Consolidated Financial Statements

 

Kofax Limited and Subsidiaries

Years Ended June 30, 2014 and 2013

With Report of Independent Auditors

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Index to Consolidated Financial Statements

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Report of Independent Auditors

Management and the Audit Committee of Kofax Limited,

We have audited the accompanying consolidated financial statements of Kofax Limited and subsidiaries, which comprise the consolidated balance sheets as of June 30, 2014 and 2013, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity and cash flows for the years then ended, and the related notes to the consolidated financial statements.

Management’s Responsibility for the Financial Statements

Management is responsible for the preparation and fair presentation of these financial statements in conformity with U.S. generally accepted accounting principles; this includes the design, implementation and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free of material misstatement, whether due to fraud or error.

Auditor’s Responsibility

Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

Opinion

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Kofax Limited and subsidiaries at June 30, 2014 and 2013, and the consolidated results of their operations and their cash flows for the years then ended in conformity with U.S. generally accepted accounting principles.

 

 

/s/ Ernst & Young LLP

Reading, UK

September 1, 2014

Kofax Limited

Consolidated Balance Sheets

($ in thousands, except number of shares which are reflected in thousands)

 

 

The accompanying notes are an integral part of these consolidated financial statements.

Kofax Limited

Consolidated Statements of Income

($ in thousands, except per share amounts and number of shares which are reflected in thousands)

 

 

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

Kofax Limited

Consolidated Statements of Comprehensive Income

($ in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

Kofax Limited

Consolidated Statements of Shareholders’ Equity

($ in thousands, except number of shares which are reflected in thousands)

 

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

Kofax Limited

Consolidated Statements of Cash Flows

($ in thousands)

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

NOTE 1          ORGANIZATION AND PRESENTATION 

We began operations in Switzerland in 1985 as a distributor of digital imaging hardware and maintenance services under the name Dicom AG. We listed the ordinary (i.e., common) shares of Kofax plc, Kofax Limited’s predecessor, on AIM (the London Stock Exchange’s market for smaller companies) in 1996 and subsequently transferred to the main market of the London Stock Exchange in 1997. Since then we have maintained a Premium Listing, which requires meeting the UK’s highest standards of regulation and corporate governance. We subsequently expanded into the distribution of related software products and services and eventually became an independent software vendor through the acquisition of a number of software businesses beginning in 1999. On December 5, 2013 we completed our initial public offering in the United States on the NASDAQ Global Select Market.

Pursuant to a scheme of arrangement approved by the shareholders of Kofax (U.K.) and sanctioned by the High Court of Justice of England and Wales, we migrated the jurisdiction of organization of our parent company from the United Kingdom to Bermuda by forming Kofax Limited, a Bermuda company.

Kofax Limited and its subsidiaries (collectively “we”, “Kofax” or “the Company”) is a leading global provider of smart process applications software and related maintenance and professional services. The Company’s software enables organizations to design, deploy, and operate comprehensive systems that create an essential link between their systems of engagement, which generate real time, information-intensive communications from constituents, and their systems of record, which are typically large scale enterprise applications and repositories used to manage their internal operations.

The Company utilizes a hybrid go-to-market model that delivers software and services through both its direct sales and service employees and an indirect channel of authorized resellers, original equipment manufacturers and distributors. 

The Company has built a portfolio of intellectual property, technologies, applications and solutions through both internal development and acquisitions. 

The Company’s presentational currency is U.S. dollars as that is the currency of the primary economic environment in which the Company operates. 

Except where otherwise stated, all references to fiscal 2014 and fiscal 2013 in these notes to the consolidated financial statements are defined as the year ended June 30, 2014 and June 30, 2013, respectively.

Note 2          SUMMARY OF SIGNIFICANT Accounting policies

Basis of Preparation

These consolidated financial statements have been prepared in accordance with United States Generally Accepted Accounting Principles (“U.S. GAAP”). 

Basis of Consolidation

These consolidated financial statements include the accounts of Kofax Limited and its wholly-owned subsidiaries.  Subsidiaries are consolidated from the date of their acquisition.  Intercompany balances and transactions between consolidated entities are eliminated.

Use of Estimates 

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts in the consolidated financial statements and footnotes. On an ongoing basis, the Company evaluates its estimates, assumptions and judgments. Estimates are used for, but not limited to, determining the selling price of products and services in multiple element arrangements and determining the period over

Note 2          SUMMARY OF SIGNIFICANT Accounting policies (continued)

which revenue should be recognized for these elements; income taxes; collectability of receivables; acquisition purchase price allocation, valuation of goodwill and acquired intangible assets; depreciable lives of property and equipment; share-based compensation; pension adjustments and contingent liabilities. The Company bases its estimates on historical experience, market participant fair value considerations and various other factors that are believed to be reasonable and supportable and result in estimates that are reasonable for the use in the preparation of the consolidated financial statements. Actual amounts could differ significantly from these estimates.

