- -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 1997 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 - -------------------------------------------------------------------------------- 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 DECEMBER 31, 1997, THERE WERE 35,997,210 SHARES OF $0.01 PAR VALUE COMMON STOCK OUTSTANDING. - -------------------------------------------------------------------------------- VITESSE SEMICONDUCTOR CORPORATION TABLE OF CONTENTS ----------------- Page Number PART I FINANCIAL INFORMATION Item 1 Financial Statements: Consolidated Balance Sheets as of December 31, 1997 2 and September 30, 1997 Consolidated Statements of Operations for the Three Months 3 ended December 31, 1997 and December 31, 1996 Consolidated Statements of Cash Flows for the Three Months 4 ended December 31, 1997 and December 31, 1996 Notes to Consolidated Financial Statements 5 Item 2 Management's Discussion and Analysis of 6 Financial Condition and Results of Operations PART II OTHER INFORMATION Item 6 Exhibits and Reports on Form 8-K 12 1 PART I FINANCIAL INFORMATION VITESSE SEMICONDUCTOR CORPORATION CONSOLIDATED BALANCE SHEETS (in thousands, except share data) Dec. 31, 1997 Sept. 30, 1997 ------------- -------------- (Unaudited) ASSETS Current assets: Cash and cash equivalents $141,078 $ 97,358 Short-term investments 10,231 58,486 Accounts receivable, net 23,768 21,072 Inventories, net: Raw material 2,715 2,421 Work in process 7,422 6,762 Finished goods 2,454 2,626 -------- -------- 12,591 11,809 Prepaid expenses 1,931 1,121 Deferred tax asset 14,800 14,800 -------- -------- Total current assets 204,399 204,646 -------- -------- Property and equipment, net 43,603 41,684 Restricted long-term deposits 58,669 45,556 Other assets 181 394 -------- -------- $306,852 $292,280 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current installments of capital lease obligations and term loans $ 163 $ 256 Accounts payable 20,802 19,758 Accrued expenses and other current liabilities 9,997 7,017 -------- -------- Total current liabilities 30,962 27,031 -------- -------- Capital lease obligations and term loans, less current installments 109 147 Shareholders' equity: Common stock, $.01 par value. Authorized 50,000,000 shares; issued and outstanding 35,997,210 shares on Dec. 31, 1997, and 35,913,738 shares on Sept. 30, 1997 360 359 Additional paid-in capital 277,468 277,169 Accumulated deficit (2,047) (12,426) -------- -------- Net shareholders' equity 275,781 265,102 -------- -------- $306,852 $292,280 ======== ======== 2 VITESSE SEMICONDUCTOR CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (in thousands, except share and per share data) Three Months Ended ------------------------------------ Dec. 31, 1997 Dec. 31, 1996 ------------------- -------------- Revenues, net $ 34,701 $ 21,832 Costs and expenses: Cost of revenues 14,194 9,858 Engineering, research & development 5,555 3,480 Selling, general & administrative 4,262 2,932 ----------- ----------- Total costs and expenses 24,011 16,270 ----------- ----------- Income from operations 10,690 5,562 Other income (expense): Interest income 2,293 1,199 Interest and other expense (10) (91) ----------- ----------- Total other income 2,283 1,108 ----------- ----------- Income before income taxes 12,973 6,670 Income taxes 2,594 667 ----------- ----------- Net income $ 10,379 $ 6,003 =========== =========== Net income per share Basic $ 0.29 $ 0.19 =========== =========== Diluted $ 0.27 $ 0.17 =========== =========== Basic weighted average common shares 35,952,714 31,753,140 =========== =========== Diluted weighted average common shares 39,058,026 35,805,873 =========== =========== 3 VITESSE SEMICONDUCTOR CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (in thousands) Three Months Ended ------------------------------------ Dec. 31, 1997 Dec. 31, 1996 ------------------- -------------- Cash flows from operating activities: Net income $ 10,379 $ 6,003 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 2,786 1,387 Change in assets and liabilities: (Increase) decrease in: Receivables, net (2,696) 529 Inventories (782) (166) Prepaid expenses (810) (356) Other assets 213 (97) Increase (decrease) in: Accounts payable 1,044 (1,101) Accrued expenses and other current liabilities 2,980 1,932 -------- -------- Net cash provided by operating activities 13,114 8,131 -------- -------- Cash flows from investing activities: Short-term investments 48,255 (64,883) Capital expenditures (4,705) (3,811) Restricted long-term deposits (13,113) (1,764) -------- -------- Net cash provided by (used in) investing activities 30,437 (70,458) -------- -------- Cash flows from financing activities: Principal payments under capital lease obligations & term loans (131) (277) Proceeds from issuance of common stock, net 300 118,382 -------- -------- Net cash provided by financing activities 169 118,105 -------- -------- Net increase in cash & cash equivalents 43,720 55,778 Cash & cash equivalents at beginning of period 97,358 52,436 -------- -------- Cash & cash equivalents at end of period $141,078 $108,214 ======== ======== Supplemental disclosures of cash flow information: Cash paid during the period for interest $ 6 $ 28 ======== ======== 4 VITESSE SEMICONDUCTOR CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. GENERAL The accompanying consolidated financial statements include the accounts of Vitesse Semiconductor Corporation and its subsidiaries. 