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Volkswagen 20-F 2009
form20f_2009.htm


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 20-F

o 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, 2009; or

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period ________ to ________; or

o SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Date of event requiring this shell company report

For the transition period from September 1, 2008 to August 31, 2009

Commission File No.0-30895

EXFO ELECTRO-OPTICAL ENGINEERING INC. /
EXFO INGÉNIERIE ÉLECTRO-OPTIQUE INC.
(Exact name of registrant as specified in its charter)

Canada
(Jurisdiction of Incorporation or organization)

400 Godin Avenue
Quebec, Quebec, G1M 2K2, 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:

Title of each class
Name of each exchange on which registered
Subordinate Voting Shares without par value
NASDAQ
Subordinate Voting Shares without par value
TSX

Securities registered or to be registered pursuant to Section 12(g) of the Act:

None

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

None
 

 
 

 

As of November 2, 2009, the registrant had 22,749,965 Subordinate Voting Shares outstanding.

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes o  No x

If this report is an annual report or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934.

Yes o No x

Indicate by check mark whether the registrant (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 the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer      o
Accelerated filer      x
Non-accelerated filer      o

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

U.S. GAAP      o
International Financial Reporting Standards as issued by the      o
International Accounting Standards Board
Other      x

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.
Item 17 o Item 18 x

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o        No x

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 of 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.

Yes o        No x


 
 

 




Item 2.                   Offer Statistics and Expected Timetable

Item 3.                   Key Information
D.      Risk Factors

Item 4.                   Information on the Company

Item 4A.               Unresolved Staff Comments

Item 5.                  Operating and Financial Review and Prospects

Item 6.                  Directors, Senior Management and Employees
B.      Compensation
C.      Board Practices
D.      Employees
E.      Share Ownership


Item 8.                  Financial Information
B.      Significant changes

Item 9.                  Offer and Listing

Item 10.                 Additional Information
A.      Share Capital
E.      Taxation



 
 






Item 15.                Controls and Procedures

Item 16.                 [Reserved]


Item 16B.              Code of Ethics








Item 17.                Financial Statements
 
Item 18.                Financial Statements

Item 19.                Exhibits

 
 

DISCLOSURE REGARDING FORWARD-LOOKING INFORMATION

This annual report contains or incorporates by reference statements which constitute forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995 and we intend that such forward-looking statements be subject to the safe harbors created thereby. Forward-looking statements are statements other than historical information or statements of current condition that refer to expectations, projections or other characterizations of future events and circumstances. They are not guarantees of future performance and involve risks and uncertainties. Actual results may differ materially from those in forward-looking statements due to various factors including those that are discussed under “Risk Factors” set forth in Item 3D of this annual report. Assumptions relating to forward-looking statements involve judgments and risks, all of which are difficult or impossible to predict and many of which are beyond our control. When used in this annual report, the words “believe”, “anticipate”, “plan”, “expect”, “intend”, “estimate” or similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain such identifying words. We believe that the expectations reflected in the forward-looking statements are reasonable based on information currently available to us, but we cannot assure you that the expectations will prove to have been correct. Accordingly, you should not place undue reliance on these forward-looking statements. These statements speak only as of the date of this document. Unless required by law or applicable regulations, we undertake no obligation to revise or update any of them to reflect events or circumstances that occur after the date of this document.

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

PART I.                      

Identity of Directors, Senior Management and Advisors
 
           Not Applicable.


Offer Statistics and Expected Timetable
 
           Not Applicable.


Key Information
 
 
The consolidated statements of earnings data for the years ended August 31, 2005 and 2006 and the consolidated balance sheets data as at August 31, 2005, 2006 and 2007 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, 2007, 2008 and 2009 and the consolidated balance sheets data as at August 31, 2008 and 2009 are derived from our audited consolidated financial statements that are included elsewhere in this annual report.

Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in Canada (“Canadian GAAP”) and significant differences in measurement and disclosure from generally accepted accounting principles in United States (“U.S. GAAP”) are set out in note 20 to our consolidated financial statements included elsewhere in this annual report. The historical results below are not necessarily indicative of the results to be expected for any future periods.
 
 
 
 
The selected financial data should be read in conjunction with our audited 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,
 
   
2009
   
2008
   
2007
   
2006
   
2005
 
   
(in thousands of US dollars, except share and per share data)
 
Consolidated Statements of Earnings Data:
                             
Amounts under Canadian GAAP
                             
Sales                                                                  
  $ 172,878     $ 183,790     $ 152,934     $ 128,253     $ 97,216  
Cost of sales (1)
    66,892       75,624       65,136       57,275       44,059  
Gross margin
    105,986       108,166       87,798       70,978       53,157  
                                         
Operating expenses
                                       
Selling and administrative
    63,808       61,153       49,580       40,298       31,782  
Net research and development
    27,698       26,867       16,668       15,404       12,190  
Amortization of property, plant and equipment
    4,607       4,292       2,983       3,523       4,256  
Amortization of intangible assets
    5,067       3,871       2,864       4,394       4,836  
Impairment of long-lived assets
                      604        
Restructuring and other charges
    1,171                         292  
Government grants
                (1,079 )     (1,307 )      
Impairment of goodwill
    21,713                          
Total operating expenses
    124,064       96,183       71,016       62,916       53,356  
Earnings (loss) from operations
    (18,078 )     11,983       16,782       8,062       (199 )
Interest income
    597       4,639       4,717       3,253       2,524  
Foreign exchange gain (loss)
    1,157       442       (49 )     (595 )     (1,336 )
Earnings (loss) before income taxes and extraordinary gain
    (16,324 )     17,064       21,450       10,720       989  
Income taxes
    261       1,676       (20,825 )     2,585       2,623  
Earnings (loss) before extraordinary gain
    (16,585 )     15,388       42,275       8,135       (1,634 )
Extraordinary gain
          3,036                    
Net earnings (loss) for the year
  $ (16,585 )   $ 18,424     $ 42,275     $ 8,135     $ (1,634 )
Basic and diluted earnings (loss) before extraordinary gain per share
  $ (0.27 )   $ 0.22     $ 0.61     $ 0.12     $ (0.02 )
Basic and diluted net earnings (loss) per share
  $ (0.27 )   $ 0.27     $ 0.61     $ 0.12     $ (0.02 )
Basic weighted average number of shares used in per share calculations (000’s)
    61,845       68,767       68,875       68,643       68,526  
Diluted weighted average number of shares used in per share calculations (000’s)
    61,845       69,318       69,555       69,275       68,526  
Other consolidated statements of earnings data:
                                       
Gross research and development
  $ 35,757     $ 32,454     $ 25,201     $ 19,488     $ 15,878  
Net research and development
  $ 27,698     $ 26,867     $ 16,668     $ 15,404     $ 12,190  
Amounts under U.S. GAAP
                                       
Net earnings (loss) for the year                                                                  
  $ (8,179 )   $ 18,424     $ 42,257     $ 8,135     $ (2,920 )
Basic and diluted net earnings (loss) per share
  $ (0.13 )   $ 0.27     $ 0.61     $ 0.12     $ (0.04 )
Basic weighted average number of shares used in per share calculations (000’s)
    61,845       68,767       68,875       68,643       68,526  
Diluted weighted average number of shares used in per share calculations (000’s)
    61,845       69,318       69,555       69,275       68,526  
       
   
As at August 31,
 
      2009       2008       2007       2006       2005  
   
(in thousands of US dollars)
 
Consolidated Balance Sheets Data:
                                       
Amounts under Canadian GAAP
                                       
Cash                                                                  
  $ 10,611     $ 5,914     $ 5,541     $ 6,853     $ 7,119  
Short-term investments                                                                  
    59,105       81,626       124,217       104,437       104,883  
Total assets                                                                  
    240,371       293,066       279,138       219,159       190,957  
Long-term debt (excluding current portion)
                      354       198  
Share capital                                                                  
    104,846       142,786       150,019       148,921       521,875  
Shareholders’ equity                                                                  
  $ 208,045     $ 259,515     $ 250,165     $ 196,234     $ 173,400  
Amounts under U.S. GAAP
                                       
Cash                                                                  
  $ 10,611     $ 5,914     $ 5,541     $ 6,853     $ 7,119  
Short-term investments                                                                  
    59,105       81,626       124,217       104,437       104,883  
Total assets                                                                  
    236,492       280,426       268,389       212,702       182,852  
Long-term debt (excluding current portion)
                      354       198  
Share capital                                                                  
    417,342       568,917       599,519       598,421       597,664  
Shareholders’ equity                                                                  
  $ 204,093     $ 246,802     $ 239,343     $ 189,777     $ 165,295  

(1)  
The cost of sales is exclusive of amortization, shown separately.
 
 

 
 
Not Applicable.
 
 
 
Not Applicable.
 
 
 
Fluctuations in the exchange rates between the Canadian dollar, US dollar and other currencies may adversely affect our operating results.
 
Most of our sales are denominated in US dollars and Euros. However, most of our operating expenses and capital expenditures are denominated in Canadian dollars and foreign currencies such as Euros, Sterling Pound (Great Britain), Rupee (India) and Renminbi (China). As a result, even though we manage to some extent our exposure to currency risks with forward exchange contracts (to sell US dollars for Canadian dollars) and certain operating expenses denominated in currencies other than the Canadian dollar, we are exposed to fluctuations in the exchange rates between the US dollar on one hand and the Canadian dollar, Euro and other currencies on the other. For example, the average exchange rate of the Canadian dollar versus the US dollar was 1.1782 in fiscal 2009 compared to 1.0071 in fiscal 2008. Moreover, from March 1, 2009 to May 31, 2009, the Canadian dollar increased 16.4% against the US dollar which negatively affected our operating results for the third quarter of fiscal 2009. Any further decrease in the value of the US dollar relative to the Canadian dollar and other currencies, and any variance between the value of the Canadian dollar and the contractual rate of our forward exchange contracts, could have a material adverse effect on our operating results and provide competitive advantages to our competitors.
 
If the global economic recession persists or worsens, our business may continue to be adversely affected by unfavorable general economic and market conditions.
 
Our business is subject to the effects of general economic conditions in North America and throughout the world and, more particularly, market conditions in the telecommunications industry. During fiscal 2009, our operating results were adversely affected by unfavorable economic conditions and reduced capital spending in the Americas, Europe, Middle East and Africa (EMEA), and Asia-Pacific (APAC). The global economic crisis included significant reductions in available capital and liquidity from banks and other providers of credit, substantial reductions and/or fluctuations in equity and currency values worldwide, and concerns that the worldwide economy will endure a prolonged recessionary period. Due to the unfavorable changes in economic and market conditions, capital spending was lower among our customers for test and service assurance solutions and, therefore, demand for our products declined which adversely affected our revenue level in 2009. Challenging economic and market conditions also impaired the ability of some customers to pay for the products and services they purchased. As a result, our reserves for doubtful accounts receivable increased. In addition, economic condition may also negatively affect the ability of some of our suppliers to supply us in a timely fashion.
 
Further effects of the global economic crisis, as well as other unforeseeable ones, are difficult to forecast and mitigate. If unfavorable economic and market conditions persist, we may continue to experience a material adverse impact on our business, operating results and financial condition.
 

 
 
We must continue to overcome significant competition in our targeted industries in order to gain market share and achieve our growth strategy.
 
The market for our primary business activity ─ namely designing, manufacturing, marketing and selling telecommunications test, measurement and service assurance equipment ─ is rapidly evolving and is marked by intense competition and technical innovation. Likewise, the market for our selected life sciences and industrial solutions is very competitive. We anticipate the pace of change to remain high or even accelerate for our targeted industries in the future. We might see the emergence of new competitors or the consolidation of current competitors, as the markets for telecommunications test, measurement and service assurance equipment as well as for life sciences and industrial solutions evolve in response to technical innovations and economic conditions. Achieving a compound annual growth rate of 20% in sales in the next three years, as we have targeted in our updated corporate performance objectives, will largely depend on our ability to gain market share by increasing sales of current products at existing accounts, expanding into new accounts, introducing new products and enhancements, and exploiting new market opportunities, all of which will be challenging given the competitive environment.
 
During the past few years, the telecommunications test, measurement and service assurance industry has witnessed consolidation. IXIA acquired Catapult Communications and Agilent Technologies’ data networks product testing line in June 2009 and October 2009, respectively. Danaher Corporation acquired Tektronix, Inc., in November 2007. Anritsu Corporation acquired NetTest A/S in August 2005 and JDS Uniphase Corporation (JDSU) acquired Acterna Corporation in the same month.
 
Competitors in test and measurement include global suppliers like Agilent, Anritsu, JDSU, Spirent and Yokogawa. Other players like AFL Noyes, Anacise, BlueLight Technologies, Dadi, Digital Lightwave, Electrodata, Empirix, Fluke Networks and Tektronix, operating divisions within Danaher Corporation, Grandway, Greenlee Tempo, Ineoquest, IXIA, Kingfisher, Nethawk, Shenick, Shunra, Sunrise Telecom and VeEX compete against us in niche test and measurement markets. On the service assurance side, we compete against Agilent, Danaher, Empirix, Ineoquest, Infovista, IXIA, Nexus Telecom, Radcom, Spirent, TTI Telecom and Whitbe. Some network equipment manufacturers also sell their in-house service assurance systems.
 
Some competitors may have greater financial, technical and/or marketing resources than us. Consequently, they may be able to devote greater resources to the development, marketing, manufacturing, selling and support of their products in order to capture market share.
 
Competitors also may be better positioned than us to capture market share or to acquire companies and new technologies that would potentially displace our products or render them obsolete. We cannot predict whether current or future competitors will develop or market products that offer higher performance, more features, or are more cost-effective than our current or future products. To remain competitive and achieve our growth strategy, we must increase our sales and develop cost-effective products and product enhancements that offer higher performance and more functionality, in current and new sectors, so that we can increase our market share. Our failure to do so may harm our business, results of operations and financial condition.
 
One of our customers has accounted for a high percentage of our sales in the past several years, and any adverse factor affecting this customer or our relationship with this customer could cause our sales to decrease.
 
A Tier-1 carrier in the US accounted for 11.6% of our sales in fiscal 2009, 7.4% in fiscal 2008, 14.7% in fiscal 2007, 13.8% in fiscal 2006 and 23.3% in fiscal 2005. Although we have reduced our exposure to this customer in recent years, we may not be able to offset lower sales at this particular account in the future. Despite the fact that this customer has a supply contract with us, it could change its purchasing practice, force us to renegotiate prices and is not obligated to purchase a specific amount of products from us or provide us with binding purchase forecasts for any period. In addition, our customers typically purchase our products under individual purchase orders and may cancel or defer purchases on short notice without significant penalties.
 
The loss of such a customer or the reduction, delay, or cancellation of orders from this customer or other significant customers could cause our sales and, therefore, net earnings to decline.
 

 
 
We have faced pricing pressure on our existing products and expect that this pressure will continue. If we do not keep lowering our manufacturing costs or introduce new products with higher margins, our gross margins may decrease and our operating results may be adversely affected.
 
We continue to implement measures to attempt to protect our gross margin, despite sharp fluctuations between the US and Canadian currencies. In addition, since September 2007, we began transferring and ramping manufacturing of our higher-volume, lower-complexity telecom products at a wholly-owned production facility in Shenzhen, China, with a goal of lowering our production costs. However, increased competition in the telecommunications test, measurement and service assurance industry and consolidation among our customers, will likely result in ongoing downward pressure on average selling prices, which may in turn negatively affect our gross margins. Pricing pressure can result from a number of factors such as:
 
·  
increased competition for business;
·  
reduced demand;
·  
limited number of potential customers;
·  
competition from companies with lower production costs, including companies operating in lower cost environments;
·  
introduction of new products by competitors;
·  
greater economies of scale for higher-volume competitors;
·  
large customers, who buy in high volumes, can exert substantial negotiating leverage over us; and
·  
resale of used equipment.
 
In addition, gross margins may also be negatively affected by increased costs of raw materials as well as obsolescence and excess costs, product and customer mix and under-absorption of fixed manufacturing costs.
 
As pricing pressure will likely continue to affect our existing products, we may have to increase the number of units sold to maintain our existing sales levels. If we are unable to increase our sales levels, lower our manufacturing costs, or introduce new products with higher margins, our gross margins may decline and our operating results may suffer.
 
Our products may have unforeseen defects that could harm our reputation, impede market acceptance of our products and negatively impact our business, results of operations and financial condition.
 
Given their complexity, our products may contain undetected software or hardware defects, inaccurate calibration 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 and diligent efforts, defects will not be found in new products after they have been fully deployed and operated under peak stress conditions, or that customized products will meet customer sign-off acceptance requirements. If we are unable to fix defects or other problems or meet custom requirements, we could experience, among other things:
 
·  
costly repairs;
·  
product returns or recalls;
·  
damage to our brand reputation;
·  
loss of customers, failure to attract new customers or achieve market acceptance;
·  
diversion of development and engineering resources;
·  
legal actions by our customers, including claims for consequential damages and loss of profits; and
·  
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, results of operations and financial condition.
 

 
 
We may not be able to make the acquisitions or strategic alliances needed for the development of our business or, if we do make such acquisitions or strategic alliances, we cannot assure you that we will successfully integrate the businesses, products, technologies and personnel. In addition, such acquisitions could distract management’s attention from our day-to-day business and operations. Ultimately, the failure to make strategic acquisitions or the inability to effectively integrate them could disrupt our overall business and harm our financial condition.
 
We intend to carefully seek businesses, whose products and technologies are complementary to ours, or which will enable us to expand our markets and/or our market share. There can be no assurance that we will ultimately make any such transactions. Our competitors may be in a better position to acquire the same businesses, products and technologies that we wish to acquire. In addition, our fluctuating stock price, our cash position, or our ability to raise capital or issue debt on favorable terms, or at all at the time of an acquisition, may affect our ability to complete such an acquisition.
 
In fiscal 2009, we  acquired  PicoSolve Inc., a  test and measurement company offering the industry’s fastest optical sampling oscilloscopes for 40G and 100G R&D, manufacturing and deployment applications We intend to continue making acquisitions of businesses, products and technologies as part of our overall growth strategy. In the event of any future acquisition, we could:
 
·  
issue shares that would dilute individual shareholder percentage ownership;
·  
incur debt;
·  
assume liabilities and commitments;
·  
incur significant expenses related to amortization of additional intangible assets;
·  
incur significant impairment losses of goodwill and intangible assets related to such acquisitions; and
·  
incur losses from operations.
 
These acquisitions also involve numerous risks, including:
 
·  
risk of not realizing the expected benefits or synergies of such acquisitions;
·  
problems integrating the acquired operations, technologies, products and personnel;
·  
risks associated with the transfer of acquired know-how and technology;
·  
unanticipated costs or liabilities;
·  
diversion of management’s attention from our core business;
·  
adverse effects on existing business relationships with suppliers and customers;
·  
risks associated with entering markets in which we have no or limited prior experience; and
·  
potential loss of key employees, particularly those of acquired organizations.
 
If we fail to adapt appropriately to the challenges associated with operating internationally, the expected growth of our business may be impeded and our operating results may be affected.
 
For the fiscal year ended August 31, 2009, customers outside of the United States and Canada accounted for 47.2% of our sales. Our international sales will be limited if we cannot establish and maintain relationships with international distributors, set up additional foreign operations, expand international sales channel management, hire additional personnel, develop relationships with international service providers and operate adequate after-sales support internationally.
 
In the third quarter of fiscal 2007, we established a software development center in Pune, India, to supplement the efforts of our R&D centers in Quebec City, Canada, Montreal, Canada, Concord, Canada, and since the third quarter of fiscal 2008, Boston, Massachusetts, United States. We also began manufacturing high-volume, low-complexity telecom products at our wholly-owned production facility in Shenzhen, China, in the first quarter of fiscal 2008 with the goal of lowering our manufacturing costs.
 

