**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, 2007; 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





**For
      the transition period from September 1, 2006 to August 31,
      2007**





Commission
      File No. **0-30895**





**EXFO
      ELECTRO-OPTICAL ENGINEERING INC. /**


**EXFO
      INGÉNIERIE ÉLECTRO-OPTIQUE INC.**


**(Exact
      name of registrant as specified in its charter)**





**Canada**


**(Jurisdiction
      of Incorporation or organization)**





**400
      Godin Avenue**


**Quebec,
      Quebec, G1M 2K2, Canada**


**(418)
      683-0211**


**(Address,
      including zip code and telephone number, including area code, of registrant’s
      principal executive offices)**





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





Title
                of each class
            Name
                of each exchange on which 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
      November 1, 2007, the registrant had 32,361,561 Subordinate Voting Shares
      outstanding.





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





Yes
o
      No x





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





Yes
oNo
x





Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      preceding 12 months (or for such shorter period that the registrant was required
      to file such reports), and (2) has been subject to such filing requirements
      for
      the past 90 days.





Yes
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 financial statement item the registrant has elected to
      follow:





Item
      17
oItem
      18 x





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





YesoNox





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





YesoNox











TABLE
      OF CONTENTS




PART
        I.
 
 Item
        1.                Identity of Directors, Senior Management and
        Advisors
 
 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,
        Plant 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
 
 Item
        8.                Financial Information
 A.      Consolidated
        Statements and Other Financial
        Information
 B.      Dividend
        Policy
 C.Significant
        changes
 
 Item
        9.                Offer and Listing
 
 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, Dividends 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
        16EPurchases of
        Equity Securities by the Issuer and Affiliated
        Purchasers
 
 
 PART
        III.
 
 Item
        17.                Financial Statements
 
 Item
        18.                Financial Statements
 
 Item
        19.                Exhibits
  Signatures


Table
          of Contents


**DISCLOSURE
      REGARDING FORWARD-LOOKING INFORMATION**





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





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











**PART
      I.**





**Item
                1.**
            **Identity
                of
                Directors, Senior Management and
                Advisors**




Not Applicable.








**Item
                2.**
            **Offer
                Statistics and Expected
                Timetable**




Not Applicable.








**Item
                3.**
            **Key
                Information**




**A.****Selected
      Financial Data**




The
      consolidated statements of earnings data for the years ended August 31, 2003
      and
      2004 and the consolidated balance sheets data as at August 31, 2003, 2004 and
      2005 are derived from our audited consolidated financial statements not included
      in this annual report.  The consolidated statements of earnings data
      for each of the three years ended August 31, 2005, 2006 and 2007 and
      the consolidated balance sheets data as at August 31, 2006 and 2007
      are derived from our audited consolidated financial statements that are included
      elsewhere in this annual report.





Our
      consolidated financial statements are prepared in accordance with generally
      accepted accounting principles in Canada (“Canadian GAAP”) and significant
      differences in measurement and disclosure from generally accepted accounting
      principles in United States (“U.S. GAAP”) are set out in note 20 to our
      consolidated financial statements included elsewhere in this annual report.
      The
      historical results below are not necessarily indicative of the results to be
      expected for any future periods.


1
 Table
          of Contents


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,****2007**
            
            
            **2006**
            
            
            **2005**
            
            
            **2004**
            
            
            **2003****(in
                thousands of US dollars, except share and per share
                data)****Consolidated
                Statements of Earnings Data:*****Amounts
                under Canadian GAAP***Sales
            
            $
            152,934
            
            
            $
            128,253
            
            
            $
            97,216
            
            
            $
            74,630
            
            
            $
            61,930Cost
                of sales (1)
            
            
            65,136
            
            
            
            57,275
            
            
            
            44,059
            
            
            
            34,556
            
            
            
            36,197Gross
                margin
            
            
            87,798
            
            
            
            70,978
            
            
            
            53,157
            
            
            
            40,074
            
            
            
            25,733Operating
                expensesSelling
                and administrative
            
            
            49,580
            
            
            
            40,298
            
            
            
            31,782
            
            
            
            25,890
            
            
            
            26,991Net
                research and development
            
            
            16,668
            
            
            
            15,404
            
            
            
            12,190
            
            
            
            12,390
            
            
            
            15,879Amortization
                of property, plant and equipment
            
            
            2,983
            
            
            
            3,523
            
            
            
            4,256
            
            
            
            4,935
            
            
            
            5,210Amortization
                of intangible assets
            
            
            2,864
            
            
            
            4,394
            
            
            
            4,836
            
            
            
            5,080
            
            
            
            5,676Impairment
                of long-lived assets and goodwill
            
            
            −
            
            
            
            604
            
            
            
            −
            
            
            
            620
            
            
            
            7,427Government
                grants
            
            
            (1,079
            )
            
            
            (1,307
            )
            
            
            −
            
            
            
            −
            
            
            
            −Restructuring
                and other charges
            
            
            −
            
            
            
            −
            
            
            
            292
            
            
            
            1,729
            
            
            
            4,134Total
                operating expenses
            
            
            71,016
            
            
            
            62,916
            
            
            
            53,356
            
            
            
            50,644
            
            
            
            65,317Earnings
                (loss) from operations
            
            
            16,782
            
            
            
            8,062
            
            
            
            (199
            )
            
            
            (10,570
            )
            
            
            (39,584
            )Interest
                and other income
            
            
            4,717
            
            
            
            3,253
            
            
            
            2,524
            
            
            
            1,438
            
            
            
            1,245Foreign
                exchange loss
            
            
            (49
            )
            
            
            (595
            )
            
            
            (1,336
            )
            
            
            (278
            )
            
            
            (1,552
            )Earnings
                (loss) before income taxes
            
            
            21,450
            
            
            
            10,720
            
            
            
            989
            
            
            
            (9,410
            )
            
            
            (39,891
            )Income
                taxes
            
            
            (20,825
            )
            
            
            2,585
            
            
            
            2,623
            
            
            
            (986
            )
            
            
            15,059Net
                earnings (loss) for the year
            
            $
            42,275
            
            
            $
            8,135
            
            
            $
            (1,634
            )
            
            $
            (8,424
            )
            
            $
            (54,950
            )Basic
                and diluted net earnings (loss) per share
            
            $
            0.61
            
            
            $
            0.12
            
            
            $
            (0.02
            )
            
            $
            (0.13
            )
            
            $
            (0.87
            )Basic
                weighted average number of shares used in per share calculations
                (000’s)
            
            
            68,875
            
            
            
            68,643
            
            
            
            68,526
            
            
            
            66,020
            
            
            
            62,852Diluted
                weighted average number of shares used in per share calculations
                (000’s)
            
            
            69,555
            
            
            
            69,275
            
            
            
            68,526
            
            
            
            66,020
            
            
            
            62,852**Other
                consolidated statements of earnings data:**Gross
                research and development
            
            $
            25,201
            
            
            $
            19,488
            
            
            $
            15,878
            
            
            $
            15,668
            
            
            $
            17,133Net
                research and development
            
            $
            16,668
            
            
            $
            15,404
            
            
            $
            12,190
            
            
            $
            12,390
            
            
            $
            15,879***Amounts
                under U.S. GAAP***Net
                earnings (loss) for the
                year
            
            $
            42,257
            
            
            $
            8,135
            
            
            $
            (2,920
            )
            
            $
            (9,571
            )
            
            $
            (48,201
            )Basic
                and diluted net earnings (loss) per
                share
            
            $
            0.61
            
            
            $
            0.12
            
            
            $
            (0.04
            )
            
            $
            (0.14
            )
            
            $
            (0.77
            )Basic
                weighted average number of shares used in per share calculations
                (000’s)
            
            
            68,875
            
            
            
            68,643
            
            
            
            68,526
            
            
            
            66,020
            
            
            
            62,852Diluted
                weighted average number of shares used in per share calculations
                (000’s)
            
            
            69,555
            
            
            
            69,275
            
            
            
            68,526
            
            
            
            66,020
            
            
            
            62,852





**As
                  at August 31,****2007**
            
            
            **2006**
            
            
            **2005**
            
            
            **2004**
            
            
            **2003****(in
                thousands of US dollars)****Consolidated
                Balance Sheets Data:*****Amounts
                under Canadian GAAP***Cash
            
            $
            5,541
            
            
            $
            6,853
            
            
            $
            7,119
            
            
            $
            5,159
            
            
            $
            5,366Short-term
                investments
            
            
            124,217
            
            
            
            104,437
            
            
            
            104,883
            
            
            
            83,969
            
            
            
            52,010Working
                capital
            
            
            180,440
            
            
            
            143,985
            
            
            
            135,288
            
            
            
            115,141
            
            
            
            77,408Total
                assets
            
            
            279,138
            
            
            
            219,159
            
            
            
            190,957
            
            
            
            172,791
            
            
            
            146,254Long-term
                debt (excluding current
                portion)
            
            
            −
            
            
            
            354
            
            
            
            198
            
            
            
            332
            
            
            
            453Share
                capital
            
            
            150,019
            
            
            
            148,921
            
            
            
            521,875
            
            
            
            521,733
            
            
            
            492,452Shareholders’
                equity
            
            $
            250,165
            
            
            $
            196,234
            
            
            $
            173,400
            
            
            $
            157,327
            
            
            $
            129,826***Amounts
                under U.S. GAAP***Cash
            
            $
            5,541
            
            
            $
            6,853
            
            
            $
            7,119
            
            
            $
            5,159
            
            
            $
            5,366Short-term
                investments
            
            
            124,217
            
            
            
            104,437
            
            
            
            104,883
            
            
            
            83,969
            
            
            
            52,010Working
                capital
            
            
            183,231
            
            
            
            149,436
            
            
            
            138,225
            
            
            
            117,116
            
            
            
            78,974Total
                assets
            
            
            268,389
            
            
            
            212,702
            
            
            
            182,852
            
            
            
            164,758
            
            
            
            138,020Long-term
                debt (excluding current
                portion)
            
            
            −
            
            
            
            354
            
            
            
            198
            
            
            
            332
            
            
            
            453Share
                capital
            
            
            599,519
            
            
            
            598,421
            
            
            
            597,664
            
            
            
            596,309
            
            
            
            565,291Shareholders’
                equity
            
            $
            239,343
            
            
            $
            189,777
            
            
            $
            165,295
            
            
            $
            149,294
            
            
            $
            121,592


_________________________





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


2
 Table
          of Contents





**B.****Capitalization
      and Indebtedness**




Not
      Applicable.





**C.****Reasons
      for the Offer and Use of Proceeds**





Not
      Applicable.





**D.****Risk
      Factors**





**We
      must continue to overcome significant competition in our targeted industries
      in
      order to gain market share and achieve our growth
      strategy.**





The
      market for our primary business activity ─ namely designing, manufacturing,
      marketing and selling telecommunications test, measurement and monitoring
      equipment ─ is rapidly evolving and is marked by intense competition and
      technical innovation. Likewise, the market for our selected life sciences and
      industrial solutions is very competitive. We anticipate the pace of change
      to
      remain high or even accelerate for our targeted industries in the future. We
      might see the emergence of new competitors or the consolidation of current
      competitors, as the markets for telecommunications test, measurement and
      monitoring equipment as well as for life sciences and industrial solutions
      might
      evolve in response to technical innovations and economic conditions. Achieving
      our key performance indicator of 20% sales growth in fiscal 2008 will largely
      depend on our ability to gain market share by increasing sales of current
      products at existing accounts, expanding into new accounts, introducing new
      products and product enhancements, and exploiting new market
      opportunities.





During
      the past few years, the telecommunications test, measurement and monitoring
      industry has witnessed consolidation. Anritsu Corporation announced the
      acquisition of NetTest A/S in August 2005 and JDS Uniphase Corporation
      (JDSU) completed its acquisition of Acterna Corporation during the same month.
      Agilent Technologies Inc. divested itself of its semiconductor division to
      refocus its efforts on test and measurement. With the exception of JDSU (which
      also sells optical components), these competitors are global test, measurement
      and monitoring vendors who complement their broad range of products with
      telecommunications test, measurement and monitoring equipment. Similarly,
      Spirent plc, Tektronix, Inc. and Yokagawa are global test, measurement and
      monitoring vendors who compete against us. Other competitors, such as Digital
      Lightwave Inc., Fluke Networks, an operating division within Danaher
      Corporation, IXIA, and Sunrise Telecom Inc., compete against us in niche
      markets. Some competitors in both groups may have greater financial, technical
      and/or marketing resources than us. Consequently, they may be able to devote
      greater resources to the development, marketing, manufacturing, selling and
      support of their products in order to capture market share.





Competitors
      also may be better positioned than us to capture market share or to acquire
      companies and new technologies that would potentially displace our products
      or
      render them obsolete. We cannot predict whether current or future competitors
      will develop or market products that offer higher performance, more features,
      or
      are more cost-effective than our current or future products. To remain
      competitive and achieve our growth strategy, we must increase our sales and
      develop cost-effective products and product enhancements that offer higher
      performance and more functionality, in current and new sectors, so that we
      can
      increase our market share. Our failure to do so may harm our business, results
      of operations and financial condition.





3
 Table
          of Contents


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





Most
      of
      our sales are denominated in currencies other than the Canadian dollar
      (principally US dollars and Euros). However, a large portion of our operating
      expenses and capital expenditures are denominated in Canadian dollars. As a
      result, even though we manage to some extent our exposure to currency risks
      with
      forward exchange contracts and certain operating expenses denominated in
      currencies other than the Canadian dollar, we are exposed to fluctuations in
      the
      exchange rates between the Canadian dollar on one hand and the US dollar
      and Euro on the other. For example, the average exchange rate of the Canadian
      dollar versus the US dollar in fiscal 2007 was 1.1215. As of November 1, 2007,
      the Canadian dollar had increased 15.2% versus the average exchange rate of
      the
      US dollar for fiscal 2007 and had increased 7.2% versus the average
      exchange rate of the Euro for 2007. Any increase in the value of the Canadian
      dollar relative to other currencies, especially the US dollar, could have
      a material adverse effect on our operating results and provide competitive
      advantages to our competitors.





**Our
        business may be adversely affected by unfavorable general economic and market
        conditions**
 
 Our
        business is subject to the effects of general economic conditions in North
        America and throughout the world and, more particularly, market conditions
        in
        the telecommunications industry. In the past, our operating results were
        adversely affected by reduced telecom capital spending in North America,
        Europe
        and Asia and by general unfavorable economic conditions. In particular, sales
        to
        network service providers in North America were significantly and adversely
        affected by a downturn in 2001 in the telecommunications industry. If there
        is a
        recession or slowdown in key geographic regions or markets, we may experience
        a
        material adverse impact on our business, operating results and financial
        condition.
 One
        of our customers has
        accounted for a high percentage of our sales in the past several years, and
        any
        adverse factor affecting this customer or our relationship with this customer
        could cause our sales to decrease.





A
      Tier-1
      carrier in the US accounted for 14.7% of our sales in fiscal 2007, 13.8% in
      2006 and 23.3% in 2005. Even if this customer has a supply contract with us,
      it
      could change its purchasing practice, force us to renegotiate prices and is
      not
      obligated to purchase a specific amount of products from us or provide us with
      binding purchase forecasts for any period. In addition, our customers typically
      purchase our products under individual purchase orders and may cancel or defer
      purchases on short notice without significant penalties.





The
      loss
      of such a customer or the reduction, delay, or cancellation of orders from
      this
      customer or other significant customers could cause our sales and, therefore,
      net earnings to decline.







**We
      have faced pricing pressure on our existing products and expect that this
      pressure will continue. If we do not keep lowering our manufacturing costs
      or
      introduce new products with higher margins, our gross margins may decrease
      and
      our operating results may be adversely affected.**





We
      continued implementing measures to protect our gross margin, which reached
      57.4%
      of sales in fiscal 2007 compared to 55.3% in 2006, despite the negative impact
      of the exchange rate between US and Canadian currencies. In addition, since
      September 2007, we began transferring and ramping the manufacturing of our
      higher-volume, lower-complexity telecom products at a wholly-owned production
      facility in Shenzhen, China, with a goal of lowering our production costs.
      However, increased competitiveness in the telecommunications test, measurement
      and monitoring industry will likely result in continuing downward pressure
      on
      average selling prices, which may in turn negatively affect our gross margins.
      Pricing pressure can result from a number of factors such as:





·
            increased
                competition for business;


·
            reduced
                demand;


·
            limited
                number of potential customers;


·
            competition
                from companies with lower production costs, including companies operating
                in lower cost environments;


·
            introduction
                of new products by competitors;


4
 Table
          of Contents


·
            greater
                economies of scale for higher-volume
                competitors;


·
            large
                customers, who buy in high volumes, can exert substantial negotiating
                leverage over us; and


·
            resale
                of used equipment.





In
      addition, gross margins may also be negatively affected by increased costs
      of
      raw materials as well as obsolescence and excess costs, product and customer
      mix
      and under-absorption of fixed manufacturing costs.





As
      pricing pressure will likely continue to affect our existing products, we may
      have to increase the number of units sold to maintain our existing sales levels.
      If we are unable to increase our sales levels, lower our manufacturing costs,
      or
      introduce new products with higher margins, our gross margins may decline and
      our operating results may suffer.





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





As
      a
      result of 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 effort, defects will not be found in new products after they have
      been
      fully deployed and operated under peak stress conditions or that customized
      products meet customer sign-off acceptance requirements. If we are unable to
      fix
      defects or other problems or meet custom requirements, we could experience,
      among other things:





·
            costly
                repairs;


·
            product
                returns or recalls;


·
            damage
                to our brand reputation;


·
            loss
                of customers, failure to attract new customers or achieve market
                acceptance;


·
            diversion
                of development and engineering
                resources;


·
            legal
                actions by our customers, including claims for consequential damages
                and
                loss of profits; and


·
            legal
                actions by governmental entities, including actions to impose product
                recalls and/or forfeitures.





The
      occurrence of any one or more of the foregoing could seriously harm our
      business, results of operations and financial condition.





**We
      may not be able to make the necessary acquisitions or strategic alliances needed
      for the development of our business or, if we do make such acquisitions or
      strategic alliances, we cannot assure you that we will successfully integrate
      the businesses, products, technologies and personnel. In addition, such
      acquisitions could distract management’s attention from our day-to-day business
      and operations. Ultimately, the failure to make strategic acquisitions or the
      inability to carry out effective integrations could disrupt our overall business
      and harm our financial condition.**





We
      intend
      to carefully seek businesses, whose products and technologies are complementary
      to ours, or which will enable us to expand our markets and/or our market share.
      There can be no assurance that we will ultimately make any such transactions.
      Our competitors may be in a better position to acquire the same businesses,
      products and technologies that we wish to acquire. In addition, our fluctuating
      stock price, our cash position or our ability to raise capital or issue debt
      on
      favorable terms or at all at the time of an acquisition may affect our ability
      to complete such an acquisition.





We
      have
      made strategic acquisitions in the past and we intend to continue making
      acquisitions of businesses, products and technologies as part of our overall
      growth strategy. In the event of any future acquisition, we could:





·
            issue
                shares that would dilute individual shareholder percentage
                ownership;


·
            incur
                debt;


·
            assume
                liabilities and commitments;


·
            incur
                significant expenses related to amortization of additional intangible
                assets;


·
            incur
                significant impairment losses of goodwill and intangible assets related
                to
                such acquisitions; and


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·
            incur
                losses from operations.





These
      acquisitions also involve numerous risks, including:





·
            risk
                of not realizing the expected benefits or synergies of such
                acquisitions;


·
            problems
                integrating the acquired operations, technologies, products and
                personnel;


·
            risks
                associated with the transfer of acquired know-how and
                technology;


·
            unanticipated
                costs or liabilities;


·
            diversion
                of management’s attention from our core
                business;


·
            adverse
                effects on existing business relationships with suppliers and
                customers;


·
            risks
                associated with entering markets in which we have no or limited prior
                experience; and


·
            potential
                loss of key employees, particularly those of acquired
                organizations.





**If
      we fail to adapt appropriately to the challenges associated with operating
      internationally, the expected growth of our business may be impeded and our
      operating results may be affected.**





For
      the
      fiscal year ended August 31, 2007, customers outside of the United States and
      Canada accounted for 45.5% 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 service providers and operate adequate after-sales support
      internationally.





In
      the
      third quarter of fiscal 2007, we began establishing a software development
      center in Pune, India, to supplement the efforts of our three R&D centers in
      Quebec City, Canada, Montreal, Canada, and Concord, Canada. We also began
      manufacturing high-volume, low-complexity telecom products at our wholly-owned
      production facility in Shenzhen, China, in the first quarter of fiscal 2008
      with
      the goal of lowering our manufacturing costs.





Even
      if
      we are able to successfully expand our international operations, we may not
      be
      able to maintain or increase international market demand for our products.
      Our
      international operations are subject to a number of risks,
      including:





·
            challenges
                in staffing and managing foreign operations due to the limited number
                of
                qualified candidates, employment laws and business practices in foreign
                countries, any of which could increase the cost and reduce the efficiency
                of operating in foreign countries;


·
            our
                inability to comply with import/export, environmental and other trade
                compliance regulations of the countries in which we do business,
                together
                with unexpected changes in such
                regulations;


·
            measures to
                ensure that we design, implement and maintain adequate controls over
                our
                financial processes and reporting in the future, especially in light
                of
                setting up new operating companies in India and China or the likely
                future
                acquisition of companies;


·
            failure
                to adhere to laws, regulations and contractual obligations relating
                to
                customer contracts in various
                countries;


·
            difficulties
                in establishing and enforcing our intellectual property
                rights;


·
            inability
                to maintain a competitive list of distributors for indirect
                sales;


·
            tariffs
                and other trade barriers;


·
            economic
                instability in foreign markets;


·
            wars,
                acts of terrorism and political
                unrest;


·
            language
                and cultural barriers;


·
            lack
                of integration of foreign
                operations;


·
            currency
                fluctuations;


·
            potential
                foreign and domestic tax
                consequences;


·
            technology
                standards that differ from those on which our products are based,
                which
                could require expensive redesign and retention of personnel familiar
                with
                those standards;


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·
            longer
                accounts receivable payment cycles and possible difficulties in collecting
                payments which may increase our operating costs and hurt our financial
                performance; and


·
            Failure
                to meet certification requirements.





Any
      of
      these factors could harm our international operations and negatively affect
      our
      business, results of operations and financial condition. The recurrence of
      weakness in these economies or of weakness in other foreign economies could
      have
      a significant negative effect on our future operating results.





**We
      may make misjudgments in our strategic planning that could have material adverse
      effects on our business, results of operations and financial
      condition.**





We
      devise
      an annual strategic business plan, which is prepared by management and approved
      by our Board of Directors. This strategic plan, reviewed by management on a
      regular basis, is mainly based on market research and analysis related to future
      market trends and demands. In our strategic plans, we have made and will
      continue to make judgments based on our analysis of future market trends and
      requirements. These decisions may involve substantial investments in the
      development of new product lines, diversification of our business on a
      geographic basis, as well as expansion into new market segments — either
      organically or through acquisitions. We may make misjudgments in our strategic
      planning that could have material adverse effects on our business, results
      of
      operations and financial condition.





**Our
      quarterly revenues and operating results are subject to significant fluctuations
      and you should not rely on them as an indication of our future
      performance.**





Our
      sales
      and operating results have fluctuated from quarter to quarter in the past and
      significant fluctuations may occur in the future. In addition, our sales and
      operating results generally depend on the volume and timing of the orders we
      receive from customers as well as our ability to fulfill received orders. Our
      operating expenses, which include manufacturing overhead costs, selling and
      administrative, research and development, and amortization expenses, are
      relatively fixed in the short term. If we sell fewer products than anticipated,
      if there is a delay in the launch of new products, or if prices for our
      products decline, we may not be able to quickly reduce our operating expenses
      in
      response to lower sales. Factors that could affect the amount and timing of
      our
      sales, and cause quarterly fluctuations in our revenue and operating results
      include:





·
            length
                of the product sales cycle for certain products, especially those
                that are
                higher priced and more complex;


·
            timing
                of product launches and market acceptance of new products for us
                as well
                as our competitors;


·
            our
                ability to sustain product volumes and high levels of quality across
                all
                product lines;


·
            timing
                of shipments for large orders;


·
            effect
                of seasonality on sales and bookings;
                and


·
            losing
                key accounts and not successfully developing new
                ones.





Our
      sales
      and operating results could also be affected by the following factors, some
      of
      which we have little or no control over:





·
            fluctuating
                demand for telecommunications test and measurement equipment as well
                as
                life sciences and industrial
                solutions;


·
            changes
                in the capital spending and operating budgets of our customers, which
                may
                cause seasonal or other fluctuations in product mix, volume, timing
                and
                number of orders we receive from our
                customers;


·
            order
                cancellations or rescheduled delivery
                dates;


·
            pricing
                changes by our competitors or
                suppliers;


·
            customer
                bankruptcies and difficulties in collecting accounts
                receivable;


·
            restructuring
                and impairment charges;


·
            foreign
                exchange rate fluctuations, as a portion of our operating expenses
                are
                denominated in Canadian dollars;
                and


·
            general
                economic conditions.




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In
      addition, we may in the future choose to reduce prices, increase spending,
      or
      modify our product portfolio in response to actions by competitors or as an
      effort to pursue new market opportunities. These actions may also adversely
      affect our business and operating results and may cause our quarterly results
      to
      be lower than the results of previous quarters. Due to these factors, you should
      not rely on quarter-to-quarter comparisons of our results of operations as
      an
      indication of our future performance.





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





The
      industries that we target are characterized by rapidly evolving technology
      and
      industry standards that result in frequent new product introductions. Any
      failure by us to anticipate or respond to new technological developments,
      customer requirements or evolving standards could have a material adverse effect
      on our business, results of operations and financial condition. The development
      of proprietary technology entails significant technical and business risks
      and
      requires substantial expenditures and lead-time. The success of our new product
      introductions will depend on several factors, including our ability
      to:





·
            properly
                identify and anticipate customer
                needs;


·
            innovate
                and develop new products;


·
            gain
                timely market acceptance for new
                products;


·
            manufacture
                and deliver our new products on time and in sufficient
                volume;


·
            price
                our products competitively;


·
            continue
                investing in our research and development programs;
                and


·
            anticipate
                competitors’ announcements of new
                products.





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





**Our
      intellectual property and proprietary technology are important to the continued
      success of our business. Our failure to protect this proprietary technology
      may
      significantly impair our competitive position.**





Our
      success and ability to compete depend to a significant extent on our proprietary
      technology, with which we attempt to keep others from using the innovations
      that
      are central to our existing and future products. We currently hold 37
      actively-maintained granted patents from the United States (including one
“design” patent), eight from Canada, three from Germany (including one "Utility
      Model"), two from the United Kingdom, two from France, and one from China.
      In addition, EXFO has nine US patent applications in
      process, nine Canadian patents applications in process, two European
      applications in process, two from China, two from Germany, one from
      Russia and four Patent Cooperation Treaty patent applications pending.
      We also rely on a combination of copyright and trademark laws, trade secrets,
      confidentiality procedures, contractual provisions and license agreements to
      protect our proprietary technology. We may have to engage in litigation in
      order
      to protect our patents and other intellectual property rights, or to determine
      the validity or scope of the proprietary rights of others. Such litigation
      can
      be time-consuming and expensive, regardless of whether we win or
      lose.





The
      process of seeking patent protection can be long and expensive and we cannot
      be
      certain that any currently pending or future applications will actually result
      in issued patents, or that, even if patents are issued, they will be of
      sufficient scope or strength to provide meaningful protection or any commercial
      advantage to us. We also rely on trade secret protection for our technology,
      in
      part through confidentiality agreements with our employees, consultants,
      distributors and third parties. However, these agreements may be breached or
      otherwise not effective and we may not have adequate remedies for any breach
      or
      shortfall of these agreements. In any case, others may come to know about our
      trade secrets through a variety of methods. In addition, the laws of some
      territories in which we sell our products may not protect our intellectual
      property rights to the same extent as do the laws of Canada and the United
      States.




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**Our
      intellectual property rights, particularly our existing or future patents,
      may
      be invalidated, circumvented, challenged or required to be licensed to others.
      Furthermore, others may develop technologies that are similar or superior to our
      technology, duplicate or reverse engineer our technology, or design around
      the
      patents owned or licensed by us. We cannot be sure that the steps that we take
      to protect our technology will prevent misappropriation or infringement. If
      we
      fail to protect our technology so that others may copy or use it, we will be
      less able to differentiate our products and our sales may
      decline.**





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





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





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





**If
      customers fail to meet their financial commitments to us, it could have a
      material adverse effect on our business, results of operations and financial
      condition.**





Some
      of
      our customers may experience cash flow problems. Consequently, we may have
      customers who delay payments or may not be able to meet their financial
      commitments to us. Furthermore, they may not order as many products from us
      as
      originally forecasted or they may cancel their orders outright. The failure
      of
      customers to order products would result in decreased revenues for us. If
      customers fail to meet their financial commitments to us, it could have a
      material adverse effect on our business, results of operations and financial
      condition.





**As
      our customers consolidate, they may reduce or halt purchases of our products,
      which would harm our sales and operating results.**





Consolidation
      in the telecommunications industry could reduce the number of customers to
      which
      our products are sold. Some of our customers have been subject to consolidation
      and could obtain products from a vendor other than us, or demand more favorable
      terms and conditions from us, which would harm our sales and operating results.
      In addition, some customers may merge with or acquire our competitors and
      discontinue their relationships with us.





**If
      we fail to predict our supply requirements accurately, we may have excess
      inventory or insufficient inventory, either of which could cause us to incur
      additional costs and/or experience manufacturing delays.**





We
      provide non-binding forecasts of our requirements to some of our suppliers
      up to
      six months prior to scheduled delivery of products to our customers. If we
      overestimate our forecasted requirements, we may have excess inventory, which
      could harm our relationships with our suppliers due to reduced future orders,
      increase our costs and require inventory write-offs. If we underestimate our
      requirements, we may have an inadequate inventory of parts, which could
      interrupt manufacturing of our products and result in shipment delays. In
      addition, lead times for materials and parts that we order may be long and
      depend on factors such as the procedures of, or supply terms with, a specific
      supplier and demand for each part at a given time.




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**We
      depend on a single supplier or a limited number of suppliers for some key
      components and materials in our products, which makes us susceptible to supply
      shortages or price fluctuations that could adversely affect our operating
      results.**





We
      depend
      on a limited number of suppliers for some of the parts used to manufacture
      our
      products for which alternative sources may not be readily available. In
      addition, all our orders are placed through individual purchase orders and,
      therefore, our suppliers may stop supplying parts to us at any time. The
      reliance on a single source or limited number of suppliers could result in
      increased costs, delivery problems and reduced control over product pricing
      and
      quality. Financial difficulties of suppliers could also affect our ability
      to
      obtain necessary parts in a timely manner. Any interruption or delay in the
      supply of any of these parts could significantly harm our ability to meet
      scheduled product deliveries to our customers and cause us to lose sales.
      Furthermore, the process of qualifying a new manufacturer for complex parts,
      designed to our specifications, such as our optical and mechanical parts, is
      lengthy and would consume a substantial amount of time of our technical
      personnel and management. If we were required to change a supplier in a short
      period of time, our business would be disrupted. In addition, we may be
      unsuccessful in identifying a new supplier capable of meeting and willing to
      meet our needs on terms that we would find acceptable. Consolidation involving
      suppliers could further reduce the number of alternatives available to us and
      increase the cost of parts, which would make our products less competitive
      and
      result in lower margins.





**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 have devoted significant
      resources and time to comply with the internal control over financial reporting
      requirements of the Sarbanes-Oxley Act of 2002. In addition, Section 404 under
      the Sarbanes-Oxley Act of 2002 requires that we assess and our auditors attest
      to the design and operating effectiveness of our controls over financial
      reporting. Our compliance with the annual internal control report requirement
      for each fiscal year will depend on the effectiveness of our financial reporting
      as well as data systems and controls throughout our company and operating
      subsidiaries. Furthermore, we cannot be certain that these measures will ensure
      that we design, implement and maintain adequate controls over our financial
      processes and reporting in the future, especially in the light of setting up
      new
      operating companies in India and China or the likely future acquisition of
      companies that are not in compliance with Section 404 of the Sarbanes-Oxley
      Act
      of 2002. As well, the complexity of our systems and controls may become more
      difficult to manage as we transform our operating structure and continue to
      reduce infrastructure costs. To effectively manage these changes, we will need
      to continue to improve our operational, financial and management controls and
      our reporting systems and procedures. Any failure to implement required new
      or
      improved controls, difficulties encountered in their implementation or
      operation, or difficulties in the assimilation of acquired businesses into
      our
      control system could harm our operating results or cause it to fail to meet
      our
      financial reporting obligations. Inferior internal controls could also cause
      investors to lose confidence in our reported financial information, which could
      have a negative effect on our share price and our access to
      capital.





**Regulatory
      changes may cause us to incur increased costs.**





Changes
      in the laws and regulations affecting public companies may increase our expenses
      as we may have to devote resources to respond to these new requirements. In
      particular, we incurred and may incur additional general administrative expenses
      to comply with Section 404 of the Sarbanes-Oxley Act, which requires management
      to report on internal controls over financial reporting. Compliance with new
      rules could also require the further commitment of significant financial
      resources and result in the diversion of management’s time and attention from
      revenue-generating activities. Finally, the impact of these changes could make
      it more difficult for us to attract and retain qualified persons to serve on
      our
      Board of Directors or as executive officers, which could harm our
      business.





**We
      require employees and management resources who are knowledgeable about the
      specialized nature of our business. If we are unable to attract and retain
      sufficient numbers of highly skilled technical, sales, marketing, senior
      management and other personnel, our operations and financial results will
      suffer.**




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Due
      to
      the specialized nature of our business, we are highly dependent on the continued
      service of and on the ability to attract qualified engineering, sales,
      marketing, senior management and other personnel. If we are unable to attract
      and retain such qualified personnel, it could have a material adverse effect
      on
      our business, results of operations and financial condition.





We
      must
      also provide significant training for our employee base due to the highly
      specialized nature of telecommunications test, measurement and monitoring as
      well as life sciences and industrial technologies. Our current personnel may
      be
      inadequate and we may fail to assimilate and train new employees. Highly skilled
      employees with the education and training that we require – especially employees
      with significant experience and expertise, international business development,
      product management, sales, engineering and operation – may be difficult to find.
      Once trained, our employees may also be hired by our competitors or leave the
      organization.





**Our
      insurance may not be sufficient to cover all potential liability. A successful
      claim exceeding our policy limits will reduce our cash position, increase our
      expenses and have a negative effect on our business, operating results and
      financial condition.**





Our
      products are designed to help network service providers, cable operators and
      manufacturers of optical networks and components ensure network reliability.
      We
      also leverage our core telecom technologies for life sciences and industrial
      applications. The failure of our products to perform to client expectations
      could give rise to product liability and warranty claims. We carry insurance
      for
      product liability and take accounting reserves for warranty claims that we
      consider adequate in view of industry practice.





In
      addition, we may face other types of claims by third parties in relation to
      the
      conduct of our business; 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.





**We
      may become involved in costly and time-consuming litigation that may
      substantially increase our costs and harm our business.**





We
      may
      from time to time become involved in various lawsuits and legal proceedings.
      For
      example, we are a defendant in a putative securities class action filed in
      the
      United States District Court for the Southern District of New York involving
      approximately 300 other issuing companies. Litigation is subject to inherent
      uncertainties, and an adverse result in these or other matters that may arise
      from time to time could have a material adverse effect on our business, results
      of operations or financial condition. Any litigation to which we are subject
      could require significant involvement of our senior management and may divert
      management attention from our business and operations.





**If
      we suffer loss to our factories or facilities, our operations could be seriously
      harmed.**





Our
      factories and facilities are subject to catastrophic loss due to fire,
      vandalism, terrorism or other natural or man-made disasters. We do not have
      redundant multiple site capacity and if any of our facilities or factories
      were
      to experience a catastrophic loss, it would disrupt our operations, delay
      production, shipments and revenue and result in large expenses, thereby harming
      our results of operation.





**Unexpected
      declines in our research and development and other tax credits and grants may
      have an adverse effect on our business.**





Our
      historical operating results reflect substantial benefits from programs
      sponsored by federal and provincial governments for the support of research
      and
      development activities, as well as in relation to other activities. For example,
      research and development tax credits and grants represented 33.9% of our gross
      research and development expenses for the year ended August 31,
      2007.




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If
      unexpected changes in the laws or government policies terminate or adversely
      modify the Canadian and Quebec government programs, under which we receive
      the
      majority of our research and development and other tax credits and grants,
      or if
      we unexpectedly become unable to participate in or take advantage of these
      programs, then our net research and development and other expenses will
      materially increase or we may decrease our research and development activities.
      In addition, to the extent that we increase our research and development
      activities outside Canada or Quebec, resulting from the establishment of our
      software development center in Pune, India or, among other things, future
      acquisitions, our increased R&D activities may not be eligible for these
      programs. If we were required to decrease our research and development
      activities, or were unable to benefit from other tax credits and grants, this
      could have a material adverse effect on our business, results of operations
      and
      financial condition.





**Changes
      in our effective tax rate or adverse outcomes resulting from tax audits may
      have
      an adverse impact on our results.**





As
      an
      international corporation, we are subject to taxation in the various
      jurisdictions in which we conduct business. Significant judgment is required
      in
      the determination of our worldwide provision for income taxes and this
      determination requires the interpretation and application of complex tax laws
      and regulations. Our effective tax rate may be adversely impacted by changes
      in
      the mix of earnings between countries which have different statutory tax rates,
      in the valuation of our deferred tax assets, and by changes in tax rules and
      regulations. We are also subject to income tax audits in the respective
      jurisdictions in which we conduct business and we regularly assess the
      likelihood of adverse outcomes resulting from these tax audits to ascertain
      the
      adequacy of our provision for income taxes. There can be no assurance that
      the
      outcomes of these tax audits will not have an adverse impact on our result
      and
      financial condition.





**Our
      current principal stockholder has effective control over our
      business.**





As
      of
      November 1, 2007, Germain Lamonde, our Chairman of the Board, President and
      Chief Executive Officer, held 91.9% of the voting rights in our stock. By virtue
      of such stock ownership, Mr. Lamonde has effective control over all matters
      submitted to our stockholders, including the election of our Directors, and
      exercises significant control over our policies and affairs. Such concentration
      of voting power could have the effect of delaying, deterring or preventing
      a
      change in control or other business combinations that might otherwise be
      beneficial to our stockholders.





**If
      we complete major acquisitions of complementary businesses, products or
      technologies, we may need additional capital, and may not be able to raise
      additional capital on favorable terms or at all, which could limit our ability
      to grow and could increase our costs.**





Our
      future liquidity and capital requirements are difficult to predict because
      they
      depend on numerous factors, including the success of our existing and new
      product offerings as well as competing technological and market developments.
      As
      a result, we may not be able to generate sufficient cash flows from our
      operations to meet additional working capital requirements, support additional
      capital expenditures or take advantage of acquisition opportunities.
      Accordingly, we may need to raise additional capital in the future.





Our
      ability to obtain additional financing will be subject to a number of factors,
      including market conditions and our operations performance. These factors may
      render the timing, amount, terms and conditions of additional financing
      unattractive for us. If we raise additional funds by selling equity securities,
      the relative ownership of our existing investors could be diluted or the new
      investors could obtain terms more favorable than previous investors. If we
      raise
      funds through debt financing, we could incur significant borrowing costs. 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. As at August
      31,
      2007, we had $129.8 million in cash and short-term investments.





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**Our
      business and operations would suffer in the event of a failure of our
      information technology infrastructure.**





We
      rely
      upon the capacity, efficiency and security of our information technology
      hardware and software infrastructures as well as our ability to expand and
      update these infrastructures in response to our evolving needs. Any failure
      to
      manage, expand or update our information technology infrastructures or any
      failure in the operation of this infrastructure could harm our
      business.





Our
      information systems are vulnerable to damages from computer viruses, natural
      disasters, unauthorized access and other similar disruptions. Any system
      failure, accident or security breach could result in disruptions to our
      operations. To the extent that any disruption or security breach results in
      a
      loss or damage to our data, or inappropriate disclosure of our confidential
      information, it could harm our business. In addition, these events may force
      us
      to devote more money and resources in order to protect ourselves against damages
      caused by these disruptions or security breaches in the
      future.


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**Item
                4.**
            **Information
                of
                the Company**




**A.****History
      and Development of the Company**





Our
      legal
      name and commercial name is EXFO Electro-Optical Engineering Inc. / EXFO
      Ingénierie électro-optique inc. Our head office is located at 400 Godin Avenue,
      Quebec, Quebec, Canada, G1M 2K2 and our main telephone number is (418) 683-0211.
      Our e-mail address is info@EXFO.com and our website is www.EXFO.com.
      Information on our website is not incorporated by reference in this annual
      report. Our agent for service in the United States is CT Corporation
      System, 111 Eighth Avenue, New York, New York 10011. Our Transfer Agent and
      Registrar is CIBC Mellon Trust Company, 2001 University Street, Suite 1600,
      Montreal, Quebec, Canada, H3A 2A6. This annual report contains trademarks
      and registered trademarks of us and other companies.





We
      were
      incorporated on September 18, 1985 pursuant to the *Canada Business
      Corporations Act.*Since that date, we have amended our articles on various
      occasions mainly to modify our legal and corporate names and our share
      capital.





On
      December 20, 2000, we acquired all of the shares of EXFO Burleigh Products
      Group
      Inc. (formerly Burleigh Instruments, Inc.) (“EXFO Burleigh”), Burleigh
      Instruments GmbH and Burleigh Instruments (U.K.) Ltd. for an aggregate purchase
      price of US$189.3 million, comprised of 6,488,816 of our subordinate voting
      shares and US$42.5 million in cash pursuant to the terms of an Agreement of
      Merger and Plan of Reorganization among us, EXFO Sub, Inc. and the selling
      shareholders, dated November 4, 2000, as amended on December 20,
      2000.  In April2002, the name of Burleigh
      Instruments, Inc. was changed to EXFO Burleigh Products Group
      Inc.  On November 12, 2002, Burleigh Instruments (UK) Ltd. was
      dissolved. EXFO Burleigh is a U.S. company that manufactures precision
      scientific instruments used in basic and applied research engineering and
      production test applications in a variety of fields.





On
      March
      15, 2001, we acquired all of the shares of EXFO Photonic Solutions Inc.
      (formerly EFOS Inc.) (“EXFO Photonic”), a privately held company in Toronto,
      Canada, for a total consideration of US$110.1 million, of which US$25.1 million
      was paid in cash. We also issued 3,700,000 of our subordinate voting shares
      in connection with the acquisition. In September 2001, the name EFOS Inc. was
      changed to EXFO Photonic Solutions Inc.





EXFO
      Photonic, operating since 1984, is a supplier of precision light-based adhesive
      spot curing products as well as curing process control for the global optical
      component manufacturing market and other non-telecom markets. Its products
      deliver precise doses of the appropriate spectral light into photo-sensitive
      and
      heat-cured adhesives to significantly reduce bonding time and increase
      repeatability in optical component and other manufacturing activities. EXFO
      Photonic light-based curing technologies are supported by an extensive
      understanding of bonding and material sciences and by a broad intellectual
      property portfolio, including, as of November 1 2005, 15 patents
      and 12 patents pending.





Also
      on
      March 16, 2001, our wholly owned subsidiary, Burleigh Automation Inc. (“Burleigh
      Automation”), acquired substantially all the assets of Vanguard Technical
      Solutions, Inc., a wholly owned subsidiary of DT Industries, Inc. for a purchase
      price of US$600,000 paid in cash. Vanguard, an automation equipment manufacturer
      in Tucson, Arizona, specialized in the design and manufacturing of
      ultra-precision assembly equipment for sensitive process and critical assembly
      challenges on the production floor.  This acquisition, which
      complemented our acquisition of Burleigh, was planned to fit with our overall
      strategy at that time of providing customers with a comprehensive solution
      for
      the assembly, alignment and testing of optical components and subsystems. Since
      September 2001, Burleigh Automation has ceased operations and we have
      transferred all material intellectual property assets and most of the physical
      assets of Burleigh Automation to EXFO Burleigh.





In
      November 2001, we acquired all of the shares of Avantas Networks Corporation
      and
      simultaneously changed the name of that company to EXFO Protocol Inc. (“EXFO
      Protocol”).  We paid a total consideration of US$69.4 million (or
      US$95.0 million for the equity minus US$25.6 million of cash in the hands of
      the
      acquired company) to acquire EXFO Protocol. Consideration paid consisted of
      4,374,573 of our subordinate voting shares and US$9.8 million in cash, net
      of
      cash acquired.  EXFO Protocol, a company based in Montreal, Canada
      operating since 1998 is a supplier of fiber-optic testing and optical network
      performance management equipment that supports a wide range of protocols and
      data transmission rates.


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During
      fiscal 2001, we were forced to align our cost structure to market conditions.
      On
      June 27, 2001, we announced the reduction of non-customer-related expenses,
      postponement of plans to build a new facility in the Quebec Metro High-Tech
      Park, termination of non-cure operations of Nortech, a subsidiary that
      specialized in manufacturing fiber-optic temperature sensors and reduction
      of
      our work force by 15%. Our plan to build a new facility has been cancelled
      since
      then.





During
      fiscal 2002, we were forced to****re-align our cost structure
      to market conditions.  First, on December 5, 2001, we announced
      the lowering of our operating expenses, a freeze in employee salaries, and
      the
      reduction of our workforce by 10%.  Then, on May 15, 2002,
      we announced a further 20% reduction of our global workforce in an effort to
      lower our cost structure. In May 2002, we performed an assessment of the
      carrying value of goodwill and intangible assets recorded in conjunction with
      the three acquisitions made during the previous 18 months. Considering the
      ongoing unfavorable market conditions, we recorded a charge of
      US$222.2 million to write down a significant portion of goodwill and a
      charge of US$23.7 million to write down a significant portion of acquired core
      technology. Also, overall for fiscal 2002, we wrote off US$18.5 million in
      excess and obsolete inventories.





In
      August
      2002, EXFO Burleigh received confirmation of the extension of its contract
      with
      the U.S. Air Force Research Laboratory into phase 2 of a project for the
      development by EXFO Burleigh of new high-precision actuator
      system.  The contract for phase 2 provided for an additional funding
      of US$1.7 million and extended through the first quarter of 2005.





In
      October 2002, our newly created, wholly owned subsidiary, EXFO Gnubi Products
      Group Inc. (“EXFO Gnubi”), acquired substantially all the assets of *gnubi
      communications L.P.,* including its technology, expertise, customer base,
      inventories and capital assets.  Consideration paid consisted of
      US$1.9 million in cash and 1,479,290 of our subordinate voting
      shares.  Furthermore, an additional cash amount of US$241,000, based
      on sales volumes, was paid in fiscal 2004 in accordance with earn out
      provisions. With the acquisition of these assets, EXFO Gnubi, based in Dallas,
      Texas, continues the operations of *gnubi communications, L.P.,* as a
      supplier of multi-channel telecom and datacom testing solutions serving optical
      transport equipment manufacturers and research and development
      laboratories.  At the time of the asset acquisition, 30 employees of
      gnubi communications transferred to EXFO Gnubi.





During
      fiscal 2003, we were required to implement further restructuring measures as
      a
      result of depressed spending levels in the telecommunications industry and
      economic uncertainty. We reduced our workforce by 30%, rationalized our business
      activities and consolidated certain manufacturing operations. These measures
      incurred charges of US$4.1 million. The rationalization and consolidation
      initiatives involved the reorganization of our business into two new reportable
      market segments: Telecom Division and Photonics and Life Sciences Division
      and
      the exiting of the optical component manufacturing automation business. Our
      Telecom Division consists of the former Portable and Monitoring and telecom
      related Industrial and Scientific product lines. Our Photonics and Life Sciences
      Division includes previous non-telecom Industrial and Scientific product lines.
      Each division has been structured with its own sales, marketing, manufacturing,
      research and development and management teams.





In
      May
      2003, we performed our annual impairment test on goodwill recorded in
      conjunction with the acquisitions of EXFO Burleigh, EXFO Photonic and EXFO
      Protocol and also reviewed the carrying value of intangible assets related
      to
      these acquisitions. As a result of this assessment, we concluded that the
      carrying value of goodwill related to EXFO Burleigh and the carrying value
      of
      intangible assets related to EXFO Burleigh and EXFO Photonic was impaired and
      we
      recorded a charge of US$4.5 million to write down goodwill and a pre-tax charge
      of US$2.9 million to write down acquired core technology. Of the total
      impairment loss of US$7.4 million, US$6.9 million is related to EXFO
      Burleigh for goodwill and acquired core technology and US$0.6 million is related
      to EXFO Photonic for acquired core technology.





In
      addition, in an effort to simplify our structure and stream-line our operations,
      the operations of EXFO Protocol were merged with those of the Corporation as
      of
      September 1, 2003 and effective December 1, 2003, the operations of
      EXFO Gnubi were merged with those of EXFO America Inc.





In
      fiscal
      2004, EXFO also closed a public offering of 5.2 million subordinate voting
      shares to a syndicate of Canadian-based underwriters for net proceeds of $29.2
      million (CA$38.4 million).





Furthermore
      in fiscal 2004, we consolidated our protocol test operations (EXFO Protocol
      and
      EXFO Gnubi) in Montreal, Canada to improve efficiency and reduce
      costs.


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In
      March
      2004, we renewed our collective bargaining agreement with unionized
      manufacturing employees in Quebec City, Canada. Such agreement will expire
      in
      February 2009.





During
      fiscal 2005, our Photonics and Life Sciences Division was renamed the Life
      Sciences and Industrial Division to better reflect its market
      focus.





During
      fiscal 2005, we completed the consolidation of our Life Sciences and Industrial
      Division in Toronto, Canada and we recorded $482,000 in restructuring expenses.
      Altogether, we incurred $2.5 million in restructuring and other charges since
      the fourth quarter of 2004 in conjunction with this consolidation process.
      Following this process all of the operating activities of EXFO Burleigh were
      transferred mainly in Toronto, Canada.





In
      January 2006, we acquired substantially all the assets of Consultronics Limited
      (“Consultronics”), a leading supplier of test equipment for copper-based
      broadband access networks. Consultronics is a privately held company based
      in
      Toronto, Canada with subsidiaries in the United Kingdom and Hungary. We acquired
      all of the subsidiaries’ respective issued and outstanding shares. Consultronics
      specializes in x-Digital Subscriber Line (xDSL), Internet Protocol TV (IPTV)
      and
      Voice-over-Internet Protocol (VoIP) test solutions for the broadband access
      market. We paid consideration equal to approximately US$19.1 million, including
      debt assumption and other acquisition-related costs.





In
      November 2006, we incorporated EXFO Electro-Optical Engineering India Private
      Limited as our wholly-owned subsidiary to establish a software development
      center in Pune, India. In October 2007, we acquired substantially all of the
      assets of JamBuster Technologies Private Limited, for an unmaterial
      consideration, a company duly incorporated in Pune, India which is engaged
      in the business of software development services.




In
      April
      2007, we established a wholly-owned foreign entity in Shenzhen China, EXFO
      Telecom Equipment (Shenzhen) Co. Ltd. for manufacturing purposes. We
      started ramping up manufacturing in September 2007 at our Chinese
      facility.





On
      November 5, 2007, the Board of Directors approved a share repurchase program,
      by
      way of a normal course issuer bid on the open market of up to 9.9% of our public
      float (as defined by the Toronto Stock Exchange), or 2,869,585 shares at the
      prevailing market price. We expect to use cash, short-term investments or future
      cash flow from operations to fund the repurchase of shares. The normal course
      issuer bid will start on November 8, 2007, and end on
      November 7, 2008, or on an earlier date if we repurchase the maximum
      number of shares permitted under the bid. The program does not required that
      we
      repurchase any specific number of shares, and it may be modified, suspended
      or
      terminated at any time and without prior notice. All shares repurchased under
      the bid will be cancelled. We shall provide to any person or company, upon
      request to our Secretary, at 400 Godin Avenue, Quebec, Province of
      Quebec, Canada, G1M 2K2, phone number (418) 683-0913 ext. 3704 or fax
      number (418) 683-9839 a copy of the notice sent to the Toronto Stock Exchange
      (TSX) according to its normal course issuer bid.







**B.****Business
      Overview**




**Company
      Overview**




EXFO
      is a
      test and measurement expert in the global telecommunications industry,
      especially in the portable test market segment. Our Telecom Division, which
      represents about 85% of our business, offers a full range of test solutions
      and
      monitoring systems to network service providers, cable TV operators, telecom
      system vendors and component manufacturers in approximately 70 countries. We
      are
      the global market leader for portable optical test solutions with an estimated
      25.5% market share and a leading supplier of protocol and access test solutions
      to enable triple-play deployments and converged IP networking. Our Windows-based
      modular AXS-200, FTB-200, FTB-400 and IQS-500 test platforms host a wide range
      of modular test solutions across optical, physical, data and network layers,
      while maximizing technology reuse across several market segments. Our Life
      Sciences and Industrial Division offers value-added light-based solutions in
      high-precision medical device and opto-electronics assembly sectors, and
      advanced fluorescence microscopy and electrophysiology solutions for the life
      sciences sector.


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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 testing products for the installation, maintenance,
      monitoring and troubleshooting of optical networks. In 1996, we supplemented
      our
      product portfolio with an extensive line of high-end products that are mainly
      dedicated to research and development as well as manufacturing activities of
      optical component manufacturers and system vendors.




Over
      the
      past years, we have enhanced our competitive position through acquisitions
      of
      copper/xDSL and protocol test businesses. In January 2006, we acquired
      substantially all the assets of Consultronics Limited, a leading supplier of
      test equipment for copper-based broadband access networks, for a total cash
      consideration of $19.1 million. In addition to copper/xDSL test solutions,
      Consultronics had a rich product portfolio for testing next-generation
      technologies, such as IPTV (Internet Protocol TV) and VoIP (Voice-over-Internet
      Protocol), which are critical for NSPs in their deployment of triple-play
      services (voice, data, video) over optical and copper links in access networks.
      This acquisition was a strategic initiative to position EXFO as a one-stop
      shop
      for broadband access and triple-play testing, because it complemented our market
      leadership in the optical FTTx (fiber-to-the-X) test market.





In
      November 2001, we acquired Avantas Networks Corporation, a supplier of
      protocol-testing and optical-network performance management equipment for NSPs.
      This transaction was highly strategic because it enabled us to combine optical
      and protocol test modules inside a single field-portable test platform to help
      our customers increase revenues and reduce operating costs. In October 2002,
      our
      wholly-owned subsidiary, EXFO Gnubi, purchased substantially all the assets
      of
      gnubi communications, L.P., a supplier of multi-channel telecom and datacom
      testing solutions for the system manufacturer market. These strategic
      acquisitions, which were consolidated in Montreal, Canada, in fiscal 2004,
      enabled us to more than double our addressable market, as we expanded from
      optical testing to protocol testing applications, and to offer a more complete
      line of test solutions to our customers.





Previously,
      we had completed two acquisitions to bolster growth in the optical component
      manufacturing market. We acquired Burleigh Instruments, Inc. in December 2000
      for its wavelength measurement instruments and nanopositioning alignment
      systems. We also added EFOS Inc. in March 2001 for its precision light-based,
      adhesive spot-curing technology. We have since exited the optical component
      manufacturing automation business and EXFO Burleigh’s operations have been
      mostly consolidated with those of EFOS Inc. in Toronto, Canada.





We
      launched 20 new products in fiscal 2007. Key product introductions included
      amongst others Internet protocol television (IPTV) test capabilities for our
      Packet Blazer Ethernet product line; a very high-speed digital subscriber loop,
      version 2 (VDSL2) test module to characterize IPTV and high-definition
      television (HDTV) over copper access links; a 10 Gigabit Ethernet module for
      our
      FTB-200 Compact Platform; a multi-purpose series of optical time domain
      reflectometers (OTDRs) for testing access, metro and long-haul networks; a
      next-generation Cable Assembly and Component Test System for production testing
      of short fiber assemblies and FTTx components, and the NQMS suite of quality
      assurance systems for the real-time monitoring of packet signals and fiber
      links. Products on the market two years or less accounted for 33.7% of sales
      in
      fiscal 2007.





Subsequent
      to the year-end, we released three additional solutions, namely a multi-service,
      multi-medium test platform for characterizing and troubleshooting commercial
      and
      residential access networks; a compact multi-service transport test set that
      combines next-generation SONET/SDH and Ethernet testing inside a single module;
      and a cost-effective handheld tester for the rapid installation and maintenance
      of ADSL/ADSL2/ADSL2+ services.





