NETSMART TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED PRO FORMA CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS
Pursuant to the merger agreement dated September 20, 2005, Netsmart Technologies, Inc. (“Netsmart”) acquired 100% of the equity of CMHC Systems, Inc. (“CMHC”). The purchase price totaled $19,565,956 as follows: 435,735 shares of Netsmart’s common stock (valued at $4,915,091), $12,994,758 in cash plus additional cash consideration currently estimated to be $792,024 as required by the “working capital adjustment” calculated and payable as defined in the merger agreement (subject to adjustment, see Note 2), and acquisition costs of $864,083. The cash consideration was paid utilizing the working capital of Netsmart. The acquisition has been accounted for under the purchase method of accounting in accordance with SFAS No. 141 by which the acquiring company records at its cost the acquired assets less liabilities assumed.
Pursuant to the asset purchase agreement dated April 27, 2005, Creative Socio-Medics Corp. (“CSM”), a wholly-owned subsidiary of Netsmart, acquired certain assets and liabilities and rights to the intellectual property and customer contracts of ContinuedLearning LLC (“CL”). The purchase price consisted of 20,000 shares of Netsmart’s common stock and $191,400 in cash. The market value of the stock issued at the date of the merger agreement was $191,400 and the source of the cash consideration was the working capital of Netsmart. The purchase has been accounted for under the purchase method of accounting in accordance with SFAS No. 141.
Pursuant to the asset purchase agreement dated June 20, 2005, CSM acquired certain assets and liabilities and rights to the intellectual property and customer contracts of Addiction Management Systems, Inc. (“AMS”). The purchase price was $3,590,778, which consisted of $948,833 of liabilities assumed for pre billed services plus $2,641,945 in cash. The source of the cash consideration was the working capital of Netsmart. The purchase has been accounted for under the purchase method of accounting in accordance with SFAS No. 141.
On October 7, 2005, Netsmart entered into a Loan Agreement consisting of (i) a $2,500,000 Revolving Credit Loan and (ii) a $2,500,000 Term Loan. On October 7, 2005, the Netsmart borrowed the full amount of the $2,500,000 Term Loan. On October 14, 2005, Netsmart issued 490,000 shares of common stock and 147,004 common stock purchase warrants in a private placement generating net proceeds of $4,218,000.
CMHC Merger
CMHC reports on a fiscal year end of March 31 and, as a result, the pro forma statement of operations for the year ended December 31, 2004 is inclusive of CMHC operations for the period of January 1, 2005 thru March 31, 2005. CMHC revenue and net income for the three months ended March 31, 2005 were $6,559,865 and $569,045 respectively.
Netsmart purchased 100% of the equity of CMHC. Netsmart did not purchase 570 Metro Place North Limited Partnership, an entity that is majority-owned by CMHC’s former majority stockholder and owns the land and the building where CMHC conducts most of its operations. The breakdown of the allocation of the assets is subject to adjustment. The total acquisition cost is based upon certain estimates and is also subject to adjustment.
The following are the details of the total acquisition cost:
| | | | | |
| Cash paid | | $ | 12,994,758 | |
| Market value of common stock issued | | | 4,915,091 | |
| Estimated working capital adjustment * | | | 792,024 | |
| Other acquisition costs | | | 864,083 | |
| Total acquisition | | $ | 19,565,956 | |
The total cost of acquisition was allocated as follows **:
| | | | | | | | |
| Current assets | | $ | 3,537,404 | | | | |
| Property and equipment | | | 527,535 | | | | |
| Customer lists | | | 5,200,000 | | | (to be amortized over 20 years) | |
| Backlog | | | 490,000 | | | (to be amortized over 1 year) | |
| Software purchased | | | 3,300,000 | | | (to be amortized over 4 years) | |
| Goodwill | | | 19,216,024 | | | | |
| Deferred taxes, long-term | | | 940,128 | | | | |
| Other assets | | | 26,208 | | | | |
| Total assets | | | 33,237,299 | | | | |
| Current liabilities | | | (10,225,331 | ) | | | |
| Long-term obligations | | | (30,012 | ) | | | |
| Deferred taxes, long-term | | | (3,416,000 | ) | | | |
| Total liablitites | | | (13,671,343 | ) | | | |
| Total acquisition allocation | | $ | 19,565,956 | | | | |
| | | | | | | | |
| * | The working capital adjustment of an estimated $792,024 is based upon the terms of the merger agreement whereby the purchase price will include an amount equal to the amount that the final net working capital of CMHC is greater than a negative $7.5 million. This estimate is based upon the unaudited balance sheet of CMHC as of September 30, 2005 and is subject to adjustment. |
| ** | The primary fair value adjustments made to CMHC’s historical cost balance sheet were to increase the value of CMHC’s software to fair value, and to record customer lists, contract backlog and goodwill and the related deferred tax liability. For all other assets and liabilities, historical cost approximated fair value. |
| · | In order to value CMHC’s software, management considered the historical costs incurred as well as projected costs to recreate the software. However, since there is a specific earnings stream that can be associated exclusively with the existing software, management applied a discounted cash flow model in its estimation of the fair value of the software. CMHC’s software consists of management information systems used by behavioral and public health organizations; the systems include financial, client administration, clinical assessment and administration. The estimated useful life of the software is four years. Such estimate considered the following: (i) the software is an integral part of each customer’s operations and is not easily replaced, (ii) however, the underlying architecture of the software is based on unsupported programming language and character-based screens (not the graphical interfaces used today) and will need to be updated, and (iii) the results of the discounted cash flow analysis. |
