UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, D.C. 20549




FORM 20-F




oREGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g)


OF THE SECURITIES EXCHANGE ACT OF 1934; or




xANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF


THE SECURITIES EXCHANGE ACT OF 1934


For the fiscal year ended August 31, 2014; or




oTRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF


THE SECURITIES EXCHANGE ACT OF 1934


For the transition period ________ to ________; or




oSHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF


THE SECURITIES EXCHANGE ACT OF 1934




Date of event requiring this shell company report




Commission File No. 0-30895




EXFO INC.


(Exact name of registrant as specified in its charter)




Not Applicable


(Translation of Registrant’s name into English)




Canada


(Jurisdiction of Incorporation or organization)




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


(Address of principal executive offices)




Benoit Ringuette, (418) 683-0211, benoit.ringuette@exfo.com, (418) 683-9839, 400 Godin Avenue, Quebec, Quebec, G1M 2K2, Canada


(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 registeredSubordinate Voting Shares without par value
NASDAQSubordinate Voting Shares without par value
TSX





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




None




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




None




















As of August 31, 2014, the registrant had 28,703,750 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 o No x





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








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 xNo o





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





Yes xNo o





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





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





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





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

International Accounting Standards Board
Other      o





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


Item 17 oItem 18 o





If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).


Yes oNo x
















TABLE OF CONTENTS






PART I.




Item 1.       Identity of Directors, Senior Management and Advisers




Item 2.       Offer Statistics and Expected Timetable




Item 3.       Key Information




A.   Selected Financial Data


B.   Capitalization and Indebtedness


C.   Reasons for the Offer and Use of Proceeds


D.   Risk Factors





Item 4.       Information on the Company




A.   History and Development of the Company


B.   Business Overview


C.   Organizational Structure


D.   Property, Plants and Equipment




Item 4A      Unresolved Staff Comments




Item 5.       Operating and Financial Review and Prospects




Item 6.       Directors, Senior Management and Employees


A.   Directors and Senior Management
 B.   Compensation
 C.   Board Practices
 D.   Employees
 E.   Share Ownership


Item 7.       Major Shareholders and Related Party Transactions


A.   Major Shareholders
 B.   Related Party Transactions
 C.   Interests of Experts and Counsel




Item 8.       Financial Information


A.   Consolidated Statements and Other Financial Information
 B.   Significant Changes




Item 9.       The Offer and Listing


A.   Offer and Listing Details
 C.   Markets












Item 10.     Additional Information




A.   Share Capital


B.   Memorandum and Articles of Association


C.   Material Contracts


D.   Exchange Controls


E.   Taxation


F.   Dividends and Paying Agents


G.  Statement by Experts


H.  Documents on Display


I.   Subsidiary Information




Item 11.     Qualitative and Quantitative Disclosures about Market Risk




Item 12.     Description of Securities Other than Equity Securities




PART II.




Item 13.     Defaults, Dividend Arrearages and Delinquencies




Item 14.     Material Modifications to the Rights of Security Holders and Use of Proceeds




Item 15.     Controls and Procedures




Item 16.     [Reserved]




Item 16A.  Audit Committee Financial Expert




Item 16B.  Code of Ethics




Item 16C.  Principal Accountant Fees and Services




Item 16D.  Exemptions from the Listing Standards for Audit Committees




Item 16E.  Purchases of Equity Securities by the Issuer and Affiliated Purchasers




Item 16F.  Change in Registrant's Certifying Accountant




Item 16G.  Corporate Governance




Item 16H.  Mine Safety Disclosure




PART III.




Item 17.     Financial Statements




Item 18.     Financial Statements




Item 19.     Exhibits








Table of Contents





DISCLOSURE REGARDING FORWARD-LOOKING INFORMATION




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 as well as capital spending and network deployment levels in the telecommunications industry (including our ability to quickly adapt cost structures with 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 telecommunications test and service assurance industry and increased competition among vendors; capacity to adapt our future product offering to future technological changes; limited visibility with regards to customer orders and the timing of such orders; 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; our ability to successfully integrate businesses that we acquire; 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 you that the expectations will prove to have been correct. Accordingly, you should not place undue reliance on these forward-looking statements. These statements speak only as of the date of this document. Unless required by law or applicable regulations, we undertake no obligation to revise or update any of them to reflect events or circumstances that occur after the date of this document.




All dollar amounts in this Annual Report are expressed in US dollars, except as otherwise noted.






PART I.






Item 1.
Identity of Directors, Senior Management and Advisers




Not Applicable.






Item 2.
Offer Statistics and Expected Timetable




Not Applicable.






Item 3.
Key Information




A.Selected Financial Data


The consolidated statements of earnings data for the years ended August 31, 2012, 2013 and 2014 and the consolidated balance sheets data as at August 31, 2013 and 2014 have been derived from our audited consolidated financial statements that are included elsewhere in this Annual Report. Consolidated statement of earnings data for the year ended August 31, 2011 and consolidated balance sheets data as at August 31, 2011 and 2012 have been derived from our audited consolidated financial statements not included in this Annual Report. Consolidated financial statements for the years ended August, 31, 2011, 2012, 2013 and 2014 have been prepared in accordance with International Financial Reporting Standards (IFRS), as issued by the International Accounting Standards Board (IASB).





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The selected financial data should be read in conjunction with our audited consolidated financial statements and the related notes included elsewhere in this Annual Report, and “Item 5. Operating and Financial Review and Prospects” of this Annual Report.




Years ended August 31,2014


2013


2012


2011(in thousands of US dollars, except share

and per share data)Consolidated Statements of Earnings Data:Sales

$
230,806


$
242,150


$
249,966


$
269,743Cost of sales (1)


86,836



92,469



91,792



100,296Selling and administrative


86,429



88,756



94,139



87,062Net research and development


44,846



45,444



49,854



47,927Depreciation of property, plant and equipment


4,995



6,028



6,169



6,655Amortization of intangible assets


4,398



6,643



7,819



9,183Changes in fair value of cash contingent consideration


–



–



(311
)


(2,685
)Interest and other income


(326
)


(113
)


(131
)


(511
)Foreign exchange (gain) loss


(1,634
)


(4,082
)


657



3,808Earnings (loss) before income taxes


5,262



7,005



(22
)


18,008Income taxes


4,479



5,664



3,571



8,814Net earnings (loss) from continuing operations


783



1,341



(3,593
)


9,194Net earnings from discontinued operations


–



–



–



12,926Net earnings (loss) for the year

$
783


$
1,341


$
(3,593
)

$
22,120Basic and diluted net earnings (loss) from continuing operations per share

$
0.01


$
0.02


$
(0.06
)

$
0.15Basic net earnings (loss) per share

$
0.01


$
0.02


$
(0.06
)

$
0.37Diluted net earnings (loss) per share

$
0.01


$
0.02


$
(0.06
)

$
0.36Basic weighted average number of shares used in per share calculations (000’s)


60,329



60,323



60,453



60,000Diluted weighted average number of shares used in per share calculations (000’s)


61,015



61,110



60,453



61,488Other Consolidated Statements of Earnings Data:Gross research and development

$
52,423


$
54,334


$
59,282


$
57,226Net research and development

$
44,846


$
45,444


$
49,854


$
47,927
 
 As at August 31,2014


2013


2012


2011(in thousands of US dollars)Consolidated Balance Sheets Data:Cash

$
54,121


$
45,386


$
58,868


$
22,771Short-term investments


5,726



4,868



8,236



47,091Total assets


278,031



281,538



306,683



322,355Long-term debt (excluding current portion)


–



–



282



968Share capital


111,491



109,837



110,965



110,341Shareholders’ equity

$
231,370


$
236,452


$
253,281


$
264,511




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






B.Capitalization and Indebtedness




Not Applicable.






C.Reasons for the Offer and Use of Proceeds




Not Applicable.


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D.Risk Factors




Our business and operating results could continue to be adversely affected by unfavorable macro-economic and market conditions, resulting in reductions of capital and operating expenditures by our customers.




Broad macro-economic weakness previously resulted in sustained periods of decreased demand for our products and services that adversely affected our business and operating results. In fact, many of our customers significantly reduced their capital and operating expenditures as they sought to conserve capital, reduce debt or address uncertainties or changes in their own business models.




The prolonged recovery from the global financial crisis, budget deficits in several key countries, the instability of the geo-political environment in many parts of the world, and other disruptions may continue to put pressure on global economic conditions. If global economic and market conditions or economic conditions in key markets, remain uncertain or deteriorate further, it could have a material adverse impact on our business and operating results.




Difficult market conditions in the telecommunications industry persisted in fiscal 2014 due to aforementioned economic conditions and uneven network operator spending, especially in the Americas. We do not know how long these uncertain macro-economic and market conditions will persist, the pace of recovery, and the magnitude of the impact of these market conditions on our business and results of operations. Continued or increasingly adverse economic and market conditions could result in, among other things:




●
difficulty 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-off of deferred tax assets and tax credits, and impairment of intangible assets and goodwill;
 
 
 
 
 ●
customers’ financial difficulties and increased difficulty in collecting accounts receivable; and
 
 ●
additional restructuring costs.


Our business and operating results could continue to be adversely affected by periods of unfavorable macro-economic and market conditions or the worsening of those conditions, globally or specific to a particular region where we operate, and any resulting reductions in the level of capital and operating expenditures by our customers.




Fluctuations in the exchange rates between the Canadian dollar, US dollar, euro and other currencies may adversely affect our operating results.




Our functional currency is the Canadian dollar. We are exposed to a currency risk as a result of our export of products manufactured in Canada, China and Finland. The majority of these export sales are denominated in US dollars and euros, while a significant portion of our cost of sales, operating expenses and capital expenditures are denominated in Canadian dollars, US dollars and other currencies such as euros, British Pounds, Rupees (India) and Renminbis (China). As a result, 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 certain operating expenses denominated in currencies other than the Canadian dollar, namely the US dollar and euro, we are 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 dollar-Canadian dollar forward exchange contracts, could result in foreign exchange losses and have a material adverse effect on our operating results.


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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 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 gain market share and achieve our growth strategy.




The market for our business activity ─ namely designing, manufacturing, marketing and selling telecommunications test and service assurance solutions for fixed and mobile networks ─ is rapidly evolving and is marked by intense competition and technical innovation. We anticipate the pace of change to remain high or even accelerate for our targeted industries in the future. We might see the emergence of new competitors or the consolidation of current competitors, as the market for telecommunications test and service assurance equipment evolves in response to technical innovations and economic conditions




Main competitors in the test environment include global suppliers like Anritsu Corporation, Danaher Corporation (namely subsidiaries like Tektronix Communications and Fluke Networks) and JDS Uniphase Corporation, as well as other players like AFL Noyse, IXIA, Kingfisher International, ShinewayTech, Spirent Communications plc, VeEX Inc., and Yokogawa Electric Corporation. On the service assurance side, we mainly compete against Anritsu Corporation, Empirix, IXIA, JDS Uniphase Corporation, NetScout Systems, Inc., Spirent Communications plc, Tektronix Communications and Teoco.




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 increase our sales and develop cost-effective products and product enhancements that offer higher performance and more functionality, in current and new sectors, so that we can increase our market share. Our failure to do so may harm our business, results of operations and financial condition.




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 telecommunications test and service assurance industry, 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, which would harm our sales and operating results. In addition, some customers may merge with or acquire our competitors and discontinue their relationships with us. This, in turn, may negatively affect our gross margin. Pricing pressure can result from a number of factors such as, among other things:


●
increased competition for business;
 
 ●
reduced demand;
 ●
limited number of potential customers;
 ●
competition from companies with lower production costs, including companies operating in lower-cost environments;
 ●
introduction of new products by competitors;
 
 
 
 
 ●
greater economies of scale for higher-volume competitors;


4
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  ●
large customers, who buy in high volumes, can exert substantial negotiating leverage over us; and
 
 ●
resale of used equipment.




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.




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 any such beneficial transactions or a sufficient number of such transactions to meet our strategic goals. Our competitors may be in a better position to acquire the same businesses, products and technologies that we wish 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. In April 2014, we acquired the assets of ByteSphere, a software company specializing in global IT management and network monitoring solutions. In June 2014, we acquired the business of Aito Technologies, a provider of customer experience analytics for mobile network operators, through an asset purchase deal. 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 debt;
 ●
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
 
 ●
incur losses from operations.




In the event that 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:


●
the risk of not realizing the expected benefits or synergies from such acquisitions or alliances;
 
 ●
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.







5
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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, 2014, customers outside of the United States and Canada accounted for 55.5% 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 network 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;
 ●
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;
 
 ●
economic instability in foreign markets;
 ●
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 
 
 
 
 ●
failure to meet certification requirements.


Any of these factors could harm our international operations and negatively affect our business, results of operations and financial condition. The recurrence of weakness in these economies or of weakness in other foreign economies could 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, Concord, Canada, Boston, United States, and Oulu, Finland, we maintain a software development center in Pune, India. We also manufacture high-volume, low-complexity products at our wholly-owned production facility in Shenzhen, China.







6
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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 compliance in India and China;
 
 
 
 
 ●
cash management and repatriation of profit; and
 
 ●
high inflation rates which could increase our operating costs.




If we are unable to adapt to current and future changes in technology or if we are unable to introduce new and enhanced products on a timely basis, our products may become obsolete, which could prevent us from achieving our growth strategy and adversely affect our operating results.




The industries that we serve are characterized by rapidly evolving technology and industry standards that result in frequent new product introductions. Any failure by us to anticipate or respond to new technological developments, customer requirements or evolving standards could have a material adverse effect on our business, results of operations and financial condition. The development of proprietary technology entails significant technical and business risks and requires substantial expenditures and lead 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;
 ●
gain timely market acceptance for new products;
 ●
manufacture and deliver our new products on time, in sufficient volume and with adequate quality;
 ●
price our products competitively;
 
 
 
 
 ●
continue investing in our research and development programs; and
 
 ●
anticipate competitors’ announcements of new products.




Failure to do the above could be exploited by our competitors. If we lose market share as a result of lapses in our product development, our business would suffer.




Our products may have unforeseen defects that could harm our reputation, impede market acceptance of our products and negatively impact our business, results of operations and financial condition.




Given their complexity, our products may contain undetected software or hardware defects, inaccurate calibration or compatibility problems, or regulatory compliance issues, particularly when they are first introduced or when new versions are released. There can be no assurance that, despite our testing and diligent efforts, defects will not be found in new products after they have been fully deployed and operated under peak stress conditions, or that customized products will meet customer sign-off acceptance requirements. If we are unable to fix defects or other problems or meet custom requirements, we could experience, among other things:


●
costly repairs;
 
 ●
product returns or recalls;
 ●
damage to our brand reputation;
 ●
loss of customers, failure to attract new customers or achieve market acceptance;
 ●
diversion of development and engineering resources;


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  ●
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, 2014, our records indicate that we held the following portfolio of utility patents: 49 actively-maintained granted U.S. patents, 41 granted or validated patents in countries of the European Union, 6 patents in Canada, 8 patents in China, and 3 patents in other jurisdictions. In addition, we have 28 utility patent applications (including provisional applications) pending in the U.S., 2 in Canada, 10 in China, 22 patent applications at the European Patent Office or directly entered at the national patent office of an EU member country, and 9 applications in other countries. In addition, there are 2 International Applications under the Patent Cooperation Treaty that have not yet entered the national/regional phase. As of August 31, 2014, our records also indicate that we hold 2 granted “design” patents in each of China and Europe, as well as 10 pending design patent applications, in the United States and several 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 in order to protect our patents and other intellectual property rights or to determine the validity or scope of the proprietary rights of others. Such litigation 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 applications will actually result in issued patents, or that, even if patents are issued, they will be of sufficient scope or strength to provide meaningful protection or 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 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.







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Others may claim that our products infringe upon their intellectual property rights, or they may infringe our intellectual property, and we may expend significant resources enforcing or defending our rights or suffer competitive injury.




Litigation regarding intellectual property rights is common in the technology industry and third-party infringement claims involving technologies may increase. If an infringement claim is filed against us, we may be prevented from using some of our technologies and may incur significant costs to resolve the claim. Conversely, we may be required to spend significant resources to monitor and enforce our intellectual property rights.




We could incur substantial costs in defending ourselves and our customers against infringement claims or in bringing infringement claims against others. Litigation could also adversely affect sales of the challenged product or technology and divert the efforts of our management and technical personnel. In the event of an infringement claim, we may be required to obtain one or more licenses from third parties. We cannot assure you that we, or our customers, could obtain necessary licenses from third parties at a reasonable cost or at all. If we fail to obtain a license where one is required, we could incur substantial liabilities and be forced to suspend the marketing of the challenged products.




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 modules 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 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. Because our service assurance and wireless test systems 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. Many of our deals involve lengthy sales cycles, contract negotiations as well as extensive product testing, 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:


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  ●
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 for us 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 telecommunications test and service assurance equipment;
 
 ●
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 some of the 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 of our technical personnel and management. If we were required to change a supplier in a short period of time, our business would be disrupted. In addition, we may be unsuccessful in identifying a new supplier capable of meeting and willing to meet our needs on acceptable terms. Consolidation involving suppliers could further reduce the number of alternatives available to us and increase the cost of parts, which would make our products less competitive and result in lower margins.


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If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial information or prevent fraud, which could harm our operating results and cause investors to lose confidence in our reported financial information.




Effective internal controls are necessary for us to provide reliable and accurate financial information and effectively prevent fraud. We devote significant resources and time to comply with the requirements of the Sarbanes-Oxley Act of 2002. In addition, Section 404 of the Sarbanes-Oxley Act of 2002 requires that we assess and that our independent auditor attests to the design and operating effectiveness of our internal controls over financial reporting. Our compliance with the annual internal control report requirement for each fiscal year will depend on the effectiveness of our financial reporting as well as data systems and controls throughout our company and operating subsidiaries. Furthermore, we cannot be certain that these measures will ensure that we design, implement and maintain adequate controls over our financial processes and reporting in the future, especially in the event of acquiring companies that are not in compliance with Section 404 of the Sarbanes-Oxley Act of 2002. As well, the complexity of our systems and controls may become more difficult to manage as we transform our operating structure and continue to reduce infrastructure costs. To effectively manage these changes, we will need to continue to improve our operational, financial and management controls and our reporting systems and procedures. Any failure to implement newly required or improved controls, difficulties encountered in their operation, or difficulties in the assimilation of acquired businesses into our control system, could harm our operating results or prevent us from meeting our financial reporting obligations. Inferior internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on our share price and our access to capital.




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 telecommunications test and service assurance industry. 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 also be hired by our competitors or leave the organization.




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.







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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 historical operating results reflect substantial benefits from programs sponsored by Canadian federal and provincial governments for the support of research and development activities. In addition, EXFO Oy (formerly NetHawk Oyj), which was acquired in 2010, is entitled to government grants from a Finnish technology organization for research and development activities conducted in Finland.  Altogether, research and development tax credits and grants represented 14.5% of our gross research and development expenses for the year ended August 31, 2014.




Our research and development projects entitled to government grants from the Finnish technology organization must be pre-approved and the grant is subject to certain conditions. In the event a specific condition is not met, we may be required to reimburse a portion or the entire amount of the grant received, which would have material adverse effect on our results of operations and financial condition.




If changes in laws or government policies terminate or adversely modify the Canadian federal and provincial government programs or the Finnish government program, under which we receive the majority of our research and development and other tax credits and grants, or if we unexpectedly become unable to participate in or take advantage of these programs, then our net research and development and other expenses will materially increase or we may decrease our research and development activities. For example, in March 2012, the Canadian federal government announced a series of measures that, among other things, reduced our Canadian federal tax credit rate on eligible expenses from 20% to 15% starting in calendar 2014. In addition, effective June 2014, our provincial tax credit rate on eligible expenses decreased from 17.5% to 14%.




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 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 can have an adverse impact on our results and financial condition.


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Our current principal stockholder has effective control over our business.




As of November 1, 2014, Germain Lamonde, our Chairman of the Board, President and Chief Executive Officer, held 92.9% 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, 2014, we held $59.8 million in cash and short-term investments.




We may need to raise additional capital in the future. Our ability to obtain additional financing will be subject to a number of factors, including market conditions, reduced access to credit facilities and our operating performance. These factors may render the timing, amount, terms and conditions of additional financing unattractive for us. If we raise additional funds by selling equity securities, the relative ownership of our existing investors could be diluted or new investors could obtain terms more favorable than previous investors. If we raise funds through debt financing, we could incur significant borrowing costs and 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.




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.







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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 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 new 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. The additional disclosure rules were effective for calendar year 2013 and we made our first filing on May 30, 2014.




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 keeping 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 or 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 conditions and cash flows.




Our stock price is volatile.




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 telecommunications 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 2014, our closing stock price on NASDAQ ranged from a high of $5.70 per share to a low of $4.13 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.




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Item 4.
Information on the Company




A.History and Development of the Company




Our legal name and commercial name is EXFO 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, New York, New York 10011. Our Transfer Agent and Registrar is CST Trust Company (CST), 2001 University Street, Suite 1600, Montreal, Quebec, Canada, H3A 2A6. This Annual Report contains trademarks and registered trademarks of us and other companies.




We were incorporated 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,  2013 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.




On January 8, 2014, we announced that our Board of Directors approved the renewal of our share repurchase program, by way of a normal course issuer bid on the open market of up to 10% of our issued and outstanding subordinate voting shares, representing 2,043,101 subordinate voting shares at the prevailing market price. The period of the normal course issuer bid commenced on January 13, 2014 and will end on January 12, 2015. As of November 10, 2014, we had repurchased for cancellation 351,743shares under that program for an aggregate net purchase price of $1.4 million.




On April 4, 2014, we acquired the assets of ByteSphere LLC, a Boston-area software company specializing in global IT management and network monitoring solutions. This transaction extends our service assurance offering into infrastructure performance visibility through highly scalable device and network element polling. This acquisition is immaterial.




On June 19, 2014, we acquired the assets of Aito Technologies Ltd, a Finnish provider of customer experience analytics for mobile network operators. This acquisition is immaterial.






B.Business Overview




We are a leading provider of next-generation test, service assurance and end-to-end quality of experience solutions for mobile and fixed network operators and equipment manufacturers in the global telecommunications industry. Our intelligent solutions with contextually relevant analytics are designed to improve end-user quality of experience, enhance network performance and drive operational efficiencies throughout the network and service delivery lifecycle. We target high-growth market opportunities related to increasing bandwidth and improving quality of experience on network infrastructures: 4G/LTE (long-term evolution), wireless backhaul, small cells and distributed antenna systems (DAS), 100G network upgrades and fiber-to-the-home (FTTH)/fiber-to-the-curb (FTTC)/fiber-to-the-node (FTTN) deployments.







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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 global telecommunications test and service assurance industry through acquisitions of transport and datacom, copper/xDSL and wireless test companies as well as an IP service assurance business.




We launched 24 new products or major enhancements in fiscal 2014. Key new product introductions in 2014 included, among others, an all-in-one optical and Ethernet test module that accelerates the deployment and troubleshooting of wireless backhaul, small cell and metro Ethernet networks; a monitoring solution designed to offer end-to-end visibility of network infrastructure performance through the distributed polling of  several thousands  of network elements; among the industry’s smallest platform  for high-speed, multi-technology testing in the field; a service assurance solution designed to enable mobile operators to proactively monitor and assure quality of experience of voice-over-LTE (VoLTE) deployments; a tablet-based OTDR series that is designed to simplify and reduce testing time on fixed and mobile networks; and a fully automated fiber inspection probe that is designed to eliminate error risks and reduce fiber connector inspection time by more than 50%.




Industry Background




Market conditions remained challenging in fiscal 2014 as the telecommunications industry faced several headwinds including reduced spending levels among tier-1 network operators, especially in the Americas; merger activity which slowed down deployments mainly in the United States; and project delays on a global basis as network operators weighed major architectural changes to network functions virtualization (NFV) and software defined networking (SDN) technologies.




Against this backdrop, wireline and wireless network operators are faced with a daunting task as the proliferation of smart phones and tablets, coupled with the explosion in video streaming, is driving an exponential increase in data traffic and network complexity. According to Cisco’s Visual Networking Index, global IP traffic will increase nearly threefold from 2013 to 2018, reaching 1.6 zettabytes per year in 2018. (A zettabyte is equal to 1,000 exabytes or 250 billion DVDs). Global mobile traffic, a subset of this larger group, is expected to increase almost 11-fold during the same period, according to Cisco. Consequently, network operators are seeking solutions that help them expand network capacity, deliver new, revenue-generating services and improve quality of experience for subscribers, while reducing the cost of operating their networks.




Growth Strategy




Our long-term goal is to become the market leader in the global telecom test and service assurance industry. Given surging bandwidth demand and the need to better monetize their networks, we believe that wireless and wireline network operators and equipment manufacturers must make considerable investments to network infrastructures.




To achieve our goal, we plan to:


●
Increase our presence with wireless operators;
 
 ●
Expand our sales with Tier-1 network operators;
 ●
Evolve from an instruments to a solutions supplier; and
 ●
Accelerate profitability.




Customers




Telecom customers on a global basis use our test and service assurance solutions to enable their wireline and wireless networks to perform optimally during their complete life cycles: research, development, manufacturing, installation, maintenance and monitoring.







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We initially developed telecom test equipment for wireline network operators and, to a lesser extent, component vendors and equipment manufacturers, but over the years we have expanded our offering to wireless network operators, cable television companies, public utilities, private network operators, third-party installers, equipment rental companies, large enterprises and laboratory researchers.




In fiscal 2014, our top customer accounted for 6.1% of our sales and our top three customers represented 11.6%. In comparison, our top customer accounted for 6.1% of sales and our top three customers represented 13.5% in 2013, while our top customer accounted for 4.4% of sales and our top three customers represented 12.0% in 2012.




Products




We offer an extensive range of wireline and wireless test and service assurance solutions to the global telecommunications industry. We believe our success has been largely predicated on our core expertise in developing test equipment for wireline networks. Following the acquisition of Brix Networks in April 2008, we expanded our product portfolio into the service assurance market for next-generation IP networks. Through the acquisition of NetHawk Oyj in March 2010, we offer test and service assurance solutions for 2G, 3G and 4G/LTE wireless networks.




In April 2014, we acquired the assets of ByteSphere, a software company specializing in global IT management and network monitoring solutions. This transaction extends our service assurance offering into infrastructure performance monitoring market through highly scalable device and network element polling technology.




In June 2014, we acquired the assets of Aito Technologies, a provider of customer experience analytics for mobile network operators. We have combined the analytics software capabilities of Aito Technologies with our wireless product portfolio to provide mobile operators with heightened, end-to-end visibility and in-depth troubleshooting capabilities of their 3G and 4G/LTE networks. Both of these asset acquisitions are non-material.




We believe the competitive advantages of our products include a high degree of innovation, modularity (especially wireline products) and ease of use. Ultimately, we believe our products enable network equipment manufacturers and operators to design, deploy, troubleshoot and monitor wireline and wireless networks, and also help customers reduce their operating expenses.




Products for Network Operators




Wireline Test Equipment




We provide an extensive range of portable test solutions that are mainly used by network operators to install, turn up and maintain their optical and copper-based telecommunications 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.




Our field-test platforms, namely the FTB-1 Platform, FTB-200 Compact Platform, FTB-500 Platform and newly launched FTB-2 Pro Platform, are at the core of our wireline product portfolio. Our FTB-1 Platform, designed for frontline technicians in the field, is a single-slot, modular platform dedicated to fiber-optic, copper, Ethernet, fiber-to-the-home and multiservice testing applications. Our FTB-200 Compact Platform, conceived for the “super field technician,” holds up to two interchangeable modules that are also fully compatible with our more advanced FTB-500 platform. Test technologies well suited for the FTB-200 Compact Platform include a wide range of singlemode and multimode optical time-domain reflectometers (OTDRs), automated optical loss test sets (OLTS), SONET/SDH analyzers up to 10 Gbit/s, as well as Gigabit Ethernet (GigE) and 10 Gigabit Ethernet testers.







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Our third-generation field-testing platform, the FTB-500, 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 multi-service 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.




Our FTB-2 Pro Platform, released in fiscal 2014, 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 and Ethernet tester, and characterize transmission rates up to 100 Gbit/s.




All four 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 called the FTB Ecosystem. Leveraging platform connectivity, customers can 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 EXFO Connect, cloud-based solution. In fiscal 2014, we released EXFO TFv (Test Function Virtualization), a cloud-based test virtualization solution that builds on our EXFO Connect solution and FTB Ecosystem by offering time-based licenses. For example, network operators can test higher transmission rates or different standards by leasing EXFO TFv across selected FTB platforms during a prescribed period. As well, network operators can share software licenses among their fleet of FTB assets to avoid lengthy delays and reduce costs. Consequently, this enhanced test environment enables customers to increase productivity and reduce operating expenses.




Wireless Test Equipment




We offer 2G, 3G and 4G/LTE test solutions mainly for network operator labs. We provide two main product lines for the wireless test and measurement market: simulators and analyzers.




EXFO’s network simulatorssimulate real-world, large-scale network traffic and end-user behavior in a laboratory environment in order to predict network behavior, uncover faults and optimize networks before wireless networks and services are deployed. Typical tests include regression and load testing.




We offer 2G, 3G and 4G/LTE protocol analyzers for network operators. These instruments analyze mobile network elements in order to validate functionality according to wireless technology specifications, whether these elements interoperate with each other effectively when combined to form a network, and how well the live network performs. These test tools allow engineers to troubleshoot networks in order to find the source of errors and fix them as fast as possible. Our protocol analyzers support multi-interface testing and all major mobile technologies: GSM/GPRS/EDGE/UMTS/LTE. They enable fully automated testing and run powerful applications for protocol monitoring, call and session tracing, quality of service and radio optimization measurement.




In fiscal 2014, we enhanced our protocol analyzer offering by acquiring the assets of Aito Technologies. By combining the analytics software capabilities of Aito Technologies with our protocol analyzers, we provide mobile network operators with contextually relevant analytics and valuable insight to improve end-user quality of experience, enhance network performance and drive operational efficiencies.




EXFO’s network simulators are used by network operators in their pre-deployment labs to simulate real-world, large-scale network traffic and end-user behavior in order to predict network behavior, uncover faults and optimize networks before new wireless network components and/or services are deployed.







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Wireline/Wireless Service Assurance Systems




We provide a comprehensive service assurance solution, called the Brix System, for wireline and wireless network operators, as well as for the managed services arms of network equipment manufacturers in support of service-level agreements (SLAs) required by their customers.




The Brix System is a hardware and software 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 Brix 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 believe a competitive advantage of EXFO’s service assurance solution is the ability to implement SLA monitoring and assure any IP service, over any network, to any endpoint—all from the same open and extensible platform. Key capabilities include:





●
Performance monitoring and analysis;
 
 ●
Advanced data correlation and analysis engine;
 ●
VoIP and VoLTE service assurance;
 ●
IP/MPLS service assurance;


●
Mobile backhaul and metro Ethernet service assurance;
 
 ●
IP video service assurance;
 ●
Advanced analytics and reports; and
 ●
Custom solutions and back-office integration services.




The Brix 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.




We believe the highly scalable BrixWorx correlation and analysis engine architecture is well suited for the needs of operators’ networks and IP services.  It works together with network-wide monitoring sources — including Brix verifiers, third-party devices and standards-based interfaces — and Brix software applications. In fiscal 2014, we acquired the assets of ByteSphere to complement BrixWorx. ByteSphere’s solutions feature advanced techniques for infrastructure performance management, including network element polling and fault management. The combination of ByteSphere and EXFO’s capabilities provides real-time correlation between network element performance metrics and probe-based service performance metrics. As a result, EXFO can drive the value of this raw data into correlated and actionable insight for customers through advanced analytics and visualization.




BrixWorx conducts network and IP service testing and monitoring, while collecting, storing, correlating and analyzing essential data to produce detailed graphical reports and analytics on end-to-end service performance.




Brix software applications include:


●
BrixCall: Voice quality and performance management;
 
 ●
BrixNGN: IP/MPLS and carrier Ethernet (mobile backhaul and metro Ethernet) service quality monitoring;
 ●
BrixVision: Comprehensive IP video quality and performance management;
 ●
BrixView: Advanced analytics and business intelligence software; and
 ●
BrixFlex: Adapted analytics and customized dashboards for integrated operations with operator backoffice and NOC systems.





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Products for Network Equipment Manufacturers




Wireline Test Equipment




Our network equipment manufacturer solutions, mainly built around our IQS-600 platform, are available as test modules or stand-alone benchtop instruments. The next-generation IQS-600 platform can efficiently run as many as 100 optical test modules using a single controller unit. Its system-based approach – one box, several test modules – combined with an open architecture (PXI, Windows, LabVIEWTM, etc.) and ease of programming, produces a highly flexible test environment.




The IQS-600 also provides backward compatibility with recent IQ-generation test modules, while delivering all the power and advantages of a next-generation platform. EXFO’s wide selection of test modules includes multiservice test solutions covering optical transport network (OTN), Ethernet and SONET/SDN technologies, high-speed power meters, light sources, WDM laser sources, tunable laser sources, variable attenuators, polarization controllers, optical spectrum analyzers and optical switches.




Outside our IQS family of products, we offer advanced, stand-alone test solutions for network equipment manufacturers in the process of developing ultra-high-speed optical networks.




Wireless Test Equipment




We offer 2G, 3G and 4G/LTE test solutions mainly for network equipment manufacturers. We provide two main product lines for the wireless test and measurement market: simulators and analyzers.




EXFO’s network simulatorssimulate real-world, large-scale network traffic and end-user behavior in a laboratory environment in order to predict network behavior, uncover faults and optimize networks before wireless networks and services are deployed. Typical tests include regression and load testing.




EXFO’s protocol analyzers analyze mobile network elements in order to validate functionality according to wireless technology specifications, whether these elements interoperate with each other effectively when combined to form a network, and how well the live network performs. These test tools allow engineers to troubleshoot networks in order to find the source of errors and quickly fix them. Our protocol analyzers support multi-interface testing and all major mobile technologies: GSM/GPRS/EDGE/UMTS/LTE. They enable fully automated testing and run powerful applications for protocol monitoring, call and session tracing, quality of service and radio optimization measurement.




We believe our wireless test tools optimize network performance and ensure a high-quality user experience. The following table summarizes our wireless test solutions and their typical applications for the telecommunications industry.




Wireless Test and SolutionsProduct Type
Product Line
Typical ApplicationProtocol Analyzer
PowerHawk & PowerHawk Pro,

TravelHawk &TravelHawk Pro
Protocol analysis to verify correct network behavior.Network Simulator
EAST portfolio, QA 600 &800 families
Regression and load testing.Mobile Communications Intelligence Tools
NetHawk F10, NetHawk X6 andNetHawk C2
Intelligence tools for police, armed forces and other governmental organizations to fight organized crime and terrorists.






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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, Toronto, Canada, Chelmsford, USA, Oulu, Finland and Pune, India. Gross research and development expenditures in fiscal 2014 totaled $52.4 million compared to $54.3 million in 2013 and $59.3 million in 2012.




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 three 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. 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:


●
Market study and research feasibility;
 
 ●
Product definition;
 ●
Development feasibility;
 ●
Development;
 ●
Qualification; and
 
 ●
Transfer to production




At each stage, we review our project risks, costs and estimated completion time. We compare our design to anticipated market needs and ensure that our new product development is synchronized with other internal departments and external industry events.




Sales




We sell our telecom wireline and wireless test and service assurance 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, Toronto, 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 sales personnel covering strategic areas in EMEA and Asia-Pacific.







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Our sales network in EMEA is supported by a main office and service center in Southampton, UK, which serves as headquarters of our European sales operations and also 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 main sales offices for South East Asia are located in Singapore and Hong Kong, while our main sales representative offices for mainland China are located in Beijing and Shenzhen. In addition, we have other sales offices in strategic locations around the world to support our network of distributors and various customers.




We also 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 direct telecom sales team consists of a vice-president responsible for each major geographic region: Americas, EMEA and Asia-Pacific. These three sales executives are supported 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 service assurance. Within each major geographic region, we have sales staff dedicated to wireline, wireless and service assurance 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 53% of our sales in fiscal 2014, while sales to customers in EMEA and Asia-Pacific accounted for 28% and 19% of our sales, respectively. In comparison, the Americas, EMEA and Asia-Pacific accounted for 53%, 28% and 19% of our sales, respectively, in 2013, and 52%, 29% and 19% respectively, in 2012.




Product Management, Marketing/Communications and Global Services




Product Management




Our telecom product management duties fall under the responsibility of two vice-presidents: 1) Physical-Layer and Wireless Testing; 2) Transport Testing and Service Assurance. Each product management executive is supported by directors and product managers who have various degrees in engineering, science and business administration. Directors and product managers are responsible for all aspects of our telecom marketing program including product strategy, new product introductions, definition of new features and functions, pricing, product launches and advertising campaigns. We follow up our marketing initiatives by attending industry trade shows. Furthermore, we have a customer relationship management (CRM) system to compile market and customer information including forecasts, opportunities, leads and competitive data. We use this information to make strategic business decisions.




Marketing/Communications




Our Marketing-Communications team, which mainly consists of a director, project managers, marketing writers, translators and graphic artists, supports our product management team by producing marketing and corporate documentation. Literature includes specification sheets, application notes, product catalogues, advertising copy and an electronic corporate newsletter. This Marketing-Communications team is also responsible for all sales tools required by our worldwide sales force and for updating the marketing contents of our website.







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Global Services




EXFO’s Global Services operation, which falls under the responsibility of a vice-president, 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:


●
Customer Relationship Management (CRM) Administration –Business Ownership of our CRM toolset and evolution;
 
 ●
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;
 ●
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;
 
 ●
Systems 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.




Manufacturing




Our telecom 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 telecom manufacturing activities, which occupy a total of 122,000 square feet, take place at our facility compound in Quebec City, Canada and Shenzhen, China, but we also have facilities in Chelmsford, USA, and Oulu, Finland, for final assembly of service assurance and wireless test equipment, respectively. 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.




All of our products meet required industry standards, and some of our products address additional voluntary standards, such as those set by Telcordia, formerly Bellcore, 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.







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Our telecom 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. Our product designs comply with WEEE Directive and RoHS Directive legislation enacted by the European Union regarding, respectively, the disposal of waste electrical and electronic equipment and the restriction of the use of certain hazardous substances in electrical and electronic equipment, for all products exported to Europe. 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 intention is to establish at least two sources of supply for materials whenever possible, we obtain certain materials 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 reduce the risk of production interruptions and shortages of parts by: (1) selecting and qualifying alternative sources of supplies for key parts whenever possible, and (2) monitoring and maintaining an appropriate supply of key parts.







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Seasonality




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 network operators’ 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 network operators. Following the acquisition of NetHawk Oyj in 2010, we are subject to increased seasonality in the fourth quarter (June, July and August), since bookings activity tends to slow down during the summer months, especially in Europe. 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.




Competition




The telecommunications wireline and wireless test and service assurance industry is highly competitive and subject to rapid change as a result of technological developments and market conditions. We compete with many different companies, depending on product family and geographical market. We believe that the main competitive factors in the industry include the following:


●
product performance and reliability;
 
 ●
solution’s contribution to productivity;
 ●
price and quality of products;
 ●
level of technological innovation;
 ●
product lead times;
 
 ●
breadth of product offerings;
 ●
ease of use;
 
 ●
brand-name recognition;
 ●
customer service and technical support;
 ●
strength of sales and distribution relationships; and
 ●
financial stability.




Main competitors in the test and measurement equipment environment include global suppliers like Anritsu Corporation, Danaher Corporation (namely subsidiaries of Danaher: Fluke Networks and Tektronix Communications) and JDS Uniphase Corporation, as well as other players like AFL Noyse, IXIA, Kingfisher International, ShinewayTech, Spirent Communications plc, VeEX Inc., and Yokogawa Electric Corporation. On the service assurance side, we mainly compete against Anritsu Corporation, Empirix, IXIA, JDS Uniphase Corporation, NetScout Systems, Inc., Spirent Communications plc, Tektronix Communications and Teoco. See Item 3D of this Annual Report under “Risk Factors ‒ We must continue to overcome significant competition in our targeted industries in order to gain market share and achieve our growth strategy.”




Main competitors in the test environment include global suppliers like Anritsu Corporation, Danaher Corporation (namely subsidiaries like Tektronix Communications and Fluke Networks until the reverse acquisition closes with NetScout Systems, Inc.) and JDS Uniphase Corporation, as well as other players like AFL Noyse, IXIA, Kingfisher International, ShinewayTech, Spirent Communications plc, VeEX Inc., and Yokogawa Electric Corporation. On the service assurance side, we mainly compete against Anritsu Corporation, Empirix, IXIA, JDS Uniphase Corporation, NetScout Systems, Inc., Spirent Communications plc, Tektronix Communications and Teoco.




Employees




As at November 1, 2014, we had 1,572 full-time employees compared to 1,583 and 1,732 for the same periods in 2013 and 2012, respectively. Our workforce as of November 1, 2014 included 339 employees in manufacturing, 655 employees in research and development, and 578 employees in sales and marketing as well as general and administrative functions.


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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. Our employees are not represented by a labor union with the exception of our manufacturing personnel in Quebec City, Canada. 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”.




Regulatory Environment




In most countries where our products are sold, our products must comply with the regulations of one or more governmental entities. These regulations often are complex and vary from country to country. Depending upon the country and the relevant product, the applicable regulations may require product testing, approval, registration, marking and unique design restrictions. Accordingly, we have appointed a team of engineers who are responsible for ensuring that our products comply with all applicable regulations.




In the United States, our products must comply with the regulations of 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 compatibility (EMC) 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-medicalperformance 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 EMC requirements adopted by Industry Canada. Countries in the European Union require product compliance as dictated by the applicable directives, which are required to be authorized to apply the CE marking on the product. This includes testing to ensure compliance with harmonized European Norm (EN) standards for product safety, EMC requirements and RoHS.




In Europe, with the implementation of the WEEE directives for recycling of electronic products in selected European Countries (2002/96/EC revisited later and named 2012/19/EU), EXFO has established a process to ensure full compliance with regulations and oversee the management, logistics, recycling rate, disposal services and activities related to recycling of electronic equipment and products within the member states.




Additionally, to address the issue of environmental compliance, the European Union has mandated the Restriction of the Use of Certain Hazardous Substances or “RoHS” Directive (2002/95/EC revisited later and named 2011/65/EU), which applies to all products included within the scope of WEEE directive with the exception of Categories 8 (Medical devices) and 9 (Monitoring and control instruments). Mandatory product compliance includes the ban of certain substances within specified concentrations, unless formally exempted by the directive. To ensure compliance to this directive, a formal restricted substances control (RSC) program was implemented for our products included within the scope of WEEE. This program ensures the design, procurement and manufacturing of affected products prevents the inclusion of the banned substances as specified by the RoHS directive.




Other significant types of regulations not described in this Annual Report also may apply, depending upon the relevant product and country of destination.


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Intellectual Property




Our success and ability to compete are dependent in part on our ability to develop and protect our proprietary technology. We file U.S. and international (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 this proprietary technology, our competitive position might be significantly impaired. Nevertheless, there 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.




As of August 31, 2014, our records indicate that we held the following portfolio of utility patents: 49 actively-maintained granted U.S. patents, 41 granted or validated patents in countries of the European Union, 6 patents in Canada, 8 patents in China, and 3 patents in other jurisdictions. In addition, we have 28 utility patent applications (including provisional applications) pending in the U.S., 2 in Canada, 10 in China, 22 patent applications at the European Patent Office or directly entered at the national patent office of an EU member country, and 9 applications in other countries, as well as 2 International Applications under the Patent Cooperation Treaty that have not yet entered the national/regional phase. The expiration dates of our active issued patents range from 2016 to 2032.




As of August 31, 2014, our records also indicate that we also hold 2 granted “design” patents in each of China and Europe, as well as 10 pending design patent applications, in the United States and several other jurisdictions.




We consider seven of our inventions for which patents have either been granted or are pending to be material. These inventions are:


●
a method and apparatus for improved characterization of loss-inducing “events” along an optical fiber using an Optical Time Domain Reflectometer (OTDR).  This invention describes how, 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.  This invention is offered as an option for almost all of the current EXFO OTDR-based products;
 ●
a method for determining the optical signal-to-noise ratio employing an optical spectrum analyzer, which is particularly advantageous for use with tightly-filtered DWDM signals used in high-bandwidth optical networks.  This invention is a key value-added option to our FTB-5240-S series of portable optical spectrum analyzers;
 ●
a method and apparatus to determine the theoretical and practical data rates for a cable under test. This invention forms the basis of the EXFO CableSHARK product, describing how two test devices, communicating with each other via the cable under test, can predict the performance of a pair of ADSL (Asymmetric Digital Subscriber Line) modems, and in case of problems, analyze the cause of the modems’ failure to synchronize;
 ●
a method and system for hardware time stamping packetized data to provide sub-microsecond accuracy in test measurements, which is embedded in the Brix100M, Brix1000, and Brix2500 Series Verifiers;


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  ●
a method for actively analyzing a data packet delivery path to provide diagnostics and root cause analysis of network delivery path issues, which is embedded in BrixCall, BrixNGN, and BrixVision applications of EXFO Service Assurance;
 ●
a distributed protocol analyzer for quality-of-service measurement. This invention underlies the combined QoS measurements offered in the NetHawk iPro and NetHawk M5 products; and
 ●
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. This invention is at the heart of the EXFO Datacom product families, including applications in conformity with our EtherSAM standard test suite.
 
 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.







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C.             Organizational Structure




As of November 1, 2014, 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.














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D.Property, Plants and Equipment




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 Concord, Ontario, Canada, in Chelmsford, Massachusetts, United States (EXFO Service Assurance Inc.), in Eastleigh, Hampshire, United Kingdom (EXFO Europe Limited), in Shenzhen, China (EXFO Telecom Equipment (Shenzhen) Co. Ltd.), in Pune, India (EXFO Electro-Optical Engineering India Private Ltd.), in Stockholm, Sweden (EXFO Sweden Aktiebolag), in Oulu, Finland (EXFO Oy), in Lappeenranta, Finland (EXFO Oy), and in Richardson, Texas, United States (EXFO America Inc.).




In addition, we maintain sales offices and/or have regional sales managers located in China, Czech Republic, France, Germany, Great Britain, India, Mexico, Singapore, Spain, Sweden, United Arab Emirates and the United States.




In September 2010, in April 2011, in August 2012 and in June 2013, we purchased premises in Magarpatta, Pune, India for research and development activities.




In May 2012, we completed the construction and relocated our R&D activities (located in Montreal) into a new building of 125,000 sq. ft. We occupy approximately 60% of the premises and intent to lease the remaining for an undetermined period. This project cost $21.5 million and was paid cash.




The following table sets forth information with respect to the main facilities that we occupy as at November 1, 2014.




Location
Use of Space
Square

Footage
% of

Utilization
Type of

Interest436 Nolin Street

Quebec (Quebec)

G1M 1E7
Occupied for manufacturing of products
44,000

90%
Owned400 Godin Avenue

Quebec (Quebec)

G1M 2K2
Occupied for research and development, customer services, manufacturing, management and administration
129,000
(1)
85%
Owned2500 Alfred-Nobel

Montreal (Quebec)

H4S 2C3
Occupied for research and development, management and administration
75,000

50%
Owned2500 Alfred-Nobel

Montreal (Quebec)

H4S 2C3
Available for rent
50,000

0%
Owned160 Drumlin Circle

Concord (Ontario)

L4K 3E5
Occupied for research and development, product management and administration
23,500

40%
Owned270 Billerica Road

Chelmsford, MA 01824

United States
Occupied for research and development, manufacturing, management and administration
29,000

75%
Leased


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 Location
Use of Space
Square

Footage
% of

Utilization
Type of

InterestWinchester House

School Lane

Chandlers Ford, Eastleigh

Hampshire SO53 4DG

United Kingdom
Occupied for European customer service, sales management and administration
13,000

70%
Leased3rd Floor, Building 10

Yu Sheng Industrial Park

(Gu Shu Crossing)

No. 467, National Highway 107

Xixiang, Bao An District

Shenzhen 518126

China
Occupied for manufacturing of products
56,000

90%
LeasedOffices No 102, 602, 603, 604, 701 and 702

Tower S-4 Cybercity

Magarpatta , Hadapsar

Pune 411 013

India
Occupied for research and development
39,960

80%
OwnedElektroniikkatie 2

FI-90590 Oulu

Finland
Occupied for research and development, manufacturing, management and administration
30,241

100%
Leased


(1)
Including the warehouse space. Premises without the warehouse are approximately 115,000 square feet.
  Item 4A.
Unresolved Staff Comments
 Not applicable.
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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 as well as capital spending and network deployment levels in the telecommunications industry (including our ability to quickly adapt cost structures with 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 telecommunications test and service assurance industry and increased competition among vendors; capacity to adapt our future product offering to future technological changes; limited visibility with regards to customer orders and the timing of such orders; 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; our ability to successfully integrate businesses that we acquire; 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 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 24, 2014.




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






COMPANY OVERVIEW




We are a leading provider of next-generation test, service assurance and end-to-end quality of experience solutions for mobile and fixed network operators and equipment manufacturers in the global telecommunications industry. Our intelligent solutions with contextually relevant analytics improve end-user quality of experience, enhance network performance and drive operational efficiencies throughout the network and service delivery lifecycle. We target high-growth market opportunities related to increasing bandwidth and improving quality of experience on network infrastructures: 4G/LTE (long-term evolution), wireless backhaul, small cells and distributed antenna systems (DAS), 100G network upgrades and fiber-to-the-home (FTTH)/fiber-to-the-curb (FTTC)/fiber-to-the-node (FTTN) deployments.







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Our success has been largely predicated on our core expertise in developing test equipment for wireline 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 called the FTB Ecosystem. Leveraging platform connectivity, customers can keep track of their entire test fleet, manage software updates and schedule calibration procedures. All test data within the FTB Ecosystem 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 expanded our product portfolio into service assurance for next-generation IP (internet protocol) networks and into test equipment for 2G, 3G and 4G/LTE wireless networks. Our service assurance solution, called the Brix System, is a probe-based hardware and software solution that delivers end-to-end, quality of service and quality of experience visibility as well as real-time, Internet Protocol (IP) service monitoring and verification of next-generation IP networks. Built around a distributed architecture, the Brix System enables the successful launch and ongoing profitable operation of IP-based voice, video and data applications and services across wireline and wireless networks.




Our 2G, 3G and 4G/LTE test portfolio mainly consists of network simulators and protocol analyzers. Our network simulators simulate real-world, large-scale network traffic and end-user behavior in a laboratory environment in order to predict network behavior, uncover faults and optimize networks before wireless networks and services are deployed. Our protocol analyzers analyze mobile network elements in order to validate functionality according to wireless technology specifications, determine whether or not these elements interoperate with each other effectively when combined to form a network, and assess how well the live network performs.




