7. Acquisition

Energy Micro

On July 1, 2013, the Company acquired Energy Micro AS, a late-stage private company. Energy Micro designed and developed energy-efficient 32-bit microcontrollers based on ARM® Cortex-M architecture. Energy Micro’s energy-friendly solutions are designed to enable a broad range of power-sensitive applications for the Internet of Things (IoT), including smart energy, home automation, security and portable electronics markets.

The Company acquired Energy Micro for approximately $140.6 million, including: 1) Initial consideration of $107.4 million; 2) Deferred consideration in the form of a promissory note with an estimated fair value of $19.2 million at the date of acquisition (the promissory note was exchanged for approximately 0.5 million shares of the Company’s restricted stock after a mandatory two-month creditor notice.); and 3) Contingent consideration (the “Earn-Out”) with an estimated fair value of $14.0 million at the date of acquisition. The Earn-Out is payable up to approximately $33.3 million based on the extent to which the annual revenue growth rate from certain Energy Micro and Silicon Laboratories products (the “Earn-Out Products”) exceeds 25% per year, over a five-year period from fiscal 2014 through 2018 (the “Earn-Out Period”). The Earn-Out is payable on an annual basis and in no event shall exceed $6,666,666 per year, unless revenue from the Earn-Out Products exceeds $400 million in a single fiscal year during the Earn-Out Period (in which case, the entire Earn-Out amount less any amounts previously paid will become payable). Approximately $20.3 million of the initial consideration was held in escrow by the Company as security for breaches of representations and warranties and certain other expressly enumerated matters. The escrow obligation was recorded in other non-current liabilities in the Consolidated Balance Sheet.

A portion of the Earn-Out (28.76%) is contingent on the continued employment of certain key employees for the three years following the acquisition date (the “Departure Percentage”). The Departure Percentage was accounted for as a transaction separate from the business combination based on its economic substance and will be recorded as post-combination compensation expense in the Company’s financial statements during the Earn-Out period.

The Company recorded the purchase of Energy Micro using the acquisition method of accounting and accordingly, recognized the assets acquired and liabilities assumed at their fair values as of the date of the acquisition. The results of Energy Micro’s operations are included in the Company’s consolidated results of operations beginning on the date of the acquisition. Pro forma information related to this acquisition has not been presented because it would not be materially different from amounts reported. The Company recorded approximately $2.4 million of acquisition-related costs in selling, general and administrative expenses during the nine months ended September 28, 2013.

The Company believes that this strategic acquisition will accelerate its deployment of energy-friendly solutions across the IoT industries, while further scaling the Company’s engineering team. These factors contributed to a purchase price that was in excess of the fair value of the net assets acquired and, as a result, the Company recorded goodwill. The goodwill is not deductible for tax purposes. The purchase price was allocated as follows (in thousands):

	Amount			Weighted-Average Amortization Period (Years)
Intangible assets:
In-process research and development	$	18,600		Not amortized
Core and developed technology	29,100			7
Customer relationships	6,400			8
Trademarks	1,300			8
	55,400
Cash and cash equivalents	919
Other current assets	5,516
Goodwill	97,023
Other non-current assets	5,917
Current liabilities	(6,255		)
Non-current deferred tax liabilities, net	(6,212		)
Long-term debt	(8,434		)
Other non-current liabilities	(3,292		)
Total purchase price	$	140,582

The allocation of the purchase price is preliminary and subject to change, primarily for the valuation of consideration, income tax matters, acquired customer-related contracts, and certain other assets and accruals. Accordingly, adjustments may be made to the values of the assets acquired and liabilities assumed as additional information is obtained about the facts and circumstances that existed at the valuation date.

In-process research and development (IPR&D) represents acquired technology that had not achieved technological feasibility as of the acquisition date and had no alternative future use. The IPR&D recorded in connection with the acquisition of Energy Micro consisted of a multi-protocol wireless RF solution. The fair value of this technology was determined using the income approach. The discount rate applicable to the cash flows was 13.0%. The remaining research and development efforts include additional design, integration and testing. The significant risks associated with the successful completion of this project include the Company’s potential inability to finish the product designs, produce working models and gain customer acceptance. The Company does not expect the products derived from this technology to begin to contribute to revenues prior to fiscal 2014.

Corporate Headquarters Buildings

The Company leased facilities at 400 W. Cesar Chavez (“400 WCC”) and 200 W. Cesar Chavez (“200 WCC”) in Austin, Texas for its corporate headquarters. During the terms of the leases, the Company had options to purchase the buildings for approximately $44.3 million for 400 WCC and $50.1 million for 200 WCC. In September 2012, the Company exercised such options and purchased the facilities.

The buildings are located on land which is leased through 2099 from a third party. The rents for these ground leases were prepaid for the term of the leases by the previous lessee. The first floor of each building was leased to the same third party for the term of the ground leases. The base rents for the first floor leases were prepaid to the previous owner of the buildings. Portions of the remaining floors were also leased to other tenants.

The Company determined that the purchase of the facilities represented a business combination. Under the acquisition method of accounting, the assets acquired and liabilities assumed were recorded at their fair values as of the date of the acquisition. The purchase price was allocated as follows (in thousands):

	Amount
Buildings	$	90,900
Leasehold interest in ground leases	23,840
Acquired unfavorable leases	(11,925		)
Lease-related charges	(8		)
Net gain on purchase	(8,457		)
Total purchase price	$	94,350

The buildings and leasehold interest in ground leases will be depreciated on a straight-line basis over their estimated useful lives of 40 years and 86 years, respectively. Acquired unfavorable leases represent the difference between contractual minimum rental payments due under previously-existing leases in each building and the market rates of those same leases. This amount was recorded in other non-current liabilities in the Consolidated Balance Sheet and will be amortized to rental income over the estimated terms of the leases.

The purchase of the facilities resulted in a net gain of approximately $8.5 million, which was recorded in selling, general and administrative expenses in the Consolidated Statement of Income. The gain resulted primarily because the assets acquired and liabilities assumed were recorded at their fair values as of the date of the acquisition, which was substantially higher than the purchase prices of the facilities. The purchase prices were fixed at the beginning of the two leases in March 2006 and March 2008. While market prices for such facilities increased over the terms of the leases, the purchase prices remained the same.