(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)
Securities registered or to be registered pursuant to Section 12(b) of the Act.
Title of each class
Name of each exchange on which registered
Subordinate Voting Shares without par value
Subordinate Voting Shares without par value
Securities registered or to be registered pursuant to Section 12(g) of the Act.
(Title of Class)
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act.
(Title of Class)
As of August 31, 2019, the registrant had 23,703,675 Subordinate Voting Shares outstanding and 31,643,000 Multiple Voting Shares outstanding.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes □ No ⌧
If this report is an annual report or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934.
Yes □ No ⌧
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes ⌧ No □
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes ⌧ No □
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or an emerging growth company. See definition of “large accelerated filer”, “accelerated filer” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer □
Accelerated filer ⌧
Non-accelerated filer □
Emerging growth company □
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
U.S. GAAP □
International Financial Reporting Standards as issued by the ⌧
International Accounting Standards Board
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b‑2 of the Exchange Act).
This Annual Report 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, expect, believe, plan, anticipate, intend, could, estimate, continue, or similar expressions or the negative of such expressions 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, but not limited to, macroeconomic uncertainty, including trade wars and recessions; our ability to successfully integrate businesses that we acquire; capital spending and network deployment levels in the telecommunications industry (including our ability to quickly adapt cost structures to anticipated levels of business and our ability to manage inventory levels with market demand); future economic, competitive, financial and market conditions; consolidation in the global communications test, monitoring and analytics solutions markets and increased competition among vendors; capacity to adapt our future product offering to future technological changes; limited visibility with regard to the timing and nature of customer orders; delay in revenue recognition due to longer sales cycles for complex systems involving customers’ acceptance; fluctuating exchange rates; concentration of sales; timely release and market acceptance of our new products and other upcoming products; our ability to successfully expand international operations and to conduct business internationally; and the retention of key technical and management personnel. Assumptions relating to the foregoing involve judgments and risks, all of which are difficult or impossible to predict and many of which are beyond our control. Other risk factors that may affect our future performance and operations are detailed in this Annual Report. We believe that the expectations reflected in the forward-looking statements are reasonable based on information currently available to us, but we cannot assure that the expectations will prove to have been correct. Accordingly, you should not place undue reliance on these forward-looking statements. These statements speak only as of the date of this document. Unless required by law or applicable regulations, we undertake no obligation to revise or update any of them to reflect events or circumstances that occur after the date of this document.
All dollar amounts in this Annual Report are expressed in US dollars, except as otherwise noted.
Identity of Directors, Senior Management and Advisers
The consolidated statements of earnings data for the years ended August 31, 2017, 2018 and 2019 and the consolidated balance sheets data as at August 31, 2018 and 2019 have been derived from our audited consolidated financial statements that are included elsewhere in this Annual Report on Form 20-F. Consolidated statements of earnings data for the years ended August 31, 2015 and 2016 and consolidated balance sheets data as at August 31, 2015, 2016 and 2017 have been derived from our audited consolidated financial statements not included in this Annual Report on Form 20-F.
Consolidated financial statements from which the selected financial data has been derived, have been prepared in accordance with International Financial Reporting Standards (IFRS), as issued by the International Accounting Standards Board (IASB).
The selected financial data should be read in conjunction with “Item 5. Operating and Financial Review and Prospects” and our audited consolidated financial statements and the related notes thereto, included in this Annual Report on Form 20-F.
Years ended August 31,
(in thousands of US dollars, except share and per share data)
Consolidated Statements of Earnings Data:
Cost of sales (1)
Selling and administrative (2)
Net research and development
Depreciation of property, plant and equipment
Amortization of intangible assets
Changes in fair value of cash contingent consideration
Interest and other (income) expense
Foreign exchange (gain) loss
Unusual charge (2)
Share in net loss of an associate
Gain on deemed disposal of the investment in an associate
Earnings (loss) before income taxes
Net earnings (loss) for the year
Net loss for the year attributable to non-controlling interest
Net earnings (loss) for the year attributable to parent interest
Basic net earnings (loss) attributable to parent interest per share
Diluted net earnings (loss) attributable to parent interest per share
Basic weighted average number of shares used in per share calculations (000’s)
Diluted weighted average number of shares used in per share calculations (000’s)
The cost of sales is exclusive of depreciation and amortization, shown separately.
Selling and administrative is exclusive of unusual charge, shown separately, which represents bad debt expenses.
Capitalization and Indebtedness
Reasons for the Offer and Use of Proceeds
Our business may be adversely affected by unfavorable general economic and market conditions.
Our business is subject to general global and regional economic conditions, particularly those in the communications test, monitoring and analytics markets. In the past, our operating results were adversely affected by unfavorable economic conditions and reduced or delayed capital spending in the Americas, Europe, Middle East and Africa (EMEA) as well as Asia-Pacific regions.
Global and regional economic conditions continue to be volatile and uncertain. If global and/or regional economic and market conditions, or economic conditions in key markets, remain uncertain or deteriorate into a recession, we may experience material adverse effects on our business. Unfavorable and/or uncertain economic and market conditions may result in lower capital spending or delayed spending by our customers on network test, monitoring and analytics solutions and, therefore, demand for our products could decline and adversely impact our revenue. Adverse economic and/or market conditions could also result in, among other things:
difficulty in forecasting, budgeting and planning due to the uncertain spending plans of current or prospective customers;
increased competition for fewer network projects and sales opportunities;
increased pricing pressure that may adversely affect revenue and gross margin;
higher cost structure compared to revenue level;
increased risk of charges related to excess and obsolete inventories, write-offs of deferred tax assets and tax credits, and impairment of intangible assets and goodwill;
customers’ financial difficulties and increased difficulty in collecting accounts receivable;
additional restructuring costs; and
increased protectionism or international trade barriers.
These effects, as well as other unforeseeable effects, are difficult to forecast and mitigate. As a result, we may experience material adverse effects on our business, operating results, financial condition, and stock price.
Geopolitical and economic policies favoring national interests could adversely affect our results of operations.
Our overall performance depends to a certain extent upon international economic and political conditions. Many of our suppliers, vendors, partners and other entities with whom we do business have ties to China, and their ability to supply materials to us or otherwise work with us is strongly affected by their ability to do business in China. If the United States’ relationship with China deteriorates or results in additional protectionist measures, retaliatory actions, more tariffs, increased barriers, increased import and export licensing requirements, or other restrictions or policies that favor domestic industries, then our operations may be adversely affected.
We have significant operations, including a large number of employees, R&D centers and other facilities in the United States, United Kingdom, France, India, Finland and Canada, among other countries. Nationalistic economic policies and political trends in some of these territories, such as opposition to globalization and free trade, sanctions or trade restrictions, withdrawal from or re-negotiation of global trade agreements, tax policies that favor domestic industries and interests, the anticipated exit of the United Kingdom from the European Union (known as Brexit), the distancing or potential exit of other countries from the European Union, and other similar actions may result in increased transaction costs, reduced ability to hire employees, diminished access to supplies and materials, lower demand or access to customers in international markets, and inability to conduct our operations as they have been conducted historically. Each of these factors may adversely affect our business.
Fluctuations in the exchange rates between the Canadian dollar, US dollar, euro, British Pound and other currencies may adversely affect our revenues and operating results.
Our functional currency is the Canadian dollar, but we report our results in US dollars. As a result, any increase in the value of the US dollar versus the Canadian dollar, euro and British Pound could adversely affect our revenues because we generate a certain percentage of our sales in Canadian dollars, euros and British Pounds but we report them in US dollars in our financial statements.
We are also exposed to a currency risk in terms of operating results for any fluctuation in the exchange rate between the Canadian dollar, on one hand, and the US dollar, euro, British Pound and other currencies on the other. In fact, the majority of our revenues are denominated in US dollars, euros and British Pounds, but a significant portion of our cost of sales, operating expenses and capital expenditures are denominated in Canadian dollars, US dollars, euros and other currencies such as British Pounds, Rupees (India) and Renminbis (China). Even though we partially manage our exposure to currency risks with forward exchange contracts (by selling US dollars for Canadian dollars and US dollars for Indian Rupees) and even though some of our operating expenses are denominated in currencies other than the Canadian dollar, namely the US dollar, euro and British Pound, we remain exposed to fluctuations in the exchange rates between the Canadian dollar, on one hand, and the US dollar, euro and other currencies on the other. Any increase in the value of the Canadian dollar relative to the US dollar and other currencies, or any unfavorable variance between the value of the Canadian dollar and the contractual rates of our US-Canadian dollar forward exchange contracts, could result in increased expenses reported in US dollars or foreign exchange losses and have a material adverse effect on our operating results.
Foreign exchange rate fluctuations also flow through statement of earnings line items, since a significant portion of our cost of sales and operating expenses are denominated in Canadian dollars, euros, British Pounds and Indian rupees, and we report our results in US dollars. Any decrease in the value of the US dollar relative to the Canadian dollar and other currencies, could have a material adverse effect on our operating results and provide competitive advantages to our competitors.
We must continue to overcome significant competition in our targeted industries in order to keep or gain market share and achieve our growth strategy.
The market for our business activity ─ namely designing, manufacturing, marketing and selling test, monitoring and analytics solutions for communications service providers, data center, cloud and web-scale operators as well as network equipment manufacturers ─ is rapidly evolving and is marked by intense competition, consolidation and technical innovation. We anticipate the pace of change to remain high or even accelerate for our targeted markets in the future. We might see the emergence of new competitors or the consolidation of current competitors, as the markets for communications test, monitoring and analytics solutions evolve in response to technical innovations and economic conditions.
Main competitors in the test and measurement environment include global suppliers like Anritsu Corporation, Fortive Corporation (Fluke Networks), Keysight and Viavi Solutions, as well as smaller players such as AFL Noyes, Deviser Instruments, Kingfisher International, Shineway Tech, VeEX Inc., and Yokogawa Electric Corporation. On the service assurance, systems and services side, we mainly compete against Accedian Networks, Anritsu Corporation, Empirix, Keysight (IXIA), Netrounds, NetScout Systems, Inc., Elisa (Polystar), Radcom, Spirent Communications plc, and Viavi Solutions.
Some competitors have greater financial, technical and/or marketing resources than us. Consequently, they may be able to devote greater resources to the development, marketing, manufacturing, selling and support of their products in order to capture market share.
Competitors also may be better positioned than us to capture market share or to acquire companies and new technologies that would potentially displace our products or render them obsolete. We cannot predict whether current or future competitors will develop or market products that offer higher performance, more features, or are more cost-effective than our current or future products. To remain competitive and achieve our growth strategy, we must develop products internally or purchase technologies through acquisitions that offer higher performance and more functionality, in current and new sectors, so that we can increase our market share. Our failure to do so may harm our business, results of operations and financial condition.
We may not be able to make the acquisitions or strategic alliances needed for the development of our business and, if we do make such acquisitions or strategic alliances, we may not be able to successfully integrate the acquired businesses, products, technologies and personnel or realize the expected benefits of strategic alliances.
We intend to carefully seek businesses through acquisitions and alliances, whose products and technologies are complementary to ours, or which will enable us to expand our markets and/or our market share. However, we may not be able to make beneficial transactions or a sufficient number of them in the future to meet our strategic goals. Our competitors may be in a better position to acquire the same businesses, products and technologies that we want to acquire. Our fluctuating stock price, cash position, or ability to raise capital or issue debt on favorable terms at the time of an acquisition may also affect our ability to complete such an acquisition. Acquisitions or alliances could also distract management’s attention from our day-to-day business and operations. In the event of any future acquisition or strategic alliance, we could, among other things:
issue shares that would dilute individual shareholder percentage ownership;
incur additional debt, be subject to additional debt covenants, and incur additional interest expense;
assume liabilities and commitments;
incur significant expenses related to acquisition costs;
incur significant expenses related to amortization of additional intangible assets;
incur significant impairment losses of goodwill and intangible assets related to such acquisitions; and
In the event we complete acquisitions or sign strategic alliances, we may be unable to successfully integrate acquired companies or realize the expected benefits of alliances. Integration risks include, among other things:
problems integrating the acquired operations, technologies, products and personnel;
risks associated with the transfer of acquired know-how and technology;
unanticipated costs or liabilities;
diversion of management’s attention from our core business;
adverse effects on existing business relationships with suppliers and customers;
risks associated with entering markets in which we have no or limited prior experience; and
potential loss of key employees, particularly those of acquired organizations.
Ultimately, the failure to make acquisitions or strategic alliances, or the inability to effectively integrate acquisitions and realize the expected benefits of alliances, could disrupt our overall business and harm our financial condition.
If we fail to adapt appropriately to the challenges associated with operating internationally, the expected growth of our business may be impeded, and our operating results may be affected.
For the fiscal year ended August 31, 2019, customers outside of Canada accounted for 94.5% of our sales. Our international sales will be limited if we cannot establish and maintain relationships with international distributors, set up additional foreign operations, expand international sales channel management, hire additional personnel, develop relationships with international communications service providers, web-scale operators and network equipment manufacturers, and operate adequate after-sales support internationally.
Even if we are able to successfully operate and expand our international operations, we may not be able to maintain or increase international market demand for our products. Our international operations are subject to a number of risks, including, among other things:
challenges in staffing and managing foreign operations due to the limited number of qualified candidates, employment laws and business practices in foreign countries, any of which could increase the cost and reduce the efficiency of operating in foreign countries;
fluctuations among currencies;
our inability to comply with import/export, environmental and other trade compliance regulations of the countries in which we do business, together with unexpected changes in such regulations and bilateral trade agreements between countries;
measures to ensure that we design, implement and maintain adequate and effective controls over our financial processes and reporting in the future;
failure to adhere to laws, regulations and contractual obligations relating to customer contracts in various countries;
difficulties in establishing and enforcing our intellectual property rights;
inability to maintain a competitive list of distributors for indirect sales;
tariffs and other trade barriers, including those between the US and China;
economic instability in foreign markets, including Britain’s decision to exit the European Union, and the impact this choice may have on doing business in Europe;
wars, acts of terrorism and political unrest;
language and cultural barriers;
lack of integration of foreign operations;
potential foreign and domestic tax consequences;
technology standards that differ from those on which our products are based, which could require expensive redesign and retention of personnel familiar with those standards;
longer accounts receivable payment cycles and possible difficulties in collecting payments which may increase our operating costs and hurt our financial performance; and
Any of these factors could harm our international operations and negatively affect our business, results of operations and financial condition. The recurrence of weakness in these economies or of weakness in other foreign economies could also have a significant negative effect on our future operating results.
Our reliance on software development resources in India and manufacturing personnel in China may expose us to unanticipated costs or liabilities.
In addition to research and development centers in Quebec City, Canada, Montreal, Canada, Oulu, Finland, Rennes, France, Lannion, France and Valencia, Spain, we maintain a software development center in Pune, India. We also manufacture products at our wholly-owned production facility in Shenzhen, China.
Over the years, we have significantly increased our software development and manufacturing activities in India and China, respectively. There is no assurance that our reliance on software development resources in India and manufacturing personnel in China will enable us to maintain our cost structure at current levels, achieve additional cost savings, or generate greater resource efficiency. Furthermore, our software development and manufacturing efforts abroad involve significant risks in addition to the ones disclosed in other risk factors:
difficulty in hiring and retaining appropriate engineering and manufacturing resources due to intense competition for such resources and resulting wage inflation;
exposure to misappropriation of intellectual property and proprietary information;
heightened exposure to changes in the economic, regulatory, security, and political conditions of these countries;
fluctuations in currency exchange rates;
changes in tax laws and regulations in India and China, including transfer pricing policies;
cash management and repatriation of profit; and
high inflation rates which could increase our operating costs and render these operations too expensive.
If we are unable to adapt to current and future changes in technology or if we are unable to introduce new and enhanced products on a timely basis, our products may become obsolete, which could prevent us from achieving our growth strategy and adversely affect our operating results.
