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EXCEL - IDEA: XBRL DOCUMENT - SEMTECH CORPFinancial_Report.xls
EX-32.2 - SECTION 906 CFO CERTIFICATION - SEMTECH CORPsmtc-07272014xex322.htm
EX-32.1 - SECTION 906 CEO CERTIFICATION - SEMTECH CORPsmtc-07272014xex321.htm
EX-31.2 - SECTION 302 CFO CERTIFICATION - SEMTECH CORPsmtc-07272014xex312.htm
EX-31.1 - SECTION 302 CEO CERTIFICATION - SEMTECH CORPsmtc-07272014xex311.htm


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 
____________________________________
FORM 10-Q
____________________________________
(Mark One)
x
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended July 27, 2014
or
o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from             to             
Commission File Number 1-6395
____________________________________ 
SEMTECH CORPORATION
(Exact name of registrant as specified in its charter)
 ____________________________________
 
 
 
Delaware
 
95-2119684
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)

200 Flynn Road, Camarillo, California, 93012-8790
(Address of principal executive offices, Zip Code)

Registrant’s telephone number, including area code: (805) 498-2111
____________________________________
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
x
  
Accelerated filer
  
o
 
 
 
 
Non-accelerated filer
 
o   (Do not check if a smaller reporting company)
  
Smaller reporting company
  
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):    Yes  o    No  x
Number of shares of Common Stock, $0.01 par value per share, outstanding at August 29, 2014: 67,356,515
 




SEMTECH CORPORATION
INDEX TO FORM 10-Q
FOR THE QUARTER ENDED July 27, 2014
 

2



Unless the context otherwise requires, the use of the terms “Semtech,” “the Company,” “we,” “us” and “our” in this Quarterly Report on Form 10-Q refers to Semtech Corporation and its consolidated subsidiaries.


Special Note Regarding Forward-Looking and Cautionary Statements
This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, as amended, based on our current expectations, estimates and projections about our operations, industry, financial condition, performance, results of operations, and liquidity. Forward-looking statements are statements other than historical information or statements of current condition and relate to matters such as future financial performance, future operational performance, the anticipated impact of specific items on future earnings, and our plans, objectives and expectations. Statements containing words such as “may,” “believe,” “anticipate,” “expect,” “intend,” “plan,” “project,” “estimate,” “should,” “will,” “designed to,” “projections,” or “business outlook,” or other similar expressions constitute forward-looking statements. Forward-looking statements involve known and unknown risks and uncertainties that could cause actual results and events to differ materially from those projected. Potential factors that could cause actual results to differ materially from those in the forward-looking statements include, but are not limited to: the continuation and/or pace of key trends considered to be main contributors to the Company's growth, such as demand for increased network bandwidth, demand for increasing energy efficiency in the Company's products or end-use applications of the products, and demand for increasing miniaturization of electronic components; shifts in demand among target customers, and other comparable changes or protracted weakness in projected or anticipated end-user markets; competitive changes in the marketplace, including, but not limited to the pace of growth or adoption rates of applicable products or technologies; shifts in focus among target customers, and other comparable changes in projected or anticipated end-user markets; adequate supply of components and materials from our suppliers, and of our products from our third-party manufacturers, to include disruptions due to natural causes or disasters, weather, or other extraordinary events; the Company's ability to forecast and achieve anticipated revenues and earnings estimates in light of periodic economic uncertainty, to include impacts arising from European and global economic dynamics; the Company's ability to manage expenses to achieve anticipated financial targets; and the amount and timing of expenditures for capital equipment deemed necessary or advisable by the Company. Additionally, forward-looking statements should be considered in conjunction with the cautionary statements contained in this Quarterly Report on Form 10-Q, including, without limitation, information under the captions “Management's Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” and additional factors that accompany the related forward-looking statements in this Quarterly Report on Form 10-Q, in our Annual Report on Form 10-K for the fiscal year ended January 26, 2014, in other filings with the Securities and Exchange Commission (“SEC”), and in material incorporated herein and therein by reference. In light of the significant risks and uncertainties inherent in the forward-looking information included herein that may cause actual performance and results to differ materially from those predicted, any such forward-looking information should not be regarded as representations or guarantees by the Company of future performance or results, or that its objectives or plans will be achieved, or that any of its operating expectations or financial forecasts will be realized. Reported results should not be considered an indication of future performance. Investors are cautioned not to place undue reliance on any forward-looking information contained herein, which reflect management's analysis only as of the date hereof. Except as required by law, the Company assumes no obligation to publicly release the results of any update or revision to any forward-looking statement that may be made to reflect new information, events or circumstances after the date hereof or to reflect the occurrence of unanticipated or future events, or otherwise.

In addition to regarding forward-looking statements with caution, you should consider that the preparation of the consolidated financial statements requires us to draw conclusions and make interpretations, judgments, assumptions and estimates with respect to certain factual, legal, and accounting matters. Our financial statements might have been materially impacted if we had reached different conclusions or made different interpretations, judgments, assumptions or estimates.

3



PART I - FINANCIAL INFORMATION
 
ITEM 1.
Financial Statements

SEMTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data)
(unaudited)
 
 
Three Months Ended
 
Six Months Ended
 
July 27,
2014
 
July 28,
2013
 
July 27,
2014
 
July 28,
2013
Net sales
$
145,742

 
$
165,010

 
$
278,601

 
$
327,417

Cost of sales
57,521

 
64,302

 
112,296

 
129,422

Gross profit
88,221

 
100,708

 
166,305


197,995

Operating costs and expenses:
 
 
 
 
 
 
 
Selling, general and administrative
31,547

 
33,315

 
63,243

 
68,109

Product development and engineering
28,173

 
33,125

 
55,986

 
67,684

Intangible amortization
6,444

 
7,211

 
12,869

 
15,067

Intangible asset impairments

 
2,600

 

 
2,600

Restructuring charge

 

 
1,001

 

Total operating costs and expenses
66,164

 
76,251

 
133,099

 
153,460

Operating income
22,057

 
24,457

 
33,206

 
44,535

Interest expense, net
(1,588
)
 
(10,584
)
 
(2,975
)
 
(14,644
)
Non-operating expense, net
(345
)
 
(198
)
 
(623
)
 
(1,005
)
Income before taxes
20,124

 
13,675

 
29,608

 
28,886

Provision (benefit) for taxes
2,226

 
(5,437
)
 
3,843

 
(5,003
)
Net income
$
17,898

 
$
19,112

 
$
25,765

 
$
33,889

Earnings per share:
 
 
 
 
 
 
 
Basic
$
0.27

 
$
0.28

 
$
0.38

 
$
0.50

Diluted
$
0.26

 
$
0.28

 
$
0.38

 
$
0.49

Weighted average number of shares used in computing earnings per share:
 
 
 
 
 
 
 
Basic
67,208

 
67,614

 
67,254

 
67,285

Diluted
67,850

 
69,090

 
67,888

 
68,812

See accompanying notes. The accompanying notes are an integral part of these financial statements.

4



SEMTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF
COMPREHENSIVE INCOME
(in thousands)
(unaudited)
 
  
Three Months Ended
 
Six Months Ended
 
July 27,
2014
 
July 28,
2013
 
July 27,
2014
 
July 28,
2013
Net income
$
17,898

 
$
19,112

 
$
25,765

 
$
33,889

Other comprehensive (loss) income, before tax:
 
 
 
 
 
 
 
Available-for-sale investments:
 
 
 
 
 
 
 
Change in unrealized holding loss on available-for-sale investments
(2
)
 
(7
)
 
(1
)
 
(8
)
Interest rate hedge:
 
 
 
 
 
 
 
Change in unrealized (loss) income on interest rate cap
(51
)
 
288

 
(161
)
 
47

Reclassification to interest expense
47

 
10

 
80

 
19

Other comprehensive (loss) income, before tax
(6
)
 
291


(82
)

58

(Provision) benefit for taxes related to items of other comprehensive (loss) income
(16
)
 
(106
)
 
12

 
(21
)
Other comprehensive (loss) income, net of tax
(22
)
 
185

 
(70
)
 
37

Total comprehensive income, net of tax
$
17,876

 
$
19,297

 
$
25,695

 
$
33,926

See accompanying notes. The accompanying notes are an integral part of these financial statements.

5



SEMTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
 
July 27, 2014
 
January 26, 2014
 
(unaudited)
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
238,667

 
$
243,194

Accounts receivable, less allowances of $4,754 at July 27, 2014 and $3,825 at January 26, 2014
68,468

 
66,333

Inventories
54,479

 
60,267

Deferred tax assets
2,998

 
2,946

Prepaid taxes
2,387

 
4,993

Other current assets
20,824

 
15,863

Total current assets
387,823

 
393,596

Non-current assets:
 
 
 
Property, plant and equipment, net of accumulated depreciation of $130,690 at July 27, 2014 and $112,610 at January 26, 2014
111,576

 
110,121

Long-term investments
550

 
3,674

Deferred tax assets
84

 
348

Goodwill
276,898

 
276,898

Other intangible assets, net
128,301

 
140,944

Other assets
29,124

 
23,359

TOTAL ASSETS
$
934,356

 
$
948,940

Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
37,819

 
$
40,016

Accrued liabilities
40,519

 
44,148

Deferred revenue
6,427

 
7,267

Current portion - long-term debt
18,539

 
18,529

Deferred tax liabilities
927

 
930

Total current liabilities
104,231

 
110,890

Non-current liabilities:
 
 
 
Deferred tax liabilities
6,802

 
3,626

Long term debt, less current portion
239,022

 
273,293

Other long-term liabilities
27,881

 
25,288

Stockholders’ equity:
 
 
 
Common stock, $0.01 par value, 250,000,000 shares authorized, 78,136,144 issued and 67,139,327 outstanding on July 27, 2014 and 78,136,144 issued and 67,283,221 outstanding on January 26, 2014
785

 
785

Treasury stock, at cost, 10,996,817 shares as of July 27, 2014 and 10,852,923 shares as of January 26, 2014
(210,521
)
 
(201,152
)
Additional paid-in capital
366,372

 
362,121

Retained earnings
399,601

 
373,836

Accumulated other comprehensive income
183

 
253

Total stockholders’ equity
556,420

 
535,843

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
934,356

 
$
948,940

See accompanying notes. The accompanying notes are an integral part of these financial statements.

