SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 20-F
[_] REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g)
OF THE SECURITIES EXCHANGE ACT OF 1934; or
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended August 31, 2001
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period ________ to ________
Commission File No. 0-30895
EXFO ELECTRO-OPTICAL ENGINEERING INC. /
EXFO INGENIERIE ELECTRO-OPTIQUE INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CANADA
(JURISDICTION OF INCORPORATION OR ORGANIZATION)
465 GODIN AVENUE
VANIER, QUEBEC G1M 3G7, CANADA
(418) 683-0211
(ADDRESS, INCLUDING ZIP CODE AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
Securities registered or to be registered pursuant to Section 12(b) of the Act:
None
Securities registered or to be registered pursuant to Section 12(g) of the Act:
Subordinate Voting Shares, no par value
Securities for which there is a reporting obligation pursuant to Section 15(d)
of the Act:
None
As of December 31, 2001, the registrant had 23,525,810 Subordinate Voting Shares
outstanding.
Indicate by check mark whether EXFO (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that EXFO was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days.
Yes [X] No [_]
Indicate by check mark which financial statement item EXFO has elected to
follow:
Item 17 [_] Item 18 [X]
TABLE OF CONTENTS
Page
PART I. ...............................................................1
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Item 1. Identity of Directors, Senior Management and Advisors..........1
Item 2. Offer Statistics and Expected Timetable........................1
Item 3. Key Information................................................1
Item 4. Information on the Company....................................16
Item 5. Operating and Financial Review and Prospects..................38
Item 6. Directors, Senior Management and Employees....................52
Item 7. Major Shareholders and Related Party Transactions.............68
Item 8. Financial Information.........................................70
Item 9. The Offer and Listing.........................................71
Item 10. Additional Information........................................71
Item 11. Qualitative and Quantitative Disclosures about Risk...........81
Item 12. Description of Securities Other than Equity Securities........82
PART II. ..............................................................82
--------
Item 13. Defaults, Dividends Arrearages and Delinquencies..............82
Item 14. Material Modifications to the Rights of Security
Holders and Use of Proceeds...................................82
Item 15. [Reserved]....................................................82
Item 16. [Reserved]....................................................82
PART III. ..............................................................82
---------
Item 17. Financial Statements..........................................82
Item 18. Financial Statements..........................................82
Item 19. Exhibits......................................................83
PART I.
-------
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS
Not Applicable
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
Not Applicable
ITEM 3. KEY INFORMATION
A. SELECTED FINANCIAL DATA
The consolidated balance sheet data as at August 31, 1997 is derived
from our unaudited consolidated financial statements not included in this annual
report. The consolidated statements of earnings data for the years ended August
31, 1997 and 1998 and the consolidated balance sheets data as at August 31, 1998
and 1999 are derived from our audited consolidated financial statements not
included in this annual report. The consolidated statements of earnings data for
each of the three years ended August 31, 1999, 2000 and 2001 and the
consolidated balance sheets data as at August 31, 2000 and 2001 are derived from
our consolidated financial statements that have been audited by
PricewaterhouseCoopers LLP, independent auditors, that are included elsewhere in
this annual report.
Our consolidated financial statements are prepared in accordance with
Canadian GAAP, which differ in certain respects from U.S. GAAP. For a
description of the material differences between Canadian GAAP and U.S. GAAP in
regard to our consolidated financial statements, see note 19 to our consolidated
financial statements. The historical results below are not necessarily
indicative of the results to be expected for any future period.
The selected financial data should be read in conjunction with our
consolidated financial statements and the related notes included elsewhere in
this annual report, and "Item 5. Operating and Financial Review and Prospects"
of this annual report.
YEARS ENDED AUGUST 31,
-------------------------------------------------------------
1997 1998 1999 2000 2001
---- ---- ---- ---- ----
(IN THOUSANDS OF US DOLLARS, EXCEPT SHARE AND PER SHARE DATA)
CONSOLIDATED STATEMENTS OF EARNINGS DATA:
AMOUNTS UNDER CANADIAN GAAP
Sales............................................... $ 24,475 $ 31,605 $ 42,166 $ 71,639 $ 146,013
Cost of sales....................................... 9,652 11,345 14,998 24,712 54,946
--------- --------- --------- --------- ---------
Gross margin........................................ 14,823 20,260 27,168 46,927 91,067
--------- --------- --------- --------- ---------
Operating expenses
Selling and administrative.......................... 7,827 9,898 13,279 24,304 46,236
Net research and development........................ 1,592 3,014 4,315 6,402 13,601
Amortization of property, plant and equipment....... 465 609 857 1,451 3,559
Amortization of intangible assets................... 14 48 41 47 9,876
Non-recurring expenses.............................. -- -- -- -- 3,288
--------- --------- --------- --------- ---------
Total operating expenses............................ 9,898 13,569 18,492 32,204 76,560
--------- --------- --------- --------- ---------
Earnings from operations............................ 4,925 6,691 8,676 14,723 14,507
Interest income (expense)-- net.................... (89) 40 136 1,480 6,098
Foreign exchange gain (loss) ....................... (184) 126 (506) (684) 3,327
--------- --------- --------- --------- ---------
Earnings before income taxes and
amortization of goodwill ..................... 4,652 6,857 8,306 15,519 23,932
Income taxes........................................ 1,582 2,356 2,492 5,298 8,150
--------- --------- --------- --------- ---------
Earnings before amortization of goodwill............ 3,070 4,501 5,814 10,221 15,782
Amortization of goodwill............................ $ -- $ -- $ -- $ 297 $ 31,076
--------- --------- --------- --------- ---------
Net earnings (loss) for the year.................... $ 3,070 $ 4,501 $ 5,814 $ 9,924 $ (15,294)
--------- --------- --------- --------- ---------
Basic and diluted net earnings (loss) per share..... $ 0.08 $ 0.12 $ 0.14 $ 0.25 $ (0.29)
Basic weighted average number of shares used in per
share calculations............................ 38,000 38,000 38,001 39,951 53,014
OTHER FINANCIAL DATA:
Gross research and development...................... $ 2,753 $ 4,406 $ 6,390 $ 9,374 $ 17,601
Net research and development........................ $ 1,592 $ 3,014 $ 4,315 $ 6,402 $ 13,601
Dividends per share
Class "A" shares.............................. $ -- $ -- $ 0.08 $ 0.45 $ --
Class "C" share............................... $ -- $ -- $ 340 $ -- $ --
Class "E" shares.............................. $ 0.005 $ 0.005 $ -- $ -- $ --
Class "F" shares.............................. $ -- $ -- $ -- $ 0.45 $ --
AMOUNTS UNDER U.S. GAAP
Sales............................................... $ 26,752 $ 32,853 $ 41,858 $ 71,639 $ 146,013
Net earnings (loss) for the year.................... $ 3,356 $ 4,538 $ 5,901 $ 7,922 $ (29,478)
Basic and diluted net earnings (loss) per share..... $ 0.09 $ 0.12 $ 0.15 $ 0.20 $ (0.56)
Basic weighted average number of shares used in per
share calculations.................................. 38,000 38,000 38,001 39,951 53,014
Dividends per share
Class "A" shares.............................. $ -- $ -- $ 0.08 $ 0.45 $ --
Class "C" share............................... $ -- $ -- $ 333 $ -- $ --
Class "E" shares.............................. $ 0.006 $ 0.005 $ -- $ -- $ --
Class "F" shares.............................. $ -- $ -- $ -- $ 0.45 $ --
AS AT AUGUST 31,
-------------------------------------------------------------
1997 1998 1999 2000 2001
---- ---- ---- ---- ----
(IN THOUSANDS OF US DOLLARS)
CONSOLIDATED BALANCE SHEETS DATA:
AMOUNTS UNDER CANADIAN GAAP
Cash and cash equivalents........................... $ 354 $ 1,262 $ 423 $ 729 $ 7,729
Working capital (1) ................................ 5,973 9,797 12,745 194,167 130,289
Total assets........................................ 13,238 17,643 22,840 219,723 442,577
Long-term debt (excluding current portion) ......... 20 -- -- 16 664
Shareholders' equity................................ $ 7,644 $ 12,045 $ 14,679 $ 206,994 $ 414,805
AMOUNTS UNDER U.S. GAAP
Cash and cash equivalents........................... $ -- $ 1,201 $ 423 $ 729 $ 7,729
Working capital (2) ................................ -- 9,179 12,781 194,204 129,987
Total assets........................................ -- 16,785 22,899 219,760 499,436
Long-term debt (excluding current portion) ......... -- -- -- -- 664
Shareholders' equity................................ $ -- $ 11,318 $ 14,715 $ 207,031 $ 471,117
------------------------
(1) Includes 19,000,000 mandatorily redeemable preferred shares with a nominal
carrying value as at August 31, 1997 and 1998 and 800,000 mandatorily
redeemable preferred shares with a carrying value of $543,000 as at August
31, 2000.
(2) Includes 19,000,000 mandatorily redeemable preferred shares, with a nominal
carrying value as at August 31, 1998 and 800,000 mandatorily redeemable
preferred shares with a carrying value of $543,000 as at August 31, 2000.
2
B. CAPITALIZATION AND INDEBTEDNESS
Not Applicable
C. REASONS FOR THE OFFER AND USE OF PROCEEDS
Not Applicable
D. RISK FACTORS
RISKS RELATED TO OUR INDUSTRY AND BUSINESS
IF THE DOWNTURN IN THE TELECOMMUNICATIONS INDUSTRY PERSISTS OR WORSENS, DEMAND
FOR OUR PRODUCTS WILL CONTINUE TO DROP AND, AS A RESULT, IT COULD CONTINUE TO
HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS, RESULTS OF OPERATIONS AND
FINANCIAL CONDITION.
Due to the downturn in the telecommunications industry and the
uncertainty following the tragic events of September 11, 2001, several
telecommunications carriers lowered their spending for network installations.
Optical equipment manufacturers, in turn, were affected by the downturn and the
subsequent buildup of inventories. These market forces on our customers
contributed to a significant decline in our sales. If the downturn persists or
worsens, demand for our products will drop and, as a result, it could have a
material adverse effect on our business, results of operations and financial
condition.
WE HAVE ADOPTED MEASURES AND MAY CONTINUE TO ADOPT MEASURES THAT ALIGN OUR COST
STRUCTURE TO CHALLENGING MARKET CONDITIONS. IF THE CHALLENGING MARKET CONDITIONS
ARE PROLONGED, IT COULD HAVE MATERIAL ADVERSE LONG-TERM EFFECTS ON OUR BUSINESS,
RESULTS OF OPERATIONS AND FINANCIAL CONDITION.
We have been forced to re-align our cost structure to market conditions
twice during the past year. On June 27, 2001, we announced the reduction of
non-customer-related expenses, postponement of plans to build a new facility in
the Quebec Metro High-Tech Park, termination of non-core operations at a
subsidiary that specialized in manufacturing fiber-optic temperature sensors,
and reduction of our workforce by 15%. On December 5, 2001, we announced the
lowering of our operating expenses, freeze in employee salaries, and reduction
of our workforce by 10%. These and, if needed, subsequent measures could have
material adverse long-term effects on our business, results of operations and
financial condition if we deplete our pool of highly qualified personnel; if we
are unable to sustain research and development efforts for the launch of new
products; if we are unable to meet the needs of our customers; and if we are not
prepared to ramp up manufacturing when market conditions improve. In addition,
if we fail to adopt and implement adequate and pertinent measures on a timely
basis to align our cost structure to challenging market conditions, it could
have a material adverse long-term effects on our business, results of operations
and financial condition.
3
WE EXPECT THE PRICE OF OUR EXISTING PRODUCTS TO DECLINE AND IF WE DO NOT REDUCE
OUR MANUFACTURING COSTS OR INTRODUCE NEW PRODUCTS WITH HIGHER MARGINS, OUR GROSS
MARGINS WILL DECLINE AND WE COULD INCUR LOSSES.
Reduced demand for fiber-optic test, measurement and automation
equipment, in addition to competitiveness in our industry will likely result in
the decline of prices for fiber-optic test, measurement and automation
equipment. These price declines result from factors such as:
o increased competition for business;
o reduced demand;
o a limited number of potential customers;
o competition from companies with lower labor and production
costs;
o introduction of new products by competitors;
o greater economies of scale for higher-volume competitors; and
o resale of used equipment.
As prices of our existing products are expected to decline, we may have
to increase our unit volume sold in order to maintain our existing sales level.
Our increased production capacity results in an increase in fixed costs. As a
result, we will have to increase the level of sales to maintain operating
margins. If we are unable to increase the level of sales, continuously reduce
our manufacturing costs or introduce new products with higher margins, our gross
margins would decline.
OUR QUARTERLY OPERATING RESULTS ARE SUBJECT TO SIGNIFICANT FLUCTUATIONS AND YOU
SHOULD NOT RELY ON THEM AS AN INDICATION OF OUR FUTURE PERFORMANCE.
Our sales and operating results have fluctuated from quarter to quarter
in the past and may fluctuate significantly in the future. In addition, our
revenue and operating results generally depend on the volume and timing of the
orders we receive from customers as well as our ability to fulfill the orders
received. Our operating expenses, which include research and development, and
selling and administrative expenses, are relatively fixed in the short term. If
our revenue is lower than we expect because we sell fewer products than we
anticipate or if there is a delay in the release of new products, we may not be
able to quickly reduce our operating expenses in response. Factors that could
affect the amount and timing of our revenue, and cause quarterly fluctuations in
our operating results include:
o the length of our product sales cycle for certain products,
especially those that are higher priced and more complex;
o the timing of introduction and market acceptance of new
products by us, our competitors or our suppliers;
o our ability to sustain product volumes and high levels of
quality across all product lines;
o the timing of shipments for large orders; and
o the effect of potential seasonality in sales.
4
Our operating results could also be affected by the following factors,
some of which we have little or no control over:
o demand for fiber-optic test, measurement and automation
equipment;
o changes in the capital budgets of our customers, which may
cause seasonal or other fluctuations in the product mix,
volume, timing and number of orders we receive from our
customers;
o difficulties in collecting accounts receivable;
o the level of used test, measurement and automation equipment
available for resale;
o restructuring charges; and
o general economic conditions.
Due to these factors, you should not rely on quarter-to-quarter
comparisons of our results of operations as an indication of our future
performance.
IF THE SUPPLY OF HIGH-BANDWIDTH TRANSMISSION NETWORKS SHOULD CONTINUE TO SURPASS
DEMAND, OR IF OPTICAL FIBER IS REPLACED BY ANOTHER MEDIUM AS THE PRIMARY
SOLUTION FOR BANDWIDTH-INTENSIVE APPLICATIONS, WE COULD EXPERIENCE A SIGNIFICANT
LONG-TERM LOSS OF SALES.
Fiber-optic deployment and network capacity increases have slowed
during recent months which has affected optical component and network equipment
manufacturers and operators causing reduced demand for fiber-optic test,
measurement and automation equipment. If such reduced demand should continue
over the mid or long term, or if optical fiber is replaced by a higher
performance medium, this could have a material adverse effect on our business,
financial condition and results of operations.
IF CUSTOMERS FAIL TO MEET THEIR FINANCIAL COMMITMENTS TO US, IT COULD HAVE A
MATERIAL ADVERSE EFFECT ON OUR BUSINESS, RESULTS OF OPERATIONS AND FINANCIAL
CONDITION.
The telecommunications industry is undergoing challenging times. Some
companies are shutting down their operations or going bankrupt. On occasion, we
have had customers who failed to meet their financial commitments to us. We
attempt to reduce the possibility of large outstanding bills remaining unpaid by
carrying out credit checks on customers and by having a diversified customer
base. For example, no customer represented more than 6.4% of our sales in fiscal
2001. However, there is no assurance that such measures will reduce or eliminate
our exposure to customer credits risks. If customers fail to meet their
financial commitments to us, it could have a material adverse effect on our
business, results of operations and financial condition.
AS OUR CUSTOMERS CONSOLIDATE OR ENCOUNTER FINANCIAL DIFFICULTIES, THEY MAY
REDUCE OR HALT PURCHASES OF OUR PRODUCTS, WHICH WOULD CAUSE OUR SALES TO
DECLINE.
Consolidation in the telecommunications industry could reduce the
number of customers to whom our products could be sold. Some of our customers
have been subject to consolidation or are encountering financial difficulty and
are reducing their orders, renegotiating pricing and
5
obtaining products from a source other than us, which cause our sales to
decline. In addition, as a result, some of our manufacturer customers may
discontinue their relationships with us.
WE DEVOTE CONSIDERABLE TIME AND RESOURCES TO SECURING NEW CUSTOMERS AND
IMPROVING SALES TO EXISTING CUSTOMERS. IF WE ARE UNSUCCESSFUL, OUR FUTURE
OPERATING RESULTS MAY SUFFER.
The long sales cycle for some of our products may cause our sales and
operating results to vary significantly from period to period. The period of
time between our initial contact with a customer and the receipt of a purchase
order may span a year or more. In addition, customers perform and require us to
perform, extensive product evaluation and testing of new instruments before
purchasing them. If we are unable to satisfy customer demands, considerable
resources would have been expended without deriving corresponding sales.
OUR CUSTOMERS ARE NOT OBLIGATED TO BUY MATERIAL AMOUNTS OF OUR PRODUCTS AND MAY
CANCEL OR DEFER PURCHASES ON SHORT NOTICE.
Our customers typically purchase our products under individual purchase
orders and may cancel or defer purchases on short notice without significant
penalty. Accordingly, sales in a particular period are difficult to predict.
Decreases in purchases, cancellations of purchase orders, or deferrals of
purchases may have a material adverse effect on our operating results,
particularly if we do not anticipate them.
IF WE FAIL TO PREDICT OUR SUPPLY REQUIREMENTS ACCURATELY, WE WILL HAVE EXCESS
INVENTORY OR INSUFFICIENT INVENTORY, EITHER OF WHICH COULD CAUSE US TO INCUR
ADDITIONAL COSTS, EXPERIENCE MANUFACTURING DELAYS OR INVENTORY OBSOLESCENCE.
We provide forecasts of our requirements to some of our suppliers up to
six months prior to scheduled delivery of products to our customers. If we
overestimate our requirements, we may have excess inventory, which could
increase our costs and harm our relationships with our suppliers due to reduced
future orders or increase the risk of inventory obsolescence for which eventual
write-offs may become necessary. If we underestimate our requirements, we may
have an inadequate inventory of parts. Inadequate inventory could interrupt
manufacturing of our products and result in delays in shipments. In addition,
lead times for materials and parts that we order may be long and depend on
factors such as the procedures of, or supply terms with, a specific supplier and
demand for each part at a given time.
WE DEPEND ON A SINGLE SUPPLIER OR A LIMITED NUMBER OF SUPPLIERS FOR SOME OF THE
KEY COMPONENTS AND MATERIALS IN OUR PRODUCTS, WHICH MAKES US SUSCEPTIBLE TO
SUPPLY SHORTAGES OR PRICE FLUCTUATIONS THAT COULD ADVERSELY AFFECT OUR OPERATING
RESULTS.
We depend on a limited number of suppliers for some of the parts used
to manufacture our products. All our orders are placed through individual
purchase orders and, therefore, our suppliers may stop supplying parts to us at
any time. The reliance on a single source or limited number of suppliers could
result in delivery problems and reduced control over product pricing and
quality. Financial difficulties of suppliers could also affect our ability to
obtain necessary parts in a timely manner. The process of qualifying a new
contract manufacturer for complex products, designed to our specifications, such
as our optical and
6
mechanical parts, is lengthy and would consume a substantial amount of time of
our technical personnel and management. If we sought to change manufacturers in
a short period of time, our business would be disrupted. In addition, we may be
unsuccessful in identifying a new manufacturer capable of and willing to meet
our needs on terms that we would find acceptable.
WE MUST CONTINUE TO OVERCOME SIGNIFICANT AND INCREASING COMPETITION IN OUR
INDUSTRY IN ORDER TO GAIN MARKET SHARE AND INCREASE OUR PRODUCTIVITY.
The market for fiber-optic test, measurement and automation equipment
is rapidly evolving and is marked by intense competition and technical
innovations. We expect the pace of change to accelerate in the future. We also
expect new competitors to emerge or current competitors to consolidate as the
market for fiber-optic test, measurement and automation equipment evolves in
response to technical innovations and economic conditions. Both of these factors
could intensify the competitive pressures that we face.
Some of our current and potential competitors are global electronic
test and measurement manufacturers who complement their broad range of products
with fiber-optic test, measurement and monitoring equipment. Competitors, such
as Acterna Corporation, Agilent Technologies Inc., ANDO Corporation, Anritsu
Corporation, GN Nettest, Newport Corporation and Tektronix, Inc. may have
greater financial, technical and marketing resources. Consequently, these
competitors may be able to devote greater resources to the development,
marketing, sale and support of their products. They may also be better
positioned than we are to acquire companies and new technologies that may
displace our products or make them obsolete.
IF WE ARE UNABLE TO ADAPT TO CURRENT AND FUTURE CHANGES IN TECHNOLOGY, OUR
PRODUCTS MAY BECOME OBSOLETE.
Any failure by us to anticipate or respond to new technological
developments and customer requirements could have a material adverse effect on
our business, financial condition and results of operations. Moreover, the
markets addressed by our current and planned products are rapidly evolving and
are characterized by emerging standards and competing technological platforms.
There can be no assurance that products destined by us for sale into these
markets will adequately address the requirements dictated by evolving standards,
or that we will be able to adapt our products to changes in technology.
Accordingly, we may invest in products and technologies that never gain market
acceptance. Such investments could have a material adverse effect on our
business, financial condition and results of operations.
WE MAY NOT BE ABLE TO INTRODUCE NEW AND ENHANCED PRODUCTS ON A TIMELY BASIS,
WHICH COULD PREVENT US FROM ACHIEVING OUR GROWTH STRATEGY AND ADVERSELY AFFECT
OUR OPERATING RESULTS.
The development of proprietary technologies entails significant
technical and business risks and requires substantial expenditures and lead
time. If we experience product delays in the future, we may face:
o customer dissatisfaction;
7
o cancellation of orders;
o negative publicity;
o loss of sales;
o slower market acceptance of our products; and
o legal actions by customers.
In the future, our efforts to remedy product delays may not be
successful and we may lose customers as a result. Delays in bringing to market
new products or product enhancements could be exploited by our competitors. If
we lose market share as a result of lapses in our product development, our
business would suffer.
OUR PRODUCTS MAY HAVE UNFORESEEN DEFECTS THAT COULD HARM OUR REPUTATION, IMPEDE
MARKET ACCEPTANCE OF OUR PRODUCTS AND NEGATIVELY IMPACT OUR RESULTS OF
OPERATIONS.
As a result of their complexity, our products may contain undetected
errors or compatibility problems or regulatory compliance issues, particularly
when they are first introduced or when new versions are released. There can be
no assurance that, despite our testing, errors will not be found in new products
after they have been fully deployed and operated under peak stress conditions.
If we are unable to fix defects or other problems, we could experience, among
other things:
o loss of customers;
o damage to our brand reputation;
o failure to attract new customers or achieve market acceptance;
o diversion of development and engineering resources;
o legal actions by our customers, including claims for
consequential damages and loss of profits; and
o legal actions by governmental entities, including actions to
impose product recalls and/or forfeitures.
The occurrence of any one or more of the foregoing could seriously harm
our business, financial condition and results of operations.
OUR PRODUCTS MAY BE REQUIRED TO CONFORM TO NEW AND UNFORESEEN REGULATORY
REQUIREMENTS THAT COULD INCREASE OUR COSTS AND REDUCE OUR MARKET SHARE.
Our products are designed to conform to the regulatory requirements of
the countries in which they are marketed. In the event that the technical
regulations applicable in a given country are in any way changed, we may be
required to modify, redesign or recall some or all of our products in order to
continue participating in that market. These changes likely would increase
manufacturing costs and could create technical advantages for products marketed
by our competitors.
8
OUR SALES WOULD SUFFER IF A KEY SALES REPRESENTATIVE OR DISTRIBUTOR STOPPED
SELLING OR REDUCED SALES OF OUR PRODUCTS.
We sell substantially all of our products through a network of
independent sales representatives and distributors, the majority of whom have
exclusive rights to sell our products in specific territories or markets. If we
are unable to provide competitive sales commissions, maintain an appropriate
sales volume, or offer sufficient channel-support, our independent sales
representatives and distributors may discontinue sales of our products and
switch to representing one or more of our competitors, which would result in
reduced sales for us.
WE CANNOT ASSURE THAT WE WILL SUCCESSFULLY INTEGRATE THE BUSINESSES, PRODUCTS,
TECHNOLOGIES OR PERSONNEL OF OUR RECENT AND FUTURE ACQUISITIONS, WHICH MAY HARM
OUR BUSINESS.
For our past and future transaction to be successful, we must
appropriately integrate the businesses, products, technologies and personnel of
Burleigh Instruments, Inc. ("Burleigh"), EXFO Photonic Solutions Inc. ("EXFO
Photonic", formerly EFOS Inc.) and EXFO Protocol Inc. ("EXFO Protocol", formerly
Avantas Networks Corporation), and those of any future acquisitions, with our
own business, products, technologies and personnel in a manner that anticipates
or responds to new technological developments and customer requirements on a
timely basis. In addition, we must coordinate the operations and technologies of
newly acquired companies with our own operations and technologies and manage
geographically dispersed operations. Integration requires the dedication of
management resources that may distract their attention from our day-to-day
business and operations. If we fail to integrate the companies quickly and
efficiently, we may not be able to realize the benefits we expect from these
transactions and there could be a material adverse effect on our business,
financial condition and results of operations.
WE MAY NOT BE ABLE TO MAKE THE NECESSARY ACQUISITIONS NEEDED FOR THE DEVELOPMENT
OF OUR BUSINESS AND ANY ACQUISITIONS WE MAKE COULD DISRUPT OUR BUSINESS AND HARM
OUR FINANCIAL CONDITION.
We intend to seek acquisitions of businesses, products and technologies
that are complementary to ours. There can be no assurance that we will
ultimately make any such acquisition. The consolidation of our competitors may
improve their capacity to acquire the same businesses, products and technologies
that we wish to acquire.
We have made strategic acquisitions, such as our acquisitions of
Nortech Fibronic Inc. ("Nortech"), Burleigh, EXFO Photonic and EXFO Protocol. We
anticipate that in the future, as part of our business strategy, we will
continue to make strategic acquisitions of complementary companies, products and
technologies. In the event of any future acquisition, we could:
o issue shares that would dilute individual shareholder
percentage ownership;
o incur debt;
o assume liabilities and commitments;
o incur expenses related to in-process research and development
and amortization of other intangible assets; or
9
o incur significant impairment losses of goodwill related to
such acquisitions.
These acquisitions also involve numerous risks, including:
o problems combining the acquired operations, technologies or
products;
o unanticipated costs or liabilities;
o diversion of management's attention from our core business;
o adverse effects on existing business relationships with
suppliers and customers;
o risks associated with entering markets in which we have no or
limited prior experience; and
o potential loss of key employees, particularly those of
acquired organizations.
During the fiscal year ended August 31, 2001, our subsidiary Nortech
Fibronic Inc., acquired in February 2000, shut down its business operations.
Though the impact of this closure is not significant, we cannot assure that we
will be able to successfully integrate the other businesses, products,
technologies or personnel acquired or that we might acquire in the future, and
further divestitures or closures could be necessary which may harm our business.
WE MAY BE SUBJECT TO CERTAIN LIABILITIES ASSUMED IN CONNECTION WITH OUR
ACQUISITIONS THAT COULD ADVERSELY AFFECT OUR BUSINESS.
We conduct due diligence in connection with our acquisitions and
incorporate indemnification provisions in our acquisition agreements. To the
extent that prior owners of any acquired businesses failed to comply with or
otherwise violated applicable laws, we may be financially responsible for these
violations or otherwise be adversely affected. The discovery of any material
liabilities after the closing of the transaction could have a material adverse
effect on our financial condition and results of operations. In connection with
our acquisition of Burleigh, EXFO Photonic and EXFO Protocol and the acquisition
by Burleigh Automation Inc. of the assets of Vanguard Technical Solutions, Inc.
("Vanguard"), there may be liabilities that we failed to discover at the time of
the acquisition or that we inadequately assessed in our due diligence efforts.
IF WE FAIL TO ADAPT APPROPRIATELY TO THE CHALLENGES ASSOCIATED WITH OPERATING
INTERNATIONALLY, THE GROWTH OF OUR BUSINESS MAY BE IMPEDED AND OUR OPERATING
RESULTS MAY BE AFFECTED.
For the fiscal year ended August 31, 2001, customers outside of the
United States and Canada accounted for 41.7 % of our sales and for the fifteen
months ended November 30, 2001, these customers accounted for 41.8 % of our
sales. We plan to increase our international sales and have opened offices in
Great Britain, China, Japan, and Singapore. Our international sales will be
limited if we cannot establish relationships with international distributors,
establish additional foreign operations, expand international sales channel
management, hire additional personnel and develop relationships with
international service providers. Even if we are able to successfully continue
our international operations, we may not be able to maintain or increase
international market demand for our products. Our international operations are
subject to a number of risks, including:
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o unexpected changes in regulatory requirements, tax rates or
tariffs that make our products and services more expensive and
therefore less attractive to present and potential customers;
o challenges in staffing and managing foreign operations due to
the limited number of qualified candidates, employment laws
and practices in foreign countries, any of which could
increase the cost and reduce the efficiency of operating in
foreign countries;
o technology standards that differ from those on which our
products are based, which could require expensive redesign and
retention of personnel familiar with those standards;
o longer accounts receivable payment cycles and possible
difficulties in collecting payments which may increase our
operating costs and hurt our financial performance;
o political and economic instability; and
o certification requirements.
Any of these factors could harm our international operations and
negatively affect our financial performance. The recurrence of weakness in these
economies or of weakness in other foreign economies could have a significant
negative effect on our future operating results.
WE RECENTLY IMPLEMENTED AN ENTERPRISE RESOURCE PLANNING (ERP) SYSTEM, AND IF
THIS INFORMATION TECHNOLOGY PROJECT PROVES TO BE UNWIELDY OR IF THE SOFTWARE
TOOL TURNS OUT TO BE INEFFECTIVE, IT COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR
BUSINESS, RESULTS OF OPERATIONS AND FINANCIAL CONDITION.
We implemented an ERP system in early December 2001 to help increase
the efficiency of our operations. This required a significant investment in
money, time and resources. More than 400 employees were trained on the software
tool and the smooth transition from one system to another has not yet been
accomplished. If this information technology project proves to be unwieldy or if
the software tool turns out to be ineffective, it could have a material adverse
effect on our business, results of operations and financial condition.
WE REQUIRE EMPLOYEES WHO ARE KNOWLEDGEABLE ABOUT THE SPECIALIZED NATURE OF OUR
BUSINESS. IF WE ARE UNABLE TO ATTRACT AND RETAIN SUFFICIENT NUMBERS OF HIGHLY
SKILLED TECHNICAL, SALES AND MARKETING AND OTHER PERSONNEL, OUR OPERATIONS AND
FINANCIAL RESULTS WOULD SUFFER.
Due to the specialized nature of our business, we are highly dependent
on the continued service of and on the ability to attract and retain, qualified
engineering, sales, marketing and senior management personnel in the area of
fiber optics. The loss of key employees or management personnel could have a
material adverse effect on our business and operating results. We may not be
able to continue to attract and retain the qualified personnel necessary for the
development of our business.
We must provide significant training for our employee base due to the
highly specialized nature of fiber-optic test, measurement and automation
equipment. Our current engineering
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personnel may be inadequate and we may fail to assimilate and train new
employees. Highly skilled employees with the education and training that we
require, especially employees with significant experience and expertise in fiber
optics, are in high demand. Once trained, our employees may be hired by our
competitors.
OUR BUSINESS STRATEGY AND OUR ABILITY TO MAINTAIN OUR COMPETITIVE POSITION
DEPEND ON THE CONTINUED SERVICES OF OUR SENIOR MANAGEMENT TEAM LED BY GERMAIN
LAMONDE, OUR CHAIRMAN OF THE BOARD, PRESIDENT AND CHIEF EXECUTIVE OFFICER. THE
LOSS OF ANY MEMBER OF THE SENIOR MANAGEMENT TEAM WOULD ADVERSELY AFFECT OUR
BUSINESS.
Our ability to maintain our competitive position depends to a
significant extent on the efforts and abilities of our senior management,
particularly Germain Lamonde, our Chairman of the Board, President and Chief
Executive Officer. The managerial, technical and other services of our senior
management team would be difficult to replace and if we lose the services of one
or more of our executive officers, or if one of them decides to join a
competitor or otherwise compete directly or indirectly against us, our business
would be seriously harmed. The loss of their services would jeopardize our
ability to maintain our competitive position. We do not have "key person" life
insurance policies covering any of our employees.
OUR INTELLECTUAL PROPERTY AND PROPRIETARY TECHNOLOGY ARE IMPORTANT TO THE
CONTINUED SUCCESS OF OUR BUSINESS. OUR FAILURE TO PROTECT THIS PROPRIETARY
TECHNOLOGY MAY SIGNIFICANTLY IMPAIR OUR COMPETITIVE POSITION.
Our success and ability to compete depend to a significant extent on
out proprietary technology, since that is how we attempt to keep others from
using the innovations that are central to our existing and future products. We
currently hold 18 U.S. and 7 Canadian issued patents and have 16 U.S. and 15
Canadian patent applications pending, along with 4 patent applications pending
under the Patent Cooperation Treaty. We also rely on a combination of copyright
and trademark laws, trade secrets, confidentiality procedures, contractual
provisions and license agreements to protect our proprietary technology. We may
have to engage in litigation in order to protect our patents and other
intellectual property rights, or to determine the validity or scope of the
proprietary rights of others. This kind of litigation can be time-consuming and
expensive, regardless of whether we win or lose. Because it is critical to our
success that we are able to prevent competitors from copying our innovations, we
intend to continue to seek patent and trade secret protection for our
technologies. The process of seeking patent protection can be long and expensive
and we cannot be certain that any currently pending or future applications will
actually result in issued patents, or that, even if patents are issued, they
will be of sufficient scope or strength to provide meaningful protection or any
commercial advantage to us. Furthermore, others may develop technologies that
are similar or superior to our technology, or design around the patents that we
own. We also rely on trade secret protection for our technology, in part through
confidentiality agreements with our employees, consultants, distributors and
third parties. However, these agreements may be breached or otherwise not
effective and we may not have adequate remedies for any breach or shortfall of
these agreements. In any case, others may come to know about our trade secrets
through a variety of methods. In addition, the laws of some territories in which
we sell our products may not protect our intellectual property rights to the
same extent as do the laws of Canada and the United States.