The markets that we serve are characterized by rapidly evolving technology and industry standards that result in frequent new product introductions. For example, we are gradually transforming ourselves from a supplier of dedicated test instruments into a supplier of software-intensive monitoring and analytics solutions to meet the emerging needs of communications service providers. While we are devoting substantial resources to meet these needs, this trend may result in lower demand for our hardware test equipment. Additionally, barriers to entry are generally lower for such software-based solutions, which may lead to increased competition for our products and services. Any failure by us to anticipate or respond to new technological developments, customer requirements or evolving standards could cause us to incur significant impairment losses of goodwill and/or losses from operations. Consequently, this could have a material adverse effect on our business, results of operations and financial condition. The development of proprietary technology entails significant technical and business risks and requires substantial expenditures and lead times. The success of our new product introductions will depend on several factors, including, among other things, our ability to:
properly identify and anticipate customer needs;
innovate and develop new products on a timely basis;
gain timely market acceptance for new products;
manufacture and deliver our new products on time, in sufficient volume and with adequate quality;
price our products competitively;
continue investing in our research and development programs;
anticipate competitors’ announcements of new products; and
successfully transform the company into an end-to-end monitoring and analytics supplier.
Failure to do the above could be exploited by our competitors. If we lose market share due to lapses in our product development, our business would suffer.
Uncertain conditions surrounding the 5G infrastructure investment cycle may cause fluctuations in our revenue growth rate and impact our financial results.
Markets for the 5G infrastructure investment cycle may not develop in the manner or in the time period that we anticipate. If global economic conditions worsen, overall spending on 5G infrastructure may be reduced, which would adversely impact demand for our solutions in these markets. In addition, unfavorable developments with evolving laws and regulations worldwide related to 5G may limit or slow the rate of global adoption, impede our strategy and negatively affect our long-term expectations in this area. Even if the 5G infrastructure market and rate of adoption develop in the manner or in the time period that we anticipate, if we do not have timely, competitively priced, market-accepted solutions available to meet our customers’ planned rollout of 5G platforms and systems, we may miss a significant market opportunity and our business, financial condition, results of operations and cash flows could be materially and adversely affected.
Increased customer demand for our technical support services may adversely affect our relationships with our customers and our financial results.
We offer technical support services for many of our solutions, including professional services for the installation of our monitoring and analytics solutions. We may be unable to respond quickly enough to accommodate short‑term increases in customer demand for our support services. We also may be unable to modify the format of our support services to compete with changes in support services provided by competitors. Our customers depend on our support organization to resolve issues related to our deployed solutions on their networks. A high level of support is critical for continued business relationships with our customers. If we or our channel partners do not effectively assist our customers in deploying our solutions, succeed in helping our customers to quickly resolve post-deployment issues, or provide effective ongoing support, it would adversely affect our ability to sell our solutions to existing customers and harm our ability to attract new customers. Consequently, any failure to maintain high-quality support and services would harm our operating results and reputation. Further customer demand for these services, without corresponding revenues, could have a material and adverse impact on our financial condition and results of operations.
We have faced pricing pressure on our existing products and expect this pressure will continue. If we do not continue to lower our manufacturing costs or introduce new products with higher margins, our gross margin may decrease, and our operating results may be adversely affected.
Increased competition in the communications test, monitoring and analytics markets, along with consolidation among competitors and customers, will likely result in ongoing downward pressure on average selling prices. For example, some of our customers have been subject to consolidation and could obtain products from a vendor other than us or demand more favorable terms and conditions from us. This, in turn, may negatively affect our gross margin. In addition, some customers may merge with or acquire our competitors and discontinue their relationships with us. Pricing pressure can result from a number of factors such as, among other things:
increased competition for business;
limited number of potential customers;
competition from companies with lower production costs, including companies operating in lower-cost environments;
introduction of new products by competitors;
greater economies of scale for higher-volume competitors;
large customers, who buy in high volumes, can exert substantial negotiating leverage over us; and
As pricing pressure will likely continue to affect our existing products, we may have to increase the number of units sold to maintain our existing sales levels. If we are unable to increase our sales levels, lower our manufacturing costs, or introduce new products with higher margins, our gross margin may decline, and our operating results may suffer.
Our products may have unforeseen defects, offer substandard technical specifications or fail to deliver the key features that customers want, all of which could harm our reputation, impede market acceptance of our products and negatively impact our business, results of operations and financial condition.
Given their complexity, our products may contain undetected software or hardware defects, inaccurate calibration or compatibility problems, or regulatory compliance issues, particularly when they are first introduced or when new versions are released. Our new products could also be substandard in terms of technical specifications or fail to deliver the key features that customers want. There can be no assurance that, despite our testing and diligent efforts, defects will not be found in new products after they have been fully deployed and operated under peak stress conditions, or that customized products will meet customer sign-off acceptance requirements. If we are unable to fix defects or other problems or meet customized requirements, we could experience, among other things:
additional development and support costs;
product returns or recalls;
damage to our brand reputation;
loss of customers, failure to attract new customers or achieve market acceptance;
diversion of development and engineering resources;
legal actions by our customers, including claims for consequential damages and loss of profits; and
legal actions by governmental entities, including actions to impose product recalls and/or forfeitures.
The occurrence of any one or more of the foregoing could seriously harm our business, results of operations and financial condition.
Our intellectual property and proprietary technology are important to the continued success of our business. Our failure to protect this proprietary technology may significantly impair our competitive position.
Our success and ability to compete depend to a significant extent on our proprietary technology, with which we attempt to prevent others from using the innovations that are central to our existing and future products. As of August 31, 2019, our records indicate that we held the following portfolio of utility patents: 94 active granted US patents, 118 granted or validated patents in European countries and 45 patents in other jurisdictions. In addition, we have 53 utility patent applications (including provisional applications) pending in the US, 19 utility patent applications pending in Europe and 19 utility patent applications pending in other countries. The expiration dates of our active issued patents range from 2019 to 2037, with no significant active patent expiring in the near future.
Our records also indicate that, as of August 31, 2019, we held 36 active granted design patents, as well as 11 pending design patent applications, in the United States, Europe, China and other jurisdictions.
We also rely on a combination of copyright and trademark laws, trade secrets, confidentiality procedures, contractual provisions and license agreements to protect our proprietary technology.
We may have to engage in litigation, formal opposition proceedings, or the like to defend our patents and other intellectual property rights or to determine the validity or scope of the proprietary rights of others. Such litigation and opposition proceedings can be time-consuming and expensive, regardless of whether we win or lose.
The process of seeking patent protection can be long and expensive and we cannot be certain that any currently pending or future application will actually result in issued patents, or that, even if a patent is issued in a particular jurisdiction, it will not be subsequently invalidated at the patent office as a result of a third-party-initiated opposition procedure. Moreover, we cannot be certain that an issued patent will be of sufficient scope or strength to provide meaningful protection or commercial advantage to us.
We also rely on trade secret protection for our technology, in part through confidentiality agreements with our employees, consultants, distributors and third parties. However, these agreements may be breached or otherwise rendered ineffective and we may not have adequate remedies for any breach or shortfall of these agreements. In any case, others may come to know about our trade secrets through a variety of methods. In addition, the laws of some jurisdictions in which we sell our products may not protect our intellectual property rights to the same extent as do the laws of Canada and the United States.
Our intellectual property rights, particularly our existing or future patents, may be invalidated, circumvented, challenged or required to be licensed to others.
Our intellectual property rights are important assets for us. Various events outside of our control pose a threat to our intellectual property rights, as well as to our products, services and technologies. For example, effective intellectual property protection may not be available in every country in which our products and services are distributed. Also, the efforts we have undertaken to protect our proprietary rights may not be sufficient or effective.
Furthermore, others may develop technologies that are similar or superior to our technology, duplicate or reverse engineer our technology, or design around the patents owned or licensed by us. We cannot be sure that the steps that we take to protect our technology will prevent misappropriation or infringement. If we fail or are unable to protect our technology, thereby enabling others to copy or use it, we will be less able to differentiate our products and our sales may decline.
Others may claim that our products infringe upon their intellectual property rights, or they may infringe our intellectual property, and we may expend significant resources enforcing or defending our rights or suffer competitive injury.
Litigation regarding intellectual property rights is common in the technology industry and third-party infringement claims involving technologies may increase. If an infringement claim is filed against us, we may be prevented from using some of our technologies and may incur significant costs to resolve the claim. Conversely, we may be required to spend significant resources to monitor and enforce our intellectual property rights.
While non-practicing entities (NPEs – also informally known as “patent trolls”) are continually asserting patent claims against companies working in the Information and Communications Technology domain, “trademark trolls” are also becoming increasingly common. These “trademark trolls” will file trademarks in countries where the trademark has not yet been registered. In both cases, because their entire business model is predicated upon undertaking legal action to extract licensing and/or royalty fees from legitimate “practicing” entities, such as EXFO, they often initiate such litigation even if the purported relevance of their trademark or patent claims may be questionable. Consequently, we may be obliged to reach a negotiated monetary settlement or embark upon costly legal proceedings if a “patent troll” or a ‘’trademark troll’’ asserts such claims against us.
More generally, we could incur substantial costs in defending ourselves and our customers against infringement claims asserted by any third party (including notably competitors), or in bringing infringement claims against others. Litigation could also adversely affect sales of the challenged product or technology and divert the efforts of our management and technical personnel. In the event of an infringement claim, we may be required to obtain one or more licenses from third parties. We cannot assure you that we, or our customers, could obtain necessary licenses from third parties at a reasonable cost or at all. If we fail to obtain a license where one is required, we could incur substantial liabilities and be forced to suspend the marketing of the challenged products.
Our use of open source software in our products could adversely affect our ability to sell our products and subject us to possible litigation.
Some of our products contain software licensed to us by third-party authors under “open source” licenses. If our proprietary commercial software were to incorporate open source software, we might, under the terms of certain open source licenses, be required to license that combined software as well as release the source code of the combined software to third parties. This could allow third parties to use our proprietary software at no charge, could enable our competitors to create similar products with lower development effort and time, and ultimately could result in a loss of product sales and lower revenues for us.
We also could be subject to suits by parties claiming infringement of intellectual property rights in what we believe to be licensed open source software. Moreover, we cannot assure you that our internal processes for controlling our use of open source software in our products will be effective. If we are held to have breached the terms of an open source software license, we could be required to seek licenses from third parties to continue offering our products, to re-engineer our products, to discontinue the sale of our products if re-engineering could not be accomplished in a timely manner, to allow third parties to use our products at no charge under the terms of that open source software license, or to make generally available, in source code form, our proprietary software, any of which could adversely affect our business, operating results, and financial condition.
Our quarterly revenues and operating results are subject to significant fluctuations and you should not rely on them as an indication of our future performance.
Our sales and operating results have fluctuated from quarter to quarter in the past and significant fluctuations may occur in the future. Given that orders for our monitoring and analytics solutions vary in size and complexity and in certain instances require customer acceptance before revenue recognition occurs, our sales may fluctuate significantly on a quarterly basis. As well, many of our deals involve lengthy sales cycles, contract negotiations, professional services, as well as extensive product testing, installation, laboratory or network certification, including network-specific or region-specific processes. In addition, our sales and operating results generally depend on the volume and timing of the orders we receive from customers as well as our ability to fulfill received orders.
On the other hand, our cost of sales and operating expenses, which include manufacturing overhead costs, selling and administrative, research and development, as well as depreciation and amortization expenses, are relatively fixed in the short term. If we sell fewer products than anticipated, if there is a delay in the launch of new products, or if prices for our products decline, we may not be able to quickly reduce our cost of sales and operating expenses in response to lower sales. Factors that could affect the amount and timing of our sales and cause quarterly fluctuations in our revenue and operating results include, among other things:
length of the sales cycle for certain products, especially those that are higher priced and more complex;
sales cycle prolonged by lengthy customer acceptance;
timing of product launches and market acceptance of our new products as well as those of our competitors;
our ability to sustain product volumes and high levels of quality across all product lines;
timing of shipments for large orders;
effect of seasonality on sales and bookings; and
losing key accounts and not successfully developing new ones.
Our sales and operating results could also be volatile due to a number of factors, some of which we have little or no control over, including, without limitation:
fluctuating demand for test, monitoring and analytics solutions;
changes in the capital spending and operating budgets of our customers, which may cause seasonal or other fluctuations in product mix, volume, timing and number of orders we receive from our customers;
order cancellations or rescheduled delivery dates;
pricing changes by our competitors or suppliers;
insufficient or excess inventory;
variations in the mix between higher and lower-margin products and services;
customer bankruptcies and difficulties in collecting accounts receivable;
restructuring and impairment charges;
foreign exchange rate fluctuations;
general economic conditions, including a slowdown or recession;
distorted effective tax rate due to non-taxable/deductible elements and unrecognized deferred tax assets; and
effects of recent acquisitions of businesses.
We may in the future choose to reduce prices, increase spending, or modify our product portfolio in response to actions by competitors or in an effort to pursue new market opportunities. These actions may also adversely affect our business and operating results and may cause our quarterly results to be lower than the results of previous quarters. Due to these factors, you should not rely on quarter-to-quarter comparisons of our results of operations as an indication of our future performance.
We depend on short-term arrangements with a single supplier or a limited number of suppliers for some key components and materials in our products, which makes us susceptible to supply shortages or price fluctuations that could adversely affect our operating results.
We depend on a single supplier or a limited number of suppliers for several parts used to manufacture our products for which alternative sources may not be readily available. In addition, all of our orders are placed through individual purchase orders and, therefore, our suppliers may stop supplying parts to us at any time. Our reliance on a single source or limited number of suppliers could result in increased costs, delivery problems, reduced control over product pricing and quality and could require us to stockpile critical parts. Financial difficulties of suppliers could also affect our ability to obtain necessary parts in a timely manner. Any interruption or delay in the supply of any of these parts could significantly harm our ability to meet scheduled product deliveries to our customers and cause us to lose sales. Furthermore, the process of qualifying a new manufacturer for complex parts designed to our specifications, such as our optical, electronic and mechanical parts, is lengthy and would consume a substantial amount of time from our technical personnel and management. If we were required to change a supplier in a short period of time, our business would be disrupted. In addition, we may be unsuccessful in identifying a new supplier capable of meeting and willing to meet our needs on acceptable terms. Consolidation involving suppliers could further reduce the number of alternatives available to us and increase the cost of parts, which would render our products less competitive and result in lower margins.
Our failure to maintain an effective system of internal control over financial reporting means that we may not be able to accurately report our financial information or prevent fraud, which could harm our operating results and cause investors to lose confidence in our reported financial information.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB).
We devote significant resources and time to comply with the requirements of the Sarbanes-Oxley Act of 2002. Our efforts to comply with the annual internal control reporting requirement for each fiscal year depends on the effectiveness of our financial reporting as well as data systems and controls throughout our company and operating subsidiaries. We cannot be certain that these measures will ensure that we design, implement and maintain adequate controls over our financial processes and reporting in the future. Our failure to implement newly required or improved controls or adapt our controls, or difficulties encountered in their operation, or difficulties in the assimilation of acquired businesses into our control system, can harm our operating results, or prevent us from meeting our financial reporting obligations or result in a restatement of previously disclosed financial statements. Inferior internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on our share price and our access to capital.
We require employees and managers who are knowledgeable about the specialized nature of our business. If we are unable to attract and retain sufficient numbers of highly skilled technical, sales, marketing, senior management and other personnel, our operations and financial results will suffer.
Due to the specialized nature of our business, we are highly dependent on the continued service of and on our ability to attract qualified engineering, sales, marketing, senior management and other personnel. If we are unable to attract and retain such qualified personnel, it could have a material adverse effect on our business, results of operations and financial condition.
We must also provide significant training for our employees due to the highly specialized nature of the communications test, monitoring and analytics markets. The knowledge base of our current personnel may be inadequate, or we may fail to assimilate and train new employees. Highly skilled employees with the education and training that we require – especially employees with significant experience and expertise in international business development, product management, sales, engineering and operations – may be difficult to find. Once trained, our employees may leave the organization or be hired by our competitors and reveal highly sensitive information to them.
We may become involved in various lawsuits and legal proceedings that may substantially increase our costs and harm our business.
We may from time to time become involved in various lawsuits and legal proceedings. Litigation is subject to inherent uncertainties and an adverse result may arise from time to time that could have a material adverse effect on our business, results of operations or financial condition. Any litigation to which we are subject could require significant involvement of our senior management and may divert management attention from our business and operations.
In addition, the failure of our products to perform to customer expectations could give rise to product liability and warranty claims. We carry insurance for product liability and take accounting reserves for warranty claims that we consider adequate in view of industry practice, but this may not be sufficient to cover all potential liability.
