EXFO Inc.
EXFO INC. (Form: 6-K, Received: 01/14/2011 11:00:33)



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


FORM 6-K


Report of Foreign Private Issuer Pursuant to Rule 13a-16 or 15d-16
Under the Securities Exchange Act of 1934

For the month of January 2011

EXFO Inc.
(Translation of registrant’s name into English)

400 Godin Avenue, Quebec, Quebec, Canada   G1M 2K2
(Address of principal executive offices)


Indicate by check mark whether the registrant files or will file annual reports under cover of Form 20-F or Form 40-F.


Form 20-F þ
Form 40-F o

Indicate by check mark whether the registrant by furnishing the information contained in this Form is also thereby furnishing the information to the Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of 1934.

Yes o
No þ


If “Yes” is marked, indicate below the file number assigned to the registrant in connection with Rule 12g3-2(b): 82-______.
 
 



 
 

 
 
 
TABLE OF CONTENTS
 
 
Signatures
Press Release
Interim Consolidated Balance Sheet
Interim Unaudited Consolidated Statements of Earnings
Interim Unaudited Consolidated Statements of Comprehensive Income and Accumulated Other Comprehensive Income
Interim Unaudited Consolidated Statements of Retained Earnings and Contributed Surplus
Interim Unaudited Consolidated Statements of Cash Flows
Notes to Unaudited Interim Consolidated Financial Statements
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
 
 
 

 
 
On January 12, 2011, EXFO Inc., a Canadian corporation, reported its results of operations for the first fiscal quarter ended November 30, 2010.  This report on Form 6-K sets forth the news release relating to EXFO’s announcement and certain information relating to EXFO’s financial condition and results of operations for the first fiscal quarter of the 2011 fiscal year.  This press release and information relating to EXFO’s financial condition and results of operations for the first fiscal quarter of the 2011 fiscal year are hereby incorporated as a document by reference to Form F-3 (Registration Statement under the Securities Act of 1933) declared effective as of July 30, 2001 and to Form F-3 (Registration Statement under the Securities Act of 1933) declared effective as of March 11, 2002 and to amend certain material information as set forth in these two Form F-3 documents.


 
Page 1 of 47


SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



 
EXFO INC.
 
 
 
By: /s/ Germain Lamonde
Name:  Germain Lamonde
Title:    President and Chief Executive Officer
   


Date: January 14, 2011
 
 
 
Page 2 of 47


 
 

EXFO Reports Record Sales and Bookings in the First Quarter of Fiscal 2011

§  
Telecom sales increase 62.9%  year-over-year to US$65.7 million
§  
Telecom bookings improve 92.0% year-over-year to US$89.8 million (book-to-bill of 1.37)
§  
Adjusted EBITDA * amounts to US$8.2 million compared to US$4.4 million in Q1 2010

QUEBEC CITY, CANADA, January 12, 2011 — EXFO Inc. (NASDAQ: EXFO; TSX: EXF) reported today record sales and bookings for its first quarter ended November 30, 2010, with total sales and GAAP net earnings above the company’s guidance range.

Total sales, including a one-month revenue contribution from the divested Life Sciences and Industrial Division (referred to as “discontinued operations” in the financial statements), increased 48.5% to US$67.6 million in the first quarter of fiscal 2011 from US$45.6 million in the first quarter of 2010 and 3.7% from US$65.2 million in the fourth quarter of 2010. Management had forecasted total sales between US$61 and US$66 million for the first quarter of 2011.

Telecom sales (referred to as “continuing operations” in the financial statements) increased 62.9% to US$65.7 million in the first quarter of 2011 from US$40.3 million in the first quarter of 2010 and 12.1% from US$58.6 million in the fourth quarter of 2010. NetHawk Oyj, which was acquired in mid-March 2010, contributed US$6.4 million to EXFO’s revenues in the first quarter of 2011. Consequently, organic telecom sales increased 47.0% year-over-year.

Telecom bookings improved 92.0% to US$89.8 million in the first quarter of fiscal 2011 from US$46.8 million in the same period last year and 60.9% from US$55.8 million in the fourth quarter of 2010. The company’s telecom book-to-bill ratio was 1.37 in the first quarter of 2011.

Telecom gross margin reached 62.2% of sales in the first quarter of fiscal 2011 compared to 65.2% in the first quarter of 2010 and 64.8% in the fourth quarter of 2010.

GAAP net earnings in the first quarter of fiscal 2011 totaled US$14.1 million, or US$0.23 per diluted share, above EXFO’s guidance between US$0.17 and US$0.21 per diluted share. In comparison, the company generated US$0.3 million, or US$0.01 per diluted share, in the same period last year and US$5.0 million, or US$0.08 per diluted share, in the fourth quarter of fiscal 2010. It should be noted that EXFO recorded an after-tax gain of US$13.1 million, or US$0.21 per diluted share, from the disposal of discontinued operations (Life Sciences and Industrial Division) in the first quarter of 2011. GAAP net earnings in the first quarter of 2011 also included US$2.6 million in amortization of intangible assets and US$0.7 million in stock-based compensation costs. The former item resulted in an income tax recovery of US$0.2 million. As well, the company reported a foreign exchange loss of US$1.1 million in the first quarter of 2011.

“I am really pleased with our overall performance in the first quarter of 2011 as we posted our fifth consecutive quarter of sales growth and delivered unprecedented telecom bookings of nearly $90 million for a book-to-bill ratio of 1.37,” said Germain Lamonde, EXFO’s Chairman, President and CEO. “We generated strong sales and bookings growth year-over-year across all our telecom business segments and sales regions, while enjoying expanded traction in the fast-growing wireless market. These outstanding results demonstrate our superior market positioning, continued market-share gains across most businesses and some year-end money from network operators.”

“As wireline and wireless operators are escalating investments in broadband deployments and IP convergence in order to increase network performance and lower operating expenses, EXFO is benefiting from ongoing VDSL2 and FTTH rollouts in access networks, upgrades from 10G to 40G and 100G in metro rings and long-haul routes and, on the wireless side, migration from 2G to 3G and 4G/LTE networks,” Mr. Lamonde added.  “As a result, I expect EXFO will continue delivering superior revenue growth, while remaining true to its commitment of increasing EBITDA even faster over a three-year horizon from 2010-2012.”
 
 
 
Page 3 of 47

 

 
 
Selected Financial Information
(In thousands of US dollars)

      Q1 2011       Q4 2010       Q1 2010  
Sales:
                       
Continuing operations (formerly the Telecom Division)
  $ 65,653     $ 58,583     $ 40,292  
Discontinued operations (formerly the Life Sciences & Industrial Division
    1,991       6,653       5,268  
Total
  $ 67,644     $ 65,236     $ 45,560  
                         
Gross margin:
                       
Continuing operations
  $ 40,868     $ 37,954     $ 26,259  
      62.2 %     64.8 %     65.2 %
Discontinued operations
  $ 989     $ 3,488     $ 2,863  
      49.7 %     52.4 %     54.3 %
Total
  $ 41,857     $ 41,442     $ 29,122  
      61.9 %     63.5 %     63.9 %
                         
Other selected information:
                       
GAAP net earnings
  $ 14,071     $ 4,962     $ 334  
Amortization of intangible assets
  $ 2,570     $ 2,493     $ 1,469  
Stock-based compensation costs
  $ 738     $ 473     $ 418  
Net income tax effect of the above items
  $ (192 )   $ (184 )   $ (471 )
After-tax gain on the disposal of discontinued operations
  $ (13,071 )   $     $  

Operating Expenses
Telecom selling and administrative expenses totaled US$19.9 million, or 30.3% of sales, in the first quarter of fiscal 2011 compared to US$13.8 million, or 34.3% of sales, in the same period last year and US$18.9 million, or 32.3% of sales, in the fourth quarter of 2010.

Telecom gross research and development expenses amounted to US$13.7 million, or 20.9% of sales, in the first quarter of fiscal 2011 compared to US$9.2 million, or 22.7% of sales, in the first quarter of 2010 and US$12.4 million, or 21.1% of sales, in the fourth quarter of 2010.

Telecom net R&D expenses totaled US$11.6 million, or 17.7% of sales, in the first quarter of fiscal 2011 compared to US$7.8 million, or 19.3% of sales, in the same period last year and US$10.5 million, or 17.9% of sales, in the fourth quarter of 2010.

First-Quarter Business Highlights — Broadband Deployments and IP Fixed-Mobile Network Convergence
§  
EXFO generated record telecom orders of US$89.8 million, reflecting strong bookings in all three businesses (Optical, Protocol and Copper Access) and sales regions (Americas, EMEA and Asia-Pacific).
§  
Two Tier-1 network operators placed follow-on orders totaling more than US$8 million for EXFO’s AXS-200/635 Triple-Play Tester in the first quarter of 2011. EXFO’s test solution will support their ongoing deployment of next-generation VDSL2 services over hybrid network access architectures.
§  
A Tier-1 US wireless operator selected EXFO’s service assurance solution for monitoring Ethernet backhaul networks. The initial contract in excess of US$1 million could reach several millions of dollars.
§  
EXFO’s wireless and 40G/100G wireline test solutions gained significant traction with customers.
§  
EXFO significantly strengthened its “FTB Ecosystem” of modular test platforms, now based on a common Windows operating system, by releasing the second generation of its highly successful FTB-200 platform, launching the entry-level FTB-1 handheld platform with related OTDR and Ethernet test modules, adding ODU0 and ODUflex test capabilities to its industry-leading 10G and 40G test solutions,   and introducing the ConnectorMax Pass/Fail Connector Endface Assessment software option.
§  
Altogether, EXFO launched seven new products in the first quarter of 2011.
 
