EXFO Inc. — Interim / Quarterly Report 2020

Jan 7, 2020

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

This discussion and analysis contains forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995, and we intend that such forward-looking statements be subject to the safe harbors created thereby. Forward-looking statements are statements other than historical information or statements of current condition. Words such as may, expect, believe, plan, anticipate, intend, could, estimate, continue, or similar expressions or the negative of such expressions are intended to identify forward-looking statements. In addition, any statements that refer to expectations, projections or other characterizations of future events and circumstances are considered forward-looking statements. They are not guarantees of future performance and involve risks and uncertainties. Actual results may differ materially from those in forward-looking statements due to various factors including, but not limited to, macroeconomic uncertainty, including trade wars and recessions; our ability to successfully integrate businesses that we acquire; capital spending and network deployment levels in the communications industry (including our ability to quickly adapt cost structures to anticipated levels of business and our ability to manage inventory levels with market demand); future economic, competitive, financial and market conditions; consolidation in the global communications test, monitoring and analytics solutions markets and increased competition among vendors; capacity to adapt our future product offering to future technological changes; limited visibility with regard to the timing and nature of customer orders; delay in revenue recognition due to longer sales cycles for complex systems involving customers’ acceptance; fluctuating exchange rates; concentration of sales; timely release and market acceptance of our new products and other upcoming products; our ability to successfully expand international operations and to conduct business internationally; and the retention of key technical and management personnel. Assumptions relating to the foregoing involve judgments and risks, all of which are difficult or impossible to predict and many of which are beyond our control. Other risk factors that may affect our future performance and operations are detailed in our Annual Report, on Form 20-F, and our other filings with the U.S. Securities and Exchange Commission and the Canadian securities commissions. We believe that the expectations reflected in the forward-looking statements are reasonable based on information currently available to us, but we cannot assure you that the expectations will prove to have been correct. Accordingly, you should not place undue reliance on these forward-looking statements. These statements speak only as of the date of this document. Unless required by law or applicable regulations, we undertake no obligation to revise or update any of them to reflect events or circumstances that occur after the date of this document. This discussion and analysis should be read in conjunction with the consolidated financial statements.

The following discussion and analysis of financial condition and results of operations is dated January 7, 2020.

All financial data are expressed in US dollars, except as otherwise noted, and are determined based on International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB). This discussion and analysis also contains financial data that do not comply with IFRS. Where such measures are presented, they are defined, and the reader is informed.

COMPANY OVERVIEW AND RECENT DEVELOPMENTS

We are a leading provider of test, monitoring and analytics solutions for fixed and mobile network operators, web-scale companies and equipment manufacturers in the global communications industry. Our broad portfolio of intelligent hardware and software solutions enable transformations related to fiber, 5G and network virtualization. Ultimately, customers rely on our solutions to increase network capacity and improve quality of experience for end-users while driving operational efficiencies.

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Our sales increased 6.3% to $73.6 million in the first quarter of fiscal 2020 compared to $69.2 million for the same period last year. Bookings (purchase orders received from customers) decreased 13.9% to $69.9 million in the first quarter of fiscal 2020, for a book-to-bill ratio of 0.95, from $81.2 million for the same period last year.

Net loss amounted to $63,000, or $0.00 per share, in the first quarter of fiscal 2020, compared to $7.5 million, or $0.14 per share, for the same period last year. Net loss for the first quarter of fiscal 2020 included net expenses totaling $2.0 million, comprising $1.4 million in after-tax amortization of intangible assets, $0.5 million in stockbased compensation costs, and a foreign exchange loss of $0.1 million. For the same period last year, net loss included net expenses totaling $6.3 million, comprising $2.5 million in after-tax amortization of intangible assets, $0.4 million in stock-based compensation costs, $2.7 million in after-tax restructuring charges, $0.9 million for the acquisition-related deferred revenue fair value adjustment, and a foreign exchange gain of $0.2 million.

