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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 6-K
REPORT OF FOREIGN PRIVATE ISSUER PURSUANT TO RULE 13a-16 OR 15d-16
UNDER THE SECURITIES EXCHANGE ACT OF 1934
For the month of November, 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-______.
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In November 2004, EXFO Electro-Optical Engineering Inc., a Canadian corporation,
issued its annual report containing its annual audited financial statements and
management's discussion and analysis thereof for its fiscal year ended August
31, 2004. At the same time, it also issued its notice of its annual and special
shareholders' meeting, its form of proxy, its management proxy circular and a
cover letter. This report on Form 6-K sets forth said documents.
The annual report containing the Corporation's annual audited financial
statements and management's discussion and analysis for its fiscal year ended
August 31, 2004, its notice of annual and special shareholders' meeting, its
form of proxy, its management proxy circular and cover letter are hereby
incorporated as documents by reference to Form F-3 (Registration Statement under
the Securities Act of 1933) declared effective as of July 30, 2001 and to Form
F-3 (Registration Statement under the Securities Act of 1933) declared effective
as of March 11, 2002 and to amend certain material information as set forth in
these two Form F-3 documents.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
By: /s/ Germain Lamonde
---------------------------------
Name: Germain Lamonde
Title: President and Chief Executive Officer
Date: November 29, 2004
2004 ANNUAL REPORT
EXFO
EXPERTISE REACHING OUT
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CORPORATE PROFILE
EXFO is a recognized test and measurement expert in the global
telecommunications industry through the design and manufacture of advanced and
innovative solutions as well as best-in-class customer support. The Telecom
Division, which represents our main business activity, offers fully integrated
and complete test solutions to network service providers, system vendors and
component manufacturers in approximately 70 countries. One of our strongest
competitive advantages is our PC/Windows-based modular platforms that host a
wide range of tests across optical, physical, data and network layers, while
maximizing technology reuse across several market segments. The Photonics and
Life Sciences Division mainly leverages core telecom technologies to offer
value-added solutions in the life sciences, high precision assembly and research
sectors. For more information about EXFO, visit www.exfo.com.
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TABLE OF CONTENTS
1 Financial Highlights
2 Letter to Shareholders
5 Corporate Highlights
6 Telecom Division
8 Photonics and Life Sciences Division
9 Management's Discussion and Analysis
24 Management's Report
24 Auditors' Report
25 Consolidated Financial Statements
29 Notes to Consolidated Financial Statements
49 Board of Directors
50 Management and Corporate Officers
51 Corporate Governance Practices
53 Glossary
54 Shareholder Information
55 Worldwide Offices
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FORWARD-LOOKING STATEMENTS
This Annual Report may contain forward-looking statements within the meaning of
the U.S. Private Securities Litigation Reform Act of 1995 and we intend that
such forward-looking statements be subject to the safe harbors created thereby.
Forward-looking statements are statements other than historical information or
statements of current condition. Words such as "may," "will," "expect,"
"believe," "anticipate," "intend," "could," "estimate" or "continue" or the
negative or comparable terminology are intended to identify forward-looking
statements. In addition, any statements that refer to expectations, projections
or other characterizations of future events or circumstances are 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 in the telecommunications and
high-tech industrial manufacturing sectors, fluctuating exchange rates and our
ability to execute successfully in these uncertain conditions; the effects of
the additional actions we have taken in response to such economic uncertainty
(including workforce reductions, ability to quickly adapt cost structures to
align with anticipated levels of business, ability to manage inventory levels to
adapt to slowdowns); market acceptance of our new products and other upcoming
new products; limited visibility with regards to customer orders and the timing
of such orders; our ability to successfully integrate and run our acquired and
to-be-acquired 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 commissions. Although we
believe that the expectations reflected in the forward-looking statements are
reasonable based on information currently available to us, we cannot assure you
that the expectations will prove to have been correct. Accordingly, you should
not place undue reliance on these forward-looking statements. In any event,
these statements speak only as of the date of this document. We undertake no
obligation to revise or update any of them to reflect events or circumstances
after the date of this document.
TRADEMARKS AND LOGOS
EXFO and the EXFO logo are registered trademarks of EXFO Electro-Optical
Engineering Inc. in Canada, the United States and/or other countries. Other EXFO
product names or logos referenced in this document are either trademarks or
registered trademarks of EXFO Electro-Optical Engineering Inc. or of its
affiliated companies. All other product names and trademarks mentioned herein
are trademarks of their respective owners. However, neither the presence nor
absence of the identification symbols (R) or TM affects the legal status of any
trademark.
All dollar amounts in this Annual Report are expressed in US dollars, except as
otherwise noted.
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1 | 2004 Annual Report | EXFO
FINANCIAL HIGHLIGHTS
(in thousands of US dollars, except per share data)
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CONSOLIDATED STATEMENTS OF EARNINGS DATA 2004 2003 2002 2001 2000
----------------------------------------------------------------------------------------------------------------------------
Sales $ 74,630 $ 61,930 $ 68,330 $ 146,013 $ 71,639
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Gross margin (1) $ 40,074 $ 25,733 $ 15,964 $ 89,806 $ 46,254
53.7% 41.6% 23.4% 61.5% 64.6%
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Gross research and development $ 15,668 $ 17,133 $ 17,005 $ 17,601 $ 9,374
21.0% 27.7% 24.9% 12.1% 13.1%
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Earnings (loss) from operations (2) $ (10,570) $ (39,584) $ (74,783) $ 14,507 $ 14,723
(14.1%) (63.9%) (109.4%) 9.9% 20.6%
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Net earnings (loss) $ (8,424) $ (54,950) $(308,524) $ (15,294) $ 9,924
(11.3%) (88.7%) (451.5%) (10.5%) 13.9%
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Basic and diluted net earnings (loss) per share $ (0.13) $ (0.87) $ (5.09) $ (0.29) $ 0.25
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OTHER STATEMENTS OF EARNINGS DATA (UNAUDITED)(3)
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Pro forma net earnings (loss) $ (1,952) $ (10,879) $ (10,702) $ 24,693 $ 10,279
(2.6%) (17.6%) (15.7%) 16.9% 14.3%
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Basic and diluted pro forma net earnings (loss) per share $ (0.03) $ (0.17) $ (0.18) $ 0.47 $ 0.26
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CONSOLIDATED BALANCE SHEETS DATA
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Cash and short-term investments $ 89,128 $ 57,376 $ 49,681 $ 74,590 $163,388
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Working capital $ 115,141 $ 77,408 $ 91,374 $ 130,289 $194,167
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Total assets $ 172,791 $ 146,254 $ 177,926 $ 442,577 $219,723
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Long-term debt (excluding current portion) $ 332 $ 453 $ 564 $ 664 $ 16
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Shareholders' equity $ 157,327 $ 129,826 $ 165,406 $ 414,805 $206,994
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(1) Including inventory write-offs of $4,121 and $18,463 for the years ended
August 31, 2003 and 2002, respectively, and nil for the years ended August
31, 2004, 2001 and 2000. Including an unusual gain of $473 for the year
ended August 31, 2003, and nil for the years ended August 31, 2004, 2002,
2001 and 2000. Excluding inventory write-offs and the unusual gain, gross
margin would have reached 47.4% for the year ended August 31, 2003.
Excluding inventory write-offs, gross margin would have reached 50.4% for
the year ended August 31, 2002. This latter information is unaudited and is
a non-GAAP measure.
(2) Including charges for stock-based compensation costs, inventory and tax
credit write-offs, unusual grants recovery, amortization of intangible
assets, impairment of long-lived assets and goodwill as well as
restructuring and other charges of $7,878, $22,943, $57,451, $13,456 and
$84 for the years ended August 31, 2004, 2003, 2002, 2001 and 2000,
respectively.
(3) Net earnings (loss) excluding stock-based compensation costs, amortization
and write-down of goodwill, unusual tax recovery, future income tax assets
valuation allowance and the after-tax effect of amortization of intangible
assets, restructuring and other charges, inventory and tax credit
write-offs, unusual grants recovery and impairment of long-lived assets.
This information may not be comparable to similarly titled measures
reported by other companies because it is non-GAAP information. Please
refer to page 20 of this Annual Report for a detailed quantitative
reconciliation. (1)
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Total Sales (in thousands of US Dollars)
2004 2003 2002
$74,360 $61,930 $68,330
[GRAPHIC OMITTED]
[PIE CHARTS]
2004 2003 2002
---- ---- ----
Geographic Sales
Americas 66% 66% 61%
EMEA 18% 18% 20%
Asia-Pacific 16% 16% 19%
Divisional Sales
Telecom Division 79% 79% 80%
Photonics & Life
Sciences Divisionw 21% 21% 20%
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2 | 2004 Annual Report | EXFO
DEAR SHAREHOLDERS,
IF NO ONE EVER TOOK RISKS, MICHELANGELO WOULD HAVE PAINTED
THE FLOOR OF THE SISTINE CHAPEL.
--NEIL SIMON, AMERICAN PLAYWRIGHT
[GRAPHIC OMITTED]
[PHOTOGRAPH - GERMAIN LAMONDE
CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE OFFICER]
EXFO made significant progress with its strategic turnaround plan in fiscal
2004. The company, which from its founding had posted 16 consecutive years of
growth and profitability before the onset of the telecommunications downturn in
2001, necessarily developed turnaround skills to increase sales 20.5%
year-over-year, even though the marketplace remained relatively flat in 2004. We
outperformed our market largely because we had made bold decisions in prior
years. Despite painstaking restructuring, we maintained our R&D investments to
position ourselves within growth vectors like protocol testing, Internet
protocol (IP) networking and fiber-to-the-premises (FTTP) deployments. We also
held onto our experienced sales team and customer support staff to increase
market share and expand customer relationships, while several of our peers were
forced to make more radical cuts. In short, we reached out to customers through
the recognized expertise of our entire staff, strengthening the EXFO brand name
in the process.
Throughout the telecom downturn, we kept all our stakeholders apprised of our
long-term direction, so they would understand and support our initiatives. I
often used a car-racing analogy, illustrating how we intended to navigate this
sharp, hairpin curve and turn it into a lasting strategic advantage for EXFO. We
also demonstrated our commitment to corporate governance by clearly spelling out
four objectives in 2004 and tagging key performance indicators (KPIs) to each
goal. Such transparency reflects my confidence in our management team and speaks
volumes about our dedication to best disclosure practices.
3 | 2004 Annual Report | EXFO
[GRAPHIC OMITTED]
[PHOTOGRAPH - EXFO MANAGEMENT TEAM]
FISCAL 2004 CORPORATE OBJECTIVES
GROWTH. Our first goal consisted of increasing sales through market-share gains.
We posted our second-best sales performance in history--better than our early
bubble results in 2000--growing sales 20.5% to $74.6 million in 2004, compared
to our KPI of 10%. Not coincidentally, Frost and Sullivan named EXFO recipient
of the 2004 Growth Strategy Excellence Award for the largest market-share
increase in the global optical test and measurement (T&M) industry between 2001
and 2003 and confirmed EXFO as No. 1 in the optical test installation and
maintenance space with an estimated 17% market share. Clearly, we captured
market share under good and dire market conditions, which for me is the ultimate
measure of corporate performance.
Corporate Performance in Fiscal 2004
------------------------------------------------------------------------
GOAL METRIC RESULT
------------------------------------------------------------------------
Increase sales 10% sales growth 20.5% sales growth [checkmark]
through year-over-year year-over-year
market-share
gains
------------------------------------------------------------------------
Maximize 50% gross margin 53.7% gross margin [checkmark]
profitability
and growth
------------------------------------------------------------------------
Innovate our way 45% of sales from new 31.7% of sales from X
out of the products new products
downturn (< two years on the
market)
------------------------------------------------------------------------
Maintain a sound Positive cash flows Positive cash flows [checkmark]
financial from from
position operations in at operations for
least one quarter fiscal year
------------------------------------------------------------------------
PROFITABILITY. We sought to maximize profitability with a focus on raising our
gross margin above 50%. We achieved a gross margin of 53.7% in 2004 from 47.4%
(excluding inventory write-offs and an unusual gain) in 2003 mainly by paying
close attention to our supply chain; focusing our R&D not only on being first to
market, but also on shaving points off our cost of goods; streamlining our
number of manufacturing sites; and delivering superior value to customers. Our
long-term objective aims to return our gross margin to the lower 60% range as
sales volume increases, fixed costs are better absorbed, revenues from our
software-intensive protocol solutions become more prominent, and new products
with higher margins gain acceptance.
INNOVATION. We reported that sales from new products (on the market two years or
less) represented 31.7% of total sales in 2004, while our KPI was 45%. Although
we fell short on that count, I remain convinced our commitment to innovation
will pay off in the long term. We have steadily invested in R&D since the
telecom peak of 2001 and brought 20 new products to the market in fiscal 2004
alone. These initiatives should enable our new products to continue gaining
traction and lead to further market-share gains in upcoming years.
STRONG BALANCE SHEET. We reported positive cash flows from operations for the
last three quarters of 2004 and for the entire fiscal year, while our KPI
required us to generate positive cash flows in at least one quarter. We also
closed a bought-deal offering of 5.2 million shares for net proceeds of $29.2
million, which raised our cash and short-term investments to $89.1 million at
the end of the year. This cash position provides comfort to customers and
positions EXFO as the long-term vendor of choice with strong organic and
acquisition growth potential.
In early fiscal 2004, we reorganized our business under the Telecom and
Photonics & Life Sciences (P&LS) divisions. This proved to be a judicious
decision as it significantly contributed to our sales growth and progress
towards profitability. Sales from our Telecom and P&LS divisions increased 21%
and 20% year-over-year, respectively. In ongoing efforts to maximize efficiency,
we merged our protocol test operations in Montreal and announced the
consolidation of our P&LS Division in Toronto, thus streamlining our
R&D/manufacturing sites from five to three. These latest actions will not only
produce significant savings in years to come, but they will also provide a
clearer focus to our respective management, R&D, sales and manufacturing teams
and, more importantly, deliver greater value to our customers.
Overall, I am pleased with our team execution during fiscal 2004--we met or
exceeded targets for three out of four goals--but I cannot be fully satisfied as
we reported a GAAP net loss of $8.4 million, or $0.13 per share, compared to
$55.0 million, or $0.87 per share, in 2003. On a pro forma* basis, we incurred a
net loss of $2.0 million, or $0.03 per share, in 2004, compared to $10.9
million, or $0.17 per share, in the prior year.
BACK TO THE FUTURE
Before moving on to our plans for 2005, I would like to paint for you a picture
of the major trends and technologies shaping the global telecom industry. The
telecom space is currently undergoing major transformations with technological
discontinuities and market shifts serving as important drivers for market-driven
companies like EXFO. We intend to leverage these new requirements and
opportunities to generate value in upcoming years. We have conscientiously been
preparing for this industry upheaval through a steady level of R&D investments,
well-defined product roadmaps and selected strategic acquisitions over the last
few years. Let's examine some of these key market trends:
- Globally, BANDWIDTH DEMAND will continue instigating backbone construction
in developing countries, further Internet penetration in other parts of the
world and facilitate rapid applications evolution in the most advanced
nations. Accessing the Web directly through wireline (or its wireless
extension) has become an essential part of our online lives for business
travel, home entertainment and schoolwork. Consumers just cannot get enough
bandwidth. Carriers in advanced countries like South Korea and Japan, for
example, are on the verge of offering 100 Mb/s to homes, enabling the
delivery of multiple high-definition television (HDTV) channels, online
gaming and a host of other bandwidth-intensive applications.
* GAAP NET LOSS EXCLUDING STOCK-BASED COMPENSATION COSTS, AMORTIZATION AND
WRITE-DOWN OF GOODWILL, UNUSUAL TAX RECOVERY, FUTURE INCOME TAX ASSETS VALUATION
ALLOWANCE AND THE AFTER-TAX EFFECT OF AMORTIZATION OF INTANGIBLE ASSETS,
RESTRUCTURING AND OTHER CHARGES, INVENTORY AND TAX CREDIT WRITE-OFFS, UNUSUAL
GRANTS RECOVERY AND IMPAIRMENT OF LONG-LIVED ASSETS. THIS INFORMATION MAY NOT BE
COMPARABLE TO SIMILARLY TITLED MEASURES REPORTED BY OTHER COMPANIES BECAUSE IT
IS NON-GAAP INFORMATION.
4 | 2004 Annual Report | EXFO
- As long-haul utilization increases and metro-ring construction progresses in
most advanced countries, the ACCESS NETWORK, or so-called "last mile", will
be the cornerstone of the network service providers' (NSPs) strategy to
increase or maintain their consumer base. This market reality will
inevitably lead to much deeper and richer fiber penetration into the
network, whether NSPs intend to leverage their existing copper plant or
deploy FIBER-TO-THE-HOME (FTTH).
- IP NETWORKING. SONET/SDH telecom transport standards were defined almost 30
years ago to optimize voice traffic, but they are largely inefficient in
today's data-centric world. A highly flexible and scalable, next-generation
SONET/SDH platform is required for the efficient and high-quality delivery
of several new applications like VoIP and IP video, while achieving
significant OPEX reductions through the management of a single network
architecture. NSPs will be streamlining their operations, deployment and
maintenance processes as well as moving to higher-margin service revenues.
- SYSTEM VENDORS are back driving the telecom innovation curve in this
post-DWDM era, whereby data networking is a primary catalyst. As a result,
these vendors are heightening their focus on delivering ubiquitous,
consumer-friendly networking solutions and highly differentiated product
offerings in order to partner with public and private network operators.
System vendors are focusing more than ever on shortening their innovation
cycle and improving operating performance--from the design phase all the way
to network deployment.
- Competition between incumbent telecom carriers and cable multiple-system
operators (MSOs), especially in North America, is intensifying as they race
to increase revenue streams. Both groups are deploying TRIPLE-PLAY SERVICES
(voice, data and video) as a pre-emptive measure to retain customers and as
an offensive means to secure new ones.
On the photonics and life sciences side:
- Industrial manufacturing sectors like microelectronics, optoelectronics and
medical devices remain strong. The distinct trend of moving high-tech
manufacturing to Asia continues, while the global market is driven by
innovative new products and stronger customer intimacy. The life sciences
market trend is towards application-based, total-solution selling and taking
advantage of new, disruptive technologies.
CUSTOMER INTIMACY AS A MOTTO
On top of offering best-in-class solutions that surpass highest expectations in
this changing environment, all EXFO employees are committed to enhancing
customer intimacy, since customer satisfaction represents our true RAISON
D'ETRE. As part of our strategic direction, we intend to raise our business
relationships to the next level--from mere supplier to partner of choice. This
customer-first mindset will enable us to expand market share to a dominant
position in optical testing and extend it to protocol testing, which represents
a major growth vehicle for our company.
To reach our ultimate goal of becoming the leading player in the telecom T&M
space, we will intensify our sales and marketing efforts, both domestic and
international, in 2005 to further leverage our strong technology base and
innovation pipeline. We will also focus on strengthening and expanding our
business relationships with major accounts. Finally, we will continue building
EXFO into one of the most respected brand names in the industry by allowing our
recognized expertise to reach out to customers where and when it is needed. In
an increasingly competitive landscape, I am counting on these actions, combined
with our strategies related to the aforementioned industry trends, to provide
our shareholders with long-term growth and profitability.
MEASURING UP
As we did in fiscal 2004, I would like to communicate the key performance
indicators against which management's performance should be measured in fiscal
2005. It should be specified that they are metrics, not guidance, for fiscal
2005. Not surprisingly, our goals reflect continuity from last year with a
renewed focus on profitable growth.
- SALES GROWTH OF 20%. As we have since our founding in 1985, we intend to
grow sales faster than the market by leveraging our sustained R&D
investments in areas such as next-generation IP and FTTP testing, as well as
increase our sales and marketing footprint worldwide.
- PROFITABILITY ON A PRO FORMA BASIS. Higher sales volumes, richer business
mix, improved manufacturing efficiency and consolidation efforts will
support our return to pro forma profitability in 2005.
- AT LEAST 45% OF REVENUES FROM NEW PRODUCTS. Our relentless focus on product
differentiation, time-to-market and astute product portfolio
management--combined with a heightened sales focus and product
traction--should increase this result in 2005.
WRAP-UP
As we embark on our 20th year of operation, I would like to thank all our
employees for their unwavering commitment and passion in returning the company
to growth; our customers for their extraordinary confidence in our products and
services and for sharing their outlook on the future--they are, after all, the
reason why EXFO is in business; our Board of Directors for its constant
availability and sage counsel; and our shareholders for their staunch belief in
our long-term vision. With the continued support of everyone, in 2005 and
beyond, I am confident that we will continue progressing towards increased
revenue, profitability and market-share gains.
Sincerely,
/s/ Germain Lamonde
----------------------------
Germain Lamonde
Chairman, President and Chief Executive Officer
October 26, 2004
5 | 2004 Annual Report | EXFO
-----------------------------------------
CORPORATE HIGHLIGHTS
-----------------------------------------
ENHANCING OUR STRATEGIC POSITION
JUNE 2004
- Introduces passive optical network (PON) power meter for FTTP
deployments
- Launches next-generation Fibre Channel test solution for storage
area networks
APRIL 2004
- Releases next-generation OTDR for FTTP, access and metro networks
MARCH 2004
- Receives 2004 Growth Strategy Excellence Award from Frost and Sullivan
- Announces consolidation of protocol test operations in Montreal
- Recognizes revenue from existing products for FTTP-related applications
FEBRUARY 2004
- Closes $29.2 million bought-deal financing
- Launches next-generation automated loss test set
- Introduces Gigabit Ethernet test solution for remote testing and turn-up
of Ethernet services
- Releases new line of handheld test instruments for FTTP networks
OCTOBER 2003
- Launches new ultraviolet/visible spot-curing platform
- Introduces 10+ Gigabit multi-rate transceiver
SEPTEMBER 2003
- Offers network testing application for multi-service provisioning
platforms
[GRAPHIC OMITTED]
[PHOTOGRAPHS:
PON Power Meter, Next-generation OTDR, Gigabit Ethernet tester,
Automated loss test set, Spot-curing platform]
6 | 2004 Annual Report | EXFO
-----------------------------------------
TELECOM DIVISION
-----------------------------------------
EXPERTISE REACHING OUT
The growing number of Internet users and their sheer demand for broadband
applications--video conferencing, data storage, e-commerce, video gaming, rich
media streaming and peer-to-peer file sharing, to name a few--have placed an
enormous strain on access networks connecting businesses and homes. This
insatiable appetite for bandwidth is driving capital expenditures much deeper
into optical networks.
Telecom carriers and cable multiple-system operators (MSOs) are increasing their
investments to deliver a bundled offering--commonly known as the triple-play--to
secure the consumer's bill for television, Internet and telephone services. The
consensus is that converged, IP-based networks represent the ideal solution to
support triple-play services via a single architecture with increased savings,
simplification and efficiency. Not surprisingly, both carriers and cable MSOs
are making significant investments in this area.
-----------------------------------------
GROWTH STRATEGY EXCELLENCE AWARD
[GRAPHIC OMITTED]
EXFO has expanded its marekt share in optical testing through ongoing
investments in R&D and a proven product portfolio review process. We introduce
produts that make a difference to our customers. As a result, Frost and Sullivan
named EXFO recipient of the 2004 Growth Strategy Excellence Award. This leading
market research firm reported that we increased overall market share from 6.4%
in 2001 to 8.4% in 2003 -- the single largest increase within the global optical
test and measurement industry. We were also deemed leader in the optical test
installation and maintenance space, with an estimated 17% market share
worldwide. These share gains should increase following 20.5% sales growth within
a flat marketplace in 2004. "With a technically advanced product line and a good
focus on the end-user, EXFO is likely to grab major market share in the near
future," Frost and Sullivan said.
-----------------------------------------
LEADING PROVIDER OF FTTx TEST SOLUTIONS
To bundle video, data and voice services in a single offering, a number of
carriers have opted for FTTx technology, which encompasses deployment strategies
such as fiber-to-the-premises (FTTP), fiber-to-the-curb (FTTC),
fiber-to-the-home (FTTH), fiber-to-the-node (FTTN) etc. In fiscal 2004, EXFO
worked closely with lead customers to develop and introduce the most advanced
products dedicated to this technology:
- A passive optical network (PON) test set for installation and
service-activation;
- A patented, multi-function automated tester to increase crew
productivity;
- A comparable multi-function automated test module for our flagship
FTB-400 platform;
- A new line of handheld instruments dedicated to service-activation
requirements;
- And next-generation OTDR module mainly used for installation
applications.
[GRAPHIC OMITTED]
[LINE OF HANDHELD FTTx PRODUCTS]
In addition, we published our FTTx PON Guide to help carriers optimize their
deployment strategies, thus positioning EXFO as the leading provider of FTTx
test solutions. KMI Research, a leading market research firm in the optical
networking industry, estimates that the FTTP market for equipment, cable and
apparatus in the U.S. will reach $3.2 billion in 2009, representing a compound
annual growth rate (CAGR) of 54% from 2003.
7 | 2004 Annual Report | EXFO
[PHOTOGRAPH OMITTED]
NEXT-GENERATION SONET/SDH AND GIGABIT ETHERNET TEST SOLUTIONS
IP-based system deployments have been widely accepted by carriers as an
effective strategy to reduce capital (CAPEX) and operating expenditures (OPEX),
while allowing highly scalable and flexible technology to support a host of
applications over a single network architecture. EXFO has prepared itself for
this market development through strategic acquisitions and significant R&D
investments as evidenced by recent product launches:
- A SONET/SDH analyzer that is fully scalable from low rates to 10 Gb/s as
well as a next-generation solution for data-centric IP networks--all
within our FTB-400 field-testing platform;
- A Gigabit Ethernet solution with VoIP test functionality;
- And Fibre Channel test solution for security-intensive network
applications.
[PHOTOGRAPH] [PHOTOGRAPH] [PHOTOGRAPH]
GIGABIT ETHERNET NEXT GENERATION FIBRE CHANNEL
TESTER SONET/SDH ANALYZER ANALYZER
Within a short period of time, EXFO has established itself as a disruptive force
in protocol testing. On the strength of our rich product pipeline, we will
continue introducing additional products in fiscal 2005 and beyond.
SERVING THE ENTIRE TELECOM SUPPLY CHAIN
EXFO covers the entire supply chain in the telecom industry through an extensive
portfolio of handheld, modular and benchtop test instruments that meet
customers' specific needs. Whether talking about installation, maintenance and
network monitoring applications for NSPs, or R&D and manufacturing applications
for system/component vendors, EXFO has the ready-made solution to enable
significant CAPEX and OPEX savings.
TEAMING UP WITH SYSTEM VENDORS
Over the years, we have forged strong relationships with system vendors because
they ultimately create the next-generation technologies that define the telecom
industry. We also have implemented a multi-platform design strategy, developing
one high-end test solution for the system manufacturing/laboratory market and
leveraging it onto the NSP market. For instance, test modules found inside our
FTB-400 field-testing platform are fully compatible with our IQS-500
manufacturing/lab platform and vice versa. Clearly, EXFO remains ahead of the
innovation curve by teaming up with system vendors and deploying a single
solution across multiple market segments.
[PHOTO] [PHOTO]
IQS-500 FTB-400
MANUFACTURING/LAB PLATFORM FIELD-TESTING PLATFORM
GLOBAL MARKET PRESENCE
EXFO has created a network of sales offices and service centers, as well as a
web of direct sales representatives and distribution partners, to reach
customers worldwide. We have a sales presence in more than 70 countries within
the Americas, Europe, Middle East and Africa (EMEA), and the Asia-Pacific
region. This global market presence will be further enhanced in fiscal 2005 as
we leverage our leading-edge solutions via direct and indirect sales channels.
-----------------------------------------
GOING THE EXTRA MILE
AS WE ENTER OUR 20TH YEAR OF OPERATION, THE 'EX' IN EXFO HAS BECOME
INCREASINGLY MEANINGFUL TO CUSTOMERS BECAUSE THEY RELY MORE THAN EVER ON OUR
'EXPERTISE' TO COPE WITH NETWORK COMPLEXITY. EXFO HAS BUILT A STRONG BRAND
NAME OVER THE YEARS, NOT ONLY BASED ON PRODUCT AND TECHNOLOGICAL LEADERSHIP,
BUT ALSO ON THE COMMITMENT OF OUR SUBJECT-MATTER EXPERTS TO GO THE EXTRA MILE
IN A MARKET ENVIRONMENT WHERE MANY CUSTOMERS HAVE REDUCED THEIR POOL OF
IN-HOUSE EXPERTS. IN SHORT, WE DO EVERYTHING WITHIN OUR POWER TO DELIVER A
BEST-IN-CLASS SOLUTION THAT CUSTOMERS HAVE COME TO EXPECT FROM A STRATEGIC
PARTNER LIKE EXFO.
EXFO
Expertise Reaching Out
-----------------------------------------
8 | 2004 Annual Report | EXFO
-----------------------------------------
PHOTONICS & LIFE SCIENCES DIVISION
-----------------------------------------
DRAWING ON OUR OWN EXPERTISE
OUR PHOTONICS AND LIFE SCIENCES DIVISION IS BARELY A YEAR OLD, BUT ALREADY IT
HAS A SUCCESS STORY TO ITS CREDIT. THE X-CITE(TM) 120 FLUORESCENCE ILLUMINATION
SYSTEM, WHICH OFFERS THREE TIMES THE AVERAGE LAMP LIFE THAN CONVENTIONAL
LIGHTING SYSTEMS, NOT ONLY GAINED MARKET ACCEPTANCE AMONG MICROSCOPE
MANUFACTURERS IN 2004, BUT WAS ALSO UPGRADED FOR AUTOMATED APPLICATIONS. AN
RS-232 CONNECTION AND A SOFTWARE INTERFACE ENABLE END-USERS TO CONTROL THE
X-CITE 120'S IRIS, LAMP, SHUTTER AND TIMER VIA A PERSONAL COMPUTER. INDUSTRY
LEADERS LIKE LEICA, NIKON INSTRUMENTS, OLYMPUS AND ZEISS MICROIMAGING HAVE
WHOLEHEARTEDLY EMBRACED THIS MICROSCOPE ACCESSORY, RESELLING IT TO CUSTOMERS
THROUGH THEIR OWN SALES CHANNELS.
The early success of the X-Cite 120 illustrates the thinking behind the creation
of the Photonics and Life Sciences Division. This division, on the strength of
its own sales, R&D, manufacturing and management teams, leverages core
technologies into high-precision assembly and life sciences markets. Our
fluorescence microscopy solution, for example, is based on patented smart-lamp
technology used for optical component manufacturing applications. Other selected
solutions include light-based spot curing and nanotechnology. To improve
efficiency, we are in the process of consolidating all of these activities at
one location in Toronto.
[GRAPHIC OMITTED]
[X-CITE 120 FLOURESCENCE MICROSOPY SOLUTION]
BUILDING ON OUR LIGHT-BASED CURING EXPERTISE
We have drawn on our expertise in light-based curing to offer optimized
solutions for the microelectronic, semiconductor and medical-device
manufacturing industries. Our Novacure(R) and Acticure(R) spot-curing systems,
which were originally designed for optical component manufacturing applications,
deliver precise doses of spectral light onto photosensitive adhesives and
coatings to significantly reduce curing time. In 2004, we continued our
migration to a single light-system platform with the release of the OmniCure(TM)
Series 1000, an entry-level system for manual-precision assembly environments.
We also released a cure-ring radiometer, which measures light output at the cure
site, to ensure a repeatable process when bonding devices that require a uniform
360-degree exposure. Following the year-end, we launched the OmniCure(TM) Series
2000 for automated manufacturing applications. These recent innovations
illustrate why EXFO is widely recognized as the authority on light-based curing
and process control.
[GRAPHIC OMITTED]
[OMNICURE SPOT-CURING PLATFORM]
TAKING ADVANTAGE OF OUR EXPERTISE IN NANOTECHNOLOGY
We have taken advantage of our expertise in nanometer-scale positioning to offer
piezoelectric-based positioning systems for life science research. The stability
of piezoelectric (PZT) technology provides extremely smooth and predictable
instrument motion used for applications like patch-clamp experimentation and
micromanipulation. In 2004, we introduced the PCS-6000 Micromanipulator, which
features PZT smoothness plus motorized long travel for electrophysiology
research. In addition, we offered new motor/memory capabilities on our
Gibraltar(R) platform to enable the prompt return of fixed-stage, upright
microscopes to their original position with a single touch of a button. These
latest developments stem from renewed customer intimacy in this market.
[GRAPHIC OMITTED]
[PCS-6000 MICROMANIPULATOR]
9 | 2004 Annual Report | EXFO
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion and analysis of the consolidated financial condition
and results of operations of EXFO Electro-Optical Engineering Inc. for the
fiscal years ended August 31, 2002, 2003 and 2004, should be read in conjunction
with our consolidated financial statements and the related notes included
elsewhere in this Annual Report. Our consolidated financial statements are
reported in US dollars and have been prepared in accordance with generally
accepted accounting principles in Canada, or Canadian GAAP. Significant
differences in measurement and disclosure from generally accepted accounting
principles in the United States, or U.S. GAAP, are set out in note 20 to our
consolidated financial statements.
The following discussion and analysis of financial condition and results of
operations is dated September 30, 2004.
INDUSTRY OVERVIEW
Following three years of reductions in capital expenditures (CAPEX) among
network service providers (NSPs), some measure of stability returned to the
marketplace in 2004. Both telecom carriers and cable multiple-system operators
(MSOs), which fall under the NSP designation, have resumed investing in their
networks to ultimately gain stronger access to the consumer's pocketbook with
their triple-play offering of video, data and voice services. Investments in IP
networking have been particularly popular among these groups, as this will allow
them to provide more cost-effective delivery of voice (i.e., VoIP). Telecom
carriers also investing in network architectures like fiber-to-the-premises
(FTTP) in order to extend their available bandwidth to the home, which will
enable them to offer video services as well. These investments, however, were
offset by CAPEX reductions in other areas of the network to produce relatively
flat spending patterns year-over-year.
This relative stability in CAPEX spending was witnessed in multiple segments of
the global telecommunications supply chain. System manufacturers benefited from
NSP orders for next-generation, converged IP networks and fiber deployments in
access areas. Component vendors, who had been hardest hit by the downturn, began
seeing incremental demand for optical components that support IP-based systems.
Some test and measurement equipment vendors, whose products enable customers to
reduce CAPEX and operating expenses (OPEX), attracted the attention of NSPs,
system manufacturers and component vendors, especially ones offering test
solutions for VoIP and/or FTTP applications.
COMPANY OVERVIEW
EXFO is a recognized expert in the global telecommunications industry through
the design and manufacture of advanced and innovative test and measurement
solutions. The Telecom Division, which represents our main business activity,
offers a complete range of dedicated and integrated test solutions to NSPs,
system vendors and component manufacturers in approximately 70 countries. One of
our strongest competitive advantages is our modular platform design, based on a
PC/Windows-centric architecture to offer a series of test solutions that
maximize technology reuse across multiple test platforms dedicated to specific
market segments. The Photonics and Life Sciences Division mainly leverages core
telecom technologies to offer value-added solutions for life sciences
applications and high-precision assembly processes, such as those required for
microelectronics and optoelectronics.
EXFO was founded in Quebec City, Canada, in 1985. Our original products were
focused on the needs of installers and operators of fiber-optic networks.
Customers use these field-portable testing products for the installation,
maintenance, monitoring and troubleshooting of optical networks. In 1996, we
supplemented our product portfolio with an extensive line of high-end products
that are mainly dedicated to research and development as well as manufacturing
activities.
In the last three years, we have enhanced our competitive position through the
acquisition of two protocol test businesses in order to extend our product
offering and address our customers' requirements more completely. In November
2001, we acquired Avantas Networks Corporation (renamed EXFO Protocol Inc.), a
supplier of protocol testing and optical-network-performance management
equipment for NSPs. This transaction was highly strategic because it enabled us
to combine optical and protocol test modules inside a single field-portable test
platform to help our customers increase revenues and reduce operating costs. In
October 2002, our wholly-owned subsidiary, EXFO Gnubi, purchased substantially
all the assets of GNUBI COMMUNICATIONS, L.P., a supplier of multi-channel
telecom and datacom testing solutions for the system manufacturer market. These
strategic acquisitions, which were consolidated in Montreal in fiscal 2004,
enabled us to double our addressable market, as we expanded from optical testing
into protocol testing applications, and to offer a more complete test solution
to customers.
Previously, we had completed two acquisitions to bolster growth in the optical
component manufacturing market. We acquired Burleigh Instruments, Inc. (renamed
EXFO Burleigh Products Group Inc.) in December 2000 for its wavelength
measurement instruments and nanopositioning alignment systems. We also added
EFOS Inc. (renamed EXFO Photonic Solutions Inc.) in March 2001 for its precision
light-based, adhesive spot-curing technology. We have since exited the optical
component manufacturing automation business.
At the beginning of fiscal 2004, we reorganized our business under two
divisions: the Telecom Division and the Photonics and Life Sciences Division.
Our objectives behind this new structure 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, is focused on NSPs, telecommunication system
manufacturers and optical component vendors on a global basis. Our Photonics and
Life Sciences Division, which includes previous non-telecom Industrial and
Scientific product lines, mainly leverages developed and acquired core telecom
technologies for diverse high-precision assembly and life sciences markets.
Following this reorganization, our two divisions now have respective sales,
marketing, manufacturing, research and development as well as management teams
and are, therefore, presented as two corresponding reportable segments in the
financial statements. We have disclosed segmented information about each of
these segments in our consolidated financial statements for fiscal 2004.
However, we did not provide comparative information for previous periods about
each reportable segment (except for sales and long-lived assets) because this
information is not available and it is impracticable to determine. Please refer
to note 18 to our consolidated financial statements for detailed segment
information.
10 | 2004 Annual Report | EXFO
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.
In fiscal 2004, we launched 20 new products, including several aimed at
establishing leadership in the emerging FTTP market and others dedicated to
expanding our life sciences product portfolio. We also strengthened our
competitive position in protocol testing through the introduction of a
next-generation Fibre Channel test set for security-intensive applications and,
subsequent to the year-end, we released a next-generation SONET/SDH analyzer for
data-centric IP networks as well as a Gigabit Ethernet test solution with VoIP
test capabilities.
In February 2004, we closed a public offering of 5.2 million subordinate voting
shares to a syndicate of Canadian-based underwriters for net proceeds of $29.2
million (Cdn$38.4 million). EXFO finished the fiscal year with a cash position
of $89.1 million.
In May 2004, we successfully renewed our collective bargaining agreement with
unionized manufacturing employees in Quebec City, Canada.
In 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.
Near the end of the fiscal year, we reached the decision to consolidate
operations of our Photonics and Life Sciences Division in order to improve its
market focus and efficiency. Consequently, we have begun transferring operations
from Victor/Fishers, NY, mostly to Toronto. To fully implement this
consolidation, we expect to incur restructuring and other charges of $2.7
million, of which $1.7 million was already recorded in the fourth quarter of
fiscal 2004; the remainder will be recorded in 2005. We estimate that we will
derive $1.5 million in annual savings from these streamlined operations.
Finally, in August 2004, we reviewed the carrying value of one of our buildings
that has been put up for sale and we concluded that the building was impaired.
We recorded an impairment charge of $620,000. This building falls within the
Telecom Division.
SALES
We sell our products to a diversified customer base in approximately 70
countries through our direct sales force and, indirectly, through distribution
channels. As mentioned above, our customers are comprised of NSPs, manufacturers
of communication systems and optical components, as well as research and
development laboratories. We have a diversified customer base, both in terms of
industry sector and geographical area, which provides us with reasonable
protection against concentration of credit risk.
COST OF SALES
Cost of sales includes raw materials, salaries and related expenses for direct
and indirect manufacturing personnel (net of government grants) as well as
overhead costs. Excess, obsolete and scrapped materials are also included in
cost of sales. However, cost of sales is exclusive of amortization, which is
shown separately in the statement of earnings.
OPERATING EXPENSES
We classify our operating expenses into three main categories: selling and
administrative expenses, research and development expenses and amortization
expenses.
Selling and administrative expenses consist primarily of salaries and related
expenses for personnel (net of government grants), sales commissions, travel
expenses, marketing programs, professional services, information systems, human
resources and other corporate expenses.
Gross research and development expenses consist primarily of salaries and
related expenses for engineers and other technical personnel, material component
costs as well as fees paid to third-party consultants. We are eligible to
receive research and development tax credits and government grants on research
and development activities carried out in Canada. All related research and
development tax credits and government grants are recorded as a reduction of
gross research and development expenses. Tax credit write-offs are also included
in net research and development expenses.
Operating charges related to our restructuring plans have been recorded as a
separate component of operating expenses. These charges consist primarily of
severance expenses, costs to exit leased facilities as well as write-offs of
long-lived assets.
OUR STRATEGY
STRATEGIC OBJECTIVES FOR FISCAL 2004
In our fiscal 2003 Annual Report, we had established four strategic objectives
for fiscal 2004. We planned to increase sales through market-share gains;
maximize profitability and growth on a long-term basis by focusing on gross
margin improvements; innovate our way out of the downturn by successfully
bringing to market differentiated products that allow us to seize targeted
market opportunities; and maintain a sound financial position both as a
strategic and defensive asset. We had also established key performance
indicators as measures to assess the realization of our objectives. The
following table summarizes these objectives and key performance indicators as
well as the results achieved in fiscal 2004:
STRATEGIC OBJECTIVES KEY PERFORMANCE INDICATORS ACTUAL RESULTS GOAL ACHIEVED
-----------------------------------------------------------------------------------------------------------------------------------
Increase sales through market-share gains 10% sales growth year-over-year 20.5% sales growth [check]
year-over-year
Maximize profitability and growth on a 50% gross margin 53.7% gross margin [check]
long-term basis
Innovate our way out of the downturn 45% of our sales from new products 31.7% of our sales from new [check]
(on the market for two years or less) products
Maintain a sound financial position Positive cash flows from operating Cash flows from operating [check]
activities for at least one quarter activities at $751,000 for
fiscal 2004
----------------------------------------------------------------------------------------------------------------------------------
11 | 2004 Annual Report | EXFO
INCREASE SALES THROUGH MARKET-SHARE GAINS
We posted our second-best sales performance in history, growing sales 20.5% to
$74.6 million in fiscal 2004, compared to our KPI of 10%. Considering that the
marketplace remained relatively flat in 2004, this is a clear indication that we
gained market share overall. For fiscal 2004, our Telecom Division and Photonics
and Life Sciences Division reported sales increases of 20.8% and 19.5%,
respectively.
MAXIMIZE PROFITABILITY AND GROWTH ON A LONG-TERM BASIS
We sought to maximize profitability with a focus on raising our gross margin
above 50%. In fact, for fiscal 2004, we achieved a gross margin of 53.7%. We
surpassed our objective mainly due to our increased sales volume and because we
paid close attention to our supply chain. We focused our R&D not only on being
first to market, but also on achieving the lowest possible cost of goods
required to meet the highest performance criteria. In addition, we streamlined
manufacturing operations into fewer sites, while continuing to deliver superior
value to customers.
INNOVATE OUR WAY OUT OF THE DOWNTURN
Ever since we founded EXFO in 1985, innovation strategies were focused on being
first to market with unique solutions that anticipate and better address
customer requirements. Our market-driven approach can be demonstrated through a
long history of industry firsts. This focus on delivering a unique value
proposition to the marketplace is of strategic importance to improve our gross
margin. As a KPI for this strategic objective, we anticipated that sales of new
products (on the market two years or less) would reach 45% of global sales for
fiscal 2004. However, in fiscal 2004, new products represented 31.7% of total
sales mainly because key customers in our space were more conservative than
expected, as they were more active planning their future strategies than
deploying them.
