industry series: technology/communications€¦ · the presentation is provided for general...
TRANSCRIPT
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Industry Series:Technology/Communications
Corporate Finance BranchDecember 6, 2012
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OSC
SME Disclaimer
“The views expressed in this presentation are the personal views of thepresenting staff and do not necessarily represent the views of theCommission or other Commission staff.
The presentation is provided for general information purposes only anddoes not constitute legal or accounting advice.
Information has been summarized and paraphrased for presentationpurposes and the examples have been provided for illustration purposesonly. Responsibility for making sufficient and appropriate disclosure andcomplying with applicable securities legislation remains with the company.
Information in this presentation reflects securities legislation and otherrelevant standards that are in effect as of the date of the presentation.
The contents of this presentation should not be modified without theexpress written permission of the presenters.”
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Presentation Outline
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Time Topic Page
1:30 – 1:40 Welcome and Introduction to the OSC SME Institute 4
1:40 – 1:50 Securities Regulation 101 6
1:50 – 1:55 Landscape of the Industry 11
1:55 – 3:00 Industry Specific Observations
Financial Statements
Management’s Discussion and Analysis (MD&A)
Other Key Obligations
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3:00 – 3:05 Case Study 87
3:05 – 3:10 Latest Developments 89
3:10 – 3:15 Helpful Information about the OSC 92
3:15 – 3:30 Questions 100
OSC SME Institute
Welcome and Introduction to theOSC SME Institute
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SMEOSC SME Institute - Objectives
Our goal is to:
Help SMEs navigate the regulatory waters
Demystify disclosure requirements so companies can focus onbuilding their business
Reduce SMEs’ cost of compliance so that this money can bebetter spent on strategic initiatives
Provide an opportunity for informal dialogue with OSC staff
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Disclosure requirements, including those for financialreporting, are a cornerstone of investor confidence
OSC SME Institute
Securities Regulation 101
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Securities Regulation 101 – Disclosure Requirements
Periodic Disclosure
• Financial statements, MD&A, CEO and CFO certifications,annual information form, information circular, executivecompensation, corporate governance
Timely Disclosure
• Material change news release and report (Securities Act)
• Material information (Exchanges)
Event-Based Disclosure
• Business acquisition reports, material contracts, insiderreporting
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SMESecurities Regulation 101 – Periodic Requirements
8
Document Venture Non-venture
Audited annual financial statementsaccompanied with:
• Annual MD&A
• Annual CEO and CFO Certificates
120 days afteryear-end
90 days afteryear-end
Interim financial report accompanied with
• Interim MD&A
• Interim CEO and CFO Certificates
60 days afterquarter end
45 days afterquarter end
Annual Information Form (AIF) N/A - but mayelect to file
Usually 90 daysafter year-end
Information Circular Generally mail 21 days beforemeeting and file promptly
Executive Compensation File with related document (usuallywith Information Circular or AIF)Corporate Governance (i.e. Board information)
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SMESecurities Regulation 101 – Timely Disclosure
Material change – a change in the business, operations or capitalof the company that would reasonably be expected to have asignificant effect on market price or value of any of the securities ofthe company (or a decision to implement such a change)
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Document Timing
Material change news release andreport
Immediately issue and filenews release
File material change reportwithin 10 days
Under stock exchange timely disclosure policies, a listed company isrequired to disclose material information including any material factimmediately upon the information becoming known to management
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SMESecurities Regulation 101 - Event-Based Disclosure
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For more information, see OSC website for presentation slides fromOSC SME Institute seminar on “Continuous Disclosure Obligations”
held on October 17, 2012
Document Timing
Business Acquisition Report Within 75 days following acquisition
News Release with Financial Information File news release immediately
Documents Affecting the Rights ofSecurityholders Earlier of filing of material change
report or AIF or 120 days after year-endMaterial Contracts
Initial Insider Report Within 10 days of becoming a reportinginsider
Subsequent Insider Report Within 5 days of any change in holdings
OSC SME Institute
Landscape of the Industry
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Tech/Comm/Biotech133 issuers
(20%)
Retail & Manufacturing56 issuers
(9%)
Mining305 issuers
(47%)
Financial Services37 issuers
(6%)
Other62 issuers
(9%)
CPC59 issuers
(9%)
Number of Ontario SME Issuers - As at March 31, 2012
Tech/Comm/Biotech Retail & Manufacturing Mining Financial Services Other CPC
Ontario’s Public SMEs by Industry
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SMEIndustry Trends
Increased austerity in the euro zone prompting businesses tobe more cautious in IT spending
Emerging markets of Asia and Latin America will remain thetechnology growth leaders
Accelerating shift from older technologies (servers, PCs,routers) to new technologies (mobile devices, sensors, cloudcomputing)
Merger and acquisition activities to slow as many activeacquirers have already broadened their business lines
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OSC SME Institute
Industry Specific Observations
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Observations at a Glance
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Financial Statements MD&A Other Key Obligations
• Revenue Recognition
• Business Combinations
• Research and Development
• Impairment of Assets
• Convertible Debt
• Going Concern
• Discussion of Operations
• Liquidity and Capital Resources
• Risks and Uncertainties
• Transactions Between Related
Parties
• Forward-Looking Information
• Material Contracts
• Non-GAAP Financial Measures
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Financial Statement Observations
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Financial Statements MD&A Other Key Obligations
• Revenue Recognition
• Business Combinations
• Research and Development
• Impairment of Assets
• Convertible Debt
• Going Concern
• Discussion of Operations
• Liquidity and Capital Resources
• Risks and Uncertainties
• Transactions Between Related
Parties
• Forward-Looking Information
• Material Contracts
• Non-GAAP Financial Measures
OSC SME Institute
Revenue Recognition
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Revenue Recognition
Complexity of sales contracts results in judgementsin the timing and amount of revenue to recognize,which typically differs from cash collection
Revenue is generally a key consideration forinvestors to assess the company’s future prospectsand stock value
Observations
Why Important
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Revenue must be earned, measurable and collectible to be recognized
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SME Revenue Recognition Hot Buttons
Areas Considerations
Amount Can returns be reasonably estimated?
