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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended
June 30, 1999
or
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 0-19654
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VITESSE SEMICONDUCTOR CORPORATION
(Exact name of registrant as specified in its charter)
- --------------------------------------------------------------------------------
Delaware 77-0138960
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
741 Calle Plano
Camarillo, CA 93012
(Address of principal executive offices)
(805) 388-3700
(Registrant's telephone number, including area code)
--------------------------
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 and (2) has been subject to such filing
requirements for the past 90 days: Yes ( x ) No ( ).
As of June 30, 1999, there were 76,735,152 shares of $0.01 par value common
stock outstanding.
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VITESSE SEMICONDUCTOR CORPORATION
TABLE OF CONTENTS
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<TABLE>
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Page Number
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PART I FINANCIAL INFORMATION
Item 1 Financial Statements:
Condensed Consolidated Balance Sheets as of June 30, 1999 2
and September 30, 1998
Condensed Consolidated Statements of Operations for the Three 3
Months ended June 30, 1999, June 30, 1998 and
March 31, 1999 and the Nine Months ended June 30, 1999
and June 30, 1998
Condensed Consolidated Statements of Cash Flows for the 4
Nine Months ended June 30, 1999 and June 30, 1998
Notes to Condensed Consolidated Financial Statements 6
Item 2 Management's Discussion and Analysis of 8
Financial Condition and Results of Operations
Item 3 Quantitative and Qualitative Disclosure About Market Risk 15
PART II OTHER INFORMATION
Item 6 Exhibits and Reports on Form 8-K 15
</TABLE>
1
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PART I
FINANCIAL INFORMATION
VITESSE SEMICONDUCTOR CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
<TABLE>
June 30, 1999 Sept. 30, 1998
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(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 72,216 $ 70,684
Short-term investments 126,773 91,610
Accounts receivable, net 64,992 39,953
Inventories, net 22,715 16,795
Prepaid expenses 3,969 3,008
Deferred tax asset 29,769 20,982
-------- --------
Total current assets 320,434 243,032
-------- --------
Property and equipment, net 74,934 56,455
Restricted long-term deposits 67,007 68,704
Intangible assets 14,961 ---
Other assets 214 220
-------- --------
$477,550 $368,411
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LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 10,833 $ 13,898
Accrued expenses and other current liabilities 13,632 9,481
Income taxes payable 2,595 4,199
Capital lease obligations 29 145
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Total current liabilities 27,089 27,723
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Other liabilities 2,725 ---
Shareholders' equity:
Common stock, $.01 par value. Authorized 100,000,000
shares; issued and outstanding 76,735,152 shares on
June 30, 1999, and 73,788,136 shares on Sept. 30, 1998 767 738
Additional paid-in capital 354,668 299,503
Retained earnings 92,301 40,447
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Total shareholders' equity 447,736 340,688
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$477,550 $368,411
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</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
2
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VITESSE SEMICONDUCTOR CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
--------------------------------------------- -----------------------------
June 30, 1999 June 30, 1998 Mar. 31, 1999 June 30, 1999 June 30, 1998
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Revenues, net $73,044 $46,108 $66,863 $200,086 $121,021
Costs and expenses:
Cost of revenues 26,736 18,168 24,907 74,604 48,374
Engineering, research & development 11,743 7,375 10,669 31,977 19,392
Selling, general & administrative 8,347 5,635 7,688 23,054 14,746
------- ------- ------- -------- --------
Total costs & expenses 46,826 31,178 43,264 129,635 82,512
------- ------- ------- -------- --------
Income from operations 26,218 14,930 23,599 70,451 38,509
Other income, net 2,743 2,467 2,735 7,887 6,931
------- ------- ------- -------- --------
Income before income taxes 28,961 17,397 26,334 78,338 45,440
Income taxes 9,557 3,470 8,689 25,851 9,078
------- ------- ------- -------- --------
Net income $19,404 $13,927 $17,645 $ 52,487 $ 36,362
======= ======= ======= ======== ========
Net income per share
Basic $ 0.25 $ 0.19 $ 0.24 $ 0.70 $ 0.50
======= ======= ======= ======== ========
Diluted $ 0.24 $ 0.18 $ 0.22 $ 0.64 $ 0.46
======= ======= ======= ======== ========
Shares used in per share computations:
Basic 76,336 72,979 75,036 75,162 72,434
======= ======= ======= ======== ========