We remain firm believers that the 20 new products and key innovations brought to
market in the last 12 months are well targeted for market opportunities and that
percentage of sales from new products is going to increase in the quarters
and year to come. Incidentally, for the fourth quarter of 2004, this innovation
rate was at 38%.
MAINTAIN A SOUND FINANCIAL POSITION
In fiscal 2004, cash flows provided by operating activities were positive at
$751,000, enabling us to meet our KPI of attaining positive cash flows from
operations in at least one quarter in the fiscal year. In fact, cash flows from
operating activities were positive for the last three quarters of 2004. Our
solid balance sheet including cash on hand and short-term investments of $89.1
million and practically no debt, are not only reassuring to customers but, more
importantly, these advantages are also strategic assets that will help ensure
our long-term development and allow for possible acquisitions.
STRATEGIC OBJECTIVES FOR FISCAL 2005
For fiscal 2005, we believe general market conditions will be relatively similar
to this year's as CAPEX spending is expected to remain fairly tight for wireline
operators overall. However, they will spend within certain growth vectors
(namely IP networking and FTTP deployments), for which we have already begun
positioning ourselves.
As you might expect, our strategic directions, and therefore our KPIs, will not
be radically different from those of 2004. Since we are highly focused on
creating value for our shareholders, providing the highest degree of profitable
growth is at the heart of our actions. We therefore intend to maintain our
long-term focus on profitable growth by increasing sales through further
market-share gains; maximize profitability through proper execution and
efficiency of our cost-reduction programs; and focus on innovation to positively
position the organization for the long-term growth opportunities that exist in
our space.
INCREASE SALES THROUGH MARKET-SHARE GAINS
In fiscal 2005, we will focus on continued market-share gains to achieve growth,
assuming the stability or slight growth of our addressable telecommunications
market. We expect the CAPEX environment to be relatively stable with a few clear
shifts made by carriers towards their key strategic initiatives. In fiscal 2004,
our 20.5% sales growth in a stable market clearly indicated that we gained
market share. For fiscal 2005, we intend once again to grow sales faster than
the market by leveraging our sustained R&D investments in areas such as
next-generation Internet protocol (IP) and fiber-to-the-premises (FTTP) testing,
by intensifying our sales and marketing efforts, both domestic and
international, as well as by strengthening and expanding our business
relationships with major accounts.
MAXIMIZE PROFITABILITY
Returning to profitability remains a top priority at EXFO. Our expected sales
growth combined with a series of internal initiatives will bring us to
profitability on a pro-forma basis in fiscal 2005. Namely, recent consolidation
efforts of our protocol activities in Montreal and our life sciences operations
in Toronto are expected to bear fruit in fiscal 2005. We have also applied
strategies to maximize supply chain efficiency, overall execution, as well as
R&D (focusing on cost of goods sold, rather than strictly on being first to
market).
FOCUS ON INNOVATION
In fiscal 2005, innovation will continue to be a key driver at EXFO. Although we
fell short of this strategic objective for fiscal 2004, we remain convinced that
our commitment to innovation will pay off in the long term and support our
growth and profitability targets. We have maintained a significant level of R&D
investment since the telecom peak in 2001 and brought 20 new products to the
marketplace in fiscal 2004--several of which were released in the second half of
the fiscal year and have therefore not yet reached their market potential. For
fiscal 2005, we intend to invest a similar amount in R&D compared to fiscal
2004. These initiatives should enable our new products to continue gaining
traction with customers and lead to further market-share gains in the coming
years.
12 | 2004 Annual Report | EXFO
KEY PERFORMANCE INDICATORS
As measures to assess the realization of our strategic plan and its objectives,
we have set out three consolidated key performance indicators for fiscal 2005.
They are summarized as follows:
STRATEGIC OBJECTIVES KEY PERFORMANCE INDICATORS
----------------------------------------------------------------------------------------------------------------------------
Increase sales through market-share gains 20% sales growth year-over-year, assuming a stable
telecommunications market
Maximize profitability Profitability on a pro-forma basis
Focus on innovation 45% of sales from new products (on the market two years or less)
----------------------------------------------------------------------------------------------------------------------------
CAPABILITY TO DELIVER RESULTS
At EXFO, we believe that we have the capabilities to deliver expected
results thanks to outstanding products, an excellent reputation in the
marketplace, a sound financial position, as well as an experienced workforce
and management team.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's discussion and analysis of financial conditions and results of
operations is based on our consolidated financial statements included
elsewhere in this Annual Report. As previously mentioned, they have been
prepared in accordance with Canadian GAAP. The preparation of financial
statements in accordance with GAAP requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
the disclosures of contingent assets and liabilities at the date of the
financial statements, as well as the reported amounts of revenues and
expenses during the reporting years. On an ongoing basis, we evaluate these
estimates and assumptions, including those related to revenue recognition,
allowance for doubtful accounts, allowance for excess and obsolete
inventories, research and development tax credits and government grants,
impairment of long-lived assets and goodwill, valuation allowance of future
income tax assets, warranty obligations, restructuring charges as well as
contingencies and other obligations. We base our estimates and assumptions
on historical experience and on other factors that we believe to be
reasonable under the circumstances, the result of which form the basis for
making judgments about the carrying values of assets and liabilities that
are not readily apparent from other sources. Actual results could differ
from these estimates.
The following summarizes our critical accounting policies as well as other
policies that require the most significant judgment and estimates in the
preparation of our consolidated financial statements.
REVENUE RECOGNITION. For products in which software is incidental, we
recognize revenue when persuasive evidence of an arrangement exists, the
product has been delivered, the price is fixed and determinable and
collection of the resulting receivable is reasonably assured. In addition,
provisions are made for estimated returns, warranties and support
obligations.
For products in which software is not incidental, revenues are separated
into two categories: product and post-contract customer support (PCS)
revenues, based upon vendor-specific objective evidence of fair value.
Product revenues for these sales are recognized as described above. PCS
revenues are deferred and recognized ratably over the years of the support
arrangement. PCS revenues are recognized at the time the product is
delivered when provided within one year of delivery, the costs of providing
this support are insignificant (and accrued at the time of delivery) and no
software upgrades are provided.
For all sales, we use a binding purchase order as evidence that a sales
arrangement exists.
Delivery generally occurs when the product is handed over to a transporter
for shipment.
At the time of the transaction, we assess whether the price associated with
our revenue transaction is fixed and determinable, and whether or not
collection is reasonably assured. We assess whether the price is fixed and
determinable based on the payment terms associated with the transaction. We
assess collection based on a number of factors, including past transaction
history and the creditworthiness of the customer. Generally, collateral or
other security is not requested from customers.
Most sales arrangements do not generally include acceptance clauses.
However, if a sales arrangement includes an acceptance provision, acceptance
occurs upon the earliest of the receipt of a written customer acceptance or
the expiration of the acceptance period. For these sales arrangements, the
sale is recognized when acceptance occurs.
Revenue for extended warranties is recognized on a straight-line basis over
warranty period.
ALLOWANCE FOR DOUBTFUL ACCOUNTS. We estimate collectibility of accounts
receivable on an ongoing basis by reviewing balances outstanding over a
certain period of time. We determine our allowance for doubtful accounts
receivable based on our historical accounts receivable collection experience
and on the information that we have about the status of our accounts
receivable balances. If the financial conditions of our customers
deteriorate, resulting in an impairment of their ability to make required
payments, additional allowance may be required, which could adversely affect
our future results.
ALLOWANCE FOR EXCESS AND OBSOLETE INVENTORIES. We state our inventories at
the lower of cost, determined on an average cost basis and replacement cost
or net realizable value, and provide reserves for excess and obsolete
inventories. We determine our reserves for excess and obsolete inventories
based on the quantities we have on hand versus expected needs for these
inventories, so as to support future sales of our products. It is possible
that additional inventory reserves may occur if future sales are less than
our forecasts or if there is a significant shift in product mix compared to
our forecasts, which could adversely affect our future results.
13 | 2004 Annual Report | EXFO
RESEARCH AND DEVELOPMENT TAX CREDITS AND GOVERNMENT GRANTS. We record research
and development tax credits and government grants based on our interpretation of
tax laws and grant programs, especially regarding related eligible projects and
expenses, and when there is reasonable assurance that we have complied and will
continue to comply with all conditions and laws. Also, our judgment and
estimates are based on historical experience. It is possible, however, that the
tax authorities have a different interpretation of laws and application of
conditions related to the programs or that we do not comply with all conditions
related to grants in the future, which could adversely affect our future
results. Furthermore, a large part of our tax credits are refundable against
income taxes payable, causing their ultimate realization to be dependent upon
the generation of taxable income. If we obtain information that causes our
forecast of future taxable income to change or if actual taxable income differs
from our forecast, we may have to revise the carrying value of these tax
credits, which would affect our results in the period in which the change was
made. We review the recoverability of such tax credits on a quarterly basis.
IMPAIRMENT OF LONG-LIVED-ASSETS AND GOODWILL. We assess impairment of goodwill
on an annual basis, or more frequently, if events or circumstances occur that
more likely than not reduce the fair value of a reporting unit below its
carrying value. Goodwill impairment exists when the carrying value of a
reporting unit exceeds its fair value. The fair value of a reporting unit is
determined based on a combination of discounted cash flows and a market
approach. The amount of impairment loss, if any, is the excess of the carrying
value of goodwill over its fair value.
We assess impairment of long-lived assets when events or circumstances indicate
that costs may not be recoverable. Impairment exists when the carrying value of
the asset is greater than the pre-tax undiscounted future cash flows expected to
be provided by the asset. The amount of impairment loss, if any, based on the
recoverability test, is the excess of the carrying value over its fair value. We
assess fair value of intangible assets based on discounted future cash flows.
FUTURE INCOME TAXES. We account for income taxes using the liability method of
tax allocation. Under this method, future income tax assets and liabilities are
determined based on deductible or taxable temporary differences between
financial statement values and tax values of assets and liabilities, using
enacted income tax rates for the years in which the differences are expected to
reverse. In assessing the recoverability of our future income tax assets, we
consider whether it is more likely than not that some or all of the future
income tax assets will not be realized. The ultimate realization of certain
future income tax assets is dependent upon the generation of future taxable
income during the periods in which those temporary differences will become
deductible. As at August 31, 2004, we had established a full valuation allowance
against our future income tax assets. The valuation allowance will be reversed
once management will have concluded that realization of future income tax assets
is more likely than not.
During fiscal 2004, we also adopted the following new Canadian Institute of
Chartered Accountants (CICA) handbook section and guideline:
o Section 3870, "Stock-Based Compensation and Other Stock-Based Payments"
o Accounting Guideline 13, "Hedging Relationship"
On September 1, 2004, we adopted new CICA handbook sections 1100 and 1400,
"Generally Accepted Accounting Principles" and "General Standards of Financial
Statements Presentation".
Please refer to note 2 to our consolidated financial statements included
elsewhere in this Annual Report for further information about these new
standards and their impact on our financial statements.
14 | 2004 Annual Report | EXFO
RESULTS OF OPERATIONS
The following table sets forth certain Canadian GAAP consolidated financial
statements data in thousands of US dollars, except per share data, and as a
percentage of sales for the years indicated:
CONSOLIDATED STATEMENTS OF EARNINGS DATA: 2004 2003 2002 2004 2003 2002
--------------------------------------------------------------------------------------------------------------------------------
Sales $ 74,630 $ 61,930 $ 68,330 100.0 % 100.0 % 100.0 %
Cost of sales(1) 34,556 36,197 52,366 46.3 58.4 76.6
--------------------------------------------------------------------------------------------------------------------------------
Gross margin 40,074 25,733 15,964 53.7 41.6 23.4
--------------------------------------------------------------------------------------------------------------------------------
Operating expenses
Selling and administrative 25,890 26,991 33,881 34.7 43.6 49.6
Net research and development 12,390 15,879 12,782 16.6 25.6 18.7
Amortization of property, plant and 4,935 5,210 5,096 6.6 8.4 7.4
equipment(2)
Amortization of intangible assets(2) 5,080 5,676 12,451 6.8 9.2 18.3
Impairment of long-lived assets and 620 7,427 23,657 0.8 12.0 34.6
goodwill
Restructuring and other charges 1,729 4,134 2,880 2.3 6.7 4.2
--------------------------------------------------------------------------------------------------------------------------------
Total operating expenses 50,644 65,317 90,747 67.8 105.5 132.8
--------------------------------------------------------------------------------------------------------------------------------
Loss from operations (10,570) (39,584) (74,783) (14.1) (63.9) (109.4)
Interest and other income 1,438 1,245 1,456 1.9 2.0 2.1
Foreign exchange loss (278) (1,552) (458) (0.4) (2.5) (0.7)
--------------------------------------------------------------------------------------------------------------------------------
Loss before income taxes and amortization (9,410) (39,891) (73,785) (12.6) (64.4) (108.0)
and write-down of goodwill
Income taxes (986) 15,059 (25,451) (1.3) 24.3 (37.3)
--------------------------------------------------------------------------------------------------------------------------------
Loss before amortization and (8,424) (54,950) (48,334) (11.3) (88.7) (70.7)
write-down of goodwill
Amortization of goodwill - - 38,021 - - 55.7
Write-down of goodwill - - 222,169 - - 325.1
Net loss for the year $ (8,424) $ (54,950) $ (308,524) (11.3) % (88.7)% (451.5) %
--------------------------------------------------------------------------------------------------------------------------------
Basic and diluted net loss per share $ (0.13) $ (0.87) $ (5.09)
--------------------------------------------------------------------------------------------------------------------------------
Segment information (3)
Sales:
Telecom Division $ 58,882 $ 48,753 $ 54,452 78.9 % 78.7 % 79.7 %
Photonics and Life Sciences Division 15,748 13,177 13,878 21.1 % 21.3 % 20.3 %
--------------------------------------------------------------------------------------------------------------------------------
$ 74,630 $ 61,930 $ 68,330 100.0 % 100.0 % 100.0 %
--------------------------------------------------------------------------------------------------------------------------------
Operating loss:
Telecom Division $ (5,557) $ - $ - (7.4)% - % - %
Photonics and Life Sciences Division (5,013) - - (6.7) - -
--------------------------------------------------------------------------------------------------------------------------------
$ (10,570) $ - $ - (14.1)% - % - %
--------------------------------------------------------------------------------------------------------------------------------
Research and development data:
Gross research and development $ 15,668 $ 17,133 $ 17,005 21.0 % 27.7 % 24.9 %
Net research and development $ 12,390 $ 15,879 $ 12,782(1) 16.6 % 25.6 % 18.7 %
--------------------------------------------------------------------------------------------------------------------------------
OTHER STATEMENTS OF EARNINGS DATA
(UNAUDITED): (4)
Pro forma net loss $ (1,952) $ (10,879) $ (10,702) (2.6)% (17.6) (15.7)
Basic and diluted pro forma net loss $ (0.03) $ (0.17) $ (0.18)
per share
--------------------------------------------------------------------------------------------------------------------------------
BALANCE SHEETS DATA:
Total assets $ 172,791 $ 146,254 $ 177,926
-------------------------------------------------------------------------------------------------------------------------------
(1) Including inventory write-offs of nil, $4,121 and $18,463 for the years
ended August 31, 2004, 2003 and 2002, respectively, and an unusual gain of
$473 for the year ended August 31, 2003. Excluding inventory write-offs and
the unusual gain, gross margin would have reached 47.4% for the year ended
August 31, 2003. Excluding inventory write-offs, gross margin would have
reached 50.4% for the year ended August 31, 2002. This latter information
is unaudited and is a non-GAAP measure. The cost of sales is exclusive of
amortization, shown separately below.
(2) Certain comparative figures were reclassified to conform to the
current-year presentation.
(3) Comparative information for the loss from operations is not available and
is impracticable to determine.
(4) Net loss excluding stock-based compensation costs, amortization and
write-down of goodwill, unusual tax recovery, future income tax assets
valuation allowance and the after-tax effect of amortization of intangible
assets, impairment of long-lived assets, restructuring and other charges,
inventory and tax credit write-offs and unusual grants recovery. This
information may not be comparable to similarly titled measures reported by
other companies because it is non-GAAP information. Please refer to page 20
of this Annual Report for a detailed quantitative reconciliation.
15 | 2004 Annual Report | EXFO
SALES
FISCAL 2004 VS. 2003
In fiscal 2004, our global sales increased 20.5% to $74.6 million from $61.9
million in 2003, with a 79%-21% split in favor of our Telecom Division.
[BAR CHART OMITTED]
SALES (IN MILLIONS)
2004 74.6
2003 61.9
2002 68.3
2001 146.0
2000 71.6
TELECOM DIVISION
In fiscal 2004, sales of our Telecom Division increased 20.8% to $58.9 million
from $48.8 million in 2003. In 2004, despite a relatively stable carrier
spending environment, compared to the previous year, we continued to gain market
share, which helped us increase our sales year-over-year. We believe these
market-share gains are mainly attributable to our optical field-testing
products, which represent our traditional core business, since sales of our
protocol-layer test solutions represented just over 10% of our Telecom sales in
fiscal 2004. In addition, we benefited from a slight recovery in the telecom
system and optical manufacturing markets. Finally, revenues from FTTP test
solutions were higher than expected, especially with a tier-one customer, which
contributed to our sales increase.
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 remain confident that the solid product portfolio we are
building for this crucial end-market will lead to long-term growth for EXFO.
Over the last few months, we have also been offering new and enhanced
extended-warranty programs, which have significantly increased extended-warranty
sales. Revenues from these sales are deferred and recognized over the warranty
period, causing our deferred revenue to increase year-over-year.
PHOTONICS AND LIFE SCIENCES DIVISION
In fiscal 2004, sales of our Photonics and Life Sciences Division increased
19.5% to $15.7 million from $13.2 million in 2003. The increase in sales is due
to the greater demand for our high-tech industrial manufacturing solutions.
Overall, for the two divisions, net accepted orders increased 34.6% to $75.0
million in fiscal 2004 from $55.7 million in 2003. Our net book-to-bill ratio
rose to 1.00 in fiscal 2004, from 0.90 in 2003.
For the upcoming quarters, we expect the sales split between the two divisions
to remain in the same ranges as for fiscal 2004.
FISCAL 2003 VS. 2002
In fiscal 2003, our global sales decreased 9.4% to $61.9 million from $68.3
million in 2002, with a 79%-21% split in favor of our Telecom Division.
TELECOM DIVISION
In fiscal 2003, sales of our Telecom Division decreased 10.5% to $48.8 million
from $54.5 million in 2002. Most of the decrease is attributable to the
collapsed market for optical components and the resulting gray market. Also,
increased pricing pressure by vendors and the continued slowdown in the global
telecommunications industry affected our sales. However, despite depressed
spending levels in the telecommunications industry, our sales of field-testing
products increased 3%, compared to 2002, mainly because of heightened traction
in the protocol-layer testing sector.
PHOTONICS AND LIFE SCIENCES DIVISION
In fiscal 2003, sales of our Photonics and Life Sciences Division decreased 5.1%
to $13.2 million from $13.9 million in 2002. The markets addressed by this
division are relatively stable, thus explaining the relative stability in this
division's sales year-over-year.
GEOGRAPHIC DISTRIBUTION
During fiscal 2004 and 2003, sales to the Americas, Europe-Middle East-Africa
(EMEA) and Asia-Pacific (APAC) accounted for 66%, 18% and 16% of global sales,
respectively. During 2002, sales to the Americas, EMEA and APAC accounted for
61%, 20% and 19% of global sales, respectively.
The geographic distribution of our sales remained unchanged as a percentage of
sales in fiscal 2004, compared to 2003, since all geographic areas had the same
growth level.
In fiscal 2003, sales to the Americas stayed relatively stable in dollars
compared to 2002, while sales to the EMEA and APAC markets decreased
year-over-year. The EMEA market was the most affected by the downturn in the
telecommunications industry, which caused our sales to this market to decrease
year-over-year. In addition, most of our sales to the APAC market are made
through tenders, which may vary in number and significance from period to
period. Finally, the SARS outbreak also affected our sales to this market to
some extent.
Through our two divisions, we sell our products to a broad range of customers,
including network service providers, optical component and system manufacturers,
as well as high-tech industrial manufacturers and research and development
laboratories. During fiscal 2004, we had only one customer that accounted for
more than 10% of sales, representing 13.8% of sales ($10.3 million). During that
same year, our top three customers accounted for 20.8% of our sales. During
2003, no customer accounted for more than 10% of our sales. In fiscal 2002, we
had one customer that accounted for more than 10% of sales, with 10.2% ($7.0
million).
16 | 2004 Annual Report | EXFO
GROSS MARGIN
Gross margin amounted to 53.7%, 41.6% and 23.4% of sales for fiscal 2004, 2003
and 2002, respectively.
[BAR CHART OMITTED]
2004 53.7%
2003 41.6%
2003 47.4% Pro Forma*
2002 23.4%
2002 50.4% Pro Forma**
2001 61.5%
2000 64.6%
* Excluding inventory write-offs
of $4.1 million and an unusual
gain of $473,000
** Excluding inventory write-offs
of $18.5 million
FISCAL 2004 VS. 2003
In fiscal 2003, we recorded write-offs for excess and obsolete inventories of
$4.1 million and an unusual gain of $473,000 related to a grant recovery.
Excluding these special items, gross margin would have reached 47.4% of sales
for that year. The increase in our gross margin in fiscal 2004, compared to
2003, can be explained by several factors. First, the rise in sales (20.5%
year-over-year) undoubtedly helped increase our gross margin. Increased
manufacturing activities allowed us to better absorb our fixed manufacturing
costs. In addition, our cost-reduction measures, the consolidation of
manufacturing sites and our enhanced efficiency further contributed to the
increase in gross margin. However, a stronger Canadian dollar, compared to the
US dollar year-over-year, prevented us, to some extent, from further improving
our gross margin as some cost of sales elements are denominated in Canadian
dollars.
FISCAL 2003 VS. 2002
In fiscal 2002, we also recorded write-offs for excess and obsolete inventories
of $18.5 million. Excluding these special charges, our gross margin would have
reached 50.4% of sales. The decrease in our gross margin in fiscal 2003,
compared to 2002, on an adjusted basis, is attributable to several factors.
First, the market condition and competitive landscape inevitably led to
increased pricing pressure. This, combined with a lower sales level in fiscal
2003, prevented a better absorption of our fixed manufacturing costs, which
ultimately caused margin erosion. In addition, shift in product mix in favor of
our field-testing products caused our gross margin to decrease, as these
products tend to have lower margins than our modular and benchtop products.
However, the decrease in our gross margin was offset in part by our increased
efficiency and restructuring efforts in 2002 and 2003.
OUTLOOK FOR FISCAL 2005
Considering the current state of the telecommunications industry, our recent
cost-cutting measures, our tight control on operating costs as well as our
expected sales growth, we believe that our gross margin will improve in fiscal
2005. However, our gross margin may fluctuate quarter-over-quarter as our sales
may fluctuate. Furthermore, our gross margin can be negatively affected by
increased competitive pricing pressure, increased obsolescence costs, shifts in
product mix, under-absorption of fixed manufacturing costs and increases in
product offerings by other suppliers in our industry. Finally, the expected
increased strength of the Canadian dollar should have, to some extent, a
negative impact on our gross margin in 2005.
SELLING AND ADMINISTRATIVE
Selling and administrative expenses were $25.9 million, $27.0 million and $33.9
million for fiscal 2004, 2003 and 2002, respectively. As a percentage of sales,
selling and administrative expenses amounted to 34.7%, 43.6% and 49.6% for
fiscal 2004, 2003 and 2002, respectively.
[BAR CHART OMITTED]
SALES (IN MILLIONS)
2004 25.9
2003 27.0
2002 33.9
2001 45.0
2000 23.6
FISCAL 2004 VS. 2003
In fiscal 2004, thanks to our restructuring actions and tight cost-control
measures, we were able to reduce our selling and administrative expenses by 4%
year-over-year, while our sales increased 20.5% in that same period. However,
several factors prevented us from further reducing these expenses
year-over-year. A higher sales volume in fiscal 2004, compared to 2003, caused
our commission and marketing expenses to increase. In addition, since September
1, 2003, we account for non-cash stock-based compensation costs related to
awards granted to our employees, which caused our selling and administrative
expenses to increase $265,000 year-over-year. Furthermore, in fiscal 2003, we
recorded an unusual gain of $239,000 related to a grant recovery. Finally, a
stronger Canadian dollar, compared to the US dollar year-over-year, further
increased our selling and administrative expenses, as some of these are incurred
in Canadian dollars.
FISCAL 2003 VS. 2002
In fiscal 2003, as a result of our restructuring plans implemented in 2002 and
2003, we were able to significantly reduce our selling and administrative
expenses year-over-year (20%). Also, the decrease in sales in fiscal 2003
resulted in lower commission and marketing expenses during that year. Finally,
in 2003, as mentioned above, we recorded an unusual gain of $239,000 related to
a grant recovery. However, this significant decrease in our selling and
administrative expenses was offset in part by the impact of the acquisitions of
EXFO Protocol and EXFO Gnubi in November 2001 and October 2002, respectively.
Also, the increased strength of the Canadian dollar, compared to the US dollar,
in fiscal 2003, prevented us from further reducing our selling and
administrative expenses, as some of these are incurred in Canadian dollars.
OUTLOOK FOR FISCAL 2005
For fiscal 2005, we expect our selling and administrative expenses to increase
in dollars and be relatively stable as a percentage of sales. In particular, we
expect our commission expenses to increase as sales volume increases. Also,
considering our goal of becoming the leading player in the telecom test and
measurement space, we will intensify our sales and marketing efforts, both
domestic and international, which will also cause our expenses to rise. Finally,
the expected increased strength of the Canadian dollar should also cause our
selling and administrative expenses to increase, as some of these are incurred
in Canadian dollars.
17 | 2004 Annual Report | EXFO
RESEARCH AND DEVELOPMENT
Gross research and development expenses totaled $15.7 million, $17.0 million,
$17.0 million for fiscal 2004, 2003 and 2002, 25 respectively. As a percentage
of sales, gross research and development expenses amounted to 21.0%, 27.7% and
24.9% for fiscal 2004, 2003 and 2002, respectively.
[BAR CHART OMITTED]
SALES (IN MILLIONS)
2004 15.7%
2003 17.1%
2002 17.0%
2001 17.6%
2000 9.4%
FISCAL 2004 VS. 2003
The decrease in our gross research and development expenses in fiscal 2004,
compared to 2003, both in dollars and as percentage of sales can be explained by
several factors. First, our restructuring actions, the consolidation of our
protocol operations in Montreal, as well as tight cost-control measures,
contributed to the reduction of our gross research and development expenses
year-over-year. In addition, we refocused our research and development
activities in our Photonics and Life Sciences Division. Finally, mix and timing
of our research and development projects, especially in our Telecom Division,
caused our gross research and development expenses to decrease year-over-year.
On the other hand, a stronger Canadian dollar, compared to the US dollar
year-over-year, increased our gross research and development expenses, as most
of these are incurred in Canadian dollars.
Although we reduced our gross research and development expenses year-over-year,
we still invested significantly in research and development activities in fiscal
2004, mainly in our Telecom Division for IP-based convergence and FTTP
deployments. 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. As mentioned
above, in fiscal 2004, we launched 20 new products, including several aimed at
establishing leadership in the emerging FTTP market and others dedicated to
expanding our life sciences product portfolio.
FISCAL 2003 VS. 2002
In fiscal 2003, our dollar-amount gross research and development expenses
remained flat compared to 2002. The savings related to our restructuring actions
were fully offset by the impact of the acquisitions of EXFO Protocol and EXFO
Gnubi, which carried out a significant level of research and development
activities, and by the strength of the Canadian dollar, compared to the US
dollar, since a large portion of our R&D expenses are incurred in Canadian
dollars. The percentage increase in fiscal 2003, compared to 2002, can be
explained by the fact that despite challenging market conditions, we continued
investing heavily in research and development, especially in the protocol-layer
sector. In fact, in 2003, we launched 15 new products, most of which were
telecom-related solutions.
Tax credits and grants from the Canadian federal and provincial governments for
research and development activities were $3.3 million, $3.6 million and $4.2
million for fiscal 2004, 2003 and 2002, respectively. The decrease in our tax
credits and government grants in fiscal 2004, compared to 2003, is mainly
related to the decrease in our eligible gross research and development expenses
incurred in Canada, since we were entitled to similar tax credits
year-over-year. The decrease in tax credits and grants in fiscal 2003, compared
to 2002, is due to several reasons. First, our government grant programs came to
an end. Second, the acquisition of U.S.-based EXFO Gnubi, early in 2003, led to
a larger portion of our R&D activities being conducted in the U.S., where such
activities are not eligible for tax credits. Finally, we did not record Canadian
federal tax credits for EXFO Protocol in the fourth quarter of 2003 because it
was more likely than not that those credits would be recovered in the medium
term.
Also, in fiscal 2003, we wrote off $2.3 million of Canadian federal tax credits
because it was more likely than not that these credits would not be recoverable.
These tax credits can be carried forward against future years' taxable income
over the next nine years.
OUTLOOK FOR FISCAL 2005
During fiscal 2005, we expect to continue investing significantly in research
and development activities, reflecting our focus on innovation, our desire to
gain market share and our goal to exceed customer needs and expectations.
AMORTIZATION OF INTANGIBLE ASSETS
In conjunction with the business combinations we completed over the past few
years, we recorded intangible assets, primarily consisting of core technology.
These intangible assets resulted in amortization expenses of $5.1 million, $5.7
million and $12.5 million for fiscal 2004, 2003 and 2002, respectively. The
decrease in amortization expenses in fiscal 2004, compared to 2003, is the
result of the $2.9 million impairment charge recorded in the third quarter of
fiscal 2003. The decrease in amortization expenses in fiscal 2003, compared to
2002, is the result of the impairment charge recorded in 2003, as discussed
above, and the significant impairment charge of $23.7 million recorded in 2002.
Also, acquired in-process R&D was fully amortized at the end of 2002, which
reduced amortization expenses in 2003.
OUTLOOK FOR FISCAL 2005
For fiscal 2005, we expect the amortization of intangible assets to approximate
$1.1 million per quarter, assuming no acquisitions are made during that time.
IMPAIRMENT OF LONG-LIVED ASSETS AND GOODWILL
FISCAL 2002
In May 2002, as part of our review of financial results, we performed an
assessment of the carrying value of goodwill and intangible assets recorded in
conjunction with the acquisitions of EXFO Burleigh Products Group Inc. (EXFO
Burleigh), EXFO Photonic Solutions Inc. (EXFO Photonic Solutions) and EXFO
Protocol Inc. (EXFO Protocol). The assessment was performed because of the
severe and continued downturn in the telecommunications industry, the persisting
unfavorable market conditions affecting our subsidiaries' industries and the
decline in technology valuations. The growth prospects for our subsidiaries were
significantly lower than previously expected and less than those of historical
periods. In addition, the decline in market conditions affecting the
subsidiaries was significant and other than temporary. As a result, we concluded
that the carrying value of goodwill and certain acquired intangible assets was
impaired and we recorded a charge of $222.2 million to write down a significant
portion of goodwill and a pre-tax charge of $23.7 million to write down a
significant portion of acquired core technology. Of the total impairment charge
of $245.8 million, $125.0 million was related to EXFO Burleigh for goodwill and
acquired core technology, $71.5 million was related to EXFO Photonic Solutions
for goodwill and acquired core technology and $49.3 million was related to EXFO
Protocol for goodwill.
The impairment charge was calculated based upon the then-existing accounting
rules and represented the excess of the carrying value of the assets over the
pre-tax undiscounted future cash flows. The pre-tax undiscounted future cash
flows were estimated at the subsidiaries' level, since we had distinct cash
flows for each of them and because they were not fully integrated into our
activities. The cash flow periods used ranged from three to five years and the
annual growth rates ranged between 15% and 30%.
18 | 2004 Annual Report | EXFO
FISCAL 2003
In May 2003, we performed our annual impairment test of goodwill for all our
reporting units, except for newly acquired EXFO Gnubi. Also, considering
market conditions in the telecommunications industry and the persisting
unfavorable conditions affecting our subsidiaries' industries, we reviewed
the carrying value of intangible assets related to these reporting units,
consisting primarily in acquired core technology.
As a result of this assessment, we concluded that the carrying value of
goodwill related to EXFO Burleigh and the carrying value of intangible
assets related to EXFO Burleigh and EXFO Photonic Solutions were impaired
and we recorded an impairment charge of $4.5 million to write down goodwill
and a pre-tax impairment charge of $2.9 million to write down acquired core
technology. Of the total impairment charge of $7.4 million, $6.9 million was
related to EXFO Burleigh for goodwill and acquired core technology and
$555,000 was related to EXFO Photonic Solutions for acquired core
technology.
The write-down of goodwill and acquired core technology of EXFO Burleigh was
required, considering that we exited the optical component manufacturing
automation business, whose revenue potential represented a long-term
prospect. The write-down of acquired core technology from EXFO Photonic
Solutions was required because revenue potential related to this long-lived
asset was less than expected in the short and medium term due to the state
of the market at the time.
However, no impairment of goodwill and intangible assets was required for EXFO
Protocol since we believed that revenue potential from the protocol-layer
testing market will remain strong in the short and medium term.
For the purposes of estimating fair values, we used a combination of discounted
future cash flows and a market approach (sales multiples). The discounted future
cash flows were estimated using periods ranging between eight and ten years,
discount rates ranging between 15% and 20%, and an annual growth rate ranging
between nil and 35%. The sales multiples used in the market approach ranged
between 0.7 and 2.3. The assumptions used reflected our best estimates.
FISCAL 2004
In May 2004, we performed our annual impairment test and concluded that
goodwill was not impaired. Goodwill will be reviewed for impairment in May
2005, or prior to that date if events or circumstances occur that more
likely than not reduce the fair value of a reporting unit below its carrying
value.
Also, at the end of fiscal 2004, we reviewed the carrying value of one of
our buildings that was put up for sale and we concluded that the building
was impaired. We recorded an impairment charge of $620,000, representing the
excess of the carrying value of the building over its expected selling
price. The building did not meet the criteria of CICA handbook section 3475,
"Disposal of Long-Lived Assets and Discontinued Operations", because it was
not available for sale in its existing condition. Consequently, it was not
shown as a long-lived asset held for sale in the balance sheet as at August
31, 2004. The decision to sell this building was made in order to consolidate
our Quebec city manufacturing operations in a single location, which will allow
us to increase efficiency and reduce costs. This building reports to our Telecom
Division.
After the end of fiscal 2004, we received a formal offer to buy this building;
the offer is conditional upon the usual building inspections. The sale price
proposed in the offer represents the fair value used by management to determine
the decrease in the value of the building as at August 31, 2004.
RESTRUCTURING AND OTHER CHARGES
FISCAL 2002
In fiscal 2002, we implemented restructuring plans to reduce our costs. Under
these plans, we recorded charges of $2.9 million, including $2.0 million in
severance expenses for the 350 employees who were terminated throughout the
company and $868,000 for impaired long-lived assets.
FISCAL 2003
In fiscal 2003, we implemented an additional restructuring plan to realign our
cost structure to market conditions. Under that plan, we recorded additional
charges of $4.1 million, including $2.8 million in severance expenses for the
172 employees who were terminated throughout the company, $512,000 for impaired
long-lived assets and $855,000 for future payments on exited leased facilities
located around the world. Our estimation of the fair value of such future
payments took into account the estimated sublease rentals over the remaining
terms of the exited leases.
FISCAL 2004
In fiscal 2004, the Board of Directors approved a restructuring plan to
consolidate EXFO Burleigh's operations, transferring them mainly to EXFO
Photonic Solutions facilities in Toronto. The consolidation process started in
August 2004 and should extend through the first two quarters of fiscal 2005. We
estimate that the overall costs to be incurred under this plan should amount to
$2.7 million during the implementation period. From this amount, $772,000,
representing severance expenses, was recorded in fiscal 2004 for the layoff of
all employees of EXFO Burleigh. In addition, we recorded an impairment charge of
$1.3 million, mainly for the building. We expect to incur most of the remaining
$667,000 during the first two quarters of fiscal 2005 for different types of
consolidation expenses such as training, recruiting and other special
termination benefits.
The EXFO Burleigh building is for sale in its present condition and we expect to
sell the property within the next twelve months. Consequently, as per CICA
handbook section 3475, "Disposal of Long-Lived Assets and Discontinued
Operations", the building has been shown in the balance sheet as a long-lived
asset held for sale. The fair value used to determine the impairment charge for
the building represents our best estimate of its selling price based upon the
municipal valuation. Since September 1, 2004, this building will cease to be
amortized.
Expenses incurred in relation with our restructuring plans have been recorded in
the restructuring and other charges in the statements of earnings of the
reporting years.
Our cost-reduction measures represented our best efforts to respond to the
difficult market conditions of the past years and we expect that they will lead
us to profitability on a pro-forma basis in fiscal 2005. However, these efforts
may be inappropriate or insufficient. Our actions in this regard may not be
successful in achieving the cost reductions or other benefits expected, may be
insufficient to align our cost structure to market conditions, or may be more
costly or extensive than anticipated.
INTEREST AND OTHER INCOME
Our interest income mainly resulted from our short-term investments, less
interests and bank charges. Interest and other income amounted to $1.4 million,
$1.2 million and $1.5 million for fiscal 2004, 2003 and 2002, respectively. In
fiscal 2004, we recorded a one-time revenue of $265,000 for the sale of non-core
technologies. Without this one-time revenue, interest and other income would
have been relatively flat year-over-year.
We expect our interest income to slightly increase in fiscal 2005 as our cash
position increased during 2004 following our public offering in February 2004.
19 | 2004 Annual Report | EXFO
FOREIGN EXCHANGE LOSS
Foreign exchange loss amounted to $278,000, $1.6 million and $458,000 for fiscal
2004, 2003 and 2002, respectively.
Foreign exchange gains and losses are the result of the translation of operating
activities denominated in currencies other than the Canadian dollar. In fiscal
2004, the Canadian dollar fluctuated less than in the previous year, resulting
in a smaller foreign exchange loss during that year, compared to 2003. In fiscal
2003, the Canadian dollar value increased significantly through the year,
compared to the US dollar, resulting in a significant exchange loss during that
year.
We manage our exposure to currency risk with forward exchange contracts. In
addition, some of our Canadian entities' operating activities are denominated
in currencies other than the Canadian dollar, which further hedges this risk.
INCOME TAXES
Our income tax recovery was $986,000 for fiscal 2004, compared to an income tax
expense of $15.1 million in 2003 and an income tax recovery of $25.5 million in
2002.
The income tax recovery recorded in fiscal 2004 is mainly due to the $1.4
million unusual income tax recovery recorded during that year, offset in part by
income taxes payable in some specific tax jurisdictions. The unusual tax
recovery was due to the receipt, during that period, of income taxes paid in
previous periods following the reception of a tax assessment.
Since the third quarter of fiscal 2003, we have been recording a full valuation
allowance against our future income tax assets. In fiscal 2003, considering
market conditions as well as the fact that we recorded losses for fiscal 2003
and the previous year, we concluded that it is more likely than not that these
assets would not be recovered and that a full valuation allowance was required.
Even though the carrying periods of our future income tax assets were very long
or indefinite, we recorded a full valuation allowance against our future income
tax assets, mainly related to the parent company, EXFO Protocol and EXFO
Burleigh. Future income tax assets written off consisted mainly in deferred tax
losses, research and development expenses, share issue expenses as well as
non-deductible provisions and accruals. In fiscal 2004, we also recorded a full
valuation allowance on new future income tax assets created during the year.
Please refer to note 15 to our consolidated financial statements included
elsewhere in this Annual Report for details about our future income tax assets
and valuation allowance.
The valuation allowance will be reversed once management concludes that
realization of future income tax assets is more likely than not. Consequently,
our future periods' income tax rates will be distorted compared to history
rates.
AMORTIZATION OF GOODWILL
In conjunction with the business combinations completed over the past few years,
we have recorded goodwill. The goodwill related to the acquisitions of EXFO
Burleigh and EXFO Photonic Solutions was amortized over five years until August
31, 2002. This resulted in amortization expenses of $38.0 million in fiscal
2002. The acquisitions of EXFO Protocol and EXFO Gnubi have been accounted for
using new accounting standards contained in CICA handbook sections 1581,
"Business Combinations" and 3062, "Goodwill and Other Intangible Assets" and,
consequently, goodwill resulting from these acquisitions was not amortized.
Since September 1, 2002, goodwill related to the acquisitions of EXFO Burleigh
and EXFO Photonic Solutions is no longer amortized under new accounting
standards. Consequently, we no longer have amortization expenses for goodwill.
NET LOSS AND PRO FORMA NET LOSS
Net loss amounted to $8.4 million, $55.0 million and $308.5 million in fiscal
2004, 2003 and 2002, respectively. In terms of per share amounts, we recorded a
net loss of $0.13, $0.87 and $5.09 in fiscal 2004, 2003 and 2002, respectively.
Also, as a measure to assess financial performance, we use pro forma net loss
and pro forma net loss per share. Pro forma net loss represents net loss
excluding stock-based compensation costs, amortization and write-down of
goodwill, unusual tax recovery, future income tax assets valuation allowance and
the after-tax effect of amortization of intangible assets, impairment of
long-lived assets, restructuring and other charges, inventory and tax credits
write-offs and unusual grants recovery.
Pro forma net loss amounted to $2.0 million, $10.9 million and $10.7 million in
fiscal 2004, 2003 and 2002, respectively. In terms of pro forma per share
amounts, we recorded a net loss of $0.03, $0.17 and $0.18 in fiscal 2004, 2003
and 2002, respectively.
20 | 2004 Annual Report | EXFO
Pro forma net loss is reconciled as follows:
YEARS ENDED AUGUST 31, 2004 2003 2002
--------------------------------------------------------------------------------------------------------------------------
(UNAUDITED) (UNAUDITED) (UNAUDITED)
Net loss according to GAAP $ (8,424) $ (54,950) $ (308,524)
Pro forma adjustments:
Stock-based compensation costs 449 - -
Amortization and write-down of goodwill - 4,505 260,190
Amortization of intangible assets 5,080 5,676 12,451
Tax effect on amortization of intangible assets - (2,031) (4,296)
Impairment of long-lived assets 620 2,922 23,657
Tax effect on impairment of long-lived assets - (1,046) (8,161)
Restructuring and other charges and inventory and tax credit
write-offs 1,729 10,549 21,343
Tax effect on restructuring and other charges and inventory and tax
credit write-offs - (3,777) (7,362)
Unusual tax and grants recovery (1,406) (1,357) -
Tax effect on unusual grants recovery - 245 -
Future income tax assets valuation allowance - 28,385 -
--------------------------------------------------------------------------------------------------------------------------
Pro forma net loss $ (1,952) $ (10,879) $ (10,702)
Basic and diluted net loss per share $ (0.13) $ (0.87) $ (5.09)
Basic and diluted pro forma net loss per share $ (0.03) $ (0.17) $ (0.18)
We provide pro forma financial information in order to provide supplemental
information regarding our results of operations and to enhance our
investors' overall understanding of our core financial performance and our
prospects for the future. We believe that our investors benefit from seeing
our results through the eyes of management in addition to seeing the GAAP
information. This non-GAAP information facilitates management's comparison
of current results with the company's historical results of operations and
with those of our peers. This information is not in accordance with, or an
alternative to, GAAP and may not be comparable to similarly titled measures
reported by other companies.
