UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 6-K
REPORT OF FOREIGN PRIVATE ISSUER PURSUANT TO RULE 13a-16 OR 15d-16
UNDER THE SECURITIES EXCHANGE ACT OF 1934
For the month of December 2003
EXFO ELECTRO-OPTICAL ENGINEERING INC.
(Translation of registrant's name into English)
400 GODIN AVENUE, VANIER, QUEBEC, CANADA G1M 2K2
(Address of principal executive offices)
Indicate by check mark whether the registrant files or will file annual reports
under cover of Form 20-F or Form 40-F.
Form 20-F [X] Form 40-F [_]
Indicate by check mark whether the registrant by furnishing the information
contained in this Form is also thereby furnishing the information to the
Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of 1934.
Yes [_] No [X]
If "Yes" is marked, indicate below the file number assigned to the registrant in
connection with Rule 12g3-2(b): 82-______.
In December 2003, EXFO Electro-Optical Engineering Inc., a Canadian corporation,
issued its annual report containing its annual audited financial statements and
management's discussion and analysis thereof for its fiscal year ended August
31, 2003. At the same time, it also issued its notice of its annual and special
shareholders' meeting, its form of proxy, its management proxy circular and a
cover letter. This report on Form 6-K sets forth said documents.
The annual report containing the Corporation's annual audited financial
statements and management's discussion and analysis for its fiscal year ended
August 31, 2003, its notice of annual and special shareholders' meeting, its
form of proxy, its management proxy circular and cover letter are hereby
incorporated as documents by reference to Form F-3 (Registration Statement under
the Securities Act of 1933) declared effective as of July 30, 2001 and to Form
F-3 (Registration Statement under the Securities Act of 1933) declared effective
as of March 11, 2002 and to amend certain material information as set forth in
these two Form F-3 documents.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
By: /s/ Germain Lamonde
---------------------------------------
Name: Germain Lamonde
Title: President and Chief Executive Officer
Date: December 3, 2003
2003 ANNUAL REPORT
[GRAPHIC OMITTED]
[PHOTOGRAPHS]
Communications test and measurement experts
[GRAPHIC OMITTED]
[LOGO - EXFO]
CORPORATE PROFILE
EXFO is the recognized expert in the global optical communications industry
through the design and manufacture of advanced and innovative test and
measurement solutions. The Telecom Division, which represents our main business
activity, offers fully integrated and complete test solutions to network service
providers, system vendors and component manufacturers in approximately 70
countries. One of our strongest competitive advantages is our modular platform
design, providing PC-based, Windows-centric test solutions that maximize
technology reuse across several market segments. The Photonics and Life Sciences
Division mainly leverages core telecom technologies to offer value-added
solutions in high-tech industrial manufacturing and research sectors. For more
information about EXFO, visit www.exfo.com.
TABLE OF CONTENTS
Financial Highlights ..........................................................1
Letter to Shareholders ........................................................2
Corporate Highlights ..........................................................5
Telecom Division ..............................................................6
Photonics and Life Sciences Division ..........................................8
Management's Discussion and Analysis ..........................................9
Management's Report ..........................................................21
Auditors' Report .............................................................21
Consolidated Financial Statements ............................................22
Notes to Consolidated Financial Statements ...................................26
Board of Directors ...........................................................46
Management and Corporate Officers ............................................47
Corporate Governance Practices ...............................................48
Glossary .....................................................................50
Shareholder Information ......................................................51
FORWARD-LOOKING STATEMENTS
This Annual Report may contain forward-looking statements within the meaning of
the U.S. Private Securities Litigation Reform Act of 1995 and we intend that
such forward-looking statements be subject to the safe harbors created thereby.
Forward-looking statements are statements other than historical information or
statements of current condition. Words such as "may," "will," "expect,"
"believe," "anticipate," "intend," "could," "estimate" or "continue" or the
negative or comparable terminology are intended to identify forward-looking
statements. In addition, any statements that refer to expectations, projections
or other characterizations of future events or circumstances are forwardlooking
statements. Forward-looking statements are not guarantees of future performance
and involve risks and uncertainties, and actual results may differ materially
from those in the forward-looking statements as a result of various factors,
including economic uncertainty, capital spending in the telecommunications
sector, fluctuating exchange rates and our ability to execute successfully in
these uncertain conditions; the effects of the additional actions we have taken
in response to such economic uncertainty (including workforce reductions,
ability to quickly adapt cost structures to align with decreased levels of
business, ability to manage inventory levels to adapt to slowdowns); market
acceptance of our new products and other upcoming new products; limited
visibility with regards to customer orders and the timing of such orders; our
ability to successfully integrate and run our acquired and to-be-acquired
companies; the retention of key technical and management personnel; and future
economic, competitive and market conditions. Assumptions relating to the
foregoing involve judgments and risks, all of which are difficult or impossible
to predict accurately and many of which are beyond our control. Other risk
factors that may affect our future performance and our operations are detailed
in our Annual Report on Form 20-F and our other filings with the U.S. Securities
and Exchange Commission and the Canadian securities commissions. Although we
believe that the expectations reflected in the forward-looking statements are
reasonable based on information currently available to us, we cannot assure you
that the expectations will prove to have been correct. Accordingly, you should
not place undue reliance on these forward-looking statements. In any event,
these statements speak only as of the date of this document. We undertake no
obligation to revise or update any of them to reflect events or circumstances
after the date of this document.
TRADEMARKS AND LOGOS
EXFO and the EXFO logo are registered trademarks of EXFO Electro-Optical
Engineering Inc. in Canada, the United States and/or other countries. Other EXFO
product names or logos referenced in this document are either trademarks or
registered trademarks of EXFO Electro-Optical Engineering Inc. or of its
affiliated companies. All other product names and trademarks mentioned herein
are trademarks of their respective owners. However, neither the presence nor
absence of the identification symbols (R) or TM affects the legal status of any
trademark.
All dollar amounts in this Annual Report are expressed in US dollars, except as
otherwise noted.
EXFO o 2003 Annual Report o 1
FINANCIAL HIGHLIGHTS
(in thousands of US dollars, except per share data)
(in thousands of US dollars, except per share data)
----------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF EARNINGS DATA 2003 2002 2001 2000 1999
----------------------------------------------------------------------------------------------------------------------------
Sales $ 61,930 $ 68,330 $ 146,013 $ 71,639 $ 42,166
Gross margin (1,2) $ 25,733 $ 15,964 $ 89,806 $ 46,254 $ 26,708
41.6% 23.4% 61.5% 64.6% 63.3%
----------------------------------------------------------------------------------------------------------------------------
Gross research and development $ 17,133 $ 17,005 $ 17,601 $ 9,374 $ 6,390
27.7% 24.9% 12.1% 13.1% 15.2%
----------------------------------------------------------------------------------------------------------------------------
Earnings (loss) from operations (3) $(35,079) $ (74,783) $ 14,507 $ 14,723 $ 8,676
(56.6%) (109.4%) 9.9% 20.6% 20.6%
----------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) $(54,950) $(308,524) $ (15,294) $ 9,924 $ 5,814
(88.7%) (451.5%) (10.5%) 13.9% 13.8%
----------------------------------------------------------------------------------------------------------------------------
Basic and diluted net earnings (loss)
per share $ (0.87) $ (5.09) $ (0.29) $ 0.25 $ 0.14
----------------------------------------------------------------------------------------------------------------------------
OTHER STATEMENTS OF EARNINGS DATA (UNAUDITED)(4)
----------------------------------------------------------------------------------------------------------------------------
Pro forma net earnings (loss) $(11,476) $ (11,248) $ 24,500 $ 10,252 $ 5,843
(18.5%) (16.5%) 16.8% 14.3% 13.9%
----------------------------------------------------------------------------------------------------------------------------
Basic and diluted pro forma net earnings
(loss) per share $ (0.18) $ (0.19) $ 0.46 $ 0.26 $ 0.14
----------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS DATA
----------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents and short-term
investments $ 57,376 $ 49,681 $ 74,590 $163,388 $ 1,794
----------------------------------------------------------------------------------------------------------------------------
Working capital $ 76,659 $ 91,374 $ 130,289 $194,167 $ 12,745
----------------------------------------------------------------------------------------------------------------------------
Total assets $146,254 $ 177,926 $ 442,577 $219,723 $ 22,840
----------------------------------------------------------------------------------------------------------------------------
Long-term debt (excluding current portion) $ 453 $ 564 $ 664 $ 16 $ --
----------------------------------------------------------------------------------------------------------------------------
Shareholders' equity $129,826 $ 165,406 $ 414,805 $206,994 $ 14,679
----------------------------------------------------------------------------------------------------------------------------
(1) Including inventory write-offs of $4,121 and $18,463 for the years ended
August 31, 2003 and 2002, respectively, and nil for the years ended August
31, 2001, 2000 and 1999. Including a non-recurring gain of $473 for the
year ended August 31, 2003, and nil for the years ended August 31, 2002,
2001, 2000 and 1999. Excluding inventory write-offs and the non-recurring
gain, gross margin would have reached 47.4% for the year ended August 31,
2003. Excluding inventory write-offs, gross margin would have reached 50.4%
for the year ended August 31, 2002. This latter information is unaudited
and is a non-GAAP measure.
(2) A new presentation was adopted in 2003 with certain expenses reclassified
from selling and administrative expenses to cost of sales. Consequently,
comparative figures have been reclassified.
(3) Including charges for inventory and tax credit write-offs, non-recurring
grants recovery, amortization and write-down of intangible assets as well
as restructuring and other charges of $17,509, $56,615, $13,164, $47 and
nil for the years ended August 31, 2003, 2002, 2001, 2000 and 1999,
respectively.
(4) Net earnings (loss) excluding amortization and write-down of goodwill,
non-recurring tax recovery, future income tax assets valuation allowance
and the after-tax effect of amortization and write-down of intangible
assets, restructuring and other charges, inventory and tax credit
write-offs and non-recurring grants recovery. This information may not be
comparable to similarly titled measures reported by other companies because
it is non-GAAP information. Please refer to page 17 of this Annual Report
for a detailed quantitative reconciliation.
TOTAL SALES (in thousands of U.S. dollars)
2003 2002 2001
---- ---- ----
$61,930 $68,330 $146,013
[GRAPHIC OMITTED]
[PIE CHARTS]
GEOGRAPHIC SALES
2003 2002 2001
---- ---- ----
North America 59% 57% 58%
Europe 15% 19% 21%
Asia 16% 14% 13%
Rest of the world 10% 10% 8%
DIVISIONAL SALES
o Portable and Monitoring
o Industrial and Scientific
2003 2002 2001
---- ---- ----
Portable and Monitoring 65% 57% 48%
Industrial and Scientific 35% 43% 52%
2 o 2003 Annual Report o EXFO
DEAR FELLOW SHAREHOLDERS,
Kites rise highest against the wind - not with it.
-- Sir Winston Churchill
Fiscal 2003 proved to be a transition year for EXFO, filled with challenges and
opportunities that will make the company stronger in the long term. The severe
two-and-a-half year downturn in the global communications industry -- compounded
by economic uncertainty -- has led to a very challenging environment for many
test and measurement players, but a select few have moved ahead to improve their
competitive position.
[GRAPHIC OMITTED]
[PHOTOGRAPH - GERMAIN LAMONDE
CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE OFFICER]
I believe EXFO belongs to the latter group. Midway into fiscal 2001, we began
refocusing our test and measurement business back toward network service
providers (NSPs), our traditional customer segment. Our thinking was based on
the premise that NSPs would continue spending moderately during the downturn
and, eventually, they would be the first market segment to recover. On the other
hand, we expected component vendors, with their colossal inventories and excess
manufacturing capacity, to be destined for a late recovery, given that
consolidation first had to occur. Accordingly, we directed our R&D efforts
toward field-testing applications and acquired Avantas Networks in November
2001, thus entering the protocol-layer test market and complementing our product
offering. The end result is that sales of our Portable and Monitoring product
lines, which progressed from approximately 40% of total revenues at our peak in
fiscal 2001 to two-thirds in 2003, increased 3% in the past year, despite
depressed spending levels. Meanwhile, optical component manufacturing test
solutions, which traditionally had represented the vast majority of our
Industrial and Scientific sales, were no longer significant in 2003.
Secondly, we expanded our presence in the system manufacturer market by
acquiring the assets of gnubi communications in October 2002. At the industry
level, we expected system manufacturers would be the next market segment to
rebound. Bandwidth demand, after all, continues to increase with new investments
required to build and deploy highly efficient, IP-based networks. This ongoing
trend enables the convergence of voice and data over a broadening range of
consumer devices. At the company level, this acquisition not only allows us to
extend our protocol-layer test portfolio to system manufacturers, but also to
reuse technologies across multiple market segments.
[GRAPHIC OMITTED]
COMMUNICATIONS SUPPLY CHAIN
Network Service Providers > System Vendors > Component Manufacturers > EXFO
Perhaps, the one point we underestimated was the duration of the market downturn
that swept across the entire communications industry. Consequently, we were
forced to implement a series of restructuring plans to adjust our cost structure
to existing spending levels. We froze salaries and trimmed our workforce by 15%
in 2001. We reduced our staff by 30% and rationalized our operations in 2002. In
2003, we pared down our workforce by 30%, exited the optical component
manufacturing automation business, and streamlined the number of our production
facilities. Overall, EXFO has gone from a peak of approximately 1400 employees
in 2001 to 600 in 2003, of which almost 30% remain dedicated to R&D activities.
EXFO o 2003 Annual Report o 3
[GRAPHIC OMITTED]
[PHOTOGRAPH]
With continued quality of execution, protocol-layer activities are expected to
play a larger role and contribute to our growth in 2004.
To summarize our fiscal 2004 strategy, we plan to increase sales through
market-share gains, maximize profitability and growth on a long-term basis,
innovate our way out of this downturn, and maintain a sound financial position.
NEW BUSINESS STRUCTURE
Although I am confident we adopted the right strategy during the downturn, I am
hardly satisfied with our financial performance. We reported total sales of
$61.9 million and a pro forma net loss of $0.18 per share, or $0.87 per share on
a GAAP basis, in fiscal 2003 compared to sales of $68.3 million and a pro forma
net loss of $0.19 per share, or $5.09 per share on a GAAP basis, in 2002. With
that in mind, we have reorganized our business under two new reportable market
segments: Telecom Division and Photonics and Life Sciences Division. Our Telecom
Division, consisting of former Portable and Monitoring and telecom-related
Industrial and Scientific product lines, would have represented 79% of total
sales in 2003. Our Photonics and Life Sciences Division includes previous
non-telecom Industrial and Scientific product lines. This simplified business
structure--with respective sales, marketing, manufacturing, R&D and management
teams for each division--will enable us to better serve our diverse customer
base and maximize shareholder value.
We are more than ever committed to becoming a dominant player in the global
communications test and measurement industry, while leveraging our technology
base toward targeted photonics and life sciences markets. To summarize our
fiscal 2004 strategy, we plan to increase sales through market-share gains,
maximize profitability and growth on a long-term basis, innovate our way out of
this downturn, and maintain a sound financial position.
INCREASE SALES THROUGH MARKET-SHARE GAINS
In fiscal 2004, we are focusing on continued market-share gains to achieve
targeted growth, since we have based our scenario on a declining communications
market; hopefully, our forecast will prove to be too conservative. In 2003, we
believe that we gained market share among NSPs by strengthening the leadership
position of our FTB-400 field-testing platform and by extending its reach to
telecom and datacom protocol-layer test applications. We also leveraged our
protocol-layer acquisitions (formerly Avantas Networks and gnubi communications)
to enhance our strategic position and sales results in this mission-critical
sector for our targeted end-markets. Evidence of this newfound traction is
reflected in our protocol-layer test sales, which reached more than 10% of total
revenues in each of the last three quarters of 2003. With continued quality of
execution, protocol-layer activities are expected to play a larger role and
contribute to our growth in 2004.
Looking ahead, we intend to further expand our presence with NSPs, who are
increasingly focusing on reducing operating expenditures (OPEX) as capital
expenditures (CAPEX) draw nearer to maintenance-level run rates. The unique
value proposition inherent to our FTB-400 platform and related suite of test
technologies reduces both CAPEX and OPEX, aptly matching the priorities of NSPs
and installation teams of system vendors. Speaking of system vendors, we also
started to target their R&D and manufacturing teams in 2003--as evidenced by the
acquisition of gnubi communications. Following significant balance sheet
restructuring, system vendors are gradually recovering with positive cash flow
and even profits. We believe they will continue to improve their financial
position in 2004, resume their role as innovation drivers and become a major
end-market for EXFO in the long term. In addition, we intend to leverage
synergies across our entire protocol R&D activities to accelerate the
development of innovative, advanced and differentiated test solutions that
maximize the reuse of technologies over multiple market segments. The design,
manufacturing and deployment of next-generation SONET/SDH networks, coupled with
the convergence of multiple applications on simplified architectures, represent
a significant market opportunity for our Telecom Division as we continue to
expand our addressable markets.
As indicated by the realignment of our operations, we also intend to maximize
revenue streams by leveraging our core telecom expertise into select adjacent
markets. For example, we recently launched the X-Cite(TM) 120 Fluorescence
Illumination System that was based on our adhesive curing technology for optical
component manufacturing. Through joint development and reseller agreements with
market-leading microscope manufacturers, we plan to take advantage of their
large sales organizations and established base of microscopes to grow revenues
in our Photonics and Life Sciences Division.
4 o 2003 Annual Report o EXFO
LETTER TO SHAREHOLDERS (CONTINUED)
MAXIMIZE PROFITABILITY AND GROWTH ON A LONG-TERM BASIS
Returning to profitability represents another top priority. We plan to keep a
tight control on operating costs with a leaner and more flexible workforce. We
will also continue to design differentiated, higher-margin products in our R&D
labs, streamline our manufacturing operations and review our supply chain to
reduce our cost of goods. As well, we will keep fine-tuning our sales process to
offset ongoing pricing pressure from some competitors. These initiatives should
help us improve our gross margin--which fell to 47.4% (excluding inventory
write-offs and a non-recurring gain) in 2003 versus our historical level of
about 60%--and accelerate our return to profitability, but not at the expense of
sacrificing long-term growth. Maximizing profitability and growth on a long-term
basis is critical to ensure the success of our company.
INNOVATE OUR WAY OUT OF THE DOWNTURN
Ever since we founded EXFO in 1985, innovation strategies were focused on being
first to market with unique solutions that anticipate and better address
customer requirements. Our market-driven approach can be demonstrated through a
long history of industry firsts--first modular optical test platform, first
all-in-one field-testing platform, first portable polarization mode dispersion
(PMD) analyzer, etc. This focus on delivering a unique value proposition to the
marketplace is of strategic importance to improve our gross margin in the
upcoming year. Despite reductions in 2003, we maintained gross R&D spending at
$17.1 million compared to $17.0 million in 2002 and $17.6 million in 2001. As a
result, our strong product pipeline delivered 15 new solutions to the
marketplace, including the next-generation PMD Analyzer that can characterize
PMD levels in high-speed optical networks, the 2.5+ Gigabit Multi-Rate
Transceiver for protocol-layer test applications, and the Packet Blazer(TM)
Fibre Channel test module for installation and commissioning of storage area
networks. Sales of new products (on the market two years or less) accounted for
49% of total sales in 2003. These numbers reflect our commitment to the future
and indicate that our innovation strategy is working at EXFO. We intend to keep
innovating our way out of this downturn in 2004. As NSPs and system
manufacturers turn their attention to metro, access and fiber-to-the-home
networks and as systems converge toward data-centric, Internet Protocol-based
technologies, we are developing the sophisticated test solutions required to
match heightened network complexity.
MAINTAIN A SOUND FINANCIAL POSITION
For more than 18 years, we have maintained a solid balance sheet and, as of
August 31, 2003, we had a cash position of approximately $57.4 million and
practically no debt. This fiscal responsibility, in turn, provides our customers
with the assurance that they can count on EXFO as a solid, long-term partner.
CONCLUSION
I would like to thank our employees for their dedication and hard work during
what can best be described as a challenging year; our customers, for the
confidence they have demonstrated in our products and services; our Board of
Directors, for its diligent governance and wise counsel; and our shareholders,
for supporting our long-term vision and profitable growth strategy. With the
continued support of everyone, I am more than ever committed to the long-term
success of the company and am confident we will soar to new heights.
Sincerely,
/s/ Germain Lamonde
Germain Lamonde
Chairman, President and Chief Executive Officer
October 27, 2003
EXFO o 2003 Annual Report o 5
CORPORATE HIGHLIGHTS
INNOVATION LIVES HERE
[GRAPHIC OMITTED]
[PHOTOGRAPH]
OCTOBER 2002
o Releases X-Cite 120 Illumination System for fluorescence microscopy
applications
o Completes acquisition of the business of gnubi communications, based near
Dallas, Texas
--------------------------------------------------------------------------------
NOVEMBER 2002
o Launches Channel Selector for commissioning and lighting channels in DWDM
networks
o Announces established base of more than 10,000 modular test platforms
worldwide
--------------------------------------------------------------------------------
FEBRUARY 2003
o Introduces next-generation PMD Analyzer
--------------------------------------------------------------------------------
MARCH 2003
o Receives Market Penetration Award from Frost and Sullivan for expanding
into the protocol-layer test market
o Accepts Growth Strategy Award from Frost and Sullivan for gaining market
share in a highly competitive and turbulent marketplace
o Obtains $1.6 million protocol order from Tier-1 network service provider
o Launches 2.5+ Gigabit Multi-Rate Transceiver for system manufacturer market
o Raises field-testing platform to a new level with launch of Integrated
Applications Suite
o Introduces Packet Blazer Fibre Channel test module for emerging storage
area networks
--------------------------------------------------------------------------------
APRIL 2003
o Signs reseller agreements for X-Cite 120 Fluorescence Illumination System
with Nikon Instruments and Zeiss MicroImaging
--------------------------------------------------------------------------------
MAY 2003
o Field-testing platform carries out dual PMD-CD tests on Hibernia Atlantic's
undersea transatlantic network
--------------------------------------------------------------------------------
JUNE 2003
o Announces major restructuring plan
o Exits optical component manufacturing automation business
--------------------------------------------------------------------------------
[GRAPHIC OMITTED]
X-Cite(TM) 120
Fluorescence Illumination System
[GRAPHIC OMITTED]
FTB-5500B
PMD Analyzer
[GRAPHIC OMITTED]
FTB-8515 Packet Blazer(TM)
SAN Test Module
6 o 2003 Annual Report o EXFO
TELECOM DIVISION
THINKING INSIDE THE BOX
As bandwidth requirements and network complexity increase year in and year out,
so have residential and business expectations for quality of service, uptime and
network reliability. These heightened requirements, increasingly becoming
mission-critical throughout the global communications industry, are addressed
with cost-effective, best-of-class solutions that only an experienced test and
measurement vendor like EXFO can deliver.
Customers rely on our expertise to ensure their optical networks perform
impeccably during each phase of the network life cycle-- research, development,
manufacturing, installation, maintenance and full-time monitoring. Our
field-testing solutions provide the utmost efficiency, cost-effectiveness and
productivity to minimize the capital (CAPEX) and operating expenditures (OPEX)
of network service providers (NSPs). Our advanced optical instruments and test
systems enable telecom/datacom system manufacturers as well as component vendors
to design and build better networks and related components.
CONSOLIDATING OUR LEADERSHIP POSITION
We have earned our leadership position in the physical-layer NSP market by
anticipating customer needs for 18-plus years. When customers encountered
problems upgrading their networks to 10 Gb/s, we were first to market with a
unique polarization mode dispersion (PMD) analyzer that detected this limiting
physical phenomenon. When customers faced test and measurement issues for their
dense wavelength-division multiplexing (DWDM) networks, we introduced the best
portable optical spectrum analyzer (OSA) and chromatic dispersion (CD) analyzer
on the market. With fiber-to-the-home (FTTH) about to become a reality, lead
customers are turning to us for another ready-made test solution. These are
merely a few examples of the value-added solutions that customers have come to
expect from a reliable, long-term partner such as EXFO, but they provide ample
evidence of why our customer list reads like a Who's Who in the global NSP
market.
At EXFO, we have reorganized our business under two new divisions--with
respective sales, marketing, R&D, manufacturing and management teams--to better
serve the needs of end-customers in different markets. Our Telecom Division
consists of former Portable and Monitoring and telecom-related Industrial and
Scientific product lines. This division is focused on network service providers,
system manufacturers and component vendors on a global basis. Our Photonics and
Life Sciences Division, which mainly leverages our core technologies, includes
former Industrial and Scientific non-telecom product lines. This division has
been created to maximize value from developed and acquired technologies.
Beginning in 2004, we will report segmented information along these separate
divisions.
[GRAPHIC OMITTED]
FTB-400 Universal Test System
EXFO o 2003 Annual Report o 7
[GRAPHIC OMITTED]
[PHOTOGRAPH]
Our PC-centric, Windows-driven platform, supported by more than a dozen
next-generation test technologies, addresses complete service provisioning needs
for DWDM, SONET/SDH, Gigabit Ethernet and, most recently, storage area network
(SAN) applications.
RAISING OUR FIELD-TESTING PLATFORM TO A NEW LEVEL
EXFO has been thinking inside the box since 1996, when we launched the original
modular optical test platform. We expanded our leadership position in 2002 by
releasing the first all-in-one test set that covers physical-, optical- and
protocol-layer field-testing requirements for long-haul, metropolitan and access
networks. In 2003, we raised the bar to a new level with the introduction of
fully integrated software suites that automate the operation of test modules
within our FTB-400 field-testing platform. This latest innovation allows complex
testing routines to be carried out with a simple touch of a button. Our
PC-centric, Windowsdriven platform, supported by more than a dozen
next-generation test technologies, addresses complete service provisioning needs
for DWDM, SONET/SDH, Gigabit Ethernet and, most recently, storage area network
(SAN) applications. We recently released a Fibre Channel test module that
provides NSPs with highly accurate bit-error-rate (BER) values, which reflect
the quality of their SAN networks. The one-two combination of best-in-class
modular platform and broadest suite of test technologies has left competitors
little choice but to play catch-up.
ADDRESSING CAPEX AND OPEX CONCERNS
It's a matter of dollars and sense. To improve cash-flow requirements and lower
debt loads, NSPs are constantly looking for ways to reduce their short-term
CAPEX and long-term OPEX budgets. EXFO proves to be the vendor of choice with
solutions that characterize high-speed optical networks with a superior level of
accuracy and repeatability, while helping NSPs improve their financials.
o Our modular platform design allows several test modules to be used inside a
single box, providing significant cost savings. (CAPEX)
o Our proprietary PMD and CD analyzers sweep through optical amplifiers along
networks, while conventional methods require dispersion levels to be
measured between one amplifier and another. The end result is considerable
savings in testing time. (OPEX)
o The Dual Test Set feature on our Packet Blazer(TM) test module provides
end-to-end Ethernet traffic testing using a remote unit, thus eliminating
the need for an extra technician in the field. (OPEX)
EXTENDING INNOVATION TO SYSTEM MANUFACTURERS
Innovation is not limited to field-testing solutions at EXFO. Our
R&D/manufacturing-floor platforms, namely the IQS-500 Intelligent Test System
and EPX Multi-Channel Test Systems, are designed for testing converging telecom
and datacom networks increasingly based on IP technology. The next-generation
IQS-500 platform can efficiently run as many as 100 physical-layer test modules
using a single controller unit. The flexible and scalable EPX platforms support
multi-channel testing, which is critical for characterizing high-speed optical
networks with multiple wavelengths, speeds and protocols. Physical- and
protocol-layer modules can be stacked in these respective platforms to produce
high-performance test stations for networks and related elements including
multiplexers, cross-connects, transponders, lambda routers, optical switches and
DWDM systems.
In 2003, we leveraged our IQS-500 platform to design a new Cable Assembly Test
System for multimode patchcord assemblies and added three test modules to our
high-performance power meter series. We also introduced the 2.5+ Gigabit
Multi-Rate Transceiver for our EPX platforms to help system manufacturers reduce
test time and increase test thoroughness on the production floor. This
protocol-layer test module simulates and monitors live traffic on each
individual channel, enabling customers to carry out critical tests like BER,
hybrid concatenation and service-disruption switch time. Subsequent to the
year-end, we released the 10+ Gigabit Multi-Rate Transceiver with deep
channelization and mixed payload concatenations for next-generation networks. We
also launched a tunable external-cavity laser (ECL), whose broad wavelength
range is optimized for coarse wavelength-division multiplexing (CWDM) and
fiber-to-the-premises (FTTP) testing. These latest innovations point to one
undeniable conclusion about EXFO: Innovation lives here!
[GRAPHIC OMITTED] [GRAPHIC OMITTED]
EPX16 Multi-Channel Test System IQS-500 Intelligent Test System
8 o 2003 Annual Report o EXFO
PHOTONICS AND LIFE SCIENCES DIVISION
LEVERAGING EXISTING TECHNOLOGIES
Over the years, EXFO has developed and acquired a number of telecom-related
technologies that we are leveraging in selected photonics and life science
applications for high-tech industrial manufacturing and research markets. For
example, we offer several light-based curing solutions for optical component
manufacturing and have optimized our approach for other industries, such as
semiconductor, electronic, and medical device manufacturing, to maximize
revenues. Our Novacure(R) and Acticure(R) spot-curing systems deliver precise
doses of the appropriate spectral light onto photosensitive adhesives to
significantly reduce bonding time and increase repeatability. These light-based
curing systems, supported by patented StepCure(R) technology, produce a
high-quality bonding solution that is unmatched in the industry.
DEVELOPING UNIQUE FLUORESCENCE MICROSCOPY SOLUTIONS
In 2003, we took advantage of our light-based curing technology to jointly
develop a unique fluorescence microscopy solution with leading manufacturers.
The X-Cite(TM) 120 Fluorescence Illumination System is an indispensable
microscope accessory, offering greater image quality, convenience and lamp life
than conventional solutions in the life sciences market. Market response proved
to be very positive following the signing of reseller agreements with industry
leaders such as Nikon Instruments and Zeiss MicroImaging, who are offering the
X-Cite 120 through their own sales channels to new and existing microscope
owners.
DEPLOYING NANOTECHNOLOGY FOR LIFE SCIENCE RESEARCH
To meet the growing demand for precision positioning instrumentation in life
science research, we have drawn on our telecom expertise in nanometer-scale
positioning to offer a unique array of piezoelectric-based positioning systems.
The stability of piezoelectric (PZT) technology provides extremely smooth and
predictable instrument motion used for applications as varied as
micromanipulation and patch-clamp experimentation, ultra-fast solution
switching, nuclear transfer and intracytoplasmic sperm injection.
[GRAPHIC OMITTED]
PCS-5000
Patch-Clamp Manipulation System
EXTENDING OUR WAVEMETER(R) TECHNOLOGY
Our Wavemeter test solutions are recognized around the world for characterizing
optical networks with the highest degree of accuracy. We take full advantage of
our leading-edge technology by extending it to non-telecom applications that
require the use of a laser. Scientists and engineers, after all, need to know
the absolute wavelength of a laser for their particular line of work such as
high-resolution laser spectroscopy, photochemistry and optical remote sensing.
[GRAPHIC OMITTED]
WA-1650
Wavemeter
As demonstrated in the above examples, we're constantly finding new ways to
leverage our technology base and maximize revenues.
[GRAPHIC OMITTED]
X-Cite(TM) 120
Fluorescence Illumination System
EXFO o 2003 Annual Report o 9
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of the consolidated financial condition
and results of operations of EXFO Electro-Optical Engineering Inc. for the
fiscal years ended August 31, 2003, 2002 and 2001, should be read in conjunction
with our consolidated financial statements and the related notes included
elsewhere in this Annual Report. Our consolidated financial statements are
reported in US dollars and have been prepared in accordance with generally
accepted accounting principles in Canada, or Canadian GAAP. To the extent
applicable to our consolidated financial statements included elsewhere in this
Annual Report, these principles conform in all material respects with generally
accepted accounting principles in the United States, or U.S. GAAP, except for
significant differences, as described in Note 20 to our consolidated financial
statements.
INDUSTRY OVERVIEW
Communications companies, still dealing with reduced spending levels, were
affected by a number of external forces during fiscal 2003, including
geo-political and economic uncertainty, the outbreak of SARS in Asia, as well as
the declining strength of the US dollar. To cope with these market realities,
network service providers, the first link in the communications supply chain,
continued to service their debt loads and conserve cash. Moreover, as capital
expenditure (CAPEX) budgets increasingly drew nearer to maintenance-level run
rates, network service providers turned their attention to operating
expenditures (OPEX) for further savings.
Lower spending levels necessarily produced a trickle-down effect throughout the
communications industry, namely for system vendors, component manufacturers as
well as for test and measurement equipment vendors. System manufacturers were
negatively affected by the significant reduction in the deployment of long-haul
optical networks, but benefited from some activity in metro and access networks.
Optical component manufacturers were hardest hit by the downturn, given their
position in the supply chain, the relative stability of technology and the
excess manufacturing capacity in this sector. The ongoing consolidation within
the component manufacturing market provides an inkling of its weaker health.
Test and measurement equipment vendors also felt the impact of reduced network
service provider spending with less demand for orders. In addition, some
competitors increasingly applied pricing pressure to obtain contracts, which
eroded margins across the board. The gray market for test and measurement
instruments, especially involving optical component manufacturing applications,
further compounded the soft market. On the other hand, test and measurement
vendors--whose products enable customers to lower CAPEX and OPEX, as well as
deploy nextgeneration architecture--still attracted the attention of network
service providers and system manufacturers for certain projects.
COMPANY OVERVIEW
EXFO is a leading designer and manufacturer of fiber-optic test, measurement and
monitoring solutions for the global telecommunications industry.We market more
than 90 product families to a diverse customer base in approximately 70
countries around the world. We develop products for two main markets. The
Portable and Monitoring Division provides handheld and modular instruments for
the physical-, optical- and protocol-layer testing needs of telecommunications
carriers and network service providers. The Industrial and Scientific Division
offers an extensive line of high-performance instruments and test systems for
optical transmission system and component vendors as well as for research and
development labs.
EXFO was founded in Quebec City, Canada, in 1985. Our original products were
focused on the needs of installers and operators of fiber-optic networks.
Customers use these field-testing products for the installation, maintenance,
monitoring and troubleshooting of optical networks. In 1996, we supplemented our
product portfolio with an extensive line of high-end products that are mainly
dedicated to research and development as well as manufacturing activities. These
products, namely modular and benchtop units, tend to be more complex and
higher-priced than field-testing ones. In 1999, we entered the remote fiber test
system (RFTS) market. This type of system allows network service providers to
monitor the integrity of their fiber-optic systems in real time, twenty-four
hours a day, seven days a week.
In the last two years, we have strengthened our competitive position through the
acquisition of two protocol-layer test businesses. In November 2001, we expanded
into protocol-layer testing with the acquisition of Avantas Networks Corporation
(renamed EXFO Protocol Inc.), a supplier of fiber-optic testing and
optical-network-performance management equipment for network service providers.
This transaction was highly strategic because it enabled us to combine
protocol-, optical- and physical-layer testing inside a single platform--the
FTB-400 Universal Test System-- to help our customers increase revenues and
reduce operational costs.
In October 2002, our newly created wholly-owned subsidiary, EXFO Gnubi,
purchased substantially all the assets of gnubi communications, L.P., a supplier
of multi-channel telecom and datacom testing solutions for the system
manufacturer market. EXFO Gnubi's protocol-layer test equipment targets the
fully complementary system manufacturer market, while EXFO Protocol's offering
focuses on the network service provider market. Jointly, these strategic
acquisitions enabled us to double our addressable market as we expanded from
physical- and optical-layer testing to also cover protocol-layer testing
applications in the telecom and datacom market, while offering a more complete
fiber-optic test solution to customers.