Diluted 82,399 79,348 81,902 81,588 78,703
======= ======= ======= ======== ========
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
3
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VITESSE SEMICONDUCTOR CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
<TABLE>
<CAPTION>
Nine Months Ended
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June 30, 1999 June 30, 1998
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<S> <C> <C>
Cash flows from operating activities:
Net income $ 52,487 $ 36,362
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 16,188 9,591
Change in assets and liabilities:
(Increase) decrease in, net of effects of acquisition:
Accounts receivable, net (25,039) (13,653)
Inventories, net (5,920) (3,174)
Prepaid expenses (961) (1,661)
Other assets 6 174
Increase (decrease) in, net of effects of acqisition:
Accounts payable (3,065) (4,755)
Accrued expenses and other current liabilities 4,151 2,029
Income taxes payable 24,180 8,077
-------- --------
Net cash provided by operating activities 62,027 32,990
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Cash flows from investing activities:
Purchases of short-term investments (35,163) (27,299)
Capital expenditures (33,942) (23,134)
Restricted long-term deposits 1,697 (20,180)
Payment for purchase of company (13,040) ---
-------- --------
Net cash used in investing activities (80,448) (70,613)
-------- --------
Cash flows from financing activities:
Principal payments under capital lease obligations & term loans (116) (222)
Proceeds from issuance of common stock, net 20,069 4,922
-------- --------
Net cash provided by financing activities 19,953 4,700
-------- --------
Net increase (decrease) in cash and cash equivalents 1,532 (32,923)
Cash and cash equivalents at beginning of period 70,684 97,358
-------- --------
Cash and cash equivalents at end of period $ 72,216 $ 64,435
======== ========
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
4
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VITESSE SEMICONDUCTOR CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
(Unaudited)
(in thousands)
<TABLE>
<CAPTION>
Nine Months Ended
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June 30, 1999 June 30, 1998
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<S> <C> <C>
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 10 $ 30
======= ======
Income taxes $ 1,670 $1,001
======= ======
Supplemental disclosures of non-cash transactions:
Issuance of stock options in purchase acquisition $ 300 $ ---
======= ======
Issuance of common stock in acquisition, net of beginning
retained earnings adjustment $ 1,109 $ ---
======= ======
Issuance of notes payable in acquisition $ 2,725 $ ---
======= ======
Increase in equity associated with tax benefit from exercise
of stock options $34,573 $ ---
======= ======
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
5
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VITESSE SEMICONDUCTOR CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Basis of Presentation and Significant Accounting Policies
The accompanying condensed consolidated financial statements are unaudited
and include the accounts of Vitesse Semiconductor Corporation and its
subsidiaries (the "Company"). All intercompany accounts and transactions have
been eliminated. In management's opinion, all adjustments (consisting only of
normal recurring accruals) which are necessary for a fair presentation of
financial condition and results of operations are reflected in the attached
interim financial statements. This report should be read in conjunction with
the audited financial statements presented in the 1998 Annual Report. Footnotes
and other disclosures which would substantially duplicate the disclosures in the
Company's audited financial statements for fiscal year 1998 contained in the
Annual Report have been omitted. The interim financial information herein is
not necessarily representative of the results to be expected for any subsequent
period.
Computation of Net Income per Share
The reconciliation of shares used to calculate basic and diluted income per
share consists of the following (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
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June 30, 1999 June 30, 1998 June 30, 1999 June 30, 1998
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<S> <C> <C> <C> <C>
Shares used in basic per share computations -
weighted average shares outstanding 76,336 72,979 75,162 72,434
Net effect of dilutive common share equivalents
based on treasury stock method 6,063 6,369 6,426 6,269
------ ------ ------ ------
Shares used in diluted per share computations 82,399 79,348 81,588 78,703
====== ====== ====== ======
</TABLE>
Options to purchase 117,863 shares and 72,736 that were outstanding at June
30, 1999 and 1998, respectively, were not included in the computation of diluted
net income per share because the exercise price of such options was greater than
the average market price of the common shares, and therefore would be
antidilutive.