Revenue Recognition

The Company generates revenue from the following sources: (1) software license agreements, (2) maintenance services (also known as post-contract customer support or PCS) and (3) professional services. The Company recognizes revenue when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the fee is fixed or determinable and (iv) collectability is probable. Our revenue recognition policies for our revenue streams are discussed below. The sale and/or license of software products and technology is deemed to have occurred when a customer either has taken possession of or has access to take immediate possession of the software or technology. Revenue from royalties on sales of our software products by original equipment manufacturers (“OEMs”), where no services or other performance obligations are included, is recognized in the quarter earned so long as we have been notified by the OEM that such royalties are due, and provided that all other revenue recognition criteria are met.

Subscription arrangements are recognized ratably over the period of subscription. The Company’s subscription software licenses are generally offered for one-year base subscription periods. The base subscription entitles the end user to the technology itself and maintenance consisting of a specified level of customer support, bug fixes, functionality enhancement to the technology, and upgrades to new versions of the license, each on a when-and-if available basis, during the term of subscription.

Transactions with customers are documented by written agreements, with direct sales generally taking the form of a sales contract, statement of work and a purchase order.  Sales through indirect channels are generally made via a master agreement, under which the key legal terms and conditions are included, and each order is then evidenced by a purchase order or other evidence of the order provided from the channel partner. 

We generate revenue from the sale of license to use our products, including royalty arrangements and from maintenance and professional services. A software arrangement generally consists of: (i) a perpetual software license, (ii) a maintenance service arrangement that includes technical support via the phone and web and the right to receive unspecified upgrades/enhancements on a when-and-if-available basis, generally for an initial period of one year, and (iii) in some cases, separate professional services engagements for software implementation, education, training and other services.

For our software and software-related multiple element arrangements where customers purchase both software-related products and software-related services, we use vendor-specific objective evidence (“VSOE”) of fair value to separate the elements and account for them separately. VSOE exists when a company can support the fair value of its software-related products and software-related services based on evidence of the prices charged when the same elements are sold separately. VSOE of fair value is required, generally, in order to separate the accounting for various elements in a software and related services arrangement. We have established VSOE of fair value for maintenance, professional services, and training.

Software arrangements generally include PCS, which includes telephone support and the right to receive unspecified upgrades/enhancements on a when-and-if-available basis, typically for one year.  Revenue from PCS is generally recognized rateably on a straight-line basis over the term that the maintenance service is provided.

Note 2          SUMMARY OF SIGNIFICANT Accounting policies (continued)

Professional services contracted under time and material arrangements are recognized as the services are performed.  With respect to professional services contracted on a fixed price basis, the Company has significant experience in providing these services and are able to estimate the stage of completion.  Accordingly, the Company recognizes the revenue and profit on fixed price professional service engagements on a percentage-of-completion basis. When we provide professional services considered essential to the functionality of the software, we recognize revenue from the professional services as well as any related software licenses on a percentage-of-completion basis whereby the arrangement consideration is recognized as the services are performed, as measured by an observable input.  In these circumstances, we separate license revenue from professional service revenue for income statement presentation by allocating VSOE of fair value of the professional services as professional services and the residual portion as product and licensing revenue.  We generally determine the percentage-of-completion by comparing the labor hours incurred to-date to the estimated total labor hours required to complete the project.  We consider labor hours to be the most reliable, available measure of progress on these projects.  Adjustments to estimates to complete are made in the periods in which facts resulting in a change become known.  When the estimate indicates that a loss will be incurred, such loss is recorded in the period identified.  Significant judgments and estimates are involved in determining the percent complete of each contract.  Different assumptions could yield materially different results.

When products are sold through distributors or resellers, title and risk of loss generally passes upon delivery, at which time the transaction is invoiced and payment is due. Delivery to distributors and resellers without right of return are recognized as revenue upon delivery, provided all other revenue recognition criteria are met.