Adjusted EBITDA (net loss before interest and other expense, income taxes, depreciation and amortization, stock-based compensation costs, restructuring charges, acquisition-related deferred revenue fair value adjustment, and foreign exchange gain or loss) reached $7.5 million, or 10.3% of sales, in the first quarter of fiscal 2020, compared to $2.7 million, or 3.9% of sales for the same period last year. We adopted IFRS 16, “ Leases ”, on September 1, 2019 using the modified retrospective method and prior period amounts were not adjusted. Accordingly, adjusted EBITDA for the first quarter of fiscal 2020 include the positive impact of adoption of IFRS 16 on September 1, 2019 of $0.9 million or 1.2% of sales. Adjusted EBITDA is a non-IFRS measure. See page 13 of this document for a complete reconciliation of adjusted EBITDA to IFRS net loss.

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RESULTS OF OPERATIONS

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

Sales Cost of sales(1) Selling and administrative Net research and development Depreciation of property, plant and equipment Depreciation of lease right-of-use assets Amortization of intangible assets Interest and other expense Foreign exchange (gain) loss Earnings (loss) before income taxes Income taxes Net loss for the period(2) Basic and diluted net loss per share Other selected information: Gross margin before depreciation and amortization(3) Gross research and development Restructuring charges included in: Cost of sales Selling and administrative expenses Net research and development expenses Adjusted EBITDA(2, 3)	Three months ended November 30, 2019 2018 $ 73,551 $ 69,201 30,241 28,897 24,504 26,375 11,749 15,224 1,443 1,429 851 – 1,632 2,940 399 377 126 (215) 2,606 (5,826) 2,669 1,641 $ (63) $ (7,467) $ (0.00) $ (0.14) $ 43,310 $ 40,304 $ 13,832 $ 17,225 $ – $ 287 $ – $ 397 $ – $ 2,057 $ 7,544 $ 2,728	Three months ended November 30,	Three months ended November 30,
	2019 $ 73,551 30,241 24,504 11,749 1,443 851 1,632 399 126 2,606 2,669 $ (63) $ (0.00) $ 43,310 $ 13,832 $ – $ – $ – $ 7,544	2019 100.0 % 41.1 33.3 16.0 2.0 1.2 2.2 0.5 0.2 3.5 3.6 (0.1)% 58.9 % 18.8 % – % – % – % 10.3 %	2018
			100.0 %
			41.8 38.1 22.0 2.1 – 4.2 0.5 (0.3)
			(8.4) 2.4
			(10.8)%
			58.2 % 24.9 % 0.4 % 0.6 % 3.0 % 3.9 %

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

(2) IFRS net loss for the three months ended November 30, 2019 takes into account the impact of the adoption of IFRS 16 on September 1, 2019. The adoption of IFRS 16 had a positive impact on adjusted EBITDA of $851 or 1.2% of sales for the three months ended November 30, 2019. Comparative figures were not adjusted.

(3) Refer to page 13 for non-IFRS measures.

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RESULTS OF OPERATIONS

Sales and Bookings

The following tables summarize sales and bookings by product line in thousands of US dollars:

Sales

Sales
Test and measurement Service assurance, systems and services Foreign exchange gains (losses) on forward exchange contracts Total sales	Three months ended November 30,
	2019 $ 55,947 17,749 73,696 (145) $ 73,551	2018
		$ 49,764 19,416
		69,180 21
		$ 69,201

Bookings

Bookings
Test and measurement Service assurance, systems and services Foreign exchange gains (losses) on forward exchange contracts Total bookings	Three months ended November 30,
	2019 $ 55,009 15,049 70,058 (145) $ 69,913	2018
		$ 63,996 17,221
		81,217 21
		$ 81,238

Sales by geographic region

The following table summarizes sales by geographic region:

Americas Europe, Middle East and Africa (EMEA) Asia-Pacific (APAC)	Three months ended November 30,	Three months ended November 30,
	2019 54 % 29 17 100 %	2018
		51 % 33 16
		100 %

For the three months ended November 30, 2019, our sales increased 6.3% to $73.6 million, compared to $69.2 million for the same period last year, while our bookings decreased 13.9% to $69.9 million, compared to $81.2 million for the same period last year, for a book-to-bill ratio of 0.95 .

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Sales

In the first quarter of fiscal 2020, the 6.3% year-over-year increase in our total sales comes from our T&M product line, which delivered an increase in sales of 12.4% to reach record-high levels, while sales of our SASS product line declined 8.6% during the same period.

