-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, W1ia2LFQeWzE0t7JVMyxZh4D6mGNCl9emY0XbnqxesPRFleJWExYaocj8bYRl5Ja fVQmzIDkt4rF7aXG7PTVvw== 0000898430-98-004535.txt : 19981228 0000898430-98-004535.hdr.sgml : 19981228 ACCESSION NUMBER: 0000898430-98-004535 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981223 FILER: COMPANY DATA: COMPANY CONFORMED NAME: VITESSE SEMICONDUCTOR CORP CENTRAL INDEX KEY: 0000880446 STANDARD INDUSTRIAL CLASSIFICATION: SEMICONDUCTORS & RELATED DEVICES [3674] IRS NUMBER: 770138960 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-19654 FILM NUMBER: 98774626 BUSINESS ADDRESS: STREET 1: 741 CALLE PLANO CITY: CAMARILLO STATE: CA ZIP: 93012 BUSINESS PHONE: 8053883700 MAIL ADDRESS: STREET 1: 741 CALLE PLANO CITY: CAMARILLO STATE: CA ZIP: 93012 10-K405 1 FORM 10-K405 ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended September 30, 1998 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 NO. 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) Registrant's telephone number, including area code: (805) 388-3700 Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, $0.01 PAR VALUE (TITLE OF CLASS) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the closing sale price of the Common Stock on September 30, 1998 as reported on the Nasdaq National Market, was approximately $1,354,962,498. Shares of Common Stock held by each officer and director and by each person who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. As of September 30, 1998, the registrant had outstanding 73,788,136 shares of Common Stock. ================================================================================ PART I ITEM 1. BUSINESS Certain statements in this Annual Report on Form 10-K, including certain statements contained in "Business" and "Management's Discussion and Analysis of Financial Condition and Results of Operations," constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Factors Affecting Future Operating Results." Vitesse is a leader in the design, development, manufacturing and marketing of digital GaAs ICs. The Company's products incorporate its proprietary H-GaAs (high integration gallium arsenide) technology to produce high-performance ICs primarily for telecommunications, data communications and automated test equipment (ATE) systems providers. The Company believes H-GaAs technology provides significant advantages over silicon-based IC technologies in addressing the combination of speed, power dissipation and complexity requirements of these high-performance systems providers. In fiscal 1998, sales of telecommunications, data communications and ATE products represented 51%, 23% and 26%, respectively, of the Company's total revenues. The Company's major customers include Alcatel, Cisco, Credence, Ericsson, Fujitsu, IBM, Lucent, NEC, Schlumberger, Seagate, Tellabs and Teradyne. BACKGROUND Telecommunications Market As a result of deregulation and heightened competition in the worldwide telecommunications industry over the past decade, domestic and foreign public network service providers have been forced to differentiate themselves by being more responsive and offering new and better services at lower costs. The volume of information required to be transmitted across public networks has increased significantly in recent years as a result of a variety of factors, including the increase in data transmission and facsimile use, the rapid growth of the internet, the emergence of corporate virtual private networks ("VPNs"), and the development of new applications such as video conferencing and multimedia. Public network service providers, including interexchange long distance carriers ("IXCs") and local exchange carriers ("LECs"), have been required to upgrade their infrastructure to provide high-speed data services to customers to meet these needs in addition to providing their standard telephone services. Infrastructure improvements to public networks have most prominently included a dramatic increase in the deployment of fiber optic technology to replace conventional copper wire. Since optical fiber offers substantially greater capacity, is less error prone and is easier to administer than copper wire, it has become the transmission medium of choice for IXCs and, increasingly, LECs. As fiber optic technology has spread, existing network standards for the transmission of information, which had been developed primarily for copper wire networks, have presented limitations to simultaneously transmitting voice and data. As a result, the SONET (Synchronous Optical Network) standard in the United States and the equivalent SDH (Synchronous Digital Hierarchy) standard in the rest of the world emerged as the next generation standards for high-speed optical fiber transmission. The SONET/SDH standard facilitates high data integrity and improved performance in terms of network reliability and reduces maintenance and other operations costs by standardizing interoperability among different vendors' equipment. More recently, the demand for system bandwidth is being addressed by transmitting multiple channels on a single fiber by a technique called wavelength division multiplexing ("WDM"). The adoption of WDM has enabled system operators to significantly increase system bandwidth without having to bury additional fiber cables, a long and costly process. While WDM increases the bandwidth carried by each optical fiber, it does not reduce the number of electronic components required. Instead, WDM has accelerated the growth of SONET/SDH deployment by eliminating fiber installation as a growth limiter. 1 Asynchronous transfer mode ("ATM") is a data transmission standard complementary to SONET/SDH that is in an early stage of development. ATM takes advantage of the additional capacity provided by fiber optic technology. The SONET/SDH standard relates to the system through which data is transmitted, while ATM is a protocol for the packaging of data for transmission over the SONET/SDH system. ATM technology enables LAN, WAN and public network systems designers to provide increasingly improved services to network users. LAN and WAN equipment vendors must enable the integration of mixed high-speed, high- volume data communications, voice, video and imaging applications, reduce bandwidth limitations of current LANs and WANs, lower equipment costs and ease administrative burdens imposed by current system architectures. Similarly, equipment vendors must provide systems that can handle integrated-switched high- speed, high-volume data communications, voice, video and imaging services. Public network equipment vendors must also seamlessly integrate their products with both LAN and WAN equipment to reduce overall networking costs. Fiber optic applications designed to the SONET/SDH and ATM standards use data transmission rates of 155 MHz, 622 MHz, 2.488 GHz or 10 GHz. The Company believes that SONET/SDH transmission systems installed by network providers generally operate at 2.488 GHz and above. The Company also believes that silicon-based approaches are not practicable solutions at such frequencies and, as a result, telecommunications systems manufacturers increasingly look to GaAs solutions because of their requirements for high bandwidth. Data Communications Market Performance improvements in processors and peripherals, along with the transition to distributed architectures such as client/server, have spawned increasingly data-intensive and high-speed networking applications. This has led to a focus on the methods of connecting high-performance computers to peripheral equipment in the data communications industry. In 1988, the American National Standards Institute established a Fibre Channel standard, which is a practical, inexpensive, yet expandable method for achieving high-speed data transfer among workstations, mainframes, data storage devices and other peripherals. The Fibre Channel standard addresses the need for very fast transfers of large volumes of information, while at the same time relieving system manufacturers from the burden of supporting the variety of networks and channels currently in place. Fibre Channel is especially effective in situations where large blocks of data must be transferred within and between buildings and over campus environments. Fibre Channel is substantially faster than existing network data transmission protocols. Fibre Channel is capable of transmitting at rates exceeding 1 gigabit per second in both directions simultaneously and is also able to transport existing protocols over both optical fiber and copper wire. Currently, the most prominent use of Fibre Channel technology is in high-density rigid disk drives of 1 gigabyte or greater. In the LAN environment, Ethernet is currently the most widespread standard, operating at 10 to 100 megabits per second. However, LAN backbones are rapidly being upgraded to Gigabit Ethernet and ATM in order to increase available bandwidth. These network protocols, which enable expanded bandwidth in excess of one gigabit per second, are emerging as the new standards for LAN backbones. The Company believes that CMOS silicon approaches are not practicable solutions at the 1 gigabit per second or higher clock rates used in the Fibre Channel and Gigabit Ethernet standards. The Company believes that its H-GaAs solutions for these markets operate at lower power and greater performance margins than competing ECL and BiCMOS ICs. Automated Test Equipment Market ATE is used for the comprehensive testing of ICs, printed circuit boards and electronic systems. The increasing worldwide demand for ICs in recent years has led to an increase in the demand for IC test equipment. The ATE industry has experienced changes arising from the increasing complexity of ICs, as manifested by growing pin counts, higher speeds and greater levels of integration. These changes have created challenges for ATE systems designers, since the equipment used to test these complex devices must be capable of performance exceeding that of the devices themselves. 2 These changes have also led to major revisions in ATE architectures. Historically, ATE systems were primarily based on a central resource architecture where timing and pattern generation hardware and software were centralized and allocated as needed to groups of pins on the "device under test" ("DUT"). Central resource architecture works best with relatively simple ICs, but with newer, higher complexity devices, the test environment can be significantly different for each pin. This has led to a "tester-per-pin" architecture in which tester resources are dedicated to each pin of the DUT. This rapid increase in system complexity has resulted in a marked increase in the number of electronic components needed in the pin channel. The Company believes these factors have led ATE designers to seek to increase component integration. For high-performance ATE systems, the Company believes that CMOS and BiCMOS silicon ICs are too slow and that the high power dissipation in ECL silicon ICs limits their integration capabilities. The Company believes that the low power dissipation and high complexity of the Company's H-GaAs ICs, which permit systems to be built with fewer ICs, are well-suited for the increasingly demanding requirements of present generation ATE equipment. STRATEGY The Company's strategy includes the following elements: Target Growing Markets Vitesse targets the growing telecommunications, data communications and ATE markets. Within the telecommunications and data communications markets, the Company's products are used in emerging high-growth markets such as SONET/SDH, ATM, Fibre Channel, and Gigabit Ethernet, which require ICs that are capable of high-bandwidth data transmission. Reduce Costs of High-Performance Products The Company continually strives to reduce the cost of its high-performance products. The Company endeavors to continue to increase manufacturing yields and decrease die sizes, as well as to decrease power dissipation to enable the use of lower-cost plastic packaging. Another critical element of this strategy involves the integration of multiple functions onto a single chip. Perform Own Wafer Fabrication Using Proprietary Manufacturing Process Technology The Company operates its own advanced wafer fabrication facilities in Camarillo, California and in Colorado Springs, Colorado. The Company believes that control of wafer fabrication assures a reliable source of supply and provides greater opportunities to enhance product quality and reliability. In addition, the Company believes such control facilitates new process and product development and provides a more dependable wafer supply to meet customer requirements. The Company's proprietary manufacturing process utilizes industry standard manufacturing equipment. This enables the Company to employ developments in silicon manufacturing technology to continue to improve minimum feature size, dimension control, deposition and etch capabilities. By eliminating the need for "custom" wafer fabrication equipment, the Company can focus its resources on developing leading process technology rather than on developing expensive customized manufacturing equipment. Develop "GaAs Transparent" Products The Company endeavors to make the process of designing Vitesse GaAs products "transparent" to the designer when compared to the design process for silicon ICs. The design of its H-GaAs products is conducted using methodologies and CAD tools essentially identical to those used to design silicon products. Customers designing Vitesse ASIC products can use industry standard CAD tools (including those offered by Cadence, Mentor Graphics, Synopsys and Viewlogic) in such a manner that there are no "GaAs-unique" factors that require special background or training beyond those for an ASIC designer generally. In addition, the Company's products do not require electronic systems manufacturers to change input/output interface levels or utilize power supply voltages unique to Vitesse products. 3 Establish Close Relationships with Customers' Engineering Management The Company establishes close relationships with its customers' engineering management and believes these relationships enable it to better understand the customers' needs and win designs for existing and new systems. PRODUCTS AND CUSTOMERS Telecommunications Telecommunications products accounted for 51% and 52% of the Company's total revenues for fiscal 1998 and fiscal 1997, respectively. In fiscal 1998, substantially all of the Company's sales in the telecommunications market were for SONET/SDH applications. In fiscal 1998, the Company's significant telecommunications customers, each of which purchased at least $100,000 of the Company's products, included Alcatel, Ciena, Ericsson, Fujitsu, Lucent, NEC and Tellabs. The Company manufactures a variety of telecommunications IC products for the transmission and reception of data over a fiber optic network. The Company supplies these products as Company standard products or as customer-designed ASIC products. With respect to the transmission of data, the Company's products take parallel data, code it and serialize it (multiplexing or "mux") for transmission. At the receiving end of the fiber optic system, the Company's telecommunications products decode and de-serialize the data (demultiplexing or "demux"). In the case of telecommunications switching, the Company offers a line of crosspoint switches for high-speed digital switching applications including data distribution and video switching. The Company also offers a line of photodetector/transimpedance amplifiers for both telecommunications and data communications applications which offer a low noise and wide bandwidth solution for converting light from a fiber optic communications channel into an electrical signal. The following is a summary of applications and related operating frequencies which the Company's telecommunications products address: Associated Crosspoint Transimpedance SONET Hierarchy Clock Rate MUX/DMUX Switches Amplifiers --------------- ---------- -------- -------- ---------- STS/OC-3 155 MHz X X X STS/OC-12 622 MHz X X X STS/OC-48 2.488 GHz X STS/OC-192 10 GHz X Data Communications Data communications products accounted for 23% and 22% of the Company's total revenues for fiscal 1998 and fiscal 1997, respectively. Vitesse has developed a line of Fibre Channel products for this market, which consist primarily of transmitters, receivers, transceivers, repeaters, and port bypass circuits. Additionally, the Company has developed physical layer interface products for the recently emerging Gigabit Ethernet and ATM markets. The Company is also in the process of developing additional products for these markets. In fiscal 1998, the Company's significant data communications customers, each of which purchased at least $100,000 of the Company's products, included Cisco, IBM, Newbridge Networks, Seagate, Sequent and Sun Microsystems. Automated Test Equipment ATE products accounted for 26% and 22% of the Company's total revenues for fiscal 1998 and fiscal 1997, respectively. Vitesse provides gate arrays and custom products that offer a combination of high complexity, low power dissipation and high speed for ATE. More recently, the Company has introduced a line of standard products targeted at the ATE industry. In fiscal 1998, the Company's significant ATE customers, each of which purchased at least $100,000 of the Company's products, included Ando, Credence, Integrated Measurement Systems, LTX, Schlumberger and Teradyne. 4 The Company's ten largest customers accounted for approximately 69% and 77% of total revenues in fiscal 1998 and fiscal 1997, respectively. In fiscal 1998 and fiscal 1997, sales to Lucent accounted for 23% and 20%, respectively, of the Company's total revenues, and sales to Schlumberger accounted for 15% and 12%, respectively, of the Company's total revenues. TECHNOLOGY The Company believes the limitations of silicon-based CMOS, BiCMOS, and ECL ICs have become more pronounced as the requirements of the telecommunications, data communications and ATE systems providers have increased. While CMOS offers certain complexity advantages over the alternative silicon processes, the Company believes it lacks the speed required for many high-performance systems. ECL technology offers higher speeds but at the cost of high power dissipation, which limits its use for high-complexity applications. BiCMOS offers higher performance than is obtainable from CMOS, but less than that offered by ECL, at levels of complexity which are greater than that available from ECL but lower than that provided by CMOS. BiCMOS is slower than ECL and, the Company believes, does not achieve the speed necessary for the highest performance telecommunications, data communications and ATE systems. GaAs has inherent physical properties which allow electrons to move several times faster than within silicon. This higher electron mobility provides the Company with the flexibility to manufacture ICs that operate at much higher speeds than silicon devices or to operate at the same speeds with reduced power consumption. The following table compares the intrinsic transistor performance and cost per function for H-GaAs with alternative process technologies: H-GaAs ECL BiCMOS CMOS -------- ------- -------- ------- Speed............... Highest High Moderate Lowest Power Dissipation... Low Highest Moderate Lowest Complexity.......... High Lowest Higher Highest Cost per Function... Moderate Highest Moderate Lowest The Company employs proprietary H-GaAs process technology based on a refractory metal self-aligned gate ("SAG") process. SAG technology is universally used in the manufacture of complex silicon ICs. The process structure and logic implementation of the Company's GaAs ICs are similar to a traditional silicon MOS process with the exception that the gate metal is deposited directly on the GaAs substrate creating a metal-semiconductor junction comparable to depositing the metal on a thin oxide layer grown on the silicon substrate in the case of metal gate n-channel MOS. The implementation of a SAG process in GaAs or silicon requires a gate metal structure that can withstand the high temperature of an ion implant activation anneal. This is in contrast to conventional microwave GaAs ("RF GaAs") process technologies which utilize a low temperature, non-self-aligned technology based on gold as the gate metal. The table below compares Vitesse's H-GaAs, traditional silicon MOS and microwave RF-GaAs: Silicon Microwave H-GaAs MOS RF-GaAs -------- -------- --------- Self-Aligned... Yes Yes No Interconnect... Aluminum Aluminum Gold Complexity..... High Highest Medium Another advantage of SAG technology in GaAs is the greater control over electrical transistor parameters compared to conventional gold gate technology. This control of the field effect transistor ("FET") characteristics has enabled the Company to be one of the few companies that have demonstrated the ability to manufacture products having lower power dissipation using direct coupled FET logic ("DCFL"). DCFL has the highest complexity, fewest elements per logic function and best available combination of speed at low power of any n-channel FET technology demonstrated in silicon or GaAs. The use of a high-temperature process also allows Vitesse to use silicon industry standard aluminum interconnect technology. This enables the Company to utilize standard deposition and dry etch equipment for interconnects. The interconnect portion of the circuit represents a majority of mask levels in the manufacturing process. 5 The Company has significantly improved its process technology:
H-GaAs H-GaAs H-GaAs H-GaSs I II III IV ------ ------ ------ ------ Product Announcement Year............... 1986 1988 1991 1995 Gate Length............................. 1.2mum 0.8mum 0.6mum 0.4mum Metal Layers............................ 2 3 4 5 Maximum Relative Speed(1)............... 1.0x 1.4x 2.0x 3.0x Minimum Relative Power Dissipation(1)... 1.0x 0.7x 0.5x 0.3x