Can the multiple elements of a sales contract beseparately valued?
Is the entity acting as principal or agent (gross vs. net)?
Timing Have significant risks and rewards of ownership beentransferred?
Which period should revenue be recognized?
Disclosure Is the revenue recognition policy understandable to areader?
Does the revenue recognition policy describe all productsand services?
Are all unique terms of the sales arrangements described?
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SME Revenue RecognitionExamples of Complex Sales Contracts
Contracts with multiple deliverables for a set price
• Company provides a bundled package of hardware, software,installation and post-contract services for $1,000
Multi-year contracts with significant up-front fees, followed bymilestone payments
• Biotech company contracted to develop a new drug
Contracts with right of return
• New product introduction with return clause
Principal vs. agent
• Telecommunications company providing data content developedby third parties
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OSC SME Institute
Business Combinations
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Business Combinations
Acquisitions of companies occur frequently in thisindustry and often involve significant amounts of“soft” assets such as goodwill and intangibles,which may be difficult to identify and value
Business combination accounting and disclosureexplain the assets and liabilities acquired by thecompany, which helps investors evaluate thenature and financial effects of the transaction
Observations
Why Important
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Companies should recognize all identifiable assets separately from goodwill
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SME Business Combinations Hot Buttons
Areas Considerations
Nature Is the acquisition an asset purchase or a businesscombination?
Amount to beallocated
Is the amount determined correctly?
Have acquisition-related costs been excluded from theamount?
Has contingent consideration been included at fair value?
Allocation Are intangible assets properly separated from goodwill?
Are the criteria met for any recognition of restructuringcosts?
Are contingent liabilities recognized appropriately?
Disclosure Will investors be able to understand why the companypaid a premium (goodwill) in the acquisition?
Are all the other IFRS required disclosures provided?
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SMEBusiness Combinations Example
1. Acquisition related costs (except debt and share issue costs) are expensed, rather thanas part of consideration
2. Has all contingent consideration been included at fair value?3. Restructuring liabilities are expensed when incurred, rather than as part of purchase
price equation (unless they meet the definition of a liability, i.e., company is obliged topay these at acquisition date)
4. Are there any contingent liabilities that need to be included?5. Too much in goodwill? Are all intangibles identified? Are other assets valued properly?
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Purchase price allocation for a company:
Inventory $ 50,000
Receivables 35,000
Patent 2,000
Goodwill 200,000
Restructuring liability (5,000)
Other liabilities (40,000)
Consideration $ 242,000
Comprising:
Cash $ 50,000
10,000 shares issued at $15.00 each (ignoring share issue costs) 150,000
Acquisition related costs 42,000
$ 242,000
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Research and Development
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Research and Development
Development expenditures may be inappropriatelyaccounted for
Investors and analysts use the amount ofdevelopment costs that have been recorded asassets as an indicator of a company’s commitmentto, and feasibility of, a project
Observations
Why Important
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Companies are required to have progressed to a certain stage indevelopment before they can capitalize costs. When that stage is reached,
development costs are required to be capitalized.
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SME Research and Development Hot Buttons
Areas Considerations
Identification How are research and development costsdistinguished from each other?
Which activities comprise research?
Which activities comprise development?
Capitalization How did the company determine that the project istechnically feasible?
How will the asset be used to generate revenue?
How will the project be financed?
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SME Research and DevelopmentExample of R&D Activities
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Engineering reportdemonstrating feasibility
Approved development budget
Expected sales
Committed financing
Researchactivities
Examples ofevents
required totrigger
capitalization
Developmentactivities
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Impairment of Assets
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Impairment of Assets
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Companies are not writing down assets to reflect adecline in value even though indicators ofimpairment are present
Assessing for indicators of impairment andperforming impairment tests ensures that assetsare not overstated
Observations
Why Important
Companies must assess for indicators of impairmentat the end of each quarter
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SME Impairment of Assets Hot Buttons
Areas Considerations
Indicators Has the intended future use of an asset changed?
How will a competitor’s announcement impact thecompany?
Has performance of an asset met initial expectations?
Has share price dropped significantly so that net bookvalue of assets exceeds market capitalization?
Value Are the assumptions used in the impairmentassessment consistent with overall operations?
Disclosure Will an investor be able to understand the eventsleading to the impairment, or why an asset is notimpaired?
Are the key assumptions used in the impairmentassessment disclosed?
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SME Impairment of AssetsExamples of Potential Indicators
Scenarios that would likely be an indicator ofimpairment:
• Company decision to no longer market a product due to thecompany’s release of an upgraded product
• Slower than anticipated customer subscriptions to a newsoftware platform offered by the company
• Competitor announcement of a technological innovation thatshifts consumer preferences
• Net book value exceeds total company market capitalization
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Intangible assets with indefinite useful lives, as well as goodwill, have to betested annually, even if there are no indicators of impairment
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Convertible Debt
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Convertible Debt
Companies often issue convertible debt anddisclosure is not always clear on whether thecompound instrument has been separated betweenits debt and equity components
Investors need to understand the substance of theinstrument, as conversion of the debt into commonshares could dilute investors’ shareholdings andcould impact the Company’s debt/equity ratios
Classification of liability/equity component is not revisedafter initial recognition
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Observations
Why Important
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Convertible Debt Hot Buttons
Areas Considerations
Classification Has the company evaluated the instrument’s terms todetermine whether it contains both a liability and equitycomponent?
Has the company presented the liability and equity componentsseparately on the Statement of Financial Position?
Measurement Has the company disclosed how the debt will be valued?
Has fair value of liability component been measured using asimilar instrument without an equity conversion option?
Has the equity component been assigned the residual amountafter deducting the liability amount from the fair value as awhole?
