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Asterias Merger

12 Months Ended

Dec. 31, 2020

3. Asterias Merger

On March 8, 2019, the Asterias Merger closed with Asterias surviving as a wholly owned subsidiary of Lineage. The former stockholders of Asterias (other than Lineage) received 0.71 common shares of Lineage (the “Merger Consideration”) for every share of Asterias common stock they owned (the “Merger Exchange Ratio”). Lineage issued 24,695,898 common shares, including 58,085 shares issued in respect of restricted stock units issued by Asterias that immediately vested in connection with the closing of the Asterias Merger. The fair value of such shares, based on the closing price of Lineage common shares on March 8, 2019, was $32.4 million.

In connection with the closing of the Asterias Merger, Lineage assumed outstanding warrants to purchase shares of Asterias common stock, as further discussed below and in Note 11, and assumed sponsorship of the Asterias 2013 Equity Incentive Plan (see Note 12). All stock options to purchase shares of Asterias common stock outstanding immediately prior to the closing of the Asterias Merger were canceled at the closing for no consideration.

As of December 31, 2019, the assets and liabilities of Asterias have been included in the consolidated balance sheet of Lineage. The results of operations of Asterias from March 8, 2019 through December 31, 2019 have been included in the consolidated statement of operations of Lineage for the year ended December 31, 2019.

Calculation of the purchase price

The calculation of the purchase price for the Asterias Merger and the Merger Consideration transferred on March 8, 2019 was as follows (in thousands, except for share and per share amounts):

	Lineage (38% ownership interest)			Shareholders other than Lineage (approximate 62% ownership interest)			Total
Outstanding Asterias common stock as of March 8, 2019		21,747,569			34,783,333	⁽¹⁾		56,530,902	⁽¹⁾
Exchange ratio		0.710			0.710			0.710

Lineage common shares issuable		15,440,774	⁽²⁾		24,695,898	⁽³⁾		40,136,672
Per share price of Lineage common shares as of March 8, 2019	$	1.31		$	1.31		$	1.31
Purchase price (in $000s)	$	20,227	⁽²⁾	$	32,353		$	52,580

⁽¹⁾	Includes 81,810 shares of Asterias restricted stock unit awards that immediately vested on March 8, 2019 and converted into the right to receive common shares of Lineage based on the Merger Exchange Ratio, resulting in 58,085 common shares of Lineage issued on March 8, 2019 as part of the Merger Consideration. These restricted stock units were principally attributable to pre-combination services and included as part of the purchase price in accordance with ASC 805. See Note 12 for Asterias restricted stock units that vested on the closing of the Asterias Merger attributable to post-combination services that were recorded outside of the purchase price as an immediate charge to stock-based compensation expense.

⁽²⁾	Estimated fair value for Lineage’s previously held 38% ownership interest in Asterias common stock is part of the total purchase price of Asterias for purposes of the purchase price allocation under ASC 805 and for Lineage’s adjustment of its 38% interest to fair value at the effective date of the Asterias Merger and immediately preceding the consolidation of Asterias’ results with Lineage. No actual common shares of Lineage were issued to Lineage in connection with the Asterias Merger.

⁽³⁾	Net of a de minimis number of fractional shares which were paid in cash.

Purchase price allocation

Lineage allocated the acquisition consideration to tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values as of the acquisition date. The fair value of the acquired tangible and identifiable intangible assets were determined based on inputs that are unobservable and significant to the overall fair value measurement. It is also based on estimates and assumptions made by management at the time of the acquisition. As such, this was classified as Level 3 fair value hierarchy measurements and disclosures.

The allocation of the purchase price in the table below is based on our estimates of the fair values of tangible and intangible assets acquired, including IPR&D, and liabilities assumed as of the acquisition date, with the excess recorded as goodwill (in thousands). As of December 31, 2019, Lineage had finalized its purchase price allocation.

