2014 TECHNOLOGY RISKFACTOR REPORT: Canadian Tech Companies Rally around Innovation but Lag on Commercialization

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1 2014 TECHNOLOGY RISKFACTOR REPORT: Canadian Tech Companies Rally around Innovation but Lag on Commercialization

2 2 BDO Technology RiskFactor Report Canadian Tech Companies Rally around Innovation, but Lag on Commercialization u Canadian technology companies are making their mark among the broader global industry. The 2014 BDO Canada Technology RiskFactor Report examines the risk factors listed in the most recent annual financial statements of Canada s publicly-traded technology companies. The risk factors were analyzed and ranked in order of frequency cited.

3 BDO Technology RiskFactor Report Canadian Tech Companies Rally around Innovation, but Lag on Commercialization 3 Spurred by a commitment to research the lifeblood of the industry the Canadian tech sector is growing increasingly attractive to investors all over the world. Our inaugural annual analysis of the risk factors cited in the annual financial statements of Canada s publicly-traded technology companies finds that innovation lies at the heart of tech businesses in Canada, serving as a key differentiator from the industry s counterparts south of the border. However, lingering obstacles such as difficulty commercializing products continue to challenge Canadian companies as they work to grow their international footprint. Brain versus Brawn Competition is the most cited risk facing Canadian tech businesses a view shared by U.S. tech companies, according to the 2014 BDO USA Technology RiskFactor Report. But each country s views diverge on the next most common risks. In Canada, the ability to develop and market new products or services is the second most cited risk, underscoring the industry s strength in innovation but lagging potential in commercialization. In the absence of the scale and capital flows seen among U.S. companies that allow for more diverse growth opportunities, Canadian companies depend on their ability to develop cutting-edge products for their survival. Recruiting and retaining key personnel an essential technical and creative ingredient in producing the right recipe for growth comes in third for Canadian businesses. In the United States, the last two risks didn t even make the top 10, falling lower in the rankings to #13 and #16, respectively. Instead, more U.S. tech companies express concern about size: the ability to manage mergers, acquisitions and divestitures ranks as the fourth greatest risk in the United States, compared to #18 in Canada. The Canadian tech market excels at creating products and nurturing early-stage companies, but often falls short on the commercialization and scaling phase. Canada s strong higher education programs provide an excellent training ground for skills that are in high demand, but U.S. companies tend to operate on a larger scale in the technology industry, and thus are better capitalized and able to purchase talent and intellectual property more easily than their Canadian counterparts. - Scott Rodie, partner and leader of the Technology & Life Sciences (T&LS) practice at BDO Top Risks for Canadian Tech Businesses Competition; pricing pressures Failure to develop or market new products or services Ability to attract or retain key personnel Foreign currency fluctuations Canadian and foreign supplier/vendor and distribution concerns 0% 20% 40% 60% 80%

4 4 BDO Technology RiskFactor Report Canadian Tech Companies Rally around Innovation, but Lag on Commercialization Sowing the Seeds The innovation of Canadian technology companies depends in part on the favorable regulatory environment provided by the Canadian government, both national and provincial. It is no surprise, then, that regulations rank as only the tenth most cited risk among Canadian companies in our study a considerable contrast from the United States, where regulation ranks as the second most noted risk. In general, it appears that compared to the United States, where tech companies are subject to a growing number of regulations, Canada has a more easily navigable regulatory system that may allow tech companies to focus more intently on the development of their products than the cost of compliance. This nurturing of innovation has valuable add-on benefits for the technology sector: it allows Canadian companies to keep their eye on the prize in terms of staying ahead of the demand curve. As a result, only about half (53 percent) of Canadian tech companies say predicting their customers demand/interest will be a risk to their business this year remarkably less than the United States, where an overwhelming 92 percent of companies cite this as a leading risk. However, the Canadian market can prove to be more challenging for companies looking to scale. The inability to acquire capital falls within the top 10 risks in Canada, reported by nearly two-thirds of companies; in the United States, it sits at #19. Growth strategies rely heavily on international markets, with eyes turned toward the United States, China and India. Threats to international sales and operations are cited as a concern by 58 percent of Canadian companies, falling just outside of the top 10 risks. International expansion will always be complex for Canadian companies; protectionist trade policies, onerous regulations and complex foreign tax regimes all pose challenges for organizations looking to set up shop abroad. Luckily for the Canadian tech sector, U.S. investors have a healthy interest in marrying the innovation of Canadian companies with the scalability of U.S. companies. U.S. buyouts and investments in recent years of Canadian innovators like Rypple and Complete Innovations tell us that there are great cross-border opportunities to be found between the United States and Canada. - Peter Matutat, PARTNER, BDO T&LS PRACTICE Canada s strength: innovation 100% 80% 60% 40% 20% 0% Regulatory environment Predicting customer demand/ interest; innovation CANADA U.S.