Business Combinations

The financial results of the businesses that the Company has acquired are included in the Company’s consolidated financial results based on the respective dates of the acquisitions. The Company allocates the purchase consideration to the identifiable assets acquired and liabilities assumed in the business combination based on their acquisition-date fair values. The excess of the purchase consideration over the amounts assigned to the identifiable assets and liabilities is recognized as goodwill. Factors giving rise to goodwill generally include synergies that are anticipated as a result of the business combination, including enhanced product and service offerings. The fair values of identifiable intangible assets acquired in business combinations are generally determined using an income approach, requiring financial forecasts and estimates as well as market participant assumptions. While we use our best estimates and assumptions as part of the purchase price allocation process to accurately value assets acquired and liabilities assumed at the business combination date, our estimates and assumptions are inherently uncertain and subject to refinement. As a result, during the purchase price allocation period, which is generally no more than one year from the business combination date, we record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. For changes in the valuation of intangible assets between preliminary and final purchase price allocation, the related amortization is adjusted effective from the acquisition date. Subsequent to the purchase price allocation period, any adjustment to assets acquired or liabilities assumed is included in operating results in the period in which the adjustment is determined.

Goodwill and Intangible Assets Arising From Business Combinations

Goodwill represents the excess of the purchase price in a business combination over the fair value of net tangible and intangible assets acquired. Goodwill and intangible assets with indefinite lives are not amortized, but rather the carrying amounts of these assets are reviewed for impairment at least annually or whenever events or changes in circumstances indicate that the carrying value of these assets may not be recoverable. Intangible assets, such as contractual relationships and technology, are amortized over their expected useful lives on a straight-line basis.  Amortization of these intangibles is included in either cost of revenue or operating expenses based on the function of the intangible asset.

Note 2          SUMMARY OF SIGNIFICANT Accounting policies (continued)

The Company evaluates goodwill for impairment on an annual basis, or more frequently if the Company believes indicators of impairment exist. The Company has identified a single reporting unit and performs an annual evaluation as of April 1 each year. Upon completion of the April 2014 annual impairment assessment, the Company determined that no impairment was indicated. As of June 30, 2014, the Company is not aware of any significant indicators of impairment that exist for our goodwill that would require additional analysis.

The Company performs sensitivity analyses to demonstrate that a reasonable change in the key assumptions would not reduce the difference between the carrying amount and recoverable amount of goodwill to zero. The Company also compares the Company’s market capitalization to the book value of net assets and this indicated a significant surplus at June 30, 2014.

Other Long-lived Assets

Purchased computer software licenses and similar rights purchased from third parties are capitalized on the basis of the costs incurred. Where internal costs are directly associated with software projects in combination with purchased licenses, such costs are deemed to be eligible for capitalization. These costs are amortized over their estimated useful lives (3-7 years) on a straight-line basis and are recorded to the respective operating expense or cost of sales line. The carrying amounts are reviewed for impairment if events or circumstances indicate that the carrying amount of the intangible asset may not be recoverable.

Items of property and equipment are initially recognized at cost. The costs include the purchase price and directly attributable costs to bring the asset into a usable condition. Depreciation on all items of property and equipment is recorded on a straight-line basis over their expected useful lives or the lease term, if shorter.

Research and Development Costs

Research and development costs related to software that is or will be sold or licensed externally to third-parties, or for which a substantive plan exists to sell or license such software in the future, incurred subsequent to the establishment of technological feasibility, but prior to the general release of the product, are capitalized and amortized to cost of license revenue over the estimated useful life of the related products. We have determined that technological feasibility is reached shortly before the general release of our software products. Costs incurred after technological feasibility is established have not been material. As a result, we expense research and development costs as incurred.

Advertising Costs

Advertising costs are expensed as incurred and are classified as sales and marketing expenses. The Company incurred advertising costs of $0.8 million and $1.1 million for fiscal 2014 and 2013, respectively.

Income taxes

Income tax expense reflects management’s best estimate of estimated current and future taxes to be paid.  Significant judgments and estimates are required in determining total income tax expense. 

Deferred income taxes arise from temporary differences between the carrying value of assets and liabilities and their tax basis, which will result in taxable or deductible amounts in the future. Deferred tax assets and liabilities are determined using enacted tax rates in effect in the years in which the differences are expected to reverse.

In evaluating the Company’s ability to recover deferred tax assets within the jurisdiction from which they arise, the Company considers all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial operations. In projecting future taxable income, the Company begins with historical results and incorporates assumptions including the amount of future state, federal and non-US pre-tax

Note 2          SUMMARY OF SIGNIFICANT Accounting policies (continued)

operating income, the impact of permanent tax adjustments, the reversal of temporary differences, and the implementations of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates the Company is using to manage the underlying businesses. In evaluating the objective evidence that historical results provide, the Company considers the most recent three years of cumulative operating income (loss). The Company maintains a valuation allowance to reduce its deferred tax assets to reflect the amount, based upon the Company’s estimates that would more likely than not be realized.

As of June 30 2014 and June 30, 2013, we have $13.5 million and 13.5 million of valuation allowances remaining for certain deferred tax assets, respectively. If results of future operations differ from those in the estimates, the Company may need to increase or decrease the valuation allowance, which could significantly affect its reported results in future periods.