 
 
Even if we are able to successfully expand 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:
 
·  
challenges in staffing and managing foreign operations due to the limited number of qualified candidates, employment laws and business practices in foreign countries, any of which could increase the cost and reduce the efficiency of operating in foreign countries;
·  
our inability to comply with import/export, environmental and other trade compliance regulations of the countries in which we do business, together with unexpected changes in such regulations;
·  
measures to ensure that we design, implement and maintain adequate controls over our financial processes and reporting in the future, especially in light of setting up new operating companies in India and China or the future acquisition of companies;
·  
failure to adhere to laws, regulations and contractual obligations relating to customer contracts in various countries;
·  
difficulties in establishing and enforcing our intellectual property rights;
·  
inability to maintain a competitive list of distributors for indirect sales;
·  
tariffs and other trade barriers;
·  
economic instability in foreign markets;
·  
wars, acts of terrorism and political unrest;
·  
language and cultural barriers;
·  
lack of integration of foreign operations;
·  
currency fluctuations;
·  
potential foreign and domestic tax consequences;
·  
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;
·  
longer accounts receivable payment cycles and possible difficulties in collecting payments which may increase our operating costs and hurt our financial performance; and
·  
failure to meet certification requirements.
 
Any of these factors could harm our international operations and negatively affect our business, results of operations and financial condition. 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 may make misjudgments in our strategic planning that could have material adverse effects on our business, results of operations and financial condition.
 
We devise a three-year strategic business plan, which is prepared by management and approved by our Board of Directors. This strategic plan, reviewed by management on a regular basis, is mainly based on market research and analysis related to future market trends and demands. In our strategic plan, we have made and will continue to make judgments based on our analysis of future market trends and requirements. These decisions may involve substantial investments in the development of new product lines, diversification of our business on a geographic basis, as well as expansion into new market segments — either organically or through acquisitions. We may make misjudgments in our strategic planning that could have material adverse effects on our business, results of operations and financial condition.
 
Our quarterly revenues and 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 significant fluctuations may occur in the future, especially following the acquisition of Brix Networks (renamed EXFO Service Assurance Inc.) in the third quarter of fiscal 2008. EXFO Service Assurance Inc. offers service assurance systems that monitor next-generation, converged IP networks. Given that these systems are more complex and mission-critical than traditional test equipment, the orders are much larger and the sales cycles are relatively longer. Therefore, sales levels for our service assurance business could fluctuate significantly quarter-over-quarter depending on when revenue is recognized.
 

 
 
In addition, our sales and operating results generally depend on the volume and timing of the orders we receive from customers as well as our ability to fulfill received orders. Our operating expenses, which include manufacturing overhead costs, selling and administrative, research and development, and amortization expenses, are relatively fixed in the short term. If we sell fewer products than anticipated, if there is a delay in the launch of new products, or if prices for our products decline, we may not be able to quickly reduce our operating expenses in response to lower sales. Factors that could affect the amount and timing of our sales, and cause quarterly fluctuations in our revenue and operating results include:
 
·  
length of the product sales cycle for certain products, especially those that are higher priced and more complex;
·  
timing of product launches and market acceptance of new products for us as well as our competitors;
·  
our ability to sustain product volumes and high levels of quality across all product lines;
·  
timing of shipments for large orders;
·  
effect of seasonality on sales and bookings; and
·  
losing key accounts and not successfully developing new ones.
 
Our sales and operating results could also be affected by the following factors, some of which we have little or no control over:
 
·  
fluctuating demand for telecommunications test, measurement and service assurance equipment as well as life sciences and industrial solutions;
·  
changes in the capital spending and operating budgets of our customers, which may cause seasonal or other fluctuations in product mix, volume, timing and number of orders we receive from our customers;
·  
order cancellations or rescheduled delivery dates;
·  
pricing changes by our competitors or suppliers;
·  
customer bankruptcies and difficulties in collecting accounts receivable;
·  
restructuring and impairment charges;
·  
foreign exchange rate fluctuations, as a portion of our operating expenses are denominated in Canadian dollars; and
·  
general economic conditions, including a slowdown or recession.
 
We may in the future choose to reduce prices, increase spending, or modify our product portfolio in response to actions by competitors or as an effort to pursue new market opportunities. These actions may also adversely affect our business and operating results and may cause our quarterly results to be lower than the results of previous quarters. 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 we are unable to adapt to current and future changes in technology or if we are unable to introduce new and enhanced products on a timely basis, our products may become obsolete, which could prevent us from achieving our growth strategy and adversely affect our operating results.
 
The industries that we target are characterized by rapidly evolving technology and industry standards that result in frequent new product introductions. Any failure by us to anticipate or respond to new technological developments, customer requirements or evolving standards could have a material adverse effect on our business, results of operations and financial condition. The development of proprietary technology entails significant technical and business risks and requires substantial expenditures and lead-time. The success of our new product introductions will depend on several factors, including our ability to:
 
·  
properly identify and anticipate customer needs;
·  
innovate and develop new products;
·  
gain timely market acceptance for new products;
·  
manufacture and deliver our new products on time, in sufficient volume and with adequate quality;
 
 
 
 
·  
price our products competitively;
·  
continue investing in our research and development programs; and
·  
anticipate competitors’ announcements of new products.
 
Failure to do the above 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 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 our proprietary technology, with which we attempt to keep others from using the innovations that are central to our existing and future products. As of August 31, 2009, we own 46 actively maintained granted patents from the U.S. (including one “design” patent), ten from Canada, four from China, five from Germany (including one “Utility Model”), four from the United Kingdom, four from France, as well as a patent in each of four other European countries.  In addition, we have in process 20 US patent applications, seven Canadian patent applications, two European applications, one application in China, and one direct national entry in Germany (not via the European application), and as well five applications under the Patent Cooperation Treaty, which have not yet entered the national phase.  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. Such litigation can be time-consuming and expensive, regardless of whether we win or lose.
 
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. 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.
 
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 may decline.
 
Others may claim that our products infringe upon their intellectual property rights, or they may infringe our intellectual property, and we may expend significant resources enforcing or defending our rights or suffer competitive injury.
 
Litigation regarding intellectual property rights is common in the technology industry and 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. Conversely, we may be required to spend significant resources to monitor and enforce our intellectual property rights.
 
We could incur substantial costs in defending ourselves and our customers against infringement claims or in bringing infringement claims against others. 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 an infringement claim, 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.
 

 
 
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.
 
Some of our customers experienced cash flow problems during the global economic recession and may continue to do so. Consequently, we may have customers who delay payments or may not be able to meet their financial commitments to us. Furthermore, they may not order as many products from us as originally forecasted or they may cancel their orders outright. The failure of customers to order products would result in decreased revenues for us. 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, they may reduce or halt purchases of our products, which would harm our sales and operating results.
 
Consolidation in the telecommunications industry could reduce the number of customers to which our products are sold. Some of our customers have been subject to consolidation and could obtain products from a vendor other than us, or demand more favorable terms and conditions from us, which would harm our sales and operating results. In addition, some customers may merge with or acquire our competitors and discontinue their relationships with us.
 
If we fail to predict our supply requirements accurately, we may have excess inventory or insufficient inventory, either of which could cause us to incur additional costs and/or experience manufacturing delays.
 
We provide non-binding 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 forecasted requirements, we may have excess inventory, which could harm our relationships with our suppliers due to reduced future orders, increase our costs and require inventory write-offs. If we underestimate our requirements, we may have an inadequate inventory of parts, which could interrupt manufacturing of our products and result in shipment delays. The likelihood of misjudging our inventory requirements increased with the onset of the global economic recession and opening of a telecom manufacturing facility in Shenzhen, China, in September 2007 for high-volume, low-complexity products. This manufacturing facility complements the low-volume, high-complexity telecom products produced at our plant in Quebec City, Canada. 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 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 for which alternative sources may not be readily available. In addition, 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 increased costs, 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. Any interruption or delay in the supply of any of these parts could significantly harm our ability to meet scheduled product deliveries to our customers and cause us to lose sales. Furthermore, the process of qualifying a new manufacturer for complex parts, designed to our specifications, such as our optical and mechanical parts, is lengthy and would consume a substantial amount of time of our technical personnel and management. If we were required to change a supplier in a short period of time, our business would be disrupted. In addition, we may be unsuccessful in identifying a new supplier capable of meeting and willing to meet our needs on terms that we would find acceptable. Consolidation involving suppliers could further reduce the number of alternatives available to us and increase the cost of parts, which would make our products less competitive and result in lower margins.
 

 
 
Our manufacturing employees in Quebec City, Canada, are unionized. Failure to renew the collective bargaining agreement may cause disruptions to our manufacturing process and could adversely affect our operating results.
 
Our collective bargaining agreement (CBA) with unionized manufacturing employees in Quebec City, Canada, expired in February 2009. Negotiations for the renewal of the CBA are underway, but no agreement has been reached. If we do not conclude negotiations that are satisfactory to both parties or in the event of a work stoppage, any extended interruption or delay to scheduled product deliveries to our customers may cause us to lose sales. Our manufacturing employees in Quebec City are the only unionized members within the company, and we’ve never had a work stoppage during the 24-year history of EXFO.
 
If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial information or prevent fraud, which could harm our operating results and cause investors to lose confidence in our reported financial information.
 
Effective internal controls are necessary for us to provide reliable and accurate financial information and effectively prevent fraud. We devote significant resources and time to comply with the internal control over financial reporting requirements of the Sarbanes-Oxley Act of 2002. In addition, Section 404 of the Sarbanes-Oxley Act of 2002 requires that we assess and that our auditors attest to the design and operating effectiveness of our controls over financial reporting. Our compliance with the annual internal control report requirement for each fiscal year will depend on the effectiveness of our financial reporting as well as data systems and controls throughout our company and operating subsidiaries. Furthermore, we cannot be certain that these measures will ensure that we design, implement and maintain adequate controls over our financial processes and reporting in the future, especially in the likelihood of acquiring companies that are not in compliance with Section 404 of the Sarbanes-Oxley Act of 2002. As well, the complexity of our systems and controls may become more difficult to manage as we transform our operating structure and continue to reduce infrastructure costs. To effectively manage these changes, we will need to continue to improve our operational, financial and management controls and our reporting systems and procedures. Any failure to implement required new or improved controls, difficulties encountered in their implementation or operation, or difficulties in the assimilation of acquired businesses into our control system could harm our operating results or cause it to fail to meet our financial reporting obligations. Inferior internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on our share price and our access to capital.
 
Regulatory changes may cause us to incur increased costs.
 
Changes in the laws and regulations affecting public companies may increase our expenses as we may have to devote resources to respond to these new requirements. In particular, we incurred and may incur additional general administrative expenses to comply with Section 404 of the Sarbanes-Oxley Act, which requires management to report on internal controls over financial reporting. In addition, the process of moving from Canadian GAAP to IFRS, which extends from fiscal 2009 to 2011, will require management’s time and attention, and cause our general and administrative expenses to increase. Compliance with new rules could require the further commitment of significant financial resources and result in the diversion of management’s time and attention from revenue-generating activities. Finally, the impact of these changes could make it more difficult for us to attract and retain qualified persons to serve on our Board of Directors or as executive officers, which could harm our business.
 
We require employees and management resources 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, marketing, senior management and other personnel, our operations and financial results will suffer.
 
Due to the specialized nature of our business, we are highly dependent on the continued service of and on the ability to attract qualified engineering, sales, marketing, senior management and other personnel. If we are unable to attract and retain such qualified personnel, it could have a material adverse effect on our business, results of operations and financial condition.
 

 
 
We must also provide significant training for our employee base due to the highly specialized nature of telecommunications test, measurement, and service assurance as well as life sciences and industrial technologies. Our current 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 international business development, product management, sales, engineering and operations – may be difficult to find. Once trained, our employees may also be hired by our competitors or leave the organization.
 
Our insurance may not be sufficient to cover all potential liability. A successful claim exceeding our policy limits will reduce our cash position, increase our expenses and have a negative effect on our business, operating results and financial condition.
 
Our products are designed to help network service providers, cable operators and manufacturers of optical networks and components ensure network reliability. We also leverage our core telecom technologies for life sciences and industrial applications. The failure of our products to perform to customer 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; 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 cash available for other uses, increase our expenses and have a negative effect on our business, results of operations and financial condition.
 
Our reported financial results could suffer if there is additional impairment of goodwill.
 
We are required to test annually, and review when circumstances warrant, our goodwill associated to business combinations, and determine if impairment has occurred. Recoverability of goodwill is determined at the reporting unit level, using a two-step approach. First, the carrying value of the reporting units is compared to their fair value. If the carrying value of a reporting unit exceeds its fair value, the second step is undertaken to determine the amount of the impairment loss. Impairment of goodwill would result in an incremental charge which would adversely impact our operating results for the period in which the impairment was determined to have occurred.
 
In the third quarter of fiscal 2009, we performed our annual impairment test for goodwill for all reporting units. Following the decrease in our stock price in June, 2009, we came to the conclusion that the carrying value of one of our reporting units exceeded its fair value and recorded an impairment charge of $21.7 million.
 
The recent turmoil in credit markets and the broader economy has contributed to share price and volume fluctuations in global stock markets that have reduced the market price of many technology stocks, including ours. Further declines in our stock price or the failure of our stock price to recover from previous declines, as well as any additional decline in our level of revenues or margins, could increase the risk that additional goodwill may become impaired in future periods. We currently have $22.5 million of goodwill on our balance sheet mainly related to the acquisition of Brix Networks. Any additional impairment of goodwill would negatively impact our operating results.
 
We may become involved in costly and time-consuming litigation that may substantially increase our costs and harm our business.
 
We may from time to time become involved in various lawsuits and legal proceedings. For example, we are a defendant in a putative securities class action suit filed in the United States District Court for the Southern District of New York involving approximately 300 other issuing companies. 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.
 

 
 
If we suffer loss to our factories or facilities, our operations could be seriously harmed.
 
Our factories and facilities are subject to catastrophic losses due to fire, vandalism, terrorism or other natural or man-made disasters. We do not have redundant multiple-site capacity and if any of our facilities or factories were to experience a catastrophic loss, it would disrupt our operations, delay production, shipments and revenue and result in large expenses, thereby harming our results of operation.
 
Unexpected declines in our research and development and other tax credits and grants may have an adverse effect on our business.
 
Our historical operating results reflect substantial benefits from programs sponsored by federal and provincial governments for the support of research and development activities, as well as in relation to other activities. For example, research and development tax credits and grants represented 17.2% of our gross research and development expenses for the year ended August 31, 2009.
 
If unexpected changes in the laws or government policies terminate or adversely modify the Canadian and Quebec government programs, under which we receive the majority of our research and development and other 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 and other expenses will materially increase or we may decrease our research and development activities. In addition, to the extent that we have increased our research and development activities outside of Canada and Quebec, resulting from the hiring of additional personnel at our software development center in Pune, India and the acquisition of Brix Networks, or potential future acquisitions, our increased R&D activities may not be eligible for these programs. If we were required to decrease our research and development activities, or were unable to benefit from other tax credits and grants, this could have a material adverse effect on our business, results of operations and financial condition.
 
Changes in our effective tax rate or adverse outcomes resulting from tax audits may have an adverse impact on our results.
 
As an international corporation, we are subject to taxation in the various jurisdictions in which we conduct business. Significant judgment is required in the determination of our worldwide provision for income taxes and this determination requires the interpretation and application of complex tax laws and regulations. Our effective tax rate may be adversely impacted by the level of earnings, by changes in the mix of earnings among companies and countries which may have different statutory tax rates, by the valuation of our deferred tax assets, and by changes in tax rules and regulations. We are also subject to income tax audits and transfer pricing audits in the respective jurisdictions in which we conduct business and we regularly assess the likelihood of adverse outcomes resulting from these audits to ascertain the adequacy of our provisions for income taxes and transfer pricing policies. There can be no assurance that the outcomes of these tax audits, if any, will not have an adverse impact on our result and financial condition.
 
Our current principal stockholder has effective control over our business.
 
As of November 2, 2009, Germain Lamonde, our Chairman of the Board, President and Chief Executive Officer, held 94.16% of the voting rights in our stock. By virtue of such stock ownership, Mr. Lamonde has effective control over all matters submitted to our stockholders, including the election of our Directors, and exercises significant control over our policies and affairs. Such concentration of voting power could have the effect of delaying, deterring or preventing a change in control or other business combinations that might otherwise be beneficial to our stockholders and may harm the market price of our shares.
 

 
 
If we complete major acquisitions of complementary businesses, products or technologies, 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 flows from our operations to meet additional working capital requirements, support additional capital expenditures or take advantage of acquisition opportunities. In fiscal 2009, the respective cash payments of $6.9 million, $2.4 million and $26.9 million for the purchase of capital assets, the contingent cash consideration for the acquisition of Brix Networks and the redemption of share capital, exceeded the $22.6 million provided by cash flows from operations. As at August 31, 2009, we held $69.7 million in cash and short-term investments.
 
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, effects of the financial crisis, reduced access to credit facilities 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 new investors could obtain terms more favorable than previous investors. If we raise funds through debt financing, we could incur significant borrowing costs and meet more restrictive debt covenants. If we are unable to raise additional funds when needed or at terms satisfactory to us, our ability to operate and grow our business could be impeded.
 
Our business and operations would suffer in the event of a failure of our information technology infrastructure.
 
We rely upon the capacity, efficiency and security of our information technology hardware and software infrastructures as well as our ability to expand and update these infrastructures in response to our evolving needs. Any failure to manage, expand or update our information technology infrastructures or any failure in the operation of this infrastructure could harm our business.
 
Our information systems are vulnerable to damages from computer viruses, natural disasters, unauthorized access and other similar disruptions. Any system failure, accident or security breach could result in disruptions to our operations. To the extent that any disruption or security breach results in a loss or damage to our data, or inappropriate disclosure of our confidential information, it could harm our business. In addition, these events may force us to devote more money and resources in order to protect ourselves against damages caused by these disruptions or security breaches in the future.

 
 

Information on the Company
 
 
Our legal name and commercial name is EXFO Electro-Optical Engineering Inc. / EXFO Ingénierie électro-optique inc. Our head office is located at 400 Godin Avenue, Quebec, Quebec, Canada, G1M 2K2 and our main telephone number is (418) 683-0211. Our e-mail address is info@EXFO.com and our website is www.EXFO.com. Information on our website 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. Our Transfer Agent and Registrar is CIBC Mellon Trust Company, 2001 University Street, Suite 1600, Montreal, Quebec, Canada, H3A 2A6. This annual report contains trademarks and registered trademarks of us 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 legal and corporate names and our share capital.
 
On December 20, 2000, we acquired all of the shares of EXFO Burleigh Products Group Inc. (formerly Burleigh Instruments, Inc.) (“EXFO Burleigh”), Burleigh Instruments GmbH and Burleigh Instruments (U.K.) Ltd. for an aggregate purchase price of US$189.3 million, comprised of 6,488,816 of our subordinate voting shares and 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.  In April 2002, the name of Burleigh Instruments, Inc. was changed to EXFO Burleigh Products Group Inc.  On November 12, 2002, Burleigh Instruments (UK) Ltd. was dissolved. EXFO Burleigh is a U.S. company that manufactures precision scientific instruments used in basic and applied research engineering and production test applications in a variety of fields.
 
On March 15, 2001, we acquired all of the shares of EXFO Photonic Solutions Inc. (formerly EFOS Inc.) (“EXFO Photonic”), a privately held company in Toronto, Canada, for a total consideration of US$110.1 million, of which US$25.1 million was paid in cash. We also issued 3,700,000 of our subordinate voting shares in connection with the acquisition. In September 2001, the name EFOS Inc. was changed to EXFO Photonic Solutions Inc.
 
EXFO Photonic, operating since 1984, is a supplier of precision light-based adhesive spot curing products 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 and heat-cured adhesives to significantly reduce bonding time and increase repeatability in optical component and other manufacturing activities. EXFO Photonic light-based curing technologies are supported by an extensive understanding of bonding and material sciences and by a broad intellectual property portfolio. EXFO Photonic, as of November 2, 2009, has 28 patents and 9 patents pending.
 
Also on March 16, 2001, our wholly owned subsidiary, Burleigh Automation Inc. (“Burleigh Automation”), acquired substantially all the assets of Vanguard Technical Solutions, Inc., a wholly owned subsidiary of DT Industries, Inc. for a purchase price of US$600,000 paid in cash. Vanguard, an automation equipment manufacturer in Tucson, Arizona, specialized in the design and manufacturing of ultra-precision assembly equipment for sensitive process and critical assembly challenges on the production floor.  This acquisition, which complemented our acquisition of Burleigh, was planned to fit with our overall strategy at that time of providing 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 transferred all material intellectual property assets and most of the physical assets of Burleigh Automation to EXFO Burleigh.
 