As
      well,
      Frost & Sullivan, a leading market research firm in the telecommunications
      test and measurement industry, named EXFO recipient of the Growth Strategy
      Leadership Award for the fourth consecutive year in the global fiber-optic
      test
      equipment (FOTE) market. According to Frost & Sullivan, EXFO generated the
      largest market-share gains in calendar 2006, moving from 11.0% in 2005 to 12.7%
      in 2006 for third place overall in the FOTE market. Frost & Sullivan
      specifically highlighted EXFO’s leadership in the handheld OTDR and optical loss
      test set (OLTS) segments with market share of 26.2% and 57.9%, respectively.
      Based on this report, we estimate that we improved our leadership position
      in
      our core installation and test market from 23.0% in 2005 to 25.5% in
      2006.


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In
      the
      third quarter of fiscal 2007, as part of ongoing efforts to improve our gross
      margin, we transferred the manufacturing activities of our protocol product
      line
      from Montreal, Canada, to our facilities in Quebec City, Canada. In the fourth
      quarter of fiscal 2007, we moved the manufacturing activities of our copper
      access product line from Concord, Canada, to Quebec City, Canada, and opened
      our
      own telecom manufacturing facility in Shenzhen, China. Our plan is to maintain
      two telecom manufacturing sites: low-volume, high-complexity products in Quebec
      City, Canada, and high-volume, low-complexity products in Shenzhen,
      China.





In
      the third
      quarter of fiscal 2007,we
      also began to
      establish a software development center in Pune, India, to supplement the
      research and development capabilities of our three Canadian centers. It will
      enable us to benefit from a wealth of IP expertise, accelerate product
      development ― especially for our software-intensive protocol test solutions ―
take advantage of a lower costs structure, and leverage business opportunities
      in this rapidly developing country.





Overall
      in fiscal 2007, we increased sales 19.2% to US$152.9 million from US$128.3
      million in 2006. GAAP net earnings reached US$42.3 million, or US$0.61 per
      diluted share, including US$24.6 million in previously unrecognized future
      income tax assets, US$3.2 million in previously unrecognized R&D tax
      credits, US$2.9 million in amortization of intangible assets, US$1.1 million
      from a government grant recovery and US$1.0 million in stock-based compensation
      costs. In 2006, GAAP net earnings totalled US$8.1 million, or US$0.12 per
      diluted share, including US$4.4 million in amortization of intangible assets,
      US$1.3 million from a government grant recovery, US$1.0 million in stock-based
      compensation costs and US$0.6 million for impairment of long-lived
      assets.





Based
      on
      the sales and earnings data for fiscal 2007, we concluded it was more likely
      than not that a portion of our future income tax assets, written off during
      the telecom downturn in 2003, would be recovered. As a result, we recognized
      US$24.6 million in previously unrecognized income tax assets and
      US$3.2 million in previously unrecognized R&D tax credits in the fourth
      quarter of fiscal 2007. These future income tax assets and tax credits relate
      to
      our operations in Canada and in the United States.





**Key
      Industry Trends and Strategy**




The
      fundamentals of the wireline telecom industry are fairly robust in most regions
      of the world, based upon exponential growth in bandwidth demand, intense
      competition – mainly in the United States – between telecom operators (telcos)
      and cable companies (cablecos) pushing massive network investments, and
      significant operational efficiencies and service revenues generated by fully
      converged IP (Internet protocol) networks.





Global
      Internet bandwidth grew at a compound annual growth rate (CAGR) of 45% from
      2003
      to 2006, according to TeleGeography Research. We believe this trend is likely
      to
      remain steady, if not accelerate, with the upcoming anticipation and explosion
      of IPTV (Internet protocol television) and HD-IPTV (high-definition Internet
      protocol television), as this will consume a significant amount of additional
      bandwidth. As a result, telecom companies and cable TV companies are investing
      substantially in their access networks to provide differentiated,
      revenue-generating services to attract and retain consumers who are increasingly
      relying on broadband network services for their work, entertainment and everyday
      activities. From a telecom company perspective, we believe that
      fiber-to-the-premises (FTTP) will become the access network architecture of
      choice, which will allow them to meet heightened bandwidth requirements and
      future-proof their access networks as residential bandwidth requirements are
      growing from the 1 to 5 Mbit/s (megabits per second) of the past to the 30
      to
      100 Mbit/s required in the future to assure multiple HD-IPTV channels, online
      gaming, high-speed content-rich Internet, VoIP (voice-over-Internet-protocol)
      telephony, and a myriad of additional IP-based applications. We believe hybrid
      architectures, combining copper and fiber (fiber-to-the-curb, or FTTC, and
      fiber-to-the-node, or FTTN), will also keep expanding in the short term, because
      they are less expensive methods to increase bandwidth and can be mass-deployed
      faster. These decisions are applicable not only to green-field deployments
      and
      high-rise buildings, but also to larger-scale rollouts as operating costs are
      less than FTTC and FTTN. The cost of deploying FTTH has largely been falling
      over the last three years as volume increased and deployment tools, like those
      we offer, are making the task increasingly effective. We are only at the early
      stages of fiber deployments in access networks both in the Americas and around
      the world.





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As
      bandwidth growth in access networks continues to increase, it has begun placing
      a strain on metro rings and core networks. It is also driving the need for
      higher-speed technologies, such as 43 Gbit/s****(gigabits per
      second)****SONET/SDH (which should start in 2008) and 100
      Gbit/s Ethernet (a longer-term trend), because these solutions are expected
      to
      be significantly more economical, especially if customers will be forced to
      dig
      trenches to deploy new fiber in metro or long-distance routes.





As
      telecommunication networks are being transformed to provide IP-based voice,
      video and data capabilities, the legacy SONET/SDH networks, which were designed
      in the 1980s and 1990s and implemented until 2005, will not be capable of
      efficiently carrying these emerging IP-based services as they are based on
      design standards aimed at PSTN point-to-point voice transmission only. As a
      result, telcos are increasingly turning to more flexible and future-proof
      IP-based, next-generation networks to allow for more versatile and efficient
      transport of a whole new range of applications and services, and to offer
      customers higher-margin triple-play services while reducing their operating
      costs.





In
      terms
      of our Life Sciences and Industrial Division, our strategy to leverage telecom
      technologies into fluorescence microscopy and industrial assembly markets
      delivered annual sales growth of 10.6% in fiscal 2007. We intend to
      maintain our focus on heightened resolution and miniaturization trends in these
      niche markets, while keeping operating costs to a minimum.





**Fiscal
      2008 Corporate Objectives**





The
      fundamentals of the telecom industry are robust in the Americas and worldwide;
      this statement is based on exponential growth in bandwidth demand (45% from
      2003-2006) for global Internet traffic; intense competitive stakes between
      telecom operators and cable companies, which drives massive network investments;
      and significant operational efficiencies and new service revenues that can
      be
      delivered by the increasing amount of fully converged IP networks.





As
      we
      remain committed to best practices in financial reporting, once again this
      year,
      we are providing our investors with our strategic objectives for fiscal 2008
      along with key performance metrics. These management goals should not be
      confused with, and are not intended to be, guidance. The strategic objectives
      for fiscal 2008 are the continuity of prior years. As always, we are highly
      focused on creating value for our shareholders, providing the highest degree
      of
      profitable growth. In fiscal 2008, we intend to maintain our long-term focus
      on
      profitable growth by increasing sales in both divisions through market-share
      gains; maximize profitability through proper execution and efficiency of our
      cost-reduction programs; and focus on innovation to positively position the
      organization for the long-term growth opportunities that exist in our
      space.


·
                  **Increase
                      sales through market-share gains***.*We plan on increasing
                      sales with a 20% growth target for fiscal 2008. We believe
                      that we can
                      continue gaining market share based on our strong positioning
                      for key
                      growth trends, such as the deployment of fiber deeper into
                      access networks
                      and the migration of networks towards converged, IP architectures;
                      our
                      history of gaining market share as evidenced by four consecutive
                      Growth
                      Strategy Leadership Awards from Frost & Sullivan for largest market
                      share gains in optical testing; strong focus on execution as
                      demonstrated
                      by a sales compound annual growth rate of 27.0% over the last
                      three years
                      and 20.1% over the last 10 years, as well as ongoing investments
                      on global
                      sales and marketing staff.
 ·
              **Maximize
                  profitability***.*We will strive to generate a GAAP
                  operating margin of 8% in 2008, even considering a moderate strengthening
                  of the Canadian dollar and our global expansion plans. We will
                  seek to
                  accomplish this through higher sales volumes enabling us to better
                  absorb
                  our fixed manufacturing costs, increased sales of higher-margin
                  protocol
                  test solutions, and a lower cost structure with some manufacturing
                  and
                  R&D being carried out in China and India,
                  respectively.
 
 ·
              **Focus
                  on innovation.** We will seek to derive at least 30% of sales from
                  new products that have been on the market two years or less in
                  fiscal
                  2008. It remains an aggressive target, because we are usually first
                  to
                  market with our new products to quickly capture market share.
                  Consequently, at the time when our new products are receiving global
                  market acceptance, they often cross the two-year threshold for
                  new
                  products. The average lifecycle of a product is about five years.
                  We
                  believe this innovation metric is critical for us because it measures
                  the
                  effectiveness of our market-driven innovation
                  program.


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**The
      EXFO Solution**




We
      offer
      an extensive range of test, measurement and monitoring solutions to the global
      telecommunications industry. Our success has been largely predicated on our
      core
      expertise in optical telecommunications. We also leverage this expertise to
      develop products for life sciences and high-precision assembly applications.
      Our
      solution is based on the following key attributes:




***Modular
      System Design.***  In 1996, we established an
      industry-first by launching the original modular optical test platform. This
      system design consists of a PC-based, Windows-driven platform that can
      accommodate several test modules performing various types of measurements.
      We
      have since developed new compatible test platforms and extended our test module
      offering for both NSPs and system manufacturers based on the same modular
      design. Our modular design provides the following advantages:




·
            unlike
                stand-alone units, new test modules can be rapidly developed to address
                changing industry requirements;




·
            as
                customers’ testing requirements change, they can purchase additional
                modules that are compatible with their previously purchased platforms,
                thus protecting their initial
                investments;




·
            our
                standard graphical user interface reduces training costs because
                customers
                are familiar with previously acquired software
                products;




·
            the
                flexibility of our systems allows customers to develop customized
                and
                automated solutions for their specific test
                requirements;




·
            our
                test platforms are PC-based and Windows-driven, thus they can support
                third-party software solutions.




***High
      Degree of Technological Innovation.*** We have established a strong
      reputation for technological innovation over the last 22 years. In fact, we
      believe this attribute represents a key differentiator for us within
      a competitive marketplace. Following are some of our industry
      firsts:




·
            the
                first PC-based modular test platform for field
                applications;




·
            the
                first all-in-one optical loss test set combining several
                instruments;




·
            the
                first portable polarization mode dispersion (PMD)
                analyzer;




·
            the
                first modular platform to combine optical and protocol test
                solutions;




·
            the
                first line of portable test instruments designed for FTTx testing;
                and




·
            the
                first fully integrated Ethernet-over-SONET test
                solution.




***High-Quality
      Products.***  Product quality is an integral part of our
      solution. Our Quebec City, Canada, operations have maintained ISO 9001
      certification since 1994 and they are now certified to the new 2000 edition
      of
      the standard. Our manufacturing plant in Shenzhen, China, which started
      operations in September 2007, is responsible for the production of high-volume,
      low-complexity telecom products. Quality control responsibilities for products
      manufactured in China will remain in Quebec City until the Shenzhen facility
      obtains full ISO-9000 certification. All of our products meet required industry
      standards, and some of our products meet additional voluntary standards, such
      as
      those set by Telcordia, formerly Bellcore, IEC, and other industry-leading
      standards bodies. During manufacturing, each product has a related
      quality-assurance plan, with rigorous checkpoints, to ensure product conformity.
      Various tasks in the quality assurance process include quality control,
      conformity testing, product documentation, product improvement, regulatory
      compliance, metrology and calibration.




Our
      product designs comply with Directive 2002/96/EC, a legislation enacted by
      the
      European Union regarding the disposal of waste electrical and electronic
      equipment (WEEE), for all products exported to Europe. In regard to the
      Directive 2002/96/EC (RoHs), test and measurement manufacturers have been
      provided an unlimited exemption.




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**Products**




Our
      test
      platforms, namely the new AXS-200 SharpTESTER, FTB-200 Compact Platform, FTB-400
      Universal Test System (UTS), and IQS-500 Intelligent Test System (ITS), are
      at
      the core of our product portfolio. The AXS-200 SharpTESTER, which was launched
      in September 2007, is a multi-service, multi-medium handheld test platform
      designed for characterizing and troubleshooting commercial and residential
      access networks. It can easily be configured for copper/DSL/triple-play,
      Ethernet or optical testing applications. The FTB-200 Compact Platform is a
      two-slot portable test unit optimized for multi-technology, multi-application
      characterization of metro and access networks. The FTB-400 field-testing
      platform provides NSPs with a simple, yet efficient way to perform multiple,
      advanced test operations for installation, maintenance and troubleshooting
      applications. Our IQS-500 ITS, designed for manufacturing and R&D
      applications, tests optical as well as telecom and datacom technologies
      increasingly based on IP technology. All platforms and related test modules
      are
      supported by integrated and highly intuitive graphical user interfaces (GUIs),
      enabling the user to easily store, handle and retrieve a large amount of data.
      In addition, EXFO offers a number of purpose-built hand-held and benchtop test
      and measurement products, some of which are modular in nature. Furthermore,
      EXFO
      offers network monitoring systems and test probes used in third-party network
      monitoring solutions.





The
      following table summarizes the principal types of test instruments for the
      telecommunications industry, typical applications and the formats in which
      we
      offer them:


**Instrument
                Type**
            **Typical
                Application**
            **NSP
                  Market**
            **Manufacturer**
              **/R&D
                  Market****FTB
                400 Modules**
            **FTB
                200 Modules**
            **AXS
                  200 Modules**
            **Handhelds**
            **IQS-500**
                **Modules**
            **Benchtop
                  Instruments**ADSL/ADSL2+
                Service Verification Tool
            Based
                on a DSL “golden modem”, these units are used to test the function, speed
                and quality of a DSL service at the subscriber premises.
            
            
            X
            XBroadband
                source
            Used
                for testing wavelength-dependent behavior of fiber cables and dense
                wavelength division multiplexing (DWDM) optical
                components.
            
            
            
            
            X
            XChromatic
                dispersion analyzer
            Measures
                increasing levels of chromatic dispersion in high-capacity optical
                networks.  Chromatic dispersion is a physical phenomenon
                inherent to optical fiber and optical components that causes information
                bits to spread along a network.  This degrades the quality of
                the transmission signal and, in turn, limits the transmission speed
                carried by optical networks.
            XClip-on
                coupling device
            Clips
                to an optical fiber and allows non-invasive testing.
            
            
            
            XFibre
                Channel tester
            Brings
                FC-0, FC-1 and FC-2 logical layer Fibre Channel testing to services
                delivered via transport protocols, such as dense wavelength division
                multiplexing (DWDM), SONET/SDH and dark fiber. It provides valuable
                timing
                information and buffer credit estimation for Fibre Channel network
                deployment.
            X
            
            
            
            XGigabit
                Ethernet tester
            Measures
                data integrity for high-speed Internet protocol telecommunications
                in
                metro and edge networks.
            X
            X
            X
            
            X10
                Gigabit Ethernet tester
            Benchmarks
                and verifies high-speed 10 Gbit/s Ethernet network performance and
                service-level agreements.
            X
            X
            
            
            XHDTV,
                SDTV and IPTV service test instrument
            Used
                to test the quality and functionality of standard and high definition
                television signals that are delivered over higher-rate ADSL, ADSL2+
                and
                VDSL2 transmission technologies.
            
            
            
            XLaser
                wavelength meter
            Performs
                high-accuracy, absolute wavelength measurements of continuous wave
                (CW)
                laser sources.
            
            
            
            
            
            XLaser
                spectrum analyzer
            Performs
                high-resolution, spectral characterization of continuous CW laser
                sources
            
            
            
            
            
            XTelephone
                for traditional voice and VoIP service testing
            Used
                by telephone line and DSL installers to test the proper functioning
                of
                both traditional and next-generation voice and data communication
                services.
            
            
            
            X





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**Instrument
                Type**
            **Typical
                Application**
            **NSP
                  Market**
            **Manufacturer**
              **/R&D
                  Market****FTB
                400 Modules**
            **FTB
                200 Modules**
            **AXS
                  200 Modules**
            **Handhelds**
            **IQS-500**
                **Modules**
            **Benchtop
                  Instruments**Live
                fiber detector
            Clips
                on to a fiber and is used to detect the presence and direction of
                a signal
                without interrupting the traffic.
            
            
            
            XLoss
                test set
            Integrates
                a power meter and a light source to manually or automatically measure
                the
                loss of optical signal along a fiber.
            X
            X
            
            X
            X
            XMultiwavelength
                meter
            Measures
                the power and drift for multiple wavelengths in a dense wavelength
                division multiplexing (DWDM) system.
            X
            
            
            
            X
            XNarrowly
                tunable laser
            A
                laser that can be precisely tuned to simulate a DWDM light
                sources.  Used primarily for testing optical
                amplifiers.
            
            
            
            
            XNext-generation
                SONET/SDH analyzer
            Full
                SONET/SDH protocol testing functionality, including support for generic
                framing procedure (GFP), virtual concatenation (VCAT), and link-capacity
                adjustment scheme (LCAS) next generation enhancements.
            X
            
            
            
            XOptical
                amplifier
            Boosts
                the power of laser sources. Used for the testing and calibration
                of test
                systems.
            
            
            
            
            XOptical
                coupler
            Used
                in test system to combine sources or signals.  Also uses as
                splitters to monitor signals.
            
            
            
            
            XOptical
                fiber parameter analyzer
            Measures
                the geometric and light guiding properties of an optical fiber. Used
                in
                new fiber research and development and quality control
                applications.
            
            
            
            
            
            XOptical
                power meter
            Measures
                the power of an optical signal.  It is the basic tool for the
                verification of transmitters, amplifiers and optical transmission
                path
                integrity.
            X
            X
            
            X
            X
            XOptical
                power reference module
            Provides
                a highly accurate and traceable measurement of power for the calibration
                or verification of other power measurement instruments.
            
            
            
            
            XOptical
                return loss meter
            Combines
                a laser and a power meter to measure the amount of potentially degrading
                back reflection.
            X
            X
            
            X
            XOptical
                spectrum analyzer
            Produces
                a graphical representation of power versus wavelength for an optical
                signal. Useful for measuring the drift, power and signal-to-noise
                ratio
                for each wavelength in a DWDM system.
            XOptical
                switch
            Provides
                switching between fibers. Used to provide flexible and automated
                test
                setups such as the measurement of multiple fibers or components with
                multiple ports with one instrument.
            X
            
            
            
            XOptical
                time domain reflectometer
              (OTDR)
            Like
                a radar, it measures the time of arrival of reflections of an optical
                signal to determine the distance to the breaks or points of excessive
                loss
                in a fiber network.
            X
            X
            
            XOptical
                waveguide analyzer
            Provides
                the refractive index profile of glass and fused silica-based devices
                used
                in next generation networks.
            
            
            
            
            
            XPassive
                component analyzer
            Characterizes
                passive wavelength-selective devices, such as multiplexers, demultiplexers
                and add/drop filters, with respect to absolute wavelength in order
                to
                guarantee their performance within dense wavelength division multiplexing
                (DWDM) systems.
            
            
            
            
            
            XPassive
                optical network (PON) power meter
            Determines
                the power level of various signal types, including continuous (e.g.,
                TV
                signal at 1550 nm) and framed (e.g., ATM or Ethernet at 1490 nm or
                1310
                nm) within a passive optical network. Various baud rates are covered,
                ranging from 155 Mbit/s to 2.5 Gbit/s, for both synchronous and
                non-synchronous signals.
            
            
            
            X





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**Instrument
                Type**
            **Typical
                Application**
            **NSP
                  Market**
            **Manufacturer**
              **/R&D
                  Market****FTB
                400 Modules**
            **FTB
                200 Modules**
            **AXS
                  200 Modules**
            **Handhelds**
            **IQS-500**
                **Modules**
            **Benchtop
                  Instruments**Polarization-dependent
                loss meter
            Measures
                the difference in loss of power for the different states of
                polarization.
            
            
            
            
            XPolarization
                mode dispersion analyzer
            Measures
                the dispersion of light that is caused by polarization. Generally
                used to
                determine the speed-distance limitation of fiber and
                cables.
            XSONET/
                SDH analyzer
            Provides
                accurate bit-error rate and performance analysis of SONET/SDH overhead
                format that reflects the quality of a transmission system.
            X
            X
            
            
            XStable
                light source
            Emitting
                diode or lasers used in connection with a power meter to measure
                signal
                loss.
            X
            
            
            X
            X
            XSynchronization
                analyzer
            Portable,
                stand-alone tester for network synchronization analysis and wander
                measurement in wireless and wireline transport networks.
            
            
            
            
            
            XTalk
                set
            A
                device that attaches to an optical fiber and serves as a temporary
                voice
                link facilitating coordination of work among installation
                crews.
            X
            
            
            XTelephone
                wire analyzer
            Used
                by telecommunications service providers that have networks that are
                comprised mostly or partially of twisted-pair local loops to ensure
                that
                those loops are of sufficient quality to carry higher-frequency signals
                required for DSL.
            
            
            
            XVariable
                optical attenuator
            Used
                in network simulation setups to provide calibrated variable reduction
                of
                the strength of an optical signal.
            
            
            
            X
            X
            XVisual
                fault locator
            A
                visible laser that can be connected to an optical fiber network to
                help
                locate breaks or points of excessive loss.
            X
            X
            
            XWidely
                tunable laser
            Can
                produce laser light across a broad range of wavelengths. Used to
                test DWDM
                components and value-added optical modules.
            
            
            
            
            X
            X





*Products
      for Network Service Providers*




We
      offer
      an extensive range of field-portable test, measurement and monitoring solutions
      that are mainly used by NSPs, but can also be utilized by system vendors. These
      products are available as handheld test instruments, portable platforms with
      related modules, and as rack-mount chassis with related modules. Our handheld
      instruments are durable, compact and easy to use. Our new AXS-200 SharpTESTER
      platform, which is designed for entry-level field technicians in access
      networks, can easily be configured for copper/DSL/triple-play, Ethernet or
      optical testing applications. We released Ethernet/IP and ADSL2+ triple-play
      test modules for the AXS-200 SharpTESTER, while several others will be
      introduced in upcoming months. Our FTB-200 Compact Platform, designed for the
      “super field technician”, holds up to two interchangeable modules that are fully
      compatible with the highly entrenched FTB-400 platform. Test technologies
      well-suited for the FTB-200 Compact Platform include a wide range of singlemode
      and multimode optical time-domain reflectometers (OTDRs), automated optical
      loss
      test sets (OLTSs), SONET/SDH analyzers from DS0 up to OC-192, as well as Gigabit
      Ethernet (GigE) testers. Our second-generation field-testing platform, the
      FTB-400 UTS, is available in three configurations: the two-slot model is ideal
      for OTDR, OLTS and Gigabit Ethernet applications; the four-slot model offers
      a
      high-speed bus, ideal for extensive datacom testing and dedicated OTDR, loss
      and
      Ethernet (up to 10 Gigabit) testing; the seven-slot model is used for dispersion
      characterization (PMD and CD), DWDM testing (OSA and MWM) and protocol
      (SONET/SDH/datacom) testing; Finally, the eight-slot model is a
      high-performance, multiple-protocol configuration that allows users to combine
      next-generation SONET/SDH functions with Ethernet, Fibre Channel and
      optical-layer testing capabilities. Our portable platforms are PC-centric,
      Windows-based, highly flexible and fully scalable. Their large robust
      touchscreens are very practical for field use.







23
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*Products
      for System/Component Manufacturers*




Our
      system/component vendor solutions, mainly built around our IQS-500 ITS, are
      available as test modules or stand-alone benchtop instruments. The
      next-generation IQS-500 platform can efficiently run as many as 100 optical
      test
      modules using a single controller unit. The IQS-500 platform is equipped with
      the software and hardware technology to support single-button operation for
      automated testing. Its system-based approach – one box, several test
      modules – combined with an open architecture (PXI, Windows, LabVIEWTM,
      etc.) and ease of programming, produces a highly flexible test
      environment.




The
      IQS-500 also provides backward compatibility with recent IQ-generation test
      modules, while delivering all the power and advantages of a next-generation
      platform. EXFO’s wide selection of high-performance test modules includes
      high-speed power meters, light sources, WDM laser sources, tunable laser
      sources, variable attenuators, multi-wavelength meters, polarization-dependent
      loss (PDL) and optical return loss (ORL) meters, polarization controllers and
      optical switches.




As
      demonstrated by the release of our IQS-12001B Cable Assembly and Component
      Test
      System in fiscal 2007, our system/component vendor solutions also address
      testing issues that cannot be handled by standard test modules or stand-alone
      benchtop instruments. We have developed a number of integrated test systems
      and
      offer them as off-the-shelf solutions to suit a wide range of customer needs.
      In
      addition, we have created a software development kit for developers who prefer
      writing their own programs for our instruments. Following is a list of
      integrated test systems that we provide for characterizing optical components,
      subsystems and networks:




·CWDM/FTTH
                passive optical component test system
            Used
                to automatically characterize all critical specifications, including
                spectral insertion loss, polarization-dependent loss and optical
                return
                loss of a CWDM passive component or a FTTH splitter with a high degree
                of
                accuracy, ease of use and speed.·Cable
                assembly and component test system
            Used
                to perform insertion loss and mandrel-free reflection measurements
                with
                the highest degree of accuracy and repeatability on short fiber assemblies
                (including multifiber patchcords, hybrids and fan-out patchcords)
                and
                components like PLC splitters and fiber arrays.·DWDM
                passive component test system
            Used
                to automatically characterize all critical specifications, including
                spectral insertion loss, polarization-dependent loss and optical
                return
                loss of a DWDM passive component with a high degree of accuracy,
                ease of
                use and speed.





*Products
      for life sciences and industrial applications*




Over
      the
      years, we have developed and acquired a number of core technologies that we
      leverage in selected high-precision assembly and life sciences markets. For
      example, we offer several light-based curing solutions for optical component
      manufacturing applications and have adapted our approach for other industries,
      such as semiconductor, microelectronic, and medical device manufacturing, in
      order to maximize revenues. Our Omnicure® systems
      deliver
      precise doses of the appropriate spectral light onto photosensitive adhesives
      to
      significantly reduce bonding time and increase repeatability. These light-based
      curing systems, supported by patented optical feedback, thermal control and
      radiometry technology, produce a high-quality bonding solution. Our technology
      and application knowledge place us at the forefront of this market.




One
      of
      our key products is the X-Cite® 120 XL
      Fluorescence Illumination System for microscope manufacturers. This
      next-generation X-Cite 120 XL system delivers excellent image quality and
      at least 2000 hours of lamp life, which is over 60% longer than the previous
      model and up to 10 times longer than conventional illumination
      systems.





The
      X-Cite 120 XL is a self-contained illumination unit separate from a
      microscope. A simple light guide attachment through custom-coupling optics
      ensures a uniform field of view with no heat from the lamp being transferred
      to
      the sample. The output intensity of the X-Cite 120 XL system can also be
      adjusted from the optional front-panel control.








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 Table
            of Contents





The
      following table summarizes the principal types of high-precision assembly and
      life science solutions we provide as well as their typical
      applications:




**Light
                Sources and Accessories*****Product
                Type***
            ***Product***
            ***Typical
                Application***UV
                Light Sources
            Omnicure®
                S1000
              Omnicure®
                S2000
            Used
                to initiate photo chemical reactions in polymer-based materials for a
                variety of end use applications. Examples include adhesive curing
                for
                manufacturing of high value-added items such as medical devices,
                micro-electronic and opto-electronic components, displays, and data
                storage devices.Fluorescent
                Light Sources
            X-Cite®
                120XL
              X-Cite®
                120 PC
            Fluorescence
                light source that attaches directly to most microscopes currently
                sold by
                major microscopes manufacturers.Optical
                Accessories
            
            Optional
                custom delivery optics used with EXFO UV light sources to tailor
                the
                properties of light beams to end-user applications.High
                Power Fiber Light Guide
            
            Provides
                an equal distribution of light energy to multiple cure sites with
                50% more
                throughput than standard fiber guides.**Optical**Instruments*****Product
                Type***
            ***Product***
            ***Typical
                Application***Radiometer
            R5000
              R2000
            Handheld,
                broadband optical radiometers used in conjunction with EXFO UV light
                sources to ensure process quality control at the end-user
                location.Cure-Site
                Radiometer
            
            Attachments
                for the R2000 and R5000 radiometers that enable optical measurements
                under
                customer specific configurations. Examples include the cure-ring
                radiometer, which measures the output power of light from an EXFO
                cure
                ring; ideal for applications that requires a uniform 360°
                exposure.


Precise
                    Motors/Stages
              IW-700
                    Inchworm Motors
                  TSE-820
                    Inchworm Stages
                  UHVL
                    Inchworm Motors
              High-resolution
                    optical alignment, fiber-optic alignment, semiconductor positioning,
                    materials research.





25
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**Precision
                  Positioning Instruments*****Product
                  Type***
              ***Product
                  Line***
              ***Typical
                  Application***Micromanipulators
              PCS-6000
                  Micromanipulators
                PCS-5000
                  Micromanipulators
              Electrophysiology
                  research such as patch clamp recording experiments on cells from
                  the brain
                  and central nervous system.Microscope
                  Platforms
              Gibraltar
                  Platform/Stage
              Stable
                  mechanical platforms that facilitate cellular research with
                  micropositioning and microinjection systems.Microinjection
                  Systems
              MIS-5000
                  Microinjection Manipulator
                PiezoDrill
                  Inertial Impact Drill
              Microinjection
                  and nuclear transfer for genetics and reproductive sciences
                  research.Microelectrode
                  Positioner
              LSS-8000
                  Inchworm System
              Electrophysiology
                  research such as intracellular recording experiments




**Research
      and Development**




We
      believe that our future success largely depends on our ability to maintain
      and
      enhance our core technology and product functionality. To keep developing new
      products and enhancements, it is important that we retain and recruit highly
      skilled personnel. Our Telecom Division’s research and development department is
      headed by a Vice-President of Research and Development, while our Life Sciences
      and Industrial Division has a Director of Research and Development.




In
      fiscal
      2007, we implemented an R&D expansion strategy into India that accelerated
      our software development capabilities at a lower cost. We made an acquisition
      agreement with a small outsourcing company based in Pune, India. From this
      base,
      we have increased the team throughout the year to reach a level of
      65 engineers.






As
      of
      November 1, 2007, our research and development departments included
      349 full-time engineers, scientists and technicians, of whom 56 hold
      post-graduate degrees. Gross research and development expenditures in fiscal
      2007 reached $25.2 million, compared to $19.5 million in 2006 and
      $15.9 million in 2005. We launched 20 new products in fiscal 2007
      compared to 18 in 2006 and 15 in 2005. Approximately 34% of sales in fiscal
      2007
      originated from products that have been on the market two years or less compared
      to 37% in 2006 and 42% in 2005.




Through
      market-oriented product portfolio review processes at our telecom sites in
      Quebec City, Canada, Montreal, Canada, Concord, Canada, and Pune, India, we
      ensure that our investments in research and development are aligned with our
      market opportunities and customers’ needs. This process enables us to maximize
      our returns on R&D investments by focusing our resources on prioritized
      projects. Quarterly product portfolio review meetings enable us to choose a
      realistic, balanced mix of new products and allocate the necessary resources
      for
      their development. All our projects, including those already underway, are
      reviewed, given a priority rating and allocated budgets and resources. Our
      existing projects can be stopped or substantially redefined if there have been
      significant changes in market conditions, or if the project development schedule
      or budget have significantly changed.







26
 Table
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To
      manage
      our research projects once they are underway, we use a structured management
      process known as the stage-gate approach. The stage-gate approach is based
      on a
      systematic review of a project’s progress at various stages of its life cycle.
      The following are the key review stages of the stage-gate approach:




·
            market
                study and research feasibility;


·
            product
                definition;


·
            development
                feasibility;


·
            development;


·
            qualification;
                and


·
            transfer
                to production.




At
      each
      stage, we review our project risks, costs and estimated completion time. We
      compare our design to anticipated market needs and ensure that our new product
      development is synchronized with other internal departments and external
      industry events. Adherence to these inter-related portfolio review and
      stage-gate processes enabled us to be named winners of the Outstanding Corporate
      Innovator Award in 2000 by the U.S.-based Product Development and Management
      Association.




We
      also
      maintain research and development programs for our life sciences and industrial
      activities in Toronto, Canada. The product development process is managed using
      a similar stage-gate process, and projects are reviewed and approved through
      a
      quarterly portfolio review. The future success of our life sciences and
      industrial operations largely depends on our ability to maintain and enhance
      our
      core technology in light-based curing, fluorescence illumination systems and
      piezoelectric positioning.




Strong
      R&D capabilities at our Life Sciences and Industrial Division site in
      Toronto, Canada have made it possible to bring a number of successful new
      products to market quickly and retain customer intimacy. In the process, it
      has
      enhanced our ability to customize products for special applications and to
      develop original equipment manufacturing (OEM) products under partnerships
      and
      exclusive contracts. Outside consultants are often used for added support in
      areas like software development, mechanical design and rapid
      prototyping.




**Customers**




Our
      global and diversified telecom customer base relies on our test and measurement
      solutions to enable optical networks to perform impeccably during their complete
      life cycles: research, development, manufacturing, installation, maintenance
      and
      real-time monitoring. We also have selected customers in high-precision assembly
      and life science sectors that require our solutions to render them more
      efficient in their respective fields. Our telecom customers include carriers,
      cable television companies, public utilities, private network operators,
      third-party installers, equipment rental companies, system manufacturers,
      component vendors and laboratory researchers. Our life science and industrial
      customers consist of major manufacturers of medical devices, microelectronics,
      optical displays, electronic storage systems, photonic components and
      microscopes, as well as universities, medical schools, governments, and private
      and industrial research laboratories. In fiscal 2007, our top customer accounted
      for 14.7% of our sales and our top three customers represented 19.6% of our
      sales. In comparison, in 2006 our top customer accounted for 13.8% of sales
      and
      our top three customers represented 19.4%, while in 2005, our top customer
      accounted for 23.3% of sales and our top three customers represented
      28.4%.




With
      regard to geographic distribution, sales to customers in the Americas (US,
      Canada and Central & South America) represented 59% of our sales in fiscal
      2007, while sales to customers in EMEA (Europe, Middle East and Africa) and
      Asia-Pacific accounted for 27% and 14% of sales, respectively. In comparison,
      the Americas, EMEA and Asia-Pacific accounted for 60%, 25% and 15% of sales,
      respectively, in 2006, and 68%, 20% and 12%, respectively, in 2005.




**Sales**




We
      sell
      our telecom test and measurement solutions through direct and indirect sales
      channels in the Americas (US, Canada, Central & South America) and around
      the world.







27
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In
      the
      Americas, we use a hybrid model, combining key account management with direct
      and indirect sales coverage. We typically use key account managers to serve
      large customers that generate high sales volumes or might potentially represent
      high sales volumes in the future. These key account managers are supplemented
      by
      regional sales managers, sales engineers, sales representatives and distributors
      in US and Central & South American metropolitan areas as well as regional
      sales managers in Canada.




We
      opt
      for a direct sales approach when selling higher-end, highly technical products
      to sophisticated buyers. Sales of low- to medium-level complexity products
      to
      less stringent technical buyers are usually done through a manufacturer
      representative organization supported by regional sales managers. Our main
      sales
      offices and service centers in the Americas are located in Addison, Texas,
      Quebec City, Canada, and Concord, Canada. They are supplemented by a regional
      presence in cities across the US, Central and South America, as well as
      Canada.




On
      the
      international front, we have sales personnel covering strategic areas such
      as
      EMEA (Europe, Middle East and Africa) and APAC (Asia-Pacific region). Our sales
      network in EMEA is supported by a main office and service center in Southampton,
      UK, which maintains our head of European sales operations and also provides
      repair and calibration services for our EMEA customers. We also have additional
      sales offices in multiple countries across EMEA to serve and support our various
      customers and distributors.




As
      for
      APAC, our main sales offices for South East Asia is located in Singapore, while
      our main sales representative offices for mainland China are located in Beijing
      and Shenzhen, which also acts as a service center to better serve our customer
      base in that geographic area. In addition, we have other sales offices in
      strategic locations around the world to support our network of distributors
      and
      various customers.




We
      rely
      on a network of more than 90 distributors worldwide to work with us in
      supporting mostly our international sales and to participate in a large number
      of our international events. We believe that the local presence and cultural
      attributes of our distributors allow us to better serve our global
      markets.




Our
      direct telecom sales team consists of a Vice-President of Sales for the Americas
      and a Vice-President of International Sales. They are supported by seven
      regional sales directors that are leading a widely distributed team of more
      than
      83 people acting as key account managers, regional sales managers, sales
      engineers and application engineers. Our sales people are located throughout
      major metropolitan areas around the world. This group of sales professionals
      has
      on average more than 13 years of experience in the fields of telecommunications,
      fiber optics, or test and measurement. We also have an in-house Customer Service
      Group to meet the needs of existing and new customers. This group is responsible
      for providing quotations to customers, supporting our sales force, managing
      demonstration units, order management, technical support and training as well
      as
      calibration and repair services.




The
      main
      office for our Life Sciences and Industrial Division is located in Toronto,
      Canada. We use mixed sales channels to serve various markets supported by this
      division, depending on product line and geography. Optical light sources and
      related accessories used for industrial applications are sold in North America
      through a network of more than 10 manufacturer representatives and,
      internationally, through a network of more than 20 distributors. The X-Cite
      120 Fluorescence Illumination System is sold through value-added reseller
      agreements with major microscope companies and system integrators in North
      America and Europe. Positioning products are sold directly to customers in
      North
      America, which includes the United States and Canada, and internationally
      through a network of technical distributors. To gain additional access to the
      positioning life science research market in the United States and Canada,
      distributor agreements are in place with major microscope manufacturers, which
      include Leica, Nikon, Olympus and Zeiss. These companies often combine the
      sale
      of their microscopes with our product.







28
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            of Contents





**Product
      Management, Marketing/Communications and Customer Support**




*Product
      Management*




Our
      telecom Product Management Group consists of one Vice-President responsible
      for
      our Optical, Protocol, Copper Access, and Systems product lines – as well as
      directors and product managers who have various degrees in engineering, science
      and business administration. Directors and product managers, under the direction
      of the Vice-President, are responsible for all aspects of our telecom marketing
      program including product strategy, new product introductions, definition of
      new
      features and functions, pricing, product launches and advertising campaigns.
      We
      follow up our marketing initiatives by attending industry trade shows.
      Furthermore, we have a customer relationship management (CRM) system to
      compile market and customer information including forecasts, opportunities,
      leads and competitive data. We use this information to make strategic business
      decisions. Finally, strategic marketing specialists analyze our markets, compile
      competitive information and identify macro-trends in our sector.




Our
      Life
      Sciences and Industrial Group consists of a Director – responsible for both life
      sciences and precision assembly sectors – as well as product managers who have
      various degrees in engineering, science and business administration. Product
      managers, under the direction of the Director, are responsible for all aspects
      of their business line marketing programs including product strategy, new
      product introductions, definition of new features and functions, pricing,
      product launches and advertising campaigns. The telecom product management
      group
      and the Life Sciences and Industrial Division product management
      group include 34 and 5 employees, respectively.




*Marketing/Communications*





The
      Telecom Division’s Marketing-Communications team, which consists mainly of
      project managers, marketing writers, translators and graphic artists, supports
      our Product Management Group by producing marketing and corporate documentation.
      Literature includes specification sheets, application notes, product catalogues,
      advertising copy and an electronic corporate newsletter. This
      Marketing-Communications team is also responsible for all sales tools required
      by our worldwide sales force and for updating the marketing contents of our
      Website. This team falls under the responsibility of the Vice-President, Telecom
      Product Management and Marketing.




The
      Life
      Sciences & Industrial Division’s Marketing-Communications team shares a
      variety of marketing initiatives.  This group is assisted by product
      managers, who provide the technical data and collaborative support required
      to
      produce product specification sheets, catalogues, application notes and
      multimedia marketing tools. This Marketing-Communications team is also
      responsible for all advertising material, Website updates, events planning
      (including trade shows) and direct promotional marketing such as mass mailings
      and telemarketing.  This team also provides the sales tools required by the
      Life Sciences and Industrial Division’s worldwide sales channels, including
      maintaining our elite partner program. This team falls under the responsiblity
      of the Director of marketing for the Life Sciences and Industrial
      Division.




*Customer
      Support*




Customer
      support is deemed a corporate mandate at EXFO. As such, our Customer Support
      Group handles requests from customers worldwide. We aim to anticipate our
      customers’ needs, offering Inside Sales, Technical Support and After-Sales
      Service. EXFO Customer Service Department offers customer support in French,
      English, Chinese, German, Spanish, Portuguese, Italian, Russian and
      Japanese.




Our
      employees in the Inside Sales Team are mainly responsible for guiding customers
      in purchasing the correct equipment for their respective applications, issuing
      quotations and promoting our Flexcare service program. In order to provide
      customers with one central point of contact, our service representatives work
      with the customer from purchasing equipment to helping them service the
      equipment, if necessary.




Within
      our Technical Support team, we have agents who provide troubleshooting support
      to our customers as well as trainers and installers who offer on-site servicing
      for more complex equipment.




To
      offer
      superior after-sales service worldwide, we have service centers in North
      America, Europe and Asia. These support centers provide technical support,
      order
      processing, inside sales, calibration and repairs for our
      customers.




All
      these
      teams fall under the responsibility of the Vice-President, Telecom Product
      Management and Marketing.





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**Manufacturing**




Our
      telecom manufacturing operations consist mainly of material planning,
      procurement, sub-assembly, final assembly and test, software loading,
      calibration, quality assurance, shipping, billing and customs management. As
      of
      November 1, 2007, we had 299 employees involved in our telecom
      manufacturing operations. Most of our telecom manufacturing activities, which
      occupy a total of approximately 115,000 square feet, are spread among three
      buildings: two in Quebec City, Canada, and one in Shenzhen, China.




These
      manufacturing operations include the following responsibilities:




·
            ***Production.***  From
                production planning to product shipment, our production department
                is
                responsible for manufacturing high-quality products on time. Factories
                are
                organized in work cells; each cell consists of specialized technicians
                and
                equipment and has full responsibility over a product family. Technicians
                are cross-trained and versatile enough, so that they can carry out
                specific functions in more than one cell. This allows shorter lead
                times
                by alleviating bottlenecks.




·
            ***Product
                Engineering and Quality.***  This department, which
                supports our production cells, acts like a gatekeeper to ensure the
                quality of our products and the effectiveness of our manufacturing
                processes. It is responsible for the transfer of products from research
                and development to manufacturing, product improvement, documentation,
                metrology, and the quality assurance and regulatory compliance process.
                Quality assurance represents a key element in our manufacturing
                operations. Quality is assured through product testing at numerous
                stages
                in the manufacturing process to ensure that our products meet stringent
                industry requirements and our customers’ performance
                requirements.




·
            ***Supply-Chain
                Management.***  This department is responsible for
                sales forecasting, raw material procurement, material-cost reduction
                and
                vendor performance management. Our products consist of optical, electronic
                and mechanical parts, which are purchased from suppliers around the
                world.
                Approximately one-third of our parts are manufactured to our
                specifications. Materials represent the biggest portion of our cost
                of
                goods and we relied more and more on outsourcing our manufacturing.
                Our
                performance is tightly linked to vendor performance, requiring greater
                emphasis on this critical aspect of our
                business.




Our
      Life
      Sciences and Industrial Division’s manufacturing operations occupy 8,000 square
      feet in Toronto, Canada. This group manufactures light sources and related
      accessories, fluorescence illumination systems and precise positioning equipment
      for the life sciences and high-precision assembly markets. Operations consist
      of manufacturing, procurement, warehousing, quality control and document
      control managed by various elements of the ISO 9001 certified quality
      system. Recognizing the importance of reduced time-to-market for our solutions,
      we have focused efforts on designing products with an emphasis on
      standardization, modularity, as well as ease of fabrication and assembly.
      Following are key manufacturing responsibilities in Toronto,
      Canada:




**Manufacturing**– consists primarily of assembly and test capabilities in which all
      major manufacturing elements are subcontracted to various key suppliers. These
      components are integrated into assemblies and tested in order to ensure all
      operating specifications have been met for each product manufactured.
      Cross-training of assembly technicians for each product group ensures
      scalability of manufacturing to meet customer demand. In addition, this
      group is responsible for capacity and production planning, which are necessary
      on an on-going basis to ensure that adequate resources are available to meet
      forecasted and actual demand.




**Supply
      Chain Management**– is responsible for the planning of materials
      required by manufacturing and developing key-supplier relationships to ensure
      materials have been manufactured to our specifications. This group’s main focus
      is to work with our worldwide supplier base to find effective manufacturing
      and
      logistic solutions in order reduce costs and cycle time. Paramount to this
      process is an effective communication system that provides timely feedback
      to
      our suppliers and forms an important element of our supplier evaluation
      system.







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**Manufacturing
      Engineering and Quality Assurance**– is responsible for product integrity
      throughout the manufacturing cycle. From the release of new products, through
      our new product introduction process, and configuration management to manage
      engineering change, we ensure consistent manufacturing processes throughout
      the
      product life cycle. In conjunction with the above process, quality is maintained
      by performing quality tests at incoming receiving and final product
      verification. The responsibility for product quality is shared by all team
      members throughout the company and does not reside solely with the quality
      group.




**Competition**




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




·
            product
                performance and reliability;


·
            price;


·
            level
                of technological innovation;


·
            product
                lead times;


·
            breadth
                of product offerings;


·
            ease
                of use;


·
            brand-name
                recognition;


·
            customer
                service and technical support;


·
            strength
                of sales and distribution relationships;
                and


·
            financial
                stability.




Generally,
      competitors fall into two categories. The first category consists of global
      test
      and measurement vendors, who complement their broad range of products with
      telecom test and measurement equipment. These companies include Agilent
      Technologies, Inc., Anritsu Corporation, JDS Uniphase Corporation, Spirent
      plc,
      and Yokogawa.




The
      second category refers to niche companies in the telecom test and measurement
      industry. These companies typically have limited product lines and in some
      cases
      may be geographically limited in their customer base. Such companies include
      Digital Lightwave Inc., Fluke Networks, an operating division within Danaher
      Corporation, IXIA, and Sunrise Telecom Inc.




Competition
      for our life sciences and industrial solutions is quite varied, depending upon
      product line. Competitors that sell light-based curing products include Dymax,
      Henkle-Loctite in North America and Europe as well as Hamamatsu, Ushio and
      Matsushita (Panasonic) in Asia, With regard to our X-Cite 120 Fluorescence
      Illumination System, main competitors consist of microscope manufacturers who
      have developed lamp housings for low-wattage mercury burners in-house. Finally,
      our motion control Life Science instruments, which are designed for various
      life
      science applications, compete against products from companies like Sutter
      Instruments and Narishige.




**Regulatory
      Environment**





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








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In
      the
      United States, our products must comply with the regulations of several agencies
      of the U.S. federal government, including the Federal Communications Commission
      (FCC), the Food and Drug Administration (FDA) and the Occupational Safety and
      Health Administration (OSHA). Under the FCC’s regulations, our products must
      comply with certain electro magnetic compatibility (EMC) requirements to insure
      they do not generate and are immune from electrical noise which could possibly
      cause undesirable operation, as well as affect other surrounding devices.
      Depending upon the product, compliance with these rules may necessitate applying
      for and obtaining an FCC equipment authorization prior to importing into the
      United States, or marketing, any units of the relevant product. Additionally,
      some of our products must comply with the FDA’s
      non-medical****performance standards and related rules
      concerning light-emitting products, such as lasers. The FDA’s regulations are
      intended to promote safety by limiting human exposure to harmful non-iodizing
      radiation. Similarly, our products must comply with safety standards adopted
      by
      OSHA.





Similar
      regulations apply in other countries. For example, in Canada our products must
      comply with the applicable standards adopted by the Standards Council of Canada
      (SCC). These include product safety standards developed by the Canadian
      Standards association as well as EMC requirements adopted by Industry Canada.
      Countries in the European Union require product compliance as dictated by an
      applicable directive, often referred to as CE marking. This includes testing
      to
      ensure compliance with harmonized European Norm (EN) standards for both product
      safety and EMC requirements. Other significant types of regulations not
      described in this annual report also may apply, depending upon the relevant
      product and country of destination.





In
      Europe, with the implementation of the WEEE directives for recycling of
      electronic products in selected European Countries (2002-96-CE), we have
      appointed a task force committee consisting of our management and employees,
      distributors and other partners as the case may be, to ensure full compliance
      with regulations and oversee the management, logistics, recycling rate, disposal
      services and activities related to recycling of electronic equipment and
      products within the member states.





**Intellectual
      Property**





Our
      success and ability to compete are dependent in part on our ability to develop
      and protect our proprietary technology. We file U.S. and international
      applications to protect technology, inventions and improvements important to
      the
      development of our business. We also rely on a combination of copyright,
      trademark, trade secret rights, licensing and confidentiality
      agreements.





As
      of
      August 31, 2007, EXFO held 37 actively maintained granted patents from the
      U.S.
      (including one “design” patent), eight from Canada, three from Germany
      (including one “Utility Model”), two from the United Kingdom, two from
      France, and one from China.  In addition, EXFO has nine US patent
      applications in process, nine Canadian patent applications in process, two
      European applications in process, two from China, two from Germany, one
      from Russia, and four Patent Cooperation Treaty patent applications pending.
      These issued and pending patents cover various aspects of our products and
      processes. The expiration dates of our issued patents range from October 3,
      2008
      to August 3, 2024.





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





·
            a
                method and apparatus for “non-intrusive” live-fiber detection and
                monitoring, for which a PCT patent application has been
                filed.  This invention permits a fiber “clip-on” device to be
                attached to a cabled fiber, essentially guaranteeing that the induced
                bending loss to a live-traffic link will never exceed 1
                dB.  This is a key invention for our new LFD-250, LFD-300, and
                TG-300 products, announced in September
                2006.





·
            the
                measurement of attenuation of optical fibers using bidirectional
                transmission of information via the fiber for which patents were
                granted
                in the United States and Canada. This invention forms the basis of
                our
                FOT-930 and FTB-3920 products;








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·
            a
                method and apparatus for characterizing optical power levels in
                three-wavelength, bidirectional fiber-to-the-home systems. This invention
                describes how the optical power can be measured at the two-downstream
                and
                one upstream wavelengths used to connect a residence or business
                customer,
                while maintaining the signal continuity necessary to keep the home-based
                Optical Network Terminal operating. A US patent and a German Utility
                Model
                have been granted, and a PCT patent application has been converted
                to
                national applications in a number of other countries. This invention
                forms
                the basis of the two-port version of our PPM-350B PON Power
                Meter.





·
            an
                optical spectrum analyzer using optical fibers as input and output
                “slits”.  This invention forms the basis of our FTB-5240,
                FTB-5240B and IQ-5250 products. A patent has been granted in the
                US, UK,
                Germany, France, and China, and an application is in process in
                Canada.





·
            a
                light-curing system with closed-loop control and work-piece recording
                which is at the heart of the spot-curing systems manufactured by
                EXFO
                Photonic Solutions and for which patents were granted in the United
                States
                and Canada;





·
            a
                special optical design used in some of the X-Cite adaptors to prevent
                structure in the beam from reducing the uniformity of illumination
                at the
                microscope objective plane, which is a key patent for our X-Cite
                fluorescent illumination system. A US patent has recently been
                granted.





·
            portable
                test gear for TDM and packet-based communications for which patent
                applications have been filed in Canada, the United States and pursuant
                to
                the Patent Cooperation Treaty form the basis of the technology used
                by
                EXFO Protocol for a number of its protocol testing
                products.





·
            a
                method and apparatus to determine the theoretical and practical data
                rates
                for a cable under test. This invention forms the basis of the EXFO
                CableSHARK product, describing how two test devices,
                communicating with each other via the cable under test, can predict
                the
                performance of a pair of ADSL (Asymmetric Digital Subscriber Line)
                modems,
                and in case of problems, analyze the cause of the modems failing
                to
                synchronize. This patent has been granted in the US and in
                Canada.





Confidentiality
      and proprietary information agreements with our senior management, employees
      and
      others generally stipulate that all confidential information developed or made
      known to these individuals by us during the course of their relationship is
      to
      be kept confidential and not disclosed to third parties, except in specific
      circumstances. The agreements also generally provide that all intellectual
      property developed by the individual in the course of rendering services to
      us
      belongs exclusively to us. These efforts afford only limited
      protection.







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 Table
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**C.****Organizational
      Structure**




As
      of
      November 1, 2007, the following chart presents our corporate structure, the
      jurisdiction of incorporation of our subsidiaries and the percentage of
      shares that we hold in those subsidiaries.













**D.****Property,
      Plant and Equipment**





Our
      head
      offices and facilities are located in Quebec City, Province of Quebec, Canada
      where we occupy two buildings. These buildings house our executive and
      administrative offices, research and development facilities and production
      facilities. We also have facilities in Montreal, Province of Quebec, Canada
      (formerly EXFO Protocol), in Concord, Ontario, Canada (formerly Consultronics
      Limited), in Mississauga, Ontario, Canada (EXFO Photonic), in Budapest, Hungary
      (EXFO Systems Development), in Eastleigh, Hampshire, United Kingdom (EXFO
      Europe), in Shenzhen, China (EXFO Telecom Equipment (Shenzhen) Co. Ltd.) and
      in
      Pune, India (EXFO India). EXFO Burleigh’s facilities located in Victor, New
      York, were sold on August 31, 2006.





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





In
      September 2002, we obtained ownership of one of the buildings housing production
      facilities in Quebec City that was previously leased from a company controlled
      by EXFO’s president and chief executive officer. In September 2003, due to
      down-sizing efforts, we were able to move all of our Quebec City activities
      into
      two buildings, rather that three. Though we no longer occupy the facilities
      at
      465 Godin Avenue in Quebec City, we remain bounded by the lease until
      November 30, 2006. However, on September 1, 2004, we were released from our
      obligations under the lease with a final payment of $194,000
      (CA$250,000).





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The
      following table sets forth information with respect to the main facilities
      that
      we occupy as of November 1, 2007.




**Location**
              **Use
                    of Space**
              **Square
                    Footage**
              **Type
                    of Interest**436
                  Nolin Street
                Quebec
                  (Quebec)
              Partially
                  occupied for manufacturing of telecom products
              44,164
                  (1)
              Owned400
                  Godin Avenue
                Quebec
                  (Quebec)
              Fully
                  occupied for research and development, manufacturing, management
                  and
                  administration
              128,800
                  (2)
              Owned2260
                  Argentia Road
                Mississauga
                  (Ontario)
              Partially
                  occupied for research and development, manufacturing of life science
                  and
                  industrial products, management and
                  administration
              25,328
                  (3)
              Leased2650
                  Marie-Curie St-Laurent (Quebec)
              Fully
                  occupied for research and development, management and
                  administration
              26,000
              Leased160
                  Drumlin Circle
                Concord
                  (Ontario)
              Partially
                  occupied for research and development, product management and
                  administration
              23,500
                  (4)
              Owned1052
                  Vármegye utca 3-5 (Ausztria Ház)
                Budapest,
                  Hungary
              Research
                  and development, services (installation, training, support and
                  maintenance) and administration
              2,500
              LeasedOmega
                  Enterprise Park
                Electron
                  Way, Chandlers Ford, Eastleigh, Hampshire S053 4SE
                United
                  Kingdom
              Partially
                  occupied for European customer service, sales management and
                  administration
              10,000
              LeasedHua
                  Chuang Da Industrial Park
                Bldg
                  D, 2/F, Hangcheng Blvd,
                Gushu,
                  Xixiang
                Shenzhen
                  518126
                China
              Partially
                  occupied for manufacturing of telecom products
              40,000
                  (5)
              Leased113/1,
                  Lane 4A
                Koregaon
                  Park
                Pune
                  411 001
                India
              Fully
                  occupied for research and development
              5,986
              Leased
 
 (1)
              Approximately
                  10% of these premises are not
                  occupied.
 (2)
              Including
                  the warehousespace. Premises without the warehouse are approximately
                  115,000 square feet.
 (3)
              9,792
                  square feet have been subleased to a third party. The total square
                  footage
                  leased is 36,000.
 (4)
              Approximately
                  1/3 of these premises are not
                  occupied.
 (5)
              Approximately
                  20% of these premises are
                  occupied.