We may also face other types of claims by third parties in relation to the conduct of our business. A successful claim against us for an amount exceeding our policy limits would force us to use our own resources to pay the claim, which could result in a reduction of our cash available for other uses, increase our expenses and have a negative effect on our business, results of operations and financial condition.
If we suffer loss to our factories or facilities, our operations could be seriously harmed.
Our factories and facilities may be subject to catastrophic losses due to fire, vandalism, terrorism or other natural or man-made disasters. We do not have redundant multiple-site capacity and if any of our facilities or factories were to experience a catastrophic loss, it would disrupt our operations, delay production, shipments and revenue and result in large expenses, thereby harming our results of operations.
Unexpected declines in our research and development and other tax credits and grants may have an adverse effect on our business.
Our operating results reflect substantial benefits from programs sponsored by governments for the support of research and development activities conducted in Canada and France. Research and development tax credits and grants represented 12.8% of our gross research and development expenses for the year ended August 31, 2019.
If changes in laws or government policies terminate or adversely modify the Canadian, French or Finnish government programs, under which we receive our research and development and other tax credits and grants, or if we unexpectedly become unable to participate in or take advantage of these programs, then our net research and development and other expenses will materially increase or we may decrease our research and development activities.
In addition, to the extent that we may increase our research and development activities in India, or potentially acquire new companies, our increased R&D activities may not be eligible for these programs. If we were required to decrease our research and development activities or were unable to benefit from other tax credits and grants, this could have a material adverse effect on our business, results of operations and financial condition.
Changes in our effective tax rate or adverse outcomes resulting from tax audits, including international inter-company transfer price audits, may have an adverse impact on our results.
As an international corporation, we are subject to taxation in the various jurisdictions in which we conduct business. Significant judgment is required in the determination of our worldwide provision for income taxes and this determination requires the interpretation and application of complex tax laws and regulations. Our global effective tax rate may be adversely impacted by the level of earnings, by changes in the mix of earnings/losses among companies and countries which may have different statutory tax rates, by the write-off of our deferred tax assets, by the intercompany transfer price used and by changes in tax rules and regulations. We are also subject to income tax and transfer pricing audits in the respective jurisdictions in which we conduct business. We regularly assess the likelihood of adverse outcomes resulting from these audits and review the adequacy of our provisions for income taxes. There can be no assurance that the outcomes of these tax audits will not result in liabilities in excess of our provisions, which could have an adverse impact on our results and financial condition.
Our current principal stockholder has effective control over our company.
As of November 1, 2019, Germain Lamonde, our Executive Chairman of the Board, held 94.06% of the voting rights in our stock. By virtue of his stock ownership, Mr. Lamonde has effective control over all matters submitted to our stockholders, including the election of our Directors, and exercises significant control over our policies and affairs. Such concentration of voting power could have the effect of delaying, deterring or preventing a change in control or other business combinations that might otherwise be beneficial to our stockholders and may harm the market price of our shares.
If we complete major acquisitions of complementary businesses, products or technologies, we may need additional capital, and may not be able to raise additional capital on favorable terms or at all, which could limit our ability to grow and could increase our costs.
Our future liquidity and capital requirements are difficult to predict because they depend on numerous factors, including the success of our existing and new product offerings as well as competing technology and market developments. As a result, we may not be able to generate sufficient cash flows from our operations to meet additional working capital requirements, support additional capital expenditures or take advantage of acquisition opportunities. As at August 31, 2019, we held $19.4 million in cash and short-term investments, while total debt and bank loans reached $10.7 million. We also had revolving credit facilities of $56.5 million available to us as at August 31, 2019.
We may need to raise additional capital in the future. Our ability to obtain additional financing will be subject to a number of factors, including market conditions, access to credit facilities, our operating performance, as well as current debt level. These factors may render the timing, amount, terms and conditions of additional financing unattractive for us. If we raise additional funds by selling equity securities, the relative ownership of our existing investors could be diluted, or new investors could obtain terms more favorable than previous investors. If we raise funds through debt financing, we could incur significant borrowing costs and be required to meet restrictive debt covenants. If we are unable to raise additional funds when needed or at terms satisfactory to us, our ability to operate and grow our business could be impeded.
We continue to realign our cost structure to current and anticipated future market conditions.
We implemented restructuring plans in previous years to realign our cost structure to current and anticipated future market conditions. The latest restructuring plan was completed after the second quarter of fiscal 2019. Delays in the implementation of anticipated workforce reductions in highly regulated locations outside of Canada and the US could materially impair our ability to achieve expected cost reductions or may disrupt our business. We may also fail to meet operational targets due to the loss of key employees. In addition, the anticipated cost savings and other benefits that we hope to achieve from these actions are based on many estimates and assumptions. These estimates and assumptions are subject to significant economic, competitive and other uncertainties, some of which are beyond our control. If these estimates and assumptions are incorrect, if we experience delays, or if other unforeseen events occur, our business and results of operations could be adversely affected.
We have outstanding indebtedness and may incur additional indebtedness in the future, which could adversely affect our financial condition, liquidity and results of operations.
We currently have outstanding indebtedness as well as availability to incur additional indebtedness under revolving credit facilities. We may borrow additional amounts in the future and use the proceeds from any future borrowing for general corporate purposes, future acquisitions, capital expenditures, expansion of our business or repurchases of our outstanding subordinate voting shares. Our incurrence of this debt, and increases in our aggregate levels of debt, may adversely affect our operating results and financial condition by, among other things:
requiring a portion of our cash flows from operations to make interest payments on this debt;
increasing our vulnerability to general adverse economic and industry conditions;
reducing cash flows available to fund capital expenditures and other corporate purposes and to grow our business; and
limiting our flexibility in planning for, or reacting to, changes in our business and the industry.
Our current revolving credit facilities and bank loan imposes restrictions on us, including restrictions on our ability to create liens on our assets and the ability of our subsidiaries to incur indebtedness, and requires us to maintain compliance with specified financial ratios. Our ability to comply with these ratios may be affected by events beyond our control. If we breach any of the covenants and do not obtain a waiver from the lenders, then, subject to applicable cure periods, our outstanding indebtedness could be declared immediately due and payable.
Our business and operations would suffer in the event of a failure of our information technology infrastructure.
We rely upon the capacity, efficiency and security of our information technology hardware and software infrastructures and those from third parties, as well as our ability to expand and update these infrastructures, in response to our evolving needs. Any failure to manage, expand, update or secure our information technology infrastructures or any failure in the operation of these infrastructures could harm our business.
Our information systems and third-party systems may be vulnerable to damages from computer viruses, natural disasters, unauthorized access, theft of information and other similar disruptions. Any system failure, accident or security breach could result in disruptions to our operations. To the extent that any disruption, security breach or cyber-attack results in a loss or damage to our data, or inappropriate disclosure of confidential information, it could harm our business. In addition, these events may force us to devote more money and resources in order to protect ourselves against damages caused by these disruptions or security breaches in the future.
The enactment of new privacy laws and regulations in the jurisdictions in which we do business could require significant company resources or limit the way our customers can use our products.
The enactment of new federal, provincial, or foreign data privacy laws and regulations could prevent customers from taking advantage of all the features or capabilities of our products which, in turn, could reduce demand for certain of our products. In addition, changes in international privacy laws have required an adjustment to some of our internal processes and significant resources in the past, and future changes could require similar efforts and resources with regard to compliance. The adoption of or changes to any such data privacy laws and regulations could affect demand for our products, increase the cost of selling our products and divert time and attention of our management, all of which could have a material and adverse effect on our financial condition and results of operations. For example, the European Union (EU) data protection law, the General Data Protection Regulation (GDPR), which became effective in May 2018, is wide-ranging in scope. To adapt to these new requirements, we have invested resources necessary to enhance our policies and controls across our business units and services, relating to how we collect and use personal data from customers and employees and how vendors handle personal data we provide to them. We will also evaluate the potential impact of the Canadian “Digital Privacy Act” and the “People’s Republic of China Network Security Law” that were implemented on November 1, 2018, and June 1, 2017, respectively, as well as that of the “California Consumer Privacy Act” coming into effect on January 1, 2020. Going forward, we expect that the international transfer of personal data will present ongoing compliance challenges and complicate our business transactions as we negotiate and implement suitable arrangements with international customers as well as international and domestic vendors.
Compliance with SEC rules relating to “conflict minerals” may require us and our suppliers to incur substantial expense and may result in disclosure by us that certain minerals used in components and/or products we contract to manufacture may contain such “conflict minerals”.
The SEC adopted disclosure requirements under Section 1502 of the Dodd-Frank Act, regarding the source of certain conflict minerals for issuers for which such conflict minerals are necessary to the functionality or production of a product manufactured, or contracted to be manufactured, by that issuer, which are mined from the Democratic Republic of Congo (“DRC”) and adjoining countries. The metals covered by the rules include tin, tantalum, tungsten and gold, commonly referred to as “3TG.” Because we use components which contain tin, tantalum, tungsten or gold, the SEC rules require us to conduct a reasonable country of origin inquiry to determine if we know or have reason to believe any of the minerals used in the production process may have originated from the DRC or an adjoining country (collectively referred to as “covered countries”) and, depending on the results of such inquiry, to perform further supply chain due diligence on the source and chain of custody of those minerals to determine if they originated in one of the covered countries and, if so, whether they financed or benefited armed groups in the covered countries. Our material sourcing is broad based and multi-tiered, and we may not be able to easily verify the origins for all metals used in our products. As a result, the costs of the aforementioned diligence efforts by us and by our suppliers could be significant. In addition, disclosures by us mandated by the rules which are perceived by the market to be “negative” may cause customers to refuse to purchase our products. We are unable to assess the cost of continuing compliance with this rule, and there can be no assurance that the cost will not have an adverse effect on our business, financial condition or results of operations.
If we are held liable for the violation of the applicable anti-bribery laws, it could have a material adverse effect on our business.
We are subject to the applicable anti-bribery laws in countries we do business, which generally prohibit companies, their subsidiaries, their affiliates and their intermediaries from making improper payments to government officials for the purpose of obtaining or retaining business or otherwise obtaining favorable treatment. The anti-bribery laws generally apply to companies, individual directors, officers, employees and agents. Under the applicable anti-bribery laws, companies may be held liable for actions taken by agents, local partners or representatives. If we or our intermediaries fail to comply with the requirements of the applicable anti-corruption laws, governmental authorities in the U.S., in Canada or other countries could seek to impose civil and/or criminal penalties, which could have a material adverse effect on our business, results of operations, financial condition and cash flows.
Our stock price has experienced substantial volatility in the past and may remain volatile in the future. Volatility in our stock price can arise from a number of factors discussed in this “Risk Factors” section. Our stock price will fluctuate based on our financial performance and growth expectations. It can also be affected by public announcements from our competitors and our customers in the communications industry. In addition, turmoil in credit markets and in the broader economy can contribute to share price and volume fluctuations in global stock markets. During fiscal 2019, our closing stock price on NASDAQ ranged from a high of $4.80 per share to a low of $2.75 per share. These aforementioned factors, including volatility often unrelated to the operating performance of our company, may materially affect our stock price in the future.
Our legal name and commercial name is EXFO Inc. / EXFO inc. Our head office is located at 400 Godin Avenue, Quebec, Quebec, Canada, G1M 2K2 and our main telephone number is (418) 683-0211. Our e-mail address is info@EXFO.com and our website is www.EXFO.com. Information on our website is not incorporated by reference in this Annual Report. Our agent for service in the United States is CT Corporation System, 111 Eighth Avenue, 13th Floor, New York, New York 10011. Our Transfer Agent and Registrar is AST Trust Company (Canada) (AST), 2001 Robert-Bourassa Blvd., Suite 1600, Montreal, Quebec, Canada, H3A 2A6. This Annual Report contains trademarks and registered trademarks of us and other companies.
We were incorporated in Canada on September 18, 1985 pursuant to the Canada Business Corporations Act. Since that date, we have amended our articles on various occasions mainly to modify our legal and corporate names and our share capital.
Since we are using this Form 20-F as an annual report, we have provided herein the information required pursuant to Item 4A(4) for the period beginning as at September 1, 2018 until the date of this Annual Report. For information responsive to this Item 4A(4) for prior periods, please refer to our previously filed Annual Reports on Form 20-F. Information in our previously filed Annual Reports on Form 20-F is not incorporated by reference in this Annual Report.
In October 2018, as part of our restructuring plan, we shut down our site in Concord, Ontario, Canada. On February 1, 2019, we sold our real estate property in Concord, Ontario, Canada for net proceeds of $3.3 million. The transfer of ownership resulted in a gain of $1.7 million recorded in the statement of earnings for fiscal 2019.
In October 2018, as part of our restructuring plan, we shut down our operations in Chelmsford, Massachusetts, USA. On December 1, 2018, we also transferred certain intellectual property held in the United States to Canada. This transfer created a one-time deferred income tax recovery of $2.4 million in the statement of earnings for fiscal 2019.
On January 8, 2019, we announced that our Board of Directors approved a share repurchase program, by way of a normal course issuer bid on the open market of up to 1,200,000 subordinate voting shares at the prevailing market price. The period of the normal course issuer bid commenced on January 14, 2019 and will end on January 13, 2020. From January 14, 2019 through November 11, 2019, we spent approximately US$0.6 million (including fees) to repurchase 127,604 subordinate voting shares.
We provide communications service providers (CSPs) as well as data center, cloud and web-scale operators with test, monitoring and analytics solutions to ensure the smooth deployment, maintenance and management of next-generation networks. We have also forged strong relationships with network equipment manufacturers (NEMs) to develop deep expertise that migrates from the lab to the field and beyond. We believe that our key differentiation comes from combining intelligent, automated and cloud-based test and monitoring solutions with real-time analytics to deliver superior network performance, service reliability and subscriber insights. We are number one in optical testing in terms of global market share and are among the top five suppliers of monitoring and analytics solutions for the communications industry worldwide.
We believe that our unique blend of hardware equipment, software and services accelerates digital transformations related to fixed and mobile network deployments. More specifically, we target high-growth market opportunities that enable customers to increase bandwidth capacity and improve quality of experience on network infrastructures: 5G and Internet of Things (IoT), 4G/LTE (long-term evolution), wireless backhaul and fronthaul, small cells and distributed antenna systems (DAS), 400G and 100G network upgrades as well as fiber-to-the-home (FTTH)/fiber-to-the-curb (FTTC)/fiber-to-the-node (FTTN) deployments.
We were founded in 1985 in Quebec City, Canada. Our original products were focused on the needs of installers and operators of fiber-optic networks. Customers use these field-portable test solutions for the installation, maintenance and troubleshooting of optical networks. Over the past several years, we have enhanced our competitive position in the communications test, monitoring and analytics markets through acquisitions of transport and datacom, copper/xDSL and wireless test companies, an IP service assurance business, an analytics software company, radio frequency (RF) test technologies for fiber-based radio access networks (RANs), automated network topology software, optical test equipment for lab and research applications, as well as performance analysis solutions for mobile networks and subscriber experience.
EXFO benefited from ongoing fiber buildouts and early 5G wireless deployments in fiscal 2019 as CSPs transformed their networks to address growing Internet usage, proliferation of smart phones and tablets, and an explosion in video services. On the wireline side, the 100G upgrade cycle continued throughout metropolitan networks, 400G made its way into some data centers, while early 800G designs were seen in labs. We also witnessed fiber rollouts and small cell deployments closer to the network edge to support the ultra-high speeds and low-latency requirements of tomorrow’s wireless infrastructures. On the wireless end, service providers worldwide became embroiled in a race to deliver 5G services first to their subscribers. Already, the two largest CSPs in the US are claiming bragging rights with partial deployments of 5G services in certain metropolitan areas. Leading service providers in South Korea and China also rolled out 5G services in calendar 2019, but massive commercial deployments are not expected until 2020 when 5G smartphones become widely available.
Against this backdrop, CSPs are grappling with the complex architectures required to manage virtualized networks, which are essential to monetizing 5G services and lowering operating costs. Early use cases revolve around fixed wireless and enhanced mobile broadband (eMBB) for ultra-high-definition video streaming, augmented reality and virtual reality applications. Next in line are massive machine type communications (mMTC), requiring a connection density of 1 million devices per square kilometer, to support the Internet of Things (IoT). Finally, ultra-reliable, low-latency communications (URLLC) are slated to come later in the 5G cycle to enable delay-sensitive applications like autonomous cars and industrial automation that require a response time as low as 1 ms.