 
 
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 US$69.4 million (or US$95.0 million for the equity minus US$25.6 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 US$9.8 million in cash, net of cash acquired. EXFO Protocol, a company based in Montreal, Canada operating since 1998 is a supplier of fiber-optic testing and optical network performance management equipment that supports a wide range of protocols and data transmission rates.
 
During fiscal 2001, we were forced to align our cost structure to market conditions. 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-cure operations of Nortech, a subsidiary that specialized in manufacturing fiber-optic temperature sensors and reduction of our work force by 15%. Our plan to build a new facility has been cancelled since then.
 
During fiscal 2002, we were forced to re-align our cost structure to market conditions. First, 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%.  Then, on May 15, 2002, we announced a further 20% reduction of our global workforce in an effort to lower our cost structure. In May 2002, we performed an assessment of the carrying value of goodwill and intangible assets recorded in conjunction with the three acquisitions made during the previous 18 months. Considering the ongoing unfavorable market conditions, we recorded a charge of US$222.2 million to write down a significant portion of goodwill and a charge of US$23.7 million to write down a significant portion of acquired core technology. Also, overall for fiscal 2002, we wrote off US$18.5 million in excess and obsolete inventories.
 
In October 2002, our newly created, wholly owned subsidiary, EXFO Gnubi Products Group Inc. (“EXFO Gnubi”), acquired substantially all the assets of gnubi communications L.P., including its technology, expertise, customer base, inventories and capital assets.  Consideration paid consisted of US$1.9 million in cash and 1,479,290 of our subordinate voting shares.  Furthermore, an additional cash amount of US$241,000, based on sales volumes, was paid in fiscal 2004 in accordance with earn out provisions. With the acquisition of these assets, EXFO Gnubi, based in Dallas, Texas, continues the operations of gnubi communications, L.P., as a supplier of multi-channel telecom and datacom testing solutions serving optical transport equipment manufacturers and research and development laboratories.  At the time of the asset acquisition, 30 employees of gnubi communications, L.P. transferred to EXFO Gnubi.
 
During fiscal 2003, we were required to implement further restructuring measures as a result of depressed spending levels in the telecommunications industry and economic uncertainty. We reduced our workforce by 30%, rationalized our business activities and consolidated certain manufacturing operations. These measures incurred charges of US$4.1 million. The rationalization and consolidation initiatives involved the reorganization of our business into two new reportable market segments: Telecom Division and Photonics and Life Sciences Division and the exiting of the optical component manufacturing automation business. Our Telecom Division consists of the former Portable and Monitoring and telecom related Industrial and Scientific product lines. Our Photonics and Life Sciences Division includes previous non-telecom Industrial and Scientific product lines. Each division has been structured with its own sales, marketing, manufacturing, research and development and management teams.
 
In May 2003, we performed our annual impairment test on goodwill recorded in conjunction with the acquisitions of EXFO Burleigh, EXFO Photonic and EXFO Protocol and also reviewed the carrying value of intangible assets related to these acquisitions. As a result of this assessment, we concluded that the carrying value of goodwill related to EXFO Burleigh and the carrying value of intangible assets related to EXFO Burleigh and EXFO Photonic was impaired and we recorded a charge of US$4.5 million to write down goodwill and a pre-tax charge of US$2.9 million to write down acquired core technology. Of the total impairment loss of US$7.4 million, US$6.9 million is related to EXFO Burleigh for goodwill and acquired core technology and US$0.6 million is related to EXFO Photonic for acquired core technology.
 
In addition, in an effort to simplify our structure and stream-line our operations, the operations of EXFO Protocol were merged with those of the Corporation as of September 1, 2003 and effective December 1, 2003, the operations of EXFO Gnubi were merged with those of EXFO America Inc.
 

 
 
In fiscal 2004, EXFO also closed a public offering of 5.2 million subordinate voting shares to a syndicate of Canadian-based underwriters for net proceeds of US$29.2 million (CA$38.4 million).
 
Furthermore in fiscal 2004, we consolidated our protocol test operations (EXFO Protocol and EXFO Gnubi) in Montreal, Canada to improve efficiency and reduce costs.
 
In March 2004, we renewed our collective bargaining agreement with unionized manufacturing employees in Quebec City, Canada. This agreement expired in February 2009.
 
During fiscal 2005, our Photonics and Life Sciences Division was renamed the Life Sciences and Industrial Division to better reflect its market focus.
 
During fiscal 2005, we completed the consolidation of our Life Sciences and Industrial Division in Toronto, Canada and we recorded US$482,000 in restructuring expenses. Altogether, we incurred US$2.5 million in restructuring and other charges since the fourth quarter of 2004 in conjunction with this consolidation process. Following this process all of the operating activities of EXFO Burleigh were transferred mainly in Toronto, Canada.
 
In January 2006, we acquired substantially all the assets of Consultronics Limited (“Consultronics”), a leading supplier of test equipment for copper-based broadband access networks. Consultronics is a privately held company based in Toronto, Canada with subsidiaries in the United Kingdom and Hungary. We acquired all of the subsidiaries’ respective issued and outstanding shares. Consultronics specializes in x-Digital Subscriber Line (xDSL), Internet Protocol TV (IPTV) and Voice-over-Internet Protocol (VoIP) test solutions for the broadband access market. We paid consideration equal to approximately US$19.1 million, including debt assumption and other acquisition-related costs.
 
In November 2006, we incorporated EXFO Electro-Optical Engineering India Private Limited as our wholly-owned subsidiary to establish a software development center in Pune, India. In October 2007, we acquired substantially all of the assets of JamBuster Technologies Private Limited, for an immaterial consideration, a company duly incorporated in Pune, India which is engaged in the business of software development services.
 
In April 2007, we established a wholly-owned foreign entity in Shenzhen China, EXFO Telecom Equipment (Shenzhen) Co. Ltd. for manufacturing purposes. We started ramping up manufacturing in September 2007 at our Chinese facility.
 
On November 5, 2007, we announced the approval by the Board of Directors of a share repurchase program, by way of a normal course issuer bid on the open market of up to 9.9% of our public float (as defined by the Toronto Stock Exchange), or 2,869,585 shares at the prevailing market price. The period of the normal course issuer bid commenced on November 8, 2007, and ended on November 7, 2008. We repurchased a total of 1,859,835 shares. All shares repurchased under the bid were cancelled.
 
In March 2008, we acquired all the issued and outstanding shares of Navtel Communications Inc. (“Navtel”), a leading provider of Internet Protocol Multimedia Subsystem (IMS) and Voice-over-Internet Protocol (VoIP) test solutions for Network Equipment Manufacturers (NEMs) and Network Service Provider (NSP) labs. Navtel is a privately held company based in Toronto, Canada with subsidiaries in the Province of Ontario, Canada, United States and Germany. We paid a consideration of US$11.5 million, or US$11.3 million net of US$145,000 of cash acquired. The total consideration included acquisition-related costs of US$172,000.
 
In April 2008, we acquired all the issued and outstanding shares of Brix Networks Inc. (“Brix”), a global provider of open and extensible converged service assurance solutions. Brix is a privately held company based near Boston, Massachusetts, USA with a subsidiary in the United Kingdom. We paid consideration of US$29.7 million, or US$29.7 million net of US$12,000 of cash acquired, plus a contingent cash consideration of US$2.4 million, based upon the achievement of a bookings volume in the 12 months following this acquisition.
 

 
 
On November 6, 2008, we announced the approval by the Board of Directors of a renewal of the share repurchase program by way of a normal course issuer bid on the open market of up to 10% of our public float (as defined by the Toronto Stock Exchange), or 2,738,518 subordinate voting shares at the prevailing market price. The period of the normal course issuer bid commenced on November 10, 2008 and ended on November 9, 2009. We repurchased a total of 311,872 shares. All shares repurchased under the bid were cancelled.
 
On November 10, 2008 we announced a substantial issuer bid (the “Offer”) to purchase for cancellation up to 8,823,529 subordinate voting shares for an aggregate purchase price not to exceed CA$30 million. The Offer was made by way of a “modified Dutch Auction” pursuant to which shareholders could tender all or a portion of their shares (i) at a price not less than CA$3.40 per share and not more than CA$3.90 per share, in increments of CA$0.05 per share, or (ii) without specifying a purchase price, in which case their shares would have been purchased at the purchase price determined in accordance with the Offer. The Offer expired at 5 p.m. (Eastern Time) on December 16, 2008. We used cash and short-term investments to fund the purchase of shares. The Offer was not conditional upon any minimum number of shares being tendered, but it was subject to certain other conditions. A complete description of the terms and conditions of the Offer were contained in the Offer to Purchase and Issuer Bid Circular and related documents filed with the applicable securities regulatory authorities in Canada and the United States and mailed to holders of shares.
 
Based on final reports from CIBC Mellon Trust Company, the depositary for the Offer, we confirmed that we had taken up and accepted for purchase and cancellation, at a price of CA$3.90 per share, a total of 7,692,307 subordinate voting shares for a total cost of CA$30 million (excluding fees and expenses relating to the Offer) in accordance with the terms of the Offer.
 
Upon the approval of the Offer, we had suspended the normal course issuer bid that we had renewed on November 6, 2008 referred above. The bid was resumed on January 26, 2009, the date that we begun repurchasing shares under such bid.
 
In February 2009, the collective bargaining agreement effective since March 2004 with unionized manufacturing employees in Quebec City, Canada, expired. We received the requests of the union in August 2009 and we began the negotiations for the renewal of the collective bargaining agreement in October 2009. It has not been renewed as of this day and remains effective until renewed.
 
In February 2009, we acquired substantially all of the assets of PicoSolve, Inc., a private test and measurement company offering the industry’s fastest optical sampling oscilloscopes for 40G and 100G R&D, manufacturing and deployment applications. This company was founded in 2004 by researchers at Chalmers University of Technology in Gothenburg, Sweden, and provides ultra-high-speed optical sampling oscilloscopes to network equipment manufacturers (NEMs) involved in the design and production of next-generation optical networks. Network service providers (NSPs) will also require such high-end test equipment for their deployment initiatives.
 

 
 
On November 6, 2009 we announced that our Board of Directors approved the second renewal of our share repurchase program, by way of a normal course issuer bid on the open market of up to 10% of our public float (as defined by the Toronto Stock Exchange), or 2,256,431 subordinate voting shares at the prevailing market price. We expect to use cash, short-term investments or future cash flow from operations to fund the repurchase of shares. The normal course issuer bid started on November 10, 2009, and end on November 9, 2010, or on an earlier date if we repurchase the maximum number of shares permitted under the bid. The program does not require that we repurchase any specific number of shares, and it may be modified, suspended or terminated at any time and without prior notice. All shares repurchased under the bid will be cancelled. We shall provide to any person or company, upon request to our Secretary, at 400 Godin Avenue, Quebec, Province of Quebec, Canada, G1M 2K2, phone number (418) 683-0913 ext. 3704 or fax number (418) 683-9839 a copy of the notice sent to the Toronto Stock Exchange (TSX) according to our normal course issuer bid.
 
In the third quarter of fiscal 2009, we performed our annual impairment test for goodwill for all reporting units. Recoverability of goodwill is determined at the reporting unit level, using a two-step approach. First, the carrying value of the reporting units is compared to their fair value. If the carrying value of a reporting unit exceeds its fair value, the second step is performed to determine the amount of the impairment loss. Following the decrease in our stock price in June 2009, we came to the conclusion that the carrying value of one of our reporting units exceeded its fair value and we recorded an impairment charge of $21.7 million in the third quarter of fiscal 2009, to bring the goodwill of this reporting unit to its fair value. This reporting unit reports to the Telecom Division.
 
We will be submitting for the approval of our shareholders at our upcoming annual and special meeting in January 2010, a proposition with respect to an amendment to our articles of incorporation, for the change of the name of the corporation to “EXFO Inc.”. We believe that the present name no longer reflects our actual business activities. We shall provide to any person or company, upon request to our Secretary, at 400 Godin Avenue, Quebec, Province of Quebec, Canada, G1M 2K2, phone number (418) 683-0913 ext. 3704 or fax number (418) 683-9839, a copy of the Management Proxy Circular dated November 2, 2009 filed on SEDAR and on EDGAR under Form 6-K.
 
 
Business Overview
 
 
Company Overview
 
EXFO is a leading provider of test and service assurance solutions for network service providers and equipment manufacturers in the global telecommunications industry. The Telecom Division, which accounts for almost 90% of the company’s revenues, offers a wide range of innovative solutions to assess optical networks, from the core to access, as well as next-generation IP infrastructures and related triple-play services. The Life Sciences and Industrial Division offers solutions in medical device and opto-electronics assembly, fluorescence microscopy and other life science sectors.
 
We were founded in 1985 in Quebec City, Canada. Our original products were focused on the needs of installers and operators of fiber-optic networks. Customers use these field-portable testing products for the installation, maintenance, monitoring and troubleshooting of optical networks. In 1996, we supplemented our product portfolio with an extensive line of high-end products that are mainly dedicated to research and development as well as manufacturing activities of optical component manufacturers and system vendors.
 
Over the past several years, we have enhanced our competitive position through acquisitions of protocol, copper/xDSL and service assurance test businesses.
 
In February 2009, we closed the acquisition of Sweden-based PicoSolve Inc., a supplier of ultra-high-speed optical sampling oscilloscopes for 40G and 100G R&D, manufacturing and deployment applications.
 

 
 
In April 2008, we acquired all issued and outstanding shares of Brix Networks Inc. (renamed EXFO Service Assurance Inc.), for a cash consideration of $32.1 million. Brix Networks, a privately held company located in the Boston (MA) area, offers VoIP and IPTV service assurance solutions across the three areas most affecting the success of a real-time service: signaling quality (signaling path performance), delivery quality (media transport performance) and content quality (overall quality of experience). Brix Networks’ service assurance solutions are mainly designed for network service providers (NSPs) and large enterprises.
 
In March 2008, we acquired all issued and outstanding shares of Navtel Communications Inc., for a cash consideration of $11.3 million. Navtel Communications, a privately held company in Toronto, Canada, is a leading provider of Internet protocol multimedia subsystem (IMS) and VoIP test solutions for network equipment manufacturers (NEMs) and NSP labs. Navtel Communications specializes in testing next-generation IP networks that are increasingly combining wireline and wireless technologies. Subsequent to the acquisition, Navtel Communications was merged into the parent company.
 
In fiscal 2008, we opened our own telecom manufacturing facilities in Shenzhen, China. We now have two main manufacturing sites for our Telecom Division and one plant for our Life Sciences Division. Over time, low-volume, high-complexity telecom products will be manufactured in Quebec City, whereas high-volume, low-complexity telecom products will be manufactured in Shenzhen.
 
In fiscal 2008 and 2009, we accelerated the deployment of a software development center in Pune, India, to supplement the research and development capabilities of our labs in Boston, Toronto, Montreal and Quebec City. This enables us to benefit from the wealth of IP expertise in India, to accelerate product developmentespecially for our software-intensive protocol test and service assurance solutionsto take advantage of a lower cost structure.
 
In January 2006, we acquired substantially all the assets of Consultronics Limited (now merged with the parent company) a leading supplier of test equipment for copper-based broadband access networks, for a total cash consideration of $19.1 million. Above and beyond copper/xDSL test solutions, Consultronics had a rich product portfolio for testing next-generation technologies, such as IPTV and VoIP, which are critical for NSPs in their deployment of triple-play services (voice, data, video) over optical and copper links in access networks.
 
In November 2001, we acquired Avantas Networks Corporation (renamed EXFO Protocol Inc. and now merged with the parent company), a supplier of protocol-testing and optical-network performance management equipment for NSPs. This transaction enabled us to combine optical and protocol test modules inside a single field-portable test platform in order to help our customers increase revenues and reduce operating costs. In October 2002, our wholly-owned subsidiary, EXFO Gnubi, purchased substantially all the assets of gnubi communications, L.P., a supplier of multichannel telecom and datacom testing solutions for the system manufacturer market. EXFO Protocol and EXFO Gnubi were consolidated in Montreal, Canada, in fiscal 2004.
 
Previously, we had completed two acquisitions to bolster growth in the optical component manufacturing market. We acquired Burleigh Instruments, Inc. (renamed EXFO Burleigh Products Group Inc.) in December 2000 for its wavelength measurement instruments and nanopositioning alignment systems. We also added EFOS Inc. (renamed EXFO Photonic Solutions Inc.) in March 2001 for its precision light-based, adhesive spot-curing technology. We have since exited the optical component manufacturing automation business, and the remaining operations of EXFO Burleigh have mostly been consolidated with those of EXFO Photonic Solutions in Toronto, Canada.
 

 
 
We launched 26 new products in fiscal 2009, including three in the fourth quarter, compared to 27 in fiscal 2008. Key product introductions in fiscal 2009 included among others a portable test solution for characterizing 100 Gbit/s Ethernet and 40/43 Gbit/s SONET/OTN networks; a patent-pending distributed PMD analyzer that allows network operators to cost-effectively upgrade their networks to 40G and 100G by measuring the level of potentially debilitating PMD on each fiber section; new software releases for the IMS InterWatch platform and Packet Blazer product lines that support the migration of voice and video applications to the IPv6 (Internet protocol, version 6) addressing scheme; 1 Gbit/s and 10 Gbit/s test probes for carrier Ethernet and mobile backhaul service assurance applications; and the next-generation FTB-500 multilayer platform for high-end test applications in the field and central office. Following the year-end, we released the first turnkey optical modulation analyzer for complete characterization of signals up to 100 Gbaud. Sales from products on the market two years or less accounted for 38.4% of total sales in fiscal 2009.
 
Overall for fiscal 2009, sales decreased 5.9% to $172.9 million from $183.8 million in 2008. This decrease in sales mainly resulted from the global economic recession as well as from currency fluctuations on our sales and the impact of such fluctuations on our forward exchange contracts since the beginning of the fiscal year. However, global sales for fiscal 2009 included $25.3 million from Brix Networks and Navtel Communications, compared to $5.4 million in fiscal 2008, which mitigated in part the decrease in sales year-over-year. These two acquisitions were closed approximately two months and one month into the third quarter of fiscal 2008, respectively. Excluding the positive impacts of these two acquisitions, our sales would have decreased 17.3% in fiscal 2009 compared to 2008, reflecting the impact of the global economic recession and the negative effects of the currency fluctuations on our sales and the impact of such fluctuations on our forward exchange contracts in fiscal 2009, compared to 2008.
 
We reported a GAAP net loss of $16.6 million, or $0.27 per share, in fiscal 2009, compared to net earnings of $18.4 million, or $0.27 per diluted share, in fiscal 2008. Net loss for fiscal 2009 included a non-cash pre-tax impairment of goodwill of $21.7 million. GAAP net loss for fiscal 2009 also included pre-tax charges of $1.2 million in severance expenses for the 65 employees who were terminated throughout the company. However, GAAP net loss included a pre-tax R&D tax credits recovery of $1.9 million and $372,000 for the recognition of previously unrecognized future income tax assets. Finally, GAAP net loss for fiscal 2009 included $4.3 million in after-tax amortization of intangible assets and $1.4 million in stock-based compensation costs. Net earnings for fiscal 2008 included $5.3 million for the recognition of previously unrecognized future income tax assets, $2.7 million for income tax recovery following the review of our tax strategy related to the changes in substantively enacted income tax rates in Canada, $1.5 million of income tax expense to account for the changes in substantively enacted income tax rates on our future income tax assets in Canada, an extraordinary gain of $3.0 million related to the negative goodwill of the Navtel acquisition, as well as $3.0 million in after-tax amortization of intangible assets and $1.3 million in stock-based compensation costs.
 
EBITDA (net earnings (loss) before interest, income taxes, amortization of property, plant and equipment, amortization of intangible assets, impairment of goodwill and extraordinary gain) were at $14.5 million, or 8.4% of sales in fiscal 2009, compared to $20.6 million, or 11.2% of sales in 2008 (see pages 77 and 78 of this document for a comprehensive reconciliation of EBITDA to GAAP net earnings (loss)). EBITDA for fiscal 2009 included pre-tax charges of $1.2 million in severance expenses for the 65 employees who were terminated throughout the company and stock-based compensation costs of $1.4 million. However, EBITDA included a pre-tax R&D tax credits recovery of $1.9 million.
 
