S O P H E O N 2 0 1 0 A N N U A L R E P O R T Where innovation means business™ Sopheon is an international provider of software and services. Sopheon's solutions define, manage, and align innovation governance processes to improve the business impact of product innovation, and generate more revenues and profits from new products. Summary Results and Trends ................................. 5 Auditors’ Report .....................................................24 Statement from the Chairman and Chief Executive Officer ........................................... 6 Financial and Operating Review ............................ 8 Product and Market Overview ............................11 Directors and Advisors .........................................16 Report on Directors’ Remuneration .................17 Directors’ Report ...................................................21 Statement of Directors’ Responsibilities ...........23 Consolidated Income Statements .......................26 Consolidated and Company Balance Sheets .........................................................27 Consolidated and Company Cash Flow Statements ...........................................28 Consolidated and Company Statements of Changes in Equity ..............................................29 Notes to the Financial Statements .....................30 Sopheon’s Accolade® software is the only solution in the industry that provides end-to-end enablement of strategic roadmapping, ideation, product portfolio management and innovation process execution for a growing range of companies. Summary Results and Trends Revenue EBITDA Profit before tax Earnings per share Net assets Gross cash Working capital Long-term liabilities 2010 2009 2008 2007 2006 10,537 1,510 171 0.10 8,260 (195) (1,494) (1.03) 9,304 1,120 44 0.02 6,332 113 (443) (0.32) 6,045 33 (303) (0.23) 3,008 3,358 4,145 (2,290) 2,685 1,624 2,001 (1,222) 4,268 2,586 3,068 (1,105) 3,310 2,053 2,140 (1,195) 1,620 1,034 1,667 - Working capital is calculated as net current assets after adding back deferred income. We are delighted to report strong growth in 2010. Revenues were £10.5m, up from £8.3m in 2009, and Sopheon also delivered a major improvement in profitability. s r e m o t s u C f o r e b m u N 180 160 140 120 100 80 60 40 20 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 In 2010 we grew our customer base to 174 licensees. 0 0 0 £ ’ 11000 10000 9000 8000 7000 6000 5000 4000 3000 2000 1000 0 s t i n U 45 40 35 30 25 20 15 10 5 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 Recurring revenue base Total revenues License extension orders We have grown our business by an annualized average of 28 percent since the launch of Accolade. After a difficult year before, business rebounded in 2010 with a total of 58 license orders, of which 41 were extensions. Revenue from new customers rose from 15 percent to 26 percent of total. 6 STATEMENT FROM THE CHAIRMAN AND CHIEF EXECUTIVE OFFICER S T A T E M E N T F R O M T h E C h A I R M A N A N D C hI E F E xE CuT I V E OF F I C E R Performance We are delighted to report strong growth in 2010. Revenues were £10.5m, up from £8.3m in 2009, and Sopheon also delivered a major improvement in profitability. The EBITDA result was a profit of £1.5m compared to a £0.2m loss in 2009. We are also very pleased to report a positive bottom line profit after tax of £152,000 (2009: £1.5m loss). Total license transactions including extension orders were 58 in 2010 (2009: 48) and license income rose to more than 37 percent of revenue (2009: 32 percent). The relative contribution of the North American market fell slightly to 66 percent of revenues from 69 percent in 2009, with the EMEA markets making up the remaining 34 percent (2009: 31 percent). In spite of the overall strong financial results, we look forward to improvements in other business areas in the coming year. Accolade® Vision Strategist™ contributed approximately 9 percent of total revenues in 2010, compared to 12 percent in 2009. We believe our continued investment and integration of this solution into Sopheon’s core value proposition will result in improved performance for Vision Strategist in 2011. Our reseller partners had a tough year, attributed to challenges in their local economies, and accounted for 5 percent of revenues, down from 9 percent the year before. An improved 2011 is forecasted across the reseller community. At the date of this report, full-year 2011 revenue visibility incorporating booked revenue, contracted services business and the run rate of recurring contracts already stands at £5.2m compared to £4.8m at the same time last year. Revenue visibility is more fully defined in Note 4. Strategy and Product We entered 2010 having devoted considerable investment and effort to product development during 2009. Tangible results included the launch of Accolade Idea Lab™, the first solution that both facilitates generation and development of ideas, and enables those ideas to be moved seamlessly through the product development life cycle; the release of a new version of our Accolade Vision Strategist strategic product planning software; and continued investment in our core Accolade Process Manager™ software. During 2010, we continued investment in all three areas. Outcomes included a further release of Vision Strategist, and a soft release of a new module that enables companies to dynamically balance resource and portfolio requirements. We also launched www.isustain.com, a website that enables users to assess the sustainability of product formulations using green chemistry principles, in partnership with Cytec Industries Inc. and the Beyond Benign Foundation. We continue to see good results in our original key markets of chemicals, food and beverage, and consumer products. Activity during 2010 also provides further evidence of progress in the aerospace, defense and high technology markets. As noted above, our reseller partners had a relatively difficult 2010, but we are encouraged by a renewed sense of optimism among our partner community. In this regard, we were pleased to welcome representatives from seven partners to our recent internal global sales conference. We continue to believe that developing our reseller and consulting partner network is key to our future growth ambitions. Accolade® is a registered trademark of Sopheon plc. Vision StrategistTM, Process Manager™ and Idea Lab™ are trademarks of Sopheon. STATEMENT FROM THE CHAIRMAN AND CHIEF EXECUTIVE OFFICER 7 In the aftermath of the global economic crisis, many companies are once again focusing their attention on growth, and innovation is returning to the forefront as a strategic priority. Eighty-four percent of the senior corporate executives participating in a recent global survey by McKinsey & Company stated that innovation is extremely or very important to their companies’ growth strategy. Principal challenges listed by McKinsey included integrating innovation with strategic planning, selecting the right product ideas to develop, and establishing a consistent process for bringing the best concepts to market. Sopheon’s solutions address these needs head-on. We are unique in offering an all-in-one software system that encompasses support for product strategy, ideation and product development process execution. We are energized by the strength of our market position, and by our potential for continued, substantial growth. Our decision to sustain internal product development investment, throughout the difficult economic period of 2009 and 2010, was a critical component of our strategy to build market share. People Sopheon continues to differentiate itself with the deep domain expertise our people have gained around innovation governance. This knowledge and experience has been created over many years from working with industry-leading companies on this emerging business process. We are very proud of the commitment that our people have shown in achieving leadership in this area, and in maintaining it through the recent economic challenges. Coming into 2011, we have taken steps to reorganize and strengthen Sopheon’s operational management team to position the company for growth. Our sales and services operations are now organized on a regional basis, with teams in North America and EMEA, led by Mike Ducatelli and Gert Staal respectively. Mike, formerly with Lawson Software and PTC, has led Sopheon’s North American sales organization since 2007, and we are delighted he has taken responsibility for all field operations in the territory. Gert joined the group in January 2011. Based in Amsterdam, Gert is a former senior executive with Reed Elsevier and has extensive experience and connections in the product development arena. Don Sarno, VP of Product Development, recently joined Sopheon to lead our product development efforts through the next stages of company growth. Based in Denver, Don has experienced and played key roles in similar transformations at companies like Intuit Corporation prior to joining Sopheon. The remainder of our leadership team remains unchanged. Together with our CFO Arif Karimjee, the two of us serve on the team, and also act as executive directors. Our CTO Paul heller, and VP of Research huub Rutten, complete the group. Executive management is complemented by a strong operational management team that leads the marketing and services functions. The Sopheon plc board is made up of three executive directors, augmented by three non-executive directors who bring a wealth of knowledge and experience to our business. Details about each board member can be found on the inside back cover of this report. Outlook The market has responded favorably to new enhancements of our products. Coming into 2011, we are encouraged by the strength of our sales pipeline, which is very active in particular in North America. We have taken steps to position Sopheon to take advantage of the improving business climate. This has involved controlled expansion of staff levels including new leadership in key areas, as noted above, and our full time headcount now stands at 95. At the end of 2009, we had a headcount of 85; we maintained staffing at this level through most of 2010. Cost controls were an important component of the sharp turnaround in profitability last year. Our plans for 2011 call for further staff expansion, but we will remain vigilant in matching costs to revenue expectations. To facilitate confident execution of our strategy, and maintain the ability to react rapidly to new market opportunities, in December we effected a major improvement to our working capital position. This involved negotiating changes to the maturity profile of the Group’s convertible loan stock, and the introduction of $2.7m of additional working capital from our existing corporate lenders, BlueCrest Capital. After a difficult 2009, which included taking some very tough spending adjustments, it is gratifying to see a return to growth and such a strong improvement in our bottom-line performance. We look to the future with renewed confidence. Barry Mence Executive Chairman 23 March 2011 Andy Michuda Chief Executive Officer 8 FINANCIAL AND OPERATING REVIEW FI N A N C I A L A N D OP E R A T I N G RE V I E W Trading Performance Sopheon’s consolidated turnover in 2010 increased by 27 percent to £10.5m compared to £8.3m in 2009. Revenues from both North American and EMEA territories showed significant improvement, with the latter somewhat stronger; as a proportion of the total, revenues from EMEA customers rose to 34 percent from 31 percent the year before. unlike previous years, Sterling was relatively stable against Dollar and Euro during 2010 and currency factors did not play a material role in income statement development. Total license transactions including extension orders were 58 in 2010 compared to 48 in 2009, an increase of 20 percent. License transactions included eight relating to the Vision Strategist solution, acquired with the Alignent business in 2007. Overall, Vision Strategist contributed approximately nine percent of total revenues during 2010 compared to 12 percent in 2009. Our new Idea Lab solution contributed three percent of revenues. In addition to the volume improvement, we also benefited from a number of very substantial individual orders. This in conjunction with the volume improvement led to the financial performance in the fourth quarter of 2010 being one of the strongest in the company’s history. Business Mix The annualized average growth of the business since the launch of Accolade is just over 28 percent. however, within this overall picture license and services revenues grew substantially, chalking up increases of 50 percent and 47 percent respectively. These impressive results were offset by a flat revenue performance in maintenance revenues. During 2009, and to a lesser extent in 2010, certain customers reacted to economic uncertainty with reorganization and rationalization, which resulted in terminations of maintenance and rental contracts. Nevertheless, when offset by new orders received, the base of recurring revenue grew from £3.7m coming into 2010, to £3.9m coming into 2011. The majority of this income is represented by maintenance services, but also includes hosting services and license rentals. Overall, in 2010 our business delivered a 37:34:29 ratio of license, maintenance, service respectively compared to 32:42:26 in the prior year. These statistics reflect the strong growth in orders for license and services as compared to recurring maintenance and hosting revenues. As noted above, in addition to the increase in order volumes year over year, the average value of each transaction rose, further increasing the contribution from new orders as compared to recurring revenue. Sixty-two percent of the value of these new orders in 2010 was derived from our existing customers, compared to 73 percent in 2009. This shift is explained by a rise in new client acquisition, demonstrating the relevance of Sopheon’s solutions to the needs of industry in today’s economy. At the same time, the fact that add-on business from existing customers remains relatively high underlines both the inherent value of our solutions, and the extended business opportunity for Sopheon from each new customer we sign. As further reinforcement of this point, analysis of our top customers over the last five years, demonstrates 20 customers with cumulative revenues in excess of $1m, of which 10 are in excess of $2m. Overall gross margins have risen to 75 percent (2009: 71 percent) which can be largely attributed to the return of license and service revenues, with only a relatively modest rise in associated costs of delivery. Within this overall picture, we did incur approximately £0.2m of third-party software costs; as we noted in our 2009 report, we anticipated that license margins would be slightly affected by decisions to embed, rather than build, certain third-party components or methods of working into our software. This is expected to continue going forward. Our professional services costs remained broadly stable overall, however, as communicated in our 2009 report, our decision to hold on hiring in favor of a subcontracting model last year has resulted in a fall in fixed salaries of around £0.3m, offset by a rise in bonuses, subcontractor fees and other variable costs. We expect this balance to shift back towards permanent resources in 2011. Research and Development Expenditure As noted in the Statement from the Chairman and Chief Executive Officer, we sustained investment in product development during the course of 2009 with a view to maintaining our goal of continued product leadership. This resulted in multiple product launches and enhancements that year. We did however make some reductions towards the end of 2009, leading to a lower fixed cost in 2010; budgets for development were then held through 2010, and then gradually released in the final quarter of the year. FINANCIAL AND OPERATING REVIEW 9 Overall, including provision for bonuses, the actual expenditure in research and development declined very slightly year over year. however, headline research and development expenditure reported in the income statement rose by nine percent from £2.2m to £2.4m. This apparent increase of £0.2m (2009: £0.1m reduction) is attributable to the net impact of capitalization, amortization and impairment charges associated with research and development. The amount of 2010 research and development expenditure that met the criteria of IAS 38 for capitalization was £0.7m (2009: £0.9m). Sopheon is committed to product leadership with excellence in research and development a core competency of the group; since 2001 Sopheon’s reported research and development costs each year have been at least 20 percent of revenues reported in that year. For 2010, this metric was 23 percent (2009: 27 percent). Operating Costs Of relevance to all aspects of the income statement is the fact that the strong performance in 2010 has led to a maximum bonus award being made to all members of the company who are on the corporate bonus scheme. This covers the majority of the group’s executives and employees, with the principal exception of the sales teams for whom incentives are tied to individual or territory results. The costs of the bonus have been allocated to the relevant categories of the income statement. Overall staff costs have increased by £0.1m. The apparent increase is entirely due to the impact of bonuses and higher commissions, offset by the reduction in average staff levels from 99 to 84, between 2009 and 2010. Detailed comments regarding professional services and research and development costs are noted above. headline sales and marketing costs have risen from £3.4m in 2009 to £3.6m in 2010. As with professional services and research and development, actual fixed costs fell year on year but this was offset by higher commissions and the incidence of bonus costs, as well as a higher amortization and impairment charges for the intangible customer assets acquired with Alignent in 2007. Average headcount in sales and marketing remained relatively constant through the year. headline administration costs have fallen by less than £0.1m. Much of the fall can be attributed to reductions in accounting costs such as exchange losses and recognition of share-based payments. Total underlying administration costs and resourcing have remained broadly constant, as they have since 2007. With this total there have been a number of movements, for example rent and insurance costs are down, whereas professional fees and information technology costs have risen. Such costs will continue to be managed tightly as the group expands operational resources. Results The combined effect of the revenue and cost performance discussed above has resulted in Sopheon’s EBITDA performance for 2010 rising to £1.5m, from a loss of £0.2m in 2009. In common with other businesses in our sector, Sopheon measures its annual performance using EBITDA (Earnings before Interest, Tax, Depreciation and Amortization) which the board believes provides a useful indicator of the operating performance of our business by removing the effect on earnings of tax, capital spend and financing. EBITDA is further defined and reconciled to the profit before tax in Note 4 of the financial statements. Our calculation of EBITDA is stated after charging (i) share based payments of £0.1m (2009: £0.1m); (ii) impairment charges of acquired intangible assets of £0.2m (2009: £0.2m); and (iii) exchange losses of £7,000 (2009: £31,000) but excludes depreciation and amortization charges for the year of £1.1m (2009: £1.1m) and net finance costs of £0.3m (2009: £0.2m). Including the effect of interest, depreciation and amortization, the group reported a profit before tax for the year of £171,000 (2009: £1.5m loss). Tax has been provided at £19,000, representing uS Alternative Minimum Tax chargeable on uS profits (2009: £nil). This reduces the retained profit after tax to £152,000 (2009: £1.5m loss). The profit per ordinary share was 0.10p (2009: 1.03p loss). In addition to the turn-around in profitability, in 2010 Sopheon also delivered a sharp improvement in cash flow generation. After deducting investment costs, the group generated cash of £1.3m compared to cash usage of £1.3m in 2009. 1 0 FINANCIAL AND OPERATING REVIEW Financing and Balance Sheet Consolidated net assets at the end of the year stood at £3.0m (2009: £2.7m). Gross cash resources at 31 December 2010 amounted to £3.4m (2009: £1.6m). Approximately £2.1m was held in uS Dollars, £1.0m in Euros and £0.4m in Sterling. Intangible assets stood at £3.6m (2009: £4.0m) at the end of the year. This includes (i) £2.4m being the net book value of capitalized research and development (2009: £2.4m) and (ii) an additional £1.2m (2009: £1.6m) being the net book value of Alignent intangible assets acquired in 2007. The apparently constant level of the capitalized research and development, disguises a capitalization value roughly equal to the amortization charged in respect of these assets. The carrying value of the Alignent intangibles has been impacted by both amortization and impairment charges. Further details are set forth in Note 14. In June 2007, the group entered into a $3.5m 48-month mezzanine term loan with BlueCrest Capital Finance (“BlueCrest”), in connection with its acquisition of Alignent Software Inc. This term loan was repayable in equal monthly installments through to July 2011. On 8 December 2010 the Company signed an agreement with BlueCrest to refresh the mezzanine term loan back up to $3.5m, for a new 39-month term, repayable in equal monthly installments of $90,000 plus interest through March 2014. The loan bears interest at 13 percent per annum and incurs a facility fee of 3.75 percent. After expenses and deducting the carrying value of the original loan, this transaction brought a net cash injection of $2.7m to the group. No warrants were issued to BlueCrest in connection with the transaction. In addition to the term loan, for a number of years the group has had access to a revolving line of credit with BlueCrest, secured against the trade receivables of Sopheon’s North American business and with a maximum draw capacity of $1.25m. This facility was renewable annually on 30 June, but in conjunction with the changes to the term loan, the next renewal date for the facility has been extended to 30 November 2011. In October 2009, the company issued £850,000 of convertible unsecured loan stock to a group of investors including key members of the board and senior management team, maturing on 2 October 2011. On 8 December 2010, the holders of the loan stock have unanimously agreed to extend the maturity date of the loan stock by sixteen months to 31 January 2013, and to remove the provision under which, if the company undertook a placing or other issue of shares at a lower price per share than the conversion price, the conversion price would be adjusted to the placing price (the “Placing Provision”). This amendment was coupled with modification of the conversion price of the loan stock to 7.75p per share, being the current market price, from 10p per share. These changes improved the net current asset and the net asset position of the group, while also removing a potential source of income statement volatility linked to the accounting treatment of the Placing Provision under the rules of IAS 39. In accordance with the AIM Rules for Companies, Daniel Metzger, having consulted with the company’s Nominated Adviser, acted as independent director with respect to this transaction and considered that the amendment to the terms of the convertible loan stock were fair and reasonable insofar as the company’s shareholders are concerned. Sopheon’s equity line of credit facility with GEM Global Yield Fund Limited ("GEM") was due to expire on 23 December 2009. During the year, GEM agreed to implement a further two year extension at no cost to Sopheon, through to 23 December 2011. The facility has been used to raise working capital once, in March 2004, leaving approximately 90 percent of the original €10m facility available under the extended agreement. Drawings under the GEM equity line of credit are subject to conditions relating inter alia to trading volumes in Sopheon shares. The principal risks and uncertainties facing the group are further described in the Directors Report on pages 21 to 22. PRODUCT AND MARKET OVERVIEW 1 1 PR O DuC T A N D MA R K E T O V E R V I E W Manufacturers throughout the world are emerging from a period of economic turmoil unlike any other in their history. At the center of this recovery is a renewed emphasis on organic growth and, with it, a widespread quest for ways to increase profitable, revenue-generating innovation. During the recessionary cycle, most companies have acted on available cost-cutting opportunities. At the same time, merger and acquisition activity has steadily declined. Innovation is increasingly viewed as the principal remaining lever for improving business value. But such opportunities do not come without risk. In their pursuit of innovation success, executives are literally betting the future of their organizations on decisions about where to invest limited resources. Poor decisions on innovation investments can generally be traced to one of three factors: 1) Lack of transparency. Decision-makers can’t get a clear picture of where their innovation resources are being spent, or on investment options. 2) Inability to judge what is valuable (and what is not). Organizations often lack market-driven processes for determining the potential business value of investment alternatives. As a result, spending decisions are based on little more than gut feel. 3) Failure to anticipate the impact of short-term decisions on long-term strategy. Operational decisions are often made without a clear understanding of their probable impact on long-term strategies, or how those decisions might be affected by shifts in market dynamics and other product and technology investments. These deficiencies typically lead to either of two negative outcomes. One is inaction, whereby low-value projects are allowed to linger and sap valuable resources while high-potential initiatives starve due to lack of support. The second outcome is even worse: truly valuable projects are unwittingly overlooked or killed, resulting in loss of business opportunity and a glut of low-margin, “me-too” products that accelerate a spiral of declining financial performance. Sopheon’s software and services provide comprehensive support for the system of cross-functional decision-making that defines, aligns and manages innovation activities. This capacity, referred to as innovation governance, helps ensure that executives make the right decisions about where to spend their innovation resources. ultimately, Sopheon’s solutions enable companies to increase profits and revenues from new products. Sopheon’s Accolade solution is the first software system in the industry to provide end-to-end enablement of strategic roadmapping, ideation, product portfolio management and innovation process execution. Sopheon’s Solutions Sopheon’s Accolade solution is the first software system in the industry to provide end-to-end enablement of strategic roadmapping, ideation, product portfolio management and innovation process execution. Accolade’s Vision Strategist component automates the strategic roadmapping process, allowing users to visualize and plan the future of products, markets and technologies. Accolade Idea Lab helps organizations generate, select and develop winning product and service ideas. Accolade Process Manager automates the product innovation process and provides strategic decision support for the management of product portfolios. 1 2 PRODUCT AND MARKET OVERVIEW Sopheon’s software helps to demystify research and development by providing dynamic, real-time visibility to planning and project information and aligning innovation efforts across the organization. It allows executives and cross-functional teams to more effectively assess the business opportunities and risks associated with product innovation initiatives, the short-term cost implications of such initiatives, and their likely impact on long-term strategies and objectives for revenue and profit growth. Through their use of Sopheon’s software, organizations are able to: 1) Improve strategic agility and “uncertainty planning." Our solutions support agility in strategic planning by rapidly moving decision-relevant information both vertically and horizontally inside the organization. The easy flow of data permits senior executives to know and react quickly when project details change or external events suddenly demand adjustments or refinements to active strategies. 2) Make faster, better-informed portfolio decisions. Strong portfolio management helps organizations optimize limited resources. Sopheon’s software makes it possible for users to see in real time where innovation resources are invested. The solutions’ dashboards aggregate and present data so that key performance indicators can be monitored at a glance. Innovation plans and projects can be stored in one place so that access is quick and easy. 3) Identify, prioritize and act on the most promising innovation opportunities. users of Sopheon’s software can separate winning products from losers early in the development cycle, helping to keep investments concentrated on high-value opportunities. unique knowledge management capabilities and “smart” technology enable brainstorming and discovery, contributing to a steady flow of innovative ideas. Features such as scorecards, tailored idea-selection criteria, resource reports and information-gathering and presentation templates grounded in best practices, strengthen process governance and minimize innovation risk. 4) Keep daily operational activities aligned with organizational strategies for growth. An estimated 65 percent of companies struggle to keep product portfolios and operational and project activity aligned with corporate strategic plans. Sopheon’s solutions create a seamless, automated process and decision framework that continually reconciles strategic product planning and operational execution. 5) Cut costs by improving innovation process and team efficiencies. According to Gartner research, companies whose product lifecycle management priorities include deployment of technology applications such as Sopheon’s software can reduce product development costs by 30 percent or more. The savings happen because users are able to identify and abandon low-value or non-strategic projects early, before valuable resources are spent on development. " F o r r eS Te r hA S b e e n Se eIn g A S Ig nI F Ic AnT In c r eA Se In InTe r eS T An d InVeS T Me nT In Pr o j e cT Po r T FoL Io M An A g eMe nT T o o L S F o r P r o d u c T d e V e L o P M e n T T o h e L P A d d r e S S T W o P e r S I S T e n T I n F o r M AT I o n c h A L L e n g e S : 1 ) o b T A I n I n g A n A c c u r AT e P I c T u r e o F r e S o u r c e u T I L I z AT I o n , A n d 2 ) A L I g n I n g I n V e S T M e n T W I T h T h e b uS In eS S S TrATe g y . " – Fo rrester re se arc h, Inc . “It ’s T ime to rev is it PP M fo r P ro du ct devel opme nt” dec em ber 2 00 9 PRODUCT AND MARKET OVERVIEW 1 3 The Market Sopheon’s solutions belong to a major class of software applications that concentrate on supporting product lifecycle management (PLM). The purpose of this applications group is to help companies develop and execute their product strategies. Product Portfolio Management Strategic Product Planning and Process Execution The Business Layer of PLM PDM/Formula Management CAD Diagrams, Change Orders, ROMs The Technical Layer of PLM ERP/CRM Sales, Supply Chain, Mfg Costs, Sales Forecasts The Transactional Layer of PLM business analysts have placed Sopheon’s Accolade system in a subclass of product lifecycle management applications referred to as product portfolio management solutions. The PLM solutions market is made of multiple subclasses. Some, such as product data management (PDM), are mature. Others are new and emerging. One of the emerging subclasses is called “Product Portfolio Management” (PPM). It is the area where Sopheon is focused. Software solutions in most areas of product lifecycle management concentrate on the engineering or technical challenges involved in managing a product while it is under development. Sopheon’s solutions are designed to instead address the business challenges associated with product innovation, including the management of innovation risk and reward. Analysts have labeled Accolade as best-of-breed among solutions in the product portfolio management subclass. They view PPM as a strategically critical applications area. Their research findings indicate that adoption of PPM methodologies enables users to more objectively assess product innovation investment options and increase the number of products that achieve commercial success. Forrester, the prominent IT research and analyst firm, has identified Sopheon as one of the clear market-share leaders among providers of project and portfolio management tools for product development. During 2010, Sopheon was among a select number of suppliers profiled in Gartner’s Who’s Who in Innovation Management Technology. A number of analyst firms have reported growing end-user interest in product portfolio management software. A recent Gartner report noted that product portfolio management and idea management, both of which are supported by Sopheon’s applications, “are becoming increasingly important to designing products for life cycles.” Research by AMR has identified product portfolio management as one of the fastest growing segments of the product lifecycle management market. Several vendors of project portfolio management solutions that have historically focused their software and go-to-market strategies on the project management needs of corporate information technology organizations continue to step up their attempts to migrate toward product portfolio management. Growth Strategy The wide-ranging impact of the recent economic climate caused many companies to adjust operational priorities and reexamine near-term growth strategies. Sopheon was no different. As the acquisition of new customers slowed, we moved thoughtfully but aggressively to reduce operational costs. While cutting in some areas, we prudently increased our spending in others. For instance, a decrease in conference exhibit activity during 2010 was offset by stepped up investment in new, more cost-effective marketing channels such as social media. Continued funding of product development reflected our commitment to making sure that we were well positioned to capture additional market share as the economy turned around. We were also unwavering in our focus on serving our client base. “As a long-standing client, Parker Hannifin has already experienced great value from Sopheon’s solutions. But we want to do more. We want to create a closed-loop development process that would allow our organization to take a 360-degree view of our innovation initiatives and growth plans – from strategic planning to ideation to process execution. Sopheon’s software, along with the team behind it, has earned our trust that they have the capabilities to enable us to get there.” — Craig Maxwell, Corporate Vice President of Technology and Innovation Parker Hannifin 1 4 PRODUCT AND MARKET OVERVIEW Client Base As the size of our customer population continues to expand, so too do Sopheon’s opportunities for growth. In 2010, more than 60 percent of Sopheon’s revenues (excluding recurring revenue) came from new orders out of the installed base. This income can be credited in part to our decision, despite the economic downturn, to maintain historic investment levels in product development. The enhancements to our solutions resulting from these investments played a direct role in encouraging current customers to take further advantage of Accolade’s value, generally in one of three scenarios: 1) Enterprise expansion of Accolade use. Existing customers continued to extend their initial deployments of our software, adding licenses to enable product innovation in more business units or other areas of the enterprise. 2) Support for advanced levels of innovation governance. Sopheon has close, extended partnerships with a growing group of customers who are strategically committed to raising the maturity of their innovation governance systems to world-class levels. The majority of these accounts invested in additional, more advanced software modules and engaged Sopheon to provide guidance services. 3) Use of Accolade for processes beyond product portfolio management within broader product lifecycle management systems. More and more customers are expanding the use of Accolade beyond product portfolio management to include the management of other PLM-related processes. Examples include cost-reduction and quality assurance programs and corporate plans and initiatives. One emerging application in this category is sustainability management, an aspect of innovation rigor that focuses on the creation and production of more environmentally friendly products. Our growing attention to this area was reflected during 2010 in the launch of an alliance involving Sopheon, Cytec Industries, a global specialty chemicals and materials manufacturer, and Beyond Benign, a highly regarded nonprofit foundation that promotes sustainable science. In May the alliance introduced a Web-based tool that measures the sustainability of new products while they are still concepts, before users incur the high costs of development. An industry first, the iSuSTAIN™ Green Chemistry Index easily integrates with the phase- and gate-based processes empowered by Sopheon’s software. In October, Sopheon convened a session of its global Product Advisory Council (PAC). The organization comprises representatives of current customers, including ConAgra, Cytec, Electrolux, h.J. heinz, Northrop Grumman, Pall, PepsiCo and Parker hannifin. The group provided substantial feedback on Sopheon’s product plans and direction. Its input has also had material impact on our 2011 go-to-market strategies. Product Development Sopheon continued to invest substantially during 2010 in expanding the capabilities of its software products. The efforts of our product development teams resulted in the market introduction of a range of new Accolade features. These enhancements provide significant advantages to users, including the ability for executives to more easily manage resource allocations across a portfolio of innovation projects and perform the advanced “what-if” analysis required to effectively prioritize and reprioritize projects. Sopheon brought two new releases of its Idea Lab idea development solution to the market in 2010. These new versions of the software introduced a variety of ease-of-use enhancements, along with features enabling increased collaboration among individual users and communities of practice, and more sophisticated search and retrieval within idea repositories. Additional improvements served to connect Idea Lab seamlessly to other components of the Accolade suite. Service Development Broadly stated, one of the principal goals of users of Sopheon’s software is to create competitive advantage through product innovation. Our Accolade line of innovation governance solutions enables the achievement of this goal by informing decisions that lead to more profitable, revenue-generating new products. In 2010, we introduced a service practice aimed at helping Accolade customers maximize the return they derive from their use of our software. Called Advisory Consulting Services (ACS), its offerings deliver advice and counsel in critical innovation process areas supported by our applications. All engagements are customized to the specific needs of the customer. Examples of deliverables include workshops to improve the effectiveness of portfolio management practices and project decision meetings, consultation on ways to increase the efficiency and strategic alignment of innovation governance systems, and the development of baselines for gauging continuous improvement of innovation performance. The complete range of ACS services is focused on supporting further adoption of our software within customer environments, leading to expanded use of our solutions and to increased revenue and profit growth for our company. PRODUCT AND MARKET OVERVIEW 1 5 Core Markets Sopheon’s marketing and business development efforts in 2010 continued to focus primarily on manufacturers of chemicals, paper, consumer packaged goods and aerospace and defense (A&D) products and programs. More than half of our customer base is comprised of companies from these markets, a circumstance that has accelerated our development of industry-specific domain expertise. The resulting best-practice knowledge and proprietary tools and techniques are often times a decisive advantage as we compete for additional business in these verticals. We recently received additional validation of our growing prominence in consumer packaged goods markets. Sopheon was named one of the top ten suppliers of new product development and introduction solutions to manufacturers in the sector based on a survey of senior-executive readers of consumer goods Technology magazine. “We are implementing Accolade as the standard for innovation process and portfolio management across the company. It will give us a clear view of what’s in our portfolio pipeline, and provide the analytical support needed to make the right project choices to deepen our differentiation and consistently meet the needs and tastes of our consumers. In effect, Accolade will allow Almarai to de-risk product innovation as a strategic component of its plans for continued, aggressive growth.” — Malcolm Jordan, General Manager of Quality and Product Development Almarai Sopheon continues its business expansion within the aerospace and defense sector. In 2010 our pipeline of sales opportunities within A&D grew steadily, as did sales and revenue results. Meanwhile we continue to learn from our expanding base of customers, including such organizations as BAE Systems, General Dynamics, honeywell Aerospace, Lockheed Martin, Northrop Grumman and Bell helicopter. We expect that aerospace and defense markets will contribute further to our growth during 2011. Partnerships reseller Partners As we previously indicated, a core element of our strategy for growing through partnerships is to distribute our solutions through third-party resellers. We previously reported having established affiliate or reseller relationships with organizations in Germany, France, the united Kingdom, Australia, New Zealand, and South Korea. During 2010, resellers generated five percent of Sopheon’s total revenues, compared to nine percent in 2009. This shift was indicative of a difficult year when we focused primarily on supporting our resellers through unusually challenging economic turbulence. We introduced them to a number of new tools and a broad range of new product capabilities. Overall, we were very pleased by the strength of their continued commitment. In February of this year, every member of our reseller network invested in joining us for our global sales conference in order to learn about our newest product and service capabilities. Supporting the growth and success of our reseller affiliates will remain a top priority for our company in the year ahead. consulting Partners In 2010 we continued our relationships with a core group of consulting services organizations, including Arthur D. Little, Deloitte, Kalypso and Stage-Gate® International. We also recently extended our association with Microsoft® as a Gold- Certified partner. The past year was marked by an increase in contact from consulting firms exploring Sopheon’s interest in partnership opportunities. As the depressed economy eroded demand for enterprise resource planning (ERP) deployments, the consulting organizations whose services are designed to support such large-scale implementations saw business decline. Many seeking new business opportunities were attracted by the growth trends and long-term promise of the innovation governance market. Sopheon is now working with a number of these firms whose services complement Sopheon’s software applications and can help us bring more value to our customers. We anticipate expanding our ecosystem of consulting partners throughout this year. Our Advisory Consulting Services team will play an important role in the education and training of these new partners as we work jointly on commercial projects. Our goal is to formalize as many as three of these relationships during 2011 where the affiliation includes the partner’s creation of a center-of-excellence practice supporting Sopheon’s Accolade offering. Stage-gate® is a registered trademark of the Product development Institute, Inc. Microsoft® is a registered trademark of Microsoft corporation. 1 6 DIRECTORS AND ADVISORS DI R E C T O R S A N D AD V I SOR S directors Barry K. Mence Andrew L. Michuda Arif Karimjee ACA Stuart A. Silcock FCA Bernard P. F. Al Daniel Metzger Executive Chairman Chief Executive Officer Finance Director Non-executive Director Non-executive Director Non-executive Director Secretary Arif Karimjee registered office Surrey Technology Centre 40 Occam Road, Surrey Research Park Guildford, Surrey Gu2 7YG registered name and number Sopheon plc. Registered in England and Wales No. 3217859 Lloyds TSB Bank plc. 77 high Street Southend-on-Sea Essex SS1 1hT Briggs and Morgan 2200 IDS Center, 80 South Eighth Street Minneapolis, MN 55402 united States Auditors Principal bankers and Financiers Solicitors and Attorneys AIM nominated Adviser and broker euronext Paying Agent registrars BDO LLP 55 Baker Street London W1u 7Eu Silicon Valley Bank 3003 Tasman Drive Santa Clara, CA 95054 united States BlueCrest Capital Finance, LLC 225 West Washington, Suite 200 Chicago, IL 60606 united States hammonds 7 Devonshire Square Cutlers Gardens London EC2M 4Yh Loyens & Loeff Fred Roeskestraat 100 1076 ED Amsterdam The Netherlands finnCap Limited 60 New Broad Street London EC2M 1JJ Kempen & Co. Beethovenstraat 300 1077 WZ Amsterdam The Netherlands Capita Registrars Northern house Woodsome Park Fenay Bridge huddersfield hD8 0LA REPORT ON DIRECTORS’ REMUNERATION 1 7 RE P O R T O N DI R E C T O R S’ RE MuN E R A T I O N The remuneration committee of Sopheon plc is responsible for oversight of the contract terms, remuneration and other benefits for executive directors, including performance-related bonus schemes. The committee comprises two non-executive directors, B.P.F. Al, as chairman, and S.A. Silcock, together with B.K. Mence, other than in respect of his own remuneration. The committee makes recommendations to the board, within agreed parameters, on an overall remuneration package for executive directors and other senior executives in order to attract, retain and motivate high quality individuals capable of achieving the group’s objectives. The package for each director consists of a basic salary, benefits and pension contributions, together with performance-related bonuses and share options on a case by case basis. Consideration is given to pay and employment policies elsewhere in the group, especially when considering annual salary increases. During 2010, the board granted a 2% pay increase to executive directors as of 1 July 2010. This was consistent with the pay increase granted to the majority of the group’s employees. There was no pay adjustment in 2009. From time to time, the remuneration committee may take advice from appropriate remuneration consultants or to consult benchmarking data. Contracts The service contract between the company and Mr. Michuda is terminable on up to three months’ notice, with twelve months’ salary in lieu of notice due by the company in the event of termination without cause. Service contracts between the company and the other executive directors are terminable on six months’ notice. Fees for Non-executive Directors The fees for non-executive directors are determined by the board. The non-executive directors are not involved in any discussions or decisions about their own remuneration. Directors’ Remuneration Set out below is a summary of the fees and emoluments received by all directors during the year, translated where applicable into Sterling at the average rate for the period. Mr. Mence’s remuneration is largely fee-based and therefore subject to fluctuations from period to period. Mr. Michuda’s remuneration is payable in uS Dollars, the average exchange rate for which has increased significantly compared with the previous year. Details of directors’ interests in shares and options are set out in the Directors’ Report. executive directors B.K. Mence A.L. Michuda A. Karimjee non-executive directors S.A. Silcock B.P.F. Al D. Metzger Pay and fees 2010 £ 131,708 156,549 104,460 18,000 18,000 18,000 _______ 446,717 _______ _______ bonus 2010 £ 57,000 78,274 38,784 - - - benefits 2010 £ 2,256 10,577 2,251 Total 2010 £ Total 2009 £ 190,964 245,400 145,495 135,477 164,418 105,509 - - - 18,000 18,000 18,000 18,000 18,000 18,000 _______ 459,404 _______ _______ _______ 174,058 _______ _______ _______ 15,084 _______ _______ _______ 635,859 _______ _______ 1 8 REPORT ON DIRECTORS’ REMUNERATION The remuneration committee establishes the objectives that must be met for each financial year if a cash bonus is to be paid. With the principal exception of members of Sopheon’s sales teams, for whom incentives are tied to individual or territory results, the committee concluded that the cash incentive should be tied to the financial performance of the group as a whole, and in 2009 objectives were set with regard to EBITDA performance. During 2010, these objectives were set such that incentive started to accrue from EBITDA of £600,000, with the maximum payment at EBITDA of £1,500,000. These measures were applied to all members of the executive board and management committee of the group, as well as the majority of the group’s employees. In addition to the amounts disclosed above, pension contributions are made to individual directors’ personal pension schemes. During 2010 contributions of £4,875, £3,139 and £4,848 (2009 - £4,875, £3,823 and £4,800) were paid respectively to the pension schemes of B.K. Mence, A.L. Michuda and A. Karimjee. Performance Graph The following graph shows the company’s share price performance on AIM since January 2005, compared with the performance of the FTSE AIM All Share index, which has been selected for this comparison as it is a broad-based index which the directors believe most closely reflect the performance of companies with similar characteristics as the company’s. REPORT ON DIRECTORS’ REMUNERATION 1 9 Directors’ Interests The interests of the directors, who held office at the end of the year, in the share capital of the company (all beneficially held except those marked with an asterisk (*), which are held as trustee), were as follows: Share options ordinary Shares 8% convertible Loan Stock 2013 At 31 December 2010 2009 2010 2009 2010 2009 B.K. Mence A.L. Michuda A. Karimjee S.A. Silcock S.A. Silcock* B.P.F. Al D. Metzger 485,000 4,002,624 1,150,000 - - 25,000 - 485,000 3,768,904 1,000,000 - - 25,000 - 14,423,847 155,188 87,667 950,000 76,639 650,000 100,000 14,423,847 155,188 87,667 950,000 76,639 650,000 100,000 £200,000 £200,000 £20,000 £20,000 £12,000 £12,000 £100,000 £100,000 - - £40,000 £40,000 - - Of the 14,423,847 ordinary shares mentioned above B.K. Mence beneficially owns and is the registered holder of 10,123,027 ordinary shares. A further 2,300,820 ordinary shares are held by Inkberrow Limited, a company in which B.K. Mence and his family trust are the majority shareholders and in which S.A. Silcock is a minority shareholder. In addition B.K. Mence is, or his wife or children are, potential beneficiaries under trusts holding an aggregate of 2,000,000 ordinary shares. The following table provides summary information for each of the directors who held office during the year and who held options to subscribe for Sopheon ordinary shares. All options were granted without monetary consideration. date of grant exercise price 1 April 2008 2 May 2001 30 April 2002 15 April 2005 B.K. Mence (1) B.K. Mence (1) B.K. Mence (5) 3 May 2006 B.K. Mence (7) B.K. Mence (8) 29 June 2007 B.K. Mence (9) 2 October 2000 A.L. Michuda 1 January 2001 A.L. Michuda (2) 2 May 2001 A.L. Michuda (3) 30 April 2002 A.L. Michuda (3) 5 November 2003 A.L. Michuda (3)(4) 15 April 2005 A.L. Michuda (5) 3 May 2006 A.L. Michuda (7) 29 June 2007 A.L. Michuda (8) 1 April 2008 A.L. Michuda (5)(9) 27 June 2008 A.L. Michuda (5) 27 June 2010 A.L. Michuda (5) A. Karimjee (1) 2 May 2001 A. Karimjee (1) 30 April 2002 5 November 2003 A. Karimjee (4)(6) 15 April 2005 A. Karimjee (5) 3 May 2006 A. Karimjee (7) 29 June 2007 A. Karimjee (8) 1 April 2008 A. Karimjee (5)(9) 27 June 2008 A. Karimjee (5) 27 June 2010 A. Karimjee (5) 2 May 2001 B.P.F. Al (1) 77.5p 14.75p 25.25p 22p 19p 13.25p 427.5p 160p 77.5p 14.75p 16.25p 25.25p 22p 19p 13.25p 14p 7.5p 77.5p 14.75p 16.25p 25.25p 22p 19p 13.25p 14p 7.5p 77.5p At 31 december 2009 22,500 100,000 62,500 100,000 100,000 100,000 16,280 5,030 54,662 487,932 2,225,000 150,000 100,000 250,000 250,000 230,000 - 12,500 150,000 300,000 62,500 100,000 100,000 175,000 100,000 - 25,000 granted during year - - - - - - - - - - - - - - - - 250,000 - - - - - - - - 150,000 - Lapsed during year - - - - - - (16,280) - - - - - - - - - - - - - - - - - - - - At 31 december 2010 22,500 100,000 62,500 100,000 100,000 100,000 0 5,030 54,662 487,932 2,225,000 150,000 100,000 250,000 250,000 230,000 250,000 12,500 150,000 300,000 62,500 100,000 100,000 175,000 100,000 150,000 25,000 2 0 REPORT ON DIRECTORS’ REMUNERATION None of the directors exercised any share options during the year. (1) Exercisable between the third and tenth anniversary of the date of grant. (2) One fourth of these options becomes exercisable on each of the first four anniversaries of the date of grant and they expire on the tenth anniversary of the date of grant. (3) One third of these options are exercisable from the date of grant, one third from the first anniversary of the date of grant and one third from the second anniversary. (4) Vesting of a proportion of these options was subject to performance conditions relating to the achievement of positive EBITDA in two successive quarters. The conditions were met. (5) One third of these options are exercisable from the first anniversary of the date of grant, one third from the second anniversary, and the remainder from the third anniversary. (6) 93,846 of these options are exercisable between the third and tenth anniversary of the date of grant and 206,154 options are exercisable as to one third immediately and one third on each of the first and second anniversaries of the date of grant. (7) Vesting of one half of these options was subject to performance conditions based on the achievement of certain financial objectives in 2006. The conditions were met. (8) Vesting of one half of these options was subject to performance conditions based on the achievement of certain financial objectives in 2007. The conditions were met. (9) Vesting of one half of these options was subject to performance conditions based on the achievement of certain financial objectives in 2008. The conditions were met. The mid-market price of Sopheon ordinary shares at 31 December 2010 was 8p. During the financial year the mid-market price of Sopheon ordinary shares ranged from 7.25p to 9p. Save as disclosed above, no director (or member of his family) or connected persons has any interest, beneficial or non- beneficial, in the share capital of the company. Auditable part of the remuneration report In their audit opinion on page 24, BDO LLP refer to their audit of the disclosures required by the Companies Act 2006. These comprise the following disclosures in this report: • The table on page 17 showing total emoluments received by directors during the year ended 31 December 2010; • The text on page 18 stating total pension contributions made on behalf of the directors during the year ended 31 December 2010; • The share options table for the year ended 31 December 2010 on page 19. Approved by the board on 23 March 2011 and signed on its behalf by: A. Karimjee Director DIRECTORS’ REPORT 2 1 DI R E C T O R S’ RE P O R T The group’s principal activities during the year continued to focus on the provision of software and services that improve the return on investment of product development, within the rapidly emerging product lifecycle management (PLM) market. A review of the development of the business during the year is given in the Statement from the Chairman and Chief Executive Officer on page 6 and the subsequent Financial and Operating Review. This also includes reference to the group’s future prospects. An overview of the group’s products and markets incorporating advances in research and development is provided on page 11. The group’s result for the year ended 31 December 2010 is a profit after tax of £152,000 (2009: loss of £1,494,000). The directors do not intend to declare a dividend. Corporate Governance The Sopheon board is committed to high standards of corporate governance and aims to follow appropriate governance practice, although as a company incorporated in the uK and listed on AIM and Euronext, the company is not subject to the requirements of the uK Combined Code or the Netherlands Tabaksblat Committee. The board currently comprises three executive directors and three independent non-executive directors. Their biographies appear on the inside back cover of this annual report, and demonstrate a range of experience and caliber to bring the right level of independent judgment to the board. The board is responsible for the group’s system of internal control and for reviewing its effectiveness. Such a system can only provide reasonable, but not absolute, assurance against material misstatement or loss. The board believes that the group has internal control systems in place appropriate to the size and nature of its business. The board is satisfied that the scale of the group’s activities do not warrant the establishment of an internal audit function. The board is also responsible for identifying the major business risks faced by the group and for determining the appropriate course of action to manage those risks. Formal meetings are held quarterly to review strategy, management and performance of the group, with additional meetings between those dates convened as necessary. During 2010, all directors attended all meetings either in person or by conference call. The audit committee, which comprises all of the non-executive directors and is chaired by Stuart Silcock, considers and determines actions in respect of any control or financial reporting issues they have identified or that are raised by the auditors. The board has a formal schedule of matters specifically reserved to it for decision. Details of the constitution of the remuneration committee are provided in the Report on Directors’ Remuneration on page 17. Principal Risk Areas As with any business at its stage of development, Sopheon faces a number of risks and uncertainties. The board monitors these risks on a regular basis. The key areas of risk identified by the board are summarized below. Sopheon’s markets continue to be at a relatively early stage of development and it is possible that Sopheon's products may not sell in the quantities or at the prices required to achieve sustained profitability. The broad market for Sopheon’s software products continues to emerge and evolve. Sopheon has sought to focus its resources on the sub-segments that it believes offer the best short-term opportunity for growth, and on developing functionality which its research indicates customers in those segments require. however, determining the potential size, growth rate and needs of a particular market segment remains challenging. This risk has become particularly relevant in view of the economic turmoil that has affected the global economy. Sopheon continues to monitor market needs carefully, and has formalized processes for soliciting input to product strategy from analysts and customers. Sopheon has a history of losses and its prospects of achieving sustained profitability are dependent on meeting sales targets. Sopheon has in past years experienced substantial net losses due, in part, to its investment in product development and marketing but also due to the fact that the timing and size of individual sales can have a substantial impact on performance in a given period. Sopheon’s ability to continue to finance its activities through to the point that its operations become cash generative on a sustained basis is dependent on the group maintaining sales growth alongside its investment strategy, or in the absence of such growth, its ability to secure funding through the company's facilities or other sources. Sopheon management carefully monitors short- and medium-term financing requirements and has regularly raised additional funding resources to meet requirements. Details of the resources available to Sopheon and the reasons why management consider that the company is able to continue as a going concern are set out in Note 2 to the financial statements. Some of Sopheon’s competitors and potential competitors have greater financial resources than Sopheon. Sopheon remains a relatively small organization by global standards. Its resources are dwarfed by those of many larger companies that are capable of developing competitive solutions and it is difficult to overcome the marketing engine of a large global firm. Sopheon seeks to compete effectively with such companies by keeping its market communications focused, clear and consistent with its product and market strategy, and working to deliver first class quality of execution so that referenceability of the customer base is maximized. Sopheon is dependent upon skilled personnel, the loss of whom could have a material impact. While service agreements have been entered into with key executives, retention of key members of staff cannot be guaranteed and departure of such employees could be damaging in the short term. In addition the competition for qualified employees continues to be difficult and 2 2 DIRECTORS' REPORT retaining key employees has become accordingly more challenging and expensive. As a relatively small business, Sopheon is more exposed to this risk than some of its larger competitors. Sopheon management checks staff remuneration against recognized benchmarks and other industry sources, and seeks to maintain pay at competitive levels appropriate to its business. Sopheon will require relationships with partners who are able to market and implement its products. historically, Sopheon has devoted substantial resources to the direct marketing of its products, and its strategy to enter into strategic alliances and other collaborative relationships to widen the customer base and create a broad sales and implementation channel for its products is not yet mature. The successful implementation of this strategy is crucial to Sopheon’s prospects and its ability to scale effectively. however, Sopheon cannot be sure that it will select the right partners, or that the partners it does select will devote adequate resources to promoting, selling and becoming familiar with Sopheon's products. Over the years Sopheon has built up a network of both resellers and consulting partners; however this has yet to mature and the revenues delivered through these relationships remain a relatively small part of the total. Sopheon could be subject to claims for damages for errors in its products and services. Sopheon may be exposed to claims for damages from customers in the event that there are errors in its software products or should support and maintenance service level agreements fail to meet agreed criteria. Sopheon has sought to protect itself from such risks through its development methodologies, its contract terms and insurance, and is not aware of any such claims at this time. Share Option Schemes Details of options granted are shown in Note 28 to the financial statements. Supplier Payment Policy and Practice It is the company’s policy that payments to suppliers are made in accordance with those terms and conditions agreed between the company and its suppliers, provided that all trading terms and conditions have been complied with. At 31 December 2010 the company had approximately 31 days’ purchases outstanding (2009: 50 days). Charitable and Political Donations The group has made no charitable or political donations during the year. Auditors All of the current directors have taken all the steps that they ought to have taken to make themselves aware of any information needed by the company’s auditors for the purposes of their audit and to ensure that the auditors are aware of that information. The directors are not aware of any relevant audit information of which the auditors are unaware. A resolution to reappoint BDO LLP as auditors will be put to the members at the Annual General Meeting. Financial Instruments Details of the group’s financial instruments and its policies with regard to financial risk management are given in Note 23 to the financial statements. Substantial Shareholdings The directors are aware of the following persons who as at 23 March 2011 were interested directly or indirectly in three percent or more of the company’s issued ordinary shares: name B.K. Mence (director) Norman Nominees Limited no. of ordinary Shares % Issued ordinary Shares 14,423,847 9,691,260 9.9 6.7 B.K. Mence’s interest represents direct beneficial holdings as well as those of his family. Approved by the board on 23 March 2011 and signed on its behalf by: A. Karimjee Director STATEMENT OF DIRECTORS’ RESPONSIBILITIES 2 3 S T A T E M E N T O F D I R E C T O R S ’ R E S P O N S I B I L I T I E S I N RE S P E C T O F ThE FI N A N C I A L ST A T E M E N T S Company law requires the directors to prepare financial statements for each financial year. under that law the directors have elected to prepare the group and company financial statements in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European union. under company law the directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the group and company and of the profit or loss of the group for that period. The directors are also required to prepare financial statements in accordance with the rules of the London Stock Exchange for companies trading securities on the Alternative Investment Market and the rules of the Euronext Amsterdam Stock Exchange. The annual report is the responsibility of, and has been approved by, the directors. The directors confirm to the best of their knowledge that: • the financial statements, prepared in accordance with International Financial Reporting Standards as endorsed by the European union and Article 4 of the IAS regulation, give a true and fair view of the assets, liabilities, financial position and profit or loss of the issuer and the undertakings included in the consolidation taken as a whole; and • the annual report includes a fair review of the development and performance of the business and the position of the issuer and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties that they face. In preparing these financial statements, the directors are required to: • select suitable accounting policies and then apply them consistently; • make judgments and accounting estimates that are reasonable and prudent; • state whether they have been prepared in accordance with IFRSs as adopted by the European Union, subject to any material departures disclosed and explained in the financial statements; and • prepare the financial statements on the going concern basis unless it is inappropriate to presume that the company will continue in business. The directors are responsible for keeping adequate accounting records that are sufficient to show and explain the company’s transactions and disclose with reasonable accuracy at any time the financial position of the company and enable them to ensure that the financial statements comply with the requirements of the Companies Act 2006. They are also responsible for safeguarding the assets of the company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities. Website Publication The directors are responsible for ensuring the annual report is made available on a website. Annual reports are published on the company's website in accordance with legislation in the united Kingdom governing the preparation and dissemination of financial statements, which may vary from legislation in other jurisdictions. The maintenance and integrity of the company's website is the responsibility of the directors. The directors' responsibility also extends to the ongoing integrity of the annual reports contained therein. 2 4 INDEPENDENT AUDITORS’ REPORT TO THE MEMBERS OF SOPHEON PLC I N D E P E N D E N T A u D I T O R S ’ R E P O R T T O T h E ME M B E R S O F SO PhE O N P L C We have audited the financial statements of Sopheon plc for the year ended 31 December 2010 which comprise the consolidated income statement, the consolidated and company balance sheets, the consolidated statement of comprehensive income, the consolidated and company cash flow statements, the consolidated and company statements of changes in equity and the related notes. The financial reporting framework that has been applied in their preparation is applicable law and International Financial Reporting Standards (IFRSs) as adopted by the European union and, as regards the parent company financial statements, as applied in accordance with the provisions of the Companies Act 2006. This report is made solely to the company’s members, as a body, in accordance with Chapter 3 of Part 16 of the Companies Act 2006. Our audit work has been undertaken so that we might state to the company’s members those matters we are required to state to them in an auditor’s report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the company and the company’s members as a body, for our audit work, for this report, or for the opinions we have formed. Respective Responsibilities of Directors and Auditors As explained more fully in the statement of directors’ responsibilities, the directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit and express an opinion on the financial statements in accordance with applicable law and International Standards on Auditing (uK and Ireland). Those standards require us to comply with the Auditing Practices Board’s (APB’s) Ethical Standards for Auditors. Scope of the Audit of the Financial Statements A description of the scope of an audit of financial statements is provided on the APB’s website at www.frc.org.uk/apb/ scope/private.cfm. Opinion on Financial Statements In our opinion: • the financial statements give a true and fair view of the state of the group’s and the parent company’s affairs as at 31 December 2010 and of the group’s profit for the year then ended; the group financial statements have been properly prepared in accordance with IFRSs as adopted by the European • union; • the parent company financial statements have been properly prepared in accordance with IFRSs as adopted by the European union and as applied in accordance with the provisions of the Companies Act 2006; and • the financial statements have been prepared in accordance with the requirements of the Companies Act 2006. Emphasis of Matter – Going Concern In forming our opinion on the financial statements, which is not modified, we have considered the adequacy of the disclosures made in Note 2 to the financial statements concerning the group’s ability to continue as a going concern. As in prior years, these disclosures identify certain factors that indicate the existence of material uncertainties which may cast significant doubt about the group’s ability to continue as a going concern. As discussed in Note 2, the appropriateness of the going concern basis remains reliant on the group achieving an adequate level of sales in order to maintain sufficient working capital to support its activities, and the possibility of having to repay in cash £850,000 of convertible loan stock on 31 January 2013, or if this objective is not met, being able to raise sufficient additional finance. The financial statements do not include the adjustments that would result if the group were unable to continue as a going concern. INDEPENDENT AUDITORS’ REPORT TO THE MEMBERS OF SOPHEON PLC 2 5 Opinion on Other Matters Prescribed by the Companies Act 2006 In our opinion: • the part of the Directors’ Remuneration report to be audited has been properly prepared in accordance with the Companies Act 2006; and • the information given in the Directors’ Report for the financial year for which the financial statements are prepared is consistent with the financial statements. Matters on Which We are Required to Report by Exception We have nothing to report in respect of the following matters where the Companies Act 2006 requires us to report to you if, in our opinion: • adequate accounting records have not been kept by the parent company, or returns adequate for our audit have not been received from branches not visited by us; or • the parent company financial statements are not in agreement with the accounting records and returns; or • certain disclosures of directors’ remuneration specified by law are not made; or • we have not received all the information and explanations we require for our audit. Iain henderson (Senior statutory auditor) For and on behalf of BDO LLP, statutory auditor 55 Baker Street London W1u 7Eu united Kingdom 23 March 2011 BDO LLP is a limited liability partnership registered in England and Wales (with registered number OC305127). 2 6 FINANCIAL STATEMENTS CO N S O L I D A T E D IN C O M E ST A T E M E N T F O R ThE YE A R EN D E D 3 1 DE C E M B E R 2 0 1 0 Revenue Cost of sales Gross profit Sales and marketing expense Research and development expense Administrative expense Operating profit/(loss) Finance income Finance expense Profit/(loss) before tax Income tax expense Profit/(loss) for the year Earnings/(loss) per share Basic and fully diluted (pence) notes 3 2010 £’000 2009 £’000 10,537 (2,603) _______ 8,260 (2,384) _______ 7,934 5,876 (3,593) (2,417) (1,488) _______ (3,379) (2,210) (1,560) _______ 436 (1,273) 8 9 6 (271) _______ 19 (240) _______ 171 (1,494) 10 (19) _______ - _______ 152 _______ (1,494) _______ 12 0.10p _______ _______ (1.03p) _______ _______ C O N S O L I D A T E D S T A T E M E N T O F C O M P R E h E N S I V E I N C O M E F O R ThE Y E A R E N D E D 3 1 D E C E M B E R 2 0 1 0 Profit/(loss) for the year Other comprehensive income Exchange differences on translation of foreign operations Total comprehensive income/(expense) for the year 2010 £’000 2009 £’000 152 (1,494) 39 _______ (206) _______ 191 _______ _______ (1,700) _______ _______ FINANCIAL STATEMENTS 2 7 C O N S O L I D A T E D A N D C O M P A N Y B A L A N C E S h E E T S A T 3 1 DE C E M B E R 2 0 1 0 Assets non-current Assets Property, plant and equipment Intangible assets Investments in subsidiaries Other receivable Total non-current assets current Assets Trade and other receivables Cash and cash equivalents Total current assets Total assets Liabilities current Liabilities Trade and other payables Borrowings Obligations under finance leases Deferred revenue Total current liabilities non-current Liabilities Borrowings Total non-current liabilities Total liabilities Net assets Equity Share capital Capital reserves Translation reserve Retained losses Total equity group company notes 2010 £’000 2009 £’000 2010 £’000 2009 £’000 13 14 15 16 17 18 19 20 21 20 24 25 141 3,633 - 12 –––––––– 3,786 –––––––– 4,119 3,358 –––––––– 7,477 –––––––– 11,263 2,346 982 4 2,633 –––––––– 5,965 –––––––– 2,290 –––––––– 2,290 –––––––– 8,255 –––––––– 3,008 –––––––– –––––––– 151 3,993 - 12 –––––––– 4,156 –––––––– 2,905 1,624 –––––––– 4,529 –––––––– 8,685 1,187 1,340 1 2,250 –––––––– 4,778 –––––––– 1,222 –––––––– 1,222 –––––––– 6,000 –––––––– 2,685 –––––––– –––––––– - - 6,119 - –––––––– 6,119 –––––––– 9 734 –––––––– 743 –––––––– 6,862 435 - - - –––––––– 435 –––––––– 799 –––––––– 799 –––––––– 1,234 –––––––– 5,628 –––––––– –––––––– 7,279 73,719 420 (78,410) –––––––– 3,008 –––––––– –––––––– 7,279 73,633 381 (78,608) –––––––– 2,685 –––––––– –––––––– 7,279 65,954 - (67,605) –––––––– 5,628 –––––––– –––––––– - - 6,119 - –––––––– 6,119 –––––––– 33 1,018 –––––––– 1,051 –––––––– 7,170 347 - - - –––––––– 347 –––––––– 850 –––––––– 850 –––––––– 1,197 –––––––– 5,973 –––––––– –––––––– 7,279 65,868 - (67,174) –––––––– 5,973 –––––––– –––––––– Approved by the board and authorized for issue on 23 March 2011. Barry K. Mence Director Arif Karimjee Director 2 8 FINANCIAL STATEMENTS C O N S O L I D A T E D A N D C O M P A N Y C A S h F L O W S T A T E M E N T S F O R T h E Y E A R E N D E D 3 1 D E C E M B E R 2 0 1 0 group company notes 2010 £’000 2009 £’000 2010 £’000 2009 £’000 Operating activities Profit/(loss) for the year Adjustments for: Finance income Finance costs Depreciation of property, plant and equipment Amortization and impairment of intangible assets Share-based payment expense Intra-group credits and charges Provisions against intra-group loans Operating cash flows before movements in working capital (Increase)/decrease in receivables Increase/(decrease) in payables Net cash generated from/(used in) operating activities Investing activities Finance income Purchases of property, plant and equipment Development costs capitalized Intra-group loans Repayment of intra-group loans Net cash (used in) investing activities Financing activities Proceeds from borrowings Repayment of borrowings (Decrease)/increase in lines of credit Interest paid Net cash from financing activities Net increase/(decrease) in cash and cash equivalents Cash and cash equivalents at the beginning of the year Effect of foreign exchange rate changes Cash and cash equivalents at the end of the year 18 152 (1,494) (477) (1,239) (6) 271 106 1,148 81 - - –––––––– 1,752 (1,146) 1,457 –––––––– 2,063 –––––––– (19) 240 109 1,149 117 - - –––––––– 102 307 (711) –––––––– (302) –––––––– (5) 65 - - 81 (280) 125 –––––––– (491) (24) 88 –––––––– (427) –––––––– (7) 8 - - 117 (220) 925 –––––––– (416) (5) (126) –––––––– (547) –––––––– 6 (92) (657) - - –––––––– 19 (48) (945) - - –––––––– 5 - - (1,742) 1,945 –––––––– 7 - - (1,699) 1,005 –––––––– (743) –––––––– (974) –––––––– 208 –––––––– (687) –––––––– 2,152 (1,014) (465) (271) –––––––– 402 –––––––– 1,722 1,624 12 –––––––– 3,358 –––––––– –––––––– 850 (545) 301 (240) –––––––– 366 –––––––– (910) 2,586 (52) –––––––– 1,624 –––––––– –––––––– - - - (65) –––––––– (65) –––––––– (284) 1,018 - –––––––– 734 –––––––– –––––––– 850 - - (19) –––––––– 831 –––––––– (403) 1,421 - –––––––– 1,018 –––––––– –––––––– FINANCIAL STATEMENTS 2 9 C O N S O L I D A T E D A N D C O M P A N Y S T A T E M E N T S O F C h A N G E S I N E Q u I T Y F O R T h E Y E A R E N D E D 3 1 D E C E M B E R 2 0 1 0 group At 1 January 2009 Loss for the year Exchange differences on translation of foreign operations Total comprehensive income for the year Recognition of share-based payments Lapsing and expiry of share options At 1 January 2010 Profit for the year Exchange differences on translation of foreign operations Total comprehensive income for the year Recognition of share-based payments Lapsing and expiry of share options Reclassification of embedded derivative as equity (see Note 20) At 31 December 2010 Share capital £’000 7,279 - - –––––––– - –––––––– - - –––––––– 7,279 - - –––––––– - –––––––– - - - –––––––– 7,279 –––––––– –––––––– capital reserves £’000 73,627 - - –––––––– - –––––––– 117 (111) –––––––– 73,633 - - –––––––– - –––––––– 81 (46) 51 –––––––– 73,719 –––––––– –––––––– Translation reserve £’000 587 - (206) –––––––– (206) –––––––– - - –––––––– 381 - 39 –––––––– 39 –––––––– - - - –––––––– 420 –––––––– –––––––– retained losses £’000 (77,225) (1,494) - –––––––– (1,494) –––––––– - 111 –––––––– (78,608) 152 - –––––––– 152 –––––––– - 46 - –––––––– (78,410) –––––––– –––––––– Total £’000 4,268 (1,494) (206) –––––––– (1,700) –––––––– 117 - –––––––– 2,685 152 39 –––––––– 191 –––––––– 81 - 51 –––––––– 3,008 –––––––– –––––––– The translation reserve represents accumulated differences on the translation of assets and liabilities of foreign operations. Retained losses represent accumulated trading losses, including amortization and impairment charges in respect of goodwill and intangible assets arising from past acquisitions. Details and description of the capital reserves are set out in Note 25. company At 1 January 2009 Loss and total comprehensive income for the year Recognition of share-based payments Lapsing and expiry of share options At 1 January 2010 Loss and total comprehensive income for the year Recognition of share-based payments Lapsing and expiry of share options Reclassification of embedded derivative as equity (see Note 20) At 31 December 2010 Share capital £’000 7,279 - - –––––––– 7,279 - - - - –––––––– 7,279 –––––––– –––––––– capital reserves £’000 retained losses £’000 Total £’000 7,095 (1,239) 117 - –––––––– 5,973 (477) 81 - (66,046) (1,239) - 111 –––––––– (67,174) (477) - 46 - –––––––– (67,605) –––––––– –––––––– 51 –––––––– 5,628 –––––––– –––––––– 65,862 - 117 (111) –––––––– 65,868 - 81 (46) 51 –––––––– 65,954 –––––––– –––––––– 3 0 NOTES TO THE FINANCIAL STATEMENTS 1 . G E N E R A L I N F O R M AT I O N Sopheon plc ("the company") is a public limited company incorporated in England and Wales. The address of its registered office and principal place of business is set out on page 16. The principal activities of the company and its subsidiaries are described in Note 3. The financial statements have been prepared in Pounds Sterling and rounded to the nearest thousand. 2 . S I G N I F I C A N T A C C O U N T I N G P O L I C I E S The financial statements have been prepared in accordance with International Financial Reporting Standards and Interpretations issued by the International Accounting Standards Board as adopted by the European union and those parts of the Companies Act 2006 which apply to companies preparing their financial statements under IFRS. The principal accounting policies are set out below. The policies have been applied consistently to all the years presented. A number of new standards, amendments and interpretations to existing standards have been adopted by the group, but have not been listed, since they have no material impact on the financial statements. The following new standards, amendments and interpretations to existing standards have been published that are mandatory for the group's accounting periods beginning on or after 2 January 2010 and which the group has decided not to adopt early. • revised IAS 24 related Party disclosures (revision to IAS 24) (Effective for periods beginning on or after 1 January 2011). This revision is yet to be endorsed by the Eu. The revision concerns the previous disclosure and the definition of a related party. Management is still assessing the impact of this revision. • IFrS 9 Financial Instruments (replacement of IAS 39) (Effective for periods beginning on or after 1 January 2013). This revision is yet to be endorsed by the Eu. This standard will eventually replace IAS 39 in its entirety. Management is still assessing the impact of this revision. • disclosures – Transfers of Financial Assets (Amendments to IFrS 7) (Effective for periods beginning on or after 1 July 2011). This revision is yet to be endorsed by the Eu. This amendment requires the disclosure of information in respect of all transferred financial assets that are not derecognized and for any continuing involvement in a transferred asset existing at the reporting date, irrespective of when the related transfer transaction occurred. It will affect inter alia companies with debt factoring arrangements. Management is still assessing the impact of this revision. None of the other new standards, amendments or interpretations in issue is expected to have a material effect on the group or company financial statements. Going Concern The financial statements have been prepared on a going concern basis. In reaching their assessment, the directors have considered a period extending at least 12 months from the date of approval of these financial statements. This assessment has included consideration of the forecast performance of the business for the foreseeable future, the cash and financing facilities available to the group, and the repayment terms in respect of the group’s borrowings, including the potential of having to repay convertible loan stock in January 2013. During 2010, the group achieved revenues of £10.5m and a profit before tax of £171,000. This represents an improvement over the previous year. The performance in 2009 was itself weaker than that achieved in 2008, which the directors attribute to the weakening of global economic conditions at the time. Coming into 2011, the group’s sales pipeline remains very active, and accordingly, the directors remain positive about the prospects for the business. In December 2010 the group renegotiated its loan note from BlueCrest Capital Finance (“BlueCrest”) for a new principal value of $3.5m, which brought in new working capital of approximately $2.7m. The principal is repayable in equal monthly instalments of $90,000, plus interest, through March 2014. The group also has access to a revolving line of credit with BlueCrest which is secured against the trade receivables of Sopheon’s North American business. This facility is renewable annually and the current term is to 30 November 2011. The facility limit is $1.25m. At 31 December 2010, $500,000 (£318,000) was drawn against this revolving facility. In addition, during 2009 the group had secured a convertible loan for £850,000, repayable or convertible by 30 September 2011. In December 2010, the term of this loan was extended to 31 January 2013. NOTES TO THE FINANCIAL STATEMENTS 3 1 Notwithstanding the group’s much improved funding and trading position, the time-to-close and the order value of individual sales continues to vary considerably. When combined with the relatively low-volume and high-value nature of the group’s business, these are factors which constrain the ability to accurately predict revenue performance. In addition, to meet its strategic objectives, the group is expanding staff. If sales fall short of expectations, there is a risk that the group’s facilities may prove insufficient to cover both operating activities and the repayment of its debt facilities, being on the one hand the regular repayment of the BlueCrest term loan and on the other hand, the possibility of having to repay in cash £850,000 of convertible loan stock on 31 January 2013. In such circumstances, the group would be obliged to seek additional funding. The directors have concluded that the circumstances set forth above represent material uncertainties, which may cast significant doubt about the group’s ability to continue as a going concern, however they believe that taken as a whole, the factors described above enable the group to continue as a going concern for the foreseeable future. The financial statements do not include the adjustments that would be required if the company or group were unable to continue as a going concern. Basis of Consolidation The consolidated financial statements incorporate the financial statements of the company and entities controlled by the company ("subsidiaries"). Control is achieved where the company has the power to govern the financial and operating policies of an entity and to obtain benefits from its activities. All intra-group transactions, balances, income and expenses are eliminated on consolidation. Business Combinations The acquisition of subsidiaries is accounted for within the consolidated financial statements using the purchase method. The cost of the acquisition is measured at the aggregate of the fair values at the date of exchange, of assets given, liabilities incurred or assumed, and equity instruments issued by the group in exchange for control of the entity being acquired, together with any costs directly attributable to the business combination. The results of the acquired entities are included in the consolidated income statement from the date on which effective control is obtained. The identifiable assets, liabilities and contingent liabilities of the entity being acquired that meet the conditions for recognition are recognized at their fair values of the date of acquisition. Identifiable intangible assets are capitalized at fair value as at the date of acquisition. The useful lives of these intangible assets are assessed and amortization is charged on a straight-line basis, with the expense taken to the income statement within sales and marketing expense (in respect of customer relationships) and research and development expense (in respect of IPR and technology). Intangible assets are tested for impairment when a trigger event occurs. useful lives are also examined on an annual basis and adjustments, where applicable, are made on a prospective basis. Goodwill Goodwill arising on the acquisition of a subsidiary represents the excess of the cost of acquisition over the group’s interest in the net fair value of the identifiable assets, liabilities and contingent liabilities of the subsidiary at the date of acquisition. Goodwill is initially recognized at cost and is subsequently measured at cost less any accumulated impairment losses. For the purposes of impairment testing, goodwill is allocated to those cash-generating units of the group expected to benefit from the synergies of the business combination. Cash-generating units to which goodwill has been allocated are tested for impairment annually, or more frequently when there is an indication that the unit may be impaired. If the recoverable amount of the cash-generating unit is less than the carrying value of the unit, the impairment loss is allocated firstly to reduce the carrying cost of any goodwill allocated to the unit and then to any other assets of the unit pro rata to the carrying value of each asset of the unit. An impairment loss recognized for goodwill is not reversed in a subsequent period. 3 2 NOTES TO THE FINANCIAL STATEMENTS Revenue Recognition Revenue is measured at the fair value of the consideration received or receivable and represents amounts receivable for goods and services provided in the normal course of business, net of discounts and sales related taxes. Sales of software products are recognized on delivery, provided that no significant obligations remain owing to the customer in connection with such product sale. Such significant obligations could include giving a customer a right to return the software product without any preconditions, or if the group has failed to deliver an element of the software product by the balance sheet date. Revenues relating to maintenance and post-contract support agreements are deferred and recognized over the period of the agreements. Revenues from implementation and consultancy services are recognized as the services are performed, or in the case of fixed price or milestone-based projects, on a percentage basis as the work is completed and any relevant milestones are met, using latest estimates to determine the expected duration and cost of the project. Leases Assets held under finance leases are recognized as assets of the group at their fair value at the inception of the lease or, if lower, at the net present value of the minimum lease payments. The corresponding liability to the lessor is included in the balance sheet as a finance lease obligation. Lease payments are apportioned between finance charges and reduction of the lease obligation so as to achieve a constant rate of interest on the remaining balance of the liability. Finance charges are charged to the income statement. Rentals payable under operating leases are charged to the income statement on a straight-line basis over the term of the relevant lease. Interest on Borrowings All interest on borrowings is recognized in the income statement in the period in which it is incurred. Retirement Benefit Costs Payments to defined contribution retirement benefit plans are charged as an expense as they fall due. The group does not operate any defined benefit retirement benefit plans. Foreign Currencies The individual financial statements of each group entity are presented in the currency of the primary economic environment in which the entity operates (its functional currency). For the purpose of the consolidated financial statements, the results and financial position of each entity are expressed in Sterling, which is the functional currency of the parent company, and the presentation currency for the consolidated financial statements. In preparing the financial statements of the individual entities, transactions in currencies other than the entity’s functional currency (foreign currencies) are recorded at rates approximating to the transaction rates. At each balance sheet date, monetary items denominated in foreign currencies are retranslated at the rates prevailing on the balance sheet date. Non- monetary items carried at fair value that are denominated in foreign currencies are retranslated at the rates prevailing on the date when the fair value was determined. Non-monetary items that are measured in terms of historical cost in a foreign currency are not retranslated. Exchange differences arising on the settlement of monetary items and on the retranslation of monetary items are included in the income statement for the period. For the purpose of presenting consolidated financial statements, the assets and liabilities of the group’s foreign operations are expressed in Sterling using exchange rates prevailing on the balance sheet date. Income and expense items (including comparatives) are translated at the average exchange rates for the period. Exchange differences arising (including exchange differences on intra-group loans where there is no intention that these should be settled) are classified as equity and transferred to the group’s translation reserve. Such translation differences are recognized in the income statement in the period in which the foreign operation is disposed of. On disposal of a foreign operation the cumulative exchange differences recognized in the foreign exchange reserve relating to that operation up to the date of disposal are transferred to the income statement as part of the profit or loss on disposal. NOTES TO THE FINANCIAL STATEMENTS 3 3 Deferred Tax Deferred tax is recognized on differences between the carrying amounts of assets and liabilities in the financial statements and the corresponding tax bases used in the computation of taxable profit, and is accounted for using the balance sheet liability method. Deferred tax liabilities are generally recognized for all taxable temporary differences, but deferred tax assets are recognized only to the extent that it is probable that taxable profits will be available against which deductible temporary differences can be utilized. Deferred tax is calculated at tax rates that have been enacted or substantively enacted at the balance sheet date, and that are expected to apply in the period when the liability is settled or the asset realized. Deferred tax is charged or credited to profit or loss, except when it relates to items charged or credited directly to equity, in which case the deferred tax is also dealt with in equity. Property, Plant and Equipment Computer equipment and fixtures and fittings are stated at cost less accumulated depreciation and any accumulated impairment losses. Depreciation is charged so as to write off the costs of assets over their estimated useful lives, using the straight-line method. Assets held under finance leases are depreciated over their expected useful lives on the same basis as owned assets, or, when shorter, over the term of the relevant lease. The gain or loss arising on the disposal or retirement of an item of property, plant and equipment is determined as the difference between the sale proceeds and the carrying amount of the asset and is recognized in the income statement. Investments Investments in subsidiaries within the company balance sheet are stated at cost less impairment. Impairment tests are undertaken whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. Where the carrying value of an investment exceeds its recoverable amount, the investment is written down accordingly. Externally Acquired Intangible Assets Externally acquired intangible assets are initially recognized at their fair values at the date of acquisition and are subsequently amortized on a straight-line basis over their useful economic lives. The amortization expense in respect of externally acquired technology and intellectual property (“IPR”) is included in research and development costs in the income statement, and the amortization expense in respect of externally acquired customer relationships is included in sales and marketing expense. Internally Generated Intangible Assets (Research and Development Expenditure) Development expenditure on internally developed software products is capitalized if it can be demonstrated that: • it is technically feasible to develop the product; • adequate resources are available to complete the development; • there is an intention to complete and sell the product; • the group is able to sell the product; • sales of the product will generate future economic benefits; and • expenditure on the product can be measured reliably. Capitalized development costs are amortized over the period over which the group expects to benefit from selling the product developed, typically over four years. The amortization expense in respect of internally generated intangible assets is included in research and development costs. Development costs not satisfying the above criteria and expenditure on the research phase of internal projects are recognized in the income statement as incurred. 3 4 NOTES TO THE FINANCIAL STATEMENTS Impairment of Tangible and Intangible Assets (Excluding Goodwill) At each balance sheet date, the group reviews the carrying amounts of its tangible and intangible assets to determine whether there is any indication that those assets have suffered an impairment loss. If any such indication exists, the recoverable amount of the asset is estimated in order to determine the extent of the impairment loss (if any). Where it is not possible to estimate the recoverable amount of an individual asset, the group estimates the recoverable amount of the cash-generating unit to which the asset belongs. Recoverable amount is the higher of the fair value less costs to sell and value in use. In assessing the value in use, the estimated future cash flows are discounted to their net present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. If the recoverable amount of an asset or cash-generating unit is estimated to be less than its carrying amount, the carrying amount of the asset or cash-generating unit is reduced to its recoverable amount. An impairment loss is recognized immediately in the administrative expenses line item in the income statement. Where an impairment loss subsequently reverses, the carrying value of the asset or cash-generating unit is increased to the revised recoverable amount, but so that the increased carrying amount does not exceed the carrying amount which would have been determined had no impairment loss been recognized in prior years. A reversal of an impairment loss is recognized immediately in profit or loss. Financial Instruments 1. Financial Assets The group’s financial assets fall into the category of loans and receivables. The group does not have any financial assets in the categories of fair value through profit and loss or available for sale. The group has not classified any of its financial assets as held to maturity. unless otherwise indicated, the carrying values of the group’s financial assets are a reasonable approximation of their fair values. Loans and receivables These assets are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. They arise principally through the provision of goods and services (e.g. trade receivables) but also include cash and cash equivalents and other types of contractual monetary asset. They are initially recognized at fair value plus transaction costs that are directly attributable to the acquisition or issue and subsequently carried at amortized cost using the effective interest rate method, less provision for impairment. The effect of discounting on these financial instruments is not considered material. Impairment provisions are recognized when there is objective evidence (such as significant financial difficulties, default or significant delay in payment on the part of the counter-party) that the group will be unable to collect all the amounts due under the terms of the receivable, the amount of such provision being the difference between the net carrying amount and the present value of the future expected cash flows associated with the receivable. For trade receivables, such provisions are recorded in a separate allowance account with the loss being recognized within administrative expenses in the income statement. On confirmation that the trade receivable will not be collectable, the gross carrying value of the asset is written off against the associated provision. 2. Financial Liabilities The group classifies its financial liabilities in the category of financial liabilities at fair value through profit or loss and those measured at amortized cost. Financial Liabilities at Fair Value through Profit or Loss Financial liabilities at fair value through profit or loss comprise the embedded derivative feature in the group’s convertible loan stock. NOTES TO THE FINANCIAL STATEMENTS 3 5 The proceeds received on issue of convertible debt that converts at a variable price and consequently for a variable number of shares are allocated into liability and derivative components. The amount attributable to the liability component equals the discounted cash flows. The derivative component is also included within liabilities, but is measured at fair value in the balance sheet, with changes in the fair value of the derivative component recognized in the consolidated income statement. Where the terms of such convertible debt are amended to remove the provisions for varying the conversion price, the derivative component is measured at fair value at the date of such amendment, and is reclassified to equity. As further detailed in Note 20, on 8 December 2010 the terms of the group's convertible loan stock were modified in accordance with the foregoing circumstances. Other than the derivative embedded in the convertible debt, the group does not have any liabilities held for trading nor has it designated any other financial liabilities as being at fair value through profit or loss. Financial Liabilities Measured at Amortized cost Financial liabilities measured at amortized cost include: • Trade payables and other short-dated monetary liabilities, which are initially recognized at fair value and subsequently carried at amortized cost using the effective interest rate method. • Bank and other borrowings (including the host debt element of the convertible loan noted above), which are initially recognized at fair value net of any transaction costs directly attributable to the acquisition of the instrument. Such interest-bearing liabilities are subsequently measured at amortized cost using the effective interest rate method, which ensures that the interest expense over the period to repayment is at a constant rate on the balance of the liability carried in the balance sheet. Interest expense in this context includes initial transaction costs and premiums payable on redemption, as well as any interest payable while the liability is outstanding. unless otherwise indicated, the carrying values of the group’s financial liabilities measured at amortized cost represent a reasonable approximation of their fair values. 3. Share Capital Financial instruments issued by the group are treated as equity only to the extent that they do not meet the definition of a financial liability. The group’s ordinary shares are classified as equity. For the purpose of the disclosures given in Note 23(f) the group considers its capital to comprise its ordinary share capital, share premium and other capital reserves less its accumulated retained loss. Share-based Payments The group issues equity-settled share-based payments to certain employees. Equity-settled share-based payments are measured at fair value (excluding the effect of non-market-based vesting conditions) at the date of grant. The fair value determined at the date of grant is expensed on a straight-line basis over the vesting period, based on the group’s estimate of the shares that will eventually vest and adjusted for the effect of non-market-based vesting conditions. Fair value is measured by the binomial option-pricing model. The expected life used in the model had been adjusted, based on management’s best estimate, for the effects of non-transferability, exercise restrictions and behavioral considerations. As set out in Note 24, the group has also issued warrants to certain financing institutions which are also treated as equity- settled share-based payments. Significant Accounting Estimates and Judgments Management is required to make judgments, estimates and assumptions about the carrying amounts of assets and liabilities that are not readily apparent from other sources. The estimates and associated assumptions are based on historical experience and other factors that are considered to be relevant. Actual results may differ from these estimates, and accordingly they are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the period in which the estimate is revised if the revision affects only that period, or in the period of the revision and future periods if the revision affects both current and future periods. 3 6 NOTES TO THE FINANCIAL STATEMENTS 3 . S E G M E N TA L A N A LY S I S All of the group’s revenue in respect of the years ended 31 December 2010 and 2009 derived from the design, development and marketing of software products with associated implementation and consultancy services, as more particularly described in the Directors’ Report. For management purposes, the group is organized geographically across two principal operating segments, which can be expressed geographically. The first segment is North America, and the second Europe, Middle East and Africa. Information relating to these two segments is given below. The information in the following table relating to external revenues includes analysis both by location of customer and by location of operations. The information relating to other items provides analysis by location of operations only. Inter- segment revenues are priced on an arm’s length basis. year ended 31 december 2010 Income Statement External revenues – by location of customers External revenues – by location of operations Operating profit before interest and tax Finance income Finance expense Profit before tax Income tax expense Depreciation and amortization EBITDA balance Sheet Fixed asset additions Total assets Total liabilities year ended 31 december 2009 Income Statement External revenues – by location of customers External revenues – by location of operations Operating (loss) before interest and tax Finance income Finance expense (Loss) before tax Income tax expense Depreciation and amortization EBITDA balance Sheet Fixed asset additions Total assets Total liabilities north America £’000 7,085 7,380 73 - (204) (131) (19) (1,068) 1,141 –––––––– 89 8,955 (5,741) –––––––– –––––––– north America £’000 5,690 6,222 (413) - (237) (650) - (1,072) 659 –––––––– 45 6,938 (4,035) –––––––– –––––––– eMeA £’000 Total £’000 3,452 3,157 363 6 (67) 302 - (6) 369 –––––––– 3 2,308 (2,514) –––––––– –––––––– 10,537 10,537 436 6 (271) 171 (19) (1,074) 1,510 –––––––– 92 11,263 (8,255) –––––––– –––––––– eMeA £’000 Total £’000 2,570 2,038 (860) 19 (3) (844) - (6) (854) –––––––– 3 1,747 (1,965) –––––––– –––––––– 8,260 8,260 (1,273) 19 (240) (1,494) - (1,078) (195) –––––––– 48 8,685 (6,000) –––––––– –––––––– One customer, served by both segments, accounted for approximately 10 percent of the group’s revenues in 2010. No customer accounted for 10 percent or more of the group’s sales in 2009. External revenues exclude inter-segment royalty charges which amounted to £572,000 (2009: £472,000) for North America and £485,000 (£465,000) for EMEA. Revenues attributable to customers in the uK in 2010 amounted to £772,000 (2009: £1,268,000). The segmental analysis above has been presented using information that is readily available to management. NOTES TO THE FINANCIAL STATEMENTS 3 7 4 . E B I T D A A N D R E V E N U E V I S I B I L I T Y ebITdA The directors consider that EBITDA, which is defined as earnings/(loss) before interest, tax, depreciation and amortization, is an important measure, since it is widely used by the investment community. It is calculated as follows: Profit/(loss)for the year after tax Interest payable Interest receivable Amortization of intangible assets Depreciation of property, plant and equipment Income tax expense EBITDA revenue visibility 2010 £’000 2009 £’000 152 (1,494) 271 (6) 968 106 19 –––––––– 1,510 –––––––– –––––––– 240 (19) 969 109 - –––––––– (195) –––––––– –––––––– Another performance indicator used by the group and referred to in narrative descriptions of the group’s performance is revenue visibility. At any point in time it comprises revenue expected from (i) closed license orders, including those which are contracted but conditional on acceptance decisions scheduled later in the year; (ii) contracted services business delivered or expected to be delivered in the year; and (iii) recurring maintenance, hosting and rental streams. The visibility calculation does not include revenues from new sales opportunities expected to close during the remainder of the year. 5 . P R O F I T / ( L O S S ) F O R T H E Y E A R The profit/(loss) for the year has been arrived at after charging/(crediting): Continuing Operations Net foreign exchange (gains)/losses Research and development costs (excluding amortization) Amortization of intangible assets Impairment of intangible assets Depreciation of property, plant and equipment Operating lease rentals – land and buildings Operating lease rentals – other 2010 £’000 2009 £’000 (7) 1,449 968 180 106 348 82 –––––––– –––––––– 31 1,241 969 180 109 375 92 –––––––– –––––––– Net foreign exchange losses or gains arise on the translation of certain cash and trade balances held in Euros and uS Dollars and are accordingly included in administration expense. 6 . A U D I T O R S ’ R E M U N E R AT I O N Audit of the financial statements of the group 2010 £’000 2009 £’000 60 –––––––– –––––––– 56 –––––––– –––––––– Fees for the audit of the company are not segregated from those for the group and are included in the above amounts. Included in auditors remuneration are the costs of the audit of Sopheon uK Limited. In addition, the group’s auditors have received £3,500 (2009: £nil) in respect of tax services, and £5,000 (2009: £5,000) in respect of the audit of the group’s uS pension plan. 3 8 NOTES TO THE FINANCIAL STATEMENTS 7 . S TA F F C O S T S Wages and salaries Social security costs Pension contributions Employee benefits expense Share-based payments expense (all equity-settled) group 2010 £’000 2009 £’000 5,942 393 103 404 81 ––––––– 6,923 –––––––– –––––––– 5,706 443 122 432 117 ––––––– 6,270 –––––––– –––––––– Included within the above are staff costs capitalized as development expenditure amounting to £657,000 (2009: £945,000). The average monthly number of employees during the year was made up as follows: Development and operations Sales and management group 2010 £’000 2009 £’000 56 28 ––––––– 84 –––––––– –––––––– 68 31 ––––––– 99 –––––––– –––––––– The above staff costs and the numbers of employees during the year include the executive directors. The remuneration of all directors were as follows: Fees and emoluments Pension contributions Share-based payments expense (all equity-settled) 2010 £’000 2009 £’000 636 13 30 –––––––– 679 –––––––– –––––––– 459 14 39 –––––––– 512 –––––––– –––––––– No director exercised share options during the year (2009: None). Pension contributions are to personal defined contribution schemes and have been made for three directors (2009: three) who served during the year. Full details of directors’ remuneration are disclosed in the Report on Directors’ Remuneration on page 17. 8 . F I N A N C E I N C O M E Income on financial assets measured at amortized cost Interest income on bank deposits 9 . F I N A N C E E X P E N S E Interest expense on financial liabilities measured at amortized cost Interest on borrowings 2010 £’000 2009 £’000 6 –––––––– –––––––– 19 –––––––– –––––––– 2010 £’000 2009 £’000 (271) –––––––– –––––––– (240) –––––––– –––––––– NOTES TO THE FINANCIAL STATEMENTS 3 9 1 0 . I N C O M E TA X E X P E N S E Income tax expense for the year – current tax The charge for the year can be reconciled to the accounting profit/(loss) as follows: Profit/(loss) before tax Tax (charge)/credit at the uK corporation tax rate of 28 percent (2008: 28 percent) Adjustment for differing rates of corporate taxation in overseas jurisdictions Tax effect of expenses that are not deductible in determining taxable losses Temporary differences arising from the capitalization and amortization of internally generated development costs Losses for the year not relievable against current tax utilization of prior year losses Income tax expense for the year 2010 £’000 2009 £’000 (19) –––––––– –––––––– - –––––––– –––––––– 2010 £’000 2009 £’000 152 –––––––– –––––––– (1,494) –––––––– –––––––– (43) (39) (175) 418 29 (205) (15) - 263 –––––––– (19) –––––––– –––––––– 85 (327) - –––––––– - –––––––– –––––––– The tax charge represents uS Alternative Minimum Tax (“AMT”) which is payable notwithstanding the availability of tax losses from prior years. For AMT purposes, the use of prior year tax losses to offset current taxable profits is restricted to 90 percent of current year profits, with AMT chargeable at a rate of 20 percent on the remaining 10 percent. There is no tax arising on other comprehensive income. The group has an unrecognized deferred tax asset arising from its unrelieved trading losses, which has not been recognized owing to uncertainty as to the level and timing of taxable profits in the future. The unrecognized deferred tax asset is made up as follows: Shortfall of tax depreciation compared to book depreciation Effect of timing differences arising from capitalization of internally generated development costs unrelieved trading losses unrecognized deferred tax asset 2010 £’000 2009 £’000 165 165 (965) 20,498 –––––––– 19,698 –––––––– –––––––– (1,052) 24,814 –––––––– 23,927 –––––––– –––––––– At 31 December 2010, tax losses estimated at £59m were available to carry forward by the Sopheon group, arising from historic losses incurred. These losses represent a potential deferred tax asset of £19.7m, based on the tax rates currently applicable in the relevant tax jurisdictions. Of these tax losses, an aggregate amount of £12m (representing £5.3m of the potential deferred tax asset) represents pre-acquisition tax losses of Sopheon Corporation (Minnesota) and Alignent Software, Inc. The future utilization of these losses may be restricted under Section 382 of the uS Internal Revenue Code, whereby the ability to utilize net operating losses arising prior to a change of ownership is limited to a percentage of the entity value of the corporation at the date of change of ownership. 4 0 NOTES TO THE FINANCIAL STATEMENTS 1 1 . L O S S D E A LT W I T H I N T H E F I N A N C I A L S TAT E M E N T S O F T H E PA R E N T C O M PA N Y The loss dealt with in the financial statements of the parent company for the year ended 31 December 2010 was £477,000 (2009: £1,239,000). Advantage has been taken of Section 408 of the Companies Act 2006 not to present an income statement for the parent company. 1 2 . E A R N I N G S / ( L O S S ) P E R S H A R E (Loss)/profit after tax Weighted average number of ordinary shares for the purpose of basic earnings per share 2010 £’000 2009 £’000 152 –––––––– –––––––– (1,494) –––––––– –––––––– ’000s ’000s 145,579 –––––––– –––––––– 145,579 –––––––– –––––––– The profit attributable to ordinary shareholders and the weighted average number of ordinary shares for the purpose of calculating the diluted earnings/(loss) per ordinary share are the same as those used for calculating the basic earnings/(loss) per ordinary share in both 2010 and 2009. This is (i) because the exercise of conversion rights attaching to the convertible loan stock (details of which are set out in Note 20), would have the effect in 2010 of increasing earnings per ordinary share and in 2009 of reducing the loss per ordinary share (by virtue of the saving of loan stock interest, which would otherwise be payable, and of interest receivable on subscription proceeds), and are therefore not dilutive; and (ii) because the warrants to subscribe for 502,790 ordinary shares and the majority of share options to subscribe for ordinary shares, (details of which are set out in Notes 24 and 28) either have a strike price above the average market price for the year, or have an immaterial impact. NOTES TO THE FINANCIAL STATEMENTS 4 1 1 3 . P R O P E R T Y, P L A N T A N D E Q U I P M E N T group Cost At 1 January 2009 Additions Exchange differences At 1 January 2010 Additions Exchange differences At 31 December 2010 Accumulated depreciation At 1 January 2009 Depreciation charge for the year Exchange differences At 1 January 2010 Depreciation charge for the year Exchange differences At 31 December 2010 Carrying amount At 31 December 2010 At 31 December 2009 computer equipment £’000 Furniture & fittings £’000 2,263 48 (145) –––––––– 2,166 86 8 –––––––– 2,260 –––––––– 2,051 99 (124) –––––––– 2,026 99 4 –––––––– 2,129 –––––––– 462 - (34) –––––––– 428 6 - –––––––– 434 –––––––– 439 10 (32) –––––––– 417 7 - –––––––– 424 –––––––– Total £’000 2,725 48 (179) –––––––– 2,594 92 8 –––––––– 2,694 –––––––– 2940 109 (156) –––––––– 2,443 106 4 –––––––– 2,553 –––––––– 131 –––––––– –––––––– 10 –––––––– –––––––– 141 –––––––– –––––––– 140 –––––––– –––––––– 11 –––––––– –––––––– 151 –––––––– –––––––– The following rates are used for the depreciation of property, plant and equipment: Computer equipment Furniture and fittings 20 to 33 percent on a straight-line basis 20 to 25 percent on a straight-line basis The net carrying amount of property, plant and equipment includes £4,000 (2009: £Nil) in respect of assets held under finance leases. company The company has no property, plant and equipment. 