**Item
      4A.     Unresolved Staff
      Comments**




Not
      applicable.




35
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**Item
                5.**
            **Management’s
                Discussion and Analysis of Financial Condition **and
                Results of
                Operations****




The
      following
      discussion and analysis of the consolidated financial condition and results
      of
      operations of EXFO Electro-Optical Engineering Inc. for the fiscal years ended
      August 31, 2005, 2006 and 2007, should be read in conjunction with our
      consolidated financial statements and the related notes included elsewhere
      in
      this Annual Report. Our consolidated financial statements have been prepared
      in
      accordance with generally accepted accounting principles in Canada, or Canadian
      GAAP.  Significant differences in measurement and disclosure from
      generally accepted accounting principles in the United States, or
      U.S. GAAP, are set out in note 20 to our consolidated financial statements.
      Our measurement currency is the Canadian dollar although we report our financial
      statements in US dollars.





The
      following
      discussion and analysis of financial condition and results of operations is
      dated November 1, 2007.





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








**INDUSTRY
      OVERVIEW**





The
      fundamentals of the wireline telecom industry are fairly robust in most regions
      of the world, based upon exponential growth in bandwidth demand, intense
      competition – mainly in the United States – between telecom operators (telcos)
      and cable companies (cablecos) pushing massive network investments, and
      significant operational efficiencies and service revenues generated by fully
      converged IP (Internet protocol) networks.





Global
      Internet bandwidth grew at a compound annual growth rate (CAGR) of 45% from
      2003
      to 2006, according to TeleGeography Research. This trend is likely to
      remain steady, if not accelerate, with the upcoming anticipation and explosion
      of IPTV (Internet protocol television) and HD-IPTV (high-definition Internet
      protocol television), as this will consume a colossal amount of additional
      bandwidth. As a result, telcos and cablecos are investing substantially in
      their
      access networks in order to provide differentiated, revenue-generating services
      to attract and retain consumers who are increasingly relying on broadband
      network services for their work, entertainment and everyday activities. From
      a
      telco perspective, it is  now clear that fiber-to-the-premises (FTTP)
      will become the access network architecture of choice, which will allow them
      to
      meet heightened bandwidth requirements and future-proof their access networks
      as
      residential bandwidth requirements are growing from the 1 to 5 Mbit/s (megabits
      per second) of the past to the 30 to 100 Mbit/s required in the future to assure
      multiple HD-IPTV channels, online gaming, high-speed content-rich Internet,
      VoIP
      (voice-over-Internet-protocol) telephony, and a myriad of additional
      IP-based applications. Hybrid architectures, combining copper and fiber
      (fiber-to-the-curb, or FTTC, and fiber-to-the-node, or FTTN), will also
      keep expanding in the short term, since they are less expensive methods to
      increase bandwidth and can be mass-deployed faster. These decisions are
      applicable not only to green-field deployments and high-rise buildings, but
      also
      to larger-scale rollouts as operating costs are less than FTTC and FTTN. It
      is
      important to mention that the cost of deploying fiber-to-the-home (FTTH) has
      largely been falling over the last three years as volume increased and
      deployment tools, like those we offer, are making the task increasingly easier.
      We are only at the early stages of fiber deployments in access networks both
      in
      the Americas and around the world.





As
      bandwidth
      growth in access networks continues to increase, it has begun placing a strain
      on metro rings and core networks. It is also driving the need for higher-speed
      technologies, such as 43 Gbit/s****(gigabits per
      second)****SONET/SDH and 100 Gbit/s Ethernet, because these
      solutions are expected to be significantly more economical, especially if one
      will be forced to dig trenches to deploy new fiber in metro or long-distance
      routes.





As
      telecommunication networks are being transformed to provide IP-based voice,
      video and data capabilities, the legacy SONET/SDH networks, which were designed
      in the 1980s and 1990s and implemented until 2005, will not be capable of
      efficiently carrying these emerging IP-based services as they are based on
      design standards aimed at public switched telephone network (PSTN)
      point-to-point voice transmission only. As a result, telcos are increasingly
      turning to more flexible and future-proof IP-based, next-generation networks
      to
      allow for more versatile and efficient transport of a new range of applications
      and services, and to offer customers higher-margin triple-play services while
      reducing their operating costs.





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These
      market
      dynamics are expected to positively affect telecom test, measurement and
      monitoring companies in 2008 and beyond.








**COMPANY
      OVERVIEW**





EXFO
      is a
      test and measurement expert in the global telecommunications industry,
      especially in the portable test market segment. Our Telecom Division, which
      represents about 85% of our business, offers a full range of test solutions
      and
      monitoring systems to network service providers, cable TV operators, telecom
      system vendors and component manufacturers in approximately 70 countries. We
      are
      the global market leader for portable optical test solutions with an estimated
      25.5% market share and a leading supplier of protocol and access test solutions
      to enable triple-play deployments and converged IP networking. Our Windows-based
      modular AXS-200, FTB-200, FTB-400 and IQS-500 test platforms host a wide range
      of modular test solutions across optical, physical, data and network layers,
      while maximizing technology reuse across several market segments. Our Life
      Sciences and Industrial Division offers value-added light-based solutions in
      high-precision medical device and opto-electronics assembly sectors, and
      advanced fluorescence microscopy and electrophysiology solutions for the life
      sciences sector.





EXFO
      was
      founded in 1985 in Quebec City, Canada. Our original products were focused
      on
      the needs of installers and operators of fiber-optic networks. Customers use
      these field-portable testing products for the installation, maintenance,
      monitoring and troubleshooting of optical networks. In 1996, we supplemented
      our
      product portfolio with an extensive line of high-end products that are mainly
      dedicated to research and development as well as manufacturing activities
      of optical component manufacturers and system vendors.





Over
      the past
      few years, we have enhanced our competitive position through acquisitions of
      copper/xDSL (digital subscriber line) and protocol test businesses. In January
      2006, we acquired substantially all the assets of Consultronics Limited, a
      leading supplier of test equipment for copper-based broadband access networks,
      for a total cash consideration of $19.1 million. Above and beyond
      copper/xDSL test solutions, Consultronics had a rich product portfolio for
      testing next-generation technologies, such as IPTV and VoIP, which are critical
      for NSPs in their deployment of triple-play services (voice, data, and
      video) over optical and copper links in access networks. This acquisition was
      a
      strategic initiative to position EXFO as a provider of a comprehensive solution
      for broadband access and triple-play testing, since it complemented our market
      leadership in the optical FTTx test market.





In
      November
      2001, we acquired Avantas Networks Corporation (renamed EXFO Protocol Inc.
      and
      now merged with EXFO), a supplier of legacy protocol-testing and optical-network
      performance management equipment for NSPs. This transaction served as a
      technology base from which we gradually expanded toward next-generation test
      capabilities; by fully integrating this technology into our modular PC-based
      FTB
      and IQS test platforms, it has allowed us to offer unique combined optical
      and
      protocol test solutions inside a single test platform to help our customers
      increase, accelerate and simplify test procedures while reducing operating
      costs. In October 2002, our wholly-owned subsidiary, EXFO Gnubi, purchased
      substantially all the assets of *gnubi communications, L.P.*,
      a supplier of multichannel telecom and datacom testing solutions for the
      system manufacturer market. As we expanded from optical testing into
      protocol testing applications, we more than doubled our addressable test market
      and started to offer a more complete line of test solutions to our
      customers.





Previously,
      we had completed two acquisitions to bolster growth in the optical component
      manufacturing market. We acquired Burleigh Instruments, Inc. (renamed EXFO
      Burleigh Products Group Inc.) in December 2000. We also added EFOS Inc. (renamed
      EXFO Photonic Solutions Inc.) in March 2001. We have since exited the optical
      component manufacturing automation business, and the operations of these two
      businesses have mostly been consolidated in Toronto, Canada to serve as our
      Life
      Sciences and industrial Division.








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In
      fiscal
      2007, we launched 20 new products, compared to 18 in 2006. Key product
      introductions included, among others, IPTV test capabilities for our Packet
      Blazer Ethernet product line; a standards-based very-high-speed digital
      subscriber line, version 2 (VDSL2) test module to characterize IPTV and
      high-definition television (HDTV) over copper access links; a 10 Gigabit
      Ethernet module for our FTB-200 Compact Platform; a multipurpose series
      of OTDRs for testing access, metro and long-haul networks; a
      next-generation cable assembly and component test system for production testing
      of short fiber assemblies and FTTx components, and the NQMS line of quality
      assurance systems for the real-time monitoring of packet signals as well as
      fiber links. Products on the market two years or less accounted for 33.7%
      of sales in fiscal 2007.





Subsequent
      to
      the year-end, we released three additional solutions, namely the AXS-200
      SharpTESTER, a multiservice, multimedium test platform for characterizing
      and troubleshooting commercial and residential access networks; a compact
      multiservice transport test set that combines next-generation SONET/SDH and
      Ethernet testing inside a single module; and a cost-effective handheld tester
      for the rapid installation and maintenance of asymmetric digital subscriber
      line
      ADSL/ADSL2/ADSL2+ services.





As
      well,
      Frost & Sullivan, a leading market research firm in the telecommunications
      test and measurement industry, named EXFO recipient of the Growth Strategy
      Leadership Award for the fourth consecutive year in the global fiber-optic
      test
      equipment (FOTE) market. According to Frost & Sullivan, EXFO generated the
      largest market-share gains in calendar 2006, moving from 11.0% in 2005 to 12.7%
      in 2006 for third place overall in the FOTE market. Based on this report, we
      estimate that we improved our leadership position in our core installation
      and
      maintenance world test market from 23.0% in 2005 to 25.5% in 2006.





In
      the third
      quarter of fiscal 2007, as part of ongoing efforts to improve our gross margin,
      we transferred the manufacturing activities of our protocol product line from
      Montreal, Canada, to our facilities in Quebec City, Canada. In the fourth
      quarter, we moved the manufacturing activities of our copper access product
      line
      from Concord, Canada, to Quebec City. Following the year-end, we opened our
      own
      telecom manufacturing facility in Shenzhen, China. Our plan is to maintain
      two main telecom manufacturing sites; low-volume, high-complexity products
      will
      be manufactured in Quebec City, whereas high-volume, low-complexity products
      will be manufactured in Shenzhen.





In
      the third
      quarter of fiscal 2007, we also began to establish a software development center
      in Pune, India, to supplement the research and development capabilities of
      our three Canadian centers. We expect this to enable us to benefit from a
      wealth of IP expertise in India, to accelerate
      product development ― especially for our software-intensive protocol test
      solutions ― to take advantage of a lower cost structure, and to leverage
      business opportunities in this rapidly developing country.





Overall
      for
      fiscal 2007, we increased sales 19.2% to $152.9 million from $128.3 million
      in
      2006. GAAP net earnings reached $42.3 million, or $0.61 per diluted share,
      including $24.6 million in recognition of previously unrecognized future income
      taxes, $3.2 million in recognition of previously unrecognized research and
      development tax credits, $2.9 million in amortization of intangible assets,
      $1.1
      million from a government grant recovery and $1.0 million in stock-based
      compensation costs. In 2006, GAAP net earnings totaled $8.1 million, or $0.12
      per diluted share, including $4.4 million in amortization of intangible assets,
      $1.3 million from a government grant recovery, $604,000 for impairment of
      long-lived assets and $1.0 million in stock-based compensation
      costs.





Based
      on this
      sales and earnings data for fiscal 2007, we concluded that it was more likely
      than not that a portion of our future income tax assets, written off during
      the telecom downturn in 2003, would be recovered. As a result, we recognized
      $24.6 million in previously unrecognized income tax assets and $3.2 million
      in
      previously unrecognized research and development tax credits in the fourth
      quarter of 2007. These future income tax assets and tax credits relate to our
      operations in Canada and in the United States.








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On
      November
      5, 2007, the Board of Directors approved a share repurchase program, by way
      of
      normal course issuer bid on the open market, up to 9,9% of our public float
      (as
      defined by the Toronto Stock Exchange), or 2.9 million of subordinate
      voting shares, at the prevailing market price. We expect to use cash, short-term
      investments, or future cash flows from operating activities to fund the
      repurchase of shares. The normal course issuer bid will start on November
      8, 2007, and end on November 7, 2008, or an earlier date if we
      repurchase the maximum number of shares permitted under the bid. The
      program does not require that we repurchase any specific number of shares,
      and
      it may be modified, suspended or terminated at any time, without prior notice.
      All shares repurchased under the bid will be canceled.





**Sales**





We
      sell our
      products to a diversified customer base in approximately 70 countries through
      our direct sales force and channel partners like sales representatives and
      distributors. Most of our sales are denominated in US dollars and
      Euros.





Over
      the last
      three fiscal years, we had one customer that accounted for more than 10% of
      our
      global sales with 23.3%, 13.8% and 14.7% in fiscal 2005, 2006 and 2007,
      respectively. The significant sales concentration with this Tier-1 carrier
      in
      fiscal 2005 was largely due to our leadership position in the FTTx test market
      and to lower investments by most other carriers. This sales concentration
      significantly decreased in fiscal 2006 as we significantly increased
      our business with several other accounts around the globe. Although we
      maintained our leadership position with this customer, as it migrated to
      lower-priced test solutions, we reduced our customer concentration to a better
      level.





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





**Cost
      of Sales**





Cost
      of sales
      includes raw materials, salaries and related expenses for direct and indirect
      manufacturing personnel (net of government grants) as well as overhead costs.
      Excess, obsolete and scrapped materials are also included in cost of sales.
      However, cost of sales is exclusive of amortization, which is shown separately
      in the statements of earnings.





**Operating
      Expenses**





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





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





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








**OUR
      STRATEGY**





**Strategic
      Objectives for Fiscal 2007**





In
      our fiscal
      2006 Annual Report, we had established three strategic objectives for fiscal
      2007. We planned to increase sales through market-share gains, maximize
      profitability and focus on innovation. The following section reviews our
      strategic objectives for fiscal 2007 and the results achieved for each of these
      objectives.





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*Increase
      sales through market-share gains*





On
      the
      strength of a solid second half, we achieved annual sales growth of 19.2% in
      fiscal 2007, while our corporate metric was 20%. In fiscal 2007, we garnered
      significant year-over-year sales growth and market-share gains in our optical
      (19.9%) and protocol (48.2%) businesses, while expanding our presence in the
      critical geographic regions of the Americas (18.7% sales growth
      year-over-year) and Europe, Middle East and Africa (27.5% sales growth
      year-over-year). On the other hand, sales from our copper-access business and
      Asia-Pacific region fell short of our plans. Targeted actions have been
      implemented for fiscal 2008 and beyond to address these issues. Overall, in
      fiscal 2007, our Telecom Division, which increased its sales by 20.9%
      year-over-year, grew substantially faster than the industry.





*Maximize
      profitability*





We
      generated
      GAAP earnings from operations of 11.0% in fiscal 2007, while our published
      metric was 7%. Our GAAP earnings from operations in fiscal 2007 included
      $3.2 million for the one-time recognition of prior years’ non-refundable
      research and development tax credits and one-time grant revenue of $1.1 million.
      These items were not initially forecasted in our corporate metric. Consequently,
      excluding these one-time items, our earnings from operations would have amounted
      to 8.2%, well above our stated goal. We believe we surpassed our goal largely
      due to operational excellence and market-driven innovation that makes a
      difference for our customers.





*Focus
      on innovation*





Sales
      from
      new products (on the market two years or less) accounted for 33.7% of total
      sales in 2007, compared to our stated goal of 35%. The ongoing success of
      our FTTx products lowered this ratio to a considerable extent, since many of
      them have surpassed the two-year threshold for new products but continue to
      generate significant sales. Nevertheless, we cannot be displeased with
      approximately one-third of our sales from new products as this figure remains
      well above industry levels.





**Strategic
      Objectives for Fiscal 2008**





The
      fundamentals of the telecom industry are robust in the Americas and worldwide;
      this statement is based on exponential growth in bandwidth demand (45% from
      2003 to 2006) for global Internet traffic; intense competitive stakes between
      telecom operators and cable companies, which drives massive network investments;
      and significant operational efficiencies and new service revenues that can
      be
      delivered by the increasing amount of fully converged IP networks.





As
      we remain
      committed to best practices in financial reporting, once again this year, we
      are
      providing our investors with our strategic objectives for fiscal 2008 along
      with
      key performance metrics. These are goals established for our management team
      and
      should not be misinterpreted as guidance. The strategic objectives for fiscal
      2008 are the continuity of prior years. As always, we are highly focused on
      creating value for our shareholders, providing the highest degree of profitable
      growth. In fiscal 2008, we intend to maintain our long-term focus on profitable
      growth by increasing sales in both divisions through market-share gains;
      maximize profitability through proper execution and efficiency of our
      cost-reduction programs; and focus on innovation to positively position the
      organization for the long-term growth opportunities that exist in our
      space.





*Increase
      sales through market-share gains*





We
      plan on
      increasing sales with a 20% growth target for fiscal 2008. We believe that
      we
      can continue gaining market share based on our strong positioning for key growth
      trends, such as the deployment of fiber deeper into access networks and the
      migration of networks towards converged, IP architectures; our history of
      gaining market share as evidenced by four consecutive Growth Strategy Leadership
      Awards from Frost & Sullivan for largest market share gains in optical
      testing; strong focus on execution as demonstrated by a sales compound annual
      growth rate of 27.0% over the last three years and 20.1% over the last 10 years,
      as well as ongoing investments on global sales and marketing staff.








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*Maximize
      profitability*





We
      intend to
      generate GAAP earnings from operations of 8% in 2008, even considering a
      moderate strengthening of the Canadian dollar and our global expansion plans.
      We
      seek to accomplish this through higher sales volumes enabling
      us to better absorb our fixed manufacturing costs, increased sales of
      higher-margin protocol test solutions, and a lower cost structure with some
      manufacturing and R&D activities being carried out in China and India,
      respectively.





*Focus
      on innovation*





We
      expect to
      derive at least 30% of sales from new products that have been on the market
      two
      years or less in fiscal 2008. It remains an aggressive target, since we are
      usually first to market with our new products to quickly capture market share.
      Consequently, just when our new products are receiving global market acceptance,
      they often cross the two-year threshold for new products. We believe this
      innovation metric is critical for us because it measures the effectiveness
      of
      our market-driven innovation program.





**Key
      Performance Indicators**





As
      measures
      to assess the realization of our strategic plan and its objectives, we have
      set
      out three consolidated key performance indicators for fiscal 2008. They are
      summarized as follows:





**Strategic
                objectives for fiscal 2008**
            **Key
                performance indicators for fiscal 2008**Increase
                sales through market-share gains
            20%
                sales growth year-over-yearMaximize
                profitability
            8%
                in earnings from operationsFocus
                on innovation
            30%
                of sales from new products (on the market two years or
                less)





**Capability
      to Deliver Results**





At
      EXFO, we
      believe that we have the capabilities to deliver expected results thanks to
      outstanding products, an excellent reputation in the marketplace, a sound
      financial position, as well as an experienced workforce and management
      team.








**CRITICAL
      ACCOUNTING POLICIES AND ESTIMATES**





Management’s
      discussion and analysis of financial conditions and results of operations is
      based on our consolidated financial statements included elsewhere in this Annual
      Report. As previously mentioned, they have been prepared in accordance with
      Canadian GAAP. The preparation of financial statements in accordance with GAAP
      requires management to make estimates and assumptions that affect the reported
      amounts of assets and liabilities and the disclosures of contingent assets
      and
      liabilities at the date of the financial statements, as well as the reported
      amounts of revenues and expenses during the reporting years. On an ongoing
      basis, we evaluate these estimates and assumptions, including those related
      to
      revenue recognition, the allowance for doubtful accounts, the amount of tax
      credits recoverable, the reserve for excess and obsolete inventories, the useful
      lives of capital assets, the valuation of long-lived assets, the valuation
      allowance of future income tax assets, the amount of certain accrued liabilities
      and deferred revenue as well as stock-based compensation costs. We base our
      estimates and assumptions on historical experience and on other factors that
      we
      believe to be reasonable under the circumstances, the result of which form
      the
      basis for making judgments about the carrying values of assets and liabilities
      that are not readily apparent from other sources. Actual results could differ
      from these estimates.





The
      following
      summarizes our critical accounting policies as well as other policies that
      require the most significant judgment and estimates in the preparation of our
      consolidated financial statements.








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*Revenue
      recognition.* For products in which software is incidental, we recognize
      revenue when persuasive evidence of an arrangement exists, the product has
      been
      delivered, the price is fixed or determinable and collection of the resulting
      receivable is reasonably assured. In addition, provisions are made for estimated
      returns, warranties and support obligations.





For
      products
      in which software is not incidental, revenues are separated into two categories:
      product and post-contract customer support (PCS) revenues, based upon
      vendor-specific objective evidence of fair value. Product revenues for these
      sales are recognized as described above. PCS revenues are deferred and
      recognized ratably over the years of the support arrangement. PCS revenues
      are
      recognized at the time the product is delivered when provided substantially
      within one year of delivery, the costs of providing this support are
      insignificant (and accrued at the time of delivery) and no (or infrequent)
      software upgrades or enhancements are provided.





For
      all
      sales, we use a binding purchase order as evidence that a sales arrangement
      exists.





Delivery
      generally occurs when the product is handed over to a transporter for
      shipment.





At
      the time
      of the transaction, we assess whether the price associated with our revenue
      transaction is fixed or determinable, and whether or not collection is
      reasonably assured. We assess whether the price is fixed or determinable
      based on the payment terms associated with the transaction. We assess collection
      based on a number of factors, including past transaction history and the
      creditworthiness of the customer. Generally, collateral or other security is
      not
      requested from customers.





Most
      sales
      arrangements do not generally include acceptance clauses. However, if a sales
      arrangement does include an acceptance provision, acceptance occurs upon the
      earliest of the receipt of a written customer acceptance or the expiration
      of
      the acceptance period. For these sales arrangements, the sale is recognized
      when
      acceptance occurs.





Revenue
      for
      extended warranties is recognized on a straight-line basis over the warranty
      period.





*Allowance
      for
      doubtful accounts.* We estimate collectibility of accounts receivable on an
      ongoing basis by reviewing balances outstanding over a certain period of time.
      We determine our allowance for doubtful accounts receivable based on our
      historical accounts receivable collection experience and on the information
      that
      we have about the status of our accounts receivable balances. If the financial
      conditions of our customers deteriorate, resulting in an impairment of
      their ability to make required payments, additional allowance may be required,
      which could adversely affect our future results.





*Reserve
      for
      excess and obsolete inventories.* We state our inventories at the lower of
      cost, determined on an average cost basis and replacement cost or net realizable
      value, and we provide reserves for excess and obsolete inventories. We determine
      our reserves for excess and obsolete inventories based on the quantities we
      have
      on hand versus expected needs for these inventories, so as to support future
      sales of our products. It is possible that additional inventory reserves may
      occur if future sales are less than our forecasts or if there is a significant
      shift in product mix compared to our forecasts, which could adversely affect
      our
      future results.





*Research
      and
      development tax credits and government grants.* We record research and
      development tax credits and government grants based on our interpretation of
      tax
      laws and grant programs, especially regarding related eligible projects and
      expenses, and when there is reasonable assurance that we have complied and
      will
      continue to comply with all conditions and laws. Also, our judgment and
      estimates are based on historical experience. It is possible, however, that
      the
      tax authorities or the sponsors of the grant programs have a different
      interpretation of laws and application of conditions related to the programs
      or
      that we do not comply with all conditions related to grants in the future,
      which
      could adversely affect our future results. Furthermore, a significant part
      of
      our research and development tax credits are refundable against income taxes
      payable, causing their ultimate realization to be dependent upon the
      generation of taxable income. If we obtain information that causes our forecast
      of future taxable income to change or if actual taxable income differs from
      our
      forecast, we may have to revise the carrying value of these tax credits, which
      would affect our results in the period in which the change was
      made.





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*Impairment
      of
      long-lived assets and goodwill.* We assess impairment of long-lived assets
      when events or circumstances indicate that costs may not be recoverable.
      Impairment exists when the carrying value of an asset, or a group of assets,
      is
      greater than the pre-tax undiscounted future cash flows expected to be provided
      by the asset or the group of assets. The amount of impairment loss, if any,
      is
      the excess of the carrying value over the fair value. We assess fair value
      of
      long-lived assets based on discounted future cash flows.





We
      assess
      impairment of goodwill on an annual basis, or more frequently, if events or
      circumstances indicate that it might be impaired. Recoverability of
      goodwill is determined at the reporting-unit level using a two-step approach.
      First, the carrying value of a reporting unit is compared to its fair value,
      which is determined based on a combination of discounted future cash flows
      and a
      market approach. If the carrying value of a reporting unit exceeds its fair
      value, the second step is performed. In this step, the amount of impairment
      loss, if any, represents the excess of the carrying value of goodwill over
      its
      fair value and the loss is charged to earnings in the period in which it is
      incurred. For the purposes of this impairment test, the fair value of goodwill
      is estimated in the same way as goodwill is determined in business
      combinations; that is, the excess of the fair value of a reporting unit over
      the
      estimated fair value of its net identifiable assets.





*Future
      income
      taxes.* We account for income taxes using the liability method of tax
      allocation. Under this method, future income tax assets and liabilities are
      determined based on deductible or taxable temporary differences between
      financial statement values and tax values of assets and liabilities as well
      as
      the carryforward of unused tax losses and reductions, using substantively
      enacted or enacted income tax rates for the years in which the assets are
      expected to be realized or the liabilities to be settled. In assessing the
      recoverability of our future income tax assets, we consider whether it is
      more likely than not that some or all of the future income tax assets will
      not
      be realized. The ultimate realization of our future income tax assets is
      dependent upon the generation of sufficient future taxable income during the
      periods in which those assets are expected to be realized.





*Stock-based
      compensation costs.* We account for all forms of employee stock-based
      compensation using the fair value-based method. This method requires that we
      make estimates about the risk-free interest rate, the expected volatility of
      our
      shares, the expected life of the awards and the forfeiture rate.





*New
      accounting standards and pronouncements to be adopted after fiscal
      2007*





In
      January
      2005, the Canadian Institute of Chartered Accountants (CICA) issued four new
      accounting standards in relation to financial instruments: Section 3855,
“Financial Instruments – Recognition and Measurement”; Section 3865,
“Hedges”; Section 1530, “Comprehensive Income”; and Section 3251,
“Equity”.





Section
      3855
      expands on Section 3860, “Financial Instruments – Disclosure and Presentation”,
      by prescribing when a financial instrument is to be recognized on the balance
      sheet and at what amount. It also specifies how financial instrument gains
      and losses are to be presented in the financial statements.





Section
      3865
      provides an alternative to Section 3855 for entities that choose to designate
      qualifying transactions as hedges for accounting purposes. It replaces and
      expands on Accounting Guideline 13, “Hedging Relationships”, and on the hedging
      guidance in Section 1650, “Foreign Currency Translation”, by specifying how
      hedge accounting is applied and what disclosures it requires.





Section
      1530,
“Comprehensive Income”, introduces a new requirement to temporarily present
      certain gains and losses outside net income.





Consequently,
      Section 3250, “Surplus”, has been revised as Section 3251,
“Equity”.








43
 Table
            of Contents





Sections
      1530, 3251, 3855 and 3865 apply to fiscal years beginning on or after October
      1,
      2006. Any adjustment to financial assets and liabilities as at September 1,
      2007, will be reflected as an adjustment to retained earnings
      or accumulated other comprehensive income.  Section 3865 also does not
      permit restatement of prior year's financial statements.  Any gains or
      losses on hedge relationships that no longer qualify are to be reflected in
      retained earnings as at September 1, 2007. Any gains or losses of hedging
      instruments are adjusted to retained earnings or the component of accumulated
      other comprehensive income associated with the hedged items. We adopted these
      new standards on September 1, 2007, and impacts consistent with the adjustments
      described under note 20 items a) and c) to our consolidated financial
      statements included elsewhere in this Annual Report will affect our financial
      statements for fiscal 2008 and beyond.





In
      December
      2006, the CICA issued three new Sections, which provide a complete set of
      disclosure and presentation requirements for financial instruments: Section
      3862, “Financial Instruments − Disclosures”; Section 3863, “Financial
      Instruments − Presentation”; and Section 1535, “Capital
      Disclosures”.





Section
      3862
      is the Canadian equivalent to International Financial Reporting Standards (IFRS)
      7, “Financial Instruments − Disclosures”, and replaces the disclosure
      portion of Section 3861, “Financial Instruments − Disclosure and
      Presentation”. The new standard places increased emphasis on disclosures about
      risks associated with both recognized and unrecognized financial instruments
      and
      how these risks are managed. It is also intended to remove any duplicate
      disclosures and simplify the disclosures about concentrations of risk, credit
      risk, liquidity risk and price risk currently found in
      Section 3861.





Section
      3863
      carries forward the presentation requirements from Section 3861,
      unchanged.





Section
      1535
      converges with the capital disclosures amendments to International Accounting
      Standards (IAS) 1, “Presentation of Financial Statements”. Section 1535 applies
      to all entities regardless of whether they have financial instruments and are
      subject to external capital requirements. The new section requires disclosure
      of
      information about an entity’s objectives, policies and processes for managing
      capital, as well as quantitative data about capital and whether the entity
      has
      complied with any capital requirements.





Sections
      1535, 3862 and 3863 apply to fiscal years beginning on or after October 1,
      2007.
      We will adopt these new standards on September 1, 2008, and are currently
      assessing the effects these new standards will have on our consolidated
      financial statements.





In
      June 2007,
      the CICA issued Section 3031, “Inventories” to harmonize accounting for
      inventories under Canadian GAAP with IFRS. This standard requires the
      measurement of inventories at the lower of cost and net realizable value and
      includes guidance on the determination of cost, including allocation of
      overheads and other costs to inventory. The standard also requires the
      consistent use of either first-in, first-out (FIFO) or weighted average cost
      formula to measure the cost of inventories and requires the reversal of previous
      write-downs to net realizable value when there is a subsequent increase in
      the
      value of inventories. The new standard applies to fiscal years beginning on
      or
      after January 1, 2008. We will adopt this new standard on September 1, 2008,
      and
      are currently assessing the effects this new standard will have on our
      consolidated financial statements.




44
 Table
          of Contents


**RESULTS
        OF OPERATIONS**
 
 The
        following
        table sets forth certain Canadian GAAP consolidated financial statements
        data in
        thousands of US dollars, except per share data and as a percentage of
        sales for the years indicated:
 
 **Consolidated
                  statements of earnings data:**
              
              **2007**
              
              
              2006
              
              
              2005
              
              
              **2007**
              
              
              2006
              
              
              2005Sales
              
              **$**
              **152,934**
              
              
              $
              128,253
              
              
              $
              97,216
              
              
              ****
              **100.0**
              **%**
              
              
              100.0
              %
              
              
              100.0
              %Cost
                  of sales (1)
              
              ****
              **65,136**
              
              
              
              57,275
              
              
              
              44,059
              
              
              ****
              **42.6**
              
              
              
              44.7
              
              
              
              45.3Gross
                  margin
              
              ****
              **87,798**
              
              
              
              70,978
              
              
              
              53,157
              
              
              ****
              **57.4**
              
              
              
              55.3
              
              
              
              54.7Operating
                  expensesSelling
                  and administrative
              
              ****
              **49,580**
              
              
              
              40,298
              
              
              
              31,782
              
              
              ****
              **32.4**
              
              
              
              31.4
              
              
              
              32.7Net
                  research and development (2)
              
              ****
              **16,668**
              
              
              
              15,404
              
              
              
              12,190
              
              
              ****
              **10.9**
              
              
              
              12.0
              
              
              
              12.5Amortization
                  of property, plant and equipment
              
              ****
              **2,983**
              
              
              
              3,523
              
              
              
              4,256
              
              
              ****
              **1.9**
              
              
              
              2.7
              
              
              
              4.4Amortization
                  of intangible assets
              
              ****
              **2,864**
              
              
              
              4,394
              
              
              
              4,836
              
              
              ****
              **1.9**
              
              
              
              3.4
              
              
              
              5.0Impairment
                  of long-lived assets
              
              
              −
              
              
              
              604
              
              
              ****
              **−**
              
              
              ****
              **−**
              
              
              
              0.5
              
              
              ****
              **−**Government
                  grants
              
              ****
              **(1,079**
              **)**
              
              
              (1,307
              )
              
              ****
              **−**
              
              
              ****
              **(0.7**
              **)**
              
              
              (1.0
              )
              
              ****
              **−**Restructuring
                  and other charges
              
              ****
              **−**
              
              
              
              −
              
              
              
              292
              
              
              ****
              **−**
              
              
              
              −
              
              
              
              0.3Total
                  operating expenses
              
              ****
              **71,016**
              
              
              
              62,916
              
              
              
              53,356
              
              
              ****
              **46.4**
              
              
              
              49.0
              
              
              
              54.9Earnings
                  (loss) from operations
              
              ****
              **16,782**
              
              
              
              8,062
              
              
              
              (199
              )
              
              ****
              **11.0**
              
              
              
              6.3
              
              
              
              (0.2
              )Interest
                  and other income
              
              ****
              **4,717**
              
              
              
              3,253
              
              
              
              2,524
              
              
              ****
              **3.0**
              
              
              
              2.5
              
              
              
              2.6Foreign
                  exchange loss
              
              ****
              **(49**
              **)**
              
              
              (595
              )
              
              
              (1,336
              )
              
              ****
              **−**
              
              
              
              (0.5
              )
              
              
              (1.4
              )Earnings
                  before income taxes
              
              ****
              **21,450**
              
              
              
              10,720
              
              
              
              989
              
              
              ****
              **14.0**
              
              
              
              8.3
              
              
              
              1.0Income
                  taxesCurrent
              
              ****
              **3,741**
              
              
              
              2,585
              
              
              
              2,623
              
              
              ****
              **2.4**
              
              
              
              2.0
              
              
              
              2.7Recognition
                  of previously unrecognized future income tax assets
              
              ****
              **(24,566**
              **)**
              
              ****
              **−**
              
              
              ****
              **−**
              
              
              ****
              **(16.0**
              **)**
              
              ****
              **−**
              
              
              ****
              **−******
              **(20,825**
              **)**
              
              
              2,585
              
              
              
              2,623
              
              
              ****
              **(13.6**
              **)**
              
              
              2.0
              
              
              
              2.7Net
                  earnings (loss) for the year
              
              **$**
              **42,275**
              
              
              $
              8,135
              
              
              $
              (1,634
              )
              
              ****
              **27.6**
              **%**
              
              
              6.3
              %
              
              
              (1.7
              )%Basic
                  and diluted net earnings (loss) per share
              
              **$**
              **0.61**
              
              
              $
              0.12
              
              
              $
              (0.02
              )Segment
                  informationSales:Telecom
                  Division
              
              **$**
              **129,839**
              
              
              $
              107,376
              
              
              $
              80,120
              
              
              ****
              **84.9**
              **%**
              
              
              83.7
              %
              
              
              82.4
              %Life
                  Sciences and Industrial Division
              
              ****
              **23,095**
              
              
              
              20,877
              
              
              
              17,096
              
              
              ****
              **15.1**
              
              
              
              16.3
              
              
              
              17.6**$**
              **152,934**
              
              
              $
              128,253
              
              
              $
              97,216
              
              
              ****
              **100.0**
              **%**
              
              
              100.0
              %
              
              
              100.0
              %Earnings
                  (loss) from operations:Telecom
                  Division
              
              **$**
              **13,132**
              
              
              $
              6,679
              
              
              $
              763
              
              
              ****
              **8.6**
              **%**
              
              
              5.2
              %
              
              
              0.8
              %Life
                  Sciences and Industrial Division
              
              ****
              **3,650**
              
              
              
              1,383
              
              
              
              (962
              )
              
              ****
              **2.4**
              
              
              
              1.1
              
              
              
              (1.0
              )**$**
              **16,782**
              
              
              $
              8,062
              
              
              $
              (199
              )
              
              ****
              **11.0**
              **%**
              
              
              6.3
              %
              
              
              (0.2
              )%Research
                  and development data:Gross
                  research and development
              
              **$**
              **25,201**
              
              
              $
              19,488
              
              
              $
              15,878
              
              
              ****
              **16.5**
              **%**
              
              
              15.2
              %
              
              
              16.3
              %Net
                  research and development(2)
              
              **$**
              **16,668**
              
              
              $
              15,404
              
              
              $
              12,190
              
              
              ****
              **10.9**
              **%**
              
              
              12.0
              %
              
              
              12.5
              %**Consolidated
                  balance sheets data:**Total
                  assets
              
              **$**
              **279,138**
              
              
              $
              219,159
              
              
              $
              190,957
 
 (1)  
                  The cost of sales is exclusive of amortization, shown
                  separately.(2)  
                  Net research and development expenses for the year ended August
                  31, 2007,
                  include recognition of previously unrecognized research and development
                  tax credits of $3,162.
 
 45
 Table
              of Contents
 
 **SALES**
 
 ***Fiscal
        2007 vs. 2006***
 
 In
        fiscal
        2007, our global sales increased 19.2% to $152.9 million from $128.3 million
        in
        2006, with an 85%-15% split in favor of our Telecom Division (84%-16% in
        2006).
 
 ***Telecom
        Division***
 
 In
        fiscal
        2007, sales of our Telecom Division increased 20.9% to $129.8 million from
        $107.4 million in 2006.
 
 In
        fiscal
        2007, we posted organic sales growth due to market-share gains in optical
        testing and next-generation IP test solutions and due to continued spending
        in access networks fueled by the competitive dynamic between telephone and
        cable
        companies. In fiscal 2007, sales of our optical test solutions increased
        19.9%
        to $102.1 million ($85.2 million in 2006), and we earned our fourth
        consecutive Growth Strategy Leadership Award from Frost & Sullivan for
        largest market-share gains in optical testing. Also, during fiscal 2007,
        protocol test solutions were our fastest-growing product line with a sales
        increase of 48.2% year-over-year as they reached $17.1 million, compared
        to
        $11.5 million in 2006. Also, in 2007, they represented more than 10% of our
        Telecom sales. Given the much larger addressable market for protocol test
        solutions and our very strong product offering – especially for next-generation
        IP-based test solutions – we believe that protocol revenues should continue to
        grow faster than our optical revenues over the next few years.
 
 In
        addition,
        during fiscal 2007, sales of our copper-access test solutions increased 15.5%
        to
        $7.7 million, compared to $6.7 million in 2006. It should be noted however,
        that
        Consultronics (acquired in January 2006) contributed to our sales during
        the whole period compared to about seven months in 2006, which contributed
        to
        the increase in our sales year-over-year.****This business
        unit did not perform as well as expected in 2007 as large-scale IPTV deployments
        have been delayed until calendar 2008. We expect sales of this sector to
        increase over time as we take advantage of a strengthening product offering,
        as
        our sales channels gain additional experience in this technology area, and
        as
        IPTV deployments accelerate. Following year-end, we launched new added-value
        products that integrate Consultronics’ core knowledge and intellectual
        property; namely, the AXS-200 SharpTESTER, a multiservice, multimedium test
        platform for characterizing and troubleshooting commercial and residential
        access networks. A large portion of our sales of copper-access products in
        fiscal 2007 were made to a Tier-1 carrier in the United States.
 
 During
        fiscal
        2007, we faced increased pricing pressure, especially in the Asia-Pacific
        region, which prevented us from further increasing our sales
        year-over-year.
 
 ***Life
        Sciences and Industrial Division***
 
 In
        fiscal
        2007, sales of our Life Sciences and Industrial Division increased 10.6%
        to
        $23.1 million from $20.9 million in 2006. The increase in sales in
        fiscal 2007, compared to 2006, is mainly due to increased sales activities
        in
        the curing market as well as market-share gains in the fluorescence illumination
        market, following our efforts to expand international markets, mainly Europe
        and
        Asia.
 
 ***Net
        bookings***
 
 Overall,
        for
        the two divisions, net accepted orders increased 21.0% to $156.7 million
        in
        fiscal 2007 from $129.4 million in 2006, for a book-to-bill ratio of 1.02
        in fiscal 2007. Our increase of 21.0% in net accepted orders in fiscal 2007,
        compared to 2006, reflects the increased demand for our test solutions
        (especially in the Americas and in the Europe, Middle East and Africa regions),
        market-share gains****in the telecommunications and
        fluorescence illumination markets as well as stronger telecommunications
        and
        curing market environment.
 
 ***Fiscal
        2006 vs. 2005***
 
 In
        fiscal
        2006, our global sales increased 31.9% to $128.3 million from $97.2 million
        in
        2005, with an 84%-16% split in favor of our Telecom Division.
 
 
 46
 Table
              of Contents
 
 ***Telecom
        Division***
 
 In
        fiscal
        2006, sales of our Telecom Division increased 34.0% to $107.4 million from
        $80.1 million in 2005.
 
 In
        fiscal
        2006, we leveraged our portfolio of new products and an increased demand
        for our
        test solutions, especially in Europe, Middle East and Africa and Asia-Pacific,
        to increase our year-over-year sales in our Telecom Division. We also
        consolidated our dominant FTTx market position in the Americas by enabling
        a
        Tier-1 carrier to migrate to less expensive test solutions. Although
        revenues were down at this customer year-over-year, we maintained our market
        share through the sales of cost-effective test solutions, such as our handheld
        AXS-100 OTDR, to help reduce cost of deployments. In addition, the positive
        spending environment, as well as the market share we gained in fiscal 2006
        for
        our optical and protocol products, helped us increase our sales of that Division
        year-over-year. Also, Consultronics contributed about seven months to our
        Telecom Division, which had a positive impact on our consolidated sales during
        fiscal 2006. The results of Consultronics have been included in our consolidated
        statement of earnings since the closing of the acquisition on January 26,
        2006.
        Finally, in fiscal 2006, our top customer accounted for 16.5% of our Telecom
        sales, compared to 28.2% of sales in 2005, reflecting the diversification
        of our
        customer base. In fact, excluding sales to our top customer, our sales of
        this
        Division would have increased 56.0% in fiscal 2006, compared to
        2005.
 
 Although,
        in
        the past few years, our market share in the protocol test market has been
        modest, our protocol-product results in the second half of fiscal 2006
        accelerated substantially year-over-year, making this sector our fastest-growing
        line of business in 2006.
 
 ***Life
        Sciences and Industrial Division***
 
 In
        fiscal
        2006, sales of our Life Sciences and Industrial Division increased 22.1%
        to
        $20.9 million from $17.1 million in 2005. As for fiscal 2007, the
        increase in sales in fiscal 2006, compared to 2005, is mainly due
        to increased sales activities in the curing market as well as market-share
        gains in the fluorescence illumination market, following our efforts to expand
        international markets, mainly Europe and Asia.
 
 ***Geographic
        distribution***
 
 ***Fiscal
        2007 vs. 2006***
 
 In
        fiscal
        2007, sales to the Americas, Europe-Middle East-Africa (EMEA) and Asia-Pacific
        (APAC) accounted for 59%, 27% and 14% of global sales, respectively, compared
        to
        60%, 25% and 15%, respectively in 2006.
 
 In
        fiscal
        2007, we reported sales increases in dollars in every geographic area. In
        fact,
        sales to the Americas, EMEA and APAC increased (in dollars) 18.7%, 27.5%
        and
        7.8% year-over-year, respectively.
 
 In
        the
        Americas, the increase in sales in dollars in fiscal 2007, compared to the
        same
        period last year, comes from the United States and Canada, where we witnessed
        an
        increase in sales of our optical and protocol test solutions. In the United
        States, we continue leveraging our dominant FTTx market position to increase
        our
        sales. In addition, sales to our top customer, who is located in the United
        States, increased in dollars in fiscal 2007, compared to 2006. Sales to this
        customer represented $22.5 million, or 14.7% of global sales in 2007, compared
        to $17.7 million, or 13.8% of our global sales in 2006, representing an
        increase of 27.0% year-over-year. In Latin America, we reported a slight
        decrease in sales in fiscal 2007 compared to 2006.
 
 The
        significant increase in sales in the EMEA market, in dollars, in fiscal 2007,
        compared to 2006, is apparent in the results for all our product lines,
        following our efforts to aggressively develop this market in the last several
        years and investment to increase our sales presence and develop stronger
        support
        and service operations in this region. Many Tier-1 carriers in EMEA are
        migrating their traditional circuit-switched core networks to higher-speed,
        dense wavelength-division multiplexing (DWDM) and next-generation packet-based
        architectures, which is creating a market demand for our protocol test
        solutions and fiber characterization test kits. In addition, we are leveraging
        our FTTx leadership gained in the United States to provide consultancy with
        many
        of the early adopters in this field in EMEA.
 
 
 47
 Table
              of Contents
 
 In
        the APAC
        market, we are starting to see the impact of the introduction of some specific
        optical, protocol and life science and industrial products as we steadily
        increase our market presence in this growth region; this explains the increase
        in sales in this region in fiscal 2007, compared to the corresponding period
        last year. However, although we reported sales growth year-over-year in
        this region, we are facing significant competitive pricing pressure, which
        prevented us from reaching expected sales growth. In addition, a significant
        portion of our sales to this market are made through tenders, which vary
        in
        number and importance year-over-year.
 
 ***Fiscal
        2006 vs. 2005***
 
 During
        fiscal
        2006, sales to the Americas, EMEA and APAC accounted for 60%, 25% and 15%
        of
        global sales, respectively, compared to 68%, 20% and 12%, respectively in
        2005.
        Although our sales increased in dollars in every geographic area, we made
        greater progress in EMEA and APAC in fiscal 2006, compared to 2005, where
        we
        gained market share in both divisions. Global sales to these two markets
        increased 66.9% and 66.4%, respectively in fiscal 2006, compared to 2005.
        In
        comparison, our sales to the Americas increased 15.6%
        year-over-year.
 
 The
        significant increase in sales in the EMEA market is mainly due to improved
        market penetration by both divisions, following our efforts to develop this
        market in the last several quarters. Namely, since the second quarter of
        fiscal
        2006, we were selected as sole-source supplier by a Tier-1 network service
        provider for all its fiber deployment test applications – including FTTx –
further increasing our sales to this market year-over-year.
 
 Over
        the last
        several quarters, we strengthened our product offering in APAC, specifically
        by
        implementing a multi-tiered platform strategy to meet different customer
        demands
        and different price points and by expanding our sales and marketing activities
        in this region. Our increased focus on and interaction with this market,
        combined with our enhanced capability to win tenders (which may vary in number
        and importance) contributed to our growth in the APAC region.
 
 In
        the
        Americas, sales to our top customer, who is located in the United States,
        decreased in fiscal 2006, compared to 2005, as it migrated to lower-priced
        test
        solutions, thus affecting our sales to the Americas year-over-year. However,
        we
        were able to leverage our customer base and increase our sales to this region
        in
        fiscal 2006, compared to 2005. Also, Consultronics, whose customers are mainly
        in the Americas, helped increase our sales to the Americas in fiscal 2006.
        In
        fact, excluding sales to our top customer, our sales to the Americas would
        have
        increased 35.1% year-over-year, which is quite remarkable considering that
        our
        end-markets increased in mid single digits in 2006.
 
 Through
        our
        two divisions, we sell our products to a broad range of customers, including
        network service providers, cable TV operators, optical system and component
        manufacturers, as well as customers in the life sciences and high-precision
        assembly sectors. During fiscal 2007, our top customer accounted for 14.7%
        ($22.5 million) of our global sales, and our top three customers accounted
        for
        19.6% of our global sales. For the corresponding period last year, our top
        customer accounted for 13.8% ($17.7 million) of our global sales, and our
        top
        three customers accounted for 19.4% of our global sales.
 
 
 **GROSS
        MARGIN**
 
 Gross
        margin
        amounted to 57.4%, 55.3% and 54.7% of sales for fiscal 2007, 2006 and 2005,
        respectively.
 
 ***Fiscal
        2007 vs. 2006***
 
 Despite
        the
        increased strength of the Canadian dollar, compared to the US dollar in fiscal
        2007 versus 2006 and the intense competitive pressure on selling prices that
        we
        faced in 2007, we were able to significantly increase our gross margin (2.1%)
        year-over-year.
 
 
 48
 Table
              of Contents
 
 This
        increase
        in our gross margin in fiscal 2007, compared to 2006 can be explained by
        several
        factors. First, the increase in sales year-over-year resulted in an increase
        in
        manufacturing activities, allowing us to better absorb our fixed manufacturing
        costs. In addition, sales of our protocol test solutions increased in dollar
        and
        as a percentage of sales year-over-year; this had a positive impact on our
        gross margin, as these products are more software-intensive and tend to have
        better gross margin than our optical test solutions. Furthermore, we were
        able
        to reduce our cost of goods sold by better leveraging our supplier base and
        by
        developing innovative new products with cost-effective design. Finally, our
        initiative to outsource the manufacturing of some product lines to China
        in
        fiscal 2007 helped us to improve our gross margin year-over-year.
 
 However,
        as
        mentioned above, we are facing continued aggressive pricing pressure worldwide,
        which negatively affected the gross margin in fiscal 2007. In addition, in
        2007,
        a stronger Canadian dollar, compared to the US dollar year-over-year,
        prevented us from further improving our gross margin, as some cost of sales
        items are denominated in Canadian dollars. Furthermore, the transfer, in
        fiscal
        2007, of our protocol and copper access manufacturing operations from Montreal
        and Concord to our Quebec City plant resulted in one-time charges, which
        negatively affected our gross margin during that period. Finally, in fiscal
        2007, the setup of our own manufacturing activities in China (which will be
        operational in 2008) resulted in additional one-time costs in 2007, thus
        reducing the gross margin of that year. We believe these two initiatives
        should
        contribute to bring our gross margin close to 60%.
 
 On
        an ongoing
        basis and when technically possible, we adjust the design of our products
        to
        reuse excess inventory, and, over the past few years, we experienced higher
        sales than expected on some product lines consuming such excess inventory.
        Consequently, we were able to reuse excess inventories that were written
        off
        following the telecom downturn in 2001 and 2002. Excess inventory reuse
        accounted for approximately $1.7 million, or 1.1% of sales in fiscal 2007,
        compared to approximately $1.2 million, or 0.9% of sales in 2006 and
        approximately $1.6 million, or 1.7% of sales in 2005. Inventory write-offs
        recorded during the telecom downturn were based on our best estimate at
        that time.
 
 ***Fiscal
        2006 vs. 2005***
 
 The
        increase
        in our gross margin in fiscal 2006, compared to 2005, can be explained by
        the
        following factors. First, we succeeded in increasing the market acceptance
        of
        our new products (designed in the last few years) on which we had focused
        our research and development efforts to simultaneously create lower cost
        of
        goods and the most advanced solutions. Second, the significant rise in sales
        year-over-year resulted in an increase in manufacturing activities, allowing
        us
        to better absorb our fixed manufacturing costs. Also, we were able to reduce
        our
        cost of goods sold by better leveraging our supplier base. Furthermore,
        streamlined operations following our consolidation action in fiscal 2005
        and
        continued cost-reduction programs allowed us to further improve our gross
        margin. However, the shift in the geographic distribution of our sales resulted
        in more sales, in percentage of total sales**,** made to the EMEA
        and APAC markets, where gross margins tend to be lower as most of our sales
        to
        these markets are made through distribution channels. In addition, we faced
        aggressive pricing pressure worldwide. Furthermore, in fiscal 2006, we incurred
        one-time charges related to the integration of Consultronics manufacturing
        activities, which reduced our gross margin year-over-year. Finally, a stronger
        Canadian dollar, compared to the US dollar, prevented us from further improving
        our gross margin as some cost of sales items are denominated in Canadian
        dollars.
 
 ***Outlook
        for Fiscal 2008***
 
 Considering
        the expected sales growth in fiscal 2008, the expected increase in sales
        of
        protocol products (which tend to generate higher margins), the cost-effective
        design of our products, our manufacturing activities in China (which we believe
        should lower our cost of goods over time), our tight control on operating
        costs,
        we expect our gross margin to improve in 2008 and beyond. However, our gross
        margin may fluctuate quarter-over-quarter as our sales may fluctuate.
        Furthermore, our gross margin can be negatively affected by increased
        competitive pricing pressure, customer concentration and/or consolidation,
        increased obsolescence costs, shifts in customer and product mix,
        under-absorption of fixed manufacturing costs, challenges encountered in
        the
        ramp-up of our manufacturing facilities in China, and increases in product
        offerings by other suppliers in our industry. Finally, any further increase
        in
        the strength of the Canadian dollar would have a negative impact on our gross
        margin in fiscal 2008.
 
 
 49
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              of Contents
 
 **SELLING
        AND ADMINISTRATIVE**
 
 Selling
        and
        administrative expenses were $49.6 million, $40.3 million and $31.8 million
        for
        fiscal 2007, 2006 and 2005, respectively. As a percentage of sales, selling
        and
        administrative expenses amounted to 32.4%, 31.4% and 32.7% for fiscal 2007,
        2006
        and 2005, respectively.
 
 ***Fiscal
        2007 vs. 2006***
 
 In
        fiscal
        2007, we continued intensifying our sales and marketing activities to develop
        our markets and leverage the significant research and development investments
        of
        the prior years; this resulted in higher sales and marketing expenditures
        (including number of employees), compared to the corresponding period last
        year.
        In addition, our overall commission expenses increased in fiscal 2007, compared
        to the corresponding period last year, due to the increase in sales
        year-over-year and the shift in customer mix. In fact, in fiscal 2007, we
        had
        large orders sold directly to international customers for which we still
        had to
        pay commissions to distributors instead of selling through our distributors
        at a
        discounted price, which increased our selling expenses year-over-year, but
        had,
        to some extent, a positive impact on our gross margin. Furthermore,
        Consultronics, acquired in January 2006, contributed for the whole period
        to our
        selling and administrative expenses, compared to about seven months in 2006,
        thus increasing these expenses year-over-year.
 
 Also,
        a
        stronger Canadian dollar on average for the period, compared to the US dollar
        during fiscal 2007 versus 2006, caused our selling and administrative expenses
        to increase year-over-year, as more than half of these expenses are denominated
        in Canadian dollars. In addition, the setup in 2007 of manufacturing facilities
        in China and a software development center in India contributed to an
        increase in our administrative expenses year-over-year.
 
 Finally,
        in
        fiscal 2007, and despite an increase in sales, our selling and administrative
        expenses increased in percentage of sales compared to the corresponding
        period last year. Larger commissions on international sales as well as our
        efforts to develop international markets and operations contributed to the
        increase in these expenses as a percentage of sales.
 
 ***Fiscal
        2006 vs. 2005***
 
 The
        increase
        in our selling and administrative expenses in dollars in fiscal 2006, compared
        to 2005, is mainly due to our decision to increase our sales activities
        worldwide. In addition, our commission expenses increased year-over-year
        due to
        the increase in sales. Furthermore, a stronger Canadian dollar, compared
        to the
        US dollar year-over-year, caused our selling and administrative expenses
        to
        increase. Finally, in fiscal 2006, Consultronics contributed about seven
        months
        to our selling and administrative expenses, increasing these expenses
        year-over-year.
 
 ***Outlook
        for Fiscal 2008***
 
 For
        fiscal
        2008, we expect our selling and administrative expenses to increase in dollars
        and range between 30% and 32% of sales. In particular, in fiscal 2008, we
        expect
        our commission expenses to increase as sales volume increases. Furthermore,
        considering our goal of becoming the leading player in the telecom test,
        measurement and monitoring space, we plan to continue intensifying our sales
        and
        marketing efforts, both domestic and international, which will also cause
        our
        expenses to rise. Finally, any further increase in the strength of the Canadian
        dollar would also cause our selling and administrative expenses to increase,
        as
        more than half of these expenses are incurred in
        Canadian dollars.
  
 50
 Table
              of Contents
 
 **RESEARCH
        AND DEVELOPMENT**
 
 ***Gross
        research and development expenses***
 
 Gross
        research and development expenses totaled $25.2 million, $19.5 million and
        $15.9
        million for fiscal 2007, 2006 and 2005, respectively. As a percentage of
        sales,
        gross research and development expenses amounted to 16.5%, 15.2% and 16.3%
        for fiscal 2007, 2006 and 2005, respectively, while net research and development
        expenses accounted for 10.9%, 12.0% and 12.5% of sales for these respective
        periods. Net research and development expenses for fiscal 2007 included the
        recognition of non-refundable research and development tax credits in the
        amount
        of $3.2 million that were written off in fiscal 2003 following the downturn
        in
        the telecommunications industry; this explains the 2.1% year-over-year decrease
        in net research and development expenses as a percentage of sales.
 
