5.

Business Combination

 

On May 23, 2011, the Company closed an APA to acquire substantially all of the assets and specified liabilities of AMS Inc. The purchase price was a number of shares of authorized but unissued shares of common stock of the Company, representing 5% of the outstanding common stock on a fully diluted basis on the closing date.  Additionally, in conjunction with the closing of the APA, the Company’s note receivable with AMS Inc. in the amount of $1,650,000 was terminated and AMS Inc. was released of all obligations under the terms of the notes.

 

The Company assessed the fair value of the tangible and intangible assets that were acquired from AMS Inc., for the purpose of purchase price allocation. The Company’s management determined fair value with assistance from its outside consultants and used fair value methodologies in accordance with generally accepted accounting principles to arrive at the fair value of both tangible and intangible assets. The fair values of the assets were significantly higher than the purchase price for the assets of AMS Inc., which were the primary factors resulting in the recording of a gain on the purchase.

 

In regard to tangible assets, the Company considered the fact that the fair value of the acquired assets greatly exceeded their nominal carrying value and concluded that the carrying value of the assets was not indicative of the fair value of these assets. The primary factor leading to this conclusion was the current price of equipment of similar type and condition, which became the basis for the values assigned to the assets acquired. Additionally, these tangible assets have been properly maintained and are expected to have a useful life that will extend another 10 years. While the carrying value at the time of acquisition was nearly $0, the fair value was determined to be approximately $1.9 million. These assets will be a significant contributor to manufacturing the Company’s product for many years in the future.

 

The valuation of the intangible assets was based on methodologies that relied upon forward looking forecasts that considered all known information at that time, the most significant assumption being the revenue growth of the Company, primarily in the magnetic sensor business.

 

AMS Inc. past financial losses were a result of the declining legacy tape head business. During 2010 production began on magnetic sensors and sales from this product have grown each quarter since. Future revenue growth, and therefore, AMS profitability, is based in part on this new market area. These assumptions were used in the valuation of intangible assets in purchase accounting of approximately $1.9 million that did not exist on the balance sheet of AMS prior to the acquisition.

 

The allocation of the purchase price and the purchase price accounting is based on the fair value of the acquired assets and liabilities measured as of May 23, 2011 in accordance with ASC Topic 805, Business Combinations.

 

Fair value of shares of common stock issued to AMS		$	385,000
Advances to AMS including interest (obligation to repay released at closing of merger)			1,707,326
Total consideration		$	2,092,326
Allocation of Purchase Price:
Cash and cash equivalents		$	180,436
Accounts receivable			332,568
Inventories			414,038
Prepaid expenses and other			54,285
Equipment			1,923,650
Intangible assets			1,881,000
Accounts payable			(538,628	)
Accrued expenses			(100,433	)
Deferred rent and other			(402,067	)
Gain on bargain purchase			(1,652,523	)
		$	2,092,326

  

 

 

The gain related to the acquisition of AMS Inc. assets and liabilities in the amount $1,652,523 was recorded in other income in the statement of operations for the three and six months ended June 30, 2011.

 

The fair value of the shares issued in the AMS acquisition was based on the enterprise value of AMS.  Using an income approach the Company first determined the fair value of AMS as a whole and then attributed 5% of this value as the estimated fair value of the shares issued to AMS Inc. In connection with the acquisition of AMS Inc, the Company incurred acquisition related costs totaling approximately $68,400 which were expensed as incurred. Included in expenses for years ended December 31, 2011 and December 31, 2010 were acquisition related expenses amounting to approximately $28,000 and $40,400 respectively of which acquisition expenses for the six months ended June 30, 2012 and June 30, 2011 were approximately $0 and $29,000 , respectively.

 

The following presents the pro forma net loss for the six months ended June 30, 2012 and 2011 for the Company’s acquisition of AMS Inc. assuming the acquisition occurred as of January 1, 2011. The pro forma results are unaudited and are derived from the historical financial results of the acquired business for the periods presented and are not necessarily indicative of the results that would have occurred had the acquisition been consummated on January 1, 2011.

 

For the six months ended June 30,		2012				2011
Revenue		$	4,535,624			$	2,811,727
Net  income (loss)		$	(855,449	)		$	(1,239,060	)

 

Customer relationships are amortized based on patterns in which the economic benefits of customer relationships are expected to be utilized. Other finite-lived identifiable assets are amortized on a straight-line basis. The following are the intangible assets acquired and their respective amortizable lives as follows:

 

		Fair Value				Estimated				Amortization				Carrying
		as of				Useful life				through				Value as of
		May 23, 2011				(years)				June 30, 2012				June 30, 2012
Technology		$	605,400				5			$	134,096			$	471,304
Tradename			132,200				14				10,458				121,742
Customer Relationships			1,143,400				9				140,702				1,002,698
Total		$	1,881,000							$	285,256			$	1,595,744