Since the sum of the carrying amounts of the liabilityand equity components is equal to fair value of the instrument as a whole,
no gain or loss arises on Day 1
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Convertible DebtExample
Company issued a $3 million, 7% convertible notematuring on January 31, 2015. The note wasissued at par and pays interest at 7% per annum
The principal amount can be converted, at theoption of the holder, into 350,000 common sharesof the company at any time up to the maturitydate
Company should account for the compound instrument by determining fairvalue of liability component first and then allocating the residual to equity
Liability component
Equity component
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Going Concern
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Going Concern
Financial fundamentals, such as a working capitaldeficiency, an excessive cash burn rate andmilestone challenges, suggest liquidity concernsthat may cast doubt on the company’s ability tocontinue operations, however a going concernnote is absent
A going concern note provides warnings about thesignificant risks being faced by the company andidentifies concerns regarding its future viability,both of which will ultimately impact investmentdecisions
Management needs to assess the company’s ability to continue as a goingconcern for at least 12 months from the end of the reporting period
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Observations
Why Important
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Going Concern Hot Buttons
Areas Considerations
Management’sassessment
Have the following factors been considered? Current and expected profitability Debt repayment schedules Availability of potential sources of financing Adequacy of capital resources to meet upcoming
milestones and commitments Working capital position Cash burn rate Economic conditions
Disclosure Does management’s assessment of the company’sfinancial fundamentals indicate that a going concernnote is warranted? If so, has the company disclosed the material
uncertainties that cast significant doubt upon the abilityto continue as a going concern?
Note: In order for this disclosure to be useful, explicitly state thatthese uncertainties cast significant doubt upon the company’sability to continue as a going concern
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MD&A Observations
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Financial Statements MD&A Other Key Obligations
• Revenue Recognition
• Business Combinations
• Research and Development
• Impairment of Assets
• Convertible Debt
• Going Concern
• Discussion of Operations
• Liquidity and Capital Resources
• Risks and Uncertainties
• Transactions Between Related
Parties
• Forward-Looking Information
• Material Contracts
• Non-GAAP Financial Measures
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MD&A Background
MD&A is a narrative explanation “through the eyes ofmanagement” which:
• Provides a balanced discussion of a company’s results, financialcondition and future prospects – openly reporting bad news aswell as good news
• Helps current and prospective investors understand what thefinancial statements show and do not show
• Discusses trends and risks that have affected or are reasonablylikely to affect the financial statements in the future
• Provides information about the quality and potential variabilityof company’s earnings and cash flow
The MD&A should complement and supplementthe company’s financial statements
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SME Annual MD&A
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AnnualMD&A
Change inaccounting
policy Overallperformance
Selectedannual
information
Risks anduncertainties
Discussions ofoperations
Summary ofquarterly
results
Liquidity andcapital
resourcesOff-balancesheet
arrangements
Transactionsbetweenrelatedparties
Fourthquarteranalysis
Criticalaccountingestimates
Proposedtransactions
Financialinstruments
Forward-looking
information
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Discussion of Operations
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SMEDiscussion of Operations
Projects not yet generating revenue
Discussion of significant projects that have not yetgenerated revenue often do not include statusupdates against originally projected plans
Investors want information on the progress ofsignificant projects to assess management, thecompany’s performance, as well as futureprospects
Observations
Why Important
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Project updates should discuss status, expenditures made, and anticipatedtiming and costs to reach the next phase or milestone
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SME Discussion of Operations Hot ButtonsProjects not yet generating revenue
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Areas Considerations
Status Is the current plan for each project disclosed?
Is there disclosure of the project’s progress compared tothe plan?
Have the results from pre-production and field tests beendisclosed?
Expenditures Have the following been disclosed? Expenditures to date Whether the company anticipates spending more than
budget on each project Amounts that need to be spent to get project to next
level Whether financing has been secured to advance the
project
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SME Discussion of OperationsVariances to the Use of Proceeds
Funds raised by way of a prospectus are often forspecific projects or stages of specific projects.Companies do not always adequately explain howproceeds raised in public offerings weresubsequently used and the impact of any changesfrom their originally intended use.
Investors should be made aware of how theirinvestment is being spent. Updating the use ofproceeds in the MD&A will allow investors to assesshow management has ultimately spent the funds.
Observations
Why Important
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Companies are required to compare, in tabular form, the changes in the use ofproceeds and to explain the impact of the changes on the company’s ability to
achieve its business objectives and milestones
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SME Discussion of Operations Hot ButtonsVariances to the Use of Proceeds
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Areas Considerations
Variances How does the nature and amount of expendituresmade by the company compare to the use of proceedsfrom previous financing?
How do variances impact future operations?
How will the variance affect the company’s ability toachieve its business objectives and milestones?
Will the company require additional financing to meetits next milestone?
Disclosure Have the above items been disclosed?
Does the disclosure comply with MD&Arequirements?
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SME Variance in the Use of ProceedsExample of Boilerplate Disclosure
Disclosure fromprospectus
Disclosurenot updated
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Although the company intends to expend thenet proceeds from the prospectus as describedin the preceding paragraph, there may becircumstances where for sound businessreasons, a reallocation of funds may be deemedprudent or necessary. While actualexpenditures may differ from the aboveamounts and allocations, the net proceeds willbe used by the company in furtherance of itsbusiness.
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SME Variance in the Use of ProceedsExample of Entity-Specific Disclosure
Impact onother projects
Additionalinvestment
49
The following table provides an update on the anticipated use ofproceeds raised in the most recent financing, along with amountsactually expended and a description of the variances. The companyrecently determined that additional investment is required to getProject A to the testing phase. The final column of the tableindicates the company’s revised estimate of the total expenditurerequired to complete the indicated phase. Given the anticipatedincreased costs for Project A, the company was not able to use thefunds for Project B as noted in the prospectus. The expected budgetfor Project B remains unchanged from that disclosed in theprospectus and the company is developing a strategy to ensurefunding is available so that the time of Project B is not delayed.