On November 6, 2008, we announced that our Board of Directors had authorized a renewal of our share repurchase program, by way of a normal course issuer bid on the open market, of up to 10% of our public float (as defined by the Toronto Stock Exchange), or 2.7 million subordinate voting shares, at the prevailing market price. The period of the normal course issuer bid started on November 10, 2008 and ended on November 9, 2009. All shares repurchased under the bid were cancelled. In fiscal 2009, we repurchased 488,786 subordinate voting shares for an aggregate net purchase price of $1.4 million.
 

 
 
On November 10, 2008, we announced that our Board of Directors had authorized a substantial issuer bid (the “Offer”) to purchase for cancellation subordinate voting shares for an aggregate purchase price not to exceed CA$30 million. On December 18, 2008, pursuant to the Offer, we purchased for cancellation 7.7 million subordinate voting shares for the aggregate purchase price of CA$30 million (US$24.9 million), plus related fees of $576,000. We used cash and short-term investments to fund the purchase of shares.
 
On November 6, 2009, we announced that our Board of Directors had authorized the second renewal of our share repurchase program, by way of a normal course issuer bid on the open market, of up to 10% of our public float (as defined by the Toronto Stock Exchange), or 2,256,431 million subordinate voting shares, at the prevailing market price. We expect to use cash, short-term investments or future cash flows from operations to fund the repurchase of shares. The period of the normal course issuer bid will start on November 10, 2009, and end on November 9, 2010, or on an earlier date if we repurchase the maximum number of shares permitted under the bid. The program does not require that we repurchase any specific number of shares, and it may be modified, suspended or terminated at any time and without prior notice. All shares repurchased under the bid will be cancelled.
 
In the third quarter of fiscal 2009, we performed our annual impairment test for goodwill for all reporting units. Recoverability of goodwill is determined at the reporting unit level, using a two-step approach. First, the carrying value of the reporting units is compared to their fair value. If the carrying value of a reporting unit exceeds its fair value, the second step is performed to determine the amount of the impairment loss. Following the decrease in our stock price in June 2009, we came to the conclusion that the carrying value of one of our reporting units exceeded its fair value and we recorded an impairment charge of $21.7 million in the third quarter of fiscal 2009, to bring the goodwill of this reporting unit to its fair value. This reporting unit reports to the Telecom Division.
 
In June 2009, we laid off a number of employees across the organization as part of a restructuring plan to cope with currently difficult market conditions. This action resulted in a one-time pre-tax restructuring charge of $1.2 million that was recorded in the fourth quarter of fiscal 2009 but is expected to deliver about $6 million in annual savings.
 
During the third quarter of fiscal 2009, we were named recipient of the Growth Strategy Leadership Award by Frost & Sullivan for the fifth consecutive time. The award is presented to the company whose growth strategy generates the largest market-share gains in the global fiber-optic test equipment (FOTE) market during the previous research period. According to Frost & Sullivan, a leading global growth consulting firm, we captured first place overall in the FOTE market with a market share of 18.0% in 2008, up from a third-place 12.7% in 2006 (Frost & Sullivan did not grant an award in 2008 for market-share gains in 2007). Frost & Sullivan estimated the FOTE market to be $567.4 million in 2008, including $247.9 million for the portable installation and maintenance (I&M) test market. Based on Frost & Sullivan’s market data, we improved our leadership position in the portable I&M test market from 25.5% in 2006 to 33.3% in 2008.
 
Key Industry Trends
 
The fundamental drivers for increased bandwidth and Internet Protocol (IP) fixed-mobile convergence in the global telecommunications industry remain intact, but they were constrained by the economic recession that has forced network operators and network equipment manufacturers to reduce their capital and operating expenses in calendar 2008 and 2009. Due to the recession, several of these players announced significant reductions in capital expenditures and staffing levels during the course of the year.
 
Despite this challenging macro-economic environment, the telecom market dynamics in 2009 are completely different from those during the industry downturn of 2001. First, there is a myriad of bandwidth-intensive applications generating strong growth in bandwidth demand, both in wireless and wireline networks. For example, monthly traffic is at the exabyte level (1 exabyte equals 1 quintillion bytes) in 2009, while in 2001 there were few applications outside of regular e-mail delivery. Second, the ongoing demand for bandwidth has placed a strain on access, metro rings and long-haul routes, whereas in 2001 there was an overabundance of bandwidth capacity in optical backbone networks, which drove bandwidth prices down significantly. Finally, most network operators have healthy balance sheets today, while in 2001 many of them were financially overextended with some declaring bankruptcy.
 

 
 
According to Cisco’s Visual Networking Index, global IP traffic will nearly double every two years (compound annual growth rate of 46%) from 2007-2012, reaching just under 44 exabytes per month in 2012. Global bandwidth demand is driven by a wide range of applications including peer-to-peer file sharing, social networking, Internet gaming as well as various forms of IP video. For example, according to Cisco, YouTube consumed more bandwidth in 2008 than traffic crossing the entire US network backbone in 2000.
 
As telecommunication networks are being transformed to deliver IP-based voice, video and data capabilities, legacy SONET/SDH standards, which were first established in the mid-1980s and implemented until 2005, do not have the payload flexibility to seamlessly mix and transport these services. Such networks are not capable of efficiently carrying IP-based services, since they were designed for public switched telephone network (PSTN), point-to-point voice transmission only. As a result, new optical transport network (OTN) standards have been defined to carry IP applications over Ethernet and are at the very foundation of what the industry is labeling next-generation networks. Network operators are increasingly turning to such next-generation, IP-based networks to allow for more flexible and efficient transport of applications and services, and to offer customers higher-margin triple-play services ― and even quadruple-play services ― as wireline and wireless technologies become increasingly interconnected. Finally, as subscribers of these new services reach a critical mass, network operators are relying on service assurance solutions to ensure that the quality of service (QoS) and quality of experience (QoE) are optimal in the post-deployment phase.
 
As well, fiber-to-the-home (FTTH) is becoming the access network architecture of choice for network operators wishing to provide a superior user experience for a combined video, data and voice offering. This architecture allows them to meet heightened bandwidth requirements and future-proof their access networks, as residential bandwidth demands are growing from the 1 to 5 Mbit/s (megabits per second) of the past to 30 to 100 Mbit/s required for the long term. Some projects, however, may be delayed due to reduced funding. Hybrid architectures, combining copper and fiber (fiber-to-the-curb, or FTTC, and fiber-to-the-node, or FTTN), will also expand in the short term, since they are less expensive methods to increase bandwidth and can be mass-deployed more quickly.
 
FTTH investment decisions are applicable not only to green-field deployments and high-rise buildings, but also to larger-scale rollouts as long-term operating costs are less than FTTC and FTTN. It should be noted that FTTH deployment costs have largely dropped over the years as increased volume and improved test tools, like those we offer, are rendering rollouts increasingly simple and efficient. FTTH is also proving to be a low-cost alternative for multi-dwelling units (MDUs) as this network architecture can deliver large amounts of bandwidth at a minimal cost per apartment. We are merely at the early stages of fiber deployments in access networks, both in North America and around the world. It is also worth noting that Western Europe and even China have become increasingly committed to deploying FTTH networks, given their high-population density.
 
As bandwidth growth in access networks continues to increase, it has begun placing a strain on metro rings and core networks. It is also driving the need for higher-speed technologies. For example, 43 Gbit/s (gigabits per second) SONET/SDH is now becoming mainstream, while a few network operators are expected to begin 100 Gbit/s Ethernet field trials later in this calendar year. In the long run, these solutions will offer a more economical way to add capacity on saturated network sections, especially if trenches need to be dug in order to deploy new fiber in metro and long-distance routes.
 
These market dynamics affected telecom test and service assurance suppliers in fiscal 2009. However, the tail-end of the economic recession in the United States and Western Europe could continue to delay network investments and necessarily reduce demand for our test and service assurance solutions.
 
For our Life Sciences and Industrial Division, key market trends for the niche markets that we serve include:
 
·  
Industrial UV Spot-Curing: Overall, the end-markets for precision assembled products manufactured with UV curing remains healthy, especially for the assembly of medical devices, despite weaker economic conditions. The optoelectronics market, dominated by high-volume manufacturing in Asia has been significantly affected by the global recession in 2009, but we expect it to begin to recover in 2010 and it is increasingly adopting LED (light emitting diode) UV spot curing equipment.
 
 
 
 
·  
Life Sciences: The fluorescence microscopy market is stable with the majority of the growth happening in live cell and quantitative imaging applications.
·  
Industrial UV Digital Print Ink Curing: The digital print markets that we target are exhibiting flat growth to light decline, due to the global recession in 2009. However, there are indications that they will resume stronger growth in 2010 as printing press equipment continues to make the transition from analog to digital technology.
 
Three-Year Corporate Objectives
 
Our goal is to become a strong market leader in the global telecom test and service assurance industry, mostly with Network Service Providers (NSPs). We are committed to offering the most advanced market-driven solutions that help NSPs efficiently install, commission and run their converged IP fixed-mobile networks. Given the myriad of applications and resultant explosion in bandwidth demand, we are increasingly covering the service and applications layers on a network infrastructure to enable quadruple-play services.
 
To achieve our long-term vision, we plan to expand our leadership position in the portable optical segment, while growing our protocol business even faster to surpass optical in terms of sales. This plan is largely based on profitable organic growth, but it will be supported by strategic acquisitions of typically small to mid-size companies with best-of-class technologies in nascent, high-growth markets complementary to EXFO’s. We also intend to improve our competitive position through strategic alliances and partnerships.
 
In our fiscal 2008 Annual Report, we had established three corporate performance objectives to gauge the success of our overall plan over the next three years:
 
o  
Increase sales significantly faster than the industry growth rate (20% CAGR*)
o  
Grow EBITDA** in dollars faster than sales (>20% CAGR)
o  
Continue raising gross margin (62%)
 
*
Compound annual growth rate
**
EBITDA is defined as net earnings (loss) before interest, income taxes, amortization of property, plant and equipment, amortization of intangible assets, impairment of goodwill and extraordinary gain.
 
Given the global economic recession in fiscal 2009, we adjusted our corporate performance metrics over a new three-year period extending from fiscal 2010 to 2012. We have maintained our 20% sales CAGR objective, proposed to double EBITDA in dollars, and raised our gross margin target to 64% for the newly defined three-year period.
 
 
Corporate Performance Objectives for FY 2010-2012
 
 
Increase sales by a CAGR of 20% or more
 
 
Raise gross margin to 64%
 
 
Double EBITDA in dollars
 
 
We expect these three-year objectives to guide our actions in upcoming years as we are committed to maximizing shareholder value, although there can be no assurance that we will be successful in meeting the objectives.
 
In fiscal 2009, sales and EBITDA decreased 5.9% and 29.7%, respectively, compared to 2008. Most of these come from the negative effect of the global economic recession in fiscal 2009 as well as from currency fluctuations since the beginning of the fiscal year. However, gross margin improved to 61.3% in fiscal 2009 from 58.9% in 2008 despite difficult market conditions and currency fluctuations, due to the contribution of newly acquired Brix Networks and Navtel Communications. See Item 5 - Operating and Financial Review and Prospects for a comprehensive analysis of our sales and gross margin.
 
The EXFO Solution
 
We offer an extensive range of test, measurement and service assurance solutions to the global telecommunications industry. Our success has been largely predicated on our core expertise in producing test equipment for optical telecommunications. We also leverage this expertise to develop products for life sciences and high-precision assembly applications. Our solution is based on the following key attributes:
 

 
 
 
·  
unlike stand-alone units, new test modules can be rapidly developed to address changing industry requirements;
·  
as customers’ testing requirements change, they can purchase additional modules that are compatible with their previously purchased platforms, thus protecting their initial investments;
·  
our standard graphical user interface reduces training costs because customers are familiar with previously acquired software products;
·  
the flexibility of our systems allows customers to develop customized and automated solutions for their specific test requirements;
·  
our test platforms are PC-based and MS Windows-driven, thus they can support third-party software solutions.
 
 
·  
the first PC-based modular test platform for field applications;
·  
the first all-in-one optical loss test set combining several instruments;
·  
the first modular platform to combine optical and protocol test solutions;
·  
the first line of portable test instruments designed for FTTx testing;
·  
the first fully integrated Ethernet-over-SONET test solution;
·  
the first distributed PMD analyzer; and
·  
the first portable test solution for characterizing 100 Gbit/s networks.
 
High-Quality Products.>  Product quality is an integral part of our solution. Our Quebec City, Canada, operations have maintained ISO 9001 certification since 1994 and they are now certified to the new 2000 edition of the standard. Our manufacturing plant in Shenzhen, China, which started operations in September 2007, is responsible for the production of high-volume, low-complexity telecom products. Our Shenzhen plant follows the same corporate quality standards and was certified ISO-9001 in January 2009. All of our products meet required industry standards, and some of our products meet additional voluntary standards, such as those set by Telcordia, formerly Bellcore, IEC, IETF, ETSI and other industry-leading standards bodies. During manufacturing, each product has a related quality-assurance plan, with rigorous checkpoints, to ensure product conformity. Various tasks in the quality assurance process include quality control, conformity testing, product documentation, product improvement, regulatory compliance, metrology and calibration.
 
Our product designs comply with Directive 2002/96/EC, a legislation enacted by the European Union regarding the disposal of waste electrical and electronic equipment (WEEE), for all products exported to Europe. In regard to the Directive 2002/96/EC (RoHs), test and measurement manufacturers have been provided a limited exemption until 2012.
 

 
 
Products
 
Our test platforms, namely the AXS-200 SharpTESTER, FTB-200 Compact Platform, FTB-500 Platform, and IQS-600 Intelligent Test System, are at the core of our product portfolio. The AXS-200 SharpTESTER is a multi-service, multi-medium handheld test platform designed for characterizing and troubleshooting commercial and residential access networks. It can easily be configured for copper/DSL/triple-play, Ethernet or optical testing applications. The FTB-200 Compact Platform is a two-slot portable test unit optimized for multi-technology, multi-application characterization of metro and access networks. The newly launched FTB-500, which is available in four-slot and eight-slot configurations, provides NSPs with a simple, yet efficient way to perform multiple, advanced test operations for installation, maintenance and troubleshooting applications. Our IQS-600 platform is designed for manufacturing and R&D applications. It tests optical as well as transport and data communications technologies increasingly based on IP. All platforms and related test modules are supported by integrated and highly intuitive graphical user interfaces (GUIs), enabling the user to easily store, handle and retrieve test results and measurement data. In addition, EXFO offers a number of handheld and benchtop test and measurement products, some of which are modular in nature.
 
Following the acquisition of Navtel Communications in March 2008, we offer the InterWatch platform series, a line of advanced hardware and software-based test systems that enable network equipment manufacturers and network service provider labs to fully test their complex digital telecommunications equipment and services more quickly and cost-effectively, while helping to ensure interoperability and reliability. These advanced software and hardware solutions assist customers in the design, integration, installation and acceptance testing of a broad range of Internet Protocol Multimedia Subsystem (IMS)/Next-Generation Network (NGN) telecommunications equipment and services by performing a variety of test functions:
 
·  
Design and feature verification;
·  
Interoperability testing;
·  
Load and stress testing; and
·  
Monitoring and analysis.
 
Following the acquisition of Brix Networks in April 2008, we also offer comprehensive service assurance and performance monitoring systems for advanced IP and carrier Ethernet services such as IPTV, voice-over-IP, IP/MPLS, virtual private networks (VPNs), video on demand, and video conferencing. The Brix System, a family of integrated software and hardware components, proactively monitors quality by providing complete visibility across all IP services, throughout the lifecycle of the service, and across the entire network.
 
Within the Brix System, advanced performance management applications, running on a central-site software engine, called BrixWorx, analyze and display performance data collected from the measurement sources, like Brix Verifiers and native network elements deployed throughout the network being monitored. Brix Verifiers execute protocol-specific tests to precisely calculate crucial availability and performance metrics through proactive testing, ongoing monitoring, and the collection of data directly from infrastructure devices.
 
BrixWorx provides all performance data analysis, configuration, and management for the distributed Brix System, while test suites offer broad and deep visibility into the performance of converged network services.
 
Furthermore, EXFO offers network monitoring systems and test probes used in third-party network monitoring solutions.
 

 
 
The following table summarizes the principal types of test instruments for the telecommunications industry, typical applications and the formats in which we offer them:
 
Instrument Type
Typical Application
NSP Market
Manufacturer
/R&D Market
   
FTB 500 Modules
FTB 200 Modules
AXS 200 Modules
Handhelds
IQS-600
Modules
Bench top Instruments
               
ADSL/ADSL2+ Service Verification Tool
Based on a DSL “golden modem”, these units are used to test the function, speed and quality of a DSL service at the subscriber premises.
   
X
X
   
               
Broadband source
Used for testing wavelength-dependent behavior of fiber cables and dense wavelength division multiplexing (DWDM) optical components.
       
X
X
               
Chromatic dispersion analyzer
Measures increasing levels of chromatic dispersion in high-capacity optical networks.  Chromatic dispersion is a physical phenomenon inherent to optical fiber and optical components that causes information bits to spread along a network.  This degrades the quality of the transmission signal and, in turn, limits the transmission speed carried by optical networks.
X
         
               
Clip-on coupling device
Clips to an optical fiber and allows non-invasive testing.
     
X
   
               
Fibre Channel tester
Brings FC-0, FC-1 and FC-2 logical layer Fibre Channel testing to services delivered via transport protocols, such as dense wavelength division multiplexing (DWDM), SONET/SDH and dark fiber. It provides valuable timing information and buffer credit estimation for Fibre Channel network deployment.
X
X
   
X
 
               
Gigabit Ethernet tester
Measures data integrity for high-speed Internet protocol telecommunications in metro and edge networks.
X
X
X
 
X
 
               
10 Gigabit Ethernet tester
Benchmarks and verifies high-speed 10 Gbit/s Ethernet network performance and service-level agreements.
X
X
   
X
 
               
HDTV, SDTV and IPTV service test instrument
Used to test the quality and functionality of standard and high definition television signals that are delivered over higher-rate ADSL, ADSL2+ and VDSL2 transmission technologies.
     
X
   
               
Laser spectrum analyzer
Performs high-resolution, spectral characterization of continuous CW laser sources
         
X
               
Telephone for traditional voice and VoIP service testing
Used by telephone line and DSL installers to test the proper functioning of both traditional and next-generation voice and data communication services.
     
X
   
               
Live fiber detector
Clips on to a fiber and is used to detect the presence and direction of a signal without interrupting the traffic.
     
X
   
               
Loss test set
Integrates a power meter and a light source to manually or automatically measure the loss of optical signal along a fiber.
X
X
X
X
X
X
               
Narrowly tunable laser
A laser that can be precisely tuned to simulate a DWDM light sources.  Used primarily for testing optical amplifiers.
       
X
 
               
Next-generation SONET/SDH analyzer
Full SONET/SDH protocol testing functionality, including support for generic framing procedure (GFP), virtual concatenation (VCAT), and link-capacity adjustment scheme (LCAS) next generation enhancements.
X
     
X
 
               
Optical coupler
Used in test system to combine sources or signals.  Also uses as splitters to monitor signals.
       
X
 
               
Optical power meter
Measures the power of an optical signal.  It is the basic tool for the verification of transmitters, amplifiers and optical transmission path integrity.
X
X
 
X
X
X
               
Optical power reference module
Provides a highly accurate and traceable measurement of power for the calibration or verification of other power measurement instruments.
       
