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 July, 2004
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-______.
On June 29, 2004, EXFO Electro-Optical Engineering Inc., a Canadian corporation,
reported its results of operations for the third fiscal quarter ended May 31,
2004. This report on Form 6-K sets forth the news release relating to EXFO's
announcement and certain information relating to EXFO's financial condition and
results of operations for the third fiscal quarter of the 2004 fiscal year. This
press release and information relating to EXFO's financial condition and results
of operations for the third fiscal quarter of the 2004 fiscal year are hereby
incorporated as a document by reference to Form F-3 (Registration Statement
under the Securities Act of 1933) declared effective as of July 30, 2001 and to
Form F-3 (Registration Statement under the Securities Act of 1933) declared
effective as of March 11, 2002 and to amend certain material information as set
forth in these two Form F-3 documents.
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: July 7, 2004
E X F O Electro-Optical Engineering Inc.
================================================================================
1 800 663-3936 info@exfo.com o www.exfo.com
Tel: 1 418 683-0211
Fax: 1 418 683-2170
P R E S S R E L E A S E
EXFO POSTS STRONG SALES GROWTH
TO REACH US$20.5 MILLION IN THE THIRD QUARTER
|X| SALES INCREASE OF 35.4% COMPARED TO THIRD QUARTER OF 2003 AND 21.2%
COMPARED TO SECOND QUARTER OF 2004
|X| FTTP TEST SOLUTIONS GENERATE HIGHER THAN EXPECTED REVENUES
|X| GAAP NET LOSS IMPROVES TO US$0.02 PER SHARE
QUEBEC CITY, CANADA, June 29, 2004--EXFO Electro-Optical Engineering Inc.
(NASDAQ: EXFO, TSX: EXF) reported today sales growth of 35.4% to reach US$20.5
million in the third quarter ended May 31, 2004, from US$15.1 million in the
third quarter of 2003 and 21.2% growth from US$16.9 million in the second
quarter of 2004.
The net book-to-bill ratio was 0.98 for the third quarter of fiscal 2004
compared to 0.93 for the same period last year and 1.05 for the second quarter
of 2004.
Gross margin amounted to 52.9% of sales in the third quarter of fiscal 2004
compared to 41.6% (excluding inventory write-offs) in the third quarter of 2003
and 55.4% in the second quarter of 2004.
GAAP net loss for the third quarter of fiscal 2004 totaled US$1.2 million, or
US$0.02 per share, compared to a net loss of US$38.4 million, or US$0.61 per
share, for the third quarter of 2003 and a net loss of US$2.9 million, or
US$0.04 per share, for the second quarter of 2004.
"Thanks to continued market-share gains, strategic focus and early success in
the fiber-to-the-premises (FTTP) market opportunity, EXFO has achieved
remarkable sales growth in a relatively flat spending environment," said Germain
Lamonde, EXFO's Chairman, President and CEO. "This marked our best sales and
bookings quarter since the fourth quarter of 2001 with significant progress
towards profitability. In fact, we would have been profitable last quarter,
excluding amortization of intangible assets and stock-based compensation costs."
"It is becoming clear that focusing on top-line growth through market-share
gains and operational excellence is the right strategy to bring us back to
profitability," Mr. Lamonde added. "I believe that our decision to sustain R&D
investments in our fiber-to-the premises (FTTP) and next-generation IP
networking test solutions will pay off."
E X F O Electro-Optical Engineering Inc.
================================================================================
1 800 663-3936 info@exfo.com o www.exfo.com
Tel: 1 418 683-0211
Fax: 1 418 683-2170
P R E S S R E L E A S E
SEGMENTED RESULTS
(IN MILLIONS OF US DOLLARS)
SALES LOSS FROM OPERATIONS*
------------------------------------- ------------------------
Q3 2004 Q2 2004 Q3 2003 Q3 2004 Q2 2004
----------- ----------- ----------- ----------- -----------
BUSINESS SEGMENT
Telecom Division $16.7 $13.4 $12.0 ($0.8) ($2.4)
Photonics and Life
Sciences Division $ 3.8 $ 3.5 $ 3.1 ($1.1) ($1.1)
* Segmented loss from operations is not available for comparative periods in
fiscal 2003.
THIRD-QUARTER BUSINESS HIGHLIGHTS
|X| Confirming its market leadership in the physical-layer field-testing
market, EXFO shipped a series of orders--many of which were
FTTP-related--to a Tier-1 network service provider. The majority of
FTTP-related sales were derived from established products.
|X| Remaining focused on market-driven innovation, EXFO launched three new
products in the third quarter, including a next-generation optical time
domain reflectometer (OTDR) available in the FTTP configuration.
Following the quarter-end, EXFO introduced three additional products:
all-in-one MultiTest module, next-generation Fibre Channel test
module--both housed inside the leading FTB-400 field-testing
platform--and a Passive Optical Network (PON) power meter. EXFO has
introduced 20 new products so far in fiscal 2004.
|X| To renew with profitability, EXFO generated higher sales volumes and
better absorbed its operating costs. Based on a GAAP net loss of US$1.2
million and excluding amortization of intangible assets of US$1.3
million and stock-based compensation costs of US$200,000, the company
would have been profitable (at US$273,000). EXFO also reported positive
cash flows from operations for the second consecutive quarter (at
US$605,000).
OPERATING EXPENSES
Selling and administrative expenses amounted to US$6.9 million, or 33.9% of
sales, for the third quarter of fiscal 2004 compared to US$7.1 million, or 46.7%
of sales, for the same period last year and US$6.8 million, or 40.0% of sales,
for the second quarter of 2004.
Gross research and development expenses totaled US$4.2 million, or 20.4% of
sales, in the third quarter of fiscal 2004 compared to US$4.6 million, or 30.7%
of sales, in the third quarter of 2003 and US$4.3 million, or 25.4% of sales, in
the second quarter of 2004.
BUSINESS OUTLOOK
EXFO forecasted sales between US$19.0 million and US$22.0 million and a GAAP net
loss between US$0.03 and US$0.00 per share for the fourth quarter of fiscal
2004.
E X F O Electro-Optical Engineering Inc.
================================================================================
1 800 663-3936 info@exfo.com o www.exfo.com
Tel: 1 418 683-0211
Fax: 1 418 683-2170
P R E S S R E L E A S E
CONFERENCE CALL AND WEBCAST
EXFO will host a conference call today at 5 p.m. (Eastern time) to review its
financial results for the third quarter of fiscal 2004. To listen to the
conference call and participate in the question period via telephone, dial
1-416-695-6120. Germain Lamonde, Chairman, President and CEO, and Pierre
Plamondon, CA, Vice-President of Finance and Chief Financial Officer, will
participate in the call. An audio replay of the conference call will be
available between 7 a.m. and 11 p.m. until July 6, 2004. The replay number is
1-416-695-5275. The audio Webcast of the conference call will also be available
on EXFO's Website at WWW.EXFO.COM, under the Investors section.
ABOUT EXFO
EXFO is the 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 the company's main business activity, offers fully
integrated and complete test solutions to network service providers, system
vendors and component manufacturers in approximately 70 countries. One of EXFO's
strongest competitive advantages is its modular platform design, providing
PC-based, Windows-centric test solutions that maximize technology reuse across
several market segments. The Photonics and Life Sciences Division mainly
leverages core telecom technologies to offer value-added solutions in high-tech
industrial manufacturing and research sectors. For more information about EXFO,
visit WWW.EXFO.COM.
FORWARD-LOOKING STATEMENTS
This news release contains forward-looking statements within the meaning of the
U. S. Private Securities Litigation Reform Act of 1995 and we intend that such
forward-looking statements be subject to the safe harbors created thereby.
Forward-looking statements are statements other than historical information or
statements of current condition that refer to expectations, projections or other
characterizations of future events and circumstances. They are not guarantees of
future performance and involve risks and uncertainties. Actual results may
differ materially from those in forward-looking statements due to various
factors including global geo-political, economic, competitive and market
uncertainty and our ability to execute successfully in these uncertain
conditions; capital spending levels in the telecommunications sector; market
acceptance of new products and upcoming new products; limited visibility of
customer orders and the timing thereof; the competitive landscape; and
successful integration of our acquired and to-be-acquired companies. Assumptions
relating to the foregoing involve judgments and risks, all of which are
difficult or impossible to predict and many of which are beyond our control.
Other risk factors that may affect our future performance and operations are
detailed in our Annual Report on Form 20-F and our other filings with the U. S.
Securities and Exchange Commission and the Canadian securities commissions. We
believe that the expectations reflected in the forward-looking statements are
reasonable based on information currently available to us, but we cannot assure
you that the expectations will prove to have been correct. Accordingly, you
should not place undue reliance on these forward-looking statements. These
statements speak only as of the date of this document and shall not be revised
or updated to reflect events after the date of this document.
-30-
FOR MORE INFORMATION
Vance Oliver
Manager, Investor Relations
(418) 683-0211
vance.oliver@exfo.com
EXFO ELECTRO-OPTICAL ENGINEERING INC.
