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 November, 2005
EXFO ELECTRO-OPTICAL ENGINEERING INC.
(Translation of registrant's name into English)
400 GODIN AVENUE, VANIER, QUEBEC, CANADA G1M 2K2
(Address of principal executive offices)
Indicate by check mark whether the registrant files or will file annual reports
under cover of Form 20-F or Form 40-F.
Form 20-F [X] Form 40-F [_]
Indicate by check mark whether the registrant by furnishing the information
contained in this Form is also thereby furnishing the information to the
Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of
1934.
Yes [_] No [X]
If "Yes" is marked, indicate below the file number assigned to the registrant in
connection with Rule 12g3-2(b): 82-______.
In November 2005, EXFO Electro-Optical Engineering Inc., a Canadian
corporation, issued its annual report containing its annual audited financial
statements and management's discussion and analysis thereof for its fiscal
year ended August 31, 2005. At the same time, it also issued its notice of its
annual shareholders' meeting, its form of proxy, its management proxy circular
and a cover letter. This report on Form 6-K sets forth said documents.
The annual report containing the Corporation's annual audited financial
statements and management's discussion and analysis for its fiscal year ended
August 31, 2005, its notice of annual shareholders' meeting, its form of
proxy, its management proxy circular and cover letter are hereby incorporated
as documents by reference to Form F-3 (Registration Statement under the
Securities Act of 1933) declared effective as of July 30, 2001 and to Form F-3
(Registration Statement under the Securities Act of 1933) declared effective
as of March 11, 2002 and to amend certain material information as set forth in
these two Form F-3 documents.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
By: /s/ Germain Lamonde
-----------------------
Name: Germain Lamonde
Title: President and Chief Executive Officer
Date: November 29, 2005
[GRAPHIC OMITTED][PHOTOGRAPHS]
[GRAPHIC OMITTED][PHOTOGRAPHS] 2005 ANNUAL REPORT
[GRAPHIC OMITTED] [GRAPHIC OMITTED]
[1985 - 20 EXFO - 2005 EXFO
YEARS OF INNOVATION EXPERTISE REACHING OUT
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Mission Statement
EXFO's mission is to be a world leader in telecommunications test and
measurement equipment. This goal will be achieved through the pursuit of
excellence and the full commitment of all our employees to exceed customer
expectations with market-driven innovation setting the highest standards.
Corporate Profile
EXFO is a recognized test and measurement expert in the global
telecommunications industry through the design and manufacture of advanced and
innovative solutions as well as best-in-class customer support. The Telecom
Division, which represents our main business activity, offers fully integrated
and complete test solutions to network service providers, cable operators,
system vendors and component manufacturers in approximately 70 countries. One
of our strongest competitive advantages is out PC/Windows-based modular
platforms that host a wide range of tests across the opttical, physical, data
and network layers, while maximizing technology reuse across several market
segments. The Life Sciences and Industrial Division mainly leverages core
telecom technologies to offer vaue-added solutions in the life sciences and
high-precision assembly sectors. For more information about EXFO vist
www.exfo.com.
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Table of Contents
1 Financial Highlights
2 Letter to Shareholders
4 Corporate Highlights
6 Telecom Division
8 Life Sciences & Industrial Division
9 Management's Discussion and Analysis
24 Management's Report
24 Report of Independent Auditors
25 Consolidated Financial Statements
29 Notes to Consolidated Financial Statements
53 Board of Directors
54 Management abd Cororate Officers
55 Corporate Governance Practices
57 Glossary
58 Shareholder Information
59 Worldwide Offices
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FORWARD-LOOKING STATEMENTS
This Annual Report 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, will,
expect, believe, anticipate, intend, could, estimate, continue, or the
negative or comparable terminology are intended to identify forward-looking
statements. In addition, any statements that refer to expectations,
projections or other characterizations of future events 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 consolidation in the global telecommunications test and measurement
industry; capital spending levels in the telecommunications, life sciences and
high-precision assembly sectors; concentration of sales; fluctuating exchange
rates and our ability to execute in these uncertain conditions; the effects of
the additional actions we have taken in response to such economic uncertainty
(including workforce reductions, ability to quickly adapt cost structures with
anticipated levels of business, ability to manage inventory levels with market
demand); market acceptance of our new products and other upcoming products;
limited visibility with regards to customer orders and the timing of such
orders; our ability to successfully integrate our acquired and to-be-acquired
businesses; the retention of key technical and management personnel; and
future economic, competitive and market conditions. Assumptions relating to
the foregoing involve judgments and risks, all of which are difficult or
impossible to predict 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 reffected in the forward-looking statements are
reasonable based on information currently available to us, but we cannot
assure you that the expectations will prove to have been correct. Accordingly,
you should not place undue reliance on these forward-looking statements. These
statements speak only as of the date of this document. We undertake no
obligation to revise or update any of them to reffect events or circumstances
that occur after the date of this document.
TRADEMARKS AND LOGOS
EXFO and the EXFO logo are registered trademarks of EXFO Electro-Optical
Engineering Inc. in Canada, the United States and/or other countries. Other
EXFO product names or logos referenced in this document are either trademarks
or registered trademarks of EXFO Electro-Optical Engineering Inc. or of its
affiiated companies. All other product names and trademarks mentioned herein
are trademarks of their respective owners. However, neither the presence nor
absence of the identification symbols (R) or TM affects the legal status of
any trademark.
All dollar amounts in this Annual Report are expressed in US dollars, except
as otherwise noted.
[GRAPHIC OMITTED]
Financial Highlights
(tabular amounts in thousands of US dollars, except per share data)
Consolidated Statements of Earnings Data 2005 2004 2003 2002 2001
----------------------------------------------------------------------------------------------------------------
Sales $ 97,216 $ 74,630 $ 61,930 $ 68,330 $ 146,013
Gross margin (1) $ 53,157 $ 40,074 $ 25,733 $ 15,964 $ 89,806
54.7% 53.7% 41.6% 23.4% 61.5%
----------------------------------------------------------------------------------------------------------------
Selling and administrative $ 31,782 $ 25,890 $ 26,991 $ 33,881 $ 44,975
32.7% 34.7% 43.6% 49.6% 30.8%
----------------------------------------------------------------------------------------------------------------
Gross research and development $ 15,878 $ 15,668 $ 17,133 $ 17,005 $ 17,601
16.3% 21.0% 27.7% 24.9% 12.1%
----------------------------------------------------------------------------------------------------------------
Earnings (loss) from operations (2) $ (199) $ (10,570) $ (39,584) $ (74,783) $ 14,507
(0.2%) (14.1%) (63.9%) (109.4%) 9.9%
----------------------------------------------------------------------------------------------------------------
Net loss $ (1,634) $ (8,424) $ (54,950) $(308,524) $ (15,294)
(1.7%) (11.3%) (88.7%) (451.5%) (10.5%)
----------------------------------------------------------------------------------------------------------------
Basic and diluted net loss per share $ (0.02) $ (0.13) $ (0.87) $ (5.09) $ (0.29)
----------------------------------------------------------------------------------------------------------------
Consolidated Balance Sheets Data
----------------------------------------------------------------------------------------------------------------
Cash and short-term investments $ 112,002 $ 89,128 $ 57,376 $ 49,681 $ 74,590
----------------------------------------------------------------------------------------------------------------
Working capital $ 135,288 $ 115,141 $ 77,408 $ 91,374 $ 130,289
----------------------------------------------------------------------------------------------------------------
Total assets $ 190,957 $ 172,791 $ 146,254 $ 177,926 $ 442,577
----------------------------------------------------------------------------------------------------------------
Long-term debt (excluding current portion) $ 198 $ 332 $ 453 $ 564 $ 664
----------------------------------------------------------------------------------------------------------------
Shareholders' equity $ 173,400 $ 157,327 $ 129,826 $ 165,406 $ 414,805
----------------------------------------------------------------------------------------------------------------
(1) Including inventory write-offs of $4,121,000 and $18,463,000 for the years ended August 31, 2003 and 2002,
respectively, and nil for the years ended August 31, 2005, 2004 and 2001. Including an unusual gain of
$473,000 for the year ended August 31, 2003, and nil for the years ended August 31, 2005, 2004, 2002 and
2001.
(2) Including charges for stock-based compensation costs, inventory and tax credit write-offs, unusual grants
recovery, amortization of intangible assets, impairment of long-lived assets and goodwill as well as
restructuring and other charges of $6,091,000, $7,878,000, $22,943,000, $57,451,000 and $13,456,000 for the
years ended August 31, 2005, 2004, 2003, 2002 and 2001, respectively.
[GRAPHIC OMITTED][PIE CHARTS]
TOTAL SALES (in thousands of dollars)
GEOGRAPHIC SALES
2005 2004 2003 2002 2001
$97,216 $74,630 $61,930 $68,330 $146,013
Americas 68% 66% 66% 61% 62%
Europe, Middle East
and Africa 20% 18% 18% 20% 25%
Asia-Pacific 12% 16% 16% 19% 13%
DIVISIONAL SALES
Telecom Division 82% 79% 79% 80% 83%
Life Sciences and
Industrial Division 18% 21% 21% 20% 17%
2005 Annual Report o EXFO :: 1
[GRAPHIC OMITTED]
[PHOTOGRAPH -- Germain Lamonde/
Chairman, President and Chief Executive Officer]
------------------------------------------------
"While our FTTx market penetration was excellent
in 2005, we believe this is just the beginning
of a long-term deployment trend."
------------------------------------------------
Dear Shareholders,
EXFO celebrated its 20th anniversary in a fitting manner in fiscal 2005 as
reflected by most of our financial indicators. We continued our long-term,
market-driven innovation strategy to tap into new, revenue-generating market
opportunities. This strong positioning led to significant progress in market
share, sales and profitability in 2005, even though we faced a highly
competitive and changing landscape as well as considerable currency
fluctuations.
Performance Highlights
| Increased sales 30.3% to $97.2 million in 2005, up from a 20.5%
increase in 2004;
| Achieved positive GAAP net earnings in the last three quarters of
2005; net loss reduced from $8.4 million in 2004 to $1.6 million in
2005;
| Generated $14.0 million in cash flows from operating activities, up
from $0.8 million in 2004;
| Reached a leadership position in the high-growth, optical FTTx test
market; and
| Derived 42.4% of sales from new products on the market two years or
less.
These results represent tangible evidence that we adopted the right long-term
strategy to be among the first to rebound from the telecom downturn as we
maintained strong investments in R&D, sales and customer support.
REPORT CARD FOR FISCAL 2005
Let's take a closer look at our quality of execution in 2005 and how we fared
against the corporate performance metrics that we had established at the
beginning of the fiscal year.
SALES GROWTH: 30.3% VS. TARGET OF 20%
With 30.3% sales growth in 2005, we surpassed our stated goal of 20% through
higher market-share gains. We delivered excellent growth results for both our
Telecom Division (36.1% growth; 82% of revenues) and our Life Sciences and
Industrial Division (8.6% growth, 18% of revenues), which was recently renamed
to better reflect its market focus. Frost & Sullivan, a leading market
research firm, reported in June 2005 that we had jumped from fifth place with
a market share of 8.4% in 2003 to second place with 10.3% of the overall
fiber-optic test market in 2004(1). Market share in our core portable
field-test instrumentation segment is estimated to have improved from 17.4% to
22.2% during the same period. Combined with stellar sales growth during our
first 16 years of operation (above 25% growth every year and ~60% CAGR from
1985 to 2001), we believe that we outperformed the optical test and
measurement market every single year of our existence, largely due to
market-driven innovation and quality of execution. I am particularly proud of
this accomplishment, since I believe it is a key measure of long-term success.
2005 Annual Report o EXFO :: 2
PRO FORMA NET EARNINGS: $4.5 MILLION(2) VS. TARGET OF > $0
We finished fiscal 2005 with pro forma net earnings of $4.5 million, or $0.06
per diluted share, while our published goal was to reach the break-even
level(2). This goal was achieved on the strength of higher sales volumes,
richer business mix and heightened cost controls. I am also encouraged that we
improved our gross margin by 100 basis points to 54.7% in fiscal 2005, despite
strong pricing pressure and a 9.7% increase in the Canadian versus US dollar
during that period. Although we were profitable on a GAAP basis in the last
three quarters, we incurred a net loss of $1.6 million in 2005, including $1.3
million in foreign-exchange losses and $1.0 million in stock-based
compensation costs. In terms of earnings power, for every additional dollar of
sales in 2005 over 2004, $0.46 flowed to earnings before income taxes. Since
the 2001 telecom crisis, I believe we have maintained the right balance
between long-term growth and short-term profitability. Our P&L statement also
reflects that we are now approaching our long-term operating model in terms of
SG&A (32.7% vs. 30-32%) and net R&D (12.5% vs. 12-14%), while there's still
more work required on the gross margin front (54.7% vs. ~60%).
SALES FROM NEW PRODUCTS: 42.4% VS. TARGET OF 45%
Sales from new products (on the market two years or less) represented 42.4% of
total sales in 2005 versus our stated goal of 45%. While we slightly missed
our target, I'm pleased with the significant improvement over the prior year
(31.7%). This metric speaks volumes about market focus, customer acceptance
and judicious R&D investment decisions. It reveals that we're reading the
market correctly, aggressively launching products worldwide and placing our
customers at the top of the innovation curve. It also reflects that our R&D
projects are on-scope, on-time and on-budget to maximize results. Over the
years, EXFO has earned the reputation of innovation leader for good reason.
2006 AND BEYOND -- KEY MARKET TRENDS
Let's discuss some major drivers that will transform the telecom industry (as
well as life sciences and industrial markets) in upcoming years. As a
market-driven company, we try to identify the key industry trends in order to
leverage technological discontinuities and convert them into value-creating
market opportunities.
BROADBAND WAR LEADING TO ACCESS INVESTMENTS
Intense competition between traditional telephone companies (telcos) and cable
operators (cablecos) continues unabated in North America. Both parties are
waging a triple-play -- even quadruple-play -- war to increase revenue and
profitability through bundled offerings, while reducing churn. This broadband
battle is prompting massive capital investments in access networks in order to
increase bandwidth, flexibility and scalability, while continuing metro ring
expansion. Telcos are deploying fiber-to-the-node (FTTN; ~20 Mb/s),
fiber-to-the-curb (FTTC; ~40 Mb/s) or fiber-to-the-premises (FTTP; ~100 Mb/s),
depending on the bets they have placed in terms of what video compression
techniques will be adopted and how much bandwidth will be required to meet the
challenge from the cablecos (~40 Mb/s). The closer the fiber is to the
premises and the higher the transmission rates, the better it is for EXFO,
which offrs the most comprehensive line of FTTx test solutions on the market.
Following agreements with Verizon and SBC Communications, we are increasingly
leveraging our leadership in passive optical network (PON) testing and broad
portfolio of FTTx-ready technologies outside North America, given our
long-established customer relationships in Europe and Asia. We are
participating in several FTTx trials worldwide and recently were selected as
sole-source supplier for all fiber deployment test applications by Deutsche
Telekom AG -- including FTTx. While our FTTx market penetration was excellent
in 2005, we believe this is just the beginning of a long-term deployment
trend.
MIGRATION TOWARDS CONVERGED, IP-BASED NETWORKING
Network operators around the world are migrating from public switched
telephone networks (PSTN) to packet-based, Internet protocol (IP) networks in
order to achieve substantial reductions in operating expenses and increased
profitability. British Telecom Group, for example, announced it will spend
(pound)10 billion over five years on its 21CN initiative (21st Century
Network) to reduce operating expenses by up to (pound)1 billion per year,
while enabling revenue expansion into differentiated, higher-margin new
services -- all thanks to a single network carrying voice, data and video
signals.
Without getting too technical, legacy SONET/SDH networks were designed in the
late 1970s to optimize voice traffic, but they can drop to 30% efficiency when
data and video applications are added. Next-generation networks, such as those
announced by British Telecom, represent a major technological improvement,
since they can deliver triple-play services at almost 100% efficiency while
significantly reducing operating and maintenance costs.
Anticipating this market opportunity, we shifted our focus from legacy
SONET/SDH and Ethernet technologies to next-generation protocol test solutions
aimed at the deployment of converged, IP-based networks. Product launches in
2005 included a next-generation SONET/SDH analyzer, featuring the latest in
generic framing procedure (GFP), virtual concatenation (VCAT) and link
capacity adjustment scheme (LCAS); a 10 Gigabit Ethernet (GigE) test solution,
a remote Ethernet tester to ensure quality of service (QoS); and additional
Ethernet test capabilities to help carriers operate their high-performance
core, metro and edge networks. We also formed an alliance with ADC Telecom to
provide a unique remote Ethernet test solution for first-mile applications.
Subsequent to the year-end, we launched 10 GigE and Fibre Channel test
solutions for the system vendor market.
Given the protocol test market is significantly larger than the optical test
market, our rich product pipeline in protocol testing, and four consecutive
quarters of sales growth in protocol testing with the last quarter exceeding
10% of Telecom Division revenues, we have high expectations for this product
line. We expect that protocol sales will outgrow optical sales to eventually
account for 50% of our Telecom Division revenues, even though our optical
segment will continue to increase.
(1) World Fiber Optic Test Equipment (FOTE) Markets, June 2005, Frost &
Sullivan.
(2) Pro forma net earnings represent a GAAP net loss of $1.6 million,
excluding $4.8 million in amortization of intangible assets, $1.0 million
in stock-based compensation costs and $0.3 million in restructuring and
other charges in 2005.
2005 Annual Report o EXFO :: 3
On the life sciences and industrial side:
Fluorescence imaging is one of the fastest-growing segments of the microscope
industry. To take advantage of this market opportunity, EXFO has partnered
with major microscope manufacturers in the last two years to deliver the
leading fluorescence illumination system in North America. We're now seeking
similar penetration in Europe and Asia through regional partnerships with
microscope manufacturers.
The aging baby-boomer market is placing stringent demands on manufacturers of
medical equipment for devices like in-vitro balloon catheters, hearing aids
and asthma inhalers. Similarly, high-tech consumers are pushing for the
continued miniaturization of devices such as digital cameras, personal digital
assistants (PDAs) and cellular phones. Given the demand for higher volumes and
miniature sizes, manufacturers of medical and electronic devices are requiring
exceptional control and repeatability for their precision assembly
applications. EXFO has responded to this dual trend by bringing to market an
automated spot-curing platform that can be controlled via a personal computer.
FISCAL 2006 CORPORATE OBJECTIVES
During meetings with investors in the past year, I often asked myself whether
they are growing tired of hearing the same story, but I have come to realize
that most investors are comforted by the consistency and coherence in our
long-term strategy. Consequently, our corporate objectives for 2006 bear a
strong resemblance to those of previous years. We intend to:
| INCREASE SALES MORE THAN 15% YEAR-OVER-YEAR MAINLY THROUGH
MARKET-SHARE GAINS. It's hardly surprising that "market-share gains"
is a mantra constantly repeated at EXFO, since we strive to grow
faster than our industry year-in and year-out. To achieve this goal,
we intend to exploit the aforementioned market opportunities and
concentrate on solid execution.
| GENERATE MORE THAN 5% IN EARNINGS FROM OPERATIONS. Higher sales
volumes, increased contribution from higher-margin protocol test
solutions, improved operating efficiencies and continued cost
controls should help us reach our objective. This metric assumes no
significant currency fluctuations nor closed acquisitions in fiscal
2006. If an acquisition is completed in 2006, this metric will be
revised accordingly.
| DERIVE AT LEAST 40% OF SALES FROM PRODUCTS ON THE MARKET TWO YEARS OR
LESS. At EXFO, we remain attuned to customer and market requirements,
not to technology for the sake of it. This ambitious innovation
target is fully aligned with our fundamental goals of differentiating
ourselves from the competition, increasing market share and revenue,
as well as improving gross margin and profitability. Stay tuned for
several new product introductions in 2006.
Clearly, EXFO is one of the best-positioned companies in the global test and
measurement industry. We generated $14.0 million in cash flows from operating
activities in 2005 to increase our cash and short-term investments to $112.0
million, or $1.62 per diluted share. This strong cash position provides
comfort to our customers, while offering us the flexibility to accelerate our
long-term growth strategy through select acquisitions. Typically, we target
companies with leading-edge technologies that are deemed strategic to our
long-term success. As a disciplined acquirer, we will only complete a
transaction if we firmly believe there are real synergies leading to long-term
value creation.
Corporate Highlights -- Fiscal 2005
[GRAPHIC OMITTED]
[PHOTOGRAPH -- PPM-350B | PON Power Meter
September 2004
| Consolidates Photonics and Life Sciences Division in Toronto
October 2004
| PON power meter selected by a Tier-1 NSP in the US
| Launches next-generation SONET/SDH analyzer
| Releases software suite for Ethernet testing
| Introduces OmniCure Series 2000 Spot-Curing System
November 2004
| Introduces optical spectrum analyzer (OSA) for metro and access networks
December 2004
| Forms alliance with ADC Telecom to offer integrated remote Ethernet test
solution
| Expands line of handheld testers with 600 series
January 2005
| Receives sole-source approval for a line of FTTx test solutions from
another Tier-1 NSP in the US
[GRAPHIC OMITTED]
[PHOTOGRAPH -- 600 SERIES | Line of handheld FTTx products]
| PMD measurement method approved by International Telecommunication Union
(ITU)
2005 Annual Report o EXFO :: 4
In terms of corporate governance, we put in place a number of charters and
policies in 2005 (see the Investors section of our Web site) in compliance
with regulatory authorities. We also implemented a "Whistleblower" mechanism
on our Web site, which enables any interested party with significant concerns
to send an anonymous e-mail to our Board's independent Lead Director. Finally,
we continued to work diligently towards compliance with Section 404 of
Sarbanes-Oxley, even though foreign issuers were given an extra year's grace
by the Securities and Exchange Commission in the US. These initiatives
demonstrate EXFO's commitment to best-in-class corporate governance practices.
WRAP-UP
We have reached an important milestone at EXFO. Closing my 20th year at the
helm, I feel privileged to lead such an accomplished team of professionals.
Most members of our senior management team have worked with me for more than
10 years and all have over a decade of industry-specific experience. Through
the years, we have found that excellent results can only be achieved through
disciplined, long-term strategic planning and a strong focus on execution at
all levels.
I'd like to sincerely thank our employees for their hard work,
excellence-driven attitude and strong commitment to growing their company --
this is no small feat given our high expectations! Similarly, I appreciate the
strong vote of confidence our increasing customer base has demonstrated in our
products and services on a daily basis. By sharing their expectations and
future requirements, they are providing us with an opportunity to showcase
what we do best at EXFO: enabling our innovations and expertise to reach out.
All of us are highly committed to making the "EXFO Experience" one that will
provide customers with unparalleled satisfaction.
---------------------------------------------------
"Through the years, we have found that excellent
results can only be achieved through
disciplined, long-term strategic planning and a
strong focus on execution at all levels."
---------------------------------------------------
Many thanks as well to our Board of Directors for its wise counsel,
availability, unwavering support and for sharing its industry-wide experience,
as well as to our shareholders for believing in our long-term vision. With the
continued support of everyone, I am looking forward to the challenges of the
new year with a large measure of confidence.
Sincerely,
/s/ Germain Lamonde
Germain Lamonde
Chairman, President and
Chief Executive Officer
October 20, 2005
March 2005
| Receives 2005 Growth Strategy Leadership Award from Frost & Sullivan
| Launches all-band component analyzer at OFC/NFOEC2005
| Achieves GAAP break-even in the second quarter
April 2005
| Releases new software suite for remote Ethernet testing
June 2005
| Launches 10 Gigabit Ethernet test solution
| Increases sales and bookings for a seventh consecutive quarter
July 2005
| Introduces key functionalities for next-generation SONET/SDH analyzer
series
[GRAPHIC OMITTED]
[PHOTOGRAPH -- FTB-8100 | Next-Generation SONET/SDH Analyzer]
August 2005
| Posts sales growth of 30.3% year-over-year
| Completes fiscal 2005 with a total of 15 new products
2005 Annual Report o EXFO :: 5
TELECOM DIVISION
TWENTY YEARS OF SHARED EXPERTISE
EXFO is no longer a teenager. The telecom test and measurement company, which
was created with a $100 investment inside a student apartment in 1985, has
turned 20! Right from the beginning, EXFO distinguished itself with
market-driven innovation, strong focus on market leadership and commitment to
excellence in order to accomplish its ambitious goal of becoming the leader in
the global test and measurement industry. Along the way, we have established a
number of industry firsts:
| The first PC-based, modular test platform for field applications;
| The first all-in-one optical loss test set combining several
instruments;
| The first portable polarization mode dispersion (PMD) analyzer;
| The first modular test platform to combine optical and protocol test
solutions;and
| The first line of portable test instruments designed for FTTx
testing.
Innovation aside, we have reached out to customers to share our expertise and
garner their feedback. Many of our best product introductions, in fact, were
the result of working with customers to resolve their problems. Not
surprisingly, several customer relationships have evolved into genuine
partnerships over the years. Marketing books call this "customer intimacy"; at
EXFO, we call this putting the customer in the driver's seat. Today, we have
grown into a global test and measurement company with more than 2,000
customers in 70 countries and 20 years of experience in our back pocket.
LEADERSHIP IN FTTx TESTING
Network operators are increasingly bundling voice, video and data services
over a common link, while stepping up transmission rates to meet growing
demand for bandwidth-hungry applications. Undoubtedly, one of the biggest
issues facing network operators today is, "How much bandwidth do end-users
really need?" Depending upon their answer, operators have opted for various
fiber-rich network configurations falling under the generic FTTx name:
| Fiber-to-the-node (FTTN), which leverages the existing copper plant
and new electronics in the field, typically brings fiber to within
3,000 feet of the premises in order to supply approximately 20 Mb/s
of bandwidth. This deployment strategy necessitates less initial
capital expenditures (CAPEX) than the other two solutions, but
requires more maintenance expenses (OPEX).
| Fiber-to-the-curb (FTTC) extends fiber to within approximately 500
feet of the premises with the remaining link being copper. This
network architecture, a compromise solution between FTTN and FTTH,
still requires significant electronics in the field and maintenance
costs to deliver around 40 Mb/s.
| Fiber-to-the-home or premises (FTTH/FTTP) represents the most
future-proof solution, since it can deliver 100 Mb/s to a home or
business. It can easily handle several HDTV channels,
video-on-demand, peer-to-peer file sharing, audio and video
downloading. FTTH/FTTP requires significant initial capital
expenditures, but less long-term support costs.
EXFO has positioned itself as the leading provider of FTTx test solutions --
whatever the preferred architecture. Twenty years of closely working with lead
customers around the world has enabled us to develop a line of FTTx products
that is unmatched in terms of breadth, scope and effectiveness. As a result, we
have become the preferred FTTx test vendor for leading carriers in the US and
Europe.
FTTx deployment architectures
[GRAPHIC OMITTED][GRAPHIC OMITTED]
[GRAPHIC OMITTED][GRAPHIC OMITTED]
2005 Annual Report o EXFO :: 6
CONVERGED, IP-BASED TEST SOLUTIONS
There's no turning back. Telecom carriers are migrating their traditional,
circuit-switched voice networks to packet-based, IP architectures in order to
better deliver cost-effective triple-play services and reduce operating
expenses. British Telecom Group, for example, has announced its 21st Century
Network with enormous potential for cost savings. Carriers worldwide are now
deploying packet-aware, add/drop multiplexers and multi-service provisioning
platforms (MSPPs) to provide efficient means of transporting packet-based
signals like Ethernet over next-generation SONET/SDH architectures.
[GRAPHIC OMITTED]
[PHOTOGRAPH -- FTB-8100 | Next-Generation SONET/SDH Analyzer]
Always attuned to technological change, EXPO introduced new protocol analyzers
that test the latest standards forming the basis of Ethernet and
next-generation SONET/SDH networks: generic framing procedure (GPP), virtual
concatenation (VCAT), link capacity adjustment scheme (LCAS) and
Ethernet-over-SOKlET (EoS). These technologies essentially optimize the
transport of packet-based services over existing SONET/SDH links. EXFO also
launched a 10 Gigabit Ethernet test solution to help carries ensure quality of
service (QoS) and formed an alliance with ADC to offer carriers a unique
remote Ethernet test solution for their first-mile applications. By combining
ADC's low-cost Ethernet network interface units (ENIUs) at customer premises
with EXFO's Remote Ethernet test capabilities, carriers can significantly
reduce truck rolls for customer complaints while monitoring networks to assure
QoS.
GROWTH STRATEGY LEADERSHIP AWARD
Market share and EXFO go hand in hand. For the second consecutive year, Frost
& Sullivan, the leading authority on the fiber-optic test industry, named EXFO
recipient of the Growth Strategy Leadership Award for the largest market-share
gains. We moved from fifth to second place overall in the global fiber-optic
test market in 2004, attaining 10.3% of the world market share. Based on the
Frost & Sullivan report, we were the only vendor among the top six to gain
market share in 2004; we finished first overall in seven portable product
categories; and we improved our leadership position in the fiber-optic
installation and maintenance test market segment from 17.4% to 22.2% during
the same period. "EXPO not only registered significant market-share growth in
multiple market segments of the optical test equipment industry in 2004, but
it has consistently done SO for the past several years," Frost & Sullivan
said.
UNIQUE MODULAR PLATFORM STRATEGY
It is well known EXPO was first to market with the introduction of PC-based,
Windows-driven modular test platforms that can accommodate several
plug-and-play modules, depending on the testing requirements. The inherent
value proposition lies in increased flexibility, reduced training and
long-term investment protection for the customer. On the other hand, it allows
EXPO to quickly develop best-in-class technologies for one market segment and
leverage the same R&D investment onto other markets through a common platform
strategy. This unique modular platform strategy has been strengthened over the
last 10 years through the release of next-generation platforms, continued
introduction of new test modules, and the development of fully automated test
sequences for ease of use in the field and optimal efficiency on the
manufacturing floor.
[GRAPHIC OMITTED]
[PHOTOGRAPHS -- FTB-400 | Universal Test System
FTB-8510G | 10 Gigabit Ethernet Packet Blazer(TM)
FTB-8520 | SAN Packet Blazer(TM)
IQS-2700 | ECL Tunable Laser Source
IQS-8510 | Ethernet Packet Blazer(TM)
IQS-8510G | 10 Gigabit Ethernet Packet Blazer(TM)
IQS-500 | Intelligent Test System]
2005 Annual Report o EXFO :: 7
LIFE SCIENCES &
INDUSTRIAL DIVISION
DIFFERENT NAME, SAME COMMITMENT
The alert-minded will have noticed the subtle name tweaking from "Photonics
and Life Sciences" to "Life Sciences and Industrial" division to better
reflect our end-market focus. Despite the change in nomenclature, the driving
force behind this division remains the same: leveraging core technologies into
life sciences and high-tech industrial markets in order to maximize revenue
streams.
FLUORESCENCE MICROSCOPY
To meet demand for instrumentation critical to life science research, we
leveraged our ultraviolet/visible spot-curing expertise used in optical
component manufacturing to develop a high-powered light source -- the X-Cite
120 Fluorescence Illumination System -- that provides unmatched performance
for laboratory microscopes. Its proprietary Intelli-LampTM technology,
generating more than 1,500 hours of lamp life, was adapted for fluorescence
microscopy applications as it delivers rich spectral excitation with a more
uniform field of view than conventional lighting systems. Most of the leading
microscope manufacturers around the world have embraced this innovative
solution, reselling it to their new and installed base of customers through
their own sales networks.
NANOTECHNOLOGY
Nanometer-scale precision is becoming increasingly important in life science
research, but we're hardly new to this market phenomenon. Our patented
Inchworm(R) motors, which were initially designed for optical component
manufacturing applications, are among the industry's best with a positioning
resolution of 0.1 nm -- smaller than the size of an atom. Our Inchworm motors
are now being used in highly advanced research and manufacturing projects such
as NASA's next-generation space telescope. In addition, we offer a unique
array of piezoelectric-based positioning systems, combining stability with
extremely smooth and predictable instrument motion, for a variety of lab
applications including patch-clamp experimentation, electrophysiology and
micromanipulation. We have also developed a PiezoDrill(R), which is used for
more esoteric procedures such as intracytoplasmic sperm injection and nuclear
transfer.
LIGHT-BASED CURING
Over the years, we have become the authority in light-based, adhesive
spot-curing as well as process control for the assembly of components for
medical devices, optoelectronics and microelectronics. Our ultraviolet/visible
spot-curing products deliver precise doses of the appropriate spectral light
onto photosensitive adhesives to significantly reduce bonding time and
increase repeatability. In fiscal 2005, our migration to a single platform
culminated with the release of the OmniCureTM Series 2000, a high-end
automated system that can easily be controlled externally from a personal
computer.
[GRAPHIC OMITTED]
[PHOTOGRAPHS -- X-Cite(TM) 120 | Fluorescence Illumination System
LSS-8000 | Inchworm(R) Microdrive System
PiezoDrill(R) | Inertial Impact Drill
OmniCure(TM) Series 2000 | Ultravioliet/Visible Spot-Curing
System]
2005 Annual Report o EXFO :: 8
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion and analysis of the consolidated financial condition
and results of operations of EXFO Electro-Optical Engineering Inc. for the
fiscal years ended August 31, 2003, 2004 and 2005, should be read in
conjunction with our consolidated financial statements and the related notes
included elsewhere in this Annual Report. Our consolidated financial
statements are reported in US dollars and have been prepared in accordance
with generally accepted accounting principles in Canada, or Canadian GAAP.
Significant differences in measurement and disclosure from generally accepted
accounting principles in the United States, or U.S. GAAP, are set out in note
21 to our consolidated financial statements.
The following discussion and analysis of financial condition and results of
operations is dated November 3, 2005.
INDUSTRY OVERVIEW
Leading telecom operators (telcos), mostly in the United States, accelerated
fiber deployments deeper in their access networks during the last year because
they are involved in a triple-play war (even quadruple-play with wireless
telephony) against cable TV operators (cablecos) to offer consumers bundled
voice, data and video services. This broadband war between telcos and cablecos
contributed to an increase in wireline capital expenditures in 2005,
especially in the United States.
Leading US telcos, along with a number of Tier-II and Tier-III players, opted
for an assortment of deployment strategies, including fiber-tothe-node (FTTN),
fiber-to-the-curb (FTTC), fiber-to-the-home (FTTH) or its equivalent
fiber-to-the premises (FTTP), depending on the bets they placed in terms of
how much bandwidth will be required to meet the challenge from the cablecos.
These deployments, which fall under the generic FTTx name, are not as
prevalent in Europe and Asia. However, test trials are underway in these
regions as a means to increase revenues by delivering video services to
undercut competition. Note that Japan and Korea already have FTTx deployment
programs, aimed at delivering 100 Mb/s to every home, well underway.
As the demand for broadband services increases worldwide, voice, data and
video are becoming mere applications on converged, IP-based networks. Telcos
around the world are migrating from public switched telephone networks (PSTN)
to packet-based, IP networks in order to achieve substantial reductions in
operating expenses and increased profitability. British Telecom Group, for
example, announced it will spend (pound)10 billion over five years on its 21st
Century Network to reduce operating expenses by up to (pound)1.0 billion per
year through a single network carrying voice, data and video signals.
Legacy SONET/SDH networks were designed in the late 1970s to carry voice
traffic. Their efficiency however can often times drop to as low as 30% when
combining voice, data and video services. Next-generation networks, such as
those announced by British Telecom, represent a major technological
improvement, since they can deliver triple-play services at near 100%
efficiency, regardless of the payload content, while significantly reducing
the cost of operating and maintaining networks.
These key market trends affected multiple segments of the global
telecommunications supply chain in 2005. System manufacturers benefited from
orders by both telcos and cablecos for next-generation, converged IP networks
as well as from major investments by telcos in access networks. Component
vendors saw incremental demand for optical components that support FTTx and
IP-based systems. Some test and measurement equipment vendors attracted the
attention of telcos, cablecos, system manufacturers and component vendors,
especially ones offering test solutions for IP optical networking and/or FTTx
applications.
COMPANY OVERVIEW
EXFO is a recognized expert in the global telecommunications industry through
the design and manufacture of advanced and innovative test and measurement
solutions. The Telecom Division, which represents our main business activity,
offers a complete range of dedicated and integrated test solutions to network
service providers (NSPs), cable operators, system vendors and component
manufacturers in approximately 70 countries. One of our strongest competitive
advantages is our modular test platform design -- based on a
PC/Windows-centric architecture -- which offers a series of test modules that
maximize technology reuse across multiple market segments at minimal cost. The
Life Sciences and Industrial Division, formerly called Photonics and Life
Sciences Division, mainly leverages core telecom technologies to offer
value-added solutions for life sciences applications and high-precision
assembly processes, such as those required for microelectronics and
optoelectronics.
This year marked EXFO's 20th anniversary, as the company was founded in 1985
in Quebec City, Canada. Our original products were focused on the needs of
installers and operators of fiber-optic networks. Customers use these
field-portable testing products for the installation, maintenance, monitoring
and troubleshooting of optical networks. In 1996, we supplemented our product
portfolio with an extensive line of high-end products that are mainly
dedicated to research and development as well as manufacturing activities of
optical component manufacturers and system vendors.
In the last four years, we have enhanced our competitive position through the
acquisition of two protocol test businesses in order to expand our product
offering and address our customers' requirements more completely. In November
2001, we acquired Avantas Networks Corporation (renamed EXFO Protocol Inc.), a
supplier of protocol-testing and optical-network performance-management
equipment for NSPs. This transaction was highly strategic because it enabled
us to combine optical and protocol test modules inside a single field-portable
test platform to help our customers increase revenues and reduce operating
costs. In October 2002, our wholly-owned subsidiary, EXFO Gnubi, purchased
substantially all the assets of gnubi communications, L.P., a supplier of
multi-channel telecom and datacom testing solutions for the system
manufacturer market. These strategic acquisitions, which were consolidated in
Montreal in fiscal 2004, enabled us to more than double our addressable
market, as we expanded from optical testing to protocol testing applications,
and to offer a more complete line of test solutions to our customers.
2005 Annual Report o EXFO :: 9
Previously, we had completed two acquisitions to bolster growth in the optical
component manufacturing market. We acquired Burleigh Instruments, Inc.
(renamed EXFO Burleigh Products Group Inc.) in December 2000 for its
wavelength measurement instruments and nanopositioning alignment systems. We
also added EFOS Inc. (renamed EXFO Photonic Solutions Inc.) in March 2001 for
its precision light-based, adhesive spot-curing technology. We have since
exited the optical component manufacturing automation business.
