NOTE 3—BUSINESS COMBINATIONS

On February 27, 2015, Real Industry, through its indirect wholly owned subsidiary, Real Alloy, acquired 100% of the voting interests of the Real Alloy Business from Aleris, under a purchase agreement (the “Real Alloy Purchase Agreement”). Upon closing, we paid $496.2 million to Aleris, and an additional $5.0 million of cash and the Redeemable Preferred Stock were placed into escrow to satisfy the indemnification obligations of Aleris under the Real Alloy Purchase Agreement, in which Aleris has agreed to indemnify Real Alloy and its affiliates for certain claims and losses. During the second quarter, we paid an additional $31.3 million of the purchase price representing the initial working capital adjustment under the Real Alloy Purchase Agreement. The final working capital adjustment, estimated to be approximately $2.4 million as of June 30, 2015, is recorded within accrued liabilities in the unaudited condensed consolidated balance sheet and was reduced by $2.2 million during the second quarter.

In addition, Real Alloy and Aleris have entered into a transition services agreement, under which Aleris will provide certain customary post-closing transition services, including information technology services, treasury services, accounts payable, cash management and payroll, credit/collection services, environmental services and human resource services, to Real Alloy, for periods ranging from three to twenty-four months following the acquisition date.

We incurred acquisition and financing-related costs and expenses associated with the Real Alloy Acquisition totaling approximately $14.4 million and $0.4 million in the first and second quarters of 2015, respectively, which are classified as nonoperating expenses in the unaudited condensed consolidated statements of operations. Acquisition and financing-related costs and expenses associated with the Real Alloy Acquisition recognized in 2014 totaled $3.4 million.

The acquisition was accounted for as a business combination, with the purchase price allocated based on the estimated fair values of the assets acquired and liabilities assumed. The purchase price allocation remains preliminary as management continues to evaluate the assumptions and methodology used in the valuation of acquired inventories, property, plant and equipment, intangible assets, accrued pension liabilities, environmental liabilities and asset retirement obligations, and the resultant deferred income tax adjustments.

(In millions)
Purchase consideration:
Consideration paid at closing	$	501.2
Redeemable Preferred Stock issued		19.6
Initial working capital adjustment		31.3
Estimated final working capital adjustment		2.4
Total purchase consideration	$	554.5

Purchase price allocation:
Assets:
Cash	$	10.2
Trade accounts receivable		150.1
Inventories		173.9
Property, plant and equipment		326.4
Deferred income taxes		5.9
Other		4.0
Identifiable intangible assets		21.0
Total assets		691.5
Liabilities:
Trade payables		112.4
Accrued liabilities		26.7
Accrued pension liabilities		46.0
Environmental liabilities		18.4
Other		13.6
Deferred income taxes		4.4
Total liabilities		221.5
Estimated fair value of net assets acquired	$	470.0

Total purchase consideration	$	554.5
Estimated fair value of net assets acquired		470.0
Goodwill	$	84.5

The estimated fair value of trade accounts receivable is based on the undiscounted receivables management expects to receive from the $150.4 million of total trade accounts receivable at the acquisition date. Due to the short-term nature of the receivables, the undiscounted receivables expected to be collected are estimated to approximate fair value.

Inventories include the estimated fair value of finished goods, work in process, raw material and supplies. The estimated fair value of finished goods was based on analyses of future selling prices and the profit associated with the manufacturing effort. The estimated fair value of work in process considered costs to complete to finished goods and was based on analyses of future selling prices and the profit associated with the manufacturing effort. The estimated fair value of raw materials and supplies was based on replacement cost. The $173.9 million of estimated fair value of inventories includes $10.7 million in fair value adjustments, of which $3.5 million and $7.2 million was recognized as noncash charges in cost of sales during the three and six months ended June 30, 2015, respectively. Based on additional analyses performed in the second quarter, management increased its estimate of the fair value of inventories by $6.5 million compared to the preliminary estimate as of March 31, 2015, primarily related to the estimate of fair value of supplies. The incremental cost of sales related to the measurement period adjustment was not material to the prior period.

Property, plant and equipment includes land, site improvements, buildings and building improvements, and machinery, equipment, furniture and fixtures. The estimated fair value of property, plant and equipment was based on appraisals and replacement cost analyses. The fair value of property, plant and equipment acquired was estimated as follows:

(In millions)	Estimated Fair Value
Land	$	63.6
Buildings		57.0
Machinery, equipment, furniture and fixtures		193.8
Construction work in progress		12.0
Property, plant and equipment	$	326.4

Identifiable intangible assets represent the estimated fair value of customer relationships and have an estimated useful life of 20 years. The valuation of the intangible assets acquired was based on management’s estimates, available information, and reasonable and supportable assumptions. The fair value of these assets was estimated using the income approach. An excess earnings approach was used to estimate the fair value of the customer relationships. Significant assumptions used include forecasted revenues, customer retention rates and profit margins, a discount rate of 13.5% based on our overall cost of equity, adjusted for perceived business risks related to these customer relationships, and an estimated economic useful life of 20 years. As a result of refinement of the methodologies and assumptions used in the valuation, management has decreased the estimated fair value of the identifiable intangible assets by $0.6 million during the second quarter. The adjustment related to an indefinite-lived asset, therefore there was no impact to amortization expense related to the measurement period adjustment.