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SME Variance in the Use of ProceedsExample of Entity-Specific Disclosure
(cont’d)
Phase Previouslydisclosed
Spentto date
Variance Reason Total revisedbudget
R&D $4,600 $5,200 $600 Extra feasibility round $5,300
Testing $1,200 Nil Nil To be started next fiscal $1,200
Total $5,800 $5,200 $600 $6,500
Revisedexpenditures
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Project A – Update of costs expended and project budget
Project B – Update of costs expended and project budget
Phase Previouslydisclosed
Spentto date
Variance Reason Total revisedbudget
R&D $700 Nil ($700) Deferred project untilfinancing can be secured
$700
Total $700 Nil ($700) $700
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Liquidity and Capital Resources
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Liquidity and Capital Resources
A meaningful analysis of the company’s ability togenerate sufficient cash, address its working capitalrequirements and its ability to access financing tomeet its committed expenditures is not alwaysprovided
Investors need to clearly understand any anticipatedfunding shortfalls and financing resources availableto meet spending commitments and continue keyprojects
Companies should explain their current liquidity position andhow they will fund upcoming operating commitments and other obligations
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Observations
Why Important
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Liquidity and Capital Resources Hot Buttons
Areas Considerations
Ability to generatesufficient cash
Is there analysis of the company’s ability to generatesufficient cash, in the short term and the long term to: Meet funding needs? Meet planned growth? Fund development activities?
Working capitalrequirements
Are the company’s working capital requirementsdisclosed?
If a working capital deficiency exists, or is expected, isthere a discussion on the company’s: Ability to meet obligations as they become due? Plans, if any, to remedy the deficiency?
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Liquidity and Capital Resources Hot Buttons
Areas Considerations
Spendingrequirements
Is analysis provided on commitments for:
Capital expenditures?
Any expenditures required to continue key projects?
Has the nature, amount and purpose of commitments,and expected source of funds to meet thesecommitments been disclosed?
Sources offinancing
Is there a discussion on how difficulties in obtainingfinancing could affect:
Status of projects?
Ability to continue as a going concern?
Have the expected sources of financing that are beingpursued been identified?
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OSC
SME Debt CovenantsExample of Boilerplate Disclosure
The amount available for borrowing under the facility issubject to certain financial and restrictive covenants asdefined under the credit facility agreement. As ofDecember 31, 2011, the company was not in breach ofthese covenants.
Breach afteryear end
not disclosed
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SME Debt CovenantsExample of Entity-specific Disclosure
The amount available for borrowing under the Facility is subjectto certain financial and restrictive covenants. These include: (1) aDebt-to-Equity Ratio of not more than 0.50; (2) AccountsReceivable Turnover of not less than 10 times in any 12 month-period; and (3) Annual Maximum Capital Expenditure of $5.0million.
As of and during the year of December 31, 2011, the companywas not in breach of these covenants. However, as of January 31,2012, the company’s Debt-To-Equity Ratio was at 0.53,temporarily exceeding the maximum stipulated under the Facility.It decreased back to 0.44 as of February 29, 2012, and as of thedate of this MD&A, the company continued to be in compliancewith all covenants. The high Debt-To-Equity Ratio as of January31, 2012 was a result of the strike as mentioned under Discussionof Operations. Management believes the company will complywith all covenants in the foreseeable future.
Covenants andrestrictions
Potential offuture breach
Breach
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SME Cash Burn RateExample of Boilerplate Disclosure
During the three months ended March 31, 2012, cash flowused in operating activities was $656.
Management believes the cash and cash equivalentsbalance of $3,253 is sufficient for the company’s operationsin the foreseeable future.
No analysis ofburn rate
No explanationof why sufficient
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SME Cash Burn RateExample of Entity-specific Disclosure
During the three months ended March 31, 2012, cash flowused in operating activities was $656. During the period fromJanuary 1, 2012 to March 31, 2012, the company’s averagemonthly cash burn rate was $198. Due to the strategic plansthe company expects to execute in the coming fiscal year,management expects the monthly cash burn rate to increaseto $265, mainly as a result of an increase in marketingexpenditures. Management believes the cash and cashequivalents balance of $3,253 is sufficient for the company’soperations in the foreseeable future, even with the increasedcash burn rate. However, management is also in the processof obtaining an additional operating line of credit to providethe company with additional working capital when necessary.
Current burnrate and trend
Plan respondingto burn rate
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SME Commitments for ExpendituresExample of Boilerplate Disclosure
Contractual Obligations Table at December 31, 2012
ContractualObligations
Total < 1 Yr 1-3 Yrs 3 – 5 Yrs > 5 Yrs
Long-term debt 4,567 724 1,320 1,407 1,116
Capital leases 775 236 539 - -
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SME Commitments for ExpendituresExample of Entity-specific Disclosure
[Contractual Obligation Table]The company has entered into a development and licenseagreement with XYBio Inc. under which the company andXYBio Inc. collaborate in certain research and developmentactivities to conduct further studies on thecommercialization potential of patent #345. The company isobligated to provide XYBio Inc. with up to $2,000 in researchfunding and milestones payments, of which $500 is to bepaid over the next 5 years at $100 per year upon thecompletion of the activities stipulated in the agreement, andthe remainder is to be paid in three instalments of $700,$400, and $400 respectively upon the achievement of threemilestones. The timing of achieving the milestones isuncertain, but the first milestone is expected to be achievedin the summer of 2013, and all milestones are expected to beachieved by 2016.
Committedexpenditures
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Risks and Uncertainties
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Risks and Uncertainties
Disclosure of risks and uncertainties is oftenboilerplate in nature and the potential impact ofhow the risks may affect the company is rarelydisclosed
Investors need to understand the entity-specificrisks and how those risks may impact the companyand its business, both of which may affect aninvestment decision or the value of theirinvestment should the risks be realized
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Throughout each section of the MD&A, companies should discloserisks and uncertainties that are material and entity-specific
Observations
Why Important
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Risks and Uncertainties Hot ButtonsAreas Considerations
Enterprise riskmanagement
Has information been sought from industryassociations and competitors to remain abreast ofemerging risks?