Previously, we completed two acquisitions to bolster growth in the optical
component manufacturing market.We acquired Burleigh Instruments, Inc. (renamed
EXFO Burleigh Products Group Inc.) in December 2000 for its wavelength
measurement instruments and nanopositioning alignment systems.We also added EFOS
Inc. (renamed EXFO Photonic Solutions Inc.) in March 2001 for its precision
light-based, adhesive spot-curing technology.We have since exited the optical
component manufacturing automation business, a market addressed by an EXFO
Burleigh product line.
One of our strongest competitive advantages is our modular platform design,
which we first launched in 1996; and with the introduction of all-in-one test
sets that cover physical-, optical- and protocol-layer test requirements in
2002, we believe that we remain the industry leader in this area. In 2003, we
raised our field-testing platform to a new level by enabling field technicians
to seamlessly automate their test applications. The first software product
within EXFO's Integrated Applications Suite, the Lambda Auto-Sweeper, automates
the interaction and common reporting of three test modules within our FTB-400
field-testing platform: SONET/SDH Analyzer, Optical Spectrum Analyzer and DWDM
Channel Selector.
As described above, we have faced difficult market conditions in the
telecommunications industry in the last two years; we experienced a decrease in
sales and incurred significant operating losses. To cope with these realities,
we implemented several restructuring actions since the last quarter of fiscal
2001. These actions resulted in workforce reductions of 245, 350 and 172
employees in fiscal 2001, 2002 and 2003, respectively.We also adopted rigorous
cost-control measures and rationalized our business model. In addition, we
incurred significant asset impairment charges related to these market
conditions, namely for inventories, goodwill, intangible assets and future
income tax assets.
To better serve the needs of end-customers in different markets and simplify our
business model, we reorganized our business under two new divisions at the
beginning of fiscal 2004. Our Telecom Division consists of former Portable and
Monitoring and telecom-related Industrial and Scientific product lines. This
division is focused on network service providers, communication system
manufacturers and optical component vendors on a global basis. Our Photonics and
Life Sciences Division, which mainly leverages our core technologies, includes
former Industrial and Scientific non-telecom product lines. This division has
been created to maximize value from developed and acquired telecom technologies.
10 o 2003 Annual Report o EXFO
Following this reorganization, our two new divisions now have respective sales,
marketing, R&D, manufacturing and management teams and will, therefore, be
presented under two corresponding operating segments. Under CICA handbook
section 1701, we will provide the required segmented disclosures in our interim
consolidated financial statements beginning in the first quarter of fiscal 2004.
However, we will not provide comparative information for previous periods about
each reportable segment, except for sales and long-lived assets, because this
information is not available.
SALES
We sell our products to a diversified customer base in approximately 70
countries around the world through our direct sales force and, indirectly,
through distribution channels. Our customers are comprised of telecommunications
carriers, network service providers, system and optical component manufacturers,
as well as research and development laboratories.We have a diversified customer
base, both in terms of sector and geographical area, which provides us with
reasonable protection regarding concentration of credit risk. As for customer
breakdown, no customer accounted for more than 9.2%, 10.2% and 6.4% of sales in
fiscal 2003, 2002 and 2001, respectively. In fiscal 2003, our three most
significant customers represented 17.5% of sales, compared to 15.4% of sales in
2002 and 12.8% of sales in 2001.
COST OF SALES
Cost of sales includes raw materials, salaries and related expenses for direct
and indirect manufacturing personnel (net of government grants) as well as
overhead costs. Excess, obsolete or scrapped materials are also included in cost
of sales.
In 2003, we reclassified certain expenses from selling and administrative
expenses to cost of sales. Comparative figures have been reclassified
accordingly.
OPERATING EXPENSES
We classify our operating expenses into three general categories: selling and
administrative expenses, research and development expenses and amortization
expenses.
Selling and administrative expenses consist primarily of salaries and related
expenses for personnel (net of government grants), sales commissions, travel
expenses, marketing 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 thirdparty consultants.We are eligible to receive
research and development tax credits and government grants on research and
development carried out in Canada. Related research and development tax credits
and government grants are recorded as a reduction of gross research and
development expenses. Tax credit write-offs are included in net research and
development expenses.
Operating expenses related to our restructuring plans have been recorded as a
separate component of operating expenses. These expenses consist primarily of
severance expenses, costs to exit leased facilities as well as write-offs of
unused long-lived assets.
OUR STRATEGY
We are more than ever committed to becoming a dominant player in the global
communications test and measurement industry, while leveraging our technology
base in targeted photonics and life science markets. To summarize our fiscal
2004 strategy, we plan to increase sales through market-share gains, maximize
profitability and growth on a long-term basis, innovate our way out of this
downturn, and maintain a sound financial position.
INCREASE SALES THROUGH MARKET-SHARE GAINS
In fiscal 2004, we will focus on continued market-share gains to achieve growth,
considering a scenario based on a slightly declining communications market. In
2003, we believe that we gained market share among network service providers by
strengthening the leadership position of our FTB-400 field-testing platform and
by extending its reach to telecom and datacom protocol-layer test applications.
We also leveraged our protocol-layer acquisitions (formerly Avantas Networks and
gnubi communications) to enhance our strategic position and sales results in
this mission-critical sector for our targeted end-markets. Evidence of this
newfound traction is reflected in our protocol-layer test sales, which accounted
for more than 10% of total revenues in each of the last three quarters of 2003.
With continued quality of execution, protocol-layer activities are expected to
play a larger role and contribute to our growth in 2004.
Looking ahead, we intend to further expand our presence with network service
providers, who are increasingly focusing on reducing operating expenditures
(OPEX) as capital expenditures (CAPEX) draw nearer to maintenance-level run
rates. The unique value proposition inherent to our flexible, PC-based FTB-400
modular test platform and related suite of test technologies reduces both CAPEX
and OPEX, aptly matching the priorities of network service providers and
installation teams of system vendors.
Speaking of system vendors, we also started to target their R&D and
manufacturing teams in fiscal 2003--as evidenced by the acquisition of gnubi
communications. Following significant balance sheet restructuring, system
vendors are gradually recovering, showing positive cash flow and even profits.We
believe they will continue to recover in 2004 and will represent a major
end-market for EXFO in the long term.
In addition, we intend to leverage synergies across our entire protocol R&D
activities to accelerate the development of innovative, advanced and
differentiated test solutions that maximize the reuse of technologies over
multiple market segments. The design, manufacturing and deployment of
next-generation SONET/SDH networks, combined with the convergence of multiple
applications on simplified architectures and our strong market position on the
physical-layer side, represent a significant market opportunity for our Telecom
Division as we continue to expand our addressable markets.
As indicated by the realignment of our operations, we also intend to maximize
revenue streams by leveraging our core telecom expertise into select adjacent
markets. For example, we recently launched the X-Cite 120 Fluorescence
Illumination System that was based on our adhesive curing technology for optical
component manufacturing. Through joint development and reseller agreements with
market-leading microscope manufacturers, we plan to take advantage of their
large sales organizations and established base of microscopes to grow revenues
in our Photonics and Life Sciences Division.
EXFO o 2003 Annual Report o 11
MAXIMIZE PROFITABILITY AND GROWTH ON A LONG-TERM BASIS
Returning to profitability is also a key priority for EXFO.We intend to design
differentiated, higher-margin products in our R&D labs, streamline our
manufacturing operations and review our supply chain in order to reduce our cost
of goods. As well, we will keep fine-tuning our sales process to offset ongoing
pricing pressure by some competitors. These initiatives should help us improve
our gross margin, which fell to 47.4% (excluding inventory write-offs and a
non-recurring gain) in fiscal 2003, to at least 50% in fiscal 2004 and
accelerate our return to profitability. A balance between profitability and
growth, however, is critical to ensure the long-term success of the company. We
believe that our operating expenses have reached a level in which we cannot make
additional significant reductions without compromising our medium- and long-term
growth prospects. We reduced our selling and general administrative expenses by
20% to $27.0 million in fiscal 2003, from $33.9 million in 2002 and by 25% in
2002, from $45.0 million in 2001. On the other hand, we maintained our gross R&D
expenses at $17.1 million in 2003 compared to $17.0 million in 2002 and $17.6
million in 2001. We plan to keep a tight control on operating costs with leaner
and more flexible operations. However, the ongoing strength of the Canadian
dollar (compared to the US dollar) may have a negative impact on our operating
costs in 2004 and may offset some of our restructuring efforts.
INNOVATE OUR WAY OUT OF THE DOWNTURN
Ever since we founded EXFO in 1985, innovation strategies were focused on being
first to market with unique solutions that anticipate and better address
customer requirements. Our marketdriven approach can be demonstrated through a
long history of industry firsts--first modular optical test platform, first
all-in-one field-testing platform, first portable polarization mode dispersion
(PMD) analyzer, etc. This focus on delivering a unique value proposition to the
marketplace is of strategic importance to improve our gross margin in the
upcoming year. Our strong product pipeline delivered 15 new products to the
marketplace in 2003, most of which include telecom-related solutions such as a
next-generation PMD analyzer that can characterize PMD levels in high-speed
optical networks, a Fibre Channel test module for installation and commissioning
of storage area networks, and a 2.5+ Gigabit multi-rate transceiver for
protocol-layer test applications. Sales of new products (on the market two years
or less) accounted for 49% of total sales in 2003. These numbers reflect our
commitment to the future and indicate that our innovation strategy is working at
EXFO. We intend to keep innovating our way out of this downturn in 2004. As
network service providers and system manufacturers turn their attention to
metro, access and fiber-to-the-home networks and as systems converge toward
data-centric, Internet Protocol-based technologies, we are developing the
sophisticated test solutions required to match heightened network complexity.
MAINTAIN A SOUND FINANCIAL POSITION
For more than 18 years, we have maintained a solid balance sheet and, at the end
of fiscal 2003, we had a cash position of $57.4 million and practically no debt.
This fiscal responsibility provides our customers with the assurance that they
can count on EXFO as a solid, long-term partner.
Our cash position will allow us to continue investing significantly in R&D in
order to develop new solutions and tap into new markets, while some of our
competitors face more significant financial pressure.
KEY PERFORMANCE INDICATORS
As measures to assess the realization of our strategic plan and its objectives,
we have set out four consolidated key performance indicators, which are
summarized as follows:
STRATEGIC OBJECTIVES KEY PERFORMANCE INDICATORS
--------------------------------------------------------------------------------
Increase sales through 10% sales growth year-over-year,
market-share gains assuming a stable or slightly
declining communications market
Maximize profitability and growth 50% gross margin in fiscal 2004
on a long-term basis
Innovate our way out of the downturn 45% of our sales from new
products (on the market two
years or less) during fiscal
2004
Maintain a sound financial position Positive cash flows from
operating activities during
fiscal 2004*
--------------------------------------------------------------------------------
* Assuming no major acquisitions of businesses and/or technologies and
stability in the value of the Canadian dollar compared to the US dollar.
CAPABILITY TO DELIVER RESULTS
At EXFO, we believe that we have the capabilities to deliver expected results
thanks to outstanding products, an excellent reputation in the marketplace, a
sound financial position, as well as an experienced workforce and management
team.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's discussion and analysis of financial conditions and results of
operations is based on our consolidated financial statements included elsewhere
in this Annual Report. As previously mentioned, they have been prepared in
accordance with Canadian GAAP. The preparation of financial statements in
accordance with GAAP requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, the disclosures of
contingent assets and liabilities at the date of the financial statements, and
the reported amounts of revenues and expenses during the reporting years. On an
ongoing basis, we evaluate these estimates and assumptions, including those
related to revenue recognition, allowance for doubtful accounts, allowance for
excess and obsolete inventories, research and development tax credits and
government grants, impairment of long-lived assets and goodwill, valuation
allowance of future income tax assets, warranty obligations, restructuring
charges as well as contingencies and other obligations. We base our estimates
and assumptions on historical experience and on other factors that we believe to
be reasonable under the circumstances, the result of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results could differ from these
estimates.
The following summarizes our critical accounting policies as well as those that
require the most significant judgment and estimates in the preparation of our
consolidated financial statements.
REVENUE RECOGNITION. For products in which software is incidental, we recognize
revenue when persuasive evidence of an arrangement exists, the product has been
delivered, the price is fixed and determinable and collection of the resulting
receivable is reasonably assured. In addition, provisions are made for estimated
returns, warranties and support obligations.
For products in which software is not incidental, revenues are separated into
two categories: product and customer support revenues based upon vendor-specific
objective evidence of fair value. Product revenues for these sales are
recognized as described above. Customer support revenues are deferred and
recognized ratably over the years of the support arrangement. Except when
provided within one year of delivery, costs of providing this support are
insignificant and accrued at the time of delivery and no software upgrades are
provided.
For all sales, we use a binding purchase order as evidence that a sales
arrangement exists.
Delivery generally occurs when the product is shipped to a transporter.
12 o 2003 Annual Report o EXFO
At the time of the transaction, we assess whether the price associated with our
revenue transaction is fixed and determinable, and whether or not collection is
reasonably assured. We assess whether the price is fixed and determinable based
on the payment terms associated with the transaction. We assess collection based
on a number of factors, including past transaction history and the
creditworthiness of the customer. Generally, collateral or other security is not
requested from customers.
Most sales arrangements do not generally include acceptance clauses. However, if
a sales arrangement includes an acceptance provision, acceptance occurs upon the
earliest of the receipt of a written customer acceptance or the expiration of
the acceptance period. For these sales arrangements, the sale is recognized when
acceptance occurs.
ALLOWANCE FOR DOUBTFUL ACCOUNTS. We estimate collectibility of accounts
receivable on an ongoing basis by periodically reviewing balances outstanding
over a certain period of time.We determine our allowance for doubtful accounts
receivable based on our historical accounts receivable collection experience and
on the information that we have about the status of our accounts receivable
balances. If the financial conditions of our customers deteriorate, resulting in
an impairment of their ability to make required payments, additional allowance
may be required, which could adversely affect our future results.
ALLOWANCE FOR EXCESS AND OBSOLETE INVENTORIES. We state our inventories at the
lower of cost, determined on an average cost basis and replacement cost or net
realizable value, and provide reserves for excess and obsolete inventories.We
determine our reserves for excess and obsolete inventories based on the
quantities we have on hand versus expected needs for these inventories, so as to
support future sales of our products. It is possible that additional inventory
reserves may occur if future sales are less than our forecasts or if there is a
significant shift in product mix compared to our forecasts, which could
adversely affect our future results.
RESEARCH AND DEVELOPMENT TAX CREDITS AND GOVERNMENT GRANTS. We record research
and development tax credits and government grants based on our interpretation of
tax laws and grant programs, especially regarding related eligible projects and
expenses, and when there is reasonable assurance that we have complied and will
continue to comply with all conditions and laws. Also, our judgment and
estimates are based on historical experience. It is possible, however, that the
tax authorities have a different interpretation of laws and application of
conditions related to the programs or that we will not comply with all
conditions related to grants in the future, which could adversely affect our
future results. Furthermore, a large part of our tax credits are refundable
against income taxes payable, causing their ultimate realization to be dependent
upon the generation of taxable income. If we obtain information that causes our
forecast of future taxable income to change or if actual taxable income differs
from our forecast, we may have to revise the carrying value of these tax
credits, which would affect our results in the period in which the change was
made. We review the recoverability of such tax credits on a quarterly basis.
Please refer to the "Research and development" section further in this document.
IMPAIRMENT OF GOODWILL AND INTANGIBLE ASSETS. We assess impairment of goodwill
on an annual basis, or more frequently, if events or circumstances occur that
more likely than not reduce the fair value of a reporting unit below its
carrying value. Goodwill impairment exists when the carrying value of a
reporting unit exceeds its fair value. The amount of impairment loss, if any, is
the excess of the carrying value of goodwill over its fair value. On September
1, 2002, upon the adoption of section 3062 of the Canadian Institute of
Chartered Accountants (CICA) handbook, "Goodwill and Other Intangible Assets",
we performed an initial impairment test of goodwill based on a fair value
method. For the purposes of this test, we allocated our existing goodwill to our
reporting units and completed an evaluation of the fair value of such reporting
units. For the purposes of this evaluation, we used discounted future cash flows
as well as sales multiples to estimate the fair value of each reporting unit.
The assumptions used reflect our best estimates. Based on the comparison of the
fair value of the reporting units to their carrying value, goodwill was not
considered impaired at that moment.
Furthermore, on September 1, 2002, we prospectively adopted section 3063 of the
CICA handbook, "Impairment of Long-Lived Assets". Based on this new standard, we
assess impairment of intangible assets when events or circumstances indicate
that costs may not be recoverable. Impairment exists when the carrying value of
the asset is greater than the pre-tax undiscounted future cash flows expected to
be provided by the asset. The amount of impairment loss, if any, based on the
recoverability test, is the excess of the carrying value over its fair value. We
assess fair value of intangible assets based on discounted future cash flows.
In the third quarter of fiscal 2003, we assessed impairment of goodwill and
intangible assets based on these new standards. Please refer to the "Write-down
of goodwill and intangible assets" section further in this document.
FUTURE INCOME TAXES. We account for income taxes using the liability method of
tax allocation. Under this method, future income tax assets and liabilities are
determined based on deductible or taxable temporary differences between
financial statement values and tax values of assets and liabilities, using
enacted income tax rates for the years in which the differences are expected to
reverse. In assessing the recoverability of our future income tax assets, we
consider whether it is more likely than not that some or all of the future
income tax assets will not be realized. The ultimate realization of certain
future income tax assets is dependent upon the generation of future taxable
income during the periods in which those temporary differences will become
deductible. If we obtain information that causes our forecast of future taxable
income to change or if actual taxable income differs from our forecast, we may
have to revise the carrying value of our future income tax assets, which would
affect our results in the period in which the change was made.We review the
recoverability of our future income tax assets on a quarterly basis. Please
refer to the "Income Taxes" section further in this document.
In addition to the two above-mentioned CICA handbook sections, we also adopted
the following new handbook sections and guideline in fiscal 2003:
o Section 3475 "Disposal of Long-Lived Assets and Discontinued
Operations"
o Section 3870 "Stock-Based Compensation and Other Stock-Based Payments"
o Accounting Guideline 14 "Disclosure of Guarantees"
Please refer to note 2 to our consolidated financial statements included
elsewhere in this Annual Report for further information about these new
standards and their impact on our financial statements.
EXFO o 2003 Annual Report o 13
RESULTS OF OPERATIONS
The following table sets forth certain Canadian GAAP consolidated statements of
earnings data in thousands of US dollars, except per share data, and as a
percentage of sales for the years indicated:
Years ended August 31, 2003 2002 2001 2003 2002 2001
====================================================================================================================================
Sales $ 61,930 $ 68,330 $ 146,013 100.0% 100.0% 100.0%
Cost of sales (1) 36,197 52,366 56,207 58.4 76.6 38.5
------------------------------------------------------------------------------------------------------------------------------------
Gross margin (2) 25,733 15,964 89,806 41.6 23.4 61.5
------------------------------------------------------------------------------------------------------------------------------------
Operating expenses
Selling and administrative (1) 26,991 33,881 44,975 43.6 49.6 30.8
Net research and development 15,879 12,782 13,601 25.6 18.7 9.3
Amortization of property, plant
and equipment 6,139 5,932 3,559 9.9 8.7 2.4
Amortization of intangible assets 4,747 11,615 9,876 7.7 17.0 6.8
Write-down of intangible assets 2,922 23,657 -- 4.7 34.6 --
Restructuring and other charges 4,134 2,880 3,288 6.7 4.2 2.3
------------------------------------------------------------------------------------------------------------------------------------
Total operating expenses 60,812 90,747 75,299 98.2 132.8 51.6
------------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) from operations (35,079) (74,783) 14,507 (56.6) (109.4) 9.9
Interest income, net 1,245 1,456 6,098 2.0 2.1 4.2
Foreign exchange gain (loss) (1,552) (458) 3,327 (2.5) (0.7) 2.3
------------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) before income taxes and
amortization and write-down of goodwill (35,386) (73,785) 23,932 (57.1) (108.0) 16.4
Income taxes 15,059 (25,451) 8,150 24.3 (37.2) 5.6
------------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) before amortization
and write-down of goodwill (50,445) (48,334) 15,782 (81.4) (70.8) 10.8
Amortization of goodwill -- 38,021 31,076 -- 55.6 21.3
Write-down of goodwill 4,505 222,169 -- 7.3 325.1 --
------------------------------------------------------------------------------------------------------------------------------------
Net loss for the year $(54,950) $(308,524) $ (15,294) (88.7)% (451.5)% (10.5)%
====================================================================================================================================
Basic and diluted net loss per share $ (0.87) $ (5.09) $ (0.29)
Research and development data:
Gross research and development $ 17,133 $ 17,005 $ 17,601 27.7% 24.9% 12.1%
Net research and development $ 15,879 $ 12,782 $ 13,601 25.6% 18.7% 9.3%
------------------------------------------------------------------------------------------------------------------------------------
OTHER DATA (UNAUDITED) (3):
Pro forma net earnings (loss) $(11,476) $ (11,248) $ 24,500 (18.5)% (16.5)% 16.8%
Basic and diluted pro forma net
earnings (loss) per share $ (0.18) $ (0.19) $ 0.46
(1) Certain comparative figures have been reclassified to conform to the
current-year presentation.
(2) Including inventory write-offs of $4,121, $18,463 and nil for the years
ended August 31, 2003, 2002 and 2001, respectively, and a non-recurring
gain of $473 for the year ended August 31, 2003. Excluding inventory
write-offs and the non-recurring gain, gross margin would have reached
47.4% for the year ended August 31, 2003. Excluding inventory write-offs,
gross margin would have reached 50.4% for the year ended August 31, 2002.
This latter information is unaudited and is a non-GAAP measure.
(3) Net earnings (loss) excluding amortization and write-down of goodwill,
non-recurring tax recovery, future income tax assets valuation allowance
and the after-tax effect of amortization and write-down of intangible
assets, restructuring and other charges, inventory and tax credit
write-offs and non-recurring grants recovery. This information may not be
comparable to similarly titled measures reported by other companies because
it is non-GAAP information. Please refer to page 17 of this document for a
detailed quantitative reconciliation.
SALES
Sales totaled $61.9 million, $68.3 million and $146.0 million in fiscal 2003,
2002 and 2001, respectively.
Compared to fiscal 2002, sales decreased 9% in 2003 due to increased pricing
pressure by vendors and the continued slowdown in the global telecommunications
industry.
Despite depressed spending levels in the telecommunications industry and the
overall decrease of our sales in fiscal 2003, our sales of Portable and
Monitoring products increased 3%, compared to 2002, mainly because of heightened
traction in the protocol-layer test sector. On the other hand, our Industrial
and Scientific product sales decreased 26% in fiscal 2003, compared to 2002,
mainly due to the collapsed market for optical components and the resulting gray
market. Overall for fiscal 2003, it was a 65%-35% sales split in favor of our
Portable and Monitoring products compared to a 57%-43% split in favor of our
Portable and Monitoring products in 2002.
It should be noted that the exited component manufacturing automation business
generated nominal sales in fiscal 2003. Therefore, the exit of this business
will not have a significant impact on our future sales.
With respect to the new business organization outlined earlier in this document,
it would have been a 79%-21% sales split in favor of our Telecom Division in
fiscal 2003. We expect this split to remain relatively unchanged in fiscal 2004.
[GRAPHIC OMITTED]
[BAR CHART]
$ Millions
03 61.9
02 68.3
01 146.0
00 71.6
99 42.2
14 o 2003 Annual Report o EXFO
Net accepted orders decreased 4% to $55.7 million in fiscal 2003 from $58.3
million in 2002. Our net book-to-bill ratio increased to 0.90 in fiscal 2003
compared to 0.85 in 2002. In fiscal 2003, our net accepted orders were more
stable quarter-over-quarter, compared to fiscal 2002, despite the continued
decline in most of our end-markets. We believe that this is a clear indication
that we gained market share overall.
Sales decreased 53% in fiscal 2002, compared to 2001, due to a reduced demand
for our products and pricing pressure attributable to the severe downturn in the
telecommunications industry. Despite the acquisitions of EXFO Burleigh, EXFO
Photonic Solutions and EXFO Protocol, we were not able to maintain our sales
level year-over-year. Both our Portable and Monitoring products and our
Industrial and Scientific products suffered from this lack of demand and pricing
pressure. Our Industrial and Scientific products, however, were the most
affected by the downturn, especially the optical component manufacturer
end-market, given significant industry consolidation and reduced sales volume
following the telecom peak. With regard to sales distribution, it was a 57%-43%
sales split in favor of our Portable and Monitoring products in fiscal 2002
compared to 52%-48% in favor of our Industrial and Scientific products in 2001.
Net accepted orders decreased 56% to $58.3 million in fiscal 2002 from $132.1
million in 2001. Our book-to-bill ratio decreased to 0.85 in fiscal 2002 from
0.90 in 2001.
North American sales accounted for 59%, 57% and 58% of global sales in fiscal
2003, 2002 and 2001, respectively. International sales represented 41%, 43% and
42% of global sales in fiscal 2003, 2002 and 2001, respectively. Despite the
relative stability in our international sales between fiscal 2003 and 2002, as a
percentage of total sales, sales to the Asian market decreased to 16% of global
sales in fiscal 2003 compared to 19% in 2002. On the other hand, sales to the
Latin American market increased to 7% of global sales in fiscal 2003 compared to
4% of sales in 2002. Most of our sales to these two markets are made through
tenders, which may vary in number and significance from period to period. In
addition, the SARS outbreak also affected our sales in Asia to some extent.
The increase in international sales in fiscal 2002, compared to 2001, mainly
reflects our sustained efforts to develop the Asian market. Sales to the Asian
market reached 19% of global sales in fiscal 2002 compared to 13% in 2001.
We expect a similar split in favor of our North American sales in fiscal 2004,
considering the current state of the market and our past results.
GROSS MARGIN
Gross margin amounted to 41.6%, 23.4% and 61.5% of sales for fiscal 2003, 2002
and 2001, respectively.
In fiscal 2003, we recorded inventory write-offs of $4.1 million for obsolete
and excess inventories. These special charges were required considering product
phase-outs, reduced needs for the 12 months following the time of the
write-offs, current market conditions as well as our exit from the optical
component manufacturing automation business. In 2003, we also recorded a
non-recurring gain of $473,000 related to a grant recovery upon a tax assessment
received in 2003. Excluding these special items, gross margin would have reached
47.4% of sales. Even excluding these special items, gross margin decreased 3% in
fiscal 2003, compared to 2002, as adjusted on the same basis. The decrease is
attributable to several reasons. First, existing market conditions and the
competitive landscape inevitably led to increased pricing pressure. This,
combined with a lower sales level in fiscal 2003, prevented a better absorption
of our fixed manufacturing costs, which ultimately caused margin erosion. In
addition, shift in product mix in favor of our Portable and Monitoring products
caused our gross margin to decrease, as these products tend to have lower
margins than our Industrial and Scientific products. However, the decrease in
our gross margin was offset in part by our increased efficiency and
restructuring efforts in 2002 and 2003.
[GRAPHIC OMITTED]
[BAR CHART]
03 41.6%
Pro Forma* 03 47.4%
02 23.4%
Pro Forma** 02 50.4%
01 61.5%
00 64.6%
99 63.3%
* Excluding inventory write-offs of $4.1 million
and a non-recurring gain of $473,000
** excluding inventory write-offs of $18.5 million
In fiscal 2002, we recorded inventory write-offs of $18.5 million for obsolete
and excess inventories. These special charges were recorded due to weaker demand
for our products and our expected needs for the 24 months following the time of
the write-offs. Excluding these special charges, our gross margin would have
reached 50.4% of sales. Even excluding these special charges, our gross margin
decreased 11.1% in fiscal 2002, from 61.5% in 2001, mainly because of the
significant decrease in sales in 2002. Weaker demand for our products and
pricing pressure prevented a better absorption of our fixed manufacturing costs.
Also, our manufacturing capacity in Quebec City, Quebec, and Victor, New York,
almost doubled in fiscal 2001, while sales decreased significantly in 2002.
With our recent cost-reduction measures and tight control on operating costs, we
believe that our gross margin should improve to at least 50% of sales in fiscal
2004 compared to 47.4% in fiscal 2003. However, our gross margin may fluctuate
quarter-over-quarter as our sales may fluctuate. Furthermore, our gross margin
can be negatively affected by increased competitive pricing pressure, increased
obsolescence and excess costs, shifts in product mix, under-absorption of fixed
manufacturing costs and increases in product offerings by other suppliers in the
communications test and measurement industry.
It should be noted that a new presentation was adopted in 2003, in which certain
expenses were reclassified from selling and administrative expenses to cost of
sales. Consequently, comparative figures have also been reclassified, resulting
in cost of sales increases of 2.3% and 0.9%, respectively for fiscal 2002 and
2001, with comparable decreases in selling and administrative expenses for these
same years.
SELLING AND ADMINISTRATIVE
Selling and administrative expenses reached $27.0 million, $33.9 million and
$45.0 million for fiscal 2003, 2002 and 2001, respectively. As a percentage of
sales, selling and administrative expenses amounted to 43.6%, 49.6% and 30.8%
for fiscal 2003, 2002 and 2001, respectively.
As a result of our restructuring plans implemented during the second and the
third quarters of fiscal 2002 and in the third quarter of 2003, we were able to
reduce our selling and administrative expenses by 20% year-over-year. The
decrease in sales in fiscal 2003 also resulted in lower commissions and
marketing expenses. Finally, in fiscal 2003, we recorded a non-recurring gain of
$239,000, related to a grant recovery upon a tax assessment. However, the
decrease in our selling and administrative expenses was offset in part by the
impact of the acquisitions of EXFO Protocol and EXFO Gnubi in November 2001 and
October 2002, respectively.
[GRAPHIC OMITTED]
[BAR CHART]
$ Millions
03 27.0
02 33.9
01 45.0
00 23.6
99 12.8
Also, the increased strength of the Canadian dollar, compared to the US dollar,
in fiscal 2003, prevented us from further reducing our selling and
administrative expenses. A large portion of our selling and administrative
expenses are incurred in Canadian dollars. Consequently, the increase in the
average value of the Canadian dollar, compared to the US dollar, in 2003, caused
our selling and administrative expenses to increase since we report our
financial results in US dollars. Overall, despite the latter reasons, we were
able to reduce our selling and administrative expenses by nearly $7 million
year-over-year, mainly because of the impact of our recent restructuring efforts
and cost-control measures on these expenses.
EXFO o 2003 Annual Report o 15
As a result of the restructuring plans we implemented since June
2001, combined with the significant sales decrease in fiscal 2002, we were able
to reduce our selling and administrative expenses, including lower commission
expenses in fiscal 2002 compared to 2001. However, this decrease was offset in
part by the impact of the acquisition of EXFO Protocol in November 2001. On the
other hand, the significant drop in sales in fiscal 2002 caused the selling and
administrative expenses percentage to increase since a large portion of these
expenses tend to be fixed and because sales decreased at a faster rate than
selling and administrative expenses.
For fiscal 2004, we expect our selling and administrative expenses in US dollars
to remain flat compared to 2003.We believe that such a level represents a good
balance between cost reduction and an acceptable cost structure to improve
sales, provide quality service to customers, as well as integrate and run our
acquired businesses, thus strategically positioning our company. Overall, our
selling and administrative expenses in Canadian dollars will decrease as a
result of our recent restructuring efforts and tight cost-control measures.
However, the rapid and significant 6.9% increase of the Canadian dollar at the
end of fiscal 2003, compared to its average value of US$0.675 during that same
year, will negatively affect our selling and administrative expenses.
RESEARCH AND DEVELOPMENT
Gross research and development expenses totaled $17.1 million, $17.0 million and
$17.6 million for fiscal 2003, 2002 and 2001, respectively. As a percentage of
sales, gross research and development expenses amounted to 27.7%, 24.9% and
12.1% for fiscal 2003, 2002 and 2001, respectively.
[GRAPHIC OMITTED]
[BAR CHART]
$ Millions
03 17.1
02 17.0
01 17.6
00 9.4
99 6.4
Although restructuring actions were fully offset by the impact of the
acquisitions of EXFO Protocol and EXFO Gnubi, our dollar-amount gross research
and development expenses remained flat in fiscal 2003 compared to 2002. These
two subsidiaries' significant level of research and development activities,
combined with the strength of the Canadian dollar, compared to the US dollar,
increased our research and development costs in Canada. The percentage increase
in fiscal 2003, compared to 2002, can be explained by the fact that despite
challenging market conditions, we continued investing heavily in research and
development, especially in the protocol-layer sector. In fact, in 2003, we
launched 15 new products, most of which were telecom-related solutions.
Furthermore, in that same year, 49% of sales originated from products that have
been on the market two years or less.
The slight decrease in gross research and development dollars in fiscal 2002,
compared to 2001, is mainly due to the mix and timing of research and
development projects and the effect of our restructuring plans implemented in
2002; these factors were partially offset by the impact of the acquisition of
EXFO Protocol. In fiscal 2002, we released 25 new products and 48% of sales
originated from products that have been on the market two years or less.
Tax credits and grants from Canadian federal and provincial governments for
research and development activities were $3.6 million, $4.2 million and $4.0
million for fiscal 2003, 2002 and 2001, respectively. The dollar-amount decrease
in tax credits and grants in fiscal 2003, compared to fiscal 2002, is mainly due
to three reasons. First, our government grant programs came to an end. Second,
the recent acquisition of U.S.-based EXFO Gnubi led to a larger portion of our
R&D activities being conducted in the U.S., where such activities are not
eligible for tax credits. And, finally, we did not record Canadian federal tax
credits for EXFO Protocol in the fourth quarter of 2003 because it is more
likely than not that those credits will be recovered in the medium term.
Considering current- and past-year tax losses, as well as current market
conditions, we concluded (according to GAAP) that it was more likely than not
that some tax credits will not be recovered and that a write-off was required.
Accordingly, in the third quarter of fiscal 2003, we wrote off $2.3 million in
Canadian federal tax credits related to EXFO Protocol and, as mentioned above,
we did not record such credits for this subsidiary in the fourth quarter of
2003. All tax credits written off can be carried forward against future years'
income taxes payable over the next ten years. Canadian federal tax credits are
only refundable against income taxes payable.
Our tax credits and grants remained relatively flat between fiscal 2002 and 2001
since our gross research and development expenses were relatively unchanged
year-over-year and since we were entitled to the same grant programs and tax
credits.
Although we intend to reduce our research and development expenses (as a
percentage of sales) in the future and despite our recent cost-reduction
measures, we expect to continue investing significantly in research and
development in the next year, reflecting our focus on innovation, our desire to
gain market share and our goal to exceed customer needs and expectations. This
investment in R&D will be focused on solutions for the network-service-provider
and system-vendor markets as they are the first two links in the global
communications supply chain that are expected to recover. More specifically, we
intend to expand our protocol-layer product offering to complement our
physical-layer product portfolio and selectively reduce our cost of goods while
improving performance.
AMORTIZATION OF INTANGIBLE ASSETS
In conjunction with the four strategic acquisitions we completed in the last
three fiscal years, we recorded $62.0 million in intangible assets, primarily
consisting of core technology. These intangible assets, which are amortized over
periods from five months to five years from the respective dates of acquisition,
resulted in amortization expenses of $4.7 million, $11.6 million and $9.9
million in fiscal 2003, 2002 and 2001, respectively.
Considering respective impairment charges of $2.9 million and $23.7 million for
intangible assets recorded in fiscal 2003 and 2002, the amortization expense
decreased by approximately $6.4 million year-over-year. Also, as at August 31,
2002, acquired in-process research and development and workforce related to the
acquisitions made in fiscal 2001 and 2002 were fully amortized, reducing
current-year amortization expenses as well.
We expect the amortization of intangible assets to be approximately $1.0 million
per quarter in fiscal 2004, assuming no acquisitions are made during this time.