Our long-term goal is to become the global leader in the communications test, monitoring and analytics markets. We believe that digital transformations are taking place throughout the communications industry to cope with surging bandwidth demand and the need to better monetize networks. Consequently, CSPs, webscale companies and NEMs are making considerable investments to modernize network infrastructures.
Our growth strategy focuses on internal investments and acquisitions in two main technology areas: fiber and 5G.
First, fiber is being deployed everywhere. Communications service providers are continuing fiber buildouts and high-speed deployments in Metro, regional and access networks to meet bandwidth demand. Cable companies are following suit with Fiber Deep initiatives to remain competitive. Webscale operators are building data centers closer to the network edge to ensure a superior quality of experience for end-users.
All these customer groups rely on fiber testing and we believe that the depth and breadth of our product portfolio and No. 1 position in the optical test equipment market will lead to our continued growth.
Second, 5G mobility. The 5G investment cycle got underway in limited geographies in 2019. Initial use cases revolve around fixed wireless and enhanced mobile broadband, but we believe that 5G is all about machines and incremental revenue. We should see massive machine type communications and ultra-reliable, low-latency applications later in the cycle.
EXFO is currently benefiting from the 5G network densification phase. Service providers are deploying small cells in densely populated areas to deliver the next-generation services that subscribers expect. These small cells need to be connected with fiber and we expect to capitalize with our leadership position in optical testing.
The next phase of 5G deployment will get underway in mid-2020 as mobile network operators deploy radio equipment for the standalone 5G standard. EXFO provides RAN optimization solutions for network operators, who must cope with the tradeoff between capacity and coverage on high-, mid- and low-band spectrum.
Finally, the network monitoring phase will begin in mid- to late-2020 when commercial rollouts of 5G networks become mainstream. This is when EXFO’s troubleshooting and monitoring solutions will provide end-to-end visibility of 5G networks.
These full-fledged 5G networks will be built around a virtualized architecture to increase monetization opportunities and reduce operating costs. Already, we have successfully deployed a virtualized service assurance solution with 3UK, a British mobile network operator.
Customers on a global basis use our test, monitoring and analytics solutions to enable their networks to perform optimally during their complete life cycles: research, development, manufacturing, installation, maintenance and monitoring.
We initially developed test equipment for wireline CSPs and, to a lesser extent, component vendors and network equipment manufacturers, but over the years we have expanded our offering to wireless CSPs, cable television companies, data center, cloud and web-scale operators, public utilities, private network operators, third-party installers, equipment rental companies, large enterprises and laboratory researchers.
In fiscal 2019, our top customer accounted for 6.9% of our sales and our top three customers represented 18.1%. In comparison, our top customer accounted for 9.1% of sales and our top three customers represented 15.9% in 2018, while our top customer accounted for 10.1% of sales and our top three customers represented 18.4% in 2017.
Beginning in fiscal 2019, we started reporting sales and bookings results based on two newly defined product families: Test and Measurement (T&M) and Service Assurance, Systems and Services (SASS). Optical, transport and copper test solutions make up the T&M product family, including portable equipment for the field and benchtop units for the lab and manufacturing environments. The SASS family mainly consists of service assurance, fiber monitoring, analytics and professional services as well as other systems-related solutions like network simulation and network topology. The SASS product family tends to be software-intensive with longer sales and revenue-recognition cycles than the T&M group. We believe this product breakdown better reflects our long-term strategy, while enhancing comparisons against industry peers and investors’ understanding of our business.
Test and Measurement (T&M)
We offer a broad range of test solutions that support customers in the digital transformation of their networks from the core to the network edge. We believe the competitive advantages of our products include a high degree of innovation, modularity and ease of use. Ultimately, we believe our products enable NEMs, CSPs as well as data center, cloud and web-scale operators to design, deploy, and troubleshoot wireline and wireless networks, as well as help customers reduce their operating expenses.
We provide portable test solutions that are mainly used by CSPs to install, turn up and maintain their optical, wireless and copper-based communications networks. These products are available as handheld test instruments, portable platforms with related modules, and as rack-mounted chassis with related modules.
Our handheld instruments are durable, compact and easy to use. They include dedicated instruments like power meters for optical networks and digital subscriber line (DSL) testers for copper access networks. They can also be multi-function units that carry out several different measurements.
Our field-test platforms, namely the FTB-1 Pro Platform, FTB-1 Platform, FTB-2 Pro Platform, FTB-4 Pro Platform and FTB-500 Platform, are at the core of our portable product portfolio. Our FTB-1 Pro, designed for frontline technicians in the field, is a single-slot, modular platform dedicated to carry out optical, Ethernet and multiservice tests simply and efficiently. It differentiates itself through ultra-strong processing power and rich features like a multi-touch, high-resolution widescreen display. The FTB-1 Platform does not possess the same processing power or rich feature set of the FTB-1 Pro, but it is suitable for optical, copper, Ethernet and multiservice testing applications.
Our FTB-2 Pro offers the power and scalability of a multi-technology, high-performance unit, but in a smaller form factor. The FTB-2 Pro Platform can host two single-slot test modules, such as an OTDR (optical time domain reflectometer), automated optical loss test set (OLTS) with a variety of fiber inspection probes (FIPs), and Ethernet tester that can characterize transmission rates up to 100 Gbit/s.
The FTB-4 Pro, the latest addition to our platform family, supports as many as four modules for tests in high-speed networks, data centers and R&D labs. It provides field technicians with a combination of 400 Gbit/s commissioning, turn-up and troubleshooting tools on a single platform for both transport and advanced dispersion testing.
Our FTB-500 platform is available in two configurations for various high-end tasks with transmission rates up to 100 Gbit/s. The four-slot model of the FTB-500 is designed for datacom testing, OTDR analysis, optical loss, Ethernet and multiservice transport (SONET/SDH/OTN) testing. The eight-slot model is a high-performance, multiple-protocol unit that allows users to combine next-generation SONET/SDH functions with Ethernet, Fibre Channel and optical-layer testing capabilities. It can handle dispersion characterization (PMD and CD), as well as DWDM/ROADM testing with optical spectrum analysis, and a variety of FIPs.
All five portable platforms support USB, mobile, Wi-Fi, and Bluetooth connectivity capabilities to efficiently manage testing and reporting operations in the field. These PC-centric, open-ended platforms, combined with cloud-based software applications, can be transformed into a fully connected test environment that allows CSPs to automate complex, labor-intensive tasks like fiber-to-the-antenna (FTTA), distributed antenna system (DAS) and small cell deployments. Leveraging platform connectivity, customers can also keep track of their entire test fleet, manage software updates and schedule calibration procedures. All test data can be stored in a central database and used as a point of reference against future measurements within our cloud-based solution. Consequently, this enhanced test environment enables customers to increase productivity and reduce operating expenses.
Our network equipment manufacturer (NEM) solutions, mainly built around our LTB-8 Rackmount Platform, are available as test modules or stand-alone benchtop instruments.
Our highly scalable LTB-8 platform, which can host as many as eight 100G test modules, addresses the numerous requirements that NEMs demand from their multiservice transport and datacom network equipment. Lab users can carry out tests for a variety of technologies including Ethernet, OTN, Fibre Channel and SONET/SDH. Optical tests can also be carried out via power meters, variable attenuators and switches. Remote control of one or several LTB‑8 platforms is available via a proprietary web-based interface. We also have a 400G test module for the LTB-8 platform that is dedicated to the lab and manufacturing markets.
Apart from our LTB-8 platform, we offer advanced optical test equipment for R&D labs. This high-end product portfolio includes benchtop optical spectrum analyzers, tunable lasers, tunable filters and passive optical component test systems for network equipment manufacturers and optical component vendors.
We provide a comprehensive portfolio of monitoring solutions for wireline and wireless CSPs, delivering full visibility of the network, service and subscriber levels.
At the network level, we offer fiber monitoring solutions, which leverage OTDR (optical time domain reflectometry) technology, enabling centralized monitoring to detect fiber breaks or performance issues 24 hours per day, seven days per week.
At the service level, the EXFO Worx System is an active monitoring solution that delivers real-time, end-to-end quality of service (QoS) and quality of experience (QoE) service monitoring for next-generation IP networks. Built around a distributed architecture, we believe the EXFO Worx System enables the successful launch and ongoing profitable operation of Ethernet/IP-based voice, video and data networks and services across wireline and wireless networks.
We have transformed our active monitoring portfolio to address the growing need for virtualized solutions. The EXFO Worx solution offers a variety of software-based probes, enabling the interworking with virtualized network architectures and functions.
We believe a competitive advantage of EXFO’s active monitoring solution is the ability to implement SLA (service level agreement) monitoring and assure any IP service, over any network, to any endpoint—all from the same open and extensible platform. Key capabilities include:
Layer 2-7 service performance monitoring and analysis for business and residential services;
Mobile backhaul and metro Ethernet service activation and assurance;
IP/MPLS core monitoring and analysis;
IP video service assurance;
Advanced data correlation and analysis engine with comprehensive northbound APIs;
Advanced analytics and reports; and
Custom solutions and back-office integration services.
The EXFO Worx System offers a multi-play capability such that customers can leverage one, several or all of the aforementioned capabilities on a single platform, which we believe delivers significant savings in capital and operating expenditures.
Our active monitoring solution is complemented by network topology software for automated root cause analysis and network inventory applications (physical, virtual and hybrid). As such, we recognized a $4.9 million deal in fiscal 2019 from a US service provider for our network topology software solution. This key contract win came with a related multi-million-dollar customer support plan over the next three years.
EXFO also offers a passive monitoring, analytics and troubleshooting solution for multi-technology mobile networks (2G, 3G, 4G), including the subscriber level. The EXFO-Astellia Nova solution provides mobile network operators with capabilities to detect, correlate, analyze, report, geolocate and troubleshoot issues related to network performance, handset behavior and service usage. It is fully virtualized and integrates rich information from call traces, probes, CRM, billing, etc., to make the most of big data.
This virtualized solution is used by 3UK for the passive monitoring of its recently launched, cloud-native, mobile core network.
The EXFO-Astellia Nova solution improves customer experience and mobile operators’ business performance, optimizes end-to-end service quality, and provides the required insights to enhance subscriber experience. It meets the requirements of network operations, service operations, customer care and marketing teams. Key strengths of this solution include:
Data agnostic (call traces, probe data, third party);
End-to-end, from radio to core;
Big data based; and
To allow customers to get the most out of their monitoring and analytics investments, our experts work hands‑on with them through value-added services that include quality assurance and performance audits as well as business consulting and customization. Additional services include training, project management and 24/7 customer support.
We also provide 2G, 3G, 4G/LTE and 5G network simulators for CSP labs and NEMs. EXFO’s network simulators emulate real-world, large-scale network traffic and end-user behavior in a laboratory environment to predict network behavior, uncover faults and optimize networks before wireless networks and services are deployed. Typical tests include wireless node (EPC, IMS) functional and network load testing.
These various assets are key building blocks of the automated service assurance offering that EXFO is proposing for increasingly complex, cloud-native and 5G networks.
Finally, we offer communications intelligence tools for police, armed forces and other governmental organizations to help fight organized crime and terrorists.
Research and Development
Our global R&D operations fall under the management of a vice president. We maintain R&D centers in Quebec City, Canada, Montreal, Canada, Oulu, Finland, Pune, India, Lannion, France, Rennes, France, Valencia, Spain, and London, UK. Gross research and development expenditures totaled $58.0 million in fiscal 2019 compared to $65.2 million in 2018 and $53.1 million in 2017.
Aligned with our strategic imperative to increase R&D synergies and efficiencies, we transferred activities from Toronto, Canada and Chelmsford, US to primary R&D centers within the company. These two R&D centers were closed down in October 2018.
We believe that our future success largely depends on our ability to introduce new solutions and product enhancements to our core technologies. Through market-oriented product portfolio review processes, we ensure that our investments in research and development are aligned with market opportunities and customers’ needs. This process enables us to maximize our returns on R&D investments by focusing our resources on prioritized projects. Product portfolio review meetings, which occur two times per year, enable us to select the right mix of new products and allocate the necessary resources for their development. All our projects, including those already underway, are reviewed, given a priority rating and allocated budgets and resources. Existing projects can be stopped or substantially redefined if there have been significant changes in market conditions, or if the project development schedule or budget has significantly changed.
Product development projects, once they are underway, are managed through a structured process known as the stage-gate approach combined with an Agile methodology. The stage-gate approach is based on a systematic review of a project’s progress at various stages of its lifecycle. The following are the key review stages of the stage-gate approach:
At each stage, we review our project risks, costs and estimated completion time. We compare our design to anticipated market needs and ensure that our new product development is synchronized with other internal departments and external industry events.
The Agile methodology allows for software development to be done in small increments with constant validation with lead customers. Efficient execution is done through collaborative teams called SCRUM team, ensuring that each increment is fully tested and validated.
We sell our test, monitoring and analytics solutions through direct and indirect sales channels in the Americas (US, Canada, Central and South America), Europe, Middle East and Africa (EMEA) and Asia-Pacific regions.
In the Americas, we use a hybrid model, combining key account management with direct and indirect sales coverage. We typically use key account managers to serve large customers that generate high sales volumes or might potentially represent high sales volumes in the future. These key account managers are supplemented by regional sales managers, sales engineers, sales representatives and distributors in the US as well as Central and South American metropolitan areas, and regional sales managers and sales engineers in Canada.
We opt for a direct sales approach when selling higher-end, highly technical products to sophisticated buyers. Sales of low- to medium-level complexity products to less stringent technical buyers are usually done through a manufacturer representative organization or distributors supported by regional sales managers. Our main sales offices in the Americas are located in Richardson, Texas, Quebec City, Canada and Mexico D.F., Mexico. They are supplemented by a regional presence in cities across the US, Central and South America, as well as Canada.
On the international front, we have a direct sales force covering strategic accounts in EMEA and Asia-Pacific and distribution partners for smaller customers from lower revenue-generating regions.
Our sales network in EMEA is supported by a main office and service center in Chandler’s Ford, Hampshire, UK, which serves as headquarters of our European sales operations and provides repair, calibration and technical support services for our EMEA customers. We also have additional sales offices in multiple countries across EMEA to serve and support our various customers and distribution partners.
As for Asia-Pacific, our regional headquarters are based in Singapore, while our main sales offices for mainland China are located in Beijing, Shenzhen and Shanghai. In addition, we have other sales offices in strategic locations around the Asia-Pacific region to support our customers and distribution partners.
We rely on a network of distributors worldwide to work with us in supporting mostly our international sales and to participate in a large number of international events. We believe that the local presence and cultural attributes of our distributors allow us to better serve our global markets.
Our sales team is led by our chief executive officer (CEO), who is supported by a vice president responsible for each major geographic region: Americas, EMEA and Asia-Pacific. These sales executives, in turn, are assisted by regional sales directors that lead a widely distributed team acting as key account managers, regional sales managers, sales engineers and application engineers. Our sales people are located throughout major metropolitan areas around the world. This group of sales professionals has on average more than 15 years of experience in the fields of telecommunications, fiber optics, or test and monitoring. Within each major geographic region, we have sales staff dedicated to test, monitoring and analytics customers.
We also have an in-house Customer Service Group to meet the needs of existing and new customers. This group is responsible for providing quotations to customers, supporting our sales force, managing demonstration units, order management, technical support and training as well as calibration and repair services.
Sales to customers in the Americas represented 50% of our sales in fiscal 2019, while sales to customers in EMEA and Asia-Pacific accounted for 32% and 18% of our sales, respectively. In comparison, the Americas, EMEA and Asia-Pacific accounted for 50%, 32% and 18% of our sales in 2018, respectively, and 55%, 26% and 19% in 2017, respectively.
All product management duties fall under the leadership of our CEO, who is supported by two vice presidents responsible for test and measurement (T&M) as well as service assurance, systems and services (SASS). Each product management executive, in turn, is assisted by directors and/or product managers who have various degrees in engineering, science and business administration. Directors and product managers are responsible for some aspects of our telecom marketing program, specifically product strategy, new product introductions, definition of new features and functions, pricing, product launches and advertising campaigns. We follow up our marketing initiatives by attending industry trade shows. Furthermore, we have a customer relationship management (CRM) system to compile market and customer information including forecasts, opportunities, leads and competitive data. We use this information to make strategic business decisions.