 
 
Page 4 of 47

 
 

 
 
Profitable Growth Path
EXFO generated adjusted EBITDA * of US$8.2 million, or 12.1% of sales, in the first quarter of fiscal 2011 on total revenue of US$67.9 million. It should be noted the company recorded a pre-tax foreign exchange loss of US$1.1 million in the first quarter of 2011. Foreign exchange losses or gains are included in EBITDA. See the section below entitled “Non-GAAP Financial Measures” for a reconciliation of EBITDA and adjusted EBITDA with GAAP net earnings.

Divestiture
EXFO sold its Life Sciences and Industrial Division in the first quarter of 2011, realizing a gain of US$13.2 million, to become a pure-play supplier in the telecom industry.

Business Outlook
EXFO forecasts sales between US$70.0 million and US$75.0 million for the second quarter of fiscal 2011, while GAAP net earnings are expected to range between US$0.03 and US$0.07 per diluted share. GAAP net earnings include US$0.04 per share in after-tax amortization of intangible assets and stock-based compensation costs. The company also anticipates a pre-tax, foreign exchange loss of US$0.03 per share following the significant increase in the value of the Canadian dollar since November 30, 2010.

This guidance was established by management based on existing backlog as of the date of this press release, seasonality, expected bookings for the remaining of the quarter, as well as exchange rates as of the day of this press release.
 
Conference Call and Webcast
EXFO will host a conference call today at 5 p.m. (Eastern time) to review its financial results for the first quarter of fiscal 2011. To listen to the conference call and participate in the question period via telephone, dial 1-416-981-9009.   Germain Lamonde, Chairman, President and CEO, and Pierre Plamondon, CA, Vice-President of Finance and Chief Financial Officer, will participate in the call. An audio replay of the conference call will be available one hour after the event until 7 p.m. on January 19, 2011. The replay number is 1-402-977-9141 and the reservation number is 21494191. The audio Webcast and replay of the conference call will also be available on EXFO’s Website at  www.EXFO.com , under the Investors section.

About EXFO
Listed on the NASDAQ and TSX stock exchanges, EXFO is among the leading providers of next-generation test and service assurance solutions for wireless and wireline network operators and equipment manufacturers in the global telecommunications industry. The company offers innovative solutions for the development, installation, management and maintenance of converged, IP fixed and mobile networks — from the core to the edge. Key technologies supported include 3G, 4G/LTE, IMS, Ethernet, OTN, FTTx, and various optical technologies (accounting for an estimated 35% of the portable fiber-optic test market). EXFO has a staff of approximately 1600 people in 25 countries, supporting more than 2000 telecom customers worldwide. For more information, visit www.EXFO.com .

EXFO Brand Name
The corporate name of the company is EXFO Inc. The company requests that all media outlets and publications use the corporate name (“EXFO Inc.”) or abbreviated name (“EXFO”) in capital letters for branding purposes. EXFO would like to thank all parties in advance for their cooperation.


 
Page 5 of 47

 

 
 
Forward-Looking Statements
This press release contains forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995, and we intend that such forward-looking statements be subject to the safe harbors created thereby. Forward-looking statements are statements other than historical information or statements of current condition. 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 our ability to successfully integrate our acquired and to-be-acquired businesses; fluctuating exchange rates; consolidation in the global telecommunications test, measurement and service assurance industry and increased competition among vendors; capital spending levels in the telecommunications industry; concentration of sales; the effects of the additional actions we have taken in response to 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 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 our Annual Report, on Form 20-F, and our other filings with the U.S. Securities and Exchange Commission and 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 press release. 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.

Non-GAAP Financial Measures
EXFO provides non-GAAP financial measures (EBITDA * and adjusted EBITDA * ) as supplemental information regarding its operational performance. The company uses these measures for the purposes of evaluating its historical and prospective financial performance, as well as its performance relative to competitors. These measures also help the company to plan and forecast for future periods as well as to make operational and strategic decisions. EXFO believes that providing this information to investors, in addition to GAAP measures, allows them to see the company’s results through the eyes of management, and to better understand its historical and future financial performance.

The presentation of this additional information is not prepared in accordance with GAAP. Therefore, the information may not necessarily be comparable to that of other companies and should be considered as a supplement to, not a substitute for, the corresponding measures calculated in accordance with GAAP.

*
EBITDA is defined as net earnings before interest, income taxes, amortization of property, plant and equipment, amortization of intangible assets. Adjusted EBITDA represents EBITDA excluding the gain from the disposal of discontinued operations.


 
Page 6 of 47

 
 

 
 
The following table summarizes the reconciliation of EBITDA and adjusted EBITDA to GAAP net earnings in thousands of US dollars:

EBITDA and adjusted EBITDA (including discontinued operations)

   
Three months
ended
November 30,
2010
   
Three months
ended
August 31,
2010
   
Three months
ended
November 30,
2009
 
                   
GAAP net earnings for the period
  $ 14,071     $ 4,962     $ 334  
                         
Add (deduct):
                       
                         
Amortization of property, plant and equipment
                       
Continuing operations
    1,674       1,623       1,258  
Discontinued operations
    14       42       33  
Amortization of intangible assets
                       
Continuing operations
    2,566       2,478       1,460  
Discontinued operations
    4       15       9  
 
Interest expense
                       
Continuing operations
    64       116       42  
 
Income taxes
                       
Continuing operations
    2,806       1,939       1,122  
Discontinued operations
    201       291       121  
                         
EBITDA for the period
    21,400       11,466       4,379  
Gain on disposal of discontinued operations
    (13,212 )            
                         
Adjusted EBITDA for the period
  $ 8,188     $ 11,466     $ 4,379  
                         
Adjusted EBITDA in percentage of total sales
    12.1 %     17.6 %     9.6 %

 
For more information
Vance Oliver
Manager, Investor Relations
(418) 683-0913, Ext. 3733
[email protected]
 
 
 
Page 7 of 47


 
EXFO INC.
Unaudited Interim Consolidated Balance Sheet
 
(in thousands of US dollars)

 
   
As at
November 30,
2010
   
As at
August 31,
2010
 
Assets
           
             
Current assets
           
Cash
  $ 23,438     $ 21,440  
Short-term investments
    27,186       10,379  
Accounts receivable (note 5)
               
Trade
    55,384       50,190  
Other
    7,190       5,217  
Income taxes and tax credits recoverable
    3,307       2,604  
Inventories (note 6)
    43,311       40,328  
Prepaid expenses
    3,229       2,816  
Future income taxes
    5,687       6,191  
Current assets held for sale (note 3)
          3,991  
      168,732       143,156  
                 
Tax credits recoverable
    31,549       29,397  
Forward exchange contracts (note 5)
    415        
Property, plant and equipment
    23,707       23,455  
Intangible assets
    26,303       27,947  
Goodwill
    29,690       29,355  
Future income taxes
    12,669       12,884  
Long-term assets held for sale (note 3)
          7,308  
                 
    $ 293,065     $ 273,502  
Liabilities
               
                 
Current liabilities
               
Accounts payable and accrued liabilities (note 7)
  $ 31,195     $ 30,870  
Income taxes payable
    1,066       426  
Current portion of long-term debt (note 8)
    584       568  
Deferred revenue
    8,431       10,354  
Current liabilities related to assets held for sale (note 3)
          2,531  
      41,276       44,749  
                 
Deferred revenue
    5,779       5,775  
Long-term debt (note 8)
    1,460       1,419  
Other liabilities
    760       603  
Future income taxes
    1,258        
Long-term liabilities related to assets held for sale (note 3)
          537  
                 
      50,533       53,083  
Contingency (note 9)
               
                 
Shareholders’ equity
               
Share capital (note 10)
    107,048       106,126  
Contributed surplus
    18,427       18,563  
Retained earnings
    64,599       50,528  
Accumulated other comprehensive income
    52,458       45,202  
                 
      242,532       220,419  
                 
    $ 293,065     $ 273,502  
 
 
The accompanying notes are an integral part of these consolidated financial statements.
Page 8 of 47


 
EXFO INC.
Unaudited Interim Consolidated Statements of Earnings
 
(in thousands of US dollars, except share and per share data)

 
   
Three months ended
November 30,
 
             
   
2010
   
2009
 
             
Sales
  $ 65,653     $ 40,292  
                 
Cost of sales (1,2)
    24,785       14,033  
Gross margin
    40,868       26,259  
                 
Operating expenses
               
Selling and administrative (1)
    19,899       13,804  
Net research and development (1) (note 11)
    11,601       7,781  
Amortization of property, plant and equipment
    1,674       1,258  
Amortization of intangible assets
    2,566       1,460  
Total operating expenses
    35,740       24,303  
Earnings from operations
    5,128       1,956  
                 
Interest expense
    (64 )     (42 )
Foreign exchange loss
    (1,113 )     (1,022 )
Earnings before income taxes
    3,951       892  
                 
Income taxes (note 12)
               
Current
    1,013       87  
Future
    1,793       1,035  
      2,806       1,122  
                 
Net earnings (loss) from continuing operations
    1,145       (230 )
                 
Net earnings from discontinued operations (note 3)
    12,926       564  
                 
Net earnings for the period
  $ 14,071     $ 334  
                 
Basic and diluted net earnings (loss) from continuing operations per share
  $ 0.02     $ (0.00 )
Basic net earnings from discontinued operations per share
  $ 0.22     $ 0.01  
Diluted net earnings from discontinued operations per share
  $ 0.21     $ 0.01  
Basic net earnings per share
  $ 0.24     $ 0.01  
Diluted net earnings per share
  $ 0.23     $ 0.01  
                 
Basic weighted average number of shares outstanding (000’s)
    59,665       59,386  
                 
Diluted weighted average number of shares outstanding (000’s) (note 13)
    61,106       60,122  
                 
(1)    Stock-based compensation costs included in:
               
Cost of sales
  $ 48     $ 39  
Selling and administrative
    322       244  
Net research and development
    104       101  
Net earnings from discontinued operations
    264       34  
    $ 738     $ 418  

(2)    The cost of sales is exclusive of amortization, shown separately.
 
