Note 2. Business Combinations

ImThera Medical, Inc.

ImThera manufactures an implantable device for the treatment of obstructive sleep apnea that stimulates multiple tongue muscles via the hypoglossal nerve, which opens the airway while a patient is sleeping. ImThera has a commercial presence in the European market, and an FDA pivotal study is ongoing in the U.S.

On January 16, 2018, we acquired the remaining 86% outstanding interest in ImThera Medical, Inc. (“ImThera”) for cash consideration of up to $225 million. Cash in the amount of $78.3 million was paid at closing with the balance to be paid based on achievement of a certain regulatory milestone and a sales-based earnout.

The following table presents the acquisition date fair value of the consideration transferred and the fair value of our interest in ImThera prior to the acquisition (in thousands):



Cash	$	78,332
Contingent consideration	112,744
Fair value of our interest in ImThera prior to the acquisition ⁽¹⁾	25,580
Fair value of consideration transferred	$	216,656

(1)

The fair value of our previously-held interest in ImThera was determined based on the fair value of total consideration transferred and application of a discount for lack of control. As a result, we recognized a gain of $11.5 million for the fair value in excess of our carrying value of $14.1 million. The gain is included in gain on acquisition on our condensed consolidated statement of income for the three months ended March 31, 2018.

The purchase price allocation for the ImThera acquisition was finalized during the first quarter of 2019 and is presented in the following table, including certain measurement period adjustments (in thousands):



	Initial Purchase Price Allocation			Measurement Period Adjustments ⁽¹⁾			Adjusted Purchase Price Allocation
In-process research and development ⁽²⁾	$	151,605		$	10,677		$	162,282
Developed technology	5,661			(5,661		)	—
Goodwill	87,063			(4,467		)	82,596
Deferred tax liabilities, net ⁽³⁾	(27,980		)	(1,278		)	(29,258		)
Other assets and liabilities, net	836			200			1,036
Net assets acquired	$	217,185		$	(529	)	$	216,656


(1)	During the second quarter of 2018, measurement period adjustments were recorded based upon new information obtained about facts and circumstances that existed as of the acquisition date.

(2)

The fair value of in-process research and development ("IPR&D") was determined using the income approach, which is a valuation technique that provides a fair value estimate based on the market participant expectations of cash flows the asset would generate. The cash flows were discounted commensurate with the level of risk associated with the asset. The discount rates were developed after assigning a probability of success to achieving the projected cash flows based on the current stage of development, inherent uncertainty in reaching certain regulatory milestones and risks associated with commercialization of the product. The IPR&D amount is included in intangible assets, net on the condensed consolidated balance sheets at March 31, 2019 and December 31, 2018.


(3)	The amounts are presented net of deferred tax assets acquired.

Goodwill arising from the ImThera acquisition, which is not deductible for tax purposes, primarily represents the synergies anticipated between ImThera and our existing neuromodulation business. The assets acquired, including goodwill, are recognized in our Neuromodulation segment.

The results of the ImThera acquisition added $0.1 million in revenue and $1.0 million in operating losses during the three months ended March 31, 2018. Additionally, we recognized ImThera acquisition-related expenses of approximately $0.2 million for legal and valuation expenses during the three months ended March 31, 2018. These expenses are included within “Selling, general and administrative” expenses in the condensed consolidated statement of income. Pro forma financial information assuming the ImThera acquisition had occurred as of the beginning of the calendar year prior to the year of acquisition was not material for disclosure purposes.

