was calculated using the basic weighted
average number of shares outstanding.
18 FINANCIAL INSTRUMENTS
SHORT-TERM INVESTMENTS
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)
Short-term investments consist of the following:
AS AT AUGUST 31,
---------------------------------
2005 2004
------------- ------------
Commercial paper denominated in Canadian dollars, bearing
interest at annual rates of 2.44% to 2.75% in 2005
and 2.00% to 2.14% in 2004, maturing on different
dates between September 2005 and January 2006 in
fiscal 2005, and October 2004 and January 2005 in
fiscal 2004 $ 104,883 $ 65,359
Mutual funds denominated in Canadian dollars - 18,610
------------- ------------
$ 104,883 $ 83,969
============= ============
F-32
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share data
and as otherwise noted)
FAIR VALUE
Cash, accounts receivable, as well as accounts payable and accrued
liabilities, are financial instruments whose carrying values approximate
their fair values.
The fair value of the long-term debt amounted to $481,000 and $344,000 as
at August 31, 2004 and 2005. The fair value of short-term investments,
based on market value, amounted to $83,969,000 and $104,883,000 as at
August 31, 2004 and 2005, respectively.
The fair value of forward exchange contracts, which represents the
difference between their contractual amounts and their current trading
value, amounted to an unrecognized gain of $1,975,000 and $2,937,000 as
at August 31, 2004 and 2005, 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 six (seven in 2004) 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.
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 $510,000 and $352,000 as at August 31, 2004 and 2005,
respectively.
INTEREST RATE RISK
As at August 31, 2005, 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-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)
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, 2004
and 2005, 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, 2004
September 2004 to August 2005 $ 7,480 1.5427
September 2005 to March 2007 8,400 1.3622
As at August 31, 2005
September 2005 to August 2006 $ 26,000 1.2630
September 2006 to November 2007 7,600 1.2500
19 SEGMENT INFORMATION
In September 2003, the company reorganized its business under two
reportable segments: the Telecom Division and the Life Sciences and
Industrial Division. The Telecom Division offers integrated test
solutions to network service providers, cable operators, system vendors
and component manufacturers throughout the global telecommunications
industry. The Life Sciences and Industrial Division mainly leverages
developed and acquired core telecom technologies for high-precision
assembly and research sectors.
The reporting structure reflects how the company manages its business and
how it classifies its operations for planning and measuring performance.
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-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)
The following tables present information by segment:
YEAR ENDED AUGUST 31, 2005
---------------------------------------------------------------------
LIFE SCIENCES AND
TELECOM DIVISION INDUSTRIAL DIVISION TOTAL
---------------- ------------------- -------------
Sales $ 80,120 $ 17,096 $ 97,216
Earnings (loss) from operations $ 763 $ (962) $ (199)
Unallocated items:
Interest and other income 2,524
Foreign exchange loss (1,336)
-------------
Earnings before income taxes 989
Income taxes 2,623
-------------
Net loss for the year $ (1,634)
=============
Amortization of capital assets $ 6,504 $ 2,588 $ 9,092
================ ============= =============
Stock-based compensation costs $ 897 $ 66 $ 963
================ ============= =============
Capital expenditures $ 1,408 $ 93 $ 1,501
================ ============= =============
YEAR ENDED AUGUST 31, 2004
---------------------------------------------------------------------
LIFE SCIENCES AND
TELECOM DIVISION INDUSTRIAL DIVISION TOTAL
---------------- ------------------- -------------
Sales $ 58,882 $ 15,748 $ 74,630
Loss from operations $ (5,557) $ (5,013) $ (10,570)
Unallocated items:
Interest and other income 1,438
Foreign exchange loss (278)
-------------
Loss before income taxes (9,410)
Income taxes (986)
-------------
Net loss for the year (8,424)
=============
Amortization of capital assets $ 6,643 $ 3,372 $ 10,015
================ ============= =============
Stock-based compensation costs $ 417 $ 32 $ 449
================ ============= =============
Impairment of long-lived assets (note 4) $ 620 $ - $ 620
================ ============= =============
Restructuring and other charges (note 4) $ - $ 1,261 $ 1,261
================ ============= =============
Capital expenditures $ 607 $ 244 $ 851
================ ============= =============
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)
YEAR ENDED AUGUST 31, 2003
---------------------------------------------------------------------
LIFE SCIENCES AND
TELECOM DIVISION INDUSTRIAL DIVISION TOTAL
---------------- ------------------- -------------
Sales $ 48,753 $ 13,177 $ 61,930
Comparative information for fiscal 2003 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.