Comprehensive Income
On October 1, 1998 the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income." This statement establishes
standards for reporting and display of comprehensive income and its components
in a full set of general-purpose
6
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financial statements. The Company has no components of other comprehensive
income. Therefore comprehensive income is the same as reported net income.
Segment Reporting
On October 1, 1998 the Company adopted Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an Enterprise and Related
Information." This statement establishes standards for reporting operating
segment information in annual financial statements and interim reports issued to
shareholders. Disclosure will be included in the Company's annual financial
statements.
Reclassifications and Restatements
Where necessary, prior periods' information has been reclassified to conform
to the current period condensed consolidated financial statement presentation.
On April 21, 1998, the Board of Directors approved a 2 for 1 stock split of
the Company's Common Stock that was effected on May 26, 1998. All references to
the number of common shares, weighted average number of common shares and per
share data for all periods presented have been adjusted to reflect the stock
split.
Note 2. Subsequent Event
On July 16, 1999 the Company completed the acquisition of all of the equity
interests of XaQti Corporation ("XaQti") for 1,092,245 shares of Common Stock
valued at $65 million. XaQti is a supplier of integrated circuits for the data
communication industry. The transaction will be accounted for under the pooling
of interests method.
The following unaudited proforma data summarizes the combined results of
operations of Vitesse and XaQti as if the combination had been consummated on
June 30, 1999 (in thousands, except per share).
Three months ended Nine months ended
------------------ -----------------
Revenues, net $73,262 $200,562
======= ========
Net income $18,111 $ 48,449
======= ========
Net income per share
Basic $ 0.23 $ 0.64
======= ========
Diluted $ 0.22 $ 0.59
======= ========
Note 3. Business Combinations
On November 25, 1998 the Company acquired all of the equity interests of
Vermont Scientific Technologies, Inc. (VTEK) for $13.0 million cash and $2.7
million in notes payable. VTEK provides integrated circuit design services
primarily in the telecommunications industry. In conjunction with the
transaction, the Company recorded goodwill and other identifiable intangibles
amounting to $9.9 million and $5.9 million, respectively, with useful lives
ranging from 5 to 15 years. The transaction is being accounted for as a
purchase. Accordingly, the operations of VTEK are included from the date of
acquisition. VTEK is not a significant subsidiary, and therefore proforma data
is not presented herein.
On January 21, 1999, the Company issued 327,628 shares of its common
stock in exchange for all of the outstanding shares of Serano Systems
Corporation (Serano). Serano is a provider of enclosure platform management
solutions for Fibre Channel and SCSI server and storage subsystems. The
transaction was accounted for as an immaterial pooling of interests, and
accordingly, the consolidated financial statements have been prepared as if
Serano had been combined beginning January 1, 1999. Consolidated financial
statements for periods prior to January 1, 1999 have not been restated. The
Company recorded an adjustment to beginning equity to reflect the 327,628 shares
issued in the transaction and Serano's shareholders equity of $633,000 at
January 1, 1999.
7
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Note 4. Inventories, net
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
June 30, 1999 Sept. 30, 1998
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<S> <C> <C>
Raw Materials $ 4,100 $ 2,949
Work in process and finished goods 18,615 13,846
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$22,715 $16,795
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</TABLE>
Management's Discussion and Analysis
of Financial Condition and Results of Operations
The information set forth in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" below includes "forward looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended (the "Securities Act"), in particular, in "Results of Operations--
Income Taxes," and in "Liquidity and Capital Resources--Investing and Financing
Activities," and is subject to the safe harbor created by that section. Factors
that realistically could cause results to differ materially from those projected
in the forward looking statements are set forth below in "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Risk Factors."