In fiscal 2005, we launched 15 new products, including a next-generation
SONET/SDH analyzer for characterizing converged, IP-based networks; a 10
Gigabit Ethernet (GigE) test solution to assess quality of service in core and
metro networks; a new software suite for remote Ethernet testing and
commissioning applications; an all-band component analyzer for FTTx and coarse
wavelength-division multiplexing (CWDM) applications in the
manufacturing/research and development market; a series of three handheld test
instruments for the installation and maintenance market; and an optical
spectrum analyzer (OSA) for CWDM applications in metro and access networks. In
addition, we formed an alliance with ADC Telecom to provide a unique remote
Ethernet test solution for first-mile applications.
In 2005, we also consolidated our leadership position in the FTTx test market
by recognizing significant revenue from two leading U.S. carriers deploying
fiber in their access networks. Our top customer accounted for 23.3% of sales
in 2005. Subsequent to the year-end, we were selected as sole-source supplier
for all fiber deployment test applications by Deutsche Telekom AG -- including
FTTx.
We recorded a foreign exchange loss of $1.3 million in fiscal 2005 due to the
significant increase in the value of the Canadian dollar versus the US dollar
during that year. In addition to this foreign exchange loss, our P&L (profits
and losses) line items in 2005 were also negatively affected by the
appreciation of the Canadian dollar, since a significant portion of our
expenses are incurred in Canadian dollars while we report our results in US
dollars.
In the third quarter of fiscal 2005, EXFO was named recipient of the 2005
Growth Strategy Leadership Award by Frost & Sullivan, a leading market
research firm in the telecommunications test sector. The award is presented
annually to the company whose visionary growth strategy generates the largest
market-share gains in the global fiber-optic test equipment market in the
previous year. Based on a report by Frost & Sullivan, we increased our market
share from 8.4% in fiscal 2003 to 10.3% in 2004. This marked the second
consecutive year that we earned this industry award.
Finally, during fiscal 2005, we completed the consolidation of our Life
Sciences and Industrial Division in Toronto and we recorded $482,000 in
restructuring expenses. Altogether, we incurred $2.5 million in restructuring
and other charges since the fourth quarter of 2004 in conjunction with this
consolidation process.
SALES
We sell our products to a diversified customer base in approximately 70
countries through our direct sales force and, indirectly, through distribution
channels. Most of our sales are denominated in US dollars and Euros.
Historically, it has been very unusual to have any customer account for more
than 10% of our sales. However, in both fiscal 2004 and 2005, we had one
customer that accounted for 13.8% and 23.3% of our sales, respectively. In
fiscal 2005, our top three customers accounted for 28.4%, compared to 20.8% in
2004. We believe the sales concentration in fiscal 2005 is largely due to our
leadership position in the FTTx test market, as a large portion of our sales
to our top customer was for a series of products related to FTTx deployment.
We expect this sales concentration to decrease in fiscal 2006, as we continue
efforts to diversify our customer base.
Despite the fact that we had one customer that accounted for a substantial
part of our sales in fiscal 2005, we believe that we have a vast array of
products and a diversified customer base, both in terms of industry sector and
geographical area, which provides us with reasonable protection against
concentration of sales and credit risk.
COST OF SALES
Cost of sales includes raw materials, salaries and related expenses for direct
and indirect manufacturing personnel (net of government grants) as well as
overhead costs. Excess, obsolete and scrapped materials are also included in
cost of sales. However, cost of sales is exclusive of amortization, which is
shown separately in the statements of earnings.
OPERATING EXPENSES
We classify our operating expenses into three main categories: selling and
administrative expenses, research and development expenses and amortization
expenses.
Selling and administrative expenses consist primarily of salaries and related
expenses for personnel (net of government grants), sales commissions, travel
expenses, marketing programs, professional services, information systems,
human resources and other corporate expenses.
Gross research and development expenses consist primarily of salaries and
related expenses for engineers and other technical personnel, material
component costs as well as fees paid to third-party consultants. We are
eligible to receive research and development tax credits and government grants
on research and development activities carried out in Canada. All related
research and development tax credits and government grants are recorded as a
reduction of gross research and development expenses. Tax credit write-offs
are also included in net research and development expenses.
Operating charges related to our restructuring plans have been recorded as a
separate component of operating expenses. These charges consist primarily of
severance expenses, costs to exit leased facilities as well as write-offs of
long-lived assets.
2005 Annual Report o EXFO :: 10
OUR STRATEGY
STRATEGIC OBJECTIVES FOR FISCAL 2005
In our fiscal 2004 Annual Report, we had established three strategic
objectives for fiscal 2005. We planned to increase sales through market-share
gains, maximize profitability and focus on innovation. The following section
reviews our strategic objectives for fiscal 2005 and the results achieved for
each of these objectives.
INCREASE SALES THROUGH MARKET-SHARE GAINS
In fiscal 2005, we focused on continued market-share gains to achieve growth.
We posted our second-best sales performance in history, growing sales 30.3% to
$97.2 million in fiscal 2005, compared to a stated goal of 20%. Considering
that the telecommunications market slightly improved in fiscal 2005, this is a
clear indication that we gained market share overall. For fiscal 2005, our
Telecom Division and our Life Sciences and Industrial Division reported sales
increases of 36.1% and 8.6%, respectively.
MAXIMIZE PROFITABILITY
Returning to profitability remains a top priority at EXFO. In fiscal 2005, we
substantially reduced our loss from operations from $10.6 million in fiscal
2004 to $199,000 in 2005. The loss from operations incurred in fiscal 2005
includes restructuring and other charges of $292,000, recorded in conjunction
with the consolidation of the operations of our Life Sciences and Industrial
Division and stock-based compensation costs of $963,000.
FOCUS ON INNOVATION
In fiscal 2005, innovation was a key driver at EXFO. We maintained a
significant level of research and development investments and introduced 15
new products to the marketplace. We invested $15.9 million in gross research
and development expenses, an amount similar to 2004. In fiscal 2005, 42.4% of
our sales originated from products that have been on the market for two years
or less, which is slightly below our stated goal of 45% for fiscal 2005. While
we slightly missed our target, this represents a significant improvement over
the prior year (31.7%), thanks to the 20 new products brought to the
marketplace in fiscal 2004 -- several of which were released in the second
half of the fiscal year -- and the 15 new ones launched in fiscal 2005.
STRATEGIC OBJECTIVES FOR FISCAL 2006
For fiscal 2006, we believe general market conditions will moderately improve
as carriers around the world intensify triple-play investments in an effort to
bolster revenues and/or provide a defensive/offensive measure in the telcos
vs. cablecos battle to deliver video, data and voice services to residential
and business customers. This ongoing trend will prompt increased capital
expenditures (CAPEX) mainly in the access network market, likely over several
years to come. On a more global basis, the migration of these services onto a
single, IP-based network to reduce operating expenditures will instigate
increased CAPEX in the network core. On the strength of our market-driven
research and development program, we are well-positioned for these latest
industry trends.
As one might expect, our strategic directions, and therefore our key
performance indicators, will not be radically different from those of 2005.
Since we are highly focused on creating value for our shareholders, providing
the highest degree of profitable growth is at the heart of our actions. We
intend to maintain our long-term focus on profitable growth by increasing
sales through further market-share gains; maximize profitability through
proper execution and efficiency of our cost-reduction programs; and focus on
innovation to positively position the organization for the long-term growth
opportunities that exist in our space.
INCREASE SALES THROUGH MARKET-SHARE GAINS
In fiscal 2006, we will continue focusing on market-share gains and growing
faster than our end markets. In fiscal 2005, our 30.3% sales growth in a
slightly increasing market clearly indicated that we gained market share. As
mentioned earlier, EXFO was named recipient of the 2005 Growth Strategy
Leadership Award by Frost & Sullivan. The award is presented annually to the
company whose visionary growth strategy generates the largest market-share
gains in the global fiber-optic test equipment market in the previous year.
Based on Frost & Sullivan, we increased our market share from 8.4% in fiscal
2003 to 10.3% in 2004. For fiscal 2006, we intend once again to grow sales
faster than the market by leveraging our sustained research and development
investments in areas such as next-generation Internet protocol (IP) and FTTx
testing, by intensifying our sales and marketing efforts, both domestic and
international, as well as by strengthening and expanding our business
relationships with major accounts.
MAXIMIZE PROFITABILITY
Profitability remains a top priority and we expect that sales growth combined
with a strong focus on operations will increase our earnings from operations
in fiscal 2006, assuming no acquisitions.
FOCUS ON INNOVATION
In fiscal 2006, innovation will continue to be a major growth vehicle for us,
as it significantly drives not only revenue and profitability, but also allows
us to better position ourselves in the long term. We remain convinced that our
commitment to innovation will pay off in the long term and support our growth
and profitability targets as demonstrated during the last fiscal year. We have
maintained a significant level of research and development investments since
the telecom peak in 2001 and brought 15 new products to the marketplace in
fiscal 2005. Now that our net research and development investments as a
percentage of sales are in line with our long-term model, we intend, for
fiscal 2006 and beyond, to increase our investment in research and development
activities in proportion to our sales growth. Our numerous but focused
research and development initiatives should enable our new products to
continue gaining traction with customers and lead to further growth,
market-share gains and increased profitability in the coming years.
KEY PERFORMANCE INDICATORS
As measures to assess the realization of our strategic plan and its
objectives, we have set out three consolidated key performance indicators for
fiscal 2006.
2005 Annual Report o EXFO :: 11
They are summarized as follows:
STRATEGIC OBJECTIVES FOR FISCAL 2006 KEY PERFORMANCE INDICATORS FOR FISCAL 2006
------------------------------------ ------------------------------------------
Increase sales through market-share gains 15% sales growth year-over-year
Maximize profitability 5% in earnings from operations
Focus on innovation 40% of sales from new products
(on the market two years or less)
CAPABILITY TO DELIVER RESULTS
At EXFO, we believe that we have the capabilities to deliver expected results
thanks to outstanding products, an excellent reputation in the marketplace, a
sound financial position, as well as an experienced workforce and management
team.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's discussion and analysis of financial conditions and results of
operations is based on our consolidated financial statements included
elsewhere in this Annual Report. As previously mentioned, they have been
prepared in accordance with Canadian GAAP. The preparation of financial
statements in accordance with GAAP requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosures of contingent assets and liabilities at the date of the financial
statements, as well as the reported amounts of revenues and expenses during
the reporting years. On an ongoing basis, we evaluate these estimates and
assumptions, including those related to revenue recognition, allowance for
doubtful accounts, allowance for excess and obsolete inventories, research and
development tax credits and government grants, impairment of long-lived assets
and goodwill, valuation allowance of future income tax assets, warranty
obligations, restructuring charges, contingencies and other obligations as
well as stock-based compensation costs. We base our estimates and assumptions
on historical experience and on other factors that we believe to be reasonable
under the circumstances, the result of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results could differ from these
estimates.
The following summarizes our critical accounting policies as well as other
policies that require the most significant judgment and estimates in the
preparation of our consolidated financial statements.
REVENUE RECOGNITION. For products in which software is incidental, we
recognize revenue when persuasive evidence of an arrangement exists, the
product has been delivered, the price is fixed and determinable and collection
of the resulting receivable is reasonably assured. In addition, provisions are
made for estimated returns, warranties and support obligations.
For products in which software is not incidental, revenues are separated into
two categories: product and post-contract customer support (PCS) revenues,
based upon vendor-specific objective evidence of fair value. Product revenues
for these sales are recognized as described above. PCS revenues are deferred
and recognized ratably over the years of the support arrangement.
PCS revenues are recognized at the time the product is delivered when provided
within one year of delivery; the costs of providing this support are
insignificant (and accrued at the time of delivery) and no software upgrades
are provided.
For all sales, we use a binding purchase order as evidence that a sales
arrangement exists.
Delivery generally occurs when the product is handed over to a transporter for
shipment.
At the time of the transaction, we assess whether the price associated with
our revenue transaction is fixed and determinable, and whether or not
collection is reasonably assured. We assess whether the price is fixed and
determinable based on the payment terms associated with the transaction. We
assess collection based on a number of factors, including past transaction
history and the creditworthiness of the customer. Generally, collateral or
other security is not requested from customers.
Most sales arrangements do not generally include acceptance clauses. However,
if a sales arrangement does include an acceptance provision, acceptance occurs
upon the earliest of the receipt of a written customer acceptance or the
expiration of the acceptance period. For these sales arrangements, the sale is
recognized when acceptance occurs.
Revenue for extended warranties is recognized on a straight-line basis over
the warranty period.
ALLOWANCE FOR DOUBTFUL ACCOUNTS. We estimate collectibility of accounts
receivable on an ongoing basis by reviewing balances outstanding over a
certain period of time. We determine our allowance for doubtful accounts
receivable based on our historical accounts receivable collection experience
and on the information that we have about the status of our accounts
receivable balances. If the financial conditions of our customers deteriorate,
resulting in an impairment of their ability to make required payments,
additional allowance may be required, which could adversely affect our future
results.
ALLOWANCE FOR EXCESS AND OBSOLETE INVENTORIES. We state our inventories at the
lower of cost, determined on an average cost basis and replacement cost or net
realizable value, and provide reserves for excess and obsolete inventories. We
determine our reserves for excess and obsolete inventories based on the
quantities we have on hand versus expected needs for these inventories, so as
to support future sales of our products. It is possible that additional
inventory reserves may occur if future sales are less than our forecasts or if
there is a significant shift in product mix compared to our forecasts, which
could adversely affect our future results.
2005 Annual Report o EXFO :: 12
RESEARCH AND DEVELOPMENT TAX CREDITS AND GOVERNMENT GRANTS. We record research
and development tax credits and government grants based on our interpretation
of tax laws and grant programs, especially regarding related eligible projects
and expenses, and when there is reasonable assurance that we have complied and
will continue to comply with all conditions and laws. Also, our judgment and
estimates are based on historical experience. It is possible, however, that
the tax authorities or the sponsors of the grant programs have a different
interpretation of laws and application of conditions related to the programs
or that we do not comply with all conditions related to grants in the future,
which could adversely affect our future results. Furthermore, a significant
part of our tax credits are refundable against income taxes payable, causing
their ultimate realization to be dependent upon the generation of taxable
income. If we obtain information that causes our forecast of future taxable
income to change or if actual taxable income differs from our forecast, we may
have to revise the carrying value of these tax credits, which would affect our
results in the period in which the change was made. We review the
recoverability of such tax credits on a quarterly basis.
IMPAIRMENT OF LONG-LIVED ASSETS AND GOODWILL. We assess impairment of goodwill
on an annual basis, or more frequently, if events or circumstances indicate
that it might be impaired. Recoverability of goodwill is determined at the
reporting unit level using a two-step approach. First, the carrying value of a
reporting unit is compared to its fair value, which is determined based on a
combination of discounted future cash flows and a market approach. If the
carrying value of a reporting unit exceeds its fair value, the second step is
performed. In this step, the amount of impairment loss, if any, represents the
excess of the carrying value of goodwill over its fair value and the loss is
charged to earnings in the period in which it is incurred. For the purposes of
this impairment test, the fair value of goodwill is estimated in the same way
as goodwill is determined in business combinations; that is, the excess of the
fair value of a reporting unit over the estimated fair value of its net
identifiable assets.
We assess impairment of long-lived assets when events or circumstances
indicate that costs may not be recoverable. Impairment exists when the
carrying value of an asset, or a group of assets, is greater than the pre-tax
undiscounted future cash flows expected to be provided by the asset or the
group of assets. The amount of impairment loss, if any, is the excess of the
carrying value over the fair value. We assess fair value of long-lived assets
based on discounted future cash flows.
FUTURE INCOME TAXES. We account for income taxes using the liability method of
tax allocation. Under this method, future income tax assets and liabilities
are determined based on deductible or taxable temporary differences between
financial statement values and tax values of assets and liabilities, using
enacted income tax rates for the years in which the differences are expected
to reverse. In assessing the recoverability of our future income tax assets,
we consider whether it is more likely than not that some or all of the future
income tax assets will not be realized. The ultimate realization of our future
income tax assets is dependent upon the generation of future taxable income
during the periods in which those temporary differences will become
deductible. As at August 31, 2005, we had established a full valuation
allowance against our future income tax assets.
The valuation allowance will be reversed once management will have concluded
that realization of future income tax assets is more likely than not.
STOCK-BASED COMPENSATION COSTS. Since September 1, 2003, we account for all
forms of employee stock-based compensation using the fair value-based method.
This method requires that we make estimates about the risk-free interest rate,
the expected volatility of our shares and the expected life of the awards.
On September 1, 2004, we prospectively adopted the following new Canadian
Institute of Chartered Accountants (CICA) handbook sections:
o Section 1100, "Generally Accepted Accounting Principles"
o Section 1400, "General Standards of Financial Statement Presentation"
Furthermore, in January 2005, the CICA issued four new accounting standards in
relation to financial instruments: Section 3855, "Financial Instruments --
Recognition and measurement"; Section 3865, "Hedges"; Section 1530,
"Comprehensive Income"; and Section 3251, "Equity". These new standards apply
to fiscal years beginning on or after October 1, 2006, and we will adopt them
on September 1, 2007.
Please refer to note 2 to our consolidated financial statements included
elsewhere in this Annual Report for further information about these new
standards and their impact on our financial statements.
2005 Annual Report o EXFO :: 13
RESULTS OF OPERATIONS
The following table sets forth certain Canadian GAAP consolidated
financial statements data in thousands of US dollars, except per share data,
and as a percentage of sales for the years indicated:
CONSOLIDATED STATEMENTS OF EARNINGS DATA: 2005 2004 2003 2005 2004 2003
--------------------------------------------------------------------------------------------------------------------------
Sales $ 97,216 $ 74,630 $ 61,930 100.0 % 100.0 % 100.0 %
Cost of sales (1) 44,059 34,556 36,197 45.3 46.3 58.4
--------------------------------------------------------------------------------------------------------------------------
Gross margin 53,157 40,074 25,733 54.7 53.7 41.6
--------------------------------------------------------------------------------------------------------------------------
Operating expenses
Selling and administrative 31,782 25,890 26,991 32.7 34.7 43.6
Net research and development 12,190 12,390 15,879 12.5 16.6 25.6
Amortization of property, plant and equipment 4,256 4,935 5,210 4.4 6.6 8.4
Amortization of intangible assets 4,836 5,080 5,676 5.0 6.8 9.2
Impairment of long-lived assets and goodwill -- 620 7,427 -- 0.8 12.0
Restructuring and other charges 292 1,729 4,134 0.3 2.3 6.7
--------------------------------------------------------------------------------------------------------------------------
Total operating expenses 53,356 50,644 65,317 54.9 67.8 105.5
--------------------------------------------------------------------------------------------------------------------------
Loss from operations (199) (10,570) (39,584) (0.2) (14.1) (63.9)
Interest and other income 2,524 1,438 1,245 2.6 1.9 2.0
Foreign exchange loss (1,336) (278) (1,552) (1.4) (0.4) (2.5)
--------------------------------------------------------------------------------------------------------------------------
Earnings (loss) before income taxes 989 (9,410) (39,891) 1.0 (12.6) (64.4)
Income taxes 2,623 (986) 15,059 2.7 (1.3) 24.3
--------------------------------------------------------------------------------------------------------------------------
Net loss for the year $ (1,634) $ (8,424) $(54,950) (1.7)% (11.3)% (88.7)%
--------------------------------------------------------------------------------------------------------------------------
Basic and diluted net loss per share $ (0.02) $ (0.13) $ (0.87)
Segment information
Sales:
Telecom Division $ 80,120 $ 58,882 $ 48,753 82.4 % 78.9 % 78.7 %
Life Sciences and Industrial Division 17,096 15,748 $ 13,177 17.6 % 21.1 % 21.3 %
--------------------------------------------------------------------------------------------------------------------------
$ 97,216 74,630 61,930 100.0 % 100.0 % 100.0 %
--------------------------------------------------------------------------------------------------------------------------
Operating earnings (loss): (2)
Telecom Division $ 763 $ (5,557) $ -- 0.8 % (7.4)% -- %
Life Sciences and Industrial Division (962) (5,013) -- (1.0) (6.7) --
--------------------------------------------------------------------------------------------------------------------------
$ (199) $(10,570) $ -- (0.2)% (14.1)% -- %
--------------------------------------------------------------------------------------------------------------------------
Research and development data:
Gross research and development $ 15,878 $ 15,668 $ 17,133 16.3 % 21.0 % 27.7 %
Net research and development $ 12,190 $ 12,390 $ 15,879 12.5 % 16.6 % 25.6 %
--------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS DATA:
Total assets $190,957 $172,791 $146,254
--------------------------------------------------------------------------------------------------------------------------
(1) The cost of sales is exclusive of amortization, shown separately. Including inventory write-offs of $4,121,000 and an
unusual gain of $473,000 for the year ended August 31, 2003.
(2) Comparative information for fiscal 2003 for the loss from operations is not available and is impracticable to
determine.
2005 Annual Report o EXFO :: 14
SALES
FISCAL 2005 VS. 2004
In fiscal 2005, our global sales increased 30.3% to $97.2 million from $74.6
million in 2004, with an 82%-18% split in favor of our Telecom Division.
[GRAPHIC OMITTED][BAR CHART] 05 04 03 02 01
($millions) 97.2 74.5 61.9 68.3 146.0
TELECOM DIVISION
In fiscal 2005, sales of our Telecom Division increased 36.1% to $80.1 million
from $58.9 million in 2004. Since the second half of fiscal 2004, we have
benefited from an increased demand for our test solutions following the
deployment of fiber deeper into access networks (FTTx). In fiscal 2005, we
consolidated our leadership position in the FTTx test market by recognizing
significant revenue from two leading U.S. carriers deploying fiber in their
access networks. Our largest customer, who purchased several orders of FTTx
test equipment, accounted for 28.2% of telecom sales in fiscal 2005 (17.5% in
2004). In addition, the positive spending environment helped us increase our
sales in 2005.
Although sales of our protocol test products increased sequentially each
quarter in fiscal 2005 and reached more than 10% of Telecom revenues in the
fourth quarter of 2005, they still fell below 10% for the whole fiscal year.
Our penetration of the protocol test market has been modest since, in 2003, we
refocused our efforts onto next-generation solutions, which are at the basis
of the whole trend toward IP convergence. We expect that protocol sales will
equal optical sales on a medium- to long-term basis given that the protocol
test market is more than double the size of the optical test market, our rich
product pipeline in protocol testing, and increasing customer traction. We
remain confident that the solid product portfolio we are building for this
crucial end-market will lead to long-term growth for EXFO.
LIFE SCIENCES AND INDUSTRIAL DIVISION
In fiscal 2005, sales of our Life Sciences and Industrial Division increased
8.6% to $17.1 million from $15.7 million in 2004. The increase in sales in
fiscal 2005, compared to 2004, is mainly due to market-share gains in the
fluorescence illumination market as well as increased sales activities in the
curing market.
Overall, for the two divisions, net accepted orders increased 35.6% to $101.7
million in fiscal 2005 from $75.0 million in 2004. Our net book-to-bill ratio
rose to 1.05 in fiscal 2005, from 1.00 in 2004. The increased demand for our
test solutions for FTTx applications, market-share gains in the
telecommunications and life sciences markets, as well as the slight
improvement in the telecommunications market environment helped us increase
our bookings year-over-year.
For the upcoming quarters, we expect the sales split between the two divisions
to remain in the same range as for fiscal 2005.
FISCAL 2004 VS. 2003
In fiscal 2004, our global sales increased 20.5% to $74.6 million from $61.9
million in 2003, with a 79%-21% split in favor of our Telecom Division.
TELECOM DIVISION
In fiscal 2004, sales of our Telecom Division increased 20.8% to $58.9 million
from $48.8 million in 2003. In 2004, despite a relatively stable carrier
spending environment compared to the previous year, we continued to gain
market share, which helped us increase our sales year-over-year. We believe
these market-share gains are mainly attributable to our optical field-testing
products, which represent our traditional core business, since sales of our
protocol-layer test solutions represented just over 10% of our Telecom sales
in fiscal 2004. In addition, we benefited from a slight recovery in the
telecom system and optical manufacturing markets. Finally, revenues from FTTx
test solutions were higher than expected, especially with a leading U.S.
carrier, which contributed to our sales increase.
LIFE SCIENCES AND INDUSTRIAL DIVISION
In fiscal 2004, sales of our Life Sciences and Industrial Division increased
19.5% to $15.7 million from $13.2 million in 2003. The increase in sales is
due to the greater demand for our high-precision assembly solutions.
GEOGRAPHIC DISTRIBUTION
During fiscal 2005, sales to the Americas, Europe-Middle East-Africa (EMEA)
and Asia-Pacific (APAC) accounted for 68%, 20% and 12% of global sales,
respectively. Our sales to the Americas, which increased 34% year-over-year,
benefited from the recent deployments of fiber deeper in access networks
(mainly in the United States). Our sales to EMEA increased more significantly
(42%) year-overyear, mainly due to market-share gains in both divisions,
following our efforts to develop this important end-market. Finally, our sales
to APAC remained flat in dollars year-over-year. A significant portion of our
sales to this region of the world are made through price-driven tenders that
may vary in number and importance from quarter to quarter. Also, the
competitive landscape in this market led to pricing pressure, which prevented
us from increasing our sales year-over-year.
The geographic distribution of our sales remained unchanged as a percentage of
sales in fiscal 2004, compared to 2003, since all geographic areas had the
same growth level. Sales to Americas, EMEA and APAC accounted for 66%, 18% and
16% of global sales, respectively, for both fiscal years.
Through our two divisions, we sell our products to a broad range of customers,
including network service providers, cable operators, optical system and
component manufacturers, as well as customers in the life sciences and
high-precison assembly sectors. In fiscal 2004 and 2005, one customer
represented more than 10% of our sales with 13.8% of sales ($10.3 million) in
fiscal 2004 and 23.3% of sales ($22.6 million) in 2005. During 2003, no
customer accounted for more than 10% of our sales. In fiscal 2005, our top
three customers accounted for 28.4% of sales, compared to 20.8% in 2004.
2005 Annual Report o EXFO :: 15
GROSS MARGIN
Gross margin amounted to 54.7%, 53.7% and 41.6% of sales for fiscal 2005, 2004
and 2003, respectively.
[GRAPHIC OMITTED][BAR CHART] 05 04 03 02 01
($millions) 54.7 53.7 41.6 23.4 61.5
FISCAL 2005 VS. 2004
The increase in our gross margin in fiscal 2005, compared to 2004, can be
explained by the following factors. First, we were able to reduce our cost of
goods sold by better leveraging our supplier base and by developing innovative
new products with a cost-effective design. Also, the significant rise in sales
(30.3% year-over-year) resulted in an increase in manufacturing activities,
allowing us to better absorb our fixed manufacturing costs. Furthermore,
streamlined operations following our consolidation actions in fiscal 2004 and
2005 and cost-reduction programs allowed us to further improve our gross
margin. In addition, the shift in the geographic distribution of our sales
resulted in more sales made to the Americas market, where gross margins tend
to be higher because we sell direct to the customers. However, a stronger
Canadian dollar, compared to the US dollar, prevented us, to some extent, from
further improving our gross margin as some cost of sales elements are
denominated in Canadian dollars. As well, the different customer mix and
aggressive pricing pressure observed in fiscal 2005 also prevented us from
further improving our gross margin.
Over the past months, we adjusted the design of some of our products and we
experienced higher sales than expected. Consequently, we were able to reuse
excess inventories that were written off during the telecom downturn for
approximately $1.6 million in fiscal 2005, or 1.7% of sales, compared to
approximately $600,000, or 0.8% of sales in 2004. Inventory write-offs
recorded during the telecom downturn were based on management's best estimate
at that time.
FISCAL 2004 VS. 2003
The increase in our gross margin in fiscal 2004, compared to 2003, can be
explained by several factors. First, the rise in sales (20.5% year-over-year)
helped increase our gross margin. Increased manufacturing activities allowed
us to better absorb our fixed manufacturing costs. In addition, our
cost-reduction measures, the consolidation of manufacturing sites and our
enhanced efficiency further contributed to the increase in gross margin.
However, a stronger Canadian dollar, compared to the US dollar year-overyear,
prevented us, to some extent, from further improving our gross margin as some
cost of sales elements are denominated in Canadian dollars. Finally, the gross
margin recorded in fiscal 2003 included a charge of $4.1 million, or 6.7% of
sales, for excess and obsolete inventories and an unusual gain of $473,000, or
0.7% of sales.
OUTLOOK FOR FISCAL 2006
Considering the expected sales growth in 2006, the effect of our recent
consolidation actions, the cost-effective design of our products and our tight
control on operating costs, we expect our gross margin to improve in fiscal
2006. However, our gross margin may fluctuate quarter-over-quarter as our
sales may fluctuate. Furthermore, our gross margin can be negatively affected
by increased competitive pricing pressure, increased obsolescence costs,
shifts in product mix, under-absorption of fixed manufacturing costs and
increases in product offerings by other suppliers in our industry. Finally, a
potential increase in the strength of the Canadian dollar would have a
negative impact on our gross margin in 2006.
SELLING AND ADMINISTRATIVE
Selling and administrative expenses were $31.8 million, $25.9 million and
$27.0 million for fiscal 2005, 2004 and 2003, respectively.
[GRAPHIC OMITTED][BAR CHART] 05 04 03 02 01
($millions) 31.8 25.9 27.0 33.9 45.0
As a percentage of sales, selling and administrative expenses amounted to
32.7%, 34.7% and 43.6% for fiscal 2005, 2004 and 2003, respectively.
FISCAL 2005 VS. 2004
The increase in our selling and administrative expenses in dollars in fiscal
2005, compared to 2004, is mainly due to our decision to significantly
increase our sales activities to better leverage the significant research and
development investments of the prior years, which resulted in higher sales and
marketing expenditures (including head-counts). In addition, our commission
expenses increased year-over-year, especially due to the increase in sales to
the Americas market. Furthermore, a stronger Canadian dollar, compared to the
US dollar year-over-year, caused our selling and administrative expenses to
increase, as more than half of these are incurred in Canadian dollars. Also,
stock-based compensation costs were higher in fiscal 2005 ($626,000) than in
2004 ($265,000), further increasing our selling and administrative expenses
year-over-year. Finally, costs to comply with Section 404 of the
Sarbanes-Oxley Act of 2002 further increased our SG&A (selling and
administrative) year-over-year. However, we were able to mitigate the increase
in our selling and administrative expenses as well as reduce these expenses in
percentage of sales year-over-year due to tight cost-control measures and the
consolidation of our Life Sciences and industrial Division. In addition, our
significant increase in revenues allowed us to reduce our selling and
administrative expenses on a percentage basis.
FISCAL 2004 VS. 2003
In fiscal 2004, thanks to our restructuring actions and tight cost-control
measures, we were able to reduce our selling and administrative expenses by 4%
year-over-year, while our sales increased 20.5% in that same period. However,
several factors prevented us from further reducing these expenses
year-over-year. A higher sales volume in fiscal 2004, compared to 2003, caused
our commission and marketing expenses to increase. In addition, since
September 1, 2003, we account for stock-based compensation costs related to
awards granted to our employees, which caused our selling and administrative
expenses to increase year-over-year. Furthermore, in fiscal 2003, we recorded
an unusual gain of $239,000 related to a grant recovery. Finally, a stronger
Canadian dollar, compared to the US dollar year-over-year, further increased
our selling and administrative expenses, as more than half of these are
incurred in Canadian dollars.
OUTLOOK FOR FISCAL 2006
For fiscal 2006, we expect our selling and administrative expenses to increase
in dollars and remain relatively stable as a percentage of sales. In
particular, we expect our commission expenses to increase as sales volume
increases. Also, considering our goal of becoming
2005 Annual Report o EXFO :: 16
the leading player in the telecom test and measurement space, we will
intensify our sales and marketing efforts, both domestic and international,
which will also cause our expenses to rise. Finally, a potential increase in
the strength of the Canadian dollar would also cause our selling and
administrative expenses to increase.
RESEARCH AND DEVELOPMENT
GROSS RESEARCH AND DEVELOPMENT EXPENSES
Gross research and development expenses totaled $15.9 million, $15.7 million
and $17.1 million for fiscal 2005, 2004 and 2003, respectively. As a
percentage of sales, gross research and development expenses amounted to
16.3%, 21.0% and 27.7% for fiscal 2005, 2004 and 2003, respectively, while net
research and development expenses accounted for 12.5%, 16.6% and 25.6% for
these respective periods.
[GRAPHIC OMITTED][BAR CHART] 05 04 03 02 01
($millions) 15.9 15.7 17.1 17.0 17.6
FISCAL 2005 VS. 2004
We incurred most of our gross research and development expenses in Canadian
dollars as we have consolidated most of our research and development
activities in Canada. Consequently, the significant increase in the strength
of the Canadian dollar, compared to the US dollar year-over-year, caused our
gross research and development expenses to increase in fiscal 2005, compared
to 2004. However, this increase was mostly offset by the decrease in our gross
research and development expenses in our Life Sciences and Industrial Division
following the consolidation of this Division in Toronto. The decrease in our
gross research and development expenses, as a percentage of sales, in fiscal
2005 compared to 2004, is directly attributable to the significant increase in
sales year-over-year while these expenses remained relatively flat.
FISCAL 2004 VS. 2003
The decrease in our gross research and development expenses in fiscal 2004,
compared to 2003, both in dollars and as percentage of sales, can be explained
by several factors. First, our restructuring actions, the consolidation of our
protocol operations in Montreal, as well as tight cost-control measures,
contributed to the reduction of our gross research and development expenses
year-over-year. In addition, before the end of the year, we refocused the
research and development activities of our Life Sciences and Industrial
Division. Finally, mix and timing of our research and development projects,
especially in our Telecom Division, caused our gross research and development
expenses to decrease year-over-year. On the other hand, a stronger Canadian
dollar, compared to the US dollar year-over-year, increased our gross research
and development expenses, as most of these are incurred in Canadian dollars.
TAX CREDITS AND GRANTS
Tax credits and grants from the Canadian federal and provincial governments
for research and development activities were $3.7 million, $3.3 million and
$3.6 million for fiscal 2005, 2004 and 2003, respectively.
FISCAL 2005 VS. 2004
The increase in our tax credits and grants in fiscal 2005, compared to 2004,
is mainly related to the increase in our eligible gross research and
development expenses in Canada, since we were entitled to similar grant
programs and tax credits year-over-year. Following the consolidation of our
research and development activities in Canada, we incurred most of our
research and development expenses in Canada, where we are entitled to research
and development tax credits.
FISCAL 2004 VS. 2003
The decrease in our tax credits and grants in fiscal 2004, compared to 2003,
is mainly related to the decrease in our eligible gross research and
development expenses incurred in Canada, since we were entitled to similar tax
credits year-over-year.
We still invested significantly in research and development activities in
fiscal 2005 as we firmly believe that innovation and new product introductions
are key in gaining market share in the current economic environment and
ensuring the long-term growth and profitability of the company.
OUTLOOK FOR FISCAL 2006
For fiscal 2006, we expect to increase our gross research and development
expenses in proportion to our revenues, as a reflection of our focus on
innovation, our desire to gain market share and our goal to exceed customer
needs and expectations. Also, a potential increase in the strength of the
Canadian dollar would cause our net research and development expenses to
increase, as most of these are incurred in Canadian dollars.
AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT
For fiscal 2005, amortization of property, plant and equipment was $4.3
million, compared to $4.9 million in 2004 and $5.2 million in 2003. The
decrease in amortization expenses in fiscal 2005, compared to 2004, despite
the significant increase in the strength of the Canadian dollar compared to
the US dollar, is mainly due to the fact that some of our property, plant and
equipment became fully amortized during fiscal 2004.
OUTLOOK FOR FISCAL 2006
For fiscal 2006, despite a potential increase in the strength of the Canadian
dollar, we expect the amortization of property, plant and equipment to
decrease compared to 2005 considering that some of these assets became fully
amortized in 2005 or will become fully amortized in 2006.
AMORTIZATION OF INTANGIBLE ASSETS
In conjunction with the business combinations we completed over the past few
years, we recorded intangible assets, primarily consisting of core technology.
These intangible assets resulted in amortization expenses of $4.8 million,
$5.1 million and $5.7 million for fiscal 2005, 2004 and 2003, respectively.
The decrease in amortization expenses in fiscal 2005, compared to 2004, is
mainly due to the fact that some of our core technologies became fully
amortized during fiscal 2005.
The decrease in amortization expenses in fiscal 2004, compared to 2003, is the
result of the $2.9 million impairment charge recorded in the third quarter of
fiscal 2003.
OUTLOOK FOR FISCAL 2006
For fiscal 2006, we expect the amortization of
intangible assets to approximate $3.3 million, assuming no acquisitions are
made during this period.
2005 Annual Report o EXFO :: 17
IMPAIRMENT OF LONG-LIVED ASSETS AND GOODWILL
FISCAL 2003
In May 2003, we performed our annual impairment test of goodwill for all our
reporting units, except for newly acquired EXFO Gnubi. Also, considering
market conditions in the telecommunications industry and the persisting
unfavorable conditions affecting our subsidiaries' industries at that time, we
reviewed the carrying value of intangible assets related to these reporting
units, consisting primarily of acquired core technology.
As a result of this assessment, we concluded that the carrying value of
goodwill related to EXFO Burleigh and the carrying value of intangible assets
related to EXFO Burleigh and EXFO Photonic Solutions were impaired, and we
recorded an impairment charge of $4.5 million to write down goodwill and a
pre-tax impairment charge of $2.9 million to write down acquired core
technology. Of the total impairment charge of $7.4 million, $6.9 million was
related to EXFO Burleigh for goodwill and acquired core technology and
$555,000 was related to EXFO Photonic Solutions for acquired core technology.
The write-down of goodwill and acquired core technology of EXFO Burleigh was
required, considering that we exited the optical component manufacturing
automation business, whose revenue potential represented a long-term prospect.
The write-down of acquired core technology from EXFO Photonic Solutions was
required because revenue potential related to this long-lived asset was less
than expected in the short and medium term due to the state of the market at
the time.
However, no impairment of goodwill and intangible assets was required for EXFO
Protocol since we believed that revenue potential from the protocol-layer
testing market would remain strong in the short and medium term.
For the purposes of estimating fair value, we used a combination of discounted
future cash flows and a market approach (sales multiples). The discounted
future cash flows were estimated using periods ranging between eight and ten
years, discount rates ranging between 15% and 20%, and an annual growth rate
ranging between nil and 35%. The sales multiples used in the market approach
ranged between 0.7 and 2.3. The assumptions used reflected our best estimates.
FISCAL 2004 AND 2005
In fiscal 2004, we put one of our buildings located in Quebec City up for sale
and received, at the beginning of fiscal 2005, a formal purchase offer for
this building. Based on that offer, we concluded that the building was
impaired and we recorded an impairment charge of $620,000 in fiscal 2004,
representing the excess of the carrying value of the building over its
expected selling price. However, during the first quarter of fiscal 2005, some
conditions of the formal offer were not met and the offer was declined. During
fiscal 2005, we withdrew the building from the market. As at August 31, 2004,
the building was not shown as a long-lived asset held for sale in the balance
sheet because it was still used and, consequently, it was not available for
immediate sale. This building reports to the Telecom Division.