In the first quarter of fiscal 2020, sales of our T&M product line increased 12.4% year-over-year to a record-high $55.9 million, up from $49.8 million for the same period last year. This year-over-year increase in sales is mainly due to the timing of orders received. In fact, in the first quarter of 2019, we reported significant bookings, as we benefited from large calendar year-end budget spending on the part of some CSPs in the Americas, and a large portion of these were back-end loaded, and recognized into revenue in the second quarter of 2019, preventing us from turning some of these bookings into revenue during the first quarter. We did not have such high level of calendar year-end budget spending in the first quarter of fiscal 2020. Also, we reported a more linear influx of orders during that quarter and we were able to ship and recognize most of the bookings of the quarter, as reflected by a book-to-bill ratio close to 1 for our T&M product line in the first quarter of 2020. The year-overyear increase in sales is also attributable to strong progress made in the APAC region due to fiber buildouts and high-speed deployments in metro, regional and access networks, as well as 5G fiber deployments.

In the first quarter of fiscal 2020, sales of our SASS product line decreased 8.6% year-over-year. Sales of the SASS product line for the first quarter of fiscal 2019 included a negative impact of $0.9 million for EXFO Solutions’ acquisition-related deferred revenue fair value adjustment. Excluding this adjustment, sales of our SASS product line would have decreased 12.5% year-over-year in the first quarter of fiscal 2020. Sales and bookings of our SASS product line are characterized by large intermittent orders from customers that may have prolonged sales and revenue recognition cycles; therefore, our quarterly sales and bookings are subject to quarterly fluctuations.

Bookings

In the first quarter of fiscal 2020, our total bookings decreased 13.9% year-over-year.

In the first quarter of fiscal 2020, bookings of our T&M product line decreased 14.1% year-over-year. In the first quarter of fiscal 2019, we had benefited from large calendar year-end budget spending on the part of some CSPs in the Americas, and we did not have such level of spending in the first quarter of 2020, which reduced our bookings year-over-year. In addition, in the first quarter of fiscal 2020, bookings of our T&M product line decreased in the EMEA region year-over-year as we had some large intermittent orders in the first quarter of fiscal 2019, which did not repeat this quarter.

In the first quarter of fiscal 2020, bookings of our SASS product line decreased 12.6% year-over-year. Most of the year-over-year decrease comes from the EMEA region and is mainly due to timing issues as some orders received in the first quarter in 2019 were received at the beginning of the second quarter in 2020. Otherwise, in the first quarter of fiscal 2020, bookings of our SASS product line increased in the Americas year-over-year mainly for our service assurance and network simulator solutions. Bookings of the SASS product line are characterized by large intermittent orders from customers, with long revenue recognition cycle, and may vary from quarter to quarter.

Customer concentration

In the first quarters of fiscal 2019 and 2020, our top customer accounted for 9.0% and 11.9% of our sales respectively. In the first quarters of fiscal 2019 and 2020, our top three customers accounted for 19.6% and 19.7% of our sales, respectively.

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GROSS MARGIN BEFORE DEPRECIATION AND AMORTIZATION

(non-IFRS measure — refer to page 13 of this document)

Gross margin before depreciation and amortization reached 58.9% of sales for the three months ended November 30, 2019, compared to 58.2% for the same period last year.

In the first quarter of fiscal 2020, the adoption of IFRS 16 had a positive effect of 0.4% of sales on our gross margin before depreciation and amortization year-over-year.

In addition, in the first quarter of fiscal 2020, we recorded lower inventory writeoffs compared to the same period last year, which contributed to increasing our gross margin before depreciation and amortization by 0.6% of sales year-over-year.

Also, in the first quarter of fiscal 2019, our sales were reduced to account for EXFO Solutions’ acquisition-related deferred revenue fair value adjustment of $0.9 million (nil in 2020); this had a negative impact on our gross margin before depreciation and amortization of 0.5% for that quarter.

Finally, in the first quarter of fiscal 2019, gross margin before depreciation and amortization included $0.3 million, or 0.4% of sales in restructuring charges (nil in 2020).

Otherwise, in the first quarter of fiscal 2020, our gross margin before depreciation and amortization was negatively impacted by a less favorable sales mix overall compared to the same period last year.

