Coreworx Inc.
Notes to the consolidated financial statements
December 31, 2007
(in Canadian dollars unless otherwise noted)
1. Description of business
On May 22, 2008, the name of the company was changed from Software Innovation Inc. to Coreworx Inc. Coreworx Inc. (the “Company”) is a privately owned corporation, incorporated under the Business Corporations Act of Ontario. The Company was formed through the amalgamation of SI Investment Holdings Inc., 612388 N.B. Inc. and Software Innovation Inc. on May 11, 2004. The Company is a leading provider of integrated project collaboration and advanced document management solutions for the Architecture, Engineering and Construction markets, particularly for large capital projects.
2. Significant accounting policies
Basis of presentation
The consolidated financial statements of the Company have been prepared in accordance with Canadian generally accepted accounting principles (“Canadian GAAP”) and include the accounts of the Company and its wholly owned subsidiary, Software Innovation USA, Inc (“SI USA Inc”). All intercompany balances have been eliminated. A reconciliation of the Company’s consolidated financial statements from Canadian GAAP to accounting principles generally accepted in the United States of America (“US GAAP”) is included in Note 18.
Cash and cash equivalents
The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents.
Capital assets
Capital assets are recorded at cost less accumulated amortization. Upon retirement or sale, the cost of the assets disposed of and the related accumulated amortization are removed from the accounts and any resulting gain or loss is credited or charged to earnings. Repairs and maintenance costs are expensed as incurred.
Amortization is calculated on a straight-line basis at rates designed to amortize the cost of the assets over their estimated useful lives, beginning the month after acquisition. The rates are as follows:
| | |
| Furniture and fixtures | 48 months |
| Computer software | 36 months |
| Computer hardware | 24 months |
| Leasehold improvements | Term of lease |
| | |
Goodwill
Goodwill representing the excess of purchase price over fair value of the net identifiable assets of acquired businesses is tested for impairment annually or more frequently when an event or circumstance occurs that indicates that goodwill might be impaired. When the carrying amount exceeds the fair value, an impairment loss is recognized in the statement of operations in an amount equal to the excess.
Intangible assets
Intangible assets consist of acquired technology or the right to use technology through a license agreement and are amortized on a straight-line basis over 24 to 36 months. Intangible assets are tested for impairment if events or circumstances indicate that the asset might be impaired.
Coreworx Inc.
Notes to the consolidated financial statements
December 31, 2007
(in Canadian dollars unless otherwise noted)
2. Significant accounting policies (continued)
Impairment of long lived assets
The Company assesses the recoverability of long lived assets when events or circumstances indicate the carrying amount of the assets may not be recoverable. If the sum of the undiscounted future cash flows expected to result from the use and eventual disposition of a group of assets is less than its carrying amount, it is considered to be impaired. An impairment loss is measured as the amount by which the carrying amount of the group of assets exceeds its fair value. The Company has determined there was no impairment of long lived assets as at December 31, 2007.
Revenue recognition
The Company’s products and services are generally sold as part of a contract and the terms of the contracts, taken as a whole, determine the appropriate revenue recognition methods. Depending upon the terms of the contract and types of products and services sold, the Company recognizes revenue in accordance with Statement of Position (“SOP”) SOP 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts” (“SOP 81-1”), issued by the American Institute of Certified Public Accountants (“AICPA”), SOP 97-2, “Software Revenue Recognition” (“SOP 97-2”), Emerging Issues Committee Abstract of Issue Discussed (“EIC”) EIC 141, “Revenue Recognition”, and EIC 142, “Revenue Arrangements with Multiple Deliverables” issued by the Canadian Institute of Chartered Accountants (“CICA”).
For elements related to customized software solutions, revenues are recognized under SOP 81-1, generally using the percentage-of-completion method or the completed contract method. In using the percentage-of-completion method, revenues are recorded based on a measure of the percentage of costs incurred to date on a contract relative to the estimated total expected contract costs. Profit estimates on long-term contracts are revised periodically based on changes in circumstances and any losses on contracts are recognized in the period that such losses become known. In certain circumstances, where reasonable cost estimates cannot be made for a customized software solution and there is no assurance that a loss will not be incurred on the element, all revenues and certain costs are deferred until the contractual obligations have been fulfilled. (“completed contract method”).