The competitive advantages of our products include a high degree of innovation, modularity (especially wireline products) and ease of use. Ultimately, our products enable network equipment manufacturers and operators to design, deploy, troubleshoot and monitor wireline and wireless networks and, in the process, help them reduce the cost of operating their networks.




We have a staff of approximately 1600 people in 25 countries, supporting more than 2000 customers in approximately 100 countries around the world. We operate three main manufacturing sites, which are located in Quebec City, Canada, in Shenzhen, China and in Oulu, Finland. We also have five main research and development expertise centers in Boston, Toronto, Montreal, Quebec City and Oulu, supported by a software development center in India.




We launched 24 new products or major upgrades in fiscal 2014. Key new product introductions during 2014 included, among others an all-in-one optical and Ethernet test module that accelerates the deployment and troubleshooting of wireless backhaul, small cell and metro Ethernet networks; a monitoring solution that offers end-to-end visibility of network infrastructure performance through the distributed polling of millions of network elements; the industry’s smallest platform for high-speed, multitechnology testing in the field; a service assurance solution that enables mobile operators to proactively monitor and assure quality of experience of voice-over-LTE (VoLTE) deployments; a tablet-based OTDR series that simplifies and reduces testing time on fixed and mobile networks; and a fully automated fiber inspection probe that eliminates error risks and reduces fiber connector inspection time by more than 50%.




We reported sales of $230.8 million in fiscal 2014, which represents a decrease of 4.7% year-over-year from $242.2 million in 2013.




We reported net earnings of $783,000, or $0.01 per diluted share, in fiscal 2014, compared to $1.3 million, or $0.02 per diluted share, in 2013. Net earnings in fiscal 2014 included $4.1 million in after-tax amortization of intangible assets, $1.7 million in stock-based compensation costs and a foreign exchange gain of $1.6 million. Net earnings in fiscal 2013 included $6.4 million in after-tax amortization of intangible assets, $1.8 million in stock-based compensation costs, $0.1 million in after-tax restructuring charges and a foreign exchange gain of $4.1 million.


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Adjusted EBITDA (net earnings before interest, income taxes, depreciation and amortization, restructuring charges, stock-based compensation costs and foreign exchange gain) amounted to $14.4 million, or 6.2% of sales, in fiscal 2014, compared to $17.3 million, or 7.2% of sales, in 2013. See further in this document for a complete reconciliation of adjusted EBITDA and IFRS net earnings.
  During the third quarter of fiscal 2014, we acquired the assets of ByteSphere LLC, a Boston-area software company specializing in global IT management and network monitoring solutions. This transaction extends our service assurance offering into infrastructure performance visibility through highly scalable device and network element polling. In addition, in the fourth quarter of fiscal 2014, we acquired assets of Aito Technologies Ltd, a Finnish provider of customer experience analytics for mobile network operators. These two acquisitions are immaterial individually and collectively. The purchase prices were allocated to intangible assets.


On January 8, 2014, we announced that our Board of Directors approved the renewal of our share repurchase program, by way of a normal course issuer bid on the open market of up to 10% of the issued and outstanding subordinate voting shares, representing 2,043,101 subordinate voting shares at the prevailing market price. The normal course issuer bid started on January 13, 2014, and will end on January 12, 2015.




Sales




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 and euros.




In fiscal 2012, 2013 and 2014, no customer accounted for more than 10% of our sales, with our top customer representing 4.4%, 6.1% and 6.1% of our sales respectively.




We believe that we have a vast array of products, a diversified customer base, and a good spread across geographical areas, which provides us with reasonable protection against the concentration of sales and credit risk.




Cost of Sales




The cost of sales includes raw materials, salaries and related expenses for direct and indirect manufacturing personnel, 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 statements of earnings.




Operating Expenses




We classify our operating expenses into three main categories: selling and administrative expenses, research and development expenses, as well as depreciation and amortization expenses.




Selling and administrative expenses consist primarily of salaries and related expenses for personnel, sales commissions, travel expenses, marketing programs, professional services, information systems, human resources and other corporate expenses.




Gross research and development expenses consist primarily of salaries and related expenses for engineers and other technical personnel, material component costs as well as fees paid to third-party consultants. We are eligible to receive research and development tax credits and grants on research and development activities carried out in Canada and Finland. All related research and development tax credits and grants are recorded as a reduction of gross research and development expenses.







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RESULTS OF OPERATIONS


(in thousands of US dollars, except per share data, and as a percentage of sales for the years indicated)




Consolidated statements of earnings data (1):

2014


2013


2012


2014


2013


2012Sales

$
230,806


$
242,150


$
249,966



100.0
%


100.0
%


100.0
%Cost of sales (2)


86,836



92,469



91,792



37.6



38.2



36.7Selling and administrative


86,429



88,756



94,139



37.4



36.6



37.7Net research and development


44,846



45,444



49,854



19.4



18.8



19.9Depreciation of property, plant and equipment


4,995



6,028



6,169



2.2



2.5



2.5Amortization of intangible assets


4,398



6,643



7,819



1.9



2.7



3.1Changes in the fair value of cash contingent consideration


–



–



(311
)


–



–



(0.1
)Interest and other income


(326
)


(113
)


(131
)


(0.1
)


–



(0.1
)Foreign exchange (gain) loss


(1,634
)


(4,082
)


657



(0.7
)


(1.7
)


0.3Earnings (loss) before income taxes


5,262



7,005



(22
)


2.3



2.9



–Income taxes


4,479



5,664



3,571



2.0



2.3



1.4Net earnings (loss) for the year

$
783


$
1,341


$
(3,593
)


0.3
%


0.6
%


(1.4
)%Basic and diluted net earnings (loss) per share

$
0.01


$
0.02


$
(0.06
)Other selected information:Gross margin (3)

$
143,970


$
149,681


$
158,174



62.4
%


61.8
%


63.3
%Research and development data:Gross research and development

$
52,423


$
54,334


$
59,282



22.7
%


22.4
%


23.7
%Net research and development

$
44,846


$
45,444


$
49,854



19.4
%


18.8
%


19.9
%Restructuring charges included in:Cost of sales

$
–


$
–


$
264



–
%


–
%


0.1
%Selling and administrative expenses

$
–


$
–


$
1,181



–
%


–
%


0.5
%Net research and development expenses

$
–


$
89


$
884



–
%


–
%


0.4
%Adjusted EBITDA (3)

$
14,391


$
17,338


$
18,372



6.2
%


7.2
%


7.3
%Consolidated balance sheets data (1):Total assets

$
278,031


$
281,538


$
306,683Long-term debt (excludingcurrent portion)

$
–


$
–


$
282




(1)
Consolidated statements of earnings and balance sheets data has been derived from our consolidated financial statements prepared according with IFRS, as issued by the IASB, except for non-IFRS measures (3).


(2)
The cost of sales is exclusive of depreciation and amortization, shown separately.





(3)
Refer to page 52 for non-IFRS measures.





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RESULTS OF OPERATIONS




Sales and Bookings




Fiscal 2014 vs. 2013




In fiscal 2014, our sales decreased 4.7% to $230.8 million, compared to $242.2 million in 2013, while our bookings increased 3.0% year-over-year to $240.4 million in 2014 from $233.5 million in 2013, for a book-to-bill ratio of 1.04 (0.96 in 2013).




The year-over-year decrease in sales in fiscal 2014 compared to 2013 is mainly explained by the timing and nature of orders received in fiscal 2014, which resulted in a significant increase in our backlog at the end of 2014 compared to 2013. In fact, some orders received in fiscal 2014 were not shipped and/or recognized in sales due to the timing and/or nature of these orders, as in some cases, they involved large systems for which revenue recognition is dependent on installation and customer acceptance.




More precisely, in fiscal 2014, most of the year-over-year decrease in sales in dollars comes from the first half of the year in the Americas, as market conditions in this region proved to be challenging during that period due to order delays and lower spending levels, especially among key customers. Although in the second half of fiscal 2014 we benefited from projects and strategic initiatives that had been pushed out later in fiscal 2014, as well as from late budget approvals from key customers, and we reported a year-over-year increase in sales and bookings during that period, it was not enough to offset the sales decrease attributable to the Americas region in the first half of the year.




In addition to the above-mentioned explanations, during the first half of fiscal 2013, we had benefited from some calendar year-end budget spending on the part of network operators in the Americas, but we did not benefit from such spending in the first half of fiscal 2014 due to the tight budget control during this period, thereby reducing our sales year-over-year. The magnitude of calendar year-end budget spending can fluctuate year-over-year.




Sales to Europe, Middle-East and Africa (EMEA) and Asia-Pacific (APAC) in 2014 also decreased year-over-year, which again is mostly attributable to a timing issue, as bookings have in fact increased year-over-year in both regions.




Furthermore, in fiscal 2014, increased pricing pressure worldwide had a negative impact on our sales and bookings year-over-year.




Finally, we recorded foreign exchange losses of $909,000 on our forward exchange contracts in 2014, compared to foreign exchange gains of $380,000 in 2013, which lowered our sales 0.5% year-over-year.




Overall, over the last four semesters, bookings amounted to $117.7 million, $115.8 million, $116.6 million and $123.8 million respectively, showing a return to growth mode.




Fiscal 2013 vs. 2012




In fiscal 2013, our sales decreased 3.1% to $242.2 million, compared to $250.0 million in 2012, and our bookings decreased 4.6% year-over-year to $233.5 million from $244.8 million in 2012, for a book-to-bill ratio of 0.96 in 2013.




In fiscal 2013, market conditions in the telecommunications industry were difficult due to an uncertain macro-economic environment, marked by challenging end-markets in several European countries and uneven network operator spending in the Asia-Pacific region while investments in the Americas have been more robust. Moreover, operators tried to monetize their investments in next-generation fixed and mobile networks as data revenue growth was not keeping pace with the required level of expenditures. Consequently, network operators reassessed their business models and spending levels in efforts to improve profitability.







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In addition, in fiscal 2013, we faced increased competition and pricing pressure compared to 2012, which reduced our sales and bookings year-over-year.




Furthermore, in fiscal 2013, calendar year-end budget spending from network operators was even more limited than the previous year, which reduced our sales and bookings for that year, compared to 2012.




Finally, in fiscal 2013, we recorded in our sales, foreign exchange gains of $380,000 on our forward exchange contracts, compared to $1.1 million in 2012, which contributed to a 0.3% decrease in sales year-over-year.




However, in the second half of fiscal 2013, we witnessed some improvements in the United States as we delivered year-over-year sales growth in this area in 2013 based in part on 4G/LTE and 100G deployments.




In fiscal 2013, we also shipped large orders of our MaxTester 635 Copper, DSL and Multiplay Test Set to two tier-1 operators. We did not recognize such large orders in fiscal 2012.




Geographic Distribution




In fiscal 2013 and 2014, sales to the Americas, Europe, Middle-East and Africa (EMEA) and Asia-Pacific (APAC) accounted for 53%, 28% and 19% of sales respectively, compared to 52%, 29% and 19% respectively in 2012.






GROSS MARGIN (non-IFRS measure – refer to page 52 of this document)




Gross margin amounted to 62.4%, 61.8% and 63.3% of sales in fiscal 2014, 2013 and 2012 respectively.




Fiscal 2014 vs. 2013




The increase in our gross margin in fiscal 2014 compared to 2013 can be explained by the following factors.




In fiscal 2014, our gross margin was favorably affected by product mix, including some software-intensive products with higher margins. Namely, in fiscal 2013, we shipped large orders of lower-margin copper-access test solutions, which negatively affected our gross margin for that year. We did not have such orders in the same period this year.




However, the following factors partly offset the increase in our gross margin year-over-year.




In fiscal 2014, a lower sales volume compared to 2013 (4.7%), resulted in lower absorption of our fixed manufacturing costs, which decreased our gross margin year-over-year.




In addition, increased pricing pressure in fiscal 2014, compared to 2013, had a negative impact on our gross margin year-over-year.




Furthermore, in fiscal 2014, we recorded an inventory write-off of $4.6 million, compared to $4.1 million in 2013. This represents a negative impact of 0.3% on our gross margin year-over-year.




Finally, in fiscal 2014, we recorded in our sales foreign exchange losses of $909,000 on our forward exchange contracts, compared to foreign exchange gains of $380,000 in 2013, which contributed to decrease our gross margin 0.1% year-over-year.







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Fiscal 2013 vs. 2012




The decrease in our gross margin in fiscal 2013, compared to 2012, can be explained by the following factors.




In fiscal 2013, our gross margin was unfavorably affected by our product mix. Namely, in fiscal 2013, we shipped large orders of lower-margin copper-access test solutions.




In addition, increased pricing pressure in fiscal 2013, compared to 2012, had a negative impact on our gross margin year-over-year.




Furthermore, a lower sales volume in fiscal 2013 compared to 2012 (3.1%), resulted in lower absorption of our fixed manufacturing costs, which resulted in a lower gross margin year-over-year.




Also, in fiscal 2012, our warranty expenses were lower, compared to 2013; this resulted in a positive impact on our gross margin in fiscal 2012.




In addition, in fiscal 2013, due to the decrease in the value of the Canadian dollar versus the US dollar, we reported lower gains on our forward exchange contracts in our sales, compared to 2012, which negatively affected our gross margin year-over-year.




Finally, the decrease in the value of the Canadian dollar, compared to the US dollar, had a negative impact on our gross margin in fiscal 2013, compared to 2012; in fact, our procurement costs increased as the Canadian dollar decreased, compared to the US dollar, since a significant portion of our raw material purchases are denominated in US dollars and our raw material costs of parts purchased in US dollars are measured in Canadian dollars in our financial statements.




However, in fiscal 2013, a larger portion of our sales came from products manufactured in our facilities in China compared to 2012, thus partly offsetting the year-over-year decrease in our gross margin; those products have a lower cost of goods than those manufactured in our facilities in Canada and Finland.




Also, in fiscal 2012, we recorded $264,000 in restructuring charges in the cost of sales (nil in 2013), which negatively affected our gross margin for that year (0.1%).




Outlook for Fiscal 2015




Considering the expected sales growth, the expected increase in sales of protocol products as well as software-intensive products and services, the cost-effective design of our products, and our tight control on costs, we expect our gross margin to improve in the future. However, our gross margin may fluctuate quarter-over-quarter due to our products mix and sales fluctuations. Furthermore, our gross margin can be negatively affected by increased competitive pricing pressure, customer concentration and/or consolidation, increased obsolescence and warranty costs, shifts in customer mix, under-absorption of fixed manufacturing costs, increases in product offerings by other suppliers in our industry, as well as unfavorable exchange rates.






SELLING AND ADMINISTRATIVE EXPENSES




Selling and administrative expenses amounted to $86.4 million, $88.8 million and $94.1 million for fiscal 2014, 2013 and 2012 respectively. As a percentage of sales, selling and administrative expenses amounted to 37.4%, 36.6% and 37.7% for fiscal 2014, 2013 and 2012 respectively.







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Fiscal 2014 vs. 2013




In fiscal 2014, despite inflation and salary increases, our selling and administrative expenses decreased, compared to 2013, due to tight control on expenses and the increase in the average value of the US dollar, compared to the Canadian dollar as a portion of these expenses are incurred in this currency and we report our results in US dollars.
  In addition, in fiscal 2014, commission expenses to our sales channels were lower compared, to 2013, due to a lower sales volume year-over-year.


In fiscal 2014, although our selling and administrative expenses decreased in dollars year-over-year, they increased as a percentage of sales as our sales decreased year-over-year and a large portion of these expenses are relatively fixed in the short term.




Fiscal 2013 vs. 2012




In fiscal 2013, our selling and administrative expenses, especially salaries and benefits as well as travel expenses, decreased year-over-year due to tight controls on expenses and the impact of our 2012 restructuring plan.




In addition, in fiscal 2012, we recorded $1.2 million, or 0.5% of sales (nil in 2013), in restructuring charges in our selling and administrative expenses for the employees laid off as part of our 2012 restructuring plan.
  Finally, in fiscal 2013, commission expenses to our sales channels were lower compared to 2012, due to a lower sales volume year-over-year.
  Outlook for Fiscal 2015





For fiscal 2015, we expect our selling and administrative expenses to decrease as a percentage of sales and range between 34% and 36%. However, any increase in the strength of the Canadian dollar and the euro versus the US dollar in the upcoming quarters would cause our selling and administrative expenses to increase, as a portion of these expenses are incurred in these currencies and we report our results in US dollars.






RESEARCH AND DEVELOPMENT EXPENSES




Gross research and development expenses




Gross research and development expenses totaled $52.4 million, $54.3 million and $59.2 million for fiscal 2014, 2013 and 2012 respectively. As a percentage of sales, gross research and development expenses amounted to 22.7%, 22.4% and 23.7% for fiscal 2014, 2013 and 2012 respectively, while net research and development expenses accounted for 19.4%, 18.8% and 19.9% of sales for these respective years.




Fiscal 2014 vs. 2013




In fiscal 2014, the year-over-year increase in the average value of the US dollar compared to the Canadian dollar and the Indian rupee had a positive impact on our gross research and development expenses as most of these expenses are incurred in these currencies and we report our results in US dollars.




In addition, in fiscal 2013, our gross research and development expenses included $89,000 in restructuring charges, compared to nil this year.




Otherwise, in fiscal 2014, inflation, salary increases, as well as a shift in the mix and timing of research and development projects resulted in increased gross research and development expenses compared to 2013.


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A large portion of our gross research and development expenses are relatively fixed in the short term and they fluctuate in percentage of sales, as sales fluctuate year-over-year.
  Fiscal 2013 vs. 2012




In fiscal 2013, our gross research and development expenses decreased year-over-year, especially salaries and benefits, due to tight controls on expenses and the impact of our 2012 restructuring plan.




In addition, in fiscal 2012, we recorded $884,000, or 0.4% of sales, in restructuring charges in our gross research and development expenses for the employees laid off as part of our 2012 restructuring plan, compared to $89,000 in 2013.




Furthermore, in fiscal 2013, a shift in the mix and timing of research and development projects resulted in decreased gross research and development expenses compared to 2012, mainly from consultants, subcontracting and material expenses.




Finally, in fiscal 2013, the year-over-year increase in the average value of the US dollar compared to the Indian rupee had a positive impact on our gross research and development expenses, as a portion of these expenses are incurred this currency and we report our results in US dollars.




Tax Credits and Grants




We are entitled to tax credits from the Canadian federal and provincial governments for eligible research and development activities conducted in Canada. We are also eligible for grants by a Finnish technology organization on certain research and development projects conducted in Finland.




Tax credits and grants for research and development activities were $7.6 million, $8.9 million and $9.4 million for fiscal 2014, 2013 and 2012 respectively. As a percentage of gross research and development expenses, tax credits and grants reached 14.5%, 16.4% and 15.9% for fiscal 2014, 2013 and 2012 respectively.




Fiscal 2014 vs. 2013




The decrease in our tax credits and grants in fiscal 2014, compared to 2013, results from the decrease in the statutory Canadian federal and provincial research and development tax credit rates in 2014, as well as from the increase in the average value of the US dollar, compared to the Canadian dollar year-over-year, as our tax credits are denominated in Canadian dollars and we report our results in US dollars.




In fiscal 2014, the decrease in tax credits and grants as percentage of gross research and development expenses, compared to 2013, mainly comes from the decrease in the statutory Canadian federal and provincial research and development tax credit rates.




Fiscal 2013 vs. 2012




The decrease in tax credits and grants in fiscal 2013, compared to 2012 mainly resulted from the decrease in gross research and development expenses year-over-year, as we were entitled to the same tax credit and grant programs year-over-year.







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Outlook for Fiscal 2015




For fiscal 2015, we expect our net research and development expenses to range between 18% and 20% of sales, which take into account the additional reduction of research and development tax credit rates in Canada. However, any increase in the strength of the Canadian dollar, the euro and the Indian rupee versus the US dollar in the upcoming quarters would cause our net research and development expenses to increase, as most of these expenses are incurred in these currencies and we report our results in US dollars.






DEPRECIATION OF PROPERTY, PLANT AND EQUIPMENT




In fiscal 2014, depreciation of property, plant and equipment amounted to $5.0 million, compared to $6.0 million and $6.2 million in 2013 and 2012 respectively.
  Fiscal 2014 vs. 2013




The decrease in depreciation expense in fiscal 2014, compared to 2013, was due to the fact that some assets became fully depreciated in fiscal 2013 as well as to the increase in the average value of the US dollar versus the Canadian dollar and the Indian rupee year-over-year, as a significant portion of our depreciation expenses are incurred in these currencies and we report our results in US dollars.






AMORTIZATION OF INTANGIBLE ASSETS




In conjunction with the business combinations we completed over the past several years, we recorded intangible assets, primarily consisting of core technology, customer relationships and brand name. In addition, intangible assets include software. These intangible assets resulted in amortization expenses of $4.4 million, $6.6 million and $7.8 million for fiscal 2014, 2013 and 2012 respectively.




The decrease in amortization expenses in fiscal 2014 and in 2013 compared to the previous year comes from the fact that core technology related to the acquisition of Brix Networks Inc. (acquired in fiscal 2008) became fully amortized during fiscal 2013. In addition, in fiscal 2014 and 2013, the increase in the average value of the US dollar compared to the Canadian dollar versus the previous year had a positive impact on our amortization expenses for those years as a significant portion of these expenses are incurred in Canadian dollars and we report our results in US dollars.
 
 Outlook for Fiscal 2015





We expect amortization of intangible assets to decrease in fiscal 2015 compared to 2014 due to the fact that acquired intangible assets related to NetHawk Oyj, acquired in 2010, will become fully amortized during fiscal 2015. However, that decrease will be partly offset by recently acquired core technologies related to ByteSphere and Aito.


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 result from the translation of cash balances and deferred income taxes denominated in US dollars. We manage our exposure to a 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.




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 We reported a foreign exchange gain of $1.6 million in fiscal 2014, compared to $4.1 million in 2013 and a foreign exchange loss of $657,000 in 2012.
 
 Fiscal 2014





In fiscal 2014, the period-end value of the Canadian dollar decreased versus the US dollar and the euro, compared to the previous year end, which resulted in a foreign exchange gain of $1.6 million during the year. The period-end value of the Canadian dollar decreased 3.0% compared to CA$1.0858 = US$1.00 in fiscal 2014, compared to CA$1.0530 = US$1.00 at the end of the previous year, and decreased 2.7% compared to CA$1.4319 = €1.00 in fiscal 2014, compared to CA$1.3936 = €1.00 at the end of the previous year.In fiscal 2014, the average value of the Canadian dollar versus the US dollar was CA$1.0782 = US$1.00.
  Fiscal 2013





In fiscal 2013, the period-end value of the Canadian dollar significantly decreased versus the US dollar and the euro, compared to the previous year end, which resulted in a significant foreign exchange gain of $4.1 million during the year. The period-end value of the Canadian dollar decreased 6.3% compared to CA$1.0530 = US$1.00 in fiscal 2013, compared to CA$0.9863 = US$1.00 at the end of the previous year, and decreased 12.0% compared to CA$1.3936 = €1.00 in fiscal 2013, compared to CA$1.2438 = €1.00 at the end of the previous year.In fiscal 2013, the average value of the Canadian dollar compared to the US dollar was CA$1.0107 = US$1.00.
 
 Fiscal 2012





In fiscal 2012, 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 $657,000. The period-end value of the Canadian dollar slightly decreased 0.9% to CA$0.9863 = US$1.00 in fiscal 2012, compared to CA$0.9784 = US$1.00 in 2011, while the average value of the Canadian dollar compared to the US dollar was CA$1.0094 = US$1.00 in 2012.
  Foreign exchange rate fluctuations also flow through the P&L line items as a significant portion of cost of sales and our operating items are denominated in Canadian dollars, euros and Indian rupees, and we report our results in US dollars.
 
 Fiscal 2014 vs. 2013





In fiscal 2014, the increase in the average value of the US dollar compared to the Canadian dollar and Indian rupee year-over-year had a positive impact on our financial results. The average value of the US dollar in fiscal 2014 increased 6.3% and 9.7%, respectively, compared to the Canadian dollar and the Indian rupee.
 Fiscal 2013 vs. 2012





In fiscal 2013, the increase in the average value of the US dollar compared to the Canadian dollar and Indian rupee year-over-year had a positive impact on our financial results. The average value of the US dollar in fiscal 2013 increased 1.3% and 7.3% respectively, compared to the Canadian dollar and the Indian rupee.


INCOME TAXES




We recorded income tax expenses of $4.5 million, $5.7 million and $3.6 million in fiscal 2014, 2013 and 2012 respectively.


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In fiscal 2014, we reported income tax expenses of $4.5 million on earnings before income taxes of $5.3 million. In fiscal 2013, we reported income tax expenses of $5.7 million on earnings before income taxes of $7.0 million. These situations mainly resulted from the fact that we did not recognize deferred income tax assets for some of our subsidiaries at loss and we had some non-deductible expenses, such as stock-based compensation costs. However, a significant portion of our foreign exchange gain was created by the translation of financial statements of our foreign subsidiaries, and was therefore non-taxable. Otherwise, the effective tax rate would have been closer to the combined Canadian and provincial statutory tax rate of 27% for those two fiscal years.




In fiscal 2012, we reported income tax expenses of $3.6 million on a loss before income taxes of $22,000. This situation mainly resulted from the fact that we did not recognize deferred income tax assets for some of our subsidiaries at loss and we had some non-deductible expenses, such as stock-based compensation costs. However, in fiscal 2012, we recognized previously unrecognized deferred income tax assets of one of our subsidiaries, which resulted in a one-time income tax recovery of $557,000. Otherwise, the effective tax rate would have been closer to the combined Canadian and provincial statutory tax rate of 27% in fiscal 2012.




Please refer to note 18 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, 2014, cash and short-term investments totaled $59.8 million, while our working capital was at $109.3 million. Our cash and short-term investments increased $9.6 million in fiscal 2014, compared to 2013. First, in fiscal 2014, operating activities generated $19.8 million in cash. However, in fiscal 2014, we made cash payments of $7.9 million for the purchases of capital assets (including assets of ByteSphere and Aito), $937,000 for the redemption of share capital under our share repurchase program and $307,000 for the final repayment of our long-term debt. In addition, in fiscal 2014, we recorded an unrealized foreign exchange loss of $1.2 million on our cash and short-term investments. This unrealized foreign exchange loss resulted from the translation, in US dollars, of our Canadian-dollar-denominated cash and short-term investments and was included in the accumulated other comprehensive income in the balance sheet.




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. Our cash and short-term investments will be used for working capital and other general corporate purposes, potential acquisitions as well as our share repurchase program. As at August 31, 2014, cash balances included an amount of $30.1 million that bears interest at an annual rate of 1.5%.




We believe that our cash balances and short-term investments will be sufficient to meet our liquidity and capital requirements for the foreseeable future, including the effect of our normal course issuer bid. In addition to these assets, we have unused available lines of credit totaling $15.4 million for working capital and other general corporate purposes and unused lines of credit of $22.0 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.




As at August 31, 2014, our commitments under operating leases amount to $2.4 million in 2015, $1.0 million in 2016, $681,000 in 2017, $158,000 in 2018 and $552,000 in 2019 and after, for total commitments of $4.8 million.


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Sources and Uses of Cash




We finance our operations and meet our capital expenditure requirements mainly through cash flows from operating activities, the use of our cash and short-term investments as well as the issuance of subordinate voting shares.




Operating activities




Cash flows provided by operating activities were $19.8 million in fiscal 2014, compared to cash flows used of $2.0 million in 2013 and cash flows provided of $25.3 million in 2012.




Fiscal 2014 vs. 2013




Cash flows provided by operating activities in fiscal 2014 were attributable to the net earnings after items not affecting cash of $11.5 million and the positive net change in non-cash operating items of $8.3 million; this was mainly due to the positive effect on cash of the $3.6 million decrease in our accounts receivable, due to the decrease in sales year-over-year and the timing of receipts and sales during the year, the $1.4 million decrease in our income taxes and tax credits recoverable mainly due to tax credits earned in previous years received during the year, as well as the $3.8 million increase in our accounts payable, accrued liabilities, provisions and other liabilities due to timing of purchases and payments during the year. These positive effects on cash were partly offset by the negative effect on cash of the $734,000 increase in our inventories to meet future demand.




Fiscal 2013 vs. 2012




Cash flows used by operating activities in fiscal 2013 were attributable to the net earnings after items not affecting cash of $16.4 million more than offset by the negative net change in non-cash operating items of $18.4 million; this was mainly due to the negative effect on cash of the $14.8 million increase in our accounts receivable due to the timing of sales during the year,  the negative effect on cash of the $4.2 million increase in our income tax and tax credits recoverable due to tax credits earned during the year and not yet recovered, as well as the negative effect on cash of the $2.6 million decrease in our accounts payable, accrued liabilities, provisions and other liabilities due to timing of purchases and payments during the year. These negative effects on cash were partly offset by the positive effect on cash of the $2.9 million decrease in our inventories due to the decrease in sales year-over-year and an improved inventory turn during the year.




Investing activities




Cash flows used by investing activities amounted to $8.9 million in fiscal 2014, compared to $5.0 million in 2013 and cash flows provided of $13.1 million in 2012.
  Fiscal 2014





In fiscal 2014, we acquired (net of disposal) $1.0 million worth of short-term investments and we paid $7.9 million for the purchase of capital assets, including the assets of ByteSphere and Aito.
  Fiscal 2013





In fiscal 2013, we paid $8.0 million for the purchase of capital assets but we disposed (net of acquisitions) of $3.0 million worth of short-term investments.
  Fiscal 2012





In fiscal 2012, we disposed (net of acquisitions) of $36.9 million worth of short-term investments, but we paid $23.8 million for the purchase of capital assets, mainly for our building in Montreal, Canada.







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Financing activities




Cash flows used by financing activities amounted to $1.0 million in fiscal 2014, compared to $3.6 million in 2013 and $3.3 million in 2012.
  Fiscal 2014





In fiscal 2014, we redeemed share capital for a cash consideration of $937,000 and repaid $307,000 of our long-term debt. However, we received $225,000 from the exercise of stock options.
  Fiscal 2013





In fiscal 2013, we redeemed share capital for a cash consideration of $3.1 million and repaid $589,000 of our long-term debt. However, we received $87,000 from the exercise of stock options.
  Fiscal 2012





In fiscal 2012, we reimbursed our bank loan of $782,000, repaid $577,000 of our long-term debt, and we redeemed share capital for a cash consideration of $2.2 million. However, we received $310,000 from the exercise of stock options.





FORWARD EXCHANGE CONTRACTS




We are exposed to a currency risk as a result of our export sales of products manufactured in Canada, China and Finland, the majority of which are denominated in US dollars and euros. In addition, we are exposed to a 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, 2014, 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




Expiry dates

Contractual

amounts

Weighted average

contractualforward ratesSeptember 2014 to August 2015

$                      22,200,000

1.0666September 2015 to August 2016

13,400,000

1.0923September 2016 to December 2016

3,400,000

1.1063Total

$                      39,000,000

1.0789




US dollars – Indian rupees




Expiry dates

Contractual

amounts

Weighted average

contractualforward rateSeptember 2014 to March 2015

$                        2,800,000

62.11






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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 $808,000 and $497,000 as at August 31, 2013 and 2014 respectively. The US dollar – Canadian dollar year-end exchange rate was CA$1.0858 = US$1.00 as at August 31, 2014.The US dollar – Indian rupee year-end exchange rate was INR 60.66 = US$1.00 as at August 31, 2014.






SHARE CAPITAL




Share Capital




As at November 10, 2014, EXFO had 31,643,000 multiple voting shares outstanding, entitling to 10 votes each and 28,682,146 subordinate voting shares outstanding. The multiple voting shares and the subordinate voting shares are unlimited as to number and without par value.






OFF-BALANCE SHEET ARRANGEMENTS




As at August 31, 2014, our off-balance sheet arrangements consisted of letters of guarantee amounting to $408,000 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 2017.






STRUCTURED ENTITIES




As at August 31, 2014, we did not have interests in any structured entities.






CRITICAL ACCOUNTING POLICIES AND ESTIMATES




The preparation of financial statements in accordance with IFRS requires management 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 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




(a)
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.


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  (b)
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 Estimated and Assumptions




(a)
Inventories




We state our inventories at the lower of cost, determined on an average cost basis and net realizable value, and we provide reserves for excess and obsolete inventories. We determine our reserves for excess and obsolete inventories based on the quantities on hand at the reporting dates compared to foreseeable needs over the next 12 months, 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 future results.




(b)
Income taxes




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.




As at August 31, 2014, we had deferred income tax assets in the balance sheet in the amount of $9.8 million mainly for operating losses in the United States. In order to realize these deferred income tax assets, we need to generate $25 million in pre-tax earnings in the United States, and in order to do so over the estimated recovery period of six years, we must generate a pre-tax earnings compound annual growth rate (CAGR) of 9%, which we believe is probable. Our operating losses in the United States can be carried forward over a twenty-year period.




(c)
Tax credits recoverable




Tax credits are recorded provided that 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 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, 2014, our non-refundable research and development tax credits recognized in the balance sheet amounted to $42.9 million. In order to recover these non-refundable research and development tax credits, we need to generate approximately $277 million (CA$301 million) in pre-tax earnings at the Canadian federal level and approximately $13 million at the Canadian provincial level. In order to generate $277 million in pre-tax earnings at the Canadian Federal level over the estimated recovery period of 18 years, we must generate pre-tax earnings CAGR of 4%, which we believe is probable. Our non-refundable research and development tax credits can be carried forward over a twenty-year period.







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(d)
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 is based on available data from binding sales transactions in an arm’s length transaction, available data from observable active market prices less incremental costs for disposing of the asset, our stock price, or data from recent transactions of similar assets, within the same industry, when available. When such information is not available, or to supplement this information, we use discounted cash flows. The establishment of discounted cash flows requires the use of estimates, including our expectations of future revenue growth, operating costs and profit margins as well as discount rates for each CGU.




i)
Growth rates




The assumptions used are based on our historical growth, internal budget, expectations of future revenue growth, sales funnel, as well as industry and market trends. We projected revenues, operating margins and cash flows for periods of five years, and we applied a perpetual growth rate thereafter.




ii)
Discount rate




The discount rate we use represents our weighted average cost of capital (WACC), plus a premium to take into account specific risks of the CGU, as the case may be.




In the fourth quarter of fiscal 2014, we performed our annual goodwill impairment test for our two CGUs, EXFO and Brix.




For the EXFO CGU, we used a market-based approach (sales multiples) based on recent comparable transactions in our industry, supplemented by an analysis of our enterprise value derived from our market capitalization to assess the CGU’s recoverable amount.




For the Brix CGU, we used a combination of a market-based approach (sales multiples), based on recent comparable transactions in our industry, and discounted cash flows to assess the CGU’s recoverable amount.




The sales multiple of recent comparable transactions for both CGUs ranged between 1.9 and 5 times sales. These comparable transactions occurred in calendar 2013 and 2014.




Discounted cash flows for the Brix CGU were based on five-year management projections, using a five-year sales compound annual growth rate (CAGR) of 23% and a perpetual growth rate of 2% thereafter. We used a discount rate of 18%. Based on these assumptions (used in the discounted cash flows calculations) as well as a sales multiple of 2.0 times fiscal 2014 sales, the recoverable amount of the Brix CGU exceeds its carrying amount by 49%. The five-year sales CAGR used in the discounted cash flows calculations differs from past experience; we determined the five-year sales CAGR based on recent market studies, the impact of recently launched and to be launched solutions, as well as our sales funnel.




The Brix CGU’s recoverable amount would equal its carrying value using five-year sales CAGR of 8%, which is below our expected market growth of 10% to 15% (excluding market share gains) over the five-year period used in the discounted cash flows calculations for that CGU, or a sales multiple of 1 time fiscal 2014 sales.




As at August 31, 2014, the recoverable amount for both CGUs exceeded their carrying value.







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As at August 31, 2014, the carrying value of goodwill totaled $26.5 million and was allocated as follows to two CGUs:




EXFO CGU

$                        10,465,000Brix CGU

16,023,000Total

$                        26,488,000






NEW IFRS PRONOUNCEMENTS AND AMENDMENTS




Adopted During the Year


We adopted the following amended and new standards, effective September 1, 2013. These changes were made in accordance with the applicable transitional provisions.




Consolidation




IFRS 10, “Consolidated Financial Statements”, requires an entity to consolidate an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. IFRS 10 replaces Standing Interpretations Committee (“SIC”) 12, “Consolidation — Special Purpose Entities”, and parts of IAS 27, “Consolidated and Separate Financial Statements”. The adoption of IFRS 10 had no impact on our consolidated financial statements.




Joint Arrangements




IFRS 11, “Joint Arrangements”, requires a venturer to classify its interest in a joint arrangement as a joint venture or joint operations. Joint ventures are accounted for using the equity method of accounting whereas for a joint operation, the venture recognizes its share of the assets, liabilities, revenues and expenses of the joint operation. IFRS 11 replaces IAS 31, “Interests in Joint Ventures”, and SIC 13, “Jointly Controlled Entities — Non-Monetary Contributions by Venturers”. The adoption of IFRS 11 had no impact on our consolidated financial statements.




Disclosure of Interests in Other Entities




IFRS 12, “Disclosure of Interests in Other Entities”, establishes disclosure requirements for interests in other entities, such as subsidiaries, joint arrangements, associates and structured entities. This standard carries forward existing disclosures and introduces significant additional disclosure requirements that address the nature of, and risks associated with, an entity’s interests in other entities. The adoption of IFRS 12 had no impact on our consolidated financial statements.




Fair Value Measurement




IFRS 13, “Fair Value Measurement”, is a comprehensive standard for fair value measurement and disclosure requirements for use across all IFRS standards. The new standard clarifies that fair value is the price that would be received to sell an asset, or paid to transfer a liability in an orderly transaction between market participants, at the measurement date. It also establishes disclosures about fair value measurement. Under existing IFRS, guidance on measuring and disclosing fair value is dispersed among the specific standards requiring fair value measurements and, in many cases, does not reflect a clear measurement basis or consistent disclosures. The adoption of IFRS 13 did not require any adjustment to the valuation techniques we used to measure fair value. We provided the required additional disclosure in our consolidated financial statements.







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Financial Instruments




IFRS 7, “Financial Instruments: Disclosures”,has been amended to enhance disclosure requirements related to offsetting of financial assets and liabilities. The adoption of these amendments had no impact on our consolidated financial statements.




Issued but Not Yet Adopted




Financial Instruments




IFRS 9, “Financial Instruments”, was issued by the IASB in October 2010 and will replace IAS 39, “Financial Instruments: Recognition and Measurement”. IFRS 9 uses a single approach to determine whether a financial asset is measured at amortized cost or fair value, replacing the multiple rules in IAS 39. The approach in IFRS 9 is based on how an entity manages its financial instruments in the context of its business model and the contractual cash flow characteristics of the financial assets. Most of the requirements in IAS 39 for classification and measurement of financial liabilities were carried forward unchanged to IFRS 9. The new standard also requires a single impairment method to be used, replacing the multiple impairment methods in IAS 39. Requirements relating to hedge accounting representing a new hedge accounting model have also been added to IFRS 9. The new standard is effective for annual periods beginning on or after January 1, 2018 and must be applied retrospectively. We have not yet assessed the impact that the new standard will have on our consolidated financial statements.




Revenue from Contracts with Customers




IFRS 15, “Revenue from Contracts with Customers”, was issued in May 2014. The objective of this new standard is to provide a single, comprehensive revenue recognition model for all contracts with customers to improve comparability. This new standard contains principles that an entity will apply to determine the measurement of revenue and timing of when it is recognized. The underlying principle is that an entity will recognize revenue to depict the transfer of goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services. This new standard is effective for annual periods beginning on or after January 1, 2017. Early adoption is permitted. We have not yet assessed the impact that the new standard will have on our consolidated financial statements or whether or not to early adopt the new standard.






RISKS AND UNCERTAINTIES




Over the past several years, we have managed our business in a difficult environment; focused on research and development programs for new and innovative solutions aimed at expected growth pockets in our sector; continued the development of our domestic and international markets; and made strategic acquisitions. However, we operate in a highly competitive and complex sector that is in constant evolution and, as a result, we encounter various risks and uncertainties that must be given appropriate consideration in our strategic management plans and policies.




Our business is subject to the effects of general economic conditions in North America and throughout the world and, more particularly, market conditions in the telecommunications industry. In the past, our operating results were adversely affected by reduced capital spending in North America, Europe and Asia and by unfavorable general economic conditions. In particular, sales to network operators in North America were significantly and adversely affected by a downturn in the telecommunications industry in 2001 and by the global economic recession in 2009. Challenging market conditions resurfaced in 2012 and continued through 2014 with network operators placing a tight rein on capital expenditures with the complexity of deploying fully converged IP networks. In the event of another recession or slowdown in key geographic regions or markets, we may experience a material adverse impact on our business, operating results and financial condition.







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Our functional currency is the Canadian. We are exposed to a currency risk as a result of our export sales of products manufactured in Canada, China and Finland, the majority of which are denominated in US dollars and euros, while a significant portion of our cost of sales and operating expenses are denominated in Canadian dollars and currencies such as euros, British pounds, Rupees (India) and CNY (China).  As a result, even though we manage to some extent our exposure to currency risk with forward exchange contracts (by selling US dollars for Canadian dollars and US dollars for Indian Rupees) and certain cost of sales and operating expenses denominated in currencies other than the Canadian dollar, namely the US dollars and euros, we are 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 dollar - Canadian dollar forward exchange contracts, could result in foreign exchange losses and have a material adverse effect on our operating results. Foreign exchange rate fluctuations also flow through the statement of earnings line items as a significant portion of cost of sales and our operating expenses are denominated in Canadian dollars, euros 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.




Risks and uncertainties related to the telecommunications test and service assurance industry involve the rapid development of new products on a timely manner that may have short lifecycles and require extensive research and development; the difficulty of adequately predicting market size, trends and customer needs; the ability to quickly adapt our cost structure to changing market conditions in order to achieve profitability; and the difficulty of retaining highly skilled employees.




Given our strategic goals for growth and competitive positioning in our industry, we are continuously expanding into international markets, such as the operation of our manufacturing facilities in China and our software development center in India as well as operating other subsidiaries in many countries. This exposes us to certain risks and uncertainties, namely changes in local laws and regulations, multiple technological standards, protective legislation, pricing pressure, cultural differences and the management of operations in different countries.




While strategic acquisitions, like those we have made in the past and possibly others in the future, are essential to our long-term growth, they also expose us to certain risks and uncertainties related to the rapid and effective integration of these businesses, their products, technologies and personnel as well as key personnel retention. Finally, integration of new acquisitions will require the dedication of management resources, which may detract their attention from our day-to-day business and operations.




The economic environment of our industry could also result in some of our customers experiencing difficulties, which, consequently, could have a negative effect on our results, especially in terms of future sales and recoverability of accounts receivable. However, the sectorial and geographic diversity of our customer base provides us with a reasonable level of protection in this area. Finally, other financial instruments, which potentially subject us to credit risks, consist mainly of cash, short-term investments and forward exchange contracts. Our short-term investments consist of debt instruments issued by high-credit quality corporations. Our cash and forward exchange contracts are held with or issued by high-credit quality financial institutions; therefore, we consider the risk of non-performance on these instruments to be limited.







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We depend on a single supplier or a limited number of suppliers for some of the parts used to manufacture our products for which alternative sources may not be readily available. In addition, all our orders are placed through individual purchase orders and, therefore, our suppliers may experience difficulties, suffer from natural disasters, delays or stop supplying parts to us at any time. The reliance on a single source or limited number of suppliers could result in increased costs, delivery problems and reduced control over product pricing and quality. 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 or mechanical parts, is lengthy and would consume a substantial amount of time for our technical personnel and management. If we were required to change a supplier in a short period of time, our business would be disrupted. In addition, we may be unsuccessful in identifying a new supplier capable of meeting and willing to meet our needs on terms that we would find acceptable.




For a more complete understanding of risk factors that may affect us, please refer to the risk factors set forth in our disclosure documents published with securities commissions at www.EXFO.com, or at www.sedar.com in Canada or www.sec.gov/edgar.shtml in the U.S.






NON-IFRS MEASURES




We provide non-IFRS measures (gross margin* and adjusted EBITDA**) as supplemental information regarding our operational performance. We use these measures for the purpose of evaluating our historical and prospective financial performance, as well as our performance relative to our competitors. These measures also help us to plan and forecast future periods as well as to make operational and strategic decisions. We believe that providing this information to our investors, in addition to the IFRS measures, allows them to see the company’s results through the eyes of management, and to better understand our historical and future financial performance.




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




*
Gross margin represents sales less cost of sales, excluding depreciation and amortization.




**
Adjusted EBITDA represents net earnings (loss) before interest, income taxes, depreciation and amortization, restructuring charges, changes in the fair value of the cash contingent consideration, stock-based compensation costs and foreign exchange gain or loss.







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The following table summarizes the reconciliation of adjusted EBITDA to IFRS net earnings (loss), in thousands of US dollars:




Adjusted EBITDA (unaudited)




Year ended August 31,2014


2013


2012IFRS net earnings (loss) for the year

$
783


$
1,341


$
(3,593
)Add (deduct):Depreciation of property, plant and equipment


4,995



6,028



6,169Amortization of intangible assets


4,398



6,643



7,819Interest and other income


(326
)


(113
)


(131
)Income taxes


4,479



5,664



3,571Restructuring charges


–



89



2,329Changes in fair value of cash contingent consideration


–



–



(311
)Stock-based compensation costs


1,696



1,768



1,862Foreign exchange (gain) loss


(1,634
)


(4,082
)


657Adjusted EBITDA for the year

$
14,391


$
17,338


$
18,372Adjusted EBITDA in percentage of total sales


6.2
%


7.2
%


7.3
%








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Item 6.
Directors, Senior Management and Employees




A.Directors and Senior Management




The following table sets forth information about our executive officers, senior managers and Directors as of November 1, 2014.




Name and Municipality of Residence

Positions with EXFOPIERRE-PAUL ALLARD

Pleasanton, California

Independent DirectorJON BRADLEY

Worminghall, United Kingdom

Vice-President, Sales — EMEASTEPHEN BULL

Quebec City, Quebec

Vice-President, Research and DevelopmentDARRYL EDWARDS

Weston Under Wetherley, United Kingdom

Independent DirectorÉTIENNE GAGNON

Quebec City, Quebec

Vice-President, Physical-Layer and Wireless DivisionLUC GAGNON

St-Augustin-de-Desmaures, Quebec

Vice-President, Manufacturing Operations and Customer ServiceGERMAIN LAMONDE

St-Augustin-de-Desmaures, Quebec

Chairman of the Board, President and Chief Executive OfficerGUY MARIER

Lakefield Gore, Quebec

Independent DirectorCLAUDIO MAZZUCA

LaSalle, Quebec

Vice-President, Transport and Service Assurance DivisionPIERRE PLAMONDON

Quebec City, Quebec

Vice-President, Finance and Chief Financial OfficerBENOIT RINGUETTE

Boischatel, Quebec

General Counsel and Corporate SecretarySYLVAIN ROULEAU

Kirkland, Quebec

Vice-President, Human CapitalCLAUDE SÉGUIN

Montreal, Quebec

Independent DirectorLEE HUAT (JOSEPH) SOO

Singapore

Vice-President, Sales — Asia-PacificRANDY E. TORNES

Frisco, Texas

Independent DirectorDANA YEARIAN

Lake Forest, Illinois

Vice-President, Sales — Americas




The address of each of our executive officers, senior managers and Directors is c/o EXFO Inc., 400 Godin Avenue, Quebec, Quebec, Canada, G1M 2K2. The following is a brief biography of each of our executive officers, senior managers and Directors.







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Pierre-Paul Allard was appointed a member of our Board of Directors in September 2008 and has been a board member of many other technology companies in Canada and in the US. Mr. Allard is Senior Vice-President, Worldwide Sales and President Global Field Operations at Avaya Inc., a global provider of business collaboration and communications solutions. As Chief Revenue Officer, Mr. Allard is responsible for all go-to-market at Avaya. Prior to joining Avaya in May 2012, Mr. Allard worked for 19 years at Cisco Systems, Inc., where he most recently held the position of Vice-President, Sales and Operations, Global Enterprise. Previously, Mr. Allard was President of Cisco Systems Canada, and before that he held various management roles at IBM Canada for 12 years. In 2002, Mr. Allard co-chaired the Canadian e-Business Initiative, a private-public partnership aiming to measure the role e-business plays in increasing productivity levels, job creation and competitive position. In 1998, he was the laureate of the Arista-Sunlife Award, for Top Young Entrepreneur in Large Enterprise, by the Montreal Chamber of Commerce. In 2003, he received the Queen's Golden Jubilee Medal, which highlights significant contributions to Canada. In the same year, he was also awarded the prestigious Trudeau Medal from the University of Ottawa's Telfer School of Management. Pierre-Paul Allard holds a bachelor's and master's degree in Business Administration from the University of Ottawa, in Canada.




Jon Bradley was appointed Vice-President, Sales, EMEA for EXFO in June 2010. He is responsible for managing telecom sales, both direct and indirect, and for the execution of sales strategies in the international arena. He manages an accomplished and diverse sales and distribution team. As a member of the Strategy and Management Committees, he also develops corporate strategy for EXFO. Prior to his appointment as Vice-President, Sales, Europe, Middle East and Africa (EMEA), Dr. Bradley held the positions of Vice-President, International Sales, from 2007-2010, Sales Director for the EMEA territory from 2003 to 2007, and Regional Sales Manager from 1999 to 2003. Before joining EXFO in 1999, Dr. Bradley was employed as Sales and Marketing Director by Queensgate Instruments (UK) from 1997 to 1999 and as Sales Engineer by Lambda Photometrics (UK) from September 1993 to September 1997. Jon Bradley holds an honors degree in chemistry, as well as a Ph.D. in Raman spectroscopy from the University of Durham in the United Kingdom.




Stephen Bull joined EXFO in 1995 as an Engineering Manager (project management) for the Advanced Optics group. From September 1997 to December 1999, he held the position of Assistant Director of Engineering responsible for all the software development. Mr. Bull was then appointed EXFO's Vice-President of Research and Development in December 1999. Today, he manages a department that includes more than 760 engineers and technicians spread out over three continents and nine locations. He is responsible for EXFO's product development initiatives and manages the Project Management Office and related processes. Prior to joining EXFO, Mr. Bull was General Manager and Managing Director of Space Research Corporation, a military engineering company in Belgium, from June 1986 to March 1990, as well as of Taurus, an IT consulting firm, from 1990 to 1995. He is currently the President of the Institut de développement de produits (an institute dedicated to the advancement of product development practices) and a member of the Product Development Management Association (PDMA). He speaks regularly at conferences on product development. Stephen Bull holds a bachelor's degree in electrical engineering from Université Laval in Quebec City, and is a certified New Product Development Professional from the PDMA.