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Despite our efforts, our intellectual property rights, particularly our
existing or future patents, may be invalidated, circumvented, challenged or
required to be licensed to others. Furthermore, others may develop technologies
that are similar or superior to our technology, duplicate or reverse engineer
our technology, or design around the patents owned or licensed by us. We cannot
be sure that the steps that we take to protect our technology will prevent
misappropriation or infringement. If we fail to protect our technology so that
others may copy or use it, we will be less able to differentiate our products
and our sales will decline.
IF OTHERS CLAIM THAT OUR PRODUCTS INFRINGE UPON THEIR INTELLECTUAL PROPERTY
RIGHTS, WE MAY BE FORCED TO SEEK EXPENSIVE LICENSES, RE-ENGINEER OUR PRODUCTS,
ENGAGE IN EXPENSIVE AND TIME-CONSUMING LITIGATION OR STOP MARKETING THE
CHALLENGED PRODUCTS, WHICH COULD ADVERSELY AFFECT OUR ABILITY TO SELL OUR
PRODUCTS AND COULD INCREASE OUR COSTS.
Litigation regarding intellectual property rights is common in the
technology industry and, for this reason, we expect that third-party
infringement claims involving technologies may increase. If an infringement
claim is filed against us, we may be prevented from using some of our
technologies and may incur significant costs to resolve the claim.
We could incur substantial costs in defending ourselves and our
customers against infringement claims. Litigation could also adversely affect
sales of the challenged product or technology and divert the efforts of our
management and technical personnel. In the event of a claim of infringement, we
may be required to obtain one or more licenses from third parties. We cannot
assure you that we, or our customers, could obtain necessary licenses from third
parties at a reasonable cost or at all. If we fail to obtain a license where one
is required, we could incur substantial liabilities and be forced to suspend the
marketing of the challenged products.
OUR INSURANCE MAY NOT BE SUFFICIENT TO COVER ALL POTENTIAL LIABILITY. A
SUCCESSFUL CLAIM EXCEEDING OUR POLICY LIMITS WILL REDUCE OUR WORKING CAPITAL,
INCREASE OUR EXPENSES AND HAVE A NEGATIVE EFFECT ON OUR OPERATING RESULTS.
Our products are designed to help telecommunications carriers and
manufacturers of optical components, value-added optical modules and optical
networking systems ensure network reliability. The failure of our products to
perform to client expectations could give rise to product liability and warranty
claims. We carry insurance for product liability and take accounting reserves
for warranty claims that we consider adequate in view of industry practice. In
addition, we may face other types of claims by third parties in relation to the
conduct of our business and a successful claim against us for an amount
exceeding our policy limits would force us to use our own resources to pay the
claim, which could result in a reduction of our working capital available for
other uses, increase our expenses and have a negative effect on our financial
condition and results of operations.
WE MAY BECOME INVOLVED IN COSTLY AND TIME-CONSUMING LITIGATION THAT MAY
SUBSTANTIALLY INCREASE OUR COSTS AND HARM OUR BUSINESS.
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We may from time to time become involved in various lawsuits and legal
proceedings. For example, EXFO is a defendant in a putative securities class
action filed in the United States District Court for the Southern District of
New York. In addition, we have instituted a claim against a former employee of
one of our subsidiaries, in relation to a breach of contractual confidentiality
obligations. Litigation is subject to inherent uncertainties, and an adverse
result in these or other matters that may arise from time to time could have a
material adverse effect on our business, results of operations or financial
condition.
Any litigation to which we are subject could require significant
involvement of our senior management and may divert management attention from
our business and operations. For more information about current legal
proceedings, see "Item 4B - Legal Proceedings".
FLUCTUATIONS IN THE EXCHANGE RATES BETWEEN THE CANADIAN DOLLAR AND THE US DOLLAR
AND OTHER CURRENCIES MAY ADVERSELY AFFECT OUR OPERATING MARGINS.
The majority of our sales is denominated in US dollars. However, a
large portion of our operating expenses and capital expenditures are denominated
in Canadian dollars. As a result, we are exposed to fluctuations in the exchange
rates between the Canadian dollar and the US dollar and other currencies. An
increase in the value of the Canadian dollar relative to the US dollar could
have a material adverse effect on our operating margins.
UNEXPECTED DECLINES IN OUR RESEARCH AND DEVELOPMENT TAX CREDITS AND GRANTS MAY
HAVE AN ADVERSE EFFECT ON OUR BUSINESS.
Our historical operating results reflect substantial benefits from
programs sponsored by federal, provincial and state governments for the support
of research and development. Research and development tax credits and grants
represented 22.7 % of our gross research and development expenses for the year
ended August 31, 2001 and 23.2 % for the fifteen months ended November 30, 2001.
If unexpected changes in the laws or government policies terminate or
adversely modify the Canadian and Quebec government programs, under which we
receive the major part of our research and development tax credits and grants,
or if we unexpectedly become unable to participate in or take advantage of these
programs, then our net research and development expenses will materially
increase. To the extent that we increase our research and development activities
outside Canada or Quebec, which could result from, among other things, future
acquisitions, the increased activities may not be eligible for these programs.
If we are required to decrease our research and development activities, we may
be unable to compete effectively.
WE MAY NEED ADDITIONAL CAPITAL, AND MAY NOT BE ABLE TO RAISE ADDITIONAL CAPITAL
ON FAVORABLE TERMS OR AT ALL, WHICH COULD LIMIT OUR ABILITY TO GROW AND COULD
INCREASE OUR COSTS.
Our future liquidity and capital requirements are difficult to predict
because they depend on numerous factors, including the success of our existing
and new product offerings as well as competing technological and market
developments. As a result, we may not be able to generate sufficient cash from
our operations to meet additional working capital requirements,
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support additional capital expenditures or take advantage of acquisition
opportunities. Accordingly, we may need to raise additional capital in the
future.
Our ability to obtain additional financing will be subject to a number
of factors, including market conditions and our operating performance. These
factors may render the timing, amount, terms and conditions of additional
financing unattractive for us. If we raise additional funds by selling equity
securities, the relative ownership of our existing investors could be diluted or
the new investors could obtain terms more favorable than previous investors. If
we raise additional funds through debt financing, we could incur significant
borrowing costs. If we are unable to raise additional funds when needed, our
ability to operate and grow our business could be impeded.
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ITEM 4. INFORMATION ON THE COMPANY
A. HISTORY AND DEVELOPMENT OF THE COMPANY
Our legal name and commercial name is EXFO Electro-Optical Engineering
Inc. /EXFO Ingenierie Electro-Optique Inc. Our head office is located at 465
Godin Avenue, Vanier, Quebec, Canada, G1M 3G7 and our telephone number is (418)
683-0211. Our e-mail address is info@exfo.com and our Web site is www.exfo.com.
Information on our Web site is not incorporated by reference in this annual
report. Our agent for service in the United States is CT Corporation System, 111
Eighth Avenue, New York, New York 10011. This annual report contains trademarks
and registered trademarks of EXFO and other companies.
We were incorporated on September 18, 1985 pursuant to the CANADA
BUSINESS CORPORATIONS ACT. Since that date, we have amended our articles on
various occasions mainly to modify our corporate name and our share capital.
In 1996, GEXFO Investissements Technologiques inc. ("GEXFO"), a company
controlled by Germain Lamonde, acquired a majority interest in GAP Optique S.A.
("GAP Optique"), a Swiss limited liability company carrying out activities in
the field of fiber-optic testing and measurement technology. In 1996, GEXFO,
EXFO, GAP Optique and the University of Geneva entered into agreements whereby
GAP Optique, EXFO and GEXFO obtained worldwide exclusive rights to commercially
develop, manufacture and market specified technologies relating to fiber-optic
telecommunications testing and measurement instruments developed by the
University of Geneva. In addition, GAP Optique, EXFO and GEXFO acquired priority
rights over the marketing of fiber-optic telecommunication testing and
measurement instruments prototypes designed by the University of Geneva. This
agreement was renegotiated under similar terms and conditions in 1999 for a
five-year term. On June 1, 2000, we acquired the 85% interest held by GEXFO in
GAP Optique for a consideration equal to its book value of approximately $16,000
and GEXFO transferred all of its rights in the agreements to us.
In February 2000, we acquired all of the shares of Nortech Fibronic
Inc., a company specializing in fiber-optic testing and temperature-sensing for
a total consideration of $2.8 million of which $2.1 million was paid in cash. We
also issued C$800,000 (approximately $553,000) of Class "G" shares, which were
converted into 800,000 preferred shares series 1 in June 2000, and a debenture
of $200,000 (approximately $138,000) bearing no interest and payable on November
30, 2000. In November 2000, the former shareholders of Nortech agreed with us to
make a purchase price adjustment, as a result of which we received $104,000 in
cash from a portion of the purchase price previously held in escrow and reduced
the purchase price for the 800,000 preferred shares series 1 from C$800,000
($543,000) to C$544,000 ($354,000), which were purchased by us on November 30,
2000 and subsequently cancelled. In June 2001, Nortech ceased operations. The
majority of its assets were sold to a third party and we acquired the remaining
assets.
In connection with and immediately prior to our initial public offering
in July 2000, we modified our authorized share capital to its current status,
which consists of:
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o an unlimited number of subordinate voting shares without par
value;
o an unlimited number of multiple voting shares without par
value;
o an unlimited number of preferred shares without par value,
issuable in series; and proceeded with the following
exchanges:
o the 38,000,000 Class "A" shares outstanding at that time were
exchanged into 38,000,000 multiple voting shares;
o the 707,264 Class "F" shares outstanding at that time were
exchanged into 707,264 subordinate voting shares;
o the 800,000 Class "G" shares outstanding at that time were
exchanged into 800,000 preferred shares series 1.
The exchange of Class "A" shares into multiple voting shares, of Class
"F" shares into subordinate voting shares and of Class "G" shares into preferred
shares series 1 was part of our capital reorganization completed prior to our
initial public offering and did not involve any disbursement of funds.
On July 6, 2000, we completed our initial public offering as a result
of which we issued a total of 8,050,000 subordinate voting shares, including
1,050,000 subordinate voting shares pursuant to the exercise of the
over-allotment by the underwriters. All the 8,050,000 subordinate voting shares
were sold to the public at an offering price of $26.00.
On December 20, 2000, we acquired all of the issued and outstanding
shares of common stock of Burleigh, Burleigh Instruments GmBH and Burleigh
Instruments (U.K.) Ltd. at an aggregate purchase price of approximately US$189.3
million, comprised of 6,488,816 of our subordinate voting shares and
approximately US$42.5 million in cash pursuant to the terms of an Agreement of
Merger and Plan of Reorganization among us, EXFO Sub, Inc. and the selling
shareholders, dated November 4, 2000, as amended on December 20, 2000.
Burleigh, which has been in operation for 30 years and had 91 employees
as of December 31, 2001, has received industry recognition for its
high-performance optical wavelength meters and precision positioning equipment.
Its Wavemeter (R) instruments offer one of the highest wavelength measurement
accuracy in the industry. These products are able to determine the absolute
wavelength of a laser under test within 0.3 picometers at 1500 nm. Its Inchworm
(R) precision positioning equipment provides nanometer accuracy, which is
critical for precision alignment in the optical component manufacturing process.
Both of these product lines are supported by a broad proprietary intellectual
property portfolio.
In March 2001, we acquired all of the shares of EFOS Inc., a privately
held company in Toronto, Canada, for a total consideration of $111 million, of
which $25 million was paid in cash. We also issued 3,700,000 of our subordinate
voting shares. In September 2001, the name EFOS Inc. was changed to EXFO
Photonic Solutions Inc.
EXFO Photonic, operating since 1984 and having 52 employees as of
December 31, 2001, is recognized as a leader in precision light-based adhesive
spot curing as well as curing process control for the global optical component
manufacturing market and other non-telecom markets. Its products deliver precise
doses of the appropriate spectral light into photo-sensitive
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and heat-cured adhesives to significantly reduce bonding time and increase
repeatability in optical component manufacturing. EXFO Photonic light-based
curing technologies are supported by an extensive understanding of bonding and
material sciences and by a broad intellectual property portfolio, including 11
patents and 11 patents pending.
Also in March 2001, our wholly owned subsidiary, Burleigh Automation
Inc. ("Burleigh Automation"), acquired substantially all the assets of Vanguard,
a wholly owned subsidiary of DT Industries, Inc. for a purchase price of
approximately $600,000 paid in cash. Vanguard, an automation equipment
manufacturer in Tucson, Arizona, specializes in the design and manufacturing of
ultra-precision assembly equipment for sensitive process and critical assembly
challenges on the production floor. This acquisition, which complements our
acquisition of Burleigh fits with our overall strategy to provide customers with
a comprehensive solution for the assembly, alignment and testing of optical
components and subsystems. Since September 2001, Burleigh Automation has ceased
operations and we have been in the process of transferring all material
intellectual property assets and most of the physical assets of Burleigh
Automation to Burleigh.
We were forced to re-align our cost structure to market conditions
twice during the past year. On June 27, 2001, we announced the reduction of
non-customer-related expenses, postponement of plans to build a new facility in
the Quebec Metro High-Tech Park, termination of non-core operations of Nortech,
a subsidiary that specialized in manufacturing fiber-optic temperature sensors,
and reduction of our workforce by 15%. On December 5, 2001, we announced the
lowering of our operating expenses, a freeze in employee salaries, and the
reduction of our workforce by 10%.
In November 2001, we acquired all of the shares of Avantas Networks
Corporation and simultaneously changed the name of that company to EXFO Protocol
Inc. ("EXFO Protocol"). We paid a total consideration of approximately $65
million (or $93 million for the equity minus $28 million of cash in the hands of
the acquired company) to acquire EXFO Protocol. Consideration paid consisted of
4,374,573 of our subordinate voting shares and $36 million in cash.
EXFO Protocol, a pre-revenue company based in Montreal, Canada
operating since 1998 and having 116 employees as of December 31, 2001 is a
supplier of fiber-optic testing and optical network performance management
equipment that supports a wide range of protocols and data transmission rates.
B. BUSINESS OVERVIEW
We are a leading designer, manufacturer and marketer of fiber-optic
test, measurement and automation solutions for the global telecommunications
industry. More than 2,000 customers rely on our test instruments and systems in
research and development laboratories and production environments and to enable
the world's optical networks to perform impeccably during their complete
lifecycles. We currently employ 1,099 employees and our products are distributed
in more than 70 countries around the world.
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EXFO was founded in 1985 in Quebec City. Our original products were
focused primarily on the needs of installers and operators of fiber-optic
networks. These products are marketed in what is known today as our Portable and
Monitoring Division. This division markets its products mainly to
telecommunications carriers and network service providers. These customers use
Portable and Monitoring Division products for installation and maintenance,
network monitoring and troubleshooting applications. In 1996, we supplemented
our product portfolio with an extensive line of Industrial and Scientific
products that are dedicated to the manufacturing as well as research and
development markets in the fiber-optic industry. Our Industrial and Scientific
products tend to be more complex and higher priced than our Portable and
Monitoring products. Industrial and Scientific Division customers include
optical component and system manufacturers as well and research and development
laboratories. In 1999, we entered the market for remote fiber test systems
("RFTS"). RFTS, which are marketed through our Portable and Monitoring Division,
allow carriers to deploy test equipment throughout their networks in order to
monitor the integrity of their fiber-optic networks on a continuous basis.
In fiscal 2001, we launched more than 20 products. Key product launches
included the FTB-400 Universal Test System, the successor to our highly
successful FTB-300 that performs essential tests for DWDM long-haul, metro and
access networks; the OWA-9500 Optical Waveguide Analyzer, the industry's first
and only commercial refractive index profiler for market-winning planar and
arrayed waveguides; the FR-3000 NanoRobot(R) Photonics Alignment System with
multi-axis alignment and 0.1 nanometer resolution for automated component
manufacturing applications; and the Novacure(R) IR, which uses infrared
spot-curing on conventional heat-cured adhesives.
In fiscal 2001, we also opened new sales offices and service centers in
Singapore and Beijing to better serve our customers in the Asia-Pacific region.
The expansion into the Asia-Pacific market proved to be a winning strategy since
sales almost tripled year-over-year in this area. Furthermore, we moved our
Paris office to a more spacious location in order to strengthen sales,
application engineering and marketing services throughout Europe.
We announced three strategic acquisitions in fiscal 2001 to penetrate
new technological sectors and increase our addressable markets. We acquired
Burleigh for its wavelength measurement instruments and nano-positioning
alignment systems. For almost three decades, Burleigh has advanced the science
of interferometric measurement techniques and developed a deep understanding of
precision positioning technology. As a result, Burleigh's Wavemeter(TM) products
offer one of the highest wavelength measurement accuracy in the industry, while
its Inchworm(TM) motor-based precision positioning line enables unmatched
position control for optical components and sub-components.
We acquired EXFO Photonic for its precision light-based, adhesive
spot-curing technology. EXFO Photonic products deliver precise doses of the
appropriate spectral light onto photosensitive and heat-cured adhesives to
significantly reduce bonding time and increase repeatability in optical
component manufacturing. Both Burleigh and EXFO Photonic will add to sales in
our Industrial and Scientific Division.
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We acquired EXFO Protocol (formerly Avantas Networks Corporation), a
supplier of leading-edge, fiber-optic testing and optical network performance
management equipment that supports a wide range of protocols and data
transmission rates. EXFO Protocol should increase sales in both product
divisions, but initially in our Portable and Monitoring Division.
This latest acquisition will enable us to enter the critical
protocol-layer testing market and almost double our addressable market size to
an estimated $3.3 billion, according to reports from Frost and Sullivan, a
world-reknown market consulting firm on emerging high-technology and industrial
markets. In lay terms, our products test the highway, or the fiber, optical
components and value-added optical modules that make up the physical layer of an
optical network. Our products also cover the numerous lanes along the highway,
or the DWDM wavelengths carrying bandwidth within the optical layer of a
network. With the acquisition of EXFO Protocol, our products will also test the
traffic, or the bits and bytes running through the protocol layer of a network.
We have received more than 45 industry and commerce awards. In 2001, we
were named one of the top 100 employers in Canada by Maclean's, a national
current affairs magazine. In 2000, we were selected winners of the Outstanding
Corporate Innovator Award by the U.S.-based Product Development and Management
Association. Prior to becoming a public company in June 2000, we had been
recognized as one of the 50 Best-Managed Private Companies in Canada by Arthur
Andersen Consulting and the Financial Post for five consecutive years.
THE EXFO SOLUTION
We believe that we offer the most extensive range of products in the
fiber-optic test, measurement, monitoring and automation industry. Our success
has been largely predicated on our exclusive focus on fiber optics. Our solution
is based on the following key attributes:
MODULAR SYSTEM DESIGN. In 1996, we introduced the first products
designed around our modular system design. This system design consists of a
Windows-based platform that can accommodate several data acquisition test
modules. We have since developed products for each of our divisions based on the
same modular design. Our modular design provides the following advantages:
o Unlike stand-alone units, new test modules can be rapidly
developed to address the changing requirements of the
industry.
o As customers' testing requirements change, they can purchase
additional modules that are compatible with their previously
purchased platforms, thus protecting their initial
investments.
o Our standard graphical user interface reduces training costs
because customers are familiar with previously acquired
software products.
o The flexibility of our systems allows customers to develop
customized and automated solutions directed at specific
testing requirements.
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HIGH DEGREE OF TECHNOLOGICAL INNOVATION. We continue to be at the
forefront of fiber-optic test, measurement and automation technology. For
example, in the past we were the first in our industry to develop and market a
number of fiber-optic test and measurement products and we have continued to do
so through recent product releases:
o PORTABLE OPTICAL SPECTRUM ANALYZER (OSA). In 2000, we supplied
the market with the first OSA to provide lab-quality
specifications for rugged, portable use in the field. This
instrument is useful for measuring key parameters of each
wavelength in a DWDM system.
o OPTICAL WAVEGUIDE ANALYZER. In 2001, we released our Optical
Waveguide Analyzer, which represents the industry's first
commercial refractive index profiler for planar and arrayed
waveguides. The refractive index profile of next-generation
optical devices like arrayed waveguides is a critical
parameter to measure in order to control and optimize the
manufacturing process.
PRODUCTS OF HIGH QUALITY. Product quality is an integral part of our
solution. Our Quebec City-based operations have maintained ISO 9001
certification since 1994 and they are now certified to the new 2000 edition of
the standard. Our subsidiaries in Montreal, Toronto and Victor, NY, have
rigorous quality assurance programs, but they are not yet certified. Our
products meet industry standards, such as those set by Telcordia, formerly
Bellcore, IEC, and other industry-leading standards bodies. During
manufacturing, each product has a related quality assurance plan, with rigorous
checkpoints, to reduce defects to a minimum. Various tasks in the quality
assurance process in all our facilities include quality control, conformity
testing, product documentation, product improvement, regulatory compliance,
metrology and calibration.
SUPERIOR CUSTOMER SUPPORT. We use highly qualified and specialized
internal groups to offer pre-sales evaluation, installation, channel and
customer training, communications and post-sales support. We believe that this
approach provides us with an advantage over our competitors, who often outsource
some of these functions. We have two Customer Service Groups, one being
responsible for the North American market and the other for our international
customers. Our Customer Service Groups are mainly responsible for supporting our
sales force, recommending instruments that best match our customers' testing,
measurement and automation needs, providing detailed quotations, order
management, technical support and training as well as calibration and repair
services. Our Communications and Marketing Group, which operates like an
internal advertising agency, educates our customers and our sales force by
providing detailed marketing and technical information. Literature includes
specification sheets, application notes, Web content, product catalogues and a
bi-monthly corporate newsletter. Finally, our Writing Services Group provides
technical writing for product instruction manuals. Our documentation is
available in several different languages.
OUR STRATEGY
We intend to expand our leadership position in the fiber-optic test,
measurement and automation industry and to increase our market share through the
following initiatives:
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EXPAND TECHNOLOGICAL LEADERSHIP. We believe that our ultimate success
will depend on our ability to introduce enhanced products that meet the changing
needs of our customers. We, therefore, will continue to invest heavily in
research and development. We increased gross research and development
expenditures 88% to $17.6 million in fiscal 2001 from $9.4 million in 2000.
Altogether, 46% of our sales in 2001 originated from products that have been on
the market for two years or less. We dedicate more than 30% of our employees to
research and development, including an advanced research group that carries out
research activities, monitors technological trends in the industry and maintains
links with numerous universities, industry associations and standards bodies.
INVEST IN STRATEGIC SECTORS. We have established an award-winning
innovation process. Our product portfolio review process ensures that our
research and development activities are aligned with our corporate strategy.
This rigorous review process has led us to focus on the following growth
vehicles for the upcoming year: new product rollouts, protocol-layer testing
solutions and semi-automated manufacturing solutions.
o NEW PRODUCT ROLLOUTS. We will continue to roll out disruptive
technologies and drive approval of international standards.
This initiative has been demonstrated by the recent
introduction of our Femtosecond PMD Analyzer, whose
revolutionary technology has been accepted as a reference test
method by international standards bodies. Our Femtosecond PMD
Analyzer enables users to measure the smallest PMD values in
narrowband DWDM channels and broadband components in the
simplest, fastest and most repeatable manner. This latest
breakthrough reflects our commitment to developing
leading-edge technologies that have tremendous competitive
advantages in high-growth nascent sectors.
o PROTOCOL-LAYER TESTING SOLUTIONS. We plan to combine newly
acquired protocol-layer testing technologies from EXFO
Protocol with our physical and optical-layer testing equipment
and integrate them inside our FTB-400 UTS field-testing
platform. Since the acquisition of EXFO Protocol, we released
a Gigabit Ethernet module for our field-testing platform to
support increasingly high-speed communications in metro and
access areas. In 2002, we intend to launch a fully integrated
solution that will enable field technicians to be far more
efficient and cost-effective because they will seamlessly
carry out physical-, optical- and protocol-layer tests with a
single platform in their hands. As a result, we will be
providing customers with the most complete and cost-effective
DWDM field-testing solution on the market.
o SEMI-AUTOMATED MANUFACTURING SOLUTIONS. We will extend our
involvement in automated component manufacturing by leveraging
our expertise in automated test stations. With this vision in
mind, we acquired Burleigh for its multi-axis,
nano-positioning alignment robots and EXFO Photonic for its
precision light-based, adhesive spot-curing systems. We plan
to combine these technologies with our automated testing
expertise to offer our customers stand-alone products and
semi-automated manufacturing solutions that help them increase
yields and reduce costs on the production floor. We also
intend to seek strategic partnerships with leading system
integrators in order to allow them to customize our
semi-automated solutions
22
to the specific processes that continue to be unique and
proprietary to each manufacturer.
LEVERAGE OUR MODULAR DESIGN. The modularity and compatibility of our
Windows-based platforms enable us to offer the same instrument design to as many
as three different market segments with a single research and development
project. This practice lessens the number of different designs, including
optical, mechanical, electronic and software, that we must develop and
manufacture. We capitalize on the flexible architecture of our Windows-based
systems to expand our solutions portfolio and to offer specialized products to
specific markets. By being able to provide new functionality through the design
of a new module rather than through the design of a completely new instrument,
we can be quicker to market with new testing technologies and provide more
specialized testing solutions.
PURSUE COMPLEMENTARY ACQUISITIONS. We believe that market fragmentation
in the test, measurement and automation industry creates opportunities for
consolidation. We plan to aggressively pursue strategic acquisitions that will
provide us with additional key technologies, complement our product offerings,
increase our sales channels and add to our overall level of expertise.
PRODUCTS
Our products are designed for the global fiber-optic test, measurement
and automation industry. We have adapted our product divisions to meet the needs
of two main markets. Our Portable and Monitoring Division serves
telecommunications carriers, cable television companies, public utilities,
private network operators, third-party installers and equipment rental
companies. This market requires rugged, field-portable and easy-to-use
equipment.
Our Industrial and Scientific Division supplies optical component and
system manufacturers as well as university and government research laboratories.
This market requires highly accurate and reliable instruments and systems that
carry out testing in the shortest periods of time possible.
At the core of our test, measurement and automation equipment are our
FTB-400 Universal Test System (UTS) and IQ-200 Optical Test System (OTS)
platforms. Our FTB-400 UTS provides carriers with a simple, yet efficient way to
perform multiple, advanced test operations for installation, maintenance and
troubleshooting applications. Our IQ-200 OTS is a scalable unit that is suited
for manufacturing, laboratory engineering and research applications. The added
benefit of our IQ-200 OTS is that manufacturers can design their own automated
test setup or we can customize a setup for them. Our FTB-400 UTS and IQ-200 OTS
platforms are fully supported by integrated and highly intuitive graphical user
interfaces, enabling the user to easily store, handle and retrieve a large
amount of data.
The following table summarizes the principal types of instruments we
provide, their typical applications and the format in which we offer them:
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FORMAT
-------------------------------------------------------
INSTRUMENT TYPE TYPICAL APPLICATION PORTABLE SCIENTIFIC
--------------- ------------------- ---------------------- --------------------------
FTB 400 IQ200 BENCHTOP
UTS MODULES HANDHELD OTS MODULES INSTRUMENTS
----------- -------- ----------- -----------
Optical time Like a radar, it measures the time
domain of arrival of reflections of an
reflectometers optical signal to determine the X
(OTDRs) distance to the breaks or points of
excessive loss in a fiber network.
Optical spectrum Produces a graphical representation
analyzers of power versus wavelength for an
optical signal. Useful for measuring
the drift, power and signal-to-noise X X
ratio for each wavelength in a DWDM
system.
Optical power Measures the power of an optical
meters signal. It is the basic tool for
the verification of transmitters, X X X X
amplifiers and optical transmission
path integrity.
Widely tunable Can produce laser light across a
lasers broad range of wavelengths. Used to
test DWDM components and value-added X X
optical modules.
Narrowly tunable A laser that can be precisely tuned to
lasers simuate a DWDM light sources. Used
primarily in testing optical X
amplifiers.
Polarization mode Measures the dispersion of light that
dispersion is cause by polarization. Generally
analyzers used to determine the speed-distance X X
limitation of fiber and cables.
Femtosecond Measures very small levels of
polarization mode polarization mode dispersion in DWDM
dispersion and broadband components in the X
analyzer simplest, fastest and most
repeatable manner.
Multi-wavelength Measures the power and drift for
meters multiple wavelengths in a DWDM X X X
system.
Variable optical Used in network simulation setups to
attenuators provide calibrated variable
reduction of the strength of an X X X
optical signal.
Polarization Measures the difference in loss of
dependent loss power for the different states of X
meters polarization.
Loss test sets Integrates a power meter and a light
source to manually or automatically
measure the loss of optical signal X X X X
along a fiber.
Stable light Emitting diode or lasers used in
sources connection with a power meter to X X X X
measure signal loss.
Optical fiber Measures the geometric and light
parameter analyzer guiding properties of an optical
fiber. Used in new fiber research X
and development and quality control
applications.
Optical amplifier Boosts the power of laser sources.
Used for the testing and calibration X
of test systems.
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FORMAT
-------------------------------------------------------
INSTRUMENT TYPE TYPICAL APPLICATION PORTABLE SCIENTIFIC
--------------- ------------------- ---------------------- --------------------------
FTB 400 IQ200 BENCHTOP
UTS MODULES HANDHELD OTS MODULES INSTRUMENTS
----------- -------- ----------- -----------
Optical switches Provides switching between fibers.
Used to provide flexible and
automated test setups such as the
measurement of multiple fibers or X X
components with multiple ports with
one instrument.
Optical power Provides a highly accurate and
reference module traceable measurement of power for
the calibration or verification of X
other power measurement instruments.
Broadband source Used for testing wavelength
dependent behavior of fiber cables X X
and DWDM optical components.
Talk sets A device which attaches to an
optical fiber and serves as a
temporary voice link facilitating X X
coordination of work among
installation crews.
Optical return Combines a laser and a power meter
loss meters to measure the amount of potentially X X X X
degrading back reflection.
Visual fault A visible laser that can be
locators connected to an optical fiber
network to help locate breaks or X X
points of excessive loss.
Live fiber Clips on to a fiber and is used to
detector detect the presence and direction of
a signal without interrupting the X
traffic.
Clip-on coupling Clips to an optical fiber and allows X
non-invasive testing.
Optical waveguide Provides the refractive index
analyzer profile of glass and fused
silica-based devices used in next X
generation networks.
Light-based Technology by which a dose of energy
curing instrument of a specific wavelength, bandwidth
and irradiance is used to cause an
adhesive, encapsulant or sealant to X
change from a liquid to a solid in a
small area. Used to bond optical
components and sub-components.
Passive component Characterizes passive wavelength-selective
analyzer devices, such as multiplexers, demultiplexers
and add/drop filters, with respect to X
absolute wavelength in order to guarantee
their performance within DWDM systems.
Gigabit Ethernet Measures data integrity for
tester high-speed internet protocol
communications in metro and edge X
networks.
SONET/ SDH Provide accurate bit-error rate and
Analyzers performance analysis of SONET/SDH
overhead format that reflect the X X
quality of a transmission system.
Nanorobot Offers multi-axis alignment and can
photonics position optical devices with a
alignment system nanometer resolution, which is
essential during the alignment of X
optical components in the
manufacturing process.
25
PORTABLE AND MONITORING PRODUCTS
We offer an extensive range of products for fiber-optic testing,
measurement and monitoring applications. Our test and measurement products are
available as handheld test instruments or as field-portable platforms with
related modules. Our handheld instruments are durable, compact and easy to use.
Our second-generation field-testing platform, the FTB-400 UTS, is available in a
two-slot configuration for basic OTDR and optical loss testing, or a seven-slot
configuration for high-end DWDM testing, PMD characterization, high fiber-count
testing as well as OTDR and optical loss testing. We also offer the FTB-100
Mini-OTDR with an integrated power meter option. This cost-effective platform
provides field technicians with basic OTDR testing capabilities. Our portable
platforms are rugged, Windows-based, battery-powered units. Their large
environmentally robust touchscreens are very practical for field use.
Our network monitoring solution is better known as FiberVisor.
FiberVisor consists of rack-mounted remote test units that are strategically
deployed along a fiber-optic network, and a test system controller that
retrieves information in real time from as many remote test units as required.
The test system controller is typically located inside a network operations
center. The information obtained from these remote test units is combined with
data from a geographic information system in our FiberVisor system to pinpoint
the exact location of a system failure and rapidly provide the required
information to a restoration team. We were first-to-market with DWDM monitoring
capabilities on our RFTS, which includes the physical and optical layer. We will
further extend its capabilities to the protocol layer with EXFO Protocol's
Network Guardian G2, an optical network performance management system that
supports a wide range of protocols and data transmission rates.
EXFO Protocol, which is exclusively dedicated to fiber-optic protocol
testing, offers the Service Test Gear (STG) Series and Network Guardian G2, a
Gigabit Ethernet test module for the FTB-400.
Its portable STG Series supports multi-protocols like Asynchronous
Transfer Mode (ATM), Synchronous Optical Network (SONET), Synchronous Digital
Hierarchy (SDH), Gigabit Ethernet and Ethernet, as well as data transmission
rates from OC-192 (10 Gb/s) down to DS0 (64 kb/s) for the North American
standard, and STM-64 (10 Gb/s) down to E0 (64 kb/s) for the equivalent
international standard. All of these functionalities are available on a single
platform.