In May 2004 and 2005, we performed our annual impairment test for goodwill and
concluded that it was not impaired. Goodwill will be reviewed for impairment
in May 2006, or prior if events or circumstances indicate it might be
impaired.
RESTRUCTURING AND OTHER CHARGES
FISCAL 2003
In fiscal 2003, we implemented a restructuring plan to align our cost
structure with market conditions. Under that plan, we recorded charges of $4.1
million, including $2.8 million in severance expenses for the 172 employees
who were terminated throughout the company, $512,000 for impaired long-lived
assets and $855,000 for future payments on exited leased facilities located
around the world. Our estimation of the fair value of such future payments
took into account the estimated sublease rentals over the remaining terms of
the exited leases.
FISCAL 2004 AND 2005
In fiscal 2004, the Board of Directors approved a restructuring plan to
consolidate the operations of our Life Sciences and Industrial Division,
transferring EXFO Burleigh's operations mainly to EXFO Photonic Solutions
facilities in Toronto. The consolidation process, which started in August
2004, was completed during fiscal 2005.
Overall, for that process, we incurred $2.5 million in restructuring and other
charges from which $2.0 million were recorded in fiscal 2004 and the remaining
of $482,000 were recorded in fiscal 2005. The overall costs, which were
recorded in the restructuring and other charges in the statements of earnings
of the corresponding years, are detailed as follows: $855,000 for severance
expenses for the layoff of all employees of EXFO Burleigh; $1.3 million mainly
for the impairment of the EXFO Burleigh building; and the remaining $399,000
for other expenses such as training and recruiting expenses and transfer of
assets.
The EXFO Burleigh building was put up for sale in fiscal 2004, but it is not
yet sold because of the diffcult real estate market in Rochester, NY. The
building is available for sale in its present condition and we expect to sell
the property within the next twelve months. Consequently, in accordance with
CICA handbook, section 3475, "Disposal of Long-Lived Assets and Discontinued
Operations", it was shown in the balance sheet as a long-lived asset held for
sale. The fair value used to determine the impairment loss of the building
represents our best estimate of its selling price based upon the municipal
valuation. Since September 1, 2004, the building is no longer amortized.
Finally, in fiscal 2005, we recorded adjustments of $190,000 to the fiscal
2003 plan because actual charges, mainly for leased equipment, were lower than
expected.
Our restructuring plans and cost-reduction measures represented our best
efforts to respond to the difficult market conditions of the past years.
Although we believe that such restructuring actions were appropriate and
delivered the expected results, changes in market or industry conditions may
lead us to incur additional restructuring actions and cost-reduction measures
in the coming years.
2005 Annual Report o EXFO :: 18
INTEREST AND OTHER INCOME
Our interest income mainly resulted from our short-term investments, less
interests and bank charges. Interest and other income amounted to $2.5
million, $1.4 million and $1.2 million for fiscal 2005, 2004 and 2003,
respectively. The increase in interest income in fiscal 2005, compared to
2004, is due in part to the increase in our cash and short-term investments
following our public off ering in February 2004, the cash flows from operating
activities and the increase in interest rates year-over-year. Also, in fiscal
2005, we recovered research and development tax credits earned in previous
years and we were granted $249,000 in interest by the tax authorities.
In fiscal 2004, we recorded one-time revenue of $265,000 for the sale of
non-core technologies. Without this revenue, interest and other income would
have been relatively flat compared to 2003.
Assuming no acquisitions are made in fiscal 2006, we expect our interest
income to increase during that fiscal year should interest rates increase and
because our cash and short-term investments should increase with cash flows
from operating activities.
FOREIGN EXCHANGE LOSS
Foreign exchange loss amounted to $1.3 million, $278,000 and $1.6 million for
fiscal 2005, 2004 and 2003, respectively.
Foreign exchange gains and losses are the result of the translation of
operating activities denominated in currencies other than the Canadian dollar.
The significant exchange loss recorded during fiscal 2005 is the result of the
significant increase in the value of the Canadian dollar compared to the US
dollar in fiscal 2005. For instance, the year-end exchange rate was Cdn$1.3167
= US$1.00 in fiscal 2004 compared to Cdn$1.1889 = US$1.00 in 2005,
representing an increase of nearly 10% in the value of the Canadian dollar.
The average exchange rate for fiscal 2005 was Cdn$1.2315 = US$1.00, compared
to Cdn$1.3300 = US$1.00 in 2004.
During the same period last year, the Canadian dollar value remained
relatively stable throughout the year, resulting in a slight exchange loss
during that period. In addition, higher levels of activity in fiscal 2005,
compared to 2004, further increased the foreign exchange loss in 2005.
It should be noted that additional foreign exchange rate fluctuations flow
through the P&L line items as a significant portion of our operating elements
are denominated in Canadian dollars and we report our results in US dollars.
We manage our exposure to currency risks with forward exchange contracts. In
addition, some of our Canadian entities' operating activities are denominated
in US dollars or other currencies, which further hedges this risk. However, a
potential increase in the value of the Canadian dollar, compared to the US
dollar, would have a negative impact on our operating results.
INCOME TAXES
Our income tax expense was $2.6 million for fiscal 2005, compared to an income
tax recovery of $986,000 for 2004, and an income tax expense of $15.1 million
for 2003.
The income tax expense recorded in fiscal 2005 represents income taxes payable
in some specific tax jurisdictions, mainly at the Canadian federal level.
Income taxes payable at this specific level is reduced by research and
development tax credits that are recorded against gross research and
development expenses.
The income tax recovery recorded in fiscal 2004 is mainly due to the $1.4
million unusual income tax recovery recorded during that year, offset in part
by income taxes payable in some specific tax jurisdictions, mainly at the
Canadian Federal level. The unusual tax recovery was due to the receipt,
during that period, of income taxes paid in previous periods following the
reception of a tax assessment.
Since fiscal 2003, we have been recording a full valuation allowance against
our future income tax assets because it is more likely than not that these
assets will not be recovered. The valuation allowance will be reversed once
management will have concluded that realization of future income tax assets is
more likely than not. Consequently, our income tax rates are distorted
compared to statutory rates. Please refer to note 16 of our consolidated
financial statements included elsewhere in this Annual Report for a full
reconciliation of the income tax provision.
LIQUIDITY AND CAPITAL RESOURCES
CASH REQUIREMENTS AND CAPITAL RESOURCES
As at August 31, 2005, cash and short-term investments consisted of $112.0
million, while our working capital was at $135.3 million. Our cash and
short-term investments increased $22.9 million in fiscal 2005, compared to
2004, mainly due to the cash flows from operating activities of $14.0 million
as well as an unrealized foreign exchange gain of $10.0 million on cash and
short-term investments. However, this increase was partially offset by the
cash payment of $1.5 million for the purchase of property, plant and equipment
as well as intangible assets. The unrealized foreign exchange gain resulted
from the translation, in US dollars, of our Canadian-dollar-denominated cash
and short-term investments and was recorded in the cumulative translation
adjustment in the balance sheet.
Our short-term investments consist of commercial paper issued by six
high-credit quality corporations and trusts; therefore, we consider the risk
of non-performance of these financial instruments to be remote. For the
purposes of managing our cash position, we have established a cash management
policy, which we follow and monitor on a regular basis. These short-term
investments will be used for working capital and other general corporate
purposes, including potential acquisitions.
We believe that our cash balances and short-term investments, combined with an
available line of credit of $5.8 million, will be sufficient to meet our
liquidity and capital requirements for the foreseeable future. However,
possible additional operating losses and/or possible investments in or
acquisitions of complementary businesses, products or technologies may require
additional financing. There can be no assurance that additional debt or equity
financing will be available when required or, if available, that it can be
secured on satisfactory terms. Our line of credit bears interest at prime
rate.
2005 Annual Report o EXFO :: 19
The following table summarizes our commitments as at August 31, 2005:
-----------------------------------------------------------------------------------------------------------------------------------
Years ending August 31, 2006 2007 2008 2009 2010 and later Total
-----------------------------------------------------------------------------------------------------------------------------------
Long-term debt $ 134,000 $ 147,000 $ 51,000 $ - $ - $ 332,000
Operating leases 1,050,000 952,000 632,000 584,000 1,029,000 4,247,000
-----------------------------------------------------------------------------------------------------------------------------------
Total commitments $ 1,184,000 $ 1,099,000 $ 683,000 $ 584,000 $ 1,029,000 $ 4,579,000
-----------------------------------------------------------------------------------------------------------------------------------
SOURCES AND USES OF CASH
We finance our operations and meet our capital expenditure requirements mainly
through cash flows from operating activities, the use of our cash and
short-term investments as well as the issuance of subordinate voting shares.
In fiscal 2004, pursuant to a public offering in Canada, we issued 5.2 million
subordinate voting shares for net proceeds of $29.2 million (Cdn$38.4 million)
after deducting underwriting commissions of $1.2 million (Cdn$1.6 million).
These net proceeds were recorded as short-term investments. Cash flows
provided by financing activities in fiscal 2004 were attributable to the net
proceeds of this offering.
OPERATING ACTIVITIES
Cash flows provided by operating activities amounted to $14.0 million in
fiscal 2005, compared to $751,000 in 2004 and $5.6 million in 2003.
Cash flows provided by operating activities in fiscal 2005 were mainly
attributable to the net earnings after items not affecting cash of $9.1
million and the positive net change in non-cash operating items of $4.9
million. This net change in non-cash operating items is mainly due to the
decrease of $6.1 million of our income taxes and tax credits recoverable
following the collection, during the year, of income taxes and tax credits
recoverable from previous periods. On the other hand, our accounts receivable
increased by $838,000 and our inventories increased by $699,000. The increase
of our accounts receivable is related to the increase in sales. Our
inventories slightly increased despite the significant rise in sales due to
tight inventory management.
Cash flows provided by operating activities in fiscal 2004 were mainly
attributable to the net earnings after items not affecting cash of $5.7
million, offset in part by the net increase of our non-cash operating items of
$4.9 million; that is, our accounts receivable increased by $2.7 million, our
income taxes and tax credits recoverable increased by $2.5 million and our
inventories decreased by $1.0 million. The increase in our accounts receivable
is directly related to the significant sales growth in fiscal 2004. The
increase in our income taxes and tax credits recoverable is mainly due to the
payment during the year of income taxes and to the recognition, during the
year, of research and development tax credits not yet recovered. On the other
hand, our increased sales level combined with tight inventory management
enabled us to reduce our inventories overall.
We have delivered positive cash flows from operating activities for the last
three fiscal years, despite the fact that we posted a net loss in each of
these years.
INVESTING ACTIVITIES
Cash flows used by investing activities totaled $13.0 million in fiscal 2005,
compared to $29.7 million in 2004 and $9.9 million in 2003.
In fiscal 2005, we acquired $11.5 million worth of short-term investments with
cash flows from operating activities and cash on-hand and paid $1.5 million
for the purchase of property, plant and equipment as well as intangible
assets.
In fiscal 2004, we acquired $28.6 million worth of short-term investments with
the net proceeds of the public offering. In addition, we paid $1.1 million for
the purchase of property, plant and equipment as well as intangible assets.
FORWARD EXCHANGE CONTRACTS
We utilize forward exchange contracts to manage our foreign currency exposure.
Our policy is not to utilize those derivative financial instruments for
trading or speculative purposes.
Our forward exchange contracts, which are used to hedge anticipated
US-dollar-denominated sales, qualify for hedge accounting; therefore, foreign
exchange translation gains and losses on these contracts are recognized as an
adjustment of the revenues when the corresponding hedged sales are recorded.
As at August 31, 2005, we held contracts to sell US dollars at various forward
rates, which are summarized as follows:
Weighted average
contractual
Expiry dates Contractual amounts forward rates
---------------------------------------------------------------
September 2005
to August 2006 $ 26,000,000 1.2630
September 2006
to November 2007 7,600,000 1.2500
As at August 31, 2005, the fair value of our forward exchange contracts, which
represents the difference between their contractual amounts and their current
trading value, amounted to an unrecognized gain of $2.9 million.
RELATED-PARTY TRANSACTIONS
In fiscal 2003, we acquired a building from a company owned by the President
of EXFO for a cash consideration of $930,000. This transaction was measured at
the fair market value since it was not conducted during the normal course of
operations, the change in ownership interest in the building was substantive
and the fair market value was supported by independent appraisal.
In addition, for the years ended August 31, 2003 and 2004, we leased
facilities from the company owned by the President of EXFO. The annual rental
expense amounted to $331,000 and nil, respectively. The rental expense for
fiscal 2003 included $234,000 for future
2005 Annual Report o EXFO :: 20
payments on an exited leased facility. As at August 31, 2004, restructuring
charges payable included $194,000 due to the company owned by the President of
EXFO in connection with this exited leased facility. In September 2004, EXFO
was released from its obligations under that lease, and it paid the full
amount due to the related company. These rental expenses were measured at the
fair market value since they were incurred during the normal course of
operations.
CONTINGENCY
As discussed in note 12 to our consolidated financial statements included
elsewhere in this Annual Report, EXFO was named as a defendant in a U.S.
securities class action related to its initial public offering (IPO) in June
2000. The complaints allege that the prospectus and the registration statement
for the IPO failed to disclose that the underwriters allegedly received
excessive commissions and that the underwriters and some investors
collaborated in order to inflate the price of EXFO's stock in the
after-market.
In June 2003, a committee of EXFO's Board of Directors conditionally approved
a proposed settlement between the issuer defendants, the individual
defendants, and the plaintiffs. If approved, the settlement would provide,
among other things, a release of EXFO and of the individual defendants for the
conduct alleged in the action to be wrongful in the amended complaint. EXFO
would agree to undertake other responsibilities under the settlement,
including agreeing to assign away, not assert, or release certain potential
claims EXPO may have against its underwriters. Any direct financial impact of
the proposed settlement is expected to be borne by EXFO's insurance carriers.
On June 25, 2004, the Plaintiffs moved for Preliminary Approval of the
settlement. The court granted the preliminary approval motion on February 15,
2005, subject to certain modifications. On August 31,2005, the court issued a
preliminary order further approving the modifications to the settlement and
certifying the settlement classes. The court also appointed the Notice
Administrator for the settlement and ordered that the notice of the settlement
be distributed to all settlement class members beginning on November 15, 2005,
and completed by January 15, 2006. The settlement fairness hearing has been
set for April 26, 2006. Following the hearing, if the court determines that
the settlement is fair to the class members, the settlement will be approved.
There can be no assurance that this proposed settlement would be approved and
implemented in its current form, or at all. Therefore, it is not possible to
predict the final outcome of the case, nor determine the amount of any
possible losses. If the settlement process fails, EXPO will continue to defend
its position in this litigation that the claims against it, and its officers,
are without merit Accordingly, no provision for this case has been made in the
consolidated financial statements as at August 31, 2005.
SHARE CAPITAL AND STOCK-BASED COMPENSATION PLANS
SHARE CAPITAL
As at November 3, 2005, EXFO had 37,900,000 multiple voting shares
outstanding, entitling to ten votes each, and 30,674,617 subordinate voting
shares outstanding. The multiple voting shares and the subordinate voting
shares are unlimited as to number and without par value.
LONG-TERM INCENTIVE PLAN
In January 2005, EXFO made certain amendments to the existing Stock Option
Plan, including the renaming of the plan to Long-Term Incentive Plan, which
now includes restricted share units (RSUs) in addition to stock options. RSUs
are "phantom" shares that rise and fall in value based on the value of EXFO's
subordinate voting shares and are redeemable for actual subordinate voting
shares or cash, at the discretion of the Board of Directors, on the vesting
dates established by the Board of Directors at the time of grant. The vesting
dates are subject to a minimum of three years and a maximum of ten years from
the award date. RSUs granted under the plan expire at the latest ten years
from the date of grant.
DEFERRED SHARE UNIT PLAN
In January 2005, EXFO established a Deferred Share Unit (DSU) Plan for the
members of the Board of Directors as part of their annual retainer fees. Each
DSU entitles the Board members to receive one subordinate voting share. DSUs
are acquired on the date of grant and will be redeemed in subordinate voting
shares when the Board member will cease to act as Director of EXFO.
The aggregate number of subordinate voting shares covered by stock options,
RSUs and DSUs granted under the Long-Term Incentive Plan and the Deferred
Share Unit Plan was 2,963,678 as at August 31, 2005. The maximum number of
subordinate voting shares issuable under these two plans cannot exceed
6,306,153 shares. The following tables summarize information about stock
options, RSUs and DSUs granted to the members of the Board of Directors and to
Management and Corporate Officers of the company and its subsidiaries as at
August 31, 2005:
% of issued Weighted average
Stock Options Number and outstanding exercise price
------------------------------------------------------------------------------
Chairman of the Board,
President and CEO
(one individual) 168,424 6 % $ 9.34
Board of Directors
(five individuals) 194,375 7 % $ 6.23
Management and Corporate
Officers (nine individuals) 340,091 12 % $14.39
------------------------------------------------------------------------------
702,890 25 % $10.92
------------------------------------------------------------------------------
2005 Annual Report o EXFO :: 21
% of issued
Restricted Share Units Number and outstanding
------------------------------------------------------------------------------
Chairman of the Board, President and CEO
(one individual) 13,089 7%
Management and Corporate Officers
(nine individuals) 151,096 86%
------------------------------------------------------------------------------
164,185 93%
% of issued
Deferred Share Units Number and outstanding
------------------------------------------------------------------------------
Board of Directors (five individuals) 23,734 100%
------------------------------------------------------------------------------
OFF-BALANCE SHEET ARRANGEMENTS
As of August 31, 2005, our off-balance sheet arrangements consisted of forward
exchange contracts, which are described in details in note 18 to our
consolidated financial statements, included elsewhere in this Annual Report.
VARIABLE INTEREST ENTITY
As of August 31, 2005, we did not have significant interests in any variable
interest entities.
RISKS AND UNCERTAINTIES
Over the past few years, we have managed our business in a difficult
environment; focused on research and development programs for new and
innovative products aimed at expected growth pockets in our sector; continued
the development of our domestic and international markets; and made strategic
acquisitions. However, we operate in a highly competitive sector that is in
constant evolution and, as a result, we encounter various risks and
uncertainties that must be given appropriate consideration in our strategic
management policies.
Firstly, we are exposed to currency risks due to the export of our
Canadian-manufactured products, the large majority of which are denominated in
US dollars. These risks are partially hedged by operating expenses denominated
in US dollars, the purchase of raw materials in US dollars and forward
exchange contracts. The increased strength of the Canadian dollar, compared to
the US dollar, over the last two years caused our operating expenses, as well
as our foreign exchange loss, to increase. Any further increase in the value
of the Canadian dollar in the coming months will negatively affect our results
of operations.
Secondly, during the last few quarters, we experienced unusual sales
concentration with a U.S.-based Tier-1 telecom carrier. Although we believe
this sales concentration is largely due to our leadership position in the FTTx
test market, orders from this customer can fluctuate in upcoming quarters,
depending on the carrier's deployment needs, products requirements and
schedule.
In addition, risks and uncertainties related to the telecommunications test
and measurement industry involve the rapid development of new products that
may have short life cycles and require extensive research and development; the
difficulty of adequately predicting market size and trends; the difficulty of
retaining highly skilled employees; and the ability to quickly adapt our cost
structure to changing market conditions in order to achieve profitability.
Furthermore, given our strategic goals for growth and competitive positioning
in our industry, we are continuously expanding into international markets.
This exposes us to certain risks and uncertainties related to changes in local
laws and regulations, multiple technological standards, protective legislation
and pricing pressure.
Also, while strategic acquisitions, like those we have made in the past and
possibly others in the future, are essential to our long-term growth, they
also expose us to certain risks and uncertainties related to the rapid and
effective integration of these businesses as well as their products,
technologies and personnel.
The economic environment of our industry could also result in some of our
customers experiencing difficulties and, consequently, this could have a
negative effect on our results especially in terms of future sales and
recoverability of accounts receivable. However, the sectorial and geographic
diversity of our customer base provides us with a reasonable level of
protection in this area. Finally, other financial instruments, which
potentially subject us to credit risks, consist mainly of cash, short-term
investments and forward exchange contracts. Our short-term investments consist
of debt instruments issued by six high-credit quality corporations and trusts.
Our cash and forward exchange contracts are held with or issued by high-credit
quality financial institutions; therefore, we consider the risk of
non-performance on these instruments to be remote.
For a more complete understanding of risk factors that may affect us, please
refer to the risk factors set forth in our disclosure documents published with
securities commissions at www.sedar.com in Canada or www.edgar.com in the U.S.
2005 Annual Report o EXFO :: 22
QUARTERLY SUMMARY FINANCIAL INFORMATION (unaudited)
(tabular amounts in thousands of US dollars, except per share data)
Years ended
1st quarter 2nd quarter 3rd quarter 4th quarter August 31,
-----------------------------------------------------------------------------------------------
2005
Sales $ 21,597 $ 23,135 $ 26,180 $ 26,304 $ 97,216
Cost of sales $ 10,225 $ 10,431 $ 11,478 $ 11,925 $ 44,059
Gross margin $ 11,372 $ 12,704 $ 14,702 $ 14,379 $ 53,157
Earnings (loss) from operations $ (1,337) $ (182) $ 509 $ 811 $ (199)
Net earnings (loss) $ (2,373) $ 9 $ 276 $ 454 $ (1,634)
Basic and diluted net earnings
(loss) per share $ (0.03) $ -- $ -- $ 0.01 $ (0.02)
2004
Sales $ 15,962 $ 16,880 $ 20,456 $ 21,332 $ 74,630
Cost of sales $ 7,815 $ 7,528 $ 9,637 $ 9,576 $ 34,556
Gross margin $ 8,147 $ 9,352 $ 10,819 $ 11,756 $ 40,074
Loss from operations $ (3,145) $ (3,485) $ (1,888) $ (2,052) $(10,570)
Net loss $ (2,008) $ (2,885) $ (1,188) $ (2,343) $ (8,424)
Basic and diluted net
loss per share (1) $ (0.03) $ (0.04) $ (0.02) $ (0.03) $ (0.13)
2003
Sales $ 17,748 $ 14,753 $ 15,103 $ 14,326 $ 61,930
Cost of sales $ 8,031 $ 7,939 $ 10,460 $ 9,767 $ 36,197
Gross margin $ 9,717 $ 6,814 $ 4,643 $ 4,559 $ 25,733
Loss from operations $ (3,562) $ (6,085) $(18,924) $(11,013) $(39,584)
Net loss $ (2,158) $ (4,246) $(38,427) $(10,119) $(54,950)
Basic and diluted net
loss per share $ (0.03) $ (0.07) $ (0.61) $ (0.16) $ (0.87)
(1) Per share data is calculated independently for each of the quarters
presented. Therefore, the sum of this quarterly information does not
equal the corresponding annual information.
FOURTH-QUARTER RESULTS
In the fourth quarter of fiscal 2005, global sales were $26.3 million,
compared to $21.3 million for the same period last year. In fiscal 2005, we
benefited from an increased demand for our test solutions following the
deployment of fiber deeper into access networks (FTTx). We also consolidated
our leadership position in the FTTx test market by recognizing significant
revenue from two leading U.S. carriers deploying fiber in their access
networks. In addition, the positive spending environment in the
telecommunications industry helped us increase our sales in 2005. Finally, we
gained market share in the fluorescence illumination market as well as
increased our sales in the curing market year-over-year.
In the fourth quarter of fiscal 2005, gross margin amounted to 54.7% of global
sales, compared to 55.1% for the same period last year. Despite the
significant increase in sales year-over-year (23.3%), gross margin decreased
40 basis points due to aggressive pricing pressure in fiscal 2005, a different
customer mix and the increase in the strength of the Canadian dollar compared
to the US dollar, year-over-year.
In the fourth quarter of fiscal 2005, earnings from operations were $811,000,
compared to a loss from operations of $2.1 million for the same period last
year. Net earnings amounted to $454,000, or $0.01 per diluted share in the
fourth quarter of fiscal 2005, compared to a net loss of $2.3 million, or
$0.03 per diluted share for the same period last year.
2005 Annual Report o EXFO :: 23
MANAGEMENT'S REPORT
EXFO's management is responsible for the preparation, integrity and
objectivity of the consolidated financial statements and other financial
information presented in this Annual Report. These consolidated financial
statements have been prepared in accordance with Canadian generally accepted
accounting principles and include some amounts that are based on estimates and
judgments. Management has determined such amounts on a reasonable basis in
order to ensure that the financial statements are presented fairly in all
material respects.
EXFO's policy is to maintain a system of internal accounting and
administrative controls -- reinforced by standards of conduct and ethics set
out in written policies -- to provide reasonable assurance that the financial
information is relevant, accurate and reliable, and that assets are
appropriately accounted for and adequately safeguarded.
The Board of Directors is responsible for ensuring that management fulfills
its responsibilities for financial reporting and is ultimately responsible for
reviewing and approving the financial statements. The Board carries out this
responsibility principally through its Audit Committee. The Audit Committee is
appointed by the Board and is composed of independent outside directors. The
Committee meets periodically with management and external auditors to review
accounting, auditing and internal control matters. These consolidated
financial statements have been reviewed and approved by the Board of Directors
on the recommendation of the Audit Committee.
The consolidated financial statements have been audited by
PricewaterhouseCoopers LLP, the external auditors, in accordance with the
Canadian generally accepted auditing standards and the standards of the Public
Company Accounting Oversight Board (United States) on behalf of the
shareholders. The external auditors have full and free access to the Audit
Committee.
REPORT OF INDEPENDENT AUDITORS
TO THE SHAREHOLDERS OF
EXFO Electro-Optical Engineering Inc.
We have audited the consolidated balance sheets of EXFO Electro-Optical
Engineering Inc. as at August 31, 2005 and 2004 and the consolidated
statements of earnings, deficit and contributed surplus and cash flows for
each of the three years in the period ended August 31, 2005. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with Canadian generally accepted
auditing standards and the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform an audit to obtain reasonable assurance whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation.
In our opinion, these consolidated financial statements present fairly, in all
material respects, the financial position of the company as at August 31, 2005
and 2004 and the results of its operations and its cash flows for each of the
three years in the period ended August 31, 2005 in accordance with Canadian
generally accepted accounting principles.
/s/ Germain Lamonde /s/ Pierre Plamondon
--------------------------- ----------------------------- /s/ PricewaterhouseCoopers LLP
Germain Lamonde | Pierre Plamondon, CA | Chartered Accountants |
Chairman, President and CEO Vice -President, Finance Quebec, Quebec, Canada
and Chief Financial Officer September 30, 2005
2005 Annual Report o EXFO :: 24
CONSOLIDATED BALANCE SHEETS
(in thousands of US dollars)
The accompanying notes are an integral part of these consolidated financial
statements.
-----------------------------------------------------------------------------------
As at August 31, 2005 2004
-----------------------------------------------------------------------------------
Assets
Current assets
Cash $ 7,119 $ 5,159
Short-term investments (notes 8 and 18) 104,883 83,969
Accounts receivable (notes 8 and 18)
Trade 13,945 12,080
Other 2,007 1,532
Income taxes and tax credits recoverable (notes 4 and 8) 2,392 7,836
Inventories (notes 4, 5 and 8) 17,749 15,371
Prepaid expenses 1,112 1,513
-----------------------------------------------------------------------------------
149,207 127,460
Income taxes and tax credits recoverable (notes 4 and 8) 459 449
Property, plant and equipment (notes 4, 6 and 8) 13,719 15,442
Long-lived asset held for sale (note 4) 1,600 1,600
Intangible assets (notes 4, 7 and 8) 5,602 9,447
Goodwill (notes 4 and 7) 20,370 18,393
-----------------------------------------------------------------------------------
$ 190,957 $ 172,791
-----------------------------------------------------------------------------------
Liabilities
Current liabilities
Accounts payable and accrued liabilities (note 9) $ 12,201 $ 11,393
Deferred revenue 1,584 805
Current portion of long-term debt 134 121
-----------------------------------------------------------------------------------
13,919 12,319
Deferred revenue 1,568 1,123
Government grants (note 15) 1,872 1,690
Long-term debt (note 10) 198 332
-----------------------------------------------------------------------------------
17,557 15,464
-----------------------------------------------------------------------------------
Commitments (note 11)
Contingencies (note 12)
Shareholders' Equity
Share capital (note 13) 521,875 521,733
Contributed surplus 2,949 1,986
Deficit (381,846) (380,212)
Cumulative translation adjustment 30,422 13,820
-----------------------------------------------------------------------------------
173,400 157,327
-----------------------------------------------------------------------------------
$ 190,957 $ 172,791
-----------------------------------------------------------------------------------
/s/ Germain Lamonde /s/ Andre Tremblay
--------------------------- -------------------------
On behalf of the Board Germain Lamonde | Andre Tremblay |
Chairman, President and CEO Chairman, Audit Committee
2005 Annual Report o EXFO :: 25
CONSOLIDATED STATEMENTS OF EARNINGS
(in thousands of US dollars, except share and per share data)
The accompanying notes are an integral part of these consolidated financial
statements.
----------------------------------------------------------------------------------------------
Years ended August 31, 2005 2004 2003
----------------------------------------------------------------------------------------------
SALES (note 19) $ 97,216 $ 74,630 $ 61,930
COST OF SALES (1,2) 44,059 34,556 36,197
----------------------------------------------------------------------------------------------
Gross margin 53,157 40,074 25,733
----------------------------------------------------------------------------------------------
OPERATING EXPENSES
Selling and administrative (1) 31,782 25,890 26,991
Net research and development (1) (notes 4 and 15) 12,190 12,390 15,879
Amortization of property, plant and equipment 4,256 4,935 5,210
Amortization of intangible assets 4,836 5,080 5,676
Impairment of long-lived assets and goodwill (note 4) -- 620 7,427
Restructuring and other charges (note 4) 292 1,729 4,134
----------------------------------------------------------------------------------------------
TOTAL OPERATING EXPENSES 53,356 50,644 65,317
----------------------------------------------------------------------------------------------
LOSS FROM OPERATIONS (199) (10,570) (39,584)
Interest and other income 2,524 1,438 1,245
Foreign exchange loss (1,336) (278) (1,552)
----------------------------------------------------------------------------------------------
EARNINGS (LOSS) BEFORE INCOME TAXES (NOTE 16) 989 (9,410) (39,891)
Income taxes (notes 4 and 16) 2,623 (986) 15,059
----------------------------------------------------------------------------------------------
NET LOSS FOR THE YEAR $ (1,634) $ (8,424) $(54,950)
----------------------------------------------------------------------------------------------
Basic and diluted net loss per share $ (0.02) $ (0.13) $ (0.87)
Basic weighted average number
of shares outstanding (OOO's) 68,526 66,020 62,852
Diluted weighted average number
of shares outstanding (OOO's) (note 17) 68,981 66,615 63,317
(1) Stock-based compensation costs included in: (note 14)
Cost of sales $ 143 $ 62 $ --
Selling and administrative 626 265 --
Net research and development 194 122 --
----------------------------------------------------------------------------------------------
$ 963 $ 449 $ --
----------------------------------------------------------------------------------------------
(2) The cost of sales is exclusive of amortization, shown separately. The
cost of sales the year ended August 31, 2003, includes inventory
write-offs of $4,1 21 (note 4).
2005 Annual Report o EXFO :: 26
Consolidated Statements of Deficit and Contributed Surplus
(in thousands of US dollars)
The accompanying notes are an integral part of these consolidated financial
statements.
DEFICIT
Years ended August 31, 2005 2004 2003
--------------------------------------------------------------------------------
BALANCE -- BEGINNING OF YEAR $(380,212) $(371,788) $(316,838)
ADD
Net loss for the year (1,634) (8,424) (54,950)
--------------------------------------------------------------------------------
BALANCE -- END OF YEAR $(381,846) $(380,212) $(371,788)
--------------------------------------------------------------------------------
CONTRIBUTED SURPLUS
Years ended August 31, 2005 2004 2003
--------------------------------------------------------------------------------
BALANCE -- BEGINNING OF YEAR $ 1,986 $ 1,519 $ 1,487
ADD
Premium on resale of share capital -- 18 32
Stock-based compensation costs 963 449 --
--------------------------------------------------------------------------------
Balance -- End of year $ 2,949 $ 1,986 $ 1,519
2005 Annual Report o EXFO :: 27
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands of US dollars)
The accompanying notes are an integral part of these consolidated financial
statements.
Years ended August 31, 2005 2004 2003
----------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss for the year $ (1,634) $ (8,424) $ (54,950)
Add (deduct) items not affecting cash
Discount on short-term investments (302) 197 (96)
Stock-based compensation costs 963 449 --
Inventory and tax credit write-offs -- -- 6,418
Amortization 9,092 10,015 10,886
Impairment of long-lived assets and goodwill -- 620 7,427
Restructuring and other charges -- 1,261 512
Future income taxes -- -- 10,138
Deferred revenue 977 1,404 (24)
Government grants -- 154 817
----------------------------------------------------------------------------------------
9,096 5,676 (18,872)
Change in non-cash operating items
Accounts receivable (838) (2,677) 3,957
Income taxes and tax credits 6,096 (2,464) 13,489
Inventories (699) 1,016 7,925
Prepaid expenses 544 (449) (569)
Accounts payable and accrued liabilities (164) (351) (349)
----------------------------------------------------------------------------------------
14,035 751 5,581
----------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to short-term investments (585,665) (653,348) (401,105)
Proceeds from disposal and maturity of short-term 574,207 624,722 395,699
investments
Additions to property, plant and equipment and (1,501) (851) (2,652)
intangible assets
Business combination -- (241) (1,867)
----------------------------------------------------------------------------------------
(12,959) (29,718) (9,925)
----------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Repayment of long-term debt (121) (109) (133)
Net proceeds of offering (note 13) -- 29,164 --
Share issue expenses (6) (137) --
Exercise of stock options 148 254 45
Redemption of share capital -- (5) (16)
Resale of share capital -- 23 48
----------------------------------------------------------------------------------------
21 29,190 (56)
EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON CASH 863 (430) 638
----------------------------------------------------------------------------------------
CHANGE IN CASH 1,960 (207) (3,762)
CASH - BEGINNING OF YEAR 5,159 5,366 9,128
----------------------------------------------------------------------------------------
CASH - END OF YEAR $ 7,119 $ 5,159 $ 5,366
----------------------------------------------------------------------------------------
SUPPLEMENTARY INFORMATION
Interest paid $ 30 $ 408 $ 417
Income taxes paid (recovered) $ (669) $ 120 $ (10,351)
2005 Annual Report o EXFO :: 28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share data
and as otherwise noted)
1 | NATURE OF ACTIVITIES
EXFO Electro-Optical Engineering Inc. ("EXFO") designs, manufactures and markets
a comprehensive line of test and measurement solutions for the global
telecommunications industry. The Telecom Division, which represents the
company's main business activity, offers integrated test solutions to network
service providers, cable operators, system vendors and optical component
manufacturers. The Life Sciences and Industrial Division mainly leverages core
telecom technologies to offer value-added solutions life sciences applications
and high-precision assembly processes, such as those required for
microelectronics, optoelectronics and medical devices. EXFO's products are sold
in approximately 70 countries around the world.
2 | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
These consolidated financial statements have been prepared in accordance with
generally accepted accounting principles ("GAAP") in Canada and significant
differences in measurement and disclosure from U.S. GAAP are set out in note
21. These consolidated financial statements include the accounts of the
company and its domestic and international subsidiaries. All significant
intercompany accounts and transactions have been eliminated.
ACCOUNTING ESTIMATES
The preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and the disclosures
of contingent assets and liabilities at the date of the financial statements,
as well as the reported amounts of revenues and expenses during the reporting
years. significant estimates include the allowance for doubtful accounts
receivable, tax credits recoverable, provision for excess and obsolete
inventories, useful lives of capital assets, valuation of intangible assets
and goodwill, future income taxes valuation allowance, certain accrued
liabilities and stock-based compensation costs. Actual results could differ
from those estimates.
REPORTING CURRENCY
The functional currency of the company is the Canadian dollar. The company has
adopted the US dollar as its reporting currency. The financial statements are
translated into the reporting currency using the current rate method. Under
this method, the financial statements are translated into the reporting
currency as follows: assets and liabilities are translated at the exchange
rate in effect on the date of the balance sheet, while revenues and expenses
are translated at the monthly average exchange rate. All gains and losses
resulting from the translation of the financial statements from the functional
currency to the reporting currency are included in the cumulative translation
adjustment in shareholders' equity.
In the event that management decides to declare dividends, such dividends
would be declared in Canadian dollars.
FOREIGN CURRENCY TRANSLATION
FOREIGN CURRENCY TRANSACTIONS
Transactions denominated in currencies other than the functional currency are
translated into the functional currency as follows: monetary assets and
liabilities are translated at the exchange rate in effect on the date of the
balance sheet, and revenues and expenses are translated at the exchange rate
in effect on the date of the transaction. Non-monetary assets and liabilities
are translated at historical rates. Gains and losses arising from such
translation are reffected in the statements of earnings.
FOREIGN SUBSIDIARIES
The financial statements of integrated foreign operations are remeasured into
the functional currency using the temporal method. Under this method, monetary
assets and liabilities are remeasured at the exchange rate in effect on the
date of the balance sheet. Non-monetary assets and liabilities are remeasured
at historical rates, unless such assets and liabilities are carried at market,
in which case, they are translated at the exchange rate in effect on the date
of the balance sheet. Revenues and expenses are remeasured at the monthly
average exchange rate. Gains and losses resulting from such remeasurement are
reffected in the statements of earnings.
FORWARD EXCHANGE CONTRACTS
Forward exchange contracts are utilized by the company to manage its foreign
currency exposure. The company's policy is not to utilize those derivative
financial instruments for trading or speculative purposes.
The company's forward exchange contracts, which are used to hedge anticipated
US-dollar-denominated sales, qualify for hedge accounting; therefore, foreign
exchange translation gains and losses on these contracts are recognized as an
adjustment of the revenues when the corresponding hedged sales are recorded.
Realized and unrealized gains or losses associated with forward exchange
contracts, which have been terminated or cease to be effective prior to
maturity, are deferred in the balance sheet and recognized in the earnings of
the period in which the underlying hedged transaction is recognized.
SHORT-TERM INVESTMENTS
Short-term investments are valued at the lower of cost and market value. Cost
consists of acquisition cost plus amortization of discount or less
amortization of premium. All investments with original maturity of three
months or less and that are not required for the purposes of meeting
short-term cash requirements are classified as short-term investments.