- ------------ (1) Compared to H-GaAs I. The Company's H-GaAs IV 0.4 micron five-layer metal GaAs FET technology is capable of achieving higher complexity and lower power dissipation than previous Vitesse technologies. The Company manufactures various standard products as well as ASICs based on the GLX family of gate arrays and the SLX family of standard cell ICs. The GLX family of gate arrays has been designed to offer the same speed as the H-GaAs III family of gate arrays, but with lower power dissipation. This is intended to enable ICs to be packaged in a lower cost plastic package in the 100 MHz to 800 MHz range, thereby offering the customer a lower cost solution in this performance range. MANUFACTURING Wafer Fabrication The Company fabricates four-inch wafers at its Camarillo plant in a 6,000 square foot clean room, which has a rating of Class 10 (meaning there are fewer than ten particles larger than 0.5 micron per cubic foot of air). In 1998 the Company started fabricating six-inch wafers at a newly constructed plant in Colorado Springs, Colorado which includes a 15,000 square foot Class 1 clean room. Wafer fabrication equipment used by the Company is generally identical to that used in a sub-micron silicon MOS fabrication facility. Process technology is generally similar to that used in advanced sub-micron silicon process technologies, with certain modifications necessary to accommodate GaAs material properties. As is typically the case with semiconductor manufacturing, the Company's manufacturing yields vary significantly among products, depending on the product's complexity and the Company's experience in manufacturing the particular ICs. While the Company's process technology utilizes standard silicon semiconductor manufacturing equipment, aggregate production quantities have been relatively low and the process technology is significantly less developed than silicon process technology used by competitors. This leads to overall yields lower than levels typically achieved in the silicon process. The Company expects that many of its current and future products may never be produced in high volume. Regardless of the process technology used, the fabrication of ICs 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 non-functional. By utilizing standard silicon IC manufacturing equipment the Company is able to employ developments in silicon manufacturing technology to continue to improve minimum feature size, dimension control, deposition and etch capabilities. By eliminating the need for `custom" wafer fabrication equipment, the Company can focus its resources on developing leading process technology rather than on developing expensive customized manufacturing equipment. Assembly and Test A majority of the Company's ICs are packaged in plastic by third parties. The Company conducts ceramic package assembly for a portion of its ICs in its Camarillo plant. The Company employs industry standard assembly equipment in an automated assembly line that is intended to reduce packaging time as well as to improve quality. For final testing, the Company utilizes advanced automated VLSI testers and has constructed several custom testers. However, in many cases, the Company cannot test its products at full speed and must rely on numerous sub-circuit path measurements to determine the performance of the IC. 6 Components and Raw Materials The Company purchases the majority of its ceramic packages from Kyocera. Kyocera is the world's largest supplier of multilayer, high-performance ceramic packages and, in many cases, is the only source of these packages. Since most of the ceramic packages used in the Company's assembly process are designed to the Company's specifications, there are typically no second sources for these packages. To date, the Company has not experienced any adverse effects due to the sole-source nature of its ceramic packages. The Company believes it maintains an adequate inventory of sole-source ceramic packages. The level of inventory of ceramic packages carried by the Company is substantially higher than standard plastic packages for IC companies that utilize standard packages available from a wide variety of sources. Since 1992, the Company has increased its use of plastic packages, and it uses multiple contract manufacturers to perform plastic packaging. GaAs substrates and other raw materials and equipment used in the production of the Company's ICs are available from several suppliers. Although lead times are occasionally extended in the industry, the Company has not experienced any material difficulty in obtaining raw materials or equipment. ENGINEERING, RESEARCH AND DEVELOPMENT The market for the Company's products is characterized by rapid changes in both GaAs and competing silicon process technologies. Because of continual improvements in these technologies, the Company believes that its future success will depend largely on its ability to continue to improve its product and process technologies, to develop new technologies in order to maintain the performance of its products relative to competitors, to adapt its products and process technologies to technological changes and to adopt emerging industry standards. Product Research and Development The Company's present product research and development efforts are focused on developing new products for its telecommunications, data communications and ATE product lines. Considerable design effort is being expended to increase the speed and complexity and reduce the power dissipation of the Company's products. Process Research and Development The Company has implemented H-GaAs IV, a 0.4 micron GaAs FET technology that offers higher complexity and lower power dissipation than previous Vitesse technologies. The Company is currently engaged in research and development projects focused on other process-related improvements to increase yields and improve the speed, complexity and power dissipation characteristics of its devices. The Company's engineering, research and development expenses in fiscal 1998, 1997 and 1996 were $27,915,000, $16,804,000 and $11,045,000, respectively. 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. 7 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. SALES AND CUSTOMER SUPPORT The Company's principal method of selling its products is through direct sales to systems manufacturers by the Vitesse sales force. In certain markets such as Japan, the Company also employs value-added distributors. Because of the large engineering support required in connection with the sale of high performance ICs, the Company provides its customers with field engineering support as well as engineering support from the Company's headquarters. Typically, a field engineer will accompany a salesperson to the initial customer visit to understand and evaluate the customer's requirements. The salesperson and field engineer will determine whether additional engineering analysis will be required by engineers based at the Company's headquarters. The Company's sales cycle is typically lengthy and requires the continued participation of salespersons, field engineers, engineers based at the Company's headquarters, and senior management. The Company's sales headquarters is located in Camarillo, California. The Company has 12 additional sales and field application support offices in the United States, and one each in Germany, Italy and Japan. The Company generally warrants its products against defects in materials and workmanship for a period of one year. LICENSES AND PATENTS The Company has been awarded 14 U.S. patents for various aspects of design and process innovations used in the design and manufacture of its products. The Company has two patent applications pending in the U.S. and three patent applications pending in Japan and is preparing to file several more patent applications. The Company believes that patents are of less significance in its industry than such factors as technical expertise, innovative skills and the abilities of its personnel. As is typical in the semiconductor industry, the Company has, from time to time, received, and may receive in the future, letters from third parties asserting patent rights, maskwork rights or copyrights on certain of the Company's products and processes. None of the claims to date has resulted in the commencement of any litigation against the Company nor has the Company to date believed it is necessary to license any of the patent rights referred to in such letters. BACKLOG Vitesse's sales are made primarily pursuant to standard purchase orders for delivery of products. Quantities of the company's products to be delivered and delivery schedules are frequently revised to reflect changes in customer needs. For these reasons, the Company's backlog as of any particular date is not representative of actual sales for any succeeding period and the Company therefore believes that backlog is not a good indicator of future revenue. The Company's backlog scheduled to be shipped in the next six months was $103,000,000 on September 30, 1998, compared to $62,000,000 on September 30, 1997. ENVIRONMENTAL MATTERS 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 8 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 operate its manufacturing facility in Colorado Springs, Colorado, or could require the Company to acquire costly equipment or incur other significant expenses to comply with environmental regulations or clean up prior discharges. EMPLOYEES As of September 30, 1998, the Company had 590 employees, including 222 in engineering, research and development, 46 in marketing and sales, 299 in operations and 23 in finance and administration. The Company's ability to attract and retain qualified personnel is essential to its continued success. None of the Company's employees is represented by a collective bargaining agreement, nor has the Company ever experienced any work stoppage. The Company believes its employee relations are good. ITEM 2. PROPERTIES The Company's executive offices and principal research and development and fabrication facility is located in Camarillo, California, and is being leased under a noncancellable operating lease that expires in 1999. The total space occupied in this building is approximately 80,000 square feet. The Company has a second wafer fabrication facility in Colorado Springs, Colorado that is being leased under a synthetic lease that expires in 2001. The Company has the option to purchase this facility at cost at the end of the lease term. The Company leases an additional 10,000 square feet in Camarillo for product development and 8,000 square feet in Santa Clara, California for a product development and sales office. The Company's Colorado Springs, Colorado facility is in a 100,000 square foot building that is being occupied on a five-year operating lease with a purchase option at the end of the lease. This facility includes a 10,000 square foot clean room for wafer fabrication, and a product development center. The Company also leases space for three other product development centers in Portland, Oregon and Dallas, Texas, and Melbourne, Florida and 15 sales and field application support offices (12 in the United States, two in Europe and one in Japan). ITEM 3. LEGAL PROCEEDINGS The Company is currently involved in several legal proceedings; however, it believes that none of them would have a material or adverse affect on the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of the Company's shareholders during the last quarter of the fiscal year ended September 30, 1998. 9 PART II ITEM 5. MARKET FOR COMPANY'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS The information required by this item which appears on page 11 of the Company's 1998 Annual Report to Shareholders is incorporated herein by reference. ITEM 6. SELECTED FINANCIAL DATA The selected financial data for each of the five years ended September 30, 1998, which appears on page 10 of the Company's 1998 Annual Report to Shareholders is incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information required by this item which appears on pages 12 to 20 of the Company's 1998 Annual Report to Shareholders is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Information required by this item is included in pages 22 to 36 of the Company's 1998 Annual Report to Shareholders, and is incorporated herein by reference. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. 10 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The directors and executive officers of the Company are as follows:
Name Age Position ---- --- -------- Louis R. Tomasetta 49 President and Chief Executive Officer, Director Ian Burrows 44 Vice President, Wafer Fab Robert J. Cutter 43 Vice President & General Manager, Colorado Springs Ira Deyhimy 58 Vice President, Product Development Christopher R. Gardner 38 Vice President & General Manager, ATE Eugene F. Hovanec 46 Vice President, Finance & Chief Financial Officer Jeanne Johnson 57 Vice President, Human Resources James Mikkelson 50 Vice President, Technology Devel., Chief Technical Officer Michael Millhollan 54 Vice President & General Manager, Data Communications Robert Nunn 37 Vice President & General Manager, Telecommunications Neil Rappaport 52 Vice President, Sales Ram Venkataraman 58 Vice President, Quality James A. Cole 56 Director Alex Daly 37 Director Pierre R. Lamond 68 Chairman of the Board John C. Lewis 63 Director
Louis R. Tomasetta, a co-founder of the Company, has been President, Chief Executive Officer and a Director since the Company's inception in February 1987. From 1984 to 1987, he served as President of the integrated circuits division of Vitesse Electronics Corporation. Prior to that, Dr. Tomasetta was the director of the Advanced Technology Implementation department at Rockwell International Corporation. Dr. Tomasetta has over 25 years experience in the management and development of GaAs based businesses, products, and technology. He received B.S., M.S., and Ph.D. degrees in electrical engineering from the Massachusetts Institute of Technology. Ian Burrows joined the Company in February 1987 as a Process Engineering Manager, became Director of Wafer Fabrication in December 1990, and Vice President of Wafer Fabrication Operations in April 1995. Prior to that, he held the position of process engineering development manager at Honeywell's GaAs product center and development process engineer at Mostek. Dr. Burrows received a B.S. in electrical engineering from Warwick University, England, and M.S. and Ph.D. degrees in electrical engineering from Texas Tech University. Robert J. Cutter joined the Company in October 1996 as Vice President & General Manager of the Colorado Springs facility. Prior to that, Mr. Cutter was Plant Manager, Colorado Springs, for Rockwell Semiconductor Systems. From 1990 to 1995, he was Director of Operations for United Technologies Microelectronics Center. From 1981 to 1988, he held a variety of management positions at Inmos Corporation. Mr. Cutter graduated from University of Southhampton, United Kingdom, with a First Class Honors Degree in Aeronautics & Astronautics. Ira Deyhimy, a co-founder of the Company, has been Vice President of Product Development since the Company's inception in February 1987. From 1984 to 1987 he was Vice President, Engineering at Vitesse Electronics Corporation. Prior to that, Mr. Deyhimy was manager of Integrated Circuit Engineering at Rockwell International Corporation. He has over 25 years of experience in GaAs electronics. Mr. Deyhimy received a B.S. degree in physics from the University of California at Los Angeles and an M.S. degree in physics from California State University at Northridge. Christopher R. Gardner joined the Company in February 1987 and held various engineering and engineering management positions through September 1996 when he became Vice President & General Manager, ATE. Prior to that, Mr. Gardner was a member of technical staff at AT&T Bell Laboratories. Mr. Gardner holds a B.S. degree in electrical engineering from Cornell University and an M.S. degree in electrical engineering from the University of California at Berkeley. 11 Eugene F. Hovanec joined the Company as Vice President, Finance and Chief Financial Officer in December 1993. From 1989 to 1993, Mr. Hovanec served as Vice President, Finance & Administration, and Chief Financial Officer at Digital Sound Corporation. Prior to that, from 1984 to 1989, he served as Vice President and Controller at Micropolis Corporation. Mr. Hovanec holds a Bachelor of Business Administration degree from Pace University, New York. Mr. Hovanec also serves as a Director of Interlink Electronics, Inc. Jeanne Johnson joined the Company in August 1987 as Director, Human Resources and became Vice President, Human Resources in September 1997. From January 1984 to August 1987, Ms. Johnson was a human resources consultant in the areas of compensation, benefits and training. Her human resources management experience also includes two years as Director of Human Resources for IBIS Systems, Inc. and eight years as Employee Relations Manager for Borg-Warner Corporation. Ms. Johnson has a B.A. degree from the University of California, Santa Barbara. James Mikkelson, a co-founder of the Company, became Chief Technical Officer in September 1997. He has served as Vice President of Technology Development since the Company's inception in February 1987. From 1984 to 1987, he served as Vice President, Operations at Vitesse Electronics Corporation. Prior to that, he served as Project Manager at Hewlett-Packard Company, responsible for the development and manufacturing of MOS VLSI circuits. Mr. Mikkelson holds B.S. and M.S. degrees in electrical engineering from the Massachusetts Institute of Technology. Michael Millhollan joined the Company in July 1989 as Director of the Sunnyvale Product Development Center and became Vice President and General Manager of Standard Products in October 1992. From 1976 to 1989, he held various senior design engineering positions with National Semiconductor Corporation, a semi-conductor manufacturer, most recently as Director of programmable logic product development. Prior to that, he was at Motorola, Inc., a semiconductor manufacturer, for seven years in various design engineering positions. Mr. Millhollan holds a B.S. degree in electrical engineering from the Georgia Institute of Technology. Robert Nunn joined the Company in July 1989, became Director of Marketing in January 1991 and Vice President and General Manager of ASIC Products in July 1992. From August 1987 to July 1989 he served as product marketing manager at Advanced Micro Devices, Inc. ("AMD"), a semiconductor manufacturer, where he managed a staff focusing on international markets. From March 1986 to August 1987 Mr. Nunn held various marketing positions at Monolithic Memories, Inc. ("MMI") in their Semi-custom Products and Programmable Products Divisions before MMI merged with AMD in 1987. Mr. Nunn holds a B.S. degree in computer engineering from the University of California at Los Angeles and an M.B.A. from Harvard Business School. Neil Rappaport joined the Company as Vice President, Sales in August 1987. From September 1982 to 1987, Mr. Rappaport was national sales manager with Applied Micro Circuits Corporation, a manufacturer of ECL integrated circuits. Prior to that, he held various sales positions with Signetics Corporation, a semiconductor manufacturer. Prior to that, he was a design engineer at Hughes Aircraft Company. Mr. Rappaport has a B.S. degree from Fairleigh Dickinson University and an A.S. degree in electronics technology from the RCA Institute. Ram Venkataraman joined the Company as Director of Quality in January 1990 and in August 1990 he became Vice President, Quality. From November 1984 to January 1990, he held various positions, including manager of reliability and quality assurance and Director of Wafer Fabrication Operations, at GigaBit Logic, Inc., a gallium arsenide semiconductor manufacturer. Mr. Venkataraman has over 20 years of experience in IC quality assurance and reliability spanning both silicon and GaAs technologies. Mr. Venkataraman holds B.S. degrees in physics and electrical engineering from Madras University, India, and an M.S. degree in electrical engineering from the Indian Institute of Technology, India. James A. Cole has served as a Director of the Company since February 1987. He has been a General Partner of Windward Ventures since 1997 and he has been a General Partner of Spectra Enterprise Associates since 1986. He was a founder and Executive Vice President of Amplica, Inc., a GaAs microwave IC and sub- system company. Mr. Cole also serves as a Director of Giga-Tronics, Inc. and Spectrian Corporation. 12 Alex Daly became a Director of the Company in January 1998. He has been President and Chief Executive Officer of Cygnus Solutions, a developer of software tools, since February 1998. From 1995 to 1998 he served as Vice President of Marketing at C-Cube Microsystems, a developer of digital video communications products. From 1990 to 1995, he served at Intel Corporation, a semiconductor company, most recently as director of marketing for the mobile computing group. Pierre R. Lamond has been the Chairman of the Board of Directors since the Company's inception in February 1987. Since August 1981, he has been a General Partner of Sequoia Capital, a venture capital firm. Sequoia has financed companies such as Cypress Semiconductor Corporation, Cisco, and C-Cube Microsystems. Mr. Lamond was founder and Vice President of National Semiconductor Corporation. He is also a Director of CKS Group and CombiChem. John C. Lewis became a Director of the Company in January 1990. He is currently Chairman of the Board of Directors of Amdahl Corporation, a manufacturer of large general purpose computer storage systems and software products. Before joining Amdahl in 1977, he was President of Xerox Business Systems. Mr. Lewis also serves as a Director of Cypress Semiconductor Corporation and Pinnacle Systems. Item 11. Executive Compensation This item is answered by reference to the information set forth under the captions "Executive Compensation," "Stock Option Plans," "1991 Employee Stock Purchase Plan," "401(k) Plan" and "Certain Transactions" in the Company's Proxy Statement for the 1999 Annual Meeting of Shareholders to be filed with the Commission on or before December 31, 1998. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT This item is answered by reference to the information set forth under the caption "Principal Share Ownership" in the Company's Proxy Statement for the 1999 Annual Meeting of Shareholders to be filed with the Commission on or before December 31, 1998. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS This item is answered by reference to the information set forth under the caption "Certain Transactions" in the Company's Proxy Statement for the 1999 Annual Meeting of Shareholders to be filed with the Commission on or before December 31, 1998. 13 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this report:
Page in ------- 1. Financial Statements: Annual Report ------------- The financial statements of the Company listed below are incorporated herein by reference to the following pages of the 1998 Annual Report to Shareholders: Independent Auditors' Report 21 Consolidated Balance Sheets as of September 30, 1998 and 1997 22 Consolidated Statements of Operations for the years ended September 30, 1998, 1997 and 1996 23 Consolidated Statements of Shareholders' Equity for the years ended September 30, 1998, 1997 and 1996 24 Consolidated Statements of Cash Flows for the years ended September 30, 1998, 1997 and 1996 25 Notes to Consolidated Financial Statements 26 2. Consolidated Financial Statement Schedules: Page ---- The Consolidated financial statement schedules of the Company are included in Part IV Of this report on the pages indicated: Independent Auditors' Report on Consolidated Financial Statement Schedule 17 For the three fiscal years ended September 30, 1998-- II -- Valuation and Qualifying Accounts 18
All other schedules are omitted because they are not applicable or are not required. 3. Exhibits: See Item 14(c) below. (b) Reports on Form 8-K No reports on Form 8-K were filed during the last quarter of the fiscal year ended September 30, 1998. (c) Exhibits The exhibits listed on the accompanying index immediately following the signature page are filed As part of this report. (d) Financial Statement Schedules See Item 14(a) above. 14 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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 Date: December 22, 1998 By: /s/ Eugene F. Hovanec --------------------- Eugene F. Hovanec Vice President, Finance & Chief Financial Officer Pursuant to the requirements of the Securities Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature Title Date --------- ----- ---- /s/ Louis R. Tomasetta President and Chief Executive December 22, 1998 ---------------------- Officer (Principal Executive Louis R. Tomasetta Officer) /s/ Eugene F. Hovanec Vice President, Finance and December 22, 1998 ---------------------- Chief Financial Officer Eugene F. Hovanec /s/ James A. Cole Director December 22, 1998 ---------------------- James A. Cole /s/ Alex Daly Director December 22, 1998 ---------------------- Alex Daly /s/ Pierre R. Lamond Chairman of the Board December 22, 1998 ---------------------- of Directors Pierre R. Lamond /s/ John C. Lewis Director December 22, 1998 ---------------------- John C. Lewis 15 ITEM 16 EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) Exhibits
Exhibit Number -------------- 3.1/1/ Certificate of Incorporation of Registrant, as amended to date. 3.2/2/ Bylaws of Registrant as amended to date. 4.1/2/ Specimen of Company's Common Stock Certificate. 10.1/2/ 1989 Stock Option Plan. 10.2/2/ 1991 Stock Option Plan. 10.3/2/ 1991 Employee Stock Purchase Plan. 10.4/2/ 1991 Directors' Stock Option Plan. 10.5/2/ Standard Form of Indemnification Agreement between Registrant and its officers and directors. 10.6/2//3/ Loan and Security Agreement dated May 8, 1991 between Silicon Valley Bank and Registrant. 10.7/1/ Amendment to Loan Agreement dated December 28, 1992 between Silicon Valley Bank and Registrant. 10.8/5/ Amendment to Loan Agreement dated June 14, 1993 between Silicon Valley Bank and Registrant. 10.9/1/ First Amendment to Lease between Carson Estate Company (formerly Victoria Partnership) and Registrant. 10.10/2/ Lease dated January 31, 1991 between Camarillo I Development Corporation and Registrant. 10.11/2/ Standard Form Proprietary Information Agreement. 10.12/4/ Amendment dated March 23, 1994, to the Loan Agreement dated May 8, 1991, as amended, by and between Silicon Valley Bank and Registrant. 10.13/5/ Amendment dated December 13, 1994, to the Loan Agreement dated May 8, 1991, as amended, by and between Silicon Valley Bank and Registrant. 10.14/6/ Amendment dated January 2, 1996, to the Loan Agreement dated May 8, 1991, as amended, by and between Silicon Valley Bank and Registrant. 10.15/7/ Amendment dated January 22, 1997, to the Loan Agreement dated May 8, 1991, as amended, by and between Silicon Valley Bank and Registrant. 10.16/7/ Agreement dated October 30, 1996 between ABN AMRO Bank N.V., Lease Plan North America, Inc. and Registrant. 10.17/7/ Agreement dated August 15, 1997 between ABN AMRO Bank N.V., Lease Plan North America, Inc. and Registrant. 10.18 Loan modification agreement dated October 10, 1997, to the Loan Agreement dated May 8, 1991, as amended, by and between Silicon Valley Bank and Registrant. 10.19 Amendment dated January 6, 1998, to the Loan Agreement dated May 8, 1991, as amended, by and between Silicon Valley Bank and Registrant. 10.20 Agreement dated July 9, 1998 between Metlife Capital Corporation and Registrant. 13.1 Annual Report to Security Holders 23.1 Report on Schedule and Consent of Independent Certified Public Accountants. 27.1 Financial Data Schedule