EXFO Protocol's remote optical network performance management system,
Network Guardian G2, provides real-time surveillance 24 hours per day, seven
days per week. A single administrator can simultaneously observe critical
quality of service parameters at key locations along the network by relying on
data from remote Network Guardians.
INDUSTRIAL AND SCIENTIFIC PRODUCTS
Our Industrial and Scientific product line is mainly built around our
IQ-200 OTS platform and is available as modules or stand-alone benchtop
instruments. The base platform is a Windows-based system, which includes a
Pentium processor, liquid crystal screen and three slots to accept test modules.
This base platform can be supplemented by as many as four expansion
26
platforms, each capable of housing six additional modules, which can be
connected and controlled to provide additional functionality and capacity. These
expansion platforms can also be controlled via a personal computer. Altogether,
the IQ-200 OTS platform and expansion platforms can hold as many as 27 modules
and test as many as 108 channels.
The modular nature of our IQ-200 OTS platform is adapted for complex
applications involving the synchronized operation of several instruments.
Our Industrial and Scientific Division also addresses testing problems
that cannot be handled by standard modules or stand-alone benchtop instruments.
We have dedicated a team of engineers to develop custom-made, integrated test
systems for customers with specific needs. Some of these integrated test
systems, in turn, are modified and offered as off-the-shelf test systems to suit
a wider range of customers. In addition, we have created a software development
kit for developers who prefer writing their own programs for our instruments. We
provide automated systems for assembly, calibration and environmental testing of
optical components, value-added optical modules and optical networking systems
such as:
o Multifiber test system Used for quality assurance
testing of multifiber
patchcords and interconnect
assemblies. These devices,
including hybrid and fan-out
patchcords, are commonly used
in fiber systems.
o Optical calibration test system Used to calibrate power
meters, light sources,
variable attenuators and
optical time domain
reflectometers.
o Environmental test system Allows users to perform
long-term qualification
testing of optical components
and value-added optical
modules under varying
environmental conditions
primarily to ensure
compliance with industry
standards.
o DWDM passive component test system Used to automatically
characterize all critical
specifications, including
spectral insertion loss,
polarization-dependent loss,
and optical return loss, of a
DWDM passive component with a
high degree of accuracy, ease
of use, and speed.
o Comb Controller Used to adjust the power of
bank of DFB-ITU lasers in
order to test loading
conditions of optical
amplifiers.
Burleigh and EXFO Photonic further enhance our Industrial and
Scientific Division product portfolio by enabling customers to automate critical
steps in the optical component manufacturing process. These critical steps
include automated fiber alignment (Burleigh) and precision light-based, adhesive
spot curing (EXFO Photonic).
Key products from Burleigh include the FR-3000 NanoRobot(R) Alignment
System, which provides multi-axis alignment and can position optical devices
with a 0.1 nanometer resolution. Burleigh also offers test and measurement
instruments like Optical Channel Analyzers and Passive Component Analyzers.
27
EXFO Photonic provides precision light-based, adhesive spot-curing
technologies as well as curing process control for the global optical component
manufacturing market. Its products deliver precise doses of the appropriate
spectral light onto photosensitive and heat-cured adhesives to significantly
reduce bonding time and increase repeatability in optical component
manufacturing. Key products include the Novacure(R) IR, which uses infrared
spot-curing on conventional heat-cure adhesives, and Novacure(R), a bonding
solution that delivers all the benefits of ultraviolet and visible spot-curing
on photosensitive adhesives.
RESEARCH AND DEVELOPMENT
We believe that our future success largely depends on our ability to
maintain and enhance our core technology and product functionality. To keep
developing new products and enhancements, it is important that we recruit and
retain highly skilled engineers, scientists and technicians. As of December 31,
2001, our research and development departments included 315 full-time engineers,
scientists and technicians, of whom 46 hold post-graduate degrees. Gross
research and development expenditures for fiscal 2001 reached $17.6 million
compared to $9.4 million for fiscal 2000.
Through a market-oriented, product portfolio review process, we ensure
that our investments in research and development are aligned with our customers'
needs and strategies. This approach enables us to maximize our returns on
research and development investments by focusing our resources on a limited
number of prioritized projects. Quarterly product portfolio review meetings
enable us to choose a realistic, balanced mix of new products and allocate the
necessary resources for their development. All our projects, including those
already underway, are reviewed, given a priority rating and allocated budgets
and resources. Our existing projects can be stopped or substantially redefined
if there have been significant changes in market conditions, or if the project
development schedule or budget has been significantly exceeded.
To manage our research projects once they are underway, we use a
structured management process known as the stage-gate approach. The stage-gate
approach is based on a systematic review of a project's feasibility at various
stages of its life cycle. The following are the key review stages of the
stage-gate approach:
o market study and research feasibility;
o product definition;
o development feasibility;
o development;
o qualification; and
o transfer to production.
28
At each stage, we review our project risks, costs and estimated
completion time. We compare our design to anticipated market needs and ensure
that our project is synchronized with other internal departments and external
industry events. The inter-related portfolio review and stage-gate processes
enabled us to be named winners of the Outstanding Corporate Innovator Award in
2000 by the U.S.-based Product Development and Management Association.
CUSTOMERS
More than 2,000 customers in 70 countries around the world rely on our
test instruments and systems in research and development laboratories and
production environments and to enable optical networks to perform impeccably
during their complete lifecycles. Our customers include telecommunications
carriers, cable television companies, public utilities, private network
operators, third-party installers, equipment rental companies as well as optical
component and system manufacturers. Our top three customers in terms of sales
for fiscal 2001 were Verizon Communications, Nortel Networks Corporation and TSH
Tech Development, a Chinese-based distributor. During fiscal 2001, no single
customer accounted for more than 6.4% of our sales. With regard to geographic
distribution, North American customers represented 58.3% of our sales, while
international customers accounted for 41.7%. Our international sales are largely
handled by a network of distributors around the world.
SALES
We sell our fiber-optic test, measurement and automation products
through direct and indirect sales networks in the United States and Canada as
well as around the world. We also have two Customer Service Groups to meet the
needs of existing and new customers in North America and on the international
front. These groups are responsible for providing quotations to customers,
supporting our sales force, managing demonstration units, order management,
technical support and training as well as calibration and repair services.
UNITED STATES AND CANADA SALES
In the United States and Canada, our direct sales network consists of a
vice-president supported by a 45-member team of regional sales managers, sales
engineers and application engineers, who are located throughout major
metropolitan areas. Our group of sales professionals has a minimum average of 12
years of experience in the fields of telecommunications, fiber optics, or test,
measurement and monitoring.
In Canada, the direct to customer sales team addresses the carrier,
manufacturing and research and development markets for our test, measurement and
monitoring equipment and our manufacturing automation products. Sales personnel
are located in metropolitan areas throughout the country.
In the United States, we have adopted a market-specific sales strategy.
Different sales organizations have been created to maximize coverage and
penetration of our main markets:
o CARRIER MARKET. This sales team targets customers who own,
operate or install networks as their primary business. This
market includes telecommunications
29
carriers, cable television companies, public utilities,
private network operators, as well as third-party installers
and equipment rental companies.
o MANUFACTURING/R&D MARKET. Two sales teams specializing
respectively in our test, measurement and monitoring equipment
and in our manufacturing automation products target customers
who research, develop or manufacture optical networking
products and components. In this market, some regional sales
managers also have direct responsibility for serving our
larger manufacturing customers. This organizational structure
allows us to adequately cover the demands of a highly
technical customer base and to identify and penetrate the
large multi-function accounts, diverse and smaller customers,
university researchers, military contractors, contract
manufacturers and other evolving market segments.
Our main sales office in the United States is located in Richardson,
Texas. We also maintain sales personnel in numerous metropolitan areas and rely
on more than 20 sales representatives situated throughout the United States.
INTERNATIONAL SALES
Our international sales network includes a vice-president, a general
manager in Europe and two sales directors covering Latin America and Asia, all
supported by a team of 24 sales professionals. Our direct sales network in
Europe is supported by a main office and service center in Paris, France, which
maintains our head European sales operations and also provides repair and
calibration services for our European, Middle East and African customers. Our
main office for Asia is in Singapore and we have also established service
centers in Singapore and Beijing to better serve our customer base in the
Asia-Pacific region. In addition, we have other sales offices in strategic
locations around the world to support our network of distributors and customers.
Finally, we rely on more than 50 distributors to support our international
sales. We feel that the local presence and cultural attributes of our
distributors allow us to better serve our global markets.
MARKETING, COMMUNICATIONS AND CUSTOMER SUPPORT
MARKETING
Our Marketing Group consists of 30 product managers and marketing
analysts who have various degrees in engineering, science and business
administration. Product managers, with the assistance of marketing analysts, are
responsible for all aspects of our marketing program including product strategy,
new product introductions, definition of new features and functions, pricing,
product launches and advertising campaigns. Marketing analysts help product
managers develop marketing programs with tools such as our Web site, CD-ROMs,
advertisements, mailouts and customer presentations. We follow up our marketing
initiatives by attending industry trade shows. Furthermore, we have implemented
a customer relationship management system to compile market and customer
information including forecasts, leads and competitive data. We use this
information to make strategic business decisions. Finally, our strategic
marketing team analyses markets, market trends, compiles competitive information
and identifies macro-trends in our sector.
30
COMMUNICATIONS
Our Communications Group, which mainly consists of commercial writers
and graphic artists, supports our Marketing Group by producing marketing and
corporate documentation. Literature includes specification sheets, application
notes, product catalogues, advertising copy and a bi-monthly corporate
newsletter. Our Communications Group is also responsible for maintaining and
updating our Web site.
CUSTOMER SUPPORT
We have developed a Customer Support Group that serves customers and
distributors around the world in English, French, Spanish and German. Our
Customer Support Group consists of three distinct units: technical support,
order management and a repair and calibration authorization service center. A
frequently asked question database is also updated regularly on our Web site.
MANUFACTURING
Manufacturing operations consist mainly of material planning,
procurement, sub-assembly, final assembly, testing, software loading,
calibration, quality assurance and shipping and billing.
As of December 31, 2001, we had 354 employees involved in our
manufacturing operations. Our manufacturing operations, which occupy
approximately 139,900 square feet, are spread among four buildings in three
cities. We have two buildings that occupy 113,900 square feet in Quebec City,
Canada, one building that occupies 10,000 square feet in Victor, United States,
and another building that occupies 16,000 square feet in Toronto, Canada. Our
manufacturing operations in Quebec City are handled by three inter-related
departments:
o PRODUCTION. Our production department is responsible for
manufacturing high-quality products on time. Each cell
consists of specialized technicians and has full
responsibility over a product group. Technicians are versatile
enough so that they can perform specific functions within a
cell and they can be transferred to other cells when required
to alleviate bottlenecks. Furthermore, this department is
responsible for manufacturing schedules, finished goods
warehousing, customs management, shipping and billing.
o PRODUCTION ENGINEERING AND QUALITY. This department, which
supports our production cells, acts like a gatekeeper to
ensure the quality of our products and the effectiveness of
our manufacturing processes. It is responsible for the
transfer of products from research and development to
manufacturing, product improvement, documentation, metrology,
repairs and the quality assurance and regulatory compliance
process. Quality assurance represents a key element in our
manufacturing operations. We meticulously verify our
instruments to ensure that they meet stringent industry
requirements and provide our customers with detailed product
test sheets. Our quality assurance program in Quebec City has
been certified ISO 9001 since 1994.
31
o SUPPLY-CHAIN MANAGEMENT. This department is responsible for
parts procurement, raw materials and forecasting. Our products
consist of optical, electronic and mechanical parts.
Approximately one-third of our parts are manufactured to our
specifications. Some parts are obtained from single-source
suppliers. We manage risks associated with single-source
suppliers, as well as parts that are subject to industry
shortages or long delivery lead times, through a strategic
forecasting process that involves procuring excess inventory
where appropriate.
Manufacturing operations at Burleigh, EXFO Photonic and EXFO Protocol
follow a similar process with the exception that some non-critical tasks, such
as the stuffing of printed circuit boards, are outsourced.
COMPETITION
The fiber-optic test, measurement and automation industry is highly
competitive and subject to rapid change as a result of technological
developments and other factors. We compete with many different companies,
depending on product family and geographical market. We believe that the main
competitive factors in the industry include the following:
o product performance and reliability;
o level of technological innovation;
o product lead times;
o breadth of product offering;
o ease of use;
o customer service and technical support;
o strength of sales and distribution relationships; and
o price.
Generally, our competitors fall into two categories. The first category
consists of global electronic test and measurement manufacturers, who complement
their broad range of products with fiber-optic test, measurement and automation
equipment. These companies include Acterna Corporation, Agilent Technologies,
Inc., Ando Corporation, Anritsu Corporation, GN Nettest and Tektronix, Inc.
The second category refers to niche companies in the fiber-optic test,
measurement and automation industry. These companies typically have limited
product lines and in some cases may be geographically limited in their customer
base. Such companies include Digital Lightwave, Inc., ILX Lightwave Corporation,
JDS Uniphase Corporation, Kingfisher International PTY Ltd., Newport Corporation
and Santec Corporation.
32
REGULATORY ENVIRONMENT
In most countries where our products are sold, our products must comply
with the regulations of one or more governmental entities. These regulations
often are complex and vary from country to country. Depending upon the country
and the relevant product, the applicable regulations may require product
testing, approval, registration, marking and unique design restrictions.
Accordingly, we have appointed a team of engineers who are responsible for
ensuring that our products comply with all applicable regulations.
In the United States, our products must comply with the regulations of
several agencies of the U.S. federal government, including the Federal
Communications Commission, or the FCC, the Food and Drug Administration, or the
FDA and the Occupational Safety and Health Administration, or OSHA. Under the
FCC's regulations, our products must comply with, among other things, rules
concerning unintentional radio frequency emissions that interfere with protected
radio communications systems. Depending upon the product, compliance with these
rules may necessitate applying for and obtaining an FCC equipment authorization
prior to importing into the United States, or marketing, any units of the
relevant product. Additionally, some of our products must comply with the FDA's
performance standards and related rules concerning light-emitting products, such
as lasers. The FDA's regulations are intended to promote safety by limiting
human exposure to harmful electromagnetic radiation. Similarly, our products
must comply with OSHA's design safety standards for systems that utilize
electricity. These rules are intended to reduce the risk of accidental human
electrocution.
Similar regulations apply in other countries. For example, our products
are subject to the safety standards of Industry Canada and the Canadian
Standards Association with respect to electricity utilization and radio
frequency emissions. Other countries in the world require equipment marking in
accordance with the standards of the European Community, often referred to as CE
marking, testing to ensure compliance with International Electrotechnical
Commission standards and other international product approval. Other significant
types of regulations not described in this annual report also may apply,
depending upon the relevant product and country.
INTELLECTUAL PROPERTY
Our success and ability to compete are dependent in part on our ability
to develop and protect our proprietary technology. We file U.S. and Canadian
patent applications to protect technology, inventions and improvements important
to the development of our business. We also rely on a combination of copyright,
trademark, trade secret rights, licensing and confidentiality agreements.
We currently hold 18 U.S.-issued and seven Canadian-issued patents and
we have 16 U.S., 15 Canadian and 4 Patent Cooperation Treaty patent applications
pending. These issued and pending patents cover various aspects of our products
and processes. The expiration dates of our issued patents range from January 16,
2010 to June 14, 2020.
We consider five of our inventions for which patents have either been
granted or are pending to be material. These inventions are:
33
o the optical time domain reflectometer with internal reference
reflector for which a patent was granted in the United States
and is pending in Canada. This invention permits the control
of the optical time domain reflectometer detector gain and the
determination of the loss of the initial optical connector and
is used in most of our optical time domain reflectometer-based
products;
o the measurement of attenuation of optical fibers using
bidirectional transmission of information via the fiber for
which patents were granted in the United States and Canada.
This invention forms the basis of our FOT-920 and FTB-3920
products;
o an adapter for interconnecting optical fiber connectors for
which patents are pending in Canada and the United States.
This invention permits a wide variety of connectors to be
joined to our test and measurement instruments;
o the light cure system with closed loop control and work piece
recording which is at the heart of the spot-curing systems
manufactured by EXFO Photonic for which patents were granted
in the United States and Canada; and
o the portable test gear for TDM and packet based communications
for which patent applications have been filed in Canada, the
United States and pursuant to the Patent Cooperation Treaty
form the basis of the technology used by EXFO Protocol for its
protocol testing products.
Confidentiality and proprietary information agreements with our senior
management, employees and others generally stipulate that all confidential
information developed or made known to these individuals by us during the course
of their relationship is to be kept confidential and not disclosed to third
parties, except in specific circumstances. The agreements also generally provide
that all intellectual property developed by the individual in the course of
rendering services to us belongs exclusively to us. These efforts afford only
limited protection.
LEGAL PROCEEDINGS
On November 27, 2001, a class action suit was filed in the United
States District Court for the Southern District of New York by John Williams,
and others similarly situated, against us, four of the underwriters of our
initial public offering (Merrill Lynch, Pierce, Fenner & Smith, Inc., RBC
Dominion Securities Inc., Wit Soundview Corporation and CIBC World Markets Inc.)
and Messrs. Germain Lamonde and Pierre Plamondon pursuant to the SECURITIES
EXCHANGE ACT OF 1934 and Rule 106-5 promulgated thereunder and sections 11, 12
and 16 of the SECURITIES ACT OF 1933. This class action alleges that our
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 our shares issued in
connection with our initial public offering; and (ii) the underwriters allegedly
entering into agreements with customers whereby our shares issued in connection
with our initial public offering would be allocated to those customers in
exchange for which such customers agreed to purchase additional amounts of our
shares in the after market at pre-determined prices. The plaintiff in this suit
seeks an unspecified amount for
34
damages suffered. We believe that our executive officers and we have fully
complied with all applicable securities laws and that the claims against our
officers and us are without merit. We have referred this matter to our insurers
and plan to vigorously defend our position in this litigation. However, we are
unable to predict the outcome of this case and if it is adversely determined, it
could have certain adverse effects on our business, including potential monetary
damages.
On December 12, 2000, GAP Optique instituted legal proceedings with the
Juridiction des Prud'hommes in Geneva, Switzerland against an ex-employee for
breach of a confidentiality obligation as stipulated in his employment contract.
GAP is claiming monetary damages only since Swiss law does not allow injunctive
relief in this case. Mr. Patrick Stamp was hired by our subsidiary, GAP Optique
on May 1, 1998. Mr. Stamp's employment contract contained a confidentiality
clause that prohibits disclosure or use of any confidential information he may
obtain during the course of his work. The contract provides that this obligation
continues for a period of one year following termination of the employment
agreement. Mr. Stamp left GAP Optique in February 2000 to create a start-up
company called LUCIOL Instruments, S.A ("LUCIOL") with the help of two former
employees of the University of Geneva. LUCIOL presently manufactures and sells
fiber optic test instruments, of which two (a chromatic dispersion analyzer and
a photon-counting OTDR) were developed jointly by GAP Optique and the University
of Geneva. Mr. Stamp participated in the development of these instruments during
employment with GAP Optique and the University. Therefore, it is the contention
of GAP Optique that Mr. Stamp is now using illegally, through LUCIOL, the
proprietary and confidential information he obtained during his employment in
order to market the particular test instruments. A preliminary hearing was held
on November 1, 2001 and the proceedings will resume in January 2002.
There are no other legal or arbitration proceedings pending or
threatened of which we are aware which may have or have had a significant effect
on our financial position.
35
C. ORGANIZATIONAL STRUCTURE
As of December 31, 2001, the following chart presents our corporate
structure, the jurisdiction of incorporation of our subsidiaries and the
percentage of shares that we hold in those subsidiaries.
[GRAPHIC OMITTED]
[ORGANIZATION CHART]
EXFO Electro-Optical
Engineering Inc.
18/09/85
(Canada)
Operating
100% 100% 100% 85% 100% 100% 100%
EXFO UK Limited EXFO Photonic GEXFO Distribution GAP Optique SA EXFO Asia Pacific Nortech Fibronic Inc. EXFO Protocol Inc.
27/02/01 Solutions Inc. Internationale Inc. 17/05/94 PTE Ltd. 14/08/91 (formerly Avantas)
(United Kingdom) (formerly Efos 17/12/92 (Switzerland) 18/01/01 (Canada) Networks
Operating Inc.) (Quebec) Operating (Singapore) Non-operating Corporation)
(Ontario) Holding Operating 02/11/2001
Operating (Canada)
Operating
GEXFO NORTECH
100% 100% 100% 100%
EXFO Europe EXFO International EXFO USA Inc. Nortech Fibronic Inc.
S.A.R.L. Services Management 07/12/00 (Texas)
08/02/94 LLC (Delaware) Dissolved 07/09/01
(France) 22/11/00 Holding
Operating (Hungary)-Operating
EXFO USA INC.
100% 100%
EXFO America Inc. Burleigh Instruments Inc.
15/12/92 25/08/72
(Delaware) (New York)
Operating Operating
BURLEIGH
100% 100% 100%
Burleigh Intruments Burleigh Instruments Burleigh
(UK) Ltd. GmbH Automation Inc.
(United Kingdom) (Germany) (Delaware)
Non-operating Non-operating Non-oeprating
D. PROPERTY, PLANT AND EQUIPMENT
Our main offices and facilities are located near Quebec City, Canada
where we occupy three buildings. These buildings house our executive and
administrative offices, research and development facilities and production
facilities. In addition, we maintain sales offices in Brazil, China, France,
Germany, Great Britain, Japan, Singapore, Russia and the United States.
Burleigh's facilities are located in Victor, in the state of New York, EXFO
Photonic is located near Toronto, Canada and EXFO Protocol is located near
Montreal, Canada.
During the fiscal year ended August 31, 2001, we increased our
manufacturing operations in Quebec City and acquired parcels of adjoining land
with a building that we use for warehouse purposes. These improvements were
completed at a cost of $4,601,241, which was financed through our short-term
investments. Our plans to build a new 150,000 square foot facility to house
research and development, administration and marketing departments in the fall
of 2001 were postponed indefinitely in order to align our cost structure to
market conditions and mitigate the impact of the slowdown being felt in the
telecommunications industry. In addition, during the fiscal year ended August
31, 2001, Burleigh completed expansion of its facilities in New York State that
effectively doubled its square footage at a cost of $362,340 incurred from
December 20, 2000, the date we acquired Burleigh, to August 31, 2001.
36
In addition, when our subsidiary, Nortech, ceased activities in June
2001, the lease for the premises situated at 500 St-Jean-Baptiste Street, Quebec
City was cancelled upon payment of CDN$51,000 to the landlord.
The following table sets forth information with respect to the main
facilities that we occupy as of December 31, 2001.
LOCATION USE OF SPACE SQUARE FOOTAGE TYPE OF INTEREST
-------- ------------ -------------- ----------------
436 Nolin Street Manufacturing 44,164 Leased
Vanier (Quebec)
400 Godin Avenue Research and Development, 128,800 Owned
Vanier (Quebec) Manufacturing and Administrative
465 Godin Avenue Executive and Administrative 24,000 Leased
Vanier (Quebec)
2260 Argentia Road Research and Development, 36,000 Leased
Mississauga (Ontario) Manufacturing and Administrative
2650 Marie-Curie Research and Development, 26,000 Leased
St-Laurent (Quebec) Manufacturing and Administrative
7647 Main Street Research and Development, 40,000 Owned
Fishers Victor (New Manufacturing and Administrative
York)
37
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
The following discussion and analysis of the consolidated financial
condition and results of operations of EXFO Electro-Optical Engineering Inc.
(EXFO) for the fiscal years ended August 31, 2001, 2000 and 1999 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 accounting
principles generally accepted in Canada, or Canadian GAAP. To the extent
applicable to our consolidated financial statements included elsewhere in this
annual report, these principles conform in all material respects with accounting
principles generally accepted in the United States, or US GAAP, except as
described in note 19 to our consolidated financial statements.
FORWARD-LOOKING STATEMENTS
This annual report contains forward-looking statements that involve
risks and uncertainties. These statements relate to our future plans,
objectives, expectations and intentions. We have identified these statements by
the use of words such as "may," "will," "expect," "anticipate," "intend,"
"plan," "estimate," "believe," "continue" or other similar expressions. These
forward-looking statements reflect our current expectations and assumptions as
to future events that may not prove to be accurate. Our actual results are
subject to a number of risks and uncertainties and could differ materially from
those discussed in these statements. Factors that could contribute to these
differences include, but are not limited to, those discussed in "Item 3 - Risk
Factors" of this annual report. In light of the many risks and uncertainties
surrounding our business and operations, you should keep in mind that we cannot
guarantee that the forward-looking statements described in this annual report
will transpire. We undertake no obligation and do not intend to update or revise
any forward-looking statement, whether as a result of new information, future
events or otherwise, except as may be required under applicable law.
CORPORATE HIGHLIGHTS
EXFO REPORTS STRONG YEAR-END FINANCIAL RESULTS
EXFO announced in October 2001 it had increased sales by 104% to $146.0
million for the fiscal year ended August 31, 2001 from $71.6 million in 2000.
Net earnings, excluding amortization of goodwill and the after-tax effect of
amortization of intangible assets and non-recurring expenses, jumped 139% to
$24.5 million, or $0.46 per share, for fiscal 2001 from $10.3 million, or $0.26
per share, for 2000. Including amortization of intangible assets and goodwill
related to acquisitions as well as non-recurring expenses, EXFO's net loss for
fiscal 2001 was $15.3 million, or $0.29 per share. In comparison, EXFO recorded
net earnings of $9.9 million, or $0.25 per share, in fiscal 2000.
38
EXFO ACQUIRES AVANTAS NETWORKS
EXFO reported in August 2001 it had entered into an agreement to
acquire Avantas Networks Corporation (now EXFO Protocol Inc.) for $68 million,
or $96 million for the equity minus $28 million of cash on hand in that company.
Consideration paid consisted of 4.4 million EXFO shares and $36 million in cash.
EXFO Protocol Inc. is a supplier of leading-edge fiber-optic testing and optical
network performance management equipment that supports a wide range of protocols
and data transmission rates.
EXFO LAUNCHES MORE THAN 20 PRODUCTS IN 2001
EXFO announced in August 2001 it had launched more than 20 products in
fiscal 2001. Key product launches included the FTB-400 Universal Test System,
which is the industry's first modular platform that can perform essential
physical layer tests for DWDM long-haul, metro and access networks; the OWA-9500
Optical Waveguide Analyzer, which represents the industry's first and only
commercial refractive index profiler for all-important planar and arrayed
waveguides; the FR-3000 NanoRobot(R) Alignment System with multi-axis alignment
and 0.1-nanometer resolution for automated component manufacturing applications;
and the Novacure(R) IR, which uses infrared spot-curing on conventional
heat-cured adhesives.
EXFO OPENS SALES OFFICES AND SERVICE CENTERS IN ASIA
EXFO opened sales offices and service centers in Singapore and Beijing
during fiscal 2001 to better serve its customers abroad. The expansion into the
Asian market proved to be a winning strategy since sales almost tripled from
fiscal 2000 to 2001 in this region. EXFO also relocated its Paris office to
strengthen sales, application engineering and marketing services throughout
Europe.
EXFO ACQUIRES EFOS
EXFO announced in March 2001 it had acquired EFOS Inc., now EXFO
Photonic Solutions Inc., for 3.7 million shares valued at $85 million and $25
million in cash. EXFO Photonic Solutions is a leader in precision light-based
adhesive spot curing technologies as well as curing process control for the
global optical component manufacturing market.
EXFO JOINS TSE 300
EXFO announced in February 2001 it had been added to the Toronto Stock
Exchange (TSE) 300 Composite Index as well as the TSE 300 Capped, S&P/TSE
Canadian SmallCap and TSE 200 Indices. The TSE 300 Composite Index is a
benchmark used to measure the price performance of the broad Canadian equity
market.
EXFO ACQUIRES BURLEIGH INSTRUMENTS
39
EXFO announced in December 2000 it had acquired Burleigh Instruments,
Inc. for $6.5 million shares valued at $147 million and $42 million in cash.
Burleigh is a leading supplier of DWDM wavelength measurement instruments and
precision positioning equipment.
INDUSTRY OVERVIEW
OPTICAL NETWORKING MARKET
The past decade has witnessed an explosive growth in the volume of data
traffic largely due to the soaring popularity of the Internet and related
bandwidth-intensive applications. According to information technology industry
analysts, the number of Internet users around the world is expected to increase
from 400 million in 2001 to nearly one billion, or 15% of the total population,
by 2005. In addition, users are increasingly seeking applications that require a
great deal of bandwidth such as video conferencing, video-on-demand, HDTV,
e-commerce and rich media streaming.
The dramatic increase in Internet users and in bandwidth-intensive
applications has created a tremendous need for high-capacity communication
networks. To meet this increasing demand for bandwidth, many telecommunication
carriers are designing and installing new networks based on optical fiber,
deploying additional fiber within their existing networks or using advances in
optical technology such as Dense Wavelength Division Multiplexing, or DWDM. DWDM
involves combining beams of light of slightly different wavelengths through a
single fiber, with each wavelength carrying its own stream of information. DWDM
has wide market acceptance because it incorporates technologies that greatly
reduce the cost of optical transmission over long distances and because it
provides network flexibility in access and metropolitan areas. According to
Kessler Marketing Intelligence (KMI), the global DWDM Transport Equipment Market
is expected to increase from $7.1 billion in 2001 to $23.2 billion in 2005.
Although the long-term outlook for the telecommunications industry
remains robust, 2001 was marked by a slowdown in the overall economy and reduced
capital spending in the optical networking market. On the carrier side, we
observed a trend towards maximizing existing networks by increasing transmission
rates and adding DWDM channels, while delaying deployment of new fiber cables.
For optical component and system manufacturers, the slowdown in the buildout of
new networks resulted in excess inventories throughout the industry. Despite
this over-supply of optical components, the most established component and
system manufacturers did not significantly slash their R&D budgets in order to
remain competitive in designing next-generation products. As a result, new
production lines are still being rolled out in significant numbers.
OPTICAL TEST, MEASUREMENT AND AUTOMATION EQUIPMENT MARKET
Fiber-optic test, measurement and automation equipment is essential for
research and development, manufacturing, network installation and maintenance as
well as network monitoring.
40
Conventional test and measurement instruments used by telecommunication
carriers and manufacturers of communications equipment were designed for
electrical transmission systems and are unsuitable for optical networking.
Unlike traditional electrical transmission systems, which transmit electrical
signals along copper wires, fiber-optic transmission systems use pulses of light
along glass or plastic fiber, referred to as optical fiber. When light travels
along optical fiber and through the optical components and systems that link
optical fibers together, it is subject to unwanted effects such as reflection,
attenuation, noise and various types of dispersion, all of which degrade signal
quality and reduce transmission performance. Fiber-optic test and measurement
equipment is critical for measuring these effects and helping carriers and
manufacturers of optical components, value-added optical modules and optical
networking systems ensure network performance, efficiency and reliability.
Data sent along an optical network must respect transmission protocols,
such as ATM, SONET, SDH, Ethernet and Gigabit Ethernet, and fall within accepted
data transmission rates from 64 kb/s to 10 Gb/s. Otherwise, the information sent
from a transmitter will not be understandable to the receiver. Fiber-optic test
and measurement equipment like a bit-error rate tester is used to ensure data
integrity.
Optical components and value-added optical modules, which make up an
optical network, are typically assembled by hand on the production floor. Yields
are inevitably low and costs are high. As a result, optical component vendors
are increasingly looking for ways to increase efficiency and reduce costs by
adopting automated manufacturing solutions. They either build these complex
solutions in-house or turn to equipment manufacturers to help them automate
critical steps in the manufacturing process such as alignment, curing and
optical testing. The latter option enables optical component vendors to devote
their scarce technical resources to developing next-generation products instead
of manufacturing tools.
The fiber-optic test, measurement and automation market has not been
immune to the challenging conditions in the optical networking sector. However,
vendors with extensive product portfolios that include advanced optical test
instruments were still able to market their products to carriers, who needed to
upgrade their networks to higher transmission rates or add DWDM channels.
Likewise, test, measurement and automation vendors, whose products increase
efficiency and reduce costs on the production floor, still attracted the
attention of optical component and system manufacturers, who kept investing in
their R&D programs to stay ahead of the competition.
CORPORATE OVERVIEW
EXFO was incorporated on September 18, 1985. Our original products were
focused primarily on the needs of installers and operators of fiber-optic
networks. These products are marketed in what is known today as our Portable and
Monitoring Division. This division markets its products mainly to
telecommunication carriers and network service providers. These customers use
Portable and Monitoring Division products for installation and maintenance,
monitoring and troubleshooting applications. In 1996, we supplemented our
product portfolio with an extensive line of Industrial and Scientific products
that are dedicated to the research and development as well as manufacturing
markets in the fiber-optic industry. Our Industrial
41
and Scientific products tend to be more complex and higher priced than our
Portable and Monitoring products. Industrial and Scientific Division customers
include optical component and system manufacturers as well and research and
development laboratories. In fiscal 1999, we entered the market for remote fiber
test systems. Remote fiber test systems, which are marketed through our Portable
and Monitoring Division, allow carriers to deploy test equipment throughout
their networks in order to monitor the integrity of their fiber-optic networks.
In fiscal 2001, we announced three strategic acquisitions to bolster
growth in both of our product divisions. We acquired Burleigh Instruments for
its wavelength measurement instruments and nano-positioning alignment systems.
We added EFOS (renamed EXFO Photonic Solutions) for its precision light-based,
adhesive spot-curing technology. Both of these companies are expected to
accelerate growth in our Industrial and Scientific Division. Finally, we reached
an agreement to acquire Avantas Networks, a supplier of leading-edge,
fiber-optic testing and optical network performance management equipment that
supports a wide range of protocols and data transmission rates. Avantas should
increase sales in both product divisions, but initially in our Portable and
Monitoring Division.