We establish unrecognized tax benefits for tax uncertainties. In accordance with the provisions of ASC 740-10, Income Taxes, we establish reserves for tax uncertainties that reflect the use of the comprehensive model for the recognition and measurement of uncertain tax positions. Under the comprehensive model, reserves are established when it is more likely than not that the position would be sustained upon examination, including resolutions of any related appeals or litigation processes, on the basis of the position’s technical merits.  The threshold for recognition is met, a tax position is recorded at the largest amount that is more than fifty percent likely of being realized upon ultimate settlement. Interest and penalties are recognized as a component of income tax expense in the Consolidated Income Statements. 

 

Share-Based Compensation

The Company recognizes compensation expense for all share-based awards made to employees. The fair value of share-based awards is estimated at the grant date and the portion that is ultimately expected to vest is recognized as compensation cost over the requisite service period. The fair value of stock option awards that vest based on a service condition is estimated using the Black-Scholes option-pricing model.

Share-based compensation expense is recognized only for those awards that are ultimately expected to vest, and we have applied an estimated forfeiture rate to unvested awards for the purpose of calculating compensation cost to be recognized. These estimates will be revised in future periods if actual forfeitures differ from the estimates. Changes in forfeiture estimates impact compensation cost recognized in the period in which the change in estimate occurs. Compensation expense for share-based awards based on a service condition is recognized using the accelerated method.

The Company also grants Long Term Incentive Plan (LTIP) awards to certain employees (including executive officers). The Company records share-based compensation expense based on the market share price at grant date and estimated achievement percentage of related performance criteria.

Under the Kofax Limited 2012 Long Term Incentive Plan, performance based restricted stock units are awarded to senior executives at the discretion of the Remuneration Committee. The shares vest after three years, contingent on the successful achievement of the following performance criteria:

 

(a) Continued employment of three years after the effective date of the award,

 

(b) 50% on the attainment of revenue goals, and

 

(c) 50% on the achievement of earnings target goals, as defined.

 

The fair value of the LTIP award is based on the market share price at grant date, with the number of shares included in the measurement of the charge reassessed each reporting period to reflect management’s best estimate of non-market performance criteria achievement.  The fair value also assumes no dividends.

Note 2          SUMMARY OF SIGNIFICANT Accounting policies (continued)

The fair value of the award is recognized as compensation cost over the requisite service period, with shares vesting after three years. At the end of each reporting period, management reassesses the estimated achievement percentages, with any downward revisions reversed to share-based compensation expense in the period in which this determination is made.  However, if at a future date conditions have changed, resulting in an increase to the estimated percentage achievement, the previously reversed share-based payment expense as well as all subsequent projected share-based compensation expense through the date of evaluation, is recognized in the period in which this new determination is made.  

Restructuring Charges

A restructuring charge is recognized when the Company has approved a detailed and formal restructuring plan and the restructuring has either commenced or been announced publicly. Severance payments and related employment costs are accrued in full when employees are identified in the restructuring plan. Costs relating to on-going activities, such as relocation, training and information systems are recognized only when incurred.  Restructuring accruals related to onerous leases are recorded when they are part of an announced restructuring and the leased space becomes no longer usable either in part or in whole and the expected remaining lease payments are expensed at the time this determination is made, net of any income from assumed sub-lease.  Additionally, the Company may recognize separate accruals for onerous lease contracts in the event a contract becomes no longer usable. 

Foreign Currency

When determining the functional currency of a foreign entity, the Company takes into consideration the economic environment, the currency influencing operational and financial transactions as well as the activity of the entity.

Transactions in foreign currencies other than the entities’ functional currency are converted using the rate of exchange at the date of transaction. Monetary assets and liabilities denominated in non-functional currencies are translated using the rate of exchange at the period end. The gains or losses arising from the revaluation of foreign currency transactions to functional currency are included in Other income (expense), net.  Differences on foreign currency borrowings from foreign currency subsidiaries that form part of the net investment are taken directly to equity until the date of disposal of the net investment, at which time they are recognized in the Other income (expense), net. Foreign currency differences arising on trading intercompany loans are charged to Other income (expense), net.

The assets and liabilities of foreign operations are translated from their respective functional currencies into U.S. dollars, the Company’s presentation currency, at the rate of exchange at the end of the period. Income and expenses are translated at monthly average exchange rates for the year as this represents a reasonable approximation of actual exchange rates at the date of transactions. While all equity components (i.e., common stock, additional paid in capital, employee stock ownership / employee benefit shares, treasury shares and retained earnings) are translated at historical rates, the remainder, resulting from the retranslation of the net assets at the applicable spot rate, are reflected in other comprehensive income (“OCI“) within shareholders’ equity.  On disposal of a foreign operation, the deferred cumulative amount of currency translation adjustments recognized in equity relating to that particular foreign operation is recognized in Other income (expense), net.

