Search the web
Welcome, Guest
[Sign Out, My Account]

Quotes & Info
Enter Symbol(s):
e.g. YHOO, ^DJI
Symbol Lookup | Financial Search
VTSS > SEC Filings for VTSS > Form 10-K/A on 16-Apr-2013All Recent SEC Filings

Show all filings for VITESSE SEMICONDUCTOR CORP | Request a Trial to NEW EDGAR Online Pro



Annual Report


Cautionary Statement
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled "Risk Factors" included in Part I, Item 1A. of this Annual Report on Form 10-K.
We are a leading supplier of high-performance ICs that are used primarily by manufacturers of networking systems for Carrier and Enterprise networking applications. We design, develop and market a diverse portfolio of high-performance, low-power and cost-competitive networking and connectivity IC solutions. For more than 25 years, we have been a leader in the adoption of new technologies in Carrier and Enterprise networking.
Carrier and Enterprise networks have experienced a dramatic increase in both bandwidth demands and complexity driven by the introduction of new content-rich services, the convergence of voice, video and data and enhanced 4G/LTE mobile networks. Media-rich devices such as smartphones and game consoles require increased bandwidth. New Enterprise deployment options such as cloud based servers and social media and tele-presence have also increased demand. These trends have forced a significant transition and consolidation of both Carrier and Enterprise networks to all-IP and packet-based Ethernet networks that can scale in terms of services, bandwidth and capability while lowering power consumption and acquisition and operations costs. These networks are based on technology that is significantly more sophisticated, service-aware, secure and reliable than traditional Enterprise-grade Ethernet LAN technology. Such networks are built on new technology that is often referred to as "Carrier Ethernet" in Carrier networks and "Converged Enhanced Ethernet" in Enterprise networks.
Industry Trends and Characteristics that Affect our Business In order to achieve sustained, increasing profitability, we must achieve a combination of revenue growth, consistent or improving margins and careful control of our operating expenses. We continue to focus on improving each of these components of our financial model.
Our new products, generally defined as products introduced since 2010, address the two largest and fastest growing segments of the communications industry-Carrier Ethernet and Enterprise networking. Many of our products also serve the biggest market within these segments, Carrier Mobile Infrastructure, which is beginning to require Carrier Ethernet capabilities.
Our future revenue opportunities are, in part, determined by our continuing ability to participate and capture new design wins within our major customer base. This opportunity depends in large part on our ability to develop, deploy and sell products in a timely manner with features that compete effectively in our markets.
We compete for market share based on our customers' selection of our components over those of our competitors during the design phase of our customers' systems. Our ability to compete is dependent on the needs of our customers, how well our products address these needs, our corporate relationships and a variety of other factors.
Once selected for a design win, we have a high probability of holding the majority market share for this product, typically for the lifetime of the customer's system. The design win is a critical milestone in the path to generating revenue, as our products, and our customers' products, are highly complex and typically require many years of development, testing and qualification before they reach full production. As a result, it may be difficult to forecast the potential revenue from new and existing products at the time we begin our development efforts or achieve our design wins. Our ability to improve gross margins depends upon several factors, including our ability to continue to reduce our cost of materials, assembly and test, improve manufacturing yields, migrate our products to next-generation process technology, and limit price erosion. We have active programs in place to address each of these factors.

