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 for the three and six months ended July 31, 2016 and July 26, 2015.



	Three Months Ended						Six Months Ended
(in thousands)	July 31, 2016			July 26, 2015			July 31, 2016			July 26, 2015
Cost of sales	$	372		$	400		$	749		$	875
Selling, general and administrative	4,183			(141		)	8,036			3,073
Product development and engineering	1,542			2,076			3,019			4,333
Stock-based compensation	$	6,097		$	2,335		$	11,804		$	8,281
Net change in stock-based compensation capitalized into inventory	$	(13	)	$	204		$	(18	)	$	279

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 2017 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 and six months ended July 31, 2016 and July 26, 2015, respectively:



	Three Months Ended		Six Months Ended
	July 31, 2016	July 26, 2015	July 31, 2016	July 26, 2015
Expected lives, in years	4.2	4.2	4.1 - 4.5	4.2 - 4.3
Estimated volatility	32%	32%	32%	29% - 32%
Dividend yield	—	—	—	—
Risk-free interest rate	1.3%	1.3%	1.1% - 1.3%	1.24% - 1.29%
Weighted average fair value on grant date	$5.84	$6.50	$4.86	$7.32

Stock Options. The Company has historically granted stock options to both employees and non-employee directors. The fair values of these grants were measured on the grant date. The grant dates for these awards are 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 3-4 years).

The following table summarizes the activity for stock options for the six months ended July 31, 2016:




(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 31, 2016	1,507		$	25.18	$	962	$	3,748	775
Options granted	228		17.61
Options exercised	(53	)	17.64		292
Options cancelled/forfeited	(78	)	22.52
Balance at July 31, 2016	1,604		$	24.48	$	4,311	$	3,542	865
Exercisable at July 31, 2016	865		$	26.56	$	1,073				2.4

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 net revenue and non-GAAP 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 582,032 shares and an additional 582,032 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 582,032 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 July 31, 2016, the performance metrics associated with the outstanding awards issued in fiscal years 2017 and 2016 are expected to be met at a level which would result in a grant at 190% and 0% 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 acquisition. These awards have a performance condition in addition to a service condition. The performance metrics are determined based on a pre-defined net 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 24,000. At July 31, 2016, the performance metrics associated with the outstanding awards issued in fiscal year 2016 are not expected to be met which would result in none of the shares being issued.

The performance-based restricted stock 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 six months ended July 31, 2016:



			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 31, 2016	384		203		181		$	237	$	26.57	$	1,925	1.5
Performance-based units granted	231		116		115				17.51
Performance-based units vested	—		—		—				—
Performance-based units cancelled/forfeited	(12	)	(6	)	(6	)			17.51
Change in liability							321
Balance at July 31, 2016	603		313		290		$	558	$	23.29	$	7,989	1.6

Changes in the liability associated with performance-based restricted stock units, which is recorded in “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 fair value of the awards was determined to be $17.26 and $14.88 for Tranche 1 and Tranche 2, respectively, on the grant date by application of the Monte Carlo simulation model.

The following table summarizes the activity for market performance restricted stock units for the six months ended July 31, 2016:



		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 31, 2016	220	$	15.59	$	143	0.1
Market performance units granted	—	—
Market performance units vested	—	—
Market performance units cancelled/forfeited	—	—
Balance at July 31, 2016	220	$	15.59	$	—	0.0

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 31, 2016:



(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 31, 2016	2,032		$	23.70			$	35,692	2.4
Stock units granted	629		18.38
Stock units vested	(360	)	27.82		$	7,152
Stock units forfeited	(128	)	20.56
Balance at July 31, 2016	2,173		$	21.67			$	35,623	2.4


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

Restricted Stock Units, Cash Settled, Non-Employee Directors. The Company maintains a compensation program pursuant to which restricted stock units are granted to the Company’s directors that are not employed by the Company or any of its subsidiaries. In June 2015, the Company changed its director compensation program so that a portion of the restricted stock units granted under the program would be settled in cash and a portion would be settled in stock. Restricted stock units awarded under the program are scheduled to vest on the earlier of (i) one year after the grant date or (ii) the day immediately preceding the annual meeting of shareholders in the year following the grant. The portion of a restricted stock unit award under the program that is to be settled in cash will, subject to vesting, be settled when the director who received the award separates from the board of directors. The portion of a restricted stock unit award under the program that is to be settled in stock will, subject to vesting, be settled promptly following vesting. There were no changes to the terms and conditions of the existing awards.

The restricted stock units that are to be settled in cash are accounted for as liabilities. 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 settled in cash for the six months ended July 31, 2016:



(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 31, 2016	28		$	3,870	$	19.70	$	221	0.4
Stock units granted	25				23.40
Stock units vested	(30	)			19.65
Stock units forfeited	—				—
Change in liability			565
Balance at July 31, 2016	23		$	4,435	$	23.67	$	580	0.9

As of July 31, 2016, the total number of vested but unsettled restricted stock units for non-employee directors is 173,657 units. As of July 31, 2016, $4.4 million of the liability associated with these awards is included in “Other long-term liabilities” within the condensed consolidated balance sheet.

Restricted Stock Units, Stock Settled, Non-Employee Directors. As a result of the June 2015 changes to the Company’s director compensation program, beginning in July 2015, the Company began granting new restricted stock units to non-employee Directors which are expected to be settled with stock at the time of vesting. 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 one year).

The following table summarizes the non-employee directors’ activity for restricted stock units settled with stock for the six months ended July 31, 2016:



(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		Period Over Which Expected to be Recognized (in years)
Balance at January 31, 2016	24		$	19.70			$	186	0.4
Stock units granted	21		23.40
Stock units vested	(25	)	24.16		$	—
Stock units forfeited	—		—
Balance at July 31, 2016	20		$	23.67			$	70	0.9


(1)	There was no vesting during the reported period. This value would typically represent the value of Semtech Corporation stock on the date that the restricted stock unit vested.

Modification of Awards

On December 19, 2014 and August 17, 2015, the Company modified the equity awards of certain executive officers by providing for the acceleration of vesting upon termination of their employment in certain circumstances in connection with a change in control of the Company. These modifications impacted the stock awards of 12 executive employees and resulted in no incremental compensation cost for the fiscal year ended January 31, 2016 or the three or six month periods ended July 31, 2016 and July 26, 2015.