(1) Incorporated by reference from the Company's annual report on Form 10-K for the period ended September 30, 1992. (2) Incorporated by reference from the Company's registration statement on Form S-1 (File no. 33-43548), effective December 10, 1991. (3) Confidential treatment previously granted as to certain portions of these exhibits. (4) Incorporated by reference from the Company's quarterly report on Form 10Q for the period ended March 30, 1994. (5) Incorporated by reference from the Company's annual report on Form 10-K for the period ended September 30, 1995. (6) Incorporated by reference from the Company's annual report on Form 10-K for the period ended September 30, 1996. (7) Incorporated by reference from the Company's annual report on Form 10-K for the period ended September 30, 1997. 16 Independent Auditors' Report ----------------------------- The Board of Directors Vitesse Semiconductor Corporation: Under date of October 14, 1998, we reported on the consolidated balance sheets Vitesse Semiconductor Corporation and subsidiaries as of September 30, 1998 and 1997, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the years in the three-year period ended September 30, 1998, as contained in the 1998 annual report to shareholders. These consolidated financial statements and our report thereon are incorporated by reference in the annual report on Form 10-K for the year 1998. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedule as listed in the accompanying index. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. (signed) KPMG PEAT MARWICK LLP Los Angeles, California October 14, 1998 17 VITESSE SEMICONDUCTOR CORPORATION SCHEDULE II -- Valuation and Qualifying Accounts Years ended September 30, 1998, 1997 and 1996 (in thousands)
Balance at Charged to Balance Beginning of Costs and Deductions/ at end Period Expenses Write-offs of Period ------------ ---------- ----------- --------- Year ended September 30, 1998 Deducted from Inventories: Reserve for obsolescence $3,121 $1,034 --- $4,155 Deducted from Accounts Receivable: Allowance for doubtful accounts 1,000 790 790 1,000 Year ended September 30, 1997 Deducted from Inventories: Reserve for obsolescence 2,797 1,988 1,664 3,121 Deducted from Accounts Receivable: Allowance for doubtful accounts 900 500 400 1,000 Year ended September 30, 1996 Deducted from Inventories: Reserve for obsolescence 2,493 1,347 1,043 2,797 Deducted from Accounts Receivable: Allowance for doubtful accounts 700 200 --- 900
18 EX-10.18 2 LOAN MODIFICATION AGREEMENT EXHIBIT 10.18 LOAN MODIFICATION AGREEMENT This Loan Modification Agreement is entered into as of October 10, 1997, by and between Vitesse Semiconductor Corporation ("Borrower") and Silicon Valley Bank ("Silicon"). 1. DESCRIPTION OF EXISTING INDEBTEDNESS: Among other indebtedness which may be ------------------------------------ owing by Borrower to Silicon, Borrower is indebted to Silicon pursuant to, among other documents, a Loan and Security Agreement dated May 8, 1991, as may be amended, together with all Schedules thereto (the "Loan Agreement"). The Loan Agreement provides for, among other things a Credit Limit in the amount of Twelve Million Five Hundred Thousand and 00/100 Dollars ($12,500,000.00). Defined terms used but not otherwise defined herein shall have the same meanings as in the Loan Agreement. Hereinafter, all indebtedness owing by Borrower to Silicon shall be referred to as the "Indebtedness". Hereinafter, other documents evidencing the Indebtedness shall be referred to as the "Existing Loan Documents". 3. DESCRIPTION OF CHANGE IN TERMS. ------------------------------ A. MODIFICATION(S) TO LOAN AGREEMENT. --------------------------------- 1. The following paragraph is hereby incorporated into the Loan Agreement: DIRECT DEPOSIT RESERVE. A maximum of $247,500.00 (the "Direct ---------------------- Deposit Reserve") shall be reserved under Borrower's Credit Limit for the purpose of supporting daylight overdrafts, from time to time, created by the issuance of checks or other debits in connection with the direct deposit of payroll for Vitesse Manufacturing & Development Corporation in the amount of $90,000.00 and Vitesse Semiconductor Sales Corp, in the amount of $157,500.00, Borrower's subsidiaries. In the event an overdraft remains uncured as result of such direct deposit activities, Borrower agrees that in such amounts shall become Borrower's Obligations under Borrower's line of credit facility and shall bear interest at the interest rate thereon until paid in full. Such Direct Deposit Reserve shall at all times be reserved under Borrower's Credit Limit. 4. CONSISTENT CHANGES. The Existing Loan Documents are hereby amended wherever ------------------ necessary to reflect the changes described above. 5. NO DEFENSES OF BORROWER. Borrower (and each guarantor and pledgor signing ----------------------- below) agrees that it has no defenses against the obligations to pay any amounts under the Indebtedness. 6. CONTINUING VALIDITY. Borrower (and each guarantor and pledgor signing ------------------- below) understands and agrees that in modifying the existing Indebtedness, Silicon is relying upon Borrower's representations, warranties, and agreements, as set forth in the Existing Loan Documents. Except as expressly modified pursuant to this Loan Modification Agreement, the terms of the Existing Loan Documents remain unchanged and in full force and effect. Silicon's agreement to modifications to the existing Indebtedness pursuant to this Loan Modification Agreement in no way shall obligate Silicon to make any future modifications to the Indebtedness. Nothing in this Loan Modification Agreement shall constitute a satisfaction of the Indebtedness. It is the intention of Silicon and Borrower to retain as liable parties all makers and endorsers of Existing Loan Documents, unless the party is expressly released by Silicon in writing. No maker, endorser, or guarantor will be released by virtue of this Loan Modification Agreement. The terms of this paragraph apply not only to this Loan Modification Agreement, but also to all subsequent loan modification agreements. 1 This Loan Modification Agreement is executed as of the date first written above. BORROWER: SILICON: VITESSE SEMICONDUCTOR CORPORATION SILICON VALLEY BANK By: /s/ Eugene Hovanec By:_____________________________ --------------------------- Name: Eugene Hovanec Name:___________________________ ------------------------- Title: Vice President Title:__________________________ ------------------------ Acknowledged and agreed: VITESSE MANUFACTURING & DEVELOPMENT CORPORATION By: /s/ Eugene Hovanec ----------------------------- Name: Eugene Hovanec --------------------------- Title: Secretary -------------------------- VITESSE SEMICONDUCTOR SALES CORP. By: /s/ Eugene Hovanec ----------------------------- Name: Eugene Hovanec --------------------------- Title: Secretary -------------------------- 2 EX-10.19 3 AMENDMENT TO LOAN AGREEMENT EXHIBIT 10.19 [LOGO SILICON VALLEY BANK APPEARS HERE] AMENDMENT TO LOAN AGREEMENT BORROWER: VITESSE SEMICONDUCTOR CORPORATION ADDRESS: 741 CALLE PLANO CAMARILLO, CALIFORNIA 93012 DATED AS OF: JANUARY 6, 1998 THIS AMENDMENT TO LOAN AGREEMENT is entered into between SILICON VALLEY BANK ("Silicon") and the borrower named above (the "Borrower"). The Parties agree to amend the Loan and Security Agreement between them dated May 8, 1991, as amended by that Amendment to Loan Agreement dated May 8, 1991, as amended by that Amendment to Loan Agreement dated August 12, 1992, as amended by that Amendment to Loan Agreement dated December 28, 1992, as amended by that Amendment to Loan Agreement dated June 14, 1993, as amended by that Amendment to Loan Agreement dated December 10, 1993, as amended by that Amendment to Loan Agreement dated March 23, 1994, as amended by that Amendment to Loan Agreement dated December 13, 1994, as amended by that Amendment to Loan Agreement dated January 2, 1996, and as amended by that Amendment to Loan Agreement dated January 22, 1997 (as so amended and as otherwise amended or modified from time to time, the "Loan Agreement"; unless otherwise defined herein, terms defined in the Loan Agreement are used herein as therein defined), as follows, effective as of the date of hereof: 1. NEW MATURITY DATE. The Maturity Date set forth in Section 5.1 of the Schedule to the Loan Agreement is hereby amended to be "January 5, 1999". 2. FEE. Borrower shall concurrently herewith pay to Silicon a fee in the amount of $12.500, which shall be in addition to all interest and to all other amounts payable hereunder, and which shall not be refundable. 3. REPRESENTATIONS TRUE. The Borrower represents and warrants to Silicon that all representations and warranties set forth in the Loan Agreement, as amended hereby, are true and correct. 4. GENERAL PROVISIONS. This Amendment, the Loan Agreement, any prior written amendments to the Loan Agreement signed by Silicon and the Borrower, and the other written documents and agreements between Silicon and the Borrower set forth in full all of the representations and agreements of the parties with respect to the subject matter hereof and supersede all prior discussions, representations, agreements and understandings between the -1- parties with respect to the subject hereof. Except as herein expressly amended, all of the terms and provisions of the Loan Agreement, and all other documents and agreements between Silicon and the Borrower shall continue in full force and effect and the same are hereby ratified and confirmed. Borrower: Silicon: VITESSE SEMICONDUCTOR SILICON VALLEY BANK CORPORATION By /s/ Eugene Hovanec By /s/ James C. Carrington ---------------------- ------------------------- Vice President Title Senior Vice President ---------------------- By /s/ Yatin Mody ----------------------- Asst's Secretary -2- EX-10.20 4 MASTER LEASE PURCHASE AGREEMENT EXHIBIT 10.20 MASTER LEASE PURCHASE AGREEMENT THIS AGREEMENT is entered into the 9/th/ day of July, 1998 between METLIFE CAPITAL CORPORATION ("Lessor") whose address is 10900 N.E. 4th Street, Suite 500, mailing address C-97550, Bellevue, Washington 98009 and VITESSE MANUFACTURING & DEVELOPMENT CORPORATION, a wholly owned subsidiary of Vitesse Semiconductor Corporation ("Lessee") whose address is 741 Calle Plano, Camarillo, CA 93012. Lessor and Lessee from time to time may enter into written agreements in the form of "Lease Purchase Addenda" for the leasing of equipment by Lessor to Lessee. To facilitate such transactions, Lessor and Lessee are entering into this Master Lease Purchase Agreement (the "Master Lease"), the terms and provisions of which shall be incorporated by reference in each such Lease Purchase Addendum, and they MUTUALLY AGREE AS FOLLOWS: 1. LEASE PURCHASE ADDENDUM ----------------------- If Lessor agrees to lease equipment when requested by Lessee, the parties shall sign a Lease Purchase Addendum ("Addendum") setting forth the particulars regarding the transaction, including, without limitation, the list of items of equipment (individually, an "Item" and, collectively, the "Equipment"), the prices of each Item (including disclosure of all rebates, discounts and other incentives received or receivable with respect thereto), "Related Costs", including taxes, transportation, installation and other applicable costs, the aggregate of the foregoing ("Total Cost"), length of the Basic Term, rental rates, purchase and renewal options, if any, and other applicable provisions. "Cost of an Item" shall mean the price of the Item plus its applicable portion of Related Costs. In the absence of a signed Addendum, this Master Lease shall not constitute a lease or a commitment by either party to enter into a lease. 2. REQUEST TO LEASE; EQUIPMENT ACCEPTANCE -------------------------------------- (A) Request; Specifications. Signing an Addendum shall constitute the ----------------------- request from Lessee to Lessor to lease the Equipment, and the Addendum and this Master Lease shall constitute the lease and agreement (the "Lease") regarding the Equipment. As security for all obligations of Lessee to Lessor now existing or hereafter arising under this Lease, Lessee grants Lessor a security interest in all Equipment. At the time of signing the Addendum, Lessee shall furnish Lessor detailed specifications ("Specifications") of the Items, including descriptions, prices, delivery terms and instructions, installation provisions and all other applicable specifications. Lessee assumes full responsibility with respect to the selection of Items supplied for lease and the specification thereof; the Lessor shall have no liability or responsibility with respect thereto regardless of whether the Specifications prove inadequate for the intended purpose or use. (B) Inspection; Acceptance. It is Lessee's responsibility to receive and ---------------------- promptly inspect and test each Item tendered for delivery by a supplier and the installation thereof. Lessee shall give Lessor written notice of acceptance of an Item as soon as it can be determined that the Item and its installation are in compliance with Specifications. As between Lessee and Lessor, the giving of such written notice shall constitute Lessee's irrevocable acceptance of the Item or Items designated in the notice, whether or not such Items or their installation are defective in any respect, and notwithstanding any failure of an Item or its installation to conform to Specifications, without prejudice however to rights which Lessor and Lessee, or either of them, may have against any other person, whether with respect to design, manufacture, condition or otherwise. (C) Purchase Cut-Off Date. If, by the "Purchase Cut-Off Date" set forth in --------------------- an Addendum, Lessee shall not have given Lessor written notice of acceptance of an Item, Lessor shall have no obligation to lease the Item to Lessee. In such event, Lessee shall immediately pay all accrued Interim Rental and reimburse Lessor for all sums Lessor may have paid for or with respect to the Item and for all Lessor's costs and expenses with respect thereto, and Lessee shall indemnify and defend Lessor against and hold Lessor harmless from any and all cost, expense, loss, liability and damage that Lessor may suffer or that may be asserted against Lessor by reason of Lessor's failure or refusal to lease such Item. Any such Item shall be deemed to be deleted from the Addendum and no longer included in the Equipment. Page 1 (D) Conditions Precedent. Lessee shall deliver to Lessor such further -------------------- instruments, documents and certifications as Lessor reasonably may request, including without limitation evidences of authority (e.g., corporate certificates, corporate resolutions, partnership documents and authorizations), evidence of insurance, purchase orders and acceptances thereof, purchase and sale agreements and public financial information, and instruments and documents to implement, perfect or continue the perfection of Lessor's rights and remedies as Lessor of the Equipment, including Uniform Commercial Code forms. Lessee's delivery of the foregoing and of the Specifications are conditions precedent to any obligation of Lessor to make any commitments to pay for the Equipment or any Item. (E) Supplemental Lease Request. If at any time prior to the Closing Date -------------------------- Lessee requests Lessor to add further Items to the Equipment, and if Lessor so agrees, Lessee shall execute a Lease Purchase Addendum Supplement in a form supplied by Lessor, which shall become part of the Addendum, subject to all of its provisions and the provisions of this Master Lease, and the equipment specified therein shall be Items of Equipment under the Lease. (F) Closing. Following the date ("Closing Date") which is the earlier of ------- (i) the date Lessee gives Lessor written notice of acceptance of the last Item or (ii) the Purchase Cut-Off Date (or on such other day as is mutually agreed), Lessor shall send Lessee a Closing Schedule ("Schedule"), setting forth any adjustments to descriptions and Costs of Items and Total Cost and confirming the Closing Date, amount of Periodic Rental installments, payment schedules, and insurance requirements. Lessee's signature on any such Schedule shall signify the Lessee's agreement that the Schedule is correct. Notwithstanding any discrepancies or disagreements between Lessor and Lessee regarding the Schedules, Lessee shall pay all rentals as they become due in accordance with the terms and conditions of the Lease. If Lessee establishes an error that affects the amount of rentals, Lessor shall give Lessee a credit for any overpayment of rentals, and Lessee promptly shall pay Lessor any underpayments. The Schedules are incorporated herein by reference. 3. LESSEE'S WARRANTIES ------------------- (A) Lessee represents and warrants to Lessor that it is a corporation or partnership duly organized, validly existing and in good standing under the laws of the jurisdiction of its organization and that it is qualified to do business in every jurisdiction where the failure to qualify would have a materially adverse effect on Lessor's rights hereunder; it has taken all corporate or partnership action which may be required to authorize the execution, delivery and performance of this Lease, and such execution, delivery and performance will not conflict with or violate any provision of its Charter or Articles or Certificate of Incorporation, By-laws or any provisions thereof, or in the case of a partnership, its Certificate of Partnership or Limited Partnership and its Partnership Agreement, or result in a default or acceleration of any obligation under any agreement, order, decree or judgment to which it is a party or by which it is bound, nor is it now in default under any of the same; there is no litigation or proceeding pending or threatened against it which may have a materially adverse effect on Lessee or which would prevent or hinder the performance by it of its obligations hereunder; this Lease and the attendant documents constitute valid obligations of the Lessee, binding and enforceable against it in accordance with their respective terms; no action by or with any commission or administrative agency is required in connection herewith; it has the power to own its assets and to transact business in which it is engaged; it will give to Lessor prompt notice of any change in its name, identity or structure. (B) Lessee's written acceptance of an Item and its installation shall constitute a REPRESENTATION AND WARRANTY BY Lessee to Lessor that: (i) the Item is personal property in good order and condition; (ii) the Item conforms to Specifications; (iii) unless otherwise specified, the Item has not been placed into commercial service by the Lessee for more than ninety (90) days prior to its acceptance by Lessee; and (iv) at all times Lessee shall keep the Equipment in Lessee's possession at the address specified in the Addendum unless Lessor shall otherwise consent in writing. Lessee shall not cause, suffer or permit any Item to be attached or affixed to real property or improvements thereon (collectively, "Realty") unless Lessor Page 2 first shall consent thereto in writing and Lessee shall have obtained from all persons having any interest in the Realty written consents which approve such attachment, waive any claims to or encumbrances upon attached Items and consent to the detachment and removal of such Items at any time by Lessor or Lessee. Notwithstanding attachment of any Items to Realty, all the Equipment at all times shall be and remain personal property. Upon termination of Lessee's right to possession of the Equipment, whether by expiration of the Term or otherwise, Lessee at its sole cost and expense shall detach and remove the Equipment from the Realty and save Lessor harmless from and indemnify and defend Lessor against any claim, demand, loss, liability, and damage arising from such detachment or removal, or both. 4. TERM OF LEASE ------------- The Term of the Lease ("Term") may consist of an "Interim Term" and a "Basic Term." The Interim Term shall begin on the date that Lessee first gives Lessor written notice of acceptance of an Item or written approval for partial payment, whichever is earlier, and shall continue until the time the Basic Term begins. The Basic Term shall begin on the Closing Date and shall continue for the length of the Basic Term set forth in the Addendum. 5. INTERIM RENTAL -------------- During the Interim Term, if any, Lessee shall pay rent monthly ("Interim Rental"), on a calendar month basis, in an amount determined by Lessor by applying the "Interim Rental Rate" set forth in the Addendum to portions of the Total Cost then or theretofore expended by Lessor, for the number of days such sums are outstanding during such calendar month. The "prime rate" referred to in this Lease shall mean the rate per annum publicly announced by Chase Manhattan Bank, New York City, from time to time as its prime rate, whether or not such rate is applied by said bank to any then outstanding loans, changing with each announced change of such prime rate. Lessee shall pay Lessor each installment of Interim Rental on the fifteenth day after the end of such calendar month. 6. PERIODIC RENTAL --------------- Lessee shall pay rent ("Periodic Rental") for the Basic Term in the amounts and in accordance with the payment schedule set forth in the Addendum. THIS IS AN IRREVOCABLE LEASE AND, ANY PRESENT OR FUTURE LAW TO THE CONTRARY NOTWITHSTANDING, LESSEE'S OBLIGATION TO PAY LESSOR OR ITS ASSIGNS ALL AMOUNTS DUE HEREUNDER IS ABSOLUTELY UNCONDITIONAL AND THIS LEASE SHALL NOT TERMINATE BY OPERATION OF LAW OR OTHERWISE, EXCEPT UPON EXPIRATION OF THE BASIC TERM AND ANY RENEWAL TERM AND PAYMENT OF ALL AMOUNTS REQUIRED TO BE PAID HEREUNDER. LESSEE SHALL NOT BE ENTITLED TO ANY ABATEMENT, REDUCTION, SETOFF, COUNTERCLAIM, DEFENSE OR DEDUCTION WITH RESPECT TO ANY OF THE RENTALS REQUIRED TO BE PAID HEREUNDER OR ANY OTHER AMOUNTS PAYABLE BY THE LESSEE HEREUNDER, NOR SHALL ANY OBLIGATIONS OF LESSEE HEREUNDER BE AFFECTED FOR ANY REASON WHATSOEVER, NO MATTER HOW, WHEN OR AGAINST WHOM ASSERTED, ARISING OR CLAIMED, provided, however, that Lessee may -------- ------- institute an independent action or claim against Lessor (but not against any collateral assignee of Lessor) for any alleged breach hereof. 7. LATE PAYMENT ------------ If any installment of rent or other sum owing under the Lease shall not be paid when due and shall remain unpaid for ten (10) days, Lessee shall pay Lessor a late charge equal to five percent (5%) of the amount delinquent, but in no event at a rate greater than limited by any applicable law. Such late charge is in addition to and not in lieu of other rights and remedies Lessor may have. 8. INSURANCE --------- Lessee shall procure and continuously maintain and pay for (a) all risk insurance, excluding earthquake and flood insurance, against loss or damage to the Equipment for not less than the full replacement value thereof naming Lessor as Loss Payee and (b) combined single limit liability insurance, insuring Lessor and Lessee, all in such amounts and against such risks and hazards as are set forth in the Addendum, with insurance companies and pursuant to contracts or policies reasonably satisfactory to Lessor. All contracts and policies shall include provisions for the protection of Lessor notwithstanding any act or neglect of or breach or Page 3 default by Lessee, shall provide that proceeds of all insurance shall be payable first to Lessor to the extent of its liability or interest as the case may be, shall provide that they may not be modified, terminated or canceled unless Lessor is given at least thirty (30) days' advance written notice thereof, and shall provide that the coverage is "primary coverage" for the protection of Lessee and Lessor notwithstanding any other coverage carried by Lessee or Lessor protecting against similar risks. Lessee shall promptly notify any appropriate insurer and Lessor of each and every occurrence which may become the basis of a claim or cause of action against the insureds and provide Lessor with all data pertinent to such occurrence. Lessee shall furnish Lessor with certificates of such insurance or copies of policies upon request, and shall furnish Lessor with renewal certificates not less than ten (10) days prior to the renewal date. 9. TAXES ----- Lessee shall pay all taxes, fees, assessments and other governmental charges of whatsoever kind or character and by whomsoever payable on or relating to any Item of Equipment or the sale, purchase, ownership, use, value, value added, possession, shipment, transportation, delivery or operation thereof or the exercise of any option, election or performance of any obligation by Lessee hereunder, which may accrue or be levied, assessed or imposed during the Term and any Renewal Term or which remain unpaid as of the date of surrender of such Item to Lessor, and all taxes of any kind imposed by any federal, state, local, or foreign taxing authority against Lessor on or measured by any amount payable by Lessee hereunder, including, without limitation, all license and registration fees and all sales, use, value, ad valorem, personal property, excise, gross receipts, stamp or other taxes, imposts, duties and charges together with any penalties, fines or interest thereon, except taxes of Lessor on net income imposed by the United States or any state. Lessee shall reimburse Lessor for any payments made by Lessor which are the obligation of Lessee under the Lease, but Lessee shall not be obligated to pay any amount under this Section so long as it shall in good faith and by appropriate proceedings contest the validity or the amount thereof, unless such contest would adversely affect Lessor's interest in any Item of Equipment or would subject any Item to forfeiture or sale. Lessee shall indemnify Lessor on an after-tax basis against any loss, claim, demand and expense, including legal expense, resulting from such nonpayment or contest and further agrees to indemnify Lessor against any and all taxes, assessments and other charges imposed upon Lessor under the laws of any federal, state, local or foreign government or taxing authority, as a result of any payment made by Lessee pursuant to this Section. On request of either Lessor or Lessee, the other will submit written evidence of all payments required of it under this Section. 