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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
March 31, 2000
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 April 28, 2000, there were 164,520,989 shares of $0.01 par value
common stock outstanding.
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VITESSE SEMICONDUCTOR CORPORATION
TABLE OF CONTENTS
-----------------
Page Number
PART I FINANCIAL INFORMATION
Item 1 Financial Statements:
Condensed Consolidated Balance Sheets as of March 31, 2000 2
(unaudited) and September 30, 1999
Unaudited Condensed Consolidated Statements of Operations for 3
the Three Months ended March 31, 2000, March 31, 1999
and December 31, 1999 and the Six Months ended March 31, 2000
and March 31, 1999
Unaudited Condensed Consolidated Statements of Cash Flows for 4
the Six Months ended March 31, 2000 and March 31, 1999
Notes to Unaudited 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 16
PART II OTHER INFORMATION
Item 2 Changes in Securities 17
Item 4 Submission of Matters to a Vote of Security Holders 17
Item 6 Exhibits and Reports on Form 8-K 18
1
PART I
FINANCIAL INFORMATION
VITESSE SEMICONDUCTOR CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
March 31, 2000 Sept. 30, 1999
-------------- --------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 33,359 $ 81,912
Short-term investments 615,916 107,245
Accounts receivable, net 88,294 69,034
Inventories, net 33,509 26,931
Prepaid expenses 16,384 5,462
Deferred tax assets, net 48,902 26,918
---------- --------
Total current assets 836,364 317,502
---------- --------
Long-term investments 295,712 38,063
Property and equipment, net 100,044 78,723
Restricted long-term deposits 76,057 67,334
Intangible assets, net 460,587 14,609
Deferred tax assets, net 6,237 6,237
Other assets 18,072 425
---------- --------
$1,793,073 $522,893
========== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 8,616 $ 15,118
Accrued expenses and other current liabilities 24,460 12,832
Income taxes payable 5,122 5,517
Current portion of long-term debt 1,852 2,013
---------- --------
Total current liabilities 40,050 35,480
---------- --------
Long-term debt 1,371 725
Convertible subordinated debt 720,000 -
Minority interest 697 -
Shareholders' equity:
Common stock, $.01 par value. Authorized 500,000,000
shares; issued and outstanding 164,299,059 and 156,176,636
shares on March 31, 2000 and Sept. 30, 1999, respectively 1,642 1,561
Additional paid-in capital 919,197 380,035
Retained earnings 110,116 105,092
---------- --------
Total shareholders' equity 1,030,955 486,688
---------- --------
$1,793,073 $522,893
========== ========
See accompanying Notes to Condensed Consolidated Financial Statements.
2
VITESSE SEMICONDUCTOR CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands, except per share data)
Three Months Ended Six Months Ended
---------------------------------------------- -----------------------------
Mar. 31, 2000 Mar. 31, 1999 Dec. 31, 1999 Mar. 31, 2000 Mar. 31, 1999
-------------- ------------- ------------- ------------- -------------
Revenues $100,167 $ 66,937 $ 89,223 $189,390 $127,645
Costs and expenses:
Cost of revenues 34,995 25,009 31,624 66,619 48,234
Engineering, research & development 17,166 12,210 14,920 32,086 23,162
Selling, general & administrative 11,387 9,100 10,195 21,582 16,948
Purchased in-process research &
development 45,614 - - 45,614 -
-------- -------- -------- -------- --------
Total costs & expenses 109,162 46,319 56,739 165,901 88,344
-------- -------- -------- -------- --------
Income (loss) from operations (8,995) 20,618 32,484 23,489 39,301
Other income, net 3,683 2,768 2,794 6,477 5,249
-------- -------- -------- -------- --------
Income (loss) before income taxes (5,312) 23,386 35,278 29,966 44,550
Income taxes 13,300 7,868 11,642 24,942 14,428
-------- -------- -------- -------- --------
Net income (loss) $(18,612) $ 15,518 $ 23,636 $ 5,024 $ 30,122
======== ======== ======== ======== ========
Net income (loss) per share
Basic $(0.12) $0.10 $0.15 $0.03 $0.20
======== ======== ======== ======== ========
Diluted $(0.12) $0.09 $0.14 $0.03 $0.18
======== ======== ======== ======== ========
Shares used in per share computations:
Basic 158,711 151,918 156,753 157,767 151,588
======== ======== ======== ======== ========
Diluted 158,711 165,880 169,845 171,058 165,630
======== ======== ======== ======== ========
See accompanying Notes to Condensed Consolidated Financial Statements.
