Attached files

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EX-10.2 - FORM OF NON-EMPLOYEE DIRECTOR OPTION AWARD CERTIFICATE - SEMTECH CORPsmtc-07262015xex102.htm
EX-10.1 - POLICY REGARDING DIRECTOR COMPENSATION - SEMTECH CORPsmtc-07262015xex101.htm
EX-10.3 - FORM OF NON-EMPLOYEE DIRECTOR NON-DEFERRED STOCK UNIT AWARD CERTIFICATE - SEMTECH CORPsmtc-07262015xex103.htm
EX-32.2 - SECTION 906 CERTIFICATION OF THE CHIEF FINANCIAL OFFICER - SEMTECH CORPsmtc-07262015xex322.htm
EX-31.1 - SECTION 302 CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER - SEMTECH CORPsmtc-07262015xex311.htm
EX-31.2 - SECTION 302 CERTIFICATION OF THE CHIEF FINANCIAL OFFICER - SEMTECH CORPsmtc-07262015xex312.htm
EX-10.4 - FORM OF NON-EMPLOYEE DIRECTOR DEFERRED STOCK UNIT AWARD CERTIFICATE - SEMTECH CORPsmtc-07262015xex104.htm
EX-32.1 - SECTION 906 CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER - SEMTECH CORPsmtc-07262015xex321.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 26, 2015
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 28, 2015: 65,291,455
 




SEMTECH CORPORATION
INDEX TO FORM 10-Q
FOR THE QUARTER ENDED JULY 26, 2015
 

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 the Company’s current expectations, estimates and projections about its operations, industry, financial condition, and expected performance. 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,” “believes,” “anticipates,” “expects,” “intends,” “plans,” “projects,” “estimates,” “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:
variation in market demand for the Company’s products including as a result of downturns in the business cycle and changes in global economic conditions;
business interruptions caused by natural disasters, health epidemics, or violence affecting the locations in which the Company, its customers or its suppliers operate;
the availability and cost of raw materials, components and equipment;
product liability or warranty claims and availability of sufficient liability insurance;
the Company‘s ability to timely develop, manufacture, market and provide support for new products that meet industry standards in a dynamic technological environment;
the Company’s ability to protect its intellectual property rights and avoid infringement of the intellectual property rights of others;
the financial impact of inadequate or excess inventory that results from demand that differs from projections;
increased business risk from trade with multiple foreign entities, including compliance with or changes in the complex laws, rules and regulations applicable to international business transactions, social, political and economic instability, increased challenges in collection and management of distributors, representatives and staff, and exposure to foreign currency fluctuations ;
potential increased tax liabilities and effective tax rate if the Company needs to repatriate funds held by foreign subsidiaries;
industry consolidation and the Company’s ability to compete against larger, more established entities;
volatility of customer demand or the loss of any one of the Company’s significant customers;
financial difficulties of our distributors or their termination of our contracts or promotion of competing product lines to the Company’s detriment;
the ability of the Company to comply, and the costs associated with complying, with the complex laws, rules and government regulations and standards to which the Company is or may become subject, and any action of an enforcement authority, that restricts our ability to manufacture our products or operate our business, or subjects us to fines, penalties, legal liabilities or reputational harm;
changes in the tax rate applicable to the Company as a result of changes in tax laws and the outcome of examinations by global taxing authorities;
the Company’s ability to maintain effective internal control over financial reporting and disclosure controls and procedures;
the Company’s ability to recruit and retain skilled personnel;
the Company’s ability to successfully integrate acquired businesses and benefit from expected synergies;
impairments of our non-financial assets;
the Company’s ability to generate cash to service its debt obligations;
the Company’s ability to pursue business strategies that may be restricted by the terms of the Company’s credit agreement;
the possible disruption of the Company’s critical communications and information systems necessary to operate its business;

3





costs associated with indemnification of customers, distributors and other parties;
the fluctuation of the Company’s share price;
the Company’s ability to realize expected benefits of the implementation of a new enterprise resource planning (“ERP”) system; and disruption of the Company’s operations caused by the adjustment to the new ERP system and the transition from the Company’s legacy systems and databases; and
the Company’s ability to achieve the expected reduction in the Company’s operating expenses from its restructuring activities.
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 25, 2015 including, without limitation information under the caption “Risk Factors”, 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.

4





PART I - FINANCIAL INFORMATION
 
ITEM 1.
Financial Statements

SEMTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
 
 
Three Months Ended
 
Six Months Ended
 
July 26, 2015
 
July 27, 2014
 
July 26, 2015
 
July 27, 2014
Net sales
$
125,712

 
$
145,742

 
$
255,800

 
$
278,601

Cost of sales
50,136

 
57,521

 
101,824

 
112,296

Gross profit
75,576

 
88,221

 
153,976


166,305

Operating costs and expenses:
 
 
 
 
 
 
 
Selling, general and administrative
34,528

 
31,547

 
72,203

 
63,243

Product development and engineering
28,239

 
28,173

 
57,917

 
55,986

Intangible amortization
6,177

 
6,444

 
12,340

 
12,869

Restructuring charge
3,564

 

 
3,564

 
1,001

Total operating costs and expenses
72,508

 
66,164

 
146,024

 
133,099

Operating income
3,068

 
22,057

 
7,952

 
33,206

Interest expense, net
(1,900
)
 
(1,588
)
 
(3,734
)
 
(2,975
)
Non-operating expense, net
117

 
(345
)
 
(376
)
 
(623
)
Income before taxes
1,285

 
20,124

 
3,842

 
29,608

Provision for taxes
1,598

 
2,226

 
4,297

 
3,843

Net (loss) income
$
(313
)
 
$
17,898

 
$
(455
)
 
$
25,765

(Loss) earnings per share:
 
 
 
 
 
 
 
Basic
$
0.00

 
$
0.27

 
$
(0.01
)
 
$
0.38

Diluted
$
0.00

 
$
0.26

 
$
(0.01
)
 
$
0.38

Weighted average number of shares used in computing earnings per share:
 
 
 
 
 
 
 
Basic
65,920

 
67,208

 
66,319

 
67,254

Diluted
65,920

 
67,850

 
66,319

 
67,888

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

5





SEMTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF
COMPREHENSIVE (LOSS) INCOME
(in thousands)
(unaudited)
 
  
Three Months Ended
 
Six Months Ended
 
July 26, 2015
 
July 27, 2014
 
July 26, 2015
 
July 27, 2014
Net (loss) income
$
(313
)
 
$
17,898

 
$
(455
)
 
$
25,765

Other comprehensive (loss) income, before tax:
 
 
 
 
 
 
 
Available-for-sale investments:
 
 
 
 
 