6



SEMTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 
Six Months Ended
 
July 27,
2014
 
July 28,
2013
Cash flows from operating activities:
 
 
 
Net income
$
25,765

 
$
33,889

Adjustments to reconcile net income to net cash provided by operating activities, net of effects of acquisitions:
 
 
 
Depreciation, amortization and impairments
24,030

 
28,937

Effect of acquisition fair value adjustments

 
2,529

Accretion of deferred financing costs and debt discount
511

 
1,010

Write off deferred financing costs & debt discount

 
8,773

Deferred income taxes
3,143

 
(6,529
)
Stock-based compensation
13,121

 
14,782

Gain on disposition of property, plant and equipment
(14
)
 
(27
)
Changes in assets and liabilities:
 
 
 
Accounts receivable, net
(2,135
)
 
(11,435
)
Inventories
5,816

 
(5,659
)
Prepaid expenses and other assets
(4,247
)
 
46

Accounts payable
(2,544
)
 
(2,479
)
Accrued liabilities
(1,681
)
 
(10,140
)
Deferred revenue
(840
)
 
1,532

Income taxes payable and prepaid taxes
(1,839
)
 
(1,389
)
Other liabilities
2,051

 
4,605

Net cash provided by operating activities
61,137

 
58,445

Cash flows from investing activities:
 
 
 
Purchases of available-for-sale investments

 
(1,050
)
Proceeds from sales and maturities of available-for-sale investments
3,124

 
8,998

Proceeds from sales of property, plant and equipment
71

 
57

Purchase of property, plant and equipment
(12,662
)
 
(23,565
)
Purchase of intangible assets
(1,000
)
 
(2,583
)
Purchase of cost method investment
(3,264
)
 

Net cash used in investing activities
(13,731
)
 
(18,143
)
Cash flows from financing activities:
 
 
 
Proceeds of debt issue, net of discount

 
326,448

Deferred financing cost

 
(2,085
)
Payment for employee stock-based compensation payroll taxes
(3,533
)
 
(5,148
)
Proceeds from exercises of stock options
5,975

 
13,476

Repurchase of outstanding common stock
(20,000
)
 

Payment of long term debt
(34,375
)
 
(359,125
)
Net cash used in financing activities
(51,933
)
 
(26,434
)
Net (decrease) increase in cash and cash equivalents
(4,527
)
 
13,868

Cash and cash equivalents at beginning of period
243,194

 
223,192

Cash and cash equivalents at end of period
$
238,667

 
$
237,060

See accompanying notes. The accompanying notes are an integral part of these financial statements.

7



SEMTECH CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1: Organization and Basis of Presentation

Nature of Business

Semtech is a global supplier of high performance analog and mixed-signal semiconductor products. The end-customers for the Company’s products are primarily original equipment manufacturers (“OEMs”) that produce and sell electronics.

The Company designs, develops and markets a wide range of products for commercial applications, the majority of which are sold into the enterprise computing, communications, high-end consumer and industrial end-markets. The Company’s classification of sales by end-market requires significant judgment by management, since many of its products are used across multiple platforms and support multiple end-markets.

Enterprise Computing: datacenters, passive optical networks, storage networks, optical receiver and transceiver, servers, desktops, notebooks, servers, graphic boards, monitors, printers and other computer peripherals.

Communications: base stations, backplane, optical networks, carrier networks, switches and routers, cable modems, signal conditioners, wireless local area network (“LAN”) and other communication infrastructure equipment.

High-End Consumer: smart phones and other handheld products, set-top boxes, digital televisions, tablets, wearable devices, digital video recorders and other consumer equipment.

Industrial: broadcast studio equipment, automated meter reading, military and aerospace, medical, security systems, automotive, industrial and home automation, video security and surveillance and other industrial equipment.
Fiscal Year
The Company reports results on the basis of 52 and 53 week periods and ends its fiscal year on the last Sunday in January. The other quarters generally end on the last Sunday of April, July and October. All quarters consist of 13 weeks except for one 14-week period in 53-week years. The second quarter of fiscal years 2015 and 2014 each consisted of 13 weeks.
Principles of Consolidation
The accompanying interim condensed consolidated financial statements of Semtech have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). In the opinion of the Company, these unaudited statements contain all adjustments (consisting of normal recurring adjustments) necessary to present fairly, in all material respects, the financial position of Semtech for the interim periods presented. All significant intercompany balances have been eliminated. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) have been condensed or omitted pursuant to such rules and regulations, and the Company believes that the included disclosures are adequate to make the information presented not misleading. The Company evaluated all subsequent events through the date these condensed consolidated financial statements were issued.
These interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended January 26, 2014. The results reported in these interim condensed consolidated financial statements should not be regarded as indicative of results that may be expected for any subsequent period or for the entire year.

Segment Information
In the second quarter of fiscal year 2015, the Company completed the reassessment of its operations in light of its recent restructuring efforts (discussed in Note 16). Based on this reassessment, the Company has identified four operating segments in total. Three of the operating segments aggregate into one reportable segment. The remaining operating segment could not be aggregated with the other operating segments and did not meet the criteria for a separate reportable segment as defined by the guidance regarding segment disclosure. The Company’s Chief Executive Officer (“CEO”) has been identified as the Chief Operating Decision Maker (“CODM”) as defined by the segment disclosure guidance (see Note 14 for further discussion) and now receives discrete financial information pertaining to the Systems Innovation group. As a result, beginning with the second quarter of fiscal 2015, the financial activity associated with the Systems Innovation group will be reported separately from the Company's reportable segment. This separate reporting is included in the "All others" category. The historical activity of the reportable segment has been recast for consistent presentation for the three and six months periods ended July 27, 2014 and July 28, 2013.

Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606), which requires an entity to recognize revenue from the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance addresses, in particular, contracts with more than one performance obligation, as well as the accounting for some costs to obtain or fulfill a contract with a customer, and provides for additional disclosures with respect to revenues and cash flows arising from contracts with customers. Public entities are required to apply the amendments on either a full- or modified-retrospective basis for annual periods beginning after December 15, 2016 and for interim periods within those annual periods. Early adoption is not permitted. The Company is currently assessing the basis of adoption and evaluating the impact of the adoption of the update on its consolidated financial statements.
Note 2: Earnings per Share
The computation of basic and diluted earnings per common share is as follows:
 
Three Months Ended
 
Six Months Ended
(in thousands, except per share amounts)
July 27,
2014
 
July 28,
2013
 
July 27,
2014
 
July 28,
2013
Net income
$
17,898

 
$
19,112

 
$
25,765

 
$
33,889

 
 
 
 
 
 
 
 
Weighted average common shares outstanding - basic
67,208

 
67,614

 
67,254

 
67,285

Dilutive effect of options and restricted stock units
642

 
1,476

 
634

 
1,527

Weighted average common shares outstanding - diluted
67,850

 
69,090

 
67,888

 
68,812

 
 
 
 
 
 
 
 
Basic earnings per common share
$
0.27

 
$
0.28

 
$
0.38

 
$
0.50

Diluted earnings per common share
$
0.26

 
$
0.28

 
$
0.38

 
$
0.49

 
 
 
 
 
 
 
 
Anti-dilutive shares not included in the above calculations
1,463

 
352

 
1,427

 
392

Basic earnings per common share is computed by dividing income available to common stockholders by the weighted-average number of shares of common stock outstanding during the reporting period. Diluted earnings per common share incorporates the incremental shares issuable, calculated using the treasury stock method, upon the assumed exercise of stock options and the vesting of restricted stock.
Note 3: Revenue Recognition
The Company recognizes product revenue when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collectability is reasonably assured. Recovery of costs associated with product design and engineering services are recognized during the period in which services are performed. The product design and engineering recovery, when recognized, will be reported as a reduction to product development and engineering expense. Historically, these recoveries have not exceeded the cost of the related development efforts.
The Company includes revenue related to granted technology licenses in “Net sales” within the condensed consolidated statements of income. Historically, revenue from these arrangements has not been significant though it is part of the Company’s recurring ordinary business.
The Company defers revenue recognition on shipment of products to certain customers, principally distributors, under agreements which provide for limited pricing credits or return privileges, until these products are sold through to end-users or the return privileges lapse. For sales subject to certain pricing credits or return privileges, the amount of future pricing credits or inventory returns cannot be reasonably estimated given the relatively long period in which a particular product may be held by the customer. Therefore, the Company has concluded that sales to customers under these agreements are not fixed and determinable at the date of the sale and revenue recognition has been deferred. The Company estimates the deferred gross margin on these sales by applying an average gross profit margin to the actual gross sales. The average gross profit margin is calculated for each category of material using standard costs which is expected to approximate actual costs at the date of sale. The estimated deferred gross margins on these sales, where there are no outstanding receivables, are included in “Deferred revenue” within the condensed consolidated balance sheets.
The Company records a provision for estimated sales returns and rebates in the same period as the related revenues are recorded. The Company bases these estimates on historical sales returns, rebates and other known factors. Actual returns could be different from Company estimates and current provisions for sales returns and allowances, resulting in future charges to earnings. There were no significant impairments of deferred cost of sales in the second quarter of fiscal year 2015 or fiscal year 2014.