All marketing and communications activities fall under the leadership of our CEO, who is supported by a director of corporate marketing. The department is responsible for promoting EXFO’s brand globally; further strengthening the company’s relevance to our customers, market and industry; positioning the T&M and SASS portfolios; supporting our Sales team and partners; and helping improve customer experience.
To accomplish these tasks, marketing and communications strategies are developed and executed by five multidisciplinary groups, responsible for the following:
Digital Marketing: Achieving marketing objectives through applying digital technologies and media;
Marketing Campaign Management: Marketing campaign planning and execution for all EXFO’s portfolios, collaborating closely with product management;
Commercial Insights: Generating and ensuring adoption of commercial insights to support our sales organization and partners; analyst relations; and our e-learning and training platform;
Field Marketing and Communications: Shining the spotlight on EXFO across the globe, showcasing our expertise and depth of portfolio at industry events, in the media, and other targeted external and internal audiences; and
EXFO’s Global Services operation provides customers with a broad array of support and services worldwide. This team has in-house staff in North America, Europe, and Asia. It also provides local support in specific countries through select partners. Such a strategy enables EXFO to have a global reach while maintaining strong local ties.
This team’s objective is to ensure customer satisfaction through a flawless business experience and to achieve our long-term mission by providing internal and customer-facing services. Specifically, it fulfills its mission by offering:
Sales Support – Leverage the effectiveness of our sales force by providing pre-sales and demo support, as well as guiding customers in purchasing the correct equipment for their respective applications, issuing quotations, and promoting our extended warranty service and support program;
Order Management – Accurately process customer orders from entry through fulfillment and delivery, and manage order changes;
Customer Service – Serve as a primary interface for inbound and outbound customer communication. Provide customers with one central point of contact and work with the customer from purchasing equipment to helping them arrange for service, if necessary;
Technical Support – Provide post-sales technical support to Test & Measurement product end-users, by providing software fixes and upgrades, troubleshooting malfunction or wrong usage of equipment and suggesting ways to improve equipment productivity and performance;
Field Support – Provide expert technical support and deliver product service worldwide. Support our Worldwide Service Centers and directly manage the Service Partner Program. Where applicable, furnish installation and on-site servicing for more complex equipment and applications;
Customer Care Services – Provide pre-sale, delivery, post-sale technical support, and systems actualization of customer’s network monitoring and converged service assurance systems;
Education Services – Aggregate expertise, develop material, and deliver free and fee-based training;
Professional Services – Provide value-added solution services for our test and system customers.
Our manufacturing operations consist mainly of material planning, supply-chain management, sub-assembly, final assembly and test, software loading, calibration, quality control, shipping, billing and customs management. Most of our manufacturing activities, which occupy a total of 125,000 square feet, take place at our facility compound in Quebec City, Canada, Shenzhen, China, and Lannion, France, but we also have facilities in Rennes, France and Oulu, Finland, for product configuration, software loading, quality control and shipping of monitoring systems. All our manufacturing operations fall under the supervision of a vice president.
Our Quebec City, Canada, operations mainly produce low-volume, high-complexity telecom products. It has maintained ISO 9001 certification since 1994 and first obtained TL 9000 certification in July 2012. Our manufacturing plant in Shenzhen, China, which started operations in September 2007, is responsible for the production of high-volume, low-complexity telecom products. Our Shenzhen plant, which follows the same corporate quality standards, was first certified ISO 9001 in January 2009 and also obtained TL 9000 certification in July 2012. Acquired from Yenista in 2017, our Lannion, France, operations, produce low-volume, high complexity test and measurement equipment for laboratory, university and production of optical components.
All of our products meet required industry standards, and some of our products address additional voluntary standards, such as those set by Telcordia, IEC, IETF, ETSI and other bodies that issue industry standards. During manufacturing, each product has a specific quality control plan, with rigorous checkpoints, to ensure product conformity. Various tasks in the quality assurance process include quality control, conformity testing, product documentation, product improvement, regulatory compliance, metrology and calibration.
Our manufacturing operations include the following responsibilities:
Production. From production planning to product shipment, our production department is responsible for manufacturing high-quality products on time. Factories are organized in work cells; each cell consists of specialized technicians with equipment and has full responsibility over a product family. Technicians are cross-trained and versatile enough, so that they can carry out specific functions in more than one cell. This allows shorter lead times by alleviating bottlenecks.
Manufacturing and Test Engineering. This department, which supports our production cells, acts like a gatekeeper to ensure the quality of our products and the effectiveness of our manufacturing processes. It is responsible for the transfer of products from research and development to manufacturing, product improvement, documentation, metrology, and the quality control and regulatory compliance process. Quality control represents a key element in our manufacturing operations. Quality is assured through product testing at numerous stages in the manufacturing process to ensure that our products meet both stringent industry and customer performance requirements.
Supply-Chain Management. This department is responsible for sales forecasting, raw material procurement, material-cost reduction and vendor performance management. Our products consist of optical, electronic and mechanical parts, which are purchased from suppliers around the world. Approximately one-third of our parts are manufactured to our specifications. Materials represent the largest portion of our cost of goods. Our performance is tightly linked to vendor performance, requiring greater emphasis on this critical aspect of our business.
Our manufacturing operations are subject to environmental laws in various jurisdictions around the world. As the world undergoes climate changes, environmental and biodiversity issues have become critical to our society. We obtained ISO 14001 certification in October 2013 and, therefore, started continuous improvement in reducing our environmental footprint.
Sources and Availability of Raw Materials
We use various suppliers to provide parts for the manufacture and support of multiple product lines. Although our intent is to establish at least two sources of supply for materials whenever possible, we obtain several parts from single or limited source supply arrangements. We may not be able to procure these parts from alternative sources at acceptable prices within a reasonable time; therefore, the loss or interruption of such arrangements could have an impact on our ability to deliver certain products on a timely basis. See Item 3D of this Annual Report under “Risk Factors ‒ We depend on short-term arrangements with a single supplier or a limited number of suppliers for some key components and materials in our products, which makes us susceptible to supply shortages or price fluctuations that could adversely affect our operating results.”
We will continue to mitigate the risk of production interruptions and shortages of parts by: (1) carrying safety stock of critical components, (2) monitoring the delivery performance of our suppliers, (3) selecting and qualifying alternative sources of supplies for key parts whenever possible, and (4) promptly assessing potential effects of worldwide natural disasters.
Historically, we have been subject to seasonality mainly in our second quarter (December, January and February) due to the Christmas holidays and delays in approval of CSP spending budgets for the new calendar year. These two factors can have negative effects on our bookings in our second quarter, but they are mitigated by the renewal of annual maintenance contracts and sometimes calendar year-end spending on the part of CSPs. We are increasingly subject to seasonality in the fourth quarter (June, July and August) because bookings activity tends to slow down during the summer months, especially in Europe. The acquisition of Astellia in 2018 could also render us more vulnerable to seasonality in the summer, since its sales are largely concentrated in Europe, Middle East and Africa (EMEA). These seasonal effects do not apply consistently and do not always correlate to our financial results. Accordingly, they should not be considered as reliable indicators of future revenue or results of operations.
The communications test, monitoring and analytics markets are highly competitive and subject to rapid change because of technological developments and market conditions. We compete with many different companies, depending on product family and geographical market. We believe that the main competitive factors in the industry include the following:
level of technical compliance and alignment to use-case;
strength of sales and distribution relationships; and
financial stability of supplier.
Main competitors in the test and measurement environment include global suppliers like Anritsu Corporation, Fortive Corporation (Fluke Networks), Keysight and Viavi Solutions, as well as smaller players such as AFL Noyes, Deviser Instruments, Kingfisher International, Shineway Tech, VeEX Inc., and Yokogawa Electric Corporation. On the service assurance, systems and services side, we mainly compete against Accedian Networks, Anritsu Corporation, Empirix, Keysight (IXIA), Netrounds, NetScout Systems, Inc., Elisa (Polystar), Radcom, Spirent Communications plc, and Viavi Solutions. See Item 3D of this Annual Report under “Risk Factors ‒ We must continue to overcome significant competition in our targeted industries in order to keep or gain market share and achieve our growth strategy.”
As at November 1, 2019, we had 1,810 full-time employees compared to 1,803 and 1,577 for the same periods in 2018 and 2017, respectively. Our workforce as of November 1, 2019 included 401 employees in manufacturing, 656 employees in research and development, and 753 employees in sales and marketing as well as general and administrative functions.
Our future performance depends, to a significant degree, on our continued ability to attract and retain highly skilled and qualified technical, sales and marketing, and senior management personnel. The majority of our employees are not represented by a labor union with the exception of our manufacturing personnel in Quebec City, Canada, R&D and Service employees in Valencia and Madrid, Spain, and R&D and Service employees in Rennes, France. We consider relations with our employees to be good. See Item 3D of this Annual Report under “Risk Factors ‒ We require employees and managers who are knowledgeable about the specialized nature of our business. If we are unable to attract and retain sufficient numbers of highly skilled technical, sales, marketing, senior management and other personnel, our operations and financial results will suffer”.
In most countries where our products are sold, our products must comply with the regulations of one or more governmental entities. These regulations often are complex and vary from country to country. Depending upon the country and the relevant product, the applicable regulations may require product testing, approval, registration, marking and unique design restrictions. Accordingly, we have appointed a team of specialists who are responsible for ensuring that our products comply with all applicable regulations.
In the United States, our products must comply with the regulations of some agencies of the U.S. federal government, including the Federal Communications Commission (FCC), the Food and Drug Administration (FDA) and the Occupational Safety and Health Administration (OSHA). Under the FCC’s regulations, our products must comply with certain electromagnetic interference (EMI) requirements to insure they do not generate electromagnetic noise which could possibly cause undesirable operation, as well as affect other surrounding devices. Additionally, some of our products must comply with the FDA’s non-medical performance standards and related rules concerning light-emitting products, such as lasers. The FDA’s regulations applicable to our products are intended to promote safety by limiting human exposure to harmful non-iodizing radiation. Similarly, our products must comply with safety standards adopted by OSHA.
Similar regulations apply in other countries. For example, in Canada our products must comply with the applicable standards adopted by the Standards Council of Canada (SCC). These include product safety standards developed in collaboration with the Canadian Standards Association as well as EMI requirements adopted by Innovation, Science and Economic Development Canada. Countries in the European Union require product compliance as dictated by the applicable directives, which are required to apply the CE marking on the product. This includes testing to ensure compliance with harmonized European Norm (EN) standards for product safety, EMC and Wireless products requirements and RoHS.
To address the issue of environmental compliance, the European Union has mandated the Restriction of the Use of Certain Hazardous Substances or “RoHS” Directive (2011/65/EU), which applies to all products included within the scope of WEEE Directive. Mandatory product compliance includes the ban of certain substances within specified concentrations, unless formally exempted by the Directive. To ensure compliance to this Directive, a formal restricted substance control (RSC) program was implemented for our products included within the scope of WEEE. This program ensures the design, procurement and manufacturing of affected products prevents the inclusion of the banned substances as specified by the RoHS Directive.
Other significant types of regulations not described in this Annual Report also may apply, depending upon the relevant product and country of destination.
Our success and ability to compete are dependent in part on our ability to develop and protect our proprietary technology. We file U.S. as well as other foreign (utility) patent applications to protect technology, inventions and improvements important to the development of our business. We also rely on a combination of design patents, copyright, trademark, trade secret rights, licensing and confidentiality agreements.
Our intellectual property and proprietary technology are important to the continued success of our business. Were we to inadequately protect our intellectual property and proprietary technology, our competitive position might be significantly impaired. There also remains a risk that our intellectual property rights, particularly our existing or future patents might be invalidated, circumvented, challenged or required to be licensed to others. Furthermore, others may claim that our products infringe upon their intellectual property rights, or they may infringe our intellectual property, and we may expend significant resources enforcing or defending our rights or suffer competitive injury.
Our success and ability to compete depend to a significant extent on our proprietary technology, with which we attempt to prevent others from using the innovations that are central to our existing and future products. As of August 31, 2019, our records indicate that we held the following portfolio of utility patents: 94 active granted US patents, 118 granted or validated patents in Europe and 45 patents in other jurisdictions. In addition, we have 53 utility patent applications (including provisional applications) pending in the US, 19 utility patent applications pending in Europe and 19 utility patent applications pending in other countries. The expiration dates of our active issued patents range from 2019 to 2037, with no significant active patent expiring in the near future.
Our records also indicate that, as of August 31, 2019, we held 36 active granted design patents, as well as 11 pending design patent applications, in the United States, Europe, China and other jurisdictions.
We consider five of our inventions to be material. These inventions are protected by granted patents and/or pending patent applications and can be described as follows:
a method and apparatus for improved characterization of loss-inducing “events” along an optical fiber using an Optical Time Domain Reflectometer (OTDR). By a judicious combination of OTDR data corresponding to different optical-pulse durations, the location and loss characteristics of an event can be quantified with much better accuracy and/or more rapidly than via conventional approaches;
a method for determining the optical signal-to-noise ratio on polarization-multiplexed signals used in high-bandwidth DWDM optical networks by employing an optical spectrum analyzer (OSA). It employs a reference trace acquired with one channel being turned off;
a scalable system for monitoring network elements, for which only a non-redundant subset of the identified network information is stored, thereby enabling monitoring of a much larger group of network elements than is possible with conventional memory-constrained monitoring systems. Furthermore, this system employs a multi-threaded architecture that dynamically spawns an array of multi-technology monitoring sub-systems. The user can leverage data from a multitude of sources and define a sequence of activities based on templates in order to accomplish a given task;
a method for actively analyzing a data packet delivery path to provide diagnostics and root cause analysis of network delivery path issues;
a communication methodology used to perform independent bi-directional protocol testing over a connection or connectionless network between two test instruments, wherein the transfer mechanism of status and intermediate test results during an active test and the transmission of the final results to one of the instruments enables the user to perform a bidirectional single-ended test.
Confidentiality and proprietary information agreements with our senior management, employees and others generally stipulate that all confidential information developed or made known to these individuals by us during the course of their relationship is to be kept confidential and not disclosed to third parties, except under specific circumstances. The agreements also generally provide that all intellectual property developed by the individual in the course of rendering services to us belongs exclusively to us. However, these efforts afford only limited protection.
Disclosure pursuant to Section 219 of the Iran Threat Reduction and Syria Human Rights Act of 2012
Under Section 219 of the Iran Threat Reduction and Syria Human Rights Act of 2012, which added section 13(r) of the Securities Exchange Act of 1934, as amended (“the Exchange Act”), public reporting issuers are required to disclose whether they or any of their affiliates knowingly engaged in certain activities, transactions, or dealings relating to Iran or certain designated individuals or entities.
From September 2018 until November 2018, EXFO Solutions (formerly Astellia), a subsidiary of EXFO organized and existing under the laws of France, engaged in transactions involving the sale of passive monitoring and troubleshooting solutions and associated services to end users in Iran. EXFO Solutions (formerly Astellia) sold the equipment for end use by Iranian mobile network operators, Mobile Communications Company of Iran (“MCCI”) and MTN Irancell. Although it is difficult to evaluate with any reasonable degree of certainty, we have concluded that we cannot exclude the possibility that MCCI or MTN Irancell is owned or controlled, directly or indirectly, by the government of Iran.
Gross revenues reported by EXFO Solutions (formerly Astellia) in connection with these transactions, for the three-month period mentioned above, were approximately US$122,379; estimated net result from these transactions was nominal.
Prior to its acquisition by EXFO, EXFO Solutions (formerly Astellia), through a subsidiary located in Lebanon, employed four (4) employees delivering services in Iran, a practice that was continued after the acquisition through the end of October 2018. These activities complied in all material respects with applicable sanction laws and regulations; however, they were inconsistent with EXFO’s internal policies. EXFO discovered this activity during the pre-acquisition due diligence of EXFO Solutions (formerly Astellia) and has conducted a comprehensive internal investigation and review. As a result of this investigation and review, EXFO has implemented additional compliance procedures designed to prevent future violations of its internal policy and is currently in the process of withdrawing from any direct activities, transactions, or dealings relating to Iran or certain designated individuals or entities and will no longer have employees providing services in Iran. In addition, EXFO revised its internal policies to allow indirect support and maintenance of EXFO Solutions’ systems deployed at MCCI and MTN Irancell through a non‑related third-party based outside Iran to honor EXFO Solutions’ (formerly Astellia) prior engagement with existing customers in compliance with applicable export controls, sanctions and other laws, rules and regulation. The withdrawal process was completed on November 4, 2018 and support services through a non-related third party was established at that date.