Total assets by reportable segment are detailed as follows:
AS AT AUGUST 31,
------------------------------------
2005 2004
------------ -------------
Telecom Division $ 64,655 $ 60,284
Life Sciences and Industrial Division 11,449 15,094
Unallocated assets 114,853 97,413
------------ -------------
$ 190,957 $ 172,791
============ =============
Unallocated assets are comprised of cash, short-term investments and
income taxes and tax credits recoverable.
Carrying value of goodwill by reportable segment is detailed as follows:
AS AT AUGUST 31,
------------------------------------
2005 2004
------------ -------------
Telecom Division $ 16,092 $ 14,530
Life Sciences and Industrial Division 4,278 3,863
------------ -------------
$ 20,370 $ 18,393
============ =============
Sales to external customers by geographic region are detailed as follows:
YEARS ENDED AUGUST 31,
-------------------------------------------------
2005 2004 2003
----------- ----------- ----------
United States $ 56,282 $ 40,019 $ 31,561
Canada 6,830 5,818 4,806
Latin America 3,127 3,547 4,467
----------- ----------- ----------
66,239 49,384 40,834
Europe, Middle East and Africa 19,396 13,706 11,092
Asia-Pacific 11,581 11,540 10,004
----------- ----------- ----------
$ 97,216 $ 74,630 $ 61,930
=========== =========== ==========
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 were allocated to geographic regions based on the country of
residence of the related customers. In fiscal 2004 and 2005, one customer
represented more than 10% of sales with 13.8% of sales ($10,325,000) in
fiscal 2004 and 23.3% ($22,629,000) in fiscal 2005. In fiscal 2003, no
single customer accounted for 10% of sales or more. For fiscal 2004 and
2005, the most important customer purchased from the Telecom Division.
Long-lived assets by geographic region are detailed as follows:
AS AT AUGUST 31,
--------------------------------
2005 2004
------------- ------------
Canada $ 35,690 $ 37,948
United States 5,601 6,934
------------- ------------
$ 41,291 $ 44,882
============= ============
Long-lived assets consist of property, plant and equipment, the long-lived
asset held for sale, intangible assets and goodwill.
20 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.
For the years ended August 31, 2003 and 2004, the company leased
facilities from the company owned by the President of EXFO. The annual
rental expense amounted to $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. However, 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.
21 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
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)
notes. The following summarizes the significant quantitative differences
between Canadian and U.S. GAAP, as well as other significant disclosures
required under U.S. GAAP and Regulation S-X of the SEC not already
provided in the accompanying financial statements.