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.
In fiscal 2004, pursuant to a public offering in Canada, we issued 5,200,000
million subordinate voting shares for net proceeds of $29.2 million
(Cdn$38.4 million) after deducting underwriting commissions of $1.2 million
(Cdn$1,600,000). 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 in fiscal 2004 are attributable
to the net proceeds of this offering.
One of the four main objectives of our strategic plan for fiscal 2004 was 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 August 31, 2004,
cash and short-term investments consisted of $89.1 million, while our
working capital was at $115.1 million. Our cash and short-term investments
increased $31.8 million in fiscal 2004, compared to 2003, mainly due to the
net proceeds of the public offering of $29.2 million, the cash flows from
operating activities of $751,000 as well as an unrealized foreign exchange
gain of $2.9 million on cash and short-term investments. However, this
increase was partially offset by the cash payment of $1.1 million for the
purchase of property, plant and equipment as well as intangible assets. The
unrealized foreign exchange gain resulted from the translation, in US
dollars, of our Canadian-dollar-denominated cash and short-term investments
and was recorded in the cumulative translation adjustment in the balance
sheet.
We believe that our cash balances and short-term investments, combined with
an available line of credit of $4.8 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, that
it can be secured on satisfactory terms. Our line of credit bears interest
at prime rate.
The following table summarizes our commitments as at August 31, 2004:
2009 AND
YEARS ENDING AUGUST 31, 2005 2006 2007 2008 LATER TOTAL
-------------------------------------------------------------------------------------------------------------------------------
Long-term debt $ 121,000 $ 135,000 $ 146,000 $ 51,000 $ - $ 453,000
Operating leases 938,000 875,000 780,000 484,000 1,305,000 4,382,000
-------------------------------------------------------------------------------------------------------------------------------
Total commitments $1,059,000 $1,010,000 $ 926,000 $ 535,000 $1,305,000 $4,835,000
===============================================================================================================================
21 | 2004 Annual Report | EXFO
OPERATING ACTIVITIES
Cash flows provided by operating activities amounted to $751,000 in fiscal 2004,
compared to $5.6 million in 2003 and cash flows used of $8.7 million in 2002.
Cash flows provided by operating activities in fiscal 2004 were mainly
attributable to the net earnings after items not affecting cash of $5.7 million,
offset in part by the net increase of our operating items of $4.9 million; that
is, our accounts receivable increased by $2.7 million, our income taxes and tax
credits recoverable increased by $2.5 million and our inventories decreased by
$1.0 million. The increase in our accounts receivable is directly related to the
significant sales growth in fiscal 2004 (20.5%). The increase in our income
taxes and tax credits recoverable is mainly due to the payment during the year
of income taxes and to the recognition, during the year, of R&D tax credits not
yet recovered. On the other hand, our increased sales level combined with tight
inventory management enabled us to reduced our inventories overall.
Cash flows provided by operating activities in fiscal 2003 were mainly the
result of a decrease in some of our operating items; that is, our accounts
receivable decreased by $4.0 million, our income taxes and tax credits
recoverable decreased by $13.9 million and our inventories decreased by $7.9
million (excluding write-offs). These positive effects on cash were offset in
part by the net loss after items not affecting cash of $18.9 million. The
decrease in our accounts receivable is directly related to the reduction in our
sales during that year. The decrease in our income taxes and tax credits
recoverable is related to the recovery, during the year, of income taxes and
research and development tax credits recoverable from previous periods. Finally,
the decrease in our inventories is due to our efforts to maintain them at the
lowest acceptable level considering the decrease in sales.
With positive cash flows from operating activities for three quarters in a row
and for fiscal 2004, we met one of our four annual strategic objectives, which
consisted in maintaining a sound financial position.
INVESTING ACTIVITIES
Cash flows used by investing activities totaled $29.7 million in fiscal 2004,
compared to $9.9 million in 2003 and cash flows provided of $10.5 million in
2002.
In fiscal 2004, we acquired $28.6 million worth of short-term investments with
the net proceeds of the public offering. In addition, we paid $1.1 million for
the purchase of property, plant and equipment and intangible assets.
In fiscal 2003, we acquired $5.4 million worth of short-term investments with
the proceeds from the recovery of income taxes and tax credits. We also made
cash payments of $1.9 million and $2.6 million for the acquisition of EXFO Gnubi
and the purchases of property, plant and equipment, respectively.
FORWARD EXCHANGE CONTRACTS
We utilize forward exchange contracts to manage our foreign currency exposure.
Our policy is not to utilize those derivative financial instruments for trading
or speculative purposes.
Our forward exchange contracts, which are used to hedge anticipated
US-dollar-denominated sales, qualify for hedge accounting; therefore, foreign
exchange translation gains and losses on these contracts are recognized as an
adjustment of the revenues when the corresponding sales are recorded.
As at August 31, 2004, we held contracts to sell US dollars at various forward
rates, which are summarized as follows:
WEIGHTED AVERAGE
CONTRACTUAL
EXPIRY DATES: CONTRACTUAL AMOUNTS FORWARD RATES
--------------------------------------------------------------------------------
September 2004 to August 2005 $ 7,480 1.5427
September 2005 to March 2007 8,400 1.3622
As at August 31, 2003 and 2004, these forward exchange contracts generated
deferred unrealized gains of US$1.8 million and US$1.5 million, respectively.
Deferred unrealized gains were calculated using year-end exchange rates of
Cdn$1.3851 = US$1.00 for fiscal 2003 and Cdn$1.3167 = US$1.00 for fiscal 2004.
RELATED-PARTY TRANSACTIONS
In fiscal 2003, EXFO acquired a building from a company owned by the President
of the company for a cash consideration of $930,000. This transaction was
measured at the fair market value since it was not conducted during the normal
course of operations, the change in ownership interest in the building was
substantive and the fair market value was supported by independent appraisal.
In addition, for the years ended August 31, 2002, 2003 and 2004, EXFO leased
facilities from a company owned by the President of the company. The annual
rental expense amounted to $234,000, $331,000 and nil, respectively. The rental
expense for fiscal 2003 included $234,000 for future payments on an exited
leased facility. As at August 31, 2004, restructuring charges payable included
$194,000 due to the company owned by the President of the company in connection
with this exited leased facility. In September 2004, EXFO was released from its
obligations under that lease, and it paid the full amount due to the related
company. These rental expenses were measured at the fair market value since they
were incurred during the normal course of operations.
CONTINGENCY
As discussed in note 12 to our consolidated financial statements, 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.
22 | 2004 Annual Report | EXFO
In June 2003, a committee of the company's Board of Directors conditionally
approved a proposed settlement between the issuer defendants, the individual
defendants, and the plaintiffs. On June 25, 2004, the Plaintiffs moved for
Preliminary Approval of the settlement, and the Underwriter defendants have
opposed that motion. If approved, the settlement would provide, among other
things, a release of the company and of the individual defendants for the
conduct alleged in the action to be wrongful in the amended complaint. The
company would agree to undertake other responsibilities under the settlement,
including agreeing to assign away, not assert, or release certain potential
claims the company may have against its underwriters. Any direct financial
impact of the proposed settlement is expected to be borne by the company's
insurance carriers.
Since the settlement process is subject to a fairness hearing and final court
approval, it is possible that it could fail. Therefore, it is not possible to
predict the final outcome of the case, nor determine the amount of any possible
losses. If the settlement process fails, the company will continue to defend its
position in this litigation that the claims against it, and its officers, are
without merit. Accordingly, no provision for this case has been made in the
consolidated financial statements as at August 31, 2004.
SHARE CAPITAL AND STOCK-BASED COMPENSATION PLANS
SHARE CAPITAL
As at November 3, 2004, EXFO had 37,900,000 multiple voting shares outstanding,
entitling to ten votes each, and 30,581,696 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 2,934,518 as at August 31, 2004. The weighted
average exercise price of those stock options was $13.89 compared to the market
price of $4.36 per share as at August 31, 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 August 31, 2004:
% OF ISSUED WEIGHTED AVERAGE
NUMBER AND OUTSTANDING EXERCISE PRICE
---------------------------------------------------------------------------------------------------------------------------
Chairman of the Board, President and CEO (one individual) 150,482 5.1 % $ 9.91
Board of Directors (five individuals) 194,375 6.6 % $ 6.23
Management and Corporate Officers (seven individuals) 315,300 10.7 % $ 15.03
---------------------------------------------------------------------------------------------------------------------------
660,157 22.5 % $ 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 53,592 as at August 31,
2004. Each restricted stock award entitles employees to receive one
subordinate voting share at a purchase price of nil.
RISKS AND UNCERTAINTIES
Over the past few years, we have managed our business in a difficult
environment; focused on research and development programs for new and
innovative products aimed at expected growth pockets in our sector;
continued the development of our domestic and international markets; and
closed strategic acquisitions. However, we operate in a highly competitive
sector that is in constant evolution and, as a result, we encounter various
risks and uncertainties that must be given appropriate consideration in our
strategic management policies.
The main risks and uncertainties related to the telecommunications test and
measurement industry involve the rapid development of new products that may
have short life cycles and require extensive research and development; the
difficulty of adequately predicting market size and trends; the difficulty
of retaining highly skilled employees; and the ability to quickly adapt our
cost structure to changing market conditions in order to achieve
profitability.
In addition, given our strategic goals for growth and competitive
positioning in our industry, we are continuously expanding into
international markets. This exposes us to certain risks and uncertainties
related to changes in local laws and regulations, multiple technological
standards, protective legislation and pricing pressure.
Furthermore, while strategic acquisitions, like those we have made in the
past and possibly others in the future, are essential to our long-term
growth, they also expose us to certain risks and uncertainties related to
the rapid and effective integration of these businesses as well as their
products, technologies and personnel.
We are also exposed to currency risks as a result of the export of our
products manufactured in Canada, the large majority of which are denominated
in US dollars for sale. These risks are partially hedged by operating
expenses denominated in US dollars, the purchase of raw materials in US
dollars and forward exchange contracts. The increased strength of the
Canadian dollar, compared to the US dollar, over the last two years caused
our operating expenses, as well as our foreign exchange loss, to be higher.
Any further increase in the value of the Canadian dollar in the coming
months will negatively affect our results of operations.
The precarious economic environment of our industry could also result in some of
our customers experiencing difficulties and, consequently, this could have a
negative effect on our results especially in terms of future sales and
recoverability of accounts receivable. However, the sectorial and geographic
diversity of our customer base provides us with a reasonable level of protection
in this area. Finally, other financial instruments, which potentially subject us
to credit risks, consist mainly of cash, short-term investments and forward
exchange contracts. Our short-term investments consist of debt instruments
issued by high-credit quality corporations and trusts. Our cash and forward
exchange contracts are held with or issued by high-credit quality financial
institutions; therefore, we consider the risk of non-performance on these
instruments to be remote.
For a more complete understanding of risk factors that may affect us, please
refer to the risk factors set forth in our disclosure documents published
with securities commissions.
23 | 2004 Annual Report | EXFO
QUARTERLY SUMMARY FINANCIAL INFORMATION (UNAUDITED)
(in thousands of US dollars, except per share data)
YEARS ENDED
1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER AUGUST 31,
--------------------------------------------------------------------------------------------------------------------------------
2004
Sales $ 15,962 $ 16,880 $ 20,456 $ 21,332 $ 74,630
Cost of sales $ 7,815 $ 7,528 $ 9,637 $ 9,576 $ 34,556
Gross margin $ 8,147 $ 9,352 $ 10,819 $ 11,756 $ 40,074
Loss from operations $ (3,145) $ (3,485) $ (1,888) $ (2,052) $ (10,570)
Net loss $ (2,008) $ (2,885) $ (1,188) $ (2,343) $ (8,424)
Pro forma net earnings (loss) (1) $ (2,124) $ (1,510) $ 273 $ 1,409 $ (1,952)
Basic and diluted net loss
per share (1) $ (0.03) $ (0.04) $ (0.02) $ (0.03) $ (0.13)
Basic and diluted pro forma net
earnings (loss) per share (1) $ (0.03) $ (0.02) $ 0.00 $ 0.02 $ (0.03)
2003
Sales $ 17,748 $ 14,753 $ 15,103 $ 14,326 $ 61,930
Cost of sales $ 8,031 $ 7,939 $ 10,460 $ 9,767 $ 36,197
Gross margin $ 9,717 $ 6,814 $ 4,643 $ 4,559 $ 25,733
Loss from operations $ (3,562) $ (6,085) $ (18,924) $ (11,013) $ (39,584)
Net loss $ (2,158) $ (4,246) $ (38,427) $ (10,119) $ (54,950)
Pro forma net loss (1) $ (1,217) $ (3,289) $ (3,922) $ (2,485) $ (10,879)
Basic and diluted net loss
per share (1) $ (0.03) $ (0.07) $ (0.61) $ (0.16) $ (0.87)
Basic and diluted pro forma net
loss per share (1) $ (0.02) $ (0.05) $ (0.06) $ (0.04) $ (0.17)
2002
Sales $ 20,138 $ 14,601 $ 16,348 $ 17,243 $ 68,330
Cost of sales $ 13,008 $ 13,172 $ 17,429 $ 8,757 $ 52,366
Gross margin (loss) $ 7,130 $ 1,429 $ (1,081) $ 8,486 $ 15,964
Loss from operations $ (10,893) $ (16,612) $ (43,396) $ (3,882) $ (74,783)
Net loss $ (19,055) $ (22,675) $ (263,826) $ (2,968) $ (308,524)
Pro forma net loss (1) $ (1,830) $ (3,948) $ (3,786) $ (1,038) $ (10,702)
Basic and diluted net loss
per share (1) $ (0.33) $ (0.37) $ (4.29) $ (0.05) $ (5.09)
Basic and diluted pro forma net
loss per share (1) $ (0.03) $ (0.06) $ (0.06) $ (0.02) $ (0.18)
(1) Pro forma net earnings (loss) and per share data are calculated
independently for each of the quarters presented. Therefore, the sum of
this quarterly information may not equal the corresponding annual
information. Pro forma net (earnings) loss represent net loss excluding
stock-based compensation costs, amortization and write-down of goodwill,
unusual tax recovery, future income tax assets valuation allowance and the
after-tax effect of amortization of intangible assets, restructuring and
other charges, inventory and tax credit write-offs, unusual grants recovery
and impairment of long-lived assets. This information may not be comparable
to similarly titled measures reported by other companies because it is
non-GAAP information.
24 | 2004 Annual Report | EXFO
MANAGEMENT'S REPORT
EXFO's management is responsible for the preparation, integrity and
objectivity of the consolidated financial statements and other financial
information presented in this Annual Report. These consolidated financial
statements have been prepared in accordance with Canadian generally
accepted accounting principles and include some amounts that are based on
estimates and judgments. Management has determined such amounts on a
reasonable basis in order to ensure that the financial statements are
presented fairly in all material respects.
EXFO's policy is to maintain a system of internal accounting and
administrative controls designed to provide reasonable assurance that the
financial information is relevant, accurate and reliable, and that assets
are appropriately accounted for and adequately safeguarded.
The Board of Directors is responsible for ensuring that management
fulfills its responsibilities for financial reporting and is ultimately
responsible for reviewing and approving the financial statements. The
Board carries out this responsibility principally through its Audit
Committee. The Audit Committee is appointed by the Board and is composed
of outside directors. The Committee meets periodically with management and
external auditors to review accounting, auditing and internal control
matters. These consolidated financial statements have been reviewed and
approved by the Board of Directors on the recommendation of the Audit
Committee.
The consolidated financial statements have been audited by
PricewaterhouseCoopers LLP, the external auditors, in accordance with the
Canadian generally accepted auditing standards and the standards of the
Public Company Accounting Oversight Board (United States) on behalf of the
shareholders. The external auditors have full and free access to the Audit
Committee.
/s/ Germain Lamonde /s/ Pierre Plamondon, CA
--------------------------------- -------------------------------------
Chairman, President and CEO Vice-President, Finance and
Chief Financial Officer
REPORT OF INDEPENDENT AUDITORS
TO THE SHAREHOLDERS OF EXFO ELECTRO-OPTICAL ENGINEERING INC.
We have audited the consolidated balance sheets of EXFO ELECTRO-OPTICAL
ENGINEERING INC. as at August 31, 2004 and 2003 and the consolidated statements
of earnings, deficit and contributed surplus and cash flows for each of the
three years in the period ended August 31, 2004. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with Canadian generally accepted auditing
standards and the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform an audit to
obtain reasonable assurance whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation.
In our opinion, these consolidated financial statements present fairly, in all
material respects, the financial position of the company as at August 31, 2004
and 2003 and the results of its operations and its cash flows for each of the
three years in the period ended August 31, 2004 in accordance with Canadian
generally accepted accounting principles.
/s/ PricewaterhouseCoopers LLP
Chartered Accountants
Quebec, Quebec, Canada
September 30, 2004
25 | 2004 Annual Report | EXFO
CONSOLIDATED BALANCE SHEETS
(in thousands of US dollars)
The accompanying notes are an integral part of these consolidated financial
statements.
As at August 31, 2004 2003
---------------------------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS
Cash $ 5,159 $ 5,366
Short-term investments (notes 8 and 17) 83,969 52,010
Accounts receivable (notes 8 and 17)
Trade 12,080 9,639
Other 1,532 834
Income taxes and tax credits recoverable (notes 4 and 8) 7,836 6,003
Inventories (notes 4, 5 and 8) 15,371 15,602
Prepaid expenses 1,513 2,041
---------------------------------------------------------------------------------------------------
127,460 91,495
---------------------------------------------------------------------------------------------------
INCOME TAXES AND TAX CREDITS RECOVERABLE (notes 4 and 8) 449 1,377
PROPERTY, PLANT AND EQUIPMENT (notes 4, 6 and 8) 15,442 21,862
LONG-LIVED ASSET HELD FOR SALE (note 4) 1,600 --
INTANGIBLE ASSETS (notes 4, 7 and 8) 9,447 13,847
GOODWILL (notes 4 and 7) 18,393 17,673
---------------------------------------------------------------------------------------------------
$ 172,791 $ 146,254
---------------------------------------------------------------------------------------------------
LIABILITIES
CURRENT LIABILITIES
Accounts payable and accrued liabilities (note 9) $ 11,393 $ 12,026
Income taxes payable - 1,803
Deferred revenue 805 148
Current portion of long-term debt 121 110
---------------------------------------------------------------------------------------------------
12,319 14,087
DEFERRED REVENUE 1,123 352
DEFERRED GRANTS (note 14) 1,690 1,536
LONG-TERM DEBT (note 10) 332 453
---------------------------------------------------------------------------------------------------
15,464 16,428
---------------------------------------------------------------------------------------------------
COMMITMENTS (note 11)
CONTINGENCIES (note 12)
SHAREHOLDERS' EQUITY
Share capital (note 13) 521,733 492,452
Contributed surplus 1,986 1,519
Cumulative translation adjustment 13,820 7,643
Deficit (380,212) (371,788)
---------------------------------------------------------------------------------------------------
157,327 129,826
---------------------------------------------------------------------------------------------------
$ 172,791 $ 146,254
---------------------------------------------------------------------------------------------------
/s/ Germain Lamonde /s/ Andre Tremblay
--------------------------- -------------------------
On behalf of the Board Germain Lamonde Andre Tremblay
Chairman, President and CEO Chairman, Audit Committee
26 | 2004 Annual Report | EXFO
CONSOLIDATED STATEMENTS OF EARNINGS
(in thousands of US dollars, except share and per share data)
The accompanying notes are an integral part of these consolidated financial
statements.
Years ended August 31, 2004 2003 2002
------------------------------------------------------------------------------------------------------------------
SALES (note 18) $ 74,630 $ 61,930 $ 68,330
COST OF SALES (1,2) 34,556 36,197 52,366
------------------------------------------------------------------------------------------------------------------
GROSS MARGIN 40,074 25,733 15,964
------------------------------------------------------------------------------------------------------------------
OPERATING EXPENSES
Selling and administrative (1) 25,890 26,991 33,881
Net research and development (1) (notes 4 and 14) 12,390 15,879 12,782
Amortization of property, plant and equipment 4,935 5,210 5,096
Amortization of intangible assets 5,080 5,676 12,451
Impairment of long-lived assets and goodwill (note 4) 620 7,427 23,657
Restructuring and other charges (note 4) 1,729 4,134 2,880
------------------------------------------------------------------------------------------------------------------
TOTAL OPERATING EXPENSES 50,644 65,317 90,747
------------------------------------------------------------------------------------------------------------------
LOSS FROM OPERATIONS (10,570) (39,584) (74,783)
Interest and other income 1,438 1,245 1,456
Foreign exchange loss (278) (1,552) (458)
------------------------------------------------------------------------------------------------------------------
LOSS BEFORE INCOME TAXES AND AMORTIZATION
AND WRITE-DOWN OF GOODWILL (note 15) (9,410) (39,891) (73,785)
INCOME TAXES (note 15) (986) 15,059 (25,451)
------------------------------------------------------------------------------------------------------------------
LOSS BEFORE AMORTIZATION AND WRITE-DOWN OF GOODWILL (8,424) (54,950) (48,334)
AMORTIZATION OF GOODWILL (note 2) - - 38,021
WRITE-DOWN OF GOODWILL (note 4) - - 222,169
------------------------------------------------------------------------------------------------------------------
NET LOSS FOR THE YEAR $ (8,424) $ (54,950) $(308,524)
------------------------------------------------------------------------------------------------------------------
BASIC AND DILUTED LOSS PER SHARE
Loss before amortization and write-down of goodwill $ (0.13) $ (0.87) $ (0.80)
Net loss $ (0.13) $ (0.87) $ (5.09)
BASIC WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING (000'S) 66,020 62,852 60,666
DILUTED WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING (000'S)(note 16) 66,615 63,317 60,966
(1) Stock-based compensation costs included in: (note 2)
Cost of sales $ 62 $ - $ -
Selling and administrative 265 - -
Net research and development 122 - -
------------------------------------------------------------------------------------------------------------------
$ 449 $ - $ -
------------------------------------------------------------------------------------------------------------------
(2) Including inventory write-offs of nil, $4,121 and $18,463 for the years
ended August 31, 2004, 2003 and 2002, respectively (note 4). The cost of
sales is exclusive of amortization, shown separately below.
27 | 2004 Annual Report | EXFO
CONSOLIDATED STATEMENTS OF DEFICIT AND CONTRIBUTED SURPLUS
(in thousands of US dollars)
The accompanying notes are an integral part of these consolidated financial
statements.
DEFICIT
Years ended August 31, 2004 2003 2002
--------------------------------------------------------------------------------------------------
BALANCE - BEGINNING OF YEAR $ (371,788) $ (316,838) $ (8,314)
ADD
Net loss for the year (8,424) (54,950) (308,524)
--------------------------------------------------------------------------------------------------
BALANCE - END OF YEAR $ (380,212) $ (371,788) $ (316,838)
--------------------------------------------------------------------------------------------------
CONTRIBUTED SURPLUS
Years ended August 31, 2004 2003 2002
--------------------------------------------------------------------------------------------------
BALANCE - BEGINNING OF YEAR $ 1,519 $ 1,487 $ 1,457
ADD
Premium on resale of share capital 18 32 30
Stock-based compensation costs (note 2) 449 - -
--------------------------------------------------------------------------------------------------
BALANCE - END OF YEAR $ 1,986 $ 1,519 $ 1,487
--------------------------------------------------------------------------------------------------
28 | 2004 Annual Report | EXFO
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands of US dollars)
The accompanying notes are an integral part of these consolidated financial
statements.
Years ended August 31, 2004 2003 2002
----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss for the year $ (8,424) $ (54,950) $ (308,524)
Add (deduct) items not affecting cash
Discount on short-term investments 197 (96) 197
Stock-based compensation costs 449 - -
Inventory and tax credit write-offs - 6,418 18,463
Amortization 10,015 10,886 55,568
Impairment of long-lived assets and goodwill 620 7,427 245,826
Restructuring and other charges 1,261 512 741
Future income taxes - 10,138 (13,397)
Deferred revenue 1,404 (24) (106)
Deferred grants 154 817 (335)
----------------------------------------------------------------------------------------------------------------------
5,676 (18,872) (1,567)
Change in non-cash operating items
Accounts receivable ( 2,677) 3,957 15,406
Income taxes and tax credits (2,464) 13,489 (19,736)
Inventories 1,016 7,925 4,332
Prepaid expenses (449) (569) 356
Accounts payable and accrued liabilities (351) (349) (7,470)
----------------------------------------------------------------------------------------------------------------------
751 5,581 (8,679)
----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to short-term investments (653,348) (401,105) (506,228)
Proceeds from disposal of short-term investments 624,722 395,699 531,733
Additions to property, plant and equipment and intangible assets (851) (2,652) (5,245)
Business combinations (241) (1,867) (9,756)
----------------------------------------------------------------------------------------------------------------------
(29,718) (9,925) 10,504
----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Repayment of long-term debt (109) (133) (106)
Net proceeds of offering (note 13) 29,164 - -
Share issue expenses (137) - (14)
Exercise of stock options 254 45 -
Redemption of share capital (5) (16) (6)
Resale of share capital 23 48 36
----------------------------------------------------------------------------------------------------------------------
29,190 (56) (90)
EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON CASH (430) 638 (336)
----------------------------------------------------------------------------------------------------------------------
CHANGE IN CASH (207) (3,762) 1,399
CASH - BEGINNING OF YEAR 5,366 9,128 7,729
----------------------------------------------------------------------------------------------------------------------
CASH - END OF YEAR $ 5,159 $ 5,366 $ 9,128
----------------------------------------------------------------------------------------------------------------------
SUPPLEMENTARY INFORMATION
Interest paid $ 408 $ 417 $ 269
Income taxes paid (recovered) $ 120 $ (10,351) $ 4,172
29 | 2004 Annual Report | EXFO
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share data and
as otherwise noted)
1 o NATURE OF ACTIVITIES
EXFO Electro-Optical Engineering Inc. ("EXFO") designs, manufactures and markets
a comprehensive suite of test and measurement solutions for the global
telecommunications industry. The Telecom Division, which represents the
company's main business activity, offers integrated test solutions to network
service providers, system vendors and optical component manufacturers. The
Photonics and Life Sciences Division mainly leverages core telecom technologies
to offer value-added solutions in high-tech industrial manufacturing and
research sectors. EXFO sells its products in approximately 70 countries around
the world.
2 o SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
These consolidated financial statements have been prepared in accordance with
generally accepted accounting principles ("GAAP") in Canada and significant
differences in measurement and disclosure from U.S. GAAP are set out in note 20.
These consolidated financial statements include the accounts of the company and
its domestic and international subsidiaries. All significant intercompany
accounts and transactions have been eliminated.
ACCOUNTING ESTIMATES
The preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosures of
contingent assets and liabilities at the date of the financial statements, as
well as the reported amounts of revenues and expenses during the reporting
years. Actual results could differ from those estimates.
REPORTING CURRENCY
The company has adopted the US dollar as its reporting currency. The financial
statements are translated into the reporting currency using the current rate
method. Under this method, the financial statements are translated into the
reporting currency as follows: assets and liabilities are translated at the
exchange rate in effect on the date of the balance sheet, while revenues and
expenses are translated at the monthly average exchange rate. All gains and
losses resulting from the translation of the financial statements into the
reporting currency are included in the cumulative translation adjustment in
shareholders' equity.
In the event that management decides to declare dividends, such dividends would
be declared in Canadian dollars.
FOREIGN CURRENCY TRANSLATION
FOREIGN CURRENCY TRANSACTIONS
Transactions denominated in currencies other than the functional currency are
translated into the functional currency as follows: monetary assets and
liabilities are translated at the exchange rate in effect on the date of the
balance sheet, while revenues and expenses are translated at the exchange rate
in effect on the date of the transaction. Non-monetary assets and liabilities
are translated at historical rates. Gains and losses arising from such
translation are reflected in the statements of earnings.
FOREIGN SUBSIDIARIES
The financial statements of integrated foreign operations are remeasured into
the functional currency using the temporal method. Under this method, monetary
assets and liabilities are remeasured at the exchange rate in effect on the date
of the balance sheet. Non-monetary assets and liabilities are remeasured at
historical rates. Revenues and expenses are remeasured at the monthly average
exchange rate. Gains and losses resulting from such remeasurement are reflected
in the statements of earnings.
FORWARD EXCHANGE CONTRACTS
Forward exchange contracts are utilized by the company in the management of its
foreign currency exposure. The company's policy is not to utilize those
derivative financial instruments for trading or speculative purposes.
The company's forward exchange contracts, which are used to hedge anticipated
US-dollar-denominated sales, qualify for hedge accounting; therefore, foreign
exchange translation gains and losses on these contracts are recognized as an
adjustment of the revenues when the corresponding sales are recorded.
Realized and unrealized gains or losses associated with forward exchange
contracts, which have been terminated or cease to be effective prior to
maturity, are deferred in the balance sheet and recognized in the earnings of
the period in which the underlying hedged transaction is recognized.
SHORT-TERM INVESTMENTS
Short-term investments are valued at the lower of cost and market value. Cost
consists of acquisition cost plus amortization of discount or less amortization
of premium. All investments with original maturity of three months or less that
are not required for the purposes of meeting short-term cash commitments are
classified as short-term investments.
INVENTORIES
Inventories are valued on an average cost basis at the lower of cost and
replacement cost for raw materials and at the lower of cost and net realizable
value for work in progress and finished goods.
On September 1, 2002, the company changed its accounting policy for determining
the cost of raw materials and work in progress from the first-in, first-out
method to the average cost method. This change in accounting policy had no
significant impact on the company's financial statements.
30 | 2004 Annual Report | EXFO
PROPERTY, PLANT AND EQUIPMENT AND AMORTIZATION
Property, plant and equipment are recorded at cost less related government
grants and research and development tax credits. Amortization is provided on a
straight-line basis over the estimated useful lives as follows:
TERM
Land improvements 5 years
Buildings 25 years
Equipment 2 to 10 years
Leasehold improvements Remaining lease term
INTANGIBLE ASSETS, GOODWILL AND AMORTIZATION
Intangible assets primarily include the cost of core technology and software,
net of accumulated amortization. Core technology represents the existing
technology acquired in business combinations that has reached technological
feasibility. Intangible assets are amortized on a straight-line basis over their
estimated useful lives of five years for core technology and four and ten years
for software.
Goodwill represents the excess of the purchase price of acquired businesses over
the estimated fair value of net identifiable assets acquired. Goodwill related
to business combinations with a date of acquisition prior to July 1, 2001, was
amortized on a straight-line basis over the estimated useful life of five years
until August 31, 2002. Goodwill related to business combinations with a date of
acquisition after June 30, 2001, is not amortized.
Goodwill must be tested for impairment on an annual basis or more frequently if
events or circumstances occur that more likely than not reduce the fair value of
a reporting unit below its carrying value. Goodwill impairment exists when the
carrying value of the reporting unit exceeds its fair value. The fair value of a
reporting unit is determined based on a combination of discounted future cash
flows and a market approach. The amount of impairment loss, if any, represents
the excess of the carrying value of goodwill over its fair value and this loss
will be charged to earnings in the period in which it is incurred. The company
elected to perform its annual impairment test in May of each fiscal year for all
its existing reporting units and recorded impairment charges for goodwill in
fiscal 2002 and 2003 (note 4).
IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived assets are reviewed for impairment when events and circumstances
indicate that cost may not be recoverable. Impairment exists when the carrying
value of the asset is greater than the undiscounted future cash flows expected
to be provided by the asset. The amount of impairment loss, if any, is the
excess of the carrying value over its fair value. The company recorded
impairment charges for long-lived assets in fiscal 2002, 2003 and 2004 (note 4).
WARRANTY
The company offers its customers warranties of one to three years, depending on
the specific products and terms of the purchase agreement. The company's typical
warranties require it to repair or replace defective products during the
warranty period at no cost to the customer. Costs related to original warranties
are accrued at the time of shipment, based upon estimates of expected rework and
warranty costs to be incurred. Costs associated with extended warranties are
expensed as incurred.
REVENUE RECOGNITION
For products in which software is incidental, the company recognizes revenue
when persuasive evidence of an arrangement exists, the product has been
delivered, the price is fixed and determinable, and collection of the resulting
receivable is reasonably assured. In addition, provisions are made for estimated
returns, warranties and support obligations.
For products in which software is not incidental, revenues are separated into
two categories: product and post-contract customer support (PCS) revenues, based
upon vendor-specific objective evidence of fair value. Product revenues for
these sales are recognized as described above. PCS revenues are deferred and
recognized ratably over the years of the support arrangement. PCS revenues are
recognized at the time the product is delivered when provided within one year of
delivery; the costs of providing this support are insignificant (and accrued at
the time of delivery) and no software upgrades are provided.
For all sales, the company uses a binding purchase order as evidence that a
sales arrangement exists.
Delivery generally occurs when the product is handed over to a transporter for
shipment.
At the time of the transaction, the company assesses whether the price
associated with its revenue transaction is fixed and determinable and whether or
not collection is reasonably assured. The company assesses whether the price is
fixed and determinable based on the payment terms associated with the
transaction. The company assesses collection based on a number of factors,
including past transaction history and the creditworthiness of the customer.
Generally, collateral or other security is not requested from customers.
Most sales arrangements do not generally include acceptance clauses. However, if
a sales arrangement includes an acceptance provision, acceptance occurs upon the
earliest of receipt of a written customer acceptance or expiration of the
acceptance period. For these sales arrangements, the sale is recognized when
acceptance occurs.
Revenue for extended warranties is recognized on a straight-line basis over the
warranty period.
ADVERTISING COSTS
Advertising costs are expensed as incurred.
GOVERNMENT GRANTS
Government grants are accrued as a receivable when there is reasonable assurance
that the company has complied and will continue to comply with all the
conditions related to the grant. Grants related to operating expenses are
included in earnings when the related expenses are incurred. Grants related to
capital expenditures are deducted from the related assets. Grants related to job
creation and training programs for extended periods are deferred and amortized
on a straight-line basis over the minimum period for which the created job must
be maintained or training provided.
31 | 2004 Annual Report | EXFO
RESEARCH AND DEVELOPMENT EXPENSES
All expenses related to development activities, which do not meet generally
accepted criteria for deferral, and research are expensed as incurred, net of
related tax credits and government grants. Development expenses that meet
generally accepted criteria for deferral are capitalized, net of related tax
credits and government grants, and amortized against earnings over the estimated
benefit period. Research and development expenses are mainly comprised of
salaries and related expenses, material costs as well as fees paid to
third-party consultants.
As at August 31, 2004, the company had not deferred any development costs.
INCOME TAXES
The company provides for income taxes using the liability method of tax
allocation. Under this method, future income tax assets and liabilities are
determined based on deductible or taxable temporary differences between
financial statement values and tax values of assets and liabilities, using
enacted income tax rates for the years in which the differences are expected to
reverse.
The company establishes a valuation allowance against future income tax assets
if, based on available information, it is more likely than not that some or all
of the future income tax assets will not be realized. Since 2003, the company
has recorded a full valuation allowance against future income tax assets (notes
4 and 15).
EARNINGS PER SHARE
Basic earnings per share are determined using the weighted average number of
common shares outstanding during the year.
Diluted earnings per share are determined using the weighted average number of
common shares outstanding during the year, plus the effect of dilutive potential
common shares outstanding during the year such as the company's stock options
and restricted stock awards. This method requires that diluted earnings per
share be calculated, using the treasury stock method, as if all dilutive
potential common shares had been exercised at the latest at the beginning of the
year or on the date of issuance, as the case may be, and that the funds obtained
thereby be used to purchase common shares of the company at the average fair
value of the common shares during the year.
NEW ACCOUNTING STANDARDS 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. Hedge
accounting can only be applied if these new rules are met. 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 corresponding 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 the financial
statements for all forms of employee stock-based compensation using a fair
value-based method. In fiscal 2004, the company granted 536,500 stock options to
its employees with a weighted average exercise price of $3.94. The weighted
average fair value of these stock options amounted to $2.73. The corresponding
stock-based compensation costs were amortized using the graded vesting method,
resulting in stock-based compensation costs of $449,000 in fiscal 2004.
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 impact on the net loss per
share in fiscal 2004 and the pro forma net loss per share would have been $0.01
higher than the net loss per share in 2003.
The fair value of options granted in fiscal 2004 was estimated using the
Black-Scholes options valuation model with the following weighted average
assumptions:
Year ended
August 31, 2004
--------------------------------------------------------------------------------
Risk-free interest rate 2.7%
Expected volatility 100%
Dividend yield Nil
Expected life 49 months
In July 2003, the CICA issued handbook sections 1100 and 1400, "Generally
Accepted Accounting Principles" and "General Standards of Financial Statement
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 any significant impact on
its financial statements.
COMPARATIVE FIGURES
Certain comparative figures were reclassified to conform to the current-year
presentation.
3 o BUSINESS COMBINATIONS
In fiscal 2002 and 2003, the company completed business combinations in which it
acquired significant intangible assets. The fair value allocated to these assets
was based upon valuations performed in conjunction with these business
combinations. Acquired goodwill, except the one from GNUBI COMMUNICATIONS L.P.,
was not deductible for income tax purposes.
32 | 2004 Annual Report | EXFO
BUSINESS COMBINATION DURING 2003
GNUBI COMMUNICATIONS, L.P.
On October 7, 2002, a newly created wholly-owned subsidiary of the company, EXFO
Gnubi Products Group Inc. ("EXFO Gnubi"), acquired substantially all the assets
of GNUBI COMMUNICATIONS, L.P., a U.S. company supplying multi-channel telecom
and datacom testing solutions for optical transport equipment manufacturers as
well as research and development laboratories.
This acquisition was settled for a total consideration valued at $4,904,000
including acquisition-related costs of $162,000. The consideration paid
consisted in $2,108,000 in cash (including a cash contingent consideration of
$241,000, paid in fiscal 2004, based on EXFO Gnubi sales volume for the twelve
months following the acquisition) and in the issuance of 1,479,290 subordinate
voting shares, valued at $2,796,000.
The cash contingent consideration was accounted for as an additional acquisition
cost and has been recognized as an additional cost of acquired core technology.
The fair value of the subordinate voting shares issued was determined based on
the market price of the shares beginning three days before and ending three days
after the number of shares became fixed based on a formula, being September 10,
2002.
This acquisition was accounted for using the purchase method and, consequently,
the results of operations of the acquired business have been included in the
consolidated statement of earnings of the company since October 7, 2002, being
the date of acquisition.
During fiscal 2004, EXFO Gnubi's operations were consolidated with the parent
company's operations in Montreal, Canada.
The purchase price, including acquisition-related costs, has been allocated
based on the estimated fair value of net assets at the date of acquisition as
follows:
Assets acquired
Current assets $ 755
Property, plant and equipment 334
Core technology 75
Current liabilities assumed (134)
--------------------------------------------------------------------------------
Net identifiable assets acquired 1,705
Goodwill 2,958
--------------------------------------------------------------------------------
Purchase price 4,663
Less: Subordinate voting shares issued 2,796
--------------------------------------------------------------------------------
Cash paid on the date of acquisition $ 1,867
================================================================================
BUSINESS COMBINATION DURING 2002
AVANTAS NETWORKS CORPORATION (RENAMED EXFO PROTOCOL INC.)
On November 2, 2001, the company acquired a 100% interest in EXFO Protocol
Inc. ("EXFO Protocol"), a Canadian company specializing in protocol-layer
testing, in exchange for a total consideration valued at $94,952,000 or
$69,381,000 net of $25,571,000 of cash and cash equivalents acquired. The
total consideration includes acquisition-related costs of $1,272,000.
The consideration paid consisted in $9,756,000 in cash, net of cash and
cash equivalents acquired of $25,571,000, and in the issuance of 4,374,573
subordinate voting shares valued at $59,625,000. The fair value of the
subordinate voting shares issued was determined based on the market price
of the shares beginning three days before and ending three days after the
terms of the acquisition were agreed upon and announced, being August 20,
2001.
This acquisition was accounted for using the purchase method and,
consequently, the results of operations of EXFO Protocol have been included
in the consolidated statement of earnings of the company since November 2,
2001, being the date of acquisition.
As of September 1, 2003, EXFO Protocol was merged with the parent company.
The purchase price, including acquisition-related costs, was allocated
based on the estimated fair value of net assets at the date of acquisition
as follows:
Assets acquired
Current assets $ 6,040
Property, plant and equipment 2,003
In-process research and development 1,400
Core technology 5,050
Future income tax assets (note 4) 476
Current liabilities assumed (3,575)
--------------------------------------------------------------------------------
Net identifiable assets acquired 11,394
Goodwill (Note 4) 57,987
--------------------------------------------------------------------------------
Purchase price 69,381
Less: Subordinate voting shares issued 59,625
--------------------------------------------------------------------------------
Cash paid, net of cash and cash equivalents acquired $ 9,756
================================================================================
33 | 2004 Annual Report | EXFO
4 o SPECIAL CHARGES
IMPAIRMENT OF LONG-LIVED ASSETS AND GOODWILL
2002
In May 2002, as part of its review of financial results, the company performed
an assessment of the carrying value of goodwill and intangible assets recorded
in conjunction with the acquisitions of EXFO Burleigh Products Group Inc. ("EXFO
Burleigh"), EXFO Photonic Solutions Inc. ("EXFO Photonic Solutions") and EXFO
Protocol Inc. ("EXFO Protocol"). The assessment was performed because of the
severe and continued downturn in the telecommunications industry, the persisting
unfavorable market conditions affecting the subsidiaries' industries and the
decline in technology valuations. The growth prospects for those subsidiaries
were significantly lower than previously expected and less than those of
historical periods, and the decline in market conditions affecting the
subsidiaries was significant and other than temporary. As a result, the company
concluded that the carrying value of goodwill and certain acquired intangible
assets was impaired and it recorded a charge of $222,169,000 to write down a
significant portion of goodwill and a pre-tax charge of $23,657,000 to write
down a significant portion of acquired core technology. Of the total impairment
loss of $245,826,000, $125,017,000 was related to EXFO Burleigh for goodwill and
acquired core technology, $71,508,000 was related to EXFO Photonic Solutions for
goodwill and acquired core technology, and $49,301,000 was related to EXFO
Protocol for goodwill.
The impairment loss was calculated based upon the then-existing accounting rules
and represented the excess of the carrying value of the assets over the pre-tax
undiscounted future cash flows. The pre-tax undiscounted future cash flows were
estimated at the subsidiaries' level since the company had distinct cash flows
for each of them and because they were not fully integrated into the company's
activities. The cash flow periods used ranged from three to five years, using
annual growth rates between 15% and 30%.
2003
In May 2003, the company performed its annual impairment test on goodwill for
all its reporting units, except for newly acquired EXFO Gnubi. Also, considering
market conditions in the telecommunications industry and the persisting
unfavorable conditions affecting the subsidiaries' industries, the company
reviewed the carrying value of intangible assets related to these reporting
units, consisting primarily of acquired core technology.
As a result of this assessment, the company concluded that the carrying value of
goodwill related to EXFO Burleigh and the carrying value of intangible assets
related to EXFO Burleigh and EXFO Photonic Solutions was impaired and it
recorded a charge of $4,505,000 to write down goodwill and a pre-tax charge of
$2,922,000 to write down acquired core technology. Of the total impairment loss
of $7,427,000, $6,872,000 was related to EXFO Burleigh for goodwill and acquired
core technology, and $555,000 was related to EXFO Photonic Solutions for
acquired core technology.
