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 June 2016

EXFO Inc.
(Translation of registrant's name into English)

400 Godin Avenue, Quebec, 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
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


If "Yes" is marked, indicate below the file number assigned to the registrant in connection with Rule 12g3-2(b): 82-______.
 
 

 
 

 
Table of Contents
 
 
Signatures
Press Release
Condensed Unaudited Interim Consolidated Balance Sheets
Condensed Unaudited Interim Consolidated Statements of Earnings
Condensed Unaudited Interim Consolidated Statements of Comprehensive Income (Loss)
Condensed Unaudited Interim Consolidated Statements of Changes in Shareholders' Equity
Condensed Unaudited Interim Consolidated Statements of Cash Flows
Notes to Condensed Unaudited Interim Consolidated Financial Statements
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
 
 
 
On June 29, 2016, EXFO Inc., a Canadian corporation, reported its results of operations for the third fiscal quarter ended May 31, 2016. This report on Form 6-K sets forth the news release relating to EXFO's announcement and certain information relating to EXFO's financial condition and results of operations for the third fiscal quarter of the 2016 fiscal year. This press release and information relating to EXFO's financial condition and results of operations for the third fiscal quarter of the 2016 fiscal year are hereby incorporated as a document by reference to Form F-3 (Registration Statement under the Securities Act of 1933) declared effective as of July 30, 2001 and to Form F‑3 (Registration Statement under the Securities Act of 1933) declared effective as of March 11, 2002 and to amend certain material information as set forth in these two Form F-3 documents.
 
 

Page 1 of 35

 
 
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 INC.
 
 
 
By: /s/ Germain Lamonde
Name:           Germain Lamonde
Title:             President and Chief Executive Officer
   


Date: June 29, 2016
 
 
Page 2 of 35

 
 
 
 
EXFO Reports Third Quarter Results for Fiscal 2016

§
Sales increase 5.4% year-over-year to US$60.9 million
§
Adjusted EBITDA improves 18.8% year-over-year to US$5.3 million
§
Cash flows from operations of US$2.3 million raises cash position to US$46.3 million

QUEBEC CITY, CANADA, June 29, 2016 — EXFO Inc. (NASDAQ: EXFO; TSX: EXF) reported today financial results for the third quarter ended May 31, 2016.
Sales reached US$60.9 million in the third quarter of fiscal 2016 compared to US$57.8 million in the third quarter of 2015 and US$53.6 million in the second quarter of 2016. After three quarters into 2016, sales increased 2.6% year-over-year to US$169.7 million.

Bookings attained US$59.7 million in the third quarter of fiscal 2016 for a book-to-bill ratio of 0.98 compared to US$59.2 million in the same period last year and US$59.7 million in the second quarter of 2016. Bookings improved 5.8% year-over-year to US$177.9 million after three quarters into 2016 for a book-to-bill ratio of 1.05 for this period.
Gross margin before depreciation and amortization* amounted to 60.8% of sales in the third quarter of fiscal 2016 compared to 61.4% in the third quarter of 2015 and 64.7% in the second quarter of 2016. After three quarters into 2016, gross margin reached 62.9% compared to 61.9% for the same period in 2015.
IFRS net earnings in the third quarter of fiscal 2016 totaled US$0.9 million, or US$0.02 per diluted share, compared US$0.6 million, or US$0.01 per diluted share, in the same period last year and US$4.0 million, or US$0.07 per diluted share, in the second quarter of 2016. IFRS net earnings in the third quarter of 2016 included US$0.3 million in after-tax amortization of intangible assets, US$0.4 million in stock-based compensation costs and a foreign exchange loss of US$1.0 million.
After three quarters into 2016, IFRS net earnings totaled US$6.6 million, or US$0.12 per diluted share, compared to US$3.0 million, or US$0.05 per diluted share, in the same period in 2015. IFRS net earnings on a year-to-date basis included US$0.8 million in after-tax amortization of intangible assets, US$1.1 million in stock-based compensation costs and a foreign exchange gain of US$0.5 million.
Adjusted EBITDA* totaled US$5.3 million, or 8.7% of sales, in the third quarter of fiscal 2016 compared to US$4.5 million, or 7.7% of sales, in the third quarter of 2015 and US$5.3 million, or 9.9% of sales, in the second quarter of 2016. On a year-to-date basis, adjusted EBITDA totaled US$15.9 million, or 9.3% of sales, compared to US$8.8 million, or 5.3% of sales, for the same period in 2015.
EXFO's cash and short-term investments amounted to US$46.3 million at the end of the third quarter of fiscal 2016 compared to US$29.9 million at the end of the third quarter of 2015 and US$44.4 million at the end of the second quarter of 2016.
"I am quite pleased with the progress of our financial results after the first three quarters of 2016, including the solid performances of both our Physical and Protocol-layer product groups," said Germain Lamonde, EXFO's Chairman, President and CEO. "During the third quarter, our instruments business delivered strong bookings and revenues, while we experienced delays in closing some systems-based deals which, in turn, limited our overall top and bottom-line results."

"After nine months into fiscal 2016, we have increased adjusted EBITDA by 80% year-over-year and generated more EBITDA than the entire reporting period in 2015," Mr. Lamonde added.
 

Page 3 of 35


 


 
Selected Financial Information
(In thousands of US dollars)

     
Q3 2016
     
Q2 2016
     
Q3 2015
 
                          
  Physical-layer sales
 
$
42,074
   
$
32,582
   
$
38,167
 
  Protocol-layer sales
   
19,260
     
21,990
     
20,492
 
  Foreign exchange losses on forward exchange contracts
   
(438
)
   
(975
)
   
(878
)
  Total sales
 
$
60,896
   
$
53,597
   
$
57,781
 
                         
  Physical-layer bookings
 
$
41,797
   
$
34,873
   
$
38,534
 
  Protocol-layer bookings
   
18,389
     
25,805
     
21,593
 
  Foreign exchange losses on forward exchange contracts
   
(438
)
   
(975
)
   
(878
)
  Total bookings
 
$
59,748
   
$
59,703
   
$
59,249
 
  Book-to-bill ratio
   
0.98
     
1.11
     
1.03
 
                         
  Gross margin*
 
$
37,016
   
$
34,693
   
$
35,500
 
     
60.8
%
   
64.7
%
   
61.4
%
                         
  Other selected information:
                       
  IFRS net earnings
 
$
919
   
$
3,963
   
$
563
 
  Amortization of intangible assets
 
$
294
   
$
286
   
$
444
 
  Stock-based compensation costs
 
$
386
   
$
314
   
$
374
 
  Net income tax effect of the above items
 
$
(31
)
 
$
(30
)
 
$
(49
)
  Foreign exchange (gain) loss
 
$
957
   
$
(1,101
)
 
$
175
 
  Adjusted EBITDA*
 
$
5,301
   
$
5,280
   
$
4,462
 

Operating Expenses
Selling and administrative expenses totaled US$20.8 million, or 34.2% of sales in the third quarter of fiscal 2016 compared to US$20.5 million, or 35.5% of sales, in the same period last year and US$19.6 million, or 36.5% of sales, in the second quarter of 2016.
Net R&D expenses totaled US$11.3 million, or 18.6% of sales, in the third quarter of fiscal 2016 compared to US$10.9 million, or 18.9% of sales, in the third quarter of 2015 and US$10.2 million, or 19.0% of sales, in the second quarter of 2016.
Third-Quarter Highlights
·
Sales. In the third quarter of 2016, sales were particularly robust within EXFO's optical and transport product lines which are benefiting from a 100G investment cycle. From a geographic standpoint, 59% of sales originated from the Americas, 22% from EMEA and 19% from Asia-Pacific. EXFO's top customer accounted for 5.0% of sales, while the top three represented 14.7%.
·
Profitability. Adjusted EBITDA improved 18.8% year-over-year to US$5.3 million in the third quarter of 2016. After nine months into fiscal 2016, EXFO generated adjusted EBITDA of US$15.9 million, or 9.3% of sales. The company also reported US$2.3 million in cash flows from operating activities in the third quarter and US$20.8 million after nine months into fiscal 2016.
·
Innovation. EXFO launched four key new solutions during the third quarter of 2016, including the LTB-8, a multi-module test platform dedicated to high-speed testing in lab and manufacturing environments; a 100G Power Blazer test module that can be swapped between the LTB-8 and FTB-2 Pro platforms to ease the transition between lab and field testing; and EXFO added two 100G portable testers to its NetBlazer product family in order to address growing turn-up and troubleshooting requirements for metro networks and data center interconnects (DCIs).
 
 
Page 4 of 35

 
 
 
 
Business Outlook
EXFO forecasts sales between US$57.0 million and US$62.0 million for the fourth quarter of fiscal 2016, while IFRS net results are expected to range between a loss of US$0.01 per share and earnings of US$0.03 per share. IFRS net loss/earnings include US$0.01 per share in after-tax amortization of intangible assets and stock-based compensation costs as well as US$0.01 per share for foreign exchange losses based on current exchange rates.
This guidance was established by management based on existing backlog as of the date of this press release, current market conditions, seasonality, expected bookings for the remaining of the quarter, as well as exchange rates as of the day of this press release.
Conference Call and Webcast
EXFO will host a conference call today at 5 p.m. (Eastern time) to review third-quarter results for fiscal 2016. To listen to the conference call and participate in the question period via telephone, dial 1-704-288-0432. Please take note the following conference ID number will be required: 20909896. Germain Lamonde, Chairman, President and CEO, and Pierre Plamondon, CPA, CA, Vice-President of Finance and Chief Financial Officer, will participate in the call. An audio replay of the conference call will be available two hours after the event until 11:59 p.m. on July 5, 2016. The replay number is 1-855-859-2056 and the conference ID number is 20909896. The audio Webcast and replay of the conference call will also be available on EXFO's Website at www.EXFO.com, under the Investors section.
About EXFO
EXFO provides communications service providers (CSPs) with test orchestration and performance intelligence solutions to ensure the smooth deployment, maintenance and management of next-generation, physical, virtual, fixed and mobile networks. The company has also forged strong relationships with network equipment manufacturers (NEMs) to develop deep expertise that migrates from the lab to the field and beyond. EXFO's key differentiation comes from combining intelligent, automated and cloud-based test and monitoring solutions with real-time analytics to deliver unmatched end-to-end visibility and assurance—from a network, services and end-user level. EXFO is no. 1 in portable optical testing and boasts the largest active service assurance deployment worldwide. For more information, visit www.EXFO.com and follow us on the EXFO Blog.