8



Note 4: 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


9



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.


10



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


11



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.

12



Note 5: Investments
Investments that have original maturities of three months or less are accounted for as cash equivalents. This includes money market funds, time deposits and United States (“U.S.”) government obligations. Temporary and long-term investments consist of government, bank and corporate obligations, and bank time deposits with original maturity dates in excess of three months. Temporary investments have original maturities in excess of three months, but mature within twelve months of the balance sheet date. Long-term investments have original maturities in excess of twelve months. The Company determines the cost of securities sold based on the specific identification method. Realized gains or losses are reported in “Non-operating expense, net” within the condensed consolidated statements of income.
The Company classifies its investments as “available-for-sale” because it may sell some securities prior to maturity. The Company’s investments are subject to market risk, primarily interest rate and credit risks. The Company’s investments are managed by a limited number of outside professional managers that operate within investment guidelines set by the Company. These guidelines include specified permissible investments, minimum credit quality ratings and maximum average duration restrictions and are intended to limit market risk by restricting the Company’s investments to high quality debt instruments with relatively short-term maturities.
As of July 27, 2014, all of the Company’s long-term investments mature on various dates through fiscal year 2016.
The following table summarizes the Company’s available-for-sale investments:
 
July 27, 2014
 
January 26, 2014
(in thousands)
Market Value
 
Adjusted
Cost
 
Gross
Unrealized Gain
 
Market Value
 
Adjusted
Cost
 
Gross
Unrealized
Gain
Agency securities
$
550

 
$
550

 
$

 
$
3,674

 
$
3,673

 
$
1

Total investments
$
550

 
$
550

 
$

 
$
3,674

 
$
3,673

 
$
1

Agency securities are specific securities that are issued by U.S. government agencies such as Ginnie Mae, Fannie Mae, Freddie Mac or the Federal Home Loan Banks. Due to the expectation of federal backing, these securities usually hold the highest credit rating possible.
The following table summarizes the maturities of the Company’s available-for-sale investments:
 
July 27, 2014
 
January 26, 2014
(in thousands)
Market Value
 
Adjusted Cost
 
Market Value
 
Adjusted Cost
Within 1 year
$

 
$

 
$

 
$

After 1 year through 5 years
550

 
550

 
3,674

 
3,673

Total investments
$
550

 
$
550

 
$
3,674

 
$
3,673

Unrealized gains and losses are the result of fluctuations in the market value of the Company’s available-for-sale investments and are included in “Accumulated other comprehensive income” within the condensed consolidated balance sheets. The following table summarizes net unrealized losses arising in the periods presented in addition to the tax associated with these comprehensive income items:
 
Three Months Ended
 
Six Months Ended
(in thousands)
July 27,
2014
 
July 28,
2013
 
July 27,
2014
 
July 28,
2013
Unrealized loss, net of tax
$
(1
)
 
$
(4
)
 
$

 
$
(5
)
Increase to deferred tax liability
(1
)
 
(3
)
 

 
(3
)
The following table summarizes interest income generated from investments and cash and cash equivalents:
 
 
Three Months Ended
 
Six Months Ended
(in thousands)
July 27,
2014
 
July 28,
2013
 
July 27,
2014
 
July 28,
2013
Interest income
$
12

 
$
91

 
$
20

 
$
191


The Company has investments in two privately held companies. The Company accounts for these equity investments under the cost method of accounting since it does not have the ability to exercise significant influence over the investees. These equity investment interests are included in “Other assets” within the condensed consolidated balance sheet as of July 27, 2014.

(in thousands)
Equity Investment
Balance at January 26, 2014
$
5,000

Additions
3,264

Balance at July 27, 2014
$
8,264


Note 6: Fair Value Measurements
Instruments Measured at Fair Value on a Recurring Basis
Financial assets measured and recorded at fair value on a recurring basis consisted of the following types of instruments:
 
 
Fair Value as of July 27, 2014
 
Fair Value as of January 26, 2014
(in thousands)
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
 
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
Agency securities
$
550

 
$

 
$
550

 
$

 
$
3,674

 
$

 
$
3,674

 
$

Total available-for-sale securities
550

 

 
550

 

 
3,674

 

 
3,674

 

Interest rate cap
155

 

 
155

 

 
316

 

 
316

 

Total financial assets
$
705

 
$

 
$
705

 
$

 
$
3,990

 
$

 
$
3,990

 
$

Available-for-sale securities included in Level 2 are valued utilizing inputs obtained from an independent service (the “Service”), which uses quoted market prices for identical or comparable instruments rather than direct observations of quoted prices in active markets. The Service gathers observable inputs for all of our fixed income securities from a variety of industry data providers, for example, large custodial institutions and other third-party sources. Once the observable inputs are gathered by the Service, all data points are considered and an average price is determined. The Service’s providers utilize a variety of inputs to determine their quoted prices. The Company reviews and evaluates the values provided by the Service and agrees with the valuation methods and assumptions used in determining the fair value of investments. The Company believes this method provides a reasonable estimate for fair value.
The fair value of the interest rate cap at July 27, 2014 is estimated as described in Note 10 and is included in “Other assets” within the condensed consolidated balance sheets.
Financial assets measured and recorded at fair value on a recurring basis were presented on the Company’s condensed consolidated balance sheets as follows:
 
 
Fair Value as of July 27, 2014
 
Fair Value as of January 26, 2014
(in thousands)
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
 
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
Long-term investments
$
550

 
$

 
$
550

 
$

 
$
3,674

 
$

 
$
3,674

 
$

Other assets
155

 

 
155

 

 
316

 

 
316

 

Total financial assets
$
705

 
$

 
$
705

 
$

 
$
3,990

 
$

 
$
3,990

 
$

During the six months ended July 27, 2014, the Company had no transfers of financial assets or liabilities between Level 1, Level 2 or Level 3. As of July 27, 2014 and January 26, 2014, the Company had not elected the fair value option for any financial assets and liabilities for which such an election would have been permitted.
Instruments Not Recorded at Fair Value on a Recurring Basis
Some of the Company’s financial instruments are not measured at fair value on a recurring basis but are recorded at amounts that approximate fair value due to their liquid or short-term nature. Such financial assets and financial liabilities include cash and cash equivalents, receivables, net, certain other assets, accounts payable, accrued expenses, accrued personnel costs, and other current liabilities.

13



The Company’s long-term debt is not recorded at fair value on a recurring basis, but is measured at fair value for disclosure purposes. The fair value of the Company’s Term Loans (as defined herein) is $105.0 million and $114.3 million and Revolving Commitments (as defined herein) is $152.6 million and $177.5 million at July 27, 2014 and January 26, 2014, respectively. These are based on Level 2 inputs which are derived from transactions with similar amounts, maturities, credit ratings and payment terms.
Assets and Liabilities Recorded at Fair Value on a Non-Recurring Basis
The Company reduces the carrying amounts of its goodwill, intangible assets, long-lived assets and non-marketable equity securities to fair value when held for sale or determined to be impaired.
For its investment in equity interests, the Company has not identified events or changes in circumstances that may have a significant adverse effect on the fair value of its cost method investments during the first six months of fiscal year 2015.
Note 7: Inventories
Inventories, consisting of material, material overhead, labor, and manufacturing overhead, are stated at the lower of cost (first-in, first-out) or market and consist of the following:
 
(in thousands)
July 27, 2014
 
January 26, 2014
Raw materials
$
1,769

 
$
1,971

Work in progress
37,256

 
45,508

Finished goods
15,454

 
12,788

Inventories
$
54,479

 
$
60,267


During the first six months of fiscal year 2015 and in the fourth quarter of fiscal year 2014, the Company reduced the cost basis of inventories by $1.1 million and $15.0 million, respectively, as a result of its strategic decision made in the fourth quarter of fiscal year 2014 to reduce investments in the long-haul optical market.

