Stock-Based Compensation

Financial Statement Effects and Presentation. The following table summarizes pre-tax, stock-based compensation expense included in the unaudited condensed consolidated statements of income captions for the three and six months ended July 27, 2014 and July 28, 2013.



	Three Months Ended				Six Months Ended
(in thousands)	July 27, 2014		July 28, 2013		July 27, 2014		July 28, 2013
Cost of sales	$	355	$	405	$	718	$	733
Selling, general and administrative	3,448		3,548		7,513		8,430
Product development and engineering	2,472		2,203		4,891		5,619
Stock-based compensation, pre-tax	$	6,274	$	6,156	$	13,121	$	14,782
Net change in stock-based compensation capitalized into inventory	$	37	$	8	$	28	$	85

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-based compensation. As of July 27, 2014, the Company has granted stock options, restricted stock and restricted stock units under the plans and has also issued some stock-based compensation outside of the plans, including stock options, restricted stock and restricted stock units 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 stock options. The estimated fair value of restricted stock units, for which vesting is not linked to a market condition, is calculated based on the market price of the Company’s common stock on the date of grant. For restricted stock units that vest according to a market condition, the Company uses a Monte Carlo simulation model to value the award.

Some of the restricted stock units granted in the first six months of fiscal year 2015 and prior years are classified as liabilities rather than equity. For grants classified as equity, stock-based compensation cost is measured at the grant date, based on the fair value of the award, and is recognized as an expense over the grantee’s requisite service period. For grants 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 grantee’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 stock options granted in the three and six months ended July 27, 2014 and July 28, 2013:



	Three Months Ended		Six Months Ended
	July 27, 2014	July 28, 2013	July 27, 2014	July 28, 2013
Expected lives, in years	4.3 - 4.4	4.7	3.0 - 4.4	4.2 - 4.7
Estimated volatility	33%	33%	33% - 34%	33% - 35%
Dividend yield	—	—	—	—
Risk-free interest rate	1.30% - 1.43%	1.30%	1.26% - 1.43%	0.65% - 1.30%
Weighted average fair value on grant date	$7.43	$10.59	$7.26	$9.33

Stock Option Awards. The Company has historically granted stock options to both employees and non-employee directors. The fair value of these grants was measured on the grant date and is being recognized as an expense over the requisite vesting period (typically 3-4 years).

The following table summarizes the activity for stock options for the six months ended July 27, 2014:




(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 26, 2014	1,935		$	21.33	$	7,722	$	4,354	1,275
Options granted	261		24.92
Options exercised	(353	)	16.94		3,102
Options cancelled/forfeited	(31	)	26.71
Balance at July 27, 2014	1,812		22.61		4,425		$	4,846	1,112
Exercisable at July 27, 2014	1,112		$	19.58	$	4,383				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 27, 2014.

Performance-based Restricted Stock Units. The Company grants performance-based restricted stock units to select employees. These awards have a performance condition in addition to a service condition. The performance metrics are determined based on a pre-defined cumulative three-year performance of the Company’s revenue and operating income measured against internal goals. The performance-based unit which is granted in any fiscal year will be tied to the Company’s performance of that fiscal year and the succeeding two fiscal years. The performance-based unit award recipient must be employed for the entire three-year period, which is the requisite service period, and be an active employee at the time of vesting of the awards (cliff vesting at the end of the third year). 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 522,532 shares and an additional 522,532 shares would be settled in cash. The Company would have a liability accrued under “Other liabilities” within the condensed consolidated balance sheets equal to the value of 522,532 shares on the settlement date, which would be settled in cash. Only cash performance-based unit awards are classified as liabilities and the value of these awards is re-measured at each reporting date. At July 27, 2014, the performance metrics associated with the outstanding awards issued in fiscal years 2015, 2014 and 2013 are expected to be met at a level which would result in a grant at 100%, 87%, and 0% of target, respectively.