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. All amounts are unaudited except the September 30, 1997 consolidated balance sheet. This report should be read in conjunction with the audited financial statements presented in the 1997 Annual Report. Footnotes and other disclosures which would substantially duplicate the disclosures in the Company's audited financial statements for fiscal year 1997 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. In the first quarter of fiscal 1998, the Company adopted Statement of Financial Accounting Standards No. 128 (SFAS No. 128), "Earnings per Share." All earnings per share amounts for all periods have been presented, and where necessary, restated to conform to SFAS No. 128 requirements. NOTE 2. YEAR 2000 PROBLEM The Company has developed a plan to address the Year 2000 problem. The plan provides for the Company's computer systems to be Year 2000 compliant by the end of fiscal 1999. The Year 2000 problem is the result of computer programs being written using two digits rather than four to define the applicable year. The Company is expensing all costs related to this issue as the costs are incurred. The Company does not believe that such costs will be material to the financial statements. 5 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 "Liquidity and Capital Resources--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 first quarter of fiscal 1998 were $34,701,000, a 59% increase over the $21,832,000 recorded in the first quarter of fiscal 1997. The increase in total revenues was the result of continued growth of shipments to customers in the communications and ATE markets. Cost of Revenues Cost of revenues as a percentage of total revenues in the first quarter of fiscal 1998 was 40.9% compared to 46.7% in the first quarter of fiscal 1997. The decrease in cost of revenues as a percentage of total revenues resulted from a reduction in per unit costs associated with increased production as well as increased manufacturing yields. 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. 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 6 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. In addition, the ability of customers to change designs and to cancel or reschedule orders can also result in adverse adjustments to inventory. 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 $5,555,000 in the first quarter of fiscal 1998 compared to $3,480,000 in the first quarter of fiscal 1997. The increase was 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 first quarters of 1998 and 1997. 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 $4,262,000 in the first quarter of fiscal 1998 compared to $2,932,000 in the first quarter of fiscal 1997. This increase was primarily due to increased headcount. As a percentage of total revenues, however, SG&A expenses declined to 12% in the first quarter of fiscal 1998 from 13% in the first quarter of fiscal 1997 as a result of the Company's revenues growing faster than SG&A expenses. Interest Income Interest income increased to $2,293,000 in the first quarter of fiscal 1998 from $1,199,000 in the first quarter of fiscal 1997. This was due to a higher average cash balance in the first quarter of fiscal 1998 as compared to the first quarter of fiscal 1997, primarily due to the proceeds from a public offering which was completed in November 1996. Interest Expense Interest expense decreased to $10,000 in the first quarter of fiscal 1998 from $98,000 in the first quarter of fiscal 1997. This decrease was the result of a decrease in the Company's average debt balance. 7 Income Taxes The Company recorded a provision for income taxes in the amount of $2,594,000 in the first quarter of fiscal 1998 and $667,000 in the first quarter of fiscal 1997 principally for the federal alternative minimum taxes, state income taxes, and taxes due to foreign jurisdictions, in light of the Company's existing net operating loss carryforwards. LIQUIDITY AND CAPITAL RESOURCES Operating Activities The Company generated $13,114,000 and $8,131,000 from operating activities in the first quarter of 1998 and 1997, respectively. The increase in operating cash flow was principally due to an improvement in profitability. Investing Activities Capital expenditures, principally for manufacturing and test equipment, were $4,705,000 in the first quarter of 1998 compared to $3,811,000 in the first quarter of 1997. The Company intends to continue investing in manufacturing, test and engineering equipment and currently expects to spend an additional $10 to $15 million for capital expenditures in fiscal 1998, which the Company intends to finance with working capital. Financing Activities In the first quarter of fiscal 1998, the Company generated $169,000 in financing activities. Net proceeds from the issuance of common stock was $300,000, offset by $131,000 in payments on debt obligations. Management believes that the Company's cash flow from operations is adequate to finance its planned growth and operating needs for the next 12 months. The Company believes it can meet its wafer fabrication needs through the second