Innovation: What's next?

Five tech plays that are ready for prime time.

Michael Hyatt, BlueCat Networks/Software/Toronto

Michael Hyatt is as snappy with a turn of phrase as he is a snappy dresser. But the BlueCat Networks CEO’s ego is not so big (he prefers to call it “tremendous”) that he would dismiss the recent economic and market turmoil in the capital markets. “If you weren’t scared, you were stupid,” he says. “I was absolutely scared. I did lose sleep.”

So far, BlueCat has escaped relatively unscathed by the downturn, and is perhaps even stronger because of it. Revenue grew by 40% in the fiscal year ended March 31, continuing a winning streak that has seen the 123-employee business expand by more than 500% since 2005. And the company, which Hyatt co-founded in 2001 with his 37-year-old brother Richard, BlueCat’s chief technology officer, is comfortably profitable. (The duo also own Toronto’s Dyadem, founded in 1995. Combined with BlueCat, the two companies will pull in about $50 million in revenue this year).

But Hyatt admits BlueCat’s resilience is partly luck, because it targets a strong niche. Its products — IT gear that automates the management of IP addresses for corporate networks — tie into corporate Internet infrastructures, including cost-saving technologies such as voice-over-IP telephone systems.

BlueCat certainly suffered from some common symptoms of the credit crisis: sales were delayed dramatically as deals required signatures two rungs higher on the corporate ladder; accounts receivable took about three weeks longer to collect; some bad debt surfaced in its extensive European reseller network, where two firms also went bankrupt; and BlueCat stopped negotiations for a strategic investment from a major global IT player after valuations plunged. That deal would have been a first for the Hyatts, who in late 2005 turned down a term sheet from legendary Silicon Valley venture capitalists Kleiner Perkins Caufield & Byers in order to maintain control.

BlueCat also started doing deeper credit checks and limiting partner credit, while improving cash management and preparing for worst-case scenarios that never happened. Still, prospective customers remain skeptical. “My CFO does at least five meetings a month to show BlueCat’s financials to companies,” says Hyatt.

Fortunately, Hyatt positioned BlueCat well for this downturn. Heeding recessionary signals, Hyatt in early 2008 diversified BlueCat’s reliance on American corporate sales and stepped up plans for Europe, moved into Latin America and created a new U.S. division specially accredited to sell to government agencies. A year ago, 80% of BlueCat’s sales came from the U.S. private sector; today they are less than 50%. “Some of the biggest deals we have coming this year are from the U.S. federal government,” says Hyatt,boasting of a US$2.5-million deal with the U.S. Postal Service in December.

Hyatt hasn’t abandoned the U.S. private sector, expanding BlueCat’s offerings to meet cash-strapped customer’s needs. For example, Hyatt in January “virtualized” BlueCat’s product. That is, rather than selling it only as a software-in-a-box dedicated appliance, it was offered as software residing in a data centre and paid for by ongoing licensing fees. Besides cutting hardware costs, the new products fit into an IT department’s operating expenses budget, rather than capital expenditures.

BlueCat did 68 transactions in March, compared to an average month’s 29, and Hyatt says May and June could be the biggest months in company history. He expects that a year from now, about 50% of BlueCat’s revenues will come from virtual products.

So has the downturn taught Hyatt anything? “Evolve or die,” comes his typically snappy reply. – Andrew Wahl

Bernard Herscovich, BelAir Networks/Wireless/Kanata,Ont.

For much of this decade, BelAir Networks has been one of Ottawa’s shining hopes. Founded in 2001 just as the market for telecom equipment was imploding, BelAir has attracted about $83 million in venture financing from nine firms, most recently a $17.5-million round in December 2007 led by Export Development Canada and Toronto venture debt financier Wellington Financial. In another era, the 70-employee company’s three straight years of annual growth of about 70% between 2006 and 2008 would have made it a shoe-in for a big IPO. And the maker of wireless local-area-network equipment, particularly for large-scale public-area Wi-Fi mesh deployments, may yet go public, but CEO Bernard Herscovich has eased up on the accelerator for now.

When the capital markets and the economy went into a tailspin last fall, BelAir moved quickly to manage costs and focused on its existing, stable customers, such as the U.S. Department of Defense, which uses BelAir equipment to quickly set up secure wireless hot spots among other applications, and large American cable companies Cablevision Systems and Comcast (also a BelAir investor), which are rolling out widespread Wi-Fi Internet networks to compete with incumbent telecom service providers.

“We put an immense amount of effort into grooming key customer relationships to make sure they continued to buy, and that they could trust a still relatively smaller Canadian supplier,” says Herscovich, a former executive at Nortel Networks and Newbridge Networks, as well as president of American boom-era wireless equipment maker Breezecom Inc. (now Alvarion Inc.). He then co-foundedBelAir with chief technology officer Stephen Rayment, a 25-year veteran of Nortel and Bell-Northern Research.