INTERIM CONSOLIDATED BALANCE SHEETYEARS
(in thousands of US dollars)
AS AT AS AT
MAY 31, AUGUST 31,
2004 2003
--------- ---------
(UNAUDITED)
ASSETS
CURRENT ASSETS
Cash $ 4,306 $ 5,366
Short-term investments (note 6) 80,375 52,010
Accounts receivable
Trade, less allowance for doubtful accounts
of $527 ($568 as at August 31, 2003) 11,238 9,639
Other 1,453 834
Income taxes and tax credits recoverable 6,401 6,003
Inventories (note 3) 16,110 15,602
Prepaid expenses 1,273 2,041
--------- ---------
121,156 91,495
INCOME TAXES AND TAX CREDITS RECOVERABLE 449 1,377
PROPERTY, PLANT AND EQUIPMENT 19,083 21,641
INTANGIBLE ASSETS 10,345 14,068
GOODWILL 17,763 17,673
--------- ---------
$ 168,796 $ 146,254
========= =========
LIABILITIES
CURRENT LIABILITIES
Accounts payable and accrued liabilities (note 4) $ 11,480 $ 12,026
Income taxes payable -- 2,200
Deferred revenue 666 148
Current portion of long-term debt 110 110
--------- ---------
12,256 14,484
DEFERRED REVENUE 1,084 352
DEFERRED GRANTS 946 1,139
LONG-TERM DEBT 372 453
--------- ---------
14,658 16,428
--------- ---------
CONTINGENCY (note 9)
SHAREHOLDERS' EQUITY
Share capital (note 6) 521,691 492,452
Contributed surplus 1,818 1,519
Cumulative translation adjustment 8,498 7,643
Deficit (377,869) (371,788)
--------- ---------
154,138 129,826
--------- ---------
$ 168,796 $ 146,254
========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
INTERIM UNAUDITED CONSOLIDATED STATEMENTS OF EARNINGS
(in thousands of US dollars, except share and per share data)
THREE MONTHS NINE MONTHS THREE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
MAY 31, 2004 MAY 31, 2004 MAY 31, 2003 MAY 31, 2003
------------ ------------ ------------ ------------
SALES $ 20,456 $ 53,298 $ 15,103 $ 47,604
COST OF SALES (1,2) 9,637 24,980 10,460 26,430
-------- -------- -------- --------
GROSS MARGIN 10,819 28,318 4,643 21,174
-------- -------- -------- --------
OPERATING EXPENSES
Selling and administrative (1) 6,927 19,543 7,052 20,955
Net research and development (1) (note 7) 3,321 9,642 5,882 12,681
Amortization of property, plant and
equipment 1,198 3,814 1,368 3,936
Amortization of intangible assets 1,261 3,837 1,490 4,398
Write-down of intangible assets -- -- 2,922 2,922
Write-down of goodwill -- -- 4,505 4,505
Restructuring charges -- -- 348 348
-------- -------- -------- --------
TOTAL OPERATING EXPENSES 12,707 36,836 23,567 49,745
-------- -------- -------- --------
LOSS FROM OPERATIONS (1,888) (8,518) (18,924) (28,571)
Interest and other income 398 1,068 379 929
Foreign exchange gain (loss) 167 124 (600) (1,310)
-------- -------- -------- --------
LOSS BEFORE INCOME TAXES (1,323) (7,326) (19,145) (28,952)
-------- -------- -------- --------
INCOME TAXES (note 8)
Current (135) (1,245) 2,206 5,887
Future -- -- 17,076 9,992
-------- -------- -------- --------
(135) (1,245) 19,282 15,879
-------- -------- -------- --------
NET LOSS FOR THE PERIOD $ (1,188) $ (6,081) $(38,427) $(44,831)
======== ======== ======== ========
BASIC AND DILUTED NET LOSS PER SHARE $ (0.02) $ (0.09) $ (0.61) $ (0.71)
BASIC WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING (000'S) 68,409 65,211 63,014 62,791
DILUTED WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING (000'S) (note 10) 68,991 65,820 63,506 63,232
(1) STOCK-BASED COMPENSATION COSTS
INCLUDED IN:(note 2)
Cost of sales $ 29 $ 37 $ -- $ --
Selling and administrative 115 174 -- --
Net research and development 56 78 -- --
-------- -------- -------- --------
$ 200 $ 289 $ -- $ --
======== ======== ======== ========
(2) Including inventory write-offs of $1,646 for the periods ended May 31,
2003.
The accompanying notes are an integral part of these consolidated financial
statements.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
INTERIM UNAUDITED CONSOLIDATED STATEMENTS OF DEFICIT
AND CONTRIBUTED SURPLUS
(in thousands of US dollars)
DEFICIT
NINE MONTHS ENDED
MAY 31,
---------------------------
2004 2003
--------- ---------
BALANCE - BEGINNING OF PERIOD $(371,788) $(316,838)
ADD
Net loss for the period (6,081) (44,831)
--------- ---------
BALANCE - END OF PERIOD $(377,869) $(361,669)
========= =========
CONTRIBUTED SURPLUS
NINE MONTHS ENDED
MAY 31,
--------------------------
2004 2003
--------- --------
BALANCE - BEGINNING OF PERIOD $ 1,519 $ 1,487
ADD
Premium on resale of share capital 10 11
Stock-based compensation plans (note 2) 289 --
--------- --------
BALANCE - END OF PERIOD $ 1,818 $ 1,498
========= ========
The accompanying notes are an integral part of these consolidated financial
statements.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
INTERIM UNAUDITED CONSOLIDATED STATEMENTSYEARS OF CASH FLOWS
(in thousands of US dollars)
THREE MONTHS NINE MONTHS THREE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
MAY 31, 2004 MAY 31, 2004 MAY 31, 2003 MAY 31, 2003
------------ ------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss for the period $ (1,188) $ (6,081) $ (38,427) $ (44,831)
Add (deduct) items not affecting cash
Discount on short-term investments 29 361 (37) 184
Stock-based compensation costs 200 289 -- --
Inventory and tax credit write-offs -- -- 3,943 3,943
Amortization 2,459 7,651 2,858 8,334
Future income taxes -- -- (7,184) (14,268)
Future income tax assets valuation allowance -- -- 24,260 24,260
Write-down of goodwill and intangible assets -- -- 7,427 7,427
Deferred revenue 503 1,286 59 (247)
Deferred grants (3) (215) 1,225 1,140
Change in non-cash operating items
Accounts receivable (2,398) (2,171) (581) 2,777
Income taxes and tax credits 295 (1,621) 5,051 15,692
Inventories 687 (281) 1,539 5,522
Prepaid expenses (194) (256) (242) (135)
Accounts payable and accrued liabilities 215 276 17 (475)
--------- --------- --------- ---------
605 (762) (92) 9,323
--------- --------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to short-term investments (259,832) (506,744) (135,708) (346,893)
Proceeds from disposal of short-term investments 260,230 478,739 134,619 337,911
Additions to property, plant and equipment
and intangible assets (238) (814) (234) (2,250)
Business combination -- -- -- (1,867)
--------- --------- --------- ---------
160 (28,819) (1,323) (13,099)
--------- --------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Repayment of long-term debt (28) (80) (30) (108)
Net proceeds of offering (note 6) -- 29,164 -- --
Share issue expenses (5) (171) -- 4
Exercise of stock options 28 246 17 17
Redemption of share capital -- (3) -- (7)
Resale of share capital -- 13 -- 18
--------- --------- --------- ---------
(5) 29,169 (13) (76)
--------- --------- --------- ---------
CHANGE IN CASH 760 (412) (1,428) (3,852)
EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON CASH (20) (648) 159 760
CASH - BEGINNING OF PERIOD 3,566 5,366 7,305 9,128
--------- --------- --------- ---------
CASH - END OF PERIOD $ 4,306 $ 4,306 $ 6,036 $ 6,036
========= ========= ========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTSYEARS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
1 INTERIM FINANCIAL INFORMATION
The financial information as at May 31, 2004, and for the three and
nine-month periods ended May 31, 2003 and 2004, is unaudited. In the
opinion of management, all adjustments necessary to present fairly the
results of these periods in accordance with generally accepted accounting
principles in Canada have been included. The adjustments made were of a
normal recurring nature. Interim results may not necessarily be indicative
of results anticipated for the entire year.
These interim consolidated financial statements are prepared in accordance
with generally accepted accounting principles in Canada and use the same
accounting policies and methods used in the preparation of the company's
most recent annual consolidated financial statements, except for changes as
described in note 2. All disclosures required for annual financial
statements have not been included in these financial statements. These
interim consolidated financial statements should be read in conjunction
with the company's most recent annual consolidated financial statements.
Certain comparative figures have been reclassified to conform to the
current periods' presentation.
2 NEW ACCOUNTING STANDARDS AND PRONOUNCEMENTS
On September 1, 2003, the company implemented the documentation required by
Accounting Guideline 13 of the Canadian Institute of Chartered Accountants
(CICA) handbook, "Hedging Relationship", which establishes new rules for
designating, documenting and assessing the effectiveness of hedging
relationships, such as the company's forward exchange contracts. If these
new rules are not met, hedge accounting can not be applied. Consequently,
the company's forward exchange contracts, which are used to hedge
anticipated US-dollar denominated sales, continue to qualify for hedge
accounting; foreign exchange translation gains and losses on these
contracts continue to be recognized as an adjustment of the revenue when
the sales are recorded.
On September 1, 2003, the company prospectively adopted the amendments made
to handbook section 3870, "Stock-Based Compensation and Other Stock-Based
Payments". These amendments require an expense to be recognized in
financial statements for all forms of employee stock-based compensation,
including stock options, using a fair value-based method. During the nine
months ended May 31, 2004, the company granted 506,500 stock options to its
employees. The aggregate fair value of these stock options amounts to
$1,463,000. The corresponding stock-based compensation costs were amortized
using the graded vesting method, resulting in stock-based compensation
costs of $200,000 and $289,000 for the three months and the nine months
ended May 31, 2004, respectively.
The company is required to disclose pro forma information with respect to
net loss and net loss per share as if stock-based compensation costs were
recognized in the financial statements using the fair value-based method
for options granted in fiscal 2003. However, if the fair value-based method
had been used to account for these costs, there would have been no
significant differences in the net loss and net loss per share figures,
compared to the net loss and net loss per share figures on a pro forma
basis. Consequently, no pro forma information is provided in these interim
consolidated financial statements.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTSYEARS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
The fair value of options granted in fiscal 2004 was estimated using the
Black-Scholes options valuation model with the following weighted average
assumptions:
THREE MONTHS ENDED NINE MONTHS ENDED
MAY 31, 2004 MAY 31, 2004
------------------ -----------------
(UNAUDITED)
Risk-free interest rate 2.2% 2.7%
Expected volatility 98% 100%
Dividend yield Nil Nil
Expected life 47 months 49 months
In July 2003, the CICA issued handbook sections 1100 and 1400, "Generally
Accepted Accounting Principles" and "General Standards of Financial
Statements Presentation", which are effective for fiscal years beginning on
or after October 1, 2003. Among other things, these new sections define
generally accepted accounting principles (GAAP), establish the relative
authority of various types of CICA Accounting Standards Board
pronouncements and clarify the role of "industry practice" in applying
GAAP. The company will adopt these new standards on September 1, 2004 and
it does not expect significant impacts on its financial statements.