 
The accompanying notes are an integral part of these consolidated financial statements.
Page 9 of 47

 
 
EXFO INC.
Unaudited Interim Consolidated Statements of Comprehensive Income
and Accumulated Other Comprehensive Income
 
(in thousands of US dollars)

 
Comprehensive income
           
   
Three months ended
November 30,
 
             
   
2010
   
2009
 
             
Net earnings for the period
  $ 14,071     $ 334  
Foreign currency translation adjustment
    6,339       7,813  
Unrealized gains on forward exchange contracts
    1,444       1,164  
Reclassification of realized (gains) losses on forward exchange contracts in net earnings
    (189 )     77  
Future income taxes effect of the above items
    (338 )     (385 )
                 
Comprehensive income
  $ 21,327     $ 9,003  



Accumulated other comprehensive income
           
   
Three months ended
November 30,
 
             
   
2010
   
2009
 
             
Foreign currency translation adjustment
           
Cumulative effect of prior periods
  $ 44,186     $ 40,458  
Current period
    6,339       7,813  
                 
      50,525       48,271  
                 
Unrealized gains on forward exchange contracts
               
Cumulative effect of prior periods
    1,018       1,076  
Current period, net of realized gains and future income taxes
    917       856  
                 
      1,935       1,932  
Unrealized losses on short-term investments
               
Cumulative effect of prior periods
    (2 )     (2 )
                 
Accumulated other comprehensive income
  $ 52,458     $ 50,201  

Total retained earnings and accumulated other comprehensive income amounted to $94,444 and $117,057 as at November 30, 2009 and 2010, respectively.
 
 
The accompanying notes are an integral part of these consolidated financial statements.
Page 10 of 47


 
EXFO INC.
Unaudited Interim Consolidated Statements of Retained Earnings
and Contributed Surplus
 
(in thousands of US dollars)
 
 
Retained earnings
     
   
Three months ended
November 30,
 
             
   
2010
   
2009
 
             
Balance – Beginning of the period
  $ 50,528     $ 43,909  
                 
Add
               
Net earnings for the period
    14,071       334  
                 
Balance – End of the period
  $ 64,599     $ 44,243  



Contributed surplus
           
   
Three months ended
November 30,
 
             
   
2010
   
2009
 
             
Balance – Beginning of the period
  $ 18,563     $ 17,758  
                 
Add (deduct)
               
Stock-based compensation costs
    725       413  
Reclassification of stock-based compensation costs to share capital upon exercise of stock awards
    (861 )     (86 )
Discount on redemption of share capital
          3  
                 
Balance – End of the period
  $ 18,427     $ 18,088  
 
 
The accompanying notes are an integral part of these consolidated financial statements.
Page 11 of 47


 
EXFO INC.
Unaudited Interim Consolidated Statements of Cash Flows
 
(in thousands of US dollars)

 
   
Three months ended
November 30,
 
             
   
2010
   
2009
 
             
Cash flows from operating activities
           
Net earnings for the period
  $ 14,071     $ 334  
Add (deduct) items not affecting cash
               
Change in discount on short-term investments
    (18 )     2  
Stock-based compensation costs
    738       418  
Amortization
    4,258       2,760  
Gain on disposal of discontinued operations (note 3)
    (13,212 )      
Deferred revenue
    (2,571 )     (542 )
Future income taxes
    1,967       1,156  
Change in unrealized foreign exchange gain/loss
    537       770  
                 
      5,770       4,898  
                 
Change in non-cash operating items
               
Accounts receivable
    (4,480 )     (4,102 )
Income taxes and tax credits
    (1,002 )     (1,505 )
Inventories
    (1,362 )     (2,351 )
Prepaid expenses
    (385 )     (605 )
Accounts payable and accrued liabilities
    (1,224 )     1,030  
Other liabilities
    135        
                 
      (2,548 )     (2,635 )
Cash flows from investing activities
               
Additions to short-term investments
    (226,146 )     (78,954 )
Proceeds from disposal and maturity of short-term investments
    209,605       81,336  
Additions to capital assets
    (1,979 )     (1,345 )
Net proceeds from disposal of discontinued operations (note 3)
    22,124        
Business combination
    (132 )      
                 
      3,472       1,037  
Cash flows from financing activities
               
Exercise of stock options
    61        
Redemption of share capital
          (14 )
                 
      61       (14 )
                 
Effect of foreign exchange rate changes on cash
    344       103  
                 
Change in cash
    1,329       (1,509 )
Cash – Beginning of the period
    22,109       10,611  
Cash – End of the period
  $ 23,438     $ 9,102  
                 
Cash related to:
               
Continuing operations
  $ 23,438     $ 8,347  
Discontinued operations
          755  
    $ 23,438     $ 9,102  

As at November 30, 2009 and 2010, unpaid purchases of capital assets amounted to $147 and $257, respectively.
 
 
The accompanying notes are an integral part of these consolidated financial statements.
Page 12 of 47

 

EXFO INC.
Notes to Unaudited Interim Consolidated Financial Statements
 
(tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)
 
 
  1   Interim Financial Information
 
The financial information as at November 30, 2010, and for the three-month periods ended November 30, 2009 and 2010, is unaudited. In the opinion of management, all adjustments necessary to present fairly the results of these periods in accordance with generally accepted accounting principles (GAAP) in Canada have been included. The adjustments made were of a normal and recurring nature. Interim results may not necessarily be indicative of results anticipated for the entire year.
 
These interim consolidated financial statements are prepared in accordance with generally accepted accounting principles in Canada and use the same accounting policies and methods used in the preparation of the company’s most recent annual consolidated financial statements, except for the changes described in note 2. However, all disclosures required for annual financial statements have not been included in these financial statements. Consequently, these interim consolidated financial statements should be read in conjunction with the company’s most recent annual consolidated financial statements.
 
 
  2   New Accounting Standards and Pronouncements
 
Adopted in fiscal 2011
 
In December, 2009, the Canadian Institute of Chartered Accountants’ (CICA) Emerging Issues Committee (EIC) issued EIC-175, “Multiple Deliverable Revenue Arrangements”, which is applicable prospectively (with retrospective adoption permitted) to revenue arrangements with multiple deliverables entered into or materially modified in the first annual  period beginning on January 1, 2011. EIC-175 amends the guidance contained in EIC-142, “Revenue Arrangements with Multiple Deliverables”, and establishes additional requirements regarding revenue recognition related to multiple deliverables as well as supplementary disclosures. The company adopted this standard on September 1, 2010 at the same time it adopted similar new U.S. GAAP requirements (note 14), and its adoption had no material effect on its consolidated financial statements.
 
Update to the accounting policy on revenue recognition
 
The company’s multiple deliverable revenue arrangements may include tangible products (software and/or non software components), extended warranties, maintenance contracts, post-contract customer support (PCS) on software components as well as installation.
 
Starting September 1, 2010, when a sales arrangement contains multiple elements and software and non software components function together to deliver the tangible products’ essential functionality, the company allocates revenue to each element based on the relative selling price of each element. Under this approach, the selling price of a deliverable is determined by using a selling price hierarchy which requires the use of vendor specific objective evidence (“VSOE”) of fair value if available, third- party evidence (“TPE”) if VSOE is not available, or best estimated selling price (“BESP”) if neither VSOE nor TPE are available.
 
The company establishes VSOE of selling price using the price charged for a deliverable when sold separately and, in some instances, using the price established by management having the relevant authority. TPE of selling price is established by evaluating similar and interchangeable competitor goods or services in sales to similarly situated customers. When VSOE or TPE are not available, the company uses BESP. The company establishes BESP using historical selling price trends if available and considering multiple factors including, but not limited to geographies, market conditions, competitive landscape, internal costs, and pricing practices. When determining BESP, the company’s management applies judgment when establishing pricing strategies and evaluating market conditions and product lifecycles. The determination of BESP is made through consultation with and approval by the company’s management. The company may modify or develop new pricing practices and strategies in the future. As these pricing strategies evolve, the company may modify its pricing practices in the future, which may result in changes in BESP. The aforementioned factors may result in a different allocation of revenue to the deliverables in multiple-element arrangements from the current period, which may change the pattern and timing of revenue recognition for these elements but will not change the total revenue recognized for the arrangement.
 