10. MAINTENANCE, ETC. ---------------- (A) Lessee at its expense at all times shall maintain, service and repair any damage to the Equipment so as to; (1) keep the Equipment in good and efficient working order, condition and repair, ordinary wear and tear resulting from the proper use excepted, and make all inspections and repairs, including replacement of worn parts (which replacement parts shall be free and clear of all liens and encumbrances and shall, upon incorporation into the item, become free and clear of all other liens and encumbrances subject Lessor's security, interest and shall be kept, to effect the foregoing and to comply with requirements of laws, regulations, rules and provisions and conditions of insurance policies; and (ii) pay all costs, expenses, fees and charges incurred in connection with the use or operation of the Equipment and of each item, including but not limited to repairs, maintenance, storage and servicing. Lessee shall, at its sole cost and expense, make all alterations, substitutions, improvements or additions to the Equipment or items required in order to comply with laws, regulations, rules and insurance policies ("Required Additions"). Additionally, Lessee may install any addition or improvement on an item which is readily removable without causing material damage to such item and which does not impair the value of such item as originally delivered to Lessee ("Severable Additions"). Lessee shall not make any alterations, substitutions, improvements or additions to the Equipment or any item, except Required Additions or Severable Additions, unless Lessor first shall have consented thereto in writing, Notwithstanding any consent of Lessor, Lessee shall pay all costs and expenses of the foregoing. All replacements, repairs, improvements, alterations, substitutions and additions shall constitute accessions to the Equipment and upon incorporation into the Equipment shall become subject to Lessor's security interest shall be kept free of any and all other liens; provided, however, that Lessee may remove Severable Additions at any time, provided that Lessee shall repair all damage to such Equipment Page 4 resulting from such installation and removal so as to restore the Equipment to the condition in which it existed prior to the installation of such Severable Additions, ordinary wear and tear excepted. In performing its obligations under this Section, Lessee will not treat the Equipment less favorable than similar equipment that it owns or leases, or reduce its performance in contemplation of expiration of the Term or any Renewal Term. (B) Lessor hereby transfers and assigns to Lessee, for so long during the Term and any Renewal Term as Lessee is not in default, Lessor's right, title and interest in, under and to any assignable factory and dealer warranty, whether express or implied, with respect to the Equipment. All claims and actions upon any warranty shall be made and prosecuted by Lessee at its sole cost and expense. Lessor shall have no obligation to make or prosecute any claim upon or under a warranty. So long as Lessee shall not be in default, Lessor shall cooperate with Lessee with respect to a claim on a non-assignable warranty, at Lessee's expense. Lessee shall have proceeds of a warranty claim or recovery paid to Lessor. Lessor shall make such proceeds available for any repair, restoration or replacement to correct such warranted condition. Excess proceeds shall be used to reduce Lessee's Lease obligations. 11. USE --- So long as Lessee shall not be in default, Lessee shall be entitled to the possession, use and quiet enjoyment of the Equipment during the Term and any Renewal Term in accordance with the terms of the Lease. Lessee warrants that the Equipment will at all times be used and operated solely in the conduct of Lessee's business for the purpose for which it was designed and intended and under and in compliance with applicable laws and all lawful acts, rules, regulations and orders of any governmental bodies or officers having power to regulate or supervise the use of such property, except that Lessee may in good faith and by appropriate proceedings contest the application of any such rule, regulation or order in any reasonable manner that will not adversely affect the interest of Lessor in any Equipment or subject the same to forfeiture or sale. Lessee will not permit its rights or interest hereunder to be subject to any lien, charge or encumbrance and will keep the Equipment free and clear of any and all liens, charges, encumbrances and adverse claims (except those arising from acts of Lessor). 12. NET LEASE; LOSS AND DAMAGE -------------------------- (A) This is a net lease. Lessee assumes all risk of and shall indemnify Lessor against all damage to and loss of the Equipment from any cause whatsoever, whether or not such loss or damage is or could have been covered by insurance. Except as otherwise specifically provided herein, the Lease shall not terminate and there shall be no abatement, reduction, suspension or deferment of Interim or Periodic Rental for any reason, including damage to or loss of the Equipment or any one or more Items. Lessee promptly shall give Lessor written notice of any material loss or damage, describing completely and in detail the cause and the extent of loss and damage. At the option Lessor, Lessee shall: (i) repair or restore the damaged or lost Items to good condition and working order; or (ii) replace the damaged or lost Items with similar equipment or equipment which in Lessor's reasonable and sole determination is of equal or greater value in good condition and working order; or (iii) pay Lessor in cash the Stipulated Loss Value of the damaged or lost Items; provided, however, that the foregoing shall be at Lessee's option rather than Lessor's option if the following conditions are met at the time of such loss or damage: (1) Lessee has paid all amounts that are required to be paid under this Master Lease and under any Addendum hereto; (2) Lessee is not otherwise in default, and no event shall have occurred that with the passage of time or the giving of notice or both would constitute a default, under any Addendum hereto or this Master Lease; (3) Lessor shall have determined, in its reasonable and sole discretion, that Lessee will be able to perform its remaining obligations hereunder and under any Addendum hereto; and (4) all Equipment then remaining subject to the Master Lease and all addenda shall have a value that is, in Lessor's sole reasonable discretion, adequate to satisfy all of Lessee's obligations then remaining due and unpaid hereunder and under all addenda hereto. Upon Lessee's complying with the foregoing, Lessor shall pay or cause to be paid over to Lessee the net proceeds of insurance, if any, with respect to such damage or loss. "Damage" and "loss" shall include damages and losses of any kind whatsoever including, without limitation, physical Page 5 damage and partial or complete destruction, including intentionally caused damage and destruction, and theft. (B) If Lessee pays Lessor the Stipulated Loss Value for an Item, then the Lease shall terminate with respect to that Item, that Item shall no longer be deemed part of the Equipment and Lessee shall be entitled to retain the Item. However, it is understood that Lessor makes no representation or warranty with respect to the Item, and further that Lessor shall have no obligation to pay any tax with respect thereto. In the event that Lessee pays Lessor the Stipulated Loss Value for an Item, no further Interim Rental shall be payable with respect to the Item, and Periodic Rental for the remainder of the Term shall be reduced accordingly. 13. STIPULATED LOSS VALUE --------------------- The "Stipulated Loss Value" of an Item shall be the Total Cost for such Item. 14. SECURITY INTEREST AND MARKING ----------------------------- (A) This lease is one intended as security and for tax purposes, both parties will treat this transaction as a secured loan by Lessor to Lessee. (B) If so requested by Lessor, Lessee will affix tags, supplied by Lessor, reflecting Lessor's security interest in the Equipment. 15. LESSEE'S INDEMNITIES -------------------- Lessee will defend, indemnify and hold harmless Lessor from and against any claim, cause of action, damage, liability, cost or expense (including but not limited to legal fees and costs) which may be asserted against or incurred in any manner by or for the account of Lessor or Lessee: (i) relating to the Equipment or any part thereof, including without limitation the manufacture, construction, purchase, delivery, acceptance or rejection, installation, ownership, sale, leasing, removal or return of the Equipment, or as a result of the use, maintenance, repair, replacement, operation or the condition thereof (whether defects are latent or discoverable); (ii) by reason or as a result of any act or omission of Lessee for itself or as agent or attorney-in-fact for Lessor hereunder; (iii) as a result of claims for patent, trademark or copyright infringement; or (iv) as a result of product liability claims or claims for strict liability. 16. LESSOR MAY PERFORM ------------------ If Lessee at any time shall fail to pay to any person any sum which Lessee is required by the Lease to pay or shall fail to do or perform any other thing Lessee is required by the Lease to do or perform, Lessor at its option may pay such sum or do or perform such thing, and Lessee shall reimburse Lessor on demand for the amount of such payment and for the cost and expense which may be incurred by Lessor for such acts or performance, together with interest thereon at the Default Rate from the date of demand until paid. 17. EVENTS OF DEFAULT AND REMEDIES ------------------------------ (A) Events Of Default. Each of the following shall constitute an event of ----------------- default: (i) Failure to perform and comply with the provisions and conditions of Section 8 hereof; or (ii) Failure to pay within 10 days of the date when due, any sum, including installments of rental, owed by Lessee or any affiliate of Lessee at anytime to Lessor; or (iii) Failure to perform and comply with any other provision or condition of the Lease within thirty (30) days after Lessor shall have given Lessee written notice of default with respect thereto; or (iv) Any event of default occurs with respect to any obligations of Lessee to Lessor (or to any affiliate of Lessor, including without limitation, MetLife Capital, Limited Partnership and Metropolitan Life Insurance Company and their respective affiliates and/or Page 6 subsidiaries) on or with respect to any transactions, debts, undertakings or agreements other than the lease; or (v) If any representation or warranty made by Lessee herein or in any statement or certificate furnished by Lessee in connection with this Agreement proves untrue in any material respect as of the date of making thereof, and shall not be made good within thirty (30) days after written notice thereof to Lessee, or Lessee becomes insolvent or is generally not paying its debts as they become due or makes an assignment for benefit of creditors; or (vi) Proceedings are commenced by Lessee under the Federal Bankruptcy Code or any similar Federal or State laws for the relief of debtors are commenced against Lessee and are not dismissed within sixty (60) days after such commencement, or a trustee or receiver is appointed for Lessee or a major part of its property and is not discharged within thirty (30) days after such appointment; or (vii) Any item of Equipment is seized or levied on under legal or governmental process against Lessee or against such item of Equipment or for any reason Lessor deems itself insecure; or (viii) The merger, consolidation, reorganization, conversion to a Subchapter "S" status or dissolution of a corporate or partnership Lessee which has a materially adverse effect upon Lessor's position under the Lease. (B) REMEDIES. The occurrence of an Event of Default shall terminate any -------- obligation of Lessor to lease Equipment or Items thereof to Lessee. When an Event of Default has occurred and is continuing, Lessor at its option may: (i) Proceed by appropriate court action or actions, either at law or in equity, to enforce performance by the Lessee of the applicable covenants of this Lease or to recover damages for the breach thereof; and/or (ii) Without notice or demand declare immediately due and payable the entire Stipulated Loss Value of any and all Items of Equipment then under lease plus any and all amounts which under the terms of the Lease may be then due; and thereupon MetLife shall have an immediate right to pursue all remedies provided by law, and, in that regard, Lessee hereby agrees as follows: (a) Lessee agrees to put Lessor in possession of the Equipment on demand; (b) Lessor is authorized to enter any premises where Equipment is situated and take possession thereof without notice or demand and without legal proceedings; (c) At Lessor's request, Lessee will assemble the Equipment and make it available to Lessor at a place designated by Lessor which is reasonably convenient to both parties; (d) Lessee agrees that ten (10) days from the time notice is sent shall be a reasonable period of notification of a sale or other disposition of the Equipment; (e) Lessee agrees to pay on demand the amount of all expenses reasonably incurred by Lessor in protecting or realizing on the Equipment; (f) If Lessor disposes of the Equipment, Lessee agrees to pay any deficiency remaining after application of the net proceeds to the amounts due hereunder. If upon the occurrence of an Event of Default, Lessor brings suit or otherwise incurs expenses for protection of Lessor's rights, Lessee will pay Lessor its legal fees, in a reasonable amount, together with Lessor's collection expenses and court costs. In addition, from and after an Event of Default, Lessee shall be liable for interest on amounts due Lessor hereunder at a rate per annum computed monthly which shall be five (5) percentage points above the prime rate, but not greater than the maximum rate, if any, limited by applicable law ("Default Rate"); provided however, that Lessee shall not be assessed a late charge during such period of time that Default Rate is accruing against Lessee as herein stated. The remedies herein provided in favor of Lessor shall not be deemed to be exclusive but shall be concurrent and cumulative and in addition to all Page 7 other remedies available at law or equity. The exercise or partial exercise of any remedy shall not restrict Lessor from further exercise of that remedy or any other remedy. 18. SURRENDER --------- At any time that Lessee is required to deliver the Equipment to Lessor, Lessee shall immediately cease using the Equipment and at Lessee's expense shall redeliver and surrender the Equipment to Lessor in good order, condition and repair, ordinary wear and tear excepted, securely crated and safely packed, at a place to be designated by Lessor in the State where the Equipment by the terms of the Addendum is required to be kept, and, if Lessor so specifies, loaded FOB on a common or contract carrier designated by Lessor. 19. HOLDOVER -------- If Lessee shall not immediately redeliver and surrender any Item of Equipment to Lessor when required by the terms hereof, Lessee shall pay Lessor, at such time or times as Lessor may demand, a sum equal to a one-month installment of Periodic Rental for each calendar month or fraction of a month during which such failure to redeliver and surrender continues. 20. INSPECTION; REPORTS ------------------- Lessor, its agents and employees shall have the right to enter upon any premises where the Equipment or Items are then located to inspect and examine the same during normal business hours and, if Lessor reasonably believes any Items or Lessor's rights are in jeopardy of damage or loss, at any other times. So long as Lessee is not in default, Lessor shall give Lessee not less than forty-eight (48) hours notice of such inspection. Lessee shall immediately give Lessor written notice of any damage to or loss of the Equipment or any Items from any cause, including without limitation damage or loss caused by accident, the elements, intentional acts and theft. Such notice shall set forth an itemization of the affected Items and a detailed account of the event, including names of any injured persons and a description of any damaged property arising from any such event or from any use or operation of the Equipment or any Items, and of any attempt to take, distrain, levy upon, seize or attach the Equipment or any Items. All rights granted to Lessor herein are for the benefit of Lessor and shall not be construed to impose any obligation on Lessor, whether or not Lessor makes any inspections or receives any reports. 21. FINANCIAL AND OTHER DATA ------------------------ During the Term and any Renewal Term, Lessee: (a) shall furnish Lessor annual balance sheets and profit and loss statements of Lessee and any guarantor of Lessee's obligations accompanied, at Lessor's request, by the audit report of an independent certified public accountant reasonably acceptable to Lessor; and (b) at Lessor's request, shall furnish Lessor all other publicly available financial information and reports reasonably requested by Lessor when publicly available, including quarterly or other interim balance sheets and profit and loss statements of Lessee and any such guarantor. Lessee shall furnish such other information as Lessor may reasonably request at any times concerning Lessee and its affairs. 22. WARRANTY OF INFORMATION ----------------------- Lessee warrants that all information furnished and to be furnished to Lessor is accurate and that all financial statements it has furnished and hereafter may furnish Lessor, including operating statements and statements of condition, are and will be prepared in accordance with generally accepted accounting principles, consistently applied, and reasonably reflect and will reflect, as of their respective dates, results of the operations and the financial condition of Lessee and of any other entity they purport to cover. 23. NON-WAIVER ---------- Neither the acceptance by Lessor of any payment or any other performance, nor any act or failure of Lessor to act or to exercise any rights, remedies or options in any one or more instances shall constitute a waiver of any such right, remedy or option or of any other then existing or thereafter accruing right, remedy or option, or of any breach or default then existing or thereafter occurring. No purported waiver by Lessor of any right, remedy, option, breach or default shall be binding unless in writing and signed by an officer of Lessor. A written waiver by Lessor of any right, remedy, option, breach or default shall not constitute a Page 8 waiver of any other then existing or thereafter accruing right, remedy or option or of any other then existing or thereafter occurring breach or default. 24. NOTICES; PAYMENTS ----------------- (A) A written notice may be given: (i) by delivering the same to a corporate officer of the party to whom it is directed (the "Addressee"), or to a general partner if the Addressee is a partnership, or to the owner if the Addressee is a sole proprietorship; or (ii) by mailing the notice to the Addressee by first class mail, registered or certified, with postage prepaid, addressed to the Addressee at the address following its name in the opening paragraph of this Master Lease or to such other address as Addressee may specify by notice in writing given in accordance with this Section. A notice so mailed shall be deemed given on the third business day following the date of mailing. A "business day" shall be any day that is not a Saturday or Sunday or a legal holiday. (B) The Lessee shall make all payments to Lessor at the place where the notice is to be mailed to Lessor pursuant to subparagraph (A). Payments are deemed paid when received by Lessor. 25. ASSIGNMENT ---------- (A) Lessee shall not assign the Lease or any rights in or to the Equipment or Items. Any attempted assignment shall be of no effect, unless Lessor first shall have consented thereto in writing. Lessor's consent to an assignment in any one or more instances shall not impose any obligation upon Lessor to consent to any other or further assignments. Lessor's consent to an assignment shall not release Lessee from any obligations with respect to the Lease unless expressly so stated in the written consent. (B) All rights of Lessor hereunder may be assigned, pledged, mortgaged, transferred or otherwise disposed of, either in whole or in part, without notice to Lessee but subject always to the rights of Lessee under this lease. If Lessee is given notice of any such assignment, Lessee shall acknowledge receipt thereof in writing. In the event that Lessor assigns this Lease or the rent due or to become due hereunder or any other interest herein, whether as security for any of its indebtedness or otherwise, no breach or default by Lessor hereunder or pursuant to any other agreement between Lessor and Lessee, should there be one, shall excuse performance by Lessee of any provision hereof, it being understood that in the event of such default or breach by Lessor that Lessee shall pursue any rights on account thereof solely against Lessor. No such assignee shall be obligated to perform any duty, covenant or condition requested to be performed by Lessor under the terms of this Lease. 26. SURVIVAL -------- The representations, warranties, indemnities and agreements of Lessee, and Lessee's obligations under any and all provisions of the Lease, shall survive the expiration or other termination of the Lease, shall be binding upon its successors and assigns and are expressly made for the benefit of and shall be enforceable by Lessor and its successors and assigns. 27. MISCELLANEOUS ------------- (A) The term "Lessor" shall mean the Lessor named herein and its successors and assigns. (B) Whenever the context so requires, any pronoun gender includes all other genders, and the singular includes the plural. If more than one person constitute Lessee, whether as a partnership or otherwise, all such persons are and shall be jointly and severally liable for all agreements, undertakings and obligations of Lessee. (C) All captions and section, paragraph and other divisions and subdivisions are for convenience of reference only and shall not affect the construction, interpretation or meaning of the agreement or Lease or of any of the provisions thereof. Page 9 (D) This Lease shall be governed by and construed according to the law of the State of Washington. (E) This Lease shall be binding upon and, except as limited in Section 25 hereof, shall inure to the benefit of Lessor and Lessee and their respective successors and assigns. (F) This Lease cannot be canceled or terminated except as expressly provided herein. (G) Wherever Lessor's consent is required hereunder, such consent will not be unreasonably withheld. (H) Lessee's obligation to pay or reimburse Lessor for expenses as provided hereunder shall be limited to reasonable expenses. 28. LESSOR'S DISCLAIMER ------------------- Lessee acknowledges and agrees that it has selected both the Equipment of the type and quantity which is the subject of this Lease and the supplier from whom the Equipment was purchased. LESSOR MAKES NO REPRESENTATION OR WARRANTY, EXPRESS OR IMPLIED, AS TO THE DESIGN, COMPLIANCE WITH SPECIFICATIONS, CONDITION, QUALITY, WORKMANSHIP, OR THE SUITABILITY, ADEQUACY, OPERATION, USE OR PERFORMANCE OF THE EQUIPMENT OR AS TO ITS MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE. ANY DELAY IN DELIVERY SHALL NOT AFFECT THE VALIDITY OF THIS LEASE. The Lessee understands and agrees that neither the supplier nor any salesman or any agent of the supplier is an agent of Lessor. No salesman or agent of supplier is authorized to waive or alter any term or condition of this Lease, and no representation as to the Equipment or any other matter by the supplier shall in any way affect Lessee's duty to pay the rent and perform its obligations as set forth in this Lease. Lessor shall not be liable to Lessee for any incidental, consequential, or indirect damages or for any act, neglect, omission, breach or default by any third party. 29. NO AFFILIATION WITH SUPPLIERS ----------------------------- Lessee warrants that neither it nor any of its officers, directors (if a corporation) or partners (if a partnership) has, directly or indirectly, a substantial financial interest in the manufacturer or supplier of any Equipment except as previously disclosed in writing to Lessor. 30. ENTIRE AGREEMENT ---------------- This Master Lease and any Lease Purchase Addenda hereto shall constitute the entire agreement between the parties and shall not be altered or amended except by an agreement in writing signed by the parties hereto or their successors or assigns. IN WITNESS WHEREOF Lessor and Lessee have signed this agreement as of the day and year first hereinabove written. LESSOR: LESSEE: METLIFE CAPITAL CORPORATION VITESSE MANUFACTURING & DEVELOPMENT CORPORATION, a wholly owned subsidiary of VITESSE SEMICONDUCTOR CORPORATION By: /s/ Scott Rhodes By: /s/ Eugene Hovanec ------------------------------ --------------------------------- Its Scott Rhodes Vice President Its VP Finance ------------------------------ --------------------------------- Page 10 LEASE PURCHASE ADDENDUM NO. 1 THIS ADDENDUM is entered into the 9 day June, 1998 of between MetLife Capital Corporation ("Lessor") whose mailing address is C-97550, Bellevue, Washington 98009 and VITESSE MANUFACTURING & DEVELOPMENT CORPORATION, a wholly owned subsidiary of VITESSE SEMICONDUCTOR CORPORATION ("Lessee") whose address is 741 Calle Plano, Camarillo, CA 93012. Lessee has requested to lease from Lessor the following items of personal property (individually, an "Item" and, collectively, the "Equipment") for the prices and for delivery as follows:
- ------------------------------------------------------------------------------------------------------------------ Name and Address Complete Description of Equipment of Supplier Quantity Price - ------------------------------------------------------------------------------------------------------------------ New Semiconductor Manufacturing Equipment 10,000,000.00 Serial No. -------------------------------------------- TOTAL PRICE $10,000,000.00 -------------------------------------------- FED. EXCISE TAX $ -------------------------------------------- TRANSPORTATION $ -------------------------------------------- OTHER $ - ------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------ Date Delivery Instructions to be Delivery as specified by Lessee TOTAL COST: $10,000,000.00 Expected: May 15, 1998 to Supplier - ------------------------------------------------------------------------------------------------------------------ SHIP TO LESSEE AT: 4323 ARROWS WEST DRIVE, COLORADO SPRINGS, CO 80907 AND 741 CALLE PLANO, CAMARILLO, CA 93012 - ------------------------------------------------------------------------------------------------------------------
Lessee and Lessor AGREE that subject to the conditions and agreements herein and in the Master Lease referred to below (i) Lessor shall lease the Equipment to Lessee, and (ii) Lessee shall lease the Equipment from Lessor and perform and comply with the provisions of this Agreement. CERTAIN DEFINITIONS AND STIPULATIONS: Purchase Cut-Off Date: September 30, 1998 Particular Lease Terms: Length of Basic Term: 48 Months "Interim Rental Rate": equal to Chase Manhattan Bank's Prime rate. "Periodic Rental Rate" will be calculated at a variable rate equal to the average weekly yield of the 30-Day Commercial Paper (financial) in effect from time to time (as published in the Federal Reserve Statistical Release H.15[519]) plus 1.5% (the "Variable Rate") computed on the basis of a 360 day year of twelve consecutive 30 day months and the payment is payable monthly in arrears. Lessee shall make Monthly Rental Payments during the Basic Term and any Renewal Term in an amount equal to (1) "Tranche A" interest only at a rate equal to two percent (2%) per annum on an assumed original balance of $8,000,000, and (2) "Tranche B" the "Level Payment Amount" set forth in the following paragraph. In addition, Lessee shall make the annual cleanup payments as set forth in the following paragraph. For the first year of the Lease, the Level Payment Amount shall be $11,666.67 per month. The monthly Level Payment Amount for each twelve month period following the initial twelve months of the Basic Term, including the Level Payment Amount for the Renewal Term, if any, will be calculated by applying the then current Variable Rate over the remaining Basic Term to the then outstanding amount due. Lessor will adjust the Level Payment Amount in accordance with the preceding formula on each anniversary of the Closing Date for each year during the Basic Term and for the Renewal Term, if any. On each anniversary of the Closing Date, the aggregate Level Payment Amount for the preceding year will be compared with what the aggregate monthly rental payments would have been for that year had they been calculated monthly using the Variable Rate. (The aggregate amount that would have been paid had the monthly payments been calculated using the actual Variable Rate is referred to herein as the "Actual Aggregate Amount"). If the Actual Aggregate Amount is greater than the aggregate Level Payment Amount paid by Lessee for that year, then Lessee shall remit the difference to Lessor upon receipt of an invoice therefor. If the Actual Aggregate Amount is less than the aggregate Level Payment Amount paid by Lessee for that year, then such over-payment shall be credited to Lessee's rental payments for the subsequent year or, in the case of the end of the Basic Term or any Renewal Term, such over- payment shall be credited to the amount Lessee owes to Lessor under the end of term provisions set forth below. END OF TERM PROVISIONS a) On the last day of the Basic Term, Lessee may purchase for cash all but not less than all of the Equipment then under the Master Lease and all schedules and addenda thereto for a price equal to 100% of the Total Cost (the "Purchase Price"). (b) If Lessee elects not to purchase the Equipment pursuant to (a) above, then Lessee may either (i) renew the Lease, pursuant to Subsection (c) below, or (ii) sell the equipment in a commercially reasonable manner, or, at Lessor's option, Lessor will sell the Equipment as agent for Lessee. In no event will Lessee sell the Equipment for less than 90% of the Total Cost without Lessor's prior written consent. All net proceeds of sale shall be paid to Lessor; provided, however, that if the net proceeds of sale exceed 100% of -------- ------- the Total Cost, then such excess shall be paid to Lessee; and, provided, further, that if the net proceeds of sale are less than 100% -------- ------- of the Total Cost, then Lessee shall pay to Lessor the difference to a maximum of 86% the Total Cost. (The amount payable to Lessor under this subsection (b) is referred to herein as the "Sale Price.") (c) If Lessee neither purchases nor sells the Equipment in accordance with Sections (a) or (b) above, then on the last day of the Basic Term the Lease will be renewed for a period of 12 months (the "Renewal Term"). The Monthly Rental Payment and the Level Payment Amount for the Renewal Term shall be an amount calculated by Lessor pursuant to the provisions set forth above under the heading "Particular Lease Terms" and shall be payable monthly in arrears. On the last day of the Renewal Term, Lessee shall have the option to purchase all but not less than all of the Equipment then under Lease for a price equal to 100% of the Total Cost. If Lessee does not exercise this purchase option, then Lessee shall sell the Equipment or, at Lessor's option, Lessor shall sell the Equipment as agent for Lessee, in a commercially reasonable manner. In no event will Lessee sell the Equipment for less than 90% of the Total Cost without Lessor's prior written consent. All net proceeds of sale shall be paid to Lessor; provided, however, that if the net proceeds of sale exceed -------- ------- 100% of the Total Cost, then such excess shall be paid to Lessee; and provided, further, that if the net proceeds of sale are less than 100% -------- ------- of the Total Cost, then Lessee shall pay to Lessor the difference to a maximum of 86% of the Total Cost. Regardless of whether Lessee elects to purchase the Equipment, to sell the Equipment, or to renew the Lease, in any such case Lessee shall deliver to Lessor written notice of its election not less than one hundred twenty (120) days prior to the last day of the Basic Term. Premises where Equipment will be kept: 4323 Arrows West Drive, -------------------------- Colorado Springs, CO 80907 -------------------------- 741 Calle Plano, Camarillo, -------------------------- CA 93012 -------------------------- INSURANCE REQUIRED: LIABILITY. Not less than $10,000,000.00 Combined Single Limit Liability insurance, including bodily injury and death and property damage, naming Lessor as additional insured. PHYSICAL DAMAGE. Not less than $ 10,000,000 All risk physical damage insurance, including loss by burglary, theft, and malicious mischief, for full replacement value of the equipment, naming Lessor as loss payee. Other: __________________________________________________________________ EARLY PURCHASE OR SALE/YIELD MAINTENANCE PREMIUM: Lessee shall have the option at any time after the 2/nd/ anniversary of the Closing Date to purchase or sell all but not less than all of the Equipment then remaining under the Master Lease and all schedules and addenda thereto. The terms of any such purchase or sale shall be as set forth under subsections (a) or (b), respectively, of the section above titled "End of Term Provisions." In addition, it shall be a condition precedent to Lessee's right to exercise the early purchase or sale option that Lessee shall not then be in default hereunder or under the Master Lease and that Lessee pays all amounts set forth in, and otherwise complies with the terms of, this subsection. If Lessee elects to purchase or sell the Equipment, Lessee shall deliver to Lessor not less than one hundred twenty (120) days prior written notice of its election. At the end of the 120 day period (the day on which the 120-day period ends being referred to herein as the "Termination Date"), Lessee shall pay to Lessor, in cash, the sum of (i) the Purchase Price or the Sale Price for all Equipment then under the Master Lease and any schedules or addenda thereto plus (ii) the Yield Maintenance Amount calculated as set forth below with respect to all Equipment then under the Master Lease and all schedules and addenda thereto plus (iii) the Periodic Rental then due under the Master Lease and any schedules and addenda thereto plus (iv) all other amounts that have accrued and remain unpaid hereunder and under the Master Lease and any schedules and addenda thereto as of the Termination Date. The Yield Maintenance Amount (YMA) is determined by multiplying the YMA Premium Factor by the Total Cost. YMA Premium Factors ------------------- YMA Premium Factor after the 2/nd/ anniversary of the Closing Date is 0.0860 YMA Premium Factor after the 3/rd/ anniversary of the Closing Date is 0.0442 MASTER LEASE: Lessor and Lessee are entering into or have entered into a Master Lease Purchase Agreement ("Master Lease") dated July 9 1998. All of the terms, conditions, agreements and provisions of the Master Lease are incorporated herein by this reference and constitute a part of this Addendum. If there shall be any conflict between any provision of the Master Lease and a provision of this Addendum, the provision of the Addendum shall govern. SUBSTITUTION OF EQUIPMENT: Notwithstanding any provision herein or in the Master Lease to the contrary. Lessee shall have the right at any time during the term of the Lease to deliver to Lessor a written request that Lessor accept as substitute collateral, equipment that (1) has a then fair market value equal to or greater than the then fair market value of the Equipment being substituted, as determined by Lessor in its sole reasonable discretion, and (2) satisfies all the other representations and warranties with respect to the Equipment that are set forth herein and in the Master Lease. If Lessor determines that the substitute equipment meets the preceding requirements, Lessor shall so notify Lessee. Lessee shall execute and deliver to Lessor such filings and documents as Lessor shall reasonably require with respect to the substitution and the substitute equipment, including without limitation financing statements or amendments thereto for filing in appropriate jurisdictions to perfect and protect Lessor's interest in the substitute equipment. Lessee shall pay any and all costs and expenses reasonably incurred by Lessor in connection with the substitution including without limitation the cost of any lien searches reasonably required by Lessor to ascertain that the substitute equipment is free and clear of all liens and encumbrances. When Lessor has determined that it has a perfected, first priority security interest in the substitute equipment, such equipment shall become Equipment for all purposes hereunder and under the Master Lease and the substituted Equipment shall be released from the lien of the Master Lease. RELEASE OF SECURITY INTEREST: Notwithstanding the provisions set forth in Section 2(A) of the Master Lease to the contrary, if the following conditions are met, Lessor shall release its security interest in the Equipment specified in this Addendum: (1) Lessee has paid all amounts that are required to be paid hereunder and under the Master Lease; (2) Lessee is not otherwise in default, and no event shall have occurred that with the passage of time or the giving of notice or both would constitute a default, under the Master Lease, this Addendum, or any other addendum; (3) Lessor shall have determined, in its reasonable and sole discretion, that Lessee will be able to perform its remaining obligations under the Master Lease; and (4) all Equipment other than the Equipment under this Schedule then remaining subject to the Master Lease and all other addenda shall have a value that is, in Lessor's sole reasonable discretion, adequate to satisfy all of Lessee's obligations then remaining due and unpaid under the Master Lease and all addenda thereto. LESSOR'S DISCLAIMER: Lessee acknowledges and agrees that it has selected both the Equipment of the type and quantity which is the subject of this Addendum and the supplier from whom Lessor purchased the Equipment. LESSOR MAKES NO REPRESENTATION OR WARRANTY, EXPRESS OR IMPLIED, AS TO THE DESIGN, COMPLIANCE WITH SPECIFICATIONS, CONDITION, QUALITY, WORKMANSHIP, OR THE SUITABILITY, ADEQUACY, OPERATION, USE OR PERFORMANCE OF THE EQUIPMENT OR AS TO ITS MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE. ANY DELAY IN DELIVERY SHALL NOT AFFECT THE VALIDITY OF THE MASTER LEASE OR THIS ADDENDUM. The Lessee understands and agrees that neither the supplier nor any salesman nor any agent of the supplier is authorized to waive or alter any term or condition of the Master Lease or this Addendum, and no representation as to the Equipment or any other matter by the supplier shall in any way affect Lessee's duty to pay the rent and perform its obligations as set forth in the Master Lease or this Addendum. Lessor shall not be liable to Lessee for incidental, consequential, or indirect damages or for any act, neglect, omission, breach or default by Lessor or any third party. LESSOR: LESSEE: VITESSE MANUFACTURING & DEVELOPMENT CORPORATION, A METLIFE CAPITAL WHOLLY OWNED SUBSIDIARY OF VITESSE SEMICONDUCTOR CORPORATION CORPORATION ------------------------------------------------- BY: /s/ SCOTT RHODES BY: /s/ EUGENE HOVANEC ---------------- ---------------------------- Its: VICE PRESIDENT ITS: V. PRESIDENT ---------------- --------------------------- By: /s/ Yatin Mody --------------------------- Its: CONTROLLER / ASST SECRETARY --------------------------- LEASE PURCHASE CLOSING SCHEDULE Lessee Name: Vitesse Manufacturing & Development Corporation ----------------------------------------------- Lease Purchase Addendum No: One ----------------------------------------------- Dated: July 29, 1998 ----------------------------------------------- Schedule Number: One ----------------------------------------------- Closing Date: August 1, 1998 ----------------------------------------------- 1. DESCRIPTION OF EQUIPMENT: New Semiconductor Manufacturing Equipment as shown on the attached Exhibit "A" hereby incorporated by this reference. 2. LOCATION OF EQUIPMENT: (Lessee agrees that the Equipment will at all times remain in the possession and control of Lessee at the location(s) specified below, and will not be removed without Lessor's prior written consent.): 741 Calle Plano, Camarillo, CA 93012 and 4323 Arrows West Drive Colorado Springs, CO 80907 3. Tranche A Equipment Cost: $2,606,534.24 ------------------------- Tranche B Equipment Cost: $ 651,633.56 ------------------------- Total Equipment Cost: $3,258,167.80 ------------------------- 4. PERIODIC RENT: As per Addendum No. 1 Particular Lease Terms section with the assumed original balance on Tranche A of interest only payments at a rate equal to 2% per annum on an assumed original balance of $2,606,534.24, and: Tranche B Level Payments for the first twelve months of the Lease shall be $3,812.06; with annual adjustments calculated per Addendum No. 1, Certain Definitions and Stipulations section. 5. PURCHASE: As per Addendum No. 1 End of Term Provisions section 6. INSURANCE REQUIRED: (All policies to require at lease 10 days' notice of cancellation to Lessor) a. Combined Single Limit Liability, including bodily injury and property damage, of not less than $20,000,000.00 naming Lessor as ---------------------- additional insured. b. All risk physical damage, including burglary and theft, for the full replacement value of the Equipment, based on the original equipment cost of $ 3,258,167.80 and Loss Payable Endorsement naming Lessor as ----------------------- loss payee. 7. EARLY TERMINATION: As per Addendum No. 1 Early Purchase or Sale/Yield Maintenance Premium section 8. STIPULATED LOSS VALUE: During the Basic Term and any Renewal Term: $3,258,167.80 such terms are defined in the Lease Purchase Addendum No. One -------------------------------------------------------------- Accepted and agreed this 29/th/ day of July, 1998, as Schedule No. One to that certain Master Lease Purchase Agreement dated July 9, 1998 by and between the parties hereto. LESSOR: LESSEE: VITESSE MANUFACTURING & DEVELOPMENT CORPORATION, a wholly owned subsidiary of METLIFE CAPITAL CORPORATION VITESSE SEMICONDUCTOR CORPORATION By: By: /S/ Scott Rhodes /s/ Yatin Mody --------------------------- --------------------------------- Scott Rhodes Its Vice President Its CONTROLLER/ASST. SECRETARY --------------------------- --------------------------------- EXHIBIT "A" TO THE LEASE PURCHASE CLOSING SCHEDULE NO. ONE
TOKYO ELECTRON LIMITED 3-6, AKASAKA 5-CHOME MINATO-KU,TOKYO 107-8481, JAPAN INVOICE #IV1358501 One (1) P-8 Full Auto Prober S/N PA05315 INVOICE #IV1358502 One (1) P-8 Full Auto Prober S/N PA05415 INVOICE #IV1358503 One (1) P-8 Full Auto Prober S/N PA05409 SCHLUMBERGER TECHNOLOGIES 1601 TECHNOLOGY DRIVE SAN JOSE, CA 95110-1397 INVOICE #163091 One (1) SX-l00 Automated Test System S/N 93136 Sub local memory - 192 pins, DPS Option, Option HCDPS Mech Ready, Option Fail Capture Memory, H V heat exchanger 60 hz, assy, power cond, exa, 58KVA, DC Ethernet thin add-on, GPIB/IEEE.488.I/F. Option Parallel interface option, RSZ32 Fiber Opticserial I/F, LM, HCKPS Expansion Option, LM, HCKPS Cal/Ver Loadboard INVOICE #168812 One (1) SX-l00 Automated Test System S/N 93143 DPS Option, Option HCDPS Mech Ready, Option Fail Capture Memory, H V heat exchanger 60 hz, assy, power cond, exa, 58KVA, DC Ethernet thin add-on, GPIB/IEEE.488.I/F. Option Parallel interface option, RSZ32 Fiber Opticserial I/F YM ------------ Initial ------------ Initial SR ------------ Initial
August 1, 1998 $2.606.534.24 Bellevue. Washington ------------- -------------------- PROMISSORY NOTE RE: ADDENDUM NO. ONE ("ADDENDUM") FOR VALUED RECEIVED, MetLife Capital Corporation ("Maker"), promises to pay to the order of Vitesse Manufacturing & Development Corporation, a wholly owned subsidiary of Vitesse Semiconductor Corporation ("Payee"), at its office at 741 Calle Plano, Camarillo, California 93012, the principal sum of Two Million Six Hundred Six Thousand Five Hundred Thirty-Four Dollars and Twenty- Four Cents ($2,606,534.24) together with interest on unpaid principal, subject to the other provisions contained herein, from the date hereof until the principal has been repaid in full at a rate of two percent (2%) per annum ("Rate") computed on the basis of a 360-day year of twelve consecutive thirty- day months. Maker shall make monthly payments of interest only on the unpaid principal commencing on August 1, 1998 and monthly thereafter on the 1/st/ day of each month until the Maturity Date, as defined below, at which time the entire principal and any accrued interest remaining unpaid shall be due and payable. The "Maturity Date" is (A) if Payee prepays all of its obligations under Addendum No. One (the "Addendum") to that certain Master Lease Purchase Agreement (the "Lease") dated July 8, 1998 between Payee and Maker, then the Maturity Date shall be the date on which Payee prepays, and (B) if Payee does not prepay all of its obligations under the Addendum, then the Maturity Date shall be the later of (1) June 1, 2002 or (2) the date on which Payee has performed all of its obligations to Maker under the Addendum and Maker. Notwithstanding the foregoing, Maker may prepay the entire balance of the Note at any time without penalty or premium. No interest shall accrue hereunder for any period during which interest is not accruing under the Addendum. If Payee fails to make any payment that is required to be made to Maker under the Lease, Maker shall have the right to set-off such amount against Maker's obligations under this Note without notice to or the consent of Payee and without any obligation to confirm with Payee in advance whether the set-off is valid. Nothing contained herein shall be deemed to require Maker to set-off any amounts owed hereunder and Payee acknowledges and agrees that Maker shall have no such set-off obligation. Payee expressly waives any right it may have to require Maker to give any notice of intent to set-off and waives any right to prohibit any set-off on any grounds; provided, however, that the foregoing waiver shall not be construed as limiting - ----------------- any legal right Payee may have to challenge any set-off after the fact. If Maker elects to exercise its set-off rights, the principal amount outstanding hereunder shall be immediately reduced by the amount of the set-off. Maker shall notify Payee of any set-off and the amount thereof, but if Maker fails to notify Payee, such failure shall not affect or invalidate Maker's right to the set-off. If Payee does not receive any payment on the date due, then, unless Maker's failure to make such payment was a result of Maker exercising its set-off rights, Maker will pay Payee a late charge of five percent (5%) of the payment outstanding together with the payment and, provided said sum is received within ten (10) days of the date due, Payee agrees not to demand immediate payment of the whole sum of principal and interest as otherwise permitted herein. If, from any circumstances whatsoever, payment of any obligation due under this Note at the time such performance shall be due shall involve exceeding the maximum amount currently prescribed by any applicable usury statute or any other applicable law, then such obligation shall be reduced to such maximum amount, so that in no event shall any payment be possible under this Note, or under any other instrument evidencing or securing the indebtedness evidenced hereby, that is in excess of such maximum amount. This Note shall be governed by and construed in accordance with the laws of the State of Washington. No amendment to this Note shall be binding unless it is in writing and duly signed by Maker and Payee. IN WITNESS WHEREOF, Maker has caused this Promissory Note to be executed by its duly authorized representative on the date first set forth above. METLIFE CAPITAL CORPORATION By /s/ Manuel G. Montanez ------------------------------ Manual G. Montanez Title: Vice President --------------------------- VITESSE MANUFACTURING & DEVELOPMENT CORPORATION a wholly owned subsidiary of VITESSE SEMICONDUCTOR CORPORATION hereby acknowledges and agrees to the terms of the foregoing Promissory Note, including without limitation the terms regarding set-off rights, waivers and abatement of interest. VITESSE MANUFACTURING & DEVELOPMENT CORPORATION A wholly owned subsidiary of VITESSE SEMICONDUCTOR CORPORPATION By:/s/ YATIN MODY ------------------------------ YATIN MODY Title: Controller/Asst. Secretary --------------------------- EX-13.1 5 ANNUAL REPORT TO SECURITY HOLDERS EXHIBIT 13.1 TABLE OF CONTENTS letter to shareholders 1 five-year selected financial data 10 quarterly results and stock market data 11 management's discussion and analysis of financial condition and results of operations 12 independent auditors' report 21 consolidated balance sheets 22 consolidated statements of operations 