Forward-Looking Statements
This press release contains forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995, and we intend that such forward-looking statements be subject to the safe harbors created thereby. Forward-looking statements are statements other than historical information or statements of current condition. Words such as may, expect, believe, plan, anticipate, intend, could, estimate, continue, or similar expressions or the negative of such expressions are intended to identify forward-looking statements. In addition, any statement that refers to expectations, projections or other characterizations of future events and circumstances are considered forward-looking statements. They are not guarantees of future performance and involve risks and uncertainties. Actual results may differ materially from those in forward-looking statements due to various factors including, but not limited to, macroeconomic uncertainty as well as capital spending and network deployment levels in the telecommunications industry (including our ability to quickly adapt cost structures with anticipated levels of business and our ability to manage inventory levels with market demand); future economic, competitive, financial and market conditions; consolidation in the global telecommunications test and service assurance industry and increased competition among vendors; capacity to adapt our future product offering to future technological changes; limited visibility with regards to timing and nature of customer orders; longer sales cycles for complex systems involving customers' acceptances delaying revenue recognition; fluctuating exchange rates; concentration of sales; timely release and market acceptance of our new products and other upcoming products; our ability to successfully expand international operations; our ability to successfully integrate businesses that we acquire; and the retention of key technical and management personnel. Assumptions relating to the foregoing involve judgments and risks, all of which are difficult or impossible to predict and many of which are beyond our control. Other risk factors that may affect our future performance and operations are detailed in our Annual Report, on Form 20-F, and our other filings with the U.S. Securities and Exchange Commission and the Canadian securities commissions. We believe that the expectations reflected in the forward-looking statements are reasonable based on information currently available to us, but we cannot assure that the expectations will prove to have been correct. Accordingly, you should not place undue reliance on these forward-looking statements. These statements speak only as of the date of this document. Unless required by law or applicable regulations, we undertake no obligation to revise or update any of them to reflect events or circumstances that occur after the date of this document.
 
 
Page 5 of 35

 
 
 
*NON-IFRS MEASURES
EXFO provides non-IFRS measures (constant currency data, gross margin before depreciation and amortization, and adjusted EBITDA) as supplemental information regarding its operational performance. The company uses these measures for the purpose of evaluating historical and prospective financial performance, as well as its performance relative to competitors. These measures also help the company to plan and forecast for future periods as well as to make operational and strategic decisions. EXFO believes that providing this information, in addition to IFRS measures, allows investors to see the company's results through the eyes of management, and to better understand its historical and future financial performance.
The presentation of this additional information is not prepared in accordance with IFRS. Therefore, the information may not necessarily be comparable to that of other companies and should be considered as a supplement to, not a substitute for, the corresponding measures calculated in accordance with IFRS.
Constant currency data represents data before foreign currency impact. Data for the current period is translated using foreign exchange rates of the corresponding period from the preceding year.
Gross margin before depreciation and amortization represents sales less cost of sales, excluding depreciation and amortization.
Adjusted EBITDA represents net earnings before interest, income taxes, depreciation and amortization, stock-based compensation costs and foreign exchange gain or loss.
The following table summarizes the reconciliation of adjusted EBITDA to IFRS net earnings, in thousands of US dollars:
Adjusted EBITDA (unaudited)
     
Q3 2016
     
Q2 2016
     
Q3 2015
 
                         
IFRS net earnings for the period
 
$
919
   
$
3,963
   
$
563
 
                         
Add (deduct):
                       
                         
Depreciation of property, plant and equipment
   
958
     
924
     
1,163
 
Amortization of intangible assets
   
294
     
286
     
444
 
Interest and other (income) expenses
   
(309
)
   
(470
)
   
36
 
Income taxes
   
2,096
     
1,364
     
1,707
 
Stock-based compensation costs
   
386
     
314
     
374
 
Foreign exchange (gain) loss
   
957
     
(1,101
)
   
175
 
Adjusted EBITDA for the period
 
$
5,301
   
$
5,280
   
$
4,462
 
                         
Adjusted EBITDA in percentage of sales
   
8.7
%
   
9.9
%
   
7.7
%
 
 
For more information
Vance Oliver
Director, Investor Relations
(418) 683-0913, Ext. 23733
vance.oliver@exfo.com
 
 
Page 6 of 35

 
 
EXFO Inc.
Condensed Unaudited Interim Consolidated Balance Sheets
 
(in thousands of US dollars)
 

   
As at
May 31,
2016
   
As at
August 31,
2015
 
Assets
           
             
Current assets
           
Cash
 
$
42,273
   
$
25,864
 
Short-term investments
   
4,039
     
1,487
 
Accounts receivable
               
Trade
   
44,288
     
48,068
 
Other
   
2,510
     
2,384
 
Income taxes and tax credits recoverable
   
4,263
     
3,855
 
Inventories
   
34,939
     
27,951
 
Prepaid expenses
   
3,235
     
2,801
 
     
135,547
     
112,410
 
                 
Tax credits recoverable
   
34,320
     
35,625
 
Property, plant and equipment
   
36,007
     
35,695
 
Intangible assets
   
3,541
     
4,096
 
Goodwill
   
21,938
     
21,860
 
Deferred income tax assets
   
7,973
     
8,900
 
Other assets
   
691
     
416
 
                 
   
$
240,017
   
$
219,002
 
Liabilities
               
                 
Current liabilities
               
Bank loan
 
$
455
   
$
 
Accounts payable and accrued liabilities
   
39,022
     
34,126
 
Provisions
   
336
     
427
 
Income taxes payable
   
421
     
779
 
Deferred revenue
   
10,729
     
7,647
 
     
50,963
     
42,979
 
                 
Deferred revenue
   
4,929
     
2,957
 
Deferred income tax liabilities
   
2,734
     
1,524
 
Other liabilities
   
195
     
791
 
     
58,821
     
48,251
 
                 
Shareholders' equity
               
Share capital (note 5)
   
86,826
     
86,045
 
Contributed surplus
   
17,635
     
17,778
 
Retained earnings
   
125,581
     
118,933
 
Accumulated other comprehensive loss
   
(48,846
)
   
(52,005
)
                 
     
181,196
     
170,751
 
                 
   
$
240,017
   
$
219,002
 
 
 
The accompanying notes are an integral part of these condensed interim consolidated financial statements.
 
 
Page 7 of 35

 
 
EXFO Inc.
Condensed Unaudited Interim Consolidated Statements of Earnings
 
(in thousands of US dollars, except share and per share data)
 
 
   
Three months
ended
May 31, 2016
   
Nine months
ended
May 31, 2016
   
Three months
ended
May 31, 2015
   
Nine months
ended
May 31, 2015
 
                         
Sales
 
$
60,896
   
$
169,725
   
$
57,781
   
$
165,495
 
                                 
Cost of sales (1) (note 6)
   
23,880
     
62,921
     
22,281
     
63,064
 
Selling and administrative (note 6)
   
20,798
     
60,615
     
20,489
     
61,689
 
Net research and development (note 6)
   
11,303
     
31,398
     
10,923
     
33,087
 
Depreciation of property, plant and equipment (note 6)
   
958
     
2,857
     
1,163
     
3,664
 
Amortization of intangible assets (note 6)
   
294
     
880
     
444
     
2,561
 
Interest and other (income) expense
   
(309
)
   
(716
)
   
36
     
(216
)
Foreign exchange (gain) loss
   
957
     
(454
)
   
175
     
(4,787
)
Earnings before income taxes
   
3,015
     
12,224
     
2,270
     
6,433
 
                                 
Income taxes (note 7)
   
2,096
     
5,576
     
1,707
     
3,458
 
                                 
Net earnings for the period
 
$
919
   
$
6,648
   
$
563
   
$
2,975
 
                                 
Basic and diluted net earnings per share
 
$
0.02
   
$
0.12
   
$
0.01
   
$
0.05
 
                                 
Basic weighted average number of shares outstanding (000s)
   
53,940
     
53,894
     
53,861
     
57,804
 
                                 
Diluted weighted average number of shares outstanding (000s) (note 8)
   
54,813
     
54,655
     
54,549
     
58,453
 

(1)  The cost of sales is exclusive of depreciation and amortization, shown separately.
 
 
The accompanying notes are an integral part of these condensed interim consolidated financial statements.
 
 
Page 8 of 35

 
 
EXFO Inc.
Condensed Unaudited Interim Consolidated Statements of Comprehensive Income (Loss)
 
(in thousands of US dollars)

 
   
Three months
ended
May 31, 2016
   
Nine months
ended
May 31, 2016
   
Three months
ended
May 31, 2015
   
Nine months
ended
May 31, 2015
 
                         
Net earnings for the period
 
$
919
   
$
6,648
   
$
563
   
$
2,975
 
Other comprehensive income (loss), net of income taxes
                               
Items that will not be reclassified subsequently to net earnings
                               
Foreign currency translation adjustment
   
5,488
     
775
     
802
     
(29,499
)
Items that may be reclassified subsequently to net earnings
                               
Unrealized gains/losses on forward exchange contracts
   
1,045
     
825
     
38
     
(4,164
)
Reclassification of realized losses on forward exchange contracts in net earnings
   
666
     
2,383
     
938
     
1,438
 
Deferred income tax effect of gains/losses on forward exchange contracts
   
(434
)
   
(824
)
   
(270
)
   
725
 
Other comprehensive income (loss)
   
6,765
     
3,159
     
1,508
     
(31,500
)
                                 
Comprehensive income (loss) for the period
 
$
7,684
   
$
9,807
   
$
2,071
   
$
(28,525
)
 
 
The accompanying notes are an integral part of these condensed interim consolidated financial statements.