 ***Fiscal
        2007 vs. 2006***
 
 In
        fiscal
        2007, we intensified our research and development activities in both divisions,
        which resulted in higher gross research and development expenses, including
        additional employees, compared to 2006. In addition, in fiscal 2007,
        we subcontracted a larger portion of our research and development projects
        in
        Canada and India, compared to the corresponding period last year, which
        resulted in an increase in our gross research and development expenses
        year-over-year.
 
 Furthermore,
        Consultronics contributed to our research and development expenses during
        the
        whole period this year, compared to about seven months in 2006, thus increasing
        these expenses year-over-year. Finally, in fiscal 2007, the increased strength
        of the Canadian dollar, on average, compared to the US dollar year-over-year,
        contributed to the increase in our gross research and development expenses,
        as
        most of these are denominated in Canadian dollars.
 
 The
        above-mentioned factors explain the increase of our gross research and
        development expenses as a percentage of sales in fiscal 2007, compared to
        2006.
 
 ***Fiscal
        2006 vs. 2005***
 
 The
        increase
        in our gross research and development expenses in dollars in fiscal 2006,
        compared to 2005, is due several reasons. First, in fiscal 2006, Consultronics
        contributed about seven months to our gross research and development expenses,
        which caused these expenses to increase year-over-year. In addition, in fiscal
        2006, our gross research and development expenses were negatively affected
        by
        the increased strength of the Canadian dollar, compared to the US dollar
        year-over-year, as most of these expenses are incurred in Canadian dollars
        following the consolidation of most of our research and development activities
        in Canada. Finally, mix and timing of research and development projects in
        fiscal 2006 resulted in more gross research and development expenses during
        that
        year compared to 2005 for both divisions.
 
 ***Tax
        credits and grants***
 
 Tax
        credits
        and grants from the Canadian federal and provincial governments for research
        and
        development activities were $8.5 million, $4.1 million and $3.7 million for
        fiscal 2007, 2006 and 2005, respectively. As percentage of gross research
        and development expenses, tax credits and grants amounted to 33.9%, 21.0%
        and
        23.2% for fiscal 2007, 2006 and 2005, respectively.
 
 ***Fiscal
        2007 vs. 2006***
 
 During
        fiscal
        2003, following the downturn in the telecommunications industry and after
        being
        in a cumulative loss position, we wrote off deferred non-refundable research
        and
        development tax credits of our parent company because it was more likely
        than
        not that these assets would not be realized.
 
 
 51
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              of Contents
 
 In
        fiscal
        2007, after reviewing both available positive and negative evidences, and
        because we were in a cumulative profit position in the parent company at
        the
        Canadian federal level, and also because we expect to generate sufficient
        taxable income in future years, we concluded that is was more likely than
        not
        that deferred non-refundable income tax credits of our parent company would
        be
        realized. Consequently, in fiscal 2007, we recorded previously unrecognized
        non-refundable research and development tax credits in the amount of $3.2
        million, or 12.5% of gross research and development expenses. These
        non-refundable tax credits of $3.2 million recognized in fiscal 2007 can
        be
        carried forward against future years’ Canadian federal income taxes payable and
        expire between 2011 and 2014.
 
 In
        addition
        to this one-time tax credit, our tax credits increased in dollars in fiscal
        2007, compared to 2006 for several reasons. First, the increase in gross
        research and development expenses in Canada in 2007, compared to 2006,
        resulted in more expenses being eligible for tax credits as we were entitled
        to
        similar grant programs and tax credits year-over-year. In addition, the
        increased strength of the Canadian dollar, compared to the US dollar
        year-over-year, resulted in higher tax credits since these credits are solely
        earned on research and development expenses incurred in Canada.
 
 Also,
        due to
        the one-time recognition of non-refundable tax credits from prior years,
        our tax
        credits significantly increased as a percentage of gross research and
        development expense. Had prior years’ credits not been recognized, our tax
        credits would have been flat year-over-year as a percentage of gross research
        and development expenses, as we incurred most of our expenses in Canada and
        were entitled to same grant programs and tax credits.
 
 ***Fiscal
        2006 vs. 2005***
 
 The
        increase
        in our tax credits in dollars in fiscal 2006, compared to 2005, is mainly
        related to the increase in our eligible gross research and development expenses
        in Canada, since we were also entitled to similar grant programs and tax
        credits
        year-over-year. In addition, the increased strength of the Canadian dollar,
        compared to the US dollar year-over-year, also resulted in higher tax credits
        since these credits are earned in Canada. However, our tax credits decreased
        as
        a percentage of gross research and development expense. In fact, following
        the
        acquisition of Consultronics, we incurred less gross expenses that were
        eligible for tax credits since a part of Consultronics research and development
        activities were held outside Canada and Quebec. In addition, the mix of research
        and development projects resulted in a lower proportion of expenses being
        eligible for tax credits in fiscal 2006, compared to 2005.
 
 ***Outlook
        for Fiscal 2008***
 
 For
        fiscal
        2008, we plan to increase our research and development expenses at about
        the
        same rate we grow our sales, given our focus on innovation, the addition
        of
        software features in our products, our desire to gain market shares and our
        goal
        to exceed customer needs and expectations. Also, we are increasingly taking
        advantage of talent pools around the world by establishing a research and
        development center focused on software development in Pune, India. Finally,
        any further increase in the strength of the Canadian dollar in the upcoming
        quarters would cause our net research and development expenses to increase,
        as
        most of these are incurred in Canadian dollars.
 
 
 **AMORTIZATION
        OF PROPERTY, PLANT AND EQUIPMENT**
 
 For
        fiscal
        2007, amortization of property, plant and equipment was $3.0 million, compared
        to $3.5 million in 2006 and $4.3 million in 2005. The decrease in
        amortization expenses over the last two fiscal years, despite the increase
        in
        the strength of the Canadian dollar compared to the US dollar as well as
        the
        acquisition of Consultronics in January 2006 is mainly due to the fact that
        some of our property, plant and equipment became fully amortized over the
        last
        three years.
 
 
 52
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              of Contents
 
 ***Outlook
        for Fiscal 2008***
 
 For
        fiscal
        2008, we expect the amortization of property, plant and equipment to increase
        in
        dollars due to the upgrade of our IT systems in fiscal 2008 and, more
        importantly, the startup of our own manufacturing and research and development
        facilities in China and India. Also, any further increase in the strength
        of the
        Canadian dollar in the upcoming quarters would cause our amortization of
        property, plant and equipment to increase, as most of these are denominated
        in
        Canadian 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.
        These intangible assets resulted in amortization expenses
        of $2.9 million, $4.4 million and $4.8 million for fiscal 2007, 2006
        and 2005, respectively. The decrease in amortization expense in the last
        two fiscal years, despite the increased strength of the Canadian dollar compared
        to the US dollar and the acquisition of Consultronics in January 2006 is
        mainly
        due to the fact that some of our core technologies became fully amortized
        during
        fiscal 2005 and 2006; namely, those related to the acquisition of EXFO Burleigh,
        EXFO Photonics Solutions and EXFO Protocol.
 
 ***Outlook
        for Fiscal 2008***
 
 For
        fiscal
        2008, we expect the amortization of intangible assets to remain flat in dollars.
        This assumes no business combinations will be made during this
        period.****Also, any further increase in the strength of the
        Canadian dollar in the upcoming quarters would cause our amortization of
        intangible assets to increase, as most of these are denominated in Canadian
        dollars.
 
 
 **IMPAIRMENT
        OF LONG-LIVED ASSETS**
 
 ***Fiscal
        2006***
 
 In
        June 2006,
        we entered into an agreement to sell one of our buildings (located in Rochester,
        NY) along with some equipment, and we recorded an impairment charge of $604,000
        in the third quarter of fiscal 2006. The impairment charge represented the
        excess of the carrying value of these assets over the expected net selling
        price
        of $1.2 million. The sale of these assets was finalized in the fourth quarter
        of
        2006 for the expected net selling price, which was received in November 2006.
        These assets were related to the Life Sciences and Industrial
        Division.
 
 
 **GOVERNMENT
        GRANTS**
 
 During
        1998,
        we entered into an agreement with the Quebec Minister of Industry, Commerce,
        Science and Technology (“The Minister”). Pursuant to this agreement, the
        Minister agreed to contribute, in the form of grants, up to CA$2.2 million
        over the period from January 1, 1998, through December 31, 2002, payable
        based
        on the number of full-time jobs created during that period.
 
 The
        above
        grants were subject to the condition that jobs created pursuant to the agreement
        be maintained for a period of at least five years from the date of
        creation. Since the beginning of the program, we deferred in the balance
        sheet
        CA$1.5 million (US$1.3 million) until we received the final approval by the
        sponsor of the program related to jobs created. In fiscal 2006, the sponsor
        of
        the program granted us with its final approval and we recorded
        CA$1.5 million (US$1.3 million) in the earnings from operations in the
        statement of earnings of fiscal 2006.
 
 
 53
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              of Contents
 
 Furthermore,
        until December 31, 2006, companies operating in the Quebec City area
        were eligible for a refundable credit granted by the Quebec provincial
        government. This credit was earned based on the increase of eligible production
        and marketing salaries incurred in the Quebec City area at a rate of 40%.
        From
        the total amount we claimed under this program, a sum of CA$1.1 million
        (US$1.1 million) was deferred in the balance sheet until we received the
        final
        approval of eligible salaries by the sponsor of the program. In fiscal 2007,
        the
        sponsor of the program granted us with its final approval, and we recorded
        CA$1.1 million (US$1.1 million) in the earnings from operations in the statement
        of earnings of fiscal 2007.
 
 As
        at August,
        31, 2007, we were not part of any significant grant programs.
 
  **INTEREST
        AND OTHER INCOME**
  Our
        interest
        income mainly resulted from our short-term investments, less interests and
        bank
        charges. Interest and other income amounted to $4.7 million, $3.3 million
        and
        $2.5 million for fiscal 2007, 2006 and 2005, respectively. The increase in
        our
        interest income in fiscal 2007, compared to 2006, is mainly due to the increase
        in interest rates year-over-year. Also, our average cash position increased
        in
        fiscal 2007 due to cash flows from operating activities, which contributed
        to
        the further increase in interest revenue year-over-year.
 
 The
        increase
        in our interest income in fiscal 2006, compared to 2005, is also mainly due
        to
        the increase in interest rates year-over-year. In addition, despite the cash
        payment of $18.1 million for the acquisition of Consultronics in January
        2006, our average cash position increased in fiscal 2006 due to cash flows
        from
        operating activities, which contributed to the further increase in interest
        revenue year-over-year.
 
 ***Outlook
        for fiscal 2008***
 
 Assuming
        no
        acquisitions paid in cash are made in fiscal 2008 and stability in interest
        rates, we expect our interest income to slightly increase as our cash position
        should increase with expected cash flows from operating activities
        in fiscal 2008, compared to 2007.
 
 
 **FOREIGN
        EXCHANGE LOSS**
 
 Foreign
        exchange gains and losses are the result of the translation of operating
        activities denominated in currencies other than the Canadian
        dollar.
 
 The
        foreign
        exchange loss amounted to $49,000, $595,000 and $1.3 million in fiscal 2007,
        2006 and 2005, respectively.
 
 In
        fiscal
        2007, the Canadian dollar fluctuated compared to the US dollar and overall,
        this
        resulted in a small exchange loss of $49,000.  During that period, we
        witnessed instability in the value of the Canadian dollar, compared to the
        US
        dollar. The average exchange rate was CA$1.1215 = US$1.00 in fiscal 2007,
        compared to a year-end exchange rate of CA$1.1066 = US$1.00 as at
        August 31, 2006 and CA$1.0564 = US$1.00
        as at August 31, 2007.
 
 The
        significant exchange losses recorded in fiscal 2005 and 2006 were the result
        of
        the significant increase in the value of the Canadian dollar, compared to
        the US
        dollar, during these periods. However, the increase in the value of the
        Canadian dollar was more significant in fiscal 2005, compared to 2006, which
        resulted in a higher exchange loss in 2005. For instance, the year-end exchange
        rate was CA$1.3167 = US$1.00 in fiscal 2004, compared to CA$1.1889 =
        US$1.00 in 2005, representing an increase of 10.7% year-over-year. This compares
        to a year-end exchange rate of CA$1.1066 = US$1.00 in fiscal 2006, which
        resulted in an increase of 7.4%, compared to 2005. Also, the average exchange
        rate was CA$1.2315 = US$1.00 in fiscal 2005, compared to CA$1.1481 = US$1.00
        in 2006. On the other hand, higher levels of activity in fiscal 2006,
        compared to 2005, contributed to the increase in exchange loss in
        2006.
 54
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              of Contents
 
 It
          should be noted that foreign exchange rate fluctuations also flow through
          the
          profit and loss line items as a significant portion of our operating
          items are denominated in Canadian dollars and we report our results
          in US dollars.
 
 We
          manage our
          exposure to currency risks with forward exchange contracts. In addition,
          some of
          our Canadian entities’ operating activities are denominated in US dollars or
          other currencies, which further hedges these risks. However, any further
          increase in the value of the Canadian dollar, compared to the US dollar,
          would have a negative impact on our operating results.
 
 
 **INCOME
          TAXES**
 
 We
          recorded
          an income tax recovery of $20.8 million in fiscal 2007, compared to an
          income
          tax expense of $2.6 million in both fiscal 2006 and 2005.
 
 During
          fiscal
          2003, following the downturn in the telecommunications industry, we recorded
          a
          full valuation allowance against our future income tax assets in every
          applicable tax jurisdictions and we wrote-off non-refundable research and
          development tax credits because it was more likely than not that these
          assets
          would not be realized.
 
 ***Fiscal
          2007***
 
 ***Canadian
          federal and provinces level and United States federal
          level***
 
 During
          fiscal
          2007, after reviewing both available positive and negative evidences, and
          because we were in a cumulative profit position in our parent company
          (Canadian federal and provinces level) and in one of our subsidiaries,
          located
          in the United States, and also because we expect to generate sufficient
          taxable
          income in future years, we concluded that it is was more likely than not
          that
          the future income tax assets of our parent company in Canada and a portion
          of our future income tax assets in the United States would be realized.
          Consequently, we recorded previously unrecognized future income tax assets
          in the amount of $24.6 million. From this amount, $16.2 million related to
          the Canadian federal level, $3.2 million related to the Canadian provinces
          level
          and $5.2 million related to the United States federal level.
 
 In
          addition,
          from the global amount of future income tax assets recognized in fiscal
          2007,
          $6.5 million relate to operating losses carried forward that expire as
          follows:
 
 **Canada****Year
                    of expiry**
                
                **Federal**
                
                
                **Provinces**
                
                
                **United
                    States**2008
                
                $
                1,230,000
                
                
                $
                869,000
                
                
                $
                –2009
                
                
                2,845,000
                
                
                
                162,000
                
                
                
                –2010
                
                
                4,663,000
                
                
                
                176,000
                
                
                
                –2014
                
                
                93,000
                
                
                
                2,000
                
                
                
                –2022
                
                
                –
                
                
                
                –
                
                
                
                3,795,0002023
                
                
                –
                
                
                
                –
                
                
                
                1,671,000Indefinite
                
                
                –
                
                
                
                –
                
                
                
                7,474,000$
                8,831,000
                
                
                $
                1,209,000
                
                
                $
                12,940,000
 
 In
          order to
          realize these future income tax assets and non-refundable research and
          development tax credits, we need to generate approximately $100 million
          in
          pretax earnings at the Canadian federal level, approximately $26 million
          at the
          Canadian provinces level, and approximately $15 million at the United States
          federal level.
 
 Based
          on the
          existing and expected level of pretax earnings in these tax jurisdictions,
          we
          believe that we should be able to recover all these assets over the next
          six years. Historically, pretax earnings for financial reporting purposes
          have
          been close to taxable income in these tax jurisdictions, exclusive of any
          tax
          planning to generate additional taxable income.
 
 Future
          income
          tax assets recognized in 2007 were recorded in the income tax
          provision.
 
 55
 Table
                of Contents
 
 ***United
          States federal level and other tax jurisdictions***
 
 In
          the United
          States (federal level), based on available positive and negative evidences
          as
          well as the level and the nature of cumulative profits, we maintained a
          valuation allowance of $7.6 million on a portion of our future income tax
          assets
          in this tax jurisdiction because it is more likely than not that these
          assets
          will not be recovered. These future income tax assets consist of operating
          losses carried forward; some of these losses expire between 2022 and 2026,
          while
          others can be carried forward indefinitely against future years’ taxable
          income.
 
 In
          other tax
          jurisdictions where we have future income tax assets, we are still in a
          cumulative loss position and available negative evidences outweigh positive
          evidences. For these tax jurisdictions, we maintained a full valuation
          allowance
          against our future income tax assets. As at August 31, 2007, the valuation
          recorded for these other tax jurisdictions amounted to $4.9 million and
          mainly
          relates to operating losses carried forward, which expire at various dates
          over the next 20 years.
 
 Overall,
          we
          maintained a valuation allowance of $12.5 million as at August 31,
          2007.
 
 Except
          for
          the reversal of the valuation allowance in fiscal 2007, most of the income
          tax
          expenses recorded in fiscal 2005, 2006 and 2007, represent income taxes
          payable
          at the Canadian federal level, which are reduced by research and development
          tax
          credits that are recorded against gross research and development expenses
          in the
          statements of earnings.
 
 Please
          refer
          to note 16 of our consolidated financial statements included elsewhere
          in this
          Annual Report for more details on income taxes and a full reconciliation
          of the
          income tax provision.
 
 
 **LIQUIDITY
          AND CAPITAL RESOURCES**
 
 ***Cash
          Requirements and Capital Resources***
 
 As
          at August
          31, 2007, cash and short-term investments increased to $129.8 million from
          $111.3 million in 2006, while our working capital was $180.4 million. During
          fiscal 2007, operating activities generated $14.4 million in cash. In
          addition, we recorded an unrealized foreign exchange gain of $5.8 million
          on our cash and short-term investments. This unrealized foreign exchange
          gain
          resulted from the translation, in US dollars, of our
          Canadian-dollar-denominated cash and short-term investments and was recorded
          in
          the cumulative translation adjustment in the balance sheet. Furthermore,
          net proceeds from disposal of capital assets of $3.1 million increased
          our cash
          position year-over-year. Finally, issuance of subordinate voting shares
          generated $802,000 in cash in fiscal 2007 following the exercise of stock
          options. On the other hand, we made cash payments of $5.6 million for the
          purchase of capital assets.
 
 Our
          short-term investments consist of commercial paper issued by seven (nine
          as of
          August 31, 2006) high-credit quality corporations and trusts;
          therefore, we consider the risk of non-performance of these financial
          instruments to be remote. None of these debt instruments are expected to be
          affected by a liquidity risk; 47% of them are guaranteed by the Government
          of
          Canada and none of them represent asset-backed commercial
          paper.****For the purposes of managing our cash position, we
          have established a cash management policy, which we follow and monitor
          on a
          regular basis. These short-term investments will be used for working capital
          and
          other general corporate purposes, including other potential
          acquisitions.
 
 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 the share repurchase program approved on November 5, 2007.
          In addition to these assets, we have unused available lines of credit of
          $12.0 million for working capital and other general corporate purposes and
          an unused line of credit of $11.3 million for foreign currency exposure
          related
          to forward exchange contracts. However, possible operating losses 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. Our lines of
          credit bear interest at prime rate.
 
 56
 Table
                of Contents
 
 The
          following
          table summarizes our commitments as at August 31, 2007:
 
 **Years
                    ending August 31,**
                
                **2008**
                
                
                **2009**
                
                
                **2010**
                
                
                **2011**
                
                
                **2012
                    and**
                  **later**
                
                
                **Total**Operating
                    leases
                
                $
                2,313,000
                
                
                $
                2,164,000
                
                
                $
                2,064,000
                
                
                $
                1,145,000
                
                
                $
                641,000
                
                
                $
                8,327,000
 
 ***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 $14.4 million in fiscal 2007, compared
          to
          $12.3 million in 2006 and $14.0 million in 2005. Cash flows provided
          by operating activities in fiscal 2007 were mainly attributable to the
          net
          earnings after items not affecting cash of $24.6 million, less the negative
          net change in non-cash operating items of $10.1 million. Our accounts
          receivable, our income taxes and tax credits recoverable as well as our
          inventories increased in fiscal 2007, resulting in negative effects on
          cash
          flows of $5.5 million, $3.4 million and $5.5 million, respectively. However,
          our
          accounts payable and accrued liabilities increased during fiscal 2007,
          resulting
          in a positive effect on cash flows of $4.1 million. The increase in
          sales year-over-year explains the increase in accounts receivable. Also,
          one-time recognition of prior years’ non-refundable tax credits of $3.2 million
          explains most of the increase in our income taxes and tax credits recoverable
          year-over-year. Furthermore, increased sales activities in fiscal 2007
          resulted
          in higher inventory levels in 2007 in order to sustain these additional
          sales
          activities. However, increased levels of activities in fiscal 2007, compared
          to
          2006, resulted in an increase in our accounts payable and accrued liabilities
          year-over-year.
 
 Cash
          flows
          provided by operating activities in fiscal 2006 were mainly attributable
          to the
          net earnings after items not affecting cash of $16.9 million, less the
          negative net change in non-cash operating items of $4.7 million.
          Our accounts receivable and our inventories increased in fiscal 2006,
          resulting in negative effects on cash flows of $2.6 million and $2.3
          million, respectively. The increase in sales year-over-year explains the
          increase in accounts receivable. Also, larger sales activities in fiscal
          2006
          resulted in higher inventory levels in 2006 in order to sustain these increased
          sales activities.
 
 *Investing
          Activities*
 
 Cash
          flows
          used by investing activities were $16.1 million in fiscal 2007, compared
          to
          $13.2 million in 2006 and $13.0 million in 2005.
 
 In
          fiscal
          2007, we acquired $13.6 million worth of short-term investments and paid
          $5.6
          million for the purchase of capital assets. On the other hand, in fiscal
          2007, we received net proceeds of $3.1 million from the disposal of capital
          assets.
 
 In
          fiscal
          2006, we made cash payments of $18.1 million and $3.4 million for the
          acquisition of Consultronics and the purchase of capital assets, respectively.
          In order to finance a part of these payments, we disposed of $8.3 million
          worth
          of short-term investments. We paid the remaining with cash flows from operating
          activities and cash on hand.
 
 
 
 57
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                of Contents
 
 **FORWARD
          EXCHANGE CONTRACTS**
 
 We
          utilize
          forward exchange contracts to manage our foreign currency exposure. Our
          policy
          is not to utilize those derivative financial instruments for trading or
          speculative purposes.
 
 Our
          forward
          exchange contracts, which are used to hedge anticipated US-dollar-denominated
          sales, qualify for hedge accounting; therefore, foreign exchange translation
          gains and losses on these contracts are recognized as an adjustment of
          the revenues when the corresponding sales are recorded.
 
 As
          at August
          31, 2007, we held forward exchange contracts to sell US dollars at various
          forward rates, which are summarized as follows:
 
 **Expiry
                    dates:**
                
                **Contractual
                    amounts**
                
                
                **Weighted
                    average contractual forward rates**September
                    2007 to August 2008
                
                $
                36,900,000
                
                
                
                1.1295September
                    2008 to December 2009
                
                
                15,400,000
                
                
                
                1.1199
 
 As
          at August
          31, 2007, the fair value of our forward exchange contracts, which represents
          the
          amount we would receive to settle the contracts, amounted to an unrecognized
          gain of $3.4 million ($5.5 million
          as at August 31, 2006).
 
 
 **CONTINGENCY**
 
 On
          November
          27, 2001, a class action suit was filed in the United States District Court
          for
          the Southern District of New York against EXFO, four of the
          underwriters of our Initial Public Offering and some of our 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 EXFO’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 pre-determined prices.
 
 On
          April 19,
          2002, the plaintiffs filed an amended complaint containing master allegations
          against all of the underwriters in all of the 310 cases included in this
          class
          action and also filed an amended complaint containing allegations specific
          to
          four of our underwriters, EXFO and two of our executive officers. In addition
          to
          the allegations mentioned above, the amended complaint alleges that the
          underwriters (i) used their analysts to manipulate the stock market; and
          (ii) implemented schemes that allowed issuer insiders to sell their shares
          rapidly after an initial public offering and benefit from high market prices.
          As
          concerns EXFO and two of our executive officers in particular, the amended
          complaint alleges that (i) the company’s registration statement was materially
          false and misleading because it failed to disclose the additional commissions
          and compensation to be received by underwriters; (ii) the two named
          executive officers learned of or recklessly disregarded the alleged misconduct
          of the underwriters; (iii) the two named executive officers had motive and
          opportunity to engage in alleged wrongful conduct due to personal holdings
          of
          EXFO’s stock and the fact that an alleged artificially inflated stock price
          could be used as currency for acquisitions; and (iv) the two named executive
          officers, by virtue of their positions with EXFO, controlled the company
          and the
          contents of the registration statement and had the ability to prevent its
          issuance or cause it to be corrected. The plaintiffs in this suit seek
          an
          unspecified amount for damages suffered.
 
 In
          July 2002,
          the issuers filed a motion to dismiss the plaintiffs’ amended complaint and a
          decision was rendered on February 19, 2003. Only one of the claims against
          EXFO was dismissed. On October 8, 2002, the claims against our
          officers were dismissed pursuant to the terms of Reservation of Rights
          and
          Tolling Agreements entered into with the plaintiffs.
 
 58
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                of Contents
 
 In
          June 2004,
          an agreement of partial settlement was submitted to the court for preliminary
          approval.  The proposed partial settlement was between the plaintiffs,
          the issuer defendants in the consolidated actions, the issuer officers
          and
          directors named as defendants, and the issuers’ insurance
          companies.  The court granted the preliminary approval motion on
          February 15, 2005, subject to certain modifications.  On
          August 31, 2005, the court issued a preliminary order further approving the
          modifications to the settlement and certifying the settlement
          classes.  The court also appointed the notice administrator for the
          settlement and ordered that notice of the settlement be distributed to
          all
          settlement class members by January 15, 2006. The settlement fairness
          hearing occurred on April 24, 2006, and the court reserved decision at that
          time.
 
 The
          plaintiffs have continued to litigate against the underwriter defendants. 
The district court has directed that the litigation proceed within a number
          of "focus cases" rather than in all of the 310 cases that have been
          consolidated. EXFO’s case is not one of these focus cases.  On October
          13, 2004, the district court certified the focus cases as class
          actions.  The underwriter defendants appealed that ruling, and on
          December 5, 2006, the Court of Appeals for the Second Circuit reversed
          the
          district court’s class certification decision.
 
 On
          April 6,
          2007, the Second Circuit denied plaintiffs’ petition for rehearing of that
          decision and, on May 18, 2007, the Second Circuit denied the plaintiffs’
petition for rehearing en banc.  In light of the Second Circuit
          opinion, liaison counsel for all issuer defendants, including EXFO, informed
          the
          court that this settlement cannot be approved, because the defined
          settlement class, like the litigation class, cannot be certified.  On
          June 25, 2007, the district court entered an order terminating the settlement
          agreement. On August 14, 2007, the plaintiffs filed their second consolidated
          amended class action complaints against the focus cases and plan to move
          for
          class certification again.
 
 It
          is not
          possible to predict whether a settlement that complies with the Second
          Circuit’s
          mandate can be negotiated. Therefore, it is not possible to predict the
          final
          outcome of the case, nor to determine the amount of any possible losses.
          We will
          continue to defend our position in this litigation that the claims against
          EXFO,
          and our officers, are without merit. Accordingly, no provision for this
          case has
          been made in the consolidated financial statements
          as at August 31, 2007.
 
  **SHARE
          CAPITAL AND STOCK-BASED COMPENSATION PLANS**
 
 **Share
          capital**
 
 As
          at
          November 1, 2007, EXFO had 36,643,000 multiple voting shares outstanding,
          entitling to 10 votes each and 32,361,561 subordinate voting shares outstanding.
          The multiple voting shares and the subordinate voting shares are unlimited
          as to
          number and without par value.
 
 **Long-Term
          Incentive Plan and Deferred Share Unit Plan**
 
 The
          aggregate
          number of subordinate voting shares covered by stock options, restricted
          share
          units (RSUs) and deferred share units (DSUs) granted under the Long-Term
          Incentive Plan and the Deferred Share Unit Plan was 2,601,045 as at November
          1,
          2007. The maximum number of subordinate voting shares issuable under these
          two
          plans cannot exceed 6,306,153 shares. The following tables summarize
          information about stock options, RSUs and DSUs granted to the members of
          the
          Board of Directors and to Management and Corporate Officers of the company
          and
          its subsidiaries as at November 1, 2007:
  **Stock
                    Options**
                
                **Number**
                
                
                **%
                    of issued and outstanding**
                
                
                **Weighted
                    average exercise price**Chairman
                    of the Board, President and CEO(one
                    individual)
                
                
                179,642
                
                
                
                9
                %
                
                $
                9.05Board
                    of Directors (five individuals)
                
                
                194,375
                
                
                
                10
                
                
                
                6.23Management
                    and Corporate Officers (eight individuals)
                
                
                212,139
                
                
                
                11
                
                
                
                14.49****
                **586,156**
                
                
                ****
                **30**
                **%**
                
                **$**
                **10.08**
 
 
 59
 Table
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  **Restricted
                      Share Units (RSUs)**
                  
                  **Number**
                  
                  
                  **%
                      of issued and outstanding**Chairman
                      of the Board, President and CEO(one
                      individual)
                  
                  
                  89,823
                  
                  
                  
                  15
                  %Management
                      and Corporate Officers (ten individuals)
                  
                  
                  292,442
                  
                  
                  
                  48****
                  **382,265**
                  
                  
                  ****
                  **63**
                  **%**
   **Deferred
                      Share Units (DSUs)**
                  
                  **Number**
                  
                  
                  **%
                      of issued and outstanding**Board
                      of Directors (five individuals)
                  
                  ****
                  **70,195**
                  
                  
                  ****
                  **100**
                  **%**
                  
                  ****
 
  **OFF-BALANCE
          SHEET ARRANGEMENTS**
 
 As
          at August
          31, 2007, our off-balance sheet arrangements consisted of letters of guarantee
          and forward exchange contracts. These off-balance sheet arrangements are
          respectively described in detail in notes 12 and 18 to our consolidated
          financial statements, included elsewhere in this Annual Report.
 
 
 **VARIABLE
          INTEREST ENTITY**
 
 As
          at August
          31, 2007, we did not have interests in any variable interest
          entities.
  60
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              of Contents
  **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, 2007.
 
 **Name
                          and Municipality of Residence**
                    
                    **Positions
                          with EXFO**JON
                        BRADLEY
                      Worminghall,
                        United Kingdom
                    
                    Vice-President,
                        Telecom Sales - InternationalSTEPHEN
                        BULL
                      Quebec
                        City, Quebec
                    
                    Vice-President,
                        Research and Development, Telecom DivisionNORMAND
                        DUROCHER
                      St-Sauveur,
                        Quebec
                    
                    Vice-President,
                        Human ResourcesALLAN
                        FIRHOJ
                      Georgestown,
                        Ontario
                    
                    Vice-President
                        and General Manager, Life Sciences and Industrial
                        DivisionROBERT
                        FITTS
                      Minesing,
                        Ontario
                    
                    Vice-President,
                        Corporate DevelopmentÉTIENNE
                        GAGNON
                      Quebec
                        City, Quebec
                    
                    Vice-President,
                        Telecom Product Management and MarketingLUC
                        GAGNON
                      St-Augustin-de-Desmaures,
                        Quebec
                    
                    Vice-President,
                        Telecom Manufacturing Operations and Customer ServiceGERMAIN
                        LAMONDE
                      St-Augustin-de-Desmaures,
                        Quebec
                    
                    Chairman
                        of the Board, President and Chief Executive OfficerPIERRE
                        MARCOUILLER
                      Magog,
                        Quebec
                    
                    Independent
                        DirectorGUY
                        MARIER
                      Lakefield
                        Gore, Quebec
                    
                    Independent
                        Lead DirectorPIERRE
                        PLAMONDON, CA
                      Quebec
                        City, Quebec
                    
                    Vice-President,
                        Finance and Chief Financial OfficerBENOIT
                        RINGUETTE
                      Quebec
                        City, Quebec
                    
                    General
                        Counsel and Corporate SecretaryDAVID
                        A. THOMPSON
                      Newton,
                        North Carolina
                    
                    Independent
                        DirectorANDRÉ
                        TREMBLAY
                      Outremont,
                        Quebec
                    
                    Independent
                        DirectorMICHAEL
                        UNGER
                      Richmond
                        Hill, Ontario
                    
                    Independent
                        DirectorDANA
                        YEARIAN
                      Lake
                        Forest, Illinois
                    
                    Vice-President,
                        Telecom Sales - Americas
 
 The
              address of each of our executive officers, senior managers and Directors
              is c/o
              EXFO Electro-Optical Engineering Inc., 400 Godin Avenue, Quebec, Quebec,
              Canada.
              The following is a brief biography of each of our executive officers,
              senior
              managers and Directors.
  61
 Table
                  of Contents
  *Jon
              Bradley*was appointed Vice-President, Telecom Sales - International for
              EXFO in March 2007. 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, International Telecom Sales, Dr. Bradley held the
              position of Sales Director for the Europe, Middle East and Africa (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. Dr.
              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*was appointed our Vice-President, Research and Development, Telecom
              Division in December 1999. He joined us in July 1995 and held the
              positions of Assistant Director-Engineering from September 1997 to
              December 1999
              and Group Leader (Engineering Management) from July 1995 to September
              1997. From
              June 1990 to March 1995, Mr. Bull held the position of General Manager
              and
              Managing Director for Space Research Corporation, a military engineering
              company
              in Belgium. Mr. Bull holds a bachelor’s degree in Electrical Engineering
              from Laval University in Quebec City, Canada.
 
 *Normand
              Durocher*was appointed Vice-President of Human Resources in April 2004.
              In
              addition to managing our human resources team, his main responsibility
              is to
              develop and implement a human resources plan that supports EXFO’s business
              strategy. Mr. Durocher began his career in labor relations in the Cable
              division
              of Nortel and then took on several key roles at Nortel Networks and
              Nordx/CDT,
              all relating to human resources and operations. Since then, Normand
              Durocher has
              accumulated more than 25 years’ experience in operations and human resources
              management within the telecommunications industry. Prior to joining
              EXFO,
              Mr. Durocher ran his own human resources consulting business. Normand
              Durocher holds a Bachelor of Science from the University de Montreal
              and also
              completed the Advanced Human Resources program at Dalhousie University in
              Halifax, Nova Scotia, Canada.
 
 *Allan
              Firhoj* was appointed Vice-President and General Manager, Life Sciences
              and
              Industrial Division in July 2003. Prior to that, he held the position
              of General
              Manager of EXFO Photonic Solutions Inc. since November 2001. He is
              responsible for the overall strategic direction and management of the
              Life
              Sciences and Industrial Division. Mr. Firhoj joined EFOS Inc. in 1996,
              where he
              was responsible for Sales, Marketing and Business Development of the
              Dental
              Curing-Products Division. Following the sale of this division to Dentsply
              International in 1997, he was appointed Director of Marketing and Business
              Development. Mr. Firhoj continued in this capacity until being appointed
              to the
              position of General Manager of EXFO Photonic Solutions Inc. Prior to
              joining us,
              Mr. Firhoj spent six years with The Horn Group, a plastics business
              involved in medical devices/instrumentation and office communication
              equipment.
              He successively held the positions of ISO 9000 Implementation Manager,
              Technical
              Sales Manager as well as Marketing and Business Development Manager.
              In this latter role, he successfully contributed to increasing sales in
              their medical market by an annual average of 60% during a three-year
              period. Mr. Firhoj holds a bachelor’s degree in Political Science from Bishop’s
              University in Lennoxville, Quebec.
 
 *Robert
              Fitts* was nominated Vice-President, Corporate Development in
              May
              2007. His main role is to seek out new business opportunities (such
              as strategic
              alliances, OEM agreements and acquisitions), which will allow the company
              to
              enhance its competitive position in the telecom test and measurement
              market.
              Prior to this appointment, Mr. Fitts acted as Vice-President,
              Product Management - Copper Access Products, since our acquisition of
              Consultronics in January 2006. Before taking on this position, Mr.
              Fitts was
              Executive Vice-President at Consultronics, where he began his career
              more than
              20 years earlier. He therefore has extensive experience in the
              telecommunications testing industry and, more specifically, has been
              an active
              participant in the field of local-loop testing, DSL, IPTV and VoIP.
              Robert Fitts
              attended the University of Guelph in Ontario, Canada, and has a degree
              in
              electrical engineering (computer option) technology from Fleming College,
              near Toronto, Canada. Mr. Fitts is also a graduate of the executive
              program
              given by Queens University School of Business, located in Kingston,
              Ontario.
 
  62
 Table
                  of Contents
  *Étienne
              Gagnon* was appointed Vice-President, Telecom Product Management and
              Marketing in May 2003 and, in May 2007, he took on the responsibility
              of all our
              telecom business units – Optical; Transport and Datacom; and Access. As such, he
              is responsible for EXFO’s general marketing direction on both the product level
              and communications level. Mr. Étienne Gagnon is not related to Mr. Luc Gagnon.
              For nearly three years, before returning to EXFO in early 2003, Mr.
              Gagnon was
              Vice-President of Sales and Marketing at TeraXion, an optical component
              manufacturer based in Quebec City. 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 our Outside Plant division in 1998, and remained in
              that
              function until he joined TeraXion in 2000. Etienne 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
*Ecole nationale supérieure des télécommunications* in
              France.
 
 *Luc
              Gagnon* was appointed Vice-President, Telecom Manufacturing Operations
              in
              May 2003 and, in May 2007, he also took on the vice-presidency of the
              Customer Services department. Mr. Luc Gagnon is not related to Mr.
Étienne Gagnon. 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 maintains 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 1991 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.
 
 *Germain
              Lamonde*, a company founder, has been Chairman of the Board, President
              and
              CEO of EXFO since its inception in his apartment in 1985. Mr. Lamonde,
              who is
              responsible for the overall management and strategic direction of EXFO
              and its
              subsidiaries and divisions, has grown the company from the ground up
              into global
              leader in the telecommunications test and measurement industry. Mr.
              Lamonde has
              served on the boards of several organizations such as the Canadian
              Institute for
              Photonic Innovations, the Pole QCA Economic Development Corporation
              and the
              National Optics Institute of Canada 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 Laval University, and is also a graduate of the Ivey Executive
              Program offered by the University of Western Ontario.
 
 *Pierre
              Marcouiller*has served as our Director since May 2000. Mr. Marcouiller is
              Chairman of the Board and CEO of Camoplast Inc., an industrial manufacturer
              specializing in rubber tracks, molded composites, thermoplastic components
              and
              off-road tracked vehicles. Prior to joining Camoplast, Mr. Marcouiller was
              President and General Manager of Venmar Ventilation Inc. (1988-1996),
              where he
              was the controlling shareholder from 1991 to 1996. Mr. Marcouiller
              is also a
              Director of Canam Group Inc., an industrial company specialized in
              the design
              and fabrication of construction products and solutionsin the commercial,
              industrial, institutional, residential, and bridge and highway infrastructures
              markets. Mr. Marcouiller also holds directorships in other privately
              held
              companies. Pierre Marcouiller holds a bachelor’s degree in business
              administration from the *Université du Québec à Trois-Rivières*and
              an MBA from the *Université de Sherbrooke*.
 
 *Guy
              Marier*has served as our Director since January 2004. Formerly President
              of
              Bell Québec (1999 to 2003), Guy 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. 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 the *Université du Québec à
Montréal.*
  63
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                  of Contents
  *Pierre
              Plamondon*has been our Vice-President, Finance and Chief Financial Officer
              since January 1996. Prior to joining us, Mr. Plamondon served as Senior
              Manager
              for Price Waterhouse, now PricewaterhouseCoopers LLP, from September
              1981 to
              December 1995 in Canada and France. Pierre Plamondon holds a bachelor’s degree
              in business administration and a license in accounting, both from Laval
              University in Quebec City, Canada. Mr. Plamondon has been a member of the
              Canadian Institute of Chartered Accountants since 1983 and a member
              of the Board
              of Directors of SOVAR Inc. (Société de valorisation des applications de la
              recherche de l’Université Laval) since December 2000.
 
 *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.
 
 *David
              A. Thompson*has served as our Director since June 2000. Dr. David A.
              Thompson is currently Vice-President and Director of Hardware & Equipment
              Technology at Corning Cable Systems, where he has held this position
              since
              January 2006. Prior to this, he was Vice President and Director of
              Hardware
& Equipment Technology Strategy for Corning Cable Systems from January
              2002
              to December 2005. Dr. Thompson first joined Corning Incorporated in
              1976 as a
              Senior Chemist in glass research.  He then took on several technology
              Directorships and strategic planning roles for Corning’s Component and Photonics
              Technologies Division between 1988 and 1998; and in 1999, he was appointed
              technical leader for the creation of the new Samsung-Corning Micro-Optics
              joint
              venture.  His last position at Corning prior to transferring to
              Corning Cable Systems in January 2002 was Division Vice-President for
              the
              Strategic Planning & Innovation Effectiveness in Research, Development and
              Engineering.  David A. Thompson holds a Bachelor of Science in
              chemistry from Ohio State University and a doctorate in inorganic chemistry
              from the University of Michigan.  He holds 18 patents and has over 20
              technical publications in the areas of inorganic chemistry, glass technology
              and
              telecommunications.
 
 *André
              Tremblay*has served as our Director since June 2000.**Mr.
              Tremblay is a Founder and Managing Partner of Trio Capital Inc, a private
              equity
              fund management company.  He has more than 20 years experience in the
              telecommunications industry, having been actively involved in the conception,
              financing and management of several companies. As a special advisor
              to the
              President of Telesystem Ltd., and as President of Telesystem Enterprises
              Ltd.
              from 1992 to 1998, he managed a portfolio of telecommunication companies.
              For
              almost 10 years, he served as President and Chief Executive Officer
              of Microcell
              Telecommunications, a wireless network and service provider, which
              he led from
              its inception on through the different phases of its evolution. During
              that
              time, he has also provided early-stage financing, along with strategic
              advice
              and direction, for start-up technology firms. In 2005, he was appointed
              by
              Canada’s Industry Minister as member of the Telecommunications Policy Review
              Panel to make recommendations on how to modernize Canada’s telecommunication
              policies and regulatory framework. André Tremblay holds bachelor’s degrees in
              management and in accounting from Laval University, a master’s degree in
              taxation from Université de Sherbrooke, and is also a graduate of Harvard
              Business School’s Advanced Management Program.
 
 *Michael
              Unger*has served as our Director since May 2000. He worked with Nortel
              Networks Limited, now Nortel Networks Corporation, from 1962 to 2000.
              Mr.
              Unger’s most recent position was President of Nortel’s Optical Networks Business
              Unit, a position he held from May 1998 to April 2000. Prior to this
              appointment,
              Mr. Unger was Nortel’s Group Vice-President, Transport Networks from March
              1990 to May 1998. Mr. Unger also serves on the Board of Directors and
              Human
              Resources Committee of Tundra Semiconductor Corporation, a publicly traded
              company with its shares listed on The Toronto Stock Exchange that designs,
              develops and markets networking and network access technology for use
              by
              communications infrastructure equipment companies.  He also chairs the
              Audit Committee of Nakina Systems and serves on the Boards and Committees
              of
              several other privately-held companies active in the areas of photonic
              and
              optical components, optical network systems and solutions for cable
              operators
              and other communications service providers. Mr. Unger holds a Bachelor
              of
              Science from Concordia University and has successfully completed several
              accounting credits, also given by Concordia University in Montreal,
              Canada. In
              addition, Mr. Unger holds an executive MBA from the University of Western
              Ontario.
  64
 Table
                  of Contents
  Dana
              Yearian was appointed our Vice President, Telecom 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. Prior to joining EXFO, Mr. Yearian held senior executive
              sales
              positions at Spirent Communications Service Assurance Division and
              Acterna
              Corp. Mr. Yearian also 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.
 
 
 **B.****Compensation**
 
 **Director
              Compensation**
 
 In
              the
              financial year ended August 31, 2007, each director who was not an employee
              of the Corporation or any of its subsidiaries received the level of
              compensation
              set forth in the table below as annual compensation payable in
              a combination of cash and Deferred Share Units (“DSUs”) as chosen by the
              Director pursuant to the Deferred Share Unit Plan.
 Annual
                          Retainer for Directors (1)
                      CA$50,000
                      (2)
                      US$44,583
                          (3)Annual
                          Retainer for Lead Director
                      CA$5,000
                      
                      US$4,458
                          (3)Annual
                          Retainer for Committee Chairman
                      CA$5,000
                      
                      US$4,458
                          (3)Annual
                          Retainer for Committee Members
                      CA$3,000
                      
                      US$2,675
                          (3)Fees
                          for all Meetings Attended per day in Person
                      CA$1,000
                      
                      US$892
                          (3)Fees
                          for all Meetings Attended per day by Telephone
                      CA$500
                      
                      US$446
                          (3)
 
 (1)
                      All
                          the Directors elected to receive 50% of their Annual Retainer
                          in form of
                          Deferred Share Units except Mr. André Tremblay who elected to receive 100%
                          of his Annual Retainer in form of Deferred Share
                          Units.
 (2)
                      The
                          Annual Retainer for Mr. David A. Thompson is US$50,000
                          (CA$56,075).
 (3)
                      The
                          compensation information has been converted from Canadian
                          dollars to U.S.
                          dollars based upon an average foreign exchange rate of
                          CA$1.1215 = US$1.00
                          for 2007.
 In
              the
              financial year ended August 31, 2007 and as of November 1, 2007, the
              Directors
              who were not employees received the following compensation in the form
              indicated:
 
 **Name**
                    **Annual
                        Compensation Paid**
                      **in
                        Cash (US$) (1)**
                    **Annual**
                      **Compensation
                        Paid**
                      **in
                        DSUs (#) (2)**
                    **Estimated
                        Value of**
                      **DSUs
                        at the time of**
                      **grant
                        (US$) (3)**
                    **Total
                        Attendance**
                      **Fees
                        Paid in Cash**
                      **(US$) (1)**Pierre
                        Marcouiller (4)
                    27,642
                    3,586
                    22,292
                    4,012Guy
                        Marier (5)
                    30,490
                    3,586
                    22,292
                    4,904Dr.
                        David A. Thompson (6)
                    27,675
                    3,975
                    25,000
                    4,283André
                        Tremblay (7)
                    7,133
                    7,172
                    44,583
                    5,796Michael
                        Unger (8)
                    29,425
                    8,586(9)
                    53,544
                    5,796
 65
 Table
                    of Contents
  
 (1)
                      The
                          compensation information has been converted from Canadian
                          dollars to U.S.
                          dollars based upon an average foreign exchange rate of
                          CA$1.1215 = US$1.00
                          for 2007 except for Mr. David A. Thompson who is paid in
                          U.S. dollar for
                          the portion of his annual retainer for Director.  The Annual
                          Compensation includes, as the case may be, the retainer
                          for Director, Lead
                          Director, Committee Members and Committee
                          Chairman.
 (2)
                      Indicates
                          the number of Subordinate Voting Shares granted under the
                          Deferred Share
                          Unit Plan. A DSU is converted in a Subordinate Voting Share when a
                          Director ceases to be a member of the
                          Board.
 (3)
                      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 on the grant date to convert the
                          NASDAQ National
                          Market closing price to Canadian 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.
 (4)
                      Member
                          of the Audit Committee and the Human Resources
                          Committee.
 (5)
                      Member
                          of the Audit Committee and the Human Resources Committee
                          and Lead
                          Director.
 (6)
                      Member
                          of the Human Resources Committee.
 (7)
                      Member
                          of the Human Resources Committee and Chairman of the Audit
                          Committee.
 (8)
                      Member
                          of the Audit Committee and Chairman of the Human Resources
                          Committee.
 (9)
                      Mr.
                          Unger received 5,000 DSUs in the financial year ended August
                          31, 2007 for
                          his past contribution as Lead
                          Director.
  **Executive
              Compensation**
 
 The
              table
              below shows compensation information during the three most recently
              completed
              financial years for Mr. Germain Lamonde, the Chairman of the Board,
              President and Chief Executive Officer of the Corporation, Mr. Pierre
              Plamondon, the Vice-President Finance and Chief Financial Officer and
              the three
              other most highly compensated executive officers of the Corporation
              and its
              subsidiaries who were serving the Corporation at the end of the financial
              year,
              and one other executive officer of the Corporation who would have been
              included
              within the three most highly compensated executive officers had he
              been in the
              employ of the Corporation, or a subsidiary, at the year end (collectively,
              the
              "Named Executive Officers"). This information includes the U.S. dollar
              value of
              base salaries, bonus awards and long-term incentive plan grants, the
              number of
              options or Restricted Share Units granted, and other compensation,
              if any,
              whether paid or deferred.
  **Name
                          and Principal**
                        **Position**
                      **Financial**
                        **Years**
                      **Salary
                          (1)
                          ($)**
                      **Bonus
                          (2)($)**
                      **Other
                          Annual Compensation ($) (3)**
                      **Securities
                          Under Options (4)
                          (#)**
                      **Restricted
                          Share Units****(5)****(#)**
                      **All
                          Other**
                        **Compensation**
                        **($)**Germain
                          Lamonde,
                        President
                          and Chief Executive Officer
                      2007
                      294,334  (US)
                        330,096  (CA)
                      131,145  (US)
                        147,080  (CA)
                      -
                      -
                      25,347
                      -2006
                      271,753  (US)
                        312,000  (CA)
                      147,558  (US)
                        169,412  (CA)
                      -
                      11,218
                      21,477
                      -2005
                      243,605  (US)
                        300,000  (CA)
                      121,729  (US)
                        149,909  (CA)
                      -
                      17,942
                      13,089
                      -Pierre
                          Plamondon,
                        Vice-President
                          Finance and Chief Financial Officer
                      2007
                      173,862  (US)
                        194,986  (CA)
                      56,906  (US)
                        63,820  (CA)
                      -
                      -
                      12,930
                      4,836  (US)(6)
                        5,423  (CA)2006
                      165,691  (US)
                        190,230  (CA)
                      60,167  (US)
                        69,078  (CA)
                      -
                      3,653
                      6,994
                      4,283  (US)(6)
                        4,918  (CA)2005
                      151,441  (US)
                        186,500  (CA)
                      48,735  (US)
                        60,017  (CA)
                      -
                      5,383
                      33,927
                      2,316  (US)(6)
                        2,852  (CA)
 Dana
                          Yearian,
                        Vice-President,
                          Telecom Sales - Americas
                      2007
                      250,592  (US)
                        281,039  (CA)
                      8,326  (US)
                        9,338  (CA)
                      -
                      -
                      6,645
                      566  (US)(6)
                        634  (CA)2006
                      7,851  (US)(7)
                        9,014  (CA)
                      -
                        -
                      -
                      -
                      5,000
                      236  (US) (6)
                        270  (CA)2005
                      -
                        -
                      -
                        -
                      -
                      -
                      -
                      -Jon
                          Bradley,
                        Vice-President,
                          Telecom Sales - International
                      2007
                      226,991  (US)
                        254,571  (CA)
                        116,011  (£)(8)
                      19,470  (US)
                        21,836  (CA)
                        9,951  (£)
                      -
                      -
                      -
                      -2006
                      194,908  (US)
                        223,774  (CA)
                        108,778 
                          (£)
                      12,684  (US)
                        14,563  (CA)
                        7,079  (£)
                      -
                      -
                      2,500
                      -2005
                      129,726  (US)
                        159,758  (CA)
                        70,258  (£)
                      13,400  (US)
                        16,502  (CA)
                        7,257  (£)
                      -
                      4,000
                      2,000
                      -
   66
 Table
                    of Contents
 **Name
                          and Principal**
                        **Position**
                      **Financial**
                        **Years**
                      **Salary
                          (1)
                          ($)**
                      **Bonus
                          (2)($)**
                      **Other
                          Annual Compensation ($) (3)**
                      **Securities
                          Under Options (4)
                          (#)**
                      **Restricted
                          Share Units****(5)****(#)**
                      **All
                          Other**
                        **Compensation**
                        **($)**
 Allan
                          Firhoj,
                        Vice-President
                          and General Manager, Life Sciences and Industrial Division
                      2007
                      148,373  (US)(9)
                        166,400  (CA)
                      58,969  (US)
                        66,133  (CA)
                      -
                      -
                      21,178
                      -2006
                      139,361  (US)
                        160,000  (CA)
                      40,632  (US)
                        46,650  (CA)
                      -
                      2,404
                      4,602
                      -2005
                      123,153  (US)
                        151,663  (CA)
                      18,355  (US)
                        22,604  (CA)
                      -
                      2,512
                      12,443
                      -
  **Named
                          Executive Officer Not in the Employ of the Corporation
                          at Year
                          End**
 Juan-Felipe
                          Gonzalez,
                        Vice-President,
                          Telecom Sales - International
                      2007
                      195,508  (US)(10)
                        219,262  (CA)
                      9,237  (US)
                        10,359  (CA)
                      -
                      -
                      -
                      -2006
                      272,518  (US)
                        312,878  (CA)
                      12,891  (US)
                        14,800  (CA)
                      -
                      3,505
                      6,716
                      -2005
                      246,323  (US)
                        303,347  (CA)
                      6,015  (US)
                        7,407  (CA)
                      -
                      5,482
                      33,998
                      -
 
 (1)
                        The
                            compensation information for Canadian residents has been
                            converted from
                            Canadian dollars to U.S. dollars based upon an average
                            foreign exchange
                            rate of CA$1.1215 = US$1.00 for 2007, CA$1.1481 = US$1.00
                            for 2006 and
                            CA$1.2315 = US$1.00 for 2005. The currency conversions
                            cause these
                            reported salaries to fluctuate from year-to-year because
                            of the
                            fluctuation in exchange rate.
 (2)
                        A
                            portion of the bonus amounts is paid in cash in the year
                            for which they
                            are awarded and the balance is paid in cash in the year
                            following the
                            financial year for which they are
                            awarded.
 (3)
                        Indicates
                            only an aggregate amount if such amount is equivalent
                            or greater than
                            $50,000 and 10% of the total of the annual salary and
                            bonus of the Named
                            Executive Officer for the financial year ended August
                            31,
                            2007.
 (4)
                        Indicates
                            the number of Subordinate Voting Shares underlying the
                            options granted
                            under the Long-Term Incentive Plan during the financial
                            year
                            indicated.
 (5)
                        Indicates
                            the number of Restricted Share Units granted under the
                            Long-Term Incentive
                            Plan during the financial year
                            indicated.
 (6)
                        Indicates
                            the amount contributed by the Corporation during the
                            financial year
                            indicated to the Deferred Profit Sharing Plan or 401K
                            Plan, as applicable,
                            for the benefit of the Named Executive Officer. Mr. Lamonde
                            is not
                            eligible to participate in the Deferred Profit Sharing
                            Plan and
                            Mr. Gonzalez did not
                            participate.
 (7)
                        This
                            amount represents the salary paid to Mr. Yearian from
                            August 14, 2006
                            until August 31, 2006 which is based on an annual salary
                            amounted to
                            US$173,424 (CA$199,109) for the financial year ended
                            August 31,
                            2006.
 (8)
                        The
                            compensation information for UK resident has been converted
                            from British
                            Pound to U.S. dollars based upon an average foreign exchange
                            rate of
                            £1.9566 = US$1.00 for 2007, £1.7918 = US$1.00 for 2006 and £1.8464 =
                            US$1.00 for 2005, for the conversion from U.S. dollars
                            to Canadian
                            dollars, please refer to note 1 above. The currency conversions
                            cause
                            these reported salaries to fluctuate from year-to-year
                            because of the
                            fluctuation in exchange rate.
 (9)
                        Mr.
                            Firhoj also received an amount of US$690 (CA$615) for
                            untaken vacations
                            during the financial year ended August 31,
                            2007.
 (10)
                        This
                            amount represents the salary paid to Mr. Gonzalez from
                            September 1st,
                            2006 until
                            March 1st,
                            2007 which
                            is based on an annual salary amounted to US$258,789 (CA$290,232)
                            for the
                            financial year ended August 31,
                            2007.
  **Employment
                  Agreements**
 
 We
                  have an employment agreement with Mr. Germain Lamonde. The agreement
                  is for
                  an indeterminate period and the compensation is reviewed annually.
                  In the event
                  of the termination of Mr. Lamonde’s employment without cause, Mr. Lamonde
                  will be entitled to severance payments (in no case exceeding 24 months of
                  remuneration) and the 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 our share capital or if
                  Mr. Lamonde voluntarily resigns, he will be entitled to the vesting
                  of all
                  stock options and RSUs.
 