Assets acquired:
Cash and cash equivalents	$	3,117
Prepaid expenses and other assets, current and noncurrent		660
Machinery and equipment		308
Long-lived intangible assets - royalty contracts		650
Acquired in-process research and development (“IPR&D”)		46,540

Total assets acquired		51,275

Liabilities assumed:
Accrued liabilities and accounts payable		982
Liability classified warrants		867
Deferred license revenue		200
Long-term deferred income tax liability		10,753

Total liabilities assumed		12,802

Net assets acquired, excluding goodwill (a)		38,473

Fair value of Lineage common shares held by Asterias (b)		3,435

Total purchase price (c)		52,580

Estimated goodwill (c-a-b)	$	10,672

The valuation of identifiable intangible assets and their estimated useful lives are as follows (in thousands, except for useful life):

	Preliminary Estimated Asset Fair Value		Useful Life (Years)
	(in thousands, except for useful life)
In process research and development (“IPR&D”)	$	46,540		n/a
Royalty contracts		650		5
	$	47,190

The following is a discussion of the valuation methods used to determine the fair value of Asterias’ significant assets and liabilities in connection with the Asterias Merger:

IPR&D and Deferred Income Tax Liability - The fair value of identifiable acquired IPR&D intangible assets consisting of $31.7 million pertaining to the OPC1 program that is currently in a Phase 1/2a clinical trial for SCI, which has been partially funded by the California Institute for Regenerative Medicine and $14.8 million pertaining to the VAC2 program, which is an allogeneic, or “off-the-shelf,” cancer immunotherapy derived from pluripotent stem cells for which a clinical trial in non-small cell lung cancer is being funded and sponsored by Cancer Research UK. The identification of these intangible assets are based on consideration of historical experience and a market participant’s view further discussed below; collectively, OPC1 and VAC2 are referred to as the “AST-Clinical Programs”. These intangible assets are valued primarily through the use of a probability weighted discounted cash flow method under the income approach further discussed below. Lineage considered Asterias’ VAC1 program, which is an autologous, or patient-specific, cancer immunotherapy derived from the patient’s own cells, to have de minimis value due to significant risks, substantial costs and limited opportunities.

Lineage determined that the estimated aggregate fair value of the AST-Clinical programs was $46.5 million as of the acquisition date using a probability weighted discounted cash flow method for each respective program. This approach estimates the probability of the AST-Clinical Programs achieving successful completion of remaining clinical trials and related approvals into the valuation technique.

To calculate fair value of the AST-Clinical programs under the discounted cash flow method, Lineage used probability-weighted, projected cash flows discounted at a rate considered appropriate given the significant inherent risks associated with cell therapy development by clinical-stage companies. Cash flows were calculated based on estimated projections of revenues and expenses related to each respective program. Cash flows were assumed to extend through a seven-year market exclusivity period for the OPC1 program from the date of market launch. Revenues from commercialization of the AST-Clinical Programs were based on estimated market potential for the indication of each program. The resultant cash flows were then discounted to present value using a weighted-average cost of capital for companies with profiles substantially similar to that of Lineage, which Lineage believes represents the rate that market participants would use to value the assets. Lineage compensated for the phase of development of the program by applying a probability factor to its estimation of the expected future cash flows. The projected cash flows were based on significant assumptions, including the indications in which Lineage will pursue development of the AST-Clinical programs, the time and resources needed to complete the development and regulatory approval, estimates of revenue and operating profit related to the program considering its stage of development, the life of the potential commercialized product, market penetration and competition, and risks associated with achieving commercialization, including delay or failure to obtain regulatory approvals to conduct clinical studies, failure of clinical studies, delay or failure to obtain required market clearances, and intellectual property litigation.

These IPR&D assets are indefinite-lived intangible assets until the completion or abandonment of the associated research and development (“R&D”) efforts. Once the R&D efforts are completed or abandoned, the IPR&D will either be amortized over the asset life as a finite-lived intangible asset or be impaired, respectively, in accordance with ASC 350, Intangibles - Goodwill and Other. In accordance with ASC 350, goodwill and acquired IPR&D are determined to have indefinite lives and, therefore, are not amortized. Instead, they are tested for impairment at least annually and between annual tests if Lineage becomes aware of an event or a change in circumstances that would indicate the asset may be impaired.