3 INVENTORIES
AS AT AS AT
MAY 31, AUGUST 31,
2004 2003
----------- -----------
(UNAUDITED)
Raw materials $ 7,563 $ 8,188
Work in progress 1,405 1,022
Finished goods 7,142 6,392
--------- ---------
$ 16,110 $ 15,602
========= =========
4 ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
AS AT AS AT
MAY 31, AUGUST 31,
2004 2003
----------- -----------
(UNAUDITED)
Trade $ 4,635 $ 4,227
Salaries and social benefits 4,271 3,462
Warranty (note 5) 362 687
Restructuring charges 1,104 2,468
Other 1,108 1,182
--------- ----------
$ 11,480 $ 12,026
========= ==========
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTSYEARS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
The following table summarizes the changes in the restructuring charges
payable since August 31, 2003:
BALANCE AS AT BALANCE AS AT
AUGUST 31, FOREIGN CURRENCY MAY 31,
2003 PAID TRANSLATION ADJUSTMENT 2004
-------------- ------------ ---------------------- -------------
(UNAUDITED)
Severance expenses $ 1,233 $ (964) $ 44 $ 313
Exited leased facilities 872 (400) 39 511
Other 363 (94) 11 280
-------------- ------------ ---------------------- -------------
$ 2,468 $ (1,458) $ 94 $ 1,104
============== ============ ====================== =============
5 WARRANTY
The company offers its customers warranties of one to three years,
depending on the specific products and terms of the customer 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 rates and warranty costs to be
incurred. Costs associated with extended warranties are charged to expense
as incurred. Revenue for these extended warranties is recognized on a
straight-line basis over the warranty period.
The following table summarizes the changes in the warranty provision since
August 31, 2003:
BALANCE AS AT
BALANCE AS AT FOREIGN CURRENCY MAY 31,
AUGUST 31, 2003 ISSUED SETTLED TRANSLATION ADJUSTMENT 2004
--------------- --------- --------- ---------------------- -------------
(UNAUDITED)
Warranty $ 687 $ 407 $ (751) $ 19 $ 362
6 SHARE CAPITAL
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 have been invested in
commercial papers issued by high-credit quality corporations and trusts
that are presented in the short-term investments in the balance sheet.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTSYEARS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
7 NET RESEARCH AND DEVELOPMENT EXPENSES
THREE MONTHS NINE MONTHS THREE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
MAY 31, 2004 MAY 31, 2004 MAY 31, 2003 MAY 31, 2003
------------ ------------ ------------ ------------
(UNAUDITED) (UNAUDITED)
Gross research and development expenses $ 4,176 $ 12,035 $ 4,639 $ 13,261
Research and development tax credits and grants (855) (2,393) (1,054) (2,877)
Research and development tax credits write-off -- -- 2,297 2,297
-------- -------- -------- --------
$ 3,321 $ 9,642 $ 5,882 $ 12,681
======== ======== ======== ========
8 INCOME TAXES
During the first quarter of fiscal 2004, the company recorded $1,406,000
for the non-recurring recovery of income taxes paid in previous periods
following the receipt of a tax assessment during that period.
Furthermore, considering current market conditions and because the company
recorded operating losses for the current nine-month period and for the
last two fiscal years, the company has recorded a full valuation allowance
against future income tax assets on deductible temporary differences, tax
losses carried forward and tax deductions. This causes its income tax
recovery to be distorted in relation to its pre-tax accounting income.
9 CONTINGENCY
On November 27, 2001, a class action suit was filed in the United States
District Court for the Southern District of New York against the company,
four of the underwriters of its Initial Public Offering and some of its
executive officers pursuant to the Securities Exchange Act of 1934 and Rule
10b-5 promulgated thereunder and sections 11, 12 and 16 of the Securities
Act of 1933. This class action alleges that the company's registration
statement and prospectus filed with the Securities and Exchange Commission
on June 29, 2000, contained material misrepresentations and/or omissions
resulting from (i) the underwriters allegedly soliciting and receiving
additional, excessive and undisclosed commissions from certain investors in
exchange for which they allocated material portions of the shares issued in
connection with the company's Initial Public Offering; and (ii) the
underwriters allegedly entering into agreements with customers whereby
shares issued in connection with the company's Initial Public Offering
would be allocated to those customers in exchange for which customers
agreed to purchase additional amounts of shares in the after market at
pre-determined prices.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTSYEARS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
On April 19, 2002, the plaintiffs filed an amended complaint containing
master allegations against all of the underwriters in all of the 310 cases
included in this class action and, also filed an amended complaint
containing allegations specific to four of the company's underwriters, the
company and two of its executive officers. In addition to the allegations
mentioned above, the amended complaint alleges that the underwriters (i)
used their analysts to manipulate the stock market; and (ii) implemented
schemes that allowed issuer insiders to sell their shares rapidly after an
initial public offering and benefit from high market prices. As concerns
the company and its two executive officers in particular, the amended
complaint alleges that (i) the company's registration statement was
materially false and misleading because it failed to disclose the
additional commissions and compensation to be received by underwriters;
(ii) the two named executive officers learned of or recklessly disregarded
the alleged misconduct of the underwriters; (iii) the two named executive
officers had motive and opportunity to engage in alleged wrongful conduct
due to personal holdings of the company's stock and the fact that an
alleged artificially inflated stock price could be used as currency for
acquisitions; and (iv) the two named executive officers, by virtue of their
positions with the company, controlled the company and the contents of the
registration statement and had the ability to prevent its issuance or cause
it to be corrected. The plaintiffs in this suit seek an unspecified amount
for damages suffered.
In July 2002, the issuers filed a motion to dismiss the plaintiffs' amended
complaint and judgment was rendered on February 19, 2003. Only one of the
claims against the company was dismissed. On October 8, 2002, the claims
against its officers were dismissed pursuant to the terms of Reservation of
Rights and Tolling Agreements entered into with the plaintiffs.
On June 26, 2003, the Plaintiff's Executive Committee announced that a
proposed settlement between the issuers and their directors and officers
and the plaintiffs had been structured. A Memorandum of Understanding
("MOU") to settle the plaintiffs' claims against the issuers and their
directors and officers has now been approved as to form and the process of
obtaining approval by all parties to the MOU is now underway. The parties
will be required to prepare many documents necessary to consummate the
settlement, which will be submitted to the Court for preliminary approval.
Final approval will be required by the Court following notice to class
members and a fairness hearing. If this tentative settlement is
successfully finalized, the company and the individual defendants will be
released from the litigation. Any direct financial impact of the proposed
settlement is expected to be borne by the company's insurance carriers.
Since the settlement process is subject to a fairness hearing and final
court approval, it is possible that it could fail. Therefore, it is not
possible to predict the final outcome of the case, nor determine the amount
of any possible losses. If the settlement process fails, the company will
continue to defend its position in this litigation that the claims against
it, and its officers, are without merit. Accordingly, no provision for this
case has been made in the interim consolidated financial statements as of
May 31, 2004.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTSYEARS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
10 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:
THREE MONTHS NINE MONTHS THREE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
MAY 31, 2004 MAY 31, 2004 MAY 31, 2003 MAY 31, 2003
------------ ------------ ------------ ------------
(UNAUDITED) (UNAUDITED)
Basic weighted average number of
shares outstanding (000's) 68,409 65,211 63,014 62,791
Dilutive effect of stock options
(000's) 515 508 347 273
Dilutive effect of restricted stock
awards (000's) 67 101 145 168
------ ------ ------ ------
Diluted weighted average number of
shares outstanding (000's) 68,991 65,820 63,506 63,232
====== ====== ====== ======
Stock options excluded from the calculation of
diluted weighted average number of shares
because their exercise price was greater
than the average market price of
the common shares (000's) 2,248 2,109 2,638 2,633
====== ====== ====== ======
The diluted loss per share for the periods ended May 31, 2003 and 2004, was
the same as the basic loss per share since the dilutive effect of stock
options and restricted stock awards should not be included in the
calculation; otherwise, the effect would be anti-dilutive. Accordingly,
diluted loss per share for those periods was calculated using the basic
weighted average number of shares outstanding.
11 SEGMENT INFORMATION
In September 2003, the company reorganized its business under two
reportable segments: Telecom Division and Photonics and Life Sciences
Division. The Telecom Division meets the physical-, optical- and
protocol-layer test and measurement needs of network service providers,
system vendors and component manufacturers throughout the global
telecommunications industry. The Photonics and Life Sciences Division
mainly leverages developed and acquired technologies for high-tech
industrial manufacturing and research markets.
EXFO's President and Chief Executive Officer ("CEO"), as the chief
operating decision-maker, assesses the performance of the two segments and
allocates resources to the segments. Each reportable segment is managed
separately. Earnings (loss) from operations represent the primary measure
used by the CEO in assessing performance of the reportable segments. The
accounting policies of the reportable segments are the same as those
applied in the consolidated financial statements.
Until August 31, 2003, the company was organized under one reportable
segment, being the development, manufacturing and marketing of fiber-optic
test, measurement and monitoring solutions for the global
telecommunications industry.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTSYEARS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
The following tables present information by segment:
THREE MONTHS ENDED MAY 31, 2004 NINE MONTHS ENDED MAY 31, 2004
--------------------------------------------- ----------------------------------------------
PHOTONICS PHOTONICS
AND LIFE AND LIFE
TELECOM SCIENCES TELECOM SCIENCES
DIVISION DIVISION TOTAL DIVISION DIVISION TOTAL
----------- ------------- ------------- ----------- -------------- -------------
(UNAUDITED) (UNAUDITED)
Sales $ 16,624 $ 3,832 $ 20,456 $ 42,106 $ 11,192 $ 53,298
Loss from operations $ (772) $ (1,116) $ (1,888) $ (5,616) $ (2,902) $ (8,518)
Unallocated items:
Interest and other income 398 1,068
Foreign exchange gain 167 124
------------- -------------
Loss before income taxes (1,323) (7,326)
Income taxes (135) (1,245)
------------- -------------
Net loss for the period $ (1,188) $ (6,081)
============= =============
Comparative information for the loss from operations is not provided for
each reportable segment because this information is not available and is
impracticable to determine.