WRITE-DOWN OF GOODWILL AND INTANGIBLE ASSETS
In May 2003, we performed our annual impairment test of goodwill for all our
reporting units, except for newly acquired EXFO Gnubi. Also, considering the
persisting unfavorable market conditions affecting our subsidiaries' industries,
we reviewed the carrying value of intangible assets related to these reporting
units.
As a result of this assessment, we concluded that the carrying value of goodwill
related to EXFO Burleigh and the carrying value of intangible assets related to
EXFO Burleigh and EXFO Photonic Solutions were impaired and we recorded an
impairment charge of $4.5 million for goodwill and a pre-tax impairment charge
of $2.9 million for acquired core technology. Of the total impairment charge, an
amount of $6.9 million was related to EXFO Burleigh for goodwill and acquired
core technology and $555,000 was related to EXFO Photonic Solutions for acquired
core technology.
The write-down of goodwill and acquired core technology of EXFO Burleigh was
required, considering that we exited the optical component manufacturing
automation business, whose revenue potential represented a long-term prospect.
The write-down of acquired core technology from EXFO Photonic Solutions was
required because revenue potential related to this long-lived asset was less
than expected in the short and medium term due to the current state of the
market.
16 o 2003 Annual Report o EXFO
However, no impairment of goodwill and intangible assets was required for EXFO
Protocol since we believe that revenue potential from the protocol-layer testing
market will remain strong in the short and medium term.
For the purposes of estimating fair values, we used a combination of discounted
future cash flows and a market approach (sales multiples). The discounted cash
flows were estimated using periods ranging between eight and ten years, discount
rates ranging between 15% and 20%, and an annual growth rate ranging between nil
and 35%. The sales multiples used in the market approach ranged between 0.7 and
2.3. The assumptions used reflect our best estimates.
Goodwill will be reviewed for impairment in May 2004, or prior to that date if
events or circumstances occur that more likely than not reduce the fair value of
a reporting unit below its carrying value.
In May 2002, as part of our review of financial results, we performed an
assessment of the carrying value of goodwill and intangible assets recorded in
conjunction with the acquisitions of EXFO Burleigh, EXFO Photonic Solutions and
EXFO Protocol. The assessment was performed because of the severe and continued
downturn in the telecommunications industry, the persisting unfavorable market
conditions affecting our subsidiaries' industries and the decline in technology
valuations. The growth prospects for our subsidiaries were significantly lower
than previously expected and less than those of historical periods. In addition,
the decline in market conditions affecting the subsidiaries was significant and
other than temporary. As a result, we concluded that the carrying value of
goodwill and certain acquired intangible assets was impaired and we recorded a
charge of $222.2 million to write down a significant portion of goodwill and a
pre-tax charge of $23.7 million to write down a significant portion of acquired
core technology. Of the total impairment loss of $245.8 million, an amount of
$125.0 million was related to EXFO Burleigh for goodwill and acquired core
technology, $71.5 million was related to EXFO Photonic Solutions for goodwill
and acquired core technology and $49.3 million was related to EXFO Protocol for
goodwill.
The impairment loss was calculated as the excess of the carrying value of the
assets over the pre-tax undiscounted future cash flows. The pre-tax undiscounted
future cash flows were estimated at the subsidiaries' level, since we had
distinct cash flows for each of them and because they were not fully integrated
into our activities. The cash flow periods used ranged from three to five years
and the annual growth rates ranged between 15% and 30%.
RESTRUCTURING AND OTHER CHARGES
In fiscal 2001, we implemented a structured plan to reduce our costs and
increase our efficiency. Under that plan, we recorded charges of $3.3 million,
including $0.8 million in severance expenses for the 245 employees who were
terminated throughout the company, $1.5 million for unused long-lived assets and
$1.0 million for future payments on exited leased facilities located in the
United States.
In fiscal 2002, we implemented additional structured plans to further reduce our
costs. Under these plans, we recorded charges of $2.9 million, including $2.0
million in severance expenses for the 350 employees who were terminated
throughout the company and $900,000 for unused long-lived assets.
In fiscal 2003, we implemented another structured plan to realign our cost
structure to current market conditions. Under this new plan, we recorded
additional charges of $4.1 million, including $2.8 million in severance expenses
for the 172 employees who were terminated throughout the company, $512,000 for
unused long-lived assets and $855,000 for future payments on exited leased
facilities located around the world. Our estimation of the fair value of such
future payments takes into account the estimated sublease rentals over the
remaining terms of the exited leases.
All these special charges are included in the restructuring and other charges in
the statements of earnings of the reporting years.
Our cost-reduction measures represent our best efforts to respond to the
difficult market conditions and we expect that they will enable us to reach
positive cash flows from operating activities at the end of fiscal 2004.
However, these efforts may be inappropriate or insufficient. Our actions in this
regard may not be successful in achieving the cost reductions or other benefits
expected, may be insufficient to align our cost structure to market conditions,
or may be more costly or extensive than anticipated.
INTEREST INCOME, NET
Our interest income mainly resulted from our short-term investments, less
interest and bank charges. Net interest income amounted to $1.2 million, $1.5
million and $6.1 million for fiscal 2003, 2002 and 2001, respectively. Our net
interest income remained relatively flat in fiscal 2003, compared to 2002, while
it significantly decreased in 2002 compared to 2001. This decrease was due to
the decline in interest rates during 2002 as well as our use of short-term
investments to finance strategic acquisitions, operating activities and the
purchase of property, plant and equipment.
We expect our net interest income to remain relatively flat in fiscal 2004,
compared to 2003, as we anticipate our cash position and interest rates to
remain relatively unchanged.
FOREIGN EXCHANGE GAIN (LOSS)
Foreign exchange loss amounted to $1.6 million in fiscal 2003 compared to a
foreign exchange loss of $458,000 in 2002 and a foreign exchange gain of $3.3
million in 2001.
The foreign exchange losses in fiscal 2003 and 2002 are the result of the
translation of operating activities denominated in currencies other than the
Canadian dollar. During fiscal 2003, the Canadian dollar value increased
significantly, as compared to the US dollar, resulting in significant foreign
exchange losses during the second and third quarters of 2003.
The foreign exchange gain in fiscal 2001 can be mostly attributed to the
disposal of short-term investments denominated in US dollars and the translation
of operating activities denominated in currencies other than the Canadian
dollar.
We manage our exposure to currency risk with forward exchange contracts and
operating activities of Canadian entities denominated in currencies other than
the Canadian dollar. Please refer to note 18 to our consolidated financial
statements included elsewhere in this Annual Report.
INCOME TAXES
Our effective income tax recovery rate was 35.8% (before the future income tax
assets valuation allowance and the non-recurring tax recovery) in fiscal 2003,
compared to 34.5% in 2002 and compared to our effective income tax rate in
fiscal 2001, which was 34.1%.
EXFO o 2003 Annual Report o 17
Compared to fiscal 2002, our effective income tax recovery rate increased in
2003 because a larger portion of our tax losses were incurred in jurisdictions,
such as in the U.S., where the recovery rates were higher.
In the third quarter of 2003, we reviewed the carrying value of our future
income tax assets. Considering existing market conditions, as well as the fact
that we recorded losses for the current and past years, and that we exited the
optical component manufacturing automation business, we concluded that it was
more likely than not that all our future income tax assets will not be
recoverable and that a valuation allowance was required. Even though the
carrying periods of our future income tax assets are very long or indefinite, we
recorded a valuation allowance of $28.4 million to write off all our future
income tax assets, mainly related to the parent company, EXFO Protocol and EXFO
Burleigh. Future income tax assets written off consisted mainly in deferred tax
losses, research and development expenses, share issue expenses as well as
non-deductible provisions and accruals.
From the $28.4 million valuation allowance, most of which is related to our
domestic and U.S. companies, an amount of $13.8 million is related to deferred
tax losses that can be carried forward against taxable income in several
jurisdictions and $13.4 million is related to research and development expenses
as well as provisions and accruals that can be carried forward indefinitely
against future years' taxable income. Note 15 to our consolidated financial
statements outlines significant components of future income tax assets and
liabilities and the valuation allowance.
The valuation allowance recognized in fiscal 2003 will be reversed once
management concludes that realization of these assets is more likely than not.
Consequently, our future period tax rates will be distorted compared to previous
periods.
AMORTIZATION OF GOODWILL
In conjunction with the four strategic acquisitions that we completed over the
last three fiscal years, we recorded $312.0 million in goodwill. The goodwill
related to the acquisitions of EXFO Burleigh and EXFO Photonic Solutions was
amortized over five years until August 31, 2002. This resulted in amortization
expenses of $38.0 million and $31.1 million in fiscal 2002 and 2001,
respectively. The acquisitions of EXFO Protocol and EXFO Gnubi have been
accounted for using new accounting standards contained in CICA handbook sections
1581 and 3062 and, consequently, goodwill resulting from these acquisitions was
not amortized.
Since September 1, 2002, goodwill related to the acquisitions of EXFO Burleigh
and EXFO Photonic Solutions is no longer amortized under new accounting
standards. Consequently, we no longer have amortization expenses for goodwill.
NET LOSS AND PRO FORMA NET EARNINGS (LOSS)
Net loss amounted to $55.0 million, $308.5 million and $15.3 million in fiscal
2003, 2002 and 2001, respectively. In terms of per share amounts, we recorded a
net loss of $0.87, $5.09 and $0.29 in fiscal 2003, 2002 and 2001, respectively.
Also, as a measure to assess financial performance, we use pro forma net
earnings (loss) and pro forma net earnings (loss) per share. Pro forma net
earnings (loss) represent net earnings (loss) excluding amortization and
write-down of goodwill, non-recurring tax recovery, future income tax assets
valuation allowance and the after-tax effect of amortization and write-down of
intangible assets, restructuring and other charges, inventory and tax credit
write-offs and non-recurring grants recovery.
Pro forma net loss amounted to $11.5 million and $11.2 million in fiscal 2003
and 2002 compared to pro forma net earnings of $24.5 million in 2001. In terms
of pro forma per share amounts, we recorded a net loss of $0.18 and $0.19 in
fiscal 2003 and 2002 compared to net earnings of $0.46 in 2001.
Pro forma net earnings (loss) are reconciled as follows:
YEARS ENDED AUGUST 31, 2003 2002 2001
--------------------------------------------------------------------------------
(unaudited) (unaudited) (unaudited)
Net loss in accordance with GAAP $ (54,950) $ (308,524) $ (15,294)
Pro forma adjustments:
Amortization of goodwill -- 38,021 31,076
Amortization of intangible assets 4,747 11,615 9,876
Write-down of goodwill 4,505 222,169 --
Write-down of intangible assets 2,922 3,657 --
Tax effect on amortization and
write-down of intangible assets (2,745) (12,167) (3,363)
Restructuring and other charges
and inventory and tax credit
write-offs 10,549 21,343 3,288
Tax effect on restructuring and
other charges and inventory
and tax credit write-offs (3,777) (7,362) (1,083)
Non-recurring tax and grants
recovery (1,357) -- --
Tax effect on non-recurring grants
recovery 245 -- --
Future income tax assets valuation
allowance 28,385 -- --
--------------------------------------------------------------------------------
Pro forma net earnings (loss) $ (11,476) $ (11,248) $ 24,500
================================================================================
Basic and diluted net loss
per share $ (0.87) $ (5.09) $ (0.29)
Basic and diluted pro forma
net earning (loss) per share $ (0.18) $ (0.19) $ 0.46
The financial information we provide is pro forma, thus helping the investor
better understand our normalized operating results as non-recurring and special
items are excluded. This information is not in accordance with, or an
alternative for, generally accepted accounting principles and may not be
comparable to similarly titled measures reported by other companies.
18 o 2003 Annual Report o EXFO
LIQUIDITY AND CAPITAL RESOURCES
Over the past years, we have financed our operations and major investments and
met our capital expenditure requirements mainly through cash flows from
operating activities, the use of cash and short-term investments and the
issuance of subordinate voting shares. For the upcoming year, we will finance
our operations and capital expenditure requirements mainly through cash flows
from operating activities and cash and short-term investments.
As mentioned earlier, maintaining a sound financial position is one of the four
main objectives of our strategic plan. We believe that such an objective is in
line with a strong cash position. As at August 31, 2003, our cash and short-term
investments amounted to $57.4 million and we had almost no debt. Our working
capital was at $76.7 million. Our cash and short-term investments increased by
$7.7 million in fiscal 2003, compared to 2002, mainly due to an unrealized
foreign exchange gain on cash and short-term investments of $6.8 million and
cash flows from operating activities of $5.6 million, less cash payments of $1.9
million and $2.7 million for the acquisition of EXFO Gnubi and the purchase of
property, plant and equipment. The unrealized foreign exchange gain resulted
from the translation of our cash and short-term investments in US dollars, which
is our reporting currency, and was recorded in the cumulative translation
adjustment in the balance sheet.
We believe that our cash balances and short-term investments, combined with an
available line of credit of $6.2 million, will be sufficient to meet our
expected liquidity and capital requirements for at least the next 18 months. Our
line of credit bears interest at prime rate. However, possible additional
operating losses and/or possible investments in or acquisitions of complementary
businesses, products or technologies may require additional financing prior to
such time. There can be no assurance that additional debt or equity financing
will be available when required or, if available, it can be secured on
satisfactory terms.
The following table summarizes our commitments as at August 31, 2003:
YEARS ENDING AUGUST 31, 2004 2005 2006 2007 2008 and later Total
-----------------------------------------------------------------------------------------------------------------------------------
Long-term debt $ 110,000 $ 122,000 $ 135,000 $ 146,000 $ 50,000 $ 563,000
Operating leases 1,078,000 908,000 898,000 764,000 1,668,000 5,316,000
Contingent cash
consideration in
business combination* 200,000 -- -- -- -- 200,000
-----------------------------------------------------------------------------------------------------------------------------------
Total commitments $1,388,000 $1,030,000 $1,033,000 $ 910,000 $1,718,000 $6,079,000
===================================================================================================================================
* estimated amount
OPERATING ACTIVITIES
Cash flows provided by operating activities amounted to $5.6 million in fiscal
2003, compared to cash flows used of $8.7 million in 2002 and cash flows
provided of $3.9 million in 2001.
Cash flows provided by operating activities in fiscal 2003 were mainly the
result of a decrease in some of our working capital items; that is, our accounts
receivable decreased by $4.0 million, our income taxes and tax credits
recoverable decreased by $13.9 million and our inventories decreased by $7.9
million (excluding write-offs). These positive effects on cash were offset in
part by the net loss after items not affecting cash of $19.7 million. The
decrease in our accounts receivable is directly related to the reduction in our
sales. The decrease in our income taxes and tax credits recoverable is related
to the recovery, during the year, of income taxes and research and development
tax credits recoverable from previous periods. Finally, the decrease in our
inventories is due to our efforts to maintain them at the lowest acceptable
level considering the decrease in sales.
Cash flows used by operating activities in fiscal 2002 were primarily due to the
net loss after items not affecting cash of $1.1 million, combined with the
increase of income taxes and tax credits receivable of $19.7 million and the
decrease in accounts payable and accrued liabilities of $7.5 million. These
figures were partially offset by the result of the net decrease in accounts
receivable and inventories of $19.7 million. The increase in our income taxes
and tax credits receivable is related to income tax recoverable following the
carry-back to previous years' taxable income of our consolidated tax loss, while
the decrease in our accounts payable and accrued liabilities is due to the
reduction in our purchases following the slowdown in our industry. The decrease
in our accounts receivable is due to the reduction in our sales level and to the
improvement in our days of sales outstanding ("DSOs"), while the decrease in our
inventories is due to our efforts to maintain them at the lowest acceptable
level considering the decrease in sales.
FINANCING ACTIVITIES
Cash flows used by financing activities amounted to $56,000, $90,000 and $4.6
million in fiscal 2003, 2002 and 2001, respectively. Cash flows used by
financing activities over the last two years were mainly due to the repayment of
our long-term debt. As at August 31, 2003, our long-term debt amounted to
$563,000.
INVESTING ACTIVITIES
Cash flows used by investing activities totaled $9.9 million in fiscal 2003
compared to cash flows provided of $10.5 million and $8.4 million in 2002 and
2001.
In fiscal 2003, we acquired $5.4 million in short-term investments with proceeds
from the recovery of income taxes and tax credits.We also made cash payments of
$1.9 million and $2.6 million for the acquisition of EXFO Gnubi and the
purchases of property, plant and equipment.
In fiscal 2002, we disposed of $25.5 million in short-term investments to
finance operating activities of $8.7 million as well as the respective cash
payments of $9.8 million and $5.2 million for the acquisition of EXFO Protocol
and the purchase of property, plant and equipment.
EXFO o 2003 Annual Report o 19
CONTINGENCY
As discussed in note 12 to our consolidated financial statements included
elsewhere in this Annual Report, in November 2001, the company was named as a
defendant in a U.S. securities class action related to its initial public
offering (IPO) in June 2000. The complaints allege that the prospectus and the
registration statement for the IPO failed to disclose that the underwriters
allegedly received excessive commissions and that the underwriters and some
investors collaborated in order to inflate the price of EXFO's stock in the
aftermarket.
On June 26, 2003, the Plaintiff's Executive Committee announced that a proposed
settlement between the issuers and their directors and officers and the
plaintiffs had been structured. A Memorandum of Understanding ("MOU") to settle
the plaintiffs' claims against the issuers and their directors and officers has
now been approved as to form and the process of obtaining approval by all
parties to the MOU is now underway. The parties will be required to prepare many
complex documents necessary to consummate the settlement, which will be
submitted to the Court for preliminary approval. Final approval will be required
by the Court following notice to class members and a fairness hearing. If this
tentative settlement is successfully finalized, the company and the individual
defendants will be released from the litigation. Any direct financial impact of
the proposed settlement is expected to be borne by our insurance carriers.
Since the settlement process is subject to a fairness hearing and final court
approval, it is possible that it could fail. Therefore, it is not possible to
predict the final outcome of the case, nor determine the amount of any possible
losses. If the settlement process fails, the company will continue to defend its
position in this litigation that the claims against EXFO, and its officers, are
without merit. Accordingly, no provision for this case has been made in the
consolidated financial statements as of August 31, 2003.
STOCK OPTION PLAN
The aggregate number of subordinate voting shares covered by options granted
under the stock option plan was 3,176,613 as at August 31, 2003. The weighted
average exercise price of those stock options was $15, compared to the market
price of $2.64 per share as at August 31, 2003. A total of 1,068,095 options
were exercisable as at August 31, 2003, with a weighted average exercise price
of $22. The maximum number of subordinate voting shares issuable under the plan
cannot exceed 4,470,961 shares. The following table summarizes information about
stock options granted to the members of the Board of Directors and to Management
and Corporate Officers of the company and its subsidiaries as at August 31,
2003:
% OF ISSUED WEIGHTED AVERAGE
NUMBER AND OUTSTANDING EXERCISE PRICE
================================================================================
Chairman of the Board,
President and CEO
(one individual) 150,482 4.74% $ 9.91
Board of Directors
(four individuals) 131,875 4.15% $ 7.41
Management and Corporate
Officers
(nine individuals) 350,775 11.04% $ 13.90
--------------------------------------------------------------------------------
633,132 19.93% $ 11.60
================================================================================
As permitted by section 3870 of the CICA handbook, we choose not to account for
stock-based compensation costs arising from awards to employees, but we complied
with the required pro forma disclosures with respect to net loss and net loss
per share in our consolidated financial statements. Please refer to note 13 to
our consolidated financial statements included elsewhere in this Annual Report
for further disclosure about our stock-based compensation plans.
RISKS AND UNCERTAINTIES
Over the past few years, we have managed our business activities, focused on
research and development of new and innovative products, prospered in
international markets and closed strategic acquisitions. However, we operate in
a highly competitive field that is in constant evolution and, as a result, we
encounter various risks and uncertainties that must be given appropriate
consideration in our strategic management policies.
The main risks and uncertainties related to the communications test and
measurement industry involve the rapid development of new products that have
short life cycles and require extensive research and development; the difficulty
of predicting market size and trends; the difficulty retaining highly skilled
employees; and the ability to quickly adapt our cost structure to changing
market conditions in order to achieve profitability.
In addition, given our strategic goals for growth and competitive positioning in
our industry, we are expanding into international markets. This exposes us to
certain risks and uncertainties related to changes in local laws and
regulations, multiple technological standards, protective legislation and
pricing pressure.
Furthermore, while the strategic acquisitions we have completed are essential to
our long-term growth, they also expose us to certain risks and uncertainties
related to the rapid and effective integration of these businesses as well as
their products, technologies and personnel.
We are also exposed to currency risks through the export of our products
manufactured in Canada, substantially all of which are denominated in US
dollars. These risks are partially hedged by operating expenses denominated in
US dollars, the purchase of raw materials in US dollars and forward exchange
contracts.
The economic slowdown in our industry could also result in some of our customers
experiencing difficulties and, consequently, this could have a negative effect
on our results, especially in terms of future sales and recoverability of
accounts receivable. However, the sectorial and geographic diversity of our
customer base provides us with a reasonable level of protection in this area.
Finally, other financial instruments, which potentially subject us to credit
risks, consist mainly of cash, short-term investments and forward exchange
contracts. Our short-term investments consist of debt instruments issued by
high-credit quality corporations. 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 of these instruments to be remote.
For a more complete understanding of risk factors that may affect us, please
refer to the risk factors set forth in our disclosure documents published with
securities commissions.
20 o 2003 Annual Report o EXFO
QUARTERLY SUMMARY FINANCIAL INFORMATION (UNAUDITED)
(in thousands of US dollars, except per share data)
YEARS ENDED
1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER AUGUST 31,
-------------------------------------------------------------------------------------------------------------
2003
Sales $ 17,748 $ 14,753 $ 15,103 $ 14,326 $ 61,930
Cost of sales (1) $ 8,031 $ 7,939 $ 10,460 $ 9,767 $ 36,197
Gross margin $ 9,717 $ 6,814 $ 4,643 $ 4,559 $ 25,733
Loss from operations $ (3,562) $ (6,085) $ (14,419) $ (11,013) $ (35,079)
Net loss $ (2,158) $ (4,246) $ (38,427) $ (10,119) $ (54,950)
Pro forma net loss (2) $ (1,354) $ (3,426) $ (4,067) $ (2,663) $ (11,476)
Basic and diluted net
loss per share (2) $ (0.03) $ (0.07) $ (0.61) $ (0.16) $ (0.87)
Basic and diluted pro forma
net loss per share (2) $ (0.02) $ (0.05) $ (0.06) $ (0.04) $ (0.18)
2002
Sales $ 20,138 $ 14,601 $ 16,348 $ 17,243 $ 68,330
Cost of sales (1) $ 13,008 $ 13,172 $ 17,429 $ 8,757 $ 52,366
Gross margin (loss) $ 7,130 $ 1,429 $ (1,081) $ 8,486 $ 15,964
Loss from operations $ (10,893) $ (16,612) $ (43,396) $ (3,882) $ (74,783)
Net loss $ (19,055) $ (22,675) $ (263,826) $ (2,968) $ (308,524)
Pro forma net loss (2) $ (1,937) $ (4,099) $ (3,930) $ (1,183) $ (11,248)
Basic and diluted net
loss per share (2) $ (0.33) $ (0.37) $ (4.29) $ (0.05) $ (5.09)
Basic and diluted pro forma
net loss per share (2) $ (0.03) $ (0.07) $ (0.06) $ (0.02) $ (0.19)
2001
Sales $ 28,519 $ 36,293 $ 45,781 $ 35,420 $ 146,013
Cost of sales (1) $ 10,525 $ 13,004 $ 17,743 $ 14,935 $ 56,207
Gross margin $ 17,994 $ 23,289 $ 28,038 $ 20,485 $ 89,806
Earnings (loss) from
operations $ 6,791 $ 6,912 $ 4,335 $ (3,531) $ 14,507
Net earnings (loss) $ 7,505 $ 24 $ (8,630) $ (14,193) $ (15,294)
Pro forma net earnings (2) $ 7,638 $ 7,511 $ 6,204 $ 3,219 $ 24,500
Basic and diluted net
earnings (loss) per
share (2) $ 0.16 $ -- $ (0.15) $ (0.25) $ (0.29)
Basic and diluted pro forma
net earnings per share (2) $ 0.16 $ 0.14 $ 0.11 $ 0.06 $ 0.46
(1) A new presentation was adopted in 2003 with certain expenses reclassified
from selling and administrative expenses to cost of sales.
(2) Pro forma net earnings (loss) and per share data are calculated
independently for each of the quarters presented. Therefore, the sum of
this quarterly information may not equal the corresponding annual
information. Pro forma net earnings (loss) represent net earnings (loss)
excluding amortization and write-down of goodwill, non-recurring tax
recovery, future income tax assets valuation allowance and the after-tax
effect of amortization and write-down of intangible assets, restructuring
and other charges, inventory and tax credit write-offs and non-recurring
grants recovery. This information may not be comparable to similarly titled
measures reported by other companies because it is non-GAAP information.
EXFO o 2003 Annual Report o 21
MANAGEMENT'S REPORT
EXFO's management is responsible for the preparation, integrity and objectivity
of the consolidated financial statements and other financial information
presented in this Annual Report. These consolidated financial statements have
been prepared in accordance with Canadian generally accepted accounting
principles and include some amounts that are based on estimates and judgments.
Management has determined such amounts on a reasonable basis in order to ensure
that the financial statements are presented fairly in all material respects.
EXFO's policy is to maintain a system of internal accounting and administrative
controls designed to provide reasonable assurance that the financial information
is relevant, accurate and reliable, and that assets are appropriately accounted
for and adequately safeguarded.
The Board of Directors is responsible for ensuring that management fulfills its
responsibilities for financial reporting and is ultimately responsible for
reviewing and approving the financial statements. The Board carries out this
responsibility principally through its Audit Committee. The Audit Committee is
appointed by the Board and is composed of outside directors. The Committee meets
periodically with management and external auditors to review accounting,
auditing and internal control matters. These consolidated financial statements
have been reviewed and approved by the Board of Directors on the recommendation
of the Audit Committee.
The consolidated financial statements have been audited by
PricewaterhouseCoopers LLP, the external auditors, in accordance with generally
accepted auditing standards on behalf of the shareholders. The external auditors
have full and free access to the Audit Committee.
/s/ Germain Lamonde /s/ Pierre Plamondon
----------------------------- -----------------------------
Germain Lamonde Pierre Plamondon, CA
Chairman, President and CEO Vice-President, Finance and
Chief Financial Officer
AUDITORS' REPORT
To the Shareholders of EXFO Electro-Optical Engineering Inc.
We have audited the consolidated balance sheets of EXFO Electro-Optical
Engineering Inc. as at August 31, 2003 and 2002 and the consolidated statements
of earnings, retained earnings (deficit) and contributed surplus and cash flows
for each of the years in the three-year period ended August 31, 2003. These
financial statements are the responsibility of the company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with Canadian and United States generally
accepted auditing standards. Those standards require that we plan and perform an
audit to obtain reasonable assurance whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation.
In our opinion, these consolidated financial statements present fairly, in all
material respects, the financial position of the company as at August 31, 2003
and 2002 and the results of its operations and its cash flows for each of the
years in the three-year period ended August 31, 2003 in accordance with Canadian
generally accepted accounting principles.
/s/ PricewaterhouseCoopers LLP
------------------------------
Chartered Accountants
Quebec, Quebec, Canada
September 26, 2003
22 o 2003 Annual Report o EXFO
CONSOLIDATED BALANCE SHEETS
(in thousands of US dollars)
The accompanying notes are an integral part of these consolidated financial
statements.
AS AT AUGUST 31, 2003 2002
--------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS
Cash $ 5,366 $ 9,128
Short-term investments (notes 8 and 18) 52,010 40,553
Accounts receivable (notes 8 and 18)
Trade 9,639 9,881
Other 834 3,267
Income taxes and tax credits recoverable
(notes 4 and 8) 6,003 13,473
Inventories (notes 4, 5 and 8) 15,602 23,822
Prepaid expenses 2,041 1,280
Future income taxes (notes 4 and 15) -- 1,272
--------------------------------------------------------------------------------
91,495 102,676
INCOME TAXES AND TAX CREDITS RECOVERABLE
(notes 4 and 8) 1,377 6,234
PROPERTY, PLANT AND EQUIPMENT (notes 6 and 8) 24,931 26,246
INTANGIBLE ASSETS (notes 4, 7 and 8) 10,778 16,464
GOODWILL (notes 4 and 7) 17,673 17,576
FUTURE INCOME TAXES (notes 4 and 15) -- 8,730
--------------------------------------------------------------------------------
$ 146,254 $ 177,926
LIABILITIES
CURRENT LIABILITIES
Accounts payable and accrued liabilities
(note 9) $ 12,026 $ 10,699
Income taxes payable 2,200 --
Deferred revenue 500 503
Current portion of long-term debt 110 100
--------------------------------------------------------------------------------
14,836 11,302
DEFERRED GRANTS (note 14) 1,139 654
LONG-TERM DEBT (note 10) 453 564
--------------------------------------------------------------------------------
16,428 12,520
--------------------------------------------------------------------------------
COMMITMENTS (note 11)
CONTINGENCIES (note 12)
SHAREHOLDERS' EQUITY
Share capital (note 13) 492,452 489,611
Contributed surplus 1,519 1,487
Cumulative translation adjustment 7,643 (8,854)
Deficit (371,788) (316,838)
--------------------------------------------------------------------------------
129,826 165,406
--------------------------------------------------------------------------------
$ 146,254 $ 177,926
================================================================================
On behalf of the Board: /s/ Germain Lamonde /s/ Andre Tremblay
----------------------- ------------------------
Germain Lamonde Andre Tremblay
Chairman, President and CEO Chairman, Audit Committee
EXFO o 2003 Annual Report o 23
CONSOLIDATED STATEMENTS OF EARNINGS
(in thousands of US dollars, except share and per share data)
The accompanying notes are an integral part of these consolidated financial
statements.
YEARS ENDED AUGUST 31, 2003 2002 2001
------------------------------------------------------------------------------------
SALES (note 16) $ 61,930 $ 68,330 $ 146,013
COST OF SALES* 36,197 52,366 56,207
------------------------------------------------------------------------------------
GROSS MARGIN 25,733 15,964 89,806
------------------------------------------------------------------------------------
OPERATING EXPENSES
Selling and administrative 26,991 33,881 44,975
Net research and development (notes 4 and 14) 15,879 12,782 13,601
Amortization of property, plant and equipment 6,139 5,932 3,559
Amortization of intangible assets 4,747 11,615 9,876
Write-down of intangible assets (note 4) 2,922 23,657 --
Restructuring and other charges (note 4) 4,134 2,880 3,288
------------------------------------------------------------------------------------
TOTAL OPERATING EXPENSES 60,812 90,747 75,299
------------------------------------------------------------------------------------
EARNINGS (LOSS) FROM OPERATIONS (35,079) (74,783) 14,507
Interest income, net 1,245 1,456 6,098
Foreign exchange gain (loss) (1,552) (458) 3,327
------------------------------------------------------------------------------------
EARNINGS (LOSS) BEFORE INCOME TAXES AND
AMORTIZATION AND WRITE-DOWN OF GOODWILL
(note 15) (35,386) (73,785) 23,932
INCOME TAXES (note 15) 15,059 (25,451) 8,150
------------------------------------------------------------------------------------
EARNINGS (LOSS) BEFORE AMORTIZATION
AND WRITE-DOWN OF GOODWILL (50,445) (48,334) 15,782
AMORTIZATION OF GOODWILL (note 2) -- 38,021 31,076
WRITE-DOWN OF GOODWILL (note 4) 4,505 222,169 --
------------------------------------------------------------------------------------
NET LOSS FOR THE YEAR $ (54,950) $(308,524) $ (15,294)
====================================================================================
BASIC AND DILUTED EARNINGS (LOSS) PER SHARE
Earnings (loss) before amortization
and write-down of goodwill $ (0.80) $ (0.80) $ 0.30
Net loss $ (0.87) $ (5.09) $ (0.29)
BASIC WEIGHTED AVERAGE NUMBER OF
SHARES OUTSTANDING (000'S) 62,852 60,666 53,014
DILUTED WEIGHTED AVERAGE NUMBER OF
SHARES OUTSTANDING (000'S) (note 17) 63,317 60,966 53,495
* Including inventory write-offs of $4,121, $18,463 and nil for the years
ended August 31, 2003, 2002 and 2001, respectively (note 4).
24 o 2003 Annual Report o EXFO
CONSOLIDATED STATEMENTS OF RETAINED EARNINGS (DEFICIT)
AND CONTRIBUTED SURPLUS
(in thousands of US dollars)
The accompanying notes are an integral part of these consolidated financial
statements.
RETAINED EARNINGS (DEFICIT)
YEARS ENDED AUGUST 31, 2003 2002 2001
------------------------------------------------------------------------------------
BALANCE - BEGINNING OF YEAR $ (316,838) $ (8,314) $ 6,980
ADD
Net loss for the year (54,950) (308,524) (15,294)
------------------------------------------------------------------------------------
BALANCE - END OF YEAR $ (371,788) $(316,838) $ (8,314)
====================================================================================
CONTRIBUTED SURPLUS
YEARS ENDED AUGUST 31, 2003 2002 2001
------------------------------------------------------------------------------------
BALANCE - BEGINNING OF YEAR $ 1,487 $ 1,457 $ --
ADD
Premium on resale of share capital 32 30 1,457
------------------------------------------------------------------------------------
BALANCE - END OF YEAR $ 1,519 $ 1,487 $ 1,457
====================================================================================
EXFO o 2003 Annual Report o 25
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands of US dollars)
The accompanying notes are an integral part of these consolidated financial
statements.
YEARS ENDED AUGUST 31, 2003 2002 2001
------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss for the year $ (54,950) $(308,524) $ (15,294)
Add (deduct) items not affecting cash
Discount on short-term investments (54) 271 191
Inventory and tax credit write-offs 6,418 18,463 --
Amortization 10,886 55,568 44,511
Foreign exchange gains on disposal of
short-term investments (42) (74) (3,437)
Restructuring and other charges 512 741 1,083
Future income taxes (18,247) (13,397) (1,779)
Future income tax assets valuation allowance 28,385 -- --
Write-down of goodwill and intangible assets 7,427 245,826 --
Change in non-cash operating items
Accounts receivable 3,957 15,406 447
Income taxes and tax credits 13,886 (19,736) 2,237
Inventories 7,925 4,332 (20,308)
Prepaid expenses (569) 356 (67)
Accounts payable and accrued liabilities (349) (7,470) (3,736)
Deferred revenue (24) (106) 100
Deferred grants 420 (335) (57)
------------------------------------------------------------------------------------
5,581 (8,679) 3,891
------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Bank advances -- -- (2,046)
Repayment of mandatorily redeemable preferred shares -- -- (354)
Repayment of long-term debt (133) (106) (3,355)
Issuance of share capital 45 -- --
Redemption of share capital (16) (6) (33)
Resale of share capital 48 36 1,490
Share issue expenses -- (14) (331)
------------------------------------------------------------------------------------
(56) (90) (4,629)
------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to short-term investments (401,105) (506,228) (772,808)
Proceeds from disposal of short-term investments 395,699 531,733 865,373
Additions to property, plant and equipment
and intangible assets (2,652) (5,245) (15,911)
Business combinations (note 3) (1,867) (9,756) (68,255)
------------------------------------------------------------------------------------
(9,925) 10,504 8,399
------------------------------------------------------------------------------------
CHANGE IN CASH (4,400) 1,735 7,661
EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON CASH 638 (336) (661)
CASH - BEGINNING OF YEAR 9,128 7,729 729
------------------------------------------------------------------------------------
CASH - END OF YEAR $ 5,366 $ 9,128 $ 7,729
====================================================================================
SUPPLEMENTARY INFORMATION
Interest paid $ 417 $ 269 $ 377
Income taxes paid (recovered) $ (10,351) $ 4,172 $ 8,171
26 o 2003 Annual Report o EXFO
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share data and
as otherwise noted)
1 o INCORPORATION AND NATURE OF ACTIVITIES
The company, incorporated in 1985 under the Canada Business Corporations Act,
designs, manufactures and markets a full line of test, measurement and
monitoring solutions for the global telecommunications industry. These solutions
characterize the physical, optical and protocol layers of optical fiber and
related hardware. The company derives substantially all of its revenue from
customers located in the United States, Canada, Europe and Asia. The company's
customers consist primarily of telecommunications carriers, network service
providers, optical component and system manufacturers, as well as research and
development laboratories.