 
Page 13 of 47

 

EXFO INC.
Notes to Unaudited Interim Consolidated Financial Statements
 
(tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)
 

Maintenance contracts are usually offered to customers for periods of twelve to thirty-six months. They generally include the right to unspecified upgrades and enhancements on a when-and-if available basis and customer service. They qualify as a separate unit of accounting. Revenue from these contracts is recognized ratably over the terms of the maintenance contracts on a straight-line basis. The selling price of the maintenance contracts is determined using VSOE.
 
Extended warranties are usually offered to customers for periods of twelve to forty-eight months. They qualify as a separate unit of accounting. Revenue from these extended warranties is recognized ratably over the warranty period on a straight-line basis. The selling price of the extended warranties is determined using BESP.
 
When a sales arrangement contains multiple elements and software and non software components do not function together to deliver the tangible products’ essential functionality, the company allocates revenue between the tangible products and the PCS, if any, based on VSOE of selling price of each element. 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.
 
To be adopted after fiscal 2011
 
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 consideration 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 September 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. The company has not yet determined the impact that adopting this standard will have on its 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 the company decide to adopt one of these three new sections earlier, it must adopt all three at the same date.
 
 
  3   Discontinued Operations
 
During the fourth quarter of 2010, the company engaged in a plan to sell its Life Sciences and Industrial Division to focus its activities in the telecom test and service assurance market. On October 1, 2010, the company closed the sale of that Division for total proceeds of $21,623,000, net of a bank overdraft of $303,000, selling costs of $909,000 and future income taxes of $141,000. As such, this Division has been considered as an operation held for sale and presented as discontinued operations. Assets and liabilities for the comparative period ended August 31, 2010 have been classified as assets held for sale and liabilities related to assets held for sale; revenues and expenses have been classified as discontinued operations for all reporting periods. As a result of the classification of the operations of the Life Sciences and Industrial Division as operation held for sale and as discontinued operations, the company has only one operating segment for all reporting periods. As at November 30, 2010, selling costs in the amount of $57,000 were unpaid and included in accounts payable and accrued liabilities in the balance sheet.
 

 
Page 14 of 47

 

EXFO INC.
Notes to Unaudited Interim Consolidated Financial Statements
 
(tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)
 

The sale of that Division resulted in a gain on disposal of $13,212,000.
 
The results of the discontinued operations are as follows:
 
   
Three months ended November 30,
 
             
   
2010
   
2009
 
   
 (30 days)
   
(91 days)
 
Sales
  $ 1,991     $ 5,268  
Gross margin
  $ 989     $ 2,863  
Earnings (loss) from operations
  $ (6 )   $ 772  
Gain from disposal of discontinued operations
  $ 13,212     $  
Net earnings from discontinued operations
  $ 12,926     $ 564  
Basic net earnings from discontinued operations per share
  $ 0.22     $ 0.01  
Diluted net earnings from discontinued operations per share
  $ 0.21     $ 0.01  
 
The assets and liabilities of the discontinued operations as at August 31, 2010 are presented as assets held for sale and liabilities related to assets held for sale as follows:
 
Assets
     
       
Current assets
     
Cash
  $ 669  
Accounts receivable
    84  
Income taxes and tax credits recoverable
    188  
Inventories
    2,670  
Prepaid expenses
    158  
Future income taxes
    222  
         
Current assets held for sale
    3,991  
         
Tax credits recoverable
    2,142  
Property, plant and equipment
    349  
Intangible assets
    48  
Goodwill
    4,769  
         
Long-term assets held for sale
    7,308  
         
    $ 11,299  
Liabilities
       
         
Current liabilities related to assets held for sale
  $ 2,531  
         
Long-term liabilities related to assets held for sale
    537  
         
    $ 3,068  
 
 
 
Page 15 of 47

 

EXFO INC.
Notes to Unaudited Interim Consolidated Financial Statements
 
(tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)
 
 
  4   Capital Disclosures
 
The company is not subject to any external restrictions on its capital.
 
The company’s objectives when managing capital are:
 
·  
To maintain a flexible capital structure, which optimizes the cost of capital at acceptable risk;
·  
To sustain future development of the company, including research and development activities, market development and potential acquisitions of complementary businesses or products; and
·  
To provide the company’s shareholders with an appropriate return on their investment.
 
The company defines its capital as shareholders’ equity, excluding accumulated other comprehensive income. Accumulated other comprehensive income’s main components are the cumulative foreign currency translation adjustment, which is the result of the translation of the company’s consolidated financial statements into US dollars (the reporting currency), as well as after-tax unrealized gains (losses) on forward exchange contracts.
 
The capital of the company amounted to $175,217,000 and $190,074,000 as at August 31, 2010 and November 30, 2010, respectively.
 
 
  5   Financial Instruments
 
Financial assets and liabilities are initially recognized at fair value and their subsequent measurement depends on their classification, as described below. Their classification depends on the intended purpose when the financial instruments have been acquired or issued, as well as on their characteristics and their designation by the company.
 
Classification
 
Financial assets
 
        Cash
Held for trading
        Short-term investments
Available for sale
        Accounts receivable
Loans and receivables
        Forward exchange contracts
 
Cash flow hedge
        Financial liabilities
 
 
        Accounts payable and accrued liabilities
Other financial liabilities
        Long-term debt
Other financial liabilities
        Other liabilities
Other financial liabilities
        Forward exchange contracts
Cash flow hedge
 
Held-for-trading, available-for-sale and cash flow hedge financial assets are subsequently measured at fair value. Loans and receivables and other financial liabilities are subsequently measured at amortized cost using the effective interest method.
 
Fair value hierarchy
 
The company’s cash, short-term investments and forward exchange contracts are measured at fair value at each balance sheet date. The company’s short-term investments are classified within level 1 of the fair value hierarchy because they are valued using quoted market prices in active markets. The company’s cash and forward exchange contracts are classified within level 2 of the hierarchy because they are valued using quoted prices and forward foreign exchange rates at the balance sheet date.
 

 
Page 16 of 47

 

EXFO INC.
Notes to Unaudited Interim Consolidated Financial Statements
 
(tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)
 

Market risk
 
Currency risk
 
The principal measurement currency of the company is the Canadian dollar. The company is exposed to a currency risk as a result of its export sales of products manufactured in Canada and China, the majority of which are denominated in US dollars and euros. This risk is partially hedged by forward exchange contracts (US dollars) and certain operating expenses (US dollars and euros). Forward exchange contracts, which are designated as cash flow hedging instruments, qualify for hedge accounting.
 
As at November 30, 2010, the company held contracts to sell US dollars for Canadian dollars at various forward rates, which are summarized as follows:
 
 
 Expiry dates
 
Contractual
amounts
 
Weighted average contractual
forward rates
           
 
 December 2010 to August 2011
 
$                    20,800
 
 1.0923
 
 September 2011 to August 2012
 
          20,400
 
 1.0802
 
 September 2012 to January 2013
 
         1,500
 
 1.0722
  
 Total
 
$                    42,700
 
 1.0858
 
The carrying amount of forward exchange contracts is equal to fair value, which is based on the amount at which they could be settled based on estimated current market rates.The fair value of forward exchange contracts amounted to net gains of $597,000 as at August 31, 2010 and $2,129,000 as at November 30, 2010.
 
Based on the portfolio of forward exchange contracts as at November 30, 2010, the company estimates that the portion of the net unrealized gains on these contracts as of that date, which will be realized and reclassified from accumulated other comprehensive income to net earnings over the next 12 months, amounts to $1,383,000.
 
As at November 30, 2010, forward exchange contracts in the amount of $1,383,000 are presented as current assets in other receivable in the balance sheet and forward exchange contracts, in the amount of $415,000, are presented as long-term assets in forward exchange contracts in the balance sheet. These forward exchange contracts are not yet recorded within sales.
 
During the three months ended November 30, 2009 and 2010, the company recognized within its sales foreign exchange gains on forward exchange contracts of $67,000 and $460,000, respectively.
 

 
Page 17 of 47

 

EXFO INC.
Notes to Unaudited Interim Consolidated Financial Statements
 
(tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)
 

The following table summarizes significant financial assets and liabilities that are subject to currency risk as at November 30, 2009 and 2010:
 
   
As at November 30,
 
   
2010
   
2009
 
   
Carrying/
nominal
amount
(in thousands
of US dollars)
   
Carrying/
nominal
amount
(in thousands
of euros)
   
Carrying/
nominal
amount
(in thousands
of US dollars)
   
Carrying/
nominal
amount
(in thousands
of euros)
 
                         
Financial assets
                       
Cash
  $ 8,266     1,535     $ 5,144     577  
Accounts receivable
    34,173       2,914       20,798       2,980  
      42,439       4,449       25,942       3,557  
Financial liabilities
                               
Accounts payable and accrued liabilities
    10,447       303       7,431       329  
Forward exchange contracts (nominal amount)
    4,900             5,900        
      15,347       303       13,331       329  
Net exposure
  $ 27,092     4,146     $ 12,611     3,228  
 
The value of the Canadian dollar compared to the US dollar was CA$1.0264 = US$1.00 as at November 30, 2010.
 
