2. Acquisition of CyDex (Restated)

On January 24, 2011, the Company acquired CyDex Pharmaceuticals, Inc. ("CyDex"), a specialty pharmaceutical company developing products and licensing its CAPTISOL technology. CAPTISOL is currently incorporated in five FDA-approved medications and marketed by three of CyDex's licensees: Pfizer, Bristol-Myers Squibb and Baxter (formerly Prism Pharmaceuticals). In addition, CyDex is supporting drug development efforts with more than 40 companies worldwide.

Under the terms of the agreement, the Company paid $31.6 million, net of a working capital adjustment of $0.5 million, to the CyDex shareholders and issued a series of Contingent Value Rights. The Company is obligated to pay $4.3 million in January 2012 and may be required to pay up to an additional $7.25 million upon achievement of certain milestones. In addition, the Company will pay CyDex shareholders, for each respective year from 2011 through 2016, 20% of all CyDex-related revenue, but only to the extent that and beginning only when CyDex-related revenue for such year exceeds $15.0 million; plus an additional 10% of all CyDex-related revenue recognized during such year, but only to the extent that and beginning only when aggregate CyDex-related revenue for such year exceeds $35.0 million.

The CyDex CVR Agreement requires the Company to, in the event of a Default, deliver to an escrow agent the future cash payments described above, and such amounts would then be delivered by the escrow agent to the CyDex shareholders if, as and when they would have by the CyDex CVR Agreement been required to be delivered to the CyDex shareholders by the Company. "Default" includes the following, subject to certain cure rights: (a) the Company fails to pay to the Shareholders' Account any amount as and when required under the CyDex CVR Agreement, (b) at any time the Company is obligated for more than $35.0 million of financial indebtedness (other than financial indebtedness which is expressly subordinated to all obligations of Ligand under the CyDex CVR Agreement pursuant to a written subordination agreement signed by and reasonably acceptable to the Shareholders' Representative), (c) at any time after March 15, 2011 the Company's cash, cash equivalents and short-term investments is less than $10.0 million, or (d) the Company commits any material breach of the CyDex CVR Agreement.

Ligand is required by the CyDex CVR Agreement to dedicate at least five experienced full-time employee equivalents per year to the acquired business and to invest at least $1.5 million per year, inclusive of such employee expenses, in the acquired business, through 2015.

At the closing of the acquisition, the Company recorded a $14.9 million contingent liability for amounts potentially due to holders of the CyDex CVRs. The initial fair value of the liability was determined using a discounted cash flow analysis incorporating the estimated future cash flows from potential milestones and revenue sharing. These cash flows were then discounted to present value using a discount rate of 21.6%. The liability will be periodically assessed based on events and circumstances related to the underlying milestones, and the change in fair value will be recorded in the Company's consolidated statements of operations. The carrying amount of the liability may fluctuate significantly and actual amounts paid under the CVR agreements may be materially different than the carrying amount of the liability. The fair value of the liability at June 30, 2011 was $19.2 million.

The components of the purchase price allocation for CyDex are as follows (in thousands):

 

Purchase Consideration:
Cash paid to CyDex shareholders		$	31,572
Estimated fair value of contingent consideration			14,905
Cash payable to CyDex shareholders			4,300
Total purchase consideration		$	50,777

 

 

		(Restated)
Allocation of Purchase Price:
Cash		$	85
Accounts receivable			1,202
Inventory			2,414
In-process research and development			3,200
Intangible assets with definite lives			46,580
Goodwill			14,060
Other assets			1,311
Liabilities assumed			(18,075	)
		$	50,777

The acquired identified intangible assets with definite lives from the acquisition with CyDex are as follows:

 

Acquired Intangible Assets
(in thousands)
Complete technology		$	14,643
Trademark and trade name			2,537
Customer relationships			29,400
		$	46,580

The weighted-average amortization period for the identified intangible assets with definite lives is 20 years.

The Company has allocated $3.2 million of the purchase price of CyDex to acquired In-Process Research and Development (IPR&D). This amount represents the estimated fair value of CyDex's two main proprietary products that have not yet reached technological feasibility and do not have future alternative use as of the date of the merger. The valuation was based on a probability-weighted present value of the expected upfront and milestone payments based on a recently signed letter of intent and term sheet The probability of success takes into account the stages of completion and the risks surrounding successful development and commercialization of the underlying product candidates. These cash flows were then discounted to present value using a discount rate of 21.5%.

The valuation of the complete technology, or CyDex's CAPTISOL technology, was based on a derivative of the discounted cash flow method that estimated the present value of a hypothetical royalty stream derived via the licensing of similar technology. These projected cash flows were then discounted to present value using a discount rate of 20.5%. The valuation of the trademark and trade name was based on the Relief from Royalty method using royalty rates paid in third-party licensing agreements involving similar trade names. These projected cash flows were then discounted to present value using a discount rate of 20.5%.The valuation of the customer relationships was based on a discounted cash flow analysis incorporating the estimated future cash flows from these relationships during their assumed life of 20 years. These cash flows were then discounted to present value using a discount rate of 21.5%.

Had the merger with CyDex been completed as of the beginning of 2011, the Company's pro forma results for the six months ended June 30, 2011 would have been as follows:

 

(in thousands, except per share data)		2011
Revenue		$	11,548
Operating loss			(2,300	)
Net income			8,974
Basic and diluted earnings per share:
Continuing operations		$	0.46
Discontinued operations		$	0.00
Net income (loss)		$	0.46
Basic and diluted weighted average shares			19,623

 

The primary adjustments relate to interest expense on long-term debt, the loss of interest income due to the timing of transaction related payments and amortization of intangible assets. The above pro forma information was determined based on historical results adjusted for the purchase price allocation and estimated related changes in income associated with the merger of CyDex. Due to limited information for CyDex, the Company determined it is impracticable to provide interim pro forma results for 2010.