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Darryl Edwards was appointed a member of EXFO’s Board of Directors in September 2011. Mr. Edwards is the President and Chief Executive Officer of ECI Telecom, a leading provider of access and transport network solutions. Prior to this, Mr. Edwards was the Chairman of the Board for MACH, a leading provider of hub-based mobile communication solutions. He was also an advisor to private equity firm Warburg Pincus, the majority shareholder in MACH, on telecommunications-related topics. He brings to EXFO more than 30 years of telecommunications experience gained from a number of senior executive leadership positions; most recently he was the Chief Executive Officer of AIRCOM International, successfully leading the company through to business sale. Mr. Edwards was previously at Nortel Networks for 17 years, where he held various executive officer positions, including President of EMEA and President of Global Sales (Carrier Networks). He also was the Chief Executive Officer for two of Nortel's key joint ventures, first in the Middle East and later in Germany. Prior to his time at Nortel, Mr. Edwards spent 13 years at GEC-Plessey Telecommunications where he worked in engineering, quality assurance and international sales. Mr. Edwards has held a number of chairs, including Chairman of the Board of Nortel's interests in Turkey, Nortel Netas, which was listed on the Istanbul Stock Exchange. He also was a member of the Advisory Counsel to the Turkish government between 2004 and 2008, and previously served on the UK Government Broadband Stakeholders Group and the Information Age Partnership. Darryl Edwards holds a Higher National Certificate (Physics) from Birmingham Polytechnic in the UK.




Étienne Gagnon was appointed Vice-President, Physical-Layer and Wireless Division in June 2010. He is responsible for EXFO's wireline and wireless test and measurement business units (Optical, Transport and Datacom, Access, Simulators and Analyzers) and Corporate Marketing (CTO Office and Marketing-Communications). In May 2003, he had been named EXFO's Vice-President, Optical Business Unit and Customer Service, and in May 2007, he had taken on the responsibility of all of EXFO's telecom business units (Optical, Transport and Datacom, Navtel Product Group, Access). Mr. Gagnon began his career as a design engineer for Bombardier/Canadair, where he worked on the Canadian Regional Jet project between 1990 and 1993. Later, he held the position of Business Development Manager for France Telecom in Hungary. In 1994, he joined EXFO's European office as a Regional Sales Manager, and in 1996, he was brought back to Quebec City to head the OSP marketing group. Mr. Gagnon then went on to become the director of EXFO's Outside Plant division in 1998, and remained in that function until 2000, when he joined TeraXion, an optical component manufacturer based in Quebec City, as Vice-President of Sales and Marketing until returning to EXFO in early 2003. Étienne Gagnon holds a bachelor's degree in mechanical engineering from the University of Montreal's School of Engineering, and a master's degree in European business from the École nationale supérieure des télécommunications in France.




Luc Gagnon  was  appointed  Vice-President,  Manufacturing  Operations  in  May  2003 and,  in  May  2007, he also took on the vice-presidency of the Customer Service department. He is responsible for ensuring the smooth operation of all manufacturing activities, which include production, purchasing, product engineering, quality assurance, planning, manufacturing engineering, product configuration, transportation and customs, as well as material resources. In addition, he must ensure that there is an ongoing and efficient relation between the manufacturing process and the end customer. Prior to his nomination in 2003, Mr. Gagnon held the position of Production Director since 2000. Before joining EXFO, he had similar roles in several other high-technology companies. He worked for Mendes from 1999 to 2000, for C-MAC from 1997 to 1999, for STERIS from 1993 to 1997 and for MITEL from 1985 to 1993. Luc Gagnon holds a bachelor's degree in electrical engineering and master's degree in engineering, both from the Université de Sherbrooke, in Canada.







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Germain Lamonde, a company founder, has been President and Chief Executive Officer of EXFO since its inception in 1985. He has also been Chairman of the Board since EXFO went public in 2000. Responsible for the overall management and strategic direction of EXFO, Mr. Lamonde has grown the company from the ground up into a global leader in the test and measurement and systems and service assurance industry. Mr. Lamonde has served on the board of directors of several organizations such as the Canadian Institute for Photonic Innovations, the POLE QCA Economic Development Corporation, the National Optics Institute of Canada (INO) and Université Laval in Quebec City, to name a few. Germain Lamonde holds a bachelor's degree in physics engineering from the University of Montreal's School of Engineering (École Polytechnique), a master's degree in optics from Université Laval, and is also a graduate of the Ivey Executive Management Program offered by the University of Western Ontario.




Guy Marierhas served as our Director since January 2004. President of Bell Québec between 1999 and 2003, Mr. Marier completed his successful 33-year career at Bell as Executive Vice-President of the Project Management Office, before retiring at the end of 2003. From 1988 to 1990, Mr. Marier headed Bell Canada International's investments and projects in Saudi Arabia and, for the three following years, served as President of Télébec, limited partnership, a member of the Bell group of companies. He then returned to the parent company to hold various senior management positions. Guy Marier holds a Bachelor of Arts from the University of Montreal and a Bachelor of Business Administration from Université du Québec à Montréal.




Claudio Mazzucawas appointed Vice-President, Transport and Service Assurance Division in March 2012. Prior to this appointment, he held the role of Director of EXFO's Transport and Datacom business unit since 2006. In this role, he was responsible for the development and execution of business and product strategy for this business unit, which now is a leading player in the Ethernet and next-generation packet transport test market segments. Mr. Mazzuca began his career as a systems engineer for Nortel Networks, where he worked on the launch of the highly successful 10G High-Speed Transport and DWDM product line, and later on Nortel's Preside Network Management solution. He then moved to technology startup Hyperchip Systems as Senior Product Manager, focusing on the development of large-scale metro and core IP routers and switches, and associated OEM components. In 2004, he joined EXFO's Transport and Datacom business unit as Product Line Manager for the next-generation SONET/SDH products, and in 2005, was promoted to Group Manager for the entire Transport and Datacom product line. Claudio Mazzuca holds a bachelor's degree in electrical engineering from Concordia University and a master's degree in business from McGill University in Montreal.




Pierre Plamondon was appointed Vice-President, Finance and Chief Financial Officer (CFO) of EXFO in January 1996. He is responsible for the accounting services, financial reporting, legal services, investor relations and information technology services. Prior to joining EXFO, Mr. Plamondon served as Senior Manager for Price Waterhouse, now PricewaterhouseCoopers LLP, from September 1981 to December 1995, in Canada and France. Pierre Plamondon holds a bachelor's degree in business administration and a license in accounting, both from Université Laval in Quebec City. Mr. Plamondon is a member of the Quebec Chartered Professional Accountants Order. He is currently a director of Urbanimmersive Inc., a public company listed on the TSX Venture Exchange. Over the years, he has been a member of the Board of Directors of several non-profit organizations among which the Fondation de l’Université Laval and SOVAR Inc. (Société de valorisation des applications de la recherche de l'Université Laval).




Benoit Ringuette has been our in-house Legal Counsel and Corporate Secretary since April 2004. Prior to joining EXFO, Mr. Ringuette practiced mainly in commercial, corporate and securities law from 1998 to 2003 as an associate in the law firms of O’Brien, Flynn Rivard in Quebec City and Desjardins Ducharme Stein Monast in Quebec City. Mr. Ringuette has been a member of the Quebec Bar since 1998. Mr. Ringuette holds a bachelor’s degree in Civil Law and a master’s degree in Business Administration (MBA) from Laval University in Quebec City, Canada.







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Sylvain Rouleauwas appointed Vice-President, Human Capital at EXFO in January 2012. As such, his main responsibility is overseeing the human resources department, and, more specifically, his mandate is to transform EXFO into an organization that optimizes its human capital and, in turn, surpasses its objectives. Mr. Rouleau has over 25 years' experience in human resources and has held several executive positions in a variety of international organizations. Namely, before joining EXFO, he was Senior Vice-President, Human Capital at Kruger since February 2009. From 2003 to 2009, he worked for the Alcan Group ─ Bauxite & Alumina as Vice-President, Human Resources, Communications and Corporate Affairs. Prior to that, he managed human resources teams for Nortel Networks as well as several divisions of the General Electric Company, such as GE Power Systems, GE Medical Systems and GE Aircraft Engines, both in Canada and abroad. Mr. Rouleau's international perspective and his proven expertise as a business partner and as a change agent serve as a reference in human resources management. Sylvain Rouleau holds a master's degree in organizational psychology (O.D. and Complex Systems) from the Université de Sherbrooke in Canada, and he has given several conferences on leading-edge organizations.




Claude Séguinwas appointed a member of EXFO’s Board of Directors in February 2013. He brings to EXFO nearly 30 years of corporate, financial, executive and provincial government experience gained through senior management positions in major corporations and government departments. Mr. Séguin is currently Senior Vice-President, Corporate Development and Strategic Investments at CGI, a global leader in information technology and business process services. In this position, he is responsible for all merger and acquisition activities. Prior to joining CGI in 2003, he served as President of CDP Capital—Private Equity, and prior to this position, he served as Teleglobe Inc.’s Executive Vice-President, Finance and Chief Financial Officer, a position that he held from 1992 to 2000. Mr. Séguin also has extensive senior-level government experience, having served as Deputy Finance Minister of the Province of Québec from 1987 to 1992, in addition to Assistant Deputy Finance Minister and Assistant Director of Social Programs at the Quebec Treasury Board. Mr. Séguin is a member of the boards of HEC-Montréal and Centraide of Greater Montreal Foundation as well as being Chairman of the Board of Finance - Montreal, an organization regrouping financial institutions in Montreal. Claude Séguin graduated from HEC Montréal and earned a Master’s and a Ph.D. in public administration from Syracuse University in New York State.




Lee Huat (Joseph) Soowas appointed EXFO's Vice-President of Asia Sales in December 2011. He is responsible for managing telecom sales, both direct and indirect, and for the execution of sales strategies in the Asian market. As a member of the Strategy and Management Committees, he also develops corporate strategy for EXFO. Mr. Soo has extensive market knowledge and sales experience in the telecom industry, as he has been leading Asia Pacific sales teams for major test and measurement providers for the last 15 years. Namely, he was Vice-President of Asia Pacific Sales at Fluke Networks from 2010 to 2011. Prior to that, he was Executive Vice-President of Rohde & Schwarz Asia Pacific Regional, where he held various management and sales positions at different Rohde & Schwarz locations since he began there in 1997. Earlier on, Mr. Soo began his career as a Senior EMC Engineer at Astec Power Pte Ltd in 1990. Lee Huat (Joseph) Soo is fluent in English and Chinese and has lived both in Asia and the US. He holds a Bachelor of Science degree from the University of Minnesota─Twin Cities and has attended several executive MBA courses at the Singapore Institute of Management.




Randy E. Tornes was appointed a member of EXFO’s Board of Directors in February 2013. He brings to EXFO nearly thirty (30) years of telecommunications experience gained through senior management positions at leading network equipment manufacturers. Mr. Tornes is Vice-President, Sales (AT&T account) at Juniper Networks, a worldwide leader in high-performance networking and telecommunications equipment. In this position, he is responsible for all sales, service and support of Juniper products to AT&T. Prior to joining Juniper Networks in May 2012, he spent two (2) years at Ericsson, where he was Vice-President Sales (AT&T account). Previous to that position, he worked for Nortel for twenty-six (26) years, holding various sales management positions, including Vice-President Sales, GSM Americas. Mr. Tornes also served as member of the Board of Governors at 3G Americas LLC. Randy E. Tornes holds a Bachelor of Science degree in Business—Organizational Development and Production and Operations Management, from the University of Colorado in Colorado Springs.


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Dana Yearian was appointed EXFO's Vice-President, Sales, Americas in March 2007. Prior to this appointment, Mr. Yearian held the position of Vice-President, Telecom Sales, North America. He is responsible for managing telecom sales, both direct and indirect, and the execution of sales strategies across North, Central and South America. Mr. Yearian oversees all sales-related functions for the EXFO sales organization throughout this territory, including sales operations, global account management and partner programs. As a member of the Strategy and Management committees, he also helps develop corporate strategy. From 2005 to 2006, Mr. Yearian held senior executive sales positions at Spirent Communications Service Assurance Division. In 2003, Mr. Yearian founded The Katrixx Group, which provided consulting and contracting services to high-technology companies. Before founding his company, Mr. Yearian worked as Vice-President of Sales at Acterna Corp. (from 1991 to 2003), where he led both North American and International sales and support operations. Prior to working for Acterna, Mr. Yearian held various executive positions, namely at Toshiba America, Silicon Sensors (Advanced Photonix, Inc.) and Impell Corporation (ABB Ltd.). Dana Yearian holds a bachelor's degree in electrical engineering from the Illinois Institute of Technology in Chicago, and has completed MBA course work at DePaul University, also in Chicago, Illinois, USA.




Term of Executive Officers




Executive officers are appointed annually by the Board of Directors and serve until their successors are appointed and qualified or until earlier resignation or removal. There are no family relations among directors and officers and no arrangements with third parties (customers, suppliers) pursuant to which they were appointed as officers or directors.






B.Compensation


COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS




Compensation Discussion and Analysis




This Compensation Discussion and Analysis focuses primarily on: (i) significant elements of the Corporation’s executive compensation program; (ii) principles on which the Corporation makes compensation decisions and determines the amount of each element of executive and director compensation; and (iii) an analysis of the material compensation decisions made by the Human Resources Committee for the financial year ended August 31, 2014.




The following is a discussion of the compensation arrangements with the Corporation’s Chief Executive Officer (“CEO”), Chief Financial Officer (“CFO”) and each of the three most highly compensated executive officers whose total compensation was, individually, more than CA$150,000, (the “Named Executive Officers” or “NEOs”). The Corporation’s NEOs for the financial year ended August 31, 2014 were Mr. Germain Lamonde (CEO), Mr. Pierre Plamondon (Vice-President, Finance and CFO), Mr. Jon Bradley (Vice-President, Sales — EMEA), Mr. Lee Huat (Joseph) Soo (Vice-President, Sales — Asia-Pacific) and Mr. Dana Yearian (Vice-President, Sales — Americas).




Members of the Human Resources Committee




During the financial year ended August 31, 2014, the Human Resources Committee was composed of:


●
Mr. Guy Marier (Chairman)
 
 ●
Mr. Pierre-Paul Allard
 ●
Mr. Darryl Edwards
 ●
Mr. Claude Séguin
 ●
Mr. Randy E. Tornes


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None of these members were officers or employees, or former officers or employees of the Corporation or its subsidiaries. All of the members of the Human Resources Committee are considered “independent”, as defined in applicable securities legislation and regulations. They each have experience in executive compensation either as a chief executive officer or a senior executive officer of a publicly-traded corporation. Mr. Guy Marier has held various senior management and executive positions in the last thirty (30) years. Mr. Pierre-Paul Allard has held management and executive positions for the last thirty (30) years. Mr. Darryl Edwards has held a number of senior executive leadership positions in the last thirty (30) years. Mr. Claude Séguin has held various senior management and executive positions in major corporations in the last thirty (30) years. Mr. Randy E. Tornes has approximately thirty (30) years of management experience through senior sales management positions. Over the course of their careers, all members have been exposed at various degrees to the complexity of balancing efficient executive compensation strategies with the evolution of business requirements, having to manage directly or indirectly impacts and consequences of executive compensation decisions. The Board of Directors believes that the Human Resources Committee collectively has the knowledge, experience and background required to fulfill its mandate.




Mandate of the Human Resources Committee




The Human Resources Committee of the Board of Directors is responsible for establishing the annual compensation and assessing the risks related thereto and overseeing the assessment of the performance of all the Corporation’s executive officers, including the President and Chief Executive Officer. The Human Resources Committee also reviews and submits to the Board of Directors recommendations for the salary structure and the short-term and long-term incentive compensation programs for all employees of the Corporation. The Human Resources Committee also evaluates and makes recommendations to the Board of Directors regarding the compensation of directors, including the number of Deferred Share Units credited to the non-employee directors pursuant to the Deferred Share Unit Plan. The Human Resources Committee’s goal is to develop and monitor executive compensation programs that are consistent with strategic business objectives and shareholders’ interests. Though the Human Resources Committee is responsible for the review and approval of the employees that will receive Restricted Share Units or options to purchase shares of the Corporation, in accordance with policies established by the Board of Directors and the terms of the Long-Term Incentive Plan, these functions may be shared between the Board of Directors and the Human Resources Committee. During the period from September 1, 2013 to August 31, 2014, these functions have been shared by the Board of Directors and the Human Resources Committee but have mainly been performed by the Human Resources Committee.




The Human Resources Committee has reviewed and discussed with the CEO and Vice-President, Human Capital of the Corporation, the compensation disclosure in this document, and has recommended to the Board of Directors that the disclosure be included in this Annual Report.




From September 1, 2013 to November 1, 2014, the Human Resources Committee held five (5) meetings and at all of those meetings executive compensation was discussed. The Human Resources Committee meetings were attended by all the members of the Human Resources Committee. The following table outlines the main activities of the Human Resources Committee during the period from September 1, 2013 to November 1, 2014:


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Meeting
Main activities of the Human Resources CommitteeOctober 8, 2013
●
Review of the Business Performance Measures results for the financial year ended August 31, 2013;●
Review and approval of the Business Performance Measures for the financial year started September 1, 2013;●
Review of the Short-Term Incentive Plan results for the financial year ended August 31, 2013;●
Review and approval of the Short-Term Incentive Plan for the financial year started September 1, 2013;●
Review of the proposed salary scales and salary increases for the year started September 1, 2013;●
Review and approval of the compensation plans of executive officers for the financial year started September 1, 2013 being the Base Salary, the Short-Term Incentive Plan and the stock-based compensation delivered through the Long-Term Incentive Plan;●
Review and approval of the stock-based compensation plan for the sales force delivered through the Long-Term Incentive Plan for the financial year started September 1, 2013;●
Review and approval of the quantum for the stock-based compensation plan for the performing employees delivered through the Long-Term Incentive Plan for the financial year started September 1, 2013;●
Review and approval of the executive compensation section of the management proxy circular for the financial year ended August 31, 2013;●
Review of the succession planning program;●
Review of the Mobilization / Motivation Plan;●
Review of the Management Structure;●
Review and approval of the CEO objectives and compensation plan;●
Review of the Risk Assessment of Executive Compensation disclosure obligations.January 8, 2014
●
Review of the quarterly payments under the Short-Term Incentive Plan for the financial year started September 1, 2013 and being part of the Short-Term Incentive Plan;●
Review and approval of the stock-based compensation for performing employees delivered through the Long-Term Incentive Plan for the financial year started September 1, 2013;●
Review of the Management Structure;●
Global Compensation Review;●
Review and approval of the compensation plans of executive officers for the financial year started September 1, 2013 being the Base Salary, the Short-Term Incentive Plan and the stock-based compensation delivered through the Long-Term Incentive Plan.March 25, 2014
●
Review of the quarterly payments under the Short-Term Incentive Plan for the financial year started September 1, 2013 and being part of the Short-Term Incentive Plan;●
Review of the Key Human Capital Initiatives;●
Global Compensation Review (benchmarking, sales commissions, pension, benefits and working conditions);●
Review of the Management Structure;●
Review of the Talent Management.June 25, 2014
●
Review of the quarterly payments under the Short-Term Incentive Plan for the financial year started September 1, 2013 and being part of the Short-Term Incentive Plan;●
Review of the succession planning process;●
Update on the Global Compensation Review;●
Update on the Management Structure Review;●
Review of the Key Human Capital Initiatives.October 8, 2014
●
Review of the Business Performance Measures results for the financial year ended August 31, 2014;●
Review and approval of the Business Performance Measures for the financial year started September 1, 2014;●
Review of the Short-Term Incentive Plan results for the financial year ended August 31, 2014;●
Review and approval of the Short-Term Incentive Plan for the financial year started September 1, 2014;●
Review and approval of the compensation plans of executive officers for the financial year started September 1, 2014 being the Base Salary, the Short-Term Incentive Plan and the stock-based compensation delivered through the Long-Term Incentive Plan;●
Review and approval of the stock-based compensation for the sales force delivered through the Long-Term Incentive Plan for the financial year started September 1, 2014;●
Review and approval of the quantum for the stock-based compensation for the performing employees delivered through the Long-Term Incentive Plan for the financial year started September 1, 2014;●
Review and approval of the executive compensation section of the management proxy circular for the financial year ended August 31, 2014;●
Review of the Management Structure;●
Review and approval of the CEO objectives and compensation plan;●
Review of the Risk Assessment of Executive Compensation disclosure obligations.


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Compensation Plan Control - Compensation Consultant and Internal Review




As a general practice, the Corporation’s relative position in terms of compensation levels is determined periodically through studies performed by independent consulting firms using a selected reference market of comparable companies. The benchmarking activities are further detailed below under the heading – “Benchmarking”.




In 2013 and 2014, the Corporation engaged Towers Watson to perform an executive compensation review and to provide recommendations regarding the short-term incentive and long-term incentive compensation design of the Corporation (hereinafter in this Annual Report referred to as the “Target Compensation Positioning”). The compensation elements covered by the analysis were: base salary; target bonus; long term incentive; perquisites and pension (hereinafter in this Annual Report referred to as the “Target Total Compensation”). Towers Watson’s work included assistance in benchmarking, assessing potential gaps between the market and the executives’ compensation levels, to propose potential changes to ensure alignment with the market and with the Corporation’s compensation policy.  Towers Watson also assessed the competitiveness of the compensation offered to the independent Directors of the Board and proposed changes to ensure alignment with market practices.




In addition, internal pay equity studies are a key factor used by the Corporation to complete the compensation review process and indicate where necessary adjustments may be required. During the financial year ended August 31, 2014, this practice continued and certain compensation adjustments were made as have been made in previous years. Notably, in 2012, the Human Resources Committee, after the evaluation of the share ownership of the CEO, determined that the CEO should no longer receive equity-based compensation within his compensation since the share ownership of the CEO is sufficient and equity-based compensation is no longer reasonably considered as an incentive to performance. Accordingly, the base salary of the CEO will be adjusted for a period of four (4) years starting from the financial year started September 1, 2012.




The Human Resources Committee has the authority to retain any independent consultants of its choice to advise its members on total executive compensation policy matters, and to determine the fees and the terms and conditions of the engagement of these consultants. The Human Resources Committee is ultimately responsible for its own decisions, which may take into consideration more than the information and recommendations provided by its compensation consultants or management.




For the financial years that ended on August 31, 2013 and 2014, the Human Resources Committee retained the services of Towers Watson for an analysis on executive officers’ and directors’ compensation and also 37-2 Conseil Inc. for an analysis on executive officers’ compensation.




The Corporation also retained the services of Towers Watson, 37-2 Conseil Inc., Aon-Hewitt, Eckler, Groupe Créacor Inc., Lee Hecht Harrison, Knightsbridge, Mercer and SPB Psychologie organisationnelle for services which were not related to executive compensation. The services provided by Towers Watson concerned an analysis on the compensation structure of the sales employees, compensation survey for all positions other than sales and the access to benefits and compensation data for employees. The services provided by 37-2 Conseil Inc. related to an analysis of the compensation structure of the Corporation, the access to compensation data for employees and the preparation of various analyses with respect to the elaboration of a new salary structure for the Corporation.  The services provided by Aon-Hewitt related to the access to compensation data and surveys for sales employees in various countries. The services provided by Eckler relates to pension plan analysis. The Corporation consulted Groupe Créacor Inc. for assistance with employees’ training. The services provided by Lee Hecht Harrison and Knightsbridge related to outplacement services. The Corporation consulted Mercer for assistance with employees’ benefits and benchmarking along with compensation data for expatriate employees. The Corporation consulted SPB Psychologie organisationnelle for tests before hiring. Fees for the services performed that are not related to executive compensation are not required to be approved by the Human Resources Committee.


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The aggregate fees paid to Towers Watson, 37-2 Conseil Inc., Aon-Hewitt, Eckler, Groupe Créacor Inc., Lee Hecht Harrison, Knightsbridge, Mercer and SPB Psychologie organisationnelle for consulting services provided to the Human Resources Committee related to determining compensation for any of the Corporation’s directors and executive officers and to the Corporation for all other services provided during the financial years ended August 31, 2013 and 2014 were as follows:




Type of Fee
Financial 2013 Fees
Percentage of

Financial 2013 Fees
Financial 2014 Fees
Percentage of

Financial 2014 FeesExecutive Compensation Related Fees
CA$58,958
(1)
39%

CA$16,823
(1) (2)
18%All Other Fees
CA$91,300

61%

CA$76,541

82%Total
CA$150,258

100%

CA$93,364

100%


(1)
The aggregate fees paid to Towers Watson are CA$58,958 and CA$13,854 respectively for financial 2013 and 2014, and the aggregate fees paid to 37-2 Conseil Inc. are CA$2,969 in 2014.


(2)
Those fees are not exclusively related to executive compensation as some work was also used for other employees.




Benchmarking




For the purpose of assessing the competiveness of the Target Total Compensation of senior executives, the Corporation considered compensation data from a comparator group including private and publicly-traded companies of comparable size and similar industry, operations in multiple countries and attracting similar profiles of employees, professionals and experts. The comparator group has been revised in 2013 with the guidance and advice from Towers Watson.


●
Canadian executives: For the executives based in Canada, the Corporation used the following comparator group: 5N Plus Inc., Aastra Technologies Ltd., ACCEO Solutions, Atos It Services and Solutions, Inc., Avigilon Corporation, Calian Technologies Ltd., COM DEV International Ltd., Constellation Software Inc., GTECH, Ericsson Canada Inc., Evertz Technologies Ltd., Hemisphere GPS Inc., Hitachi Data Systems, Miranda Technologies Inc., OpenText Corporation, Redline Communications Group Inc., Sandvine Corporation, Sierra Wireless Inc., Smart Technologies Inc., Vecima Networks Inc. and Wi-Lan Inc.
 
 ●
United States executives: For the executives based in the United States, the Corporation used the following comparator group: AMETEK, Aricent Group, Cincinnati Bell, Consolidated Communications, Crown Castle, ESRI, Fidessa Group, Globecomm Systems, Hutchinson Technology, Itron, Kaspersky Lab, Omgeo, Openet, PASCO Scientific, Plexus, SAS Institute, Sensata Technologies, Spotify, Teradata and Total System Services.
 ●
United Kingdom executives: For the executives based in the United Kingdom, the Corporation used the following comparator group: ARM Holdings, BT, Cable & Wireless, COLT Telecom, Computacenter, Electrocomponents, Everything Everywhere, hibu (prev. Yell Group), Hitachi Data Systems, Office Depot, Pearson Group, Pitney Bowes, Reed Elsevier, Sage UK, Telefonica O2, Three, Virgin Media and Vodafone.




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  ●
Asia executives: For the executives based in Asia, the Corporation used a broader comparator group, based on general industry data: Abbott Laboratories, Ace Insurance Limited, Acr Capital Holdings Pte Ltd, Aeg Power Solutions, Agilent Technologies, Aia Co. Ltd (Singapore), Allianz Insurance, Allianz Se Reinsurance Branch Asia Pacific, Amlin Plc, Aon Asia Pacific, Astrazeneca Singapore Pte Ltd, Atos, Australia And New Zealand Banking Group Limited, Avanade, Aviva Asia, Aviva Ltd, Axa Asia Regional Centre Pte Ltd, Axa Insurance Singapore Pte Ltd, Axa Life Insurance Singapore, Bank Of America, Bank Of East Asia, Barclays Capital, Baxter Healthcare (Asia) Pte Ltd, BBC Worldwide, Belgacom, Biosensors Interventional Technologies Pte Ltd, Boeing (United States), Bombardier Transportation Gmbh, Boston Scientific Asia Pacific, BP, British Telecomms, Cable & Wireless, Canon, Catlin Singapore Pte Ltd, Celgene Pte Ltd, Cerebos Pacific, Certis Cisco Security, Chartis S'Pore, Chubb Pacific Underwriting, Cimb, Cisco, Citigroup, Clearwater Capital, Colt Technology Services Sa, Commerzbank Ag, Commscope Solutions Singapore Pte Ltd, Credit Suisse, Dbs, De Lage Landen Pte Ltd, Delphi Automotive Systems, Dematic, Dentsply, Deutsche Bank, Dhl Global Forwarding Management (Asia Pacific) Pte Ltd, Dhl Global Fowarding Singapore, Dhl Supply Chain Singapore, Diageo Plc, Discovery, Edwards Lifesciences (Asia) Pte Ltd, Edwards Lifesciences (Singapore) Pte Ltd, Energy Market Company, Enpro, Espnstar Sports, Estee Lauder Asia, Euler Hermes Credit Insurance Agency (S) Pte Ltd, Expedia, Inc., Experian Plc, Franklin Templeton Capital Holdings Pte Ltd, Friends Provident International Ltd, General Reinsurance Ag, Goldman Sachs, Great Eastern Life Insurance, Hewlett-Packard, Hill-Rom, Hilton Worldwide, Htc Corporation, Ida, Ii-Vi, Img, Ing Bank N.V., Singapore, Intel, Jabil Circuit, Inc., Jardine Lloyd Thompson Limited, John Wiley & Sons, Jones Lang Lasalle, JPMorgan Chase, Lenovo, Lexmark, Liberty Insurance Pte Ltd, Liberty Insurance Underwriters, Lilly-Nus Centre For Clinical Pharmacology Pte Ltd, M1, Malayan Banking Berhad, Manulife (Singapore) Pte Ltd, Marvell, Mastercard, Merck Pte Ltd, Microsoft, Mine Safety Appliances (United States), Molex, Morgan Stanley, Mp Biomedicals Asia Pacific Pte Ltd, Msig Insurance, MTV Asia, Mundipharma Pte Ltd, Munich Management Pte Ltd, Nagravision, National Australia Bank, NBC Universal, Nomura, Ocbc, Orange Business Services, Pacific Life Re Limited, Singapore Branch, Pall Corporation, Pearson Education South Asia Pte Ltd, Pfizer Asia Pacific Pte Ltd, Philips Electronic (S) Pte Ltd, Pramerica Financial Asia Hq Pte Ltd, Premier Farnell (Element14), Printronix, Prudential Assurance Company Singapore (Pte) Ltd, Qbe Insurance (International) Ltd, Qliktech International, Rbc Dexia Investor Services Bank, Reckitt Benckiser, East Asia, Reed Elsevier, Rentokil Initial Asia Pacific Management Pte Ltd, Research In Motion, Rhb Bank, Rolls Royce, Royal Bank Of Scotland, Royal Bank Of Scotland Gbm, Royal Dutch Shell, Royal Philips Electronics, Rsa Insurance, Sakari Resources Limited, Sandoz International Gmbh, Sanofi-Aventis Singapore Pte Ltd, SAS Institute, Scor Services Asia Pacific Pte Ltd, Sirtex Medical Ltd, Skandinaviska Enskilda Banken Ab Publ, Smith & Nephew Pte Ltd, Sompo Japan Insurance (Singapore) Pte Ltd, Standard & Poors, Standard Chartered Bank, Standard Life International, Starhub, Straits Developments, Swarovski Management Pte, Swiss Reinsurance Co, Takeda Pharmaceuticals (Asia Pacific) Pte Ltd, Teleplan, Tellabs, Temasek International, Tenet Insurance Co. Ltd., The Economist Group (A/P) Limited, The Walt Disney Company, Thomsonreuters, Tokio Marine Life Insurance Singapore Ltd, Transamerica Life (Bermuda) Ltd, Transitlink, T-Systems International, Tui Travel, UBS, Underwriters Laboratories (United States), Unilever, Unisys, United Overseas Insurance Ltd., Verizon Business, Xl Re Ltd, Zimmer Pte Ltd, Zurich Insurance Company (S`Pore Branch) and Urich International.


To be considered in the comparator group, a company had to meet the following specific criteria:




a)
Similar industry: Technology Hardware and Equipment, Telecommunications Equipment and Services or Software and Services; and




b)
Comparable in size: revenues under CA$1 billion. Only one publicly traded company had revenues slightly above the equivalent of CA$1 billion. The compensation market comparison is done using the regression analysis which is a method to predict the “size-adjusted” competitive level of compensation to reflect the size of the Corporation in relation to that of the other companies of the reference group. This method mitigates the impact that larger companies may have on the competitive compensation levels for the Corporation.


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The Corporation also participates in two major surveys on an annual basis and accordingly is permitted to purchase the results in order to continue the benchmarking of our compensation on a regular basis. The first one is Towers Watson High Tech Middle Management, Professional and Support Compensation Survey, providing and receiving data for Canada, USA, UK, Finland and Lebanon. The other one is Radford (AON Hewitt) Global Sales Survey, providing and receiving data for all the countries where the Corporation employs sales force.




Guiding Principles for Compensation of Executive Officers




The Corporation’s executive compensation plans are designed to attract, retain and motivate key executives who directly impact the Corporation’s long-term success and the creation of shareholder value. In determining executive compensation, the Human Resources Committee considers the following four principles:




●
Performance-based: Executive compensation levels reflect both the results of the Corporation and individual results based on specific quantitative and qualitative objectives established at the beginning of each financial year in keeping with the Corporation’s long-term strategic objectives.
 ●
Aligned with shareholder interests: An important portion of incentive compensation for executives is composed of equity awards to ensure that executives are aligned with the principles of sustained long-term shareholder value growth.
 ●
Market competitive: Compensation of executives is designed to be externally competitive when compared against executives of comparable peer companies, and in consideration of the Corporation’s results.
 ●
Individually equitable: Compensation levels are also designed to reflect individual factors such as scope of responsibility, experience, and performance against individual measures.


Compensation Policies and Practices




In April 2007, the Corporation adopted a Best Practice Regarding the Granting Date of Stock Incentive Compensation. The purpose of this best practice is to ensure that the Corporation complies with securities regulation and avoids the back-dating of equity based incentive compensation. The best practice states that the Corporation shall: (i) grant recurrent equity based incentive compensation pursuant to its Long Term Incentive Plan on the fifth business day following the public release of the Corporation’s financial results; and (ii) grant recurrent stock based incentive compensation pursuant to its Deferred Share Unit Plan on the last business day of each quarter. In October 2014, the Corporation amended the Human Resources Committee Charter in order to adapt it to the latest NASDAQ Rules on compensation committees.




Risk Assessment of Executive Compensation Program




The Human Resources Committee considers the implications of the risks associated with the Corporation’s compensation policies and practices when establishing recommendations for the compensation of executive officers. As such, for the financial year ended August 31, 2014, the Human Resources Committee conducted an internal risk assessment for executive compensation. The Human Resources Committee individually examined the compensation plans for each potential NEO against a list of elements that could trigger executives taking inappropriate or excessive risks. For the financial year ended August 31, 2014, the Human Resources Committee did not identify any risks associated with the Corporation’s executive compensation policies and practices that are reasonably likely to have a material adverse effect on the Corporation.




On October 9, 2012 the Human Resources Committee Charter was amended in order to expressly reflect the responsibility of the Human Resources Committee to conduct an annual assessment of the risks associated with the Corporation’s executive compensation policies and procedures.


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Purchase of Hedging Financial Instruments by an Executive Officer or Director




While the Corporation has not adopted a policy prohibiting or restricting its executive officers and directors from purchasing financial instruments, including prepaid variable forward contracts, equity swaps, collars, or units of exchange funds, that are designated to hedge or offset a decrease in market value of equity securities granted as compensation or held, directly or indirectly, by the executive officer or director, to management’s knowledge, no executive officer or director has purchased any such financial instruments as of November 1, 2014. In addition, according to the Security Trading Policy of the Corporation, executive officers and directors are required to pre-clear with the Corporation’s legal counsel’s office any transaction concerning the Corporation’s securities, which includes the entering into any of the above-mentioned financial instruments.




Compensation Elements




The key elements of the Corporation’s 2014 executive compensation program were (i) base salary, (ii) short-term incentive compensation (by way of the Short-Term Incentive Plan or the Sales Incentive Plan) and (iii) the stock-based incentive compensation delivered through the Long-Term Incentive Plan. In addition, the Corporation has also offered benefit plans and, if applicable, contributed to a Deferred Profit-Sharing Plan or a 401K Plan. To determine appropriate compensation levels for each compensation component, the Human Resources Committee considered all key elements of the executive compensation program. The Human Resources Committee did not assign specific weightings to any key element of the Corporation’s 2014 executive compensation program.




Base Salaries




In establishing the base salaries of senior officers, including the President and Chief Executive Officer, the Corporation takes into consideration responsibilities, job descriptions and salaries paid by other similar organizations for positions similar in magnitude, scope and complexity. The Human Resources Committee’s objective is to align executive compensation levels with the Target Compensation Positioning offered within a reference market of comparable companies that are similar in size to the Corporation, with a particular focus on those within the high-technology/telecommunications and manufacturing-durable goods industries. The Human Resources Committee reviews the base salary of each executive officer on an annual basis at the beginning of each financial year and recommends that the Board of Directors approve appropriate adjustments, if required, within the salary range in order to maintain a competitive position within the market place.




Short-Term Incentive Compensation




The Short-Term Incentive Plan (“STIP”), or the Sales Incentive Plan (“SIP”) for the executive officers that are included within the sales force, provides executive officers with the opportunity to earn annual bonuses based on the Corporation’s financial performance and the achievement of strategic corporate and departmental objectives established on a yearly basis (the “Business Performance Measures”) as well as the achievement of individual performance objectives (“Individual Performance Measures”). The Business Performance Measures under the STIP also apply to all other employees of the Corporation, except the sales force, for which the SIP applies.




Annually the Human Resources Committee determines the annual incentive target for each executive officer, being a percentage of the executive’s base salary (“Annual Incentive Target”). The Annual Incentive Targets for executive officers eligible for incentive bonuses in the financial year ended August 31, 2014 were established to be progressively in line with the objective of the Human Resources Committee of aligning compensation with the Target Compensation Positioning offered in the reference market. For the most recently ended financial year, the Annual Incentive Target for the NEOs was:


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Name & Position
Annual Incentive Target as % of base salaryGermain Lamonde, CEO
65.0%Pierre Plamondon, Vice-President, Finance and CFO
40.0%Jon Bradley, Vice-President, Sales — EMEA
70.0%Lee Huat (Joseph) Soo, Vice-President, Sales — Asia-Pacific
55.0%Dana Yearian, Vice-President, Sales — Americas
89.0%


●
Short-Term Incentive Plan


The STIP awards are calculated as follows:




Base Salary
X
Annual Incentive

Target (%)
X
Business Performance

Measures (%)
X
Individual Performance

Measures (%)




At the beginning of each financial year, the Human Resources Committee recommends for approval by the Board of Directors the Business Performance Measures that will account for the annual incentive compensation. The following table provides the Business Performance Measures, their weight and result within the overall Business Performance Measures applicable to all executive officers and employees of the Corporation except those executives and employees that are within the sale force:




Business Performance Measure
Weight
Annual Target
Result (%)Sales (1)
25%

US$269.9 million
16.2%EBITDA (2)
25%

US$29.4 million
13.2%Gross margin (3)
20%

US$170.6 million
12.9%Quality (3)
15%

100%
18.2%On-time delivery (3)
15%

95%
19.6%Total
100%


80.1%





(1)
For sales metric, results will range from nil to 100% of the weight upon attainment of 50% of the annual target up to the annual target and will range from 100% to 150% of the weight from the annual target up to 112.5% of the annual target.


(2)
For EBITDA metric, results will range from nil to 100% of the weight upon attainment of 0% of the annual target up to the annual target and will range from 100% to 150% of the weight from the annual target up to 125% of the annual target.


(3)
For gross margin, quality and on-time delivery metrics, results will range from nil to 100% of the weight upon attainment of a minimum threshold of US$85.3M, 50% and 87%, respectively, up to the annual target and from 100% to 150% of the weight from the annual target to the maximum threshold of US$191.9M, 125% and 98%, respectively.




The Individual Performance Measures are determined annually by the executive’s supervisor or the Human Resources Committee and approved by the Board of Directors of the Corporation. They are based upon the position, role and responsibilities of each executive within the Corporation, departmental objectives and personal management objectives. At the conclusion of each year, the executive’s supervisor or, the Human Resources Committee evaluates the performance of the executive against the pre-determined objectives and the executive’s performance is evaluated by progress, achievements and contributions. The following tables provide for each NEO subject to the STIP an overview of the elements included within the Individual Performance Measures, their weight and result for financial year 2014 within the overall Individual Performance Measures:


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Germain Lamonde, CEOElements of Individual Performance Measures
Weight

(from 0% to 125%)
Result

(%)Financial objectivesCorporate revenues
From 0% to 35%
28.6Corporate EBITDA
From 0% to 25%
12.6Strategic contributionEstablishment and implementation of a three (3) year strategic plan and profitability improvementin identified products family
From 0% to 40%
20.0Management structure
From 0% to 25%
12.5Total
73.7







Pierre Plamondon, Vice-President, Finance and CFOElements of Individual Performance Measures
Weight

(from 0% to 125%)
Result

(%)Financial objectives
Weight
From 0% to 55%
28.3Corporate revenues, gross margin, profitability objectives and improving cash flows from operations
40%Corporate EBITDA
15%Strategic contribution
Weight
From 0% to 70%
57.3Delivering the strategies and objectives under the NEO’s responsibility as set forth in the Corporation’s strategic plan
30%Maintaining the highest standard and compliance in the Corporation’s financial reporting; internal controlsand corporate governance;

corporate development and risk management
25%Delivering the strategies and objectives under the NEO’s responsibility as set forth in the Corporation’sinformation technology strategic plan
15%Total
85.6


●
The Sales Incentive Plan


The SIP objectives for executive officers in the sales force are aimed to reward five (5) elements: three (3) elements are shareholder oriented (contribution margins, billings and EBITDA) and two (2) are based on specific objectives. The objectives are determined by the executive’s supervisor and are for the territory under the executive’s supervision. The following tables outline the SIP objectives for each NEO who is within the sales force:




Jon Bradley, Vice-President Sales — Europe, Middle East and Africa (EMEA)Business Performance Measure
Incentive Target (US$)
Result (US$)Contribution Margin Bonus (1)
58,323

62,263Bonus on Billings (2)
32,402

30,357Bonus on Specific Product Lines Objectives (3)
12,961

7,904Tier-1 Operator Objectives Discretionary Bonus (4)
12,961

9,504Corporate EBITDA Bonus
12,961

6,535TOTAL
129,608

116,563


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  (1)
The amount of bonus for the attainment of the quarterly and annual contribution margin targets for the territory of the EMEA is based on the percentage of achievement from above 50% to 150% of the quarterly and annual contribution margin targets defined at the beginning of the financial year. An additional amount of bonus based on the percentage of attainment of the annual contribution margin target from 70% to 100% is also payable.
 (2)
The amount of bonus for the attainment of the billings targets for the territory of the EMEA is based on the percentage of achievement from above 50% to 150% of the quarterly and annual billings targets defined at the beginning of the financial year. An additional amount of bonus based on the percentage of attainment of one third (1/3) of the quarterly billings targets on a monthly basis from 80% to 100% is also payable. An additional amount of bonus based on the percentage of attainment of the annual billings targets from 80% to 100% is also payable.
 (3)
The amount of bonus for the attainment of the specific product lines bookings targets for the territory of the EMEA is based on the percentage of achievement from above 50% to 200% of the annual bookings targets of the specific product lines defined at the beginning of the financial year.
 (4)
The amount of bonus for the attainment of the selected tier-1 operators’ revenue progression for the territory of the EMEA is defined at the beginning of the financial year and is payable on a discretionary basis.
 Lee Huat (Joseph) Soo, Vice-President Sales — Asia-Pacific (APAC)Business Performance Measure
Incentive Target (US$)
Result (US$)Contribution Margin Bonus (1)
54,971

31,620Bonus on Billings (2)
30,539

26,783Bonus on Specific Product Lines Objectives (3)
12,216

8,517Tier-1 Territories Objectives Discretionary Bonus (4)
12,216

8,246Corporate EBITDA Bonus
12,216

6,159TOTAL
122,158

81,325





(1)
The amount of bonus for the attainment of the quarterly and annual contribution margin targets for the territory of the APAC is based on the percentage of achievement from above 50% to 150% of the quarterly and annual contribution margin targets defined at the beginning of the financial year. An additional amount of bonus based on the percentage of attainment of the annual contribution margin target from 70% to 100% is also payable.


(2)
The amount of bonus for the attainment of the billings targets for the territory of the APAC is based on the percentage of achievement from above 50% to 150% of the quarterly and annual billings targets defined at the beginning of the financial year. An additional amount of bonus based on the percentage of attainment of one third (1/3) of the quarterly billings targets on a monthly basis from 80% to 100% is also payable. An additional amount of bonus based on the percentage of attainment of the annual billings targets from 80% to 100% is also payable.


(3)
The amount of bonus for the attainment of the specific product lines bookings targets for the territory of the APAC is based on the percentage of achievement from above 50% to 200% of the annual bookings targets of the specific product lines defined at the beginning of the financial year.


(4)
The amount of bonus for the attainment of the selected tier-1 territories’ revenue progression for the territory of the APAC is defined at the beginning of the financial year and is payable on a discretionary basis.




Dana Yearian, Vice-President Sales — AmericasBusiness Performance Measure
Incentive Target (US$)
Result (US$)Contribution Margin Bonus (1)
89,570

65,348Bonus on Billings (2)
49,760

41,050Bonus on Specific Product Lines Objectives (3)
24,880

18,175Tier-1 Operator Objectives Discretionary Bonus (4)
14,928

5,971Corporate EBITDA Bonus
19,904

10,035TOTAL
199,042

140,579


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 (1)
The amount of bonus for the attainment of the quarterly and annual contribution margin targets for the territory of the Americas is based on the percentage of achievement from above 50% to 150% of the quarterly and annual contribution margin targets defined at the beginning of the financial year. An additional amount of bonus based on the percentage of attainment of the annual contribution margin target from 70% to 100% is also payable.
 (2)
The amount of bonus for the attainment of the billings targets for the territory of the Americas is based on the percentage of achievement from above 50% to 150% of the quarterly and annual billings targets defined at the beginning of the financial year. An additional amount of bonus based on the percentage of attainment of one third (1/3) of the quarterly billings targets on a monthly basis from 80% to 100% is also payable. An additional amount of bonus based on the percentage of attainment of the annual billings targets from 80% to 100% is also payable.
 (3)
The amount of bonus for the attainment of the specific product lines bookings targets for the territory of the Americas is based on the percentage of achievement from above 50% to 200% of the annual bookings targets of the specific product lines defined at the beginning of the financial year.
 (4)
The amount of bonus for the attainment of the selected tier-1 operators’ revenue progression for the territory of the Americas is defined at the beginning of the financial year and is payable on a discretionary basis.


Long-Term Incentive Compensation


●
Long-Term Incentive Plan




The principal component of the long-term incentive compensation offered by the Corporation is made up of the Long-Term Incentive Plan (the “LTIP”) for directors, officers,employees and consultants of the Corporation and its subsidiaries.




Introduced in May 2000, amended in October 2004 and effective as of January 2005, the LTIP is designed to provide directors, officers, employees and consultants with an incentive to create value and accordingly ensures that their interests are aligned with those of the Corporation’s shareholders and to further attract, motivate and retain all of its employees, including the NEOs with the exception of the CEO who as of August 31, 2012 is no longer participating. The LTIP is subject to review by the Human Resources Committee to ensure maintenance of its market competitiveness. The Board of Directors has full and complete authority to interpret the LTIP and to establish the rules and regulations applying to it and to make all other determinations it deems necessary or useful for the administration of the LTIP, provided that such interpretations, rules, regulations and determinations are consistent with the rules of all stock exchanges on which the securities of the Corporation are then traded and with all applicable securities legislation and regulations.




The LTIP provides for the issuance of options to purchase Subordinate Voting Shares and the issuance of Restricted Share Units (“RSUs”) redeemable for actual Subordinate Voting Shares or the equivalent in cash to participating directors, officers, employees and consultants. The Board of Directors, upon recommendation from the Human Resources Committee, designates the recipients of options or RSUs and determines the number of Subordinate Voting Shares covered by each option or RSU, the dates of vesting, the expiry date and any other conditions relating to these options or RSUs, in each case in accordance with the applicable legislation of the securities regulatory authorities. During the financial year ended August 31, 2014, target awards for eligible officers under the LTIP were established to be in line with the objective of the Human Resources Committee to align compensation with the Target Compensation Positioning offered in the reference market. Each NEO, with the exception of the CEO since the end of the financial year ended August 31, 2013, is entitled to receive annually RSUs in accordance with the following policy:




Name & Position
Grant Levels (1)(% of previous year base salary)Pierre Plamondon, Vice-President, Finance and CFO
42.5%Jon Bradley, Vice-President, Sales ─ EMEA
42.5%Lee Huat (Joseph) Soo, Vice-President, Sales ─ Asia-Pacific
32.5%Dana Yearian, Vice-President, Sales ─ Americas
42.5%


(1)
Actual grant value may differ from the grant level guidelines as the stock price may vary between the time of the grant and its approval.


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RSU awards are based on the expected impact of the role of the executive officer on the Corporation’s performance and strategic development as well as market benchmarking. The Human Resources Committee undertakes an analysis from time to time to determine the possible payouts from the LTIP under various scenarios and at various levels of share price growth to ensure that the LTIP is aligned with the interests of the Corporation’s shareholders.




RSUs are also used to attract and retain top executives, as well as in business acquisitions. For the year ended August 31, 2014, the Corporation determined the number of RSUs granted to each executive officer according to their individual contribution, specifically with respect to additional responsibilities as the case may be. As disclosed under the section “Summary Compensation Table” hereof, all of the NEOs, with the exception of the CEO as described earlier, were granted RSUs during the last financial year. The purpose of the grants was to focus the executives on developing and successfully implementing the continuing growth strategy of the Corporation and to align the executives with the principles of sustained long-term shareholder value growth. The grants were also considered to contribute to the Corporation’s objective to align the compensation of the executives with the reference market. The Corporation did not take into account the amount and terms of outstanding options or RSUs or the restrictions on resale of such units, when determining the grants mentioned above.




The exercise price of the options is determined by the Board of Directors at the time of granting the options, subject to compliance with the rules of all stock exchanges on which the Subordinate Voting Shares are listed and with all applicable securities legislation and regulation. In any event, the exercise price may not be lower than the highest of the closing prices of the Subordinate Voting Shares on the Toronto Stock Exchange and the NASDAQ National Market on the last trading day preceding the grant date, using the noon buying rate of the Federal Reserve Bank of New York (for grants of options prior to January 1, 2009) or the Bank of Canada (for grants of options on or after January 1, 2009) on the grant date to convert either the NASDAQ National Market closing price to Canadian dollars or the Toronto Stock Exchange closing price to United States dollars. Any option issued is non-transferable. As at August 31, 2014, there were a total of 87,454 options granted to all LTIP participants and outstanding pursuant to the LTIP having a weighted average exercise price of US$4.62 (CA$5.65) per option.