2005 Annual Report o EXFO :: 29
INVENTORIES
Inventories are valued on an average cost basis, at the lower of cost and
replacement cost for raw materials and at the lower of cost and net realizable
value for work in progress and finished goods.
PROPERTY, PLANT AND EQUIPMENT AND AMORTIZATION
Property, plant and equipment are recorded at cost less related government
grants and research and development tax credits. Amortization is provided on a
straight-line basis over the estimated useful lives as follows:
----------------------------------------------------------------------
TERM
Land improvements 5 years
Buildings 25 years
Equipment 2 to 10 years
Leasehold improvements The lesser of useful life
and remaining lease term
----------------------------------------------------------------------
INTANGIBLE ASSETS, GOODWILL AND AMORTIZATION
Intangible assets primarily include the cost of core technology and software,
net of accumulated amortization. Core technology represents the existing
technology acquired in business combinations that has reached technological
feasibility. Amortization is provided on a straight-line basis over the
estimated useful lives of five years for core technology and four and ten
years for software.
Goodwill represents the excess of the purchase price of acquired businesses
over the estimated fair value of net identifiable assets acquired. Goodwill is
not amortized but must be tested for impairment on an annual basis or more
frequently if events or circumstances indicate that it might be impaired.
Recoverability of goodwill is determined at the reporting unit level using a
two-step approach. First, the carrying value of a reporting unit is compared
to its fair value, which is determined based on a combination of discounted
future cash flows and a market approach. If the carrying value of a reporting
unit exceeds its fair value, the second step is performed. In this step, the
amount of impairment loss, if any, represents the excess of the carrying value
of goodwill over its fair value and the loss is charged to earnings in the
period in which it is incurred. For the purposes of this impairment test, the
fair value of goodwill is estimated in the same way as goodwill is determined
in business combinations; that is, the excess of the fair value of a reporting
unit over the estimated fair value of its net identifiable assets.
The company elected to perform its annual impairment test in May of each
fiscal year for all its existing reporting units and it recorded an impairment
charge for goodwill in fiscal 2003 (note 4).
IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived assets are reviewed for impairment when events and circumstances
indicate that cost may not be recoverable. Impairment exists when the carrying
value of an asset or group of assets is greater than the undiscounted future
cash flows expected to be provided by the asset or group of assets. The amount
of impairment loss, if any, is the excess of the carrying value over the fair
value.
The company assesses fair value of long-lived assets based on discounted
future cash flows. The company recorded impairment charges for long-lived
assets in fiscal 2003 and 2004 (note 4).
WARRANTY
The company offers its customers warranties of one to three years, depending
on the specific products and terms of the purchase agreement. The company's
typical warranties require it to repair or replace defective products during
the warranty period at no cost to the customer. Costs related to original
warranties are accrued at the time of shipment, based upon estimates of
expected rework and warranty costs to be incurred. Costs associated with
separately priced extended warranties are expensed as incurred.
REVENUE RECOGNITION
For products in which software is incidental, the company recognizes revenue
when persuasive evidence of an arrangement exists, the product has been
delivered, the price is fixed and determinable, and collection of the
resulting receivable is reasonably assured. In addition, provisions are made
for estimated returns, warranties and support obligations.
For products in which software is not incidental, revenues are separated into
two categories: product and post-contract customer support (PCS) revenues,
based upon vendor-specific objective evidence of fair value. Product revenues
for these sales are recognized as described above. PCS revenues are deferred
and recognized ratably over the years of the support arrangement. PCS revenues
are recognized at the time the product is delivered when provided within one
year of delivery; the costs of providing this support are insignificant (and
accrued at the time of delivery) and no software upgrades are provided.
For all sales, the company uses a binding purchase order as evidence that a
sales arrangement exists.
Delivery generally occurs when the product is handed over to a transporter for
shipment.
At the time of the transaction, the company assesses whether the price
associated with its revenue transaction is fixed and determinable and whether
or not collection is reasonably assured. The company assesses whether the
price is fixed and determinable based on the payment terms associated with the
transaction. The company assesses collection based on a number of factors,
including past transaction history and the creditworthiness of the customer.
Generally, collateral or other security is not requested from customers.
Most sales arrangements do not generally include acceptance clauses. However,
when a sales arrangement does include an acceptance provision, acceptance
occurs upon the earliest of receipt of a written customer acceptance or
expiration of the acceptance period. For these sales arrangements, the sale is
recognized when acceptance occurs.
Revenue for extended warranties is recognized on a straight-line basis over
the warranty period.
2005 Annual Report o EXFO :: 30
[GRAPHIC OMITTED][GRAPHIC OMITTED]
ADVERTISING COSTS
Advertising costs are expensed as incurred.
GOVERNMENT GRANTS
Grants related to operating expenses are included in earnings when the related
expenses are incurred. Grants related to capital expenditures are deducted
from the related assets. Grants related to job creation and training programs
for extended periods are deferred and amortized on a straight-line basis over
the minimum period during which the created job must be maintained or training
provided. Grants are included in earnings or deducted from the related assets,
provided there is reasonable assurance that the company has complied and will
comply with all the conditions related to the grant.
RESEARCH AND DEVELOPMENT EXPENSES
All expenses related to research, as well as development activities that do
not meet generally accepted criteria for deferral are expensed as incurred,
net of related tax credits and government grants. Development expenses that
meet generally accepted criteria for deferral, in accordance with the Canadian
Institute of Chartered Accountants (CICA) handbook Section 3450, "Research and
Development", are capitalized, net of related tax credits and government
grants, and are amortized against earnings over the estimated benefit period.
Research and development expenses are mainly comprised of salaries and related
expenses, material costs as well as fees paid to third-party consultants.
As at August 31, 2005, the company had not deferred any development costs.
INCOME TAXES
The company provides for income taxes using the liability method of tax
allocation. Under this method, future income tax assets and liabilities are
determined based on deductible or taxable temporary differences between
financial statement values and tax values of assets and liabilities, using
enacted income tax rates for the years in which the differences are expected
to reverse.
The company establishes a valuation allowance against future income tax assets
if, based on available information, it is more likely than not that some or
all of the future income tax assets will not be realized. Since 2003, the
company records a full valuation allowance against future income tax assets
(notes 4 and 16).
EARNINGS PER SHARE
Basic earnings per share are determined using the weighted average number of
common shares outstanding during the year.
Diluted earnings per share are determined using the weighted average number of
common shares outstanding during the year, plus the effect of dilutive
potential common shares outstanding during the year. This method requires that
diluted earnings per share be calculated (using the treasury stock method) as
if all dilutive potential common shares had been exercised at the latest at
the beginning of the year or on the date of issuance, as the case may be, and
that the funds obtained thereby (plus an amount equivalent to the unamortized
portion of related stock-based compensation costs) be used to purchase common
shares of the company at the average market price of the common shares during
the year.
STOCK-BASED COMPENSATION COSTS
Since September 1, 2003, the company accounts for all forms of employee
stock-based compensation using the fair value-based method. Stock-based
compensation costs are amortized to expense over the vesting periods.
Prior to fiscal 2004, no stock-based compensation costs were recognized for
employee stock-based compensation. However, the company is required to
disclose pro forma information with respect to net loss and net loss per share
as if stock-based compensation costs were recognized in the financial
statements using the fair value-based method for outstanding stock options
granted prior to September 1, 2003 (note 14).
NEW ACCOUNTING STANDARDS AND PRONOUNCEMENTS
ADOPTED IN FISCAL 2005
On September 1, 2004, the company prospectively adopted the CICA handbook
Sections 1100 and 1400, "Generally Accepted Accounting Principles" and
"General Standards of Financial Statement Presentation". Among other things,
these new sections define generally accepted accounting principles (GAAP),
establish the relative authority of various types of CICA Accounting Standards
Board pronouncements and clarify the role of "industry practice" in applying
GAAP. The adoption of these new standards had no impact on the financial
statements of the company.
TO BE ADOPTED AFTER FISCAL 2005
In January 2005, the CICA issued four new accounting standards in relation to
financial instruments: Section 3855, "Financial Instruments -- Recognition and
measurement"; Section 3865, "Hedges"; Section 1530, "Comprehensive Income";
and Section 3251, "Equity".
Section 3855 expands on Section 3860, "Financial Instruments -- Disclosure and
Presentation", by prescribing when a financial instrument is to be recognized
on the balance sheet and at what amount. It also specifies how financial
instrument gains and losses are to be presented in the financial statements.
Section 3865 provides an alternative to Section 3855 for entities that choose
to designate qualifying transactions as hedges for accounting purposes. It
replaces and expands on Accounting Guideline 13, "Hedging Relationships", and
on the hedging guidance in Section 1650, "Foreign Currency Translation", by
specifying how hedge accounting is applied and what disclosures it requires.
Section 1530, "Comprehensive Income", introduces a new requirement to
temporarily present certain gains and losses outside net income.
Consequently, Section 3250, "Surplus", has been revised as Section 3251,
"Equity".
Sections 1530, 3251, 3855 and 3865 apply to fiscal years beginning on or after
October 1, 2006. The company will adopt these new standards on September 1,
2007. While the company is currently assessing the effects of these new
standards, impacts consistent with the adjustments described under note 21
item b) of these consolidated financial statements are expected.
2005 Annual Report o EXFO :: 31
3 | BUSINESS COMBINATION
GNUBI COMMUNICATIONS, L.P.
On October 7, 2002, a newly created wholly-owned subsidiary of the company,
EXFO Gnubi Products Group Inc. ("EXFO Gnubi"), acquired substantially all the
assets of gnubi communications, L.P., a U.S. company supplying multi-channel
telecom and datacom testing solutions for optical transport equipment
manufacturers as well as research and development laboratories.
This acquisition was settled for a total consideration valued at $4,904,000
including acquisition-related costs of $162,000. The consideration paid
consisted of $2,108,000 in cash (including a cash contingent consideration of
$241,000, paid in fiscal 2004, based on EXFO Gnubi sales volume for the twelve
months following the acquisition) and the issuance of 1,479,290 subordinate
voting shares, valued at $2,796,000.
The cash contingent consideration was accounted for as an additional
acquisition cost and was allocated to acquired core technology.
The fair value of the subordinate voting shares issued was determined based on
the market price of the shares beginning three days before and ending three
days after the number of shares became fixed based on a formula, being
September 10, 2002.
This acquisition was accounted for using the purchase method and,
consequently, the results of operations of the acquired business have been
included in the consolidated statement of earnings of the company since
October 7, 2002, being the date of acquisition.
During fiscal 2004, EXFO Gnubi's operations were consolidated with the parent
company's operations in Montreal, Canada.
The purchase price, including acquisition-related costs, was allocated based
on the estimated fair value of net assets at the date of acquisition as
follows:
-------------------------------------------------------
Assets acquired
Current assets $ 755
Property, plant and equipment 334
Core technology 750
Current liabilities assumed (134)
-------------------------------------------------------
Net identifiable assets acquired 1,705
Goodwill 2,958
-------------------------------------------------------
Purchase price 4,663
Less: Subordinate voting shares issued 2,796
-------------------------------------------------------
Cash paid on the date of acquisition $ 1,867
=======================================================
Acquired goodwill is deductible for income tax purposes.
4 | SPECIAL CHARGES
IMPAIRMENT OF LONG-LIVED ASSETS AND GOODWILL
2003
In May 2003, the company performed its annual impairment test on goodwill for
all its reporting units, except for newly acquired EXFO Gnubi. Also,
considering market conditions in the telecommunications industry and the
persisting unfavorable conditions affecting the subsidiaries' industries at
the time, the company reviewed the carrying value of intangible assets related
to these reporting units, consisting primarily of acquired core technology.
As a result of this assessment, the company concluded that the carrying value
of goodwill related to EXFO Burleigh and the carrying value of intangible
assets related to EXFO Burleigh and EXFO Photonic Solutions was impaired, and
it recorded a charge of $4,505,000 to write down goodwill and a pre-tax charge
of $2,922,000 to write down acquired core technology. Of the total impairment
loss of $7,427,000, $6,872,000 was related to EXFO Burleigh for goodwill and
acquired core technology, and $555,000 was related to EXFO Photonic Solutions
for acquired core technology.
For the purposes of estimating the fair values, the company used a combination
of discounted future cash flows and a market approach (sales multiples). The
discounted future cash flows were estimated using periods ranging between
eight and ten years, discount rates ranging between 15% and 20% and annual
growth rates ranging between nil and 35%. The sales multiples used in the
market approach ranged between 0.7 and 2.3.
The assumptions supporting the estimates of the fair values and the
undiscounted future cash flows, including industry conditions, reffected
management's best estimations.
2004
In fiscal 2004, the company put one of its buildings (located in Quebec City)
up for sale and received, at the beginning of fiscal 2005, a formal purchase
offer for this building. Based on that offer, the company concluded that the
building was impaired and it recorded an impairment loss of $620,000 in fiscal
2004, representing the excess of the carrying value of the building over its
expected selling price. However, during the first quarter of fiscal 2005, some
conditions of the formal offer were not met and the offer was declined. During
fiscal 2005, the company withdrew the building from the market. As at August
31, 2004, the building was not shown as a long-lived asset held for sale in
the balance sheet because it was still used by the company and, consequently,
it was not available for immediate sale. This building reports to the Telecom
Division.
2005 Annual Report o EXFO :: 32
RESTRUCTURING AND OTHER CHARGES AND INVENTORY WRITE-OFF S
2003
During fiscal 2003, the company implemented a restructuring plan to align its
cost structure to market conditions. Under that plan, the company recorded
charges of $4,134,000, including $2,767,000 in severance expenses for the 172
employees who were terminated throughout the company, $512,000 for impaired
long-lived assets and $855,000 for future payments on exited leased
facilities. Those charges were included in the restructuring and other charges
in the statement of earnings for the year ended August 31, 2003. In addition,
the company recorded $4,121,000 in inventory writeoffs for excess and obsolete
inventories, which were included in the cost of sales in the statement of
earnings for that same year.
2004 and 2005
During fiscal 2004, the company approved a restructuring plan to consolidate
the operations of its Life Sciences and Industrial Division, transferring EXFO
Burleigh's operations mainly to EXFO Photonic Solutions facilities in Toronto.
This consolidation process, which started in August 2004, was completed during
fiscal 2005.
Overall, for that process, the company incurred $2,515,000 in restructuring
and other charges from which $2,033,000 were recorded in fiscal 2004 and the
remaining of $482,000 were recorded in fiscal 2005. The overall costs, which
were recorded in the restructuring and other charges in the statements of
earnings of the corresponding years, are detailed as follows: $855,000 for
severance expenses for the layoff of all employees of EXFO Burleigh,
$1,261,000 mainly for the impairment of the EXFO Burleigh building and the
remaining $399,000 for other expenses such as training and recruiting expenses
and transfer of assets.
The EXFO Burleigh building was put up for sale in fiscal 2004, but it is not
yet sold because of the difficult real estate market in Rochester, NY. The
building is available for sale in its present condition and management expects
to sell the property within the next twelve months. Consequently, in
accordance with CICA handbook, section 3475, "Disposal of Long-Lived Assets
and Discontinued Operations", it was shown in the balance sheet as a
long-lived asset held for sale. The fair value used to determine the
impairment loss of the building represents the company's best estimate of its
selling price based upon the municipal valuation. Since September 1, 2004, the
building is no longer amortized.
Finally, in fiscal 2005, the company recorded adjustments of $190,000 to the
fiscal 2003 plan because actual charges, mainly for leased equipment, were
lower than expected.
2005 Annual Report o EXFO :: 33
The following table summarizes changes in restructuring charges payable since
August 31, 2002:
--------------------------------------------------------------------------------------------------------------
Year ended August 31, 2005 Balance as at Balance as at
August 31, 2004 Additions Payments Adjustments August 31, 2005
--------------------------------------------------------------------------------------------------------------
FISCAL 2004 PLAN
Severance expenses $ 467 $ 83 $ (550) $ -- $ --
Other -- 399 (399) -- --
--------------------------------------------------------------------------------------------------------------
467 482 (949) -- --
--------------------------------------------------------------------------------------------------------------
FISCAL 2003 PLAN
Severance expenses 109 -- (77) (32) --
Exited leased facilities 386 -- (229) (7) 150
Other 197 -- (46) (151) --
--------------------------------------------------------------------------------------------------------------
692 -- (352) (190) 150
--------------------------------------------------------------------------------------------------------------
FISCAL 2001 PLAN
Exited leased facilities 10 -- (10) -- --
--------------------------------------------------------------------------------------------------------------
10 -- (10) -- --
--------------------------------------------------------------------------------------------------------------
Total for all plans (note 9) $ 1,169 $ 482 $(1,311) $ (190) $ 150
==============================================================================================================
Year ended August 31, 2004 Balance as at Balance as at
August 31, 2003 Additions Payments Adjustments August 31, 2004
--------------------------------------------------------------------------------------------------------------
FISCAL 2004 PLAN
Severance expenses $ -- $ 772 $ (305) $ -- $ 467
--------------------------------------------------------------------------------------------------------------
-- 772 (305) -- 467
--------------------------------------------------------------------------------------------------------------
FISCAL 2003 PLAN
Severance expenses 1,233 -- (870) (254) 109
Exited leased facilities 748 -- (362) -- 386
Other 295 -- (90) (8) 197
--------------------------------------------------------------------------------------------------------------
2,276 -- (1,322) (262) 692
--------------------------------------------------------------------------------------------------------------
FISCAL 2002 PLANS 68 -- (68) -- --
Other
--------------------------------------------------------------------------------------------------------------
68 -- (68) -- --
--------------------------------------------------------------------------------------------------------------
FISCAL 2001 PLAN
Exited leased facilities 124 -- (72) (42) 10
--------------------------------------------------------------------------------------------------------------
124 -- (72) (42) 10
--------------------------------------------------------------------------------------------------------------
Total for all plans (note 9) $ 2,468 $ 772 $(1,767) $ (304) $ 1,169
==============================================================================================================
Year ended August 31, 2003 Balance as at Balance as at
August 31, 2002 Additions Payments Adjustments August 31, 2003
--------------------------------------------------------------------------------------------------------------
FISCAL 2003 PLAN
Severance expenses $ -- $ 2,767 $(1,534) $ -- $ 1,233
Exited leased facilities -- 855 (107) -- 748
Other -- 512 (217) -- 295
--------------------------------------------------------------------------------------------------------------
-- 4,134 (1,858) -- 2,276
--------------------------------------------------------------------------------------------------------------
FISCAL 2002 PLANS
Severance expenses 231 -- (231) -- --
Other 68 -- -- -- 68
--------------------------------------------------------------------------------------------------------------
299 -- (231) -- 68
--------------------------------------------------------------------------------------------------------------
FISCAL 2001 PLAN
Exited leased facilities 483 -- (359) -- 124
--------------------------------------------------------------------------------------------------------------
483 -- (359) -- 124
--------------------------------------------------------------------------------------------------------------
Total for all plans $ 782 $ 4,134 $(2,448) $ -- $ 2,468
==============================================================================================================
2005 Annual Report o EXFO :: 34
FUTURE INCOME TAX ASSETS AND RESEARCH AND DEVELOPMENT TAX CREDITS RECOVERABLE
During fiscal 2003, the company reviewed the carrying value of its future
income tax assets and its research and development tax credits recoverable.
Considering market conditions and because the company recorded losses in
fiscal 2002 and 2003, it concluded that it was more likely than not that its
future income tax assets and some of its non-refundable research and
development tax credits were not recoverable and that a valuation allowance
and a write-off were required. Accordingly, the company recorded a full
valuation allowance of $28,385,000 against its future income tax assets,
mainly related to the parent company, EXFO Protocol and EXFO Burleigh and
wrote off $2,297,000 in non-refundable research and development tax credits
related to EXFO Protocol. The valuation allowance was included in the income
taxes in the statement of earnings for the year ended August 31, 2003 (note
16). Research and development tax credit write-offs were included in the net
research and development expenses in the statement of earnings for that same
year (note 15).
5 | INVENTORIES
As at August 31, 2005 2004
Raw materials $ 9,373 $ 7,244
Work in progress 934 1,370
Finished goods 7,442 6,757
$ 17,749 $ 15,371
6 | PROPERTY, PLANT AND EQUIPMENT
---------------------------------------------------------------------------------------
As at August 31 , 2005 2004
---------------------------------------------------------------------------------------
Accumulated Accumulated
Cost amortization Cost amortization
---------------------------------------------------------------------------------------
Land and land improvements $ 3,179 $ 815 $ 2,868 $ 558
Buildings 9,206 2,250 8,311 1,699
Equipment 33,216 29,553 29,110 23,422
Leasehold improvements 2,395 1,659 2,110 1,278
---------------------------------------------------------------------------------------
47,996 $34,277 42,399 $26,957
------- =======
Less: Accumulated amortization 34,277 26,957
------------------------------------------ -------
$ 13,719 $15,442
========================================== =======
As at August 31, 2004 and 2005, unpaid purchases of property, plant and
equipment amounted to $358,000 and $111,000, respectively.
7 | INTANGIBLE ASSETS AND GOODWILL
--------------------------------------------------------------------------------------
As at August 31 , 2005 2004
--------------------------------------------------------------------------------------
Accumulated Accumulated
Cost amortization Cost amortization
--------------------------------------------------------------------------------------
Core technology $35,554 $ 32,214 $32,815 $ 25,733
Software 6,607 4,345 5,847 3,482
--------------------------------------------------------------------------------------
42,161 $ 36,559 38,662 $ 29,215
-------- ========
Less: Accumulated amortization 36,559 29,215
------------------------------------------ -------
$ 5,602 $ 9,447
========================================== =======
Amortization expenses for intangible assets in each of the next five fiscal
years will amount to $3,190,000 in 2006, $893,000 in 2007, $429,000 in 2008,
$352,000 in 2009 and $325,000 in 2010.
2005 Annual Report o EXFO :: 35
Changes in the carrying value of goodwill are as follows:
------------------------------------------------------------------------------
As at August 31, 2005 2004
------------------------------------------------------------------------------
Balance - Beginning of year $ 18,393 $ 17,673
Foreign currency translation adjustment 1,977 720
------------------------------------------------------------------------------
Balance - End of year (note 19) $ 20,370 $ 18,393
==============================================================================
8 | CREDIT FACILITIES
The company has a line of credit which provides for advances of up to
Cdn$10,000,000 (US$8,411,000). This line of credit, which is renewable
annually, bears interest at prime rate (prime rate in 2004). Short-term
investments, accounts receivable, inventories and all tangible and intangible
assets of the company were pledged as collateral against this line of credit.
As at August 31, 2005, an amount of Cdn$3,163,000 (US$2,661,000) was reserved
from this line of credit for letters of guarantee and forward exchange
contracts.
9 | ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
-------------------------------------------------------------------------------
As at August 31, 2005 2004
-------------------------------------------------------------------------------
Trade $ 5,781 $ 4,484
Salaries and social benefits 4,526 3,932
Warranty 725 390
Tax on capital 538 526
Restructuring charges (notes 4 and 20) 150 1,169
Other 481 892
-------------------------------------------------------------------------------
$12,201 $11,393
==============================================================================
Changes in the warranty provision are as follows:
-------------------------------------------------------------------------------
As at August 31, 2005 2004
-------------------------------------------------------------------------------
Balance - Beginning of year $ 390 $ 687
Provision 869 564
Settlements (583) (889)
Foreign currency translation adjustment 49 28
-------------------------------------------------------------------------------
Balance - End of year $ 725 $ 390
===============================================================================
10 | LONG-TERM DEBT
As at August 31, 2005 2004
------------------------------------------------------------------------------
Loans collateralized by equipment, bearing interest
at 9.6%, repayable in monthly instalments of
$13,000 including principal and interest, maturing
in 2008 $ 332 $ 453
Less: Current portion 134 121
------------------------------------------------------------------------------
$ 198 $ 332
==============================================================================
As at August 31, 2005, minimum principal repayments required in each of the
next three years will amount to $134,000 in 2006, $147,000 in 2007 and $51,000
in 2008.
2005 Annual Report o EXFO :: 36
11 | COMMITMENTS
The company entered into operating leases for certain of its premises and
equipment, which expire at various dates through May 2011. As at August 31,
2005, minimum rentals payable under these operating leases in each of the next
five years will amount to $1,050,000 in 2006, $952,000 in 2007, $632,000 in
2008, $584,000 in 2009 and $594,000 in 2010. As at August 31, 2005, the total
commitment under these operating leases amounts to $4,247,000.
For the years ended August 31, 2003, 2004 and 2005, rental expenses amounted
to $1,718,000, $1,219,000 and $1,370,000, respectively (note 20).
12 | CONTINGENCIES
CLASS ACTION
On November 27, 2001, a class action suit was filed in the United States
District Court for the Southern District of New York against the company, four
of the underwriters of its Initial Public Offering and some of its executive
officers pursuant to the Securities Exchange Act of 1934 and Rule 10b-5
promulgated thereunder and Sections 11, 12 and 16 of the Securities Act of
1933. This class action alleges that the company's registration statement and
prospectus filed with the Securities and Exchange Commission on June 29, 2000,
contained material misrepresentations and/or omissions resulting from (i) the
underwriters allegedly soliciting and receiving additional, excessive and
undisclosed commissions from certain investors in exchange for which they
allocated material portions of the shares issued in connection with the
company's Initial Public offering; and (ii) the underwriters allegedly
entering into agreements with customers whereby shares issued in connection
with the company's Initial Public Offering would be allocated to those
customers in exchange for which customers agreed to purchase additional
amounts of shares in the after-market at pre-determined prices.
On April 19, 2002, the plaintiffs filed an amended complaint containing master
allegations against all of the underwriters in all of the 310 cases included
in this class action and also filed an amended complaint containing
allegations specific to four of the company's underwriters, the company and
two of its executive officers. In addition to the allegations mentioned above,
the amended complaint alleges that the underwriters (i) used their analysts to
manipulate the stock market; and (ii) implemented schemes that allowed issuer
insiders to sell their shares rapidly after an initial public offering and
benefit from high market prices. As concerns the company and its two executive
officers in particular, the amended complaint alleges that (i) the company's
registration statement was materially false and misleading because it failed
to disclose the additional commissions and compensation to be received by
underwriters; (ii) the two named executive officers learned of or recklessly
disregarded the alleged misconduct of the underwriters; (iii) the two named
executive officers had motive and opportunity to engage in alleged wrongful
conduct due to personal holdings of the company's stock and the fact that an
alleged artificially inflated stock price could be used as currency for
acquisitions; and (iv) the two named executive officers, by virtue of their
positions with the company, controlled the company and the contents of the
registration statement and had the ability to prevent its issuance or cause it
to be corrected. The plaintiffs in this suit seek an unspecified amount for
damages suffered.
In July 2002, the issuers filed a motion to dismiss the plaintiffs' amended
complaint and judgment was rendered on February 19, 2003. Only one of the
claims against the company was dismissed. On October 8, 2002, the claims
against its officers were dismissed pursuant to the terms of Reservation of
Rights and Tolling Agreements entered into with the plaintiffs.
In June 2003, a committee of the company's Board of Directors conditionally
approved a proposed settlement between the issuer defendants, the individual
defendants, and the plaintiffs. If approved, the settlement would provide,
among other things, a release of the company and of the individual defendants
for the conduct alleged in the action to be wrongful in the amended complaint.
The company would agree to undertake other responsibilities under the
settlement, including agreeing to assign away, not assert, or release certain
potential claims the company may have against its underwriters. Any direct
financial impact of the proposed settlement is expected to be borne by the
company's insurance carriers.
On June 25, 2004, the Plaintiffs moved for Preliminary Approval of the
settlement. The court granted the preliminary approval motion on February 15,
2005, subject to certain modifications. On August 31, 2005, the court issued a
preliminary order further approving the modifications to the settlement and
certifying the settlement classes. The court also appointed the Notice
Administrator for the settlement and ordered that notice of the settlement be
distributed to all settlement class members beginning on November 15, 2005,
and completed by January 15, 2006. The settlement fairness hearing has been
set for April 26, 2006. Following the hearing, if the court determines that
the settlement is fair to the class members, the settlement will be approved.
There can be no assurance that this proposed settlement would be approved and
implemented in its current form, or at all. Therefore, it is not possible to
predict the final outcome of the case, nor determine the amount of any
possible losses. If the settlement process fails, the company will continue to
defend its position in this litigation that the claims against it, and its
officers, are without merit. Accordingly, no provision for this case has been
made in the consolidated financial statements as at August 31, 2005.
LETTERS OF GUARANTEE
As at August 31, 2005, in the normal course of its operations, the company had
outstanding letters of guarantee of Cdn$1,418,000 (US$1,193,000), which expire
at various dates through fiscal 2008 and that were reserved from the line of
credit.
2005 Annual Report o EXFO :: 37
13 | SHARE CAPITAL
Authorized -- unlimited as to number, without par value
Subordinate voting and participating, bearing a non-cumulative dividend
to be determined by the Board of Directors, ranking pari passu with
multiple voting shares
Multiple voting and participating, entitling to ten votes each, bearing a
non-cumulative dividend to be determined by the Board of Directors,
convertible at the holder's option into subordinate voting shares on a
one-for-one basis, ranking pari passu with subordinate voting shares
The following table summarizes the share capital activity since August 31,
2002:
------------------------------------------------------------------------------------------------------------
Multiple voting shares Subordinate voting shares
------------------------------------------------------------------------------------------------------------
Number Amount Number Amount Total amount
------------------------------------------------------------------------------------------------------------
Balance as at August 31, 2002 37,900,000 $ 1 23,565,185 $ 489,610 $ 489,611
Business combination (note 3) -- -- 1,479,290 2,796 2,796
Exercise of stock options (note 14) -- -- 25,498 45 45
Exercise of stock awards (note 14) -- -- 69,935 -- --
Redemption -- -- (21,515) (16) (16)
Resale -- -- 21,515 16 16
------------------------------------------------------------------------------------------------------------
Balance as at August 31, 2003 37,900,000 1 25,139,908 492,451 492,452
Public offering (1) -- -- 5,200,000 29,164 29,164
Exercise of stock options (note 14) -- -- 111,071 254 254
Exercise of stock awards (note 14) -- -- 89,504 -- --
Redemption -- -- (5,340) (5) (5)
Resale -- -- 5,340 5 5
Share issue expenses -- -- -- (137) (137)
------------------------------------------------------------------------------------------------------------
Balance as at August 31, 2004 37,900,000 1 30,540,483 521,732 521,733
Exercise of stock options (note 14) -- -- 71,699 148 148
Exercise of stock awards (note 14) -- -- 53,592 -- --
Share issue expenses -- -- -- (6) (6)
------------------------------------------------------------------------------------------------------------
Balance as at August 31, 2005 37,900,000 $ 1 30,665,774 $ 521,874 $521,875
============================================================================================================
(1) On February 12, 2004, pursuant to a Canadian public offering, the company
issued 5,200,000 subordinate voting shares for net proceeds of
$29,164,000 (Cdn$38,438,400), after deduction of underwriting commission
of $1,215,000 (Cdn$1,601,000). The net proceeds of this offering were
invested in commercial paper that is presented in the short-term
investments in the balance sheet (note 18).
2005 Annual Report o EXFO :: 38
14 | STOCK-BASED COMPENSATION PLANS
The maximum number of subordinate voting shares issuable under the Long-Term
Incentive Plan and the Deferred Share Unit Plan cannot exceed 6,306,153
shares. The maximum number of subordinate voting shares that may be granted to
any individual on an annual basis cannot exceed 5% of the number of
outstanding subordinate voting shares.
LONG-TERM INCENTIVE PLAN
In May 2000, the company established a Stock Option Plan for directors,
executive officers, employees and consultants and those of the company's
subsidiaries, as determined by the Board of Directors. In January 2005, the
company made certain amendments to the existing Stock Option Plan, including
the renaming of the plan to Long-Term Incentive Plan, which includes stock
options and restricted share units.
STOCK OPTIONS
The exercise price of stock options granted under the Long-Term Incentive Plan
is the market price of the common shares on the date of grant. Stock options
granted under the plan generally expire ten years from the date of grant.
Stock options granted under the plan generally vest over a four-year period,
with 25% vesting on an annual basis commencing on the first anniversary of the
date of grant. The Board of Directors may accelerate the vesting of any or all
outstanding stock options upon the occurrence of a change of control.
The following table summarizes stock option activity since August 31, 2002:
Years ended August 31, 2005 2004 2003
-----------------------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
average average average
Number exercise price Number exercise price Number exercise price
(Cdn$) (Cdn$) (Cdn$)
-----------------------------------------------------------------------------------------------------------------------
Outstanding -- Beginning of year 2,934,518 $ 21 3,176,613 $ 23 2,597,574 $ 34
Granted 246,233 6 536,500 5 1,268,450 3
Exercised (71,699) (3) (111,071) (3) (25,498) (3)
Forfeited (345,293) (27) (667,524) (23) (663,913) (25)
-----------------------------------------------------------------------------------------------------------------------
Outstanding -- End of year 2,763,759 $ 19 2,934,518 $ 21 3,176,613 $ 23
-----------------------------------------------------------------------------------------------------------------------
Exercisable -- End of year 1,650,404 $ 28 1,331,707 $ 32 1,068,595 $ 33
=======================================================================================================================
The weighted average grant-date fair value of stock options granted during
fiscal 2004 and 2005 amounted to $2.73 and $3.51, respectively.
The fair value of stock options granted in fiscal 2003 (for pro forma only),
2004 and 2005 was estimated using the Black-Scholes options valuation model
with the following weighted average assumptions:
Years ended August 31, 2005 2004 2003
--------------------------------------------------------------------------------
Risk-free interest rate 3.6% 2.7% 4.8%
Expected volatility 95% 100% 80%
Dividend yield Nil Nil Nil
Expected life 66 months 49 months 36 months
If the fair value-based method had been applied to stock options granted prior
to September 1, 2003 and outstanding as at August 31, 2003, 2004 and 2005, the
net loss and the net loss per share would have been as follows on a pro forma
basis:
Years ended August 31, 2005 2004 2003
------------------------------------------------------------------------------
Net loss for the year $ (1,634) $ (8,424) $ (54,950)
Pro forma adjustment for stock-based
compensation costs 131 (174) (683)
------------------------------------------------------------------------------
Pro forma net loss for the year $ (1,503) $ (8,598) $ (55,633)
------------------------------------------------------------------------------
Basic and diluted net loss per share $ (0.02) $ (0.13) $ (0.87)
Basic and diluted pro forma net loss
per share $ (0.02) $ (0.13) $ (0.88)
2005 Annual Report o EXFO :: 39
The following table summarizes information about stock options as at August
31, 2005:
Stock options outstanding Stocks options exercisable
------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
average average remaining average
Number exercise contractual life Number exercise
Exercise price price price
(Cdn$) (Cdn$) (Cdn$)
------------------------------------------------------------------------------------------------------
$2.50 to $3.36 542,054 $ 2.50 7.1 years 226,993 $ 2.50
$3.96 to $5.60 620,342 5.04 5.2 years 122,275 4.78
$6.22 to $9.02 243,770 6.53 8.4 years 70,397 7.01
$14.27 to $20.00 507,446 15.87 6.2 years 380,592 15.87
$29.70 to $43.00 600,846 36.29 5.2 years 600,846 36.29
$51.25 to $68.17 205,771 65.83 5.0 years 205,771 65.83
$83.66 43,530 83.66 5.0 years 43,530 83.66
------------------------------------------------------------------------------------------------------
2,763,759 $ 19.22 6.0 years 1,650,404 $ 28.28
======================================================================================================
RESTRICTED SHARE UNITS (RSUS)
RSUs are "phantom" shares that rise and fall in value based on the value of
the company's subordinate voting shares and are redeemable for actual
subordinate voting shares or cash at the discretion of the Board of Directors
on the vesting dates established by the Board of Directors at the time of
grant. The vesting dates are subject to a minimum term of three years and a
maximum term of ten years from the award date. RSUs granted under the plan
expire at the latest ten years from the date of grant.
During fiscal 2005, the company granted 176,185 RSUs that were outstanding as
at August 31, 2005. However, none of them were exercisable at that date. As at
August 31, 2005, the weighted average remaining contractual life of the
outstanding RSUs was 9.4 years. The weighted average grant-date fair value of
these RSUs was $4.68.
DEFERRED SHARE UNIT PLAN
In January 2005, the company established a Deferred Share Unit (DSU) Plan for
the members of the Board of Directors as part of their annual retainer fees.
Each DSU entitles the Board members to receive one subordinate voting share.
DSUs are acquired on the date of grant and will be redeemed in subordinate
voting shares when the Board member will cease to be Director of the company.
During fiscal 2005, the company granted 23,734 DSUs that were outstanding as
at August 31, 2005 to the members of the Board of Directors.
The weighted average grant-date fair value of these DSUs was $4.47.
STOCK APPRECIATION RIGHTS PLAN
In August 2001, the company established the Stock Appreciation Rights Plan for
certain employees. Under that plan, eligible employees are entitled to receive
a cash amount equivalent to the difference between the market price of the
common shares on the date of exercise and the exercise price determined on the
date of grant. Stock appreciation rights granted under the plan generally
expire ten years from the date of grant. Stock appreciation rights vest over a
four-year period, with 25% vesting on an annual basis commencing on the first
anniversary of the date of grant.
Considering the market price of the common shares of $4.67 as at August 31,
2005, compensation cost for those stock appreciation rights was nominal as at
August 31, 2005.
The following table summarizes stock appreciation rights activity since August
31, 2002:
Years ended August 31, 2005 2004 2003
-----------------------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
average average average
Number exercise price Number exercise price Number exercise price
-----------------------------------------------------------------------------------------------------------------------
Outstanding -- Beginning of year 13,000 $ 16 9,000 $ 24 10,000 $ 26
Granted 6,000 4 6,000 5 5,000 2
Forfeited -- -- (2,000) (19) (6,000) (9)
-----------------------------------------------------------------------------------------------------------------------
Outstanding -- End of year 19,000 $ 12 13,000 $ 16 9,000 $ 24
=======================================================================================================================
Exercisable -- End of year 7,500 $ 24 4,250 $ 30 3,500 $ 30
=======================================================================================================================
2005 Annual Report o EXFO :: 40
The following table summarizes information about stock appreciation rights as
at August 31, 2005:
Stock appreciation Stock appreciation
rights outstanding rights exercisable
------------------------------------------------------------------------------
Weighted
average remaining
Exercise price Number contractual life Number
------------------------------------------------------------------------------
$2.10 2,000 7.6 years 1,000
$4.51 to $4.65 12,000 9.0 years 1,500
$22.25 2,500 5.4 years 2,500
$45.94 2,500 5.0 years 2,500
------------------------------------------------------------------------------
19,000 7.9 years 7,500
==============================================================================
RESTRICTED STOCK AWARD PLAN
In December 2000, the company established a Restricted Stock Award Plan for
employees of EXFO Burleigh. This plan expired in December 2004. Each stock
award entitled employees to receive one subordinate voting share at a purchase
price of nil. Stock awards granted under the plan vested over a four-year
period, with 25% vesting on an annual basis commencing on the first
anniversary of the date of grant. According to the plan, upon the involuntary
termination of a member of the defined management team, all outstanding
restricted stock awards granted to such an employee automatically vested.
