3. Merger

As described in Note 1, on June 15, 2015, the Company completed the Merger with Pulmatrix Operating. Pursuant to the Merger Agreement, each outstanding share of capital stock of Pulmatrix Operating was exchanged for 0.148187124066461 pre-Reverse Stock Split shares of Company Common Stock (the “Exchange Ratio”). All Pulmatrix Operating stock options granted under the Pulmatrix Operating stock option plans (whether or not then exercisable) that were outstanding prior to the Effective Time converted into options to purchase Company Common Stock at the same ratio as described below. Immediately prior to the Effective Time, the outstanding shares of convertible preferred stock of Pulmatrix Operating converted into an aggregate of 70,105,854 shares (pre-Reverse Stock Split and before giving effect to the Exchange Ratio) of Pulmatrix Operating common stock, which shares were exchanged in the Merger for an aggregate of 4,155,539 shares of Company Common Stock, and convertible debt of Pulmatrix Operating converted into an aggregate of 86,118,402 shares of Pulmatrix Operating common stock (pre-Reverse Stock Split and before giving effect to the Exchange Ratio), which shares were exchanged in the Merger for an aggregate of 5,104,661 shares of Company Common Stock. All outstanding Pulmatrix Operating preferred stock warrants were cancelled immediately prior to the Effective Time. In addition, immediately following the Effective Time the Company issued 664,559 shares of Company Common Stock in exchange for $4,500 aggregate principal amount of bridge notes and $69 in related accrued interest assumed by the Company in the Merger.

All Pulmatrix Operating stock options granted under the Pulmatrix Operating stock option plans (whether or not then exercisable) that were outstanding at the Effective Time converted into options to purchase Company Common Stock. After the Effective Time, all outstanding and unexercised Pulmatrix Operating stock options assumed by the Company may be exercised solely for shares of Company Common Stock. The number of shares of Company Common Stock subject to each Pulmatrix Operating stock option assumed by the Company was determined by multiplying (a) the number of shares of Pulmatrix Operating common stock that were subject to such Pulmatrix Operating stock option, as in effect immediately prior to the Effective Time, by (b) the Exchange Ratio, and rounding the resulting number down to the nearest whole number of shares of Company Common Stock. The per share exercise price for the Company Common Stock issuable upon exercise of each Pulmatrix Operating stock option assumed by the Company was determined by dividing (a) the per share exercise price of Pulmatrix Operating common stock subject to such Pulmatrix Operating stock option, as in effect immediately prior to the Effective Time, by (b) the Exchange Ratio and rounding the resulting exercise price up to the nearest whole cent.

As a result of the Merger, the vesting of 67,732 restricted stock units and 24,400 options granted prior to the Merger by Ruthigen under the Ruthigen 2013 Employee, Director and Consultant Equity Incentive Plan was accelerated. The acceleration clause was included as part of the original terms of the equity awards.

The Merger has been accounted for as a reverse acquisition under the acquisition method of accounting with Pulmatrix Operating treated as the accounting acquirer and Ruthigen treated as the acquired company for financial reporting purposes. Pulmatrix Operating was determined to be the accounting acquirer based upon the terms of the Merger and other factors, such as relative voting rights and the composition of the combined company’s board of directors and senior management. Accordingly, the Ruthigen tangible and identifiable intangible assets acquired and liabilities assumed were recorded at fair value as of the date of acquisition, with the excess consideration transferred recorded as goodwill.

See Note 12, “Stock-Based Compensation,” for additional details regarding the accounting treatment for the equity awards of Pulmatrix Operating and Ruthigen.

The acquisition-date fair value of the consideration transferred is as follows:


Number of shares of Company Common Stock owned by Ruthigen stockholders (1)		2,404,835
Multiplied by the price per share of Company Common Stock (2)	$	12.65

Total consideration transferred	$	30,422

(1)

The stock transferred in the table above is calculated as the sum of a) 1,921,716 shares of Company Common Stock outstanding at the time of the Merger, b) 379,387 shares of Company Common Stock issued immediately following the closing of the Merger in a private placement, c) 36,000 shares of Company Common Stock issued to certain employees, pursuant to the terms of the Merger Agreement and d) 67,732 shares of Company Common Stock issued pursuant to restricted stock units that became fully vested upon completion of the Merger.

(2)	The shares outstanding are multiplied by the closing trading price of Company Common Stock as of the Merger date.

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


	June 15, 2015
Cash and cash equivalents	$	9,671
In-process research and development		7,534
Goodwill		15,942
Property and equipment		156
Prepaid and other current assets		141

Total assets acquired		33,444

Accrued expenses and other current liabilities		(63	)
Deferred tax liability		(2,959	)

Total liabilities assumed		(3,022	)

Total net assets acquired	$	30,422

The purchase price allocation is subject to change as additional information becomes available concerning the fair value and tax basis of the assets acquired and the liabilities assumed. Any adjustments to the purchase price allocation will be made as soon as practicable but no later than one year from June 15, 2015, the acquisition date. As of December 31, 2016, no adjustments have been made.