The fair value at the time of grant of an RSU is equal to the market value of Subordinate Voting Shares at the time the RSU is granted. The grant date market value is equal to the highest of the closing prices of the Subordinate Voting Shares on the Toronto Stock Exchange and the NASDAQ National Market on the last trading day preceding the grant date, using the noon buying rate of the Federal Reserve Bank of New York (for grants of RSUs prior to January 1, 2009) or the Bank of Canada (for grants of RSUs on or after January 1, 2009) on the grant date to convert either the NASDAQ National Market closing price to Canadian dollars or the Toronto Stock Exchange closing price to United States dollars. At the end of financial year ended August 31, 2014, there were a total of 1,225,135 RSUs granted and outstanding pursuant to the LTIP having a weighted average fair value at the time of grant of US$5.46 (CA$5.58) per RSU.




The maximum number of Subordinate Voting Shares that are issuable under the LTIP shall not exceed 6,306,153 Subordinate Voting Shares, which represents 10.4% of the Corporation’s issued and outstanding voting shares as of November 1, 2014. The maximum number of Subordinate Voting Shares that may be granted to any one individual shall not exceed 5% of the number of outstanding Subordinate Voting Shares, which represents 1,436,369 issued and outstanding Subordinate Voting Shares as of November 1, 2014.




Some options granted to directors and employees vest on the first anniversary date of their grant. Some options granted in the financial years ended August 31, 2004 and 2005 vested at a rate of 12.5% six (6) months after the date of grant, 12.5% twelve (12) months after the date of grant and 25% annually thereafter commencing on the second anniversary date of the grant in October 2005. Otherwise all options vest at a rate of 25% annually commencing on the first anniversary date of the grant. All options may be exercised in whole or in part once vested. All of the options that are granted under the LTIP must be exercised within a maximum period of ten (10) years following the date of their grant or they will be forfeited.







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The vesting dates of RSUs are subject to a minimum term of three (3) years and a maximum term of ten (10) years from the award date. The following table presents, for the last five (5) financial years, the RSUs granted and their respective vesting schedule.




Financial

year ended
Grant Date
RSUs

granted

(#)
Fair Value

at the Time

of Grant

(US$/RSU)
Vesting scheduleAugust 31, 2014
October 16, 2013
36,950

5.28
50% on each of the third and fourth anniversary dates of the grant.January 15, 2014
132,000

4.36July 3, 2014
29,502

4.77October 16, 2013
138,233

5.28
100% on the fifth anniversary date of the grant subject to early vesting of up to 1/3 on the third anniversary date of the grant and up to 50% of the remaining units on the fourth anniversary date of the grant if performance objectives namely related to long-term growth of revenue and profitability, as determined by the Board of Directors of the Corporation, are fully attained.August 31, 2013
October 16, 2012
30,006

5.06
50% on each of the third and fourth anniversary dates of the grant.January 16, 2013
145,750

5.61October 16, 2012
140,404

5.06
100% on the fifth anniversary date of the grant subject to early vesting of up to 1/3 on the third anniversary date of the grant and up to 50% of the remaining units on the fourth anniversary date of the grant if performance objectives namely related to long-term growth of revenue and profitability, as determined by the Board of Directors of the Corporation, are fully attained.August 31, 2012
October 18, 2011
23,000

5.43
50% on each of the third and fourth anniversary dates of the grant.January 17, 2012
8,321

6.61January 18, 2012
122,000

6.47January 23, 2012
7,576

6.55April 3, 2012
2,571

7.06October 18, 2011
163,651

5.43
100% on the fifth anniversary date of the grant subject to early vesting of up to 1/3 on the third anniversary date of the grant and up to 50% of the remaining units on the fourth anniversary date of the grant if performance objectives namely related to long-term growth of revenue and profitability, as determined by the Board of Directors of the Corporation are fully attained.January 23, 2012
6,330

6.55
100% on the fifth anniversary date of the grant subject to early vesting of up to 1/3 on the third anniversary date of the grant and up to 50% of the remaining units on the fourth anniversary date of the grant if performance objectives namely related to long-term growth of revenue and profitability, as determined by the Board of Directors of the Corporation are fully attained.April 3, 2012
1,429

7.06
100% on the fifth anniversary date of the grant subject to early vesting of up to 1/3 on the third anniversary date of the grant and up to 50% of the remaining units on the fourth anniversary date of the grant if performance objectives namely related to long-term growth of revenue and profitability, as determined by the Board of Directors of the Corporation are fully attained.August 31, 2011
October 19, 2010
30,250

6.03
50% on each of the third and fourth anniversary dates of the grant.January 19, 2011
119,900

9.32April 7, 2011
7,297

8.28April 18, 2011
8,226

8.64October 19, 2010
56,361

6.03
100% on the fifth anniversary date of the grant subject to early vesting of up to 100% on the third or fourth anniversary date of the grant when performance objectives related to revenue, as determined by the Board of Directors of the Corporation, are fully attained.
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   Financial

year ended
Grant Date
RSUs

granted

(#)
Fair Value

at the Time

of Grant

(US$/RSU)
Vesting schedule
 October 19, 2010
128,348

6.03
100% on the fifth anniversary date of the grant subject to early vesting of up to 1/3 on the third anniversary date of the grant and up to 50% of the remaining units on the fourth anniversary date of the grant if performance objectives namely related to long-term growth of revenue and profitability, as determined by the Board of Directors of the Corporation, are fully attained.August 31, 2010
October 20, 2009
36,500

3.74
50% on each of the third and fourth anniversary dates of the grant.January 19, 2010
130,000

5.13April 7, 2010
37,900

5.68April 7, 2010
6,155

5.68
1/3 on the third, fourth and fifth anniversary dates of the grant.July 7, 2010
3,759

5.32October 20, 2009
174,686

3.74
100% on the fifth anniversary date of the grant subject to early vesting of up to 1/3 on the third anniversary date of the grant and up to 50% of the remaining units on the fourth anniversary date of the grant if performance objectives namely related to long-term growth of revenue and profitability, as determined by the Board of Directors of the Corporation, are fully attained.April 7, 2010
7,575

5.68July 7, 2010
18,963

5.32




If any vesting dates fall into any black-out period or any other restrictive period during which the RSU holder is not entitled to trade the Corporation’s Subordinate Voting Shares, the RSUs shall: (i) vest on the fifth trading day the RSU holder is entitled to trade after such black-out period or restrictive period; or (ii) if the RSU holder decides, prior to such vesting date, to pay his/her income tax without using any of the Subordinate Voting Shares’ proceeds, then and only then, the vesting date shall remain the one determined on the granting date for such RSUs.




With the exceptions mentioned under the section entitled “termination and change of control”, any option granted pursuant to the LTIP will lapse: (i) immediately upon the termination of the relationship with the Corporation or one of its subsidiaries for a good and sufficient cause for employees or officers or at the date on which an employee or an officer resigns or leaves his employment with the Corporation or one of its subsidiaries (or within thirty (30) days if the holder’s employment is terminated for reasons not related to cause); and (ii) thirty (30) days after a director ceases to be a member of the Board of Directors of the Corporation or one of its subsidiaries. In the event of retirement or disability, any option held by an employee lapses thirty (30) days after the date of any such disability or retirement. In the event of death, any option held by the optionee lapses six (6) months after the date of death.




With the exceptions mentioned under the section entitled “termination and change of control”, any RSU granted pursuant to the LTIP will lapse: (i) immediately, where vesting of a unit is subject to the attainment of performance objectives, if such performance objectives have not been attained (or postponed at a further vesting date as determined by the Board of Directors); and (ii) immediately, whether or not subject to attainment of performance objectives, upon the termination of the relationship with the Corporation or one of its subsidiaries for a good and sufficient cause for employees or officers or at the date on which an employee or an officer resigns or leaves his employment with the Corporation or one of its subsidiaries.




Any RSU granted pursuant to the LTIP will vest immediately, to a certain proportion as determined by the LTIP, upon the termination of the relationship of an employee or officer with the Corporation or one of its subsidiaries: (i) for reasons not related to cause; (ii) because of death or permanent disability; and (iii) retirement.







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●
Restricted Share Unit Grants in Last Financial Year


The aggregate number of RSUs granted during the financial year ended August 31, 2014 was 336,685 having a weighted average fair value at the time of grant of US$4.87 (CA$5.15) per RSU. The fair value at the time of grant of a RSU is equal to the market value of Subordinate Voting Shares at the time RSUs are granted. At August 31, 2014, there were a total of 1,225,135 RSUs granted and outstanding pursuant to the LTIP having a weighted average fair value at the time of grant of US$5.46 (CA$5.58) per RSU.




The RSUs may be redeemed for actual Subordinate Voting Shares or the equivalent in cash at the discretion of the Board of Directors of the Corporation on the vesting dates established by the Board of Directors of the Corporation at the time of grant in its sole discretion.




Therefore, the value at vesting of a RSU, when converted to Subordinate Voting Shares, is equivalent to the market value of a Subordinate Voting Share at the time the conversion takes place and is taxable as employment income. The table above shows information regarding RSU grants made under the LTIP during the financial year ended August 31, 2014.




During the financial year ended August 31, 2014, the following RSUs were granted to the following NEOs:




Name
RSUs

granted

(#)
Percentage of Total

RSUs Granted to

Employees in

Financial Year (%) (1)
Fair Value

at the Time

of Grant

(US$/RSU) (2)
Grant Date
Vesting schedule (3)Pierre Plamondon
19,839
5.89%
5.28
October 16, 2013
100% on the fifth anniversary date of the grant subject to early vesting up to 1/3 on the third anniversary date of the grant and up to 50% of the remaining units on the fourth anniversary date of the grant if performance objectives namely related to long-term growth of revenue and profitability, as determined by the Board of Directors of the Corporation are fully attained. (4)Jon Bradley
14,100
4.19%
5.28
October 16, 2013
100% on the fifth anniversary date of the grant subject to early vesting up to 1/3 on the third anniversary date of the grant and up to 50% of the remaining units on the fourth anniversary date of the grant if performance objectives namely related to long-term growth of revenue and profitability, as determined by the Board of Directors of the Corporation are fully attained. (4)Lee Huat (Joseph) Soo
12,958
3.85%
5.28
October 16, 2013
100% on the fifth anniversary date of the grant subject to early vesting up to 1/3 on the third anniversary date of the grant and up to 50% of the remaining units on the fourth anniversary date of the grant if performance objectives namely related to long-term growth of revenue and profitability, as determined by the Board of Directors of the Corporation are fully attained. (4)Dana Yearian
17,676
5.25%
5.28
October 16, 2013
100% on the fifth anniversary date of the grant subject to early vesting up to 1/3 on the third anniversary date of the grant and up to 50% of the remaining units on the fourth anniversary date of the grant if performance objectives namely related to long-term growth of revenue and profitability, as determined by the Board of Directors of the Corporation are fully attained. (4)
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(1)
Such percentage does not include any cancelled RSUs.


(2)
The fair value at the time of grant of a RSU is equal to the market value of Subordinate Voting Shares at the time RSUs are granted. The grant date market value is equal to the highest of the closing prices of the Subordinate Voting Shares on the Toronto Stock Exchange and the NASDAQ National Market on the last trading day preceding the grant date, using the noon buying rate of the Bank of Canada on the grant date to convert either the NASDAQ National Market closing price to Canadian dollars or the Toronto Stock Exchange closing price to United States dollars as required.


(3)
All RSUs first vesting cannot be earlier than the third anniversary date of their grant.


(4)
Those RSUs granted in the financial year ended August 31, 2014 vest on the fifth anniversary date of the grant but are subject to early vesting on the third and fourth anniversary date of the grant on the attainment of performance objectives, as determined by the Board of Directors of the Corporation. Accordingly, subject to the attainment of performance objectives, the first early vesting is up to 1/3 of the units on the third anniversary date of the grant and the second early vesting is up to 50% of the remaining units on the fourth anniversary date of the grant. The early vesting shall be subject to the attainment of performance objectives. Such performance objectives are based on the attainment of a sales growth metric combined with profitability metric. The sales growth metric is determined by the Compound Annual Growth Rate of sales of the Corporation for the period described below (SALES CAGR). The profitability metric is determined as the Cumulative Corporation’s IFRS net earnings before interest, income taxes, depreciation of property, plant and equipment, amortization of intangible assets, foreign exchange gain or loss, change in fair value of cash contingent consideration, and extraordinary gain or loss over the Cumulative Sales for the same period (LTIP EBITDA). Accordingly, the first early vesting performance objectives will be attained, calculated on a pro-rated basis as follows: i) 100% for a SALES CAGR of 20% or more and 0% for a SALES CAGR of 5% or less for the three-year period ending on August 31, 2016; cumulated with ii) 100% for a LTIP EBITDA of 15% and 0% for a LTIP EBITDA of 7.5% or less for the three-year period ending on August 31, 2016. The second early vesting performance objectives will be attained on the same premises as described above but for the four-year period ending on August 31, 2017.




The following table summarizes information about RSUs granted to the members of the Board of Directors and to Management and Corporate Officers of the Corporation and its subsidiaries as at August 31, 2014:




Number of

RSUs (#)
% of Issued and

Outstanding RSUs
Weighted Average Fair Value at

the Time of Grant ($US/RSU)President and CEO (one (1) individual)
140,150

11.44%

5.11Board of Directors (five (5) individuals)
–

–

–Management and Corporate Officers (ten (10) individuals)
551,953

45.05%

5.32


●
Option Grants in Last Financial Year




There were no options to purchase the Corporation’s Subordinate Voting Shares granted during the financial year ended August 31, 2014. As at August 31, 2014, there were a total of 87,454 Subordinate Voting Shares covered by options granted and outstanding pursuant to the LTIP having a weighted average exercise price of US$4.62 (CA$5.65) per option.




The following table summarizes information about stock options granted to the members of the Board of Directors and to Management and Corporate Officers of the Corporation and its subsidiaries as at August 31, 2014:




Number of

Options (#)
% of Issued and

Outstanding Options
Weighted Average Exercise Price

($US/Security)President and CEO (one (1) individual)
29,160

33.34%

4.61Board of Directors (five (5) individuals)
‒

‒

‒Management and Corporate Officers (two (2) individuals)
14,494

16.57%

4.98


●
Deferred Share Unit Plan


Introduced in October 2004 and effective as of January 2005, the Corporation’s DSU plan (the “Deferred Share Unit Plan”) is designed to align more closely the interests of the Corporation’s non-employee directors with those of its shareholders.







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Under the Deferred Share Unit Plan, non-employee directors may elect to receive up to 100% of their retainer fees in the form of DSUs, each of which has an estimated value determined based on the highest of the closing prices of the Subordinate Voting Shares on the Toronto Stock Exchange and the NASDAQ National Market on the last trading day preceding the grant date, using the noon buying rate of the Federal Reserve Bank of New York (for grants of DSUs prior to January 1, 2009) or the Bank of Canada (for grants of DSUs on or after January 1, 2009) on the grant date to convert either the NASDAQ National Market closing price to Canadian dollars or the Toronto Stock Exchange closing price to United States dollars, as required. The value at vesting of a DSU is equivalent to the market value of a Subordinate Voting Share when a DSU is converted to such Subordinate Voting Share. DSUs attract dividends in the form of additional DSUs at the same rate as dividends on Subordinate Voting Share. When a director ceases to be a member of the Board of Directors, the DSUs are converted and paid in Subordinate Voting Shares that are either purchased on the open market or issued by the Corporation. Such Subordinate Voting Shares issued by the Corporation will be issued from the same pool of Subordinate Voting Shares reserved for issuance pursuant to the LTIP, which is 10.4% of the total issued and outstanding voting shares.


●
Deferred Share Unit Grants in Last Financial Year


The aggregate number of DSUs credited to non-employee directors during the financial year ended August 31, 2014 was 35,803. The estimated value at the time of grant of a DSU is determined based on the highest of the closing prices of the Subordinate Voting Shares on the Toronto Stock Exchange and the NASDAQ National Market on the last trading day preceding the grant date, using the noon buying rate of the Federal Reserve Bank of New York (for grants of DSUs prior to January 1, 2009) or the Bank of Canada (for grants of DSUs on or after January 1, 2009) on the grant date to convert either the NASDAQ National Market closing price to Canadian dollars or the Toronto Stock Exchange closing price to United States dollars, as required. The value at vesting of a DSU is equivalent to the market value of the Subordinate Voting Shares when a DSU is converted to such Subordinate Voting Shares. As at August 31, 2014, there were a total of 117,701 DSUs credited and outstanding pursuant to the Deferred Share Unit Plan having a weighted average fair value at the time of grant of US$4.89 (CA$5.21).




During the financial year ended August 31, 2014, the following DSUs were granted to the non-employee members of the Board of Directors:


DSUs

granted (#)
Weighted Average Fair Value

at the Time of Grant (US$/DSU)
Total of the Fair Value

at the Time of Grant (US$)
Vesting35,803
4.59
164,336
At the time director ceases to be a member of the Board of Directors of the Corporation




The following table summarizes information about DSUs granted to the non-employee members of the Board of Directors as at November 1, 2014:




Number of

DSUs (#)
% of Issued and

Outstanding DSUs
Total of the Fair Value at

the Time of Grant (US$)
Weighted Average Fair Value

at the Time of Grant (US$/DSU)Board of Directors (five (5) individuals)
117,701
100%
575,558
4.89


●
Number of Subordinate Voting Shares Reserved for Future Issuance




During the financial year ended August 31, 2014, 35,803 DSUs and 336,685 RSUs were granted to directors, officers and employees. Such awards were issued from the pool of Subordinate Voting Shares reserved for issuance pursuant to the LTIP and the Deferred Share Unit Plan of which the maximum number of Subordinate Voting Shares issuable shall not exceed 6,306,153, which represents 10.4% of the Corporation’s issued and outstanding voting shares as at November 1, 2014. As at November 1, 2014, the number of Subordinate Voting Shares reserved for future issuance is 1,491,782 representing 2.5% of the Corporation’s issued and outstanding voting shares as at November 1, 2014.


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  ●
Stock Appreciation Rights Plan




On August 4, 2001, the Corporation established a Stock Appreciation Rights Plan (the “SAR Plan”), as amended on January 12, 2010, for the benefit of certain employees residing in countries where the granting of stock-based compensation under the LTIP is not feasible in the opinion of the Corporation. The Board of Directors has full and complete authority to interpret the SAR Plan and to establish the rules and regulations applying to it and to make all other determinations it deems necessary or useful for the administration of the SAR Plan.




Under the SAR Plan, eligible employees are entitled to receive a cash amount equivalent to the difference between the market price of the Subordinate Voting Shares on the date of exercise or the date of vesting and the exercise price determined on the date of grant. No Subordinate Voting Shares are issuable under the SAR Plan.




The Board of Directors has delegated to Management the task of designating the recipients of stock appreciation rights, the date of exercise or vesting, the expiry date and other conditions. Under the terms of the SAR Plan, the exercise price determined on the date of grant of the stock appreciation right is equal to zero (0) if the stock appreciation right is to reflect a RSU under the LTIP or, if the stock appreciation right is to reflect an option under the LTIP, the exercise price determined on the date of grant may not be lower than the highest of the closing prices of the Subordinate Voting Shares on the Toronto Stock Exchange and on the NASDAQ National Market on the last trading day preceding the grant date, using the noon buying rate of the Bank of Canada on the grant date to convert either the NASDAQ National Market closing price to Canadian dollars or the Toronto Stock Exchange closing price to United States dollars. Stock appreciation rights are non-transferable.




The stock appreciation rights, reflecting a RSU under the LTIP, vest at a rate of 50% annually commencing on the third anniversary date of the date of grants made in October 2010, October 2011, October 2012, January 2013, October 2013 and January 2014.




The stock appreciation rights, reflecting a RSU under the LTIP, will: i) lapse immediately upon the termination of the relationship with the Corporation or one (1) of its subsidiaries for a good and sufficient cause or at the date on which an employee resigns or leaves his employment with the Corporation or one (1) of its subsidiaries; and ii) vest immediately, to a certain proportion as determined by the SAR Plan, upon the termination without cause of the relationship of an employee with the Corporation or one (1) of its subsidiaries.




The stock appreciation rights, reflecting an option under the LTIP, vest over a four-year period, with 25% vesting annually commencing on the first anniversary date of the date of grant. However, since October 2007, some stock appreciation rights, representing an option under the LTIP, vest at a rate of 50% annually commencing on the third anniversary date of the grants made in October 2007, October 2008 and October 2009.




For stock appreciation rights, reflecting an option under the LTIP, once vested, such right may be exercised between the second and the fifteenth business day following each release of the Corporation’s quarterly financial results and will lapse immediately upon the termination of the relationship with the Corporation or one (1) of its subsidiaries for a good and sufficient cause or at the date on which an employee resigns or leaves his employment with the Corporation or one (1) of its subsidiaries (or within thirty (30) days if the holder is dismissed without cause). In the event of retirement or disability, any stock appreciation right held by an employee lapses thirty (30) days after the date of any such disability or retirement. In the event of death, any stock appreciation right lapses six (6) months after the date of death.




All of the stock appreciation rights that are granted under the SAR Plan may be exercised within a maximum period of ten (10) years following the date of their grant.




No Stock Appreciation Rights (“SARs”) were exercised during the financial year ended August 31, 2014.




During the financial year ended August 31, 2014, 7,150 SARs were granted to employees. As at August 31, 2014, there were 39,874 SARs outstanding.


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Benefits and Perquisites




Certain employees of the Corporation, including the NEOs, are eligible to participate in the Corporation’s benefits programs, which may include life insurance, extended health and dental coverage, short and long-term disability coverage, accidental death and dismemberment (AD&D) compensation and emergency travel assistance. Although the majority of costs of the benefits are paid by the Corporation, employees (including the NEOs) may also be required to contribute to obtain such benefits.




With the exception of car allowances that are provided to the Corporation’s CEO and Vice-Presidents of Sales, executive officers, including other NEOs, do not receive any perquisites. The value of the perquisites for each of the NEOs, if applicable, is less than CA$50,000 or 10% of total annual salary and bonus for the financial year and, as such, is not included in the table provided under the heading “Summary Compensation Table” and in the table provided under the heading “Termination and Change of Control Benefits”.




Deferred Profit-Sharing Plan




The Corporation maintains a deferred profit-sharing plan (the “DPSP”) for certain eligible Canadian resident employees, including NEOs but excluding the Corporation’s CEO, under which the Corporation may elect to match the employees’ contributions up to a maximum of 4% (3% prior to January 2014) of an employee’s gross salary, provided that the employee has contributed to a tax-deferred registered retirement savings plan. Cash contributions, for eligible employees to this plan, and expenses for the years ended August 31, 2012, 2013 and 2014 amounted to US$1,178,000, US$1,165,000 and US$1,451,000, respectively. The amounts contributed to the DPSP are invested at the employee’s will in the investment vehicles offered by Standard Life, the Corporation’s fund administrator. Withdrawals of funds from the DPSP account are not permitted. In the event of termination of the employment, if the employee has been a member of the DPSP for more than two (2) years, the employee is entitled to receive the funds accumulated in his DPSP account.




401K Plan




The Corporation maintains a 401K plan for eligible United States resident employees of its subsidiaries. Employees become eligible to participate in the 401K plan on the date they are hired. Under this plan, the Corporation must contribute an amount equal to 3% of an employee’s current compensation. In addition, employees may elect to defer their current compensation up to the lesser of 1% of eligible compensation or the statutorily prescribed annual limit and have the deferral contributed to the 401K plan. The 401K plan permits, but does not require the Corporation to make additional matching contributions to the 401K plan on behalf of the eligible participants, subject to a maximum of 50% of the first 6% of the participant’s current compensation subject to certain legislated maximum contribution limits. The Corporation contributes up to 3% of the participant’s current compensation, subject to certain legislated maximum contribution limits. In the years ended August 31, 2012, 2013 and 2014, the Corporation made aggregate contributions of US$693,000, US$632,000 and US$616,000 respectively, to the 401K plan. Contributions by participants or by the Corporation to the 401K plan and income earned on plan contributions are generally not taxable to the participant until withdrawn and contributions by the Corporation are generally deductible by the Corporation when made. At the direction of each participant, the trustees of the 401K plan invest the assets of the 401K plan in selected investment options.




2014 Performance and Compensation




Compensation for the NEOs is awarded through the Corporation’s executive compensation plan, which aligns compensation with key strategic objectives and individual performance. The Corporation has established Business Performance Measures outlining key performance indicators which are applicable to all employees. You will find more information on such indicators under the heading “Short-Term Incentive Compensation”. These performance indicators focus efforts, communicate priorities and enable performance to be benchmarked.


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The following table highlights the NEOs early vesting achievement in accordance with the Corporation’s LTIP:




Long-Term Incentive Plan (LTIP) - RSUsDate of Grant
Vesting Date
% of early vesting achievement (1)October 19, 2010
October 20, 2014
0%October 19, 2010
October 20, 2014
0%October 18, 2011
October 20, 2014
0%


(1)
The vesting schedules are provided in the table under the heading “Long-Term Incentive Plan”.




CEO Performance Compensation during Last Three (3) Financial Years




The following table compares the compensation awarded to Mr. Germain Lamonde in respect of his performance as CEO to the Total Market Capitalization Growth for the last three (3) financial years. The compensation includes base salary, short-term incentive payments, as well as long-term incentive payments at grant date pursuant to the LTIP.


Compensation Elements
2014
2013
2012
Three-Year TotalCashBase Salary
CA$557,767

CA$498,663

CA$441,000

CA$1,497,430Short-term incentive
CA$214,300

CA$185,866

CA$143,784

CA543,950EquityLong-term incentive
–

–

CA$294,001
(1)
CA$294,001
(1)Total Direct Compensation
CA$772,067

CA$684,529

CA$878,785

CA$2,335,381Pension Value
–

–

–

–All Other Compensation
–

–

–

–Total Compensation
CA$772,067

CA$684,529

CA$878,785

CA$2,335,381Annual Average
–

–

–

CA$778,460Total Market Capitalization Growth (CA$ millions)
(2.2)
(2)
2.1
(2)
(105.6)
(2)
(105.7)
(2)Total Cost as a % of Market Capitalization Growth
(35.6)%

32.1%

(0.8)%

(2.2)%


(1)
Indicates the dollar amount based on the grant date fair value of the RSUs awarded under the LTIP for the financial year. The grant date fair value is equal to the highest of the closing prices of the Subordinate Voting Shares on the Toronto Stock Exchange and the NASDAQ National Market on the last trading day preceding the grant date, using the noon buying rate of the Bank of Canada on the grant date to convert either the NASDAQ National Market closing price to Canadian dollars or the Toronto Stock Exchange closing price to United States dollars. Grants of RSUs to NEOs are detailed under section “Compensation Discussion and Analysis – Long-Term Incentive Plan”.


(2)
Includes the redemption of 438,894, 663,256 and 214,470 Subordinate Voting Shares respectively in financial years 2012, 2013 and 2014 under the normal course issuer bid of the Corporation during these years.




Conclusion




By way of application of the Corporation’s executive compensation policy, an important part of executive compensation is linked to corporate performance and long-term value creation. The Human Resources Committee continuously reviews executive compensation programs to ensure that they maintain their competitiveness and continue to focus on the Corporation’s objectives, values and business strategies.


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For the financial year ending August 31, 2013, we made a significant change to the CEO compensation structure. Following the evaluation of the share ownership of the CEO, it was decided by the Human Resources Committee that the CEO should no longer receive equity-based compensation within his compensation as the share ownership of the CEO has been determined to be sufficient and that equity-based compensation was no longer reasonably considered as an incentive to performance.




Depending on specific circumstances, the Human Resources Committee may also recommend employment terms and conditions that deviate from the policies and the execution by the Corporation or its subsidiaries of employment contracts on a case-by-case basis.




Summary Compensation Table




The table below shows compensation information during the three (3) most recently completed financial years for the NEOs. This information includes, as applicable, the Canadian, US and Singapore dollar and British pound value of base salaries, share-based and option-based awards, non-equity incentive plan compensations, pension value and all other compensation, if any, whether paid or deferred.




Name and

Principal Position
Financial

Year
Salary (1) (2)

($)
Share-Based

Awards (2) (3)

($)
Option-

based

Awards

($)
Non-equity incentive

plan compensation ($)
Pension

value

($)
All other

compensation

($) (2) (5)
Total

Compensation

($)Annual

Incentive

plans (2) (4)
Long-term

Incentive

plansGermain Lamonde,

President and CEO
2014
517,313

557,767
(US)

(CA)
─

─
(US)

(CA)
–
198,757

214,300
(US)

(CA)
–
–
–

716,070

772,067
(US)

(CA)2013
493,384

498,663
(US)

(CA)
─

─
(US)

(CA)
–
183,899

185,866
(US)

(CA)
–
–
–

677,283

684,529
(US)

(CA)2012
436,893

441,000
(US)

(CA)
291,263

294,001
(US)

(CA)
–
142,446

143,784
(US)

(CA)
–
–
–

870,602

878,785
(US)

(CA)Pierre Plamondon,

Vice-President,

Finance and CFO
2014
252,938

272,718
(US)

(CA)
100,465

108,321
(US)

(CA)
–
69,448

74,879
(US)

(CA)
–
–
11,667

12,579
(US)

(CA)
434,518

468,497
(US)

(CA)2013
252,673

255,377
(US)

(CA)
97,460

98,502
(US)

(CA)
–
58,709

59,337
(US)

(CA)
–
–
9,473

9,575
(US)

(CA)
418,315

422,791
(US)

(CA)2012
245,149

247,453
(US)

(CA)
94,743

95,634
(US)

(CA)
–
63,948

64,549
(US)

(CA)
–
–
9,431

9,519
(US)

(CA)
413,271

417,155
(US)

(CA)Jon Bradley,

Vice-President,

Sales — EMEA
2014
200,594

216,280

121,459
(US)

(CA)

(£)
71,402

76,986

45,740
(US)

(CA)

(£)
–
116,563

125,678

70,579
(US)

(CA)

(£)
–
–
–

388,559

418,944

237,778
(US)

(CA)

(£)2013
178,871

180,785

114,585
(US)

(CA)

(£)
69,560

70,304

44,560
(US)

(CA)

(£)
–
81,369

82,240

52,125
(US)

(CA)

(£)
–
–
–

329,800

333,329

211,270
(US)

(CA)

(£)2012
165,355

166,909

105,083
(US)

(CA)

(£)
61,549

62,128

39,114
(US)

(CA)

(£)
–
87,328

88,148

55,497
(US)

(CA)

(£)
–
–
–

314,232

317,185

199,694
(US)

(CA)

(£)





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Name and

Principal Position
Financial

Year
Salary (1) (2)

($)
Share-Based

Awards (2) (3)

($)
Option-

based

Awards

($)
Non-equity incentive

plan compensation ($)
Pension

value

($)
All other

compensation

($) (2) (5)
Total

Compensation

($)Annual

Incentive

plans (2) (4)
Long-term

Incentive

plansLee Huat (Joseph) Soo,

Vice-President,

Sales — Asia-Pacific
2014
224,908

242,495

282,529
(US)

(CA)

(SGD)
65,619

70,751

82,431
(US)

(CA)

(SGD)
–
81,325

87,684

102,160
(US)

(CA)

(SGD)
–
–
–

371,852

400,930

467,120
(US)

(CA)

(SGD)2013
215,672

217,980

267,800
(US)

(CA)

(SGD)
62,875

63,548

78,072
(US)

(CA)

(SGD)
–
76,926

77,749

95,520
(US)

(CA)

(SGD)
–
–
–

355,473

359,277

441,392
(US)

(CA)

(SGD)2012
153,894

155,340

195,000
(US) (6)

(CA)

(SGD)
55,232

55,751

69,984
(US)

(CA)

(SGD)
–
52,772

53,268

66,867
(US)

(CA)

(SGD)
–
–
–

261,898

264,359

331,851
(US)

(CA)

(SGD)Dana Yearian,

Vice-President,

Sales — Americas
2014
224,400

241,948
(US)

(CA)
93,329

100,627
(US)

(CA)
–
140,579

151,573
(US)

(CA)
–
–
7,049

7,601
(US)

(CA)
465,357

501,749
(US)

(CA)2013
219,596

221,946
(US)

(CA)
91,050

92,024
(US)

(CA)
–
134,529

135,968
(US)

(CA)
–
–
7,009

7,084
(US)

(CA)
452,184

457,022
(US)

(CA)2012
214,240

216,254
(US)

(CA)
83,198

83,980
(US)

(CA)
–
149,851

151,260
(US)

(CA)
–
–
7,293

7,361
(US)

(CA)
454,582

458,855
(US)

(CA)


(1)
Base salary earned in the financial year, regardless when paid.


(2)
The compensation information for Canadian residents has been converted from Canadian dollars to US dollars based upon an average foreign exchange rate of CA$1.0782 = US$1.00 for the financial year ended August 31, 2014, CA$1.0107 = US$1.00 for the financial year ended August 31, 2013 and CA$1.0094 = US$1.00 for the financial year ended August 31, 2012. The compensation information for UK resident has been converted from British Pounds to US dollars based upon an average foreign exchange rate of £0.6055 = US$1.00 for the financial year ended August 31, 2014, £0.6406 = US$1.00 for the financial year ended August 31, 2013 and £0.6355 = US$1.00 for the financial year ended August 31, 2012 and the conversion from US dollars to Canadian dollars is made as described above. The compensation information for Singapore resident has been converted from Singapore dollars to US dollars based upon an average foreign exchange rate of SGD1.2562 = US$1.00 for the financial year ended August 31, 2014, SGD1.2417 = US$1.00 for the financial year ended August 31, 2013 and SGD1.2671 = US$1.00 for the financial year ended August 31, 2012 and the conversion from US dollars to Canadian dollars is made as described above.


(3)
Indicates the dollar amount based on the grant date fair value of the RSUs awarded under the LTIP for the financial year. The grant date fair value is equal to the highest of the closing prices of the Subordinate Voting Shares on the Toronto Stock Exchange and the NASDAQ National Market on the last trading day preceding the grant date, using the noon buying rate of the Bank of Canada on the grant date to convert either the NASDAQ National Market closing price to Canadian dollars or the Toronto Stock Exchange closing price to United States dollars. Grants of RSUs to NEOs are detailed under section “Compensation Discussion and Analysis – Long-Term Incentive Plan”.


(4)
Indicates the total bonus earned during the financial year whether paid during the financial year or payable on a later date:




Name
Paid during the

financial year ended

August 31, 2014 (i)

($)
Paid in the first quarter

of the financial year

ending on August 31, 2015 (i)

($)
Total bonus earned during

the financial year

ended August 31, 2014 (i)

($)Germain Lamonde
149,643

161,345
(US)

(CA)
49,114

52,955
(US)

(CA)
198,757

214,300
(US)

(CA)Pierre Plamondon
45,026

48,547
(US)

(CA)
24,422

26,332
(US)

(CA)
69,448

74,879
(US)

(CA)Jon Bradley
67,941

73,254

41,138
(US)

(CA)

(£)
48,622

52,424

29,441
(US)

(CA)

(£)
116,563

125,678

70,579
(US)

(CA)

(£)Lee Huat (Joseph) Soo
38,987

42,035

48,975
(US)

(CA)

(SGD)
42,338

45,649

53,185
(US)

(CA)

(SGD)
81,325

87,684

102,160
(US)

(CA)

(SGD)Dana Yearian
67,746

73,044
(US)

(CA)
72,833

78,529
(US)

(CA)
140,579

151,573
(US)

(CA)


(i)
Refer to note 2 above.




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(5)
Indicates the amount contributed by the Corporation during the financial year to the DPSP as detailed under section “Compensation Discussion and Analysis – Deferred Profit-Sharing Plan”, the 401K plan as detailed under section “Compensation Discussion and Analysis – 401K Plan”, as applicable, for the benefit of the NEOs. Mr. Lamonde is not eligible to participate in the DPSP and Mr. Bradley and Mr. Soo did not participate.


(6)
This amount represents the salary paid to Mr. Lee Huat (Joseph) Soo from January 17, 2012 until August 31, 2012 which is based on an annual salary amounted to US$205,193 (CA$207,122) (SGD260,000) for the financial year ended August 31, 2012.




Incentive Plan Awards




The significant terms of all plan-based awards and non-equity incentive plan awards, issued or vested, or under which options have been exercised, during the financial year, or outstanding at the end of the financial year are described herein under the section entitled “Compensation Discussion and Analysis – Long-Term Incentive Plan” and “Compensation Discussion and Analysis – Short Term Incentive Compensation”.




Outstanding Share-Based Awards and Option-Based Awards




The following sets out for each NEO all option and RSU awards outstanding as at August 31, 2014, if any, including those granted before August 31, 2014.





Name
Outstanding Option-based Awards (Options)
Outstanding Share-based Awards (RSUs)Number of

securities

underlying

unexercised

options

(#)
Option

Exercise

Price (1)
Option

expiration

date
Value (2) of

unexercised

“in-the-money”

options (3)
Number of

shares

or units of

shares

that have not

vested (#)
Market or

payout value of

share-based

awards that

have not vested

(US$) (4)
Market or

payout value of

vested share-

based awards

not paid out or

distributed

(US$)Germain Lamonde
17,942

4.51

5.60
(US)

(CA)
Feb. 1, 2015
–

–
140,150

616,660
–11,218

4.76

5.50
(US)

(CA)
Dec. 6, 2015
–

–Pierre Plamondon
5,383

5.13

6.28
(US)

(CA)
Oct. 26, 2014
–

–
89,385

393,294
–3,653

4.76

5.50
(US)

(CA)
Dec. 6, 2015
–

–Jon Bradley
–

–

–
–
63,285

278,454
–Lee Huat (Joseph) Soo
–

–

–
–
34,014

149,662
–Dana Yearian
–

–

–
–
81,085

356,774
–





(1)
These options were granted in Canadian dollars. The exercise price was calculated by using the highest of the closing prices of the Subordinate Voting Shares on the Toronto Stock Exchange and on the NASDAQ National Market on the business day preceding the grant date using the noon buying rate of the Bank of Canada to convert either the NASDAQ National Market closing price to Canadian dollars or the Toronto Stock Exchange closing price to United States dollars on the grant date.


(2)
The unexercised options have not been and may never be exercised and actual gains if any, on exercise will depend on the value of the Subordinate Voting Shares on the date of exercise. There can be no assurance that these options will be exercised or any gain realized.


(3)
Indicates an aggregate value of “in-the-money” unexercised options held at the financial year ended August 31, 2014. “in-the-money” options are options for which the market value of the underlying securities is higher than the exercise price. The value of unexercised “in-the-money” options at financial year end is the difference between its exercise or base price and the market value of the underlying Subordinate Voting Share at August 31, 2014, which was US$4.40 (CA$4.78). The market value of the Subordinate Voting Shares was calculated by using the highest of the closing prices of the Subordinate Voting Shares on the Toronto Stock Exchange and on the NASDAQ National Market on August 29, 2014 using the noon buying rate of the Bank of Canada to convert either the NASDAQ National Market closing price to Canadian dollars or the Toronto Stock Exchange closing price to United States dollars as required. For a Canadian resident, the value of unexercised “in-the-money” options is calculated using the option exercise price and the market value of the subordinate voting shares on the Toronto Stock Exchange in Canadian dollars.








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   (4)
The value of unvested RSUs at the financial year-end is the market value of the Subordinate Voting Shares on August 31, 2014, which was US$4.40 (CA$4.78). The market value of the Subordinate Voting Shares was calculated by using the highest of the closing prices of the Subordinate Voting Shares on the Toronto Stock Exchange and on the NASDAQ National Market on August 29, 2014 using the noon buying rate of the Bank of Canada to convert either the NASDAQ National Market closing price to Canadian dollars or the Toronto Stock Exchange closing price to United States dollars as required. The actual gains on vesting will depend on the value of the Subordinate Voting Shares on the date of vesting. There can be no assurance that these values will be realized.





Exercised Option-Based Awards




No stock options were exercised during the financial year ended August 31, 2014 by the NEOs having outstanding option-based awards of the Corporation.




Incentive Plan Awards – Value Vested or Earned during the Year




The following table summarizes, for each of the NEOs, the value of share-based awards vested during the financial year ended August 31, 2014, if any, and the value of non-equity incentive plan compensation earned during the financial year ended August 31, 2014, if any. In the financial year that ended August 31, 2014, all of the options granted to an NEO were exercisable.





Name
Share-based awards – value

vested during the year (US$) (1)
Non-equity incentive plan compensation –

Value earned during the year (US$) (2)Germain Lamonde
327,629

198,757Pierre Plamondon
224,612

69,448Jon Bradley
211,481

116,563Lee Huat (Joseph) Soo
‒

81,325Dana Yearian
245,784

140,579





(1)
The aggregate dollar value realized is equivalent to the market value of the Subordinate Voting Shares underlying the RSUs at vesting. This value, as the case may be, has been converted from Canadian dollars to US dollars based upon the noon buying rate of the Bank of Canada on the day of vesting.


(2)
Includes total non-equity incentive plan compensation earned by each NEO in respect to the financial year ended on August 31, 2014 (as indicated under the “Summary Compensation Table”).




Pension Plan Benefits




The Corporation does not have a defined benefit pension plan. The significant terms of the DPSP and the 401K plan of the Corporation are described herein under the sections entitled “Compensation Discussion and Analysis – Deferred Profit-Sharing Plan” and “Compensation Discussion and Analysis – 401K Plan”. The amounts paid by the Corporation to the NEOs under such plans are detailed in the column entitled “All other compensation” in the “Summary Compensation Table”.




Termination and Change of Control Benefits




The Corporation has an employment agreement with Mr. Germain Lamonde. The agreement is for an indeterminate period and compensation is reviewed annually. In the event of the termination of Mr. Lamonde’s employment without cause, Mr. Lamonde will be entitled to a severance payment equal to twenty-four (24) months of his current rate of remuneration (base salary, STIP compensation and benefits) and the immediate vesting of all stock options and RSUs. In addition, in the event that Mr. Lamonde’s employment is terminated following a merger or an acquisition by a third party of substantially all of the Corporation’s assets or of the majority of its share capital, he will be entitled to a severance payment equal to twenty-four (24) months of his current rate of remuneration (base salary, STIP compensation and benefits) and to the immediate vesting of all stock options and RSUs. If Mr. Lamonde voluntarily resigns he will be entitled to immediate vesting of all stock options and RSUs.


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The Corporation has an employment agreement with Mr. Pierre Plamondon, the Corporation’s Vice-President, Finance and Chief Financial Officer. The agreement is for an indeterminate period and compensation is reviewed annually. In the event of termination of Mr. Plamondon’s employment without cause, Mr. Plamondon will be entitled to a severance payment equal to twelve (12) months of his current base salary. In addition, in the event Mr. Plamondon’s employment is terminated following a merger or an acquisition by a third party of substantially all of the Corporation’s assets or of the majority of its share capital, he will be entitled to a severance payment equal to eighteen (18) months of his current rate of remuneration (base salary, STIP compensation and benefits) and to the immediate vesting of all stock options and RSUs.




The Corporation has an employment agreement with Mr. Jon Bradley, the Corporation’s Vice-President, Sales — EMEA. The agreement is for an indeterminate period and compensation is reviewed annually. In the event of termination of Mr. Bradley’s employment without cause, Mr. Bradley will be entitled to severance payments equal to two (2) months of his current base salary per year of service as a Vice-President of the Corporation but in no case exceeding twelve (12) months. In addition, in the event Mr. Bradley’s employment is terminated following a merger or an acquisition by a third party of substantially all of the Corporation’s assets or of the majority of its share capital, he will be entitled to severance payments equal to two (2) months of his current rate of remuneration (base salary, SIP compensation and benefits) per year of service as a Vice-President of the Corporation but in no case exceeding eighteen (18) months of remuneration and to the immediate vesting of all RSUs.




The Corporation has an employment agreement with Mr. Lee Huat (Joseph) Soo, the Corporation’s Vice-President, Sales — Asia-Pacific. The agreement is for an indeterminate period and compensation is reviewed annually. In the event of termination of Mr. Soo’s employment without cause, Mr. Soo will be entitled to severance payments equal to two (2) months of his current base salary per year of service as a Vice-President of the Corporation but in no case exceeding twelve (12) months. In addition, in the event Mr. Soo’s employment is terminated following a merger or an acquisition by a third party of substantially all of the Corporation’s assets or of the majority of its share capital, he will be entitled to severance payments equal to two (2) months of his current rate of remuneration (base salary, SIP compensation and benefits) per year of service as a Vice-President of the Corporation but in no case exceeding eighteen (18) months of remuneration and to the immediate vesting of all RSUs.




The Corporation has an employment agreement with Mr. Dana Yearian, the Corporation’s Vice-President, Sales — Americas. The agreement is for an indeterminate period and compensation is reviewed annually. In the event of termination of Mr. Yearian’s employment without cause, Mr. Yearian will be entitled to a severance payment equal to twelve (12) months of his current base salary. In addition, in the event Mr. Yearian’s employment is terminated following a merger or an acquisition by a third party of substantially all of the Corporation’s assets or of the majority of its share capital, he will be entitled to a severance payment equal to eighteen (18) months of his current rate of remuneration (base salary, SIP compensation and benefits) and to the immediate vesting of all stock options and RSUs.




The following table outlines the estimated incremental payments NEOs would be entitled to receive if a termination payment event occurred on August 31, 2014, which includes all payments, payables and benefits that would be given by the Corporation to a NEO upon such termination payment event.





Named Executive Officer
Termination Payment EventWithout Cause ($) (1) (2)
Change of Control ($) (2) (3) (4)
Voluntary ($)Germain Lamonde
2,019,084

2,157,183
(US) (5)

(CA)
2,019,084

2,157,183
(US)

(CA)
616,660

669,917
(US) (6)

(CA)Pierre Plamondon
464,402

502,445
(US)

(CA)
860,765

925,343
(US)

(CA)
–Jon Bradley
345,112

373,319

208,965
(US)

(CA)

(£)
601,702

644,621

367,663
(US)

(CA)

(£)
–





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 Table of Contents





Named Executive Officer
Termination Payment EventWithout Cause ($) (1) (2)
Change of Control ($) (2) (3) (4)
Voluntary ($)Lee Huat (Joseph) Soo
133,859

144,807

141,055
(US)

(CA)

(SGD)
250,278

269,340

314,010
(US)

(CA)

(SGD)
–Dana Yearian
417,270

451,475
(US)

(CA)
895,168

954,460
(US)

(CA)
–


(1)
The aggregate amount disclosed includes an evaluation of the amount that the NEO would have been entitled to should a termination of employment without cause have occurred on August 31, 2014 and includes, as the case may be for each NEO, the base salary that would have been received and total value of RSUs and options that would have vested (with the exception of Mr. Lamonde’s evaluation which is described in note 6 below and includes: the base salary, STIP compensation, and total value of RSUs and options that would have vested). The amount for base salary compensation is calculated according to those amounts provided under the section entitled “Summary Compensation Table” included in this Annual Report. The amount for the total value attached to the vesting of RSUs and options determined pursuant to the LTIP as described in the section entitled “Long-Term Incentive Compensation – Long-Term Incentive Plan”for termination without cause.
 (2)
The aggregate amount for Canadian residents has been converted from Canadian dollars to US dollars based upon an average foreign exchange rate of CA$1.0782 = US$1.00 for the financial year ended August 31, 2014. The aggregate amount for UK resident has been converted from British Pounds to US dollars based upon an average foreign exchange rate of £0.6055 = US$1.00 for the financial year ended August 31, 2014. The aggregate amount for Singapore resident has been converted from Singapore dollars to US dollars based upon an average foreign exchange rate of SGD1.2562 = US$1.00 for the financial year ended August 31, 2014.
 (3)
“Change of Control” is defined as a merger or an acquisition by a third party of substantially all of the Corporation’s assets or of the majority of its share capital.
 (4)
The aggregate amount disclosed includes, as the case may be for each NEO, an evaluation of the amount that the NEO would have been entitled to should a termination of employment for Change of Control have occurred on August 31, 2014 and includes, as the case may be, namely, the base salary, STIP or SIP compensation and total value of RSUs and options that would have vested. The amount for base salary and STIP or SIP compensation are calculated according to those amounts provided under the section entitled “Summary Compensation Table” included in this Annual Report, the total value attached to the vesting of RSUs and options is calculated according to those amounts provided in the columns named “Value of unexercised “in-the-money” options” and “Market or payout value of share-based awards that have not vested” of the table included under the heading entitled “Outstanding share-based awards and option-based awards”.
 
 (5)
The aggregate amount disclosed includes an evaluation of the amount that Mr. Lamonde would have been entitled to should a termination of employment without cause have occurred on August 31, 2014 and includes: the base salary, STIP compensation, and total value of RSUs and options that would have vested. The amount for base salary and STIP compensation are calculated according to those amounts provided under the section entitled “Summary Compensation Table” included in this Annual Report; the total value attached to the vesting of RSUs and options are calculated according to those amounts provided in the columns named “Value of unexercised “in-the-money” options” and “Market or payout value of share-based awards that have not vested” of the table included under the heading entitled – “Outstanding share-based awards and option-based awards”.
 (6)
The aggregate amount disclosed includes an evaluation of the amount that Mr. Lamonde would have been entitled to should a voluntary termination of employment have occurred on August 31, 2014 and includes: the total value of RSUs and options that would have vested. The amount for the total value attached to the vesting of RSUs and options are calculated according to those amounts provided in the columns named “Value of unexercised “in-the-money” options” and “Market or payout value of share-based awards that have not vested” of the table included under the heading entitled “Outstanding share-based awards and option-based awards”.


Compensation of Directors




Director Compensation Table




In the financial year ended August 31, 2014, the decision was made to increase the Annual Retainer and eliminate the attendance fees and each Director who was not an employee of the Corporation or any of its subsidiaries received an Annual Retainer as set forth in the following table, payable in a combination of cash and DSUs as chosen by the director pursuant to the DSU Plan. The significant terms of the DSU Plan is described herein under the section entitled “Long-Term Incentive Compensation – Deferred Share Unit Plan”.