THREE MONTHS ENDED MAY 31, 2004 NINE MONTHS ENDED MAY 31, 2004
--------------------------------------------- ----------------------------------------------
PHOTONICS PHOTONICS
AND LIFE AND LIFE
TELECOM SCIENCES TELECOM SCIENCES
DIVISION DIVISION TOTAL DIVISION DIVISION TOTAL
----------- ------------- ------------- ----------- -------------- -------------
(UNAUDITED) (UNAUDITED)
Sales $ 12,020 $ 3,083 $ 15,103 $ 37,957 $ 9,647 $ 47,604
AS AT AS AT
MAY 31, AUGUST 31,
2004 2003
------------- -----------
(UNAUDITED)
TOTAL ASSETS
Telecom Division $ 58,909 $ 57,997
Photonics and Life Sciences Division 18,356 23,501
Unallocated assets 91,531 64,756
-------------- -------------
$ 168,796 $ 146,254
============== =============
Unallocated assets are comprised of cash, short-term investments and income
taxes and tax credits recoverable.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTSYEARS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
12 DIFFERENCES BETWEEN CANADIAN AND U.S. GAAP
These interim consolidated financial statements are prepared in accordance
with Canadian GAAP, which differ in certain respects from U.S. GAAP. Note
20 to the company's most recent annual consolidated financial statements
describes the significant differences between Canadian and U.S. GAAP that
affect the company. This note describes the additional significant changes
that have occurred since the most recent consolidated annual financial
statements and provides a quantitative analysis of all significant
differences. All disclosures required in annual financial statements under
U.S. GAAP have not been provided in these interim consolidated financial
statements.
RECONCILIATION OF NET LOSS TO CONFORM WITH U.S. GAAP
THREE MONTHS NINE MONTHS THREE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
MAY 31, 2004 MAY 31, 2004 MAY 31, 2003 MAY 31, 2003
------------ ------------ ------------ ------------
(UNAUDITED) (UNAUDITED)
Net loss for the period in accordance
with Canadian GAAP $ (1,188) $ (6,081) $(38,427) $(44,831)
Stock-based compensation costs
related to stock option plan (9) 131 (34) (89)
Stock-based compensation costs
related to stock purchase plan (365) (486) 368 228
Stock-based compensation costs
related to restricted stock award plan (227) (421) (201) (769)
Unrealized gains (losses) on forward
exchange contracts a) (511) (256) 1,809 1,809
Future income taxes on forward
exchange contracts -- -- (597) (597)
Write-down of goodwill and intangible assets -- -- 6,178 6,178
Amortization of intangible assets -- -- 239 717
Future income taxes on amortization
of intangible assets -- -- (80) (240)
Valuation allowance on future income tax assets -- -- (237) (237)
-------- -------- -------- --------
Net loss for the period in accordance with U.S. GAAP (2,300) (7,113) (30,982) (37,831)
Other comprehensive loss
Foreign currency translation adjustment (3,276) 72 10,272 18,528
Unrealized gains on forward exchange contracts a) 364 364 -- --
-------- -------- -------- --------
Comprehensive loss $ (5,212) $ (6,677) $(20,710) $(19,303)
======== ======== ======== ========
Basic and diluted net loss per share
in accordance with U.S. GAAP $ (0.03) $ (0.11) $ (0.49) $ (0.60)
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTSYEARS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
SHAREHOLDERS' EQUITY
As a result of the aforementioned adjustments to net loss and other
comprehensive loss, significant differences with respect to shareholders'
equity under U.S. GAAP are as follows:
SHARE CAPITAL
AS AT AS AT
MAY 31, AUGUST 31,
2004 2003
--------- ---------
(UNAUDITED)
Share capital in accordance with Canadian GAAP $ 521,691 $ 492,452
Stock-based compensation costs related to stock purchase plan
Current period (26) (75)
Cumulative effect of prior periods 2,403 2,478
Reclassification from other capital upon exercise of
restricted stock awards
Current period 1,784 1,582
Cumulative effect of prior periods 4,852 3,270
Shares issued upon business combinations
Cumulative effect of prior periods 65,584 65,584
--------- ---------
Share capital in accordance with U.S. GAAP $ 596,288 $ 565,291
========= =========
DEFERRED STOCK-BASED COMPENSATION COSTS
AS AT AS AT
MAY 31, AUGUST 31,
2004 2003
---------- ----------
(UNAUDITED)
Deferred stock-based compensation costs in accordance with Canadian GAAP $ -- $ --
Stock-based compensation costs related to stock-based compensation plans
Current period (1,463) --
Cumulative effect of prior periods (1,278) (2,867)
Amortization for the period 1,406 1,483
Reduction of stock-based compensation costs for the period upon
departure of employees 46 106
---------- ----------
Deferred stock-based compensation costs in accordance with U.S. GAAP $ (1,289) $ (1,278)
========== ==========
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTSYEARS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
OTHER CAPITAL
AS AT AS AT
MAY 31, AUGUST 31,
2004 2003
----------- -----------
(UNAUDITED)
Other capital in accordance with Canadian GAAP $ -- $ --
Stock-based compensation costs related to stock-based compensation plans
Current period 1,463 --
Cumulative effect of prior periods 10,281 10,963
Reduction of stock-based compensation costs upon departure of employees (356) (682)
Reclassification to share capital upon exercise of restricted stock awards
Current period (1,784) (1,582)
Cumulative effect of prior periods (4,852) (3,270)
-------- --------
Other capital in accordance with U.S. GAAP $ 4,752 $ 5,429
======== ========
DEFICIT
AS AT AS AT
MAY 31, AUGUST 31,
2004 2003
----------- -----------
(UNAUDITED)
Deficit in accordance with Canadian GAAP $(377,869) $(371,788)
Stock-based compensation costs related to stock-based compensation plans
Current period (776) (832)
Cumulative effect of prior periods (11,406) (10,574)
Unrealized gains (losses) on forward exchange contracts, net of
related future income taxes
Current period (256) 1,102
Cumulative effect of prior periods 1,451 349
Change in reporting currency
Cumulative effect of prior periods 1,016 1,016
Future income taxes on acquired in-process research and development
Cumulative effect of prior periods (1,380) (1,380)
Amortization of intangible assets
Current period -- 832
Cumulative effect of prior periods 1,071 239
Future income taxes on amortization of intangible assets
Current period -- (279)
Cumulative effect of prior periods (359) (80)
Write-down of goodwill and intangible assets
Current period -- 6,178
Cumulative effect of prior periods (56,379) (62,557)
Future income taxes on write-down of intangible assets
Cumulative effect of prior periods 1,154 1,154
Valuation allowance on future income tax assets
Current period -- (252)
Cumulative effect of prior periods (252) --
Amortization of goodwill
Cumulative effect of prior periods (17,716) (17,716)
--------- ---------
Deficit in accordance with U.S. GAAP $(461,701) $(454,588)
========= =========
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTSYEARS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
ACCUMULATED OTHER COMPREHENSIVE INCOME
AS AT AS AT
MAY 31, AUGUST 31,
2004 2003
----------- -----------
(UNAUDITED)
Accumulated other comprehensive income in accordance with Canadian GAAP $ -- $ --
Foreign currency translation adjustment
Current period 72 15,974
Cumulative effect of prior periods 6,104 (9,870)
Unrealized gains on forward exchange contracts
Current period a) 364 --
-------- --------
Accumulated other comprehensive income in accordance with U.S. GAAP $ 6,540 $ 6,104
======== ========
BALANCE SHEETS
The following table summarizes the significant differences in balance sheet
items between Canadian GAAP and U.S. GAAP:
AS AT MAY 31, 2004 AS AT AUGUST 31, 2003
-------------------------------- ----------------------------------
AS REPORTED U.S. GAAP AS REPORTED U.S. GAAP
(UNAUDITED)
Goodwill
Cost $ 92,459 $ 100,881 $ 89,721 $ 101,397
Accumulated amortization (74,696) (92,783) (72,048) (92,610)
--------- --------- --------- ---------
$ 17,763 $ 8,098 $ 17,673 $ 8,787
========= ========= ========= =========
Shareholders' equity
Share capital $ 521,691 $ 596,288 $ 492,452 $ 565,291
Deferred stock-based compensation costs -- (1,289) -- (1,278)
Other capital -- 4,752 -- 5,429
Contributed surplus 1,818 1,529 1,519 1,519
Cumulative translation adjustment 8,498 -- 7,643 --
Deficit (377,869) (461,701) (371,788) (454,588)
Accumulated other comprehensive income -- 6,540 -- 6,104
--------- --------- --------- ---------
$ 154,138 $ 146,119 $ 129,826 $ 122,477
========= ========= ========= =========
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTSYEARS
(tabular amounts in thousands of US dollars,
except share and per share data and as otherwise noted)
STATEMENTS OF CASH FLOWS
For the periods ended May 31, 2003 and 2004, there are no significant
differences between the statements of cash flows under Canadian GAAP as compared
to U.S. GAAP.
RECONCILIATION ITEM
a) Forward exchange contracts
On September 1, 2003, the company implemented the documentation required by
Accounting Guideline 13 of the CICA handbook "Hedging Relationship" for the
designation, documentation and assessment of the effectiveness of its
forward exchange contracts, for the purposes of applying hedge accounting,
as described in note 2.
With this documentation in place, the forward exchange contracts entered
into by the company after September 1, 2003 qualify for hedge accounting
treatment under U.S. GAAP. Consequently, under U.S. GAAP, changes in the
fair value of these contracts are charged to other comprehensive loss.
However, changes in the fair value of contracts entered into prior to
September 1, 2003 continue to be charged to the statements of earnings.
Under Canadian GAAP, foreign exchange translation gains and losses on
contracts entered into either before or after September 1, 2003, are
recognized as an adjustment of the revenue when the sales are recorded.