14



Note 8: Goodwill and Intangible Assets
Goodwill – Changes in the carrying amount of goodwill were as follows:
(in thousands)
Signal Integrity
 
Signal, Integrity and Timing
 
Wireless and Sensing
 
Wireless, Sensing and Timing
 
Total
Balance as of January 26, 2014
$

 
$
261,891

 
$
15,007

 
$

 
$
276,898

Transfers
261,891

 
(261,891
)
 
(15,007
)
 
15,007

 

Balance at July 27, 2014
$
261,891

 
$

 
$

 
$
15,007

 
$
276,898


On January 27, 2014, the Timing product line was integrated with the Wireless and Sensing reporting unit to form the Wireless, Sensing and Timing reporting unit. Simultaneously, the Signal, Integrity and Timing reporting unit was reorganized into the Signal Integrity reporting unit. No portion of the goodwill associated with the previous Signal, Integrity and Timing reporting unit, which originated with the March 2012 acquisition of Gennum Corporation, was allocated to the Timing product line as it was never integrated into the Signal, Integrity and Timing reporting unit. In reaching this conclusion, the Company considered the events leading up to the multiple reorganizations and the short time span between the December 2013 and January 27, 2014 reorganizations.
Goodwill is not amortized, but is tested for impairment using a two-step method on an annual basis and whenever events or changes in circumstances indicate that the carrying value may not be recoverable. The recoverability of goodwill is measured at the reporting unit level by comparing the reporting unit’s carrying amount, including goodwill, to the fair market value of the reporting unit.
Goodwill is allocated to two reporting units (Signal Integrity and Wireless, Sensing and Timing). These reporting units also represent the related operating segment since segment management who report to the CODM regularly review operating results and make resource allocation decisions at this level. The difference between the fair value and the carrying amount of these reporting units is one of several factors the Company will consider before reaching its conclusion about whether to perform the first step of the goodwill impairment test. No Goodwill is allocated to the newly identified Systems Innovation Group operating segment (see Note 14).
Goodwill was tested for impairment as of November 30, 2013 at the reporting unit level, the date of the Company’s annual impairment review. The Company estimated the fair values using an income approach, as well as other generally accepted valuation methodologies. The cash flows for each reporting unit were based on discrete financial forecasts developed by management for planning purposes. Cash flows beyond the discrete forecasts were estimated using a terminal value calculation, which incorporated historical and forecasted financial trends for each identified reporting unit and considered perpetual earnings growth rates for publicly traded peer companies.
Goodwill is measured at fair value on a non-recurring basis. That is, goodwill is not measured at fair value on an ongoing basis, but is subject to fair value adjustments using Level 3 inputs in certain circumstances (e.g. when there is evidence of impairment). At July 27, 2014, the Company concluded that there were no indicators of such impairment.
Purchased Intangibles – The following table sets forth the Company’s finite-lived intangible assets resulting from business acquisitions and technology licenses purchased, which continue to be amortized:
 
 
 
 
July 27, 2014
 
January 26, 2014
(in thousands)
Estimated
Useful Life
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net Carrying
Amount
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net Carrying
Amount
Core technologies
2-10 years
 
$
146,925

 
$
(45,817
)
 
$
101,108

 
$
146,925

 
$
(35,357
)
 
$
111,568

Customer relationships
7-10 years
 
28,630

 
(9,579
)
 
19,051

 
28,630

 
(7,505
)
 
21,125

Technology licenses (1)
5-10 years
 
4,842

 
(1,103
)
 
3,739

 
3,842

 
(367
)
 
3,475

Other intangibles assets
1-5 years
 
6,600

 
(6,197
)
 
403

 
6,600

 
(5,824
)
 
776

Total finite-lived intangible assets
 
 
$
186,997

 
$
(62,696
)
 
$
124,301

 
$
185,997

 
$
(49,053
)
 
$
136,944

 
(1)
Technology licenses relate to in-license agreements for intellectual property that is used by the Company in research and development activities and also has alternative future uses. Amortization expense related to technology licenses is reported as “Product development and engineering” in the condensed consolidated statements of income.

15



The Company’s finite-lived intangible assets resulting from purchases, additions from acquisitions, and transfers from In-process Research and Development (“IPR&D”) was $187.0 million and $186.0 million as of July 27, 2014 and January 26, 2014, respectively.
For the three months ended July 27, 2014 and July 28, 2013, amortization expense related to acquired finite-lived intangible assets was $6.4 million and $7.2 million, respectively. For the six months ended July 27, 2014 and July 28, 2013, amortization expense related to finite-lived intangible assets was $12.9 million and $15.1 million, respectively. Amortization expense related to acquired finite-lived intangible assets is reported as “Intangible amortization and impairments” in the condensed consolidated statements of income.
The estimated annual amount of future amortization expense for all finite-lived intangible assets will be as follows:
(in thousands)
 
 
 
 
 
 
 
 
 
To be recognized in:
Core Technologies
 
Customer Relationships
 
Technology Licenses
 
Other Intangibles
 
Total
Remaining six months of fiscal year 2015
$
10,459

 
$
2,075

 
$
898

 
$
310

 
$
13,742

Fiscal year 2016
20,919

 
4,149

 
1,798

 
93

 
26,959

Fiscal year 2017
20,919

 
4,149

 
1,043

 

 
26,111

Fiscal year 2018
20,919

 
4,130

 

 

 
25,049

Fiscal year 2019
17,507

 
4,000

 

 

 
21,507

Thereafter
10,385

 
548

 

 

 
10,933

Total expected amortization expense
$
101,108

 
$
19,051

 
$
3,739

 
$
403

 
$
124,301


At July 27, 2014 and January 26, 2014, the Company had a total of $4.0 million of indefinite-lived intangible assets consisting of IPR&D from previous acquisitions for which development is continuing.
The Company reviews indefinite-lived intangible assets for impairment annually or whenever events or changes in circumstances indicate the carrying value may not be recoverable. Recoverability of indefinite-lived intangible assets is measured by comparing the carrying amount of the asset to the future discounted cash flows the asset is expected to generate.
Indefinite-lived intangible assets are measured at fair value on a non-recurring basis using Level 3 inputs in certain circumstances (e.g. when there is evidence of impairment). At July 27, 2014 the Company concluded that there were no indicators of impairment. During the three month period ending July 28, 2013, the Company made the strategic decision to discontinue development of microwave products which resulted in the Company recording a $2.6 million impairment to IPR&D from the acquisition of Sierra Monolithics, Inc.

16



Note 9: Credit Facilities
On March 20, 2012, Semtech Corporation entered into a credit agreement with certain lenders (the “Prior Lenders”) and Jefferies Finance LLC, as administrative and collateral agent (the “Prior Credit Agreement”). Pursuant to the Prior Credit Agreement, the Prior Lenders provided the Company with senior secured first lien credit facilities in an aggregate principal amount of $350.0 million (the “Prior Credit Facilities”), consisting of term A loans in an aggregate principal amount of $100.0 million (the “Term A Loans”) and term B loans in an aggregate principal amount of $250.0 million (the “Term B Loans”). The initial carrying amounts totaled $99.5 million (net of original issue discount of $0.5 million) for the Term A Loans and $247.5 million (net of original issue discount of $2.5 million) for the Term B Loans.
On May 2, 2013 (the “Closing Date”), Semtech Corporation, with each of its domestic subsidiaries as guarantors (the “Guarantors”), entered into a new Credit Agreement (the “New Credit Agreement”) with the lenders referred to therein (the “Lenders”) and HSBC Bank USA, National Association, as administrative agent and as swing line lender and letter of credit issuer. In accordance with the New Credit Agreement, the Lenders provided Semtech with senior secured first lien credit facilities in an aggregate principal amount of $400.0 million (the “New Facilities”) for a five year term, consisting of term loans in an aggregate principal amount of $150.0 million (the “Term Loans”) and revolving line of credit commitments in an aggregate principal amount of $250.0 million (the “Revolving Commitments”). The Revolving Commitments can be used as follows: up to $40.0 million for letters of credit, up to $25.0 million for swing line loans (as defined below), and up to $40.0 million for revolving loans and letters of credit in certain currencies other than U.S. Dollars (“Alternative Currencies”). Swing line loans are Base Rate (as defined below) loans made in immediately available funds denominated in dollars by a swing line lender in its sole and absolute discretion. As of July 27, 2014, there were no amounts outstanding under the letters of credit, swing line loans, and Alternative Currencies.
At the Closing Date, $326.6 million of borrowings were outstanding under the New Facilities consisting of $149.3 million of Term Loans and $177.3 million of Revolving Commitments, net of $1.4 million of debt discounts resulting from amounts paid to the Lenders. As a result of debt refinancing and changes in some of the Lenders, $0.8 million of debt discounts were expensed in the second quarter of fiscal year 2014 and $0.6 million was capitalized as of May 2, 2013 and is being amortized using the effective interest method over the five year term of the New Credit Agreement. The expense is included in “Interest expense, net” in the condensed consolidated statements of income. The proceeds from the New Credit Facilities were used to repay in full the outstanding obligations of $327.5 million under the Prior Credit Facilities, which was terminated. The portion of the transaction associated with Prior Lenders was accounted for as a debt modification.
Deferred financing costs incurred in the second quarter of fiscal year 2014, in connection with the New Facilities, were approximately $2.2 million, of which $1.0 million was expensed, inclusive of certain legal costs directly related to the refinancing. Of this amount $1.2 million was capitalized and is being amortized using the effective interest method over the five year term of the New Facilities. The expense is included in “Interest expense, net” in the condensed consolidated statements of income for the six months ended July 27, 2014.
As a result of the debt refinancing, the Company recorded a $7.1 million loss on debt modification of unamortized deferred financing costs and original issue discount associated with the Prior Credit Facilities in the fiscal year ended January 26, 2014. The remaining $1.7 million of unamortized deferred financing costs and original issue discount associated with the Prior Credit Facilities is being amortized over the five year terms of the New Facilities. The expense is included in “Interest expense, net” within the condensed consolidated statements of income for the six months ended July 27, 2014.
The New Credit Agreement provides that, subject to certain conditions, Semtech Corporation may request, at any time and from time to time, the establishment of one or more additional term loan facilities and/or increases to the Revolving Commitments in an aggregate principal amount not to exceed $100.0 million, the proceeds of which may be used for working capital and general corporate purposes; however the Lenders are not required to provide such increase upon our request.
Interest on loans made under the New Credit Agreement in U.S. Dollars accrues, at Semtech’s option, at a rate per annum equal to (1) the Base Rate plus a margin ranging from 0.25% to 1.25% depending upon Semtech’s consolidated leverage ratio or (2) London Interbank Offered Rate (“LIBOR”) (determined with respect to deposits in U.S. Dollars) for an interest period to be selected by Semtech plus a margin ranging from 1.25% to 2.25% depending upon Semtech’s consolidated leverage ratio. The “Base Rate” is equal to a fluctuating rate equal to the highest of (a) the prime rate (as published by The Wall Street Journal), (b) ½ of 1% above the federal funds effective rate or (c) one-month LIBOR (determined with respect to deposits in U.S. Dollars) plus 1%. Alternative Currencies, other than Canadian Dollars, accrues at a rate per annum equal to LIBOR (determined with respect to deposits in the applicable Alternative Currency) for an interest period to be selected by Semtech plus a margin ranging from 1.25% to 2.25% depending upon Semtech’s consolidated leverage ratio. Interest on loans in Canadian Dollars accrues at a rate per annum equal to the CDOR Rate (as defined below) for an interest period to be selected by Semtech plus a margin ranging from 1.25% to 2.25% depending upon Semtech’s consolidated leverage ratio. The “CDOR Rate” for any interest period is the rate equal to the sum of: (a) the rate determined by the administrative agent with reference to the arithmetic average of the discount rate quotations of all institutions listed for CAD Dollar-denominated bankers’ acceptances displayed and identified on the “Reuters Screen CDOR Page” and (b) 0.10% per annum. CDOR Commitment fees on the