Results of Operations
Revenues
Total revenues in the third quarter of fiscal 1999 were $73.0 million, a 58%
increase over the $46.1 million recorded in the third quarter of fiscal 1998 and
a 9% increase over the $66.9 million recorded in the prior quarter. For the
nine months ended June 30, 1999, total revenues were $200.1 million, a 65%
increase over the $121.0 million recorded in the nine months ended June 30,
1998. The increase in total revenues in the third quarter of 1999 and in the
nine months ended June 30, 1999 was primarily due to an increase in the number
of units shipped to customers in the communications and ATE markets.
Cost of Revenues
Cost of revenues as a percentage of total revenues in the third quarter of
fiscal 1999 was 36.6% compared to 39.4% in the third quarter of fiscal 1998 and
37.3% in the prior quarter. The decrease in cost of revenues as a percentage of
total revenues resulted primarily from a reduction in per unit costs associated
with increased utilization of the Company's Camarillo and Colorado Springs wafer
fabrication facilities, as well as improved yields at both facilities.
The Company's manufacturing yields vary significantly among products,
depending on a particular IC's complexity and the Company's experience in
manufacturing it. Historically, the Company has experienced difficulties
achieving acceptable yields on some ICs, which has resulted in shipment delays.
The Company's overall yields are lower than yields experienced in a silicon
process because of the large number of different products manufactured in
limited volume and because the Company's H-GaAs process technology is
significantly less developed. The Company expects that many of its current and
future products may never be produced in volume.
8
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Regardless of the process technology used, the fabrication of semiconductors
is a highly complex and precise process. Defects in masks, impurities in the
materials used, contamination of the manufacturing environment, equipment
failure and other difficulties in the fabrication process can cause a
substantial percentage of wafers to be rejected or numerous die on each wafer to
be nonfunctional.
Because the majority of the Company's costs of manufacturing are relatively
fixed, maintenance of the number of shippable die per wafer is critical to the
Company's results of operations. Yield decreases can result in substantially
higher unit costs and may result in reduced gross profit and net income. There
can be no assurance that the Company will not suffer periodic yield problems in
connection with new or existing products which could cause the Company's
business, operating results and financial condition to be materially adversely
affected.
Inventory is valued at the lower of cost or market. Because allocable
manufacturing costs can be high, new product inventory is often valued at
market. In addition, a portion of work-in-process inventory consists of wafers
in various stages of fabrication. Consequently, the Company estimates yields
per wafer in order to estimate the value of inventory. If yields are materially
different than projected, work-in-process inventory may need to be revalued.
There can be no assurance that such adjustments will not occur in the future and
have a material adverse effect on the Company's results of operations.
Engineering, Research and Development Costs
Engineering, research and development expenses were $11.7 million in the
third quarter of fiscal 1999 compared to $7.4 million in the third quarter of
fiscal 1998 and $10.7 million in the prior quarter. For the nine months ended
June 30, 1999, engineering, research and development costs were $31.9 million
compared to $19.4 million in the nine months ended June 30, 1998. The increases
were principally due to increased headcount and higher costs to support the
Company's continuing efforts to develop new products. As a percentage of total
revenues, engineering, research and development costs were 16% in each of the
third quarters of 1999 and 1998, in the prior quarter, and in the nine months
ended June 30, 1999 and 1998. The Company's engineering, research and
development costs are expensed as incurred.
Selling, General and Administrative Expenses
Selling, general and administrative expenses (SG&A) were $8.3 million in the
third quarter of 1999, compared to $5.6 million in the third quarter of 1998 and
$7.7 million in the prior quarter. For the nine months ended June 30, 1999, SG&A
expenses were $23.1 million compared to $14.7 million in the same period in
1998. The increase in SG&A expenses was due to increased headcount, higher
commissions earned by sales representatives resulting from increased sales, and
increased advertising costs. As a percentage of total revenues, SG&A expenses
decreased to 11% in the third quarter of 1999 from 12% in both the third quarter
ended June 30, 1998 and in the prior quarter. For the nine month periods ended
June 30, 1999 and June 30, 1998, SG&A expenses as a percentage of total revenues
were 12%.
9
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Other Income, Net
Other income consists of interest income, net of interest and other expenses.