X
 
 
 
 
 
Instrument Type
Typical Application
NSP Market
Manufacturer
/R&D Market
   
FTB 500 Modules
FTB 200 Modules
AXS 200 Modules
Handhelds
IQS-600
Modules
Bench top Instruments
               
Optical return loss meter
Combines a laser and a power meter to measure the amount of potentially degrading back reflection.
X
X
 
X
X
 
               
Optical spectrum analyzer
Produces a graphical representation of power versus wavelength for an optical signal. Useful for measuring the drift, power and signal-to-noise ratio for each wavelength in a DWDM system.
X
         
               
Optical switch
Provides switching between fibers. Used to provide flexible and automated test setups such as the measurement of multiple fibers or components with multiple ports with one instrument.
X
     
X
 
               
Optical time domain reflectometer
(OTDR)
Like a radar, it measures the time of arrival of reflections of an optical signal to determine the distance to the breaks or points of excessive loss in a fiber network.
X
X
 
X
   
               
Passive component analyzer
Characterizes passive wavelength-selective devices, such as multiplexers, demultiplexers and add/drop filters, with respect to absolute wavelength in order to guarantee their performance within dense wavelength division multiplexing (DWDM) systems.
         
X
               
Passive optical network (PON) power meter
Determines the power level of various signal types, including continuous (e.g., TV signal at 1550 nm) and framed (e.g., ATM or Ethernet at 1490 nm or 1310 nm) within a passive optical network. Various baud rates are covered, ranging from 155 Mbit/s to 2.5 Gbit/s, for both synchronous and non-synchronous signals.
     
X
   
               
Polarization-dependent loss meter
Measures the difference in loss of power for the different states of polarization.
       
X
 
               
Polarization mode dispersion analyzer
Measures the dispersion of light that is caused by polarization. Generally used to determine the speed-distance limitation of fiber and cables.
X
         
               
SONET/ SDH analyzer
Provides accurate bit-error rate and performance analysis of SONET/SDH overhead format that reflects the quality of a transmission system.
X
X
   
X
 
               
Stable light source
Emitting diode or lasers used in connection with a power meter to measure signal loss.
X
   
X
X
X
               
Synchronization analyzer
Portable, stand-alone tester for network synchronization analysis and wander measurement in wireless and wireline transport networks.
         
X
               
Talk set
A device that attaches to an optical fiber and serves as a temporary voice link facilitating coordination of work among installation crews.
X
   
X
   
               
Telephone wire analyzer
Used by telecommunications service providers that have networks that are comprised mostly or partially of twisted-pair local loops to ensure that those loops are of sufficient quality to carry higher-frequency signals required for DSL.
     
X
   
               
Variable optical attenuator
Used in network simulation setups to provide calibrated variable reduction of the strength of an optical signal.
     
X
X
X
               
Visual fault locator
A visible laser that can be connected to an optical fiber network to help locate breaks or points of excessive loss.
X
X
 
X
   
               
Widely tunable laser
Can produce laser light across a broad range of wavelengths. Used to test DWDM components and value-added optical modules.
       
X
X

 
 
 
Products for Network Service Providers
 
Test Equipment
 
We offer an extensive range of field-portable test, measurement and monitoring solutions that are mainly used by network service providers and can also be utilized by network equipment manufacturers. These products are available as handheld test instruments, portable platforms with related modules, and as rack-mount chassis with related modules. Our handheld instruments are durable, compact and easy to use. Our AXS-200 SharpTESTER platform, which is designed for entry-level field technicians in access networks, can easily be configured for copper/DSL/triple-play, Ethernet or optical testing applications. Since the introduction of the AXS-200 SharpTESTER in 2008, we have released several access test solutions, such as Ethernet/IP, 30 MHz copper and ADSL2+ triple-play test modules; several others will be released in upcoming months. Our FTB-200 Compact Platform, designed for the “super field technician”, holds up to two interchangeable modules that are fully compatible with our more advanced FTB-500 platform. Test technologies well-suited for the FTB-200 Compact Platform include a wide range of singlemode and multimode optical time-domain reflectometers (OTDRs), automated optical loss test sets (OLTSs), SONET/SDH analyzers from DS0 up to OC-192, as well as Gigabit Ethernet (GigE) and 10 Gigabit Ethernet testers. Our third-generation field-testing platform, the FTB-500, is available in two configurations. The four-slot model is designed for datacom testing, OTDR analysis, optical loss, and Ethernet (up to 10 Gbit/s) testing. The eight-slot model is a high-performance, multiple-protocol unit that allows users to combine next-generation SONET/SDH functions with Ethernet, Fibre Channel and optical-layer testing capabilities. It also supports dispersion characterization (PMD and CD), as well as DWDM/ROADM testing with optical spectrum analysis. Our portable platforms are PC-centric, Windows-based, highly flexible and fully scalable. Their large robust touchscreens are very practical for field use.
 
Service Assurance Systems
 
We also offer a family of service assurance and performance monitoring solutions, collectively known as the Brix System, to network service provider labs and large enterprises. The following describes the software and hardware elements of the Brix System:
 
Centralized Management and Correlation -- BrixWorx
 
BrixWorx represents the core of the Brix System. BrixWorx provides network- and service-wide control, visibility, and analysis for the fully integrated Brix System. Using the BrixWorx Operations Center user interface, administrators remotely control each component of the system and can easily configure and modify all aspects of the geographically distributed network of Verifiers and third-party measurement sources, including: choosing the desired performance tests and configuring their parameters, threshold values, and schedules.
 
The BrixWorx unified correlation engine quickly turns data into actionable information through a visualization layer for service-level agreement (SLA) conformance, root-cause analysis, troubleshooting, usage patterns, and trending.
 
The highly scalable BrixWorx architecture easily accommodates hundreds of thousands of Brix Verifier test points and third-party measurement sources.
 
Visualisation and Business Intelligence -- BrixView
 
Seamlessly integrated with the BrixWorx correlation engine, BrixView enables the flexible presentation of performance and quality information to all decision makers. With interactive dashboard views, customizable reporting packages, and individual content portals, BrixView delivers fast, simple access to information when it is needed and in the format it is needed for all levels of users across an organization.
 
BrixView produces visualization and reports of varying levels to allow a broad audience to take the appropriate actions. With the appropriate information, network operators spend less time working with static charts and spreadsheets, and business owners and executives have the information and insights they need to make intelligent decisions and drive business value for the organization.
 

 
 
Testing Across the Entire Network -- Brix Verifiers
 
Installed at customer premise locations, the Brix Verifiers’ various interfaces include Ethernet, ATM, and Euro/ISDN PRI. Similarly, Verifier test capacity scales from the modest requirements of an enterprise branch office running hundreds of tests to a network core running hundreds of thousands of tests.
 
In addition to Brix Verifiers, the Brix System also supports selected third-party measurement sources. Brix Verifiers are designed for long-term 24x7 deployments in the lights-out, production networks of service providers and enterprises. Once a Brix Verifier is deployed, administrators do not need to locally access it again.
 
End-to-End IP/MPLS/Carrier Ethernet Service Assurance:  BrixNGN
 
The network core is the heart of the service delivery network, and where successful providers’ service assurance strategies start. To effectively guarantee end-to-end SLAs and meet customers’ requirements, providers must implement a service assurance solution that provides visibility from the provider edge and to end-users, while allowing segmented views of service quality for problem isolation. By continually monitoring the performance and quality of real-time IP and carrier Ethernet services, and not just the physical network devices, BrixNGN provides the most effective service assurance solution.
 
With BrixNGN, providers can continuously collect, correlate, analyze, and visualize critical quality of service (QoS) and quality of experience (QoE) data from the network core to the customer endpoint for capacity planning, verifying service turn-ups, and identifying, diagnosing, and quickly resolving network and service performance issues before customers are impacted—thereby guaranteeing quality.
 
The BrixNGN software module performs proactive monitoring of the network core, extended Ethernet and IP networks between partners and customers, and data services, including E-mail, web-based applications, file transfers, and more.  BrixNGN enables early detection and quick resolution of service affecting issues.
 
Performance Monitoring for IP Video: BrixVision
 
The BrixVision product line is a family of IPTV service assurance products that measure the end-to-end quality of IP-based video services and validate the performance of video broadcast, on-demand channel, over-the-top video, and video-conferencing quality. The BrixVision product line provides full service lifecycle performance monitoring for IP Video services such as broadcast TV, video on demand, gaming, and videoconferencing. BrixVision provides visibility into service performance using a combination of proactive testing and user transaction generation, passive monitoring, and the collection of performance metrics from service delivery or home network devices.
 
Voice over IP Testing and Monitoring: BrixCall
 
BrixCall provides comprehensive visibility into the performance of live VoIP traffic to ensure call quality from the network core to customer care.  Deployed in conjunction with the Brix family of Verifiers, BrixCall is an integrated component of EXFO Service Assurance’s live call monitoring solution and employs Brix Verifiers to monitor call signaling and media traffic throughout the network with the advanced BrixCall stream correlation and analysis engine.  The solution delivers a single detailed Call Quality Report for each call monitored as well as visibility across all monitored calls.
 
In addition, the BrixCall dashboard presents critical information about the current state of the service, including all performance threshold violations, call disposition, average Mean Opinion Score (MOS), peak call volume and bandwidth utilization, answer seizure and network efficiency ratios, and call duration information.
 
BrixCall features the unique Brix Tri-Q Analysis, and graphically displays the impact of each of the elements that contribute to a user’s satisfaction with a call — signaling quality, delivery quality, and call quality.
 

 
 
The following table summarizes the principal service assurance solutions we provide as well as their typical applications:
 
Service Assurance Solutions
Product Type
Product
Typical Application
Software Products
BrixWorx
Central site operations center
 
BrixCall
Advanced analysis and correlation of VoIP calls
 
BrixVision
Advanced analysis and correlation of live video sessions
 
BrixNGN
Network core and MPLS analysis, correlation and reporting
Brix Verifier
Brix 100M Verifier
Customer premise end point monitoring
 
Brix 1000 Verifier
Network edge and lower capacity monitoring
 
Brix 2500 Verifier
Network core, at a higher capacity
 
Brix 3500T Verifier
PSTN monitoring
 
Brix 4100 Verifier family
In-network live voice or video monitoring
 
Products for Network Equipment/Component Manufacturers
 
Test Equipment
 
Our network equipment/component vendor solutions, mainly built around our IQS-600 platform, are available as test modules or stand-alone benchtop instruments. The next-generation IQS-600 platform can efficiently run as many as 100 optical test modules using a single controller unit. The IQS-600 platform is equipped with the software and hardware technology to support single-button operation for automated testing. Its system-based approach – one box, several test modules – combined with an open architecture (PXI, Windows, LabVIEW™, etc.) and ease of programming, produces a highly flexible test environment.
 
The IQS-600 also provides backward compatibility with recent IQ-generation test modules, while delivering all the power and advantages of a next-generation platform. EXFO’s wide selection of high-performance test modules includes high-speed power meters, light sources, WDM laser sources, tunable laser sources, variable attenuators, multi-wavelength meters, polarization-dependent loss (PDL) and optical return loss (ORL) meters, polarization controllers and optical switches.
 
Our system/component vendor solutions also address testing issues that cannot be handled by standard test modules or stand-alone benchtop instruments. Over the years, we have developed a number of integrated test systems and offer them as off-the-shelf solutions to suit a wide range of customer needs. In addition, we have created a software development kit for developers who prefer writing their own programs for our instruments. Following is a list of integrated test systems that we provide for characterizing optical components, subsystems and networks:
 
· CWDM/FTTH passive optical component test system
Used to automatically characterize all critical specifications, including spectral insertion loss, polarization-dependent loss and optical return loss of a CWDM passive component or a FTTH splitter with a high degree of accuracy, ease of use and speed.
 
· Cable assembly and component test system
Used to perform insertion loss and mandrel-free reflection measurements with the highest degree of accuracy and repeatability on short fiber assemblies (including multifiber patchcords, hybrids and fan-out patchcords) and components like PLC splitters and fiber arrays.
 
· 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.



 
Following the acquisition of PicoSolve Inc. in February 2009, we also offer advanced test solutions for network equipment manufacturers in the process of developing ultra high-speed optical networks.
 
PSO-200 Optical Modulation Analyzer
 
The PSO-200 is the first turn-key optical modulation analyzer for complete characterization of signals up to 100 GBaud. Very high-speed network transmission is enabled through the efficient modulation of signals, whether it is phase, amplitude or both. To design 100G systems based on such advanced modulation schemes and to make sure they are ready for deployment, network equipment manufacturers (NEMs) have used in-house test solutions, which are often complex or limited. The introduction of the PSO-200 Optical Modulation Analyzer changes the picture as engineers working in R&D labs and manufacturing environments now have access to a turnkey and comprehensive test instrument that makes bandwidth limitation irrelevant.
 
PSO-100 Optical Sampling Oscilloscope Series
 
The PSO-100 Series are the industry's fastest sampling oscilloscopes, allowing characterization of optical signals at data rates up to 640 Gbits/s. The PSO-100 all optical sampling oscilloscopes enable distortion-free, eye-diagram analysis and pattern visualization within existing high-speed optical networks.
 
IMS/VoIP Test Systems
 
InterWatch Product Line
 
In addition, we offer a line of hardware modules and SolarisTM software-based telecommunications test products operating on a common hardware platform range. This product line consists of the QA-604 platform that was introduced in April 2009 and the InterWatch R14 system. Our products simulate both network subscribers and network elements used in emerging IMS and next-generation networks.
 
We maintain a library of software modules that provide test support for a large number of standardized industry protocols and variants. Our emphasis is on testing complex, high-level and emerging protocols, including IP Multimedia Subsystem (IMS) and IP Telephony (Voice over IP or VoIP).
 
Our extensive technical know-how and proprietary software development tools enable us to implement test support for new protocols and protocol variants rapidly in response to customer needs. With their extensive libraries of software protocol test modules, large selection of proprietary hardware physical interfaces and versatile range of hardware platforms, our products are easily configured to support a wide variety of digital testing functions, thereby reducing a customer’s need for multiple test systems. In addition, the systems’ multi-protocol, multi-user capabilities allow multiple complex testing operations to be performed simultaneously, helping our customers to accelerate their product development cycles.
 
Our InterWatch test systems consist of advanced proprietary software together with our proprietary hardware interface and co-processor cards. When acquiring a system, customers typically license one or more software modules and purchase hardware and ongoing software support. Customers may upgrade their systems by purchasing additional software protocol test modules and additional hardware interfaces to meet future testing needs. Prices for our systems vary widely depending upon the overall system configuration parameters, including the number and type of software protocol modules and the number of physical interfaces required by the customer.
 
Applications
 
The principal applications of our InterWatch test systems are:
 
Feature Verification.  Our systems are used to perform feature verification by simulating one or more network devices and testing a wide variety of possible scenarios to establish if the device under test can handle all features specified by the protocol. Users are able to initiate multiple simultaneous calls across one or many links, create correct call scenarios, send messages out of sequence to verify error response mechanisms and verify a voice or data path.
 

 
 
Interoperability Testing.  Our systems are used to simulate one or more network devices, emulating their actions and responses. By simulating various network devices, such as digital switches, network access nodes and network databases, our products assist engineers with the cost-effective development of equipment that will be compatible with other devices in the networks within which they will be deployed. This helps ensure that network equipment will interoperate reliably, thereby reducing costly failures after installation.
 
Load and Stress Testing.  Our systems are used to verify that a device under test can successfully handle its designed traffic capacity and that its performance will degrade gracefully, rather than fail completely, when stressed beyond its specifications. The scalable architectures of the systems significantly improve our ability to address our customers’ growing need to generate and maintain high traffic volumes for load testing.
 
Voice and Video Quality Analysis. Our systems are used to simulate subscribers’ voice and video traffic and measure the impact on the quality of customer experience (QoE). This type of testing helps ensure that the network can deliver an acceptable quality of voice and video to customers even when subjected to large volumes of network traffic.
 
Products for Life Sciences and Industrial Applications
 
Over the years, we have developed and acquired a number of core technologies that we leverage in selected high-precision assembly and life sciences markets. For example, we offer several light-based curing solutions for optical component manufacturing applications and have adapted our approach for other industries, such as semiconductor, microelectronic, and medical device manufacturing, in order to maximize revenues. Our Omnicure® systems deliver precise doses of the appropriate spectral light onto photosensitive adhesives to significantly reduce bonding time and increase repeatability. These light-based curing systems, supported by patented optical feedback, thermal control and radiometry technology, produce a high-quality bonding solution. Our technology and application knowledge place us at the forefront of this market.
 
Another key product line is the X-Cite fluorescence illumination systems for microscope manufacturers.  X-Cite systems deliver excellent image quality and at least 2000 hours of lamp life, which is over 60% longer than previous models and up to 10 times longer than conventional illumination systems. 
 
X-Cite systems are self-contained illumination units separate from a microscope.  A simple light guide attachment through custom-coupling optics ensures a uniformly illuminated field of view with no heat from the lamp being transferred to the microscope.  Models range from the basic X-Cite 120XL for routine imaging applications to the full-featured X-Cite Exacte, designed to provide maximum illumination stability and control for the most advanced live cell research. 
 
The following table summarizes the principal types of high-precision assembly and life science solutions we provide as well as their typical applications:
 
Light Sources and Accessories
Product Type
Product
Typical Application
UV Curing Light Sources
Omnicure® S1000
Omnicure® S1500
Omnicure® S2000
Used to initiate photo chemical reactions in polymer-based materials for a variety of end use applications. Examples include adhesive curing for manufacturing of high value-added items such as medical devices, micro-electronic and opto-electronic components, displays, and data storage devices.
    UV LED Curing Light Sources     Omnicure® LX300  
Fluorescent Light Sources
X-Cite® 120XL
X-Cite® 120 PC
X-Cite® exacte
Fluorescence light source that attaches directly to most microscopes currently sold by major microscopes manufacturers.
Optical Accessories
 
Optional custom delivery optics used with EXFO UV light sources to tailor the properties of light beams to end-user applications.
 
 
 
 
Light Sources and Accessories
Product Type
Product
Typical Application
High Power Fiber Light Guide
 
Provides an equal distribution of light energy to multiple cure sites with 50% more throughput than standard fiber guides.
UV LED Curing Pinning System
ExcelerateTM PIN-100
ExcelerateTM PIN-101
Used to pin (partially cure) UV ink immediately after jetting to enhance the management of drop size and image integrity, minimizing the unwanted mixing of drops and providing the highest possible image quality and the sharpest color rendering.
Optical Instruments
Product Type
Product
Typical Application
Radiometer
R5000
R2000
X-Cite® Radiometer
Handheld, broadband optical radiometers used in conjunction with EXFO UV light sources to ensure process quality control at the end-user location.
Cure-Site Radiometer
 
Attachments for the R2000 and R5000 radiometers that enable optical measurements under customer specific configurations. Examples include the cure-ring radiometer, which measures the output power of light from an EXFO cure ring; ideal for applications that requires a uniform 360° exposure.
Precision Positioning Instruments
Product Type
Product Line
Typical Application
Micromanipulators
PCS-6000 Micromanipulators
Electrophysiology research such as patch clamp recording experiments on cells from the brain and central nervous system.
PCS-5000 Micromanipulators
Microscope Platforms
Gibraltar Platform/Stage
Stable mechanical platforms that facilitate cellular research with micropositioning and microinjection systems.
Microinjection Systems
MIS-5000 Microinjection manipulator
Microinjection and nuclear transfer for genetics and reproductive sciences research.
 
Research and Development
 
We believe that our future success largely depends on our ability to maintain and enhance our core technologies and product functionality. To keep developing new products and enhancements, it is important that we retain and recruit highly skilled personnel. Our Telecom Division’s research and development department is headed by a Vice-President of Research and Development, while our Life Sciences and Industrial Division has a Director of Research and Development.
 
In fiscal 2009, we continued to increase our software development capabilities at our R&D center in India at a lower cost. We had initially acquired a small outsourcing company based in Pune, India. Today, this group is our largest R&D center with 152 employees.
 

 
 
As of November 2, 2009, our research and development departments included 454 full-time engineers, scientists and technicians, of whom 121 hold post-graduate degrees. Gross research and development expenditures in fiscal 2009 reached $35.8 million, compared to $32.5 million in 2008 and $25.2 million in 2007. We launched 26 new products in fiscal 2009 compared to 27 in 2008 and 20 in 2007. Approximately 38% of sales in fiscal 2009 originated from products that have been on the market two years or less compared to 35% in 2008 and 34% in 2007.
 