The following table summarizes restricted stock awards activity since August
31, 2002:
Years ended August 31, 2005 2004 2003
-------------------------------------------------------------------------------
Outstanding -- Beginning of year 53,592 143,096 215,249
Exercised (53,592) (89,504) (69,935)
Forfeited -- -- (2,218)
-------------------------------------------------------------------------------
Outstanding -- End of year -- 53,592 143,096
===============================================================================
15 | OTHER DISCLOSURES
NET RESEARCH AND DEVELOPMENT EXPENSES
Net research and development expenses comprise the following:
--------------------------------------------------------------------------------------------
Years ended August 31 , 2005 2004 2003
--------------------------------------------------------------------------------------------
Gross research and development expenses $ 15,878 $ 15,668 $ 17,133
Research and development tax credits and grants (3,688) (3,278) (3,551)
Research and development tax credit write-offs (note 4) -- -- 2,297
--------------------------------------------------------------------------------------------
$ 12,190 $ 12,390 $ 15,879
============================================================================================
Tax credits written off in fiscal 2003 can be carried forward against future
years' income taxes payable over the next eight years.
2005 Annual Report o EXFO :: 41
GOVERNMENT GRANTS
During 1998, the company entered into an agreement with the Quebec Minister of
Industry, Commerce, Science and Technology (the "Minister"). Pursuant to this
agreement, the Minister agreed to contribute, in the form of grants, up to a
maximum of Cdn$2,220,000 (US$1,867,000) over the period from January 1, 1998,
through December 31, 2002, payable based on the number of full-time jobs
created during the period.
The above grants are subject to the condition that jobs created pursuant to
the agreement be maintained for a period of at least five years from the date
of creation. Should this condition not be met by the company, the Minister may
enforce various recourse options, which include suspension or cancellation of
the agreement or repayment of amounts received by the company. Since the
beginning of this program, the company has claimed the maximum amount of
Cdn$2,220,000 (US$1,867,000), of which Cdn$770,000 (US$647,000) was credited
to earnings. The balance of Cdn$1,450,000 (US$1,220,000) was included in
government grants in the balance sheet. This latter amount will be recognized
upon the final approval by the sponsor of the program.
Furthermore, since 2000, companies operating in the Quebec City area are
eligible for a refundable credit granted by the Quebec provincial government.
This credit is earned based on the increase of eligible production and
marketing salaries incurred in the Quebec City area at a rate of 40%. Since
2000, the company has claimed a total of Cdn$5,815,000 (US$4,891,000) under
this program, of which Cdn$5,041,000 (US$4,239,000) was credited to earnings,
the balance of Cdn$774,000 (US$652,000) was included in government grants in
the balance sheet. This latter amount will be recognized in the statement of
earnings upon the final approval of eligible salaries by the sponsor of the
program.
Should repayments of any amounts received pursuant to these agreements be
required, such repayments, less related deferred revenue, will be charged to
earnings as the amount of any repayment becomes known.
Following is a summary of the classification of these and certain other grants
and credits (government grants) in the statements of earnings of the reporting
years.
Cost of sales for the years ended August 31, 2003, 2004 and 2005, is net of
government grants of $518,000, $3,000 and $89,000, respectively.
Selling and administrative expenses for the years ended August 31, 2003, 2004
and 2005, are net of government grants of $286,000, $5,000 and $32,000,
respectively.
Research and development expenses for the years ended August 31, 2003, 2004
and 2005, are net of government grants of $45,000, $80,000 and $22,000,
respectively.
DEFINED CONTRIBUTION PLANS
The company maintains separate defined contribution plans for certain eligible
employees. These plans, which are accounted for on an accrual basis, are
summarized as follows:
o Deferred profit-sharing plan
The company maintains a plan for certain eligible Canadian resident
employees, under which the company may elect to contribute an amount
equal to 1% (until May 2005 and 2% thereafter) of an employee's gross
salary, provided that the employee has contributed at least 2% of
his/her gross salary to a tax-deferred registered retirement savings
plan. Cash contributions to this plan and expenses for the years
ended August 31, 2003, 2004 and 2005, amounted to Cdn$93,000
(US$63,000), Cdn$141,000 (US$106,000) and Cdn$221,000 (US$179,000),
respectively.
o 401K plan
The company maintains a 401K plan for eligible U.S. resident
employees. Under this plan, the company must contribute an amount
equal to 3% of an employee's current compensation. During the years
ended August 31, 2003, 2004 and 2005, the company recorded cash
contributions and expenses totaling $253,000, $187,000 and $134,000,
respectively.
2005 Annual Report o EXFO :: 42
16 | INCOME TAXES
The reconciliation of the income tax provision calculated using the combined
Canadian federal and provincial statutory income tax rate with the income tax
provision in the financial statements is as follows:
---------------------------------------------------------------------------------------------
Years ended August 31, 2005 2004 2003
---------------------------------------------------------------------------------------------
Income tax provision at combined Canadian federal and
provincial statutory tax rate (31 % in 2005, 32% in
2004 and 34% in 2003) $ 307 $ (3,011) $(13,563)
Increase (decrease) due to:
Foreign income taxed at different rates (580) (767) (999)
Non-taxable income (827) (128) (298)
Non-deductible expenses 784 1,205 1609
Tax deductions (81) (169) (80)
Reduction of Canadian federal statutory tax rate -- 274 92
Effect of consolidation of subsidiaries (209) (1,384) 184
Previous year tax recovery upon a tax assessment -- (1,406) (645)
Other (146) 446 374
Change in valuation allowance 3,375 3,954 28,385
---------------------------------------------------------------------------------------------
$ 2,623 $ (986) $ 15,059
---------------------------------------------------------------------------------------------
The income tax provision consists of the following:
Current
Canadian $ 2,513 $ (577) $ 4,829
United States 6 -- (247)
Other 104 (409) 339
---------------------------------------------------------------------------------------------
2,623 (986) 4,921
Future
Canadian (569) (1,104) (13,553)
United States (1,988) (2,448) (4,307)
Other (206) (402) (387)
---------------------------------------------------------------------------------------------
(2,763) (3,954) (18,247)
Valuation allowance
Canadian 569 1,104 20,359
United States 1,988 2,448 7,374
Other 206 402 652
---------------------------------------------------------------------------------------------
2,763 3,954 28,385
---------------------------------------------------------------------------------------------
$ 2,623 $ (986) $ 15,059
---------------------------------------------------------------------------------------------
Details of the company's income taxes:
Earnings (loss) before income taxes
Canadian $ 3,092 $ (7,740) $(20,449)
United States (953) (5,879) (13,116)
Other (1,150) 4,209 (6,326)
---------------------------------------------------------------------------------------------
$ 989 $ (9,410) $(39,891)
=============================================================================================
Most of the company's income tax provision for fiscal 2005 represents
income taxes payable at the Canadian federal level, which are reduced by
research and development tax credits that are recorded against gross research
and development expenses.
2005 Annual Report o EXFO :: 43
Significant components of the company's future income tax assets and
liabilities are as follows:
----------------------------------------------------------------
As at August 31, 2005 2004
----------------------------------------------------------------
Future income tax assets
Long-lived assets $ 4,902 $ 3,291
Provisions and accruals 7,406 8,755
Government grants 209 188
Deferred revenue 318 336
Share issue expenses 590 657
Research and development expenses 7,292 5,064
Losses carried forward 18,424 15,110
----------------------------------------------------------------
39,141 33,401
Valuation allowance (38,406) (32,613)
----------------------------------------------------------------
735 788
Future income tax liabilities
Research and development tax credits (735) (788)
----------------------------------------------------------------
Future income tax assets, net $ -- $ --
===============================================================
As at August 31, 2005, the company had available operating losses in several
tax jurisdictions, against which a full valuation allowance of $18,424,000 was
established. The following table summarizes the year of expiry of these
operating losses by tax jurisdiction:
--------------------------------------------------------------------------
Canada United States
Year of expiry Federal Provincial and Other
--------------------------------------------------------------------------
2006 $ 63,000 $ -- $ --
2007 1,710,000 73,000 206,000
2008 5,614,000 61,000 1,916,000
2009 5,921,000 3,563,000 571,000
2010 4,211,000 2,211,000 257,000
2014 81,000 -- --
2015 1,775,000 1 ,778,000 --
2022 -- -- 9,025,000
2023 -- -- 10,517,000
2024 -- -- 6,818,000
2025 -- -- 8,207,000
Indefinite 2,041,000 2,349,000 1,750,000
--------------------------------------------------------------------------
$21,416,000 $10,035,000 $39,267,000
==========================================================================
In addition to operating losses, as at August 31, 2005, the company had
available research and development expenses in Canada amounting to $24,420,000
at the federal level and $20,668,000 at the provincial level, against which a
full valuation allowance of $7,292,000 was established. These expenses can be
carried forward indefinitely against future years' taxable income in their
respective tax jurisdiction.
2005 Annual Report o EXFO :: 44
17 | LOSS PER SHARE
The following table summarizes the reconciliation of the basic weighted
average number of shares outstanding and the diluted weighted average number
of shares outstanding:
Years ended August 31, 2005 2004 2003
------------------------------------------------------------------------------
Basic weighted average number of shares
outstanding (000's) 68,526 66,020 62,852
Dilutive effect of stock options (000's) 422 502 301
Dilutive effect of restricted stock
awards (000's) 17 93 164
Dilutive effect of deferred share
units (000's) 8 -- --
Dilutive effect of restricted share
units (000's) 8 -- --
------------------------------------------------------------------------------
Diluted weighted average number of shares
outstanding (000's) 68,981 66,615 63,317
------------------------------------------------------------------------------
Stock options excluded from the calculation of
the diluted weighted average number of
shares because their exercise price was
greater than the average market price of
the common shares (000's) 1,962 2,128 2,533
------------------------------------------------------------------------------
The diluted net loss per share for the years ended August 31, 2003, 2004 and
2005, was the same as the basic net loss per share since the dilutive effect
of stock options, restricted stock awards, deferred share units and restricted
share units should not be included in the calculation; otherwise, the effect
would be anti-dilutive. Accordingly, diluted net loss per share for those
years was calculated using the basic weighted average number of shares
outstanding.
18 | FINANCIAL INSTRUMENTS
SHORT-TERM INVESTMENTS
Short-term investments consist of the following:
As at August 31, 2005 2004
------------------------------------------------------------------------------------------
Commercial paper denominated in Canadian dollars, bearing
interest at annual rates of 2.44% to 2.75% in 2005 and 2.00%
to 2.14% in 2004, maturing on different dates between
September 2005 and January 2006 in fiscal 2005, and October
2004 and January 2005 in fiscal 2004 $ 104,883 $ 65,359
Mutual funds denominated in Canadian dollars -- 18,610
------------------------------------------------------------------------------------------
$ 104,883 $ 83,969
==========================================================================================
FAIR VALUE
Cash, accounts receivable, as well as accounts payable and accrued
liabilities, are financial instruments whose carrying values approximate their
fair values.
The fair value of the long-term debt amounted to $481,000 and $344,000 as at
August 31, 2004 and 2005.
The fair value of short-term investments, based on market value, amounted to
$83,969,000 and $104,883,000 as at August 31, 2004 and 2005, respectively.
The fair value of forward exchange contracts, which represents the difference
between their contractual amounts and their current trading value, amounted to
an unrecognized gain of $1,975,000 and $2,937,000 as at August 31, 2004 and
2005, respectively.
CREDIT RISK
Financial instruments that potentially subject the company to credit risk
consist primarily of cash, short-term investments, accounts receivable and
forward exchange contracts. The company's short-term investments consist of
debt instruments issued by six (seven in 2004) high-credit quality
corporations and trusts. The company's cash and forward exchange contracts are
held with or issued by high-credit quality financial institutions; therefore,
the company considers the risk of non-performance on these instruments to be
remote.
2005 Annual Report o EXFO :: 45
Generally, the company does not require collateral or other security from
customers for trade accounts receivable; however, credit is extended to
customers following an evaluation of creditworthiness. In addition, the
company performs ongoing credit reviews of all its customers and establishes
an allowance for doubtful accounts receivable when accounts are determined to
be uncollectible. Allowance for doubtful accounts amounted to $510,000 and
$352,000 as at August 31, 2004 and 2005, respectively.
INTEREST RATE RISK
As at August 31, 2005, the company's exposure to interest rate risk is
summarized as follows:
------------------------------------------------------------------------------
Cash Non-interest bearing
Short-term investments As described above
Accounts receivable Non-interest bearing
Accounts payable and accrued liabilities Non-interest bearing
Long-term debt As described in note 10
------------------------------------------------------------------------------
FORWARD EXCHANGE CONTRACTS
The company is exposed to currency risks as a result of its export sales of
products manufactured in Canada, substantially all of which are denominated in
US dollars. These risks are partially hedged by forward exchange contracts and
certain operating expenses. As at August 31, 2004 and 2005, the company held
contracts to sell US dollars at various forward rates, which are summarized as
follows:
-------------------------------------------------------------------------------
Weighted average
Contractual amounts contractual forward rates
-------------------------------------------------------------------------------
As at August 31, 2004
September 2004 to August 2005 $ 7,480 1.5427
September 2005 to March 2007 8,400 1.3622
As at August 31, 2005
September 2005 to August 2006 $ 26,000 1.2630
September 2006 to November 2007 7,600 1.2500
-------------------------------------------------------------------------------
19 | SEGMENT INFORMATION
In September 2003, the company reorganized its business under two reportable
segments: the Telecom Division and the Life Sciences and Industrial Division.
The Telecom Division offers integrated test solutions to network service
providers, cable operators, system vendors and component manufacturers
throughout the global telecommunications industry. The Life Sciences and
Industrial Division mainly leverages developed and acquired core telecom
technologies for high-precision assembly and research sectors.
The reporting structure reffects how the company manages its business and how
it classifies its operations for planning and measuring performance.
Until August 31, 2003, the company was organized under one reportable segment,
being the development, manufacturing and marketing of fiber-optic test,
measurement and monitoring solutions for the global telecommunications
industry.
The following tables present information by segment:
-------------------------------------------------------------------------------------------
Life Sciences
and Industrial
Year ended August 31 , 2005 Telecom Division Division Total
-------------------------------------------------------------------------------------------
Sales Earnings (loss) from operations $ 80,120 $ 17,096 $ 97,216
Unallocated items: $ 763 $ (962) $ (199)
Interest and other income 2,524
Foreign exchange loss (1,336)
-------------------------------------------------------------------------------------------
Earnings before income taxes 989
Income taxes 2,623
-------------------------------------------------------------------------------------------
Net loss for the year $ (1,634)
===========================================================================================
Amortization of capital assets $ 6,504 $ 2,588 $ 9,092
===========================================================================================
Stock-based compensation costs $ 897 $ 66 $ 963
===========================================================================================
Capital expenditures $ 1,408 $ 93 $ 1,501
===========================================================================================
2005 Annual Report o EXFO :: 46
-------------------------------------------------------------------------------------------
Life Sciences
and Industrial
Year ended August 31 , 2004 Telecom Division Division Total
-------------------------------------------------------------------------------------------
Sales $ 58,882 $ 15,748 $ 74,630
Loss from operations $ (5,557) $ (5,013) $ (10,570)
Unallocated items:
Interest and other income 1,438
Foreign exchange loss (278)
-------------------------------------------------------------------------------------------
Loss before income taxes (9,410)
Income taxes (986)
-------------------------------------------------------------------------------------------
Net loss for the year $ (8,424)
===========================================================================================
Amortization of capital assets $ 6,643 $ 3,372 $ 10,015
===========================================================================================
Stock-based compensation costs $ 417 $ 32 $ 449
===========================================================================================
Impairment of long-lived assets (note 4) $ 620 $ -- $ 620
===========================================================================================
Restructuring and other charges (note 4) $ -- $ 1,261 $ 1,261
===========================================================================================
Capital expenditures $ 607 $ 244 $ 851
===========================================================================================
-------------------------------------------------------------------------------------------
Life Sciences
and Industrial
Year ended August 31, 2003 Telecom Division Division Total
-------------------------------------------------------------------------------------------
Sales $ 48,753 $ 13,177 $ 61,930
-------------------------------------------------------------------------------------------
Comparative information for fiscal 2003 for the loss from operations and
related information as well as capital expenditures is not provided for each
reportable segment because this information is not available and is
impracticable to determine.
Total assets by reportable segment are detailed as follows:
As at August 31, 2005 2004
------------------------------------------------------------------------------
Telecom Division $ 64,655 $ 60,284
Life Sciences and Industrial Division 11,449 15,094
Unallocated assets 114,853 97,413
------------------------------------------------------------------------------
$ 190,957 $ 172,791
==============================================================================
Unallocated assets are comprised of cash, short-term investments and income
taxes and tax credits recoverable.
Carrying value of goodwill by reportable segment is detailed as follows:
As at August 31, 2005 2004
------------------------------------------------------------------------------
Telecom Division $ 16,092 $ 14,530
Life Sciences and Industrial Division 4,278 3,863
------------------------------------------------------------------------------
$ 20,370 $ 18,393
==============================================================================
Sales to external customers by geographic region are detailed as follows:
-----------------------------------------------------------------------------
Years ended August 31, 2005 2004 2003
-----------------------------------------------------------------------------
United States $ 56,282 $ 40,019 $ 31,561
Canada 6,830 5,818 4,806
Latin America 3,127 3,547 4,467
-----------------------------------------------------------------------------
66,239 49,384 40,834
Europe, Middle East and Africa 19,396 13,706 11,092
Asia-Pacific 11,581 11,540 10,004
-----------------------------------------------------------------------------
$ 97,216 $ 74,630 $ 61,930
=============================================================================
2005 Annual Report o EXFO :: 47
Sales were allocated to geographic regions based on the country of residence
of the related customers. In fiscal 2004 and 2005, one customer represented
more than 10% of sales with 13.8% of sales ($10,325,000) in fiscal 2004 and
23.3% ($22,629,000) in fiscal 2005. In fiscal 2003, no single customer
accounted for 10% of sales or more. For fiscal 2004 and 2005, the most
important customer purchased from the Telecom Division.
Long-lived assets by geographic region are detailed as follows:
As at August 31, 2005 2004
------------------------------------------------------------------------------
Canada $ 35,690 $ 37,948
United States 5,601 6,934
------------------------------------------------------------------------------
$ 41,291 $ 44,882
==============================================================================
Long-lived assets consist of property, plant and equipment, the long-lived
asset held for sale, intangible assets and goodwill.
20 | RELATED PARTY TRANSACTIONS
In fiscal 2003, the company acquired a building from a company owned by the
President of EXFO for a cash consideration of $930,000. This transaction was
measured at the fair market value since it was not conducted during the normal
course of operations, the change in ownership interest in the building was
substantive and the fair market value was supported by an independent
appraisal.
For the years ended August 31, 2003 and 2004, the company leased facilities
from the company owned by the President of EXFO. The annual rental expense
amounted to $331,000 and nil, respectively. The rental expense for fiscal 2003
included $234,000 for future payments on an exited leased facility; this
expense was recorded in the restructuring and other charges in the statement
of earnings for that year (notes 4 and 9).
As at August 31, 2004, restructuring charges payable included $194,000 due to
the company owned by the President of the EXFO in connection with this exited
leased facility. However, in September 2004, EXFO was released from its
obligations under that lease, and it paid the full amount due to the related
company. These rental expenses were measured at the fair market value since
they were incurred during the normal course of operations.
2005 Annual Report o EXFO :: 48
21 | UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
As a registrant with the Securities and Exchange Commission in the United
States (SEC), the company is required to reconcile its financial statements
for significant differences between generally accepted accounting principles
as applied in Canada (Canadian GAAP) and those applied in the United States
(U.S. GAAP). Furthermore, additional significant disclosures required under
U.S. GAAP and Regulation S-X of the SEC are also provided in the accompanying
financial statements and notes. The following summarizes the significant
quantitative differences between Canadian and U.S. GAAP, as well as other
significant disclosures required under U.S. GAAP and Regulation S-X of the SEC
not already provided in the accompanying financial statements.
RECONCILIATION OF NET LOSS TO CONFORM TO U.S. GAAP
The following summary sets out the significant differences between the
company's reported net loss and net loss per share under Canadian GAAP as
compared to U.S. GAAP. Please see corresponding explanatory notes in the
Reconciliation Items section.
Years ended August 31, 2005 2004 2003
-------------------------------------------------------------------------------------------------------------
Net loss for the year in accordance with Canadian GAAP $ (1,634) $ (8,424) $ (54,950)
Stock-based compensation costs a) -- (867) (832)
Unrealized gains (losses) on forward exchange contracts b) (1,286) (280) 1,645
Amortization of intangible assets c) -- -- 832
Write-down of goodwill and intangible assets c) -- -- 6,178
Income tax effect on reconciliation items -- -- (1,074)
-------------------------------------------------------------------------------------------------------------
Net loss for the year in accordance with U.S. GAAP (2,920) (9,571) (48,201)
Other comprehensive income (loss)
Foreign currency translation adjustment 15,669 5,969 15,089
Unrealized gains on forward exchange contracts b) 2,313 689 --
Reclassification of losses on forward
exchange contracts in net loss b) (65) -- --
-------------------------------------------------------------------------------------------------------------
Comprehensive income (loss) $ 14,997 $ (2,913) $ (33,112)
=============================================================================================================
Basic and diluted net loss per share in accordance
with U.S. GAAP $ (0.04) $ (0.14) $ (0.77)
Basic weighted average number of shares outstanding (000's) 68,526 66,020 62,852
RECONCILIATION OF SHAREHOLDERS' EQUITY TO CONFORM TO U.S. GAAP
The following summary sets out the significant differences between the
company's reported shareholders' equity under Canadian GAAP as compared to
U.S. GAAP. Please see corresponding explanatory notes in the Reconciliation
Items section.
As at August 31, 2005 2004 2003
-------------------------------------------------------------------------------------------------------------
Shareholders' equity in accordance with Canadian GAAP $173,400 $ 157,327 $ 129,826
Forward exchange contracts b) 2,937 1,975 1,566
Goodwill c) (11,042) (10,008) (9,771)
Other -- -- (29)
-------------------------------------------------------------------------------------------------------------
Shareholders' equity in accordance with U.S. GAAP $165,295 $ 149,294 $ 121,592
=============================================================================================================
2005 Annual Report o EXFO :: 49
The following table summarizes the shareholders' activity under U.S. GAAP
since August 31, 2002:
---------------------------------------------------------------------------------------------------------------------------
Deferred Accumulated
stock-based other
Share Contributed compensation Other comprehensive Shareholders'
capital surplus Deficit costs capital income (loss) equity
-------------------------------------------------------------------------------------------------------------------------
Balance as at August 31, 2002 $ 560,943 $ 1,487 $ (406,387) $ (2,867) $ 7,693 $ (9,870) $ 150,999
Net loss for the year -- -- (48,201) -- -- (48,201)
Stock-based compensation 1,507 -- -- 1,589 (2,264) -- 832
costs a)
Foreign currency
transaction adjustment -- -- -- -- -- 15,089 15,089
Business combination (note 13) 2,796 -- -- -- -- -- 2,796
Exercise of stock options
(note 13) 45 -- -- -- -- -- 45
Premium on resale of share
capital -- 32 -- -- -- -- 32
-------------------------------------------------------------------------------------------------------------------------
Balance as at August 31, 2003 565,291 1,519 (454,588) (1,278) 5,429 5,219 121,592
Net loss for the year -- -- (9,571) -- -- -- (9,571)
Stock-based compensation
costs a), e) 1,737 -- -- 339 (760) -- 1,316
Foreign currency
transaction adjustment -- -- -- -- -- 5,969 5,969
Unrealized gains on forward
exchange contracts b) -- -- -- -- -- 689 689
Public offering (note 13) 29,164 -- -- -- -- -- 29,164
Exercise of stock options
(note 13) 254 -- -- -- -- -- 254
Share issue expenses (note 13) (137) -- -- -- -- -- (137)
Premium on resale of share
capital -- 18 -- -- -- -- 18
-------------------------------------------------------------------------------------------------------------------------
Balance as at August 31, 2004 596,309 1,537 (464,159) (939) 4,669 11,877 149,294
Net loss for the year -- -- (2,920) -- (2,920)
Stock-based compensation
costs a), e) 1,213 -- -- (776) 425 -- 862
Foreign currency
transaction adjustment -- -- -- -- -- 15,669 15,669
Unrealized gains on forward
exchange contracts b) -- -- -- -- -- 2,248 2,248
Exercise of stock options
(note 13) 148 -- -- -- -- -- 148
Share issue expenses (note 13) (6) -- -- -- -- -- (6)
-------------------------------------------------------------------------------------------------------------------------
Balance as at August 31, 2005 $ 597,664 $ 1,537 $ (467,079) $ (1,715) $ 5,094 $ 29,794 $ 165,295
=========================================================================================================================
2005 Annual Report o EXFO :: 50
Accumulated other comprehensive income (loss) is comprised of the following:
As at August 31, 2005 2004 2003
--------------------------------------------------------------------------------
Foreign currency translation adjustment
Current year $ 15,669 $ 5,969 $ 15,089
Cumulative effect of prior years 11,188 5,219 (9,870)
--------------------------------------------------------------------------------
26,857 11,188 5,219
Unrealized gains on forward exchange contracts
Current year 2,248 689 --
Cumulative effect of prior years 689 -- --
--------------------------------------------------------------------------------
2,937 689 --
--------------------------------------------------------------------------------
$ 29,794 $ 11,877 $ 5,219
================================================================================
STATEMENTS OF CASH FLOWS
For the years ended August 31, 2003, 2004 and 2005, there were no significant
differences between the statements of cash flows under Canadian GAAP as
compared to U.S. GAAP, except for the subtotal before change in non-cash
operating items, whose presentation is not permitted under U.S. GAAP.
RECONCILIATION ITEMS
a) ACCOUNTING FOR STOCK-BASED COMPENSATION
Until August 31, 2003, and to conform to U.S. GAAP, the company measured
stock-based compensation costs using the intrinsic value method (APB 25,
"Accounting for Stock Issued to Employees"). However, since September 1,
2003, and as described in item e) below, the company accounts for
stock-based compensation costs for awards granted after that date, using
the fair value-based method to conform to Statement of Financial
Accounting Standard (SFAS) 123, "Accounting for Stock-Based
Compensation".
STOCK PURCHASE PLAN
Under APB 25, compensation costs related to the stock purchase plan were
measured as the difference between the fair value of the purchased stock
and the purchase price paid by plan participants. Compensation costs
were amortized to expense over a period of five years, being the
restriction period. This plan terminated at the time of the Initial
Public Offering on June 29, 2000. Compensation costs related to this
plan became fully amortized during fiscal 2004.
LONG-TERM INCENTIVE PLAN (FORMELY STOCK OPTION PLAN)
Until August 31, 2003, and under APB 25, compensation costs related to
the long-term incentive plan were measured as the difference between the
market price of the underlying stock at the date of grant and the
exercise price of the option. These compensation costs were amortized to
expense over the estimated vesting period up to a maximum of four years.
Compensation costs related to stock options granted prior to September
1, 2003, and accounted for under APB 25 became fully amortized during
fiscal 2004.
RESTRICTED STOCK AWARD PLAN
Under APB 25, compensation costs related to the restricted stock award
plan were measured as the difference between the market price of the
underlying stock at the date of grant and the exercise price, which is
nil. These compensation costs were amortized to expense over the
estimated vesting period up to a maximum of four years, being the
acquisition period. Compensation costs related to this plan became fully
amortized during fiscal 2004.
Until August 31, 2003, no compensation costs were recognized for these
stock-based compensation plans under Canadian GAAP.
b) FORWARD EXCHANGE CONTRACTS
The forward exchange contracts entered into by the company prior to
September 1, 2003, do not qualify for hedge accounting treatment under
SFAS 133, "Accounting for Derivative Instruments and Hedging
Activities"; accordingly, changes in the fair value of these derivatives
are charged to earnings. However, on September 1, 2003, the company
implemented the documentation for the designation, documentation and
assessment of the effectiveness of its forward exchange contracts, for
the purposes of applying hedge accounting. With this documentation in
place, the forward exchange contracts entered into by the company after
September 1, 2003, qualify for hedge accounting treatment under U.S.
GAAP. Consequently, under U.S. GAAP, changes in the fair value of these
contracts are charged to other comprehensive income. Upon the
recognition of the hedged sales, accumulated changes in fair value are
reclassified in the statements of earnings.
Under Canadian GAAP, foreign exchange translation gains and losses on
forward exchange contracts are recognized as an adjustment of the
revenue when the corresponding sales are recorded, regardless of whether
the contracts were entered into before or after September 1, 2003.
The company estimates to $950,000 the amount of unrealized gain on
forward exchange contracts as of August 31, 2005 that will be
reclassified to net earnings over the next twelve months.
2005 Annual Report o EXFO :: 51
c) WRITE-DOWN OF GOODWILL AND INTANGIBLE ASSETS
2003
In fiscal 2003, Canadian and U.S. GAAP were harmonized to eliminate the
existing differences in the assessment and measurement of impairment
loss for goodwill and intangible assets. Thus, in fiscal 2003, goodwill
and intangible assets were tested for impairment using similar
methodologies. However, considering that the existing carrying value of
goodwill and intangible assets was lower under U.S. GAAP than under
Canadian GAAP, the required impairment loss under U.S. GAAP was lower
and a permanent difference in the carrying value of goodwill exists
between Canadian and U.S. GAAP.
Upon the impairment test, under U.S. GAAP, the company recorded a charge
of $872,000 to write down the goodwill of EXFO Burleigh and a pre-tax
charge of $377,000 to write down the acquired core technology of EXFO
Burleigh, compared to a write-down of $4,505,000 for goodwill and a
write-down of $2,922,000 for intangible assets under Canadian GAAP,
creating a reconciliation item of $6,178,000 in the statement of
earnings for the year ended August 31, 2003.
Furthermore, considering differences in the carrying value of intangible
assets between Canadian GAAP and U.S. GAAP due to impairment losses,
adjustments to the amortization of such assets and related future income
taxes were also required in fiscal 2003.
d) RESEARCH AND DEVELOPMENT TAX CREDITS
Under Canadian GAAP, all research and development tax credits are
recorded as a reduction of gross research and development expenses.
Under U.S. GAAP, tax credits that are refundable against taxable income
are recorded in the income taxes. These tax credits amounted to
$1,761,000 and $2,169,000 for fiscal 2004 and 2005, respectively. In
fiscal 2003, we had a net expense of $176,000 following the write-off of
tax credits. This difference had no impact on the net loss and the net
loss per share figures for the reporting years.
e) NEW ACCOUNTING STANDARDS AND PRONOUNCEMENTS
ADOPTED IN FISCAL 2004 AND STILL APPLICABLE IN 2005
On September 1, 2003, the company prospectively adopted SFAS 123,
"Accounting for Stock-Based Compensation", under the revised transition
provisions of SFAS 148, "Accounting for Stock-Based Compensation --
Transition and Disclosure". Upon the adoption of SFAS 123 and SFAS 148,
the company recognized stock-based compensation costs for stock options
granted to employees since September 1, 2003, using the fair value-based
method. The company adopted this Statement in order to conform to the
newly adopted rules under Canadian GAAP. As a result of the adoption of
the fair value-based method, the accounting for stock-based compensation
under Canadian GAAP and U.S. GAAP is the same for awards granted on or
after September 1, 2003.
TO BE ADOPTED AFTER FISCAL 2005
In November 2004, the Financial Accounting Standard Board (FASB) issued
SFAS 151, "Inventory Costs", an amendment to ARB No. 43, Chapter 4. The
amendments made by SFAS 151 will improve financial reporting by
clarifying that any abnormal amount of idle facility expenses, freight,
handling costs, and wasted materials (spoilage) should be recognized as
current-period charges and by requiring the allocation of fixed
production overheads to inventory based on the normal capacity of the
production facilities. This SFAS is effective for inventory costs
incurred during fiscal years beginning after June 15, 2005. The company
will adopt this new statement on September 1, 2005, and its adoption
will have no significant impact on its financial statements.
In December 2004, the FASB issued SFAS 123(R), "Share-Based Payments".
This Statement supersedes ABP 25, "Accounting for Stock Issued to
Employees" and related implementation guidance, and revises SFAS 123 in
a number of areas. Under SFAS 123(R), all forms of share-based payment
to employees result in compensation cost recognized in financial
statements. This statement is effective for fiscal years beginning after
June 15, 2005. The company will adopt this Statement on September 1,
2005, and its adoption will have no significant impact on its financial
statements.
In May 2005, the FASB issued SFAS 154, "Accounting Changes and Errors
Corrections -- a replacement of APB Opinion No. 20 and FASB Statement
No. 3". This Statement replaces APB Opinion No. 20, "Accounting
Changes", and FASB Statement No. 3, "Reporting Accounting Changes in
Interim Financial Statements", and changes the requirements for the
accounting for and reporting of a change in accounting principle. This
Statement applies to all voluntary changes in accounting principle. It
also applies to changes required by an accounting pronouncement in the
unusual instance that the pronouncement does not include specific
transition provisions. In general, this Statement requires a company to
account for the adoption of a new accounting policy by applying the new
principle to prior accounting periods as if that principle had always
been adopted. This statement is effective for accounting changes or
corrections of errors in fiscal years beginning after December 15, 2005.
ACCOUNTING FOR STOCK-BASED COMPENSATION
Under U.S. GAAP, until August 31, 2003, the company elected to measure
compensation costs related to grants of stock options and stock awards using
the intrinsic value method of accounting. In this instance, however, under
SFAS 123, the company is required to make pro forma disclosures of net loss,
and net loss per share as if the fair value-based method of accounting had
been applied to awards granted prior to September 1, 2003. Consequently, if
the fair value-based method had been applied to these awards, the pro forma
net loss per share would have been the same as the net loss per share in
fiscal 2005, lower than the net loss per share in 2004 (by $0.01) and higher
than the net loss per share in 2003 (by $0.01).
The fair value of options or awards granted was estimated using the
Black-Scholes options pricing model.
2005 Annual Report o EXFO :: 52
[GRAPHIC OMITTED][PHOTOGRAPH]
Germain Lamonde | Chairman of the Board,
President and CEO, EXFO Electro-Optical Engineering Inc.
Germain Lamonde, a company founder, has been Chairman of the Board, President
and CEO of EXFO since its inception in 1985. Mr. Lamonde, who is responsible
for the overall management and direction of EXFO and its subsidiaries, has
grown the company into a global leader in the telecommunications test and
measurement industry. Mr. Lamonde has served on the boards of several
organizations such as the Canadian Institute for Photonic Innovations, the
Pole QCA Economic Development Corporation and the National Optics Institute of
Canada. Germain Lamonde holds a bachelor's degree in physics engineering from
the University of Montreal's School of Engineering, a master's degree in
optics from Laval University, and is also a graduate of the Ivey Executive
Program offered by the University of Western Ontario.
[GRAPHIC OMITTED][PHOTOGRAPH]
Pierre Marcouiller (1,2) | Chairman of the Board and CEO, Camoplast Inc.
Pierre Marcouiller is Chairman of the Board and CEO of Camoplast Inc., an
industrial manufacturer specializing in rubber tracks, molded composites,
thermoplastic components and off-road tracked vehicles. In addition, Mr.
Marcouiller is founder and sole shareholder of Nexcap Inc., an investment
company in the manufacturing sector. Prior to joining Camoplast, Mr.
Marcouiller was President and General Manager of Venmar Ventilation Inc.
(1988-1996), where he was the controlling shareholder from 1991 to 1996. Mr.
Marcouiller is also a Director of Heroux-Devtek Inc., a public company
specialized in the design, development and manufacturing of aerospace, defense
and industrial products. Pierre Marcouiller holds a bachelor's degree in
business administration from the Universite du Quebec a Trois-Rivieres and an
MBA from the Universite de Sherbrooke.
[GRAPHIC OMITTED][PHOTOGRAPH]
Guy Marier (1,2) | Corporate Director
Formerly President of Bell Quebec (1999 to 2003), Guy Marier completed his
successful 33-year career at Bell as Executive Vice-President of the Project
Management Office before retiring at the end of 2003. From 1988 to 1990, Mr.
Marier headed Bell Canada International's investments and projects in Saudi
Arabia and, for the three following years, served as President of Telebec. He
then returned to the parent company to hold various senior management
positions. Mr. Marier currently sits on the board of Bell Nordiq, a
wholly-owned subsidiary of Bell Canada. Guy Marier holds a Bachelor of Arts
from the University of Montreal and a Bachelor of Business Administration from
the Universite du Quebec a Montreal.
[GRAPHIC OMITTED][PHOTOGRAPH]
Dr. David A. Thompson (2) | Vice-President and Director, Hardware & Equipment
Technology Strategy, Corning Cable Systems
Dr. David Thompson is Vice-President and Director of Hardware & Equipment
Technology Strategy at Corning Cable Systems, where he has held this position
since January 2002. Prior to this nomination, he acted as Corning
Incorporated's Division Vice-President for the Strategic Planning & Innovation
Effectiveness in Research, Development and Engineering.
Dr. Thompson first joined Corning Incorporated in 1976 and later took on
several technology directorship and strategic planning roles. David A.
Thompson holds a bachelor's degree in chemistry from Ohio State University and
a doctorate in inorganic chemistry from the University of Michigan.
[GRAPHIC OMITTED][PHOTOGRAPH]
Andre Tremblay (1,2) | Corporate Director
Andre Tremblay has more than 20 years' experience in the telecommunications
industry. During this time, he has been actively involved in the creation,
financing and management of several companies in this field. For almost 10
years, Mr. Tremblay served as President and CEO of Microcell
Telecommunications Inc., which he led through the different phases of its
evolution. He has also provided early-stage financing, strategic advice and
direction to startup technology firms and sits on the boards of various
corporations and non-profit organizations. Andre Tremblay holds bachelor's
degrees in management and in accounting from Laval University, a master's
degree in taxation from the Universite de Sherbrooke, and is also a graduate
of Harvard Business School's Advanced Management Program.