3
VITESSE SEMICONDUCTOR CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
Six Months Ended
-------------------------------
Mar. 31, 2000 Mar. 31, 1999
-------------- --------------
Cash flows from operating activities:
Net income $ 5,024 $ 30,122
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 14,033 10,535
Interest expense on debt issue costs 158 --
Amortization of debt discount 178 --
Purchased in-process research & development 45,614 --
Change in assets and liabilities:
(Increase) decrease in, net of effects of acquisition:
Accounts receivable, net (19,250) (7,675)
Inventories (6,578) (3,584)
Prepaid expenses (10,818) (1,754)
Other assets 200 (5,335)
Increase (decrease) in, net of effects of acquisition:
Accounts payable (6,586) 282
Accrued expenses and other current liabilities (7,870) 3,445
Income taxes payable 24,547 11,408
--------- --------
Net cash provided by operating activities 38,652 37,444
--------- --------
Cash flows from investing activities:
Investments, net (766,320) 3,740
Capital expenditures (33,086) (18,897)
Restricted long-term deposits (8,723) 1,594
Cash acquired in business combination 991 (12,816)
--------- --------
Net cash used in investing activities (807,138) (26,379)
--------- --------
Cash flows from financing activities:
Principal payments under long-term debt (2,008) (464)
Proceeds from issuance of convertible subordinated debt 720,000 --
Cash paid for debt issue costs (18,000) --
Capital contributions by minority interest limited partners 697 --
Elimination of duplicate period of pooled companies - 834
Proceeds from issuance of common stock 19,244 13,322
--------- --------
Net cash provided by financing activities 719,933 13,692
--------- --------
Net increase (decrease) in cash and cash equivalents (48,553) 24,757
Cash and cash equivalents at beginning of period 81,912 76,963
--------- --------
Cash and cash equivalents at end of period $ 33,359 $101,720
========= ========
See accompanying Notes to Condensed Consolidated Financial Statements.
4
VITESSE SEMICONDUCTOR CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
Six Months Ended
--------------------------------
Mar. 31, 2000 Mar. 31, 1999
---------------- -------------
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ -- $ 7
======== =======
Income taxes $ 256 $ 1,582
======== =======
Supplemental disclosures of non-cash transactions:
Issuance of stock options in purchase transaction $ 50,531 $ 300
======== =======
Issuance of common stock in purchase transaction $422,542 $ --
======== =======
Issuance of notes payable in purchase transaction $ -- $ 2,725
======== =======
Increase in equity associated with tax benefit from exercise
of stock options $ 46,926 $22,643
======== =======
See accompanying Notes to Condensed Consolidated Financial Statements.
5
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 1999 Annual Report. Footnotes
and other disclosures which would substantially duplicate the disclosures in the
Company's audited financial statements for fiscal year 1999 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):
Three Months Ended Six Months Ended
--------------------------------------------- -----------------------------
Mar. 31, 2000 Mar. 31, 1999 Dec. 31, 2000 Mar. 31, 2000 Mar. 31, 1999
------------- ------------- ------------- ------------- -------------
Shares used in basic per share computations -
weighted average shares outstanding 158,711 151,918 156,753 157,767 151,588
Net effect of dilutive common share equivalents
based on treasury stock method -- 13,962 13,092 13,291 14,042
------- ------- ------- ------- -------
Shares used in diluted per share computations 158,711 165,880 169,845 171,058 165,630
======= ======= ======= ======= =======
Common stock equivalents to purchase 283,102 shares that were outstanding at
March 31, 1999, were not included in the computation of diluted net income per
share, as their effect would have been antidilutive. Common stock equivalents
to purchase 19,685,685 shares that were outstanding at March 31, 2000, were not
included in the computation of diluted net income per share for the quarter
ended March 31, 2000, because, due to the net loss position, the effect 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 financial statements. The Company has no
components of other comprehensive income. Therefore comprehensive income is the
same as reported net income.