17



unused portion of the Revolving Commitments accrue at a rate per annum ranging from 0.20% to 0.45% depending upon Semtech’s consolidated leverage ratio. Interest is paid monthly for a Base Rate loan and swing line loan and quarterly for a Euro dollar rate loan. Interest is payable on the revolving line of credit maturity date in the case of Revolving Commitments and the additional term maturity date in the case of additional Term Loans, respectively. As of July 27, 2014, the interest rates payable on both the Term Loans and the Revolving Commitments was 1.90%.
As of July 27, 2014, there was $105.3 million outstanding under the Term Loans. Under the terms of the New Credit Agreement, the Company is required to make $4.7 million in quarterly principal payment on the Term Loans through the second quarter of fiscal year 2018. Beginning in the third quarter of fiscal year 2018, the required quarterly principal payment will increase to $7.5 million. Quarterly principal payments for Term Loans are due beginning on the last day of the Company’s fiscal quarter-end months, beginning on October 27, 2013 and ending on April 30, 2018. The principal payments related to the Term Loans are due as follows: $9.4 million remaining in fiscal year 2015; $18.8 million in fiscal year 2016; $18.8 million in fiscal year 2017; $24.4 million in fiscal year 2018. The final remaining principal payment is due on the maturity date of May 1, 2018.
There are no scheduled principal payments for the Revolving Commitments which had an outstanding balance of $153.0 million at July 27, 2014 and is due on or before May 1, 2018. The Company may, upon notice to the administrative agent, at any time or from time to time voluntarily prepay the Term Loans or Revolving Commitments in whole or in part without premium or penalty. On June 3, 2013, the Company made an early prepayment of $26.0 million against the Term Loans. On July 14, 2014, the Company made a voluntary payment of $25.0 million against the Revolving Commitments.
All obligations of Semtech Corporation under the New Facilities are unconditionally guaranteed by each of the Guarantors and are secured by a first priority security interest in substantially all of the assets of Semtech and the Guarantors, subject to certain customary exceptions.
Semtech Corporation and the Guarantors are subject to customary covenants under the New Facilities, including the maintenance of a minimum interest ratio of 3.50:1.00 as of July 27, 2014 and a maximum total consolidated leverage ratio of 3.00:1.00 as of July 27, 2014. Semtech Corporation was in compliance with such financial covenants as of July 27, 2014.
The New Facilities also contain customary provisions pertaining to events of default. If any event of default occurs, the principal, interest, and any other monetary obligations on all the then outstanding amounts can become due and payable immediately.

18



Note 10: Interest Rate Derivative Agreement
In June 2012, in connection with the Prior Credit Agreement (see Note 9), the Company entered into an interest rate cap agreement (“Cap Agreement”) with a $175.0 million notional amount and an upfront payment of $1.1 million. The Cap Agreement matures on February 22, 2016 and caps interest rates on one-month LIBOR at 1.00%.
The purpose of the Cap Agreement is to hedge the Company’s exposure to fluctuations in LIBOR-indexed interest payments. Although the Prior Credit Agreement was terminated on May 2, 2013, the New Credit Agreement, in an aggregate principal amount of $400.0 million (see Note 9), permits the Company to elect LIBOR or Base Rate loans. Since the Company intends to make interest payments based on one-month LIBOR-indexed rates and will not elect interest rates based on alternative indices during the term of the Cap Agreement, the Cap Agreement was re-designated as a hedge of one month LIBOR-indexed interest payments associated with the New Credit Agreement. The effectiveness of the interest rate cap was assessed and the Cap Agreement continues to be an effective cash flow hedge of interest rate risk for the Company. No ineffectiveness was recorded during the six months ended July 27, 2014.
The Cap Agreement is recorded at estimated fair value at the end of each reporting period. The fair value of the Cap Agreement at July 27, 2014 was determined using Level 2 inputs, including observable market-based inputs such as interest rate curves and implied volatilities for similar instruments with similar contractual terms.
The Company has determined that the Cap Agreement is highly effective in offsetting future variable interest payments associated with the hedged portion of the Company’s New Credit Agreement. Gains or losses associated with the value of the Cap Agreement are initially reported in other comprehensive income or loss and amortized as an increase to interest expense through the maturity of the Cap Agreement. The amount of unrealized losses on the Cap Agreement recorded in “Accumulated other comprehensive income” at July 27, 2014 that is expected to be reclassified into interest expense in the next twelve months, if interest rates remain unchanged, is approximately $0.4 million.

19



Note 11: Income Taxes
The Company’s effective tax rate differs from the statutory federal income tax rate of 35% due primarily to regional mix of income and certain undistributed foreign earnings for which no U.S. taxes are provided because such earnings are intended to be indefinitely reinvested outside of the U.S.
The Company uses a two-step approach to recognize and measure uncertain tax positions (“UTP”). The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement.
A reconciliation of the beginning and ending amount of gross unrecognized tax benefits (before federal impact of state items) is as follows:
(in thousands)
July 27, 2014
Balance as of January 26, 2014
14,414

Reductions for settlements with tax authorities
(4,513
)
Balance as of July 27, 2014
9,901

The gross unrecognized tax benefit (before federal impact of state items) was $9.9 million and $14.4 million at July 27, 2014 and January 26, 2014, respectively. Included in the balance of unrecognized tax benefits at July 27, 2014 and January 26, 2014, is $7.8 million and $12.3 million of net tax benefit (after federal impact of state items), respectively, that, if recognized, would impact the effective tax rate, subject to the valuation allowance.
The liability for UTP is reflected within the consolidated balance sheets as follows:
 
(in thousands)
July 27, 2014
 
January 26, 2014
Deferred tax assets - non-current
$
7,582

 
$
12,095

Other long-term liabilities
252

 
252

Total accrued taxes
$
7,834

 
$
12,347

The Company’s policy is to include net interest and penalties related to unrecognized tax benefits within the provision for taxes on the condensed consolidated statements of income. The Company had approximately $293,000 of net interest and penalties accrued at July 27, 2014 and January 26, 2014.
Tax years prior to 2010 (the Company’s fiscal year 2011) are generally not subject to examination by the Internal Revenue Service (“IRS”) except for items involving tax attributes that have been carried forward to tax years whose statute of limitations remains open. The Company is currently under IRS audit for fiscal years 2011, 2012 and 2013. The Company is also currently under audit by the Canadian Revenue Agency for fiscal years 2010, 2011 and the short-year ended March 19, 2012. For state returns, the Company is generally not subject to income tax examinations for years prior to 2008 (the Company’s fiscal year 2009). The Company has a significant tax presence in Switzerland for which Swiss tax filings have been examined through fiscal year 2013. The Company is also subject to routine examinations by various foreign tax jurisdictions in which it operates.