The value of the Canadian dollar compared to the euro was CA$1.3379 = €1.00 as at November 30, 2010.
 
The following sensitivity analysis summarizes the effect that a change in the value of the Canadian dollar (compared to the US dollar and euro) on financial assets and liabilities denominated in US dollars and euros would have on net earnings, net earnings per diluted share and comprehensive income, based on the foreign exchange rates as at November 30, 2010:
 
·  
An increase (decrease) of 10% in the period-end value of the Canadian dollar compared to the US dollar would decrease (increase) net earnings by $1,210,000 or $0.02 per diluted share and $2,514,000, or $0.04 per diluted share as at November 30, 2009 and 2010, respectively.
 
·  
An increase (decrease) of 10% in the period-end value of the Canadian dollar compared to the euro would decrease (increase) net earnings by $490,000 or $0.01 per diluted share and $542,000, or $0.01 per diluted share as at November 30, 2009 and 2010, respectively.
 
·  
An increase (decrease) of 10% in the period-end value of the Canadian dollar compared to the US dollar would increase (decrease) other comprehensive income by $2,773,000 and $2,721,000 as at November 30, 2009 and 2010, respectively.
 
The impact of the change in the value of the Canadian dollar compared to the US dollar and the euro on these financial assets and liabilities is recorded in the foreign exchange gain or loss line item in the consolidated statements of earnings, except for outstanding forward contracts, which impact is recorded in other comprehensive income. The change in the value of the Canadian dollar compared to the US dollar and the euro also impacts the company’s balances of income tax and tax credits recoverable or payable and future income tax assets and liabilities of its integrated foreign subsidiaries; this may result in additional and significant foreign exchange gain or loss. However, these assets and liabilities are not considered financial instruments and are excluded from the sensitivity analysis above. The foreign exchange rate fluctuations also flow through the statements of earnings line items, as the company has a significant net exposure in Canadian dollars and in euros, and the company reports its results in US dollars; that effect is not reflected in the sensitivity analysis above.
 
 
 
Page 18 of 47

 

EXFO INC.
Notes to Unaudited Interim Consolidated Financial Statements
 
(tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)
 

Interest rate risk
 
The company is exposed to interest rate risks through its short-term investments and its long-term debt.
 
Short-term investments
 
As at November 30, 2010, the company’s short-term investments, in the amount of $27,186,000, bear interest at rates ranging between 1.0% and 1.2% and mature between December 2010 and February 2011.
 
The fair value of short-term investments based on market value amounted to $58,914,000 and $27,186,000 as at November 30, 2009 and 2010, respectively.
 
Due to their short-term maturity of usually three months or less, the company’s short-term investments are not subject to significant fair value interest rate risk. Accordingly, change in fair value has been nominal to the degree that amortized cost has historically approximated the fair value. Any change in fair value of the company’s short-term investments, all of which are classified as available for sale, is recorded in other comprehensive income.
 
Long-term debt
 
As at November 30, 2010, the company’s long-term debt, in the amount of $2,044,000, bears interest at an annual rate of 2.95% and matures in December 2013 (note 8).
 
Other financial instruments
 
Cash, accounts receivable and accounts payable and accrued liabilities are non-interest-bearing financial assets and liabilities. Accounts receivable and accounts payable and accrued liabilities are financial instruments whose carrying value approximates their fair value due to their short-term maturity.
 
Credit risk
 
Financial instruments that potentially subject the company to credit risk consist primarily of cash, short-term investments, accounts receivable and forward exchange contracts (with a positive fair value). As at November 30, 2010, the company’s short-term investments consist of debt instruments issued by nine (nine as at August 31, 2010) high-credit quality corporations and trusts. None of these debt instruments are expected to be affected by a significant liquidity risk. The company’s cash and forward exchange contracts are held with or issued by high-credit quality financial institutions; therefore, the company considers the risk of non-performance on these instruments to be limited.
 
Generally, the company does not require collateral or other security from customers for trade accounts receivable; however, credit is extended to customers following an evaluation of creditworthiness. In addition, the company performs ongoing credit reviews of all its customers and establishes an allowance for doubtful accounts receivable when accounts are determined to be uncollectible. Allowance for doubtful accounts amounted to $1,243,000 and $1,318,000 as at August 31, 2010 and November 30, 2010, respectively. Bad debt recovery amounted to $17,000 and $139,000 for the three months ended November 30, 2009 and 2010, respectively.
 
For the three months ended November 30, 2009 and 2010, no customer represented more than 10% of consolidated sales.
 

 
Page 19 of 47

 

EXFO INC.
Notes to Unaudited Interim Consolidated Financial Statements
 
(tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)
 

The following table summarizes the age of trade accounts receivable:
 
   
As at
November 30, 2010
   
As at
August 31,
2010
 
             
Current
  $ 45,037     $ 38,663  
Past due, 0 to 30 days
    5,604       6,787  
Past due, 31 to 60 days
    534       1,991  
Past due, more than 60 days, less allowance for doubtful accounts of $1,243 and $1,318 as at August 31, 2010 and  November 30, 2010, respectively
    4,209       2,749  
Total accounts receivable
  $ 55,384     $ 50,190  
 
Liquidity risk
 
Liquidity risk is defined as the potential that the company cannot meet its obligations as they become due.
 
The following table summarizes the contractual maturity of the company’s derivative and non-derivative financial liabilities as at November 30, 2010:
 
   
As at November 30, 2010
 
                         
   
0-12
months
   
13-24
months
   
25-36
months
   
Over 36
months
 
                         
Accounts payable and accrued liabilities
  $ 30,229     $     $     $  
Long-term debt
    584       584       584       292  
Other liabilities
          343              
Forward exchange contracts
                               
Outflow
    27,100       15,000       600        
Inflow
    (28,773 )     (15,772 )     (627 )      
Total
  $ 29,140     $ 155     $ 557     $ 292  

 
   
As at August 31, 2010
 
                         
   
0-12
months
   
13-24
months
   
25-36
months
   
Over 36
months
 
                         
                         
Accounts payable and accrued liabilities
  $ 29,711     $     $     $  
Long-term debt
    568       568       568       283  
Other liabilities
          295              
Forward exchange contracts
                               
Outflow
    29,500       20,400       1,500        
Inflow
    (30,141 )     (20,662 )     (1,508 )      
Total
  $ 29,638     $ 601     $ 560     $ 283  
 
As at November 30, 2010, the company had $50,624,000 in cash and short-term investments and $62,574,000 in accounts receivable. In addition to these financial assets, the company has unused available lines of credit totalling $15,508,000 for working capital and other general corporate purposes, including potential acquisitions and its share repurchase program as well as unused lines of credit of $15,223,000 for foreign currency exposure related to its forward exchange contracts.
 

 
Page 20 of 47

 

EXFO INC.
Notes to Unaudited Interim Consolidated Financial Statements
 
(tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)
 
 
  6   Inventories
 
   
As at
November 30,
2010
   
As at
August 31,
2010
 
             
Raw materials
  $ 22,332     $ 21,505  
Work in progress
    2,749       1,975  
Finished goods
    18,230       16,848  
                 
    $ 43,311     $ 40,328  
 
The cost of sales comprised almost exclusively the amount of inventory recognized as an expense during the reporting periods, except for the related amortization, which is shown separately in operating expenses.
 
Inventory write-down amounted to $590,000 and $711,000 for the three months ended November 30, 2009 and 2010, respectively.
 
 
  7   Accounts Payable and Accrued Liabilities
 
   
As at
November 30,
2010
   
As at
August 31,
2010
 
             
Trade
  $ 14,292     $ 14,244  
Salaries and social benefits
    11,916       12,400  
Warranty
    603       579  
Commissions
    1,019       831  
Forward exchange contracts
          232  
Other
    3,365       2,584  
                 
    $ 31,195     $ 30,870  
 
Changes in the warranty provision are as follows:
 
   
Three months ended
November 30,
 
             
   
2010
   
2009
 
             
Balance – Beginning of period
  $ 579     $ 647  
Provision
    181       137  
Settlements
    (157 )     (135 )
                 
Balance – End of period
  $ 603     $ 649  
 
 
 
Page 21 of 47

 

EXFO INC.
Notes to Unaudited Interim Consolidated Financial Statements
 
(tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)
 
 
  8   Long-Term Debt
 
   
As at
November 30,
2010
   
As at
August 31,
2010
 
             
Loan collateralized by assets of NetHawk Oyj, denominated in euros (€1,568), bearing interest at 2.95%, repayable in semi-annual installments of $292 (€224), maturing in December 2013
  $ 2,044     $ 1,987  
                 
Less: current portion
    584       568  
                 
    $ 1,460     $ 1,419  
 
 
  9   Contingency
 
On November 27, 2001, a class action suit was filed in the United States District Court for the Southern District of New York against the company, four of the underwriters of its Initial Public Offering and some of its executive officers pursuant to the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder and Sections 11, 12 and 16 of the Securities Act of 1933. This class action alleges that the company’s registration statement and prospectus filed with the Securities and Exchange Commission on June 29, 2000, contained material misrepresentations and/or omissions resulting from (i) the underwriters allegedly soliciting and receiving additional, excessive and undisclosed commissions from certain investors in exchange for which they allocated material portions of the shares issued in connection with the company’s Initial Public Offering; and (ii) the underwriters allegedly entering into agreements with customers whereby shares issued in connection with the company’s Initial Public Offering would be allocated to those customers in exchange for which customers agreed to purchase additional amounts of shares in the after-market at predetermined prices.
 