 
 
Change in unrealized holding income on available-for-sale investments

 
(2
)
 

 
(1
)
Interest rate hedge:
 
 
 
 
 
 
 
Change in unrealized loss on interest rate cap
(14
)
 
(51
)
 
(33
)
 
(161
)
Reclassification to interest expense
154

 
47

 
269

 
80

Other comprehensive income (loss), before tax
140

 
(6
)

236


(82
)
(Provision) benefit for taxes related to items of other comprehensive income
(56
)
 
(16
)
 
(98
)
 
12

Other comprehensive income (loss), net of tax
84

 
(22
)
 
138

 
(70
)
Total comprehensive (loss) income
$
(229
)
 
$
17,876

 
$
(317
)
 
$
25,695

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

6





SEMTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
 
July 26, 2015
 
January 25, 2015
 
(unaudited)
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
212,602

 
$
230,328

Accounts receivable, less allowances of $4,285 at July, 26 2015 and $3,523 at January 25, 2015
61,509

 
69,301

Inventories
80,291

 
73,668

Deferred tax assets
2,486

 
2,478

Prepaid taxes
2,891

 
1,544

Other current assets
17,171

 
19,369

Total current assets
376,950

 
396,688

Non-current assets:
 
 
 
Property, plant and equipment, net of accumulated depreciation of $132,306 at July 26, 2015 and $120,588 at January 25, 2015
109,075

 
115,471

Deferred tax assets
23

 
106

Goodwill
329,703

 
280,319

Other intangible assets, net
101,166

 
101,600

Other assets
32,988

 
35,247

TOTAL ASSETS
$
949,905

 
$
929,431

Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
46,540

 
$
32,448

Accrued liabilities
41,744

 
49,754

Deferred revenue
6,890

 
5,848

Current portion - long-term debt
18,555

 
18,547

Other current liabilities
10,000

 

Deferred tax liabilities
1,444

 
1,444

Total current liabilities
125,173

 
108,041

Non-current liabilities:
 
 
 
Deferred tax liabilities
2,477

 
2,477

Long term debt, less current portion
260,464

 
234,746

Other long-term liabilities
51,090

 
32,809

Stockholders’ equity:
 
 
 
Common stock, $0.01 par value, 250,000,000 shares authorized, 78,136,144 issued and 65,050,133 outstanding on July 26, 2015 and 78,136,144 issued and 66,812,919 outstanding on January 25, 2015
785

 
785

Treasury stock, at cost, 13,086,011 shares as of July 26, 2015 and 11,323,225 shares as of January 25, 2015
(265,974
)
 
(222,969
)
Additional paid-in capital
374,260

 
371,596

Retained earnings
401,329

 
401,783

Accumulated other comprehensive income
301

 
163

Total stockholders’ equity
510,701

 
551,358

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
949,905

 
$
929,431

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

7





SEMTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 
Six Months Ended
 
July 26, 2015
 
July 27, 2014
Cash flows from operating activities:
 
 
 
Net (loss) income
$
(455
)
 
$
25,765

Adjustments to reconcile net (loss) income to net cash provided by operating activities, net of effects of acquisitions:
 
 
 
Depreciation, amortization and impairments
24,020

 
24,030

Accretion of deferred financing costs and debt discount
660

 
511

Deferred income taxes
(430
)
 
3,143

Stock-based compensation
8,282

 
13,121

Earn-out liabilities
568

 
(46
)
Environmental reserve
2,855

 

Loss (gain) on disposition of property, plant and equipment
23

 
(14
)
Changes in assets and liabilities:
 
 
 
Accounts receivable, net
7,977

 
(2,135
)
Inventories
(6,335
)
 
5,816

Prepaid expenses and other assets
988

 
(4,247
)
Accounts payable
15,960

 
(2,544
)
Accrued liabilities
(9,353
)
 
(1,681
)
Deferred revenue
1,042

 
(840
)
Income taxes payable and prepaid taxes
1,398

 
(1,839
)
Other liabilities
1,546

 
2,097

Net cash provided by operating activities
48,746

 
61,137

Cash flows from investing activities:
 
 
 
Proceeds from sales and maturities of available-for-sale investments

 
3,124

Proceeds from sales of property, plant and equipment

 
71

Purchase of property, plant and equipment
(8,244
)
 
(12,662
)
Purchase of intangible assets

 
(1,000
)
Acquisitions, net of cash acquired
(34,932
)
 

Purchases of other investments
(3,230
)
 
(3,264
)
Proceeds from sale of equity investments
5,261

 

Net cash used in investing activities
(41,145
)
 
(13,731
)
Cash flows from financing activities:
 
 
 
Borrowings under line of credit
35,000

 

Payment for employee stock-based compensation payroll taxes
(4,073
)
 
(3,533
)
Proceeds from exercises of stock options
2,968

 
5,975

Repurchase of outstanding common stock
(49,847
)
 
(20,000
)
Payment of long term debt
(9,375
)
 
(34,375
)
Net cash used in financing activities
(25,327
)
 
(51,933
)
Net decrease in cash and cash equivalents
(17,726
)
 