SELLING AND ADMINISTRATIVE EXPENSES

For the three months ended November 30, 2019, selling and administrative expenses were $24.5 million, or 33.3% of sales, compared to $26.4 million, or 38.1% of sales, for the same period last year.

In the first quarter of fiscal 2020, our selling and administrative expenses decreased $1.9 million compared to the same period last year.

In the first quarter of fiscal 2020, the adoption of IFRS 16 had a positive effect of $0.4 million or 0.5% of sales on our selling and administrative expenses year-over-year.

In addition, in the first quarter of fiscal 2019, we incurred restructuring charges of $0.4 million or 0.6% of sales (nil in 2020).

Also, in the first quarter of fiscal 2020, we had the full impact of our 2018 restructuring plan, which reduced our selling and administrative expenses year-over-year.

Finally, in the first quarter of fiscal 2020, the increase in the average value of the US dollar compared to other currencies had a positive impact on our selling and administrative expenses year-over-year.

However, in the first quarter of fiscal 2020, inflation and salary increases, as well as higher commissions to our sales channel due to higher sales contributed to increase our selling and administrative expenses year-over-year.

In the first quarter of fiscal 2020, our selling and administrative expenses amounted to 33.3% of sales, 4.8% lower compared to 38.1% of sales in the same period last year, as these expenses decreased while our sales increased year-over-year.

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RESEARCH AND DEVELOPMENT EXPENSES

Gross Research and Development Expenses

For the three months ended November 30, 2019, gross research and development expenses totaled $13.8 million, or 18.8% of sales, compared to $17.2 million, or 24.9% of sales for the same period last year.

In the first quarter of fiscal 2020, our gross research and development expenses decreased $3.4 million year-over-year.

In the first quarter of fiscal 2020, the adoption of IFRS 16 had a positive effect of $0.2 million or 0.3% of sales on our gross research and development expenses year-over-year.

In addition, in the first quarter of fiscal 2019, we incurred restructuring charges of $2.1 million or 3.0% of sales (nil in 2020).

Also, in the first quarter of fiscal 2020, we had the full impact of our 2018 restructuring plan, which reduced our gross research and development expenses year-over-year.

Finally, in the first quarter of fiscal 2020, the increase in the average value of the US dollar compared to other currencies had a positive impact on our gross research and development expenses year-over-year.

However, in the first quarter of fiscal 2020, inflation and salary increases contributed to increasing our gross research and development expenses year-over-year.

In the first quarter of fiscal 2020, our gross research and development expenses amounted to 18.8% of sales, 6.1% lower compared to 24.9% of sales in the same period last year, as these expenses decreased while our sales increased year-over-year.

Tax Credits

For the three months ended November 30, 2019, tax credits for research and development activities were $2.1 million, or 15.1% of gross research and development expenses, compared to $2.0 million, or 11.6% of gross research and development expenses, for the same period last year.

For the three months ended November 30, 2019, the increase in our tax credits as a percentage of sales compared to the same period last year mainly comes from restructuring expenses incurred in the first quarter of 2019, which did not entitle to tax credits.

DEPRECIATION OF LEASE RIGHT-OF-USE ASSETS

On September 1, 2019, following the adoption of IFRS 16, we recorded $11.3 million for lease right-of-use (ROU) assets in the consolidated balance sheet. These assets are depreciated over the lease terms and resulted in a depreciation expense of $0.9 million during the three months ended November 30, 2019, compared to nil for the same period last year, as fiscal 2019 comparative figures were not adjusted. Upon the adoption of IFRS 16, the lease expense, previously recorded under the cost of sales, selling and administrative expenses and net research and development expenses line items is now mainly recorded under depreciation expenses for the ROU asset in the consolidated statements of earnings.

This new standard was adopted using the modified retrospective method and, accordingly, comparative figures were not adjusted.

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AMORTIZATION OF INTANGIBLE ASSETS

In conjunction with the business combinations we completed, we recorded intangible assets primarily consisting of core technology and customer relationships. In addition, intangible assets include software.

For the three months ended November 30, 2019, amortization of intangible assets reached $1.6 million, compared to $2.9 million for the same period last year.