quarter of fiscal 1998 at its Camarillo facility assuming that the Company successfully completes planned substantial incremental increases in production capacity at the facility. The Company has recently completed equipment installation at its new Colorado Springs, Colorado wafer fabrication facility and is currently conducting extensive process qualification procedures. This facility is not expected to begin volume commercial production until the third quarter of fiscal 1998. FACTORS AFFECTING FUTURE OPERATING RESULTS CUSTOMER AND INDUSTRY CONCENTRATION The Company is, and intends to continue, focusing its sales efforts on a relatively small number of companies in the telecommunications, data communications and ATE markets that require high performance ICs. Certain of these companies are also competitors of Vitesse. 8 VARIABILITY OF QUARTERLY RESULTS The Company's quarterly results of operations have varied significantly in the past and may continue to do so in the future. These variations have been due to a number of factors, including: the loss of major customers; variations in manufacturing yields; the timing and level of new product and process development costs; changes in inventory levels; changes in the type and mix of products being sold; changes in manufacturing capacity and variations in the utilization of this capacity; and customer design changes, delays or cancellations. The Company has also from time to time incurred significant new product and process development costs due to the Company's policy of expensing costs as incurred relating to the manufacture of new products and the development of new process technology. There can be no assurance that the Company will not incur such charges or experience revenue declines in the future. MANUFACTURING CAPACITY LIMITATIONS; NEW PRODUCTION FACILITY The Company currently manufactures all of its ICs at its four-inch wafer fabrication facility located in Camarillo, California. The Company believes that this facility should be able to satisfy its production needs through the second quarter of fiscal 1998, assuming that the Company successfully completes planned substantial incremental increases in production capacity at the facility through such date. The Company has recently completed equipment installation at a new six-inch wafer fabrication facility in Colorado Springs, Colorado, to supplement its existing facility in Camarillo. The facility includes a 10,000 square foot Class 1 clean room with the capability for future expansion to 15,000 square feet. The Company is currently conducting extensive process qualification procedures at this facility and does not believe that it will begin volume commercial production until the third quarter of fiscal 1998. The successful operation of the new wafer fabrication facility, as well as the Company's overall production operations, will be subject to numerous risks. The Company has no prior experience with the operation of equipment or the processes involved in producing finished six-inch wafers, which differ significantly from those involved in the production of four-inch wafers. The Company will be required to hire, train and manage production personnel successfully in order to effectively operate the new facility. The Company does not have excess production capacity at its Camarillo facility to offset any failure of the new facility to meet planned production goals. As a result of these and other factors, the failure of the Company to successfully operate the new wafer fabrication facility would have a material adverse effect on its business, operating results or financial condition. The Company will also have to effectively coordinate and manage the Colorado Springs and Camarillo facilities to successfully meet its overall production goals. The Company has no experience in coordinating and managing full scale production facilities which are located at different sites. The failure to successfully coordinate and manage the two sites would adversely affect the Company's overall production and would have a material adverse effect on its business, operating results or financial condition. 9 COMPETITION The high-performance semiconductor market is highly competitive and subject to rapid technological change, price erosion and heightened international competition. The telecommunications, data communications and ATE industries, which are the primary target markets for the Company, are also becoming intensely competitive because of deregulation and heightened international competition, among other factors. In the telecommunications market, the Company currently competes primarily against other GaAs-based companies such as Triquint Semiconductor and the GaAs fabrication operations of system companies such as Rockwell. In the data communications and the ATE markets, the Company competes primarily against silicon ECL and BiCMOS products offered principally by semiconductor manufacturers such as Fujitsu, Hewlett Packard, Motorola, National Semiconductor and Texas Instruments and bipolar silicon IC manufacturers such as Applied Micro Circuits Corporation and Synergy Semiconductor Corporation. Many of these companies have significantly greater financial, technical, manufacturing and marketing resources than the Company. In addition, in lower-frequency