6
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. The Company operates in only one segment, as defined by SFAS No.
133. Substantially all long-lived assets are located in the United States.
Reclassifications and Restatements
Where necessary, prior periods' information has been reclassified to conform
to the current period condensed consolidated financial statement presentation.
On September 13, 1999, the Board of Directors approved a 2 for 1 stock split
of the Company's Common Stock that was effected on October 20, 1999. 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. Inventories, net
Inventories consist of the following (in thousands):
March 31, 2000 September 30, 1999
-------------- ------------------
Raw materials $ 6,258 $ 5,168
Work in process and finished goods 27,251 21,763
------- -------
$33,509 $26,931
======= =======
Note 3. Long Term Debt
During March 2000, the Company completed a private offering of $720 million of
4% convertible subordinated debentures due 2005. Net proceeds received by the
Company, after costs of issuance, were approximately $702 million. Interest is
payable in arrears semiannually on March 15 and September 15 of each year,
beginning September 15, 2000. The debentures are convertible into the Company's
common stock at $112.19 per share, subject to certain adjustments. The notes
may be redeemed, at the Company's option, on or after March 15, 2003 at
specified redemption prices. For the quarter ended March 31, 2000, interest
expense relating to the convertible subordinated debentures aggregated $1.4
million.
Note 4. Business Combinations
On March 31, 2000, the Company acquired all of the equity interests of Orologic,
Inc. ("Orologic") in exchange for 4,546,883 shares of common stock and stock
options to purchase 543,815 shares of common stock valued, in the aggregate, at
approximately $490 million, which
7
includes estimated direct acquisition costs of $17 million. Orologic is a
"fabless" semiconductor company that develops high performance system on a chip
solutions that enable data packet processing at OC-48 and OC-192 rates. The
acquisition of Orologic was recorded using the purchase method of accounting.
Therefore, the consideration was allocated based upon the relative fair values
of the tangible and intangible assets and liabilities acquired. The allocation
includes purchased in-process research and development of $45.6 million, which
has been charged to expense in the three month period ended March 31, 2000,
identifiable intangibles of $813,000, and excess consideration of $446 million
recorded as goodwill. Goodwill and the other identifiable intangibles will be
amortized over their estimated useful lives ranging from 2 to 6 years. Pro forma
consolidated results of operations for the six month period ended March 31, 2000
and 1999 are summarized below to reflect the acquisition of Orologic as if it
had occurred on October 1, 1999 and 1998, respectively:
Six months ended
March 31,
(in thousands except per share data) 2000 1999
- ----------------------------------------------------------------------
Revenues $189,640 127,705
Net loss (36,872) (7,518)
Net loss per share - basic and diluted (0.23) (0.05)
Note 5. Subsequent Event
In April 2000, the Company agreed to acquire all of the equity interests of
SiTera, Inc. (SiTera) in exchange for $750 million of the Company's common
stock. SiTera is a provider of Intelligent Network Processing for service
provider, carrier edge and large enterprise markets. The transaction is
expected to be completed in the quarter ending June 30, 2000. The Company
expects the transaction to be accounted for as a pooling-of-interests; however,
pooling-of-interests accounting is not a condition to closing.
Item 2. 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--
Orologic Acquisition and 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 management believes 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 "Factors That May Affect Future Operating Results."
8
Results of Operations
Revenues
Total revenues in the second quarter of fiscal 2000 were $100.2 million, a
50% increase over the $66.9 million recorded in the second quarter of fiscal
1999 and a 12% increase over the $89.2 million recorded in the prior quarter.
For the six months ended March 31, 2000, total revenues were $189.4 million, a
48% over the $127.6 million recorded in the six months ended March 31, 1999.
The increase in total revenues was due to unit growth in shipments of existing
products, as well as the introduction of new products to customers in the
communications market.