Other income increased to $2.7 million in the third quarter of fiscal 1999 from
$2.5 million in the third quarter of 1998 and was unchanged from the prior
quarter. For the nine months ended June 30, 1999, other income increased to
$7.9 million from $6.9 million in the comparable period a year ago. The
increases are due to higher average cash, short-term investments and long-term
deposit balances.
Income Taxes
The Company recorded a provision for income taxes in the amount of $9.6
million in the third quarter of fiscal 1999 and $3.5 million in the third
quarter of fiscal 1998, representing an effective rate of 33% and 20%
respectively. The increase in the effective tax rate is due to the full
utilization in previous years of available net operating loss carryforwards.
The Company expects the effective tax rate to be 33% in fiscal 1999.
Liquidity and Capital Resources
Operating Activities
The Company generated $62.0 million and $32.9 million from operating
activities in the nine month periods ended June 30, 1999 and 1998, respectively.
The increase in cash flow from operations was principally due to an improvement
in profitability.
Investing Activities
Capital expenditures, principally for manufacturing and test equipment, were
$33.9 million in the nine month period ended June 30, 1999 compared to $23.1
million in the nine month period ended June 30, 1998. The Company intends to
continue investing in manufacturing, test and engineering equipment.
Additionally, as discussed in Note 2 above, the Company paid $13.0 million in
cash for the purchase of VTEK during the first quarter of fiscal 1999.
Financing Activities
In the nine month period ended June 30, 1999, the Company generated $20
million of cash from financing activities primarily from the proceeds from the
issuance of common stock associated with the exercise of stock options.
Management believes that the Company's cash and cash equivalents, short-tem
investments, and cash flow from operations are adequate to finance its planned
growth and operating needs for the next 12 months.
10
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Factors Affecting Future Operating Results
We Are Dependent on a Small Number of Customers in a Few Industries
We intend to continue focusing our sales effort on a small number of
customers in the communications and test equipment markets that require high-
performance integrated circuits. Some of these customers are also our
competitors. In fiscal 1998, our two largest customers accounted for 23% and
15% of our total revenues and no other customers accounted for more than 10% of
our total revenues. If any of our major customers delays orders of our products
or stops buying our products, our business and financial condition would be
severely affected.
Our Operating Results May Fluctuate
Our quarterly revenues and expenses may fluctuate in the future. These
variations may be due to a number of factors, many of which are outside our
control. Factors that could affect our future operating results include the
following:
. The loss of major customers
. Variations, delays or cancellations of orders and shipments of our products
. Reduction in the selling prices of our products
. Significant changes in the type and mix of products being sold
. Delays in introducing new products
. Design changes made by our customers
. Our failure to manufacture and ship products on time
. Changes in manufacturing capacity, the utilization of this capacity and
manufacturing yields
. Variations in product and process development costs; and
. Changes in inventory levels
In the past, we have recorded significant new product and process development
costs because our policy is to expense these costs at the time that they are
incurred. We may incur these types of expenses in the future. The occurrence
of any of the above factors could have a material adverse effect on our business
and on our financial results.
We Have Limited Manufacturing Capacity and We Depend on a New Production
Facility
During 1998, we started producing high-performance integrated circuits at our
new six-inch wafer fabrication factory in Colorado Springs, Colorado. This
facility includes a 10,000 square-foot Class I clean room with capacity for
future expansion to 15,000 square feet. We are faced with several risks in the
successful operation of this facility as well as in our overall production
operations. We have only produced finished four-inch wafers in the past and we
have limited experience with the equipment and processes involved in producing
finished six-inch wafers. We do not have excess production capacity at our
Camarillo plant to offset failure of the new Colorado facility to meet
production goals. Consequently, our failure to successfully operate the new
facility could severely damage financial results.
We also must now effectively coordinate and manage two facilities. We have
limited experience in managing production facilities located at two different
sites, and our failure to successfully do so could have a material adverse
effect on our business and operating results.