The Company’s revenues are generated principally from (i) software licenses that grant customers the right to use the Company’s software products, (ii) professional services revenues from a variety of services related to the implementation, training in use and support of the Company’s software, including consulting, training and other services, (iii) maintenance and support revenues, which include revenues associated with annual software subscription agreements and annual software maintenance and support services, (iv) reimbursable expenses, and (v) interest and other income.
Coreworx Inc.
Notes to the consolidated financial statements
December 31, 2007
(in Canadian dollars unless otherwise noted)
2. Significant accounting policies (continued)
Revenue recognition (continued)
(i) License revenues
The Company records product revenue from software licenses and products when persuasive evidence of an arrangement exists, the software product has been shipped or access to use the software has been granted by the Company, there are no significant uncertainties surrounding product acceptance, the fees are fixed and determinable and collection is reasonably assured. The Company uses the residual method to recognize revenue on delivered elements when a license agreement includes one or more elements to be delivered at a future date if evidence of the fair value of all undelivered elements exists. If an undelivered element for the arrangement exists under the license arrangement, revenue related to the undelivered element is deferred based on vendor-specific objective evidence (“VSOE”) of the fair value of the undelivered element. In accordance with SOP 97-2, as amended, revenues derived from multiple-element software sale arrangements are recognized in earnings based on the relative fair values of the individual elements.
The Company’s multiple-element sales arrangements include arrangements where software licenses and the associated post contract customer support (“PCS”) are sold together. The Company has established VSOE of the fair value of the undelivered PCS element based on the contracted price for renewal PCS included in the original multiple element sales arrangement, as substantiated by contractual terms and the Company’s significant PCS renewal experience. The Company’s multiple element sales arrangements generally include rights for the customer to renew PCS after the bundled term ends. These rights are irrevocable to the customer’s benefit, are for specified prices and the customer is not subject to any economic or other penalty for failure to renew. Further, the renewal PCS options are for services comparable to the bundled PCS and cover similar terms.
In the renewal transaction, PCS is sold on a stand-alone basis to the licensees one year or more after the license sale arrangement. The renewal PCS price is consistent with the renewal price in the original license sale arrangement although an adjustment to reflect consumer price changes is not uncommon. If VSOE of fair value does not exist for all undelivered elements, all revenue is deferred until sufficient evidence exists or all elements have been delivered.
The Company assesses whether payment terms are customary or extended in accordance with normal practice relative to the market in which the sale is occurring. The Company’s sales arrangements generally include standard payment terms. These terms effectively relate to all customers, products, and arrangements regardless of customer type, product mix or arrangement size.
If the revenue recognition criteria above are not satisfied, amounts received from customers are classified as deferred revenue on the balance sheet until such time as the revenue recognition criteria are met.
Coreworx Inc.
Notes to the consolidated financial statements
December 31, 2007
(in Canadian dollars unless otherwise noted)
2. Significant accounting policies (continued)
Revenue recognition (continued)
(ii) Professional service revenues
Professional service revenues consist of revenues from consulting contracts, customer support agreements, training and integration services contracts and reimbursable expenses. Contract revenues are derived from contracts to develop applications and to provide consulting services. All service revenues are recognized in the period in which the services are performed provided that the revenue recognition criteria in SOP 97-2 are met.
(iii) Maintenance and support revenues
Maintenance and support revenues consist of revenue derived from contracts to provide post contract support to license holders. Maintenance and support revenues are normally billed in advance and recorded as deferred revenue. Deferred revenue resulting from maintenance and support contracts is amortized to earnings ratably over the term of the service period. Prepaid expenses include prepayments of maintenance and support services that have been subcontracted out. These expenses are recognized ratably over the period that the services are provided.
(iv) Reimbursable expenses
In providing services, the Company may incur expenses which are contractually reimbursable from customers. Reimbursable expenses, including those relating to travel, other out-of-pocket expenses and any third-party costs, are included at gross amounts as components of revenue and cost of sales. Expenses paid to the Company’s employees are recorded as cost of sales and amounts receivable from customers for reimbursable expenses are recorded as revenues.