Page 9 of 35

 
 
EXFO Inc.
Condensed Unaudited Interim Consolidated Statements of Changes in Shareholders' Equity
 
(in thousands of US dollars)

 
   
Nine months ended May 31, 2015
 
   
Share
capital
   
Contributed surplus
   
Retained earnings
   
Accumulated other comprehensive loss
   
Total
shareholders' equity
 
                               
Balance as at September 1, 2014
 
$
111,491
   
$
16,503
   
$
113,635
   
$
(10,259
)
 
$
231,370
 
Redemption of share capital (note 5)
   
(26,396
)
   
1,222
     
     
     
(25,174
)
Reclassification of stock-based compensation costs (note 5)
   
1,376
     
(1,376
)
   
     
     
 
Stock-based compensation costs
   
     
1,175
     
     
     
1,175
 
Net earnings for the period
   
     
     
2,975
     
     
2,975
 
Other comprehensive loss
                                       
Foreign currency translation adjustment
   
     
     
     
(29,499
)
   
(29,499
)
Changes in unrealized losses on forward exchange contracts, net of deferred income taxes of $725
   
     
     
     
(2,001
)
   
(2,001
)
                                         
Total comprehensive loss for the period
                                   
(28,525
)
                                         
Balance as at May 31, 2015
 
$
86,471
   
$
17,524
   
$
116,610
   
$
(41,759
)
 
$
178,846
 



   
Nine months ended May 31, 2016
 
   
Share
capital
   
Contributed surplus
   
Retained earnings
   
Accumulated other comprehensive loss
   
Total
shareholders' equity
 
                               
Balance as at September 1, 2015
 
$
86,045
   
$
17,778
   
$
118,933
   
$
(52,005
)
 
$
170,751
 
Redemption of share capital (note 5)
   
(457
)
   
55
     
     
     
(402
)
Reclassification of stock-based compensation costs (note 5)
   
1,238
     
(1,238
)
   
     
     
 
Stock-based compensation costs
   
     
1,040
     
     
     
1,040
 
Net earnings for the period
   
     
     
6,648
     
     
6,648
 
Other comprehensive income
                                       
Foreign currency translation adjustment
   
     
     
     
775
     
775
 
Changes in unrealized gains/losses on forward exchange contracts, net of deferred income taxes of $824
   
     
     
     
2,384
     
2,384
 
                                         
Total comprehensive income for the period
                                   
9,807
 
                                         
Balance as at May 31, 2016
 
$
86,826
   
$
17,635
   
$
125,581
   
$
(48,846
)
 
$
181,196
 
 
 
The accompanying notes are an integral part of these condensed interim consolidated financial statements.

Page 10 of 35

 
 
EXFO Inc.
Condensed Unaudited Interim Consolidated Statements of Cash Flows
 
(in thousands of US dollars)

 
   
Three months
ended
May 31, 2016
   
Nine months
ended
May 31, 2016
   
Three months
ended
May 31, 2015
   
Nine months
ended
May 31, 2015
 
                         
Cash flows from operating activities
                       
Net earnings for the period
 
$
919
   
$
6,648
   
$
563
   
$
2,975
 
Add (deduct) items not affecting cash
                               
Stock-based compensation costs
   
386
     
1,076
     
374
     
1,162
 
Depreciation and amortization
   
1,252
     
3,737
     
1,607
     
6,225
 
Deferred revenue
   
1,203
     
4,876
     
854
     
1,358
 
Deferred income taxes
   
611
     
1,285
     
542
     
199
 
Changes in foreign exchange gain/loss
   
626
     
(333
)
   
(77
)
   
(2,875
)
     
4,997
     
17,289
     
3,863
     
9,044
 
Changes in non-cash operating items
                               
Accounts receivable
   
(5,887
)
   
3,394
     
(6,494
)
   
(7,811
)
Income taxes and tax credits
   
(301
)
   
632
     
(541
)
   
(1,964
)
Inventories
   
(759
)
   
(6,627
)
   
950
     
(983
)
Prepaid expenses
   
(452
)
   
(418
)
   
(374
)
   
(875
)
Other assets
 
     
203
     
30
     
29
 
Accounts payable, accrued liabilities and provisions
   
4,675
     
6,406
     
1,334
     
8,994
 
Other liabilities
   
(5
)
   
(59
)
   
(30
)
   
(62
)
     
2,268
     
20,820
     
(1,262
)
   
6,372
 
Cash flows from investing activities
                               
Additions to short-term investments
   
(3,109
)
   
(3,130
)
 
     
(19,509
)
Proceeds from disposal and maturity of short-term investments
 
     
501
     
1,619
     
23,685
 
Purchases capital assets
   
(1,138
)
   
(3,374
)
   
(1,826
)
   
(4,625
)
     
(4,247
)
   
(6,003
)
   
(207
)
   
(449
)
Cash flows from financing activities
                               
Bank loan
 
     
468
   
   
 
Redemption of share capital (note 5)
   
(215
)
   
(402
)
   
(71
)
   
(25,174
)
     
(215
)
   
66
     
(71
)
   
(25,174
)
Effect of foreign exchange rate changes on cash
   
1,049
     
1,526
     
78
     
(5,975
)
                                 
Change in cash
   
(1,145
)
   
16,409
     
(1,462
)
   
(25,226
)
Cash – Beginning of the period
   
43,418
     
25,864
     
30,357
     
54,121
 
Cash – End of the period
 
$
42,273
   
$
42,273
   
$
28,895
   
$
28,895
 
                                 
Supplementary information
                               
Income taxes paid
 
$
505
   
$
1,621
   
$
350
   
$
1,174
 
Additions to capital assets
 
$
1,011
   
$
3,386
   
$
1,700
   
$
4,638
 

As at May 31, 2015 and 2016, unpaid purchases of capital assets amounted to $369 and $389 respectively.
 
 
The accompanying notes are an integral part of these condensed interim consolidated financial statements.
 
 
Page 11 of 35

 
 
EXFO Inc.
Notes to Condensed Unaudited Interim Consolidated Financial Statements
 
(tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)


1
Nature of Activities and Incorporation
 
EXFO Inc. and its subsidiaries (together "EXFO" or the "the company") design, manufacture and market test, service assurance and network visibility solutions for fixed and mobile network operators, web-scale service providers as well as equipment manufacturers in the global telecommunications industry.

EXFO is a company incorporated under the Canada Business Corporations Act and domiciled in Canada. The address of its headquarters is 400 Godin Avenue, Quebec, Province of Quebec, Canada, G1M 2K2.

These condensed interim consolidated financial statements were authorized for issue by the Board of Directors on June 29, 2016.
 

2
Basis of Presentation
 
These condensed interim consolidated financial statements have been prepared in accordance with the International Financial Reporting Standards (IFRS), as issued by the International Accounting Standards Board (IASB) applicable to the preparation of interim financial statements, including IAS 34, "Interim Financial Reporting", and using the same accounting policies and methods used in the preparation of the company's most recent annual consolidated financial statements. Consequently, these condensed interim consolidated financial statements should be read in conjunction with the company's most recent annual consolidated financial statements, which have been prepared in accordance with IFRS as issued by the IASB.

New IFRS Pronouncements Not Yet Adopted

Financial instruments

The final version of IFRS 9, "Financial Instruments", was issued in July 2014 and will replace IAS 39, "Financial Instruments: Recognition and Measurement". IFRS 9 uses a single approach to determine whether a financial asset is measured at amortized cost or fair value, replacing the multiple rules in IAS 39. The approach in IFRS 9 is based on how an entity manages its financial instruments in the context of its business model and the contractual cash flow characteristics of the financial assets. Most of the requirements in IAS 39 for classification and measurement of financial liabilities were carried forward unchanged to IFRS 9. The new standard also requires a single impairment method to be used, replacing the multiple impairment methods in IAS 39. Requirements relating to hedge accounting representing a new hedge accounting model have also been added to IFRS 9. The new standard is effective for annual periods beginning on or after January 1, 2018, and must be applied retrospectively. The company has not yet assessed the impact that the new standard will have on its consolidated financial statements.

Revenue from contracts with customers

IFRS 15, "Revenue from Contracts with Customers", was issued in May 2014. The objective of this new standard is to provide a single, comprehensive revenue recognition model for all contracts with customers to improve comparability. This new standard contains principles that an entity will apply to determine the measurement of revenue, and timing of when it is recognized. The underlying principle is that an entity will recognize revenue to depict the transfer of goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services. This new standard is effective for annual periods beginning on or after January 1, 2018. Early adoption is permitted. The company has not yet assessed the impact that the new standard will have on its consolidated financial statements, or whether to early adopt the new standard.
 
 

Page 12 of 35

 
 
EXFO Inc.
Notes to Condensed Unaudited Interim Consolidated Financial Statements
 
(tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)


Leases

IFRS 16, "Leases", was issued in January 2016. IFRS 16 sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract, i.e., the customer (lessee) and the supplier (lessor). IFRS 16 will supersede IAS 17, "Leases", and related Interpretations. This new standard is effective for annual periods beginning on or after January 1, 2019, with earlier adoption permitted if IFRS 15, "Revenue from Contracts with Customers", is also applied. The company has not yet assessed the impact that the new standard will have on its consolidated financial statements.


3
Restructuring Charges

In the fourth quarter of the year ended August 31, 2015, the company implemented a restructuring plan to align its cost structure to the challenging market conditions. This plan resulted in severance expenses of $1,637,000 recorded in fiscal 2015. These expenses were fully paid during the three months ended November 30, 2015.


4
Financial Instruments

Fair Value of Financial Instruments

The company classifies its derivative and non-derivative financial assets and liabilities measured at fair value using the fair value hierarchy as follows:

Level 1: Quoted prices (unadjusted) in active market for identical assets or liabilities

Level 2: Inputs other than quoted prices included within Level 1 that are observable for the asset and liability, either directly or indirectly

Level 3: Unobservable inputs for the asset or liability

The company's short-term investments and forward exchange contracts are measured at fair value at each balance sheet date. The company's short-term investments are classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices in active markets. The company's forward exchange contracts are classified within Level 2 of the fair value hierarchy because they are valued using quoted prices and forward exchange rates at the balance sheet dates.

The fair value of forward exchange contracts represents the amount at which they could be settled based on estimated current market rates.

The fair value of derivative and non-derivative financial assets and liabilities measured at fair value by level of fair value hierarchy, is as follows:
 
   
As at May 31, 2016
   
As at August 31, 2015
 
   
Level 1
   
Level 2
   
Level 1
   
Level 2
 
Financial Assets
                       
Short-term investments
 
$
4,039
   
$
   
$
1,487
   
$
 
Forward exchange contracts
 
$
   
$
1,066
   
$
   
$
 
                                 
Financial Liabilities
                               
Forward exchange contracts
 
$
   
$
1,694
   
$
   
$
4,154
 
 
 
Page 13 of 35

 
 
EXFO Inc.
Notes to Condensed Unaudited Interim Consolidated Financial Statements
 
(tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)


Derivative Financial Instruments

The functional currency of the company is the Canadian dollar. The company is exposed to currency risk as a result of its export sales of products manufactured in Canada, China and Finland, the majority of which are denominated in US dollars and euros. This risk is partially hedged by forward exchange contracts and certain cost of sales and operating expenses (US dollars and euros). In addition, the company is exposed to currency risk as a result of its research and development activities in India (Indian rupees). This risk is partially hedged by forward exchange contracts. The company's forward exchange contracts, which are designated as cash flow hedging instruments, qualify for hedge accounting.