Because the IPR&D (prior to completion or abandonment of the R&D) is considered an indefinite-lived asset for accounting purposes, the fair value of the IPR&D on the acquisition date creates a deferred income tax liability (“DTL”) in accordance with ASC 740, Income Taxes (see Note 13). This DTL is computed using the fair value of the IPR&D assets on the acquisition date multiplied by Lineage’s federal and state income tax rates. While this DTL would reverse on impairment or sale or commencement of amortization of the related intangible assets, those events are not anticipated under ASC 740 for purposes of predicting reversal of a temporary difference to support the realization of deferred tax assets, except for certain deferred tax assets and credit carryforwards that are also indefinite in nature as of the closing of the Asterias Merger, which may be considered for reversal under ASC 740 as further discussed in Note 13.

Royalty contracts – Asterias has certain royalty revenues for “research only use” culture media for preclinical research applications under certain, specific patent families under contracts which preclude the customers to sell for commercial use or for clinical trials. These royalty cash flows are generated under certain specific patent families which Asterias previously acquired from Geron Corporation (“Geron”). Asterias pays Geron a royalty for all royalty revenues received from these contracts. Because these patents are a subset of the clinical programs discussed above, are expected to continue to generate revenues for Asterias and are not to be used in the OPC1 or the VAC2 programs, these patents are considered to be separate long-lived intangible assets under ASC 805. These intangible assets are also valued primarily through the use of the discounted cash flow method under the income approach, and will be amortized over their useful life, estimated to be 5 years. The discounted cash flow method estimated the amount of net royalty income that can be expected under the contracts in future years. The amounts were based on observed historical trends in the growth of these revenue streams, and were estimated to terminate in approximately five years, when the key patents under these contracts will begin to expire. The resulting cash flows were discounted to the valuation date based on a rate of return that recognizes a lower level of risk associated with these assets as compared to the AST-Clinical programs discussed above.

Deferred license revenue – In September 2018, Asterias and Novo Nordisk A/S (“Novo Nordisk”) entered into an option for Novo Nordisk or its designated U.S. affiliate to license, on a non-exclusive basis, certain intellectual property related to culturing pluripotent stem cells, such as hES cells, in suspension. Under the terms of the option, Asterias received a one-time upfront payment of $1.0 million, in exchange for a 24-month period option to negotiate a non-exclusive license during which time Asterias has agreed to not grant any exclusive licenses inconsistent with the Novo Nordisk option. This option is considered a performance obligation as it provides Novo Nordisk with a material right that it would not receive without entering into the contract.

For business combination purposes under ASC 805, the fair value of this performance obligation to Lineage, from a market participant perspective, is the estimated costs Lineage may incur, plus a normal profit margin for the level of effort required to perform under the contract after the acquisition date, assuming Novo Nordisk exercised its option, including, but not limited to, negotiation costs, legal fees, arbitration, if any, and other related costs. Management has estimated those costs, plus a normal profit margin, to be approximately $200,000 in the purchase price allocation. This amount was originally recorded as deferred revenue and subsequently recognized as revenue in September 2020 when Novo Nordisk did not exercise the option.

Liability classified warrants – On May 13, 2016, in connection with a common stock offering, Asterias issued warrants to purchase 2,959,559 shares of Asterias common stock (the “Asterias Warrants”) with an exercise price of $4.37 per share that expire in five years from the issuance date, or May 13, 2021. As of the closing of the Asterias Merger, there were 2,813,159 Asterias Warrants outstanding. The Asterias Warrants contain certain provisions in the event of a Fundamental Transaction, as defined in the warrant agreement governing the Asterias Warrants (“Warrant Agreement”), that Asterias or any successor entity will be required to purchase, at a holder’s option, exercisable at any time concurrently with or within thirty days after the consummation of the fundamental transaction, the Asterias Warrants for cash in an amount equal to the calculated value of the unexercised portion of such holder’s warrants, determined in accordance with the Black-Scholes option pricing model with significant inputs as specified in the Warrant Agreement. The Asterias Merger was a Fundamental Transaction for purposes of the Asterias Warrants.