(4,527
)
Cash and cash equivalents at beginning of period
230,328

 
243,194

Cash and cash equivalents at end of period
$
212,602

 
$
238,667

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

8





SEMTECH CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1: Organization and Basis of Presentation
Nature of Business
The Company is a global supplier of analog and mixed-signal semiconductor products. The end-customers for the Company’s products are primarily original equipment manufacturers (“OEM’s”) 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.
Enterprise Computing: datacenters, passive optical networks, desktops, notebooks, servers, graphic boards, monitors, printers and other computer peripherals.
Communications: base stations, optical networks, carrier networks, switches and routers, cable modems, wireless LAN and other communication infrastructure equipment.
High-End Consumer: handheld products, smartphones, set-top boxes, digital televisions, tablets, digital video recorders and other consumer equipment.
Industrial: video broadcast equipment, automated meter reading, alternative energy, Internet of Things (“IoT”), smart grid, 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 2016 and 2015 each consisted of 13 weeks.
Principles of Consolidation
The accompanying interim condensed consolidated financial statements 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 the Company 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 interim condensed consolidated financial statements were issued.
In January 2015, the Company completed the acquisition of EnVerv, Inc. (“EnVerv”). In March 2015, the Company completed the acquisition of Triune Systems, L.L.C. (“Triune”). These interim condensed consolidated financial statements include the results of operations of EnVerv and Triune commencing as of their acquisition dates.
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 25, 2015. 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 first quarter of fiscal year 2016, the Company completed a reassessment of its operations in light of its recent strategic business decisions. Based on this reassessment, the Company has identified five operating segments in total. Four of the operating segments aggregate into one reportable segment, the Semiconductor Products Group. The remaining operating segment, the Systems Innovation Group (shown as “All others”), 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, the financial activity associated with the Systems Innovation Group is being reported separately from the Company’s reportable segment. This separate reporting is included in the “All others” category. The Company reported “All others” separately from the Company’s Semiconductor Products Group beginning in the three month period ended July 27, 2014. The historical activity of the reportable segment has been recast for consistent presentation for the three and six month periods ended July 27, 2014.
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 April 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. ASU 2014-08 changes the requirements for reporting discontinued operations in FASB Accounting Standards Codification (“ASC”) Subtopic 205-20, such that a disposal of a component of an entity or a group of components of an entity is required to be reported in discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results. ASU 2014-08 requires an entity to present, for each comparative period, the assets and liabilities of a disposal group that includes a discontinued operation separately in the asset and liability sections, respectively, of the statement of financial position, as well as additional disclosures about discontinued operations. Additionally, ASU 2014-08 requires disclosures about a disposal of an individually significant component of an entity that does not qualify for discontinued operations presentation in the financial statements and expands the disclosures about an entity’s significant continuing involvement with a discontinued operation. The accounting update is effective for annual periods beginning on or after December 15, 2014. Accordingly, the Company has adopted the provisions of this new accounting standard at the beginning of fiscal year 2016, and has assessed the impact on its consolidated financial statements to be immaterial.
In May 2014, the FASB issued 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, 2017 and for interim periods within those annual periods. This update will be effective for the Company beginning in the first quarter of fiscal year 2018. 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.
In April 2015, the FASB issued ASU 2015-03, Simplifying the Presentation of Debt Issuance Costs. The new standard intends to simplify the presentation of debt issuance costs to be presented in the balance sheet as a direct deduction from the carrying value of the associated debt liability. The new guidance is effective for annual reporting periods beginning after December 15, 2015, including interim reporting periods within that reporting period and early application is permitted. The Company plans to adopt the provisions of this new accounting standard at the beginning of fiscal year 2017. The adoption of this standard is not expected to have a significant impact on the Company’s consolidated financial statements.

9





Note 2: Acquisitions
Triune Systems, L.L.C
On March 4, 2015 the Company acquired Triune Systems, L.L.C., a privately-held supplier of isolated switching wireless charging and power management platforms targeted at, among other things, high and low power, high efficiency applications. Under the terms of the purchase agreement the Company acquired all of the outstanding equity interest in Triune for a guaranteed minimum purchase price of $45.0 million consisting of $35.0 million in cash paid at closing, with an additional cash consideration of $10.0 million to be paid six months after the transaction closing date and additional contingent consideration subject to achieving certain future financial goals (“Triune Earn-out”). Under the terms of the Triune Earn-out, up to $70.0 million of consideration will be paid over three years if certain revenue targets are achieved in each of the fiscal years 2016 through 2018. An additional payment of up to $16.0 million will be paid after fiscal year 2018 if certain cumulative revenue and operating income targets are achieved. During the six months ended July 26, 2015, the Company borrowed $35.0 million under its revolving line of credit in connection with this acquisition (see Note 10 for discussion regarding Credit Facilities).
The Triune Systems L.L.C. business meets the definition of a business and is accounted for under the acquisition method of accounting in accordance with the FASB’s ASC Topic 805, Business Combinations. Total acquisition consideration will be allocated to the acquired tangible and intangible assets and assumed liabilities of Triune based on their respective estimated fair values as of the acquisition date. Acquisition-related transaction costs are not included as a component of consideration transferred, but are accounted for as an expense in the period in which the costs are incurred. Any excess of the acquisition consideration over the fair value of the assets acquired and liabilities assumed will be allocated to goodwill. The goodwill resulted from expected synergies from the transaction, including complementary products that will enhance the Company’s overall product portfolio, and opportunities within new markets. As of July 26, 2015, $10.0 million of the total acquisition consideration has been allocated to core technologies, $2.0 million to customer relationships and $49.4 million to goodwill. The remaining balance was allocated to identifiable tangible assets and assumed liabilities. The Company expects that all such goodwill will be deductible for tax purposes.
The purchase price allocation for the Triune acquisition was finalized in the second quarter of fiscal year 2016.
Net revenues and earnings attributable to Triune since the acquisition date were not material. Pro forma results of operations have not been presented as Triune’s annual operating results are not material to the Company’s consolidated financial results.
EnVerv, Inc.
On January 13, 2015, the Company paid $4.9 million to acquire select assets from EnVerv, Inc., a privately-held supplier of power line communications (“PLC”) and Smart Grid solutions targeted at advanced metering infrastructure, home energy management systems and IoT applications. The Company has concluded that the acquired assets constituted a business and accordingly accounted for this transaction as a business combination.
The purchase price allocation for the EnVerv acquisition was finalized in the first quarter of fiscal year 2016. Total acquisition consideration has been allocated to the acquired tangible and intangible assets and assumed liabilities based on their respective estimated fair values as of the acquisition date. The excess of the acquisition consideration over the fair value of assets acquired and liabilities assumed has been allocated to goodwill. As of July 26, 2015, $1.4 million of the total acquisition consideration has been allocated to core technologies and $3.4 million has been allocated to goodwill. The remaining balance has been allocated to acquired tangible assets and assumed liabilities. The Company expects that all such goodwill will be deductible for tax purposes.
Net revenues and earnings attributable to EnVerv since the acquisition date were not material. Pro forma results of operations have not been presented as EnVerv’s annual operating results are not material to the Company’s consolidated financial statements.

10





Note 3: (Loss) Earnings per Share
The computation of basic and diluted (loss) earnings per common share is as follows:
 
Three Months Ended
 
Six Months Ended
(in thousands, except per share amounts)
July 26, 2015
 
July 27, 2014
 
July 26, 2015
 
July 27, 2014
Net (loss) income
$
(313
)
 
$
17,898

 
$
(455
)
 
$
25,765

 
 
 
 
 
 
 
 
Weighted average common shares outstanding - basic
65,920

 
$
67,208

 
$
66,319

 
$
67,254

Dilutive effect of options and restricted stock units

 
642

 

 
634

Weighted average common shares outstanding - diluted
65,920

 
$
67,850

 
$
66,319

 
$
67,888

 
 
 
 
 
 
 
 
Basic (loss) earnings per common share
$
0.00

 
$
0.27

 
$
(0.01
)
 
$
0.38

Diluted (loss) earnings per common share
$
0.00

 
$
0.26

 
$
(0.01
)
 
$
0.38

 
 
 
 
 
 
 
 
Anti-dilutive shares not included in the above calculations
2,894

 
1,463

 
2,418

 
1,427

Basic (loss) earnings per common share is computed by dividing net (loss) 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 incorporate the incremental shares issuable, calculated using the treasury stock method, upon the assumed exercise of stock options and the vesting of restricted stock. For periods of operating loss, no common share equivalents are included because their effect would be anti-dilutive.
Note 4: 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 operations. 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 arrangements 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. The Company reviews material subject to return for impairment for purposes of computing deferred cost of sales. There were no significant impairments of deferred cost of sales in the second quarter or first half of fiscal year 2016 or fiscal year 2015.