 We
                  also
                  have employment agreements with Mr. Pierre Plamondon, Mr. Dana
                  Yearian, Mr. Jon Bradley and Mr. Allan Firhoj.
 
 67
 Table
                      of Contents
  We
                  have an employment agreement with Mr. Pierre Plamondon, ourVice-President,
                  Finance and Chief Financial Officer. The agreement is for an indeterminate
                  period and the compensation is reviewed annually. In the event
                  of termination of
                  Mr. Plamondon’s employment without cause, Mr. Plamondon will be entitled to
                  severance payments (in no case exceeding 12 months of the 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 our
                  assets or of the majority of our share capital, he will be entitled
                  to severance
                  payments (in no case exceeding 18 months remuneration plus health
                  benefits) and
                  to the immediate vesting of all stock options and RSUs.
 
 We
                  have an
                  employment agreement with Mr. Dana Yearian, our Vice-President, Telecom
                  Sales - Americas. The agreement is for an indeterminate period
                  and the
                  compensation is reviewed annually. In the event of termination
                  of Mr. Yearian’s
                  employment without cause, Mr. Yearian will be entitled to severance
                  payments (in
                  no case exceeding 12 months of the 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 our assets
                  or of the
                  majority of our share capital, he will be entitled to severance
                  payments (in no
                  case exceeding 18 months remuneration plus health benefits) and
                  to the immediate
                  vesting of all stock options and RSUs.
 
 We
                  have an
                  employment agreement with Mr. Jon Bradley, our Vice-President, Telecom
                  Sales - International. The agreement is for an indeterminate period
                  and the
                  compensation is reviewed annually. In the event of termination
                  of Mr. Bradley’s
                  employment without cause, Mr. Bradley will be entitled to severance
                  payments (in
                  no case exceeding 12 months of the current base salary). 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 our assets
                  or of the
                  majority of our share capital, he will be entitled to severance
                  payments (in no
                  case exceeding 18 months remuneration plus health benefits) and
                  to the immediate
                  vesting of all stock options and RSUs.
 
 We
                  have an
                  employment agreement with Mr. Allan Firhoj, the Vice-President
                  and General
                  Manager, Life Sciences and Industrial Division. The agreement is
                  for an
                  indeterminate period and the compensation is reviewed annually. In the
                  event of termination of Mr. Firhoj’s employment without cause, Mr. Firhoj will
                  be entitled to severance payments (in no case exceeding 12 months
                  of the
                  current base salary). In addition, in the event Mr. Firhoj’s employment is
                  terminated following a merger or an acquisition by a third party
                  of
                  substantially all of our assets or of the majority of our share
                  capital, he will
                  be entitled to the immediate vesting of all stock options and
                  RSUs.
  **Key
                  Elements and Policies for Compensation of Executive
                  Officers**
 
 Our
                  executive
                  compensation plans are designed to attract, retain and motivate
                  key executives
                  who directly impact our long-term success and the creation of shareholder
                  value.
                  In determining executive compensation, the Committee considers
                  the following
                  four principles:
 
 ·
                        **Performance-based:**
                            Executive compensation levels reflect both corporation
                            and individual
                            results based on specific quantitative and qualitative
                            objectives
                            established at the start of each financial year in keeping
                            with
                            Corporation’s long-term strategic
                            objectives.
 
 ·
                        **Aligned
                            with shareholder interests:** A significant proportion 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 Corporation results
                            relative to the
                            results of peers.
 
 ·
                        **Individually
                            equitable:** Compensation levels are also designed to reflect
                            individual factors such as scope of responsibility, experience,
                            and
                            performance against individual
                            measures.
 
 The
                  key
                  elements of our 2007 executive compensation program were Base Salary,
                  the Short
                  Term Incentive Plan, and stock-based incentive compensation delivered
                  through
                  the Long Term Incentive Plan.  To determine appropriate
                  compensation levels for each pay component, the Committee considered
                  all
                  elements of the executive compensation program. The Committee did
                  not assign
                  specific weightings to any key element of the Corporation’s 2007 executive
                  compensation program.
 
 68
 Table
                      of Contents
  **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
                  Canadian
                  organizations for positions similar in magnitude, scope and complexity.
                  The
                  Committee’s objective is to align executive compensation levels with the
                  median
                  compensation offered within a reference group 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 Committee reviews the base salary of each senior officer on
                  an annual basis and recommends that our Board 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”) provides senior executives with the
                  opportunity to earn annual bonuses based on our financial performance
                  and the
                  achievement of strategic corporate and business unit objectives
                  established on a
                  yearly basis.
 
 Target
                  payout
                  levels for Named Executive Officers eligible for incentive bonuses
                  in the year
                  ended August 31, 2007 were established to be in line with the
                  objective of the Committee to align compensation with the median
                  compensation
                  offered in the reference group. The minimum, target and maximum
                  payouts to
                  senior officers under the STIP (expressed as a percentage of their
                  base salary)
                  for 2007 were as follows:
  Our
                  President
                  and Chief Executive Officer, Mr. Germain Lamonde, has a short term
                  incentive
                  target of 50% of his annual base salary. That bonus is based on
                  the achievement
                  of financial, strategic and individual objectives as shown in the
                  following
                  table.
  Our
                  Chief
                  Financial Officer, Mr. Pierre Plamondon, has a short term incentive
                  target of
                  35% of his annual base salary. That bonus is based on the achievement
                  of
                  financial, strategic and individual objectives as shown in the
                  following
                  table.
  Our
                  Vice-President and General Manager, Life Sciences and Industrial
                  Division, Mr.
                  Allan Firhoj, has a short term incentive target of 30% of his annual
                  base
                  salary. That bonus is based on the achievement of financial, strategic
                  and
                  individual objectives as shown in the following table.
  **Measure
                              (1)**
                          **Weighting
                              Mr. Lamonde and Mr. Plamondon**
                          **Weighting
                              Mr. Firhoj**Corporate
                              objectivesSales
                          35%
                          30%Earnings
                          15%
                          25%Gross
                              margin
                          25%
                          25%Customer
                              satisfaction (quality and on time delivery)
                          25%
                          20%Total
                          0%
                              - 150%
                          0%
                              - 150%Personal
                              objectives (multiplier)
                          0%
                              - 125%
                          0%
                              - 125%Bonus
                              portion: corporate objectives (0% - 150%) x personal
                              objectives (0% -
                              125%)
                          Total
                              bonus portion
                          Total
                              bonus portion
 
 (1)
                          Sales,
                              Earnings, Gross margin and Customer satisfaction measures
                              are established
                              to provide a metric from 0% to 150% and such a metric
                              is multiplied by the
                              personal objectives measure. This result is then multiplied
                              by the short
                              term incentive target % of the individual annual base
                              salary.
 Our
                  Vice-President, Telecom Sales - International, Mr. Jon Bradley,
                  and
                  Vice-President, Telecom Sales - Americas, Mr. Dana Yearian, do
                  not participate
                  in the short term incentive plan that is available to the company’s other senior
                  executives. Instead, Mr. Bradley and Mr. Yearian participate in
                  the company’s
                  sales incentive plan (SIP). Under the SIP, Mr. Bradley and Mr.
                  Yearian have
                  target incentives of 40% of their annual base salaries. The SIP
                  is based
                  40% on the achievement of revenue targets (billings), 40% on margin
                  targets
                  and 20% on sales quotas achievements.
  69
 Table
                      of Contents
  **Long-Term
                  Incentive Compensation**
 
 ***Long-Term
                  Incentive Plan***
  We
                  have a Long-Term
                  Incentive Plan for our Directors, executive officers, employees
                  and consultants
                  and those of our subsidiaries as determined by our Board of Directors,
                  to
                  attract and retain competent Directors, executive officers, employees
                  and
                  consultants motivated to work toward ensuring our success and to
                  encourage them
                  to acquire our shares. A copy of the Long-Term Incentive Plan has
                  been filed as
                  exhibit 4.35 to our fiscal year 2005 annual report.
  The
                  principal
                  component of the long-term incentive compensation that we offer
                  is made up of
                  the Long-Term Incentive Plan for directors, employees and consultants
                  of us and
                  our subsidiaries.
  Introduced
                  in
                  May 2000, amended in October 2004 and effective in January 2005,
                  the Long-Term
                  Incentive Plan 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. The LTIP is
                  subject to Human Resources Committee review to ensure maintenance
                  of its market
                  competitiveness. Our Board has full and complete authority to interpret
                  the 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 Plan,
                  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 relevant securities
                  legislation.
 
 The
                  Long-Term
                  Incentive Plan 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 directors,
                  officers, employees and consultants. Our Board of Directors upon
                  recommendation
                  of 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, 2007, target awards for eligible officers under the LTIP
                  were established to be in line with the objective of the Committee
                  to align
                  compensation with the median compensation offered in the reference
                  group. A
                  portion of the target RSU awards are fixed, in order to encourage executive
                  retention over the longer term, and the balance are made at, above, or
                  below target levels based on merit, as determined by each executive's
                  individual performance over the previous year.
 
 The
                  exercise
                  price of the options is determined by our 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
                  relevant securities legislation.  In any event, the price at which the
                  Subordinate Voting Shares may be purchased 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
                  on the grant date to convert the NASDAQ National Market closing
                  price to
                  Canadian dollars.  Any option issued is non-transferable. At the end
                  of our financial year ended August 31, 2007, there were a total of
                  1,929,388 options granted and outstanding pursuant to the Long-Term
                  Incentive
                  Plan having a weighted average exercise price of US$18.53
                  (CA$20.78).
 
 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 the end of financial
                  year ended
                  August 31, 2007, there were a total of 488,015 RSUs granted and
                  outstanding
                  pursuant to the Long-Term Incentive Plan having a weighted average
                  fair value at
                  the time of grant of US$5.67 (CA$6.62) per RSU.
 
 The
                  maximum
                  number of Subordinate Voting Shares that are issuable under the
                  Plan shall not
                  exceed 6,306,153 Subordinate Voting Shares, which represents 9.1%
                  of our issued and outstanding voting shares as of November 1,
                  2007.  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.
   70
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                      of Contents
 
 Some
                  options
                  granted to Directors and employees vest on the first anniversary
                  date of their
                  grant. Some options granted in the financial year ended August
                  31, 2004 and 2005
                  vest 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 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 Plan
                  must be
                  exercised within a maximum period of ten (10) years following the
                  date
                  of their grant or they will be forfeited.
  All
                  RSUs
                  first vesting cannot be earlier than the third anniversary date
                  of their grant.
                  Some RSUs granted in the financial year ended August 31, 2007,
                  vest at a rate of
                  1/2 annually commencing on the third anniversary date of the grants
                  in September
                  2006, January 2007 and July 2007 and others at a rate of 1/3 annually on
                  the third, fourth and fifth anniversary dates of the grants in
                  September 2006,
                  October 2006 and January 2007. Some RSUs granted in the financial
                  year ended
                  August 31, 2006 vest at a rate of 1/2 annually commencing on the
                  third
                  anniversary date of the grant in February 2006 and in June 2006
                  and others at a
                  rate of 1/3 annually commencing on the third anniversary date of
                  the grant in
                  August 2006. Some RSUs granted in the financial year ended August
                  31, 2005 vest
                  at a rate of 1/3 annually commencing on the third anniversary date
                  of the grant
                  in February 2005 and others at a rate of 55%, 35% and 10%, on the third,
                  fourth and fifth anniversary dates of the grant in January 2005.
                  Some RSUs
                  granted during the last three financial years vest on the fifth
                  anniversary date
                  of each grant respectively in October 2006, December 2005 and in January
                  2005. However, these RSUs are subject to early vesting on the third
                  and fourth
                  anniversary dates of the grant on the attainment of performance
                  objectives,
                  namely related to long term growth of revenue and profitability,
                  as determined
                  by our 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. If such vesting date falls 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, then the units shall vest on the first
                  trading day the RSU holder is entitled to trade after such black-out
                  period or
                  restrictive period.
 
 Any
                  option
                  granted pursuant to the Long-Term Incentive Plan will lapse (i)
                  immediately upon
                  the termination of the relationship with us or one of our 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 usor
                  one
                  of our subsidiaries (or within 30 days if the holder’s employment is
                  terminated for reasons not related to cause); and (ii) 30 days after a
                  Director ceases to be a member of our Board of Directors or one
                  of our
                  subsidiaries. In the event of retirement or disability, any option
                  held by an
                  employee lapses 30 days after the date of any such disability or
                  retirement.  In the event of death, any option held by the optionee
                  lapses 6 months after the date of death.
 
 Any
                  RSU
                  granted pursuant to the Long-Term Incentive Plan 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 our Board of Directors);
                  (ii) immediately,
                  whether or not subject to attainment of performance objectives,
                  upon the
                  termination of the relationship with us or one of our 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 us or one of
                  our subsidiaries.
 
 Any
                  RSU
                  granted pursuant to the Long-Term Incentive Plan will vest immediately,
                  to a
                  certain proportion as determined by the Plan, upon the termination
                  of the
                  relationship of an employee or officer with us or one of our subsidiaries
                  (i) for reasons not related to cause; (ii) because of death or
                  permanent
                  disability and (iii) retirement.
 
 The
                  following
                  table summarizes information about stock options granted to the
                  members of our
                  Board of Directors, and to Management and Corporate Officers of us and our
                  subsidiaries as at August 31, 2007:
  **Number
                              of Options**
                          
                          
                          **%
                              of Issued and**
                            **Outstanding
                              Options**
                          
                          
                          **Weighted
                              Average Exercise Price ($US/Security)**President
                              and CEO (one individual)
                          
                          
                          179,642
                          
                          
                          
                          9.31
                          %
                          
                          
                          9.05Board
                              of Directors (five individuals)
                          
                          
                          194,375
                          
                          
                          
                          10.07
                          %
                          
                          
                          6.23Management
                              and Corporate Officers (eight individuals)
                          
                          
                          212,139
                          
                          
                          
                          11.00
                          %
                          
                          
                          14.49
  The
                  following table summarizes information about
                  RSUs granted to the members of our Board of Directors and to Management
                  and
                  Corporate Officers of us and our subsidiaries as at August 31, 2007:  **Number
                                of RSUs**
                            
                            
                            **%
                                of Issued and**
                              **Outstanding
                                RSUs**
                            
                            
                            **Weighted
                                Average Fair Value at the Time of Grant
                                $US/RSU**President
                                and CEO (one individual)
                            
                            
                            59,913
                            
                            
                            
                            12.28
                            %
                            
                            
                            5.28Board
                                of Directors (five individuals)
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -Management
                                and Corporate Officers (ten individuals)
                            
                            
                            236,185
                            
                            
                            
                            48.40
                            %
                            
                            
                            5.25
 71
 Table
                      of Contents
  **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, 2007. At the end of the financial
                    year ended
                    August 31, 2007, there were a total of 1,929,388 Subordinate Voting Shares
                    covered by options granted and outstanding pursuant to the Long-Term
                    Incentive
                    Plan having a weighted average exercise price of US$18.53 (CA$20.78).
 **Aggregated
                    Option Exercises in Last Financial Year and Financial Year End
                    Option
                    Values**
 
 The
                    following
                    table summarizes, for each of the Named Executive Officers, the
                    number of stock
                    options, if any, exercised during the financial year ended August
                    31, 2007, the
                    aggregate value realized upon exercise and the total number of
                    unexercised
                    options, if any, held at August 31, 2007. Value realized upon exercise
                    is the difference between the market value of the underlying
                    Subordinate Voting
                    Shares on the exercise date and the exercise or base price of
                    the option. 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 Shares on August 31, 2007, which
                    was US$6.66
                    (CA$7.07) per share. These values, unlike the amounts set forth
                    in the column
“Aggregate Value Realized,” have not been, and may never be, realized. The
                    underlying options have not been, and may never be exercised,
                    and actual gains,
                    if any, on exercise will depend on the value of the Subordinate
                    Voting Shares on
                    the date of exercise. There can be no assurance that these values
                    will be
                    realized. Unexercisable options are those that have been held
                    for less than the
                    time required for vesting.
  **Name**
                          **Securities
                              Acquired on Exercise (#)**
                          **Aggregate**
                            **Value
                              Realized**
                            **(US$)**(1)(4)
                          **Unexercised
                              Options**
                            **at
                              August 31, 2007**
                          **Value
                              of Unexercised**
                            **“In-the-Money”
                              Options at**
                            **August
                              31, 200****7******(2)
                              (3)(4)**Exercisable**
                            **(#)**
                          **Unexercisable**
                            **(#)**
                          **Exercisable**
                            **(US$)**
                          **Unexercisable**
                            **(US$)**Germain
                              Lamonde
                          -
                          -
                          162,258
                          17,384
                          233,041
                          24,996Pierre
                              Plamondon
                          -
                          -
                          75,545
                          5,431
                          89,925
                          6,086Dana
                              Yearian
                          -
                          -
                          -
                          -
                          -
                          -Jon
                              Bradley
                          -
                          -
                          22,000
                          4,500
                          23,011
                          8,537Allan
                              Firhoj
                          5,188
                          21,093
                          18,000
                          3,478
                          -
                          3,934**Named
                              Executive Officer Not in the Employ of the Corporation
                              at year
                              End**Juan-Felipe
                              Gonzalez
                          11,118
                          39,437
                          Cancelled 
                              (5)
                          Cancelled 
                              (5)
                          -
                          - 
 (1)
                              The
                                  aggregate value realized is equivalent to the difference
                                  between the
                                  market value of the securities underlying the options
                                  at exercise and the
                                  exercise price of the options. This value, as the
                                  case maybe, has been
                                  converted from Canadian dollars to U.S. Dollars
                                  based upon the average
                                  foreign exchange rate on the day of the
                                  exercise.
 (2)
                              “In-the-money”
                                  options are options for which the market value
                                  of the underlying
                                  securities is higher than the price at which such
                                  securities may be bought
                                  from the Corporation.
 (3)
                              The
                                  value of unexercisable “in-the-money” options is calculated 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 31,
                                  2007 using the noon buying rate of the Federal
                                  Reserve Bank of New York to
                                  convert the NASDAQ National Market closing price
                                  to Canadian dollars, as
                                  required, less the exercise price of “in-the-money”
                                  options.
 (4)
                              This
                                  value has been converted from Canadian to US dollars
                                  based upon the
                                  foreign exchange rate on August 31, 2007 of
                                  1.056.
 (5)
                              In
                                  accordance with the terms of the Long-Term Incentive
                                  Plan, unexercised
                                  options that had been attributed to this person
                                  were cancelled upon his
                                  departure date.
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 Table
                          of
                          Contents
  **Compensation
              of Chief Executive Officer**
 
 In
              establishing Mr. Lamonde’s compensation for the year ending August 31, 2007, the
              Corporation relied on a study completed by an independent consulting
              firm
              (Mercer Human Resource Consulting). Such study indicated average salaries
              and
              bonuses, median salaries and bonuses and maximum salaries and bonuses
              paid to
              chief executive officers by Canadian and American computer hardware
              and software
              companies as well as by a specific group of companies active in the
              fiber optics
              industry identified by the Corporation that it considers to be the
              best
              available comparisons. It was decided that Mr. Lamonde’s compensation
              should reflect the median of Canadian computer hardware and software
              companies
              and of the specific group of companies in fiber optics identified by
              the
              Corporation. In the financial year ended August 31, 2007, Mr.
              Lamonde’s compensation was adjusted accordingly.
 
 In
              the
              financial year ended August 31, 2007, the bonus portion of Mr. Lamonde’s
              compensation was tied to the financial and strategic objectives of
              the
              Corporation based on the following factors:
  **Measure
                          (1)**
                      **Weighting
                          ALL**Corporate
                          objectivesSales
                      35%Earnings
                      15%Gross
                          margin
                      25%Customer
                          satisfaction (quality and on time delivery)
                      25%Total
                      0%
                          - 150%Personal
                          objectives (multiplier)
                      0%
                          - 125%Bonus
                          portion: corporate objectives (0% - 150%) x personal objectives
                          (0% -
                          125%)
                      Total
                          bonus portion
 
 (1)
                      Sales,
                          Earnings, Gross margin and Customer satisfaction measures
                          are established
                          to provide a metric from 0% to 150% and such a metric is
                          multiplied by the
                          personal objectives measure. This result is then multiplied
                          by the short
                          term incentive target % of the individual annual base
                          salary.
  Mr. Lamonde’s
              bonus is payable in the same proportion at which the Corporation attains
              such
              objectives.  When the objectives are exceeded, the bonus is higher;
              when objectives are not met, the bonus is lower**.**
 
 **Deferred
              Share Unit Plan**
  Introduced
                in October 2004 and effective as of January 2005, the Deferred Share
                Unit Plan
                is designed to align more closely the interests of its non-employee
                Directors
                with those of our shareholders. A copy of the Deferred Share Unit
                Plan has been
                filed as exhibit 4.36 to our fiscal year 2005 annual report.
 
 Under
                the
                Deferred Share Unit Plan, non-employee Directors shall receive up
                to 100 % of
                their retainer fees in the form of Deferred Share Units (“DSUs”), each of which
                has a fair value at the time of grant equal to the market value of
                a Subordinate
                Voting Share at the time DSUs are credited to the Directors.  The
                value of a DSU, when converted to Subordinate Voting Shares, is equivalent
                to
                the market value of a Subordinate Voting Share at the time the conversion
                takes
                place.  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 our Board of Directors, the DSUs are either
                converted
                and paid in Subordinate Voting Shares purchased on the open market
                or issued by
                us. Such Subordinate Voting Shares issued by us will be issued from
                the same
                pool of Subordinate Voting Shares reserved for issuance pursuant
                to the
                Long-Term Incentive Plan, which is 9.1% of the total issued and outstanding
                voting shares.
  73
 Table
                    of Contents
 The
              following
              table summarizes information about DSUs granted to the non-employee
              members of
              the Board of Directors as at November 1, 2007:
  **Number
                        of DSUs**
                    **%
                        of Issued and**
                      **Outstanding
                        DSUs**
                    **Weighted
                        Average Estimated Value  at the Time of Grant
                        $US/DSU**Board
                        of Directors (five individuals)
                    70,195
                    100%
                    5.55
 **Deferred
                Share Unit Grants in Last Financial Year**
 
 The
                  aggregate number of Deferred Share Units (“DSUs”) credited to non-employee
                  directors during the financial year ended August 31, 2007 and as
                  of November 1,
                  2007 was 26,905. 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 on the grant date to convert the NASDAQ National
                  Market closing
                  price to Canadian 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. As of November 1, 2007,
                  there were a total of 70,195 DSUs credited to directors pursuant
                  to the Deferred
                  Share Unit Plan having an estimated value at the time of grant
                  of US$389,672
                  (CA$442,017).
 
 DSUs
                  attract dividends in the form of additional DSUs at the same rate
                  as dividends
                  on Subordinate Voting Shares. The DSUs are converted and paid in
                  Subordinate
                  Voting Shares at the time a director ceases to be a member of our
                  Board.
 
 Therefore,
                  the value at vesting of a DSU, when converted to Subordinate Voting
                  Shares, is
                  equivalent to the market value of a Subordinate Voting Share at
                  the time the
                  conversion takes place. The table below shows information regarding
                  DSU grants
                  made under the Deferred Share Unit Plan during the financial year
                  ended
                  August 31, 2007 and as of November 1, 2007.
 
 During
                  the financial year ended August 31, 2007 and as of November 1,
                  2007, the
                  following DSUs were granted to the directors:
 **DSUs
                          #**
                      **Weighted
                          Average Estimated Value  at the**
                        **Time
                          of Grant US$/DSU**
                      **Vesting**26,905
                      6.32
                      At
                          the time director cease to be a member of the Board of
                          the
                          Corporation
  **Restricted
                Share Unit Grants in Last Financial Year**
  The
                  aggregate number of Restricted Share Units (RSUs) granted during
                  the financial
                  year ended August 31, 2007 was 219,002, having a weighted average fair
                  value at the time of grant of US$6.48 (CA$7.48) 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 the end of the financial year
                  ended
                  August 31, 2007, there were a total of 488,015 RSUs granted and
                  outstanding pursuant to the Long-Term Incentive Plan having a weighted
                  average
                  fair value at the time of grant of US$5.67 (CA$6.62) per RSU. All
                  RSUs first
                  vesting cannot be earlier than the third anniversary date of their
                  grant. Some RSUs granted in the financial year ended August 31, 2007,
                  vest
                  at a rate of 1/2 annually commencing on the third anniversary date
                  of the grants
                  in September 2006, January 2007 and July 2007 and others at a rate
                  of
                  1/3 annually on the third, fourth and fifth anniversary dates of the
                  grants
                  in September 2006, October 2006 and January 2007. Some RSUs granted in the
                  fiscal year ended August 31, 2006, vest at a rate of 1/2 annually
                  commencing on the third anniversary date of the grant in February
                  2006 and in
                  June 2006 and others at a rate of 1/3 annually on the third, fourth and
                  fifth anniversary dates of the grant in August 2006. Some RSUs
                  granted in the
                  financial year ended August 31, 2005 vest at a rate of 1/3 annually
                  commencing
                  on the third anniversary date of the grant in February 2005 and
                  others at a rate
                  of 55%, 35% and 10%, on the third, fourth and fifth anniversary
                  dates of the
                  grant in January 2005. Some RSUs granted during the last three
                  financial years
                  vest on the fifth anniversary date of each grant respectively in
                  October 2006,
                  December 2005 and in January 2005. However, these RSUs are subject
                  to early
                  vesting on the third and fourth anniversary dates of the grant
                  on the
                  attainment of performance objectives, namely related to long term
                  growth of revenue and profitability, as determined by our 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.
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 Table
                      of Contents
 The
                  RSUs
                  are redeemed for actual Subordinate Voting Shares or the equivalent
                  in cash at
                  the discretion of our Board of Directors on the vesting dates established
                  by our
                  Board of Directors 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. The table below shows information regarding
                  RSU grants
                  made under the Long-Term Incentive Plan during the financial year
                  ended
                  August 31, 2007.
 
 During
                  the financial year ended August 31, 2007, the following RSUs were
                  granted:
 **RSUs
                          #**
                      **Fair
                          Value at the Time of**
                        **Grant
                          US$/RSU**
                      **Vesting** (1)2,000
                      5.38
                      1/3
                          on each of the third, fourth and fifth anniversary dates
                          of the grant in
                          September 2006 (2)1,200
                      5.83
                      50%
                          on the third and fourth anniversary dates of the grant
                          in September 2006
                          (3)71,802
                      6.02
                      100%
                          on the fifth anniversary date of the grant in October 2011
                          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 the performance objectives are fully attained (4)25,000
                      6.02
                      1/3
                          on each of the third, fourth and fifth anniversary dates
                          of the grant in
                          October 2006 (5)22,550
                      6.42
                      1/3
                          on each of the third, fourth and fifth anniversary dates
                          of the grant in
                          January 2007 (6)34,250
                      6.42
                      50%
                          on the third and fourth anniversary dates of the grant
                          in January
                          2007 (7)60,200
                      7.32
                      50%
                          on the third and fourth anniversary dates of the grant
                          in January
                          2007 (7)2,000
                      7.14
                      50%
                          on the third and fourth anniversary dates of the grant
                          in July
                          2007 (8)
  
 (1)
                      All
                          RSUs first vesting cannot be earlier than the third anniversary
                          date of
                          their grant.
 (2)
                      Those
                          RSUs granted in the financial year ended August 31, 2007
                          vest at a rate of
                          1/3 annually commencing on the third anniversary date of
                          the grant in
                          September 2006.
 (3)
                      Those
                          RSUs granted in the financial year ended August 31, 2007
                          vest at a rate of
                          1/2 annually commencing on the third anniversary date of
                          the grant in
                          September 2006.
 (4)
                      Those
                          RSUs granted in the financial year ended August 31, 2007
                          vest on the fifth
                          anniversary date of the grant in October 2011 but are subject to
                          early vesting on the third and fourth anniversary dates
                          of the grant on
                          the attainment of performance objectives, namely related to long term
                          growth of revenue and profitability, as determined by our
                          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 granted in the financial year ended August 31, 2007
                          vest at a rate of
                          1/3 annually commencing on the third anniversary date of
                          the grant in
                          October 2006.
 (6)
                      Those
                          RSUs granted in the financial year ended August 31, 2007
                          vest at a rate of
                          1/3 annually commencing on the third anniversary date of
                          the grant in
                          January 2007.
 (7)
                      Those
                          RSUs granted in the financial year ended August 31, 2007
                          vest at a rate of
                          1/2 annually commencing on the third anniversary date of
                          the grant in
                          January 2007.
 (8)
                      Those
                          RSUs granted in the financial year ended August 31, 2007
                          vest at a rate of
                          1/2 annually commencing on the third anniversary date of
                          the grant in July
                          2007.
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  During
                the
                financial year ended August 31, 2007, the following RSUs were granted
                to the
                following Named Executive Officers:
  **Name**
                        **RSUs
                            #**
                        **Percentage
                            of Net**
                          **Total
                            of RSUs**
                          **Granted
                            to Employees**
                          **in
                            Financial Year**
                          **(%)**
                        **Fair
                            Value at**
                          **the
                            Time of Grant US$/RSU**
                        **Vesting**(1)Germain
                            Lamonde
                        25,347
                        11.57%
                        6.02
                        100%
                            on the fifth anniversary date of the grant in October 2006 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 the performance objectives are fully attained (2)Pierre
                            Plamondon
                        8,430
                        3.85%
                        6.02
                        100%
                            on the fifth anniversary date of the grant in October 2006 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 the performance objectives are fully attained (2)Pierre
                            Plamondon
                        4,500
                        2.05%
                        6.02
                        1/3
                            on each of third, fourth and fifth anniversary dates
                            of the grant in
                            October 2006 (3)Dana
                            Yearian
                        6,645
                        3.03%
                        6.02
                        100%
                            on the fifth anniversary date of the grant in October 2006 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 the performance objectives are fully attained (2)Jon
                            Bradley
                        −
                        −
                        −
                        −Allan
                            Firhoj
                        6,145
                        2.81%
                        6.02
                        100%
                            on the fifth anniversary date of the grant in October 2006 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 the performance objectives are fully attained (2)Allan
                            Firhoj
                        15,033
                        6.86%
                        6.42
                        1/3
                            on each of third, fourth and fifth anniversary dates
                            of the grant in
                            January 2007 (4)
  **Named
                              Executive Officer Not in the Employ of the Corporation
                              at year
                              End**
 Juan-Felipe
                          Gonzalez
                        −
                        −
                        −
                        **−**
 (1)
                          All
                              RSUs first vesting cannot be earlier than the third
                              anniversary date of
                              their grant.
 (2)
                          Those
                              RSUs granted in the financial year ended August 31,
                              2007 vest on the fifth
                              anniversary date of the grant in October 2006 but are subject to
                              early vesting on the third and fourth anniversary date
                              of the grant on the
                              attainment of performance objectives, namely related to long term
                              growth of revenue and profitability, 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.
 (3)
                          Those
                              RSUs granted in the financial year ended August 31,
                              2007 vest at a rate of
                              1/3 annually commencing on the third anniversary date
                              of the grant in
                              October 2006.
 (4)
                          Those
                              RSUs granted in the financial year ended August 31,
                              2007 vest at a rate of
                              1/3 annually commencing on the third anniversary date
                              of the grant in
                              January 2007.
 **Aggregated
            RSUs vested in Last Financial Year and Financial Year-End RSU
            Values**
 
 The
            following table summarizes, for each of the Named Executive Officers,
            the number
            of RSUs, if any, vested during the financial year ended August 31, 2007,
            the
            aggregate value realized upon vesting and the total number of unvested
            RSUs, if
            any, held at August 31, 2007. Value realized upon vesting is the
            market value of the Subordinate Voting Shares on the vesting date. The
            value of
            unvested RSUs at financial year-end is the market value of the Subordinate
            Voting Shares on August 31, 2007, which was US$6.66 per share. These
            values,
            unlike the amounts set forth in the column "Aggregate Value Realized",
            have not
            been and may never be realized. 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.
 
 
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 **Name**
                      **Securities
                          Acquired**
                        **on
                          Vesting (#)**
                      **Aggregate
                          Value Realized**
                        **(US$)**(1)
                      **Unvested
                          RSUs**
                        **at
                          August 31, 2007 (#)**
                      **Value
                          of Unvested RSUs**
                        **at
                          August 31, 2007 (US$)**(2)
                          (3)Germain
                          Lamonde
                      -
                      -
                      59,913
                      401,417Pierre
                          Plamondon
                      -
                      -
                      53,851
                      360,802Dana
                          Yearian
                      -
                      -
                      11,645
                      78,022Jon
                          Bradley
                      -
                      -
                      4,500
                      30,150Allan
                          Firhoj
                      -
                      -
                      38,223
                      256,094
 **Named
                            Executive Officer Not in the Employ of the Corporation
                            at year
                            End**
 Juan-Felipe
                          Gonzalez
                      -
                      -
                      Cancelled  (4)
                      Cancelled  (4)
 (1)
                      The
                          aggregate value realized is equivalent to the market value
                          of the
                          securities underlying the RSUs at vesting. This value,
                          as the case maybe,
                          has been converted from Canadian dollars to U.S. dollars
                          based upon the
                          average foreign exchange rate on the day of
                          vesting.
 (2)
                      The
                          value of RSUs is calculated 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 31, 2007 using the noon buying
                          rate of the
                          Federal Reserve Bank of New York to convert the NASDAQ
                          National Market
                          closing price to Canadian dollars, as
                          required.
 (3)
                      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.
 (4)
                      In
                          accordance with the terms of the Long-Term Incentive Plan,
                          unvested RSUs
                          that had been attributed to this person were cancelled
                          upon his departure
                          date.
 **Number
            of Subordinate Voting Shares reserved for future issuance**
 
 During
            the financial year ended August 31, 2007, 26,905 Deferred Share Units
            (as of
            November 1, 2007) and 219,002 Restricted Share Units were granted to
            directors, officers and employees. Such awards were issued from the same
            pool of
            Subordinate Voting Shares reserved for issuance pursuant to the Long-Term
            Incentive Plan which is 9.1% of the total and outstanding voting shares
            as of
            November 1, 2007. Therefore, as of November 1, 2007 the number of
            Subordinate Voting Shares reserved for future issuance is
            3,060,490.
 
 **Restricted
            Stock Award Plan**
 
 The
            EXFO
            Electrical-Optical Engineering Restricted Stock Award Plan (the "RSAP")
            was
            established to provide a means through which employees of EXFO Burleigh
            Products
            Group Inc. can be granted awards of restricted shares ("Restricted Shares")
            of
            Subordinate Voting Shares to promote retention and foster identity of
            interest
            between stockholders and employees of EXFO Burleigh Products Group
            Inc.
 
 The
            effective date of the RSAP was December 20, 2000.  The expiration date
            of the RSAP is the business day next following the final grant of Restricted
            Shares under the RSAP, which was December 20, 2000.  However, the
            administration of the RSAP did continue until all awards of Restricted
            Shares
            have been forfeited or settled.  The aggregate number of shares
            subject to the RSAP was 360,000.  Stock awards granted under the RSAP
            vest over a 4 year period, with 25% vesting on an annual basis
            commencing on the first anniversary of the date of grant. The last vesting
            occurred on December 20, 2004; the Human Resources Committee administered
            the
            RSAP until that date. Therefore the administration of the RSAP terminated
            on
            December 20, 2004.
 
 Awards
            of
            Restricted Shares were subject to forfeiture and restrictions on transfer
            until
            the Restricted Shares became vested at which point a stock certificate
            was
            issued to a participant with respect to the number of vested shares,
            which are
            then freely transferable.  Restricted Shares become vested, subject to
            a participant's continued employment with the Corporation or its affiliates,
            on
            each of the first four anniversaries of the date of grant of an award
            of
            Restricted Shares.
 
 Upon
            a
            participant's termination of employment with the Corporation or any of
            its
            affiliates due to the participant's death, disability or retirement on
            or after
            age 60, the participant's award of restricted shares became fully vested
            and was
            no longer subject to forfeiture.  However, the transfer restrictions
            remained in place until the occurrence of the vesting dates originally
            contemplated by the award.
 
 
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 Upon
            the
            voluntary resignation of a participant, the termination of a participant's
            employment for cause, the termination of a participant who is not designated
            a
            member of EXFO Burleigh Products Group Inc. "Management Team" without
            cause
            prior to a change in control of the Corporation or a termination without
            cause
            of a participant who is designated a member of EXFO Burleigh Products
            Group Inc.
            Management Team that is initiated by EXFO Burleigh Products Group Inc.
            prior to
            a change in control of the Corporation, the unvested portion of the
            participant's award of Restricted Shares were forfeited.  However the
            RSAP provided discretion to the Human Resources Committee in the application
            of
            the forfeiture provisions where a change in circumstances rendered such
            action
            appropriate.  During the financial year ended August 31, 2005, EXFO
            Burleigh Products Group Inc. was required to lay off the remaining of
            the
            participants (excluding a few that were transferred to our other offices)
            as
            a result of a consolidation due to a sharp downturn in its
            market.  The Human Resources Committee decided that the awards of RSAP
            participants affected by the lay-offs would not be subject to forfeiture,
            though
            the transfer restrictions remained in place until the occurrence of the
            vesting
            dates originally contemplated by the award.
 
 Upon
            the
            termination without cause of a participant who was designated a member
            of EXFO
            Burleigh Products Group Inc. Management Team that was initiated by the
            Corporation or a termination of a participant's employment without cause
            following a change in control of the Corporation, a participant's award
            of
            Restricted Stock became fully vested and all restrictions lapsed.
 
 In
            the
            event of a change in control, the committee administering the RSAP could
            in its
            discretion remove restrictions on Restricted Shares or provide for the
            cancellation of awards in exchange for payment in respect of the Restricted
            Shares subject to an award.
 
 **Stock
            Appreciation Rights Plan**
 
 On
            August
            4, 2001, the Corporation established a Stock Appreciation Rights Plan
            (“SAR
            Plan”) for the benefit of certain employees residing in countries where the
            granting of options under the Long-Term Incentive Plan is not feasible
            in the
            opinion of the Corporation.  The Board has full and complete authority
            to interpret the SAR Plan and to establish the rules and regulations
            applying to
            it and to make all other determinations it deems necessary or useful
            for the
            administration of the SAR Plan.
 
 Under
            the
            SAR Plan, eligible employees are entitled to receive a cash amount equivalent
            to
            the difference between the market price of the Subordinate Voting Shares
            on the
            date of exercise and the exercise price determined on the date of
            grant.  No Subordinate Voting Shares are issuable under the SAR
            Plan.
 
 The
            Board
            of Directors has delegated to Management the task of designating the
            recipients
            of stock appreciation rights, the date of vesting, the expiry date and
            other
            conditions.  Under the terms of the SAR Plan, the exercise price of
            the stock appreciation rights may not be lower than the highest of the
            closing
            prices of the Subordinate Voting Shares on the Toronto Stock Exchange
            and on the
            NASDAQ National Market on the last trading day preceding the grant date,
            using
            the noon buying rate of the Federal Reserve Bank of New York on the grant
            date
            to convert the NASDAQ National Market closing price to Canadian
            dollars.  Stock appreciation rights are non-transferable.
 
 The
            stock
            appreciation rights vest over a four-year period, with 25% vesting annually
            commencing on the first anniversary date of the date of grant. However,
            since
            October 2007, some stock appreciation rights vest at a rate of 50% annually
            commencing on the third anniversary date of the grant in October 2007.
            Once
            vested, stock appreciation rights may be exercised between the second
            and the
            fifteenth business day following each release of the Corporation’s quarterly
            financial results.  All of the stock appreciation rights that are
            granted under the SAR Plan may be exercised within a maximum period of
            10 years following the date of their grant.  Any stock
            appreciation rights granted under the SAR Plan will lapse immediately
            upon the
            termination of the relationship with the Corporation or one of its subsidiaries
            for a good and sufficient cause or at the date on which an employee resigns
            or
            leaves his employment with the Corporation or one of its subsidiaries
            (or within
            30 days if the holder is dismissed without cause).  In the event
            of retirement or disability, any stock appreciation right held by an
            employee
            lapses 30 days after the date of any such disability or
            retirement.  In the event of death, any stock appreciation right
            lapses 6 months after the date of death.
 
 As
            of
            November 1, 2007, there were 30,700 SAR’s outstanding.
 
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 **Deferred
            Profit Sharing Plan**
 
 We
            maintain a deferred profit sharing plan for certain eligible Canadian
            resident
            employees.  Under this plan, we may contribute an amount equal to 1%
            until May 31, 2005 and 2% starting June 1, 2005, of each employee’s
            gross salary to that employee’s individual deferred profit sharing plan to the
            extent that such employee contributes at least 2% of his or her gross
            salary to
            his or her individual tax-deferred registered retirement savings plan.
            In the
            financial year ended August 31, 2007, the aggregate amount of contributions
            paid
            under the plan was US$419,000 (CA$470,000).  Mr. Germain Lamonde
            is not entitled to participate in this plan. As of August 31, 2007, the
            aggregate amount of contributions under the plan was US$1,679,000
            (CA$2,189,000).
 
 **401(k)
            Plan**
 
 We
            maintain a 401(k) plan for eligible United States resident employees
            of our
            subsidiaries. Employees become eligible to participate in the 401(k)
            plan on the
            first day of the month following the completion of three months of continuous
            service. Employees may elect to defer their current compensation up to
            the
            lesser of 1% of eligible compensation or the statutorily prescribed annual
            limit
            and have the deferral contributed to the 401(k) plan. The 401(k) plan
            permits,
            but does not require us to make additional matching contributions to
            the 401(k)
            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. In the year ended August 31, 2007, we made
            an
            aggregate of US$166,000 in matching contributions to the 401(k) plan.
            Contributions by employees or by us to the 401(k) plan and income earned
            on plan
            contributions are generally not taxable to the employees until withdrawn
            and
            contributions by us are generally deductible by us when made. At the
            direction
            of each participant, the trustees of the 401(k) plan invest the assets
            of the
            401(k) plan in selected investment options. As of August 31, 2007, we
            made an aggregate of US$1,526,000 in matching contributions to the 401(k)
            plan.
 
 **Indemnification
            of Directors and Executive Officers and Limitation of
            Liability**
 
 Our
            by-laws require us, subject to the limitations provided by law, to indemnify
            our
            present or former Directors and officers or any persons who act or acted
            at our
            request as Directors or officers of a body corporate****for
            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. A
            policy of
            Directors’ and officers’ liability insurance is maintained by us which insures
            our Directors and officers and those of our subsidiaries against liability
            incurred by, arising from or against them for certain of their acts,
            errors or
            omissions. Accordingly, we maintain insurance protection against liability
            incurred by our officers and Directors as well as those of our subsidiaries
            in
            the performance of their duties. The entire premium, amounting to US$165,000
            from September 30, 2007 to September 30, 2008, is paid by us. The aggregate
            limit of liability in respect of any and all claims is US$10 million
            per year.
            The policy provides for the indemnification of Directors and officers
            in the
            case of claims for which we have not indemnified or are not permitted
            by law to
            indemnify them, and for the reimbursement of us, subject to a deductible
            of
            US$250,000.
 
 
 **C.****Board
            Practices**
 
 **Board
            of Directors**
 
 Our
            Directors are elected at the annual meeting of shareholders for one-year
            terms
            and serve until their successors are elected or appointed, unless they
            resign or
            are removed earlier. Our articles of incorporation provide for a Board
            of
            Directors of a minimum of three (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 table and notes set out the name of each of the individuals
            who served
            as a director of the Corporation during the last year term, all other
            positions
            and offices with the Corporation and its subsidiaries now held by each
            such
            individual, if any, the principal occupation or employment of each such
            individual, their respective period of service as a director.
 
 79
 Table
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  **Name
                        and Position or Office**
                      **with
                        the Corporation**
                    **Principal
                        Occupation or**
                      **Employment**
                    **Residence**
                    **Director
                        Since**
                    **Number
                        of**
                      **Subordinate**
                      **Voting
                        Shares**
                    **Number
                        of**
                      **Multiple
                        Voting**
                      **Shares**Germain
                        Lamonde
                      Chairman
                        of the Board, President and Chief Executive Officer
                    Chairman
                        of the Board, President and Chief Executive Officer, EXFO
                        Electro-Optical
                        Engineering Inc.
                    St-Augustin-de-Desmaures,
                      Quebec,
                      Canada
                    September
                        1985
                    −
                    36,643,000
                        (1)Pierre
                        Marcouiller (2)
                        (3)
                      Independent
                        Director
                    Chairman
                        of the Board and Chief Executive Officer,
                      Camoplast
                        Inc. (4)
                    Magog,
                        Quebec,
                      Canada
                    May
                        2000
                    5,000
                    −Guy
                        Marier (2)
                        (3)
                      Independent
                        Lead Director
                    Executive
                        Consultant
                    Lakefield
                        Gore, Quebec,
                      Canada
                    January
                        2004
                    1,000
                    −
 André
                        Tremblay (2)
                        (3)
                      Independent
                        Director
                    Founder
                        and Managing Partner, Trio Capital Inc.,  a private equity
                        fund
                    Outremont,
                        Quebec,
                      Canada
                    May
                        2000
                    6,650
(5)
                    −Dr.
                        David A. Thompson, Ph.D.(3)
                      Independent
                        Director
                    Vice-President &
                        Director,  Hardware & Equipment Technology, Corning Cable
                        Systems (6)
                    Newton,
                      North
                        Carolina,
                      USA
                    June
                        2000
                    2,100
                    −Michael
                        Unger (2)
                        (3)
                      Independent
                        Director
                    Executive
                        Consultant
                    Richmond
                        Hill, Ontario,
                      Canada
                    May
                        2000
                    −
                    −
 (1)
                      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.
 (2)
                      Member
                          of the Audit Committee.
 (3)
                      Member
                          of the Human Resources Committee.
 (4)
                      Camoplast
                          Inc. designs, develops and manufactures specialized components,
                          sub-systems and assemblies for the world leading original
                          equipment
                          manufacturers (OEMs) of both on- and off-road vehicles
                          in a variety of
                          markets including automotive, agricultural, construction
                          and industrial,
                          defense and powersports.
 (5)
                      Mr.
                          Tremblay exercises control over this number of Subordinate
                          Voting Shares
                          through 9104-5559 Quebec inc. a company controlled by Mr.
                          Tremblay.
 (6)
                      Corning
                          Incorporated is a diversified technology company that concentrates
                          its
                          efforts on high-impact growth opportunities. Corning combines
                          its
                          expertise in specialty glass, ceramic materials, polymers
                          and the
                          manipulation of the properties of light, with strong process
                          and
                          manufacturing capabilities to develop, engineer and commercialize
                          significant innovative products for the telecommunications,
                          flat panel
                          display, environmental, semiconductor, and life sciences
                          industries.
  Since
            September 1, 2006 until November 1, 2007, the Board met a total of eight
            (8)
            times. Attendance at all meetings was perfect, except Mr. David A. Thompson
            who
            was absent two (2) times and Mr. Pierre Marcouiller who was absent one
            time.
 
 **Committees
            of the Board of Directors**
 
 Our
            Board
            of Directors has established an audit committee, a human resources committee
            and
            a disclosure committee.
 
 Our
            audit
            committee will recommend a firm to be appointed as independent auditors
            to audit
            financial statements and to perform services related to the audit, review
            the
            scope and results of the audit with the independent auditors, review
            with
            management and the independent auditors our annual operating results
            and
            consider the adequacy of the internal accounting procedures and the effect
            of
            the procedures relating to the auditors’ independence. Further to changes to
            NASDAQ corporate governance rules and Securities and Exchange rules flowing
            from
            the adoption of the *Sarbanes-Oxley Act*, our audit committee charter is
            being revised every financial year to ensure that we comply with all
            new
            requirements.  Accordingly, in March 2005, the Board updated and
            adopted an Audit Committee Charter. A copy of this Audit Committee Charter
            has
            been filed as Exhibit 11.6 to our fiscal year 2005 annual report and
            is also
            readily available from EXFO’s website at www.EXFO.com. The audit committee
            revised such Charter in October 2007 but no amendment was required. The
            audit
            committee is composed of four independent Directors:  André Tremblay,
            Michael Unger, Guy Marier and Pierre Marcouiller. The chairperson of the
            audit committee is André Tremblay.
 
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                  of Contents
 
 During
            the fiscal year ended August 31, 2007, the Audit Committee met a total
            of four
            (4) times and attendance was perfect at all meetings, except Mr. Pierre
            Marcouiller who was absent one time.
 
 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.
            Accordingly, in March 2005, the Board updated and adopted a Human Resources
            Committee Charter which integrates the Compensation Committee Charter
            and the
            Nominating and Governance Committee Charter. A copy of this Human Resources
            Committee Charter has been filed as Exhibit 11.7 to our fiscal year 2005
            annual
            report and is also readily available from EXFO’s website at www.EXFO.com. The
            human resources committee is composed of five independent
            Directors:  Pierre Marcouiller, Guy Marier, David A. Thompson,
            André Tremblay and Michael Unger. The chairperson of the human resources
            committee is Michael Unger.
 
 During
            the fiscal year ended August 31, 2007, the Human Resources committee
            met a total
            of four (4) times and attendance was perfect at all meetings, except
            Mr. David
            A. Thompson who was absent two (2) times and Mr. Pierre Marcouiller who was
            absent one time.
 
 The
            disclosure committee is responsible for overseeing our disclosure practices.
            This committee consists of the chief executive officer, the chief financial
            officer, the manager of investor relations, the manager of financial
            reporting
            and accounting as well as our legal counsel and corporate
            secretary.
 
 In
            addition, in order to deal with issues arising from our implication in
            the IPO
            class action suit, in October 2002, our Board of Directors appointed a
            litigation committee composed of four of our independent Directors.
 
 
 **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, 2007, we had a total of 1,046 employees, up from a total of 862
            on November 1, 2006. We have 835 employees in Canada, primarily based
            in Quebec, and 211 employees based outside of Canada. 349 are
            involved in research and development, 331 in manufacturing, 183 in sales
            and marketing, 96 in general administrative positions and 87 in
            communications and customer support. We have agreements with almost all
            of our
            employees covering confidentiality and non-competition. Only manufacturing
            employees based in Quebec City plants are represented by a collective
            bargaining
            agreement, which expires in 2009. 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 of November 1, 2007 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 and one other
            executive
            officer of the Corporation who would have been included within the three
            most
            highly compensated executive officers had he been in the employ of the
            Corporation, or a subsidiary, at the year end.
 
 
 81
 Table
                  of Contents
 
 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.
 
 **Name**
                  **Subordinate
                      Voting**
                    **Shares
                      Owned**
                  **Currently
                      Exercisable Options Owned**
                    **as
                      of November 1, 2007**
                  **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**
                  **Percent**Germain
                      Lamonde (4)
                  –
                  *
                  61,776
                  *
                  100,482
                  *
                  162,258
                  *
                  36,643,000
                  100
                  91,9Pierre
                      Plamondon
                  34,527 (5)
                  *
                  20,914
                  *
                  55,977
                  *
                  111,418
                  *
                  –
                  –
                  *Pierre
                      Marcouiller
                  5,000
                  *
                  25,000
                  *
                  23,882
                  *
                  53,882
                  *
                  –
                  –
                  *Guy
                      Marier
                  1,000
                  *
                  –
                  *
                  9,375
                  *
                  10,375
                  *
                  –
                  –
                  *David
                      A. Thompson
                  2,100
                  *
                  25,000
                  *
                  17,734
                  *
                  44,834
                  *
                  –
                  –
                  *André
                      Tremblay
                  6,650 (6)
                  *
                  25,000
                  *
                  19,691
                  *
                  51,341
                  *
                  –
                  –
                  *Michael
                      Unger
                  –
                  *
                  25,000
                  *
                  20,568
                  *
                  45,568
                  *
                  –
                  –
                  *Dana
                      Yearian
                  –
                  *
                  –
                  *
                  –
                  *
                  –
                  *
                  –
                  –
                  *Jon
                      Bradley
                  –
                  *
                  11,000
                  *
                  11,000
                  *
                  22,000
                  *
                  –
                  –
                  *Allan
                      Firhoj
                  –
                  *
                  0
                  *
                  18,837
                  *
                  18,837
                  *
                  –
                  –
                  *Other
                      executive officers as a group
                  35,025
                  *
                  22,181
                  *
                  50,365
                  *
                  107,571
                  *
                  –
                  –
                  *All
                      of our Directors and executive officers as a group
                  84,302
                  *
                  215,871
                  *
                  327,911
                  *
                  628,084
                  *
                  36,643,000
                  100
                  92.0**Named
                      Executive Officer Not in the Employ of the Corporation at year
                      End**Juan-Felipe
                      Gonzalez
                  –
                  *
                  –
                  *
                  –
                  *
                  –
                  *
                  –
                  –
                  *
 
 *
                  Less
                      than 1%.
 (1)
                  “In-the-money”
                      options are options for which the market value of the underlying
                      securities is higher than the price at which such securities
                      may be bought
                      from the Corporation. As of November 1, 2007 the market value
                      of a
                      Subordinate Voting Share was
                      US$6.35.
 (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 (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 1,900,000
                      multiple
                      voting shares held of record by Fiducie Germain Lamonde and
                      34,743,000
                      multiple voting shares held of record by G. Lamonde Investissements
                      Financiers inc.
 (5)
                  The
                      number of shares held by Pierre Plamondon includes 6,874 subordinate
                      voting shares held of record by Fiducie Pierre
                      Plamondon.
 (6)
                  The
                      number of subordinate voting shares held of record by André Tremblay is
                      held by 9104-5559 Québec Inc, a company controlled by Mr.
                      Tremblay.
 
 
 82
 Table
                  of Contents
 
 The
            following table presents information regarding stock options held as
            of
            November 1, 2007****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 and one
            other
            executive officer of the Corporation who would have been included within
            the
            three most highly compensated executive officers had he been in the employ
            of
            the Corporation, or a subsidiary, at the year end.
 