| · | The customer list has been valued using a discounted cash flow model. CMHC provides computer-based management information systems for approximately 400 behavioral and public healthcare organizations. CMHC’s relationships with its customers are long-term in nature, indicating that the customer relationships are an important intangible asset to the Company. CMHC has been in business since 1978, and based upon their historical attrition rate, and the 30 year projections used for the cash flow analysis, the useful life of the customer lists is estimated to be 20 years. |
| · | The contract backlog represents the fair value of various customer contracts and purchase orders that have already been billed to the customers, but for which services have not yet been performed. The value was determined using a discounted cash flow model. The contract backlog is being amortized over 12 months, since the services to be performed with respect to the underlying customer contracts are expected to be completed within one year. |
| · | The deferred tax liability represents a long term deferred tax liability related to the above fair valuation adjustments for the capitalized software, customer list and contract backlog intangible assets. These intangibles are not deductible expenses for tax purposes. The tax effect has been calculated utilizing Netsmart's blended statutory tax rate of 38%. |
| · | Goodwill represents the excess of the cost of CMHC over the net of the amounts assigned to tangible and identifiable intangible assets acquired and liabilities assumed. The goodwill is not amortized for book or income tax purposes. |
The Company only recently purchased CMHC, and accordingly, is still gathering data related to the allocation of the purchase price. As such, the purchase price allocation is subject to change. Changes could include a reallocation of intangible assets which would likely have the effect of increasing or decreasing future amortization expense, since the intangible assets have initially been assigned varied lives ranging from no amortization (for goodwill) to 20 year amortization (for the customer list). Additionally, the lives assigned to the identifiable intangible assets represent management’s best estimates of the time period in which it will continue to receive benefits from these assets. The useful lives may need to be adjusted in the future based upon changes to the expected useful lives of such assets. As a result, future amortization expense could be materially different from the pro forma amortization expense presented herein.
Strategic headcount adjustments related to the CMHC merger decreasing cost of sales, selling, general and administrative and research, development and maintenance expenses have not been reflected in the pro forma adjustments to the statement of operations. These adjustments are the result of planned strategic employee terminations that occurred on and shortly after the closing date of the merger.
Consulting contracts were entered into with several senior executives of CMHC ranging in duration from day-to-day to up to six months. These contracts, in effect, replace the salaries of the executives and, as a result, do not have a significant impact on operations going forward.
As a result of the merger, Netsmart assumed the lease agreement on the premises located at 570 Metro Place North in Dublin, Ohio. The subject building is owned by CMHC’s former majority stockholder who is a current employee of Netsmart. Netsmart has reviewed Fin 46 R and has determined that the consolidation is not required The lease ends on October 31, 2013 and, based upon research of comparable rental property, Netsmart has determined that the current rent being paid under the terms of the lease represents a fair market price for leases currently being negotiated in that market. In addition, the rental payments that are required for the next twelve months approximate the rental payments that have been made over the past year by CMHC and, as a result, no pro forma adjustment has been made.
Subsequent to the acquisition of CMHC, Netsmart sold to investors , pursuant to a private placement agreement (the “Agreement”), an aggregate 490,000 shares of common stock and warrants to purchase 122,504 shares of common stock. Netsmart has received $4,493,104 in gross proceeds and paid commissions of $275,000 related to the private placement. Netsmart has also issued a warrant to purchase 24,500 shares to the placement agent. The Agreement requires Netsmart to file a registration statement within 30 days of the closing of the private placement, and to use its reasonable best efforts to have such registration statement declared effective by the SEC within 90 days of the closing. Generally, the Agreement further provides for a penalty to be paid to the investors should Netsmart fail to meet its registration obligations. Such penalty is payable to the investors in cash at the rate of 2.5% of the gross proceeds per month, up to a maximum penalty of 20% of the gross proceeds. In accordance with View C of EITF 05-4, Netsmart intends to record 20% of the gross proceeds (approximately $899,000) as a liability until Netsmart has no further obligations pursuant to the registration rights provision that are outside of its control.