As at May 31, 2016, the company held contracts to sell US dollars for Canadian dollars and Indian rupees at various forward rates, which are summarized as follows:

US dollars – Canadian dollars
 
 
Expiry dates
 
Contractual
amounts
   
Weighted average
contractual forward rates
 
               
 
June 2016 to August 2016
 
$
6,300
     
1.2142
 
 
September 2016 to August 2017
   
22,200
     
1.2784
 
 
September 2017 to August 2018
   
9,900
     
1.3367
 
 
September 2018 to December 2018
   
1,900
     
1.3639
 
 
Total
 
$
40,300
     
1.2867
 

US dollars – Indian rupees

 
Expiry dates
 
Contractual
amounts
   
Weighted average
contractual forward rates
 
               
 
June 2016 to August 2016
 
$
1,000
     
67.88
 
 
September 2016 to May 2017
   
2,600
     
70.82
 
 
Total
 
$
3,600
     
70.00
 
 
The carrying amount of forward exchange contracts is equal to fair value, which is based on the amount at which they could be settled based on estimated current market rates. The fair value of forward exchange contracts amounted to net losses of $4,154,000 as at August 31, 2015, and $628,000 as at May 31, 2016.

As at May 31, 2016, forward exchange contracts in the amount of $586,000 are presented as current assets in other accounts receivable; forward exchange contracts in the amount of $480,000 are presented as long-term assets in other long-term assets; forward exchange contracts in the amount of $1,535,000 are presented as current liabilities in accounts payable and accrued liabilities; and forward exchange contracts of $159,000 are presented as long-term liabilities in other long-term liabilities in the balance sheet. Forward exchange contracts of $313,000 included in accounts payable and accrued liabilities, for which related hedged sales are recognized, are recorded in the consolidated statement of earnings; otherwise, other forward exchange contracts are not yet recorded in the consolidated statement of earnings and are recorded in other comprehensive income.

Based on the portfolio of forward exchange contracts as at May 31, 2016, the company estimates that the portion of the net unrealized losses on these contracts as of that date, which will be realized and reclassified from accumulated other comprehensive income to net earnings over the next 12 months, amounts to $636,000.
 
 

Page 14 of 35

 
 
EXFO Inc.
Notes to Condensed Unaudited Interim Consolidated Financial Statements
 
(tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)


During the three and nine months ended May 31, 2015 and 2016, the company recognized within its sales the following foreign exchange losses on forward exchange contracts:

   
Three months
ended
May 31, 2016
   
Nine months
ended
May 31, 2016
   
Three months
ended
May 31, 2015
   
Nine months
ended
May 31, 2015
 
                         
Losses on forward exchange contracts
 
$
438
   
$
2,287
   
$
878
   
$
1,770
 


5
Share Capital

The following tables summarize changes in share capital for the nine months ended May 31, 2015 and 2016.
 
   
Nine months ended May 31, 2015
 
   
Multiple voting shares
   
Subordinate voting shares
       
   
Number
   
Amount
   
Number
   
Amount
   
Total
Amount
 
                               
Balance as at September 1, 2014
   
31,643,000
   
$
1
     
28,703,750
   
$
111,490
   
$
111,491
 
Redemption of restricted share units
   
     
     
115,669
     
     
 
Redemption of share capital
   
     
     
(236,486
)
   
(919
)
   
(919
)
Reclassification of stock-based compensation costs to share capital upon exercise of stock awards
   
     
     
     
443
     
443
 
Balance as at November 30, 2014
   
31,643,000
     
1
     
28,582,933
     
111,014
     
111,015
 
Redemption of restricted share units
   
     
     
107,099
     
     
 
Redemption of deferred share units
   
     
     
48,697
     
     
 
Redemption of share capital
   
     
     
(6,521,739
)
   
(25,395
)
   
(25,395
)
Reclassification of stock-based compensation costs to share capital upon exercise of stock awards
   
     
     
     
907
     
907
 
Balance as at February 28, 2015
   
31,643,000
     
1
     
22,216,990
     
86,526
     
86,527
 
Redemption of restricted share units
   
     
     
5,636
     
     
 
Redemption of share capital
   
     
     
(21,154
)
   
(82
)
   
(82
)
Reclassification of stock-based compensation costs to share capital upon exercise of stock awards
   
     
     
     
26
     
26
 
                                         
Balance as at May 31, 2015
   
31,643,000
   
$
1
     
22,201,472
   
$
86,470
   
$
86,471
 

 
Page 15 of 35

 
 
EXFO Inc.
Notes to Condensed Unaudited Interim Consolidated Financial Statements
 
(tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)
 

   
Nine months ended May 31, 2016
 
   
Multiple voting shares
   
Subordinate voting shares
       
   
Number
   
Amount
   
Number
   
Amount
   
Total
amount
 
                               
Balance as at September 1, 2015
   
31,643,000
   
$
1
     
22,092,034
   
$
86,044
   
$
86,045
 
Redemption of restricted share units
   
     
     
155,784
     
     
 
Redemption of deferred share units
   
     
     
653
     
     
 
Redemption of share capital
   
     
     
(200
)
   
(1
)
   
(1
)
Reclassification of stock-based compensation costs to share capital upon exercise of stock awards
   
     
     
     
723
     
723
 
Balance as at November 30, 2015
   
31,643,000
     
1
     
22,248,271
     
86,766
     
86,767
 
Redemption of restricted share units
   
     
     
119,973
     
     
 
Redemption of share capital
   
     
     
(62,442
)
   
(243
)
   
(243
)
Reclassification of stock-based compensation costs to share capital upon exercise of stock awards
   
     
     
     
507
     
507
 
Balance as at February 29, 2016
   
31,643,000
     
1
     
22,305,802
     
87,030
     
87,031
 
Redemption of restricted share units
   
     
     
1,807
     
     
 
Redemption of share capital
   
     
     
(54,369
)
   
(213
)
   
(213
)
Reclassification of stock-based compensation costs to share capital upon exercise of stock awards
   
     
     
     
8
     
8
 
                                         
Balance as at May 31, 2016
   
31,643,000
   
$
1
     
22,253,240
   
$
86,825
   
$
86,826
 


6
Statements of Earnings

Net research and development expenses comprise the following:

   
Three months
ended
May 31, 2016
   
Nine months
ended
May 31, 2016
   
Three months
ended
May 31, 2015
   
Nine months
ended
May 31, 2015
 
                         
Gross research and development expenses
 
$
12,612
   
$
35,363
   
$
12,462
   
$
37,947
 
Research and development tax credits and grants
   
(1,309
)
   
(3,965
)
   
(1,539
)
   
(4,860
)
Net research and development expenses for the period
 
$
11,303
   
$
31,398
   
$
10,923
   
$
33,087
 

Inventory write-down is as follows:

   
Three months
ended
May 31, 2016
   
Nine months
ended
May 31, 2016
   
Three months
ended
May 31, 2015
   
Nine months
ended
May 31, 2015
 
                         
Inventory write-down for the period
 
$
596
   
$
2,052
   
$
1,083
   
$
3,062
 
 
 
Page 16 of 35

 
 
EXFO Inc.
Notes to Condensed Unaudited Interim Consolidated Financial Statements
 
(tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)
 

Depreciation and amortization expenses by functional area are as follows:

   
Three months
ended
May 31, 2016
   
Nine months
ended
May 31, 2016
   
Three months
ended
May 31, 2015
   
Nine months
ended
May 31, 2015
 
                         
Cost of sales
                       
Depreciation of property, plant and equipment
 
$
325
   
$
960
   
$
367
   
$
1,136
 
Amortization of intangible assets
   
179
     
524
     
243
     
1,355
 
     
504
     
1,484
     
610
     
2,491
 
                                 
Selling and administrative expenses
                               
Depreciation of property, plant and equipment
   
125
     
385
     
124
     
401
 
Amortization of intangible assets
   
19
     
55
     
69
     
771
 
     
144
     
440
     
193
     
1,172
 
                                 
Net research and development expenses
                               
Depreciation of property, plant and equipment
   
508
     
1,512
     
672
     
2,127
 
Amortization of intangible assets
   
96
     
301
     
132
     
435
 
     
604
     
1,813
     
804
     
2,562
 
                                 
   
$
1,252
   
$
3,737
   
$
1,607
   
$
6,225
 
                                 
Depreciation of property, plant and equipment
 
$
958
   
$
2,857
   
$
1,163
   
$
3,664
 
Amortization of intangible assets
   
294
     
880
     
444
     
2,561
 
                                 
Total depreciation and amortization expenses for the period
 
$
1,252
   
$
3,737
   
$
1,607
   
$
6,225
 


Employee compensation comprises the following:

   
Three months
ended
May 31, 2016
   
Nine months
ended
May 31, 2016
   
Three months
ended
May 31, 2015
   
Nine months
ended
May 31, 2015
 
                         
Salaries and benefits
 
$
28,983
   
$
83,741
   
$
28,724
   
$
88,031
 
Stock-based compensation costs
   
386
     
1,076
     
374
     
1,162
 
                                 
Total employee compensation for the period
 
$
29,369
   
$
84,817
   
$
29,098
   
$
89,193
 

 
Page 17 of 35

 
 
EXFO Inc.
Notes to Condensed Unaudited Interim Consolidated Financial Statements
 
(tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)
 

Stock-based compensation costs by functional area are as follows:

   
Three months
ended
May 31, 2016
   
Nine months
ended
May 31, 2016
   
Three months
ended
May 31, 2015
   
Nine months
ended
May 31, 2015
 
                         
Cost of sales
 
$
25
   
$
80
   
$
43
   
$
126
 
Selling and administrative expenses
   
285
     
775
     
247
     
770
 
Net research and development expenses
   
76
     
221
     
84
     
266
 
                                 
Total stock-based compensation for the period
 
$
386
   
$
1,076
   
$
374
   
$
1,162
 


7
Income Taxes

For the three and nine months ended May 31, 2015 and 2016, the reconciliation of the income tax provision calculated using the combined Canadian federal and provincial statutory income tax rate with the income tax provision in the financial statements is as follows:

   
Three months
ended
May 31, 2016
   
Nine months
ended
May 31, 2016
   
Three months
ended
May 31, 2015
   
Nine months
ended
May 31, 2015
 
                         
Income tax provision at combined Canadian federal and provincial statutory tax rate (27%)
 
$
814
   
$
3,300
   
$
613
   
$
1,737
 
                                 
Increase (decrease) due to:
                               
Foreign income taxed at different rates
   
(212
)
   
(612
)
   
223
     
800
 
Non-taxable (income)/loss
   
(203
)
   
(273
)
   
14
     
1,088
 
Non-deductible expenses
   
171
     
486
     
186
     
560
 
Foreign exchange effect of translation of foreign subsidiaries in the functional currency
   
227
     
328
     
(280
)
   
