Note 3. Acquisitions

Kremers Urban Pharmaceuticals Inc.

On November 25, 2015, the Company completed the acquisition of KUPI, the former U.S. specialty generic pharmaceuticals subsidiary of global biopharmaceuticals company UCB S.A., pursuant to the terms and conditions of a Stock Purchase Agreement. KUPI is a specialty pharmaceuticals manufacturer focused on the development of products that are difficult to formulate or utilize specialized delivery technologies. Strategic benefits of the acquisition include expanded manufacturing capacity, a diversified product portfolio and pipeline and complementary research and development expertise.

Pursuant to the terms of the Stock Purchase Agreement, Lannett purchased 100% of the outstanding equity interests of KUPI for total estimated consideration of approximately $1.2 billion.

The following table summarizes the fair value of total consideration transferred to KUPI shareholders at the acquisition date of November 25, 2015:

(In thousands)
Cash purchase price paid to KUPI shareholders	$	1,030,000
Working capital adjustment	(41,605		)
Certain amounts reimbursed by UCB	(37,340		)

Total cash consideration transferred to KUPI shareholders	951,055
12.0% Senior Notes issued to UCB	200,000
Acquisition-related contingent consideration	35,000
Warrant issued to UCB	29,920

Total consideration to KUPI shareholders	$	1,215,975

The Company funded the acquisition and transaction expenses with proceeds from the issuance of the $910.0 million of term loans, $22.8 million borrowings from a revolving credit facility, the issuance of $250.0 million Senior Notes (see Note 11 “Long-term Debt”) and cash on hand of $94.6 million. Lannett also issued a warrant with an estimated fair value of $29.9 million.

As part of the acquisition, the Company and UCB have agreed to jointly make an election under Section 338(h)(10) of the Internal Revenue Code of 1986, as amended and under the corresponding provisions of state law, to treat the acquisition as a deemed purchase and sale of assets for income tax purposes. The Company has agreed to reimburse UCB for 50% of the incremental tax cost of making such election, subject to a reimbursement cap of $35.0 million. This liability has been recorded as acquisition-related contingent consideration on the Consolidated Balance Sheet. This election is expected to result in additional tax benefits to the Company of approximately $100.0 million.

The Company also agreed to contingent payments related to Methylphenidate ER provided the FDA reinstates the AB-rating for such product and certain sales thresholds are met.

The Company used the acquisition method of accounting to account for this transaction. Under the acquisition method of accounting, the assets acquired and liabilities assumed in the transaction were recorded at the date of acquisition at their respective preliminary fair values using preliminary assumptions that are subject to change as the Company obtains additional information during the measurement period. The Company has not finalized its valuation of certain assets and liabilities recorded in connection with this transaction, primarily related to revenue-related reserves and tax-related accounts. Thus, the estimated fair values recorded to date are subject to change and any changes will be recorded as adjustments to the fair value of those assets and liabilities and residual amounts will be allocated to goodwill. The final valuation adjustments may also require adjustment to the Consolidated Statements of Operations and Cash Flows.

The preliminary purchase price has been allocated to the assets acquired and liabilities assumed for the KUPI business as follows:

(In thousands)	Preliminary Purchase Price Allocation as of November 25, 2015 (a)			Measurement Period Adjustments (b)			Preliminary Purchase Price Allocation as of June 30, 2016
Cash and cash equivalents	$	16,877		$	—		$	16,877
Accounts receivable, net of revenue-related reserves	149,209			(13,846		)	135,363
Inventories	83,815			194			84,009
Other current assets	12,873			(1,635		)	11,238
Property, plant and equipment	97,418			14,431			111,849
Product rights	409,000			18,000			427,000
Trade name	2,920			—			2,920
Other intangible assets	20,000			(1,000		)	19,000
In-process research and development	232,000			(107,000		)	125,000
Goodwill	240,575			92,895			333,470
Deferred tax assets	4,956			(770		)	4,186
Other assets	4,859			5,359			10,218

Total assets acquired	1,274,502			6,628			1,281,130

Accounts payable	(19,249		)	—			(19,249		)
Accrued expenses	(4,161		)	(1,918		)	(6,079		)
Accrued payroll and payroll-related expenses	(20,731		)	(309		)	(21,040		)
Rebates payable	(9,816		)	—			(9,816		)
Royalties payable	(3,798		)	196			(3,602		)
Other liabilities	(5,369		)	—			(5,369		)

Total net assets acquired	$	1,211,378		$	4,597		$	1,215,975

(a)

As originally reported in the Company’s Quarterly Report on Form 10-Q for the period ended December 31, 2015.

(b)

The measurement period adjustments relate to 1) finalizing working capital adjustments totaling $4.6 million 2) finalized valuations for inventories and property, plant and equipment, 3) receipt of additional information related to product development timelines and 4) revenue-related reserve estimates, all of which reflect facts and circumstances that existed as of the acquisition date. These adjustments did not have a significant impact on the Company’s previously reported consolidated financial statements.