BelAir also stopped expending effort on prospective projects with iffy returns on investment for end customers, assuming such projects would be killed anyway. “In a booming market,” says Herscovich, “marginal things go through, but in a recession, only the most solid business cases get funded.” Indeed, market research firm Dell’Oro Group forecasts BelAir’s niche market segment — of which the company has a leading share — will retract 18% in 2009, to just US$76 million globally.

The company is not completely retrenching, though, and Herscovich still expects sales to grow by about 20% this year. He proudly reports that BelAir has about $400,000 in sales per employee, and the company is now chalking up quarterly operating profits, putting itself in prime position for better economic times. “Things seem to be sorting themselves out,” says Herscovich. “Give it another quarter, and I think many of the companies that have survived well are going to press very hard on the gas pedal again.”

And once the IPO market begins to show more benevolence toward technology companies, BelAir could be one of the first in line. A public offering seems to be the preferred exit route for investors, according to Herscovich, who would like to use such a cash infusion for global expansion. “Right now, about 80% of what we’re doing is in the United States. But there is a world out there, and our products and services are equally applicable in Europe, Asia, everywhere around the world.”

Having witnessed the carnage in the telecom equipment industry earlier this decade, Herscovich knows how quickly the market can turn. For now, he’s content to grow cautiously and wait for BelAir’s time to finally come. – A.W.

Tim Haig, Biox Corp./Clean-Tech/Hamilton

Tim Haig isn’t discouraged by the fact that equity markets have tanked and few investors are interested in listening to growth stories these days. Indeed, he sounds downright Zen about the whole mess. “There’s no point in talking,” says the CEO of biodiesel producer Biox Corp. “Might as well just shut up and make some money.”

That’s certainly what Haig is trying to do from the company’s only commercial production facility in Hamilton. Since 2007 Biox has converted inedible materials such as animal fat and restaurant grease into about 60 million litres of biodiesel annually through a patented process, making it the largest such facility in Canada. Oil and gas distributors, mostly in the U.S., blend their regular diesel with Biox’s product, one litre of which produces up to 90% fewer greenhouse-gas emissions than a litre of petroleum-based diesel.

But countries have been turning to biofuels for more than the environmental benefit. Energy security and rural economic development factor prominently, too. For instance, Canada has mandated that diesel contain 2% renewable content by no later than 2012, and U.S. President Barack Obama wants to aggressively boost investment and production of biofuels.

The outlook for biodiesel seemed so strong a couple of years ago that Haig, who co-founded Biox in 2000 after licensing the technology from a University of Toronto chemical engineering professor, wanted to take the company public. The plan was to raise $150 million to finance the construction of four biodiesel plants. Haig spent July 2007 constantly on the road, attending nearly 150 investor meetings in four weeks — and then the markets started roiling. “The whole credit crunch began the week we were going to try to price our deal,” he says. It didn’t take long for those involved to decide to pull the plug.

“Was it frustrating and disappointing? Sure it was. But we were probably lucky we weren’t a few weeks early,” Haig says. The companymight have raised the cash had the IPO gone through, but its share price likely would have plummeted, and Haig is glad he doesn’t have to deal with that kind of fallout. “I don’t want to be the CEO who’s getting calls from irate shareholders for things that we can’t control,” he says.

There are enough challenges to deal with anyway. Although demand for biodiesel hasn’t been affected much during the recession (thanks in part to the aforementioned government policies), the volatility of all commodities, including oil, makes it difficult for Biox to predict its profit margins. But one advantage Biox claims to have is that the company’s technology can use a variety of feedstock, unlike some competing biodiesel producers, which means it can switch to the lowest-cost material.

Funding for expansion is still an issue, too. After the aborted IPO, the company raised $14 million in debt financing from investors, including Wellington Financial in Toronto. Wellington’s CEO Mark McQueen saw the potential for Biox’s technology to be exported around the world, particularly because it relies on relatively inexpensive materials for feedstock. He also thinks Biox could have an easier time with an IPO in the future. “A pre-IPO story with zero revenue is tough,” he says. “They’ve now proven they can run the plant all day and all night, and make a positive operating margin.”

Haig hasn’t ruled out another shot at an IPO either. “We need to see a lot more good things going down with the markets,” he says, “but it might be time to start telling the story again, and to be a little bit more aggressive.” – Joe Castaldo

Bryan McLeod, Storage Appliance Corp./Hardware/Toronto

At midnight on July 3, 2008, U.S. shopping channel QVC aired an eight-minute segment on a new computer backup product called Clickfree. By the end of it, all 6,000 units had been sold, and QVC was calling Storage Appliance to order another 16,000. After just five more on-air segments, those, too, sold out.

For CEO Bryan McLeod, it was the beginning of 12 months of sales growth that belies a recession that has crimped consumer spending and pushed some U.S. electronics retailers, including giant Circuit City, into bankruptcy. Four-year-old Storage Appliance, which started shipping Clickfree in April 2008, has made in-roads into the crowded computer storage market with a product line that removes all the complexity of preserving the vast quantities of digital media and other files that vulnerably reside on computers. Plug a Clickfree external hard drive into a USB port, and it automatically backs everything up with no software to install or settings to configure.