5 BDO Technology RiskFactor Report Canadian Tech Companies Rally around Innovation, but Lag on Commercialization 5 Canadian tech companies most common financial concerns: 77% Companies cite Companies foreign currency fluctuation. 53% Companies cite cyclical nature of their revenue streams. 49% cite Companies quarterly results fluctuation. 34% cite worries about indebtedness. Financial Flux Tech companies raise a variety of financial concerns in their annual reports. Among the most common are foreign currency fluctuations, cited by 77 percent of companies. Given that Canadian companies may choose to operate in U.S. dollars while booking costs in Canadian currency, this isn t necessarily a surprising result. Any fluctuation in the value of the U.S. dollar relative to the loonie can impact margins, both positively and negatively. General economic conditions also remain a concern, infiltrating a variety of business issues and ranking sixth on the risk factor list. About half of all companies (53 percent) cite concerns about the cyclical nature of their revenue streams, and another 49 percent highlight quarterly results fluctuation as a risk. These fluctuations are also common in the United States but don t rank as highly, possibly indicating that investors are more tolerant or accustomed to these changes in the market south of the border. About one-third (34 percent) of Canadian tech firms list worries about indebtedness, falling toward the bottom of the top 25 list. In other words, while Canadian companies remain cognizant of their borrowing, they appear optimistic that they will be able to meet their financial obligations as the industry continues to thrive. General economic conditions also remain a concern, infiltrating a variety of business issues. (ranked 6 th on RiskFactor list)

6 6 BDO Technology RiskFactor Report Canadian Tech Companies Rally around Innovation, but Lag on Commercialization IT TAKES A VILLAGE A company s success is intricately tied to that of others their customers, partners, vendors, suppliers and employees. That message is abundantly clear when scanning the top 25 risks for Canadian tech companies. Supplier and distribution concerns are referenced frequently, with 74 percent of companies citing risk factors that typically fall outside of their control, such as the cost and availability of components and materials. In many cases, companies rely on resellers and distributors to get their products to market, so maintaining and building new relationships with partners is critical. Disruptions to the supply and distribution process can add time to an already lengthy sales and implementation cycle, a risk cited by 34 percent of companies. The fiscal health of customers, partners, vendors and suppliers is an additional concern to many companies (51 percent). For 36 percent of companies, the loss of a major customer who may comprise a significant portion of their annual sales can be detrimental. Top 25 Risk Factors for Canadian Technology Companies 1. Competition in the tech sector; pricing pressures 83% 2. Failure to develop or market new products or services 79% 3. Ability to attract or retain key personnel 77% 3t. Foreign currency fluctuations 77% 5. Canadian and foreign supplier/vendor and distribution concerns 74% 6. General economic conditions 70% 6t. Intellectual property infringement 70% 8. Failure to execute corporate strategy 64% 9. Inability to acquire capital 64% 10. Federal or local regulations 62% 11. Legal proceedings 58% 11t. Threats to international operations and sales 58% 13. Predicting customer demand and interest; innovation 53% 13t. Cyclical revenue and stock fluctuation 53% 15. Equipment failure and product liability 51% 15t. Credit worthiness of a customer, partner, vendor or supplier 51% 17. Quarterly results fluctuation 49% 18. Management of current and future M&A and divestitures 47% 19. Labour concerns 40% 51% Companies cite the fiscal health of customers, partners, vendors and suppliers as an additional concern. 20. Insurance costs and potential uninsured liabilities 36% 20t. Loss of a major customer 36% 22. Accounting, internal controls and compliance standards 34% 22t. Indebtedness 34% 22t. Lengthy sales and implementation cycle 34% 25. Breaches of technology security or privacy 32% *t indicates a tie in the risk factor ranking