Table of Contents

As a fabless semiconductor company, we outsource the substantial majority of our manufacturing. We must manage our supply chain efficiently to ensure competitive materials pricing and effective lead-times for the materials that we purchase. The semiconductor industry is highly cyclical. In periods of strong demand, we may experience longer lead times, and difficulties in obtaining capacity and/or meeting commitments for our required deliveries. Today, almost all of our wafer fabrication and assembly is outsourced. This production model provides us substantial advantages in terms of lower fixed costs, reduced cycle times and lower inventory levels.
Improving product yields is critical to maintaining and improving our cost of revenues. We have a team of engineers focused on yield improvements. Yields are affected by a variety of factors including design quality, wafer fabrication, assembly and test processes and controls, product volumes, and life cycles. We work closely with all our manufacturing subcontractors to improve product manufacturability and yields. We manufacture a wide variety of products, some at low volumes, which likely limits our ability to improve yields on some products. Gross margin is also impacted by the selling prices of our products, which is primarily determined by competitive factors within the specific markets we serve. Average margins vary widely within the markets we serve, with the Carrier networking market having the highest average margins and the Enterprise networking market having the lowest average margins. We endeavor to increase margins by providing products that have substantial added value relative to our competition. We also increase margins with sales from our intellectual property portfolio in the form of licensing, royalties and patent sales.
To remain competitive, we must efficiently deploy our engineering, research and development ("R&D") resources into markets that will provide our future revenue growth. The percentage of our total headcount that is attributed to R&D has steadily increased during the last three years from 46.8% in 2010 to 49.3% in 2011 and to 49.4% in 2012. A large part of this growth is in our Hyderabad, India design center where we can more efficiently design software and execute product verification and validation.
Our R&D costs increased from $45.7 million in 2009 to $51.0 million in 2010 to $53.0 million in 2011, as a result of our developing and releasing over 60 new products. Our R&D costs decreased to $42.7 million in 2012 as we consolidated our R&D locations to better focus our R&D efforts. Although we decreased our R&D costs, we have increased our headcount levels by expanding our teams in lower-cost regions that have technical talent pools and proximity to our customers. We intend to continue to focus our R&D efforts and to seek opportunities to more efficiently deploy our R&D resources into larger, growing markets.
As is common in the industry, we sell semiconductor products direct to OEMs and also use a number of distributors and logistics providers to sell products indirectly to our customer base. Product revenues from direct customer sales were $53.2 million or 48.4% of product revenue in fiscal year 2012, compared to $73.6 million or 55.4% of product revenue in fiscal year 2011, and $82.5 million or 49.8% of product revenue in fiscal year 2010. Revenues from direct customer sales, as a percentage of total sales, declined in 2012 due to declining sales to our largest direct customers.
In the normal course of business, we regularly assess our product portfolio to ensure it aligns with our strategy. At such time, we may make the determination to phase out products ("end-of-life"). When we end-of-life a product, we typically provide up to six months notice for our customers to make a last-time-buy of product and six additional months to take receipt of that product. As a result, the end-of-life announcement can result in near-term increases in our revenues as customers typically respond to these announcements by making last-time-buys to ensure that they have adequate stock on hand to support their production forecast. In 2012, we announced the end-of-life of several legacy products, allowing us to focus our manufacturing and distribution on our new products.
Our accounting policy generally uses the "sell-through" model for sales to our distributors. The "sell-through" model recognizes revenue only upon shipment of the merchandise from our distributor to the final customer. Because we use the "sell-through" methodology we may have variability in our revenue from quarter to quarter as customers have substantial flexibility to reschedule backlog with most of our channel partners as part of the terms and conditions of sale. In addition, the "sell-through" policy requires that we include all distributor channel inventory on our balance sheet as part of our reported inventory. Our product revenues from channel sales were $56.7 million, $59.2 million and $83.1 million, in fiscal years 2012, 2011 and 2010, respectively.
Our sales are distributed geographically around the world. Revenue by geographic region is based upon country of billing. The geographic locations of distributors and third-party manufacturing service providers may be different from the geographic location of the ultimate end users. We believe a substantial portion of the products billed to OEMs and third-party manufacturing service providers in the Asia Pacific region are ultimately shipped to end-markets in the United States and Europe. In 2012, 34.8% of our sales were to the United States, 52.1% to Asia and 13.1% to Europe, the Middle East and Africa