It’s the kind of simple risk-reward proposition that plays well on shopping television. QVC continues to be a thriving sales channel for Clickfree — some 300,000 units have been sold in the past six months on QVC; in January, an 85-minute segment sold 32,000 units, reaping more than US$4 million in sales — but it’s also been key in getting the product widely recognized.

“Every time we’re on the air for 15 minutes, between half a million and 1.5 million people see a demonstration of the product. So the awareness curve just skyrocketed,” says McLeod. “I’ve even had [executives from] some giant corporations phone up and say, ‘Hey, my wife bought one of these on QVC and we would like to issue them to all of our field employees.’ We just closed a deal for 83,000 units to one company.”

Storage Appliance is also using the channel to expand into Germany, the U.K., Brazil and Australia, as well as exploring licensing deals inIndia and China and retail sales in the U.S.

Canada is rarely home to a consumer electronics success story, but McLeod has credibility. In 2001, his Intrigue Technologies, based in Mississauga, Ont., launched the Harmony universal remote for home entertainment systems; three years later, he sold the company to Logitech International, a computer accessories firm based in Fremont, Calif., for just over $80 million. Some of that cash went into Storage Appliance, where McLeod came on as CEO in December 2007 to lead its Clickfree branded strategy as opposed to the licensing model it was previously pursuing.

To support marketing efforts and provide working capital, Storage Appliance raised a further US$10 million in a round that wrapped in February, with Toronto venture capital firm Jefferson Partners and McLeod himself putting in nearly equal amounts, as well as follow-on investments from management and existing shareholders. “Everything is about timing,” says McLeod. “You will not find a bigger market in consumer electronics in the next two years than consumer backup.” He expects sales in 2009 to triple, and the company has been profitable each month since December. “We had a great first 12 months of shipping product, but this year is the real year.”

And next year? Maybe Storage Appliance will go public. “If there was an IPO market a year from now, I would probably take the opportunity,” says McLeod. “Because the product has such visibility, I think it would be perfect. But not now, not yet. I would like to put one more year behind us, put some nice profits down and then go for it.”- A.W.

Gregory Koss, BTI Systems Inc./Networking/Ottawa

While many people in the Ottawa tech community wring their hands over the fate of Nortel Networks, one local company senses an opportunity to beat up the one-time industry icon. BTI Systems, a 200-employee optical networking concern founded in 2000, has undergone an ambitious transformation under the leadership of Gregory Koss and now has weakened incumbents such as Nortel firmly in its sights.

Recruited in October 2007 by Boston-area venture capital firm Kodiak Ventures and Toronto’s VenGrowth Capital Partners (both investors in BTI Systems since 2000), Koss is a Boston-based 30-year veteran of the communications equipment industry. He quickly pushed the company to ramp up its growth by expanding its product line after taking over as CEO a year ago. Koss also struck partnerships with China’s FibreHome Networks, moved its supply chain to China with Flextronics and opened up design centres in Belfast and Boston. The result: 2008 revenue of US$38 million, compared to US$10 million a year earlier.

It could have been even better. BTI Systems technology sits at the edge of wireline and wireless networks, helping to manage the growing demands that high-quality Internet video and other bandwidth-greedy media are placing on communication carriers, a trend that shows no sign of abating. Its gear is compact and low-energy, giving it a competitive advantage. “We’ve done well in this kind of environment of constrained capital spending,” says Koss, “because there is an intuitive perception that customers are going to get more value for less money than from maybe some of the larger incumbents.” Uncertainty around Nortel’s business has opened the door further.But BTI Systems has struggled to fund its manufacturing supply chain because of tight credit markets. “We actually have had more demand for our products than we could ship,” says Koss. “The banks are very stringent about wanting the company to be quite mature and have quite a bit of cash on the balance sheet. Well, if we had a lot of cash on the balance sheet, maybe we don’t need the operating line.” Nortel’s bankruptcy protection has only made it worse, especially at Flextronics — a BTI Systems partner and Nortel’s largest contract manufacturer. “It sent shock waves through the whole supply chain. Suppliers want cash up front now, and they are loath to hold inventory, says Koss.”

Koss has managed to raised US$58 million in financing during his short tenure — the company now has nine institutional backers, including key sales partner Fujitsu, Canadian VC GrowthWorks and Export Development Canada, which led a US$15-million round in November — which is pretty impressive considering the company had raised only US$32 million in the previous seven years.

At press time, BTI Systems was on the brink of getting more financing from EDC and others to put up collateral for an operating credit line from Flextronics and Comerica Bank. Koss expects the deal will allow BTI Systems to grow revenues by another 50% over 2008. Should it succeed, director Richard Charlebois of GrowthWorks thinks BTI Systems will be big enough for an investment banker to take it public. “You have to have at least over $50 million in revenue, and probably closer to $70 million, $80 million, before somebody would consider doing an IPO,” says Charlebois. “If they continue their growth rate, by the end of this year or in 2010, they would be a potential candidate.”

Having sunk some US$90 million into BTI System, that would be good news for the company’s institutional backers, who are likely eager to exit. And good news for Ottawa, too. – A.W.