(v) Interest and other income
Interest income is recognized as earned in accordance with the terms of the financial instrument. Other income is recognized when persuasive evidence of an arrangement exists, delivery has occurred and/or the service has been provided, the amount is fixed or determinable and collection of the amount is reasonably assured.
Research and development costs
The Company incurs costs on activities that relate to research and development of new software. These costs are charged to earnings in the period in which they are incurred. Research and development expenditures are reduced by investment tax credits, related government grants and third party contract revenues. Investment tax credits arising from qualifying scientific research and experimental development expenditures are applied to reduce related research and development expenditures when the claims have been accepted by the Canada Revenue Agency (“CRA”) and the Ontario Ministry of Finance.
Stock-based compensation
The Company's stock-based compensation plan is described in Note 11(b). The Company uses the fair value method to measure compensation expense at the date of grant of stock options to employees and non-employees. The fair value of options is determined using the Black-Scholes option pricing model and is amortized to earnings over the vesting period with an offset to Contributed Surplus. When options are exercised, the corresponding Contributed Surplus and the proceeds received by the Company are credited to Capital Stock.
If stock or stock options are repurchased from employees, the excess of the consideration paid over the carrying amount of the stock or stock option repurchased is charged to deficit.
Coreworx Inc.
Notes to the consolidated financial statements
December 31, 2007
(in Canadian dollars unless otherwise noted)
2. Significant accounting policies (continued)
Foreign currency translation
Monetary assets and liabilities denominated in foreign currencies have been translated into Canadian dollars at rates of exchange in effect at the balance sheet date and non-monetary assets and liabilities are translated at historical rates. Gains or losses resulting from such translations are included in income.
Transactions in foreign currencies throughout the year have been converted at the prevailing exchange rate on the date of the transactions.
The foreign operations of SI USA Inc. are considered to be integrated foreign operations of the Company, and are translated to Canadian dollars as described above.
Guarantees
A Company is required to disclose the nature of its obligations under guarantees, the maximum potential amount of future payments and the current carrying amount of the liability for the non-contingent component of the guarantee, which is the obligation to stand ready to perform in the event that specified triggering events or conditions occur.
The disclosure is required even if it is not probable those payments will be required under the guarantee or if the guarantee was issued with a premium payment or as part of a transaction with multiple elements.
Income taxes
The Company follows the liability method of accounting for income taxes. Under this method, future income taxes are recognized based on the expected future tax consequences of differences between the carrying amount of balance sheet items and their corresponding tax basis, using the enacted and substantively enacted income tax rates for the years in which the differences are expected to reverse. Future income tax assets are recognized to the extent it is more likely than not they will be realized.
Use of estimates
The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as at the date of the financial statements and the reported amount of earnings and expenses during the reporting period. Estimates are used when accounting for items and matters such as asset valuations, impairment assessments, discounted liabilities, the fair value of the Company’s common shares, stock-based compensation and contingencies. Actual results could differ from those estimates and assumptions.
Future accounting changes
(i) Financial instruments
In December 2006, the CICA issued Section 3862, Financial Instruments - Disclosures; Section 3863, Financial Instruments - Presentation; and Section 1535, Capital Disclosures. All three Sections will be applicable to financial statements relating to fiscal years beginning on or after October 1, 2007. Accordingly, the Company will adopt the new standards for its fiscal year beginning January 1, 2008. Section 3862 on financial instruments disclosures, requires the disclosure of information about: a) the significance of financial instruments for the entity's financial position and performance and b) the nature and extent of risks arising from financial instruments to which the entity is exposed during the period and at the balance sheet date, and how the entity manages those risks. Section 3863 on the presentation of financial instruments establishes standards for presentation of financial instruments and non-financial derivatives.
Coreworx Inc.
Notes to the consolidated financial statements
December 31, 2007
(in Canadian dollars unless otherwise noted)
2. Significant accounting policies (continued)
(i) Financial instruments (continued)
Section 1535 on capital disclosures requires the disclosure of information about an entity's objectives, policies and processes for managing capital.