NEW ACCOUNTING STANDARD
On September 1, 2003, the company prospectively adopted Statement of Financial
Accounting Standard (SFAS) 123, "Accounting for Stock-Based Compensation", under
the revised transition provisions of SFAS 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure". Upon the adoption of SFAS 123 and
SFAS 148, the company recognized stock-based compensation costs for stock
options granted to employees since September 1, 2003, using the fair value-based
method. The company adopted this Statement in order to conform to the newly
adopted rules under Canadian GAAP, as described in note 2. As a result of the
adoption of the fair value-based method, the accounting for stock-based
compensation under Canadian GAAP and U.S. GAAP is the same.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
THIS DISCUSSION AND ANALYSIS MAY CONTAIN FORWARD-LOOKING STATEMENTS
WITHIN THE MEANING OF THE U.S. PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
AND WE INTEND THAT SUCH FORWARD- LOOKING STATEMENTS BE SUBJECT TO THE SAFE
HARBORS CREATED THEREBY. FORWARD-LOOKING STATEMENTS ARE STATEMENTS OTHER THAN
HISTORICAL INFORMATION OR STATEMENTS OF CURRENT CONDITION. WORDS SUCH AS "MAY,"
"WILL," "EXPECT," "BELIEVE," "ANTICIPATE," "INTEND," "COULD," "ESTIMATE" OR
"CONTINUE" OR THE NEGATIVE OR COMPARABLE TERMINOLOGY ARE INTENDED TO IDENTIFY
FORWARD-LOOKING STATEMENTS. IN ADDITION, ANY STATEMENTS THAT REFER TO
EXPECTATIONS, PROJECTIONS OR OTHER CHARACTERIZATIONS OF FUTURE EVENTS OR
CIRCUMSTANCES ARE FORWARD-LOOKING STATEMENTS. FORWARD-LOOKING STATEMENTS ARE NOT
GUARANTEES OF FUTURE PERFORMANCE AND INVOLVE RISKS AND UNCERTAINTIES, AND ACTUAL
RESULTS MAY DIFFER MATERIALLY FROM THOSE IN THE FORWARD-LOOKING STATEMENTS AS A
RESULT OF VARIOUS FACTORS, INCLUDING ECONOMIC UNCERTAINTY, CAPITAL SPENDING
LEVELS IN THE TELECOMMUNICATIONS AND HIGH-TECH INDUSTRIAL MANUFACTURING SECTORS,
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 TO ALIGN WITH ANTICIPATED LEVELS OF BUSINESS, ABILITY TO
MANAGE INVENTORY LEVELS TO ADAPT TO SLOWDOWNS); 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; OUR ABILITY TO
SUCCESSFULLY REALIGN OUR STRATEGIC BUSINESS PLAN; THE RETENTION OF KEY TECHNICAL
AND MANAGEMENT PERSONNEL; AND FUTURE ECONOMIC, COMPETITIVE AND MARKET
CONDITIONS. ASSUMPTIONS RELATING TO THE FOREGOING INVOLVE JUDGMENTS AND RISKS,
ALL OF WHICH ARE DIFFICULT OR IMPOSSIBLE TO PREDICT ACCURATELY AND MANY OF WHICH
ARE BEYOND OUR CONTROL. OTHER RISK FACTORS THAT MAY AFFECT OUR FUTURE
PERFORMANCE AND OUR OPERATIONS ARE DETAILED IN OUR ANNUAL REPORT ON FORM 20-F
AND OUR OTHER FILINGS WITH THE U.S. SECURITIES AND EXCHANGE COMMISSION AND THE
CANADIAN SECURITIES COMMISSION. ALTHOUGH WE BELIEVE THAT THE EXPECTATIONS
REFLECTED IN THE FORWARD-LOOKING STATEMENTS ARE REASONABLE BASED ON INFORMATION
CURRENTLY AVAILABLE TO US, WE CANNOT ASSURE YOU THAT THE EXPECTATIONS WILL PROVE
TO HAVE BEEN CORRECT. ACCORDINGLY, YOU SHOULD NOT PLACE UNDUE RELIANCE ON THESE
FORWARD-LOOKING STATEMENTS. IN ANY EVENT, THESE STATEMENTS SPEAK ONLY AS OF THE
DATE OF THIS DOCUMENT. WE UNDERTAKE NO OBLIGATION TO REVISE OR UPDATE ANY OF
THEM TO REFLECT EVENTS OR CIRCUMSTANCES AFTER THE DATE OF THIS DOCUMENT.
THE FOLLOWING DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS IS DATED JUNE 15, 2004.
ALL DOLLAR AMOUNTS ARE EXPRESSED IN US DOLLARS, EXCEPT AS OTHERWISE
NOTED.
INDUSTRY OVERVIEW
Network service providers (NSPs), the first link in the global
telecommunications supply chain, continuously reduced their capital expenditure
(CAPEX) budgets for almost three years, but in the first nine months of fiscal
2004, some measure of stability returned to the marketplace. NSPs even began
investing in growth pockets, such as Voice over Internet Protocol (VoIP) and
fiber-to-the-premises (FTTP), in order to offer end-customers triple-play
services (voice, data and video). These investments, however, were offset by
CAPEX reductions in other areas to produce relatively flat spending patterns
year-over-year.
This relative stability in CAPEX spending was witnessed in multiple
segments of the global telecommunications industry. System manufacturers
benefited from NSP demand for
1
next-generation converged networks and fiber deployments in access areas.
Optical component vendors, who had been hardest hit by the downturn, still
represented a depressed end-market due to scarce demand for new types of
components. Some test and measurement equipment vendors, whose products enable
customers to reduce both CAPEX and operating expenses (OPEX), attracted the
attention of NSPs and system manufacturers, especially those offering test
solutions for VoIP and/or FTTP applications.
COMPANY OVERVIEW
In the second quarter of fiscal 2004, we began recognizing revenues
from FTTP test solutions. In the third quarter, revenues derived from FTTP test
solutions generated higher-than- expected revenues as we shipped a series of
orders--many of which were FTTP-related--to a Tier-1 NSP that accounted for
25.7% of total sales. This represents an unusually high percentage for the
company, since we typically do not have any 10%-customers in our quarterly sales
figures. The majority of FTTP-related sales were derived from established
products. For the upcoming quarter, we are counting on further market-share
gains and increased acceptance of recently launched products, since we are not
expecting same level of customer concentration.
Based on our GAAP net loss of $1.2 million in the third quarter of
fiscal 2004 and excluding amortization of intangible assets of $1.3 million and
stock-based compensation costs of $200,000, we would have been profitable
($273,000) mainly due to a larger sales volume. In addition, during that same
quarter, operating activities provided positive cash flows for the second
quarter in a row ($605,000). These positive cash flows from operations enabled
us to meet one of our four strategic annual objectives, which consisted of
maintaining a sound financial position.
Remaining focused on market-driven innovation, we launched three new
products in the third quarter, including a next-generation optical time-domain
reflectometer (OTDR). This OTDR is available in the 1310/1490/1550-nm
triple-wavelength configuration sanctioned by leading FTTP standards bodies.
Following the quarter-end, we introduced three additional products: all-in-one
MultiTest module, next-generation Fibre Channel test module - both housed inside
the leading FTB-400 filed-testing plateform - and a passive optical network
(PON) power meter. So far in fiscal 2004, we have released 20 new products.
In the second quarter of fiscal 2004, we introduced seven new products,
including a new line of handheld test instruments that specifically target the
emerging demand for FTTP deployments; as well as our new Packet Blazer TM
Ethernet module, a new protocol-based solution for central offices. In the first
quarter of 2004, we also introduced seven new products, including the 10+
Gigabit Multi-Rate Transceiver with deep channelization and mixed payload
concatenations for next-generation optical networks.
In addition, during the second quarter of fiscal 2004, we successfully
closed the public offering of 5.2 million subordinate voting shares to a
syndicate of Canadian-based underwriters for net proceeds of $29.2 million
(Cdn$38.4 million). As a result, we had a cash position of $84.7 million as of
May 31, 2004.
Furthermore, over the last two quarters, we consolidated our
protocol-layer activities in Montreal to increase efficiency and optimize cost
structure.
2
Also, during the third quarter of fiscal 2004, we succesfully renewed
our collective bargaining agreement with our unionized manufacturing employees
in Quebec City, Canada.
Finally, during the third quarter of fiscal 2004, we performed our
annual impairment test for goodwill and reviewed the carrying value of certain
acquired intangible assets for impairment. Based on our impairment tests, we
concluded that goodwill and these intangible assets were not impaired.
NEW BUSINESS STRUCTURE
At the beginning of fiscal 2004, we reorganized our business under two
new divisions: Telecom Division and Photonics and Life Sciences Division. Our
objectives behind this reorganization were to simplify our business model, adopt
a market approach rather than a product approach and increase accountability
throughout the organization. Our Telecom Division, which consists of the former
Portable and Monitoring and telecom-related Industrial and Scientific product
lines, meets the physical-, optical- and protocol-layer test and measurement
needs of NSPs, system vendors and component manufacturers throughout the global
telecommunications industry. Our Photonics and Life Sciences Division, which
includes previous non-telecom Industrial and Scientific product lines, mainly
leverages developed and acquired technologies for diverse high-tech industrial
manufacturing and research markets.
This simplified business structure - with respective sales, marketing,
manufacturing, research and development and management teams for each division -
enables us to better serve our diverse customer base and to maximize shareholder
value.
EXFO's President and Chief Executive Officer ("CEO"), as the chief
operating decision-maker, assesses the performance of the two segments and
allocates resources to the segments. Earnings (loss) from operations represent
the primary measure used by the CEO in assessing performance of the reportable
segments. Please refer to note 11 to our interim consolidated financial
statements for detailed segment information.
Until August 31, 2003, the company was organized under one reportable
segment; that is, the development, manufacturing and marketing of fiber-optic
test, measurement and monitoring solutions for the global telecommunications
industry.
As part of this reorganization and consistent with our overall business
strategy, we are continuously reviewing our various assets.
OUR STRATEGY, KEY PERFORMANCE INDICATORS AND CAPABILITY TO DELIVER RESULTS
For a complete description of our strategy and the related key
performance indicators as well as our capability to deliver results, please
refer to the corresponding sections in our most recent annual report filed with
the securities commissions.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
For a complete description of our critical accounting policies and
estimates, please refer to the critical accounting policies and estimates in our
most recent annual report filed with the securities commissions. The following
points detail the changes in critical accounting policies that have occurred
since our most recent annual report:
3
HEDGING RELATIONSHIP. On September 1, 2003, we implemented the
documentation required by Accounting Guideline 13 of the Canadian Institute of
Chartered Accountants (CICA) handbook, "Hedging Relationship", which establishes
new rules for designating, documenting and assessing the effectiveness of
hedging relationships, such as our forward exchange contracts. If these rules
are not met, hedge accounting can not be applied. Consequently, our forward
exchange contracts, which are used to hedge anticipated US-dollar-denominated
sales, continue to qualify for hedge accounting; foreign exchange translation
gains and losses on these contracts continue to be recognized as an adjustment
of the revenue when the sales are recorded.
STOCK-BASED COMPENSATION COSTS. On September 1, 2003, we prospectively
adopted the amendments made to handbook section 3870, "Stock-Based Compensation
and Other Stock-Based Payments". These amendments require an expense to be
recognized in financial statements for all forms of employee stock-based
compensation, including stock options, using a fair value-based method. The fair
value-based method involves significant subjective assumptions such as the
expected volatility of our stocks and the expected life of the options. During
the nine months ended May 31, 2004, we granted 506,500 stock options to our
employees. The aggregate fair value of these stock options amounted to
$1,463,000. The corresponding stock-based compensation costs were amortized
using the graded vesting method, resulting in stock-based compensation costs of
$200,000 and $289,000 for the three months and the nine months ended May 31,
2004, respectively. Most of these costs have been recorded in selling and
administrative expenses and in research and development expenses in the
statements of earnings.
4
RESULTS OF OPERATIONS
The following discussion and analysis of our consolidated financial
condition and results of operations for the three months and nine months ended
May 31, 2003 and 2004, should be read in conjunction with our interim
consolidated financial statements and the related notes thereto. Our interim
consolidated financial statements have been prepared in accordance with Canadian
generally accepted accounting principles (Canadian GAAP), which conform in all
material respects with United States generally accepted accounting principles
(U.S. GAAP), except as described in note 12 to our interim consolidated
financial statements. Our functional currency is the Canadian dollar although we
report our financial statements in US dollars. The following tables set forth
our interim consolidated statements of earnings in thousands of US dollars,
except per share data, and as a percentage of sales for the periods indicated:
THREE MONTHS NINE MONTHS THREE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
MAY 31, 2004 MAY 31, 2004 MAY 31, 2003 MAY 31, 2003
------------ ------------ ------------ ------------
(UNAUDITED) (UNAUDITED)
Sales $ 20,456 $ 15,103 $ 53,298 $ 47,604
Cost of sales (1,2) 9,637 10,460 24,980 26,430
-------- -------- -------- --------
Gross margin 10,819 4,643 28,318 21,174
-------- -------- -------- --------
Operating expenses
Selling and administrative (1) 6,927 7,052 19,543 20,955
Net research and development 3,321 5,882 9,642 12,681
Amortization of property, plant and
equipment (1) 1,198 1,368 3,814 3,936
Amortization of intangible assets (1) 1,261 1,490 3,837 4,398
Write-down of intangible assets -- 2,922 -- 2,922
Write-down of goodwill -- 4,505 -- 4,505
Restructuring charges -- 348 -- 348
-------- -------- -------- --------
Total operating expenses 12,707 23,567 36,836 49,745
-------- -------- -------- --------
Loss from operations (1,888) (18,924) (8,518) (28,571)
Interest and other income 398 379 1,068 929
Foreign exchange gain (loss) 167 (600) 124 (1,310)
-------- -------- -------- --------
Loss before income taxes (1,323) (19,145) (7,326) (28,952)
Income taxes (135) 19,282 (1,245) 15,879
-------- -------- -------- --------
Net loss for the period $ (1,188) $(38,427) $ (6,081) $(44,831)
======== ======== ======== ========
Basic and diluted net loss per share $ (0.02) $ (0.61) $ (0.09) $ (0.71)
OTHER STATEMENTS OF EARNINGS DATA:
Segment information:
Sales:
16,624 12,020 $ 42,106 37,957
Telecom Division
Photonics and Life Sciences Division $ 3,832 $ 3,083 $ 11,192 $ 9,647
-------- -------- -------- --------
$ 20,456 $ 15,103 $ 53,298 $ 47,604
======== ======== ======== ========
Loss from operations: (3)
(772) -- $ (5,616) --
Telecom Division $ $ $
Photonics and Life Sciences Division (1,116) -- (2,902) --
-------- -------- -------- --------
$ (1,888) $ -- $ (8,518) $ --
======== ======== ======== ========
Research and development data:
Gross research and development $ 4,176 $ 4,639 $ 12,035 $ 13,261
Net research and development $ 3,321 $ 5,882 $ 9,642 $ 12,681
(1) Certain comparative figures have been reclassified to conform to the
current periods' presentation.
(2) Including inventory write-offs of $1,646 for the periods ended May 31, 2003
(3) Comparative segment information for the loss from operations is not
available and is impracticable to determine.
5
THREE MONTHS NINE MONTHS THREE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
MAY 31, 2004 MAY 31, 2004 MAY 31, 2003 MAY 31, 2003
------------ ------------ ------------ ------------
(UNAUDITED) (UNAUDITED)
Sales 100.0% 100.0% 100.0% 100.0%
Cost of sales (1,2) 47.1 69.3 46.9 55.5
-------- ------- ------- -------
Gross margin 52.9 30.7 53.1 44.5
-------- ------- ------- -------
Operating expenses
Selling and administrative (1) 33.9 46.7 36.7 44.0
Net research and development 16.2 38.9 18.1 26.7
Amortization of property, plant and equipment (1) 5.8 9.1 7.1 8.3
Amortization of intangible assets (1) 6.2 9.9 7.2 9.2
Write-down of intangible assets -- 19.3 -- 6.1
Write-down of goodwill -- 29.8 -- 9.5
Restructuring charges -- 2.3 -- 0.7
-------- ------- ------- -------
Total operating expenses 62.1 156.0 69.1 104.5
-------- ------- ------- -------
Loss from operations (9.2) (125.3) (16.0) (60.0)
Interest and other income 1.9 2.5 2.0 2.0
Foreign exchange gain (loss) 0.8 (4.0) 0.3 (2.8)
-------- ------- ------- -------
Loss before income taxes (6.5) (126.8) (13.7) (60.8)
Income taxes (0.7) 127.6 (2.3) 33.4
-------- ------- ------- -------
Net loss for the period (5.8)% (254.4)% (11.4)% (94.2)%
======== ======= ======= =======
OTHER STATEMENTS OF EARNINGS DATA:
Segment information:
Loss from operations: (3)
Telecom Division (3.8)% -- % (10.5)% -- %
Photonics and Life Sciences Division (5.4) -- (5.5) --
-------- ------- ------- -------
(9.2)% -- % (16.0)% -- %
======== ======= ======= =======
Research and development data:
Gross research and development 20.4% 30.7% 22.6% 27.9%
Net research and development 16.2% 38.9% 18.1% 26.7%
-------- ------- ------- -------
(1) Certain comparative figures have been reclassified to conform to the
current periods' presentation.
(2) Including inventory write-offs 10.9% and 3.5% of sales for the three months
and the nine months ended May 31, 2003, respectively. Excluding these
inventory write-offs, gross margin would have reached 41.6% and 47.9% of
sales for the three months and the nine months ended May 31, 2003,
respectively. This latter information is a non-GAAP measure.
(3) Comparative segment information for the loss from operations is not
available and is impracticable to determine.
6
SALES
THREE MONTHS ENDED MAY 31, 2004, VS. THREE MONTHS ENDED MAY 31, 2003
For the three months ended May 31, 2004, our global sales increased
35.4% to $20.5 million from $15.1 million for the same period last year, with a
81%-19% split in favor of our Telecom Division.
TELECOM DIVISION
For the three months ended May 31, 2004, sales of our Telecom Division
increased 38.3% to $16.7 million from $12.0 million for the same period last
year. During the third quarter of fiscal 2004, revenues from FTTP test solutions
were higher than expected, which contributed to increase our sales. Also, the
positive environment spending helped us to increase our sales for this quarter.
Finally, we believe that we have gained market share for our physical-layer
field-testing products.
However, despite the significant increase in our Telecom sales in the
third quarter of fiscal 2004, sales of our protocol-layer test solutions
represented less than 10% of our global sales in the third quarter of fiscal
2004. The current protocol-layer test market proves to be highly competitive as
it prepares for deployment of next-generation SONET/SDH and new IP-intensive
architectures. We are remaining confident the solid product portfolio we are
building for this crucial end-market for EXFO will lead to good long-term
growth.
PHOTONICS AND LIFE SCIENCES DIVISION
For the three months ended May 31, 2004, sales of our Photonics and
Life Sciences Division increased 24.3% to $3.8 million from $3.1 million for the
same period last year. The increase in sales is due to the greater demand for
our high-tech industrial manufacturing solutions, mainly our X-CITETM 120
Fluorescence Illumination System.
Overall, for the two divisions, net accepted orders increased 41.8% to
$20.0 million in the third quarter of fiscal 2004 from $14.1 million for the
same period last year. The relative stability in CAPEX spending and market-share
gain helped us increase our bookings. Our net book-to-bill ratio rose to 0.98 in
the third quarter of 2004, from 0.93 for the same period last year. In the
previous quarter, the net book-to-bill ratio reached 1.05.
For the upcoming quarter, we expect the sales split between the two
divisions to remain in the same ranges as for the two previous quarters.
NINE MONTHS ENDED MAY 31, 2004, VS. NINE MONTHS ENDED MAY 31, 2003
For the nine months ended May 31, 2004, our global sales increased
12.0% to $53.3 million from $47.6 million for the same period last year, with a
79%-21% split in favor of our Telecom Division.
TELECOM DIVISION
For the nine months ended May 31, 2004, Telecom Division sales
increased 10.9% to $42.1 million from $38.0 million for the same period last
year. As explained above, this significant growth in the third quarter of fiscal
2004 helped us increase our sales year-over-year.
7
It should be noted that this division's sales have been increasing since the
last quarter of fiscal 2003.
Since the last few months, we have been offering new and enhanced
warranty programs, significantly increasing extended-warranty sales. Revenues
from these sales of these warranties are deferred and recognized over the
warranty-period, causing our deferred revenue to increase.
PHOTONICS AND LIFE SCIENCES DIVISION
For the nine months ended May 31, 2004, Photonics and Life Sciences
Division sales increased 16.0% to $11.2 million from $9.6 million for the same
period last year. This growth in sales is due to the greater demand for our
high-tech industrial manufacturing solutions, mainly our X-CITETM 120
Fluorescence Illumination System.
GEOGRAPHIC DISTRIBUTION
For the three months ended May 31, 2004, sales to the Americas,
Europe-Middle East- Africa (EMEA) and Asia-Pacific (APAC) accounted for 65%, 20%
and 15% of global sales, respectively. For the corresponding period last year,
sales to the Americas, EMEA and APAC accounted for 72%, 15% and 13% of global
sales, respectively. During the third quarter of fiscal 2003, our sales to the
EMEA and APAC markets were unusually low, thus causing sales to the Americas to
represent a larger portion of our global sales. In the third quarter of fiscal
2004, our sales to the EMEA and APAC markets were closer to their usual level in
percentage of global sales.
For the nine months ended May 31, 2004, sales to the Americas, EMEA and
APAC accounted for 66%, 18% and 16% of global sales, respectively. For the
corresponding period last year, sales to the Americas, EMEA and APAC accounted
for 66%, 19% and 15%, respectively.
Through our two divisions, we sell our products to a broad range of
customers, including NSPs, optical component and system manufacturers, as well
as high-tech industrial manufacturers and research and development laboratories.
During the three months ended May 31, 2004, we had an unusually high amount of
sales to a single customer that accounted for 25.7% of our sales. During that
same period, our top three customers accounted for 32.9% of our sales. For the
corresponding period last year, no customer accounted for more than 9.5% of our
sales and our top three customers accounted for 19.4% of our sales the same
period last year. For the nine months ended May 31, 2004, our top customer
accounted for 14.0% of our sales and our top three customers accounted for 21.6%
of our sales. For the nine months ended May 31, 2003, no customer accounted for
more than 6.5% of sales and our top three customers accounted for 19.4% of our
sales for that same period.
Considering the sales level and the net book-to-bill ratio for the
first three quarters of fiscal 2004 as well as the expected market-share gain in
protocol-testing and FTTP solutions, we still believe that we will achieve our
KPI; that is, 10% sales growth year-over-year in a stable or slightly declining
telecommunications market.
GROSS MARGIN
Gross margin amounted to 52.9% of sales for the three months ended May
31, 2004, compared to 30.7% for the same period last year. For the three months
ended May 31, 2003,
8
we recorded write-offs for excess and obsolete inventories of $1.6 million.
Excluding this special charge, gross margin would have reached 41.6% of sales
for that period. The increase in our gross margin can be explained by several
factors. First, the rise in sales (35.4% year-over-year) has undoubtedly helped
increase our gross margin during the quarter. Increased manufacturing activities
allowed us to better absorb our fixed manufacturing costs. In addition, our
cost-reduction measures and our enhanced efficiency further contributed to the
increase in gross margin. However, the increase was offset in part by the shift
in the geographic distribution of our sales. In the third quarter of 2004, this
shift resulted in more sales made to the EMEA and APAC markets, where gross
margins tend to be lower. Also, a stronger Canadian dollar, compared to the US
dollar year-over-year, prevented us, to some extent, from further improving our
gross margin as some cost of sales elements are denominated in Canadian dollars.
Our gross margin amounted to 53.1% of sales for the nine months ended
May 31, 2004, compared to 44.5% for the same period last year. Excluding the
special charge recorded in the third quarter of fiscal 2003 for excess and
obsolete inventories, gross margin would have reached 47.9% of sales for the
nine months ended May 31, 2003. The increase in our gross margin can be
explained by the increase in our sales, the positive effects of our cost-cutting
measures, our enhanced efficiency and increased manufacturing activities, which
led to a better absorption of our fixed manufacturing costs. However, a stronger
Canadian dollar, compared to the US dollar year-over-year, prevented us, to some
extent, from further improving our gross margin.
The 53.1% gross margin reached for the nine months ended May 31, 2004,
leads us to believe that our 50% gross margin objective for fiscal 2004 will be
attained.
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.
It should be noted that a new presentation was adopted, where certain
expenses were reclassified from selling and administrative expenses to cost of
sales. Consequently, comparative figures have also been reclassified, resulting
in a cost of sales increase of 4.0% and 2.8% for the three and nine months ended
May 31, 2003, respectively, with comparable percentage of sales decreases in
selling and administrative expenses for these same periods.
SELLING AND ADMINISTRATIVE
For the three months ended May 31, 2004, selling and administrative
expenses were $6.9 million, or 33.9% of sales, compared to $7.1 million, or
46.7% of sales for the same period last year. Our restructuring actions combined
with tight cost-control measures contributed to the reduction of our selling and
administrative expenses year-over-year. However, several factors prevented us
from further reducing these expenses year-over-year. Higher sales volume in the
third quarter of fiscal 2004, compared to the same period last year caused our
commission expenses to increase. In addition, since September 1, 2003, we
account for the non-cash stock-based compensation costs related to awards
granted to our employees, which caused our selling and administrative expenses
to increase $115,000 year-over-year. Finally, a stronger Canadian dollar,
compared to the US dollar year-over-year, further increased our selling and
administrative expenses, as some of our selling and administrative expenses are
incurred in Canadian dollars.
9
For the nine months ended May 31, 2004, selling and administrative
expenses were $19.5 million, or 36.7% of sales, compared to $21.0 million, or
44.0% of sales for the same period last year. As mentioned above, our
restructuring actions combined with tight cost-control measures contributed to
the reduction of our selling and administrative expenses year-over-year.
However, several factors, such as increased commissions on higher sales volume,
a stronger Canadian dollar as well as the recognition of non-cash stock-based
compensation costs of $174,000 prevented us from further reducing our selling
and administrative expenses year-over-year.
Considering the challenging market conditions, we will continue to
maintain our selling and administrative expenses at an acceptable level without
impeding our efforts to strategically position our company, improve our sales,
and provide quality service to customers. However, any further increase in the
value of the Canadian dollar will negatively affect our selling and
administrative expenses in the upcoming quarter.
RESEARCH AND DEVELOPMENT
For the three months ended May 31, 2004, gross research and development
expenses totaled $4.2 million, or 20.4% of sales, compared to $4.6 million, or
30.7% of sales for the same period last year. The decrease in our gross research
and development in dollars and as percentage of sales can be explained by
several factors. First, our restructuring actions combined with tight
cost-control measures contributed to the reduction of our gross research and
development expenses year-over-year. In addition, we refocused our research and
development activities in our Photonics and Life Sciences Division based on our
strategy to leverage existing core telecom technologies. 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 expenses are incurred in Canadian dollars.
Although we reduced our gross research and development expenses
year-over-year, we still invested significantly in research and development
activities in the third quarter of fiscal 2004, mainly in our Telecom Division,
as we firmly believe that innovation and new product introductions are the key
to gaining market share in the current economic environment and to ensuring the
long-term growth and profitability of the company.
In the third quarter of fiscal 2004, 21% of sales originated from
products that have been on the market for two years or less. For the third
quarter of 2003, this number reached 48% of sales.
For the three months ended May 31, 2004, tax credits and grants from
the Canadian federal and provincial governments for research and development
activities were $855,000, or 20.5% of gross research and development expenses,
compared to $1.1 million, or 22.7% of gross research and development expenses
for the same period last year. The decrease in our tax credits and government
grants is mainly related to the decrease in our eligible gross research and
development expenses in Canada, since we were entitled to similar grant programs
and tax credits year-over-year.
For the nine months ended May 31, 2004, gross research and development
expenses totaled $12.0 million, or 22.6% of sales, compared to $13.3 million, or
27.9% of sales for the
10
same period last year. The decrease in gross research and development dollars
and as percentage of sales year-over-year is mostly attributable to our
restructuring efforts as well as tight cost-control measures and the fact that
we refocused our research and development activities in our Photonics and Life
Sciences Division as explained above. However, it should be noted that the
overall decrease in dollar amount was offset in part by the increased value of
the Canadian dollar (compared to the US dollar) year-over-year, since a large
portion of our research and development expenses are denominated in Canadian
dollars.
For the nine months ended May 31, 2004, tax credits and grants from the
Canadian federal and provincial governments for research and development
activities were $2.4 million, or 19.9% of gross research and development
expenses, compared to $2.9 million, or 21.7% of gross research and development
expenses for the same period last year. The decrease in our tax credits and
government grants is mainly related to the decrease in our eligible gross
research and development expenses in Canada, since we were also entitled to
almost the same grant programs and tax credits year-over-year.
In the third quarter of fiscal 2003, we wrote off $2.3 million of
Canadian federal tax credits that can be carried forward against future years'
taxable income over the next nine years.
In the third quarter of fiscal 2004, 21% of our sales originated from
products that have been on the market for two years or less. For the third
quarter of 2003, this number reached 48% of sales. For the nine months ended May
31, 2004, 29% of sales originated from products that have been on the market for
two years or less. The 2004 figures are well below our fiscal 2004 objective of
45%. A higher portion of our sales came from established products, mainly for
FTTP deployments, which caused our percentage of sales of new products to be
lower than expected. With only one quarter left in the year, we won't reach our
objective of 45%. Based on current results and expected sales for the next
quarter, we believe that new-product sales will represent 30% of our sales for
fiscal 2004. However, based on the importance and on the number of products
introduced over the last two years, and so far in fiscal 2004, we still believe
that new products will represent in excess of 40% of our sales in the foreseable
future.
We expect to continue investing significantly in the research and
development activities of our Telecom Division in the upcoming quarters,
reflecting our focus on innovation, our desire to gain market share and our goal
to exceed customer needs and expectations.
AMORTIZATION OF INTANGIBLE ASSETS
For the three months and the nine months ended May 31, 2004,
amortization of intangible assets was $1.3 million and $3.8 million,
respectively, compared to $1.5 million and $4.4 million, for the corresponding
periods last year. The decrease in the amortization expense in fiscal 2004
compared to 2003 is the result of the impairment charge recorded in the third
quarter of fiscal 2003.