Through market-oriented product portfolio review processes at our telecom sites in Quebec City, Canada, Montreal, Canada, Concord, Canada, Chelmsford (MA), USA, and Pune, India, we ensure that our investments in research and development are aligned with our market opportunities and customers’ needs. This process enables us to maximize our returns on R&D investments by focusing our resources on prioritized projects. Quarterly product portfolio review meetings enable us to select 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 have significantly changed.
 
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 progress at various stages of its life cycle. The following are the key review stages of the stage-gate approach:
 
·  
market study and research feasibility;
·  
product definition;
·  
development feasibility;
·  
development;
·  
qualification; and
·  
transfer to production.
 
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 new product development is synchronized with other internal departments and external industry events. Adherence to these 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.
 
We also maintain research and development programs for our life sciences and industrial activities in Toronto, Canada. The product development process is managed using a similar stage-gate process, and projects are reviewed and approved through a quarterly portfolio review. The future success of our life sciences and industrial operations largely depends on our ability to maintain and enhance our core technology in light-based curing, fluorescence illumination systems and piezoelectric positioning.
 
Strong R&D capabilities at our Life Sciences and Industrial Division site in Toronto, Canada have made it possible to bring a number of successful new products to market quickly and retain customer intimacy. In the process, it has enhanced our ability to customize products for special applications and to develop original equipment manufacturing (OEM) products under partnerships and exclusive contracts. Outside consultants are often used for added support in areas like software development, mechanical design and rapid prototyping.
 

 
 
Customers
 
Our global and diversified telecom customer base relies on our test and service assurance solutions to enable optical networks to perform optimally during their complete life cycles: research, development, manufacturing, installation, maintenance and monitoring. We also have selected customers in high-precision assembly and life science sectors that require our solutions to render them more efficient in their respective fields. Our telecom customers include network service providers, cable television companies, public utilities, private network operators, third-party installers, equipment rental companies, large enterprises, network equipment manufacturers, component vendors and laboratory researchers. Our life science and industrial customers consist of major manufacturers of medical devices, microelectronics, optical displays, electronic storage systems, photonic components and microscopes, as well as universities, medical schools, governments, and private and industrial research laboratories. Our UV digital print customers consist of printing equipment manufacturers who develop products for label production and product marking. In fiscal 2009, our top customer accounted for 11.6% of our sales and our top three customers represented 17.8% of our sales. In comparison, in 2008 our top customer accounted for 7.4% of sales and our top three customers represented 13.1%, while in 2007, our top customer accounted for 14.7% of sales and our top three customers represented 19.6%.
 
With regard to geographic distribution, sales to customers in the Americas (US, Canada, Central and Latin America) represented 57% of our sales in fiscal 2009, while sales to customers in EMEA (Europe, Middle East and Africa) and Asia-Pacific accounted for 27% and 16% of sales, respectively. In comparison, the Americas, EMEA and Asia-Pacific accounted for 56%, 28% and 16% of sales, respectively, in 2008, and 59%, 27% and 14%, respectively, in 2007.
 
Sales
 
We sell our telecom test, measurement and service assurance solutions through direct and indirect sales channels in the Americas (US, Canada, Central and South America) and around the world.
 
In the Americas, we use a hybrid model, combining key account management with direct and indirect sales coverage. We typically use key account managers to serve large customers that generate high sales volumes or might potentially represent high sales volumes in the future. These key account managers are supplemented by regional sales managers, sales engineers, sales representatives and distributors in US as well as Central and South American metropolitan areas, and regional sales managers in Canada.
 
We opt for a direct sales approach when selling higher-end, highly technical products to sophisticated buyers. Sales of low- to medium-level complexity products to less stringent technical buyers are usually done through a manufacturer representative organization supported by regional sales managers. Our main sales offices and service centers in the Americas are located in Plano, Texas, Quebec City, Canada, and Concord, Canada. They are supplemented by a regional presence in cities across the US, Central and South America, as well as Canada.
 
On the international front, we have sales personnel covering strategic areas such as the EMEA (Europe, Middle-East and Africa) and APAC (Asia-Pacific) regions. Our sales network in EMEA is supported by a main office and service center in Southampton, UK, which maintains our head of European sales operations and also provides repair and calibration services for our EMEA customers. We also have additional sales offices in multiple countries across EMEA to serve and support our various customers and distributors.
 
As for APAC, our main sales offices for South East Asia is located in Singapore, while our main sales representative offices for mainland China are located in Shenzhen and Beijing, which also acts as a service center to better serve our customer base in that geographic area. In addition, we have other sales offices in strategic locations around the world to support our network of distributors and various customers.
 
We rely on a network of more than 90 distributors worldwide to work with us in supporting mostly our international sales and to participate in a large number of international events. We believe that the local presence and cultural attributes of our distributors allow us to better serve our global markets.
 

 
 
Our direct telecom sales team consists of a Vice-President of Sales for the Americas and a Vice-President of International Sales. They are supported by nine regional sales directors that are leading a widely distributed team of more than 121 people acting as key account managers, regional sales managers, sales engineers and application engineers. Our sales people are located throughout major metropolitan areas around the world. This group of sales professionals has on average more than 15 years of experience in the fields of telecommunications, fiber optics, or test and measurement. We also have an in-house Customer Service Group to meet the needs of existing and new customers. This group is 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.
 
Following the acquisitions of Navtel Communications and Brix Networks (renamed EXFO Service Assurance Inc.) in 2008, sales responsibilities within our Telecom Division were modified. Navtel Communications’ sales team was fully integrated within the Telecom Division, while EXFO Service Assurance’s sales force remained stand-alone as its systems are more complex than traditional test equipment and require longer sales cycles. EXFO Service Assurance, with its main sales office located in Chelmsford, MA, USA, consists of regionally based account executives and sales engineers that target carriers, service providers and cable MSOs. Regional sales offices are located in Southampton, England, Singapore and Beijing, China.
 
EXFO Service Assurance sells its solutions mainly through direct channels in the Americas (US, Canada, Central and Latin America) and around the world. In the EMEA and Asia/Pac regions, its sales teams work with resellers that have a strong local presence.
 
The main office for our Life Sciences and Industrial Division is located in Toronto, Canada. We use mixed sales channels to serve various markets supported by this division, depending on product line and geography. Optical light sources and related accessories used for industrial applications are sold in North America through a network of more than 10 manufacturer representatives and, internationally, through a network of more than 20 distributors. UV light sources for digital print applications are sold directly to customers globally. The X-Cite 120 and Exacte Fluorescence Illumination Systems are sold through value-added reseller agreements with major microscope companies and system integrators in North America and Europe. Positioning products are sold directly to customers in North America, which includes the United States and Canada, and internationally through a network of technical distributors. To gain additional access to the positioning life science research market in the United States and Canada, business relationships are in place with major microscope manufacturers, which include Nikon, Olympus and Zeiss. These companies often combine the sale of their microscopes with our product.
 
Product Management, Marketing/Communications and Global Services
 
Product Management
 
Our telecom test and measurement Product Management Group consists of one Vice-President responsible for our Optical, Transport & Datacom, Copper Access, and IMS/VoIP product lines – as well as directors and product managers who have various degrees in engineering, science and business administration. Directors and product managers, under the direction of the Vice-President, are responsible for all aspects of our telecom marketing program including product strategy, new product introductions, definition of new features and functions, pricing, product launches and advertising campaigns. We follow up our marketing initiatives by attending industry trade shows. Furthermore, we have a customer relationship management (CRM) system to compile market and customer information including forecasts, opportunities, leads and competitive data. We use this information to make strategic business decisions. Finally, strategic marketing specialists analyze our markets of interests, compile competitive information and identify macro-trends in our sector.
 
Our Service Assurance activities fall under the management of a separate Vice-President/General Manager, who is supported by a Director and Product Managers responsible for product strategy, new product introductions, definition of new features and functions, pricing, product launches and advertising campaigns.
 

 
 
Our Life Sciences and Industrial Group consists of a Director – responsible for both life sciences and precision assembly sectors – as well as product managers who have various degrees in engineering, science and business administration. Product managers, under the direction of the Director, are responsible for all aspects of their business line marketing programs including product strategy, new product introductions, definition of new features and functions, pricing, product launches and advertising campaigns.
 
The Telecom Division product management group and the Life Sciences and Industrial Division product management group include 59 and 11 employees, respectively.
 
Marketing/Communications
 
The Telecom Division’s Marketing-Communications team, which mainly consists of project managers, marketing writers, translators and graphic artists, supports our Product Management Group by producing marketing and corporate documentation. Literature includes specification sheets, application notes, product catalogues, advertising copy and an electronic corporate newsletter. This Marketing-Communications team is also responsible for all sales tools required by our worldwide sales force and for updating the marketing contents of our website. This team falls under the responsibility of the Vice-President, Telecom Product Management and Marketing.
 
The Life Sciences & Industrial Division’s Marketing-Communications team shares a variety of marketing initiatives.  This group is assisted by product managers, who provide the technical data and collaborative support required to produce product specification sheets, catalogues, application notes and multimedia marketing tools. This Marketing-Communications team is responsible for all advertising material, Website updates, events planning (including trade shows) and direct promotional marketing such as mass mailings and telemarketing.  This team also provides the sales tools required by the Life Sciences and Industrial Division’s worldwide sales channels, including maintaining our elite partner program. This team falls under the responsibility of the Director of Marketing for the Life Sciences and Industrial Division.
 
Global Services
 
EXFO’s Global Services operation, which falls under the responsibility of a Director, provides customers with a broad array of support and services worldwide. This team has direct staff in North America, Europe, and Asia. It also provides local support in other regions through select partners. Such a strategy enables EXFO to have a global reach while maintaining strong local ties.
 
This team’s objective is to directly contribute to the customer’s success and to achieve EXFO’s long-term mission by providing internal and customer-facing services.  Specifically, it fulfills its mission by offering:
 
·  
Customer Relationship Management (CRM) Administration – Business Ownership of EXFO’s CRM toolset and evolution.
 
·  
Sales Support – Leverage the effectiveness of its sales force by providing pre-sales and demo support, as well as guiding customers in purchasing the correct equipment for their respective applications, issuing quotations, and promoting the Flexcare extended warranty service and support program.
 
·  
Order Management – Accurately process customer orders from entry through fulfillment and delivery.
 
·  
Customer Service – Serve as a primary interface for inbound and outbound customer communication. Provide customers with one central point of contact and work with the customer from purchasing equipment to helping them arrange for service, if necessary.
 
·  
Product Support – Provide expert technical support and deliver product service worldwide. Directly manage EXFO’s Worldwide Service Centers. Where applicable, furnish installation and on-site servicing for more complex equipment and applications.
 

 
 
·  
Systems Services – Provide pre-sale, delivery, post-sale technical support, and system actualization of EXFO’s test and service assurance systems.
 
·  
Education Services – Aggregate expertise, develop material, and deliver free and fee-based training.
 
 
·  
Professional Services – Provide value-added solution services for EXFO’s test and system customers.
 
Manufacturing
 
Our telecom manufacturing operations consist mainly of material planning, procurement, sub-assembly, final assembly and test, software loading, calibration, quality control, shipping, billing and customs management. As at November 2, 2009, we had 314 employees involved in our telecom manufacturing operations. Most of our telecom manufacturing activities, which occupy a total of approximately 115,000 square feet, are spread among four buildings: two in Quebec City, Canada, one in Shenzhen, China, and one in Chelmsford, MA, USA.
 
These manufacturing operations include the following responsibilities:
 
·  
Production.  From production planning to product shipment, our production department is responsible for manufacturing high-quality products on time. Factories are organized in work cells; each cell consists of specialized technicians and equipment and has full responsibility over a product family. Technicians are cross-trained and versatile enough, so that they can carry out specific functions in more than one cell. This allows shorter lead times by alleviating bottlenecks.
 
·  
Product 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, and the quality control and regulatory compliance process. Quality control represents a key element in our manufacturing operations. Quality is assured through product testing at numerous stages in the manufacturing process to ensure that our products meet stringent industry requirements and our customers’ performance requirements.
 
·  
Supply-Chain Management.  This department is responsible for sales forecasting, raw material procurement, material-cost reduction and vendor performance management. Our products consist of optical, electronic and mechanical parts, which are purchased from suppliers around the world. Approximately one-third of our parts are manufactured to our specifications. Materials represent the biggest portion of our cost of goods. Our performance is tightly linked to vendor performance, requiring greater emphasis on this critical aspect of our business.
 
Our Life Sciences and Industrial Division’s manufacturing operations occupy 8,000 square feet in Toronto, Canada and 23 employees were involved in manufacturing operations as at November 2, 2009 . This group manufactures light sources and related accessories, fluorescence illumination systems and precise positioning equipment for the life sciences and high-precision assembly markets. Operations consist of manufacturing, procurement, warehousing, quality control and document control managed by various elements of the ISO 9001 certified quality system. Recognizing the importance of reduced time-to-market for our solutions, we have focused efforts on designing products with an emphasis on standardization, modularity, as well as ease of fabrication and assembly. Following are key manufacturing responsibilities in Toronto, Canada:
 
 

 
 
 
Manufacturing Engineering and Quality Assurance> – is responsible for product integrity throughout the manufacturing cycle. From the release of new products, through our new product introduction process, and configuration management to manage engineering change, we ensure consistent manufacturing processes throughout the product life cycle. In conjunction with the above process, quality is maintained by performing quality tests at incoming receiving and final product verification. The responsibility for product quality is shared by all team members throughout the company and does not reside solely with the quality group.
 
Competition
 
The telecommunications test, measurement and monitoring industry is highly competitive and subject to rapid change as a result of technological developments and market conditions. 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:
 
·  
product performance and reliability;
·  
price;
·  
level of technological innovation;
·  
product lead times;
·  
breadth of product offerings;
·  
ease of use;
·  
brand-name recognition;
·  
customer service and technical support;
·  
strength of sales and distribution relationships; and
·  
financial stability.
 
Competitors in test and measurement include global suppliers like Agilent Technologies Inc., Anritsu Corporation, JDS Uniphase Corporation, Spirent Communications plc and Yokogawa Electric Corporation. Other players like AFL Telecommunications LLC, AnaCise Testnology Corporation, BlueLight Technology Inc., DADI Telecommunication Equipment CO., Ltd, Digital Lightwave Inc., Electrodata, Inc., Empirix, Inc., Fluke Corporation and Tektronix, Inc. (which both are operating divisions within Danaher Corporation), Shanghai Grandway Telecom Tech. co., Ltd, Greenlee Textron, Inc., Ineoquest Technologies, Inc., IXIA, Kingfisher International Pty Ltd, Nethawk Oyj, Shenick Network Systems Limited, Shunra Software Ltd, Sunrise Telecom Incorporated and VeEX Inc. compete against us in niche test and measurement markets. On the service assurance side, we compete against Agilent Technologies Inc., Anritsu Corporation, JDS Uniphase Corporation, Tektronix, Inc. (which is an operating division within Danaher Corporation), Empirix, Inc., Ineoquest Technologies, Inc., InfoVista S.A., IXIA, Nexus Telecom AG, RADCOM Ltd., Spirent Communications plc, TTI Telecom International Ltd. and Whitbe. Some network equipment manufacturers also sell their in-house service assurance systems.
 
Competition for our life sciences and industrial solutions is quite varied, depending upon product line. OmniCure‘s competitors, which sell light-based curing products, include Dymax Corporation, Henkel Corporation in North America and Europe, as well as Hamamatsu, Photonics K.K., Ushio Inc. and Panasonic Corporation in Asia. Excelerate, a new brand and product line, competes globally with products from well established companies such as Dr. Honle, Nordson and Integration Technologies. With regard to our X-Cite 120 Fluorescence Illumination System, main competitors consist of microscope manufacturers who have developed lamp housings for low-wattage mercury burners in-house. Finally, our motion-control instruments, which are designed for various life science applications, compete against products from companies like Sutter Instruments and Narishige.
 
 
 
 
 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 (FCC), the Food and Drug Administration (FDA) and the Occupational Safety and Health Administration (OSHA). Under the FCC’s regulations, our products must comply with certain electro magnetic compatibility (EMC) requirements to insure they do not generate and are immune from electrical noise which could possibly cause undesirable operation, as well as affect other surrounding devices. 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 non-medical 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 non-iodizing radiation. Similarly, our products must comply with safety standards adopted by OSHA. Furthermore, for our Life Science and Industrial Division, certain U.S. states require mandatory product registration and reporting of Mercury-added products being imported. This registration is controlled by the Interstate Mercury Education and Reduction Clearinghouse (IMERC).
 
Similar regulations apply in other countries. For example, in Canada our products must comply with the applicable standards adopted by the Standards Council of Canada (SCC). These include product safety standards developed by the Canadian Standards association as well as EMC requirements adopted by Industry Canada. Countries in the European Union require product compliance as dictated by an applicable directive, often referred to as CE marking. This includes testing to ensure compliance with harmonized European Norm (EN) standards for both product safety and EMC requirements.
 
In Europe, with the implementation of the WEEE directives for recycling of electronic products in selected European Countries (2002-96-CE), we have appointed a task force committee consisting of our management and employees, distributors and other partners as the case may be, to ensure full compliance with regulations and oversee the management, logistics, recycling rate, disposal services and activities related to recycling of electronic equipment and products within the member states.
 
Additionally, to address the issue of environmental compliance, the European Union has mandated the Restriction of the Use of Certain Hazardous Substances or "RoHS" Directive, which applies to all products included within the scope of WEEE directive with the exception of Categories 8 (Medical devices) and 9 (Monitoring and control instruments). Mandatory product compliance includes the ban of certain substances within specified concentrations, unless formally exempted by the directive. To ensure compliance to this directive, a formal restricted substances control (RSC) program was implemented for our products included within the scope of WEEE. This program ensures the design, procurement and manufacturing of affected products prevents the inclusion of the banned substances as specified by the RoHS directive.
 
Other significant types of regulations not described in this annual report also may apply, depending upon the relevant product and country of destination.
 
 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 international 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.
 

 
 
As of August 31, 2009, we held 46 actively maintained granted patents from the U.S. (including one “design” patent), ten from Canada, four from China, five from Germany (including one “Utility Model”), four from the United Kingdom, four from France, as well as a patent in each of four other European countries. In addition, we have in process 20 US patent applications, seven Canadian patent applications, two European applications, one application in China, and one direct national entry in Germany (not via the European application), and as well as five applications under the Patent Cooperation Treaty, which have not yet entered the national phase. The expiration dates of our issued patents range from December 2011 to January 2027.
 
We consider eight of our inventions for which patents have either been granted or are pending to be material. These inventions are:
 
·  
a method and apparatus for measuring a polarization-related parameter of an optical fiber path, such as the differential group delay, the overall polarization mode dispersion, or the cumulative polarization mode dispersion. This invention underlies our FTB-5600 Polarization OTDR and our FTB-5700 Single-ended Dispersion Analyzer products, and may serve as the basis for a number of other potential products;
 
·  
a method and apparatus for characterizing optical power levels in three-wavelength, bidirectional fiber-to-the-home systems. This invention describes how the optical power can be measured at the two-downstream and one upstream wavelengths used to connect a residence or business customer, while maintaining the signal continuity necessary to keep the home-based Optical Network Terminal operating.  This invention underlies the two-port version of our PPM-350B PON Power Meter;
 
·  
an optical spectrum analyzer using optical fibers as input and output “slits”.  This invention forms the basis of our FTB-5240, FTB-5240B and IQ-5250 products;
 
·  
a light-curing system with closed-loop control and work-piece recording which is at the heart of the spot-curing systems manufactured by EXFO Photonic Solutions;
 
·  
a special optical design used in some of the X-Cite adaptors to prevent structure in the beam from reducing the uniformity of illumination at the microscope objective plane, which is a key patent for our X-Cite fluorescent illumination system;
 
·  
a method and apparatus to determine the theoretical and practical data rates for a cable under test. This invention forms the basis of the EXFO CableSHARK product, describing how two test devices, communicating with each other via the cable under test, can predict the performance of a pair of ADSL (Asymmetric Digital Subscriber Line) modems, and in case of problems, analyze the cause of the modems failing to synchronize;
 
·  
a method and system for hardware time stamping packetized data to provide sub-microsecond accuracy in test measurements, which is embedded in the Brix100M, Brix1000, and Brix2500 Series Verifiers.
 