Note 2          SUMMARY OF SIGNIFICANT Accounting policies (continued)

Fair Value Measurements

The Company defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities, which are required to be recorded at fair value, the Company considers the principal or most advantageous market in which the Company would transact and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability, such as risks inherent in valuation techniques, transfer restrictions and credit risk. Fair value is estimated by applying the following hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement:

Level 1 – Quoted prices in active markets for identical assets or liabilities.

Level 2 – Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 – Inputs that are generally unobservable and typically reflect management’s estimate of assumptions that market participants would use in pricing the asset or liability.

The valuation techniques used to measure the fair value of all other financial instruments, all of which have counterparties with high credit ratings, were valued based on quoted market prices or model driven valuations using significant inputs derived from or corroborated by observable market data.

Earnings Per Share

Basic earnings per share (“EPS”) is computed by dividing income available to common shareholders by the weighted-average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing income available to common shareholders by the weighted-average number of shares of common stock outstanding during the period increased to include the number of additional shares of common stock that would have been outstanding if the potentially dilutive securities had been issued. Potentially dilutive securities include outstanding stock options, and unvested shares granted under the Long Term Incentive Plans. The dilutive effect of potentially dilutive securities is reflected in diluted earnings per share by application of the treasury stock method. Under the treasury stock method, an increase in the fair market value of the Company’s common stock can result in a greater dilutive effect from potentially dilutive securities. No options or LTIPs have been excluded from the calculation of diluted EPS.

 

 

 

Note 2          SUMMARY OF SIGNIFICANT Accounting policies (continued)

Comprehensive Income

 

Comprehensive Income consists of net income, current period foreign currency translation adjustments, and pension adjustments, net of any applicable income tax amounts. For the purposes of comprehensive loss disclosures, the Company does not record tax provisions or benefits for the net changes in the foreign currency translation adjustment, as the Company intends to reinvest undistributed earnings in its foreign subsidiaries permanently.

Cash and Cash Equivalents

We classify all highly liquid instruments with an original maturity of three months or less at the time of purchase as cash equivalents.

Accounts Receivable Allowances

The Company records its allowance for doubtful accounts based upon its assessment of various factors. The Company considers historical experience, the age of the accounts receivable balances, credit quality of the Company’s customers, current economic conditions, and other factors that may affect customers’ ability to pay.  Activity in the allowance for doubtful accounts was as follows:

Contingent Consideration and Acquisition-related costs

Contingent consideration to be transferred by the Company will be recognized at fair value at the acquisition date. A subsequent change to the fair value of the contingent consideration is recorded to Acquisition-related costs in the Consolidated Statements of Income. Direct transaction costs are expensed through the Consolidated Statements of Income in Acquisition-related costs. This account consists of (i) costs directly attributable to acquisition strategy and the evaluation, consummation and integration of acquisitions, which are composed substantially of professional services fees including legal, accounting and other consultants and, (ii) compensation costs, which are composed substantially of contingent payments for shares that are treated as compensation expense and retention payments that are anticipated to become payable to employees both of which require continuing employment of the recipients, as well as severance payments to employees whose positions were made redundant.

Financial Instruments and Hedging Activities

The Company utilizes derivative instruments to hedge specific financial risks such as interest rate and foreign exchange risk. Derivatives are initially recognized at fair value on the date a contract is entered into and are subsequently re-measured at fair value. The fair values of derivatives are measured using observable market prices or, where market prices are not available, by using discounted expected future cash flows at prevailing interest and exchange rates. The gain or loss on re-measurement is taken to the Consolidated Income Statements except where the derivative is part of a designated cash flow hedge or a designated hedge of a net investment in a foreign operation. The Company does not apply hedge accounting for these forward contracts or any other hedging activity.

 

 

Note 2          SUMMARY OF SIGNIFICANT Accounting policies (continued)

Pensions

We sponsor various defined benefit pension plans and other postretirement benefit plans internationally in accordance with local laws and regulations. Our Swiss defined benefit pension plan account for a large majority of our aggregate pension plans' net periodic benefit costs and projected benefit obligations. In connection with these plans, we use certain actuarial assumptions to determine the plans' net periodic benefit costs and projected benefit obligations, the most significant of which are the expected long-term rate of return on assets and the discount rate.

