Business Acquisition

12 Months Ended

Dec. 31, 2016

Business Acquisition

Business Acquisition

NOTE 8 - Business Acquisition

On July 1, 2015, we completed the acquisition of substantially all of the assets of Devicix, LLC upon the terms and conditions contained in an Asset Purchase Agreement entered into on June 17, 2015.

Devicix is an innovative medical product design and engineering firm with a proven track record of helping clients move from concept to production. The addition of Devicix will enhance and broaden our capabilities for complete design, manufacturing and service, particularly for regulated medical devices.

Acquisition date fair value of the consideration transferred totaled $5.1 million which was comprised of cash payments of $2.0 million from our operating line of credit at closing and two promissory notes payable to the seller in the aggregate principal amounts of $1.0 million and $1.3 million. The $1.0 million promissory note has a four-year term, bearing interest at 4% per annum and is subject to offsets if certain revenue levels are not met. The $1.3 million promissory note has a four year term and bears interest at 4% per annum and is not subject to offset.

The asset purchase agreement also includes additional consideration payable within 90 days of the completion of each of the first four 12-month periods after July 1, 2015. The earnout will be equal to 15% of eligible engineering revenue over a $6,000,000 threshold and 3% of eligible production revenue generated from Devicix customers. The maximum dollar amount of earnout payments under the Asset Purchase Agreement is $2,500,000. We estimated the fair value of the contingent consideration to be $851,000 using a probability weighted discounted cash flow model. This fair value measurement is based on significant inputs not observable in the market and thus represents a level 3 measurement as defined in ASC 820. The estimated fair value of the contingent considerations was determined using the following assumptions: discount rates of 21-23%, probability levels of milestone range of outcomes, and expected timing of achievement of contingent consideration earn-out amounts.

During 2016, the contingent consideration was adjusted from $851,000 to $556,000. The change in estimate of $294,342 is shown in general & administrative expenses in the statement of comprehensive income.

The following table summarizes the contingent consideration balance and activity for the years ended December 31, 2016 and December 31, 2015:

Beginning fair value of contingent liability, December 31, 2014	$	—
Initial fair value of contingent consideration	851,000
Period change in valuation	—
Contingent liability balance, December 31, 2015	851,000
Period change in valuation	(294,342		)
Payments	(658		)
Contingent liability balance, December 31, 2016	556,000
Less: Current liability	21,700
Non-current liability	$	534,300

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the acquisition date:

	July 1, 2015
Total Purchase Consideration:
Cash	$	2,121,000
Loans to Seller	2,141,000
Contingent Consideration	851,000
Total Purchase Consideration	$	5,113,000
Assets Acquired and Liabilities Assumed:
Cash	$	131,000
Accounts Receivable	373,000
AR due to seller	(173,000		)
Prepaid Expenses and Inventory	35,000
Fixed Assets	83,000
Trade Names	814,000
Customer Relationship	1,302,000
Goodwill	3,208,000
Accounts Payable	(63,000		)
Accrued Payroll, Benefits and Other Current Liabilities	(122,000		)
Customer Deposits	(475,000		)
Total Assets Acquired and Liabilities Assumed	$	5,113,000

The Devicix acquisition resulted in $3.2 million of goodwill, which is deductible for tax purposes. Specifically, the goodwill recorded as part of the acquisition of Devicix includes the expected synergies and other benefits that we believe will result from combining the operations of Devicix with the operations of Nortech Systems.

Included in our consolidated statements of comprehensive income for the year ended December 31, 2015 are net sales of approximately $2.5 million and net income before income taxes of approximately $0.3 million, since the July 1, 2015 acquisition.

We incurred $62,000 in legal, professional, and other costs related to this acquisition accounted for as general and administrative expenses. The weighted-average useful life of intangible assets acquired is 11.4 years.

The table below reflects our unaudited pro forma combined results of operations as if the acquisition had taken place as of January 1, 2015:

	Pro Forma
	Year Ended
	December 31, 2015
	(unaudited)
Net Sales	$	117,937,523
Income (Loss) from Operations	$	(223,717	)
Net Income (Loss)	$	(381,360	)
Basic & Diluted
Loss per Common Share	$	(0.14	)

The pro forma unaudited results do not purport to be indicative of the results which would have been obtained had the acquisition been completed as of the beginning of the earliest period presented. In addition they do not include any benefits that may result from the acquisition due to synergies that may be derived from the elimination of any duplicative costs.

Pro forma results presented above reflect: (1) amortization adjustments relating to fair value estimates of intangible assets and (2) incremental interest expense on assumed indebtedness. Pro forma adjustments described above have been tax effected using the effective rate during the respective periods.