The Avantas acquisition will enable us to enter the critical
protocol-layer testing market and, more importantly, almost double our
addressable market size to an estimated $3.3 billion, according to reports from
Frost and Sullivan. In layman's terms, EXFO products test the highway, or the
fiber, optical components and value-added optical modules that make up the
physical layer of an optical network. Our products also cover the numerous lanes
along the highway, or the DWDM wavelengths carrying bandwidth within the optical
layer of a network. With the Avantas acquisition, EXFO products will also test
the traffic, or the bits and bytes, running through the protocol layer of a
network.
We sell our products to more than 2000 customers through our direct
sales force and indirectly through distribution channels. Cost of sales include
raw materials, salaries and related expenses for direct and indirect
manufacturing personnel and manufacturing overhead.
Selling and administrative expenses consist primarily of salaries and
related expenses for personnel, sales commissions, travel expenses, marketing
programs, professional services, management 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 as well as fees
paid to third-party consultants. We are eligible to receive research and
development (R&D) tax credits and government grants. Related R&D tax credits and
government grants are recorded as a reduction of gross R&D expenses.
42
RESULTS OF OPERATIONS
The following table sets forth certain Canadian GAAP consolidated
statements of earnings data in thousands of US dollars, except per share data,
and as a percentage of sales for the years indicated:
$ %
YEARS ENDED AUGUST 31, 1999 2000 2001 1999 2000 2001
-----------------------------------------------------------------------------------------------------------------------
Sales .................................... $ 42,166 $ 71,639 $ 146,013 100.0% 100.0% 100.0%
Cost of Sales ............................ 14,998 24,712 54,946 35.6 34.5 37.6
-----------------------------------------------------------------------------------------------------------------------
Gross margin ............................. 27,168 46,297 91,067 64.4 65.5 62.4
-----------------------------------------------------------------------------------------------------------------------
Operating expenses
Selling and administrative ............. 13,279 24,304 46,236 31.5 33.9 31.7
Net research and development ........... 4,315 6,402 13,601 10.2 8.9 9.3
Amortization of property, plant
and equipment .......................... 857 1,451 3,559 2.0 2.0 2.4
Amortization of intangible assets ...... 41 47 9,876 0.1 0.1 6.8
Non-recurring expenses ................. -- -- 3,288 -- -- 2.3
-----------------------------------------------------------------------------------------------------------------------
Earnings from operations ................. 8,676 14,723 14,507 20.6 20.6 9.9
Interest income, net ..................... 136 1,480 6,098 0.3 2.1 4.2
Foreign exchange gain (loss) ............. (506) (684) 3,327 (1.2) (1.0) 2.3
-----------------------------------------------------------------------------------------------------------------------
Earnings before income taxes and
amortization of goodwill ................. 8,306 15,519 23,932 19.7 21.7 16.4
Income taxes ............................. 2,492 5,298 8,150 5.9 7.4 5.6
-----------------------------------------------------------------------------------------------------------------------
Earnings before amortization of
goodwill ................................. 5,814 10,221 15,782 13.8 14.3 10.8
Amortization of goodwill ................. -- 297 31,076 -- 0.4 21.3
-----------------------------------------------------------------------------------------------------------------------
Net earnings (loss) for the year ......... $ 5,814 $ 9,924 $ (15,294) 13.8% 13.9% (10.5%)
-----------------------------------------------------------------------------------------------------------------------
Basic and diluted net earnings
(loss) per share ......................... $ 0.14 $ 0.25 $ (0.29)
Research and development data:
Gross research and development ........... $ 6,390 $ 9,374 $ 17,601 15.2% 13.1% 12.1%
Net research and development ............. $ 4,315 $ 6,402 $ 13,601 10.2% 8.9% 9.3%
-----------------------------------------------------------------------------------------------------------------------
Other data (unaudited):
Adjusted net earnings* ................... $ 5,843 $ 10,252 $ 24,463 13.9% 14.3% 16.8%
Basic and diluted adjusted net
earnings per share* ...................... $ 0.14 $ 0.26 $ 0.46
* net earnings excluding amortization of goodwill and the after-tax effect of
amortization of intangible assets and non-recurring expenses. This
information may not be comparable to similarly titled measures reported by
other companies because it is non-GAAP information.
SALES
Sales totalled $146.0 million, $71.6 million and $42.2 million in
fiscal 2001, 2000 and 1999, respectively. Sales increased 104% in fiscal 2001
compared to 2000 due to increased demand for our Industrial and Scientific
products as well as our Portable and Monitoring products, market acceptance of
several products launched in 2001 and the impact of the Burleigh Instruments and
EXFO Photonic Solutions acquisitions completed during the year. In addition, the
increase in sales of our Industrial and Scientific products significantly
affected our top line because these products have a higher average selling price
than Portable and Monitoring products.
Altogether, Industrial and Scientific products accounted for almost 50%
of our sales in fiscal 2001 compared to just over 30% in 2000. In fiscal 2002,
we expect our Portable
43
and Monitoring products to regain a larger share of our total sales due to
continued carrier spending and the impact of the Avantas acquisition in the
second half of the year. Although telecommunication carriers have lowered their
capital expenditures for network deployment, they are upgrading networks by
adding DWDM channels and increasing data transmission rates. As a result, they
still need to purchase test and measurement equipment to ensure network
reliability. The Avantas acquisition will initially benefit the Portable and
Monitoring Division, but it should eventually increase sales in the Industrial
and Scientific Division.
Accepted orders increased 53% to $132.1 million in fiscal 2001 from
$86.2 million for 2000. Our book-to-bill ratio, however, decreased 25% to 0.90
in fiscal 2001 compared to 1.20 in 2000. The decrease in our book-to-bill ratio
reflects the downturn in the telecommunications industry, which began impacting
our booking in the third quarter of 2001.
In fiscal 2000, sales increased 70% compared to 1999. Growth in sales
was mainly due to increased demand for our Industrial and Scientific products as
well as a general sales increase in our other products.
North American sales accounted for 58.3%, 61.6% and 56.3% of global
sales in fiscal 2001, 2000 and 1999, respectively. International sales
represented 41.7%, 38.4% and 43.7% of global sales in fiscal 2001, 2000 and
1999, respectively. The increase in international sales in fiscal 2001 compared
to 2000 mainly reflects our sustained efforts to develop the Asian market. We
almost tripled our sales in this region and added service centers in Beijing and
Singapore to better serve our customers. The jump in North American sales in
fiscal 2000 compared to 1999 was the result of our ability to exploit a robust
economy in that region during that period.
We sell our products to a broad range of customers including
telecommunication carriers, optical component and system manufacturers as well
as research and development laboratories. No customer accounted for more than
6.4%, 5.8% and 6.8% of sales in fiscal 2001, 2000 and 1999, respectively.
GROSS MARGIN
Gross margin amounted to 62.4%, 65.5% and 64.4% of sales for fiscal
2001, 2000 and 1999, respectively. Despite the increase in sales of Industrial
and Scientific products, which tend to be slightly higher-margin products, gross
margin decreased in fiscal 2001 compared to 2000 due to a number of reasons.
First of all, we significantly increased our manufacturing capacity as well as
hired and trained related manufacturing employees to face current and future
demand for our products. Secondly, we re-engineered our manufacturing processes
to be more cost-effective and to better mitigate the impact of potential pricing
pressure in the future. Thirdly, we acquired EXFO Photonic Solutions, which
operates in a market that has relatively lower-margin products. Finally, the
slowdown in the telecommunications industry, which affected us mostly in the
last quarter of fiscal 2001, prevented us from a better absorption of our fixed
costs.
44
The improvement in gross margin in fiscal 2000 compared to 1999
reflects the increase in government grants earned in 2000, increased sales of
higher-margin products and our cost-reduction manufacturing programs.
Gross margin can be negatively affected by competitive pricing
pressure, increases in component costs and obsolescence costs, shifts in product
mix, reductions in government grants, under-absorption of manufacturing fixed
costs and increases in product offerings by other suppliers in the fiber-optic
test, measurement and automation industry.
SELLING AND ADMINISTRATIVE
Selling and administrative expenses reached $46.2 million, $24.3
million and $13.3 million for fiscal 2001, 2000 and 1999, respectively. As a
percentage of sales, selling and administrative expenses amounted to 31.7%,
33.9% and 31.5% for fiscal 2001, 2000 and 1999, respectively. The dollar
increase for fiscal 2001 compared to 2000 is directly related to higher
commissions resulting from increased sales activity, increased promotional and
marketing expenses, expenses to consolidate our sales force in Asia, expenses
related to running a public company and the impact of the Burleigh Instruments
and EXFO Photonic Solutions acquisitions. The percentage decrease is mainly due
to a better absorption of these expenses because sales are increasing at a
faster rate than selling and administrative expenses.
The increase in selling and administrative expenses in fiscal 2000
compared to 1999 reflects increased personnel expenses for sales and marketing
staff, increased expenses related to customer support, increased sales
commissions related to higher sales, increased promotional and marketing
expenses as well as the expenses related to running a public company since June
2000. Considering current market conditions, efforts will be undertaken to
maintain our selling and administrative expenses at an acceptable level without
impeding our efforts to strategically position our company, improve our sales,
marketing and customer service teams, integrate our acquired companies and
satisfy our customers.
RESEARCH AND DEVELOPMENT
Gross R&D expenses totalled $17.6 million, $9.4 million and $6.4
million for fiscal 2001, 2000 and 1999, respectively. As a percentage of sales,
gross R&D expenses were 12.1%, 13.1% and 15.2% for fiscal 2001, 2000 and 1999,
respectively. The increase in gross R&D dollars in fiscal 2001 compared to 2000
reflects our commitment to innovation by hiring additional R&D personnel as well
as by the acquisitions of Burleigh Instruments and EXFO Photonic Solutions.
Taking into account these acquisitions, we added 95 employees to our R&D
departments in fiscal 2001, supporting our continued focus on innovative product
development. Our sustained efforts in R&D allowed us to launch more than 20 new
products in 2001. Altogether, 46% of our sales in fiscal 2001 originated from
products that have been on the market for two years or less. This figure
confirms our dedication to innovation and our anticipation of customers' needs
and expectations.
The decrease, as percentage of sales, in fiscal 2001 compared to 2000
is mainly due to the fact that sales increased at a faster rate than R&D
expenses during this period.
45
The increase in R&D dollars in fiscal 2000 compared to 1999 reflects
the hiring of additional personnel to develop new products and enhance current
ones. During fiscal 2000, we added 45 employees to our R&D Department.
Tax credits and grants from federal, provincial and state governments
for R&D activities were $4.0 million, $3.0 million and $2.1 million for fiscal
2001, 2000 and 1999, respectively. The increase in tax credits and grants in
fiscal 2001 compared to 2000 is directly related to the hiring of additional R&D
personnel as well as the impact of the EXFO Photonic Solutions acquisition. The
increase in tax credits and grants in fiscal 2000 compared to 1999 is the result
of hiring additional R&D personnel.
Tax credits and grants, as a percentage of gross R&D expenses, were
22.7%, 31.7% and 32.5% for fiscal 2001, 2000 and 1999, respectively. The
decrease in fiscal 2001 compared to 2000 is related to a reduction in the
effective tax credit rate and grants on R&D carried out in Canada. It should be
noted that R&D carried out by US-based Burleigh Instruments is not eligible for
tax credits. As a result, the gross R&D percentage was further reduced in fiscal
2001.
In terms of net R&D expenses, they amounted to 9.3%, 8.9% and 10.2% of
sales for fiscal 2001, 2000 and 1999, respectively. We expect to continue
investing heavily in R&D in the upcoming year, reflecting our focus on
innovation and our desire to exceed our customers' needs and expectations.
AMORTIZATION OF INTANGIBLE ASSETS
In conjunction with the acquisitions of Burleigh Instruments and EXFO
Photonic Solutions, we recorded $54.7 million in intangible assets primarily
consisting of core technology. These intangible assets, which are amortized over
periods from five months to five years, resulted in an amortization expense of
$9.9 million in fiscal 2001.
NON-RECURRING EXPENSES
In June 2001, we implemented a structured plan to reduce costs and
increase efficiency in order to align our cost structure to market conditions
and be better positioned amidst a challenging environment.
Under this plan, we incurred non-recurring expenses of $3.3 million,
including $0.8 million in severance expenses for the 245 employees who were
terminated and $2.5 million in unused facilities and assets. No such expenses
were incurred in fiscal 2000 and 1999.
This plan should enable us to reduce our operating expenses by
approximately $8 million in fiscal 2002.
46
INTEREST INCOME, NET
Interest income amounted to $6.1 million, $1.5 million and $0.1 million
for fiscal 2001, 2000 and 1999, respectively. The increase in our interest
income results solely from short-term investments of the remaining net proceeds
of our Initial Public Offering on June 29, 2000. The increase in interest income
is somewhat offset by interest expenses and bank charges related to borrowings
under our lines of credit. Our interest income will decrease in fiscal 2002
because we used short-term investments to pay for cash considerations in recent
acquisitions and because interest rates may continue to drop.
FOREIGN EXCHANGE GAIN (LOSS)
Foreign exchange gain amounted to $3.3 million in fiscal 2001 compared
to foreign exchange losses of $0.7 million in 2000 and $0.5 million in 1999.
The foreign exchange gain in fiscal 2001 can be mostly attributed to
the disposal of short-term investments denominated in US dollars and to the
foreign exchange impact on operating activities of Canadian entities denominated
in currencies other than the Canadian dollar. Foreign exchange losses incurred
in fiscal 2000 and 1999 are solely due to the foreign exchange impact on
operating activities of Canadian entities denominated in currencies other than
the Canadian dollar.
INCOME TAXES
Our effective income tax rates were 34.1%, 34.1% and 30.0% for fiscal
2001, 2000 and 1999, respectively. Our effective income tax rate was flat in
fiscal 2001 compared to 2000. The increase from fiscal 1999 to 2000 can be
attributed to a decrease in our manufacturing and processing deduction.
AMORTIZATION OF GOODWILL
In conjunction with the acquisitions of Burleigh Instruments and EXFO
Photonic Solutions, we recorded $248.5 million in goodwill. Goodwill, which is
amortized over five years, resulted in an amortization expense of $31.1 million
in fiscal 2001.
NET EARNINGS (LOSS)
Net loss amounted to $15.3 million in fiscal 2001 compared to net
earnings of $9.9 million in 2000 and $5.8 million in 1999. In terms of per share
amounts, we recorded a net loss of $0.29 in fiscal 2001 compared to net earnings
of $0.25 in 2000 and $0.14 in 1999.
ADJUSTED NET EARNINGS
As a measure to assess financial performance, we use adjusted net
earnings and adjusted net earnings per share. Adjusted net earnings represent
net earnings excluding amortization of goodwill and the after-tax effect of
amortization of intangible assets and non-recurring
47
expenses. Adjusted net earnings amounted to $24.5 million, $10.3 million and
$5.8 million in fiscal 2001, 2000 and 1999, respectively. In terms of adjusted
net earnings per share, it reached $0.46, $0.26 and $0.14 in fiscal 2001, 2000
and 1999, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Prior to our Initial Public Offering, we had financed operations and
met our capital expenditure requirements mainly through cash flows from
operations, research and development tax credits and government grants. On June
29, 2000, we closed our Initial Public Offering of 8,050,000 subordinate voting
shares at a price of US$26.00 per share in the United States and Cdn$38.55 per
share in Canada. Total proceeds, including the over-allotment option exercised
by the underwriters, were approximately US$209 million.
CASH POSITION AND SHORT-TERM INVESTMENTS
As at August 31, 2001, cash and cash equivalents as well as short-term
investments consisted of $74.6 million. Our working capital was at $130.3
million. The announced acquisition of Avantas Networks Corporation will be
partially financed with $8.0 million of cash on hand.
OPERATING ACTIVITIES
Cash flows provided by operating activities were $3.1 million in fiscal
2001 compared to cash flows used of $4.0 million in 2000 and cash flows provided
of $3.7 million in 1999. Cash flows provided by operating activities in fiscal
2001 were primarily due to net earnings after items not affecting cash and cash
equivalents of $24.5 million. This figure was mainly offset by an increase of
$20.3 million in inventories required to ensure minimal manufacturing and
delivery lead times.
Cash flows used in operating activities in fiscal 2000 were primarily
due to net earnings after items not affecting cash and cash equivalents of $10.9
million. This figure was mainly offset by an increase of $10.5 million in
accounts receivable, resulting from higher volumes of sales and $10.7 million in
inventories that were required to ensure minimal manufacturing and delivery lead
times.
The major items not affecting cash and cash equivalents consisted of
net amortization expenses of $43.9 million for fiscal 2001 and $1.0 million for
2000.
FINANCING ACTIVITIES
Cash flows used in financing activities were $4.6 million in fiscal
2001 compared to cash flows provided of $172.9 million in 2000 and cash flows
used of $3.3 million in 1999. Cash flows used in financing activities in fiscal
2001 were mainly due to the repayment of bank advances and long-term debt of
$5.4 million. Considering these repayments, we have available credit facilities
as at August 31, 2001 that provide for advances of up to $11.4 million under
lines of credit. These lines of credit bear interest at prime rate.
48
Cash flows provided by financing activities in fiscal 2000 were the
result of the net proceeds of our Initial Public Offering of $192.9 million less
the dividends paid of $17.6 million. Cash flows used in financing activities in
fiscal 1999 were due to the payment of $3.2 million in dividends that were
declared that year. We do not foresee payments of additional dividends during
the next three fiscal years.
INVESTING ACTIVITIES
Cash flows provided by investing activities were $9.2 million in fiscal
2001 compared to cash flows used of $169.0 million in 2000 and $1.2 million in
1999.
In fiscal 2001, we disposed of $93.4 million in short-term investments
to finance the $15.9 million purchase of property, plant and equipment as well
as to pay the cash consideration of $68.3 million for the Burleigh Instruments
and EXFO Photonic Solutions acquisitions. Despite these investments, the
disposal of short-term investments generated net cash flows of $9.2 million in
fiscal 2001.
The purchases of $159.8 million in short-term investments from the net
proceeds of our Initial Public Offering and of $7.2 million in property, plant
and equipment explain the use of cash flows for investing activities in fiscal
2000. In fiscal 1999, the purchase of $1.2 million in property, plant and
equipment explain the use of cash flows in investing activities. As at August
31, 2001, property, plant and equipment amounted to $27.1 million, while
intangible assets and goodwill related to the acquisitions of Burleigh
instruments and EXFO Photonic Solutions totalled $264.2 million, net of related
accumulated amortization.
OUTLOOK
We believe that our existing cash balances and short-term investments,
together with cash flows from operations and available credit facilities, will
be sufficient to meet our expected liquidity and capital requirements for the
upcoming year, taking into account the cash consideration to be paid for the
previously announced acquisition of Avantas Networks. However, possible
investments in or acquisitions of complementary businesses, products or
technologies may require additional financing prior to such time. There can be
no assurance that additional debt or equity financing will be available when
required or, if available, it can be secured on terms satisfactory to us.
NEW ACCOUNTING STANDARDS
On August 1, 2001, the Canadian Institute of Chartered Accountants
issued section 1581 "Business Combinations," which supersedes section 1580, and
issued section 3062 "Goodwill and Other Intangible Assets." Section 1581
requires business combinations initiated after June 30, 2001 or business
combinations accounted for by the purchase method with a date of acquisition
after June 30, 2001, to be accounted for using the purchase method of
accounting. This section also broadens criteria for recording intangible assets
separately from goodwill. Upon the adoption of section 3062, recorded goodwill
and intangible assets will be evaluated against these new criteria and may
result in certain intangible assets being reclassified into
49
goodwill or, alternatively, amounts initially recorded as goodwill being
separately identified and recognized apart from goodwill as intangible assets.
Section 3062 requires the use of a non-amortization approach to account for
purchased goodwill and indefinite-lived intangibles. Under the non-amortization
approach, goodwill and indefinite-lived intangibles will not be amortized, but
instead they will be reviewed for impairment and written down and charged to
earnings only in the periods in which the recorded value of goodwill and
indefinite-lived intangibles exceed their fair value. This section will be
adopted on September 1, 2002.
The impact of adopting section 3062 will allow us to use the
non-amortization approach for goodwill and will reduce annual goodwill
amortization by approximately $50 million. Moreover, we will implement a new
goodwill impairment methodology and any potential initial impairment losses on
goodwill determined by this methodology will be charged to deficit. Any
subsequent impairment losses on goodwill will be charged to earnings in the
period in which it is incurred.
Under US GAAP, any potential initial impairment losses on goodwill
determined by this methodology will be charged to earnings.
For more details on new US accounting standards, see note 19 to our
consolidated financial statements.
RISKS AND UNCERTAINTIES
Over the past few years, we have been successful in maintaining a
strong rate of growth by effectively managing our activities, by focusing on the
research and development of new and innovative products, by penetrating
international markets, by seeking and closing important strategic acquisitions
and, finally, by attracting and retaining highly skilled employees. However, we
operate in a highly competitive field that is in constant evolution and, as a
result, we encounter various risks and uncertainties that must be given
appropriate consideration in our strategic management policies.
The main risks and uncertainties related to the fiber-optic test,
measurement and automation industry involve the quick development of new
products that have short lifecycles and require extensive research and
development; the difficulty of attracting and retaining highly skilled employees
as well as offering them effective training programs; and the ability to quickly
adapt our cost structure to changing market conditions in order to maintain or
increase our growth.
In addition, given our strategic goals for growth and competitive
positioning in our industry, we are expanding into international markets. This
exposes us to certain risks and uncertainties related to changes in local laws
and regulations, multiple technological standards, protective legislation and
pricing pressure.
Furthermore, while the important strategic acquisitions we have made
are essential to our long-term growth, they also expose us to certain risks and
uncertainties related to the rapid
50
and effective integration of these companies as well as their products,
technologies and personnel.
We are also exposed to currency risks as a result of the export of our
products manufactured in Canada, substantially all of which are denominated in
US dollars. These risks are partially hedged by the operating expenses of
certain international subsidiaries, the purchase of raw materials in US dollars
and forward exchange contracts. (See note 18 to our consolidated financial
statements).
Also, an economic slowdown in our industry could result in some of our
customers experiencing difficulties and, consequently, this could have a
negative effect on our results. 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 principally of cash and cash equivalents, short-term
investments and forward exchange contracts. Our short-term investments consist
of debt instruments issued by high-credit quality financial institutions and
corporations and units of a low-risk mutual fund. Our cash and cash equivalents
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. (See Item 3 for a list of risk factors).
51
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
A. DIRECTORS AND SENIOR MANAGEMENT
The following table sets forth information about our executive
officers, senior managers and directors as of December 31, 2001.
NAME AND
MUNICIPALITY OF RESIDENCE POSITIONS WITH EXFO
------------------------- -------------------------------------------
GERMAIN LAMONDE Chairman of the Board, President and Chief
Cap-Rouge, Quebec Executive Officer
PIERRE PLAMONDON, CA Vice-President, Finance and Chief Financial
Quebec City, Quebec Officer
MARIO LAROSE Vice-President, Marketing
Laval, Quebec
STEPHEN BULL Vice-President, Research and Development
Lac-Beauport, Quebec
JEAN-FRANCOIS BOULET Vice-President, Human Resources
Montmagny, Quebec
BRUCE BONINI Vice-President, North American Sales
Fairview, Texas
JUAN-FELIPE GONZALEZ Vice-President, International Sales
Singapore
GREGORY SCHINN Chief Technology Officer
Quebec City, Quebec
PIERRE MARCOUILLER Director
Magog, Quebec
DAVID A. THOMPSON Director
Horseheads, New York
ANDRE TREMBLAY Director
Outremont, Quebec
MICHAEL UNGER Director
Woodbridge, Ontario
KIMBERLEY ANN OKELL Secretary and Legal Counsel
Quebec City, Quebec
The address of each of our executive officers, senior managers and
directors is c/o EXFO Electro-Optical Engineering Inc., 465 Godin Avenue,
Vanier, Quebec, Canada. The following is a brief biography of each of our
executive officers, senior managers and directors.
GERMAIN LAMONDE is one of our founders. Germain Lamonde has been our
Chairman of the Board, President and Chief Executive Officer since our inception
in 1985. Mr. Lamonde holds a bachelor's degree in Physics Engineering from Ecole
Polytechnique, University of Montreal in Canada and a master's degree in Optics
from Laval University in Canada.
PIERRE PLAMONDON has been our Vice-President, Finance and Chief
Financial Officer since January 1996 and was a director from December 1999 to
May 2000. Prior to joining us, Mr. Plamondon served as senior manager for Price
Waterhouse, now PricewaterhouseCoopers LLP, from September 1981 to December 1995
in Canada and France. Mr. Plamondon holds a bachelor's degree in Business
Administration and a license in Accounting, both from Laval
52
University in Canada. Mr. Plamondon has been a member of the Canadian Institute
of Chartered Accountants since 1983.
MARIO LAROSE was appointed Vice-President, Marketing on June 7, 2000.
Prior to joining us, Mr. Larose was Interim General Manager with C-MAC
Corporation, a manufacturer of microelectronic products, from September 1999 to
January 2000. Prior to the acquisition by C-MAC of L.G. Technologies Ltee, Mr.
Larose held the position of Vice-President, Marketing and Sales with L.G.
Technologies Ltee, a sub-contract electronic manufacturer from January 1998 to
September 1999. Prior to that, Mr. Larose was Vice-President, Engineering with
Unican Security Systems Limited, a public security systems manufacturer, from
August 1995 to December 1997. Prior to joining Unican, Mr. Larose held various
positions with Northern Telecom, now Nortel Networks Limited, a provider of
telephony, data, wireless and wire-line solutions for the Internet. Mr. Larose
is President and a shareholder of LAMA2 inc., a private management consulting
company. Mr. Larose holds a bachelor's degree in Applied Sciences, Engineering
Physics from Ecole Polytechnique, University of Montreal in Canada and a
master's in Business Administration from Universite du Quebec a Montreal in
Canada.
STEPHEN BULL was appointed our Vice-President, Research and Development
in December 1999. He joined us in July 1995 and held the positions of Assistant
Director-Engineering from September 1997 to December 1999 and Group Leader
(Engineering Management) from July 1995 to September 1997. From June 1990 to
March 1995, Mr. Bull held the position of General Manager and Managing Director
for Space Research Corporation, a military engineering company in Belgium. Mr.
Bull holds a bachelor's degree in Electrical Engineering from Laval University
in Canada.
JEAN-FRANCOIS BOULET joined us in March 2000 as Vice-President, Human
Resources. Mr. Boulet was formerly employed by Societe de portefeuille du Groupe
Desjardins -- Assurances Generales since 1996 where he had been successively
Senior Vice-President, Human Resources and Senior Vice-President, Human
Resources and Corporate Communications. From 1992 to 1996, Mr. Boulet held
different senior management positions related to human resources and
organizational development for Inglis Limited, a leading manufacturer of home
appliances. Mr. Boulet holds a bachelor's degree in Industrial Relations from
Laval University in Canada.
BRUCE BONINI has been our Vice-President, North American Sales since
December 1998. Prior to joining us, Mr. Bonini held the position of
Vice-President Sales-Eastern Region for Wandel & Golterman, now Wavetek Wandel &
Golterman, a company specializing in communications test solutions, from
September 1997 to December 1998. Mr. Bonini was successively Sales Director and
Vice-President of Sales for Digital Lightwave Inc., a synchronous optical
network test equipment manufacturer, from August 1996 to January 1997. From
August 1987 to August 1996, Mr. Bonini held different sales and senior
management positions for Laser Precision Corporation, an optical test equipment
manufacturer. Following the acquisition of Laser Precision by GN Nettest, Mr.
Bonini was named Global Vice-President of Sales for GN Nettest/Fiber-Optics
Division. Mr. Bonini holds a bachelor's degree in Business Administration
(industrial marketing) from Western Michigan University in the United States.
53
JUAN-FELIPE GONZALEZ has been our Vice-President, International Sales
since September 1998. From January 1997 to September 1998, he was our
International Sales Director and, from September 1993 to January 1997, our Sales
Manager for Latin America and the Caribbean. Prior to joining us in September
1993, Mr. Gonzalez was Marketing and Sales Director at Reyde, Barcelona, a
plastics technical product corporation in Spain. Mr. Gonzalez holds a bachelor's
degree in Industrial Chemistry from Complutense University of Madrid in Spain
and a master's degree in Business Administration from the School of Industrial
Organization in Spain.
GREGORY SCHINN was appointed our Chief Technology Officer in November
1999, after simultaneously holding the positions of Scientific Director and Head
of the Research Group since joining us in April 1996. Prior to joining us, Dr.
Schinn led the research and development team responsible for optical amplifier
and fiber laser development at MPB Technologies, Inc., a diversified technology
company, in Montreal from 1990 to 1996. Dr. Schinn holds a bachelor's degree in
Engineering Science and a master's degree in Aerospace Engineering from the
University of Toronto. He also holds a Ph.D. in Physics from the University of
Colorado at Boulder and has spent two years as a post-doctoral research
associate at the University of Virginia. Dr. Schinn has been published in
numerous scientific journals and he has served on the technical organizing
committees of several international scientific conferences. He is currently the
Director of the Division of Applied Physics of the Canadian Association of
Physicists.
PIERRE MARCOUILLER has served as our director since May 2000. Mr.
Marcouiller is Chairman of the Board and Chief Executive Officer of Camoplast
Inc., a supplier of components to the recreational and motorized vehicle and
automotive parts markets. He is the founder and has been 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. Mr. Marcouiller was
the controlling shareholder of Venmar from 1991 to 1996 and held the position of
President and General Manager of Venmar from December 1986 to December 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. Mr. Marcouiller holds a bachelor's degree in
Business Administration from Universite du Quebec a Trois-Rivieres in Canada and
a Master in Business Administration from Sherbrooke University in Canada.
DAVID A. THOMPSON has served as our director since June 2000. He has
held various positions with Corning Inc., a manufacturer of optical fiber and
other products for the telecommunications, television and other
communications-related industries, since 1976. Mr. Thompson was the Director --
Technology and Strategy of Corning's Components Business-Photonic Technologies
since March 1995, after which he acted as Director, Operations and Project
Management for the Optical Physics Technology Directorate and in February 2001,
he was named Division Vice President Strategy and Innovation. Mr. Thompson holds
a bachelor's degree in Chemistry from the Ohio State University, in the United
States, and a doctorate in Inorganic Chemistry from the University of Michigan,
in the United States.
ANDRE TREMBLAY has served as our director since May 2000. He has been
President and Chief Executive Officer of Microcell Telecommunications Inc., a
wireless telecommunications
54
provider, since May 1995. Mr. Tremblay has been a member of the board of
directors of Microcell since November 1995. In addition, Mr. Tremblay is a
member of the executive committee and a member of the board of directors of
Telesystem Ltd. and, since 1992, Executive Vice-President of Telesystem Ltd.
Prior to joining Telesystem Ltd., a privately-held holding company, Mr. Tremblay
was a tax partner and member of the management committee of Raymond, Chabot,
Martin, Pare, a Canadian accounting firm. Mr. Tremblay is also a member of the
Boards of Directors of Telesystem International Wireless Inc., a global mobile
communications company; Boomerang Tracking Inc., a publicly traded company that
assembles, markets and distributes a cellular-based asset tracking system; and
SignalGene Inc., a genomics-based drug discovery company. Mr. Tremblay holds a
bachelor's degree in Business Administration and a license in Accounting from
Laval University in Canada, as well as a master's degree in taxation from
Sherbrooke University in Canada. He also completed the Advanced Management
Program offered by the Harvard Business School in the United States.
MICHAEL UNGER has served as our director since May 2000. He 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,
Mr. Unger was Nortel's Group Vice-President, Transport Networks from March 1990
to May 1998. Mr. Unger also serves on the board of Tundra Semiconductor
Corporation a publicly traded company with its shares listed on The Toronto
Stock Exchange that designs, develops and markets networking and network access
technology for use by communications infrastructure equipment companies. He is
also a member of the boards of a number of privately-held companies active in
the areas of photonic and optical components, optical network systems and
solutions for cable operators and other communications service providers. Mr.
Unger holds a bachelor's degree in Science from Concordia University in Canada.
KIMBERLEY ANN OKELL has been our in-house legal counsel since February
2000 and our Secretary since May 2000. Prior to joining us, Ms. Okell was
Vice-President Legal Affairs and Secretary with Groupe Equiconcept Inc. from
October 1999 to February 2000 and Director of Legal Services and Secretary with
Informission Group Inc., now nurun Inc., an information technology company, from
December 1997 to October 1999. Prior to that, Ms. Okell was an associate with
the law firm McCarthy Tetrault from August 1994 to December 1997. Ms. Okell has
been a member of the Quebec Bar since September 1993. Ms. Okell holds a
bachelor's degree in Civil Law from Laval University in Canada, a bachelor's
degree in Common Law from The University of Western Ontario in Canada and an
Honors bachelor of Arts degree from York University in Canada.
TERM OF EXECUTIVE OFFICERS
Executive officers are appointed annually by the board of directors and
serve until their successors are appointed and qualified or until earlier
resignation or removal.
55
B. COMPENSATION
DIRECTOR COMPENSATION
In the financial year terminated August 31, 2001, our directors who are
not officers or employees received annual compensation of C$18,000 comprised of
cash, the equivalent value of our subordinate voting shares under our directors'
compensation plan or options to purchase some of our subordinate voting shares
under our stock option plan. Directors who are also committee members received
additional annual compensation of C$3,000 per committee and committee
chairpersons received C$5,000 annually comprised of cash, the equivalent value
of our subordinate voting shares under our directors' compensation plan or
options to purchase some of our subordinate voting shares under our stock option
plan. Fees of C$1,000 (US$655) for each meeting of the Board of Directors or of
a Committee attended by them in person and fees of C$500 (US$327) if such
participation was made by telephone were also paid. All directors will be
reimbursed for traveling and other expenses incurred in connection with
attendance at meetings.
As partial remuneration for the financial year ended August 31, 2001, a
total of 20,359 options were granted under our Stock Option Plan in October 2001
to directors who are not employees.
For the financial year commencing September 1, 2001, the annual
compensation of directors who are not officers or employees was increased to
C$25,000 payable by way of cash, the equivalent value of our subordinate voting
shares under our director's compensation plan or options to purchase some of our
subordinate voting shares under our stock option plan. In addition, such
directors each received 12,500 options under our stock option plan as partial
compensation for the financial year commencing September 1, 2001.