Annual Retainer for Directors (1)
CA$57,000
(2)
US$52,866
(3)Annual Retainer for Lead Director
CA$8,000

US$7,420
(3)Annual Retainer for Audit Committee Chairman
CA$8,000

US$7,420
(3)Annual Retainer for Audit Committee Members
CA$4,000

US$3,710
(3)





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Annual Retainer for Human Resources Committee Chairman
CA$6,000

US$5,565
(3)Annual Retainer for Human Resources Committee Members
CA$3,000

US$2,782
(3)


(1)
All the Directors elected to receive 50% of their Annual Retainer for Directors in form of DSUs except Mr. Randy E. Tornes who elected to receive 100% of his Annual Retainer in form of DSUs.


(2)
The Annual Retainer for Mr. Pierre-Paul Allard and Mr. Randy E. Tornes is US$57,000 (CA$61,457).


(3)
The compensation information has been converted from Canadian dollars to US dollars based upon an average foreign exchange rate of CA$1.0782 = US$1.00 for the financial year ended August 31, 2014.




In the financial year ended August 31, 2014, the Directors who were not employees of the Corporation earned the following compensation:




Name
Fees earned (1)

($)
Share-based

Awards

($)
Option-

based

awards

($)
Non-equity

incentive plan

compensation

($)
Pension

Value

($)
All other

Compensation

($)
Total

($)Pierre-Paul Allard
63,492

68,457
(US)

(CA)
–
–
–
–
–
63,492

68,457
(US)

(CA)Darryl Edwards
66,778

72,000
(US)

(CA)
–
–
–
–
–
66,778

72,000
(US)

(CA)Guy Marier
63,470

68,433
(US)

(CA)
–
–
–
–
–
63,470

68,433
(US)

(CA)Claude Séguin
61,739

66,567
(US)

(CA)
–
–
–
–
–
61,739

66,567
(US)

(CA)Randy E. Tornes
63,492

68,457
(US)

(CA)
–
–
–
–
–
63,492

68,457
(US)

(CA)





(1)
The compensation information has been converted from Canadian dollars to US dollars based upon an average foreign exchange rate of CA$1.0782 = US$1.00 for the financial year ended August 31, 2014 except for compensation amounts paid to Mr. Pierre-Paul Allard and Mr. Randy E. Tornes which were paid in US dollars for the portion of their annual retainer for Directors. The fees are always payable in cash, but executives are provided the opportunity to elect to exchange all or a portion of their Annual Retainer for Directors into DSUs. The following table identifies the portion of the fees earned by the directors that were paid in DSUs and the portion that were paid in cash.




Name
Fees earnedDSUs ($) (i)
Cash ($)
Total ($)Pierre-Paul Allard (ii)
28,500

30,728
(US)

(CA)
34,992

37,729
(US)

(CA)
63,492

68,457
(US)

(CA)Darryl Edwards (ii)
26,433

28,500
(US)

(CA)
40,345

43,500
(US)

(CA)
66,778

72,000
(US)

(CA)Guy Marier (ii)
26,433

28,500
(US)

(CA)
37,037

39,933
(US)

(CA)
63,470

68,433
(US)

(CA)Claude Séguin (ii)
26,433

28,500
(US)

(CA)
35,306

38,067
(US)

(CA)
61,739

66,567
(US)

(CA)Randy E. Tornes (iii)
57,000

61,457
(US)

(CA)
6,492

7,000
(US)

(CA)
63,492

68,457
(US)

(CA)





(i)
The estimated value at the time of grant of a DSU is determined based on the highest of the closing prices of the Subordinate Voting Shares on the Toronto Stock Exchange and the NASDAQ National Market on the last trading day preceding the grant date, using the noon buying rate of the Bank of Canada on the grant date to convert either the NASDAQ National Market closing price to Canadian dollars or the Toronto Stock Exchange closing price to United States dollars, as required. The value at vesting of a DSU is equivalent to the market value of a Subordinate Voting Share when a DSU is converted to such Subordinate Voting Share.


(ii)
Elected to receive 50% of his Annual Retainer for Directors in form of DSUs.


(iii)
Elected to receive 100% of his Annual Retainer for Directors in form of DSUs.


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Director Incentive Plan Awards




The significant terms of all plan-based awards and non-equity-incentive plan awards, issued or vested, or under which options have been exercised, during the year, or outstanding at the end of the financial year are described herein under section entitled “Compensation Discussion and Analysis – Long-Term Incentive Plan”.




Outstanding Share-Based Awards and Option-Based Awards




The following table sets out for each Director of the Corporation all awards outstanding as at August 31, 2014, if any, including awards granted before August 31, 2014.





Name
Outstanding Share-based Awards (DSUs)Number of shares or units of

shares that have not vested

(#)
Market or payout value of

share-based awards that

have not vested

(US$) (1)
Market or payout value of

vested share-based awards

not paid out or distributed

(US$)Pierre-Paul Allard
31,882

140,281

–Darryl Edwards
14,960

65,824

–Guy Marier
46,902

206,369

–Claude Séguin
8,498

37,391

–Randy E. Tornes
15,459

68,020

–





(1)
The value of unvested DSUs at the financial year-end is the market value of the Subordinate Voting Shares on August 31, 2014, which was US$4.40 (CA$4.78). The market value of the Subordinate Voting Shares was calculated by using the highest of the closing prices of the Subordinate Voting Shares on the Toronto Stock Exchange and on the NASDAQ National Market on August 29, 2014 using the noon buying rate of the Bank of Canada to convert either the NASDAQ National Market closing price to Canadian dollars or the Toronto Stock Exchange closing price to United States dollars as required. The actual gains on vesting will depend on the value of the Subordinate Voting Shares on the date of vesting. There can be no assurance that these values will be realized.




No Director holds outstanding option-based awards of the Corporation as at August 31, 2014.




Exercised Share-Based Awards




In the financial year that ended August 31, 2014, none of the DSUs of Directors vested with the exception of Mr. Pierre Marcouiller, a former Director, as detailed below and the Directors did not receive any non-equity incentive compensation from the Corporation.




The following table summarizes information about DSUs converted and paid in Subordinate Voting Shares when a Director ceased to be a member of the Board as at November 1, 2014:




Name
Number of DSUs converted
Aggregate Value Realized (US$) (1)Pierre Marcouiller (2)
38,010
210,944


(1)
The aggregate value realized is equivalent to the market value of the securities underlying the DSUs at conversion.


(2)
Mr. Marcouiller ceased to be a member of the Board of Directors as of January 10, 2013.




Securities Authorized for Issuance under Equity Compensation Plans




The following table sets forth the number of Subordinate Voting Shares of the Corporation issued and outstanding as at August 31, 2014, or that may be issued, under the Corporation’s LTIP and Deferred Share Unit Plan, both of which were approved by the Corporation’s shareholders.


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  Plan category
Number of securities to be

issued upon exercise of

outstanding options,

RSUs and DSUs (#)

(a)
Weighted-average exercise

price of outstanding options,

RSUs and DSUs (US$)

(b)
Number of securities remaining

available for future issuance under

equity compensation plans (excluding

securities reflected in column (a)) (#)

(c)LTIP – RSUs
1,225,135

n/a
(1)
1,704,822LTIP – Options
87,454

4.62Deferred Share Unit Plan – DSUs
117,701

n/a
(1)





(1)
The value of RSUs and DSUs will be equal to the market value of the Subordinate Voting Shares of the Corporation on the date of vesting.






PERFORMANCE GRAPH




The line graph below compares the cumulative total shareholder return of our Subordinate Voting Shares with the cumulative shareholder return of the S&P/TSX Composite Index for the last five (5) financial years ended August 31, 2014. It assumes that the initial value of the investment in our Subordinate Voting Shares and in the S&P/TSX Composite Index was CA$100 on September 1, 2009. The bar chart below illustrates the trend in total compensation paid to the NEOs in office during such periods; the CEO and CFO are included in each period but the remaining three (3) named executive officers changed from one period to another. For further information about the identity and compensation of the NEOs, please refer to our previous five (5) Annual Reports and this Annual Report under the section “Summary Compensation Table”.




The Corporation’s Stock Performance


(September 1, 2009 to August 31, 2014)










August 31,2009
2010
2011
2012
2013
2014EXFO Subordinate Voting Shares (CA$)
$100
$183
$202
$148
$149
$148S&P/TSX Composite Index (CA$)
$100
$111
$119
$112
$118
$146NEOs’ total compensation (in millions of CA$)
$2.3
$2.5
$2.7
$2.5
$2.3
$2.6


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The line graph above reflects that we slightly outperformed the S&P/TSX Composite Index for the five-year period ended August 31, 2014. Our total shareholder return significantly increased in financial 2010 and 2011, followed by a marked decline in 2012 and a relatively flat performance in the last two (2) years. Total shareholder return for the Index gradually increased during the same five-year period with the exception of a decline in financial 2012.




Following the end of a global recession in 2009, we reported record sales and robust earnings in financial 2010 and 2011. This superior performance demonstrated the soundness of our growth strategy under adequate market conditions. We, however, were negatively affected by the debt crisis in Europe in 2012 as well as uneven macro-economic conditions in recent years. Likewise, the Index rebounded from the global recession in 2009 and suffered from the European financial crisis in 2012, but it was not perturbed by unsteady macro-economic conditions from 2012 to 2014. Due to our size and market capitalization, our Subordinate Voting Shares tend to be more volatile and more severely impacted, either positively or negatively, than the Index.




The bar chart illustrates that over the same five-year period, the total level of compensation received by the NEOs generally followed our share performance. The exceptions to this trend were witnessed in financial 2013 and 2014. The following information should be considered when analyzing the chart:


●
Our share performance improved from the financial year that began on September 1, 2009 to the financial year ended August 31, 2011 and decreased from the financial year that began on September 1, 2011 to the financial year ended August 31, 2012. This share performance is aligned with the respective increase and decrease in total compensation received by the NEOs during these periods. This decrease in NEOs compensation mainly reflects the decision of the Human Resources Committee to no longer grant equity-based compensation to the CEO and progressively adjust base salaries of the CEO over a four (4) year-period and also reflects to some extent financial results below expectations for financial 2013.
 ●
Despite the relative stability of our share price as at August 31, 2013 compared to the previous financial year, total compensation of the NEOs decreased. This decrease in NEOs compensation reflects financial results below expectations for financial 2013 and consequently is aligned with shareholders’ interests.
 ●
Similarly, our share price remained relatively flat as at August 31, 2014 compared to the previous financial year, but this year total compensation of the NEOs increased. This can be explained mainly by the progressive adjustment of the base salary of the CEO, as he no longer receives equity-based compensation, and required adjustments to align executive compensation with the target compensation positioning offered within a reference market of comparable companies that are similar in size to us. This is necessary to maintain a competitive position within the market place and retain key executives.




Total compensation received by the NEOs over the identified period should also be considered with the increase in our annual telecom revenues from US$153.1 million for the financial year ended August 31, 2009 to US$230.8 million for the financial year ended August 31, 2014, which represents an increase of 50%. This significant revenue increase was achieved despite market uncertainty over the last three (3) years.







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Total compensation to our NEOs is defined as the aggregate of base salary, short-term compensation and long-term compensation. Base salary is established at the beginning of each financial year, according to recommendations made by the Board of Directors’ Human Resources Committee. Short-term compensation, which varies from one year to the next, is contingent upon the achievement of pre-established objectives measured against corporate and individual targets for a given financial year. For more information about short-term compensation, refer to the heading entitled “Short Term Incentive Compensation.” Long-term compensation, which is provided in the form of RSUs, vests over a three- to five-year period, depending on the achievement of pre-established corporate goals. For more information about long-term compensation, refer to the heading entitled “Long Term Incentive Plan”.




Consequently, base salary and short-term compensation do not necessarily track the market value of our share price. Long-term compensation, however, is directly aligned with share-price performance, since the market value of RSUs is equal to the market value of our shares on any vesting day. Accordingly, the market value of our share price will affect the planned value of NEOs’ total compensation, thereby partially aligning their experience with that of shareholders.




Indemnification of Directors and Executive Officers and Limitation of Liability




Our by-laws require us, subject to the limitations provided by law, to indemnify our present or former Directors and officers or any persons who act or acted at our request as Directors or officers of a body corporatefor all costs, losses, charges and expenses that arose or may arise by reason of their status as Directors or officers of us or such body corporate. We maintain a Directors’ and officers’ liability insurance policy, which insures our Directors and officers and those of our subsidiaries against liability incurred by, arising from or against them for certain of their acts, errors or omissions. Accordingly, we maintain insurance protection against liability incurred by the Corporation’s officers and directors as well as those of its subsidiaries in the performance of their duties. The entire premium, amounting to US$116,750 from September 30, 2014 to September 30, 2015, is paid by the Corporation. The aggregate limit of liability in respect of any and all claims is US$10 million per year, subject to a deductible of US$250,000. A separate excess director and officer liability policy (Chubb Executive Elite) with aggregate limit of US$5 million provides broad form side A coverage, featuring difference-in-conditions (DIC) drop-down coverage that fills in potential coverage gaps that may exist under restrictive or unresponsive underlying insurance. This specific policy provides coverage for personal directors and officers liability if the organization fails or refuses to indemnify, or is financially unable to do so, or is prevented by law from indemnifying and will also respond if the primary D&O policy limit is consumed.







C.Board Practices




Board of Directors




Our Directors are elected at the annual meeting of shareholders for one-year terms and serve until their successors are elected or appointed, unless they resign or are removed earlier. We plan to hold our next annual meeting of shareholders on January 8, 2015. Our articles of incorporation provide for a Board of Directors of a minimum of three (3) and a maximum of twelve (12) Directors. Our Board of Directors presently consists of six Directors. Under the Canada Business Corporations Act, twenty-five percent of the Directors and of the members of any committee of the Board of Directors must be resident Canadians. We have no arrangements with any of our Directors providing for the payment of benefits upon their termination of service as Director except for the vesting of their respective Deferred Share Units as detailed above.




The following charts and notes set out the name of each of the individuals proposed to be nominated at the Meeting for election as a director of the Corporation. Included in these charts is information relating to the proposed directors’ committee memberships, meeting attendance, period of service as a director, principal directorships with other organizations and equity ownership (or securities over which each of them exercises control or direction) in the Corporation.







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GERMAIN LAMONDESt-Augustin-de-Desmaures,

Quebec, Canada



Director sinceSeptember 1985



Not Independent(Management)



Principal Occupation:

Chairman of the Board of

Directors,President and

Chief ExecutiveOfficer of

theCorporation
Germain Lamonde, a founder of EXFO, has been President and Chief Executive Officer of EXFO since its inception in 1985. He has also been Chairman of the Board since EXFO went public in 2000. Responsible for the overall management and strategic direction of EXFO, Mr. Lamonde has grown the company from the ground up into a global leader in the test and measurement and systems and service assurance industry. Mr. Lamonde has served on the board of directors of several organizations such as the Canadian Institute for Photonic Innovations, the POLE QCA Economic Development Corporation, the National Optics Institute of Canada (INO) and Université Laval in Quebec City, to name a few. Germain Lamonde holds a bachelor's degree in engineering physics from the University of Montreal's School of Engineering (École Polytechnique), a master's degree in optics from Université Laval, and is also a graduate of the Ivey Executive Management Program offered by the University of Western Ontario.Board/Committee Membership
Attendance(1)
Board Memberships of Another Reporting IssuerChairman of the Board of Directors
7/7
100%
–Securities HeldAs at
Subordinate

Voting Shares (#)
Multiple Voting

Shares (#)
RSUs (#)
Total Shares(2)

and RSUs (#)
Total Market Value(3)

of Shares(2)and RSUs (US$)August 31, 2014
4,229,358 (4)
31,643,000(5)
140,150
36,012,508
158,455,035Options Held as at August 31, 2014Date Granted
Number(#)
Exercise Price

(US$) (6)
Total Unexercised (#)
Value of Options

Unexercised (US$)(7)February 1, 2005

December 6, 2005
17,942

11,218
4.51

4.76
17,942

11,218
‒

‒Total


29,160
‒


(1)
From September 1, 2013 until November 1, 2014, Mr. Lamonde attended six (6) board meetings in person and one (1) by telephone.
 (2)
Includes both Subordinate Voting Shares and Multiple Voting Shares.
 (3)
The value of unvested RSUs at the financial year-end is the market value of the Subordinate Voting Shares on August 31, 2014, which was US$4.40 (CA$4.78). The market value of the Subordinate Voting Shares and Multiple Voting Shares was calculated by using the highest of the closing prices of the Subordinate Voting Shares on the Toronto Stock Exchange and on the NASDAQ National Market on August 29, 2014 using the noon buying rate of the Bank of Canada to convert either the NASDAQ National Market closing price to Canadian dollars or the Toronto Stock Exchange closing price to United States dollars as required. The actual gains on vesting of RSUs will depend on the value of the Subordinate Voting Shares on the date of vesting. There can be no assurance that these values will be realized.
 (4)
Mr. Lamonde exercises control over 4,000,000 of Subordinate Voting Shares through G. Lamonde Investissements Financiers inc., a company controlled by Mr. Lamonde.
 (5)
Mr. Lamonde exercises control over this number of Multiple Voting Shares through G. Lamonde Investissements Financiers inc., a company controlled by Mr. Lamonde and through Fiducie Germain Lamonde, a family trust for the benefit of Mr. Lamonde’s family.
 (6)
These options were granted in Canadian dollars. The exercise price was calculated by using the highest of the closing prices of the Subordinate Voting Shares on the Toronto Stock Exchange and on the NASDAQ National Market on the business day preceding the grant date using the noon buying rate of the Bank of Canada to convert either the NASDAQ National Market closing price to Canadian dollars or the Toronto Stock Exchange closing price to United States dollars on the grant date.
 (7)
Indicates an aggregate value of “in-the-money” unexercised options held at the financial year ended August 31, 2014. “In-the-money” options are options for which the market value of the underlying securities is higher than the exercise price. The value of unexercised “in-the-money” options at financial year end is the difference between its exercise or base price and the market value of the underlying Subordinate Voting Share as at August 31, 2014, which was US$4.40 (CA$4.78). The market value of the Subordinate Voting Shares was calculated by using the highest of the closing prices of the Subordinate Voting Shares on the Toronto Stock Exchange and on the NASDAQ National Market on August 29, 2014 using the noon buying rate of the Bank of Canada to convert either the NASDAQ National Market closing price to Canadian dollars or the Toronto Stock Exchange closing price to United States dollars as required. For a Canadian resident, the value of options unexercised is calculated using the exercise price and the market value of the subordinate voting shares on the Toronto Stock Exchange in Canadian dollars.






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PIERRE-PAUL ALLARDPleasanton,

California, USA



Director since

September 2008



Independent



Principal Occupation:

Senior Vice-President,

Worldwide Sales and

President  Global Field

Operations at Avaya Inc. (1)
Pierre-Paul Allard was appointed a member of our Board of Directors in September 2008 and has been a board member of many other technology companies in Canada and in the US. Mr. Allard is Senior Vice-President, Worldwide Sales and President Global Field Operations at Avaya Inc., a global provider of business collaboration and communications solutions. As Chief Revenue Officer, Mr. Allard is responsible for all go-to-market at Avaya. Prior to joining Avaya in May 2012, Mr. Allard worked for nineteen (19) years at Cisco Systems, Inc., where he most recently held the position of Vice-President, Sales and Operations, Global Enterprise. Previously, Mr. Allard was President of Cisco Systems Canada, and before that he held various management roles at IBM Canada for twelve (12) years. In 2002, Mr. Allard co-chaired the Canadian e-Business Initiative, a private-public partnership aiming to measure the role e-Business plays in increasing productivity levels, job creation and competitive position. In 1998, he was the laureate of the Arista-Sunlife Award, for Top Young Entrepreneur in Large Enterprise, conferred by the Montreal Chamber of Commerce. In 2003, he received the Queen’s Golden Jubilee Medal, which highlights significant contributions to Canada. In the same year, he was also awarded the prestigious Trudeau Medal from the University of Ottawa, Tefler School of Management. Pierre-Paul Allard holds a bachelor’s and masters’ degree in Business Administration from the University of Ottawa, Canada.Board/Committee Membership
Attendance(2)
Board Memberships of Another Reporting IssuerBoard of Directors
  Audit Committee
  Human Resources Committee
  Independent Board of Directors
7/7
5/5
5/5
5/5
100%
100%
100%
100%
–
 Securities HeldAs at
Subordinate
Voting Shares (#)
DSUs (#)
Total Shares and DSUs  (#)
Total Market Value (3)
of Shares (4) and DSUs (US$)August 31, 2014
8,000
31,882
39,882
175,481
 Options Held as at August 31, 2014Date Granted
Number(#)
Exercise Price (US$) (6)
Total Unexercised (#)
Value of Options

Unexercised (US$)‒
‒
‒
‒
‒





(1)
Avaya Inc. is a global provider of business collaboration and communications solutions.


(2)
From September 1, 2013 until November 1, 2014, Mr. Allard attended six (6) board meetings in person and one (1) by telephone.
 (3)
The value of unvested DSUs at the financial year-end is the market value of the Subordinate Voting Shares on August 31, 2014, which was US$4.40 (CA$4.78). The market value of the Subordinate Voting Shares was calculated by using the highest of the closing prices of the Subordinate Voting Shares on the Toronto Stock Exchange and on the NASDAQ National Market on August 29, 2014 using the noon buying rate of the Bank of Canada to convert either the NASDAQ National Market closing price to Canadian dollars or the Toronto Stock Exchange closing price to United States dollars as required. The actual gains on vesting of DSUs will depend on the value of the Subordinate Voting Shares on the date of vesting. There can be no assurance that these values will be realized.
 (4)
Refers to Subordinate Voting Shares.




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 FRANÇOIS CÔTÉMontreal, Quebec,

Canada



Proposed nominee for

Director to the January

2015 shareholders' meeting



Independent



Principal Occupation:

Chairman,

TELUS Ventures (1)
François Côtéoversees the development and implementation of TELUS Ventures’ investment strategy. He also actively manages investments which drive return on investment and value creation for TELUS Corporation. Mr. Côté held a variety of executive positions at Bell Canada prior to becoming President and Chief Executive Officer of Emergis. Following the acquisition of Emergis by TELUS in January 2008, he was appointed President of TELUS Quebec, TELUS Health & TELUS Ventures. In this role, Mr. Côté was responsible for broadening TELUS’ Quebec presence and driving the company’s national health strategy through timely investments in information technology and innovative wireless solutions. Mr. Côté holds a Bachelor’s degree in Industrial Relations from Laval University. In 2007, he was named Entrepreneur of the Year by Ernst & Young, in the Corporate Restructuring category for the Quebec City region. Mr. Côté serves on the boards of the Montreal Heart Institute and Lumenpulse Inc. as well as the Advisory Board of the McGill Centre for the Convergence of Health and Economics (MCCHE). He is also Chairman of the Board for FitSpirit. In June 2013, Mr. Côté was named Honourary Lieutenant-Colonel of the Canadian Armed Forces’ 34th Signal Regiment. He is also Vice Chair of the TELUS Fund, an independent organization established to finance the creation of health and wellness content.Board/Committee Membership
Attendance(2)
Board Memberships of Another Reporting IssuerBoard of Directors
  Audit Committee
  Human Resources Committee
  Independent Board of Directors
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
Lumenpulse Inc.
 Securities HeldAs at
Subordinate
Voting Shares (#)
DSUs (#)
Total Shares and DSUs  (#)
Total Market Value
of Shares and DSUs (US$)August 31, 2014
‒
‒
‒
‒
 Options Held as at August 31, 2014Date Granted
Number(#)
Exercise Price (US$) (6)
Total Unexercised (#)
Value of Options

Unexercised (US$)‒
‒
‒
‒
‒
 
 
 
 (1)
Telus is a national telecommunications company in Canada that provides a wide range of telecommunications products and services.
 (2)
Mr. Côté, if elected, will join our Board of Directors on January 8, 2015. Hence, from September 1, 2013 until November 1, 2014, Mr. Côté did not attend any meetings.




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 DARRYL EDWARDSWeston Under

Wetherley

Warwickshire,

United Kingdom



Director since

September 2011



Independent



Principal Occupation:

President and Chief

Executive Officer,

ECI Telecom
Darryl Edwardswas appointed a member of our Board of Directors in September 2011. Mr. Edwards is the President and Chief Executive Officer of ECI Telecom, a leading provider of access and transport solutions. Prior to leading ECI, Mr. Edwards was the Chairman of the Board for MACH, a leading provider of hub-based mobile communication solutions. He brings to EXFO more than thirty (30) years of telecommunications experience gained from a number of senior executive leadership positions; most recently he was the Chief Executive Officer of AIRCOM International, successfully leading the company through to business sale. Mr. Edwards was previously at Nortel Networks for seventeen (17) years, where he held various executive officer positions, including President of EMEA and President of Global Sales (Carrier Networks). He also was the Chief Executive Officer for two (2) of Nortel's key joint ventures, first in the Middle East and later in Germany. Prior to his time at Nortel, Mr. Edwards spent thirteen (13) years at GEC-Plessey Telecommunications where he worked in engineering, quality assurance and international sales. He was also an advisor to private equity firm Warburg Pincus, the majority shareholder of MACH, on telecommunications-related topics. Mr. Edwards has held a number of chairs, including Chairman of the Board of Nortel's interests in Turkey, Nortel Netas, which was listed on the Istanbul Stock Exchange. He also was a member of the Advisory Counsel to the Turkish government between 2004 and 2008, and previously served on the UK Government Broadband Stakeholders Group and the Information Age Partnership. Darryl Edwards holds a Higher National Certificate (Physics) from Birmingham Polytechnic in the UK.Board/Committee Membership
Attendance(1)
Board Memberships of Another Reporting IssuerBoard of Directors
  Audit Committee
  Human Resources Committee
  Independent Board of Directors
7/7
5/5
5/5
5/5
100%
100%
100%
100%
–
 Securities HeldAs at
Subordinate
Voting Shares (#)
DSUs (#)
Total Shares and DSUs  (#)
Total Market Value (2)
of Shares (3) and DSUs (US$)August 31, 2014
‒
14,960
14,960
65,824
 Options Held as at August 31, 2014Date Granted
Number(#)
Exercise Price (US$) (6)
Total Unexercised (#)
Value of Options

Unexercised (US$)‒
‒
‒
‒
‒
 (1)
From September 1, 2013 until November 1, 2014, Mr. Edwards attended five (5) board meetings in person and two (2) by telephone.
 (2)
The value of unvested DSUs at the financial year-end is the market value of the Subordinate Voting Shares on August 31, 2014, which was US$4.40 (CA$4.78). The market value of the Subordinate Voting Shares was calculated by using the highest of the closing prices of the Subordinate Voting Shares on the Toronto Stock Exchange and on the NASDAQ National Market on August 29, 2014 using the noon buying rate of the Bank of Canada to convert either the NASDAQ National Market closing price to Canadian dollars or the Toronto Stock Exchange closing price to United States dollars as required. The actual gains on vesting of DSUs will depend on the value of the Subordinate Voting Shares on the date of vesting. There can be no assurance that these values will be realized.
 (3)
Refers to Subordinate Voting Shares.
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 CLAUDE SÉGUINMontreal, Quebec,

Canada



Director since

February 2013



Independent



Principal Occupation:

Senior Vice-President,

Corporate Development

and Strategic Investments,

CGI Group Inc. (1)
Claude Séguin was appointed a member of EXFO’s Board of Directors in February 2013. He brings to EXFO nearly thirty (30) years of corporate, financial, executive and provincial government experience gained through senior management positions in major corporations and government departments. Mr. Séguin is currently Senior Vice-President, Corporate Development and Strategic Investments at CGI Group Inc., a global leader in information technology and business process services. In this position, he is responsible for all merger and acquisition activities. Prior to joining CGI in 2003, he served as President of CDP Capital—Private Equity, and prior to this position, he served as Teleglobe Inc.’s Executive Vice-President, Finance and Chief Financial Officer, a position that he held from 1992 to 2000. Mr. Séguin also has extensive senior-level government experience, having served as Deputy Finance Minister of the Province of Québec from 1987 to 1992, in addition to Assistant Deputy Finance Minister and Assistant Director of Social Programs at the Quebec Treasury Board. Mr. Séguin is a member of the boards of HEC-Montréal and Centraide of Greater Montreal Foundation as well as being Chairman of the Board of Finance - Montreal, an organization regrouping financial institutions in Montreal. Claude Séguin graduated from HEC-Montréal and earned a Master’s and a Ph.D. in public administration from the Syracuse University in New York State.Board/Committee Membership
Attendance(2)
Board Memberships of Another Reporting IssuerBoard of Directors
  Audit Committee
  Human Resources Committee
  Independent Board of Directors
7/7
5/5
5/5
5/5
100%
100%
100%
100%
–
 Securities HeldAs at
Subordinate
Voting Shares (#)
DSUs (#)
Total Shares and DSUs  (#)
Total Market Value (3)
of Shares (4) and DSUs (US$)August 31, 2014
‒
8,498
8,498
37,391
 Options Held as at August 31, 2014Date Granted
Number(#)
Exercise Price (US$) (6)
Total Unexercised (#)
Value of Options

Unexercised (US$)‒
‒
‒
‒
‒
 
 
 
 (1)
CGI Group Inc. is an information technology consulting, systems integration, outsourcing and solutions company.
 (2)
From September 1, 2013 until November 1, 2014, Mr. Séguin attended six (6) board meetings in person and one (1) by telephone.
 (3)
The value of unvested DSUs at the financial year-end is the market value of the Subordinate Voting Shares on August 31, 2014, which was US$4.40 (CA$4.78). The market value of the Subordinate Voting Shares was calculated by using the highest of the closing prices of the Subordinate Voting Shares on the Toronto Stock Exchange and on the NASDAQ National Market on August 29, 2014 using the noon buying rate of the Bank of Canada to convert either the NASDAQ National Market closing price to Canadian dollars or the Toronto Stock Exchange closing price to United States dollars as required. The actual gains on vesting of DSUs will depend on the value of the Subordinate Voting Shares on the date of vesting. There can be no assurance that these values will be realized.
 (4)
Refers to Subordinate Voting Shares.
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 RANDY E. TORNESFrisco, Texas, USA



Director since

February 2013



Independent



Principal Occupation:

Vice-President, Sales,

Juniper Networks (1)
Randy E. Tornes was appointed a member of EXFO’s Board of Directors in February 2013. He brings to EXFO nearly thirty (30) years of telecommunications experience gained through senior management positions at leading network equipment manufacturers. Mr. Tornes is Vice-President, Sales (AT&T account) at Juniper Networks, a worldwide leader in high-performance networking and telecommunications equipment. In this position, he is responsible for all sales, service and support of Juniper products to AT&T. Prior to joining Juniper Networks in May 2012, he spent two (2) years at Ericsson, where he was Vice-President Sales (AT&T account). Previous to that position, he worked for Nortel for twenty-six (26) years, holding various sales management positions, including Vice-President Sales, GSM Americas. Mr. Tornes also served as member of the Board of Governors at 3G Americas LLC. Randy E. Tornes holds a Bachelor of Science degree in Business—Organizational Development and Production and Operations Management, from the University of Colorado in Colorado Springs.Board/Committee Membership
Attendance(2)
Board Memberships of Another Reporting IssuerBoard of Directors
  Audit Committee
  Human Resources Committee
  Independent Board of Directors
7/7
5/5
5/5
5/5
100%
100%
100%
100%
–
 Securities HeldAs at
Subordinate
Voting Shares (#)
DSUs (#)
Total Shares and DSUs  (#)
Total Market Value (3)
of Shares (4) and DSUs (US$)August 31, 2014
‒
15,459
15,459
68,020
 Options Held as at August 31, 2014Date Granted
Number(#)
Exercise Price (US$) (6)
Total Unexercised (#)
Value of Options

Unexercised (US$)‒
‒
‒
‒
‒
 
 
 
 (1)
Juniper Networks is a manufacturer of networking equipment.
 (2)
From September 1, 2013 until November 1, 2014, Mr. Tornes attended six (6) board meetings in person and one (1) by telephone.
 (3)
The value of unvested DSUs at the financial year-end is the market value of the Subordinate Voting Shares on August 31, 2014, which was US$4.40 (CA$4.78). The market value of the Subordinate Voting Shares was calculated by using the highest of the closing prices of the Subordinate Voting Shares on the Toronto Stock Exchange and on the NASDAQ National Market on August 29, 2014 using the noon buying rate of the Bank of Canada to convert either the NASDAQ National Market closing price to Canadian dollars or the Toronto Stock Exchange closing price to United States dollars as required. The actual gains on vesting of DSUs will depend on the value of the Subordinate Voting Shares on the date of vesting. There can be no assurance that these values will be realized.
 (4)
Refers to Subordinate Voting Shares.


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The information as to Subordinate Voting Shares and Multiple Voting Shares beneficially owned or over which the above-named individuals exercise control or direction is not within the direct knowledge of the Corporation and has been furnished by the respective individuals. The information as to the Principal Board Memberships is also not within the direct knowledge of the Corporation and has been furnished by the respective individuals.




With the exception of Mr. Darryl Edwards (as disclosed below), none of the individuals who are proposed to be nominated at the Meeting for election as a director of the Corporation:




(a)
is, as at the date hereof, or has been, within ten (10) years before the date hereof, a director, chief executive officer or chief financial officer of any company that (i) was subject to an order that was issued while such individual was acting in the capacity as director, chief executive officer or chief financial officer, or (ii) was subject to an order that was issued after such individual ceased to be a director, chief executive officer or chief financial officer and which resulted from an event that occurred while that person was acting in the capacity as director, chief executive officer or chief financial officer;




(b)
is, as at the date hereof, or has been within ten (10) years before the date hereof, a director or executive officer of any company that, while such individual was acting in that capacity, or within a year of that individual ceasing to act in that capacity, became bankrupt, made a proposal under any legislation relating to bankruptcy or insolvency or was subject to or instituted any proceedings, arrangement or compromise with creditors or had a receiver, receiver manager or trustee appointed to hold its assets;




(c)
has, within the ten (10) years before the date hereof, become bankrupt, made a proposal under any legislation relating to bankruptcy or insolvency, or become subject to or instituted any proceedings, arrangement or compromise with creditors, or had a receiver, receiver manager or trustee appointed to hold his assets; or




(d)
has been subject to (i) any penalties or sanctions imposed by a court relating to securities legislation or by a securities regulatory authority or has entered into a settlement agreement with a securities regulatory authority, or (ii) any other penalties or sanctions imposed by a court or regulatory body that would likely be considered important to a reasonable security holder in deciding whether to vote for such individual.




Mr. Darryl Edwards acted as an executive officer of Nortel Networks Corporation (“Nortel”) and its affiliates from 2001 to 2009, most recently acting as President of Global Carrier Sales of Nortel in 2009 and as President, EMEA sales of Nortel from 2006 to 2009. Nortel and certain of its affiliates filed for bankruptcy protection in a number of jurisdictions in January 2009.




From September 1, 2013 through November 1, 2014, the Board met a total of seven (7) times. Each member attended all meetings.




Committees of the Board of Directors




Our Board of Directors has established an audit committee, a human resources committee and a disclosure committee.







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Our audit committee will recommend a firm to be appointed as independent auditors to audit financial statements and to perform services related to the audit, review the scope and results of the audit with the independent auditors, review with management and the independent auditors our annual operating results and consider the adequacy of the internal accounting procedures and the effect of the procedures relating to the auditors’ independence. Further to changes to NASDAQ corporate governance rules and Securities and Exchange Act rules flowing from the adoption of the Sarbanes-Oxley Act, we review our audit committee charter annually to ensure that we comply with all new requirements. Accordingly, in October 2014, the Audit Committee reviewed and amended the Audit Committee Charter, a copy of which is filed as Exhibit 11.5 to this Annual Report and is also readily available from EXFO’s website at www.EXFO.com. Information on our Web site is not incorporated by reference in this Annual Report. As at November 1, 2014, the audit committee is composed of five independent Directors: Pierre-Paul Allard, Darryl Edwards, Guy Marier, Claude Séguin and Randy E. Tornes. The chairperson of the audit committee is Claude Séguin.




From September 1, 2013 through November 1, 2014, the Audit Committee met a total of five (5) times. Each member attended all meetings.




Our human resources committee will evaluate, review and supervise our procedures with regards to human resources and will assess the performance of our executive officers and the chief executive officer. This committee will also review annually the remuneration of the Directors and will recommend to the Board of Directors general remuneration policies regarding salaries, bonuses and other forms of remuneration for our Directors, executive officers and employees as a whole. Finally, the human resources committee will review our organizational structure annually and the development and maintenance of a succession plan. In October 2014, the Human Resources Committee reviewed and amended the Human Resources Committee Charter which integrates the Compensation Committee Charter and the Nominating and Governance Committee Charter, copy of which is filed as Exhibit 11.6 to this Annual Report and is also readily available from EXFO’s website at www.EXFO.com. Information on our Web site is not incorporated by reference in this Annual Report. As at November 1, 2014, the human resources committee is composed of five (5) independent Directors: Pierre-Paul Allard, Darryl Edwards, Guy Marier, Claude Séguin and Randy E. Tornes. The chairperson of the Human Resources Committee is Mr. Guy Marier.




From September 1, 2013 through November 1, 2014, the Human Resources committee met a total of five (5) times and all members attended all meetings.




The disclosure committee is responsible for overseeing our disclosure practices. This committee consists of the chief executive officer, the chief financial officer, the director of investor relations, the director of financial reporting and accounting as well as our general counsel and corporate secretary.




Furthermore, our independent Directors hold regularly scheduled meetings at which non-independent directors and members of management are not in attendance. The independent Directors hold as many meetings, as needed, annually and any Director may request such meeting at any time. From September 1, 2013 through November 1, 2014, five (5) meetings of independent Directors without management occurred and all members attended all meetings. In June 2011, an Independent Members Committee Charter was adopted. A copy of this Independent Members Committee Charter has been filed as Exhibit 11.9 to our 2011 Annual Report.







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REPORT ON CORPORATE GOVERNANCE PRACTICES




Corporate Governance Developments in Canada




In January 2004, the Canadian Securities Administrators (the “CSA”) adopted Multilateral Instrument 52-110—Audit Committees, which was amended as of January 1, 2011 (“MI 52-110”). MI 52-110 sets forth certain requirements regarding Audit Committee composition and responsibilities, as well as reporting obligations with respect to audit-related matters. The disclosure of the MI 52-110 requirements is included in our 2014 Annual Information Form on Form 20-F under Exhibit 11.5 (Audit Committee Charter), Items 6.A (Directors and Senior Management) and 16.C (Principal Accountant Fees and Services) available as described below. For the composition of the Audit committee, refer to the table provided under heading “Nominees for Election as Directors and their Beneficial Ownership of Voting Securities”.




Effective  June  30,  2005,  the  CSA  also  adopted  National  Instrument  58-101—Disclosure  of  Corporate  Governance  Practices (“NI 58-101”) and National Policy 58-201—Effective Corporate Governance (“NP 58-201” and, together with MI 52-110, the “CSA Corporate Governance Standards”). NP 58-201 provides guidance to Canadian issuers with respect to corporate governance practices, while NI 58-101 requires issuers to make certain disclosures regarding their governance practices. The CSA Corporate Governance Standards, particularly NI 58-101 and NP 58-201, have replaced the former guidelines of the Toronto Stock Exchange that had, prior to the coming into force of the CSA Corporate Governance Standards, served as the primary source of codified recommendations in respect of corporate governance practices in Canada.




Corporate Governance Practices




In accordance with NI 58-101, we are required to disclose information with respect to our system of corporate governance. Over the past few years, we have undertaken a comprehensive review of our corporate governance practices in order to best comply with and, whenever practicable, exceed the CSA Standards.




We adopted in March 2005 and are updating on a regular basis a number of charters and policies, including an Audit Committee Charter, a Board of Directors Corporate Governance Guidelines, a Code of Ethics for our Principal Executive Officer and Senior Financial Officers, a Disclosure Guidelines, an Ethics and Business Conduct Policy, a Human Resources Committee Charter, a Securities Trading Policy and a Statement on Reporting Ethical Violations (Whistleblower Policy). We adopted in October 2006 a policy regarding Hiring Employees and Former Employees of Independent Auditor. We adopted in June 2011 an Independent Members Committee Charter. We also adopted in October 2011 a majority voting policy for the election of our Directors. We amended in October 2012 the Human Resources Committee Charter in order to expressly reflect the responsibility of the Human Resources Committee to conduct an annual assessment of the risks associated with the Corporation’s executive compensation policies and procedures.




We amended in January 2013 and in October 2014 the Human Resources Committee Charter in order to respectively receive and discuss suggestions from shareholders for potential Directors’ nominees and to adapt it to the latest NASDAQ Rules on compensation committee along with an update on the nomination of Directors process. We adopted in January 2013 a Policy Regarding Conflict Minerals. We amended our Ethics and Business Conduct Policy and our Statement on Reporting Ethical Violations (Whistleblower Policy) in June 2013 and adopted in September 2013 the Agent Code of Conduct to formalize our anti-corruption compliance program. We adopted also in September 2013 a Director share Ownership Policy. We also amended in October 2014 the Audit Committee Charter in order to harmonize its terminology with MI 52-110. We are also implementing best practices such as Best Practice regarding the Granting Date of Stock Incentive Compensation and the establishment of guidelines regarding the filing and disclosure of material contracts. We refer to our Board of Directors and Committee Charters as our “Corporate Governance Rules”.







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We are of the view that adopting and implementing good corporate governance practices is a cornerstone of our corporate and management practices and policies and that our existing corporate governance practices already meet the prevailing corporate governance standards. We further believe that the measures we have adopted with respect to corporate governance comply substantially with the CSA Standards.




We encourage our shareholders to consult our Corporate Governance Rules and Ethics and Business Conduct Policy available on our website (www.EXFO.com) and also available in print to any shareholder who requests copies by contacting our Corporate Secretary.




We are dedicated to updating our corporate governance practices on an ongoing basis in order to respond to the evolution of best practices. We and our Board of Directors are of the view that our corporate governance practices, as summarized in the Exhibit 11.7 attached to this Annual Report, are in substantial compliance with the CSA Corporate Governance Standards. Copies of our Corporate Governance Rules and all related policies (including those mentioned above) are available on our website (www.EXFO.com) as mentioned in Exhibit 11.7.






D.            Employees




We have fostered a corporate culture where growth and change are strongly encouraged. In fact, employees are constantly evolving with the rapid pace of technology to meet new challenges and realities. We believe that we possess a good cross-section of experience and youth to handle these inevitable changes in the industry.




As of November 1, 2014, we had a total of 1,572 employees, down from a total of 1,583 on November 1, 2013. We have 680 employees in Canada, primarily based in Quebec, and 892 employees based outside of Canada. 655 are involved in research and development, 339 in manufacturing, 337 in sales and marketing, 120 in general administrative positions and 121 in communications and customer support. We have agreements with almost all of our employees covering confidentiality and non-competition. Only our 88 manufacturing employees based in Quebec City plants are represented by a collective bargaining agreement through “Syndicat des employé(e)s d’EXFO”. We have never experienced a work stoppage. We believe that relations with our employees and bargaining unit are good.






E.Share Ownership




The following table presents information regarding the ownership of Subordinate Voting Shares, Exercisable “in-the-money” and “out-the-money” options and the beneficial ownership of our share capital as at November 1, 2014 by our Chief Executive Officer, Chief Financial Officer, our Directors, our three other most highly compensated executive officers, our other executive officers as a group, all of our Directors and executive officers as a group.




Each multiple voting share is convertible at the option of the holder into one subordinate voting share. Holders of our subordinate voting shares are entitled to one (1) vote per share and holders of our multiple voting shares are entitled to ten (10) votes per share.


100
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  Name
Subordinate Voting

Shares Owned
Currently Exercisable Options Owned as at November 1, 2014
Total Subordinate Voting Shares Beneficially Owned (3)
Multiple Voting Shares Beneficially Owned (3)
Total Percentage

of Voting Power“In-the-money” (1)
Out-the-money (2)Number
Percent
Number
Percent
Number
Percent
Number
Percent
Number
Percent
PercentGermain Lamonde
4,271,699
(4)
14.87
–
*
29,160
37.95
4,300,859
14.96
31,643,000
(5)
100
92.92Pierre Plamondon
88,906
(6)
*
–
*
3,653
4.75
92,559
*
–

–
*Pierre-Paul Allard
8,000

*
–
*
–
*
8,000
*
–

–
*Darryl Edwards
–

*
–
*
–
*
–
*
–

–
*Guy Marier
1,000

*
–
*
–
*
1,000
*
–

–
*Claude Séguin
–

*
–
*
–
*
–
*
–

–
*Randy E. Tornes
–

*
–
*
–
*
–
*
–

–
*Jon Bradley
–

*
–
*
–
*
–
*
–

–
*Lee Huat (Joseph) Soo
–

*
–
*
–
*
–
*
–

–
*Dana Yearian
34,181

*
–
*
–
*
34,181
*
–

–
*Other executive officers as a group
64,221

*
–
*
2,228
2.90
66,449
*
–

–
*All of our Directors and executive officers as a group
4,468,007

15.55
–
*
35,041
45.60
4,503,048
15.66
31,643,000

100
92.97





*
Less than 1%.


(1)
“In-the-money” options are options for which the market value of the underlying securities is higher than the exercise price at which such securities may be bought from the Corporation. As at November 1, 2014 the market value of a Subordinate Voting Share was US$3.84 or CA$4.19 as applicable.


(2)
“Out-the-money” options are options for which the market value of the underlying securities is lower than the price of which such securities may be bought from the Corporation.


(3)
Beneficial ownership is determined in accordance with the rules of the SEC and generally includes voting or investment power with respect to securities. Options that are currently exercisable or exercisable within sixty (60) days as at November 1, 2014 (including options that have an exercise price above the market price) are deemed to be outstanding and to be beneficially owned by the person holding such options for the purpose of computing the percentage ownership of such person, but are not treated as outstanding for the purpose of computing the percentage ownership of any other person. Accordingly, DSUs and RSUs are not included.


(4)
The number of shares held by Germain Lamonde includes 4,000,000 subordinate voting shares held of record by G. Lamonde Investissements financiers inc.


(5)
The number of shares held by Germain Lamonde includes 1,900,000 multiple voting shares held of record by Fiducie Germain Lamonde and 29,743,000 multiple voting shares held of record by G. Lamonde Investissements Financiers inc.


(6)
The number of shares held by Pierre Plamondon includes 6,874 subordinate voting shares held of record by Fiducie Pierre Plamondon.




The following table presents information regarding stock options held as of November 1, 2014 by our Chief Executive Officer, Chief Financial Officer, our Directors, our three other most highly compensated executive officers and our other executive officers as a group.




Name
Securities Under Options

Granted (1) (#)

Exercise Price (2)

(US$/Security)

Expiration DateGermain Lamonde
17,942

11,218

$4.51

$4.76

February 1, 2015

December 6, 2015Pierre Plamondon
3,653

$4.76

December 6, 2015Pierre-Paul Allard
−

−

−Darryl Edwards
−

−

−Guy Marier
−

−

−Claude Séguin
−

−

−Randy E. Tornes
−

−

−Jon Bradley
−

−

−Lee Huat (Joseph) Soo
−

−

−








101
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  Name
Securities Under Options

Granted (1) (#)

Exercise Price (2)

(US$/Security)

Expiration DateDana Yearian
−

−

−Other Executive Officers as a group
2,228

$4.76

Decembre 6, 2015
 
 (1)
Underlying securities: subordinate voting shares.
 (2)
The exercise price of options granted is determined based on the highest of the closing prices of the subordinate voting shares on the Toronto Stock Exchange and the NASDAQ National Market on the last trading day preceding the grant date, using the noon buying rate of the Federal Reserve Bank of New York on the grant date to convert either the NASDAQ National Market closing price to Canadian dollars or the Toronto Stock Exchange closing price to United States dollars, as required.


The following table presents information regarding Deferred Share Units and Restricted Share Units held by our Chief Executive Officer, our Chief Financial Officer, our Directors, our three other most highly compensated executive officers, our other executive officers as a group, all of our Directors and executive officers as a group, as at November 1, 2014.


Name
DSUs
RSUsNumber
Percentage
Estimated Average

Value at the time of

grant US$/DSU (1)
Number
Percentage
Fair Value at the

time of grant

US$/RSU (2)Germain Lamonde
–

–
–
44,548
(3)
3.34%
6.03–

–
–
53,261
(4)
4.00%
5.43Pierre Plamondon
–

–
–
12,863
(3)
0.96%
6.03–

–
–
8,857
(5)
0.66%
6.03–

–
–
17,325
(4)
1.30%
5.43–

–
–
19,740
(6)
1.48%
5.06–

–
–
19,839
(7)
1.49%
5.28–

–
–
27,729
(8)
2.08%
3.71Pierre-Paul Allard
31,882
(9)
27.1%
4.81
–

–
–Darryl Edwards
14,960
(9)
12.7%
5.04
–

–
–Guy Marier
46,902
(9)
39.9%
5.03
–

–
–Claude Séguin
8,498
(9)
7.2%
4.63
–

–
–Randy E. Tornes
15,459
(9)
13.1%
4.62
–

–
–Jon Bradley
–

–
–
8,342
(3)
0.63%
6.03–

–
–
8,857
(5)
0.66%
6.03–

–
–
11,255
(4)
0.84%
5.43–

–
–
14,089
(6)
1.06%
5.06–

–
–
14,100
(7)
1.06%
5.28–

–
–
22,528
(8)
1.69%
3.71Lee Huat (Joseph) Soo
–

–
–
8,321
(10)
0.62%
6.61–

–
–
12,735
(6)
0.96%
5.06–

–
–
12,958
(7)
0.97%
5.28–

–
–
21,332
(8)
1.60%
3.71Dana Yearian
–

–
–
11,470
(3)
0.86%
6.03–

–
–
8,857
(5)
0.66%
6.03–

–
–
15,322
(4)
1.15%
5.43–

–
–
17,994
(6)
1.35%
5.06–

–
–
17,676
(7)
1.33%
5.28–

–
–
25,706
(8)
1.93%
3.71Other executive officers as a group
–

–
–
29,709
(3)
2.23%
6.03–

–
–
12,882
(5)
0.97%
6.03–

–
–
2,300
(11)
0.17%
9.32–

–
–
41,420
(4)
3.11%
5.43–

–
–
4,600
(12)
0.30%
6.47–

–
–
7,576
(15)
0.57%
6.55–

–
–
6,330
(16)
0.47%
6.55–

–
–
1,429
(13)
0.11%
7.06–

–
–
75,846
(6)
5.69%
5.06–

–
–
2,200
(14)
0.17%
5.61–

–
–
73,660
(7)
5.53%
5.28–

–
–
1,650
(17)
0.12%
4.36–

–
–
100,431
(8)
7.53%
3.71





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 Table of Contents




Name
DSUs
RSUsNumber
Percentage
Estimated Average

Value at the time of

grant US$/DSU (1)
Number
Percentage
Fair Value at the

time of grant

US$/RSU (2)All of the directors and executive officers as a group
–

–
–
106,932
(3)
8.02%
6.03–

–
–
39,453
(5)
2.96%
6.03–

–
–
2,300
(11)
0.17%
9.32–

–
–
138,583
(4)
10.40%
5.43–

–
–
4,000
(12)
0.30%
6.47–

–
–
8,321
(10)
0.62%
6.61–

–
–
7,576
(15)
0.57%
6.55–

–
–
6,330
(16)
0.47%
6.55–

–
–
1,429
(13)
0.11%
7.06–

–
–
140,404
(6)
10.53%
5.06–

–
–
2,200
(14)
0.17%
5.61–

–
–
138,233
(7)
10.37%
5.28–

–
–
1,650
(17)
0.12%
4.36–

–
–
197,726
(8)
14.83%
3.71Total
117,701

100%
4.89
795,137

59.64%
5.07





(1)
The estimated average value at the time of grant of a DSU is the average of the estimated value at the time of grant of a DSU which is determined based on the highest of the closing prices of the Subordinate Voting Shares on the Toronto Stock Exchange and the NASDAQ National Market on the last trading day preceding the grant date, using the noon buying rate of the Federal Reserve Bank of New York (for grants of DSUs prior to January 1, 2009) or the Bank of Canada (for grants of DSUs on or after January 1, 2009) on the grant date to convert either the NASDAQ National Market closing price to Canadian dollars or the Toronto Stock Exchange closing price to United States dollars, as required. The value at vesting of a DSU is equivalent to the market value of a Subordinate Voting Share when a DSU is converted to such Subordinate Voting Share.