Table of Contents

("EMEA"). In 2011, 36.7% of our sales were to the United States, 45.3% to Asia and 18.0% to EMEA. In 2010, 32.7% of our sales were to the United States, 50.6% to Asia, and 16.7% to EMEA.
Realization of Our Strategy
Several years ago, we embarked on the strategic mission of re-inventing Vitesse to take advantage of the dramatic ongoing transformation of our target networking markets. Our objective is to be the leading supplier of high-performance ICs for the global communications infrastructure markets. Towards that goal, we re-positioned our R&D teams and invested heavily to enter new markets, develop new products and penetrate new customers in an effort to diversify ourselves and provide new opportunities for growth.
In order to optimize the efficiency of our R&D team we chose to serve two large, growing, independent markets which rely increasingly on Ethernet technology:
Carrier networking and Enterprise networking. We estimate our total addressable market to have a CAGR of 17% and will approach $2.1 billion by 2016. The Carrier networking market includes core, metro and access equipment used for transport, switching, routing and backhaul in service provider networks. The Enterprise networking market covers Ethernet switching and routing equipment used within LANs in SME networks, SMB, and cloud and security appliances. While both market segments are unique, there is tremendous synergy and cost savings in terms of R&D effort for Ethernet switch and PHY devices allowing us to address these two large markets. Within the Carrier networking segment, our focus and growth is driven by mobile backhaul applications, and within the enterprise segment our focus and growth is driven by the migration from 100 Mbps to 1 GE and 10 GE port speeds. In both markets, Vitesse provides unique low power and low cost solutions by optimizing the feature set for target applications. As with any high technology company, growth opportunities begin with new products. Over the past three years, we introduced over 60 new products. These included many new "platform" products and technologies that will serve as the basis for future product development. These new products allowed us to substantially increase our served markets in both Carrier and Enterprise networking.
The next step to generating growth is creating market traction and design wins where we are selected by our customers over our competitors. As we have taken our new products to market, we have seen an increase in our customer engagements and the number of design opportunities that were being identified by our sales team. Early adoption of our products by our customers has exceeded our goals. In the past two years, we recorded over 600 new design wins.
Together with our customers, we are now preparing to ramp these new products. In our industry it typically takes six to twenty four months for our customers to go from first product sample received to first customer shipment as customers do the necessary development work to complete and qualify their systems in the network. In 2012, we shipped samples and pre-production on the majority of these new products, and we expect our customers to phase into volume production over the course of 2013.
In 2012, we began a migration of our revenues to our new product portfolio. In 2011, only 6% of our product revenue was from our new product portfolio. In 2012, this grew to 14% of product revenues. We expect revenue from our new products to double in 2013 compared to 2012 and double again in 2014. Augmenting our product revenues, we leverage our substantial intellectual property portfolio to generate revenues. Our primary focus for intellectual property licensing has been our Gigabit Ethernet Copper PHY and switch cores and eFEC technology. We license to non-competing third parties in adjacent or similar markets.
We have also made progress on our strategy to strengthen our operational performance and execution. Our efforts in operations include reduction in materials costs and cycle times, improved product yields, implementation of programs such as lean manufacturing, and an enhanced customer-centric focus. During the last three years, we accelerated our comprehensive efforts to increase our product gross margins and operating margins, which together have substantially increased our operating leverage. In addition, we strengthened our cash balance by reducing inventory at September 30, 2012, by $15.2 million compared to September 30, 2010.

Critical Accounting Policies and Estimates Our accounting policies are more fully described in Note 1 of the consolidated financial statements. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ significantly from those estimates. We base our estimates on