[GRAPHIC OMITTED][PHOTOGRAPH]
Michael Unger (1,2,3) | Executive Consultant
Michael Unger had a distinguished career with Nortel Networks (1962 to 2000),
where he took on a number of key roles over the years. Mr. Unger's most recent
position was President of Nortel's Optical Networks Business Unit (1998 to
2000). Prior to this appointment, he was Nortel's Group Vice-President,
Transport Networks (1990 to 1998). Currently, Mr. Unger serves on the board of
directors of several companies active in the areas of network management
software, photonic and optical components, optical network systems and
solutions for cable operators, as well as other communications network service
providers. Michael Unger holds a Bachelor of Science from Concordia
University.
(1) Audit Committee
(2) Human Resources Committee
(3) Independent Lead Director
2005 Annual Report o EXFO :: 53
MANAGEMENT AND CORPORATE OFFICERS
[GRAPHIC OMITTED][PHOTOGRAPH] [GRAPHIC OMITTED][PHOTOGRAPH]
GERMAIN LAMONDE | ETIENNE GAGNON |
Chairman, President and Vice-President. Optical-Layer Product
Chief Executive Officer Management and Customer Service
[GRAPHIC OMITTED][PHOTOGRAPH] [GRAPHIC OMITTED][PHOTOGRAPH]
STEPHEN BULL | LUC GAGNON J
Vice-President, Research and Vice-President, Telecom
Development, Telecom Division Manufacturing Operations
[GRAPHIC OMITTED][PHOTOGRAPH] [GRAPHIC OMITTED][PHOTOGRAPH]
NORMAND DUROCHER | JUAN FELIPE GONZALEZ
Vice-President Human Resources Vice-President Global Telecom Sales
[GRAPHIC OMITTED][PHOTOGRAPH] [GRAPHIC OMITTED][PHOTOGRAPH]
ALLAN FIRHOJ | PIERRE PLAMONDON, CA |
Vice-President and General Manager Vice-President, Finance and Chief
Life Sciences and Industrial Division Financial Officer
[GRAPHIC OMITTED][PHOTOGRAPH] [GRAPHIC OMITTED][PHOTOGRAPH]
BENOIT FLEURY | BENOIT RINGUETTE
Vice-President. Protocol-Layer Product Legal Counsel
Management and Business Development and Corporate Secretary
2005 Annual Report o EXFO :: 54
CORPORATE GOVERNANCE PRACTICES
As in the previous year, fiscal 2005 was marked by changes in the corporate
governance landscape. More specifically, the Board of Directors and management
continued to keep abreast of new Canadian and U.S. regulatory requirements.
Futhermore, the Audit Committee was very active throughout the year with the
implementation of and compliance with various rules adopted by the Securities
and Exchange Commission pursuant to the Sarbanes-Oxley Act of 2002 that apply
to Canadian companies with shares registered in the U.S. In addition, the
Board of Directors implemented procedures to monitor the effectiveness of the
Board. Since new corporate governance rules from applicable regulatory
authorities came into force, management amended corporate policies and
disclosure guidelines and adopted the following new policies: Ethics and
Business Conduct Policy; Code of Ethics for Our Principal Executive Officer
and Senior Financial Officers; Board of Directors Corporate Governance
Guidelines; and Statement on Reporting Ethical Violations ("Whistleblowing").
All these policies are readily available from EXFO's Web site. As this past
year has demonstrated, achieving best practices in corporate governance is an
ongoing process in an ever-changing context.
The Board of Directors believes that EXFO's corporate governance practices do
comply with current regulatory requirements. As new guidelines come into
effect, we will continue to comply with these requirements. Further details
about our corporate governance practices, policies and guidelines are
published in the Management Proxy Circular and on EXFO's Web site.
The present Board members were elected at our last Annual and Special Meeting
of Shareholders, held on January 12, 2005, pursuant to the General By-Laws of
the Corporation.
RESPONSIBILITIES OF THE BOARD
The Board is responsible for the stewardship of our business and affairs by
reviewing, discussing and approving our strategic direction and organizational
structure, as well as for the review and approval of management's strategic
plan on an annual basis. The Board also identifies the principal risks of our
business and reviews our risk management systems on an annual and ongoing
basis.
In addition to matters requiring Board approval under applicable laws, the
Board grants final approval with respect to each of the following: (i) the
strategic direction of EXFO; (ii) material contracts, acquisitions or
dispositions of our assets; and (iii) the annual operational plan, as well as
capital and operating budgets.
The Board of Directors assumes direct responsibility for corporate governance
practices and for monitoring the powers, the mandates and the performance of
the committees.
The Board is also responsible for the establishment and functioning of all
Board committees, the appointment of members to serve on such committees,
their compensation and their good standing. At regularly scheduled meetings of
the Board, the Directors receive, consider and discuss committee reports.
During the fiscal year ended August 31, 2005, the Board met a total of five
(5) times. Attendance was exemplary, as all members attended all meetings.
Mr. Michael Unger, Chairman of the Human Resources Committee and independent
Director of EXFO, is the Lead Director. As such, he is responsible for
ensuring that the Board properly discharges its duties, independent of
management. The Lead Director is required to hold as many Board of Directors
meetings as necessary without management members present, and additional
meetings of independent Board members may be held at their request.
The Corporation also adopted a Human Resources Committee Charter, which
integrates the Compensation Committee Charter and the Nominating and
Governance Committee Charter. Therefore, the Corporation now has a formal
procedure in place for recruiting new Directors.
COMPOSITION OF THE BOARD
Our articles of incorporation provide for a Board of Directors with a minimum
of three (3) and a maximum of twelve (12) Directors. Our Board presently
consists of six (6) Directors, five (5) of whom are independent of management
and free from any interest and any business or other relationship which could,
or could reasonably be perceived to, materially interfere with a Director's
ability to act with a view to the best interests of EXFO, other than interests
arising from non-significant shareholding. Our Directors are elected at the
Annual General Meeting of Shareholders for one-year terms and serve until
their successors are elected or appointed, unless they resign or are removed
earlier.
Our Chairman of the Board and Chief Executive Officer, Mr. Germain Lamonde, is
a significant shareholder of EXFO as he has the ability to exercise a majority
of the votes for the election of the Board of Directors. Since the other five
Board members do not have interests in EXFO or relationships with either EXFO
or Mr. Lamonde, except for non-significant shareholding in the company, we
believe that the interests of investors in EXFO, other than Mr. Lamonde's, are
fairly represented.
COMMITTEES OF THE BOARD
Board committees play a significant role in the discharge of Board duties and
obligations; committee chairs submit items for Board agendas and report on
committee activities. The members of these committees are appointed annually,
and the Board may appoint additional ad hoc committees periodically, as
needed. EXFO has a practice of permitting the Board, any committee thereof,
and any individual Director to hire independent, external advisors at our
expense. The Audit Committee and the Human Resources Committee are entirely
comprised of independent Directors.
The following is a general description of the composition and general duties
of each Board committee as contained in its mandate as at the fiscal year
ended August 31, 2005.
2005 Annual Report o EXFO :: 55
AUDIT COMMITTEE
The Board of Directors updated and amended the Audit Committee Charter to
fully comply with all applicable regulations. The Audit Committee reviews
interim in-house financial statements and annual audited financial statements
and related disclosure documents, including "Management's Discussion and
Analysis of Financial Condition and Results of Operations", with management
and external auditors and approves them prior to public release. The Audit
Committee is responsible for reviewing our internal control systems with
regard to finance, accounting, legal compliance and ethical behavior. The
Committee meets regularly with external auditors, with and without management,
to consider the scope and results of their audits, including analysis of the
adequacy of the internal controls and the effect of the procedures relating to
the outside auditors' independence. The Committee also recommends to the
shareholders the selection of external auditors for their appointment by the
shareholders. The Audit Committee is comprised of the following independent
Directors: Mr. Pierre Marcouiller, Mr. Guy Marier, Mr. Andre Tremblay and Mr.
Michael Unger. The Chair of the Audit Committee is Mr. Tremblay. During the
fiscal year ended August 31, 2005, the Audit Committee met a total of four (4)
times and all members attended all meetings.
HUMAN RESOURCES COMMITTEE
The Board of Directors updated and amended the Human Resources Committee
Charter, which integrates the Compensation Committee Charter and the
Nominating and Governance Committee Charter to fully comply with all
applicable regulations.
The Human Resources Committee is responsible for assessing the performance and
establishing the annual compensation of all our senior officers, including the
CEO.
This Committee also reviews and submits to the Board the salary structure and
the short-term and long-term incentive compensation programs for all our
employees.
The Committee is responsible for the review and approval of the employees who
will receive restricted share units (RSUs) and options to purchase EXFO shares
in accordance with policies established by the Board and the terms of the
Long-Term Incentive Plan. In addition, the Committee reports annually to the
Board regarding the organizational structure and succession plan for senior
management. The remuneration to be paid by EXFO to the Directors, either in
cash or in the form of deferred share units (DSUs) pursuant to the Deferred
Share Unit Plan, is recommended to the Board by the Human Resources Committee.
The Human Resources Committee is comprised of the following independent
Directors: Mr. Pierre Marcouiller, Mr. Guy Marier, Dr. David A. Thompson, Mr.
Andre Tremblay and Mr. Michael Unger. The Chair of the Human Resources
Committee is Mr. Unger. During the fiscal year ended August 31, 2005, the
Human Resources Committee met a total of two (2) times and attendance was
perfect at all meetings.
DISCLOSURE COMMITTEE
The Board of Directors also updated the Disclosure Guidelines to fully comply
with all applicable regulations. The Disclosure Committee is responsible for
overseeing our disclosure practices. The Disclosure Committee consists of the
Chief Executive Officer, Chief Financial Officer, Investor Relations Manager,
Manager of Financial Reporting and Accounting, as well as Legal Counsel and
Corporate Secretary.
During the year ended August 31, 2005, the Disclosure Committee ensured that
the corporate governance and disclosure policies adopted by the Board of
Directors on March 29, 2005, were made publicly available. This was done by
posting the following documents on our Web site: The Audit Committee Charter;
Board of Directors Corporate Governance Guidelines; Code of Ethics for Our
Principal Executive Officer and Senior Financial Officers; Ethics and Business
Conduct Policy; Human Resources Committee Charter; and Statement on Reporting
Ethical Violations. The Disclosure Committee also ensured that a contact to
the Lead Director and the Legal Counsel was made available via the
Corporation's Web site.
SHAREHOLDER/INVESTOR COMMUNICATIONS AND FEEDBACK
The Chief Financial Officer assumes responsibility for investor relations. He
is responsible for facilitating communications between senior management and
EXFO's shareholders and financial analysts. Information to shareholders is
disseminated through annual and quarterly reports, press releases, proxy
circular, the Annual General Shareholders' Meeting and investor presentations.
EXFO receives and responds to all shareholders' inquiries in an appropriate
and timely manner. In communications to senior management, the Chief Financial
Officer also provides feedback from shareholders.
SECURITIES TRADING POLICY
The Board of Directors of the Corporation updated and amended the Securities
Policy to fully comply with applicable regulations. This policy is among the
necessary measures to prevent trading by persons in possession of Material
Information.
2005 Annual Report o EXFO :: 56
GLOSSARY
| ADD/DROP MULTIPLEXER (ADM): A SONET/SDH term for a device that can either
insert or drop DS1, DS2 or DS3 channels or SONET signals into/from a SONET
bit stream. The ADM can reach up into the SONET pipe and extract a DS1-level
signal, without going through the rigorous process of demultiplexing and
remultiplexing.
| BANDWIDTH: Represents the amount of data that can be transmitted through a
communications channel in a fixed amount of time. For digital devices,
bandwidth is usually expressed in bits (or bytes) per second. For analog
devices, it is expressed in cycles per second, or in hertz (Hz). The greater
the bandwidth, the greater the information-carrying capacity and the faster
the speed.
| ETHERNET: Protocol for data networking. Ethernet networks typically operate
at 10, 100 or 1000 Mb/s.
| FIBER-TO-THE-X (FTTX) TECHNOLOGY: The x in fiber-to-the-x is a variable
indicating the point at which the fiber in a network stops and copper
(coaxial or twisted-pair) cabling takes over. The further the fiber goes,
the wider the bandwidth, the quicker the speed, and the more applications
and services can be offered.
| GENERIC FRAMING PROCEDURE (GFP): Traffic adaptation protocol providing
convergence between packet-switched and transmission networks. GFP elegantly
maps packet-based protocols such as Ethernet, Fibre Channel, FICON, ESCON,
and various forms of digital video into SONET/SDH, typically using virtual
concatenation to provide right-sized pipes for data services.
| GIGABIT ETHERNET: A version of Ethernet that operates at 1 Gb/s (1000 Mb/s).
| INTERNET PROTOCOL (IP): Method or protocol by which data is sent from one
computer to another on the Internet. Each computer on the Internet has at
least one IP address that uniquely identifies it from all other computers on
the Internet. Because of these standardized IP addresses, the gateway
receiving the data can keep track of, recognize and route messages
appropriately.
| INTRACYTOPLASMIC SPERM INJECTION (ICSI): Laboratory procedure that involves
the injection of a single sperm cell directly into an oocyte (mature egg)
using a glass needle (pipette). Some of EXFO's life sciences products are
used in the reproduction of genetically identical mice for medical research,
helping improve the yield of the ICSI procedure.
| LINK CAPACITY ADJUSTMENT SCHEME (LCAS): LCAS is a bidirectional signaling
protocol between network elements that continually monitors a link, ensuring
that changes in network capacity do not impair a client's traffic
transmission. This protocol uses virtual concatenation (VCAT) to dynamically
allocate bandwidth by reconfiguring VCAT groups in real-time. LCAS allows
carriers using next-generation SONET/SDH networks to provide
bandwidth-on-demand to users.
| MULTISERVICE PROVISIONING PLATFORM (MSPP): A packet-aware SONET/SDH add/drop
multiplexer that offers network service providers (NSPs) an efficient means
of transporting various types of packet-based client signals (such as
Ethernet and Fibre Channel) over existing SONET/SDH infrastructures. This
allows NSPs to offer multiple services to consumers and generate additional
revenue without having to invest heavily in a new infrastructure.
| NANOTECHNOLOGY: Technology that involves manipulating materials on a very
small and precise scale (nanometers; i.e., one billionth of a meter) in
order to build microscopic machinery.
| PACKET: Bits grouped serially in a defined format, containing a command or
data message sent over a network. Same as a frame.
| PIEZOELECTRIC (PZT) TECHNOLOGY: Technology of piezoelectricity, which refers
to the electrical field created by some ceramic materials when subjected to
pressure. Precision positioning devices use the inverse effect; that is,
when an electric field is applied to a piezoelectric material, it changes
shape, and this shape change is used to create precise mechanical movements.
| POLARIZATION MODE DISPERSION (PMD): Dispersion of light causing a delay
between the two principal states of polarization propagating along a fiber
or through a device due to the birefringence properties of the material.
| PROTOCOL: A formal set of rules governing the format, timing, sequencing and
error control of data exchange across a network. Many protocols may be
required and used on a single network.
| SDH: Synchronous Digital Hierarchy. Standardized by the International
Telecommunication Union (ITU-TSS). A protocol for transmitting information
over optical fiber.
| SONET: Synchronous Optical NETwork. Standardized by the American National
Standards Institute (ANSI). A protocol for backbone networks capable of
transmitting at extremely high speeds and accommodating gigabit-level
bandwidth.
| SPOT CURING: Technology by which a dose of energy of a specific wavelength
band and irradiance is used to cause an adhesive, encapsulant or sealant to
change from a liquid to a solid in a small area.
| TRIPLE-PLAY SERVICES: Also known as bundled services. The ability of a
telecommunications carrier to supply voice, data and video applications at
once. A typical example of a triple-play proposal would include one or
multiple phone lines, a high-speed Internet connection and television/ video
services (such as HDTV), all offered by the same provider.
| VIRTUAL CONCATENATION (VCAT): Process enabling transport pipes to be
"right-sized" for various data payloads by allowing SONET/SDH channels to be
multiplexed in arbitrary arrangements. VCAT breaks down data packets and
maps them into the base units of time-division multiplex frames. This data
is then grouped in multiple data flows of various sizes to create larger,
aggregate payloads optimally sized to match available SONET/SDH capacity.
VCAT is applied to the end-points of the connections, which permits each
channel to be independently transmitted through a legacy transport network.
2005 Annual Report o EXFO :: 57
SHAREHOLDER INFORMATION
The subordinate voting shares of EXFO are listed on the Toronto Stock Exchange
under the stock symbol "EXF.SV" and on the NASDAQ Stock Exchange under the
stock symbol "EXFO".
ANNUAL GENERAL MEETING
The Annual General Meeting of Shareholders of EXFO Electro-Optical Engineering
Inc. will be held on January 11, 2006, 9 a.m., at the TSX Broadcast &
Conference Centre, The Exchange Tower (Gallery Room), 130 King Street West,
Toronto, Ontario.
TRANSFER AGENTS AND REGISTRARS
CANADA UNITED STATES
CIBC Mellon Trust Company Mellon Investor Services, LLC
2001 University Street Overpeck Center
Suite 1600 85 Challenger Road
Montreal, Quebec H3A 2A6 Ridgefield Park, New Jersey 07660
Tel.: (514) 285-3600 Tel.: (201) 296-4000
INDEPENDENT AUDITORS
PricewaterhouseCoopers LLP
Place de la Cite, Tour Cominar
2640 Laurier Blvd., Suite 1700
Sainte-Foy, Quebec G1V 5C2
Tel.: (418) 522-7001
CONTACT INFORMATION
GENERAL ACCESS INVESTOR RELATIONS
EXFO Electro-Optical Engineering Inc. Vance Oliver
400 Godin Avenue Manager, Investor Relations
Vanier, Quebec G1M 2K2 Tel.: (418) 683-0913, Ext. 3733
Tel.: (418) 683-0211 E-mail: vance.oliver@exfo.com
E-mail: ir@exfo.com
www.exfo.com
The Annual Report is available in English and in French, both in print and on
our Web site at www.exfo.com.
STOCK PERFORMANCE
[GRAPHIC OMITTED][LINE CHART]
2005 Annual Report o EXFO :: 58
WORLDWIDE OFFICES
EXFO PHOTONIC SOLUTIONS INC. EXFO PROTOCOL
2260 Argentia Road 2650 Marie-Curie West
Mississauga, Ontario L5N 6H7 CANADA St-Laurent, Quebec H4S 2C3 CANADA
Tel.: 1 800 668-8752 (USA and Canada) Tel.: 1 888 972-7666 (USA and Canada)
or 1 905 821-2600 or 1 514 856-2222
Fax: 1 905 821-2055 Fax: 1 514 856-2232
CORPORATE HEADQUARTERS
EXFO AMERICA INC. 400 Godin Avenue
3701 Plano Parkway, Suite 160 Vanier, Quebec G1M 2K2 CANADA
Plano, TX 75075 USA Tel.: 1 800 663-3936 (USA and Canada)
Tel.: 1 800 663-3936 (USA and Canada) or 1 418 683-0211
or 1 972 907-1505 Fax: 1 418 683-2170
Fax: 1 972 836-0164
EXFO EUROPE S.A.R.L.
Le Dynasteur
10/12, rue Andras Beck
92366 Meudon la Foret
Cedex FRANCE
Tel.: +33.1.40.83.85.85
Fax: +33.1.40.83.04.42
EXFO ASIA-PACIFIC PTE LTD. EXFO CHINA
151 Chin Swee Road #03-29 Beijing New Century Hotel Office Tower
Manhattan House Room 1754-1755
SINGAPORE 169876 No. 6 Southern Capital Gym Road
Tel.: +65 6333 8241 Beijing 100044, P. R., CHINA
Fax: +65 6333 8242 Tel.: +86 (10) 6849 2738
Fax: +86 (10) 6849 2662
No. 88 Fuhua First Road
Central Tower, Room 801
Futian District
Shenzhen 518048, P.R. CHINA
Tel.: +86 (755) 8203 2300
Fax: +86 (755) 8203 2306
EXFO JAPAN
4-6-3-202 Akasaka, Minato-ku
Tokyo 107-0052, JAPAN
Tel.: +81-3-5562-5344
Fax: +81-3-5562-5777
[GRAPHIC OMITTED][WORLD MAP SHOWING OFFICE LOCATIONS]
2005 Annual Report o EXFO :: 59
Notes
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2005 Annual Report o EXFO :: 60
[GRAPHIC OMITTED]
www.exfo.com
Telecommunications Test and Measurement EXFO
Expertise Reaching Out
(c)2005 EXFO Electro-Optical Engineering Inc. All rights reserved.
Printed in Canada
[GRAPHIC OMITTED]
[LOGO - EXFO]
Corporate Headquarters > 400 Godin Avenue, Vanier (Quebec) G1M 2K2 CANADA
Tel: 1 418 683-0211 | Fax: 1 418 683-2170 | info@exfo.com
================================================================================
www.exfo.com
------------
Quebec City, November 1, 2005
Re: Annual General Meeting of Shareholders
Dear Shareholder:
EXFO celebrated its 20th anniversary in a fitting manner in fiscal 2005. We
continued our long-term, market-driven innovation strategy to tap into new,
revenue-generating market opportunities. This strong positioning led to
significant progress in market share, sales and profitability in 2005, even
though we faced a highly competitive and changing landscape as well as
considerable currency fluctuations. Consider some of our key performance
highlights in fiscal 2005:
o Increased sales 30.3% to $97.2 million in 2005, up from a 20.5%
increase in 2004;
o Achieved positive GAAP net earnings in the last three quarters of
2005; net loss reduced from $8.4 million in 2004 to $1.6 million in
2005;
o Generated $14.0 million in cash flows from operating activities, up
from $0.8 million in 2004;
o Reached a leadership position in the high-growth, optical
fiber-to-the-x (FTTx) test market; and
o Derived 42.4% of sales from new products on the market two years or
less.
Looking ahead to fiscal 2006, I would like to communicate the key performance
indicators against which our management team should be measured. It should be
noted that these are metrics, not guidance, for fiscal 2006. We intend to take
advantage of key market trends, such as fiber deployments in access networks
and the migration to converged IP-based networks, to reach our objectives.
CORPORATE OBJECTIVES FOR FISCAL 2006
---------------------------------------------------------------------------------------------------------------------
GOAL METRIC
---------------------------------------------------------------------------------------------------------------------
Increase sales through market-share gains Increase sales more than 15% year-over-year
---------------------------------------------------------------------------------------------------------------------
Maximize profitability Generate more than 5% in earnings from operations
---------------------------------------------------------------------------------------------------------------------
Focus on innovation Derive at least 40% of sales from new products
(less than two years on the market)
---------------------------------------------------------------------------------------------------------------------
I will discuss these objectives in greater detail at our upcoming Annual
General Meeting of Shareholders. Please consider this letter as a formal
invitation to attend our Meeting, which will be held on January 11, 2006, 9
a.m., at the TSX Broadcast & Conference Centre, The Exchange Tower (Gallery
Room), 130 King Street West, Toronto, Ontario.
Details of the business to be conducted at the Meeting are provided in the
attached Management Proxy Circular and Notice of Annual General Meeting of
Shareholders.
It is important that your shares be represented at the Meeting. WHETHER OR NOT
YOU PLAN TO ATTEND THE MEETING, PLEASE COMPLETE, SIGN, DATE AND PROMPTLY
RETURN THE ACCOMPANYING PROXY IN THE ENCLOSED POSTAGE-PAID ENVELOPE.
If you send in your proxy card and then decide to attend the Meeting to vote
your shares in person, you may still do so. Your proxy is revocable in
accordance with the procedures set forth in the Management Proxy Circular.
On behalf of the Board of Directors, I would like to express our appreciation
for your continued interest in EXFO. We look forward to seeing you at the
Meeting.
Sincerely,
/s/ Germain Lamonde
-----------------------------
Germain Lamonde
Chairman, President and
Chief Executive Officer
EXFO Electro-Optical Engineering Inc.
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[EXFO LOGO]
EXFO ELECTRO-OPTICAL ENGINEERING INC.
-------------------------
NOTICE OF ANNUAL GENERAL MEETING OF SHAREHOLDERS
NOTICE IS HEREBY GIVEN that the Annual General Meeting (the "Meeting")
of shareholders of EXFO Electro-Optical Engineering Inc. (the "Corporation")
will be held at 9:00 a.m. (Eastern Standard Time), on Wednesday, January 11,
2006, at the Toronto Stock Exchange Broadcast & Conference Centre, The
Exchange Tower ( Gallery Room), 130 King Street West, Toronto, Ontario, Canada
for the following purposes:
1. to receive the consolidated financial statements of the Corporation for
the financial year ended August 31, 2005, and the Auditor's report
thereon;
2. to elect Directors of the Corporation;
3. to appoint PricewaterhouseCoopers LLP as auditors and to authorize the
Audit Committee to fix their remuneration;
4. to transact such further or other business as may properly come before
the Meeting or any adjournment or adjournments thereof.
Enclosed is a copy of the 2005 Annual Report of the Corporation including the
consolidated financial statements and the Auditor's Report thereon, together
with the Management Proxy Circular and a form of Proxy.
DATED at Vanier, Quebec, this 1st day of November, 2005.
BY ORDER OF THE BOARD OF DIRECTORS
/s/ Benoit Ringuette
-----------------------------
Benoit Ringuette
Secretary
SHAREHOLDERS UNABLE TO ATTEND THE MEETING ARE REQUESTED TO COMPLETE THE
ENCLOSED PROXY FORM AND RETURN IT IN THE ENVELOPE PROVIDED. TO BE VALID,
PROXIES MUST REACH THE OFFICE OF CIBC MELLON TRUST COMPANY, 2001 UNIVERSITY
STREET, SUITE 1600, MONTREAL, QUEBEC, CANADA, H3A 2A6, NO LATER THAN THE LAST
DAY PRIOR TO THE DATE OF THE MEETING OR ANY RECONVENING OF THE MEETING IN CASE
OF ADJOURNMENT. SHAREHOLDERS MAY ALSO HAVE THE PROXY FORM DELIVERED TO THE
CHAIRMAN OF THE MEETING PRIOR TO THE TIME OF VOTING ON THE DAY OF THE MEETING
OR ANY ADJOURNMENT THEREOF.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
MANAGEMENT PROXY CIRCULAR OF THE CORPORATION
FOR THE ANNUAL GENERAL MEETING OF SHAREHOLDERS
THIS PROXY IS SOLICITED BY THE MANAGEMENT OF THE CORPORATION
The undersigned shareholder of EXFO ELECTRO-OPTICAL ENGINEERING INC. hereby
appoints (CHECK EITHER (A) or (B)):
[_] (A) Mr. Germain Lamonde of Cap-Rouge, Quebec, or failing him, Mr. Pierre
Plamondon of Quebec, Quebec;
[_] (B) _______________________________ of ________________________________;
(Name) (Address)
as the representative of the undersigned to attend, act and vote on behalf of
the undersigned at the ANNUAL GENERAL MEETING OF THE SHAREHOLDERS (THE
"MEETING") OF THE CORPORATION TO BE HELD AT THE TORONTO STOCK EXCHANGE
BROADCAST & CONFERENCE CENTRE, THE EXCHANGE TOWER (GALLERY ROOM), 130 KING
STREET WEST, TORONTO, ONTARIO, CANADA, ON JANUARY 11, 2006, AT 9:00 O'CLOCK
A.M. (EASTERN STANDARD TIME) AND AT ANY ADJOURNMENTS OF SUCH MEETING.
THE UNDERSIGNED WISHES THAT ALL SHARES REPRESENTED BY THIS PROXY BE VOTED IN
ACCORDANCE WITH THE INSTRUCTIONS HEREINBELOW. ALL SHARES REPRESENTED BY THIS
PROXY WILL BE VOTED FOR, AGAINST OR BE THE SUBJECT OF ABSTENTIONS, AS
SPECIFIED BY THE SHAREHOLDER. HOWEVER, IN THE ABSENCE OF INSTRUCTIONS, THE
SHARES REPRESENTED BY PROXY WILL BE VOTED IN FAVOR OF EACH OF THE PROPOSALS
SET FORTH HEREIN.
(MARK WITH AN X)
To elect Germain Lamonde, Pierre Marcouiller, Guy FOR [_]
Marier, David A. Thompson, Andre Tremblay and Michael
Unger, whose cities of residence are indicated in the
Management Proxy Circular, as Directors of the
Corporation. ABSTENTION [_]
To appoint PricewaterhouseCoopers LLP as auditors FOR [_]
and to authorize the Audit Committee to fix their
remuneration.
ABSTENTION [_]
A DISCRETIONARY POWER IS HEREBY CONFERRED as to any amendment or change made to
the matters mentioned in the Notice of Meeting or as to such other matters as
may legally come before the Meeting. The Management of the Corporation is not
aware of any amendments, changes or other matters that may come before the
Meeting.
* A SHAREHOLDER IS ENTITLED TO APPOINT, TO DATED this day of
ATTEND AND ACT FOR AND ON BEHALF OF SUCH
SHAREHOLDER AT THE MEETING, A PERSON OTHER
THAN THE PERSON MENTIONED IN (A) HEREIN ABOVE ______________________________
AND MAY DO SO BY CHECKING (B) HEREINABOVE AND SIGNATURE OF SHAREHOLDER
ADDING THE NAME OF SUCH OTHER PERSON IN THE
SPACE RESERVED FOR SUCH PURPOSE. [ ]
name of shareholder
[ ]
THIS PROXY MUST BE SIGNED BY THE SHAREHOLDER OR HIS PROXYHOLDER AUTHORIZED IN
WRITING OR, IF THE SHAREHOLDER IS A CORPORATION, UNDER ITS CORPORATE SEAL, BY
A DULY AUTHORIZED OFFICER OR PROXYHOLDER OF THE CORPORATION. PLEASE REMEMBER
TO DATE AND SIGN THIS PROXY. IF THIS PROXY IS NOT DATED, IT WILL BE DEEMED TO
BEAR THE DATE OF ITS MAILING BY MANAGEMENT.
YOU ARE REFERRED TO THE MANAGEMENT PROXY CIRCULAR APPENDED.
FRANCAIS AU VERSO
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[EXFO LOGO]
--------------------------------------------------------------------------------
NOTIC OF ANNUAL
MEETING OF SHAREHOLDERS
AND
MANAGEMENT PROXY CIRCULAR
--------------------------------------------------------------------------------
NOVEMBER 1, 2005
EXFO ELECTRO-OPTICAL ENGINEERING INC.
MANAGEMENT PROXY CIRCULAR
SOLICITATION OF PROXIES
THIS MANAGEMENT PROXY CIRCULAR IS PROVIDED IN CONNECTION WITH THE SOLICITATION
BY THE MANAGEMENT OF EXFO ELECTRO-OPTICAL ENGINEERING INC. (THE "CORPORATION"
OR "EXFO") OF PROXIES TO BE USED AT THE ANNUAL MEETING OF SHAREHOLDERS (THE
"MEETING") OF THE CORPORATION TO BE HELD AT THE TIME AND PLACE AND FOR THE
PURPOSES STATED IN THE ACCOMPANYING NOTICE OF MEETING AND AT ANY ADJOURNMENT
THEREOF. UNLESS OTHERWISE INDICATED, THE INFORMATION CONTAINED HEREIN IS GIVEN
AS OF NOVEMBER 1, 2005.
It is expected that the solicitation will be made primarily by mail but
proxies may also be solicited personally by officers, employees or agents of
the Corporation. The Corporation may also reimburse brokers and other persons
holding shares in their names, or in the names of nominees, for their costs
incurred in sending proxy material to principals and obtaining their proxies.
The cost of solicitation will be borne by the Corporation and is expected to
be nominal.
APPOINTMENT AND REVOCATION OF PROXIES AND ATTENDANCE OF BENEFICIAL SHAREHOLDERS
The persons named in the enclosed Form of Proxy (the "Form of Proxy") are
officers of the Corporation. A SHAREHOLDER DESIRING TO APPOINT SOME OTHER
PERSON (WHO NEED NOT BE A SHAREHOLDER) TO REPRESENT HIM OR HER AT THE MEETING
MAY DO SO BY INSERTING SUCH PERSON'S NAME IN THE BLANK SPACE PROVIDED IN THE
FORM OF PROXY AND CHECKING ITEM (B).
To be valid, proxies must be received at the Montreal, Canada office of CIBC
Mellon Trust Company, 2001 University Street, Suite 1600, Montreal, Quebec,
Canada, H3A 2A6, the transfer agent of the Corporation, no later than the
close of business on the last business day preceding the day of the Meeting or
any adjournment thereof, or proxies may be delivered to the Chairman of the
Meeting on the day of the Meeting or any adjournment thereof. A beneficial
shareholder who completes a Form of Proxy and who wishes to attend and vote at
the Meeting personally must appoint himself or herself proxy holder in the
foregoing manner.
A proxy given pursuant to this solicitation may be revoked by instrument in
writing executed by the shareholder or by his or her attorney authorized in
writing if such instrument is deposited either at the registered office of the
Corporation to the attention of the Secretary no later than the close of
business on the last business day preceding the day of the Meeting or any
adjournment thereof or with the Chairman of the Meeting on the day of the
Meeting or any adjournment thereof.
VOTING OF PROXIES
The shares represented by proxies appointing the persons, or any one of them,
designated by Management thereon to represent the shareholder at the Meeting
will be voted in accordance with the instructions given by the shareholder.
UNLESS OTHERWISE INDICATED, THE VOTING RIGHTS ATTACHING TO THE SHARES
REPRESENTED BY A FORM OF PROXY WILL BE VOTED "FOR" IN RESPECT OF ALL THE
PROPOSALS DESCRIBED HEREIN.
The Form of Proxy confers discretionary authority upon the persons named
therein with respect to amendments or variations to matters identified in the
accompanying Notice of Meeting. As at the date hereof, Management is not aware
that any other matter is to be presented at the Meeting. If, however, other
matters properly come before the Meeting, the persons designated in the Form
of Proxy will vote thereon in accordance with their judgment pursuant to the
discretionary authority conferred by such proxy with respect to such matters.
1
VOTING SHARES AND PRINCIPAL HOLDERS THEREOF
As at November 1, 2005, 30,672,617 Subordinate Voting Shares and 37,900,000
Multiple Voting Shares were outstanding, being the only classes of shares
entitled to be voted at the Meeting. Each holder of Subordinate Voting Shares
is entitled to one vote and the holder of Multiple Voting Shares is entitled
to 10 votes for each share registered in his or her name at the close of
business on November 21, 2005, being the date fixed by the Board of Directors
for the purpose of determining registered shareholders entitled to receive the
accompanying Notice of Meeting and to vote (the "Record Date"). A list of
shareholders entitled to vote as of the Record Date, showing the number of
shares held by each shareholder, shall be prepared within 10 days of the
Record Date. This list of shareholders will be available for inspection during
normal business hours at the Montreal, Canada office of CIBC Mellon Trust
Company, the transfer agent of the Corporation, 2001 University Street, Suite
1600, Montreal, Quebec, Canada, H3A 2A6, and at the Meeting.
Unless otherwise indicated, the resolutions submitted to a vote at the Meeting
must be passed by a majority of the votes cast by the holders of Subordinate
Voting Shares and Multiple Voting Shares, as a single class, present at the
Meeting in person or by proxy and voting in respect of all resolutions to be
voted on by the shareholders of the Corporation.
To the knowledge of executive officers and directors of the Corporation, as of
November 1, 2005, the only persons who are beneficial owners or who exercise
control or direction, directly or indirectly, over shares carrying more than
10% of the voting rights attaching to any class of shares of the Corporation
are:
-----------------------------------------------------------------------------------------------------------------------
PERCENTAGE OF PERCENTAGE OF VOTING
PERCENTAGE OF VOTING NUMBER OF VOTING RIGHTS RIGHTS ATTACHED TO
NUMBER OF RIGHTS ATTACHED TO MULTIPLE ATTACHED TO ALL ALL SUBORDINATE AND
SUBORDINATE ALL SUBORDINATE VOTING MULTIPLE VOTING MULTIPLE VOTING
NAME OF SHAREHOLDER VOTING SHARES VOTING SHARES SHARES (1) SHARES SHARES
--------------------------------------------------------------------------------------------------------------------
Germain Lamonde 93,000 (2) 0.30% 37,900,000(3) 100% 92.54%
-----------------------------------------------------------------------------------------------------------------------
Kern Capital 4,658,000 (4) 15.19% - - 1.14%
Management LLC
-----------------------------------------------------------------------------------------------------------------------
FMR Corporation 4,595,100 (5) 14.98% - - 1.12%
-----------------------------------------------------------------------------------------------------------------------
-----------------
(1) The holder of Multiple Voting Shares is entitled to 10 votes for each
share.
(2) Mr. Lamonde exercises control over this number of Subordinate Voting
Shares through Placements Lamonde, SENC, a partnership controlled by Mr.
Lamonde.
(3) Mr. Lamonde exercises control over this number of Multiple Voting Shares
through G. Lamonde Investissements Financiers inc., a company controlled
by Mr. Lamonde and through Fiducie Germain Lamonde, a family trust for
the benefit of Mr. Lamonde's family.
(4) As of June 30, 2005, Kern Capital Management LLC controls the voting
rights attached to this number of subordinate voting shares through
relationships with several clients and does not beneficially own
directly this number of subordinate voting shares.
(5) As of June 30, 2005, Fidelity Management and Research Company, a
wholly-owned subsidiary of FMR Corporation, is the beneficial owner of
this number of subordinate voting shares as a result of acting as
investment advisor to various investment companies.
ELECTRONIC DELIVERY
The Corporation has a voluntary program for e-mail notification to our
shareholders that documents which must be delivered pursuant to securities
legislation are available on EXFO's website. Every year, EXFO delivers
documentation to shareholders, such as this Management Proxy Circular and its
Annual Report that must be delivered to shareholders of a public company by
law. EXFO has made this process more convenient for its shareholders, as
shareholders who so wish, may be notified by e-mail when the Corporation's
documentation is posted in the "Investors" section on its website
(www.exfo.com). Accordingly such documentation will not be sent in paper form
by mail. The Corporation believes that electronic delivery will benefit the
environment and reduce its costs. Shareholders who do not consent to receive
documentation by e-mail will continue to receive such documentation by mail.
2
Registered shareholders can consent to electronic delivery by completing and
returning the consent form accompanying this Circular to CIBC Mellon Trust
Company. Unregistered shareholders (i.e. shares are held through a securities
broker, bank, trust company or other nominee) can consent to electronic
delivery by completing and returning the appropriate form received from the
applicable intermediary.
BUSINESS TO BE TRANSACTED AT THE MEETING
PRESENTATION OF THE FINANCIAL STATEMENTS
The consolidated financial statements of the Corporation for the financial
year ended August 31, 2005 and the Auditors' report thereon contained in
EXFO's Annual Report accompanying this Circular will be submitted to
shareholders at the Meeting but no vote with respect thereto is required or
proposed to be taken.