(2)
The fair value at the time of grant of a RSU is equal to the market value of Subordinate Voting Shares at the time RSUs are granted.


(3)
Those RSUs will vest on the fifth anniversary date of the grant in October 2010 but are subject to early vesting on the third and fourth anniversary date of the grant on the attainment of performance objectives as determined by the Board of Directors. Accordingly, subject to the attainment of performance objectives, the first early vesting is up to 1/3 of the units on the third anniversary date of the grant and the second early vesting is up to 50% of the remaining units on the fourth anniversary date of the grant.


(4)
Those RSUs will vest on the fifth anniversary date of the grant in October 2011 but are subject to early vesting on the third and fourth anniversary date of the grant on the attainment of performance objectives as determined by the Board of Directors. Accordingly, subject to the attainment of performance objectives, the first early vesting is up to 1/3 of the units on the third anniversary date of the grant and the second early vesting is up to 50% of the remaining units on the fourth anniversary date of the grant.


(5)
Those RSUs will vest on the fifth anniversary date of the grant in October 2010 but are subject to early vesting on the third or fourth anniversary date of the grant on the attainment of performance objectives as determined by the Board of Directors. Accordingly, subject to the attainment of performance objectives, the early vesting is up to 100% of the units on the third or fourth anniversary date of the grant.


(6)
Those RSUs will vest on the fifth anniversary date of the grant in October 2012 but are subject to early vesting on the third and fourth anniversary date of the grant on the attainment of performance objectives as determined by the Board of Directors. Accordingly, subject to the attainment of performance objectives, the first early vesting is up to 1/3 of the units on the third anniversary date of the grant and the second early vesting is up to 50% of the remaining units on the fourth anniversary date of the grant.


(7)
Those RSUs will vest on the fifth anniversary date of the grant in October 2013 but are subject to early vesting on the third and fourth anniversary date of the grant on the attainment of performance objectives as determined by the Board of Directors. Accordingly, subject to the attainment of performance objectives, the first early vesting is up to 1/3 of the units on the third anniversary date of the grant and the second early vesting is up to 50% of the remaining units on the fourth anniversary date of the grant.


(8)
Those RSUs will vest on the fifth anniversary date of the grant in October 2014 but are subject to early vesting on the third and fourth anniversary date of the grant on the attainment of performance objectives as determined by the Board of Directors. Accordingly, subject to the attainment of performance objectives, the first early vesting is up to 1/3 of the units on the third anniversary date of the grant and the second early vesting is up to 50% of the remaining units on the fourth anniversary date of the grant.


(9)
Those DSUs will vest at the time Director ceases to be a member of the Board of the Corporation.


(10)
Those RSUs will vest at a rate of 1/2 annually commencing on the third anniversary date of the grant in January 2012.


(11)
Those RSUs will vest at a rate of 1/2 annually commencing on the third anniversary date of the grant in January 2011.


(12)
Those RSUs will vest at a rate of 1/2 annually commencing on the third anniversary date of the grant in January 2012.


(13)
Those RSUs will vest on the fifth anniversary date of the grant in April 2012 but are subject to early vesting on the third and fourth anniversary date of the grant on the attainment of performance objectives as determined by the Board of Directors. Accordingly, subject to the attainment of performance objectives, the first early vesting is up to 1/3 of the units on the third anniversary date of the grant and the second early vesting is up to 50% of the remaining units on the fourth anniversary date of the grant.


(14)
Those RSUs will vest at a rate of 1/2 annually commencing on the third anniversary date of the grant in January 2013.


(15)
Those RSUs will vest at a rate of 1/2 annually commencing on the third anniversary date of the grant in January 2012.












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 Table of Contents







(16)
Those RSUs will vest on the fifth anniversary date of the grant in January 2012 but are subject to early vesting on the third and fourth anniversary date of the grant on the attainment of performance objectives as determined by the Board of Directors. Accordingly, subject to the attainment of performance objectives, the first early vesting is up to 1/3 of the units on the third anniversary date of the grant and the second early vesting is up to 50% of the remaining units on the fourth anniversary date of the grant.
 (17)
Those RSUs will vest at a rate of 1/2 annually commencing on the third anniversary date of the grant in January 2014.




Escrowed Securities




To our knowledge as at November 1, 2014, none of the equity securities of the Company were held in escrow.







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Item 7.
Major Shareholders and Related Party Transactions




A.Major Shareholders




The following table presents information regarding the beneficial ownership of our share capital as at November 1, 2014 by persons or groups of affiliated persons known by us to own more than 5% of our voting shares.




Multiple Voting Shares
Beneficially Owned (1)
Subordinate Voting Shares
Beneficially Owned (1)
Total Percentage
of Voting PowerName
Number
Percent
Number
Percent
PercentGermain Lamonde (2)
31,643,000
100.00%
4,271,699
14.87%
92.91%Fiducie Germain Lamonde (3)
1,900,000
6.00%
–
–
5.50%G. Lamonde Investissements Financiers inc. (4)
29,743,000
94.00%
4,000,000
13.92%
87.33%EdgePoint Investment Group, Inc.
–
–
3,775,600
13.14%
1.09%Royce & Associates LLC
–
–
2,268,534
7.90%
*Brown Investment Advisory, Inc.
–
–
1,550,182
5.40%
*


*
Less than 1%


(1)
Beneficial ownership is determined in accordance with the rules of the SEC and generally includes voting or investment power with respect to securities. Options that are currently exercisable within 60 days of November 1, 2014 (including options that have an exercise price above the market price) are deemed to be outstanding and to be beneficially owned by the person holding such options for the purpose of computing the percentage ownership of such person, but are not treated as outstanding for the purpose of computing the percentage ownership of any other person.


(2)
The number of shares held by Germain Lamonde includes 1,900,000 multiple voting shares held of record by Fiducie Germain Lamonde, 29,743,000 multiple voting shares held of record by G. Lamonde Investissements Financiers inc. and 4,000,000 subordinate voting shares held of record by G. Lamonde Investissements Financiers inc.


(3)
Fiducie Germain Lamonde is a family trust for the benefit of Mr. Lamonde and members of his family.


(4)
G. Lamonde Investissements Financiers inc. is a company controlled by Mr. Lamonde.




Each multiple voting share is convertible at the option of the holder into one subordinate voting share. Holders of our subordinate voting shares are entitled to one vote per share and holders of our multiple voting shares are entitled to ten votes per share.




Ever since EXFO became a publicly traded company in June 2000, including the most recent three-year period, Mr. Lamonde and his related companies have maintained majority ownership. Mr. Lamonde converted five million multiple voting shares into subordinate voting shares in fiscal 2011 and sold one million of those subordinate voting shares on the open market. (Only subordinate voting shares can be traded on the open market). According to publicly available information, EdgePoint Investment Group remains EXFO’s second-largest shareholder with 3.8 million subordinate voting shares or 13.1% of the public float. Royce & Associates LLC holds 7.9% of the public float (2.3 million shares). Finally, Brown Investment Advisory, holding 1.6 million subordinate voting shares, rounds up the list of investors accounting for more than 5% of the public float (5.4%).







105
 Table of Contents







As at November 10, 2014, 28,682,146subordinate voting shares were outstanding. Approximately 97.96% (28,096,932) of our subordinate voting shares were held in bearer form and the remainder (585,214 subordinate voting shares) was held by 224 record holders. As at November 10, 2014, we believe approximately 61.51% of our outstanding subordinate voting shares were held in the United States.






B.Related Party Transactions




Indebtedness of Directors, Executive Officers and Employees




From September 1, 2014 through the date of this Annual Report, none of our directors, executive officers, associates or affiliates had any material interest in any transaction with us or in any proposed transaction which has materially affected or could materially affect us.






C.Interests of Experts and Counsel




Not applicable.







106
 Table of Contents







Item 8.
Financial Information




A.Consolidated Statements and Other Financial Information




See Item 18, “Financial Statements” for certain other information required by this item.




Export Sales




Export and domestic sales in thousands of US dollars and as a percentage of sales are as follows:




Years ended August 31,2014


2013


2012Export Sales

$
211,324



92
%

$
216,077



89
%

$
220,022



88
%Domestic Sales


19,482



8



26,073



11



29,944



12$
230,806



100
%

$
242,150



100
%

$
249,966



100
%




Legal Proceedings




On November 27, 2001, a class action suit was filed in the United States District Court for the Southern District of New York against the company, four of the underwriters of its Initial Public Offering and some of its executive officers pursuant to the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder and Sections 11, 12 and 16 of the Securities Act of 1933. This class action alleges that the company’s registration statement and prospectus filed with the Securities and Exchange Commission on June 29, 2000, contained material misrepresentations and/or omissions resulting from (i) the underwriters allegedly soliciting and receiving additional, excessive and undisclosed commissions from certain investors in exchange for which they allocated material portions of the shares issued in connection with the company’s Initial Public Offering; and (ii) the underwriters allegedly entering into agreements with customers whereby shares issued in connection with the company’s Initial Public Offering would be allocated to those customers in exchange for which customers agreed to purchase additional amounts of shares in the after-market at predetermined prices.




On April 2, 2009, a stipulation and agreement of settlement between the plaintiffs, issuer defendants and underwriter defendants was submitted to the Court for preliminary approval. The Court granted the plaintiffs’ motion for preliminary approval and preliminarily certified the settlement classes on June 10, 2009. The settlement fairness hearing was held on September 10, 2009. On October 6, 2009, the Court entered an opinion granting final approval to the settlement and directing that the Clerk of the Court close these actions. Appeals of the opinion granting final approval were filed, all of which have been dismissed or settled as of January 9, 2012. The settlement payment on behalf of EXFO has been made by the insurers, the settlement among the parties is final, and the case is concluded.




There are no other legal or arbitration proceedings pending or threatened of which we are aware which may have or have had a significant effect on our financial position.




Dividend Policy




We do not currently anticipate paying dividends for at least the next three years. Our current intention is to reinvest any earnings in our business long-term growth. Any future determination by us to pay dividends will be at the discretion of our Board of Directors and in accordance with the terms and conditions of any outstanding indebtedness and will depend on our financial condition, results of operations, capital requirements and such other functions as our Board of Directors considers relevant.






B.Significant Changes




No significant changes occurred since the date of our annual consolidated financial statements.







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Item 9.
The Offer and Listing




Not Applicable, except for Item 9A (4) and Item 9C.




A.Offer and Listing Details





NASDAQ (US$)
TSX (CA$)High
Low
High
LowSeptember 1, 2009 to August 31, 2010
6.59
2.81
6.70
3.10September 1, 2010 to August 31, 2011
12.96
5.28
12.56
5.50September 1, 2011 to August 31, 2012
8.23
4.56
8.24
4.59September 1, 2012 to August 31, 2013
5.90
4.00
5.86
4.14September 1, 2013 to August 31, 2014
5.70
4.13
5.88
4.51September 1, 2012 to November 30, 2012 (2013 1st Quarter)
5.20
4.38
5.10
4.40December 1, 2012 to February 28, 2013 (2013 2nd Quarter)
5.90
4.51
5.86
4.40March 1, 2013 to May 31, 2013 (2013 3rd Quarter)
5.65
4.33
5.76
4.40June 1, 2013 to August 31, 2013 (2013 4th Quarter)
5.05
4.00
5.25
4.14September 1, 2013 to November 30, 2013 (2014 1st Quarter)
5.70
4.46
5.88
4.67December 1, 2013 to February 28, 2014 (2014 2nd Quarter)
5.32
4.13
5.68
4.51March 1, 2014 to May 31, 2014 (2014 3rd Quarter)
5.15
4.22
5.70
4.60June 1, 2014 to August 31, 2014 (2014 4th Quarter)
4.86
4.19
5.17
4.56May 2014
4.60
4.22
5.01
4.60June 2014
4.86
4.19
5.17
4.56July 2014
4.80
4.35
5.15
4.73August 2014
4.62
4.35
5.05
4.75September 2014
4.40
3.94
4.80
4.40October 2014
3.95
3.47
4.41
3.91November 2014
3.67
3.45
4.20
3.90(until November 10)








C.             Markets


Our subordinate voting shares have been quoted on the NASDAQ National Market under the symbol EXFO and listed on The Toronto Stock Exchange under the symbol EXF since our initial public offering on June 29, 2000. Prior to that time, there was no public market for our subordinate voting shares. The table above sets forth, for the periods indicated, the high and low closing sales prices per subordinate voting share as reported on the NASDAQ National Market and the Toronto Stock Exchange.




On November 10, 2014, the last reported sale price for our subordinate voting shares on the NASDAQ National Market was US$3.45 per share and the last reported sale price for our subordinate voting shares on the Toronto Stock Exchange was CA$4.04 per share.







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Item 10.
Additional Information




A.             Share Capital


Not Applicable






B.Memorandum and Articles of Association




Our Amended Articles of Incorporation and By-laws are incorporated by reference to our registration statement on Form F-1 dated June 9, 2000 (File No. 333-38956) and amendments to our Articles by reference to Exhibit 1.4 to our fiscal year 2009 Annual Report on Form 20-F and Exhibit 1.5 to our fiscal year 2010 Annual Report on Form 20-F.






C.Material Contracts




Except as otherwise disclosed in this Annual Report and our consolidated financial statements and notes included elsewhere in this Annual Report, we have no other material contracts.






D.Exchange Controls




Subject to the following paragraph, there is no law or governmental decree or regulation in Canada that restricts the export or import of capital, or affects the remittance of dividends, interest or other payments to non-resident holders of our subordinate voting shares, other than withholding tax requirements.




There is no limitation imposed by Canadian law or by our articles of incorporation or our other charter documents on the right of a non-resident to hold or vote subordinate voting shares, other than as provided by the Investment Canada Act, the North American Free Trade Agreement Implementation Act(Canada) and the World Trade Organization Agreement Implementation Act. The Investment Canada Actrequires notification and, in certain cases, advance review and approval by the Government of Canada of an investment to establish a new Canadian business by a non-Canadian or of the acquisition by a “non-Canadian” of “control” of a “Canadian business”, all as defined in the Investment Canada Act. Generally, the threshold for review will be higher in monetary terms for a member of the World Trade Organization or North American Free Trade Agreement.






E.Taxation




United States Taxation




The information set forth below under the caption “United States Taxation” is a summary of the material U.S. federal income tax consequences of the ownership and disposition of subordinate voting shares by a U.S. Holder, as defined below. These discussions are not a complete analysis or listing of all of the possible tax consequences of such transactions and do not address all tax considerations that may be relevant to particular holders in light of their personal circumstances or to persons that are subject to special tax rules. In particular, the information set forth under the caption “United States Taxation” deals only with U.S. Holders that hold subordinate voting shares as capital assets within the meaning of Section 1221 of the Internal Revenue Code of 1986, as amended (the “Code”), and who do not at any time own individually, nor are treated as owning, 10% or more of the total combined voting power of all classes of our stock entitled to vote.







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In addition, this description of U.S. tax consequences does not address the tax treatment of special classes of U.S. Holders, such as financial institutions, regulated investment companies, traders in securities who elect to mark-to-market their securities, tax-exempt entities, insurance companies, partnerships, persons holding subordinate voting shares as part of a hedging, integrated or conversion transaction or as part of a “straddle,” U.S. expatriates, persons subject to the alternative minimum tax, persons who acquired their subordinate voting shares through the exercise or cancellation of employee stock options or otherwise as compensation for services, dealers or traders in securities or currencies and holders whose “functional currency” is not the U.S. dollar. This summary does not address U.S. estate and gift tax consequences or tax consequences under any state and local tax laws or non-U.S. tax laws.




As used in this section, the term “U.S. Holder” means a beneficial owner of subordinate voting shares that is for U.S. federal income tax purposes:




(a)
an individual citizen or resident of the United States;




(b)
a corporation created or organized under the laws of the United States or any state thereof and the District of Columbia;




(c)
an estate the income of which is subject to United States federal income taxation regardless of its source;




(d)
a trust if (1) a court within the United States is able to exercise primary supervision over its administration and one or more U.S. persons as described in Section 7701 (a) (30) of the Code have authority to control all substantial decisions of the trust or (2) the trust has a valid election in effect under applicable U.S. Treasury regulations to be treated as a U.S. person; or




(e)
any other person whose worldwide income or gain is otherwise subject to U.S. federal income taxation on a net income basis.




If a partnership or other flow-through entity holds subordinate voting shares, the U.S. federal income tax treatment of a partner will generally depend upon the status of the partner or other owner and upon the activities of the partnership or other flow-through entity.  If you are a partner of a partnership holding subordinate voting shares, you should consult your tax advisor.




Holders of subordinate voting shares who are not U.S. Holders, sometimes referred to as “Non-U.S. Holders”, should also consult their own tax advisors, particularly as to the applicability of any tax treaty.




The following discussion is based upon:


●
the Code;
 
 ●
U.S. judicial decisions;
 ●
administrative pronouncements;
 ●
existing and proposed Treasury regulations; and
 ●
the Canada – U.S. Income Tax Treaty.


Any of the above is subject to change, possibly with retroactive effect, so as to result in U.S. federal income tax consequences different from those discussed below. We have not requested, and will not request, a ruling from the U.S. Internal Revenue Service (the “IRS”) with respect to any of the U.S. federal income tax consequences described below, and as a result, there can be no assurance that the IRS will not disagree with or challenge any of the conclusions we have reached and described here.







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The following discussion is for general information only and is not intended to be, nor should it be construed to be, legal or tax advice to any holder of subordinate voting shares and no opinion or representation with respect to the U.S. federal income tax consequences to any holder is made.  Holders of subordinate voting shares are urged to consult their tax advisors as to the particular consequences to them under U.S. federal, state, local and applicable non-U.S. tax laws of the acquisition, ownership and disposition of subordinate voting shares.




Dividends




Subject to the discussion of passive foreign investment companies below, the gross amount of any distribution paid by us to a U.S. Holder will generally be subject to U.S. federal income tax as foreign source dividend income to the extent paid out of our current or accumulated earnings and profits, as determined under U.S. federal income tax principles. Such income will be includable in the gross income of a U.S. Holder on the day received by the U.S. Holder.  The amount of any distribution of property other than cash will be the fair market value of such property on the date of the distribution. In the case of a taxable corporate U.S. Holder, such dividends will be taxable as ordinary income and will not be eligible for the corporate dividends received deduction, which is generally allowed to U.S. corporate shareholders on dividends received from a domestic corporation. In the case of a non-corporate U.S. Holder, including individuals, such dividends should generally be eligible for a maximum tax rate of 23.8% provided, as we believe to be the case, that we are not a “passive foreign investment company”. To the extent that an amount received by a U.S. Holder exceeds such holder’s allocable share of our current and accumulated earnings and profits, such excess will be applied first to reduce such U.S. Holder’s tax basis in his subordinate voting shares, thereby increasing the amount of gain or decreasing the amount of loss recognized on a subsequent disposition of the subordinate voting shares. Then, to the extent such distribution exceeds such U.S. Holder’s tax basis, it will be treated as capital gain. We do not currently maintain calculations of our earnings and profits for U.S. federal income tax purposes.




The gross amount of distributions paid in Canadian dollars, or any successor or other foreign currency, will be included in the income of such U.S. Holder in a U.S. dollar amount calculated by reference to the spot exchange rate in effect on the day the distributions are paid regardless of whether the payment is in fact converted into U.S. dollars.  If the Canadian dollars, or any successor or other foreign currency, are converted into U.S. dollars on the date of the payment, the U.S. Holder should not be required to recognize any foreign currency gain or loss with respect to the receipt of Canadian dollars as distributions. The U.S. Holder will have a basis in any Canadian dollars or other foreign currency distributed equal to their U.S. dollar value on the payment date.  If, instead, the Canadian dollars are converted at a later date, any currency gains or losses resulting from the conversion of the Canadian dollars will be treated as U.S. source ordinary income or loss. U.S. Holders are urged to consult their own tax advisors concerning the U.S. tax consequences of acquiring, holding and disposing of Canadian dollars.




A U.S. Holder may be entitled to deduct, or claim a foreign tax credit for, Canadian taxes that are withheld on dividends received by the U.S. Holder, subject to applicable limitations in the Code. The limitation on foreign taxes eligible for credit is calculated separately with respect to specific classes of income. For this purpose, such dividends should generally constitute foreign source “passive category income” or, in the case of certain U.S. Holders, “general category income”. The rules governing the foreign tax credit are complex. U.S. Holders are urged to consult their tax advisors regarding the availability of the foreign tax credit under their particular circumstances.




A Non-U.S. Holder of subordinate voting shares generally will not be subject to U.S. federal income or withholding tax on dividends received on subordinate voting shares unless such income is effectively connected with the conduct by such Non-U.S. Holder of a trade or business in the United States.







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Sale or Exchange




A U.S. Holder’s initial tax basis in the subordinate voting shares will generally be cost to the holder. A U.S. Holder’s adjusted tax basis in the subordinate voting shares will generally be the same as cost, but may differ for various reasons including the receipt by such holder of a distribution that was not made up wholly of earnings and profits as described above under the heading “Dividends.” Subject to the discussion of passive foreign investment companies below, gain or loss realized by a U.S. Holder on the sale or other disposition of subordinate voting shares will be subject to U.S. federal income taxation as capital gain or loss in an amount equal to the difference (if any) between the U.S. Holder’s adjusted tax basis (determined in U.S. dollars) in the subordinate voting shares and the U.S. dollar value of the amount realized on the disposition of such subordinate voting shares. Capital gains of non-corporate U.S. Holders, including individuals, derived with respect to a sale, exchange or other disposition of subordinate voting shares held for more than one year are subject to a maximum federal income tax rate of 23.8%. The deductibility of capital losses is subject to limitations. In the case of a non-corporate U.S. Holder, the federal tax rate applicable to capital gains will depend upon:


●
the holder’s holding period for the subordinate voting shares, with a preferential rate available for subordinate voting shares held for more than one year; and
 
 ●
the holder’s marginal tax rate for ordinary income.




Any gain realized will generally be treated as U.S. source gain, and loss realized by a U.S. Holder generally also will be treated as from sources within the United States.




The ability of a U.S. Holder to utilize foreign taxes as a credit to offset U.S. taxes is subject to complex limitations and conditions. The consequences of the separate limitation calculation will depend upon the nature and sources of each U.S. Holder’s income and the deductions allocable thereto. Alternatively, a U.S. Holder may elect to claim all foreign taxes paid as an itemized deduction in lieu of claiming a foreign tax credit. A deduction does not reduce U.S. tax on a dollar-for-dollar basis like a tax credit, but the availability of the deduction is not subject to the same conditions and limitations applicable to foreign tax credits.




If a U.S. Holder receives any foreign currency on the sale of subordinate voting shares, such U.S. Holder may recognize ordinary income or loss as a result of currency fluctuations between the date of the sale of subordinate voting shares and the date the sale proceeds are converted into U.S. dollars.




A Non-U.S. Holder of subordinate voting shares generally will not be subject to U.S. federal income or withholding tax on any gain realized on the sale or exchange of such subordinate voting shares unless:


●
such gain is effectively connected with the conduct by such Non-U.S. Holder of a trade or business in the United States; or
 
 ●
in the case of any gain realized by an individual Non-U.S. Holder, such Non-U.S. Holder is present in the United States for 183 days or more in the taxable year of such sale and certain other conditions are met.


Passive Foreign Investment Company




We believe that our subordinate voting shares should not currently be treated as stock of a passive foreign investment company for United States federal income tax purposes, but this conclusion is a factual determination made annually and thus may be subject to change based on future operations as well as the composition and valuation of our assets. In particular, a significant portion of our gross assets is comprised of cash and short-term investments, which the PFIC rules treat as passive without regard to the purpose for which we hold those assets. If the proportion of these passive assets were to increase relative to the fair market value of our other assets, we may be treated as a passive foreign investment company. In general, we will be a passive foreign investment company with respect to a U.S. Holder if, for any taxable year in which the U.S. Holder holds our subordinate voting shares, either:







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●
at least 75% of our gross income for the taxable year is passive income; or
 
 ●
at least 50% of the average value of our assets is attributable to assets that produce or are held for the production of passive income.




For this purpose, passive income includes, among other things, income such as:


●
dividends;
 
 ●
interest;
 ●
rents or royalties, other than certain rents or royalties derived from the active conduct of trade or business;
 ●
annuities; and
 ●
gains from assets that produce passive income.




If a non-U.S. corporation owns at least 25% by value of the stock of another corporation, the non-U.S. corporation is treated for purposes of the passive foreign investment company tests as owning its proportionate share of the assets of the other corporation and as receiving directly its proportionate share of the other corporation’s income.




If we are treated as a passive foreign investment company, a U.S. Holder that did not make a qualified electing fund election, if available, or a mark-to-market election, as described below, would be subject to special rules with respect to:


●
any gain realized on the sale or other disposition of subordinate voting shares; and
 
 ●
any “excess distribution” by us to the U.S. Holder.




Generally, “excess distributions” are any distributions to the U.S. Holder in respect of the subordinate voting shares during a single taxable year that are greater than 125% of the average annual distributions received by the U.S. Holder in respect of the subordinate voting shares during the three preceding taxable years or, if shorter, the U.S. Holder’s holding period for the subordinate voting shares.




Under the passive foreign investment company rules,


●
the gain or excess distribution would be allocated ratably over the U.S. Holder’s holding period for the subordinate voting shares;
 
 ●
the amount allocated to the taxable year in which the gain or excess distribution was realized and to taxable years prior to the first year in which we were classified as a PFIC would be taxable as ordinary income; and
 ●
the amount allocated to each other prior year would be subject to tax as ordinary income at the highest tax rate in effect for that year, and the interest charge generally applicable to underpayments of tax would be imposed in respect of the tax attributable to each such year.




A U.S. Holder owning actually or constructively “marketable stock” of a passive foreign investment company may be able to avoid the imposition of the passive foreign investment company tax rules described above by making a mark-to-market election. Generally, pursuant to this election, a U.S. Holder would include in ordinary income or, subject to the following sentence, loss, for each taxable year during which such stock is held, an amount equal to the difference as of the close of the taxable year between the fair market value of its stock and its adjusted tax basis in such stock.  Any mark-to-market loss is treated as an ordinary deduction, but only to the extent of the ordinary income that the U.S. Holder has included pursuant to the election in prior taxable years.  The electing U.S. Holder’s basis in its stock would be adjusted to reflect any of these income or loss amounts.  Holders desiring to make the mark-to-market election should consult their tax advisors with respect to the application and effect of making such election.







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In the case of a U.S. Holder who does not make a mark-to-market election, the special passive foreign investment company tax rules described above will not apply to such U.S. Holder if the U.S. Holder makes an election to have us treated as a qualified electing fund and we provide certain required information to holders. For a U.S. Holder to make a qualified electing fund election, we would have to satisfy certain reporting requirements. We have not determined whether we will undertake the necessary measures to be able to satisfy such requirements in the event that we were treated as a passive foreign investment company.




A U.S. Holder that makes a qualified electing fund election will be currently taxable on its pro rata share of our ordinary earnings and net capital gain, at ordinary income and capital gains rates, respectively, for each of our taxable years, regardless of whether or not distributions were received. The U.S. Holder’s basis in the subordinate voting shares will be increased to reflect taxed but undistributed income. Distributions of income that had previously been taxed will result in a corresponding reduction of basis in the subordinate voting shares and will not be taxed again as a distribution to the U.S. Holder. U.S. Holders desiring to make a qualified electing fund election should consult their tax advisors with respect to the advisability of making such election.




United States Backup Withholding and Information Reporting




A U.S. Holder will generally be subject to information reporting with respect to dividends paid on, or proceeds of the sale or other disposition of, our subordinate voting shares that are paid within the United States or through some U.S. related financial intermediaries to U.S. Holders, unless the U.S. Holder is a corporation or comes within certain other categories of exempt recipients. A U.S. Holder that is not an exempt recipient will generally be subject to backup withholding with respect to the proceeds from the sale or the disposition of, or with respect to dividends on, subordinate voting shares unless the U.S. Holder timely provides a taxpayer identification number and complies with the other applicable requirements of the backup withholding rules. A U.S Holder who fails to provide a correct taxpayer identification number may be subject to penalties imposed by the United States Internal Revenue Service.




Non-U.S. Holders will generally be subject to information reporting and possible backup withholding with respect to the proceeds of the sale or other disposition of subordinate voting shares effected within the United States, unless the holder certifies to its foreign status or otherwise establishes an exemption and the broker does not have actual knowledge or reason to know that the holder is a U.S. Holder.  Payments of dividends on or proceeds from the sale of subordinate voting shares within the United States by a payor within the United States to a non-exempt U.S. or Non-U.S. Holder will be subject to backup withholding if such holder fails to provide appropriate certification. In the case of such payments by a payor within the United States to a foreign partnership other than a foreign partnership that qualifies as a “withholding foreign partnership” within the meaning of such Treasury regulations, the partners of such partnership will be required to provide the certification discussed above in order to establish an exemption from backup withholding tax and information reporting requirements.




Backup withholding is not an additional tax.  Any amounts withheld under the backup withholding rules will be allowed as a refund or credit against a holder’s U.S. federal income tax liability, provided that the required information is furnished to the IRS.




Canadian Federal Income Tax Considerations




The following is a summary of the material Canadian federal income tax considerations generally applicable to a U.S. person who holds subordinate voting shares and who, for the purposes of the Income Tax Act(Canada) (the “ITA”), and the Canada-United States Income Tax Convention(1980) (the “Convention”), as applicable and at all relevant times:


●
is resident in the United States and not resident in Canada;
 
 ●
holds the subordinate voting shares as capital property;
 ●
does not have a “permanent establishment” or “fixed base” in Canada, as defined in the Convention; and


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  ●
deals at arm’s length with us. Special rules, which are not discussed below, may apply to “financial institutions”, as defined in the ITA, and to non-resident insurers carrying on an insurance business in Canada and elsewhere.


This discussion is based on the current provisions of the ITA and the Convention and on the regulations promulgated under the ITA, all specific proposals to amend the ITA or the regulations promulgated under the ITA announced by or on behalf of the Canadian Minister of Finance prior to the date of this Annual Report and the current published administrative practices of the Canada Revenue Agency. It does not otherwise take into account or anticipate any changes in law or administrative practice nor any income tax laws or considerations of any province or territory of Canada or any jurisdiction other than Canada, which may differ from the Canadian federal income tax consequences described in this document.




Under the ITA and the Convention, dividends paid or credited, or deemed to be paid or credited, on the subordinate voting shares to a U.S. person who owns less than 10% of the voting shares will be subject to Canadian withholding tax at the rate of 15% of the gross amount of those dividends or deemed dividends. If a U.S. person is a corporation and owns 10% or more of the voting shares, the rate is reduced from 15% to 5%. Subject to specified limitations, a U.S. person may be entitled to credit against U.S. federal income tax liability for the amount of tax withheld by Canada.




Under the Convention, dividends paid to specified religious, scientific, charitable and similar tax exempt organizations and specified organizations that are resident and exempt from tax in the United States and that have complied with specified administrative procedures are exempt from this Canadian withholding tax.




A capital gain realized by a U.S. person on a disposition or deemed disposition of the subordinate voting shares will not be subject to tax under the ITA unless the subordinate voting shares constitute taxable Canadian property within the meaning of the ITA at the time of the disposition or deemed disposition. In general, the subordinate voting shares will not be “taxable Canadian property” to a U.S. person if they are listed on a prescribed stock exchange, which includes The Toronto Stock Exchange, unless, at any time within the five-year period immediately preceding the disposition, the U.S. person, persons with whom the U.S. person did not deal at arm’s length, or the U.S. person together with those persons, owned or had an interest in or a right to acquire more than 25% of any class or series of our shares.




If the subordinate voting shares are taxable Canadian property to a U.S. person, any capital gain realized on a disposition or deemed disposition of those subordinate voting shares will generally be exempt from tax by virtue of the Convention if the value of the subordinate voting shares at the time of the disposition or deemed disposition is not derived principally from real property, as defined by the Convention, situated in Canada. The determination as to whether Canadian tax would be applicable on a disposition or deemed disposition of the subordinate voting shares must be made at the time of the disposition or deemed disposition.




Holders of subordinate voting shares are urged to consult their own tax advisors to determine the particular tax consequences to them, including the application and effect of any state, local or foreign income and other tax laws, of the acquisition, ownership and disposition of subordinate voting shares.






F.Dividends and Paying Agents




Not Applicable.






G.Statement by Experts




Not Applicable.







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H.Documents on Display




Any statement in this Annual Report about any of our contracts or other documents is not necessarily complete. If the contract or document is filed as an exhibit to the registration statement, the contract or document is deemed to modify the description contained in this Annual Report. You must review the exhibits themselves for a complete description of the contract or document.




You may review a copy of our filings with the SEC, including exhibits and schedules filed with it, at the SEC’s public reference facilities at 100 F Street, N.E., Washington, D.C. 20549 and at the regional offices of the SEC located at 233 Broadway, New York, New York 10279 and at the Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. You may also obtain copies of such materials from the Public Reference Section of the SEC, 100 F Street, N.E., Washington, D.C. 20549, at prescribed rates. You may call the SEC at 1-800-SEC-0330 for further information on the public reference rooms. The SEC maintains a Web site (http://www.sec.gov)that contains reports, proxy and information statements and other information regarding registrants that file electronically with the SEC.




You may read and copy any reports, statements or other information that we file with the SEC at the addresses indicated above and you may also access them electronically at the Web site set forth above. These SEC filings are also available to the public from commercial document retrieval services.




We are required to file reports and other information with the SEC under the Securities Exchange Act of 1934. Reports and other information filed by us with the SEC may be inspected and copied at the SEC’s public reference facilities described above. As a foreign private issuer, we are exempt from the rules under the Exchange Act prescribing the furnishing and content of proxy statements and our officers, directors and principal shareholders are exempt from the reporting and short-swing profit recovery provisions contained in Section 16 of the Exchange Act. Under the Exchange Act, as a foreign private issuer, we are not required to publish financial statements as frequently or as promptly as United States companies.






I.Subsidiary Information




See Item 4.C. of this Annual Report.







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Item 11.
Qualitative and Quantitative Disclosures about Market Risk




Market Risk




Currency Risk




Our functional currency is the Canadian dollar. In addition, we have adopted the US dollar as our reporting currency as it is the most commonly used reporting currency in our industry. We are exposed to a currency risk as a result of our export sales of products manufactured in Canada, China and Finland, the majority of which are denominated in US dollars and euros. This risk is partially hedged by forward exchange contracts and certain cost of sales and operating expenses (US dollars and euros). In addition, we are exposed to a currency risk as a result of our research and development activities in India (Indian rupees). This risk is partially hedged by forward exchange contracts. We do not enter into forward exchange contracts for trading or speculative purposes. Forward exchange contracts, which are designated as cash flow hedging instruments, qualify for hedge accounting.




The following tables summarize the forward exchange contracts in effect as at August 31, 2014, classified by expected transaction dates, none of which exceed three fiscal years, as well as the notional amounts of such contracts (in thousands of US dollars) along with the weighted average contractual forward rates under such contracts. The notional amounts of such contracts are used to calculate the contractual payments to be made under these contracts.




US dollars – Canadian dollars forward exchange contracts




Years ending August 31,2015


2016


2017Forward exchange contracts to sell US dollars in exchange for Canadian dollarsContractual amounts

$
22,200


$
13,400


$
3,400Weighted average contractual forward rates


1.0666



1.0923



1.1063




US dollars – Indian rupees forward exchange contracts




Year ending August 31,2015Forward exchange contracts to sell US dollars in exchange for Indian rupeesContractual amounts

$
2,800Weighted average contractual forward rate


62.11




Fair Value




The carrying amount of forward exchange contracts is equal to fair value, which represents the amount at which they could be settled based on estimated current market rates. The fair value of our forward exchange contracts amounted to net losses of $497,000 as at August 31, 2014.







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The following table summarizes significant derivative and non-derivative financial assets and liabilities that are subject to currency risk as at August 31, 2014:




Carrying/nominal

amount

(in thousands

of US dollars)


Carrying/nominal

amount

(in thousands

of euros)Financial assetsCash

$
15,382


€
3,353Accounts receivable


33,127



6,32548,509



9,678Financial liabilitiesAccounts payable and accrued liabilities


10,824



880Forward exchange contracts (nominal amount)


3,800



–14,624



880Net exposure

$
33,885


€
8,798




The value of the Canadian dollar compared to the US dollar was CA$1.0858 = US$1.00 as at August 31, 2014.




The value of the Canadian dollar compared to the euro was CA$1.4319 = €1.00 as at August 31, 2014.




The following sensitivity analysis summarizes the effect that a change in the value of the Canadian dollar (compared to the US dollar and euro) on derivatives and non-derivatives financial assets and liabilities denominated in US dollars and euros, would have on net earnings, net earnings per diluted share and comprehensive income, based on the foreign exchange rates as at August 31, 2014:


●
An increase (decrease) of 10% in the period-end value of the Canadian dollar compared to the US dollar would decrease (increase) net earnings by and $3.0 million, or $0.05 per diluted share, as at August 31, 2014.
 
 
 ●
An increase (decrease) of 10% in the period-end value of the Canadian dollar compared to the euro would decrease (increase) net earnings by $1.1 million or $0.02 per diluted share, as at August 31, 2014.
 
 
 ●
An increase (decrease) of 10% in the period-end value of the Canadian dollar compared to the US dollar would increase (decrease) comprehensive income by $2.6 million as at August 31, 2014.




The impact of the change in the value of the Canadian dollar compared to the US dollar and the euro on these derivative and non-derivative financial assets and liabilities is recorded in the foreign exchange gain or loss line item in the consolidated statements of earnings, except for outstanding forward contracts, which impact is recorded in other comprehensive income. The change in the value of the Canadian dollar compared to the US dollar and the euro also impacts our balances of income tax recoverable or payable, as well as deferred income tax assets and liabilities denominated in US dollars and euros; this may result in additional and significant foreign exchange gains or losses. However, these tax-related assets and liabilities are not considered financial instruments and are excluded from the sensitivity analysis above. The foreign exchange rate fluctuations also flow through the statements of earnings line items, as a significant portion of our cost of sales and operating expenses is denominated in Canadian dollars, euros and Indian rupees, and we report our results in US dollars; that effect is not reflected in the sensitivity analysis above.







118
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Interest rate risk




We have limited exposure to interest risk. We are mainly exposed to interest rate risks through our cash and short-term investments.




Cash




As at August 31, 2014, our cash balances included an amount of $30.1 million that bears interest at a rate of 1.5%.




Short-term investments




Our Short-term investments consist of the following as at August 31, 2014:




Bankers acceptance denominated in Canadian dollars, bearing interest at an annual rate of 1.1%, maturing in September 2014

$
4,730Term deposits denominated in Indian rupees, bearing interest at an annual rate of 9.0%, maturing in December 2014 and January 2015


569Term deposits denominated in Indian rupees, bearing interest at an annual rate of 8.0%, maturing between September 2014 and May 2015


427$
5,726




Due to their short-term maturity of usually three months or less, our short-term investments are not subject to significant fair value interest rate risk. Accordingly, changes in fair value have been nominal to the degree that amortized cost approximates the fair value. Any change in the fair value of our short-term investments, all of which are classified as available for sale, is recorded in other comprehensive income. Based on market value, the fair value of our short-term investments amounted to $5.7 million as at August 31, 2014.




Other financial instruments




Accounts receivable, other assets and accounts payable and accrued liabilities are non-interest-bearing financial assets and liabilities. Accounts receivable, other assets and accounts payable are financial instruments whose carrying value approximates their fair value due to their relatively short-term maturity.




Credit risk




Financial instruments that potentially subject us to credit risk consist primarily of cash, short-term investments, accounts receivable and forward exchange contracts (with a positive fair value). As at August 31, 2014, our short-term investments consist of debt instruments issued by a high-credit quality corporations. These debt instruments are not expected to be affected by a significant liquidity risk. Our cash and forward exchange contracts are held with or issued by high-credit quality financial institutions; therefore, we consider the risk of non-performance on these instruments to be limited.




Generally, we do not require collateral or other security from our customers for trade accounts receivable; however, credit is extended to customers following an evaluation of creditworthiness. In addition, we perform ongoing credit reviews of all our customers and establish an allowance for doubtful accounts receivable when accounts are determined to be uncollectible. Allowance for doubtful accounts amounted to $396,000 as at August 31, 2014.




In fiscal 2014, no customer represented more than 10% of our sales.







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The following table summarizes the age of trade accounts receivable as at August 31, 2014 (in thousands of US dollars):




Current

$
36,700Past due, 0 to 30 days


5,508Past due, 31 to 60 days


1,372Past due, more than 60 days, less allowance for doubtful accounts of $396


2,451Total trade accounts receivable

$
46,031




Liquidity risk




Liquidity risk is defined as the potential that we cannot meet our obligations as they become due.




The following table summarizes the contractual maturity of our derivative and non-derivative financial liabilities as at August 31, 2014 (in thousands of US dollars):




0-12

months


13-24

months


25-36

MonthsAccounts payable and accrued liabilities

$
28,990


$
–


$
–Forward exchange contractsOutflow (nominal amount)


25,000



13,400



3,400Inflow


(24,675
)


(13,480
)


(3,464
)Total

$
29,315


$
(80
)

$
(64
)




As at August 31, 2014, we had $59.8 million in cash and short-term investments and $48.0 million in accounts receivable. In addition to these financial assets, we have unused available lines of credit totaling $15.4 million for working capital and other general corporate purposes, including potential acquisitions and our share repurchase program as well as unused lines of credit of $22.0 million for foreign currency exposure related to our forward exchange contracts.






Item 12.
Description of Securities Other than Equity Securities




Not Applicable.








PART II.






Item 13.
Defaults, Dividend Arrearages and Delinquencies




Not Applicable.






Item 14.
Material Modifications to the Rights of Security Holders and Use of Proceeds




Not Applicable.







120
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Item 15.
Controls and Procedures




(a) Disclosure Controls and Procedures




Under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures as at the end of the period covered by this Annual Report. Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that these disclosure controls and procedures are effective as at August 31, 2014.




(b) Management’s Annual Report on Internal Control over Financial Reporting




Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our 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).




EXFO’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of EXFO; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with IFRS, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of EXFO; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of EXFO’s assets that could have a material effect on the financial statements.




Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.




Management conducted an evaluation of the effectiveness of EXFO’s internal control over financial reporting based on the criteria established in Internal Control – Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this evaluation, management concluded that EXFO’s internal control over financial reporting was effective as at August 31, 2014.




(c) Attestation Report of the Registered Public Accounting Firm




The effectiveness of EXFO’s internal control over financial reporting at August 31, 2014, has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.




(d) Changes in Internal Control over Financial Reporting




There were no changes in our internal control over financial reporting during the period covered by this Annual Report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.







121
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Item 16.
[Reserved]




Item 16A.
Audit Committee Financial Expert


Our Board of Directors has determined that Mr. Claude Séguin, chairman of our Audit Committee, is an Audit Committee financial expert. Mr. Séguin is independent of management, in accordance with the CSA Standards as described in Item 6C – Board Practices of this Annual Report. For a description of Mr. Séguin’s education and experience, please refer to Item 6A. The other members of the Audit Committee are Mr. Pierre-Paul Allard, Mr. Darryl Edwards, Mr. Guy Marier and Mr. Randy E. Tornes, all of whom are independent. For a description of their respective education and experience, please also refer to Item 6A.




Item 16B.
Code of Ethics


In 2003, we adopted a code of ethics that applies to our chief executive officer, our chief financial officer and our manager of financial reporting and accounting. A copy of this code of ethics has been filed as exhibit 11.1 to our 2010 Annual Report. In March 2005, the Board adopted and, in 2010 and 2013, updated the following policies:


●
Code of Ethics for our Principal Executive Officer and Senior Financial Officers;
 
 ●
Board of Directors Corporate Governance Guidelines;
 ●
Ethics and Business Conduct Policy;
 
 
 ●
Statement of Reporting Ethical Violations (Whistleblower).




A copy of those policies has been filed respectively as exhibits 11.1 and 11.2 inclusively to our 2010 Annual Report and as exhibits 11.3 and 11.4 to our 2013 Annual Report. All these policies are also readily available on our website at www.EXFO.com. Accordingly, we believe that our corporate governance practices are in alignment to current regulatory requirements. We will provide without charge to each person, on the written or oral request of such person, a copy of our code of ethics. Requests for such copies should be directed to us at the following address: 400 Godin Avenue, Quebec, Quebec, G1M 2K2, Canada, Attention: Corporate Secretary, telephone number (418) 683-0211.




Item 16C.
Principal Accountant Fees and Services


Audit Fees




During the financial years ended August 31, 2013 and 2014, our principal accountant, PricewaterhouseCoopers LLP, billed us aggregate amounts of $357,000 and $358,000 respectively for the audit of our annual consolidated financial statements and services in connection with statutory and regulatory filings.




Audit-Related Fees




During the financial years ended August 31, 2013 and 2014, our principal accountant, PricewaterhouseCoopers LLP, billed us aggregate amounts of $99,000 and $80,000 respectively for audit-related fees namely for the quarterly review of interim consolidated financial statements and the IFRS convergence project.




Tax Fees




During the financial years ended August 31, 2013 and 2014, our principal accountant, PricewaterhouseCoopers LLP, billed us aggregate amounts of $110,000 and $147,000 respectively for services related to tax compliance, tax advice and tax planning.


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All Other Fees




No other fees were billed in fiscal 2013 and 2014.




Audit Committee Pre-Approval Policies and Procedures




Our Audit Committee Charter requires that the Audit Committee give prior approval of the annual audit plan (refer to Item 6C for further details on the Audit Committee Charter). In the event any adjustments to the audit plan may be required during the course of a financial year, such adjustments shall be approved by the chairman of the Audit Committee, acting alone, and shall be reported to the full Audit Committee at its next meeting.




In the case of non-audit services (excluding tax matters), the policy provides that proposals shall be submitted to the chairman of the Audit Committee and our chief financial officer at the same time and the chairman of the Audit Committee will be responsible for approval of such proposal, subject to any modifications that he may require. The chairman will make a report to the full Audit Committee at its next meeting.




As concerns tax services to be provided by our principal accountant, our policy provides that the principal accountant will present to the Audit Committee for pre-approval, on or before the beginning of each financial year, an engagement for tax matters that are foreseeable for the upcoming year and the Audit Committee shall be responsible for pre-approval thereof, subject to any modifications it may make to such proposals. In the event tax services are required that were not pre-approved by the Audit Committee, the procedure set forth in the previous paragraph will apply.




During the financial year ended on August 31, 2014, 100% of tax fees were approved by the Audit Committee pursuant to this policy. During the financial year ended on August 31, 2014, only full-time permanent employees of our principal accountant, PricewaterhouseCoopers LLP, performed work to audit our financial statements.




Item 16D.
Exemptions from the Listing Standards for Audit Committees


Not Applicable.







Item 16E.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers




Issuer Purchases of Equity Securities




On January 8, 2014, we announced the approval of the renewal of the share repurchase program effective from January 13, 2014 to January 12, 2015, by way of a normal course issuer bid on the open market of up to 2,043,101 subordinate voting shares (“2014 NCIB”).




From September 1, 2013 through November 10, 2014, we spent approximately US$1.4million (including fees) to repurchase 351,743subordinate voting shares.


123
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 Period
(a) Total

Number

of Shares

(or Units)

Purchased

(#)
(b) Average Price Paid

per Share (or Units)
(c) Total Number of

Shares (or Units)

Purchased as Part of

Publicly Announced

Plans or Programs

(#)
(d) Maximum Number

of Shares (or Units) that

May Yet Be Purchased

Under the Plans or

Programs

(#)NASDAQ

(US$)
TSX

(CA$)From September 1, 2013
‒
‒
‒
‒
1,569,965To September 30, 2013From October 1, 2013
‒
‒
‒
‒
1,569,965To October 31, 2013From November 1, 2013
‒
‒
‒
‒
1,569,965To November 11, 2013From November 12, 2013
‒
‒
‒
‒
‒To November 30, 2013From December 1, 2013
‒
‒
‒
‒
‒To December 31, 2013From January 1, 2014
‒
‒
‒
‒
‒To January 12, 2014From January 13, 2014
117,316
4.33
4.74
117,316
2,043,101To January 31, 2014From February 1, 2014
97,154
4.35
4.79
97,154
1,828,631To February 28, 2014From March 1, 2014
‒
‒
‒
‒
1,828,631To March 31, 2014From April 1, 2014
‒
‒
‒
‒
1,828,631To April 30, 2014From May 1, 2014
‒
‒
‒
‒
1,828,631To May 31, 2014From June 1, 2014
‒
‒
‒
‒
1,828,631To June 30, 2014From July 1, 2014
‒
‒
‒
‒
1,828,631To July 31, 2014From August 1, 2014
‒
‒
‒
‒
1,828,631To August 31, 2014From September 1, 2014
‒
‒
‒
‒
1,828,631To September 30, 2014From October 1, 2014
92,048
3.61
4.05
92,048
1,736,583To October 31, 2014From November 1, 2014
45,225
3.69
4.15
45,225
1,691,358To November 10, 2014Total
351,743


351,743
   124
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Item 16F.                      Change in Registrant’s Certifying Accountant




Not Applicable.