(ii) Goodwill and intangible assets
In February 2008, the CICA issued Section 3064, Goodwill and intangible assets, replacing Section 3062, Goodwill and other intangible assets and Section 3450, Research and development costs. Various changes have been made to other sections of the CICA Handbook for consistency purposes. The new Section will be applicable to financial statements relating to fiscal years beginning on or after October 1, 2008. Accordingly, the Company will adopt the new standard for its fiscal year beginning January 1, 2009. It establishes standards for the recognition, measurement, presentation and disclosure of goodwill subsequent to its initial recognition and of intangible assets by profit-oriented enterprises. Standards concerning goodwill are unchanged from the standards included in the previous Section 3062.
The Company is currently evaluating the impact of the adoption of this new Section on its consolidated financial statements. The Company does not expect that the adoption of this new Section will have a material impact on its consolidated financial statements.
3. Changes in accounting policies
The Company adopted the following recommendations of the CICA Handbook as of January 1, 2007:
| | a) | Section 3855, Financial Instruments - Recognition and Measurement. This Section describes the standards for recognizing and measuring financial instruments in the balance sheet and the standards for reporting gains and losses in the financial statements. Under the new standard, financial assets and liabilities are initially recorded at fair value. Subsequently, financial instruments classified as financial assets or liabilities held for trading, financial assets available-for-sale and derivative financial instruments, part of a hedging relationship or not, have to be measured at fair value on the balance sheet at each reporting date, whereas other financial instruments are measured at amortized cost using the effective interest method. |
| | | |
| | b) | Section 1530, Comprehensive Income. This Section describes reporting and disclosure recommendations with respect to comprehensive income and its components. Comprehensive income is the change in Shareholders’ equity, which results from transactions and other events and circumstances from non-shareholder sources. These transactions and events include unrealized gains and losses resulting from changes in fair value of investments classified as available-for-sale and from foreign currency translation of self-sustaining foreign subsidiaries. |
| | | |
| | c) | Section 3861, Financial instruments - Disclosure and Presentation. This Section establishes standards for presentation of financial instruments and non-financial derivatives, and identifies the information that should be disclosed about them. |
| | | |
| | d) | Section 3251, Equity. This Section establishes standards for the presentation of equity and changes in equity during the reporting period. |
Coreworx Inc.
Notes to the consolidated financial statements
December 31, 2007
(in Canadian dollars unless otherwise noted)
3. Changes in accounting policies (continued)
The Company has made the following classifications in respect of its financial instruments:
| | · | Cash and cash equivalents are classified as financial assets held for trading and are measured at fair value. |
| | · | Accounts receivable are classified as loans and receivables and are recorded at amortized cost using the effective interest method. |
| | · | Demand loan, capital leases, accounts payable and accrued liabilities and long-term debt are classified as other liabilities and measured at amortized cost using the effective interest method. |
There was no effect on the opening deficit as at January 1, 2007, or on the financial statements as at and for the year ended December 31, 2007 as a result of adopting the changes in accounting policies noted above. Accordingly, a statement of accumulated other comprehensive income has not been provided.
The Company selected January 1, 2003 as its transition date for accounting for embedded derivatives. Based on a review of the Company’s financial instruments as at January 1, 2007, there were no embedded derivatives at that date that were required to be accounted for separately as derivatives.
Transaction costs
Transaction costs related to held for trading financial assets are expensed as incurred. Transaction costs related to available-for-sale financial assets, held-to-maturity financial assets, other liabilities and loans and receivables are added to the carrying value of the asset or are netted against the carrying value of the liability and are then recognized over the expected life of the instrument using the effective interest method.
4. Capital assets
| | | | | | | 2007 | |
| | | | Accumulated | | Net book | |
| | Cost | | amortization | | value | |
| | $ | | $ | | $ | |
| Furniture and fixtures | | | 445,137 | | | 315,748 | | | 129,389 | |
| Computer hardware | | | 202,481 | | | 140,130 | | | 62,351 | |
| Computer hardware under capital lease | | | 64,145 | | | 64,145 | | | - | |
| Computer software | | | 39,525 | | | 21,650 | | | 17,875 | |
| Leasehold improvements | | | 66,953 | | | 21,569 | | | 45,384 | |
| | | | 818,241 | | | 563,242 | | | 254,999 | |
| | | | | | | | | | | |
| | | | | | | 2007 | |
| | | | | | Net book | |
| | Cost | | Amortization | | value | |
| | | $ | | $ | | $ | |
| | | | | | | | |
| Acquired or licensed technology | | | 2,729,812 | | | 1,370,755 | | | 1,359,057 | |
Coreworx Inc.