2 o SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
These consolidated financial statements have been prepared in accordance with
generally accepted accounting principles in Canada. These principles conform, in
all material respects, with accounting principles generally accepted in the
United States, except for the significant differences and additional disclosures
provided in note 20.
ACCOUNTING ESTIMATES
The preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting years. Actual
results could differ from those estimates.
CONSOLIDATION
These consolidated financial statements include the accounts of the company and
its domestic and international subsidiaries. All significant intercompany
accounts and transactions have been eliminated.
REPORTING CURRENCY
The functional currency of the company is the Canadian dollar. However, the
company has adopted the US dollar as its reporting currency. The financial
statements are translated into the reporting currency using the current rate
method. Under this method, the financial statements are translated into the
reporting currency as follows: assets and liabilities are translated at the
exchange rate in effect at the date of the balance sheet, while revenues and
expenses are translated at the monthly average exchange rate. All gains and
losses resulting from the translation of the financial statements into the
reporting currency are included in the cumulative translation adjustment in
shareholders' equity.
In the event that management decides to declare dividends, such dividends would
be declared in Canadian dollars.
FOREIGN CURRENCY TRANSLATION
FOREIGN CURRENCY TRANSACTIONS
Transactions denominated in currencies other than the functional currency are
translated into the functional currency as follows: monetary assets and
liabilities are translated at the exchange rate in effect at the balance sheet
date, while revenues and expenses are translated at the exchange rate in effect
on the date of the transaction. Non-monetary assets and liabilities are
translated at historical rates. Gains and losses arising from such translation
are reflected in the statements of earnings.
FOREIGN SUBSIDIARIES
The financial statements of integrated foreign operations with a functional
currency other than the Canadian dollar are remeasured into the functional
currency using the temporal method. Under this method, monetary assets and
liabilities are remeasured at the exchange rate in effect at the balance sheet
date. Non-monetary assets and liabilities are remeasured at historical rates.
Revenues and expenses are remeasured at the monthly average exchange rate. Gains
and losses resulting from remeasurement are reflected in the statements of
earnings.
FORWARD EXCHANGE CONTRACTS
Forward exchange contracts are utilized by the company in the management of its
foreign currency exposure. The company's policy is not to utilize those
derivative financial instruments for trading or speculative purposes.
Foreign exchange translation gains and losses on forward exchange contracts,
used to hedge anticipated US-dollar-denominated sales, are recognized as an
adjustment of the revenues when the sale is recorded.
Realized and unrealized gains or losses associated with forward exchange
contracts, which have been terminated or cease to be effective prior to
maturity, are deferred in the balance sheet and recognized in the earnings of
the period in which the underlying hedged transaction is recognized.
SHORT-TERM INVESTMENTS
Short-term investments are valued at the lower of cost and market value. Cost
consists of acquisition cost plus amortization of discount or less amortization
of premium.
INVENTORIES
Inventories are valued on an average cost basis at the lower of cost and
replacement cost for raw materials and at the lower of cost and net realizable
value for work in progress and finished goods.
On September 1, 2002, the company changed its accounting policy for determining
the cost of raw materials and work in progress from the first-in, first-out
method to the average cost method. This change in accounting policy had no
significant impact on the company's financial statements.
EXFO o 2003 Annual Report o 27
PROPERTY, PLANT AND EQUIPMENT AND AMORTIZATION
Property, plant and equipment are recorded at cost less related government
grants and research and development tax credits. Amortization is provided on a
straight-line basis over the estimated useful lives as follows:
TERM
Land improvements 5 years
Buildings 15 and 25 years
Equipment 2 to 10 years
Leasehold improvements Remaining lease term
INTANGIBLE ASSETS, GOODWILL AND AMORTIZATION
Intangible assets primarily include the cost of acquired in-process research and
development and core technology, net of accumulated amortization. Core
technology represents the existing technology acquired in business combinations
that has reached technological feasibility, while acquired in-process research
and development represents the existing technology that has not reached
technological feasibility and has no future alternative use. Intangible assets
are amortized on a straight-line basis over their estimated useful lives,
ranging from five to ten months for in-process research and development, and
five years for core technology.
Goodwill represents the excess of the purchase price of acquired businesses over
the estimated fair value of net identifiable assets acquired. Goodwill related
to business combinations with a date of acquisition prior to July 1, 2001, was
amortized on a straight-line basis over the estimated useful life of five years
until August 31, 2002. Goodwill related to business combinations with a date of
acquisition after June 30, 2001, is not amortized.
Goodwill must be tested for impairment on an annual basis or more frequently if
events or circumstances occur that more likely than not reduce the fair value of
a reporting unit below its carrying value. Any impairment loss arising from this
test will be charged to earnings in the period in which it is incurred. The
company elected to perform its annual impairment test in May of each fiscal year
for all its existing reporting units (note 4).
IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived assets are reviewed for impairment when events and circumstances
indicate that cost may not be recoverable. Impairment exists when the carrying
value of the asset is greater than the undiscounted future cash flows expected
to be provided by the asset. The amount of impairment loss, if any, is the
excess of the carrying value over its fair value. The company has recorded
impairment charges for intangible assets in 2002 and 2003 (note 4).
REVENUE RECOGNITION
For products in which software is incidental, the company recognizes revenue
when persuasive evidence of an arrangement exists, the product has been
delivered, the price is fixed and determinable, and collection of the resulting
receivable is reasonably assured. In addition, provisions are made for estimated
returns, warranties and support obligations.
For products in which software is not incidental, revenues are separated into
two categories: product and customer support revenues, based upon
vendor-specific objective evidence of fair value. Product revenues for these
sales are recognized as described above. Customer support revenues are deferred
and recognized ratably over the years of the support arrangement. Except when
provided within one year of delivery, costs of providing this support are
insignificant and accrued at the time of delivery and no software upgrades are
provided.
For all sales, the company uses a binding purchase order as evidence that a
sales arrangement exists.
Delivery generally occurs when the product is shipped to a transporter.
At the time of the transaction, the company assesses whether the price
associated with its revenue transaction is fixed and determinable and whether or
not collection is reasonably assured. The company assesses whether the price is
fixed and determinable based on the payment terms associated with the
transaction. The company assesses collection based on a number of factors,
including past transaction history and the creditworthiness of the customer.
Generally, collateral or other security is not requested from customers.
Most sales arrangements do not generally include acceptance clauses. However, if
a sales arrangement includes an acceptance provision, acceptance occurs upon the
earliest of receipt of a written customer acceptance or expiration of the
acceptance period. For these sales arrangements, the sale is recognized when
acceptance occurs.
Extended warranties are recognized ratably over the service periods.
ADVERTISING COSTS
Advertising costs are expensed as incurred.
GOVERNMENT GRANTS
Government grants are accrued as a receivable when there is reasonable assurance
that the company has complied and will continue to comply with all the
conditions related to the grant. Grants related to operating expenses are
included in earnings when the related expenses are incurred. Grants related to
capital expenditures are deducted from the related assets. Grants related to job
creation and training programs for extended periods are deferred and amortized
on a straight-line basis over the minimum period for which the created job must
be maintained or training provided.
RESEARCH AND DEVELOPMENT EXPENSES
All expenses related to development activities, which do not meet generally
accepted criteria for deferral, and research are expensed as incurred, net of
related tax credits and government grants. Development expenses that meet
generally accepted criteria for deferral are capitalized, net of related tax
credits and government grants, and amortized against earnings over the estimated
benefit period.
As at August 31, 2003, the company had not deferred any development costs.
28 o 2003 Annual Report o EXFO
INCOME TAXES
The company provides for income taxes using the liability method of tax
allocation. Under this method, future income tax assets and liabilities are
determined based on deductible or taxable temporary differences between
financial statement values and tax values of assets and liabilities, using
enacted income tax rates for the years in which the differences are expected to
reverse.
The company establishes a valuation allowance against future income tax assets
if, based on available information, it is more likely than not that some or all
of the future income tax assets will not be realized. In 2003, the company
recorded a valuation allowance for all its future income tax assets (note 4).
EARNINGS PER SHARE
Basic earnings per share are determined using the weighted average number of
common shares outstanding during the year.
Diluted earnings per share are determined using the weighted average number of
common shares outstanding during the year, plus the effect of dilutive potential
common shares outstanding during the year. This method requires that diluted
earnings per share be calculated, using the treasury stock method, as if all
dilutive potential common shares had been exercised at the latest at the
beginning of the year or on the date of issuance, as the case may be, and that
the funds obtained thereby be used to purchase common shares of the company at
the average fair value of the common shares during the year.
NEW ACCOUNTING STANDARDS
On September 1, 2002, the company prospectively adopted section 3870 of the
Canadian Institute of Chartered Accountants (CICA) handbook, "Stock-Based
Compensation and Other Stock-Based Payments", which applies to awards granted on
or after the date of adoption, and requires that stock-based payments to
non-employees and direct awards of stock to employees be accounted for using a
fair value-based method. The new section also encourages, but does not require,
the use of a fair value-based method to account for stock-based compensation
costs arising from awards to employees. The company, to continue with its
existing policy, elected not to account for stock-based compensation costs
arising from awards to employees using the fair value-based method. The new
section requires pro forma disclosures with respect to net earnings and net
earnings per share if a fair value-based method of accounting is not adopted for
awards granted to employees. The company complied with the standard by providing
the required pro forma disclosures (note 13). The adoption of this new standard
had no impact on the company's financial results.
On September 1, 2002, the company adopted section 3062 of the CICA handbook,
"Goodwill and Other Intangible Assets". This new section changes the accounting
for goodwill from an amortization method to an impairment-only approach. Thus,
amortization of goodwill, including goodwill recorded in past business
combinations ceased upon the adoption of this section. For any acquisitions
completed after June 30, 2001, goodwill is not amortized. Until August 31, 2002,
goodwill recorded in business combinations completed prior to July 1, 2001, was
amortized on a straight-line basis over five years.
Also, under the transitional provisions of the section, the company performed an
initial impairment test in September 2002 to identify goodwill impairment using
a fair value-based method. Under the new section, goodwill impairment exists
when the carrying value of a reporting unit exceeds its fair value. For the
purposes of the impairment test, the company allocated its existing goodwill to
its reporting units and completed an evaluation of the fair value of such
reporting units. Based on the comparison of the fair value of the reporting
units to their carrying value, goodwill of the reporting units was not
considered impaired.
Furthermore, under this new section, goodwill must be tested for impairment on
an annual basis or more frequently if events or circumstances occur that more
likely than not reduce the fair value of a reporting unit below its carrying
value. Any impairment loss arising from this test will be charged to earnings in
the period in which it is incurred. The company elected to perform its annual
impairment test in May of each fiscal year for all its existing reporting units
(note 4).
This change in accounting policy has been applied prospectively and,
consequently, the amounts presented for prior years have not been restated. The
consolidated statements of earnings for the years ended August 31, 2001 and
2002, show the net loss and the net loss per share figures before the
amortization and write-down of goodwill.
On September 1, 2002, the company prospectively adopted section 3063 of the CICA
handbook, "Impairment of Long-Lived Assets". This new section changes existing
rules for recognition and measurement of long-lived assets held for use. The
section requires that an impairment loss be measured as the excess of the
carrying value of a long-lived asset over its fair value. Longlived assets were
tested for impairment in 2003 under these new provisions (note 4).
On March 1, 2003, the company prospectively adopted accounting guideline 14 of
the CICA handbook, "Disclosure of Guarantees". This new guideline requires
certain disclosure about obligations under guarantees other than product
warranties. The adoption of this guideline had no impact on the company's
financial statements since the company has no guarantee that falls into the
scope of this new guideline.
On May 1, 2003, the company prospectively adopted section 3475 of the CICA
handbook, "Disposal of Long-Lived Assets and Discontinued Operations". Under
this new section, a long-lived asset to be disposed of other than by sale
continues to be classified as held and used until it is disposed of; a
long-lived asset classified as held for sale is measured at the lower of its
carrying value or fair value less cost to sell; a loss recognized on
classification of long-lived assets as held for sale or a group of assets as a
discontinued operation does not include future operating losses, other than to
the extent to which they are included in the fair value of the asset; and
discontinued operations are defined more broadly than under existing rules. The
adoption of this new standard had no impact on the company's financial
statements since the company did not have such operations.
In July 2003, the CICA issued new handbook section 1100, "Generally Accepted
Accounting Principles", which is effective for fiscal years beginning on or
after October 1, 2003. This new section defines GAAP, establishes the relative
authority of various types of CICA Accounting Standards Board pronouncements,
says what to do when the handbook does not cover a particular situation, and
clarifies the role of "industry practice" in setting GAAP. The company will
adopt this new standard on September 1, 2004, and has not yet determined the
impact it will have on its financial statements.
In July 2003, the CICA issued new handbook section 1400, "General Standards of
Financial Statements Presentation", which is effective for fiscal years
beginning on or after October 1, 2003. This new section confirms that the
financial statements of an entity must "present fairly in accordance with
Canadian generally accepted accounting principles" its financial position,
results of operations and cash flows. The company will adopt this new standard
on September 1, 2004, and has not yet determined the impact it will have on its
financial statements.
EXFO o 2003 Annual Report o 29
3 o BUSINESS COMBINATIONS
The company completed a number of business combinations in 2001, 2002 and 2003.
The fair value allocated to significant intangible assets acquired in these
business combinations was based upon independent valuations performed in
conjunction with the business combinations. Acquired goodwill, except the one
from gnubi communications L.P., is not deductible for income tax purposes.
BUSINESS COMBINATION DURING 2003
GNUBI COMMUNICATIONS, L.P.
On October 7, 2002, a newly created wholly-owned subsidiary of the company, EXFO
Gnubi Products Group Inc. ("EXFO Gnubi"), acquired substantially all the assets
of gnubi communications, L.P., a U.S. company supplying multi-channel telecom
and datacom testing solutions for optical transport equipment manufacturers as
well as research and development laboratories. This acquisition was made to
fully complement the company's offering, to enhance its competitive position
with network service providers and system vendors as well as to expand its
presence in the data communications test market.
This acquisition was settled for a total consideration valued at $4,663,000
including acquisition-related costs of $162,000. The consideration paid
consisted of $1,867,000 in cash, $2,796,000 by the issuance of 1,479,290
subordinate voting shares and a cash contingent consideration up to a maximum of
$2,900,000, based on sales volume of EXFO Gnubi for the twelve months following
the acquisition.
The cash contingent consideration to be paid upon the realization of the defined
sales volume is accounted for as an additional acquisition cost and is
recognized as an additional cost of acquired core technology as sales occur.
Since October 7, 2002, the company recognized $173,000 as an additional cost of
acquired core technology based on realized sales of EXFO Gnubi.
The fair value of the subordinate voting shares issued was determined based on
the market price of the shares beginning three days before and ending three days
after the number of shares became fixed based on a formula, being September 10,
2002.
This acquisition has been accounted for using the purchase method and,
consequently, the results of operations of the acquired business have been
included in the consolidated statement of earnings of the company since October
7, 2002, being the date of acquisition.
The purchase price, including acquisition-related costs, has been allocated
based on the estimated fair value of net assets at the date of acquisition as
follows:
Assets acquired
Current assets $ 755
Property, plant and equipment 334
Core technology 750
Current liabilities assumed (134)
-----------------------------------------------
Net identifiable assets acquired 1,705
Goodwill 2,958
-----------------------------------------------
Purchase price 4,663
Less: Subordinate voting shares issued 2,796
-----------------------------------------------
Cash paid $ 1,867
===============================================
BUSINESS COMBINATION DURING 2002
AVANTAS NETWORKS CORPORATION (RENAMED EXFO PROTOCOL INC.)
On November 2, 2001, the company acquired a 100% interest in EXFO Protocol Inc.
("EXFO Protocol"), a Canadian company specializing in protocol-layer testing, in
exchange for a total consideration valued at $94,952,000 or $69,381,000 net of
$25,571,000 of cash and cash equivalents acquired. The total consideration
includes acquisition-related costs of $1,272,000.
The consideration paid consisted of $9,756,000 in cash, net of cash and cash
equivalents acquired of $25,571,000 and the issuance of 4,374,573 subordinate
voting shares valued at $59,625,000. The fair value of the subordinate voting
shares issued was determined based on the market price of the shares beginning
three days before and ending three days after the terms of the acquisition were
agreed upon and announced, being August 20, 2001.
This acquisition has been accounted for using the purchase method and,
consequently, the results of operations of EXFO Protocol have been included in
the consolidated statement of earnings of the company since November 2, 2001,
being the date of acquisition.
The purchase price, including acquisition-related costs, has been allocated
based on the estimated fair value of net assets at the date of acquisition as
follows:
Assets acquired
Current assets $ 6,040
Property, plant and equipment 2,003
In-process research and development 1,400
Core technology 5,050
Future income tax assets (note 4) 476
Current liabilities assumed (3,575)
-----------------------------------------------
Net identifiable assets acquired 11,394
Goodwill (note 4) 57,987
-----------------------------------------------
Purchase price 69,381
Less: Subordinate voting shares issued 59,625
-----------------------------------------------
Cash paid, net of cash and cash
equivalents acquired $ 9,756
===============================================
30 o 2003 Annual Report o EXFO
BUSINESS COMBINATIONS DURING 2001
BURLEIGH INSTRUMENTS, INC. (RENAMED EXFO BURLEIGH PRODUCTS GROUP INC.)
On December 20, 2000, the company acquired a 100% interest in EXFO Burleigh
Products Group Inc. ("EXFO Burleigh"), a U.S. company manufacturing precision
scientific instruments used in basic and applied research, engineering and
production test applications in a variety of fields, in exchange for a total
consideration valued at $189,270,000, including acquisition-related costs of
$2,461,000.
The consideration paid consisted of $42,461,000 in cash and the issuance of
6,488,816 subordinate voting shares valued at $146,809,000.
Furthermore, as part of this acquisition, the company established a restricted
stock award plan for employees of EXFO Burleigh (note 13). This plan provides
that in the event of an employee's voluntary termination, shares to be issued to
this employee under the plan will be issued to EXFO Burleigh's former
shareholders. In such circumstances, this issuance of shares will be recorded as
additional goodwill. As of August 31, 2003, $5,000 has been recorded as
additional goodwill upon voluntary termination of EXFO Burleigh's employees.
EFOS INC. (RENAMED EXFO PHOTONIC SOLUTIONS INC.)
On March 15, 2001, the company acquired a 100% interest in EXFO Photonic
Solutions Inc. ("EXFO Photonic Solutions"), a Canadian company specializing in
precision light-based adhesive spot-curing technologies as well as curing
process control for the global optical component manufacturing market. This
acquisition was settled for a total consideration valued at $110,146,000,
including acquisition-related costs of $194,000. The consideration paid
consisted of $25,194,000 in cash and the issuance of 3,700,000 subordinate
voting shares valued at $84,952,000.
The 2001 acquisitions have been accounted for using the purchase method and,
consequently, the results of operations of EXFO Burleigh and EXFO Photonic
Solutions have been included in the consolidated statements of earnings of the
company from the date of acquisition of these subsidiaries, being December 20,
2000, for EXFO Burleigh and March 15, 2001, for EXFO Photonic Solutions.
The fair value of subordinate voting shares issued as part of these business
combinations was determined based on the market price of the shares beginning
three days before and ending three days after the dates of acquisition of the
subsidiaries.
The purchase price, including acquisition-related costs, has been allocated
based on the estimated fair value of net assets at the dates of acquisition as
follows:
EXFO BURLEIGH EXFO PHOTONIC SOLUTIONS
--------------------------------------------------------------------------------
Assets acquired
Current assets $ 7,092 $ 9,195
Property, plant and equipment 4,457 1,054
In-process research and development 1,800 972
Core technology (note 4) 24,000 25,324
Workforce 1,250 907
Trademark -- 421
Liabilities assumed (9,068) (7,169)
Future income tax liabilities (8,342) (983)
--------------------------------------------------------------------------------
Net identifiable assets acquired 21,189 29,721
Goodwill (note 4) 168,081 80,425
--------------------------------------------------------------------------------
Purchase price 189,270 110,146
Less: Subordinate voting shares issued 146,809 84,952
--------------------------------------------------------------------------------
Cash paid, net of cash acquired $ 42,461 $ 25,194
================================================================================
VANGUARD TECHNICAL SOLUTIONS, INC.
On March 16, 2001, the company, through one of its subsidiaries, Burleigh
Automation Inc., acquired substantially all the assets of Vanguard Technical
Solutions, Inc., a U.S. company specializing in the design and manufacturing of
ultra-precision assembly equipment for sensitive process and critical assembly
challenges on the production floor. This acquisition, which was settled for a
total cash consideration of $600,000 allocated to property, plant and equipment,
has been accounted for using the purchase method.
4 o SPECIAL CHARGES
WRITE-DOWN OF GOODWILL AND INTANGIBLE ASSETS
In May 2003, the company performed its annual impairment test on goodwill for
all its reporting units, except for newly acquired EXFO Gnubi. Also, considering
market conditions in the telecommunications industry and the persisting
unfavorable conditions affecting the subsidiaries' industries, the company
reviewed the carrying value of intangible assets related to these reporting
units, consisting primarily in acquired core technology.
As a result of this assessment, the company concluded that the carrying value of
goodwill related to EXFO Burleigh and the carrying value of intangible assets
related to EXFO Burleigh and EXFO Photonic Solutions was impaired and it
recorded a charge of $4,505,000 to write down goodwill and a pre-tax charge of
$2,922,000 to write down acquired core technology. Of the total impairment loss
of $7,427,000, $6,872,000 is related to EXFO Burleigh for goodwill and acquired
core technology, and $555,000 is related to EXFO Photonic Solutions for acquired
core technology.
For the purposes of estimating the fair values, the company used a combination
of discounted future cash flows and a market approach (sales multiples). The
discounted cash flows were estimated using periods ranging between eight and ten
years, discount rates ranging between 15% and 20% and annual growth rates
ranging between nil and 35%. The sales multiples used in the market approach
ranged between 0.7 and 2.3.
EXFO o 2003 Annual Report o 31
In May 2002, as part of its review of financial results, the company performed
an assessment of the carrying value of goodwill and intangible assets recorded
in conjunction with the acquisitions of EXFO Burleigh, EXFO Photonic Solutions
and EXFO Protocol. The assessment was performed because of the severe and
continued downturn in the telecommunications industry, the persisting
unfavorable market conditions affecting the subsidiaries' industries and the
decline in technology valuations. The growth prospects for those subsidiaries
were significantly lower than previously expected and less than those of
historical periods, and the decline in market conditions affecting the
subsidiaries was significant and other than temporary. As a result, the company
concluded that the carrying value of goodwill and certain acquired intangible
assets was impaired and it recorded a charge of $222,169,000 to write down a
significant portion of goodwill and a pre-tax charge of $23,657,000 to write
down a significant portion of acquired core technology. Of the total impairment
loss of $245,826,000, $125,017,000 was related to EXFO Burleigh for goodwill and
acquired core technology, $71,508,000 was related to EXFO Photonic Solutions for
goodwill and acquired core technology, and $49,301,000 was related to EXFO
Protocol for goodwill.
The impairment loss was calculated based upon existing accounting rules and
represented the excess of the carrying value of the assets over the pre-tax
undiscounted future cash flows. The pre-tax undiscounted future cash flows were
estimated at the subsidiaries' level since the company had distinct cash flows
for each of them and because they were not fully integrated into the company's
activities. The cash flow periods used ranged from three to five years, using
annual growth rates between 15% and 30%.
The assumptions supporting the estimated fair values and undiscounted future
cash flows, including current and future industry conditions, reflect
management's best estimates.
RESTRUCTURING AND OTHER CHARGES AND INVENTORY WRITE-OFFS
During 2001, the company implemented a structured plan to reduce costs and
increase efficiency. Under that plan, the company recorded charges of
$3,288,000, including $844,000 in severance expenses for the 245 employees who
were terminated throughout the company, $1,476,000 for unused long-lived assets
and $968,000 for future payments on exited leased facilities. These charges are
included in the restructuring and other charges in the statement of earnings for
the year ended August 31, 2001. As at August 31, 2003, the accrued liabilities
related to this restructuring plan amounted to $124,000 and consisted primarily
of future payments on exited leased facilities.
During 2002, the company implemented additional structured plans to further
reduce its costs. Under these plans, the company recorded additional charges of
$2,880,000, including $2,012,000 in severance expenses for the 350 employees who
were terminated throughout the company and $868,000 for unused long-lived
assets. These charges are included in the restructuring and other charges in the
statement of earnings for the year ended August 31, 2002. Furthermore, the
company recorded $18,463,000 in inventory write-offs for excess and obsolete
inventories, which are included in the cost of sales in the statement of
earnings for that same year. As at August 31, 2003, the accrued liabilities
related to these restructuring plans amounted to $68,000 and consisted of
accrued cost for unused long-lived assets.
During 2003, the company implemented an additional restructuring plan to realign
its cost structure to current market conditions. Under that plan, the company
recorded additional charges of $4,134,000, including $2,767,000 in severance
expenses for the 172 employees who were terminated throughout the company,
$512,000 for unused long-lived assets and $855,000 for future payments on exited
leased facilities. Those charges are included in the restructuring and other
charges in the statement of earnings for the year ended August 31, 2003. In
addition, the company recorded $4,121,000 in inventory write-offs for excess and
obsolete inventories, which are included in the cost of sales in the statement
of earnings for that same year. As at August 31, 2003, the accrued liabilities
related to the severance expenses and exited leased facilities incurred in 2003
amounted to $2,276,000.
FUTURE INCOME TAX ASSETS AND RESEARCH AND DEVELOPMENT TAX CREDITS
During 2003, the company reviewed the carrying value of its future income tax
assets and its research and development tax credits. Considering current market
conditions and because the company recorded losses for current and past fiscal
years, it concluded that it is more likely than not that its future income tax
assets and some of its research and development tax credits will not be
recoverable and that a valuation allowance and a write-off were required.
Accordingly, the company recorded a valuation allowance of $28,385,000 to write
off all its future income tax assets mainly related to the parent company, EXFO
Protocol and EXFO Burleigh and wrote off $2,297,000 in research and development
tax credits related to EXFO Protocol. The valuation allowance has been included
in the income taxes in the statement of earnings for the year ended August 31,
2003 (note 15). The write-off of research and development tax credits has been
included in the net research and development expenses in the statement of
earnings for that same year (note 14).
5 o INVENTORIES
AS AT AUGUST 31, 2003 2002
--------------------------------------------------------------------------------
Raw materials $ 8,188 $ 13,507
Work in progress 1,022 1,382
Finished goods 6,392 8,933
--------------------------------------------------------------------------------
$ 15,602 $ 23,822
================================================================================
6 o PROPERTY, PLANT AND EQUIPMENT
AS AT AUGUST 31, 2003 2002
--------------------------------------------------------------------------------
ACCUMULATED Accumulated
COST AMORTIZATION Cost Amortization
Land and land improvements $ 3,323 $ 350 $ 2,124 $ --
Buildings 11,177 1,784 8,043 695
Equipment 33,560 21,790 29,177 14,662
Leasehold improvements 1,837 1,042 4,121 1,862
--------------------------------------------------------------------------------
49,897 $ 24,966 43,465 $ 17,219
======== ========
Less:
Accumulated amortization 24,966 17,219
--------------------------------------------------------------------------------
$ 24,931 $ 26,246
================================================================================
32 o 2003 Annual Report o EXFO
7 o Intangible Assets and Goodwill
AS AT AUGUST 31, 2003 2002
--------------------------------------------------------------------------------
Core technology, net of accumulated
amortization of $20,986
($15,120 in 2002) (notes 3 and 4) $ 10,778 $ 16,464
In-process research and development,
net of accumulated amortization of
$4,496 ($4,195 in 2002) -- --
--------------------------------------------------------------------------------
$ 10,778 $ 16,464
================================================================================
Amortization expense for intangible assets in each of the next four years is
$3,932,000 in 2004, $3,932,000 in 2005, $2,497,000 in 2006 and $417,000 in 2007.
The net carrying value of goodwill is comprised of the following:
AS AT AUGUST 31, 2003 2002
--------------------------------------------------------------------------------
Balance - Beginning of year $ 17,576 $ 219,172
Business combination (note 3) 2,958 57,987
Amortization (note 2) -- (38,021)
Write-down (note 4) (4,505) (222,169)
Effect of foreign exchange rate 1,644 607
--------------------------------------------------------------------------------
Balance - End of year $ 17,673 $ 17,576
================================================================================
8 o CREDIT FACILITIES
The company has a line of credit which provides for advances of up to
Cdn$10,000,000 (US$7,220,000). This line of credit, which is renewable annually,
bears interest at prime rate (prime rate in 2002). Short-term investments,
accounts receivable, inventories and all tangible and intangible assets of the
company have been pledged as collateral against this line of credit. As at
August 31, 2003, Cdn$1,400,000 (US$1,000,000) has been reserved from this line
of credit for letters of guarantee (note 12). As at August 31, 2002, this line
of credit was unused.
9 o ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
AS AT AUGUST 31, 2003 2002
--------------------------------------------------------------------------------
Trade $ 4,227 $ 4,738
Salaries and social benefits 3,462 2,638
Warranty 687 849
Tax on capital 381 856
Restructuring charges (notes 4 and 19) 2,468 782
Other 801 836
--------------------------------------------------------------------------------
$ 12,026 $ 10,699
================================================================================
10 o LONG-TERM DEBT
AS AT AUGUST 31, 2003 2002
--------------------------------------------------------------------------------
Loans collateralized by equipment,
bearing interest at 9.6%, repayable
in monthly installments of $13,000
including principal and interest,
maturing in 2008 $ 563 $ 664
Less: Current portion 110 100
--------------------------------------------------------------------------------
$ 453 $ 564
================================================================================
As at August 31, 2003, minimum principal repayments required in each of the next
five years are $110,000 in 2004, $122,000 in 2005, $135,000 in 2006, $146,000 in
2007 and $50,000 in 2008.
11 o COMMITMENTS
The company has entered into operating leases for certain of its premises and
equipment, which expire at various dates through May 2011. As at August 31,
2003, minimum rentals payable under these operating leases in each of the next
five years are $1,078,000 in 2004, $908,000 in 2005, $898,000 in 2006, $764,000
in 2007 and $448,000 in 2008. As at August 31, 2003, total commitments under
these operating leases amounted to $5,316,000.
For the years ended August 31, 2001, 2002 and 2003, rental expense amounted to
$1,580,000, $1,936,000 and $1,718,000, respectively (note 19).
12 o CONTINGENCIES
On November 27, 2001, a class action suit was filed in the United States
District Court for the Southern District of New York against the company, four
of the underwriters of its Initial Public Offering and some of its executive
officers pursuant to the Securities Exchange Act of 1934 and Rule 10b-5
promulgated thereunder and sections 11, 12 and 16 of the Securities Act of 1933.
This class action alleges that the company's registration statement and
prospectus filed with the Securities and Exchange Commission on June 29, 2000,
contained material misrepresentations and/or omissions resulting from (i) the
underwriters allegedly soliciting and receiving additional, excessive and
undisclosed commissions from certain investors in exchange for which they
allocated material portions of the shares issued in connection with the
company's Initial Public Offering; and (ii) the underwriters allegedly entering
into agreements with customers whereby shares issued in connection with the
company's Initial Public Offering would be allocated to those customers in
exchange for which customers agreed to purchase additional amounts of shares in
the after-market at pre-determined prices.
EXFO o 2003 Annual Report o 33
On April 19, 2002, the plaintiffs filed an amended complaint containing master
allegations against all of the underwriters in all of the 310 cases included in
this class action and also filed an amended complaint containing allegations
specific to four of the company's underwriters, the company and two of its
executive officers. In addition to the allegations mentioned above, the amended
complaint alleges that the underwriters (i) used their analysts to manipulate
the stock market; and (ii) implemented schemes that allowed issuer insiders to
sell their shares rapidly after an initial public offering and benefit from high
market prices. As concerns the company and its two executive officers in
particular, the amended complaint alleges that (i) the company's registration
statement was materially false and misleading because it failed to disclose the
additional commissions and compensation to be received by underwriters; (ii) the
two named executive officers learned of or recklessly disregarded the alleged
misconduct of the underwriters; (iii) the two named executive officers had
motive and opportunity to engage in alleged wrongful conduct due to personal
holdings of the company's stock and the fact that an alleged artificially
inflated stock price could be used as currency for acquisitions; and (iv) the
two named executive officers, by virtue of their positions with the company,
controlled the company and the contents of the registration statement and had
the ability to prevent its issuance or cause it to be corrected. The plaintiffs
in this suit seek an unspecified amount for damages suffered.
In July 2002, the issuers filed a motion to dismiss the plaintiffs' amended
complaint and judgment was rendered on February 19, 2003. Only one of the claims
against the company was dismissed. On October 8, 2002, the claims against its
officers were dismissed pursuant to the terms of Reservation of Rights and
Tolling Agreements entered into with the plaintiffs.
On June 26, 2003, the Plaintiff's Executive Committee announced that a proposed
settlement between the issuers and their directors and officers and the
plaintiffs had been structured. A Memorandum of Understanding ("MOU") to settle
the plaintiffs' claims against the issuers and their directors and officers has
now been approved as to form and the process of obtaining approval by all
parties to the MOU is now underway. The parties will be required to prepare many
complex documents necessary to consummate the settlement, which will be
submitted to the Court for preliminary approval. Final approval will be required
by the Court following notice to class members and a fairness hearing. If this
tentative settlement is successfully finalized, the company and the individual
defendants will be released from the litigation. Any direct financial impact of
the proposed settlement is expected to be borne by the company's insurance
carriers.
Since the settlement process is subject to a fairness hearing and final court
approval, it is possible that it could fail. Therefore, it is not possible to
predict the final outcome of the case, nor determine the amount of any possible
losses. If the settlement process fails, the company will continue to defend its
position in this litigation that the claims against it, and its officers, are
without merit. Accordingly, no provision for this case has been made in the
consolidated financial statements as of August 31, 2003.
As at August 31, 2003, the company has outstanding letters of guarantee of
$1,232,000, which expire at various dates through 2006. From this amount,
$1,000,000 has been reserved from the line of credit (note 8).