Item 16G.                      Corporate Governance




The Corporation’s corporate governance practices do not differ significantly from the practices followed by United States domestic companies listed on the NASDAQ National Market. A copy of the Corporation’s Corporate Governance Policies are included as Exhibits 11.1 and 11.2 to our 2010 Annual Report on Form 20-F; as Exhibits 11.8 and 11.9 to our 2011 Annual Report on Form 20-F, as Exhibit 11.3, 11.4, 11.10, 11.11 and 11.12, to our 2013 Annual Report on Form 20-F and as Exhibits 11.5, 11.6 and 11.7 to this Annual Report on Form 20-F.






Item 16H.                      Mine Safety Disclosure




Not Applicable.








PART III.






Item 17.
Financial Statements




Not Applicable.






Item 18.
Financial Statements




See pages F-4 to F-43.





125
 Table of Contents





Item 19.
Exhibits




Number
Exhibit1.1
Amended Articles of Incorporation of EXFO (incorporated by reference to Exhibit 3.1 of EXFO’s Registration Statement on Form F-1 filed on June 9, 2000, File No. 333-38956).1.2
Amended By-laws of EXFO (incorporated by reference to Exhibit 1.2 of EXFO’s Annual Report on Form-20F dated January 15, 2003, File No. 000-30895).1.3
Amended and Restated Articles of Incorporation of EXFO (incorporated by reference to Exhibit 1.3 of EXFO’s Annual Report on Form 20-F dated January 18, 2001, File No. 000-30895).1.4
Certificate of Amendment, Canada Business Corporations Act (incorporated by reference to Exhibit 10.1 of EXFO’s Annual Report on Form 20-F dated November 25, 2009, File No. 000-30895).1.5
Certificate of Amendment (Change of Name), Canada Business Corporations Act (incorporated by reference to Exhibit 1.5 of EXFO’s Annual Report on Form 20-F dated November 24, 2010, File No. 000-30895).2.1
Form of Subordinate Voting Share Certificate (incorporated by reference to Exhibit 4.1 of EXFO’s Registration Statement on Form F-1 filed on June 9, 2000, File No. 333-38956).2.2
Form of Registration Rights Agreement between EXFO and Germain Lamonde dated July 6, 2000) (incorporated by reference to Exhibit 10.13 of EXFO’s Registration Statement on Form F-1 filed on June 9, 2000, File No. 333-38956).3.1
Form of Trust Agreement among EXFO, Germain Lamonde, GEXFO Investissements Technologiques inc., Fiducie Germain Lamonde and G. Lamonde Investissements Financiers inc. (incorporated by reference to Exhibit 4.2  of EXFO’s Registration Statement on Form F-1 filed on June 9, 2000, File No. 333-38956).4.1
Agreement of Merger and Plan of Reorganization, dated as of November 4, 2000, by and among EXFO, EXFO Sub, Inc., EXFO Burleigh Instruments, Inc., Robert G. Klimasewski, William G. May, Jr., David J. Farrell and William S. Gornall (incorporated by reference to Exhibit 4.1 of EXFO’s Annual Report on Form 20-F dated January 18, 2001, File No. 000-30895).4.2
Amendment No. 1 to Agreement of Merger and Plan of Agreement, dated as of December 20, 2000, by and among EXFO, EXFO Sub, Inc., EXFO Burleigh Instruments, Inc., Robert G. Klimasewski, William G. May, Jr., David J. Farrell and William S. Gornall (incorporated by reference to Exhibit 4.2 of EXFO’s Annual Report on Form 20-F dated January 18, 2001, File No. 000-30895).4.3
Agreement of Merger, dated as of August 20, 2001, by and among EXFO, Buyer Sub, and Avantas Networks Corporation and Shareholders of Avantas Networks corporation (incorporated by reference to Exhibit 4.3 of EXFO’s Annual Report on Form 20-F dated January 18, 2002, File No. 000-30895).4.4
Amendment No. 1 dated as of November 1, 2002 to Agreement of Merger, dated as of August 20, 2001, by and among EXFO, 3905268 Canada Inc., Avantas Networks Corporation and Shareholders of Avantas Networks (incorporated by reference to Exhibit 4.4 of EXFO’s Annual Report on Form 20-F dated January 18, 2002, File No. 000-30895).4.5
Offer to purchase shares of Nortech Fibronic Inc., dated February 6, 2000 among EXFO, Claude Adrien Noel, 9086-9314 Québec inc., Michel Bédard, Christine Bergeron and Société en Commandite Capidem Québec Enr. and Certificate of Closing, dated February 7, 2000 among the same parties (including summary in English) (incorporated by reference to Exhibit 10.2 of EXFO’s Registration Statement on Form F-1 filed on June 9, 2000, File No. 333-38956).4.6
Share Purchase Agreement, dated as of March 5, 2001, among EXFO Electro-Optical Engineering, Inc., John Kennedy, Glenn Harvey and EFOS Corporation (incorporated by reference to Exhibit 4.1 of EXFO’s Registration Statement on Form F-3 filed on July 13, 2001, File No. 333-65122). 
 126
 Table of Contents
   Number
Exhibit
 4.7
Amendment Number One, dated as of March 15, 2001, to Share Purchase Agreement, dated as of March 5, 2001, among EXFO Electro-Optical Engineering, Inc., John Kennedy, Glenn Harvey and EFOS Corporation. (incorporated by reference to Exhibit 4.2 of EXFO’s Registration Statement on Form F-3 filed on July 13, 2001, File No. 333-65122).4.8
Share Purchase Agreement, dated as of November 2, 2001 between JDS Uniphase Inc. and 3905268 Canada Inc. (incorporated by reference to Exhibit 4.8 of EXFO’s Annual Report on Form 20-F dated January 18, 2002, File No. 000-30895).4.9
Intellectual Property Assignment and Sale Agreement between EFOS Inc., EXFO Electro-Optical Engineering, Inc., John Kennedy, Glenn Harvey and EFOS Corporation. (incorporated by reference to Exhibit 4.3 of EXFO’s Registration Statement on Form F-3 filed on July 13, 2001, File No. 333-65122).4.10
Offer to acquire a building, dated February 23, 2000, between EXFO and Groupe Mirabau inc. and as accepted by Groupe Mirabau inc. on February 24, 2000 (including summary in English) (incorporated by reference to Exhibit 10.3 of EXFO’s Registration Statement on Form F-1 filed on June 9, 2000, File No. 333-38956).4.11
Lease Agreement, dated December 1, 1996, between EXFO and GEXFO Investissements Technologiques inc., as assigned to 9080-9823 Québec inc. on September 1, 1999 (including summary in English) (incorporated by reference to Exhibit 10.4 of EXFO’s Registration Statement on Form F-1 filed on June 9, 2000, File No. 333-38956).4.12
Lease Agreement, dated March 1, 1996, between EXFO and GEXFO Investissements Technologiques inc., as assigned to 9080-9823 Québec inc. on September 1, 1999 (including summary in English) (incorporated by reference to Exhibit 10.5 of EXFO’s Registration Statement on Form F-1 filed on June 9, 2000, File No. 333-38956).4.13
Lease renewal of the existing leases between 9080-9823 Québec inc. and EXFO, dated November 30, 2001(incorporated by reference to Exhibit 4.13 of EXFO’s Annual Report on Form 20-F dated January 18, 2002, File No. 000-30895).4.14
Loan Agreement between EXFO and GEXFO Investissements Technologiques inc., dated May 11, 1993, as assigned to 9080-9823 Québec inc. on September 1, 1999 (including summary in English)  (incorporated by reference to Exhibit 10.9 of EXFO’s Registration Statement on Form F-1 filed on June 9, 2000, File No. 333-38956).4.15
Resolution of the Board of Directors of EXFO, dated September 1, 1999, authorizing EXFO to acquire GEXFO Distribution Internationale inc. from GEXFO Investissements Technologiques inc. (including summary in English) (incorporated by reference to Exhibit 10.10 of EXFO’s Registration Statement on Form F-1 filed on June 9, 2000, File No. 333-38956).4.16
Form of Promissory Note of EXFO issued to GEXFO Investissements Technologiques inc. dated June 27, 2000 )  (incorporated by reference to Exhibit 10.12 of EXFO’s Registration Statement on Form F-1 filed on June 9, 2000, File No. 333-38956).4.17
Term Loan Offer, dated March 28, 2000, among EXFO and National Bank of Canada as accepted by EXFO on April 3, 2000 (including summary in English) (incorporated by reference to Exhibit 10.11 of EXFO’s Registration Statement on Form F-1 filed on June 9, 2000, File No. 333-38956).4.18
Employment Agreement of Germain Lamonde dated May 29, 2000 (incorporated by reference to Exhibit 10.15 of EXFO’s Registration Statement on Form F-1 filed on June 9, 2000, File No. 333-38956).4.19
Employment Agreement of Bruce Bonini dated as of September 1, 2000 (incorporated by reference to Exhibit 4.24 of EXFO’s Annual Report on Form 20-F dated January 18, 2002, File No. 000-30895).4.20
Employment Agreement of Juan-Felipe Gonzalez dated as of September 1, 2000 (incorporated by reference to Exhibit 4.25 of EXFO’s Annual Report on Form 20-F dated January 18, 2002, File No. 000-30895).  127
 Table of Contents
  Number
Exhibit
 4.21
Employment Agreement of David J. Farrell dated as of December 20, 2000 (incorporated by reference to Exhibit 4.26 of EXFO’s Annual Report on Form 20-F dated January 18, 2002, File No. 000-30895).4.22
Deferred Profit Sharing Plan, dated September 1, 1998 (incorporated by reference to Exhibit 10.6 of EXFO’s Registration Statement on Form F-1 filed on June 9, 2000, File No. 333-38956).4.23
Stock Option Plan, dated May 25, 2000 (incorporated by Reference to Exhibit 10.7 of EXFO’s Registration Statement on Form F-1 filed on June 9, 2000, File No. 333-38956).4.24
Share Plan, dated April 3, 2000 (incorporated by reference to Exhibit 10.8 of EXFO’s Registration Statement on Form F-1 filed on June 9, 2000, File No. 333-38956).4.25
Directors’ Compensation Plan (incorporated by reference to Exhibit 10.17 of EXFO’s Registration Statement on Form F-1 filed on June 9, 2000, File No. 333-38956).4.26
Restricted Stock Award Plan, dated December 20, 2000 (incorporated by reference to Exhibit 4.21 of EXFO’s Annual Report on Form 20-F dated January 18, 2001, File No. 000-30895).4.27
Asset Purchase Agreementby and Among EXFO Electro-Optical Engineering Inc., EXFO Gnubi Products Group Inc., gnubi communications, L.P., gnubi communications General Partner, LLC, gnubi communications Limited Partner, LLC, gnubi communications, Inc., Voting Trust created by The Irrevocable Voting Trust Agreement Among Carol Abraham Bolton, Paul Abraham and James Ray Stevens, James Ray Stevens and Daniel J. Ernst dated September 5, 2002 (incorporated by reference to Exhibit 4.30 of EXFO’s Annual Report on Form 20-F dated January 15, 2003, File No. 000-30895).4.28
EXFO Protocol Inc. Executive Employment Agreement with Sami Yazdi signed November2, 2001 (incorporated by reference to Exhibit 4.28 of EXFO’s Annual Report on Form 20-F dated January 15, 2003, File No. 000-30895).4.29
Second Amending Agreement to the Employment Agreement of Bruce Bonini dated as of September 1, 2002, (incorporated by reference to Exhibit 4.29 of EXFO’s Annual Report on Form 20-F dated January 15, 2004, File No. 000-30895).4.30
Severance and General Release Agreement with Bruce Bonini dated August 8, 2003, (incorporated by reference to Exhibit 4.30 of EXFO’s Annual Report on Form 20-F dated January 15, 2004, File No. 000-30895).4.31
Separation Agreement and General Release with Sami Yazdi dated April 1, 2003, (incorporated by reference to Exhibit 4.31 of EXFO’s Annual Report on Form 20-F dated January 15, 2004, File No. 000-30895).4.32
Executive Employment Agreement of James Stevens dated as of October 4, 2003, (incorporated by reference to Exhibit 4.32 of EXFO’s Annual Report on Form 20-F dated January 15, 2004, File No. 000-30895).4.33
Termination Terms for John Holloran Jr. dated May 28, 2003, (incorporated by reference to Exhibit 4.33 of EXFO’s Annual Report on Form 20-F dated January 15, 2004, File No. 000-30895).4.34
Employment Agreement of Pierre Plamondon dated as of September 1, 2002, (incorporated by reference to Exhibit 4.34 of EXFO’s Annual Report on Form 20-F dated January 15, 2004, File No. 000-30895).4.35
Long-Term Incentive Plan, dated May 25, 2000, amended in October 2004 and effective January 12, 2005 (incorporated by reference to Exhibit 4.35 of EXFO’s Annual Report on Form 20-F dated November 29, 2005, File No. 000-30895).4.36
Deferred Share Unit Plan, effective January 12, 2005 (incorporated by reference to Exhibit 4.36 of EXFO’s Annual Report on Form 20-F dated November 29, 2005, File No. 000-30895).   128
 Table of Contents
   Number
Exhibit
 4.37
Asset Purchase Agreement by and Among EXFO Electro-Optical Engineering Inc., Consultronics Limited., Andre Rekai, Consultronics Europe Limited, Consultronics Development Kft. and Consultronics Inc. dated January 5, 2006 (incorporated by reference to Exhibit 4.37 of EXFO’s Annual Report on Form 20-F dated November 23, 2006, File No. 000-30895).4.38
Share Repurchase Program by Way of Normal Course Issuer Bid dated November 6, 2007 (incorporated by reference to EXFO’s report on Form 6-K dated November 6, 2007, file No. 000-30895).4.39
Share Purchase Agreement by and Among EXFO Electro-Optical Engineering Inc., Navtel Communications Inc. and Vengrowth Investment Fund, BDC Capital Inc. and others, dated March 26, 2008 (incorporated by reference to Exhibit 4.38 of EXFO’s Annual Report on Form 20-F dated November 26, 2008, File No. 000-30895).4.40
Agreement and Plan of Merger by and among Gexfo Distribution Internationale Inc., EXFO Service Assurance Inc. and Brix Networks, Inc. and Charles River Ventures, LLC dated April 2, 2008 (incorporated by reference to EXFO’s Material Change Report on Form 6-K dated May 2, 2008, File No. 000-30895).4.41
Issuer Tender Offer, Letter of Transmittal and Notice of Guaranteed Delivery dated November 10, 2008 (incorporated by reference as Exhibits (a) (1) (i), (a) (1) (ii) and (a) (1) (iii) to EXFO’s Schedule TO dated November 10, 2008, File No. 000-30895).4.42
Renewal of EXFO’s Share Repurchase Program by Way of Normal Course Issuer Bid dated November 6, 2008 (incorporated by reference to EXFO’s report on Form 6-K dated November 6, 2008, file No. 000-30895).4.43
Final results of Issuer Bid Tender Offer, dated December 18, 2009 (incorporated by reference to EXFO’s Material Change Report on Form 6-K dated December 19, 2008, file No. 000-30895).4.44
Share Transfer Agreement by and among GEXFO Distribution Internationale Inc. and AWS Holding AB (PicoSolve AB) and Patent Transfer Agreement by and among EXFO Electro-Optical Engineering Inc. and Starta Eget Boxen 11629 AB dated February 5, 2009 (incorporated by reference to Exhibit 4.44 of EXFO’s Annual Report on Form 20-F dated November 25, 2009, File No. 000-30895).4.45
Renewal of EXFO’s Share Repurchase Program by Way of Normal Course Issuer Bid dated November 10, 2009 (incorporated by reference to EXFO’s report on Form 6-K dated November 6, 2009, file No. 000-30895).4.46
Share Purchase Agreement by and among EXFO Finland Oy and NetHawk Oyj’s majority shareholders dated March 12, 2010 (incorporated by reference to EXFO’s Material Change Report on Form 6-K dated March 19, 2010, File No. 000-30895).4.47
Share Purchase Agreement by and among EXFO Inc. and Photonic Acquisition Inc. dated October 1, 2010 (incorporated by reference to EXFO’s Material Change Report on Form 6-K dated October 8, 2010, File No. 000-30895).4.48
Renewal of EXFO’s Share Repurchase Program by Way of Normal Course Issuer Bid dated November 5, 2010 (incorporated by reference to EXFO’s report on Form 6-K dated November 5, 2010, file No. 000-30895).4.49
Renewal of EXFO’s Share Repurchase Program by Way of Normal Course Issuer Bid dated November 7, 2011 (incorporated by reference to EXFO’s report on Form 6-K dated November 7, 2011, file No. 000-30895).4.50
Renewal of EXFO’s Share Repurchase Program by Way of Normal Course Issuer Bid dated November 7, 2012 (incorporated by reference to EXFO’s report on Form 6-K dated November 7, 2012, file No. 000-30895).4.51
Renewal of EXFO’s Share Repurchase Program by Wayof Normal Course Issuer Bid dated January 8, 2014 (incorporated by reference to EXFO’s report on Form 6-K dated January 9, 2014, file No. 000-30895).  129
 Table of Contents
  Number
Exhibit
 8.1
Subsidiaries of EXFO (list included in Item 4C of this Annual Report).11.1
Code of Ethics for our Principal Executive Officer and Senior Financial Officers (incorporated by reference to Exhibit 11.1 of EXFO’s Annual Report on Form 20-F dated November 24, 2010, File No. 000-30895).11.2
Board of Directors Corporate Governance Guidelines (incorporated by reference to Exhibit 11.2 of EXFO’s Annual Report on Form 20-F dated November 24, 2010, File No. 000-30895).11.3
Ethics and Business Conduct Policy (incorporated by reference to Exhibit 11.3 of EXFO’s Annual Report on Form 20-F dated November 25, 2013, File No. 000-30895).11.4
Statement of Reporting Ethical Violations (Whistleblower) (incorporated by reference to Exhibit 11.4 of EXFO’s Annual Report on Form 20-F dated November 25, 2013, File No. 000-30895).11.5
Audit Committee Charter.11.6
Human Resources Committee Charter.11.7
Corporate Governance Practices.11.8
Majority Voting Policy (incorporated by reference to Exhibit 11.8 of EXFO’s Annual Report on Form 20-F dated November 23, 2011, File No. 000-30895).11.9
Independent Members Committee Charter (incorporated by reference to Exhibit 11.9 of EXFO’s Annual Report on Form 20-F dated November 23, 2011, File No. 000-30895).11.10
Agent Code of Conduct (incorporated by reference to Exhibit 11.10 of EXFO’s Annual Report on Form 20-F dated November 25, 2013, File No. 000-30895).11.11
Policy Regarding Conflict Minerals (incorporated by reference to Exhibit 11.11 of EXFO’s Annual Report on Form 20-F dated November 25, 2013, File No. 000-30895).11.12
Director Share Ownership Policy (incorporated by reference to Exhibit 11.12 of EXFO’s Annual Report on Form 20-F dated November 25, 2013, File No. 000-30895).12.1
Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.12.2
Certification of the Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.13.1
Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.13.2
Certification of the Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.






130
 Table of Contents







SIGNATURES




The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this Annual Report on its behalf.










EXFO INC.














By:           /s/Germain Lamonde


Name:     Germain Lamonde


Title:       Chairman of the Board, President


and Chief Executive Officer





Date:       November 24, 2014






131
 Table of Contents






Independent Auditor's Report


To the Shareholders of
 EXFO Inc.
 
 
 We have completed integrated audits of EXFO Inc.'s and its subsidiaries 2014, 2013 and 2012 consolidated financial statements and their internal control over financial reporting as at August 31, 2014. Our opinions, based on our audits, are presented below.
 
 Report on the consolidated financial statements
 We have audited the accompanying consolidated financial statements of EXFO Inc. and its subsidiaries, which comprise the consolidated balance sheets as at August 31, 2014 and August 31, 2013 and the consolidated statements of earnings, comprehensive loss, changes in shareholders' equity and cash flows for each of the three years in the period ended August 31, 2014, and the related notes, which comprise a summary of significant accounting policies and other explanatory information.
 
 Management's responsibility for the consolidated financial statements
 Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.
 
 Auditor's responsibility
 Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. Canadian generally accepted auditing standards also require that we comply with ethical requirements.
 
 An audit involves performing procedures to obtain audit evidence, on a test basis, about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor's judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the company's preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances. An audit also includes evaluating the appropriateness of accounting principles and policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.




F-1
 Table of Contents
 We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion on the consolidated financial statements.
 
 Opinion
 In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of EXFO Inc. and its subsidiaries as at August 31, 2014 and August 31, 2013 and their financial performance and their cash flows for each of the three years in the period ended August 31, 2014 in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board.
 
 Report on internal control over financial reporting
 We have also audited EXFO Inc.'s and its subsidiaries' internal control over financial reporting as at August 31, 2014, based on criteria established in Internal Control - Integrated Framework (1992), issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
 
 Management's responsibility for internal control over financial reporting
 Management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the section "Management's Annual Report on Internal Control over Financial Reporting" included in Item 15b) of the Annual Report on Form 20-F.
 
 Auditor's responsibility
 Our responsibility is to express an opinion on the company's internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.
 
 An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control, based on the assessed risk, and performing such other procedures as we consider necessary in the circumstances.
 
 We believe that our audit provides a reasonable basis for our audit opinion on the company's internal control over financial reporting.
  F-2
 Table of Contents
 Definition of internal control over financial reporting
 A company's 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 generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
 
 Inherent limitations
 Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.
 
 Opinion
 In our opinion, EXFO Inc. and its subsidiaries maintained, in all material respects, effective internal control over financial reporting as at August 31, 2014, based on criteria established in Internal Control - Integrated Framework (1992) issued by COSO.
 
 
 
 
 
 
 Montréal, Québec, Canada
 November 24, 2014
  
 
 
 
 
 
 
 
 
 
 
 
 
 
 1 CPA auditor, CA, public accountancy permit No. A119427
 F-3
 Table of Contents




EXFO Inc.


Consolidated Balance Sheets




(in thousands of US dollars)






As at August 31,2014


2013AssetsCurrent assetsCash

$
54,121


$
45,386Short-term investments (note 5)


5,726



4,868Accounts receivable (note 5)Trade


46,031



50,117Other


2,001



2,778Income taxes and tax credits recoverable (note 18)


3,796



6,525Inventories (note 6)


35,232



35,705Prepaid expenses


2,281



2,561149,188



147,940Tax credits recoverable(note 18)


41,745



41,719Property, plant and equipment(notes 7 and 20)


42,780



45,523Intangible assets(notes 8 and 20)


7,293



7,543Goodwill(notes 8 and 20)


26,488



27,313Deferred income tax assets (note 18)


9,816



10,807Other assets


721



693$
278,031


$
281,538LiabilitiesCurrent liabilitiesAccounts payable and accrued liabilities (note 10)

$
29,553


$
26,253Provisions (note 10)


532



756Income taxes payable


840



679Current portion of long-term debt

‒



296Deferred revenue


8,990



9,46739,915



37,451Deferred revenue


3,319



3,932Deferred income tax liabilities (note 18)


3,087



3,226Other liabilities


340



47746,661



45,086Commitments (note 11)Shareholders’ equityShare capital (note 12)


111,491



109,837Contributed surplus


16,503



17,186Retained earnings


113,635



112,852Accumulated other comprehensive loss (note 13)


(10,259
)


(3,423
)231,370



236,452$
278,031


$
281,538





The accompanying notes are an integral part of these consolidated financial statements.




On behalf of the Board/s/ Germain Lamonde
/s/ Claude SéguinGERMAIN LAMONDE
CLAUDE SÉGUINChairman, President and CEO
Chairman, Audit Committee






F-4
 Table of Contents


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


Years ended August 31,2014


2013


2012Sales (note 20)

$
230,806


$
242,150


$
249,966Cost of sales(1)(note 16)


86,836



92,469



91,792Selling and administrative (note 16)


86,429



88,756



94,139Net research and development(note 16)


44,846



45,444



49,854Depreciation of property, plant and equipment (note 16)


4,995



6,028



6,169Amortization of intangible assets (note 16)


4,398



6,643



7,819Changes in fair value of cash contingent consideration


–



–



(311
)Interest and other income


(326
)


(113
)


(131
)Foreign exchange (gain) loss


(1,634
)


(4,082
)


657Earnings (loss) before income taxes


5,262



7,005



(22
)Income taxes(note 18)


4,479



5,664



3,571Net earnings (loss) for the year

$
783


$
1,341


$
(3,593
)Basic and diluted net earnings (loss) per share

$
0.01


$
0.02


$
(0.06
)Basic weighted average number of shares outstanding (000’s)


60,329



60,323



60,453Diluted weighted average number of shares outstanding (000’s)(note 19)


61,015



61,110



60,453




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





F-5
 Table of Contents


EXFO Inc.
 Consolidated Statements of Comprehensive Loss
  (in thousands of US dollars)


Years ended August 31,2014


2013


2012Net earnings (loss) for the year

$
783


$
1,341


$
(3,593
)Other comprehensive income (loss), net of income taxesItems that will not be reclassified subsequently to net earningsForeign currency translation adjustment


(7,086
)


(15,830
)


(6,875
)Items that may be reclassified subsequently to net earningsUnrealized gains/losses on forward exchange contracts


(618
)


(1,256
)


185Reclassification of realized gains/losses on forward exchange contracts in net earnings (loss)


959



(247
)


(1,108
)Deferred income tax effect of gains/losses on forward exchange contracts


(91
)


403



256Other comprehensive loss


(6,836
)


(16,930
)


(7,542
)Comprehensive loss for the year

$
(6,053
)

$
(15,589
)

$
(11,135
)







F-6
 Table of Contents






EXFO Inc.


Consolidated Statements of Changes in Shareholders' Equity




(in thousands of US dollars)






Year ended August 31, 2012Share

capital


Contributed surplus


Retained earnings


Accumulated other comprehensive income


Total

shareholders’ equityBalance as at September 1, 2011

$
110,341


$
18,017


$
115,104


$
21,049


$
264,511Exercise of stock options (note 12)


310



–



–



–



310Redemption of share capital (note 12)


(1,696
)


(540
)


–



–



(2,236
)Reclassification of stock-based compensation costs (note 12)


2,010



(2,010
)


–



–



–Stock-based compensation costs


–



1,831



–



–



1,831Net loss for the year


–



–



(3,593
)


–



(3,593
)Other comprehensive lossForeign currency translation adjustment


–



–



–



(6,875
)


(6,875
)Changes in unrealized gains on forward exchange contracts, net of deferred income taxes of $256


–



–



–



(667
)


(667
)Total comprehensive loss for the year


–



–



(3,593
)


(7,542
)


(11,135
)Balance as at August 31, 2012

$
110,965


$
17,298


$
111,511


$
13,507


$
253,281






Year ended August 31, 2013Share

capital


Contributed surplus


Retained earnings


Accumulated other comprehensive income (loss)


Total

shareholders’ equityBalance as at September 1, 2012

$
110,965


$
17,298


$
111,511


$
13,507


$
253,281Exercise of stock options (note 12)


87



–



–



–



87Redemption of share capital (note 12)


(2,565
)


(531
)


–



–



(3,096
)Reclassification of stock-based compensation costs (note 12)


1,350



(1,350
)


–



–



–Stock-based compensation costs


–



1,769



–



–



1,769Net earnings for the year


–



–



1,341



–



1,341Other comprehensive lossForeign currency translation adjustment


–



–



–



(15,830
)


(15,830
)Changes in unrealized gains/losses on forward exchange contracts, net of deferred income taxes of $403


–



–



–



(1,100
)


(1,100
)Total comprehensive income (loss) for the year


–



–



1,341



(16,930
)


(15,589
)Balance as at August 31, 2013

$
109,837


$
17,186


$
112,852


$
(3,423
)

$
236,452






Year ended August 31, 2014Share

capital


Contributed surplus


Retained earnings


Accumulated other comprehensive loss


Total

shareholders’ equityBalance as at September 1, 2013

$
109,837


$
17,186


$
112,852


$
(3,423
)

$
236,452Exercise of stock options (note 12)


225



–



–



–



225Redemption of share capital (note 12)


(831
)


(106
)


–



–



(937
)Reclassification of stock-based compensation costs (note 12)


2,260



(2,260
)


–



–



–Stock-based compensation costs


–



1,683



–



–



1,683Net earnings for the year


–



–



783



–



783Other comprehensive income (loss)Foreign currency translation adjustment


–



–



–



(7,086
)


(7,086
)Changes in unrealized losses on forward exchange contracts, net of deferred income taxes of $91


–



–



–



250



250Total comprehensive income (loss) for the year


–



–



783



(6,836
)


(6,053
)Balance as at August 31, 2014

$
111,491


$
16,503


$
113,635


$
(10,259
)

$
231,370






F-7
 Table of Contents






EXFO Inc.


Consolidated Statements of Cash Flows




(in thousands of US dollars)




Years ended August 31,2014


2013


2012Cash flows from operating activitiesNet earnings (loss) for the year

$
783


$
1,341


$
(3,593
)Add (deduct) items not affecting cashChanges in discount on short-term investments


–



–



45Stock-based compensation costs


1,696



1,768



1,862Depreciation and amortization


9,393



12,671



13,988Changes in fair value of cash contingent consideration


–



–



(311
)Deferred revenue


(804
)


(1,266
)


(506
)Deferred income taxes


891



2,951



2,050Changes in foreign exchange gain/loss


(491
)


(1,091
)


(1,510
)11,468



16,374



12,025Changes in non-cash operating itemsAccounts receivable


3,578



(14,765
)


7,974Income taxes and tax credits


1,447



(4,205
)


(5,570
)Inventories


(734
)


2,916



10,879Prepaid expenses


210



993



(589
)Other assets


92



(703
)


–Accounts payable and accrued liabilities and provisions


3,832



(2,373
)


643Other liabilities


(107
)


(258
)


(105
)19,786



(2,021
)


25,257Cash flows from investing activitiesAdditions to short-term investments


(34,222
)


(54,489
)


(115,886
)Proceeds from disposal and maturity of short-term investments


33,208



57,514



152,797Additions to capital assets (notes 7 and 8)


(7,931
)


(8,026
)


(23,849
)(8,945
)


(5,001
)


13,062Cash flows from financing activitiesBank loan


–



–



(782
)Repayment of long-term debt


(307
)


(589
)


(577
)Exercise of stock options


225



87



310Redemption of share capital


(937
)


(3,096
)


(2,236
)(1,019
)


(3,598
)


(3,285
)Effect of foreign exchange rate changes on cash


(1,087
)


(2,862
)


1,063Change in cash


8,735



(13,482
)


36,097Cash – Beginning of year


45,386



58,868



22,771Cash – End of year

$
54,121


$
45,386


$
58,868Supplementary informationInterest received

$
550


$
668


$
591Interest paid

$
16


$
37


$
76Income taxes paid

$
1,272


$
1,373


$
1,494






F-8
 Table of Contents


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




1
Nature of Activities and Incorporation




EXFO Inc. and its subsidiaries (together “EXFO” or the company) design, manufacture and market test, service assurance and quality of experience solutions for wireless and wireline network operators and equipment manufacturers in the global telecommunications industry. The company’s core-to-edge solutions assess the performance and reliability of converged Internet protocol (IP) fixed and mobile networks.




EXFO is a company incorporated under the Canada Business Corporations Act and domiciled in Canada. The address of its headquarters is 400 Godin Avenue, Quebec, Province of Quebec, Canada, G1M 2K2.




These consolidated financial statements were authorized for issue by the Board of Directors on November 24, 2014.




2
Basis of Presentation


These consolidated financial statements have been prepared in accordance with the International Financial Reporting Standards (IFRS), as issued by the International Accounting Standards Board (IASB). The company has consistently applied the same accounting policies through all periods presented.




These IFRS consolidated financial statements have been prepared based on the following accounting policies:




Basis of measurement




These consolidated financial statements have been prepared under the historical cost convention, except for the revaluation of derivative financial instruments and available-for-sale investments.




Consolidation




These consolidated financial statements include the accounts of the company and its domestic and international subsidiaries. Intercompany accounts and transactions have been eliminated.




Revenue recognition




Revenue comprises the fair value of the consideration received or receivable for the sales of goods and services in the ordinary course of business.




Sales of goods




Revenue from the sales of goods, which represents the majority of the sales of the company, is recognized when the significant risks and rewards of ownership of the goods have passed to the buyer, usually upon delivery of the goods. Revenue is recorded based on the price specified in the sales arrangement.




Maintenance contracts




Maintenance contracts are usually offered to customers for periods of 12 to 36 months. They generally include the right to unspecified upgrades and enhancements on a when-and-if-available basis as well as customer service. Revenue from these contracts is recognized ratably over the terms of the maintenance contracts on a straight-line basis.






F-9
 Table of Contents
  EXFO Inc.
 Notes to Consolidated Financial Statements
  (tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)
  Extended warranties




Extended warranties are usually offered to customers for periods of 6 to 48 months. Revenue from these extended warranties is recognized ratably over the warranty period on a straight-line basis.




Multiple-component arrangements




When a sales arrangement includes multiple separately identifiable components such as goods, extended warranties, maintenance contracts and installation, the revenue recognition criteria are applied to each separately identifiable component. A component is considered separately identifiable if the delivered item has value to the customer on a stand-alone basis and the fair value associated with the component can be measured reliably. The company allocates the selling price of a multiple-component arrangement to each component based on the fair value of each component in relation to the fair value of the arrangement as a whole.




Sales arrangements may include acceptance clauses. When a sales arrangement does include an acceptance provision, acceptance occurs upon the earliest of receipt of a written customer acceptance or expiration of the acceptance period. For these sales arrangements, the sale is recognized when acceptance occurs.




Presentation currency




The functional currency of the company is the Canadian dollar. The company has adopted the US dollar as its presentation currency as it is the most commonly used reporting currency in its industry. The consolidated financial statements are translated into the presentation currency as follows: assets and liabilities are translated at the exchange rate in effect on the date of the balance sheet; revenues and expenses are translated at the monthly average exchange rate. The foreign currency translation adjustment arising from such translation is included in accumulated other comprehensive income in the shareholders’ equity.




Foreign currency translation




a)
Foreign currency transactions




Transactions denominated in currencies other than the functional currency are translated into the relevant functional currency as follows: Monetary assets and liabilities are translated at the exchange rate in effect on the date of the balance sheet, and revenues and expenses are translated at the exchange rate in effect on the date of the transaction. Non-monetary assets and liabilities measured at historical cost and denominated in a foreign currency are translated using the exchange rate at the date of the transaction, whereas non-monetary items that are measured at fair value and denominated in a foreign currency are translated using the exchange rates at the date when the fair value was determined. Foreign exchange gains and losses arising from such translation are included in the consolidated statements of earnings.




b)
Foreign operations




Each foreign operation determines its own functional currency and items included in the financial statements of each foreign operation are measured using that functional currency. The financial statements of each foreign operation that has a functional currency different from the company are translated into Canadian dollars as follows: Assets and liabilities are translated at the exchange rate in effect on the date of the balance sheet, whereas revenues and expenses are translated at the monthly average exchange rate. The foreign currency translation adjustment arising from such translation is included in accumulated other comprehensive income in the shareholders’ equity.




F-10
 Table of Contents
 EXFO Inc.
 Notes to Consolidated Financial Statements
  (tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)


Financial instruments




The classification of financial instruments depends on the intended purpose when the financial instruments were acquired or issued, as well as on their characteristics and designation by the company.




Classification




Financial assets




Cash
Loans and receivablesShort-term investments
Available for saleAccounts receivable
Loans and receivablesOther assets
Loans and receivables




Financial liabilities




Accounts payable and accrued liabilities
Other financial liabilitiesLong-term debt
Other financial liabilities




Available-for-sale financial assets




Available-for-sale financial assets are non-derivative financial assets that are designated as available for sale, or are not classified in any of the other categories. They are initially recognized at fair value plus transaction costs andthey are subsequently measured at fair value. After their initial recognition, any changes in their fair value are reflected in other comprehensive income.




Loans and receivables




Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. After their initial measurement at fair valueplus transaction costs, they are carried at amortized cost, using the effective interest rate method, which generally corresponds to the nominal amount due to their short-term maturity.




Other financial liabilities




Other financial liabilities are non-derivative financial liabilities initially measured at fair valueplus transaction costs and they are subsequently carried at amortized cost, using the effective interest rate method, which generally corresponds to the nominal amount due to their short-term maturity.




Derivative financial instruments and hedging activities




Forward exchange contracts are utilized by the company to manage its foreign currency exposure. Forward exchange contracts are entered into by the company to hedge anticipated US-dollar-denominated sales and the related accounts receivable as well as Indian-rupee-denominated operating expenses and the related accounts payable. The company’s policy is not to utilize those derivative financial instruments for trading or speculative purposes.




The company’s forward exchange contracts, which are designated as cash flow hedging instruments, qualify for hedge accounting.




F-11
 Table of Contents
 EXFO Inc.
 Notes to Consolidated Financial Statements
  (tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)


They are initially recorded at fair value plus transaction costs and they are subsequently measured at fair value. After initial recognition, the effective portion of changes in their fair value is reflected in other comprehensive income. Any ineffective portion is recognized immediately in the consolidated statements of earnings. Upon the recognition of related hedged sales and operating expenses, accumulated changes in fair value are respectively reclassified in sales and net research and development expenses in the consolidated statements of earnings.




At the inception of a hedge relationship, the company formally designates and documents the hedge relationship to which the company wishes to apply hedge accounting, the risk management objectives, the hedging instrument, the hedged item and the method used to test effectiveness. The company assesses effectiveness of the hedge relationship at inception and on an ongoing basis using the dollar-offset method.




Fair value hierarchy




The company classifies its derivative and non-derivative financial assets and liabilities measured at fair value using the fair value hierarchy as follows:




Level 1:
Quoted prices (unadjusted) in active market for identical assets or liabilities;




Level 2:
Inputs other than quoted prices included within level 1 that are observable for the asset and liability, either directly or indirectly;




Level 3:
Unobservable inputs for the asset or liability.




The company’s short-term investments and forward exchange contracts are measured at fair value at each balance sheet date. The company’s short-term investments are classified within level 1 of the fair value hierarchy because they are valued using quoted market prices in active markets. The company’s forward exchange contracts are classified within level 2 of the fair value hierarchy because they are valued using quoted prices and forward foreign exchange rates at the balance sheet dates.




Short-term investments




All investments with original terms to maturity of three months or less and that are not required for the purposes of meeting short-term cash requirements are classified as short-term investments. Short-term investments are classified as available-for-sale financial assets; therefore, they are carried at fair value in the balance sheet, and any changes in their fair value are reflected in other comprehensive income. Upon the disposal or maturity of these assets, accumulated changes in their fair value are reclassified in the consolidated statements of earnings.




Inventories




Inventories are valued on an average cost basis, at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course of business less the estimated costs necessary to make the sale.




The cost of work in progress and finished goods includes material, labor and an allocation of manufacturing overhead.




Property, plant and equipment and depreciation




Property, plant and equipment are recorded at cost, net of accumulated depreciation and accumulated impairment losses. Such cost is reduced by related research and development tax credits.






F-12
 Table of Contents
 EXFO Inc.
 Notes to Consolidated Financial Statements
  (tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)


Depreciation is provided on a straight-line basis over the estimated useful lives of the asset as follows:




TermLand improvements

15 yearsBuildings

20 to 60 yearsEquipment

3 to 15 yearsLeasehold improvements

The lesser of useful life and remaining lease term




The assets’ residual values and useful lives are reviewed at each financial year-end, and adjusted prospectively, if appropriate.




Intangible assets, goodwill and amortization




Intangible assets




Intangible assets with finite useful lives primarily include the cost of core technology, customer relationships, brand name and software. The cost of intangible assets acquired in a business combination is the fair value of the assets at the date of acquisition. Following initial recognition, intangible assets are carried at cost less accumulated amortization and accumulated impairment losses. Amortization is provided on a straight-line basis over the estimated useful lives of five years for core technology, customer relationships and brand name, and four and ten years for software. None of the company’s intangible assets were developed internally.




The amortization method and the useful lives of intangible assets are reviewed at each financial year-end, and adjusted prospectively, if appropriate.




Goodwill




Goodwill represents the excess of the purchase price of acquired businesses over the estimated fair value of net identifiable assets acquired, and is allocated to each cash-generating unit (CGU) or group of CGUs that are expected to benefit from the related business combination. A group of CGUs represents the lowest level within the company at which the goodwill is monitored for internal management purposes, which is not higher than an operating segment. Goodwill is not amortized but must be tested for impairment on an annual basis or more frequently if events or circumstances indicate that it might be impaired.




Research and development




All costs related to research are expensed as incurred, net of related tax credits and grants. Development costs are expensed as incurred, net of related tax credits and grants, unless they meet the recognition criteria of intangible assets of IAS 38, “Intangible Assets’’, in which case they are capitalized, net of related tax credits and grants and amortized on a straight-line basis over the estimated benefit period. Research and development expenses are mainly comprised of salaries and related expenses, material costs as well as fees paid to third-party consultants. As at August 31, 2013 and 2014, the company had not capitalized any development costs.




The company elected to account for non-refundable research and development tax credits under IAS 20, “Accounting for Governmental Grants and Disclosures of Governmental Assistance’’, and as such, these tax credits are presented against gross research and development expenses in the consolidated statements of earnings. Non-refundable research and development tax credits are included in earnings or deducted from the related assets, provided there is reasonable assurance that the company has complied and will comply with the conditions related to the tax credits and that the tax credits will be received.






F-13
 Table of Contents


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








Impairment of non-financial assets




The company assesses at each reporting date whether there is an indication that the carrying value of property, plant and equipment and finite-life intangible assets may not be recoverable. Non-financial assets that are not amortized (such as goodwill) are subject to an annual impairment test. If any indication exists, or when annual impairment testing is required, the company estimates the asset or asset group’s recoverable amount. For the purpose of measuring recoverable amounts, assets are grouped at the lowest levels for which there are separately identifiable cash flows (CGUs). The recoverable amount is the higher of an asset or CGU’s fair value less costs of disposal and its value in use. Where the carrying value of an asset or CGU exceeds its recoverable amount, the asset or the CGU is considered impaired and is written down to its recoverable amount. The company performs its annual goodwill impairment test in the fourth quarter of each fiscal year.




For property, plant and equipment and finite-life intangible assets, the reversal of impairment is limited so that the carrying value of the asset does not exceed its recoverable amount, nor exceed the carrying value that would have been determined, net of depreciation or amortization, had no impairment loss been recognized for the asset in prior periods. Impairment losses on goodwill are not reversed.




Leases




Operating leases are leases for which the company does not assume substantially all the risks and rewards of ownership of the asset. Operating lease rentals are charged to the consolidated statements of earnings on a straight-line basis over the lease term.




As at August 31, 2013 and 2014, all significant leases of the company were classified as operating leases.




Government grants




Grants related to operating expenses are included in earnings when the related expenses are incurred. Grants related to capital expenditures are deducted from the related assets. Grants are included in earnings or deducted from the related assets, provided there is reasonable assurance that the company has complied and will comply with all the conditions related to the grants and that the grants will be received.




Warranty




The company offers its customers basic warranties of one to three years, depending on the specific products and terms of the purchase agreement. The company’s typical warranties require it to repair or replace defective products during the warranty period at no cost to the customer. Costs related to basic warranties are accrued at the time of shipment, based upon estimates of expected rework and warranty costs to be incurred. Costs associated with separately priced extended warranties are expensed as incurred.




Income taxes




Income taxes comprise current and deferred income taxes.




Current income taxes




The current income tax assets and liabilities for the current and prior years are measured at the amount expected to be recovered or paid to the taxation authorities. The income tax rates used to calculate the amount are those that are enacted or substantively enacted at the balance sheet dates in the tax jurisdiction where the company generates taxable income/loss.






F-14
 Table of Contents
 EXFO Inc.
 Notes to Consolidated Financial Statements
  (tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)


Deferred income taxes




The company provides for deferred income taxes using the liability method. Under this method, deferred income tax assets and liabilities are determined based on deductible or taxable temporary differences between financial statement values and tax values of assets and liabilities as well as the carry-forward of unused tax losses and deductions, using enacted or substantively enacted income tax rates at the balance sheet dates, that are expected to be in effect for the years in which the assets are expected to be recovered or the liabilities to be settled.




Deferred income tax assets are recognized only to the extent that it is probable that future taxable income will be available against which the deductible temporary differences as well as unused tax losses and deductions can be utilized.




Deferred tax liabilities are recognized for all taxable temporary differences and for taxable temporary differences arising on investments in subsidiaries, except where the reversal of these temporary differences can be controlled and it is probable that the differences will not reverse in the foreseeable future.




Deferred income tax assets and liabilities are presented as non-current in the consolidated balance sheets.




Uncertain tax positions




The company is subject to income tax laws and regulations in several jurisdictions. There are many transactions and calculations during the course of business for which the ultimate tax determination is uncertain. The company maintains provisions for uncertain tax positions that it believes appropriately reflect its risk. These provisions are made using the best estimate of the amount expected to be paid based on a qualitative assessment of all relevant factors. The company reviews the adequacy of these provisions at the end of the reporting periods and any changes in the provisions are recognized in the statements of earnings when they occur. However, it is possible that at some future dates, liabilities in excess of the company’s provisions could result from audits by, or litigation with, the relevant taxing authorities. Where the final outcome of these tax-related matters is different from the amounts that were initially recorded, such differences will be recognized in the statement of earnings in the period in which such determination is made.




Earnings per share




Basic earnings per share are calculated by dividing net earnings attributable to common equity holders of the company by the weighted average number of common shares outstanding during the year.




Diluted earnings per share are calculated by dividing net earnings attributable to common equity holders of the company by the weighted average number of common shares outstanding during the year, plus the effect of dilutive potential common shares outstanding during the year. This method requires that diluted earnings per share be calculated (using the treasury stock method) as if all dilutive potential common shares had been exercised at the latest at the beginning of the year or on the date of issuance, as the case may be, and that the funds obtained thereby (plus an amount equivalent to the unamortized portion of related stock-based compensation costs) be used to purchase common shares of the company at the average market price of the common shares during the year.






F-15
 Table of Contents


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








Stock-based compensation




Equity-settled awards




The company’s stock options, restricted share units and deferred share units are equity-settled awards. The company accounts for stock-based compensation costs on equity-settled awards using the Black-Scholes option valuation model. The fair value of equity-settled awards is measured at the date of grant. Stock-based compensation costs are amortized to expense over the vesting periods together with a corresponding change in contributed surplus in the shareholders’ equity. For equity-settled awards with graded vesting, each tranche is considered a separate grant with a different vesting date and fair value, and each tranche is accounted for separately.




Cash-settled awards




The company’s stock appreciation rights are cash-settled awards. The company accounts for stock-based compensation costs on cash-settled awards using the Black-Scholes option valuation model. The fair value of the cash-settled awards is remeasured at the end of each reporting period, with any changes in the fair value recognized in the consolidated statements of earnings.




Operating segments




Operating segments are defined as components of an entity engaged in business activities form which it may earn revenues and incur expenses, and whose operating results are regularly reviewed by the chief operating decision maker (CODM) to make decisions about resources to be allocated to segments and assess their performance and for which discrete information is available. The company’s CODM is the Chief Executive Officer who reviews consolidated results for the purposes of allocating resources and evaluation performance. Accordingly, the company determined that it operates within one operating segment as of, and for the years ended August 31, 2012, 2013 and 2014. Entity-wide disclosures are presented in note 20.




Critical accounting judgments and estimates in applying accounting policies




The preparation of financial statements in accordance with IFRS requires management to make judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses as well as the disclosures of contingent assets and liabilities at the date of the financial statements. Actual results could differ from those judgments, estimates and assumptions.




Critical judgments, estimates and assumptions are the following:




Critical judgments




a)
Determination of functional currency




The company operates in multiple countries and generates revenue and incurs 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 the company and its subsidiaries may require significant judgment. In determining the functional currency of the company and its subsidiaries, management takes into account primary, secondary and tertiary indicators. When indicators are mixed and the functional currency is not obvious, management uses its judgment to determine the functional currency.






F-16
 Table of Contents
 EXFO Inc.
 Notes to Consolidated Financial Statements
  (tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)


b)
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




a)
Inventories




The company states its inventories at the lower of cost, determined on an average cost basis, and net realizable value, and provides reserves for excess and obsolete inventories. The company determines its reserves for excess and obsolete inventories based on the quantities on hand at the reporting dates compared to foreseeable needs over the next 12 months, taking into account changes in demand, technology or market.


b)
Income taxes
 
 The company is 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 laws and regulations and the amount and timing of future taxable income. The company maintains provisions for uncertain tax positions that it believes appropriately reflect its risk based on its interpretation of laws and regulations. In addition, management has made reasonable estimates and assumptions to determine the amount of deferred tax assets that can be recognized in the consolidated financial statements, based upon the likely timing and level of anticipated future taxable income together with tax planning strategies. The ultimate realization of the company’s 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.


c)
Tax credits recoverable


Tax credits are recorded provided that there is reasonable assurance that the company has 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 the company’s non-refundable tax credits is dependent upon the generation of sufficient future taxable income during the tax credits carry-forward periods. Management has made reasonable estimates and assumptions to determine the amount of non-refundable tax credits that can be recognized in the consolidated financial statements, based upon the likely timing and level of anticipated future taxable income together with tax planning strategies (note 18).


d)
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 is based on available data from a binding sales agreement in an arm’s length transaction, including data from recent transactions of similar assets, within the same industry, when available, available data from observable active market prices less incremental costs for disposing of the asset, or the company’s stock price. To supplement this information or when such information is not available, the company uses discounted cash flows. The establishment of discounted cash flows requires the use of estimates and assumptions, including management’s expectations of future revenue growth, operating costs and profit margins as well as discount rates for each CGU. Estimates and assumptions used to establish discounted cash flows are described in note 8.






F-17
 Table of Contents
 EXFO Inc.
 Notes to Consolidated Financial Statements
  (tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)


i)
Growth rates




The assumptions used are based on the company’s historical growth, internal budget, expectations of future revenue growth, sales funnel, as well as industry and market trends.




ii)
Discount rate




The discount rate used by the company represents its weighted average cost of capital (WACC), plus a premium to take into account specific risks of the CGU, as the case may be.




New IFRS pronouncements and amendments




Adopted during the year




The company has adopted the following amended and new standards, effective September 1, 2013. These changes were made in accordance with the applicable transitional provisions.




Consolidation




IFRS 10, “Consolidated Financial Statements”, requires an entity to consolidate an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. IFRS 10 replaces Standing Interpretations Committee (“SIC”) 12, “Consolidation — Special Purpose Entities”, and parts of IAS 27, “Consolidated and Separate Financial Statements”. The adoption of IFRS 10 had no impact on the company’s consolidated financial statements.