RECONCILIATION OF NET 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,
------------------------------------------------
2005 2004 2003
----------- ----------- -----------
Net loss for the year in accordance with Canadian GAAP $ (1,634) $ (8,424) $ (54,950)
Stock-based compensation costs a) - (867) (832)
Unrealized gains (losses) on forward exchange contracts b) (1,286) (280) 1,645
Amortization of intangible assets c) - - 832
Write-down of goodwill and intangible assets c) - - 6,178
Income tax effect on reconciliation items - - (1,074)
----------- ----------- -----------
Net loss for the year in accordance with
U.S. GAAP (2,920) (9,571) (48,201)
Other comprehensive income (loss)
Foreign currency translation adjustment 15,669 5,969 15,089
Unrealized gains on forward exchange contracts b) 2,313 689 -
Reclassification of losses on forward exchange contracts in
net loss b) (65) - -
----------- ----------- -----------
Comprehensive income (loss) $ 14,997 $ (2,913) $ (33,112)
=========== =========== ===========
Basic and diluted net loss per share in accordance $ (0.04) $ (0.14) $ (0.77)
with U.S. GAAP
Basic weighted average number of shares outstanding (000's) 68,526 66,020 62,852
F-38
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share data
and as otherwise noted)
RECONCILIATION OF SHAREHOLDERS' EQUITY TO CONFORM TO U.S. GAAP
The following summary sets out the significant differences between the
company's reported shareholders' equity under Canadian GAAP as compared
to U.S. GAAP. Please see corresponding explanatory notes in the
Reconciliation Items section.
AS AT AUGUST 31,
---------------------------------------------------
2005 2004 2003
-------------- ------------- -------------
Shareholders' equity in accordance with Canadian GAAP $ 173,400 $ 157,327 $ 129,826
Forward exchange contracts b) 2,937 1,975 1,566
Goodwill c) (11,042) (10,008) (9,771)
Other - - (29)
-------------- ------------- -------------
Shareholders' equity in accordance with U.S. GAAP $ 165,295 $ 149,294 $ 121,592
============== ============= =============
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)
The following table summarizes the shareholders' equity activity under
U.S. GAAP since August 31, 2002:
DEFERRED ACCUMULATED
STOCK-BASED OTHER
SHARE CONTRIBUTED COMPENSATION OTHER COMPREHENSIVE SHAREHOLDERS'
CAPITAL SURPLUS DEFICIT COSTS CAPITAL INCOME (LOSS) EQUITY
---------- ---------- ---------- ------------ --------- ------------- ------------
Balance as at August
31, 2002 $ 560,943 $ 1,487 $(406,387) $ (2,867) $ 7,693 $ (9,870) $ 150,999
Net loss for the year - - (48,201) - - - (48,201)
Stock-based
compensation costs a) 1,507 - - 1,589 (2,264) - 832
Foreign currency
transaction adjustment - - - - - 15,089 15,089
Business combination
(note 13) 2,796 - - - - - 2,796
Exercise of stock
options (note 13) 45 - - - - - 45
Premium on resale of
share capital - 32 - - - - 32
---------- --------- --------- ---------- --------- ---------- ----------
Balance as at August
31, 2003 565,291 1,519 (454,588) (1,278) 5,429 5,219 121,592
Net loss for the year - - (9,571) - - - (9,571)
Stock-based a)
compensation costs e) 1,737 - - 339 (760) - 1,316
Foreign currency
transaction adjustment - - - - - 5,969 5,969
Unrealized gains on
forward exchange
contracts b) - - - - - 689 689
Public offering (note 13) 29,164 - - - - - 29,164
Exercise of stock
options (note 13) 254 - - - - - 254
Share issue expenses
(note 13) (137) - - - - - (137)
Premium on resale of
share capital - 18 - - - - 18
---------- --------- --------- ---------- --------- ---------- ----------
Balance as at August
31, 2004 596,309 1,537 (464,159) (939) 4,669 11,877 149,294
Net loss for the year - - (2,920) - - - (2,920)
Stock-based a)
compensation costs e) 1,213 - - (776) 425 - 862
Foreign currency
transaction adjustment - - - - - 15,669 15,669
Unrealized gains on
forward exchange
contracts b) - - - - - 2,248 2,248
Exercise of stock
options (note 13) 148 - - - - - 148
Share issue expenses
(note 13) (6) - - - - - (6)
---------- --------- --------- ---------- --------- ---------- ----------
Balance as at August
31, 2005 $ 597,664 $ 1,537 $(467,079) $ (1,715) $ 5,094 $ 29,794 $ 165,295
========== ========= ========= ========== ========= ========== ==========
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)
Accumulated other comprehensive income (loss) is comprised of the
following:
AS AT AUGUST 31,
------------------------------------------------
2005 2004 2003
----------- ----------- ------------
Foreign currency translation adjustment
Current year $ 15,669 $ 5,969 $ 15,089
Cumulative effect of prior years 11,188 5,219 (9,870)
----------- ----------- ------------
26,857 11,188 5,219
Unrealized gains on forward exchange contracts
Current year 2,248 689 -
Cumulative effect of prior years 689 - -
----------- ----------- ------------
2,937 689 -
----------- ----------- ------------
$ 29,794 $ 11,877 $ 5,219
=========== =========== ============
STATEMENTS OF CASH FLOWS
For the years ended August 31, 2003, 2004 and 2005, there were no
significant differences between the statements of cash flows under
Canadian GAAP as compared to U.S. GAAP, except for the subtotal before
change in non-cash operating items, whose presentation is not permitted
under U.S. GAAP.