13 o SHARE CAPITAL
Authorized - unlimited as to number, without par value
Subordinate voting and participating, bearing a non-cumulative
dividend to be determined by the Board of Directors,
ranking pari passu with multiple voting shares
Multiple voting and participating, entitling to ten votes each,
bearing a non-cumulative dividend to be determined by
the Board of Directors, convertible at the holder's
option into subordinate voting shares on a one-for-one
basis, ranking pari passu with subordinate voting shares
The following table summarizes the share capital activity since August 31, 2000:
MULTIPLE VOTING SHARES SUBORDINATE VOTING SHARES
-------------------------------------------------------------------------------------------------------------
NUMBER AMOUNT NUMBER AMOUNT TOTAL AMOUNT
-------------------------------------------------------------------------------------------------------------
Balance as at August 31, 2000 38,000,000 $ 1 8,757,264 $ 198,458 $ 198,459
Business combinations (note 3) -- -- 10,188,816 231,761 231,761
Conversion of multiple voting
shares into subordinate
voting shares (100,000) -- 100,000 -- --
Redemption -- -- (43,999) (33) (33)
Resale -- -- 43,999 33 33
Share issue expenses,
net of related income taxes -- -- -- (225) (225)
-------------------------------------------------------------------------------------------------------------
Balance as at August 31, 2001 37,900,000 1 19,046,080 429,994 429,995
Business combination (note 3) -- -- 4,374,573 59,625 59,625
Exercise of stock awards -- -- 144,532 -- --
Redemption -- -- (7,022) (6) (6)
Resale -- -- 7,022 6 6
Share issue expenses,
net of related income taxes -- -- -- (9) (9)
-------------------------------------------------------------------------------------------------------------
Balance as at August 31, 2002 37,900,000 1 23,565,185 489,610 489,611
Business combination (note 3) -- -- 1,479,290 2,796 2,796
Exercise of stock options -- -- 25,498 45 45
Exercise of stock awards -- -- 69,935 -- --
Redemption -- -- (21,515) (16) (16)
Resale -- -- 21,515 16 16
-------------------------------------------------------------------------------------------------------------
Balance as at August 31, 2003 37,900,000 $ 1 25,139,908 $ 492,451 $ 492,452
=============================================================================================================
34 o 2003 Annual Report o EXFO
STOCK PURCHASE PLAN
The company's stock purchase plan terminated at the time of the initial public
offering, being June 29, 2000. In accordance with that plan, officers, directors
and key employees could purchase Class F shares up to a maximum of 5% of all
participating, issued and outstanding shares of the company. The purchase price
of shares under that plan was determined as a multiple of the company's equity
as at the end of the preceding fiscal year. Shares issued under that plan are
restricted as to sale and transferability for a period of at least five years
from the date of acquisition. Prior to its initial public offering, the company
issued 707,264 Class F shares in exchange for a weighted average cash
consideration of Cdn$0.98 (US$0.67) per share. On June 29, 2000, the 707,264
issued and outstanding Class F shares were converted into 707,264 subordinate
voting shares on a one-for-one basis.
STOCK OPTION PLAN
In May 2000, the company established a stock option plan for directors,
executive officers, employees and consultants and those of the company's
subsidiaries, as determined by the Board of Directors.
The maximum number of subordinate voting shares issuable under the plan cannot
exceed 4,470,961 shares. The maximum number of subordinate voting shares that
may be granted to any individual cannot exceed 5% of the number of outstanding
subordinate voting shares. The exercise price is the market price of the common
shares on the date of grant. Options granted under the plan generally expire ten
years from the date of grant. Options granted under the plan generally vest over
a four-year period, with 25% vesting on an annual basis commencing on the first
anniversary of the date of grant. Up to October 10, 2000, the number of options,
which ultimately would become exercisable in any given year, and in aggregate,
was dependent on the degree to which the company's financial performance
objectives were met. Nevertheless, on October 10, 2000, the Board of Directors
of the company amended the vesting terms for options granted pursuant to the
option plan to remove the financial performance criterion. Accordingly, options
granted vest over the four-year period. The Board of Directors may accelerate
the vesting of any or all outstanding options upon the occurrence of a change of
control.
The following table summarizes stock option activity since August 31, 2000:
YEARS ENDED AUGUST 31, 2003 2002 2001
--------------------------------------------------------------------------------------------------------
WEIGHTED Weighted Weighted
AVERAGE Average Average
EXERCISE Exercise Exercise
NUMBER PRICE Number Price Number Price
--------------------------------------------------------------------------------------------------------
Outstanding - Beginning of year 2,597,574 $ 22 2,414,231 $ 28 609,734 $ 26
Granted 1,268,450 2 1,039,805 10 2,153,352 29
Exercised (25,498) (2) -- -- -- --
Forfeited (663,913) (17) (856,462) (25) (348,855) (29)
--------------------------------------------------------------------------------------------------------
Outstanding - End of year 3,176,613 $ 15 2,597,574 $ 22 2,414,231 $ 28
========================================================================================================
Exercisable - End of year 1,068,595 $ 22 512,161 $ 28 127,561 $ 26
========================================================================================================
The following table summarizes information about stock options as at August 31,
2003:
OPTIONS OUTSTANDING AS AT AUGUST 31, 2003 OPTIONS EXERCISABLE AS AT AUGUST 31, 2003
------------------------------------------------------------------------------------------------------------------
WEIGHTED WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE AVERAGE
EXERCISE REMAINING EXERCISE REMAINING
PRICE CONTRACTUAL PRICE CONTRACTUAL
EXERCISE PRICE NUMBER LIFE NUMBER LIFE
------------------------------------------------------------------------------------------------------------------
$1.58 to $2.16 873,850 $ 1.59 3.1 years 108,224 $ 1.58 3.1 years
$2.59 to $3.63 224,400 3.39 3.3 years 28,744 3.37 3.3 years
$5.65 35,479 5.65 2.5 years 8,870 5.65 2.5 years
$9.13 to $12.69 676,246 10.12 2.2 years 169,062 10.12 2.2 years
$19.19 to $27.80 1,047,812 23.90 1.2 years 594,282 24.15 1.2 years
$34.07 to $45.94 269,276 43.58 1.1 years 134,638 43.58 1.1 years
$56.75 49,550 56.75 1.0 year 24,775 56.75 1.0 year
------------------------------------------------------------------------------------------------------------------
3,176,613 $ 15.36 2.1 years 1,068,595 $ 22.14 1.6 years
==================================================================================================================
RESTRICTED STOCK AWARD PLAN
On December 20, 2000, the company established a restricted stock award plan for
employees of EXFO Burleigh. Each stock award entitles employees to receive one
subordinate voting share at a purchase price of nil. Stock awards granted under
the plan vest over a four-year period, with 25% vesting on an annual basis
commencing on the first anniversary of the date of grant. According to the plan,
upon the involuntary termination of a member of the defined management team, all
outstanding restricted stock awards granted to such an employee automatically
vest. The plan will expire on December 20, 2004.
The following table summarizes restricted stock awards activity since December
2000:
YEARS ENDED AUGUST 31, 2003 2002 2001
--------------------------------------------------------------------------------------------------------
Outstanding - Beginning of year 215,249 359,781 --
Granted -- -- 359,781
Exercised (69,935) (144,532) --
Forfeited (2,218) -- --
--------------------------------------------------------------------------------------------------------
Outstanding - End of year 143,096 215,249 359,781
========================================================================================================
Exercisable - End of year -- -- --
========================================================================================================
As of August 31, 2003, the weighted average remaining contractual life of the
outstanding restricted stock awards was 1.3 years.
EXFO o 2003 Annual Report o 35
STOCK APPRECIATION RIGHTS PLAN
On August 4, 2001, the company established a stock appreciation rights plan for
certain employees. Under that plan, eligible employees are entitled to receive a
cash amount equivalent to the difference between the market price of the common
shares on the date of exercise and the exercise price determined on the date of
grant. Stock appreciation rights granted under the plan generally expire ten
years from the date of grant. Stock appreciation rights vest over a four-year
period, with 25% vesting on an annual basis commencing on the first anniversary
of the date of grant.
Considering the market price of the common shares of US$2.64 as at August 31,
2003, compensation expense for those stock appreciation rights was nominal as at
August 31, 2003.
The following table summarizes stock appreciation rights activity since August
2001:
YEARS ENDED AUGUST 31, 2003 2002 2001
--------------------------------------------------------------------------------------------------------
WEIGHTED Weighted Weighted
AVERAGE Average Average
EXERCISE Exercise Exercise
NUMBER PRICE Number Price Number Price
--------------------------------------------------------------------------------------------------------
Outstanding - Beginning of year 10,000 $ 26 22,400 $ 30 -- $ --
Granted 5,000 2 1,000 12 22,400 30
Forfeited (6,000) (9) (13,400) (31) -- --
--------------------------------------------------------------------------------------------------------
Outstanding - End of year 9,000 $ 24 10,000 $ 26 22,400 $ 30
========================================================================================================
Exercisable - End of year 3,500 $ 30 2,250 $ 27 -- $ --
========================================================================================================
The following table summarizes information about stock appreciation rights as at
August 31, 2003:
STOCK APPRECIATION STOCK APPRECIATION
RIGHTS OUTSTANDING AS AT RIGHTS EXERCISABLE AS AT
AUGUST 31, 2003 AUGUST 31, 2003
------------------------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE
EXERCISE PRICE NUMBER REMAINING CONTRACTUAL LIFE NUMBER REMAINING CONTRACTUAL LIFE
------------------------------------------------------------------------------------------------------------------
$2.10 2,000 3.7 years -- --
$19.19 to $22.25 4,500 1.3 years 2,250 1.3 years
$45.94 2,500 1.0 year 1,250 1.0 year
------------------------------------------------------------------------------------------------------------------
9,000 1.8 years 3,500 1.2 years
==================================================================================================================
PRO FORMA INFORMATION ON STOCK-BASED COMPENSATION PLANS
The company has elected not to account for stock-based compensation costs
arising from awards to employees using the fair value-based method as permitted
by the new accounting standard (note 2). However, the company is required to
make pro forma disclosures of net loss and net loss per share as if the fair
value-based method of accounting had been applied.
Therefore, if the fair value-based method had been used to account for
stock-based compensation costs related to stock options granted to employees
since the adoption of the new standard on September 1, 2002, the net loss and
the related net loss per share figures would be as follows on a pro forma basis:
YEAR ENDED
AUGUST 31, 2003
--------------------------------------------------------------------------------
Net loss for the year $ (54,950)
Pro forma adjustment for stock-based compensation costs (338)
--------------------------------------------------------------------------------
Pro forma net loss for the year $ (55,288)
================================================================================
Basic and diluted net loss per share $ (0.87)
Basic and diluted pro forma net loss per share $ (0.88)
These options, which have a weighted average fair value of $0.81, will generate
aggregate stock-based compensation costs of $887,000 over their vesting periods.
Those costs will be amortized over their vesting periods using the graded
vesting method resulting in annual stock-based compensation costs of $282,000 in
2004, $175,000 in 2005, $84,000 in 2006 and $8,000 in 2007.
The fair value of options granted was estimated using the Black-Scholes options
valuation model with the following weighted average assumptions:
YEAR ENDED
AUGUST 31, 2003
--------------------------------------------------------------------------------
Risk-free interest rate 4.2%
Expected volatility 80%
Dividend yield Nil
Expected life 29 months
The Black-Scholes options valuation model was developed for use in estimating
the fair value of traded options and awards which have no vesting restrictions,
and are fully transferable. In addition, option and award valuation models
require the input of highly subjective assumptions, including the expected stock
price volatility. Because the company's employee stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its employee
stock options.
36 o 2003 Annual Report o EXFO
14 o OTHER DISCLOSURES
NET RESEARCH AND DEVELOPMENT EXPENSES
Net research and development expenses comprise the following:
Years ended August 31, 2003 2002 2001
--------------------------------------------------------------------------------
Gross research and development expenses $17,133 $ 17,005 $17,601
Research and development tax credits (3,506) (3,890) (3,369)
Government grants (45) (333) (631)
Write-off of research and development
tax credits (note 4) 2,297 -- --
--------------------------------------------------------------------------------
$15,879 $12,782 $13,601
================================================================================
All tax credits written off can be carried forward against future years' income
taxes payable over the next ten years.
OTHER GRANTS AND TAX CREDITS
During 1998, the company entered into an agreement with the Quebec Minister of
Industry, Commerce, Science and Technology (the "Minister"). Pursuant to this
agreement, the Minister agreed to contribute, in the form of grants, up to a
maximum of Cdn$600,000 (US$433,000) toward interest costs incurred over the
period from January 1, 1998, through December 31, 2002. In addition, the
Minister agreed to provide grants up to a maximum of Cdn$2,220,000
(US$1,603,000) over the period from January 1, 1998, through December 31, 2002,
payable based on the number of full-time jobs created during the period.
The above grants are subject to the condition that jobs created pursuant to the
agreement be maintained for a period of at least five years from the date of
creation. Should this condition not be met by the company, the Minister may
enforce various recourse options, which include suspension or cancellation of
the agreement or requiring the repayment of amounts received by the company.
Since the beginning of this program, the company recognized the maximum amount
of Cdn$2,820,000 (US$2,036,000), of which Cdn$2,003,000 (US$1,446,000) has been
credited to earnings with the balance of Cdn$817,000 (US$590,000) having been
included in deferred grants in the balance sheet.
Furthermore, in 1999, the company entered into another agreement with the
Minister. Pursuant to this agreement, the Minister agreed to provide grants over
the period from February 1998 to June 2002, payable based on the number of jobs
created and certain specific training expenses related to such jobs. The above
grant is subject to the condition that the new employees continue to participate
in the specific training program for a period of at least ten consecutive
months. Should this condition not be met by the company, the Minister may
enforce various recourse options, which include suspension or cancellation of
the agreement or requiring the repayment of amounts received by the company.
Since 1998, the company has recognized a total of Cdn$2,965,000 (US$2,141,000)
under this program, which has been credited to earnings.
Should repayments of any amounts received pursuant to these agreements be
required, such repayments will be charged to earnings as the amount of any
repayment becomes known.
Finally, since 2000, companies operating in the Quebec City area are eligible
for a refundable tax credit granted by the Quebec provincial government. This
credit is earned on the increase of production and marketing salaries incurred
in the Quebec City area at a rate of 40%. Since 2000, the company has recognized
a total of Cdn$5,664,000 (US$4,089,000) under this program, of which
Cdn$4,905,000 (US$3,540,000) has been credited to earnings with the balance of
Cdn$759,000 (US$549,000) having been included in deferred grants in the balance
sheet.
The reduction in the company's workforce described in note 4 had no effect on
amounts already recognized in the statements of earnings under these programs.
Following is a summary of the classification of these and certain other grants
and tax credits (government grants) in the statements of earnings of the
reporting years.
Cost of sales for the years ended August 31, 2001, 2002 and 2003, is net of
government grants of $1,742,000, $546,000 and $518,000, respectively.
Selling and administrative expenses for the years ended August 31, 2001, 2002
and 2003, are net of government grants of $260,000, $213,000 and $286,000,
respectively.
Research and development expenses for the years ended August 31, 2001, 2002 and
2003, are net of government grants of $631,000, $333,000 and $45,000,
respectively.
DEFINED CONTRIBUTION PLANS
The company maintains separate defined contribution plans for certain eligible
employees. These plans, which are accounted for on an accrual basis, are
summarized as follows:
o Deferred profit-sharing plan
The company maintains a plan for certain eligible Canadian resident
employees, under which the company may elect to contribute an amount equal
to 1% of an employee's gross salary, provided that the employee has
contributed at least 2% of his/her gross salary to a tax-deferred
registered retirement savings plan. From June 2002 to December 2002, the
company suspended its contributions to the plan as part of its
cost-reduction efforts. Contributions to this plan during the years ended
August 31, 2001, 2002 and 2003, amounted to Cdn$407,000 (US$266,000),
Cdn$136,000 (US$86,000) and Cdn$93,000 (US$63,000), respectively.
o 401K plan
The company maintains a 401K plan for eligible U.S. resident employees.
Under this plan, the company may elect to contribute an amount equal to 3%
of an employee's current compensation. During the years ended August 31,
2001, 2002 and 2003, the company recorded contributions totaling $285,000,
$317,000 and $253,000, respectively.
EXFO o 2003 Annual Report o 37
15 o INCOME TAXES
The reconciliation of the income tax provision calculated using the
combined Canadian federal and provincial statutory income tax rate to the
provision for income taxes per the financial statements is as follows:
Years ended August 31, 2003 2002 2001
--------------------------------------------------------------------------------
Income taxes at combined Canadian federal
and provincial statutory tax rate (34%
in 2003, 36% in 2002 and 37% in 2001) $ (12,031) $ (26,563) $ 8,855
Increase (decrease) due to:
Manufacturing and processing deduction 307 525 (1,201)
Difference between combined Canadian federal
and provincial statutory tax rate and
foreign subsidiaries statutory tax rates (999) (1,101) 60
Non-taxable income (298) (143) (144)
Non-deductible expenses 77 334 274
Reduction of Canadian federal statutory
tax rate 92 168 --
Effect of consolidation of subsidiaries 184 1,325 (276)
Tax deductions (80) (518) (136)
Previous year tax recovery upon a tax
assessment (645) -- --
Other 67 522 356
Change in valuation allowance 28,385 -- 362
--------------------------------------------------------------------------------
$ 15,059 $ (25,451) $ 8,150
================================================================================
The provision for income taxes consist of the following:
Current
Canadian $ 4,829 (10,816) $ 8,416
United States (247) (1,232) 1,305
Other 339 (6) 208
--------------------------------------------------------------------------------
4,921 (12,054) 9,929
Future
Canadian (13,553) (4,475) 578
United States (4,307) (8,694) (2,719)
Other (387) (228) --
--------------------------------------------------------------------------------
(18,247) (13,397) (2,141)
Valuation allowance
Canadian 20,359 -- --
United States 7,374 -- --
Other 652 -- 362
--------------------------------------------------------------------------------
28,385 -- 362
--------------------------------------------------------------------------------
$ 15,059 $ (25,451) $ 8,150
================================================================================
Details of the company's income taxes:
Earnings (loss) before income taxes and
amortization and write-down of goodwill
Canadian $(20,449) $ (47,431) $28,202
United States (8,611) (28,228) (5,356)
Other (6,326) 1,874 1,086
--------------------------------------------------------------------------------
$(35,386) $ (73,785) $23,932
================================================================================
As at August 31, 2003 2002
--------------------------------------------------------------------------------
Future income tax assets
Property, plant and equipment and intangible assets $ 3,287 $ 3,725
Provisions and accruals 9,786 1,339
Government grants 185 206
Deferred revenue 140 --
Share issue expenses 1,434 1,069
Restructuring charges -- 715
Research and development expenses 3,621 1,178
Losses carried forward 13,770 6,911
--------------------------------------------------------------------------------
32,223 15,143
Valuation allowance (28,846) (359)
--------------------------------------------------------------------------------
$ 3,377 $ 14,784
================================================================================
Future income tax liabilities
Property, plant and equipment and intangible assets $ (2,848) $ (4,566)
Research and development tax credits (497) (150)
Provisions and accruals (32) (66)
--------------------------------------------------------------------------------
(3,377) (4,782)
--------------------------------------------------------------------------------
Future income tax assets, net $ -- $ 10,002
================================================================================
38 o 2003 Annual Report o EXFO
As at August 31, 2003, the company had
available operating losses in several tax jurisdictions, for which a valuation
allowance was established. The following table summarizes the year of expiry of
these operating losses by tax jurisdiction:
Canada United
Year of expiry Federal Provincial States and Other
--------------------------------------------------------------------------------
2005 $ 40,000 $ 7,000 $ --
2006 189,000 233,000 --
2007 1,467,000 1,799,000 155,000
2008 4,959,000 5,259,000 1,431,000
2009 2,390,000 2,070,000 --
2010 12,261,000 1,585,000 --
2022 -- -- 9,102,000
2023 -- -- 11,115,000
Indefinite -- -- 1,267,000
--------------------------------------------------------------------------------
$ 21,306,000 $ 10,953,000 $ 23,070,000
================================================================================
Also, as at August 31, 2003, the company had available research and development
expenses in Canada of $11,982,000 at the federal level and $12,330,000 at the
provincial level, for which a valuation allowance was established. These
expenses can be carried forward indefinitely against future years' taxable
income.
16 o SEGMENT INFORMATION
Management has organized the company under one operating segment, being the
development, manufacturing and marketing of fiber-optic test, measurement and
monitoring solutions. This operating segment is composed of Portable and
Monitoring products and Industrial and Scientific products (note 21).
Product sales are detailed as follows:
Years ended August 31, 2003 2002 2001
--------------------------------------------------------------------------------
Portable and Monitoring products $ 40,069 $ 38,887 $ 69,399
Industrial and Scientific products 21,861 29,443 76,614
--------------------------------------------------------------------------------
$ 61,930 $ 68,330 $146,013
================================================================================
Sales to external customers by geographic region are detailed as follows:
Years ended August 31, 2003 2002 2001
--------------------------------------------------------------------------------
United States $ 31,561 $ 35,129 $ 72,604
Canada 4,806 3,971 12,531
Europe 9,584 9,539 30,568
Asia 10,004 12,971 19,059
Latin America 4,467 2,581 5,838
Other 1,508 4,139 5,413
--------------------------------------------------------------------------------
$ 61,930 $ 68,330 $ 146,013
================================================================================
Sales have been allocated to geographic regions based on the country of
residence of the related customers. In 2003 and 2001, there were no customers
from which 10% or more of sales were derived, while in 2002, one customer
represented more than 10% of sales with 10.2% of sales ($6,965,000).
Long-lived assets by geographic region are detailed as follows:
As at August 31, 2003 2002
--------------------------------------------------------------------
Canada $ 43,402 $ 44,145
United States 9,980 16,141
--------------------------------------------------------------------
$ 53,382 $ 60,286
====================================================================
Long-lived assets consist of property, plant and equipment, intangible assets
and goodwill.
EXFO o 2003 Annual Report o 39
17 o LOSS PER SHARE
The following table summarizes the reconciliation of the basic weighted average
number of shares outstanding and the diluted weighted average number of shares
outstanding used in the diluted loss per share calculations:
Years ended August 31, 2003 2002 2001
--------------------------------------------------------------------------------
Basic weighted average number of shares
outstanding (000's) 62,852 60,666 53,014
Dilutive effect of stock options (000's) 301 31 231
Dilutive effect of restricted stock
awards (000's) 164 269 250
--------------------------------------------------------------------------------
Diluted weighted average number of shares
outstanding (000's) 63,317 60,966 53,495
================================================================================
Stock options excluded from the calculation
of diluted loss per share because the
exercise price was greater than the average
market price of the common shares (000's) 2,533 2,734 953
================================================================================
The diluted loss per share for the years ended August 31, 2001, 2002 and 2003,
was the same as the basic loss per share since the dilutive effect of stock
options and restricted stock awards should not be included in the calculation;
otherwise, the effect would be anti-dilutive. Accordingly, diluted loss per
share for those years was calculated using the basic weighted average number of
shares outstanding.
18 o FINANCIAL INSTRUMENTS
SHORT-TERM INVESTMENTS
Short-term investments consist of the following:
As at August 31, 2003 2002
-----------------------------------------------------------------------------
Commercial paper denominated in Canadian
dollars, bearing interest at annual rates of
2.61% to 2.93% in 2002 and 2.65% to 3.10% in
2003, maturing on different dates between
September 2002 and November 2002 in 2002, and
October 2003 and January 2004 in 2003 $ 52,010 $ 40,553
=============================================================================
FAIR VALUE
Cash, accounts receivable, accounts payable and accrued liabilities and
long-term debt are financial instruments whose fair values approximate their
carrying values.
The fair value of short-term investments, based on market value, amounted to
$40,553,000 and $52,010,000 as at August 31, 2002 and 2003, respectively.
The fair value of forward exchange contracts, based on the current trading
value, amounted to Cdn$13,510,000 and Cdn$18,550,000 as at August 31, 2002 and
2003, respectively. As at August 31, 2002, these forward exchange contracts
generated deferred unrealized losses of US$39,000, compared to deferred
unrealized gains of US$1,800,000 as at August 31, 2003. Deferred unrealized
gains or losses were calculated using year-end exchange rates.
CREDIT RISK
Financial instruments which potentially subject the company to credit risk
consist primarily of cash, short-term investments, accounts receivable and
forward exchange contracts. The company's short-term investments consist of debt
instruments issued by high-credit quality corporations. The company's cash and
forward exchange contracts are held with or issued by high-credit quality
financial institutions; therefore, the company considers the risk of
non-performance on these instruments to be remote.
Due to the geographic distribution of the company's customers, there is no
particular concentration of credit risk. Generally, the company does not require
collateral or other security from customers for trade accounts receivable;
however, credit is extended to customers following an evaluation of
creditworthiness. In addition, the company performs ongoing credit reviews of
all its customers and establishes an allowance for doubtful accounts receivable
when accounts are determined to be uncollectible. Allowance for doubtful
accounts amounted to $520,000 and $568,000 as at August 31, 2002 and 2003,
respectively.
INTEREST RATE RISK
As at August 31, 2003, the company's exposure to interest rate risk is
summarized as follows:
Cash Non-interest bearing
Short-term investments As described above
Accounts receivable Non-interest bearing
Accounts payable and accrued liabilities Non-interest bearing
Long-term debt As described in note 10
40 o 2003 Annual Report o EXFO
FORWARD EXCHANGE CONTRACTS
The company is exposed to currency
risks as a result of its export sales of products manufactured in Canada,
substantially all of which are denominated in US dollars. These risks are
partially hedged by forward exchange contracts and certain operating expenses.
As at August 31, 2002 and 2003, the company held contracts to sell US dollars at
various forward rates, which are summarized as follows:
Weighted
Contractual average contractual
amounts forward rates
--------------------------------------------------------------------------------
As at August 31, 2002
September 2002 to August 2003 $ 6,400 1.5464
September 2003 to June 2004 2,200 1.5679
As at August 31, 2003
September 2003 to August 2004 $ 6,470 1.5869
September 2004 to August 2005 6,680 1.5647
19 o RELATED PARTY TRANSACTIONS
In 2003, EXFO acquired a building from a company owned by the President of the
company for a cash consideration of $930,000. This transaction was measured at
the fair market value since it was not in the normal course of operations, the
change in ownership interest in the building was substantive and the fair market
value was supported by an independent appraisal.
For the years ended August 31, 2001, 2002 and 2003, EXFO leased facilities from
a company owned by the President of the company. The annual rental expense
amounted to $238,000, $234,000 and $331,000, respectively. The rental expense
for 2003 included $234,000 for future payments on an exited leased facility;
this expense has been recorded in the restructuring and other charges in the
statement of earnings (notes 4 and 9). This lease will not be renewed at expiry.
These rental expenses were measured at the fair market value since they were
made in the normal course of operations.
20 o UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
As a registrant with the Securities and Exchange Commission in the
United States, the company is required to reconcile its financial statements for
significant differences between generally accepted accounting principles as
applied in Canada (Canadian GAAP) and those applied in the United States (U.S.
GAAP). Additional significant disclosures required under U.S. GAAP have also
been provided in the accompanying financial statements and notes. The following
summarizes the significant differences between Canadian and U.S. GAAP and other
significant required disclosures under U.S. GAAP not already provided in the
accompanying financial statements.
RECONCILIATION OF NET LOSS TO CONFORM WITH U.S. GAAP
The following summary sets out the significant differences between the company's
reported net loss and net loss per share under Canadian GAAP as compared to U.S.
GAAP. Please see corresponding explanatory notes in the Reconciliation Items
section.
Years ended August 31, 2003 2002 2001
--------------------------------------------------------------------------------------------------------------------------------
Net loss for the year in accordance with Canadian GAAP $ (54,950) $ (308,524) $ (15,294)
Non-cash stock-based compensation costs related to stock option plan a) 216 49 (954)
Non-cash stock-based compensation costs related to stock purchase plan a) (61) (661) (477)
Non-cash stock-based compensation costs related to restricted stock award plan a) (987) (3,038) (3,481)
Unrealized gains on forward exchange contracts b) 1,645 444 97
Future income taxes on forward exchange contracts b) (543) (212) 20
Future income taxes on acquired in-process research and development d) -- (444) (936)
Amortization of intangible assets e) 832 239 --
Future income taxes on amortization of intangible assets e) (279) (80) --
Valuation allowance on future income tax assets f) (252) -- --
Amortization of goodwill d),e) -- (9,263) (8,453)
Write-down of goodwill and intangible assets e) 6,178 (62,557) --
Future income taxes on write-down of intangible assets e) -- 1,154 --
--------------------------------------------------------------------------------------------------------------------------------
Net loss for the year in accordance with U.S. GAAP (48,201) (382,893) (29,478)
Other comprehensive income (loss)
Foreign currency translation adjustments 15,974 (521) (9,888)
--------------------------------------------------------------------------------------------------------------------------------
Comprehensive loss $ (32,227) $ (383,414) $ (39,366)
================================================================================================================================
Basic and diluted net loss per share in accordance with U.S. GAAP g) $ (0.77) $ (6.31) $ (0.56)
SHAREHOLDERS' EQUITY
As a result of the aforementioned adjustments to net loss, significant
differences with respect to shareholders' equity under U.S. GAAP are as follows:
SHARE CAPITAL
As at August 31, 2003 2002 2001
--------------------------------------------------------------------------------------------------------------------------------
Share capital in accordance with Canadian GAAP $ 492,452 $ 489,611 $ 429,995
Stock-based compensation costs related to stock purchase plan a), h)
Current year (75) (64) (150)
Cumulative effect of prior years 2,478 2,542 2,692
Reclassification from other capital upon exercise of restricted stock awards
Current year 1,582 3,270 --
Cumulative effect of prior years 3,270 -- --
Shares issued upon business combinations d)
Cumulative effect of prior years 65,584 65,584 65,584
--------------------------------------------------------------------------------------------------------------------------------
Share capital in accordance with U.S. GAAP $ 565,291 $ 560,943 $ 498,121
================================================================================================================================
EXFO o 2003 Annual Report o 41
DEFERRED STOCK-BASED COMPENSATION COSTS
As at August 31, 2003 2002 2001
--------------------------------------------------------------------------------------------------------------------------------
Deferred stock-based compensation costs in accordance with Canadian GAAP $ -- $ -- $ --
Stock-based compensation costs related to stock-based compensation plans a), h)
Current year -- -- (8,145)
Cumulative effect of prior years (2,867) (7,968) (19,429)
Amortization for the year 1,483 4,698 4,912
Reduction of stock-based compensation costs 106 403 14,694
--------------------------------------------------------------------------------------------------------------------------------
Deferred stock-based compensation costs in accordance with U.S. GAAP $ (1,278) $ (2,867) $ (7,968)
================================================================================================================================
OTHER CAPITAL
As at August 31, 2003 2002 2001
--------------------------------------------------------------------------------------------------------------------------------
Other capital in accordance with Canadian GAAP $ -- $ -- $ --
Stock-based compensation costs related to stock-based compensation plans a), h)
Current year -- -- 8,145
Cumulative effect of prior years 10,963 12,350 18,749
Reduction of stock-based compensation costs (682) (1,387) (14,544)
Reclassification to share capital upon exercise of restricted stock awards
Current year (1,582) (3,270) --
Cumulative effect of prior years (3,270) -- --
--------------------------------------------------------------------------------------------------------------------------------
Other capital in accordance with U.S. GAAP $ 5,429 $ 7,693 $ 12,350
================================================================================================================================
DEFICIT
As at August 31, 2003 2002 2001
--------------------------------------------------------------------------------------------------------------------------------
Deficit in accordance with Canadian GAAP $ (371,788) $ (316,838) $ (8,314)
Stock-based compensation costs related to stock-based compensation plans a)
Current year (832) (3,650) (4,912)
Cumulative effect of prior years (10,574) (6,924) (2,012)
Unrealized gains on forward exchange contracts, net of related future
income taxes b)
Current year 1,102 232 117
Cumulative effect of prior years 349 117 --
Change in reporting currency c)
Cumulative effect of prior years 1,016 1,016 1,016
Future income taxes on acquired in-process research and development d)
Current year -- (444) (936)
Cumulative effect of prior years (1,380) (936) --
Amortization of intangible assets e)
Current year 832 239 --
Cumulative effect of prior years 239 -- --
Future income taxes on amortization of intangible assets e)
Current year (279) (80) --
Cumulative effect of prior years (80) -- --
Write-down of goodwill and intangible assets e)
Current year 6,178 (62,557) --
Cumulative effect of prior years (62,557) -- --
Future income taxes on write-down of intangible assets e)
Current year -- 1,154 --
Cumulative effect of prior years 1,154 -- --
Valuation allowance on future income tax assets f)
Current year (252) -- --
Amortization of goodwill d), e)
Current year -- (9,263) (8,453)
Cumulative effect of prior years (17,716) (8,453) --
--------------------------------------------------------------------------------------------------------------------------------
Deficit in accordance with U.S. GAAP $ (454,588) $ (406,387) $ (23,494)
================================================================================================================================
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
As at August 31, 2003 2002 2001
--------------------------------------------------------------------------------------------------------------------------------
Foreign currency translation adjustments c)
Balance - Beginning of year $ (9,870) $ (9,349) $ 539
Change during the year 15,974 (521) (9,888)
--------------------------------------------------------------------------------------------------------------------------------
Balance - End of year $ 6,104 $ (9,870) $ (9,349)
================================================================================================================================
42 o 2003 Annual Report o EXFO
BALANCE SHEETS
The following table summarizes the significant differences in balance sheet
items between Canadian GAAP and U.S. GAAP:
As at August 31, 2003 As at August 31, 2002
--------------------------------------------------------------------------------------------------------------------------------
As reported U.S. GAAP As reported U.S. GAAP
Intangible assets d), e)
Cost $ 36,260 $ 32,322 $ 37,927 $ 30,301
Accumulated amortization (25,482) (21,652) (21,463) (17,030)
--------------------------------------------------------------------------------------------------------------------------------
$ 10,778 $ 10,670 $ 16,464 $ 13,271
================================================================================================================================
Goodwill d), e)
Cost $ 89,721 $ 99,137 $ 87,025 $ 92,747
Accumulated amortization (72,048) (90,350) (69,449) (87,251)
--------------------------------------------------------------------------------------------------------------------------------
$ 17,673 $ 8,787 $ 17,576 $ 5,496
================================================================================================================================
Shareholders' equity
Share capital a), d), h) $492,452 $565,291 $489,611 $560,943
Contributed surplus 1,519 1,519 1,487 1,487
Cumulative translation adjustment c) 7,643 -- (8,854) --
Deferred stock-based compensation costs a), h) -- (1,278) -- (2,867)
Other capital a) -- 5,429 -- 7,693
Deficit a), b), c), d), e), f) (371,788) (454,588) (316,838) (406,387)
Accumulated other comprehensive income (loss) c) -- 6,104 -- (9,870)
--------------------------------------------------------------------------------------------------------------------------------
$129,826 $122,477 $165,406 $150,999
================================================================================================================================
STATEMENTS OF CASH FLOWS
For the years ended August 31, 2001, 2002 and 2003, there are no significant
differences between the statements of cash flows under Canadian GAAP as compared
to U.S. GAAP.
RECONCILIATION ITEMS
a) ACCOUNTING FOR STOCK-BASED COMPENSATION
To conform with U.S. GAAP, the company measures stock-based compensation costs
using the intrinsic value method (APB 25 "Accounting for Stock Issued to
Employees").
STOCK PURCHASE PLAN
Under APB 25, compensation cost related to the stock purchase plan is measured
as the difference between the fair value of the purchased stock and the purchase
price paid by plan participants. Compensation cost is amortized to expense over
a period of five years, being the restriction period. This plan terminated at
the time of the Initial Public Offering on June 29, 2000.
STOCK OPTION PLAN
In accordance with APB 25, the company's stock option plan was considered to be
a variable plan until October 10, 2000. As a result of the amendment to the
stock option plan described in note 13, the performance criterion was removed
and the number of shares to be issued under the plan was fixed and the company
recorded, in 2001, a net reduction of the compensation cost and deferred
compensation cost previously recognized of $467,000 and $14,544,000,
respectively. Compensation cost under this plan is measured as the difference
between the fair value of the underlying stock at the date of grant and the
exercise price of the option. Compensation cost is amortized to expense over the
estimated vesting period up to a maximum of four years.
RESTRICTED STOCK AWARD PLAN
Under APB 25, compensation cost related to the restricted stock award plan is
measured as the difference between the fair value of the underlying stock at the
date of grant and the exercise price, which is nil. Compensation cost is
amortized to expense over the estimated vesting period up to a maximum of four
years, being the acquisition period.