·  
a method for actively analyzing a data packet delivery path to provide diagnostics and root cause analysis of network delivery path issues, which is embedded in BrixCall, BrixNGN, and BrixVision applications of EXFO Service Assurance.
 
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.
 

 
 
Organizational Structure
 
As of November 2, 2009, the following chart presents our corporate structure, the jurisdiction of incorporation of our subsidiaries and the percentage of shares (which is also the percentage of voting power) that we hold in those subsidiaries.

 


 
 
Property, Plant and Equipment
 
Our head offices and facilities are located in Quebec City, Province of Quebec, Canada where we occupy two buildings. These buildings house our executive and administrative offices, research and development facilities and production facilities. We also have facilities in Montreal, Province of Quebec, Canada (formerly EXFO Protocol), in Concord, Ontario, Canada (formerly Consultronics Limited), in Mississauga, Ontario, Canada (EXFO Photonic Solutions Inc.), in Chelmsford, Massachusetts, United States (EXFO Service Assurance Inc.), in Eastleigh, Hampshire, United Kingdom (EXFO Europe Limited), in Shenzhen, China (EXFO Telecom Equipment (Shenzhen) Co. Ltd.), in Pune, India (EXFO Electro-Optical Engineering India Private Ltd.) and in Gothenburg, Sweden (EXFO Sweden Aktiebolag). EXFO Burleigh Products Group Inc.’s facilities located in Victor, New York, were sold on August 31, 2006.
 
In addition, we maintain sales offices and/or have regional sales managers located in China, Czech Republic, France, Germany, Great Britain, Mexico, Singapore, Spain, United Arab Emirates and the United States.
 
During our 2009 fiscal year, two relocation activities were completed. In September 2008, our Navtel operations were relocated within our Concord, Ontario, facility. The lease of the vacant building was terminated as per the original lease agreement in March 2009. In July 2009, our Shenzhen manufacturing operations were relocated in a brand new and improved facility supporting both the short- and long-term growth plans.
 
The following table sets forth information with respect to the main facilities that we occupy as of November 2, 2009.
 
Location
Use of Space
Square Footage
Type of Interest
436 Nolin Street
Quebec (Quebec)
G1M 1E7
 
Partially occupied for manufacturing of telecom products
   44,164 (1)
Owned
400 Godin Avenue
Quebec (Quebec)
G1M 2K2
 
Fully occupied for research and development, manufacturing, management and administration
 128,800 (2)
Owned
2260 Argentia Road
Mississauga (Ontario)
L5N 6H7
 
Partially occupied for research and development, manufacturing of life science and industrial products, management and administration
 
   25,328 (3)
Leased
2650 Marie-Curie
St-Laurent (Quebec)
H4S 2C3
 
Fully occupied for research and development, management  and administration
 
   26,000
Leased
160 Drumlin Circle
Concord (Ontario)
L4K 3E5
 
Partially occupied for research and development, product management and administration
 
   23,500 (4)
Owned
285 Mill Road
Chelmsford, MA 01824
United States
 
Partially occupied for research and development, manufacturing, management and administration
   23,052 (5)
Leased
Omega Enterprise Park
Electron Way, Chandlers Ford,
Eastleigh, Hampshire S053 4SE
United Kingdom
 
Fully occupied for European customer service, sales management and administration
   10,000
Leased
 
 
 
 
Location
Use of Space
Square Footage
Type of Interest
3rd Floor, Building 10,
Yu Sheng Industrial Park
(Gu Shu Crossing)
No. 467, National Highway 107
Xixiang, Bao An District
Shenzhen 518126
China
 
Partially occupied for manufacturing of telecom products
   56,000 (6)
Leased
113/1, Lane 4A
Koregaon Park
Pune 411001
India
 
Fully occupied for research and development
     5,986
Leased
Office No 701, Building 1
The Cerebrum IT Park
Wadgaon Sheri, Pune 411014
India
 
Fully occupied for research and development
   16,840
Leased
Arvid Hedvalls Backe 4
SE-411 33 Gothenburg
Sweden
Fully occupied for research and development
    538
Leased

(1)  
Approximately 5% of these premises are not occupied.
(2)  
Including the warehouse space. Premises without the warehouse are approximately 115,000 square feet.
(3)  
9,792 square feet have been subleased to a third party. The total square footage leased is 36,000.
(4)  
Approximately 1/3 of these premises are not occupied.
(5)  
7,950 square feet have been subleased to a third party. The total square footage leased is 31,002.
(6)  
Approximately 60% of this premise is occupied.


Unresolved Staff Comments
 
Not applicable.
 

 
 
Operating and Financial Review and Prospects
 
This discussion and analysis contains forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995, and we intend that such forward-looking statements be subject to the safe harbors created thereby. Forward-looking statements are statements other than historical information or statements of current condition. Words such as may, will, expect, believe, anticipate, intend, could, estimate, continue, or the negative or comparable terminology are intended to identify forward-looking statements. In addition, any statements that refer to expectations, projections or other characterizations of future events and circumstances are considered forward-looking statements. They are not guarantees of future performance and involve risks and uncertainties. Actual results may differ materially from those in forward-looking statements due to various factors including the effect of the worldwide recession and the timing of the expected recovery on the telecom market for our customers and suppliers; fluctuating exchange rates and our ability to execute in these uncertain conditions; consolidation in the global telecommunications test, measurement and service assurance industry; capital spending levels in the telecommunications, life sciences and high-precision assembly sectors; concentration of sales; the effects of the additional actions we have taken in response to such economic uncertainty (including our ability to quickly adapt cost structures with anticipated levels of business, ability to manage inventory levels with market demand); market acceptance of our new products and other upcoming products; limited visibility with regards to customer orders and the timing of such orders; our ability to successfully integrate our acquired and to-be-acquired businesses; our ability to successfully expand international operations; the retention of key technical and management personnel; and future economic, competitive, financial and market condition. Assumptions relating to the foregoing involve judgments and risks, all of which are difficult or impossible to predict and many of which are beyond our control. Other risk factors that may affect our future performance and operations are detailed in this Annual Report, on Form 20-F, including in Item 3D – Risk Factors, and our other filings with the U.S. Securities and Exchange Commission and the Canadian securities commissions. We believe that the expectations reflected in the forward-looking statements are reasonable based on information currently available to us, but we cannot assure you that the expectations will prove to have been correct. Accordingly, you should not place undue reliance on these forward-looking statements. These statements speak only as of the date of this document. Unless required by law or applicable regulations, we undertake no obligation to revise or update any of them to reflect events or circumstances that occur after the date of this document.
 
The following discussion and analysis of the consolidated financial condition and results of operations of EXFO Electro-Optical Engineering Inc. for the fiscal years ended August 31, 2007, 2008 and 2009, should be read in conjunction with our consolidated financial statements and the related notes included elsewhere in this Annual Report. Our consolidated financial statements have been prepared in accordance with generally accepted accounting principles in Canada, or Canadian GAAP. Significant differences in measurement and disclosure from generally accepted accounting principles in the United States, or U.S. GAAP, are set out in note 20 to our consolidated financial statements. Our measurement currency is the Canadian dollar although we report our financial statements in US dollars.
 
The following discussion and analysis of the consolidated financial condition and results of operations is dated November 6, 2009.
 
All dollar amounts are expressed in US dollars, except as otherwise noted.
 
 
INDUSTRY OVERVIEW
 
The fundamental drivers for increased bandwidth and Internet protocol (IP) fixed-mobile convergence in the global telecommunications industry remain intact, but they were constrained by an economic recession that forced network operators and network equipment manufacturers to reduce their capital and operating expenses in calendar 2009. Several of these players announced significant reductions in capital expenditures and staffing levels during the course of the year. Most industry analysts are forecasting, even in the event of general overall economic conditions, only a moderate improvement rather than a prompt return to previous revenue levels.
 

 
 
Despite this challenging macro-economic environment, it should be noted that telecom market dynamics in 2009 are completely different from those during the industry downturn of 2001. First, there is a myriad of bandwidth-intensive applications generating strong growth in bandwidth demand, both in wireless and wireline networks. For example, monthly traffic is at the exabyte level (1 exabyte equals 1 quintillion bytes) in 2009, while in 2001 there were few applications outside of regular e-mail delivery. Second, the ongoing demand for bandwidth has placed a strain on access links, metro rings and long-haul routes, whereas in 2001 there was an overabundance of bandwidth capacity in optical backbone networks, which drove bandwidth prices down significantly. Finally, most network operators have healthy balance sheets today, while in 2001 many of them were financially overextended with some declaring bankruptcy.
 
According to Cisco’s Visual Networking Index, global IP traffic will nearly double every two years (compound annual growth rate of 46%) from 2007-2012, reaching just under 44 exabytes per month in 2012. Global bandwidth demand is driven by a wide range of applications including peer-to-peer file sharing, social networking, Internet gaming as well as various forms of IP video. For example, YouTube consumed more bandwidth in 2008 than traffic crossing the entire U.S. network backbone in 2000.
 
As telecommunication networks are being transformed to deliver IP-based voice, video and data capabilities, legacy SONET/SDH standards, which were first established in the mid-1980s and implemented until 2005, do not have the payload flexibility to seamlessly mix and transport these services. Such networks are not capable of efficiently carrying IP-based services, since they were designed for public switched telephone network (PSTN), point-to-point voice transmission only. As a result, new optical transport network (OTN) standards have been defined to carry IP applications over Ethernet and are at the very foundation of what the industry is labeling next-generation networks. Network operators are increasingly turning to such next-generation, IP-based networks to allow for more flexible and efficient transport of applications and services, and to offer customers higher-margin triple-play services ― and even quadruple-play services ― as wireline and wireless technologies become increasingly interconnected. Finally, as subscribers of these new services reach a critical mass, network operators are relying on service assurance solutions to ensure that the quality of service (QoS) and quality of experience (QoE) are optimal in the post-deployment phase.
 
As well, it is now clear that fiber-to-the-home (FTTH) is becoming the access network architecture of choice for network operators wishing to provide a superior user experience for a combined video, data and voice offering. This architecture allows them to meet heightened bandwidth requirements and future-proof their access networks, as residential bandwidth demands are growing from the 1 to 5 Mbit/s (megabits per second) of the past to 30 to 100 Mbit/s required for the long term. Some projects, however, may be delayed due to reduced funding. Hybrid architectures, combining copper and fiber (fiber-to-the-curb, or FTTC, and fiber-to-the-node, or FTTN), will also expand in the short term, since they are less expensive methods to increase bandwidth and can be mass-deployed more quickly.
 
FTTH investment decisions are applicable not only to green-field deployments and high-rise buildings, but also to larger-scale rollouts as long-term operating costs are less than FTTC and FTTN. FTTH deployment costs have largely dropped over the years as increased volume and improved test tools, like those we offer, are rendering rollouts increasingly simple and efficient. FTTH is also proving to be a low-cost alternative for multidwelling units (MDUs) as this network architecture can deliver large amounts of bandwidth at a minimal cost per apartment. We are merely at the early stages of fiber deployments in access networks, both in North America and around the world. It is also worth noting that Western Europe and even China have become increasingly committed to deploying FTTH networks, given their high-population density.
 
As bandwidth growth in access networks continues to increase, it has begun placing a strain on metro rings and core networks. It is also driving the need for higher-speed technologies. For example, 43 Gbit/s (gigabits per second) SONET/SDH is now becoming mainstream, while a few network operators are expected to begin 100 Gbit/s Ethernet field trials later in this calendar year. In the long run, these solutions will offer a more economical way to add capacity on saturated network sections, especially if trenches need to be dug in order to deploy new fiber in metro and long-distance routes.
 

 
 
These market dynamics affected telecom test and service assurance suppliers in fiscal 2009. However, the tail end of the economic recession in the United States and Western Europe could potentially continue to delay network investments and necessarily reduce demand for our test and service assurance solutions.
 
 
COMPANY OVERVIEW
 
EXFO is a leading provider of test and service assurance solutions for network operators and network equipment manufacturers in the global telecommunications industry. The Telecom Division, which represents nearly 90% of our business, offers a wide range of innovative test and service assurance solutions to assess next-generation and traditional telecom networks. The Life Sciences and Industrial Division offers solutions in medical-device and opto-electronics assembly, fluorescence microscopy and other life sciences sectors.
 
We were founded in 1985 in Quebec City, Canada. Our original products were focused on the needs of installers and operators of fiber-optic networks. Customers use these field-portable testing products for the installation, maintenance, monitoring and troubleshooting of optical networks. In 1996, we supplemented our product portfolio with an extensive line of high-end products that are mainly dedicated to research and development as well as manufacturing activities of optical component manufacturers and system vendors.
 
Over the past several years, we have enhanced our competitive position through acquisitions of protocol, copper/xDSL and service assurance test businesses.
 
In February 2009, we closed the acquisition of Sweden-based PicoSolve Inc., a supplier of ultra-high-speed optical sampling oscilloscopes for 40G and 100G R&D, manufacturing and deployment applications.
 
In April 2008, we acquired all issued and outstanding shares of Brix Networks Inc. (renamed EXFO Service Assurance Inc.), for a cash consideration of $32.1 million. Brix Networks, a privately held company located in the Boston, MA area, offers VoIP and IPTV service assurance solutions across the three areas most affecting the success of a real-time service: signaling quality (signaling path performance), delivery quality (media transport performance) and content quality (overall quality of experience). Brix Networks’ service assurance solutions are mainly designed for network service providers (NSPs) and large enterprises.
 
In March 2008, we acquired all issued and outstanding shares of Navtel Communications Inc., for a cash consideration of $11.3 million. Navtel Communications, a privately held company in Toronto, Canada, is a leading provider of Internet protocol multimedia subsystem (IMS) and VoIP test solutions for network equipment manufacturers (NEMs) and NSP labs. Navtel Communications specializes in testing next-generation IP networks that are increasingly combining wireline and wireless technologies. Subsequent to the acquisition, Navtel Communications was merged into the parent company.
 
In fiscal 2008, we opened our own telecom manufacturing facilities in Shenzhen, China. We now have two main manufacturing sites for our Telecom Division and one plant for our Life Sciences Division. Over time, low-volume, high-complexity telecom products will be manufactured in Quebec City, whereas high-volume, low-complexity telecom products will be manufactured in Shenzhen.
 
In fiscal 2008 and 2009, we accelerated the deployment of a software development center in Pune, India, to supplement the research and development capabilities of our labs in Boston, Toronto, Montreal and Quebec City. This enables us to benefit from the wealth of IP expertise in India, to accelerate product developmentespecially for our software-intensive protocol test and service assurance solutionsto take advantage of a lower cost structure.
 
In January 2006, we acquired substantially all the assets of Consultronics Limited (now merged with the parent company), a leading supplier of test equipment for copper-based broadband access networks, for a total cash consideration of $19.1 million. Above and beyond copper/xDSL test solutions, Consultronics had a rich product portfolio for testing next-generation technologies, such as IPTV and VoIP, which are critical for NSPs in their deployment of triple-play services (voice, data, video) over optical and copper links in access networks.
 

 
 
In November 2001, we acquired Avantas Networks Corporation (renamed EXFO Protocol Inc. and now merged with the parent company), a supplier of protocol-testing and optical-network performance management equipment for NSPs. This transaction enabled us to combine optical and protocol test modules inside a single field-portable test platform in order to help our customers increase revenues and reduce operating costs. In October 2002, our wholly-owned subsidiary, EXFO Gnubi, purchased substantially all the assets of gnubi communications, L.P., a supplier of multichannel telecom and datacom testing solutions for the system manufacturer market. EXFO Protocol and EXFO Gnubi were consolidated in Montreal, Canada, in fiscal 2004.
 
Previously, we had completed two acquisitions to bolster growth in the optical component manufacturing market. We acquired Burleigh Instruments, Inc. (renamed EXFO Burleigh Products Group Inc.) in December 2000 for its wavelength measurement instruments and nanopositioning alignment systems. We also added EFOS Inc. (renamed EXFO Photonic Solutions Inc.) in March 2001 for its precision light-based, adhesive spot-curing technology. We have since exited the optical component manufacturing automation business, and the remaining operations of EXFO Burleigh have mostly been consolidated with those of EXFO Photonic Solutions in Toronto, Canada.
 
We launched 26 new products in fiscal 2009, including three in the fourth quarter, compared to 27 in fiscal 2008. Key product introductions in fiscal 2009 included among others a portable test solution for characterizing 100 Gbit/s Ethernet and 40/43 Gbit/s SONET/OTN networks; a patent-pending distributed PMD analyzer that allows network operators to cost-effectively upgrade their networks to 40G and 100G by measuring the level of potentially debilitating PMD on each fiber section; new software releases for the IMS InterWatch platform and Packet Blazer product lines that support the migration of voice and video applications to the IPv6 (Internet protocol, version 6) addressing scheme; 1 Gbit/s and 10 Gbit/s test probes for carrier Ethernet and mobile backhaul service assurance applications; and the next-generation FTB-500 multilayer platform for high-end test applications in the field and central office. Following the year-end, we released the first turnkey optical modulation analyzer for complete characterization of signals up to 100 Gbaud. Sales from products on the market two years or less accounted for 38.4% of total sales in fiscal 2009.
 
Overall for fiscal 2009, sales decreased 5.9% to $172.9 million from $183.8 million in 2008. This decrease in sales mainly resulted from the global economic recession as well as from currency fluctuations on our sales and the impact of such fluctuations on our forward exchange contracts since the beginning of the fiscal year. However, global sales for fiscal 2009 included $25.3 million from Brix Networks and Navtel Communications, compared to $5.4 million in fiscal 2008, which mitigated in part the decrease in sales year-over-year. These two acquisitions were closed approximately two months and one month into the third quarter of fiscal 2008, respectively. Excluding the positive impact of these two acquisitions, our sales would have decreased 17.3% in fiscal 2009 compared to 2008, reflecting the impact of the global economic recession and the negative effects of the currency fluctuations on our sales and the impact of such fluctuations on our forward exchange contracts in fiscal 2009, compared to 2008.
 
We reported a GAAP net loss of $16.6 million, or $0.27 per share, in fiscal 2009, compared to net earnings of $18.4 million, or $0.27 per diluted share, in fiscal 2008. Net loss for fiscal 2009 included a non-cash pre-tax impairment of goodwill of $21.7 million. GAAP net loss for fiscal 2009 also included pre-tax charges of $1.2 million in severance expenses for the 65 employees who were terminated throughout the company. However, GAAP net loss included a pre-tax R&D tax credits recovery of $1.9 million and $372,000 for the recognition of previously unrecognized future income tax assets. Finally, GAAP net loss for fiscal 2009 included $4.3 million in after-tax amortization of intangible assets and $1.4 million in stock-based compensation costs. Net earnings for fiscal 2008 included $5.3 million for the recognition of previously unrecognized future income tax assets, $2.7 million for income tax recovery following the review of our tax strategy related to the changes in substantively enacted income tax rates in Canada, $1.5 million of income tax expense to account for the changes in substantively enacted income tax rates on our future income tax assets in Canada, an extraordinary gain of $3.0 million related to the negative goodwill of the Navtel Communications acquisition, as well as $3.0 million in after-tax amortization of intangible assets and $1.3 million in stock-based compensation costs.
 

 
 
EBITDA (net earnings (loss) before interest, income taxes, amortization of property, plant and equipment, amortization of intangible assets, impairment of goodwill and extraordinary gain) were at $14.5 million, or 8.4% of sales in fiscal 2009, compared to $20.6 million, or 11.2% of sales in 2008 (see pages 76 and 77 of this document for a comprehensive reconciliation of EBITDA to GAAP net earnings (loss)). EBITDA for fiscal 2009 included pre-tax charges of $1.2 million in severance expenses for the 65 employees who were terminated throughout the company and stock-based compensation costs of $1.4 million. However, EBITDA included a pre-tax R&D tax credits recovery of $1.9 million.
 
On November 6, 2008, we announced that our Board of Directors had authorized a renewal of our share repurchase program, by way of a normal course issuer bid on the open market, of up to 10% of our public float (as defined by the Toronto Stock Exchange), or 2.7 million subordinate voting shares, at the prevailing market price. We have used and expect to continue to use cash, short-term investments or future cash flows from operations to fund the repurchase of shares. The period of the normal course issuer bid started on November 10, 2008, and will end on November 9, 2009. All shares repurchased under the bid are cancelled. In fiscal 2009, we repurchased 488,786 subordinate voting shares for an aggregate net purchase price of $1.4 million.
 