11





Note 5: Stock-Based Compensation
Financial Statement Effects and Presentation. The following table summarizes pre-tax, stock-based compensation expense included in the unaudited condensed consolidated statements of operations captions for the three and six months ended July 26, 2015 and July 27, 2014, respectively.
 
 
Three Months Ended
 
Six Months Ended
(in thousands)
July 26, 2015
 
July 27, 2014
 
July 26, 2015
 
July 27, 2014
Cost of sales
$
400

 
$
355

 
$
875

 
$
718

Selling, general and administrative
(141
)
 
3,448

 
3,073

 
7,513

Product development and engineering
2,076

 
2,472

 
4,333

 
4,891

Stock-based compensation
$
2,335

 
$
6,275

 
$
8,281

 
$
13,122

Net change in stock-based compensation capitalized into inventory
$
204

 
$
37

 
$
279

 
$
28

Stock-based Payment Arrangements
The Company has various equity award plans that provide for granting stock-based awards to employees and non-employee directors of the Company. The plans provide for the granting of several available forms of stock-based compensation. As of July 26, 2015, the Company has granted stock options, restricted stock and restricted stock units under the plans and has also issued some stock-based compensation outside of the plans, including stock options, restricted stock and restricted stock units issued as inducements to join the Company.
Grant Date Fair Values and Underlying Assumptions: Contractual Terms
The Company uses the Black-Scholes pricing model to value stock options. The estimated fair value of restricted stock units, for which vesting is not linked to a market condition, is calculated based on the market price of the Company’s common stock on the date of grant. For restricted stock units that vest according to a market condition, the Company uses a Monte Carlo simulation model to value the award.
Some of the restricted stock units granted in the first six months of fiscal year 2016 and prior years are classified as liabilities rather than equity. For grants classified as equity, stock-based compensation cost is measured at the grant date, based on the fair value of the award, and is recognized as an expense over the grantee’s requisite service period. For grants classified as liabilities, stock-based compensation cost is measured at fair value at the end of each reporting period until the date of settlement, and is recognized as an expense over the grantee’s requisite service period. Expected volatilities are based on historical volatility using daily and monthly stock price observations.
The following table summarizes the assumptions used in the Black-Scholes model to determine the fair value of stock options granted in the three and six months ended July 26, 2015 and July 27, 2014, respectively:
 
 
Three Months Ended
 
Six Months Ended
 
July 26, 2015
 
July 27, 2014
 
July 26, 2015
 
July 27, 2014
Expected lives, in years
4.2
 
4.3 - 4.4
 
4.2 - 4.3
 
3.0 - 4.4
Estimated volatility
32%
 
33%
 
29% - 32%
 
33% - 34%
Dividend yield
 
 
 
Risk-free interest rate
1.3%
 
1.30% - 1.43%
 
1.24% - 1.29%
 
1.26% - 1.43%
Weighted average fair value on grant date
$6.50
 
$7.43
 
$7.32
 
$7.26


12





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 26, 2015:
 
 
 
 
 
 
 
 
 
 
 
 
(in thousands, except for per share amounts)
Number
of
Shares
 
Weighted
Average
Exercise
Price
(per share)
 
Aggregate
Intrinsic
Value
 
Aggregate
Unrecognized
Compensation
 
Number of
Shares
Exercisable
 
Weighted
Average
Contractual
Term
(in years)
Balance at January 25, 2015
1,763

 
$
23.70

 
$
7,722

 
$
4,688

 
986
 
 
Options granted
184

 
28.21

 
 
 
 
 
 
 
 
Options exercised
(186
)
 
15.96

 
1,592

 
 
 
 
 
 
Options cancelled/forfeited
(132
)
 
26.18

 
 
 
 
 
 
 
 
Balance at July 26, 2015
1,629

 
$
24.89

 
$
552

 
$
4,340

 
943
 
 
Exercisable at July 26, 2015
943

 
$
23.25

 
$
552

 
 
 
 
 
2.5
Performance-Based 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 award which is granted in any fiscal year will be tied to the Company’s performance of that fiscal year and the succeeding two fiscal years. The performance award recipients must be employed for the entire three-year period, which is the explicit service and requisite service period, and be an active employee at the time of vesting of the awards (cliff vesting at the end of the third year). Under the terms of these awards, assuming the highest performance level of 200% with no cancellations due to forfeitures, the maximum number of shares that can be earned would be 547,032 shares and an additional 547,032 shares would be settled in cash. The Company would have a liability accrued under “Other liabilities” within the condensed consolidated balance sheet equal to the value of 547,032 shares on the settlement date, which would be settled in cash. Only cash performance-based restricted stock unit awards are classified as liabilities and the value of these awards is re-measured at each reporting date. At July 26, 2015, the performance metrics associated with the outstanding awards issued in fiscal years 2016, 2015 and 2014 are expected to be met at a level which would result in a grant at 50%, 65%, and 0% of target, respectively.
In the first quarter of fiscal year 2016 the Company granted performance-based vesting restricted stock units to select employees as part of the EnVerv acquisition. These awards have a performance condition in addition to a service condition. The performance metrics are determined based on a pre-defined revenue target. In addition to the performance vesting condition, these awards have a requisite four year vesting term (which is also the requisite vesting period) whereby 25% will vest, subject to attainment of the performance condition, on each anniversary of the grant date. Under the terms of these awards, assuming the highest performance level of 100% with no cancellations due to forfeitures, the maximum number of shares that can be earned would be 45,000. At July 26, 2015, the performance metrics associated with the outstanding awards issued in fiscal year 2016 are expected to be met at a level which would result in a grant at 30,000 shares.
The Performance-based restricted stock units are valued as of the measurement date and expense is recognized on a straight line basis for the awards expected to vest based on the probability of attainment of the performance condition for each separately vesting portion of the award.