Our assumption for the weighted average expected long-term rate of return on assets in our Swiss pension plan for determining the net periodic benefit cost is 3.30% and 3.40% for 2014 and 2013, respectively. We determine, based upon recommendations from our pension plan's investment advisors, the expected rate of return using a building block approach that considers diversification and rebalancing for a long-term portfolio of invested assets. Our investment advisors study historical market returns and preserve long-term historical relationships between equities and fixed income in a manner consistent with the widely-accepted capital market principle that assets with higher volatility generate a greater return over the long run. They also evaluate market factors such as inflation and interest rates before long-term capital market assumptions are determined. Market conditions and other factors can vary over time and could significantly affect our estimates of the weighted average expected long-term rate of return on plan assets. The expected rate of return is applied to the market-related value of plan assets.

The weighted average discount rates used to calculate our pension benefit obligations at June 30, 2014 and 2013 were 2.23% and 2.36%, respectively. The weighted average discount rates used to calculate our net periodic benefit costs for 2014 and 2013 were 2.36% and 2.47%, respectively. We determine the discount rate based upon a hypothetical portfolio of high quality fixed income investments with maturities that mirror the pension benefit obligations at the plans' measurement date. Market conditions and other factors can vary over time and could significantly affect our estimates for the discount rates used to calculate our pension benefit obligations and net periodic benefit costs for future years.

Treasury Stock

Kofax Limited shares held by the Company are classified in shareholders’ equity as treasury shares and are recognized at cost. Consideration received for the sale of such shares is also recognized in equity, with any difference between the proceeds from sale and the original cost being taken to equity. No gain or loss is recognized in the Consolidated Financial Statements on the purchase, sale, issue or cancellation of equity shares

Concentration of Risk

Financial instruments that potentially subject the Company to significant concentrations of credit risk principally consist of cash, cash equivalents, marketable securities and trade accounts receivable. The Company places its cash and cash equivalents and marketable securities with financial institutions with high credit ratings.  As part of its cash and investment management processes, the Company performs periodic evaluations of the credit standing of the financial institutions with whom it maintain deposits, and has not recorded any credit losses to date. The Company performs ongoing credit evaluations of its customers’ financial condition and limits the amount of credit extended when deemed appropriate. At June 30, 2014 and 2013, no customer accounted for greater than 10% of the Company’s accounts receivable or 10% of its total revenue for fiscal 2014 or 2013.

Note 2          SUMMARY OF SIGNIFICANT Accounting policies (continued)

Recently Adopted Accounting Standards

In February 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update (“ASU”) 2013-02: Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, an update to Comprehensive Income (Topic 220). ASU 2013-02 requires an entity to present either on the face of the statement where net income is presented or in the notes to the financial statements any significant amounts reclassified out of accumulated other comprehensive income by the respective line items in the statement presenting net income. Additionally, disclosures about the changes in each component of accumulated other comprehensive income are also required. ASU 2013-02 requires prospective application and is effective for fiscal years, and interim periods within those years, beginning after December 15, 2012. We adopted ASU 2013-02 in the first quarter of fiscal 2013, and there was no impact on our financial statements as ASU 2013-02 related to disclosure only.

In July 2013, the Financial Accounting Standards Board (“FASB”) issued an ASU on Income Taxes, to improve the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. This guidance is expected to reduce diversity in practice and is expected to better reflect the manner in which an entity would settle at the reporting date any additional income taxes that would result from the disallowance of a tax position when net operating loss carryforwards, similar tax losses, or tax credit carryforwards exist. This guidance is effective for the Company’s interim and annual periods beginning after December 15, 2013. The adoption of this amended guidance did not have an impact on our consolidated results of operations or financial condition.

New Accounting Standards Not Yet Adopted

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, issued as a new topic, ASC 606. The new revenue recognition standard provides a five-step analysis of transactions to determine when and how revenue is recognized. The core principle of the guidance is that a Company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new standard will also result in enhanced disclosures about revenue, providing guidance for transactions that were not previously addressed comprehensively, and improve guidance for multiple-element arrangements. This ASU is effective for us beginning in fiscal 2018 and can be adopted by the Company either retrospectively or as a cumulative-effect adjustment as of the date of adoption. We are currently evaluating the effect that adopting this new accounting guidance will have on our consolidated financial statements.

NOTE 3          ACQUISITIONS

Fiscal Year 2014 Acquisition

 

On July 31, 2013, Kofax acquired 100% of the shares of Kapow Technologies Holdings, Inc. (Kapow), a company incorporated in the United States, specializing in data integration software. Kapow’s software will assist in Kofax’s ability to integrate smart process applications with third party software for content import and export purposes as well as data validation during a business process. In addition, it will assist in penetrating the emerging electronic content transformation segment of the multichannel capture market, and is highly complementary to the recent acquisition of Altosoft’s business intelligence and analytics products. Kapow was consolidated into our results of operations on the acquisition date.