Has the Board been informed of the risks that are notbeing actively managed and those that are beingactively managed?
Disclosure Have all risks material to the company been disclosed?
Is there disclosure on how the risk may impact the
company?
Has the risk disclosure been updated to reflect changes
in current and expected conditions?
Note: Do not provide a ‘laundry list’ of every conceivable risk
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To provide meaningful information, companies shoulddisclose the strategies used to manage its risks
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SME Risk and UncertaintiesExample of Boilerplate Disclosure
Competition Risk
Our industry is very competitive. We facesignificant competition from other softwarecompanies in all aspects of our business. Ourcompetitors are larger in size, well established,international in scope and have significant financialresources. We continue to actively monitor theactivities of our competitors with a view toensuring that we will be able to effectivelycompete in the marketplace and attract newcustomers.
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General and notspecific to company
Potential impactis not disclosed
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SME Risk and UncertaintiesExample of Entity-Specific Disclosure
Competition Risk
We face significant competition from othermanufacturers in Canada and Country ABC. Ourcompetitors include Company Calao and CompanyLagos. These competitors are well established,international in scope and have significantfinancial resources that permit them to developnew products, modify existing products, useproprietary software and market products on aglobal basis. Competition is based mainly on price,quality of product and efficiency of production.The increased competition may affect our sales,cash flow and financial condition.
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Entity-specific
Potential impact
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SME Risk and UncertaintiesExample of Entity-Specific Disclosure (cont’d)
Risk Management Strategies
To mitigate competition risk, our strategies includecreating long-term value for our customers andimplementing efficient processes to manufactureour main product TopProgram.
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Risk management
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Transactions Between Related Parties
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Transactions Between Related Parties
The business purpose and economic substance ofrelated party transactions (RPTs) is sometimes notdisclosed
By virtue of their nature, related party transactionslack the independence inherent in arm’s lengthtransactions. Investors need to understand thebusiness purpose and economic substance of RPTs,so they can understand the rationale fortransactions and impact on the business
Companies should clearly discuss ALL related party transactions, including theidentity of the parties and their relationship to the company, as well as the business
purpose and economic substance of each transaction
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Why Important
Observations
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Transactions between Related PartiesExample of Boilerplate Disclosure
During the year, the company paid$3,000,000 to a company with commondirectors with the company services andinterest on a loan.
Lacks detail on thetransaction and the
identity of therelated party
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SME Transactions between Related PartiesExample of Entity-Specific Disclosure
During the year, the company paid $3,000,000 to Drug Co, whohas common directors with the company. The company paid$200,000 to DrugCo for the use of laboratory space, and$2,400,000 for materials in connection with Phase 2 of thedevelopment of NewDrug . The laboratory space and materials,which were both provided in the normal course of operations atrates comparable to what would have been paid to unrelatedparties, were measured at the exchange amount.
The company also paid DrugCo $400,000 in interest on a loanhe provided in the principal amount of $4,000,000. Theunsecured loan bears interest at 10% per annum, and maturesin five years with an option by the company to extinguish thedebt at any time without penalty. The company entered into thisrelated party transaction because alternate sources of financingwere unavailable due to the company’s limited operatinghistory, lack of collateral and limited access to public financingdue to current market conditions.
Relationship/identity
Business purposeand amount
Measurementbasis used
Business purposeand amount
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Forward-Looking Information
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Forward-Looking Information
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Companies are not always aware that disclosure offuture operational activities is considered forward-looking information (FLI) which is subject toadditional disclosure requirements undersecurities legislation
Securities legislation requires companies to discussin their MD&A occurrences that are likely to causeactual results to differ materially from previouslydisclosed FLI. This allows investors to evaluate thecompany’s forecast and see how it is progressingtoward the achievement of its objectives.
If companies choose to disclose FLI, then they are also required to provideupdates in subsequent MD&A.
Observations
Why Important
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Forward-Looking Information Hot Buttons
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Areas Considerations
General Is there a reasonable basis for the disclosed FLI?
Are assumptions supportable and entity-specific?
Is the FLI presented for a reasonable period?
Disclosure Is FLI identified?
Are the assumptions used to develop FLIdisclosed?
Has previously disclosed FLI been updated ifactual results differ materially?
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SMEForward-Looking Information
Example of Boilerplate Disclosure
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In fiscal 2012, the company anticipates meetingthe following targets:
Total revenues expected to be between $1.5 -$2 billion
Organic product sales growth > 4% Cash EPS expected to be between $3.00 - $3.50 Adjusted Cash Flow from Operations > $350
million
FLI not identified
No assumptionsprovided
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SME Forward-Looking InformationExample of Entity-Specific Disclosure
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The following represents forward-looking information andusers are cautioned that actual results may vary. In fiscal2012, the company expects total sales to increase by 5.0%to 6.0%. This expectation is based on same-store salesgrowth of between 3.0% and 4.0% and the introduction ofnew brands to our city centre stores. It is expected that newbrands will contribute to the increase in sales and will beoffset by increased competition from U.S. retailers. Keyperformance indicator for the company includes retail persquare foot, this target is assuming an average sale persquare feet of $45. Increase of 25 basis points in theinterest rates may cause sales target to decrease by 1-2%.
Identification ofFLI
Assumptions
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SMEForward-Looking Information
Example of Updating Previously Disclosed FLI
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2011 objectives Accomplishments in 2011
Sales growth of 3-4% Sales growth of 10.5%The increase in sales growth achievedduring fiscal 2011 was due to theintroduction of product XX in Q4 whichresulted in a growth of 6% of sales,reduction of the selling price of product Ywhich resulted in the increase in salesvolume of 75%, and the increase in the salesvolume of product R.