On November 10, 2008, we announced that our Board of Directors had authorized a substantial issuer bid (the “Offer”) to purchase for cancellation subordinate voting shares for an aggregate purchase price not to exceed CA$30 million. On December 18, 2008, pursuant to the Offer, we purchased for cancellation 7.7 million subordinate voting shares for the aggregate purchase price of CA$30 million (US$24.9 million), plus related fees of $576,000. We used cash and short-term investments to fund the purchase of shares.
 
On November 6, 2009, we announced that our Board of Directors had authorized the second renewal of our share repurchase program, by way of a normal course issuer bid on the open market, of up to 10% of our public float (as defined by the Toronto Stock Exchange), or 2.3 million subordinate voting shares, at the prevailing market price. We expect to use cash, short-term investments or future cash flows from operations to fund the repurchase of shares. The period of the normal course issuer bid will start on November 10, 2009, and end on November 9, 2010, or on an earlier date if we repurchase the maximum number of shares permitted under the bid. The program does not require that we repurchase any specific number of shares, and it may be modified, suspended or terminated at any time and without prior notice. All shares repurchased under the bid will be cancelled.
 
In the third quarter of fiscal 2009, we performed our annual impairment test for goodwill for all reporting units. Recoverability of goodwill is determined at the reporting unit level, using a two-step approach. First, the carrying value of the reporting units is compared to their fair value. If the carrying value of a reporting unit exceeds its fair value, the second step is performed to determine the amount of the impairment loss. Following the decrease in our stock price in June 2009, we came to the conclusion that the carrying value of one of our reporting units exceeded its fair value and we recorded an impairment charge of $21.7 million in the third quarter of fiscal 2009, to bring the goodwill of this reporting unit to its fair value. This reporting unit reports to the Telecom Division.
 
In June 2009, we laid off 65 employees across the organization as part of a restructuring plan to cope with currently difficult market conditions. This action resulted in a one-time pre-tax restructuring charge of $1.2 million that was recorded in the fourth quarter of fiscal 2009, but is expected to deliver about $6 million in annual savings.
 
During the third quarter of fiscal 2009, we were named recipient of the Growth Strategy Leadership Award by Frost & Sullivan for the fifth consecutive time. The award is presented to the company whose growth strategy generates the largest market-share gains in the global fiber-optic test equipment (FOTE) market during the previous research period. According to Frost & Sullivan, a leading global growth consulting firm, we captured first place overall in the FOTE market with a market share of 18.0% in 2008, up from a third-place 12.7% in 2006 (Frost & Sullivan did not grant an award in 2008 for market-share gains in 2007). Frost & Sullivan estimated the FOTE market to be $567.4 million in 2008, including $247.9 million for the portable installation and maintenance (I&M) test market. Based on Frost & Sullivan’s market data, we improved our leadership position in the portable I&M test market from 25.5% in 2006 to 33.3% in 2008.
 

 
 
Sales
 
We sell our products to a diversified customer base in approximately 95 countries through our direct sales force and channel partners like sales representatives and distributors. Most of our sales are denominated in US dollars and euros.
 
In fiscal 2007 and 2009, our top customer accounted for 14.7% and 11.6% of global sales, respectively. In fiscal 2008, no customer accounted for more than 10% of our global sales, with our top customer representing 7.4% of our global sales. The significant sales concentration with this Tier-1 carrier in fiscal 2007 was largely due to our leadership position in the FTTx test market and the fact that we benefited from aggressive FTTH rollouts from this customer. This sales concentration significantly decreased in fiscal 2008. However, in fiscal 2009, sales to this customer were positively impacted by significant orders for newly acquired Brix service assurance products. Sales levels with this customer may fluctuate year-over-year, based on available budgets, the allocation of such budgets and the timing and scope of projects, especially those related to our service assurance business.
 
We believe that we have a vast array of products, a diversified customer base, and a good spread across geographical areas, which provides us with reasonable protection against the concentration of sales and credit risk.
 
Cost of Sales
 
The cost of sales includes raw materials, salaries and related expenses for direct and indirect manufacturing personnel (net of government grants), as well as overhead costs. Excess, obsolete and scrapped materials are also included in the cost of sales. However, the cost of sales is exclusive of amortization, which is shown separately in the statements of earnings.
 
Operating Expenses
 
We classify our operating expenses into three main categories: selling and administrative expenses, research and development expenses, and amortization expenses.
 
Selling and administrative expenses consist primarily of salaries and related expenses for personnel, sales commissions, travel expenses, marketing programs, professional services, information systems, human resources and other corporate expenses.
 
Gross research and development expenses consist primarily of salaries and related expenses for engineers and other technical personnel, material component costs as well as fees paid to third-party consultants. We are eligible to receive research and development tax credits and government grants on research and development activities carried out in Canada. All related research and development tax credits and government grants are recorded as a reduction of gross research and development expenses.
 
 
OUR STRATEGY, KEY PERFORMANCE INDICATORS AND CAPABILITY TO DELIVER RESULTS
 
Three-Year Strategic Objectives
 
Our goal is to become a strong market leader in the global telecom test and service assurance industry, mostly with network service providers (NSPs). We are committed to offering the most advanced market-driven solutions that help NSPs efficiently install, commission and run their converged IP fixed-mobile networks. Given the myriad of video applications and resultant explosion in bandwidth demand, we are increasingly covering the service and application layers on a network infrastructure to enable quadruple-play services.
 
To achieve our long-term vision, we plan to expand our leadership position in the portable optical segment, while growing our protocol business even faster to surpass optical sales. This plan is largely based on profitable organic growth and will be supported by strategic acquisitions of typically small to mid-size companies with best-of-class technologies in nascent, high-growth markets complementary to EXFO’s. We also intend to improve our competitive position through strategic alliances and partnerships.
 

 
 
In our fiscal 2008 Annual Report, we established three corporate performance objectives to gauge the success of our overall plan over the next three years:
 
o  
Increase sales significantly faster than the industry growth rate (20% CAGR*)
o  
Grow EBITDA** in dollars faster than sales (>20% CAGR)
o  
Continue raising gross margin (62%)
 
*
Compound annual growth rate
**
EBITDA is defined as net earnings (loss) before interest, income taxes, amortization of property, plant and equipment, amortization of intangible assets, impairment of goodwill and extraordinary gain (see pages 77 and 78 of this document for a comprehensive reconciliation of EBITDA to GAAP net earnings (loss)).
 
Given the global economic recession in fiscal 2009, we have adjusted our corporate performance metrics over a new three-year period extending from fiscal 2010 to 2012. We have maintained our 20% sales CAGR objective, proposed to double EBITDA in dollars, and raised our gross margin target to 64% for the newly defined three-year period.
 
 
Corporate Performance Objectives for FY 2010-2012
 
 
Increase sales by a CAGR of 20% or more
 
 
Raise gross margin to 64%
 
 
Double EBITDA in dollars
 
 
We expect these three-year objectives to guide our actions in upcoming years as we are committed to maximizing shareholder value, although there can be no assurance that we will be successful in meeting these objectives.
 
Results Achieved in Fiscal 2009
 
In fiscal 2009, sales and EBITDA decreased 5.9% and 29.7%, respectively, compared to 2008. Most of these come from the negative effect of the global economic recession in fiscal 2009 as well as from currency fluctuations since the beginning of the fiscal year. However, gross margin improved to 61.3% in fiscal 2009 from 58.9% in 2008 despite difficult market conditions and currency fluctuations, due to the contribution of newly acquired Brix Networks and Navtel Communications. See further in this discussion and analysis for a comprehensive analysis of our sales and gross margin.
 
 
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
 
Management’s discussion and analysis of financial conditions and results of operations is based on our consolidated financial statements included elsewhere in this Annual Report. As previously mentioned, they have been prepared in accordance with Canadian GAAP. The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting years. On an ongoing basis, we evaluate these estimates and assumptions, including those related to the fair value of financial instruments,  the allowance for doubtful accounts receivable, the amount of tax credits recoverable, the provision for excess and obsolete inventories, the useful lives of capital assets, the valuation of long-lived assets, the impairment of goodwill, the valuation allowance of future income tax assets, the amount of certain accrued liabilities and deferred revenue as well as stock-based compensation costs. We base our estimates and assumptions on historical experience and on other factors that we believe to be reasonable under the circumstances, the result of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from these estimates.
 
The following summarizes our critical accounting policies as well as other policies that require the most significant judgment and estimates in the preparation of our consolidated financial statements.
 

 
 
Revenue recognition. For products in which software is incidental, we recognize revenue when persuasive evidence of an arrangement exists, the product has been delivered, the price is fixed or determinable, and collection of the resulting receivable is reasonably assured. Provisions are made for estimated returns, warranties and support obligations.
 
For products in which software is not incidental, revenues are separated into two categories: product and post-contract customer support (PCS) revenues, based upon vendor-specific objective evidence of fair value. Product revenues for these sales are recognized as described above. PCS revenues are deferred and recognized ratably over the years of the support arrangement. PCS revenues are recognized at the time the product is delivered when provided substantially within one year of delivery, the costs of providing this support are insignificant (and accrued at the time of delivery) and no (or infrequent) software upgrades or enhancements are provided.
 
Maintenance contracts generally include the right to unspecified upgrades and enhancements on a when-and-if available basis and ongoing customer support. Revenue from these contracts is recognized ratably over the terms of the maintenance contracts on a straight-line basis.
 
Revenue for extended warranties is recognized on a straight-line basis over the warranty period.
 
For all sales, we use a binding purchase order as evidence that a sales arrangement exists.
 
Delivery generally occurs when the product is handed over to a transporter for shipment.
 
At the time of the transaction, we assess whether the price associated with our revenue transaction is fixed or determinable, and whether or not collection is reasonably assured. We assess whether the price is fixed or determinable based on the payment terms associated with the transaction. We assess collection based on a number of factors, including past transaction history and the creditworthiness of the customer. Generally, collateral or other security is not requested from customers.
 
Most sales arrangements do not generally include acceptance clauses. However, when a sales arrangement does include an acceptance provision, acceptance occurs upon the earliest of the receipt of a written customer acceptance or the expiration of the acceptance period. For these sales arrangements, the sale is recognized when acceptance occurs.
 
Allowance for doubtful accounts. We estimate collectibility of accounts receivable on an ongoing basis by reviewing balances outstanding over a certain period of time. We determine our allowance for doubtful accounts receivable based on our historical accounts receivable collection experience and on the information that we have about the status of our accounts receivable balances. If the financial conditions of our customers deteriorate, resulting in an impairment of their ability to make required payments, additional allowance may be required, which could adversely affect our future results.
 
Reserve for excess and obsolete inventories. We state our inventories at the lower of cost, determined on an average cost basis, and net realizable value, and we provide reserves for excess and obsolete inventories. We determine our reserves for excess and obsolete inventories based on the quantities we have on hand versus expected needs for these inventories, so as to support future sales of our products. It is possible that additional inventory reserves may occur if future sales are less than our forecasts or if there is a significant shift in product mix compared to our forecasts, which could adversely affect our future results.
 
Research and development tax credits and government grants. We record research and development tax credits and government grants based on our interpretation of tax laws and grant programs, especially regarding related eligible projects and expenses, and when there is reasonable assurance that we have complied and will continue to comply with all conditions and laws. Also, our judgment and estimates are based on historical experience. It is possible, however, that the tax authorities or the sponsors of the grant programs have a different interpretation of laws and application of conditions related to the programs or that we do not comply with all conditions related to grants in the future, which could adversely affect our future results. Furthermore, a significant part of our research and development tax credits are refundable against income taxes payable, causing their ultimate realization to be dependent upon the generation of taxable income. If we obtain information that causes our forecast of future taxable income to change or if actual taxable income differs from our forecast, we may have to revise the carrying value of these tax credits, which would affect our results in the period in which the change was made.
 

 
 
Impairment of long-lived assets and goodwill. Long-lived assets are reviewed for impairment when events or circumstances indicate that cost may not be recoverable. Impairment exists when the carrying amount of an asset, or a group of assets is greater than the undiscounted future cash flows expected to be provided by the asset or the group of assets. The amount of impairment loss, if any, is the excess of the carrying value over the fair value. We assess fair value of long-lived assets based on discounted future cash flows.
 
We assess impairment of goodwill on an annual basis, or more frequently, if events or circumstances indicate that it might be impaired. Recoverability of goodwill is determined at the reporting unit level, using a two-step approach. First, the carrying value of a reporting unit is compared to its fair value, which is usually determined based on a combination of discounted future cash flows and a market approach. If the carrying value of a reporting unit exceeds its fair value, the second step is performed. In this step, the amount of impairment loss, if any, represents the excess of the carrying value of goodwill over its fair value, and the loss is charged to earnings in the period in which it is incurred. For the purposes of this impairment test, the fair value of goodwill is estimated in the same way as goodwill is determined in business combinations; that is, the excess of the fair value of a reporting unit over the fair value of its net identifiable assets.
 
Future income taxes. We provide 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 as well as the carry forward of unused tax losses and deductions, using substantively enacted income tax rates expected for the years in which the assets are expected to be realized or the liabilities to be settled. In assessing the recoverability of our future income tax assets, we consider whether it is more likely than not that some or all of the future income tax assets will not be realized. The ultimate realization of our future income tax assets is dependent upon the generation of sufficient future taxable income during the periods in which those assets are expected to be realized.
 
Stock-based compensation costs. We account for all forms of employee stock-based compensation using the fair value-based method. This method requires that we make estimates about the expected volatility of our shares, the expected life of the awards and the forfeiture rate.
 
Adopted in fiscal 2009
 
In December 2006, the Canadian Institute of Chartered Accountants (CICA) issued three new sections, which provide a complete set of disclosure and presentation requirements for financial instruments: Section 3862, “Financial Instruments − Disclosures”; Section 3863, “Financial Instruments − Presentation”; and Section 1535, “Capital Disclosures”.
 
Section 3862 replaces the disclosure portion of Section 3861, “Financial Instruments − Disclosure and Presentation”. The new standard places increased emphasis on disclosures regarding risks associated with both recognized and unrecognized financial instruments and how these risks are managed. It is also intended to remove any duplicate disclosures and simplify the disclosures about concentrations of risk, credit risk, liquidity risk and price risk previously found in Section 3861.
 
Section 3863 carries forward the presentation requirements from Section 3861, unchanged.
 
Section 1535 applies to all entities, regardless of whether they have financial instruments or are subject to external capital requirements. The new section requires disclosure of information about an entity’s objectives, policies and processes for managing capital, as well as quantitative data about capital and whether the entity has complied with any capital requirements.
 
We adopted these new standards on September 1, 2008 and provided the required disclosure in our consolidated financial statements.
 

 
 
In June 2007, the CICA issued Section 3031, “Inventories”. This standard requires the measurement of inventories at the lower of cost and net realizable value and includes guidance on the determination of cost, including allocation of overheads and other costs to inventory. The standard also requires the consistent use of either first-in, first-out (FIFO) or weighted average cost formula to measure the cost of inventories and requires the reversal of previous write-downs to net realizable value when there is a subsequent increase in the value of inventories. The new standard applies to fiscal years beginning on or after January 1, 2008. We adopted this new standard on September 1, 2008, and its adoption had no material measurement effect on our consolidated financial statements. The additional disclosure is provided in our consolidated financial statements.
 
In June 2007, the CICA amended Section 1400, “General Standards of Financial Statement Presentation”, to include new requirements regarding an entity’s ability to continue as a going concern. These amendments apply to fiscal years beginning on or after January 1, 2008. We adopted these amendments on September 1, 2008, and their adoption had no material effect on our consolidated financial statements.
 
In January 2009, the CICA issued Emerging Issues Committee 173 (EIC-173), “Credit Risk and the Fair Value of Financial Assets and Financial Liabilities”. This abstract clarifies that an entity’s own credit risk and the credit risk of its counterparty should be taken into account in determining the fair value of financial assets and liabilities. We adopted this standard on January 20, 2009, and its adoption had no material effect on our consolidated financial statements.
 
To be adopted after fiscal 2009
 
In February 2008, the CICA issued Section 3064, “Goodwill and Intangible Assets”, which supersedes Section 3062, “Goodwill and Other Intangible Assets”, and Section 3450, “Research and Development Costs”. Various changes have been made to other sections of the CICA Handbook for consistency purposes. Section 3064 establishes standards for the recognition, measurement, presentation and disclosure of goodwill subsequent to its initial recognition and of intangible assets by profit-oriented enterprises. Standards concerning goodwill remain unchanged from the standards included in Section 3062. This new section applies to fiscal years beginning on or after October 1, 2008. We will adopt this new standard on September 1, 2009, and have not yet determined the effects its adoption will have on our consolidated financial statements.
 
In January 2009, the CICA issued Section 1582, “Business Combinations”, which replaces Section 1581, “Business Combinations”. This new section establishes the standards for the accounting of business combinations and states that all assets and liabilities of an acquired business will be recorded at fair value. Obligations for contingent considerations and contingencies will also be recorded at fair value at the acquisition date. The standard also states that acquisition-related costs will be expensed as incurred and that restructuring charges will be expensed in the periods after the acquisition date. This standard applies prospectively to business combinations with acquisition dates on or after January 1, 2011; earlier adoption is permitted.
 
In January 2009, the CICA issued Section 1601, “Consolidated Financial Statements”, which replaces Section 1600, “Consolidated Financial Statements”, and establishes the standards for preparing consolidated financial statements. This new section applies to fiscal years beginning on or after January 1, 2011; earlier adoption is permitted. We have not yet determined the impact that adopting this standard will have on our consolidated financial statements.
 
In January 2009, the CICA issued Section 1602, “Non-controlling Interests”, which establishes standards for the accounting of non-controlling interests of a subsidiary in the preparation of consolidated financial statements subsequent to a business combination. This new section applies to fiscal years beginning on or after January 1, 2011; earlier adoption is permitted as of the beginning of a fiscal year.
 
Should we decide to adopt one of these three new sections earlier, we must adopt all three on the same date.
 

 
 
In June 2009, the CICA amended section 3862, "Financial Instruments − Disclosures", to include enhanced disclosures on liquidity risk of financial instruments and new disclosures on fair value measurements of financial instruments. The amendments apply to fiscal years ending after September 30, 2009, with early adoption permitted. We will adopt these amendments on September 1, 2010, and have not yet determined the effects their adoption will have on our consolidated financial statements.
 
In February 2008, the Canadian Accounting Standards Board announced that the use of International Financial Reporting Standards (IFRS) established by the International Accounting Standard Board (IASB) will be required for fiscal years beginning January 1, 2011, for publicly accountable profit-oriented enterprises. Accordingly, we will adopt these new standards during our fiscal year beginning on September 1, 2011. The IASB has also stated that during the transition period, companies will be required to provide comparative data for the previous year established under IFRS. IFRS issued by the IASB require the submission of additional information in the financial statements and, although the conceptual framework of IFRS is similar to Canadian GAAP, companies must take into account differences in accounting principles. We are currently evaluating the impact of adopting these new standards on our consolidated financial statements. In fact, we have completed the diagnostic phase to assess and scope the significant differences between existing Canadian GAAP and IFRS and the impact on our consolidated financial statements. Following the diagnostic phase, we have begun a detailed analysis of the accounting policies impacted by the adoption of IFRS, which is expected to be completed throughout fiscal 2010. Some transitional options permitted under IFRS are currently under analysis. A summary analysis indicates that in most cases, we would opt for a prospective application when the choice is available. The changeover to IFRS may result in changes to our accounting and internal control systems.
 

 
 
RESULTS OF OPERATIONS
 
The following table sets forth certain Canadian GAAP consolidated financial statements data in thousands of US dollars, except per-share data, and as a percentage of sales for the years indicated:
 
Consolidated statements of earnings data:
 
2009
   
2008
   
2007
   
2009
   
2008
   
2007
 
Sales
  $ 172,878     $ 183,790     $ 152,934       100.0 %     100.0 %     100.0 %<