20



Note 12: Commitments and Contingencies
From time to time in the ordinary course of its business, the Company is involved in various claims, litigation, and other legal actions that are normal to the nature of its business, including with respect to Intellectual Property (“IP”), contract, product liability, employment, and environmental matters.
In accordance with accounting standards regarding loss contingencies, the Company accrues an undiscounted liability for those contingencies where the incurrence of a loss is probable and the amount can be reasonably estimated. The Company also discloses the amount accrued and the amount of a reasonably possible loss in excess of the amount accrued, if such disclosure is necessary for its financial statements not to be misleading. The Company does not record liabilities when the likelihood that the liability has been incurred is probable but the amount cannot be reasonably estimated, or when the liability is believed to be only reasonably possible or remote. The Company evaluates, at least quarterly, developments in its legal matters that could affect the amount of liability that has been previously accrued, and makes adjustments as appropriate. Significant judgment is required to determine both probability and the estimated amount. The Company may be unable to estimate a possible loss or range of possible loss due to various reasons, including, among others: (i) if the damages sought are indeterminate; (ii) if the proceedings are in early stages, (iii) if there is uncertainty as to the outcome of pending appeals, motions or settlements, (iv) if there are significant factual issues to be determined or resolved, and (v) if there are novel or unsettled legal theories presented. In such instances, there is considerable uncertainty regarding the ultimate resolution of such matters, including a possible eventual loss, if any.
Because litigation outcomes are inherently unpredictable, the Company’s evaluation of legal proceedings often involves a series of complex assessments by management about future events and can rely heavily on estimates and assumptions. While the consequences of certain unresolved proceedings are not presently determinable, and an estimate of the probable and reasonably possible loss or range of loss in excess of amounts accrued for such proceedings cannot be reasonably made, an adverse outcome from such proceedings could have a material adverse effect on the Company’s earnings in any given reporting period. However, in the opinion of management, after consulting with legal counsel, and taking into account insurance coverage, any ultimate liability related to current outstanding claims and lawsuits, individually or in the aggregate, is not expected to have a material adverse effect on the Company’s financial statements, as a whole. However, legal matters are inherently unpredictable and subject to significant uncertainties, some of which are beyond the Company’s control. As such, even though the Company intends to vigorously defend itself with respect to its legal matters, there can be no assurance that the final outcome of these matters will not materially and adversely affect the Company’s business, financial condition, results of operations, or cash flows.
Environmental Matters
In 2001, the Company was notified by the California Department of Toxic Substances Control (“State”) that it may have liability associated with the clean-up of the one-third acre Davis Chemical Company site in Los Angeles, California. The Company has been included in the clean-up program because it was one of the companies that used the Davis Chemical Company site for waste recycling and/or disposal between 1949 and 1990. The Company joined with other potentially responsible parties and entered into a Consent Order with the State that required the group to perform a soils investigation at the site and submit a remediation plan. The State has approved the remediation plan, which addressed the group’s obligations under the Consent Order. Although the Consent Order does not require the group to remediate the site and the State has indicated it intends to look to other parties for remediation, the State has not yet issued “no further action” letters to the group members and has not been able to obtain reimbursement from the former site owner. To date, the Company’s share of the group’s expenses has not been material and has been expensed as incurred.
The Company has used an environmental firm, specializing in hydrogeology, to perform monitoring of the groundwater at the Company’s former facility in Newbury Park, California that was leased for approximately forty years. The Company vacated the building in May 2002. Certain contaminants have been found in the local groundwater and site soils. Responsibility for soil contamination remains under investigation. The location of key soil contamination (and some related site groundwater impact associated with the soil contamination) is concentrated in and found to emanate from an area of an underground storage tank that the Company believes to have been installed and primarily used in the early 1960s by a former tenant at the site who preceded the Company’s tenancy. There are no claims pending with respect to environmental matters at the Newbury Park site. The Los Angeles Regional Water Quality Control Board having authority over the site issued joint instructions in November 2008, ordering the Company and the current owner of the site to perform additional assessments and surveys, and to create ongoing groundwater monitoring plans before any final regulatory action for “no further action” may be approved. In September 2009, the regulatory agency issued supplemental instructions to the Company and the current site owner regarding previously ordered site assessments, surveys and groundwater monitoring. In October 2013, an order was issued including a scope of proposed additional site work, monitoring, and proposed remediation activities. The Company has filed an appeal of the October 2013 order seeking reconsideration of the removal of two other potentially responsible parties, and seeking clarification of certain other factual findings by the regulatory agency. Other parties have filed their own responses to the October 2013 order. The parties are expected to work cooperatively in responding to and determining the appropriate scope and extent of additional site investigative and categorization work, as well as in relation to any ultimate proposed clean up and abatement work. The Company has retained the services of an environmental firm which has engaged with the regulatory agency and has begun activities to comply with the order.
The Company has accrued liabilities where it is probable that a loss will be incurred and the cost or amount of loss can be reasonably estimated. Based on the Company’s preliminary assessment following a November 2012 draft cleanup and abatement order, which has been reviewed under the October 2013 order pending the current appeal by the Company and other impacted parties, the Company has determined a likely range of probable loss between $2.5 million and $5.7 million. Given the yet unresolved status of the clean up and abatement order and uncertainties associated with environmental assessment and the remediation activities, the Company is unable to determine a best estimate within the range of loss. Therefore, the Company recorded the minimum amount of $2.5 million in the third quarter of fiscal year 2013, and such reserve remains on the Company’s books under “Other long-term liabilities” on the condensed consolidated balance sheets. These estimates could change as a result of changes in planned remedial actions, further actions from the regulatory agency, remediation technology, and other factors.
Commercial Disputes
The Company periodically is involved in disputes arising in the normal course of business regarding products or services provided to the Company by vendors or service providers. Historically, the cost of commercial disputes has been immaterial to the Company’s consolidated financial statements.
Indemnification
The Company has entered into agreements with its current executive and some former officers and directors indemnifying them against certain liabilities incurred in connection with the performance of their duties. The Company’s Certificate of Incorporation and Bylaws contain comparable indemnification obligations with respect to the Company’s current directors and employees.
Product Warranties
The Company’s general warranty policy provides for repair or replacement of defective parts. In some cases, a refund of the purchase price is offered. In certain instances the Company has agreed to other warranty terms, including some indemnification provisions.
The product warranty accrual reflects the Company’s best estimate of probable liability under its product warranties. The Company accrues for known warranty issues if a loss is probable and can be reasonably estimated, and accrues for estimated incurred but unidentified issues based on historical experience. Historically, warranty expense has been immaterial to the Company’s consolidated financial statements.
Earnout Liability
Pursuant to the earn-out arrangement with stockholders of Cycleo SAS (“Cycleo”), which the Company acquired on March 7, 2012, the Company potentially may make payments totaling up to approximately $16.0 million based on the achievement of a combination of certain revenue and operating income milestones by Cycleo over a period of four years beginning on April 30, 2012. For certain of the Cycleo stockholders, payment of the earn-out liability is contingent upon employment at the end of the four-year period and is accounted for as post-acquisition compensation expense over the service period. The portion of the earn-out liability that is not dependent on continued employment was included in the purchase price allocation at March 7, 2012. The Company has recorded a cumulative liability of $0.9 million and $0.9 million as of July 27, 2014 and January 26, 2014, respectively.

21



Note 13: Concentration of Risk
Sales to the Company’s customers are generally made on open account, subject to credit limits the Company may impose, and the receivables are subject to the risk of being uncollectible.
The following significant customer accounted for at least 10% of net sales in all but one of the periods indicated:
 
 
Three Months Ended
 
Six Months Ended
(percentage of net sales)
July 27,
2014
 
July 28,
2013
 
July 27,
2014
 
July 28,
2013
Samsung Electronics (and affiliates)
9
%
 
11
%
 
11
%
 
13
%
The following table shows the customer that has an outstanding receivable balance that represents at least 10% of total net receivables for the periods indicated:
 
 
Balance as of
(percentage of net accounts receivable)
July 27,
2014
 
January 26,
2014
Samsung Electronics (and affiliates)
10
%
 
13
%
Outside Subcontractors and Suppliers
The Company relies on a limited number of outside subcontractors and suppliers for the production of silicon wafers, packaging and certain other tasks. Disruption or termination of supply sources or subcontractors, due to natural disasters such as an earthquake or other causes, could delay shipments and could have a material adverse effect on the Company. Although there are generally alternate sources for these materials and services, qualification of the alternate sources could cause delays sufficient to have a material adverse effect on the Company. Several of the Company’s outside subcontractors and suppliers, including third-party foundries that supply silicon wafers, are located in foreign countries, including China, Taiwan, Europe and Israel. The Company’s largest source of silicon wafers is an outside foundry located in China and a significant amount of the Company’s assembly and test operations are conducted by third-party contractors in China, Malaysia, Taiwan, Thailand, Korea and the Philippines. For the second quarter of fiscal years 2015 and 2014, respectively, approximately 43% and 35% of the Company’s silicon in terms of cost of wafers was supplied by a third-party foundry in China, and this percentage could be higher in future periods.
In the second quarter of fiscal year 2015, authorized distributors accounted for approximately 60% of the Company’s net sales compared to 44% in the second quarter of fiscal year 2014. Generally, the Company does not have long-term contracts with its distributors and most can terminate their agreement with little or no notice. For the second quarter of fiscal year 2015, the Company’s two largest distributors were based in Asia.


22



Note 14: Segment information
Segment Information
In the second quarter of fiscal year 2015, the Company completed the reassessment of its operations in light of its restructuring efforts (discussed in Note 16). Based on this reassessment, the Company identified four operating segments. The Company’s CEO continues to function as the CODM. The Company’s CODM makes operating decisions and assesses performance based on these operating segments. Three of the operating segments: Protection, Power and High Reliability Products; Signal Integrity Products; and Wireless, Sensing and Timing Products, all have similar economic characteristics and have been aggregated into one reportable segment identified in the table below as the “Semiconductor Products Group”. The Company concluded that the remaining operating segment, the Systems Innovation Group, could not be aggregated with the other operating segments and did not meet the thresholds for a separate reportable segment as defined by the guidance regarding segment disclosure. Therefore the Company has classified it as “All others” in the tables below. Historically, the Company has shown “All others” as part of the Company’s one reportable segment for the three and six month periods ended July 28, 2013. The reportable segment has been reclassified for comparison purposes for the three and six month periods ended July 28, 2013. The Company’s assets are commingled among the various reporting units and the CODM does not use that information in making operating decisions or assessing performance. Therefore, the Company has not included asset information by segment below.