RECONCILIATION ITEMS
a) ACCOUNTING FOR STOCK-BASED COMPENSATION
Until August 31, 2003, and to conform to U.S. GAAP, the company
measured stock-based compensation costs using the intrinsic value
method (APB 25, "Accounting for Stock Issued to Employees").
However, since September 1, 2003, and as described in item e) below,
the company accounts for stock-based compensation costs for awards
granted after that date, using the fair value-based method to
conform to Statement of Financial Accounting Standard (SFAS) 123,
"Accounting for Stock-Based Compensation".
STOCK PURCHASE PLAN
Under APB 25, compensation costs related to the stock purchase plan
were measured as the difference between the fair value of the
purchased stock and the purchase price paid by plan participants.
Compensation costs were amortized to expense over a period of five
years, being the restriction period. This plan terminated at the
time of the Initial Public Offering on June 29, 2000. Compensation
costs related to this plan became fully amortized during fiscal
2004.
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)
LONG-TERM INCENTIVE PLAN (FORMELY STOCK OPTION PLAN)
Until August 31, 2003, and under APB 25, compensation costs related
to the long-term incentive plan were measured as the difference
between the market price of the underlying stock at the date of
grant and the exercise price of the option. These compensation costs
were amortized to expense over the estimated vesting period up to a
maximum of four years. Compensation costs related to stock options
granted prior to September 1, 2003, and accounted for under APB 25
became fully amortized during fiscal 2004.
RESTRICTED STOCK AWARD PLAN
Under APB 25, compensation costs related to the restricted stock
award plan were measured as the difference between the market price
of the underlying stock at the date of grant and the exercise price,
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. Compensation costs related to this
plan became fully amortized during fiscal 2004.
Until August 31, 2003, no compensation costs were recognized for
these stock-based compensation plans under Canadian GAAP.
b) FORWARD EXCHANGE CONTRACTS
The forward exchange contracts entered into by the company prior to
September 1, 2003, do not qualify for hedge accounting treatment
under SFAS 133, "Accounting for Derivative Instruments and Hedging
Activities"; accordingly, changes in the fair value of these
derivatives are charged to earnings. However, on September 1, 2003,
the company implemented the documentation for the designation,
documentation and assessment of the effectiveness of its forward
exchange contracts, for the purposes of applying hedge accounting.
With this documentation in place, the forward exchange contracts
entered into by the company 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 income. Upon the recognition of the hedged
sales, accumulated changes in fair value are reclassified in the
statements of earnings.
Under Canadian GAAP, foreign exchange translation gains and losses
on forward exchange contracts are recognized as an adjustment of the
revenue when the corresponding sales are recorded, regardless of
whether the contracts were entered into before or after September 1,
2003.
The company estimates to $950,000 the amount of unrealized gain on
forward exchange contracts as of August 31, 2005 that will be
reclassified to net earnings over the next twelve months.
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)
c) WRITE-DOWN OF GOODWILL AND INTANGIBLE ASSETS
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 and a permanent difference in the carrying
value of goodwill exists between Canadian and U.S. GAAP.