For acquired working capital accounts such as prepaid expenses and other current assets, property and equipment, accounts payable and certain accrued expenses, the Company determined that no fair value adjustments were required due to the short timeframe until settlement for these assets and liabilities.

The acquired IPR&D consisted of RUT58-60, a proprietary formulation of HOCl and Ruthigen’s lead drug candidate, which was designed to prevent and treat infection in invasive applications. RUT58-60 was developed in collaboration with Ruthigen’s former parent, Oculus Innovative Sciences, Inc. (“Oculus”), under a license agreement. Concurrent with entering into the Merger Agreement, Pulmatrix, Ruthigen and Oculus entered into a side letter agreement that clarified certain rights and obligations of each party following the closing date of the Merger with respect to certain agreements previously executed between Ruthigen and Oculus, including the license agreement. Under the terms of the side letter agreement, the Company’s obligation to develop and commercialize RUT58-60 was waived for one year following the Merger closing date. Also under the terms of the agreement, the Company may sell its rights to develop RUT58-60 if it receives at least $1,000 therefor, and Oculus has a right of first refusal with respect to any offers to purchase RUT58-60, such that Oculus could elect to purchase RUT58-60 for identical terms negotiated with a prospective buyer. In the event that the Company sells its rights to develop RUT58-60 for an amount in excess of $10,000, the Company must pay 10% of the gross consideration received to Oculus.

The fair value of the IPR&D was determined using a discounted cash flow analysis of the expected cash flows to be generated by the IPR&D over its remaining life, net of returns on contributory assets including working capital and real and personal property assets. A discount rate of 26.6% was used in the analysis. The resulting present value of the cash flows was combined with the estimated present value of the amortization tax benefit that a purchaser of the asset could be expected to receive to arrive at the estimated fair value of the IPR&D. The Company believes the assumptions used are consistent and representative of those a market participant would use in estimating the fair value of the IPR&D. If, at the end of the one year waiver period, the Company has not been successful in finding a buyer for RUT58-60, Oculus will have the right to cancel the license agreement and reclaim all rights to RUT58-60. During the year ended December 31, 2016, as a sale of RUT58-60 did not take place within the waiver period, the Company revalued its IPR&D of $7,534 to $0 in a complete write-off .

The deferred tax liability of $2,959 relates to the temporary difference associated with the $7,534 value of the IPR&D asset, which is not deductible for tax purposes. The deferred tax liability was recorded based on a 39.28% effective tax rate. A full write-off of the deferred tax liability was recorded on June 15, 2016, as the term for the license agreement has terminated.

Goodwill is calculated as the difference between the acquisition-date fair value of the consideration transferred and the fair values of the assets acquired and liabilities assumed. The goodwill is not expected to be deductible for income tax purposes. Goodwill is recorded as an indefinite-lived asset and is not amortized but tested for impairment on an annual basis or when indications of impairment exist. The Company determined that goodwill was impaired and recorded an impairment charge of $5,029 that revalued goodwill to $10,914 as of December 31, 2016.

The operating results of Ruthigen for the period from June 16, 2015 to December 31, 2015, including operating losses of $1,388 have been included in the Company’s consolidated financial statements as of and for the year ended December 31, 2015.

The Company incurred a total of $6,863 in transaction costs in connection with the Merger, excluding Ruthigen transaction costs, which were included in general and administrative expense within the consolidated statements of operations for the year ended December 31, 2015. The following supplemental audited pro forma information presents the Company’s financial results as if the acquisition of Ruthigen had occurred on January 1, 2015:


	For the Year ended December 31,
	2015
Total revenues, net	$	1,201
Net loss	$	(19,093	)

The above pro forma information was determined based on the historical GAAP results of the Company and Ruthigen. The audited pro forma consolidated results are not necessarily indicative of what the Company’s consolidated results of operations actually would have been if the acquisition was completed on January 1, 2015. The audited pro forma consolidated net loss includes pro forma adjustments primarily relating to the following non-recurring items directly attributable to the business combination:

(1)	Elimination of $9,956 of transaction costs for both the Company and Ruthigen from the year ended December 31, 2015.

(2)	Elimination of $901 of stock-based compensation expense related to the acceleration of vesting of previously unvested Ruthigen awards in connection with the Merger from the year ended December 31, 2015;

(3)	Elimination of $995 of expense related to stay bonuses from the year ended December 31, 2015;

(4)

Elimination of $1,309 of other income and $2,291 of other expense related to the change in the fair values of liability-classified warrants and derivative instruments from the year ended December 31, 2015, respectively, as the Company’s outstanding preferred stock warrants and certain derivative instruments were extinguished in connection with the completion of the Merger;

(5)	Elimination of $1,170 loss on conversion of convertible notes from the year ended December 31, 2015, as the Company’s 2015 Bridge Notes (defined below) were automatically converted to equity upon completion of the Merger; and

(6)	Elimination of $477 and $6,868 of interest expense related to our convertible notes, including the 2015 Bridge Notes, from the year ended December 31, 2015, as all of the Company’s outstanding convertible notes were automatically converted to equity in connection with the closing of the Merger.