Capital expenditure $25-35million
Capital expenditure of $15 million.Spending was substantially lower thananticipated due to lower informationtechnology enhancement requirements ($8million) and less equipment replacements($7 million).
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Other Key Obligations Observations
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Financial Statements MD&A Other Key Obligations
• Revenue Recognition
• Business Combinations
• Research and Development
• Impairment of Assets
• Convertible Debt
• Going Concern
• Discussion of Operations
• Liquidity and Capital Resources
• Risks and Uncertainties
• Transactions Between Related
Parties
• Forward-Looking Information
• Material Contracts
• Non-GAAP Financial Measures
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Material Contracts
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Material Contracts
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Companies often do not identify and file materialcontracts such as contracts to sell the majority ofthe company's products, or contracts to purchasethe majority of the company’s requirements ofgoods, services or raw materials
Material contracts are important for investors inunderstanding the company's business and thepotential impact of these contracts on operations
Observations
Why Important
Companies are required to file copies of material contractsand should be aware of the exceptions to the use
of the ordinary course of business exemption
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Material Contracts - Example
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Examples of material contracts enteredinto in the ordinary course of business
Required to file?
Employment contract In general, no
Customer sales contract Yes, if
Company’s business is substantiallydependent on the contract, or
Continuing contract to sell the majorityof the company’s goods or services
Credit agreement with financial institution Yes, if
Company’s business is substantiallydependent on the contract, or
Contract has terms that have a directcorrelation with anticipated cashdistributions
OSC SME Institute
Non-GAAP Financial Measures
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Non-GAAP Financial Measures
Many companies disclose non-GAAP financialmeasures, such as EBITDA, however they often donot explain why these measures provide usefulinformation to investors. As well, these measuresare not always reconciled to the most directlycomparable GAAP measure
Since non-GAAP financial measures do not formpart of IFRS and as such do not have astandardized meaning or calculation, it is criticalthat companies explain the composition of themeasure and its relevance so that investors andanalysts are fully informed
When providing non-GAAP financial information, companies should notmislead investors nor obscure the company’s GAAP results
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Observations
Why Important
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Areas Considerations
Usefulness Has the company disclosed: Why the non-GAAP financial measure is useful to an
investor? Why management considers the non-GAAP financial
measure to be useful?
Reconciliation Is a reconciliation between the non-GAAP financialmeasure and the most directly comparable GAAPmeasure provided?
No standardizedmeaning
Does the disclosure explicitly state that there is nostandardized meaning of the non-GAAP financialmeasure?
Prominence Has the comparable GAAP measure been presented withequal or greater prominence to the non-GAAP financialmeasure?
Explain changesfrom previousyears
If composition of the non-GAAP financial measure haschanged from the previous year, has disclosure of thereasons for these changes been made?
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SME Non-GAAP Financial MeasuresExample of Boilerplate Disclosure
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Our operating income before specific itemsrose 31%, reaching a new peak of $101million.
No reconciliationprovided
No explanation ofwhy useful
Standardizedlanguage missing
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SME Non-GAAP Financial MeasuresExample of Entity-Specific Disclosure
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Our profit for the fiscal year was $50 million comparedto $31 million in the previous fiscal year. Operatingincome before specific items (OIBI) rose 31%, reachinga new peak of $101 million. OIBI of the previous fiscalyear was $77 million.
OIBI is a non-GAAP measure and is mainly derived fromthe consolidated financial statements but does nothave any standardized meaning prescribed by IFRS.Therefore it is unlikely to be comparable to similarmeasures presented by other companies.
OIBI is used by management to evaluate theperformance of its operations based on a comparablebasis which excludes specific items that are non-recurring. When a specific item occurs in twoconsecutive fiscal years, it is no longer considered to benon-recurring by management. continued on next page
Highlights thatthere is nostandardizedmeaning
Why useful
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SME Non-GAAP Financial MeasuresExample of Entity-Specific Disclosure (cont’d)
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We believe that a significant number of users of ourMD&A analyze our results based on OIBI since it is ayearly comparable measure of the performance ofthe Company.
Reconciliation of OIBI to profit in thousands ofdollars:
Why useful
Presented withequal prominenceto IFRS
OIBI $101 $77
Restructuring of distribution network ($6) $0
Relocation of production $0 ($9)
Gross income as per financial statements $95 $68
Sales and administrative expenses. $23 $19
Financial expenses $12 $9
Tax expenses $10 $9
Net income as per financial statements $50 $31
Quantitativereconciliation
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Take a Chance Technology Inc.Case Study
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SMECase Study
Please take 5 minutes to review the sample newsrelease for Take a Chance Technology Inc.
What information in the news release would prompt aquestion from the regulator during a continuousdisclosure review• Consider all topics covered in the session• Hint: there are 6 triggers in the news release
This exercise is for illustrative purposes only
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Latest Developments
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Exempt Market Review
Published CSA Staff Notice 45-310 Update on StaffConsultation Note 45-401 Review of Minimum Amountand Accredited Investor Exemptions
• Review of the minimum amount and accredited investorprospectus exemptions
OSC Staff Notice 45-707 OSC Broadening Scope ofReview of Prospectus Exemptions
• Considering the introduction of new capital raising prospectusexemptions
• Subject to further consultation
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SMEProportionate Regulation for Venture Issuers
Proposed National Instrument 51-103 OngoingGovernance and Disclosure Requirements for VentureIssuers was republished on September 13, 2012
Purpose of initiative
• To streamline and tailor venture issuer disclosure to make itmore useful and user-friendly for investors
• To make the disclosure requirements for venture issuers moresuitable and more manageable for issuers at this stage ofdevelopment
The 90-day comment period ends December 12, 2012
• Please provide your input
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Helpful Information about the OSC
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Useful Links for Companies
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Useful Links for Companies
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Responding to OSC Comment Letters
Contact staff if clarification is required
Provide a comprehensive response to each questionasked
Include detailed analysis, if requested, which reconcilesto financial statements and other filings
Cite authoritative accounting references in response toquestions related to financial statements
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What if I Don’t Comply?