(3,399
)
Utilization of previously unrecognized deferred income tax assets
   
32
     
     
74
     
(6
)
Unrecognized deferred income tax assets on temporary deductible differences and unused tax losses
   
1,340
     
2,682
     
926
     
2,909
 
Other
   
(73
)
   
(335
)
   
(49
)
   
(231
)
                                 
Income tax provision for the period
 
$
2,096
   
$
5,576
   
$
1,707
   
$
3,458
 

 
Page 18 of 35

 
EXFO Inc.
Notes to Condensed Unaudited Interim Consolidated Financial Statements
 
(tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)


The income tax provision consists of the following:

   
Three months
ended
May 31, 2016
   
Nine months
ended
May 31, 2016
   
Three months
ended
May 31, 2015
   
Nine months
ended
May 31, 2015
 
                         
Current
 
$
1,485
   
$
4,291
   
$
1,165
   
$
3,259
 
Deferred
   
611
     
1,285
     
542
     
199
 
                                 
   
$
2,096
   
$
5,576
   
$
1,707
   
$
3,458
 


8
Earnings per Share

The following table summarizes the reconciliation of the basic weighted average number of shares outstanding and the diluted weighted average number of shares outstanding:
 
   
Three months
ended
May 31, 2016
   
Nine months
ended
May 31, 2016
   
Three months
ended
May 31, 2015
   
Nine months
ended
May 31, 2015
 
                         
Basic weighted average number of shares outstanding (000s)
   
53,940
     
53,894
     
53,861
     
57,804
 
Plus dilutive effect of (000s):
                               
Restricted share units
   
735
     
635
     
597
     
545
 
Deferred share units
   
138
     
126
     
91
     
104
 
                                 
Diluted weighted average number of shares outstanding (000s)
   
54,813
     
54,655
     
54,549
     
58,453
 
                                 
Stock awards excluded from the calculation of diluted weighted average number of shares because their exercise price was greater than the average market price of the common shares (000s)
   
     
101
     
20
     
65
 
 
 
Page 19 of 35

 
 
Management's Discussion and Analysis of Financial Condition
and Results of Operations


This discussion and analysis contains forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995, and we intend that such forward-looking statements be subject to the safe harbors created thereby. Forward-looking statements are statements other than historical information or statements of current condition. Words such as may, expect, believe, plan, anticipate, intend, could, estimate, continue, or similar expressions or the negative of such expressions are intended to identify forward-looking statements. In addition, any statements that refer to expectations, projections or other characterizations of future events and circumstances are considered forward-looking statements. They are not guarantees of future performance and involve risks and uncertainties. Actual results may differ materially from those in forward-looking statements due to various factors including, but not limited to, macroeconomic uncertainty as well as capital spending and network deployment levels in the telecommunications industry (including our ability to quickly adapt cost structures with anticipated levels of business and our ability to manage inventory levels with market demand); future economic, competitive, financial and market conditions; consolidation in the global telecommunications test, service assurance and network visibility markets and increased competition among vendors; capacity to adapt our future product offering to future technological changes; limited visibility with regards to the timing and nature of customer orders; delay in revenue recognition due to longer sales cycles for complex systems involving customers' acceptance; fluctuating exchange rates; concentration of sales; timely release and market acceptance of our new products and other upcoming products; our ability to successfully expand international operations; our ability to successfully integrate businesses that we acquire; and the retention of key technical and management personnel. Assumptions relating to the foregoing involve judgments and risks, all of which are difficult or impossible to predict and many of which are beyond our control. Other risk factors that may affect our future performance and operations are detailed in our Annual Report, on Form 20-F, and our other filings with the U.S. Securities and Exchange Commission and the Canadian securities commissions. We believe that the expectations reflected in the forward-looking statements are reasonable based on information currently available to us, but we cannot assure that the expectations will prove to have been correct. Accordingly, you should not place undue reliance on these forward-looking statements. These statements speak only as of the date of this document. Unless required by law or applicable regulations, we undertake no obligation to revise or update any of them to reflect events or circumstances that occur after the date of this document. This discussion and analysis should be read in conjunction with the consolidated financial statements.

The following discussion and analysis of financial condition and results of operations is dated June 29, 2016.

All dollar amounts are expressed in US dollars, except as otherwise noted.


COMPANY OVERVIEW AND RECENT DEVELOPMENTS

We provide communications service providers (CSPs) with test orchestration and performance intelligence solutions to ensure the smooth deployment, maintenance and management of next-generation physical, virtual, fixed and mobile networks. We have also forged strong relationships with network equipment manufacturers (NEMs) to develop deep expertise that migrates from the lab to the field and beyond. Our key differentiation comes from combining intelligent, automated and cloud-based test and monitoring solutions with real-time analytics to deliver unmatched end-to-end visibility and assurance—from a network, services and end-user level.
 

Page 20 of 35


 
Our original products were focused on the needs of installers and operators of fiber-optic networks. Customers use these field-portable test solutions for the installation, maintenance and troubleshooting of optical networks. Over the past several years, we have enhanced our competitive position in telecommunications test, service assurance and network visibility markets through acquisitions of transport and datacom, copper/xDSL (digital subscriber lines) and wireless test companies, an IP (internet protocol) service assurance business as well as an analytics software company.

We target high-growth market opportunities related to increasing bandwidth and improving quality of experience on network infrastructures: 4G/LTE (long-term evolution), wireless backhaul, small cells and distributed antenna systems (DAS), 100G network upgrades and fiber-to-the-home (FTTH)/fiber-to-the-curb (FTTC)/fiber-to-the-node (FTTN) deployments.

We launched four key new solutions during the third quarter of 2016, including the LTB-8, a multi-module test platform dedicated to high-speed testing in lab and manufacturing environments; a 100G Power Blazer test module that can be swapped between the LTB-8 and FTB-2 Pro platforms to ease the transition between lab and field testing; and we added two 100G portable testers to our NetBlazer product family in order to address growing turn-up and troubleshooting requirements for metro networks and data center interconnects (DCIs).

Our sales increased 5.4% to $60.9 million in the third quarter of fiscal 2016 compared to $57.8 million for the same period last year. Bookings slightly increased 0.8% to $59.7 million in the third quarter of fiscal 2016, for a book-to-bill ratio of 0.98, from $59.2 million for the same period last year.

Net earnings amounted to $0.9 million, or $0.02 per diluted share, in the third quarter of fiscal 2016, compared to $0.6 million, or $0.01 per diluted share, for the same period last year. Net earnings for the third quarter of fiscal 2016 included $0.3 million in after-tax amortization of intangible assets, $0.4 million in stock-based compensation costs and a foreign exchange loss of $1.0 million. For the same period last year, net earnings included $0.4 million in after-tax amortization of intangible assets, $0.4 million in stock-based compensation costs and a foreign exchange loss of $0.2 million.

Adjusted EBITDA (net earnings before interest, income taxes, depreciation and amortization, stock-based compensation costs and foreign exchange gain or loss) reached $5.3 million, or 8.7% of sales, in the third quarter of fiscal 2016, compared to $4.5 million, or 7.7% of sales for the same period last year. See page 34 in this document for a complete reconciliation of adjusted EBITDA to IFRS net earnings.
 
On March 29, 2016, we announced that our Board of Directors approved the renewal of our share repurchase program by way of a normal course issuer bid on the open market of up to approximately 6.6% (0.9 million subordinate voting shares) of the public float of 13.6 million subordinate voting shares (as defined by the Toronto Stock Exchange (TSX)), as of March 21, 2016, at the prevailing market price. We expect to use cash, short-term investments or future cash flows from operations to fund the repurchase of shares. The normal course issuer bid started on April 1, 2016, and will end on March 31, 2017, or on an earlier date if we repurchase the maximum number of shares permitted under the bid. The program does not require that we repurchase any specific number of shares, and it may be modified, suspended or terminated at any time and without prior notice. All shares repurchased under the bid will be cancelled.
 
 
Page 21 of 35


 
RESULTS OF OPERATIONS
(in thousands of US dollars, except per share data, and as a percentage of sales for the periods indicated)

   
Three months
ended
May 31, 2016
   
Three months
ended
May 31, 2015
   
Nine months
ended
May 31, 2016
   
Nine months
ended
May 31, 2015
 
                         
Sales
 
$
60,896
   
$
57,781
   
$
169,725
   
$
165,495
 
                                 
Cost of sales (1)
   
23,880
     
22,281
     
62,921
     
63,064
 
Selling and administrative
   
20,798
     
20,489
     
60,615
     
61,689
 
Net research and development
   
11,303
     
10,923
     
31,398
     
33,087
 
Depreciation of property, plant and equipment
   
958
     
1,163
     
2,857
     
3,664
 
Amortization of intangible assets
   
294
     
444
     
880
     
2,561
 
Interest and other (income) expense
   
(309
)
   
36
     
(716
)
   
(216
)
Foreign exchange (gain) loss
   
957
     
175
     
(454
)
   
(4,787
)
                                 
Earnings before income taxes
   
3,015
     
2,270
     
12,224
     
6,433
 
                                 
Income taxes
   
2,096
     
1,707
     
5,576
     
3,458
 
                                 
Net earnings for the period
 
$
919
   
$
563
   
$
6,648
   
$
2,975
 
                                 
Basic and diluted net earnings per share
 
$
0.02
   
$
0.01
   
$
0.12
   
$
0.05
 
                                 
Other selected information:
                               
                                 
Gross margin before depreciation and amortization (2)
 
$
37,016
   
$
35,500
   
$
106,804
   
$
102,431
 
                                 
Research and development:
                               
Gross research and development
 
$
12,612
   
$
12,462
   
$
35,363
   
$
37,947
 
Net research and development
 
$
11,303
   
$
10,923
   
$
31,398
   
$
33,087
 
                                 
Adjusted EBITDA (2)
 
$
5,301
   
$
4,462
   
$
15,867
   
$
8,817
 

(1)
The cost of sales is exclusive of depreciation and amortization, shown separately.
(2)
Refer to page 34 for non-IFRS measures.
 