ELECTION OF THE DIRECTORS
According to the articles of the Corporation, the Board of Directors shall
consist of a minimum of 3 and a maximum of 12 directors. At the Meeting,
Management proposes the 6 persons named hereafter on pages 3 and 4 as nominees
for election as directors to hold office until the next annual meeting or
until the office is otherwise vacated in accordance with the Corporation's
by-laws.
Management does not anticipate that any of the nominees will be unable, or for
any reason whatsoever, be reluctant to fulfill their duties as directors.
Should this occur for any reason whatsoever before the election, the persons
named in the Form of Proxy reserve the right to vote for another nominee of
their choice unless the shareholder specified on the Form of Proxy to abstain
from voting for the election of the directors.
APPOINTMENT AND REMUNERATION OF AUDITORS
A firm of auditors is to be appointed by vote of the shareholders at the
Meeting to serve as auditors of the Corporation until the close of the next
annual meeting. The Audit Committee is to be authorized to fix the
remuneration of the auditors so appointed. The Board of Directors and
Management, upon the advice of the Audit Committee, recommend that
PricewaterhouseCoopers LLP be re-appointed as Auditors of the Corporation. The
re-appointment of PricewaterhouseCoopers LLP must be approved by a majority of
the votes cast on the matter at the Meeting.
NOMINEES FOR ELECTION AS DIRECTORS AND THEIR BENEFICIAL OWNERSHIP OF
VOTING SECURITIES
The following table and notes set out the name of each of the individuals whom
is proposed to be nominated at the Meeting for election as a director of the
Corporation, all other positions and offices with the Corporation and its
subsidiaries now held by each such individual, if any, the principal
occupation or employment of each such individual, their respective period of
service as a director and the approximate number of shares of the Corporation
beneficially owned by each such individual or over which each of them
exercised control or direction.
--------------------------------------------------------------------------------------------------------------------
NUMBER OF NUMBER OF
NAME AND POSITION OR OFFICE PRINCIPAL OCCUPATION CITY OF SUBORDINATE MULTIPLE VOTING
WITH THE CORPORATION OR EMPLOYMENT RESIDENCE DIRECTOR SINCE VOTING SHARES SHARES
--------------------------------------------------------------------------------------------------------------------
Germain Lamonde(1) Chairman of the Cap-Rouge, September 1985 93,000 (1) 37,900,000 (2)
Chairman of the Board, Board, President and Quebec
President and Chief Chief Executive
Executive Officer Officer, EXFO
Electro-Optical
Engineering Inc.
--------------------------------------------------------------------------------------------------------------------
3
--------------------------------------------------------------------------------------------------------------------
NUMBER OF NUMBER OF
NAME AND POSITION OR OFFICE PRINCIPAL OCCUPATION CITY OF SUBORDINATE MULTIPLE VOTING
WITH THE CORPORATION OR EMPLOYMENT RESIDENCE DIRECTOR SINCE VOTING SHARES SHARES
--------------------------------------------------------------------------------------------------------------------
Pierre Marcouiller(3)(4) Chairman of the Board Magog, May 2000 5,000 -
Independent Director and Chief Executive Quebec
Officer,
Camoplast Inc.
(a supplier of
automotive and
recreational vehicle
parts)
--------------------------------------------------------------------------------------------------------------------
Guy Marier (3)(4) Executive Consultant Lakefield January 2004 1,000 -
Independent Director Gore, Quebec
--------------------------------------------------------------------------------------------------------------------
Andre Tremblay(3)(4) Executive Consultant Outremont, May 2000 6,650 (5) -
Independent Director Quebec
--------------------------------------------------------------------------------------------------------------------
Dr. David A. Thompson, Vice-President& Newton, June 2000 2,100 -
Ph.D.(4) Director, Hardware & North
Independent Director Equipment Technology Carolina
Strategy, Corning
Cable Systems
--------------------------------------------------------------------------------------------------------------------
Michael Unger(3)(4) Executive Consultant Woodbridge, May 2000 - -
Independent Lead Director Ontario
--------------------------------------------------------------------------------------------------------------------
--------------
(1) Mr. Lamonde exercises control over this number of Subordinate Voting
Shares through Placements Lamonde, SENC, a partnership controlled by Mr.
Lamonde.
(2) Mr. Lamonde exercises control over this number of Multiple Voting Shares
through G. Lamonde Investissements Financiers inc., a company controlled
by Mr. Lamonde and through Fiducie Germain Lamonde, a family trust for
the benefit of Mr. Lamonde's family.
(3) Member of the Audit Committee.
(4) Member of the Human Resources Committee.
(5) Mr. Tremblay exercises control over this number of Subordinate Voting
Shares through 9104-5559 Quebec inc. a company controlled by Mr.
Tremblay.
The information as to Subordinate Voting Shares and Multiple Voting Shares
beneficially owned or over which the above-named individuals exercise control
or direction is not within the direct knowledge of the Corporation and has
been furnished by the respective individual.
COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS
In the financial year ended August 31, 2005, each director who are not
employees of the Corporation or any of its subsidiaries received the level of
compensation set forth in the table below as annual compensation payable in a
combination of cash and Deferred Share Units ("DSUs") as chosen by the
director pursuant to the Deferred Share Unit Plan.
------------------------------------------------------------------------------------------
Annual Retainer for Directors: (1) CDN$50,000(2) US$40,600 (3)
------------------------------------------------------------------------------------------
Annual Retainer for Committee Chairman: CDN$5,000 US$4,060 (3)
------------------------------------------------------------------------------------------
Annual Retainer for Committee Members: CDN$3,000 US$2,436 (3)
------------------------------------------------------------------------------------------
Fees for all Meetings Attended per day in Person: CDN$1,000 US$812 (3)
------------------------------------------------------------------------------------------
Fees for all Meetings Attended per day by Telephone: CDN$500 US$406 (3)
------------------------------------------------------------------------------------------
---------------
(1) All the Directors elected to receive 50% of their Annual Retainer in form
of Deferred Share Units.
(2) The Annual Retainer for Mr. David A. Thompson is US$50,000 (CDN$61,575).
(3) The compensation information has been converted from Canadian dollars to
U.S. dollars based upon an average foreign exchange rate of CDN$1.2315 =
US$1.00 for 2005.
4
In the financial year ended August 31, 2005, the Directors who are not
employees received the following compensation in the form indicated:
--------------------------------------------------------------------------------------------------------------------
ANNUAL FAIR VALUE OF DSUS AT TOTAL ATTENDANCE
COMPENSATION PAID ANNUAL COMPENSATION THE TIME OF GRANT FEES PAID IN CASH
NAME IN CASH (US$) (1) PAID IN DSUS (#) (2) (US$) (3) (US$) (1)
--------------------------------------------------------------------------------------------------------------------
Pierre Marcouiller (4) 25,173 4,537 20,300 4,466
--------------------------------------------------------------------------------------------------------------------
Guy Marier (5) 25,173 4,537 20,300 4,466
--------------------------------------------------------------------------------------------------------------------
Dr. David A. Thompson (6) 27,440 5,586 25,000 3,256
--------------------------------------------------------------------------------------------------------------------
Andre Tremblay (7) 26,797 4,537 20,300 4,466
--------------------------------------------------------------------------------------------------------------------
Michael Unger (8) 26,797 4,537 20,300 4,466
--------------------------------------------------------------------------------------------------------------------
---------------
(1) The compensation information has been converted from Canadian dollars to
U.S. dollars based upon an average foreign exchange rate of CDN$1.2315 =
US$1.00 for 2005 except for Mr. David A. Thompson who is paid in U.S.
dollar. The Annual Compensation includes, as the case may be, the
retainer for Director, Committee Members and Committee Chairman.
(2) Indicates the number of Subordinate Voting Shares granted under the
Deferred Share Unit Plan. A DSU is converted in a Subordinate Voting
Share when a Director ceases to be a member of the Board.
(3) The fair value at the time of grant of a DSU is determined based on the
highest of the closing prices of the Subordinate Voting Shares on the
Toronto Stock Exchange and the NASDAQ National Market on the last
trading day preceding the grant date, using the noon buying rate of the
Federal Reserve Bank of New York on the grant date to convert the NASDAQ
National Market closing price to Canadian dollars, as required. The
value at vesting of a DSU is equivalent to the market value of a
Subordinate Voting Share when a DSU is converted to such Subordinate
Voting Share.
(4) Member of the Audit Committee and the Human Resources Committee.
(5) Member of the Audit Committee and the Human Resources Committee.
(6) Member of the Human Resources Committee.
(7) Member of the Human Resources Committee and Chairman of the Audit
Committee.
(8) Member of the Audit Committee, Chairman of the Human Resources Committee
and Lead Director.
COMPENSATION OF NAMED EXECUTIVE OFFICERS
The table below shows compensation information during the three most recently
completed financial years for Mr. Germain Lamonde, the Chairman of the Board,
President and Chief Executive Officer of the Corporation, Mr. Pierre
Plamondon, the Vice-President Finance and Chief Financial Officer and the
three other most highly compensated executive officers of the Corporation and
its subsidiaries who were serving the Corporation at the end of the financial
year (collectively, the "Named Executive Officers"). This information includes
the US dollar value of base salaries, bonus awards and long-term incentive
plan payments, the number of options or Restricted Share Units granted, and
other compensation, if any, whether paid or deferred.
---------------------------------------------------------------------------------------------------------------------------
SECURITIES
OTHER ANNUAL UNDER RESTRICTED ALL OTHER
NAME AND PRINCIPAL FINANCIAL SALARY (1) BONUS (2) COMPENSATION OPTIONS SHARE UNITS COMPENSATION
POSITION YEARS ($) ($) ($) (3) (#) (4) ($)
---------------------------------------------------------------------------------------------------------------------------
Germain Lamonde, 2005 243,605 (US) 121,729 (US) - 17,942 13,089 -
President and Chief 300,000 (CDN) 149,909 (CDN)
Executive Officer
2004 206,751 (US) 57,115 (US) - - - -
275,000 (CDN) 75,969 (CDN)
2003 185,848 (US) 25,247 (US) - 50,000 - -
275,000 (CDN) 37,359 (CDN)
---------------------------------------------------------------------------------------------------------------------------
Pierre Plamondon, 2005 151,441 (US) 48,735 (US) - 5,383 33,927 2,316 (US) (5)
Vice-President Finance 186,500 (CDN) 60,017 (CDN) 2,852 (CDN)
and Chief Financial
Officer 2004 135,328 (US) 17,451 (US) - - - 1,429 (US) (5)
180,000 (CDN) 23,211 (CDN) 1,901 (CDN)
2003 118,267 (US) 9,547 (US) - 25,000 - 866 (US) (5)
175,000 (CDN) 14,127 (CDN) 1,281 (CDN)
---------------------------------------------------------------------------------------------------------------------------
5
------------------------------------------------------------------------------------------------------------------------------
SECURITIES
OTHER ANNUAL UNDER RESTRICTED ALL OTHER
NAME AND PRINCIPAL FINANCIAL SALARY (1) BONUS (2) COMPENSATION OPTIONS SHARE UNITS COMPENSATION
POSITION YEARS ($) ($) ($) (3) (#) (4) ($)
------------------------------------------------------------------------------------------------------------------------------
Juan-Felipe Gonzalez, 2005 246,323 (US) 6,015 (US) - 5,482 33,998 -
Vice-President, 303,347 (CDN) 7,407 (CDN)
Global Telecom Sales
2004 231,597 (US) 563,867 (US) - - -
308,047 (CDN) 750,000 (CDN)(6) -
2003 163,896 (US) 7,500 (US) - 30,000 - -
------------------------------------------------------------------------------------------------------------------------------
Stephen Bull 2005 121,803 (US) 32,559 (US) - 3,589 32,618 1,758 (US) (5)
Vice-President 150,000 (CDN) 40,097 (CDN) 2,165 (CDN)
Research & Development
2004 112,773 (US) 12,437 (US) - - - 16,221 (US)(7)
150,000 (CDN) 16,543 (CDN) 21,576 (CDN)
2003 81,098 (US) 8,138 (US) - 15,000 - 588
120,000 (CDN) 12,042 (CDN) 871
------------------------------------------------------------------------------------------------------------------------------
Etienne Gagnon 2005 113,683 (US) 34,389 (US) - 3,158 9,804 1,067 (US)(5)
Vice-President, 140,000 (CDN) 42,349 (CDN) 1,314 (CDN)
Optical-Layer Product
Management and 2004 99,241 (US) 7,540 (US) - - - -
Customer Service 132,000 (CDN) 11,157 (CDN)
2003 81,098 (US) (8) 2,550 (US) - 20,000 - -
120,000 (CDN) 4,013 (CDN)
-----------------------------------------------------------------------------------------------------------------------------
---------------
(1) The compensation information for Canadian residents has been converted
from Canadian dollars to U.S. dollars based upon an average foreign
exchange rate of CDN$1.2315 = US$1.00 for 2005, CDN$1.3301 = US$1.00 for
2004 and CDN$1.4797 = US$1.00 for 2003. The currency conversions cause
these reported salaries to fluctuate from year-to-year because of the
fluctuation in exchange rate.
(2) A portion of the bonus amounts is paid in cash in the year for which
they are awarded and the balance is paid in cash in the year following
the financial year for which they are awarded.
(3) Indicates the number of Subordinate Voting Shares underlying the options
granted under the Long-Term Incentive Plan during the financial year
indicated.
(4) Indicates the number of Restricted Share Units granted under the
Long-Term Incentive Plan during the financial year indicated.
(5) Indicates the amount contributed by the Corporation during the financial
year indicated to the Deferred Profit Sharing Plan, as applicable, for
the benefit of the Named Executive Officer. Mr. Lamonde is not eligible
to participate in the Deferred Profit Sharing Plan and Mr. Gonzalez did
not participate.
(6) Pursuant to the terms of his employment agreement, Mr. Juan-Felipe
Gonzalez did receive a cash payment of CDN$750,000 since he did not
voluntarily resign and was not dismissed with cause prior to September
2003. An amount of CDN$500,000 was disbursed on October 17, 2003 and the
remaining CDN$250,000 was disbursed on January 25, 2004.
(7) Indicates the amount paid by the Corporation during the financial year
for relocation allowance (CDN$20,000) (US$15,036) plus the amount
referred in note 5 above (CDN$1,576) (US$1,185).
(8) This amount represents Mr. Gagnon annual base salary. Since Mr. Gagnon
joined the Corporation in January 13, 2003, the base salary paid to Mr.
Gagnon for the financial year ended August 31, 2003 amounted to
US$49,906 (CDN$73,846).
Other than its Long-Term Incentive Plan, Deferred Share Unit Plan, Restricted
Stock Award Plan and Stock Appreciation Rights Plan, which are described below
in the "Report on Executive Compensation by the Human Resources Committee -
Long-Term Incentive Compensation", the Corporation does not have any other
formal long-term incentive plans for its directors, officers and employees.
SHARE PURCHASE PLAN
In September 1998, prior to becoming a public company, the Corporation adopted
a share purchase plan for officers, directors and key employees, as amended in
April 2000. On April 3, 2000, the Corporation adopted a share plan which
replaced the 1998 share plan and on June 29, 2000, at the time of the
Corporation's initial public offering, all of the 707,264 Class "F" shares
issued under this plan to Officers, directors and key employees and fully paid
by them were converted into Subordinate Voting Shares. No additional shares
will be issued under this share plan. This share plan required the Subordinate
Voting Shares previously acquired by participants to be held in trust by a
trustee until August 31, 2004, except for 249,977 Subordinate Voting Shares,
of which 216,548 Subordinate Voting Shares were released on October 21, 2003,
6,020 Subordinate Voting Shares were released on December 23, 2003 and 27,409
Subordinate Voting Shares were released on January 20, 2004.
6
For further information regarding this share plan, please refer to the
Corporation's Management Proxy Circular dated November 1, 2004 in the section
named "Share Plan" available on SEDAR website at www.sedar.com under "This
Public's Company's Documents" - Management Information Circular - English
filed on November 29, 2004.
DEFERRED PROFIT SHARING PLAN
The Corporation maintains a deferred profit sharing plan for certain eligible
Canadian resident employees. Under this plan, the Corporation may contribute
an amount equal to 1% until May 31, 2005 and 2% from June 1, 2005 of each
employee's gross salary to that employee's individual deferred profit sharing
plan to the extent that such employee contributes at least 2% of his or her
gross salary to his or her individual tax-deferred registered retirement
savings plan. In the financial year ended August 31, 2005, the aggregate
amount of contributions paid under the plan was US$179,000 (CDN$221,000). Mr.
Germain Lamonde is not entitled to participate in this plan.
401K PLAN
The Corporation maintains a 401K plan for eligible United States resident
employees of its subsidiaries. Under this plan, the Corporation must
contribute an amount equivalent to 3% of an employee's current compensation,
subject to certain legislated maximum contribution limits. During the
financial year ended August 31, 2005, the Corporation paid contributions
totaling US$134,000.
DEFERRED SHARE UNIT GRANTS IN LAST FINANCIAL YEAR
The aggregate number of Deferred Share Units ("DSUs") credited to non-employee
directors during the financial year ended August 31, 2005 was 23,734. The fair
value at the time of grant of a DSU is equal to the market value of a
Subordinate Voting Share at the time DSUs are credited to the directors. At
the end of the financial year ended August 31, 2005, there were a total of
23,734 DSUs credited to directors pursuant to the Deferred Share Unit Plan
having a fair value at the time of grant of US$105,998 (CDN$130,421).
DSUs attract dividends in the form of additional DSUs at the same rate as
dividends on Subordinate Voting Shares. The DSUs are converted and paid in
Subordinate Voting Shares at the time a director ceases to be a member of the
Board.
Therefore, the value at vesting of a DSU, when converted to Subordinate Voting
Shares, is equivalent to the market value of a Subordinate Voting Share at the
time the conversion takes place. The table below shows information regarding
DSU grants made under the Deferred Share Unit Plan during the financial year
ended August 31, 2005.
See "Report on Executive Compensation by the Human Resources Committee -
Long-Term Incentive Compensation - Deferred Share Unit Plan" for a description
of the Deferred Share Unit Plan.
During the financial year ended August 31, 2005, the following DSUs were granted
to the directors:
-------------------------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE FAIR VALUE AT THE TIME OF GRANT
DSUS # US$/DSU VESTING
-------------------------------------------------------------------------------------------------------------------
23,734 4.47 At the time director cease to be a member
of the Board of the Corporation
-------------------------------------------------------------------------------------------------------------------
RESTRICTED SHARE UNIT GRANTS IN LAST FINANCIAL YEAR
The aggregate number of Restricted Share Units (RSUs) granted during the
financial year ended August 31, 2005 was 176,185. The fair value at the time
of grant of a RSU is equal to the market value of Subordinate Voting Shares at
the time RSUs are granted. At the end of the financial year ended August 31,
2005, there were a total of 176,185 RSUs granted pursuant to the Long-Term
Incentive Plan having a weighted average fair value at the time of grant of
US$4.68 (CDN$5.72) per RSU. All RSUs first vesting can not be earlier than the
third anniversary date of their grant. Some RSUs granted in the financial year
ended August 31, 2005 vest at a rate of 1/3 annually commencing on the third
7
anniversary date of the grant in February 2005 and others at a rate of 55%,
35% and 10%, on the third, fourth and fifth anniversary dates of the grant in
January 2005. Some RSUs granted in the financial year ended August 31, 2005
vest on the fifth anniversary date of the grant in January 2005 but are
subject to early vesting on the third and fourth anniversary dates of the
grant on the attainment of performance objectives as determined by the Board
of Directors of the Corporation. Accordingly, subject to the attainment of
performance objectives, the first early vesting is up to 1/3 of the units on
the third anniversary date of the grant and the second early vesting is up to
50% of the remaining units on the fourth anniversary date of the grant.
RSUs attract dividends in the form of additional RSUs at the same rate as
dividends on Subordinate Voting Shares. The RSUs are redeemed for actual
Subordinate Voting Shares or the equivalent in cash at the discretion of the
Board of Directors of the Corporation on the vesting dates established by the
Board of Directors of the Corporation at the time of grant in its sole
discretion.
Therefore, the value at vesting of a RSU, when converted to Subordinate Voting
Shares, is equivalent to the market value of a Subordinate Voting Share at the
time the conversion takes place. The table below shows information regarding
RSU grants made under the Long-Term Incentive Plan during the financial year
ended August 31, 2005. See "Report on Executive Compensation by the Human
Resources Committee - Long-Term Incentive Compensation - Long-Term Incentive
Plan" for a description of the Long-Term Incentive Plan.
During the financial year ended August 31, 2005, the following RSUs were
granted:
------------------------------------------------------------------------------------------------------------
FAIR VALUE AT THE
TIME OF GRANT
RSUS # US$/RSU VESTING (1)
------------------------------------------------------------------------------------------------------------
129,000 4.69 55%, 35% and 10%, on the third, fourth and fifth anniversary dates of the
grant in January 2005 (2)
------------------------------------------------------------------------------------------------------------
35,185 4.69 100% on the fifth anniversary date of the grant in January 2005 subject
to early vesting up to 1/3 on the third anniversary date of the grant and
up to 50% of the remaining units on the fourth anniversary date of the
grant if the performance objectives are fully attained (3)
------------------------------------------------------------------------------------------------------------
12,000 4.51 1/3 on each of the third, fourth and fifth anniversary dates of the grant
in February 2005 (4)
------------------------------------------------------------------------------------------------------------
---------------
(1) All RSUs first vesting can not be earlier than the third anniversary
date of their grant.
(2) Those RSUs granted in the financial year ended August 31, 2005 vest at a
rate of 55% , 35% and 10% on the third, fourth and fifth anniversary
dates of the grant in January 2005.
(3) Those RSUs granted in the financial year ended August 31, 2005 vest on
the fifth anniversary date of the grant in January 2005 but are subject
to early vesting on the third and fourth anniversary dates of the grant
on the attainment of performance objectives as determined by the Board
of Directors of the Corporation. Accordingly, subject to the attainment
of performance objectives, the first early vesting is up to 1/3 of the
units on the third anniversary date of the grant and the second early
vesting is up to 50% of the remaining units on the fourth anniversary
date of the grant.
(4) Those RSUs granted in the financial year ended August 31, 2005 vest at a
rate of 1/3 annually commencing on the third anniversary date of the
grant in February 2005.
During the financial year ended August 31, 2005, the following RSUs were
granted to the following Named Executive Officers:
-----------------------------------------------------------------------------------------------------------------
FAIR VALUE AT
THE TIME OF
NAME RSUS # GRANT US$/RSU VESTING (1)
-----------------------------------------------------------------------------------------------------------------
Germain Lamonde 13,089 4.69 100% on the fifth anniversary date of the grant in January 2005
subject to early vesting up to 1/3 on the third anniversary date
of the grant and up to 50% of the remaining units on the fourth
anniversary date of the grant if the performance objectives are
fully attained (2)
-----------------------------------------------------------------------------------------------------------------
Pierre Plamondon 3,927 4.69 100% on the fifth anniversary date of the grant in January 2005
subject to early vesting up to 1/3 on the third anniversary date
of the grant and up to 50% of the remaining units on the fourth
anniversary date of the grant if the performance objectives are
fully attained (2)
------------------------------------------------------------------------------------------
55%, 35% and 10%, on the third, fourth and fifth anniversary
30,000 4.69 dates of the grant in January 2005 (3)
-----------------------------------------------------------------------------------------------------------------
8
--------------------------------------------------------------------------------------------------------------------
FAIR VALUE AT
THE TIME OF
NAME RSUS # GRANT US$/RSU VESTING (1)
-----------------------------------------------------------------------------------------------------------------
Juan-Felipe Gonzalez 3,998 4.69 100% on the fifth anniversary date of the grant in January 2005
subject to early vesting up to 1/3 on the third anniversary date
of the grant and up to 50% of the remaining units on the fourth
anniversary date of the grant if the performance objectives are
fully attained (2)
------------------------------------------------------------------------------------------
55%, 35% and 10%, on the third, fourth and fifth anniversary
30,000 4.69 dates of the grant in January 2005 (3)
-----------------------------------------------------------------------------------------------------------------
Stephen Bull 2,618 4.69 100% on the fifth anniversary date of the grant in January 2005
subject to early vesting up to 1/3 on the third anniversary date
of the grant and up to 50% of the remaining units on the fourth
anniversary date of the grant if the performance objectives are
fully attained (2)
------------------------------------------------------------------------------------------
55%, 35% and 10%, on the third, fourth and fifth anniversary
30,000 4.69 dates of the grant in January 2005 (3)
-----------------------------------------------------------------------------------------------------------------
Etienne Gagnon 2,304 4.69 100% on the fifth anniversary date of the grant in January 2005
subject to early vesting up to 1/3 on the third anniversary
date of the grant and up to 50% of the remaining units on the
fourth anniversary date of the grant if the performance
objectives are fully attained (2)
------------------------------------------------------------------------------------------
55%, 35% and 10%, on the third, fourth and fifth anniversary
7,500 dates of the grant in January 2005 (3)
-----------------------------------------------------------------------------------------------------------------
---------------
(1) All RSUs first vesting can not be earlier than the third anniversary
date of their grant.
(2) Those RSUs granted in the financial year ended August 31, 2005 vest on
the fifth anniversary date of the grant in January 2005 but are subject
to early vesting on the third and fourth anniversary date of the grant
on the attainment of performance objectives as determined by the Board
of Directors of the Corporation. Accordingly, subject to the attainment
of performance objectives, the first early vesting is up to 1/3 of the
units on the third anniversary date of the grant and the second early
vesting is up to 50% of the remaining units on the fourth anniversary
date of the grant.
(3) Those RSUs granted in the financial year ended August 31, 2005 vest at a
rate of 55% , 35% and 10% on the third, fourth and fifth anniversary
dates of the grant in January 2005.
AGGREGATED RSUS VESTED IN LAST FINANCIAL YEAR AND FINANCIAL YEAR-END RSU VALUES
The following table summarizes, for each of the Named Executive Officers, the
number of RSUs, if any, vested during the financial year ended August 31,
2005, the aggregate value realized upon vesting and the total number of
unvested RSUs, if any, held at August 31, 2005. Value realized upon vesting is
the market value of the Subordinate Voting Shares on the vesting date. The
value of unvested RSUs at financial year-end is the market value of the
Subordinate Voting Shares on August 31, 2005, which was US$4.67 per share.
These values, unlike the amounts set forth in the column "Aggregate Value
Realized", have not been and may never be realized. The actual gains on
vesting will depend on the value of the Subordinate Voting Shares on the date
of vesting. There can be no assurance that these values will be realized. See
"Report on Executive Compensation by the Human Resources Committee - Long-Term
Incentive Compensation - Long-Term Incentive Plan."
--------------------------------------------------------------------------------------------------------------------
SECURITIES UNVESTED RSUS VALUE OF UNVESTED RSUS
ACQUIRED ON AGGREGATE VALUE AT AUGUST 31, 2005 AT AUGUST 31, 2005 (US$)
NAME VESTING (#) REALIZED (US$) (1) (#) (2) (3)
--------------------------------------------------------------------------------------------------------------------
Germain Lamonde - - 13,089 61,126
--------------------------------------------------------------------------------------------------------------------
Pierre Plamondon - - 33,927 158,439
--------------------------------------------------------------------------------------------------------------------
Juan-Felipe Gonzalez - - 33,998 158,771
--------------------------------------------------------------------------------------------------------------------
Stephen Bull - - 32,618 152,326
--------------------------------------------------------------------------------------------------------------------
Etienne Gagnon - - 9,804 45,785
--------------------------------------------------------------------------------------------------------------------
---------------
(1) The aggregate value realized is equivalent to the market value of the
securities underlying the RSUs at vesting. This value, as the case
maybe, has been converted from Canadian dollars to U.S. dollars based
upon the average foreign exchange rate on the day of vesting.
(2) The value of RSUs is calculated using the highest of the closing prices
of the Subordinate Voting Shares on the Toronto Stock Exchange and on
the NASDAQ National Market on August 31, 2005 using the noon buying rate
of the Federal Reserve Bank of New York to convert the NASDAQ National
Market closing price to Canadian dollars, as required.
(3) The actual gains on vesting will depend on the value of the Subordinate
Voting Shares on the date of vesting. There can be no assurance that
these values will be realized.
9
OPTION GRANTS IN LAST FINANCIAL YEAR
The aggregate number of Subordinate Voting Shares covered by options granted
during the financial year ended August 31, 2005 was 246,233 at a weighted
average exercise price of US$4.59 (CDN$5.68) per Subordinate Voting Share. At
the end of the financial year ended August 31, 2005, there were a total of
2,763,759 Subordinate Voting Shares covered by options granted and outstanding
pursuant to the Long-Term Incentive Plan having a weighted average exercise
price of US$12.87 (CDN$19.22). The table below shows information regarding
stock option grants made to the Named Executive Officers under the Long-Term
Incentive Plan during the financial year ended August 31, 2005. See "Report on
Executive Compensation by the Human Resources Committee - Long-Term Incentive
Compensation" for a description of the Long-Term Incentive Plan.
During the financial year ended August 31, 2005, the following options were
granted to the following Named Executive Officers:
--------------------------------------------------------------------------------------------------------------------
PERCENTAGE OF NET MARKET VALUE OF
SECURITIES TOTAL OF OPTIONS SECURITIES UNDERLYING
UNDER OPTIONS GRANTED TO EMPLOYEES EXERCISE OR OPTIONS ON THE DATE
GRANTED(1) IN FINANCIAL YEAR BASE PRICE (2) OF GRANT
NAME (#) (%) (US$/ SECURITY) (US$/SECURITY) (3) EXPIRATION DATE
--------------------------------------------------------------------------------------------------------------------
Germain Lamonde 17,942 7.29 4.51 (4) 4.57 (5) February 1, 2015
--------------------------------------------------------------------------------------------------------------------
Pierre Plamondon 5,383 2.19 5.13 (6) 5.15 (7) October 26, 2014
--------------------------------------------------------------------------------------------------------------------
Juan-Felipe Gonzalez 5,482 2.23 5.13 (6) 5.15 (7) October 26, 2014
--------------------------------------------------------------------------------------------------------------------
Stephen Bull 3,589 1.46 5.13 (6) 5.15 (7) October 26, 2014
--------------------------------------------------------------------------------------------------------------------
Etienne Gagnon 3,158 1.28 5.13 (6) 5.15 (7) October 26, 2014
--------------------------------------------------------------------------------------------------------------------
---------------
(1) Underlying securities: Subordinate Voting Shares.
(2) The exercise price of options granted is determined based on the highest
of the closing prices of the Subordinate Voting Shares on the Toronto
Stock Exchange and the NASDAQ National Market on the last trading day
preceding the grant date, using the noon buying rate of the Federal
Reserve Bank of New York on the grant date to convert the NASDAQ
National Market closing price to Canadian dollars, as required. These
options vest at a rate of 12.5% 6 months after the grant date, 12.5% 12
months after the grant date, and 25% annually thereafter commencing on
the second anniversary date of the grant except for Mr. Germain Lamonde,
whose options vest at a rate of 25% annually commencing on the first
anniversary date of the grant.
(3) Based on the closing price on the NASDAQ National Market on the date of
the grant.
(4) Being CDN$5.60.
(5) Being CDN$5.63.
(6) Being CDN$6.28.
(7) Being CDN$6.29.
AGGREGATED OPTION EXERCISES IN LAST FINANCIAL YEAR AND FINANCIAL YEAR END
OPTION VALUES
The following table summarizes, for each of the Named Executive Officers, the
number of stock options, if any, exercised during the financial year ended
August 31, 2005, the aggregate value realized upon exercise and the total
number of unexercised options, if any, held at August 31, 2005. Value realized
upon exercise is the difference between the market value of the underlying
Subordinate Voting Shares on the exercise date and the exercise or base price
of the option. The value of unexercised in-the-money options at financial
year-end is the difference between its exercise or base price and the market
value of the underlying Subordinate Voting Shares on August 31, 2005, which
was US$4.67 (CDN$5.55) per share. These values, unlike the amounts set forth
in the column "Aggregate Value Realized," have not been, and may never be,
realized. The underlying options have not been, and may never be exercised,
and actual gains, if any, on exercise will depend on the value of the
Subordinate Voting Shares on the date of exercise. There can be no assurance
that these values will be realized. Unexercisable options are those that have
been held for less than the time required for vesting. See "Report on
Executive Compensation by the Human Resources Committee - Long-Term Incentive
Compensation."
10
--------------------------------------------------------------------------------------------------------------------
AGGREGATE
SECURITIES VALUE VALUE OF UNEXERCISED
ACQUIRED ON REALIZED UNEXERCISED OPTIONS "IN-THE-MONEY" OPTIONS AT
NAME EXERCISE (#) (US$) (1) (4) AT AUGUST 31, 2005 AUGUST 31, 2005 (2) (3) (4)
--------------------------------------------------------------------------------------------------------------------
EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
(#) (#) (US$) (US$)
--------------------------------------------------------------------------------------------------------------------
Germain Lamonde - - 107,982 60,442 64,135 64,135
--------------------------------------------------------------------------------------------------------------------
Pierre Plamondon - - 60,363 21,960 32,067 32,067
--------------------------------------------------------------------------------------------------------------------
Juan-Felipe Gonzalez 7,500 21,007 75,715 27,297 - 38,481
--------------------------------------------------------------------------------------------------------------------
Stephen Bull - - 28,029 14,390 19,240 19,240
--------------------------------------------------------------------------------------------------------------------
Etienne Gagnon - - 5,395 12,763 2,397 4,794
--------------------------------------------------------------------------------------------------------------------
---------------
(1) The aggregate value realized is equivalent to the difference between the
market value of the securities underlying the options at exercise and
the exercise price of the options. This value, as the case maybe, has
been converted from Canadian dollars to U.S. Dollars based upon the
average foreign exchange rate on the day of the exercise.
(2) "In-the-money" options are options for which the market value of the
underlying securities is higher than the price at which such securities
may be bought from the Corporation.
(3) The value of unexercisable "in-the-money" options is calculated using
the highest of the closing prices of the Subordinate Voting Shares on
the Toronto Stock Exchange and on the NASDAQ National Market on August
31, 2005 using the noon buying rate of the Federal Reserve Bank of New
York to convert the NASDAQ National Market closing price to Canadian
dollars, as required, less the exercise price of "in-the-money" options.
(4) This value has been converted from Canadian to US dollars based upon the
foreign exchange rate on August 31, 2005 of 1.1889.
NUMBER OF SUBORDINATE VOTING SHARES RESERVED FOR FUTURE ISSUANCE
During the financial year ended August 31, 2005, 23,734 Deferred Share Units,
176,185 Restricted Share Units and 246,233 options were granted to directors,
officers and employees. Such awards were issued from the same pool of
Subordinate Voting Shares reserved for issuance pursuant to the Long-Term
Incentive Plan which is 9.2% of the total and outstanding voting shares.
Therefore, as of November 1, 2005 the number of Subordinate Voting Shares
reserved for future issuance is 3,182,504.
TERMINATION OF EMPLOYMENT, CHANGE IN RESPONSIBILITIES AND EMPLOYMENT CONTRACTS
The Corporation has an employment agreement with Mr. Germain Lamonde. The
agreement is for an indeterminate period and the compensation is reviewed
annually. In the event of the termination of Mr. Lamonde's employment without
cause, Mr. Lamonde will be entitled to severance payments (in no case
exceeding 24 months of remuneration) and the vesting of all stock options and
RSUs. In addition, in the event that Mr. Lamonde's employment is terminated
following a merger or an acquisition by a third party of substantially all of
the Corporation's assets or of the majority of its share capital or if Mr.
Lamonde voluntarily resigns, he will be entitled to the vesting of all stock
options and RSUs.
The Corporation also has employment agreements with Mr. Pierre Plamondon, Mr.
Juan-Felipe Gonzalez, Mr. Stephen Bull and Mr. Etienne Gagnon.
The Corporation has an employment agreement with Mr. Pierre Plamondon, the
Corporation's Vice-President, Finance and Chief Financial Officer. The
agreement is for an indeterminate period and the compensation is reviewed
annually. In the event of termination of Mr. Plamondon's employment without
cause, Mr. Plamondon will be entitled to severance payments (in no case
exceeding 18 months of the current base salary). In addition, in the event Mr.
Plamondon's employment is terminated following a merger or an acquisition by a
third party of substantially all of the Corporation's assets or of the
majority of its share capital, he will be entitled to the immediate vesting of
all stock options and RSUs.
The agreement with Mr. Gonzalez provided for Mr. Gonzalez's employment as
Vice-President Global Telecom Sales. In the event Mr. Gonzalez's employment
terminates for any reason whatsoever and he is unable to accept new employment
due to his non-competition obligations to the Corporation, Mr. Gonzalez may
receive compensation for a period of 18 months following the date of
termination in amounts varying from 5% to 50% of his base monthly salary at
11
the time of termination depending on the cause of the termination. The
employment agreement is for an indeterminate period and compensation is
reviewed annually.
The Corporation has an employment agreement with Mr. Stephen Bull, the
Corporation's Vice-President, Research and Development. The agreement is for
an indeterminate period and the compensation is reviewed annually. In the
event of termination of Mr. Bull's employment without cause, Mr. Bull will be
entitled to severance payments (in no case exceeding 18 months of the current
base salary). In addition, in the event Mr. Bull's employment is terminated
following a merger or an acquisition by a third party of substantially all of
the Corporation's assets or of the majority of its share capital, he will be
entitled to the immediate vesting of all stock options and RSUs.
The Corporation has an employment agreement with Mr. Etienne Gagnon, the
Corporation's Vice-President, Optical-Layer Product Management and Customer
Service. The agreement is for an indeterminate period and the compensation is
reviewed annually. In the event of termination of Mr. Gagnon's employment
without cause, Mr. Gagnon's will be entitled to severance payments (in no case
exceeding 18 months of the current base salary). In addition, in the event Mr.
Gagnon's employment is terminated following a merger or an acquisition by a
third party of substantially all of the Corporation's assets or of the
majority of its share capital, he will be entitled to the immediate vesting of
all stock options and RSUs.
REPORT ON EXECUTIVE COMPENSATION BY THE HUMAN RESOURCES COMMITTEE
MEMBERS OF THE HUMAN RESOURCES COMMITTEE
During the financial year ended August 31, 2005, the Human Resources Committee
was composed of Michael Unger, as Chairman, Pierre Marcouiller, Guy Marier,
David A. Thompson and Andre Tremblay, none of whom were officers or employees,
or former officers or employees of the Corporation or its subsidiaries.