Under Canadian GAAP, no compensation cost is recognized for these stock-based
compensation plans.
b) FORWARD EXCHANGE CONTRACTS
On September 1, 2000, the company prospectively adopted Statement of Financial
Accounting Standard No. 133, "Accounting for Derivative Instruments and Hedging
Activities" (SFAS 133) and its amendments (SFAS 138), which require all
derivatives to be carried onto the balance sheet at fair value. The forward
exchange contracts used by the company have not qualified for hedging accounting
treatment during the years ended August 31, 2001, 2002 and 2003 under U.S. GAAP;
accordingly, changes in the fair value of the derivatives have been charged to
earnings during these years.
Under Canadian GAAP, the company's forward exchange contracts held for the
purpose of hedging anticipated sales qualified for hedge accounting and any
foreign exchange translation gains or losses on those contracts were recognized
as an adjustment of the revenues when the sale was recognized.
c) CHANGE IN REPORTING CURRENCY
On September 1, 1999, the company adopted the US dollar as its reporting
currency. Under U.S. GAAP, the financial statements, including prior years, are
translated according to the current rate method. Under Canadian GAAP, at the
time of change in reporting currency, the historical financial statements are
presented using a translation of convenience. This difference between U.S. GAAP
and Canadian GAAP created a permanent difference of $1,016,000 affecting the
cumulative translation adjustment and the retained earnings.
d) BUSINESS COMBINATIONS
Under Canadian GAAP, until June 30, 2001, the value of shares issued upon a
business combination was determined based on the market price of the shares over
a reasonable period of time before and after the date of acquisition. Under U.S.
GAAP, the value of shares was determined based on the market price of the shares
over a reasonable period of time before and after the companies had reached an
agreement on the purchase price; the significant terms of the agreement were
known and the proposed transaction was announced.
EXFO o 2003 Annual Report o 43
Consequently, the measurement dates of the acquisitions of EXFO Burleigh and
EXFO Photonic Solutions for U.S. GAAP purposes occurred on December 14, 2000,
and on March 6, 2001, respectively; that is, the dates on which all significant
terms of the agreements were known. The average market price of the shares a few
days before and after those dates was $31.09 and $25.84, respectively.
Considering the number of shares issued upon those acquisitions, the total
consideration for U.S. GAAP purposes amounts to $244,198,000 ($189,270,000 under
Canadian GAAP) for EXFO Burleigh and $120,802,000 ($110,146,000 under Canadian
GAAP) for EXFO Photonic Solutions, thus increasing share capital and goodwill
under U.S. GAAP.
However, since July 1, 2001, the shares issued upon a business combination are
valued under Canadian GAAP using the same method as used under U.S. GAAP.
Furthermore, under U.S. GAAP, in-process research and development acquired in a
business combination is written off at the time of acquisition and no future
income taxes are recognized on this asset in the purchase price allocation
process. Under Canadian GAAP, in-process research and development acquired in a
business combination is capitalized and amortized over the estimated useful
life. Future income taxes are recognized on the acquisition date on that asset
in the purchase price allocation process. As at August 31, 2001, 2002 and 2003,
in-process research and development recorded under Canadian GAAP was fully
amortized.
e) WRITE-DOWN OF GOODWILL AND INTANGIBLE ASSETS
2002
Under U.S. GAAP, until the adoption of SFAS 142, when assets being tested for
recoverability were acquired in business combinations accounted for by the
purchase method, the goodwill that arose in that transaction had to be included
as part of the assets grouping in determining recoverability. The intangible
assets tested for recoverability in 2002 were acquired in business combinations
accounted for using the purchase method and, consequently, the company allocated
goodwill to those assets on a pro rata basis using the relative fair values of
the long-lived assets and identifiable intangible assets acquired as determined
at the date of acquisition. The carrying value of goodwill identified with the
impaired intangible assets was written down before any reduction was made to the
intangible assets. Intangible assets were then written down to their fair value.
The fair value of intangible assets was determined based on discounted future
cash flows. The cash flow periods used were ten and eleven years, using annual
growth rates ranging between 10% and 30% and discount rates between 15% and 18%.
The assumptions supporting discounted cash flows, including the cash flow
periods, the annual growth rates and the discount rates, reflect management's
best estimates. The discount rates were based upon the company's weighted
average cost of capital as adjusted for the risks associated with operations.
The unallocated portion of goodwill was tested for recoverability at the
subsidiaries' level based on the related pre-tax undiscounted future cash flows
using the same assumptions and methodology as used for Canadian GAAP purposes.
Under U.S. GAAP, the company recorded a charge of $281,278,000 to write down a
significant portion of goodwill and a pre-tax charge of $27,105,000 to write
down a significant portion of acquired core technology. Of the total charge of
$308,383,000, $170,079,000 was related to EXFO Burleigh for goodwill and
acquired core technology, $83,637,000 was related to EXFO Photonic Solutions for
goodwill and acquired core technology and $54,667,000 was related to EXFO
Protocol for goodwill.
Under Canadian GAAP, no allocation of goodwill was required and each asset was
tested for recoverability separately based on its pre-tax undiscounted future
cash flows over its expected period of use.
Also, under Canadian GAAP, the impairment loss for intangible assets was
measured as the difference between the carrying value and the pre-tax
undiscounted future cash flows.
Finally, under U.S. GAAP, the carrying value of goodwill reviewed for impairment
was $46,380,000 higher than the carrying value of the same goodwill tested under
Canadian GAAP because the measurement dates used to account for the business
combinations were different between Canadian GAAP and U.S. GAAP as explained in
item d).
2003
In 2003, Canadian and U.S. GAAP were harmonized to eliminate the existing
differences in the assessment and measurement of impairment loss for goodwill
and intangible assets. Thus, in 2003, goodwill and intangible assets were tested
for impairment using similar methodologies. However, considering that the
existing carrying value of goodwill and intangible assets was lower under U.S.
GAAP than under Canadian GAAP, the required impairment loss under U.S. GAAP was
lower.
Consequently, under U.S. GAAP, the company recorded a charge of $872,000 to
write down goodwill of EXFO Burleigh and a pre-tax charge of $377,000 to write
down acquired core technology of EXFO Burleigh, compared to a write-down of
$4,505,000 for goodwill and a write-down of $2,922,000 for intangible assets
under Canadian GAAP, creating a reconciliation item of $6,178,000 in the
statement of earnings.
Furthermore, considering differences in the carrying value of intangible assets
between Canadian GAAP and U.S. GAAP due to impairment losses, adjustments to
amortization of such assets and related future income taxes were required as
well.
f) INCOME TAXES
Considering the tax effects of the adjustments discussed in items b), d) and e),
the valuation allowance required under U.S. GAAP was $252,000 higher than under
Canadian GAAP.
g) LOSS PER SHARE
Under U.S. GAAP, the presentation of per share figures for loss before
amortization and write-down of goodwill is not permitted.
h) SHARE CAPITAL
Under Canadian GAAP, restricted shares reacquired from employees under the stock
purchase plan are treated as arm's length repurchases of shares, whereas under
U.S. GAAP, the reacquisition of shares would be accounted for as a forfeiture by
the employee, which means that any difference between the amount originally
credited to share capital and the remaining deferred compensation cost will be
credited to compensation expense in the current period. The subsequent resale of
the shares would be treated as an issuance of shares for the proceeds received.
i) RESEARCH AND DEVELOPMENT TAX CREDITS
Under Canadian GAAP, all research and development tax credits are recorded as a
reduction of research and development expenses. Under U.S. GAAP, tax credits
that are refundable against taxable income are recorded in the income taxes.
This difference had no impact on the net loss and the net loss per share figures
for the reporting years.
j) NEW ACCOUNTING STANDARDS
On September 1, 2002, the company prospectively adopted SFAS 142, "Goodwill and
Other Intangible Assets", which is similar to CICA handbook section 3062
described in note 2.
44 o 2003 Annual Report o EXFO
The following table summarizes the impact of this change in accounting policy on
the net loss and the net loss per share for the comparative previous periods on
an adjusted basis:
Years ended August 31, 2002 2001
-------------------------------------------------------------------------------------------
Net loss for the year $ (382,893) $ (29,478)
Add-back:
Amortization of goodwill for the year 47,284 39,529
-------------------------------------------------------------------------------------------
Adjusted net earnings (loss) for the year $ (335,609) $ 10,051
===========================================================================================
Basic and diluted net loss per share $ (6.31) $ (0.56)
Basic and diluted adjusted net earnings (loss) per share $ (5.53) $ 0.19
UNAUDITED PRO FORMA INFORMATION ON BUSINESS COMBINATIONS
Under U.S. GAAP, pro forma information must be provided as though the business
combinations had occurred at the beginning of the reported periods.
The following unaudited pro forma information reflects the results of operations
as if the 2002 acquisition had been completed on September 1, 2001:
Year ended
August 31, 2002
-------------------------------------------------------------------------------
(unaudited)
Sales $ 75,282
Net loss $ (393,039)
Basic and diluted net loss per share $ (6.25)
The acquisition of EXFO Gnubi in 2003 was considered insignificant for the
purposes of the pro forma information.
Such information is not necessarily indicative of the actual results which would
have been achieved, nor is it necessarily indicative of future consolidated
results of the company.
ACCOUNTING FOR STOCK-BASED COMPENSATION
Under U.S. GAAP, the company has elected to measure compensation costs related
to grants of stock options and stock awards using the intrinsic value method of
accounting. In this instance, however, under SFAS 123, "Accounting for
Stock-Based Compensation", the company is required to make pro forma disclosures
of net loss, basic and diluted net loss per share as if the fair value-based
method of accounting had been applied.
The fair value of options or awards granted was estimated using the
Black-Scholes options pricing model with the following weighted average
assumptions:
Years ended August 31, 2003 2002 2001
----------------------------------------------------------------------------------------------
Risk-free interest rate 4.83% 4.50% 5.36%
Expected volatility 80% 80% 75%
Dividend yield Nil Nil Nil
Expected life 36 months 40 months 33 months
If the fair value-based method had been used to account for stock-based
compensation costs related to stock options and stock awards issued to
employees, the net loss and related net loss per share figures under U.S. GAAP
would be as follows:
Years ended August 31, 2003 2002 2001
------------------------------------------------------------------------------------------------
Net loss for the year $ (48,201) $ (382,893) $ (29,478)
Add-back:
Stock-based compensation costs under APB 25 (216) (49) 954
Deduction:
Stock-based compensation costs under SFAS 123 (683) (4,618) (10,585)
------------------------------------------------------------------------------------------------
Pro forma net loss for the year $ (49,100) $ (387,560) $ (39,109)
================================================================================================
Basic and diluted net loss per share $ (0.77) $ (6.31) $ (0.56)
Basic and diluted pro forma net loss per share $ (0.78) $ (6.39) $ (0.74)
EXFO o 2003 Annual Report o 45
21 o SUBSEQUENT EVENT
In September 2003, the company reorganized its business under two reportable
segments: Telecom Division and Photonics and Life Sciences Division. The Telecom
Division meets the physical-, optical- and protocol-layer test and measurement
needs of network service providers, system vendors and component manufacturers
throughout the global communications industry. The Photonics and Life Sciences
Division mainly leverages developed and acquired technologies for high-tech
industrial manufacturing and research markets.
EXFO's President and Chief Executive Officer ("CEO") has been identified as the
chief operating decision-maker in assessing the performance of the two segments
and the allocation of resources to the segments. Each reportable segment will be
managed separately. Earnings from operations represent the primary measure used
by the CEO in assessing performance of the reportable segments. Costs associated
with shared services and corporate costs will be allocated to segments.
Starting September 1, 2003, the company will provide the required information
about each reportable segment. However, the company will not provide comparative
information for previous periods about each segment because this information is
not available and it is impracticable to do so. The accounting policies of the
reportable segments will be the same as those applied in the consolidated
financial statements.
Until August 31, 2003, the company was organized under one reportable segment,
being the development, manufacturing and marketing of fiber-optic test,
measurement and monitoring solutions for the global telecommunications industry
(note 16).
22 o COMPARATIVE FIGURES
Certain comparative figures have been reclassified to conform with the
current-year presentation.
46 o 2003 Annual Report o EXFO
BOARD OF DIRECTORS
GERMAIN LAMONDE, CHAIRMAN OF THE BOARD, PRESIDENT AND CEO
Germain Lamonde, one of the company's founders, has been Chairman of the Board,
President and Chief Executive Officer since EXFO's inception in 1985. He is
responsible for the overall management and direction of EXFO, its subsidiaries
and its employees worldwide. Mr. Lamonde has held a number of board positions in
other firms and organizations, including the Network of Centers for Excellence
in Photonics at Laval University and the Action Group for the Advancement of
Technology and Industry in Quebec City. Mr. Lamonde holds a bachelor's degree in
Physics Engineering from the ECOLE POLYTECHNIQUE School of Engineering
(University of Montreal), and a master's degree in Optics from Laval University,
both in Canada.
PIERRE MARCOUILLER, CHAIRMAN OF THE BOARD AND CEO, CAMOPLAST INC.
Pierre Marcouiller is Chairman of the Board of Camoplast Inc., a supplier of
components to the recreational and motorized vehicle and automotive parts
markets. He is the founder and has been the sole shareholder of Nexcap Inc., an
investment company in the manufacturing sector, since December 1996. Mr.
Marcouiller worked with Venmar Ventilation Inc., a private ventilation equipment
manufacturer, from January 1983 to December 1996. 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 Inc., a publicly traded company that manufactures aerospace and
industrial turbines, and holds directorships in other privately held companies.
Mr. Marcouiller holds a bachelor's degree in Business Administration from the
UNIVERSITE DU QUEBEC A TROIS-RIVIERES and an MBA from the UNIVERSITE DE
SHERBROOKE, both in Canada.
DAVID A. THOMPSON, VICE-PRESIDENT, HARDWARE & EQUIPMENT TECHNOLOGY STRATEGY,
CORNING CABLE SYSTEMS
Dr. Thompson joined Corning's Research and Development Division in 1976 as a
Senior Chemist in glass research. Most recently, he was named Division
Vice-President for Strategic Planning and Innovation Effectiveness in Research,
Development and Engineering. Between 1988 and 1998, Dr. Thompson held technology
Director and Strategic Planning roles for Corning's Component and Photonics
Technologies Divisions. In 1999, he was named Technical Leader for the creation
of the new Samsung-Corning Micro-Optics joint venture. Dr. Thompson received a
bachelor's degree in Chemistry from Ohio State University and a doctorate in
Inorganic Chemistry from the University of Michigan. He holds 13 patents and has
more than 20 technical publications in the areas of inorganic chemistry, glass
technology and telecommunications.
ANDRE TREMBLAY, PRESIDENT AND CEO, MICROCELL TELECOMMUNICATIONS INC.
Andre Tremblay has been President and Chief Executive Officer of Microcell
Telecommunications since May 1995, and has also been a member Microcell's Board
of Directors since November of that same year. In addition to his role at
Microcell, Mr. Tremblay sits on the Board of Directors of the Communications
Research Centre (a research arm of the federal government's Department of
Industry) as well as the boards of other private and public corporations. Andre
Tremblay began his career in the telecommunications industry in 1985, as an
advisor to the Chairman and Chief Executive Officer of Telesystem Ltd. He
subsequently held various executive positions within that company. Mr. Tremblay
holds bachelor's degrees in Management and in Accounting from Laval University,
as well as a master's degree in Taxation from the UNIVERSITE DE SHERBROOKE, both
in Canada. He also completed the Advanced Management Program offered by the
Harvard Business School in the United States.
MICHAEL UNGER, EXECUTIVE CONSULTANT
Michael Unger has served as our director since May 2000. He previously 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, he 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 that designs, develops and
markets standardsbased system interconnect products for use by the world's
leading communications and storage companies. He is also a member of the boards
of a number of privately held companies active in the areas of network
management software, photonic and optical components, optical network systems
and solutions for cable operators, as well as other communications network
service providers. Mr. Unger holds a bachelor's degree in Science from Concordia
University in Canada.
EXFO o 2003 Annual Report o 47
MANAGEMENT AND CORPORATE OFFICERS
GERMAIN LAMONDE
Chairman of the Board, President and Chief Executive Officer
STEPHEN BULL
Vice-President, Research and Development, Telecom Division
ALLAN FIRHOJ
Vice-President and General Manager, Photonics and Life Sciences Division
ETIENNE GAGNON
Vice-President, Physical-Layer Product Management and Customer Service
LUC GAGNON
Vice-President, Telecom Manufacturing Operations
JUAN FELIPE GONZALEZ
Vice-President, Global Telecom Sales
JOHN HOLLORAN
Interim General Manager, Protocol-Layer Products and Special Projects
KIMBERLEY OKELL
Legal Counsel and Corporate Secretary
PIERRE PLAMONDON, CA
Vice-President, Finance and Chief Financial Officer
JAMES STEVENS
Vice-President, Protocol-Layer Product Management and Chief Technology Officer
48 o 2003 Annual Report o EXFO
CORPORATE GOVERNANCE PRACTICES
The past fiscal year has been one of continued change in the corporate
governance landscape. During this time, the Board of Directors and management
have kept abreast of, and even surpassed, in certain circumstances, new Canadian
and American regulatory requirements. In particular, the Audit Committee has
been very active throughout the year with the implementation of and compliance
with the rules adopted by the Securities and Exchange Commission pursuant to the
Sarbanes-Oxley Act of 2002 that apply to Canadian companies with shares
registered in the U.S. In addition, the Board of Directors has implemented
procedures to monitor the effectiveness of the Board. New corporate governance
rules for NASDAQ and the Toronto Stock Exchange are expected to come into force
in the coming months and management is already analyzing their impact on the
company. As this past year has demonstrated, achieving best practices in
corporate governance is an ongoing process in an ever-changing context.
The Board of Directors believes that EXFO's corporate governance practices
comply with current regulatory requirements. As new guidelines come into effect,
we will comply with these new requirements. Further details about our corporate
governance practices are available in the proxy circular.
The present Board members were elected at our last Annual and Special Meeting of
the Shareholders, held on January 14, 2003.
RESPONSIBILITIES OF THE BOARD
The Board is responsible for the stewardship of our business and affairs by
reviewing, discussing and approving our strategic direction and organizational
structure, as well as for the review of management's strategic planning on an
annual basis. The Board also identifies the principal risks of our business and
reviews our risk management systems on an annual and ongoing basis.
In addition to matters requiring Board approval under applicable laws, the Board
grants final approval with respect to each of the following: (i) the strategic
direction of EXFO; (ii) material contracts, acquisitions or dispositions of our
assets; and (iii) the annual operational plan, as well as capital and operating
budgets.
In September 2003, the Board of Directors decided to assume direct
responsibility for corporate governance practices and for monitoring the powers,
the mandates and the performance of the committees. These matters were
previously the responsibility of the Human Resources Committee.
The Board is also responsible for the establishment and functioning of all Board
committees, the appointment of members to serve on such committees, their
compensation and their good standing. At regularly scheduled meetings of the
Board, the Directors receive, consider and discuss committee reports.
During the fiscal year ended August 31, 2003, the Board met a total of ten
times. Attendance at all meetings was perfect, with the exception of the absence
of Mr. Pierre Marcouiller at one meeting.
Mr. Michael Unger, Chairman of the Human Resources Committee and independent
Director of EXFO, was appointed Lead Director last year. As such, he is
responsible for ensuring that the Board properly discharges its duties,
independent of management. The Lead Director is required to hold a minimum of
two meetings of the Board of Directors without management members present, and
additional meetings of independent Board members may be held at their request.
During the fiscal year ended August 31, 2003, independent Board members met
twice.
At the present time, EXFO has no formal procedures in place for recruiting new
Directors.
COMPOSITION OF THE BOARD
Our articles of incorporation provide for a Board of Directors with a minimum of
three and a maximum of twelve Directors. Our Board presently consists of five
Directors, four of whom are independent of management and free from any interest
and any business or other relationship which could, or could reasonably be
perceived to, materially interfere with a Director's ability to act with a view
to the best interests of EXFO, other than interests arising from non-significant
shareholding. Our Directors are elected at the Annual General Meeting of the
Shareholders for one-year terms and serve until their successors are elected or
appointed, unless they resign or are removed earlier.
Our Chairman of the Board and Chief Executive Officer, Mr. Germain Lamonde, is a
significant shareholder of EXFO as he has the ability to exercise a majority of
the votes for the election of the Board of Directors. Since the other four Board
members do not have interests in EXFO or relationships with either EXFO or Mr.
Lamonde, except for non-significant shareholding in EXFO, we believe that the
interests of investors in EXFO, other than Mr. Lamonde's, are fairly
represented.
COMMITTEES OF THE BOARD
Board committees play a significant role in the discharge of Board duties and
obligations; committee chairs submit items for Board agendas and report on
committee activities. The members of these committees are appointed annually,
and the Board may appoint additional ad hoc committees periodically, as needed.
EXFO has a practice of permitting the Board, any committee thereof and any
individual Director to hire independent, external advisors at our expense. The
Audit Committee and the Human Resources Committee are entirely comprised of
unrelated Directors.
The following is a general description of the composition and general duties of
each Board committee as contained in its mandate as at the fiscal year ended
August 31, 2003.
AUDIT COMMITTEE
The Audit Committee reviews interim in-house financial statements and all annual
audited financial statements and related disclosure documents, including
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", with management and external auditors and approves them prior to
public release. The Audit Committee is responsible for reviewing our internal
control systems with regard to finance, accounting, legal compliance and ethical
behavior. The Committee meets regularly with external auditors, with and without
management, to consider the scope and results of their audits, including
analysis of the adequacy of the internal controls and the effect of the
procedures relating to the outside auditors' independence. The Committee also
recommends to the shareholders the selection of external auditors for their
appointment by the shareholders. The Audit Committee is comprised of the
following independent Directors: Mr. Andre Tremblay, Mr. Michael Unger and Mr.
Pierre Marcouiller. The Chair of the Audit Committee is Mr. Tremblay. During the
fiscal year ended August 31, 2003, the Audit Committee met a total of five times
and all members attended all meetings.
EXFO o 2003 Annual Report o 49
Further to proposed changes to NASDAQ corporate governance rules and new
Securities and Exchange Commission rules flowing from the adoption of the
Sarbanes-Oxley Act, our Audit Committee charter was revised during the fiscal
year ended August 31, 2003, to comply with all new requirements.
HUMAN RESOURCES COMMITTEE
The Human Resources Committee is responsible for assessing the performance and
establishing the annual compensation of all our senior officers, including the
CEO. This Committee also reviews and submits to the Board the salary structure
and the short-term and long-term incentive compensation programs for all our
employees. The Committee is responsible for the review and approval of the
employees who will receive options to purchase EXFO shares in accordance with
policies established by the Board and the terms of the Stock Option Plan. In
addition, the Committee reports annually to the Board regarding the
organizational structure and succession plan for senior management. The
remuneration to be paid by EXFO to the Directors is recommended to the Board by
the Human Resources Committee. The Human Resources Committee is comprised of the
following independent Directors: Mr. Pierre Marcouiller, Dr. David A. Thompson,
Mr. Andre Tremblay and Mr. Michael Unger. The Chair of the Human Resources
Committee is Mr. Unger. During the fiscal year ended August 31, 2003, the Human
Resources committee met a total of five times and attendance was perfect at all
meetings, with the exception of one meeting missed by Dr. David Thompson.
DISCLOSURE COMMITTEE
The Disclosure Committee is responsible for overseeing our disclosure practices.
Due to restructuring that occurred during the fiscal year ended August 31, 2003,
the structure of the Disclosure Committee was modified slightly and now consists
of the Chief Executive Officer, Chief Financial Officer, Investor Relations,
Manager of Financial Reporting and Accounting, as well as Legal Counsel and
Corporate Secretary.
SHAREHOLDER/INVESTOR COMMUNICATIONS AND FEEDBACK
As a result of restructuring changes at EXFO during the fiscal year ended August
31, 2003, the Chief Financial Officer has assumed responsibility for investor
relations. He is responsible for facilitating communications between senior
management and EXFO's shareholders and financial analysts. Information to
shareholders is disseminated through annual and quarterly reports, press
releases, the Annual General Shareholders' Meeting and investor presentations.
EXFO receives and responds to all shareholders' inquiries in an appropriate and
timely manner. In communications to senior management, the Chief Financial
Officer also provides feedback from shareholders.
50 o 2003 Annual Report o EXFO
GLOSSARY
ACCESS NETWORK: Last link in a network between the customer premises and the
first point of connection to the network infrastructure--a point of presence
(PoP) on the edge of a metropolitan network or a central office (CO). Access
networks have, up to now, consisted primarily of passive, twisted-pair copper
wires, but there is a strong trend toward optical-fiber connections either
directly or very close to the customer (fiber-to-the-curb).
COARSE WAVELENGTH-DIVISION MULTIPLEXING (CWDM): Form of wavelength-division
multiplexing that uses wider spacing between wavelengths than does DWDM. CWDM
can be used over multimode and singlemode fibers, but signal distances are
generally shorter than DWDM, and costs of deploying CWDM are significantly lower
than for DWDM.
CHROMATIC DISPERSION (CD): Phenomenon caused by the wavelength dependence of
group velocity in an optical fiber. Since any practical light source has a
certain spectral width, CD results in pulse broadening.
CROSS-CONNECT: Optical cross-connect (OXC). Generally refers to an optical
switch with multiple ports (or channels) at both the input and the output. An
OXC allows any optical signal entering any input port to be directed to any
desired output port. Also see Lambda Router.
DEEP CHANNELIZATION: The ability to process all channels in a signal
simultaneously, thus testing the entire channelized bandwidth.
DENSE WAVELENGTH-DIVISION MULTIPLEXING (DWDM): A technology that enables a
single optical fiber to carry multiple data channels (or wavelengths).
Commercial DWDM systems can have as many as 160 separate channels.
ETHERNET: Protocol for data networking. Ethernet networks typically operate at
10, 100 or 1000 Mb/s.
FIBER-TO-THE-HOME (FTTH): Also known as fiber-to-the-premises (FTTP) and
fiber-to-thebuilding (FTTB). FTTH refers to a carrier network's optical fiber
that is connected directly to the subscriber's home or enterprise. FTTH is
distinguished from fiber-to-the-curb, which is only installed within 1000 feet
of the premises, leaving the curb-to-building section made out of coaxial cable.
GIGABIT ETHERNET: A version of Ethernet that operates at 1 Gb/s (1000 Mb/s).
HYBRID CONCATENATION: The ability to use many different payload mappings, or
channel types, in one signal (also known as mixed payload concatenation). Thanks
to this technique, different channel types (e.g., STS-1, STS-3C and STS-12c) can
be sent through the same OC-48 signal, rather than limiting processing to only
one channel type at a time (e.g., STS-1). With new standards and technology to
embed services into SONET/SDH, hybrid concatenation includes new channel types
such as STS-6c, STS-9c and STS-24c.
INTERNET PROTOCOL (IP): Method or protocol by which data is sent from one
computer to another on the Internet. Each computer on the Internet has at least
one IP address that uniquely identifies it from all other computers on the
Internet. Because of these standardized IP addresses, the gateway receiving the
data can keep track of, recognize and route messages appropriately.
INTRACYTOPLASMIC SPERM INJECTION (ICSI): Laboratory procedure that involves the
injection of a single sperm cell directly into an oocyte (mature egg) using a
glass needle (pipette). EXFO Burleigh products are used in the reproduction of
genetically identical mice for medical research, helping improve the yield of
the ICSI procedure.
LAMBDA ROUTER: Also called a wavelength router, this device is part of the
broader class of optical cross-connects (OXC). A lambda router takes in a single
wavelength of light from a specific fiber-optic strand and recombines it into
another strand that is set on a different path. Lambda routers are positioned at
network junction points. Also see Cross-Connect.
METROPOLITAN NETWORK: Metropolitan area network (MAN or metro). A network, often
ringed in structure, that covers an entire city and its suburbs.
MULTIPLEXER (MUX): A device that combines several different signals, typically
at different wavelengths, into one aggregate signal to be transported via a
single fiber (or transmission channel).
NANOPOSITIONING: A positioning technique used during optical component
manufacturing to align components with a precision measured in nanometers (one
billionth of a meter).
OPTICAL LAYER: Commonly used to refer to specific wavelengths or channels of a
DWDM network. Each wavelength carries a separate stream of data encoded in a
light signal.
OPTICAL SWITCH: A device that enables light signals in optical fibers to be
selectively transferred from one input port to a desired output port.
PAYLOAD: Part of the SONET/SDH signal that carries data or traffic.
PHYSICAL LAYER: Commonly used to refer to the propagation medium of an optical
network, including the glass fiber and all in-line active and passive
components. Light signals, which are forms of encoded data, are transmitted over
this layer.
POLARIZATION MODE DISPERSION (PMD): Dispersion of light causing a delay between
the two principal states of polarization propagating along a fiber or through a
device due to the birefringence properties of the material.
PROTOCOL: A formal set of rules governing the format, timing, sequencing and
error control of data exchange across a network. Many protocols may be required
and used on a single network.
PROTOCOL LAYER: Commonly used to refer to the formatting rules for transmitting
data over an optical network. Networks send and receive data using industry-wide
formats; some examples are SONET, SDH, ATM and Ethernet.
SDH: Synchronous Digital Hierarchy. Standardized by the International
Telecommunication Union (ITU-TSS). A protocol for transmitting information over
optical fiber.
SONET: Synchronous Optical NETwork. Standardized by the American National
Standards Institute (ANSI). A protocol for backbone networks, capable of
transmitting at extremely high speeds and accommodating gigabit-level bandwidth.
SPOT CURING: Technology by which a dose of energy of a specific wavelength band
and irradiance is used to cause an adhesive, encapsulant or sealant to change
from a liquid to a solid in a small area.
STORAGE AREA NETWORK (SAN): A special high-speed network that interconnects
different kinds of data storage devices with associated data servers on behalf
of a larger network of users. Within an enterprise, the data is typically stored
in other on-site computers, but can also be archived in a geographically remote
location for disaster recovery.
TRANSPONDER: Communication, monitoring or control device that picks up and
automatically responds to an incoming signal. The term is a contraction of the
words transmitter and responder.
EXFO o 2003 Annual Report o 51
SHAREHOLDER INFORMATION
The common shares of EXFO are listed on the Toronto Stock Exchange under the
stock symbol "EXF". The shares are also listed on the NASDAQ Stock Exchange
under the symbol "EXFO".
ANNUAL AND SPECIAL MEETING
The Annual and Special Meeting of Shareholders of EXFO Electro-Optical
Engineering Inc. will be held on January 7, 2004, 10:00 a.m., at the TSX
Broadcast & Conference Centre, The Exchange Tower (Gallery Room), 130 King
Street West, Toronto, Ontario.
TRANSFER AGENTS AND REGISTRARS
CIBC Mellon Trust Company
Montreal, Toronto and Vancouver, Canada
Mellon Investor Services, LLC
New Jersey, USA
AUDITORS
PricewaterhouseCoopers LLP
INVESTOR RELATIONS CONTACT
Vance Oliver
Investor Relations
Tel.: 1 418 683-0211, ext. 3733
E-mail: vance.oliver@exfo.com
GENERAL ACCESS
EXFO Electro-Optical Engineering Inc.
400 Godin Avenue
Vanier, Quebec G1M 2K2
Tel.: 1 418 683-0211
E-mail: ir@exfo.com www.exfo.com
This Annual Report is available in English and in French, both in print and on
our Web site at www.exfo.com.
STOCK PERFORMANCE
[GRAPHIC OMITTED - Stock Performance Graph]
200% EXFO S&P/TSX Composite Index NASDAQ
Composite Index 180% 160% 140% 120% 100% 80% 60% Sep-02 Oct-02 Nov-02 Dec-02
Jan-03 Feb-03 Mar-03 Apr-03 May-03 Jun-03 Jul-03 Aug-03
NOTES
---------------
WORLDWIDE OFFICES
o CORPORATE HEADQUARTERS
400 Godin Avenue, Vanier, Quebec G1M 2K2 CANADA
Tel.: 1 418 683-0211o Fax: 1 418 683-2170
o EXFO AMERICA INC.
4275 Kellway Circle, Suite 122, Addison, TX 75001 USA
Tel.: 1 800 663-3936 (USA and Canada) or 1 972 907-1505
Fax: 1 972 836-0164
o EXFO EUROPE S.A.R.L.
Le Dynasteur 10/12, rue Andras Beck
92366 Meudon la Foret Cedex FRANCE
Tel.: +33.1.40.83.85.85 o Fax: +33.1.40.83.04.42
o EXFO ASIA-PACIFIC PTE LTD.
151 Chin Swee Road #03-29
Manhattan House, SINGAPORE 169876
Tel.: +65 6333 8241o Fax: +65 6333 8242
o EXFO CHINA
- Beijing New Century Hotel Office Tower, Room 1754-1755
No. 6 Southern Capital Gym Road, Beijing 100044, P. R. CHINA
Tel.: +86 (10) 6849 2738 o Fax: +86 (10) 6849 2662
- World Trade Plaza, BLK A, Room 3208A
9 Fuhong Road, Futian District, Shenzhen 518033, P. R. CHINA
Tel.: +86 (755) 8369 0951/8369 0955 o Fax: +86 (755) 8369 0817
o EXFO JAPAN
JP Hamacho Bldg.10F, Nihonbashi Hamacho 2-23-5 Chuo-ku
Tokyo 103-0007 JAPAN
Tel.: +81-3-5643-2677 o Fax: +81-3-5643-2678
o EXFO PHOTONIC SOLUTIONS INC.
2260 Argentia Road, Mississauga, Ontario L5N 6H7 CANADA
Tel.: 1 800 668-8752 (USA and Canada) or 1 905 821-2600
Fax: 1 905 821-2055
o EXFO BURLEIGH PRODUCTS GROUP INC.
7647 Main St. Fishers, Victor, NY 14564-8909 USA
Tel.: 1 585 924-9355 o Fax: 1 585 924-9072
o EXFO PROTOCOL INC.
2650 Marie-Curie West, St-Laurent, Quebec H4S 2C3 CANADA
Tel.: 1 888 972-7666 (USA and Canada) or 1 514 856-2222
Fax: 1 514 856-2232
o EXFO GNUBI PRODUCTS GROUP INC.
4275 Kellway Circle, Suite 122, Addison, TX 75001 USA
Tel.: 1 866 464 6824 (USA and Canada) or 1 972 836-0100
Fax: 1 972 836-0164
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[LOGO - EXFO]
www.exfo.com
(c) 2003 EXFO Electro-Optical Engineering Inc. All rights reserved. Printed in
Canada.
[GRAPHIC OMITTED]
[LOGO - EXFO]
Quebec, November 7, 2003
Re: Annual and Special Meeting of Shareholders
Dear Fellow Shareholder:
Fiscal 2003 proved to be a transition year, filled with challenges and
opportunities that will make the company stronger in the long term. The severe
downturn in the global communications industry, compounded by economic
uncertainty, has led to a very challenging environment for many test and
measurement players, but a select few have moved ahead to improve their
competitive position.
EXFO belongs to the latter group because we made the necessary moves during the
past two-and-a-half years to adapt to new market realities:
o We believe that we gained market share (sales of Portable & Monitoring
product lines increased 3% year-over-year despite reduced capital
spending);
o We increased our addressable markets through acquisitions of two
protocol-layer test companies (protocol-layer test sales accounted for
more than 10% of revenue in each of the last three quarters of 2003);
o We launched revenue-generating products (new products on the market two
years or less represented 49% of total revenue in 2003); and
o We reduced our cost structure (selling and general administrative
expenses dropped 20% year-over-year).
Clearly, we are more than ever committed to becoming a dominant player in the
global communications test and measurement industry, while leveraging our
technology base towards targeted photonics and life sciences markets.
Accordingly, we have reorganized our business under two new reportable market
segments: Telecom Division and Photonics and Life Sciences Division. This
simplified structure, with respective sales, marketing, R&D, manufacturing and
management teams, will enable us to better serve our diverse customer base and
maximize shareholder value.