The ImThera business combination involved contingent consideration arrangements composed of potential cash payments upon the achievement of a certain regulatory milestone and a sales-based earnout associated with sales of products covered by the purchase agreement. The sales-based earnout was valued using projected sales from our internal strategic plan. Both arrangements are Level 3 fair value measurements and include the following significant unobservable inputs (in thousands):



ImThera Acquisition	Fair value at January 16, 2018		Valuation Technique	Unobservable Input	Ranges
Regulatory milestone-based payment	$	50,429	Discounted cash flow	Discount rate	4.3% - 4.7%
				Probability of payment	85% - 95%
				Projected payment years	2020 - 2021

Sales-based earnout	62,315		Monte Carlo simulation	Risk-adjusted discount rate	11.5%
				Credit risk discount rate	4.7% - 5.8%
				Revenue volatility	29.3%
				Probability of payment	85% - 95%
				Projected years of earnout	2020 - 2025
	$	112,744

For a reconciliation of the beginning and ending balance of the contingent consideration refer to “Note 7. Fair Value Measurements.”

TandemLife

TandemLife is focused on the delivery of leading-edge temporary life support systems, including cardiopulmonary and respiratory support solutions. TandemLife complements our Cardiovascular portfolio, and expands our existing line of cardiopulmonary products.

On April 4, 2018, we acquired CardiacAssist, Inc., doing business as TandemLife (“TandemLife”) for cash consideration of up to $254 million. Cash of $204 million was paid at closing with up to $50 million in contingent consideration based on achieving regulatory milestones.

The following table presents the acquisition date fair value of the consideration transferred (in thousands):



Cash	$	203,671
Contingent consideration	40,190
Fair value of consideration transferred	$	243,861

The following table presents the preliminary purchase price allocation at fair value for the TandemLife acquisition (in thousands):



	Initial Purchase Price Allocation			Measurement Period Adjustments ⁽¹⁾			Adjusted Purchase Price Allocation
In-process research and development ^{(2) (3)}	$	110,977		$	(3,474	)	$	107,503
Trade names ⁽²⁾	11,539			—			11,539
Developed technology ⁽²⁾	6,387			—			6,387
Goodwill	118,917			(797		)	118,120
Inventory	10,296			(140		)	10,156
Other assets and liabilities, net	3,632			242			3,874
Deferred tax liabilities, net	(17,887		)	4,169			(13,718		)
Net assets acquired	$	243,861		$	—		$	243,861

(1)

During the third quarter of 2018, measurement period adjustments were recorded based upon new information regarding future estimates of R&D expenses that existed as of the acquisition date. In addition, during the first quarter of 2019, measurement period adjustments related to finalizing our tax attributes were recorded, which resulted in an increase of $3.3 million in deferred tax assets and a commensurate decrease to goodwill.


(2)	The amounts are included in intangible assets, net in the condensed consolidated balance sheets at March 31, 2019 and December 31, 2018. Trade names and developed technology are amortized over remaining useful lives of 15 and 2 years, respectively.

(3)

The fair value of IPR&D was determined using the income approach, which is a valuation technique that provides a fair value estimate based on the market participant expectations of cash flows the asset would generate. The cash flows were discounted commensurate with the level of risk associated with the asset. The discount rates were developed after assigning a probability of success to achieving the projected cash flows based on the current stage of development, inherent uncertainty in reaching certain regulatory milestones and risks associated with commercialization of the product.

Goodwill arising from the TandemLife acquisition, which is not deductible for tax purposes, primarily represents the synergies anticipated between TandemLife and our existing cardiovascular business. The assets acquired, including goodwill, are recognized in our Cardiovascular segment. Pro forma financial information assuming the TandemLife acquisition had occurred as of the beginning of the calendar year prior to the year of acquisition was not material for disclosure purposes.

The TandemLife business combination involved a contingent consideration arrangement composed of potential cash payments upon the achievement of certain regulatory milestones. The arrangement is a Level 3 fair value measurement and includes the following significant unobservable inputs (in thousands):



TandemLife Acquisition	Fair value at April 4, 2018		Valuation Technique	Unobservable Input	Ranges
Regulatory milestone-based payments	$	40,190	Discounted cash flow	Discount rate	4.2% - 4.8%
				Probability of payments	75% - 95%
				Projected payment years	2019 - 2020

For a reconciliation of the beginning and ending balance of the contingent consideration refer to “Note 7. Fair Value Measurements.”