The fair value of the Asterias Warrants was determined by using Black-Scholes option pricing models which take into consideration the probability of the Fundamental Transaction, which for purposes of the above valuation was assumed to be at 100% and net cash settlement occurring, using the contractual remaining term of the warrants. In applying these models, these inputs included key assumptions including the per share closing price of Lineage common shares on March 8, 2019, volatility computed in accordance with the provisions of the Warrant Agreement and, to a large extent, assumptions based on discussions with a majority of the holders of the Asterias Warrants since the closing of the Asterias Merger to settle the Asterias Warrants in cash or in common shares of Lineage. Based on such discussions, Lineage believes the fair value of the Asterias Warrants as of the closing of the Asterias Merger is not subject to change significantly, however, to the extent any Asterias Warrants that were not settled in cash or in Lineage common shares discussed below, were automatically converted to Lineage warrants 30 days after the closing of the Asterias Merger. In April 2019, Asterias Warrants representing approximately $372,000 in fair value were settled: $332,000 in fair value was settled in exchange for 251,835 common shares of Lineage, and $40,000 in fair value was settled in exchange for cash. The Asterias Warrants settled in exchange for common shares of Lineage were held by Broadwood Partners, L.P., an Asterias and Lineage shareholder. The Asterias Warrants settled in exchange for cash were held by other parties. The remaining Asterias Warrants (representing approximately $495,000 in fair value as of March 31, 2019) were converted into warrants to purchase common shares of Lineage using the Merger Exchange Ratio (the “Lineage Warrants”).

As of December 31, 2020, the total number of common shares of Lineage subject to warrants that were assumed by Lineage in connection with the Asterias Merger was 1,089,900, with similar terms and conditions retained under the Lineage Warrants as per the original Warrant Agreements. The Lineage Warrants have an exercise price of $6.15 per warrant share and expire on May 13, 2021. Lineage is accounting for the outstanding Lineage Warrants as a liability at fair value, with subsequent changes to the fair value of the Lineage Warrants at each reporting period thereafter included in the consolidated statement of operations (see Note 11).

Fair value of Lineage common shares held by Asterias – As of March 8, 2019, Asterias held 2,621,811 common shares of Lineage as marketable securities on its standalone financial statements. The fair value of those shares acquired by Lineage from Asterias is determined based on the $1.31 per share closing price of Lineage common shares on March 8, 2019. Although treasury shares are not considered an asset and were retired upon Lineage’s acquisition of Asterias, the fair value of those shares is a part of the purchase price allocation shown in the tables above. These Lineage shares were retired at the completion of the Asterias Merger.

Goodwill – Goodwill is calculated as the difference between the acquisition date fair value of the consideration transferred and the values assigned to the assets acquired and liabilities assumed. Goodwill is not amortized but is tested for impairment at least annually, or more frequently if circumstances indicate potential impairment.

Depending on the structure of a particular acquisition, goodwill and identifiable intangible assets may not be deductible for tax purposes. Goodwill recorded in the Asterias Merger is not expected to be deductible for tax purposes (see Note 13).

During the years ended December 31, 2020 and 2019, Lineage incurred $0.7 million and $5.1 million, respectively, in acquisition related costs which were recorded in general and administrative expenses in the accompanying consolidated statements of operations.

Prior to the Asterias Merger being consummated in March 2019, Lineage elected to account for its 21.7 million shares of Asterias common stock at fair value using the equity method of accounting. The fair value of the Asterias shares was approximately $20.2 million as of March 8, 2019, the closing date of the Asterias Merger, based on $0.93 per share, which was calculated by multiplying (a) $1.31, the closing price of Lineage common shares on such date by (b) the Merger Exchange Ratio. The fair value of the Asterias shares was approximately $13.5 million as of December 31, 2018, based on the closing price of Asterias common stock of $0.62 per share on such date. Accordingly, Lineage recorded an unrealized gain of $6.7 million for the year ended December 31, 2019, representing the change in fair value of Asterias common stock from December 31, 2018 to March 8, 2019. All share prices were determined based on the closing price of Lineage or Asterias common stock on the NYSE American on the applicable dates.

Asterias Merger Related Litigation – See Note 14 Commitments and Contingencies for discussion regarding litigation related to the Asterias Merger.