5. Acquisitions

Validity

On November 7, 2013, or the Acquisition Date, we acquired 100% of the outstanding common and preferred shares and voting interest of a privately held company, Validity Sensors, Inc., or Validity. We accounted for this acquisition using the purchase method for business combinations. The results of Validity’s operations have been included in our consolidated financial statements since the Acquisition Date. Validity was a leading provider of capacitive-based biometric fingerprint authentication solutions for notebook applications. Prior to the acquisition, Validity began targeting its biometric fingerprint authentication solutions for smartphone and tablet applications and, as of the Acquisition Date, had one revenue-generating design win with one customer. This acquisition is intended to bring together substantial synergies through the combination of the Validity technologies and workforce and our financial stability, scale, infrastructure, customer relationships, and technology delivery performance record. Our goal is to gain access to the fast-growing biometrics market, significantly expanding our market opportunity and underscoring our commitment to making smart devices easier to use.

The Acquisition Date fair value of the consideration transferred totaled $127.8 million, which consisted of the following (in thousands):


Cash	$	19,985
Shares issued		70,280
Contingent consideration		37,499

	$	127,764

In connection with the acquisition, we issued 1,577,559 shares of our common stock to the former Validity stockholders valued at $70.3 million based on the closing price of our common stock of $44.55 on the Acquisition Date. The contingent consideration arrangement requires us to make earn-out consideration payments of up to $162.5 million, based primarily on sales, calculated quarterly, ending on March 31, 2016, of certain products embodying Validity fingerprint sensor technology. The earn-out consideration will be payable in cash, except for the initial $16.3 million of contingent consideration, which will be satisfied by delivery of 338,427 shares of our common stock, based on the transaction reference price of $48.278. Under certain conditions, we may be required to deliver additional shares to ensure that at least 40% of the value of consideration transferred to the former Validity stockholders is paid in shares of our common stock.

We estimated the fair value of the contingent consideration using a probability-weighted discounted cash flow model. These fair value measurements were based on significant inputs not observable in the market and thus represent a Level 3 measurement. Key assumptions in applying the probability-weighted discounted cash flow model was a 23% discount rate under three unequally weighted cash flow scenarios reviewed by senior management and our board to assess the transaction.

The estimated fair value of the contingent consideration arrangement as of the Acquisition Date was $37.5 million. The contingent consideration is remeasured to fair value each reporting period and adjustments are recorded through earnings. As of the end of fiscal 2014, the estimated fair value of the contingent consideration was $104.0 million. The increase in the estimated fair value of the contingent consideration during fiscal 2014 was primarily due to the increase in the forecasted unit sales of products embodying Validity fingerprint sensor technology and, to a lesser extent, the increase in our stock price for the portion of contingent consideration to be settled with our stock at the reference price.

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed as of the Acquisition Date (in thousands):


Cash	$	365
Accounts receivable		3,840
Inventory		2,154
Prepaid expenses and other		984
Property and equipment		326
Deferred tax assets		12,242
Acquired intangible assets		76,400
Other assets		1,283

Total identifiable assets acquired		97,594
Accounts payable		2,141
Accrued liabilities		1,497
Non-current deferred tax liabilities		5,327
Non-current taxes payable		700
Other non-current accrued liabilities		500

Net identifiable assets acquired		87,429
Goodwill		40,335

Net assets acquired	$	127,764

Of the $76.4 million of acquired intangible assets, $57.0 million was assigned to in-process research and development projects and will be amortized over estimated useful lives to be determined at the date the underlying projects are determined to be substantively complete; $18.6 million was assigned to developed technology and is amortizing over estimated useful lives of 2-3 years; and $750,000 was assigned to backlog and was amortized during the quarter ended December 31, 2013. We estimated the fair value of the identified intangible assets using a discounted cash flow model for each of the underlying identified intangible assets. These fair value measurements were based on significant inputs not observable in the market and thus represent a Level 3 measurement. Key assumptions in applying the discounted cash flow model to the identified intangible assets included discount rates ranging from 17% to 25%.