13





The following table summarizes the activity for performance-based restricted stock units for the six months ended July 26, 2015:
 
 
 
Subject to
Share Settlement
 
Subject to
Cash Settlement
 
Weighted 
Average
Grant Date Fair Value
(per unit)
 
Aggregate Unrecognized
Compensation
 
Weighted Average Period Over
Which Expected to be Recognized
(in years)
(in thousands, except for per unit amounts)
Total
Units
 
Units
 
Units
 
Recorded
Liability
 
 
 
Balance at January 25, 2015
426

 
211

 
215

 
$
1,891

 
$
27.17

 
$
6,164

 
1.6
Performance-based units granted
235

 
145

 
90

 
 
 
28.60

 
 
 
 
Performance-based units vested

 

 

 
 
 

 
 
 
 
Performance-based units cancelled/forfeited
(70
)
 
(40
)
 
(30
)
 
 
 
27.93

 
 
 
 
Change in liability
 
 
 
 
 
 
(1,317
)
 
 
 
 
 
 
Balance at July 26, 2015
591

 
316

 
275

 
$
574

 
$
27.65

 
$
4,485

 
1.7

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

Market Performance Restricted Stock Units. On February 26, 2014, the Company granted its CEO restricted stock units with a market performance condition. The award is eligible to vest during the period commencing February 26, 2014 and ending February 26, 2019 (the “Performance Period”) as follows: 30% of the restricted stock units covered by the award will vest if, during any consecutive 120 calendar day period that commences and ends during the Performance Period, the average per-share closing price of the Company’s common stock equals or exceeds $35.00 (“Tranche 1”) and the award will vest in full if, during any consecutive 120 calendar day period that commences and ends during the Performance Period, the average per-share closing price of the Company’s common stock equals or exceeds $40.00 (“Tranche 2”). The award will also vest if a majority change in control of the Company occurs during the Performance Period and, in connection with such event, the Company’s stockholders become entitled to receive per-share consideration having a value equal to or greater than $40.00. The fair value of the awards was determined to be $17.26 and $14.88 for Tranche 1 and Tranche 2, respectively, on the grant date by application of the Monte Carlo simulation model.
The following table summarizes the activity for market performance restricted stock units for the six months ended July 26, 2015:
 
 
 
Weighted 
Average
Grant Date Fair Value
(per unit)
 
Aggregate Unrecognized
Compensation
 
Period Over
Which Expected to be Recognized
(in years)
(in thousands, except for per unit amounts)
Total
Units
 
 
 
Balance at January 25, 2015
220

 
$
15.59

 
$

 
1.2
Market performance units granted

 

 
 
 
 
Market performance units vested

 

 
 
 
 
Market performance units cancelled/forfeited

 

 
 
 
 
Balance at July 26, 2015
220

 
$
15.59

 
$
827

 
0.5


14





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 26, 2015:
(in thousands, except for per unit amounts)
Number of
Units
 
Weighted Average
Grant Date
Fair Value
(per unit)
 
Aggregate
Intrinsic
Value (1)
 
Aggregate
Unrecognized
Compensation
 
Weighted Average
Period Over
Which Expected
to be Recognized
(in years)
Balance at January 25, 2015
2,138

 
$
26.43

 
 
 
$
44,506

 
2.4
Restricted stock units granted
370

 
27.10

 
 
 
 
 
 
Restricted stock units vested
(340
)
 
27.78

 
$
9,325

 
 
 
 
Restricted stock units forfeited
(220
)
 
26.15

 
 
 
 
 
 
Balance at July 26, 2015
1,948

 
$
26.35

 
 
 
$
39,039

 
2.3

(1)
Reflects the value of Semtech Corporation stock on the date that the restricted stock unit vested.
Restricted Stock Units, Cash Settled, Non-Employee Directors. The Company maintains a compensation program pursuant to which restricted stock units are granted to the Company’s directors that are not employed by the Company or any of its subsidiaries. In June 2015, the Company changed its director compensation program so that a portion of the stock units granted under the program would be settled in cash and a portion would be settled in stock. Restricted stock units awarded under the program are scheduled to vest on the earlier of (i) one year after the grant date or (ii) the day immediately preceding the annual meeting of shareholders in the year following the grant. The portion of a restricted stock unit award under the program that is to be settled in cash will, subject to vesting, be paid when the director who received the award separates from the board of directors. The portion of a restricted stock unit award under the program that is to be settled in stock will, subject to vesting, be paid promptly following vesting. There were no changes to the terms and conditions of the existing awards.
The restricted stock units that are to be settled in cash are accounted for as liabilities because they are cash settled. Because these awards are not typically settled until a non-employee director’s separation from service, the value of these awards is re-measured at the end of each reporting period until settlement. The following table summarizes the non-employee directors’ activity for restricted stock units settled in cash for the six months ended July 26, 2015:
 
(in thousands, except for per unit amounts)
Number of
Units
 
Recorded
Liability
 
Weighted Average
Grant Date
Fair Value
(per unit)
 
Aggregate
Unrecognized
Compensation
 
Period Over
Which Expected
to  be Recognized
(in years)
Balance at January 25, 2015
24

 
$
5,214

 
$
26.59

 
$
275

 
0.4
Restricted stock units granted
28

 
 
 
19.70

 
 
 
 
Restricted stock units vested
(24
)
 
 
 
26.59

 
 
 
 
Restricted stock units forfeited

 
 
 

 
 
 
 
Change in liability
 
 
(1,447
)
 
 
 
 
 
 
Balance at July 26, 2015
28

 
$
3,767

 
$
19.70

 
$
472

 
0.9
As of July 26, 2015, the total number of vested but unsettled restricted stock units for non-employee directors is 175,132 units. As of July 26, 2015, $1.4 million of the liability associated with these awards is included in “Other long-term liabilities” within the condensed consolidated balance sheet.

15





Restricted Stock Units, Stock Settled, Non-Employee Directors. As a result of the June 2015 changes to the Company’s director compensation program, beginning in July 2015, the Company began granting restricted stock units to non-employee Directors which are expected to be settled with stock at the time of vesting. The grant date for these awards is equal to the measurement date. These awards are valued as of the measurement date and recognized as an expense over the requisite vesting period (typically one year).
The following table summarizes the non-employee directors’ activity for restricted stock units settled with stock for the six months ended July 26, 2015:
 
(in thousands, except for per unit amounts)
Number of
Units
 
Weighted Average
Grant Date
Fair Value
(per unit)
 
Aggregate Intrinsic Value (1)
 
Aggregate
Unrecognized
Compensation
 
Period Over
Which Expected
to  be Recognized
(in years)
Balance at January 25, 2015

 
$

 
 
 
$

 
0.0
Restricted stock units granted
24

 
19.70

 
 
 
 
 
 
Restricted stock units vested

 
 
 

 
 
 
 
Restricted stock units forfeited

 
 
 
 
 
 
 
 
Balance at July 26, 2015
24

 
$
19.70

 
 