applications, the Company faces increasing competition from CMOS-based products, particularly as the performance of such products continues to improve. Competition in the Company's markets for high-performance ICs 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 Vitesse's products because of perceived risks relating to GaAs technology. In addition, product qualification is typically a lengthy process and certain prospective customers may be unwilling to invest the time or incur the costs necessary to qualify suppliers such as the Company. Prospective customers may also have concerns about the relative speed, complexity and power advantages of the Company's products compared to more familiar ECL of BiCMOS semiconductors or about the risks associated with relying on a relatively small company for a critical sole-sourced component. PRODUCT AND PROCESS DEVELOPMENT AND TECHNOLOGICAL CHANGE The market for the Company's products is characterized by rapid changes in both product and process technologies. The Company believes that its future success will depend, in part, upon its ability to continue to improve its product and process technologies and develop new technologies in order to maintain its competitive position, to adapt its products and processes to technological changes and to adopt emerging industry standards. There can be no assurance that the Company will be able to improve its product and process technologies and develop new technologies in a timely manner or that such improvements or developments will result in products that achieve market acceptance. The failure to successfully improve its existing technologies or develop new technologies in a timely manner could adversely affect the Company's business, operating results and financial condition. DEPENDENCE ON THIRD PARTIES The Company depends upon third parties for performing certain processes and providing a variety of components and materials necessary for the production of its H-GaAs ICs. A majority of the Company's ICs are packaged in plastic by third parties. The Company packages the balance of its ICs in its Camarillo facility using customized ceramic packaging which is 10 presently available from only one source. The inability to obtain sufficient sole- or limited-source services or components as required could result in delays or reductions in product shipments which could adversely affect the Company's business, operating results and financial condition. ENVIRONMENTAL REGULATIONS The Company is subject to a variety of federal, state and local governmental regulations related to the use, storage, discharge and disposal of toxic, volatile or otherwise hazardous chemicals used in its manufacturing process. Any failure to comply with present or future regulations could result in the imposition of fines on the Company, the suspension of production or a cessation of operations. In addition, such regulations could restrict the Company's ability to expand its facilities at its present location or could require the Company to acquire costly equipment or to incur other significant expenses to comply with environmental regulations or to clean up prior discharges. The Company uses significant amounts of water throughout its manufacturing process. Previous droughts in California have resulted in restrictions being placed on water use by manufacturers and residents. In the event of future drought, reductions in water use may be mandated generally, and it is unclear how such reductions will be allocated among California's different users. No assurance can be given that near term reductions in water allocations to manufacturers will not occur, possibly requiring a reduction in the Company's level of production, and materially and adversely affecting the Company's operations. See "Business-- Environmental Matters." MANAGEMENT OF GROWTH The management of the Company's growth requires qualified personnel and systems. In particular, the operation of the Company's planned wafer fabrication facility in Colorado Springs and its integration with the Company's current facility will require significant management, technical and administrative resources. There can be no assurance that the Company will be able to manage its growth or effectively integrate its planned wafer fabrication facility, and failure to do so could have a material adverse effect on the Company's business, operating results or financial condition. DEPENDENCE ON KEY PERSONNEL The Company's success depends in part upon attracting and retaining the services of its managerial and technical personnel. The competition for qualified personnel is intense. There can be no assurance that the Company can retain its key managerial and technical employees or that it can attract, assimilate or retain other skilled technical personnel in the future, and failure to do so could have a material adverse effect on the Company's business, operating results or financial condition. 11 PART II OTHER INFORMATION ITEM 6. EXHIBITS & REPORTS ON FORM 8-K (a) EXHIBITS 27 Financial Data Schedule (b) REPORTS ON FORM 8-K None. 12 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 Dated: 2/13/1998 By: /s/ Eugene F. Hovanec ------------- ---------------------------------- Eugene F. Hovanec Vice President, Finance and Chief Financial Officer 13