The year-over-year decrease in our amortization expense in the first quarter of fiscal 2020, compared to the same period last year, was mainly due to the fact that some acquired intangible assets became fully amortized in 2019.

FOREIGN EXCHANGE GAIN (LOSS)

Foreign exchange gains and losses are mainly the result of the translation of operating activities denominated in currencies other than our functional currency, which is the Canadian dollar. A portion of our foreign exchange gains or losses results from the translation of cash balances and deferred income taxes denominated in US dollars. We manage our exposure to currency risk in part with forward exchange contracts. In addition, some of our entities’ operating activities are denominated in US dollars, euros and British pounds, which further hedges this risk. However, we remain exposed to a currency risk; namely, any increase in the value of the Canadian dollar compared to the US dollar would have a negative impact on our operating results.

For the three months ended November 30, 2019, we recorded a foreign exchange loss of $0.1 million compared to a foreign exchange gain of $0.2 million for the same period last year.

During the first quarter of fiscal 2020, the period-end value of the Canadian dollar was almost flat versus the US dollar, and we reported a foreign exchange loss of $0.1 million during that period. In fact, the period-end value of the Canadian dollar slightly increased to CA$1.3289 = US$1.00 in the first quarter of fiscal 2020, compared to CA$1.3294 = US$1.00 at the end of the previous quarter.

During the same period last year, the period-end value of the Canadian dollar decreased versus the US dollar but increased compared to the euro, compared to the previous quarter, and overall we reported a foreign exchange gain of $0.2 million during that period. In fact, the period-end value of the Canadian dollar decreased 1.9% versus the US dollar to CA$1.3301 = US$1.00 in the first quarter of fiscal 2019, compared to CA$1.3055 = US$1.00 at the end of the previous quarter. However, the period-end value of the Canadian dollar increased 0.9% versus the euro to CA$1.5069 = €1.00 in the first quarter of fiscal 2019, compared to CA$1.5210 = €1.00 at the end of the previous quarter.

Foreign exchange rate fluctuations also flow through the P&L line items as a portion of our sales are denominated in Canadian dollars and euros and a significant portion of our cost of sales and operating items are denominated in Canadian dollars, euros, Indian rupees and British pounds and we report our results in US dollars. In the first quarter of fiscal 2020, the increase in the average value of the US dollar compared to the Canadian dollar, the euro and the British pound year-over-year resulted in a positive impact on our operating expenses. In the first quarter of fiscal 2020, the average value of the US dollar increased 1.3%, 4.3% and 3.1% year-over-year respectively, compared to the Canadian dollar, the euro and the British pound.

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INCOME TAXES

For the three months ended November 30, 2019, we reported income tax expenses of $2.7 million on earnings before income taxes of $2.6 million. For the corresponding period last year, we reported income tax expenses of $1.6 million on a loss before income taxes of $5.8 million.

These distorted tax rates mainly resulted from the fact that we did not recognize deferred income tax assets for some of our subsidiaries at loss. In addition, we had some other non-deductible losses and expenses, such as stock-based compensation costs. Otherwise, our effective tax rate would have been closer to the combined Canadian and provincial statutory tax rate of 27% for these periods.

Please refer to note 9 to our condensed unaudited interim consolidated financial statements for a full reconciliation of our income tax provision.

LIQUIDITY AND CAPITAL RESOURCES

Cash Requirements and Capital Resources

As at November 30, 2019, cash and short-term investments totaled $17.5 million, while our working capital was at $37.5 million. Our cash and short-term investments decreased by $1.9 million in the first quarter of fiscal 2020 compared to the previous quarter-end.

The following table summarizes the decrease in cash and short-term investments during the first quarter of fiscal 2020 in thousands of US dollars:

Cash flows used by operating activities Purchases of capital assets Repayment of lease liabilities and long-term debt Redemption of share capital Increase in bank loan Other	$ (6,470) (2,040) (1,520) (225) 8,354 1
	$ (1,900)

Our short-term investments of $2.5 million consist of debt instruments issued by high-credit-quality corporations; therefore, we consider the risk of non-performance of these financial instruments to be limited. These debt instruments are not expected to be affected by a significant liquidity risk. For the purpose of managing our cash position, we have established a cash management policy, which we follow and monitor on a regular basis.