Of the total cash payment of $41.5 million, $40.5 million was paid to acquire all of the issued and outstanding shares of Kapow. Additionally, $0.9 million and $0.1 million were charged directly to operations and were included in Acquisition-related costs on the Consolidated Statements of Income for the periods ended June 30, 2014 and June 30, 2013, respectively. Acquisition-related costs include finder's fees, legal, advisory, valuation, accounting, and other fees incurred to effect the business combination.

 

NOTE 3          ACQUISITIONS (CONTINUED)

The goodwill of $25.9 million arising from the acquisition consists largely of the synergies and economies of scale expected from combining the operations of Kofax and Kapow. None of the goodwill recognized is expected to be deductible for income tax purposes. The following table summarizes the consideration paid for Kapow and the fair values of the assets acquired and liabilities assumed at the acquisition date:

 

The fair value of the trade receivables was $3.1 million. The trade receivables have been fully collected subsequent to the acquisition.

Following are the details of the purchase price allocated to the intangible assets acquired;

 

 

NOTE 3          ACQUISITIONS (CONTINUED)

Fiscal Year 2013 Acquisitions

 

On February 28, 2013, Kofax acquired 100% of the shares of Altosoft Corporation (Altosoft), a company incorporated in the United States, which is a provider of business intelligence and analytics software. The Company acquired Altosoft to enhance Kofax’s product portfolio with near real-time process and data analytics, visualization and extract, transform load capabilities. Altosoft was consolidated into our results of operations on the acquisition date.

Of the total cash payment of $12.8 million, $12.6 million was paid to acquire all of the issued and outstanding shares of Altosoft. Additionally, $0.2 million was charged directly to operations and were included in Acquisition-related costs on the Consolidated Statements of Income. Acquisition-related costs include finder's fees, legal, advisory, valuation, accounting, and other fees incurred to effect the business combination. None of the goodwill is expected to be deductible for tax purposes. The following table summarizes the consideration paid for Altosoft and the fair values of the assets acquired and liabilities assumed at the acquisition date:

The fair value of the trade receivables was $0.6 million. None of the trade receivables have been impaired and the full contractual amounts have been fully collected subsequent to the acquisition.

Following are the details of the purchase price allocated to the intangible assets acquired;

NOTE 3          ACQUISITIONS (CONTINUED)

Contingent consideration payments range between zero and $4.4 million. $2.0 million represents the acquisition-date fair value of the payments that management estimated at that time will become payable to the former shareholders of Altosoft and is included in the purchase price allocation; however, none of the payments are guaranteed. The contingent consideration payments are based on the achievement of specific annual revenue growth rates and Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”) levels during calendar years 2013, 2014 and 2015.

Of the total purchase price, $2.0 million was withheld as deferred consideration relating to representations and warranties made by the sellers, including those related to the level of cash and certain other net assets acquired.  The Company paid the full amount of deferred consideration in fiscal year 2014.

The Company has entered into separate employment agreements with certain Altosoft employees subsequent to the acquisition in which the Company will provide the employees with a retention package that will include a cash bonus. The total anticipated payment is $0.6 million, with the latest payment due in January 2015. The retention bonus is being accrued as the employees provide services and as of June 30, 2014 and June 30, 2013 there was $0.1 million and $0.1 million, respectively accrued and included in Acquisition-related costs.

Pro forma results of operations have not been presented because the effects of the business combinations described in this Note, individually and in aggregate, were not material to our consolidated results of operations

Note 4          Contingent acquisition payments

As discussed in Note 3, certain of the Company’s acquisitions have included contingent payments.  The following summarizes the movement of the Company’s contingent acquisition payments during fiscal 2014 and fiscal 2013:

 

Included in the change in fair value is $0.3 million (2013: $0.5 million) related to the accretion of discounts initially recorded upon acquisitions.

On December 5, 2011, Kofax acquired 100% of the shares of Singularity Limited (Singularity), a company incorporated in Northern Ireland, which is a provider of business process management (BPM) software and dynamic case management solutions. Singularity has historically conducted the majority of its operations in the United Kingdom, and has subsidiaries that include a substantial operating presence in India. The arrangement includes contingent consideration payments based on the continuing employment of certain continuing employees of Singularity and its subsidiaries and license revenue arising from Singularity‘s license products during calendar year 2012 and 2013.  In 2013, an amendment to the original agreement was made to include calendar year 2014. The total for the range of these payments, before and after the amendment is between zero and $14.7 million. Management determined that $8.4 million of the contingent consideration should be treated as compensation expense for financial accounting purposes, and that $0.6 million was included as a component of the purchase price consideration at the time of the acquisition.