Cost of Revenues
Cost of revenues as a percentage of total revenues in the second quarter of
fiscal 2000 was 34.9% compared to 37.4% in the second quarter of fiscal 1999 and
35.4% 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 Colorado Springs wafer fabrication
facility, as well as improved manufacturing yields during the first and second
quarters of fiscal 2000.
Engineering, Research and Development Costs
Engineering, research and development expenses were $17.2 million in the
second quarter of fiscal 2000 compared to $12.2 million in the second quarter of
fiscal 1999 and $14.9 million in the prior quarter. For the six months ended
March 31, 2000, engineering, research, and development costs were $32.1 million
compared to $23.2 million in the six month period ended March 31, 1999. 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
17.1% in the second quarter of fiscal 2000, 18.2% in the second quarter of
fiscal 1999, and 16.7% in the prior quarter. For the six months ended March 31,
2000, engineering, research and development costs as a percentage of total
revenues decreased to 16.9% from 18.1%, in the comparable period a year ago. The
Company expects these costs to continue to increase as a result of continued
efforts to develop new products and increased headcount related to recent
acquisitions. 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 $11.4 million in the
second quarter of 2000, compared to $9.1 million in the second quarter of 1999
and $10.2 million in the prior quarter. For the six months ended March 31, 2000,
SG&A expenses were $21.6 million compared to $16.9 million in the same period in
fiscal 1999. The increase was due principally to increased headcount and higher
commissions earned by sales representatives resulting from increased sales. As
a percentage of total revenues, SG&A expenses were 11.4% in the second quarter
of 2000, compared to 13.6% in the second quarter of 1999 and 11.3% in the prior
quarter. For the six months ended March 31, 2000, SG&A expenses as a
percentage of total revenues
9
decreased to 11.4% from 13.3%, in the comparable period a year ago. The Company
expects these costs to continue to increase as a result of expected future
growth.
Orologic Acquisition
In connection with the acquisition of Orologic, the Company recorded a second
quarter fiscal 2000 charge of $45.6 million for the fair value of purchased in-
process research and development ("IPR&D"). In addition, $446 million was
allocated to identifiable intangible assets and goodwill. Such assets are being
amortized over their expected lives, ranging from 2 to 6 years, increasing
annual and quarterly amortization expense by approximately $74.5 million and
$18.6 million, respectively. The fair values allocated to the intangible assets
acquired, including the IPR&D, were based upon independent appraisals.
Other Income, Net
Other income consists of interest income, net of interest and other expenses.
Other income increased to $3.7 million in the second quarter of fiscal 2000 from
$2.8 million in the second quarter of 1999 and the prior quarter. For the six
months ended March 31, 2000, other income increased to $6.5 million from $5.2
million in the comparable period a year ago. The increase is due to higher
average cash, short-term investments, long-term investments and long-term
deposit balances resulting from increased profitability and proceeds received
from the convertible debenture offering. This was slightly offset with
increased interest expense relating to the debentures and amortization of debt
issuance costs. As a result of the convertible debenture offering, the Company
expects to record additional interest expense of approximately $7.2 million per
quarter in future periods.
Income Taxes
The Company's year to date effective income tax rate is 83.2 % as of March
31, 2000 compared to 34% for the same period in the prior year. For the quarter
ended March 31, 2000, the effective income tax rate is (250%) compared to 34%
for the quarter ending March 31, 1999. Excluding the effects of the Orologic
transaction, the quarter and year to date effective income tax rates are
approximately 33% through March 31, 2000.
Liquidity and Capital Resources
Operating Activities
The Company generated $38.7 million and $37.4 million from operating
activities in the six months ended March 31, 2000 and 1999, respectively. The
increase in cash flow from operations was principally due to an improvement in
profitability, excluding the one time non-cash charge of $45.6 million relating
to purchased in-process research and development.
10
Investing Activities
The Company used $807.1 million and $26.4 million in investing activities
during the six months ended March 31, 2000 and 1999, respectively. The increase
in cash used in investing activities was primarily due to the net investment of
$766.3 million, in held to maturity debt and equity securities, from the
proceeds received from the private placement offering. Capital expenditures,
principally for manufacturing and test equipment, were $33.1 million in the six
months ended March 31, 2000 compared to $18.9 million in the six months ended
March 31, 1999. The Company intends to continue investing in manufacturing,
test and engineering equipment.