 
Page 22 of 35

 
 
   
Three months
ended
May 31, 2016
   
Three months
ended
May 31, 2015
   
Nine months
ended
May 31, 2016
   
Nine months
ended
May 31, 2015
 
                         
Sales
   
100.0
%
   
100.0
%
   
100.0
%
   
100.0
%
                                 
Cost of sales (1)
   
39.2
     
38.6
     
37.1
     
38.1
 
Selling and administrative
   
34.2
     
35.5
     
35.7
     
37.3
 
Net research and development
   
18.6
     
18.9
     
18.5
     
20.0
 
Depreciation of property, plant and equipment
   
1.5
     
2.0
     
1.7
     
2.2
 
Amortization of intangible assets
   
0.5
     
0.8
     
0.5
     
1.5
 
Interest and other (income) expense
   
(0.5
)
   
     
(0.4
)
   
(0.1
)
Foreign exchange (gain) loss
   
1.5
     
0.3
     
(0.3
)
   
(2.9
)
                                 
Earnings before income taxes
   
5.0
     
3.9
     
7.2
     
3.9
 
                                 
Income taxes
   
3.5
     
2.9
     
3.3
     
2.1
 
                                 
Net earnings for the period
   
1.5
%
   
1.0
%
   
3.9
%
   
1.8
%
                                 
                                 
Other selected information:
                               
                                 
Gross margin before depreciation and amortization (2)
   
60.8
%
   
61.4
%
   
62.9
%
   
61.9
%
                                 
Research and development:
                               
Gross research and development
   
20.7
%
   
21.6
%
   
20.8
%
   
22.9
%
Net research and development
   
18.6
%
   
18.9
%
   
18.5
%
   
20.0
%
                                 
Adjusted EBITDA (2)
   
8.7
%
   
7.7
%
   
9.3
%
   
5.3
%
(1)
The cost of sales is exclusive of depreciation and amortization, shown separately.
(2)
Refer to page 34 for non-IFRS measures.

 
Page 23 of 35

 
 
RESULTS OF OPERATIONS

SALES AND BOOKINGS

The following tables summarize sales and bookings by product line in thousands of US dollars:

Sales

   
Three months
ended
May 31, 2016
   
Three months
ended
May 31, 2015
   
Nine months
ended
May 31, 2016
   
Nine months
ended
May 31, 2015
 
                         
Physical-layer product line
 
$
42,074
   
$
38,167
   
$
112,133
   
$
109,074
 
Protocol-layer product line
   
19,260
     
20,492
     
59,879
     
58,191
 
     
61,334
     
58,659
     
172,012
     
167,265
 
Foreign exchange losses on forward exchange contracts
   
(438
)
   
(878
)
   
(2,287
)
   
(1,770
)
Total sales
 
$
60,896
   
$
57,781
   
$
169,725
   
$
165,495
 

Bookings

   
Three months
ended
May 31, 2016
   
Three months
ended
May 31, 2015
   
Nine months
ended
May 31, 2016
   
Nine months
ended
May 31, 2015
 
                         
Physical-layer product line
 
$
41,797
   
$
38,534
   
$
115,549
   
$
109,151
 
Protocol-layer product line
   
18,389
     
21,593
     
64,662
     
60,762
 
     
60,186
     
60,127
     
180,211
     
169,913
 
Foreign exchange losses on forward exchange contracts
   
(438
)
   
(878
)
   
(2,287
)
   
(1,770
)
Total bookings
 
$
59,748
   
$
59,249
   
$
177,924
   
$
168,143
 
 
For the three months ended May 31, 2016, our sales increased 5.4% to $60.9 million, from $57.8 million for the same period last year, while our bookings slightly increased 0.8% to $59.7 million, from $59.2 million for the same period last year, for a book-to-bill ratio of 0.98.

For the nine months ended May 31, 2016, our sales increased 2.6% to $169.7 million, from $165.5 million for the same period last year, while our bookings increased 5.8% to $177.9 million, from $168.1 million for the same period last year, for a book-to-bill ratio of 1.05.

Sales

In the third quarter of fiscal 2016, the year-over-year sales increase in our Physical-layer product line is mainly due to our leadership position in portable optical testing and a 100G investment cycle among communications service providers (CSPs), especially in the Americas. On the other hand, our Protocol-layer product line reported a year-over-year sales decrease since longer-than-expected sales cycles for systems-related solutions postponed some deals after the end of the third quarter. Our transport and datacom product line mitigated this negative impact with year-over-year sales growth as this sub-group within our Protocol-layer product line also benefited from the 100G investment cycle.
 

Page 24 of 35


 
On a year-to-date basis, despite strong sales results in the first nine months of fiscal 2016, we faced a significant headwind from a stronger US dollar compared to the same last year. Given that we generate a portion of our revenue in Canadian dollars (Americas) and in euros (Europe, Middle East and Africa [EMEA]) but report our results in US dollars, it had a negative impact on our total sales and bookings year-over-year, as the US dollar increased against these currencies. In fact, for the first nine months of fiscal 2016, our total sales would have increased by approximately 5% and our total bookings would have increased by approximately 8% year-over-year in constant currencies.

In the first nine months of fiscal 2016, both product lines delivered year-over-year increases in sales, despite the negative currency impact. Overall, the year-over-year increase in sales in the first nine months of fiscal 2016 comes from the Americas, as sales to EMEA slightly decreased and sales to the Asia-Pacific (APAC) region were flat.

Bookings

In the third quarter of fiscal 2016, we delivered robust 8.5% year-over-year increases in bookings for our physical-layer product line, especially in the EMEA and APAC regions. These strong results were offset in part by a year-over-year decrease in bookings for our protocol-layer product line, which decreased 14.8% year-over-year, especially in the Americas. As we evolve from a supplier of dedicated test instruments to a supplier of end-to-end solutions, our quarterly sales and bookings are increasingly subject to quarterly fluctuations, because we are managing more complex, multi-million dollar deals that have prolonged sales and revenue recognition cycles related to our protocol-layer products. In the third quarter of fiscal 2016, a longer than expected sales cycle resulted in some deals postponed to after the quarter, mainly in the Americas.

In the first nine months of fiscal 2016, we delivered solid year-over-year increases in bookings for our two product lines, despite the negative currency impact. The year-over-year increase in bookings was manifested through heightened penetration of mobile network operators for their fronthaul and backhaul networks, increased traction with fixed network operators for their 100G long-haul and metro links, and growing business with web-scale operators for their data center interconnects. In addition, in the second quarter of 2016, we received significant orders from two network operators in the Americas for our EXFO Xtract solution, which resulted in increased bookings for our protocol-layer product line year-over-year. Overall, in the first nine months of fiscal 2016, we reported year-over-year increases in bookings in every geographic area, with robust growth in EMEA and APAC, and modest growth in the Americas.

We delivered book-to-bill ratios of 0.98 and 1.05 for the third quarter and the first nine months of fiscal 2016 respectively.

Sales by geographic region

The following table summarizes sales by geographic region:
 
   
Three months
ended
May 31, 2016
 
Three months
ended
May 31, 2015
 
Nine months
ended
May 31, 2016
 
Nine months
ended
May 31, 2015
                         
Americas
 
59
%
 
58
%
 
55
%
 
53
%
EMEA
 
22
   
23
   
25
   
27
 
APAC
 
19
   
19
   
20
   
20
 
                         
   
100
%
 
100
%
 
100
%
 
100
%
 
 
Page 25 of 35


 
Customer concentration

We sell our products to a broad range of customers, including fixed and mobile network operators, web-scale service providers as well as equipment manufacturers. In the third quarters of fiscal 2015 and 2016, no customer accounted for more than 10% of our sales, and our top three customers accounted for 15.7% and 14.7% of sales respectively. In the first nine months of fiscal 2015 and 2016, no customer accounted for more than 10% of our sales, and our top three customers accounted for 12.8% and 14.2% of our sales respectively.


GROSS MARGIN BEFORE DEPRECIATION AND AMORTIZATION
(non-IFRS measure — refer to page 34 of this document)

Gross margin before depreciation and amortization (gross margin) decreased to 60.8% of sales for the three months ended May 31, 2016, from 61.4% for the same period last year.

Gross margin increased to 62.9% of sales for the nine months ended May 31, 2016, from 61.9% for the same period last year.

In the third quarter of fiscal 2016, our gross margin was unfavorably affected by our product mix. In fact, the year-over-year increase in sales comes from our physical-layer product line, which delivers lower margins compared to our protocol-layer product line, which has richer software content. In addition, an unfavorable product mix within our physical-layer product line, reduced our gross margin year-over-year.

On the other hand, in the third quarter of fiscal 2016, we recorded lower inventory write-off compared to the same period last year, which contributed to increase our gross margin by 0.9% year-over-year.
 
In addition, in the third quarter of fiscal 2016, we recorded in our sales foreign exchange losses of $0.4 million on our forward exchange contracts, which were lower compared to $0.9 million for the same period last year; this contributed to increase our gross margin by 0.3% year-over-year.
 
Finally, in the third quarter of fiscal 2016, a stronger US dollar compared to other currencies reduced our manufacturing costs and had a positive impact on our gross margin year-over-year.

In the first nine months of fiscal 2016, our gross margin was favorably affected by a richer product mix within our protocol-layer product line. Namely, year-over-year sales increases for our transport and datacom (T&D) products, as well as the recognition of a large order with a tier-1 network operator for our EXFO Xtract software analytics solution, had a positive impact on our gross margin during the first nine months of fiscal 2016, compared to the same period last year; this was offset in part by an unfavorable product mix within our physical-layer product line year-over-year.

In addition, in the first nine months of fiscal 2016, we recorded lower inventory write-off compared to the same period last year, which contributed to increase our gross margin by 0.7% year-over-year.

Finally, in the first nine months of fiscal 2016, a stronger US dollar compared to other currencies reduced our manufacturing costs and had a positive impact on our gross margin year-over-year.


SELLING AND ADMINISTRATIVE EXPENSES

For the three months ended May 31, 2016, selling and administrative expenses were $20.8 million, or 34.2% of sales, compared to $20.5 million, or 35.5% of sales for the same period last year.

For the nine months ended May 31, 2016, selling and administrative expenses were $60.6 million, or 35.7% of sales, compared to $61.7 million, or 37.3% of sales for the same period last year.
 
 
Page 26 of 35


 
In the third quarter of fiscal 2016, our selling and administrative expenses increased year-over-year due to higher expenses on higher sales, as well as inflation and salary increases. These elements were offset in part by the positive impact of the increase in the average value of the US dollar compared to the Canadian dollar year-over-year, as a portion of our selling and administrative expenses are incurred in Canadian dollars and we report our results in US dollars.

In the first nine months of fiscal 2016, our selling and administrative expenses decreased due to the increase in the average value of the US dollar compared to the Canadian dollar and the euro year-over-year, as a portion of our selling and administrative expenses are incurred in Canadian dollars and euros, and we report our results in US dollars, and the positive impact of our latest restructuring plan, which more than offset inflation, salary increases, and increased commission expenses on increased sales.

In the third quarter and the first nine months of fiscal 2016, our selling and administrative expenses decreased as a percentage of sales compared to the same periods last year; this is because our sales increased year-over-year and a large portion of these expenses are relatively fixed in the short term.