The following table summarizes the activity for performance-based restricted stock units for the first six months ended July 27, 2014:



			Subject to Share Settlement		Subject to Cash Settlement					Weighted Average Grant Date		Aggregate		Period Over Which Expected
(in thousands, except for per unit amounts)	Total Units		Units		Units		Recorded Liability			Fair Value (per unit)		Unrecognized Compensation		to be Recognized (in years)
Balance at January 26, 2014	376		192		184		$	1,305		$	28.50	$	3,893	1.3
Performance-based units granted	256		128		128					24.74
Performance-based units vested	(93	)	(52	)	(41	)				23.36
Performance-based units cancelled/forfeited	(17	)	(9	)	(8	)				25.51
Change in liability							(318		)
Balance at July 27, 2014	522		259		263		$	987		$	27.57	$	7,577	1.9

The liability associated with performance-based restricted stock units, which is recorded in “Other liabilities” within the condensed consolidated balance sheets, has been reduced by $0.3 million in the first six months of fiscal year 2015 due to vesting in the first quarter of fiscal year 2014, forfeitures, re-measurement adjustments and change in the expected performance results.

Market Performance Units. On February 26, 2014, the Company granted its CEO restricted stock units with a market performance condition. The award is eligible to vest during the period commencing February 26, 2014 and ending February 26, 2019 (the “Performance Period”) as follows: 30% of the restricted stock units covered by the award will vest if, during any consecutive 120 calendar day period that commences and ends during the Performance Period, the average per-share closing price of the Company’s common stock equals or exceeds $35.00 (“Tranche 1”) and the award will vest in full if, during any consecutive 120 calendar day period that commences and ends during the Performance Period, the average per-share closing price of the Company’s common stock equals or exceeds $40.00 (“Tranche 2”). The award will also vest if a majority change in control of the Company occurs during the Performance Period and, in connection with such event, the Company’s stockholders become entitled to receive per-share consideration having a value equal to or greater than $40.00.

The following tables summarize the assumptions used in the Monte Carlo simulation model to determine the fair value of restricted stock units granted in the first quarter of fiscal year 2015 for both Tranche 1 and Tranche 2. The Company did not grant any restricted stock units that vest according to a market performance conditions in the second quarter of fiscal year 2015. The Company did not grant any restricted stock units that vest according to a market performance condition in the three and six months ended July 28, 2013.

Tranche 1:



	Six Months Ended
	July 27, 2014
Expected lives, in years	1.6
Estimated volatility	34%
Dividend yield	—
Risk-free interest rate	1.50%
Fair value on grant date	$17.26

Tranche 2:



	Six Months Ended
	July 27, 2014
Expected lives, in years	2.1
Estimated volatility	34%
Dividend yield	—
Risk-free interest rate	1.50%
Fair value on grant date	$14.88

The following table summarizes the activity for market performance units for the six months ended July 27, 2014:



		Weighted Average Grant Date		Aggregate		Period Over Which Expected
(in thousands, except for per unit amounts)	Total Units	Fair Value (per unit)		Unrecognized Compensation		to be Recognized (in years)
Balance at January 26, 2014	—	$	—	$	—	0.0
Market performance units granted	220	15.59
Market performance units vested	—	—
Market performance units cancelled/forfeited	—	—
Balance at July 27, 2014	220	$	15.59	$	2,664	1.5

Restricted Stock Units, Employees. The Company grants restricted stock units 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 recognized as an expense over the requisite vesting period (typically 4 years).

The following table summarizes the employees’ restricted stock unit activity for the six months ended July 27, 2014:



(in thousands, except for per unit amounts)	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 26, 2014	2,195		$	27.18			$	49,563	2.5
Restricted stock units granted	333		24.18
Restricted stock units vested	(319	)	27.37		$	7,905
Restricted stock units forfeited	(142	)	26.65
Balance at July 27, 2014	2,067		$	26.71			$	44,313	2.3


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

Restricted Stock Units, Non-Employee Directors. The Company grants restricted stock units to non-employee directors. These restricted stock units are accounted for as liabilities and accrued under “Other liabilities” in the condensed consolidated 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 non-employee directors’ activity for stock units for the six months ended July 27, 2014:



(in thousands, except for per unit amounts)	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 26, 2014	18		$	3,981		$	35.17	$	177	0.4
Restricted stock units granted	24					26.59
Restricted stock units vested	(18	)				35.17
Restricted stock units forfeited	—					—
Change in liability			(39		)
Balance at July 27, 2014	24		$	3,942		$	26.59	$	478	0.9

As of July 27, 2014, the total number of vested but unsettled restricted stock units for non-employee directors is 179,092 units. The liability associated with these awards as of July 27, 2014 and January 26, 2014, respectively, is included in “Other liabilities” within the condensed consolidated balance sheets.