On April 19, 2002, the plaintiffs filed an amended complaint containing master allegations against all of the defendants in all of the 310 cases included in this class action and also filed an amended complaint containing allegations specific to four of the company’s underwriters, the company and two of its executive officers. In addition to the allegations mentioned above, the amended complaint alleges that the underwriters (i) used their analysts to manipulate the stock market; and (ii) implemented schemes that allowed issuer insiders to sell their shares rapidly after an initial public offering and benefit from high market prices. As concerns the company and its two executive officers in particular, the amended complaint alleges that (i) the company’s registration statement was materially false and misleading because it failed to disclose the additional commissions and compensation to be received by underwriters; (ii) the two named executive officers learned of or recklessly disregarded the alleged misconduct of the underwriters; (iii) the two named executive officers had motive and opportunity to engage in alleged wrongful conduct due to personal holdings of the company’s stock and the fact that an alleged artificially inflated stock price could be used as currency for acquisitions; and (iv) the two named executive officers, by virtue of their positions with the company, controlled the company and the contents of the registration statement and had the ability to prevent its issuance or cause it to be corrected. The plaintiffs in this suit seek an unspecified amount for damages suffered.
 
In July 2002, the issuers filed a motion to dismiss the plaintiffs’ amended complaint and a decision was rendered on February 19, 2003. Only one of the claims against the company was dismissed. On October 8, 2002, the claims against its officers were dismissed pursuant to the terms of Reservation of Rights and Tolling Agreements entered into with the plaintiffs.
 

 
Page 22 of 47

 

EXFO INC.
Notes to Unaudited Interim Consolidated Financial Statements
 
(tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)
 

In June 2004, an agreement of partial settlement was submitted to the court for preliminary approval. The proposed partial settlement was between the plaintiffs, the issuer defendants in the consolidated actions, the issuer officers and directors named as defendants, and the issuers’ insurance companies. The court granted the preliminary approval motion on February 15, 2005, subject to certain modifications. On August 31, 2005, the court issued a preliminary order further approving the modifications to the settlement and certifying the settlement classes. The court also appointed the notice administrator for the settlement and ordered that notice of the settlement be distributed to all settlement class members by January 15, 2006. The settlement fairness hearing occurred on April 24, 2006, and the court reserved decision at that time.
 
While the partial settlement was pending approval, the plaintiffs continued to litigate against the underwriter defendants. The district court directed that the litigation proceed within a number of “focus cases” rather than in all of the 310 cases that have been consolidated. The company's case is not one of these focus cases. On October 13, 2004, the district court certified the focus cases as class actions. The underwriter defendants appealed that ruling, and on December 5, 2006, the Court of Appeals for the Second Circuit reversed the district court’s class certification decision.
 
On April 6, 2007, the Second Circuit denied the plaintiffs’ petition for rehearing of that decision and, on May 18, 2007, the Second Circuit denied the plaintiffs’ petition for rehearing en banc . In light of the Second Circuit’s opinion, liaison counsel for all issuer defendants, including the company, informed the court that this settlement cannot be approved, because the defined settlement class, like the litigation class, cannot be certified. On June 25, 2007, the district court entered an order terminating the settlement agreement. On August 14, 2007, the plaintiffs filed their second consolidated amended class action complaints against the focus cases and, on September 27, 2007, again moved for class certification. On November 12, 2007, certain defendants in the focus cases moved to dismiss the second consolidated amended class action complaints. On March 26, 2008, the district court denied the motions to dismiss, except as to Section 11 claims raised by those plaintiffs who sold their securities for a price in excess of the initial offering price and those who purchased outside of the previously certified class period. Briefing on the class certification motion was completed in May 2008. That motion was withdrawn without prejudice on October 10, 2008.
 
On April 2, 2009, a stipulation and agreement of settlement between the plaintiffs, issuer defendants and underwriter defendants was submitted to the Court for preliminary approval. The Court granted the plaintiffs’ motion for preliminary approval and preliminarily certified the settlement classes on June 10, 2009. The settlement fairness hearing was held on September 10, 2009. On October 6, 2009, the Court entered an opinion granting final approval to the settlement and directing that the Clerk of the Court close these actions. On August 26, 2010, based on the expiration of the tolling period stated in the Tolling Agreements, the plaintiffs filed a Notice of Termination of Tolling Agreement and Recommencement of Litigation against the two named executive officers. The plaintiffs stated to the Court that they do not intend to take any further action against the named executive officers at this time. Appeals of the opinion granting final approval have been filed. Given that the settlement remains subject to appeal as of the date of issuance of these financial statements, the ultimate outcome of the contingency is uncertain. However, based on the settlement approved on October 6, 2009, and the related insurance against such claims, management has determined the impact to its financial position and results of operations as at and for the three months ended November 30, 2010 to be immaterial.
 
 
  10   Share Capital
 
On November 5, 2010, the company announced that its Board of Directors had authorized the third renewal of its share repurchase program, by way of a normal course issuer bid on the open market, of up to 10% of its public float (as defined by the Toronto Stock Exchange), or 2,012,562 subordinate voting shares, at the prevailing market price. The company expects 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, 2010, and will end on November 9, 2011, or at an earlier date if the company repurchases the maximum number of shares permitted under the bid. The program does not require that the company repurchases 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.
 

 
Page 23 of 47

 

EXFO INC.
Notes to Unaudited Interim Consolidated Financial Statements
 
(tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)
 

The following tables summarize changes in share capital for the three months ended November 30, 2009 and 2010.
 
   
Three months ended November 30, 2009
 
   
Multiple voting shares
   
Subordinate voting shares
       
   
Number
   
Amount
   
Number
   
Amount
   
Total
amount
 
                               
Balance as at August 31, 2009
    36,643,000     $ 1       22,736,302     $ 104,845     $ 104,846  
    Redemption of restricted share units
                13,663              
Reclassification of stock-based compensation costs to share capital upon exercise of stock awards
                      86       86  
    Redemption of share capital
                (3,600 )     (17 )     (17 )
                                         
Balance as at November 30, 2009
    36,643,000     $ 1       22,746,365     $ 104,914     $ 104,915  

   
Three months ended November 30, 2010
 
   
Multiple voting shares
   
Subordinate voting shares
       
   
Number
   
Amount
   
Number
   
Amount
   
Total
amount
 
                               
Balance as at August 31, 2010
    36,643,000     $ 1       22,936,709     $ 106,125     $ 106,126  
    Exercise of stock options
                11,478       61       61  
    Redemption of restricted share units
                157,790              
Reclassification of stock-based compensation costs to share capital upon exercise of stock awards
                      861       861  
                                         
Balance as at November 30, 2010
    36,643,000     $ 1       23,105,977     $ 107,047     $ 107,048  
 
 
  11   Net Research and Development Expenses
 
Net research and development expenses comprise the following:
 
   
Three months ended
November 30,
 
             
   
2010
   
2009
 
             
Gross research and development expenses
  $ 13,690     $ 9,153  
Research and development tax credits and grants
    (2,089 )     (1,372 )
                 
    $ 11,601     $ 7,781  
 
 
 
Page 24 of 47

 

EXFO INC.
Notes to Unaudited Interim Consolidated Financial Statements
 
(tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)
 
 
  12   Income Taxes
 
For the three months ended November 30, 2009 and 2010, the reconciliation of the income tax provision calculated using the combined Canadian federal and provincial statutory income tax rate with the income tax provision in the financial statements is as follows:
 
   
Three months ended
November 30,
 
             
   
2010
   
2009
 
             
Income tax provision at combined Canadian federal and provincial statutory tax rate (29% in 2010 and 31% in 2009)
  $ 1,146     $ 277  
                 
Increase (decrease) due to:
               
Foreign income taxed at different rates
    113       (7 )
Non-taxable income
    (756 )     (59 )
Non-deductible expenses
    260       201  
Change in tax rates
          122  
Foreign exchange effect of translation of foreign integrated subsidiaries
    492       207  
Utilization of previously unrecognized future income tax assets
    (70 )     (90 )
Unrecognized future income tax assets on temporary deductible differences and unused tax losses and deductions
    1,497       214  
Other
    124       257  
                 
    $ 2,806     $ 1,122  
 
The income tax provision consists of the following:
 
Current
  $ 1,013     $ 87  
                 
Future
    366       911  
Valuation allowance
    1,427       124  
                 
      1,793       1,035  
                 
    $ 2,806     $ 1,122  
 
The income tax provision for the discontinued operations is as follows:
 
Current
  $ 27     $  
Future
    174       121  
                 
    $ 201     $ 121  
 
 
 
Page 25 of 47

 

EXFO INC.
Notes to Unaudited Interim Consolidated Financial Statements
 
(tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)
 
 
  13   Earnings per Share
 
The following table summarizes the reconciliation of the basic weighted average number of shares outstanding and the diluted weighted average number of shares outstanding:
 
   
Three months ended
November 30,
 
             
   
2010
   
2009
 
             
Basic weighted average number of shares outstanding (000’s)
    59,665       59,386  
Plus dilutive effect of:
               
Stock options (000’s)
    273       140  
Restricted share units (000’s)
    1,033       430  
Deferred share units (000’s)
    135       166  
                 
Diluted weighted average number of shares outstanding (000’s)
    61,106       60,122  
Stock awards excluded from the calculation of diluted weighted average number of shares because their exercise price was greater than the average market price of the common shares (000’s)
    669       1,297  
 
 
  14   Differences between Canadian and U.S. GAAP
 
These interim consolidated financial statements are prepared in accordance with Canadian GAAP and significant differences in measurement and disclosure from U.S. GAAP are set out in note 22 to the company’s most recent annual consolidated financial statements. This note describes significant changes occurring since the most recent annual consolidated financial statements and provides a quantitative analysis of all significant differences. All disclosures required in annual financial statements under U.S. GAAP and Regulation S-X of the Securities and Exchange Commission (SEC) in the United States are not provided in these interim consolidated financial statements.
 