Upon the impairment test, 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 2003.
d) RESEARCH AND DEVELOPMENT TAX CREDITS
Under Canadian GAAP, all research and development tax credits are
recorded as a reduction of gross research and development expenses.
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 $2,169,000 for fiscal 2004 and 2005, 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.
e) NEW ACCOUNTING STANDARDS AND PRONOUNCEMENTS
ADOPTED IN FISCAL 2004 AND STILL APPLICABLE IN 2005
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 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 on or after
September 1, 2003.
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)
TO BE ADOPTED AFTER FISCAL 2005
In November 2004, the Financial Accounting Standard Board (FASB)
issued SFAS 151, "Inventory Costs", an amendment to ARB No. 43,
Chapter 4. The amendments made by SFAS 151 will improve financial
reporting by clarifying that any abnormal amount of idle facility
expenses, freight, handling costs, and wasted materials (spoilage)
should be recognized as current-period charges and by requiring the
allocation of fixed production overheads to inventory based on the
normal capacity of the production facilities. This SFAS is effective
for inventory costs incurred during fiscal years beginning after
June 15, 2005. The company will adopt this new statement on
September 1, 2005, and its adoption will have no significant impact
on its financial statements.
In December 2004, the FASB issued SFAS 123(R), "Share-Based
Payments". This statement supersedes ABP 25, "Accounting for Stock
Issued to Employees" and related implementation guidance, and
revises SFAS 123 in a number of areas. Under SFAS 123(R), all forms
of share-based payment to employees result in compensation cost
recognized in financial statements. This statement is effective for
fiscal years beginning after June 15, 2005. The company will adopt
this statement on September 1, 2005, and its adoption will have no
significant impact on its financial statements.
In May 2005, the FASB issued SFAS 154, "Accounting Changes and
Errors Corrections - a replacement of APB Opinion No. 20 and FASB
Statement No. 3". This statement replaces APB Opinion No. 20,
"Accounting Changes", and FASB Statement No. 3, "Reporting
Accounting Changes in Interim Financial Statements", and changes the
requirements for the accounting for and reporting of a change in
accounting principle. This statement applies to all voluntary
changes in accounting principle. It also applies to changes required
by an accounting pronouncement in the unusual instance that the
pronouncement does not include specific transition provisions. In
general, this statement requires a company to account for the
adoption of a new accounting policy by applying the new principle to
prior accounting periods as if that principle had always been
adopted. This statement is effective for accounting changes or
corrections of errors in fiscal years beginning after December 15,
2005.
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 to awards granted prior
to September 1, 2003. Consequently, if the fair value-based method had
been applied to these awards, the pro forma net loss per share would have
been the same as the net loss per share in fiscal 2005, lower than the
net loss per share in 2004 (by $0.01) and higher than the net loss per
share in 2003 (by $0.01).
The fair value of options or awards granted was estimated using the
Black-Scholes options pricing model.