In-process research and development consists of next generation fingerprint authentication technology designed for the mobile product and PC markets. Developed technology consists of established fingerprint authentication technology initially designed for and sold into the PC market and adapted for the mobile product market. We anticipate that all in-process research and development projects will be substantially completed within the next three months. The value of goodwill reflects the anticipated synergies of the combined operations and workforce of Validity as of the Acquisition Date.

During fiscal 2014, we made one purchase price allocation adjustment reducing a deferred tax asset by $1.4 million with a corresponding increase in goodwill. As of the end of fiscal 2014, we believe our purchase price allocation is complete and no additional adjustments to the recorded assets and liabilities are required.

In connection with the acquisition, we recognized $1.2 million of indemnification assets, consisting of $700,000 for foreign income tax and $500,000 for foreign service tax. These amounts represent estimated tax settlements plus interest and penalties. Under the merger agreement, we are indemnified for any additional tax liability incurred (as well as other reasonable expenses) before the acquisition.

The Validity fingerprint authentication products are an extension of our existing interactive user interface solution products and are marketed to our existing customer base. We report revenue from these products on a combined basis with our other products based on device type. We continue to operate in one segment and therefore the goodwill applies to a company-wide reporting unit. None of the goodwill is expected to be deductible for income tax purposes.

We recognized approximately $2.0 million of legal and consulting costs that were expensed in fiscal 2014. These costs are included in our consolidated statements of income as selling, general, and administrative expenses.

Prior to the acquisition, we did not have an existing relationship or transactions with Validity.

The consolidated financial statements include $105.4 million of revenue from Validity fingerprint authentication products from the Acquisition Date through the end of fiscal 2014.

The following unaudited pro forma financial information presents the combined results of operations for us and Validity as if the acquisition had occurred at the beginning of fiscal 2012. The unaudited pro forma financial information has been prepared for comparative purposes only and does not purport to be indicative of the actual operating results that would have been recorded had the acquisition actually taken place at the beginning of fiscal 2012, and should not be taken as indicative of future consolidated operating results. Additionally, the unaudited pro forma financial results do not include any anticipated synergies or other expected benefits from the acquisition. The following table presents unaudited pro forma financial results for fiscal 2014 and 2013 (in thousands, except per share data).


	2014		2013
Revenue	$	955,422	$	680,171
Net income		36,095		74,924
Net income per share—diluted		0.96		2.09

Pro forma adjustments used to arrive at pro forma net income for fiscal 2014 and 2013, were as follows (in thousands):


	2014			2013
Buyer transaction costs	$	2,000		$	—
Seller transaction costs		517			—
Inventory adjustment		575			—
Share-based compensation		280			350
Intangible amortization		(8,242	)		(7,618	)
Deferred compensation		47			(75	)

	$	(4,823	)	$	(7,343	)

Renesas SP Drivers

On June 10, 2014, we entered into a stock purchase agreement, or Agreement, to acquire a privately held company, Renesas SP Drivers, Inc., or RSP, a leading provider of small and medium-sized display driver ICs for smartphones and tablets. The transaction was approved by our board of directors, RSP’s boards of directors and the board of directors of the companies that own RSP. The transaction is subject to certain financing and other customary closing conditions and is expected to close in the second quarter of our fiscal 2015.

In connection with the Agreement, we received a commitment from a Wells Fargo for $150 million of senior secured term loans and $150 million of senior secured revolving credit commitments. This acquisition is intended to increase our addressable market and to accelerate our product roadmap for touch-and-display driver integration. The acquisition is expected to be completed by acquiring all outstanding capital stock of RSP for an aggregate base purchase price of JPY48.5 billion (or approximately $475 million based on a Japanese Yen to U.S. Dollar reference conversion rate of JPY102 to US$1). The purchase price is based on cash and other adjustments and is subject to customary adjustments for net working capital, net debt, target inventory, and third party expenses. We incurred approximately $4.7 million in direct acquisition related costs during fiscal 2014, which were expensed as incurred.

The acquisition will be accounted for using the purchase method of accounting in accordance with the business acquisition guidance. Under the purchase accounting method, the total estimated purchase consideration of the acquisition will be allocated to the tangible and identifiable intangible assets acquired and liabilities assumed based on their relative fair values. The excess of the purchase consideration over the net tangible and identifiable intangible assets acquired and liabilities will be recorded as goodwill.