The Company entered into an operating lease transaction providing for the
financing of $11.1 million for the acquisition of certain test equipment.
Payments under this lease commenced in November 1999. If at the end of the
lease term the Company does not purchase the property, the Company would
guarantee the residual value to the lessor equal to a specified percentage of
the lessor's cost of the equipment. As of March 31, 2000, the lessor advanced a
total of $11.1 million under this lease and had held $8.8 million as cash
collateral, which amount is included in restricted long-term deposits.
Financing Activities
The Company's financing activities provided $719.9 million for the six months
ended March 31, 2000, representing proceeds, net of issuance costs, of $702
million received from the convertible subordinated debentures offering and
proceeds of $19.2 million received from the issuance and sale of common stock
pursuant to the Company's stock option and stock purchase plans.
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.
Impact of Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133
will require recognition of all derivatives as either assets or liabilities on
the balance sheet at fair value. The Company will adopt SFAS No. 133, as
amended by SFAS No. 137, in the first quarter of its fiscal year ending
September 30, 2001. Management has not completed an evaluation of the effects
this standard will have on the Company's consolidated financial statements.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial
Statements." The objective of this SAB is to provide further guidance on revenue
recognition issues in the absence of authoritative literature addressing a
specific arrangement or a specific industry. The Company is required to follow
the guidance in the SAB no later than the first quarter of its year 2001. The
SEC has recently indicated it intends to issue further guidance with respect to
adoption of specific issues addressed by SAB No. 101. Until such time as this
additional guidance is issued, the Company is unable to assess the impact, if
any, it may have, however based on current guidance the Company believes
adoption of the SAB will not have a material impact on the Company's financial
position or results of operations.
In March 2000, the Financial Accounting Standards Board issued FASB
Interpretation No. 44, "Accounting for Certain Transactions involving Stock
Compensation" (FIN 44). FIN 44 provides guidance for issues arising in applying
APB Opinion No. 25, "Accounting for Stock Issued to Employees". FIN 44 applies
specifically to new awards, exchanges of awards in a business combination,
modification to outstanding awards, and changes in grantee status that occur on
or after July 1, 2000, except for the provisions related to repricings and the
definition of an employee which apply to awards issued after December 15, 1998.
Application of FIN 44 did not have an effect on the Company's financial
reporting.
11
Factors That May Affect 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. For the six months ended March 31, 2000, our three largest customer
accounted for 16%, 15% and 11% of our total revenues and no other customer
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
. Changes in inventory levels; and
. Expenses or operational disruptions resulting from acquisitions
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. In future periods,
we expect a substantial increase in amortization of intangibles assets resulting
from recent acquisitions and interest expense resulting from recent financing
activities. These additional expenses will have a material and adverse effect
on our earnings in future periods. The occurrence of any of the above mentioned
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. We are
faced with several risks in the
12
successful operation of this facility as well as in our overall production
operations. We had only produced finished four-inch wafers until 1998 and
therefore 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. Further, some of our products have been qualified for
manufacture at only one of the two facilities. 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.
There Are Risks Associated with Recent and Future Acquisitions
In fiscal 1999, we made four strategic acquisitions. In March 2000, we
completed the acquisition of Orologic, Inc., in exchange for approximately 4.6
million shares of our common stock. In April 2000, we agreed to acquire SiTera,
Inc., for approximately $750 million of our common stock, and we expect to
complete the acquisition in the quarter ending June 30, 2000. 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 and
adversely affected.