EXECUTIVE COMPENSATION
The table below shows certain compensation information for Mr. Germain
Lamonde, the President and Chief Executive Officer of the Corporation, and the
four other most highly compensated executive officers of the Corporation and its
subsidiaries during the financial year ended August 31, 2001 (collectively, the
"Named Executive Officers"). This information includes the US dollar value of
base salaries, bonus awards and long term incentive plan payments, the number of
options granted, and certain other compensation, if any, whether paid or
deferred.
56
SUMMARY COMPENSATION TABLE
------------------------------------------------------------------------------------------------------------------------
OTHER ANNUAL SECURITIES ALL OTHER
NAME AND PRINCIPAL FINANCIAL SALARY BONUS(1) COMPENSATION UNDER COMPENSATION
POSITION YEAR (US$) (US$) (US$) OPTIONS(2)(#) (US$)(3)
------------------------------------------------------------------------------------------------------------------------
Germain Lamonde, President and 2001 180,044 99,024 - 5,080 -
Chief Executive Officer
2000 134,932 63,566 - 25,402 -
Bruce Bonini, 2001 272,678(4) 33,450 - 82,780 4,565
Vice-President,
North American Sales 2000 309,801 20,000 - 3,900 6,768
Juan-Felipe Gonzalez, 2001 204,781(5) 129,629(8) - 45,630 -
Vice-President,
International Sales 2000 153,502 15,879 - 6,900 -
David J. Farrell, 2001 184,500(6) 16,326(9) - 40,000 4,513(9)
President, Burleigh
Instruments, Inc.
William S. Gornall, 2001 135,000(7) 11,874(9) - 30,000 3,332(9)
Vice-President of
Technology, Burleigh
Instruments, Inc.
------------------------
(1) 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.
(2) Indicates the number of Subordinate Voting Shares underlying the options
granted under the Stock Option Plan during the financial year indicated.
(3) 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.
(4) This amount includes an amount of US$28,654 paid as a retroactive
adjustment to salary for the financial year ended August 31, 2000.
(5) This amount includes an amount of US$4,935 paid as a retroactive adjustment
to salary for the financial year ended August 31, 2000.
(6) This amount represents Mr. Farrell's base annual salary. Since he joined
the Corporation on December 20, 2000, the base salary paid to him for the
financial year ended August 31, 2001 amounted to US$134,097.
(7) This amount represents Mr. Gornall's base annual salary. Since he joined
the Corporation on December 20, 2000, the base salary paid to him for the
financial year ended August 31, 2001 amounted to US$99,193.
(8) This amount includes an amount of US$2,771 paid as a retroactive adjustment
to bonus for the financial year ended August 31, 2000.
(9) These are the amounts paid or payable for the financial year ended August
31, 2001 to Messrs Farrell and Gornall, as applicable, since December 20,
2000, the date that they joined the Corporation.
57
The following table indicates additional information on the options
granted to our Named Executive Officers during the 2001 fiscal year.
PERCENTAGE
OF NET
TOTAL OF MARKET VALUE OF
OPTIONS SECURITIES
SECURITIES GRANTED TO EXERCISE OR UNDERLYING
UNDER OPTIONS EMPLOYEES IN BASE OPTIONS ON THE
GRANTED(1) FINANCIAL YEAR PRICE(2) (US$/ DATE OF GRANT
NAME (#) (%) SECURITY) (US$/SECURITY)(3) EXPIRATION DATE
------------------------- ------------- -------------- -------------- ----------------- -------------------
Germain Lamonde 5,080 0.28 % $22.25 $23.56 January 10, 2011
Bruce Bonini 20,000 1.10 % $45.94 $48.19 September 13, 2010
30,000 1.67 % $34.07 $36.88 October 11, 2010
32,780 1.82 % $22.25 $23.56 January 10, 2011
Juan-Felipe Gonzalez 15,000 0.83 % $45.94 $48.19 September 13, 2010
15,000 0.83 % $34.07 $36.88 October 11, 2010
15,630 0.87 % $22.25 $23.56 January 10, 2011
David J. Farrell 40,000 2.22 % $22.62 $19.69 December 20, 2010
William S. Gornall 30,000 1.67 % $22.62 $19.69 December 20, 2010
------------------------
(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.
(3) Based on the closing price on the NASDAQ National Market on the date of the
grant.
EMPLOYMENT AGREEMENTS
We have an employment agreement with Germain Lamonde. The agreement
provides for Mr. Lamonde's employment as President and Chief Executive Officer
at a base salary applicable from September 1, 2000 to August 31, 2001 of
C$275,000 (approximately $180,044) per year. In addition, a bonus of C$137,500
(approximately $90,022) will be payable if performance-based objectives are met.
If performance objectives are exceeded, such bonus will be greater in a
proportional amount. The agreement is for an indeterminate period and the salary
is reviewed annually. In the event of the termination of Mr. Lamonde's
employment other than for 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 our assets or of the majority of our share capital or if
Mr. Lamonde voluntarily resigns, he will be entitled to the vesting of all stock
options.
We also have employment agreements with Mr. Bruce Bonini and Mr.
Juan-Felipe Gonzalez, and Burleigh has employment agreements with David J.
Farrell and William S. Gornall.
The agreement with Mr. Bonini provides for Mr. Bonini's employment as
Vice-President, North American Sales at a base salary of $145,000, plus
commissions of $100,000 if sales objectives are met, for the period from
September 1, 2000 to August 31, 2001. If sales objectives are exceeded,
commissions will be greater. The agreement is for an indeterminate period and
58
salary is reviewed annually. In addition, bonuses totaling $39,000 will be
payable if various performance-based objectives are met. If performance
objectives are exceeded, such bonus will be greater in a proportional amount. In
the event Mr. Bonini's employment terminates for any reason whatsoever and he is
unable to accept new employment due to his non-competition obligations to us,
Mr. Bonini may receive compensation for a period of 18 months following the date
of termination in amounts varying from 5% to 125% of his base monthly salary at
the time of termination depending on the cause of the termination.
The agreement with Mr. Gonzalez provides for Mr. Gonzalez's employment
as Vice-President International Sales at a base salary of $110,000, plus
commissions on sales of $72,540, for the period from September 1, 2000 to August
31, 2001. If sales objectives are exceeded, commissions will be greater. Upon
Mr. Gonzalez's move to Singapore, effective March 1, 2001, the agreement
provides that the annual base salary is $120,753 to take into account cost of
living differences. The agreement is for an indeterminate period and salary is
reviewed annually. In addition, bonuses totaling $140,500 will be payable if
various performance-based objectives are met. If performance objectives are
exceeded, such bonus will be greater in a proportional amount. In addition, Mr.
Gonzalez shall be paid a bonus of C$750,000 if he has not voluntarily resigned
or been dismissed with cause prior to September 2003. 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 us, 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 agreement between Burleigh and Mr. Farrell provides for Mr.
Farrell's employment as President of Burleigh at an annual base salary of
$184,500. In addition, a bonus of $16,326 was payable based on Burleigh's
performance for the financial year ended August 31, 2001. The agreement is for
an indeterminate period and salary is reviewed annually. In the event of
termination of Mr. Farrell's employment other than for cause, Mr. Farrell will
be entitled to severance payments equivalent to 6 months of remuneration. In the
event of Mr. Farrell's termination due to a merger or acquisition by a third
party of substantially all of Burleigh's assets or of the majority of its share
capital, Mr. Farrell shall be entitled to severance benefits ranging from 6 to
12 months of remuneration, based on his length of service with Burleigh since
such merger or acquisition.
The agreement between Burleigh and Mr. Gornall provides for Mr.
Gornall's employment as Vice-President of Technology of Burleigh at an annual
base salary of $135,000. In addition, a bonus of $11,874 was payable based on
Burleigh's performance for the financial year ended August 31, 2001. The
agreement is for an indeterminate period and salary is reviewed annually. In the
event of termination of Mr. Gornall's employment other than for cause, Mr.
Gornall will be entitled to severance payments equivalent to 6 months of
remuneration. In the event of Mr. Gornall's termination due to a merger or
acquisition by a third party of substantially all of Burleigh's assets or of the
majority of its share capital, Mr. Gornall shall be entitled to severance
benefits ranging from 6 to 12 months of remuneration, based on his length of
service with Burleigh since such merger or acquisition.
59
STOCK OPTION PLAN
We have a stock option plan for our directors, executive officers,
employees and consultants and those of our subsidiaries as determined by our
board of directors, to attract and retain competent directors, executive
officers, employees and consultants motivated to work toward ensuring our
success and to encourage them to acquire our shares.
All of the options that will be granted under the plan must be
exercised within a maximum period of ten years following the grant date of the
options or they will be forfeited. The board of directors will designate the
recipients of options and determine the number of subordinate voting shares
covered by each of these options, the date of vesting of each option, the
exercise price of each option, 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. The price at which the subordinate voting
shares may be purchased under the plan will not be lower than the highest of the
closing prices of the subordinate voting shares on the stock exchanges where the
subordinate voting shares are listed at the date preceding the date of grant.
The maximum number of subordinate voting shares that is issuable under
the plan may not exceed 4,470,961 shares, which represents 7.3 % of our issued
and outstanding share capital as at December 31, 2001. The maximum number of
subordinate voting shares that may be granted to any individual may not exceed
5% of the outstanding subordinate voting shares. The board of directors may
accelerate the vesting of any or all outstanding options of any or all options
upon the occurrence of a change of control.
The aggregate number of subordinate voting shares covered by options
granted during the financial year ended August 31, 2001 was 1,804,497 (net of
cancelled options due to employment terminations) at a weighted average exercise
price of $29.00 (C$44.29) per subordinate voting share. At the end of the
financial year ended August 31, 2001, there were 2,414,231 subordinate voting
shares covered by options granted and outstanding pursuant to the stock option
plan. Following these grants, and net of cancelled options for departures, as of
August 31, 2001, there were 2,056,730 options available for future grants under
the plan. Since August 31, 2001 we have made the following grants to directors
and employees: September 1, 2001: 60,980 options, October 10, 2001: 506,259
options, November 2, 2001: 250,000 options and December 3, 2001: 42,437 options.
Except for certain options granted to non-employee directors of the
Corporation, options vest on a cumulative basis at a rate of 25 % annually
commencing on the first anniversary date of their grant and may be exercised in
whole or in part once vested. Some options granted to non-employee directors
vest on the first anniversary date of their grant and may be exercised in whole
or in part once vested.
In the financial year ended August 31, 2000 we had commenced a process
to obtain approval for the re-pricing of options granted to employees and
consultants on September 1, 2000, on September 13, 2000 and on October 11, 2000,
in the respective amounts of 122,908, 313,835 and 75,000 to purchase the same
amounts of subordinate voting shares at the price of
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C$83.66, C$68.17 and C$51.25 respectively. Prior to obtaining shareholder
approval and final approval from NASDAQ and The Toronto Stock Exchange, we
learned that such re-pricing would have future negative tax implications for a
large number of our employees. Management therefore withdrew its request for
shareholder approval and aborted the re-pricing process.
SHARE PLAN
In September 1998, we established a stock purchase plan for officers,
directors and key employees as amended in April 2000. A total of 707,264
subordinate voting shares were issued and fully paid under the 1998 Stock
Purchase Plan, having a weighted average cash consideration of C$0.98 per share.
The plan provides that all shares issued under the plan are restricted as to
sale and transferability for a minimum period of five years upon the date of
acquisition.
On April 3, 2000, we adopted a new share plan that replaced the 1998
Stock Purchase Plan. No additional shares will be issued under the new share
plan. The new share plan established restrictions on the rights of the holders
of subordinate voting shares who hold those shares as a result of the conversion
of the Class "F" shares issued under the 1998 Stock Purchase Plan. The new share
plan also requires the subordinate voting shares to be held in trust by a
trustee until August 31, 2004, except for 256,017 subordinate voting shares that
will be released between October 21, 2003 and January 20, 2004. The new share
plan also provides for the earlier release of shares in the event that the
employment of a holder of shares is terminated or upon the occurrence of a
change of control. The new share plan does not permit any transfer, except
within the trust to a registered retirement savings plan or a registered
retirement income fund or to a trustee in bankruptcy. The new share plan also
established the conditions pursuant to which the shares of a shareholder are to
be sold by the trustee on the public market. As of August 31, 2001, 663,265
subordinate voting shares were being held in trust under the new share plan.
RESTRICTED STOCK AWARD PLAN
The EXFO Electrical-Optical Engineering Restricted Stock Award Plan
(the "Plan") was established to provide a means through which employees of
Burleigh can be granted awards of restricted shares ("Restricted Shares") of our
subordinate voting shares to promote retention and foster identity of interest
between our stockholders and employees of Burleigh.
The effective date of the Plan is December 20, 2000. The expiration
date of the Plan is the business day next following the final grant of
Restricted Shares under the Plan. However, the administration of the Plan shall
continue until all awards of Restricted Shares have been forfeited or settled.
The aggregate number of shares subject to the Plan is 360,000. Grants of
Restricted Shares are to be made in accordance with a pre-determined schedule.
The Plan is administered by the committee that is designated to administer our
Stock Option Plan.
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 Company or its
61
affiliates, on each of the first four anniversaries of the date of grant of an
award of Restricted Shares. On December 20, 2001, we issued an aggregate of
83,657 subordinate voting shares in accordance with the vesting schedule under
the Plan.
Upon a participant's termination of employment with us, or any of our
affiliates due to the participant's death, disability or retirement on or after
age 60, the participant's award of restricted shares becomes fully vested and is
no longer subject to forfeiture. However, the transfer restrictions remain in
place until the occurrence of the vesting dates originally contemplated by the
award.
Upon the voluntary resignation of a participant, the termination of a
participant's employment for cause, the termination of a participant who is not
designated a member of Burleigh's "Management Team" without cause prior to a
change in control of EXFO or a termination without cause of a participant who is
designated a member of Burleigh's Management Team that is initiated by Burleigh
prior to a change in control of EXFO, the unvested portion of the participant's
award of Restricted Shares will be forfeited.
Upon the termination without cause of a participant who is designated a
member of Burleigh's Management Team that is initiated by us or a termination of
a participant's employment without cause following a change in control of EXFO,
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
Plan 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
62
date to convert the NASDAQ National Market closing price to Canadian dollars.
Stock appreciation rights are non-transferable.
The stock appreciation rights vest over a four-year period, with 25%
vesting annually commencing on the first anniversary date of the date of grant.
Once vested, stock appreciation rights may be exercised between the second and
the fifteenth business day following each release of the Corporation's quarterly
financial results. All of the stock appreciation rights that are granted under
the SAR Plan may be exercised within a maximum period of 10 years following the
date of their grant. Any stock appreciation rights granted under the SAR Plan
will lapse immediately upon the termination of the relationship with the
Corporation or one of its subsidiaries for a good and sufficient cause or at the
date on which an employee resigns or leaves his employment with the Corporation
or one of its subsidiaries (or within 30 days if the holder is dismissed without
cause). In the event of retirement or disability, any stock appreciation right
held by an employee lapses 30 days after the date of any such disability or
retirement. In the event of death, any stock appreciation right lapses 6 months
after the date of death.
As of December 31, 2001, 22,400 SAR's had been granted.
DEFERRED PROFIT SHARING PLAN
Under the plan, we 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
year ended August 31, 2001, the aggregate amount of contributions under the plan
was $419,000 (C$642,000).
401(K) PLANS
We maintain 401(k) plans for eligible United States resident employees
of our subsidiaries. Employees become eligible to participate in the 401(k)
plans on the first day of the month following the completion of three months of
continuous service. Employees may elect to defer their current compensation up
to the lesser of 1% of eligible compensation or the statutorily prescribed
annual limit and have the deferral contributed to the 401(k) plans. The 401(k)
plans permit, but do not require, us to make additional matching contributions
to the 401(k) plans on behalf of the eligible participants, subject to a maximum
of 50% of the first 6% of the participant's current compensation subject to
certain legislated maximum contribution limits. In the year ended August 31,
2001, we made an aggregate of $285,000 in matching contributions to the 401(k)
plans. Contributions by employees or by us to the 401(k) plans and income earned
on plan contributions are generally not taxable to the employees until withdrawn
and contributions by us are generally deductible by us when made. At the
direction of each participant, the trustees of the 401(k) plans invest the
assets of the 401(k) plans in selected investment options.
INDEMNIFICATION OF DIRECTORS AND EXECUTIVE OFFICERS AND LIMITATION OF LIABILITY
Our by-laws require us, subject to the limitations provided by law, to
indemnify our present or former directors and officers or any persons who act or
acted at our request as directors or officers of a body corporate of which we
are or were a shareholder and for all costs,
63
losses, charges and expenses that arose or may arise by reason of their status
as directors or officers of EXFO or such body corporate. A policy of directors'
and officers' liability insurance is maintained by us which insures our
directors and officers and those of our subsidiaries against liability incurred
by, arising from or against them for certain of their acts, errors or omissions.
C. BOARD PRACTICES
BOARD OF DIRECTORS
Our directors are elected at the annual meeting of shareholders for
one-year terms and serve until their successors are elected or appointed, unless
they resign or are removed earlier. Our articles of incorporation provide for a
board of directors of a minimum of three and a maximum of 12 directors. Our
board presently consists of five directors. Under the CANADA BUSINESS
CORPORATIONS ACT, twenty-five percent of the directors and of the members of any
committee of the board of directors must be resident Canadians. We have no
arrangements with any of our directors providing for the payment of benefits
upon their termination of service as director.
COMMITTEES OF THE BOARD OF DIRECTORS
Our board of directors has established an audit committee and a human
resources committee.
Our audit committee will recommend a firm to be appointed as
independent auditors to audit financial statements and to perform services
related to the audit, review the scope and results of the audit with the
independent auditors, review with management and the independent auditors our
annual operating results and consider the adequacy of the internal accounting
procedures and the effect of the procedures relating to the auditors'
independence. The audit committee is composed of three independent directors:
Andre Tremblay, Michael Unger and Pierre Marcouiller. The chairperson of the
audit committee is Andre Tremblay.
Our human resources committee will evaluate, review and supervise our
procedures with regards to human resources and will assess the performance of
our executive officers and the chief executive officer. This committee will also
review annually the remuneration of the directors and will recommend to the
board of directors general remuneration policies regarding salaries, bonuses and
other forms of remuneration for our directors, executive officers and employees
as a whole. In addition, the human resources committee will monitor the board's
corporate governance practices and generally review the functioning of the board
and the powers, mandates and performance of the committees. Finally, the human
resources committee will review our organizational structure annually and the
development and maintenance of a succession plan. The human resources committee
is composed of three independent directors: David A. Thompson, Michael Unger and
Pierre Marcouiller. The chairperson of the human resources committee is Michael
Unger.
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D. EMPLOYEES
We have fostered a corporate culture where growth and change are
strongly encouraged. In fact, employees are constantly evolving with the rapid
pace of technology to meet new challenges and realities. We believe that we
possess a good cross-section of experience and youth to handle these inevitable
changes in the industry. The average age of our employees is around 33 years
old.
As of December 31, 2001, we had 928 employees primarily based in
Quebec, Canada, with 171 employees based outside of Canada. As of December 31,
2001, we employed 1,099 full-time employees. Three hundred and thirty-seven are
involved in research and development, 354 in manufacturing, 198 in sales and
marketing, 127 in general administrative positions and 83 in communications and
customer support. Over the summer of 2001, we were forced to lay off a total of
245 employees as part of our efforts to reduce costs in response to a general
slowdown in the telecommunications industry. In December 2001, we announced
further layoffs totaling 10 % of our global workforce. Notwithstanding these
layoffs, during the 12-month period ended December 31, 2001, we added 136
employees. We have agreements with almost all of our employees covering
confidentiality and non-competition. Only manufacturing employees are
represented by a collective bargaining agreement, which expires in 2004. We have
never experienced a work stoppage. We believe that relations with our employees
are good.
E. SHARE OWNERSHIP
The following table presents information regarding the beneficial
ownership of our share capital as of December 31, 2001 by our directors, our
Chief Executive Officer and our four highest compensated executive officers; and
all of our directors and executive officers as a group.
Each multiple voting share is convertible at the option of the holder
into one subordinate voting share. Holders of our subordinate voting shares are
entitled to one vote per share and holders of our multiple voting shares are
entitled to ten votes per share.
65
TOTAL
MULTIPLE VOTING SHARES SUBORDINATE VOTING SHARES PERCENTAGE OF
BENEFICIALLY OWNED (1) BENEFICIALLY OWNED (1) VOTING POWER
---------------------------- --------------------------- ---------------
NAME NUMBER PERCENT NUMBER PERCENT PERCENT
----------------------------------- ------------- ------------ ------------ ------------ ---------------
Germain Lamonde (2)............. 37,900,000 100 6,351 * 94.16
Juan Felipe Gonzalez............ -- -- 60,677 * *
Bruce Bonini.................... -- -- 68,299 * *
David J. Farrell................ 768,549 3.17 *
William S. Gornall.............. -- -- 450,171 1.88 *
Pierre Marcouiller.............. -- -- 3,500 * *
David A. Thompson............... -- -- 2,600 * *
Andre Tremblay (3)............. -- -- 7,500 * *
Michael Unger................... -- -- 500 * *
---------- ---- ---------- --------- ----------
TOTAL........................... 37,900,000 100 1,368,147 5.69 94.5
------------------------
* Less than 1%.
(1) Beneficial ownership is determined in accordance with the rules of the SEC
and generally includes voting or investment power with respect to
securities. Options that are currently exercisable are deemed to be
outstanding and to be beneficially owned by the person holding such options
for the purpose of computing the percentage ownership of such person, but
are not treated as outstanding for the purpose of computing the percentage
ownership of any other person.
(2) The number of shares held by Germain Lamonde includes 1,900,000 multiple
voting shares held of record by Fiducie Germain Lamonde and 36,000,000
multiple voting shares held of record by G. Lamonde Investissements
Financiers inc.
(3) The number of subordinate voting shares held of record by Andre Tremblay
includes 6,650 subordinate voting shares held of record by 9044-6451 Quebec
Inc. and 350 subordinate voting shares held of record by 9089-3082 Quebec
Inc., companies controlled by Mr. Tremblay.
66
The following table presents information regarding stock options held
as of December 31, 2001 by our directors, our Chief Executive Officer and our
four highest compensated executive officers.
SECURITIES UNDER OPTIONS EXERCISE PRICE (2)
NAME GRANTED (1) (#) (US$/SECURITY) EXPIRATION DATE
-------------------------------- ------------------------ ------------------ -----------------------
Germain Lamonde................. 25,402 $26.00 June 29, 2010
5,080 $22.25 January 10, 2011
70,000 $9.13 October 10, 2011
70,000
Juan Felipe Gonzalez............ 6,900 $26.00 June 29, 2010
15,000 $45.94 September 13, 2010
15,000 $34.07 October 11, 2010
15,630 $22.25 January 10, 2011
15,000 $9.13 October 10, 2011
Bruce Bonini.................... 3,900 $26.00 June 29, 2010
20,000 $45.94 September 13, 2010
30,000 $34.07 October 11, 2010
32,780 $22.25 January 10, 2011
15,000 $9.13 October 10, 2011
David J. Farrell................ 40,000 $22.62 December 20, 2010
10,000 $9.13 October 10, 2011
William S. Gornall.............. 30,000 $22.62 December 20, 2010
5,000 $9.13 October 10, 2011
Pierre Marcouiller.............. 2,000 $26.00 June 29, 2010
400 $22.25 January 10, 2011
17,966 $9.13 October 10, 2011
David A. Thompson............... 2,000 $26.00 June 29, 2010
400 $22.25 January 10, 2011
15,334 $9.13 October 10, 2011
Andre Tremblay.................. 2,000 $26.00 June 29, 2010
400 $22.25 January 10, 2011
17,291 $9.13 October 10, 2011
Michael Unger................... 2,000 $26.00 June 29, 2010
400 $22.25 January 10, 2011
18,168 $9.13 October 10, 2011
------------------------
(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.
67
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
A. MAJOR SHAREHOLDERS
The following table presents information regarding the beneficial
ownership of our share capital as of December 31, 2001 by persons or groups of
affiliated persons known by us to own more than 5% of our voting shares.
TOTAL PERCENTAGE OF
MULTIPLE VOTING SHARES SUBORDINATE VOTING SHARES ---------------------
BENEFICIALLY OWNED (1) BENEFICIALLY OWNED (1) VOTING POWER
-------------------------- -------------------------- ---------------------
NAME NUMBER PERCENT NUMBER PERCENT PERCENT
--------------------------- ------------ ----------- ------------ ----------- ---------------------
Germain Lamonde (2) 37,900,000 100 % 6,351 * 94.16 %
Fiducie Germain Lamonde (3) 1,900,000 5 % Nil Nil 4.72 %
G. Lamonde Investissements
Financiers inc. (4) 36,000,000 95 % Nil Nil 89.44 %
------------------------
* Less than 1%
(1) Beneficial ownership is determined in accordance with the rules of the SEC
and generally includes voting or investment power with respect to
securities. Options that are currently exercisable are deemed to be
outstanding and to be beneficially owned by the person holding such options
for the purpose of computing the percentage ownership of such person, but
are not treated as outstanding for the purpose of computing the percentage
ownership of any other person.
(2) The number of shares held by Germain Lamonde includes 1,900,000 multiple
voting shares held of record by Fiducie Germain Lamonde and 36,000,000
multiple voting shares held of record by G. Lamonde Investissements
Financiers inc.
(3) Fiducie Germain Lamonde is a family trust for the benefit of Mr. Lamonde
and members of his family.
(4) G. Lamonde Investissements Financiers inc. is a company controlled by Mr.
Lamonde.
Each multiple voting share is convertible at the option of the holder
into one subordinate voting share. Holders of our subordinate voting shares are
entitled to one vote per share and holders of our multiple voting shares are
entitled to ten votes per share.
Unless otherwise indicated, the address of each person who beneficially
owns 5% or more of our subordinate voting shares or multiple voting shares is
c/o EXFO Electro-Optical Engineering Inc., 465 Godin Avenue, Vanier, Quebec,
Canada.
As of December 31, 2001, approximately 57.48% of our subordinate voting
shares were held in bearer form and the remainder (10,003,174 subordinate voting
shares) were held by 279 record holders. As of December 31, 2001, we believe
approximately 46.62% of our outstanding subordinate voting shares were held in
the United States.
B. RELATED PARTY TRANSACTIONS
INDEBTEDNESS OF DIRECTORS, EXECUTIVE OFFICERS AND EMPLOYEES
We have guaranteed the repayment of loans granted to employees by a
financial institution for the purchase of our Class "F" shares that were
converted into subordinate voting shares immediately prior to our initial public
offering. As of August 31, 2001, the total principal
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amount guaranteed by us is C$130,899 (approximately $85,700) and $56,200. We
have outstanding loans to some of our employees up to $8,840 to finance the
acquisition of our Class "F" shares. These loans are to be reimbursed no later
than five years from the date of the loans. These loans accrue interest at prime
rate and are secured by a pledge of the employees' shares to us.
Except as disclosed in this section, none of our directors, executive
officers, associates or affiliates had any material interest in any transaction
with us during the past three years or in any proposed transaction which has
materially affected or could materially affect us.
LEASES
We have entered into lease agreements with 9080-9823 Quebec inc., a
company controlled by Mr. Germain Lamonde, for the manufacturing facilities
located at 436 Nolin Street and the executive and administrative offices located
at 465 Godin Avenue in Vanier, Quebec. These leases were renewed in December
2001, with all terms and conditions remaining the same. The table below sets
forth the leased space and annual rent:
LOCATION SQUARE FOOTAGE ANNUAL RENT EXPIRY DATE
---------------------- -------------- ----------- -----------------
436 Nolin 43,000 C$220,820 November 30, 2006
465 Godin 24,000 C$144,000 November 30, 2006
Based on third-party valuations of the property values, we believe
these lease agreements are at prevailing market terms.
REGISTRATION RIGHTS AGREEMENTS
REGISTRATION RIGHTS AGREEMENT WITH MR. LAMONDE
In July 2000, we entered into a registration rights agreement with
Germain Lamonde, under which Mr. Lamonde and entities affiliated with him were
granted demand registration rights in the United States in respect of the
subordinate voting shares, including the subordinate voting shares issued upon
conversion of the multiple voting shares held by him or entities affiliated with
him. With respect to the demand registration rights of Mr. Lamonde, subject to
minimum dollar amounts, Mr. Lamonde may make a demand once every 12 consecutive
month period. Mr. Lamonde also has an unlimited number of piggyback registration
rights in respect of the subordinate voting shares issued upon conversion of the
multiple voting shares held by him or entities affiliated with him. The
piggyback registration rights generally will allow Mr. Lamonde to include all or
a portion of the subordinate voting shares issuable upon conversion of the
multiple voting shares under any registration statement filed by us.
We will pay all expenses, other than underwriting discounts and
commissions and taxes, in connection with the exercise of any demand
registration rights or piggyback registration rights. We also will agree to
indemnify any sellers and underwriters against some liabilities, including
liabilities arising under applicable securities laws. Mr. Lamonde agreed not to
exercise his registration rights without the prior written consent of Merrill
Lynch on behalf of the underwriters of the initial public offering for a period
of 180 days following June 29, 2000.
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REGISTRATION RIGHTS AGREEMENT WITH BURLEIGH SHAREHOLDERS
In December 2000 in connection with the acquisition of Burleigh, we
issued registration rights to the former shareholders of Burleigh. In July 2001,
we fulfilled our obligations to the former shareholders of Burleigh by filing a
registration statement on Form F-3 relating to the resale of the subordinate
voting shares held by the former shareholders of Burleigh. The Burleigh
shareholders also have an unlimited number of piggyback registration rights in
respect of their subordinate voting shares. The piggyback registration rights
generally will allow the Burleigh shareholders to include all or a portion of
their subordinate voting shares under any registration statement filed by us.
The piggyback registration rights cease to apply on June 1, 2002.
We will pay all expenses, other than underwriting commissions or
discounts, taxes and fees and expenses of counsel and advisors to the Burleigh
shareholders, in connection with the preparation and filing of any of the
foregoing registration statements. We also agreed to indemnify any sellers and
underwriters against some liabilities, including liabilities arising under
applicable securities laws, incurred in connection with the registration
statement on Form F-3.
REGISTRATION RIGHTS AGREEMENT WITH AVANTAS SHAREHOLDERS
In November 2001, in connection with the acquisition of EXFO Protocol
(formerly Avantas Networks Corporation), we issued registration rights to the
former shareholders of EXFO Protocol. We agreed to file a registration statement
on Form F-3 or Form F-10 in the United States prior to February 28, 2002 in
order to register the resale of the shares issued to the former shareholders of
EXFO Protocol.
We will pay all expenses, other than underwriting commissions or
discounts, taxes and fees and expenses of counsel and advisors to the EXFO
Protocol shareholders, in connection with the preparation and filing of any of
the foregoing registration statements. We also agreed to indemnify any sellers
against some liabilities, including liabilities arising under applicable
securities laws, incurred in connection with any of the foregoing registration
statements.
ITEM 8. FINANCIAL INFORMATION
Consolidated financial statements: pages F-1 to F-44
Valuation and qualifying accounts are as follows (in thousands of US
dollars):
--------------------------------------
Allowance for doubtful accounts YEARS ENDED NOVEMBER 30,
--------------------------------------
1999 2000 2001
----------- ----------- -----------
Balance - Beginning of year $ 26 $ 30 $ 149
Addition charged to earnings 12 147 1,134
Write off of uncollectible accounts (8) (41) (184)
Reversal of collectible accounts - (3) (268)
Foreign currency translation adjustment - 16 62
----------- ----------- -----------
Balance - End of year $ 30 $ 149 $ 893
----------- ----------- -----------
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LEGAL PROCEEDINGS
A description of legal proceedings is set forth in Item 4 of this
annual report.
DIVIDEND POLICY
We do not currently anticipate paying dividends for at least the three
next years. Our current intention is to reinvest our earnings in our business
long-term growth. Any future determination by us to pay dividends will be at the
discretion of our board of directors and in accordance with the terms and
conditions of any outstanding indebtedness and will depend on our financial
condition, results of operations, capital requirements and such other functions
as our board of directors considers relevant.
ITEM 9. THE OFFER AND LISTING
Not Applicable, except for Item 9A (4) and Item 9C.
Our subordinate voting shares have been quoted on the NASDAQ National
Market under the symbol "EXFO" and listed on The Toronto Stock Exchange under
the symbol "EXF" since our initial public offering on June 29, 2000. Prior to
that time, there was no public market for our subordinate voting shares. The
following table sets forth, for the periods indicated, the high and low closing
sales prices per subordinate voting share as reported on the NASDAQ National
Market and The Toronto Stock Exchange.
On January 16, 2002, the last reported sale price for our subordinate
voting shares on the NASDAQ National Market was $10.32 per share and the last
reported sale price for our subordinate voting shares on The Toronto Stock
Exchange was C$16.55 per share.
NASDAQ | TSE
PERIOD HIGH LOW | HIGH LOW
--------------------------|-------------------------------------
June 29, 2000 to August 31, 2000 92.50 26.00 | 134.00 51.00
September 1, 2000 to August 31, 2001 57.75 11.80 | 85.00 17.82
|
2001 1st Quarter 57.75 19.19 | 85.00 29.70
2001 2nd Quarter 50.44 17.63 | 76.00 27.50
2001 3rd Quarter 39.16 21.69 | 60.50 33.80
2001 4th Quarter 30.53 11.80 | 46.50 17.82
|
2002 1st Quarter 15.00 9.00 | 23.80 13.49
|
2001 July 16.55 14.13 | 25.10 21.45
2001 August 16.76 11.80 | 25.75 17.82
2001 September 11.71 9.00 | 18.59 14.36
2001 October 12.36 8.51 | 19.50 13.49
2001 November 15.00 10.60 | 23.80 16.95
2001 December 14.00 10.96 | 22.10 17.17
71
ITEM 10. ADDITIONAL INFORMATION
A. SHARE CAPITAL
Not Applicable
B. MEMORANDUM AND ARTICLES OF ASSOCIATION
Incorporated by reference to our registration statement on Form F-1
(Reg. No. 333-38956).