Included in the preliminary purchase price allocation above are indemnification assets totaling approximately $20.7 million, of which $10.4 million relates to compensation-related payments, $4.9 million relates to unrecognized tax benefits and $5.4 million for chargeback and rebate-related items. The inventory balance above includes $19.1 million to reflect fair value step-up adjustments. KUPI’s intangible assets primarily consist of product rights and in-process research and development. See Note 10 “Goodwill and Intangible Assets.”

Amounts allocated to acquired in-process research and development represent an estimate of the fair value of purchased in-process technology for research projects that, as of the closing date of the acquisition, had not yet reached technological feasibility and had no alternative future use. The fair value of in-process research and development was based on the excess earnings method, which utilizes forecasts of expected cash inflows (including estimates for ongoing costs) and other contributory charges, on a project-by-project basis at the appropriate discount rate for the inherent risk in each project and will be tested for impairment in accordance with the Company’s policy for testing indefinite-lived intangible assets. In the fourth quarter of Fiscal 2016, the Company recorded an $8.0 million impairment charge related to certain intangible assets acquired as part of the KUPI acquisition. The impairment was mainly related to delays in expected launch dates as well as competitive pricing factors for two products in development.

Goodwill of $333.5 million arising from the acquisition consists primarily of the value of the employee workforce and the value of products to be developed in the future. The goodwill was assigned to the Company’s only reporting unit. Goodwill recognized is expected to be fully deductible for income tax purposes.

The amounts of KUPI Net Sales and Net income attributable to Lannett Company, Inc. included in the Company’s Consolidated Statements of Operations from November 25, 2015 to June 30, 2016 are as follows:

	For the fiscal year ended June 30,
(In thousands, except per share data)	2016
Total net sales	$	165,649
Loss attributable to Lannett Company, Inc.	(3,431		)
Loss per common share attributable to Lannett Company, Inc.:
Basic	$	(0.09	)
Diluted	$	(0.09	)

During the fiscal year ended June 30, 2016, the Company recorded $21.5 million of acquisition-related expenses directly related to the KUPI acquisition.

Unaudited Pro Forma Financial Results

The following supplemental unaudited pro forma information presents the financial results as if the acquisition of KUPI had occurred on July 1, 2014 for the fiscal years ended June 30, 2016 and 2015. This supplemental pro forma information has been prepared for comparative purposes and does not purport to be indicative of what would have occurred had the acquisition been made on July 1, 2014, nor are they indicative of any future results:

	For the fiscal year ended June 30,
(In thousands, except per share data)	2016		2015
Total net sales	$	689,754	$	809,379
Net income attributable to Lannett Company, Inc.	61,916		116,119
Earnings per common share attributable to Lannett Company, Inc.:
Basic	$	1.70	$	3.24
Diluted	$	1.66	$	3.13

The supplemental pro forma earnings for the fiscal year ended June 30, 2016 were adjusted to exclude $28.9 million of acquisition-related costs, of which $21.5 million was incurred by Lannett and $7.4 million was incurred by KUPI, as well as to exclude $17.0 million of expense related to the amortization of fair value adjustments to acquisition-date inventory.

The supplemental pro forma earnings for the fiscal year ended June 30, 2015 were adjusted to include $28.9 million of acquisition-related costs, of which $21.5 million was incurred by Lannett and $7.4 million was incurred by KUPI, as well as to include $18.9 million of expense related to the amortization of fair value step-up adjustments to acquisition-date inventory.

Silarx

On June 1, 2015, the Company completed the acquisition of Silarx Pharmaceuticals, Inc., a New York corporation and Stoneleigh Realty, LLC, a New York limited liability company (together “Silarx”), pursuant to the terms and conditions of a Stock Purchase Agreement. Silarx manufactures and markets high-quality liquid pharmaceutical products, including generic prescription and over-the-counter products. Silarx operates within a manufacturing facility located in Carmel, New York. Strategic benefits of the acquisition include an FDA-approved manufacturing facility, research and development expertise and added diversity to Lannett’s portfolio of existing and pipeline products.

Pursuant to the terms of the Stock Purchase Agreement, Lannett purchased 100% of the outstanding equity interests of Silarx for cash consideration totaling $42.5 million. The Company used the acquisition method of accounting to account for this transaction. Under the acquisition method of accounting, the assets acquired and liabilities assumed in the transaction were recorded at the date of acquisition at their respective fair values using assumptions that were subject to change.

The purchase price has been allocated to the assets acquired and liabilities assumed for the Silarx business as follows:

(In thousands)
Cash	$	664
Accounts receivable, net of revenue-related reserves	4,396
Inventories	2,705
Other current assets	467
Property, plant and equipment	7,247
Product rights	10,000
In-process research and development	18,000
Goodwill	141
Other current assets	9
Total assets acquired	43,629
Accounts payable	(711		)
Income taxes payable	(392		)

Total net assets acquired	$	42,526

Product rights totaling $10.0 million are comprised of currently marketed products that have an estimated useful life of 15 years. The goodwill of $141 thousand arising from the acquisition consists primarily of the value of the employee workforce and the value of products to be developed in the future. The goodwill was assigned to the Company’s only reporting unit. Goodwill recognized is expected to be fully deductible for income tax purposes.