 
$
444

 
0.9

(1)
There was no vesting during the reported period. This value would typically represent the value of Semtech Corporation stock on the date that the restricted stock unit vested.
Note 6: 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, 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 operations.
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.
The following table summarizes the Company’s cash and available-for-sale investments:
 
July 26, 2015
 
January 25, 2015
(in thousands)
Market Value
 
Adjusted
Cost
 
Gross
Unrealized Gain
 
Market Value
 
Adjusted
Cost
 
Gross
Unrealized
Gain
Cash equivalents
$
16,859

 
$
16,859

 
$

 
$
23,271

 
$
23,271

 
$

Total investments
$
16,859

 
$
16,859

 
$

 
$
23,271

 
$
23,271

 
$

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 cash and available-for-sale investments:
 
July 26, 2015
 
January 25, 2015
(in thousands)
Market Value
 
Adjusted Cost
 
Market Value
 
Adjusted Cost
Within 1 year
$
16,859

 
$
16,859

 
$
23,271

 
$
23,271

After 1 year through 5 years

 

 

 

Total investments
$
16,859

 
$
16,859

 
$
23,271

 
$
23,271

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 gains (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 26, 2015
 
July 27, 2014
 
July 26, 2015
 
July 27, 2014
Unrealized gain (loss), net of tax
$
84

 
$
(1
)
 
$
138

 
$

Increase to deferred tax liability
56

 
(1
)
 
98

 

The following table summarizes interest income generated from investments and cash and cash equivalents:
 
 
Three Months Ended
 
Six Months Ended
(in thousands)
July 26, 2015
 
July 27, 2014
 
July 26, 2015
 
July 27, 2014
Interest income
$
3,447

 
$
12

 
$
8,236

 
$
20


The Company accounts for its equity investments under the cost method of accounting when it does not have the ability to exercise significant influence over the investees. For investments where the Company has the ability to exercise significant influence, it uses the equity method of accounting.
In the first six months of fiscal year 2016, the Company acquired an equity stake in Idosens S.A.S. (“Idosens”).
Cost Method Investments
(in thousands)
Equity Investment
Balance at January 25, 2015
$
12,148

Additions
1,600

Disposals
(5,384
)
Balance at July 26, 2015
$
8,364

Equity Method Investments
(in thousands)
Equity Investment
Balance at January 25, 2015
$

Investment in Idosens
30

Balance at July 26, 2015
$
30


16





Note 7: Fair Value Measurements
Instruments Measured at Fair Value on a Recurring Basis
Financial assets and liabilities measured and recorded at fair value on a recurring basis consisted of the following types of instruments:
 
 
Fair Value as of July 26, 2015
 
Fair Value as of January 25, 2015
(in thousands)
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
 
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
Financial Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash equivalents
$
16,859

 
$
16,859

 
$

 
$

 
$
23,271

 
$
23,271

 
$

 
$

Total available-for-sale securities
16,859

 
16,859

 

 

 
23,271

 
23,271

 

 

Interest rate cap

 

 

 

 
33

 

 
33

 

Total financial assets
$
16,859

 
$
16,859

 
$

 
$

 
$
23,304

 
$
23,271

 
$
33

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Triune Earn-Out
$
16,930

 
$

 
$

 
$
16,930

 
$

 
$

 
$

 
$

Cycleo Earn-Out
1,457

 

 

 
1,457

 
1,619

 

 

 
1,619

Total financial liabilities
$
18,387


$


$


$
18,387


$
1,619


$


$


$
1,619

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 26, 2015 and January 25, 2015 is estimated using Level 2 inputs, including observable market-based inputs such as interest rate curves and implied volatilities for similar instruments with similar contractual terms, and is included in “Other assets” within the condensed consolidated balance sheets.
The Triune Earn-Out liability is valued utilizing estimates of cumulative revenue and operating income (Level 3 inputs). These estimates represent inputs for which market data are not available and are developed using the best information available about the assumptions that market participants would use when pricing the liability.
The Cycleo Earn-Out liability valued utilizing estimates of cumulative revenue (Level 3 inputs). These estimates represent inputs for which market data are not available and are developed using the best information available about the assumptions that market participants would use when pricing the liability.
Financial assets measured and recorded at fair value on a recurring basis were presented on the Company’s condensed consolidated balance sheets as follows:

17





 
Fair Value as of July 26, 2015
 
Fair Value as of January 25, 2015
(in thousands)
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
 
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
Financial assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash equivalents
$
16,859

 
$
16,859

 
$

 
$

 
$
23,271

 
$
23,271

 
$

 
$

Other assets

 

 

 

 
33

 

 
33

 

Total financial assets
$
16,859

 
$
16,859

 
$

 
$

 
$
23,304

 
$
23,271

 
$
33

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Triune Earn-Out
$
16,930

 
$

 
$

 
$
16,930

 
$

 
$

 
$

 
$

Cycleo Earn-Out
1,457

 

 

 
1,457

 
1,619

 

 

 
1,619

Total financial liabilities
$
18,387


$


$


$
18,387


$
1,619


$


$


$
1,619

During the six months ended July 26, 2015, the Company had no transfers of financial assets or liabilities between Level 1, Level 2 or Level 3. As of July 26, 2015 and January 25, 2015, 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.
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 in Note 10) is $86.5 million and $95.9 million and Revolving Commitments (as defined in Note 10) is $193.0 million and $158.0 million at July 26, 2015 and January 25, 2015, 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 investments during the first six months of fiscal year 2016.
Note 8: 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 26, 2015
 
January 25, 2015
Raw materials
$
2,689

 
$
1,624

Work in progress
49,625

 
36,759

Finished goods
27,977

 
35,285

Inventories
$
80,291

 
$
73,668


18





Note 9: Goodwill and Intangible Assets
Goodwill – Changes in the carrying amount of goodwill were as follows:
(in thousands)
Signal Integrity
 
Power and High Reliability
 
Wireless, Sensing and Timing
 
Total
Balance at January 25, 2015
$
261,891

 
$

 
$
18,428

 
$
280,319

Additions

 
49,384

 

 
49,384

Balance at July 26, 2015
$
261,891

 
$
49,384

 
$
18,428

 
$
329,703


During the first six months of fiscal year 2016 goodwill associated with the Power and High Reliability product group increased due to the Company’s acquisition of Triune (see Note 2).
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 three reporting units (Signal Integrity, Power and High Reliability and Wireless, Sensing and Timing) (see Note 14). 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.
Goodwill was tested for impairment as of November 30, 2014, the date of the Company’s annual impairment review, at the reporting unit level for Signal Integrity and Wireless, Sensing and Timing. 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 26, 2015, 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 26, 2015
 