Gross revenues reported by EXFO Solutions (formerly Astellia) in connection with these support services through a non-related third party for fiscal year 2019 were approximately US$50,472; estimated net result from these transactions was nominal.
As of November 1, 2019, the following chart presents our corporate structure, the jurisdiction of incorporation of our subsidiaries and the percentage of shares (which is also the percentage of voting power) that we hold in those subsidiaries.
Our head offices are located in Quebec City, Province of Quebec, Canada where we occupy two buildings. These buildings house our executive and administrative offices, research and development facilities and production facilities. We also have offices in Montreal, Province of Quebec, Canada, in Richardson, Texas, United States (EXFO America Inc.), in Pune, India (EXFO Electro-Optical Engineering India Private Ltd.), in Chandler’s Ford, Hampshire, United Kingdom (EXFO Europe Limited), in Lannion, France (EXFO Optics SAS), in Oulu, Finland (EXFO Oy), in Rennes, France (EXFO Solutions SAS), in Shenzhen, China (EXFO Telecom Equipment (Shenzhen) Co. Ltd.), in Valencia, Spain (EXFO Telecom Spain SL) and in London, United Kingdom (Ontology-Partners Limited).
In addition, we maintain sales offices and/or have regional sales managers located in Australia, China, Czech Republic, France, Germany, Great Britain, India, Japan, Lebanon, Mexico, Morocco, Singapore, South Africa, Spain, Sweden, United Arab Emirates and the United States.
The following table sets forth information with respect to the main facilities that we occupy as at November 1, 2019.
Use of Space
% of Utilization
Type of Interest
400 Godin Avenue Quebec (Quebec) G1M 2K2
Occupied for research and development, customer services, repair/calibration services, manufacturing, management and administration
2500 Alfred-Nobel Montreal (Quebec) H4S 2C3
Occupied for research and development, management and administration
2500 Alfred-Nobel Montreal (Quebec) H4S 2C3
Leased to third parties
2500 Alfred-Nobel Montreal (Quebec) H4S 2C3
Available for rent
F1 to F3, No. 71-3, Xintian Avenue,
Fuhai Subdistrict, Bao’an District Shenzhen, Guangdong 518103 China
Occupied for manufacturing of products, repair/calibration services
ZAC Airlande 2, rue Jacqueline Auriol CS 69123 Saint-Jacques-de-la-Lande 35091 Rennes Cedex 9 France
Occupied for research and development, customer services, manufacturing, management and administration
Item 5. Operating and Financial Review and Prospects
This discussion and analysis contains forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995, and we intend that such forward-looking statements be subject to the safe harbors created thereby. Forward-looking statements are statements other than historical information or statements of current condition. Words such as may, expect, believe, plan, anticipate, intend, could, estimate, continue, or similar expressions or the negative of such expressions 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, but not limited to, macroeconomic uncertainty, including trade wars and recessions; our ability to successfully integrate businesses that we acquire; capital spending and network deployment levels in the telecommunications industry (including our ability to quickly adapt cost structures to anticipated levels of business and our ability to manage inventory levels with market demand); future economic, competitive, financial and market conditions; consolidation in the global communications test, monitoring and analytics solutions markets and increased competition among vendors; capacity to adapt our future product offering to future technological changes; limited visibility with regard to the timing and nature of customer orders; delay in revenue recognition due to longer sales cycles for complex systems involving customers’ acceptance; fluctuating exchange rates; concentration of sales; timely release and market acceptance of our new products and other upcoming products; our ability to successfully expand international operations and to conduct business internationally; and the retention of key technical and management personnel. 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. This discussion and analysis should be read in conjunction with the consolidated financial statements.
The following discussion and analysis of financial condition and results of operations is dated November 26, 2019.
All financial data are expressed in US dollars, except as otherwise noted, and determined based on International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB). This discussion and analysis also contains financial data that do not comply with IFRS. Where such measures are presented, they are defined, and the reader is informed.
We are a leading provider of test, monitoring and analytics solutions for fixed and mobile communications service providers (CSPs), web-scale operators and network equipment manufacturers (NEMs) in the global communications industry. Our broad portfolio of intelligent hardware and software solutions enable transformations related to fiber, 5G and network virtualization. Ultimately, customers rely on our solutions to increase network capacity and improve quality of experience for end-users while driving operational efficiencies.
Our success has been largely predicated on our core expertise in developing test equipment for fixed networks. These solutions are available as handheld test instruments, portable platforms with related modules, and as rack-mounted chassis with related modules. Our PC-centric, open-ended platforms, combined with cloud-based software applications, can be transformed into a fully connected test environment that allows CSPs to automate complex, labor-intensive tasks like fiber-to-the-antenna (FTTA), distributed antenna system (DAS) and small cell deployments. Leveraging platform connectivity, CSPs can also keep track of their entire test fleet, manage software updates and schedule calibration procedures. All test data can be stored in a central database and used as a point of reference against future measurements. Consequently, this enhanced test environment enables customers to increase productivity and reduce operating expenses.
Over the years, we have expanded our product portfolio into fiber monitoring, IP (Internet protocol) service assurance as well as monitoring of 2G, 3G, 4G/LTE and 5G mobile networks. Our fiber-monitoring solution leverages EXFO’s expertise and market leadership in optical time domain reflectometry (OTDR) by using this technology as remote test units (RTUs) to monitor an optical plant 24 hours per day, seven days per week. This fiber monitoring solution proactively detects any fiber degradation or locates any fiber cut to optimize quality of service along long‑haul, metro and access networks. Our IP service assurance solution is a probe-based hardware and software offering that delivers quality-of-service visibility as well as real-time service monitoring and verification of next-generation IP networks. We have enriched our IP service assurance offering, which can also be virtualized, with infrastructure performance management tools, analytics software and network topology discovery solutions via technology acquisitions.
Following the acquisition of Astellia S.A. (renamed EXFO Solutions S.A.S.) in January 2018, EXFO offers monitoring solutions for multi-technology mobile networks (2G, 3G, 4G, 5G). The EXFO-Astellia portfolio provides mobile CSPs with capabilities to detect, correlate, analyze, report, geolocate and troubleshoot issues related to network performance, handset behavior and service usage. These solutions can be fully virtualized and combined with information from call traces, third-party probes, CRM, billing, etc., to optimize a big data framework.
Our mobile portfolio also consists of network simulators and optical radio frequency (RF) test solutions. Our network simulators simulate real-world, large-scale network traffic and end-user behavior in a laboratory environment to predict network behavior, uncover faults and optimize networks before mobile networks and services are deployed. Our optical RF test solutions are dedicated to turning up and troubleshooting fiber-based mobile networks. These solutions are critical for locating and analyzing RF interference issues in FTTA, DAS, remote radio heads and baseband units that support 4G/LTE and 5G networks.
The competitive advantages of our products include a high degree of innovation, modularity (especially wireline products) and ease of use. Our products enable NEMs, CSPs and web-scale operators to design, deploy, troubleshoot and monitor fixed and mobile networks and, in the process, they help them reduce the cost of operating their networks.
We have a staff of approximately 1,900 people in 25 countries, supporting more than 2,000 customers around the world. We operate three main manufacturing sites, which are located in Québec City, Canada, Shenzhen, China, and Lannion, France, and we have facilities in Rennes, France, and Oulu, Finland, for product configuration, software loading, quality control and shipping of monitoring systems. We also have five main research and development expertise centers in Montréal, Québec City, Rennes, Oulu and London, supported by a software development center in India.
We released a number of key solutions in fiscal 2019 that enable customers to accelerate their network transformations. We introduced a new category of fiber-testing solutions with the launch of the industry’s first optical fiber multimeter. This innovative test instrument simplifies the task of frontline technicians by automatically evaluating the quality of fiber links in a matter of seconds. We also expanded our 400G test portfolio with the launch of a module featuring an Open Transceiver System. This modular design enables compatibility between current and future high-speed transceivers with EXFO’s field and lab test platforms. In addition, we released an automated fiber inspection tool for testing polarity, continuity and connector cleanliness on multifiber cables.
Our sales, which include a full-year contribution from newly acquired EXFO Solutions S.A.S. (formerly Astellia S.A.), compared to a seven-month contribution last year, increased 6.4% to $286.9 million in fiscal 2019 from $269.5 million in 2018. Bookings (purchase orders received from customers), which include a full-year contribution from EXFO Solutions, increased 11.2% to $297.8 million in fiscal 2019, for a book-to-bill ratio of 1.04, from $267.7 million in 2018.
Net loss attributable to the parent interest amounted to $2.5 million, or $0.04 per share, in fiscal 2019, compared to $11.9 million, or $0.22 per share in fiscal 2018. Net loss attributable to the parent interest in fiscal 2019 included net expenses totaling $15.1 million, comprising $7.8 million in after-tax amortization of intangible assets, $1.8 million in stock-based compensation costs, $3.2 million in after-tax restructuring charges, $1.4 million for the acquisition-related deferred revenue fair value adjustment, and a foreign exchange loss of $0.9 million. Net loss attributable to the parent interest also includes $1.7 million for a gain on disposal of capital assets and $2.4 million for a deferred income tax recovery. Net loss attributable to the parent interest in fiscal 2018 included net expenses totaling $17.1 million, comprising $9.4 million in after-tax amortization of intangible assets, $1.7 million in stock-based compensation costs, $3.4 million in after-tax restructuring charges, $2.1 million for the acquisition-related deferred revenue fair value adjustment, $0.7 million in positive change in the fair value of the cash contingent consideration, $2.5 million in after-tax acquisition-related costs, and a foreign exchange gain of $1.3 million.
Adjusted EBITDA (net earnings (loss) attributable to the parent interest before interest and other expense, income taxes, depreciation and amortization, stock-based compensation costs, restructuring charges, acquisition-related deferred revenue fair value adjustment, change in fair value of cash contingent consideration, and foreign exchange gain or loss) amounted to $25.6 million, or 8.9% of sales, in fiscal 2019, compared to $17.2 million, or 6.4% of sales in 2018. Adjusted EBITDA is a non-IFRS measure. See page 56 of this document for a complete reconciliation of adjusted EBITDA to IFRS net earnings (loss) attributable to the parent interest.
In September 2018, as part of our fiscal 2018 restructuring plan and the shutdown of our operations in Toronto, Canada, we entered into a binding agreement to sell one of our buildings for net proceeds of $3.3 million. The transfer of ownership occurred during fiscal 2019 and resulted in a gain of $1.7 million that was recorded in interest and other income (expense) line item in our consolidated statement of earnings for that year.
In addition, in fiscal 2019, as part of our fiscal 2018 restructuring plan and the shutdown of some of our facilities in the United States, we transferred the ownership of certain intellectual property held in the United States to Canada. This created a deductible tax asset in Canada and resulted in the recognition of a one-time deferred income tax recovery of $2.4 million in fiscal 2019 as the recovery of this asset is probable. This deferred income tax recovery was recorded in our consolidated statement of earnings for that year.
Adjusted EBITDA outlook
In fiscal 2018, we had established an adjusted EBITDA target of $24 million for fiscal 2019. Actual adjusted EBITDA reached $25.6 million, or 8.9% of sales, slightly higher than expected.
For fiscal 2020, considering results achieved in fiscal 2019, the anticipated increase in sales volume and the resulting improved fixed-cost absorption, the full impact of our fiscal 2018 restructuring plan, as well as the impact of the upcoming adoption of IFRS 16, ‘’Leases’’, on September 1, 2019, we forecast adjusted EBITDA of $33 million. The adoption of IFRS 16 is expected to increase adjusted EBITDA by approximately $4 million in fiscal 2020. Our adjusted EBITDA target also considers constant currencies.
In fiscal 2018, we established an adjusted EBITDA margin target of 15% of sales for the next three years (2019 to 2021). This medium-term adjusted EBITDA target was established based on expected sales increase mainly from our service assurance, systems and services (SASS) product line (which represented 27% of sales in fiscal 2018). This product line delivers a higher gross margin before depreciation and amortization than our test and measurement (T&M) product line (which represented 73% of our sales in fiscal 2018), due to its richer software content. In addition, we expect higher growth from our SASS product line over the next three years, as it represents a much larger addressable market ($2.5 billion+) compared to our T&M product line ($900 million) and for which our market share is lower compared to our T&M product line. This growth is expected to come from organic growth as well as through acquisitions, like those completed in fiscal 2017 and 2018 (Absolute Analysis Inc. (Absolute), Ontology Partners Limited (Ontology) and EXFO Solutions) and from related synergies. Furthermore, this sales growth should result in better absorption of our fixed manufacturing costs, which would increase our gross margin before depreciation and amortization and our adjusted EBITDA. A large portion of our operating costs is fixed mainly for research and development expenses as well as administrative expenses. Our adjusted EBITDA target also considers constant currencies.
Despite the positive impact the adoption of IFRS 16 will have on Adjusted EBITDA going forward, we reaffirm our adjusted EBITDA target of 15% for the next two years.
These short-term and medium-term adjusted EBITDA targets are forward-looking statements. In addition, as they exclude items that pertain to future events that are not currently estimable with a reasonable degree of accuracy, such as foreign exchange gain or loss and income taxes, no corresponding IFRS measure has been provided.
We sell our products to a diversified customer base in approximately 100 countries through our direct sales force and channel partners, such as sales representatives and distributors. Most of our sales are denominated in US dollars, euros and Canadian dollars.
In fiscal 2018 and 2019, no customer accounted for more than 10% of our sales, with our top customer representing 9.1% and 6.9% of our sales respectively. In fiscal 2017, our top customer represented 10.1% of our sales.
We believe that we have a vast array of products, a diversified customer base and a good spread across geographical areas, which provides us with reasonable protection against concentration of sales and credit risk.
Cost of Sales
The cost of sales includes raw materials, salaries and related expenses for direct and indirect manufacturing personnel and professional services, as well as overhead costs. Excess, obsolete and scrapped materials are also included in the cost of sales. However, the cost of sales is presented exclusive of depreciation and amortization, which are shown separately in the consolidated statements of earnings.
Selling and administrative, and research and development expenses
Selling and administrative expenses consist primarily of salaries and related expenses for personnel, sales commissions, travel expenses, marketing programs, professional services, information systems, human resources and other corporate expenses.
Gross research and development expenses consist primarily of salaries and related expenses for engineers and other technical personnel, material component costs as well as fees paid to third-party consultants. We are eligible to receive research and development tax credits on research and development activities carried out in Canada and France. All related research and development tax credits are recorded as a reduction of gross research and development expenses.
The following tables summarize sales and bookings by product line, in thousands of US dollars:
Years ended August 31,
Test and measurement
Service assurance, systems and services
Foreign exchange gains (losses) on forward exchange contracts
Years ended August 31,
Test and measurement
Service assurance, systems and services
Foreign exchange gains (losses) on forward exchange contracts
Sales by geographic region
The following table summarizes sales by geographic region:
Years ended August 31,
Europe, Middle East and Africa (EMEA)
Fiscal 2019 vs. 2018
In fiscal 2019, our sales increased 6.4% to $286.9 million, compared to $269.5 million in 2018, while our bookings increased 11.2% year-over-year to $297.8 million in 2019 from $267.7 million in 2018, for a book-to-bill ratio of 1.04.
In fiscal 2019, the 6.4% increase in total sales year-over-year can be attributed to the positive effect of the acquisition of EXFO Solutions. EXFO Solutions contributed to our sales for the full reporting year in fiscal 2019 versus seven months in 2018. We also benefited from a $4.9 million order that was recognized in fiscal 2019 for our real-time network topology solution (no such order in fiscal 2018). Otherwise, our total sales were negatively affected by currency fluctuations year-over-year.
In fiscal 2019, sales of our T&M product line improved 3.7% year-over-year, despite a negative currency impact. In fiscal 2019, we generated increased sales from our high-speed optical transport solutions, as well as higher sales from EXFO Optics for advanced solutions dedicated to labs and NEM environments, compared to 2018.