 **Name**
                  **Securities
                        Under Options**
                      **Granted
                        (1)
                        (#)**
                  **Exercise
                        Price (2)**
                      **(US$/Security)**
                  **Expiration
                        Date**Germain
                      Lamonde
                  25,402
                    5,080
                    70,000
                    50,000
                    17,942
                    11,218
                  $26.00
                    $22.25
                    $9.13
                    $1.58
                    $4.51
                    $4.76
                  June
                      29, 2010
                    January
                      10, 2011
                    October
                      10, 2011
                    September
                      25, 2012
                    February
                      1, 2015
                    December
                      6, 2015Pierre
                      Plamondon
                  8,700
                    10,000
                    5,000
                    9,240
                    19,000
                    20,000
                    5,383
                    3,653
                  $26.00
                    $45.94
                    $34.07
                    $22.25
                    $9.13
                    $1.58
                    $5.13
                    $4.76
                  June
                      29, 2010
                    September
                      13, 2010
                    October
                      11, 2010
                    January
                      10, 2011
                    October
                      10, 2011
                    September
                      25, 2012
                    October
                      26, 2014
                    December
                      6, 2015Pierre
                      Marcouiller
                  2,000
                    400
                    17,966
                    1,037
                    2,479
                    12,500
                    12,500
                  $26.00
                    $22.25
                    $9.13
                    $12.69
                    $5.65
                    $1.58
                    $3.51
                  June
                      29, 2010
                    January
                      10, 2011
                    October
                      10, 2011
                    December
                      1, 2011
                    March
                      1, 2012
                    September
                      25, 2012
                    October
                      27, 2013Guy
                      Marier
                  12,500
                  $4.65
                  March
                      24, 2014David
                      A. Thompson
                  2,000
                    400
                    15,334
                    12,500
                    12,500
                  $26.00
                    $22.25
                    $9.13
                    $1.58
                    $3.51
                  June
                      29, 2010
                    January
                      10, 2011
                    October
                      10, 2011
                    September
                      25, 2012
                    October
                      27, 2013André
                      Tremblay
                  2,000
                    400
                    17,291
                    12,500
                    12,500
                  $26.00
                    $22.25
                    $9.13
                    $1.58
                    $3.51
                  June
                      29, 2010
                    January
                      10, 2011
                    October
                      10, 2011
                    September
                      25, 2012
                    October
                      27, 2013Michael
                      Unger
                  2,000
                    400
                    18,168
                    12,500
                    12,500
                  $26.00
                    $22.25
                    $9.13
                    $1.58
                    $3.51
                  June
                      29, 2010
                    January
                      10, 2011
                    October
                      10, 2011
                    September
                      25, 2012
                    October
                      27, 2013Dana
                      Yearian
                  −
                  −
                  −Jon
                      Bradley
                  5,000
                    5,000
                    1,000
                    1,500
                    10,000
                    4,000
                  $45.94
                    $22.25
                    $12.22
                    $3.19
                    $3.50
                    $4.51
                  September
                      13, 2010
                    January
                      10, 2011
                    January
                      3, 2012
                    January
                      7, 2013
                    December
                      17, 2013
                    February
                      1, 2015Allan
                      Firhoj
                  10,000
                    8,000
                    1,675
                    1,803
                  $23.40
                    $9.13
                    $5.13
                    $4.76
                  March
                      15, 2011
                    October
                      10, 2011
                    October
                      26, 2014
                    December
                      6, 2015
 
 
 83
 Table
                  of Contents
 
 
 **Name**
                  **Securities
                        Under Options**
                      **Granted
                        (1)
                        (#)**
                  **Exercise
                        Price (2)**
                      **(US$/Security)**
                  **Expiration
                        Date**Other
                      Executive Officers as a group
                  900
                    8,000
                    4,000
                    6,180
                    25,000
                    15,000
                    5,000
                    9,379
                    2,000
                    7,726
                  $26.00
                    $45.94
                    $34.07
                    $22.25
                    $9.13
                    $1.58
                    $3.19
                    $5.13
                    $4.51
                    $4.76
                  June
                      29, 2010
                    September
                      13, 2010
                    October
                      11, 2010
                    January
                      10, 2011
                    October
                      10, 2011
                    September
                      25, 2012
                    January
                      7, 2013
                    October
                      26, 2014
                    February
                      1, 2015
                    December
                      6, 2015Named
                      Executive Officer Not in the Employ of the Corporation at year
                      EndJuan
                      Felipe Gonzalez
                  −
                  −
                  −____________________________
 (1)
                  Underlying
                      securities: subordinate voting
                      shares
 (2)
                  The
                      exercise price of options granted is determined based on the
                      highest of
                      the closing prices of the subordinate voting shares on the
                      Toronto Stock
                      Exchange and the NASDAQ National Market on the last trading
                      day preceding
                      the grant date, using the noon buying rate of the Federal Reserve
                      Bank of
                      New York on the grant date to convert the NASDAQ National Market
                      closing
                      price to Canadian dollars, as
                      required.
 
 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 and one other executive officer of the
            Corporation
            who would have been included within the three most highly compensated
            executive
            officers had he been in the employ of the Corporation, or a subsidiary,
            at the
            year end, as of November 1, 2007.
 
 **Name**
                  **DSUs**
                  **RSUs****Number**
                  **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
                  –
                  –
                  –
                  13,089 (3)
                  2.2%
                  4.69–
                  –
                  –
                  21,477 (4)
                  3.6%
                  4.76–
                  –
                  –
                  25,347 (5)
                  4.2%
                  6.02–
                  –
                  –
                  29,910 (6)
                  5.0%
                  6.28Pierre
                      Plamondon
                  –
                  –
                  –
                  3,927 (3)
                  0.7%
                  4.69–
                  –
                  –
                  30,000 (7)
                  5.0%
                  4.69–
                  –
                  –
                  6,994 (4)
                  1.2%
                  4.76–
                  –
                  –
                  8,430 (5)
                  1.4%
                  6.02–
                  –
                  –
                  4,500 (8)
                  0.8%
                  6.02–
                  –
                  –
                  9,637 (6)
                  1.6%
                  6.28Pierre
                      Marcouiller
                  11,935 (9)
                  17.0%
                  5.55
                  –
                  –
                  –Guy
                      Marier
                  11,935 (9)
                  17.0%
                  5.55
                  –
                  –
                  –David
                      A. Thompson
                  13,869 (9)
                  19.8%
                  5.55
                  –
                  –
                  –André
                      Tremblay
                  15,521 (9)
                  22.1%
                  5.55
                  –
                  –
                  –Michael
                      Unger
                  16,935 (9)
                  24.1%
                  5.55
                  –
                  –
                  –Dana
                      Yearian
                  –
                  –
                  –
                  5,000 (10)
                  0.8%
                  5.16–
                  –
                  –
                  6,645 (5)
                  1.1%
                  6.02–
                  –
                  –
                  7,225 (6)
                  1.2%
                  6.28Jon
                      Bradley
                  –
                  –
                  –
                  2,000 (11)
                  0.3%
                  4.51–
                  –
                  –
                  2,500 (12)
                  0.4%
                  5.59–
                  –
                  –
                  6,122 (6)
                  1.0%
                  6.28Allan
                      Firhoj
                  –
                  –
                  –
                  2,443 (3)
                  0.4%
                  4.69–
                  –
                  –
                  10,000 (7)
                  1.7%
                  4.69–
                  –
                  –
                  4,602 (4)
                  0.7%
                  4.76–
                  –
                  –
                  6,145 (5)
                  1.0%
                  6.02–
                  –
                  –
                  15,033 (13)
                  2.5%
                  6.42–
                  –
                  –
                  7,676 (6)
                  1.3%
                  6.28
 
 
 84
 Table
                  of Contents
  **Name**
                  **DSUs**
                  **RSUs****Number**
                  **Percentage**
                  **Estimated
                      Average**
                    **Value
                      at the time of**
                    **grant
                      US$/DSU (1)**
                  **Number**
                  **Percentage**
                  **Fair
                      Value at the**
                    **time
                      of grant**
                    **US$/RSU
                      (2)**Other
                      executive officers as a group
                  –
                  –
                  –
                  9,023 (3)
                  1.5%
                  4.69–
                  –
                  –
                  51,500 (7)
                  8.5%
                  4.69–
                  –
                  –
                  16,708 (4)
                  2.8%
                  4.76–
                  –
                  –
                  3,250 (12)
                  0.5%
                  5.59–
                  –
                  –
                  25,235 (5)
                  4.2%
                  6.02–
                  –
                  –
                  20,500 (8)
                  3.4%
                  6.02–
                  –
                  –
                  1,750 (13)
                  0.3%
                  6.42–
                  –
                  –
                  25,597 (6)
                  4.2%
                  6.28All
                      of the directors and executive officers as a group
                  –
                  –
                  –
                  28,842 (3)
                  4.7%
                  4.69–
                  –
                  –
                  91,500 (7)
                  15.2%
                  4.69–
                  –
                  –
                  2,000 (11)
                  0.3%
                  4.51–
                  –
                  –
                  49,781 (4)
                  8.3%
                  4.76–
                  –
                  –
                  5,750 (12)
                  1.0%
                  5.59–
                  –
                  –
                  5,000 (10)
                  0.8%
                  5.16–
                  –
                  –
                  71,802 (5)
                  7.7%
                  6.02–
                  –
                  –
                  25,000 (8)
                  4.1%
                  6.02–
                  –
                  –
                  16,783 (13)
                  2.8%
                  6.42–
                  –
                  –
                  86,167 (6)
                  14.3%
                  6.2870,195
                  100%
                  5.55
                  382,265**Named
                      Executive Officer Not in the Employ of the Corporation at year
                      End**Juan-Felipe
                      Gonzalez
                  –
                  –
                  –
                  Cancelled (14)
                  −
                  −__________________________
 (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 on the grant date to
                        convert the
                        NASDAQ National Market closing price to Canadian 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
                      January 2005
                      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
                      December 2005
                      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 2006
                      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.
 (6)
                  Those
                      RSUs will vest on the fifth anniversary date of the grant in
                      October 2007
                      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 at a rate of 55%, 35% and 10%, on the third,
                      fourth and
                      fifth anniversary dates of the grant in
                      January 2005.
 (8)
                  Those
                      RSUs will vest at a rate of 1/3 annually commencing on the
                      third
                      anniversary date of the grant in
                      October 2006.
 (9)
                  Those
                      DSUs will vest at the time Director cease to be a member of
                      the Board of
                      the Corporation.
 (10)
                  Those
                      RSUs will vest at a rate of 1/3 annually commencing on the
                      third
                      anniversary date of the grant in August
                      2006.
 (11)
                  Those
                      RSUs will vest at a rate of 1/3 annually commencing on the
                      third
                      anniversary date of the grant in February
                      2005.
 (12)
                  Those
                      RSUs will vest at a rate of 1/2 annually commencing on the
                      third
                      anniversary date of the grant in
                      February 2006.
 (13)
                  Those
                      RSUs will vest at a rate of 1/3 annually commencing on the
                      third
                      anniversary date of the grant in January
                      2007.
 (14)
                  In
                      accordance with the terms of the Long-Term Incentive Plan,
                      unvested RSUs
                      that had been attributed to this person were cancelled upon
                      his departure
                      date.
 85
 Table
                  of Contents
  **Escrowed
            Securities**
  The
            following table presents
            information regarding the number of securities of each class of the Corporation
            held, to our knowledge as of November 1, 2007, in escrow and the percentage
            outstanding securities of that class.
 
 **Designation
                      of Class**
                  
                  **Number
                      of Securities held in escrow**
                  
                  **Percentage
                      of Class**Subordinate
                      Voting Shares
                  
                  nil
                  
                  nilMultiple
                      Voting Shares
                  
                  nil
                  
                  nil
 
  86
 Table
                  of Contents
  **Item
              7.**  **Major
              Shareholders and Related Party Transactions**
 
 **A.****Major
              Shareholders**
 
 The
              following table presents information regarding the beneficial ownership
              of our
              share capital as of November 1, 2007 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
                          Power****Name**
                    **Number**
                    **Percent**
                    **Number**
                    **Percent**
                    **Percent**Germain
                        Lamonde (2)
                    36,643,000
                    100%
                    Nil
                    Nil
                    91.89%Fiducie
                        Germain Lamonde (3)
                    1,900,000
                    5%
                    Nil
                    Nil
                    4.76%G.
                        Lamonde Investissements Financiers inc. (4)
                    34,743,000
                    95%
                    Nil
                    Nil
                    87.13%Pyramis
                        Global Advisors, LLC (5)
                    Nil
                    Nil
                    3,576,400
                    11.05%
                    *Kern
                        Capital Management, LLC (6)
                    Nil
                    Nil
                    1,855,113
                    5.73%
                    *
 
 *
                    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 (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 and
                        34,743,000
                        multiple voting shares held of record by G. Lamonde Investissements
                        Financiers inc.
 (3)
                    Fiducie
                        Germain Lamonde is a family trust for the benefit of Mr.
                        Lamonde and
                        members of his family.
 (4)
                    G.
                        Lamonde Investissements Financiers inc. is a company controlled
                        by Mr.
                        Lamonde.
 (5)
                    As
                        of September 30, 2007, Pyramis Global Advisors, LLC, an indirect
                        wholly-owned subsidiary of FMR Corporation (Fidelity Management
                        and
                        Research Company), is the beneficial owner of this number
                        of subordinate
                        voting shares as a result of acting as investment advisor
                        to various
                        investment companies.
 (6)
                    As
                        of September 30, 2007, Kern Capital Management LLC controls
                        the voting
                        rights attached to this number of subordinate voting shares
                        through
                        relationships with several clients and does not beneficially
                        own directly
                        this number of subordinate voting
                        shares.
 
 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.
 
 As
              of
              November 12, 2007, 32,361,561 subordinate voting shares were outstanding.
              Approximately 98.5% (31,887,322) of our subordinate voting shares were
              held in
              bearer form and the remainder (474,239 subordinate voting shares) was
              held by
              151 record holders.  As of November 12, 2007, we believe approximately
              57.5% of our outstanding subordinate voting shares were held in the
              United
              States.
 
 
 **B.****Related
              Party Transactions**
 
 **Indebtedness
              of Directors, Executive Officers and Employees**
 
 We
              have
              guaranteed the repayment of a loan granted to an employee by a financial
              institution for the purchase of our Class “F” shares that were converted into
              subordinate voting shares immediately prior to our initial public offering.
              As
              of August 31, 2006 and November 1, 2006, the total principal amount
              guaranteed
              by us was$37,400. As
              of August 31, 2007 and November 1, 2007, no amount was guaranteed by
              us.
 
 Except
              as
              disclosed in this section, none of our directors, executive officers,
              associates
              or affiliates had any material interest in any transaction with us
              during the
              past three years or in any proposed transaction which has materially
              affected or
              could materially affect us.
 
  87
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  **Leases**
 
 Until
              September 1, 2004, we had a lease agreement with G. Lamonde Investissements
              financiers inc., a company controlled by Mr. Germain Lamonde, for premises
              located at 465 Godin Avenue in Quebec City, Quebec. Until September
              1, 2003,
              there premises were used for our executive and administrative offices
              which
              were, since then, moved into a building that we own. For fiscal year
              2004, this
              space was unoccupied. This lease was renewed in December 2001 for five
              years,
              with all terms and conditions remaining the same. However, on September
              1, 2004,
              we were released from our obligations under the lease with a final
              payment of
              $194,000 (CA$250,000). The annual rent for this lease was
              CA$144,000.
 
 **Location**
                    **Square
                          Footage**
                    **Annual
                          Rent**
                    **Expiry
                          Date**465
                        Godin
                    24,000
                    CA$144,000
                    November
                        30, 2006
 
 Based
              on
              third-party valuation of the property values, we believe this lease
              agreement
              was at prevailing market terms.
  88
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  **Item
              8.                      Financial
              Information**
  **A.******Consolidated
              Statements and Other Financial
              Information****
  See
              Item
              18, “Financial Statements” for certain other information required by this
              item.
 
 **Valuation
              and qualifying accounts are as follows (in thousands of
              US dollars):**
 
 ***Allowance
              for doubtful accounts***
 
 **Years
                        ended August 31,****2007**
                    
                    
                    **2006**
                    
                    
                    **2005**Balance
                        – Beginning of year
                    
                    $
                    451
                    
                    
                    $
                    352
                    
                    
                    $
                    510Addition
                        charged to earnings
                    
                    
                    42
                    
                    
                    
                    115
                    
                    
                    
                    329Write-offs
                        of uncollectible accounts
                    
                    
                    (271
                    )
                    
                    
                    (123
                    )
                    
                    
                    (23
                    )Recovery
                        of uncollectible accounts
                    
                    
                    (16
                    )
                    
                    
                    (111
                    )
                    
                    
                    (464
                    )Business
                        combination
                    
                    
                    −
                    
                    
                    
                    218
                    
                    
                    
                    −Balance
                        – End of year
                    
                    $
                    206
                    
                    
                    $
                    451
                    
                    
                    $
                    352
 
 ***Valuation
              allowance on future income tax assets***
 
 **Years
                        ended August 31,****2007**
                    
                    
                    **2006**
                    
                    
                    **2005**Balance
                        – Beginning of year
                    
                    $
                    38,543
                    
                    
                    $
                    38,406
                    
                    
                    $
                    32,613Change
                        in valuation allowance
                    
                    
                    (28,646
                    )
                    
                    
                    (1,877
                    )
                    
                    
                    3,375Foreign
                        currency translation adjustment
                    
                    
                    2,595
                    
                    
                    
                    2,014
                    
                    
                    
                    2,418Balance
                        – End of year
                    
                    $
                    12,492
                    
                    
                    $
                    38,543
                    
                    
                    $
                    38,406
 
 **Export
              Sales**
 
 Export
              and domestic sales in thousands of US dollars and as a percentage of
              total sales
              are as follows:
 
 **Years
                        ended August 31,****2007**
                    
                    
                    **2006**
                    
                    
                    **2005**Export
                        Sales
                    
                    $
                    143,315
                    
                    
                    
                    94
                    %
                    
                    $
                    119,486
                    
                    
                    
                    93
                    %
                    
                    $
                    90,386
                    
                    
                    
                    92
                    %Domestic
                        Sales
                    
                    $
                    9,619
                    
                    
                    
                    6
                    
                    
                    $
                    8,767
                    
                    
                    
                    7
                    
                    
                    $
                    6,830
                    
                    
                    
                    8$
                    152,934
                    
                    
                    
                    100
                    %
                    
                    $
                    128,253
                    
                    
                    
                    100
                    %
                    
                    $
                    97,216
                    
                    
                    
                    100
                    %
 
  89
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                  of Contents
  **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 EXFO, four of the
              underwriters of our Initial Public Offering and some of our 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 EXFO’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 pre-determined prices.
 
 On
              April
              19, 2002, the plaintiffs filed an amended complaint containing master
              allegations against all of the underwriters in all of the 310 cases
              included in
              this class action and also filed an amended complaint containing allegations
              specific to four of our underwriters, EXFO and two of our executive
              officers. In
              addition to the allegations mentioned above, the amended complaint
              alleges that
              the underwriters (i) used their analysts to manipulate the stock market;
              and
              (ii) implemented schemes that allowed issuer insiders to sell their shares
              rapidly after an initial public offering and benefit from high market
              prices. As
              concerns EXFO and two of our executive officers in particular, the
              amended
              complaint alleges that (i) the company’s registration statement was materially
              false and misleading because it failed to disclose the additional commissions
              and compensation to be received by underwriters; (ii) the two named
              executive
              officers learned of or recklessly disregarded the alleged misconduct
              of the
              underwriters; (iii) the two named executive officers had motive and
              opportunity
              to engage in alleged wrongful conduct due to personal holdings of EXFO’s stock
              and the fact that an alleged artificially inflated stock price could
              be used as
              currency for acquisitions; and (iv) the two named executive officers,
              by virtue
              of their positions with EXFO, controlled the company and the contents
              of the
              registration statement and had the ability to prevent its issuance
              or cause it
              to be corrected. The plaintiffs in this suit seek an unspecified amount
              for
              damages suffered.
 
 In
              July
              2002, the issuers filed a motion to dismiss the plaintiffs’ amended complaint
              and a decision was rendered on February 19, 2003. Only one of the claims
              against EXFO was dismissed. On October 8, 2002, the claims against our
              officers were dismissed pursuant to the terms of Reservation of Rights
              and
              Tolling Agreements entered into with the plaintiffs.
 
 In
              June
              2004, an agreement of partial settlement was submitted to the court
              for
              preliminary approval.  The proposed partial settlement was between the
              plaintiffs, the issuer defendants in the consolidated actions, the
              issuer
              officers and directors named as defendants, and the issuers’ insurance
              companies.  The court granted the preliminary approval motion on
              February 15, 2005, subject to certain modifications.  On
              August 31, 2005, the court issued a preliminary order further approving the
              modifications to the settlement and certifying the settlement
              classes.  The court also appointed the notice administrator for the
              settlement and ordered that notice of the settlement be distributed
              to all
              settlement class members by January 15, 2006. The settlement fairness
              hearing occurred on April 24, 2006, and the court reserved decision at that
              time.
 
 The
              plaintiffs have continued to litigate against the underwriter defendants. 
The district court has directed that the litigation proceed within a number
              of "focus cases" rather than in all of the 310 cases that have been
              consolidated.  EXFO’s case is not one of these focus cases.  On
              October 13, 2004, the district court certified the focus cases as class
              actions.  The underwriter defendants appealed that ruling, and on
              December 5, 2006, the Court of Appeals for the Second Circuit reversed
              the
              district court’s class certification decision.
 
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  On
              April
              6, 2007, the Second Circuit denied plaintiffs’ petition for rehearing of that
              decision and, on May 18, 2007, the Second Circuit denied the plaintiffs’
petition for rehearing en banc.  In light of the Second Circuit
              opinion, liaison counsel for all issuer defendants, including EXFO,
              informed the
              court that this settlement cannot be approved, because the defined
              settlement
              class, like the litigation class, cannot be certified.  On June 25,
              2007, the district court entered an order terminating the settlement
              agreement.
              On August 14, 2007, the plaintiffs filed their second consolidated
              amended class
              action complaints against the focus cases and plan to move for class
              certification again.
 
 It
              is not
              possible to predict whether a settlement that complies with the Second
              Circuit’s
              mandate can be negotiated.  Therefore, it is not possible to predict the
              final outcome of the case, nor to determine the amount of any possible
              losses.
              We will continue to defend our position in this litigation that the
              claims
              against EXFO, and our officers, are without merit. Accordingly, no
              provision for
              this case has been made in the consolidated financial statements as
              at
              August 31, 2007.
 
 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.
   **B.********Dividend
              Policy******
 We
              do not
              currently anticipate paying dividends for at least the three next 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.
   **C.********Significant
              changes******
  No
              significant changes occurred since the date of our annual consolidated
              financial
              statements included elsewhere in this annual report.
 
  91
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                  of Contents
  **Item
              9.                      Offer
              and Listing**
 
 Not
              Applicable, except for Item 9A (4)
              and Item 9C.
 
 **NASDAQ
                        (US$)**
                    
                    
                    **TSX (CA$)****High**
                    
                    
                    **Low**
                    
                    
                    **High**
                    
                    
                    **Low**September
                        1, 2002 to August 31, 2003
                    
                    
                    3.63
                    
                    
                    
                    1.40
                    
                    
                    
                    5.60
                    
                    
                    
                    2.30September
                        1, 2003 to August 31, 2004
                    
                    
                    7.09
                    
                    
                    
                    2.71
                    
                    
                    
                    9.15
                    
                    
                    
                    3.75September
                        1, 2004 to August 31, 2005
                    
                    
                    5.51
                    
                    
                    
                    3.92
                    
                    
                    
                    6.90
                    
                    
                    
                    4.92September
                        1, 2005 to August 31, 2006
                    
                    
                    8.69
                    
                    
                    
                    4.32
                    
                    
                    
                    9.60
                    
                    
                    
                    5.15September
                        1, 2006 to August 31, 2007
                    
                    
                    7.57
                    
                    
                    
                    4.89
                    
                    
                    
                    8.85
                    
                    
                    
                    5.552006
                        1st Quarter
                    
                    
                    5.05
                    
                    
                    
                    4.32
                    
                    
                    
                    5.92
                    
                    
                    
                    5.152006
                        2nd Quarter
                    
                    
                    6.70
                    
                    
                    
                    4.39
                    
                    
                    
                    7.64
                    
                    
                    
                    5.162006
                        3rd Quarter
                    
                    
                    8.69
                    
                    
                    
                    6.44
                    
                    
                    
                    9.60
                    
                    
                    
                    7.182006
                        4th Quarter
                    
                    
                    7.01
                    
                    
                    
                    4.86
                    
                    
                    
                    7.80
                    
                    
                    
                    5.452007
                        1st Quarter
                    
                    
                    6.13
                    
                    
                    
                    4.89
                    
                    
                    
                    6.90
                    
                    
                    
                    5.552007
                        2nd Quarter
                    
                    
                    7.48
                    
                    
                    
                    5.21
                    
                    
                    
                    8.85
                    
                    
                    
                    6.052007
                        3rd Quarter
                    
                    
                    6.94
                    
                    
                    
                    5.92
                    
                    
                    
                    7.82
                    
                    
                    
                    6.702007
                        4th Quarter
                    
                    
                    7.57
                    
                    
                    
                    5.94
                    
                    
                    
                    7.95
                    
                    
                    
                    6.422007
                        May
                    
                    
                    6.65
                    
                    
                    
                    6.01
                    
                    
                    
                    7.23
                    
                    
                    
                    6.702007
                        June
                    
                    
                    7.03
                    
                    
                    
                    6.60
                    
                    
                    
                    7.60
                    
                    
                    
                    7.072007
                        July
                    
                    
                    7.57
                    
                    
                    
                    6.83
                    
                    
                    
                    7.95
                    
                    
                    
                    7.472007
                        August
                    
                    
                    7.55
                    
                    
                    
                    5.94
                    
                    
                    
                    7.93
                    
                    
                    
                    6.422007
                        September
                    
                    
                    7.28
                    
                    
                    
                    6.61
                    
                    
                    
                    7.35
                    
                    
                    
                    6.622007
                        October
                    
                    
                    7.07
                    
                    
                    
                    6.17
                    
                    
                    
                    6.92
                    
                    
                    
                    5.932007
                        November
                    
                    
                    6.41
                    
                    
                    
                    5.86
                    
                    
                    
                    6.05
                    
                    
                    
                    5.56(until
                        November 12)
 
 Our
              subordinate voting shares have been quoted on the NASDAQ National Market
              under
              the symbol EXFO and listed on The Toronto Stock Exchange under the
              symbol EXF
              since our initial public offering on June 29, 2000. Prior to that time,
              there was no public market for our subordinate voting shares. The following
              table sets forth, for the periods indicated, the high and low closing
              sales
              prices per subordinate voting share as reported on the NASDAQ National
              Market
              and the Toronto Stock Exchange.
 
 On
              November 12, 2007, the last reported sale price for our subordinate
              voting
              shares on the NASDAQ National Market was US$6.09 per share and the
              last reported
              sale price for our subordinate voting shares on the Toronto Stock Exchange
              was
              CA$5.92 per share.
 
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  **Item
              10.**                      **Additional
              Information******
  **A.**********Share
              Capital********
  Not
              Applicable
 
 
 **B.****Memorandum
              and Articles of Association**
 
 Incorporated
              by reference to our registration statement on Form F-1 dated
              June 9, 2000 (File No. 333-38956).
 
 
 **C.****Material
              Contracts**
 
 Except
              as
              otherwise disclosed in this annual report and our financial statements
              and notes
              included elsewhere in this annual report, we have no other material
              contracts.
 
 
 **D.****Exchange
              Controls**
 
 Subject
              to the following paragraph, there is no law or governmental decree
              or regulation
              in Canada that restricts the export or import of capital, or affects
              the
              remittance of dividends, interest or other payments to non-resident
              holders of
              our subordinate voting shares, other than withholding tax
              requirements.
 
 There
              is
              no limitation imposed by Canadian law or by our articles of incorporation
              or our
              other charter documents on the right of a non-resident to hold or vote
              subordinate voting shares, other than as provided by the *Investment Canada
              Act,* the *North American Free Trade Agreement Implementation Act*(Canada) and the *World Trade Organization Agreement Implementation
              Act*. The *Investment Canada Act*requires notification and, in
              certain cases, advance review and approval by the Government of Canada
              of an
              investment to establish a new Canadian business by a non-Canadian or
              of the
              acquisition by a “non-Canadian” of “control” of a “Canadian business”, all as
              defined in the *Investment Canada Act*. Generally, the threshold for
              review will be higher in monetary terms for a member of the World Trade
              Organization or North American Free Trade Agreement.
 
 
 **E.****Taxation**
 
 **United
              States Taxation**
 
 The
              information set forth below under the caption “United States Taxation” is a
              summary of the material U.S. federal income tax consequences of the
              ownership
              and disposition of subordinate voting shares by a U.S. Holder, as
              defined below. These discussions are not a complete analysis or listing
              of all
              of the possible tax consequences of such transactions and do not address
              all tax
              considerations that may be relevant to particular holders in light
              of their
              personal circumstances or to persons that are subject to special tax
              rules. In
              particular, the information set forth under the caption “United States Taxation”
deals only with U.S. Holders that 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. 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
              estate and gift tax consequences or tax consequences under any foreign,
              state or
              local laws other than as provided in the section entitled “Canadian Federal
              Income Tax Considerations” provided below.
  93
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  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
                        jurisdiction 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 describe here.
 
 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
              foreign tax laws of the acquisition, ownership and disposition of subordinate
              voting shares.
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  *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 an individual
              U.S. Holder, under recently enacted tax legislation such dividends
              should
              generally be eligible for a maximum tax rate of 15% for dividends received
              before January 1, 2011, provided such holder holds the subordinate
              voting shares
              for at least 60 days and certain other conditions are satisfied, including,
              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. 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 for foreign
              tax credit purposes. 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, for taxable years beginning before January 1, 2007, dividends
              distributed generally will constitute foreign source “passive income”, or, in
              the case of certain U.S. Holders, “financial services income”, and, for taxable
              years beginning after December 31, 2006, such dividends should generally
              constitute foreign source “passive category income”, or, in the case of certain
              U.S. Holders, “general category income”. A U.S. Holder will have a
              basis in any Canadian dollars distributed equal to their U.S. dollar
              value on
              the payment date.  The rules governing the foreign tax credit are
              complex, and additional limitations on the credit apply to individuals
              receiving
              dividends from foreign corporations if the dividends are eligible for
              the 15%
              maximum tax rate on dividends described above.  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
              taxpayers, including individuals, derived with respect to a sale, exchange
              or
              other disposition prior to January 1, 2011 of subordinate voting shares
              held for
              more than one year are subject to a maximum federal income tax rate of 15%.
              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.
 
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  *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 are 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:
 
 ·
                    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 income such as:
 
 ·
                    dividends;
 ·
                    interest;
 ·
                    rents
                        or royalties, other than certain rents or royalties derived
                        from the
                        active conduct of trade or
                        business;
 ·
                    annuities;
                        or
 ·
                    gains
                        from assets that produce passive
                        income.
 
 If
              a
              foreign corporation owns at least 25% by value of the stock of another
              corporation, the foreign corporation is treated for purposes of the
              passive
              foreign investment company tests as owning its proportionate share
              of the assets
              of the other corporation and as receiving directly its proportionate
              share of
              the other corporation’s income.
 
 If
              we are
              treated as a passive foreign investment company, a U.S. Holder that
              did not make
              a qualified electing fund election or, if available, a mark-to-market
              election,
              as described below, would be subject to special rules with respect
              to:
 
 ·
                    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 would be taxable as ordinary
                        income;
 ·
                    the
                        amount allocated to each prior year, with certain exceptions,
                        would be
                        subject to tax at the highest tax rate in effect for that
                        year;
                        and
 ·
                    the
                        interest charge generally applicable to underpayments of
                        tax would be
                        imposed in respect of the tax attributable to each such
                        year.
 
  97
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  A
              U.S.
              Holder owning actually or constructively “marketable stock” of a passive foreign
              investment company may be able to avoid the imposition of the passive
              foreign
              investment company tax rules described above by making a mark-to-market
              election. Generally, pursuant to this election, such holder would include
              in
              ordinary income, for each taxable year during which such stock is held,
              an
              amount equal to the increase in value of the stock, which increase
              will be
              determined by reference to the value of such stock at the end of the
              current
              taxable year compared with their value as of the end of the prior taxable
              year.
              Holders desiring to make the mark-to-market election should consult
              their tax
              advisors with respect to the application and effect of making such
              election.
 
 In
              the
              case of a U.S. Holder who does not make a mark-to-market election,
              the special
              passive foreign investment company tax rules described above will not
              apply to
              such U.S. Holder if the U.S. Holder makes an election to have us treated as
              a qualified electing fund and we provide certain required information
              to
              holders. For a U.S. Holder to make a qualified electing fund election, we
              would have to satisfy certain reporting requirements. We have not determined
              whether we will undertake the necessary measures to be able to satisfy
              such
              requirements in the event that we were treated as a passive foreign
              investment
              company.
 
 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 provides a taxpayer identification number and otherwise complies
              with
              applicable requirements of the backup withholding rules. In addition,
              backup
              withholding may apply if the U.S. Holder fails to provide an accurate
              taxpayer
              identification number, or to report interest and dividends required
              to be shown
              on its federal income tax returns.  Backup withholding is not an
              additional tax. Any amount withheld under these rules will be creditable
              against
              the U.S. Holder’s U.S. federal income tax liability or refundable to the extent
              that it exceeds such liability. A U.S Holder who does not provide a
              correct
              taxpayer identification number may be subject to penalties imposed
              by the United
              States Internal Revenue Service.
 
 Non-U.S.
              Holders will generally be subject to information reporting and possible
              backup
              withholding with respect to the proceeds of the sale or other disposition
              of
              subordinate voting shares effected within the United States, unless
              the holder
              certifies to its foreign status or otherwise establishes an exemption
              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.
 
 **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:
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  ·
                    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
 ·
                    deals
                        at arm’s length with us. Special rules, which are not discussed
                        below, may
                        apply to “financial institutions”, as defined in the ITA, and to
                        non-resident insurers carrying on an insurance business in
                        Canada and
                        elsewhere.
 
 This
              discussion is based on the current provisions of the ITA and the Convention
              and
              on the regulations promulgated under the ITA, all specific proposals
              to amend
              the ITA or the regulations promulgated under the ITA announced by or
              on behalf
              of the Canadian Minister of Finance prior to the date of this annual
              report and
              the current published administrative practices of the Canada Customs
              and Revenue
              Agency. 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,
              Room
              1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, at
              prescribed rates. You may call the SEC at 1-800-SEC-0330 for further
              information
              on the public reference rooms. The SEC maintains a Web site
*(http://www.sec.gov)*that contains reports, proxy and information
              statements and other information regarding registrants that file electronically
              with the SEC. Although we make many of our filings with the SEC electronically
              as a foreign private issuer, we are not obligated to do so.
 
 You
              may
              read and copy any reports, statements or other information that we
              file with the
              SEC at the addresses indicated above and you may also access them electronically
              at the Web site set forth above. These SEC filings are also available
              to the
              public from commercial document retrieval services.
 
 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.
 
  100
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  **Item
              11.                      Qualitative
              and Quantitative Disclosures about Market Risk**
 
 **Market
              Risk**
 
 *Currency
              Risk*
 
 Our
              measurement currency is the Canadian dollar. We are exposed to currency
              risks
              due to the export of our Canadian-manufactured products, the large majority
              of which are denominated in US dollars. These risks are partially hedged
              by
              operating expenses denominated in US dollars, the purchase of raw materials
              in US dollars and forward exchange contracts. The increased strength
              of the
              Canadian dollar, compared to the US dollar, over the last couple of
              years caused
              our operating expenses to increase and we incurred foreign exchange
              loss. Any
              further increase in the value of the Canadian dollar in the upcoming
              months will
              negatively affect our results of operations.
 
 We
              enter
              into forward exchange contracts to manage the risk of exchange rate
              fluctuations
              between the Canadian and US dollar on cash flows related to anticipated
              future
              revenue streams denominated in US dollars. We do not enter into forward
              exchange contracts for hedging purposes.
 
 The
              following table summarizes the forward exchange contracts in effect
              as at
              August 31, 2007, 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 exchange rates under such contracts. The notional amounts
              of such
              contracts are used to calculate the contractual payments to be made
              under these
              contracts.
 
 **Years
                          ending August 31,****2008**
                    
                    
                    **2009**
                    
                    
                    **2010**Forward
                        exchange contracts to sell US dollars in exchange for Canadian
                        dollars
                      Contractual
                        amounts
                    
                    $
                    36,900
                    
                    
                    $
                    14,200
                    
                    
                    $
                    1,200Weighted
                        average contractual exchange rates
                    
                    
                    1.1295
                    
                    
                    
                    1.1180
                    
                    
                    
                    1.1425
 
 *Fair
              Value*
 
 The
              fair
              value of forward exchange contracts, which represents the amount we
              would
              receive to settle the contracts, amounted to an unrecognized gain of
              $3.4
              million as at August 31, 2007 ($5.5 million as at
              August 31, 2006).
 
 *Interest
              rate and liquidity risks*
 
 We
              are
              exposed to the impact of interest rate changes and changes in the market
              values
              of our short-term investments. We do not use derivative financial instruments
              for our short-term investments. As at August 31, 2007, our short-term
              investments consist of commercial paper issued by seven (nine as of
              August 31,
              2006) high-credit quality corporations and trusts; therefore, we consider
              the
              risk of non-performance of these financial instruments to be remote.
              None of
              these debts instruments are expected to be affected by a liquidity
              risk; 47% of
              them are guaranteed by the Government of Canada and none of them represent
              asset-backed commercial paper. For the purposes of managing our cash
              position,
              we have established a cash management policy, which we follow and monitor
              on a
              regular basis. These short-term investments will be used for working
              capital and
              other general corporate purposes, including other potential
              acquisitions.
 
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  *Credit
              risk*
 
 Financial
              instruments that potentially subject us to credit risk consist primarily
              of our
              cash, our short-term investments, our accounts receivable and our forward
              exchange contracts. As mentioned in the interest rate risk section,
              our
              short-term investments consist of debt instruments issued by high credit
              quality, corporations and trusts. 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
              remote.
 
 Generally,
              we do 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, 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 $451,000 and $206,000 as at August 31, 2006 and 2007,
              respectively.
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  **Item
              12.                      Description
              of Securities Other than Equity Securities**
 
 Not
              Applicable.
 
 
 
 **PART
              II.**
 
 **Item
              13.                      Defaults,
              Dividends Arrearages and Delinquencies**
 
 Not
              Applicable.
 
 
 **Item
              14.                      Material
              Modifications to the Rights of Security Holders and Use of
              Proceeds**
 
 Not
              Applicable.
 
 
 **Item
              15.                      Controls
              and Procedures**
 
 **(a)
              Evaluation of Disclosure Controls and Procedures**
 
 Under
              the
              supervision and with the participation of our management, including
              the Chief
              Executive Officer and 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, the
              Chief
              Executive Officer and Chief Financial Office have concluded that these
              disclosure controls and procedures are effective.
 
 **(b)
              Management’s Annual Report on Internal Control over Financial
              Reporting**
 
 EXFO
              management is responsible for establishing and maintaining adequate
              internal
              control over financial reporting. EXFO’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 in Canada.1
 
 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
              generally accepted accounting principles in Canada, 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.
 
 1
                      Our
                          consolidated financial
                          statements are prepared in accordance with generally accepted
                          accounting
                          principles in Canada (“Canadian GAAP”) and significant differences in
                          measurement and disclosure from generally accepted accounting
                          principles
                          in United States (“U.S. GAAP”) are set out in note 20 to our consolidated
                          financial statements included elsewhere in this annual
                          report.
  103
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  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* 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, 2007.
 
 **(c)
              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.
  104
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  **Item
              16.                        
[Reserved]**
  **Item
              16A.                      Audit
              Committee Financial Expert**
 
 Our
              Board
              of Directors has determined that Mr. André Tremblay, CA, chairman of our audit
              committee is an audit committee financial expert. Mr. Tremblay is
              independent of management. For a description of Mr. Tremblay’s
              education and experience, please refer to Item 6A. The other members
              of the
              Audit Committee are Mr. Pierre Marcouiller, Mr. Guy Marier and Mr.
              Michael Unger
              which are all 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 fiscal
              year 2005 annual report. In March 2005, the Board updated and adopted
              the
              following policies:
 
 ·
                    Board
                        of Directors Corporate Governance
                        Guidelines;
 ·
                    Code
                        of Ethics for our Principal Executive Officer and Senior
                        Financial
                        Officers;
 ·
                    Ethics
                        and Business Conduct Policy;
 ·
                    Statement
                        of Reporting Ethical Violations (Whistle
                        Blower).
 
 A
              copy of
              those policies has been filed respectively as exhibits 11.2 through
              11.5
              inclusively to our fiscal year 2005 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.
 
 As
              reported at item 7B of this annual report, previous to the coming into
              force of
              the requirement for a code of ethics, we had entered into a lease agreement
              with
              G. Lamonde Investissements financiers inc., a company controlled by
              our chief
              executive officer, for premises located at 465 Godin Avenue in Quebec
              City,
              Quebec and on September 1, 2004, we were released from our obligations
              under
              this lease with a final payment of $194,000. In addition, in September
              2002, we acquired from G. Lamonde Investissements financiers inc. the
              building
              located at 436 Nolin Street. The purchase price paid was based on an
              independent
              third party valuation and the transaction was approved by our audit
              committee
              and Board of Directors with Mr. Lamonde abstaining.
 
 **Item
              16C.                      Principal
              Accountant Fees and Services**
 
 **Audit
              Fees**
 
 During
              the financial years ended August 31, 2006 and August 31, 2007, our
              principal
              accountant, PricewaterhouseCoopers LLP, billed us aggregate amounts
              of $247,000
              and $190,000 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, 2006 and August 31, 2007, our
              principal
              accountant, PricewaterhouseCoopers LLP, billed us aggregate amounts
              of $148,000
              and $313,000, respectively for services mainly related to Sarbanes-Oxley
              Act.
 
 **Tax
              Fees**
 
 During
              the financial years ended August 31, 2006 and August 31, 2007, our
              principal
              accountant, PricewaterhouseCoopers LLP, billed us aggregate amounts
              of $210,000
              and $135,000, respectively for services related to tax compliance,
              tax advice
              and tax planning.
 
  105
 Table
                  of Contents
  **All
              Other Fees**
  Not
            applicable.   **Audit
              Committee Pre-Approval Policies and Procedures**
 
 On
              September 25, 2002, our audit committee adopted a policy requiring
              prior
              approval by the audit committee of the annual audit plan and fees which
              has been
              integrated in the Audit Committee Charter (refer to Item 6C for further
              details
              on the Audit Committee Charter). In the event any adjustments to audit
              fees 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 fees (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, 2007, 100% of tax fees were
              approved by
              the audit committee pursuant to this policy. During the financial year
              ended on
              August 31, 2007, 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**
 
 Not
              Applicable.
  
  **PART
              III.**
  Item
              17.                        
**Financial
              Statements**
  Not
              Applicable.
  
 Item
              18.                        
**Financial
              Statements**
  See
              pages
              F-3 to F-40.
  106
 Table
                  of Contents
  **Item
              19.**  **Exhibits**
 
 **Number**
                    **Exhibit**1.1
                    Amended
                        Articles of Incorporation of EXFO (incorporated by reference
                        to Exhibit
                        3.1 of EXFO’s Registration Statement on Form F-1 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).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).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).
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  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).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 Agreement****by 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).
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  4.28
                    EXFO
                        Protocol Inc. Executive Employment Agreement with Sami Yazdi
                        signed
                        November 2, 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).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).8.1
                    Subsidiaries
                        of EXFO (list included in Item 4C of this annual
                        report).11.1
                    Code
                        of Ethics for senior financial officers, (incorporated by
                        reference to
                        Exhibit 11.1 of EXFO’s annual report on Form 20-F dated January 15, 2004,
                        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 29, 2005,
                        File No. 000-30895).11.3
                    Code
                        of Ethics for our Principal Executive Officer and Senior
                        Financial
                        Officers (incorporated by reference to Exhibit 11.3 of EXFO’s annual
                        report on Form 20-F dated November 29, 2005, File No.
                        000-30895).11.4
                    Ethics
                        and Business Conduct Policy (incorporated by reference to
                        Exhibit 11.4 of
                        EXFO’s annual report on Form 20-F dated November 29, 2005, File
                        No.
                        000-30895).11.5
                    Statement
                        of Reporting Ethical Violations (Whistle Blower) (incorporated
                        by
                        reference to Exhibit 11.5 of EXFO’s annual report on Form 20-F dated
                        November 29, 2005, File No. 000-30895).11.6
                    Audit
                        Committee Charter (incorporated by reference to Exhibit 11.6
                        of EXFO’s
                        annual report on Form 20-F dated November 29, 2005, File
                        No.
                        000-30895).11.7
                    Human
                        Resources Committee Charter (incorporated by reference to
                        Exhibit 11.7 of
                        EXFO’s annual report on Form 20-F dated November 29, 2005, 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.
  109
 Table
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  **SIGNATURES**
 
  The
              registrant hereby certifies that it meets all of the requirements for
              filing on
              Form 20 -F and that it has duly caused and authorized the
              undersigned to sign this annual report on its behalf.
 
 
 EXFO
              ELECTRO-OPTICAL ENGINEERING INC.
 
 
 
 
 By:               /s/*Germain Lamonde*
 Name:         Germain
              Lamonde
 Title:           Chairman
              of the Board, President and
              Chief
              Executive Officer
 
 Date:           November
              28, 2007.
   110
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                  of Contents
  **Exhibit
              12.1**
 **Certification
              pursuant to Section 302 of the Sarbanes-Oxley Act of 2002**
 
 I,
              Germain Lamonde, certify that:
  1.
                    I
                        have reviewed this annual report on Form 20-F of EXFO Electro-Optical
                        Engineering Inc. ("EXFO");
  2.
                    Based
                        on my knowledge, this report does not contain any untrue
                        statement of a
                        material fact or omit to state a material fact necessary to make the
                        statements made, in light of the circumstances under which
                        such statements
                        were made, not misleading with respect to the period covered
                        by this
                        report;
  3.
                    Based
                        on my knowledge, the financial statements, and other financial
                        information
                        included in this report, fairly present in all material respects
                        the
                        financial condition, results of operations and cash flows
                        of EXFO as at,
                        and for, the periods presented in this
                        report;
  4.
                    EXFO's
                        other certifying officer and I are responsible for establishing
                        and
                        maintaining disclosure controls and procedures (as defined
                        in Exchange Act
                        Rules 13a-15(e) and 15d-15(e)) and internal control over financial
                        reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f))
                        for EXFO and have:
  a.
                    Designed
                        such disclosure controls and procedures or caused such disclosure
                        controls
                        and procedures to be designed under our supervision, to ensure that
                        material information relating to EXFO, including its consolidated
                        subsidiaries, is made known to us by others within those
                        entities,
                        particularly during the period in which this report is being
                        prepared;
  b.
                    Designed
                        such internal control over financial reporting, or caused
                        such internal
                        control over financial reporting to be designed under our
                        supervision, 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;
  c.
                    Evaluated
                        the effectiveness of EXFO's disclosure controls and procedures
                        and
                        presented in this report our conclusions about the effectiveness
                        of the
                        disclosure controls and procedures, as at the end of the
                        period covered by
                        this report based on such evaluation;
                        and
  d.
                    Disclosed
                        in this report any change in EXFO's internal control over
                        financial
                        reporting that occurred during the period covered by the
                        annual report
                        that has materially affected, or is reasonably likely to
                        materially
                        affect, EXFO's internal control over financial
                        reporting.
  5.
                    EXFO's
                        other certifying officer and I have disclosed, based on our
                        most recent
                        evaluation of internal control over financial reporting,
                        to EXFO's
                        auditors and the audit committee of EXFO's board of
                        directors:
  a.
                    All
                        significant deficiencies and material weaknesses in the design
                        or
                        operation of internal control over financial reporting which
                        are
                        reasonably likely to adversely affect EXFO's ability to record,
                        process,
                        summarize and report financial information;
                        and
  b.
                    Any
                        fraud, whether or not material, that involves management
                        or other
                        employees who have a significant role in EXFO’s internal control over
                        financial reporting.
  
 Date:
              November 28, 2007
 
 
 /s/*Germain Lamonde*
 Germain
              Lamonde
 Chairman
              of the Board,
 President
              and Chief Executive Officer
 (Principal
              Executive Officer)
  111
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                  of Contents
  **Exhibit
              12.2**
 **Certification
              pursuant to Section 906 of the Sarbanes-Oxley Act of 2002**
 
 Pursuant
              to section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and
              (b) of
              section 1350, chapter 63 of title 18, United States Code), the undersigned
              officer of EXFO, hereby certifies, that:
 
 1.
                    The
                        annual report of Form 20-F for the year ended August 31,
                        2007 of EXFO
                        fully complies with the requirements of section 13(a) or
                        15(d) of the
                        Securities Exchange Act of 1934;
                        and
 
 2.
                    The
                        information contained in this annual report fairly presents,
                        in all
                        material respects, the financial condition and results of
                        operations of
                        EXFO.
 
 
 Date:           November
              28, 2007.
 
 
 
 /s/*Germain
              Lamonde*
 Germain
              Lamonde
 Chairman
              of the Board,
 President
              and Chief Executive Officer
 (Principal
              Executive Officer)
 
 The
              foregoing certification is being furnished solely pursuant to section
              906 of the
              Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of section 1350,
              chapter 63 of title 18, United States Code) and is not being filed
              as part
              of the Report or as separate disclosure document.
 
  112
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                  of Contents
  **Exhibit
              13.1**
 **Certification
              pursuant to Section 302 of the Sarbanes-Oxley Act of 2002**
 
 I,
              Pierre
              Plamondon, certify that:
  1.
                    I
                        have reviewed this annual report on Form 20-F of EXFO Electro-Optical
                        Engineering Inc. ("EXFO");
  2.
                    Based
                        on my knowledge, this report does not contain any untrue
                        statement of a
                        material fact or omit to state a material fact necessary to make the
                        statements made, in light of the circumstances under which
                        such statements
                        were made, not misleading with respect to the period covered
                        by this
                        report;
  3.
                    Based
                        on my knowledge, the financial statements, and other financial
                        information
                        included in this report, fairly present in all material respects
                        the
                        financial condition, results of operations and cash flows
                        of EXFO as at,
                        and for, the periods presented in this
                        report;
  4.
                    EXFO's
                        other certifying officer and I are responsible for establishing
                        and
                        maintaining disclosure controls and procedures (as defined
                        in Exchange Act
                        Rules 13a-15(e) and 15d-15(e)) and internal control over financial
                        reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f))
                        for EXFO and have:
  a.
                    Designed
                        such disclosure controls and procedures or caused such disclosure
                        controls
                        and procedures to be designed under our supervision, to ensure that
                        material information relating to EXFO, including its consolidated
                        subsidiaries, is made known to us by others within those
                        entities,
                        particularly during the period in which this report is being
                        prepared;
  b.
                    Designed
                        such internal control over financial reporting, or caused
                        such internal
                        control over financial reporting to be designed under our
                        supervision, 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;
  c.
                    Evaluated
                        the effectiveness of EXFO's disclosure controls and procedures
                        and
                        presented in this report our conclusions about the effectiveness
                        of the
                        disclosure controls and procedures, as at the end of the
                        period covered by
                        this report based on such evaluation;
                        and
  d.
                    Disclosed
                        in this report any change in EXFO's internal control over
                        financial
                        reporting that occurred during the period covered by the
                        annual report
                        that has materially affected, or is reasonably likely to
                        materially
                        affect, EXFO's internal control over financial
                        reporting.
  5.
                    EXFO's
                        other certifying officer and I have disclosed, based on our
                        most recent
                        evaluation of internal control over financial reporting,
                        to EXFO's
                        auditors and the audit committee of EXFO's board of
                        directors:
  a.
                    All
                        significant deficiencies and material weaknesses in the design
                        or
                        operation of internal control over financial reporting which
                        are
                        reasonably likely to adversely affect EXFO's ability to record,
                        process,
                        summarize and report financial information;
                        and
  b.
                    Any
                        fraud, whether or not material, that involves management
                        or other
                        employees who have a significant role in EXFO's internal control over
                        financial reporting.
  
 Date:
              November 28, 2007
 
 
 /s/*Pierre Plamondon*
 Pierre
              Plamondon, CA
 Vice-President
              Finance
 and
              Chief
              Financial Officer
 (Principal
              Financial Officer)
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                  of Contents
  **Exhibit
              13.2**
 **Certification
              pursuant to Section 906 of the Sarbanes-Oxley Act of 2002**
 
 Pursuant
              to section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and
              (b) of
              section 1350, chapter 63 of title 18, United States Code), the undersigned
              officer of EXFO, hereby certifies, that:
 
 1.
                    The
                        annual report of Form 20-F for the year ended August 31,
                        2007 of EXFO
                        fully complies with the requirements of section 13(a) or
                        15(d) of the
                        Securities Exchange Act of 1934;
                        and
 
 2.
                    The
                        information contained in this annual report fairly presents,
                        in all
                        material respects, the financial condition and results of
                        operations of
                        EXFO.
 
 
 Date:           November
              28, 2007.
 
 
 
 /s/*Pierre Plamondon*
 Pierre
              Plamondon, CA
 Vice-President
              Finance
 and
              Chief
              Financial Officer
 (Principal
              Financial Officer)
 
 The
              foregoing certification is being furnished solely pursuant to section
              906 of the
              Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of section 1350,
              chapter 63 of title 18, United States Code) and is not being filed
              as part
              of the Report or as separate disclosure document.
  116
 Table
              of Contents
  **Report
            of Independent Auditors**
 
  **To
            the Shareholders of**
 **EXFO
            Electro-Optical Engineering Inc.**
 
 
 We
            have
            completed an integrated audit of the consolidated financial statements
            and
            internal control over financial reporting of EXFO Electro-Optical Engineering
            Inc. as of August 31, 2007 and audits of its August 31, 2006 and August
            31, 2005
            consolidated financial statements. Our opinions, based on our audits,
            are
            presented below.
 
 **Consolidated
            financial statements**
 
 We
            have
            audited the accompanying consolidated balance sheets of EXFO Electro-Optical
            Engineering Inc. as of August 31, 2007 and 2006, and the related
            consolidated statements of earnings, retained earnings and contributed
            surplus
            and cash flows for each of the three years in the period ended August
            31, 2007.
            These financial statements are the responsibility of the Company's management.
            Our responsibility is to express an opinion on these financial statements
            based
            on our audits.
 
 We
            conducted our audits in accordance with Canadian generally accepted auditing
            standards and the standards of the Public Company Accounting Oversight
            Board (United States). Those standards require that we plan and perform
            an audit
            to obtain reasonable assurance about whether the financial statements
            are free
            of material misstatement. An audit of financial statements includes examining,
            on a test basis, evidence supporting the amounts and disclosures in the
            financial statements. A financial statement audit also includes assessing
            the
            accounting principles used and significant estimates made by management,
            and
            evaluating the overall financial statement presentation. We believe that
            our
            audits provide a reasonable basis for our opinion.
 
 In
            our
            opinion, the consolidated financial statements referred to above present
            fairly,
            in all material respects, the financial position of the Company as of
            August 31,
            2007 and 2006 and the results of its operations and its cash flows for
            each of
            the three years in the period ended August 31, 2007 in accordance with
            Canadian
            generally accepted accounting principles. Furthermore, in our opinion,
            the
            financial statements schedules on the changes in the allowance for doubtful
            accounts and in the valuation allowance on future income tax assets included
            in
            Form 20-F present fairly, in all material respects, the information set
            forth therein when read in conjunction with the related consolidated
            financial
            statements.
 
 **Internal
            control over financial reporting**
 
 We
            have
            also audited EXFO Electro-Optical Engineering Inc.'s internal control
            over
            financial reporting as of August 31, 2007, based on criteria established
            in
            Internal Control - Integrated Framework issued by the Committee
            of Sponsoring Organizations of the Treadway Commission (COSO). The
            Company's management is responsible for maintaining effective internal
            control
            over financial reporting and for its assessment of the effectiveness
            of internal
            control over financial reporting. 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. Our audit of internal
            control
            over financial reporting included obtaining an understanding of internal
            control over financial reporting, assessing the risk that a material
            weakness
            exists, and testing and evaluating the design and operating effectiveness
            of
            internal control based on the assessed risk. Our audit also included
            performing
            such other procedures as we considered necessary in the circumstances.
            We
            believe that our audit provides a reasonable basis for our opinion.
  F-1
 Table
                of Contents
  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.
 
 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.
 
