NOTE 4. ACQUISITIONS

Roche Madison

On October 21, 2011, the Company entered into a Stock and Asset Purchase Agreement (the “RNAi Purchase Agreement”) with Hoffmann-La Roche Inc. and F Hoffmann-La Roche Ltd (collectively, “Roche”), pursuant to which the Company purchased from Roche (i) all of the outstanding common stock of Roche Madison Inc. (“Roche Madison”, now “Arrowhead Madison”) and (ii) the intellectual property rights then held by Roche related to its RNAi business and identified in the RNAi Purchase Agreement (the “Transaction”). In consideration for the purchase of Roche Madison and the Roche RNAi assets, the Company issued to Roche a promissory note with a principal value of $50,000 and 1,288,158 shares of Common Stock.

Pursuant to the RNAi Purchase Agreement, Roche has a right of first negotiation on certain product candidates developed by the Company and its affiliates relating to the purchased assets. If the Company proposes to out-license or enters into substantive negotiations to out-license, any Clinical Candidate or Existing Candidate (as such terms are defined in the RNAi Purchase Agreement), the Company must give notice of the Candidate it proposes to out-license and negotiate exclusively and in good faith with Roche for 90 days regarding the applicable out-license. This right of first negotiation applies to all Existing Candidates (as defined in the RNAi Purchase Agreement) and the first five Clinical Candidates for which the Company delivers notice to Roche and subsequently enters into an out-license.

In addition to the consideration paid by the Company as per the closing terms, the Company is obligated to make certain royalty and milestone payments to Roche upon the occurrence of certain events. For certain product candidates that are developed by the Company that are covered by a valid claim by the patent rights transferred in the Transaction for which the Company and Roche do not enter into a licensing arrangement, the Company will be obligated to pay a 3% royalty on Net Sales (as defined in the RNAi Purchase Agreement), provided that the royalty rate may be reduced or offset in certain circumstances. The obligation to pay royalties on such candidates will last until the later of (i) the expiration of the last to expire patent right related to such product candidate that was transferred in the Transaction and (ii) ten years after the first commercial sale of such product candidate.

The Company will also be obligated to make cash payments to Roche upon the achievement of various milestones for certain clinical candidates, for which the Company and Roche do not enter into a licensing arrangement, including the first regulatory approval in certain jurisdictions, and upon certain annual sales milestones for candidates that receive regulatory approval. The potential payments range from $2,500,000 to $6,000,000 per milestone. At the time of acquisition, the Company’s estimate of future payments for potential royalties and milestones had a net present value of $84,935 which was recorded as contingent consideration as a part of other noncurrent liabilities. Contingent consideration is calculated by modeling research and development activities for clinical candidates, forecasting timelines to market, and using “peak sales” estimate modeling, cash flows and potential milestone and royalty payments are calculated. The modeling assumes certain success rates, and discount factors related to riskiness of projects and the time value of money to calculate a net present value of future consideration payments to Roche. These estimates are based on many unknown variables that are difficult to estimate, and due to the extended process of drug development prior to marketing of drug candidates, the models must extend many years into the future. Such predictions are inherently uncertain. Each year, the Company re-evaluates its contingent consideration, and if material, makes adjustments to the recorded liability. Any adjustment to the contingent consideration liability is reflected in the Company’s Statement of Operations. As of September 30, 2013, the contingent consideration liability had been increased by $1.4 million, which is recorded as a part of other noncurrent liabilities on the Company’s Consolidated Balance Sheet. For additional information related to our valuation of this obligation, see Note 11, Fair Value Measurements.

The following table summarizes the estimated fair values at the date of acquisition:

Current assets	$	432,709
Property and equipment		7,215,206
Intangible assets		1,174,935
Other noncurrent assets		6,264
Current liabilities		(414,122	)
Noncurrent liabilities		(1,570,072	)
Gain on purchase		(1,576,106	)
Total purchase consideration	$	5,268,814

The purchase consideration was composed of the following:

Promissory note due Roche	$	50,000
Contingent consideration		84,935
Shares issued to Roche		5,133,879
Total purchase consideration	$	5,268,814

We estimated the fair value of the assets and liabilities acquired through various valuation techniques including a market approach and an income approach. Because the net identifiable tangible and intangible assets and liabilities were in excess of the purchase price, a gain on the purchase of $1.6 million was recorded. The most significant assets capitalized were research equipment and certain in-process research and development. We believe that we were able to acquire these assets at a reasonable purchase price and generate a gain on the transaction due in part from the seller’s desire to exit the relatively early stage of the RNAi business, as compared to the seller’s other business operations, as well as the seller’s desire to dispose of certain on-going costs associated with the facility, primarily lease costs and personnel costs, which were synergistic to the Company’s strategy to establish a research facility to advance development efforts for its drug product candidates.

Alvos Therapeutics

On April 5, 2012, the Company entered into a Stock Purchase Agreement to purchase all of the outstanding shares of Alvos Therapeutics, Inc., (“Alvos”), a privately held company that licensed a large platform of proprietary human-derived Homing Peptides, and the method for their discovery, from MD Anderson Cancer Center. In conjunction with the acquisition, Arrowhead hired one employee from Alvos. In exchange for all of the outstanding shares of Alvos, Arrowhead issued an upfront payment of 315,457 shares of Common Stock. The former Alvos stockholders are also eligible to receive additional issuances of stock valued at up to $23.5 million at the time of issuance based on the future achievement of clinical, regulatory and sales milestones. Based on the Company’s estimate of future payments, a net present value of $88,686 was calculated as contingent consideration, and is recorded as a part of other noncurrent liabilities. Similar to contingent consideration related to the Roche Madison acquisition, a forecasting model was used to determine potential future payments to the former shareholders of Alvos. Each year, the Company re-evaluates its contingent consideration, and if material, makes adjustments to the recorded liability. Any adjustment to the contingent consideration liability is reflected in the Company’s Statement of Operations. No adjustments to this contingent consideration have been made since the date of acquisition. For additional information related to our valuation of this obligation, see Note 11, Fair Value Measurements.

The following table summarizes the estimated fair values at the date of acquisition:

Current assets	$	29,332
In-process R&D		2,172,387
Current liabilities		(113,033	)
Total purchase consideration	$	2,088,686

The purchase consideration was comprised solely of shares of Arrowhead Common Stock issued to the former shareholders of Alvos Therapeutics, Inc.

Shares issued		315,457
Price per share	$	6.34
Share consideration	$	2,000,000
Contingent consideration		88,686
Total purchase consideration	$	2,088,686