Essentialis, Inc. Acquisition

3 Months Ended

Mar. 31, 2017

Business Combinations [Abstract]

Essentialis, Inc. Acquisition

Essentialis, Inc. Acquisition

On March 7, 2017, the Company acquired Essentialis through the merger of the Company's wholly-owned subsidiary Company E Merger Sub, Inc., a Delaware corporation ("Merger Sub"), whereby Merger Sub merged into Essentialis,with Essentialis surviving the merger as a wholly owned subsidiary of the Company.

In consideration, the Company issued 18,916,940 shares of common stock to stockholders of Essentialis. The Company held back 913,379 shares of common stock as partial recourse to satisfy indemnification claims, and such shares will be issued to Essentialis stockholders on the 1 year anniversary of the closing of the merger. The Company is also obligated to issue an additional 4,566,948 shares of common stock to Essentialis stockholders upon the achievement of a development milestone. Additionally, upon the achievement of certain commercial milestones associated with the sale of Essentialis’ product in accordance with the terms of the Merger Agreement, the Company is obligated to make cash earnout payments of up to a maximum of $30 million to Essentialis stockholders.

The transaction has been accounted for as an asset acquisition under the acquisition method of accounting. The amendments in ASU 2017-01 provide a screen to determine when a set of assets and activities is not a business. The screen requires that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the set of assets and activities is not a business.

Since the acquisition was determined to be an asset acquisition, the total value of the purchase consideration will be allocated to the asset acquired. The value of the shares issued on the completion of the merger and the shares to be issue was based on the stock price of the Company on the date of completion of the merger. In addition, the trading history of the Company was reviewed to assess the reliability of the implied consideration value. The Company trades on the NASDAQ, a major U.S. stock exchange, and has significant average daily trading volume with tight intraday bid-ask spreads. These characteristics indicate Capnia’s shares are actively traded and provide a reliable indication of value. On March 7, 2017, the date of the transaction close, the Company's stock was trading at $0.77 per common share. Additionally, the average closing price of the stock in the 30 calendar days leading up to the close was also approximately $0.77. Accordingly, the identifiable intangible assets acquired are recorded at fair value based on this stock price.

The agreement to pay the commercial milestones resulted in the recognition of a contingent consideration ,which is recognized at the inception of the transaction, and subsequent changes to estimate of the amounts of contingent consideration to be paid will be recognized as charges or credits in the statement of operations. The fair value of the contingent consideration is based on the Company's analysis of the likelihood of the drug indication moving from phase II through approval in the Federal Drug Administration approval process and then reaching the cumulative revenue milestones. In determining the likelihood of this occurring, the analysis relied on 2016 research published by BIO, Biomedtraker, & Amplion titles “Clinical Development Success Rates 2006-2015.” Based on Management's assessment, a 15.3% probability of achieving each milestone was determined to be reasonable. Additionally, the Company anticipates that it could reach the commercial milestones of $100 million and $200 million in applicable revenue in 2023 and 2025, respectively.

The probability weighted milestone payments were discounted to determine the present value of future payments. The analysis utilized the weighted average cost of capital (WACC) discount rate. The WACC used for the first and second milestones were 30% and 21%, respectively.

The aggregate purchase price consideration was as follows:

Fair value of stock consideration	$	18,785,926
Fair value of contingent consideration	1,090,125
Total purchase price consideration	$	19,876,051

The fair value of the asset acquired is as follows:

Patents	19,876,051
Net Assets Acquired	$	19,876,051

As an asset acquisition, the Company also capitalized $573 thousand of total costs of acquiring the assets. These included legal fees of $469 thousand, printing fees of $75 thousand and accounting and other fees of $29 thousand. The total intangible asset of $20.4 million was recorded on the balance sheet and amortized over the life of the patents through June 30, 2028.

The following table presents the unaudited pro forma results of Capnia, Inc. (including the operations of Essentialis) for the three months ended March 31, 2016 and March 31, 2017 (in thousands, except per share amounts). The unaudited pro forma financial information combines the results of operations of Capnia and Essentialis as though the companies had been combined as of the beginning of each of the fiscal periods presented. The unaudited pro forma financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had taken place at the beginning of fiscal 2016 or 2017.

	March 31,			March 31,
	2017			2016
Pro forma total revenue	$	265		$	447
Pro forma net loss	$	(4,233	)	$	(3,814	)
Pro forma net loss per share - basic and diluted	$	(0.09	)	$	(0.1	)
Proforma weighted-average shares - basic and diluted	44,841,090			38,759,486