Net sales by segment are as follows:
 
Three Months Ended
 
Six Months Ended
(in thousands)
July 27,
2014
 
July 28,
2013
 
July 27,
2014
 
July 28,
2013
Semiconductor Products Group
$
145,451

 
$
158,149

 
$
277,195

 
$
316,708

All others
291

 
6,861

 
1,406

 
10,709

Total
$
145,742

 
$
165,010

 
$
278,601

 
$
327,417

Income (loss) by segment and reconciliation to consolidated operating income:
 
Three Months Ended
 
Six Months Ended
(in thousands)
July 27,
2014
 
July 28,
2013
 
July 27,
2014
 
July 28,
2013
Semiconductor Products Group
$
36,517

 
$
39,137

 
$
66,478

 
$
81,160

All others
(1,345
)
 
2,131

 
(4,049
)
 
346

   Operating Income by segment
35,172

 
41,268

 
62,429

 
81,506

Items to reconcile segment operating income (loss) to consolidated income before taxes
 
 
 
 
 
 
 
Intangible amortization and impairments
6,444

 
9,811

 
12,869

 
17,667

Stock-based compensation expense
6,274

 
6,156

 
13,121

 
14,782

Inventory write-down

 

 
1,052

 

Restructuring charges

 

 
1,001

 

Other non-segment related expenses
58

 
506

 
502

 
1,437

Amortization of fair value adjustments related to acquired PP&E
339

 
338

 
678

 
3,085

Interest expense, net
1,588

 
10,584

 
2,975

 
14,644

Non-operating expense, net
345

 
198

 
623

 
1,005

Income before taxes
$
20,124

 
$
13,675

 
$
29,608

 
$
28,886


23



Geographic Information
The Company generates virtually all of its sales from its Semiconductor Products Group through sales of analog and mixed-signal devices.
Net sales activity by geographic region is as follows:
 
Three Months Ended
 
Six Months Ended
 
July 27,
2014
 
July 28,
2013
 
July 27,
2014
 
July 28,
2013
Asia-Pacific
77
%
 
72
%
 
76
%
 
73
%
North America
13
%
 
17
%
 
13
%
 
16
%
Europe
10
%
 
11
%
 
11
%
 
11
%
 
100
%
 
100
%
 
100
%
 
100
%
The Company generally attributes sales to a country based on the ship-to address. The table below summarizes sales activity to countries that represented greater than 10% of total net sales for one or more of the periods presented:
 
Three Months Ended
 
Six Months Ended
(percentage of total sales)
July 27,
2014
 
July 28,
2013
 
July 27,
2014
 
July 28,
2013
China (including Hong Kong)
36
%
 
32
%
 
35
%
 
33
%
United States
12
%
 
15
%
 
13
%
 
15
%
Japan
12
%
 
13
%
 
11
%
 
12
%
South Korea
8
%
 
11
%
 
10
%
 
11
%

Income (loss) from continuing operations before income taxes is as follows:
 
 
Three Months Ended
 
Six Months Ended
(in thousands)
July 27,
2014
 
July 28,
2013
 
July 27,
2014
 
July 28,
2013
Domestic
$
(6,002
)
 
$
(11,831
)
 
$
(11,139
)
 
$
(18,245
)
Foreign
26,126

 
25,506

 
40,747

 
47,131

Total
$
20,124

 
$
13,675

 
$
29,608

 
$
28,886


Note 15: Stock Repurchase Program
The Company maintains an active stock repurchase program which was approved by the Company’s Board of Directors (the “Program”). The Program does not have an expiration date and the Board of Directors has authorized expansion of the program over the years. In November 2011 the Board of Directors authorized the Company to repurchase up to $50.0 million of shares of the Company’s common stock from time to time through negotiated or open market transactions, and in August 2013 the Company announced an additional $50.0 million expansion of the Program, for a total authorized Program of $100.0 million, such authorization being subject to certain limitations, guidelines and conditions as directed by the Board of Directors. As of July 27, 2014, the Company had repurchased $57.5 million shares of common stock under the Program.

In the first six months of fiscal year 2015, we repurchased 761,294 shares for $20.0 million. There were no shares repurchased in the first six months of fiscal year 2014.
The Company currently intends to hold the repurchased shares as treasury stock. The Company typically reissues treasury shares to settle stock option exercises and vested restricted stock units.

24



Note 16: Restructuring

In the fourth quarter of fiscal year 2014, the Company made a strategic decision to reduce its investment in the long-haul optical market, realign its product groupings and align spending to current demand levels. As a result of these actions, the Company recorded restructuring charges of $1.0 million in the first quarter of fiscal year 2015. The Company recorded no restructuring charges in the second quarter of fiscal year 2015. Restructuring related liabilities are included in “Accrued liabilities” within the condensed consolidated balance sheet as of July 27, 2014.

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

(in thousands)
One-time employee termination benefits
 
Contract commitments
 
Total
Balance at January 26, 2014
1,387

 
1,245

 
2,632

Charges
378

 
623

 
1,001

Cash payments
(1,702
)
 
(1,586
)
 
(3,288
)
Reclassifications

 
(115
)
 
(115
)
Balance at July 27, 2014
$
63

 
$
167

 
$
230


Restructuring charges are presented in “Restructuring charge” within the condensed consolidated statements of income. The Company does not expect to incur additional costs related to this restructuring event.

25



ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following "Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our condensed consolidated financial statements and the accompanying s included in Item 1 of this Quarterly Report on Form 10-Q (this “Quarterly Report”).
Overview
Semtech Corporation (together with its consolidated subsidiaries, "Semtech", the "Company", "we", "our", or "us") designs, develops, manufactures and markets high-performance analog and mixed signal semiconductor products. We operate and account for results in one reportable segment. In the second quarter of fiscal year 2015, the Company reassessed its operations in light of its recent restructuring efforts undertaken in the fourth quarter of fiscal year 2014 and first quarter of fiscal year 2015. Based on this reassessment, the Company has identified a total of four operating segments. Three of the operating segments aggregate into one reportable segment. The remaining operating segment could not be aggregated with the other operating segments and did not meet the criteria for a separate reportable segment as defined by the guidance regarding segment disclosure. Therefore, the Company operates and accounts for its results in one reportable segment and one non-reportable segment. See Note 14 to our condensed consolidated financial statements.

Our product lines include:
Protection, Power and High-Reliability Products. We design, develop and market high performance protection devices, which are often referred to as transient voltage suppressors (“TVS”). TVS devices provide protection for electronic systems where voltage spikes (called transients), such as electrostatic discharge or secondary lightning surge energy, can permanently damage sensitive complementary metal-oxide-semiconductor integrated circuits (“ICs”). Our portfolio of protection solutions include filter and termination devices that are integrated with the TVS device. Our products provide robust protection while preserving signal integrity in high-speed communications, networking and video interfaces. These products also operate at very low voltage. Our protection products can be found in a broad range of applications including smart phones, LCD TVs, set-top boxes, tablet computers, notebooks, base stations, routers, and industrial instruments.
Our Power products control, alter, regulate and condition the power within electronic systems. The highest volume product types within the power management product line are switching voltage regulators, combination switching and linear regulators, smart regulators and charge pumps. Our power products feature highly integrated functionality for the telecom industry and low-power, small form factor and high-efficiency products for mobile phones, notebook computers, computer peripherals and other portable devices. The primary application for these products is power regulation for computer, communications, high-end consumer and industrial systems.
Our high-reliability discrete semiconductor products comprised of rectifiers, assemblies (packaged discrete rectifiers) and other products are typically used to convert alternating currents into direct currents and to protect circuits against very high voltage spikes or high current surges. Our high-reliability products can be found in a broad range of applications including industrial, military, medical, automotive, aerospace and defense systems, including satellite communications.
Signal Integrity Products. We design, develop and market a portfolio of optical communications, broadcast video, surveillance video, active cable transceiver and backplane products used in a wide variety of enterprise computing, industrial, communications and high-end consumer applications. Our comprehensive portfolio of ICs for optical transceivers, backplane applications and high-speed interfaces ranges from 100Mbps to 100Gbps and supports key industry standards such as Fibre Channel, Infiniband, Ethernet, PON and SONET. Our broadcast video products offer advanced solutions for next generation video formats, ever increasing data rates and evolving I/O and distance requirements. Our security and surveillance products for high-definition closed circuit television (“HDcctv”) enable upgrade of analog closed circuit television installations to full digital HD, leveraging the installed base of COAX cabling, and our fully integrated transmit and receive products enable the highest performance, longest reach HDcctv standards-compliant designs.
We also sell proprietary advanced wired communication, ultra-high speed Serializer/Deserializer (“SerDes”) products for long-haul optical transport communication. These ICs perform transmission functions used in high-speed networks at 40Gbps and 100Gbps. We have ceased development of new products for this market due to our strategic decision to reduce investment in the long-haul optical market in the fourth quarter of fiscal 2014, but we continue to service our existing customer base and we will continue to leverage the underlying in-process Research and Development ("IPR&D") on other products.
Wireless, Sensing and Timing Products. We design, develop and market a portfolio of specialized radio frequency products used in a wide variety of industrial, medical and networking applications, and specialized sensing products used in industrial and consumer applications. Our wireless products feature industry leading and longest range industrial, scientific and medical radio, enabling a lower total cost of ownership and increased reliability in all environments, making them particularly suitable for Machine to Machine and Internet of Things applications. Our unique sensing interface platforms can interface to any sensor