For the purposes of estimating the fair values, the company used a combination
of discounted future cash flows and a market approach (sales multiples). The
discounted future cash flows were estimated using periods ranging between eight
and ten years, discount rates ranging between 15% and 20% and annual growth
rates ranging between nil and 35%. The sales multiples used in the market
approach ranged between 0.7 and 2.3.
The assumptions supporting the estimated fair values and undiscounted future
cash flows, including industry conditions, reflected management's best
estimates.
2004
In fiscal 2004, the company reviewed the carrying value of one of its buildings
that was put up for sale and it concluded that the building was impaired. The
company recorded an impairment charge of $620,000, representing the excess of
the net carrying value of the building over its expected selling price. The
building did not meet the criteria of CICA handbook section 3475, "Disposal of
Long-Lived Assets and Discontinued Operations", because it was not available for
immediate sale in its existing condition. Consequently, it was not shown as a
long-lived asset held for sale in the balance sheet as at August 31, 2004. This
building reports to the Telecom Division.
RESTRUCTURING AND OTHER CHARGES AND INVENTORY WRITE-OFFS
During fiscal 2002, the company implemented restructuring plans to reduce its
costs. Under these plans, the company recorded charges of $2,880,000, including
$2,012,000 in severance expenses for the 350 employees who were terminated
throughout the company and $868,000 for impaired long-lived assets. These
charges are included in the restructuring and other charges in the statement of
earnings for the year ended August 31, 2002. Furthermore, the company recorded
$18,463,000 in inventory write-offs for excess and obsolete inventories, which
are included in the cost of sales in the statement of earnings for that same
year.
During fiscal 2003, the company implemented an additional restructuring plan to
realign its cost structure to market conditions. Under that plan, the company
recorded additional charges of $4,134,000, including $2,767,000 in severance
expenses for the 172 employees who were terminated throughout the company,
$512,000 for impaired long-lived assets and $855,000 for future payments on
exited leased facilities. Those charges are included in the restructuring and
other charges in the statement of earnings for the year ended August 31, 2003.
In addition, the company recorded $4,121,000 in inventory write-offs for excess
and obsolete inventories, which are included in the cost of sales in the
statement of earnings for that same year.
During fiscal 2004, the company approved a restructuring plan to consolidate
EXFO Burleigh's operations, transferring them mainly to EXFO Photonic Solutions'
facilities in Toronto. The consolidation process started in August 2004 and
will extend through the first two quarters of fiscal 2005. EXFO Burleigh's
operations and assets reported to the Photonics and Life Sciences Division and
all expenses related to this consolidation process also report to this division.
Management estimates that the overall costs to be incurred under this plan
should amount to $2,700,000 during the implemntation period. From this amount,
$772,000, representing severance expenses, has been recorded in fiscal 2004 for
the layoff of all employees of EXFO Burleigh. In addition, in fiscal 2004, the
company recorded an impairment charge of $1,261,000, mainly for the building.
Management expects to incur the remaining $667,000 during the first two quarters
of fiscal 2005 for different types of consolidation expenses such as training,
recruiting and other special termination benefits.
The EXFO Burleigh building is for sale in its present condition and management
expects to sell the property within the next twelve months. Consequently, in
accordance with section 3475 of the handbook, it has been shown in the balance
sheet as a long-lived asset held for sale. The fair value used to determine the
impairment charge for the building represents the company's best estimate of its
selling price based upon the municipal valuation. Starting September 1, 2004,
the building will cease to be amortized.
34 | 2004 Annual Report | EXFO
Expenses relating to this plan, amounting to $2,033,000 have been recorded in
the restructuring and other charges in the statement of earnings for the year
ended August 31, 2004.
The following table summarizes the restructuring charges payable activity since
August 31, 2001:
YEAR ENDED AUGUST 31, 2004
Balance as at Balance as at
August 31, 2003 Additions Payments Adjustments August 31, 2004
-----------------------------------------------------------------------------------------------------------------
FISCAL 2004 PLAN
Severance expenses $ - $ 772 $ (305) $ - $ 467
-----------------------------------------------------------------------------------------------------------------
- 772 (305) - 467
-----------------------------------------------------------------------------------------------------------------
FISCAL 2003 PLAN
Severance expenses 1,233 - (870) (254) 109
Exited leased facilities 748 - (362) - 386
Other 295 - (90) (8) 197
-----------------------------------------------------------------------------------------------------------------
2,276 - (1,322) (262) 692
-----------------------------------------------------------------------------------------------------------------
FISCAL 2002 PLANS
Other 68 - (68) - -
-----------------------------------------------------------------------------------------------------------------
68 - (68) - -
-----------------------------------------------------------------------------------------------------------------
FISCAL 2001 PLAN
Exited leased facilities 124 - (72) (42) 10
-----------------------------------------------------------------------------------------------------------------
124 - (72) (42) 10
-----------------------------------------------------------------------------------------------------------------
Total for all plans (note 9) $ 2,468 $ 772 $ (1,767) $ (304) $ 1,169
================================================================================================================
YEAR ENDED AUGUST 31, 2003
Balance as at Balance as at
August 31, 2002 Additions Payments Adjustments August 31, 2003
-----------------------------------------------------------------------------------------------------------------
FISCAL 2003 PLAN
Severance expenses $ - $ 2,767 $ (1,534) $ - $ 1,233
Exited leased facilities - 855 (107) 748
Other - 512 (217) - 295
-----------------------------------------------------------------------------------------------------------------
- 4,134 (1,858) - 2,276
-----------------------------------------------------------------------------------------------------------------
FISCAL 2002 PLANS
Severance expenses 231 - (231) - -
Other 68 - - - 68
-----------------------------------------------------------------------------------------------------------------
299 - (231) - 68
-----------------------------------------------------------------------------------------------------------------
FISCAL 2001 PLAN
Exited leased facilities 483 - (359) - 124
-----------------------------------------------------------------------------------------------------------------
483 - (359) - 124
-----------------------------------------------------------------------------------------------------------------
Total for all plans (note 9) $ 782 $ 4,134 $ (2,448) $ - $ 2,468
================================================================================================================
YEAR ENDED AUGUST 31, 2002
Balance as at Balance as at
August 31, 2001 Additions Payments Adjustments August 31, 2002
-----------------------------------------------------------------------------------------------------------------
FISCAL 2002 PLANS
Severance expenses $ - $ 2,012 $ (1,781) $ - $ 231
Other - 868 (800) $ - 68
-----------------------------------------------------------------------------------------------------------------
- 2,880 (2,581) - 299
-----------------------------------------------------------------------------------------------------------------
FISCAL 2001 PLAN
Severance expenses 372 - (372) - -
Exited leased facilities 858 - (375) - 483
-----------------------------------------------------------------------------------------------------------------
1,230 - (747) - 483
-----------------------------------------------------------------------------------------------------------------
Total for all plans $ 1,230 $ 2,880 $ (3,328) $ - $ 782
================================================================================================================
FUTURE INCOME TAX ASSETS AND RESEARCH AND DEVELOPMENT TAX CREDITS
During fiscal 2003, the company reviewed the carrying value of its future
income tax assets and its research and development tax credits. Considering
market conditions and because the company recorded losses in fiscal 2002
and 2003, it concluded that it was more likely than not that its future
income tax assets and some of its non-refundable research and development
tax credits were not recoverable and that a full valuation allowance and a
write-off were required. Accordingly, the company recorded a full valuation
allowance of $28,385,000 against its future income tax assets, mainly
related to the parent company, EXFO Protocol and EXFO Burleigh and wrote
off $2,297,000 in non-refundable research and development tax credits
related to EXFO Protocol. The valuation allowance was included in the
income taxes in the statement of earnings for the year ended August 31,
2003 (note 15). Research and development tax credit write-offs were
included in the net research and development expenses in the statement of
earnings for that same year (note 14).
5 o INVENTORIES
As at August 31, 2004 2003
----------------------------------------------------------------------------------------------------------------
Raw materials $ 7,244 $ 8,188
Work in progress 1,370 1,022
Finished goods 6,757 6,392
----------------------------------------------------------------------------------------------------------------
$ 15,371 $ 15,602
================================================================================================================
35 | 2004 Annual Report | EXFO
6 o PROPERTY, PLANT AND EQUIPMENT
As at August 31, 2004 2003
------------------------------------------------------------------------------------------------------------------
ACCUMULATED Accumulated
COST AMORTIZATION Cost amortization
------------------------------------------------------------------------------------------------------------------
Land and land improvements $ 2,868 $ 558 $ 3,323 $ 350
Buildings 8,311 1,699 11,177 1,784
Equipment 29,110 23,422 27,800 19,099
Leasehold improvements 2,110 1,278 1,837 1,042
------------------------------------------------------------------------------------------------------------------
42,399 $ 26,957 44,137 $ 22,275
----------- -------------
Less: Accumulated amortization 26,957 22,275
------------------------------------------------------ ------------
$ 15,442 $ 21,862
------------------------------------------------------ ------------
As of August 31, 2003 and 2004, unpaid purchases of property, plant and
equipment amounted to $156,000 and $358,000, respectively.
The net carrying value of property, plant and equipment as at August 31, 2003,
included $2,867,000 for the EXFO Burleigh building shown as a long-lived asset
held for sale as at August 31, 2004 (note 4).
7 o INTANGIBLE ASSETS AND GOODWILL
The net carrying value of intangible assets is comprised of the following:
As at August 31, 2004 2003
----------------------------------------------------------------------------------------------------------------
Software, net of accumulated amortization of $3,482 ($2,691 in 2003) $ 2,365 $ 3,069
Core technology, net of accumulated amortization of $25,733 ($20,986 in 2003) 7,082 10,778
----------------------------------------------------------------------------------------------------------------
$ 9,447 $ 13,847
----------------------------------------------------------------------------------------------------------------
Amortization expenses for intangible assets in each of the next five fiscal
years will be $4,550,200 in 2005, $2,825,600 in 2006, $735,600 in 2007, $315,900
in 2008 and $296,200 in 2009.
Changes in the net carrying value of goodwill are as follows:
As at August 31, 2004 2003
----------------------------------------------------------------------------------------------------------------
Balance - Beginning of year $ 17,673 $ 17,576
Business combination (note 3) - 2,958
Write-down (note 4) - (4,505)
Foreign currency translation adjustment 720 1,644
----------------------------------------------------------------------------------------------------------------
Balance - End of year $ 18,393 $ 17,673
----------------------------------------------------------------------------------------------------------------
8 o CREDIT FACILITIES
The company has a line of credit which provides for advances of up to
Cdn$10,000,000 (US$7,595,000). This line of credit, which is renewable annually,
bears interest at prime rate (prime rate in 2003). Short-term investments,
accounts receivable, inventories and all tangible and intangible assets of the
company were pledged as collateral against this line of credit. As at August 31,
2004, an amount of Cdn$3,737,000 (US$2,838,000) is reserved from this line of
credit for letters of guarantee and forward exchange contracts.
9 O ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
As at August 31, 2004 2003
----------------------------------------------------------------------------------------------------------------
Trade $ 4,484 $ 4,227
Salaries and social benefits 3,932 3,462
Warranty 390 687
Restructuring charges (notes 4 and 19) 1,169 2,468
Other 1,418 1,182
----------------------------------------------------------------------------------------------------------------
$ 11,393 $ 12,026
----------------------------------------------------------------------------------------------------------------
Changes in the warranty provision are as follows:
As at August 31, 2004 2003
----------------------------------------------------------------------------------------------------------------
Balance - Beginning of year $ 687 $ 849
Provision 564 520
Settlement (889) (749)
Foreign currency translation adjustment 28 67
----------------------------------------------------------------------------------------------------------------
Balance - End of year $ 390 687
----------------------------------------------------------------------------------------------------------------
36 | 2004 Annual Report | EXFO
10 o LONG-TERM DEBT
As at August 31, 2004 2003
----------------------------------------------------------------------------------------------------------------
Loans collateralized by equipment, bearing interest at 9.6%, repayable in
monthly instalments of $13,000 including principal and interest, maturing
in 2008 $ 453 $ 563
Less: Current portion 121 110
----------------------------------------------------------------------------------------------------------------
$ 332 $ 453
----------------------------------------------------------------------------------------------------------------
As at August 31, 2004, minimum principal repayments required in each of the next
four years will amount to $121,000 in 2005, $135,000 in 2006, $146,000 in 2007
and $51,000 in 2008.
11 o COMMITMENTS
The company entered into operating leases for certain of its premises and
equipment, which expire at various dates through May 2011. As at August 31,
2004, minimum rentals payable under these operating leases in each of the next
five years will amount to $938,000 in 2005, $875,000 in 2006, $780,000 in 2007,
$484,000 in 2008 and $467,000 in 2009. As at August 31, 2004, the total
commitment under these operating leases amounts to $4,382,000.
For the years ended August 31, 2002, 2003 and 2004, rental expenses amounted to
$1,936,000, $1,718,000 and $1,219,000, respectively (note 19).
12 O CONTINGENCIES
On November 27, 2001, a class action suit was filed in the United States
District Court for the Southern District of New York against the company,
four of the underwriters of its Initial Public Offering and some of its
executive officers pursuant to the Securities Exchange Act of 1934 and Rule
10b-5 promulgated thereunder and sections 11, 12 and 16 of the Securities
Act of 1933. Approximately 300 other issuers and their underwriters have
had similar suits filed against them, all of which are included in a single
coordinated proceeding in the Southern District of New York (the "IPO
Litigations"). This class action alleges that the company's registration
statement and prospectus filed with the Securities and Exchange Commission
on June 29, 2000, contained material misrepresentations and/or omissions
resulting from (i) the underwriters allegedly soliciting and receiving
additional, excessive and undisclosed commissions from certain investors in
exchange for which they allocated material portions of the shares issued in
connection with the company's Initial Public Offering; and (ii) the
underwriters allegedly entering into agreements with customers whereby
shares issued in connection with the company's Initial Public Offering
would be allocated to those customers in exchange for which customers
agreed to purchase additional amounts of shares in the after-market at
pre-determined prices.
On April 19, 2002, the plaintiffs filed two amended complaints: one
containing master allegations against all of the underwriters in the IPO
Litigations, and the other 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. The Court granted
the company's motion to dismiss the claims against it under Section 11 of
the Securities Act. The Court denied the company's motion to dismiss the
claims against it under Rule 10b-5. In October 2002, the claims against its
officers were dismissed without prejudice pursuant to the terms of the
Reservation of Rights and Tolling Agreements entered into with the
plaintiffs.
In June 2003, a committee of the company's Board of Directors conditionally
approved a proposed settlement between the issuer defendants, the
individual defendants, and the plaintiffs. On June 25, 2004, the Plaintiffs
moved for Preliminary Approval of the settlement, and the Underwriter
defendants have opposed that motion. If approved, the settlement would
provide, among other things, a release of the company and of the individual
defendants for the conduct alleged in the action to be wrongful in the
amended complaint. The company would agree to undertake other
responsibilities under the settlement, including agreeing to assign away,
not assert, or release certain potential claims the company may have
against its underwriters. Any direct financial impact of the proposed
settlement is expected to be borne by the company's insurance carriers.
Since the settlement process is subject to a fairness hearing and final
court approval, it is possible that it could fail. Therefore, it is not
possible to predict the final outcome of the case, nor determine the amount
of any possible losses. If the settlement process fails, the company will
continue to defend its position in this litigation that the claims against
it, and its officers, are without merit. Accordingly, no provision for this
case has been made in the consolidated financial statements as at August
31, 2004.
As at August 31, 2004, the company has outstanding letters of guarantee of
Cdn$1,273,000 (US$967,000), which expire at various dates through fiscal
2008 and that were reserved from the line of credit.
37 | 2004 Annual Report | EXFO
13 o SHARE CAPITAL
Authorized - unlimited as to number, without par value
Subordinate voting and participating, bearing a non-cumulative dividend
to be determined by the Board of Directors, ranking pari passu
with multiple voting shares
Multiple voting and participating, entitling to ten votes each, bearing
a non-cumulative dividend to be determined by the Board of
Directors, convertible at the holder's option into subordinate
voting shares on a one-for-one basis, ranking pari passu with
subordinate voting shares
The following table summarizes the share capital activity since August 31, 2001:
MULTIPLE VOTING SHARES SUBORDINATE VOTING SHARES
--------------------------------------------------------------------------------------------------------------------------
NUMBER AMOUNT NUMBER AMOUNT TOTAL AMOUNT
--------------------------------------------------------------------------------------------------------------------------
Balance as at August 31, 2001 37,900,000 $ 1 19,046,080 $ 429,994 $ 429,995
Business combination (note 3) - - 4,374,573 59,625 59,625
Exercise of stock awards - - 144,532 - -
Redemption - - (7,022) (6) (6)
Resale - - 7,022 6 6
Share issue expenses - - - (9) (9)
--------------------------------------------------------------------------------------------------------------------------
Balance as at August 31, 2002 37,900,000 1 23,565,185 489,610 489,611
Business combination (note 3) - - 1,479,290 2,796 2,796
Exercise of stock options - - 25,498 45 45
Exercise of stock awards - - 69,935 - -
Redemption - - (21,515) (16) (16)
Resale - - 21,515 16 16
--------------------------------------------------------------------------------------------------------------------------
Balance as at August 31, 2003 37,900,000 1 25,139,908 492,451 492,452
Public offering(1) - - 5,200,000 29,164 29,164
Exercise of stock options - - 111,071 254 254
Exercise of stock awards - - 89,504 - -
Redemption - - (5,340) (5) (5)
Resale - - 5,340 5 5
Share issue expenses - - - (137) (137)
--------------------------------------------------------------------------------------------------------------------------
Balance as at August 31, 2004 37,900,000 $ 1 30,540,483 $ 521,732 $ 521,733
==========================================================================================================================
(1) On February 12, 2004, pursuant to a Canadian public offering, the company
issued 5,200,000 subordinate voting shares for net proceeds of $29,164,000
(Cdn$38,438,400), after deduction of underwriting commission of $1,215,000
(Cdn$1,601,000). The net proceeds of this offering were invested in
commercial paper that is presented in the short-term investments in the
balance sheet (note 17).
STOCK PURCHASE PLAN
The company's stock purchase plan terminated at the time of the initial public
offering, being June 29, 2000. In accordance with that plan, officers, directors
and key employees could purchase Class F shares up to a maximum of 5% of all
participating, issued and outstanding shares of the company. The purchase price
of shares under that plan was determined as a multiple of the company's equity
as at the end of the preceding fiscal year. All 707,264 shares issued under that
plan, which were restricted as to sale and transferability for a period of at
least five years from the date of acquisition, were released in fiscal 2004.
STOCK OPTION PLAN
In May 2000, the company established a stock option plan for directors,
executive officers, employees and consultants and those of the company's
subsidiaries, as determined by the Board of Directors.
The maximum number of subordinate voting shares issuable under the plan cannot
exceed 6,306,153 shares. The maximum number of subordinate voting shares that
may be granted to any individual cannot exceed 5% of the number of outstanding
subordinate voting shares. The exercise price is the market price of the common
shares on the date of grant. Options granted under the plan generally expire ten
years from the date of grant. Options granted under the plan generally vest over
a four-year period, with 25% vesting on an annual basis commencing on the first
anniversary of the date of grant. The Board of Directors may accelerate the
vesting of any or all outstanding options upon the occurrence of a change of
control.
The following table summarizes stock option activity since August 31, 2001:
Years ended August 31, 2004 2003 2002
-----------------------------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE Weighted average Weighted average
NUMBER EXERCISE PRICE Number exercise price Number exercise price
-----------------------------------------------------------------------------------------------------------------------
Outstanding - Beginning of year 3,176,613 $ 15 2,597,574 $ 22 2,414,231 $ 28
Granted 536,500 4 1,268,450 2 1,039,805 10
Exercised (111,071) (2) (25,498) (2) - -
Forfeited (667,524) (15) (663,913) (17) (856,462) (25)
-----------------------------------------------------------------------------------------------------------------------
Outstanding - End of year 2,934,518 $ 14 3,176,613 $ 15 2,597,574 $ 22
=======================================================================================================================
Exercisable - End of year 1,331,707 $ 21 1,068,595 $ 22 512,161 $ 28
=======================================================================================================================
38 | 2004 Annual Report | EXFO
The following table summarizes information about stock options as at
August 31, 2004:
Stock options outstanding Stocks options exercisable
-------------------------------------------------------------------------------------------------------------------------
Weighted average
Weighted average remaining Weighted average
Exercise price Number exercise price contractual life Number exercise price
-------------------------------------------------------------------------------------------------------------------------
$1.58 to $2.16 653,254 $ 1.58 8.1 years 118,900 $ 1.58
$2.59 to $3.63 436,250 3.44 9.0 years 63,208 3.39
$4.65 to $5.65 223,979 4.77 9.3 years 13,240 5.65
$9.13 to $12.69 567,396 10.10 7.2 years 283,698 10.10
$19.19 to $27.80 785,608 24.05 6.2 years 651,629 24.24
$34.07 to $45.94 216,601 44.38 6.0 years 162,459 44.38
$56.74 51,430 56.74 6.0 years 38,573 56.74
-------------------------------------------------------------------------------------------------------------------------
2,934,518 $ 13.89 7.5 years 1,331,707 $ 21.43
=========================================================================================================================
RESTRICTED STOCK AWARD PLAN
On December 20, 2000, the company established a restricted stock award plan
for employees of EXFO Burleigh. Each stock award entitles employees to
receive one subordinate voting share at a purchase price of nil. Stock
awards granted under the plan vest over a four-year period, with 25%
vesting on an annual basis commencing on the first anniversary of the date
of grant. According to the plan, upon the involuntary termination of a
member of the defined management team, all outstanding restricted stock
awards granted to such an employee automatically vest. The plan will expire
on December 20, 2004.
The following table summarizes restricted stock awards activity since
August 31, 2001:
Years ended August 31, 2004 2003 2002
-------------------------------------------------------------------------------------------------------------------------
Outstanding - Beginning of year 143,096 215,249 359,781
Granted - - -
Exercised (89,504) (69,935) (144,532)
Forfeited - (2,218) -
-------------------------------------------------------------------------------------------------------------------------
Outstanding - End of year 53,592 143,096 215,249
=========================================================================================================================
Exercisable - End of year - - -
=========================================================================================================================
As of August 31, 2004, the weighted average remaining contractual life of the
outstanding restricted stock awards was four months.
STOCK APPRECIATION RIGHTS PLAN
On August 4, 2001, the company established a stock appreciation rights plan for
certain employees. Under that plan, eligible employees are entitled to receive a
cash amount equivalent to the difference between the market price of the common
shares on the date of exercise and the exercise price determined on the date of
grant. Stock appreciation rights granted under the plan generally expire ten
years from the date of grant. Stock appreciation rights vest over a four-year
period, with 25% vesting on an annual basis commencing on the first anniversary
of the date of grant.
Considering the market price of the common shares of $4.36 as at August 31,
2004, compensation cost for those stock appreciation rights was nominal as at
August 31, 2004.
The following table summarizes stock appreciation rights activity since
August 31, 2001:
Years ended August 31, 2004 2003 2002
--------------------------------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE Weighted average Weighted average
NUMBER EXERCISE PRICE Number exercise price Number exercise price
--------------------------------------------------------------------------------------------------------------------------
Outstanding - Beginning of year 9,000 $ 24 10,000 $ 26 22,400 $ 30
Granted 6,000 5 5,000 2 1,000 12
Forfeited (2,000) 19 (6,000) (9) (13,400) (31)
--------------------------------------------------------------------------------------------------------------------------
Outstanding - End of year 13,000 $ 16 9,000 $ 24 10,000 $ 26
==========================================================================================================================
Exercisable - End of year 4,250 $ 30 3,500 $ 30 2,250 $ 27
==========================================================================================================================
The following table summarizes information about stock appreciation rights
as at August 31, 2004:
Stock Stock
appreciation appreciation
rights rights
outstanding exercisable
--------------------------------------------------------------------------------------------------------------------------
Weighted average
remaining
Exercise price Number contractual life Number
--------------------------------------------------------------------------------------------------------------------------
$2.10 2,000 8.6 years 500
$4.65 6,000 9.6 years -
$22.25 2,500 6.4 years 1,875
$45.94 2,500 6.0 years 1,875
--------------------------------------------------------------------------------------------------------------------------
13,000 8.1 years 4,250
--------------------------------------------------------------------------------------------------------------------------
39 | 2004 Annual Report | EXFO
14 o OTHER DISCLOSURES
NET RESEARCH AND DEVELOPMENT EXPENSES
Net research and development expenses comprise the following:
Years ended August 31, 2004 2003 2002
--------------------------------------------------------------------------------------------------------------------------
Gross research and development expenses $ 15,668 $ 17,133 $ 17,005
Research and development tax credits and grants (3,278) (3,551) (4,223)
Research and development tax credit write-offs (note 4) - 2,297 -
--------------------------------------------------------------------------------------------------------------------------
$ 12,390 $ 15,879 $ 12,782
==========================================================================================================================
All tax credits written off can be carried forward against future years' income
taxes payable over the next nine years.
OTHER GRANTS AND TAX CREDITS
During 1998, the company entered into an agreement with the Quebec Minister of
Industry, Commerce, Science and Technology (the "Minister"). Pursuant to this
agreement, the Minister agreed to contribute, in the form of grants, up to a
maximum of Cdn$600,000 (US$456,000) towards interest costs incurred over the
period from January 1, 1998, through December 31, 2002. In addition, the
Minister agreed to provide grants up to a maximum of Cdn$2,220,000
(US$1,686,000) over the period from January 1, 1998, through December 31, 2002,
payable based on the number of full-time jobs created during the period.
The above grants are subject to the condition that jobs created pursuant to the
agreement be maintained for a period of at least five years from the date of
creation. Should this condition not be met by the company, the Minister may
enforce various recourse options, which include suspension or cancellation of
the agreement or repayment of amounts received by the company. Since the
beginning of this program, the company received the maximum amount of
Cdn$2,820,000 (US$2,142,000), of which Cdn$1,370,000 (US$1,040,000) has been
credited to earnings with the balance of Cdn$1,450,000 (US$1,102,000) having
been included in deferred grants in the balance sheet.
Furthermore, since 2000, companies operating in the Quebec City area are
eligible for a refundable tax credit granted by the Quebec provincial
government. This credit is earned on the increase of production and marketing
eligible salaries incurred in the Quebec City area at a rate of 40%. Since 2000,
the company has received a total of Cdn$5,679,000 (US$4,313,000) under this
program, of which Cdn$4,905,000 (US$3,725,000) has been credited to earnings
with the balance of Cdn$774,000 (US$588,000) having been included in deferred
grants in the balance sheet. The deferred grants will be recognized in the
statement of earnings upon the final approval of eligible salaries by the
sponsor of the program.
Should repayments of any amounts received pursuant to these agreements be
required, such repayments, less related deferred revenue, if any, will be
charged to earnings as the amount of any repayment becomes known.
Following is a summary of the classification of these and certain other grants
and tax credits (government grants) in the statements of earnings of the
reporting years.
Cost of sales for the years ended August 31, 2002, 2003 and 2004, is net of
government grants of $546,000, $518,000 and $3,000, respectively.
Selling and administrative expenses for the years ended August 31, 2002, 2003
and 2004, are net of government grants of $213,000, $286,000 and $5,000,
respectively.
Research and development expenses for the years ended August 31, 2002, 2003 and
2004, are net of government grants of $333,000, $45,000 and $80,000,
respectively.
DEFINED CONTRIBUTION PLANS
The company maintains separate defined contribution plans for certain eligible
employees. These plans, which are accounted for on an accrual basis, are
summarized as follows:
o Deferred profit-sharing plan
The company maintains a plan for certain eligible Canadian resident
employees, under which the company may elect to contribute an amount equal
to 1% of an employee's gross salary, provided that the employee has
contributed at least 2% of his/her gross salary to a tax-deferred
registered retirement savings plan. From June 2002 to December 2002, the
company suspended its contributions to the plan as part of its
cost-reduction efforts. Contributions to this plan for the years ended
August 31, 2002, 2003 and 2004, amounted to Cdn$136,000 (US$86,000),
Cdn$93,000 (US$63,000) and Cdn$141,000 (US$106,000), respectively.
o 401 K plan
The company maintains a 401 K plan for eligible U.S. resident employees.
Under this plan, the company must contribute an amount equal to 3% of an
employee's current compensation. During the years ended August 31, 2002,
2003 and 2004, the company recorded contributions totaling $317,000,
$253,000 and $187,000, respectively.
40 | 2004 Annual Report | EXFO
15 o INCOME TAXES
The reconciliation of the income tax provision, calculated using the
combined Canadian federal and provincial statutory income tax rate, with the
income tax provision per the financial statements is as follows:
Years ended August 31, 2004 2003 2002
-------------------------------------------------------------------------------------------------------------------------
Income tax provision at combined Canadian federal and provincial
statutory tax rate (32% in 2004, 34% in 2003 and 36% in 2002) $ (3,011) $ (13,563) $ (26,563)
Increase (decrease) due to:
Manufacturing and processing deduction 6 307 525
Foreign income taxed at different rates (767) (999) (1,101)
Non-taxable income (128) (298) (143)
Non-deductible expenses 1,205 1,609 334
Tax deductions (169) (80) (518)
Reduction of Canadian federal statutory tax rate 274 92 168
Effect of consolidation of subsidiaries (1,384) 184 1,325
Previous year tax recovery upon a tax assessment (1,406) (645) -
Other 440 67 522
Change in valuation allowance 3,954 28,385 -
-------------------------------------------------------------------------------------------------------------------------
$ (986) $ 15,059 $ (25,451)
=========================================================================================================================
The income tax provision consists of the following:
Current
Canadian $ (577) $ 4,829 $ (10,816)
United States - (247) (1,232)
Other (409) 339 (6)
-------------------------------------------------------------------------------------------------------------------------
(986) 4,921 (12,054)
Future
Canadian (1,104) (13,553) (4,475)
United States (2,448) (4,307) (8,694)
Other (402) (387) (228)
-------------------------------------------------------------------------------------------------------------------------
(3,954) (18,247) (13,397)
Valuation allowance
Canadian 1,104 20,359 -
United States 2,448 7,374 -
Other 402 652 -
-------------------------------------------------------------------------------------------------------------------------
3,954 28,385 -
-------------------------------------------------------------------------------------------------------------------------
$ (986) $ 15,059 $ (25,451)
-------------------------------------------------------------------------------------------------------------------------
Details of the company's income taxes:
Loss before income taxes and amortization and write-down of goodwill
Canadian $ (7,740) $ (20,449) $ (47,431)
United States (5,879) (13,116) (28,228)
Other 4,209 (6,326) (1,874)
-------------------------------------------------------------------------------------------------------------------------
$ (9,410) $ (39,891) $ (73,785)
=========================================================================================================================
Significant components of the company's future income tax assets and
liabilities are as follows:
As at August 31, 2004 2003
-------------------------------------------------------------------------------------------------------------------------
Future income tax assets
Long-lived assets $ 3,291 $ 2,053
Provisions and accruals 8,755 9,786
Government grants 188 185
Deferred revenue 336 140
Share issue expenses 657 1,434
Research and development expenses 5,064 3,621
Losses carried forward 15,110 13,770
-------------------------------------------------------------------------------------------------------------------------
33,401 30,989
Valuation allowance (32,613) (28,846)
-------------------------------------------------------------------------------------------------------------------------
$ 788 $ 2,143
=========================================================================================================================
Future income tax liabilities
Long-lived assets $ - $ (1,614)
Research and development tax credits (788) (497)
Provisions and accruals - (32)
-------------------------------------------------------------------------------------------------------------------------
(788) (2,143)
-------------------------------------------------------------------------------------------------------------------------
Future income tax assets, net $ - $ -
=========================================================================================================================
41 | 2004 Annual Report | EXFO
As at August 31, 2004, the company had available operating losses in several tax
jurisdictions, against which a full valuation allowance was established. The
following table summarizes the year of expiry of these operating losses by tax
jurisdiction:
CANADA
FEDERAL PROVINCIAL UNITED STATES
YEAR OF EXPIRY AND OTHER
--------------------------------------------------------------------------------------------------------------------------
2005 $ 643,000 $ 955,000 $ -
2006 199,000 199,000 -
2007 1,544,000 1,609,000 207,000
2008 4,278,000 4,313,000 1,916,000
2009 5,346,000 3,256,000 575,000
2010 3,802,000 1,996,000 -
2014 182,000 - -
2022 - - 9,044,000
2023 - - 11,943,000
2024 - - 6,225,000
Indefinite 631,000 - 1,651,000
--------------------------------------------------------------------------------------------------------------------------
$ 16,625,000 $ 12,328,000 $ 31,561,000
--------------------------------------------------------------------------------------------------------------------------
Also, as at August 31, 2004, the company had available research and development
expenses in Canada amounting to $16,110,000 at the federal level and $16,600,000
at the provincial level, against which a full valuation allowance was
established. These expenses can be carried forward indefinitely against future
years' taxable income in their respective tax jurisdiction.
16 o LOSS PER SHARE
The following table summarizes the reconciliation of the basic weighted average
number of shares outstanding and the diluted weighted average number of shares
outstanding:
YEARS ENDED AUGUST 31, 2004 2003 2002
--------------------------------------------------------------------------------------------------------------------------
Basic weighted average number of shares outstanding (000's) 66,020 62,852 60,666
Dilutive effect of stock options (000's) 502 301 31
Dilutive effect of restricted stock awards (000's) 93 164 269
--------------------------------------------------------------------------------------------------------------------------
Diluted weighted average number of shares outstanding (000's) 66,615 63,317 60,966
--------------------------------------------------------------------------------------------------------------------------
Stock options excluded from the calculation of the diluted weighted average
number of shares because their exercise price was greater
than the average market price of the common shares (000's) 2,128 2,533 2,734
--------------------------------------------------------------------------------------------------------------------------
The diluted loss per share for the years ended August 31, 2002, 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 years was calculated using the basic weighted average number of
shares outstanding.
17 o FINANCIAL INSTRUMENTS
SHORT-TERM INVESTMENTS
Short-term investments consist of the following:
AS AT AUGUST 31, 2004 2003
--------------------------------------------------------------------------------------------------------------------------
Commercial paper denominated in Canadian dollars, bearing interest at annual
rates of 2.00% to 2.14% in 2004 and 2.65% to 3.10% in 2003, maturing on
different dates between October 2004 and January 2005 in fiscal 2004, and
October 2003 and January 2004 in fiscal 2003
$ 65,359 $ 52,010
Mutual funds denominated in Canadian dollars 18,610 -
--------------------------------------------------------------------------------------------------------------------------
$ 83,969 $ 52,010
--------------------------------------------------------------------------------------------------------------------------
FAIR VALUE
Cash, accounts receivable, accounts payable and accrued liabilities and
long-term debt are financial instruments whose carrying values approximate their
fair values.
The fair value of short-term investments, based on market value, amounted to
$52,010,000 and $83,969,000 as at August 31, 2003 and 2004, respectively.
The fair value of forward exchange contracts, based on the current trading
value, amounted to Cdn$18,550,000 and Cdn$20,371,000 as at August 31, 2003 and
2004, respectively.
42 | 2004 Annual Report | EXFO
CREDIT RISK
Financial instruments that potentially subject the company to credit risk
consist primarily of cash, short-term investments, accounts receivable and
forward exchange contracts. The company's short-term investments consist of debt
instruments issued by high-credit quality corporations and trusts. The company's
cash and forward exchange contracts are held with or issued by high-credit
quality financial institutions; therefore, the company considers the risk of
non-performance on these instruments to be remote.
Due to the geographic distribution of the company's customers, there is no
particular concentration of credit risk. Generally, the company does not require
collateral or other security from customers for trade accounts receivable;
however, credit is extended to customers following an evaluation of
creditworthiness. In addition, the company performs ongoing credit reviews of
all its customers and establishes an allowance for doubtful accounts receivable
when accounts are determined to be uncollectible. Allowance for doubtful
accounts amounted to $568,000 and $510,000 as at August 31, 2003 and 2004,
respectively.
INTEREST RATE RISK
As at August 31, 2004, the company's exposure to interest rate risk is
summarized as follows:
Cash Non-interest bearing
Short-term investments As described above
Accounts receivable Non-interest bearing
Accounts payable and accrued liabilities Non-interest bearing
Long-term debt As described in note 10
FORWARD EXCHANGE CONTRACTS
The company is exposed to currency risks as a result of its export sales of
products manufactured in Canada, substantially all of which are denominated
in US dollars. These risks are partially hedged by forward exchange
contracts and certain operating expenses. As at August 31, 2003 and 2004,
the company held contracts to sell US dollars at various forward rates,
which are summarized as follows:
WEIGHTED AVERAGE
CONTRACTUAL AMOUNTS CONTRACTUAL FORWARD RATES
---------------------------------------------------------------------------------------------------------------------------
As at August 31, 2003
September 2003 to August 2004 $ 6,470 1.5869
September 2004 to August 2005 6,680 1.5647
As at August 31, 2004
September 2004 to August 2004 $ 7,480 1.5427
September 2005 to March 2007 8,400 1.3622
As at August 31, 2003 and 2004, these forward exchange contracts generated
deferred unrealized gains of US$1,800,000 and US$1,500,000, respectively.
Deferred unrealized gains were calculated using year-end exchange rates of
Cdn$1.3851 = US$1.00 for fiscal 2003 and Cdn$1.3167 = US$1.00 for fiscal 2004.
18 o SEGMENT INFORMATION
In September 2003, the company reorganized its business under two reportable
segments: Telecom Division and the Photonics and Life Sciences Division. The
Telecom Division offers integrated test solutions to network service providers,
system vendors and component manufacturers throughout the global
telecommunications industry. The Photonics and Life Sciences Division mainly
leverages developed and acquired core telecom 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.
The following tables present information by segment:
PHOTONICS AND LIFE
YEAR ENDED AUGUST 31, 2004 TELECOM DIVISION SCIENCES DIVISION TOTAL
---------------------------------------------------------------------------------------------------------------------------
Sales $ 58,882 $ 15,748 $ 74,630
Loss from operations $ (5,557) $ (5,013) $ (10,570)
Unallocated items:
Interest and other income
Foreign exchange loss 1,438
(278)
---------------------------------------------------------------------------------------------------------------------------
Loss before income taxes (9,410)
Income taxes (986)
---------------------------------------------------------------------------------------------------------------------------
Net loss for the year $ (8,424)
---------------------------------------------------------------------------------------------------------------------------
Amortization of capital assets $ 6,643 $ 3,372 $ 10,015
---------------------------------------------------------------------------------------------------------------------------
Stock-based compensation costs $ 417 $ 32 $ 449
---------------------------------------------------------------------------------------------------------------------------
Capital expenditures $ 607 $ 244 $ 851
---------------------------------------------------------------------------------------------------------------------------
43 | 2004 Annual Report | EXFO
PHOTONICS AND LIFE
YEAR ENDED AUGUST 31, 2003 TELECOM DIVISION SCIENCES DIVISION TOTAL
--------------------------------------------------------------------------------------------------------------------------
Sales $ 48,753 $ 13,177 $ 61,930
PHOTONICS AND LIFE
YEAR ENDED AUGUST 31, 2002 TELECOM DIVISION SCIENCES DIVISION TOTAL
--------------------------------------------------------------------------------------------------------------------------
Sales $ 54,452 $ 13,878 $ 68,330
Comparative information for the loss from operations and related information as
well as capital expenditures is not provided for each reportable segment because
this information is not available and is impracticable to determine.
AS AT AUGUST 31, 2004 2003
--------------------------------------------------------------------------------------------------------------------------
Total assets
Telecom Division $ 59,463 $ 59,466
Photonics and Life Sciences Division 15,915 22,032
Unallocated assets 97,413 64,756
--------------------------------------------------------------------------------------------------------------------------
$ 172,791 $ 146,254
--------------------------------------------------------------------------------------------------------------------------
Unallocated assets are comprised of cash, short-term investments and income
taxes and tax credits recoverable.
As at August 31, 2004, the net carrying value of goodwill that reported to the
Telecom Division and the Photonics and Life Sciences Division amounted to
$14,530,000 and $3,863,000, respectively.
Sales to external customers by geographic region are detailed as follows:
YEARS ENDED AUGUST 31, 2004 2003 2002
--------------------------------------------------------------------------------------------------------------------------
United States $ 40,019 $ 31,561 $ 35,129
Canada 5,818 4,806 3,971
Latin America 3,547 4,467 2,581
--------------------------------------------------------------------------------------------------------------------------
49,384 40,834 41,681
Europe, Middle East and Africa 13,706 11,092 13,678
Asia-Pacific 11,540 10,004 12,971
--------------------------------------------------------------------------------------------------------------------------
$ 74,630 $ 61,930 $ 68,330
--------------------------------------------------------------------------------------------------------------------------
Sales were allocated to geographic regions based on the country of residence of
the related customers. In fiscal 2002 and 2004, one customer represented more
than 10% of sales with 10.2% of sales ($6,965,000) in fiscal 2002 and 13.8% of
sales ($10,325,000) in fiscal 2004. In fiscal 2003, no single customer accounted
for 10% of sales or more. For fiscal 2004, the most important customer reported
to the Telecom Division.
Long-lived assets by geographic region are detailed as follows:
AS AT AUGUST 31, 2004 2003
--------------------------------------------------------------------------------------------------------------------------
Canada $ 37,948 $ 43,402
United States 6,934 9,980
--------------------------------------------------------------------------------------------------------------------------
$ 44,882 $ 53,382
--------------------------------------------------------------------------------------------------------------------------
Long-lived assets consist of property, plant and equipment, the long-lived asset
held for sale, intangible assets and goodwill.
19 o RELATED PARTY TRANSACTIONS
In fiscal 2003, the company acquired a building from a company owned by the
President of the company for a cash consideration of $930,000. This transaction
was measured at the fair market value since it was not in the normal course of
operations, the change in ownership interest in the building was substantive and
the fair market value was supported by an independent appraisal.
For the years ended August 31, 2002, 2003 and 2004, EXFO leased facilities from
a company owned by the President of the company. The annual rental expense
amounted to $234,000, $331,000 and nil, respectively. The rental expense for
fiscal 2003 included $234,000 for future payments on an exited leased facility;
this expense was recorded in the restructuring and other charges in the
statement of earnings for that year (notes 4 and 9). As at August 31, 2004,
restructuring charges payable included $194,000 due to the company owned by the
President of the company in connection with this exited leased facility. In
September 2004, EXFO was released from its obligations under that lease, and it
paid the full amount due to the related company. These rental expenses were
measured at the fair market value since they were incurred during the normal
course of operations.
44 | 2004 Annual Report | EXFO
20 o UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
As a registrant with the Securities and Exchange Commission in the United States
(SEC), the company is required to reconcile its financial statements for
significant differences between generally accepted accounting principles as
applied in Canada (Canadian GAAP) and those applied in the United States (U.S.
GAAP). Furthermore, additional significant disclosures required under U.S. GAAP
and Regulation S-X of the SEC are also been provided in the accompanying
financial statements and notes. The following summarizes the significant
quantitative differences between Canadian and U.S. GAAP, as well as other
significant disclosures required under U.S. GAAP and Regulation S-X not already
provided in the accompanying financial statements.
RECONCILIATION OF NET LOSS TO CONFORM TO U.S. GAAP
The following summary sets out the significant differences between the company's
reported net loss and net loss per share under Canadian GAAP as compared to U.S.
GAAP. Please see corresponding explanatory notes in the Reconciliation Items
section.