In addition, acquisitions we will make could result in dilutive issuances of
equity securities, substantial debt, and amortization expenses related to
goodwill and other intangible assets. In particular, in connection with our
acquisition of Orologic, Inc., we were required to record acquisition related
expenses of $45.6 million in the three months ended March 31, 2000. Further, we
expect to amortize an aggregate of approximately $446 million of goodwill and
other identifiable intangible assets over the next 2 to 6 years. In addition,
we presently expect to account for our acquisition of SiTera, Inc., as a
pooling-of-interests, however, this accounting treatment is not a condition for
the completion of the acquisition. If we are required to account for the
acquisition of SiTera, Inc., under the purchase method of accounting, we would
be required to record additional acquisition related expenses and amortization
expense related to intangible assets acquired. 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:
13
. Gallium Arsenide fabrication operations of systems companies such as
Conexant and Fujitsu
. High-performance silicon integrated circuit manufacturers who use Emitter
Coupled Logic ("ECL"), Bipolar Complementary Metal-Oxide-Semiconductor
("BiCMOS") or Complementary Metal-Oxide-Semiconductor ("CMOS")
technologies such as Hewlett Packard, Fujitsu, Motorola, Lucent
Technologies, Texas Instruments and Applied Micro Circuits Corporation
. Internal integrated circuit manufacturing units of systems companies such
as Lucent Technologies, Siemens and Fujitsu
Our current and prospective competitors include many large companies that
have substantially greater marketing, financial, technical and manufacturing
resources than we do.
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. 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.
There is Risk Associated with Doing Business in Foreign Countries
In fiscal 1999, international sales accounted for 33% of our total revenues,
and we expect international sales to constitute a substantial portion of our
total revenues for the foreseeable future. International sales involve a
variety of risks and uncertainties, including risks related to:
. Reliance on strategic alliance partners
. Compliance with foreign regulatory requirements
. Variability of foreign economic conditions
. Changing restrictions imposed by U.S. export laws, and
. Competition from U.S. based companies that have firmly established
significant international operations
Failure to successfully address these risks and uncertainties could adversely
affect our international sales, which could in turn have a material and adverse
effect on our results of operations and financial condition.
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
14
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 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 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
a 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 material 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.
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
15
resources. Additionally, we have recently established several product design
centers worldwide. Finally, we acquired Vermont Scientific Technologies, Inc.
("VTEK") in November 1998, Serano Systems Corporation ("Serano") in January
1999, XaQti Corporation ("XaQti") in July 1999, and Orologic, Inc. ("Orologic")
in March 2000, and agreed to acquire SiTera, Inc. ("SiTera") in April 2000, and
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
of our key employees or the failure to hire additional skilled technical
personnel could have a material adverse effect on our business and financial
results.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
At March 31, 2000, the Company's long-term debt consists of convertible
subordinated debentures with interest at a fixed rate. Consequently, the
Company does not have significant cash flow exposure on its long-term debt.
However, the fair value of the convertible subordinated debentures is subject to
significant fluctuation due to their convertibility into shares of Vitesse
common stock.
16
PART II
OTHER INFORMATION
Item 2. Changes in Securities
In March 2000, we issued 4,546,883 shares of our common stock and assumed stock
options to purchase 543,815 shares of our common stock, in connection with the
acquisition of all the equity interests of Orologic, Inc. The issuance of
shares and assumption of stock options were made pursuant to the exemption from
registration provided by Section 4(2) of the Securities Act of 1933, as amended,
based on the limited number of securities holders of Orologic, the relationship
of such security holders to Orologic, and the lack of any advertisement or
general solicitation in connection with the acquisition.
In March 2000, we issued $720 million in aggregate principal amount of our 4%
convertible subordinated debentures, due 2005. Net proceeds to Vitesse of this
offering, after costs of issuance, were approximately $702 million. The
debentures are convertible into the Company's common stock at $112.19 per share,
subject to certain adjustments. The initial purchasers of our debentures were
Lehman Brothers Inc., Goldman, Sachs & Co. and Prudential Securities
Incorporated. The debentures were issued pursuant to the exemption from
registration provided for by Section 4(2) of the Securities Act of 1933, as
amended.