January 25, 2015
(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
 
$
144,156

 
$
(63,440
)
 
$
80,716

 
$
134,155

 
$
(53,286
)
 
$
80,869

Customer relationships
7-10 years
 
30,030

 
(13,647
)
 
16,383

 
28,030

 
(11,480
)
 
16,550

Technology licenses (1)
5-10 years
 
263

 
(196
)
 
67

 
263

 
(169
)
 
94

Other intangibles assets
1-5 years
 
6,600

 
(6,600
)
 

 
6,600

 
(6,513
)
 
87

Total finite-lived intangible assets
 
 
$
181,049

 
$
(83,883
)
 
$
97,166

 
$
169,048

 
$
(71,448
)
 
$
97,600

 
(1)
Technology licenses relate to end-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 operations.
For the three months ended July 26, 2015 and July 27, 2014, amortization expense related to acquired finite-lived intangible assets was $6.2 million and $6.4 million, respectively. For the six months ended July 26, 2015 and July 27, 2014, amortization expense related to finite-lived intangible assets was $12.3 million and $12.9 million, respectively. Amortization expense related to acquired finite-lived intangible assets is reported as “Intangible amortization” in the condensed consolidated statements of operations.

19





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
 
Total
Remaining six months of fiscal year 2016
$
10,322

 
$
2,200

 
$
25

 
$
12,547

Fiscal year 2017
20,641

 
4,400

 
42

 
25,083

Fiscal year 2018
20,641

 
4,400

 

 
25,041

Fiscal year 2019
17,229

 
4,400

 

 
21,629

Fiscal year 2020
9,398

 
950

 

 
10,348

Thereafter
2,485

 
33

 

 
2,518

Total expected amortization expense
$
80,716

 
$
16,383

 
$
67

 
$
97,166


At July 26, 2015 and January 25, 2015, the Company had a total of $4.0 million of indefinite-lived intangible assets consisting of in-process Research and Development (“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 26, 2015 the Company concluded that there were no indicators of impairment.

20





Note 10: 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 Corporation 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 26, 2015, 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 operations. The proceeds from the New Facilities were used to repay in full the outstanding obligations of $327.5 million under the Prior Credit Facilities, which were 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 operations for the six months ended July 26, 2015.
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 operations for the six months ended July 26, 2015.
The New Credit Agreement provides that, subject to certain conditions, Semtech 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

21





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 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 26, 2015, the interest rates payable on both the Term Loans and the Revolving Commitments was 1.93%.
As of July 26, 2015, there was $86.5 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 payments 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 payments 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 and will continue through April 30, 2018. The principal payments related to the Term Loans are due as follows: $9.4 million remaining 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 $193.0 million at July 26, 2015 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. On March 4, 2015 the Company borrowed $35.0 million under the Revolving Commitments in connection with the acquisition of Triune (see Note 2).
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 Corporation 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 26, 2015 and a maximum total consolidated leverage ratio of 3.00:1.00 as of July 26, 2015. Semtech Corporation was in compliance with such financial covenants as of July 26, 2015.
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.

22





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 net unrecognized tax benefits is as follows:
(in thousands)
 
Balance at January 25, 2015
7,774

Additions based on tax positions related to the current year
92

Reductions for tax positions of prior years, net
(252
)
Reductions for settlements with tax authorities
(139
)
Balance as of July 26, 2015
7,475

The gross unrecognized tax benefit (before federal impact of state items) was $9.6 million and $9.9 million at July 26, 2015 and January 25, 2015, respectively. Included in the balance of unrecognized tax benefits at July 26, 2015 and January 25, 2015, is $7.5 million and $7.8 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 26, 2015
 
January 25, 2015
Deferred tax assets - non-current
$
7,475

 
$
7,522

Other long-term liabilities

 
252

Total accrued taxes
$
7,475

 
$
7,774

The Company’s policy is to include net interest and penalties related to unrecognized tax benefits within the provision for taxes on the consolidated statements of income. The Company had approximately $293,000 of net interest and penalties accrued at July 26, 2015 and January 25, 2015.
Tax years prior to 2012 (the Company’s fiscal year 2013) 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 year 2013 and expects to close those audits within the next twelve months. The Company’s positions are expected to be sufficient to address matters that may arise under examination. For state returns, the Company is generally not subject to income tax examinations for years prior to 2010 (the Company’s fiscal year 2011). 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.

23





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 completes 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. 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.  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 litigation claims pending with respect to environmental matters at the Newbury Park site. 
The Los Angeles Regional Water Quality Control Board (“RWQCB”) 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 filed appeals of the October 2013 order seeking reconsideration by the RWQCB and review by the State Water Resources Control Board (“SWRCB”) of the removal of two other potentially responsible parties, and seeking clarification of certain other factual findings.  In April 2015, the RWQCB denied the Company’s request to name the two other potentially responsible parties to the order, but did correct certain findings of fact identified by the Company in its petition for reconsideration. The SWRCB has not yet ruled on the Company’s petition for review of the RWQCB’s action as the petition was filed with a request it be held in abeyance.
The Company has been engaged with the regulatory agency, including technical discussion between the Company’s environmental firm and RWQCB staff, and has initiated the technical efforts to comply with the order. The Company submitted technical reports prepared by the environmental firm to the RWQCB and has received confirmation regarding the satisfaction of portions of the order.  The Company also submitted a remedial action plan prepared by the environmental firm outlining the cleanup of soil, groundwater, and soil vapor at the site. The parties are continuing to work toward compliance with the October 2013 order and anticipate working cooperatively on any ultimate proposed cleanup and abatement work.
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 had determined a likely range of probable loss between $2.7 million and $5.7 million. Based on recent determinations by the RWQCB and refinement of the draft remedial action plan, the Company has determined a likely range of probable loss between $5.3 million and $7.5 million.  Given the 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 has recorded the minimum amount of $5.3 million, and such reserve remains on the Company’s books under “Other long-term liabilities” on the unaudited consolidated condensed 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
In November 2012, the Company terminated the services of Intrigo Systems, Inc. (“Intrigo”) for default under its agreement with the Company for consulting services pertaining to the implementation of an enterprise resource planning (“ERP”) system. On January 23, 2013, the Company received a letter from Intrigo claiming that the Company breached the agreement and demanding payment of $2.6 million. The Company responded to this letter and denied liability for the claim, based on Intrigo’s failure to perform as required under the agreement. On November 13, 2014, Intrigo filed its complaint (the “Complaint”) against Semtech in Alameda County Superior Court, seeking in excess of $2.7 million in monetary damages and alleging breach of contract, breach of the covenant of good faith and fair dealing, and fraud. On December 18, 2014, the Company answered the Complaint and filed its own cross-complaint (the “Cross-Complaint”) against Intrigo, seeking in excess of $3.7 million in monetary damages and alleging breach of contract, breach of the implied covenant of good faith and fair dealing, fraud, negligent misrepresentation, false advertising, money had and received, and unfair competition. The Cross-Complaint also seeks a declaration that the Company’s contractual agreement with Intrigo was terminated and that the Company has no remaining obligations under any contract. Discovery is proceeding. At this time, the Company is unable to express an opinion on the outcome of this case.
Indemnification
The Company has entered into agreements with its current and former executives 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.
Earn-out Liability
Pursuant to the terms of the amended earn-out arrangement (“Cycleo Amended Earn-out”) with the former stockholders of Cycleo SAS (“Cycleo Earn-out Beneficiaries”), 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 over a defined period (“Cycleo Defined Earn-out Period”). The Cycleo Defined Earn-out Period covers the period April 27, 2015 to April 26, 2020. For certain of the Cycleo Earn-out Beneficiaries, payment of the earn-out liability is contingent upon continued employment 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 is not considered as compensation expense. The Company has recorded a liability for the Cycleo Amended Earn-out of $3.9 million and $1.7 million as of July 26, 2015 and January 25, 2015, respectively.
Pursuant to the terms of the Triune Earn-out with the former members of Triune (“Triune Earn-out Beneficiaries”), which the Company acquired on March 4, 2015, the Company potentially may make payments totaling up to approximately $70.0 million based on achievement of certain revenue targets measured at each fiscal year end, starting with fiscal year 2016 and ending in fiscal year 2018. An additional payment of up to $16.0 million may be made based upon a combination of cumulative revenue and operating income targets measured from the acquisition date through the end of the Company’s fiscal year 2018. For certain of the Triune Earn-out Beneficiaries, payment of the earn-out liability is contingent upon continued employment 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 is not considered as compensation expense. The Company has recorded a liability for the Triune Earn-out of $16.9 million, which represents the fair value as of July 26, 2015.