Notes to the consolidated financial statements
December 31, 2007
(in Canadian dollars unless otherwise noted)
6. Obligations under capital leases
Future minimum payments under capital lease obligations are as follows:
| | | $ | |
| | | | |
| 2008 | | | 23,661 | |
| 2009 | | | 5,161 | |
| | | | 28,822 | |
| Less: amount representing interest at an approximate rate of 5.67% | | | 1,619 | |
| | | | 27,203 | |
| Less: current portion | | | 22,294 | |
| Balance of obligation | | | 4,909 | |
| | | | | |
Interest expense on capital lease obligations during the year amounted to $3,961.
7. Demand loan
The demand loan bears interest at prime plus 1.5%, is payable on demand with minimum monthly installments of $5,000 plus interest, and is secured by the personal property of the Company.
8. Related party transactions
Due to related parties
During the year, the Company entered into transactions with shareholders as follows:
| | | 2007 | |
| | | $ | |
| | | | |
| Direct costs | | | 24,055 | |
| Consulting fees | | | 105,886 | |
| | | | | |
Direct costs were related to maintenance services performed by a shareholder of the Company.
The above transactions were in the normal course of operations and were measured at the exchange amount of consideration established and agreed to by the related parties.
Coreworx Inc.
Notes to the consolidated financial statements
December 31, 2007
(in Canadian dollars unless otherwise noted)
9. Convertible debentures
On March 31, 2005, and December 31, 2005, the Company issued $6,400,000 and $3,550,000 convertible debentures (the “convertible debentures”), respectively. The convertible debentures had maturity dates of March 31, 2009 and December 31, 2009, respectively, and accrued interest at 8.5% per annum. The outstanding principal amount of the debentures, plus any unpaid and accrued interest thereon, were convertible into Class A Preferred shares at the option of the holder at any time up to the maturity date and had conversion rates of $1.4827 per share, with the exception of $1,100,000 of the convertible debentures which had a conversion rate of $0.5437 per share. The convertible debentures were secured by a general security agreement over all of the assets of the Company.
The conversion feature required the bifurcation of the financial instrument into debt and equity components based on their relative fair values. The fair value of the debt was determined using discounted cash flows at an estimated cost of borrowing of 16%, which represented management’s estimate of what the Company could borrow secured debt without a conversion option. The fair value of the conversion option was determined as the residual between the principal amount of the convertible debentures and the fair value of the debt component. The resulting allocations resulted in an initial liability component of $7,858,808 and an equity component of $2,091,192.
Interest expense was recorded as a charge to income at the effective rate of 16%, with the difference between the coupon rate of 8.5% and the effective rate of 16% being credited to the carrying value of the liability component, such that, at maturity, the carrying value of the liability component would be equal to the face value of the then outstanding convertible debentures.
(a) Extinguishment of convertible debentures through repurchase
On February 28, 2007, the Company completed a transaction with Software Innovation ASA, a shareholder of the Company, for the license of software technology. The total consideration for this transaction was US$2,300,000 which included the cost of the licensed technology and the early settlement of Software Innovation ASA’s outstanding convertible debentures, which had a face value of $300,000, plus accrued interest of $52,497 at the time of settlement.
The Company adopted the guidance provided by EIC 96, "Accounting for the Early Extinguishment of Convertible securities through (1) early redemption or repurchase and (2) Induced Early Conversion" in accounting for the early extinguishment of the convertible debentures.
Coreworx Inc.