Placed on default list
• OSC Policy 51-601 Reporting Issuer Defaults
• Lists key deficiencies resulting in a reportingissuer being noted in default, such as, financialstatements, MD&A and technical reports
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SMEWhat if I Don’t Remedy?
National Policy 12-203 Cease Trade Orders forContinuous Disclosure Defaults
• Describes how CSA generally responds to CD defaultsby reporting issuers
If default not remedied within specified time
• Staff recommends whether CTO/MCTO is appropriate
• Issuer must apply for MCTO
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How do I Lift my CTO/MCTO?
National Policy 12-202 Revocation of CeaseTrade Orders
• Explains what reporting issuers must do for partial orfull revocation of cease trade orders
• Explains some of the factors staff may take intoaccount when considering the appropriateness ofpartial or full revocation
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SMEWhen I Remedy
If done quickly – avoid default/MCTO/CTO
Once deficiency is remedied – placed onRefilings & Errors List
• File press release (OSC Staff Notice 51-711List of Refilings and Corrections of Errors as aResult of Regulatory Reviews) communicatingthe refiling to the marketplace
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Questions?
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Appendices
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Appendix A – Key References
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Topic Reference
Financial Statements
Revenue recognition IAS 18 Revenue Recognition
Business combinations IFRS 3 Business Combinations
Research and development IAS 38 Intangible Assets
Impairment of assets IAS 36 Impairment of Assets
Convertible debt IAS 39 Financial Instruments: Recognition andMeasurement
Going concern IAS 1 Presentation of Financial StatementsOSC Staff Notice 52-719 Going Concern Disclosure Review
Management’s Discussion and Analysis
Discussion of operations Item 1.4 of Form 51-102F1 of NI 51-102 Continuous DisclosureObligations
Liquidity and capital resources Items 1.6 and 1.7 of Form 51-102F1 of NI 51-102 ContinuousDisclosure Obligations
Risk and uncertainties Form 51-102F1 of NI 51-102 Continuous Disclosure Obligations
• Part 1 (a) General Provisions• Item 1.2 Overall Performance• Item 1.4 Results of Operations• Item 1.6 Liquidity• Item 1.14 Financial Instruments and Other Instruments
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Appendix A – Key References (cont’d)
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Topic Reference
Management’s Discussion and Analysis (cont’d)
Transactions with Related Parties Item 1.9 of Form 51-102F1
Forward-looking information Part 4A , 4B and 5.8 of NI 51-102 Continuous DisclosureObligations
Other Key Disclosures
Material contracts Item 12.2 of NI 51-102 Continuous Disclosure Obligations
Non-GAAP financial measures CSA Staff Notice 52-306 (Revised) – Non-GAAP Financial Measuresand Additional GAAP Measures
Disclosure standards NP 51-201 Disclosure Standards
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Appendix B – Financial Examiners
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SMEAppendix B - Financial Examiners
Financial Examiners maintain CD records, monitorSEDAR filings, and provide assistance for Ontarioreporting issuers
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Companies with names beginning with… Financial examiner
Numbers, A, B, G, N Sheryl [email protected]
D, O, P, Q, R, S Shirley [email protected]
E, F, H, T, U, V, W, X, Y, Z Sonia [email protected]
C, I, J, K, L, M Diana [email protected]
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Appendix C – Contact Information
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Appendix C – Contact Information
Kelly Gorman
Deputy Director, Corporate Finance
Email: [email protected]
Phone: 416-593-8251
Lisa Enright
Manager, Corporate Finance
Email: [email protected]
Phone: 416-593-3686
Heidi Franken
Senior Accountant, Corporate Finance
Email: [email protected]
Phone: 416-593-8249
Charlmane Wong
Senior Accountant, Corporate Finance
Email: [email protected]
Phone: 416-593-8151
Kelly Mireault
Senior Accountant, Corporate Finance
Email: [email protected]
Phone: 416-595-8774
Ray Ho
Accountant, Corporate Finance
Email: [email protected]
Phone: 416-593-8106
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Industry Series – Technology and CommunicationsFinancial Statement Disclosure Examples
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SME Disclaimer
The examples provided herein are for illustration purposesonly, and only illustrate certain disclosure requirementsunder IFRS. They do not, and are not intended to, fullycomply with all IFRS disclosure requirements. Responsibilityfor making sufficient and appropriate disclosure andcomplying with applicable IFRS and securities legislationremains with the company.
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Revenue Recognition
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SME Revenue Recognition Accounting PolicyExample of Boilerplate Disclosure
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Revenue is recognized upon deliverywhen the selling price is fixed, costs canbe measured reliably and collection isreasonably assured.
Unclear whatproducts are sold
Unclear how keycriteria are met
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SME Revenue Recognition Accounting PolicyExample of Entity-Specific Disclosure
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The company generates revenue from the sale of productsand the provision of services.
The company recognizes revenue when it has transferred thesignificant risks and rewards of ownership, legal title haspassed, it retains neither continuing managerial involvementto the degree usually associated with ownership noreffective control over the goods sold, the amount of revenuecan be measured reliably, it is probable that the economicbenefits associated with the transaction will flow to thecompany, and the costs incurred or to be incurred in respectof the transaction can be measured reliably.
ProductsSale of products comprises the sale of hardware andportable devices. Significant risks and rewards of ownershipare considered to have passed when the product is shipped.The company provides customers with a right of return onlyif the product shipped is defective, and records reductions torevenue for expected future product returns based on thecompany’s historical experience.
Earned
Collectible
Measurable
Specific policyfor first
revenue stream
Revenue streams
Unique termsand related policy
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SME Revenue Recognition Accounting PolicyExample of Entity-Specific Disclosure (cont’d)
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ServicesServices comprise maintenance services and consulting.Revenue from maintenance services is recognized rateably ona monthly basis when the service is provided. Revenue fromconsulting services is recognized by reference to the stage ofcompletion of the contract at the reporting date.