23 consolidated statements of shareholders' equity 24 consolidated statements of cash flows 25 notes to consolidated financial statements 26 letter to shareholders December 1998 It is a pleasure to report to you that fiscal 1998 was our most successful year. We continued to build on our strategy to focus our efforts on developing the intellectual property expertise and the advanced process technology needed to be the dominant supplier of high-performance integrated circuits (ICs) for the communications and test equipment markets. Specific highlights for 1998 were: . Revenues exceeded $175 million, a 67% increase over the $105 million achieved in 1997. . Operating income grew to $57 million from $29 million in 1997, a 98% increase. . Earnings per share grew to $0.67 from $0.43 in 1997, a 56% increase, despite a twofold increase in the effective tax rate. . Bookings were strong throughout the year. Backlog grew to $103 million from $62 million. . We successfully brought on line the Pierre Lamond Wafer Fabrication Facility -our new plant in Colorado Springs. In 1998, revenues increased by 67% over the prior year, principally from very strong growth in our focus markets of telecommunications, data communications and test equipment. Revenues increased sequentially by more than 10% each quarter, and with the output from the new fab in Colorado Springs we were able to make significant strides in meeting our customers' requirements. The Colorado Springs facility is the world's first commercial six-inch GaAs wafer fab. We began construction of this facility in November 1996, completed the clean room by July 1997, and installed the initial equipment in September 1997. We started shipping the first products from this fab in March 1998 and are currently continuing the production ramp to meet the growing needs of our customers. With its current equipment set, the fab should be able to produce approximately $200 million per year in incremental revenue. With additional equipment and personnel, the capacity can be expanded to nearly $400 million. In addition to generating the added manufacturing capacity, the use of six-inch wafers and a very simple CMOS-like process and equipment set gives Vitesse a considerable cost advantage over any of the bipolar processes such as ECL or Silicon-Germanium. It is our goal to provide the highest performing technology at a cost-effective price. As a result of the strong revenue growth, both gross margins and operating margins improved, resulting in a 98% increase in operating income and a 56% increase in income per share, year over year. Due to continued cost controls, operating expense grew at a rate lower than revenue, despite the addition of over 145 personnel at the Colorado Springs facility. Communications Over the last few years, Vitesse has become one of the dominant suppliers of physical layer ICs for high-performance optical fiber communication systems. Vitesse telecommunication products are principally used in SONET/SDH transmission systems. SONET/SDH is the international standard for high-speed fiberoptic transmission that is used in the communication infrastructure by both long-distance carriers and local operating companies. In 1998, SONET/SDH applications represented approximately 51% of the Company's revenue. Industry sources estimate that the market for physical layer SONET/SDH circuits will increase from approximately $275 million in 1998 to over $600 million in 2001. This growth is being driven by the need to add a nearly fivefold increase in system bandwidth to accommodate the explosion of digital data transmission resulting from increased use of the Internet, enterprise wide networking, remote access and dedicated data lines. The need for system bandwidth is being addressed in three ways: increased speed in each transmission channel, transmitting multiple channels on a single fiber by a technique called wavelength division multiplexing (WDM), and by installing additional fiber cables. Today, most systems utilize the 2.5 Gb/s standard (OC48, STM16), and initial shipments are being made with the 10 Gb/s standard (OC192, STM 48). These data rates are beyond the capability of conventional silicon CMOS technology and are a natural application where we can bring performance and cost-effectiveness through the use of our GaAs technology. The widespread adoption of WDM has enabled system operators to dramatically increase their system bandwidth without the need to bury additional fiber cables, which is a long and costly process. While WDM increases the bandwidth carried by each optical fiber by a factor of 8 to 120, it does not reduce the number of electronic components required. Instead, WDM has accelerated the growth of SONET/SDH demand by eliminating fiber installation as a growth limiter. We have instituted a number of actions to continue to grow our SONET business at a faster rate than the market as a whole. These include: . Increasing revenue per port through the integration of other analog components that are used in conjunction with our traditional multiplexers and demultiplexers. This can nearly double our revenue per port while significantly reducing system costs. In 1998, we introduced the VSC 816x family of highly integrated products and began initial shipments in the September quarter. . Stimulating the growth of 10 Gb/s (OC 192) systems by dramatically reducing both die and package costs. The VSC 8073 and VSC 8074 should sample in early fiscal 1999. . Increasing the addressed market by leveraging our system-level expertise and intellectual property developed over the last 10 years to provide circuits for other levels of the system architecture. While these products will most likely be built using a state-of-the-art CMOS process, they will be used by many of our existing customers who have had to either develop or fund custom designs. . Exploiting our unique highly integrated GaAs process technology to expand into other product segments of the communication IC market. In fiscal 1998, we sampled our first switching element IC that will enable a nearly tenfold improvement in performance for the same physical size switch. We plan to accomplish this by running each port of the switch at a 2.5 Gb/s data rate compared to 100-200 Mb/s in traditional CMOS implementations. The VSC 83x which sampled in fiscal 1998 is our first product in this area. In 1998, we doubled our revenue in data communications markets. Datacom applications now account for 23% of revenue. This dramatic increase in revenue was a result of the production ramp in 1.06 Gb/s Fibre Channel products which are used in a wide variety of high-speed applications, including serial SCSI disk drives and disk arrays, backplanes in switches and routers and point-to- point data links. In addition to Fibre Channel, 1998 saw a continuation in the growth of Asynchronous Transfer Mode (ATM), 1000T Ethernet (Gigabit Ethernet) and a number of datacom-oriented optoelectronic products. We believe that ATM and Gigabit Ethernet will become the leading high- performance private and Internet-related protocols over the next four years. To support these markets, we introduced 18 new products in 1998. Among the new products introduced were: a 4-channel 1.25 Gb/s backplane interconnect chip (VSC 7215), a 622 Mb/s ATM transceiver (VSC 8114), a 3.3V optical receiver for Gigabit Ethernet (VSC 7809), a 2.5 Gb/s Mux/Demux Section Terminator chipset for ATM/SDH/SONET applications (VSC 8025/VSC 8026) and a gigabit interconnect for high-speed backplanes (VSC 7211). In datacom applications there is a need for a great variety of application specific standard products to address the time-to-market needs of the equipment suppliers. Our focus is to work closely with major equipment suppliers so that we can bring these products to market in a timely fashion. TEST EQUIPMENT Our Automatic test equipment (ate) business grew rapidly in 1998 despite a downturn in ate capital purchases. We accomplished this by continuing to gain market share at the expense of bipolar silicon by offering products with higher speed, higher levels of integration, lower cost, and the ability to combine logic, SRAM and analog functions. Moreover, trends in new memory standards (RAMBUS) have opened up new applications that formerly did not need the performance Vitesse provides. the softness in ATE equipment spending will continue in fiscal 1999. while we anticipate that our ate business will continue to grow, we do not expect it to grow at the rapid pace of the past two years. To expand our opportunities we have introduced our first standard products in ATE. These products are designed for applications that may not require the higher performance provided by custom designs and which cannot afford the longer design cycles and higher costs associated with custom solutions. MANUFACTURING The single most important competitive advantage in the markets we serve is our ability to manufacture very complex, very high-speed ICS using GaAs as the semiconducting material. The Vitesse GaAs technology is based on conventional CMOS equipment and techniques instead of the more common RF GaAs technology used in low complexity circuits principally for wireless applications. Over the past 10 years, our technology has matured and by exploiting the advances made in CMOS equipment and technology, it has enabled us to achieve a substantial cost and performance advantage over any of the older and obsolete (at least for VLSI digital and mixed signal applications) silicon bipolar technologies, which suffer from greater manufacturing complexity, larger die size and higher power. The addition of our six-inch fab in Colorado Springs only extends this advantage. This Class 1 fab will further improve our competitive position through the use of six-inch wafers compared to four-inch wafers used in our Camarillo facility. Six-inch wafers will more than double the number of available die per wafer thereby significantly decreasing die costs. Moreover, the equipment used in Colorado Springs is state-of-the-art silicon equipment, which will be capable of supporting 0.25 micron or better design rules. this will allow future products and selected current products to have a smaller die size and thus more available die per wafer. BALANCE SHEET IMPROVEMENT in 1998, we continued to improve our balance sheet through management of inventory and accounts receivable. in addition, we generated over $51 million in cash from operations. We ended 1998 with $162 million in cash and investments, an increase of $6.5 million over 1997, despite the significant Investment in our Colorado Springs facility. SUMMARY in 1998, we exceeded our growth level in 1997, continuing the strategy set forth in the 1994 Annual Report. While it is impossible to predict every opportunity that might arise, we believe we have selected outstanding growth opportunities that are well matched to our technology and expertise. Moreover, our employees have continued to focus on making Vitesse a leading supplier of high-performance circuits for communications and instrumentation. We greatly appreciate your support and remain fully committed to making Vitesse an outstanding company and an outstanding investment. LOUIS R. TOMASETTA President Chief Executive Officer five-year selected financial data
Year Ended September 30, 1998 1997 1996 1995 1994 - --------------------------------------------------------------------------------------------------------- (in thousands except per share amounts) Operating Results Revenues $175,082 $104,850 $ 66,046 $42,882 $35,581 Income (loss) from operations 56,756 28,662 13,432 2,788 (3,233) Net income (loss) 52,873 32,888 12,645 1,507 (4,141) Net income (loss) per share - diluted 0.67 0.43 0.21 0.03 (0.09) Balance Sheet Cash and short-term investments 162,294 155,844 52,436 6,315 5,171 Working capital 215,309 177,468 70,215 17,889 14,644 Total assets 368,411 292,280 100,416 42,111 39,496 Long-term debt, less current portion - - 406 5,518 6,029 Net shareholders' equity 340,688 265,102 88,370 25,000 21,517
quarterly results and stock market data [unaudited]
First Second Third Fourth Total Quarter Quarter Quarter Quarter Year - ------------------------------------------------------------------------------------------------------- (in thousands except stock price and per share amounts) Fiscal Year 1998 Revenues $34,701 $40,212 $46,108 $54,061 $175,082 Net income 10,379 12,056 13,927 16,511 52,873 Net income per share - diluted (A) 0.13 0.15 0.18 0.21 0.67 Common stock price range (B): High 26.06 25.44 30.88 36.31 36.31 Low 16.44 18.59 23.11 23.38 16.44 Fiscal Year 1997 Revenues $21,832 $24,562 $27,607 $30,849 $104,850 Net income 6,003 7,782 8,955 10,148 32,888 Net income per share - diluted (A) 0.09 0.10 0.12 0.13 0.43 Common stock price range (B): High 16.59 18.29 18.50 26.94 26.94 Low 10.42 11.25 13.75 16.07 10.42 Fiscal Year 1996 Revenues $14,022 $15,628 $17,274 $19,122 $ 66,046 Net income 1,778 2,562 3,788 4,517 12,645 Net income per share - diluted (A) 0.04 0.05 0.06 0.07 0.21 Common stock price range (B): High 4.63 5.28 11.29 14.38 14.38 Low 3.54 3.46 6.00 7.00 3.46
(A) Net income per share computations for each quarter are independent and may not add to the net income per share computation for the year. (B) The Company's common stock is traded on the Nasdaq National Market System under the symbol VTSS. At September 30, 1998, there were approximately 758 shareholders of record. Common stock prices are closing prices as reported on the Nasdaq National Market System. All share and per share data for all periods presented have been adjusted to reflect a 2 for 1 stock split of the common stock that was effected on May 26, 1998, and a 3 for 2 stock split of the common stock that was effected on February 28, 1997. The Company has never paid cash dividends and has no present plans to do so. The Company's bank line of credit agreement and synthetic lease agreements prohibit the payment of dividends without the banks' consent. See Notes 5 and 11 of Notes to Consolidated Financial Statements. management's discussion and analysis of financial condition and results of operations The following discussion of the financial condition and results of operations of the Company should be read in conjunction with the Consolidated Financial Statements and Notes thereto included elsewhere in this Annual Report. 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 and Section 21E of the Exchange Act that involve risks and uncertainties. Factors that realistically could cause results to differ materially from those projected in the forward-looking statements are set forth in "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Factors Affecting Future Operating Results." Overview The Company is a leader in the design, development, manufacturing and marketing of digital GaAs ICs. The Company's target customers are systems manufacturers in the telecommunications, data communications and automatic test equipment (ATE) markets. As a result of the deployment of communications standards such as SONET/SDH, ATM, Fibre Channel and Gigabit Ethernet as well as other advances, there has been growing demand for high-performance ICs to meet the increasingly rigorous standards of the telecommunications and data communications industries. The requirements for high-performance ICs in the ATE industry have also become more stringent in order to meet testing requirements of increasingly faster and more complex ICs. In fiscal 1998, sales of telecommunications, data communications and ATE products represented 51%, 23% and 26%, respectively, of the Company's total revenues. The Company generates both production revenues and development revenues. Production revenues are generally recognized upon shipment of the product, and costs associated with production are included in cost of revenues. Development revenues are much less significant and are generally recognized upon attainment of milestones established under customer contracts, such as the release or shipment of the Company's cell library or design tools, the release by the customer of a design net list or design tape and the Company's shipment of prototype ICs. The majority of costs associated with development revenues, including prototype fabrication costs, are included in cost of revenues, and the remaining portion is expensed as engineering, research and development expenses. The Company believes such revenues will continue to decline as a percentage of total revenues in the foreseeable future. The Company has focused its sales efforts on a relatively small number of systems manufacturers who require high-performance ICs. Sales to the Company's 10 largest customers represented approximately 69%, 77% and 75% of total revenues in fiscal 1998, 1997 and 1996, respectively. As of September 30, 1998, the Company had $22.5 million and $10.0 million of federal and state net operating loss carryforwards, respectively, which will be recoverable only if future taxable income is sufficient to utilize such tax loss carryforwards. Based on historical results of operations, estimated future taxable income and other factors, management believes that it is more likely than not that the tax benefits associated with such loss carryforwards will be realized, and therefore the Company has eliminated the valuation allowance for all deductible differences. In 1997 and 1998, recognition of the Company's net operating loss carryforward benefits resulted in relatively low effective income tax rates for the Company. This reduction of the available future benefit related to these net operating loss carryforwards will result in the Company experiencing higher effective income tax rates in fiscal 1999 and thereafter. See Note 8 of Notes to Consolidated Financial Statements. Results of Operations The following table sets forth statements of operations data of the Company expressed as a percentage of total revenues for the fiscal years indicated:
Year Ended September 30, 1998 1997 1996 Revenues 100.0% 100.0% 100.0% - ------------------------------------------------------------------------------------------------------------ Costs and expenses: Cost of revenues 39.6 43.4 48.1 Engineering, research and development 16.0 16.0 16.7 Selling, general and administrative 12.0 13.2 14.9 - ------------------------------------------------------------------------------------------------------------ Total costs and expenses 67.6 72.7 79.7 - ------------------------------------------------------------------------------------------------------------ Income from operations 32.4 27.3 20.3 Other income, net 5.3 7.5 0.9 - ------------------------------------------------------------------------------------------------------------ Income before income taxes 37.7 34.8 21.3 Income taxes 7.5 3.5 2.1 Net income 30.2% 31.4% 19.1% - ------------------------------------------------------------------------------------------------------------
Year Ended September 30, 1998, as Compared to Year Ended September 30, 1997 Revenues Revenues in fiscal 1998 were $175.1 million, a 67% increase over the $104.9 million recorded in fiscal 1997. The increase in total revenues was due to an increase in production revenues as a result of the growth in shipments to customers in the communications and ATE markets. Cost of Revenues Cost of revenues as a percentage of total revenues in fiscal 1998 was 39.6% compared to 43.4% in fiscal 1997. 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 Camarillo wafer fabrication facility, as well as improved manufacturing yields, partially offset by an increase in per unit costs associated with the Colorado facility which did not start volume production until the third quarter of fiscal 1998. Engineering, Research and Development Engineering, research and development expenses were $27.9 million in fiscal 1998 compared to $16.8 million in fiscal 1997. The increase was principally due to increased headcount and higher costs to support the Company's continuing efforts to develop new products. The Company's engineering, research and development costs are expensed as incurred. The Company intends to continue to increase the dollar amount of engineering, research and development expenses in the future. As a percentage of total revenues, engineering, research and development expenses were 16% in fiscal 1998 and 1997. Selling, General and Administrative Selling, general and administrative expenses were $21.1 million in fiscal 1998 compared to $13.9 million in fiscal 1997. The increase was principally due to increased headcount, higher commissions earned by sales representatives resulting from increased sales, and increased advertising costs. As a percentage of total revenues, selling, general and administrative expenses declined to 12.0% in fiscal 1998 from 13.2% in fiscal 1997 primarily as a result of the Company's revenues growing faster than these expenses. Other Income, Net Other income consists of interest income, net of interest and other expenses. Other income increased to $9.2 million in fiscal 1998 from $7.9 million in fiscal 1997 due to a higher average cash, short-term investments and long-term deposit balances in fiscal 1998 as compared to fiscal 1997 resulting primarily from the Company's equity offering in November 1996. Income Taxes The Company recorded a provision for income taxes in the amount of $13.1 million in fiscal 1998 and $3.7 million in fiscal 1997, representing an effective tax rate of 20% and 10%, respectively. The Company expects its effective tax rate to increase significantly in fiscal 1999 as a result of utilization in previous years of available net operating loss carryforwards. Net Operating Loss Carryforwards As of September 30, 1998, the Company had federal net operating loss carryforwards of approximately $22.5 million, state net operating loss carryforwards of approximately $10.0 million and federal and state research and development tax credits of approximately $3.6 million and $1.4 million, respectively. The Company accounts for income taxes pursuant to the provisions of Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS No. 109). Year Ended September 30, 1997, as Compared to Year Ended September 30, 1996 Revenues Revenues in fiscal 1997 were $104.9 million, a 59% increase over the $66.0 million recorded in fiscal 1996. The increase in revenues was due to an increase in production revenues as a result of the growth of shipments to customers in the data communications, telecommunications and ATE markets. Cost of Revenues Cost of revenues as a percentage of total revenues in fiscal 1997 was 43.4% compared to 48.1% in fiscal 1996. 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 at the Camarillo manufacturing facility. Engineering, Research and Development Engineering, research and development expenses were $16.8 million in fiscal 1997 compared to $11.0 million in fiscal 1996. 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 expenses declined to 16.0% in fiscal 1997 from 16.7% in fiscal 1996 due primarily to the Company's revenues growing faster than these expenses. Selling, General and Administrative Selling, general and administrative expenses were $13.9 million in fiscal 1997 compared to $9.8 million in fiscal 1996. This increase was principally due to increased headcount, salary increases, higher commissions resulting from increased sales and increased advertising costs. As a percentage of total revenues, selling, general and administrative expenses declined to 13.2% in fiscal 1997 from 14.9% in fiscal 1996 primarily as a result of the Company's revenues growing faster than these expenses. Other Income, Net Other income consists of interest income, net of interest and other expenses. Other income increased to $7.9 million in fiscal 1997 from $0.6 million in fiscal 1996 due to a higher average cash balance in fiscal 1997 as compared to fiscal 1996 resulting primarily from the Company's equity offerings in March 1996 and November 1996. Income Taxes The Company recorded a provision for income taxes in the amount of $3.7 million in fiscal 1997 and $1.4 million in fiscal 1996. Liquidity and Capital Resources Operating Activities The Company generated $51.0 million, $55.2 million and $16.7 million from operating activities in fiscal 1998, 1997 and 1996, respectively. Investing Activities Capital expenditures, primarily for manufacturing and test equipment, were $29.7 million, $30.7 million and $11.0 million in fiscal 1998, 1997 and 1996, respectively. As a result of increased demand for its products, the Company has been increasing capacity at its Camarillo plant. Additionally, during the current fiscal year the Company purchased manufacturing equipment in order to begin volume production of six-inch wafers at its wafer fabrication facility in Colorado Springs. Consequently, the Company incurred a significant increase in capital expenditures in fiscal 1998 and 1997. The majority of the costs associated with the Colorado Springs facility was financed through three operating lease transactions. See Note 11 of Notes to Consolidated Financial Statements. The Company intends to continue investing in new manufacturing, test and engineering equipment. Financing Activities In fiscal 1998, the Company generated $8.3 million of cash from financing activities consisting of $8.5 million of proceeds from the issuance of common stock pursuant to the Company's stock option and stock purchase plans, partially offset by $0.3 million in repayments of debt obligations. In fiscal 1997, the Company generated $124.5 million of cash from financing activities consisting of $125.4 million of proceeds from the issuance and sale of common stock in the Company's public offering in November 1996 and proceeds from the issuance of common stock pursuant to the Company's stock option and stock purchase plans partially offset by $0.9 million in repayments of debt obligations. The Company has an agreement with a bank for a revolving line of credit which expires on January 5, 1999. The maximum amount available under the revolving line of credit is $12.5 million. The interest rate on borrowings under this revolving line of credit is equal to the bank's prime rate. See Note 5 of Notes to Consolidated Financial Statements. Management believes that the Company's cash and cash equivalents, short-term investments, cash flow from operations and revolving line of credit agreement are adequate to finance its planned growth and operating needs for the next 12 months. In 1998, the Company entered into an operating lease transaction providing for the financing of $10 million for the acquisition of certain test equipment. Payments under this lease began in fiscal 1998. If at the end of the lease term the Company does not purchase the property, the Company would guarantee a residual value to the lessor equal to a specified percentage of the lessor's cost of the facility and equipment. See Note 11 of Notes to Consolidated Financial Statements. Impact of Recent Accounting Pronouncements In June 1997, the Financial Accounting Standards Board issued SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997. The Company has determined that the impact of adopting the standard will not be material to the financial position or results of operations of the Company. In June 1997, the Financial Accounting Standards Board issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 establishes standards for the reporting of operating segment information in annual financial statements and in interim financial reports issued to shareholders. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997. Adoption of this standard will result only in additional disclosures. 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. In fiscal 1998, two customers accounted for 23% and 15% of total revenues. 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. From time to time, the Company has also 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 technologies. 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 During 1998, the Company began volume commercial production at its six-inch wafer fabrication facility in Colorado Springs, Colorado. The facility includes a 10,000-square- foot Class 1 clean room with capacity for future expansion to 15,000 square feet. The successful continued 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 limited experience with the operation of equipment or the processes involved in producing finished six-inch wafers. 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 continue successful operation of the new wafer fabrication facility could 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 limited experience in coordinating and managing full-scale production facilities that are located at different sites. The failure to successfully coordinate and manage the two sites could adversely affect the Company's overall production and could have a material adverse effect on its business, operating results or financial condition. Competition The high-performance semiconductor market is highly competitive and subject to rapid technological change, price erosion and heightened international competition. The communications and ATE industries, which are primary target markets for the Company, are also becoming intensely competitive because of deregulation and heightened international competition, among other factors. The Company currently competes against other GaAs fabrication operations of systems companies, such as Rockwell, and Silicon IC manufacturers employing ECL and BiCMOS technologies such as Fujitsu, Hewlett-Packard, Motorola, National Semiconductor, Texas Instruments and Applied Micro Circuits 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 or BiCMOS semiconductors or about the risks associated with relying on a relatively small company for a critical sole-sourced component. Asian Economic Issues The Company's international business is subject to risks customarily encountered in foreign operation, including the recent financial turmoil in Asia. Although management believes the financial turmoil in Asia will not have a material impact on the financial statements, there can be no assurance that the Company will not be affected by such economic issues in Asia. 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 on 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 since the Company has no internal capability to perform such plastic packaging. The balance of the Company's ICs are packaged in its Camarillo facility using customized ceramic packaging which is presently sole sourced. Other components and materials for H-GaAs ICs are available from only a limited number of sources. 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. Variability of Manufacturing Yields The Company's manufacturing yields vary 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 reduced gross profit and net income. As most work-in-process inventory consists of wafers at various stages of fabrication, the Company estimates yields per wafer in order to estimate the value of inventory. If yields are materially different from projected, work-in-process inventory may need to be revalued. 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. Environmental Regulations The Company is subject to a variety of federal, state and local government 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 cessation of operations. In addition, such regulation could restrict the Company's ability to expand its operations at its present locations or could require the Company to acquire costly equipment or to incur other significant expenses to comply with governmental regulations or to clean up prior discharges. Management of Growth The management of the Company's growth requires qualified personnel and systems. In particular, the operation of the Company's wafer fabrication facility in Colorado Springs and its integration with the Company's Camarillo facility 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 Colorado Springs 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. Year 2000 The "Year 2000 Problem" is the result of computer programs being written using two digits rather than four to define the applicable year. This can affect both information technology (IT) and non-IT systems, as non-IT systems typically include embedded technology such as microcontrollers. The Company is evaluating and addressing Year 2000 issues associated with its IT and non-IT systems. Many of the IT and non-IT systems are compliant. 'ther systems, which have been identified as noncompliant, are planned to be replaced or upgraded. Certain non-IT systems in Vitesse's manufacturing facility have not been fully evaluated for Year 2000 compliance. The Company anticipates that remediation and testing will be substantially complete not later than July 1999 at a cost not material to the consolidated financial statements. The Company's products have no specific date functions or date dependencies and will operate according to specifications through the Year 2000 date rollover and thereafter. The Company may also be affected by customer or supplier Year 2000 issues. The Company is contacting critical suppliers of products and services to determine that the suppliers' operations and the products and services they provide are Year 2000 compliant, or to monitor their progress toward Year 2000 compliance. Management believes that Year 2000 issues will not materially impact the Company's business, operating results or financial condition. The most reasonably likely worst case would be minor delays in production and shipments. The Company has not yet fully developed contingency plans to address any failure of its Year 2000 risk assessment plan to identify and fully remediate any significant risk to its ongoing operations. Development of contingency plans is in progress and will be completed by July 1999. Independent auditors' report The Board of Directors and Shareholders Vitesse Semiconductor Corporation: We have audited the accompanying consolidated balance sheets of Vitesse Semiconductor Corporation and subsidiaries as of September 30, 1998 and 1997, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the years in the three-year period ended September 30, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Vitesse Semiconductor Corporation and subsidiaries as of September 30, 1998 and 1997 and the results of their operations and their cash flows for each of the years in the three-year period ended September 30, 1998 in conformity with generally accepted accounting principles. KPMG PEAT MARWICK LLP Los Angeles, California October 14, 1998 consolidated balance sheets
September 30, 1998 and 1997 September 30, (in thousands, except share data) 1998 1997 - --------------------------------------------------------------------------------------------------------- Assets Current assets: Cash and cash equivalents $ 70,684 $ 97,358 Short-term investments 91,610 58,486 Accounts receivable, net of allowance for doubtful accounts of $1,000 in 1998 and 1997 39,953 21,072 Inventories, net 16,795 11,809 Prepaid expenses 3,008 1,121 Deferred tax assets, net 20,982 14,800 - --------------------------------------------------------------------------------------------------------- Total current assets 243,032 204,646 ------------------------------------------------------------------------------------------------------ Property and equipment, net 56,455 41,684 Restricted long-term deposits 68,704 45,556 Other assets 220 394 - --------------------------------------------------------------------------------------------------------- $368,411 $292,280 ------------------------------------------------------------------------------------------------------ Liabilities And Shareholders' Equity Current liabilities: Accounts payable $ 13,898 $ 19,758 Accrued expenses and other current liabilities 13,680 7,017 Capital lease obligations and term loans 145 403 Total current liabilities 27,723 27,178 -------------------------------------------------------------------------------------------------------- Commitments and contingencies Shareholders' equity: Preferred stock, $.01 par value. Authorized 10,000,000 shares; none issued or outstanding - - Common stock, $.01 par value. Authorized 100,000,000 shares; issued and outstanding 73,788,136 and 71,827,476 shares at September 30, 1998 and 1997, respectively 738 718 Additional paid-in capital 299,503 276,810 Retained earnings (accumulated deficit) 40,447 (12,426) - --------------------------------------------------------------------------------------------------------- Net shareholders' equity 340,688 265,102 ------------------------------------------------------------------------------------------------------ $368,411 $292,280 - ---------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
consolidated statements of operations Years ended September 30, 1998, 1997 and 1996 Years ended September 30, (in thousands, except per share data) 1998 1997 1996 Revenues $175,082 $104,850 $66,046 - ----------------------------------------------------------------------------------------------------- Costs and expenses: Cost of revenues 69,352 45,500 31,792 Engineering, research & development 27,915 16,804 11,045 Selling, general & administrative 21,059 13,884 9,777 ---------------------------------------------------------------------------------------------------- Total costs and expenses 118,326 76,188 52,614 -------------------------------------------------------------------------------------------------- Income from operations 56,756 28,662 13,432 Other income, net 9,195 7,878 618 - ----------------------------------------------------------------------------------------------------- Income before income taxes 65,951 36,540 14,050 Income taxes 13,078 3,652 1,405 Net income $ 52,873 $ 32,888 $12,645 - ----------------------------------------------------------------------------------------------------- Net income per share: Basic $ 0.73 $ 0.48 $ 0.24 Diluted $ 0.67 $ 0.43 $ 0.21 ---------------------------------------------------------------------------------------------------- Shares used in per share computations: Basic 72,711 68,390 52,151 Diluted 79,219 75,703 59,613 ----------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. consolidated statements of shareholders' equity
Retained Additional Earnings Net Years ended September 30, 1998, 1997 and 1996 Common Stock Paid-in (Accumulated Shareholders' (in thousands, except share data) Shares Amount Capital Deficit) Equity - ------------------------------------------------------------------------------------------------------------------------------------ Balance, October 1, 1995 46,529,274 $465 $ 82,494 $(57,959) $ 25,000 Exercise of stock options 2,917,248 29 3,382 - 3,411 Exercise of warrants 170,830 2 13 - 15 Shares issued under Employee Stock Purchase Plan 322,230 3 972 - 975 Issuance of common stock, net of expenses 8,280,000 83 46,241 - 46,324 Net income - - - 12,645 12,645 - ------------------------------------------------------------------------------------------------------------------------------------ Balance, September 30, 1996 58,219,582 582 133,102 (45,314) 88,370 Exercise of stock options 3,120,558 31 5,621 - 5,652 Shares issued under Employee Stock Purchase Plan 142,416 1 1,596 - 1,597 Issuance of common stock, net of expenses 10,350,000 104 118,094 - 118,198 Repurchase of fractional shares related to stock split (5,080) - (3) - (3) Tax benefit of disqualifying dispositions - - 18,400 - 18,400 Net income - - - 32,888 32,888 - ------------------------------------------------------------------------------------------------------------------------------------ Balance, September 30, 1997 71,827,476 718 276,810 (12,426) 265,102 Exercise of stock options 1,843,297 19 6,258 - 6,277 Shares issued under Employee Stock Purchase Plan 117,363 1 2,239 - 2,240 Tax benefit of disqualifying dispositions - - 14,196 - 14,196 Net income - - - 52,873 52,873 Balance, September 30, 1998 73,788,136 $738 $299,503 $ 40,447 $340,688 - ------------------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. consolidated statements of cash flows
Years ended September 30, 1998, 1997 and 1996 Years ended September 30, (in thousands) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------------------ Cash flows from operating activities: Net income $ 52,873 $ 32,888 $ 12,645 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 14,900 6,938 4,973 Deferred tax assets 8,010 3,600 - Changes in assets and liabilities: Receivables, net (18,881) (2,453) (5,889) Inventories, net (4,986) (1,850) (64) Prepaid expenses (1,887) (280) (299) Other assets 174 275 98 Accounts payable (5,860) 13,027 3,178 Accrued expenses and other current liabilities 6,664 3,039 2,094 ------------------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 51,007 55,184 16,736 ---------------------------------------------------------------------------------------------------------------------------- Cash flows from investing activities: Short-term investments (33,124) (58,486) - Restricted long-term deposits (23,148) (45,556) - Capital expenditures (29,671) (30,730) (11,003) - ------------------------------------------------------------------------------------------------------------------------------------ Net cash used in investing activities (85,943) (134,772) (11,003) - ------------------------------------------------------------------------------------------------------------------------------------ Cash flows from financing activities: Principal payments under capital lease obligations and term loans (255) (934) (7,632) Proceeds from term loans - - 245 Repayments of short-term borrowings - - (2,950) Net proceeds from issuance of common stock 8,517 125,444 50,725 - ------------------------------------------------------------------------------------------------------------------------------------ Net cash provided by financing activities 8,262 124,510 40,388 ------------------------------------------------------------------------------------------------------------------------------ Net increase (decrease) in cash and cash equivalents (26,674) 44,922 46,121 Cash and cash equivalents at beginning of year 97,358 52,436 6,315 Cash and cash equivalents at end of year $ 70,684 $ 97,358 $ 52,436 - ------------------------------------------------------------------------------------------------------------------------------------ Supplemental disclosures of cash flow information Cash paid during the year for: Interest $ 35 $ 165 $ 656 Income taxes $ 1,703 $ 296 $ 347 - ------------------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. notes to consolidated financial statements Note 1 - The Company and Its Significant Accounting Policies Description of Business Vitesse Semiconductor Corporation was incorporated under the laws of Delaware on February 3, 1987. Vitesse Semiconductor Corporation is a leader in the design, development, manufacturing and marketing of digital GaAs ICs. Principles of Consolidation The consolidated financial statements include the accounts of Vitesse Semiconductor Corporation and its wholly-owned subsidiaries (collectively, the Company). All significant intercompany accounts and transactions have been eliminated in consolidation. Revenue Recognition Production revenue is recognized when products are shipped to customers. Revenue from development contracts is recognized upon attainment of specific milestones established under customer contracts. Revenue from products deliverable under development contracts, including design tools and prototype products, is recognized upon delivery. Costs related to development contracts are expensed as incurred. Cash Equivalents and Short-term Investments The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. Cash equivalents and short-term investments are principally composed of money market accounts and obligations of the U.S. government and its agencies. Pursuant to Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" (SFAS No. 115), the Company classifies its securities included under short-term investments as held-to-maturity securities, which are recorded at amortized cost, adjusted for the amortization or accretion of premiums or discounts. As of September 30, 1998 and 1997, carrying value was substantially the same as market value. Inventories Inventories are stated at the lower of cost (determined by the first-in, first-out method) or market (net realizable value). Costs associated with the manufacture of a new product are charged to engineering, research and development expense as incurred until the product is proven through testing and acceptance by the customer. Inventories are shown net of a valuation reserve of $4,155,000 and $3,121,000 at September 30, 1998 and 1997, respectively. Depreciation Depreciation of property and equipment is provided on the straight-line method over the estimated useful lives of the related assets as follows: Machinery and equipment 5 years Furniture and fixtures 5 years Computer equipment 3 years Leasehold improvements Term of lease Income Taxes The Company accounts for income taxes pursuant to the provisions of Financial Accounting Standards Board Statement No. 109. Under the asset and liability method of Statement No. 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Research and Development Costs The Company charges all research and development costs to expense when incurred. Manufacturing costs associated with the development of a new fabrication process or a new product are expensed until such times as these processes or products are proven through final testing and initial acceptance by the customer. Costs related to revenues on nonrecurring engineering services billed to customers are generally classified as cost of revenues; however, certain related contract engineering and research costs are included in engineering, research and development expense because these costs cannot be directly related to individual contracts. Computation of Net Income per Share In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings per Share." SFAS No. 128 replaced the previously reported primary and fully diluted earnings per share with basic and diluted earnings per share and became effective for both interim and annual periods ending after December 15, 1997. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options and convertible securities. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. All earnings per share amounts for all periods presented have been restated to conform to the SFAS No. 128 requirements. The reconciliation of shares used to calculate basic and diluted income per share consists of the following (in thousands):
1998 1997 1996 - -------------------------------------------------------------------------------- Shares used in basic per share computations - weighted average shares outstanding 72,711 68,390 52,151 Net effect of dilutive common share equivalents based on treasury stock method 6,508 7,313 7,462 - -------------------------------------------------------------------------------- Shares used in diluted per share computations 79,219 75,703 59,613
Options to purchase 26,745 and 61,836 shares were outstanding at September 30, 1998 and 1997, respectively, but were not included in the computation of diluted net income per share because the exercise price of the options was greater than the average market price of the common shares, and therefore, the effect would be antidilutive. Financial Instruments The Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments," defines fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties. The Company's carrying value of cash equivalents, short-term investments, restricted long-term deposits, accounts receivable, accounts payable, accrued expenses, capital lease obligations and term loans approximates fair value because the instrument has a short-term maturity or because the applicable interest rates are comparable to current borrowing rates of those instruments. Long-Lived Assets In 1997, the Company adopted Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." This statement provides guidelines for recognition of impairment of losses related to long-term assets. The adoption of this new standard did not have a material effect on the Company's financial statements. Accounting for Stock Options In October 1995, Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation," was issued. This statement encourages, but does not require, a fair value based method of accounting for employee stock options. The Company has elected to continue to measure and to recognize compensation costs under APB Opinion No. 25, "Accounting for Stock Issued to Employees," and to adopt the disclosure-only requirements of Statement No. 123. Use of Estimates Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities to prepare these financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates. Reclassifications and Restatements Certain reclassifications have been made to the prior year financial statements to conform to the current year presentation. On April 22, 1998, the Company's Board of Directors announced a 2 for 1 stock split of the common stock effected in the form of a stock dividend to shareholders of record as of May 4, 1998. On January 29, 1997, the Company's Board of Directors announced a 3 for 2 stock split of the common stock effected in the form of a stock dividend to shareholders of record as of February 12, 1997. Accordingly, historical share and per share amounts have been restated to reflect retroactively the stock splits. Note 2 - Inventories Inventories consist of the following:
September 30, 1998 1997 - ------------------------------------------------------------------------------------------------------------------------------------ (in thousands) Raw materials $ 2,949 $ 2,421 Work in process 10,561 6,762 Finished goods 3,285 2,626 $16,795 $11,809 - ------------------------------------------------------------------------------------------------------------------------------------
Note 3 - Property and Equipment Property and equipment, stated at cost, are summarized as follows:
September 30, 1998 1997 - ------------------------------------------------------------------------------------------------------------------------------------ (in thousands) Machinery and equipment $71,155 $53,807 Furniture and fixtures 1,424 747 Computer equipment 14,580 10,652 Leasehold improvements 6,880 4,423 Land 1,039 - - ------------------------------------------------------------------------------------------------------------------------------------ 95,078 69,629 Less accumulated depreciation 38,623 27,945 $56,455 $41,684 - ------------------------------------------------------------------------------------------------------------------------------------