26



and output digital data in any form. Specifically, the proximity sensing capability of our devices enable advanced user interface solutions for mobile and consumer products. Our wireless and sensing products can be found in a broad range of applications in the industrial, medical and consumer markets. The timing and synchronous products used in packet based communication networks provide leading edge timing solutions where IEEE1588 packet synchronization is used.
Systems Innovation Group. Our systems Innovation Group combines the analog/mixed signal design competencies from our previous Sierra Monolithics and Gennum acquisitions and is chartered with developing innovative analog/mixed signal IP for emerging systems. These IP cores are targeted at the Datacenter, Cloud Computing and Storage Networking markets and complement our rapidly growing library of analog/mixed signal IP Cores that have been developed over several years by our Snowbush IP team based in Canada. We also have developed advanced products in Data Converter IP at the latest, cutting edge CMOS process nodes that are targeted at high performance radar and digital microwave systems. We believe this IP will contribute a critical part of the future IP and product roadmap for the Company.
Our sales by product line are as follows:
 
Three Months Ended
 
Six Months Ended
(in thousands)
July 27, 2014
 
July 28, 2013
 
July 27, 2014
 
July 28, 2013
Protection, Power Management and High-Reliability
$
65,426

 
$
67,574

 
$
127,543

 
$
140,252

Signal Integrity
60,232

 
73,388

 
111,511

 
142,337

Wireless, Sensing and Timing
19,793

 
17,187

 
38,141

 
34,119

Systems Innovation
291

 
6,861

 
$
1,406

 
$
10,709

Total
$
145,742

 
$
165,010

 
$
278,601

 
$
327,417

Most of our sales to customers are made on the basis of individual customer purchase orders. Many customers include cancellation provisions in their purchase orders. Trends within the industry toward shorter lead-times and “just-in-time” deliveries have resulted in our reduced ability to predict future shipments. As a result, we rely on orders received and shipped within the same quarter for a significant portion of our sales. Orders received and shipped in the second quarters of fiscal years 2015 and 2014 represented 42% and 45% of net sales, respectively. Sales made directly to customers during the second quarters of fiscal years 2015 and 2014 were 40% and 56% of net sales, respectively. The remaining sales were made through independent distributors. Our business relies on foreign-based entities. Most of our outside subcontractors and suppliers, including third-party foundries that supply silicon wafers, are located in foreign countries, including China, Taiwan, Germany, Poland, United Kingdom and Israel. For the second quarters of fiscal years 2015 and 2014, approximately 43% and 35% of our silicon, in terms of cost of wafers purchased, was manufactured in China, respectively. Foreign sales during the second quarter of fiscal years 2015 and 2014 constituted approximately 88% and 85% of our net sales, respectively. Approximately 88% and 84% of of foreign sales during the second quarters of fiscal year 2015 and 2014 were to customers located in the Asia-Pacific region, respectively. The remaining foreign sales were primarily to customers in Europe, Canada, and Mexico.
We use several metrics as indicators of future potential growth. The indicators that we believe best correlate to potential future revenue growth are design wins and new product releases. There are many factors that may cause a design win or new product release not to result in revenue, including a customer decision not to go to system production, a change in a customer’s perspective regarding a product’s value or a customer’s product failing in the end-market. As a result, although a design win or new product introduction is an important step towards generating future revenue, it does not inevitably result in us being awarded business or receiving a purchase commitment.
Historically, our results have reflected some seasonality, with demand levels generally lower in the computer and high-end consumer product lines during the first and fourth quarters of our fiscal year in comparison to the second and third quarters.
Restructuring
In December 2013, after filing our Quarterly Report on Form 10-Q for the period ended October 27, 2013, we became aware of changes tied to the decision of a customer, disclosed in our filings as a key customer, to transition from our standard product to their internal application specific integrated circuit (“ASIC”) solution. This decision by our key customer to utilize an internal ASIC solution was accelerated by continued delays in the release of capital investment tenders, primarily within China, which also provided other potential customers of ours with additional time to develop their internal solutions. While some of these potential customers had indicated an interest in transitioning to an internal ASIC solution, it was our key customer’s decision to do so that prompted our strategic reassessment and resulting restructuring.

Upon completing the reassessment of our strategic options in January 2014, we decided to reduce the level of investments that we are making in the long-haul optical market. This reduction in investment is expected to significantly impact our ability to

27



generate future revenue from the long-haul optical market. This anticipated reduction in potential future revenue resulted in us recording significant impairments of goodwill and other intangibles in the fourth quarter of fiscal year 2014. Additionally, certain long-lived assets were determined to be impaired. As a result of our communications to our customers regarding our operational changes, customers have started to transition away from some of our current platforms, including certain products in the 40Gbps and 100Gbps SerDes class which resulted in us reducing the cost basis of inventories in the fourth quarter of fiscal year 2014. Additionally, we incurred $1.0 million and $3.1 million of restructuring costs in the first quarter of fiscal year 2015 and the fourth quarter of fiscal year 2014, respectively, to terminate certain contract commitments and to provide for certain severance benefits to employees who were terminated as a result of these investment reductions. We completed the restructuring activities in the first quarter of fiscal year 2015.

We do not expect any significant changes to our liquidity as a result of our restructuring activities as most of the charges associated with these actions do not require settlement in cash.

As a result of these restructuring actions, we have realized significant operating cost savings. For fiscal year 2015, we expect an annual reduction in compensation costs of approximately $10.0 million, development costs of approximately $10.0 million and depreciation and amortization costs of approximately $5.2 million. These savings are expected to be offset by an anticipated $80.0 to $90.0 million reduction in revenues from long-haul optical products which are included in our Signal Integrity products group.
Critical Accounting Policies and Estimates
In addition to the discussion below, you should refer to the disclosures regarding our critical accounting policies in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Item 7 of our Annual Report on Form 10-K for the fiscal year ended January 26, 2014 filed with the Securities and Exchange Commission (“SEC”) on March 27, 2014.
Fiscal Periods
We report results on the basis of 52 or 53 week annual periods and end our fiscal year on the last Sunday in January. The interim periods generally end on the last Sunday of April, July and October. All interim periods consist of 13 weeks, with the exception of one 14-week interim period in 53-week fiscal years. The three and six month periods presented in this discussion for fiscal years 2015 and 2014 consisted of 13 and 26 weeks, respectively.
Revenue and Cost of Sales
We recognize product revenue when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collectability is reasonably assured. Product design and engineering recoveries are recognized during the period in which services are performed. We include revenue related to granted technology licenses as part of “Net sales.” Historically, revenue from these arrangements has not been significant though it is part of our recurring ordinary business.
We record a provision for estimated sales returns in the same period as the related revenues are recorded. We base these estimates on historical sales returns and other known factors. Actual returns could be different from our estimates and current provisions for sales returns and allowances, resulting in future charges to earnings.
We defer revenue recognition on shipment of products to certain customers, principally distributors, under agreements which provide for limited pricing credits or product return privileges, until these products are sold through to end-users or the return privileges lapse. For sales subject to certain pricing credits or return privileges, the amount of future pricing credits or inventory returns cannot be reasonably estimated given the relatively long period in which a particular product may be held by the customer. Therefore, we have concluded that sales to customers under these agreements are not fixed and determinable at the date of the sale and revenue recognition has been deferred. We estimate the deferred gross margin on these sales by applying an average gross profit margin to the actual gross sales. The average gross profit margin is calculated for each category of material using current standard costs which is expected to approximate actual costs at the date of sale. The estimated deferred gross margin on these sales, where there are no outstanding receivables, is recorded within the condensed consolidated balance sheet under the heading of “Deferred revenue.” There were no significant impairments of deferred cost of sales in fiscal year 2014 or the first six months of fiscal year 2015.

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The following table summarizes the deferred revenue balance:
(in thousands)
July 27,
2014
 
January 26,
2014
Deferred revenue
$
6,499

 
$
7,179

Deferred cost of revenue
1,507

 
1,698

Deferred revenue, net
4,992

 
5,481

Deferred product design and engineering recoveries
1,434

 
1,786

Total deferred revenue
$
6,427

 
$
7,267

Gross Profit
Gross profit is equal to our net sales less our cost of sales. Our cost of sales includes materials, depreciation on fixed assets used in the manufacturing process, shipping costs, direct labor and overhead. We determine the cost of inventory by the first-in, first-out method.
Operating Costs
Our operating costs and expenses generally consist of selling, general and administrative, product development and engineering costs, costs associated with acquisitions, restructuring charges, and other operating related charges.
Results of Operations
The following table sets forth, for the periods indicated, our condensed consolidated statements of income expressed as a percentage of revenues.
 
Three Months Ended
 
Six Months Ended
 
July 27, 2014
 
July 28, 2013
 
July 27, 2014
 
July 28, 2013
Net sales
100.0
 %
 
100.0
 %
 
100.0
 %
 
100.0
 %
Cost of sales
39.5
 %
 
39.0
 %
 
40.3
 %
 
39.5
 %
Gross profit
60.5
 %
 
61.0
 %
 
59.7
 %
 
60.5
 %
Operating costs and expenses:
 
 
 
 
 
 
 
Selling, general and administrative
21.6
 %
 
20.2
 %
 
22.7
 %
 
20.8
 %
Product development and engineering
19.3
 %
 
20.1
 %
 
20.1
 %
 
20.7
 %
Intangible amortization
4.4
 %
 
4.4
 %
 
4.6
 %
 
4.6
 %
Intangible asset impairments
 %
 
1.6
 %
 
 %
 
0.8
 %
Restructuring charge
 %
 
 %
 
0.4
 %
 
 %
Total operating costs and expenses
45.4
 %
 
46.3
 %
 
47.8
 %
 
46.9
 %
Operating income
15.1
 %
 
14.7
 %
 
11.9
 %
 
13.6
 %
Interest expense, net
(1.1
)%
 
(6.4
)%
 
(1.1
)%