Table of Contents

historical experience and on various other assumptions that we believe are reasonable in the circumstances. We regularly discuss with our audit committee the basis of our estimates. These estimates could change under different assumptions or conditions. We believe that the following discussion addresses our most critical accounting policies, which are those that are most important to the portrayal of our financial condition and results of operations and require management's most difficult, subjective and complex judgments. Revenue Recognition
Product Revenues
In accordance with Accounting Standards Codification ("ASC") Topic 605, Revenue Recognition, we recognize product revenue when the following fundamental criteria are met: (i) persuasive evidence of an arrangement exists;
(ii) delivery has occurred; (iii) the price to the customer is fixed or determinable; and (iv) collection of the sales price is reasonably assured. Delivery occurs when goods are shipped and title and risk of loss transfer to the customer, in accordance with the terms specified in the arrangement with the customer. Revenue recognition is deferred where the earnings process is incomplete. A substantial portion of our product sales is made through distributors under agreements allowing for pricing credits and/or right of return. Our past history with these pricing credits and/or right of return provisions prevent us from being able to reasonably estimate the final price of our inventory to be sold and the amount of inventory that could be returned pursuant to these agreements. As a result, the fixed and determinable revenue recognition criterion has not been met at the time we deliver products allowing for pricing credits or right of returns. Accordingly, product revenue from sales made through these distributors is not recognized until the distributors ship the product to their customers. We also maintain inventory, or hub, arrangements with certain customers. Pursuant to these arrangements, we deliver products to a customer or a designated third-party warehouse based upon the customer's projected needs, but do not recognize revenue unless and until the customer reports that it has removed our product from the warehouse and taken title and risk of loss. From time-to-time, we may ship goods to our distributors with no pricing credits and/or no or limited right of return. Under these circumstances, at the time of shipment, product prices are fixed or determinable and the amount of future returns and pricing allowances to be granted in the future can be reasonably estimated and are accrued. Accordingly, revenues are recorded net of these estimated amounts. Intellectual Property Revenues
We derive intellectual property revenues from the sale and licensing of our intellectual property, maintenance and support fees and royalty revenue following the sale by our licensees of products incorporating the licensed technology. We enter into intellectual property licensing agreements that generally provide licensees the right to incorporate our intellectual property components in their products with terms and conditions that vary by licensee. Our intellectual property licensing agreements may include multiple elements with an intellectual property license bundled with support services. For such multiple element intellectual property licensing arrangements, we follow the guidance in ASC Topic 605-025, Multiple-Element Arrangements, to determine whether there is more than one unit of accounting.
We recognize revenue from the sale of patents when there is persuasive evidence of an arrangement, fees are fixed or determinable, delivery has occurred, and collectability is reasonably assured. All of the requirements are generally fulfilled upon execution of the patent sale arrangement.
License and contract revenues are recorded upon delivery of the technology when there is persuasive evidence of an arrangement, fees are fixed or determinable, delivery has occurred, and collectability is reasonably assured. The timing of delivery is dependent on, and varies with, the terms of each contract. Other than maintenance and support, there is no continuing obligation under these arrangements after delivery of the intellectual property. Deferred revenue is created when we bill a customer in accordance with a contract prior to having met the requirements for revenue recognition.
Certain of our agreements may contain support obligations. Under such agreements we provide unspecified bug fixes and technical support. No other upgrades, products, or post-contract support are provided. These arrangements may be renewable annually by the customer. Support revenue is recognized ratably over the period during which the obligation exists, typically 12 months or less. We recognize royalty revenue in the period in which the licensee reports shipment of products incorporating our intellectual property components. Royalties are calculated on a per unit basis, as specified in our agreement with the licensee. We may, at

Table of Contents

our discretion and in accordance with our agreements, engage a third-party to perform royalty audits of our licensees. Any correction of royalties previously reported would occur when the results are resolved.
For multiple-element arrangements, we allocate revenue to all deliverables based on their relative selling prices. In such circumstances, we use a hierarchy to determine the selling price to be used for allocating revenues to deliverables:
(i) vendor-specific objective evidence of fair value (VSOE); (ii) third-party evidence of selling price (TPE); and (iii) best estimate of the selling price (ESP). VSOE generally exists only when we sell the deliverable separately and revenue is the price actually charged by us for that deliverable. Generally, we are not able to determine TPE because our licensing arrangements differ from that of our peers. We have concluded that no VSOE or TPE exists because it is rare that either we or our competitors sell the deliverables on a stand-alone basis. ESPs reflect our best estimate of what the selling prices of the elements would be if they were sold regularly on a stand-alone basis. While changes in the allocation of the estimated sales price between the units of accounting will not affect the amount of total revenue recognized for a particular sales arrangement, any material changes in these allocations could impact the timing of revenue recognition, which could affect our results of operations. In determining ESPs, we apply significant judgment as we weigh a variety of factors, based on the facts and circumstances of the arrangement. The facts and circumstances we may consider include, but are not limited to, prices charged for similar offerings, if any, our historical pricing practices as well as the nature and complexity of different technologies being licensed, geographies and the number of uses allowed for a given license. Inventory Valuation
Inventories are stated at lower of cost or market and consist of materials, labor and overhead. Inventory costs are determined using standard costs which approximate actual costs under the first-in, first-out method. Costs include the costs of purchased finished products, sorted wafers, and outsourced assembly and test, and internal overhead. We evaluate inventories for excess quantities and obsolescence. Our evaluation considers market and economic conditions; technology changes, new product introductions, and changes in strategic business direction; and requires estimates that may include elements that are uncertain. In order to state the inventory at lower of cost or market, we maintain reserves against individual stocking units. Inventory write-downs, once established, are not reversed until the related inventories have been sold or scrapped. If future demand or market conditions are less favorable than our projections, a write-down of inventory may be required, and would be reflected in cost of goods sold in the period the revision is made. Fair Value
ASC Topic 820, Fair Value Measurements ("ASC 820"), establishes a framework for measuring fair value and requires disclosures about fair value measurement. ASC 820 emphasizes that a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, ASC 820 established the following fair value hierarchy that distinguishes between (1) market participant assumptions developed based on market data obtained from sources independent of the reporting entity (observable inputs) and (2) the reporting entity's own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs):
Level 1: Observable inputs such as quoted prices for identical assets or liabilities in active markets;
Level 2: Other inputs observable directly or indirectly, such as quoted prices for similar assets or liabilities or market-corroborate inputs; and Level 3: Unobservable inputs for which there is little or no market data and which requires the owner of the assets or liabilities to develop its own assumptions about how market participants would price these assets or liabilities. We only have one Level 3 recurring fair value measurement, the compound embedded derivative.
Our assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the valuation of assets and liabilities and their placement within the fair value hierarchy. Financial Instruments
ASC Topic 825, Financial Instruments, defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties. Our financial instruments include cash, accounts receivable, accounts payable, and accrued expenses. These financial instruments are stated at their carrying values, which are estimates of their fair values because of their nearness to cash settlement or the comparability of their terms to the terms we