Multiple Deliverable ArrangementsThe company offers certain products and its maintenanceservices as multiple deliverable arrangements. The companydivides multiple deliverable arrangements into separate unitsof accounting. Units of multiple deliverable arrangements areseparately accounted for provided the delivered units havestandalone value to the customers and the fair value of anyundelivered units can be objectively and reliably determined.Consideration for these units is measured and allocatedamongst the accounting units according to their fair values,determined based upon their relative selling prices when soldon a stand-alone basis. The company’s relevant revenuerecognition policies are then applied to the units.
Policyfor multipledeliverable
arrangements
Specific policyfor second
revenue stream
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Business Combinations
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Reasons for the Business Combination
On March 4, 2012, the Company acquiredSupertechCo, a technology company specializing inintelligence database technology. The Company paid$3.4 million in cash as consideration. The acquisitionof SupertechCo expands the Company’stechnological capabilities and creates synergies.
Non specific aboutthe reasons behind
the acquisition
Business CombinationsExample of Boilerplate Disclosures
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Reasons for the Business Combination
On March 4, 2012, the Company acquiredSupertechCo, a technology company specializing inintelligence database technology. The Companypaid $3.4 million in cash as consideration. Theacquisition of SupertechCo will allow the Companyaccess to the proprietary technology developed bySupertechCo, as well as to its unique customerbase. SupertechCo has developed a technology forthe management of security intelligencedatabases. Its customers include governments inthe Middle East. SupertechCo’s technologycomplements the Company’s databasemanagement products.
Specific disclosure of thebusiness reasonsfor the acquisition
Business CombinationsExample of Entity-Specific Disclosure
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What Constitutes Goodwill
The goodwill recognized on the acquisition ofSupertechCo is a result of the synergies created bythe acquisition.
Business CombinationsExample of Boilerplate Disclosures (Cont’d)
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Non specific about thenature of the synergies
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What Constitutes Goodwill
The goodwill recognized on the acquisition ofSupertechCo is mainly attributable to its technicaldevelopment staff, who posses unique experiencein the intelligence requirements of its customers.In addition, the expansion into the Middle Eastmarkets allows the Company to tap into newmarkets which complement its existing customerbase of primarily government entities.
Specific disclosure of thefactors that
constitute goodwill
Business CombinationsExample of Entity-Specific Disclosure (Cont’d)
OSC SME Institute
Impairment of Assets
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Events and Circumstances Leading to Impairment
The Company performed an impairment assessmentat year end as a result of the economic downturn.
The reason providedis too broad and general
Impairment of AssetsExample of Boilerplate Disclosures
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Events and Circumstances Leading to Impairment
The Company performed an impairmentassessment at year end as a result of the economicdownturn, which has led the Company’scustomers, who have experienced an aboveaverage impact of the economic downturn due totheir exposure to the speculative real estatemarket, to cut back on their technological budgets.As a result, many of our customers have delayedtheir scheduled renewals of equipment as well asreduced their service requirements. The Companyhas revised its cash flow projections as a result.
Specific disclosure of theevents and circumstances
leading to impairment
Impairment of AssetsExample of Entity-Specific Disclosure
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Description of Cash Generating Units
A cash generating unit is the smallest identifiablegroup of assets that generates cash inflows that arelargely independent of cash inflows from otherassets or groups of assets.
Merely repeats thedefinition of a CGUaccording to IFRS
Impairment of AssetsExample of Boilerplate Disclosures (Cont’d)
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Description of Cash Generating Units
A cash generating unit is the smallest identifiablegroup of assets that generates cash inflows thatare largely independent of cash inflows from otherassets or groups of assets. The Company has twocash generating units, represented by the twomarkets (Canada and the United States) that itoperates in.
Specifies what the CGUs are
Impairment of AssetsExample of Entity-Specific Disclosure (Cont’d)
OSC SME Institute
Going Concern
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While these financial statements have been preparedon a going concern basis, the company continues toremain dependent on its ability to obtain sufficientfunding to sustain operations and complete clinicaltrials for Wonder Drug.
While the company has been successful in raisingfinancing in the past, there can be no assurance thatit will be able to do so in the future.
If the going concern assumption was not appropriate,then adjustments might be necessary to the financialstatements.
Unclear if this is meantto highlight a
material uncertainty
Missing clear disclosuresof material uncertaintiesthat cast significant doubt
Going ConcernExample of Boilerplate Disclosure
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The financial statements were prepared on a goingconcern basis. The going concern basis assumes thatthe company will continue in operation for theforeseeable future and will be able to realize its assetsand discharge its liabilities and commitments in thenormal course of business.
During the year ended December 31, 2011, thecompany had a net loss of $2 million, negative cashflow from operations of $800,000, and positiveworking capital of $3.2 million. The positive workingcapital balance was mainly due to having a cashbalance of $5.5 million. Given the companymaintained positive working capital, it believes that itwill have sufficient capital to operate over the next 12months, however additional funding will be necessaryto complete clinical trials for Wonder Drug.
Specific disclosure of thematerial uncertainties
that cast significant doubt
Going ConcernExample of Entity-Specific Disclosure
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Historically the company has had operating losses,negative cash flows from operations, and workingcapital deficiencies. Whether, and when, the companycan attain profitability and positive cash flows fromoperations is uncertain. The company is also uncertainwhether it can obtain financing to complete clinicaltrials for Wonder Drug. These uncertainties castsignificant doubt upon the company’s ability tocontinue as a going concern.
The company will need to raise capital in order to fundits operations. This need may be adversely impactedby: uncertain market conditions, regulatory review,and adverse results from clinical trials. To address itsfinancing requirements, the company will seekfinancing through debt and equity financings, assetsales, and rights offerings to existing shareholders. Theoutcome of these matters cannot be predicted at thistime.
Explicit link betweendisclosed uncertaintiesand ability to continue
as going concern
Going ConcernExample of Entity-Specific Disclosure (cont’d)