HUMAN RESOURCES COMMITTEE MANDATE
The Human Resources Committee is a committee of the Board of Directors. It is
responsible for overseeing the assessment and the performance, and
establishing the annual compensation of all the Corporation's executive
officers, including the President and Chief Executive Officer. This Committee
also reviews and submits to the Board the salary structure and the short-term
and long-term incentive compensation programs for all employees of the
Corporation. Though the Committee is responsible for the review and approval
of the employees that will receive Restricted Share Units or options to
purchase shares of the Corporation, in accordance with policies established by
the Board and the terms of the Long-Term Incentive Plan, these functions have
been shared by the Board of Directors and the Human Resources Committee during
the period from September 1, 2004 to August 31, 2005. The remuneration to be
paid by the Corporation to its Directors and the number of Deferred Share
Units credited pursuant to the Deferred Share Unit Plan to the non-employee
directors is recommended to the Board by the Human Resources Committee.
Since September 1, 2004, the Human Resources Committee held 4 meetings prior
to November 1, 2005, which were attended by all the members of the Committee,
except Mr. Thompson who was absent at one meeting and Mr. Tremblay who was
also absent at one meeting.
COMPENSATION OF CHIEF EXECUTIVE OFFICER
In establishing Mr. Lamonde's compensation for the year ending August 31,
2005, the Corporation relied on a study completed by an independent consulting
firm. Such study indicated average salaries and bonuses, median salaries and
bonuses and maximum salaries and bonuses paid to chief executive officers by
Canadian and American computer hardware and software companies as well as by a
specific group of companies active in the fiber optics industry identified by
the Corporation that it considers to be the best available comparisons. It was
decided that Mr. Lamonde's compensation should reflect the median of Canadian
computer hardware and software companies and of the specific group of
companies in fiber optics identified by the Corporation. In the financial year
ended August 31, 2005, Mr. Lamonde's compensation was adjusted accordingly.
12
In the financial year ended August 31, 2005, the bonus portion of Mr.
Lamonde's compensation was tied to the financial and strategic objectives of
the Corporation based on the following factors: sales, earnings, gross margin,
customer satisfaction (quality and on-time delivery), departmental or
divisional objectives and personal objectives. Mr. Lamonde's bonus is payable
in the same proportion at which the Corporation attains such objectives. When
the objectives are exceeded, the bonus is higher; when objectives are not met,
the bonus is lower.
SHORT-TERM INCENTIVE COMPENSATION
The short-term incentive plan offers bonuses tied to the Corporation's
financial performance and the achievement of strategic corporate and business
unit objectives established on a yearly basis.
In the case of the Named Executive Officers eligible for incentive bonuses in
the year ended August 31, 2005, such bonuses constituted a certain percentage
of base salary which is tied to the achievement of the financial and strategic
objectives of the Corporation based on the following factors: sales, earnings,
gross margin, customer satisfaction (quality and on-time delivery),
departmental or divisional objectives and personal objectives. When such
objectives are exceeded, bonuses are higher; when objectives are not met, the
incentive bonuses are lower.
LONG-TERM INCENTIVE COMPENSATION
LONG-TERM INCENTIVE PLAN
The principal component of the long-term incentive compensation offered by the
Corporation is made up of the Long-Term Incentive Plan for directors,
officers, employees and consultants of the Corporation and its subsidiaries.
Introduced in May 2000, amended in October 2004 and effective in January 2005,
the Long-Term Incentive Plan is designed to motivate directors, officers,
employees and consultants to share interest with the Corporation's
shareholders over the long-term. It is subject to Human Resources Committee
review to ensure maintenance of its market competitiveness. The Board has full
and complete authority to interpret the Plan and to establish the rules and
regulations applying to it and to make all other determinations it deems
necessary or useful for the administration of the Plan, provided that such
interpretations, rules, regulations and determinations are consistent with the
rules of all stock exchanges on which the securities of the Corporation are
then traded and with all relevant securities legislation.
The Long-Term Incentive Plan provides for the issuance of options to purchase
Subordinate Voting Shares and the issuance of Restricted Share Units ("RSUs")
redeemable for actual Subordinate Voting Shares or the equivalent in cash to
directors, officers, employees and consultants. The Board of Directors upon
recommendation of the Human Resources Committee designates the recipients of
options or RSUs and determines the number of Subordinate Voting Shares covered
by each option or RSU, the dates of vesting, the expiry date and any other
conditions relating to these options or RSUs, in each case in accordance with
the applicable legislation of the securities regulatory authorities. During
the financial year ended August 31, 2005, options and RSUs were granted based
on merit.
The exercise price of the options is determined by the Board of Directors at
the time of granting the options, subject to compliance with the rules of all
stock exchanges on which the Subordinate Voting Shares are listed and with all
relevant securities legislation. In any event, the price at which the
Subordinate Voting Shares may be purchased may not be lower than the highest
of the closing prices of the Subordinate Voting Shares on the Toronto Stock
Exchange and the NASDAQ National Market on the last trading day preceding the
grant date, using the noon buying rate of the Federal Reserve Bank of New York
on the grant date to convert the NASDAQ National Market closing price to
Canadian dollars. Any option issued is non-transferable.
The fair value at the time of grant of a RSU is equal to the market value of
Subordinate Voting Shares at the time RSUs are granted. At the end of
financial year ended August 31, 2005, there were a total of 176,185 RSUs
granted pursuant to the Long-Term Incentive Plan having a weighted average
fair value at the time of grant of US$4.68 (CDN$5.72) per RSU.
13
The maximum number of Subordinate Voting Shares that are issuable under the
Plan shall not exceed 6,306,153 Subordinate Voting Shares, which represents
9.2% of the Corporation's issued and outstanding voting shares as of November
1, 2005. The maximum number of Subordinate Voting Shares that may be granted
to any one individual shall not exceed 5% of the number of outstanding
Subordinate Voting Shares.
Some options granted to Directors vest on the first anniversary date of their
grant. Some options granted in the financial year ended August 31, 2004 and
2005 vest at a rate of 12.5% six (6) months after the date of grant, 12.5%
twelve (12) months after the date of grant and 25% annually thereafter
commencing on the second anniversary date of the grant in October 2005.
Otherwise all options vest a rate of 25% annually commencing on the first
anniversary date of the grant. All options may be exercised in whole or in
part once vested. All of the options that are granted under the Plan must be
exercised within a maximum period of ten (10) years following the date of
their grant or they will be forfeited.
All RSUs first vesting can not be earlier than the third anniversary date of
their grant. Some RSUs granted in the financial year ended August 31, 2005
vest at a rate of 1/3 annually commencing on the third anniversary date of the
grant in February 2005 and others at a rate of 55%, 35% and 10%, on the third,
fourth and fifth anniversary dates of the grant in January 2005. Some RSUs
granted in the financial year ended August 31, 2005 vest on the fifth
anniversary date of the grant in January 2005 but are subject to early vesting
on the third and fourth anniversary dates of the grant on the attainment of
performance objectives as determined by the Board of Directors of the
Corporation. Accordingly, subject to the attainment of performance objectives,
the first early vesting is up to 1/3 of the units on the third anniversary
date of the grant and the second early vesting is up to 50% of the remaining
units on the fourth anniversary date of the grant. If such vesting date falls
into any black-out period or any other restrictive period during which the RSU
holder is not entitled to trade the Corporation's Subordinate Voting Shares,
then the units shall vest on the first trading day the RSU holder is entitled
to trade after such black-out period or restrictive period.
Any option granted pursuant to the Long-Term Incentive Plan will lapse (i)
immediately upon the termination of the relationship with the Corporation or
one of its subsidiaries for a good and sufficient cause for employees or
officers or at the date on which an employee or an officer resigns or leaves
his employment with the Corporation or one of its subsidiaries (or within 30
days if the holder's employment is terminated for reasons not related to
cause); and (ii) 30 days after a Director ceases to be a member of the Board
of Directors of the Corporation or one of its subsidiaries. In the event of
retirement or disability, any option held by an employee lapses 30 days after
the date of any such disability or retirement. In the event of death, any
option held by the optionee lapses 6 months after the date of death.
Any RSU granted pursuant to the Long-Term Incentive Plan will lapse (i)
immediately, where vesting of a unit is subject to the attainment of
performance objectives, if such performance objectives have not been attained
(or postponed at a further vesting date as determined by the Board of
Directors.); (ii) immediately, whether or not subject to attainment of
performance objectives, upon the termination of the relationship with the
Corporation or one of its subsidiaries for a good and sufficient cause for
employees or officers or at the date on which an employee or an officer
resigns or leaves his employment with the Corporation or one of its
subsidiaries.
Any RSU granted pursuant to the Long-Term Incentive Plan will vest
immediately, to a certain proportion as determined by the Plan, upon the
termination of the relationship of an employee or officer with the Corporation
or one of its subsidiaries (i) for reasons not related to cause; (ii) because
of death or permanent disability and (iii) retirement.
The following table summarizes information about stock options granted to the
members of the Board of Directors, and to Management and Corporate Officers of
the Corporation and its subsidiaries as at August 31, 2005:
------------------------------------------------------------------------------------------------------------
NUMBER OF % OF ISSUED AND WEIGHTED AVERAGE EXERCISE
OPTIONS OUTSTANDING OPTIONS PRICE ($US/SECURITY)
------------------------------------------------------------------------------------------------------------
President and CEO (one individual) 168,424 6.09% 9.34
------------------------------------------------------------------------------------------------------------
Board of Directors (five individuals) 194,375 7.03% 6.23
------------------------------------------------------------------------------------------------------------
Management and Corporate Officers (nine
individuals 340,091 12.31% 14.39
------------------------------------------------------------------------------------------------------------
14
The following table summarizes information about RSUs granted to the members
of the Board of Directors and to Management and Corporate Officers of the
Corporation and its subsidiaries as at August 31, 2005:
--------------------------------------------------------------------------------------------------------------
NUMBER OF % OF ISSUED AND WEIGHTED AVERAGE FAIR VALUE
RSUS OUTSTANDING RSUS AT THE TIME OF GRANT $US/RSU
--------------------------------------------------------------------------------------------------------------
President and CEO (one individual) 13,089 7.43% 4.69
--------------------------------------------------------------------------------------------------------------
Board of Directors (five individuals) - - -
--------------------------------------------------------------------------------------------------------------
Management and Corporate Officers (nine 151,096 85.76% 4.69
individuals)
--------------------------------------------------------------------------------------------------------------
DEFERRED SHARE UNIT PLAN
Introduced in October 2004 and effective as of January 2005, the Deferred
Share Unit Plan is designed to align more closely the interests of its
non-employee directors with those of the Corporation's shareholders.
Under the Deferred Share Unit Plan, non-employee directors shall receive up to
100 % of their retainer fees in the form of Deferred Share Units ("DSUs"),
each of which has a fair value at the time of grant equal to the market value
of a Subordinate Voting Share at the time DSUs are credited to the directors.
The value of a DSU, when converted to Subordinate Voting Shares, is equivalent
to the market value of a Subordinate Voting Share at the time the conversion
takes place. DUSs attract dividends in the form of additional DSUs at the same
rate as dividends on Subordinate Voting Share. When a director ceases to be a
member of the Board, the DSUs are either converted and paid in Subordinate
Voting Shares purchased on the open market or issued by the Corporation. Such
Subordinate Voting Shares issued by the Corporation will be issued from the
same pool of Subordinate Voting Shares reserved for issuance pursuant to the
Long-Term Incentive Plan, which is 9.2% of the total issued and outstanding
voting shares.
The following table summarizes information about DSUs granted to the
non-employee members of the Board of Directors as at August 31, 2005:
--------------------------------------------------------------------------------------------------------------------
NUMBER OF % OF ISSUED AND WEIGHTED AVERAGE FAIR VALUE
--------------------------------------------------------------------------------------------------------------------
Board of Directors (five individuals) 23,734 100% 4.47
--------------------------------------------------------------------------------------------------------------------
RESTRICTED STOCK AWARD PLAN
The EXFO Electrical-Optical Engineering Restricted Stock Award Plan (the
"RSAP") was established to provide a means through which employees of EXFO
Burleigh Products Group Inc. can be granted awards of restricted shares
("Restricted Shares") of Subordinate Voting Shares to promote retention and
foster identity of interest between stockholders and employees of EXFO
Burleigh Products Group Inc.
The effective date of the RSAP was December 20, 2000. The expiration date of
the RSAP is the business day next following the final grant of Restricted
Shares under the RSAP, which was December 20, 2000. However, the
administration of the RSAP did continue until all awards of Restricted Shares
have been forfeited or settled. The aggregate number of shares subject to the
RSAP was 360,000. Stock awards granted under the RSAP vest over a 4 year
period, with 25% vesting on an annual basis commencing on the first
anniversary of the date of grant. The last vesting occurred on December 20,
2004, the Human Resources Committee administered the RSAP until that date.
Therefore the administration of the RSAP terminated on December 20, 2004.
Awards of Restricted Shares were subject to forfeiture and restrictions on
transfer until the Restricted Shares became vested at which point a stock
certificate was issued to a participant with respect to the number of vested
shares, which are then freely transferable. Restricted Shares become vested,
subject to a participant's continued employment with the Corporation or its
affiliates, on each of the first four anniversaries of the date of grant of an
award of Restricted Shares.
15
Upon a participant's termination of employment with the Corporation or any of
its affiliates due to the participant's death, disability or retirement on or
after age 60, the participant's award of restricted shares became fully vested
and was no longer subject to forfeiture. However, the transfer restrictions
remained in place until the occurrence of the vesting dates originally
contemplated by the award.
Upon the voluntary resignation of a participant, the termination of a
participant's employment for cause, the termination of a participant who is
not designated a member of EXFO Burleigh Products Group Inc. "Management Team"
without cause prior to a change in control of the Corporation or a termination
without cause of a participant who is designated a member of EXFO Burleigh
Products Group Inc. Management Team that is initiated by EXFO Burleigh
Products Group Inc. prior to a change in control of the Corporation, the
unvested portion of the participant's award of Restricted Shares were
forfeited. However the RSAP provided discretion to the Human Resources
Committee in the application of the forfeiture provisions where a change in
circumstances rendered such action appropriate. During the financial year
ended August 31, 2005, EXFO Burleigh Products Group Inc. was required to lay
off the remaining of the participants (excluding a few that were transferred
to our other offices) as a result of a consolidation due to a sharp downturn
in its market. The Human Resources Committee decided that the awards of RSAP
participants affected by the lay-offs would not be subject to forfeiture,
though the transfer restrictions remained in place until the occurrence of the
vesting dates originally contemplated by the award.
Upon the termination without cause of a participant who was designated a
member of EXFO Burleigh Products Group Inc. Management Team that was initiated
by the Corporation or a termination of a participant's employment without
cause following a change in control of the Corporation, a participant's award
of Restricted Stock became fully vested and all restrictions lapsed.
In the event of a change in control, the committee administering the RSAP
could in its discretion remove restrictions on Restricted Shares or provide
for the cancellation of awards in exchange for payment in respect of the
Restricted Shares subject to an award.
STOCK APPRECIATION RIGHTS PLAN
On August 4, 2001, the Corporation established a Stock Appreciation Rights
Plan ("SAR Plan") for the benefit of certain employees residing in countries
where the granting of options under the Stock Option Plan is not feasible in
the opinion of the Corporation. The Board has full and complete authority to
interpret the SAR Plan and to establish the rules and regulations applying to
it and to make all other determinations it deems necessary or useful for the
administration of the SAR Plan.
Under the SAR Plan, eligible employees are entitled to receive a cash amount
equivalent to the difference between the market price of the Subordinate
Voting Shares on the date of exercise and the exercise price determined on the
date of grant. No Subordinate Voting Shares are issuable under the SAR Plan.
The Board of Directors has delegated to Management the task of designating the
recipients of stock appreciation rights, the date of vesting, the expiry date
and other conditions. Under the terms of the SAR Plan, the exercise price of
the stock appreciation rights may not be lower than the highest of the closing
prices of the Subordinate Voting Shares on the Toronto Stock Exchange and on
the NASDAQ National Market on the last trading day preceding the grant date,
using the noon buying rate of the Federal Reserve Bank of New York on the
grant date to convert the NASDAQ National Market closing price to Canadian
dollars. Stock appreciation rights are non-transferable.
The stock appreciation rights vest over a four-year period, with 25% vesting
annually commencing on the first anniversary date of the date of grant. Once
vested, stock appreciation rights may be exercised between the second and the
fifteenth business day following each release of the Corporation's quarterly
financial results. All of the stock appreciation rights that are granted under
the SAR Plan may be exercised within a maximum period of 10 years following
the date of their grant. Any stock appreciation rights granted under the SAR
Plan will lapse immediately upon the termination of the relationship with the
Corporation or one of its subsidiaries for a good and sufficient cause or at
the date on which an employee resigns or leaves his employment with the
Corporation or one of its subsidiaries (or within 30 days if the holder is
dismissed without cause). In the event of retirement or disability, any stock
appreciation right held by an employee lapses 30 days after the date of any
such disability or retirement. In the event of death, any stock appreciation
right lapses 6 months after the date of death.
16
COMPENSATION PLAN CONTROL AND REVIEW
As a general practice, the Corporation's relative position in terms of
compensation levels is determined annually through studies performed by
independent consulting firms using a selected reference market of comparable
companies. In addition, internal pay equity studies are a key factor to
complete the compensation review process and indicate where necessary
adjustments may be required. During the fiscal year ended August 31, 2005,
this practice continued and certain compensation adjustments that became
necessary were made.
CONCLUSION
By way of application of the Corporation's executive compensation policy, an
important part of executive compensation is linked to corporate performance
and long-term value creation. The Human Resources Committee continuously
reviews executive compensation programs to ensure that they maintain their
competitiveness and continue to focus on the Corporation's objectives, values
and business strategies.
Depending on specific circumstances, the Committee may also recommend
employment terms and conditions that deviate from the policies and the
execution by the Corporation or its subsidiaries of employment contracts on a
case-by-case basis.
By the Human Resources Committee:
Michael Unger, Chairman
Pierre Marcouiller
Guy Marier
David A. Thompson
Andre Tremblay
17
PERFORMANCE GRAPH
The performance graph presented below compares the cumulative total
shareholder return of a $100 investment in the Subordinate Voting Shares and
the cumulative total return of the S&P/TSX Stock Index for the period
commencing June 30, 2000, the date EXFO's Subordinate Voting Shares commenced
trading, and ending August 31, 2005.
THE CORPORATION'S STOCK PERFORMANCE
(JUNE 30, 2000 TO AUGUST 31, 2005)
[LINE CHART OMITTED]
DIRECTORS AND OFFICERS' LIABILITY INSURANCE
The Corporation maintains insurance protection against liability incurred by
its officers and directors as well as those of its subsidiaries in the
performance of their duties. The entire premium, amounting to US$245,000 from
September 30, 2005 to September 30, 2006, is paid by the Corporation. The
aggregate limit of liability in respect of any and all claims is US$10 million
per year. The policy provides for the indemnification of directors and
officers in the case of claims for which the Corporation has not indemnified
or is not permitted by law to indemnify them, and for the reimbursement of the
Corporation, subject to a deductible of US$100,000, except for securities
claims where the deductible is US$500,000.
18
REPORT ON CORPORATE GOVERNANCE PRACTICES
National Policy 58-201 Corporate Governance Guidelines establishes corporate
governance guidelines which apply to all publicly listed companies. National
Instrument 58-101 Disclosure of Corporate Governance Practices mandates
disclosure of corporate governance practices, which disclosure is set out in
Schedule A attached to this Management Proxy Circular.
ADDITIONAL INFORMATION
Additional information relating to the Corporation is on SEDAR at
www.sedar.com. The Corporation shall provide to any person or company, upon
request to the Secretary of the Corporation, at 400 Godin Avenue, Vanier,
Quebec, Canada, G1M 2K2, phone number (418) 683-0913 ext. 3704 or fax number
(418) 683-9839:
(a) one copy of the Annual Report on Form 20-F of the Corporation filed with
the Securities and Exchange Commission (the "SEC") in the United States
pursuant to the SECURITIES EXCHANGE ACT OF 1934, and with securities
commissions or similar authorities;
(b) one copy of the comparative consolidated financial statements of the
Corporation for its most recently completed financial year and the
Auditors report thereon, included in the Annual Report of the
Corporation and one copy of any interim consolidated financial
statements of the Corporation subsequent to the consolidated financial
statements for its most recently completed financial year;
(c) one copy of this Management Proxy Circular.
Additional information relating to the Corporation is also included in the
Corporation's Annual Report for the year ended August 31, 2005. The Annual
Report containing the consolidated audited financial statements, the report of
the auditor and management's discussion and analysis is being mailed to
shareholders with the Notice of Meeting and this Management Proxy Circular.
Additional copies of the Annual Report are available on SEDAR at www.sedar.com
and may be obtained free of charge from the Corporation upon request and will
be available at the Meeting.
DIRECTORS' APPROVAL
The contents and the sending of this Management Proxy Circular have been
approved by the Directors of the Corporation.
DATED at Vanier, Quebec, Canada, this 1st day of November, 2005.
/s/ Benoit Ringuette
------------------------------
Benoit Ringuette
Corporate Secretary
EXFO ELECTRO-OPTICAL ENGINEERING INC.
400 Godin Avenue
Vanier, Quebec, Canada, G1M 2K2
19
EXFO ELECTRO-OPTICAL ENGINEERING INC.
SCHEDULE A
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National Instrument 58-101 DISCLOSURE OF
CORPORATE GOVERNANCE PRACTICES & National COMMENTS
Policy 58-201 CORPORATE GOVERNANCE GUIDELINES
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1. The Board delineates its role and
responsibilities as follows:
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(a) Adoption of a strategic planning The Board provides guidance for the development of the
process strategic planning process and approves the process and the
plan developed by management annually. In addition, the
Board carefully reviews the strategic plan and deals with
strategic planning matters that arise during the year.
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(b) Identification of principal risks and The Board works with management to identify the Corporation's
implementing of risk management principal risks and manages these risks through regular
systems appraisal of management's practices on an ongoing basis.
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(c) Succession planning including The Human Resources Committee is responsible for the
appointing, training and monitoring elaboration and implementation of a succession planning
senior management process and its updates as required. The Human Resources
Committee is responsible to monitor and review the
performance of the Chief Executive Officer and that of all
other senior officers.
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(d) Communications policy The Chief Financial Officer of the Corporation is responsible
for communications between Management and the Corporation's
current and potential shareholders and financial analysts.
The Board adopted and implemented Disclosure Guidelines to
ensure consistency in the manner that communications with
shareholders and the public are managed. The Audit Committee
reviews press releases containing the quarterly results of
the Corporation prior to release. In addition, all material
press releases of the Corporation are reviewed by the
President and Chief Executive Officer, Chief Financial
Officer, Investor Relations Manager, Manager of Financial
Reporting and Accounting and Internal Legal Counsel. The
Disclosure Guidelines have been established in accordance
with the relevant disclosure requirements under applicable
Canadian and United States securities laws.
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20
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National Instrument 58-101 DISCLOSURE OF
CORPORATE GOVERNANCE PRACTICES & National COMMENTS
Policy 58-201 CORPORATE GOVERNANCE GUIDELINES
--------------------------------------------------------------------------------------------------------------------------
(e) Integrity of internal control and The Audit Committee has the responsibility to review the
management information systems Corporation's systems of internal controls regarding finance,
accounting, legal compliance and ethical behaviour. The
Audit Committee meets with the Corporation's external
auditors on a quarterly basis. Accordingly, it is expected
that the Corporation will fully comply with Sarbanes-Oxley
Act requirements within the required period of time which is
by August 31, 2006.
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(f) Approach to corporate governance The Board assumes direct responsibility for the monitoring of
including developing a set of the Board's corporate governance practices, the functioning
corporate governance principles and of the Board and the powers, mandates and performance of the
guidelines that are specifically committees. These responsibilities were previously assumed by
applicable to the issuer the Human Resources Committee. Accordingly, the Board
updated and adopted in March 2005 the following policies to
fully comply with these responsibilities:
o Audit Committee Charter*;
o Board of Directors Corporate Governance Guidelines*;
o Code of Ethics for our Principal Executive Officer
and Senior Financial Officers*;
o Disclosure Guidelines;
o Ethics and Business Conduct Policy*;
o Human Resources Committee Charter*;
o Securities Trading Policy;
o Statement of Reporting Ethical Violations (Whistle
Blower)*.
* available on EXFO website at www.exfo.com.
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(g) Expectations and responsibilities of The Board is also responsible for the establishment and
Directors, including basic duties and functioning of all Board committees, the appointment of
responsibilities with respect to members to serve on such committees, their compensation and
attendance at board meetings and their good standing. At regularly scheduled meetings of the
advance review of meeting materials Board, the Directors receive, consider and discuss committee
reports. The Directors also receive in advance of any
meeting, all documentation required for the upcoming
meetings and they are expected to review and consult this
documentation.
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2. Majority of Directors should be The Board presently consists of six Directors, five of which
independent (no direct or indirect are independent Directors within the meaning of the
material relationship with the issuer) Instrument. The Chairman of the Board, Mr. Germain Lamonde
is a significant shareholder in the Corporation as he has the
ability to exercise a majority of the votes for the election
of the Board of Directors. The Board believes that the
current majority of independent Directors provide appropriate
independent representation for the public shareholders of the
Corporation.
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21
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National Instrument 58-101 DISCLOSURE OF
CORPORATE GOVERNANCE PRACTICES & National COMMENTS
Policy 58-201 CORPORATE GOVERNANCE GUIDELINES
--------------------------------------------------------------------------------------------------------------------------
The chair of the Board should be an During the financial year ended August 31, 2002, the Board of
independent Director. Where this is Directors designated Mr. Michael Unger to act as the
not appropriate, an independent independent "Lead Director".
Director should be appointed to act
as "Lead Director"
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3. Annual Disclosure for each Director Mr. Germain Lamonde - Non-Independent - is President and
whether he or she is independent Chief Executive Officer of the Corporation.
For the remainder of the proposed Directors, none of them or
their associates have any interest or any business or other
relationship which could or could reasonably be perceived to
materially interfere with the Director's ability to act with
a view to the best interests of the Corporation, other than
interests arising from shareholding.
Mr. Pierre Marcouiller - Independent
Mr. Guy Marier - Independent
Mr. Andre Tremblay - Independent
Dr. David A. Thompson - Independent
Mr. Michael Unger - Independent
--------------------------------------------------------------------------------------------------------------------------
4. (a) Appoint a committee responsible for The Board adopted and implemented a Human Resources
nomination/assessment and Committee Charter which integrates the Compensation
compensation of Directors and Officers Committee Charter and the Nominating and Governance
Committee Charter. The Human Resources Committee is
responsible for nomination, assessment and compensation of
Directors and Officers. Therefore, this Human Resources
Committee Charter namely foresees:
o The Committee to identify individuals qualified to
become members of the Board, to conduct background
checks respecting such individuals, to recommend that
the Board select the director nominees for the next
annual meeting of shareholders;
o The Committee to review and approve on an annual
basis corporate goals and objectives relevant to
Chief Executive Officer ("CEO") compensation,
evaluate the CEO's performance in light of those
goals and objectives and set the CEO's compensation
level based on this evaluation;
o The Committee to review and approve on an annual
basis with respect to the annual compensation of all
senior officers;
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22
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National Instrument 58-101 DISCLOSURE OF
CORPORATE GOVERNANCE PRACTICES & National COMMENTS
Policy 58-201 CORPORATE GOVERNANCE GUIDELINES
--------------------------------------------------------------------------------------------------------------------------
o The Committee to review and approve, on behalf of the
Board of Directors (the "Board") or in collaboration
with the Board as applicable, on the basis of the
attribution authorized by the Board, to whom options
to purchase shares of the Corporation, RSUs or DSUs
shall be offered as the case may be and if so, the
terms of such options, RSUs or DSUs in accordance
with the terms of the Corporation's Long-Term
Incentive Plan or the Deferred Share Unit Plan
provided that no options, RSUs or DSUs shall be
granted to members of this Committee without the
approval of the Board.
o The Committee to annually review and report to the
Board on organizational structure and to ensure that
senior management has developed a succession plan for
the CEO and the CEO's direct reports and to review
such report with senior management.
o The Committee to recommend to the Board from time to
time the remuneration to be paid by the Corporation
to Directors.
o The Committee to make recommendations to the Board
with respect to the Corporation's incentive
compensation plans and equity-based plans.
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(b) Composed entirely of independent The Human Resources Committee consists of five members all of
Directors who are independent Directors. The Chairman of the Human
Resources Committee is Mr. Michael Unger.
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5. Implement a process for assessing the The Board assumes direct responsibility for the monitoring of
effectiveness of the Board, its the Board's corporate governance practices, the functioning
committees and contribution of of the Board and the powers, mandates and performance of the
individual Directors Committees. The Human Resources Committee, composed solely of
independent Directors, initiates a self-evaluation of the
Board's performance on an annual basis.
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6. Provide orientation and education Presentations and reports relating to the Corporation's
programs for new Directors business and affairs are provided to new Directors. In
addition, new Board members meet with senior management of
the Corporation to review the business and affairs of the
Corporation.
The Board should provide continuing The Human Resources Committee Charter foresees that the Human
education opportunities for all Resources Committee maintains an orientation program for new
Directors Directors and continuing education programs for Directors.
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23
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National Instrument 58-101 DISCLOSURE OF
CORPORATE GOVERNANCE PRACTICES & National COMMENTS
Policy 58-201 CORPORATE GOVERNANCE GUIDELINES
--------------------------------------------------------------------------------------------------------------------------
7. Consider reducing size of board, with The Board is presently composed of six members. The Board
a view to improving effectiveness considers that this is close to the optimum number of
Directors required to provide the flexibility to respond
quickly to corporate opportunities and challenges as they
arise, while also providing increased resources and improved
succession planning. The Board as currently constituted
brings together a mix of experience and backgrounds that the
Board considers appropriate for the stewardship of the
Corporation and these factors will continue to be considered
in the nomination process of new Directors.
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8. Review and ensure compensation of The Human Resources Committee reviews periodically
Directors in light of risks and compensation policies in light of market conditions, industry
responsibilities practice and level of responsibilities. Only independent
Directors are compensated for acting as a Director of the
Corporation.
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9. (a) Committees should generally be The Board has two committees: the Audit Committee and the
composed of outside Directors Human Resources Committee. Each of the members of the Audit
Committee and Human Resources Committee are outside
Directors. The Chairman of the Audit Committee is Mr. Andre
Tremblay and the Chairman of the Human Resources Committee is
Mr. Michael Unger.
(b) Majority of committee members should The Audit Committee consists of four members and the Human
be independent Resources Committee consists of five members, all of who are
independent Directors.
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10. Appoint a committee responsible for The Board assumes direct responsibility for the monitoring of
developing approach to corporate the Board's corporate governance practices, the functioning
governance issues and response to of the Board and the powers, mandates and performance of the
guidelines committees. These responsibilities were previously assumed by
the Human Resources Committee. Accordingly, the Board
updated and adopted in March 2005 the following policies to
fully comply with these responsibilities
o Audit Committee Charter*;
o Board of Directors Corporate Governance Guidelines*;
o Code of Ethics for our Principal Executive Officer
and Senior Financial Officers*;
o Disclosure Guidelines;
o Ethics and Business Conduct Policy*;
o Human Resources Committee Charter*;
o Securities Trading Policy;
o Statement of Reporting Ethical Violations (Whistle
Blower)*.
* available on EXFO website at www.exfo.com.
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24
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National Instrument 58-101 DISCLOSURE OF
CORPORATE GOVERNANCE PRACTICES & National COMMENTS
Policy 58-201 CORPORATE GOVERNANCE GUIDELINES
--------------------------------------------------------------------------------------------------------------------------
11. (a) Define limits to management's
responsibilities by developing
position descriptions for:
--------------------------------------------------------------------------------------------------------------------------
(i) the chair of the Board and the There is no specific mandate for the Board, however the Board
chair of each Board Committee of Directors is, by law, responsible for managing the
business and affairs of the Corporation. Any responsibility
which is not delegated to senior management or to a committee
of the Board remains the responsibility of the Board.
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(ii) the CEO The President and Chief Executive Officer, along with the
rest of management placed under his supervision, is
responsible for meeting the corporate objectives as
determined by the strategic objectives and budget as they are
presented each year to the Board of Directors.
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(b) Board should develop and approve The Board, in conjunction with Management, develops and
CEO's corporate objectives reviews the corporate objectives of the Corporation annually
which, in turn, are expected to be implemented by the CEO.
In addition, individual objectives for the CEO and the rest
of management are submitted annually to the Board for
approval.
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12. Establish structures and procedures During the financial year ended August 31, 2002, the Board of
to enable the Board to function Directors designated Mr. Michael Unger to act as independent
independently of management "Lead Director". As many meetings as needed, annually will
be held by the independent, unrelated Directors without
management and any independent, unrelated Director may
request such meetings at any time. Since September 1, 2004
and prior to November 1, 2005, one independent unrelated
Directors without management meeting occurred.
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13. (a) Establish an audit committee with a The Audit Committee is mandated to monitor audit functions,
specifically defined mandate to the preparation of financial statements, review press
ensure direct communications with releases on financial results, review other regulatory
external and internal auditors, documents as required and meet with outside auditors
oversight of management reporting independently of Management. The Committee also recommends
the selection of the external auditors for appointment by the
shareholders.
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25
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National Instrument 58-101 DISCLOSURE OF
CORPORATE GOVERNANCE PRACTICES & National COMMENTS
Policy 58-201 CORPORATE GOVERNANCE GUIDELINES
--------------------------------------------------------------------------------------------------------------------------
The aggregate fees billed for professional services rendered
by PricewaterhouseCoopers ("PWC") for the audit of the
Corporation's consolidated annual financial statements for
the financial year ended August 31, 2005 were approximately
US$214,000. The aggregate fees billed for services rendered
by PWC, other than services covered for auditing services
above, for the financial year ended August 31, 2005 were
approximately US$247,000 which related for the most part to
compliance and tax planning services. No fees were billed by
PWC for professional services related to financial
information systems design and implementation.
--------------------------------------------------------------------------------------------------------------------------
(b) All members should be non-management All four members of the Audit Committee are non-management
Directors Directors.
--------------------------------------------------------------------------------------------------------------------------
14. Implement a system to enable The Corporation has a practice of permitting the Board, any
individual Directors to engage Committee thereof and any individual Director to engage
outside advisors, at Corporation's independent, external advisors at the Corporation's expense.
expense
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15. Satisfy itself as to the integrity of The Board established, adopted and updated Corporate
the CEO and other executive officers Governance policies to satisfy this requirement such as Code
and creation of a culture of of Ethics for our Principal Executive Officer and Senior
integrity throughout the organisation Financial Officers, Disclosure Guidelines, Securities Trading
Policies and Statement on Reporting Ethical Violations
(Whistle Blower).
--------------------------------------------------------------------------------------------------------------------------
16. Setting out measures for receiving The Board established and adopted a statement of reporting
feedback from stakeholders , such as Ethical Violations permitting anyone to contact our Lead
the establishment of a process to Director on an anonymous basis via the Corporation's website.
permit stakeholders to directly
contact the independent Directors
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17. Disclose if a Director is a Director Michael Unger is a Director of Tundra Semiconductor
of any other reporting issuer Corporation, a public corporation of Ottawa. Guy Marier is a
Director of Bell Nordic Income Fund. Pierre Marcouiller is a
Director of Heroux-Devtek Inc.
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18. Disclose attendance record of each BOARD MEETINGS
Director for all Board meetings
Since September 1, 2004, the Board of Directors held
7 meetings prior to November 1, 2005, which were attended by
all the members of the Board, except Mr. Thompson who was
absent 2 times at the meetings on October 14, 2004, September
26-27, 2005 and Mr. Andre Tremblay who was absent one time at
the meeting of October 20, 2005.
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26
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National Instrument 58-101 DISCLOSURE OF
CORPORATE GOVERNANCE PRACTICES & National COMMENTS
Policy 58-201 CORPORATE GOVERNANCE GUIDELINES
--------------------------------------------------------------------------------------------------------------------------
HUMAN RESOURCES
Since September 1, 2004, the Human Resources Committee held 4
meetings prior to November 1 2005, which were attended by all
the members of the Committee, except Mr. Thompson who was
absent two times at the October 14, 2004 meeting and the
September 26, 2005 meeting and Mr. Andre Tremblay who was
absent one time at the meeting of October 20, 2005.
AUDIT COMMITTEE
Since September 1, 2004, the Audit Committee held 5 meetings
prior to November 1, 2005 which were attended by all the
members of the Committee.
INDEPENDENT BOARD MEETING
Since September 1, 2004 and prior to November 1, 2005, the
Independent Board Members held one meeting which was attended
by all the members except Mr. Pierre Marcouiller.
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19. Disclose identity of consultant or In 2005, the Corporation has hired Mercer Human Resource
advisor retained to assist in Consulting for different compensation studies. Mercer has
determining compensation of Directors completed surveys on the following topics:
and Officers
o Executive & CEO salary survey (Objective: compare
the Corporation executives & CEO salaries and benefits
with comparable market);
o USA Sales salary survey (compare the Corporation's
Sales workforce salary vs the comparable market);
o Job classification structure & salary scale (Define
Job positions vs comparable market including salary
scale);
o Annual study on proposed salary increase for 2006.
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20. The independent directors should hold During the financial year ended August 31, 2002, the Board of
regularly scheduled meetings at which Directors designated Mr. Michael Unger to act as independent
non-independent directors and members "lead director". As many meetings, as needed, annually will
of management are not in attendance be held by the independent, unrelated Directors without
management and any independent, unrelated Director may
request such meetings at any time. Since September 1, 2004
and prior to November 1, 2005, one meeting of independent
unrelated Directors without management occurred.
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27
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National Instrument 58-101 DISCLOSURE OF
CORPORATE GOVERNANCE PRACTICES & National COMMENTS
Policy 58-201 CORPORATE GOVERNANCE GUIDELINES
--------------------------------------------------------------------------------------------------------------------------
21. The Board should adopt a written code The Corporation is committed to maintaining the highest
of business conduct and ethics (a standard of business conduct and ethics. Accordingly, the
code). The code should be applicable Board updated and established (i) a Board of Directors
to directors, officers and employees Corporate Governance Guidelines (ii) a Code of Ethics for our
of the issuer. The Board should be Principal Executive Officer and Senior Financial Officers
responsible for monitoring compliance (iii) Ethics and Business Conduct Policy and (iv) a Statement
with the code. on Reporting Ethical Violations "Whistleblower Policy" which
are available on the Corporation's website at www.exfo.com.
Therefore, the Corporation has instituted and follows a
"Whistleblower Policy" where each member of the Board as well
as any senior officer, every employee of the Corporation and
any person is invited and encouraged to report anything
appearing or suspected of being non-ethical to our Lead
Director, in confidence. The Lead Director has the power to
hire professional assistance to conduct an internal
investigation should he so feel required.
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28