Looking ahead, we intend to focus on the following strategic initiatives for
fiscal 2004:
|X| Increase sales through market-share gains; |X| Maximize profitability and
growth on a long-term basis; |X| Innovate our way out of this downturn; and |X|
Maintain a sound financial position.
I will discuss these objectives in greater detail at our upcoming Annual and
Special Meeting of Shareholders, as well as presenting the first quarter results
for fiscal 2004. Please consider this letter as a formal invitation to attend
our Meeting, which will be held January 7, 2004, 10 a.m., at the TSX Broadcast &
Conference Centre, The Exchange Tower (Gallery Room), 130 King Street West,
Toronto, Ontario.
Details of the business to be conducted at the Meeting are provided in the
attached Management Proxy Circular and Notice of the Annual and Special Meeting
of Shareholders.
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[LOGO - EXFO]
It is important that your shares be represented at the Meeting. WHETHER OR NOT
YOU PLAN TO ATTEND THE MEETING, PLEASE COMPLETE, SIGN, DATE AND PROMPTLY RETURN
THE ACCOMPANYING PROXY IN THE ENCLOSED POSTAGE-PAID ENVELOPE. If you send in
your proxy card and then decide to attend the Meeting to vote your shares in
person, you may still do so. Your proxy is revocable in accordance with the
procedures set forth in the Management Proxy Circular.
On behalf of the Board of Directors, I would like to express our appreciation
for your continued interest in EXFO. We look forward to seeing you at the
Meeting.
Sincerely,
/s/ Germain Lamonde
-----------------------------
Germain Lamonde
Chairman, President and
Chief Executive Officer
EXFO Electro-Optical Engineering Inc.
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[LOGO - EXFO]
EXFO ELECTRO-OPTICAL ENGINEERING INC.
_________________________
NOTICE OF ANNUAL AND SPECIAL MEETING OF SHAREHOLDERS
NOTICE IS HEREBY GIVEN that the Annual and Special Meeting (the
"Meeting") of shareholders of EXFO Electro-Optical Engineering Inc. (the
"Corporation") will be held at 10:00 a.m. local time, on Tuesday, January 7,
2004, at the Toronto Stock Exchange, TSX Broadcast & Conference Centre, The
Exchange Tower (Gallery Room), 130 King Street West, Toronto, Canada for the
following purposes:
1. to receive the consolidated financial statements of the Corporation for the
financial year ended August 31, 2003, and the Auditor's report thereon;
2. to elect Directors of the Corporation;
3. to appoint PricewaterhouseCoopers LLP as auditors and to authorize the
Audit Committee to fix their remuneration;
4. to approve the amendments to the Corporation's Stock Option Plan as set
forth in Schedule A to the Management Proxy Circular enclosed herewith; and
5. to transact such further or other business as may properly come before the
Meeting or any adjournment or adjournments thereof.
Enclosed is a copy of the 2003 Annual Report of the Corporation including the
consolidated financial statements and the Auditor's Report thereon, together
with the Management Proxy Circular and a form of Proxy.
DATED at Vanier, Quebec, this 7th day of November, 2003.
BY ORDER OF THE BOARD OF DIRECTORS
/s/ Kimberley Okell
Kimberley Okell
Secretary
SHAREHOLDERS UNABLE TO ATTEND THE MEETING ARE REQUESTED TO COMPLETE THE ENCLOSED
PROXY FORM AND RETURN IT IN THE ENVELOPE PROVIDED. TO BE VALID, PROXIES MUST
REACH THE OFFICE OF CIBC MELLON TRUST COMPANY, 2001 UNIVERSITY STREET, SUITE
1600, MONTREAL, QUEBEC, CANADA, H3A 2A6, NO LATER THAN THE LAST DAY PRIOR TO THE
DATE OF THE MEETING OR ANY RECONVENING OF THE MEETING IN CASE OF ADJOURNMENT.
SHAREHOLDERS MAY ALSO HAVE THE PROXY FORM DELIVERED TO THE CHAIRMAN OF THE
MEETING PRIOR TO THE TIME OF VOTING ON THE DAY OF THE MEETING OR ANY ADJOURNMENT
THEREOF.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
MANAGEMENT PROXY CIRCULAR OF THE CORPORATION
FOR THE ANNUAL AND SPECIAL MEETING OF SHAREHOLDERS
THIS PROXY IS SOLICITED BY THE MANAGEMENT OF THE CORPORATION
The undersigned shareholder of EXFO ELECTRO-OPTICAL ENGINEERING INC. hereby
appoints (CHECK EITHER (A) or (B)):
o (A) Mr. Germain Lamonde of Cap-Rouge, Quebec, or failing him, Mr. Pierre
Plamondon of Quebec, Quebec;
o (B) __________________________________ of ________________________________;
(Name) (Address)
as the representative of the undersigned to attend, act and vote on behalf of
the undersigned at the ANNUAL AND SPECIAL MEETING OF THE SHAREHOLDERS (THE
"MEETING") OF THE CORPORATION TO BE HELD AT THE TORONTO STOCK EXCHANGE, TSX
BROADCAST & CONFERENCE CENTRE, THE EXCHANGE TOWER (GALLERY ROOM), 130 KING
STREET WEST, TORONTO, PROVINCE OF ONTARIO, CANADA, ON TUESDAY, JANUARY 7, 2004,
AT 10:00 O'CLOCK A.M. (TORONTO TIME) AND AT ANY ADJOURNMENTS OF SUCH MEETING.
THE UNDERSIGNED WISHES THAT ALL SHARES REPRESENTED BY THIS PROXY BE VOTED IN
ACCORDANCE WITH THE INSTRUCTIONS HEREINBELOW. ALL SHARES REPRESENTED BY THIS
PROXY WILL BE VOTED FOR, AGAINST OR BE THE SUBJECT OF ABSTENTIONS, AS SPECIFIED
BY THE SHAREHOLDER. HOWEVER, IN THE ABSENCE OF INSTRUCTIONS, THE SHARES
REPRESENTED BY PROXY WILL BE VOTED IN FAVOUR OF EACH OF THE PROPOSALS SET FORTH
HEREIN.
(MARK WITH AN X)
To elect Germain Lamonde, Pierre Marcouiller, David A. FOR [_]
Thompson, Andre Tremblay and Michael Unger, whose cities of
residence are indicated in the Management Proxy Circular, as ABSTENTION [_]
Directors of the Corporation.
To appoint PricewaterhouseCoopers LLP as auditors and to FOR [_]
authorize the Audit Committee to fix their remuneration.
ABSTENTION [_]
To approve the amendments to the Corporation's Stock Option FOR [_]
Plan as set forth in Schedule A to the Management Proxy
Circular. AGAINST [_]
A DISCRETIONARY POWER IS HEREBY CONFERRED as to any amendment or change made to
the matters mentioned in the Notice of Meeting or as to such other matters as
may legally come before the Meeting. The Management of the Corporation is not
aware of any amendments, changes or other matters that may come before the
Meeting.
DATED this _____ day of _______.
* A SHAREHOLDER IS ENTITLED TO APPOINT,
TO ATTEND AND ACT FOR AND ON BEHALF OF ________________________________
SUCH SHAREHOLDER AT THE MEETING, A SIGNATURE OF SHAREHOLDER
PERSON OTHER THAN THE PERSON MENTIONED
IN (A) HEREIN ABOVE AND MAY DO SO BY
CHECKING (B) HEREINABOVE AND ADDING THE
NAME OF SUCH OTHER PERSON IN THE SPACE
RESERVED FOR SUCH PURPOSE. [ ]
name of shareholder
[ ]
THIS PROXY MUST BE SIGNED BY THE SHAREHOLDER OR HIS PROXYHOLDER AUTHORIZED IN
WRITING OR, IF THE SHAREHOLDER IS A CORPORATION, UNDER ITS CORPORATE SEAL, BY A
DULY AUTHORIZED OFFICER OR PROXYHOLDER OF THE CORPORATION. PLEASE REMEMBER TO
DATE AND SIGN THIS PROXY. IF THIS PROXY IS NOT DATED, IT WILL BE DEEMED TO BEAR
THE DATE OF ITS MAILING BY MANAGEMENT.
YOU ARE REFERRED TO THE MANAGEMENT PROXY CIRCULAR APPENDED.
Francais au verso
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[LOGO - EXFO]
================================================================================
NOTICE OF ANNUAL AND SPECIAL
MEETING OF SHAREHOLDERS
AND
MANAGEMENT PROXY CIRCULAR
================================================================================
November 7, 2003
EXFO ELECTRO-OPTICAL ENGINEERING INC.
MANAGEMENT PROXY CIRCULAR
SOLICITATION OF PROXIES
THIS MANAGEMENT PROXY CIRCULAR IS PROVIDED IN CONNECTION WITH THE SOLICITATION
BY THE MANAGEMENT OF EXFO ELECTRO-OPTICAL ENGINEERING INC. (THE "CORPORATION" OR
"EXFO") OF PROXIES TO BE USED AT THE ANNUAL AND SPECIAL MEETING OF SHAREHOLDERS
(THE "MEETING") OF THE CORPORATION TO BE HELD AT THE TIME AND PLACE AND FOR THE
PURPOSES STATED IN THE ACCOMPANYING NOTICE OF MEETING AND AT ANY ADJOURNMENT
THEREOF. UNLESS OTHERWISE INDICATED, THE INFORMATION CONTAINED HEREIN IS GIVEN
AS OF NOVEMBER 7, 2003.
It is expected that the solicitation will be made primarily by mail but proxies
may also be solicited personally by officers, employees or agents of the
Corporation. The Corporation may also reimburse brokers and other persons
holding shares in their names, or in the names of nominees, for their costs
incurred in sending proxy material to principals and obtaining their proxies.
The cost of solicitation will be borne by the Corporation and is expected to be
nominal.
APPOINTMENT AND REVOCATION OF PROXIES AND ATTENDANCE OF BENEFICIAL SHAREHOLDERS
The persons named in the enclosed Form of Proxy (the "Form of Proxy") are
officers of the Corporation. A SHAREHOLDER DESIRING TO APPOINT SOME OTHER PERSON
(WHO NEED NOT BE A SHAREHOLDER) TO REPRESENT HIM OR HER AT THE MEETING MAY DO SO
BY INSERTING SUCH PERSON'S NAME IN THE BLANK SPACE PROVIDED IN THE FORM OF PROXY
AND CHECKING ITEM (B).
To be valid, proxies must be received at the Montreal, Canada office of CIBC
Mellon Trust Company, 2001 University Street, Suite 1600, Montreal, Quebec,
Canada, H3A 2A6, the transfer agent of the Corporation, no later than the close
of business on the last business day preceding the day of the Meeting or any
adjournment thereof, or proxies may be delivered to the Chairman of the Meeting
on the day of the Meeting or any adjournment thereof. A beneficial shareholder
who completes a Form of Proxy and who wishes to attend and vote at the Meeting
personally must appoint himself or herself proxy holder in the foregoing manner.
A proxy given pursuant to this solicitation may be revoked by instrument in
writing executed by the shareholder or by his or her attorney authorized in
writing if such instrument is deposited either at the registered office of the
Corporation to the attention of the Secretary no later than the close of
business on the last business day preceding the day of the Meeting or any
adjournment thereof or with the Chairman of the Meeting on the day of the
Meeting or any adjournment thereof.
VOTING OF PROXIES
The shares represented by proxies appointing the persons, or any one of them,
designated by Management thereon to represent the shareholder at the Meeting
will be voted in accordance with the instructions given by the shareholder.
UNLESS OTHERWISE INDICATED, THE VOTING RIGHTS ATTACHING TO THE SHARES
REPRESENTED BY A FORM OF PROXY WILL BE VOTED "FOR" IN RESPECT OF ALL THE
PROPOSALS DESCRIBED HEREIN.
1
The Form of Proxy confers discretionary authority upon the persons named therein
with respect to amendments or variations to matters identified in the
accompanying Notice of Meeting. As at the date hereof, Management is not aware
that any other matter is to be presented at the Meeting. If, however, other
matters properly come before the Meeting, the persons designated in the Form of
Proxy will vote thereon in accordance with their judgment pursuant to the
discretionary authority conferred by such proxy with respect to such matters.
VOTING SHARES AND PRINCIPAL HOLDERS THEREOF
As at November 7, 2003, 25,170,533 Subordinate Voting Shares and 37,900,000
Multiple Voting Shares were outstanding, being the only classes of shares
entitled to be voted at the Meeting. Each holder of Subordinate Voting Shares is
entitled to one vote and the holder of Multiple Voting Shares is entitled to 10
votes for each share registered in his or her name at the close of business on
November 28, 2003, being the date fixed by the Board of Directors for the
purpose of determining registered shareholders entitled to receive the
accompanying Notice of Meeting and to vote (the "Record Date"). A list of
shareholders entitled to vote as of the Record Date, showing the number of
shares held by each shareholder, shall be prepared within 10 days of the Record
Date. This list of shareholders will be available for inspection during normal
business hours at the Montreal, Canada office of CIBC Mellon Trust Company, the
transfer agent of the Corporation, 2001 University Street, Suite 1600, Montreal,
Quebec, Canada, H3A 2A6, and at the Meeting.
Unless otherwise indicated, the resolutions submitted to a vote at the Meeting
must be passed by a majority of the votes cast by the holders of Subordinate
Voting Shares and Multiple Voting Shares, as a single class, present at the
Meeting in person or by proxy and voting in respect of all resolutions to be
voted on by the shareholders of the Corporation.
To the knowledge of executive officers and directors of the Corporation, as of
November 7, 2003, the only persons who are beneficial owners or who exercise
control or direction, directly or indirectly, over shares carrying more than 10%
of the voting rights attaching to any class of shares of the Corporation are:
-----------------------------------------------------------------------------------------------------------------------
PERCENTAGE OF VOTING PERCENTAGE OF VOTING PERCENTAGE OF VOTING
NUMBER OF RIGHTS ATTACHED TO ALL NUMBER OF RIGHTS ATTACHED TO ALL RIGHTS ATTACHED TO ALL
SUBORDINATE SUBORDINATE VOTING MULTIPLE MULTIPLE VOTING SUBORDINATE AND
NAME OF SHAREHOLDER VOTING SHARES SHARES VOTING SHARES SHARES MULTIPLE VOTING SHARES
-----------------------------------------------------------------------------------------------------------------------
Germain Lamonde 93,000 (1) 0.4% 37,900,000 (2) 100% 93.8%
-----------------------------------------------------------------------------------------------------------------------
FMR Corporation 3,283,100 (3) 13.1% -- -- 0.9%
-----------------------------------------------------------------------------------------------------------------------
-------------------------
(1) Mr. Lamonde exercises control over this number of Subordinate Voting Shares
through Placements Lamonde, SENC, a partnership controlled by Mr. Lamonde.
(2) Mr. Lamonde exercises control over this number of Multiple Voting Shares
through G. Lamonde Investissements Financiers inc., a company controlled by
Mr. Lamonde and through Fiducie Germain Lamonde, a family trust for the
benefit of Mr. Lamonde's family.
(3) 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.
2
ELECTRONIC DELIVERY
The Corporation has a voluntary program for e-mail notification to our
shareholders that documents which must be delivered pursuant to securities
legislation are available on EXFO's website. Every year, EXFO delivers
documentation to shareholders, such as this Management Proxy Circular and our
Annual Report that must be delivered to shareholders of a public company by law.
EXFO has made this process more convenient for its shareholders, as shareholders
who so wish, may be notified by e-mail when the Corporation's documentation is
posted in the "Investors" section on its website (www.exfo.com). Accordingly
such documentation will not be sent in paper form by mail. The Corporation
believes that electronic delivery will benefit the environment and reduce its
costs. Shareholders who do not consent to receive documentation by e-mail will
continue to receive such documentation by mail.
Registered shareholders can consent to electronic delivery by completing and
returning the consent form accompanying this Circular to CIBC Mellon Trust
Company. Unregistered shareholders (i.e. shares are held through a securities
broker, bank, trust company or other nominee) can consent to electronic delivery
by completing and returning the appropriate form received from the applicable
intermediary.
BUSINESS TO BE TRANSACTED AT THE MEETING
PRESENTATION OF THE FINANCIAL STATEMENTS
The consolidated financial statements of the Corporation for the financial year
ended August 31, 2003 and the Auditors' report thereon contained in EXFO's
Annual Report accompanying this Circular will be submitted to shareholders at
the Meeting but no vote with respect thereto is required or proposed to be
taken.
ELECTION OF THE DIRECTORS
According to the articles of the Corporation, the Board of Directors shall
consist of a minimum of 3 and a maximum of 12 directors. At the Meeting,
Management proposes the 5 persons named hereafter on page 5 as nominees for
election as directors to hold office until the next annual meeting or until the
office is otherwise vacated in accordance with the Corporation's by-laws.
Management does not anticipate that any of the nominees will be unable, or for
any reason whatsoever, be reluctant to fulfill their duties as directors. Should
this occur for any reason whatsoever before the election, the persons named in
the Form of Proxy reserve the right to vote for another nominee of their choice
unless the shareholder specified on the Form of Proxy to abstain from voting for
the election of the directors.
APPOINTMENT AND REMUNERATION OF AUDITORS
A firm of auditors is to be appointed by vote of the shareholders at the Meeting
to serve as auditors of the Corporation until the close of the next annual
meeting. The Audit Committee is to be authorized to fix the remuneration of the
auditors so appointed. The Board of Directors and Management, upon the advice of
the Audit Committee, recommend that PricewaterhouseCoopers LLP be re-appointed
as Auditors of the Corporation. The re-appointment of PricewaterhouseCoopers LLP
must be approved by a majority of the votes cast on the matter at the Meeting.
3
RESOLUTION FOR APPROVAL OF INCREASE IN SHARES RESERVED FOR ISSUANCE UNDER THE
STOCK OPTION PLAN
The Corporation's Stock Option Plan is designed to increase the performance of
employees, senior management, officers and directors, as the case may be, and
further align the interests of each with shareholder interests. As of November
7, 2003, there are 2,879,034 options to purchase Subordinate Voting Shares
outstanding under the Stock Option Plan with exercise prices ranging from
US$1.58 to US$56.75, from a total authorized reserve amount of 4,470,961,
leaving 1,591,927 share reservations available for further option grants (for
additional detail on stock option grants, see Note 13 of the Corporation's
financial statements for the financial year ended August 31, 2003). On October
27, 2003, the Board of Directors approved, subject to confirmation by the
Toronto Stock Exchange, NASDAQ and other regulatory authorities, modifications
to the Corporation's Stock Option Plan to increase the number of shares reserved
for issuance thereunder. The modification proposed to the Stock Option Plan
would result in the increase of the aggregate number of Subordinate Voting
Shares reserved for issuance under the Stock Option Plan from 4,470,961 to
6,306,153 Subordinate Voting Shares, representing 10% of the total 63,061,533
issued outstanding share capital of the Corporation (including Subordinate
Voting Shares and Multiple Voting Shares) as of the date of approval by the
Board of Directors (October 27, 2003). This would mean that Subordinate Voting
Shares available for future grants would then increase from 1,591,927 to
3,427,119. These modifications to the Stock Option Plan are subject to approval
by the Shareholders.
The Directors believe that the increase for which approval is requested is
necessary for use as a tool to attract, motivate and retain talented personnel,
whether through organic growth or acquisitions. The text of the resolution to be
presented for approval by the shareholders of the amendment to the Stock Option
Plan is attached as Schedule A. The adoption of the resolution requires the
approval of a majority of all the shares voted at the meeting.
NOMINEES FOR ELECTION AS DIRECTORS AND THEIR BENEFICIAL OWNERSHIP OF VOTING
SECURITIES
The following table and notes set out the name of each of the individuals whom
is proposed to be nominated at the Meeting for election as a director of the
Corporation, all other positions and offices with the Corporation and its
subsidiaries now held by each such individual, if any, the principal occupation
or employment of each such individual, their respective period of service as a
director and the approximate number of shares of the Corporation beneficially
owned by each such individual or over which each of them exercised control or
direction.
4
--------------------------------------------------------------------------------------------------------------------
NUMBER OF NUMBER OF
NAME AND POSITION OR OFFICE PRINCIPAL OCCUPATION CITY OF SUBORDINATE MULTIPLE VOTING
WITH THE CORPORATION OR EMPLOYMENT RESIDENCE DIRECTOR SINCE VOTING SHARES SHARES
--------------------------------------------------------------------------------------------------------------------
Germain Lamonde (1) Chairman of the Board, Cap-Rouge, September 1985 93,000 37,900,000
Chairman of the Board, President and Chief Quebec
President and Chief Executive Officer, EXFO
Executive Officer Electro-Optical
Engineering Inc.
--------------------------------------------------------------------------------------------------------------------
Pierre Marcouiller (2)(3) Chairman of the Board Magog, May 2000 5,000 --
Director and Chief Executive Quebec
Officer,
Camoplast Inc.
(a supplier of
automotive and
recreational vehicle
parts)
--------------------------------------------------------------------------------------------------------------------
Dr. David A. Thompson, Vice-President, Newton, June 2000 2,100 --
Ph.D. (3) Hardware & Equipment North
Director Technology Strategy, Carolina
Corning Cable Systems
--------------------------------------------------------------------------------------------------------------------
Andre Tremblay (2)(3)(4) President and Chief Outremont, May 2000 7,000 --
Director Executive Officer, Quebec
Microcell
Telecommunications
Inc.
--------------------------------------------------------------------------------------------------------------------
Michael Unger (2)(3) Executive Consultant Woodbridge, May 2000 -- --
Director Ontario
--------------------------------------------------------------------------------------------------------------------
-------------------------
(1) Mr. Lamonde exercises control over this number of Multiple Voting Shares
through G. Lamonde Investissements Financiers inc., a company controlled by
Mr. Lamonde and through Fiducie Germain Lamonde, a family trust for the
benefit of Mr. Lamonde's family. He exercises control over this number of
Subordinate Voting Shares through Placements Lamonde, SENC, a partnership
controlled by Mr. Lamonde.
(2) Member of the Audit Committee.
(3) Member of the Human Resources Committee.
(4) Mr. Tremblay exercises control over this number of Subordinate Voting
Shares through 9044-6451 Quebec inc. and 9089-3082 Quebec inc., companies
controlled by Mr. Tremblay.
The information as to Subordinate Voting Shares and Multiple Voting Shares
beneficially owned or over which the above-named individuals exercise control or
direction is not within the direct knowledge of the Corporation and has been
furnished by the respective individual.
COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS
COMPENSATION OF DIRECTORS
In the financial year ended August 31, 2003, directors who are not employees of
the Corporation or any of its subsidiaries receive the level of compensation set
forth in the table below as annual compensation payable in the form of cash,
stock or stock options as chosen by the director. In addition, each director is
granted 12,500 stock options under the Corporation's Stock Option Plan (the
"Stock Option Plan") as part of his annual compensation.
5
--------------------------------------------------------------------------------
Annual Retainer for Directors: CDN$25,000 US$16,895
--------------------------------------------------------------------------------
Annual Retainer for Committee Chairman: CDN$5,000 US$3,379
--------------------------------------------------------------------------------
Annual Retainer for Committee Members: CDN$3,000 US$2,027
--------------------------------------------------------------------------------
Fees for all Meetings Attended per day in Person: CDN$1,000 US$675
--------------------------------------------------------------------------------
Fees for all Meetings Attended per day by Telephone: CDN$500 US$338
--------------------------------------------------------------------------------
In the financial year ended August 31, 2003, the directors who were not
employees received the following compensation in the form indicated:
-----------------------------------------------------------------------------------------------------------------------
ANNUAL ANNUAL COMPENSATION TOTAL ATTENDANCE
COMPENSATION PAID IN STOCK OPTIONS EXERCISE PRICE EXPIRATION FEES PAID IN CASH
NAME PAID IN CASH ($) (#) (1) OF OPTIONS (2) DATE OF OPTIONS (US$)
-----------------------------------------------------------------------------------------------------------------------
Pierre Marcouiller (3) 20,950 12,500 US$1.58 Sept. 25, 7,434
2012
-----------------------------------------------------------------------------------------------------------------------
Dr. David A. Thompson (4) 18,923 12,500 US$1.58 Sept. 25, 7,771
2012
-----------------------------------------------------------------------------------------------------------------------
Andre Tremblay (5) 22,302 12,500 US$1.58 Sept. 25, 7,434
2012
-----------------------------------------------------------------------------------------------------------------------
Michael Unger (6) 22,302 12,500 US$1.58 Sept. 25, 8,110
2012
-----------------------------------------------------------------------------------------------------------------------
-------------------------
(1) Indicates the number of Subordinate Voting Shares underlying the options
granted under the Stock Option Plan.
(2) The exercise price of options is determined based on the highest of the
closing prices of the Subordinate Voting Shares on the Toronto Stock
Exchange and the NASDAQ National Market on the last trading day preceding
the grant date, using the noon buying rate of the Federal Reserve Bank of
New York on the grant date to convert the NASDAQ National Market closing
price to Canadian dollars, as required. These options vest at a rate of
12.5% after the first 6 months, 12.5% after 12 months and 25% annually
thereafter commencing on the second anniversary date of the grant.
(3) Member of the Audit Committee and the Human Resources Committee.
(4) Member of the Human Resources Committee.
(5) Member of the Human Resources Committee and Chairman of the Audit
Committee.
(6) Member of the Audit Committee and Chairman of the Human Resources
Committee.
COMPENSATION OF NAMED EXECUTIVE OFFICERS
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, the four other most
highly compensated executive officers of the Corporation and its subsidiaries
who were serving the Corporation at the end of the financial year, and three
other executive officers of the Corporation who would have been included within
the four most highly compensated executive officers had they been in the employ
of the Corporation, or a subsidiary, at the year end (collectively, the "Named
Executive Officers"). This information includes the US dollar value of base
salaries, bonus awards and long-term incentive plan payments, the number of
options granted, and other compensation, if any, whether paid or deferred.
6
---------------------------------------------------------------------------------------------------------------------------------
SECURITIES
OTHER ANNUAL UNDER ALL OTHER
NAME AND PRINCIPAL FINANCIAL SALARY (1) BONUS (2) COMPENSATION OPTIONS (3) COMPENSATION
POSITION YEAR ($) ($) ($) (#) ($)
--------------------------------------------------------------------------------------------------------------------------------
Germain Lamonde, 2003 185,848 (US) 25,247 (US) - 50,000 -
President and Chief 275,000 (CDN) 37,359 (CDN)
Executive Officer 2002 174,758 (US) 21,329 (US) - 70,000 -
275,000 (CDN) 33,563 (CDN)
2001 180,044 (US) 99,024 (US) - 5,080 -
275,000 (CDN) 137,500 (CDN)
--------------------------------------------------------------------------------------------------------------------------------
Juan-Felipe Gonzalez, 2003 163,896 (US) 7,500 (US) - 30,000 -
Vice-President,
Global Telecom Sales 2002 158,193 (US) - - 30,000 -
2001 204,781 (US) (4) 129,629 (US)(5) - 45,630 -
--------------------------------------------------------------------------------------------------------------------------------
James Stevens,
Vice-President Product
Management and Chief
Technology Officer 2003 175,000 (US) (6) - - 12,000 4,624 (US)(7)
(Protocol)
--------------------------------------------------------------------------------------------------------------------------------
John Holloran Jr.,
Interim General Manager 2003 140,000 (US) (8) 12,692 (US) - 9,000 4,114 (7)
and Special Projects
--------------------------------------------------------------------------------------------------------------------------------
Pierre Plamondon, 2003 118,267 (US) 9,547 (US) - 25,000 866 (US) (7)
Vice-President Finance and 175,000 (CDN) 14,127 (CDN) 1,281 (CDN)
Chief Financial Officer 2002 95,323 (US) 5,817 (US) - 19,000 886 (US) (7)
150,000 (CDN) 9,153 (CDN) 1,394 (CDN)
2001 98,206 (US) 21,783 (US) - 24,240 1,830 (US) (7)
150,000 (CDN) 33,271 (CDN) 2,795 (CDN)(7)
--------------------------------------------------------------------------------------------------------------------------------
NAMED EXECUTIVES NOT IN THE EMPLOY OF THE CORPORATION AT YEAR END
--------------------------------------------------------------------------------------------------------------------------------
Bruce Bonini, 2003 200,160 (US) - - 40,000 265,824 (US)
Vice-President North
American Sales (9) 2002 217,500 (US) - - 20,000 7,042 (US) (7)
2001 272,678 (US)(10) 33,450 (US) - 82,780 4,565 (US) (7)
--------------------------------------------------------------------------------------------------------------------------------
David J. Farrell, 2003 186,346 (US) - - 15,000 152,938 (US)
President, EXFO Burleigh
Products Group Inc. (11) 2002 184,500 (US) - - 10,000 3,193 (US) (7)
2001 184,500 (US) (12) 16,326 (US) - 40,000 4,513 (US) (7)
--------------------------------------------------------------------------------------------------------------------------------
Sami Yazdi, 2003 71,196 (US) - - 25,000 158,249 (US)
President, EXFO Protocol Inc. 105,350 (CDN) 234,162 (CDN)
(13) 2002 111,210 (US) (14) 5,550 (US) - 50,000 -
175,000 (CDN) 8,735 (CDN)
--------------------------------------------------------------------------------------------------------------------------------
-------------------------
(1) The compensation information for Canadian residents has been converted from
Canadian dollars to U.S. dollars based upon an average foreign exchange
rate of 1.4797 for 2003, 1.5736 for 2002, and 1.5274 for 2001. The currency
conversions cause these reported salaries to fluctuate from year-to-year
because of the conversion of Canadian dollars to U.S. dollars.
(2) A portion of the bonus amounts is paid in cash in the year for which they
are awarded and the balance is paid in cash in the year following the
financial year for which they are awarded.
(3) Indicates the number of Subordinate Voting Shares underlying the options
granted under the Stock Option Plan during the financial year indicated.
(4) This amount includes an amount of US$4,935 paid as a retroactive adjustment
to salary for the financial year ended August 31, 2000.
(5) This amount includes an amount of US$2,771 paid as a retroactive adjustment
to bonus for the financial year ended August 31, 2000.
(6) This amount represents Mr. Stevens' base annual salary. Since he joined the
Corporation on October 7, 2002, the base annual salary paid to him for the
financial year ended August 31, 2003 amounted to US$154,135.
(7) Indicates the amount contributed by the Corporation during the financial
year indicated to the Deferred Profit Sharing Plan or the 401K plans, as
applicable, for the benefit of the Named Executive Officer. Mr. Lamonde is
not eligible to participate in the Deferred Profit Sharing Plan and Mr.
Gonzalez and Mr. Yazdi did not participate.
(8) This amount represents Mr. Holloran's base annual salary. Since he joined
the Corporation on October 7, 2002, the base annual salary paid to him for
the financial year ended August 31, 2003 amounted to US$124,462.
(9) For the 2003 financial year, salary shown for Mr. Bonini indicates full
salary to termination date, being August 15, 2003, and All Other
Compensation includes an amount of US$244,352 in severance and an amount of
US$6,499 contributed by the Corporation to the 401K plan.
(10) This amount includes an amount of US$28,654 paid as a retroactive
adjustment to salary for the financial year ended August 31, 2000.
7
(11) For the 2003 financial year, salary shown for Mr. Farrell indicates full
salary to termination date, being August 29, 2003, and All Other
Compensation includes an amount of US$127,687 in severance and an amount of
US$5,774 contributed by the Corporation to the 401K plan.
(12) This amount represents Mr. Farrell's base annual salary. Since he joined
the Corporation on December 20, 2000, the base annual salary paid to him
for the financial year ended August 31, 2001 amounted to US$134,097.
(13) For the 2003 financial year, salary shown for Mr. Yazdi indicates full
salary to termination date being March 21, 2003, and All Other Compensation
represents an amount of US$158,249 in severance.
(14) This amount represents Mr. Yazdi's base annual salary. Since he joined the
Corporation on November 2, 2001, the base salary paid to him for the
financial year ended August 31, 2002 amounted to US$90,959 (CDN$143,134).
Other than its Stock Option Plan, Restricted Stock Award Plan and Stock
Appreciation Rights Plan, which are described below in the "Report on Executive
Compensation by the Human Resources Committee - Long-Term Incentive
Compensation", the Corporation does not have any other formal long-term
incentive plans. However, pursuant to the terms of his employment agreement, Mr.
Juan-Felipe Gonzalez will 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 is scheduled for disbursement in January 2004.
SHARE PLAN
In September 1998, prior to becoming a public company, the Corporation adopted a
share purchase plan for officers, directors and key employees, as amended in
April 2000. On April 3, 2000, the Corporation adopted a new share plan which
replaced the 1998 share plan and on June 29, 2000, at the time of the
Corporation's initial public offering, all of the 707,264 Class "F" shares
issued under this plan to Officers, directors and key employees and fully paid
by them were converted into Subordinate Voting Shares. No additional shares will
be issued under the new share plan. The new share plan requires the Subordinate
Voting Shares previously acquired by participants to be held in trust by a
trustee until August 31, 2004, except for 249,977 Subordinate Voting Shares, of
which 216,548 Subordinate Voting Shares were released on October 21, 2003, 6,020
Subordinate Voting Shares will be released on December 23, 2003 and 27,409
Subordinate Voting Shares will be released on January 20, 2004.
The new share plan provides for the earlier release of these Subordinate Voting
Shares in the event the employment of a holder of Subordinate Voting Shares
terminates or upon the occurrence of a change of control and establishes
conditions pursuant to which the Subordinate Voting Shares of a holder under
this plan are to be sold by the trustee on the public market. For example, if
the employment is terminated before the end of the trust period for reasons
other than death, retirement, disability or without cause, the trustee will, on
instructions from the Corporation, sell the holder's Subordinate Voting Shares
on the public market, reimburse the lesser of the proceeds of sale or the
purchase price paid by the holder plus 8% interest annually, with the balance
being paid to the Corporation. As of August 31, 2003, 635,118 Subordinate Voting
Shares were being held in trust under the plan.
The following table shows the breakdown, as of August 31, 2003, of the
Subordinate Voting Shares that have been allocated and released from trust to
the Named Executive Officers.
8
------------------------------------------------------------------------------------------------------------------
Subordinate Voting Subordinate Voting Value of Subordinate Voting
Name of Executive Shares Allocated (1) Shares released from Shares released from Trust
Officers (#) Trust (#) (US$)
------------------------------------------------------------------------------------------------------------------
Germain Lamonde (2) - - -
------------------------------------------------------------------------------------------------------------------
Juan-Felipe Gonzalez 51,452 - -
------------------------------------------------------------------------------------------------------------------
James Stevens (2) - - -
------------------------------------------------------------------------------------------------------------------
John Holloran Jr. (2) - - -
------------------------------------------------------------------------------------------------------------------
Pierre Plamondon (3) 32,927 - -
------------------------------------------------------------------------------------------------------------------
NAMED EXECUTIVES NOT IN THE EMPLOY OF THE CORPORATION AT YEAR END
------------------------------------------------------------------------------------------------------------------
Bruce Bonini 49,324 - -
------------------------------------------------------------------------------------------------------------------
David J. Farrell (2) - - -
------------------------------------------------------------------------------------------------------------------
Sami Yazdi (2) - - -
------------------------------------------------------------------------------------------------------------------
-------------------------
(1) If the employment is terminated before the end of the trust period for
reasons other than death, retirement, disability or without cause, the
trustee will, on instructions from the Corporation, sell the holder's
Subordinate Voting Shares on the public market, reimburse the lesser of the
proceeds of sale or the purchase price paid by the holder plus 8% interest
annually, with the balance being paid to the Corporation.
(2) These persons do not participate in the Share Plan.
(3) Mr. Plamondon exercises control over 6,874 of these Subordinate Voting
Shares through Fiducie Pierre Plamondon, a trust for the benefit of Mr.