In fiscal 2019, sales of our SASS product line increased 16.2% year-over-year, despite a negative currency impact, mainly because we benefited from the EXFO Solutions acquisition for the full reporting year versus seven months in 2018. We also benefited from a $4.9 million order that was recognized in fiscal 2019 for our real-time network topology solution (no such order in fiscal 2018).
In fiscal 2019, our total bookings increased 11.2% year-over-year, mainly due to the positive effect of the acquisition of EXFO Solutions. EXFO Solutions contributed to our bookings for the full reporting year in fiscal 2019 versus seven months in 2018.
We also benefited from larger calendar year-end budget spending from CSPs in the Americas for our T&M products and we received a $4.9 million order for our real-time network topology solution (no such order in fiscal 2018), as well as four monitoring orders related to 5G deployments in fiscal 2019. Otherwise, in fiscal 2019, total bookings were negatively impacted by currency fluctuations year-over-year.
In fiscal 2019, bookings of our T&M product line increased 8.4% year-over-year mainly due to larger calendar year‑end budget spending on the part of some CSPs in the Americas. Our high-speed optical transport and advanced solutions for NEMs and R&D labs also delivered higher bookings compared to 2018. This bookings increase was partially mitigated by the negative currency impact year-over-year.
In fiscal 2019, bookings of our SASS product line increased 21.0% year-over-year mainly due to the positive effect of the acquisition of EXFO Solutions. EXFO Solutions contributed to our bookings for the full period in fiscal 2019 versus seven months in 2018. We also benefited from the $4.9 million order for our real-time network topology solution, as well as four monitoring orders related to 5G deployments. Otherwise, in fiscal 2019, total bookings were negatively impacted by currency fluctuations year-over-year.
Fiscal 2018 vs. 2017
In fiscal 2018, our sales increased 10.8% to $269.5 million, compared to $243.3 million in 2017, while our bookings increased 6.3% year-over-year to $267.7 million in 2018 from $251.8 million in 2017, for a book-to-bill ratio of 0.99.
In fiscal 2018, the increase in total sales year-over-year comes from the positive effect of our acquisitions of EXFO Solutions (seven-month contribution) and EXFO Optics (eleven-month contribution), as well as the positive currency impact.
In fiscal 2018, sales of our T&M line increased 1.8% year-over-year mainly due to the acquisition of EXFO Optics and the positive currency impact.
Sales of our SASS product line increased 42.8% year-over-year in fiscal 2018, due to the positive effect of the acquisition of EXFO Solutions, higher sales of our network-quality fiber-monitoring systems (NQMS), as well as the positive currency impact. Otherwise, sales of our SASS product line slightly decreased year-over-year due to the streamlining of our passive monitoring product line in the second half of fiscal 2017, as well as the year‑over-year decrease in sales of our legacy active monitoring product line.
In fiscal 2018, the 6.3% increase in total bookings year-over-year comes from the positive effect of our acquisitions of EXFO Solutions (seven-month contribution), EXFO Optics (eleven-month contribution) and Ontology (full-year contribution in 2018 versus six-month contribution in 2017), a solid performance of our NQMS worldwide, as well as the positive currency impact, offset in part by lower bookings from our Transport and Datacom and passive monitoring product lines.
In fiscal 2018, bookings of our T&M product line decreased 2.4% year-over-year, despite the positive effect of the acquisition of EXFO Optics, as well as the positive currency impact year-over-year. In fiscal 2018, we reported lower bookings in APAC for our Transport and Datacom product line, which had delivered strong bookings in fiscal 2017 in this region. In addition, T&M bookings decreased year-over-year in APAC for both our optical (mainly in China due to delayed investments from NEMs as they prepare for 5G investments) and copper-access product lines, as well as in the Americas for our copper-access product line. Bookings of copper-testing solutions are characterized by large intermittent orders from customers.
Bookings of our SASS product line increased 36.0% year-over-year in fiscal 2018, due to the positive effect of the recent acquisition of EXFO Solutions, higher bookings for our NQMS solutions worldwide, as well as the positive currency impact. Bookings of NQMS are characterized by large intermittent orders from customers. However, we reported lower bookings for our passive-monitoring product line due to the streamlining of this product line in the second half of fiscal 2017.
As we gradually evolve from a supplier of dedicated test instruments to a supplier of end-to-end system-based solutions, our quarterly sales and bookings are becoming increasingly subject to quarterly fluctuations, as we are managing more complex, multimillion-dollar deals that have prolonged sales and revenue recognition cycles related to our protocol-layer products. This has been amplified with the recent acquisitions of EXFO Solutions and Ontology.
GROSS MARGIN BEFORE DEPRECIATION AND AMORTIZATION
(non-IFRS measure – refer to page 55 of this document)
Gross margin before depreciation and amortization amounted to 58.6%, 61.0% and 61.2% of sales in fiscal 2019, 2018 and 2017 respectively.
Fiscal 2019 vs. 2018
In fiscal 2019, EXFO Solutions, which contributed to our gross margin before depreciation and amortization for the full period compared to seven months in the same period last year, delivered lower margins than our typical corporate margin, as a large portion of its sales comprise professional services, which had a negative impact on our gross margin before depreciation and amortization year-over-year.
In addition, in fiscal 2019, our gross margin before depreciation and amortization was negatively affected by a less favorable sales mix compared to 2018.
Furthermore, in fiscal 2019, we recorded in our sales foreign exchange losses on our forward exchange contracts of $0.6 million, compared to foreign exchange gains of $0.9 million in 2018. This gap reduced our gross margin before depreciation and amortization by 0.2% year-over-year.
In addition, in fiscal 2019, we recorded higher inventory writeoffs compared to 2018, which contributed to decrease our gross margin before depreciation and amortization by 0.3% year-over-year.
In fiscal 2018, gross margin before depreciation and amortization included a negative impact of 0.3% of sales for the acquisition-related deferred revenue fair value adjustment from the acquisition of EXFO Solutions (nil in 2017).
In fiscal 2018, gross margin before depreciation and amortization included $0.5 million, or 0.2% of sales in restructuring charges for severance expenses, compared to $1.7 million or 0.7% of sales in 2017, which had a positive impact on our gross margin before depreciation and amortization year-over-year.
In addition, in fiscal 2018, we recorded in our sales foreign exchange gains on our forward exchange contracts, compared to foreign exchange losses in 2017, which contributed to an increase of 0.2% in gross margin before depreciation and amortization year-over-year.
However, newly acquired EXFO Solutions delivered lower margins than our typical average corporate margin, and we recorded slightly higher writeoffs (excluding those in restructuring expenses) compared to 2017, which had a negative impact on our gross margin before depreciation and amortization year-over-year.
SELLING AND ADMINISTRATIVE EXPENSES
Selling and administrative expenses amounted to $98.6 million, $98.8 million and $86.3 million for fiscal 2019, 2018 and 2017 respectively. As a percentage of sales, selling and administrative expenses amounted to 34.4%, 36.7% and 35.5% for fiscal 2019, 2018 and 2017 respectively.
Fiscal 2019 vs. 2018
In fiscal 2019, our selling and administrative expenses were slightly down ($0.2 million) in dollars compared to 2018.
In fiscal 2019, our selling and administrative expense includes $0.5 million in restructuring expenses compared to $ 0.7 million in fiscal 2018. In addition, in fiscal 2018, our selling and administrative expenses included $2.1 million (1.0% of sales) in acquisition-related costs following our business acquisitions, compared to nil in 2019.
In addition, in fiscal 2019, the positive impact of our 2018 restructuring plan reduced our selling and administrative expenses compared to 2018. Finally, the increase in the average value of the US dollar compared to other currencies had a positive impact on our selling and administrative expenses year-over-year.
However, in fiscal 2019, we incurred additional expenses compared to 2018, as we had the full-year contribution of EXFO Solutions, compared to a seven-month contribution in 2018. In addition, inflation and salary increases contributed to increasing our selling and administrative expenses year-over-year.
Fiscal 2018 vs. 2017
In fiscal 2018, our selling and administrative expenses increased $12.5 million year-over-year, mainly due to additional expenses following the acquisitions of EXFO Solutions (seven-month contribution), EXFO Optics (eleven-month contribution) and Ontology (full contribution in 2018 versus six-month contribution in 2017), inflation, salary increases, as well as increased acquisition-related costs of $1.1 million following the recent business acquisitions. In addition, in fiscal 2018, the decrease in the average value of the US dollar compared to other currencies had a negative impact on our selling and administrative expenses year-over-year.
However, in fiscal 2018, selling and administrative expenses included $0.7 million in restructuring charges compared to $1.2 million in 2017. In addition, the positive impact of our 2017 restructuring plan reduced our selling and administrative expenses year-over-year in fiscal 2018.
Excluding restructuring charges and acquisition-related costs for business combinations, our selling and administrative expenses would have represented 35.7% of sales, 1.1% higher compared to 34.6% of sales in 2017, due to the impact of the recent acquisitions and the negative currency impact.
RESEARCH AND DEVELOPMENT EXPENSES
Gross research and development expenses
Gross research and development expenses totaled $58.0 million, $65.2 million and $53.1 million for fiscal 2019, 2018 and 2017 respectively. As a percentage of sales, gross research and development expenses amounted to 20.2%, 24.2% and 21.8% for fiscal 2019, 2018 and 2017 respectively, while net research and development expenses accounted for 17.6%, 21.2% and 19.4% of sales for these respective years.
Fiscal 2019 vs. 2018
In fiscal 2019, our gross research and development expenses decreased $7.3 million compared to 2018.
In fiscal 2019, the positive impact of our 2018 restructuring plan reduced our gross research and development expenses compared to 2018. In addition, in fiscal 2019, the increase in the average value of the US dollar compared to other currencies had a positive impact on our gross research and development expenses year-over-year.
In addition, in fiscal 2018, we incurred restructuring charges of $3.2 million as part of our 2018 plan, compared to $2.5 million in 2019, which reduced our gross research and development expenses year-over-year.
On the other hand, in fiscal 2019, we incurred additional expenses compared to 2018, as we had the full contribution of EXFO Solutions, compared to a seven-month contribution in 2018. Gross research and development expenses were also subject to inflation and salary increases in fiscal 2019, which increased our expenses year-over-year.
In fiscal 2019, the impact of our fiscal 2018 restructuring plan resulted in lower gross research and development expenses as a percentage of sales compared to 2018.
Fiscal 2018 vs. 2017
In fiscal 2018, our gross research and development expenses increased $12.1 million year-over-year, mainly due to additional expenses following the acquisitions of EXFO Solutions (seven-month contribution), EXFO Optics (eleven-month contribution) and Ontology (full contribution in 2018 versus six-month contribution in 2017), as well as inflation and salary increases.
In addition, in fiscal 2018, our gross research and development expenses included $3.2 million in restructuring charges compared to $2.2 million in 2017.
Finally, in fiscal 2018, the decrease in the average value of the US dollar compared to other currencies had a negative impact on our gross research and development expenses year-over-year.
However, our gross research and development expenses decreased year-over-year due to the positive impact of our 2017 recent restructuring plan.
Excluding restructuring charges, which represent 1.2% of sales in fiscal 2018 compared to 0.9% of sales in 2017, our gross research and development expenses would have represented 23.0% of sales in 2018, 2.1% higher compared to 20.9% of sales in 2017, due to the impact of the recent acquisitions and the negative currency impact.
We are entitled to tax credits for eligible research and development activities conducted in Canada and France.
Tax credits and grants for research and development activities were $7.4 million, $8.1 million and $6.0 million for fiscal 2019, 2018 and 2017 respectively. As a percentage of gross research and development expenses, tax credits and grants reached 12.8%, 12.4% and 11.2% for fiscal 2019, 2018 and 2017 respectively.
Fiscal 2019 vs. 2018
The decrease in our tax credits and grants in fiscal 2019, compared to 2018, comes from reduced gross research and development expenses in Canada and France as a result of the impact of our 2018 restructuring plan.
Fiscal 2018 vs. 2017
The increase in our tax credits and grants in fiscal 2018, compared to 2017, is mainly due to the acquisitions of EXFO Solutions (seven-month contribution) and EXFO Optics (eleven-month contribution) that are entitled to tax credits and grants on research and development activities carried out in France. This also explains the increase in tax credits and grants as a percentage of gross research and development expenses year-over-year.
AMORTIZATION OF INTANGIBLE ASSETS
In conjunction with the business combinations we completed, we recorded intangible assets primarily consisting of core technologies and customer relationships. In addition, intangible assets include software. These intangible assets resulted in amortization expenses of $9.0 million, $10.3 million and $3.3 million for fiscal 2019, 2018 and 2017 respectively.
Fiscal 2019 vs. 2018
In fiscal 2019, amortization of intangible assets decreased of 1.3 million year-over-year, despite the full contribution of EXFO Solutions, compared to a seven-month contribution in 2018. The year-over-year decrease is due to the fact that some acquired intangible assets became fully amortized in fiscal 2019.
Fiscal 2018 vs. 2017
The increase in our amortization expense in fiscal 2018, compared to 2017, is due to the acquisitions of EXFO Solutions (seven-month contribution), EXFO Optics (eleven-month contribution) and Ontology (full contribution in 2018 compared to six-month contribution in 2017), as well as the decrease in the average value of the US dollar compared to other currencies year-over-year.
FOREIGN EXCHANGE GAIN (LOSS)
Foreign exchange gains and losses are mainly the result of the translation of operating activities denominated in currencies other than our functional currency, which is the Canadian dollar. A portion of our foreign exchange gains or losses results from the translation of cash balances and deferred income taxes denominated in US dollars. We manage our exposure to currency risk in part with forward exchange contracts. In addition, some of our entities’ operating activities are denominated in US dollars, euros and British pounds, which further hedges this risk. However, we remain exposed to a currency risk; namely, any increase in the value of the Canadian dollar compared to the US dollar would have a negative impact on our operating results.
We reported a foreign exchange loss of $0.9 million in fiscal 2019, compared to a gain of $1.3 million in 2018 and a loss of $1.0 million in 2017.
In fiscal 2019, we witnessed some volatility in the value of the Canadian dollar as it fluctuated compared to the US dollar, which overall resulted in a foreign exchange loss of $0.9 million. The period-end value of the Canadian dollar decreased 1.8% versus the US dollar to CA$1.3294 = US$1.00 in fiscal 2019 compared to CA$1.3055 = US$1.00 at the end of the previous year. In fiscal 2019, the average value of the Canadian dollar versus the US dollar was CA$1.3247 = US$1.00.
In fiscal 2018, the period-end value of the Canadian dollar decreased versus the US dollar, compared to the previous year-end, which resulted in a foreign exchange gain of $1.3 million during that year. The period-end value of the Canadian dollar decreased 4.1% versus the US dollar to CA$1.3055 = US$1.00 in fiscal 2018, compared to CA$1.2536 = US$1.00 at the end of the previous year. In fiscal 2018, the average value of the Canadian dollar versus the US dollar was CA$1.2768 = US$1.00.
In fiscal 2017, the period-end value of the Canadian dollar increased versus the US dollar compared to the previous year-end, which resulted in a foreign exchange loss of $1.0 million during the year. The period-end value of the Canadian dollar increased 4.4% versus the US dollar to CA$1.2536 = US$1.00 in fiscal 2017 compared to CA$1.3116 = US$1.00 at the end of the previous year. In fiscal 2017, the average value of the Canadian dollar versus the US dollar was CA$1.3212 = US$1.00.
Foreign exchange rate fluctuations also flow through the consolidated statement of earnings line items as portions of our sales are dominated in Canadian dollars and euros and significant portions of our cost of sales and operating items are denominated in Canadian dollars, euros, Indian rupees, British pounds, and CNY, and we report our results in US dollars. In fiscal 2019, the increase in the average value of the US dollar compared to the Canadian dollar, the euro, the British pound, the Indian Rupee and the CNY year-over-year, resulted in a positive impact on our expenses. The average value of the US dollar increased 3.8%, 4.9%, 4.8%, 7.2% and 3.9% respectively year-over-year, compared to the Canadian dollar, the euro, the British pound, the Indian Rupee and the CNY.
In fiscal 2019, we reported income tax expenses of $5.3 million on earnings before income taxes of $2.9 million, compared to income tax expenses of $5.7 million on a loss before income taxes of $6.6 million in 2018 and income tax expenses of $6.6 million on earnings before income taxes of $7.5 million in 2017.