Note 4          Contingent acquisition payments (CONTINUED)

During 2014 and 2013, management reassessed the estimated fair value of the Singularity contingent consideration to be paid based on actual and forecasted performance through calendar 2014, and determined that a fair value adjustment was necessary to reverse $2.9 million and $1.1 million, respectively, of the previously accrued and expensed amounts to Acquisition-related costs. During 2014 and 2013, $2.4 million and $3.0 million, respectively, of the contingent consideration determined to be remuneration was recognized as Acquisition-related costs. During 2013, the Company paid the first year of Singularity contingent consideration of $6.6 million of the total estimated contingent consideration.

In addition to the contingent consideration described above, a retention and incentive bonus arrangement has been implemented for certain continuing employees of Singularity. Under the retention and incentive bonus structure, total payments ranging from zero to $4.7 million may be paid. The incentive bonus has been structured to mirror the contingent consideration payments described above. In 2012, based on the same estimates used to determine the fair value of the contingent consideration, management estimated for financial accounting purposes that $2.9 million of the incentive bonus would become payable. During the period from the acquisition date to June 30, 2013 $2.2 million was recognized as Acquisition-related costs.  Retention and incentive bonus payments were $1.3 million during the year ended June 30, 2013. Based on the 2013 reassessment of the retention and incentive bonus amounts expected to ultimately be paid, management determined that a fair value adjustment to reverse $0.4 million of the previously accrued and expensed amounts also be recorded to Acquisition-related costs. 

On May 26, 2011, Kofax acquired 100% of the shares of Atalasoft, Inc. (Atalasoft), a U.S. based company which is a provider of imaging software development kits. The acquisition included contingent consideration payments that range between zero and $5.1 million. $4.7 million represented the acquisition-date fair value of the payments that management estimated at that time would become payable to the former shareholders of Atalasoft; however, none of the payments were guaranteed. The contingent consideration was payable based on metrics to measure through September 30, 2013.  Payments of contingent consideration were $1.2 million and $2.0 million during the years ended June 30, 2014 and 2013, respectively.

Note 5          GOODWILL and Intangible assets, net

 

The changes in the carrying amount of goodwill for our reportable segment for fiscal years 2014 and 2013 were as follows:

 

 

Note 5          GOODWILL and Intangible assets, net (CONTINUED)

Intangible assets consist of the following as of June 30, 2014 and 2013, respectively:

 

 

Amortization of acquired technology and patents is included in the cost of revenue from amortization of intangible assets in the accompanying statements of operations and amounted to $5.5 million and $4.7 million in fiscal 2014 and 2013, respectively. Amortization of customer relationships, trade names, trademarks, and other, and non-competition agreements is included in operating expenses and amounted to $3.4 million and $2.0 million in fiscal 2014 and 2013, respectively.   Amortization of backlog is included as a reduction of revenue in the accompanying statements of operations and amounted to $0.1 million and $0.1 million in fiscal 2014 and fiscal 2013, respectively.

Estimated amortization expense for each of the five succeeding years as of June 30, 2014 follows:

 

Note 6          income Tax expense

The components of Income (loss) from operations, before tax are as follows:

 

The components of the provision for income taxes consist of the following:

 

 

The provision for income taxes differed from the amount computed by applying the U.K. enacted statutory rate to our income before income taxes as follows:

 

 

Note 6          income Tax expense (CONTINUED)

The significant items impacting the fiscal 2014 effective tax rate to vary from U.K. statutory rate of 22.5% are the foreign earnings taxed at a higher tax rate, increase to the valuation reserve in respect of losses which are not 'more likely than not' to be realizable and non-deductible acquisition related expenses, these were partially offset by the impact of tax credits and prior year tax adjustments. The trading operations outside of the U.K. are subject to an effective tax rate which is higher than the U.K. statutory rate, specifically, the U.S. where the majority of the trading profits are generated.

Temporary differences and carryforwards/carrybacks which give rise to a significant portion of deferred tax assets and liabilities as June 30, 2014 and 2013 are as follows:

 

 

As of June 30 2014 and 2013, the valuation allowance represented a full valuation allowance against the majority of the Company's net operating losses and its U.S. Research and Development credits.

 

Deferred tax assets are reduced by a valuation allowance if, based on the weight of available positive and negative evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. During 2014 and 2013, the valuation allowance for deferred tax assets was increased by $0.0 million and $1.3 million respectively. This related to an increase in respect of net operating losses of $1.2 million and ($1.7 million in 2013) and increase for the U.S. research and development credits of $0.2 million ($0.4 million reduction in 2013). Accordingly, by the end of fiscal 2014, we continued to hold the opinion that the net operating losses would remain unrealized, increasing for the incremental increases in these losses during fiscal 2014.