ContinuedLearning Asset Purchase
Netsmart did not purchase any of the assets on the CL balance sheet other than the purchase of computer hardware utilized to service then-existing clients, the value of which has been recorded as $17,000. Netsmart did not assume any of the liabilities reflected on the CL balance sheet other than for contract performance related to revenue collected from clients in advance of performance of work contracted for in the amount of $19,206.
The following are the details of the total acquisition cost:
| | | | | |
| Cash paid | | $ | 250,000 | |
| Market value of common stock issued | | | 191,400 | |
| Liabilities assumed | | | 19,206 | |
| Other acquisition costs | | | 28,632 | |
| Total acquisition | | $ | 489,238 | |
The total cost of acquisition was allocated as follows:
| | | | | | | | |
| Customer lists | | $ | 3,347 | | | (to be amortized over 3 years) | |
| Software purchased | | | 443,891 | | | (to be amortized over 6 years) | |
| Non-compete and Non solicitation 25,000 | | | | | | (to be amortized over 2 years) | |
| Hardware purchased | | | 17,000 | | | | |
| Total acquisition allocation | | $ | 489,238 | | | | |
Pro forma adjustments were made to the unaudited condensed consolidated statements of operations for the year ended December 31, 2004 and the for the four months ended April 2005 to reflect amortization of $87,598 and $29,199, respectively, for customer lists, software purchased and certain non-compete and non-solicitation covenants.
A contingent purchase price adjustment of up to $250,000 may be incurred if, in accordance with the agreement, the CL product line retains a certain level of recurring revenue during the twelve-month period commencing on the closing date of the agreement and ending on the first anniversary date. This contingent adjustment has not been reflected as a pro forma adjustment due to its uncertainty.
Addiction Management Systems, Inc. Asset Purchase
Netsmart did not purchase any of the assets on the AMS balance sheet other than the purchase of certain inventory items utilized to resell to then-existing clients, the value of which has been recorded as $32,048, certain accounts receivable in the amount of $127,698 and a lease security deposit in the amount of $3,334. Netsmart did not assume any of the liabilities reflected on the AMS balance sheet other than for contract performance related to revenue collected from clients in advance of performance of work contracted for in the amount of $948,833.
The following are the details of the total acquisition cost:
| | | | | |
| Cash paid | | $ | 2,641,945 | |
| Liabilities assumed | | | 948,833 | |
| Other acquisition costs | | | 19,904 | |
| Total acquisition | | $ | 3,610,682 | |
The total cost of acquisition was allocated as follows:
| Customer lists | | $ | 1,396,902 | | | (to be amortized over 8 years) | ) |
| Software purchased | | | 2,050,700 | | | (to be amortized over 8 years) | ) |
| Accounts Receivable purchased | | | 127,698 | | | | |
| Inventory purchased | | | 32,048 | | | | |
| Lease security deposit | | | 3,334 | | | | |
| Total acquisition allocation | | $ | 3,610,682 | | | | |
Pro forma adjustments were made to the unaudited condensed consolidated statements of operations for the year ended December 31, 2004 and for the six months ended June 30, 2005 to reflect amortization of $430,950 and $215,475, respectively, for customer lists and software purchased.
The following are the notes explaining pro forma adjustments to the unaudited condensed consolidated balance sheet as of June 30, 2005:
| (A) | The acquired assets and liabilities of AMS and CL are already incorporated in the Netsmart consolidated balance sheet as of June 30, 2005. These acquisitions occurred prior to the balance sheet date and are therefore not shown separately for pro forma balance sheet purposes. |
| (A1) | This adjustment represents the recording of Netsmart's acquisition of CMHC totaling $19,565,956. The investment was paid for with cash consideration of $12,994,758, the market value of 435,735 shares of common stock issued of $4,915,091; the working capital adjustment of an estimated $792,024, and certain other costs of completing the acquisition of $864,083 are included in accrued expenses (reflecting an aggregate of $1,656,106). |
| (A2) | On October 14, 2005, Netsmart sold in a private placement an aggregate 490,000 shares of common stock and warrants to purchase 122,504 shares of common stock. Netsmart received $4,218,104 (net of commissions of $275,000) related to the private placement. Netsmart also issued to the placement agent a warrant to purchase 24,500 shares of common stock. All of the warrants have an exercise price of $11.00 and have a term of 5 years. |
| (A3) | On October 7, 2005, Netsmart entered into a Loan Agreement consisting of (i) a $2,500,000 Revolving Credit Loan and (ii) a $2,500,000 Term Loan. On October 7, 2005, Netsmart borrowed the full amount of the $2,500,000 Term Loan. Netsmart has not borrowed any amounts under the Revolving Credit Loan. The principal amount of the Term Loan is payable in sixty (60) consecutive monthly installments. The unpaid principal amount of the Term Loan bears interest at the LIBOR Rate plus 2.25%, which rate was swapped into a fixed rate equivalent of 7.1% for the term of the Term Loan. |