 In
            our
            opinion, the Company maintained, in all material respects, effective
            internal
            control over financial reporting as of August 31, 2007 based on criteria
            established in Internal Control – Integrated Framework issued by the
            COSO.
    /s/PricewaterhouseCoopers
            LLP
 **Chartered
            Accountants**
 
 Quebec,
            Quebec, Canada
 October
            30, 2007, except as to note 21 which is as of November 5, 2007
  
 F-2
 Table
                  of Contents
 **EXFO
            Electro-Optical Engineering Inc.**
 **Consolidated
            Balance Sheets**
  
 **As
                      at August 31,****2007**
                  
                  
                  **2006****Assets****Current
                      assets**Cash
                  
                  $
                  5,541
                  
                  
                  $
                  6,853Short-term
                      investments (notes 8 and 18)
                  
                  
                  124,217
                  
                  
                  
                  104,437Accounts
                      receivable (notes 8 and 18)Trade
                  
                  
                  26,699
                  
                  
                  
                  20,891Other
                      (note 4)
                  
                  
                  2,479
                  
                  
                  
                  2,792Income
                      taxes and tax credits recoverable (note 15)
                  
                  
                  6,310
                  
                  
                  
                  2,201Inventories
                      (notes 5 and 8)
                  
                  
                  31,513
                  
                  
                  
                  24,623Prepaid
                      expenses
                  
                  
                  1,391
                  
                  
                  
                  1,404Future
                      income taxes (note 16)
                  
                  
                  7,609
                  
                  
                  
                  −205,759
                  
                  
                  
                  163,201**Income
                      taxes recoverable**
                  
                  
                  −
                  
                  
                  
                  476**Property,
                      plant and equipment**(notes 6 and 8)
                  
                  
                  18,117
                  
                  
                  
                  17,392**Intangible
                      assets**(notes 7 and 8)
                  
                  
                  9,628
                  
                  
                  
                  10,948**Goodwill**(note 7)
                  
                  
                  28,437
                  
                  
                  
                  27,142**Future
                      income taxes**(note 16)
                  
                  
                  17,197
                  
                  
                  
                  −$
                  279,138
                  
                  
                  $
                  219,159**Liabilities****Current
                      liabilities**Accounts
                      payable and accrued liabilities (note 9)
                  
                  $
                  22,721
                  
                  
                  $
                  17,337Deferred
                      revenue
                  
                  
                  2,598
                  
                  
                  
                  1,772Current
                      portion of long-term debt
                  
                  
                  −
                  
                  
                  
                  10725,319
                  
                  
                  
                  19,216**Deferred
                      revenue**
                  
                  
                  3,414
                  
                  
                  
                  2,632**Government
                      grants**(note 15)
                  
                  
                  −
                  
                  
                  
                  723**Long-term
                      debt**(note 10)
                  
                  
                  −
                  
                  
                  
                  354**Future
                      income taxes**(note 16)
                  
                  
                  240
                  
                  
                  
                  −28,973
                  
                  
                  
                  22,925**Commitments**
                      (note 11)**Contingencies**
                      (note 12)**Shareholders’
                      equity**Share
                      capital (note 13)
                  
                  
                  150,019
                  
                  
                  
                  148,921Contributed
                      surplus
                  
                  
                  4,453
                  
                  
                  
                  3,776Retained
                      earnings (note 13)
                  
                  
                  42,275
                  
                  
                  
                  −Cumulative
                      translation adjustment
                  
                  
                  53,418
                  
                  
                  
                  43,537250,165
                  
                  
                  
                  196,234$
                  279,138
                  
                  
                  $
                  219,159
  The accompanying notes are an integral part of these
            consolidated financial statements.
 F-3
 Table
                  of Contents
  **EXFO
            Electro-Optical Engineering Inc.** Consolidated
              Statement of Earnings
 **Years
                      ended August 31,****2007**
                  
                  
                  **2006**
                  
                  
                  **2005****Sales**
                      (note 19)
                  
                  $
                  152,934
                  
                  
                  $
                  128,253
                  
                  
                  $
                  97,216**Cost
                      of sales**(1,2)
                  
                  
                  65,136
                  
                  
                  
                  57,275
                  
                  
                  
                  44,059**Gross
                      margin**
                  
                  
                  87,798
                  
                  
                  
                  70,978
                  
                  
                  
                  53,157**Operating
                      expenses**Selling
                      and administrative (1)
                  
                  
                  49,580
                  
                  
                  
                  40,298
                  
                  
                  
                  31,782Net
                      research and development (1)(notes
                      15
                      and 16)
                  
                  
                  16,668
                  
                  
                  
                  15,404
                  
                  
                  
                  12,190Amortization
                      of property, plant and equipment
                  
                  
                  2,983
                  
                  
                  
                  3,523
                  
                  
                  
                  4,256Amortization
                      of intangible assets
                  
                  
                  2,864
                  
                  
                  
                  4,394
                  
                  
                  
                  4,836Impairment
                      of long-lived assets (note 4)
                  
                  
                  –
                  
                  
                  
                  604
                  
                  
                  
                  –Government
                      grants (note 15)
                  
                  
                  (1,079
                  )
                  
                  
                  (1,307
                  )
                  
                  
                  –Restructuring
                      and other charges (note 4)
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  292**Total
                      operating expenses**
                  
                  
                  71,016
                  
                  
                  
                  62,916
                  
                  
                  
                  53,356**Earnings
                      (loss) from operations**
                  
                  
                  16,782
                  
                  
                  
                  8,062
                  
                  
                  
                  (199
                  )Interest
                      and other income
                  
                  
                  4,717
                  
                  
                  
                  3,253
                  
                  
                  
                  2,524Foreign
                      exchange loss
                  
                  
                  (49
                  )
                  
                  
                  (595
                  )
                  
                  
                  (1,336
                  )**Earnings
                      before income taxes**(note 16)
                  
                  
                  21,450
                  
                  
                  
                  10,720
                  
                  
                  
                  989**Income
                      taxes**(note 16)Current
                  
                  
                  3,741
                  
                  
                  
                  2,585
                  
                  
                  
                  2,623Recognition
                      of previously unrecognized future income tax assets
                  
                  
                  (24,566
                  )
                  
                  
                  –
                  
                  
                  
                  –(20,825
                  )
                  
                  
                  2,585
                  
                  
                  
                  2,623**Net
                      earnings (loss) for the year**
                  
                  $
                  42,275
                  
                  
                  $
                  8,135
                  
                  
                  $
                  (1,634
                  )**Basic
                      and diluted net earnings (loss) per share**
                  
                  $
                  0.61
                  
                  
                  $
                  0.12
                  
                  
                  $
                  (0.02
                  )**Basic
                      weighted average number of shares
                      outstanding (000’s)**
                  
                  
                  68,875
                  
                  
                  
                  68,643
                  
                  
                  
                  68,526**Diluted
                      weighted average number of shares outstanding (000’s)**(note
                      17)
                  
                  
                  69,555
                  
                  
                  
                  69,275
                  
                  
                  
                  68,526(1)  
                      **Stock-based compensation costs included
                      in:**Cost
                      of sales
                  
                  $
                  118
                  
                  
                  $
                  127
                  
                  
                  $
                  143Selling
                      and administrative
                  
                  
                  633
                  
                  
                  
                  701
                  
                  
                  
                  626Net
                      research and development
                  
                  
                  230
                  
                  
                  
                  204
                  
                  
                  
                  194$
                  981
                  
                  
                  $
                  1,032
                  
                  
                  $
                  963(2)  
                      The cost of sales is exclusive of amortization, shown
                      separately.
  The accompanying notes are an integral part of these
            consolidated financial statements.
 
 F-4
 Table
                  of Contents
 EXFO
            Electro-Optical Engineering Inc. Consolidated
              Statements of Retained Earnings (Deficit) and
              Contributed Surplus
 
 **Retained
                      earnings (deficit)****Years
                      ended August 31,****2007**
                  
                  
                  **2006**
                  
                  
                  **2005****Balance
                      – Beginning of year**
                  
                  $
                  –
                  
                  
                  $
                  (381,846
                  )
                  
                  $
                  (380,212
                  )**Add
                      (deduct)**Net
                      earnings (loss) for the year
                  
                  
                  42,275
                  
                  
                  
                  8,135
                  
                  
                  
                  (1,634
                  )Elimination
                      of deficit by reduction of share capital (note 13)
                  
                  
                  –
                  
                  
                  
                  373,711
                  
                  
                  
                  –**Balance
                      – End of year**
                  
                  $
                  42,275
                  
                  
                  $
                  –
                  
                  
                  $
                  (381,846
                  )
 
 
 
 
 
 **Contributed
                      surplus****Years
                      ended August 31,****2007**
                  
                  
                  **2006**
                  
                  
                  **2005****Balance
                      – Beginning of year**
                  
                  $
                  3,776
                  
                  
                  $
                  2,949
                  
                  
                  $
                  1,986**Add
                      (deduct)**Stock-based
                      compensation costs
                  
                  
                  973
                  
                  
                  
                  1,027
                  
                  
                  
                  963Reclassification
                      of stock-based compensation costs to share capital upon exercise
                      of stock
                      awards (note 13)
                  
                  
                  (296
                  )
                  
                  
                  (200
                  )
                  
                  
                  –**Balance
                      – End of year**
                  
                  $
                  4,453
                  
                  
                  $
                  3,776
                  
                  
                  $
                  2,949
 
 The accompanying notes are an integral part of these
            consolidated financial statements.
 F-5
 Table
                  of Contents
 EXFO
            Electro-Optical Engineering Inc. Consolidated
              Statements of Cash Flows
  
 **Years
                        ended August 31,****2007**
                    
                    
                    **2006**
                    
                    
                    **2005****Cash
                        flows from operating activities**Net
                        earnings (loss) for the year
                    
                    $
                    42,275
                    
                    
                    $
                    8,135
                    
                    
                    $
                    (1,634
                    )Add
                        (deduct) items not affecting cashDiscount
                        on short-term investments
                    
                    
                    (404
                    )
                    
                    
                    (229
                    )
                    
                    
                    (302
                    )Stock-based
                        compensation costs
                    
                    
                    981
                    
                    
                    
                    1,032
                    
                    
                    
                    963Amortization
                    
                    
                    5,847
                    
                    
                    
                    7,917
                    
                    
                    
                    9,092Impairment
                        of long-lived assets
                    
                    
                    –
                    
                    
                    
                    604
                    
                    
                    
                    –Gain
                        on disposal of capital assets
                    
                    
                    (117
                    )
                    
                    
                    –
                    
                    
                    
                    –Future
                        income taxes
                    
                    
                    (24,566
                    )
                    
                    
                    –
                    
                    
                    
                    –Deferred
                        revenue
                    
                    
                    1,299
                    
                    
                    
                    786
                    
                    
                    
                    977Government
                        grants
                    
                    
                    (752
                    )
                    
                    
                    (1,307
                    )
                    
                    
                    –24,563
                    
                    
                    
                    16,938
                    
                    
                    
                    9,096Change
                        in non-cash operating itemsAccounts
                        receivable
                    
                    
                    (5,468
                    )
                    
                    
                    (2,637
                    )
                    
                    
                    (838
                    )Income
                        taxes and tax credits
                    
                    
                    (3,403
                    )
                    
                    
                    329
                    
                    
                    
                    6,096Inventories
                    
                    
                    (5,456
                    )
                    
                    
                    (2,287
                    )
                    
                    
                    (699
                    )Prepaid
                        expenses
                    
                    
                    85
                    
                    
                    
                    79
                    
                    
                    
                    544Accounts
                        payable and accrued liabilities
                    
                    
                    4,105
                    
                    
                    
                    (144
                    )
                    
                    
                    (164
                    )14,426
                    
                    
                    
                    12,278
                    
                    
                    
                    14,035**Cash
                        flows from investing activities**Additions
                        to short-term investments
                    
                    
                    (807,056
                    )
                    
                    
                    (673,289
                    )
                    
                    
                    (585,665
                    )Proceeds
                        from disposal and maturity of short-term investments
                    
                    
                    793,435
                    
                    
                    
                    681,500
                    
                    
                    
                    574,207Additions
                        to capital assets
                    
                    
                    (5,547
                    )
                    
                    
                    (3,378
                    )
                    
                    
                    (1,501
                    )Net
                        proceeds from disposal of capital assets
                    
                    
                    3,092
                    
                    
                    
                    –
                    
                    
                    
                    –Business
                        combination, net of cash acquired (note 3)
                    
                    
                    –
                    
                    
                    
                    (18,054
                    )
                    
                    
                    –(16,076
                    )
                    
                    
                    (13,221
                    )
                    
                    
                    (12,959
                    )**Cash
                        flows from financing activities**Repayment
                        of long-term debt
                    
                    
                    (472
                    )
                    
                    
                    (415
                    )
                    
                    
                    (121
                    )Exercise
                        of stock options
                    
                    
                    802
                    
                    
                    
                    557
                    
                    
                    
                    148Share
                        issue expenses
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    (6
                    )330
                    
                    
                    
                    142
                    
                    
                    
                    21**Effect
                        of foreign exchange rate changes on cash**
                    
                    
                    8
                    
                    
                    
                    535
                    
                    
                    
                    863**Change
                        in cash**
                    
                    
                    (1,312
                    )
                    
                    
                    (266
                    )
                    
                    
                    1,960**Cash
                        – Beginning of year**
                    
                    
                    6,853
                    
                    
                    
                    7,119
                    
                    
                    
                    5,159**Cash
                        – End of year**
                    
                    $
                    5,541
                    
                    
                    $
                    6,853
                    
                    
                    $
                    7,119**Supplementary
                        information**Interest
                        paid
                    
                    $
                    57
                    
                    
                    $
                    65
                    
                    
                    $
                    30Income
                        taxes paid (recovered)
                    
                    $
                    3,527
                    
                    
                    $
                    2,541
                    
                    
                    $
                    (669
                    )
  The
            accompanying notes are an integral part of these
            consolidated financial statements.
 F-6
 Table
                    of Contents
  EXFO
              Electro-Optical Engineering Inc. Notes
                to Consolidated Financial Statements
  **1**  **Nature
              of Activities**
  EXFO
              Electro-Optical Engineering Inc. (“EXFO”) designs, manufactures and markets
              a comprehensive line of test, measurement and monitoring solutions for
              the
              global telecommunications industry. The Telecom Division, which represents
              the
              company’s main business activity, offers integrated test solutions to network
              service providers, cable operators, system vendors and optical component
              manufacturers. The Life Sciences and Industrial Division mainly leverages
              core
              telecom technologies to offer value-added solutions for life sciences
              applications and high-precision assembly processes, such as those required
              for
              microelectronics, optoelectronics and medical devices.  EXFO’s
              products are sold in approximately 70 countries around the
              world.
 **2**  **Summary
            of Significant Accounting Policies**
 
 **Basis
            of presentation**
 
 These
            consolidated financial statements have been prepared in accordance with
            generally accepted accounting principles (“GAAP”) in Canada, and significant
            differences in measurement and disclosure from U.S. GAAP are set out
            in note 20.
            These consolidated financial statements include the accounts of the company
            and
            its domestic and international subsidiaries. All significant intercompany
            accounts and transactions have been eliminated.
 
 **Accounting
            estimates**
 
 The
            preparation of financial statements in accordance with generally accepted
            accounting principles requires management to make estimates and assumptions
            that
            affect the reported amounts of assets and liabilities and the disclosures
            of
            contingent assets and liabilities at the date of the financial statements,
            as
            well as the reported amounts of revenues and expenses during the reporting
            years. Significant estimates include the allowance for doubtful accounts
            receivable, the amount of tax credits recoverable, the provision for
            excess and
            obsolete inventories, the useful lives of capital assets, the valuation
            of
            long-lived assets, the valuation allowance for future income taxes, the
            amount
            of certain accrued liabilities and deferred revenue as well as stock-based
            compensation costs. Actual results could differ from those
            estimates.
 
 **Reporting
            currency**
 
 The
            measurement currency of the company is the Canadian dollar. The company
            has
            adopted the US dollar as its reporting currency. The financial statements
            are translated into the reporting currency using the current rate method.
            Under
            this method, the financial statements are translated into the reporting
            currency
            as follows: assets and liabilities are translated at the exchange rate
            in effect
            on the date of the balance sheet, while revenues and expenses are translated
            at
            the monthly average exchange rate. Foreign exchange gains and losses
            arising
            from such translation are included in the cumulative translation adjustment
            in
            shareholders’ equity. Cumulative translation adjustment solely consists of
            such gains and losses.
 
 In
            the
            event that management decides to declare dividends, such dividends would
            be
            declared in Canadian dollars.
 
 **Foreign
            currency translation**
 
 *Foreign
            currency transactions*
 
 Transactions
            denominated in currencies other than the measurement currency are translated
            into the measurement 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 are translated
            at
            historical rates. Foreign exchange gains and losses arising from such
            translation are reflected in the statements of earnings.
 
 F-7
 Table
                  of Contents
 EXFO
              Electro-Optical Engineering Inc.
 Notes
              to Consolidated Financial Statements
 *Integrated
            foreign operations*
 
 The
            financial statements of integrated foreign operations are remeasured
            into the
            measurement currency using the temporal method. Under this method, monetary
            assets and liabilities are remeasured at the exchange rate in effect
            on the date
            of the balance sheet. Non-monetary assets and liabilities are remeasured
            at
            historical rates, unless such assets and liabilities are carried at market
            value, in which case, they are remeasured at the exchange rate in effect
            on the
            date of the balance sheet. Revenues and expenses are remeasured at the
            monthly
            average exchange rate. Foreign exchange gains and losses arising from
            such
            remeasurement are reflected in the statements of earnings.
 
 *Forward
            exchange contracts*
 
 Forward
            exchange contracts are utilized by the company to manage its foreign
            currency
            exposure. 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 used to hedge anticipated
            US-dollar-denominated sales, qualify for hedge accounting; therefore,
            foreign
            exchange translation gains and losses on these contracts are recognized
            as an
            adjustment of the revenues when the corresponding hedged sales are
            recorded.
 
 Realized
            and unrealized foreign exchange gains or losses associated with forward
            exchange
            contracts, which have been terminated or cease to be effective prior
            to
            maturity, are deferred in the balance sheet and recognized in the earnings
            of
            the period in which the underlying hedged transaction is
            recognized.
 
 **Short-term
            investments**
 
 Short-term
            investments are valued at the lower of cost and market value. Cost consists
            of
            acquisition cost plus amortization of discount or less amortization of
            premium.
            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.
 
 **Inventories**
 
 Inventories
            are valued on an average cost basis, at the lower of cost and replacement
            cost
            for raw materials and at the lower of cost and net realizable value for
            work in
            progress and finished goods.
 
 **Property,
            plant and equipment and amortization**
 
 Property,
            plant and equipment are recorded at cost, less related government grants
            and
            research and development tax credits. Amortization is provided on a
            straight-line basis over the estimated useful lives as follows:
 
 **Term**Land
                      improvements
                  
                  5
                      yearsBuildings
                  
                  25
                      yearsEquipment
                  
                  2
                      to 10 yearsLeasehold
                      improvements
                  
                  The
                      lesser of useful life and remaining lease
                      term
 
 **Intangible
            assets, goodwill and amortization**
 
 Intangible
            assets primarily include the cost of core technology and software, net
            of
            accumulated amortization. Core technology represents existing technology
            that
            was acquired in business combinations and that has reached technological
            feasibility. Amortization is provided on a straight-line basis over the
            estimated useful lives of five years for core technology and four and
            ten years
            for software.
 
 F-8
 Table
                  of Contents
 EXFO
              Electro-Optical Engineering Inc.
 Notes
              to Consolidated Financial Statements
 Goodwill
            represents the excess of the purchase price of acquired businesses over
            the
            estimated fair value of net identifiable assets acquired. 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.
            Recoverability of goodwill is determined at the reporting unit level
            using a
            two-step approach. First, the carrying value of a reporting unit is compared
            to
            its fair value, which is usually determined based on a combination of
            discounted
            future cash flows and a market approach. If the carrying value of a reporting
            unit exceeds its fair value, the second step is performed. In this step,
            the
            amount of impairment loss, if any, represents the excess of the carrying
            value
            of goodwill over its fair value, and the loss is charged to earnings
            in the
            period in which it is incurred. For the purposes of this impairment test,
            the
            fair value of goodwill is estimated in the same way as goodwill is determined
            in
            business combinations; that is, the excess of the fair value of a reporting
            unit
            over the estimated fair value of its net identifiable assets.
 
 The
            company elected to perform its annual impairment test in May of each
            fiscal year
            for all its existing reporting units.
 
 **Impairment
            of long-lived assets**
 
 Long-lived
            assets are reviewed for impairment when events or circumstances indicate
            that
            cost may not be recoverable. Impairment exists when the carrying value
            of an
            asset or group of assets is greater than the undiscounted future cash
            flows
            expected to be provided by the asset or group of assets. The amount of
            impairment loss, if any, is the excess of the carrying value over the
            fair
            value. The company assesses fair value of long-lived assets based on
            discounted
            future cash flows.
 
 **Warranty**
 
 The
            company offers its customers 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 original
            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.
 
 **Revenue
            recognition**
 
 For
            products in which software is incidental, the company recognizes revenue
            when
            persuasive evidence of an arrangement exists, the product has been delivered,
            the price is fixed or determinable, and collection of the resulting receivable
            is reasonably assured. In addition, provisions are made for estimated
            returns,
            warranties and support obligations.
 
 For
            products in which software is not incidental, revenues are separated
            into two
            categories: product and post-contract customer support (PCS) revenues,
            based
            upon vendor-specific objective evidence of fair value. Product revenues
            for
            these sales are recognized as described above. PCS revenues are deferred
            and
            recognized ratably over the years of the support arrangement. PCS revenues
            are
            recognized at the time the product is delivered when provided substantially
            within one year of delivery, the costs of providing this support are
            insignificant (and accrued at the time of delivery), and no (or infrequent)
            software upgrades or enhancements are provided.
 
 For
            all
            sales, the company uses a binding purchase order as evidence that a sales
            arrangement exists.
 
 Delivery
            generally occurs when the product is handed over to a transporter for
            shipment.
 
 At
            the
            time of the transaction, the company assesses whether the price associated
            with
            its revenue transaction is fixed or determinable and whether or not collection
            is reasonably assured. The company assesses whether the price is fixed
            or
            determinable based on the payment terms associated with the transaction.
            The
            company assesses collection based on a number of factors, including past
            transaction history and the creditworthiness of the customer. Generally,
            collateral or other security is not requested from customers.
 
 F-9
 Table
                  of Contents
 EXFO
              Electro-Optical Engineering Inc.
 Notes
              to Consolidated Financial Statements
 Most
            sales arrangements do not generally include acceptance clauses. However,
            when a
            sales arrangement does include an acceptance provision, acceptance occurs
            upon
            the earliest of receipt of a written customer acceptance or expiration
            of the
            acceptance period. For these sales arrangements, the sale is recognized
            when
            acceptance occurs.
 
 Revenue
            for extended warranties is recognized on a straight-line basis over the
            warranty
            period.
 
 **Advertising
            costs**
 
 Advertising
            costs are expensed as incurred.
 
 **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 grant.
 
 **Research
            and development expenses**
 
 All
            expenses related to research, as well as development activities that
            do not meet
            generally accepted criteria for deferral are expensed as incurred, net
            of
            related tax credits and government grants. Development expenses that
            meet
            generally accepted criteria for deferral, in accordance with the Canadian
            Institute of Chartered Accountants (CICA) handbook Section 3450, “Research and
            Development”, are capitalized, net of related tax credits and government grants,
            and are amortized against earnings 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, 2007, the company had not deferred any development
            costs.
 
 **Income
            taxes**
 
 The
            company provides for income taxes using the liability method of tax allocation.
            Under this method, future income tax assets and liabilities are determined
            based
            on deductible or taxable temporary differences between financial statement
            values and tax values of assets and liabilities as well as the carry
            forward of
            unused tax losses and reductions, using enacted or substantively enacted
            income
            tax rates expected to be in effect for the years in which the assets
            are
            expected to be realized or the liabilities to be settled.
 
 The
            company establishes a valuation allowance against future income tax assets
            if,
            based on available information, it is more likely than not that some
            or all of
            the future income tax assets will not be realized.
 
 **Earnings
            per share**
 
 Basic
            earnings per share are determined using the weighted average number of
            common
            shares outstanding during the year.
 
 Diluted
            earnings per share are determined using 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-10
 Table
                  of Contents
  EXFO
              Electro-Optical Engineering Inc. Notes
                to Consolidated Financial Statements
 **Stock-based
            compensation costs**
 
 Since
            September 1, 2003, the company accounts for all forms of employee stock-based
            compensation using the fair value-based method. Stock-based compensation
            costs
            are amortized to expense over the vesting periods.
 
 Prior
            to
            fiscal 2004, no stock-based compensation costs were recognized for employee
            stock-based compensation. However, the company is required to disclose
            pro forma
            information with respect to net earnings (loss) and net earnings (loss)
            per
            share as if stock-based compensation costs were recognized in the financial
            statements for all reporting years using the fair value-based method
            for
            unvested outstanding stock options granted prior to September 1, 2003
            (note 14).
 
 **New
            accounting standards and pronouncements**
 
 *To
            be
            adopted after fiscal 2007*
 
 In
            January 2005, the CICA issued four new accounting standards in relation
            to
            financial instruments: Section 3855, “Financial Instruments – Recognition and
            Measurement”; Section 3865, “Hedges”; Section 1530, “Comprehensive Income”; and
            Section 3251, “Equity”.
 
 Section
            3855 expands on Section 3860, “Financial Instruments – Disclosure and
            Presentation”, by prescribing when a financial instrument is to be recognized on
            the balance sheet and at what amount. It also specifies how financial
            instrument
            gains and losses are to be presented in the financial statements.
 
 Section
            3865 provides an alternative to Section 3855 for entities that choose
            to
            designate qualifying transactions as hedges for accounting purposes.
            It replaces
            and expands on Accounting Guideline 13, “Hedging Relationships”, and on the
            hedging guidance in Section 1650, “Foreign Currency Translation”, by specifying
            how hedge accounting is applied and what disclosures it requires.
 
 Section
            1530, “Comprehensive Income”, introduces a new requirement to temporarily
            present certain gains and losses outside net income.
 
 Consequently,
            Section 3250, “Surplus”, has been revised as Section 3251,
“Equity”.
 
 Sections
            1530,
            3251, 3855 and 3865 apply to fiscal years beginning on or after October
            1, 2006.Section 3855 is to be applied retroactively without restatement
            of prior
            years' financial statements.  Any adjustment to financial assets and
            liabilities as at September 1, 2007 will be reflected as an adjustment
            to
            retained earnings or accumulated other comprehensive income.  Section 3865
            also does not permit restatement of prior year's financial statements.
 Any
            gains or losses on hedge relationships that no longer qualify are to
            be
            reflected in retained earnings as at September 1, 2007.  Any gains or
            losses of hedging instruments are adjusted to retained earnings or the
            component
            of accumulated other comprehensive income associated with the hedged
            items.
The
            company
            will adopt these new standards on September 1, 2007 and impacts consistent
            with
            the adjustments described under note 20 items a) and c) will affect the
            consolidated financial statements.
 
 In
            December 2006, the CICA issued three new sections, which provide a complete
            set
            of disclosure and presentation requirements for financial instruments:
            Section
            3862, “Financial Instruments − Disclosures”; Section 3863, “Financial
            Instruments − Presentation”; and Section 1535, “Capital
            Disclosures”.
 
 Section
            3862 is the Canadian equivalent to International Financial Reporting
            Standards
            (IFRS) 7, “Financial Instruments − Disclosures”, and replaces the
            disclosure portion of Section 3861, “Financial
            Instruments − Disclosure and Presentation”. The new standard places
            increased emphasis on disclosures about risks associated with both recognized
            and unrecognized financial instruments and how these risks are managed.
            It is
            also intended to remove any duplicate disclosures and simplify the disclosures
            about concentrations of risk, credit risk, liquidity risk and price risk
            currently found in Section 3861.
 
 Section
            3863 carries forward the presentation requirements from Section 3861,
            unchanged.
 
 F-11
 Table
                  of Contents
 EXFO
              Electro-Optical Engineering Inc.
 Notes
              to Consolidated Financial Statements
 Section
            1535 converges with the capital disclosures amendments to International
            Accounting Standards (IAS) 1, “Presentation of Financial Statements”. Section
            1535 applies to all entities regardless of whether they have financial
            instruments and are subject to external capital requirements. The new
            section
            requires disclosure of information about an entity’s objectives, policies and
            processes for managing capital, as well as quantitative data about capital
            and
            whether the entity has complied with any capital requirements.
 
 Sections
            1535, 3862 and 3863 apply to fiscal years beginning on or after October
            1, 2007.
            The company will adopt these new standards on September 1, 2008, and
            is
            currently assessing the effects these new standards will have on its
            consolidated financial statements.
 
 In
            June
            2007, the CICA issued Section 3031, “Inventories” to harmonize accounting for
            inventories under Canadian GAAP with IFRS. This standard requires the
            measurement of inventories at the lower of cost and net realizable value
            and
            includes guidance on the determination of cost, including allocation
            of
            overheads and other costs to inventory. The standard also requires the
            consistent use of either first-in, first-out (FIFO) or weighted average
            cost
            formula to measure the cost of inventories and requires the reversal
            of previous
            write-downs to net realizable value when there is a subsequent increase
            in the
            value of inventories. The new standard applies to fiscal years beginning
            on or
            after January 1, 2008. The company will adopt this new standard on September
            1,
            2008, and is currently assessing the effects this new standard will have
            on its
            consolidated financial statements.
 
 
 **3**  **Business
            Combination**
 
 On
            January 26, 2006, the company acquired substantially all the assets of
            Consultronics Limited. Based in Toronto, Canada, and with operations
            in the
            United Kingdom and Hungary, Consultronics was a privately held company
            specializing in x-Digital Subscriber Line (xDSL), Internet Protocol TV
            and
            Voice-over-Internet Protocol (VoIP) test solutions for broadband access
            networks.
 
 This
            acquisition was settled for a total cash consideration valued at $19,093,000
            or
            $18,838,000 net of $255,000 of cash acquired. The purchase price allocation
            took
            into account severance expenses of $660,000 (note 4) for the termination
            of
            employees of the acquired business, as well as other acquisition-related
            costs
            of $822,000.
 
 This
            acquisition was accounted for using the purchase method and, consequently,
            the
            results of operations of the acquired business have been included in
            the
            consolidated statements of earnings of the company since January 26,
            2006, being
            the date of acquisition.
 
 The
            purchase price, including acquisition-related costs, was allocated based
            on the
            estimated fair value of acquired net assets at the date of acquisition
            as
            follows:
 
 Assets
                      acquiredCurrent
                      assets, net of cash acquired
                  
                  $
                  5,135Property,
                      plant and equipment
                  
                  
                  3,115Core
                      technology
                  
                  
                  8,709Current
                      liabilities assumed
                  
                  
                  (2,826
                  )Loans
                      assumed
                  
                  
                  (402
                  )Net
                      identifiable assets acquired
                  
                  
                  13,731Goodwill
                  
                  
                  5,107Purchase
                      price, net of cash acquired
                  
                  $
                  18,838
 
 Acquired
            core technology is amortized on a straight-line basis over its estimated
            useful
            life of five years.
 
 This
            business, including acquired goodwill, reports to the Telecom Division.
            Acquired
            goodwill is deductible for tax purposes.
 
 
 F-12
 Table
                  of Contents
 EXFO
              Electro-Optical Engineering Inc.
 Notes
              to Consolidated Financial Statements
 **4**  **Special
            Charges**
 
 **Impairment
            of long-lived assets**
 
 *Year
            ended August 31, 2006*
 
 In
            June
            2006, the company entered into an agreement to sell one of its buildings
            (located in Rochester, NY) along with some equipment, and it recorded
            an
            impairment charge of $604,000 in the third quarter of fiscal 2006. The
            impairment charge represented the excess of the carrying value of these
            assets
            over the expected net selling price of $1,200,000. The sale of these
            assets was
            finalized in the fourth quarter of 2006 for the expected net selling
            price,
            which was received in November 2006. These assets were related to the
            Life
            Science and Industrial Division.
 
 **Restructuring
            and other charges**
 
 *Year
            ended August 31, 2005*
 
 During
            fiscal 2004, the company approved a restructuring plan to consolidate
            the
            operations of its Life Sciences and Industrial Division, transferring
            its
            Rochester, NY, operations mainly to its facilities in Toronto, Canada.
            This
            consolidation process, which started in August 2004, was completed during
            fiscal
            2005.
 
 Overall,
            for that process, the company incurred $2,515,000 in restructuring and
            other
            charges, from which $2,033,000 was recorded in fiscal 2004 and the remaining
            $482,000 was recorded in 2005. The overall costs, which were recorded
            in the
            restructuring and other charges in the statements of earnings of the
            corresponding years, are detailed as follows: $855,000 for severance
            expenses
            for the layoff of all employees at the Rochester facilities, $1,261,000
            mainly
            for the impairment of the building in Rochester, and the remaining $399,000
            for
            other expenses such as training and recruiting expenses and transfer
            of
            assets.
 
 Finally,
            in fiscal 2005, the company recorded adjustments of $190,000 to the fiscal
            2003
            plan because actual charges, mainly for leased equipment, were lower
            than
            expected.
 
 The
            following tables summarize changes in the restructuring charges payable
            since
            August 31, 2004:
 
 **Year
            ended August 31, 2007**
  **Balance
                      as at**
                    **August
                      31,**
                    **2006**
                  
                  
                  **Additions**
                  
                  
                  **Payments**
                  
                  
                  **Adjustments**
                  
                  
                  **Balance
                      as at**
                    **August
                      31,**
                    **2007***Fiscal 2006 plan*Severance expenses (note 3)
                  
                  $
                  631
                  
                  
                  $
                  −
                  
                  
                  $
                  (631
                  )
                  
                  $
                  −
                  
                  
                  $
                  −*Fiscal 2003 plan*Exited leased facilities
                  
                  
                  60
                  
                  
                  
                  −
                  
                  
                  
                  (60
                  )
                  
                  
                  −
                  
                  
                  
                  −Total for all plans (note 9)
                  
                  $
                  691
                  
                  
                  $
                  −
                  
                  
                  $
                  (691
                  )
                  
                  $
                  −
                  
                  
                  $
                  −
 
 
 F-13
 Table
                  of Contents
 EXFO
              Electro-Optical Engineering Inc.
 Notes
              to Consolidated Financial Statements
 **Year
            ended August 31, 2006**
 
 **Balance
                      as at**
                    **August
                      31,**
                    **2005**
                  
                  
                  **Additions**
                  
                  
                  **Payments**
                  
                  
                  **Adjustments**
                  
                  
                  **Balance
                      as at**
                    **August
                      31,**
                    **2006***Fiscal 2006 plan*Severance expenses (note 3)
                  
                  $
                  –
                  
                  
                  $
                  660
                  
                  
                  $
                  (29
                  )
                  
                  $
                  –
                  
                  
                  $
                  631*Fiscal 2003 plan*Exited leased facilities
                  
                  
                  150
                  
                  
                  
                  –
                  
                  
                  
                  (90
                  )
                  
                  
                  –
                  
                  
                  
                  60Total for all plans (note 9)
                  
                  $
                  150
                  
                  
                  $
                  660
                  
                  
                  $
                  (119
                  )
                  
                  $
                  –
                  
                  
                  $
                  691
 
 **Year
            ended August 31, 2005**
 
 **Balance
                      as at**
                    **August
                      31,**
                    **2004**
                  
                  
                  **Additions**
                  
                  
                  **Payments**
                  
                  
                  **Adjustments**
                  
                  
                  **Balance
                      as at**
                    **August
                      31,**
                    **2005***Fiscal 2004 plan*Severance expenses
                  
                  $
                  467
                  
                  
                  $
                  83
                  
                  
                  $
                  (550
                  )
                  
                  $
                  −
                  
                  
                  $
                  −Other
                  
                  
                  −
                  
                  
                  
                  399
                  
                  
                  
                  (399
                  )
                  
                  
                  −
                  
                  
                  
                  −467
                  
                  
                  
                  482
                  
                  
                  
                  (949
                  )
                  
                  
                  −
                  
                  
                  
                  −*Fiscal 2003 plan*Severance expenses
                  
                  
                  109
                  
                  
                  
                  −
                  
                  
                  
                  (77
                  )
                  
                  
                  (32
                  )
                  
                  
                  −Exited leased facilities
                  
                  
                  386
                  
                  
                  
                  −
                  
                  
                  
                  (229
                  )
                  
                  
                  (7
                  )
                  
                  
                  150Other
                  
                  
                  197
                  
                  
                  
                  −
                  
                  
                  
                  (46
                  )
                  
                  
                  (151
                  )
                  
                  
                  −692
                  
                  
                  
                  −
                  
                  
                  
                  (352
                  )
                  
                  
                  (190
                  )
                  
                  
                  150*Fiscal 2001 plan*Exited leased facilities
                  
                  
                  10
                  
                  
                  
                  −
                  
                  
                  
                  (10
                  )
                  
                  
                  −
                  
                  
                  
                  −Total for all plans
                  
                  $
                  1,169
                  
                  
                  $
                  482
                  
                  
                  $
                  (1,311
                  )
                  
                  $
                  (190
                  )
                  
                  $
                  150
 
 
 **5**  **Inventories**
 
 **As
                      at August 31,****2007**
                  
                  
                  **2006**Raw
                      materials
                  
                  $
                  16,898
                  
                  
                  $
                  14,353Work
                      in progress
                  
                  
                  1,387
                  
                  
                  
                  1,043Finished
                      goods
                  
                  
                  13,228
                  
                  
                  
                  9,227$
                  31,513
                  
                  
                  $
                  24,623
 
 
 F-14
 Table
                  of Contents
 EXFO
              Electro-Optical Engineering Inc.
 Notes
              to Consolidated Financial Statements
 **6**  **Property,
            Plant and Equipment**
 
 **As
                      at August 31,****2007**
                  
                  
                  **2006****Cost**
                  
                  
                  **Accumulated**
                    **amortization**
                  
                  
                  **Cost**
                  
                  
                  **Accumulated**
                    **amortization**Land
                      and land improvements
                  
                  $
                  2,265
                  
                  
                  $
                  1,177
                  
                  
                  $
                  4,249
                  
                  
                  $
                  1,082Buildings
                  
                  
                  12,300
                  
                  
                  
                  3,516
                  
                  
                  
                  14,417
                  
                  
                  
                  6,262Equipment
                  
                  
                  33,184
                  
                  
                  
                  25,710
                  
                  
                  
                  33,562
                  
                  
                  
                  28,263Leasehold
                      improvements
                  
                  
                  3,236
                  
                  
                  
                  2,465
                  
                  
                  
                  2,788
                  
                  
                  
                  2,01750,985
                  
                  
                  $
                  32,868
                  
                  
                  
                  55,016
                  
                  
                  $
                  37,624Less:Accumulated
                      amortization
                  
                  
                  32,868
                  
                  
                  
                  
                  
                  
                  
                  37,624$
                  18,117
                  
                  
                  
                  
                  
                  
                  $
                  17,392
 
 As
            at
            August 31, 2007, the carrying value of property, plant and equipment,
            which were
            in the process of being installed and which were not yet amortized, amounted
            to
            $1,488,000.
 
 As
            at
            August 31, 2005, 2006 and 2007, unpaid purchases of property, plant and
            equipment amounted to $111,000, $176,000 and $464,000,
            respectively.
 
 
 **7**  **Intangible
            Assets and Goodwill**
 
 **As
                      at August 31,****2007**
                  
                  
                  **2006****Cost**
                  
                  
                  **Accumulated**
                    **amortization**
                  
                  
                  **Cost**
                  
                  
                  **Accumulated**
                    **amortization**Core
                      technology
                  
                  $
                  50,014
                  
                  
                  $
                  43,298
                  
                  
                  $
                  47,629
                  
                  
                  $
                  38,972Software
                  
                  
                  8,083
                  
                  
                  
                  5,171
                  
                  
                  
                  6,781
                  
                  
                  
                  4,49058,097
                  
                  
                  $
                  48,469
                  
                  
                  
                  54,410
                  
                  
                  $
                  43,462Less:Accumulated
                      amortization
                  
                  
                  48,469
                  
                  
                  
                  
                  
                  
                  
                  43,462$
                  9,628
                  
                  
                  
                  
                  
                  
                  $
                  10,948
 
 Estimated
            amortization expense for intangible assets in each of the next five fiscal
            years
            will amount to $2,705,000 in 2008, $2,658,000 in 2009, $2,606,000 in
            2010,
            $1,392,000 in 2011 and $196,000 in 2012.
 
 Additions
            to intangible assets for the years ended August 31, 2005, 2006 and 2007
            amounted
            to $236,000, $9,190,000 and $1,156,000, respectively.
 
 F-15
 Table
                  of Contents
 EXFO
              Electro-Optical Engineering Inc.
 Notes
              to Consolidated Financial Statements
 Changes
            in the carrying value of goodwill are as follows:
 
 **As
                      at August 31,****2007**
                  
                  
                  **2006**Balance
                      – Beginning of year
                  
                  $
                  27,142
                  
                  
                  $
                  20,370Addition
                      from business combination (note 3)
                  
                  
                  −
                  
                  
                  
                  5,107Foreign
                      currency translation adjustment
                  
                  
                  1,295
                  
                  
                  
                  1,665Balance
                      – End of year (note 19)
                  
                  $
                  28,437
                  
                  
                  $
                  27,142
 
 
 **8**  **Credit
            Facilities**
 
 The
            company has a line of credit that provides for advances of up to CA$10,000,000
            (US$9,466,000). This line of credit bears interest at prime rate (prime
            rate in
            2006).  As at August 31, 2007, this line of credit was
            unused.
 
 The
            company also has another line of credit, which provides for advances
            of up to
            CA$4,500,000 (US$4,260,000) for letters of guarantee. As at August 31,
            2007, an
            amount of CA$1,811,000 (US$1,714,000) was reserved from this line of
            credit
            (note 12).
 
 Finally,
            the company has a third line of credit of $12,000,000 for the foreign
            currency
            exposure related to its forward exchange contracts. As at August 31,
            2007, an
            amount of $701,000 was reserved from this line of credit.
 
 These
            lines of credit are renewable annually. Short-term investments, accounts
            receivable, inventories and all tangible and intangible assets of the
            company
            are pledged as collateral against these lines of credit.
 
 
 **9**  **Accounts
            Payable and Accrued Liabilities**
 
 **As
                      at August 31,****2007**
                  
                  
                  **2006**Trade
                  
                  $
                  11,749
                  
                  
                  $
                  7,487Salaries
                      and social benefits
                  
                  
                  7,929
                  
                  
                  
                  5,991Warranty
                  
                  
                  800
                  
                  
                  
                  1,006Commissions
                  
                  
                  824
                  
                  
                  
                  835Restructuring
                      charges (note 4)
                  
                  
                  −
                  
                  
                  
                  691Other
                  
                  
                  1,419
                  
                  
                  
                  1,327$
                  22,721
                  
                  
                  $
                  17,337
 
 
 F-16
 Table
                  of Contents
 EXFO
              Electro-Optical Engineering Inc.
 Notes
              to Consolidated Financial Statements
 Changes
            in the warranty provision are as follows:
  **As
                      at August 31,****2007**
                  
                  
                  **2006**Balance
                      – Beginning of year
                  
                  $
                  1,006
                  
                  
                  $
                  725Provision
                  
                  
                  801
                  
                  
                  
                  895Settlements
                  
                  
                  (1,007
                  )
                  
                  
                  (645
                  )Addition
                      from business combination
                  
                  
                  −
                  
                  
                  
                  31Balance
                      – End of year
                  
                  $
                  800
                  
                  
                  $
                  1,006
   **10**  **Long-Term
            Debt**
 
 **As
                      at August 31,****2007**
                  
                  
                  **2006**Loans
                      collateralized by equipment, bearing interest at 4.9%, fully
                      repaid in
                      fiscal 2007
                  
                  $
                  −
                  
                  
                  $
                  461Less:
                      Current portion
                  
                  
                  −
                  
                  
                  
                  107$
                  −
                  
                  
                  $
                  354
 
 
 **11**  **Commitments**
 
 The
            company entered into operating leases for certain of its premises and
            equipment,
            which expire at various dates through September 2012. As at August 31,
            2007,
            minimum rentals payable under these operating leases in each of the next
            five
            years will amount to $2,313,000 in 2008, $2,164,000 in 2009, $2,064,000
            in 2010,
            $1,145,000 in 2011 and $598,000 in 2012. Total commitments for these
            operating
            leases amount to $8,327,000.
 
 For
            the
            years ended August 31, 2005, 2006 and 2007, rental expenses amounted
            to
            $1,370,000, $1,523,000 and $1,847,000, respectively.
 
 
 
 F-17
 Table
                  of Contents
 EXFO
              Electro-Optical Engineering Inc.
 Notes
              to Consolidated Financial Statements
 **12**  **Contingencies**
 
 *Class
            action*
 
 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 pre-determined prices.
 
 On
            April
            19, 2002, the plaintiffs filed an amended complaint containing master
            allegations against all of the underwriters in all of the 310 cases included
            in
            this class action and also filed an amended complaint containing allegations
            specific to four of the company’s underwriters, the company and two of its
            executive officers. In addition to the allegations mentioned above, the
            amended
            complaint alleges that the underwriters (i) used their analysts to manipulate
            the stock market; and (ii) implemented schemes that allowed issuer insiders
            to sell their shares rapidly after an initial public offering and benefit
            from
            high market prices. As concerns the company and its two executive officers
            in
            particular, the amended complaint alleges that (i) the company’s registration
            statement was materially false and misleading because it failed to disclose
            the
            additional commissions and compensation to be received by underwriters;
            (ii) the
            two named executive officers learned of or recklessly disregarded the
            alleged
            misconduct of the underwriters; (iii) the two named executive officers
            had
            motive and opportunity to engage in alleged wrongful conduct due to personal
            holdings of the company’s stock and the fact that an alleged artificially
            inflated stock price could be used as currency for acquisitions; and
            (iv) the
            two named executive officers, by virtue of their positions with the company,
            controlled the company and the contents of the registration statement
            and had
            the ability to prevent its issuance or cause it to be corrected. The
            plaintiffs
            in this suit seek an unspecified amount for damages suffered.
 
 In
            July
            2002, the issuers filed a motion to dismiss the plaintiffs’ amended complaint
            and a decision was rendered on February 19, 2003. Only one of the claims
            against the company was dismissed. On October 8, 2002, the claims against
            its officers were dismissed pursuant to the terms of Reservation of Rights
            and
            Tolling Agreements entered into with the plaintiffs.
 
 In
            June
            2004, an agreement of partial settlement was submitted to the court for
            preliminary approval.  The proposed partial settlement was between the
            plaintiffs, the issuer defendants in the consolidated actions, the issuer
            officers and directors named as defendants, and the issuers’ insurance
            companies.  The court granted the preliminary approval motion on
            February 15, 2005, subject to certain modifications.  On
            August 31, 2005, the court issued a preliminary order further approving the
            modifications to the settlement and certifying the settlement
            classes.  The court also appointed the notice administrator for the
            settlement and ordered that notice of the settlement be distributed to
            all
            settlement class members by January 15, 2006.  The settlement
            fairness hearing occurred on April 24, 2006, and the court reserved
            decision at that time.
 
 The
            plaintiffs have continued to litigate against the underwriter defendants. 
The district court has directed that the litigation proceed within a number
            of “focus cases” rather than in all of the 310 cases that have been
            consolidated.  The company's case is not one of these focus
            cases.  On October 13, 2004, the district court certified the focus
            cases as class actions.  The underwriter defendants appealed that
            ruling, and on December 5, 2006, the Court of Appeals for the Second
            Circuit
            reversed the district court’s class certification decision.
 
 
 F-18
 Table
                  of Contents
 EXFO
              Electro-Optical Engineering Inc.
 Notes
              to Consolidated Financial Statements
 On
            April
            6, 2007, the Second Circuit denied the plaintiffs’ petition for rehearing of
            that decision and, on May 18, 2007, the Second Circuit denied the plaintiffs’
petition for rehearing en banc.  In light of the Second Circuit
            opinion, liaison counsel for all issuer defendants, including the company,
            informed the court that this settlement cannot be approved, because the
            defined
            settlement class, like the litigation class, cannot be certified.  On
            June 25, 2007, the district court entered an order terminating the settlement
            agreement.  On August 14, 2007, the plaintiffs filed their second
            consolidated amended class action complaints against the focus cases
            and plan to
            move for class certification again.
 
 It
            is not
            possible to predict whether a settlement that complies with the Second
            Circuit’s
            mandate can be negotiated.  Therefore, it is not possible to predict the
            final outcome of the case, nor to determine the amount of any possible
            losses.
            The company will continue to defend its position in this litigation that
            the
            claims against it, and its officers, are without merit. Accordingly,
            no
            provision for this case has been made in the consolidated financial statements
            as at August 31, 2007.
 
 *Letters
            of guarantee*
 
 As
            at
            August 31, 2007, in the normal course of its operations, the company
            had
            outstanding letters of guarantee for its own selling and purchase requirements
            in the amount of CA$1,811,000 (US$1,714,000), which expire at various
            dates
            through fiscal 2010; these letters of guarantee were reserved from one
            of the
            lines of credit (note 8).
 
 
 **13**  **Share
            Capital**
 
 Authorized –
            unlimited as to number, without par value
 Subordinate
                      voting and participating, bearing a non-cumulative dividend
                      to be
                      determined by the Board of Directors,ranking
                      pari passu with multiple voting
                      shares
 Multiple
                        voting and participating, entitling to ten votes each, bearing
                        a
                        non-cumulative dividend to be determined by the Board of
                        Directors,
                        convertible at the holder’s option into subordinate voting shares on a
                        one-for-  one basis, ranking pari passu with subordinate voting
                        shares
 
 F-19
 Table
                  of Contents
  EXFO
              Electro-Optical Engineering Inc. Notes
                to Consolidated Financial Statements
 The
            following table summarizes the share capital activity since August 31,
            2004:
 **Multiple
                        voting shares**
                    
                    
                    **Subordinate
                        voting shares****Number**
                    
                    
                    **Amount**
                    
                    
                    **Number**
                    
                    
                    **Amount**
                    
                    
                    **Total amount**Balance
                        as at August 31, 2004
                    
                    
                    37,900,000
                    
                    
                    $
                    1
                    
                    
                    
                    30,540,483
                    
                    
                    $
                    521,732
                    
                    
                    $
                    521,733Exercise
                        of stock options (note 14)
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    71,699
                    
                    
                    
                    148
                    
                    
                    
                    148Redemption
                        of restricted stock awards
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    53,592
                    
                    
                    
                    –
                    
                    
                    
                    –Share
                        issue expenses
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    (6
                    )
                    
                    
                    (6
                    )Balance
                        as at August 31, 2005
                    
                    
                    37,900,000
                    
                    
                    
                    1
                    
                    
                    
                    30,665,774
                    
                    
                    
                    521,874
                    
                    
                    
                    521,875Exercise
                        of stock options (note 14)
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    182,425
                    
                    
                    
                    557
                    
                    
                    
                    557Redemption
                        of  restricted share units (note 14)
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    4,770
                    
                    
                    
                    –
                    
                    
                    
                    –Conversion
                        of multiple voting shares into subordinate voting shares
                    
                    
                    (757,000
                    )
                    
                    
                    –
                    
                    
                    
                    757,000
                    
                    
                    
                    –
                    
                    
                    
                    –Reclassification
                        of stock-based compensation costs to share capital upon exercise
                        of stock
                        awards
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    200
                    
                    
                    
                    200Elimination
                        of deficit by reduction of share capital (1)
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    (373,711
                    )
                    
                    
                    (373,711
                    )Balance
                        as at August 31, 2006
                    
                    
                    37,143,000
                    
                    
                    
                    1
                    
                    
                    
                    31,609,969
                    
                    
                    
                    148,920
                    
                    
                    
                    148,921Exercise
                        of stock options (note 14)
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    250,528
                    
                    
                    
                    802
                    
                    
                    
                    802Redemption
                        of  restricted share units (note 14)
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    1,064
                    
                    
                    
                    –
                    
                    
                    
                    –Conversion
                        of multiple voting shares into subordinate voting shares
                    
                    
                    (500,000
                    )
                    
                    
                    –
                    
                    
                    
                    500,000
                    
                    
                    
                    –
                    
                    
                    
                    –Reclassification
                        of stock-based compensation costs to share capital upon exercise
                        of stock
                        awards
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    296
                    
                    
                    
                    296Balance
                        as at August 31, 2007
                    
                    
                    36,643,000
                    
                    
                    $
                    1
                    
                    
                    
                    32,361,561
                    
                    
                    $
                    150,018
                    
                    
                    $
                    150,019
  (1)
                  On
                      August 31, 2006, upon the approval of the Board of Directors,
                      the company
                      eliminated its deficit against its share
                      capital.
 
 
 **14**  **Stock-Based
            Compensation Plans**
 
 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.
 
 
 F-20
 Table
                  of Contents
 EXFO
              Electro-Optical Engineering Inc.
 Notes
              to Consolidated Financial Statements
 **Long-term
            incentive plan**
 
 In
            May
            2000, the company established a Stock Option Plan for directors, executive
            officers and employees and those of the company’s subsidiaries, as determined by
            the Board of Directors. In January 2005, the company made certain amendments
            to
            the existing Stock Option Plan, including the renaming of the plan to
            Long-Term
            Incentive Plan, which includes stock options and restricted share units.
            This
            plan 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 generally expire ten years from the date of grant
            and
            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. The Board of Directors may accelerate
            the
            vesting of any or all outstanding stock options upon the occurrence of
            a change
            of control.
 
 The
            following table summarizes stock option activity since August 31,
            2004:
  **Years
                        ended August 31,****2007**
                    
                    
                    **2006**
                    
                    
                    **2005****Number**
                    
                    
                    **Weighted**
                      **average**
                      **exercise**
                      **price**
                    
                    
                    **Number**
                    
                    
                    **Weighted
                        average**
                      **exercise**
                      **price**
                    
                    
                    **Number**
                    
                    
                    **Weighted
                        average**
                      **exercise**
                      **price****(CA$)**
                    
                    
                    
                    
                    
                    **(CA$)**
                    
                    
                    
                    
                    
                    **(CA$)**Outstanding
                        – Beginning of year
                    
                    
                    2,439,375
                    
                    
                    $
                    20
                    
                    
                    
                    2,763,759
                    
                    
                    $
                    19
                    
                    
                    
                    2,934,518
                    
                    
                    $
                    21Granted
                    
                    
                    −
                    
                    
                    
                    −
                    
                    
                    
                    31,992
                    
                    
                    
                    6
                    
                    
                    
                    246,233
                    
                    
                    
                    6Exercised
                    
                    
                    (250,528
                    )
                    
                    
                    (4
                    )
                    
                    
                    (182,425
                    )
                    
                    
                    (4
                    )
                    
                    
                    (71,699
                    )
                    
                    
                    (3
                    )Forfeited
                    
                    
                    (259,459
                    )
                    
                    
                    (32
                    )
                    
                    
                    (173,951
                    )
                    
                    
                    (18
                    )
                    
                    
                    (345,293
                    )
                    
                    
                    (27
                    )Outstanding
                        – End of year
                    
                    
                    1,929,388
                    
                    
                    $
                    21
                    
                    
                    
                    2,439,375
                    
                    
                    $
                    20
                    
                    
                    
                    2,763,759
                    
                    
                    $
                    19Exercisable
                        – End of year
                    
                    
                    1,746,699
                    
                    
                    $
                    22
                    
                    
                    
                    1,852,870
                    
                    
                    $
                    25
                    
                    
                    
                    1,650,404
                    
                    
                    $
                    28
  The
            intrinsic value of stock options exercised during fiscal 2005, 2006 and
            2007,
            was CA$214,000 (US$174,000), CA$552,000 (US$481,000) and CA$833,000
            (US$743,000), respectively.
 
 The
            weighted average grant-date fair value of stock options granted during
            fiscal
            2005 and 2006 amounted to CA$5.68, and CA$5.50, respectively.
 
 Expected
            forfeitures are immaterial to the company and are not reflected in the
            table
            above.
 
 As
            at
            August 31, 2007, unrecognized stock-based compensation costs of unvested
            stock
            options amounted to $159,000. The weighted average period over which
            they are
            expected to be recognized is 1.5 year.
 
 The
            fair
            value of stock options granted in fiscal 2005 and 2006 was estimated
            using the
            Black-Scholes options valuation model with the following weighted average
            assumptions:
 
 **Years
                      ended August 31,****2006**
                  
                  **2005**Risk-free
                      interest rate
                  
                  3.9%
                  
                  3.6%Expected
                      volatility
                  
                  87%
                  
                  95%Dividend
                      yield
                  
                  Nil
                  
                  NilExpected
                      life
                  
                  66
                      months
                  
                  66
                      months
 
 
 F-21
 Table
                  of Contents
 EXFO
              Electro-Optical Engineering Inc.
 Notes
              to Consolidated Financial Statements
 The
            factors considered in developing assumptions used in the Black-Scholes
            option
            valuation model are the following:
 
 The
            risk-free interest rate is based on the interest rate on Government of
            Canada
            bonds for maturities consistent with the expected life of the stock options.
            The
            historical volatility of the company’s common shares price is used to establish
            the expected share price volatility. Finally, the company estimates the
            expected
            life of the stock options based on historical data related to employees’
exercise of stock options.
 
 The
            company is required to make pro forma disclosures of net earnings (loss)
            and net
            earnings (loss) per share for any periods included in the financial statements,
            as if the fair value-based method of accounting had been applied to outstanding
            unvested awards granted prior to September 1, 2003. Consequently, if
            the fair value-based method had been applied to unvested stock options
            granted
            prior to September 1, 2003, and outstanding as at August 31, 2005,
            2006 and 2007, the net earnings (loss) per share and the pro forma net
            earnings
            (loss) per share would have been the same for all reporting years.
 