Notes to the consolidated financial statements
December 31, 2007
(in Canadian dollars unless otherwise noted)
9. Convertible debentures (continued)
(a) Extinguishment of convertible debentures through repurchase (continued)
Following the guidance provided by EIC 96, management allocated the consideration paid on extinguishment of the convertible security to the liability and equity components based on their relative fair values at the date of the transaction. The fair value of the debt as at February 28, 2007 was determined using discounted cash flows at an estimated cost of borrowing of 18%, which represented management’s estimate of the rate that the Company could borrow secured debt without a conversion option. The fair value of the conversion option was determined as the residual between the consideration paid to extinguish the face value of the convertible debenture plus accrued interest, less the fair value of the debt component at the date of settlement. The settlement of the convertible debenture resulted in a gain of $53,120 on the settlement of the liability component and an increase in deficit of $35,094 relating to the equity component calculated as follows:
| | | | | | | | |
| | Carrying value | | Fair value | | Gain/(Loss) | |
| | | | $ | | $ | |
| | | | | | | | |
| Convertible debentures - liability component | | | 307,472 | | | 254,352 | | | 53,120 | |
| Convertible debentures - equity component | | | 63,051 | | | 98,145 | | | (35,094 | ) |
| | | | | | | | | | | |
On June 11, 2007, the Company completed a private placement of $5,254,316 in the form of senior secured debentures as disclosed in Note 10. In order to secure this financing, the existing convertible debenture holders converted their convertible debentures into Class A common shares of the Company. The original conversion terms on the debentures were changed from 1.4827 to 0.5437 Class A common shares for each dollar of outstanding convertible debenture principal plus accrued interest. As of the closing date, debenture holders converted an aggregate of $9,650,000 of debenture principal together with $1,708,092 of accrued interest.
In accordance with EIC 96, management first calculated the total number of Class A common shares issued on conversion (20,890,370 Class A common shares), which included the 11,699,169 incremental Class A common shares that arose as a result of the change in conversion terms, as noted above. The estimated fair value of the incremental Class A common shares issued was determined to be $3,258,661 and was recorded as a capital transaction, resulting in an increase in share capital and a corresponding charge to deficit in the same amount.
During the year, the Company recorded $585,499 of interest expense on the convertible debentures.
To finance the acquisition of the licensed software technology as described in Note 9(a), the Company entered into a Bridge Loan Arrangement with two existing investors who each advanced $1,500,000. The bridge loans carried an interest rate of 20% per annum, compounded on a semi-annual basis. Each of the lenders also received a $100,000 work fee as a condition to the bridge loan facility. Interest expense on the bridge loans for the year ended December 31, 2007 amounted to $369,316. On June 11, 2007, the principal amount of the bridge loans plus the accrued interest and work fees outstanding were converted into senior secured debentures (“senior debentures”).
On June 11, 2007, the Company completed a private placement of $5,254,316 ($4,885,000 net of the $369,316 bridge loan interest and work fee expense as noted above) in the form of senior debentures which carry no conversion features, bear interest at a rate of 12% compounded semi-annually, and mature on December 31, 2010. As an inducement to subscribe for the senior debentures, the Company issued Class A common shares equal to the principal amount of senior debentures subscribed for divided by 0.2648, for a total of 19,842,583 Class A common shares.
The pro-rata method was used to measure the liability and equity components of the financing separately, which adjusts these amounts so that the sum of the components equals the amount of the instrument as a whole.
The equity component was valued by assigning a fair value of $0.2788 per Class A common share, for a total value of $5,532,112. The debt component was valued by using discounted cash flows at an estimated cost of borrowing of 18%, which represented management’s estimate of what the Company could borrow secured debt without a conversion option. The total value assigned to the senior debentures was $4,480,034, for a total assigned value of $10,012,146. A discount was then applied to the debt and equity components based on their relative fair values to the total value assigned which resulted in a carrying value of the debt and equity issued at inception of $2,903,220 and $2,351,096, respectively.
Interest expense on the carrying value of the senior debentures is recorded as a charge to income at an effective rate of 36.1%, with the difference between the coupon rate of 12% and the effective rate of 36.1% being credited to the carrying value of the senior debentures such that, at maturity, the carrying value of the senior debentures would be equal to the face value of the then outstanding senior debentures. During the year, the Company recorded $583,403 of interest expense on the senior debentures and senior debenture interest payable amounted to $350,672 as at December 31, 2007.
The debentures are secured by a general security agreement over all of the assets of the Company.
The carrying amount of the senior secured debentures as at December 31, 2007 is broken down as follows:
