3. Business combination

PocketSonics, Inc.

In April 2010, we entered into an agreement with PocketSonics, Inc., or PocketSonics, a privately held ultrasound technology company based in Charlottesville, Virginia, which granted us an exclusive license to certain ultrasound technology owned or controlled by PocketSonics and a ten percent (10%) equity interest in PocketSonics. The equity investment was recorded as in-process research and development, or IPR&D, of $1.9 million. Since that time, we have collaborated with PocketSonics to develop patented ultrasound technology to enable the acceleration of high acuity guided procedures to lower cost point-of-care settings and other technical applications. On September 20, 2013, we acquired all of the remaining stock of PocketSonics. The purchase price includes base consideration of $11.1 million paid in cash at closing, fair value of contingent consideration of $1.9 million, and revaluation of our initial equity investment. We undertook this acquisition to further strengthen our competitive position in procedure guidance for point-of-care and other advanced guidance applications. The acquisition was funded from our existing cash on hand and has been accounted for as an acquisition of a business.

We finalized the purchase accounting for the PocketSonics acquisition during fiscal year 2014. The following table summarizes the fair values of the separately identifiable assets acquired and liabilities assumed as of September 20, 2013:


(in millions)
Cash	$	0.5
Goodwill		6.9
IPR&D		11.5

Total assets acquired		18.9
Accounts payable and accrued expenses		(0.3	)
Deferred taxes		(4.1	)

Total liabilities assumed		(4.4	)

Total purchase price	$	14.5


(in millions)
Cash consideration paid	$	11.1
Fair value of contingent consideration		1.9
Previously held equity interest in PocketSonics		1.5

Total purchase price	$	14.5

In determining the fair value, we considered, among other factors, market participants’ intentions to use the acquired assets and the historical and estimated future demand for PocketSonics products and services. We recognized an IPR&D asset of $11.5 million. The fair value of the asset was determined by a probability adjusted cash flow analysis. In May 2014, we determined that the IPR&D was completed and performed a qualitative assessment and determined that there was no impairment. Accordingly, the carrying amount of the IPR&D asset was reclassified as developed technology and will be amortized over its estimated useful life of 10 years.

In connection with this acquisition, we recorded a fair value contingent consideration obligation of $1.9 million, related to potential additional consideration of up to $3.0 million payable upon the achievement of certain milestones relating to the PocketSonics technology. The contingent earn-out payments payable to the sellers of PocketSonics would be met upon commercial launch and a volume sales target. The $1.9 million fair value was estimated through a valuation model that incorporates probability adjusted assumptions relating to the achievement of these milestones and the likelihood of us making payments. This fair value measurement is based upon significant inputs not observable in the market and therefore represents a Level 3 input measurement. Subsequent changes in the fair value of this obligation will be recognized as adjustments to contingent consideration liability and reflected within other income (expense), net in our Consolidated Statement of Operations. During fiscal year 2014, the estimated fair value of our contingent consideration obligation increased by $0.2 million. The total fair value of our contingent consideration obligation was $2.1 million as of July 31, 2014. For additional information related to the fair value of this obligation, please refer to Note 8. Fair Value Measurements.

We recorded goodwill of $6.9 million related to the PocketSonics acquisition, representing the value of the opportunity of further strengthening our competitive position in procedure guidance for point-of-care and other advanced guidance applications. This goodwill will not be deductible for tax purposes.

Upon the acquisition of PocketSonics, we recognized a loss of $0.5 million related to our 10% pre-acquisition equity interest, which is reflected as a component of other expense, net within our Consolidated Statement of Operations for fiscal year 2014.

During fiscal year 2014, we incurred acquisition costs of $0.1 million consisting primarily of legal and due diligence expenses that are included in our general and administrative expenses in our Consolidated Statement of Operations.

We have expensed $0.9 million and $1.5 million for engineering services related to PocketSonics during fiscal years 2013 and 2012, respectively, prior to our acquisition of its remaining stock.

Ultrasonix Medical Corporation

On March 1, 2013, we completed our acquisition of all of the outstanding equity securities of Ultrasonix Medical Corporation, or Ultrasonix, a Nevada Corporation, whose principal assets included customer lists and intangibles related solely to sales destined to the U.S. On March 2, 2013, we completed our acquisition of all of the outstanding equity securities of Ultrasonix Medical Corporation, a Canadian Corporation, pursuant to a “plan of arrangement” under Canadian law. Ultrasonix is a supplier of advanced ultrasound systems for point-of-care and general imaging applications. We undertook the acquisition to accelerate our expansion into the point-of-care ultrasound market. The purchase price, net of cash acquired, of $79.9 million was funded from our existing cash on hand. The acquisition has been accounted for as an acquisition of a business.

We finalized the purchase accounting for the Ultrasonix acquisition during fiscal year 2014. The following table summarizes the purchase price allocation that includes the fair values of the separately identifiable assets acquired and liabilities assumed as of March 2, 2013:


(in millions)
Cash		$	0.4
Accounts receivable (A)			6.5
Inventory (B)			9.4
Prepaids and other assets			2.9
Property, plant, and equipment			0.3
Goodwill			48.2
Intangible assets:
Developed technology (weighted-average useful life of 10 years)	5.9
Customer relationships (weighted-average useful life of 10.6 years)	18.5
Tradename (estimate useful life of 2 years)	0.9

Total intangible assets			25.3
Other assets			0.1

Total assets acquired			93.1
Accounts payable and accrued expenses			(5.4	)
Deferred revenue (B)			(0.8	)
Accrued warranty			(1.1	)
Debt			(0.8	)
Deferred taxes			(4.7	)

Total liabilities assumed			(12.8	)

Total purchase price		$	80.3

(A)	The gross amount due is $8.7 million, of which $2.2 million is expected to be uncollectible. We did not acquire any other class of receivables other than trade receivables as a result of the acquisition of Ultrasonix.

(B)

The inventory fair value adjustment of $3.7 million associated with the acquisition was fully amortized as of October 31, 2013. The deferred revenue adjustment of $0.8 million associated with the acquisition will be amortized over 4.5 years. The inventory fair value and deferred revenue adjustments were recognized in Product cost of sales and Net product revenue in our Consolidated Statement of Operations, respectively.

In determining the purchase price allocation, we considered, among other factors, market participants’ intentions to use the acquired assets and the historical and estimated future demand for Ultrasonix products and services. The fair value of developed technology and trade name intangible assets were based on the relief from royalty approach while the customer relationships intangible asset was based on the excess earnings income approach.

The rate used to discount the estimated future net cash flows to their present values for each intangible asset was based upon a weighted average cost of capital calculation. The discount rate was determined after consideration of market rates of return on debt and equity capital, the weighted average return on invested capital and the risk associated with achieving forecasted sales related to the technology and assets acquired from Ultrasonix.

The total weighted average amortization period for the intangible assets is approximately 10 years. The intangible assets are being amortized on an economic consumption basis, which is consistent with the pattern that the economic benefits of the intangible assets are expected to be utilized based upon estimated cash flows generated from such assets. Goodwill associated with the acquisition was primarily attributable to the opportunities from the addition of Ultrasonix’s product portfolio which complements our direct Ultrasound business suite of products. The goodwill attributable to the U.S. will be deductible for tax purposes over the statutory 15 year period. The goodwill attributable to non-U.S. jurisdictions is not deductible for tax purposes.

During fiscal year 2014, we incurred acquisition-related costs of approximately $8.7 million primarily related to intangible amortization of $7.8 million as well as an inventory fair value step up charge of $0.6 million. Intangible amortization of $5.4 million and $2.4 million were included in our Selling and marketing expense and Product cost of sales, respectively, in our Consolidated Statement of Operations. The inventory fair value step up charge was recorded in Product cost of sales in our Consolidated Statement of Operations.

During fiscal year 2013, we incurred approximately $5.6 million of acquisition-related costs comprised of $3.0 million of inventory step up amortization, $1.4 million of intangible and deferred revenue amortization, and $1.2 million of legal and due diligence related expenses. These costs are included in Net product revenue, Product costs of sales, Selling and marketing expenses, and General and administrative expenses in our Consolidated Statement of Operations.

Pro Forma Financial Information

The following unaudited pro forma information for the fiscal years ended July 31, 2014 and July 31, 2013, respectively presents consolidated information as if both the PocketSonics and the Ultrasonix acquisitions occurred on August 1, 2012, which is the first day of our fiscal year 2013:


	Years Ended July 31,
(in millions, except per share data)	2014		2013
Net revenue	$	517.5	$	572.4
Net income	$	33.8	$	30.4
Net income per share, basic	$	2.73	$	2.48
Net income per share, diluted	$	2.67	$	2.42