We believe that our cash balances and short-term investments totaling $17.5 million, combined with our available revolving credit facilities of up to $47.8 million, will be sufficient to meet our liquidity and capital requirements for the foreseeable future, including any possible working capital requirements from our recent acquisitions. In addition to these assets and credit facilities, we have unused available lines of credit of $22.6 million for foreign currency exposure related to forward exchange contracts. However, possible operating losses, additional restructuring costs and/or possible investments in or acquisitions of complementary businesses, products or technologies may require additional financing. There can be no assurance that additional debt or equity financing will be available when required or, if available, that it can be secured on satisfactory terms.

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Sources and Uses of Cash

We finance our operations and meet our capital expenditure requirements through a combination of cash flows from operating activities, the use of our cash and short-term investments, borrowing under our existing credit facilities and the issuance of subordinate voting shares.

Operating activities

Cash flows used by operating activities were $6.5 million for the three months ended November 30, 2019, compared to $2.5 million for the same period last year.

Cash flows used by operating activities in the first quarter of fiscal 2020 were attributable to the net loss after items not affecting cash of $0.3 million, and the negative net change in non-cash operating items of $6.2 million; this was mainly due to the negative effect on cash of the $3.5 million increase in inventories to meet future demand and the $3.7 million decrease in our accounts payable, accrued liabilities and provisions due to the timing of purchases and payments during the quarter. These negative effects on cash were offset in part by the positive effect on cash of the $0.5 million decrease in our income taxes and tax credits due to tax credits and income taxes recovered during the quarter, and the $0.4 million decrease in our prepaid expenses due to the timing of payments made during the quarter.

Cash flows used by operating activities in the first quarter of fiscal 2019 were attributable to the net earnings after items not affecting cash of $0.7 million, more than offset by the negative net change in non-cash operating items of $3.2 million; this was mainly due to the negative effect on cash of the $4.1 million increase in our accounts receivable due to the timing of sales and receipts during the quarter, the $1.0 million increase in our income taxes and tax credits due to tax credits earned during the quarter not yet recovered, and the $1.4 million increase in inventories to meet future demand. These negative effects on cash were offset in part by the positive effect on cash of the $3.1 million increase in our accounts payable, accrued liabilities and provisions due to the timing of purchases and payments made during the quarter.

Investing activities

Cash flows used by investing activities were $1.6 million for the three months ended November 30, 2019, compared to $2.5 million for the same period last year.

In the first quarter of fiscal 2020, we made cash payments of $2.0 million for the purchase of capital assets. However, we disposed of $0.4 million worth of short-term investments during the quarter.

For the corresponding period last year, we made cash payments of $2.9 million for the purchase of capital assets. However, we disposed of $0.4 million worth of short-term investments during the quarter.

Financing activities

Cash flows provided by financing activities amounted to $6.6 million in the first quarter of fiscal 2020, compared to $10.5 million during the same period last year.

In the first quarter of fiscal 2020, our bank loan increased by $8.4 million, but we repaid $1.5 million of our lease liabilities and long-term debt and we redeemed share capital for $0.2 million.

For the corresponding period last year, our bank loan increased by $11.2 million, but we repaid $0.7 million of our long-term debt.

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Contractual Obligations

We are committed under the terms of contractual obligations, which have various expiration dates, primarily for our lease liabilities, our long-term debt and licensing of intellectual property. The following table summarizes our contractual obligations as at November 30, 2019 in thousands of US dollars:

No later than 1 year Later than 1 year and no later than 5 years Later than 5 years	Lease liabilities $ 2,962 6,499 659 $ 10,120	Long-term debt $ 2,335 2,668 50 $ 5,053	Licensing agreements $ 1,874 1,901 ‒ $ 3,775	Total
				$ 7,171 11,068 709
				$ 18,948

In addition, as at November 30, 2019, we had letters of guarantee amounting to $1.1 million for our own selling and purchasing requirements, which were reserved from our lines of credit; these letters of guarantee expire at various dates through fiscal 2022.

