Stock-Based Compensation

Financial Statement Effects and Presentation. The following table shows total pre-tax, stock-based compensation expense included in the unaudited consolidated condensed statements of income for the three and six months ended July 28, 2013 and July 29, 2012.



	Three Months Ended				Six Months Ended
(in thousands)	July 28, 2013		July 29, 2012		July 28, 2013		July 29, 2012
Cost of sales	$	405	$	297	$	733	$	528
Selling, general and administrative	3,548		2,657		8,430		5,881
Product development and engineering	2,203		1,965		5,619		3,836
Stock-based compensation, pre-tax	$	6,156	$	4,919	$	14,782	$	10,245
Net change in stock-based compensation capitalized into inventory	$	8	$	16	$	85	$	82

Share-based Payment Arrangements

The Company has various equity award plans that provide for granting stock-based awards to employees and non-employee directors of the Company. The plans provide for the granting of several available forms of stock compensation. As of July 28, 2013, the Company has granted options and restricted stock under the plans and has also issued some stock-based compensation outside of the plans, including options and restricted stock issued as inducements to join the Company.

Grant Date Fair Values and Underlying Assumptions; Contractual Terms

The Company uses the Black-Scholes pricing model to value options. For awards classified as equity, stock-based compensation cost is measured at grant date, based on the fair value of the award, and is recognized as an expense over the employee’s or director’s requisite service period. For awards classified as liabilities, stock-based compensation cost is measured at fair value at the end of each reporting date until the date of settlement, and is recognized as an expense over the employee’s or director’s requisite service period. Expected volatilities are based on historical volatility using daily and monthly stock price observations.

The following table summarizes the assumptions used in the Black-Scholes model to determine the fair value of options granted in the three and six months ended July 28, 2013 and July 29, 2012:



	Three Months Ended		Six Months Ended
	July 28, 2013	July 29, 2012	July 28, 2013	July 29, 2012
Expected lives, in years	4.7	4.4 - 4.6	4.2 - 4.7	4.4 - 4.6
Estimated volatility	33%	40%	33% - 35%	40% - 41%
Dividend yield	—	—	—	—
Risk-free interest rate	1.3%	0.70%	0.65% - 1.3%	0.70%
Weighted average fair value on grant date	$10.59	$8.31	$9.33	$9.68

The estimated fair value of restricted stock awards was calculated based on the market price of the Company’s common stock on the date of grant. Some of the restricted stock units awarded in the second quarter of fiscal year 2014 and prior years are classified as liabilities rather than equity. For awards classified as liabilities, the value of these awards is re-measured at the end of each quarter.

Stock Option Awards. The Company has historically granted stock option awards to both employees and non-employee directors. The grant date for these awards is equal to the measurement date. These awards were valued as of the measurement date and are amortized over the requisite vesting period (typically 3-4 years).

A summary of the activity for stock option awards during the first six months of fiscal year 2014 is presented below:




(in thousands, except for per share amounts)	Number of Shares		Weighted Average Exercise Price (per share)		Aggregate Intrinsic Value		Aggregate Unrecognized Compensation		Number of Shares Exercisable	Weighted Average Contractual Term (in years)
Balance at January 27, 2013	2,579		$	18.29	$	29,789	$	3,817	1,937
Options granted	240		32.04
Options exercised	(790	)	16.71		13,982
Options cancelled/forfeited	(12	)	23.56
Balance at July 28, 2013	2,017		$	20.28	$	22,092	$	4,651	1,370
Exercisable at July 28, 2013	1,370		$	17.28	$	19,262				2.4

Restricted Stock. The Company has not granted any restricted stock to employees since fiscal year 2009. There is no outstanding and unvested restricted stock as of July 28, 2013.

Performance Units. The Company grants performance-based vesting restricted stock units to select employees. These awards have a performance condition in addition to a service condition. The performance condition generally relates to the Company’s revenue and operating income measured against internal goals. Under the terms of these awards, assuming the highest performance level of 200% with no cancellations due to forfeitures, the maximum number of shares that can be earned would be 412,500 shares and 402,500 shares settled in cash. The Company would have a liability accrued in the unaudited consolidated condensed balance sheet equal to the value of 402,500 shares on the settlement date, which would be settled in cash. Only cash performance unit awards are classified as liabilities and the value of these awards is re-measured at each reporting date. At July 28, 2013, the performance metrics associated with the outstanding awards issued in fiscal years 2014, 2013 and 2012 are expected to be met at a level which would result in a grant at 100%, 80%, and 97% of target, respectively.

The following table summarizes the activity for performance units for the first six months of fiscal year 2014:



			Subject to Share Settlement		Subject to Cash Settlement					Weighted Average Grant Date		Aggregate		Period Over Which Expected
(in thousands, except for per share amounts)	Total Units		Units		Units		Recorded Liability			Fair Value (per share)		Unrecognized Compensation		to be Recognized (in years)
Balance at January 27, 2013	353		181		172		$	4,422		$	23.50	$	4,754	1.1
Performance units granted	186		93		93					30.82
Performance units vested	(114	)	(57	)	(57	)				16.68
Performance units cancelled/forfeited	(13	)	(7	)	(6	)				25.70
Change in liability							(2,405		)
Balance at July 28, 2013	412		210		202		$	2,017		$	28.62	$	7,646	1.8

Stock Units, Employees. The Company issues stock unit awards to employees which are expected to be settled with stock. The grant date for these awards is equal to the measurement date. These awards are valued as of the measurement date and amortized over the requisite vesting period (typically 4 years).

The following table summarizes the stock unit award activity for the first six months of fiscal year 2014:




(in thousands, except per share amount)	Number of Units		Weighted Average Grant Date Fair Value (per unit)		Aggregate Intrinsic Value (1)		Aggregate Unrecognized Compensation		Weighted Average Period Over Which Expected to be Recognized (in years)
Balance at January 27, 2013	2,558		$	23.41			$	49,374	2.5
Stock units granted	308		32.50
Stock units vested	(504	)	22.59		$	16,317
Stock units forfeited	(97	)	24.60
Balance at July 28, 2013	2,265		$	24.78			$	45,996	2.3


(1)	Reflects the value of Semtech stock on the date that the stock unit vested.

Stock Units, Non-Employee Directors. The Company grants stock unit awards to non-employee directors. These restricted stock units are accounted for as liabilities and accrued in the unaudited consolidated condensed balance sheets because they are cash settled. These awards are vested after 1 year of service. However, because these awards are not typically settled until a non-employee director’s separation from service, the value of these awards is re-measured at the end of each reporting period until settlement. The following table summarizes the activity for stock unit awards for the first six months of fiscal year 2014:




(in thousands, except per share amount)	Number of Units		Recorded Liability		Weighted Average Grant Date Fair Value (per unit)		Aggregate Unrecognized Compensation		Period Over Which Expected to be Recognized (in years)
Balance at January 27, 2013	20		$	4,557	$	24.46	$	253	0.4
Stock units granted	18				35.17
Stock units vested	(20	)			24.46
Stock units forfeited	—				—
Change in liability			537
Balance at July 28, 2013	18		$	5,094	$	35.17	$	518	0.9

As of July 28, 2013, the total number of vested but unsettled stock units for Non-Employee Directors is 161,182 units which are included in the recorded liability.