Note 4. Acquisitions

Kremers Urban Pharmaceuticals Inc.

On November 25, 2015, the Company completed the acquisition of Kremers Urban Pharmaceuticals Inc. (“KUPI”), the 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 $1.21 billion, subject to a customary post-closing working capital adjustment.

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
Estimated working capital adjustment	(46,202		)
Certain amounts reimbursable by UCB	(37,340		)

Total cash consideration transferred to KUPI shareholders	946,458
Unsecured 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	$	1,211,378

The Company funded the acquisition and transaction expenses with proceeds from the issuance of the $910.0 million Senior Secured Credit Facility, $22.8 million borrowings on the Revolving Credit Facility, the issuance of the $250.0 million Senior Notes (see Note 12 “Long-term Debt”) and cash on hand of $90.1 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 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 fair values using assumptions that are subject to change. The Company has not finalized its valuation of certain assets and liabilities recorded in connection with this transaction. 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 December 31, 2015 (a)			Measurement Period Adjustments (b)			Preliminary Purchase Price Allocation as of March 31, 2016
Cash and cash equivalents	$	16,877		$	—		$	16,877
Accounts receivable, net of revenue-related reserves	149,209			(6,190		)	143,019
Inventories	83,815			(215		)	83,600
Other current assets	12,873			(1,468		)	11,405
Property, plant and equipment	97,418			20,169			117,587
Product rights	409,000			21,000			430,000
Trade name	2,920			—			2,920
Other intangible assets	20,000			(1,000		)	19,000
In-process research and development	232,000			(103,000		)	129,000
Goodwill	240,575			72,735			313,310
Deferred tax assets	4,956			—			4,956
Other assets	4,859			—			4,859

Total assets acquired	1,274,502			2,031			1,276,533

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 long-term liabilities	(5,369		)	—			(5,369		)

Total net assets acquired	$	1,211,378		—			$	1,211,378

(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 are for 1) certain working capital adjustments and 2) updated valuations on inventories, property, plant and equipment and intangible assets. 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 $15.3 million, of which $10.4 million relates to compensation-related payments and $4.9 million relates to unrecognized tax benefits. 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 11 “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.

Goodwill of $313.3 million arising from the acquisition consists largely 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 Revenue and Net income attributable to Lannett Company, Inc. included in the Company’s Consolidated Statements of Operations from November 25, 2015 to March 31, 2016 are as follows:

	For the Three Months Ended March 31,		For the Nine Months Ended March 31,
(In thousands, except per share data)	2016		2016
Revenues	$	69,933	$	96,064
Net income (loss) attributable to Lannett Company, Inc.	2,260		(4,047		)
Earnings (loss) per common share attributable to Lannett Company, Inc.:
Basic	$	0.06	$	(0.11	)
Diluted	$	0.06	$	(0.11	)

During the nine months ended March 31, 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 three and nine months ended March 31, 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 Three Months Ended March 31,				For the Nine Months Ended March 31,
(In thousands, except per share data)	2016		2015		2016		2015
Revenues	$	163,712	$	193,612	$	520,867	$	616,083
Net income attributable to Lannett Company, Inc.	896		29,889		55,596		89,527
Earnings per common share attributable to Lannett Company, Inc.:
Basic	$	0.02	$	0.83	$	1.53	$	2.50
Diluted	$	0.02	$	0.80	$	1.49	$	2.41

The supplemental pro forma earnings for the three months ended March 31, 2016 were adjusted to exclude $8.6 million of expense related to the amortization of fair value step-up adjustments to acquisition-date inventory.

The supplemental pro forma earnings for the three months ended March 31, 2015 were adjusted to exclude $1.0 million of acquisition-related costs incurred by KUPI.

The supplemental pro forma earnings for the nine months ended March 31, 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, and $14.4 million of expense related to the amortization of fair value adjustments to acquisition-date inventory.

The supplemental pro forma earnings for the nine months ended March 31, 2015 were adjusted to include $30.7 million of acquisition-related costs, of which $21.5 million was incurred by Lannett and $9.2 million was incurred by KUPI, as well as $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, subject to a post-closing working capital adjustment. 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 are subject to change. Any adjustments, if necessary, will be recorded in the measurement period.

The preliminary 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 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 largely 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.

Unaudited Pro Forma Financial Results

The results of Silarx are included in the Company’s Consolidated Financial Statements from the date of acquisition. The pro forma results assuming the acquisition had occurred as of July 1, 2013 were not material to the Company’s revenues, net income, and earnings per share.