 
Page 26 of 47

 

EXFO INC.
Notes to Unaudited Interim Consolidated Financial Statements
 
(tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)
 

Statements of earnings and comprehensive income
 
Reconciliation of net earnings and comprehensive income to conform to U.S. GAAP
 
         
Three months ended
November 30,
 
                   
         
2010
   
2009
 
                   
Net earnings for the period in accordance with Canadian GAAP
        $ 14,071     $ 334  
Gain on disposal of discontinued operations (note 3)
    a )     4,130        
                         
Net earnings for the period in accordance with U.S. GAAP
            18,201       334  
                         
Foreign currency translation adjustment
            6,488       7,813  
Unrealized gains on forward exchange contracts
            1,444       1,164  
Reclassification of realized (gains) loss on forward exchange contracts in net earnings
            (189 )     77  
Future income taxes effect of the above items
            (338 )     (385 )
                         
Comprehensive income under U.S. GAAP
          $ 25,606     $ 9,003  
                         
U.S. GAAP net earnings are comprised of:
                       
Net earnings (loss) from continuing operations
          $ 1,145     $ (230 )
Net earnings from discontinued operations
          $ 17,056     $ 564  
                         
Basic and diluted net earnings (loss) from continuing operations per share in accordance with U.S. GAAP
          $ 0.02     $ (0.00 )
Basic net earnings from discontinued operations per share in accordance with U.S. GAAP
          $ 0.29     $ 0.01  
Diluted net earnings from discontinued operations per share in accordance with U.S. GAAP
          $ 0.28     $ 0.01  
Basic net earnings per share in accordance with U.S. GAAP
          $ 0.31     $ 0.01  
Diluted net earnings per share in accordance with U.S. GAAP
          $ 0.30     $ 0.01  
 
Reconciliation of shareholders’ equity to conform to U.S. GAAP
 
The following summary sets out the significant differences in the company’s reported shareholders’ equity under Canadian GAAP as compared to U.S. GAAP:
 
   
As at
November 30,
2010
   
As at
August 31,
2010
 
             
Shareholders’ equity in accordance with Canadian GAAP
  $ 242,532     $ 220,419  
Goodwill
    43       42  
Long-term assets held for sale
          (3,988 )
Cash contingent consideration payable
    (2,736 )     (2,660 )
Stock appreciation rights
    (73 )     (73 )
                 
Shareholders’ equity in accordance with U.S. GAAP
  $ 239,766     $ 213,740  
 
 
 
Page 27 of 47

 

EXFO INC.
Notes to Unaudited Interim Consolidated Financial Statements
 
(tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)
 

Research and development tax credits
 
Under Canadian GAAP, all research and development tax credits are recorded as a reduction of gross research and development expenses in the statements of earnings. Under U.S. GAAP, tax credits that are refundable against taxable income are recorded in the income taxes. These tax credits amounted to $820,000 and $985,000 for the three months ended November 30, 2009 and 2010, respectively. This difference has no impact on the net earnings and the net earnings per share for the reporting periods.
 
Statements of cash flows
 
For the three months ended November 30, 2010, cash flows from operating activities under U.S. GAAP were $132,000 lower compared to those established under Canadian GAAP; this difference arose from NetHawk’s acquisition-related costs paid during this period and expensed under U.S. GAAP. A corresponding difference also impacted cash flows from investing activities. In addition, under U.S. GAAP, the presentation of subtotal before change in non-cash operating items is not permitted.
 
For the three months ended November 30, 2009, there were no significant differences between the statements of cash flows under Canadian GAAP as compared to U.S. GAAP, except for the subtotal before change in non-cash operating items, whose presentation is not permitted under U.S. GAAP.
 
Reconciliation item
 
        a)  
 Gain on disposal of discontinued operations
 
Under U.S. GAAP, the carrying value of goodwill of the Life Sciences and Industrial Division (discontinued operations) was $4,130,000 lower than the carrying value under Canadian GAAP. As a result, under U.S. GAAP, the gain on the disposal of that Division was higher for the same amount.
 
New accounting standards and pronouncements
 
Adopted in fiscal 2011
 
In October 2009, the FASB issued guidance now codified as ASC Topic 985 “Software”, to change the accounting model for revenue arrangements that include both tangible products and software elements. Under this guidance, tangible products containing software components and non-software components that function together to deliver the tangible product’s essential functionality are excluded from the software revenue guidance. In addition, hardware components of a tangible product containing software components are always excluded from the software revenue guidance. This guidance is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010.
 
In October 2009, the FASB amended guidance now codified as Topic 605, “Revenue Recognition”, to include a consensus relating to multiple-deliverable revenue arrangements. These amendments significantly change certain guidance pertaining to revenue arrangements with multiple deliverables and modify the separation criteria of Topic 605 by eliminating the criterion for objective and reliable evidence of fair value for the undelivered products or services. The amendments also eliminate the use of the residual method of allocation and require, instead, that arrangement consideration be allocated, at the inception of the arrangement, to all deliverables based on their relative selling price. This guidance is effective for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010.
 
The company adopted Topics 985 and 605 on September 1, 2010, at the same time it adopted similar new requirements under Canadian GAAP (note 2), and their adoption had no significant impact on its consolidated financial statements.
 
 


 
Page 28 of 47

 
 
Management’s  Discussion and Analysis of Financial Condition
and Results of Operations

 
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 our ability to successfully integrate our acquired and to-be-acquired businesses; fluctuating exchange rates; consolidation in the global telecommunications test and service assurance industry and increased competition among vendors; capital spending levels in the telecommunications industry; concentration of sales; the effects of the additional actions we have taken in response to 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 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 our Annual Report, on Form 20-F, and our other filings with the U.S. Securities and Exchange Commission and the Canadian securities commissions. We believe that the expectations reflected in the forward-looking statements are reasonable based on information currently available to us, but we cannot assure you that the expectations will prove to have been correct. Accordingly, you should not place undue reliance on these forward-looking statements. These statements speak only as of the date of this document. 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 financial condition and results of operations is dated January 12, 2011.
 
All dollar amounts are expressed in US dollars, except as otherwise noted.
 
 
INDUSTRY OVERVIEW
 
The fundamental drivers toward broadband deployments and fixed-mobile IP (Internet protocol) network convergence are firmly entrenched in the global telecommunications industry despite a slow recovery in the general economic environment. Although network operators did not significantly increase capital expenditures in calendar 2010, they did spend more in select, high-growth areas to accommodate bandwidth-intensive broadband applications and to facilitate the migration to more flexible and cost-effective fixed and mobile IP networks.
 
According to Cisco’s updated Visual Networking Index, global IP traffic will quadruple from 2009 to 2014, reaching almost 64 exabytes per month in 2014. (An exabyte is equal to 1 billion gigabytes or 250 million DVDs). Global mobile traffic, a subset of this larger group, is expected to increase 39-fold during the same period. Bandwidth demand is driven by a wide range of applications including various forms of IP video, peer-to-peer file sharing, social networking, Internet gaming as well as increased penetration of media-rich smartphones and notebooks.
 

 
Page 29 of 47

 
 
To support such explosive bandwidth growth, wireline networks are being transformed into next-generation IP-based infrastructures. Legacy SONET/SDH networks, which were established in the mid-1980s, do not have the flexibility to seamlessly mix and transport voice, data and video services. Such networks are not capable of efficiently carrying triple-play services because they were designed for point-to-point voice communication. As a result, new optical transport network (OTN) standards, which are at the very heart of what the industry is labeling next-generation IP networks, have been defined to carry IP applications over Ethernet. Network operators are increasingly turning to such next-generation, IP-based networks in order to offer customers higher-margin triple-play services while lowering their operating costs.
 
Fiber-to-the-home (FTTH) has also become the access network architecture of choice for wireline operators wishing to provide a superior user experience for a combined voice, data and video offering. This architecture allows operators to meet heightened bandwidth requirements and future-proof their access networks as residential bandwidth demands grow from 1 to 5 Mbit/s (megabits per second) to 30 to 100 Mbit/s required for the long term. Hybrid architectures, combining copper and fiber (fiber-to-the-curb, or FTTC, and fiber-to-the-node, or FTTN), will also increase in the short term, since they are less expensive methods to increase bandwidth and can be mass-deployed quickly.
 