4 2 NOTES TO THE FINANCIAL STATEMENTS 1 4 . I N TA N G I B L E A S S E T S development Technology and IPr costs customer relationships goodwill Total Cost At 1 January 2009 Additions (internally generated) Exchange differences At 1 January 2010 Additions (internally generated) Exchange differences At 31 December 2010 Amortization At 1 January 2009 Charge for the year Exchange differences At 1 January 2010 Charge for the year Exchange differences At 31 December 2010 Accumulated Impairment Losses At 1 January 2009 Impairment losses in year Exchange differences At 1 January 2010 Impairment losses in year Exchange differences At 31 December 2010 Carrying Amount At 31 December 2010 At 31 December 2009 £’000 £’000 £’000 £’000 (internally generated) £’000 5,135 945 (596) –––––––– 5,484 657 166 –––––––– 6,307 –––––––– 2,779 642 (327) –––––––– 3,094 710 90 –––––––– 3,894 –––––––– - - - –––––––– - - - –––––––– - –––––––– 924 - (61) –––––––– 863 - 28 –––––––– 891 –––––––– 364 147 (45) –––––––– 466 96 13 –––––––– 575 –––––––– 161 78 20 –––––––– 259 - 9 –––––––– 268 –––––––– 2,413 –––––––– –––––––– 2,390 –––––––– –––––––– 48 –––––––– –––––––– 138 –––––––– –––––––– 1,771 - (152) –––––––– 1,619 - 51 –––––––– 1,670 –––––––– 341 180 (43) –––––––– 478 162 12 –––––––– 652 –––––––– 163 102 20 –––––––– 285 180 8 –––––––– 473 –––––––– 545 –––––––– –––––––– 856 –––––––– –––––––– 684 - (75) –––––––– 609 - 18 –––––––– 627 –––––––– - - - –––––––– - - - –––––––– - –––––––– - - - –––––––– - - - –––––––– - –––––––– 627 –––––––– –––––––– 609 –––––––– –––––––– 8,514 945 (884) –––––––– 8,575 657 263 –––––––– 9,495 –––––––– 3,484 969 (415) –––––––– 4,038 968 115 –––––––– 5,121 –––––––– 324 180 40 –––––––– 544 180 17 –––––––– 741 –––––––– 3,633 –––––––– –––––––– 3,993 –––––––– –––––––– The amortization period for the internally generated development costs relating to the group’s software products is four years. The amortization periods for (a) technology & IPR and (b) customer relationships, arising from the acquisition of Alignent Software, Inc. in June 2007, are four years and eight years respectively. Goodwill is not amortized. The residual goodwill arising on the acquisition of Alignent is attributable to the enhanced market position of each of the group’s operating segments, due to the completeness of the solution that Sopheon can offer the market, in addition to the ability to penetrate wholly new markets such as aerospace and defense for the overall product set. The recoverable amount of the goodwill can be underpinned on a value in use basis by the expected performance of each of the group’s operating segments. The valuation used for this purpose is based on cash-flow projections for the next two years, then extrapolated using a pre-tax discount rate of 14.6 percent and an annual growth assumption of 20 percent for five years, and thereafter for an indefinite period at a growth assumption of 3 percent. Sensitivity analysis performed on these projections demonstrates significant valuation headroom above the carrying value of goodwill even at considerably lower growth rates. The annualized average growth of the business since the launch of our core Accolade solution is approximately 28 percent. The initial valuation of the intangible assets acquired with Alignent relating to technology and IPR, and to customer relationships, used an income-based approach. During 2008 and 2009 the recurring income from the acquired Alignent customer base reduced, due to a mix of factors including the conversion of certain rental licenses to perpetual, changes in rental levels, and cancellations. The overall reduction exceeded the rate of attrition of such recurring income estimated in the original valuation exercise, leading to impairments in the carrying value of the acquired Alignent technology and IPR, and the acquired Alignent customer relationships, of £Nil (2009: £78,000) and £180,000 (2009: £102,000) respectively. NOTES TO THE FINANCIAL STATEMENTS 4 3 All other assumptions of the original valuation have been retained in the impairment review. The valuation exercise, and the recoverable amount of the intangible assets and goodwill, are based on value in use with a pre-tax discount rate of 14.6 percent. The remaining amortization period for the acquired Alignent technology and IPR and the acquired Alignent customer relationships, are 0.5 and 4.5 years respectively. company The company has no intangible assets. 1 5 . I N V E S T M E N T I N S U B S I D I A R I E S At 31 December 2009 and at 31 December 2010 Cost Less: Amounts provided Carrying amount company £’000 41,560 35,441 –––––––– 6,119 –––––––– –––––––– Details of the company’s subsidiaries at 31 December 2010 are set out below. Companies marked with an asterisk(*) are held via Sopheon uK Ltd and those with an obelus(†) are held via Orbital Software holdings plc. The common stock of Alignent Software, Inc. is held by Sopheon Corporation, Delaware, uSA. name of company Place of Incorporation Sopheon Corporation Minnesota, uSA Sopheon Corporation Delaware, uSA Alignent Software, Inc. California, uSA Sopheon NV The Netherlands Sopheon uK Ltd. united Kingdom Orbital Software holdings plc. united Kingdom Orbital Software Inc.† Delaware, uSA Sopheon Edinburgh Ltd.† united Kingdom Orbital Software Europe Ltd.† united Kingdom Network Managers (uK) Ltd.* united Kingdom AppliedNet Ltd.* united Kingdom Future Tense Ltd.* united Kingdom Polydoc Ltd. united Kingdom nature of ownership Interest Proportion of Voting rights held nature of business Common Stock 100 percent Software sales and services Common Stock 100 percent Software development and sales Common Stock 100 percent Software sales and services Ordinary Shares 100 percent Software sales and services Ordinary Shares 100 percent Software sales and services Ordinary Shares 100 percent holding company Common Stock 100 percent Dormant Ordinary Shares 100 percent Dormant Ordinary Shares 100 percent Dormant Ordinary Shares 100 percent Dormant Ordinary Shares 100 percent Dormant Ordinary Shares 100 percent Dormant Ordinary Shares 100 percent Dormant Applied Network Technology Ltd.* united Kingdom Ordinary Shares 100 percent Employee Share Ownership Trust 4 4 NOTES TO THE FINANCIAL STATEMENTS 1 6 . O T H E R R E C E I V A B L E Other receivable group company 2010 £’000 2009 £’000 2010 £’000 2009 £’000 12 –––––––– –––––––– 12 –––––––– –––––––– - –––––––– –––––––– - –––––––– –––––––– The other receivable represents a deposit paid in respect of a property leased by the group. 1 7 . T R A D E A N D O T H E R R E C E I V A B L E S Trade receivables Other receivables Total receivables Prepayments Accrued income group company 2010 £’000 2009 £’000 2010 £’000 2009 £’000 3,870 5 –––––––– 3,875 232 12 –––––––– 4,119 –––––––– –––––––– 2,693 7 –––––––– 2,700 203 2 –––––––– 2,905 –––––––– –––––––– - - –––––––– - 9 - –––––––– 9 –––––––– –––––––– - 18 –––––––– 18 15 - –––––––– 33 –––––––– –––––––– Trade and other receivables are stated net of allowances totaling £28,000 (2009: £20,000) for estimated irrecoverable amounts. The directors consider that the carrying amount of trade and other receivables approximates to their fair value. A full provision has been made against amounts totaling £40,460,000 (2009: £40,337,000) owed to the company by subsidiary undertakings, which are due after more than one year and are subordinated to the claims of all other creditors. 1 8 . C A S H A N D S H O R T- T E R M B A N K D E P O S I T S Cash at bank Short-term bank deposits group company 2010 £’000 2009 £’000 2010 £’000 2009 £’000 2,129 1,229 –––––––– 3,358 –––––––– –––––––– 1,214 410 –––––––– 1,624 –––––––– –––––––– 76 658 –––––––– 734 –––––––– –––––––– 648 370 –––––––– 1,018 –––––––– –––––––– Cash and short-term bank deposits comprise cash held by the group, bank current accounts and short-term bank deposit accounts with maturities of three months or less and bearing interest at variable rates. The carrying amount of these assets represents a reasonable approximation to their fair value. Included in cash at bank of the group is an amount of £23,000 (2009: ₤23,000) held by the group’s employee share ownership trust. NOTES TO THE FINANCIAL STATEMENTS 4 5 1 9 . T R A D E A N D O T H E R PAYA B L E S Trade payables Other payables Tax and social security costs Accruals group company 2010 £’000 2009 £’000 2010 £’000 2009 £’000 444 91 208 1,603 –––––––– 2,346 –––––––– –––––––– 276 121 139 651 –––––––– 1,187 –––––––– –––––––– 29 141 - 265 –––––––– 435 –––––––– –––––––– 31 146 - 170 –––––––– 347 –––––––– –––––––– Trade payables principally comprise amounts outstanding for trade purchases and ongoing costs. The directors consider that the carrying amounts of trade and other payables represent a reasonable approximation to their fair values. 2 0 . B O R R O W I N G S current Loans and borrowings Line of credit Loan notes (current portion) non-current Loans and borrowings Loan notes 8 % convertible loan stock 2013 Embedded derivative represented by conversion rights attaching to loan stock Total non-current loans and borrowings Total loans and borrowings a) Line of credit group company 2010 £’000 2009 £’000 2010 £’000 2009 £’000 319 663 –––––––– 1,340 756 584 –––––––– 1,080 - - –––––––– - - - –––––––– - 1,491 799 372 755 - –––––––– 2,290 –––––––– 3,272 –––––––– –––––––– 95 –––––––– 1,222 –––––––– 2,562 –––––––– –––––––– 799 - –––––––– 799 –––––––– 799 –––––––– –––––––– - 755 95 –––––––– 850 –––––––– 850 –––––––– –––––––– The line of credit is denominated in uS Dollars and bears interest at a variable rate currently 10.95 percent. The line of credit is a revolving facility limited to the lower of $1,250,000 and 75 percent of the eligible trade receivables of the group’s uS subsidiaries, which at 31 December 2010 amounted to $4,968,000 (£3,173,000) (2009: $3,533,000 (£2,187,000)). At 31 December 2010 $500,000 (£319,000) was drawn down under the line of credit facility (2009: $1,220,000 (£756,0000)). 4 6 NOTES TO THE FINANCIAL STATEMENTS b) Loan notes The loan notes are denominated in uS Dollars and represent mezzanine loan finance provided BlueCrest Capital Finance LLC (“BlueCrest”). The loan notes were issued in June 2007 for an initial principal amount of $3.5m repayable in equal installments over the four-year period to July 2011 bearing interest at a fixed rate of 11.03 percent. On 8 December 2010 the group entered into a new mezzanine loan with BlueCrest, for an amount of $3.5m, equal to the principal amount of the original loan. Part of the proceeds after expenses were applied in repayment of the remaining balance outstanding on the original mezzanine loan, with the balance to provide additional working capital of approximately $2.7m for the group. The new mezzanine loan is repayable in 39 monthly installments of $90,000, together with interest at a fixed rate of 13 percent per annum, over the period to March 2014. The mezzanine loan and the line of credit, which is also provided by BlueCrest, are secured by a debenture and guarantee provided by Sopheon plc. The company has estimated the risk of this guarantee being called at five percent of the carrying value of the loan, and in its financial statements has included a provision for this amount within other payables. The directors consider that the carrying amounts for loan notes, and the line of credit, represent a reasonable approximation of the financial instruments’ fair values. c) 8 Percent convertible Loan Stock 2013 The convertible loan stock is denominated in Sterling and bears interest at a fixed rate of eight percent per annum. The loan stock was issued at par in a nominal amount of £850,000 on 1 October 2009 with a maturity date of 30 September 2011. On 8 December 2010, the holders of the loan stock unanimously agreed to extend the maturity date by a further sixteen months to 31 January 2013. The original terms provided that the loan stock was convertible into Sopheon ordinary shares at a conversion price of 10p per share, and contained provisions for the amendment of the conversion price in the case of any subsequent equity issues by the company at a price per share lower than the conversion price. The conversion price was amended, in conjunction with the extension of the maturity date, to 7.75p, being the market price for Sopheon shares on 7 December 2010. At the same time, the provisions for future amendment of the conversion price were removed. The loan stock is convertible at any time up to the extended maturity date of 31 January 2013, and any loan stock not converted will be repaid at par on that date. The liability at maturity of the loan stock is £850,000. The carrying value of the liability component of the loan stock at 31 December 2010 was £799,000 based on discounted cash flows using a discount rate of 16.4 percent. Following the removal on 8 December 2010 of the provisions for future amendment of the conversion price, the carrying value of the embedded derivative represented by the conversion rights attaching to the loan stock has been reclassified from debt to equity in the financial statements. The carrying value of the embedded derivative at 8 December 2010 amounted to £51,000 representing the fair value of the conversion rights at that date using the binomial option pricing model. NOTES TO THE FINANCIAL STATEMENTS 4 7 2 1 . O B L I G AT I O N S U N D E R F I N A N C E L E A S E S The present value of future lease payments is analyzed as: Current liabilities Non-current liabilities group company 2010 £’000 2009 £’000 2010 £’000 2009 £’000 2 2 –––––––– 4 –––––––– –––––––– 1 1 –––––––– 1 –––––––– –––––––– - - –––––––– - –––––––– –––––––– - - –––––––– - –––––––– –––––––– The group leases a telephone system with a net carrying value at 31 December 2010 of £4,000. The balances at 31 December 2009 refer to an earlier lease of telephone equipment which was fully depreciated at that date. Future lease payments are due as follows: At 31 december 2010 Within one year Due in one-to-five years At 31 december 2009 Within one year Due in one-to-five years Minimum lease payments £’000 2 2 –––––––– 4 –––––––– –––––––– Minimum lease payments £’000 1 - –––––––– 1 –––––––– –––––––– Interest Present value £’000 £’000 - - –––––––– - –––––––– –––––––– Interest 2 2 –––––––– 4 –––––––– –––––––– Present value £’000 £’000 - - –––––––– - –––––––– –––––––– 1 - –––––––– 1 –––––––– –––––––– 2 2 . O P E R AT I N G L E A S E A R R A N G E M E N T S At the balance sheet date, the group had outstanding commitments under operating leases in respect of which the total future minimum lease payments were due as follows: Due within one year Due after one year and within five years Land & buildings 2010 £’000 other 2010 £’000 334 422 –––––––– 756 –––––––– –––––––– 58 37 –––––––– 95 –––––––– –––––––– Land & buildings 2009 £’000 358 194 –––––––– 552 –––––––– –––––––– other 2009 £’000 71 88 –––––––– 159 –––––––– –––––––– The group leases its office accommodation in the uS, uK and the Netherlands and has operating leases for office equipment and vehicles. company The company has no operating leases. 4 8 NOTES TO THE FINANCIAL STATEMENTS 2 3 . F I N A N C I A L I N S T R U M E N T S Categories of Financial Assets and Liabilities The following table sets out the categories of financial instruments held by the group. All of the group’s financial assets are in the category of loans and receivables, and all of its financial liabilities are in the category of financial liabilities measured at amortized cost, other than the embedded derivative represented by the conversion rights attaching to the group's 8 percent convertible loan stock 2013, which is stated at fair value through profit or loss at 31 December 2009, but is classified within equity at 31 December 2010. a) Financial Assets i) Loans and receivables current Financial Assets Trade receivables Other receivables Accrued income Cash and cash equivalents non-current Financial Assets Other receivable group company notes 2010 £’000 2009 £’000 2010 £’000 2009 £’000 17 17 17 18 3,870 5 12 3,358 –––––––– 7,245 –––––––– –––––––– 2,693 7 2 1,624 –––––––– 4,326 –––––––– –––––––– - - - 734 –––––––– 734 –––––––– –––––––– - - - 1,018 –––––––– 1,018 –––––––– –––––––– 16 12 –––––––– –––––––– 12 –––––––– –––––––– - –––––––– –––––––– - –––––––– –––––––– The group does not have any financial assets in any other categories. b) Financial Liabilities group company notes 2010 £’000 2009 £’000 2010 £’000 2009 £’000 i) Financial liabilities at fair value through profit or loss Embedded derivative represented by conversion rights attaching to loan stock ii) Financial liabilities measured at amortized cost current Financial Liabilities Trade payables Other payables Accruals Loans and borrowings Obligations under finance lease non-current Financial Liabilities Loans and borrowings 8% convertible loan stock 2013 Obligations under finance lease 20 - –––––––– –––––––– 95 –––––––– –––––––– - –––––––– –––––––– 95 –––––––– –––––––– 19 19 19 20 21 20 20 21 444 91 1603 982 2 –––––––– 3,122 –––––––– –––––––– 1,491 799 2 –––––––– 2,292 –––––––– 5,414 –––––––– –––––––– 276 121 651 1,340 1 –––––––– 2,389 –––––––– –––––––– 372 755 - –––––––– 1,127 –––––––– 3,516 –––––––– –––––––– 29 141 265 - - –––––––– 435 –––––––– –––––––– 799 - –––––––– 799 –––––––– 1,234 –––––––– –––––––– 31 146 170 - - –––––––– 347 –––––––– –––––––– - 755 - –––––––– 755 –––––––– 1,102 –––––––– –––––––– NOTES TO THE FINANCIAL STATEMENTS 4 9 Financial Instrument Risk Exposure and Management The group is exposed to risks that arise from its use of financial instruments. This note describes the group’s objectives, policies and processes for managing those risks and the methods used to measure them. There have been no changes in the group’s exposure to financial instrument risks, its objectives, policies and processes for managing those risks or the methods used to measure them from previous periods, unless otherwise disclosed in this note. Principal Financial Instruments The principal financial instruments used by the group, from which financial instrument risk arises, are as follows: • Trade and other receivables • Cash and cash equivalents • Trade and other payables • Loan notes • Bank line of credit • Convertible loan stock general objectives, Policies and Processes The board has overall responsibility for the determination of the group’s risk management objectives and policies and, whilst retaining ultimate responsibility for them, it has delegated the authority for designing and operating processes that ensure the effective implementation of the objectives and policies to the group’s finance function. The board receives quarterly reports from the group finance director through which it reviews the effectiveness of the processes put in place and the appropriateness of the objectives and policies it sets. The group’s risk management procedures are also reviewed periodically by the audit committee. The overall objective of the board is to set policies that seek to reduce risk as far as possible without unduly affecting the group’s competitiveness and flexibility. Further details regarding these policies are set out below: 1. credit risk Credit risk arises principally from the group’s trade receivables, other receivables and accrued income. It is the risk that the counterparty fails to discharge its obligations in respect of the instrument. The group’s software is principally marketed at major international corporations of good credit standing, and the group’s historical bad debt experience is very low. Due to the potentially large size of certain individual sales, in a particular year one customer can account for a substantial proportion of revenues recorded. however, such concentrations rarely persist for multiple years and therefore the directors do not believe that the group is systematically exposed to credit risk concentration in respect of particular customers. In 2010, the largest single customer accounted for 10 percent of group revenues (2009: 5 percent). Credit risk also arises from cash and cash equivalents and deposits with banks and financial institutions. At the year end the group was holding a proportion of its deposits and bank balances with each of Lloyds Banking Group plc, Royal Bank of Scotland plc, and Silicon Valley Bank. The group does not enter into derivatives to manage credit risk. 5 0 NOTES TO THE FINANCIAL STATEMENTS The group's customers are major international corporations of high credit standing and therefore the group does not typically obtain credit ratings for individual customers. Nevertheless, current economic conditions have resulted in such major corporations slowing down payments and this is reflected in the ageing profile of the group’s receivables. however, impairment of trade receivables is very rare, and in the three years ending 31 December 2010 provisions or write offs against customer receivables amounted in total to less than 0.5 percent of revenues. Such impairments do not arise from credit defaults, but principally from disagreements with a very small number of former customers over their responsibility for renewal fees for maintenance or hosting contracts. Sopheon's policy is to pursue collection of such fees but to make provision against the applicable receivable if collection is uncertain. The following is an analysis of the group’s trade receivables identifying the totals of trade receivables which are current and those which are past due but not impaired: At 31 December 2010 At 31 December 2009 Total £’000 current £’000 Past due +30 days £’000 Past due +60 days £’000 3,870 ––––––––– ––––––––– 2,418 ––––––––– ––––––––– 793 ––––––––– ––––––––– 659 ––––––––– ––––––––– 2,693 ––––––––– ––––––––– 2,196 ––––––––– ––––––––– 287 ––––––––– ––––––––– 210 ––––––––– ––––––––– The following is an analysis of the group’s provisions against trade receivables, analyzed between the geographical segments in which the group’s operations are located: 2010 £’000 Provision £’000 gross value £’000 carrying value £’000 gross value 2009 £’000 Provision £’000 carrying value Trade receivables North America united Kingdom Rest of Europe 3,098 554 246 ––––––––– 3,898 ––––––––– ––––––––– 16 12 - ––––––––– 28 ––––––––– ––––––––– 3,082 542 246 ––––––––– 