YEARS ENDED AUGUST 31, 2004 2003 2002
---------------------------------------------------------------------------------------------------------------------------------
Net loss for the year in accordance with Canadian GAAP $ (8,424) $ (54,950) $ (308,524)
Stock-based compensation costs related to stock option plan a) 146 216 49
Stock-based compensation costs related to stock purchase plan a) (611) (61) (661)
Stock-based compensation costs related to restricted stock award plan a) (402) (987) (3,038)
Unrealized gains (losses) on forward exchange contracts b) (280) 1,645 444
Future income taxes on forward exchange contracts b) - (543) (212)
Future income taxes on acquired in-process research and development d) - - (444)
Amortization of intangible assets e) - 832 239
Future income taxes on amortization of intangible assets e) - (279) (80)
Amortization of goodwill d),e) - - (9,263)
Write-down of goodwill and intangible assets e) - 6,178 (62,557)
Future income taxes on write-down of intangible assets e) - - 1,154
Valuation allowance on future income tax assets f) - (252) -
---------------------------------------------------------------------------------------------------------------------------------
Net loss for the year in accordance with U.S. GAAP (9,571) (48,201) (382,893)
Other comprehensive loss
Foreign currency translation adjustment 5,969 15,089 (521)
Unrealized gains on forward exchange contracts b) 689 - -
---------------------------------------------------------------------------------------------------------------------------------
Comprehensive loss $ (2,913) $ (33,112) $ (383,414)
---------------------------------------------------------------------------------------------------------------------------------
Basic and diluted net loss per share in accordance with U.S. GAAP h) $ (0.14) $ (0.77) $ (6.31)
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 AUGUST 31, 2004 2003 2002
---------------------------------------------------------------------------------------------------------------------------------
Share capital in accordance with Canadian GAAP $ 521,733 $ 492,452 $ 489,611
Stock-based compensation costs related to stock purchase plan a),g)
Current year (47) (75) (64)
Cumulative effect of prior years 2,403 2,478 2,542
Reclassification from other capital upon exercise of restricted stock awards
Current year 1,784 1,582 3,270
Cumulative effect of prior years 4,852 3,270 -
Shares issued upon business combinations d)
Cumulative effect of prior years 65,584 65,584 65,584
---------------------------------------------------------------------------------------------------------------------------------
Share capital in accordance with U.S. GAAP $ 596,309 $ 565,291 $ 560,943
---------------------------------------------------------------------------------------------------------------------------------
DEFERRED STOCK-BASED COMPENSATION COSTS
AS AT AUGUST 31, 2004 2003 2002
---------------------------------------------------------------------------------------------------------------------------------
Deferred stock-based compensation costs in accordance
with Canadian GAAP $ - $ - $ -
Stock-based compensation costs related to stock-based
compensation plans a),g)
Current year (1,463) - -
Cumulative effect of prior years (29,576) (29,576) (29,576)
Amortization
Current year 1,718 1,483 4,698
Cumulative effect of prior years 13,095 11,612 6,914
Reduction of stock-based compensation costs
Current year 84 106 403
Cumulative effect of prior years 15,203 15,097 14,694
---------------------------------------------------------------------------------------------------------------------------------
Deferred stock-based compensation costs in accordance with U.S. GAAP $ (939) $ (1,278) (2,867)
---------------------------------------------------------------------------------------------------------------------------------
45 | 2004 Annual Report | EXFO
OTHER CAPITAL
AS AT AUGUST 31, 2004 2003 2002
---------------------------------------------------------------------------------------------------------------------------------
Other capital in accordance with Canadian GAAP $ - $ - $ -
Stock-based compensation costs related to stock-based
compensation plans a),g)
Current year 1,463 - -
Cumulative effect of prior years 26,894 26,894 26,894
Reduction of stock-based compensation costs
Current year (439) (682) (1,387)
Cumulative effect of prior years (16,613) (15,931) (14,544)
Reclassification to share capital upon exercise of restricted stock awards
Current year (1,784) (1,582) (3,270)
Cumulative effect of prior years (4,852) (3,270) -
---------------------------------------------------------------------------------------------------------------------------------
Other capital in accordance with U.S. GAAP $ 4,669 $ 5,429 $ 7,693
---------------------------------------------------------------------------------------------------------------------------------
DEFICIT
AS AT AUGUST 31, 2004 2003 2002
---------------------------------------------------------------------------------------------------------------------------------
Deficit in accordance with Canadian GAAP $ (380,212) $ (371,788) $ (316,838)
Stock-based compensation costs a)
Current year (867) (832) (3,650)
Cumulative effect of prior years (11,406) (10,574) (6,924)
Unrealized gains (losses) on forward exchange contracts, net of b)
income taxes
Current year (280) 1,102 232
Cumulative effect of prior years 1,451 349 117
Change in reporting currency c)
Cumulative effect of prior years 1,016 1,016 1,016
Future income taxes on acquired in-process research and development d)
Current year - - (444)
Cumulative effect of prior years (1,380) (1,380) (936)
Amortization of intangible assets, net of income taxes e)
Current year - 553 159
Cumulative effect of prior years 712 159 -
Write-down of goodwill and intangible assets, net of e)
income taxes
Current year - 6,178 (61,403)
Cumulative effect of prior years (55,225) (61,403) -
Valuation allowance on future income tax assets f)
Current year - (252) -
Cumulative effect of prior years (252) - -
Amortization of goodwill d), e)
Current year - - (9,263)
Cumulative effect of prior years (17,716) (17,716) (8,453)
---------------------------------------------------------------------------------------------------------------------------------
Deficit in accordance with U.S. GAAP $ (464,159) $ (454,588) $ (406,387)
---------------------------------------------------------------------------------------------------------------------------------
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
AS AT AUGUST 31, 2004 2003 2002
---------------------------------------------------------------------------------------------------------------------------------
Accumulated other comprehensive income in accordance with Canadian GAAP $ - $ - $ -
Foreign currency translation adjustment
Current year 5,969 15,089 (521)
Cumulative effect of prior years 5,219 (9,870) (9,349)
Unrealized gains on forward exchange contracts
Current year b) 689 - -
---------------------------------------------------------------------------------------------------------------------------------
Accumulated other comprehensive income (loss) in accordance with U.S. GAAP $ 11,877 $ 5,219 $ (9,870)
---------------------------------------------------------------------------------------------------------------------------------
46 | 2004 Annual Report | EXFO
BALANCE SHEETS
The following table summarizes the significant differences in balance sheet
items between Canadian GAAP and U.S. GAAP:
AS AT AUGUST 31, 2004 As at August 31, 2003
---------------------------------------------------------------------------------------------------------------------------------
AS REPORTED U.S. GAAP As reported U.S. GAAP
---------------------------------------------------------------------------------------------------------------------------------
Goodwill d), e)
Cost $ 93,967 $ 102,138 $ 91,982 $ 100,512
Accumulated amortization (75,574) (93,753) (74,309) (92,610)
---------------------------------------------------------------------------------------------------------------------------------
$ 18,393 $ 8,385 $ 17,673 $ 7,902
---------------------------------------------------------------------------------------------------------------------------------
Shareholders' equity
Share capital a), d), g) $ 521,733 $ 596,309 $ 492,452 $ 565,291
Contributed surplus 1,986 1,537 1,519 1,519
Cumulative translation adjustment c) 13,820 - 7,643 -
Deficit a), b), c), d), e), f) (380,212) (464,159) (371,788) (454,588)
Deferred stock-based compensation costs a), g) - (939) - (1,278)
Other capital a) - 4,669 - 5,429
Accumulated other comprehensive income c) - 11,877 - 5,219
---------------------------------------------------------------------------------------------------------------------------------
$ 157,327 $ 149,294 $ 129,826 $ 121,592
---------------------------------------------------------------------------------------------------------------------------------
STATEMENTS OF CASH FLOWS
For the years ended August 31, 2002, 2003 and 2004, there were no significant
differences between the statements of cash flows under Canadian GAAP as compared
to U.S. GAAP.
RECONCILIATION ITEMS
a) ACCOUNTING FOR STOCK-BASED COMPENSATION PLANS
Until August 31, 2003, to conform to U.S. GAAP, the company measured
stock-based compensation costs using the intrinsic value method (APB 25,
"Accounting for Stock Issued to Employees"). However, since September 1,
2003, and as described in item j) below, the company accounts for
stock-based compensation costs for awards granted after that date, using the
fair-value based method to conform to Statement of Financial Accounting
Standard (SFAS) 123, "Accounting for Stock-Based Compensation". As at August
31, 2004, deferred stock-based compensation costs related to awards
accounted for under SFAS 123 amounted to $939,000.
STOCK PURCHASE PLAN
Under APB 25, compensation costs related to the stock purchase plan were
measured as the difference between the fair value of the purchased stock and
the purchase price paid by plan participants. Compensation costs were
amortized to expense over a period of five years, being the restriction
period. This plan terminated at the time of the Initial Public Offering on
June 29, 2000. As at August 31, 2004, compensation costs related to this
plan were fully amortized.
STOCK OPTION PLAN
Until August 31, 2003, and under APB 25, compensation costs related to the
stock option plan were measured as the difference between the fair value of
the underlying stock at the date of grant and the exercise price of the
option. These compensation costs were amortized to expense over the
estimated vesting period up to a maximum of four years. As at August 31,
2004, compensation costs related to stock options granted prior to September
1, 2003, and accounted for under APB 25 were fully amortized.
RESTRICTED STOCK AWARD PLAN
Under APB 25, compensation costs related to the restricted stock award plan
were measured as the difference between the fair value of the underlying
stock at the date of grant and the exercise price of the option. These
compensation costs were amortized to expense over the estimated vesting
period up to a maximum of four years, being the acquisition period. As at
August 31, 2004, compensation costs related to this plan were fully
amortized.
STOCK OPTION PLAN
Until August 31, 2003, and under APB 25, compensation costs related to the
stock option plan were measured as the difference between the fair value of
the underlying stock at the date of grant and the exercise price of the
option. These compensation costs were amortized to expense over the
estimated vesting period up to a maximum of four years. As at August 31,
2004, compensation costs related to stock options granted prior to September
1, 2003, and accounted for under APB 25 were fully amortized.
RESTRICTED STOCK AWARD PLAN
Under APB 25, compensation costs related to the restricted stock award plan
were measured as the difference between the fair value of the underlying
stock at the date of grant and the exercise price, which is nil. These
compensation costs were amortized to expense over the estimated vesting
period up to a maximum of four years, being the acquisition period. As at
August 31, 2004, compensation costs related to this plan were fully
amortized.
Until August 31, 2003, no compensation costs were recognized for these
stock-based compensation plans under Canadian GAAP.
b) FORWARD EXCHANGE CONTRACTS
On September 1, 2000, the company prospectively adopted SFAS 133,
"Accounting for Derivative Instruments and Hedging Activities", and its
amendments (SFAS 138), which require all derivatives to be carried onto the
balance sheet at fair value. The forward exchange contracts used by the
company have not qualified for hedging accounting treatment during the years
ended August 31, 2002 and 2003 under U.S. GAAP; accordingly, changes in the
fair value of the derivatives have been charged to earnings during these
years.
However, 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. Upon
settlement of the forward exchange contracts, changes in fair value are
reclassified in the statement of earnings.
Under Canadian GAAP, foreign exchange translation gains and losses on
contracts are recognized as an adjustment of the revenue when the
corresponding sales are recorded, regardless of whether the contracts were
entered into before or after September 1, 2003.
47 | 2004 Annual Report | EXFO
c) CHANGE IN REPORTING CURRENCY
On September 1, 1999, the company adopted the US dollar as its reporting
currency. Under U.S. GAAP, the financial statements, including those of
prior years, are translated according to the current rate method.
Under Canadian GAAP, at the time of change in reporting currency, the
historical financial statements are presented using a translation of
convenience. This difference between U.S. GAAP and Canadian GAAP created a
permanent difference of $1,016,000 affecting the cumulative translation
adjustment and the retained earnings.
d) BUSINESS COMBINATIONS
Under Canadian GAAP, until June 30, 2001, the value of shares issued upon a
business combination was determined based on the market price of the shares
over a reasonable period of time before and after the date of acquisition.
Under U.S. GAAP, the value of shares was determined based on the market
price of the shares over a reasonable period of time before and after the
companies had reached an agreement on the purchase price; the significant
terms of the agreement were known and the proposed transaction was
announced.
Consequently, the measurement dates of the acquisitions of EXFO Burleigh and
EXFO Photonic Solutions for U.S. GAAP purposes occurred on December 14,
2000, and on March 6, 2001, respectively; that is, the dates on which all
significant terms of the agreements were known. The average market price of
the shares a few days before and after those dates was $31.09 and $25.84,
respectively. Considering the number of shares issued upon those
acquisitions, the total consideration for U.S. GAAP purposes amounts to
$244,198,000 ($189,270,000 under Canadian GAAP) for EXFO Burleigh and
$120,802,000 ($110,146,000 under Canadian GAAP) for EXFO Photonic Solutions,
thus increasing share capital and goodwill under U.S. GAAP.
However, since July 1, 2001, the shares issued upon a business combination
are valued under Canadian GAAP using the same method as used under U.S.
GAAP.
Furthermore, under U.S. GAAP, in-process research and development acquired
in a business combination is written off at the time of acquisition and no
future income taxes are recognized on this asset in the purchase price
allocation process. Under Canadian GAAP, in-process research and development
acquired in a business combination is capitalized and amortized over the
estimated useful life. Future income taxes are recognized on the acquisition
date on that asset in the purchase price allocation process. As at August
31, 2002, 2003 and 2004, in-process research and development recorded under
Canadian GAAP was fully amortized.
e) WRITE-DOWN OF GOODWILL AND INTANGIBLE ASSETS
2002
Under U.S. GAAP, until the adoption of SFAS 142, "Goodwill and Other
Intangible Assets", when assets being tested for recoverability were
acquired in business combinations accounted for by the purchase method, the
goodwill that arose in that transaction had to be included as part of the
assets grouping in determining recoverability. The intangible assets tested
for recoverability in fiscal 2002 were acquired in business combinations
that were accounted for using the purchase method and, consequently, the
company allocated goodwill to those assets on a pro rata basis using the
relative fair values of the long-lived assets and identifiable intangible
assets acquired as determined at the date of acquisition. The carrying value
of goodwill identified with the impaired intangible assets was written down
before any reduction was made to the intangible assets. Intangible assets
were then written down to their fair value.
The fair value of intangible assets was determined based on discounted
future cash flows. The cash flow periods used were ten and eleven years,
using annual growth rates ranging between 10% and 30% and discount rates
between 15% and 18%. The assumptions supporting discounted cash flows,
including the cash flow periods, the annual growth rates and the discount
rates reflected management's best estimates. The discount rates were based
upon the company's weighted average cost of capital as adjusted for the
risks associated with operations.
The unallocated portion of goodwill was tested for recoverability at the
subsidiaries' level based on the related pre-tax undiscounted future cash
flows using the same assumptions and methodology used for Canadian GAAP
purposes.
Under U.S. GAAP, the company recorded a charge of $281,278,000 to write down
a significant portion of goodwill and a pre-tax charge of $27,105,000 to
write down a significant portion of acquired core technology. Of the total
charge of $308,383,000, $170,079,000 was related to EXFO Burleigh for
goodwill and acquired core technology, $83,637,000 was related to EXFO
Photonic Solutions for goodwill and acquired core technology and $54,667,000
was related to EXFO Protocol for goodwill.
Under Canadian GAAP, no allocation of goodwill was required and each asset
was tested for recoverability separately based on its pre-tax undiscounted
future cash flows over its expected period of use.
Also, under Canadian GAAP, the impairment loss for intangible assets was
measured as the difference between the carrying value and the pre-tax
undiscounted future cash flows.
Finally, under U.S. GAAP, the carrying value of goodwill reviewed for
impairment was $46,380,000 higher than the carrying value of the same
goodwill tested under Canadian GAAP because the measurement dates used to
account for the business combinations were different between Canadian GAAP
and U.S. GAAP as explained in item d).
2003
In fiscal 2003, Canadian and U.S. GAAP were harmonized to eliminate the
existing differences in the assessment and measurement of impairment loss
for goodwill and intangible assets. Thus, in fiscal 2003, goodwill and
intangible assets were tested for impairment using similar methodologies.
However, considering that the existing carrying value of goodwill and
intangible assets was lower under U.S. GAAP than under Canadian GAAP, the
required impairment loss under U.S. GAAP was lower.
Consequently, under U.S. GAAP, the company recorded a charge of $872,000 to
write down the goodwill of EXFO Burleigh and a pre-tax charge of $377,000 to
write down the acquired core technology of EXFO Burleigh, compared to a
write-down of $4,505,000 for goodwill and a write-down of $2,922,000 for
intangible assets under Canadian GAAP, creating a reconciliation item of
$6,178,000 in the statement of earnings for the year ended August 31, 2003.
Furthermore, considering differences in the carrying value of intangible
assets between Canadian GAAP and U.S. GAAP due to impairment losses,
adjustments to the amortization of such assets and related future income
taxes were also required in fiscal 2002 and 2003.
48 | 2004 Annual Report | EXFO
f) INCOME TAXES
In fiscal 2003, considering the tax effects of the adjustments discussed in
items b), d) and e), the valuation allowance required under U.S. GAAP was
$252,000 higher than under Canadian GAAP.
g) SHARE CAPITAL
Under Canadian GAAP, restricted shares reacquired from employees under the
stock purchase plan are treated as arm's length repurchases of shares,
whereas under U.S. GAAP, the reacquisition of shares would be accounted for
as a forfeiture by the employee, which means that any difference between the
amount originally credited to share capital and the remaining deferred
compensation cost will be credited to compensation expense in the current
period. The subsequent resale of the shares would be treated as an issuance
of shares for the proceeds received.
h) LOSS PER SHARE
Under U.S. GAAP, the presentation of per share figures for loss before
amortization and write-down of goodwill is not permitted.
i) RESEARCH AND DEVELOPMENT TAX CREDITS
Under Canadian GAAP, all research and development tax credits are recorded
as a reduction of research and development expenses. Under U.S. GAAP, tax
credits that are refundable against taxable income are recorded in the
income taxes. These tax credits amounted to $1,761,000 and $2,599,000 for
fiscal 2004 and 2002, respectively. In fiscal 2003, we had a net expense of
$176,000 following the write-off of tax credits. This difference had no
impact on the net loss and the net loss per share figures for the reporting
years.
j) NEW ACCOUNTING STANDARD
On September 1, 2003, the company prospectively adopted SFAS 123,
"Accounting for Stock-Based Compensation", under the revised transition
provisions of SFAS 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure". Upon the adoption of SFAS 123 and SFAS 148, the
company recognized stock-based compensation costs for stock options granted
to employees since September 1, 2003, using the fair value-based method. The
company adopted this Statement in order to conform to the newly adopted
rules under Canadian GAAP, as 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 for awards
granted after September 1, 2003.
ACCOUNTING FOR STOCK-BASED COMPENSATION
Under U.S. GAAP, and until August 31, 2003, the company elected to measure
compensation costs related to grants of stock options and stock awards using the
intrinsic value method of accounting. In this instance, however, under SFAS 123,
the company is required to make pro forma disclosures of net loss, and net loss
per share, as if the fair value-based method of accounting had been applied. If
the fair value-based method had been applied, the pro forma net loss per share
would have been lower than the net loss per share by $0.02 in fiscal 2004 and
higher by $0.01 and $0.08 in 2003 and 2002, respectively.
The fair value of options or awards granted was estimated using the
Black-Scholes options pricing model with the following weighted average
assumptions:
YEARS ENDED AUGUST 31, 2004 2003 2002
-------------------------------------------------------------------------------
Risk-free interest rate 2.7% 4.8% 4.5%
Expected volatility 100% 80% 80%
Dividend yield NIL Nil Nil
Expected life 49 MONTHS 36 months 40 months
49 | 2004 Annual Report | EXFO
------------------------------
BOARD OF DIRECTORS
------------------------------
GERMAIN LAMONDE, Chairman of the Board, President and CEO, EXFO Electro-Optical
Engineering Inc.
Germain Lamonde, a company founder, has been Chairman of the Board, President
and Chief Executive Officer of EXFO since its inception in 1985, when
operations first began in his apartment. From these humble beginnings, Mr.
Lamonde, who is responsible for the overall management and direction of EXFO
and its subsidiaries, has grown the company into a global leader in the
telecommunications test and measurement industry. Mr. Lamonde has served on
the boards of several private firms and public organizations, including the
Canadian Institute for Photonic Innovations (part of Canada's Networks of
Centres of Excellence), Pole QCA Economic Development Corporation and the
National Optics Institue of Canada. He is also a founding member and Governor
of the International Institute of Telecommunications of Canada and an Emeritus
Member of the Canadian Academy of Engineering. Germain Lamonde holds a
bachelor's degree in physics engineering from the University of Montreal's
School of Engineering, a master's degree in optics from Laval University, and
is also a graduate of the Ivey Executive Program offered by the University of
Western Ontario.
PIERRE MARCOUILLER, Chairman of the Board and CEO, Camoplast Inc.
Pierre Marcouiller is Chairman of the Board and CEO of Camoplast Inc., a
supplier of components and systems to motor vehicle equipment manufacturers and
manufacturers of utility vehicles. He is the founder and has been the sole
shareholder of Nexcap Inc., an investment company in the manufacturing sector,
since December 1996. Mr. Marcouiller worked with Venmar Ventilation Inc., a
private ventilation equipment manufacturer, from January 1983 to December 1996.
From 1991 to 1996, he was the controlling shareholder of Venmar, where he also
held the position of President and General Manager from 1986 to 1996. Mr.
Marcouiller is also a Director of Heroux-Devtek Inc., a publicly traded company
that manufactures aerospace and industrial turbines, and holds directorships in
other privately held companies. Pierre Marcouiller holds a bachelor's degree in
business administration from the UNIVERSITE DU QUEBEC A TROIS-RIVIERES and an
MBA from the UNIVERSITE DE SHERBROOKE, both in Canada.
GUY MARIER, Corporate Director
Formerly President of Bell Quebec between 1999 and 2003, Guy Marier completed
his successful 33-year career at Bell as Executive Vice-President of the Project
Management Office of Bell Quebec, before retiring at the end of 2003. Mr. Marier
began at Bell Canada in 1970 and quickly became an executive. From 1988 to 1990,
he headed up Bell Canada International's investments and projects in Saudi
Arabia and, for the three following years, served as President of Telebec, a
subsidiary of Bell Canada. He then returned to the parent company to hold
various senior management positions. Mr. Marier was appointed to our Board of
Directors in January 2004 and also sits on the Board of Bell Nordiq, a
wholly-owned subsidiary of Bell Canada that manages the business and affairs of
both Telebec L.P. and NorthernTel L.P. Guy Marier holds a Bachelor of Arts from
the University of Montreal and a Bachelor of Business Administration from the
UNIVERSITE DU QUEBEC A MONTREAL.
DR. DAVID A. THOMPSON, Vice-President and Director, Hardware & Equipment
Technology Strategy, Corning Cable Systems
Dr. David Thompson is currently Vice-President and Director of Hardware &
Equipment Technology Strategy at Corning Cable Systems, where he has held this
position since January 2002. Prior to this nomination, he acted as Corning
Incorporated's Division Vice-President for the Strategic Planning & Innovation
Effectiveness in Research, Development and Engineering. Dr. Thompson first
joined Corning Incorporated's R&D Division in 1976 as a Senior Chemist in glass
research. He then took on several technology directorship and strategic planning
roles for Corning's Component and Photonics Technologies Divisions between 1988
and 1998; and, in 1999, he was appointed technical leader for the creation of
the new Samsung-Corning Micro Optics joint venture. David A. Thompson holds a
Bachelor of Science in chemistry from Ohio State University and a doctorate in
inorganic chemistry from the University of Michigan. He holds 13 patents and has
over 20 technical publications in the areas of inorganic chemistry, glass
technology and telecommunications.
ANDRE TREMBLAY, President and CEO, Microcell Telecommunications Inc.
Andre Tremblay has been President and Chief Executive Officer of Microcell
Telecommunications since 1995. In addition to his role at Microcell, Mr.
Tremblay sits on the Board of Directors of the Communications Research Centre (a
research arm of the federal government's Department of Industry) as well as the
boards of other private and public corporations. Mr. Tremblay began his career
in the telecommunications industry a decade earlier, as an advisor to Charles
Sirois, Chairman and Chief Executive Officer of Telesystem Ltd. He subsequently
held various executive positions within that company. Andre Tremblay holds
bachelor's degrees in management and in accounting from Laval University, a
master's degree in taxation from the UNIVERSITE DE SHERBROOKE, and is also a
graduate of Harvard Business School's Advanced Management Program.
MICHAEL UNGER, Executive Consultant
Michael Unger has served as our director since May 2000. He previously worked
with Nortel Networks Limited, now Nortel Networks Corporation, from 1962 to
2000. Mr. Unger's most recent position was President of Nortel's Optical
Networks Business Unit, a position he held from May 1998 to April 2000. Prior to
this appointment, he was Nortel's Group Vice-President, Transport Networks from
March 1990 to May 1998. Mr. Unger also sits on the board of Tundra Semiconductor
Corporation, a publicly traded company that designs, develops and markets
standards-based system interconnect products for use by the world's leading
communications and storage companies. He is also a member of the boards of a
number of privately held companies active in the areas of networks management
software, photonic and optical components, optical network systems and solutions
for cable operators, as well as other communications network service providers.
Michael Unger holds a Bachelor of Science from Concordia University in Canada.
50 | 2004 Annual Report | EXFO
--------------------------------------
Management and Corporate Officers
--------------------------------------
GERMAIN LAMONDE ETIENNE GAGNON
Chairman of the Board, President Vice President, Optical-Layer
and Chief Executive Officer Product Management and Customer
Service
STEPHEN BULL LUC GAGNON
Vice President, Research and Vice President, Telecom
Development, Telecom Division Manfacturing Operations
NORMAND DUROCHER JUAN FELIPE GONZALEZ
Vice President, Human Resources Vice President, Global
Telecom Sales
ALLAN FIRHOJ PIERRE PLAMONDON
Vice-President and General Manager, Vice President, Finance
Photonics and Life Sciences Division and Chief Financial Officer
BENOIT FLEURY BENOIT RINGUETTE
Vice-President, Protocol-Layer Product Legal Counsel and
Management and Business Development Corporate Secretary
51 | 2004 Annual Report | EXFO
CORPORATE GOVERNANCE PRACTICES
As in the previous year, fiscal 2004 was marked by changes in the corporate
governance landscape. More specifically, the Board of Directors and management
continued to keep abreast of new Canadian and American regulatory requirements.
Furthermore, the Audit Committee has been very active throughout the year with
the implementation of and compliance with various rules adopted by the
Securities and Exchange Commission pursuant to the Sarbanes-Oxley Act of 2002
that apply to Canadian companies with shares registered in the U.S. In addition,
the Board of Directors implemented procedures to monitor the effectiveness of
the Board. New corporate governance rules for NASDAQ and the Toronto Stock
Exchange are expected to come into force in the coming months and management is
already analyzing their impact on the company. As this past year has
demonstrated, achieving best practices in corporate governance is an ongoing
process in an ever-changing context.
The Board of Directors believes that EXFO's corporate governance practices
comply with current regulatory requirements. As new guidelines come into effect,
we will comply with these requirements. Further details about our corporate
governance practices are available in the proxy circular.
The present Board members were elected at our last Annual and Special Meeting of
Shareholders, held on January 7, 2004, except for Mr. Guy Marier, who was
nominated by the Board of Directors on January 7, 2004, pursuant to the General
By-Laws of the Corporation.
RESPONSIBILITIES OF THE BOARD
The Board is responsible for the stewardship of our business and affairs by
reviewing, discussing and approving our strategic direction and organizational
structure, as well as for the review and approval of management's strategic
planning on an annual basis. The Board also identifies the principal risks of
our business and reviews our risk management systems on an annual and ongoing
basis.
In addition to matters requiring Board approval under applicable laws, the Board
grants final approval with respect to each of the following: (i) the strategic
direction of EXFO; (ii) material contracts, acquisitions or dispositions of our
assets; and (iii) the annual operational plan, as well as capital and operating
budgets.
The Board of Directors assumes direct responsibility for corporate governance
practices and for monitoring the powers, the mandates and the performance of the
committees.
The Board is also responsible for the establishment and functioning of all Board
committees, the appointment of members to serve on such committees, their
compensation and their good standing. At regularly scheduled meetings of the
Board, the Directors receive, consider and discuss committee reports.
During the fiscal year ended August 31, 2004, the Board met a total of ten
times. Attendance at all meetings was exemplary: Mr. Pierre Marcouiller was
absent from one meeting, Mr. David Thompson was absent from one meeting and Mr.
Michael Unger was absent from one meeting.
Mr. Michael Unger, Chairman of the Human Resources Committee and independent
Director of EXFO, is the Lead Director. As such, he is responsible for ensuring
that the Board properly discharges its duties, independent of management. The
Lead Director is required to hold a minimum of two meetings of the Board of
Directors without management members present, and additional meetings of
independent Board members may be held at their request. During the fiscal year
ended August 31, 2004, independent Board members met twice.
At the present time, EXFO has no formal procedures in place for recruiting new
Directors.
COMPOSITION OF THE BOARD
Our articles of incorporation provide for a Board of Directors with a minimum of
three and a maximum of twelve Directors. Our Board presently consists of six
Directors, five of whom are independent of management and free from any interest
and any business or other relationship which could, or could reasonably be
perceived to, materially interfere with a Director's ability to act with a view
to the best interests of EXFO, other than interests arising from non-significant
shareholding. Our Directors are elected at the Annual General Meeting of
Shareholders for one-year terms and serve until their successors are elected or
appointed, unless they resign or are removed earlier.
Our Chairman of the Board and Chief Executive Officer, Mr. Germain Lamonde, is a
significant shareholder of EXFO as he has the ability to exercise a majority of
the votes for the election of the Board of Directors. Since the other five Board
members do not have interests in EXFO or relationships with either EXFO or Mr.
Lamonde, except for non-significant shareholding in EXFO, we believe that the
interests of investors in EXFO, other than Mr. Lamonde's, are fairly
represented.
COMMITTEES OF THE BOARD
Board committees play a significant role in the discharge of Board duties and
obligations; committee chairs submit items for Board agendas and report on
committee activities. The members of these committees are appointed annually,
and the Board may appoint additional ad hoc committees periodically, as needed.
EXFO has a practice of permitting the Board, any committee thereof, and any
individual Director to hire independent, external advisors at our expense. The
Audit Committee and the Human Resources Committee are entirely comprised of
unrelated Directors.
The following is a general description of the composition and general duties of
each Board committee as contained in its mandate as at the fiscal year ended
August 31, 2004.
AUDIT COMMITTEE
The Audit Committee reviews interim in-house financial statements and annual
audited financial statements and related disclosure documents, including
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", with management and external auditors and approves them prior to
public release. The Audit Committee is responsible for reviewing our internal
control systems with regard to finance, accounting, legal compliance and ethical
behavior. The Committee meets regularly with external auditors, with and without
management, to consider the scope and results of their audits, including
analysis of the adequacy of the internal controls and the effect of the
procedures relating to the outside auditors' independence. The Committee also
recommends to the shareholders the selection of external auditors for their
appointment by the shareholders. The Audit Committee is comprised of the
following independent Directors: Mr. Pierre Marcouiller, Mr. Guy Marier, Mr.
Andre Tremblay and Mr. Michael Unger. The Chair of the Audit Committee is Mr.
Tremblay. During the fiscal year ended August 31, 2004, the Audit Committee met
a total of five times and all members attended all meetings, except for Mr.
Pierre Marcouiller, who was absent from one meeting.
52 | 2004 Annual Report | EXFO
Further to proposed changes to NASDAQ corporate governance rules and new
Securites and Exchange Commission rules flowing from the adoption of the
Sarbanes-Oxley Act, our Audit Committee charter was revised during the fiscal
year ended August 31, 2004, to comply with all new requirements.
HUMAN RESOURCES COMMITTEE
The Human Resources Committee is responsible for assessing the performance and
establishing the annual compensation of all our senior officers, including the
CEO. This Committee also reviews and submits to the Board the salary structure
and the short-term and long-term incentive compensation programs for all our
employees. The Committee is responsible for the review and approval of the
employees who will receive options to purchase EXFO shares in accordance with
policies established by the Board and the terms of the Stock Option Plan. In
addition, the Committee reports annually to the Board regarding the
organizational structure and succession plan for senior management. The
remuneration to be paid by EXFO to the Directors is recommended to the Board by
the Human Resources Committee. The Human Resources Committee is comprised of the
following independent Directors: Mr. Pierre Marcouiller, Mr. Guy Marier, Dr.
David A. Thompson, Mr. Andre Tremblay and Mr. Michael Unger. The Chair of the
Human Resources Committee is Mr. Unger. During the fiscal year ended August 31,
2004, the Human Resources committee met a total of two times and attendance was
perfect at all meetings.
DISCLOSURE COMMITTEE
The Disclosure Committee is responsible for overseeing our disclosure practices.
The Disclosure Committee consists of the Chief Executive Officer, Chief
Financial Officer, Investor Relations Manager, Manager of Financial Reporting
and Accounting, as well as Legal Counsel and Corporate Secretary.
SHAREHOLDER/INVESTOR COMMUNICATIONS AND FEEDBACK
The Chief Financial Officer assumes responsibility for investor relations. He is
responsible for facilitating communications between senior management and EXFO's
shareholders and financial analysts. Information to shareholders is disseminated
through annual and quarterly reports, press releases, proxy circular, the Annual
General Shareholders' Meeting and investor presentations. EXFO receives and
responds to all shareholders' inquiries in an appropriate and timely manner. In
communications to senior management, the Chief Financial Officer also provides
feedback from shareholders.
53 | 2004 Annual Report | EXFO
GLOSSARY
ACCESS NETWORK: Last link in a network between the customer premises and the
first point of connection to the network infrastructure--a point of presence
(PoP) on the edge of a metropolitan network or a central office (CO). Access
networks have, up to now, consisted primarily of passive, twisted-pair copper
wires, but there is a strong trend towards optical-fiber connections either
directly or very close to the customer (fiber-to-the-curb).
BANDWIDTH: Represents the amount of data that can be transmitted through a
communications channel in a fixed amount of time. For digital devices, bandwidth
is usually expressed in bits (or bytes) per second. For analog devices, it is
expressed in cycles per second, or in Hertz (Hz). The greater the bandwidth, the
greater the information-carrying capacity and the faster the speed.
BACKBONE: Part of the communications network that carries the heaviest traffic.
The backbone is also the part of the network that joins several local area
networks, either inside a building or across a city or country.
DENSE WAVELENGTH-DIVISION MULTIPLEXING (DWDM): A technology that enables a
single optical fiber to carry multiple data channels (or wavelengths).
Commercial DWDM systems can have as many as 160 separate channels.
ETHERNET: Protocol for data networking. Ethernet networks typically operate at
10, 100 or 1000 Mb/s.
FIBER-TO-THE-X (FTTX) TECHNOLOGY: The x in fiber-to-the-x is a variable
indicating the point at which the fiber in a network stops and copper (coaxial
or twisted-pair) cabling takes over. The further the fiber goes, the wider the
bandwidth, the quicker the speed, and the more applications and services can be
offered.
FIBER-TO-THE-CURB (FTTC): Network in which fiber is installed typically within
1000 feet of the premises, leaving the curb-to-building section made out of
twisted-pair copper cable.
FIBER-TO-THE-HOME (FTTH): Also known as fiber-to-the-premises (FTTP) and
fiber-to-the-building (FTTB). FTTH refers to a carrier network's optical fiber
that is connected directly to the subscriber's home or enterprise.
FIBER-TO-THE-NODE (FTTN): Network in which fiber is used for part, but not all,
of the link from the fiber distribution hub to the end-user. An optical to
electrical conversion takes place at an active device called a node, which
typically serves a neighborhood or geographically similar area. Most current
cable TV and telephony networks have FTTN architectures.
FIBRE CHANNEL: The DE FACTO, serialized protocol developed specifically for
storage-area-network communications by the American National Standards
Institute. Fibre Channel technology provides an inexpensive and scalable way of
using fiberoptic cables to connect storage devices, thus allowing network
operators to combine the best features of storage and networking techniques.
GIGABIT ETHERNET: A version of Ethernet that operates at 1 Gb/s (1000 Mb/s).
INTERNET PROTOCOL (IP): Method or protocol by which data is sent from one
computer to another on the Internet. Each computer on the Internet has at least
one IP address that uniquely identifies it from all other computers on the
Internet. Because of these standardized IP addresses, the gateway receiving the
data can keep track of, recognize and route messages appropriately.
METRO NETWORK: Metropolitan area network (MAN). A network, often ringed in
structure, that covers an entire city and its suburbs.
NANOMETER-SCALE POSITIONING: Also known as nanopositioning. A positioning
technique used during optical component manufacturing to align components with a
precision measured in nanometers (one billionth of a meter).
OPTICAL LAYER: Commonly used to refer to specific wavelengths or channels of a
DWDM network. Each wavelength carries a separate stream of data encoded in a
light signal.
PASSIVE OPTICAL NETWORK (PON): Network in which fiber-optic cabling (instead of
copper) brings signals all or most of the way to the end-user. It is described
as passive because no active equipment (electrically powered) is required
between the central office (or hub) and the customer premises. Depending on
where the PON terminates, the system can be described as an FTTx network, which
typically allows a point-to-point or point-to-multipoint connection from the
central office to the subscriber's premises; in a point-to-multipoint
architecture, a number of subscribers (for example, up to 32) can be connected
to just one of the various feeder fibers located in a fiber distribution hub,
dramatically reducing network installation, management and maintenance costs.
PHYSICAL LAYER: Commonly used to refer to the propagation medium of an optical
network, including the fiber and all in-line active and passive components.
Light signals, which are forms of encoded data, are transmitted over this layer.
PIEZOELECTRIC (PZT) TECHNOLOGY: Technology of piezoelectricity, which refers to
the electrical field created by some ceramic materials when subjected to
pressure. Precision positioning devices use the inverse effect; that is, when an
electric field is applied to a piezoelectric material, it changes shape, and
this shape change is used to create precise mechanical movements.
PROTOCOL: A formal set of rules governing the format, timing, sequencing and
error control of data exchange across a network. Many protocols may be required
and used on a single network.
PROTOCOL LAYER: Commonly used to refer to the formatting rules for transmitting
data over an optical network. Networks send and receive data using industry-wide
formats; some examples are SONET, SDH, ATM and Ethernet.
SDH: Synchronous Digital Hierarchy. Standardized by the International
Telecommunication Union (ITU -TSS). A protocol for transmitting information over
optical fiber.
SONET: Synchronous Optical NETwork. Standardized by the American National
Standards Institute (ANSI). A protocol for backbone networks, capable of
transmitting at extremely high speeds and accommodating gigabit-level bandwidth.
SPOT CURING: Technology by which a dose of energy of a specific wavelength band
and irradiance is used to cause an adhesive, encapsulant or sealant to change
from a liquid to a solid in a small area.
STORAGE AREA NETWORK (SAN): A special high-speed network that interconnects
different kinds of data storage devices with associated data servers on behalf
of a larger network of users. Within an enterprise, the data is typically stored
in other on-site computers, but can also be archived in a geographically remote
location for disaster recovery.
TRIPLE-PLAY SERVICES: Also known as bundled services. The ability of a
telecommunications carrier to supply voice, data and video applications at once.
A typical example of a triple-play proposal would include one or multiple phone
lines, a high-speed Internet connection and television/video services (such as
HDTV), all offered by the same provider.
VOICE-OVER-INTERNET-PROTOCOL (VOIP): Refers to communications services--voice,
facsimile and/or voice-messaging applications--that are transported via the
Internet, rather than the public switched telephone network. In an
Internet-based telephone call, the voice signals are converted to digital format
and compressed/translated into Internet protocol (IP) packets for transmission
over the Internet; the process is reversed at the receiving end.
WIRELINE: A term associated with a land or underwater network or link that uses
metallic wire conductors (and/or optical fibers) for telecommunications. While
wireline access interfaces with the network via a physical wired connection, the
connection itself can be employed by either a wired or wireless terminal
operating in a wired mode via a standard physical interface.
54 | 2004 Annual Report | EXFO
SHAREHOLDER INFORMATION
The subordinate voting shares of EXFO are listed on the Toronto Stock Exchange
under the stock symbol "EXF.SV" and on the NASDAQ Stock Exchange under the stock
symbol "EXFO".
ANNUAL AND SPECIAL MEETING
The Annual and Special Meeting of Shareholders of EXFO Electro-Optical
Engineering Inc. will be held on January 12, 2005, 10 a.m., at the McCord
Museum, J.-Armand-Bombardier Theatre, 690 Sherbrooke Street West, Montreal,
Quebec.
TRANSFER AGENTS AND REGISTRARS
CANADA
CIBC Mellon Trust Company
2001 University Street, Suite 1600
Montreal, Quebec H3A 2A6
Tel.: (514) 285-3600
UNITED STATES
Mellon Investor Services, LLC
Overpeck Center 85 Challenger
Road
Ridgefield Park, New Jersey 07660
Tel.: (201) 296-4000
INDEPENDENT AUDITORS
PricewaterhouseCoopers LLP
Place de la Cite, Tour Cominar
2640 Laurier Blvd., Suite 1700
Sainte-Foy, Quebec G1V 5C2
Tel.: (418) 522-7001
GENERAL ACCESS
EXFO Electro-Optical Engineering Inc.
400 Godin Avenue Vanier,
Quebec G1M 2K2
Tel.: (418) 683-0211
e-mail: ir@exfo.com
www.exfo.com
CONTACT INFORMATION
INVESTOR RELATIONS
Vance Oliver
Manager, Investor Relations Tel.:
(418) 683-0913, Ext. 3733
E-MAIL: VANCE.OLIVER@EXFO.COM
The Annual Report is available in English and in French, both in print and on
our Web site at WWW.EXFO.COM.
[STOCK PERFORMANCE LINE CHART OMITTED]
Worldwide Offices
CORPORATE HEADQUARTERS
400 Godin Avenue,
Vanier, Quebec G1M 2K2 CANADA
Tel.: 1 418 683-0211 | Fax: 1 418 683-2170
EXFO AMERICA INC.
4275 Kellway Circle, Suite 122,
Addison, TX 75001 USA
Tel.: 1 800 663-3936 (USA and Canada) or 1 972 907-1505
Fax: 1 972 836-0164
EXFO EUROPE S.A.R.L.
Le Dynasteur 10/12, rue Andras Beck
92366 Meudon la Foret Cedex FRANCE
Tel.: +33.1.40.83.85.85 | Fax: +33.1.40.83.04.42
EXFO ASIA-PACIFIC PTE LTD.
151 Chin Swee Road #03-29
Manhattan House, SINGAPORE 169876
Tel.: +65 6333 8241 | Fax: +65 6333 8242
EXFO CHINA
- Beijing New Century Hotel Office Tower, Room 1754-1755
No. 6 Southern Capital Gym Road, Beijing 100044, P. R. CHINA
Tel.: +86 (10) 6849 2738 | Fax: +86 (10) 6849 2662
- World Trade Plaza, BLK A, Room 3208A
9 Fuhong Road, Futian District, Shenzhen 518033, P. R. CHINA
Tel.: +86 (755) 8369 0951 /8369 0955 | Fax: +86 (755) 8369 0817
EXFO JAPAN
JP Hamacho Bldg.10F, Nihonbashi Hamacho 2-23-5 Chuo-ku
Tokyo 103-0007 JAPAN
Tel.: +81-3-5643-2677 | Fax: +81-3-5643-2678
EXFO PHOTONIC SOLUTIONS INC.
