Corporate Overview

EXFO is a leading provider of test and monitoring solutions for network service providers and equipment manufacturers in the global telecommunications industry. The Telecom Division offers a wide range of innovative solutions extending across the full technology lifecycle – from design to technology deployment and onto service assurance – and covering all layers on a network infrastructure to enable triple-play services and next-generation, converged IP networking. The Life Sciences and Industrial Division offers solutions in medical device and opto-electronics assembly, fluorescence microscopy and other life science sectors.

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. Since then, we have continuously extended our product portfolio and our addressable market through consistent R&D as well as several acquisitions.

Sales and Earnings Summary ─ Q3 2008

We reported sales of $48.6 million in the third quarter of fiscal 2008, which represented an increase of 23.9% over the third quarter of 2007. Year-over-year sales growth was largely organic since the acquisitions of Navtel Communications Inc. and Brix Networks Inc., renamed EXFO Service Assurance Inc., which closed approximately one month and two months into the quarter, respectively, contributed $2.2 million in sales. Net accepted orders amounted to $50.7 million in the third quarter of fiscal 2008 for a book-to-bill ratio of 1.04, excluding the backlogs of Navtel Communications and Brix Networks at their acquisition dates. Nine months into fiscal 2008, sales increased 20.8% year-over-year to $132.8 million, while our corporate performance metric for sales growth is 20% for fiscal 2008.

Looking at our bottom line, we generated GAAP net earnings of $11.2 million, or $0.16 per diluted share, in the third quarter of fiscal 2008, compared to net earnings of $2.6 million, or $0.04 per diluted share, in the same period last year. GAAP net earnings in the third quarter of fiscal 2008 included $5.3 million for the recognition of previously unrecognized future income tax assets in the United States, an extraordinary gain of $3.0 million related to the negative goodwill on the Navtel acquisition, as well as $0.8 million in after-tax amortization of intangible assets and $0.3 million in stock-based compensation costs. In terms of earnings from operations, it reached 9.2% of sales in the third quarter and 6.3% year-to-date in fiscal 2008, while our stated goal is 8% for the whole fiscal year.

New Product Introductions

We launched five new products in the third quarter of fiscal 2008, for a total of 20 so far for the fiscal year. Key product launches in the third quarter included an IP test module for the installation and troubleshooting of Ethernet-based triple-play services in access networks; 1X/2X/4X/10X Fibre Channel test functionalities on the IQS-8130-NGE and IQS-8130-NGE Packet Blazer multiservice test modules for field-test and manufacturing applications; and Fiber Guardian, a remotely controllable test head and related software to allow real-time monitoring of optical networks. Following the quarter-end, we introduced a triple-play test set for the deployment and troubleshooting of ADSL2+/VDSL2 networks and a new software release that enables the field-test and manufacturing Packet Blazer test modules to support Provider Backbone Bridge-Traffic Engineering (PBB-TE) and Internet Protocol/Multiprotocol Label Switching (IP/MPLS) functionalities. Sales from products that have been on the market two years or less accounted for 32.2 % of total sales in the third quarter and 36.7% so far for fiscal 2008, while our published goal is 30% for the fiscal year.

Latest Acquisitions

On March 26, 2008, we acquired all the shares issued and outstanding of Navtel Communications Inc., for a cash consideration of $11.3 million including acquisition-related costs, net of $145,000 of cash acquired. Navtel Communications Inc., a privately held company in Toronto, Canada, is a leading provider of Internet Protocol Multimedia Subsystem (IMS) and Voice-over-Internet Protocol (VoIP) test solutions for network equipment manufacturers (NEMs) and network service provider (NSP) labs. Navtel specializes in testing next-generation Internet Protocol networks that are increasingly combining wireline and wireless technologies. This acquisition was accounted for using the purchase method and, consequently, the results of operations of the acquired business have been included in our consolidated financial statements since March 26, 2008, being the date of acquisition. Upon the preliminary purchase price allocation, we recognized $12.9 million of tax credits and future income tax assets, which lead to the recognition of an extraordinary gain of $3.0 million in the statement of earnings for the third quarter of fiscal 2008. The purchase price allocation, which takes into account acquisition-related costs of $172,000, is preliminary because the acquisition was closed during the quarter and we are still waiting for critical information to complete the final allocation. Assets and liabilities susceptible to change upon the finalization of the purchase price allocation mainly consist of intangible assets and future income taxes. We expect to complete the final allocation in the fourth quarter of fiscal 2008.

On April 2, 2008, we announced that we had reached an agreement to acquire all issued and outstanding shares of Brix Networks Inc. (renamed EXFO Service Assurance Inc.). We closed this acquisition on April 22, 2008. Based in the Boston area (MA), Brix Network Inc. was a privately held company offering VoIP and IPTV service testing across the three areas that most affect the success of a real-time service: signaling quality (signaling path performance), delivery quality (media transport performance) and content quality (overall quality of experience). This acquisition was settled for a cash consideration of $29.7 million including acquisition related costs, net of $12,000 of cash acquired, plus a contingent cash consideration of up to a maximum of $7.5 million, based upon the achievement of bookings volume exceeding $16 million up to $40 million in the 12 months following the acquisition. The preliminary estimated fair value of acquired intangible assets amounts to $13.8 million. These intangible assets, namely core technology, are amortized on a straight-line basis over their estimated useful life of five years. This acquisition was accounted for using the purchase method and, consequently, the results of operations of the acquired business have been included in our consolidated financial statements since April 22, 2008, being the closing date of the deal and date of acquisition. The purchase price allocation, which takes into account severance expenses of $497,000 as well as acquisition-related costs of $1.0 million, is preliminary because the acquisition was closed during the quarter and we are still waiting for critical information to complete the final allocation. Assets and liabilities susceptible to change upon the finalization of the purchase price allocation mainly consist of intangible assets, deferred revenue and future income taxes. We expect to complete the final allocation in the fourth quarter of fiscal 2008.

These two acquisitions report to the Telecom Division.

Strength of the Canadian Dollar

During the first nine months of fiscal 2008, we faced a substantial and sudden increase in the value of the Canadian dollar versus the US dollar, which had a two-fold impact on our financial results. Firstly, the average value of the Canadian dollar increased 14.2% in the first nine months of fiscal 2008, compared to the same period last year. Given that most of our sales are denominated in US dollars but a significant portion of our expenses are denominated in Canadian dollars, our financial results were negatively affected. Secondly, we incurred an exchange loss of $907,000 in the first nine months of fiscal 2008, which represents the effect of the increase in the value of the Canadian dollar versus the US dollar on our balance sheet items denominated in foreign currencies. In comparison, we reported a foreign exchange gain of $107,000 for the same period of fiscal 2007. However, over the last few months, we witnessed some stability in the value of the Canadian dollar compared to the US dollar (close to par). We incurred an exchange loss of $59,000 in the third quarter of fiscal 2008.

Share Repurchase Program

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 started on November 8, 2007, and will 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. So far in fiscal 2008, we redeemed 589,607 subordinated voting shares for a total consideration of $3.4 million.

Finally, during the third quarter of fiscal 2008, we performed our annual impairment test for goodwill and reviewed the carrying value of certain acquired intangible assets for impairment. Based on our impairment tests, we concluded that goodwill and these intangible assets were not impaired.