INTEREST AND OTHER INCOME
For the three months and nine months ended May 31, 2004, interest and
other income amounted to $398,000 and $1.1 million, respectively, compared to
$379,000 and $929,000 for the corresponding periods last year. During the second
quarter of fiscal 2004, we recorded a one-time revenue of $225,000 for the sale
of a non-core technology to a third party. Without this one-time revenue,
interest and other income would have been relatively flat year-over-year.
We expect our interest income to increase in upcoming quarters
following our public offering in the second quarter of fiscal 2004.
11
FOREIGN EXCHANGE GAIN (LOSS)
For the three months and nine months ended May 31, 2004, the foreign
exchange gain amounted to $167,000 and $124,000, respectively, compared to a
foreign exchange loss of $600,000 and $1.3 million for the corresponding periods
last year.
Foreign exchange gains and losses are the result of the translation of
operating activities denominated in currencies other than the Canadian dollar.
During the three months and the nine months ended May 31, 2004, the Canadian
dollar value remained relatively stable resulting in a small foreign exchange
gains during these periods. In contrast, during the three months and the nine
months ended May 31, 2003, the Canadian dollar value increased significantly,
resulting in a significant exchange loss during these periods.
We manage our exposure to currency risk with forward exchange contracts
and operating activities, denominated in currencies other than the Canadian
dollar, of our Canadian entities.
INCOME TAXES
For the three months ended May 31, 2004, we recorded a tax recovery of
$135,000. The income tax recovery represents income taxes recoverable in some
specific tax jurisdictions. Since the third quarter of fiscal 2003, we recorded
a full valuation allowance on our future income tax assets because it is more
likely than not that these assets will not be recovered. For the three months
ended May 31, 2003, we recorded a tax expense of $19.3 million, mainly related
to the valuation allowance recorded on our future income tax assets during that
quarter.
For the nine months ended May 31, 2004, we recorded a tax recovery of
$1.2 million mainly due to the $1.4 million non-recurring income tax recovery
recorded in the first quarter of 2004. This non-recurring gain was due to the
recovery, during that period, of income taxes paid in previous periods following
the receipt of a tax assessment.
LIQUIDITY AND CAPITAL RESOURCES
We finance our operations and meet our capital expenditure requirements
mainly through cash flows from operating activities, the use of our cash and
short-term investments as well as the issuance of subordinate voting shares.
During the second quarter of fiscal 2004, pursuant to a public offering
in Canada, we issued 5,200,000 subordinate voting shares for net proceeds of
$29.2 million (Cdn$38.4 million) after deducting underwriting commissions of
$1.2 million (Cdn$1,601,000). These net proceeds will be used for working
capital and other general corporate purposes, including potential acquisitions,
although we currently have no commitments or agreements regarding any
acquisitions. Cash flows provided by financing activities for the nine months
ended May 31, 2004 are attributable to the net proceeds of this offering.
One of the four main objectives of our strategic plan for fiscal 2004
is to maintain a sound financial position. We believe that such an objective is
in line with a strong cash position and working capital. As at May 31, 2004 cash
and short-term investments consisted of $84.7 million, while our working capital
was at $108.9 million. Our cash and short-term investments decreased $1.1
million compared to February 29, 2004, mainly due the cash payment of $238,000
for the purchase of property, plant and equipment as well as an unrealized
foreign
12
exchange loss of $1.4 million on cash and short-term investments. However, the
decrease in cash and short-term investment was offset in part by cash flows from
operating activities of $605,000. The unrealized foreign exchange loss 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. It should be noted that any decline in the
Canadian dollar value compared with the US dollar in future periods will
negatively affect the value of our cash and short-term investments.
We believe that our cash balances and short-term investments, combined
with an available line of credit of $6.4 million, will be sufficient to meet our
liquidity and capital requirements for the foreseeable future. However, possible
additional operating losses and/or possible investment in or acquisition of
complementary businesses, products or technologies may require additional
financing. There can be no assurance that additional debt or equity financing
will be available when required or, if available, it can be secured on
satisfactory terms. Our line of credit bears interest at prime rate.
OPERATING ACTIVITIES
Cash flows provided by operating activities were $605,000 for the three
months ended May 31, 2004, compared to cash flows used of $92,000 for the same
period last year. Cash flows provided by operating activities in the third
quarter of fiscal 2004 were mainly attributable to the net earnings after items
not affecting cash of $2.0 million, offset in part by the net increase of our
operating items of $1.4 million; that is, our accounts receivable increased by
$2.4 million and our inventories decreased by $687,000. The increase in our
accounts receivable is directly related to the significant sales growth in the
third quarter of fiscal 2004. On the other hand, the increased sales level
enabled us to reduced our inventories overall.
Cash flows used by operating activities were $762,000 for the nine
months ended May 31, 2004, compared to cash flows provided of $9.3 million for
the same period last year. Cash flows used by operating activities for the nine
months ended May 31, 2004 were mainly the result of the increase of some of our
operating items; that is, accounts receivable increased by $2.2 million and
income taxes and tax credits recoverable increased by $1.6 million. The increase
in our accounts receivable is directly related to the significant sales growth
in the third quarter of fiscal 2004. The increase in our income taxes and tax
credits recoverable is due to the payment, during the period, of income taxes
payable for previous periods and the recognition of tax credits earned during
the period but not yet recovered. The increase of these two items was offset in
part by the net earnings after items not affecting cash of $3.3 million.
With positive cash flows from operating activities for the last two
quarters, we met one of our four annual strategic objectives, which consisted in
maintaining a sound financial position.
INVESTING ACTIVITIES
Cash flows provided by investing activities were $160,000 for the three
months ended May 31, 2004, compared to cash flows used of $1.3 million for the
same period last year. In the third quarter of fiscal 2004, we sold $398,000
worth of short-term investments and paid $238,000 for the purchase of property,
plant and equipment.
Cash flows used by investing activities amounted to $28.8 million for
the nine months ended May 31, 2004, compared to $13.1 million for the same
period last year. During the second quarter of fiscal 2004, we acquired $28.4
million worth of short-term investments with the net proceeds of the public
offering.
13
CONTINGENCY
As discussed in note 9 to our interim consolidated financial
statements, in November 2001, the company was named as a defendant in a U.S.
securities class action related to its initial public offering (IPO) in June
2000. The complaints allege that the prospectus and the registration statement
for the IPO failed to disclose that the underwriters allegedly received
excessive commissions and that the underwriters and some investors collaborated
in order to inflate the price of EXFO's stock in the aftermarket. Even though
the process is continuing in this class action, we have no significant
developments to report in this quarter.
SHARE CAPITAL AND STOCK-BASED COMPENSATION PLANS
SHARE CAPITAL
As at May 31, 2004, EXFO had 37,900,000 multiple voting shares
outstanding, entitling to ten votes each and 30,526,108 subordinate voting
shares outstanding. The multiple voting shares and the subordinate voting shares
are unlimited as to number and without par value.
STOCK OPTION PLAN
The aggregate number of subordinate voting shares covered by options
granted under the stock option plan was 3,124,243 as at May 31, 2004. The
weighted average exercise price of those stock options was $13.69 compared to
the market price of $4.59 per share as at May 28, 2004. The maximum number of
subordinate voting shares issuable under the plan cannot exceed 6,306,153
shares. The following table summarizes information about stock options granted
to the members of the Board of Directors and to Management and Corporate
Officers of the company and its subsidiaries as at May 31, 2004:
WEIGHTED
% OF ISSUED AVERAGE
AND EXERCISE
NUMBER OUTSTANDING PRICE
--------------- --------------- --------------
Chairman of the Board, President and CEO
(one individual) 150,482 4.8% $ 9.91
Board of Directors (five individuals) 194,375 6.2% $ 6.23
Management and Corporate Officers
(seven individuals) 315,300 10.1% $ 15.03
--------------- --------------- --------------
660,157 21.1% $ 11.27
--------------- --------------- --------------
RESTRICTED STOCK AWARD PLAN
In addition to the stock option plan, we maintain a restricted stock
award plan for some U.S.-based employees. The aggregate number of subordinate
voting shares covered by restricted stock awards was 66,654 as at May 31, 2004.
Each restricted stock award entitles employees to receive one subordinate voting
share at a purchase price of nil.
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RISKS AND UNCERTAINTIES
Over the past few years, we have managed our business, focused on
research and development of new and innovative products, prospered in
international markets and closed strategic acquisitions. However, we operate in
a highly competitive field that is in constant evolution and, as a result, we
encounter various risks and uncertainties that must be given appropriate
consideration in our strategic management policies.
The main risks and uncertainties related to the telecommunication test
and measurement industry involve the rapid development of new products that have
short life cycles and require extensive research and development; the difficulty
of predicting market size and trends; the difficulty of retaining highly skilled
employees; and the ability to quickly adapt our cost structure to changing
market conditions in order to achieve profitability.
In addition, given our strategic goals for growth and competitive
positioning in our industry, we are expanding into international markets. This
exposes us to certain risks and uncertainties related to changes in local laws
and regulations, multiple technological standards, protective legislation and
pricing pressure.
Furthermore, while some strategic acquisitions we have completed are
essential to our long-term growth, they also expose us to certain risks and
uncertainties related to the rapid and effective integration of these businesses
as well as their products, technologies and personnel.
We are also exposed to currency risks as a result of the export of our
products manufactured in Canada, substantially all of which are denominated in
US dollars. These risks are partially hedged by operating expenses denominated
in US dollars, the purchase of raw materials in US dollars and forward exchange
contracts.
The economic slowdown in our industry could also result in some of our
customers experiencing difficulties and, consequently, this could have a
negative effect on our results especially in terms of future sales and
recoverability of accounts receivable. However, the sectorial and geographic
diversity of our customer base provides us with a reasonable level of protection
in this area. Finally, other financial instruments, which potentially subject us
to credit risks, consist mainly of cash, short-term investments and forward
exchange contracts. Our short-term investments consist of debt instruments
issued by high-credit quality corporations 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 disclosures documents
published with securities commissions.
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