RESEARCH AND DEVELOPMENT EXPENSES

Gross research and development expenses

For the three months ended May 31, 2016, gross research and development expenses totaled $12.6 million, or 20.7% of sales, compared to $12.5 million, or 21.6% of sales, for the same period last year.

For the nine months ended May 31, 2016, gross research and development expenses totaled $35.4 million, or 20.8% of sales, compared to $37.9 million, or 22.9% of sales, for the same period last year.
 
In the third quarter of fiscal 2016, our gross research and development expenses increased year-over-year due to a shift in the mix and timing of research and development projects, compared to the same period last year, as well as inflation and salary increases; these elements were offset in part by the positive impact of the increase in the average value of the US dollar compared to the Canadian dollar year-over-year, as a portion of our gross research and development expenses are incurred in Canadian dollars and we report our results in US dollars.

In the first nine months of fiscal 2016, the year-over-year increase in the average value of the US dollar, compared to the Canadian dollar and the euro had a positive impact on our gross research and development expenses as a large portion of these expenses are incurred in Canadian dollars and euros, and we report our results in US dollars. However, these positive impacts year-over-year were offset in part by inflation, salary increases, as well as a shift in the mix and timing of research and development projects, compared to the same period last year.

Tax credits and grants

We are entitled to tax credits from the Canadian federal and provincial governments for eligible research and development activities conducted in Canada. We are also eligible for grants issued by a Finnish technology organization on certain research and development projects conducted in Finland.

For the three months ended May 31, 2016, tax credits and grants for research and development activities were $1.3 million, or 10.4% of gross research and development expenses, compared to $1.5 million, or 12.3% of gross research and development expenses for the same period last year.

For the nine months ended May 31, 2016, tax credits and grants for research and development activities were $4.0 million, or 11.2% of gross research and development expenses, compared to $4.9 million, or 12.8% of gross research and development expenses for the same period last year.
 
 
Page 27 of 35


 
In the third quarter and the first nine months of fiscal 2016, the year-over-year decrease in our tax credits and grants mainly results from the increase in the average value of the US dollar, compared to the Canadian dollar year-over-year, as our tax credits are denominated in Canadian dollars and we report our results in US dollars.


DEPRECIATION OF PROPERTY, PLANT AND EQUIPMENT

For the three months ended May 31, 2016, depreciation of property, plant and equipment amounted to $1.0 million compared to $1.2 million for the same period last year.

For the nine months ended May 31, 2016, depreciation of property, plant and equipment amounted to $2.9 million compared to $3.7 million for the same period last year.

In the third quarter and the first nine months of fiscal 2016, the year-over-year increase in the average value of the US dollar compared to the Canadian dollar had a positive impact on our depreciation expenses as these expenses are incurred in Canadian dollars and we report our results in US dollars.


AMORTIZATION OF INTANGIBLE ASSETS

For the three months ended May 31, 2016, amortization of intangible assets amounted to $0.3 million compared to $0.4 million for the same period last year.

For the nine months ended May 31, 2016, amortization of intangible assets amounted to $0.9 million compared to $2.6 million for the same period last year.

The decrease in our amortization expenses in the third quarter and the first nine months of fiscal 2016, compared to the same period last years, is mainly due to the fact that core technology related to the acquisition of NetHawk Oyj (acquired in fiscal 2010) became fully amortized in the third quarter of fiscal 2015, and that the average value of the US dollar increased compared to the Canadian dollar year-over-year, as our amortization expenses is incurred in this currency and we report our results in US dollars.


FOREIGN EXCHANGE GAIN (LOSS)

Foreign exchange gains and losses are mainly the result of the translation of operating activities denominated in currencies other than our functional currency, which is the Canadian dollar. A portion of our foreign exchange gains or losses result from the translation of cash balances and deferred income taxes denominated in US dollars. We manage our exposure to currency risk in part with forward exchange contracts. In addition, some of our entities' operating activities are denominated in US dollars, euros and British pounds, which further hedges this risk. However, we remain exposed to a currency risk; namely, any increase in the value of the Canadian dollar, compared to the US dollar, would have a negative impact on our operating results.

For the three months ended May 31, 2016, we recorded a foreign exchange loss of $1.0 million compared to $0.2 million for the same period last year.

For the nine months ended May 31, 2016, foreign exchange gain amounted to $0.5 million compared to $4.8 million for the same period last year.

During the third quarter of fiscal 2016, the period-end value of the Canadian dollar increased versus the US dollar, compared to the previous quarter, which resulted in a foreign exchange loss of $1.0 million during the quarter. In fact, the period-end value of the Canadian dollar increased 3.2% versus the US dollar to CAD$1.3110 = US$1.00 in the third quarter of fiscal 2016, compared to CAD$1.3531 = US$1.00 at the end of the previous quarter.
 
 
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During the same period last year, the period-end value of the Canadian dollar slightly increased versus the US dollar, compared to the previous quarter, which resulted in a foreign exchange loss of $0.2 million during that period. The period-end value of the Canadian dollar increased 0.5% versus the US dollar to CAD$1.2437= US$1.00 in the third quarter of fiscal 2015, compared to CAD$1.2503 = US$1.00 at the end of the previous quarter.

During the first nine months of fiscal 2016, we witnessed some volatility in the value of the Canadian dollar as it fluctuated compared to the US dollar, which overall resulted in a foreign exchange gain of $0.5 million during that period. The period-end value of the Canadian dollar slightly increased 0.4% versus the US dollar to CAD$1.3110 = US$1.00 in the first nine months of fiscal 2016, compared to CAD$1.3157 = US$1.00 at the end of the previous year.

During the same period last year, the period-end value of the Canadian dollar significantly decreased versus the US dollar, compared to the previous year end, which resulted in a foreign exchange gain of $4.8 million during that period. The period-end value of the Canadian dollar decreased 12.7% versus the US dollar to CAD$1.2437 = US$1.00 in the first nine months of fiscal 2015, compared to CAD$1.0858 = US$1.00 at the end of the previous year.

Foreign exchange rate fluctuations also flow through the P&L line items as a portion of our sales, which are dominated in Canadian dollars and euros, and a significant portion of cost of sales and our operating items are denominated in Canadian dollars, euros and Indian rupees, and we report our results in US dollars. Consequently, the increase in the average value of the US dollar in the third quarter compared to the Canadian dollar year-over-year, resulted in a positive impact on our financial results. In fact, the average value of the US dollar in the third quarter of fiscal 2016 increased 4.8% year-over-year, compared to the Canadian dollar. In the first nine months of fiscal 2016, the increase in the average value of the US dollar compared to the Canadian dollar and the euro year-over-year, resulted in a positive impact on our financial results. In fact, during the first nine months of fiscal 2016, it increased 11.3% and 6.1% respectively year-over-year, compared to the Canadian dollar and the euro.


INCOME TAXES

For the three months ended May 31, 2016, we reported income tax expenses of $2.1 million on earnings before income taxes of $3.0 million. For the corresponding period last year, we reported income tax expenses of $1.7 million on earnings before income taxes of $2.3 million.

For the nine months ended May 31, 2016, we reported income tax expenses of $5.6 million on earnings before income taxes of $12.2 million. For the corresponding period last year, we reported income tax expenses of $3.5 million on earnings before income taxes of $6.4 million.

These distorted tax rates mainly resulted from the fact that we did not recognize deferred income tax assets for some of our subsidiaries at loss and had some non-deductible losses and expenses, such as stock-based compensation costs. In addition, a significant portion of our foreign exchange gain or loss was created by the translation of financial statements of our foreign subsidiaries into the functional currency, and was therefore non-taxable or non-deductible. Otherwise, our effective tax rate would have been closer to the combined Canadian and provincial statutory tax rate of 27% for both periods.

Please refer to note 7 to our condensed unaudited interim consolidated financial statements for a full reconciliation of our income tax provision.
 
 

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LIQUIDITY AND CAPITAL RESOURCES

Cash requirements and capital resources

As at May 31, 2016, cash and short-term investments totaled $46.3 million, while our working capital was at $84.6 million. Our cash and short-term investments increased by $1.9 million in the third quarter of fiscal 2016, compared to the previous quarter, mainly due to cash flows from operating activities of $2.3 million.

Our short-term investments consist of debt instruments issued by high-credit quality corporations; therefore, we consider the risk of non-performance of these financial instruments to be limited. These debt instruments are not expected to be affected by a significant liquidity risk. For the purpose of managing our cash position, we have established a cash management policy, which we follow and monitor on a regular basis. Our cash and short-term investments will be used for working capital and other general corporate purposes, potential acquisitions as well as our share repurchase program. As at May 31, 2016, cash balances included an amount of $25.0 million that bears interest at an annual rate of 1.2%.

We believe that our cash balances and short-term investments will be sufficient to meet our liquidity and capital requirements for the foreseeable future, including the effect of our normal course issuer bid. In addition to these assets, we have unused available lines of credit totaling $15.2 million for working capital and other general corporate purposes, and unused lines of credit of $20.7 million for foreign currency exposure related to forward exchange contracts. However, possible operating losses, additional restructuring costs and/or possible investments in or acquisitions of complementary businesses, products or technologies may require additional financing. There can be no assurance that additional debt or equity financing will be available when required or, if available, that it can be secured on satisfactory terms.

Sources and uses of cash

We finance our operations and meet our capital expenditure requirements mainly through cash flows from operating activities, the use of our cash and short-term investments as well as the issuance of subordinate voting shares.

Operating activities

Cash flows provided by operating activities were $2.3 million for the three months ended May 31, 2016, compared to cash flows used of $1.3 million for the same period last year.

Cash flows provided by operating activities were $20.8 million for the nine months ended May 31, 2016, compared to $6.4 million for the same period last year.

Cash flows provided by operating activities in the third quarter of fiscal 2016 were attributable to the net earnings after items not affecting cash of $5.0 million, offset in part by the negative net change in non-cash operating items of $2.7 million. This was mainly due to the negative effect on cash of the increase of $5.9 million in our accounts receivable due to the sequential increase in sales, as well as the timing of receipts and sales during the quarter, the $0.3 million increase in our income tax and tax credits recoverable due to tax credits earned during the quarter not yet recovered, the $0.8 million increase in our inventories to meet future demand, and the $0.5 million increase in our prepaid expenses due to timing of payments during the quarter. These negative effects on cash were offset in part by the positive effect on cash of the $4.7 million increase in our accounts payable, accrued liabilities and provisions due to the timing of purchases and payments during the quarter.
 