Included in property and equipment are items not yet placed in service of $5,140,000 and $17,688,000 as of September 30, 1998 and 1997, respectively. Note 4 - Term Loans The Company has various equipment term loans totaling $145,000 at September 30, 1998, bearing interest rates between 9% and 10% per annum payable in monthly installments through fiscal 1999. Note 5 - Revolving Line of Credit The Company has a $12,500,000 revolving line of credit agreement with a bank, which expires in January 1999. The agreement provides for interest to be paid monthly at the bank's prime rate (8.5% on September 30, 1998). The Company must adhere to certain requirements and provisions to be in compliance with the terms of the agreement and is prohibited from paying dividends without the consent of the bank. As of September 30, 1998 and 1997, no amounts were outstanding under the line of credit. Note 6 - Accrued Expenses Accrued expenses consist of the following:
September 30, 1998 1997 - -------------------------------------------------------------------------------- (in thousands) Accrued vacation $ 1,231 $ 756 Accrued salaries, wages and bonuses 3,661 3,156 Accrued income taxes 4,199 825 Other 4,589 2,280 $13,680 $7,017 - --------------------------------------------------------------------------------
Note 7 - Shareholder's Equity Preferred Stock In fiscal 1991, the Board of Directors authorized 10,000,000 shares of undesignated preferred stock. The Company has no present plans to issue any of this preferred stock. Common Stock In 1998, the Company's shareholders approved an increase in the number of authorized shares of common stock from 50,000,000 to 100,000,000. Stock Option Plans The Company currently has three stock option plans in place: the 1987 Stock Option Plan, the 1989 Stock Option Plan and the 1991 Stock Option Plan (collectively referred to as the "Plans"). The 1987 Stock Option Plan expired in fiscal 1997 and consequently no additional options are available for grant from this plan. The 1989 Plan was adopted by the Board of Directors in April 1989 and approved by the shareholders in April 1990. Pursuant to the 1989 Plan, 1,750,000 shares of the Company's common stock were reserved for issuance. The 1991 Plan was adopted by the Board of Directors and approved by the shareholders in August 1991. Pursuant to the 1991 Plan the number of shares reserved under the Plan automatically increases by a number of shares equal to 3.5% of the Company's common stock outstanding at the end of each fiscal year. The Plans provide for the granting of incentive stock options to employees of the Company and for the granting of nonstatutory stock options to employees and consultants of the Company. Options granted under the Plans generally vest and become exercisable at the rate of 25% per year; however, certain options granted prior to June 30, 1992, under the 1991 Plan and all of the options under the 1987 and 1989 Plans vest and become exercisable at the rate of 24% at the end of the first year, and thereafter at a rate of 2% of the shares subject to the options per month. The exercise price of all incentive and nonstatutory stock options granted under the Plans must be at least equal to the fair market value of the shares of common stock on the date of grant. With respect to any participant who owns stock possessing more than 10% of the voting power of all classes of stock of the Company, the exercise price of any incentive stock option granted must equal at least 110% of the fair market value on the grant date and, in the case of the 1991 Plan, the maximum term of such options must not exceed five years. The term of all other options under the 1991 Plan and all options under the 1987 Plan and 1989 Plan may not exceed 10 years. Under the 1987 Plan, the 1989 Plan and the 1991 Plan, as of September 30, 1998, options to purchase an aggregate of 10,228,735 shares had been exercised, options to purchase an aggregate of 10,294,601 shares were outstanding at a weighted average exercise price of $10.19 per share and 191,812 shares (which increased to 2,774,396 effective October 1, 1998, pursuant to the terms of the 1991 Plan) remained available for future grant. Of the 10,294,601 options outstanding, 1,562,914 options were vested and exercisable under the Plans pursuant to incentive stock options and 989,906 options were vested and exercisable pursuant to nonstatutory stock options. 1991 Directors' Stock Option Plan The 1991 Directors' Stock Option Plan (the Directors' Plan) was adopted by the Board of Directors and approved by the shareholders in August 1991. Pursuant to the Directors' Plan, 1,200,000 shares have been reserved for issuance. As of September 30, 1998, 1,005,000 options had been granted under the Directors' Plan; 559,200 of such grants had been exercised and 97,200 had been canceled. At September 30, 1998, 130,800 options were exercisable. The Directors' Plan provides that each non-employee director automatically will be granted a nonstatutory option to purchase 20,000 shares (except in the case of the Chairman of the Board of the Company who shall receive an option to purchase 30,000 shares) of common stock upon first becoming a director. In addition, the Directors' Plan provides that each director serving on January 1 of each calendar year will automatically be granted a nonstatutory option to purchase 20,000 shares (except in the case of the Chairman of the Board of the Company who shall receive an option to purchase 30,000 shares) of common stock. The options granted to the non-employee directors are for a 10-year term and vest at the rate of 2% of the shares subject to the option at the end of each month following the date of grant. The exercise price of the options may not be less than the fair market value of the common stock on the last business day prior to the date of grant of the option. Activity under the 1987, 1989 and 1991 Plans and the 1991 Directors' Stock Option Plan is as follows:
Number of Option Price Shares Per Share Aggregate - ------------------------------------------------------------------------------------------------------------------------------------ (in thousands) Options outstanding at October 1, 1995 9,547,070 $ .01 - 3.89 $ 13,621 Options: Granted 3,571,800 3.67 - 11.92 15,346 Exercised (2,917,248) .01 - 3.13 (3,411) Canceled or expired (427,544) 1.21 - 4.63 (1,057) - ------------------------------------------------------------------------------------------------------------------------------------ Options outstanding at September 30, 1996 9,774,078 .01 - 11.92 24,499 Options: Granted 3,096,402 10.42 - 25.25 38,977 Exercised (3,120,558) .01 - 14.07 (5,652) Canceled or expired (142,824) 1.38 - 14.46 (959) - ------------------------------------------------------------------------------------------------------------------------------------ Options outstanding at September 30, 1997 9,607,098 .01 - 25.25 56,865 Options: Granted 3,189,450 16.44 - 31.25 61,735 Exercised (1,843,297) .01 - 18.88 (6,277) Canceled or expired (310,050) 1.50 - 28.19 (3,828) - ------------------------------------------------------------------------------------------------------------------------------------ Options outstanding at September 30, 1998 10,643,201 $ .05 - 31.25 $108,495 - ------------------------------------------------------------------------------------------------------------------------------------
The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation." The Company used the Black-Scholes option pricing model to value stock options for pro forma presentation. The assumptions used to estimate the value of options under the various stock option plans and the shares under the Employee Stock Purchase Plan are as follows:
Employee Stock Option Stock Purchase Plan Shares Plan Shares 1998 1997 1998 1997 - -------------------------------------------------------------------------------- Average expected life (years) 5.39 5.45 0.50 0.50 Expected volatility 0.51 0.55 0.51 0.55 Risk-free interest rate 4.40% 5.81% 4.22% 5.50% Dividends - - - - Weighted average fair values $10.15 $7.07 $8.05 $5.13
Pro forma compensation costs for fiscal 1998 and 1997 awards under the stock option and stock purchase plans recognized in accordance with SFAS No. 123 would reduce the Company's net income from $52.9 million (basic income per share of $0.73 and diluted income per share of $0.67 per share) to $42.9 million (basic income per share of $0.59 and diluted income per share of $0.54 per share) in fiscal 1998, and from $32.9 million (basic income per share of $0.48 and diluted income per share of $0.43) to $27.6 million (basic income per share of $0.40 per share and diluted income per share of $0.36) in fiscal 1997. Pro forma net income reflects only options granted and shares issued in fiscal 1998 and fiscal 1997. Because the pro forma compensation cost for the stock option program is recognized over the four-year vesting period, the foregoing pro forma reductions in the Company's net income are not representative of anticipated amounts in future years. The following table summarizes information regarding options outstanding and options exercisable at September 30, 1998:
Options Outstanding Options Exercisable Weighted Number Average Weighted Number Weighted Range of Outstanding Remaining Average Exercisable Average Exercise Prices As of 9/30/98 Contractual Life Exercise Price As of 9/30/98 Exercise Price $ 0.05 - $ 3.75 4,492,243 6.56 $ 2.65 2,179,085 $ 2.24 $ 3.87 - $14.46 2,751,158 8.31 $10.97 1,107,846 $10.94 $15.75 - $18.87 2,830,800 9.22 $18.79 509,025 $18.79 $19.12 - $31.25 569,000 9.24 $23.24 55,150 $22.55 - ------------------------------------------------------------------------------------------------------------------------------------ $ 0.05 - $31.25 10,643,201 7.86 $10.19 3,851,106 $ 7.22
1991 Employee Stock Purchase Plan The Company's 1991 Employee Stock Purchase Plan (the Purchase Plan) was adopted by the Board of Directors and approved by the shareholders effective December 11, 1991. A total of 1,500,000 shares of common stock has been reserved for issuance under the Purchase Plan. Under the Purchase Plan, eligible employees may purchase shares of the Company's common stock at six-month intervals at 85% of the lower of the fair market value on the first or the last day of each six-month period. Employees may purchase shares having a value not exceeding 20% of their compensation, including commissions and overtime, but excluding bonuses. Employees may end their participation in the offering at any time during the offering period, and participation ends automatically on termination of employment with the Company. In fiscal 1998 and 1997, 117,363 and 142,416 shares, respectively, were issued under the Purchase Plan at average prices of $19.09 and $11.21. At September 30, 1998, 771,077 shares were reserved for future issuance. Note 8 - Income Taxes Income tax expense consists of the following:
September 30, 1998 1997 1996 - -------------------------------------------------------------------------------- (in thousands) Current: Federal $ 9,775 $ - $ 300 State 6,563 101 755 Foreign - - 350 $16,338 $ 101 $1,405 - -------------------------------------------------------------------------------- Deferred: Federal $ (946) $ 3,018 $ - State (2,314) 533 - $(3,260) $ 3,551 $ - - -------------------------------------------------------------------------------- Total: Federal $ 8,829 $ 3,018 $ 300 State 4,249 634 755 Foreign - - 350 $13,078 $ 3,652 $1,405 - --------------------------------------------------------------------------------
The actual income tax expense differs from the expected tax expense computed by applying the federal corporate tax rate of 35% for the years ended September 30, 1998, 1997 and 1996, to income before income taxes as follows:
September 30, 1998 1997 1996 - ----------------------------------------------------------------------------------------------------- (in thousands) Federal income taxes at statutory rate $ 23,083 $ 12,790 $ 4,918 State income taxes, net of federal benefit 4,139 2,146 755 Alternative minimum taxes -- -- 300 Foreign income taxes -- -- 350 Research & development credits (595) (700) -- Adjustment for deferred tax assets for enacted changes in tax laws and rates -- (479) -- Reduction in valuation allowance (net of valuation allowance of $2,923 in 1998 credited to Shareholders equity) (14,124) (10,105) (4,918) Other 575 -- -- - ----------------------------------------------------------------------------------------------------- $ 13,078 $ 3,652 $ 1,405 - -----------------------------------------------------------------------------------------------------
The tax effects of temporary differences that give rise to a significant portion of the deferred tax assets are summarized as follows (in thousands):
September 30, 1998 1997 - ------------------------------------------------------------------ Deferred tax assets: Net operating loss carryforwards $ 8,423 $ 22,114 Research & development tax credits 4,582 3,995 Allowances and reserves 4,256 2,981 Accumulated depreciation & amortization 510 1,620 Federal AMT and foreign tax credits 851 18 California manufacturers investment credit 1,144 491 State taxes 812 -- Other 404 628 - ------------------------------------------------------------------ Total gross deferred tax assets 20,982 31,847 Less valuation allowance -- (17,047) - ------------------------------------------------------------------ Net deferred tax assets $20,982 $ 14,800 - ------------------------------------------------------------------
In assessing the realizability of deferred tax assets, management considered whether it is more likely than not that some portions or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent on the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the projected future taxable income and tax-planning strategies in making this assessment. Based on the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, the Company has eliminated the valuation allowance for all deductible differences. Management believes that it is more likely than not that the results of future operations will generate sufficient taxable income to realize the net deferred tax assets. During fiscal 1998, the Company recognized tax benefits associated with employee stock options aggregating $11,273,000. Such benefits have been recorded directly to shareholders equity. The change in the valuation allowance for the year ended September 30, 1998 was $17,047,000, of which $14,124,000 reduced income tax expense for the year. The remaining $2,923,000 was credited to additional paid-in capital which was the amount attributable to net operating losses created by the exercise of stock options previously unrecognized. As of September 30, 1998, the Company had net operating loss carryforwards for federal and state income tax purposes of $22,546,000 and $10,009,000, respectively, which are available to offset future taxable income through 2012 and 2003, respectively. Additionally, the Company had research and development tax credit carryforwards for federal and state income tax purposes of $3,623,000 and $1,477,000, respectively, which are available to offset future income taxes, if any, through 2013. Note 9 - Significant Customers, Concentration of Credit Risk and Segment Information In fiscal 1998, two customers accounted for 23% and 15% of total revenues. In fiscal 1997, three customers accounted for 22%, 20% and 12% of total revenues. In fiscal 1996, two customers accounted for 25% and 11% of total revenues. The Company generally sells its products to customers engaged in the design and/or manufacture of high technology products either recently introduced or not yet introduced to the marketplace. Substantially all the Company's trade accounts receivable are due from such sources. The Company's major customers who account for more than 10% of total revenues aggregated 41% and 44% of total trade receivables at September 30, 1998 and 1997, respectively. Export revenues are summarized by geographic areas as follows (in thousands): 1998 1997 1996 - -------------------------------------------------------------- Europe $18,197 $ 6,452 $ 6,505 Japan 13,603 24,102 7,972 Other 12,052 4,849 1,147 $43,852 $35,403 $15,624 - -------------------------------------------------------------- Note 10 - Retirement Savings Plan The Company has a qualified retirement plan under the provisions of Section 401(k) of the Internal Revenue Code covering substantially all employees. Participants in this plan may defer up to the maximum annual amount allowable under IRS regulations. The contributions are fully vested and nonforfeitable at all times. The Company does not make matching contributions under the plan. Note 11 - Commitments and Contingencies The Company leases facilities under noncancelable operating leases that expire through 2003. The Company also leases certain machinery and equipment under noncancelable operating leases that expire through 2003. Approximate minimum rental commitments under these operating leases as of September 30, 1998, were as follows (in thousands): Year ending September 30: - ------------------------------------------------------------------------------ 1999 $1,221 2000 1,183 2001 1,024 2002 897 2003 787 $5,112 - ------------------------------------------------------------------------------ Rent expense under operating leases was approximately $1,844,000, $1,980,000 and $2,507,000 for the years ended September 30, 1998, 1997 and 1996, respectively. In October 1996, the Company entered into a five-year operating lease agreement with a bank providing for $27.5 million of financing for the acquisition and construction of a wafer fabrication facility in Colorado Springs, Colorado. Payments under this lease commenced in fiscal 1998 and are based on LIBOR rates plus a spread of 1.75%. The Company has the option to renew the lease for an additional three-year term. The Company has the option of purchasing the property at the end of the initial lease term, and at the end of each renewal period for the lessor's original cost, which is not less than the fair market value at each option date. If at the end of the lease term the Company does not purchase the property, the Company would guarantee a residual value to the lessor equal to 84% of the lessor's cost of the facility, equal to $23,100,000. As of September 30, 1998, the lessor had advanced a total of $26,987,000 under this lease and had held $22,669,000 as cash collateral, which amount is included in restricted long-term deposits. In August 1997, the Company entered into a three-year operating lease arrangement with the same bank providing for $45 million of financing for the acquisition of capital equipment for the Colorado Springs wafer fabrication facility. The Company has the option to renew the lease for up to two one-year extensions. Payments under this lease commenced in fiscal 1998 and are based on LIBOR rates plus a spread of 1.50%. The Company has the option of purchasing the property at the end of the initial lease term, and at the end of each renewal period for the lessor's original cost, which is not less than the fair market value at each option date. If at the end of the lease term the Company does not purchase the equipment, the Company would guarantee a residual value to the lessor equal to 86% of the lessor's cost of the equipment, equal to $38,700,000. As of September 30, 1998, the lessor had advanced a total of $45,000,000 under this lease and had held $36,000,000 as cash collateral, which amount is included in restricted long-term deposits. In July 1998, the Company entered into a four-year operating lease arrangement with a bank providing for $10 million of financing for the acquisition of certain test equipment. The Company has the option to renew the lease for one year. Payments under this lease began in fiscal 1998 and are based on the 30-Day Commercial Paper rate plus a spread of 1.5%. The Company has the option of purchasing the property at the end of the initial lease term, and at the end of each renewal period for the lessor's original cost, which is not less than the fair market value at each option date. If at the end of the lease term the Company does not purchase the equipment, the Company would guarantee a residual value to the lessor equal to 86% of the lessor's cost of the equipment, equal to $8,600,000. As of September 30, 1998, the lessor had advanced a total of $3,258,000 under this lease and had held $2,607,000 as cash collateral, which amount is included in restricted long-term deposits. The $27.5 million and the $45 million operating leases require the Company to meet certain financial and other covenants, including a restriction on the payment of cash dividends to its shareholders. As of September 30, 1998, the Company was in compliance with all covenants. The Company is a party to various investigations, lawsuits and claims arising in the normal course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company's consolidated financial position, results of operations or liquidity. Note 12 - Subsequent Event (unaudited) In November 1998, the Company entered into an agreement to acquire all of the outstanding capital stock of Vermont Scientific Technologies, Inc. for $16 million in cash. The transaction will be accounted for as a purchase. Officers Louis R. Tomasetta President and Chief Executive Officer, Director Ian Burrows Vice President, Fab 1 - Camarillo Robert Cutter Vice President Manufacturing and General Manager, Colorado Springs Ira Deyhimy Vice President, Product Development Christopher R. Gardner Vice President and General Manager, ATE Division Eugene F. Hovanec Vice President, Finance and Chief Financial Officer Jeanne Johnson Vice President, Human Resources James Mikkelson Vice President and Chief Technology Officer Michael S. Millhollan Vice President and General Manager, Data Communications Division Robert R. Nunn Vice President and General Manager, Telecommunications Division Neil J. Rappaport Vice President, Sales Ram Venkataraman Vice President, Quality Directors James A. Cole General Partner of Windward Ventures Alex Daly President and Chief Executive Officer, Cygnus Solutions, Inc. Pierre R. Lamond Chairman of the Board, Vitesse Semiconductor Corporation General Partner of Sequoia Capital John C. Lewis Chairman of the Board, Amdahl Corporation Louis R. Tomasetta President and Chief Executive Officer, Vitesse Semiconductor Corporation Corporate Information Stock Listing: Common stock traded on Nasdaq National Market System Symbol: VTSS Options: The Company's options are traded on the Chicago Board Option Exchange General Counsel Wilson, Sonsini, Goodrich & Rosati 650 Page Mill Road Palo Alto, CA 94304-1050 Independent Auditors KPMG Peat Marwick LLP 21700 Oxnard Street, Suite 1200 Woodland Hills, CA 91367 Transfer Agent and Registrar BankBoston, N.A. c/o Boston EquiServe, LP Mail Stop 45-02-62 P.O. Box 1865 Boston, MA 02105-1865 Form 10-K The Company, upon written request, will provide without charge to each shareholder a copy of its annual report on Securities and Exchange Commission Form 10-K for the year ended September 30, 1998. Requests should be directed to: Vitesse Semiconductor Corporation Investor Relations 741 Calle Plano Camarillo, CA 93012 Annual Meeting The Vitesse Semiconductor Corporation annual meeting will be held on Tuesday, January 26, 1999 at 10:30 a.m. at the Hyatt Westlake Plaza, 880 S. Westlake Boulevard, Westlake Village, California. EX-23.1 6 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Consent of Independent Accountants ---------------------------------- The Board of Directors Vitesse Semiconductor Corporation We consent to incorporation by reference in the registration statement (No. 333- 53463) on Form S-8 of our report dated October 14, 1998, relating to the consolidated balance sheets of Vitesse Semiconductor Corporation and subsidiaries as of September 30, 1998 and 1997, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the years in the three year period ended September 30, 1998, and related schedule, which report appears in the September 30, 1998 annual report on Form 10-K of Vitesse Semiconductor Corporation. (signed) KPMG PEAT MARWICK LLP Los Angeles, California December 21, 1998 EX-27 7 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM 1998 ANNUAL REPORT AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR YEAR SEP-30-1998 SEP-30-1997 OCT-01-1997 OCT-01-1996 SEP-30-1998 SEP-30-1997 70,684 97,358 91,610 58,486 40,953 22,072 1,000 1,000 16,795 11,809 243,032 204,646 95,078 69,629 38,623 27,945 368,411 292,280 27,723 27,178 0 147 0 0 0 0 300,241 277,528 40,447 (12,426) 368,411 292,280 175,082 104,850 175,082 104,850 69,352 45,500 118,326 76,188 0 (84) 0 0 0 157 65,951 36,540 13,078 3,652 52,873 32,888 0 0 0 0 0 0 52,873 32,888 0.73 0.48 0.67 0.43
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