FORWARD EXCHANGE CONTRACTS

We are exposed to currency risk as a result of our export sales of products manufactured in Canada, China, Finland and France, the majority of which are denominated in US dollars and euros. In addition, we are exposed to currency risk as a result of our research and development activities in India (Indian rupees). These risks are partially hedged by forward exchange contracts. Forward exchange contracts, which are designated as cash flow hedging instruments, qualify for hedge accounting.

As at November 30, 2019, we held forward exchange contracts to sell US dollars for Canadian dollars and Indian rupees at various forward rates, which are summarized as follows:

US dollars – Canadian dollars

Expiry dates December 2019 to August 2020 September 2020 to August 2021 September 2021 to August 2022 September 2022 to October 2022 Total	Contractual amounts $ 26,800,000 22,800,000 7,100,000 1,000,000 $ 57,700,000	Weighted average contractual forward rates
		1.3038 1.3130 1.3229 1.3309
		1.3102

US dollars – Indian rupees

Expiry dates December 2019 to August 2020	Contractual amounts $ 2,400,000	Weighted average contractual forward rates
		71.88

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The carrying amount of forward exchange contracts is equal to their fair value, which is based on the amount at which they could be settled based on estimated current market rates. The fair value of forward exchange contracts amounted to net losses of $1.0 million as at August 31, 2019, and $0.8 million as at November 30, 2019, mainly for our US/Canadian dollar forward exchange contracts. The quarter-end exchange rate was CA$1.3289 = US$1.00 as at November 30, 2019.

SHARE CAPITAL

As at January 7, 2020, EXFO had 31,643,000 multiple voting shares outstanding, entitling to 10 votes each and 23,905,787 subordinate voting shares outstanding. The multiple voting shares and the subordinate voting shares are unlimited as to number and are without par value.

STRUCTURED ENTITIES

As at November 30, 2019, we did not have interests in any structured entities.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

For a description of the critical accounting policies, judgments in applying accounting policies as well as estimates and assumptions used in the preparation of our consolidated financial statements, refer to our Annual Report on Form 20-F for the year ended August 31, 2019, filed with the U.S. Securities and Exchange Commission and the Canadian securities commissions.

NEW IFRS PRONOUNCEMENTS

Recently Issued IFRS Pronouncements Adopted in Fiscal 2020

Leases

IFRS 16, “ Leases ”, was issued in January 2016. IFRS 16 sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract, i.e., the customer (lessee) and the supplier (lessor). IFRS 16 supersedes IAS 17, “ Leases ”, and related interpretations. Under IFRS 16, lessees recognize a rightof-use (ROU) asset and a lease liability measured at the present value of lease payments for virtually all their leases. Short-term leases with a term of 12 months or less are not required to be recognized. This new standard is effective for annual periods beginning on or after January 1, 2019.

We adopted this new standard on September 1, 2019, using the modified retrospective method, which did not require adjustments to comparative periods. We applied IFRS 16 at the adoption date and recognized ROU assets and lease liabilities in the period of adoption. The new standard provides several optional practical expedients in transition. Upon implementation of the new standard, we elected the practical expedients to combine lease and non-lease components, and to not recognize ROU assets and lease liabilities for short-term leases. We identified appropriate changes to our accounting policies, information technology systems, business processes, and related internal controls to support recognition and disclosure requirements under IFRS 16.

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The adoption of IFRS 16 on September 1, 2019 resulted in the recognition of ROU assets of $11.3 million, lease liabilities of $10.8 million, and the elimination of prepaid rents of $0.5 million in the balance sheet as of that date. In addition, lease payments for ROU assets, previously reported in cash flow from operating activities are reported in cash flow from financing activities in the consolidated statements of cash flows. However, the adoption of this standard had no significant impact on net loss.

Upon the adoption of IFRS 16, the lease expense, previously recorded under cost of sales, selling and administrative expenses and net research and development expenses line items is recorded as depreciation expenses for the ROU asset and as interest expenses on the lease liability in the consolidated statements of earnings.

Finally, the adoption of IFRS 16 had no significant impact on liquidity and debt-covenants compliance under existing debt agreements.