Item 4. Submission of Matters to a Vote of Security Holders
On January 25, 2000, the Company held its regular Annual Meeting of
Stockholders. The purpose of the meeting was to elect Directors to serve for
the ensuing year, to approve an amendment to the Directors' Stock Option Plan to
reserve an additional 250,000 shares of Vitesse common stock thereunder for
issuance, to approve a proposal to amend the Company's Amended and Restated
Certificate of Incorporation to provide for an increase in the authorized shares
of common stock, par value $0.01 per share, of the Company, from 250,000,000 to
500,000,000 and to ratify the appointment of KPMG LLP as independent auditors
for the Company for the 2000 fiscal year. The following individuals were
elected to serve as Directors for the ensuing year:
Name Age Principal Occupation
---- --- --------------------
Pierre R. Lamond 69 General Partner of Sequoia Capital and Chairman
of the Board of Directors of the Company
James A. Cole 57 General Partner of Windward Ventures and
Spectra Enterprise Associates
Alex Daly 38 President and Chief Executive Officer of Cygnus
Solutions
John C. Lewis 64 Chairman of Amdahl Corporation
Louis R. Tomasetta 51 President, Chief Executive Officer and Director of
the Company
17
Additionally, the following items were voted upon and approved by the
shareholders:
Against or Votes
Votes for Withheld Abstained
----------- ---------- ---------
Approval of an amendment to the Directors' Stock
Option Plan to reserve an additional 250,000 shares
of Vitesse common stock thereunder for issuance 97,979,964 36,880,772 283,498
Approval of a proposal to amend the Company's
Amended and Restated Certificate of Incorporation
to provide for an increase in authorized shares of
common stock, par value $0.01 per share, of the
Company, from 250,000,000 to 500,000,000 126,519,952 8,479,076 145,206
Ratification of appointment of KPMG LLP
as independent auditors for the fiscal year
ending September 30, 2000 134,946,799 68,881 128,554
Item 6. Exhibits & Reports on Form 8-K
(a) Exhibits
2.1 Agreement and Plan of Merger and Reorganization, entered into as of
March 24, 2000, by and among Vitesse Semiconductor Corp., Holiday
Acquisition Corp., and Orologic, Inc., incorporated by reference to
Current Report on Form 8-K dated March 31, 2000.
3.1 Restated Certificate of Incorporation of Vitesse Semiconductor Corp.,
filed herewith.
4.1 Indenture, dated as of March 7, 2000, between the Company and Lehman
Brothers Inc., Goldman, Sachs & Co. and Prudential Securities
Incorporated, including the form of the Company's 4% Convertible
Subordinated Notes Due 2005, filed herewith.
4.2 Registration Rights Agreement, dated as of March 13, 2000, between the
Company and Lehman Brothers Inc., Goldman, Sachs & Co. and Prudential
Securities Incorporated, filed herewith.
27 Financial Data Schedule.
(b) Reports on Form 8-K
Report on Form 8-K, dated March 6, 2000, reporting the announcement of
the anticipated offering of $600,000,000 in aggregate principal amount
of convertible subordinated debentures due 2005 in a private placement
transaction.
18
Report on Form 8-K, dated March 13, 2000, reporting the completion of
the offering of $600,000,000 in aggregate principal amount of 4%
Convertible Subordinated Debentures due 2005 in a private placement
transaction.
Report on Form 8-K, dated March 24, 2000, reporting the Company's
agreement to acquire all of the equity interest of Orologic, Inc.
Report on Form 8-K, dated March 31, 2000, reporting the completion of
the Company's acquisition of all the equity interests of Orologic, Inc.
Report on Form 8-K, dated March 31, 2000, reporting the completion of
an offering of an additional $120,000,000 in aggregate principal amount
of 4% Convertible Subordinated Debentures due 2005 in a private
placement transaction pursuant to the exercise by the initial
purchasers of their over-allotment option.
Report on Form 8-K, dated April 19, 2000, reporting the Company's
agreement to acquire all of the equity interest of SiTera, Inc.
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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
May 15, 2000 By: /s/Eugene F. Hovanec
--------------------
Eugene F. Hovanec
Vice President, Finance and
Chief Financial Officer
20
INDEX TO EXHIBITS
3.1 Restated Certificate of Incorporation of Vitesse Semiconductor Corp.
4.1 Indenture
4.2 Registration Rights Agreement
27 Financial Data Schedule
21