| (A4) | These amounts represent the adjustments to the historical cost balance sheet of CMHC to bring the balances to estimated fair value. The software development costs, the customer lists and the contract backlog are currently expected to be amortized over 4, 20 and 1 years, respectively. |
| (A4a) | Represents the fair value of software purchased ($3,300,000) less existing historical value of CMHC software ($1,490,238). |
| (A4b) | Represents the fair value of the CMHC customer list. |
| (A4c) | Represents the fair value of the CMHC customer backlog. |
| (A5) | This consolidation adjustment represents the recording of a long term deferred tax liability related to the fair valuation adjustments for the capitalized software, customer list and contract backlog intangible assets. These intangibles are not deductible expenses for tax purposes. The tax effect has been calculated utilizing Netsmart's blended statutory tax rate of 38%. This results in a long term deferred tax liability of $3,416,000. |
| (A6) | This represents the excess of the purchase price of CMHC (including currently estimated adjustments) over the fair value of the assets acquired and liabilities assumed. |
| (A7) | This consolidation adjustment represents the elimination of Netsmart’s investment in CMHC and the elimination of CMHC’s equity. |
| (A8) | The Registration Rights Agreement related to the CMHC acquisition requires Netsmart to file a registration statement within 30 days of the closing of the private placement, and to use its reasonable best efforts to have such registration statement declared effective by the SEC within 90 days of the closing. Generally, the Agreement further provides for a penalty to be paid to the investors should Netsmart fail to meet its registration obligations. Such penalty is payable to the investors in cash at the rate of 2.5% of the gross proceeds per month, up to a maximum penalty of 20% of the gross proceeds. In accordance with View C of EITF 05-4, this adjustment represents 20% of the gross proceeds from the transaction which Netsmart intends to record as a current liability until Netsmart has no further obligations pursuant to the registration rights provision that are outside of its control. |
Pro forma adjustments were made to the unaudited condensed consolidated statements of operations for the year ended December 31, 2004 and the six months ended June 30, 2005 to reflect changes resulting from merger that are directly attributable, factually supportable and are expected to have continuing impact on the combined operations. The following are the notes explaining such pro forma adjustments:
| (B1a) | The adjustment increasing cost of sales is due mainly to the amortization of the of the acquired software related to the CMHC merger and the amortization of the acquired software related to each each of th CL and AMS acquisitions. The amounts specific to each acquisition are as follows: |
| | | Year ended | | Six Months ended | |
| | | December 31,2004 | | June 30,2005 | |
| CMHC | | $ | 1,315,000 | | $ | 657,500 | |
| CL | | | 73,982 | | | 24,661 | |
| AMS | | | 256,337 | | | 128,168 | |
| Total | | $ | 1,645,319 | | $ | 810,329 | |
| (B1b) | The adjustment decreasing cost of sales is the result of eliminating amortization of the acquired software that is already reflected in the historical statements of operations. |
| (B1c) | The adjustment increasing selling, general and administrative expenses is due mainly to the amortization of the customer list related to the CMHC merger and the amortization of customer list related to each of the CL and AMS acquisitions. The amounts specific to each acquisition are as follows: |
| | | Year ended | | Six Months ended | |
| | | December 31,2004 | | June 30,2005 | |
| CMHC | | $ | 260,000 | | $ | 130,000 | |
| CL | | | 13,616 | | | 4,539 | |
| AMS | | | 174,613 | | | 87,306 | |
| Total | | $ | 448,229 | | $ | 221,845 | |
| (B2) | The adjustment to the income tax provision is to reflect the overall 38% normal tax rate for Netsmart. |
| (B3) | This adjustment represents interest expense on the Term Loan entered into on October 7, 2005. |
| (B4) | The pro forma adjustment to the number of common shares outstanding is a direct result of: |
| 1. | The issuance of 435,735 shares related to the CMHC merger. |
| 2. | An adjustment to the weighted average shares outstanding related to the 20,000 shares issued in connection with the CL acquisition. The number of weighted average shares is increased by 13,333 for the six months ended June 30, 2005 and by 20,000 shares for the year ended December 31, 2004. |
| 3. | The shares issued pursuant to the private placement contracts resulting in the issuance of 490,000 shares of common stock and warrants to purchase 122,504 shares of common stock plus an additional warrant to purchase 24,500 shares of common stock issued to the placement agent. |
The common shares issued have been reflected in both the basic and diluted earnings per share calculation and the warrants issued to purchase common stock have not been reflected in the diluted earning per share calculation as the result would be antidilutive.