 The
            following table summarizes information about stock options as at August
            31,
            2007:
  **Stock
                        options outstanding**
                    
                    **Stock
                        options exercisable****Exercise
                        price**
                    
                    **Number**
                    
                    **Weighted**
                      **average**
                      **exercise**
                      **price**
                    
                    **Intrinsic**
                      **value**
                    
                    **Weighted**
                      **average**
                      **remaining**
                      **contractual**
                      **life**
                    
                    **Number**
                    
                    **Weighted**
                      **average**
                      **exercise**
                      **price**
                    
                    **Intrinsic**
                      **value**
                    
                    **Weighted**
                      **average**
                      **remaining**
                      **contractual**
                      **life****(CA$)**
                    
                    
                    
                    **(CA$)**
                    
                    **(CA$)**
                    
                    
                    
                    
                    
                    **(CA$)**
                    
                    **(CA$)**$2.50
                        to $3.36
                    
                    280,625
                    
                    $ 2.51
                    
                    $1,280
                    
                    5.1
                        years
                    
                    280,625
                    
                    $ 2.51
                    
                    $1,280
                    
                    5.1
                        years$3.96
                        to $5.84
                    
                    429,404
                    
                    5.11
                    
                    841
                    
                    6.7
                        years
                    
                    285,133
                    
                    5.01
                    
                    587
                    
                    6.4
                        years$6.22
                        to $9.02
                    
                    157,316
                    
                    6.58
                    
                    116
                    
                    6.4
                        years
                    
                    118,898
                    
                    6.70
                    
                    83
                    
                    6.3
                        years$14.27
                        to $20.00
                    
                    412,296
                    
                    15.61
                    
                    −
                    
                    4.1
                        years
                    
                    412,296
                    
                    15.61
                    
                    −
                    
                    4.1
                        years$29.70
                        to $43.00
                    
                    468,926
                    
                    36.36
                    
                    −
                    
                    3.2
                        years
                    
                    468,926
                    
                    36.36
                    
                    −
                    
                    3.2
                        years$51.25
                        to $68.17
                    
                    143,391
                    
                    66.58
                    
                    −
                    
                    3.0
                        years
                    
                    143,391
                    
                    66.58
                    
                    −
                    
                    3.0
                        years$83.66
                    
                    37,430
                    
                    83.66
                    
                    −
                    
                    3.0
                        years
                    
                    37,430
                    
                    83.66
                    
                    −
                    
                    3.0
                        years1,929,388
                    
                    $20.78
                    
                    $2,237
                    
                    4.7
                        years
                    
                    1,746,699
                    
                    $ 22.38
                    
                    $1,950
                    
                    4.4
                        years
  *Restricted
            Share Units (RSUs)*
 
 RSUs
            are
“phantom” shares that rise and fall in value based on the value 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 ten years from the award date, being the
            required
            period of service from employees. RSUs granted under the plan expire
            at the
            latest ten years from the date of grant. Fair value of RSUs equals the
            market
            price of the common shares on the date of grant. This plan was approved
            by the
            shareholders of the company.
 
 The
            following table summarizes RSUs activity since January 2005:
 
 **Years
                      ended August 31,****2007**
                  
                  
                  **2006**
                  
                  
                  **2005**Outstanding
                      – Beginning of year
                  
                  
                  327,877
                  
                  
                  
                  176,185
                  
                  
                  
                  –Granted
                  
                  
                  219,002
                  
                  
                  
                  173,803
                  
                  
                  
                  176,185Redeemed
                  
                  
                  (1,064
                  )
                  
                  
                  (4,770
                  )
                  
                  
                  –Forfeited
                  
                  
                  (57,800
                  )
                  
                  
                  (17,341
                  )
                  
                  
                  –Outstanding
                      – End of year
                  
                  
                  488,015
                  
                  
                  
                  327,877
                  
                  
                  
                  176,185
 
 
 F-22
 Table
                  of Contents
 EXFO
              Electro-Optical Engineering Inc.
 Notes
              to Consolidated Financial Statements
 None
            of
            the RSUs outstanding as at August 31, 2005, 2006 and 2007, were redeemable.
            As
            at August 31, 2007, the weighted average remaining contractual life of
            the outstanding RSUs was 8.5 years. The weighted average grant-date fair
            value of RSUs granted during fiscal 2005, 2006 and 2007 amounted to CA$5.72,
            CA$6.18 and CA$7.48, respectively.
 
 As
            at
            August 31, 2007, the intrinsic value of RSUs outstanding was CA$3,450,000
            (US$3,266,000).
 
 Expected
            forfeitures are immaterial to the company and are not reflected in the
            table
            above.
 
 As
            at
            August 31, 2007, unrecognized stock-based compensation costs of unvested
            RSUs
            amounted to $1,843,000. The weighted average period over which they are
            expected
            to be recognized is 3.4 years.
 
 **Deferred
            share unit plan**
 
 In
            January 2005, 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 will be redeemed in subordinate voting
            shares
            when the Board member will cease to be Director of the company. This
            plan was
            approved by the shareholders of the company.
 
 The
            following table summarizes DSU activity since January 2005:
 
 **Years
                      ended August 31,****2007**
                  
                  
                  **2006**
                  
                  
                  **2005**Outstanding
                      – Beginning of year
                  
                  
                  43,290
                  
                  
                  
                  23,734
                  
                  
                  
                  –Granted
                  
                  
                  21,428
                  
                  
                  
                  19,556
                  
                  
                  
                  23,734Outstanding
                      – End of year
                  
                  
                  64,718
                  
                  
                  
                  43,290
                  
                  
                  
                  23,734
 
 None
            of
            the DSUs outstanding as at August 31, 2005, 2006 and 2007 were redeemable.
            The
            weighted average grant-date fair value of DSUs granted during fiscal
            2005, 2006
            and 2007 amounted to CA$5.50, CA$6.56 and CA$7.00.
 
 As
            at
            August 31, 2007, the intrinsic value of DSUs outstanding was CA$458,000
            (US$433,000).
 
 **Stock
            appreciation rights plan**
 
 In
            August
            2001, 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 generally expire
            ten
            years from the date of grant and vest over a four-year period, being
            the
            required period of service from employees, with 25% vesting on an annual
            basis
            commencing on the first anniversary of the date of grant. This plan was
            approved
            by the shareholders of the company.
 
 
 F-23
 Table
                  of Contents
 EXFO
              Electro-Optical Engineering Inc.
 Notes
              to Consolidated Financial Statements
 The
            following table summarizes stock appreciation rights activity since August
            31,
            2004:
 
 **Years
                      ended August 31,****2007**
                  
                  
                  **2006**
                  
                  
                  **2005****Number**
                  
                  
                  **Weighted
                      average exercise**
                    **price**
                  
                  
                  **Number**
                  
                  
                  **Weighted
                      average exercise**
                    **price**
                  
                  
                  **Number**
                  
                  
                  **Weighted
                      average exercise**
                    **price**Outstanding
                      – Beginning of year
                  
                  
                  24,500
                  
                  
                  $
                  11
                  
                  
                  
                  19,000
                  
                  
                  $
                  12
                  
                  
                  
                  13,000
                  
                  
                  $
                  16Granted
                  
                  
                  5,200
                  
                  
                  
                  6
                  
                  
                  
                  5,500
                  
                  
                  
                  6
                  
                  
                  
                  6,000
                  
                  
                  
                  4Forfeited
                  
                  
                  (2,000
                  )
                  
                  
                  (2
                  )
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  –Outstanding
                      – End of year
                  
                  
                  27,700
                  
                  
                  $
                  11
                  
                  
                  
                  24,500
                  
                  
                  $
                  11
                  
                  
                  
                  19,000
                  
                  
                  $
                  12Exercisable
                      – End of year
                  
                  
                  13,875
                  
                  
                  $
                  15
                  
                  
                  
                  11,000
                  
                  
                  $
                  18
                  
                  
                  
                  7,500
                  
                  
                  $
                  24
 
 The
            following table summarizes information about stock appreciation rights
            as at
            August 31, 2007:
 
 **Stock
                      appreciation**
                    **rights
                      outstanding**
                  
                  **Stock
                      appreciation**
                    **rights
                      exercisable****Exercise
                      price**
                  
                  **Number**
                  
                  **Weighted
                      average remaining contractual life**
                  
                  **Number**$4.51
                      to $6.50
                  
                  22,700
                  
                  7.9
                      years
                  
                  8,875$22.25
                  
                  2,500
                  
                  3.4
                      years
                  
                  2,500$45.94
                  
                  2,500
                  
                  3.0
                      years
                  
                  2,50027,700
                  
                  6.6
                      years
                  
                  13,875
 
 
 **15**  **Other
            Disclosures**
 
 **Net
            research and development expenses**
 
 Net
            research and development expenses comprise the following:
 
 **Years
                      ended August 31,****2007**
                  
                  
                  **2006**
                  
                  
                  **2005**Gross
                      research and development expenses
                  
                  $
                  25,201
                  
                  
                  $
                  19,488
                  
                  
                  $
                  15,878Research
                      and development tax credits and grants
                  
                  
                  (5,371
                  )
                  
                  
                  (4,084
                  )
                  
                  
                  (3,688
                  )Recognition
                      of previously unrecognized research and development tax credits
                      (note
                      16)
                  
                  
                  (3,162
                  )
                  
                  
                  –
                  
                  
                  
                  –$
                  16,668
                  
                  
                  $
                  15,404
                  
                  
                  $
                  12,190
 
 
 F-24
 Table
                  of Contents
 EXFO
              Electro-Optical Engineering Inc.
 Notes
              to Consolidated Financial Statements
 **Government
            grants**
 
 During
            1998, the company entered into an agreement with the Quebec Minister
            of
            Industry, Commerce, Science and Technology (“The Minister”). Pursuant to this
            agreement, the Minister agreed to contribute, in the form of grants,
            up to
            CA$2,220,000 over the period from January 1, 1998, through December 31,
            2002,
            payable based on the number of full-time jobs created during that
            period.
 
 The
            above
            grants were subject to the condition that jobs created pursuant to the
            agreement
            be maintained for a period of at least five years from the date of creation.
            Since the beginning of the program, the company had deferred in the balance
            sheet CA$1,450,000 (US$1,307,000) from the amounts received until it
            received
            the final approval by the sponsor of the program related to jobs created.
            In
            fiscal 2006, the sponsor of the program granted the company with its
            final
            approval and the company recorded CA$1,450,000 (US$1,307,000) in the
            earnings
            from operations in the statement of earnings of fiscal 2006.
 
 Furthermore,
            until December 31, 2006, companies operating in the Quebec City area
            were
            eligible for a refundable credit granted by the Quebec provincial government.
            This credit was earned based on the increase of eligible production and
            marketing salaries incurred in the Quebec City area at a rate of 40%.
            From the
            total amount claimed by the company under this program, a sum of CA$1,142,000
            (US$1,079,000) was deferred in the balance sheet until the company received
            the
            final approval of eligible salaries by the sponsor of the program. In
            fiscal
            2007, the sponsor of the program granted the company with its final approval,
            and the company recorded CA$1,142,000 (US$1,079,000) in the earnings
            from
            operations in the statement of earnings of fiscal 2007.
 
 Following
            is a summary of the classification of these and certain other grants
            and credits
            (government grants) in the statements of earnings of the reporting
            years:
 
 **Years
                      ended August 31,****2007**
                  
                  
                  **2006**
                  
                  
                  **2005**Cost
                      of sales
                  
                  $
                  186
                  
                  
                  $
                  262
                  
                  
                  $
                  89Selling
                      and administrative
                  
                  $
                  11
                  
                  
                  $
                  76
                  
                  
                  $
                  32Net
                      research and development
                  
                  $
                  9
                  
                  
                  $
                  4
                  
                  
                  $
                  22Government
                      grants
                  
                  $
                  1,079
                  
                  
                  $
                  1,307
                  
                  
                  $
                  –
 
 **Defined
            contribution plans**
 
 The
            company maintains separate defined contribution plans for certain eligible
            employees. These plans, which are accounted for on an accrual basis,
            are
            summarized as follows:
  ·
                  Deferred
                      profit-sharing plan
  The
            company maintains a plan for certain eligible Canadian resident employees,
            under
            which the company may elect to contribute an amount equal to 2% (1% prior
            to
            June 2005) of an employee’s gross salary, provided that the employee has
            contributed at least 2% of his gross salary to a tax-deferred registered
            retirement savings plan. Cash contributions to this plan and expenses
            for the
            years ended August 31, 2005, 2006 and 2007, amounted to CA$221,000 (US$179,000),
            CA$363,000 (US$316,000) and CA$470,000 (US$419,000), respectively.
 
 ·
                  401K
                      plan
 
 The
            company maintains a 401K plan for eligible U.S. resident employees. Under
            this
            plan, the company must contribute an amount equal to 3% of an employee’s current
            compensation. During the years ended August 31, 2005, 2006 and 2007,
            the company
            recorded cash contributions and expenses totaling $134,000, $126,000
            and
            $166,000, respectively.
 
 F-25
 Table
                  of Contents
 EXFO
              Electro-Optical Engineering Inc.
 Notes
              to Consolidated Financial Statements
 **16**  **Income
            Taxes**
 
 During
            fiscal 2003, following the downturn in the telecommunications industry,
            the
            company recorded a full valuation allowance on its future income tax
            assets in
            every applicable tax jurisdictions and we wrote off non-refundable research
            and
            development tax credits because it was more likely than not that these
            assets
            would not be realized.
 
 On
            an
            ongoing basis, the company reviews available positive and negative evidences
            to
            evaluate the recoverability of its future income tax assets and deferred
            non-refundable research and development tax credits.
 
 During
            fiscal 2007, after reviewing both available positive and negative evidences,
            and
            because the company is in a cumulative profit position in the parent
            company
            (Canadian federal and provinces level) and in one of its subsidiaries,
            located
            in the United States, and also because the company expects to generate
            sufficient taxable income in future years, management concluded that
            it was more
            likely than not that future income tax assets and deferred non-refundable
            research and development tax credits of the parent company and a portion
            of the
            company’s future income tax assets in the United States would be realizable.
            Consequently, it reversed a portion of its valuation allowance against
            future
            income tax assets in the amount of $24,566,000 and recognized previously
            unrecognized non-refundable research and development tax credits in the
            amount
            of $3,162,000 (note 15). Future income tax assets recognized in 2007
            were
            recorded in the income tax provision, while research and development
            tax credits
            were recorded against gross research and development expenses in the
            statement
            of earnings.
 
 However,
            in the United States (federal level), based on available positive and
            negative
            evidences as well as the level and the nature of cumulative profits,
            the company
            maintained a valuation allowance of $7,568,000 on a portion of its future
            income
            tax assets in this tax jurisdiction because it is more likely than not
            that
            these assets will not be recovered. These future income tax assets consist
            of
            deferred operating losses; some of these losses expire between 2022 and
            2026,
            while others can be carried forward indefinitely against future years’ taxable
            income.
 
 In
            other
            tax jurisdictions where the company has future income tax assets, the
            company is
            still in a cumulative loss position and available negative evidences
            outweigh
            positive evidences. For these tax jurisdictions, the company maintains
            a full
            valuation allowance against its future income tax assets. As at August
            31, 2007,
            the valuation allowance recorded by the company for these tax jurisdictions
            amounted to $4,924,000 and mainly relates to deferred operating losses,
            which
            expire at various dates over the next 20 years.
 
 
 F-26
 Table
                  of Contents
 EXFO
              Electro-Optical Engineering Inc.
 Notes
              to Consolidated Financial Statements
 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,****2007**
                  
                  
                  **2006**
                  
                  
                  **2005**Income
                      tax provision at combined Canadian federal and provincial statutory
                      tax
                      rate (32% in 2007 and 2006 and 31% in 2005)
                  
                  $
                  6,864
                  
                  
                  $
                  3,430
                  
                  
                  $
                  307Increase
                      (decrease) due to:Foreign
                      income taxed at different rates
                  
                  
                  (12
                  )
                  
                  
                  (85
                  )
                  
                  
                  (580
                  )Non-taxable
                      income
                  
                  
                  (109
                  )
                  
                  
                  (207
                  )
                  
                  
                  (827
                  )Non-deductible
                      expenses
                  
                  
                  692
                  
                  
                  
                  527
                  
                  
                  
                  784Tax
                      deductions
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  (81
                  )Change
                      in tax rates
                  
                  
                  105
                  
                  
                  
                  497
                  
                  
                  
                  –Foreign
                      exchange effect of translation of foreign integrated
                      subsidiaries
                  
                  
                  45
                  
                  
                  
                  61
                  
                  
                  
                  (209
                  )Other
                  
                  
                  236
                  
                  
                  
                  239
                  
                  
                  
                  (146
                  )Recognition
                      of previously unrecognized future income tax assets
                  
                  
                  (24,566
                  )
                  
                  
                  –
                  
                  
                  
                  –Utilization
                      of previously unrecognized  future income tax
                      assets
                  
                  
                  (4,080
                  )
                  
                  
                  (1,877
                  )
                  
                  
                  –Unrecognized  future
                      income tax assets on temporary deductible differences and unused
                      tax
                      losses and deductions
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  3,375$
                  (20,825
                  )
                  
                  $
                  2,585
                  
                  
                  $
                  2,623The
                      income tax provision consists of the following:CurrentCanadian
                  
                  $
                  3,568
                  
                  
                  $
                  2,573
                  
                  
                  $
                  2,513Other
                  
                  
                  173
                  
                  
                  
                  12
                  
                  
                  
                  1103,741
                  
                  
                  
                  2,585
                  
                  
                  
                  2,623FutureCanadian
                  
                  
                  3,726
                  
                  
                  
                  2,687
                  
                  
                  
                  (1,445
                  )United
                      States
                  
                  
                  428
                  
                  
                  
                  (601
                  )
                  
                  
                  (1,723
                  )Other
                  
                  
                  (74
                  )
                  
                  
                  (209
                  )
                  
                  
                  (207
                  )4,080
                  
                  
                  
                  1,877
                  
                  
                  
                  (3,375
                  )Valuation
                      allowanceCanadian
                  
                  
                  (23,092
                  )
                  
                  
                  (2,687
                  )
                  
                  
                  1,445United
                      States
                  
                  
                  (5,628
                  )
                  
                  
                  601
                  
                  
                  
                  1,723Other
                  
                  
                  74
                  
                  
                  
                  209
                  
                  
                  
                  207(28,646
                  )
                  
                  
                  (1,877
                  )
                  
                  
                  3,375(24,566
                  )
                  
                  
                  –
                  
                  
                  
                  –$
                  (20,825
                  )
                  
                  $
                  2,585
                  
                  
                  $
                  2,623Details
                      of the company’s income taxes:Earnings
                      (loss) before income taxesCanadian
                  
                  $
                  19,634
                  
                  
                  $
                  13,202
                  
                  
                  $
                  3,092United
                      States
                  
                  
                  1,059
                  
                  
                  
                  (2,103
                  )
                  
                  
                  (953
                  )Other
                  
                  
                  757
                  
                  
                  
                  (379
                  )
                  
                  
                  (1,150
                  )$
                  21,450
                  
                  
                  $
                  10,720
                  
                  
                  $
                  989
 
 Except
            for the reversal of the valuation allowance recorded in fiscal 2007,
            most of the
            company’s income tax provision for fiscal 2005, 2006 and 2007 represents income
            taxes payable at the Canadian federal level, which are reduced by research
            and
            development tax credits that are recorded against gross research and
            development
            expenses in the statements of earnings.
 
 F-27
 Table
                  of Contents
 EXFO
              Electro-Optical Engineering Inc.
 Notes
              to Consolidated Financial Statements
 Significant
            components of the company’s future income tax assets and liabilities are as
            follows:
 
 **As
                      at August 31,****2007**
                  
                  
                  **2006**Future
                      income tax assetsLong-lived
                      assets
                  
                  $
                  4,304
                  
                  
                  $
                  4,453Provisions
                      and accruals
                  
                  
                  6,257
                  
                  
                  
                  7,315Deferred
                      revenue
                  
                  
                  1,005
                  
                  
                  
                  486Share
                      issue expenses
                  
                  
                  106
                  
                  
                  
                  531Research
                      and development expenses
                  
                  
                  10,422
                  
                  
                  
                  8,527Losses
                      carried forward
                  
                  
                  17,230
                  
                  
                  
                  18,11839,324
                  
                  
                  
                  39,430Valuation
                      allowance
                  
                  
                  (12,492
                  )
                  
                  
                  (38,543
                  )26,832
                  
                  
                  
                  887Future
                      income tax liabilitiesResearch
                      and development tax credits
                  
                  
                  (2,026
                  )
                  
                  
                  (887
                  )Provisions
                      and accruals
                  
                  
                  (240
                  )
                  
                  
                  –(2,266
                  )
                  
                  
                  (887
                  )Future
                      income tax assets, net
                  
                  $
                  24,566
                  
                  
                  $
                  –
 
 As
            at
            August 31, 2007, the company had available operating and capital losses
            in
            several tax jurisdictions, against which a valuation allowance of $10,663,000
            was recorded. The following table summarizes the year of expiry of these
            losses
            by tax jurisdiction:
 
 **Canada**
                  
                  
                  **United
                      States****Year
                      of expiry**
                  
                  **Federal**
                  
                  
                  **Provinces**
                  
                  
                  **and
                      Other**2008
                  
                  $
                  1,230
                  
                  
                  $
                  869
                  
                  
                  $
                  –2009
                  
                  
                  2,845
                  
                  
                  
                  162
                  
                  
                  
                  –2010
                  
                  
                  4,663
                  
                  
                  
                  176
                  
                  
                  
                  –2014
                  
                  
                  177
                  
                  
                  
                  84
                  
                  
                  
                  –2015
                  
                  
                  1,181
                  
                  
                  
                  1,181
                  
                  
                  
                  –2022
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  3,7952023
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  7,4992024
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  4,5642025
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  5,2172026
                  
                  
                  1,081
                  
                  
                  
                  1,081
                  
                  
                  
                  2,3082027
                  
                  
                  1,103
                  
                  
                  
                  1,103
                  
                  
                  
                  –Indefinite
                  
                  
                  1,523
                  
                  
                  
                  1,855
                  
                  
                  
                  17,610$
                  13,803
                  
                  
                  $
                  6,511
                  
                  
                  $
                  40,993
 
 As
            at
            August 31, 2007, in addition to operating and capital losses, the company
            had
            available research and development expenses in Canada amounting to $47,717,000
            at the federal level and $9,352,000 at the provinces level, against which
            a
            valuation allowance of $1,331,000 was recorded. These expenses can be
            carried
            forward indefinitely against future years’ taxable income in their respective
            tax jurisdiction.
 
 F-28
 Table
                  of Contents
 EXFO
              Electro-Optical Engineering Inc.
 Notes
              to Consolidated Financial Statements
 Finally,
            as at August 31, 2007, the company had non-refundable research and development
            tax credits at the Canadian federal level in the amount of $3,815,000
            that can
            be carried forward against future years’ income taxes payable over the next 20
            years. As at August 31, 2007, from this amount, $653,000 was not recorded
            in the
            financial statements.
 
 
 **17**  **Earnings
            per Share**
  The
            following table summarizes the reconciliation of the basic weighted average
            number of shares outstanding and the diluted weighted average number
            of shares
            outstanding:
 
 **Years
                      ended August 31,****2007**
                  
                  
                  **2006**
                  
                  
                  **2005**Basic
                      weighted average number of shares
                    outstanding
                      (000’s)
                  
                  
                  68,875
                  
                  
                  
                  68,643
                  
                  
                  
                  68,526Plus
                      dilutive effect of:Stock
                      options (000’s)
                  
                  
                  448
                  
                  
                  
                  502
                  
                  
                  
                  422Restricted
                      share units (000’s)
                  
                  
                  179
                  
                  
                  
                  99
                  
                  
                  
                  8Deferred
                      share units (000’s)
                  
                  
                  53
                  
                  
                  
                  31
                  
                  
                  
                  8Restricted
                      stock awards (000’s)
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  17Diluted
                      weighted average number of shares outstanding (000’s)
                  
                  
                  69,555
                  
                  
                  
                  69,275
                  
                  
                  
                  68,981Stock
                      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)
                  
                  
                  1,207
                  
                  
                  
                  1,628
                  
                  
                  
                  1,962
 
 The
            diluted net loss per share for the year ended August 31, 2005, was the
            same as
            the basic net loss per share since the dilutive effect of stock options,
            restricted share units, deferred share units and restricted stock awards
            should
            not be included in the calculation; otherwise, the effect would be
            anti-dilutive.  Accordingly, the diluted net loss per share for this
            year was calculated using the basic weighted average number of shares
            outstanding.
 
 
 **18**  **Financial
            Instruments**
 
 **Short-term
            investments**
 
 Short-term
            investments consist of the following:
 
 **As
                      at August 31,****2007**
                  
                  
                  **2006**Commercial
                      paper denominated in Canadian dollars, bearing interest at
                      annual rates of
                      3.98% to 4.67% in 2007 and 3.92% to 4.31% in 2006, maturing
                      on different
                      dates between September 2007 and January 2008 in fiscal 2007,
                      and
                      September 2006 and January 2007 in fiscal 2006
                  
                  $
                  124,217
                  
                  
                  $
                  104,437
 
 
 F-29
 Table
                  of Contents
 EXFO
              Electro-Optical Engineering Inc.
 Notes
              to Consolidated Financial Statements
 **Fair
            value**
 
 Cash,
            accounts receivable, accounts payable and accrued liabilities as well
            as
            long-term debt, are financial instruments whose carrying values approximate
            their fair values.
 
 The
            fair
            value of short-term investments, based on market value, amounted to $104,437,000
            and $124,217,000 as at August 31, 2006 and 2007, respectively.
 
 The
            fair
            value of forward exchange contracts, which represents the amount that
            the
            company would receive to settle the contracts, amounted to unrecognized
            gains of
            $5,451,000 and $3,422,000 as at August 31, 2006 and 2007, respectively.
            The
            carrying value of these contracts amounted to $555,000 as at August 31,
            2007.
 
 **Credit
            risk**
 
 Financial
            instruments that potentially subject the company to credit risk consist
            primarily of cash, short-term investments, accounts receivable and forward
            exchange contracts. The company’s short-term investments consist of debt
            instruments issued by seven (nine in 2006) high-credit quality corporations
            and
            trusts. None of these debt instruments are expected to be affected by
            a
            liquidity risk and 47% of them are guaranteed by the Government of Canada.
            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 remote.
 
 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 $451,000 and $206,000 as at
            August 31, 2006 and 2007, respectively.
 
 **Interest
            rate risk**
 
 As
            at
            August 31, 2007, the company’s exposure to interest rate risk is summarized
            as follows:
 
 Cash
                  
                  Non-interest
                      bearingShort-term
                      investments
                  
                  As
                      described aboveAccounts
                      receivable
                  
                  Non-interest
                      bearingAccounts
                      payable and accrued liabilities
                  
                  Non-interest
                      bearing
 
 **Forward
            exchange contracts**
 
 The
            company is exposed to currency risks as a result of its export sales
            of products
            manufactured in Canada, the majority of which are denominated in US dollars.
            These risks are partially hedged by forward exchange contracts and certain
            operating expenses. As at August 31, 2006 and 2007, the company held
            contracts to sell US dollars at various forward rates, which are summarized
            as
            follows:
  **Contractual**
                      **amounts**
                    
                    
                    **Weighted
                        average contractual**
                      **forward
                        rates**As
                        at August 31, 2006September
                        2006 to August 2007
                    
                    $
                    37,000
                    
                    
                    
                    1.1676September
                        2007 to June 2009
                    
                    
                    26,800
                    
                    
                    
                    1.1261As
                        at August 31, 2007September
                        2007 to August 2008
                    
                    $
                    36,900
                    
                    
                    
                    1.1295September
                        2008 to December 2009
                    
                    
                    15,400
                    
                    
                    
                    1.1199
  F-30
 Table
                  of Contents
 EXFO
              Electro-Optical Engineering Inc.
 Notes
              to Consolidated Financial Statements
 **19**  **Segment
            Information**
  The
            company is organized under two reportable segments: the Telecom Division
            and the
            Life Sciences and Industrial Division. The Telecom Division offers integrated
            test solutions to network service providers, cable operators, system
            vendors and
            component manufacturers throughout the global telecommunications industry.
            The
            Life Sciences and Industrial Division mainly leverages developed and
            acquired
            core telecom technologies for high-precision assembly and research
            sectors.
 
 The
            reporting structure reflects how the company manages its business and
            how it
            classifies its operations for planning and measuring performance.
 
 The
            following tables present information by segment:
 
 **Year
                      ended August 31, 2007****Telecom
                      Division**
                  
                  
                  **Life
                      Sciences and Industrial Division**
                  
                  
                  **Total**Sales
                  
                  $
                  129,839
                  
                  
                  $
                  23,095
                  
                  
                  $
                  152,934Earnings
                      from operations
                  
                  $
                  13,132
                  
                  
                  $
                  3,650
                  
                  
                  $
                  16,782Unallocated
                      items:Interest
                      and other income
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  4,717Foreign
                      exchange loss
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (49
                  )Earnings
                      before income taxes
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  21,450Income
                      taxes
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (20,825
                  )Net
                      earnings for the year
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  42,275Recognition
                      of previously unrecognized research and development tax credits
                      (note
                      15)
                  
                  $
                  (3,162
                  )
                  
                  $
                  −
                  
                  
                  $
                  (3,162
                  )Government
                      grants (note 15)
                  
                  $
                  (1,079
                  )
                  
                  $
                  −
                  
                  
                  $
                  (1,079
                  )Amortization
                      of capital assets
                  
                  $
                  5,557
                  
                  
                  $
                  290
                  
                  
                  $
                  5,847Stock-based
                      compensation costs
                  
                  $
                  886
                  
                  
                  $
                  95
                  
                  
                  $
                  981Capital
                      expenditures
                  
                  $
                  5,424
                  
                  
                  $
                  123
                  
                  
                  $
                  5,547
 
 
 F-31
 Table
                  of Contents
 EXFO
              Electro-Optical Engineering Inc.
 Notes
              to Consolidated Financial Statements
  **Year
                        ended August 31, 2006****Telecom
                        Division**
                    
                    
                    **Life
                        Sciences and Industrial Division**
                    
                    
                    **Total**Sales
                    
                    $
                    107,376
                    
                    
                    $
                    20,877
                    
                    
                    $
                    128,253Earnings
                        from operations
                    
                    $
                    6,679
                    
                    
                    $
                    1,383
                    
                    
                    $
                    8,062Unallocated
                        items:Interest
                        and other income
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    3,253Foreign
                        exchange loss
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (595
                    )Earnings
                        before income taxes
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    10,720Income
                        taxes
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    2,585Net
                        earnings for the year
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    $
                    8,135Government
                        grants (note 15)
                    
                    $
                    (1,307
                    )
                    
                    $
                    −
                    
                    
                    $
                    (1,307
                    )Amortization
                        of capital assets
                    
                    $
                    6,689
                    
                    
                    $
                    1,228
                    
                    
                    $
                    7,917Stock-based
                        compensation costs
                    
                    $
                    962
                    
                    
                    $
                    70
                    
                    
                    $
                    1,032Impairment
                        of long-lived assets (note 4)
                    
                    $
                    −
                    
                    
                    $
                    604
                    
                    
                    $
                    604Capital
                        expenditures
                    
                    $
                    3,049
                    
                    
                    $
                    329
                    
                    
                    $
                    3,378
  
 **Year
                      ended August 31, 2005****Telecom
                      Division**
                  
                  
                  **Life
                      Sciences and Industrial Division**
                  
                  
                  **Total**Sales
                  
                  $
                  80,120
                  
                  
                  $
                  17,096
                  
                  
                  $
                  97,216Earnings
                      (loss) from operations
                  
                  $
                  763
                  
                  
                  $
                  (962
                  )
                  
                  $
                  (199
                  )Unallocated
                      items:Interest
                      and other income
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  2,524Foreign
                      exchange loss
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (1,336
                  )Earnings
                      before income taxes
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  989Income
                      taxes
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  2,623Net
                      loss for the year
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  (1,634
                  )Amortization
                      of capital assets
                  
                  $
                  6,504
                  
                  
                  $
                  2,588
                  
                  
                  $
                  9,092Stock-based
                      compensation costs
                  
                  $
                  897
                  
                  
                  $
                  66
                  
                  
                  $
                  963Capital
                      expenditures
                  
                  $
                  1,408
                  
                  
                  $
                  93
                  
                  
                  $
                  1,501
 
 
 F-32
 Table
                  of Contents
 EXFO
              Electro-Optical Engineering Inc.
 Notes
              to Consolidated Financial Statements
 Total
            assets by reportable segment are detailed as follows:
 
 **As
                      at August 31,****2007**
                  
                  
                  **2006**Telecom
                      Division
                  
                  $
                  109,065
                  
                  
                  $
                  93,853Life
                      Sciences and Industrial Division
                  
                  
                  9,199
                  
                  
                  
                  11,339Unallocated
                      assets
                  
                  
                  160,874
                  
                  
                  
                  113,967$
                  279,138
                  
                  
                  $
                  219,159
 
 Unallocated
            assets consist of cash, short-term investments, income taxes and tax
            credits
            recoverable and future income taxes.
 
 Carrying
            value of goodwill by reportable segment is detailed as follows:
 
 **As
                      at August 31,****2007**
                  
                  
                  **2006**Telecom
                      Division
                  
                  $
                  23,622
                  
                  
                  $
                  22,545Life
                      Sciences and Industrial Division
                  
                  
                  4,815
                  
                  
                  
                  4,597$
                  28,437
                  
                  
                  $
                  27,142
 
 Sales
            to
            external customers by geographic region are detailed as follows:
 
 **Years
                      ended August 31,****2007**
                  
                  
                  **2006**
                  
                  
                  **2005**United
                      States
                  
                  $
                  73,679
                  
                  
                  $
                  59,457
                  
                  
                  $
                  56,282Canada
                  
                  
                  9,619
                  
                  
                  
                  8,767
                  
                  
                  
                  6,830Latin
                      America
                  
                  
                  7,592
                  
                  
                  
                  8,380
                  
                  
                  
                  3,127Americas
                  
                  
                  90,890
                  
                  
                  
                  76,604
                  
                  
                  
                  66,239Europe-Middle
                      East-Africa
                  
                  
                  41,270
                  
                  
                  
                  32,379
                  
                  
                  
                  19,396Asia-Pacific
                  
                  
                  20,774
                  
                  
                  
                  19,270
                  
                  
                  
                  11,581$
                  152,934
                  
                  
                  $
                  128,253
                  
                  
                  $
                  97,216
 
 Sales
            were allocated to geographic regions based on the country of residence
            of the
            related customers. In fiscal 2005, 2006 and 2007, one customer represented
            more
            than 10% of sales with 23.3% of sales ($22,629,000) in fiscal 2005, 13.8%
            of
            sales ($17,706,000) in 2006 and 14.7% of sales ($22,480,000) in 2007.
            For fiscal
            2005, 2006 and 2007, this customer purchased from the Telecom
            Division.
 
 
 F-33
 Table
                  of Contents
 EXFO
              Electro-Optical Engineering Inc.
 Notes
              to Consolidated Financial Statements
 Long-lived
            assets by geographic region are detailed as follows:
  **As
                      at August 31,****2007**
                  
                  
                  
                  
                  
                  **2006****Property,
                      plant and equipment**
                  
                  
                  **Intangible
                      assets**
                  
                  
                  **Goodwill**
                  
                  
                  **Property,
                      plant and equipment**
                  
                  
                  **Intangible
                      assets**
                  
                  
                  **Goodwill**Canada
                  
                  $
                  16,434
                  
                  
                  $
                  9,580
                  
                  
                  $
                  24,801
                  
                  
                  $
                  17,364
                  
                  
                  $
                  10,690
                  
                  
                  $
                  23,670United
                      States
                  
                  
                  13
                  
                  
                  
                  21
                  
                  
                  
                  3,636
                  
                  
                  
                  28
                  
                  
                  
                  258
                  
                  
                  
                  3,472China
                  
                  
                  1,670
                  
                  
                  
                  27
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –$
                  18,117
                  
                  
                  $
                  9,628
                  
                  
                  $
                  28,437
                  
                  
                  $
                  17,392
                  
                  
                  $
                  10,948
                  
                  
                  $
                  27,142
 
 
 **20**  **United
            States Generally Accepted Accounting Principles**
 
 As
            a
            registrant with the Securities and Exchange Commission in the United
            States
            (SEC), the company is required to reconcile its financial statements
            for
            significant differences in measurement and disclosure between generally
            accepted
            accounting principles as applied in Canada (Canadian GAAP) and those
            applied in
            the United States (U.S. GAAP). Furthermore, additional significant disclosures
            required under U.S. GAAP and Regulation S-X of the SEC are also provided
            in the
            accompanying financial statements and notes. The following summarizes
            the
            significant quantitative differences between Canadian and U.S. GAAP, as
            well as other significant disclosures required under U.S. GAAP and
            Regulation S-X of the SEC not already provided in the accompanying financial
            statements.
 
 
 F-34
 Table
                  of Contents
 EXFO
              Electro-Optical Engineering Inc.
 Notes
              to Consolidated Financial Statements
 **Reconciliation
            of net earnings (loss) to conform to U.S. GAAP**
 
 The
            following summary sets out the significant differences between the company’s
            reported net earnings (loss) and net earnings (loss) per share under
            Canadian
            GAAP as compared to U.S. GAAP. Refer to corresponding explanatory notes in
            the Reconciliation Items section.
 
 **Years
                      ended August 31,****2007**
                  
                  
                  **2006**
                  
                  
                  **2005**Net
                      earnings (loss) for the year in accordance with Canadian
                      GAAP
                  
                  
                  
                  
                  $
                  42,275
                  
                  
                  $
                  8,135
                  
                  
                  $
                  (1,634
                  )Unrealized
                      losses on available-for-sale securities
                  
                  
                  a
                  )
                  
                  
                  55
                  
                  
                  
                  –
                  
                  
                  
                  –Stock-based
                      compensation costs related to stock appreciation rights
                  
                  
                  b
                  )
                  
                  
                  (73
                  )
                  
                  
                  –
                  
                  
                  
                  –Unrealized
                      losses on forward exchange contracts
                  
                  
                  c
                  )
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  (1,286
                  )Net
                      earnings (loss) for the year in accordance with U.S. GAAP
                  
                  
                  
                  
                  
                  
                  42,257
                  
                  
                  
                  8,135
                  
                  
                  
                  (2,920
                  )Other
                      comprehensive income (loss)Foreign
                      currency translation adjustment
                  
                  
                  
                  
                  
                  
                  9,218
                  
                  
                  
                  12,322
                  
                  
                  
                  15,669Unrealized
                      losses on available-for-sale securities
                  
                  
                  a
                  )
                  
                  
                  (55
                  )
                  
                  
                  –
                  
                  
                  
                  –Unrealized
                      gains (losses) on forward exchange contracts
                  
                  
                  c
                  )
                  
                  
                  (1,548
                  )
                  
                  
                  5,394
                  
                  
                  
                  2,313Reclassification
                      of realized gains on forward exchange contracts in net earnings
                      (loss)
                  
                  
                  c
                  )
                  
                  
                  (1,039
                  )
                  
                  
                  (2,880
                  )
                  
                  
                  (65
                  )Future
                      income taxes on unrealized gains on forward exchange
                      contracts
                  
                  
                  d
                  )
                  
                  
                  (916
                  )
                  
                  
                  –
                  
                  
                  
                  –Comprehensive
                      income
                  
                  
                  
                  
                  
                  $
                  47,917
                  
                  
                  $
                  22,971
                  
                  
                  $
                  14,997Basic
                      and diluted net earnings (loss) per share in accordance with
                      U.S.
                      GAAP
                  
                  
                  
                  
                  
                  $
                  0.61
                  
                  
                  $
                  0.12
                  
                  
                  $
                  (0.04
                  )Basic
                      weighted average number of shares outstanding (000’s)
                  
                  
                  
                  
                  
                  
                  68,875
                  
                  
                  
                  68,643
                  
                  
                  
                  68,526Diluted
                      weighted average number of shares outstanding (000’s)
                  
                  
                  
                  
                  
                  
                  69,555
                  
                  
                  
                  69,275
                  
                  
                  
                  68,526
 
 **Reconciliation
            of shareholders’ equity to conform to U.S. GAAP**
 
 The
            following summary sets out the significant differences between the company’s
            reported shareholders’ equity under Canadian GAAP as compared to U.S. GAAP.
            Refer to the corresponding explanatory note in the Reconciliation Items
            section.
 
 **As
                      at August 31,****2007**
                  
                  
                  **2006**
                  
                  
                  **2005**Shareholders’
                      equity in accordance with Canadian GAAP
                  
                  
                  
                  
                  $
                  250,165
                  
                  
                  $
                  196,234
                  
                  
                  $
                  173,400Forward
                      exchange contracts
                  
                  
                  c
                  )
                  
                  
                  2,864
                  
                  
                  
                  5,451
                  
                  
                  
                  2,937Goodwill
                  
                  
                  e
                  )
                  
                  
                  (12,697
                  )
                  
                  
                  (11,908
                  )
                  
                  
                  (11,042
                  )Future
                      income tax assets
                  
                  
                  d
                  )
                  
                  
                  (916
                  )
                  
                  
                  –
                  
                  
                  
                  –Stock
                      appreciation rights
                  
                  
                  b
                  )
                  
                  
                  (73
                  )
                  
                  
                  –
                  
                  
                  
                  –Shareholders’
                      equity in accordance with U.S. GAAP
                  
                  
                  
                  
                  
                  $
                  239,343
                  
                  
                  $
                  189,777
                  
                  
                  $
                  165,295
 
 
 F-35
 Table
                  of Contents
 EXFO
              Electro-Optical Engineering Inc.
 Notes
              to Consolidated Financial Statements
 The
            following table summarizes the shareholders’ equity activity under U.S. GAAP
            since August 31, 2004:
 
 **Share**
                    **capital**
                  
                  
                  **Contributed
                      surplus**
                  
                  
                  **Deficit**
                  
                  
                  **Deferred
                      stock-based compensation costs**
                  
                  
                  **Other**
                    **capital**
                  
                  
                  **Accumulated
                      other comprehensive income**
                  
                  
                  **Shareholders’
                      equity**Balance
                      as at August 31, 2004
                  
                  $
                  596,309
                  
                  
                  $
                  1,537
                  
                  
                  $
                  (464,159
                  )
                  
                  $
                  (939
                  )
                  
                  $
                  4,669
                  
                  
                  $
                  11,877
                  
                  
                  $
                  149,294Net
                      loss for the year
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  (2,920
                  )
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  (2,920
                  )Stock-based
                      compensation costs
                  
                  
                  1,213
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  (776
                  )
                  
                  
                  425
                  
                  
                  
                  −
                  
                  
                  
                  862Foreign
                      currency translation adjustment
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  15,669
                  
                  
                  
                  15,669Unrealized
                      gains on forward exchange contracts
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  2,248
                  
                  
                  
                  2,248Exercise
                      of stock options
                    (note
                      13)
                  
                  
                  148
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  148Share
                      issue expenses (note 13)
                  
                  
                  (6
                  )
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  (6
                  )Balance
                      as at August 31, 2005
                  
                  
                  597,664
                  
                  
                  
                  1,537
                  
                  
                  
                  (467,079
                  )
                  
                  
                  (1,715
                  )
                  
                  
                  5,094
                  
                  
                  
                  29,794
                  
                  
                  
                  165,295Net
                      earnings for the year
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  8,135
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  8,135Stock-based
                      compensation costs
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  954
                  
                  
                  
                  −
                  
                  
                  
                  954Reclassification  upon
                      adoption of SFAS 123(R)
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  1,715
                  
                  
                  
                  (1,715
                  )
                  
                  
                  −
                  
                  
                  
                  −Foreign
                      currency translation adjustment
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  12,322
                  
                  
                  
                  12,322Unrealized
                      gains on forward exchange contracts
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  2,514
                  
                  
                  
                  2,514Exercise
                      of stock options
                    (note
                      13)
                  
                  
                  557
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  557Reclassification
                      of stock-based compensation costs upon exercise of stock
                      awards
                    (note
                      13)
                  
                  
                  200
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  (200
                  )
                  
                  
                  −
                  
                  
                  
                  −Balance
                      as at August 31, 2006
                  
                  
                  598,421
                  
                  
                  
                  1,537
                  
                  
                  
                  (458,944
                  )
                  
                  
                  −
                  
                  
                  
                  4,133
                  
                  
                  
                  44,630
                  
                  
                  
                  189,777Net
                      earnings for the year
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  42,257
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  42,257Stock-based
                      compensation costs
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  847
                  
                  
                  
                  −
                  
                  
                  
                  847Foreign
                      currency translation adjustment
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  9,218
                  
                  
                  
                  9,218Unrealized
                      losses on
                    available-for-sale
                      securities
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  (55
                  )
                  
                  
                  (55
                  )Unrealized
                      losses on forward exchange contracts
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  (2,587
                  )
                  
                  
                  (2,587
                  )Future
                      income taxes on unrealized gains on forward exchange
                      contracts
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  (916
                  )
                  
                  
                  (916
                  )Exercise
                      of stock options
                    (note
                      13)
                  
                  
                  802
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  802Reclassification
                      of stock-based compensation costs upon exercise of stock awards
                      (note
                      13)
                  
                  
                  296
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  −
                  
                  
                  
                  (296
                  )
                  
                  
                  −
                  
                  
                  
                  −Balance
                      as at August 31, 2007
                  
                  $
                  599,519
                  
                  
                  $
                  1,537
                  
                  
                  $
                  (416,687
                  )
                  
                  $
                  −
                  
                  
                  $
                  4,684
                  
                  
                  $
                  50,290
                  
                  
                  $
                  239,343
 
 F-36
 Table
                  of Contents
 EXFO
              Electro-Optical Engineering Inc.
 Notes
              to Consolidated Financial Statements
 Accumulated
            other comprehensive income consists of the following:
 
 **As
                      at August 31,****2007**
                  
                  
                  **2006**
                  
                  
                  **2005**Foreign
                      currency translation adjustmentCurrent
                      year
                  
                  
                  
                  
                  $
                  9,218
                  
                  
                  $
                  12,322
                  
                  
                  $
                  15,669Cumulative
                      effect of prior years
                  
                  
                  
                  
                  
                  39,179
                  
                  
                  
                  26,857
                  
                  
                  
                  11,18848,397
                  
                  
                  
                  39,179
                  
                  
                  
                  26,857Unrealized
                      losses on available-for-sale securities
                  
                  
                  a
                  )Current
                      year
                  
                  
                  
                  
                  
                  
                  (55
                  )
                  
                  
                  −
                  
                  
                  
                  −Unrealized
                      gains on forward exchange contracts
                  
                  
                  c
                  )Current
                      year
                  
                  
                  
                  
                  
                  
                  (2,587
                  )
                  
                  
                  2,514
                  
                  
                  
                  2,248Cumulative
                      effect of prior years
                  
                  
                  
                  
                  
                  
                  5,451
                  
                  
                  
                  2,937
                  
                  
                  
                  6892,864
                  
                  
                  
                  5,451
                  
                  
                  
                  2,937Future
                      income taxes on unrealized gains on forward exchange
                      contracts
                  
                  
                  d
                  )Current
                      year
                  
                  
                  
                  
                  
                  
                  (916
                  )
                  
                  
                  −
                  
                  
                  
                  −$
                  50,290
                  
                  
                  $
                  44,630
                  
                  
                  $
                  29,794
 
 **Statements
            of cash flows**
 
 For
            the
            years ended August 31, 2005, 2006 and 2007, there were no significant
            differences between the statements of cash flows under Canadian GAAP
            as compared
            to U.S. GAAP, except for the subtotal before change in non-cash operating
            items,
            whose presentation is not permitted under U.S. GAAP.
 
 **Reconciliation
            items**
 
 **a)**
                  **Short-term
                      investments**
 
 Under
            U.S. GAAP, short-term investments would be classified as “available-for-sale
            securities” and carried at their fair value and any changes in their fair value
            would be reflected in other comprehensive income. Under Canadian GAAP,
            short-term investments are carried at the lower of cost and market value
            and any
            unrealized loss is reflected in the statements of earnings.
 
 **b)**
                  **Stock-based
                      compensation costs related to stock appreciation
                      rights**
 
 Under
            U.S. GAAP, stock-based compensation costs related to stock appreciation
            rights
            must be measured using the fair value-based method at the end of each
            period.
            The company uses the Black-Scholes options valuation model to measure
            the fair
            value of its stock appreciation rights, based on the same assumptions
            than those
            used for stock options. Changes in the fair value of these awards must
            be
            charged to earnings. Under Canadian GAAP, stock appreciation rights are measured
            using the intrinsic value method, based on the market price of the common
            shares
            at the end of each period, and changes in the intrinsic value of these
            awards
            are charged to earnings.
 
 
 F-37
 Table
                  of Contents
 EXFO
              Electro-Optical Engineering Inc.
 Notes
              to Consolidated Financial Statements
 **c)**
                  **Forward
                      exchange contracts**
 
 The
            forward exchange contracts entered into by the company prior to September
            1,
            2003, did not qualify for hedge accounting treatment under Statement
            of
            Financial Accounting Standard  (SFAS) 133, “Accounting for Derivative
            Instruments and Hedging Activities”; accordingly, changes in the fair value of
            these derivatives were recorded in earnings. However, since September
            1, 2003,
            the company has been maintaining the documentation for the designation,
            documentation and assessment of the effectiveness of its forward exchange
            contracts, for the purposes of applying hedge accounting.
 
 Consequently,
            under U.S. GAAP, the forward exchange contracts entered into by the company
            after September 1, 2003 qualify for hedge accounting treatment and are
            recorded at fair value in the balance sheet and changes in their fair
            value are
            reported in other comprehensive income. Upon the recognition of the hedged
            sales, accumulated changes in fair value are reclassified in the statements
            of
            earnings.
 
 Under
            Canadian GAAP, foreign exchange contracts qualifying for hedge accounting
            are
            not recognized on the balance sheet and foreign exchange translation
            gains and
            losses on these contracts are only recognized as an adjustment of the
            revenue
            when the corresponding hedged sales are recorded.
 
 Based
            on
            the portfolio of forward exchange contracts as at August 31, 2007, the
            company
            estimates that the portion of the unrealized gains on forward exchange
            contracts
            as of August 31, 2007, which will be realized and reclassified from
            other comprehensive income to net earnings over the next fiscal year
            amounts to
            $2,514,000.
  **d)**
                  **Future
                      income taxes**
 
 In
            fiscal
            2007, considering the effect of the adjustments described in item c),
            future
            income tax assets would have been $916,000 lower than under Canadian
            GAAP.
 
 **e)**
                  **Goodwill**
 
 Under
            U.S. GAAP, until the adoption of SFAS 142, “Goodwill and Other Intangible
            Assets”, when assets being tested for recoverability were acquired in business
            combinations accounted for by the purchase method, the goodwill that
            arose in
            that transaction had to be included as part of the assets grouping in
            determining recoverability. The intangible assets tested for recoverability
            prior to the adoption of SFAS 142 were acquired in business combinations
            that
            were accounted for using the purchase method and, consequently, the company
            allocated goodwill to those assets on a pro rata basis using the relative
            fair
            values of the long-lived assets and identifiable intangible assets acquired
            as
            determined at the date of acquisition. The carrying value of goodwill
            identified
            with the impaired intangible assets was written down before any reduction
            was
            made to the intangible assets.
 
 Under
            Canadian GAAP, no allocation of goodwill was required and each asset
            was tested
            for recoverability separately based on its pre-tax undiscounted future
            cash
            flows over its expected period of use.
 
 This
            created a permanent difference in the carrying value of goodwill under
            Canadian
            GAAP and U.S. GAAP
 
 **f)**
                  **Research
                      and development tax
                      credits**
 
 Under
            Canadian GAAP, all research and development tax credits are recorded
            as a
            reduction of gross research and development expenses in the statements
            or
            earnings. Under U.S. GAAP, tax credits that are refundable against taxable
            income are recorded in the income taxes. These tax credits amounted to
            $2,169,000, $2,546,000 and $6,639,000 for fiscal 2005, 2006 and 2007,
            respectively. This difference has no impact on the net earnings (loss)
            and the
            net earnings (loss) per share figures for the reporting years.
 
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              Electro-Optical Engineering Inc.
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  **g)**
                  **Elimination
                      of deficit by reduction of share
                      capital**
  As
            at
            August 31, 2006, under Canadian GAAP, the company proceeded to eliminate
            its
            deficit against its share capital (note 13). However, under U.S. GAAP,
            such
            elimination is not permitted, which creates a permanent difference of
            $373,711,000 in the deficit and the share capital between the Canadian
            GAAP and
            U.S. GAAP figures. This difference has no impact on the total amount
            of the
            shareholders’ equity.
 
 **h)**
                  **New
                      accounting standards and
                      pronouncements**
 
 *Adopted
            in fiscal 2006*
 
 In
            December 2004, the FASB issued SFAS 123(R), “Share-Based Payments”. This
            statement supersedes ABP 25, “Accounting for Stock Issued to Employees” and
            related implementation guidance, and revises SFAS 123 in a number of
            areas.
            Under SFAS 123(R), all forms of share-based payment to employees result
            in
            compensation cost recognized in financial statements. This statement
            is
            effective for fiscal years beginning after June 15, 2005. The company
            adopted
            this statement on September 1, 2005, using the modified prospective application
            method of transition and its adoption had no significant impact on its
            financial
            statements.
 
 *Adopted
            in fiscal 2007*
 
 In
            May
            2005, the FASB issued SFAS 154, “Accounting Changes and Error Corrections – a
            replacement of APB Opinion No. 20 and FASB Statement No. 3”. This statement
            replaces APB 20, “Accounting Changes”*,* and SFAS 3, “Reporting
            Accounting Changes in Interim Financial Statements”*,* and changes the
            requirements for the accounting for and reporting of a change in accounting
            principle. This statement applies to all voluntary changes in accounting
            principle. It also applies to changes required by an accounting pronouncement
            in
            the unusual instance that the pronouncement does not include specific
            transition
            provisions. In general, this statement requires a company to account
            for the
            adoption of a new accounting policy by applying the new principle to
            prior
            accounting periods as if that principle had always been adopted. The
            company
            adopted this new statement on September 1, 2006, and its adoption had
            no effect
            on its consolidated financial statements.
 
 *To
            be
            adopted after fiscal 2007*
 
 In
            June
            2006, the FASB issued FASB Interpretation No. 48 (FIN 48), “Accounting for
            Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109”,
            which clarifies the accounting for uncertainties in income taxes recognized
            in
            accordance with SFAS 109, “Accounting for Income Taxes”. The interpretation is
            effective for fiscal years beginning after December 15, 2006. The company
            will
            adopt this interpretation on September 1, 2007, and its adoption is not
            expected
            to have significant impacts on its consolidated financial
            statements.
 
 On
            September 15, 2006, the FASB issued SFAS 157, “Fair Value Measurements”, which
            establishes a framework for measuring fair value in GAAP and is applicable
            to
            other accounting pronouncements, in which fair value is considered to
            be the
            relevant measurement attribute. SFAS 157 also expands disclosures about
            fair
            value measurement. This statement is effective for fiscal years beginning
            after
            November 15, 2007. The company will adopt this statement on
            September 1, 2008, and has not yet assessed the impact its adoption
            will have on its consolidated financial statements.
 
 On
            February 15, 2007, the FASB issued SFAS 159, “The Fair Value Option for
            Financial Assets and Financial Liabilities – Including an amendment of FASB
            Statement No. 115”, which permits entities to choose to measure many financial
            instruments and certain other items at fair value. Most of the provisions
            of
            this statement apply only to entities that elect the fair value option.
            However,
            the amendment to SFAS 115, “Accounting for Certain Investments in Debt and
            Equity Securities”, applies to all entities with available-for-sale and trading
            securities. This statement is effective for fiscal years beginning after
            November 15, 2007, but the company has not yet determined if it will
            adopt this
            statement, nor the impact it might have on its financial statements.
            Should the
            company decide to adopt SFAS 159, it will be adopted on
            September 1, 2008.
 
 
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              Electro-Optical Engineering Inc.
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 **21**    **Subsequent
            Event**
 
 On
            November 5, 2007, the Board of Directors of the company approved a share
            repurchase program, by way of a normal course issuer bid on the open
            market, of
            up to 9.9% of the company’s public float (as defined by the Toronto Stock
            Exchange), or 2,869,585 subordinate voting shares, at the prevailing
            market
            price. The company expects to use cash, short-term investments or future
            cash
            flows from operations to fund the repurchase of shares. The normal course
            issuer
            bid will start on November 8, 2007, and end on November 7, 2008, or on
            an earlier date if the company repurchases the maximum number of shares
            permitted under the bid. The program does not require the company to
            repurchase
            any specific number of shares, and it may be modified, suspended or terminated
            at any time and without prior notice. All shares repurchased by the company
            under the bid will be canceled.


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