2260 Argentia Road, Mississauga,
Ontario L5N 6H7 CANADA
Tel.: 1 800 668-8752 (USA and Canada) or 1 905 821-2600
Fax: 1 905 821-2055
EXFO PROTOCOL
2650 Marie-Curie West, St-Laurent, Quebec H4S 2C3 CANADA
Tel.: 1 888 972-7666 (USA and Canada) or 1 514 856-2222
Fax: 1 514 856-2232
[GRAPHIC OMITTED]
NOTES
-----
E X F O
EXPERTISE REACHING OUT
www.exfo.com
Telecommunications Test and Measurement
(c) 2004 EXFO Electro-Optical Engineering Inc. All rights reserved.
Printed in Canada.
E X F O
Corporate Headquarters 400 Godin Avenue, Vanier (Quebec) G1M2K2 CANADA
Tel: 1 418 683-0211 | Fax: 1 418 683-2170 | info@exfo.com | www.exfo.com
========================================================================
Quebec City, November 1, 2004
Re: Annual and Special Meeting of Shareholders
Dear Shareholder:
Although EXFO has not yet reached profitability, it made significant progress
with its strategic turnaround plan in fiscal 2004. The company, which from its
founding had posted 16 consecutive years of growth and profitability before the
onset of the telecommunications downturn in 2001, necessarily developed
turnaround skills leading to increased sales of 20.5% year-over-year, even
though the marketplace remained relatively flat in 2004. We outperformed our
market largely because we had made bold decisions in prior years and remained
long-term focused. Despite painstaking restructuring, we continued our strong
investments in R&D to position ourselves within growth vectors like protocol
testing, Internet protocol (IP)-convergence and fiber-to-the-home or
fiber-to-the-curb (FTTx) deployments. We also held onto our experienced sales
team and customer support staff to increase market share and expand customer
relationships, while several of our peers were forced to make more radical cuts.
In short, we reached out to customers through the recognized expertise of our
entire staff, strengthening the EXFO brand name in the process.
We also demonstrated good corporate governance by clearly spelling out four
objectives in 2004 and tagging key performance indicators (KPIs) to each goal.
Such transparency reflects my confidence in our management team and our
dedication to best disclosure practices. Take a look at the following table and
our focus on quality of execution:
CORPORATE PERFORMANCE IN FISCAL 2004
GOAL METRIC RESULT
-----------------------------------------------------------------------------------------------------------------------
Increase sales through market-share 10% sales growth year-over-year 20.5% sales growth [checkmark]
gains year-over-year
-----------------------------------------------------------------------------------------------------------------------
Maximize profitability and growth 50% gross margin 53.7% gross margin [checkmark]
-----------------------------------------------------------------------------------------------------------------------
Innovate out of the downturn 45% of sales from new products (< two 31.7% of sales from new X
years on the market) products
-----------------------------------------------------------------------------------------------------------------------
Maintain a sound financial position Positive cash flows from operations Positive cash flows from [checkmark]
in at least one quarter operations for fiscal year
-----------------------------------------------------------------------------------------------------------------------
As in fiscal 2004, I would like to communicate the key performance indicators
against which our performance should be measured in 2005. It should be specified
that these are metrics, not guidance, for fiscal 2005. Not surprisingly, our
goals reflect continuity from last year with a renewed focus on profitable
growth.
CORPORATE OBJECTIVES FOR FISCAL 2005
GOAL METRIC
----------------------------------------------------------------------------------------------------
Increase sales through market-share gains 20% sales growth year-over-year
----------------------------------------------------------------------------------------------------
Maximize profitability Profitable on a pro forma basis for the fiscal year*
----------------------------------------------------------------------------------------------------
Focus on innovation 45% of sales from new products (less than two years on
the market)
----------------------------------------------------------------------------------------------------
*GAAP NET LOSS EXCLUDING STOCK-BASED COMPENSATION COSTS, AMORTIZATION OF
INTANGIBLE ASSETS, RESTRUCTURING CHARGES AND OTHER UNUSUAL ITEMS.
I will discuss these objectives in greater detail at our upcoming Annual and
Special Meeting of Shareholders, along with results for the first quarter of
fiscal 2005. Please consider this letter as a formal invitation to attend our
Meeting, which will be held January 12, 2005, 10 a.m., at the McCord Museum,
J.-Armand Bombardier Theatre, 690 Sherbrooke Street West, Montreal, Quebec.
Details of the business to be conducted at the Meeting are provided in the
attached Management Proxy Circular and Notice of Annual and Special Meeting of
Shareholders.
It is important that your shares be represented at the Meeting. WHETHER OR NOT
YOU PLAN TO ATTEND THE MEETING, PLEASE COMPLETE, SIGN, DATE AND PROMPTLY RETURN
THE ACCOMPANYING PROXY IN THE ENCLOSED POSTAGE-PAID ENVELOPE.
If you send in your proxy card and then decide to attend the Meeting to vote
your shares in person, you may still do so. Your proxy is revocable in
accordance with the procedures set forth in the Management Proxy Circular.
On behalf of the Board of Directors, I would like to express our appreciation
for your continued interest in EXFO. We look forward to seeing you at the
Meeting.
Sincerely,
/s/ Germain Lamonde
-----------------------------
Germain Lamonde
Chairman, President and
Chief Executive Officer
EXFO Electro-Optical Engineering Inc.
[EXFO LOGO OMITTED]
EXFO ELECTRO-OPTICAL ENGINEERING INC.
_________________________
NOTICE OF ANNUAL AND SPECIAL MEETING OF SHAREHOLDERS
NOTICE IS HEREBY GIVEN that the Annual and Special Meeting (the
"Meeting") of shareholders of EXFO Electro-Optical Engineering Inc. (the
"Corporation") will be held at 10:00 a.m. (Eastern Standard Time), on Wednesday,
January 12, 2005, at the McCord Museum, in the J. Armand Bombardier Theatre, 690
Sherbrooke Street West, Montreal, Canada for the following purposes:
1. to receive the consolidated financial statements of the Corporation for the
financial year ended August 31, 2004, and the Auditor's report thereon;
2. to elect Directors of the Corporation;
3. to appoint PricewaterhouseCoopers LLP as auditors and to authorize the
Audit Committee to fix their remuneration;
4. to approve the amendments to the Corporation's Stock Option Plan as set
forth in Schedules A and A-1 to the Management Proxy Circular enclosed
herewith;
5. to approve the Corporation's Deferred Share Unit Plan for the members of
the Board of Directors as set forth in Schedules B and B-1 to the
Management Proxy Circular enclosed herewith; and
6. to transact such further or other business as may properly come before the
Meeting or any adjournment or adjournments thereof.
Enclosed is a copy of the 2004 Annual Report of the Corporation including the
consolidated financial statements and the Auditor's Report thereon, together
with the Management Proxy Circular and a form of Proxy.
DATED at Vanier, Quebec, this 1st day of November, 2004.
BY ORDER OF THE BOARD OF DIRECTORS
/s/ Benoit Ringuette
----------------------------
Benoit Ringuette
Secretary
SHAREHOLDERS UNABLE TO ATTEND THE MEETING ARE REQUESTED TO COMPLETE THE ENCLOSED
PROXY FORM AND RETURN IT IN THE ENVELOPE PROVIDED. TO BE VALID, PROXIES MUST
REACH THE OFFICE OF CIBC MELLON TRUST COMPANY, 2001 UNIVERSITY STREET, SUITE
1600, MONTREAL, QUEBEC, CANADA, H3A 2A6, NO LATER THAN THE LAST DAY PRIOR TO THE
DATE OF THE MEETING OR ANY RECONVENING OF THE MEETING IN CASE OF ADJOURNMENT.
SHAREHOLDERS MAY ALSO HAVE THE PROXY FORM DELIVERED TO THE CHAIRMAN OF THE
MEETING PRIOR TO THE TIME OF VOTING ON THE DAY OF THE MEETING OR ANY ADJOURNMENT
THEREOF.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
MANAGEMENT PROXY CIRCULAR OF THE CORPORATION
FOR THE ANNUAL AND SPECIAL MEETING OF SHAREHOLDERS
THIS PROXY IS SOLICITED BY THE MANAGEMENT OF THE CORPORATION
The undersigned shareholder of EXFO ELECTRO-OPTICAL ENGINEERING INC. hereby
appoints (CHECK EITHER (A) or (B)):
[_] (A) Mr. Germain Lamonde of Cap-Rouge, Quebec, or failing him,
Mr. Pierre Plamondon of Quebec, Quebec;
[_] (B) _____________________________ of ____________________________________;
(Name) (Address)
as the representative of the undersigned to attend, act and vote on behalf of
the undersigned at the ANNUAL AND SPECIAL MEETING OF THE SHAREHOLDERS (THE
"MEETING") OF THE CORPORATION TO BE HELD AT THE MCCORD MUSEUM, IN THE J. ARMAND
BOMBARDIER THEATRE, 690 SHERBROOKE STREET WEST, MONTREAL, PROVINCE OF QUEBEC,
CANADA, ON WEDNESDAY, JANUARY 12, 2005, AT 10:00 O'CLOCK A.M. (EASTERN STANDARD
TIME) AND AT ANY ADJOURNMENTS OF SUCH MEETING.
THE UNDERSIGNED WISHES THAT ALL SHARES REPRESENTED BY THIS PROXY BE VOTED IN
ACCORDANCE WITH THE INSTRUCTIONS HEREINBELOW. ALL SHARES REPRESENTED BY THIS
PROXY WILL BE VOTED FOR, AGAINST OR BE THE SUBJECT OF ABSTENTIONS, AS SPECIFIED
BY THE SHAREHOLDER. HOWEVER, IN THE ABSENCE OF INSTRUCTIONS, THE SHARES
REPRESENTED BY PROXY WILL BE VOTED IN FAVOR OF EACH OF THE PROPOSALS SET FORTH
HEREIN.
(MARK WITH AN X)
To elect Germain Lamonde, Pierre Marcouiller, Guy
Marier, David A. Thompson, Andre Tremblay and Michael FOR [_]
Unger, whose cities of residence are indicated in the
Management Proxy Circular, as Directors of the ABSTENTION [_]
Corporation.
To appoint PricewaterhouseCoopers LLP as auditors and FOR [_]
to authorize the Audit Committee to fix their
remuneration. ABSTENTION [_]
To approve the amendments to the Corporation's Stock FOR [_]
Option Plan as set forth in Schedules A and A-1 to the
Management Proxy Circular. ABSTENTION [_]
To approve the Corporation's Deferred Share Unit Plan FOR [_]
for the members of the Board of Directors as set forth
in Schedules B and B-1 to the Management Proxy ABSTENTION [_]
Circular.
A DISCRETIONARY POWER IS HEREBY CONFERRED as to any amendment or change made to
the matters mentioned in the Notice of Meeting or as to such other matters as
may legally come before the Meeting. The Management of the Corporation is not
aware of any amendments, changes or other matters that may come before the
Meeting.
DATED this _____ day of _______.
* A SHAREHOLDER IS ENTITLED TO APPOINT,
TO ATTEND AND ACT FOR AND ON BEHALF OF ________________________________
SUCH SHAREHOLDER AT THE MEETING, A SIGNATURE OF SHAREHOLDER
PERSON OTHER THAN THE PERSON MENTIONED
IN (A) HEREIN ABOVE AND MAY DO SO BY
CHECKING (B) HEREINABOVE AND ADDING THE
NAME OF SUCH OTHER PERSON IN THE SPACE
RESERVED FOR SUCH PURPOSE. [ ]
name of shareholder
[ ]
THIS PROXY MUST BE SIGNED BY THE SHAREHOLDER OR HIS PROXYHOLDER AUTHORIZED IN
WRITING OR, IF THE SHAREHOLDER IS A CORPORATION, UNDER ITS CORPORATE SEAL, BY A
DULY AUTHORIZED OFFICER OR PROXYHOLDER OF THE CORPORATION. PLEASE REMEMBER TO
DATE AND SIGN THIS PROXY. IF THIS PROXY IS NOT DATED, IT WILL BE DEEMED TO BEAR
THE DATE OF ITS MAILING BY MANAGEMENT.
YOU ARE REFERRED TO THE MANAGEMENT PROXY CIRCULAR APPENDED.
FRANCAIS AU VERSO
E X F O
================================================================================
NOTICE OF ANNUAL AND SPECIAL
MEETING OF SHAREHOLDERS
AND
MANAGEMENT PROXY CIRCULAR
================================================================================
November 1, 2004
EXFO ELECTRO-OPTICAL ENGINEERING INC.
MANAGEMENT PROXY CIRCULAR
SOLICITATION OF PROXIES
THIS MANAGEMENT PROXY CIRCULAR IS PROVIDED IN CONNECTION WITH THE SOLICITATION
BY THE MANAGEMENT OF EXFO ELECTRO-OPTICAL ENGINEERING INC. (THE "CORPORATION" OR
"EXFO") OF PROXIES TO BE USED AT THE ANNUAL AND SPECIAL MEETING OF SHAREHOLDERS
(THE "MEETING") OF THE CORPORATION TO BE HELD AT THE TIME AND PLACE AND FOR THE
PURPOSES STATED IN THE ACCOMPANYING NOTICE OF MEETING AND AT ANY ADJOURNMENT
THEREOF. UNLESS OTHERWISE INDICATED, THE INFORMATION CONTAINED HEREIN IS GIVEN
AS OF NOVEMBER 1, 2004.
It is expected that the solicitation will be made primarily by mail but proxies
may also be solicited personally by officers, employees or agents of the
Corporation. The Corporation may also reimburse brokers and other persons
holding shares in their names, or in the names of nominees, for their costs
incurred in sending proxy material to principals and obtaining their proxies.
The cost of solicitation will be borne by the Corporation and is expected to be
nominal.
APPOINTMENT AND REVOCATION OF PROXIES AND ATTENDANCE OF BENEFICIAL SHAREHOLDERS
The persons named in the enclosed Form of Proxy (the "Form of Proxy") are
officers of the Corporation. A SHAREHOLDER DESIRING TO APPOINT SOME OTHER PERSON
(WHO NEED NOT BE A SHAREHOLDER) TO REPRESENT HIM OR HER AT THE MEETING MAY DO SO
BY INSERTING SUCH PERSON'S NAME IN THE BLANK SPACE PROVIDED IN THE FORM OF PROXY
AND CHECKING ITEM (B).
To be valid, proxies must be received at the Montreal, Canada office of CIBC
Mellon Trust Company, 2001 University Street, Suite 1600, Montreal, Quebec,
Canada, H3A 2A6, the transfer agent of the Corporation, no later than the close
of business on the last business day preceding the day of the Meeting or any
adjournment thereof, or proxies may be delivered to the Chairman of the Meeting
on the day of the Meeting or any adjournment thereof. A beneficial shareholder
who completes a Form of Proxy and who wishes to attend and vote at the Meeting
personally must appoint himself or herself proxy holder in the foregoing manner.
A proxy given pursuant to this solicitation may be revoked by instrument in
writing executed by the shareholder or by his or her attorney authorized in
writing if such instrument is deposited either at the registered office of the
Corporation to the attention of the Secretary no later than the close of
business on the last business day preceding the day of the Meeting or any
adjournment thereof or with the Chairman of the Meeting on the day of the
Meeting or any adjournment thereof.
VOTING OF PROXIES
The shares represented by proxies appointing the persons, or any one of them,
designated by Management thereon to represent the shareholder at the Meeting
will be voted in accordance with the instructions given by the shareholder.
UNLESS OTHERWISE INDICATED, THE VOTING RIGHTS ATTACHING TO THE SHARES
REPRESENTED BY A FORM OF PROXY WILL BE VOTED "FOR" IN RESPECT OF ALL THE
PROPOSALS DESCRIBED HEREIN.
1
The Form of Proxy confers discretionary authority upon the persons named therein
with respect to amendments or variations to matters identified in the
accompanying Notice of Meeting. As at the date hereof, Management is not aware
that any other matter is to be presented at the Meeting. If, however, other
matters properly come before the Meeting, the persons designated in the Form of
Proxy will vote thereon in accordance with their judgment pursuant to the
discretionary authority conferred by such proxy with respect to such matters.
VOTING SHARES AND PRINCIPAL HOLDERS THEREOF
As at November 1, 2004, 30,571,946 Subordinate Voting Shares and 37,900,000
Multiple Voting Shares were outstanding, being the only classes of shares
entitled to be voted at the Meeting. Each holder of Subordinate Voting Shares is
entitled to one vote and the holder of Multiple Voting Shares is entitled to 10
votes for each share registered in his or her name at the close of business on
November 22, 2004, being the date fixed by the Board of Directors for the
purpose of determining registered shareholders entitled to receive the
accompanying Notice of Meeting and to vote (the "Record Date"). A list of
shareholders entitled to vote as of the Record Date, showing the number of
shares held by each shareholder, shall be prepared within 10 days of the Record
Date. This list of shareholders will be available for inspection during normal
business hours at the Montreal, Canada office of CIBC Mellon Trust Company, the
transfer agent of the Corporation, 2001 University Street, Suite 1600, Montreal,
Quebec, Canada, H3A 2A6, and at the Meeting.
Unless otherwise indicated, the resolutions submitted to a vote at the Meeting
must be passed by a majority of the votes cast by the holders of Subordinate
Voting Shares and Multiple Voting Shares, as a single class, present at the
Meeting in person or by proxy and voting in respect of all resolutions to be
voted on by the shareholders of the Corporation.
To the knowledge of executive officers and directors of the Corporation, as of
November 1, 2004, the only persons who are beneficial owners or who exercise
control or direction, directly or indirectly, over shares carrying more than 10%
of the voting rights attaching to any class of shares of the Corporation are:
------------------------------------------------------------------------------------------------------------------------------
Percentage of Percentage of Voting
Percentage of Voting Number of Voting Rights Rights Attached to
Number of Rights attached to Multiple attached to all all Subordinate and
Subordinate all Subordinate Voting Multiple Voting Multiple Voting
Name of Shareholder Voting Shares Voting Shares Shares Shares Shares
------------------------------------------------------------------------------------------------------------------------------
Germain Lamonde 93,000 (1) 0.3% 37,900,000(2) 100% 55.5%
------------------------------------------------------------------------------------------------------------------------------
Kern Capital 4,658,000 (3) 15.2% - - 6.8 %
Management LLC
------------------------------------------------------------------------------------------------------------------------------
FMR Corporation 4,574,800 (4) 15.0% - - 6.7 %
------------------------------------------------------------------------------------------------------------------------------
---------------
(1) Mr. Lamonde exercises control over this number of Subordinate Voting Shares
through Placements Lamonde, SENC, a partnership controlled by Mr. Lamonde.
(2) Mr. Lamonde exercises control over this number of Multiple Voting Shares
through G. Lamonde Investissements Financiers inc., a company controlled by
Mr. Lamonde and through Fiducie Germain Lamonde, a family trust for the
benefit of Mr. Lamonde's family.
(3) Kern Capital Management LLC controls the voting rights attached to this
number of subordinate voting shares through relationships with several
clients and does not beneficially own directly this number of subordinate
voting shares.
(4) As of June 30, 2004, Fidelity Management and Research Company, a
wholly-owned subsidiary of FMR Corporation, is the beneficial owner of this
number of subordinate voting shares as a result of acting as investment
advisor to various investment companies.
2
ELECTRONIC DELIVERY
The Corporation has a voluntary program for e-mail notification to our
shareholders that documents which must be delivered pursuant to securities
legislation are available on EXFO's website. Every year, EXFO delivers
documentation to shareholders, such as this Management Proxy Circular and our
Annual Report that must be delivered to shareholders of a public company by law.
EXFO has made this process more convenient for its shareholders, as shareholders
who so wish, may be notified by e-mail when the Corporation's documentation is
posted in the "Investors" section on its website (www.exfo.com). Accordingly
such documentation will not be sent in paper form by mail. The Corporation
believes that electronic delivery will benefit the environment and reduce its
costs. Shareholders who do not consent to receive documentation by e-mail will
continue to receive such documentation by mail.
Registered shareholders can consent to electronic delivery by completing and
returning the consent form accompanying this Circular to CIBC Mellon Trust
Company. Unregistered shareholders (i.e. shares are held through a securities
broker, bank, trust company or other nominee) can consent to electronic delivery
by completing and returning the appropriate form received from the applicable
intermediary.
BUSINESS TO BE TRANSACTED AT THE MEETING
PRESENTATION OF THE FINANCIAL STATEMENTS
The consolidated financial statements of the Corporation for the financial year
ended August 31, 2004 and the Auditors' report thereon contained in EXFO's
Annual Report accompanying this Circular will be submitted to shareholders at
the Meeting but no vote with respect thereto is required or proposed to be
taken.
ELECTION OF THE DIRECTORS
According to the articles of the Corporation, the Board of Directors shall
consist of a minimum of 3 and a maximum of 12 directors. At the Meeting,
Management proposes the 6 persons named hereafter on page 6 as nominees for
election as directors to hold office until the next annual meeting or until the
office is otherwise vacated in accordance with the Corporation's by-laws.
Management does not anticipate that any of the nominees will be unable, or for
any reason whatsoever, be reluctant to fulfill their duties as directors. Should
this occur for any reason whatsoever before the election, the persons named in
the Form of Proxy reserve the right to vote for another nominee of their choice
unless the shareholder specified on the Form of Proxy to abstain from voting for
the election of the directors.
APPOINTMENT AND REMUNERATION OF AUDITORS
A firm of auditors is to be appointed by vote of the shareholders at the Meeting
to serve as auditors of the Corporation until the close of the next annual
meeting. The Audit Committee is to be authorized to fix the remuneration of the
auditors so appointed. The Board of Directors and Management, upon the advice of
the Audit Committee, recommend that PricewaterhouseCoopers LLP be re-appointed
as Auditors of the Corporation. The re-appointment of PricewaterhouseCoopers LLP
must be approved by a majority of the votes cast on the matter at the Meeting.
3
RESOLUTION FOR THE APPROVAL OF AMENDMENTS TO THE STOCK OPTION PLAN
The Corporation's Stock Option Plan is designed to increase the performance of
employees, senior management, officers and directors of the Corporation and its
subsidiaries and persons and companies providing ongoing management or
consulting services ("consultants") to the Corporation and its subsidiaries.
On October 26, 2004, the Board of Directors of the Corporation, on the
recommendation of outside consultants and the Human Resources Committee in
alignment with the practice in the industry and in the best interest of the
shareholders, authorized, subject to regulatory and shareholders' approvals,
certain amendments to the current Stock Option Plan, including the renaming of
the Stock Option Plan to Long Term Incentive Plan (the "Proposed Amendments").
Under the Proposed Amendments, Restricted Share Units ("RSU") are granted to
designated directors, officers, employees and consultants. The RSU are "phantom"
shares that rise and fall in value based on the value of the Corporation's
Subordinate Voting Shares, and are redeemed for actual Subordinate Voting Shares
or cash equivalent at the discretion of the Board of Directors of the
Corporation on the vesting dates established by the Board of Directors of the
Corporation at the time of grant in its sole discretion. Such Subordinate Voting
Shares issued by the Corporation will be issued from the pool of Subordinate
Voting Shares reserved for issuance pursuant to the Stock Option Plan, which
shall not exceed 10% of the total issued and outstanding voting shares.
The Proposed Amendments are meant to modify the existing Stock Option Plan of
the Corporation to offer, through combinations of equity-based incentive
programs, optimal alignment of the interest of management and employees of the
Corporation to that of its shareholders. The choice of amending the existing
Stock Option Plan was taken by the Board of Directors after an analysis of
various alternative equity-based plans. The Proposed Amendments were considered
to provide the best balance between alignment with shareholder interests,
protection against downside risk, share price volatility protection and employee
retention.
The full text of the Stock Option Plan including the Proposed Amendments is
appended hereto as Schedule A-1 to this Management Proxy Circular.
THE BOARD OF DIRECTORS RECOMMENDS THAT THE SHAREHOLDERS VOTE "FOR" THE ADOPTION
OF A RESOLUTION TO APPROVE THE PROPOSED AMENDMENTS. A COPY OF THE RESOLUTION IS
APPENDED HERETO AS SCHEDULE "A" TO THIS MANAGEMENT PROXY CIRCULAR. IN ORDER TO
ADOPT THE RESOLUTION APPROVING THE PROPOSED AMENDMENTS, AT LEAST A MAJORITY OF
THE VOTES CAST BY HOLDERS OF VOTING SHARES, PRESENT IN PERSON OR BY PROXY, MUST
BE VOTED IN FAVOR OF THE RESOLUTION. HOWEVER, IN ACCORDANCE WITH THE RULES OF
THE TORONTO STOCK EXCHANGE, CERTAIN PARTICIPANTS TO THE LONG TERM INCENTIVE PLAN
WILL NOT BE ENTITLED TO VOTE AT THE MEETING WITH RESPECT TO THE APPROVAL OF THE
PLAN. THEREFORE, TO THE BEST OF THE CORPORATION'S KNOWLEDGE, AT THE TIME THE
INFORMATION WAS PROVIDED, 37,900,000 MULTIPLE VOTING SHARES AND 236,704
SUBORDINATE VOTING SHARES OWNED BY INSIDERS OF THE CORPORATION WHO ARE
PARTICIPANTS TO THE NEW LONG TERM INCENTIVE PLAN AS WELL AS THEIR ASSOCIATES
WILL NOT BE COUNTED IN DETERMINING WHETHER OR NOT THE RESOLUTION IS ADOPTED.
UNLESS SPECIFIED IN THE ENCLOSED FORM OF PROXY THAT MULTIPLE VOTING SHARES AND
SUBORDINATE VOTING SHARES REPRESENTED BY THE FORM OF PROXY SHALL BE VOTED
AGAINST THIS RESOLUTION, THE PERSONS DESIGNATED IN THE ENCLOSED FORM OF PROXY
INTEND TO VOTE "FOR" THIS RESOLUTION.
4
RESOLUTION FOR THE APPROVAL OF THE DEFERRED SHARE UNIT PLAN
On October 26, 2004, the Board of Directors of the Corporation, on the
recommendation of outside consultants and the Human Resources Committee in
alignment with the practice in the industry, in the best interest of the
shareholders and in order to align more closely the interests of its
non-employee directors with those of its shareholders, the Corporation
authorized, subject to regulatory and shareholders' approvals, a Deferred Share
Unit Plan.
Under the Deferred Share Unit Plan, non-employee directors shall receive up to
100 % of their retainer fees in the form of Deferred Share Units ("DSUs"), each
of which has an initial value equal to the market value of a Subordinate Voting
Share at the time DSUs are credited to the directors. The value of a DSU, when
converted to Subordinate Voting Shares, is equivalent to the market value of a
Subordinate Voting Share at the time the conversion takes place. DUSs attract
dividends in the form of additional DSUs at the same rate as dividends on
Subordinate Voting Share. When a director ceases to be a member of the Board,
the DSUs are converted and paid in Subordinate Voting Shares purchased on the
open market or issued by the Corporation. Such Subordinate Voting Shares issued
by the Corporation will be issued from the same pool of Subordinate Voting
Shares reserved for issuance pursuant to the Stock Option Plan, which shall not
exceed 10% of the total issued and outstanding voting shares.
The full text of the Deferred Share Unit Plan is appended hereto as Schedule B-1
to this Management Proxy Circular.
THE BOARD OF DIRECTORS RECOMMENDS THAT THE SHAREHOLDERS VOTE "FOR" THE ADOPTION
OF A RESOLUTION TO APPROVE THE DEFERRED SHARE UNIT PLAN. A COPY OF THE
RESOLUTION IS APPENDED HERETO AS SCHEDULE "B" TO THIS MANAGEMENT PROXY CIRCULAR.
IN ORDER TO ADOPT THE RESOLUTION APPROVING THE DEFERRED SHARE UNIT PLAN, AT
LEAST A MAJORITY OF THE VOTES CAST BY HOLDERS OF VOTING SHARES, PRESENT IN
PERSON OR BY PROXY, MUST BE VOTED IN FAVOR OF THE RESOLUTION. HOWEVER, IN
ACCORDANCE WITH THE RULES OF THE TORONTO STOCK EXCHANGE, CERTAIN PARTICIPANTS TO
THE DEFERRED SHARE UNIT PLAN WILL NOT BE ENTITLED TO VOTE AT THE MEETING WITH
RESPECT TO THE APPROVAL OF THE PLAN. THEREFORE, TO THE BEST OF THE CORPORATION'S
KNOWLEDGE, AT THE TIME THE INFORMATION WAS PROVIDED, 14,750 SUBORDINATE VOTING
SHARES OWNED BY INSIDERS OF THE CORPORATION WHO ARE PARTICIPANTS TO THE DEFERRED
SHARE UNIT PLAN AS WELL AS THEIR ASSOCIATES WILL NOT BE COUNTED IN DETERMINING
WHETHER OR NOT THE RESOLUTION IS ADOPTED. UNLESS SPECIFIED IN THE ENCLOSED FORM
OF PROXY THAT MULTIPLE VOTING SHARES AND SUBORDINATE VOTING SHARES REPRESENTED
BY THE FORM OF PROXY SHALL BE VOTED AGAINST THIS RESOLUTION, THE PERSONS
DESIGNATED IN THE ENCLOSED FORM OF PROXY INTEND TO VOTE "FOR" THIS RESOLUTION.
NOMINEES FOR ELECTION AS DIRECTORS AND THEIR BENEFICIAL OWNERSHIP OF VOTING
SECURITIES
The following table and notes set out the name of each of the individuals whom
is proposed to be nominated at the Meeting for election as a director of the
Corporation, all other positions and offices with the Corporation and its
subsidiaries now held by each such individual, if any, the principal occupation
or employment of each such individual, their respective period of service as a
director and the approximate number of shares of the Corporation beneficially
owned by each such individual or over which each of them exercised control or
direction.
5
--------------------------------------------------------------------------------------------------------------------------------
Number of Number of
Name and Position or Office Principal Occupation City of Subordinate Multiple Voting
with the Corporation or Employment Residence Director Since Voting Shares Shares
--------------------------------------------------------------------------------------------------------------------------------
Germain Lamonde(1) Chairman of the Board, Cap-Rouge, September 1985 93,000 37,900,000
Chairman of the Board, President and Chief Quebec
President and Chief Executive Officer,
Executive Officer EXFO Electro-Optical
Engineering Inc.
--------------------------------------------------------------------------------------------------------------------------------
Pierre Marcouiller(2) (3) Chairman of the Board Magog, May 2000 5,000 -
Director and Chief Executive Quebec
Officer, Camoplast
Inc. (a supplier of
automotive and
recreational vehicle
parts)
--------------------------------------------------------------------------------------------------------------------------------
Guy Marier (2) (3) Executive Consultant Lakefield January 2004 1,000 -
Director Gore, Quebec
--------------------------------------------------------------------------------------------------------------------------------
Andre Tremblay(2) (3) President and Chief Outremont, May 2000 6,650 (4) -
Director Executive Officer, Quebec
Microcell
Telecommunications
Inc.
--------------------------------------------------------------------------------------------------------------------------------
Dr. David A. Thompson, Vice-President& Newton, June 2000 2,100 -
Ph.D.(3) Director, Hardware & North
Director Equipment Technology Carolina
Strategy, Corning
Cable Systems
--------------------------------------------------------------------------------------------------------------------------------
Michael Unger(2) (3) Executive Consultant Woodbridge, May 2000 - -
Lead Director Ontario
--------------------------------------------------------------------------------------------------------------------------------
---------------
(1) Mr. Lamonde exercises control over this number of Multiple Voting Shares
through G. Lamonde Investissements Financiers inc., a company controlled by
Mr. Lamonde and through Fiducie Germain Lamonde, a family trust for the
benefit of Mr. Lamonde's family. He exercises control over this number of
Subordinate Voting Shares through Placements Lamonde, SENC, a partnership
controlled by Mr. Lamonde.
(2) Member of the Audit Committee.
(3) Member of the Human Resources Committee.
(4) Mr. Tremblay exercises control over this number of Subordinate Voting
Shares through 9044-6451 Quebec inc. a company controlled by Mr. Tremblay.
The information as to Subordinate Voting Shares and Multiple Voting Shares
beneficially owned or over which the above-named individuals exercise control or
direction is not within the direct knowledge of the Corporation and has been
furnished by the respective individual.
COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS
In the financial year ended August 31, 2004, directors who are not employees of
the Corporation or any of its subsidiaries receive the level of compensation set
forth in the table below as annual compensation payable in the form of cash,
stock or stock options as chosen by the director. In addition, each director is
granted 12,500 stock options under the current Corporation's Stock Option Plan
(the "Stock Option Plan") as part of his annual compensation.
6
-----------------------------------------------------------------------------------------------------------------------
Annual Retainer for Directors: CDN$25,000 US$18,796
-----------------------------------------------------------------------------------------------------------------------
Annual Retainer for Committee Chairman: CDN$5,000 US$3,759
-----------------------------------------------------------------------------------------------------------------------
Annual Retainer for Committee Members: CDN$3,000 US$2,255
-----------------------------------------------------------------------------------------------------------------------
Fees for all Meetings Attended per day in Person: CDN$1,000 US$752
-----------------------------------------------------------------------------------------------------------------------
Fees for all Meetings Attended per day by Telephone: CDN$500 US$376
-----------------------------------------------------------------------------------------------------------------------
---------------
Note: The compensation information has been converted from Canadian dollars to
U.S. Dollars based upon an average foreign exchange rate of 1.3301 for 2004.
In the financial year ended August 31, 2004, the directors who were not
employees received the following compensation in the form indicated:
-----------------------------------------------------------------------------------------------------------------------
Annual
Compensation Annual Compensation Exercise Expiration Total Attendance
Paid in Cash Paid in Stock Price of Date of Fees Paid in
Name (US$)(1) Options (#) (2) Options (3) Options Cash (US$)(1)
-----------------------------------------------------------------------------------------------------------------------
Pierre Marcouiller (4) 23,307 12,500 US$3.51 Oct. 27, 2013 5,639
-----------------------------------------------------------------------------------------------------------------------
Guy Marier (5) 16,352 12,500 US$4.65 March 24, 2014 4,887
-----------------------------------------------------------------------------------------------------------------------
Dr. David A. Thompson (6) 21,051 12,500 US$3.51 Oct. 27, 2013 5,639
-----------------------------------------------------------------------------------------------------------------------
Andre Tremblay (7) 24,810 12,500 US$3.51 Oct. 27, 2013 6,766
-----------------------------------------------------------------------------------------------------------------------
Michael Unger (8) 24,810 12,500 US$3.51 Oct. 27, 2013 6,016
-----------------------------------------------------------------------------------------------------------------------
---------------
(1) The compensation information has been converted from Canadian dollars to
U.S. Dollars based upon an average foreign exchange rate of 1.3301 for
2004.
(2) Indicates the number of Subordinate Voting Shares underlying the options
granted under the Stock Option Plan.
(3) The exercise price of options is determined based on the highest of the
closing prices of the Subordinate Voting Shares on the Toronto Stock
Exchange and the NASDAQ National Market on the last trading day preceding
the grant date, using the noon buying rate of the Federal Reserve Bank of
New York on the grant date to convert the NASDAQ National Market closing
price to Canadian dollars, as required. These options vest at a rate of
12.5% after the first 6 months, 12.5% after 12 months and 25% annually
thereafter commencing on the second anniversary date of the grant.
(4) Member of the Audit Committee and the Human Resources Committee.
(5) Member of the Audit Committee and the Human Resources Committee.
(6) Member of the Human Resources Committee.
(7) Member of the Human Resources Committee and Chairman of the Audit
Committee.
(8) Member of the Audit Committee and Chairman of the Human Resources Committee
and Lead Director.
COMPENSATION OF NAMED EXECUTIVE OFFICERS
The table below shows compensation information during the three most recently
completed financial years for Mr. Germain Lamonde, the Chairman of the Board,
President and Chief Executive Officer of the Corporation, Mr. Pierre Plamondon,
the Vice-President Finance and Chief Financial Officer, the three other most
highly compensated executive officers of the Corporation and its subsidiaries
who were serving the Corporation at the end of the financial year, and two other
executive officers of the Corporation who would have been included within the
four most highly compensated executive officers
7
had they been in the employ of the Corporation, or a subsidiary, at the year end
(collectively, the "Named Executive Officers"). This information includes the US
dollar value of base salaries, bonus awards and long-term incentive plan
payments, the number of options granted, and other compensation, if any, whether
paid or deferred.
-------------------------------------------------------------------------------------------------------------------------------
Securities
Other Annual Under All Other
Name and Principal Financial Salary (1) Compensation Options(3) Compensation
Position Year ($) Bonus(2) ($) ($) (#) ($)
-------------------------------------------------------------------------------------------------------------------------------
Germain Lamonde, 2004 206,751 (US) 57,115 (US) - - -
President and Chief 275,000 (CDN) 75,969 (CDN))
Executive Officer
2003 185,848 (US) 25,247 (US) - 50,000 -
275,000 (CDN) 37,359 (CDN)
2002 174,758 (US) 21,329 (US) - 70,000 -
275,000 (CDN) 33,563 (CDN)
-------------------------------------------------------------------------------------------------------------------------------
Pierre Plamondon, 2004 135,328 (US) 17,451 (US) - - 1,429 (US)(4)
Vice-President Finance and 180,000 (CDN) 23,211 (CDN) 1,901(CDN)
Chief Financial Officer
2003 118,267 (US) 9,547 (US) - 25,000 866 (US)(4)
175,000 (CDN) 14,127 (CDN) 1,281 (CDN)
2002 95,323 (US) 5,817 (US) - 19,000 886 (US)(4)
150,000 (CDN) 9,153 (CDN) 1,394 (CDN)
-------------------------------------------------------------------------------------------------------------------------------
Juan-Felipe Gonzalez, 2004 231,597 (US) 563,867 (US) - - -
Vice-President, 308,047 (CDN) 750,000 (CDN)(5)
Global Telecom Sales
2003 163,896 (US) 7,500 (US) - 30,000 -
2002 158,193 (US) - - 30,000 -
-------------------------------------------------------------------------------------------------------------------------------
Stephen Bull 2004 112,773 (US) 12,437 (US) - - 16,221 (US)(6)
Vice-President Research & 150,000 (CDN) 16,543 (CDN) 21,576 (CDN)
Development
2003 81,098 (US) 8,138 (US) - 15,000 588 (US)(4)
120,000 (CDN) 12,042 (CDN) 871 (CDN)
2002 73,081 (US) 4,425 (US) - 17,930 577 (US)(4)
115,000 (CDN) 6,964 (CDN) 908 (CDN)
-------------------------------------------------------------------------------------------------------------------------------
Benoit Fleury 2004 112,773 (US)(7) 8,656 (US) - 15,000 15,036 (US)(8)
Vice-President, Protocol 150,000 (CDN) 11,421 (CDN) 20,000 (CDN)
Product Management
-------------------------------------------------------------------------------------------------------------------------------
NAMED EXECUTIVES NOT IN THE EMPLOY OF THE CORPORATION AT YEAR END
-------------------------------------------------------------------------------------------------------------------------------
James Stevens, 2004 175,000 (US)(9) - - - 4,016 (US)(4)
Vice-President Product
Management and Chief 2003 175,000 (US)(10) - - 12,000 4,624 (US)(4)
Technology Officer
(Protocol)
-------------------------------------------------------------------------------------------------------------------------------
John Holloran Jr., 2004 140,000 (US)(11) 10,385 (US) - - 22,996 (US)(12
Interim General Manager
and Special Projects 2003 140,000 (US)(13) 12,692 (US) - 9,000 4,114 (US)(4)
-------------------------------------------------------------------------------------------------------------------------------
8
---------------
(1) The compensation information for Canadian residents has been converted from
Canadian dollars to U.S. dollars based upon an average foreign exchange
rate of 1.3301 for 2004, 1.4797 for 2003 and 1.5736 for 2002. The currency
conversions cause these reported salaries to fluctuate from year-to-year
because of the conversion of Canadian dollars to U.S. dollars.
(2) A portion of the bonus amounts is paid in cash in the year for which they
are awarded and the balance is paid in cash in the year following the
financial year for which they are awarded.
(3) Indicates the number of Subordinate Voting Shares underlying the options
granted under the Stock Option Plan during the financial year indicated.
(4) Indicates the amount contributed by the Corporation during the financial
year indicated to the Deferred Profit Sharing Plan or the 401K plans, as
applicable, for the benefit of the Named Executive Officer. Mr. Lamonde is
not eligible to participate in the Deferred Profit Sharing Plan and Mr.
Gonzalez did not participate.
(5) Pursuant to the terms of his employment agreement, Mr. Juan-Felipe Gonzalez
did receive a cash payment of CDN$750,000 since he did not voluntarily
resign and was not dismissed with cause prior to September 2003. An amount
of CDN$500,000 was disbursed on October 17, 2003 and the remaining
CDN$250,000 was disbursed on January 25, 2004.
(6) Indicates the amount paid by the Corporation during the financial year
for relocation allowance (CDN$20,000) (US$15,036) plus the amount referred
in note 4 above (CDN$1,576) (US$1,185).
(7) This amount represents Mr. Fleury annual base salary. Since Mr. Fleury
joined the Corporation on February 16, 2004, the base salary paid to Mr.
Fleury for the financial year ended August 31, 2004 amounted to US$ 58,555
(CDN$ 77,884).
(8) Indicates the amount paid by the Corporation during the financial year for
relocation allowance (CDN$20,000) (US$15,036 ).
(9) This amount represents Mr. Stevens' base annual salary. Since he left the
Corporation on May 21, 2004, the base salary paid to him for the financial
year ended August 31, 2004 amounted to US$147,654.
(10) This amount represents Mr. Stevens' base annual salary. Since he joined
the Corporation on October 7, 2002, the base annual salary paid to him for
the financial year ended August 31, 2003 amounted to US$154,135.
(11) This amount represents Mr. Holloran's base annual salary. Since he left
the Corporation on December 31, 2003, the base annual salary paid to him
for the financial year ended August 31, 2004 amounted to US$55,346.
(12) Indicates the amount paid by the Corporation during the financial year
for severance package (US$21,231) plus the amount referred in note 4 above
(US$1,765).
(13) This amount represents Mr. Holloran's base annual salary. Since he joined
the Corporation on October 7, 2002, the base annual salary paid to him for
the financial year ended August 31, 2003 amounted to US$124,462.
Other than its Stock Option Plan, Restricted Stock Award Plan and Stock
Appreciation Rights Plan, which are described below in the "Report on Executive
Compensation by the Human Resources Committee - Long-Term Incentive
Compensation", the Corporation does not have any other formal long-term
incentive plans.
SHARE PLAN
In September 1998, prior to becoming a public company, the Corporation adopted a
share purchase plan for officers, directors and key employees, as amended in
April 2000. On April 3, 2000, the Corporation adopted a share plan which
replaced the 1998 share plan and on June 29, 2000, at the time of the
Corporation's initial public offering, all of the 707,264 Class "F" shares
issued under this plan to Officers, directors and key employees and fully paid
by them were converted into Subordinate Voting Shares. No additional shares will
be issued under this share plan. This share plan requires the Subordinate Voting
Shares previously acquired by participants to be held in trust by a trustee
until August 31, 2004, except for 249,977 Subordinate Voting Shares, of which
216,548 Subordinate Voting Shares were released on October 21, 2003, 6,020
Subordinate Voting Shares were released on December 23, 2003 and 27,409
Subordinate Voting Shares were released on January 20, 2004 and the remaining
Class "F" shares were released on August 31, 2004.
