Note 5. Business Combination

On March 29, 2013 (the “closing date”) the Company acquired certain assets and assumed certain liabilities related to the Optical Components Business Unit (the “OCU”) of LAPIS Semiconductor Co., Ltd., a wholly owned subsidiary of Rohm Co., Ltd (“LAPIS”) of Japan with the intention of operating the OCU as an ongoing business. The business is now known as NeoPhotonics Semiconductor. NeoPhotonics Semiconductor is a leader in high speed semiconductor and high speed laser and photodetector devices for communications networks. The Company believes the acquisition will expand the Company’s solutions for high speed telecom and datacom applications and strengthen the Company’s customer base in Japan.

Total consideration for NeoPhotonics Semiconductor was approximately $24.3 million, including cash of $13.1 million and notes payable of $11.1 million. The cash of $13.1 million includes $2.0 million that was withheld and placed into escrow to cover certain indemnity obligations from the closing date through March 29, 2014. The notes payable of $11.1 million are to be paid in three equal installments on the first, second and third anniversaries of the closing date. Each year an additional amount calculated as 1.5% per year of the unpaid balance of the notes becomes due. LAPIS retains a lien on the land and building sold until the third payment is paid. The notes payable to Lapis are denominated in Japanese Yen.

In connection with the acquisition, the Company incurred approximately $5.3 million in acquisition-related transaction costs related to investment banking, legal, accounting and other professional services and transfer taxes related to real property acquired. The acquisition costs were expensed as incurred and were included in operating expenses in the Company’s condensed consolidated statement of operations for the nine months ended September 30, 2013.

The results of operations of NeoPhotonics Semiconductor and the estimated fair values of the assets acquired and liabilities assumed have been included in the Company’s consolidated financial statements since the date of the acquisition. For the three months and nine months ended September 30, 2013, NeoPhotonics Semiconductor‘s contribution to total revenues was $14.0 million and $25.3 million, respectively. The portion of total expenses and net loss associated with NeoPhotonics Semiconductor cannot be separately identified due to the integration with the Company’s operations.

The Company accounted for its acquisition of the NeoPhotonics Semiconductor assets and assumed liabilities as a business combination. NeoPhotonics Semiconductor’s tangible and identifiable intangible assets acquired and liabilities assumed were recorded based upon their estimated fair values as of the closing date of the acquisition. The estimated fair values of the identifiable assets acquired and liabilities assumed approximated the purchase price; therefore, no goodwill was recorded.

The following table summarizes the acquisition accounting and the tangible and intangible assets acquired as of the date of acquisition and subsequent adjustments (in thousands):

Total purchase consideration:
Cash paid	$	13,128
Notes payable		11,130
	$	24,258
Liabilities assumed:
Pension and retirement obligations	$	6,471
Other compensation-related liabilities		1,083
Other current liabilities		1,265
	$	8,819
Fair value of assets acquired:
Inventory	$	13,309
Other current assets		35
Land, property, plant and equipment⁽¹⁾		14,433
Intangible assets acquired:
Developed technology		2,120
Customer relationships		3,180
	$	33,077

⁽¹⁾	Includes land of $3.5 million, buildings of $3.9 million and machinery, equipment, furniture and fixtures of $7.0 million.

The approach for measuring the fair value of the assets acquired and liabilities assumed is described below:

Net Tangible Assets

NeoPhotonics Semiconductor’s tangible assets acquired and liabilities assumed as of March 29, 2013 were recorded at estimated fair value. The Company estimated fair value by adjusting NeoPhotonics Semiconductor’s historical value of property, plant and equipment to an estimate of depreciated replacement cost, adjusted for economic obsolescence. The Company depreciates property, plant and equipment over estimated lives of 2 to 10 years, and records the expense to cost of goods sold and operating expense. The fair value of inventory acquired was determined using a net realizable value approach based upon the expected sales value of the inventory, less any costs to complete and selling costs along with a reasonable profit margin based on historical and expected results.

Intangible Assets

Developed technology represents products that have reached technological feasibility. NeoPhotonics Semiconductor’s current product offerings include high speed semiconductor and high speed laser and photodetector devices for communication networks. The fair value of developed technology intangibles acquired was determined by using a royalty-avoidance method. The share of future revenue relating to current technology was forecasted, using an estimate for obsolescence such that the share declines over time. A royalty rate of two percent was used to calculate royalty savings on that revenue that are avoided since the Company owns the technology and does not need to license it from other parties. The after-tax royalty savings was then discounted to present value using the Company’s discount rate. The Company amortizes the developed technology intangible assets over estimated lives of 4 to 5 years, and amortization expense is recorded to cost of goods sold.

The customer relationships asset represents the value of the ability to sell existing, in-process, and future versions of the technology to the NeoPhotonics Semiconductor existing customer base. The Company utilized the excess earnings method, estimating future cash flows that will result from existing customers given assumed retention rates, and then discounting those flows to their present value using the Company’s discount rate. The Company amortizes the customer relationships intangible asset over an average estimated life of 6 years, and amortization expense is recorded to operating expenses.

The weighted average amortization period for the total amount of intangible assets acquired is 5.4 years.

Pro Forma Financial Information (unaudited)

The following unaudited supplemental pro forma information presents the combined results of operations of NeoPhotonics Corporation and NeoPhotonics Semiconductor for the three and nine months ended September 30, 2013 and 2012, as if the NeoPhotonics Semiconductor acquisition had been completed at the beginning of fiscal 2012. The pro forma financial information includes adjustments related to one time charges, amortization of fair value adjustments and elimination of NeoPhotonics Semiconductor’s revenues and cost of goods sold on sales to the Company in the appropriate pro forma periods as though the companies were combined as of the beginning of 2012. As a result of the elimination adjustments, revenues were reduced by $1.9 million for the nine months ended September 30, 2013 and were reduced by $1.5 million and $2.9 million for the three and nine months ended September 30, 2012, respectively, and cost of goods sold was reduced by $1.8 million for the nine months ended September 30, 2013 and was reduced by $1.3 million and $2.5 million in the three and nine months ended September 30, 2012, respectively. The pro forma financial information for the nine months ended September 30, 2013 also included elimination of $5.3 million in transaction costs and cost of goods sold was decreased by $1.1 million in the three months ended September 30, 2013 and was decreased by $2.9 million and increased by $4.2 million in the nine months ended September 30, 2013 and 2012, respectively, due to a change in the value of inventory as a result of acquisition accounting.

The unaudited pro forma results do not assume any operating efficiencies as a result of the consolidation of operations (in thousands, except per share data):

	Three Months Ended September 30,					Nine Months Ended September 30,
	2013			2012		2013			2012
Revenue	$	76,814		$	81,816	$	220,558		$	228,158
Net income (loss)	$	(8,146	)	$	3,499	$	(18,942	)	$	(10,822	)
Basic net income (loss) per share	$	(0.26	)	$	0.12	$	(0.61	)	$	(0.39	)
Diluted net income (loss) per share	$	(0.26	)	$	0.11	$	(0.61	)	$	(0.39	)

The pro forma financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved had the acquisition taken place at the beginning of the period presented, nor does it intend to be a projection of future results.