F-44
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................................17
A. HISTORY AND DEVELOPMENT OF THE COMPANY................17
B. BUSINESS OVERVIEW.....................................19
C. ORGANIZATIONAL STRUCTURE..............................40
D. PROPERTY, PLANT AND EQUIPMENT.........................40
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS..............42
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES................67
A. DIRECTORS AND SENIOR MANAGEMENT.......................67
B. COMPENSATION..........................................71
C. BOARD PRACTICES.......................................83
D. EMPLOYEES.............................................84
E. SHARE OWNERSHIP.......................................84
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS.........89
A. MAJOR SHAREHOLDERS....................................89
B. RELATED PARTY TRANSACTIONS............................90
ITEM 8. FINANCIAL INFORMATION.....................................91
A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL
INFORMATION...........................................91
B. SIGNIFICANT CHANGES...................................93
ITEM 9. OFFER AND LISTING.........................................94
ITEM 10. ADDITIONAL INFORMATION...................................95
A. SHARE CAPITAL.........................................95
B. MEMORANDUM AND ARTICLES OF ASSOCIATION................95
C. MATERIAL CONTRACTS....................................95
D. EXCHANGE CONTROLS.....................................95
E. TAXATION..............................................95
F. DIVIDENDS AND PAYING AGENTS..........................102
G. STATEMENT BY EXPERTS.................................102
H. DOCUMENTS ON DISPLAY.................................102
I. SUBSIDIARY INFORMATION...............................103
ITEM 11. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT
MARKET RISK..............................................104
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES...106
PART II....................................................................106
ITEM 13. DEFAULTS, DIVIDENDS ARREARAGES AND DELINQUENCIES.........106
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY
HOLDERS AND USE OF PROCEEDS..............................106
ITEM 15. CONTROLS AND PROCEDURES..................................106
ITEM 16. [RESERVED]...............................................107
ITEM 16A. AUDIT COMMITTE FINANCIAL EXPERT..............107
ITEM 16B. CODE OF ETHICS...............................107
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES.......107
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS
FOR AUDIT COMMITTEES.........................108
ITEM 16E. PURCHASES OF EQUITIES SECURITIES
BY THE ISSUER AND AFFILIATED
PURCHASERS...................................108
PART III...................................................................109
ITEM 17. FINANCIAL STATEMENTS.....................................109
ITEM 18. FINANCIAL STATEMENTS.....................................109
ITEM 19. EXHIBITS.................................................110
EXHIBIT INDEX
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NUMBER EXHIBIT
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1.1 Amended Articles of Incorporation of EXFO (incorporated by
reference to Exhibit 3.1 of EXFO's Registration Statement on
Form F-1 filed on June 9, 2000, 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, File No. 000-30895).
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, File No.
000-30895).
2.1 Form of Subordinate Voting Share Certificate (incorporated by
reference to Exhibit 4.1 of EXFO's Registration Statement on
Form F-1 filed on June 9, 2000, 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 filed on June 9, 2000, 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 filed on June 9, 2000, 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, File No.
000-30895).
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, File No.
000-30895).
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, File No. 000-30895).
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, File No. 000-30895).
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 filed on
June 9, 2000, 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
filed on July 13, 2001, 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 filed on
July 13, 2001 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, File No.
000-30895).
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 filed on July 13, 2001 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 filed on June 9, 2000,
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 filed on June 9,
2000, File No. 333-38956).
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NUMBER EXHIBIT
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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 Exhibit 10.5 of EXFO's
Registration Statement on Form F-1 filed on June 9, 2000,
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, File No. 000-30895).
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 filed on June 9,
2000, 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 filed on June 9, 2000, 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 filed on June 9, 2000,
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
filed on June 9, 2000, 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 filed on June 9, 2000,
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, File No.
000-30895).
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,
File No. 000-30895).
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, File No.
000-30895).
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 filed on June 9, 2000,
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 filed on June 9, 2000, 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
filed on June 9, 2000, 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
filed on June 9, 2000, 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, File No.
000-30895).
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, File No. 000-30895).
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, File No. 000-30895).
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, File No. 000-30895).
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, File No. 000-30895).
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NUMBER EXHIBIT
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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, File No. 000-30895).
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,
File No. 000-30895).
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, File No.
000-30895).
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,
File No. 000-30895).
4.35 Long-Term Incentive Plan, dated May 25, 2000, amended in
October 2004 and effective January 12, 2005.
4.36 Deferred Share Unit Plan, effective January 12, 2005.
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, File No. 000-30895).
11.2 Board of Directors Corporate Governance Guidelines.
11.3 Code of Ethics for our Principal Executive Officer and Senior
Financial Officers.
11.4 Ethics and Business Conduct Policy.
11.5 Statement of Reporting Ethical Violations (Whistle Blower).
11.6 Audit Committee Charter.
11.7 Human Resources Committee Charter.
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.