This share plan provides for the earlier release of these Subordinate Voting
Shares in the event the employment of a holder of Subordinate Voting Shares
terminates or upon the occurrence of a change of control and establishes
conditions pursuant to which the Subordinate Voting Shares of a holder under
this plan are to be sold by the trustee on the public market. For example, if
the employment is terminated before the end of the trust period for reasons
other than death, retirement, disability or without cause, the trustee will, on
instructions from the Corporation, sell the holder's Subordinate Voting Shares
on the public market, reimburse the lesser of the proceeds of sale or the
purchase price paid by the holder plus 8% interest annually, with the balance
being paid to the Corporation. As of August 31, 2004, all of the remaining
Subordinate Voting Shares that were held in trust under the plan were released.
The following table shows the breakdown, as of August 31, 2004, of the
Subordinate Voting Shares that have been allocated and released from trust to
the Named Executive Officers.
9
-------------------------------------------------------------------------------------------------------------------
Subordinate Voting Subordinate Voting Value of Subordinate Voting
Name of Executive Shares Allocated (1) Shares released from Shares released from Trust
Officers (#) Trust (#) (US$) (2)
-------------------------------------------------------------------------------------------------------------------
Germain Lamonde (3) - - -
-------------------------------------------------------------------------------------------------------------------
Juan-Felipe Gonzalez 51,452 51,452 US$140,841
-------------------------------------------------------------------------------------------------------------------
Pierre Plamondon (4) 32,927 32,927 US$161,513
-------------------------------------------------------------------------------------------------------------------
Stephen Bull 20,573 20,573 US$ 67,974
-------------------------------------------------------------------------------------------------------------------
Benoit Fleury (3) - - -
-------------------------------------------------------------------------------------------------------------------
NAMED EXECUTIVES NOT IN THE EMPLOY OF THE CORPORATION AT YEAR END
-------------------------------------------------------------------------------------------------------------------
John Holloran Jr. (3) - - -
-------------------------------------------------------------------------------------------------------------------
James Stevens (3) - - -
-------------------------------------------------------------------------------------------------------------------
---------------
(1) If the employment is terminated before the end of the trust period for
reasons other than death, retirement, disability or without cause, the
trustee will, on instructions from the Corporation, sell the holder's
Subordinate Voting Shares on the public market, reimburse the lesser of the
proceeds of sale or the purchase price paid by the holder plus 8% interest
annually, with the balance being paid to the Corporation.
(2) These values are calculated based on the closing price of the Subordinate
Voting Shares on the Toronto Stock Exchange on the release dates less the
purchase price paid by the Shareholder, using an average foreign exchange
rate of 1.3301. These values have not been, and may never be, realized. The
actual gains, if any, will depend on the value of the Subordinate Voting
Shares on the date of sale. There can be no assurance that these values
will be realized and will be entirely depending on the fluctuation of the
value of the Subordinate Voting Shares on the date of sale.
(3) These persons do not participate in the Share Plan.
(4) Mr. Plamondon exercises control over 6,874 of these Subordinate Voting
Shares through Fiducie Pierre Plamondon, a trust for the benefit of Mr.
Plamondon's family.
DEFERRED PROFIT SHARING PLAN
The Corporation maintains a deferred profit sharing plan for certain eligible
Canadian resident employees. Under this plan, the Corporation may contribute an
amount equal to 1% of each employee's gross salary to that employee's individual
deferred profit sharing plan to the extent that such employee contributes at
least 2% of his or her gross salary to his or her individual tax-deferred
registered retirement savings plan. In the financial year ended August 31, 2004,
the aggregate amount of contributions under the plan was US$106,000
(CDN$141,000). Mr. Germain Lamonde is not entitled to participate in this plan.
401K PLAN
The Corporation maintains a 401K plan for eligible United States resident
employees of its subsidiaries. Under this plan, the Corporation must contribute
an amount equivalent to 3% of an employee's current compensation, subject to
certain legislated maximum contribution limits. During the financial year ended
August 31, 2004, the Corporation recorded contributions totaling US$187,000.
OPTION GRANTS IN LAST FINANCIAL YEAR
The aggregate number of Subordinate Voting Shares covered by options granted
during the financial year ended August 31, 2004 was 536,500 at a weighted
average exercise price of US$3.94 (CDN$ 5.24) per Subordinate Voting Share. At
the end of financial year ended August 31, 2004, there were a total of 2,934,518
Subordinate Voting Shares covered by options granted and outstanding pursuant to
the Stock Option Plan having a weighted average exercise price of US$13.89
(CDN$20.89). The table below shows
10
information regarding stock option grants made to the Named Executive Officers
under the Stock Option Plan during the financial year ended August 31, 2004. See
"Report on Executive Compensation by the Human Resources Committee - Long-Term
Incentive Compensation" for a description of the Stock Option Plan.
During the financial year ended August 31, 2004, the following options were
granted to the following named Executive Officer:
------------------------------------------------------------------------------------------------------------------------------------
Percentage of Net Market Value of
Securities Total of Options Securities Underlying
Under Options Granted to Employees Exercise or Options on the Date
Granted (1) in Financial Year Base Price (2) of Grant
Name (#) (%) (US$/ Security) (US$/Security) (3) Expiration Date
------------------------------------------------------------------------------------------------------------------------------------
Benoit Fleury 15,000 2.80 % 4.65US 4.63 US March 24, 2014
------------------------------------------------------------------------------------------------------------------------------------
---------------
(1) Underlying securities: Subordinate Voting Shares.
(2) The exercise price of options granted is determined based on the highest of
the closing prices of the Subordinate Voting Shares on The Toronto Stock
Exchange and the NASDAQ National Market on the last trading day preceding
the grant date, using the noon buying rate of the Federal Reserve Bank of
New York on the grant date to convert the NASDAQ National Market closing
price to Canadian dollars, as required. These options These options vest at
a rate of 12.5% 6 months after the grant date, 12.5% 12 months after the
grant date, and 25% annually thereafter commencing on the second
anniversary date of the grant.
(3) Based on the closing price on the NASDAQ National Market on the date of
the grant.
AGGREGATED OPTION EXERCISES IN LAST FINANCIAL YEAR AND FINANCIAL YEAR END
OPTION VALUES
The following table summarizes, for each of the Named Executive Officers, the
number of stock options, if any, exercised during the financial year ended
August 31, 2004, the aggregate value realized upon exercise and the total number
of unexercised options, if any, held at August 31, 2004. Value realized upon
exercise is the difference between the market value of the underlying
Subordinate Voting Shares on the exercise date and the exercise or base price of
the option. The value of unexercised in-the-money options at financial year-end
is the difference between its exercise or base price and the market value of the
underlying Subordinate Voting Shares on August 31, 2004, which was US$4.36 per
share. These values, unlike the amounts set forth in the column "Aggregate Value
Realized," have not been, and may never be, realized. The underlying options
have not been, and may never be exercised, and actual gains, if any, on exercise
will depend on the value of the Subordinate Voting Shares on the date of
exercise. There can be no assurance that these values will be realized.
Unexercisable options are those that have been held for less than the time
required for vesting. See "Report on Executive Compensation by the Human
Resources Committee - Long-Term Incentive Compensation."
------------------------------------------------------------------------------------------------------------------------------
VALUE OF UNEXERCISED
UNEXERCISED OPTIONS "IN-THE-MONEY" OPTIONS AT
AGGREGATE AT AUGUST 31, 2004 AUGUST 31, 2004 (2) (3)
SECURITIES VALUE -------------------------------- ------------------------------------
ACQUIRED ON REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
NAME EXERCISE (#) (US$) (1) (#) (#) (US$) (US$)
------------------------------------------------------------------------------------------------------------------------------
Germain Lamonde - - 76,712 73,770 34,750 104,250
------------------------------------------------------------------------------------------------------------------------------
Juan-Felipe Gonzalez 7,500 19,256 56,123 48,907 - 62,550
------------------------------------------------------------------------------------------------------------------------------
Pierre Plamondon - - 42,630 34,310 17,375 52,125
------------------------------------------------------------------------------------------------------------------------------
Stephen Bull - - 18,098 20,732 10,425 31,275
------------------------------------------------------------------------------------------------------------------------------
Benoit Fleury - - - 15,000 0 0
------------------------------------------------------------------------------------------------------------------------------
11
NAMED EXECUTIVES NOT IN THE EMPLOY OF THE CORPORATION AT YEAR END
------------------------------------------------------------------------------------------------------------------------------
JAMES STEVENS 3,000 4,410 Cancelled (4) Cancelled (4) - -
------------------------------------------------------------------------------------------------------------------------------
JOHN H. HOLLORAN 2,250 3,150 Cancelled (4) Cancelled (4) - -
------------------------------------------------------------------------------------------------------------------------------
---------------
(1) The aggregate value realized is equivalent to the difference between the
market value of the securities underlying the options at exercise and the
exercise price of the options. This value, as the case maybe, has been
converted from Canadian dollars to U.S. Dollars based upon the average
foreign exchange rate on the day of the exercise.
(2) "In-the-money" options are options for which the market value of the
underlying securities is higher than the price at which such securities may
be bought from the Corporation.
(3) The value of unexercisable "in-the-money" options is calculated using the
highest of the closing prices of the Subordinate Voting Shares on The
Toronto Stock Exchange and on the NASDAQ National Market on August 31, 2004
using the noon buying rate of the Federal Reserve Bank of New York to
convert the NASDAQ National Market closing price to Canadian dollars, as
required, less the exercise price of "in-the-money" options.
(4) In accordance with the terms of the Stock Option Plan, unexercised options
that had been attributed to these persons were cancelled thirty days after
their termination dates.
TERMINATION OF EMPLOYMENT, CHANGE IN RESPONSIBILITIES AND EMPLOYMENT CONTRACTS
The Corporation has an employment agreement with Mr. Germain Lamonde. The
agreement is for an indeterminate period and the salary is reviewed annually. In
the event of the termination of Mr. Lamonde's employment without cause, Mr.
Lamonde will be entitled to severance payments (in no case exceeding 24 months
of remuneration) and the vesting of all stock options. In addition, in the event
that Mr. Lamonde's employment is terminated following a merger or an acquisition
by a third party of substantially all of the Corporation's assets or of the
majority of its share capital or if Mr. Lamonde voluntarily resigns, he will be
entitled to the vesting of all stock options.
The Corporation also has employment agreements with Mr. Juan-Felipe Gonzalez,
Mr. Pierre Plamondon, Mr. Stephen Bull and Mr. Benoit Fleury.
The agreement with Mr. Gonzalez provided for Mr. Gonzalez's employment as
Vice-President Global Telecom Sales. In the event Mr. Gonzalez's employment
terminates for any reason whatsoever and he is unable to accept new employment
due to his non-competition obligations to the Corporation, Mr. Gonzalez may
receive compensation for a period of 18 months following the date of termination
in amounts varying from 5% to 50% of his base monthly salary at the time of
termination depending on the cause of the termination. The employment agreement
is for an indeterminate period and salary and bonuses are reviewed annually.
The Corporation has an employment agreement with Mr. Pierre Plamondon, the
Corporation's Vice President, Finance and Chief Financial Officer. The agreement
is for an indeterminate period and the salary is reviewed annually. In the event
of termination of Mr. Plamondon's employment without cause, Mr. Plamondon will
be entitled to severance payments (in no case exceeding 18 months of the current
base salary). In addition, in the event Mr. Plamondon's employment is terminated
following a merger or an acquisition by a third party of substantially all of
the Corporation assets or of the majority of its share capital, he will be
entitled to the immediate vesting of all stock options.
The Corporation has an employment agreement with Mr. Stephen Bull, the
Corporation's Vice President, Research & Development. The agreement is for an
indeterminate period and the salary is reviewed annually. In the event of
termination of Mr. Bull's employment without cause, Mr. Bull will be entitled to
severance payments (in no case exceeding 18 months of the current base salary).
In addition, in the event Mr. Bull's employment is terminated following a merger
or an acquisition by a third party of substantially all of the Corporation
assets or of the majority of its share capital, he will be entitled to the
immediate vesting of all stock options.
12
The Corporation has an employment agreement with Mr. Benoit Fleury, the
Corporation's Vice President, Protocol Product Management. The agreement is for
an indeterminate period and the salary is reviewed annually. In the event of
termination of Mr. Fleury's employment without cause, Mr. Fleury's will be
entitled to severance payments (in no case exceeding 18 months of the current
base salary). In addition, in the event Mr. Fleury's employment is terminated
following a merger or an acquisition by a third party of substantially all of
the Corporation assets or of the majority of its share capital, he will be
entitled to the immediate vesting of all stock options.
REPORT ON EXECUTIVE COMPENSATION BY THE HUMAN RESOURCES COMMITTEE
MEMBERS OF THE HUMAN RESOURCES COMMITTEE
During the financial year ended August 31, 2004, the Human Resources Committee
was composed of Michael Unger, as Chairman, Pierre Marcouiller, David A.
Thompson , Andre Tremblay and Guy Marier since January 7, 2004, none of whom
were officers or employees, or former officers or employees, of the Corporation
or its subsidiaries.
HUMAN RESOURCES COMMITTEE MANDATE
The Human Resources Committee is a committee of the Board of Directors. It is
responsible for overseeing the assessment and the performance, and establishing
the annual compensation of all the Corporation's executive officers, including
the President and Chief Executive Officer. This Committee also reviews and
submits to the Board the salary structure and the short-term and long-term
incentive compensation programs for all employees of the Corporation. Though the
Committee is responsible for the review and approval of the employees that will
receive options to purchase shares of the Corporation, in accordance with
policies established by the Board and the terms of the Stock Option Plan, these
functions have been shared by the Board of Directors and the Human Resources
Committee during the period from September 1, 2003 to August 31, 2004. The
remuneration to be paid by the Corporation to its Directors is recommended to
the Board by the Human Resources Committee.
Since September 1, 2003, the Human Resources Committee held 3 meetings prior to
November 1 2004, which were attended by all the members of the Committee, except
Mr. Thompson who was absent at the last meeting.
COMPENSATION OF CHIEF EXECUTIVE OFFICER
In establishing Mr. Lamonde's salary for the year ending August 31, 2001, the
Corporation relied on a study completed by an independent consulting firm. Such
study indicated average salaries and bonuses, median salaries and bonuses and
maximum salaries and bonuses paid to chief executive officers by Canadian and
American computer hardware and software companies as well as by a specific group
of companies active in the fiber optics industry identified by the Corporation
that it considers to be the best available comparisons. It was decided that Mr.
Lamonde's salary and bonus reflected the median of Canadian computer hardware
and software companies and of the specific group of companies in fiber optics
identified by the Corporation. In financial year ended August 31, 2004, Mr.
Lamonde's salary was not adjusted.
In the financial year ended August 31, 2004, the bonus portion of Mr. Lamonde's
salary was tied to the financial and strategic objectives of the Corporation
based on the following factors: sales, earnings, gross margin, and customer
satisfaction (quality and production) and departmental or divisional and
personal objectives. Mr. Lamonde's bonus is payable in the same proportion at
which the Corporation attains such objectives. When the objectives are exceeded,
the bonus is higher; when objectives are not met, the bonus is lower.
13
SHORT-TERM INCENTIVE COMPENSATION
The short-term incentive plan offers bonuses tied to the Corporation's financial
performance and the achievement of strategic corporate and business unit
objectives established on a yearly basis.
In the case of the Named Executive Officers eligible for incentive bonuses in
the year ended August 31, 2004, such bonuses constituted a certain percentage of
base salary which is tied to the achievement of the financial and strategic
objectives of the Corporation based on the following factors: sales, gross
margin, earnings and customer satisfaction (quality and production), and
departmental or divisional and personal objectives. When such objectives are
exceeded, bonuses are higher; when objectives are not met, the incentive bonuses
are lower.
LONG-TERM INCENTIVE COMPENSATION
STOCK OPTION PLAN
The principal component of the long-term incentive compensation offered by the
Corporation is made up of the Stock Option Plan for directors, officers,
employees and consultants of the Corporation and its subsidiaries.
Introduced in May 2000, the Stock Option Plan is designed to motivate directors,
officers, employees and consultants to share interest with the Corporation's
shareholders over the long-term. It is subject to Human Resources Committee
review to ensure maintenance of its market competitiveness. The Board has full
and complete authority to interpret the Plan and to establish the rules and
regulations applying to it and to make all other determinations it deems
necessary or useful for the administration of the Plan, provided that such
interpretations, rules, regulations and determinations are consistent with the
rules of all stock exchanges on which the securities of the Corporation are then
traded and with all relevant securities legislation.
The Stock Option Plan provides for the issuance of options to directors,
officers, employees and consultants to purchase Subordinate Voting Shares. The
Board of Directors designates the recipients of options and determines the
number of Subordinate Voting Shares covered by each option, the date of vesting,
the expiry date and any other conditions relating to these options, in each case
in accordance with the applicable legislation of the securities regulatory
authorities. During the financial year ended August 31, 2004, options were
granted based on merit.
The exercise price of the options is determined by the Board of Directors at the
time of granting the options, subject to compliance with the rules of all stock
exchanges on which the Subordinate Voting Shares are listed and with all
relevant securities legislation. In any event, the price at which the
Subordinate Voting Shares may be purchased may not be lower than the highest of
the closing prices of the Subordinate Voting Shares on The Toronto Stock
Exchange and the NASDAQ National Market on the last trading day preceding the
grant date, using the noon buying rate of the Federal Reserve Bank of New York
on the grant date to convert the NASDAQ National Market closing price to
Canadian dollars. Any option issued is non-transferable.
The maximum number of Subordinate Voting Shares that are issuable under the Plan
shall not exceed 6,306,153 Subordinate Voting Shares, which represents 9.21% of
the Corporation's issued and outstanding share capital as of November 1, 2004.
The maximum number of Subordinate Voting Shares that may be granted to any one
individual shall not exceed 5% of the number of outstanding Subordinate Voting
Shares.
14
Some options granted to Directors vest on the first anniversary date of their
grant. Some options granted in the financial year ended August 31, 2004 vest at
a rate of 12.5% 6 months after the date of grant, 12.5% 12 months after the date
of grant and 25% annually thereafter commencing on the second anniversary date
of the grant in October 2005. Otherwise all options vest a rate of 25% annually
commencing on the first anniversary date of the grant. All options may be
exercised in whole or in part once vested. All of the options that are granted
under the Plan must be exercised within a maximum period of 10 years following
the date of their grant or they will be forfeited.
Any option granted pursuant to the Stock Option Plan will lapse (i) immediately
upon the termination of the relationship with the Corporation or one of its
subsidiaries for a good and sufficient cause for employees or officers or at the
date on which an employee or an officer resigns or leaves his employment with
the Corporation or one of its subsidiaries (or within 30 days if the holder's
employment is terminated for reasons not related to cause); and (ii) 30 days
after a Director ceases to be a member of the Board of Directors of the
Corporation or one of its subsidiaries. In the event of retirement or
disability, any option held by an employee lapses 30 days after the date of any
such disability or retirement. In the event of death, any option held by the
optionee lapses 6 months after the date of death.
The following table summarizes information about stock options granted to the
members of the Board of Directors, and to Management and corporate officers of
the Corporation and its subsidiaries as at August 31, 2004:
--------------------------------------------------------------------------------------------------------------------
Number of % of Issued and Weighted Average Exercise
Options Outstanding Options Price ($US/Security)
--------------------------------------------------------------------------------------------------------------------
President and CEO (one individual) 150,482 5.13% 9.91
--------------------------------------------------------------------------------------------------------------------
Board of Directors (five individuals) 194,375 6.62% 6.23
--------------------------------------------------------------------------------------------------------------------
Management and corporate officers 315,300 10.74% 15.03
(seven individuals)
--------------------------------------------------------------------------------------------------------------------
RESTRICTED STOCK AWARD PLAN
The EXFO Electrical-Optical Engineering Restricted Stock Award Plan (the "RSAP")
was established to provide a means through which employees of EXFO Burleigh
Products Group Inc. can be granted awards of restricted shares ("Restricted
Shares") of Subordinate Voting Shares to promote retention and foster identity
of interest between stockholders and employees of EXFO Burleigh Products Group
Inc.
The effective date of the RSAP is December 20, 2000. The expiration date of the
RSAP is the business day next following the final grant of Restricted Shares
under the RSAP, which was December 20, 2000. However, the administration of the
RSAP shall continue until all awards of Restricted Shares have been forfeited or
settled. The aggregate number of shares subject to the RSAP is 360,000. Stock
awards granted under the RSAP vest over a 4 year period, with 25% vesting on an
annual basis commencing on the first anniversary of the date of grant. The Human
Resources Committee administers the RSAP.
Awards of Restricted Shares are subject to forfeiture and restrictions on
transfer until the Restricted Shares become vested at which point a stock
certificate will be issued to a participant with respect to the number of vested
shares, which are then freely transferable. Restricted Shares become vested,
subject to a participant's continued employment with the Corporation or its
affiliates, on each of the first four anniversaries of the date of grant of an
award of Restricted Shares.
Upon a participant's termination of employment with the Corporation or any of
its affiliates due to the participant's death, disability or retirement on or
after age 60, the participant's award of restricted shares
15
becomes fully vested and is no longer subject to forfeiture. However, the
transfer restrictions remain in place until the occurrence of the vesting dates
originally contemplated by the award.
Upon the voluntary resignation of a participant, the termination of a
participant's employment for cause, the termination of a participant who is not
designated a member of EXFO Burleigh Products Group Inc. "Management Team"
without cause prior to a change in control of the Corporation or a termination
without cause of a participant who is designated a member of EXFO Burleigh
Products Group Inc. Management Team that is initiated by EXFO Burleigh Products
Group Inc. prior to a change in control of the Corporation, the unvested portion
of the participant's award of Restricted Shares will be forfeited. However the
RSAP provides discretion to the Human Resources Committee in the application of
the forfeiture provisions where a change in circumstances renders such action
appropriate. During the financial year ended August 31, 2004, EXFO Burleigh
Products Group Inc. was required to lay off participants as a result of
restructuring due to a sharp downturn in it's market. The Human Resources
Committee decided that the awards of RSAP participants affected by the lay-offs
would not be subject to forfeiture, though the transfer restrictions would
remain in place until the occurrence of the vesting dates originally
contemplated by the award.
Upon the termination without cause of a participant who is designated a member
of EXFO Burleigh Products Group Inc. Management Team that is initiated by the
Corporation or a termination of a participant's employment without cause
following a change in control of the Corporation, a participant's award of
Restricted Stock will become fully vested and all restrictions will lapse.
In the event of a change in control, the committee administering the RSAP may in
its discretion remove restrictions on Restricted Shares or provide for the
cancellation of awards in exchange for payment in respect of the Restricted
Shares subject to an award.
STOCK APPRECIATION RIGHTS PLAN
On August 4, 2001, the Corporation established a Stock Appreciation Rights Plan
("SAR Plan") for the benefit of certain employees residing in countries where
the granting of options under the Stock Option Plan is not feasible in the
opinion of the Corporation. The Board has full and complete authority to
interpret the SAR Plan and to establish the rules and regulations applying to it
and to make all other determinations it deems necessary or useful for the
administration of the SAR Plan.
Under the SAR Plan, eligible employees are entitled to receive a cash amount
equivalent to the difference between the market price of the Subordinate Voting
Shares on the date of exercise and the exercise price determined on the date of
grant. No Subordinate Voting Shares are issuable under the SAR Plan.
The Board of Directors has delegated to Management the task of designating the
recipients of stock appreciation rights, the date of vesting, the expiry date
and other conditions. Under the terms of the SAR Plan, the exercise price of the
stock appreciation rights may not be lower than the highest of the closing
prices of the Subordinate Voting Shares on The Toronto Stock Exchange and on the
NASDAQ National Market on the last trading day preceding the grant date, using
the noon buying rate of the Federal Reserve Bank of New York on the grant date
to convert the NASDAQ National Market closing price to Canadian dollars. Stock
appreciation rights are non-transferable.
The stock appreciation rights vest over a four-year period, with 25% vesting
annually commencing on the first anniversary date of the date of grant. Once
vested, stock appreciation rights may be exercised between the second and the
fifteenth business day following each release of the Corporation's quarterly
financial results. All of the stock appreciation rights that are granted under
the SAR Plan may be exercised within a maximum period of 10 years following the
date of their grant. Any stock appreciation rights granted under the SAR Plan
will lapse immediately upon the termination of the relationship with
16
the Corporation or one of its subsidiaries for a good and sufficient cause or at
the date on which an employee resigns or leaves his employment with the
Corporation or one of its subsidiaries (or within 30 days if the holder is
dismissed without cause). In the event of retirement or disability, any stock
appreciation right held by an employee lapses 30 days after the date of any such
disability or retirement. In the event of death, any stock appreciation right
lapses 6 months after the date of death.
PROPOSED AMENDMENTS TO THE STOCK OPTION PLAN
On October 26, 2004, the Board of Directors of the Corporation, on the
recommendation of outside consultants and the Human Resources Committee in
alignment with the practice in the industry and in the best interest of the
shareholders, authorized, subject to regulatory and shareholders' approvals,
certain amendments of the current Stock Option Plan, including the renaming of
the Stock Option Plan to Long Term Incentive Plan (the "Proposed Amendments").
If approved by shareholders at this Meeting, by the TSX and by the necessary
securities commissions, the Proposed Amendments will become effective as of
January 12, 2005.
Under the Proposed Amendments, Restricted Share Units ("RSU") are granted to
designated directors, officers, employees and consultants. The RSU are "phantom"
shares that rise and fall in value based on the value of the Corporation's
Subordinate Voting Shares and are redeemed for actual Subordinate Voting Shares
or cash equivalent at the discretion of the Board of Directors of the
Corporation on the vesting dates established by the Board of Directors of the
Corporation at the time of grant in its sole discretion. Such Subordinate Voting
Shares issued by the Corporation will be issued from the pool of Subordinate
Voting Shares reserved for issuance pursuant to the Stock Option Plan, which
shall not exceed 10% of the total issued and outstanding voting shares.
The Proposed Amendments are meant to modify the existing Stock Option Plan of
the Corporation to offer, through combinations of equity-based incentive
programs, optimal alignment of the interest of management and employees of the
Corporation to that of its shareholders. The choice of amending the existing
Stock Option Plan was taken by the Board of Directors after an analysis of
various alternative equity-based plans. The Proposed Amendments were considered
to provide the best balance between alignment with shareholder interests,
protection against downside risk, share price volatility protection and employee
retention.
PROPOSED DEFERRED SHARE UNIT PLAN
On October 26, 2004, the Board of Directors of the Corporation, on the
recommendation of outside consultants and the Human Resources Committee in
alignment with the practice in the industry and in the best interest of the
shareholders and in order to align more closely the interests of its
non-employee directors with those of its shareholders, the Corporation
authorized, subject to regulatory and shareholders' approvals, a Deferred Share
Unit Plan.
If approved by shareholders at this Meeting, by the Toronto Stock Exchange and
by the necessary securities commissions, the Deferred Share Unit Plan will
become effective as of January 12, 2005.
Under the Deferred Share Unit Plan, non-employee directors shall receive up to
100 % of their retainer fees in the form of Deferred Share Units ("DSUs"), each
of which has an initial value equal to the market value of a Subordinate Voting
Share at the time DSUs are credited to the directors. The value of a DSU, when
converted to Subordinate Voting Shares, is equivalent to the market value of a
Subordinate Voting Share at the time the conversion takes place. DUSs attract
dividends in the form of additional DSUs at the same rate as dividends on
Subordinate Voting Share. When a director ceases to be a member of the Board,
the DSUs are either converted and paid in Subordinate Voting Shares purchased on
the open
17
market or issued by the Corporation. Such Subordinate Voting Shares issued by
the Corporation will be issued from the same pool of Subordinate Voting Shares
reserved for issuance pursuant to the Stock Option Plan, which shall not exceed
10% of the total issued and outstanding voting shares.
COMPENSATION PLAN CONTROL AND REVIEW
As a general practice, the Corporation's relative position in terms of
compensation levels is determined annually through studies performed by
independent consulting firms using a selected reference market of comparable
companies. In addition, internal pay equity studies are a key factor to complete
the compensation review process and indicate where necessary adjustments may be
required. During the fiscal year ended August 31, 2004, this practice
recommenced and certain salary adjustments that became necessary.
CONCLUSION
By way of application of the Corporation's executive compensation policy, an
important part of executive compensation is linked to corporate performance and
long-term value creation. The Human Resources Committee continuously reviews
executive compensation programs to ensure that they maintain their
competitiveness and continue to focus on the Corporation's objectives, values
and business strategies.
Depending on specific circumstances, the Committee may also recommend employment
terms and conditions that deviate from the policies and the execution by the
Corporation or its subsidiaries of employment contracts on a case-by-case basis.
By the Human Resources Committee:
Michael Unger, Chairman
Pierre Marcouiller
Guy Marier
David A. Thompson
Andre Tremblay
18
PERFORMANCE GRAPH
The performance graph presented below compares the cumulative total shareholder
return of a $100 investment in the Subordinate Voting Shares and the cumulative
total return of the S&P TSX Stock Index for the period commencing June 30, 2000,
the date EXFO's Subordinate Voting Shares commenced trading, and ending August
31, 2004.
THE CORPORATION'S STOCK PERFORMANCE
(JUNE 30, 2000 TO AUGUST 31, 2004)
[LINE CHART OMITTED]
DIRECTORS' AND OFFICERS' LIABILITY INSURANCE
The Corporation maintains insurance protection against liability incurred by its
officers and directors as well as those of its subsidiaries in the performance
of their duties. The entire premium, amounting to US$ 245,000 from September 30,
2004 to September 30, 2005, is paid by the Corporation. The aggregate limit of
liability in respect of any and all claims is US$10 million per year. The policy
provides for the indemnification of directors and officers in the case of claims
for which the Corporation has not indemnified or is not permitted by law to
indemnify them, and for the reimbursement of the Corporation, subject to a
deductible of US$100,000, except for security claims where the deductible is
US$500,000.
19
REPORT ON CORPORATE GOVERNANCE PRACTICES
The Toronto Stock Exchange requires that issuers listed on The Toronto Stock
Exchange provide annual disclosure on their corporate governance practices
through a Statement of Corporate Governance Practices. The Corporation's
disclosure of its corporate governance practices is set out in matrix form and
attached to this Management Proxy Circular as Schedule C.
ADDITIONAL INFORMATION
The Corporation shall provide to any person or company, upon request to the
Secretary of the Corporation, at 400 Godin Avenue, Vanier, Quebec, Canada, G1M
2K2.
(a) one copy of the Form 20-F of the Corporation filed with the Securities and
Exchange Commission (the "SEC") in the United States pursuant to the
SECURITIES EXCHANGE ACT OF 1934, and with securities commissions or
similar authorities;
(b) one copy of the comparative financial statements of the Corporation for
its most recently completed financial year and the Auditors report
thereon, included in the Annual Report of the Corporation, and one copy of
any interim financial statements of the Corporation subsequent to the
financial statements for its most recently completed financial year;
(c) one copy of this Management Proxy Circular.
DIRECTORS' APPROVAL
The contents and the sending of this Management Proxy Circular have been
approved by the Directors of the Corporation.
DATED at Vanier, Quebec, Canada, this 1st day of November, 2004.
/s/ Benoit Ringuette
--------------------------
Benoit Ringuette
Corporate Secretary
EXFO ELECTRO-OPTICAL ENGINEERING INC.
400 Godin Avenue
Vanier, Quebec, Canada, G1M 2K2
20
EXFO ELECTRO-OPTICAL ENGINEERING INC.
SCHEDULE A
BE IT RESOLVED AS A RESOLUTION OF THE SHAREHOLDERS THAT:
1. The proposed amendments to the existing Stock Option Plan of the
Corporation, the full text of which is attached as Schedule "A-1" to
the Management Proxy Circular dated November 1, 2004, is hereby
authorized and approved, subject to the Corporation obtaining all
required approvals from the Toronto Stock Exchange and other regulatory
authorities;
2. Any officer or director of the Corporation be and is hereby authorized
and directed, for and on behalf of the Corporation, to execute and
deliver all such documents and to do all such acts and things as may be
deemed requisite or desirable as such director or officer may determine
in consultation with the Toronto Stock Exchange, NASDAQ National Market
and other regulatory authorities for the carrying out of the foregoing
provisions of this resolution; and
3. Any director or officer of the Corporation be, and he is hereby
authorized to do all acts and things and to execute and deliver all
documents required, as in the opinion of such director or officer may
be necessary or appropriate in order to give effect to this resolution.
21
EXFO ELECTRO-OPTICAL ENGINEERING INC.
SCHEDULE A-1
PROPOSED AMENDMENTS TO THE STOCK OPTION PLAN
LONG TERM INCENTIVE PLAN
1. PURPOSE OF THE PLAN
1.1 The purpose of the long-term incentive plan (the "PLAN") for directors,
executive officers, employees and other persons or companies providing
ongoing management or consulting services (the "CONSULTANTS") to EXFO
Electro-Optical Engineering Inc. (the "CORPORATION") or to any of the
Subsidiaries of the Corporation is to secure for the Corporation and
its shareholders the benefit of an incentive to partake in share
ownership by directors, executive officers and employees of the
Corporation and its Subsidiaries, as the case may be, and by certain
Consultants who provide services on a continuous basis. For the
purposes of the Plan, "SUBSIDIARIES" shall mean (i) any legal entity of
which the Corporation is the holder or the beneficiary, at the time of
the granting of the option or RSUs, directly or indirectly, otherwise
than by way of security only, of securities to which are attached over
50% of the votes enabling it to elect the majority of the directors of
such entity as well as any subsidiary of such legal entity and (ii) any
legal entity in which the Corporation or a subsidiary of the
Corporation holds at least 50% of the voting rights or in which it has
a majority interest and of which the Corporation or a subsidiary of the
Corporation manages the operations.
2. DEFINITIONS
For the purposes of this Plan, the following terms shall have the
following meanings:
"Award" means the RSUs granted to an Eligible Participant under the
Plan on an Award Date, evidenced by an Award Agreement and subject to
the terms and conditions of the Plan and the Award Agreement;
"Award Agreement" means an agreement, substantially in the form of the
agreement set out in Schedule 2 to this Plan, entered into by an
Eligible Participant and the Corporation pursuant to which an Award is
granted to the Eligible Participant in accordance with the Plan, and
containing such additional terms and conditions not inconsistent with
the Plan as the Board shall deem desirable;
"Award Date" means the date on which an Award is granted, which date
may be on or, if determined by the Board at the time of grant, after
the date that the Board resolves to grant the Award;
"Board" means the board of directors of the Corporation;
"Change of Control" shall have the meaning as set forth in Section 7;
"Committee" means the Human Resources Committee composed solely of
non-employee members or any other committee composed solely of
non-employee members constituted from time to time at the Board's
discretion to administrate the Plan;
22
"Continuing Directors" shall have the meaning as set forth in Section
7.2;
"Consultants" means persons or companies providing ongoing management
or consulting services to the Corporation;
"Corporation" means EXFO Electro-Optical Engineering Inc.;
"DSU" means Deferred Share Units that may be granted from time to time
to non employee Directors of the Corporation pursuant to the provisions
of a Deferred Share Unit Plan for the Directors;
"Early Expiry Date" shall have the meaning as set forth in Section
5.3.2;
"Early Vesting or Expiry Awards" shall have the meaning as set forth in
Section 6.4;
"Eligible Participant" means any officer, employee, non-employee
director of the Corporation or Consultants designated by the Board as
eligible to participate in the Plan;
"Grant Date" means the date on which an Option is granted, which date
may be on or, if determined by the Board at the time of grant, after
the date that the Board resolves to grant the Option;
"Option" means an option to subscribe Shares granted to an Eligible
Participant pursuant to the terms of the Plan;
"Optionee" means the directors, officers or employees of the
Corporation or any of its Subsidiaries, as the case may be, or the
Consultants to whom Options are granted;
"Option Period" shall have the meaning as set forth in Section 5.3.1;
"Plan" means the Long Term Incentive Plan of the Corporation, as
amended;
"Restricted Share Unit" or "RSU" means the right of an Eligible
Participant to whom a grant of such unit is made to receive a Share on
the Vesting Date (or Early Vesting Date, as the case may be) upon the
attainment of specified performance objectives, if any, as determined
by the Board in accordance with section 6, unless such unit expires
prior to its Vesting Date. The Corporation shall have the option, at
its entire discretion, and in replacement of Share, to provide the
Eligible Participant with a cash equivalent to the EXFO Market Value of
such Share on the Vesting Date (or Early Vesting Date, as the case may
be);
"RSU Holder" shall have the meaning as set forth in Section 6.2;
"RSU Shares" means the Shares that an RSU Holder may receive pursuant
to a particular Award Agreement;
"Shares" means the Subordinate Voting Shares of the Corporation;
"Subscription Price" shall have the meaning as set forth in Section
5.2;
"Subsidiaries" shall have the meaning as set forth in Section 1.
23
3. ADMINISTRATION
The Plan shall be administered by the Corporation's Board of
non-employee Directors (the "BOARD") or at the Board's decision by the
Human Resources Committee composed solely of non-employee members or
any other committee composed solely of non-employee members constituted
from time to time (the "COMMITTEE"). The Board or the Committee shall
have full and complete latitude to interpret the Plan and to establish
the rules and regulations applying to it and to make all other
determinations it deems necessary or useful for the administration of
the Plan, including without limiting the scope of the foregoing and
subject to subsection 5.3.3, to change an Early Expiry Date (as defined
hereinafter) provided that such interpretations, rules, regulations and
determinations shall be consistent with the relevant policy statements
of the competent securities authorities and the rules of the stock
exchanges on which the securities of the Corporation are listed.
4. SHARES SUBJECT TO THE PLAN
The shares subject to the Plan are the Subordinate Voting Shares (the
"SHARES") of the Corporation. The total number of Shares that may be
issued under the Plan and under the Deferred Share Unit Plan for the
Directors shall not exceed 6,306,153 Shares of the Corporation, subject
to the adjustment under Section 8, and no Eligible Participant shall
hold in total options to purchase and RSUs representing more than 5% of
the number of Shares issued and outstanding from time to time. All of
the Shares covered by options that will have expired or have been
cancelled shall become reserved Shares for the purposes of options or
RSUs that may be subsequently granted under the terms of the Plan.
For greater clarity, the issuance of Shares under the Plan shall be
subject to the following:
(i) the number of Shares reserved for issuance pursuant to options
and RSUs granted to insiders of the Corporation shall not
exceed 10% of the total issued and outstanding Shares;
(ii) the issuance to insiders, within a one-year period, of a
number of Shares shall not exceed 10% of the total issued and
outstanding Shares; and
(iii) the issuance to any one insider and such insider's associates,
within a one-year period, of a number of Shares shall not
exceed 5% of the total issued and outstanding Shares.
5. OPTIONS
5.1 GRANT OF OPTIONS
The Board or the Committee shall from time to time designate the
directors, officers or employees of the Corporation or any of its
Subsidiaries, as the case may be, or the Consultants to whom Options
shall be granted (an "OPTIONEE") and the number of Shares covered by
each of such option. Any Optionee may hold more than one option. The
granting of each option shall be evidenced by a letter from the
Corporation addressed to the Optionee setting forth the number of
Shares covered by such option, the subscription price, the terms and
conditions of exercise of the option and the option period.
24
5.2 SUBSCRIPTION PRICE
The subscription price of the Shares subject to an option shall be
established by the Board of Directors or its designated Committee at
the time of the grant, but such price shall not be less than the market
price of the Shares at the date of the granting of the option (the
"GRANT DATE"), calculated as the greater of the closing prices of the
Shares on The Toronto Stock Exchange and the NASDAQ National Market on
the last trading day preceding the Grant Date or, if the Shares did not
trade on such last trading day, the greater of the average, rounded off
to the nearest cent, of the bid and ask prices for the Shares on The
Toronto Stock Exchange and the NASDAQ National Market at the close of
trading on such last trading day preceding the Grant Date (the
"SUBSCRIPTION PRICE").
The closing price of the Shares or, as the case may be, the average of
the bid and ask prices of the Shares at the close of trading on the
NASDAQ National Market shall be converted into Canadian dollars at the
noon buying rate of Federal Reserve Bank of New York on the Grant Date
when such conversion is required.
5.3 OPTION PERIOD
5.3.1 Subject to the provisions of subsections 5.3.2 and 5.3.3, each option
shall be exercisable during a period established by the Board or the
Committee (the "OPTION PERIOD"); such period shall commence no earlier
than the Grant Date and shall terminate no later than ten years after
such date.
5.3.2 Notwithstanding the provisions of subsection 5.3.1, an option shall not
be exercisable by an Optionee from and after each and every one of the
following dates (an "EARLY EXPIRY DATE"), unless the Board or the
Committee decides otherwise:
5.3.2(a) in the case where the Optionee is an officer or an employee,
the date on which the Optionee resigns and voluntary leaves
his employment with the Corporation or one of its
Subsidiaries, as the case may be, or the date on which the
employment of the Optionee with the Corporation or one of its
Subsidiaries is terminated for a good and sufficient cause,
as the case may be;
5.3.2(b) in the case where the Optionee is a director of the
Corporation or one of its Subsidiaries, as the case may be,
but is not employed by either the Corporation or one of its
subsidiaries, 30 days following the date on which such
Optionee ceases to be a member of the Board of Directors for
any reason other than death;
5.3.2(c) (i) in the case where the Optionee is an officer or employee,
6 months following the date on which the Optionee's
employment with the Corporation or any of its Subsidiaries,
as the case may be, is terminated by reason of death or (ii)
in the case where the Optionee is a director of the
Corporation or any of its Subsidiaries, as the case may be,
but is not employed by either the Corporation or any of its
Subsidiaries, 6 months following the date on which such
Optionee ceases to be a member of the Board of Directors by
reason of death;
5.3.2(d) in the case where the Optionee is an officer or employee, 30
days following the date on which the Optionee's employment
with the Corporation or any of its Subsidiaries, as the
25
case may be, is terminated for any cause or reason other than
those mentioned in paragraphs 5.3.2(a) and 5.3.2(c),
including, without limiting the scope of the foregoing,
disability, illness, retirement or early retirement.
Notwithstanding the foregoing, in case of retirement or early
retirement of an officer or employee, the Board or the
Committee may at its own discretion but subject to Section 3,
extend the Early Expiry Date mentioned in this paragraph
5.3.2(d);
5.3.2(e) in the case where the Optionee is a Consultant, 30 days
following the date on which his contract as a Consultant is
terminated or, as the case may be, 30 days following the
receipt by the Consultant of a notice from the Corporation
indicating that the options must be exercised within 30 days
from the date of receipt of the notice.
5.3.3 The rules set forth in paragraph 5.3.2 shall not be interpreted in such
a manner as to extend the Option Period beyond 10 years.
5.3.4 All rights conferred by an option not exercised at the termination of
the Option Period or from and after any Early Expiry Date shall be
forfeited.
5.3.5 EXERCISE OF OPTIONS
(a) Subject to the provisions of section 5.3, an option may be exercised in
whole, at any time, or in part, from time to time, during the Option
Period, but in all cases in accordance with the exercise frequency
established by the Board or the Committee and applicable at the time of
the grant.