Plamondon's family.
DEFERRED PROFIT SHARING PLAN
The Corporation maintains a deferred profit sharing plan for certain
eligible Canadian resident employees. Under this plan, the Corporation may
contribute an amount equal to 1% of each employee's gross salary to that
employee's individual deferred profit sharing plan to the extent that such
employee contributes at least 2% of his or her gross salary to his or her
individual tax-deferred registered retirement savings plan. As a cost control
measure, the Corporation temporarily suspended its contributions under this plan
commencing in June 2002 and contributions by the Corporation were reestablished
commencing January 2003. In the financial year ended August 31, 2003, the
aggregate amount of contributions under the plan was US$63,000 (CDN$93,000). Mr.
Germain Lamonde is not entitled to participate in this plan.
401K PLAN
The Corporation maintains a 401K plan for eligible United States resident
employees of its subsidiaries. Under this plan, the Corporation may elect to
contribute an amount equivalent to 3% of an employee's current compensation,
subject to certain legislated maximum contribution limits. During the financial
year ended August 31, 2003, the Corporation recorded contributions totaling
US$253,000.
OPTION GRANTS IN LAST FINANCIAL YEAR
The aggregate number of Subordinate Voting Shares covered by options granted
during the financial year ended August 31, 2003 was 1,268,450 at a weighted
average exercise price of US$1.94 (CDN$2.96) per Subordinate Voting Share. At
the end of financial year ended August 31, 2003, there were a total of 3,176,613
Subordinate Voting Shares covered by options granted and outstanding pursuant to
the Stock Option Plan having a weighted average exercise price of US$15.36
(CDN$22.73). The table below shows information regarding stock option grants
made to the Named Executive Officers under the Stock Option Plan during the
financial year ended August 31, 2003. See "Report on Executive Compensation by
the
9
Human Resources Committee - Long-Term Incentive Compensation" for a description
of the Stock Option Plan.
--------------------------------------------------------------------------------------------------------------------
Percentage of Net Market Value of
Securities Total of Options Securities Underlying
Under Options Granted to Employees Exercise or Options on the Date
Granted(1) in Financial Year Base Price (2) of Grant
Name (#) (%) (US$/ Security) (US$/Security) (3) Expiration Date
--------------------------------------------------------------------------------------------------------------------
Germain Lamonde 50,000 4.98 1.58 1.66 September 25, 2012
--------------------------------------------------------------------------------------------------------------------
Juan-Felipe Gonzalez 30,000 2.99 1.58 1.66 September 25, 2012
--------------------------------------------------------------------------------------------------------------------
James Stevens 12,000 1.20 3.53 3.63 December 2, 2012
--------------------------------------------------------------------------------------------------------------------
John Holloran 9,000 0.90 3.53 3.63 December 2, 2012
--------------------------------------------------------------------------------------------------------------------
Pierre Plamondon 25,000 2.49 1.58 1.66 September 25, 2012
--------------------------------------------------------------------------------------------------------------------
NAMED EXECUTIVES NOT IN THE EMPLOY OF THE CORPORATION AT YEAR END
--------------------------------------------------------------------------------------------------------------------
Bruce Bonini 40,000 4.00 1.58 1.66 Cancelled (4)
--------------------------------------------------------------------------------------------------------------------
David J. Farrell 15,000 1.49 1.58 1.66 Cancelled (4)
--------------------------------------------------------------------------------------------------------------------
Sami Yazdi 25,000 2.49 1.58 1.66 Cancelled (4)
--------------------------------------------------------------------------------------------------------------------
-------------------------
(1) Underlying securities: Subordinate Voting Shares.
(2) The exercise price of options granted is determined based on the highest of
the closing prices of the Subordinate Voting Shares on The Toronto Stock
Exchange and the NASDAQ National Market on the last trading day preceding
the grant date, using the noon buying rate of the Federal Reserve Bank of
New York on the grant date to convert the NASDAQ National Market closing
price to Canadian dollars, as required. Some of these options vest at a
rate of 25% annually commencing on the first anniversary date of the grant
and some vest at a rate of 12.5% 6 months after the grant date, 12.5% 12
months after the grant date, and 25% annually thereafter commencing on the
second anniversary date of the grant.
(3) Based on the closing price on the NASDAQ National Market on the date of the
grant.
(4) In accordance with the terms of the Stock Option Plan, remaining
unexercised options were cancelled thirty days after the respective
termination dates of each of these persons.
AGGREGATED OPTION EXERCISES IN LAST FINANCIAL YEAR AND FINANCIAL YEAR END
OPTION VALUES
The following table summarizes, for each of the Named Executive Officers, the
number of stock options, if any, exercised during the financial year ended
August 31, 2003, the aggregate value realized upon exercise and the total number
of unexercised options, if any, held at August 31, 2003. Value realized upon
exercise is the difference between the market value of the underlying
Subordinate Voting Shares on the exercise date and the exercise or base price of
the option. The value of unexercised in-the-money options at financial year-end
is the difference between its exercise or base price and the market value of the
underlying Subordinate Voting Shares on August 29, 2003, which was US$2.64 per
share. These values, unlike the amounts set forth in the column "Aggregate Value
Realized," have not been, and may never be, realized. The underlying options
have not been, and may never be exercised, and actual gains, if any, on exercise
will depend on the value of the Subordinate Voting Shares on the date of
exercise. There can be no assurance that these values will be realized.
Unexercisable options are those that have been held for less than the time
required for vesting. See "Report on Executive Compensation by the Human
Resources Committee - Long-Term Incentive Compensation."
10
--------------------------------------------------------------------------------------------------------------------
Value of Unexercised
Unexercised Options "In-the-Money" Options at
Aggregate at August 31, 2003 August 31, 2003 (2)(3)
Securities Value ----------------------------- ------------------------------
Acquired on Realized EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
NAME Exercise (#) (US$) (1) (#) (#) (US$) (US$)
--------------------------------------------------------------------------------------------------------------------
Germain Lamonde - - 45,342 105,140 6,625 46,375
--------------------------------------------------------------------------------------------------------------------
Juan-Felipe Gonzalez - - 39,240 73,290 3,975 27,825
--------------------------------------------------------------------------------------------------------------------
James Stevens - - 1,500 10,500 - -
--------------------------------------------------------------------------------------------------------------------
John Holloran Jr. - - 1,125 7,875 - -
--------------------------------------------------------------------------------------------------------------------
Pierre Plamondon - - 26,520 50,420 3,312 23,188
--------------------------------------------------------------------------------------------------------------------
NAMED EXECUTIVES NOT IN THE EMPLOY OF THE CORPORATION AT YEAR END
--------------------------------------------------------------------------------------------------------------------
Bruce Bonini (4) 5,000 5,104 - - - -
--------------------------------------------------------------------------------------------------------------------
David J. Farrell (4) 1,875 2,682 - - - -
--------------------------------------------------------------------------------------------------------------------
Sami Yazdi (4) 3,125 1,263 - - - -
--------------------------------------------------------------------------------------------------------------------
-------------------------
(1) The aggregate value realized is equivalent to the difference between the
market value of the securities underlying the options at exercise and the
exercise price of the options.
(2) "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.
(3) The value of unexercisable "in-the-money" options is calculated using the
highest of the closing prices of the Subordinate Voting Shares on The
Toronto Stock Exchange and on the NASDAQ National Market on August 29, 2003
using the noon buying rate of the Federal Reserve Bank of New York to
convert the NASDAQ National Market closing price to Canadian dollars, as
required, less the exercise price of "in-the-money" options.
(4) In accordance with the terms of the Stock Option Plan, unexercised options
that had been attributed to these persons were cancelled thirty days after
their termination dates.
TERMINATION OF EMPLOYMENT, CHANGE IN RESPONSIBILITIES AND EMPLOYMENT CONTRACTS
The Corporation has an employment agreement with Mr. Germain Lamonde. The
agreement is for an indeterminate period and the salary is reviewed annually. In
the event of the termination of Mr. Lamonde's employment without cause, Mr.
Lamonde will be entitled to severance payments (in no case exceeding 24 months
of remuneration) and the vesting of all stock options. In addition, in the event
that Mr. Lamonde's employment is terminated following a merger or an acquisition
by a third party of substantially all of the Corporation's assets or of the
majority of its share capital or if Mr. Lamonde voluntarily resigns, he will be
entitled to the vesting of all stock options.
The Corporation also has employment agreements with Mr. Juan-Felipe Gonzalez and
Mr. Pierre Plamondon, and its subsidiary, EXFO Gnubi Products Group Inc. has
employment agreements with Mr. James Stevens and Mr. John Holloran Jr.
The agreement with Mr. Gonzalez provided for Mr. Gonzalez's employment as
Vice-President International Sales but in July 2003, Mr. Gonzalez assumed the
position of Vice-President Global Telecom Sales. Mr. Gonzalez earned a long-term
incentive bonus of CDN$750,000 as he did not voluntarily resign and was not
dismissed with cause prior to September 2003. An amount of CDN$500,000 was
disbursed on October 17, 2003 and the remaining CDN$250,000 is scheduled for
disbursement in January 2004. In the event Mr. Gonzalez's employment terminates
for any reason whatsoever and he is unable to accept new employment due to his
non-competition obligations to the Corporation, 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
11
depending on the cause of the termination. The employment agreement is for an
indeterminate period and salary and bonuses are reviewed annually.
Mr. Stevens was the Chief Executive Officer of gnubi communications, L.P. when
the assets of this company were acquired by EXFO Gnubi Products Group Inc. on
October 7, 2002. Further to this acquisition, Mr. Stevens entered into an
employment agreement between Mr. Stevens and EXFO Gnubi Products Group Inc. that
provided for Mr. Stevens' employment as Vice President, Director of Dallas
Operations. However in July 2003, Mr. Stevens assumed the position of Vice
President, Product Management and Chief Technology Officer (Protocol). The
agreement is for an indeterminate period and the salary is reviewed annually. In
the event of termination of the agreement by EXFO Gnubi Products Group Inc. for
reasons other than just cause, Mr. Stevens must be given at least 6 months'
prior notice.
Mr. Holloran held the position of Executive Vice President and Chief Operations
Officer of gnubi communications, L.P. when the assets of this company were
acquired by EXFO Gnubi Products Group Inc. on October 7, 2002. Further to this
acquisition, Mr. Holloran became employed by EXFO Gnubi Products Group Inc., but
did not have a written employment agreement. However, in May 2003, Mr. Holloran
entered into a written agreement with the Corporation whereby Mr. Holloran
assumed the position of Interim General Manager and Special Projects at the same
base annual salary, and a monthly bonus of US$2,500 for the period from March
24, 2003 to December 26, 2003. The agreement further provides that Mr.
Holloran's employment will terminate on December 26, 2003, at which time he will
receive a severance payment equivalent to 6 weeks of base annual salary plus the
prorata bonus amount applicable to a 6 week period. In the event that Mr.
Holloran voluntarily leaves his employment prior to December 26, 2003, he will
forfeit the severance payment.
The Corporation has an employment agreement with Mr. Pierre Plamondon, the
Corporation's Vice President, Finance and Chief Financial Officer. The agreement
is for an indeterminate period and the salary is reviewed annually. In the event
of termination of Mr. Plamondon's employment without cause, Mr. Plamondon will
be entitled to severance payments (in no case exceeding 18 months of the current
base salary). In addition, in the event Mr. Plamondon's employment is terminated
following a merger or an acquisition by a third party of substantially all of
the Corporation assets or of the majority of its share capital, he will be
entitled to the immediate vesting of all stock options.
REPORT ON EXECUTIVE COMPENSATION BY THE HUMAN RESOURCES COMMITTEE
MEMBERS OF THE HUMAN RESOURCES COMMITTEE
During the financial year ended August 31, 2003, the Human Resources Committee
was composed of Michael Unger, as Chairman, Pierre Marcouiller, David A.
Thompson and Andre Tremblay, none of whom were officers or employees, or former
officers or employees, of the Corporation or its subsidiaries.
HUMAN RESOURCES COMMITTEE MANDATE
The Human Resources Committee is a committee of the Board of Directors. It is
responsible for overseeing the assessment and the performance, and establishing
the annual compensation of all the Corporation's executive officers, including
the President and Chief Executive Officer. This Committee also reviews and
submits to the Board the salary structure and the short-term and long-term
incentive compensation programs for all employees of the Corporation. Though the
Committee is responsible for the review and approval of the employees that will
receive options to purchase shares of the Corporation, in accordance with
policies established by the Board and the terms of the Stock Option Plan, these
functions have been shared by the Board of Directors and the Human Resources
Committee during the
12
period from September 1, 2002 to August 31, 2003. The remuneration to be paid by
the Corporation to its Directors is recommended to the Board by the Human
Resources Committee.
Since September 1, 2002, the Human Resources Committee held 5 meetings prior to
November 7, 2003, which were attended by all the members of the Committee with
the exception of one meeting where Dr. David Thompson was absent.
COMPENSATION OF CHIEF EXECUTIVE OFFICER
In establishing Mr. Lamonde's salary for the year ending August 31, 2001, the
Corporation relied on a study completed by an independent consulting firm. Such
study indicated average salaries and bonuses, median salaries and bonuses and
maximum salaries and bonuses paid to chief executive officers by Canadian and
American computer hardware and software companies as well as by a specific group
of companies active in the fiber optics industry identified by the Corporation
that it considers to be the best available comparisons. It was decided that Mr.
Lamonde's salary and bonus reflected the median of Canadian computer hardware
and software companies and of the specific group of companies in fiber optics
identified by the Corporation. In the financial year ended August 31, 2003, Mr.
Lamonde's salary was not adjusted.
In the financial year ended August 31, 2003, the bonus portion of Mr. Lamonde's
salary was tied to the financial and strategic objectives of the Corporation
based on the following factors: sales, earnings and customer satisfaction
(quality and production). Mr. Lamonde's bonus is payable in the same proportion
at which the Corporation attains such objectives. When the objectives are
exceeded, the bonus is higher; when objectives are not met, the bonus is lower.
SHORT-TERM INCENTIVE COMPENSATION
The short-term incentive plan offers bonuses tied to the Corporation's financial
performance and the achievement of strategic corporate and business unit
objectives established on a yearly basis.
In the case of the Named Executive Officers eligible for incentive bonuses in
the year ended August 31, 2003, such bonuses constituted a certain percentage of
base salary which is tied to the achievement of the financial and strategic
objectives of the Corporation based on the following factors: sales, earnings
and customer satisfaction (quality and production), and departmental or
divisional and personal objectives. When such objectives are exceeded, bonuses
are higher; when objectives are not met, the incentive bonuses are lower.
LONG-TERM INCENTIVE COMPENSATION
STOCK OPTION PLAN
The principal component of the long-term incentive compensation offered by the
Corporation is made up of the Stock Option Plan for directors, officers and
employees of the Corporation and its subsidiaries and persons or companies
providing ongoing management or consulting services ("consultants") to the
Corporation and its subsidiaries.
Introduced in May 2000, the Stock Option Plan is designed to motivate directors,
officers, employees and consultants to share interest with the Corporation's
shareholders over the long-term. It is subject to Human Resources Committee
review to ensure maintenance of its market competitiveness. The 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,
13
provided that such interpretations, rules, regulations and determinations are
consistent with the rules of all stock exchanges on which the securities of the
Corporation are then traded and with all relevant securities legislation.
The Stock Option Plan provides for the issuance of options to directors,
officers, employees and consultants to purchase Subordinate Voting Shares. The
Board of Directors designates the recipients of options and determines the
number of Subordinate Voting Shares covered by each option, the date of vesting,
the expiry date and any other conditions relating to these options, in each case
in accordance with the applicable legislation of the securities regulatory
authorities. During the financial year ended August 31, 2003, options were
granted based on merit.
The exercise price of the options is determined by the 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 maximum number of Subordinate Voting Shares that are issuable under the Plan
shall not exceed 4,470,961 Subordinate Voting Shares, which represents 7.1% of
the Corporation's issued and outstanding share capital as of November 7, 2003. A
resolution has been submitted to the shareholders to increase the number of
Subordinate Voting Shares that are issuable under the Plan to a maximum of
6,306,153 Subordinate Voting Shares, which represents 10% of the Corporation's
issued and outstanding share capital as of November 7, 2003. 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, 2003 vest at
a rate of 12.5% 6 months after the date of grant, 12.5% 12 months after the date
of grant and 25% annually thereafter commencing on the second anniversary date
of the grant. Otherwise all options vest a rate of 25% annually commencing on
the first anniversary date of the grant. All options may be exercised in whole
or in part once vested. All of the options that are granted under the Plan must
be exercised within a maximum period of 10 years following the date of their
grant or they will be forfeited.
Any option granted pursuant to the Stock Option Plan will lapse (i) immediately
upon the termination of the relationship with the Corporation or one of its
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
the Corporation or one of its 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 the Board of Directors of the
Corporation or one of its 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.
14
The following table summarizes information about stock options granted to the
members of the Board of Directors, and to Management and corporate officers of
the Corporation and its subsidiaries as at August 31, 2003:
--------------------------------------------------------------------------------------------------------------------
Number of % of Issued and Weighted Average Exercise
Options Outstanding Options Price ($US/Security)
--------------------------------------------------------------------------------------------------------------------
President and CEO (one individual) 150,482 4.74% 9.91
--------------------------------------------------------------------------------------------------------------------
Board of Directors (four individuals) 131,875 4.15% 7.41
--------------------------------------------------------------------------------------------------------------------
Management and corporate officers (nine 350,775 11.04% 13.90
individuals)
--------------------------------------------------------------------------------------------------------------------
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 is 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 shall continue until all awards of Restricted Shares have been forfeited or
settled. The aggregate number of shares subject to the RSAP is 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 Human
Resources Committee administers the RSAP.
Awards of Restricted Shares are subject to forfeiture and restrictions on
transfer until the Restricted Shares become vested at which point a stock
certificate will be issued to a participant with respect to the number of vested
shares, which are then freely transferable. Restricted Shares become vested,
subject to a participant's continued employment with the Corporation or its
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 the Corporation or any of
its affiliates due to the participant's death, disability or retirement on or
after age 60, the participant's award of restricted shares becomes fully vested
and is no longer subject to forfeiture. However, the transfer restrictions
remain in place until the occurrence of the vesting dates originally
contemplated by the award.
Upon the voluntary resignation of a participant, the termination of a
participant's employment for cause, the termination of a participant who is not
designated a member of EXFO Burleigh Products Group Inc. "Management Team"
without cause prior to a change in control of the Corporation 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 the Corporation, the unvested portion
of the participant's award of Restricted Shares will be forfeited. However the
RSAP provides discretion to the Human Resources Committee in the application of
the forfeiture provisions where a change in circumstances renders such action
appropriate. During the financial year ended August 31, 2003, EXFO Burleigh
Products Group Inc. was required to lay off 22 participants as a result of
restructuring due to a sharp downturn in it's market. At that time, 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
would remain in place until the occurrence of the vesting dates originally
contemplated by the award.
15
Upon the termination without cause of a participant who is designated a member
of EXFO Burleigh Products Group Inc. Management Team that is initiated by the
Corporation 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 will become fully vested and all restrictions will lapse.
In the event of a change in control, the committee administering the RSAP may in
its discretion remove restrictions on Restricted Shares or provide for the
cancellation of awards in exchange for payment in respect of the Restricted
Shares subject to an award.
STOCK APPRECIATION RIGHTS PLAN
On August 4, 2001, the Corporation established a Stock Appreciation Rights Plan
("SAR Plan") for the benefit of certain employees residing in countries where
the granting of options under the Stock Option Plan is not feasible in the
opinion of the Corporation. The Board has full and complete authority to
interpret the SAR Plan and to establish the rules and regulations applying to it
and to make all other determinations it deems necessary or useful for the
administration of the SAR Plan.
Under the SAR Plan, eligible employees are entitled to receive a cash amount
equivalent to the difference between the market price of the Subordinate Voting
Shares on the date of exercise and the exercise price determined on the date of
grant. No Subordinate Voting Shares are issuable under the SAR Plan.
The Board of Directors has delegated to Management the task of designating the
recipients of stock appreciation rights, the date of vesting, the expiry date
and other conditions. Under the terms of the SAR Plan, the exercise price of the
stock appreciation rights may not be lower than the highest of the closing
prices of the Subordinate Voting Shares on The Toronto Stock Exchange and on the
NASDAQ National Market on the last trading day preceding the grant date, using
the noon buying rate of the Federal Reserve Bank of New York on the grant date
to convert the NASDAQ National Market closing price to Canadian dollars. Stock
appreciation rights are non-transferable.
The stock appreciation rights vest over a four-year period, with 25% vesting
annually commencing on the first anniversary date of the date of grant. Once
vested, stock appreciation rights may be exercised between the second and the
fifteenth business day following each release of the Corporation's quarterly
financial results. All of the stock appreciation rights that are granted under
the SAR Plan may be exercised within a maximum period of 10 years following the
date of their grant. Any stock appreciation rights granted under the SAR Plan
will lapse immediately upon the termination of the relationship with the
Corporation or one of its subsidiaries for a good and sufficient cause or at the
date on which an employee resigns or leaves his employment with the Corporation
or one of its subsidiaries (or within 30 days if the holder is dismissed without
cause). In the event of retirement or disability, any stock appreciation right
held by an employee lapses 30 days after the date of any such disability or
retirement. In the event of death, any stock appreciation right lapses 6 months
after the date of death.
COMPENSATION PLAN CONTROL AND REVIEW
As a general practice, the Corporation's relative position in terms of
compensation levels is determined annually through studies performed by
independent consulting firms using a selected reference market of comparable
companies. In addition, internal pay equity studies are a key factor to complete
the compensation review process and indicate where necessary adjustments may be
required. During the fiscal year ended August 31, 2003, this practice
recommenced and certain salary adjustments that became necessary as a result of
the previous year's salary freeze were made.
16
CONCLUSION
By way of application of the Corporation's executive compensation policy, an
important part of executive compensation is linked to corporate performance and
particularly to stock performance and long-term improvement. The Human Resources
Committee continuously reviews executive compensation programs to ensure that
they maintain their competitiveness and continue to focus on the Corporation's
objectives, values and business strategies.
Depending on specific circumstances, the Committee may also recommend employment
terms and conditions that deviate from the policies and the execution by the
Corporation or its subsidiaries of employment contracts on a case-by-case basis.
By the Human Resources Committee:
Michael Unger, Chairman
Pierre Marcouiller
David A. Thompson
Andre Tremblay
17
PERFORMANCE GRAPH
The performance graph presented below compares the cumulative total shareholder
return of a $100 investment in the Subordinate Voting Shares and the cumulative
total return of the S&P TSX Stock Index for the period commencing June 30, 2000,
the date EXFO'S Subordinate Voting Shares commenced trading, and ending August
29, 2003.
THE CORPORATION'S STOCK PERFORMANCE
(JUNE 30, 2000 TO AUGUST 29, 2003)
[LINE CHART OMITTED]
DIRECTORS' AND OFFICERS' LIABILITY INSURANCE
The Corporation maintains insurance protection against liability incurred by its
officers and directors as well as those of its subsidiaries in the performance
of their duties. The entire premium, amounting to US$500,000 from June 30, 2003
to June 30, 2004, is paid by the Corporation. 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 the Corporation has not indemnified or is not permitted by law to
indemnify them, and for the reimbursement of the Corporation, subject to a
deductible of US$500,000.
REPORT ON CORPORATE GOVERNANCE PRACTICES
The Toronto Stock Exchange requires that issuers listed on The Toronto Stock
Exchange provide annual disclosure on their corporate governance practices
through a Statement of Corporate Governance Practices. The Corporation's
disclosure of its corporate governance practices is set out in matrix form and
attached to this Management Proxy Circular as Schedule B.
18
ADDITIONAL INFORMATION
The Corporation shall provide to any person or company, upon request to the
Secretary of the Corporation, at 400 Godin Avenue, Vanier, Quebec, Canada, G1M
2K2.
(a) one copy of the Form 20-F of the Corporation filed with the Securities and
Exchange Commission (the "SEC") in the United States pursuant to the
SECURITIES EXCHANGE ACT OF 1934, and with securities commissions or
similar authorities;
(b) one copy of the comparative financial statements of the Corporation for
its most recently completed financial year and the Auditors report
thereon, included in the Annual Report of the Corporation, and one copy of
any interim financial statements of the Corporation subsequent to the
financial statements for its most recently completed financial year;
(c) one copy of this Management Proxy Circular.
DIRECTORS' APPROVAL
The contents and the sending of this Management Proxy Circular have been
approved by the Directors of the Corporation.
DATED at Vanier, Quebec, Canada, this 7th day of November, 2003.
/s/ Kimberley Okell
-------------------------------
Kimberley Okell
Corporate Secretary
EXFO ELECTRO-OPTICAL ENGINEERING INC.
400 Godin Avenue
Vanier, Quebec, Canada, G1M 2K2
19
EXFO ELECTRO-OPTICAL ENGINEERING INC.
SCHEDULE A
BE IT RESOLVED AS A RESOLUTION OF THE SHAREHOLDERS THAT:
1. the amendment to the Stock Option Plan approved by the directors by
resolution dated October 27, 2003, to increase the aggregate of all
Subordinate Voting Shares of the Corporation reserved for issuance
from 4,470,961 to 6,306,153 be and the same is hereby confirmed,
ratified and approved subject to the Corporation obtaining all
required approvals from the Toronto Stock Exchange, NASDAQ and other
regulatory authorities;
2. paragraph 3 of the Stock Option Plan be, and hereby is modified
according to the directives of the Toronto Stock Exchange by the
addition of the following:
"FOR GREATER CLARITY, THE ISSUANCE OF SHARES UNDER THE PLAN SHALL BE
SUBJECT TO THE FOLLOWING:
(i) THE NUMBER OF SHARES RESERVED FOR ISSUANCE PURSUANT TO OPTIONS
GRANTED TO INSIDERS OF THE CORPORATION SHALL NOT EXCEED 10% OF
THE TOTAL ISSUED AND OUTSTANDING SHARES;
(ii) THE ISSUANCE TO INSIDERS, WITHIN A ONE-YEAR PERIOD, OF A NUMBER
OF SHARES SHALL NOT EXCEED 10% OF THE TOTAL ISSUED AND
OUTSTANDING SHARES; AND
(iii) THE ISSUANCE TO ANY ONE INSIDER AND SUCH INSIDER'S ASSOCIATES,
WITHIN A ONE-YEAR PERIOD, OF A NUMBER OF SHARES SHALL NOT
EXCEED 5% OF THE TOTAL ISSUED AND OUTSTANDING SHARES.";
3. any officer or director of the Corporation be and is hereby authorized
and directed, for and on behalf of the Corporation, to execute and
deliver all such documents and to do all such acts and things as may
be deemed requisite or desirable as such director or officer may
determine in consultation with the Toronto Stock Exchange, NASDAQ and
other regulatory authorities for the carrying out of the foregoing
provisions of this resolution; and
4. the directors of the Corporation may, in their discretion, revoke this
resolution before it is implemented, without further notice to, or
approval of the shareholders.
20
EXFO ELECTRO-OPTICAL ENGINEERING INC.
SCHEDULE B
--------------------------------------------------------------------------------------------------------------------
TSX Corporate Governance Guidelines Comments
--------------------------------------------------------------------------------------------------------------------
1. Board should explicitly assume
responsibility for stewardship of
the Corporation specifically for:
--------------------------------------------------------------------------------------------------------------------
(a) Adoption of a strategic planning The Board provides guidance for the development of
process the strategic planning process and approves the
process adopted by management annually. In
addition, the Board carefully reviews the strategic
plan and deals with strategic planning matters that
arise during the year.
--------------------------------------------------------------------------------------------------------------------
(b) Identification of principal risks, The Board works with management to identify the
and implementing risk management Corporation's principal risks and manages these
systems risks through regular management systems appraisal
of management's practices on an ongoing basis.
--------------------------------------------------------------------------------------------------------------------
(c) Succession planning and monitoring The Human Resources Committee is responsible for
senior management elaboration and implementation of a succession
planning process and during the financial year
ended August 31, 2003, the succession plan was
updated as a result of restructuring. In addition,
the Human Resources Committee is responsible for
monitoring the performance of the Chief Executive
Officer and that of all other senior officers.
--------------------------------------------------------------------------------------------------------------------
(d) Communications policy The Chief Financial Officer of the Corporation is
responsible for communications between Management
and the Corporation's current and potential
shareholders and financial analysts. The Board
adopted and implemented Disclosure Guidelines to
ensure consistency in the manner that
communications with shareholders and the public are
managed. The Audit Committee reviews press releases
containing the quarterly results of the Corporation
prior to release. In addition, all material press
releases of the Corporation are reviewed by the
President and Chief Executive Officer and internal
legal counsel. The Disclosure Guidelines have been
established in accordance with the relevant
disclosure requirements under applicable Canadian
and United States securities laws.
--------------------------------------------------------------------------------------------------------------------
(e) Integrity of internal control and The Audit Committee has the responsibility to
management information systems review the Corporation's systems of internal
controls regarding finance, accounting, legal
compliance and ethical behaviour. The Audit
Committee meets with the Corporation's external
auditors on a quarterly basis.
--------------------------------------------------------------------------------------------------------------------
21
--------------------------------------------------------------------------------------------------------------------
TSX Corporate Governance Guidelines Comments
--------------------------------------------------------------------------------------------------------------------
2. Majority of Directors should be The Board presently consists of five Directors,
"unrelated" (independent of four of which are unrelated Directors within the
management and free from meaning of the Guidelines. The Chairman of the
Board, Mr. Germain Lamonde conflicting interest) is
a significant shareholder in the Corporation as he
has the ability to exercise a majority of the votes
for the election of the Board of Directors. The
Board believes that the current majority of
unrelated Directors provides appropriate
independent representation for the public
shareholders of the Corporation.
--------------------------------------------------------------------------------------------------------------------
3. Disclosure for each Director Mr. Germain Lamonde - Related - is President and
whether he or she is related, and Chief Executive Officer of the Corporation.
how that conclusion was reached
For the remainder of the proposed Directors, none
of them or their associates have any interest or
any business or other relationship which could, or
could reasonably be perceived to, materially
interfere with the Director's ability to act with a
view to the best interests of the Corporation,
other than interests arising from shareholding.
Mr. Pierre Marcouiller - Unrelated
Mr. Andre Tremblay - Unrelated
Dr. David A. Thompson - Unrelated
Mr. Michael Unger - Unrelated
--------------------------------------------------------------------------------------------------------------------
4. (a) Appoint a committee responsible At the present time, the Corporation has no formal
for appointment/assessment procedures of in place for recruiting new
of Directors Directors. While there is no formal process for
assessing Directors on an ongoing basis, the
Directors feel free to discuss specific situations
from time to time among themselves and/or with the
Chairman of the Board. In addition, the unrelated
Directors carry out a self-evaluation of the
Board's performance on an annual basis based on
attainment of annual objectives.
--------------------------------------------------------------------------------------------------------------------
(b) Composed exclusively of non-management
directors, the majority of whom are
unrelated
--------------------------------------------------------------------------------------------------------------------
5. Implement a process for assessing the In September 2003, the Board resolved to assume
effectiveness of the Board, its direct responsibility for the monitoring of the
committees and directors Board's corporate governance practices, the
functioning of the Board and the powers, mandates
and performance of the Committees. These
responsibilities were previously assumed by the
Human Resources Committee. The unrelated Directors
carry out a self-evaluation of the Board's
performance on an annual basis.
--------------------------------------------------------------------------------------------------------------------
22
--------------------------------------------------------------------------------------------------------------------
TSX Corporate Governance Guidelines Comments
--------------------------------------------------------------------------------------------------------------------
6. Provide orientation and education Presentations and reports relating to the
programs for new directors Corporation's business and affairs are provided to
new Directors. In addition, new Board members meet
with senior management of the Corporation to review
the business and affairs of the Corporation.
--------------------------------------------------------------------------------------------------------------------
7. Consider reducing size of board, with The Board is presently composed of five members.
a view to improving effectiveness The Board considers that a slight increase in the
number of directors would continue to offer the
flexibility to respond quickly to corporate
opportunities and challenges as they arise from
time to time, while also providing increased
resources and improved succession planning. The
Board as currently constituted brings together a
mix of experience and backgrounds that the Board
considers appropriate for the stewardship of the
Corporation, and these factors will continue to be
considered in the nomination process of new
directors.
--------------------------------------------------------------------------------------------------------------------
8. Review compensation of directors in The Human Resources Committee reviews periodically
light of risks and responsibilities compensation policies in light of market
conditions, industry and responsibilities practice
and level of responsibilities. Only non-related
directors are compensated for acting as a director
of the Corporation.
--------------------------------------------------------------------------------------------------------------------
9. (a) Committees should generally be The Board has two committees: the Audit Committee
composed of non-management and the Human Resources Committee. Each of the
directors members of the Audit Committee and Human Resources
Committee are non-management.
--------------------------------------------------------------------------------------------------------------------
(b) Majority of committee members should The Audit Committee consists of three members, and
be unrelated the Human Resources Committee consists of four
members, all of who are unrelated Directors.
--------------------------------------------------------------------------------------------------------------------
10. Appoint a committee responsible for In September 2003, the Board resolved to assume
approach to corporate governance issues direct responsibility for the monitoring of the
Board's corporate governance practices, the
functioning of the Board and the powers, mandates
and performance of the committees. These
responsibilities were previously assumed by the
Human Resources Committee.
--------------------------------------------------------------------------------------------------------------------
11. (a) Define limits to management's
responsibilities by developing
mandates for:
--------------------------------------------------------------------------------------------------------------------
(i) the board There is no specific mandate for the Board, however
the Board of Directors is, by law, responsible for
managing the business and affairs of the
Corporation. Any responsibility, which is not
delegated to senior management or to a committee of
the Board remains the responsibility of the Board.
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TSX Corporate Governance Guidelines Comments
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(ii) the CEO The corporate objectives which the President and
Chief Executive Officer is responsible for meeting,
with the rest of management placed under his
supervision, are determined by the strategic
objectives and budget as they are presented each
year to the Board of Directors.
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(b) Board should approve CEO's corporate The Board, in conjunction with Management,
objectives establishes the corporate objectives of the
Corporation annually which, in turn, are expected
to be implemented by the CEO. In addition,
individual objectives for the CEO and the rest of
management are submitted to the Board for approval
annually.
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12. Establish structures and the During the financial year ended August 31, 2002,
procedures to enable the Board to the Board of Directors designated Mr. Michael Unger
function independently of to act as independent "lead director". A minimum of
management two meetings annually will be held by the
independent, unrelated directors without
management, and any independent, unrelated director
may request additional meetings at any time.
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13. (a) Establish an audit committee with The Audit Committee is mandated to monitor audit
a specifically defined mandate functions, the preparation of financial statements,
review press releases on financial results, review
other regulatory documents as required, and meet
with outside auditors independently of Management.
The Committee also recommends the selection of the
external auditors for appointment by the
shareholders. The mandate of the Audit Committee
was modified during the financial year ended August
31, 2003 to comply with new Canadian and American
corporate governance and accounting standards.
The aggregate fees billed for professional services
rendered by PricewaterhouseCoopers for the audit of
the Corporation's consolidated annual financial
statements for the financial year ended August 31,
2003 were approximately US$202,459. The aggregate
fees billed for services rendered by PWC, other
than services covered for auditing services above,
for the financial year ended August 31, 2003 were
approximately US$233,660 which related, for the
most part, to tax planning matters. No fees were
billed by PWC for professional services related to
financial information systems design and
implementation.
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(b) All members should be non-management All of the three members of the Audit Committee are
directors non-management Directors.
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14. Implement a system to enable individual The Corporation has a practice of permitting the
directors to engage outside advisors, Board, any Committee thereof and any individual
at Corporation's expense Director to engage independent, external advisors
at the Corporation's expense.
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