Table of Contents

could obtain, for similar instruments, in the current market. Our debt instruments are included in long-term debt, net, and convertible subordinated debt, net, on our consolidated balance sheets. Senior Term A Loan
At its inception, the fair value of the Term A Loan was computed using a cash flow analysis in which the periodic cash coupon payments and the principal payment at maturity were discounted to the valuation date using an appropriate market discount rate. The discount rate was determined by analyzing the seniority and securitization of the instrument, our financial condition and observing the quoted bond yields in the fixed income market as of the valuation date. The valuation was determined using Level 3 inputs. Senior Term B Loan
At its inception, the fair value of the Term B Loan was computed using a binomial lattice model. The valuation was determined using Level 3 inputs. The valuation model combined expected cash outflows with market-based assumptions regarding risk-adjusted yields, stock price volatility, recent price quotes and trading information of our common stock into which the Term B Loan is convertible.
Convertible Subordinated Debt
The compound embedded derivative included in our convertible subordinated debentures due October 2014 ("2014 Debentures") required bifurcation and accounting at fair value because the economic and contractual characteristics of the compound embedded derivative met the criteria for bifurcation and separate accounting due to the conversion price not being indexed to our own stock. The compound embedded derivative is comprised of the conversion option and a make-whole payment for foregone interest if the holder converts the debenture early. The make-whole payment for foregone interest expired October 30, 2012, and upon its expiration, the compound embedded derivative no longer met the criteria for bifurcation as all components of the conversion feature are now indexed to our own stock. A final valuation was completed on October 30, 2012. We recorded a gain of $0.8 million into earnings due to the change in value and reclassified the final liability value of $2.1 million from other long-term liabilities into equity.
At its inception, the approximate fair value of the compound embedded derivative included in our 2014 Debentures was computed as the difference between the estimated value of the 2014 Debentures with and without the compound embedded derivative features. The fair value of the 2014 Debentures was estimated using a . . .

  Add VTSS to Portfolio     Set Alert         Email to a Friend  
Get SEC Filings for Another Symbol: Symbol Lookup
Quotes & Info for VTSS - All Recent SEC Filings
Sign Up for a Free Trial to the NEW EDGAR Online Pro
Detailed SEC, Financial, Ownership and Offering Data on over 12,000 U.S. Public Companies.
Actionable and easy-to-use with searching, alerting, downloading and more.
Request a Trial      Sign Up Now

Copyright © 2014 Yahoo! Inc. All rights reserved. Privacy Policy - Terms of Service
SEC Filing data and information provided by EDGAR Online, Inc. (1-800-416-6651). All information provided "as is" for informational purposes only, not intended for trading purposes or advice. Neither Yahoo! nor any of independent providers is liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein. By accessing the Yahoo! site, you agree not to redistribute the information found therein.