C. MATERIAL CONTRACTS
Except as otherwise disclosed in this annual report and our financial
statements and notes included elsewhere in this annual report, we have no other
material contracts.
D. EXCHANGE CONTROLS
Subject to the following paragraph, there is no law or governmental
decree or regulation in Canada that restricts the export or import of capital,
or affects the remittance of dividends, interest or other payments to
non-resident holders of our subordinate voting shares, other than withholding
tax requirements.
There is no limitation imposed by Canadian law or by our articles of
incorporation or our other charter documents on the right of a non-resident to
hold or vote subordinate voting shares, other than as provided by the INVESTMENT
CANADA ACT, the NORTH AMERICAN FREE TRADE AGREEMENT IMPLEMENTATION ACT (Canada)
and the WORLD TRADE ORGANIZATION AGREEMENT IMPLEMENTATION ACT. The INVESTMENT
CANADA ACT requires notification and, in certain cases, advance review and
approval by the Government of Canada of an investment to establish a new
Canadian business by a non-Canadian or of the acquisition by a "non-Canadian" of
"control" of a "Canadian business", all as defined in the INVESTMENT CANADA ACT.
Generally, the threshold for review will be higher in monetary terms for a
member of the World Trade Organization or North American Free Trade Agreement.
E. TAXATION
UNITED STATES TAXATION
The information set forth below under the caption "United States
Taxation" is a summary of the material U.S. federal income tax consequences of
the ownership and disposition of subordinate voting shares by a U.S. Holder, as
defined below. These discussions are not a complete analysis or listing of all
of the possible tax consequences of such transactions and do not address all tax
considerations that may be relevant to particular holders in light of their
personal circumstances or to persons that are subject to special tax rules. In
particular, the information set forth under the caption "United States Taxation"
deals only with U.S. Holders that will hold subordinate voting shares as capital
assets within the meaning of the Internal
72
Revenue Code of 1986, as amended, and who do not at any time own individually,
nor are treated as owning 10% or more of the total combined voting power of all
classes of our stock entitled to vote. In addition, this description of U.S. tax
consequences does not address the tax treatment of special classes of U.S.
Holders, such as banks, tax-exempt entities, insurance companies, persons
holding subordinate voting shares as part of a hedging or conversion transaction
or as part of a "straddle," U.S. expatriates, persons subject to the alternative
minimum tax, dealers or traders in securities or currencies and holders whose
"functional currency" is not the U.S. dollar. This summary does not address
estate and gift tax consequences or tax consequences under any foreign, state or
local laws other than as provided in the section entitled "Canadian Federal
Income Tax Considerations" provided below.
As used in this section, the term "U.S. Holder" means:
(a) an individual citizen or resident of the United States;
(b) a corporation created or organized under the laws of the United
States or any state thereof including the District of Columbia;
(c) an estate the income of which is subject to United States federal
income taxation regardless of its source;
(d) a trust if a court within the United States is able to exercise
primary jurisdiction over its administration and one or more U.S.
persons have authority to control all substantial decisions of the
trust; or
(e) a partnership to the extent the interests therein are owned by any
of the persons described in clauses (a), (b), (c) or (d) above.
Holders of subordinate voting shares who are not U.S. Holders,
sometimes referred to as "Non-U.S. Holders", should also consult their own tax
advisors, particularly as to the applicability of any tax treaty.
The following discussion is based upon:
o the Internal Revenue Code;
o U.S. judicial decisions;
o administrative pronouncements;
o existing and proposed Treasury regulations; and
o the Canada-- U.S. Income Tax Treaty.
Any of the above is subject to change, possibly with retroactive
effect. We have not requested, and will not request, a ruling from the U.S.
Internal Revenue Service with respect to any of the U.S. federal income tax
consequences described below, and as a result, there can be no assurance that
the U.S. Internal Revenue Service will not disagree with or challenge any of the
conclusions we have reached and describe here.
HOLDERS OF SUBORDINATE VOTING SHARES ARE URGED TO CONSULT THEIR TAX ADVISORS AS
TO THE PARTICULAR CONSEQUENCES TO THEM UNDER U.S. FEDERAL, STATE, LOCAL AND
APPLICABLE FOREIGN TAX LAWS OF THE ACQUISITION, OWNERSHIP AND DISPOSITION OF
SUBORDINATE VOTING SHARES.
73
DIVIDENDS
Subject to the discussion of passive foreign investment companies
below, the gross amount of any distribution paid by us to a U.S. Holder will
generally be subject to U.S. federal income tax as foreign source dividend
income to the extent paid out of our current or accumulated earnings and
profits, as determined under U.S. federal income tax principles. The amount of
any distribution of property other than cash will be the fair market value of
such property on the date of the distribution. Dividends received by a U.S.
Holder will not be eligible for the dividends received deduction allowed to
corporations. To the extent that an amount received by a U.S. Holder exceeds
such holder's allocable share of our current and accumulated earnings and
profits, such excess will be applied first to reduce such U.S. Holder's tax
basis in his subordinate voting shares, thereby increasing the amount of gain or
decreasing the amount of loss recognized on a subsequent disposition of the
subordinate voting shares. Then, to the extent such distribution exceeds such
U.S. Holder's tax basis, it will be treated as capital gain. We do not currently
maintain calculations of our earnings and profits for U.S. federal income tax
purposes.
The gross amount of distributions paid in Canadian dollars, or any
successor or other foreign currency, will be included in the income of such U.S.
Holder in a dollar amount calculated by reference to the spot exchange rate in
effect on the day the distributions are paid regardless of whether the payment
is in fact converted into U.S. dollars. If the Canadian dollars, or any
successor or other foreign currency, are converted into U.S. dollars on the date
of the payment, the U.S. Holder should not be required to recognize any foreign
currency gain or loss with respect to the receipt of Canadian dollars as
distributions. If, instead, the Canadian dollars are converted at a later date,
any currency gains or losses resulting from the conversion of the Canadian
dollars will be treated as U.S. source ordinary income or loss. Any amounts
recognized as dividends will generally constitute foreign source "passive
income" or, in the case of certain U.S. Holders, "financial services income" for
U.S. foreign tax credit purposes. A U.S. Holder will have a basis in any
Canadian dollars distributed equal to their dollar value on the payment date.
A Non-U.S. Holder of subordinate voting shares generally will not be
subject to U.S. federal income or withholding tax on dividends received on
subordinate voting shares unless such income is effectively connected with the
conduct by such Non-U.S. Holder of a trade or business in the United States.
SALE OR EXCHANGE
A U.S. Holder's initial tax basis in the subordinate voting shares will
generally be cost to the holder. A U.S. Holder's adjusted tax basis in the
subordinate voting shares will generally be the same as cost, but may differ for
various reasons including the receipt by such holder of a distribution that was
not made up wholly of earnings and profits as described above under the heading
"Dividends." Subject to the discussion of passive foreign investment companies
below, gain or loss realized by a U.S. Holder on the sale or other disposition
of subordinate voting shares will be subject to U.S. federal income taxation as
capital gain or loss in an amount equal to the difference between the U.S.
Holder's adjusted tax basis in the subordinate voting shares
74
and the amount realized on the disposition. In the case of a non-corporate U.S.
Holder, the federal tax rate applicable to capital gains will depend upon:
o the holder's holding period for the subordinate voting shares,
with a preferential rate available for subordinate voting shares
held for more than one year; and
o the holder's marginal tax rate for ordinary income.
Any gain realized will generally be treated as U.S. source gain and
loss realized by a U.S. Holder generally also will be treated as from sources
within the United States.
The ability of a U.S. Holder to utilize foreign taxes as a credit to
offset U.S. taxes is subject to complex limitations and conditions. The
consequences of the separate limitation calculation will depend upon the nature
and sources of each U.S. Holder's income and the deductions allocable thereto.
Alternatively, a U.S. Holder may elect to claim all foreign taxes paid as an
itemized deduction in lieu of claiming a foreign tax credit. A deduction does
not reduce U.S. tax on a dollar-for-dollar basis like a tax credit, but the
availability of the deduction is not subject to the same conditions and
limitations applicable to foreign tax credits.
If a U.S. Holder receives any foreign currency on the sale of
subordinate voting shares, such U.S. Holder may recognize ordinary income or
loss as a result of currency fluctuations between the date of the sale of
subordinate voting shares and the date the sale proceeds are converted into U.S.
dollars.
A Non-U.S. Holder of subordinate voting shares generally will not be
subject to U.S. federal income or withholding tax on any gain realized on the
sale or exchange of such subordinate voting shares unless:
o such gain is effectively connected with the conduct by such
Non-U.S. Holder of a trade or business in the United States; or
o in the case of any gain realized by an individual Non-U.S. Holder,
such Non-U.S. Holder is present in the United States for 183 days
or more in the taxable year of such sale and certain other
conditions are met.
Personal Holding Company
We could be classified as a personal holding company for U.S. federal
income tax purposes if both of the following tests are satisfied:
o if at any time during the last half of our taxable year, five or
fewer individuals own or are deemed to own more than 50% of the
total value of our shares; and
o we receive 60% or more of our U.S. related gross income from
specified passive sources, such as royalty payments.
A personal holding company is taxed on a portion of its undistributed
U.S. source income, including specific types of foreign source income which are
connected with the conduct of a U.S. trade or business, to the extent this
income is not distributed to shareholders. We do not
75
believe we are a personal holding company presently and we do not expect to
become one. However, we can not assure you that we will not qualify as a
personal holding company in the future.
FOREIGN PERSONAL HOLDING COMPANY
We could be classified as a foreign personal holding company if in any
taxable year both of the following tests are satisfied:
o five or fewer individuals who are United States citizens or
residents own or are deemed to own more than 50% of the total
voting power of all classes of our shares entitled to vote or the
total value of our shares; and
o at least 60%, 50% in some cases, of our gross income, as adjusted,
consists of "foreign personal holding company income", which
generally includes passive income such as dividends, interests,
gains from the sale or exchange of shares or securities, rent and
royalties.
If we are classified as a foreign personal holding company and if you
hold shares in us, you may have to include in your gross income as a dividend
your pro rata portion of our undistributed foreign personal holding company
income. If you dispose of your shares prior to such date, you will not be
subject to tax under these rules. We do not believe we are a foreign personal
holding company presently and we do not expect to become one. However, we can
not assure you that we will not qualify as a foreign personal holding company in
the future.
PASSIVE FOREIGN INVESTMENT COMPANY
We believe that our subordinate voting shares should not currently be
treated as stock of a passive foreign investment company for United States
federal income tax purposes, but this conclusion is a factual determination made
annually and thus may be subject to change based on future operations and
composition and valuation of our assets. In general, we will be a passive
foreign investment company with respect to a U.S. Holder if, for any taxable
year in which the U.S. Holder holds our subordinate voting shares, either:
o at least 75% of our gross income for the taxable year is passive
income; or
o at least 50% of the average value of our assets is attributable to
assets that produce or are held for the production of passive
income.
For this purpose, passive income includes income such as:
o dividends;
o interest;
o rents or royalties, other than certain rents or royalties derived
from the active conduct of trade or business;
o annuities; or
o gains from assets that produce passive income.
76
If a foreign corporation owns at least 25% by value of the stock of
another corporation, the foreign corporation is treated for purposes of the
passive foreign investment company tests as owning its proportionate share of
the assets of the other corporation and as receiving directly its proportionate
share of the other corporation's income.
If we are treated as a passive foreign investment company, a U.S.
Holder that did not make a qualified electing fund election or, if available, a
mark-to-market election, as described below, would be subject to special rules
with respect to:
o any gain realized on the sale or other disposition of subordinate
voting shares; and
o any "excess distribution" by us to the U.S. Holder.
Generally, "excess distributions" are any distributions to the U.S.
Holder in respect of the subordinate voting shares during a single taxable year
that are greater than 125% of the average annual distributions received by the
U.S. Holder in respect of the subordinate voting shares during the three
preceding taxable years or, if shorter, the U.S. Holder's holding period for the
subordinate voting shares.
Under the passive foreign investment company rules,
o the gain or excess distribution would be allocated ratably over
the U.S. Holder's holding period for the subordinate voting
shares;
o the amount allocated to the taxable year in which the gain or
excess distribution was realized would be taxable as ordinary
income;
o the amount allocated to each prior year, with certain exceptions,
would be subject to tax at the highest tax rate in effect for that
year; and
o the interest charge generally applicable to underpayments of tax
would be imposed in respect of the tax attributable to each such
year.
A U.S. Holder owning actually or constructively "marketable stock" of a
passive foreign investment company may be able to avoid the imposition of the
passive foreign investment company tax rules described above by making a
mark-to-market election. Generally, pursuant to this election, such holder would
include in ordinary income, for each taxable year during which such stock is
held, an amount equal to the increase in value of the stock, which increase will
be determined by reference to the value of such stock at the end of the current
taxable year compared with their value as of the end of the prior taxable year.
Holders desiring to make the mark-to-market election should consult their tax
advisors with respect to the application and effect of making such election.
In the case of a U.S. Holder who does not make a mark-to-market
election, the special passive foreign investment company tax rules described
above will not apply to such U.S. Holder if the U.S. Holder makes an election to
have us treated as a qualified electing fund and we provide certain required
information to holders. For a U.S. Holder to make a qualified electing fund
election, we would have to satisfy certain reporting requirements. We have not
determined whether we will undertake the necessary measures to be able to
satisfy such requirements in the event that we were treated as a passive foreign
investment company.
77
A U.S. Holder that makes a qualified electing fund election will be
currently taxable on its pro rata share of our ordinary earnings and net capital
gain, at ordinary income and capital gains rates, respectively, for each of our
taxable years, regardless of whether or not distributions were received. The
U.S. Holder's basis in the subordinate voting shares will be increased to
reflect taxed but undistributed income. Distributions of income that had
previously been taxed will result in a corresponding reduction of basis in the
subordinate voting shares and will not be taxed again as a distribution to the
U.S. Holder. U.S. Holders desiring to make a qualified electing fund election
should consult their tax advisors with respect to the advisability of making
such election.
UNITED STATES BACKUP WITHHOLDING AND INFORMATION REPORTING
A U.S. Holder will generally be subject to information reporting with
respect to dividends paid on, or proceeds of the sale or other disposition of,
our subordinate voting shares, unless the U.S. Holder is a corporation or comes
within certain other categories of exempt recipients. A U.S. Holder that is not
an exempt recipient will generally be subject to backup withholding with respect
to the proceeds from the sale or the disposition of, or with respect to
dividends on, subordinate voting shares unless the U.S. Holder provides a
taxpayer identification number and otherwise complies with applicable
requirements of the backup withholding rules. Any amount withheld under these
rules will be creditable against the U.S. Holder's U.S. federal income tax
liability or refundable to the extent that it exceeds such liability. A U.S
Holder who does not provide a correct taxpayer identification number may be
subject to penalties imposed by the United States Internal Revenue Service.
Non-U.S. Holders will generally be subject to information reporting and
possible backup withholding with respect to the proceeds of the sale or other
disposition of subordinate voting shares effected within the United States,
unless the holder certifies to its foreign status or otherwise establishes an
exemption if the broker does not have actual knowledge that the holder is a U.S.
holder. Payments of dividends on or proceeds from the sale of subordinate voting
shares within the United States by a payor within the United States to a
non-exempt U.S. or Non-U.S. Holder will be subject to backup withholding if such
holder fails to provide appropriate certification. In the case of such payments
by a payor within the United States to a foreign partnership other than a
foreign partnership that qualifies as a "withholding foreign partnership" within
the meaning of such Treasury regulations, the partners of such partnership will
be required to provide the certification discussed above in order to establish
an exemption from backup withholding tax and information reporting requirements.
CANADIAN FEDERAL INCOME TAX CONSIDERATIONS
The following is a summary of the material Canadian federal income tax
considerations generally applicable to a U.S. person who holds subordinate
voting shares and who, for the purposes of the INCOME TAX ACT (Canada), or the
ITA, and the CANADA-UNITED STATES INCOME TAX CONVENTION (1980), or the
Convention, as applicable and at all relevant times:
o is resident in the United States and not resident in Canada,
o holds the subordinate voting shares as capital property,
78
o does not have a "permanent establishment" or "fixed base" in
Canada, as defined in the Convention; and
o deals at arm's length with us. Special rules, which are not
discussed below, may apply to "financial institutions", as defined
in the ITA, and to non-resident insurers carrying on an insurance
business in Canada and elsewhere.
This discussion is based on the current provisions of the ITA and the
Convention and on the regulations promulgated under the ITA, all specific
proposals to amend the ITA or the regulations promulgated under the ITA
announced by or on behalf of the Canadian Minister of Finance prior to the date
of this annual report and the current published administrative practices of the
Canada Customs and Revenue Agency, or the Agency. It does not otherwise take
into account or anticipate any changes in law or administrative practice nor any
income tax laws or considerations of any province or territory of Canada or any
jurisdiction other than Canada, which may differ from the Canadian federal
income tax consequences described in this document.
Under the ITA and the Convention, dividends paid or credited, or deemed
to be paid or credited, on the subordinate voting shares to a U.S. person who
owns less than 10% of the voting shares will be subject to Canadian withholding
tax at the rate of 15% of the gross amount of those dividends or deemed
dividends. If a U.S. person is a corporation and owns 10% or more of the voting
shares, the rate is reduced from 15% to 5%. As described above and subject to
specified limitations, a U.S. person may be entitled to credit against U.S.
federal income tax liability for the amount of tax withheld by Canada.
Under the Convention, dividends paid to specified religious,
scientific, charitable and similar tax exempt organizations and specified
organizations that are resident and exempt from tax in the United States and
that have complied with specified administrative procedures are exempt from this
Canadian withholding tax.
A capital gain realized by a U.S. person on a disposition or deemed
disposition of the subordinate voting shares will not be subject to tax under
the ITA unless the subordinate voting shares constitute taxable Canadian
property within the meaning of the ITA at the time of the disposition or deemed
disposition. In general, the subordinate voting shares will not be "taxable
Canadian property" to a U.S. person if they are listed on a prescribed stock
exchange, which includes The Toronto Stock Exchange, unless, at any time within
the five-year period immediately preceding the dispositions, the U.S. person,
persons with whom the U.S. person did not deal at arm's length, or the U.S.
person together with those persons, owned or had an interest in or a right to
acquire more than 25% of any class or series of our shares.
If the subordinate voting shares are taxable Canadian property to a
U.S. person, any capital gain realized on a disposition or deemed disposition of
those subordinate voting shares will generally be exempt from tax under the ITA
by virtue of the Convention if the value of the subordinate voting shares at the
time of the disposition or deemed disposition is not derived principally from
real property, as defined by the Convention, situated in Canada. The
determination as to whether Canadian tax would be applicable on a disposition or
deemed
79
disposition of the subordinate voting shares must be made at the time of the
disposition or deemed disposition.
HOLDERS OF SUBORDINATE VOTING SHARES ARE URGED TO CONSULT THEIR OWN TAX
ADVISORS TO DETERMINE THE PARTICULAR TAX CONSEQUENCES TO THEM, INCLUDING THE
APPLICATION AND EFFECT OF ANY STATE, LOCAL OR FOREIGN INCOME AND OTHER TAX LAWS,
OF THE ACQUISITION, OWNERSHIP AND DISPOSITION OF SUBORDINATE VOTING SHARES.
F. DIVIDENDS AND PAYING AGENTS
Not Applicable
G. STATEMENT BY EXPERTS
Not Applicable
H. DOCUMENTS ON DISPLAY
Any statement in this annual report about any of our contracts or other
documents is not necessarily complete. If the contract or document is filed as
an exhibit to the registration statement, the contract or document is deemed to
modify the description contained in this annual report. You must review the
exhibits themselves for a complete description of the contract or document.
You may review a copy of our filings with the SEC, including exhibits
and schedules filed with it, at the SEC's public reference facilities in Room
1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 and at the
regional offices of the SEC located at 233 Broadway, New York, New York 10279
and at the Northwestern Atrium Center, 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661. You may also obtain copies of such materials from the
Public Reference Section of the SEC, Room 1024, Judiciary Plaza, 450 Fifth
Street, N.W., Washington, D.C. 20549, at prescribed rates. You may call the SEC
at 1-800-SEC-0330 for further information on the public reference rooms. The SEC
maintains a Web site (HTTP://WWW.SEC.GOV) that contains reports, proxy and
information statements and other information regarding registrants that file
electronically with the SEC . Although we make many of our filings with the SEC
electronically as a foreign private issuer, we are not obligated to do so.
You may read and copy any reports, statements or other information that
we file with the SEC at the addresses indicated above and you may also access
them electronically at the Web site set forth above. These SEC filings are also
available to the public from commercial document retrieval services.
80
WE ARE REQUIRED TO FILE REPORTS AND OTHER INFORMATION WITH THE SEC
UNDER THE SECURITIES EXCHANGE ACT OF 1934. REPORTS AND OTHER INFORMATION FILED
BY US WITH THE SEC MAY BE INSPECTED AND COPIED AT THE SEC'S PUBLIC REFERENCE
FACILITIES DESCRIBED ABOVE. AS A FOREIGN PRIVATE ISSUER, WE ARE EXEMPT FROM THE
RULES UNDER THE EXCHANGE ACT PRESCRIBING THE FURNISHING AND CONTENT OF PROXY
STATEMENTS AND OUR OFFICERS, DIRECTORS AND PRINCIPAL SHAREHOLDERS ARE EXEMPT
FROM THE REPORTING AND SHORT-SWING PROFIT RECOVERY PROVISIONS CONTAINED IN
SECTION 16 OF THE EXCHANGE ACT. UNDER THE EXCHANGE ACT, AS A FOREIGN PRIVATE
ISSUER, WE ARE NOT REQUIRED TO PUBLISH FINANCIAL STATEMENTS AS FREQUENTLY OR AS
PROMPTLY AS UNITED STATES COMPANIES.
I. SUBSIDIARY INFORMATION
See Item 4.C. of this annual report.
ITEM 11. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK
CURRENCY RISK
We are exposed to currency risk as a result of our export sales of
products manufactured in Canada, substantially all of which are denominated in
US dollars. Our exposure to foreign exchange rate fluctuations is partially
hedged by operating expenses and the portion of our raw materials purchased in
US dollars. In addition, we frequently enter into forward exchange contracts to
sell US dollars at fixed forward rates in exchange for Canadian dollars. We
enter into such contracts to manage the risk of exchange rate fluctuations
between the Canadian and US dollars on cash flows related to anticipated future
revenue streams and firmly committed future sales transactions denominated in US
dollars. We do not enter into forward exchange contracts for trading purposes.
The following table summarizes the forward exchange contracts in effect
as at August 31, 2001, classified by expected transaction dates, none of which
exceed two years. The table below presents the notional amounts of such
contracts (in thousands of US dollars) along with the weighted average
contractual forward rates under such contracts. The notional amounts of such
contracts are used to calculate the contractual payments to be exchanged under
these contracts.
YEARS ENDING
AUGUST 31,
----------------------
2002 2003
-------- --------
Forward exchange contracts to sell US
dollars in exchange for Canadian dollars
Contractual amounts.................................... $ 15,200 $ 1,800
Weighted average contractual exchange rates............ 1.4969 1.5184
81
FAIR VALUE
The fair value of these contracts as at August 31, 2001, based on the
prevailing exchange rate at that date of $1.00 = C$1.5477, amounted to C$26,3
million compared to a contractual value of C$25,5 million, resulting in a
deferred unrealized loss of C$825,000 (approximately $533,000).
INTEREST RATE RISK
We are exposed to the impact of interest rate changes and changes in
the market values of our available-for-sale securities. We do not use derivative
financial instruments for our available-for-sale securities. Our
available-for-sale securities consist of debt instruments issued by high-credit
quality financial institutions and corporations and units of a low-risk mutual
fund.
The debt instruments bear interest at fixed rate and may have their fair market
value adversely impacted due to a rise in interest rate. However, due to their
very short-term maturity, we consider this risk to be insignificant.
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES.
Not Applicable
PART II.
--------
ITEM 13. DEFAULTS, DIVIDENDS ARREARAGES AND DELINQUENCIES
Not Applicable
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY
HOLDERS AND USE OF PROCEEDS
Not Applicable
ITEM 15. [RESERVED]
ITEM 16. [RESERVED]
PART III.
---------
ITEM 17. FINANCIAL STATEMENTS
Not Applicable.
ITEM 18. FINANCIAL STATEMENTS
See pages F-1 to F-44
82
ITEM 19. EXHIBITS
NUMBER EXHIBIT
-------------- --------------------------------------------------------------
1.1 Amended Articles of Incorporation of EXFO (incorporated by
reference to Exhibit 3.1 of EXFO's Registration Statement on
Form F-1, File No. 333-38956).
1.2 By-laws of EXFO (incorporated by reference to Exhibit 3.2 of
EXFO's Registration Statement on Form F-1, File No.
333-38956).
1.3 Amended and Restated Articles of Incorporation of EXFO
(incorporated by reference to Exhibit 1.3 of EXFO's annual
report on Form 20-F dated January 18, 2001).
2.1 Form of Subordinate Voting Share Certificate (incorporated by
reference to Exhibit 4.1 of EXFO's Registration Statement on
Form F-1, File No. 333-38956).
2.2 Form of Registration Rights Agreement between EXFO and Germain
Lamonde dated July 6, 2000 ) (incorporated by reference to
Exhibit 10.13 of EXFO's Registration Statement on Form F-1,
File No. 333-38956).
3.1 Form of Trust Agreement among EXFO, Germain Lamonde, GEXFO
Investissements Technologiques inc., Fiducie Germain Lamonde
and G. Lamonde Investissements Financiers inc. (incorporated
by reference to Exhibit 4.2 of EXFO's Registration Statement
on Form F-1, File No. 333-38956).
4.1 Agreement of Merger and Plan of Reorganization, dated as of
November 4, 2000, by and among EXFO, EXFO Sub, Inc., Burleigh
Instruments, Inc., Robert G. Klimasewki, William G. May, Jr.,
David J. Farrell and William S. Gornall (incorporated by
reference to Exhibit 4.1 of EXFO's annual report on Form 20-F
dated January 18, 2001)
4.2 Amendment No. 1 to Agreement of Merger and Plan of Agreement,
dated as of December 20, 2000, by and among EXFO, EXFO Sub,
Inc., Burleigh Instruments, Inc., Robert G. Klimasewski,
William G. May, Jr., David J. Farrell and William S. Gornall
(incorporated by reference to Exhibit 4.2 of EXFO's annual
report on Form 20-F dated January 18, 2001).
4.3 Agreement of Merger, dated as of August 20, 2001, by and among
EXFO, Buyer Sub, and Avantas Networks Corporation and
Shareholders of Avantas Networks corporation.
4.4 Amendment No. 1 dated as of November 1, 2002 to Agreement of
Merger, dated as of August 20, 2001, by and among EXFO,
3905268 Canada Inc., Avantas Networks Corporation and
Shareholders of Avantas Networks.
4.5 Offer to purchase shares of Nortech Fibronic Inc., dated
February 6, 2000 among EXFO, Claude Adrien Noel, 9086-9314
Quebec inc., Michel Bedard, Christine Bergeron and Societe en
Commandite Capidem Quebec Enr. and Certificate of Closing,
dated February 7, 2000 among the same parties (including
summary in English) (incorporated by reference to Exhibit 10.2
of EXFO's Registration Statement on Form F-1, File No.
333-38956).
4.6 Share Purchase Agreement, dated as of March 5, 2001, among
EXFO Electro-Optical Engineering, Inc., John Kennedy, Glenn
Harvey and EFOS Corporation (incorporated by reference to
Exhibit 4.1 of EXFO's Registration Statement on Form F-3, File
No. 333-65122).
4.7 Amendment Number One, dated as of March 15, 2001, to Share
Purchase Agreement, dated as of March 5, 2001, among EXFO
Electro-Optical Engineering, Inc., John Kennedy, Glenn Harvey
and EFOS Corporation. (incorporated by reference to Exhibit
4.2 of EXFO's Registration Statement on Form F-3, File No.
333-65122).
4.8 Share Purchase Agreement, dated as of November 2, 2001 between
JDS Uniphase Inc. and 3905268 Canada Inc.
4.9 Intellectual Property Assignment and Sale Agreement between
EFOS Inc., EXFO Electro-Optical Engineering, Inc., John
Kennedy, Glenn Harvey and EFOS Corporation. (incorporated by
reference to Exhibit 4.3 of EXFO's Registration Statement on
Form F-3, File No. 333-65122).
4.10 Offer to acquire a building, dated February 23, 2000, between
EXFO and Groupe Mirabau inc. and as accepted by Groupe Mirabau
inc. on February 24, 2000 (including summary in English)
(incorporated by reference to Exhibit 10.3 of EXFO's
Registration Statement on Form F-1, File No. 333-38956).
4.11 Lease Agreement, dated December 1, 1996, between EXFO and
GEXFO Investissements Technologiques inc., as assigned to
9080-9823 Quebec inc. on September 1, 1999 (including
83
summary in English) (incorporated by reference to Exhibit 10.4
of EXFO's Registration Statement on Form F-1, File No.
333-38956).
4.12 Lease Agreement, dated March 1, 1996, between EXFO and GEXFO
Investissements Technologiques inc., as assigned to 9080-9823
Quebec inc. on September 1, 1999 (including summary in
English) (incorporated by reference to Exhibit10.5 of EXFO's
Registration Statement on Form F-1, File No. 333-38956).
4.13 Lease renewal of the existing leases between 9080-9823 Quebec
inc. and EXFO, dated November 30, 2001.
4.14 Loan Agreement between EXFO and GEXFO Investissements
Technologiques inc., dated May 11, 1993, as assigned to
9080-9823 Quebec inc. on September 1, 1999 (including summary
in English) (incorporated by reference to Exhibit 10.9 of
EXFO's Registration Statement on Form F-1, File No.
333-38956).
4.15 Resolution of the board of directors of EXFO, dated September
1, 1999, authorizing EXFO to acquire GEXFO Distribution
Internationale inc. from GEXFO Investissements Technologiques
inc. (including summary in English) (incorporated by reference
to Exhibit 10.10 of EXFO's Registration Statement on Form F-1,
File No. 333-38956).
4.16 Form of Promissory Note of EXFO issued to GEXFO
Investissements Technologiques inc. dated June 27, 2000 )
(incorporated by reference to Exhibit 10.12 of EXFO's
Registration Statement on Form F-1, File No. 333-38956).
4.17 Credit Agreement, dated July 6, 1995, among EXFO, National
Bank of Canada and Banque Nationale de Paris(Canada), as
amended on December 22, 1999 and on March 28, 2000 (including
summary in English) (incorporated by reference to Exhibit 10.1
of EXFO's Registration Statement on Form F-1, File No.
333-38956).
4.18 Term Loan Offer, dated March 28, 2000, among EXFO and National
Bank of Canada as accepted by EXFO on April 3, 2000 (including
summary in English) (incorporated by reference to Exhibit
10.11 of EXFO's Registration Statement on Form F-1, File No.
333-38956).
4.119 Sale Agreement, dated September 1, 1999, between EXFO and
GEXFO Investissements Technologiques inc. (including summary
in English) (incorporated by reference to Exhibit 10.14 of
EXFO's Registration Statement on Form F-1, File No.
333-38956).
4.120 Purchase Agreement to acquire a building dated June 7, 2000,
between EXFO and Groupe Mirabau inc. (incorporated by
reference to Exhibit 10.16 of EXFO's Registration Statement on
Form F-1, File No. 333-38956).
4.21 Employment Agreement of Germain Lamonde dated May 29, 2000
(incorporated by reference to Exhibit 10.15 of EXFO's
Registration Statement on Form F-1, File No. 333-38956).
4.22 Employment Agreement of Mario Larose dated as of May 30, 2000.
(incorporated by reference to Exhibit 4.15 of EXFO's annual
report on Form 20-F dated January 18, 2001)
4.23 First Amending Agreement to Employment Agreement of Mario
Larose dated as of September 1, 2000. (incorporated by
reference to Exhibit. 4.16 of EXFO's annual report on Form
20-F dated January 18, 2001)
4.24 Employment Agreement of Bruce Bonini dated as of September 1,
2000.
4.25 Employment Agreement of Juan-Felipe Gonzalez dated as of
September 1, 2000.
4.26 Employment Agreement of David J. Farrell dated as of December
20, 2000.
4.27 Employment Agreement of William S. Gornall dated as of
December 20, 2000.
4.28 Deferred Profit Sharing Plan, dated September 1, 1998
(incorporated by reference to Exhibit 10.6 of EXFO's
Registration Statement on Form F-1, File No. 333-38956).
4.29 Stock Option Plan, dated May 25, 2000 (incorporated by
Reference to Exhibit 10.7 of EXFO's Registration Statement on
Form F-1, File No. 333-38956).
4.30 Share Plan, dated April 3, 2000 (incorporated by reference to
Exhibit 10.8 of EXFO's Registration Statement on Form F-1,
File No. 333-38956).
4.31 Directors' Compensation Plan (incorporated by reference to
Exhibit 10.17 of EXFO's Registration Statement on Form F-1,
File No. 333-38956).
4.32 Restricted Stock Award Plan, dated December 20, 2000
(incorporated by reference to Exhibit 4.21 of EXFO's annual
report on Form 20-F dated January 18, 2001).
8.1 Subsidiaries of EXFO.
84
SIGNATURES
The registrant hereby certifies that it meets all of the requirements for filing
on Form 20 -F and that it has duly caused and authorized the undersigned to sign
this annual report on its behalf.
EXFO ELECTRO-OPTICAL ENGINEERING INC.
By: /s/ Germain Lamonde
-------------------------------------
Name: Germain Lamonde
Title: Chairman of the Board, President
and Chief Executive Officer
Date: January 17, 2002.