Joint arrangements




IFRS 11, “Joint Arrangements”, requires a venturer to classify its interest in a joint arrangement as a joint venture or joint operations. Joint ventures are accounted for using the equity method of accounting whereas for a joint operation, the venture recognizes its share of the assets, liabilities, revenues and expenses of the joint operation. IFRS 11 replaces IAS 31, “Interests in Joint Ventures”, and SIC 13, “Jointly Controlled Entities — Non-Monetary Contributions by Venturers”. The adoption of IFRS 11 had no impact on the company’s consolidated financial statements.




Disclosure of interests in other entities




IFRS 12, “Disclosure of Interests in Other Entities”, establishes disclosure requirements for interests in other entities, such as subsidiaries, joint arrangements, associates and structured entities. This standard carries forward existing disclosures and introduces significant additional disclosure requirements that address the nature of, and risks associated with, an entity’s interests in other entities. The adoption of IFRS 12 had no impact on the company’s consolidated financial statements.




Fair value measurement




IFRS 13, “Fair Value Measurement”, is a comprehensive standard for fair value measurement and disclosure requirements for use across all IFRS standards. The new standard clarifies that fair value is the price that would be received to sell an asset, or paid to transfer a liability in an orderly transaction between market participants, at the measurement date. It also establishes disclosures about fair value measurement. Under existing IFRS, guidance on measuring and disclosing fair value is dispersed among the specific standards requiring fair value measurements and, in many cases, does not reflect a clear measurement basis or consistent disclosures. The adoption of IFRS 13 did not require any adjustment to the valuation techniques used by the company to measure fair value. The company provided the required additional disclosure in its consolidated financial statements (note 5).






F-18
 Table of Contents
 EXFO Inc.
 Notes to Consolidated Financial Statements
  (tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)


Financial instruments




IFRS 7, “Financial Instruments: Disclosures”,has been amended to enhance disclosure requirements related to offsetting of financial assets and liabilities. The adoption of these amendments had no impact on the company’s consolidated financial statements.




Issued but not yet adopted




Financial instruments




IFRS 9, “Financial Instruments”, was issued in October 2010 and will replace IAS 39, “Financial Instruments: Recognition and Measurement”. IFRS 9 uses a single approach to determine whether a financial asset is measured at amortized cost or fair value, replacing the multiple rules in IAS 39. The approach in IFRS 9 is based on how an entity manages its financial instruments in the context of its business model and the contractual cash flow characteristics of the financial assets. Most of the requirements in IAS 39 for classification and measurement of financial liabilities were carried forward unchanged to IFRS 9. The new standard also requires a single impairment method to be used, replacing the multiple impairment methods in IAS 39. Requirements relating to hedge accounting representing a new hedge accounting model have also been added to IFRS 9. The new standard is effective for annual periods beginning on or after January 1, 2018 and must be applied retrospectively. The company has not yet assessed the impact that the new standard will have on its consolidated financial statements.




Revenue from contracts with customers




IFRS 15, “Revenue from Contracts with Customers”, was issued in May 2014. The objective of this new standard is to provide a single, comprehensive revenue recognition model for all contracts with customers to improve comparability. This new standard contains principles that an entity will apply to determine the measurement of revenue and timing of when it is recognized. The underlying principle is that an entity will recognize revenue to depict the transfer of goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services. Thisnew standard is effective for annual periods beginning on or after January 1, 2017. Early adoption is permitted. The company has not yet assessed the impact that the new standard will have on its consolidated financial statements or whether or not to early adopt the new standard.




3
Restructuring Charges


In June 2012, the company implemented a restructuring plan to align its cost structure to the challenging market environment. This plan resulted in one-time severance expenses of $2,418,000. During the year ended August 31, 2012, the company recorded charges of $2,329,000 in severance expenses under that plan. The remaining expenses of $89,000 were recorded during the year ended August 31, 2013 (note 16).




4
Capital Disclosures


The company is not subject to any external restrictions on its capital.




The company’s objectives when managing capital are:


●
To maintain a flexible capital structure that optimizes the cost of capital at acceptable risk;
 
 ●
To sustain future development of the company, including research and development activities, market development and potential acquisitions of complementary businesses or products; and
 ●
To provide the company’s shareholders with an appropriate return on their investment.


F-19
 Table of Contents
 EXFO Inc.
 Notes to Consolidated Financial Statements
  (tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)


No changes were made to the objectives and policies during the years ended August 31, 2013 and 2014.





The company defines its capital as shareholders’ equity, excluding accumulated other comprehensive loss. The capital of the company amounted to $239,875,000 and $241,629,000 as at August 31, 2013 and 2014 respectively.




5
Financial Instruments


The following tables summarize financial instruments by category:




As at August 31, 2014Loans and receivable


Available

for sale


Other

financial

liabilities


Derivatives

used for

hedging


TotalFinancial assetsCash

$
54,121


$
–


$
–


$
–


$
54,121Short-term investments

$
–


$
5,726


$
–


$
–


$
5,726Accounts receivable

$
47,981


$
–


$
–


$
–


$
47,981Other assets

$
114


$
–


$
–


$
–


$
114Forward exchange contracts

$
–


$
–


$
–


$
193


$
193Financial liabilitiesAccounts payable and accrued liabilities

$
–


$
–


$
28,990


$
–


$
28,990Forward exchange contracts

$
–


$
–


$
–


$
690


$
690







As at August 31, 2013Loans and receivable


Available

for sale


Other

financial

liabilities


Derivatives

used for

hedging


TotalFinancial assetsCash

$
45,386


$
–


$
–


$
–


$
45,386Short-term investments

$
–


$
4,868


$
–


$
–


$
4,868Accounts receivable

$
52,895


$
–


$
–


$
–


$
52,895Other assets

$
167


$
–


$
–


$
–


$
167Financial liabilitiesAccounts payable and accrued liabilities

$
–


$
–


$
25,679


$
–


$
25,679Forward exchange contracts

$
–


$
–


$
–


$
722


$
722Long-term debt

$
–


$
–


$
296


$
–


$
296




Fair value




Cash, accounts receivable and accounts payable and accrued liabilities are financial instruments whose carrying values approximate their fair values due to their short-term maturities. The fair value of other assets and the long-term debt approximates their carrying value due to their relatively short-term maturities.




F-20
 Table of Contents
 EXFO Inc.
 Notes to Consolidated Financial Statements
  (tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)


The fair value of derivative and non-derivative financial assets and liabilities measured at fair value by level of hierarchy is as follows:




As at August 31, 2014


As at August 31, 2013Level 1


Level 2


Level 1


Level 2Financial assetsShort-term investments

$
5,726


$
–


$
4,868


$
–Forward exchange contracts

$
–


$
193


$
–


$
–Financial liabilitiesForward exchange contracts

$
–


$
690


$
–


$
808




Market risk




Currency risk




The functional currency of the company is the Canadian dollar. The company is exposed to a currency risk as a result of its export sales of products manufactured in Canada, China and Finland, the majority of which are denominated in US dollars and euros. This risk is partially hedged by forward exchange contracts and certain cost of sales and operating expenses (US dollars and euros). In addition, the company is exposed to a currency risk as a result of its research and development activities in India (Indian rupees). This risk is 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, 2013 and 2014, the company held contracts to sell US dollars for Canadian dollars and Indian rupees at various forward rates, which are summarized as follows:




US dollars – Canadian dollars




Expiry dates

Contractual

amounts


Weighted average

contractual forward ratesAs at August 31, 2013September 2013 to August 2014

$
22,200



1.0280September 2014 to August 2015


15,000



1.0529September 2015 to August 2016


5,000



1.0716Total

$
42,200



1.0420As at August 31, 2014September 2014 to August 2015

$
22,200



1.0666September 2015 to August 2016


13,400



1.0923September 2016 to December 2016


3,400



1.1063Total

$
39,000



1.0789




US dollars – Indian rupees


Expiry dates

Contractual

amounts


Weighted average

contractual forward ratesAs at August 31, 2014September 2014 to August 2015

$
2,800



62.11






F-21
 Table of Contents
 EXFO Inc.
 Notes to Consolidated Financial Statements
  (tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)


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 $808,000 and $497,000 as at August 31, 2013 and 2014.




As at August 31, 2014, forward exchange contracts of $51,000 are presented as current assets in other accounts receivable, forward exchange contracts of $142,000 are presented as long-term assets in other long-term assets, forward exchange contracts of $563,000 are presented as current liabilities in accounts payable and accrued liabilities and forward exchange contracts of $127,000 are presented as long-term liabilities in other long-term liabilities in the balance sheet. Forward exchange contracts of $116,000 included in accounts payable and accrued liabilities are recorded in the statement of earnings; otherwise, other forward exchange contracts are not yet recorded in the statement of earnings.




As at August 31, 2013, forward exchange contracts of $574,000 were presented as current liabilities in accounts payable and accrued liabilities and forward exchange contracts of $148,000 were presented as long-term liabilities in other long-term liabilities in the balance sheet.




Based on the portfolio of forward exchange contracts as at August 31, 2014, the company estimates that the portion of net unrealized losses on these contracts as of that date, which will be realized and reclassified from accumulated other comprehensive income to net earnings over the next 12 months, amounts to $396,000.




For the years ended August 31, 2012, 2013 and 2014, the company recognized within its sales foreign exchange gains (losses) on forward exchange contracts of $1,125,000, $380,000 and $(909,000) respectively.




The following table summarizes significant derivative and non-derivative financial assets and liabilities that are subject to currency risk as at August 31, 2013 and 2014:




As at August 31,2014


2013Carrying/nominal

amount (in thousands

of US dollars)


Carrying/nominal

amount (in thousands

of euros)


Carrying/nominal

amount (in thousands

of US dollars)


Carrying/nominal

amount (in thousands

of euros)Financial assetsCash

$
15,382


€
3,353


$
9,728


€
2,106Accounts receivable


33,127



6,325



33,191



5,28448,509



9,678



42,919



7,390Financial liabilitiesAccounts payable and accrued liabilities


10,824



880



10,355



1,075Forward exchange contracts (nominal value)


3,800



–



3,800



–14,624



880



14,155



1,075Net exposure

$
33,885


€
8,798


$
28,764


€
6,315




The value of the Canadian dollar compared to the US dollar was CA$1.0530 = US$1.00 and CA$1.0858 = US$1.00 as at August 31, 2013 and 2014 respectively.




The value of the Canadian dollar compared to the euro was CA$1.3936 = €1.00 and CA$1.4319 = €1.00 as at August 31, 2013 and 2014 respectively.




The following sensitivity analysis summarizes the effect that a change in the value of the Canadian dollar (compared to the US dollar and euro) on derivative and non-derivative financial assets and liabilities denominated in US dollars and euros would have on net earnings, net earnings per diluted share and comprehensive income, based on the foreign exchange rates as at August 31, 2013 and 2014:






F-22
 Table of Contents
 EXFO Inc.
 Notes to Consolidated Financial Statements
  (tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)
 ●
An increase (decrease) of 10% in the period-end value of the Canadian dollar compared to the US dollar would decrease (increase) net earnings by $2,702,000, or $0.04 per diluted share, and $3,001,000, or $0.05 per diluted share, as at August 31, 2013 and 2014 respectively.
 ●
An increase (decrease) of 10% in the period-end value of the Canadian dollar compared to the euro would decrease (increase) net earnings by $870,000, or $0.01 per diluted share, and $1,142,000 or $0.02 per diluted share, as at August 31, 2013 and 2014 respectively.
 ●
An increase (decrease) of 10% in the period-end value of the Canadian dollar compared to the US dollar would increase (decrease) comprehensive income by $2,951,000 and $2,617,000 as at August 31, 2013 and 2014 respectively.




The impact of the change in the value of the Canadian dollar compared to the US dollar and the euro on these derivative and non-derivative financial assets and liabilities is recorded in the foreign exchange gain or loss line item in the consolidated statements of earnings, except for outstanding forward contracts, whose impact is recorded in other comprehensive income. The change in the value of the Canadian dollar compared to the US dollar and the euro also affects the company’s balances of income tax recoverable or payable, as well as deferred income tax assets and liabilities denominated in US dollars and euros; this may result in additional and significant foreign exchange gains or losses. However, these tax-related assets and liabilities are not considered financial instruments and are excluded from the sensitivity analysis above. The foreign exchange rate fluctuations also flow through the statements of earnings line items, as a significant portion of the company’s cost of sales and operating expenses are denominated in Canadian dollars, euros and Indian rupees, and the company reports its results in US dollars; that effect is not reflected in the sensitivity analysis above.




Interest rate risk




The company has limited exposure to interest rate risk. The company is mainly exposed to interest rate risks through its cash and short-term investments.




Cash




As at August 31, 2013 and 2014, the company’s cash balances included an amount of $30,392,000 and $30,102,000 respectively that bears interest at an annual rate of 1.5%.




Short-term investments




Short-term investments consist of the following:




As at August 312014


2013Bankers acceptance denominated in Canadian dollars, bearing interest at an annual rate of 1.1%, maturing in September 2014

$
4,730


$
–Term deposits denominated in Indian rupees, bearing interest at an annual rate of 9.0%, maturing in December 2014 and January 2015


569



–Term deposits denominated in Indian rupees, bearing interest at an annual rate of 8.0%, maturing between September 2014 and May 2015 (note 9)


427



–Commercial paper denominated in Canadian dollars, bearing interest at an annual rate of 1.2%, matured in October 2013


–



4,868$
5,726


$
4,868




F-23
 Table of Contents
 EXFO Inc.
 Notes to Consolidated Financial Statements
  (tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)


Due to their short-term maturity of usually three months or less, the company’s short-term investments are not subject to a significant fair value interest rate risk. Accordingly, changes in fair value have been nominal to the degree that amortized cost approximates the fair value. Any change in the fair value of the company’s short-term investments, all of which are classified as available for sale, is recorded in other comprehensive income.




Other financial instruments




Accounts receivable, other assets and accounts payable and accrued liabilities are non-interest-bearing financial assets and liabilities.




Credit risk




Financial instruments that potentially subject the company to credit risk consist of cash, short-term investments, accounts receivable, other assets and forward exchange contracts (with a positive fair value). As at August 31, 2014, the company’s short-term investments consist of debt instruments issued by three (one as at August 31, 2013) high-credit quality corporations. These debt instruments are not expected to be affected by a significant liquidity risk. The company’s cash and forward exchange contracts are held with or issued by high-credit quality financial institutions; therefore, the company considers the risk of non-performance on these instruments to be limited.




Generally, the company does not require collateral or other security from customers for trade accounts receivable; however, credit is extended to customers following an evaluation of creditworthiness. In addition, the company performs ongoing credit reviews of all its customers and establishes an allowance for doubtful accounts receivable when accounts are determined to be uncollectible. Allowance for doubtful accounts amounted to $766,000 and $396,000 as at August 31, 2013 and 2014, respectively.




For the years ended August 31, 2013 and 2014, no customer represented more than 10% of sales.




The following table summarizes the age of trade accounts receivable:




As at August 31,2014


2013Current

$
36,700


$
41,557Past due, 0 to 30 days


5,508



6,210Past due, 31 to 60 days


1,372



2,088Past due, more than 60 days, net of allowance for doubtful accounts of $766 and $396 as at August 31, 2013 and 2014, respectively


2,451



262$
46,031


$
50,117




Changes in the allowance for doubtful accounts are as follows:




Years ended August 31,2014


2013Balance – Beginning of year

$
766


$
583Addition charged to earnings


210



323Write-off of uncollectible accounts


(580
)


(140
)Balance – End of year

$
396


$
766




F-24
 Table of Contents
 EXFO Inc.
 Notes to Consolidated Financial Statements
  (tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)


Liquidity risk




Liquidity risk is defined as the potential that the company cannot meet its obligations as they become due.




The following tables summarize the contractual maturity of the company’s derivative and non-derivative financial liabilities:




As at August 31, 20140-12

months


13-24

months


25-36

monthsAccounts payable and accrued liabilities

$
28,990


$
–


$
–Forward exchange contractsOutflow


25,000



13,400



3,400Inflow


(24,675
)


(13,480
)


(3,464
)Total

$
29,315


$
(80
)

$
(64
)
  
 As at August 31, 20130-12

months


13-24

months


25-36

monthsAccounts payable and accrued liabilities

$
25,679


$
–


$
–Long-term debt


296



–



–Forward exchange contractsOutflow


22,200



15,000



5,000Inflow


(21,673
)


(14,999
)


(5,088
)Total

$
26,502


$
1


$
(88
)




As at August 31, 2014, the company had $59,847,000 in cash and short-term investments and $48,032,000 in accounts receivable. In addition to these financial assets, the company has unused available lines of credit totaling $15,407,000 for working capital and other general corporate purposes, including potential acquisitions and its share repurchase program as well as unused lines of credit totaling $21,993,000 for foreign currency exposure related to its forward exchange contracts (note 9).




6
Inventories


As at August 31,2014


2013Raw materials

$
16,464


$
16,645Work in progress


1,100



1,179Finished goods


17,668



17,881$
35,232


$
35,705






F-25
 Table of Contents


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








The cost of sales comprised almost exclusively the amount of inventory recognized as an expense during the reporting years, and amounts to $98,147,000 and $90,445,000 as at August 31, 2013 and 2014 respectively, including related depreciation and amortization, which are shown separately in operating expenses (note 16).




Inventory write-down amounted to $3,838,000, $4,120,000 and $4,600,000 for the years ended August 31, 2012, 2013 and 2014 respectively.


7
Property, Plant and Equipment
  Land and land improvements


Buildings


Equipment


Leasehold improvements


TotalCost as at September 1, 2012

$
5,585


$
38,355


$
47,962


$
2,367


$
94,269Additions


5



866



3,824



167



4,862Disposals


–



–



(6,569
)


–



(6,569
)Foreign currency translation adjustment


(358
)


(2,439
)


(2,661
)


(171
)


(5,629
)Cost as at August 31, 2013


5,232



36,782



42,556



2,363



86,933Additions


148



18



3,550



164



3,880Disposals


–



–



(5,799
)


(34
)


(5,833
)Foreign currency translation adjustment


(158
)


(1,203
)


(1,337
)


(51
)


(2,749
)Cost as at August 31, 2014

$
5,222


$
35,597


$
38,970


$
2,442


$
82,231Accumulated depreciation as at September 1, 2012

$
1,317


$
6,242


$
36,171


$
691


$
44,421Depreciation for the year


62



664



4,935



367



6,028Disposals


–



–



(6,423
)


–



(6,423
)Foreign currency translation adjustment


(71
)


(437
)


(2,033
)


(75
)


(2,616
)Accumulated depreciation as at August 31, 2013


1,308



6,469



32,650



983



41,410Depreciation for the year


58



697



3,891



349



4,995Disposals


–



–



(5,633
)


(40
)


(5,673
)Foreign currency translation adjustment


(39
)


(182
)


(1,020
)


(40
)


(1,281
)Accumulated depreciation as at August 31, 2014

$
1,327


$
6,984


$
29,888


$
1,252


$
39,451Net carrying value as at:August 31, 2013

$
3,924


$
30,313


$
9,906


$
1,380


$
45,523August 31, 2014

$
3,895


$
28,613


$
9,082


$
1,190


$
42,780


As at August 31, 2013 and 2014, unpaid purchases of property, plant and equipment amounted to $231,000 and $356,000 respectively.




F-26
 Table of Contents


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





8
Intangible Assets and Goodwill


Intangible assets




Core technology


Customer relationships


Brand name


Software


TotalCost as at September 1, 2012

$
26,077


$
6,582


$
656


$
14,069


$
47,384Additions


145


‒


‒



515



660Disposals

‒


‒


‒



(66
)


(66
)Foreign currency translation adjustment


(1,349
)


(416
)


(42
)


(1,509
)


(3,316
)Cost as at August 31, 2013


24,873



6,166



614



13,009



44,662Additions


3,582


‒


‒



754



4,336Disposals


(15,281
)

‒


‒



(193
)


(15,474
)Foreign currency translation adjustment


(488
)


(187
)


(18
)


(645
)


(1,338
)Cost as at August 31, 2014

$
12,686


$
5,979


$
596


$
12,925


$
32,186Accumulated amortization as at September 1, 2012

$
19,122


$
3,252


$
324


$
10,554


$
33,252Amortization for the year


4,068



1,285



128



1,162



6,643Disposals

‒


‒


‒



(51
)


(51
)Foreign currency translation adjustment


(1,334
)


(258
)


(26
)


(1,107
)


(2,725
)Accumulated amortization as at August 31, 2013


21,856



4,279



426



10,558



37,119Amortization for the year


2,046



1,204



120



1,028



4,398Disposals


(15,281
)

‒


‒



(193
)


(15,474
)Foreign currency translation adjustment


(559
)


(137
)


(12
)


(442
)


(1,150
)Accumulated amortization as at August 31, 2014

$
8,062


$
5,346


$
534


$
10,951


$
24,893Net carrying value as at:August 31, 2013

$
3,017


$
1,887


$
188


$
2,451


$
7,543August 31, 2014

$
4,624


$
633


$
62


$
1,974


$
7,293Remaining amortization period as at August 31, 2014

4 years


1 year


1 year


2 years




Goodwill


Years ended August 31,2014


2013Balance – Beginning of year

$
27,313


$
29,160Foreign currency translation adjustment


(825
)


(1,847
)Balance – End of year

$
26,488


$
27,313




In the fourth quarter of fiscal 2014, the company performed its annual goodwill impairment test for its two CGUs, EXFO and Brix. For the purposes of the impairment test, goodwill was allocated as follows to the two CGUs:




As at August 31,2014


2013EXFO CGU

$
10,465


$
10,791Brix CGU


16,023



16,522Total

$
26,488


$
27,313






F-27
 Table of Contents


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








The company used a market-based approach (sales multiples) based on recent comparable transactions in its industry, supplemented by an analysis of its enterprise value derived from its market capitalization to assess the recoverable amount of the EXFO CGU. To assess the recoverable amount of the Brix CGU, the company used a combination of a market-based approach (sales multiples), based on recent comparable transactions in its industry, and discounted cash flows. The recoverable amount of the company’s CGUs is classified within level 3 of the fair value hierarchy.




The sales multiple of recent comparable transactions for both CGUs ranged between 1.9 and 5 times sales. These comparable transactions occurred in calendar 2013 and 2014.




Discounted cash flows for the Brix CGU were based on five-year management projections, using five-year sales compound annual growth rate (CAGR) of 23% and a perpetual growth rate of 2% thereafter. The company used a discount rate of 18%. Based on these assumptions (used in the discounted cash flows calculations) as well as a sales multiple of 2.0 times fiscal 2014 sales, the recoverable amount of the Brix CGU exceeds its carrying amount by 49%. The five-year sales CAGR used in the discounted cash flows calculations differs from past experience; management has determined the five-year sales CAGR based on recent market studies, the impact of recently launched and to be launched solutions, as well as its sales funnel.




The Brix CGU’s recoverable amount would equal its carrying value using five-year sales CAGR of 8%, which is below management’s expected market growth of 10% to 15% (excluding market share gains) over the five-year period used in the discounted cash flows calculations for that CGU, or a sales multiple of 1 time fiscal 2014 sales.




As at August 31, 2014, the recoverable amount for both CGUs exceeded their carrying value.




9
Credit Facilities


The company has lines of credit that provide for advances of up to CA$15,000,000 (US$13,815,000) and up to US$2,000,000. These lines of credit bear interest at the Canadian prime rate. As at August 31, 2014, an amount of CA$443,000 (US$408,000) was drawn from these lines of credit for letters of guarantee in the normal course of the company’s operations for its own selling and purchasing requirements. These lines of credit are subject to a negative pledge whereby the company has agreed with the bank not to pledge its assets to anyother party without its consent.




In addition, the company has lines of credit totaling $25,681,000 for the foreign currency risk exposure related to its US dollar – Canadian dollar forward exchange contracts (note 5). As at August 31, 2014, an amount of $4,114,000 was reserved from these lines of credit. These lines of credit are unsecured.




Finally, the company has a line of credit of INR 47,000,000 ($775,000) for the foreign currency risk exposure related to its US dollar – Indian rupee forward exchange contracts (note 5). As at August 31, 2014, an amount of INR 21,180,000 ($349,000) was reserved from this line of credit. This line of credit is secured by term deposits totaling INR 25,000,000 ($427,000) (note 5).






F-28
 Table of Contents
  EXFO Inc.
 Notes to Consolidated Financial Statements
  (tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)
 10
Accounts Payable and Accrued Liabilities and Provisions


Accounts payable and accrued liabilities




As at August 31,2014


2013Trade

$
11,848


$
10,002Salaries and social benefits


13,353



12,883Forward exchange contracts (note 5)


563



574Other


3,789



2,794$
29,553


$
26,253




Provisions




As at August 31,2014


2013Warranty

$
500


$
721Other


32



35$
532


$
756




Changes in the warranty provision are as follows:




Years ended August 31,2014


2013Balance – Beginning of year

$
721


$
675Provision


513



650Settlements


(734
)


(604
)Balance – End of year

$
500


$
721




11
Commitments


The company entered into operating leases for certain of its premises and equipment, which expire at various dates through 2020. Minimum rentals payable under operating leases are as follows:




As at August 312014


2013No later than 1 year

$
2,390


$
2,514Later than 1 year and no later than 5 years


1,993



3,479Later than 5 years


398



517$
4,781


$
6,510




For the years ended August 31, 2012, 2013 and 2014, rental expenses amounted to $4,308,000, $3,533,000 and $2,892,000 respectively.




F-29
 Table of Contents
  EXFO Inc.
 Notes to Consolidated Financial Statements
  (tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)
 12
Share Capital


Authorized – unlimited as to number, without par valueSubordinate voting and participating, bearing a non-cumulative dividend to be determined by the Board of Directors, ranking pari passu with multiple voting sharesMultiple voting and participating, entitling to 10 votes each, bearing a non-cumulative dividend to be determined by the Board of Directors, convertible at the holder’s option into subordinate voting shares on a one-for-one basis, ranking pari passu with subordinate voting shares




The following table summarizes the share capital activity:




Multiple voting shares


Subordinate voting sharesNumber


Amount


Number


Amount


Total amountBalance as at September 1, 2011


31,643,000


$
1



28,621,999


$
110,340


$
110,341Exercise of stock options (note 14)


–



–



109,700



310



310Redemption of restricted share units (note 14)


–



–



418,086



–



–Redemption of share capital


–



–



(438,894
)


(1,696
)


(1,696
)Reclassification of stock-based compensation costs to share capital upon exercise of stock awards


–



–



–



2,010



2,010Balance as at August 31, 2012


31,643,000



1



28,710,891



110,964



110,965Exercise of stock options (note 14)


–



–



30,675



87



87Redemption of restricted share units (note 14)


–



–



286,426



–



–Redemption of deferred share units (note 14)


–



–



37,054



–



–Redemption of share capital


–



–



(663,256
)


(2,565
)


(2,565
)Reclassification of stock-based compensation costs to share capital upon exercise of stock awards


–



–



–



1,350



1,350Balance as at August 31, 2013


31,643,000



1



28,401,790



109,836



109,837Exercise of stock options (note 14)


–



–



52,800



225



225Redemption of restricted share units (note 14)


–



–



425,620



–



–Redemption of deferred share units (note 14)


–



–



38,010



–



–Redemption of share capital


–



–



(214,470
)


(831
)


(831
)Reclassification of stock-based compensation costs to share capital upon exercise of stock awards


–



–



–



2,260



2,260Balance as at August 31, 2014


31,643,000


$
1



28,703,750


$
111,490


$
111,491






F-30
 Table of Contents
 EXFO Inc.
 Notes to Consolidated Financial Statements
  (tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)


a)
On November 7, 2012, the company announced that its Board of Directors had approved the renewal of its share repurchase program, by way of a normal course issuer bid on the open market of up to 10% of its issued and outstanding subordinate voting shares, representing 2,072,721 subordinate voting shares at the prevailing market price. The normal course issuer bid started on November 12, 2012, and ended on November 11, 2013. All shares repurchased under the bid were cancelled.




b)
On January 8, 2014, the company announced that its Board of Directors had approved the renewal of its share repurchase program, by way of a normal course issuer bid on the open market of up to 10% of the issued and outstanding subordinate voting shares, representing 2,043,101 subordinate voting shares at the prevailing market price. The normal course issuer bid started on January 13, 2014, and will end on January 12, 2015. All shares repurchased under the bid are cancelled.




13
Accumulated Other Comprehensive Income (loss)




Changes in accumulated other comprehensive incomes (loss) are as follows:




Foreign currency translation adjustment


Cash-flow

hedge


Accumulate other comprehensive income (loss)Balance as at September 1, 2011

$
19,123


$
1,926


$
21,049Foreign currency translation adjustment


(6,875
)


–



(6,875
)Changes in unrealized gains on forward exchange contracts, net of deferred income taxes


–



(667
)


(667
)Balance as at August 31, 2012


12,248



1,259



13,507Foreign currency translation adjustment


(15,830
)


–



(15,830
)Changes in unrealized gains/losses on forward exchange contracts, net of deferred income taxes


–



(1,100
)


(1,100
)Balance as at August 31, 2013


(3,582
)


159



(3,423
)Foreign currency translation adjustment


(7,086
)


–



(7,086
)Changes in unrealized losses on forward exchange contracts, net of deferred income taxes


–



250



250Balance as at August 31, 2014

$
(10,668
)

$
409


$
(10,259
)




F-31
 Table of Contents
 EXFO Inc.
 Notes to Consolidated Financial Statements
  (tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)
 14
Stock-Based Compensation Plans


The following table summarizes the stock-based compensation costs recognized for employee services received during the years ended August 31, 2012, 2013 and 2014:




Years ended August 31,2014


2013


2012Stock-based compensation costs arising fromequity-settled awards

$
1,683


$
1,769


$
1,831Stock-based compensation costs arising fromcash-settled awards


13



(1
)


31$
1,696


$
1,768


$
1,862




The maximum number of additional subordinate voting shares issuable under the Long-Term Incentive Plan and the Deferred Share Unit Plan cannot exceed 6,306,153 shares. The maximum number of subordinate voting shares that may be granted to any individual on an annual basis cannot exceed 5% of the number of outstanding subordinate voting shares. The company settles stock options and redeems restricted share units and deferred share units through the issuance of common shares from treasury.




Long-Term Incentive Plan




The company established the Long-Term Incentive Plan for its directors, executive officers and employees and those of its subsidiaries, as determined by the Board of Directors. The plan, which includes stock options and restricted share units, was approved by the shareholders of the company.




Stock Options




The exercise price of stock options granted under the Long-Term Incentive Plan is the market price of the common shares on the date of grant. Stock options granted under the plan expire 10 years from the date of grant and generally vest over a four-year period, being the required period of service from employees, generally with 25% vesting on an annual basis commencing on the first anniversary of the date of grant. As at August 31, 2013 and 2014, all stock options outstanding were vested.




The following table summarizes stock option activity for the years ended August 31, 2012, 2013 and 2014:




Years ended August 31,2014


2013


2012Number


Weighted

average

exercise

price


Number


Weighted average

exercise

price


Number


Weighted average

exercise

price(CA$)





(CA$)





(CA$)Outstanding – Beginning of year


201,254


$
6



244,354


$
5



641,357


$
9Exercised


(52,800
)


5



(30,675
)


3



(109,700
)


3Forfeited


(4,500
)


6



(2,000
)


6



(1,500
)


5Expired


(56,500
)


6



(10,425
)


5



(285,803
)


15Outstanding – End of year


87,454


$
6



201,254


$
6



244,354


$
5Exercisable – End of year


87,454


$
6



201,254


$
6



244,354


$
5




F-32
 Table of Contents
 EXFO Inc.
 Notes to Consolidated Financial Statements
  (tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)


The weighted-average market price of the shares at the date of exercise of stock options for the years ended August 31, 2012, 2013 and 2014, was $5.84, $5.08 and $5.08 respectively.




The following table summarizes information about stock options as at August 31, 2014:




Stock options outstanding and exercisableExercise price

Number

Weighted average

exercise price

Weighted average

remaining contractual life(CA$)



(CA$)$5.50 to $6.28

87,454

$               5,64

6 months




Restricted Share Units (RSUs)




RSUs are stock awards that rise and fall in value based on the market price of the company’s subordinate voting shares and are redeemable for actual subordinate voting shares or cash at the discretion of the Board of Directors as determined on the date of grant. Vesting dates are also established by the Board of Directors on the date of grant. The vesting dates are subject to a minimum term of three years and a maximum term of 10 years from the award date, being the required period of service from employees. Fair value of RSUs equals the market price of the common shares on the date of grant.




The following table summarizes RSU activity for the years ended August 31, 2012, 2013 and 2014:




Years ended August 31,2014


2013


2012Outstanding – Beginning of year


1,333,092



1,337,730



1,551,658Granted


336,685



316,160



334,878Redeemed


(425,620
)


(286,426
)


(418,086
)Forfeited


(19,022
)


(34,372
)


(130,720
)Outstanding – End of year


1,225,135



1,333,092



1,337,730




None of the RSUs outstanding as at August 31, 2013 and 2014, were redeemable. The weighted average grant-date fair value of RSUs granted during the years ended August 31, 2012, 2013 and 2014, amounted to $5.90, $5.31 and $4.84 respectively.




The weighted-average market price of the shares at the date of redemption of RSUs redeemed during the years ended August 31, 2012, 2013 and 2014 was $6.07, $5.15 and $5.21 respectively.




Deferred Share Unit Plan




The company established a Deferred Share Unit (DSU) Plan for the members of the Board of Directors as part of their annual retainer fees. Each DSU entitles the Board members to receive one subordinate voting share. DSUs are acquired on the date of grant and are redeemed in subordinate voting shares when the Board member ceases to be Director of the company. This plan was approved by the shareholders of the company.




F-33
 Table of Contents
 EXFO Inc.
 Notes to Consolidated Financial Statements
  (tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)


The following table summarizes DSU activity for the years ended August 31, 2012, 2013 and 2014:




Years ended August 31,2014


2013


2012Outstanding – Beginning of year


119,908



133,090



110,298Granted


35,803



23,872



22,792Redeemed


(38,010
)


(37,054
)


–Outstanding – End of year


117,701



119,908



133,090




As at August 31, 2014, none of the DSUs outstanding were redeemable. As at August 31, 2013, 38,010 DSUs were redeemable. The weighted average grant-date fair value of DSUs granted during the years ended August 31, 2012, 2013 and 2014, amounted to $5.86, $4.84 and $4.59 respectively.




The weighted-average market price of the shares at the date of redemption of DSUs redeemed during the years ended August 31, 2013 and 2014, was $4.94 and $5.21 respectively.




Stock Appreciation Rights Plan




The company established the Stock Appreciation Rights Plan for certain employees. Under that plan, eligible employees are entitled to receive a cash amount equivalent to the difference between the market price of the common shares on the date of exercise and the exercise price determined on the date of grant. Stock appreciation rights granted under the plan expire 10 years from the date of grant and generally vest over a four-year period, being the required period of service from employees, generally with 25% vesting on an annual basis commencing on the first anniversary of the date ofgrant. This plan was approved by the shareholders of the company.




The following table summarizes stock appreciation rights activity for the years ended August 31, 2012, 2013 and 2014:




Years ended August 31,2014


2013


2012Number


Weighted

average

exercise

price


Number


Weighted

average

exercise

price


Number


Weighted

average

exercise

priceOutstanding – Beginning of year


37,224


$
3



33,124


$
3



29,124


$
3Granted


7,150



–



4,100



–



4,000



–Expired


(4,500
)


5


─


─


─


─Outstanding – End of year


39,874


$
2



37,224


$
3



33,124


$
3Exercisable – End of year


22,374


$
3



22,624


$
4



15,787


$
4




The liability arising from stock appreciation rights as at August 31, 2013 and 2014, amounted to $107,000 and $119,000 respectively and is recorded in accounts payable and accrued liabilities in the balance sheets.






F-34
 Table of Contents
 EXFO Inc.
 Notes to Consolidated Financial Statements
  (tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)


The following table summarizes information about stock appreciation rights as at August 31, 2014:




Stock appreciation

rights outstanding

Stock appreciation

rights exercisableExercise price

Number

Weighted average

remaining contractual

life

Number$     –

19,750

8 years

2,250$2.36

9,674

4 years

9,674$3.74 to $4.51

6,000

4 years

6,000$6.28 to $6.50

4,450

2 years

4,45039,874

6 years

22,374


15
Related Party Disclosures


Ultimate controlling party




Mr. Germain Lamonde, the company’s Chairman, President and Chief Executive Officer, is the company’s ultimate controlling party.




Compensation of key management personnel




Years ended August 31,2014


2013


2012Salaries and short-term employee benefits

$
3,627


$
3,442


$
3,398Restructuring charges


–



–



177Stock-based compensation costs


906



907



793$
4,533


$
4,349


$
4,368




Key management personnel includes senior management and directors.






16
Statements of earnings




Net research and development




Net research and development expenses comprise the following:




Years ended August 31,2014


2013


2012Gross research and development expenses

$
52,423


$
54,334


$
59,282Research and development tax credits and grants


(7,577
)


(8,890
)


(9,428
)$
44,846


$
45,444


$
49,854




F-35
 Table of Contents
 EXFO Inc.
 Notes to Consolidated Financial Statements
  (tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)


Depreciation and amortization




Depreciation and amortization expenses by functional area are as follows:




Years ended August 31,2014


2013


2012Cost of salesDepreciation of property, plant and equipment

$
1,522


$
1,651


$
2,009Amortization of intangible assets


2,087



4,027



5,0763,609



5,678



7,085Selling and administrative expensesDepreciation of property, plant and equipment


951



1,100



1,037Amortization of intangible assets


1,534



1,687



1,8062,485



2,787



2,843Net research and development expensesDepreciation of property, plant and equipment


2,522



3,277



3,123Amortization of intangible assets


777



929



9373,299



4,206



4,060$
9,393


$
12,671


$
13,988Depreciation of property, plant and equipment

$
4,995


$
6,028


$
6,169Amortization of intangible assets


4,398



6,643



7,819$
9,393


$
12,671


$
13,988




Employee compensation




Employee compensation comprises the following:




Years ended August 31,2014


2013


2012Salaries and benefits

$
121,515


$
122,433


$
127,007Restructuring charges

─



89



2,329Stock-based compensation costs


1,696



1,768



1,862$
123,211


$
124,290


$
131,198




Restructuring charges by functional area are as follows:


Years ended August 31,2014


2013


2012Cost of sales

$
–


$
–


$
264Selling and administrative expenses


–



–



1,181Net research and development costs


–



89



884$
–


$
89


$
2,329






F-36
 Table of Contents
 EXFO Inc.
 Notes to Consolidated Financial Statements
  (tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)


Stock-based compensation costs by functional area are as follows:




Years ended August 31,2014


2013


2012Cost of sales

$
191


$
226


$
248Selling and administrative expenses


1,140



1,160



1,145Net research and development expenses


365



382



469$
1,696


$
1,768


$
1,862




17
Other Disclosures


Government grants




The company is entitled to receive grants on certain eligible research and development projects conducted in Finland from TEKES, a Finnish technology organization, which funds Finnish companies’ high technology, research and innovations. The company’s eligible research and development projects must be pre-approved by TEKES and the grant is subject to certain conditions. In the event that a condition is not met, TEKES can require reimbursement of a portion or the entire amount of the grant received. A liability to repay the funding is recognized in the period in which conditions arise that will cause the funding to be repayable. As at August 31, 2014, the company was in compliance with the conditions of the funding. This funding is accounted for as a reduction of gross research and development expenses in the statements of earnings. For the years ended August 31, 2012, 2013 and 2014, the company recorded $1,903,000, $1,498,000 and $1,348,000 respectively, under that program in the statements of earnings.




Defined contribution pension plans




The company maintains separate defined contribution pension plans for certain eligible employees. These plans, which are accounted for on an accrual basis, are summarized as follows:




●
Canadian defined contribution pension plan
 The company maintains a plan for certain eligible employees residing in Canada, under which the company may elect to match the employees’ contributions up to a maximum of 4% (3% prior to January 1, 2014) of an employee’s gross salary. Cash contributions to this plan and expenses for the years ended August 31, 2012, 2013 and 2014, amounted to $1,178,000, $1,165,000 and $1,451,000 respectively.


●
US defined contribution pension plan (401K plan)
 The company maintains a 401K plan for eligible employees residing in the U.S. Under this plan, the company must contribute an amount equal to 3% of an employee’s current compensation. In addition, eligible employees may contribute up to the lesser of 1% of eligible compensation or the statutorily prescribed annual limit to the 401K plan. The 401K plan permits but does not require the company to make additional matching contributions to the 401K plan on behalf of the eligible participants, subject to a maximum of 50% of the first 6% of the participant’s current compensation subject to certain legislated maximum contribution limits. During the years ended August 31, 2012, 2013 and 2014, the company recorded cash contributions and expenses totaling $693,000, $632,000 and $616,000 respectively.






F-37
 Table of Contents
  EXFO Inc.
 Notes to Consolidated Financial Statements
  (tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)
 18
Income Taxes


The reconciliation of the income tax provision calculated using the combined Canadian federal and provincial statutory income tax rate with the income tax provision in the financial statements is as follows:




Years ended August 31,2014


2013


2012Income tax provision (recovery) at combined Canadian federal and provincial statutory tax rate (27%)

$
1,421


$
1,891


$
(6
)Increase (decrease) due to:Foreign income taxed at different rates


(20
)


(249
)


285Non-taxable (income)/loss


(540
)


(2,077
)


535Non-deductible expenses


1,011



792



1,028Foreign exchange effect of translation of foreign subsidiaries


(547
)


148



(2,205
)Recognition of previously unrecognized deferred income tax assets

─


─



(557
)Unrecognized deferred income tax assets on temporary deductible differences and unused tax losses


3,013



4,385



4,509Other


141



774



(18
)Income tax provision for the year

$
4,479


$
5,664


$
3,571






Years ended August 31,2014


2013


2012The income tax provision consists of the following:CurrentCurrent income taxes

$
3,588


$
2,713


$
1,521DeferredDeferred income taxes relating to the origination and reversal of temporary differences


(2,122
)


(1,434
)


(1,902
)Benefit arising from previously unrecognized tax losses and deductible temporary differences

─


─



(557
)(2,122
)


(1,434
)


(2,459
)Unrecognized deferred income tax assets on temporary deductible differences and unused tax losses


3,013



4,385



4,509891



2,951



2,050Income tax provision for the year

$
4,479


$
5,664


$
3,571


F-38
 Table of Contents
 EXFO Inc.
 Notes to Consolidated Financial Statements
  (tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)


Deferred taxes




As at August 31,2014


2013Deferred income tax assetsDeferred income tax assets recoverable within 12 months

$
3,142


$
3,193Deferred income tax assets recoverable after 12 months


6,674



7,6149,816



10,807Deferred income tax liabilitiesDeferred income tax liabilities payable within 12 months


529



252Deferred income tax liabilities payable after 12 months


2,558



2,9743,087



3,226Deferred income tax assets net

$
6,729


$
7,581




The changes in deferred income tax assets and liabilities for the year ended August 31, 2013 are as follows:




Balance as at September 1, 2012


Credited (charged) to the statement of earnings


Credited (charged) to shareholders’ equity


Foreign currency translation adjustment


Balance as at August 31, 2013Deferred income tax assetsLong-lived assets

$
4,389


$
(449
)

$
–


$
(201
)

$
3,739Provisions and accruals


3,431



213



403



(197
)


3,850Deferred revenue


2,044



(164
)


–



(85
)


1,795Research and development expenses


2,362



(608
)


–



(125
)


1,629Losses carried forward


9,207



(808
)


–



(8
)


8,391Deferred income tax liabilitiesLong-lived assets


(494
)


45



–



28



(421
)Research and development tax credits


(10,964
)


(1,180
)


–



742



(11,402
)Total

$
9,975


$
(2,951
)

$
403


$
154


$
7,581Classified as follows:Deferred income tax assets

$
12,080














$
10,807Deferred income tax liabilities


(2,105
)














(3,226
)$
9,975














$
7,581
 F-39
 Table of Contents
 EXFO Inc.
 Notes to Consolidated Financial Statements
  (tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)


The changes in deferred income tax assets and liabilities for the year ended August 31, 2014 are as follows:




Balance as at September 1, 2013


Credited (charged) to the statement of earnings


Credited (charged) to shareholders’ equity


Foreign currency translation adjustment


Balance as at August 31, 2014Deferred income tax assetsLong-lived assets

$
3,739


$
(812
)

$
–


$
(90
)

$
2,837Provisions and accruals


3,850



229



(91
)


(50
)


3,938Deferred revenue


1,795



(120
)


–



(37
)


1,638Research and development expenses


1,629



1,160



–



(57
)


2,732Losses carried forward


8,391



(991
)


–



6



7,406Deferred income tax liabilitiesLong-lived assets


(421
)


371



–



9



(41
)Research and development tax credits


(11,402
)


(728
)


–



349



(11,781
)Total

$
7,581


$
(891
)

$
(91
)

$
130


$
6,729Classified as follows:Deferred income tax assets

$
10,807














$
9,816Deferred income tax liabilities


(3,226
)














(3,087
)$
7,581














$
6,729




Unrecognized deferred income tax assets on temporary deductible differences, unused tax losses and research and development expenses are as follows:




As at August 312014


2013Temporary deductible differences

$
1,050


$
205Losses carried forward


35,806



35,914Research and development expenses


641



1,370$
37,497


$
37,489




F-40
 Table of Contents
 EXFO Inc.
 Notes to Consolidated Financial Statements
  (tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)


As at August 31, 2014, the year of expiry of operating losses and research and development expenses for which no deferred income tax assets were recognized in the balance sheets are as follows, presented by tax jurisdiction:




CanadaYear of expiry

Federal


Provincial


Finland


United States


Other2015

$
–


$
1,096


$
1,539


$
997


$
–2016


–



–



–



553



–2017


–



–



4



–



–2018


–



–



382



–



–2019


–



–



–



741



–2020


–



–



8,747



3,470



–2021


–



–



7,582



10,202



–2022


–



–



13,145



7,435



–2023


–



–



8,516



1,972



–2024


–



–



2,269



1,351



–2025


–



–



–



1,351



–2026


–



990



–



1,351



–2027


–



1,256



–



1,351



–2028


–



–



–



2,447



–2030


11



11



–



2,713



–2031


35



35



–



109



–2032


8



8



–



–



–2033


44



44



–



4,681



–2034


17



17



–



4,684



–Indefinite


–



–



–



–



2,216$
115


$
3,457


$
42,184


$
45,408


$
2,216




Furthermore, as at August 31, 2014, the company had available capital losses in Canada amounting to $62,818,000 at the federal level and $66,827,000 at the provincial level for which no deferred income tax assets were recognized. These losses can be carried forward indefinitely against capital gains.




As at August 31, 2014, non-refundable research and development tax credits recognized in the balance sheet amounted to $42,864,000. In order to recover these non-refundable research and development tax credits, the company needs to generate approximately $277,000,000 (CA$301,000,000) in pre-tax earnings at the Canadian federal level and approximately $13,000,000 at the Canadian provincial level. In order to generate $277,000,000 in pre-tax earnings at the Canadian Federal level over the estimated recovery period of 18 years, the company must generate a pre-tax earnings compound annual growth rate (CAGR) of 4%, which the company believes is probable. The company’s non-refundable research and development tax credits can be carried forward over a twenty-year period.




In addition, as at August 31, 2014, the company had deferred income tax assets in the balance sheet in the amount of $9,816,000 mainly for operating losses in the United States. In order to recover these deferred income tax assets, the company needs to generate approximately $25,000,000 in pre-tax earnings at the United States, and in order to do so over the estimated recovery period of six years, the company must generate pre-tax earnings CAGR of 9%, which the company believes is probable. The company’s operating losses in the United States can be carried forward over a twenty-year period.






F-41
 Table of Contents
 EXFO Inc.
 Notes to Consolidated Financial Statements
  (tabular amounts in thousands of US dollars, except share and per share data and as otherwise noted)


As at August 31, 2014, taxable temporary differences of $9,393,000 were not recognized for taxes that would be payable on the unremitted earnings of certain of the company’s subsidiaries, as the company has determined that:




(1)
Undistributed profits of its foreign subsidiaries will not be distributed in the foreseeable future; and


(2)
Undistributed profits of its domestic subsidiaries will not be taxable when distributed.




19
Earnings per Share


The following table summarizes the reconciliation of the basic weighted average number of shares outstanding and the diluted weighted average number of shares outstanding:




Years ended August 31,2014


2013


2012Basic weighted average number of shares outstanding (000’s)


60,329



60,323



60,453Plus dilutive effect of (000’s):Stock options


9



24



149Restricted share units


574



648



910Deferred share units


103



115



118Diluted weighted average number of shares outstanding (000’s)


61,015



61,110



61,630Stock awards excluded from the calculation of the diluted weighted average number of shares outstanding because their exercise price was greater than the average market price of the common shares (000’s)


77



75



54




For the year ended August 31, 2012, the diluted amount per share was the same amount as the basic amount per share since the dilutive effect of stock options, restricted share units and deferred share units was not included in the calculation; otherwise, the effect would have been antidilutive. Accordingly, the diluted amount per share for that year was calculated using the basic weighted average number of shares outstanding.




20
Segment Information


Sales for products and services are detailed as follows:




Years ended August 31,2014


2013


2012Products

$
201,724


$
213,042


$
220,356Services


29,082



29,108



29,610$
230,806


$
242,150


$
249,966






F-42
 Table of Contents


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








Sales to external customers by geographic region are detailed as follows:




Years ended August 31,2014


2013


2012United States

$
83,172


$
87,145


$
83,401Canada


19,482



26,073



29,944Other


19,195



14,910



17,838Americas


121,849



128,128



131,183United Kingdom


12,736



13,206



9,862Other


51,243



53,802



61,449Europe, Middle-East and Africa


63,979



67,008



71,311China


22,468



21,778



21,802Other


22,510



25,236



25,670Asia-Pacific


44,978



47,014



47,472$
230,806


$
242,150


$
249,966




Sales were allocated to geographic regions based on the country of residence of the related customers.




Long-lived assets by geographic region are detailed as follows:




As at August 31, 2014


As at August 31, 2013Property, plant and equipment


Intangible assets


Goodwill


Property, plant and equipment


Intangible assets


GoodwillCanada

$
33,094


$
2,006


$
–


$
34,833


$
2,274


$
–United States


1,333



1,960



16,023



1,305



186



16,522Finland


448



3,231



10,465



589



4,762



10,791India


5,479



56



–



6,190



42



–China


1,397



32



–



1,517



25



–Other


1,029



8



–



1,089



254



–$
42,780


$
7,293


$
26,488


$
45,523


$
7,543


$
27,313








F-43
 Table of Contents