11
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We Have Risks Associated With Recent and Future Acquisitions
During the past nine months, we have made two strategic acquisitions. These
acquisitions may result in the diversion of management's attention from the day-
to-day operations of the Company's business. Risks of making these acquisitions
include difficulties in the integration of acquired operations, products and
personnel. If we fail in our efforts to integrate recent and future
acquisitions, our business and operating results could be materially adversely
affected. In addition, acquisitions we have made or will make could result in
dilutive issuances of equity securities, substantial debt, and amortization
expenses related to goodwill and other intangible assets. We do not have any
binding obligations with respect to any particular acquisition, however our
management frequently evaluates strategic opportunities available. In the future
we may pursue additional acquisitions of complementary products, technologies or
businesses.
Our Industry is Highly Competitive
The high-performance semiconductor market is extremely competitive and is
characterized by rapid technological change, price-erosion and increased
international competition. The communications and test equipment industries,
which are our primary target markets, are also becoming intensely competitive
because of deregulation and international competition. We compete directly or
indirectly with the following categories of companies:
. Gallium Arsenide fabrication operations of systems companies such as Rockwell
and Fujitsu
. Silicon high-performance integrated circuit manufacturers who use Emitter
Coupled Logic ("ECL") or Bipolar Complementary Metal-Oxide-Semiconductor
BiCMOS technologies such as Hewlett Packard, Fujitsu, Motorola, National
Semiconductor, Texas Instruments and Applied Micro Circuits Corporation
Additionally, in lower frequency applications we face increased competition
with Complementary Metal-Oxide-Semiconductor ("CMOS")-based products,
particularly as the performance of these products continues to improve. Our
current and prospective competitors include many large companies that have
substantially greater marketing, financial, technical and manufacturing
resources than we have.
Competition in the markets that we serve is primarily based on
price/performance, product quality and the ability to deliver products in a
timely fashion. Some prospective customers may be reluctant to adopt our
products because of perceived risks relating to H-GaAs ("High-integration
Gallium Arsenide") technology. Additionally, product qualification is typically
a lengthy process and some prospective customers may be unwilling to invest the
time or expense necessary to qualify suppliers such as Vitesse. Prospective
customers may also have concerns about the relative advantages of our products
compared to more familiar silicon-based semiconductors. Further, customers may
also be concerned about relying on a relatively small company for a critical
sole-sourced component. To the extent we fail to overcome these challenges,
there could be material and adverse effects on our business and financial
results.
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Asian Economic Issues
Our international business is subject to risks customarily encountered
overseas such as the recent financial turmoil in Asia. Although we have not
been materially impacted by the recent downturn in the Asian economy, similar
problems in the future could affect us adversely.
We Must Keep Pace With Product and Process Development and Technological Change
The market for our products is characterized by rapid changes in both product
and process technologies. We believe that our success to a large extent depends
on our ability to continue to improve our product and process technologies and
to develop new products and technologies in order to maintain our competitive
position. Further, we must adapt our products and processes to technological
changes and adopt emerging industry standards. Our failure to accomplish any of
the above could have a negative impact on our business and financial results.
We Are Dependent on Key Suppliers
We manufacture our products using a variety of components procured from
third-party suppliers. Most of our high-performance integrated circuits are
packaged by third parties. Other components and materials used in our
manufacturing process are available from only a limited number of sources. Any
difficulty in obtaining sole- or limited-sourced parts or services from third
parties could affect our ability to meet scheduled product deliveries to
customers. This in turn could have a material adverse effect on our customer
relationships, business and financial results.
Our Manufacturing Yields Are Subject to Fluctuation
Semiconductor fabrication is a highly complex and precise process. Defects
in masks, impurities in the materials used, contamination of the manufacturing
environment and equipment failures can cause a large percentage of wafers or die
to be rejected. Manufacturing yields vary among products, depending on a
particular high-performance integrated circuit's complexity and on our
experience in manufacturing it. In the past, we have experienced difficulties
in achieving acceptable yields on some high-performance integrated circuits,
which has led to shipment delays. Our overall yields are lower than yields
obtained in a mature silicon process because we manufacture a large number of
different products in limited volume and because our process technology is less
developed. We anticipate that many of our current and future products may never
be produced in volume.