24





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 one or more of the periods indicated:
 
Three Months Ended
 
Six Months Ended
(percentage of net sales)
July 26, 2015
 
July 27, 2014
 
July 26, 2015
 
July 27, 2014
Samsung Electronics (and affiliates)
6
%
 
9
%
 
7
%
 
11
%
The following table shows the customer that has an outstanding receivable balance that represents at least 10% of total net receivables as of one or more of the dates indicated:
 
Balance as of
(percentage of net accounts receivable)
July 26, 2015
 
January 25, 2015
Samsung Electronics (and affiliates)
7
%
 
12
%
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 2016 and 2015, respectively, approximately 26% and 43%, respectively, of the Company’s silicon in terms of cost of wafers was supplied by a third-party foundry in China, and these percentages could be higher in future periods.
In the second quarter of fiscal year 2016, authorized distributors accounted for approximately 61% of the Company’s net sales compared to approximately 60% in the second quarter of fiscal year 2015. 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 2016, the Company’s two largest distributors were based in Asia.
Note 14: Segment information
Segment Information
See Note 1 regarding recent developments affecting the Company’s operating segments.

The Company has five operating segments in total. 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. Four of the operating segments: Protection Products; 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 remaining operating segment, the Systems Innovation Group, cannot be aggregated with the other operating segments and does 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. 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.


25





Net sales by segment are as follows:
 
Three Months Ended
 
Six Months Ended
(in thousands)
July 26, 2015
 
July 27, 2014
 
July 26, 2015
 
July 27, 2014
Semiconductor Products Group
$
125,648

 
$
145,451

 
$
253,895

 
$
277,195

All others
64

 
291

 
1,905

 
1,406

Total
$
125,712

 
$
145,742

 
$
255,800

 
$
278,601

Income by segment and reconciliation to consolidated operating income:
 
Three Months Ended
 
Six Months Ended
(in thousands)
July 26, 2015
 
July 27, 2014
 
July 26, 2015
 
July 27, 2014
Semiconductor Products Group
$
22,709

 
$
36,517

 
$
48,038

 
$
66,478

All others
(2,307
)
 
(1,345
)
 
(4,558
)
 
(4,049
)
   Operating Income by segment
20,402

 
35,172

 
43,480

 
62,429

Items to reconcile segment operating income to consolidated income before taxes
 
 
 
 
 
 
 
Intangible amortization and impairments
6,177

 
6,444

 
12,340

 
12,869

Stock-based compensation expense
2,335

 
6,274

 
8,281

 
13,121

Inventory write-down

 

 

 
1,052

Restructuring charges
3,564

 

 
3,564

 
1,001

Environmental reserve
520

 

 
2,855

 

Other non-segment related expenses
4,426

 
58

 
7,585

 
502

Amortization of fair value adjustments related to acquired PP&E
312

 
339

 
903

 
678

Interest expense, net
1,900

 
1,588

 
3,734

 
2,975

Non-operating (income) expense, net
(117
)
 
345

 
376

 
623

Income before taxes
$
1,285

 
$
20,124

 
$
3,842

 
$
29,608

Information by Product Line
The Company operates exclusively in the semiconductor industry and primarily within the analog and mixed-signal sector.
The table below provides net sales activity by product line on a comparative basis for all periods.
 
Three Months Ended
 
Six Months Ended
(in thousands, except percentages)
July 26, 2015
 
July 27, 2014
 
July 26, 2015
 
July 27, 2014
Signal Integrity
59,024

 
47
%
 
60,232

 
41
%
 
113,333

 
44
%
 
111,511

 
40
%
Protection
34,986

 
28
%
 
48,905

 
33
%
 
72,113

 
28
%
 
97,577

 
34
%
Wireless, Sensing and Timing
15,533

 
12
%
 
19,793

 
14
%
 
38,331

 
15
%
 
38,141

 
14
%
Power and High-Reliability
16,105

 
13
%
 
16,521

 
11
%
 
30,118

 
12
%
 
29,966

 
11
%
Systems Innovation
64

 
%
 
291

 
1
%
 
1,905

 
1
%
 
1,406

 
1
%
Total net sales
125,712

 
100
%
 
145,742

 
100
%
 
255,800

 
100
%
 
278,601

 
100
%

26





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 26, 2015
 
July 27, 2014
 
July 26, 2015
 
July 27, 2014
Asia-Pacific
73
%
 
77
%
 
73
%
 
76
%
North America
16
%
 
13
%
 
17
%
 
13
%
Europe
11
%
 
10
%
 
10
%
 
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 26, 2015
 
July 27, 2014
 
July 26, 2015
 
July 27, 2014
China (including Hong Kong)
45
%
 
36
%
 
44
%
 
35
%