85
AUDITORS' REPORT
TO THE SHAREHOLDERS OF
EXFO ELECTRO-OPTICAL ENGINEERING INC.
We have audited the consolidated balance sheets of EXFO ELECTRO-OPTICAL
ENGINEERING INC. as at August 31, 2000 and 2001 and the consolidated statements
of earnings, retained earnings (deficit) and contributed surplus and cash flows
for each of the years in the three-year period ended August 31, 2001. These
financial statements are the responsibility of the company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with Canadian and United States generally
accepted auditing standards. Those standards require that we plan and perform an
audit to obtain reasonable assurance whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation.
In our opinion, these consolidated financial statements present fairly, in all
material respects, the financial position of the company as at August 31, 2000
and 2001 and the results of its operations and its cash flows for each of the
years in the three-year period ended August 31, 2001 in accordance with Canadian
generally accepted accounting principles.
In addition, in our opinion, the financial statement schedule on the variation
in the allowance for doubtful accounts included in Form 20-F presents fairly, in
all material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements.
/S/ PRICEWATERHOUSECOOPERS LLP
CHARTERED ACCOUNTANTS
Quebec, Quebec, Canada
September 21, 2001
F-1
EXFO ELECTRO-OPTICAL ENGINEERING INC.
CONSOLIDATED STATEMENTS OF EARNINGS
(in thousands of US dollars)
AS AT AUGUST 31,
---------------------
2000 2001
--------- ---------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 729 $ 7,729
Short-term investments (notes 7 and 18) 162,659 66,861
Accounts receivable (notes 7 and 18)
Trade 18,272 24,531
Other 2,790 3,660
Income taxes receivable (note 7) 284 --
Inventories (notes 4 and 7) 18,868 44,345
Prepaid expenses 1,023 1,265
Future income taxes (note 15) 995 1,423
--------- ---------
205,620 149,814
PROPERTY, PLANT AND EQUIPMENT (notes 5 and 7) 8,694 27,140
INTANGIBLE ASSETS AND GOODWILL (notes 6 and 7) 2,320 264,242
FUTURE INCOME TAXES (note 15) 3,089 1,381
--------- ---------
$ 219,723 $ 442,577
========= =========
LIABILITIES
CURRENT LIABILITIES
Bank advances (note 7) $ 10 $ --
Accounts payable and accrued liabilities (note 8) 10,353 16,180
Income taxes payable -- 2,623
Mandatorily redeemable preferred shares (note 9) 543 --
Deferred revenue 395 616
Current portion of long-term debt 152 106
--------- ---------
11,453 19,525
DEFERRED REVENUE 151 --
DEFERRED GRANTS (note 13) 1,109 1,002
LONG-TERM DEBT (note 10) 16 664
FUTURE INCOME TAXES (note 15) -- 6,581
--------- ---------
12,729 27,772
--------- ---------
COMMITMENTS (note 11)
SHAREHOLDERS' EQUITY
SHARE CAPITAL (note 12) 198,459 429,995
CONTRIBUTED SURPLUS -- 1,457
CUMULATIVE TRANSLATION ADJUSTMENT 1,555 (8,333)
RETAINED EARNINGS (DEFICIT) 6,980 (8,314)
--------- ---------
206,994 414,805
--------- ---------
$ 219,723 $ 442,577
========= =========
ON BEHALF OF THE BOARD
/s/ GERMAIN LAMONDE /s/ ANDRE TREMBLAY
----------------------------- ----------------------------
GERMAIN LAMONDE ANDRE TREMBLAY
Chairman, President and CEO Chairman, Audit Committee
The accompanying notes are an integral part of these consolidated
financial statements.
F-2
EXFO ELECTRO-OPTICAL ENGINEERING INC.
CONSOLIDATED BALANCE SHEET
(in thousands of US dollars, except share and per share data)
YEARS ENDED AUGUST 31,
-----------------------------------------
1999 2000 2001
--------- --------- ---------
SALES (note 16) $ 42,166 $ 71,639 $ 146,013
COST OF SALES 14,998 24,712 54,946
--------- --------- ---------
GROSS MARGIN 27,168 46,927 91,067
--------- --------- ---------
OPERATING EXPENSES
Selling and administrative 13,279 24,304 46,236
Net research and development (note 13) 4,315 6,402 13,601
Amortization of property, plant and equipment 857 1,451 3,559
Amortization of intangible assets 41 47 9,876
Non-recurring expenses (note 14) -- -- 3,288
--------- --------- ---------
TOTAL OPERATING EXPENSES 18,492 32,204 76,560
--------- --------- ---------
EARNINGS FROM OPERATIONS 8,676 14,723 14,507
Interest income, net 136 1,480 6,098
Foreign exchange gain (loss) (506) (684) 3,327
--------- --------- ---------
EARNINGS BEFORE INCOME TAXES AND AMORTIZATION OF GOODWILL 8,306 15,519 23,932
INCOME TAXES (note 15) 2,492 5,298 8,150
--------- --------- ---------
EARNINGS BEFORE AMORTIZATION OF GOODWILL 5,814 10,221 15,782
AMORTIZATION OF GOODWILL -- 297 31,076
--------- --------- ---------
NET EARNINGS (LOSS) FOR THE YEAR $ 5,814 $ 9,924 $ (15,294)
========= ========= =========
BASIC AND DILUTED EARNINGS (LOSS) PER SHARE
Earnings before amortization of goodwill $ 0.14 $ 0.26 $ 0.30
Net earnings (loss) $ 0.14 $ 0.25 $ (0.29)
BASIC WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING (000'S) 38,001 39,951 53,014
DILUTED WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING (000'S) (note 17) 38,001 40,086 53,014
The accompanying notes are an integral part of these consolidated
financial statements.
F-3
EXFO ELECTRO-OPTICAL ENGINEERING INC.
CONSOLIDATED BALANCE SHEET
(in thousands of US dollars, except share and per share data)
RETAINED EARNINGS (DEFICIT)
YEARS ENDED AUGUST 31,
----------------------------------
1999 2000 2001
-------- -------- --------
BALANCE - BEGINNING OF YEAR $ 12,044 $ 14,592 $ 6,980
ADD
Net earnings (loss) for the year 5,814 9,924 (15,294)
-------- -------- --------
17,858 24,516 (8,314)
-------- -------- --------
DEDUCT
Dividends
Class A shares 2,926 17,216 --
Class C share (note 3) 340 -- --
Class F shares -- 320 --
-------- -------- --------
3,266 17,536 --
-------- -------- --------
BALANCE - END OF YEAR $ 14,592 $ 6,980 $ (8,314)
======== ======== ========
DIVIDENDS PER SHARE
Class A shares $ 0.08 $ 0.45 $ --
Class C share $ 340 $ -- $ --
Class F shares $ -- $ 0.45 $ --
CONTRIBUTED SURPLUS
YEARS ENDED AUGUST 31,
----------------------------------
1999 2000 2001
-------- -------- --------
BALANCE - BEGINNING OF YEAR $ -- $ -- $ --
ADD
Premium on resale of share capital -- -- 1,457
-------- -------- --------
BALANCE - END OF YEAR $ -- $ -- $ 1,457
======== ======== ========
The accompanying notes are an integral part of these consolidated
financial statements.
F-4
EXFO ELECTRO-OPTICAL ENGINEERING INC.
CONSOLIDATED BALANCE SHEET
(in thousands of US dollars)
YEARS ENDED AUGUST 31,
-------------------------------------------
1999 2000 2001
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net earnings (loss) for the year $ 5,814 $ 9,924 $ (15,294)
Add (deduct) items not affecting cash and cash equivalents
Amortization of discount on short-term investments -- (807) (594)
Amortization of property, plant and equipment 857 1,451 3,559
Amortization of intangible assets 41 47 9,876
Foreign exchange gains on disposal of short-term investments -- -- (3,437)
Non-recurring expenses -- -- 1,083
Future income taxes (42) (33) (1,779)
Amortization of goodwill -- 297 31,076
Change in non-cash operating working capital items
Accounts receivable (3,875) (10,476) 447
Income taxes receivable (381) 2,149 (2,291)
Inventories (1,259) (10,732) (20,308)
Prepaid expenses (205) (519) (67)
Accounts payable and accrued liabilities 1,965 3,917 (3,736)
Income taxes payable (115) -- 4,528
Deferred revenue 327 215 100
Deferred grants 533 567 (57)
--------- --------- ---------
3,660 (4,000) 3,106
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Bank advances (136) (357) (2,046)
Repayment of mandatorily redeemable preferred shares -- -- (354)
Repayment of loan from a company under common control -- (1,349) --
Repayment of long-term debt (20) (812) (3,355)
Issuance of share capital 86 209,690 --
Resale of share capital -- -- 1,490
Redemption of share capital -- -- (33)
Share issue expenses -- (16,743) (331)
Dividends paid (3,215) (17,587) --
--------- --------- ---------
(3,285) 172,842 (4,629)
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to short-term investments (33) (519,645) (772,808)
Proceeds from disposal of short-term investments -- 359,886 866,158
Additions to property, plant and equipment and intangible assets (1,181) (7,180) (15,911)
Business combinations (note 3) -- (2,108) (68,255)
--------- --------- ---------
(1,214) (169,047) 9,184
--------- --------- ---------
CHANGE IN CASH AND CASH EQUIVALENTS (839) (205) 7,661
EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS -- 511 (661)
CASH AND CASH EQUIVALENTS - BEGINNING OF YEAR 1,262 423 729
--------- --------- ---------
CASH AND CASH EQUIVALENTS- END OF YEAR $ 423 $ 729 $ 7,729
========= ========= =========
SUPPLEMENTARY INFORMATION
Interest paid $ (148) $ (480) $ (377)
Interest received $ 98 $ 949 $ 6,046
Income taxes paid $ (2,801) $ (3,761) $ (8,171)
The accompanying notes are an integral part of these consolidated
financial statements.
F-5
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
1 INCORPORATION AND NATURE OF ACTIVITIES
The company, incorporated in 1985 under the Canada Business Corporations
Act, designs, manufactures and markets a full line of fiber-optic test,
measurement and automation solutions for the telecommunications industry
to measure the physical characteristics of optical fiber and related
hardware and to automate manufacturing processes. The company derives
substantially all of its revenue from customers located in the United
States, Canada, Europe, Asia and South America. The company's customers
consist primarily of telecommunications carriers, optical component and
system manufacturers, as well as research and development laboratories.
2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
These consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in Canada. These principles
conform, in all material respects, with accounting principles generally
accepted in the United States, except as described in note 19. The
principal accounting policies of the company, which have been consistently
applied, are summarized as follows:
ACCOUNTING ESTIMATES
The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting year. Actual results could differ from those
estimates.
CONSOLIDATION
These consolidated financial statements include the accounts of the
company and its domestic and international subsidiaries. Intercompany
accounts and transactions have been eliminated.
REPORTING CURRENCY
The consolidated financial statements of the company were presented in
Canadian dollars up to August 31, 1999. Effective September 1, 1999, the
US dollar has been adopted as the reporting currency. The functional
currency continues to be the Canadian dollar. The financial statements for
the year ended August 31, 1999 are presented in US dollars in accordance
with a translation of convenience method using the representative exchange
rate as at August 31, 1999 of US$1.00 = Cdn$1.4958. The translated amount
for monetary and
F-6
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
non-monetary items as at August 31, 1999 became the historical basis for
those items in subsequent years.
The financial statements as at August 31, 2000 and 2001 and for the years
then ended have been translated using the current rate method. Under this
method, the financial statements are translated into the reporting
currency as follows: assets and liabilities are translated at the exchange
rate in effect at the date of the balance sheet and revenues and expenses
are translated at the average exchange rate for the year. 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.
FOREIGN CURRENCY TRANSLATION
Foreign currency transactions
Transactions denominated in currencies other than the functional currency
are translated into the functional currency as follows: monetary assets
and liabilities are translated at the exchange rate in effect at the
balance sheet date and revenues and expenses are translated at the average
rate for the year. 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 rates in
effect at the balance sheet date. Non-monetary assets and liabilities are
remeasured at historical rates. Revenues and expenses are remeasured at
the average rate for the year. Gains and losses resulting from
remeasurement are reflected in the statements of earnings.
The financial statements of self-sustaining operations with a functional
currency other than the US dollar are remeasured into the functional
currency using the current rate method. Under this method, assets and
liabilities are remeasured at the exchange rates in effect at the balance
sheet date and revenues and expenses are remeasured at the average rate
for the year. Gains and losses resulting from remeasurement are reflected
in the cumulative translation adjustment in shareholders' equity.
Forward exchange contracts
The company enters into forward exchange contracts in order to hedge
against potential exchange rate fluctuations on cash flows related to
anticipated future revenue streams denominated in foreign currencies.
Unrealized gains and losses on these forward exchange contracts are
deferred and recognized upon settlement of the related transactions.
F-7
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
Accordingly, cash flows resulting from forward exchange contract
settlements are classified as cash flows from operating activities along
with the corresponding cash flows being hedged.
In 2000, the company entered into forward exchange contracts to sell
Canadian dollars in exchange for US dollars. These contracts, which were
speculative in nature, were carried on at fair value as at August 31,
2000. The unrealized loss on these contracts as at August 31, 2000 has
been included in earnings for that year. As at August 31, 2001, the
company does not hold such forward exchange contracts.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash on hand and balances with banks
and all highly liquid short-term investments with original maturities of
three months or less.
SHORT-TERM INVESTMENTS
Short-term investments are valued at the lower of cost and market value.
Cost is composed of acquisition cost plus amortization of discount or less
amortization of premium.
INVENTORIES
Inventories are valued at the lower of cost and net realizable value. The
cost of raw materials and work in progress is determined using the
first-in, first-out method. The cost of finished goods is determined using
the average cost method.
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 their estimated useful lives as follows:
TERM
Buildings 15 and 25 years
Equipment 2 to 7 years
Leasehold improvements Remaining lease term including
lease renewal option
The carrying value of property, plant and equipment is evaluated for
impairment whenever significant events occur which may indicate an
impairment in value, based upon a comparison of the carrying value to the
net recoverable amount.
F-8
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
INTANGIBLE ASSETS, GOODWILL AND AMORTIZATION
Intangible assets include the cost of acquired in process research and
development, core technology, work force and trademark, net of accumulated
amortization. Intangible assets are amortized on a straight-line basis
over their estimated useful lives ranging from five to eight months for in
process research and development, of five years for core technology, of
one year for work force and of two years for trademark.
Goodwill, which represents the excess of the purchase price of acquired
businesses over the estimated fair value of net identifiable assets
acquired, is amortized on a straight-line basis over the estimated useful
life of five years.
Intangible assets and goodwill are reviewed for impairment 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, is the excess of the carrying value
over the estimated pre-tax undiscounted future cash flows. Intangible
assets and goodwill are written down for any permanent impairment in value
of the unamortized portion. As at August 31, 2001, there are no events or
circumstances indicating that the carrying value may not be recoverable.
REVENUE RECOGNITION
For products where the software is incidental, the company recognizes
revenue when the products are delivered, with provisions made for
estimated returns, warranties and support obligations.
For products where software is not incidental, the revenues are separated
into two categories, product and customer support revenues based upon
vendor-specific objective evidence of fair value. The product revenues for
these sales are recognized when the products are delivered with provisions
made for estimated returns and warranties. The customer support revenues
are deferred and recognized ratably over the years of the support
arrangement, except where provided within one year of delivery, costs of
providing this support are insignificant and accrued at the time of
delivery and no upgrades of software are provided.
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
F-9
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
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 asset. Grants related to job creation and
training programs for extended periods are deferred and amortized on a
straight-line basis over the minimum period for which the created job must
be maintained or training provided.
RESEARCH AND DEVELOPMENT EXPENSES
All expenses related to development activities, which do not meet
generally accepted criteria for deferral, and research are expensed as
incurred, net of related tax credits and government grants. Development
expenses which meet generally accepted criteria for deferral are
capitalized, net of related tax credits and government grants, and
amortized against earnings over the estimated period of benefit.
As at August 31, 2001, 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 expected to be in effect 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.
EARNINGS (LOSS) PER SHARE
During the year, the company adopted the Canadian Institute of Chartered
Accountants (CICA) section 3500 "Earnings per Share", which requires the
use of the treasury stock method in calculating diluted earnings per share
and to apply the concept of contingently issuable shares. This standard
has been applied retroactively and did not result in any material change
to previously reported basic and diluted earnings per share.
Basic earnings (loss) and dividends per share are determined using the
weighted average number of common shares outstanding during the year, as
adjusted for the effects of reorganizations of share capital in prior
years.
Diluted earnings (loss) per share are determined using the weighted
average number of common shares outstanding during the year, plus the
effects of dilutive potential common shares outstanding during the year.
This method requires that diluted earnings (loss) per share be calculated,
using the treasury stock method, as if all potential common shares had
F-10
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
been exercised at the later of the beginning of the year or 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.
STOCK-BASED COMPENSATION PLANS
The company maintains stock-based compensation plans, which are described
in note 12. Under accounting principles generally accepted in Canada, no
compensation cost is recognized when stocks, stock options or stock awards
are issued to plan participants. Any consideration received from plan
participants upon the purchase of stock or the exercise of stock options
or stock awards is credited to share capital. Cash amounts paid upon the
exercise of stock appreciation rights are charged to earnings.
NEW ACCOUNTING STANDARDS
On August 1, 2001, the CICA issued section 1581 "Business combinations",
which supersedes section 1580, and issued section 3062 "Goodwill and Other
Intangible Assets". Section 1581 requires business combinations initiated
after June 30, 2001 or business combinations accounted for by the purchase
method with a date of acquisition after June 30, 2001 to be accounted for
using the purchase method of accounting. This section also broadens
criteria for recording intangible assets separately from goodwill. Upon
the adoption of section 3062, recorded goodwill and intangible assets will
be evaluated against those new criteria and may result in certain
intangible assets being reclassified into goodwill or, alternatively,
amounts initially recorded as goodwill being separately identified and
recognized apart from goodwill as intangible assets. Section 3062 requires
the use of a non-amortization approach to account for purchased goodwill
and indefinite-lived intangibles. Under non-amortization approach,
goodwill and indefinite-lived intangibles will not be amortized, but
instead they will be reviewed for impairment and written down and charged
to earnings only in the periods in which the recorded value of goodwill
and indefinite-lived intangibles exceeds their fair value. This section
will be adopted on September 1, 2002.
The impact of adopting section 3062 will allow the company to use the
non-amortization approach for goodwill and will reduce annual goodwill
amortization by approximately $50,000,000. Moreover, the company will
implement a new goodwill impairment methodology and any potential initial
impairment losses on goodwill determined by this methodology will be
charged to deficit. Any subsequent impairment losses on goodwill will be
charged to earnings in the period in which it is incurred.
F-11
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
3 BUSINESS COMBINATIONS
BUSINESS COMBINATIONS DURING 2001
BURLEIGH INSTRUMENTS, INC.
On December 20, 2000, the company acquired a 100% interest in Burleigh
Instruments, Inc. ("Burleigh"), a U.S. company which manufactures
precision scientific instruments used in basic and applied research,
engineering and production test applications in a variety of fields, in
exchange for a total consideration valued at US$189,270,000, including
acquisition-related costs of US$2,461,000.
The consideration paid consisted of US$42,461,000 in cash and the issuance
of 6,488,816 subordinate voting shares for an amount of US$146,809,000.
Furthermore, as part of this acquisition, the company established a
restricted stock award plan for employees of Burleigh (note 12). This plan
provides that in the event of an employee's departure, shares to be issued
to this employee under the plan will be issued to Burleigh's former
shareholders. In such circumstances, this issuance of shares will be
recorded as additional goodwill.
EFOS INC. (RENAMED EXFO PHOTONIC SOLUTIONS INC.)
On March 15, 2001, the company acquired a 100% interest in EXFO Photonic
Solutions Inc. ("EXFO Photonic"), a Canadian company specializing in
precision light-based adhesive spot curing technologies as well as curing
process control for the global optical component manufacturing market.
This acquisition was settled for a total consideration valued at
US$110,146,000, including acquisition-related costs of US$194,000. The
consideration paid consisted of US$25,194,000 in cash and the issuance of
3,700,000 subordinate voting shares for an amount of US$84,952,000.
These acquisitions have been accounted for using the purchase method and
consequently, the net earnings of Burleigh and EXFO Photonic have been
included in the consolidated statement of earnings of the company from the
date of acquisition of these subsidiaries, being December 20, 2000 for
Burleigh and March 15, 2001 for EXFO Photonic.
F-12
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
The purchase price, including acquisition-related costs, has been
allocated based on the estimated fair value of net assets at the dates of
acquisition as follows:
EXFO
BURLEIGH PHOTONIC
--------- ----------
Assets acquired
Current assets $ 7,092 $ 9,195
Property, plant and equipment 4,457 1,054
In process research and development 1,800 972
Core technology 24,000 25,324
Work force 1,250 907
Trademark - 421
Liabilities assumed (9,068) (7,169)
Future income taxes (8,342) (983)
--------- ----------
Net identifiable assets acquired 21,189 29,721
Goodwill 168,081 80,425
--------- ----------
Purchase price 189,270 110,146
Less: Subordinate voting shares issued 146,809 84,952
--------- ----------
Cash paid $ 42,461 $ 25,194
========= ==========
The fair value allocated to intangible assets acquired from Burleigh and
EXFO Photonic was based upon independent valuations performed in
conjunction with these acquisitions.
The existing technology that has reached technological feasibility was
classified as core technology.
Acquired in process research and development represents the existing
technology that has not reached technological feasibility and has no
future alternative use.
The fair value of subordinate voting shares issued as part of these
business combinations was determined based on the market price of the
shares over a reasonable period of time before and after the dates of
acquisition of the subsidiaries.
VANGUARD TECHNICAL SOLUTIONS, INC.
On March 16, 2001, the company, through one of its subsidiaries, Burleigh
Automation Inc., acquired substantially all the assets of Vanguard
Technical Solutions, Inc., a U.S. company
F-13
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
specializing in the design and manufacturing of ultra-precision assembly
equipment for sensitive process and critical assembly challenges on the
production floor. This acquisition, which was settled for a total cash
consideration of US$600,000 allocated to property and equipment, has been
accounted for using the purchase method.
BUSINESS COMBINATIONS DURING 2000
NORTECH FIBRONIC INC.
On February 4, 2000, the company acquired a 100% interest in Nortech
Fibronic Inc. ("Nortech"), a Canadian company specializing in fiber-optic
testing and temperature sensing, in exchange for total consideration
valued at US$2,799,000. The consideration paid consisted of US$2,108,000
in cash, the issuance of 800,000 Class G shares which were mandatorily
redeemable, for cash or subordinate voting shares at the option of the
company, for an amount of US$553,000 (note 9), and a non-interest-bearing
debenture in the amount of US$138,000 (note 10).
This acquisition has been accounted for using the purchase method. The
estimated fair value of assets and liabilities acquired amounted to
US$2,488,000 and US$2,231,000 respectively, resulting in goodwill of
US$2,542,000 related to the telecommunication core business.
The net earnings of Nortech have been included in the consolidated
statement of earnings of the company from the date of acquisition, being
February 4, 2000.
The mandatorily redeemable preferred shares were settled during the year
for US$354,000, resulting in a purchase price adjustment of US$189,000
(note 9), which has been applied against goodwill.
GAP OPTIQUE S.A.
On June 1, 2000, the company acquired the 85% interest in GAP Optique S.A.
held by its parent company for a cash consideration of US$16,000. The
carrying value of the net assets of GAP Optique S.A. was US$19,000 as at
December 31, 1999. Since the exchange occurred between entities under
common control, the exchange has been accounted for in a manner similar to
a pooling of interests. The assets, liabilities and shareholders' equity
of the company and GAP Optique S.A. have been combined using their
respective carrying amounts, and financial statements of prior years have
been restated as if the companies had always been combined.
F-14
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
BUSINESS COMBINATION DURING 1999
GEXFO DISTRIBUTION INTERNATIONALE INC.
On September 1, 1998, the company acquired, from its parent company, all
the issued and outstanding shares of GEXFO Distribution Internationale
Inc. in exchange for 1 Class C share of the company, which was redeemed at
a price of US$340,000. This holding company had two wholly-owned
subsidiaries, EXFO America Inc. and EXFO Europe S.A.R.L., which market the
company's products for the American and European markets.
Since the exchange was between entities under common control, the exchange
has been accounted for in a manner similar to a pooling of interests. The
assets, liabilities and shareholders' equity of the company and these
companies have been combined using their respective carrying amounts, and
financial statements of prior years have been restated as if the companies
had always been combined.
4 INVENTORIES
AS AT AUGUST 31,
------------------------
2000 2001
-------- --------
Raw materials $ 12,057 $ 29,891
Work in progress 2,910 3,507
Finished goods 3,901 10,947
-------- --------
$ 18,868 $ 44,345
======== ========
5 PROPERTY, PLANT AND EQUIPMENT
AS AT AUGUST 31, 2000
------------------------------------------------
ACCUMULATED
COST AMORTIZATION NET
-------- ------------ --------
Land $ 299 $ - $ 299
Building 3,442 32 3,410
Equipment 8,451 4,158 4,293
Leasehold improvements 1,373 681 692
-------- -------- --------
$ 13,565 $ 4,871 $ 8,694
F-15
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
AS AT AUGUST 31, 2001
------------------------------------------------
ACCUMULATED
COST AMORTIZATION NET
-------- ------------ --------
Land $ 2,735 $ - $ 2,735
Buildings 9,077 326 8,751
Equipment 23,906 9,286 14,620
Leasehold improvements 2,390 1,356 1,034
-------- -------- --------
$ 38,108 $ 10,968 $ 27,140
======== ======== ========
6 INTANGIBLE ASSETS AND GOODWILL
AS AT
AUGUST 31,
2000 AS AT AUGUST 31, 2001
---------- -------------------------------------
ACCUMULATED
NET COST AMORTIZATION NET
---------- --------- ------------ ---------
In process research and development $ - $ 2,769 2,769 -
Core technology - 49,483 5,678 43,805
Work force - 2,155 1,281 874
Other assets 68 637 246 391
---------- --------- ---------- ---------
68 55,044 9,974 45,070
Goodwill 2,252 250,497 31,325 219,172
---------- --------- ---------- ---------
$ 2,320 $ 305,541 $ 41,299 $ 264,242
========== ========= ========== =========
7 CREDIT FACILITIES
The company has available credit facilities under lines of credit which
provide for advances of up to Cdn$13,000,000 (US$8,400,000) and up to
US$3,000,000. These facilities, which are renewable annually, bear
interest at prime rate (prime rate in 2000). Accounts receivable,
inventories and all tangible and intangible assets of the company have
been pledged as security against these facilities. Amounts of Cdn$15,000
(US$10,000) and nil were drawn against these facilities as at August 31,
2000 and 2001, respectively.
F-16
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
8 ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
AS AT AUGUST 31,
------------------------
2000 2001
-------- --------
Trade $ 6,847 $ 7,732
Salaries and social benefits 1,698 3,917
Commissions 966 1,307
Non-recurring expenses (note 14) - 1,230
Warranty 392 901
Other 450 1,093
-------- --------
$ 10,353 $ 16,180
======== ========
9 MANDATORILY REDEEMABLE PREFERRED SHARES
Authorized - unlimited as to number, without par value Preferred,
non-voting, ranking in priority to subordinate and multiple voting shares,
each series ranking pari passu with the preferred shares of every other
series, issuable in one or more series Preferred Series 1, non-voting,
redeemed on November 30, 2000.
On February 7, 2000, the company filed articles of amendment pursuant to
which the Class G shares were created.
Prior to June 29, 2000, the company's authorized mandatorily redeemable
preferred shares consisted of Class B, C, E and G shares.
On June 29, 2000, the company filed articles of amendment pursuant to
which preferred shares issuable in series and preferred shares Series 1
were created, the 800,000 issued and outstanding Class G shares were
converted into 800,000 preferred shares Series 1 and Class B, C, E and G
shares were cancelled.
F-17
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
The following tables summarize the preferred share activity since August
31, 1998:
CLASS C SHARE CLASS E SHARES
------------------------- ------------------------ TOTAL
NUMBER AMOUNT NUMBER AMOUNT AMOUNT
Balance as at August 31, 1998 - $ - 19,000,000 $ - $ -
Business combination (note 3) 1 340 - - 340
Redemption (1) (340) - - (340)
Conversion of Class E shares
into Class A shares (note 12) - - (19,000,000) - -
--------- --------- ---------- ------- ---------
Balance as at August 31, 1999, 2000 and 2001 - $ - - $ - $ -
========= ========= ========== ======= =========
CLASS G SHARE PREFERRED SHARES SERIES 1
------------------------- -------------------------- TOTAL
NUMBER AMOUNT NUMBER AMOUNT AMOUNT
Balance as at August 31, 1998 and 1999 - $ - - $ - $ -
Business combination
(note 3) 800,000 555 - - 555
Conversion of Class G
shares into preferred
shares Series 1 (800,000) (555) 800,000 555 -
Foreign currency
translation adjustment - - - (12) (12)
--------- --------- ---------- ------- ---------
Balance as at August 31,
2000 - - 800,000 543 543
Redemption - - (800,000) (354) (354)
Purchase price adjustment
(note 3) - - - (189) (189)
--------- --------- ---------- ------- ---------
Balance as at August 31, 2001 - $ - - $ - $ -
========= ========= ========== ======= =========
F-18
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
10 LONG-TERM DEBT
AS AT AUGUST 31,
------------------
2000 2001
------ ------
Loans collateralized by equipment, bearing interest at
9.6%, repayable in monthly instalments of $13,000
including principal and interest, maturing in 2008 $ - $ 754
Unsecured non-interest-bearing debenture, repaid during
the year (note 3) 136 -
Unsecured non-interest-bearing loan repayable through
July 2002 32 16
------ -----
168 770
Less: Current portion 152 106
------ -----
$ 16 $ 664
====== =====
As at August 31, 2001, minimum principal repayments required in each of
the next five years are $106,000 in 2002, $100,000 in 2003, $110,000 in
2004, $122,000 in 2005 and $134,000 in 2006.
11 COMMITMENTS
The company has entered into operating leases for its premises, which
expire at various dates through to 2007. Minimum rentals payable under
these operating leases amount to $3,170,000 as at August 31, 2001.
For the years ended August 31, 1999, 2000 and 2001, rental expense
amounted to $344,000, $579,000 and $1,580,000, respectively.
12 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
F-19
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
Prior to June 29, 2000, the company's authorized share capital consisted
of Class A, D and F shares.
On September 2, 1998, the company filed articles of amendment pursuant to
which the Class A shares were split on a 190,000-to-one basis. Pursuant to
articles of amendment dated September 3, 1998, the 100 issued and
outstanding Class E shares (note 9) were converted into Class A shares on
a 190,000-to-one basis. All references to numbers of shares and per share
amounts have been restated in order to reflect the share split and
conversion noted above.
On June 29, 2000, the company filed articles of amendment pursuant to
which subordinate and multiple voting shares were created, the 38,000,000
issued and outstanding Class A shares were converted into 38,000,000
multiple voting shares, the 707,264 issued and outstanding Class F shares
were converted into 707,264 subordinate voting shares and the Class A, D
and F shares were cancelled.
The following tables summarize the share capital activity since August 31,
1998:
CLASS A SHARES CLASS F SHARES
TOTAL
NUMBER AMOUNT NUMBER AMOUNT AMOUNT
Balance as at August 31, 1998 19,000,000 $ 1 -- $ -- $ --
Conversion of Class E shares
into Class A shares (note 9) 19,000,000 -- -- -- --
Issued for cash under stock purchase plan -- -- 197,588 86 86
---------- -------- ------- -------- ---------
Balance as at August 31, 1999 38,000,000 $ 1 197,588 $ 86 $ 87
Issued for cash under stock purchase plan -- -- 509,676 390 390
Conversion of Class F shares into
subordinate voting shares -- -- (707,264) (476) (476)
Conversion of Class A shares into multiple
voting shares (38,000,000) (1) -- -- (1)
Balance as at August 31, 2000 and 2001 -- $ -- --
========== ======== ======= ======== =========
F-20
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
MULTIPLE VOTING SHARES SUBORDINATE VOTING SHARES
---------------------- ------------------------- TOTAL
NUMBER AMOUNT NUMBER AMOUNT AMOUNT
Balance as at August 31, 1998 and 1999 - $ - - $ - $ -
Conversion of Class F shares into
subordinate voting shares - - 707,264 476 476
Conversion of Class A shares into
multiple voting shares 38,000,000 1 - - 1
Issued pursuant to the initial
public offering - - 8,050,000 209,300 209,300
Share issue expenses, net of
related income taxes of
$5,425,000 - - - (11,318) (11,318)
---------- ------- ---------- --------- ----------
Balance as at August 31, 2000 38,000,000 1 8,757,264 198,458 198,459
Business combinations (note 3) - - 10,188,816 231,761 231,761
Conversion of multiple voting
shares into subordinate
voting shares (100,000) - 100,000 - -
Redemption - - (43,999) (33) (33)
Resale - - 43,999 33 33
Share issue expenses, net of
related income taxes of
$106,000 - - - (225) (225)
---------- ------- ---------- --------- ----------
Balance as at August 31, 2001 37,900,000 $ 1 19,046,080 $ 429,994 $ 429,995
========== ======= ========== ========= ==========
STOCK PURCHASE PLAN
The company's stock purchase plan terminated at the time of the initial
public offering, being June 29, 2000. In accordance with that plan,
officers, directors and key employees could purchase Class F shares up to
a maximum of 5% of all participating, issued and outstanding shares of the
company. The purchase price of shares under that plan was determined as a
multiple of the company's equity as at the end of the preceding fiscal
year. Shares issued under that plan are restricted as to sale and
transferability for a period of at least five years from the date of
acquisition. Prior to its initial public offering, the company issued
707,264 Class F shares in exchange for a weighted average cash
consideration of Cdn$0.98 (US$0.68) per share. As at August 31, 2001, the
company has guaranteed the repayment of third party loans totalling
Cdn$218,000 (US$141,000) obtained by certain employees with respect to the
purchase of Class F shares.