(b) An option may be exercised by forwarding a duly executed subscription
form as attached hereto as Schedule 1 (the "Subscription Form") to the
Secretary of the Corporation. Such Subscription Form shall set forth
the number of Shares so subscribed and the address to which the Share
Certificate is to be delivered. The Subscription Form shall also be
accompanied by a certified cheque made payable to the Corporation in
the amount of the Subscription Price. The Corporation shall cause a
certificate for the number of Shares specified in the Subscription Form
to be issued in the name of the Optionee and delivered to the address
specified in the Subscription Form no later than 10 business days
following the receipt of such Subscription Form and cheque.
5.3.6 NO ASSIGNMENT
No option or interest therein shall be assignable for purpose of
transfer of guarantee or otherwise by the Optionee other than by will
or the operation of applicable legal dispositions regarding succession.
5.3.7 NOT A SHAREHOLDER
An Optionee shall have no rights as a shareholder of the Corporation
with respect to any Shares covered by his/her option until he/she shall
have become the holder of record of such Shares.
26
6. GRANT OF RSU AWARDS
6.1 GRANT OF AWARDS
The Board shall from time to time designate the Eligible Participants
to whom a grant of RSUs shall be made and shall determine the number of
RSUs granted under the Award. The Board shall further have discretion
to establish at the time of grant, within the restrictions set forth in
the Plan, the Award Date, the Vesting Date, the performance objectives
which must be attained for the Award to vest, if any, and other
particulars applicable to an Award granted hereunder.
6.2 AWARD AGREEMENT
Upon the grant of an Award, the Corporation will deliver to the
Eligible Participant selected to receive same an Award Agreement dated
as of the Award Date, containing the terms of the Award and executed by
the Corporation, and upon delivery to the Corporation of the Award
Agreement executed by the Eligible Participant in question, the
Eligible Participant in question will be an RSU Holder under the Plan
and, subject to vesting, have the right to receive the RSU Shares (or,
at the Corporation's option, cash equal to the EXFO Market Value of
such Shares on the Vesting Date (or the Early Vesting Date, as the case
may be) on the terms set out in the Award Agreement and in the Plan.
6.3 VESTING DATE
The Vesting Date of an Award will be determined by the Board at the
time of grant, subject however to a minimum term of three years and a
maximum term of ten years from the Award Date and will be subject to
the provisions of section 6.4 relating to early vesting or expiry.
6.4 EARLY VESTING OR EXPIRY OF AWARDS
(a) Unless otherwise determined by the Board at or after the time of grant,
and subject to the minimum and maximum term referred to at section 6.3
hereof, except for events described in section 6.4 (b) where minimum
term is not applicable:
(i) Where vesting of an Award is subject to the attainment of
performance objectives, such Award, or part thereof, shall
expire on the Vesting Date if such performance objectives have
not been attained or shall be postpone at a further Vesting
Date as determined by the Board from time to time, the whole
in accordance with the terms and conditions of the applicable
Award Agreement.
(ii) Any Award, whether or not subject to the attainment of
performance objectives, shall expire immediately upon the RSU
Holder thereof ceasing to be an Eligible Participant as a
result of being dismissed from his office or employment for
cause.
(iii) Any Award, whether or not subject to the attainment of
performance objectives, shall vest before its Vesting Date or
expire, as the case may be, in the following events and
manner:
27
(1) if an RSU Holder resigns and voluntary leaves his
office or employment, the Award held by such RSU
Holder shall expire immediately on the date he
resigns and leaves his office or employment;
(2) if an RSU Holder is dismissed without cause, the
Award held by such RSU Holder shall vest immediately
on the date of dismissal in accordance with section
6.4(b);
(3) if an RSU Holder dies or his employment with the
Corporation is terminated due to Permanent
Disability, the Award held by such RSU Holder shall
vest immediately on the date of the death of the RSU
Holder or on the date of termination, as the case may
be, in accordance with section 6.4(b) or as
established by the Board from time to time; and
(4) if an RSU Holder attains the normal retirement age
established by the Corporation from time to time, the
Award held by such RSU Holder shall vest immediately
on the date of retirement in accordance with section
6.4(b).
(b) In the case of the occurrence of an event contemplated in sections
6.4(a)(iii)(2), (3) and (4), and notwithstanding anything to the
contrary herein provided, the RSU Holder (or, if deceased, his legal
representative) of such early vesting Award shall be entitled to
receive, on the date of the death of the RSU Holder, the date of
termination due to Permanent Disability, the date of retirement the
date of dismissal without cause or the date of the Change of Control,
as the case may be (each an "Early Vesting Date"), the number of Shares
(or, at the Corporation's option, cash equal to the EXFO Market Value
of such Shares on the Early Vesting Date) equal to:
The number of RSU Shares X Number of days elapsed between
underlying the Award the Award Date and the
Early Vesting Date
----------------------------------
Number of days in the Vesting
Period of such Award
unless otherwise determined by the Board at or after the time of
the grant.
6.5 NON-ASSIGNABLE
An Award will not be assignable. Notwithstanding the foregoing, in the
case where an RSU Holder dies and the vesting of his Award is
accelerated in the manner set forth in section 6.4(a)(iii)(3), his
legal representative shall have the rights of such RSU Holder under the
Plan and the Award Agreement.
6.6 NO IMPLIED RIGHTS
An RSU Holder will only have rights as a shareholder of the Corporation
with respect to those of the RSUs Shares, if any, that the RSU Holder
has received upon the vesting of an Award in accordance with its terms.
Nothing in this Plan or in any Award Agreement will confer or be
construed as conferring on an RSU Holder any right to remain as an
officer, key employee or non-employee director of the Corporation, or
an Eligible Participant the right to be granted Options or Awards
hereunder.
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6.7 VESTING OF THE AWARD
Unless an Award has expired in accordance with sections 6.4(a)(i),
(ii), and (iii) (1), the Corporation shall not later than five (5)
business days after the Vesting Date (or after the Early Vesting Date,
as the case may be):
(a) issue from treasury the number of RSU Shares represented by such vested
Award (or the number of Shares determined in accordance with section
6.4(b), as the case may be) and direct its transfer agent to issue a
certificate in the name of the RSU Holder of such vested Award (or, if
deceased, his legal representative) which will be issued as fully paid
and non-assessable Shares; or
(b) purchase the number of RSU Shares represented by such vested Award (or
the number of Shares determined in accordance with section 6.4(b), as
the case may be) on the secondary market for delivery to the RSU Holder
of such vested Award (or, if deceased, his legal representative); or
(c) unless the Award Agreement provides otherwise, pay to the RSU Holder of
such vested Award (or, if deceased, his legal representative), an
amount in cash equal to the EXFO Market Value on the Vesting Date (or
the Early Vesting Date, as the case may be) of the Shares represented
thereby.
Whether an Award is settled in accordance with sections 6.7(a), (b) or
(c) shall be at the entire discretion of the Corporation.
7. CHANGE OF CONTROL
7.1 FOR THE PURPOSES OF THIS SECTION 7, "CHANGE OF CONTROL" SHALL MEAN:
7.1.1 the acquisition by any person or entity, or any persons or
entities acting jointly or in concert, whether directly or
indirectly, of voting securities of the Corporation which
together with all other voting securities of the Corporation
held by such persons or entities, constitute, in the
aggregate, either (a) fifty percent (50%) or more of the votes
attached to all outstanding voting securities of the
Corporation, or (b) forty percent (40%) or more of the votes
attached to all outstanding voting securities of the
Corporation and is followed within twenty-four (24) months by
changes of the members of the Board resulting in a change of
the majority of the Board;
7.1.2 an amalgamation, arrangement or other form of business
combination of the Corporation with another entity which
results in the holders of voting securities of that other
entity holding, in the aggregate, either (a) fifty percent
(50%) or more of the votes attached to all outstanding voting
securities of the entity resulting from the business
combination, or (b) forty percent (40%) or more of the votes
attached to all outstanding voting securities of the entity
resulting from the business combination and is followed within
twenty-four (24) months by changes of the members of the Board
resulting in a change of the majority of the Board;
29
7.1.3 any event or series of events (which event or series of events
may include, without limitation, a proxy fight or proxy
solicitation with respect to the election of directors of the
Corporation made in opposition to the nominees recommended by
the Continuing Directors during any period of twenty-four (24)
consecutive months) as a result of which a majority of the
members of the Board consists of individuals other than
Continuing Directors; or
7.1.4 the sale, lease or exchange of all or substantially all of the
property of the Corporation to another person or entity, other
than in the ordinary course of business of the Corporation or
any of its Subsidiaries.
7.2 For the purposes of this section 7.2, "CONTINUING DIRECTORS" shall mean
with respect to any period of twenty-four (24) consecutive months, (a)
any members of the Board on the first (1st) day of such period, (b) any
members of the Board elected after the first (1st ) day of such period
at any annual meeting of shareholders who were nominated by the Board
or a committee thereof, if a majority of the members of the Board or
such committee were Continuing Directors at the time of such
nomination, and (c) any members of the Board elected to succeed
Continuing Directors by the Board or a committee thereof, if a majority
of the members of the Board or such committee were Continuing Directors
at the time of such election.
7.3 Notwithstanding any provisions to the contrary contained in this Plan,
the Board or the Committee shall have the power to accelerate the time
at which an option or RSU may first be exercised or the time during
which an option or RSU or any part thereof will become exercisable
including, without limitation, prior to or in connection with a Change
of Control.
8. EFFECTS OF ALTERATION OF SHARE CAPITAL
In the event of any change in the number of outstanding Shares of the
Corporation by reason of any stock dividend, stock split,
recapitalization, merger, consolidation, combination or exchange of
Shares or other similar change, subject to the prior approval of the
competent regulatory authorities, an equitable adjustment shall be made
by the Board or the Committee in the maximum number or kind of Shares
issuable under the Plan or subject to outstanding RSUs or options and
in the Subscription Price of such Shares for purposes of the options.
Such adjustment will be definitive and mandatory for the purposes of
the Plan.
9. AMENDMENT AND TERMINATION
9.1 The Board or the Committee may, at any time, with the prior approval of
the competent regulatory authorities, amend, suspend or terminate the
Plan in whole or in part. Subject to the provisions of section 9, any
material amendment (including an increase in the maximum number of
Shares issuable under the Plan) or a reduction in the Subscription
Price of an option (other than for standard anti-dilution purposes) or
a change in the terms of a RSU award shall be approved by a majority of
votes cast at a meeting of shareholders of the Corporation.
9.2 In addition to the foregoing, any material amendment to a RSU award or
an option held by an insider (within the meaning of the SECURITIES ACT
(Quebec)) (other than a person who is an insider solely by virtue of
being a director or an executive officer of a Subsidiary of the
Corporation) or an associate of an insider, including a change in the
Subscription Price or expiry date, shall be
30
approved by a majority of votes cast at a meeting of shareholders of
the Corporation, other than votes attaching to Shares beneficially
owned by the insider and the insider's associates.
9.3 For the purposes of this section 9, an amendment does not include an
accelerated expiry of an option or RSU or change of the time during
which an option or RSU may first be exercised or time during which an
option or RSU or any part thereof will become exercisable as provided
for herein.
9.4 The shareholders' approval of an amendment may be given by way of
confirmation at the next meeting of shareholders after the amendment is
made, provided that no Shares are issued pursuant to the amended terms
prior thereto.
10. FINAL PROVISIONS
10.1 The Corporation's obligation to issue options granted or Shares under
the terms of the Plan is subject to all of the applicable laws,
regulations or rules of any governmental regulatory agency or other
competent authority in respect of the issuance or distribution of
securities and to the rules of any stock exchange on which the Shares
of the Corporation are listed. Each Optionee shall agree to comply with
such laws, regulations and rules and to provide to the Corporation any
information or undertaking required to comply with such laws,
regulations and rules.
10.2 The participation in the Plan of a director, an executive officer or an
employee of the Corporation or any of its Subsidiaries, as well as any
Consultant, shall be entirely optional and shall not be interpreted as
conferring upon a director, an executive officer or an employee of the
Corporation or any of its Subsidiaries, as well as any Consultant, any
right or privilege whatsoever, except for the rights and privileges set
out expressly in the Plan. Neither the Plan nor any act that is done
under the terms of the Plan shall be interpreted as restricting the
right of the Corporation or any of its Subsidiaries to terminate the
employment of an executive officer or employee at any time, as well as
any contractual relationship with any Consultant. Any notice of
dismissal given to an executive officer or employee, as well as to any
Consultant, at the time his/her employment is terminated, or any
payment in the place and stead of such notice, or any combination of
the two, shall not have the effect of extending the duration of the
employment or the contractual relationship for purposes of the Plan.
10.3 No director, executive officer or employee of the Corporation or any of
its Subsidiaries, as well as any Consultant, shall acquire the
automatic right to be granted one or more options or RSUs under the
terms of the Plan by reason of any previous grant of options or RSUs
under the terms of the Plan.
10.4 The Plan does not provide for any guarantee in respect of any loss or
profit that may result from fluctuations in the price of the Shares.
10.5 (i) The Corporation and its Subsidiaries shall assume no
responsibility as regards the tax consequences that
participation in the Plan will have for a director, an
executive officer or an employee of the Corporation or any of
its Subsidiaries, as well as any Consultant, and such persons
are urged to consult their own tax advisors in such regard.
(ii) A plan participant may be required to pay to the Corporation
or any subsidiary and the Corporation or any Subsidiary shall
have the right and is hereby authorized to withhold from any
Shares or other property deliverable under any Option or RSU
or from any compensation or other amounts owing to a plan
participant the amount (in cash or
31
Shares) of any required tax withholding and payroll taxes in
respect of an Option, its exercise, or any payment or transfer
under an Option or in respect of a RSU and to take such other
action as may be necessary in the opinion of the Corporation
to satisfy all obligations for the payment of such taxes.
(iii) Without limiting the generality of clause (ii) above a plan
participant may satisfy, in whole or in part, the foregoing
withholding liability (but no more than the minimum required
withholding liability) by delivery of Shares owned by the plan
participant with a fair market value equal to such withholding
liability (provided that such Shares are not subject to any
pledge or other security interest and have either been held by
the plan participant for 6 months, previously acquired by the
plan participant on the open market or meet such other
requirements as the Committee may determine necessary in order
to avoid an accounting earnings charge), or by having the
Corporation withhold from the number of Shares otherwise
issuable pursuant to the exercise or settlement of the Option
or RSU award a number of Shares with a fair market value equal
to such withholding liability.
10.6 The Plan and any option or RSU granted under the terms of the Plan
shall be governed and interpreted according to the laws of the province
of Quebec and the laws of Canada applicable thereto.
10.7 The Plan is dated as of May 25, 2000 and amended as of January 9, 2004
and amended as of January 12, 2005.
32
EXFO ELECTRO-OPTICAL ENGINEERING INC.
SCHEDULE 1
STOCK OPTION PLAN
SUBSCRIPTION FORM
______________________
(DATE)
EXFO ELECTRO-OPTICAL ENGINEERING INC.
400 Avenue Godin
Vanier, Quebec
G1M 2K2
ATTENTION OF THE SECRETARY
I, the undersigned, ___________________, hereby subscribe for out of
the ______________ Subordinate Voting Shares of EXFO Electro-Optical
Engineering Inc. (the "Corporation") to which I am entitled to
subscribe pursuant to an option granted on ___________ in accordance
with the terms and conditions mentioned in paragraph 7.2 of the
Corporation's Stock Option Plan. I enclose herewith my certified cheque
(or money order) made payable to the order of EXFO Electro-Optical
Engineering Inc., in the amount of $ in payment of the said
subscription.
(X)
--------------------------------------------
(SIGNATURE)
--------------------------------------------
(NUMBER) (STREET)
--------------------------------------------
(CITY) (PROVINCE) (POSTAL CODE)
( )
--------------------------------------------
(TELEPHONE)
33
EXFO ELECTRO-OPTICAL ENGINEERING INC.
SCHEDULE 2
FORM OF AWARD AGREEMENT
LONG TERM INCENTIVE PLAN
This Award Agreement is entered into between EXFO (the "Corporation")
and the RSU Holder named below pursuant to the Long Term Incentive Plan
of the Corporation (the "Plan"), a copy of which is attached hereto,
and confirms that:
1. on______________________(the "Award Date");
2. ________________________(the "RSU Holder");
3. was granted non-assignable restricted shares units (the
"Award");
4. vesting of the Award shall:
|_| not be subject to the attainment of performance objectives; or
|_| be subject to the attainment of the following performance
objectives:
_____________________________________________________________________
_____________________________________________________________________;
5. the Award shall vest at 5:00 P.M., Eastern Time ________________
(the "Vesting Date");
all on the terms and subject to the conditions set out in the Plan. By
signing this agreement, the RSU Holder acknowledges that he or she has
read and understands the Plan, and agrees to be bound thereby.
This Agreement and all related documents have been drawn up in the
English language at the specific request of the parties hereto. La
presente entente, ainsi que tout autre document y afferent, ont ete
rediges en langue anglaise a la demande expresse des parties.
IN WITNESS WHEREOF the Corporation and the RSU Holder have executed
this Award Agreement as of ____________________ ______
By:_______________________________
By:_______________________________
__________________________________
Name of RSU Holder
__________________________________
Signature of RSU Holder
34
EXFO ELECTRO-OPTICAL ENGINEERING INC.
SCHEDULE B
APPROVAL OF DEFERRED SHARE UNIT PLAN
BE IT RESOLVED AS A RESOLUTION OF THE SHAREHOLDERS THAT:
1. The Deferred Share Unit Plan in the form submitted to the shareholders
of the Corporation is hereby approved, subject to any modifications as
may be required by regulatory authorities.
2. Any officer or director of the Corporation be and is hereby authorized
to do all acts and things and to execute and deliver all documents
required, as in the opinion of such director or officer may be and to
do all acts necessary or appropriate in order to give effect to this
resolution.
35
EXFO ELECTRO-OPTICAL ENGINEERING INC.
SCHEDULE B-1
DEFERRED SHARE UNIT PLAN
FOR THE MEMBERS OF THE BOARD OF DIRECTORS
1. DEFINITIONS
For the purpose of this Deferred Share Unit Plan, except as otherwise
expressly provided or unless the context otherwise requires:
"BOARD" means the non-employee members of the Board of Directors of the
Corporation or such Committee of the Board composed solely of
non-employee members, as the Board may select from time to time to
administer this DSUP;
"BUSINESS DAY" means any day on which banks are open for business in
the province of Quebec;
"CORPORATION" means EXFO Electro-Optical Engineering Inc;
"DEFERRED REMUNERATION" means, in respect of a Participant, the sum of
the Portion as may be elected by such Participant under section 4;
"DIRECTOR" means a member of the Board who is not an employee of the
Corporation and who is entitled to compensation under a resolution of
the Board;
"DSUP" means this Deferred Share Unit Plan for the Directors;
"ELECTION NOTICE" has the meaning ascribed thereto in section 4.1;
"PORTION" has the meaning ascribed thereto in section 3.2;
"OPTIONS" has the meaning ascribed thereto in the Corporation's Long
Term Incentive Plan;
"PARTICIPANT" means any Director participating in the DSUP;
"REDEMPTION DATE" has the meaning ascribed thereto in section 6.2;
"REDEMPTION NOTICE" has the meaning ascribed thereto in section 6.2;
"RSUS" has the meaning ascribed thereto in the Corporation's Long Term
Incentive Plan; "SHARE" means a Subordinate Voting Share of the
Corporation;
"TERMINATION DATE" in respect of a Participant means the earliest date
on which both of the following conditions are satisfied:
(i) the Participant has ceased to be a director of the Corporation
by reason of his or her death or retirement or loss of office
as a director; and
36
(ii) he or she is neither an employee nor a member of the board of
directors of the Corporation or any person related to the
Corporation for the purposes of the INCOME TAX ACT (Canada).
"TERMINATION NOTICE" has the meaning ascribed thereto in section 4.3;
"UNITS" means Deferred Share Units that may be granted from time to
time to Participants pursuant to the provisions of this DSUP;
"VALUE OF A UNIT" or "VALUE OF THE UNITS" means, at any particular
date, the market value of the Shares at that date, calculated as the
greater of the closing prices of the Shares on The Toronto Stock
Exchange and the NASDAQ National Market on the last trading day
preceding such date or, if the Shares did not trade on such last
trading day, the greater of the average, rounded off to the nearest
cent, of the bid and ask prices for the Shares on The Toronto Stock
Exchange and the NASDAQ National Market at the close of trading on such
last trading day preceding such date, subject to adjustments made
pursuant to section 5.2 of this DSUP. The closing price of the Shares
or, as the case may be, the average of the bid and ask prices of the
Shares at the close of trading on the NASDAQ National Market shall be
converted into Canadian dollars at the noon buying rate of Federal
Reserve Bank of New York on the Grant Date when such conversion is
required;
2. ADMINISTRATION
2.1 This DSUP shall be administered by the Board, which may
delegate its duties and powers in whole or in part to any
subcommittee thereof consisting solely of non-employee
directors. The Board is authorized to interpret this DSUP, to
establish, amend and rescind any rules and regulations
relating to this DSUP, and to make any other determinations
that it deems necessary or desirable for the administration of
this DSUP. The Board may correct any defect or supply any
omission or reconcile any inconsistency in this DSUP in the
manner and to the extent the Board deems necessary or
desirable. Any decision of the Board in the interpretation and
administration of this DSUP, as described herein, shall lie
within its sole and absolute discretion and shall be final,
conclusive and binding on all parties concerned.
Notwithstanding the foregoing, all actions of the Board shall
be such that this DSUP continuously meets the conditions of
paragraph 6801(d) of the Regulations under the INCOME TAX ACT
(Canada). Neither the Board or any member thereof, nor any
officer or employee of the Corporation, shall be liable for
any act, omission, interpretation, construction or
determination made in good faith in connection with this DSUP,
and the members of the Board and the officers and employees of
the Corporation shall be entitled to indemnification by the
Corporation in respect of any claim, loss, damage or expense
(including legal fees and disbursements) arising therefrom to
the fullest extent permitted by law. The expenses of
administering this DSUP shall be borne by the Corporation.
3. ELIGIBILITY
3.1 The Corporation is establishing a DSUP for Directors beginning
from the date of the approval by the shareholders of the
Corporation.
3.2 Each Participant is entitled to receive in the form of units a
percentage of the annual board retainer fee payable annually
to a Director and may, subject to the conditions set forth
herein, elect to receive in the form of Units any percentage,
up to 100%, of the annual board retainer fee (the "PORTION").
37
4. ELECTION TO PARTICIPATE
4.1 Each Participant who elects to participate in the DSUP will be
required to file a notice of election, in the form of Schedule
A hereto (the "ELECTION NOTICE"), with the Corporation's
Secretary before August 1st in each year and for each new
Director such Election Notice must be delivered not later than
7 days after the date on which his or her term as a director
commenced, indicating the percentage of the Portion payable
(a) in the following calendar year for a continuing
director and
(b) in the current calendar year beginning on the first
day of the financial quarter of the Corporation next
following the date of receipt by the Corporation of
the Election Notice for a new director in respect of
which the Participant elects to receive Units.
4.2 The election of a Participant (who has not filed a Termination
Notice in respect of such election) to participate in the DSUP
shall be effective for the fiscal year or balance thereof in
respect of which it is made and shall be deemed to apply to
all fiscal years of the Corporation subsequent to the filing
of the Election Notice until and unless a Termination Notice
is filed per Section 4.3. If no Election Notice is made, and
no prior election is deemed effective, the Participant shall
be deemed to have elected to be paid 100% of the Portion in
Units.
4.3 Each Participant is entitled, at any time, to terminate such
Participant's future participation in the DSUP by filing with
the Secretary of the Corporation a notice of termination in
the form of Schedule B hereto (the "TERMINATION NOTICE"). A
Participant who has filed a Termination Notice may elect to
participate again in the DSUP in respect of any period
following the filing of such Termination Notice by filing an
Election Notice in accordance with Section 4.1, and so on.
5. GRANT OF UNITS
5.1 Participants will be credited for each fiscal year of the
Corporation, a number of Units determined on the basis of the
amount of Deferred Remuneration payable to such Director in
respect of such fiscal year, divided by the Value of a Unit.
5.2 Participants to whose accounts Units stand credited will be
credited with additional Units whenever cash dividends are
paid on Shares.
5.3 In the event of a stock dividend, stock split, combination or
exchange of shares, merger, consolidation, spin-off or other
distribution (other than normal cash dividends) of the
Corporation's assets to shareholders, or any other change
affecting the Shares, including the conversion thereof into
shares of another entity upon an amalgamation or
reorganization of the Corporation, such proportionate
adjustments, if any, as the Board in its discretion may deem
appropriate to reflect such change, will be made with respect
to the number of Units outstanding under the DSUP.
6. REDEMPTION OF UNITS
6.1 Subject to the limitations contained in sections 6.2 to 6.4,
Units will be redeemable and the value thereof payable after
the Termination Date of a Participant.
38
6.2 In the case where a Participant ceases to act as a Director,
the Participant (or in the case of death, the beneficiary of
the Units) may, after the Termination Date, subject to section
6.3, cause the Corporation to redeem the Units by filing a
notice of redemption in the form of Schedule C hereto (the
"REDEMPTION NOTICE") with the Corporation's Secretary
specifying the redemption date, which shall be at least five
Business Days following the date on which the Redemption
Notice is filed with the Corporation, but no later than
December 15 of the first calendar year commencing after the
year of the Termination Date (the "REDEMPTION DATE").
Within ten Business Days after the Redemption Date but no
later than December 31 of the first calendar year commencing
after the year of the Termination Date (the "PAYMENT DATE"),
the Participant shall receive, at the discretion of the
Corporation, in satisfaction of the number of Units credited
to his or her account on such date, any of the following:
(a) a number of Shares purchased on the open market by
the Broker having a Value of the Units, net of any
applicable withholdings, equal to the Value of a Unit
on the Redemption Date multiplied by the number of
Units credited to his or her notional account on the
Payment Date, in accordance with the terms of Section
7 hereof,
(b) a number of Shares issued by the Corporation equal to
the number of Units credited to his or her notional
account on the Payment Date,
(c) any combination of clauses (a) and (b).
The Corporation will pay all brokerage commissions arising in
connection with the purchase of Shares by the Broker on the
open market and. A Participant shall not be entitled to
require payment of any amount on account of Units credited to
such Participant's account prior to his or her Termination
Date nor later than the last business day in December of the
first calendar year commencing after the Termination Date.
6.3 If the Participant or his/her beneficiary or legal
representative, as the case may be, fails to file a Redemption
Notice with the Corporation before the Deadline, the
Participant or his/her beneficiary or legal representative,
shall be deemed to have filed on the Deadline a Redemption
Notice with the Corporation for such Participant's Units
specifying December 15 of such year as the Redemption Date.
6.4 If a Participant dies after ceasing to act as a Director, but
before filing a Redemption Notice with the Corporation,
sections 6.2 and 6.3 shall apply with such modifications as
the circumstances require.
6.5 A Redemption Notice shall apply to all Units held by the
Participant or his/her beneficiary or legal representative, as
the case may be, at the time it is filed.
7. PURCHASE OF SHARES ON THE OPEN MARKET
7.1 Purchase of Shares pursuant to Section 6 hereof shall be made
on the open market by a broker independent from the
Corporation and who is a member of The Toronto Stock Exchange
or NASDAQ National Market or if the Shares are no longer
listed or traded on The Toronto Stock Exchange or NASDAQ
National Market or both, then of such other
39
stock exchange or quotation service as the Board may determine
constitutes the principal market for the Shares (the
"BROKER"). Any such designation may be changed from time to
time. Upon designation of a broker or at any time thereafter,
the Corporation may elect to provide the Broker with a letter
of agreement to be executed by the Broker and entered into
with the Participant and to which the Corporation would also
be a party, setting forth, inter alia, (i) the Broker's
concurrence to being so designated, to acting for the
Participant's account in accordance with customary usage of
the trade with a view to obtaining the best share price for
the Participant and to delivering to the Participant or his or
her representative the share certificate for the Shares
purchased upon payment by the Corporation of the purchase
price and the related reasonable brokerage commissions, and
(ii) the Corporation's agreement to notify the Broker of the
number of Shares to be purchased and to pay the purchase price
and the related reasonable brokerage commissions, provided
however that no terms of such letter agreement shall have the
effect of making the Broker or deeming the broker to be an
affiliate of (or not independent from) the Corporation for
purposes of any applicable corporate, securities or stock
exchange requirement.
7.2 Prior to 11:00 a.m. (Montreal time) on the Payment Date, the
Corporation shall notify the Broker as to the number of Shares
to be purchased by the Broker on behalf of the Participant on
the open market. As soon as practicable thereafter, the Broker
shall purchase on the open market the number of Shares which
the Corporation has requested the Broker to purchase and shall
notify the Participant and the Corporation of (a) the
aggregate purchase price ("AGGREGATE PURCHASE PRICE") of the
Shares, (b) the purchase price per Share or, if the Shares
were purchased at different prices, the average purchase price
(computed on a weighted average basis) per Share, (c) the
amount of any related reasonable brokerage commissions and (d)
the settlement date for the purchase of the Shares. On the
settlement date, upon payment of the Aggregate Purchase Price
and related reasonable commissions by the Corporation, the
Broker shall deliver to the Participant or to his or her
representative the certificate representing the Shares. No
settlement date shall be after the last business day in
December of the first calendar year commencing after the
Termination Date.
7.3 The Units, that may be delivered under this DSUP, have not
been registered under the U.S. Securities Act of 1933, as
amended, as of the effective date of this DSUP and the
Corporation has no obligation to register such units.
8. SHARES SUBJECT TO THIS DEFERRED SHARE UNIT PLAN
8.1 The total number of Shares that may be issued under this DSUP
shall not exceed 6,306,153 Shares of the Corporation,
including such Shares that may be issued under the Long Term
Incentive Plan of the Corporation, subject to the adjustment
under Section 9, and no Participant shall hold in total
Options, RSUs and Units which may be redeemed for more than 5%
of the number of Shares issued and outstanding from time to
time.
For greater clarity, the issuance of Shares under this DSUP
shall be subject to the following:
(i) the number of Shares reserved for issuance pursuant
to Options, RSUs and Units granted to insiders of the
Corporation shall not exceed 10% of the total issued
and outstanding Shares;
40
(ii) the issuance to insiders, within a one-year period,
of a number of Options, RSUs and Units shall not
exceed 10% of the total issued and outstanding
Shares; and
(iii) the issuance to any one insider and such insider's
associates, within a one-year period, of a number of
Options, RSUs and Units shall not exceed 5% of the
total issued and outstanding Shares.
9. ADJUSTMENTS AND REORGANIZATIONS
9.1 In the event of any change in the number of outstanding Shares
of the Corporation by reason of any stock dividend, stock
split, recapitalization, merger, consolidation, combination or
exchange of Shares or other similar change, subject to the
prior approval of the competent regulatory authorities, an
equitable adjustment shall be made by the Board in the maximum
number or kind of Shares issuable under this DSUP. Such
adjustment will be definitive and mandatory for the purposes
of this DSUP.
10. AMENDMENT OR TERMINATION OF THE DSUP
10.1 The DSUP may be amended or terminated (including without
limitation to suspend or limit the right of a Participant to
elect to participate in the DSUP) at any time and from time to
time by the Board, provided that any such amendment or
termination does not in any way infringe upon any rights of
Participants in respect of Units previously credited to the
account of Participants.
11. GENERAL
11.1 The DSUP will be administered by the Board or, if determined
by the Board, by a committee of the Board, and all costs
related to the implementation and administration of the DSUP
will be paid by the Corporation.
11.2 A Participant may not sell, assign or otherwise dispose of
Units or any rights in respect thereof, except by will or
other testamentary document or according to the laws
respecting the devolution and allotment of estates.
11.3 Unless otherwise determined by the Board, no funds will be set
aside to guarantee the payment of the Units and future payment
of Units will remain an unfunded liability recorded on the
books of the Corporation.
11.4 This Plan will be effective as of January 12, 2005.
41
SCHEDULE A
Election Notice
EXFO ELECTRO-OPTICAL ENGINEERING INC.
DEFERRED SHARE UNIT PLAN FOR THE MEMBERS OF THE BOARD OF DIRECTORS
(THE "DEFERRED SHARE UNIT PLAN" OR THE "PLAN")
--------------------------------------------------------------------------------
NOTE: ALL CAPITALIZED TERMS NOT OTHERWISE DEFINED HEREIN SHALL HAVE THE
MEANING ASCRIBED THERETO IN THE DEFERRED SHARE UNIT PLAN.
--------------------------------------------------------------------------------
PLEASE TICK THE APPROPRIATE BOX AND COMPLETE AS APPROPRIATE:
[_] I hereby elect to participate in the Corporation's Deferred Share Unit
Plan and my elected percentage is %.
[_] I hereby elect not to participate in the Corporation's Deferred Share
Unit Plan.
I CONFIRM THAT:
I have received and reviewed a copy of the Deferred Share Unit Plan and agree to
be bound by it. I understand that I will not be able to cause the Corporation to
redeem Units until I cease to act as a Director.
I recognize that, when Units credited pursuant to this election are redeemed in
accordance with the terms of the Deferred Share Unit Plan after I cease to be a
Director, income tax and other withholdings will arise at that time. Upon
redemption of Units, the Corporation will make the appropriate withholdings as
required by law at that time. These may include deductions at source on account
of federal and provincial income taxes, Canada Pension Plan, Quebec Pension
Plan, Quebec Health Insurance Plan, etc. and, with respect to U.S. residents, on
account of applicable federal, state and local taxes.
I will respect any applicable limitation imposed by the Corporation's insider
trading policies and any applicable laws and regulations regarding insider
trading.
THE FOREGOING INCLUDES A BRIEF OUTLINE OF CERTAIN KEY PROVISIONS OF THE DEFERRED
SHARE UNIT PLAN. FOR MORE COMPLETE INFORMATION, REFERENCE SHOULD BE MADE TO THE
TEXT OF THE DEFERRED SHARE UNIT PLAN.
__________________________ ________________________________________
Date (Signature of Participant)
________________________________________
(Name of Participant in Block Letters)
42
SCHEDULE B
Termination Notice
EXFO ELECTRO-OPTICAL ENGINEERING INC.
DEFERRED SHARE UNIT PLAN FOR THE MEMBERS OF THE BOARD OF DIRECTORS
(THE "DEFERRED SHARE UNIT PLAN")
--------------------------------------------------------------------------------
NOTE: ALL CAPITALIZED TERMS NOT OTHERWISE DEFINED HEREIN SHALL HAVE THE
MEANING ASCRIBED THERETO IN THE DEFERRED SHARE UNIT PLAN.
--------------------------------------------------------------------------------
I hereby advise the Corporation that I wish to terminate my participation in the
Deferred Share Unit Plan. I understand that my participation in the Deferred
Share Unit Plan shall be terminated as of and from the first fiscal year of the
Corporation following the filing of this Termination Notice. Any Units credited
to my account shall remain in such account and will be redeemable only in
accordance with the terms of the Deferred Share Unit Plan.
__________________________ ________________________________________
Date (Signature of Participant)
________________________________________
(Name of Participant in Block Letters)
43
SCHEDULE C
Redemption Notice
EXFO ELECTRO-OPTICAL ENGINEERING INC.
DEFERRED SHARE UNIT PLAN FOR THE MEMBERS OF THE BOARD OF DIRECTORS
(THE "DEFERRED SHARE UNIT PLAN")
--------------------------------------------------------------------------------
NOTE: ALL CAPITALIZED TERMS NOT OTHERWISE DEFINED HEREIN SHALL HAVE THE
MEANING ASCRIBED THERETO IN THE DEFERRED SHARE UNIT PLAN.
--------------------------------------------------------------------------------
I hereby advise the Corporation that I wish the Corporation to redeem all the
Units credited to my account under the Deferred Share Unit Plan on
______________ (INSERT REDEMPTION DATE, WHICH SHALL BE AT LEAST FIVE (5)
BUSINESS DAYS FOLLOWING THE DATE ON WHICH SUCH REDEMPTION NOTICE IS FILED WITH
THE CORPORATION but no later than December 15 of the first calendar year
commencing after the year of the Termination Date).
__________________________ ________________________________________
Date (Signature of Participant)
________________________________________
(Name of Participant in Block Letters)
44
EXFO ELECTRO-OPTICAL ENGINEERING INC.
SCHEDULE C
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TSX CORPORATE GOVERNANCE GUIDELINES COMMENTS
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1. Board should explicitly assume
responsibility for stewardship of
the Corporation specifically for:
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(a) Adoption of a strategic planning The Board provides guidance for the development of the
process strategic planning process and approves the process and the
plan adopted by management annually. In addition, the Board
carefully reviews the strategic plan and deals with strategic
planning matters that arise during the year.
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(b) Identification of principal risks, The Board works with management to identify the Corporation's
and implementing risk principal risks and manages these risks through regular management
systems appraisal of management's practices on an ongoing
basis.
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(c) Succession planning and monitoring The Human Resources Committee is responsible for the
senior management elaboration and implementation of a succession planning
process and its updates as required. The Human Resources
Committee is responsible to monitor and review the performance
of the Chief Executive Officer and that of all other senior
officers.
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(d) Communications policy The Chief Financial Officer of the Corporation is responsible
for communications between Management and the Corporation's
current and potential shareholders and financial analysts. The
Board adopted and implemented Disclosure Guidelines to ensure
consistency in the manner that communications with shareholders
and the public are managed. The Audit Committee reviews press
releases containing the quarterly results of the Corporation
prior to release. In addition, all material press releases of
the Corporation are reviewed by the President and Chief
Executive Officer and internal legal counsel. The Disclosure
Guidelines have been established in accordance with the
relevant disclosure requirements under applicable Canadian and
United States securities laws.
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(e) Integrity of internal control and The Audit Committee has the responsibility to review the
management information systems Corporation's systems of internal controls regarding finance,
accounting, legal compliance and ethical behaviour. The Audit
Committee meets with the Corporation's external auditors on a
quarterly basis.
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2. Majority of Directors should be The Board presently consists of six Directors, five of which
"unrelated" (independent of management are unrelated Directors within the meaning of the Guidelines.
and free from conflicting interest) The Chairman of the Board, Mr. Germain Lamonde is a significant
shareholder in the Corporation as he has the ability to
exercise a majority of the votes for the election of the Board
of Directors. The Board believes that the current majority of
unrelated Directors provides appropriate independent
representation for the public shareholders of the Corporation.
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45
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TSX CORPORATE GOVERNANCE GUIDELINES COMMENTS
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3. Disclosure for each Director whether Mr. Germain Lamonde - Related - is President and Chief
he or she is related, and how that Executive Officer of the Corporation.
conclusion was reached
For the remainder of the proposed Directors, none of them or
their associates have any interest or any business or other
relationship which could, or could reasonably be perceived to,
materially interfere with the Director's ability to act with a
view to the best interests of the Corporation, other than
interests arising from shareholding.
Mr. Pierre Marcouiller - Unrelated
Mr. Guy Marier - Unrelated
Mr. Andre Tremblay - Unrelated
Dr. David A. Thompson - Unrelated
Mr. Michael Unger - Unrelated
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4. (a) Appoint a committee responsible At the present time, the Corporation has no formal procedures
for appointment/assessment of in place for recruiting new Directors. While there is no
Directors formal process for assessing Directors on an ongoing basis,
the Directors meet on an ongoing basis to discuss the future
governance requirements and to take necessary actions to meet
those requirements.
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(b) Composed exclusively of non-
management directors, the majority
of whom are unrelated
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5. Implement a process for assessing The Board assumes direct responsibility for the monitoring of
effectiveness of the Board, its Board's corporate governance practices, the functioning of
committees and directors the Board and the powers, mandates and performance of the
Committees. The Human Resources Committee, composed solely of
unrelated Directors, initiates a self-evaluation of the Board's
performance on an annual basis.
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6. Provide orientation and education Presentations and reports relating to the Corporation's
programs for new directors business and affairs are provided to new Directors. In
addition, new Board members meet with senior management of
the Corporation to review the business and affairs of the
Corporation.
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46
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TSX CORPORATE GOVERNANCE GUIDELINES COMMENTS
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7. Consider reducing size of The Board is presently composed of six members. The Board
board, with a view to improving considers that this is close to the optimum number of
effectiveness Directors required to provide the flexibility to respond
quickly to corporate opportunities and challenges as they
arise, while also providing increased resources and improved
succession planning. The Board as currently constituted brings
together a mix of experience and backgrounds that the Board
considers appropriate for the stewardship of the Corporation,
and these factors will continue to be considered in the
nomination process of new directors.
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8. Review compensation of The Human Resources Committee reviews periodically
directors in light of risks compensation policies in light of market conditions, industry
and responsibilities practice and level of responsibilities. Only non-related
directors are compensated for acting as a director of the
Corporation.
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9. (a) Committees should generally be The Board has two committees: the Audit Committee and the
composed of non-management Human Resources Committee. Each of the members of the Audit
directors Committee and Human Resources Committee are non-management.
(b) Majority of committee members should The Audit Committee consists of four members, and the Human
be unrelated Resources Committee consists of five members, all of who are
unrelated Directors.
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10. Appoint a committee The Board assumes direct responsibility for the monitoring of
responsible for approach to the Board's corporate governance practices, the functioning
corporate governance issues of the Board and the powers, mandates and performance of the
committees. These responsibilities were previously assumed by
the Human Resources Committee.
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11. (a) Define limits to management's
responsibilities by developing
mandates for:
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(i) the board There is no specific mandate for the Board, however the Board
of Directors is, by law, responsible for managing the
business and affairs of the Corporation. Any responsibility,
which is not delegated to senior management or to a committee
of the Board remains the responsibility of the Board.
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(ii) the CEO The corporate objectives which the President and Chief
Executive Officer is responsible for meeting, with the rest
of management placed under his supervision, are determined by
the strategic objectives and budget as they are presented
each year to the Board of Directors.
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47
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TSX CORPORATE GOVERNANCE GUIDELINES COMMENTS
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(b) Board should approve CEO's corporate The Board, in conjunction with Management, develops and
objectives reviews the corporate objectives of the Corporation annually
which, in turn, are expected to be implemented by the CEO.
In addition, individual objectives for the CEO and the rest
of management are submitted to the Board for approval
annually.
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12. Establish structures and the During the financial year ended August 31, 2002, the Board of
procedures to enable the Board Directors designated Mr. Michael Unger to act as independent to
function independently of "lead director". A minimum of two
meetings annually will be management held by the independent,
unrelated directors without management, and any independent,
unrelated director may request additional meetings at any
time.
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13. (a) Establish an audit committee The Audit Committee is mandated to monitor audit functions,
with a specifically defined the preparation of financial statements, review press
mandate releases on financial results, review other regulatory
documents as required, and meet with outside auditors
independently of Management. The Committee also recommends
the selection of the external auditors for appointment
by the shareholders.
The aggregate fees billed for professional services rendered
by PricewaterhouseCoopers for the audit of the Corporation's
consolidated annual financial statements for the financial
year ended August 31, 2004 were approximately US$ 189,000.
The aggregate fees billed for services rendered by PWC,
other than services covered for auditing services above, for
the financial year ended August 31, 2004 were approximately
US$301,000 which related, for the most part, to tax planning
matters. No fees were billed by PWC for professional
services related to financial information systems design and
implementation.
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(b) All members should be non-management All of the four members of the Audit Committee are
directors non-management Directors.
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14. Implement a system to enable The Corporation has a practice of permitting the Board, any
individual directors to engage Committee thereof and any individual Director to engage
outside advisors, at independent, external advisors at the Corporation's expense.
Corporation's expense
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48