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 becoming mainstream, while several network operators have already begun 100 Gbit/s Ethernet field trials. In the long run, these solutions will offer a more economical way to add capacity to saturated network links, especially if trenches need to be dug in order to deploy new fiber in metro and long-distance routes.
 
On the wireless side, operators are also faced with major investments to meet soaring bandwidth demand. Wireless operators are accelerating deployments of 3G networks, fast-tracking 4G/LTE (long-term evolution) adoption, and investing in mobile backhaul networks in order to increase transmission rates for bandwidth-hungry consumers to approach wireline speeds. Furthermore, as these consumers expect wireline and wireless networks to transport any content to any device at any time, both fixed and mobile networks are converging to a common IP-based infrastructure supported by IMS (IP multimedia subsystem) for seamless network interoperability.
 
These market dynamics affected telecom test and service assurance suppliers in the first quarter of fiscal 2011.
 
 
COMPANY OVERVIEW
 
We reported record-high sales of $65.7 million for our continuing operations (formerly our Telecom Division) in the first quarter of fiscal 2011, which represents an increase of 62.9% compared to the same period last year. Sales for the first quarter of fiscal 2011 included $6.4 million from NetHawk, which was acquired in the third quarter of fiscal 2010. We also reported record-high net accepted orders for our continuing operations of $89.8 million in the first quarter of fiscal 2011, which represents an increase of 92.0% compared to the same period last year, for a book-to-bill ratio of 1.37. During the first quarter of fiscal 2011, in addition to the positive impact of the acquisition of NetHawk on our sales and bookings, we benefited from worldwide capital-intensive deployments and capacity expansion from network operators and we believe we gained market share, especially in the wireline space. Namely, in the first quarter of fiscal 2011, two tier-1 network operators placed follow-on orders totaling more than $8 million for our AXS-200/635 triple-play tester and a tier-1 US wireless operator selected our service assurance solution for monitoring its Ethernet backhaul networks with an initial order in excess of $1 million. A significant portion of these orders were shipped during the quarter. In addition, we benefited from our strong product offering and from larger year-end budget flush-outs compared to the same period last year. These factors contributed to the significant increase of our sales and booking numbers year-over-year.
 
We generated GAAP net earnings from continuing operations of $1.1 million, or $0.02 per diluted share, in the first quarter of fiscal 2011, compared to a GAAP net loss from continuing operations of $230,000, or $0.00 per share, for the same period last year. Net earnings from continuing operations for the first quarter of fiscal 2011 included $2.4 million in after-tax amortization of intangible assets and $474,000 in stock-based compensation costs. Earnings from operations (from continuing operations) significantly improved year-over-year from $2.0 million, or 4.9% of sales in the first quarter of fiscal 2010 to $5.1 million, or 7.8% of sales for the same period this year. Global net earnings for the first quarter of fiscal 2011, which include the net earnings from the discontinued operations, amounted to $14.1 million, or $0.23 per diluted share, compared to $334,000, or $0.01 per diluted share, for the same period last year.
 

 
Page 30 of 47

 
 
Adjusted EBITDA (net earnings before interest, income taxes, depreciation and amortization and gain from disposal of discontinued operations) reached $8.2 million, or 12.1% of global sales in the first quarter of fiscal 2011, compared to $4.4 million, or 9.6% of global sales for the same period last year. Adjusted EBIDTA for the first quarter of fiscal 2011 included a foreign exchange loss of $1.1 million ($1.0 million in 2010). See further in this document for a complete reconciliation of adjusted EBITDA to GAAP net earnings.
 
On October 1, 2010, we closed the sale of our Life Sciences and Industrial Division for total proceeds of $21.6 million, net of a bank overdraft of $303,000, selling costs of $909,000 and future income taxes of $141,000. As such, this Division has been presented as discontinued operations in our interim consolidated financial statements with revenues and expenses being reclassified from continuing operations to discontinued operations for all reporting periods. The sale of that Division resulted in a gain of $13.2 million.
 
On November 5, 2010 we announced that our Board of Directors approved the third 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 2.0 million of 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, 2010, and will end on November 9, 2011, 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 terms of new products, we introduced seven innovations in the first quarter of 2011, including several solutions dedicated to strengthening our FTB Ecosystem of Windows XP-based modular test platforms. We launched the FTB-1 handheld platform with related OTDR and Ethernet test modules for field technicians; we enhanced our FTB-200 platform with increased performance and functionality; we added ODU0 and ODUflex test capabilities to our industry-leading 10G and 40G Transport Blazer test solutions; and we released the ConnectorMax pass/fail connector endface assessment software option.
 
 
OUR STRATEGY, KEY PERFORMANCE INDICATORS AND CAPABILITY TO DELIVER RESULTS
 
For a complete description of our strategy and the related key performance indicators, as well as our capability to deliver results in fiscal 2011, please refer to the corresponding sections in our most recent Annual Report, filed with the securities commissions.
 
 
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
 
For a complete description of our critical accounting policies and estimates, please refer to the corresponding section in our most recent Annual Report, filed with the securities commissions. The following details the changes in critical accounting policies that were adopted in fiscal 2011 and those to be adopted after 2011.
 
Adopted in fiscal 2011

In December, 2009, the Canadian Institute of Chartered Accountants’ (CICA) Emerging Issues Committee (EIC) issued EIC-175, “Multiple Deliverable Revenue Arrangements”, which is applicable prospectively (with retrospective adoption permitted) to revenue arrangements with multiple deliverables entered into or materially modified in the first annual period beginning on January 1, 2011. EIC-175 amends the guidance contained in EIC-142, “Revenue Arrangements with Multiple Deliverables“, and establishes additional requirements regarding revenue recognition related to multiple deliverables as well as supplementary disclosures. We adopted this standard on September 1, 2010, and its adoption had no material effect on our consolidated financial statements.
 
Update to the accounting policy on revenue recognition
 
Our multiple deliverable revenue arrangements may include tangible products (software and/or non software components), extended warranties, maintenance contracts, post-contract customer support (PCS) on software components as well as installation.
 

 
Page 31 of 47

 
 
Starting September 1, 2010, when a sales arrangement contains multiple elements and software and non software components function together to deliver the tangible products’ essential functionality, we allocate revenue to each element based on the relative selling price of each element. Under this approach, the selling price of a deliverable is determined by using a selling price hierarchy which requires the use of vendor specific objective evidence (“VSOE”) of fair value if available, third-party evidence (“TPE”) if VSOE is not available, or best estimated selling price (“BESP”) if neither VSOE nor TPE are available.
 
We establish VSOE of selling price using the price charged for a deliverable when sold separately and, in some instances, using the price established by management having the relevant authority. TPE of selling price is established by evaluating similar and interchangeable competitor goods or services in sales to similarly situated customers. When VSOE or TPE are not available, we use BESP. We establish BESP using historical selling price trends if available and considering multiple factors including, but not limited to geographies, market conditions, competitive landscape, internal costs, gross margin objectives, and pricing practices. When determining BESP, management applies judgment when establishing pricing strategies and evaluating market conditions and product lifecycles. The determination of BESP is made through consultation with and approval by management. We may modify or develop new pricing practices and strategies in the future. As these pricing strategies evolve, we may modify our pricing practices in the future, which may result in changes in BESP. The aforementioned factors may result in a different allocation of revenue to the deliverables in multiple-element arrangements from the current period, which may change the pattern and timing of revenue recognition for these elements but will not change the total revenue recognized for the arrangement.
 
Maintenance contracts are usually offered to customers for periods of twelve to thirty-six months. They generally include the right to unspecified upgrades and enhancements on a when-and-if available basis and customer service. They qualify as a separate unit of accounting. Revenue from these contracts is recognized ratably over the terms of the maintenance contracts on a straight-line basis. The selling price of the maintenance contracts is determined using VSOE.
 
Extended warranties are usually offered to customers for periods of twelve to forty-eight months. They qualify as a separate unit of accounting. Revenue from these extended warranties is recognized ratably over the warranty period on a straight-line basis. The selling price of the extended warranties is determined using BESP.
 
When a sales arrangement contains multiple elements and software and non−software components do not function together to deliver the tangible products’ essential functionality, we allocate revenue between the tangible products and the PCS, if any, based on VSOE of selling price of each element. 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.
 
To be adopted after fiscal 2011
 
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 consideration 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 September 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.
 

 
Page 32 of 47

 
 
Should we decide to adopt one of these three new sections earlier, we must adopt all three on the same date.
 
In February 2008, the Canadian Accounting Standards Board announced that Canadian GAAP, as used by publicly accountable enterprises, will be converged with the International Financial Reporting Standards (IFRS) as issued by the International Accounting Standard Board (IASB). Accordingly, we will adopted these standards during our fiscal year beginning on September 1, 2011 and we will be required to report under IFRS and to provide IFRS comparative information for the fiscal year ending on August 31, 2011 (current fiscal year). Although the conceptual framework of IFRS is similar to Canadian GAAP, there are significant differences on recognition, measurement and disclosures.