Discrete items affecting our effective income tax rate
In fiscal 2019, as part of our fiscal 2018 restructuring plan and the shutdown of some of our facilities in the United States, we transferred the ownership of certain intellectual property held in the United States to Canada. This created a deductible tax asset in Canada and resulted in the recognition of a deferred income tax recovery of $2.4 million in fiscal 2019 as the recovery of this asset is probable.
In December 2017, the US tax reform ("Tax Cuts and Jobs Act") was substantively enacted and reduced the maximum corporate income tax rate from 35% to 21%, effective January 1, 2018. Based on our estimate of deferred tax assets expected to be used in fiscal 2018 and beyond against taxable income in the United States, we recorded a deferred income tax expense of $1.5 million in fiscal 2018 to account for the effect of this new substantively enacted tax rate.
Our distorted tax rates for all periods mainly resulted from the fact that we did not recognize deferred income tax assets for some of our subsidiaries at loss and acquisition-related costs for business combinations incurred in fiscal 2017 and 2018 were non-deductible for tax purposes. In addition, we had some other non-deductible losses and expenses, such as stock-based compensation costs. However, a significant portion of our foreign exchange gain or loss was a result of the translation of the financial statements of our foreign subsidiaries from their local currency to the functional currency and was therefore non-taxable or non-deductible. Otherwise, our effective tax rate would have been closer to the combined Canadian and provincial statutory tax rate of 27% for this year.
Please refer to note 20 to our consolidated financial statements for a full reconciliation of our income tax provision.
LIQUIDITY AND CAPITAL RESOURCES
Cash Requirements and Capital Resources
As at August 31, 2019, cash and short-term investments totaled $19.4 million, while our working capital was at $39.1 million. Our cash and short-term investments increased $4.4 million in fiscal 2019, compared to 2018.
The following table summarizes the increase of cash and short-term investments in fiscal 2019 in thousands of US dollars:
Cash flows provided by operating activities
Proceeds from disposal of capital assets
Purchases of capital assets
Repayment of bank loan
Repayment of long-term debt and other liabilities
Redemption of share capital
Unrealized foreign exchange loss on cash and short-term investments
Our short-term investments consist of debt instruments issued by high-credit quality corporations; therefore, we consider the risk of non-performance of these financial instruments to be limited. These debt instruments are not expected to be affected by a significant liquidity risk. For the purpose of managing our cash position, we have established a cash management policy, which we follow and monitor on a regular basis.
We believe that our cash balances and short-term investments totaling $19.4 million, combined with our available revolving credit facilities of up to $56.5 million, will be sufficient to meet our liquidity and capital requirements for the foreseeable future, including any possible working capital requirements from our new acquisitions. In addition to these assets and credit facilities, we have unused available lines of credit of $21.9 million for foreign currency exposure related to forward exchange contracts. However, possible operating losses, additional restructuring costs and/or possible investments in or acquisitions of complementary businesses, products or technologies may require additional financing. There can be no assurance that additional debt or equity financing will be available when required or, if available, that it can be secured on satisfactory terms.
We finance our operations and meet our capital expenditure requirements through a combination of cash flows from operating activities, the use of our cash and short-term investments, borrowing under our existing credit facilities as well as the issuance of subordinate voting shares.
Cash flows provided by operating activities were $17.2 million in fiscal 2019, compared to $14.4 million in 2018 and $12.9 million in 2017.
Fiscal 2019 vs. 2018
Cash flows provided by operating activities in fiscal 2019 were attributable to net earnings after items not affecting cash of $21.8 million, offset in part by the negative net change in non-cash operating items of $4.6 million; this was mainly due to the negative effect on cash of the increase of $4.8 million in our accounts receivable due to the timing of receipts and sales during the year, the negative effect on cash of the increase of $1.3 million in our prepaid expenses due to timing of payments during the year, the negative effect on cash of the $1.5 million increase in our other assets due to the timing of payments during the year, and the negative effect on cash of the $1.6 million decrease in our other liabilities due to the repayments made during the year. These negative effects on cash were offset in part by the positive effect on cash of the $1.5 million decrease in our income tax and tax credits recoverable due to tax credits recovered during the year and the positive effect on cash of the increase of $3.2 million in our accounts payable and accrued liabilities and provisions due to timing of purchases and payments during the year.
Fiscal 2018 vs. 2017
Cash flows provided by operating activities in fiscal 2018 were attributable to net earnings after items not affecting cash of $8.4 million, and the positive net change in non-cash operating items of $6.0 million; this was mainly due to the positive effect on cash of the decrease of $7.3 million in our accounts receivable due to the timing of receipts and sales during the year, and the increase of $1.0 million in our accounts payable and accrued liabilities and provisions due to timing of purchases and payments during the year. These positive effects on cash were offset in part by the negative effect on cash of the $1.0 million increase in our inventories to meet future demand and the negative effect on cash of the $1.3 million increase in our other assets due to the timing of payments during the year.
Cash flows used by investing activities amounted to $4.9 million in fiscal 2019, compared to $43.9 million in 2018 and $16.5 million in 2017.
In fiscal 2019, we made cash payments of $7.5 million for the purchase of capital assets and we acquired (net of disposal) $0.7 million worth of short-term investments. However, during the year, we received net proceeds of $3.3 million from the sale of capital assets.
In fiscal 2018, we made cash payments of $10.5 million and $32.1 million respectively for the purchase of capital assets and the acquisitions of EXFO Optics and EXFO Solutions. In addition, we acquired (net of disposal) $1.3 million worth of short-term investments during the year.
In fiscal 2017, we made cash payments of $12.8 million and $7.2 million respectively for the acquisitions of Absolute and Ontology and the purchase of capital assets. Otherwise, we disposed (net of acquisitions) of $3.5 million worth of short-term investments.
Cash flows used by financing activities amounted to $8.3 million in fiscal 2019, compared to cash flows provided of $4.3 million in 2018 and cash flows used of $1.5 million in 2017.
In fiscal 2019, our bank loan decreased by $5.2 million, we repaid $2.8 million of our long-term debt and other liabilities, and we redeemed share capital for $0.3 million.
In fiscal 2018, our bank loan increased by $11.1 million, but we repaid $3.1 million of our long-term debt and other liabilities and paid $3.7 million for the purchase of the non-controlling interest in EXFO Solutions.
In fiscal 2017, we repaid the long-term debt of $1.5 million assumed as part of the acquisition of Ontology.
We are committed under the terms of contractual obligations which have various expiration dates, primarily for the rental of premises and equipment, licensing of intellectual property and long-term debt. The following table summarizes our contractual obligations, on an undiscounted basis, as at August 31, 2019 in thousands of US dollars:
No later than one year
Later than one year and no later than five years
Later than five years
Upon the adoption of IFRS 16, ‘’Leases’’, on September 1, 2019, obligations under operating leases will be accounted in the consolidated balance sheet as right-of-use assets and lease liabilities measured at the present value of lease payments on date of adoption. See the New IFRS pronouncements section further in this document for a complete description of the impacts of the adoption of IFRS 16.
In addition, on August 31, 2019, we had letters of guarantee amounting to $0.7 million for our own selling and purchasing requirements, which were reserved from our lines of credit; these letters of guarantee expire at various dates through fiscal 2022.
We are exposed to currency risk as a result of our export sales of products manufactured in Canada, China, France, and Finland, the majority of which are denominated in US dollars and euros. In addition, we are exposed to currency risk as a result of our research and development activities in India (Indian rupees). These risks are partially hedged by forward exchange contracts. Forward exchange contracts, which are designated as cash flow hedging instruments, qualify for hedge accounting.
As at August 31, 2019, we held forward exchange contracts to sell US dollars for Canadian dollars and Indian rupees at various forward rates, which are summarized as follows:
US dollars – Canadian dollars
September 2019 to August 2020
September 2020 to August 2021
September 2021 to July 2022
US dollars – Indian rupees
September 2019 to August 2020
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 losses of $0.5 million and of $1.0 million as at August 31, 2018 and 2019 respectively. The US dollar – Canadian dollar year-end exchange rate was CA$1.3294 = US$1.00 as at August 31, 2019.
As at November 11, 2019, EXFO had 31,643,000 multiple voting shares outstanding, entitling to 10 votes each and 23,869,117 subordinate voting shares outstanding. The multiple voting shares and the subordinate voting shares are unlimited as to number and are without par value.
OFF-BALANCE SHEET ARRANGEMENTS
As at August 31, 2019, our off-balance sheet arrangements consisted of letters of guarantee amounting to $0.7 million for our own selling and purchasing requirements, which were reserved from our lines of credit; these letters of guarantee expire at various dates through fiscal 2022.
As at August 31, 2019, we did not have interests in any structured entities.
The preparation of financial statements in accordance with IFRS requires us to make judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses and the disclosures of contingent assets and liabilities at the date of the financial statements. On an ongoing basis, we evaluate these estimates and assumptions, including those related to the fair value of assets and liabilities acquired in business combinations, the fair value of financial instruments, the allowance for doubtful accounts receivable, the amount of tax credits recoverable, the provision for excess and obsolete inventories, the estimated useful lives of capital assets, the valuation of long-lived assets, the impairment of goodwill, the recoverable amount of deferred income tax assets, the amount of certain accrued liabilities, provisions and deferred revenue as well as stock-based compensation costs. We base our estimates and assumptions on historical experience and on other factors that we believe to be reasonable under the circumstances.
Critical Judgments in Applying Accounting Policies
Determination of functional currency
We operate in multiple countries and generate revenue and incur expenses in several currencies, namely the Canadian dollar, the US dollar, the euro, the British pound, the Indian rupee and the CNY (Chinese currency). The determination of the functional currency of EXFO and its subsidiaries may require significant judgment. In determining the functional currency of EXFO and its subsidiaries, we take into account primary, secondary and tertiary indicators. When indicators are mixed, and the functional currency is not obvious, we use our judgment to determine the functional currency.
Determination of cash generating units and allocation of goodwill
For the purpose of impairment testing, goodwill must be allocated to each cash-generating unit (CGU) or group of CGUs that are expected to benefit from the synergies of the business combination. Initial allocation and possible reallocation of goodwill to a CGU or a group of CGUs requires judgment.
Critical Estimates and Assumptions
We state our inventories at the lower of cost, determined on an average cost basis, and net realizable value, and we provide reserves for excess and obsolete inventories. We determine our reserves for excess and obsolete inventories based on the quantities on hand at the reporting dates compared to foreseeable needs, taking into account changes in demand, technology or market. It is possible that additional inventory reserves may occur if future sales are less than our forecasts or if there is a significant shift in product mix compared to our forecasts, which could adversely affect our results.
We are subject to income tax laws and regulations in several jurisdictions. Under these laws and regulations, uncertainties exist with respect to the interpretation of complex tax regulations and the amount and timing of future taxable income. We maintain provisions for uncertain tax positions that we believe appropriately reflect our risk based on our interpretation of laws and regulations. In addition, we make reasonable estimates and assumptions to determine the amount of deferred tax assets that can be recognized in our consolidated financial statements, based upon the likely timing and level of anticipated future taxable income together with tax planning strategies. The ultimate realization of our deferred income tax assets is dependent upon the generation of sufficient future taxable income during the periods in which those assets are expected to be realized.
Tax credits are recorded if there is reasonable assurance that we have complied and will comply with all the conditions related to the tax credits and that the tax credits will be received. The ultimate recovery of our Canadian non-refundable tax credits is dependent upon the generation of sufficient future taxable income during the tax credits carry-forward periods. We have made reasonable estimates and assumptions to determine the amount of non-refundable tax credits that can be recognized in our consolidated financial statements, based upon the likely timing and level of anticipated future taxable income together with tax planning strategies.
As at August 31, 2019, our Canadian non-refundable research and development tax credits recognized in the consolidated balance sheet amounted to $38.9 million. To recover these non-refundable research and development tax credits, we need to generate approximately $260 million (CA$345 million) in pre-tax earnings at the Canadian federal level. To generate this level pre-tax earnings at the Canadian federal level over the estimated recovery period of 16 years, we must generate a pre-tax earnings compound annual growth rate of 1%, which we believe is probable. Our non-refundable research and development tax credits can be carried forward over a 20-year period.
Impairment of non-financial assets
Impairment exists when the carrying value of an asset or group of assets (cash generating unit (CGU)) exceeds its recoverable amount, which is the higher of its fair value less costs of disposal and its value in use. The fair value less costs of disposal calculation for our CGUs is based on a market approach that relies on input from implicit valuation multiples and recent transactions for comparable assets or businesses, within the same industry. We apply judgment in making adjustments for factors such as size, risk profile or profitability and also consider EXFO’s value derived from its market capitalization considering a control premium based on comparable situations. Depending on the market evidence available, we, from time to time, may further supplement this market approach with an income approach that considers discounted cash flows to determine fair value less costs of disposal, as well as the nature and magnitude of research and development activities carried out by the CGU. The discounted cash flow model involves significant judgment with respect to estimating cash flows (based on market participant assumptions) and the appropriate discount rate.
In the fourth quarter of fiscal 2019, we performed our annual goodwill impairment test for all CGUs.
For the purposes of the impairment test, goodwill has been allocated to the lowest level within the company at which it is monitored by management to make business decisions, which are the following CGUs:
EXFO Optics CGU
Service assurance, systems and services (SASS) CGU
Prior to fiscal 2019, the Brix, Ontology and EXFO Solutions CGUs have been identified as three separate CGUs for goodwill impairment testing as they represented the lowest level within EXFO at which the goodwill was monitored for internal management purposes, and the smallest group of assets that generated cash inflows that were largely independent of the cash inflows from other CGUs. However, at the end of August 2018, we implemented a restructuring plan to fast-track the integration of newly acquired EXFO Solutions’ and Ontology’s technologies with those of our service assurance on a common monitoring and analytics platform to better position the company’s offering and reduce its costs. Consequently, starting September 1, 2018, following the announcement of this plan, all future operating and investing decisions related to these three CGUs have been aligned with the restructuring plan and related goodwill, previously allocated to each of these three CGUs, has been monitored for internal management purposes on a combined basis under the Service assurance, systems and services (SASS) CGU, which represented the smallest group of assets that would generate future cash inflows that would largely be independent of the cash inflows from the other CGUs.
In fiscal 2018, the goodwill impairment test has been performed closely to the date of the goodwill reallocation from the Brix, Ontology and EXFO Solutions’ GCUs to the SASS CGU and goodwill of each of the three CGUs was not impaired. Consequently, no goodwill impairment test was performed on the date of goodwill reallocation to the combined goodwill.
In performing the fiscal 2019 goodwill impairment review of our CGUs, we determined the recoverable amount of goodwill based on fair value less costs of disposal. In estimating the recoverable amount of its CGUs, we used a market approach, which is based on sales multiples within the range of 1.0 to 7.6 times sales, for comparable businesses with similar operations within the same industry over the past year. We applied judgment in making certain adjustments for factors such as size, risk profile or profitability of the comparable businesses, when compared to our CGUs. In addition, for the SASS CGU, we also used a liquidation approach based on the level of research and development expenses incurred over the last two years.
As at August 31, 2019, the recoverable amount for all CGUs exceeded their carrying value.
Purchase price allocation in business combinations
The fair value of the total consideration transferred in business combinations (purchase price) must be allocated based on the estimated fair value of acquired net assets at the date of acquisition. Allocating the purchase price requires management to make estimates and judgments to determine assets acquired and liabilities assumed, useful lives of certain long-lived assets and the respective fair value of assets acquired, and liabilities assumed; this may require the use of unobservable inputs, including management’s expectations of future revenue growth, operating costs and profit margins as well as discount rates.
The assumptions used are based on acquired companies’ historical growth, expectations of future revenue growth, expected synergies as well as industry and market trends.
We use a discount rate to calculate the present value of estimated future cash flows, which represents our weighted average cost of capital (WACC).
Identification of performance obligations
Customer contracts may include promises to transfer multiple products and services to a customer. Determining whether the products and services are considered distinct performance obligations that should be accounted for separately or as one single performance obligation may require significant judgment. We assess whether each promised good or service is distinct for the purpose of identifying the various performance obligations in each contract. Promised goods and services are considered distinct provided that: (i) the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer; and (ii) our promise to transfer the good or service to the customer is separately identifiable or distinct from other promises in the contract.