 

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Cash flows used by operating activities in the third quarter of fiscal 2015 were attributable to the net earnings after items not affecting cash of $3.9 million, which was more than offset by the $5.1 million negative net change in non-cash operating items. This was mainly due to the negative effect on cash of the increase of $6.5 million in our accounts receivable due to the sequential increase in sales as well as the timing of receipts and sales during the quarter, the negative effect on cash of the increase of $0.5 million in our income tax and tax credits recoverable due to tax credits earned during the quarter not yet recovered, and the negative effect on cash of the increase of $0.4 million in our prepaid expenses due to timing of payments during the quarter. These negative effects on cash were offset in part by the positive effect on cash of the decrease of $1.0 million in our inventories due to improved inventory turns and the positive effect on cash of the increase of $1.3 million in our accounts payable, accrued liabilities and provisions due to timing of purchases and payments during the quarter.

Cash flows provided by operating activities in the first nine months of fiscal 2016 were attributable to the net earnings after items not affecting cash of $17.3 million, and the positive net change in non-cash operating items of $3.5 million. This was mainly due to the positive effect on cash of the decrease of $3.4 million in our accounts receivable due to the timing of receipts and sales during the period, the $0.6 million decrease in our income tax and tax credits recoverable due to tax credits earned in previous periods recovered during the period, and the $6.4 million increase in our accounts payable, accrued liabilities and provisions due to the timing of purchases and payments during the period. These positive effects on cash were offset in part by the negative effect on cash of the $6.6 million increase in our inventories to meet future demand, and the negative effect on cash of the increase of $0.4 million in our prepaid expenses due to timing of payments during the period.

Cash flows provided by operating activities in the first nine months of fiscal 2015 were attributable to the net earnings after items not affecting cash of $9.0 million, offset in part by the negative net change in non-cash operating items of $2.7 million. This was mainly due to the positive effect on cash of the increase of $9.0 million in our accounts payable, accrued liabilities and provisions due to timing of purchases and payments during the period. This positive effect on cash was offset in part by the negative effect on cash of the increase of $7.8 million in our accounts receivable due to the timing of receipts and sales during the period, the negative effect on cash of the increase of $2.0 million in our income tax and tax credits recoverable due to tax credits earned during the period not yet recovered, the negative effect on cash of the increase of $1.0 million in our inventories to meet future demand, and the negative effect on cash of the increase of $0.9 million in our prepaid expenses due to timing of payments during the period.

Investing activities

Cash flows used by investing activities were $4.2 million for the three months ended May 31, 2016, compared to $0.2 million for the same period last year.

Cash flows used by investing activities were $6.0 million for the nine months ended May 31, 2016, compared to $0.4 million for the same period last year.

In the third quarter of fiscal 2016, we acquired $3.1 million worth of short-term investment and we paid $1.1 million for the purchase of capital assets.

For the corresponding period last year, we paid $1.8 million for the purchase of capital assets but we disposed (net of acquisitions) of $1.6 million worth of short-term investments.

In the first nine months of fiscal 2016, we acquired (net of disposals) $2.6 million worth or short-term investments, and we paid $3.4 million for the purchase of capital assets.

For the corresponding period last year, we paid $4.6 million for the purchase of capital assets, but we disposed (net of acquisitions) of $4.2 million worth of short-term investments.
 
 
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Financing activities

Cash flows used by financing activities were $0.2 million for the three months ended May 31, 2016, compared to $0.1 million for the same period last year.

Cash flows provided by financing activities were $0.1 million for the nine months ended May 31, 2016, compared to cash flows used of $25.2 million for the same period last year.

In the third quarter of fiscal 2016, we redeemed share capital under our share repurchase program for a cash consideration of $0.2 million.

In the first nine months of fiscal 2016, our bank loan increased by $0.5 million, but we redeemed share capital under our share repurchase program for a cash consideration of $0.4 million.

For the corresponding period last year, we redeemed share capital under our share repurchase programs (namely our substantial issuer bid) for a cash consideration of $25.2 million.


FORWARD EXCHANGE CONTRACTS

We are exposed to a currency risk as a result of our export sales of products manufactured in Canada, China and Finland, the majority of which are denominated in US dollars and euros. In addition, we are exposed to a currency risk as a result of our research and development activities in India (Indian rupees). These risks are partially hedged by forward exchange contracts. Forward exchange contracts, which are designated as cash flow hedging instruments, qualify for hedge accounting.

As at May 31, 2016, we held forward exchange contracts to sell US dollars for Canadian dollars and Indian rupees at various forward rates, which are summarized as follows:

US dollars – Canadian dollars

Expiry dates
 
Contractual
amounts
   
Weighted average
contractual
forward rates
 
             
June 2016 to August 2016
 
$
6,300,000
     
1.2142
 
September 2016 to August 2017
   
22,200,000
     
1.2784
 
September 2017 to August 2018
   
9,900,000
     
1.3367
 
September 2018 to December 2018
   
1,900,000
     
1.3639
 
Total
 
$
40,300,000
     
1.2867
 

US dollars – Indian rupees

Expiry dates
 
Contractual
amounts
   
Weighted average
contractual
forward rates
 
             
June 2016 to August 2016
 
$
1,000,000
     
67.88
 
September 2016 to May 2017
   
2,600,000
     
70.82
 
   
$
3,600,000
     
70.00
 
 
 
Page 32 of 35

 
 
The carrying amount of forward exchange contracts is equal to fair value, which is based on the amount at which they could be settled based on estimated current market rates. The fair value of forward exchange contracts amounted to net losses of $4.2 million as at August 31, 2015 and $0.6 million as at May 31, 2016, mainly for our US/Canadian dollars forward exchange contracts. The quarter-end exchange rate was CAD$1.3110 = US$1.00 as at May 31, 2016.


SHARE CAPITAL

As at June 29, 2016, EXFO had 31,643,000 multiple voting shares outstanding, each entitled to 10 votes per share, and 22,253,240 subordinate voting shares outstanding. The multiple voting shares and the subordinate voting shares are unlimited as to number and without par value.


OFF-BALANCE SHEET ARRANGEMENTS

As at May 31, 2016, our off-balance sheet arrangements consisted of letters of guarantee amounting to $469,000 for our own selling and purchasing requirements, which were reserved from our lines of credit; these letters of guarantee expire at various dates through fiscal 2020.


STRUCTURED ENTITIES

As at May 31, 2016, we did not have interests in any structured entities.


CRITICAL ACCOUNTING POLICIES AND ESTIMATES

For a description of the critical accounting policies, judgments in applying accounting policies as well as estimates and assumptions used in the preparation of our consolidated financial statements, refer to our Annual Report on Form 20-F for the year ended August 31, 2015, filed with the U.S. Securities and Exchange Commission and the Canadian securities commissions.


NEW IFRS PRONOUNCEMENTS

Refer to note 2 to our condensed unaudited interim consolidated financial statements for the three and nine months ended May 31, 2016 and to our consolidated financial statements for the year ended August 31, 2015, for the effect of certain recent accounting pronouncements on our consolidated financial statements.


RISKS AND UNCERTAINTIES

For the first nine months of fiscal 2016, there have been no material changes from the risk factors disclosed in our Annual Report on Form 20-F for the year ended August 31, 2015.
 

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NON-IFRS MEASURES

We provide non-IFRS measures (constant currency data, gross margin before depreciation and amortization and adjusted EBITDA) as supplemental information regarding our operational performance. We use these measures for the purpose of evaluating our historical and prospective financial performance, as well as our performance relative to our competitors. These measures also help us plan and forecast future periods as well as make operational and strategic decisions. We believe that providing this information to our investors, in addition to the IFRS measures, allows them to see the company's results through the eyes of management, and to better understand our historical and future financial performance.

The presentation of this additional information is not prepared in accordance with IFRS. Therefore, the information may not necessarily be comparable to that of other companies and should be considered as a supplement to, not a substitute for, the corresponding measures calculated in accordance with IFRS.

Constant currency data represents data before foreign currency impact. Data for the current period is translated using foreign exchange rates of the corresponding period from the preceding year.

Gross margin before depreciation and amortization represents sales, less cost of sales, excluding depreciation and amortization.

Adjusted EBITDA represents net earnings before interest, income taxes, depreciation and amortization, stock-based compensation costs and foreign exchange gain or loss.

The following table summarizes the reconciliation of adjusted EBITDA to IFRS net earnings, in thousands of US dollars:

Adjusted EBITDA (unaudited)

   
Three months
ended
May 31, 2016
   
Three months
ended
May 31, 2015
   
Nine months
ended
May 31, 2016
   
Nine months
ended
May 31, 2015
 
                         
IFRS net earnings for the period
 
$
919
   
$
563
   
$
6,648
   
$
2,975
 
                                 
Add (deduct):
                               
                                 
Depreciation of property, plant and equipment
   
958
     
1,163
     
2,857
     
3,664
 
Amortization of intangible assets
   
294
     
444
     
880
     
2,561
 
Interest and other (income) expense
   
(309
)
   
36
     
(716
)
   
(216
)
Income taxes
   
2,096
     
1,707
     
5,576
     
3,458
 
Stock-based compensation costs
   
386
     
374
     
1,076
     
1,162
 
Foreign exchange (gain) loss
   
957
     
175
     
(454
)
   
(4,787
)
Adjusted EBITDA for the period
 
$
5,301
   
$
4,462
   
$
15,867
   
$
8,817
 
                                 
Adjusted EBITDA in percentage of sales
   
8.7
%
   
7.7
%
   
9.3
%
   
5.3
%

 
Page 34 of 35


 
QUARTERLY SUMMARY FINANCIAL INFORMATION (unaudited)
(tabular amounts in thousands of US dollars, except per share data)

   
Quarters ended
 
   
May 31,
2016
   
February 29,
2016
   
November 30,
2015
   
August 31,
2015
 
                         
Sales
 
$
60,896
   
$
53,597
   
$
55,232
   
$
56,594
 
Cost of sales (1)
 
$
23,880
   
$
18,904
   
$
20,137
   
$
21,975
 
Net earnings
 
$
919
   
$
3,963
   
$
1,766
   
$
2,323
 
Basic and diluted net earnings per share
 
$
0.02
   
$
0.07
   
$
0.03
   
$
0.04
 


   
Quarters ended
 
   
May 31,
2015
   
February 28,
2015
   
November 30,
2014
   
August 31,
2014
 
                         
Sales
 
$
57,781
   
$
50,990
   
$
56,724
   
$
59,742
 
Cost of sales (1)
 
$
22,281
   
$
19,546
   
$
21,237
   
$
22,109
 
Net earnings
 
$
563
   
$
931
   
$
1,481
   
$
1,204
 
Basic and diluted net earnings per share
 
$
0.01
   
$
0.02
   
$
0.02
   
$
0.02
 

(1)
The cost of sales is exclusive of depreciation and amortization.

 
 
 
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