3,870 ––––––––– ––––––––– 2,204 339 170 ––––––––– 2,713 ––––––––– ––––––––– 16 4 - ––––––––– 20 ––––––––– ––––––––– 2,188 335 170 ––––––––– 2,693 ––––––––– ––––––––– The group records impairment losses on its trade receivables separately from the gross amounts receivable. The movements on this allowance during the year are summarized below: Opening balance Increases in provisions Closing balance 2010 £’000 2009 £’000 20 8 ––––––––– 28 ––––––––– ––––––––– 4 16 ––––––––– 20 ––––––––– ––––––––– The main factors used in assessing the impairment of the group’s trade receivables are the age of the balances and the circumstances of the individual customer. The company provides in full for amounts due from subsidiaries. The company is exposed to credit risk in respect of its cash and cash equivalents, which are held in the form of current account and money market balances with leading uK, uS and European banking institutions. NOTES TO THE FINANCIAL STATEMENTS 5 1 2. Liquidity risk Liquidity risk arises from the group’s management of working capital, and more particularly its ability to reach a point where its trading is cash generative, together with the finance charges and principal repayments on its debt instruments. It is the risk that the group will encounter difficulties in meeting its financial obligations as they fall due. The group’s policy is to maintain significant cash balances, short-term bank deposits and facilities with a view to having sufficient cash to meet its liabilities when they become due. The board annually approves budgets including cash flow projections for each of the operating companies within the group and receives regular information as to cash balances held and progress against budget. Attention is particularly drawn to the detailed discussion of the factors which enable the group to continue as a going concern for the foreseeable future in the section headed “Going Concern” in Note 2 to the financial statements. The following table sets out an analysis of the contractual maturity of the group’s and the company’s financial liabilities that must be settled gross, based on exchange rates prevailing at the relevant balance sheet date. group At 31 december 2010 Trade and other payables Line of credit Loan notes Future interest – loan notes Convertible loan stock Future interest – convertible loan stock Finance lease Total financial liabilities At 31 december 2009 Trade and other payables Line of credit Loan notes Future interest – loan notes Convertible loan stock Future interest – convertible loan stock Finance lease Total financial liabilities company At 31 december 2010 Trade and other payables Convertible loan stock Future interest – convertible loan stock Total financial liabilities At 31 december 2009 Trade and other payables Convertible loan stock Future interest – convertible loan stock Total financial liabilities Within one year £’000 2,346 319 663 249 - 68 2 ––––––––– 3,628 ––––––––– ––––––––– Within one year £’000 1,187 756 584 78 - 68 1 ––––––––– 2,674 ––––––––– ––––––––– Within one year £’000 435 - 68 ––––––––– 503 ––––––––– ––––––––– Within one year £’000 347 - 68 ––––––––– 415 ––––––––– ––––––––– Within five years £’000 - - 1,491 235 850 74 2 ––––––––– 2,652 ––––––––– ––––––––– Within five years £’000 - - 372 14 850 51 - ––––––––– 1,287 ––––––––– ––––––––– one to five years £’000 - 799 74 ––––––––– 873 ––––––––– ––––––––– one to five years £’000 - 850 51 ––––––––– 901 ––––––––– ––––––––– Total £’000 2,346 319 2,154 484 850 142 4 ––––––––– 6,280 ––––––––– ––––––––– Total £’000 1,187 756 956 92 850 119 1 ––––––––– 3,961 ––––––––– ––––––––– Total £’000 435 799 142 ––––––––– 1,376 ––––––––– ––––––––– Total £’000 347 850 119 ––––––––– 1,316 ––––––––– ––––––––– 5 2 NOTES TO THE FINANCIAL STATEMENTS 3. Market risk Market risk arises from the group’s use of interest-bearing and foreign currency financial instruments. It is the risk that the future cash flows of a financial instrument will fluctuate because of changes in interest rates (interest rate risk) or foreign exchange rates (currency risk). The group does not have any financial instruments that are publicly traded securities and is not exposed to other price risk associated with changes in the market prices of such securities. 4. Interest rate risk The group’s fixed rate interest bearing liabilities comprise loan notes with a carrying value at 31 December 2010 of £2,154,000 which bear a fixed interest rate of 13 percent and convertible loan stock with a carrying value of ₤799,000 which bears a fixed interest rate of eight percent. These liabilities do not give rise to interest rate risk. The group also has a line of credit, on which £319,000 was outstanding at 31 December 2010, and which bears a variable interest rate based on a margin of 1.25 percent above the lender’s Prime Rate. Should this rate vary by one percent, the annualized effect would be to increase or reduce finance costs by £3,000. The company’s interest bearing liabilities consist of its convertible loan stock which bears a fixed rate of interest of eight percent, which does not give rise to interest rate risk. The group invests its surplus cash in bank deposits denominated in uS Dollars, Euros or Sterling, which bear interest based on short-term money market rates, and in doing so exposes itself to fluctuations in money market interest rates. The group’s surplus cash held in the form of bank deposits at 31 December 2010 was £1,229,000. During 2010 interest rates on uS dollar or Sterling money market deposits averaged around 0.5%. The annualized effect of a movement of 0.5 percent in the average interest rate received on the group’s bank deposits at the balance sheet date would result in an increase or decrease in the group’s and the company’s interest income of £6,000. The company’s interest bearing deposits at the balance sheet date were £658,000. The annualized effect of a movement of 0.5 percent in the average interest rate received on the group’s bank deposits at the balance sheet date would result in an increase or decrease the company’s interest income of £3,000. 5. currency risk The following is an analysis of the group’s financial assets and liabilities, analyzed by the currency in which they are denominated: At 31 december 2010 Financial assets: Receivables and accrued income Cash and cash equivalents Total financial assets Financial liabilities: Trade and other payables Borrowings Total financial liabilities At 31 december 2009 Financial assets: Receivables and accrued income Cash and cash equivalents Total financial assets Financial liabilities: Trade and other payables Borrowings Total financial liabilities uS dollars £’000 3,094 1,904 ––––––––– 4,998 ––––––––– ––––––––– 1,386 2,477 ––––––––– 3,863 Sterling £’000 euro £’000 Total £’000 552 773 ––––––––– 1,325 ––––––––– ––––––––– 335 799 ––––––––– 1,134 253 681 ––––––––– 934 ––––––––– ––––––––– 417 - ––––––––– 417 3,899 3,358 ––––––––– 7,257 ––––––––– ––––––––– 2,138 3,276 ––––––––– 5,414 ––––––––– ––––––––– ––––––––– ––––––––– ––––––––– ––––––––– ––––––––– ––––––––– uS dollars £’000 2,202 788 ––––––––– 2,990 Sterling £’000 euro £’000 Total £’000 341 451 ––––––––– 792 171 385 ––––––––– 556 2,714 1,624 ––––––––– 4,338 ––––––––– ––––––––– ––––––––– ––––––––– ––––––––– ––––––––– ––––––––– ––––––––– 528 1,712 ––––––––– 2,240 369 850 ––––––––– 1,219 290 - ––––––––– 290 1,187 2,562 ––––––––– 3,749 ––––––––– ––––––––– ––––––––– ––––––––– ––––––––– ––––––––– ––––––––– ––––––––– NOTES TO THE FINANCIAL STATEMENTS 5 3 The group’s policy is, where possible, to allow group entities to settle liabilities denominated in the functional currency with cash generated from their own operations in that currency. The group also maintains cash and bank deposits in the currencies which are the functional currencies of its operating entities, which are the uS Dollar, the Euro and Sterling. The group is exposed to currency risk in respect of foreign currency denominated bank deposits and bank loans. Taking into account the fact that a large proportion of the group’s income and expenditure arise in uS Dollars and, to a lesser extent, in Euros, the group’s policy is not to seek to hedge such currency risk. Foreign currency risk also arises where individual group entities enter into transactions denominated in currencies other than their functional currency, with fluctuations in exchange rates giving rise to gains or losses in the income statement. Where the foreign currency risk to the group is significant, consideration is given to hedging the risk through the forward currency market and, whilst this would be an economic hedge of the cash-flow risk, the group does not employ hedge accounting. The following table shows the effects, all other things being equal, of changes to exchange rates on the group’s loss after tax and on the exchange differences on retranslation of the assets and liabilities of foreign operations which is recognized directly in equity. It illustrates the effects if the exchange rates for the uS Dollar and the Euro had been higher or lower than those which actually applied during the year and at the year end. 2010 2009 2010 2009 decrease/ (increase) in loss after tax (decrease)/ increase in profit after tax effect of exchange differences on translation of assets and liabilities of foreign operations £’000 £’000 £’000 £’000 18 (23) 15 (18) ––––––––– ––––––––– 22 (24) 77 (92) (212) 242 (26) 31 ––––––––– ––––––––– ––––––––– ––––––––– (93) 106 (69) 82 ––––––––– ––––––––– Weakening of uS Dollar by 10c Strengthening of uS Dollar by 10c Weakening of Euro by 10c Strengthening of Euro by 10c The company holds certain assets, mainly bank deposits, and liabilities denominated in the functional currencies of its principal operating subsidiaries, which are the uS Dollar, the Euro and Sterling. The following table shows the effects, all other things being equal, of changes to exchange rates at the year end on the loss after tax of the company. It is based on the company’s assets and liabilities at the relevant balance sheet date. 2009 2010 (Increase)/decrease in loss after tax £’000 £’000 (7) 8 (25) 29 ––––––––– ––––––––– (16) 18 (22) 27 ––––––––– ––––––––– Weakening of uS Dollar by 10c Strengthening of uS Dollar by 10c Weakening of Euro by 10c Strengthening of Euro by 10c 6. capital The group considers its capital to comprise its share capital and share premium and other capital reserves less the accumulated retained losses. The group is not subject to any externally imposed capital requirements. In managing its capital, the group’s primary objective is to support the development of the group’s activities through to the point where they are cash generative on a sustained basis. The group’s capital is all equity capital and is summarized in Note 24. 5 4 NOTES TO THE FINANCIAL STATEMENTS 2 4 . S H A R E C A P I TA L Issued and Fully Paid Ordinary shares of 5p each 2010 number 2010 £’000 2009 number 2009 £’000 145,579,027 ––––––––– ––––––––– 7,279 145,579,027 ––––––––– ––––––––– ––––––––– ––––––––– 7,279 ––––––––– ––––––––– The company has one class of ordinary shares, which carry no right to fixed income. At 31 December 2010 the company had outstanding 502,790 warrants to subscribe for ordinary shares at a price of 20p per share, which were issued in June 2007 to BlueCrest Capital Finance LLC in connection with the financing of the acquisition of Alignent Software, Inc. 2 5 . C A P I TA L R E S E R V E S group At 1 January 2009 Recognition of share-based payments Lapsing of share options At 1 January 2010 Recognition of share-based payments Lapsing of share options Reclassification of embedded derivative as equity (see Note 20) At 31 December 2010 company At 1 January 2009 Recognition of share-based payments Lapsing of share options At 1 January 2010 Recognition of share-based payments Lapsing of share options Reclassification of embedded derivative as equity (see Note 20) At 31 December 2010 Share premium £’000 52,096 - - –––––––– 52,096 - - - –––––––– 52,096 –––––––– –––––––– Share premium £’000 52,096 - - –––––––– 52,096 - - - –––––––– –––––––– 52,096 –––––––– –––––––– Merger reserve £’000 17,944 - - –––––––– 17,944 - - - –––––––– 17,944 –––––––– –––––––– Merger reserve £’000 10,179 - - –––––––– 10,179 - - - –––––––– 10,179 –––––––– –––––––– capital redemption reserve £’000 2,884 - - –––––––– 2,884 - - - –––––––– 2,884 –––––––– –––––––– capital redemption reserve £’000 2,884 - - –––––––– 2,884 - - - –––––––– 2,884 –––––––– –––––––– Share options reserve £’000 703 117 (111) –––––––– 709 81 (46) 51 –––––––– 795 –––––––– –––––––– Share options reserve £’000 703 117 (111) –––––––– 709 81 (46) 51 –––––––– 795 –––––––– –––––––– Total £’000 73,627 117 (111) –––––––– 73,633 81 (46) 51 –––––––– 73,719 –––––––– –––––––– Total £’000 65,862 117 (111) –––––––– 65,868 81 (46) 51 –––––––– 65,954 –––––––– –––––––– Share premium represents the premium arising on the issue of shares and its use is governed by the provisions of the Companies Act 2006. Merger reserve is a non-statutory reserve representing the premium on the issue of shares pursuant to certain past business combinations which meet specified criteria. The capital redemption reserve is a non-distributable reserve arising from the cancellation in 2001 of deferred shares. The equity reserve comprises the deemed value of outstanding share options granted in connection with the acquisition of Orbital Software holdings plc in 2001, together with the fair value of share-based payments to employees pursuant to the group’s share option schemes, the fair value of warrants to subscribe for Sopheon shares issued to BlueCrest Capital Finance LLC, and the equity component of the group’s 8 percent convertible loan stock 2013. NOTES TO THE FINANCIAL STATEMENTS 5 5 2 6 . R E T I R E M E N T B E N E F I T P L A N S The group operates defined contribution retirement benefit plans which employees are entitled to join. The total expense recognized in the income statement of £103,000 (2009: £122,000) represents contributions paid to such plans at rates specified in the rules of the plans. 2 7 . R E L AT E D PA R T Y T R A N S A C T I O N S Details of transactions between the group and related parties are disclosed below. Compensation of Key Management Personnel Details of directors’ remuneration are given in Note 7. The total remuneration of directors and members of the group’s executive management committee during the year was as follows: Emoluments and benefits Pension contributions Share-based payments 2010 £’000 2009 £’000 900 21 43 ––––––– 964 ––––––– ––––––– 718 21 56 ––––––– 795 ––––––– ––––––– Transactions with Related Parties who are Subsidiaries of the Company The following is a summary of the transactions of the company with its subsidiaries during the year: Net amounts repaid by/(advanced to) subsidiaries by way of interest-free loans Net management charges to subsidiaries 2010 £’000 2009 £’000 203 288 ––––––– (694) 220 ––––––– The amounts owed by subsidiary companies to the parent company at 31 December 2010 totaled £40,460,000 (2009: £40,337,000). A full provision has been made against these amounts, which are unsecured and are subordinated to the claims of all other creditors. During 2010 the company granted share options to employees of subsidiary companies (2009: Nil). Details of grants of share options are disclosed in Note 28. Other Related Party Transactions There were no other related party transactions during the year under review or the previous year. 5 6 NOTES TO THE FINANCIAL STATEMENTS 2 8 . S H A R E - B A S E D PAY M E N T S Equity-Settled Share Option Schemes The group has a number of share option schemes for all employees. Options are exercisable at a price equal to the market price on the date of grant. The normal vesting periods are as set out below. Vesting Sopheon plc (uSA) stock option plan Sopheon uK approved share option scheme Sopheon uK unapproved share option scheme Sopheon NV share option scheme In three equal tranches between the first and third anniversary of grant On third anniversary of grant Immediate or as per uSA plan Immediate or as per uSA plan Details of the share options outstanding during the year are as follows: Outstanding at the beginning of the year Granted during the year Lapsed or expired during the year Outstanding at the end of the year Exercisable at the end of the year number of share options 2010 12,141,618 1,460,000 (1,096,694) ––––––– 12,504,924 ––––––– ––––––– 10,338,100 ––––––– ––––––– Weighted average exercise price 2010 £ 0.22 0.08 0.61 ––––––– 0.17 ––––––– ––––––– 0.18 ––––––– ––––––– number of share options 2009 13,104,438 - (962,820) ––––––– 12,141,618 ––––––– ––––––– 10,272,293 ––––––– ––––––– Weighted average exercise price 2009 £ 0.24 - 0.55 ––––––– 0.22 ––––––– ––––––– 0.23 ––––––– ––––––– No share options were exercised during the year (2009: Nil). The options outstanding at the end of the year have a weighted average contractual life of 5.0 years (2009: 5.2 years). In 2010 share options were granted on 27 August 2010. The exercise prices of the options granted was 7.5p, and the estimated fair value was 4.4p. In 2009, there were no grants of share options. The fair values for options granted in 2010 were calculated using the binomial option-pricing model. The principal assumptions used were: Share price at time of grant Exercise price Expected volatility Risk-free rate Expected dividend yield 7.5p 7.5p 40% 5% Nil The expected contractual life of the options used was either five or ten years depending on the particular scheme rules. Expected volatility was determined by reference to the historic volatility of the company’s share price in the period before the date of grant. The group and company recognized total expenses of £81,000 (2009: £117,000) relating to equity-settled share-based payments during the year. DI R E C T O R S barry Mence, Executive Chairman. Barry Mence has served as executive chairman and as a director and substantial shareholder of Sopheon since its inception in 1993 when he was one of the founding members. From 1976 to 1990, Mr. Mence was a major shareholder and group managing director of the Rendeck Group of Companies, a software and services group based in the Netherlands. Andrew Michuda, Executive Director. Andrew Michuda was appointed chief executive officer of Sopheon in September 2000. From 1997 to 2000 he served as chief executive officer and an executive director of Teltech Resource Network Corporation, which was acquired by Sopheon. he earlier held senior leadership positions at Control Data, including general manager of the business that evolved into Decision Data, the world's largest independent computer services provider. Arif Karimjee, ACA, Executive Director. Arif Karimjee has served as chief financial officer of Sopheon since February 2000. Mr. Karimjee was previously an auditor and consultant with Ernst & Young in London, Brussels and Reading, from August 1988 until joining Sopheon. Stuart Silcock, FCA, Non-executive Director. Stuart Silcock has served as a director of Sopheon from its inception in 1993. Since 1982, Mr Silcock has been a principal partner of Lawford & Co, chartered accountants and until 2010 a director of Lawfords Ltd. also chartered accountants. Mr. Silcock was a non-executive director of Brown & Jackson plc. for four years from June 2001 to July 2005 and currently holds a number of other directorships in the united Kingdom. bernard Al, Non-executive Director. Bernard Al was appointed as director of Sopheon in January 2001. he is a former chief executive officer of Wolters Kluwer in the Netherlands and has a background in science and linguistics. daniel Metzger, Non-executive Director. Daniel Metzger was until 1998 an executive vice president of Lawson Software, a leading ERP provider, where he was responsible for corporate strategy and marketing. Since then he has held similar roles at Parametric Technologies, where he led the business strategy and marketing around collaborative product development technologies, and at nQuire Software, which was subsequently sold to Siebel. Where innovation means business™ Where innovation means business™
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