Uncertainty over Income Tax Treatments

IFRIC 23, “ Uncertainty over Income Tax Treatments ”, was issued in June 2017. IFRIC 23 provides guidance on how to value uncertain income tax positions based on the probability of whether the relevant tax authorities will accept the company's tax treatments. A company is to assume that a taxation authority with the right to examine any amounts reported to it will examine those amounts and will have full knowledge of all relevant information when doing so. IFRIC 23 is effective for annual periods beginning on or after January 1, 2019. We adopted this interpretation on September 1, 2019 and its adoption had no significant impact on our consolidated financial statements.

RISKS AND UNCERTAINTIES

For the first quarter of fiscal 2020, there have been no material changes from the risk factors disclosed in our Annual Report on Form 20-F for the year ended August 31, 2019.

NON-IFRS MEASURES

We provide non-IFRS measures (gross margin before depreciation and amortization and adjusted EBITDA) as supplemental information regarding our operational performance. Gross margin before depreciation and amortization represents sales, less cost of sales, excluding depreciation and amortization. Adjusted EBITDA represent net loss before interest, income taxes, depreciation and amortization, stock-based compensation costs, restructuring charges, acquisition-related deferred revenue fair value adjustment, and foreign exchange gain or loss.

These non-IFRS measures eliminate the effect on our IFRS results of non-cash statement of earnings elements, restructuring charges as well as elements subject to significant volatility such as foreign exchange gain or loss. We use these measures for evaluating our historical and prospective financial performance, as well as our performance relative to our competitors. These non-IFRS measures are also used by financial analysts that evaluate and compare our performance against that of our competitors and industry players in our sector.

Finally, these measures help us plan and forecast future periods as well as make operational and strategic decisions. We believe that providing this information to our investors, in addition to the IFRS measures, allows them to see the company’s results through the eyes of management, and to better understand our historical and future financial performance. More importantly, it enables the comparison of our performance on a relatively similar basis against that of other public and private companies in our industry worldwide.

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

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

Adjusted EBITDA

Adjusted EBITDA
IFRS net loss for the period(1) Add (deduct): Depreciation and amortization Interest and other expense Income taxes Stock-based compensation costs Restructuring charges Acquisition-related deferred revenue fair value adjustment Foreign exchange (gain) loss Adjusted EBITDA for the period(1) Adjusted EBITDA in percentage of sales(1)	Three months ended November 30,
	2019 $ (63) 3,926 399 2,669 487 ‒ ‒ 126 $ 7,544 10.3 %	2018
		$ (7,467) 4,369 377 1,641 418 2,741 864 (215)
		$ 2,728
		3.9 %

(1) IFRS net loss for the three months ended November 30, 2019 takes into account the impact of the adoption of IFRS 16 on September 1, 2019. The adoption of IFRS 16 on September 1, 2019 had a positive impact on adjusted EBITDA of $851,000 or 1.2% of sales for the three months ended November 30, 2019. Comparative figures were not adjusted.

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QUARTERLY SUMMARY FINANCIAL INFORMATION[(1)]

(tabular amounts in thousands of US dollars, except per share data)

Sales Cost of sales(2) Net earnings (loss) Basic and diluted net earnings (loss) per share Sales Cost of sales(2) Net loss Basic and diluted net loss per share	Quarters ended
	November 30, 2019 August 31, 2019 May 31, 2019 February 28, 2019
	$ 73,551 $ 70,175 $ 73,587 $ 73,927 $ 30,241 $ 30,260 $ 30,458 $ 29,062 $ (63) $ (227) $ 21 $ 5,193 $ (0.00) $ (0.00) $ 0.00 $ 0.09 Quarters ended
	November 30, 2018 August 31, 2018 May 31, 2018 February 28, 2018
	$ 69,201 $ 69,216 $ 72,217 $ 64,722 $ 28,897 $ 27,426 $ 28,963 $ 25,326 $ (7,467) $ (3,951) $ (5,970) $ (4,660) $ (0.14) $ (0.07) $ (0.11) $ (0.08)

(1) Quarterly financial information has been derived from our condensed unaudited interim consolidated financial statements, which are prepared in accordance with IFRS, as issued by the IASB, applicable to the preparation of interim financial statements, including IAS 34, “ Interim Financial Reporting ”. The presentation currency is the US dollar, which differs from the functional currency of the company (Canadian dollar).

(2) Cost of sales is exclusive of depreciation and amortization.

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