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 operations captions for the three months ended April 26, 2015 and April 27, 2014, respectively.



	Three Months Ended
(in thousands)	April 26, 2015		April 27, 2014
Cost of sales	$	475	$	363
Selling, general and administrative	3,214		4,065
Product development and engineering	2,257		2,419
Stock-based compensation	$	5,946	$	6,847
Net change in stock-based compensation capitalized into inventory	$	74	$	(9	)

Stock-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 April 26, 2015, 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 three months of fiscal year 2016 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 period 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 months ended April 26, 2015 and April 27, 2014, respectively:



	Three Months Ended
	April 26, 2015	April 27, 2014
Expected lives, in years	4.2 - 4.3	3.0 - 4.4
Estimated volatility	29%	33% - 34%
Dividend yield	—	—
Risk-free interest rate	1.24% - 1.27%	1.26% - 1.31%
Weighted average fair value on grant date	$7.38	$7.22

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 three months ended April 26, 2015:




(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 25, 2015	1,763		$	23.70	$	7,722	$	4,688	986
Options granted	170		28.60
Options exercised	(114	)	15.60		1,321
Options cancelled/forfeited	(51	)	24.31
Balance at April 26, 2015	1,768		$	24.68	$	3,024	$	4,962	1,032
Exercisable at April 26, 2015	1,032		$	22.80	$	3,017				2.4

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 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 award 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 award recipients must be employed for the entire three-year period, which is the explicit service and 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 547,032 shares and an additional 547,032 shares would be settled in cash. The Company would have a liability accrued under “Other liabilities” within the condensed consolidated balance sheet equal to the value of 547,032 shares on the settlement date, which would be settled in cash. Only cash performance-based restricted stock unit awards are classified as liabilities and the value of these awards is re-measured at each reporting date. At April 26, 2015, the performance metrics associated with the outstanding awards issued in fiscal years 2016, 2015 and 2014 are expected to be met at a level which would result in a grant at 100%, 95%, and 75% of target, respectively.

In the first quarter of fiscal year 2016 the Company granted performance-based vesting restricted stock units to select employees as part of the EnVerv transaction. These awards have a performance condition in addition to a service condition. The performance metrics are determined based on a pre-defined revenue target. In addition to the performance vesting condition, these awards have a requisite four year vesting term (which is also the requisite vesting period) whereby 25% will vest, subject to attainment of the performance condition, on each anniversary of the grant date. Under the terms of these awards, assuming the highest performance level of 100% with no cancellations due to forfeitures, the maximum number of shares that can be earned would be 54,000. At April 26, 2015, the performance metrics associated with the outstanding awards issued in fiscal year 2016 are expected to be met at a level which would result in a grant at 54,000 shares.

The Performance Units are valued as of the measurement date and expense is recognized on a straight line basis for the awards expected to vest based on the probability of attainment of the performance condition for each separately vesting portion of the award.

The following table summarizes the activity for performance-based restricted stock units for the three months ended April 26, 2015:



			Subject to Share Settlement		Subject to Cash Settlement					Weighted Average Grant Date Fair Value (per unit)		Aggregate Unrecognized Compensation		Weighted Average Period Over Which Expected to be Recognized (in years)
(in thousands, except for per unit amounts)	Total Units		Units		Units		Recorded Liability			Weighted Average Grant Date Fair Value (per unit)		Aggregate Unrecognized Compensation
Balance at January 25, 2015	426		211		215		$	1,891		$	27.17	$	6,164	1.6
Performance-based units granted	235		145		90					28.60
Performance-based units vested	—		—		—					—
Performance-based units cancelled/forfeited	(61	)	(30	)	(31	)				27.83
Change in liability							(18		)
Balance at April 26, 2015	600		326		274		$	1,873		$	27.67	$	10,161	2.0

Changes in the liability associated with performance-based restricted stock units, which is recorded in “Other current liabilities” and “Other long-term liabilities” within the condensed consolidated balance sheets, is due to changes in proportionate vesting and estimated forfeitures, re-measurement adjustments related to changes in market value and changes in the expected performance results.

Market Performance Restricted Stock 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 three months of fiscal year 2015 for both Tranche 1 and Tranche 2.

Tranche 1:



	Three Months Ended
	April 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:



	Three Months Ended
	April 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 restricted stock units for the three months ended April 26, 2015:



		Weighted Average Grant Date Fair Value (per unit)		Aggregate Unrecognized Compensation		Period Over Which Expected to be Recognized (in years)
(in thousands, except for per unit amounts)	Total Units	Weighted Average Grant Date Fair Value (per unit)		Aggregate Unrecognized Compensation		Period Over Which Expected to be Recognized (in years)
Balance at January 25, 2015	220	$	15.59	$	—	1.2
Market performance units granted	—	—
Market performance units vested	—	—
Market performance units cancelled/forfeited	—	—
Balance at April 26, 2015	220	$	15.59	$	1,286	0.7

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 three months ended April 26, 2015:



(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 25, 2015	2,138		$	26.43			$	44,506	2.4
Restricted stock units granted	266		28.60
Restricted stock units vested	(275	)	27.66		$	7,797
Restricted stock units forfeited	(132	)	25.98
Balance at April 26, 2015	1,997		$	26.58			$	43,649	2.4


(1)	Reflects the value of Semtech Corporation 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 because they are cash settled. These awards are vested after one 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 restricted stock units for the three months ended April 26, 2015:



(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 25, 2015	24	$	5,214		$	26.59	$	275	0.4
Restricted stock units granted	—				—
Restricted stock units vested	—				—
Restricted stock units forfeited	—				—
Change in liability		(529		)
Balance at April 26, 2015	24	$	4,685		$	26.59	$	101	0.2

As of April 26, 2015, the total number of vested but unsettled restricted stock units for non-employee directors is 202,780 units. As of April 26, 2015, $0.5 million of the liability associated with these awards is included in “Accrued liabilities” within the condensed consolidated balance sheet, with the remainder of the liability included in “Other long-term liabilities” within the condensed consolidated balance sheet.