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.
F-21
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
The maximum number of subordinate voting shares issuable under the plan
cannot exceed 4,470,961 shares. The maximum number of subordinate voting
shares that may be granted to any individual cannot exceed 5% of the
number of outstanding subordinate voting shares. The exercise price is the
market price of the common shares on the date of grant. Options granted
under the plan generally expire ten years from the date of grant. Options
granted under the plan generally vest over a four-year period, with 25%
vesting on an annual basis commencing on the first anniversary of the date
of grant. Up to October 10, 2000, the number of options which ultimately
would become exercisable in any given year, and in aggregate, was
dependent on the degree to which the company's financial performance
objectives were met. Nevertheless, on October 10, 2000, the Board of
Directors of the company amended the vesting terms for options granted
pursuant to the option plan to remove the financial performance criterion.
Accordingly, options granted vest over the four-year period. The Board of
Directors may accelerate the vesting of any or all outstanding options
upon the occurrence of a change of control.
The following table summarizes the stock option activity since May 2000:
YEARS ENDED AUGUST 31,
-----------------------------------------------------------------
2000 2001
------------------------------ --------------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE
NUMBER EXERCISE PRICE NUMBER EXERCISE PRICE
------------------------------ --------------------------------
Outstanding - Beginning of year - $ - 609,734 $ 26
Granted 609,734 26 2,153,352 29
Forfeited - - (348,855) (29)
-------- ----------- ---------- ----------
Outstanding - End of year 609,734 $ 26 2,414,231 $ 28
======== =========== ========== ==========
Exercisable - End of year - $ - 510,244 $ 26
======== =========== ========== ==========
F-22
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
The following table summarizes information about stock options as at
August 31, 2001:
OPTIONS OUTSTANDING AS AT AUGUST OPTIONS EXERCISABLE AS AT AUGUST
31, 2001 31, 2001
------------------------------------- ---------------------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE
REMAINING REMAINING
EXERCISE PRICE NUMBER CONTRACTUAL LIFE NUMBER CONTRACTUAL LIFE
$19.19 to $29.99 1,965,551 9.3 years 510,244 8.8 years
$30.00 to $39.99 72,500 9.1 years - -
$40.00 to $49.99 282,550 9 years - -
$50.00 to $56.75 93,630 9 years - -
------------------------------------- ---------------------------------------
2,414,231 9.2 years 510,244 8.8 years
===================================== =======================================
RESTRICTED STOCK AWARD PLAN
On December 20, 2000, the company established a restricted stock award
plan for employees of Burleigh. A total of 359,781 stock awards entitle
employees to receive an equal aggregate number of subordinate voting
shares 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. The plan will
expire on December 20, 2004.
As at August 31, 2001, none of the 359,781 outstanding stock awards were
exercisable.
STOCK APPRECIATION RIGHT PLAN
On August 4, 2001, the company established a stock appreciation right plan
for certain of its 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 generally vest over a four-year period, with 25%
vesting on an annual basis commencing on the first anniversary of the date
of grant.
During the year, the company granted 22,400 stock appreciation rights with
a weighted average exercise price of US$29.72 and none of them were
exercisable as at August 31, 2001.
F-23
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
Considering the market price of the common shares of US$12.09 as at August
31, 2001, no compensation expense has been recorded in 2001 under that
plan.
13 OTHER DISCLOSURES
NET RESEARCH AND DEVELOPMENT EXPENSES
Net research and development expenses comprise the following:
YEARS ENDED AUGUST 31,
---------------------------------------
1999 2000 2001
--------- --------- ---------
Gross research and development expenses $ 6,390 $ 9,374 $ 17,601
Research and development tax credits (1,935) (2,436) (3,369)
Government grants (140) (536) (631)
--------- --------- ---------
$ 4,315 $ 6,402 $ 13,601
========= ========= =========
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$388,000) 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$1,434,000) 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 the company maintains
its Canadian principal place of business within the Province of Quebec
until at least December 31, 2002 and that jobs created pursuant to the
agreement be maintained for a period of at least five years from the date
of creation. Should these conditions not be met by the company, the
Minister may enforce various recourse options, which include suspension or
cancellation of the agreement or requiring the repayment of amounts
received by the company. During the period from January 1, 1998 to August
31, 2001, the company recognized a total of Cdn$2,820,000 (US$1,822,000)
under this program, of which Cdn$1,505,000 (US$972,000) has been credited
to earnings with the balance of Cdn$1,315,000 (US$850,000) having been
included in deferred grants in the balance sheet.
F-24
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
Furthermore, in 1999, the company entered into another agreement with the
Minister. Pursuant to this agreement, the Minister agreed to provide
grants up to a maximum of Cdn$3,756,000 (US$2,427,000) over the period
from February 1998 to June 2002, payable based on the number of jobs
created and certain specific training expenses related to such jobs. The
above grant is subject to the condition that 361 jobs be created pursuant
to the agreement and that the new employees continue to participate in the
specific training program for a period of at least ten consecutive months.
Should these conditions not be met by the company, the Minister may
enforce various recourse, which include suspension or cancellation of the
agreement or requiring the repayment of amounts received by the company.
Since 1998, the company has recognized a total of Cdn$2,552,000
(US$1,649,000) under this program, of which Cdn$2,317,000 (US$1,497,000)
has been credited to earnings with the balance of Cdn$235,000 (US$152,000)
having been included in deferred grants in the balance sheet.
Should any repayments of amounts received pursuant to these agreements be
required, such repayments will be charged to earnings as the amounts of
any repayments become known.
Finally, since 2000, companies operating in the Quebec City area are
eligible for a refundable tax credit granted by the government of the
Province of Quebec. This credit is earned on the increase of production
and marketing salaries incurred in the Quebec City area at a rate of 40%.
Since 2000, the company has recognized a total of Cdn$3,387,000
(US$2,188,000) under this program which has been credited to earnings.
The reduction in the company's work force described in note 14 had no
effect on amounts recognized under these programs.
Following is a summary of the classification of these and certain other
grants and tax credits (government grants) in the statements of earnings.
Interest income for the years ended August 31, 1999, 2000 and 2001 is net
of related government grants of $126,000, $196,000 and $15,000,
respectively.
Cost of sales for the years ended August 31, 1999, 2000 and 2001 is net of
government grants of $33,000, $915,000 and $1,742,000, respectively.
Selling and administrative expenses for the years ended August 31, 1999,
2000 and 2001 are net of government grants of $21,000, $386,000 and
$260,000, respectively.
Research and development expenses for the years ended August 31, 1999,
2000 and 2001 are net of government grants of $140,000, $536,000 and
$631,000, respectively.
F-25
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
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 eligible Canadian resident
employees, that requires the company to contribute an amount equal to
1% of an employee's gross salary, provided that the employee has
contributed at least 2% of gross salary to a tax-deferred registered
retirement savings plan. Contributions to this plan during the years
ended August 31, 1999, 2000 and 2001 amounted to Cdn$156,000
(US$104,000), Cdn$202,000 (US$137,000) and Cdn$642,000 (US$419,000),
respectively.
o 401K plans
The company maintains 401K plans for eligible U.S. resident
employees. Under these plans, the company may elect to contribute an
amount of up to 50% of the first 6% of an employee's current
compensation, subject to certain legislated maximum contribution
limits. During the years ended August 31, 1999, 2000 and 2001, the
company recorded contributions totalling $21,000, $23,000 and
$285,000, respectively.
14 NON-RECURRING EXPENSES
During 2001, the company implemented a structured plan to reduce costs and
increase efficiency.
Under that plan, the company recorded non-recurring expenses of
$3,288,000, including $844,000 in severance expenses for the 245 employees
who were terminated, $1,476,000 for unused assets and $968,000 for future
payments on exit leased facilities. These expenses are recorded as
non-recurring expenses in the statement of earnings. As at August 31,
2001, the accrued liabilities related to this structured plan are
$1,230,000, including $372,000 for severance expenses and $858,000 for
future payments on exit leased facilities.
F-26
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
15 INCOME TAXES
The reconciliation of the income tax provision calculated using the
combined Canadian federal and provincial statutory income tax rate to the
provision for income taxes per the financial statements is as follows:
YEARS ENDED AUGUST 31,
----------------------------------
1999 2000 2001
--------- -------- ---------
Income taxes at combined Canadian federal and
provincial statutory tax rate (38% in 1999
and 2000 and 37% in 2001) $ 3,156 $ 5,897 $ 8,855
Increase (decrease) due to:
Manufacturing and processing deduction (519) (645) (1,201)
Non-taxable income - - (144)
Non-deductible expenses 40 57 274
Higher rate on interest income - 133 480
Lower rate on foreign exchange gain - - (283)
Difference between combined Canadian federal
and provincial statutory tax rate and
foreign subsidiaries statutory tax rates - - 60
Effect of consolidation of subsidiaries - - (276)
Tax deductions - - (136)
Other (185) (144) 159
Change in valuation allowance - - 362
--------- -------- ---------
$ 2,492 $ 5,298 $ 8,150
========= ======== =========
Income taxes consist of the following:
Current $ 2,534 $ 5,331 $ 9,929
Future (42) (33) (1,779)
--------- -------- ---------
$ 2,492 $ 5,298 $ 8,150
========= ======== =========
F-27
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
Significant components of the company's future tax assets and liabilities
are as follows:
AS AT AUGUST 31,
----------------------
2000 2001
-------- --------
Future tax assets
Property, plant and equipment
and intangible assets $ - $ 107
Provisions and accruals 266 1,208
Government grants - 247
Deferred revenue 175 198
Share issue expenses 4,358 3,128
Non-recurring expenses - 930
Research and development expenses 94 86
Losses carried forward 105 272
Other (6) 39
-------- --------
4,992 6,215
Valuation allowance - (362)
-------- --------
$ 4,992 $ 5,853
======== ========
Future tax liabilities
Property, plant and equipment
and intangible assets $ (419) $ (8,640)
Research and development tax credits (474) (680)
Government grants (15) (310)
-------- --------
(908) (9,630)
-------- --------
Future tax assets (liabilities), net $ 4,084 $ (3,777)
======== ========
As at August 31, 2001, a company's subsidiary has accumulated losses for
income tax purposes of approximately $902,000 and research and development
expenses of approximately $961,000 at the provincial level for which a
valuation allowance of $362,000 has been established. These losses can be
carried forward against the subsidiary's future years' taxable income
until 2008. These accumulated research and development expenses can be
carried forward indefinitely against the subsidiary's future years'
provincial taxable income.
F-28
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
Significant components of the company's future tax assets and liabilities
are as follows:
16 SEGMENT INFORMATION
Management has organized the company under one operating segment, that
being the development, manufacture and marketing of fiber-optic test,
measurement and automation solutions.
Sales to external customers by geographic region are detailed as follows:
YEARS ENDED AUGUST 31,
-----------------------------------
1999 2000 2001
--------- --------- ---------
United States $ 20,755 $ 36,139 $ 72,604
Canada 2,973 8,006 12,531
Europe 8,721 14,503 30,568
Asia 3,199 6,486 19,059
South America 2,271 2,221 5,838
Other 4,247 4,284 5,413
--------- --------- ---------
$ 42,166 $ 71,639 $ 146,013
========= ========= =========
Sales have been allocated to geographic regions based on the country of
residence of the related customers.
During all years presented above, there were no customers from which 10%
or more of total sales were derived.
Long-lived assets by geographic region are detailed as follows:
AS AT AUGUST 31,
----------------------------
2000 2001
--------- ----------
United States $ - $ 171,450
Canada 11,014 119,932
--------- ----------
$ 11,014 $ 291,382
========= ==========
Long-lived assets consist of property, plant and equipment, intangible
assets and goodwill.
F-29
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
17 EARNINGS PER SHARE
The following table summarizes the reconciliation of the basic weighted
average number of shares outstanding and the diluted weighted average
number of shares outstanding used in the diluted earnings per share
calculations:
YEARS ENDED AUGUST 31,
---------------------------------
1999 2000 2001
------- ------- -------
Basic weighted average number of shares
outstanding (000's) 38,001 39,951 53,014
Conversion of preferred shares Series I - 26 -
Exercise of stock options - 109 -
------- ------- -------
Diluted weighted average number of shares
outstanding (000's) 38,001 40,086 53,014
======= ======= =======
UNAUDITED SUPPLEMENTARY PER SHARE INFORMATION
The following supplementary per share information is calculated from net
earnings before the amortization of goodwill of $31,076,000 ($297,000 in
2000 and nil in 1999), the after-tax effect of amortization of intangible
assets of $6,513,000 ($31,000 in 2000 and $28,700 in 1999) and the
after-tax effect of non-recurring expenses of $2,168,000 (nil in 2000 and
1999). The unaudited supplementary information may not be comparable to
similarly titled measures reported by other companies because it is
non-GAAP information.
YEARS ENDED AUGUST 31,
-------------------------------------
1999 2000 2001
-------- -------- --------
Net earnings before amortization of goodwill
and after-tax effect of amortization of
intangible assets and non-recurring
expenses $ 5,843 $ 10,252 $ 24,463
Basic and diluted per share net earnings
before amortization of goodwill and
after-tax effect of amortization of
intangible assets and non-recurring
expenses $ 0.14 $ 0.26 $ 0.46
F-30
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
18 FINANCIAL INSTRUMENTS
SHORT-TERM INVESTMENTS
Short-term investments consist of the following:
AS AT AUGUST 31,
-------------------------------
2000 2001
---------- ----------
Mutual fund denominated in Canadian dollars $ - $ 14,861
Commercial paper denominated in Canadian dollars,
bearing interest at annual rates of 5.77% to
5.98% in 2000 and 4.35% to 4.60% in 2001,
maturing on different dates between November
2000 and February 2001 in 2000 and September
2001 and November 2001 in 2001 41,872 52,000
Commercial paper denominated in US dollars,
bearing interest at annual rates of 6.51%
to 6.79%, matured in 2001 120,787 -
---------- ----------
$ 162,659 $ 66,861
========== ==========
FAIR VALUE
Cash and cash equivalents, accounts receivable, bank advances, accounts
payable and accrued liabilities and long-term debt are financial
instruments whose fair values approximate their carrying values.
The fair value of short-term investments, determined based on market
value, amounted to $162,719,000 and $66,861,000 as at August 31, 2000 and
2001, respectively.
CREDIT RISK
Financial instruments which potentially subject the company to credit risk
consist principally of cash and cash equivalents, short-term investments,
accounts receivable and forward exchange contracts. The company's
short-term investments consist of debt instruments issued by high-credit
quality financial institutions and corporations and units of a low-risk
mutual fund. The company's cash and cash equivalents 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.
F-31
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
Due to the North American, European, Asian and South American 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 $149,000 and $893,000 as at August 31, 2000 and 2001,
respectively.
INTEREST RATE RISK
As at August 31, 2001, the company's exposure to interest rate risk is
summarized as follows:
Cash and cash equivalents Non-interest bearing
Short-term investments As described above
Accounts receivable Non-interest bearing
Bank advances Prime rate
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, 2000
and 2001, the company held contracts to sell US dollars at various forward
rates, which are summarized as follows:
CONTRACTUAL WEIGHTED AVERAGE CONTRACTUAL
AMOUNTS FORWARD RATES
------------- ----------------------------
As at August 31, 2000
September 2000 to August 2001 $ 5,400 1.4871
September 2001 to April 2002 1,200 1.4602
As at August 31, 2001
September 2001 to August 2002 $ 15,200 1.4969
September 2002 to February 2003 1,800 1.5184
As at August 31, 2000 and 2001, these contracts resulted in deferred
unrealized losses of US$45,000 and US$533,000, respectively, which have
not been reflected in the statements of earnings.
F-32
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
As at August 31, 2000, the company held forward exchange contracts to buy
US dollars at various forward rates, which are summarized as follows:
CONTRACTUAL WEIGHTED AVERAGE CONTRACTUAL
AMOUNTS FORWARD RATES
------------- ----------------------------
Maturing between November 2000 and January 2001 $ 40,500 1.4777
As at August 31, 2000, these contracts resulted in an unrealized loss of
US$24,000 which has been reflected in the statement of earnings for that
year.
19 UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
As a registrant with the Securities and Exchange Commission in the United
States, the company is required to reconcile its financial results for
significant differences between generally accepted accounting principles
as applied in Canada (Canadian GAAP) and those applied in the United
States (U.S. GAAP).
Additional significant disclosures required under U.S. GAAP have also been
provided in the accompanying financial statements and notes. The following
summarizes the significant differences between Canadian and U.S. GAAP and
other required disclosures under U.S. GAAP not already disclosed in the
accompanying financial statements.
RECONCILIATION OF NET EARNINGS (LOSS) TO CONFORM WITH U.S. GAAP
The following summary sets out the significant differences to the
company's reported net earnings (loss) and net earnings (loss) per share
which would be made to conform with U.S. GAAP:
F-33
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
YEARS ENDED AUGUST 31,
-----------------------------------------
1999 2000 2001
-------- ------- --------
Net earnings (loss) for the year in accordance
with Canadian GAAP $ 5,814 $ 9,924 $(15,294)
Non-cash stock-based compensation costs
related to stock option plan a) - (1,464) (954)
Non-cash stock-based compensation costs
related to stock purchase plan a) (10) (538) (477)
Non-cash stock-based compensation costs
related to restricted stock award plan a) - - (3,481)
Change in reporting currency b) (44) - -
Unrealized gains on forward exchange contracts c) 208 - 97
Future income taxes on forward exchange
contracts c) (67) - 20
Future income taxes on acquired in process
research and development d) - - (936)
Amortization of goodwill d) - - (8,453)
-------- ------- --------
Net earnings (loss) for the year in accordance
with U.S. GAAP 5,901 7,922 (29,478)
Other comprehensive income (loss)
Foreign currency translation adjustments b) 606 1,555 (9,888)
Unrealized holding gains on available-for-sale
securities, net of related future income
taxes e) 36 37 -
Reclassification of holding gains on
available-for-sale securities included in
net earnings (loss), net of related
future income taxes e) - (36) (37)
-------- ------- --------
Comprehensive income (loss) 6,543 $ 9,478 $(39,403)
======== ======= ========
Basic and diluted net earnings (loss) per
share in accordance with U.S. GAAP f) $ 0.15 $ 0.20 (0.56)
F-34
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
As a result of the aforementioned adjustments to net earnings (loss),
significant differences with respect to shareholders' equity under U.S.
GAAP are as follows:
SHARE CAPITAL
AS AT AUGUST 31,
--------------------------------------------
1999 2000 2001
--------- --------- ---------
Share capital in accordance with Canadian GAAP $ 87 $ 198,459 $ 429,995
Stock-based compensation costs related to
stock purchase plan a), g)
Current year 45 2,647 (150)
Cumulative effect of prior years - 45 2,692
Shares issued upon business combinations d) - - 65,584
--------- --------- ---------
Share capital in accordance with U.S. GAAP $ 132 $ 201,151 $ 498,121
========= ========= =========
DEFERRED STOCK-BASED COMPENSATION COSTS
AS AT AUGUST 31,
--------------------------------------------
1999 2000 2001
--------- --------- ---------
Deferred stock-based compensation costs in
accordance with Canadian GAAP $ 87 $ 198,459 $ 429,995
Stock-based compensation costs related to
stock-based compensation plans a), g)
Current year (45) (21,396) (8,145)
Cumulative effect of prior years - (35) (19,429)
Amortization for the year 10 2,002 4,912
Reduction of stock-based compensation costs - - 14,694
--------- --------- ---------
Deferred stock-based compensation costs in
accordance with U.S. GAAP $ (35) $ (19,429) $ (7,968)
========= ========= =========
F-35
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
OTHER CAPITAL
AS AT AUGUST 31,
----------------------------------------
1999 2000 2001
---------- --------- ----------
Other capital in accordance with Canadian GAAP $ - $ - $ -
Stock-based compensation costs related to
stock-based compensation plans a)
Current year - 18,749 8,145
Cumulative effect of prior years - - 18,749
Reduction of stock-based compensation costs - - (14,544)
---------- --------- ----------
Other capital in accordance with U.S. GAAP $ - $ 18,749 $ 12,350
========== ========= ==========
RETAINED EARNINGS (DEFICIT)
AS AT AUGUST 31,
----------------------------------------
1999 2000 2001
---------- --------- ----------
Retained earnings (deficit) in accordance with
Canadian GAAP $ 14,592 $ 6,980 $ (8,314)
Stock-based compensation costs related to a)
stock-based compensation plans
Current year (10) (2,002) (4,912)
Cumulative effect of prior years - (10) (2,012)
Unrealized gains on forward exchange contracts, c)
net of related future income taxes
Current year - - 117
Future income taxes on acquired in process research d)
and development
Current year - - (936)
Amortization of goodwill d)
Current year - - (8,453)
Change in reporting currency b)
Current year
Net earnings (44) - -
Dividends 24 - -
Cumulative effect of prior years 1,036 1,016 1,016
---------- --------- ----------
Retained earnings (deficit) in accordance
with U.S. GAAP $ 15,598 $ 5,984 $ (23,494)
========== ========= ==========
F-36
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
AS AT AUGUST 31,
----------------------------------------
1999 2000 2001
---------- --------- ----------
Foreign currency translation adjustments b)
Balance - Beginning of year $ (1,622) $ (1,016) $ 539
Change during the year 606 1,555 (9,888)
---------- --------- ----------
Balance - End of year (1,016) 539 (9,349)
---------- --------- ----------
Unrealized holding gains on available-for-sale
securities, net of future income taxes e)
Balance - Beginning of year - 36 37
Unrealized gains arising during the year, net
of related future income taxes 36 37 -
Reclassification adjustment for amounts
included in net earnings (loss), net of
related future income taxes - (36) (37)
---------- --------- ----------
Balance - End of year 36 37 -
---------- --------- ----------
Accumulated other comprehensive income (loss) $ (980) $ 576 $ (9,349)
========== ========= ==========
F-37
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
BALANCE SHEETS
The following table summarizes the significant differences in balance
sheet items between Canadian GAAP and U.S. GAAP:
AS AT AUGUST 31, 2000 AS AT AUGUST 31, 2001
---------------------------- --------------------------
AS REPORTED U.S. GAAP AS REPORTED U.S. GAAP
Goodwill d)
Cost $ 2,549 $ 2,549 $ 250,497 $ 315,547
Accumulated amortization (297) (297) (31,125) (39,762)
---------- ---------- ---------- ----------
$ 2,252 $ 2,252 $ 219,172 $ 275,785
========== ========== ========== ==========
Shareholders' equity
Share capital a), d)
g), $ 198,459 $ 201,151 $ 429,995 $ 498,121
Contributed surplus - - 1,457 1,457
Cumulative translation
adjustment b) 1,555 - (8,333) -
Deferred stock-based
compensation costs a), g) - (19,429) - (7,968)
Other capital a) - 18,749 - 12,350
Retained earnings (deficit) a), b)
c), d) 6,980 5,984 (8,314) (23,494)
Accumulated other
comprehensive income
(loss) b), e) - 576 - (9,349)
---------- ---------- ---------- ----------
$ 206,994 $ 207,031 $ 414,805 $ 471,117
========== ========== ========== ==========
STATEMENTS OF CASH FLOWS
For the years ended August 31, 1999, 2000 and 2001, there are no
significant differences between the statements of cash flows under
Canadian GAAP as compared to U.S. GAAP.
RECONCILIATION ITEMS
A) ACCOUNTING FOR STOCK-BASED COMPENSATION
To conform with U.S. GAAP, the company measures stock-based
compensation costs using the intrinsic value method (APB 25
"Accounting for Stock Issued to Employees").
Stock purchase plan
Under APB 25, compensation cost related to the stock purchase plan is
measured as the difference between the fair value of the purchased
stock and the purchase price paid by
F-38
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
plan participants. Compensation cost is amortized to expense over a
period of five years, being the restriction period. This plan
terminated at the time of the Initial Public Offering on June 29,
2000.
During the years ended August 31, 1999 and 2000, the weighted average
fair value per share under the stock purchase plan amounted to $0.68
and $10.80, respectively. The fair value per share since inception of
the plan to June 29, 2000 ranged between $0.68 and $18.00.
Stock option plan
In accordance with APB 25, the company's stock option plan was
considered to be a variable plan until October 10, 2000. As a result
of the amendment to the stock option plan described in note 12, the
performance criterion was removed and the number of shares to be
issued under the plan was fixed. Aggregate compensation cost for the
period from the date of grant to August 31, 2001 amounts to
$2,418,000. Accordingly, the current year reflects a net reduction of
the compensation cost and deferred compensation cost previously
recognized of $467,000 and $14,544,000, respectively. Compensation
cost under this plan is measured as the difference between the fair
value of the underlying stock at the date of grant and the exercise
price of the option. Compensation cost is amortized to expense over
the estimated vesting period up to a maximum of four years.
Restricted stock award plan
Under APB 25, compensation cost related to the restricted stock award
plan is measured as the difference between the fair value of the
underlying stock at the date of grant and the exercise price which is
nil. Compensation cost is amortized to expense over the estimated
vesting period up to a maximum of four years, being the acquisition
period.
Under Canadian GAAP, no compensation cost is recognized for these
stock-based compensation plans.
B) CHANGE IN REPORTING CURRENCY
As mentioned in note 2, on September 1, 1999, the company adopted the
US dollar as its reporting currency. Under U.S. GAAP, the financial
statements, including prior years, are translated according to the
current rate method. Under Canadian GAAP, at the time of change in
reporting currency, the historical financial statements are presented
using a translation of convenience.
F-39
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
Under Canadian GAAP, the statement of earnings for the year ended
August 31, 1999 was translated into US dollars using an exchange rate
of US$1.00 = Cdn$1.4958. Under U.S. GAAP, revenues and expenses would
be translated at exchange rates prevailing at the respective
transaction dates. Average exchange rate for the year ended August
31, 1999 was US$1.00 = Cdn$1.5068. The exchange rate as at August 31,
1999 was US$1.00 = Cdn$1.4958.
C) FORWARD EXCHANGE CONTRACTS
On September 1, 2000, the company prospectively adopted Statement of
Financial Accounting Standard No. 133, Accounting for Derivative
Instruments and Hedging Activities (SFAS 133) and its amendments
(SFAS 138), which requires all derivatives to be carried on the
balance sheet at fair value. The forward exchange contracts used by
the company have not qualified for hedging accounting treatment
during the year ended August 31, 2001 and accordingly, changes in the
fair value of the derivatives have been charged to earnings during
the year.
Prior to the adoption of SFAS 133, forward exchange contracts held by
the company were accounted for in accordance with SFAS 52 under U.S.
GAAP. Accordingly, certain of the forward exchange contracts held for
hedging and other purposes in 1998 and 1999, for which the underlying
transactions were not firmly committed, did not qualify for hedge
accounting. Consequently, unrealized gains or losses on these
contracts at each balance sheet date were reflected in earnings for
the corresponding year.
Under Canadian GAAP, the company's forward exchange contracts held
for the purpose of hedging anticipated sales qualified for hedge
accounting and any unrealized gains or losses were deferred and
recognized in the statement of earnings upon settlement of the
related transactions.
D) BUSINESS COMBINATIONS
Under U.S. GAAP, the value of shares issued upon a business
combination should be determined based on the market price of the
shares over a reasonable period of time before and after the
companies have reached an agreement on the purchase price, the
significant terms of the agreement are known and the proposed
transaction is announced.
Consequently, the measurement dates of the acquisitions of Burleigh
and EXFO Photonic occurred on December 14, 2000 and March 6, 2001,
respectively, 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
F-40
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
GAAP) for Burleigh and $120,802,000 ($110,146,000 under Canadian
GAAP) for EXFO Photonic, thus increasing share capital and goodwill
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 its estimated useful life. Future
income taxes are recognized on the acquisition date on that asset in
the purchase price allocation process. As at August 31, 2001, in
process research and development recorded under Canadian GAAP was
fully amortized.
E) SHORT-TERM INVESTMENTS
Under U.S. GAAP, the short-term investments would be classified as
"available-for-sale" securities. Consequently, these securities would
be carried at fair value, with any unrealized holding gains or losses
at each balance sheet date being reflected in other comprehensive
income (loss) on a net-of-tax basis. Under Canadian GAAP, short-term
investments are carried at the lower of cost and market value and
cost is composed of acquisition cost plus amortization of discount or
less amortization of premium.
F) EARNINGS (LOSS) PER SHARE
Under U.S. GAAP, the presentation of per share figures for earnings
before amortization of goodwill and of any other unaudited
supplementary per share non-GAAP information is not permitted. In
addition, under U.S. GAAP, amortization of goodwill would be included
in the computation of earnings from operations.
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, resulting in any
difference between the amount originally credited to share capital
and the remaining deferred compensation cost being 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) NEW ACCOUNTING STANDARDS
On June 15, 2001, the Financial Accounting Standards Board issued
SFAS 143, "Accounting for Asset Retirement Obligation", which is
effective for fiscal years beginning on or after June 15, 2002. This
standard requires that the fair value of a liability for an asset
retirement obligation be recognized in the period in which it is
F-41
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
incurred if a reasonable estimate of fair value can be made. The
company has not yet assessed the impact of the adoption of this new
standard.
On July 20, 2001, the Financial Accounting Standards Board issued
SFAS 141, "Business Combinations" and SFAS 142, "Goodwill and Other
Intangible Assets". SFAS 141 requires business combinations initiated
after June 30, 2001 or business combinations accounted for by the
purchase method with a date of acquisition after June 30, 2001 to be
accounted for using the purchase method of accounting. This section
also broadens criteria for recording intangible assets separately
from goodwill. Upon the adoption of SFAS 142, recorded goodwill and
intangible assets will be evaluated against those new criteria and
may result in certain intangible assets being reclassified into
goodwill, or alternatively, amounts initially recorded as goodwill
being separately identified and recognized apart from goodwill as
intangible assets. SFAS 142 requires the use of a non-amortization
approach to account for purchased goodwill and indefinite-lived
intangibles. Under non-amortization approach, goodwill and
indefinite-lived intangibles will not be amortized, but instead would
be reviewed for impairment and written down and charged to earnings
only in the periods in which the recorded value of goodwill and
indefinite-lived intangibles exceeds their fair value. This section
will be adopted on September 1, 2002.
The impact of adopting SFAS 142 will allow the company to use the
non-amortization approach for goodwill and will reduce annual
goodwill amortization by approximately $63,000,000. Moreover, the
company will implement a new goodwill impairment methodology and any
potential initial impairment losses on goodwill determined by this
methodology will be charged to earnings.
UNAUDITED PRO FORMA INFORMATION ON BUSINESS COMBINATIONS
Under U.S. GAAP, pro forma information must be provided as though the
business combinations had occurred at the beginning of the reported
periods.
The following unaudited pro forma information reflects the results of
operations as if the 2001 acquisitions had been completed on September 1,
2000 and 1999, the 2000 acquisitions had been completed on September 1,
1999 and 1998, and the 1999 acquisition had been completed on September 1,
1998.
Such information is not necessarily indicative of the actual results which
would have been achieved, nor is it necessarily indicative of future
consolidated results of the company.
F-42
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
YEARS ENDED AUGUST 31,
---------------------------------------------
1999 2000 2001
-------- ---------- ----------
Sales $ 44,948 $ 107,262 $ 165,754
Net earnings (loss) $ 5,689 (71,143) $ (56,498)
Basic and diluted net earnings (loss)
per share $ 0.14 $ (1.42) $ (0.99)
ACCOUNTING FOR STOCK-BASED COMPENSATION
Under U.S. GAAP, the company has elected to measure compensation cost
related to grants of stock options and stock awards using the intrinsic
value method of accounting. In this instance, however, under SFAS 123,
Accounting for Stock-Based Compensation, the company is required to make
pro forma disclosures of net earnings (loss), basic and diluted net
earnings (loss) per share as if the fair value based method of accounting
had been applied.
The fair value of options or awards granted was estimated using the
Black-Scholes options pricing model with the following weighted average
assumptions:
YEARS ENDED AUGUST 31,
---------------------------------
2000 2001
----------- -----------
Risk-free interest rate 6.04% 5.36%
Expected volatility 75% 75%
Dividend yield Nil Nil
Weighted average expected life 32 months 33 months
The Black-Scholes options valuation model was developed for use in
estimating the fair value of traded options and awards which have no
vesting restrictions, and are fully transferable. In addition, option and
award valuation models require the input of highly subjective assumptions
including the expected stock price volatility. Because the company's
employee stock options and stock awards have characteristics significantly
different from those of traded options and awards, and because changes in
the subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its employee stock
options and stock awards.
F-43
EXFO ELECTRO-OPTICAL ENGINEERING INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands of US dollars, except share and per share
data and as otherwise noted)
If the fair value based method had been used to account for stock-based
compensation costs related to stock options and stock awards issued to
employees, directors and executive officers, the net earnings (loss) and
related net earnings (loss) per share figures under U.S. GAAP would be as
follows:
YEARS ENDED AUGUST 31,
------------------------------
2000 2001
---------- ----------
Pro forma net earnings (loss)
for the year $ 8,939 $ (39,109)
Pro forma basic and diluted net
earnings (loss) per share $ 0.22 $ (0.74)
20 SUBSEQUENT EVENT
ACQUISITION OF AVANTAS NETWORKS CORPORATION
On August 20, 2001, the company entered into an agreement to acquire a
100% interest in Avantas Networks Corporation, a Canadian company
specializing in fiber-optic protocol testing. This acquisition is expected
to be settled for a total consideration of approximately US$95,625,000,
less cash acquired of US$28,000,000. The consideration paid will consist
of US$36,000,000 in cash and the issuance of approximately 4,400,000
subordinate voting shares. The fair value of subordinate voting shares to
be issued was determined based on the market price of the shares over a
reasonable period of time before and after the terms of the acquisition
were agreed to and announced. This acquisition will be accounted for using
the purchase method according to the new CICA section 1581. The goodwill
resulting from this acquisition will not be amortized according to CICA
section 3062 but will be subject to an impairment test.
This acquisition is expected to be closed in the first quarter of 2002.
F-44