The fair value of trade payables was estimated to approximate carrying value due to the short-term nature of the liabilities. Based on additional analyses performed in the second quarter, management reduced the estimated fair value of trade payables by $10.7 million, primarily due to the exclusion of trade payables due certain Aleris affiliates that were not assumed in the Real Alloy Acquisition, but had been erroneously reported in the preliminary purchase price allocation as of March 31, 2015.

The fair value of accrued liabilities was estimated to approximate carrying value due to the short-term nature of the liabilities.

Accrued pension liabilities include defined benefit pension plans for the German employees. The plans are based on final pay and service, but some senior officers are entitled to receive enhanced pension benefits. Benefit payments are financed, in part, by contributions to a relief fund which establishes a life insurance contract to secure future pension payments. Based on statutory pension contributions calculations proscribed under German law, the plans are substantially underfunded. The unfunded accrued pension costs are covered under a pension insurance association under German law should Real Alloy, or its subsidiaries, be unable to fulfill their pension obligations.

The following assumptions were utilized to measure the accrued pension liabilities:

Discount rate	1.7	%
Salary increase	3.0	%
Pension increase	1.8	%
Turnover	2.0	%

Environmental liabilities represent estimated reserves for environmental remediation costs, which have been recognized based on the guidance in FASB ASC 450, Contingencies, and FASB ASC 410, Asset Retirement and Environmental Obligations. Real Alloy is subject to various environmental laws and regulations governing, among other things, the handling, disposal and remediation of hazardous substances and wastes and employee safety. Given the changing nature of environmental legal requirements, Real Alloy may be required to take environmental control measures at some of its facilities to meet future requirements.

The estimated fair value of the Redeemable Preferred Stock was determined based on a discounted cash flow using estimates of market rates and redemption probabilities. For more information on the Redeemable Preferred Stock, refer to Note 5—Debt, Other Financing Arrangements and Redeemable Preferred Stock and Note 12—Derivative and Other Financial Instruments and Fair Value Measurements.

Deferred income taxes represent the differences between the book and tax bases of the assets acquired. As a result of an election under section 338(h)(10) of the Internal Revenue Code of 1986, as amended (the “Tax Code”), the tax bases of U.S. assets acquired were adjusted to the acquisition date fair values. Deferred income taxes represent book and tax differences of non-U.S. assets acquired.

Other liabilities assumed include asset retirement obligations, which represent obligations associated with the retirement of tangible long-lived assets. Assumed asset retirement obligations relate primarily to the requirement of capping three landfills, as well as costs related to the future removal of asbestos and costs to remove underground storage tanks. The estimated fair value is based upon the present value of the future cash flows expected to be required to satisfy the obligation using discount rates ranging from 6.7% to 13.2%. Determining the fair value of asset retirement obligations requires judgment, including estimates of the credit adjusted interest rate and estimates of future cash flows. The present value of the obligations is accreted over time.

Based on the estimated fair value of assets acquired and liabilities assumed, goodwill of $84.5 million is attributable to Real Alloy’s strong management team, assembled workforce and its defensible market share. As the purchase price allocation for the Real Alloy Acquisition has not yet been finalized, the allocation of goodwill to our reporting units has not yet been finalized. The following table reflects the activity associated with goodwill during the six months ended June 30, 2015:

(In millions)
Balance at beginning of period	$	—
Preliminary purchase price allocation for the Real Alloy Acquisition reported as of March 31, 2015		102.3
Adjustments to preliminary purchase price allocation for the Real Alloy Acquisition recorded in the quarter ended June 30, 2015		(17.8	)
Balance at end of period	$	84.5

The operating results of Real Alloy are included in the Company’s unaudited condensed consolidated financial statements from the acquisition date. For the period from the acquisition date to June 30, 2015, Real Alloy’s total revenues and loss from continuing operations before income taxes were $506.4 million and $20.8 million, respectively. The following selected unaudited pro forma results of operations of the Company for the three and six months ended June 30, 2015 and 2014, give effect to this business combination as though the transaction occurred on January 1, 2014:

	Three Months Ended June 30,						Six Months Ended June 30,
(In millions)		2015			2014			2015			2014
Total revenues:
As reported	$	368.7		$	—		$	506.5		$	0.1
Pro forma		368.7			394.5			743.3			773.0
Loss from continuing operations before income taxes:
As reported	$	(13.5	)	$	(2.6	)	$	(38.7	)	$	(4.7	)
Pro forma		(12.9	)		(8.2	)		(27.4	)		(35.3	)