Since a majority of our manufacturing costs are relatively fixed, maintaining
the number of shippable die per wafer is critical to our operating results.
Yield decreases can result in higher unit costs and may lead to reduced gross
profit and net income. We use estimated yields for valuing work-in-process
inventory. If actual yields are materially different than these estimates, we
may need to revalue work-in-process inventory. Consequently, if any of our
current or future products experience yield problems, our financial results may
be adversely affected.
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Our Business is Subject to Environmental Regulations
We are subject to various governmental regulations related to toxic, volatile
and other hazardous chemicals used in our manufacturing process. Our failure to
comply with these regulations could result in the imposition of fines or in the
suspension or cessation of our operations. Additionally, we may be restricted
in our ability to expand operations at our present locations or we may be
required to incur significant expenses to comply with these regulations.
Our Failure to Manage Growth May Adversely Affect Us
The management of our growth requires qualified personnel, systems and other
resources. In particular, the continued operation of the new facility in
Colorado Springs and its integration with the Camarillo facility will require
significant management, technical and administrative resources. Additionally,
we have recently established several product design centers worldwide. Finally,
we acquired Vermont Scientific Technologies, Inc. in November 1998 and Serano
Systems Corporation in January 1999, and we have only limited experience in
integrating the operations of acquired businesses. Failure to manage our growth
or to successfully integrate new and future facilities or newly acquired
businesses could have a material adverse effect on our business and financial
results.
We Are Dependent on Key Personnel
Due to the specialized nature of our business, our success depends in part
upon attracting and retaining the services of qualified managerial and technical
personnel. The competition for qualified personnel is intense. The loss of any
our key employees or the failure to hire additional skilled technical personnel
could have a material adverse effect on our business and financial results.
Our Business Could Be Impacted by Year 2000 Issues
The "Year 2000 Problem" is the result of computer programs being written
using two digits rather than four to define the applicable year. Computer
programs that contain date-sensitive software may recognize a date using "00" as
the year 1900 rather than the year 2000. This can affect both information
technology (IT) and non-IT systems such as manufacturing equipment, as the
latter may contain date-sensitive embedded devices such as microcontrollers.
We have formed an internal task force to evaluate Year 2000 issues associated
with both our IT and non-IT systems. Many of these systems are already
compliant. We have replaced or upgraded other systems that have been identified
as non-compliant. As of July 1999 we are substantially complete in our
remediation and testing efforts. None of our products are date-sensitive and
will operate according to specifications through the Year 2000 and thereafter.
To date, we have not incurred incremental material costs associated with our
efforts to become Year 2000 compliant, as the majority of the costs have
occurred as a result of normal upgrade procedures. Furthermore, we believe that
future costs associated with these compliance efforts will not be material.
14
<PAGE>
We may also be affected by Year 2000 compliance by our suppliers and
customers. We have contacted several critical suppliers to determine whether
the products and services they provide are Year 2000 compliant or to monitor
their progress towards being fully compliant. Our business and results of
operations could experience material adverse effects if our key suppliers were
to experience Year 2000 issues that caused them to delay shipment of critical
components to us.
Based on our efforts to date, we do not believe that the Year 2000 Problem
will have a material impact on our business or financial results. The most
reasonably likely worst case would be minor delays in production and shipments.
We are in the process of developing a contingency plan detailing actions that
will be taken in the event that our compliance efforts fail to fully remediate
any risk to our operations and expect that it will be completed by August 1999.
The information in this risk factor is "Year 2000 Readiness Disclosure" within
the meaning of the Year 2000 Information and Readiness Disclosure Act.
Item 3. Quantitative and Qualitative Disclosure About Market Risk - None
PART II
OTHER INFORMATION
Item 6. Exhibits & Reports on Form 8-K
(a) Exhibits
Exhibit 27 - Financial Data Schedule.
(b) Reports on Form 8-K - None
15
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VITESSE SEMICONDUCTOR CORPORATION
August 13, 1999 By: /s/Eugene F. Hovanec
--------------------
Eugene F. Hovanec
Vice President, Finance and
Chief Financial Officer
16
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