7 BDO Technology RiskFactor Report Canadian Tech Companies Rally around Innovation, but Lag on Commercialization 7 business disrupters IP infringement Equipment failure and product liability Loss of a major customer Security and privacy breaches 0% 10% 20% 30% 40% 50% 60% 70% While cybersecurity is certainly a concern for Canadian technology companies, it appears to be less of an immediate threat here than in the United States. Still, even though the Canadian tech sector generally doesn t collect data on the scale that U.S. companies do, they would be wise to revisit their cybersecurity capabilities and controls. - John Keserich, PARTNER, BDO T&LS PRACTICE Laundry List of Liabilities Canadian tech companies hold their intellectual property near and dear, so IP infringement ranks high among their list of concerns, tied at #6 with general economic conditions. Many companies are rightfully worried about how to maintain control over their IP as they expand internationally, where they may not be afforded the same protections as they are domestically. Moreover, IP protection in Canada is an evolving field, and there is no guarantee for many companies that the protection they enjoy now will persist in the future or not face new challenges. Companies also express concern about the necessity and cost of ongoing litigation to protect, maintain and enforce patents and trademarks. Legal proceedings, most frequently referenced in relation to IP protections, are cited as a concern by 58 percent of companies. Security and privacy breaches have grown increasingly worrisome for companies across all sectors in recent years. Yet, surprisingly, it ranks at the bottom of the list of the top 25 risks for Canadian tech firms in stark contrast to the United States, where it sits at #7. Given the ongoing maintenance, testing and improvements necessary to keep tech products and services current, the risk of errors and failure is a perennial concern and a potential major liability for the tech industry, cited by 51 percent of companies. It also leads into another risk cited by 36 percent of companies: potential uninsured liabilities. Other factors driving potential uninsured losses include system failures, business disruption and settling environmental claims. Detours and Diversions Among the many factors that can hamper companies growth visions for the future are unforeseen competitive issues, legislative developments and branding issues. An inability to execute against the corporate strategy is the seventh most cited risk to tech companies, mentioned in 64 percent of annual filings. Concerns abound on accounting and compliance issues as well, noted by 34 percent of companies. New disclosure requirements around sourcing conflict-free minerals for use in technology manufacturing surfaced in many reports, in addition to transitioning to IFRS and rising levels and scrutiny of tax audits globally. Navigating diverse local laws and cultures can also prove challenging as companies employ an increasingly global workforce. Attracting and retaining the necessary skilled talent is a major struggle for companies building and maintaining international operations. 40 percent of companies cite these and other labour concerns as a risk to their business. Overall, the inaugural BDO Technology RiskFactor Report suggests that Canadian companies are poised to continue serving as important contributors to the global technology industry. A rich tradition of innovation, combined with a supportive regulatory and business environment, has fostered numerous successful companies and continued to position North America as the preeminent global player in the tech space.

8 To learn more about how BDO can help your company with these and other challenges, contact your local BDO office or one of our Technology & Life Sciences Practice Leaders below: Montreal Scott Rodie BDO T&LS Practice Leader Partner, Audit Greater Toronto Area Peter Matutat Partner, Audit Vancouver John Keserich Partner, Audit Albert Pesce Partner, Tax Ext Harry Chana Partner, Tax Daryl Maduke Partner, Tax About BDO: BDO is one of the largest national accounting and advisory partnerships in Canada with over 100 offices nationwide. Our professionals have the expertise to serve owner-managed businesses, large enterprises, public companies, the public sector, and communities and not-for-profit organizations in a broad range of industries. As a member firm of the international BDO network, we also have access to advisors around the globe with over 1,300 offices in more than 150 countries. About BDO S Technology & Life Sciences Practice: BDO s dedicated team of professionals serving the Technology and Life Sciences sectors brings you broad-based experience, in-depth knowledge and business savvy that can be critical to your success. Our professionals propose solutions to your challenges and support every phase of your growth from startup to listed public company. The BDO T&LS team, comprised of leaders in 7 Centres of Excellence across Canada, brings together the resources of our global network of over 1,300 offices in more than 150 countries around the world. We are entrepreneurial, we understand your issues, and we are focused on providing you with exceptional client service. BDO Canada LLP, a Canadian limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms.